-----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, Gj4VdB8DquKm/Mj5ozfj7hwNqlZdw7efPMKxcZX37Swuu2sSLbZbFJDBFtYFYVmp QOCV5JSMSc1nlxpXOy8gKA== 0001019056-99-000187.txt : 19990403 0001019056-99-000187.hdr.sgml : 19990403 ACCESSION NUMBER: 0001019056-99-000187 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALL AMERICAN SEMICONDUCTOR INC CENTRAL INDEX KEY: 0000818074 STANDARD INDUSTRIAL CLASSIFICATION: WHOLESALE-ELECTRONIC PARTS & EQUIPMENT, NEC [5065] IRS NUMBER: 592814714 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-16207 FILM NUMBER: 99583597 BUSINESS ADDRESS: STREET 1: 16115 N W 52ND AVENUE CITY: MIAMI STATE: FL ZIP: 33014 BUSINESS PHONE: 3056218282 MAIL ADDRESS: STREET 1: 16115 NW 52ND AVENUE CITY: MIAMI STATE: FL ZIP: 33014 10-K 1 FORM 10-K ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 COMMISSION FILE NUMBER: 0-16207 ALL AMERICAN SEMICONDUCTOR, INC. (Exact name of registrant as specified in its charter) DELAWARE 59-2814714 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 16115 N.W. 52ND AVENUE MIAMI, FLORIDA 33014 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (305) 621-8282 Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ___ As of March 17, 1999, 19,866,906 shares (including 160,703 held by a wholly-owned subsidiary of the Registrant) of the common stock of ALL AMERICAN SEMICONDUCTOR, INC. were outstanding, and the aggregate market value of the common stock held by non-affiliates was $13,200,000. Documents Incorporated by Reference: Portions of the definitive proxy statement to be filed within 120 days after the end of the Registrant's fiscal year are incorporated by reference into Part III. ================================================================================ ALL AMERICAN SEMICONDUCTOR, INC. FORM 10-K - 1998 TABLE OF CONTENTS
PART ITEM PAGE NO. NO. DESCRIPTION NO. - --- --- ----------- --- I 1 Business................................................................................ 1 2 Properties.............................................................................. 13 3 Legal Proceedings ...................................................................... 13 4 Submission of Matters to a Vote of Security-Holders..................................... 13 II 5 Market for the Registrant's Common Equity and Related Stockholder Matters............... 14 6 Selected Financial Data................................................................. 15 7 Management's Discussion and Analysis of Financial Condition and Results of Operations................................................... 17 7A Quantitative and Qualitative Disclosures about Market Risk.............................. 22 8 Financial Statements and Supplementary Data............................................. 22 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................................... 22 III 10 Directors and Executive Officers of the Registrant...................................... 22 11 Executive Compensation.................................................................. 22 12 Security Ownership of Certain Beneficial Owners and Management.......................... 22 13 Certain Relationships and Related Transactions.......................................... 22 IV 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................ 22
i PART I ITEM 1. BUSINESS GENERAL All American Semiconductor, Inc. and its subsidiaries (collectively, the "Company"; sometimes referred to herein as "Registrant") is a national distributor of electronic components manufactured by others. The Company distributes a full range of semiconductors (active components), including transistors, diodes, memory devices and other integrated circuits, as well as passive components, such as capacitors, resistors, inductors and electromechanical products, including cable, switches, connectors, filters and sockets. These products are sold primarily to original equipment manufacturers ("OEMs") in a diverse and growing range of industries, including manufacturers of computers and computer-related products; networking, satellite and communications products; consumer goods; robotics and industrial equipment; defense and aerospace equipment; and medical instrumentation. The Company also sells products to contract electronics manufacturers ("CEMs") who manufacture products for companies in all electronics industry segments. Through the Aved Memory Products ("AMP") and Aved Display Technologies ("ADT") divisions of its subsidiary, Aved Industries, Inc., the Company also designs and has manufactured under the label of its subsidiary's divisions, certain board level products including memory modules and flat panel display driver boards. See "Business Strategy-Expansion" and "Products." These products are also sold to OEMs. In 1995 and 1996 the Company also distributed a limited offering of computer products including motherboards, computer upgrade kits, keyboards and disk drives. During the third quarter of 1996, the Company discontinued its computer products division ("CPD"). See "Products." While the Company reincorporated in Delaware in 1987, it and its predecessors have operated since 1964. The Company was recognized by industry trade publications as the seventh largest distributor of semiconductors and the 14th largest electronic components distributor overall in the United States, out of an industry group that numbers more than 1,000 distributors. The Company's principal executive office is located at 16115 N.W. 52nd Avenue, Miami, Florida 33014. THE ELECTRONICS DISTRIBUTION INDUSTRY The electronics industry is one of the largest and fastest growing industries in the United States. Industry associations estimate total U.S. factory sales of electronic products at approximately $475 billion for 1998 compared to $276 billion in 1991. The growth of this industry has been driven by increased demand for new products incorporating sophisticated electronic components, such as laptop computers, networking, satellite and telecommunications equipment, multimedia, Internet-related products; as well as the increased utilization of electronic components in a wide range of industrial, consumer and military products. The three product groups included in the electronic components subsegment of the electronics industry are semiconductors, passive/electromechanical components, and systems and computer products (such as disk drives, terminals and computer peripherals). The Company believes that semiconductors and passive/electromechanical products account for approximately 33% and 28%, respectively, of the electronic components distribution marketplace, while systems and computer products account for the remaining 39%. Prior to June 1995, the Company was a distributor of only semiconductors and passive/electromechanical products. In mid 1995, the Company created a computer products division ("CPD"). The operations of this division, which had carried a very limited product offering, were discontinued in the third quarter of 1996. See "Products." Distributors are an integral part of the electronics industry. During 1998, an estimated $22 billion of electronic components were sold through distribution in the United States, up from $10 billion in 1992. In 1 recent years, there has been a growing trend for distribution to play an increasing role in the electronics industry. OEMs and CEMS which utilize electronic components are increasingly looking to outsource their procurement, inventory and materials management processes to third parties in order to concentrate their resources (including management talent, personnel costs and capital investment) on their core competencies, which include product development, sales and marketing. Large distribution companies not only fill these procurement and materials management roles, but further serve as a single supply source for OEMs and CEMs, offering a much broader line of products, incremental quality control measures and more support services than individual electronic component manufacturers. Management believes that OEMs and CEMs will continue to increase their service and quality requirements, and that this trend will result in OEMs, CEMs and electronic component manufacturers continuing to be dependent on distributors in the future. Electronic component manufacturers are under similar pressure to allocate a larger share of their resources to research, product development and manufacturing capacity as technological advances continue to shorten product lifecycles. Electronic component manufacturers sell directly to only a small number of their potential customers. This small segment of their customer base accounts for a large portion of the total available revenues. It is not economical for component manufacturers to provide a broad range of sales support services to handle the large amount of customers that account for the balance of available revenues. With their expanded technology and service capabilities, large distributors have now become a reliable means for component manufacturers to outsource their sales, marketing, customer service and distribution functions. This trend particularly benefits larger distributors with nationwide distribution capabilities such as the Company, as manufacturers continue to allocate a larger amount of their business to a more limited number of full service distribution companies. Management believes that this trend should also provide consolidation opportunities within the electronic components distribution industry. As a result of the trends discussed above, management believes that distribution will be involved in an increasing portion of the electronics industry. BUSINESS STRATEGY The Company's strategy is to continue its managed growth and to gain market share by: (i) increasing the number of customers it sells to through a combination of expanding existing sales offices, opening new sales offices and making selective acquisitions, and (ii) increasing sales to existing customers by continuing to expand its product offerings and service capabilities. While the Company's aggressive growth plans caused an adverse effect on profitability in 1996 and prior years, the Company believes that the investment in expansion was necessary to position the Company to participate in the dynamics of its rapidly changing industry and to achieve greater profitability in the future. Once the Company achieved a critical mass, obtained the necessary geographic coverage and expanded its distribution capacity to facilitate additional growth, the Company began to shift its focus from increasing market share to a combination of continued market share growth with a greater focus on increasing profitability. In this regard, during 1996 the Company eliminated or reduced certain aspects of its operations and services that were not economically feasible to continue or expand and, in 1997, achieved record levels of profitability. While the Company was poised to continue to improve its profitability during 1998, the industry was changing. At the same time, the industry was marred with continued price erosion and intensely increased competitive market conditions. In an effort to better position itself to address these changing conditions and to become a more formidable force in facing the challenges of an increasingly competitive and consolidating industry, the Company entertained a merger proposal which resulted in the Company entering into a letter of intent to merge with the distribution operations of a sizeable competitor. While efforts to complete the transaction were underway, financial markets were in turmoil, industry market conditions were worsening and industry dynamics were undergoing changes. As a result of these and other factors, efforts to complete the transaction were prolonged for several months and ultimately the transaction was terminated due to factors beyond the Company's control. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Selling, General and Administrative Expenses" and Note 5 to Notes to Consolidated Financial Statements. As a result of the attempted merger, the Company put internal expansion on hold and lost its 2 momentum for internally generated growth. Additionally, throughout 1998 the Company was negatively impacted by the distraction resulting from the evaluation of, and preparations for the integration of operations in connection with the proposed merger. These merger-related factors, as well as negative market conditions and price erosion, combined to result in a decline in the Company's revenues in 1998. Once the merger efforts were terminated in the fourth quarter of 1998, management invested a significant amount of time refocusing the Company on facing the industry challenges and once again achieving internal growth. While management believes that it can increase market share and that it can increase profitability, there can be no assurance that these goals will be achieved. EXPANSION The Company had undergone significant expansion prior to 1998, including opening new offices, relocating and expanding existing offices and acquiring other companies, all in order to increase its sales volume, expand its geographic coverage and become recognized as a national distributor. See "Sales and Marketing-Sales Office Locations" and Note 3 to Notes to Consolidated Financial Statements. As a result of the implementation of the Company's business strategy, the Company had until 1998 experienced significant growth. In order to effectively drive and manage its expansion, the Company had over the last several years prior to 1998: (i) restructured, enhanced and expanded its sales staff and sales management and marketing team; (ii) expanded its quality control programs, including the implementation of its total quality management ("TQM") and continuous process improvement programs that ensure quality service, enhance productivity and, over time, reduce costs; (iii) created and staffed a corporate operations department; (iv) developed state-of-the-art distribution technology, (v) enhanced its asset management capabilities through new computer and telecommunications equipment and (vi) opened an additional west coast credit department and an east coast regional credit department. To keep up with industry trends the Company has made significant investments in its web site and Internet capabilities as well as other forms of electronic commerce; has expanded its investment in its Field Application Engineer ("FAE") program; and has increased its investment in its materials management solutions, or "MMS", capabilities. To better service the large customer base in the western part of the United States and to enhance relationships with a supplier base that is predominantly based in California, during 1994 the Company opened a west coast corporate office which initially housed sales and marketing executives and the head of the Company's FAE program. In 1995 the Company also opened a west coast distribution center in Fremont, California (near San Jose). In 1998 the Company dramatically expanded its west coast corporate offices and relocated the President and CEO of the Company to San Jose to be based where sales and marketing functions are headquartered. In December 1995 the Company purchased through two separate mergers with and into the Company's wholly-owned subsidiaries (the "Added Value Acquisitions"; see Note 3 to Notes to Consolidated Financial Statements) all of the capital stock of Added Value Electronics Distribution, Inc. ("Added Value") and A.V.E.D.-Rocky Mountain, Inc. ("Rocky Mountain;" Rocky Mountain together with Added Value, collectively the "Added Value Companies"). As a result of these acquisitions, the Company added new sales locations, new operations facilities and several new product offerings. See "Sales and Marketing-Sales Office Locations" and "Products." The Company expanded its international presence during 1998 with the opening of a sales office in Guadalajara, Mexico. The Company plans to open new offices and may acquire additional companies in the future. The Company also plans to continue its focus on improving the financial performance and market penetration of each existing location. INCREASING PRODUCT OFFERINGS The Company intends to continue its effort to increase the number and breadth of its product offerings, thereby allowing it to attract new customers and to represent a larger percentage of the purchases being 3 made by its existing customers. As part of its efforts to attract new suppliers and expand its product offerings, the Company expanded its service capabilities and has opened new sales offices (see "Expansion") in order to achieve the geographic coverage necessary to be recognized as a national distributor. During 1998, the Company added new suppliers and expects to add additional suppliers in the future. These new suppliers are intended to offer larger growth opportunities than some of the smaller suppliers that the Company has done business with in the past. New supplier relationships generally require up-front investments that could take substantial time to provide a return. SERVICE CAPABILITIES During the past several years, customers have been reducing their approved vendor base in an effort to place a greater percentage of their purchases with fewer, more capable distributors. As part of its overall strategy to increase market penetration, the Company has endeavored to develop state-of-the-art service capabilities. The Company refers to these service capabilities as "distribution technology." The Company believes that it has developed service capabilities comparable to some of the largest distributors in the industry, which service capabilities the Company believes are not yet readily available at many distributors of comparable size to the Company. The Company further believes that these capabilities are not generally made available by the largest distributors to middle market customers, which represent the vast majority of the Company's customer base. See "Competition." Management believes that smaller distributors generally do not have the ability to offer as broad an array of services as the Company. The Company differentiates itself from its competition by making state-of-the-art distribution technology available to both large and middle market customers. Although the Company believes that this differentiation will assist the Company's growth, there can be no assurance that such differentiation exists to the extent that the Company currently believes or that it will continue in the future. The Company's distribution technology incorporates nationwide access to real-time inventory and pricing information, electronic order entry and rapid order processing. During the past few years, the Company has expanded its services capabilities to include just-in-time deliveries, bar coding, bonded inventory programs, in-plant stores, in-plant terminals and automatic inventory replenishment programs. The Company has also implemented electronic data interchange ("EDI") programs. EDI programs permit the electronic exchange of information between the Company and its customers and suppliers, thus facilitating transactions between them by reducing labor costs, errors and paperwork. In an effort to reduce the number of distributors they deal with, and ultimately reduce their procurement costs, many customers have been selecting distributors that, in addition to providing their standard components, are also able to provide products that are not part of the distributors' regular product offerings. This service is referred to as "kitting." In order to expand its service offerings to address this growing customer requirement, the Company created a kitting department toward the end of 1994. One of the strategic purposes of the Added Value Acquisitions was to enhance the Company's ability to provide kitting services, as one of the acquired companies had kitting capabilities. In addition to kitting capabilities, as a result of the Added Value Acquisitions the Company began developing the expertise in turnkey manufacturing which enables customers to outsource their entire procurement and manufacturing process. Turnkey services are especially attractive to smaller OEMs which do not have the capital resources necessary to invest in state-of-the-art manufacturing equipment nor the capacity requirement necessary to justify such an investment. In performing turnkey services, the Company subcontracts out all of the manufacturing work to third party assemblers. The Company offers warranties against defects in workmanship with respect to its turnkey services, which is a pass-through from the assembler. In order to better support its customer base and improve the utilization of its distribution technology and kitting and turnkey services, the Company has focused on consulting with customers to jointly develop complete materials management solutions or "MMS". In the fourth quarter of 1996, the Company created an MMS Group to facilitate the consultation as well as the development and implementation of materials 4 management solutions. The MMS Group is staffed with personnel experienced in the manufacturing environment and in supply chain management who can better understand the customers' processes and needs. In order to further enhance its service capabilities, the Company also expanded its technical support by creating an engineering or technical sales program in 1994. As part of this program, the Company has hired electrical engineers, or Field Application Engineers (FAEs), at various sales offices across the country. The Company expects to hire additional FAEs in the future. The program is intended to generate sales by providing customers with engineering support and increased service at the design and development stages. The program is also intended to enhance the technical capabilities of the Company's entire sales force through regular training sessions. Management believes that this capability is also of great importance in attracting new suppliers. Another rapidly growing segment of electronics distribution is the sale of programmable semiconductor products. Programmable semiconductors enable customers to reduce the number of components they use by highly customizing one semiconductor to perform a function that otherwise would require several components to accomplish. This saves space and enables customers to reduce the size and cost of their products. In order to effectively sell programmable products, most major distributors have established their own semiconductor programming centers. To participate in this growing segment of the industry, the Company opened a semiconductor programming center during the third quarter of 1995 and in January 1996 moved its programming center into the Company's 20,000 square foot facility in Fremont, California (near San Jose). In order to service growing customer demand as well as changing technologies, in early 1999 the Company significantly increased its investments in its programming capabilities by purchasing programming equipment and increasing its programming staff. In addition to enabling the Company to address a rapidly growing market for programmable products, this capability will allow the Company to attract new product lines that require programming capabilities. The Company believes that in the upcoming years an increasing amount of transactions in its industry will be processed over the Internet. In this regard, the Company designed and developed its own web site which became operational during the first quarter of 1997. In order to further expand its visibility and functionality on the Internet, the Company has engaged with third party Internet service companies. These engagements are expected to increase revenues, reduce transaction costs and afford the Company an opportunity to do business in a new and still developing marketplace. While these engagements have increased operating costs in 1997 and 1998 and may increase costs further in future years, many benefits are expected to be realized from these investments, however, no assurances can be made that the Company will realize such benefits. In an attempt to further drive the sales of value-added services, the Company created its American Assemblies & Design division in Chicago during the fourth quarter of 1994. American Assemblies & Design was intended to expand the Company's value-added capabilities with respect to electromechanical products. As a result of continued losses as well as a shift in the Company's focus, the operations of American Assemblies were relocated and consolidated into the Company's Miami distribution center in the first quarter of 1996. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Selling, General and Administrative Expenses." QUALITY CONTROLS AND ISO CERTIFICATION The Company has a TQM program in order to improve service, increase efficiency and productivity and, over time, reduce costs. The expansion in capacity and service capabilities discussed above were done within the confines of increasing strictness in quality control programs and traceability procedures. As a result, the Company's Miami and Fremont distribution centers and its Fremont programming center have all successfully completed a procedure and quality audit that resulted in their certification under the international quality standard of ISO 9002. This quality standard was established by the International Standards Organization (the "ISO") created by the European Economic Community ("EEC"). The ISO 5 created uniform standards of measuring a company's processes, traceability procedures and quality control in order to assist and facilitate business among the EEC. The Company believes that this certification is becoming a requirement of an increasing portion of the customer base. PRODUCTS ACTIVE AND PASSIVE COMPONENTS The Company markets both semiconductors and passive products. Semiconductors, which are active components, respond to or activate upon receipt of electronic current. Active products include transistors, diodes, memory devices and other integrated circuits. Passive components, on the other hand, are designed to facilitate completion of electronic functions. Passive products include capacitors, resistors, inductors and electromechanical products such as cable, switches, connectors, filters and sockets. Virtually all of the Company's customers purchase both active and passive products. While the Company offers many of the latest technology semiconductor and passive products, its focus historically had been on mature products that have a more predictable demand, more stable pricing and more constant sourcing. The Company believes that the greater predictability in the demand for these products and the fact that component manufacturers are not likely to invest capital in order to increase production of older technologies combine to reduce the risks inherent in large volume purchases of mature products. By making large volume purchases, the Company decreases its per-unit cost, thus increasing its potential for higher profit margins upon resale of these mature products. Although the Company continues to position itself as a leader in the more mature product lines, as part of its growth strategy, the Company has expanded its focus to include offering newer technology products as well as on selling high volumes of commodity products. These newer technologies and commodity products are playing a greater role in the overall sales mix of the Company and are expected to play an even greater role in the overall sales mix to the extent the Company's sales grow. Most of the commodity products, and many of the newer technology products, have lower profit margins than the more mature product lines. The Company does not offer express warranties with respect to any of its component products, instead passing on only those warranties, if any, granted by its suppliers. FLAT PANEL DISPLAY PRODUCTS The Company believes that one of the faster growing segments of the electronics industry will result from the expanded utilization of flat panel displays or FPDs. Flat panel displays are commonly used in laptop computers and are currently replacing standard cathode ray tubes in a variety of applications, including medical, industrial and commercial equipment, as well as personal computers and video monitors. FPDs are also being utilized in high definition television ("HDTV"). In order to properly function in any application, flat panel displays need certain electronic impulses. One solution for generating these electronic impulses is the use of board level products that control and regulate the electronic input that drives the flat panel display. These products are commonly referred to as driver boards. In addition to the driver board, FPDs require a back-light inverter to run the back-light, and cable assemblies to connect the display, inverter and the driver board to each other and to the equipment of which it is a part. The Company has addressed the FPD market in three ways. First, the Company has assembled a comprehensive offering of FPD products, including products from manufacturers of FPDs, as well as manufacturers of the necessary support products such as back-light inverters and driver boards. The second aspect in addressing the FPD market is to develop the technical support necessary to assist customers with integrating FPD applications. In this regard the Company's FAE program and marketing department have been developing expertise in FPD applications and integration. Additionally, the Company has added FPD specialists to its sales and marketing groups. 6 The third aspect to the Company's approach to the FPD marketplace was accomplished with the creation of Aved Display Technologies ("ADT"). ADT, which is run as a separate division, was established in 1996 with certain of the personnel and assets acquired in the Added Value Acquisitions. ADT designs, develops and has manufactured under its own label, several proprietary driver board products for FPD applications. In addition to ADT, the Company also has other suppliers of FPD driver board products. MEMORY MODULES As a result of the Added Value Acquisitions, the Company also designs, has manufactured and sells memory modules under the Aved Memory Products, or AMP label. Memory products, which include the memory module subsegment, represent the largest product sector of semiconductor revenues. Memory modules facilitate the incorporation of expanded memory in limited space. In addition to Aved Memory Products, the Company has other suppliers of memory module products. With respect to all products manufactured or assembled for ADT and AMP, the Company offers a warranty for a period of one year against defects in workmanship and materials under normal use and service and in their original, unmodified condition. COMPUTER PRODUCTS While the Company currently believes that 39% of electronics distributors' revenues relate to computer products, the Company has not in the past derived significant revenues from the sale of these products. In June 1995, the Company began to distribute motherboards, and in connection therewith, established a computer products division or CPD. This division expanded its offering to include computer upgrade kits, disk drives and keyboards. Sales from this division generated substantially lower profit margins than were generated by the Company's other products. As a result of supply problems and related losses, as well as a decision by the Company to focus its resources on its active and passive components business, the operations of CPD were discontinued in the third quarter of 1996. CUSTOMERS The Company markets its products primarily to OEMs in a diverse and growing range of industries. The Company's customer base includes manufacturers of computers and computer-related products; networking, satellite and communications products; consumer goods; robotics and industrial equipment; defense and aerospace equipment; and medical instrumentation. The Company also sells products to contract electronics manufacturers ("CEMs") who manufacture products for companies in all electronics industry segments. The Company's customer list includes approximately 12,000 accounts. During 1998, no customer accounted for more than 4% of the Company's sales and the Company does not believe that the loss of any one customer would have a material adverse impact on its business. SALES AND MARKETING OVERALL STRATEGY The Company differentiates itself from its competitors in the marketplace by the combination of products and services that it can provide to its customers. The Company is a broad-line distributor offering over 60,000 different products representing approximately 85 different component manufacturers. In addition, the Company employs a decentralized management philosophy whereby branch managers are given latitude to run their operations based on their experience within their particular regions and the needs of their particular customer base. This decentralization results in greater flexibility and a higher level of customer service. Thus, the Company believes it can provide the broad product offering and competitive pricing normally associated with the largest national distributors, while still providing the personalized service levels usually associated only with regional or local distributors. Additionally, because of its size and capabilities, the 7 Company brings to the middle market customers a level of service capabilities that the smaller distributor cannot provide. The Company's marketing strategy is to be a preferred and expanding source of supply for all middle market customers. The Company is achieving this by providing a broader range of products and services than is available from smaller and comparably sized distributors, and a higher level of attention than these customers receive from the larger distributors. In addition, the Company continues its efforts to become a more significant supplier for the top tier customers by focusing on a niche of products not emphasized by the larger distributors while providing the high level of quality, service and technical capabilities required to do business with these accounts. MARKETING TECHNIQUES The Company expanded its marketing group by adding a west coast marketing department strategically situated in Silicon Valley during 1996. The Company uses various techniques in marketing its products which include: (i) direct marketing through personal visits to customers by management, field salespeople and sales representatives, supported by a staff of inside sales personnel who handle the quoting, accepting, processing and administration of sales orders; (ii) ongoing advertising in various national industry publications and trade journals; (iii) general advertising, sales referrals and marketing support from component manufacturers; (iv) the Company's telemarketing efforts; and (v) a web site on the Internet. The Company also uses its expanded service capabilities, FAE Program, its MMS Group and its status as an authorized distributor as marketing tools. See "Business Strategy-Service Capabilities" and "Suppliers." SALES PERSONNEL As of March 1, 1999, the Company employed 290 people in sales on a full-time basis, of which 113 are field salespeople, 114 are inside salespeople, 24 are in management, 23 are in administration and 16 are electrical engineers in the technical sales or FAE Program. The Company also had 19 sales representatives covering various territories where the Company does not have sales offices. Salespeople are generally compensated by a combination of salary and commissions based upon the gross profits obtained on their sales. Each branch is run by a general manager who reports to a regional manager, who in turn reports to an area manager. All area managers report to the Company's Senior Vice President of Sales. Area, regional and general managers are compensated by a combination of salary and incentives based on achieving gross profit and operating income goals. SALES OFFICE LOCATIONS The Company currently operates 30 sales offices in 20 states, Canada and Mexico. The locations of the sales offices are in each of the following geographic markets: Huntsville, Alabama; Phoenix, Arizona; Orange County, San Diego, San Fernando Valley, San Jose and Tustin, California; Toronto, Canada; Denver, Colorado; Fort Lauderdale, Miami and Tampa, Florida; Atlanta, Georgia; Chicago, Illinois; Kansas City, Kansas; Baltimore, Maryland; Boston, Massachusetts; Guadalajara, Mexico; Detroit, Michigan; Minneapolis, Minnesota; Long Island and Rochester, New York; Cleveland, Ohio; Portland, Oregon; Philadelphia, Pennsylvania; Austin and Dallas, Texas; Salt Lake City, Utah; Seattle, Washington and Milwaukee, Wisconsin. The Company also retains field sales representatives to market other territories throughout the United States, Canada, Puerto Rico and Mexico. The Company may consider opening branches in these other territories if the representatives located there achieve certain sales levels. TRANSPORTATION All of the Company's products are shipped through third party carriers. Incoming freight charges are generally paid by the Company, while outgoing freight charges are typically paid by the customer. 8 SEASONALITY The Company's sales have not historically been materially greater in any particular season or part of the year. FOREIGN SALES Sales to foreign countries aggregated approximately $9.4 million, $5.4 million and $1.9 million for 1998, 1997 and 1996, respectively. BACKLOG As is typical of distributors, the Company has a backlog of customer orders. While these customer orders are cancelable, the Company believes its backlog is an indicator of future sales. At December 31, 1998, the Company had a backlog in excess of $43 million, compared to a backlog in excess of $50 million at December 31, 1997 and $49 million at December 31, 1996. In 1993, 1994 and 1995, the Company operated in a highly allocated market where the demand for products was much greater than the supply. As a result of these product shortages, customers had a practice of placing longer term product needs on order with distributors to increase their probabilities of receiving their products on time and to protect against rising prices. At the end of 1995 and during 1996, product availability increased and there was a dramatic shift to an oversupply market which continued through 1997 and 1998. In response to this dramatic shift customers began canceling order backlogs to lower their inventories and to take advantage of the better pricing which became available. Today the customer practice is to keep much lower levels of product on order as delivery times are much shorter than they were in 1993, 1994 and 1995. Additionally, the Company has increased its practices of EDI transactions where the Company purchases inventory based on electronically transmitted customer forecasts that do not become an order until the date of shipment and, therefore, are not reflected in the Company's backlog. As a result of the dramatic shift in the supply-demand balance and the increase in EDI transactions, the Company's backlog is lower than it was in the past two years and the Company believes that the backlog figures have a different indication of future sales levels than the backlog figures of the 1993 through 1995 period. By February 28, 1999, the Company's backlog had risen to approximately $50 million. The Company believes that a substantial portion of its backlog represents products due to be delivered within the next three months. Approximately 40% of the backlog relates to purchase orders which call for scheduled shipments of inventory over a period of time, with the balance representing products that are on back-order with suppliers. The scheduled shipments enable the Company to plan purchases of inventory over extended time periods to satisfy such requirements. SUPPLIERS The Company generally purchases products from component manufacturers pursuant to non-exclusive distribution agreements. Such suppliers generally limit the number of distributors they will authorize in a given territory in order to heighten the distributor's focus on their products as well as to prevent over-distribution. Suppliers also limit the number of distributors in order to reduce the costs associated with managing multiple distributors. As a factory authorized distributor, the Company obtains sales referrals, as well as sales, marketing and engineering support, from component manufacturers. This support assists the Company in closing sales and obtaining new customers. The Company's status as an authorized distributor is a valuable marketing tool as customers recognize that when dealing with an authorized distributor they receive greater support from the component manufacturers. The Company believes that an important factor which suppliers consider in determining whether to grant or to continue to provide distribution rights to a certain distributor is that distributor's geographic coverage. In meeting its goal of being recognized as a national distributor, the Company has opened and acquired sales offices in a number of markets throughout the United States and has advertised in national industry 9 publications to demonstrate its distribution capabilities to current and potential customers and suppliers. Another important factor that suppliers consider is whether the distributor has in place an engineering staff capable of designing-in the suppliers' products at the customer base. To address this requirement, the Company established an engineering or FAE Program in 1994 which is currently staffed with 16 electrical engineers. As a result of the Company's strategy, from 1980 to 1996, the Company increased the number of suppliers it represented from 20 to over 100 in order to expand its product offerings and better serve its customers. As a result of its rapid growth and the acquisitions it has completed over the years, the Company has an overlap of suppliers in many product areas and, while still maintaining an expanded offering of products, the Company began in 1996 to reduce the number of suppliers with which it does business. While this causes the Company to incur costs and may require the Company to increase inventory reserves, this move is expected to increase the return on investment with, and the productivity of, the remaining suppliers in future periods. The Company presently represents 85 suppliers. All distribution agreements are cancelable by either party, typically upon 30 to 90 days notice. For the year ended December 31, 1998, the Company's three largest suppliers accounted for 20%, 7% and 5% of consolidated purchases, respectively. Most of the products that the Company sells are available from other sources. While the Company believes that the loss of a key supplier could have an adverse impact on its business in the short term, the Company would attempt to replace the products offered by that supplier with the products of other suppliers. If the Company were to lose its rights to distribute the products of any particular supplier, there can be no assurance that the Company would be able to replace the products which were available from that particular supplier. The loss of a significant number of suppliers in a short period of time could have a material adverse effect on the Company. The Company, from time to time, alters its list of authorized suppliers in an attempt to provide its customers with a better product mix. As a distributor of electronic components, the Company believes that it benefits from technological change within the electronics industry as new product introductions accelerate industry growth and provide the Company with additional sales opportunities. The Company believes its inventory risk due to technological obsolescence is significantly reduced by certain provisions typically found in its distribution agreements including price protection, stock rotation privileges, obsolescence credits and return privileges. Price protection is typically in the form of a credit to the Company for any inventory the Company has of products for which the manufacturer reduces its prices. Stock rotation privileges typically allow the Company to exchange inventory in an amount up to 5% of a prior period's purchases. Obsolescence credits allow the Company to return any products which the manufacturer discontinues. Upon termination of a distribution agreement, the return privileges typically require the manufacturer to repurchase the Company's inventory at the Company's average purchase price, however, if the Company terminates the distribution agreement, there is typically a 10% to 15% restocking charge. The vast majority of the Company's inventory is purchased pursuant to its distribution agreements. The Company does not generally purchase product for inventory unless it is a commonly sold product, there is an outstanding customer order to be filled, a special purchase is available or unless it is an initial stocking package in connection with a new line of products. FACILITIES AND SYSTEMS FACILITIES The Company's corporate headquarters and main distribution center are located in a 110,800 square foot facility in Miami, Florida. The Company occupies this facility through a lease which expires in 2014, subject to the Company's right to terminate at any time after May 1999 upon twenty-four months prior written notice and the payment of all outstanding debt owed to the landlord. The lease for this facility contains three six-year options to renew at the then fair market value rental rates. The lease, which began in May 1994, provides for annual fixed rental payments totaling approximately $264,000 in the first year; $267,000 in the 10 second year; $279,000 in each of the third, fourth and fifth years; $300,600 in the sixth year; $307,800 in the seventh year; and in each year thereafter during the term the rent shall increase once per year in an amount equal to the annual percentage increase in the consumer price index not to exceed 4% in any one year. Although continued growth is not assured, the Company estimates that this facility has capacity to handle over $400 million in annual revenues. As a result of the Added Value Acquisitions, the Company leases a 13,900 square foot facility in Tustin, California and a 7,600 square foot facility in Denver, Colorado. The Tustin facility presently contains the separate divisions created for flat panel displays (ADT) and memory module (AMP) operations as well as a distribution center. See "Products." During 1998 the Denver sales operations were moved to a separate office. The 7,600 square foot facility is now dedicated solely to certain value-added services and a regional distribution center. During 1995, the Company entered into a lease for a west coast distribution and semiconductor programming center located in Fremont, California (near San Jose). This facility contains approximately 20,000 square feet of space. The Company moved into this facility in January 1996. The Company has used this space to expand its semiconductor programming and component distribution capabilities and to further improve quality control and service capabilities for its west coast customers. Additionally, this space was originally intended to house the Company's distribution and operational support for its computer products division. As a result of the Company's decision to discontinue operations of its CPD, this additional facility was initially underutilized. The Company has been moving more of its component distribution inventory to this facility and, with the additional investment in programming equipment made in early 1999, the Company expects that any excess capacity will be utilized. No future growth of its programming and components distribution businesses can be assured in future periods. During 1998, the Company entered into a new lease for approximately 20,000 square feet of space in San Jose, California to house its expanded west coast corporate offices as well as its northern California sales operation. This lease incorporates the previously leased space of approximately 11,000 square feet and adds a new adjoining space of approximately 9,000 square feet. Approximately 8,000 square feet of the space is being used for corporate offices including the office of the President and CEO of the Company and 8,000 square feet of the space is being utilized for the sales operation. The remaining area of approximately 4,000 square feet is not presently being utilized and the Company is currently pursuing a tenant to sublet this space. In addition, the Company leases space for its other sales offices, which offices range in size from approximately 1,000 square feet to 8,000 square feet. See "Sales and Marketing-Sales Office Locations." Due to the dramatic price erosion during the past few years, the Company believes its unit volume shipped has increased. As a result, the Company has utilized some of its excess capacity. Although the excess capacity is somewhat diminished, the Company still has excess capacity with its distribution centers in Miami, Florida; Fremont, California; and Denver, Colorado. To the extent that the Company increases sales in future periods, management expects to realize improved operating efficiencies and economies of scale. There can be no assurance, however, that any sales growth will be obtained. SYSTEMS The Company's systems and operations are designed to facilitate centralized warehousing which allows salespeople across the country to have real-time access to inventory and pricing information and allows a salesperson in any office to enter orders electronically, which instantaneously print in the appropriate distribution facility for shipping and invoicing. The combination of the centralized distribution centers and the electronic order entry enable the Company to provide rapid order processing at low costs. The system also provides for automatic credit checks, which prohibit any product from being shipped until the customer's credit has been approved. Additionally, the systems allow the Company to participate with customers and suppliers in electronic data interchange, or EDI, and to expand customer services, including just-in-time deliveries, kitting programs, bar coding, automatic inventory replenishment programs, bonded inventory programs, in-plant stores and in-plant terminals. 11 As a result of rapidly increasing advances in technology, the Company has recognized that its computer and communications systems will be subject to continual enhancements. In order to meet the increasing demands of customers and suppliers, to maintain state-of-the-art capabilities, and to participate in electronic commerce, since 1995 the Company has expanded, and in the future will continue to develop and expand, its systems capabilities, including hardware and software upgrades to meet its computer and communications needs. The Company believes that these systems enhancements should assist in increasing sales and in improving efficiencies and the potential for greater profitability in future periods through increased employee productivity, enhanced asset management, improved quality control capabilities and expanded customer service capabilities. See "Business Strategy-Service Capabilities." There can be no assurance, however, that these benefits will be achieved. FOREIGN MANUFACTURING AND TRADE REGULATION A significant number of the components sold by the Company are manufactured outside the United States and purchased by the Company from United States subsidiaries or affiliates of those foreign manufacturers. As a result, the Company and its ability to sell at competitive prices could be adversely affected by increases in tariffs or duties, changes in trade treaties, currency fluctuations, economic or financial turbulence abroad, strikes or delays in air or sea transportation, and possible future United States legislation with respect to pricing and import quotas on products from foreign countries. The Company's ability to be competitive in or with the sales of imported components could also be affected by other governmental actions and changes in policies related to, among other things, anti-dumping legislation and currency fluctuations. The Company believes that these factors may have had an adverse impact on its business during the past year, and there can be no assurance that such factors will not have a more significant adverse affect on the Company in the future. Since the Company purchases from United States subsidiaries or affiliates of foreign manufacturers, the Company's purchases are paid for in U.S. dollars. EMPLOYEES As of March 1, 1999, the Company employed 523 persons, of which 290 are involved in sales and sales management; 77 are involved in marketing; 54 are involved in the distribution centers; 38 are involved in operations; 10 are involved in management; 35 are involved in bookkeeping and clerical; and 19 are involved in management information systems. None of the Company's employees are covered by collective bargaining agreements. The Company believes that management's relations with its employees are good. COMPETITION The Company believes that there are over 1,000 electronic components distributors throughout the United States, ranging in size from less than $1 million in revenues to companies with annual sales exceeding $8 billion worldwide. These distributors can generally be divided into global distributors who have operations around the world, national distributors who have offices throughout the United States, regional distributors and local distributors. With sales offices in 20 states, the Company competes as a national distributor. Additionally, the Company is one of the few national distributors which has offices in Canada and Mexico. The Company, which was recently recognized by industry sources as the seventh largest distributor of semiconductors and the 14th largest electronic components distributor overall in the United States, believes its primary competition comes from the top 50 distributors in the industry. Recently, there has been an emergence of additional competition from the advent of third party logistics companies and businesses commonly referred to as e-brokers which have grown as a result of the expanded use of the Internet. The Company competes with many companies that distribute electronic components and, to a lesser extent, companies that manufacture such products and sell them directly. Some of these companies have greater assets and possess greater financial and personnel resources than does the Company. The competition in the electronics distribution industry can be segregated by target customers: major (or top tier) accounts; middle market accounts; and emerging growth accounts. Competition to be the primary supplier for the major customers is dominated by the top six distributors as a result of the product offerings, pricing and 12 distribution technology offered by these distributors. The Company competes for a portion of the available business at these major industry customers by seeking to provide the very best service and quality and by focusing on products that are not emphasized by the top six distributors, or are fill-in or niche products. With its expanded service capabilities and quality assurance procedures in place, the Company believes that it can compete for a bigger portion of the business at the top tier customer base, although there can be no assurance that the Company will be successful in doing so. The Company believes competition from the top six distributors for the middle market customer base is not as strong since the largest distributors focus their efforts on the major account base. For this reason, the Company has focused strong efforts on servicing this middle market customer base. The Company competes for this business by seeking to offer a broader product base, better pricing and more sophisticated distribution technology than the regional or local distributors, by seeking to offer more sophisticated distribution technology than comparably-sized distributors and by seeking to offer to such middle market companies a higher service level than is offered to them by the major national and global distributors. The Company believes that today the top six distributors are seeking to penetrate the middle market customer base more than they have in the past. ITEM 2. PROPERTIES See "Item 1. Business-Facilities and Systems" and "Sales and Marketing-Sales Office Locations" and Note 10 to Notes to Consolidated Financial Statements. ITEM 3. LEGAL PROCEEDINGS The Company is from time to time involved in litigation relating to claims arising out of its operations in the ordinary course of business. Many of such claims are covered by insurance or, if they relate to products manufactured by others for which it distributes, the Company would expect that the manufacturers of such products would indemnify the Company, as well as defend such claims on the Company's behalf, although no assurance can be given that any manufacturer would do so. The Company believes that none of these claims should have a material adverse impact on its financial condition or results of operations. There has been a recent trend throughout the United States of increased grievances over various employee matters. While the Company is presently not involved in any material litigation relating to such matters, the Company believes that costs associated with such matters may increase in the future. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS (a) On December 10, 1998, the Company held its 1998 annual meeting of shareholders (the "Annual Meeting"). (b) One matter voted on at the Annual Meeting was the election of three directors of the Company. The three nominees, who were existing directors of the Company and nominees of the Company's Board of Directors, were re-elected at the Annual Meeting as directors of the Company, receiving the number and percentage of votes for election and abstentions as set forth next to their respective names below: NOMINEE FOR DIRECTOR FOR ABSTAIN -------------------- ---------- -------- Sheldon Lieberbaum 18,519,025 97.5% 468,149 2.5% S. Cye Mandel 18,612,733 98.0% 374,441 2.0% Daniel M. Robbin 18,613,653 98.0% 373,521 2.0% The other directors whose term of office as directors continued after the Annual Meeting are Paul Goldberg, Bruce M. Goldberg, Howard L. Flanders and Rick Gordon. 13 (c) The following additional matter was separately voted upon at the Annual Meeting and received the votes of the holders of the number of shares of the Company's common stock voted in person or by proxy at the Annual Meeting and the percentage of total votes cast as indicated below: Ratification of selection of independent accountants for 1998 fiscal year For 18,735,779 98.7% Against 143,195 0.8% Abstain 108,200 0.5% (d) Not applicable. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock currently trades on The Nasdaq Stock Market (Nasdaq National Market) under the symbol SEMI. The following table sets forth the range of high and low sale prices for the Company's common stock as reported on The Nasdaq Stock Market during each of the quarters presented: QUARTER OF FISCAL YEAR HIGH LOW - ---------------------- ---- --- 1997 - ---- First Quarter 1 7/16 15/16 Second Quarter 1 3/32 27/32 Third Quarter 1 21/32 31/32 Fourth Quarter 2 1/2 1 3/8 1998 - ---- First Quarter 2 1 3/8 Second Quarter 2 15/32 1 7/16 Third Quarter 2 3/16 27/32 Fourth Quarter 1 7/16 3/4 1999 - ---- First Quarter (through March 17, 1999) 1 1/16 3/4 As of March 17, 1999, there were approximately 500 holders of record of the Company's common stock, based on the stockholders list maintained by the Company's transfer agent. Many of these record holders hold these securities for the benefit of their customers. The Company believes that it has over 6,300 beneficial holders of its common stock. On March 17, 1999, the Company was advised by the Nasdaq Listing Qualifications department of The Nasdaq Stock Market that, based upon its review of the Company's closing stock price for the past thirty days, that the Company's common stock had failed to maintain a closing bid price of greater than or equal to $1.00 for any trading day during such period as required under The Nasdaq Stock Market maintenance standards for a stock to be continued to be listed on The Nasdaq Stock Market. Although no delisting action was initiated at this time, the Company was provided ninety (90) calendar days in which to regain compliance with this maintenance standard. In the event that during the period ending June 17, 1999 (or any extended period granted by The Nasdaq Stock Market in its sole discretion upon application by the Company), the closing bid price of the Company's common stock is not greater than or equal to $1.00 for a minimum of ten (10) consecutive trading days, the Company's common stock would be delisted. If the Company's common stock is not listed on The Nasdaq Stock Market, trading, if any, in the Company's common stock would thereafter be conducted in the non-Nasdaq over-the-counter market in the so-called "pink sheets" or the NASD's "Electronic Bulletin Board." The Company is currently reviewing its options with respect to the 14 Company's listing on The Nasdaq Stock Market. There can be no assurance that the Company's common stock will continue to remain eligible for listing on The Nasdaq Stock Market. DIVIDEND POLICY The Company has never paid cash dividends. In 1989, the Company's Board of Directors declared a 25% stock split effected in the form of a stock dividend. Future dividend policy will depend on the Company's earnings, capital requirements, financial condition and other relevant factors. It is not anticipated, however, that the Company will pay cash dividends on its common stock in the foreseeable future, inasmuch as it expects to employ all available cash in the continued growth of its business. In addition, the Company's revolving line of credit agreement prohibits the payment of any dividends. See Note 7 to Notes to Consolidated Financial Statements. SALES OF UNREGISTERED SECURITIES The Company has not issued or sold any unregistered securities during the quarter ended December 31, 1998. ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial data for the Company for and as of the years 1994 through 1998 has been derived from the audited Consolidated Financial Statements of the Company. Such information should be read in conjunction with the Consolidated Financial Statements and related notes included elsewhere in this report and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." Statement of Operations Data
YEARS ENDED DECEMBER 31 1998 1997 1996 1995(1) 1994 - ------------------------------------------------------------------------------------------------------------------- Net Sales (2)....................... $ 250,044,000 $ 265,640,000 $ 237,846,000 $ 177,335,000 $ 101,085,000 Cost of Sales (3)................... (194,599,000) (207,173,000) (185,367,000) (138,089,000) (74,632,000) ------------- ------------- ------------- ------------- ------------- Gross Profit........................ 55,445,000 58,467,000 52,479,000 39,246,000 26,453,000 Selling, General and Administrative Expenses........... (46,880,000) (48,257,000) (51,675,000) (32,321,000) (23,374,000) Restructuring and Other Nonrecurring Expenses (4)...................... (2,860,000) - (4,942,000) (1,098,000) (548,000) -------------- ------------- ------------- ------------- ------------- Income (Loss) from Continuing Operations........................ 5,705,000 10,210,000 (4,138,000) 5,827,000 2,531,000 Interest Expense (5)................ (4,313,000) (4,797,000) (7,025,000) (2,739,000) (1,772,000) ------------- ------------- ------------- ------------- ------------- Income (Loss) from Continuing Operations Before Income Taxes.... 1,392,000 5,413,000 (11,163,000) 3,088,000 759,000 Income Tax (Provision) Benefit...... (561,000) (2,163,000) 2,942,000 (1,281,000) (407,000) ------------- ------------- ------------- ------------- ------------- Income (Loss) from Continuing Operations Before Discontinued Operations and Extraordinary Items 831,000 3,250,000 (8,221,000) 1,807,000 352,000 Discontinued Operations (6)......... - - (1,757,000) 79,000 - Extraordinary Items (7)............. - - 58,000 - - ------------- ------------- ------------- ------------- ------------- Net Income (Loss)................... $ 831,000 $ 3,250,000 $ (9,920,000) $ 1,886,000 $ 352,000 ============= ============= ============= ============= ============= Earnings (Loss) Per Share (8): Basic............................. $.04 $.17 $(.50) $.12 $.03 Diluted........................... $.04 $.16 $(.49) $.12 $.03
15 Balance Sheet Data
DECEMBER 31 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------------------------------------------- Working Capital..................... $ 68,192,000 $ 63,308,000 $ 69,823,000 $ 59,352,000 $ 39,800,000 Total Assets........................ 118,957,000 112,286,000 112,921,000 114,474,000 57,858,000 Long-Term Debt, Including Current Portion................... 50,978,000 46,900,000 58,221,000 37,604,000 27,775,000 Shareholders' Equity................ 26,509,000 25,674,000 22,396,000 32,267,000 16,950,000 Book Value Per Common Share......... $1.33 $1.29 $1.13 $1.62 $1.37
- ------------------------- (1) On December 29, 1995, the Company completed the Added Value Acquisitions. The statement of operations data for 1995 reflects only the nonrecurring expenses associated with such acquisitions, while the balance sheet data reflects the assets and liabilities of the acquired companies at December 31, 1995. (2) Net sales, including sales generated by the Company's computer products division which was discontinued in the third quarter of 1996, were $244,668,000 for 1996 and $180,794,000 for 1995. (3) 1996 includes non-cash inventory write-offs of $2,000,000 associated with the Company's restructuring of its kitting and turnkey operations. (4) 1998 reflects a nonrecurring charge relating to the failed merger of Reptron Electronics, Inc.'s distribution operations with the Company. The nonrecurring charge includes expansion costs incurred in anticipation of supporting the proposed combined entity, employee-related expenses, professional fees and other merger-related out of pocket costs. 1996 includes non-recurring expenses consisting of: $1,092,000 relating to restructuring the Company's kitting and turnkey operations, $587,000 relating to the termination of certain employment agreements, $445,000 relating to relocating the Company's cable assembly division, $625,000 relating to the accrual of a postretirement benefit cost associated with an amendment to an employment agreement with one of the Company's executive officers, and $2,193,000 relating to an impairment of goodwill primarily related to the acquisitions of the Added Value Companies. 1995 reflects a charge for front-end incentive employment compensation associated with the Added Value Acquisitions. 1994 includes a charge for relocation of plant facilities in the amount of $185,000 and a write-off of the Company's product development investment of $363,000. (5) Interest expense for 1996 includes amortization and a write-down of deferred financing fees relating to obtaining the Company's $100 million credit facility of approximately $2,148,000. (6) Includes income (losses) from discontinued operations of $(166,000) (net of $125,000 income tax benefit) and $79,000 (net of $56,000 income tax provision) for 1996 and 1995, respectively, and a loss on disposal of $(1,591,000) (net of $1,200,000 income tax benefit) in 1996 relating to management's decision to discontinue its computer products division. (7) Reflects an after-tax gain of $272,000 (net of $205,000 income tax provision) associated with the Company's settlement of a civil litigation and an after-tax non-cash expense of $214,000 (net of $161,000 income tax benefit) resulting from the early extinguishment of the Company's $15 million senior subordinated promissory note. (8) Weighted average common shares outstanding for the years ended December 31, 1998, 1997, 1996, 1995 and 1994 were 19,685,106, 19,672,559, 19,742,849, 15,241,458 and 12,338,932, respectively, for basic earnings per share and were 19,994,009, 19,784,837, 20,105,761, 15,866,866, and 12,941,264, respectively, for diluted earnings per share. 16 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS OVERVIEW The following table sets forth for the years ended December 31, 1998, 1997 and 1996, certain items in the Company's Consolidated Statements of Operations expressed as a percentage of net sales. All percentages are based on net sales after excluding sales from discontinued operations.
Items as a Percentage of Net Sales -------------------------------- Years Ended December 31 -------------------------------- 1998 1997 1996 ----- ------ ------ Net Sales.................................................................. 100.0% 100.0% 100.0% Gross Profit............................................................... 22.2 22.0 22.1 Selling, General and Administrative Expenses............................... (18.7) (18.2) (21.7) Restructuring and Other Nonrecurring Expenses.............................. (1.1) - (2.1) Income (Loss) from Continuing Operations................................... 2.3 3.8 (1.7) Interest Expense........................................................... (1.7) (1.8) (3.0) Income (Loss) from Continuing Operations Before Income Taxes............... 0.6 2.0 (4.7) Income (Loss) from Continuing Operations Before Discontinued Operations and Extraordinary Items....................................... 0.3 1.2 (3.5) Discontinued Operations.................................................... - - (.7) Extraordinary Items........................................................ - - * Net Income (Loss).......................................................... 0.3 1.2 (4.2)
- ------------------- * not meaningful COMPARISON OF YEARS ENDED DECEMBER 31, 1998 AND 1997 SALES Net sales for the year ended December 31, 1998 were $250.0 million, compared to net sales of $265.6 million for 1997. The decrease in net sales was partially attributable to price erosion and adverse market conditions within our industry. Sales for 1998 were also negatively impacted by the distractions resulting from a failed merger. See "Selling, General and Administrative Expenses" below and Note 5 to Notes to Consolidated Financial Statements. GROSS PROFIT Gross profit was $55.4 million in 1998 compared to $58.5 million in 1997. The decrease in gross profit was due to the decrease in net sales. Gross profit margins as a percentage of net sales were 22.2% for 1998 compared to 22.0% for 1997. While the gross profit margin for the year was slightly higher than for the prior year, the gross profit margin began declining toward the end of 1998, reflecting increased competition and a greater number of low margin, large volume transactions. In addition, the Company has experienced lower margins relating to the development of long-term strategic relationships with accounts which have required aggressive pricing programs. The Company has also experienced margin pressures resulting from price increases from certain suppliers that the Company has not been able to pass on to its customers at the same rate. Management expects downward pressure on gross profit margins to continue in the future. 17 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expenses ("SG&A") was $46.9 million for 1998, down from $48.3 million for 1997. The decrease in SG&A reflects a reduction in variable expenses associated with the decrease in gross profit as well as the continued benefits of the Company's cost control programs. SG&A as a percentage of net sales was 18.7% for 1998, compared to 18.2% for 1997. The increase in SG&A as a percentage of net sales reflects the impact of the reduction in net sales discussed above. As a result of the industry-wide price erosion experienced over the past three years, the Company has had to ship more units for each dollar of revenue. As a result, the Company's excess capacity has been diminished. Additionally, customer requirements have increased significantly, resulting in the Company increasing its infrastructure to support the additional customer needs. Due to these factors, the Company expects that SG&A will increase in future periods. During 1998, the Company was involved in merger discussions which led to a letter of intent being signed in June 1998 with Reptron Electronics, Inc. ("Reptron") regarding the merger of Reptron's distribution operations with the Company ("the Merger"). Throughout 1998 the Company was actively involved in the evaluation of, and preparations for the integration of operations in connection with the proposed Merger. In October 1998, the Merger negotiations between the Company and Reptron were terminated. As a result, the Company recorded a nonrecurring charge in 1998, which included expansion costs incurred in anticipation of supporting the proposed combined entity, certain employee-related expenses, professional fees and other Merger-related out of pocket costs, all of which aggregated $2,860,000. See Note 5 to Notes to Consolidated Financial Statements. INCOME FROM CONTINUING OPERATIONS Income from operations was $8.6 million for 1998 excluding the $2.9 million nonrecurring charge, compared to income from operations of $10.2 million for 1997. The decrease in income from operations was attributable to the decrease in net sales which more than offset the decrease in SG&A. After reflecting the nonrecurring charge, income from operations was $5.7 million for 1998. INTEREST EXPENSE Interest expense decreased to $4.3 million for the year ended December 31, 1998 compared to $4.8 million for 1997. The decrease in interest expense resulted from lower average borrowings during 1998 as well as a decrease in the Company's borrowing rate. See "Liquidity and Capital Resources" and Note 7 to Notes to Consolidated Financial Statements. NET INCOME After giving effect to the nonrecurring charge, net income was $831,000, or $.04 per share (basic), for the year ended December 31, 1998, compared to net income of $3.3 million, or $.17 per share (basic), for 1997. The decrease in net income reflects the decrease in sales and the nonrecurring expenses (approximately $1.7 million on an after-tax basis) which more than offset the decreases in SG&A and interest expense. COMPARISON OF YEARS ENDED DECEMBER 31, 1997 AND 1996 SALES For the year ended December 31, 1997, net sales were $265.6 million, up from net sales of $237.8 million in 1996. The increase in net sales was accomplished without acquisitions or new branch openings and reflects higher sales in most territories. Substantially all of the increase was attributable to volume increases and the introduction of new products. The increase in volume more than offset the decline in unit prices on certain products. In addition, the Company continued to benefit from its expanded service capabilities including electronic commerce programs. 18 GROSS PROFIT Gross profit was $58.5 million in 1997 compared to $52.5 million for 1996. The increase in gross profit was primarily due to the growth in net sales which more than offset the decrease in gross profit margins as a percentage of net sales. The 1996 figure included a $2.0 million inventory write-off associated primarily with the restructuring of the Company's kitting and turnkey operations. Gross profit margins as a percentage of net sales were 22.0% for 1997 compared to 22.9% for 1996 without giving effect to the inventory write-off. The decrease in gross profit margins reflects a greater number of low margin, large volume transactions during 1997 than in the previous year, as well as continued changes in the Company's product mix. In addition, the Company has experienced lower margins relating to the development of long-term strategic relationships with accounts which have required aggressive pricing programs. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES SG&A was $48.3 million for 1997 down from $51.7 million for 1996. Even with an increase in net sales, SG&A decreased in absolute dollars reflecting the benefits of the expense control programs and the restructurings initiated during the second half of 1996. SG&A as a percentage of net sales improved dramatically to 18.2% for the year ended December 31, 1997, compared to 21.7% for 1996. The improvement in SG&A as a percentage of sales reflects the decrease in SG&A in absolute dollars as well as the increase in sales. INCOME (LOSS) FROM CONTINUING OPERATIONS After achieving a broad geographic coverage and a critical mass through its aggressive growth strategies in previous years, the Company began to shift its focus from increasing market share to a combination of continued market share growth with a greater focus on increasing profitability. As a result, income from continuing operations reached a record $10.2 million for 1997, compared to a loss from continuing operations of $(4.1) million for 1996 which included restructuring and nonrecurring expenses aggregating $6.9 million. The significant increase in income from continuing operations was attributable to the increase in net sales, the benefits derived from the Company's restructurings, improved operating efficiencies and economies of scale as well as the decrease in SG&A in both absolute dollars and as a percentage of net sales. The restructuring and nonrecurring expenses during 1996 included the above mentioned inventory write-offs; an impairment of goodwill in connection with the acquisition of the Added Value Companies; restructuring expenses associated with the kitting and turnkey operations; the termination of certain employment agreements entered into in connection with certain acquisitions; the relocation of the Company's cable assembly division; and the acceleration of an existing accrual schedule associated with certain postretirement benefits for one of the Company's executive officers. See Notes 5 and 10 to Notes to Consolidated Financial Statements. INTEREST EXPENSE Interest expense decreased significantly to $4.8 million for the year ended December 31, 1997 compared to $7.0 million for 1996. The decrease in interest expense resulted from lower average borrowings during 1997 primarily as a result of an increase in cash provided from operations and a decrease in amortization of deferred financing fees associated with a write-down of $1.7 million of deferred financing fees in 1996. See Note 7 to Notes to Consolidated Financial Statements. NET INCOME Net income was $3.3 million for the year ended December 31, 1997, compared to a net loss of $(9.9) million for 1996. Earnings per share (basic) increased to $.17 in 1997 from a loss of $(.50) per share in 1996. The increase in earnings for 1997 reflects the increase in sales, improved operating efficiencies, the dramatic 19 improvement in SG&A and the reduction in interest expense all as previously discussed. Included in 1996 were the restructuring and nonrecurring items described above, as well as an after-tax loss from discontinued operations of $1.8 million associated with the discontinuance of the Company's computer products division. LIQUIDITY AND CAPITAL RESOURCES Working capital at December 31, 1998 was $68.2 million, compared to working capital of $63.3 million at December 31, 1997. The current ratio was 2.63:1 at December 31, 1998, compared to 2.58:1 at December 31, 1997. The increases in working capital and in the current ratio were due primarily to increases in accounts receivable and inventory. These changes more than offset an increase in accounts payable. Accounts receivable levels at December 31, 1998 were $37.8 million, compared to $32.9 million at December 31, 1997. The increase in accounts receivable reflects an increase in the rate of sales during the end of 1998 compared to the end of 1997. The Company achieved a slight improvement in the average number of days that accounts receivables were outstanding from 53 days as of December 31, 1997 to 50 days as of December 31, 1998. Inventory levels were $69.1 million at December 31, 1998 compared to $67.9 million at December 31, 1997. The increase primarily reflects higher inventory levels needed to support sales of new products. Accounts payable and accrued expenses increased to $41.2 million at December 31, 1998 from $39.2 million at December 31, 1997, primarily as a result of the purchases of inventory. On May 3, 1996 the Company entered into a $100 million line of credit facility with a group of banks (the "Credit Facility") which expires May 3, 2001. The Credit Facility replaced the Company's then existing $45 million line of credit which was to expire in May 1997 and bore interest, at the Company's option, either at one-quarter of one percent (.25%) below prime or two percent (2%) above certain LIBOR rates. See Note 7 to Notes to Consolidated Financial Statements. At the time of entering into the Credit Facility, borrowings under the Credit Facility bore interest, at the Company's option, at either prime plus one-quarter of one percent (.25%) or LIBOR plus two and one-quarter percent (2.25%), which interest rate was increased slightly and then in 1998 reduced by said increase, as described below. Borrowings under the Credit Facility are secured by all of the Company's assets including accounts receivable, inventories and equipment. The amounts that the Company may borrow under the Credit Facility are based upon specified percentages of the Company's eligible accounts receivable and inventories, as defined. Under the Credit Facility, the Company is required to comply with certain affirmative and negative covenants as well as to comply with certain financial ratios. These covenants, among other things, place limitations and restrictions on the Company's borrowings, investments and transactions with affiliates and prohibit dividends and stock redemptions. Furthermore, the Credit Facility requires the Company to maintain certain minimum levels of tangible net worth throughout the term of the agreement and a minimum debt service coverage ratio which is tested on a quarterly basis. During 1996, the Company's Credit Facility was amended whereby certain financial covenants were modified and the Company's borrowing rate was increased by one-quarter of one percent (.25%). During the first quarter of 1998, as a result of the Company satisfying certain conditions, the Company's borrowing rate under its Credit Facility was decreased by one-quarter of one percent (.25%). The Company's Credit Facility was further amended on March 23, 1999 whereby certain financial covenants were modified. See Note 7 to Notes to Consolidated Financial Statements. At December 31, 1998, outstanding borrowings under the Credit Facility aggregated $43.3 million compared to $39.0 million at December 31, 1997. The Company expects that its cash flows from operations and additional borrowings available under the Credit Facility will be sufficient to meet its current financial requirements over the next twelve months. INFLATION AND CURRENCY FLUCTUATIONS The Company does not believe that inflation significantly impacted its business during 1998; however, inflation has had significant effects on the economy in the past and could adversely impact the Company's 20 results in the future. The Company believes that currency fluctuations may have had an indirect adverse effect on its business during 1998 due to limitation of customer production resulting from declining exports and limitation of the Company's offshore suppliers' exports to the United States. The Company believes that currency fluctuations may continue to have a negative impact in the future. YEAR 2000 ISSUE The Company has evaluated its business information technology (IT) systems as well as its non-IT systems and has surveyed its major vendors. The Company currently believes that its internal systems are in compliance with Year 2000 requirements or, to the extent any further required modifications are necessary, will comply with Year 2000 requirements without material expenditures of funds or internal resources. Based upon the survey of the Company's major suppliers, the Company currently believes that Year 2000 issues of its suppliers should not have a material adverse effect on the Company's business, operations or financial condition. Nevertheless, to the extent the Company's vendors (particularly its major vendors) experience Year 2000 difficulties, the Company may face delays in obtaining or even be unable to obtain certain products and services and therefore may be unable to make shipments to customers resulting in a material adverse effect on the Company's business, operations and financial condition. The Company has not surveyed its customers and on a limited basis has surveyed certain other third parties with which it has a business relationship. As no assessment has been made of any potential impact by customers' non-compliance (such as the ability of customers to electronically interface with the Company), the Company does not have a cost estimate to address any non-compliance by these customers nor can any assurance be given that such non-compliance will not result in a material adverse effect on the Company's business, operations and financial condition. The Company has not undertaken an analysis (nor does it currently intend to analyze) the effect of a worst-case Year 2000 scenario on the Company's business, operations or financial condition and, accordingly, the materiality of such effect (if any) is uncertain and the Company does not have a contingency plan and currently does not intend to create one. FORWARD-LOOKING STATEMENTS This Form 10-K contains forward-looking statements (within the meaning of Section 21E. of the Securities Exchange Act of 1934, as amended), representing the Company's current expectations and beliefs concerning the Company's future performance and operating results, its products, services, markets and industry, and/or future events relating to or effecting the Company and its business and operations. When used in this Form 10-K, the words "believes," "estimates," "plans," "expects," "intends," "anticipates," and similar expressions as they relate to the Company or its management are intended to identify forward-looking statements. The actual results or achievements of the Company could differ materially from those indicated by the forward-looking statements because of various risks and uncertainties. Factors that could adversely affect the Company's future results, performance or achievements include, without limitation, the effectiveness of the Company's business and marketing strategies, timing of delivery of products from suppliers, price increases from suppliers that cannot be passed on to the Company's customers at the same rate, the product mix sold by the Company, the Company's development of new customers, existing customer demand as well as the level of demand for products of its customers, utilization by the Company of excess capacity, availability of products from and the establishment and maintenance of relationships with suppliers, price erosion in and price competition for products sold by the Company, the ability of the Company to enter or expand new market areas, the ability of the Company to expand its product offerings and to continue to enhance its service capabilities, the ability of the Company to open new branches in a timely and cost-effective manner, the availability of acquisition opportunities and the associated costs, management of growth and expenses, the Company's ability to collect accounts receivable, price decreases on inventory that is not price protected, gross profit margins, including decreasing margins relating to the Company being required to have aggressive pricing programs, increased competition from third party logistics companies and e-brokers through the use of the Internet as well as from its traditional competitors, availability and terms of financing to fund capital needs, the continued enhancement of telecommunication, computer and information systems, the achievement by 21 the Company and its vendors and customers and other third parties with which the Company has a business relationship of Year 2000 compliance in a timely and cost efficient manner, the continued and anticipated growth of the electronics industry and electronic components distribution industry, the impact on certain of the Company's suppliers and customers of economic or financial turbulence in off-shore economies and/or financial markets, change in government tariffs or duties, currency fluctuations, a change in interest rates, the state of the general economy, the success of the Company in avoiding the delisting of its common stock from The Nasdaq Stock Market, and the other risks and factors detailed in this Form 10-K and in the Company's other filings with the Securities and Exchange Commission. These risks and uncertainties are beyond the ability of the Company to control. In many cases, the Company cannot predict the risks and uncertainties that could cause actual results to differ materially from those indicated by the forward-looking statements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's Credit Facility bears interest based on interest rates tied to the prime or LIBOR rate, either of which may fluctuate over time based on economic conditions. As a result, the Company is subject to market risk for changes in interest rates and could be subjected to increased or decreased interest payments if market interest rates fluctuate. If market interest rates increase, the impact may have a material adverse effect on the Company's financial results. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources." ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements of the Company and its subsidiaries and supplementary data required by this item are included in Item 14(a)(1) and (2) of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEMS 10, 11, 12 AND 13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT; AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The response to these items will be included in a definitive proxy statement filed within 120 days after the end of the Registrant's fiscal year, which proxy statement is incorporated herein by this reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) LIST OF DOCUMENTS FILED AS PART OF THIS REPORT PAGE ---- 1. FINANCIAL STATEMENTS Management's Responsibility for Financial Reporting............... F-1 Independent Auditors' Report...................................... F-1 Consolidated Balance Sheets....................................... F-2 Consolidated Statements of Operations............................. F-3 Consolidated Statements of Changes in Shareholders' Equity........ F-4 Consolidated Statements of Cash Flows............................. F-5 Notes to Consolidated Financial Statements........................ F-6 2. FINANCIAL STATEMENT SCHEDULES None 22 3. EXHIBITS 3.1 Certificate of Incorporation, as amended (incorporated by reference to Exhibits 3.1 to the Company's Registration Statement on Form S-1, File No. 33-15345-A, and to the Company's Form 10-K for the fiscal year ended December 31, 1991), as further amended by Certificate of Amendment of Certificate of Incorporation dated August 21, 1995 of the Company (incorporated by reference to Exhibit 3.1 to the Company's Form 10-K for the year ended December 31, 1995). 3.2 By-Laws, as amended July 29, 1994 (incorporated by reference to Exhibit 3.1 to the Company's Form 10-Q for the quarter ended June 30, 1994). 4.1 Specimen Certificate of Common Stock (incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-2, File No. 33-47512). 4.2 Fiscal Agency Agreement, dated as of June 8, 1994, between the Company and American Stock Transfer & Trust Co. ("American Stock Transfer"), as fiscal agent, paying agent and securities registrar (incorporated by reference to Exhibit 4.1 to the Company's Form 8-K dated June 14, 1994 and filed with the Securities and Exchange Commission on June 15, 1994). 4.3 Warrant Agreement, dated as of June 8, 1994, between the Company and American Stock Transfer, as warrant agent (incorporated by reference to Exhibit 4.2 to the Company's Form 8-K dated June 14, 1994 and filed with the Securities and Exchange Commission on June 15, 1994). 4.4 Placement Agent's Warrant Agreement, dated as of June 8, 1994, between the Company and RAS Securities Corp. (incorporated by reference to Exhibit 4.3 to the Company's Form 8-K dated June 14, 1994 and filed with the Securities and Exchange Commission on June 15, 1994). 4.5 Underwriter's Warrant Agreement between the Company and Lew Lieberbaum & Co., Inc. (incorporated by reference to Exhibit 4.2 to Amendment No. 1 to the Company's Registration Statement on Form S-1, File No. 33-58661). 9.1 Form of Voting Trust Agreement attached as Exhibit "E" to Purchase Agreement (incorporated by reference to Exhibit 9.1 to the Company's Registration Statement on Form S-4, File No. 033-64019). 10.1 Form of Indemnification Contracts with Directors and Executive Officers (incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-2, File No. 33-47512). 10.2 Lease Agreement for Headquarters dated May 1, 1994 between Sam Berman d/b/a Drake Enterprises ("Drake") and the Company (incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended March 31, 1994). 10.3 Lease Agreement for west coast corporate office and northern California sales office in San Jose, California dated October 1, 1998 between San Jose Technology Properties, LLC and the Company.* 10.4 Promissory Notes, all dated May 1, 1994 payable to the Company's landlord in the amounts of $865,000, $150,000 and $32,718 (incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q for the quarter ended March 31, 1994). 10.5 Promissory Note, dated May 1, 1995, payable to Drake, the Company's landlord, in the amount of $90,300 (incorporated by reference to Exhibit 10.35 to Amendment No. 1 to the Company's Registration Statement on Form S-1, File No. 33-58661). 10.6 Agreement between Drake and the Company dated May 1, 1994 (incorporated by reference to Exhibit 10.5 to the Company's Form 10-K for the year ended December 31, 1994). 10.7 Amended and Restated All American Semiconductor, Inc. Employees', Officers', Directors' Stock Option Plan (incorporated by reference to Exhibit 10.36 to Amendment No. 1 to the Company's Registration Statement on Form S-1, File No. 33-58661).** 10.8 Deferred Compensation Plan (incorporated by reference to Exhibit 10.5 to the Company's Registration Statement on Form S-2, File No. 33-47512).** 23 10.9 Master Lease Agreement dated March 21, 1994, together with lease schedules for computer and other equipment (incorporated by reference to Exhibit 10.9 to the Company's Form 10-K for the year ended December 31, 1994). 10.10 Employment Agreement dated as of May 24, 1995, between the Company and Paul Goldberg (incorporated by reference to Exhibit 10.22 to Amendment No. 1 to the Company's Registration Statement on Form S-1, File No. 33-58661), as amended by First Amendment to Employment Agreement dated as of December 31, 1996, between the Company and Paul Goldberg (incorporated by reference to Exhibit 10.9 to the Company's Form 10-K for the year ended December 31, 1996), as amended by Second Amendment to Employment Agreement dated as of August 21, 1998, between the Company and Paul Goldberg (incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended September 30, 1998).** 10.11 Employment Agreement dated as of May 24, 1995, between the Company and Bruce M. Goldberg (incorporated by reference to Exhibit 10.24 to Amendment No. 1 to the Company's Registration Statement on Form S-1, File No. 33-58661), as amended by First Amendment to Employment Agreement dated as of August 21, 1998, between the Company and Bruce M. Goldberg (incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q for the quarter ended September 30, 1998).** 10.12 Asset Purchase Agreement dated as of July 1, 1994 by and between the Company and GCI Corp.; Letter Agreement dated July 1, 1994 among the Company, GCI Corp., Robert Andreini, Joseph Cardarelli and Joseph Nelson; Guaranty dated July 1, 1994 and Amendment Letter to Asset Purchase Agreement and Letter Agreement dated July 15, 1994 (incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended June 30, 1994). 10.13 Merger Purchase Agreement (the "Purchase Agreement") dated as of October 31, 1995, among the Company, All American Added Value, Inc., All American A.V.E.D., Inc. and the Added Value Companies (incorporated by reference to Appendix A to the Proxy Statement/Prospectus included in and to Exhibit 2.1 to the Company's Registration Statement on Form S-4, File No. 033-64019). 10.14 Loan and Security Agreement (without exhibits or schedules) among Harris Trust and Savings Bank, as a lender and administrative agent, American National Bank and Trust Company of Chicago, as a lender and collateral agent, and the Other Lenders Party thereto and the Company, as borrower, together with six (6) Revolving Credit Notes, all dated May 10, 1996, aggregating $100,000,000 (incorporated by reference to Exhibit 10.2 to the Company's Form 10-Q for the quarter ended March 31, 1996). 10.15 Amendment No. 1 to Loan and Security Agreement dated August 2, 1996 (incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended June 30, 1996). 10.16 Amendment No. 2 to Loan and Security Agreement dated November 14, 1996 (incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended September 30, 1996). 10.17 Amendment No. 3 to Loan and Security Agreement dated July 31, 1998 (incorporated by reference to Exhibit 10.1 to the Company's Form 10-Q for the quarter ended June 30, 1998). 10.18 Amendment No. 4 to Loan and Security Agreement dated March 23, 1999.* 10.19 Consulting Contract dated July 1, 1995 by and between All American Semiconductor, Inc. and The Equity Group, Inc. (incorporated by reference to Exhibit 10.23 to the Company's Form 10-K for the year ended December 31, 1995). 10.20 All American Semiconductor, Inc. 401(k) Profit Sharing Plan (incorporated by reference to Exhibit 10.25 to the Company's Form 10-K for the year ended December 31, 1994).** 10.21 Employment Agreement dated as of May 24, 1995, between the Company and Howard L. Flanders (incorporated by reference to Exhibit 10.25 to Amendment No. 1 to the Company's Registration Statement on Form S-1, File No. 33-58661), as amended by First Amendment to Employment Agreement dated as of August 21, 1998, between the Company and Howard L. Flanders (incorporated by reference to Exhibit 10.3 to the Company's Form 10-Q for the quarter ended September 30, 1998).** 24 10.22 Employment Agreement dated as of May 24, 1995, between the Company and Rick Gordon (incorporated by reference to Exhibit 10.26 to Amendment No. 1 to the Company's Registration Statement on Form S-1, File No. 33-58661), as amended by First Amendment to Employment Agreement dated as of August 21, 1998, between the Company and Rick Gordon (incorporated by reference to Exhibit 10.4 to the Company's Form 10-Q for the quarter ended September 30, 1998).** 10.23 Settlement Agreement dated December 17, 1996, by and among the Company, certain of its subsidiaries and certain selling stockholders of the Added Value Companies (incorporated by reference to Exhibit 10.35 to the Company's Form 10-K for the year ended December 31, 1996). 10.24 Settlement Agreement dated January 22, 1997, by and among the Company, certain of its subsidiaries and Thomas Broesamle (incorporated by reference to Exhibit 10.36 to the Company's Form 10-K for the year ended December 31, 1996). 10.25 Form of Salary Continuation Plan (incorporated by reference to Exhibit 10.37 to the Company's Form 10-K for the year ended December 31, 1996).** 10.26 Promissory Note, dated October 1, 1996, payable to Sam Berman, d/b/a Drake Enterprises, in the amount of $161,500 (incorporated by reference to Exhibit 10.38 to the Company's Form 10-K for the year ended December 31, 1996). 10.27 Note dated August 21, 1998, by Bruce Mitchell Goldberg and Jayne Ellen Goldberg in favor of the Company in the principal amount of $125,000 (incorporated by reference to Exhibit 10.5 to the Company's Form 10-Q for the quarter ended September 30, 1998). 11.1 Statement Re: Computation of Per Share Earnings.* 21.1 List of subsidiaries of the Registrant.* 23.1 Consent of Lazar Levine & Felix LLP, independent certified public accountants.* 27.1 Financial Data Schedule.* - ------------------ * Filed herewith ** Management contract or compensation plan or arrangement required to be filed as an exhibit to this report pursuant to Item 14(c) of Form 10-K. (b) REPORTS ON FORM 8-K No reports were filed during the fourth quarter of 1998. 25 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. ALL AMERICAN SEMICONDUCTOR, INC. (Registrant) By: /s/ PAUL GOLDBERG ------------------------------------------- Paul Goldberg, Chairman of the Board Dated: March 31, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 31, 1999.
/s/ PAUL GOLDBERG Chairman of the Board, Director - ------------------------------- Paul Goldberg /s/ BRUCE M. GOLDBERG President and Chief Executive Officer, Director - ------------------------------- (Principal Executive Officer) Bruce M. Goldberg /s/ HOWARD L. FLANDERS Executive Vice President and Chief Financial Officer, - ------------------------------- Director Howard L. Flanders (Principal Financial and Accounting Officer) /s/ RICK GORDON Senior Vice President of Sales, Director - ------------------------------- Rick Gordon /s/ SHELDON LIEBERBAUM Director - ------------------------------- Sheldon Lieberbaum /s/ S. CYE MANDEL Director - ------------------------------- S. Cye Mandel /s/ DANIEL M. ROBBIN Director - ------------------------------- Daniel M. Robbin
26 MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING The Company's management is responsible for the preparation of the Consolidated Financial Statements in accordance with generally accepted accounting principles and for the integrity of all the financial data included in this Form 10-K. In preparing the Consolidated Financial Statements, management makes informed judgements and estimates of the expected effects of events and transactions that are currently being reported. Management maintains a system of internal accounting controls that is designed to provide reasonable assurance that assets are safeguarded and that transactions are executed and recorded in accordance with management's policies for conducting its business. This system includes policies which require adherence to ethical business standards and compliance with all laws to which the Company is subject. The internal controls process is continuously monitored by direct management review. The Board of Directors, through its Audit Committee, is responsible for determining that management fulfils its responsibility with respect to the Company's Consolidated Financial Statements and the system of internal auditing controls. The Audit Committee, comprised solely of directors who are not officers or employees of the Company, meets annually with representatives of management and the Company's independent accountants to review and monitor the financial, accounting, and auditing procedures of the Company in addition to reviewing the Company's financial reports. The Company's independent accountants have full and free access to the Audit Committee. /s/ BRUCE M. GOLDBERG /s/ HOWARD L. FLANDERS - ---------------------------- --------------------------- Bruce M. Goldberg Howard L. Flanders President, Executive Vice President, Chief Executive Officer Chief Financial Officer INDEPENDENT AUDITORS' REPORT To The Board of Directors All American Semiconductor, Inc. Miami, Florida We have audited the accompanying consolidated balance sheets of All American Semiconductor, Inc. and subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of operations, changes in shareholders' equity and cash flows for the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of All American Semiconductor, Inc. and subsidiaries at December 31, 1998 and 1997 and the results of their operations and their cash flows for the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. /s/ LAZAR LEVINE & FELIX LLP - -------------------------------------------- LAZAR LEVINE & FELIX LLP New York, New York March 5, 1999, except as to Note 14, the date of which is March 17, 1999 and Note 7, the date of which is March 23, 1999 F-1
ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ASSETS DECEMBER 31 1998 1997 - ---------------------------------------------------------------------------------------------- Current assets: Cash ....................................................... $ 473,000 $ 444,000 Accounts receivable, less allowances for doubtful accounts of $1,412,000 and $1,166,000 .................... 37,821,000 32,897,000 Inventories ................................................ 69,063,000 67,909,000 Other current assets ....................................... 2,574,000 2,074,000 ------------- ------------- Total current assets ..................................... 109,931,000 103,324,000 Property, plant and equipment - net .......................... 4,506,000 4,779,000 Deposits and other assets .................................... 3,458,000 3,157,000 Excess of cost over fair value of net assets acquired - net .. 1,062,000 1,026,000 ------------- ------------- $ 118,957,000 $ 112,286,000 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt .......................... $ 269,000 $ 304,000 Accounts payable and accrued expenses ...................... 41,229,000 39,154,000 Income taxes payable ....................................... 56,000 389,000 Other current liabilities .................................. 185,000 169,000 ------------- ------------- Total current liabilities ................................ 41,739,000 40,016,000 Long-term debt: Notes payable .............................................. 43,306,000 39,084,000 Subordinated debt .......................................... 6,187,000 6,293,000 Other long-term debt ....................................... 1,216,000 1,219,000 ------------- ------------- 92,448,000 86,612,000 ------------- ------------- Commitments and contingencies Shareholders' equity: Preferred stock, $.01 par value, 1,000,000 shares authorized, none issued .................................. - - Common stock, $.01 par value, 40,000,000 shares authorized, 19,866,906 and 20,353,894 shares issued, 19,866,906 and 19,863,895 shares outstanding ............................ 199,000 199,000 Capital in excess of par value ............................. 25,592,000 25,588,000 Retained earnings .......................................... 1,169,000 338,000 Treasury stock, at cost, 180,295 shares .................... (451,000) (451,000) ------------- ------------- 26,509,000 25,674,000 ------------- ------------- $ 118,957,000 $ 112,286,000 ============= =============
See notes to consolidated financial statements F-2
ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31 1998 1997 1996 - --------------------------------------------------------------------------------------------- NET SALES ................................ $ 250,044,000 $ 265,640,000 $ 237,846,000 Cost of sales ............................ (194,599,000) (207,173,000) (185,367,000) ------------- ------------- ------------- Gross profit ............................. 55,445,000 58,467,000 52,479,000 Selling, general and administrative expenses ................ (46,880,000) (48,257,000) (51,675,000) Impairment of goodwill ................... - - (2,193,000) Restructuring and other nonrecurring expenses ............................... (2,860,000) - (2,749,000) ------------- ------------- ------------- INCOME (LOSS) FROM CONTINUING OPERATIONS ............................. 5,705,000 10,210,000 (4,138,000) Interest expense ......................... (4,313,000) (4,797,000) (7,025,000) ------------- ------------- ------------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ......... 1,392,000 5,413,000 (11,163,000) Income tax (provision) benefit ........... (561,000) (2,163,000) 2,942,000 ------------- ------------- ------------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE DISCONTINUED OPERATIONS AND EXTRAORDINARY ITEMS .................................. 831,000 3,250,000 (8,221,000) Discontinued operations: Loss from operations (net of $125,000 income tax benefit) .................... - - (166,000) Loss on disposal (net of $1,200,000 income tax benefit) .................... - - (1,591,000) ------------- ------------- ------------- INCOME (LOSS) BEFORE EXTRAORDINARY ITEMS .................... 831,000 3,250,000 (9,978,000) Extraordinary items: Gain from settlement of litigation (net of $205,000 income tax provision) ......... - - 272,000 Loss on early retirement of debt (net of $161,000 income tax benefit) ........... - - (214,000) ------------- ------------- ------------- NET INCOME (LOSS) ........................ $ 831,000 $ 3,250,000 $ (9,920,000) ============= ============= ============= EARNINGS (LOSS) PER SHARE: Basic: INCOME (LOSS) FROM CONTINUING OPERATIONS ........................... $ .04 $ .17 $ (.41) Discontinued operations ................ - - (.09) Extraordinary items .................... - - - ----- ----- ------ NET INCOME (LOSS) ...................... $ .04 $ .17 $ (.50) ===== ===== ====== Diluted: INCOME (LOSS) FROM CONTINUING OPERATIONS ........................... $ .04 $ .16 $ (.40) Discontinued operations ................ - - (.09) Extraordinary items .................... - - - ---- ----- ------ NET INCOME (LOSS) ...................... $ .04 $ .16 $ (.49) ===== ===== ======
See notes to consolidated financial statements F-3 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
CAPITAL IN RETAINED TOTAL COMMON EXCESS OF EARNINGS TREASURY SHAREHOLDERS' SHARES STOCK PAR VALUE (DEFICIT) STOCK EQUITY - ------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995...... 19,863,895 $ 199,000 $ 25,511,000 $ 7,008,000 $ (451,000) $ 32,267,000 Exercise of stock options....... 5,000 - 9,000 - - 9,000 Issuance of equity securities... 60,000 - 150,000 - - 150,000 Reacquisition and cancellation of equity securities.......... (95,000) (1,000) (109,000) - - (110,000) Net loss........................ - - - (9,920,000) - (9,920,000) ---------- ---------- ------------ ------------ ------------ -------------- Balance, December 31, 1996...... 19,833,895 198,000 25,561,000 (2,912,000) (451,000) 22,396,000 Exercise of stock options....... 30,000 1,000 27,000 - - 28,000 Net income...................... - - - 3,250,000 - 3,250,000 ---------- ---------- ------------ ------------ ------------ -------------- Balance, December 31, 1997...... 19,863,895 199,000 25,588,000 338,000 (451,000) 25,674,000 EXERCISE OF STOCK OPTIONS....... 3,011 - 4,000 - - 4,000 NET INCOME...................... - - - 831,000 - 831,000 ---------- ---------- ------------ ------------ ------------ -------------- BALANCE, DECEMBER 31, 1998...... 19,866,906 $ 199,000 $ 25,592,000 $ 1,169,000 $ (451,000) $ 26,509,000 ========== ========== ============ ============ ============ ==============
See notes to consolidated financial statements F-4 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)................................................ $ 831,000 $ 3,250,000 $ (9,920,000) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization.................................. 1,236,000 1,440,000 2,757,000 Non-cash interest expense...................................... 352,000 254,000 2,273,000 Nonrecurring expenses.......................................... - - 4,428,000 Changes in assets and liabilities of continuing operations: Decrease (increase) in accounts receivable................... (4,924,000) (972,000) 1,569,000 Decrease (increase) in inventories........................... (1,154,000) (3,697,000) 1,206,000 Decrease (increase) in other current assets.................. (500,000) 3,039,000 (2,014,000) Increase (decrease) in accounts payable and accrued expenses........................................... 2,075,000 7,356,000 (14,032,000) Increase (decrease) in other current liabilities............. (317,000) 62,000 (669,000) Decrease in net assets of discontinued operations.............. - 830,000 1,796,000 ------------ ------------ ------------ Net cash provided by (used for) operating activities....... (2,401,000) 11,562,000 (12,606,000) ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of property and equipment............................ (564,000) (298,000) (2,293,000) Increase in other assets......................................... (944,000) (83,000) (4,438,000) Net investing activities of discontinued operations.............. - - (39,000) ------------ ------------ ------------ Net cash used for investing activities..................... (1,508,000) (381,000) (6,770,000) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings (repayments) under line of credit agreements...... 4,263,000 (11,000,000) 20,290,000 Increase in notes payable........................................ 10,000 - 15,161,000 Repayments of notes payable...................................... (339,000) (290,000) (15,835,000) Net proceeds from issuance of equity securities.................. 4,000 28,000 9,000 ------------ ------------ ------------ Net cash provided by (used for) financing activities....... 3,938,000 (11,262,000) 19,625,000 ------------ ------------ ------------ Increase (decrease) in cash...................................... 29,000 (81,000) 249,000 Cash, beginning of year.......................................... 444,000 525,000 276,000 ------------ ------------ ------------ Cash, end of year................................................ $ 473,000 $ 444,000 $ 525,000 ============ ============ ============ SUPPLEMENTAL CASH FLOW INFORMATION: Interest paid.................................................... $ 4,223,000 $ 4,906,000 $ 3,839,000 ============ ============ ============ Income taxes paid (refunded) - net............................... $ 1,756,000 $ (989,000) $ 1,108,000 ============ ============ ============
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: During 1997 a capital lease in the amount of $634,000 for computer equipment, which first took effect in 1994, was renewed for an additional three years. Effective January 1, 1996, the Company purchased all of the capital stock of Programming Plus Incorporated ("PPI"). The consideration paid by the Company for such capital stock consisted of 549,999 shares of common stock of the Company valued at $1,375,000 (or $2.50 per share); however, only 60,000 shares of common stock (valued at $150,000) were released to the PPI selling shareholders at closing. The balance, which was retained in escrow subject to certain conditions subsequent, has been canceled and retired. See notes to consolidated financial statements F-5 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company is a national distributor of electronic components manufactured by others. The Company primarily distributes a full range of semiconductors (active components), including transistors, diodes, memory devices and other integrated circuits, as well as passive components, such as capacitors, resistors, inductors and electromechanical products, including cable, switches, connectors, filters and sockets. The Company's products are sold primarily to original equipment manufacturers ("OEMs") in a diverse and growing range of industries, including manufacturers of computers and computer-related products; networking; satellite and communications products; consumer goods; robotics and industrial equipment; defense and aerospace equipment; and medical instrumentation. The Company also sells products to contract electronics manufacturers ("CEMs") who manufacture products for companies in all electronics industry segments. The Company also designs and has manufactured certain board level products including memory modules and flat panel display driver boards, both of which are sold to OEMs. The Company's financial statements are prepared in accordance with generally accepted accounting principles ("GAAP"). Those principles considered particularly significant are detailed below. GAAP requires management to make estimates and assumptions affecting the reported amounts of assets, liabilities, revenues and expenses. While actual results may differ from these estimates, management does not expect the variances, if any, to have a material effect on the Consolidated Financial Statements. BASIS OF CONSOLIDATION AND PRESENTATION The Consolidated Financial Statements of the Company include the accounts of all subsidiaries, all of which are wholly-owned. All material intercompany balances and transactions have been eliminated in consolidation. The Company has a Canadian subsidiary which conducts substantially all of its business in U.S. dollars. Prior years' financial statements have been reclassified to conform with the current year's presentation. CONCENTRATION OF CREDIT RISK Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash and accounts receivable. The Company, from time to time, maintains cash balances which exceed the federal depository insurance coverage limit. The Company performs periodic reviews of the relative credit rating of its bank to lower its risk. The Company believes that concentration with regards to accounts receivable is limited due to its large customer base. Fair values of cash, accounts receivable, accounts payable and long-term debt reflected in the December 31, 1998 and 1997 Consolidated Balance Sheets approximate carrying value at these dates. MARKET RISK The Company's Credit Facility bears interest based on interest rates tied to the prime or LIBOR rate, either of which may fluctuate over time based on economic conditions. As a result, the Company is subject to market risk for changes in interest rates and could be subjected to increased or decreased interest payments if market interest rates fluctuate. If market interest rates increase, the impact may have a material adverse effect on the Company's financial results. INVENTORIES Inventories are stated at the lower of cost (determined on an average cost basis) or market. F-6 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ FIXED ASSETS Fixed assets are reflected at cost. Depreciation of office furniture and equipment and computer equipment is provided on straight-line and accelerated methods over the estimated useful lives of the respective assets. Amortization of leasehold improvements is provided using the straight-line method over the term of the related lease or the life of the respective asset, whichever is shorter. Maintenance and repairs are charged to expense as incurred; major renewals and betterments are capitalized. EXCESS OF COST OVER FAIR VALUE OF NET ASSETS ACQUIRED (GOODWILL) The excess of cost over the fair value of net assets acquired is being amortized over periods ranging from 15 years to 40 years using the straight-line method. The Company periodically reviews the value of its excess of cost over the fair value of net assets acquired to determine if an impairment has occurred. As part of this review the Company measures the estimated future operating cash flows of acquired businesses and compares that with the carrying value of excess of cost over the fair value of net assets. See Note 4 to Notes to Consolidated Financial Statements. INCOME TAXES The Company has elected to file a consolidated federal income tax return with its subsidiaries. Deferred income taxes are provided on transactions which are reported in the financial statements in different periods than for income tax purposes. The Company utilizes Financial Accounting Standards Board Statement No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 requires recognition of deferred tax liabilities and assets for expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the difference is expected to reverse. Under SFAS 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. See Note 8 to Notes to Consolidated Financial Statements. EARNINGS PER SHARE In 1997, the Company adopted Financial Accounting Standards Board Statement No. 128, "Earnings Per Share" ("SFAS 128"), which changed the method for calculating earnings per share. SFAS 128 requires the presentation of "basic" and "diluted" earnings per share on the face of the statement of operations. Prior period earnings per share data has been restated in accordance with SFAS 128. Earnings per common share is computed by dividing net income by the weighted average, during each period, of the number of common shares outstanding and for diluted earnings per share also common equivalent shares outstanding. The following average shares were used for the computation of basic and diluted earnings per share: YEARS ENDED DECEMBER 31 1998 1997 1996 - -------------------------------------------------------------------------------- Basic........................... 19,685,106 19,672,559 19,742,849 Diluted......................... 19,994,009 19,784,837 20,105,761 STATEMENTS OF CASH FLOWS For purposes of the statements of cash flows, the Company considers all investments purchased with an original maturity of three months or less to be cash. F-7 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ STOCK-BASED COMPENSATION In 1996, the Company adopted Financial Accounting Standards Board Statement No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). See Note 9 to Notes to Consolidated Financial Statements. COMPREHENSIVE INCOME In 1998, the Company adopted Financial Accounting Standards Board Statement No. 130, "Reporting Comprehensive Income", which prescribes standards for reporting comprehensive income and its components. The Company had no items of other comprehensive income in any period presented and accordingly is not required to report comprehensive income. SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION In 1998, the Company adopted Financial Accounting Standards Board Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information", which establishes standards for reporting about operating segments. The Company has determined that no operating segment outside of its core business met the quantitative thresholds for separate reporting. Accordingly, no separate information has been reported. PENSIONS AND OTHER POSTRETIREMENT BENEFITS In 1998, the Company adopted Financial Accounting Standards Board Statement No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." The effect of the adoption of this statement was not material. NOTE 2 - PROPERTY, PLANT AND EQUIPMENT
DECEMBER 31 1998 1997 - -------------------------------------------------------------------------------------------- Office furniture and equipment.................. $ 4,179,000 $ 4,074,000 Computer equipment.............................. 3,924,000 3,554,000 Leasehold improvements.......................... 2,017,000 1,800,000 ---------------- --------------- 10,120,000 9,428,000 Accumulated depreciation and amortization....... (5,614,000) (4,649,000) ---------------- --------------- $ 4,506,000 $ 4,779,000 ================ ===============
NOTE 3 - ACQUISITIONS Effective January 1, 1996, the Company purchased all of the capital stock of Programming Plus Incorporated ("PPI"), which provided programming and tape and reel services with respect to electronic components. The purchase price for PPI consisted of $1,375,000 of common stock of the Company, valued at $2.50 per share. Only 60,000 shares of the Company's common stock, valued at $150,000, were released to the PPI selling shareholders at closing. The $1,225,000 balance of the consideration ("Additional Consideration"), represented by 489,999 shares of common stock of the Company, was retained in escrow by the Company, as escrow agent. The Additional Consideration was to be released to the PPI selling shareholders annually if certain levels of pre-tax net income were attained by the acquired company for the years ended December 31, 1996 through December 31, 2000. For the year ended December 31, 1996, the acquired company did not attain that certain level of pre-tax net income and, accordingly, none of the Additional Consideration was released. During 1997, the Company and the PPI selling shareholders agreed to cease the operations of PPI. As a result, all of the Additional Consideration held in escrow was canceled and retired. F-8 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ On December 29, 1995, the Company purchased through two separate mergers with and into the Company's wholly-owned subsidiaries (the "Added Value Acquisitions") all of the capital stock of Added Value Electronics Distribution, Inc. ("Added Value") and A.V.E.D.-Rocky Mountain, Inc. ("Rocky Mountain," and together with Added Value, collectively the "Added Value Companies"). The purchase price for the Added Value Companies included approximately $2,936,000 in cash and 2,013,401 shares of common stock of the Company valued at approximately $4,893,000 (exclusive of the 160,703 shares of common stock issued in the transaction to a wholly-owned subsidiary of the Company). In addition, the Company paid an aggregate of $1,200,000 in cash to the selling stockholders in exchange for covenants not to compete, and an aggregate of $1,098,000 in cash as front-end incentive employment compensation paid to certain key employees of the Added Value Companies. The Company also assumed substantially all of the sellers' disclosed liabilities of approximately $8,017,000, including approximately $3,809,000 in bank notes which have since been repaid. The Company has also paid approximately $107,000 of additional consideration to certain of the selling stockholders of the Added Value Companies since the aggregate value of the shares of the Company's common stock issued to these individuals did not, by June 30, 1998, appreciate in the aggregate by $107,000. The additional consideration is included in excess of cost over fair value of net assets acquired in the accompanying Consolidated Balance Sheet as of December 31, 1998. The Company has not included in excess of cost over fair value of net assets acquired as of December 31, 1998 approximately $159,000 of additional consideration that would have been payable to another selling stockholder of the Added Value Companies since such additional consideration has been applied by the Company to partially satisfy certain claims alleged by the Company against such selling stockholder arising with respect to the transaction with the Added Value Companies. The Company entered into a settlement agreement with certain of the selling stockholders in December 1996 and with an additional selling stockholder in January 1997 (collectively the "Settlement Agreements"). The Settlement Agreements provided, among other things, that the additional consideration that could have been payable to those selling stockholders be eliminated, that certain of the selling stockholders reconvey to the Company an aggregate of 95,000 shares of common stock of the Company which were issued as part of the purchase price for the Added Value Companies and that the Company grant to certain selling stockholders stock options to purchase an aggregate of 50,000 shares of the Company's common stock at an exercise price of $1.50 per share exercisable through December 30, 2001. The acquisitions were accounted for by the purchase method of accounting which resulted in the recognition of approximately $2,937,000 of excess cost over fair value of net assets acquired. As a result of a reduction in the estimated future cash flows from the Added Value Companies, the Company recognized an impairment of goodwill of approximately $2,200,000 in 1996. See Note 4 to Notes to Consolidated Financial Statements. The assets, liabilities and operating results of the acquired companies are included in the Consolidated Financial Statements of the Company from the date of the acquisitions, December 29, 1995. In connection with the acquisition of substantially all of the assets of GCI Corp. in 1994, a Philadelphia-area distributor of electronic components, the seller was able to earn up to an additional $760,000 of contingent purchase price over the three-year period ending December 31, 1997 if certain gross profit targets were met. The gross profit targets were not met and, therefore, no additional purchase price was earned. NOTE 4 - IMPAIRMENT OF GOODWILL In connection with the Company's acquisitions of the Added Value Companies and PPI, at September 30, 1996, the Company recognized an impairment of goodwill. This non-cash charge was primarily related to the Added Value Companies and had no associated tax benefit. A variety of factors contributed to the impairment of the goodwill relating to the Added Value Companies. These factors included a significant reduction in the revenues and operating results generated by the Added Value Companies' customer base acquired by the Company, a restructuring of the Added Value Companies' kitting and turnkey operations due to the Company determining that it was not economically feasible to continue and expand such division as originally planned, as well as the termination of certain principals and senior management of the Added Value Companies who became employees of the Company at the time of the closing of the acquisitions. F-9 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ See Note 5 to Notes to Consolidated Financial Statements. These factors greatly reduced the estimated future cash flows from the Added Value Companies. In determining the amount of the impairment charge, the Company developed its best estimate of projected operating cash flows over the remaining period of expected benefit. Projected future cash flows were discounted and compared to the carrying value of the related goodwill and as a result a write-down of approximately $2,400,000 with respect to the Added Value Companies was recorded in 1996. In December 1996 and January 1997, as part of the Settlement Agreements (see Note 3 to Notes to Consolidated Financial Statements), the Company reacquired and canceled 95,000 shares of the Company's common stock valued at approximately $110,000, which, together with certain excess distributions made to certain principals of the Added Value Companies in connection with the acquisitions, reduced the impairment of goodwill to $2,193,000. NOTE 5 - RESTRUCTURING AND OTHER NONRECURRING EXPENSES During 1998, the Company was involved in merger discussions which led to a letter of intent being signed in June 1998 with Reptron Electronics, Inc. ("Reptron") regarding the merger of Reptron's distribution operations with the Company ("the Merger"). Throughout 1998 the Company was actively involved in the evaluation of, and preparations for the integration of operations in connection with the proposed Merger. In October 1998, the Merger negotiations between the Company and Reptron were terminated. As a result, the Company recorded a nonrecurring charge in 1998, which included expansion costs incurred in anticipation of supporting the proposed combined entity, certain employee-related expenses, professional fees and other Merger-related out of pocket costs, all of which aggregated $2,860,000. During 1996, the Company recorded restructuring and nonrecurring expenses aggregating $2,749,000. Of this total, $1,092,000 represented expenses in connection with the restructuring of the Company's kitting and turnkey operations, $625,000 represented a non-cash charge associated with the Company accelerating a postretirement benefit accrual relating to an amendment of an executive officer's employment agreement, $587,000 represented the aggregate payments made in connection with the termination of certain employment agreements relating to prior acquisitions, and $445,000 represented expenses associated with the closing and relocation of the Company's cable assembly division. In addition, during 1996, the Company wrote-off $2,000,000 of inventory associated primarily with the restructuring of the kitting and turnkey operations which is reflected in cost of sales in the accompanying Consolidated Statement of Operations for the year ended December 31, 1996. NOTE 6 - DISCONTINUED OPERATIONS In June 1995, the Company established a computer products division ("CPD") which operated under the name Access Micro Products. This division sold microprocessors, motherboards, computer upgrade kits, keyboards and disk drives. During 1996, the Company was notified by the division's primary supplier that it had discontinued the production of certain products that were the mainstay of the Company's computer products division. Although the Company obtained additional product offerings, revenues of Access Micro Products were severely impacted without these mainstay products and, as a result, management decided to discontinue CPD. Accordingly, this division was accounted for as discontinued operations and the results of operations for 1996 are segregated in the accompanying Consolidated Statement of Operations. Sales from this division were $6,822,000 for 1996. The loss on disposal of $2,791,000, on a pretax basis, included the estimated costs and expenses associated with the disposal of $2,326,000 as well as a provision of $465,000 for operating losses during the phase-out period, which continued through March 31, 1997. F-10 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 7 - LONG-TERM DEBT LINE OF CREDIT In May 1996, the Company entered into a new $100 million line of credit facility with a group of banks (the "Credit Facility") which expires May 3, 2001. At the time of entering into such facility, borrowings under the Credit Facility bore interest, at the Company's option, at either prime plus one-quarter of one percent (.25%) or LIBOR plus two and one-quarter percent (2.25%). Outstanding borrowings under the Credit Facility, which are secured by all of the Company's assets including accounts receivable, inventories and equipment, amounted to $43,263,000 at December 31, 1998 compared to $39,000,000 at December 31, 1997. The amounts that the Company may borrow under the Credit Facility are based upon specified percentages of the Company's eligible accounts receivable and inventories, as defined. Under the Credit Facility, the Company is required to comply with certain affirmative and negative covenants as well as to comply with certain financial ratios. These covenants, among other things, place limitations and restrictions on the Company's borrowings, investments and transactions with affiliates and prohibit dividends and stock redemptions. Furthermore, the Credit Facility requires the Company to maintain certain minimum levels of tangible net worth throughout the term of the agreement and a minimum debt service coverage ratio which is tested on a quarterly basis. In connection with obtaining the Credit Facility the Company paid financing fees which aggregated $3,326,000. During 1996, the Company's Credit Facility was amended whereby certain financial covenants were modified and the Company's borrowing rate was increased by one-quarter of one percent (.25%). During the first quarter of 1998, as a result of the Company satisfying certain conditions, the Company's borrowing rate under its Credit Facility was decreased by one-quarter of one percent (.25%). The Company's Credit Facility was further amended on March 23, 1999 whereby certain financial covenants were modified. During 1996, as a result of a projected decrease in the Company's future anticipated utilization of the Credit Facility based on projected cash flows as well as certain changes to the terms of the initial agreement, $1,704,000 of the deferred financing fees was written off to interest expense in 1996, since it was deemed to have no future economic benefit. In connection with the Credit Facility, in May 1996, the Company repaid all outstanding borrowings under the Company's previous $45 million line of credit which was to expire in May 1997 and bore interest, at the Company's option, either at one-quarter of one percent (.25%) below prime or two percent (2%) above certain LIBOR rates and repaid the Company's $15 million senior subordinated promissory note (the "Subordinated Note"). The Subordinated Note had been issued in March 1996 and was scheduled to mature on July 31, 1997. As a result of the early extinguishment of the Subordinated Note, the Company recognized an extraordinary after-tax expense of $214,000, net of a related income tax benefit of $161,000, in 1996. SUBORDINATED DEBT In September 1994, in connection with the acquisition of GCI Corp., the Company issued a promissory note to the seller bearing interest at 7% per annum in the approximate amount of $306,000 due in 1999. The promissory note, which is subordinate to the Company's line of credit, is payable interest only on a quarterly basis for the first two years with the principal amount, together with accrued interest thereon, payable in equal quarterly installments over the next three years. In addition, the Company executed a promissory note in the approximate amount of $37,300 payable to GCI Corp. in connection with the earn-out provision contained in the asset purchase agreement. This note bears interest at 7% per annum, payable quarterly. This note, which is subordinate to the Company's institutional lenders, matures in 2001. In June 1994, the Company completed a private placement (the "1994 Private Placement") of 51.5 units, with each unit consisting of a 9% non-convertible subordinated debenture due 2004 in the principal amount of $100,000 issuable at par, together with 7,500 common stock purchase warrants exercisable at $3.15 per F-11 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ share. The 51.5 units issued represent debentures aggregating $5,150,000 together with an aggregate of 386,250 warrants. See Note 9 to Notes to Consolidated Financial Statements. The debentures are payable in semi-annual installments of interest only commencing December 1, 1994, with the principal amount maturing in full on June 13, 2004. The Company is not required to make any mandatory redemptions or sinking fund payments. The debentures are subordinated to the Company's senior indebtedness including the Credit Facility and notes issued to the Company's landlord. The 386,250 warrants were valued at $.50 per warrant as of the date of the 1994 Private Placement and, accordingly, the Company recorded the discount in the aggregate amount of $193,125 as additional paid-in capital. This discount is being amortized over the ten-year term of the debentures and approximately $19,000 was expensed in 1998, 1997 and 1996. In May 1994, the Company executed a promissory note in the amount of $865,000 in favor of the Company's landlord to finance substantially all of the tenant improvements necessary for the Company's Miami facility. This $865,000 note requires no payments in the first year (interest accrues and is added to the principal balance), is payable interest only in the second year and has a repayment schedule with varying monthly payments over the remaining 18 years. At the same time, the Company entered into another promissory note with the Company's landlord for $150,000 to finance certain personal property for the facility. This $150,000 note is payable interest only for six months and thereafter in 60 equal self-amortizing monthly payments of principal and interest. These notes, which are subordinate to the Credit Facility, bear interest at 8% per annum and are payable monthly. Certain additional improvements to the Company's Miami corporate facility aggregating approximately $90,300 were financed as of May 1, 1995 by the landlord. This $90,300 is evidenced by a promissory note payable in 240 consecutive, equal self-amortizing monthly installments of principal and interest. This note, which is subordinate to the Credit Facility, accrues interest at a fixed rate of 8% per annum. In October 1996, the Company executed a promissory note in the amount of $161,500 with the Company's landlord to finance certain additional improvements to the Company's Miami corporate facility. This note, which is subordinate to the Credit Facility, is payable monthly with interest at 8.5% per annum and matures in October 2011. Long-term debt of the Company as of December 31, 1998, other than the Credit Facility, matures as follows: 1999......................................................... $ 230,000 2000......................................................... 96,000 2001......................................................... 99,000 2002......................................................... 88,000 2003......................................................... 75,000 Thereafter................................................... 7,053,000 -------------- $ 7,641,000 ============== OBLIGATIONS UNDER CAPITAL LEASES During 1997 the Company renewed a capital lease for computer equipment which will expire in 2000. The assets, aggregating $634,000, and liabilities under the capital lease are recorded at the lower of the present value of the minimum lease payments or the fair value of the assets. The assets are depreciated over their estimated productive lives. As of December 31, 1998, accumulated depreciation of these assets aggregated approximately $408,000. Depreciation of assets under this capital lease is included in depreciation expense. F-12 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ Minimum future lease payments under this capital lease as of December 31, 1998 and for each of the remaining years and in the aggregate are approximately as follows: 1999......................................................... $ 51,000 2000......................................................... 38,000 -------------- Total minimum lease payments................................. 89,000 Less amount representing interest............................ (15,000) -------------- Total obligations under capital leases....................... 74,000 Current portion.............................................. (39,000) -------------- $ 35,000 ============== The interest rate on this capital lease is 8.50% per annum and is imputed based on the lower of the Company's incremental borrowing rate at the inception of the lease or the lessor's implicit rate of return. NOTE 8 - INCOME TAXES The tax effects of the temporary differences that give rise to the deferred tax assets and liabilities as of December 31, 1998 and 1997 are as follows: Deferred tax assets: 1998 1997 -------------- ------------- Accounts receivable.................. $ 524,000 $ 433,000 Inventory............................ 384,000 334,000 Accrued expenses..................... 1,569,000 761,000 Postretirement benefits.............. 481,000 481,000 Other................................ 649,000 671,000 -------------- ------------- 3,607,000 2,680,000 Deferred tax liabilities: Fixed assets......................... 387,000 319,000 -------------- ------------- Net deferred tax asset................. $ 3,220,000 $ 2,361,000 ============== ============= At December 31, 1998 $1,930,000 of the net deferred tax asset was included in "Other Current Assets" and $1,290,000 was included in "Deposits and Other Assets" in the accompanying Consolidated Balance Sheet. The components of income tax expense (benefit) are as follows: YEARS ENDED DECEMBER 31 1998 1997 1996 - -------------------------------------------------------------------------------- Current - ------- Federal................... $ 1,210,000 $ 1,836,000 $ (2,018,000) State..................... 210,000 207,000 (262,000) -------------- -------------- ------------- 1,420,000 2,043,000 (2,280,000) -------------- -------------- ------------- Deferred - -------- Federal................... (749,000) 105,000 (1,657,000) State..................... (110,000) 15,000 (286,000) -------------- -------------- ------------- (859,000) 120,000 (1,943,000) -------------- -------------- ------------- $ 561,000 $ 2,163,000 $ (4,223,000) ============== ============== ============= F-13 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ The provision for income tax expense (benefit) included in the Consolidated Financial Statements is as follows:
YEARS ENDED DECEMBER 31 1998 1997 1996 - -------------------------------------------------------------------------------------------------------- Continuing operations................................. $ 561,000 $ 2,163,000 $ (2,942,000) Discontinued operations............................... - - (1,325,000) Extraordinary items................................... - - 44,000 -------------- -------------- ------------- $ 561,000 $ 2,163,000 $ (4,223,000) ============== ============== ============= A reconciliation of the difference between the expected income tax rate using the statutory federal tax rate and the Company's effective tax rate is as follows: YEARS ENDED DECEMBER 31 1998 1997 1996 - -------------------------------------------------------------------------------------------------------- U.S. Federal income tax statutory rate................ 34.0% 34.0% (34.0)% State income tax, net of federal income tax benefit... 5.4 2.7 (2.6) Goodwill amortization................................. 4.2 .9 16.6 Other - including non-deductible items................ (2.1) 2.4 (9.9) ------ ----- ----- Effective tax rate.................................... 41.5% 40.0% (29.9)% ====== ===== =====
NOTE 9 - CAPITAL STOCK, OPTIONS AND WARRANTS Effective January 1996, in connection with the acquisition of PPI, the Company issued an aggregate of 549,999 shares of its common stock, valued at $2.50 per share. Only 60,000 shares of the Company's common stock, valued at $150,000, were released to the PPI selling shareholders at closing. The remaining 489,999 shares of common stock were retained in escrow by the Company, as escrow agent, and were to be released to the PPI selling shareholders annually if certain levels of pre-tax net income were attained by PPI for the years ended December 31, 1996 through December 31, 2000. For the year ended December 31, 1996, the acquired company did not attain that certain level of pre-tax net income and, accordingly, none of the Additional Consideration was released. During 1997, the Company and the PPI selling shareholders agreed to cease the operations of PPI. As a result, all of the Additional Consideration held in escrow was canceled and retired as of December 31, 1997. In December 1995, in connection with the acquisition of the Added Value Companies, the Company issued an aggregate of 2,174,104 shares of common stock. As a result of Added Value previously owning approximately 37% of Rocky Mountain, 160,703 shares, valued at approximately $391,000, issued as part of the Rocky Mountain merger were acquired by the Company's wholly-owned subsidiary. In addition, in connection with such acquisitions, certain selling stockholders were granted an aggregate of 50,000 stock options (30,000 stock options of which have since been canceled) to acquire the Company's common stock at an exercise price of $2.313 per share exercisable, subject to a six-year vesting period, through December 29, 2002. In connection with the Company entering into a settlement agreement with certain of the selling stockholders in December 1996, an aggregate of 95,000 shares of the Company's common stock was canceled and the Company granted to certain selling shareholders (who are employees of the Company) stock options to purchase an aggregate of 50,000 shares of the Company's common stock at an exercise price of $1.50 per share exercisable through December 30, 2001. At December 31, 1998, 37,500 of these options remained unexercised and 12,500 were canceled. In July 1995, the Company issued to a consulting firm a warrant to acquire 45,000 shares of the Company's common stock at an exercise price of $2.50 per share exercisable through July 20, 2000. The warrant was issued in consideration of such consulting firm entering into a new one-year consulting agreement with the Company covering financial public relations/investor relations services. At December 31, 1998, these warrants remained unexercised. The same consulting firm had previously been issued warrants to acquire F-14 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ an aggregate of 180,000 shares in September 1987 and May 1993 in connection with prior consulting agreements as discussed below. In connection with new employment agreements between the Company and each of its four executive officers entered into in May 1995, an aggregate of 1,000,000 stock options were granted on June 8, 1995 to such four executive officers pursuant to the Employees', Officers', Directors' Stock Option Plan, as previously amended and restated (the "Option Plan"). These options have an exercise price of $1.875 per share and are exercisable through June 7, 2005, subject to a vesting schedule. In connection with the public offering in 1995, the Company issued to the underwriter common stock purchase warrants covering an aggregate of 523,250 shares of common stock (including warrants issued in connection with the underwriter's exercise of the over-allotment option). These warrants are exercisable at a price of $2.625 per share for a period of four years commencing one year from June 8, 1995. At December 31, 1998, these warrants had not been exercised. In June 1994, the Company issued an aggregate of 386,250 common stock purchase warrants in connection with a private placement of subordinated debentures (see Note 7 to Notes to Consolidated Financial Statements). The warrants are exercisable at any time between December 14, 1994 and June 13, 1999 at an exercise price of $3.15 per share. In connection with this private placement, the placement agent received warrants to purchase 38,625 shares of the Company's common stock. The placement agent's warrants are exercisable for a four-year period commencing June 14, 1995 at an exercise price of $3.78 per share. At December 31, 1998, these warrants had not been exercised. In May 1993, in connection with a consulting agreement, the Company issued warrants to acquire 90,000 shares of its common stock at $1.35 per share. These warrants were not exercised and expired in May 1998. In addition, a warrant to acquire 90,000 shares of the Company's common stock at $1.60 per share expired in June 1997. The Company has reserved 3,250,000 shares of common stock for issuance under the Option Plan. A summary of options granted and related information for the years ended December 31, 1996, 1997 and 1998 under the Option Plan follows:
Weighted Average Options Exercise Price ------------ -------------- Outstanding, December 31, 1996 2,374,813 $1.77 Weighted average fair value of options granted during the year .24 Granted 1,551,000 1.15 Exercised (30,000) .94 Canceled (1,167,500) 1.68 ------------ Outstanding, December 31, 1997 2,728,313 1.46 Weighted average fair value of options granted during the year .42 Granted 195,000 1.44 Exercised (3,011) 1.12 Canceled (88,750) 1.39 ------------ Outstanding, December 31, 1998 2,831,552 1.46 ============ Weighted average fair value of options granted during the year .27 Options exercisable: December 31, 1996 860,495 1.43 December 31, 1997 468,124 1.27 December 31, 1998 832,080 1.22
F-15 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ Exercise prices for options outstanding as of December 31, 1998 ranged from $1.00 to $2.53. The weighted-average remaining contractual life of these options is approximately 5 years. Outstanding options at December 31, 1998 were held by 83 individuals. The Company applies APB 25 and related Interpretations in accounting for the Option Plan. Accordingly, no compensation cost has been recognized for the Option Plan. Had compensation cost for the Option Plan been determined using the fair value based method, as defined in SFAS 123, the Company's net earnings (loss) and earnings (loss) per share would have been adjusted to the pro forma amounts indicated below: YEARS ENDED DECEMBER 31 1998 1997 1996 - ------------------------------------------------------------------------------ Net earnings (loss): As reported $831,000 $3,250,000 $(9,920,000) Pro forma 800,000 2,859,000 (9,967,000) Basic earnings (loss) per share: As reported $.04 $.17 $(.50) Pro forma .04 .15 (.50) Diluted earnings (loss) per share: As reported $.04 $.16 $(.49) Pro forma .04 .14 (.50) The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for 1998, 1997 and 1996, respectively: expected volatility of 60.0%, 50.0% and 43.4%; risk-free interest rate of 5.7%, 6.1% and 6.5%; and expected lives of 5 to 8 years. The effects of applying SFAS 123 in the above pro forma disclosures are not indicative of future amounts as they do not include the effects of awards granted prior to 1995. Additionally, future amounts are likely to be affected by the number of grants awarded since additional awards are generally expected to be made at varying amounts. In connection with the acquisition of the assets of GCI Corp. in 1994, the Company issued 117,551 unqualified stock options exercisable from September 1995 through September 1999 at an exercise price of $1.65 per share. In connection with the acquisition of the assets of Components Incorporated in 1994, the Company issued 98,160 unqualified stock options at an exercise price of $1.65 per share. These options expired in January 1999. NOTE 10 - COMMITMENTS/RELATED PARTY TRANSACTIONS In May 1994, the Company entered into a new lease with its then existing landlord to lease a 110,800 square foot facility for its corporate headquarters and Miami distribution center. The lease has a term expiring in 2014 (subject to the Company's right to terminate at any time after the fifth year of the term upon twenty-four months prior written notice and the payment of all outstanding debt owed to the landlord). The lease gives the Company three six-year options to renew at the fair market value rental rates. The lease provides for annual fixed rental payments totaling approximately $264,000 in the first year; $267,000 in the second year; $279,000 in each of the third, fourth and fifth years; $300,600 in the sixth year; $307,800 in the seventh year; and in each year thereafter during the term the rent shall increase once per year in an amount equal to the annual percentage increase in the consumer price index not to exceed 4% in any one year. F-16 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ As a result of the Added Value Acquisitions, the Company leases a 13,900 square foot facility in Tustin, California and a 7,600 square foot facility in Denver, Colorado. The Tustin facility presently contains the separate divisions created for flat panel displays (ADT) and memory module (AMP) operations as well as a distribution center. See "Products." During 1998 the Denver sales operations were moved to a separate office. The 7,600 square foot facility is now dedicated solely to certain value-added services and a regional distribution center. During 1995, the Company entered into a lease for a west coast distribution and semiconductor programming center located in Fremont, California (near San Jose). This facility contains approximately 20,000 square feet of space. The Company moved into this facility in January 1996. The Company has used this space to expand its semiconductor programming and component distribution capabilities and to further improve quality control and service capabilities for its west coast customers. During 1998, the Company entered into a new lease for approximately 20,000 square feet of space in San Jose, California to house its expanded west coast corporate offices as well as its northern California sales operation. This lease incorporates the previously leased space of approximately 11,000 square feet and adds a new adjoining space of approximately 9,000 square feet. Approximately 8,000 square feet of the space is being used for corporate offices including the office of the President and CEO of the Company and 8,000 square feet of the space is being utilized for the sales operation. The remaining area of approximately 4,000 square feet is not presently being utilized and the Company is currently pursuing a tenant to sublet this space. The Company leases space for its other sales offices, which range in size from approximately 1,000 square feet to 8,000 square feet. The leases for these offices expire at various dates and include various escalation clauses and renewal options. Approximate minimum future lease payments required under operating leases for office leases as well as equipment leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1998, are as follows for the next five years: YEAR ENDING DECEMBER 31 1999............................................................ $3,281,000 2000............................................................ 2,583,000 2001............................................................ 1,343,000 2002............................................................ 699,000 2003............................................................ 660,000 Total rent expense for office leases, including real estate taxes and net of sublease income, amounted to approximately $2,165,000, $1,940,000 and $1,772,000 for the years ended December 31, 1998, 1997 and 1996, respectively. In 1998, the Board of Directors approved a loan to the President and CEO of the Company in the amount of $125,000 in connection with his relocation to Silicon Valley. This loan is evidenced by a promissory note, which bears interest at 5% per annum and is payable interest only for the first five years and four months; principal and interest thereafter until maturity on a twenty-year self-amortizing annual basis; and any unpaid principal and accrued interest is payable in full in August 2013. This note receivable is included in "Deposits and Other Assets" in the accompanying Consolidated Balance Sheet at December 31, 1998. Effective January 1, 1988, the Company established a deferred compensation plan (the "1988 Deferred Compensation Plan") for executive officers and key employees of the Company. The employees eligible to participate in the 1988 Deferred Compensation Plan (the "Participants") are chosen at the sole discretion of F-17 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ the Board of Directors upon a recommendation from the Board of Directors' Compensation Committee. Pursuant to the 1988 Deferred Compensation Plan, commencing on a Participant's retirement date, he or she will receive an annuity for ten years. The amount of the annuity shall be computed at 30% of the Participant's Salary, as defined. Any Participant with less than ten years of service to the Company as of his or her retirement date will only receive a pro rata portion of the annuity. Retirement benefits paid under the 1988 Deferred Compensation Plan will be distributed monthly. The Company paid benefits under this plan of approximately $15,600 during each of 1998, 1997 and 1996, none of which was paid to any executive officer. The maximum benefit payable to a Participant (including each of the executive officers) under the 1988 Deferred Compensation Plan is presently $30,000 per annum. At December 31, 1998, the cash surrender values of insurance policies owned by the Company under the 1988 Deferred Compensation Plan, which provide for the accrued deferred compensation benefits, aggregated approximately $133,000. During 1996, the Company established a second deferred compensation plan (the "Salary Continuation Plan") for executives of the Company. The executives eligible to participate in the Salary Continuation Plan are chosen at the sole discretion of the Board of Directors upon a recommendation from the Board of Directors' Compensation Committee. The Company may make contributions each year in its sole discretion and is under no obligation to make a contribution in any given year. For 1996, 1997, and 1998 the Company committed to contribute $63,000, $160,000, and $192,000 respectively, under this plan. Participants in the plan will vest in their plan benefits over a ten-year period. If the participant's employment is terminated due to death, disability or due to a change in control of management, they will vest 100% in all benefits under the plan. Retirement benefits will be paid, as selected by the participant, based on the sum of the net contributions made and the net investment activity. In connection with an employment agreement with an executive officer an unfunded postretirement benefit obligation of $1,171,000 is included in the Consolidated Balance Sheets at December 31, 1998 and 1997. The Company maintains a 401(k) plan (the "401(k) Plan"), which is intended to qualify under Section 401(k) of the Internal Revenue Code. All full-time employees of the Company over the age of 21 are eligible to participate in the 401(k) Plan after completing 90 days of employment. Each eligible employee may elect to contribute to the 401(k) Plan, through payroll deductions, up to 15% of his or her salary, limited to $10,000 in 1998. The Company makes matching contributions and in 1998 its contributions were in the amount of 25% on the first 6% contributed of each participating employee's salary. The Company expensed $521,000, $472,000 and $305,000 for such matching contributions for the years ended December 31, 1998, 1997 and 1996, respectively. NOTE 11 - SETTLEMENT OF LITIGATION In June 1996, the Company settled a civil action in connection with the Company's prior acquisition of certain computer equipment. In connection with the settlement agreement, the Company recognized an extraordinary after-tax gain of $272,000, net of related expenses, which is reflected in the Consolidated Statement of Operations for the year ended December 31, 1996. NOTE 12 - CONTINGENCIES From time to time the Company may be named as a defendant in suits for product defects, breach of warranty, breach of implied warranty of merchantability, patent infringement or other actions relating to products which it distributes which are manufactured by others. In those cases, the Company expects that the manufacturer of such products will indemnify the Company, as well as defend such actions on the Company's behalf although there is no guarantee that the manufacturers will do so. In addition, as a result of the acquisitions of the Added Value Companies, the Company offers a warranty with respect to its manufactured products for a period of one year against defects in workmanship and materials under normal use and service and in the original, unmodified condition. F-18 ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ================================================================================ NOTE 13 - ECONOMIC DEPENDENCY For each of the years ended December 31, 1998, 1997 and 1996, purchases from one supplier were in excess of 10% of the Company's total annual purchases and aggregated approximately $39,893,000, $43,435,000 and $35,579,000, respectively. The net outstanding accounts payable to this supplier at December 31, 1998, 1997 and 1996 amounted to approximately $5,832,000, $2,854,000 and $2,285,000, respectively. NOTE 14 - SUBSEQUENT EVENT On March 17, 1999, the Company was advised by the Nasdaq Listing Qualifications department of The Nasdaq Stock Market that the Company has failed to maintain a closing bid price for its common stock in excess of $1 per share as required under The Nasdaq Stock Market maintenance standards. Although no delisting action was initiated at this time, the Company was provided ninety (90) calendar days in which to regain compliance with this maintenance standard. Failure to meet this standard could result in delisting from The Nasdaq Stock Market. The Company is currently reviewing its options with respect to the Company's listing on The Nasdaq Stock Market. There can be no assurance that the Company's common stock will continue to remain eligible for listing on The Nasdaq Stock Market. See "Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters." F-19 EX-10.3 2 EXHIBIT 10.3 EXHIBIT 10.3 LEASE BY AND BETWEEN SAN JOSE TECHNOLOGY PROPERTIES, LLC, A DELAWARE LIMITED LIABILITY COMPANY, AS LANDLORD AND ALL AMERICAN SEMICONDUCTOR OF NORTHERN CALIFORNIA, INC. A CALIFORNIA CORPORATION AS TENANT AFFECTING PREMISES COMMONLY KNOWN AS 1851 ZANKER ROAD AND 230 DEVCON DRIVE, SAN JOSE, CA 1 TABLE OF CONTENTS PAGE ---- ARTICLE 1 - DEFINITIONS 7 ARTICLE 2 - DEMISE, CONSTRUCTION, AND ACCEPTANCE 9 ARTICLE 3 - RENT 10 ARTICLE 4 - USE OF PREMISES 12 ARTICLE 5 - TRADE FIXTURES AND ALTERATIONS 14 ARTICLE 6 - REPAIR AND MAINTENANCE 16 ARTICLE 7 - WASTE DISPOSAL AND UTILITIES 18 ARTICLE 8 - COMMON OPERATING EXPENSES 19 ARTICLE 9 - INSURANCE 21 ARTICLE 10 - LIMITATION ON LANDLORD'S LIABILITY AND INDEMNITY 23 ARTICLE 11 - DAMAGE TO PREMISES 24 ARTICLE 12 - CONDEMNATION 25 ARTICLE 13 - DEFAULT AND REMEDIES 26 ARTICLE 14 - ASSIGNMENT AND SUBLETTING 28 ARTICLE 15 - GENERAL PROVISIONS 32 EXHIBITS Exhibit A - Site plan of the Project containing a description of the Premises Exhibit B - Work Letter for Tenant Improvements (with Exhibit B-1, the Space Plan) Exhibit C - Acceptance Agreement Addendum No. 1 2 SUMMARY OF BASIC LEASE TERMS SECTION TERMS (LEASE REFERENCE) A. LEASE REFERENCE DATE: October 1, 1998 (Introduction) B. LANDLORD: SAN JOSE TECHNOLOGY PROPERTIES, (Introduction) LLC a Delaware limited liability company C. TENANT: ALL AMERICAN SEMICONDUCTOR OF (Introduction) NORTHERN CALIFORNIA, INC. a California corporation D. PREMISES: That area consisting of (a) (ss.1.21) approximately 9,400 square feet of gross leasable area, the address of which is 1851 Zanker Road, San Jose, CA (the "Zanker Road Space"), and (b) approximately 10,791 square feet of gross leasable area, the address of which is 230 Devcon Drive, San Jose, CA (the "Devcon Drive Space"). The Zanker Road Space and the Devcon Drive Space are both located within the Building as shown on EXHIBIT A. E. PROJECT: The land and improvements shown (ss.1.22) on EXHIBIT A consisting of the Building and three other commercial buildings the aggregate gross leasable area of which is 163,073 square feet. F. BUILDING: The building in which the (ss.1.7) Premises are located, as outlined in Exhibit A attached hereto, which building contains approximately 45,123 square feet of gross leasable area. G. TENANT'S SHARE: Prior to the Commencement Date (ss.1.29) for the Devcon Drive Space, Tenant's Share shall be 20.83% of the Building (i.e., 9,400/45,123) and 5.76 of the Project (i.e., 9,400/163,073). From and after the Commencement Date for the Devcon Drive Space, Tenant's Share shall be 44.75% of the Building (i.e., 20,191/45,123) and 12.38% of the Project (i.e.,20,191/163,073). H. TENANT'S ALLOCATED (ss.4.5) PARKING STALLS: A total of eighty-one (81) parking stalls for all of the Premises (i.e., the Zanker Road Space and the Devcon Drive Space). Prior to the Commencement Date for the Devcon Drive Space, Tenant shall be allocated 38 parking stalls for the Zanker Road Space and upon the Commencement Date for the Devcon Drive Space, an additional 43 parking stalls. Based approximately on a ratio of four stalls per 1,000 square feet of space. 3 I. SCHEDULED COMMENCEMENT February 1, 1999 for the Zanker (ss.1.26) DATE: Road Space, and March 1, 1999 for the Devcon Drive Space. Tenant has been leasing the Devcon Drive Space pursuant to the terms of the certain Industrial Real Estate Lease dated November 11, 1993, initially by and between the State Teachers' Retirement System and Tenant (the "Existing Devcon Space Lease"). Landlord has succeeded to the interests of the Landlord under the Existing Devcon Space Lease. Effective as of March 1, 1999, Tenant will be leasing the Devcon Drive Space pursuant to the terms of this Lease and the Existing Devcon Space Lease shall be terminated automatically. J. LEASE TERM: For the Zanker Road Space, (ss.1.18) commencing on the earlier of (a) "Substantial Completion" of the "Tenant Improvements" (as such terms are defined in Exhibit B attached hereto), or (b) the date that Tenant takes possession of the Zanker Road Space and expiring on February 28, 2004; and for the Devcon Drive Space, commencing on March 1, 1999, with the Lease Term expiring for all of the Premises (i.e., the Zanker Road Space and Devcon Drive Space) on February 28, 2004. If the Commencement Date is other than the first day of the calendar month and such date is prior to March 1, 1999, the first calendar month shall include such partial month in which such Commencement Date occurs plus the next full calendar month and Base Monthly Rent for such first month shall include the full monthly rent for the first full calendar month plus monthly rent for the partial month in which the Commencement Date occurs prorated on a daily basis at the monthly rent provided for the first calendar month. SEE ADDENDUM NO. 1 FOR TENANT'S OPTION TO EXTEND. 4
K. Base Monthly Rent: (ss.3.1) ------------------ Monthly Amount Monthly Amount Months Zanker Road Space Devcon Drive Space ------ ----------------- ------------------ 1st month - 2/28/99 $14,570.00 Governed by Existing Devcon Space Lease 3/1/99 - 2/28/00 $14,570.00 $16,726.05 3/1/00 - 2/28/01 $15,298.50 $17,562.35 3/1/01 - 2/28/02 $16,063.43 $18,440.47 3/1/02 - 2/28/03 $16,866.60 $19,362.49 3/1/03 - 2/28/04 $17,709.93 $20,330.62
L. PREPAID RENT: $14,570.00, plus Tenant's Share of (ss.3.3) Common Operating Expenses for the Zanker Road Space. M. SECURITY DEPOSIT: The sum of $38,071.78, of which (ss.3.5) $6,700.00 is currently held by Landlord as the security deposit under the Existing Devcon Space Lease and will be applied to the security deposit required under this Lease immediately following the expiration of the term of the Existing Devcon Space Lease. N. PERMITTED USE: administrative offices, (ss.4.1) engineering and sales offices, light manufacturing and warehouse for electronic components for the semiconductor industry and uses incidental thereto. O. PERMITTED TENANT'S ALTERATIONS LIMIT: $5,000.00, which (ss.5.2) is applicable separately for each alteration project. As provided in Exhibit B attached hereto, the Construction Plans may also reflect work that may be done in approximately 6,000 square feet of space in the front of the Zanker Road Space ("Future Alteration Work") , which is the area that Tenant may sublet as hereinafter provided. Landlord's approval of the Construction Plans in accordance with Exhibit B shall constitute approval for the construction of the Future Alteration Work to the extent such work is shown in the Construction Plans even though such work will not be done by the Landlord in connection with the construction of the Tenant Improvements. P. TENANT'S LIABILITY (ss.9.1) INSURANCE MINIMUM: $3,000,000.00 Q. LANDLORD'S ADDRESS: c/o Divco West Group, LLC (ss.1.3) 100 Park Center Plaza, Ste. 425 San Jose, California 95113 Attn: Property Manager With a copy to: Divco West Group, LLC 150 Almaden Boulevard, Ste. 700 San Jose, CA 95113 Attn.: Asset Manager 5 R. TENANT'S ADDRESS: All American Semiconductor of (ss. 1.3) Northern California, Inc. 230 Devcon Drive San Jose,CA 95112 Attn.: Bruce Goldberg With a copy to: All American Semiconductor,Inc. 16115 N.W. 52nd Avenue Miami, Florida 33014 Attention: Howard Flanders S. RETAINED REAL ESTATE BROKERS: Craig Fordyce and (ss.15.13) Michael Rosendin, of Colliers Parrish International, Inc., representing the Landlord, and Tom Taylor and Christian Marent of Bishop Hawk, Inc., representing the Tenant. T. LEASE: This Lease includes the summary of the (ss.1.17) Basic Lease Terms, the Lease, and the following exhibits and addenda: EXHIBIT A - Project Site Plan and Outline of the Premises EXHIBIT B - Work Letter for Tenant Improvements (with Exhibit B-1, the Space Plan) EXHIBIT C - Acceptance Agreement ADDENDUM NO. 1 The foregoing Summary is hereby incorporated into and made a part of this Lease. Each reference in this Lease to any term of the Summary shall mean the respective information set forth above and shall be construed to incorporate all of the terms provided under the particular paragraph pertaining to such information. In the event of any conflict between the Summary and the Lease, the Summary shall control. LANDLORD: TENANT: SAN JOSE TECHNOLOGY PROPERTIES, LLC, By: ALL AMERICAN SEMICONDUCTOR a Delaware limited liability company OF NORTHERN CALIFORNIA, INC. a California corporation By: Divco West Group, LLC, a Delaware limited liability company By: /s/ BRUCE M. GOLDBERG Its Manager --------------------------- Name: Bruce M. Goldberg Title: Pres. & CEO By: /s/ SCOTT SMITHERS ------------------------ Name: Scott Smithers Its: President 6 LEASE This Lease is dated as of the lease reference date specified in SECTION A of the Summary and is made by and between the party identified as Landlord in SECTION B of the Summary and the party identified as Tenant in SECTION C of the Summary. ARTICLE 1 DEFINITIONS 1.1 GENERAL: Any initially capitalized term that is given a special meaning by this Article 1, the Summary, or by any other provision of this Lease (including the exhibits attached hereto) shall have such meaning when used in this Lease or any addendum or amendment hereto unless otherwise clearly indicated by the context. 1.2 ADDITIONAL RENT: The term "Additional Rent" is defined in P. 3.2. 1.3 ADDRESS FOR NOTICES: The term "Address for Notices" shall mean the addresses set forth in SECTIONS Q AND R of the Summary; provided, however, that after the Commencement Date, Tenant's Address for Notices shall be the address of the Premises. 1.4 AGENTS: The term "Agents" shall mean the following: (i) with respect to Landlord or Tenant, the agents, employees, and contractors of such party; and (ii) in addition with respect to Tenant, Tenant's subtenants and their respective agents, employees and contractors. 1.5 AGREED INTEREST RATE: The term "Agreed Interest Rate" shall mean that interest rate determined as of the time it is to be applied that is equal to the lesser of (i) 5% in excess of the discount rate established by the Federal Reserve Bank of San Francisco as it may be adjusted from time to time, or (ii) the maximum interest rate permitted by Law. 1.6 BASE MONTHLY RENT: The term "Base Monthly Rent" shall mean the fixed monthly rent payable by Tenant pursuant to P. 3.1 which is specified in SECTION K of the Summary. 1.7 BUILDING: The term "Building" shall mean the building in which the Premises are located which Building is identified in SECTION F of the Summary, the gross leasable area of which is referred to herein as the "Building Gross Leasable Area." 1.8 COMMENCEMENT DATE: The term "Commencement Date" is the date the Lease Term commences, which term is defined in P. 2.2. 1.9 COMMON AREA: The term "Common Area" shall mean all areas and facilities within the Project that are not designated by Landlord for the exclusive use of Tenant or any other lessee or other occupant of the Project, including the parking areas, access and perimeter roads, pedestrian sidewalks, landscaped areas, trash enclosures, recreation areas and the like. 1.10 COMMON OPERATING EXPENSES: The term "Common Operating Expenses" is defined in P. 8.2. 7 1.11 EFFECTIVE DATE: The term "Effective Date" shall mean the date the last signatory to this Lease whose execution is required to make it binding on the parties hereto shall have executed this Lease. 1.12 EVENT OF TENANT'S DEFAULT: The term "Event of Tenant's Default" is defined in P. 13.1. 1.13 HAZARDOUS MATERIALS: The terms "Hazardous Materials" and "Hazardous Materials Laws" are defined in P. 7.2E. 1.14 INSURED AND UNINSURED PERIL: The terms "Insured Peril" and "Uninsured Peril" are defined in P. 11.2E. 1.15 LAW: The term "Law" shall mean any judicial decision, statute, constitution, ordinance, resolution, regulation, rule, administrative order, or other requirement of any municipal, county, state, federal or other government agency or authority having jurisdiction over the parties to this Lease or the Premises, or both, in effect either at the Effective Date or any time during the Lease Term, including, without limitation, any Hazardous Material Law (as defined in P. 7.2E) and the Americans with Disabilities Act, 42 U.S.C. ss.ss. 12101 et. SEQ. and any rules, regulations, restrictions, guidelines, requirements or publications promulgated or published pursuant thereto. 1.16 LEASE: The term "Lease" shall mean the Summary and all elements of this Lease identified in SECTION T of the Summary, all of which are attached hereto and incorporated herein by this reference. 1.17 LEASE TERM: The term "Lease Term" shall mean the term of this Lease which shall commence on the Commencement Date and continue for the period specified in SECTION J of the Summary. 1.18 LENDER: The term "Lender" shall mean any beneficiary, mortgagee, secured party, lessor, or other holder of any Security Instrument. 1.19 PERMITTED USE: The term "Permitted Use" shall mean the use specified in SECTION N of the Summary. 1.20 PREMISES: The term "Premises" shall mean that building area described in SECTION D of the Summary that is within the Building. Prior to the Commencement Date for the Devcon Drive Space, the term "Premises" shall mean the Zanker Road Space and from and after the Commencement Date for the Devcon Drive Space, the term "Premises" shall mean the Zanker Road Space and the Devcon Drive Space. 1.21 PROJECT: The term "Project" shall mean that real property and the improvements thereon which are specified in SECTION E of the Summary, the aggregate gross leasable area of which is referred to herein as the "Project Gross Leasable Area." 1.22 PRIVATE RESTRICTIONS: The term "Private Restrictions" shall mean all recorded covenants, conditions and restrictions, private agreements, reciprocal easement agreements, and any other recorded instruments affecting the use of the Premises which (i) exist as of the Effective Date, or (ii) are recorded after the Effective Date and are approved by Tenant. 1.23 REAL PROPERTY TAXES: The term "Real Property Taxes" is defined in P. 8.3. 8 1.24 SCHEDULED COMMENCEMENT DATE: The term "Scheduled Commencement Date" shall mean the date specified in SECTION I of the Summary. 1.25 SECURITY INSTRUMENT: The term "Security Instrument" shall mean any underlying lease, mortgage or deed of trust which now or hereafter affects the Project, and any renewal, modification, consolidation, replacement or extension thereof. 1.26 SUMMARY: The term "Summary" shall mean the Summary of Basic Lease Terms executed by Landlord and Tenant that is part of this Lease. 1.27 TENANT'S ALTERATIONS: The term "Tenant's Alterations" shall mean all improvements, additions, alterations, and fixtures installed in the Premises by Tenant at its expense which are not Trade Fixtures. 1.28 TENANT'S SHARE: The term "Tenant's Share" shall mean the percentage obtained by dividing Tenant's Gross Leasable Area by the Building Gross Leasable Area for Tenant's Share of the Building and by the Project Gross Leasable Area for Tenant's Share of the Project, which as of the Effective Date is the percentage identified in SECTION G of the Summary. 1.29 TRADE FIXTURES: The term "Trade Fixtures" shall mean (i) Tenant's inventory, furniture, signs, and business equipment, and (ii) anything affixed to the Premises by Tenant at its expense for purposes of trade, manufacture, ornament or domestic use (except replacement of similar work or material originally installed by Landlord) which can be removed without material injury to the Premises unless such thing has, by the manner in which it is affixed, become an integral part of the Premises. ARTICLE 2 DEMISE, CONSTRUCTION, AND ACCEPTANCE 2.1 DEMISE OF PREMISES: Landlord hereby leases to Tenant, and Tenant leases from Landlord, for the Lease Term upon the terms and conditions of this Lease, the Premises for Tenant's own use in the conduct of Tenant's business together with (i) the non-exclusive right to use the number of Tenant's Allocated Parking Stalls within the Common Area (subject to the limitations set forth in P. 4.5), and (ii) the non-exclusive right to use the Common Area for ingress to and egress from the Premises. Landlord reserves the use of the exterior walls, the roof and the area beneath and above the Premises, together with the right to install, maintain, use, and replace ducts, wires, conduits and pipes leading through the Premises in locations which will not materially interfere with Tenant's use of the Premises. 2.2 COMMENCEMENT DATE: The Scheduled Commencement Date for the Zanker Road Space is only an estimate of the actual Commencement Date for such space, and the term of this Lease for the Zanker Road Space shall begin on the earlier of: (a) "Substantial Completion" of the "Tenant Improvements" (as such terms are defined in Exhibit B attached hereto), or (b) the date that Tenant takes possession of the Zanker Road Space (herein referred to as the "Commencement Date" as it pertains to the Zanker Road Space. As of the date of this Lease, Tenant is currently leasing the Devcon Drive Space pursuant to the Existing Devcon Space Lease which is scheduled to expire on February 28, 1998. Immediately following the expiration of the Existing Devcon Space Lease, Tenant shall lease the Devcon Space pursuant to this Lease and the "Commencement Date" for the Devcon Drive Space shall be the date set forth as the Scheduled Commencement Date for such space notwithstanding that the Tenant Improvements for such space may not be completed by such date. 2.3 CONSTRUCTION OF IMPROVEMENTS: Landlord shall construct the Tenant Improvements in the Premises in accordance with, the terms of EXHIBIT B. 2.4 DELIVERY AND ACCEPTANCE OF POSSESSION: If Landlord is unable to deliver possession of the Zanker Road Space to Tenant with the Tenant Improvements for such space Substantially Completed as provided in Exhibit B on or before the Scheduled Commencement Date for such space, this Lease shall not be void or voidable, and Landlord shall not be liable to Tenant for any loss or damage resulting therefrom. However, if the Commencement Date is delayed due to any Tenant Delay (as defined in Exhibit B attached hereto), then the Commencement Date shall be deemed the date the Tenant Improvements would have been completed but for the Tenant Delays and Tenant shall be obligated to commencement paying Base Monthly Rent, Additional Rent and all other charges notwithstanding that it may not be able to occupy or use the Premises at the time. 9 If the Tenant Improvements have not been Substantially Completed (as defined in Exhibit B attached hereto) within the later of sixty (60) days after (a) the approval of the Construction Plans by Landlord, Tenant and the local governmental authority and the issuance to Landlord of all building permits by the local governmental authority, or (b) the date provided in the construction contract between Landlord and its general contractor to Substantially Complete the Tenant Improvements, subject to in any event Tenant Delays and Force Majeure Delays (as defined in Exhibit B attached hereto), then Tenant shall have the right as its sole and exclusive remedy to terminate this Lease upon written notice to Landlord within the earlier of (i) ten days after receipt of notice from Landlord of the delay or (b) ten days after the end of said sixty (60) day period but prior to Substantial Completion of the Tenant Improvements. Tenant acknowledges that it has been leasing the Devcon Drive Space and is thoroughly familiar with such space, the Common Areas and the Project. Tenant also acknowledges that it has had an opportunity to conduct, and has conducted, such inspections of the Zanker Road Space as it deems necessary to evaluate its condition. Tenant agrees to accept possession of the Premises in, "as-is", including all patent and latent defects, subject to completion of the Tenant Improvements. Tenant's taking possession of any part of the Premises shall be deemed to be an acceptance by Tenant of any work of improvement done by Landlord in such part as complete and in accordance with the terms of this Lease except for defects of which Tenant has given Landlord written notice prior to the time Tenant takes possession. After Substantial Completion of the separate Tenant Improvements for the Zanker Road Space and Devcon Drive Space, Tenant, at the request of Landlord, shall execute an acceptance agreement in the form attached as EXHIBIT C, appropriately completed. 2.5 EARLY OCCUPANCY: If Tenant enters or permits its contractors to enter the Zanker Road Space prior to the Commencement Date with the written permission of Landlord, it shall do so upon all of the terms of this Lease (including its obligations regarding indemnity and insurance) except those regarding the obligation to pay rent, which shall commence on the Commencement Date. ARTICLE 3 RENT 3.1 BASE MONTHLY RENT: Commencing on the Commencement Date and continuing throughout the Lease Term, Tenant shall pay to Landlord the Base Monthly Rent set forth in SECTION K of the Summary. 3.2 ADDITIONAL RENT: Commencing on the Commencement Date and continuing throughout the Lease Term, Tenant shall pay the following as additional rent (the "Additional Rent"): (i) any late charges or interest due Landlord pursuant to P. 3.4; (ii) Tenant's Share of Common Operating Expenses as provided in P. 8.1; (iii) Landlord's share of any Subrent received by Tenant upon certain assignments and sublettings as required by P. 14.1; (iv) any legal fees and costs due Landlord pursuant to P. 15.9; and (v) any other charges due Landlord pursuant to this Lease. 3.3 PAYMENT OF RENT: Concurrently with the execution of this Lease by Tenant, Tenant shall pay to Landlord the amount set forth in SECTION L of the Summary as prepayment of rent for credit against the first installment(s) of Base Monthly Rent. All rent required to be paid in monthly installments shall be paid in advance on the first day of each calendar month during the Lease Term. If SECTION K of the Summary provides that the Base Monthly Rent is to be increased during the Lease Term and if the date of such increase does not fall on the first day of a calendar month, such increase shall become effective on the first day of the next calendar month. All rent shall be paid in lawful money of the United States, without any abatement, deduction or offset whatsoever (except as specifically provided in P. 11.4 and P. 12.3), and without any prior demand therefor. Rent shall be paid to Landlord at its address set forth in SECTION Q of the Summary, or at such other place as Landlord may designate from time to time. Tenant's obligation to pay Base Monthly Rent and Tenant's Share of Common Operating Expenses shall be prorated at the commencement and expiration of the Lease Term. 10 3.4 LATE CHARGE, INTEREST AND QUARTERLY PAYMENTS: (a) LATE CHARGE. Tenant acknowledges that the late payment by Tenant of any installment of rent, or any other sum of money required to be paid by Tenant under this Lease, will cause Landlord to incur certain costs and expenses not contemplated under this Lease, the exact amount of such costs being extremely difficult and impractical to fix. Such costs and expenses will include, without limitation, attorneys' fees, administrative and collection costs, and processing and accounting expenses and other costs and expenses necessary and incidental thereto. If any Base Monthly Rent or Additional Rent is not received by Landlord from Tenant within three (3) business days after receipt of written notice, then Tenant shall immediately pay to Landlord a late charge equal to 5% of such delinquent rent as liquidated damages for Tenant's failure to make timely payment, provided, however, that if Landlord has provided two notices of a late payment or default during any calendar year, Landlord shall not be obligated to provide any notice during the remainder of the calendar year in order for Tenant to be obligated to pay such late charge. In no event shall this provision for a late charge be deemed to grant to Tenant a grace period or extension of time within which to pay any rent or prevent Landlord from exercising any right or remedy available to Landlord upon Tenant's failure to pay any rent due under this Lease in a timely fashion, including any right to terminate this Lease pursuant to this Lease. (b) INTEREST. If any rent remains delinquent for a period in excess of five (5) business days then, in addition to such late charge, Tenant shall pay to Landlord interest on any rent that is not paid when due at the Agreed Interest Rate following the date such amount became due until paid. (c) QUARTERLY PAYMENTS. If Tenant during any calendar year shall be more than five (5) business days after receipt of written notice delinquent in the payment of any rent or other amount payable by Tenant hereunder on three (3) or more occasions, then, notwithstanding anything herein to the contrary, Landlord may, by written notice to Tenant, elect to require Tenant to pay all Base Monthly Rent and Additional Rent quarterly in advance. Such right shall be in addition to and not in lieu of any other right or remedy available to Landlord hereunder or at law on account of Tenant's default hereunder 3.5 SECURITY DEPOSIT: On the Effective Date, Tenant shall deposit with Landlord the amount set forth in SECTION M of the Summary as security for the performance by Tenant of its obligations under this Lease, and not as prepayment of rent (the "Security Deposit"). Landlord may from time to time apply such portion of the Security Deposit as is reasonably necessary for the following purposes: (i) to remedy any default by Tenant in the payment of rent; (ii) to repair damage to the Premises caused by Tenant; (iii) to clean the Premises upon termination of the Lease only if Tenant fails to clean the Premises to the extent required by this Lease; and (iv) to remedy any other default of Tenant to the extent permitted by Law and, in this regard, Tenant hereby waives any restriction on the uses to which the Security Deposit may be put contained in California Civil Code Section 1950.7. In the event the Security Deposit or any portion thereof is so used, Tenant agrees to pay to Landlord promptly upon demand an amount in cash sufficient to restore the Security Deposit to the full original amount. Landlord shall not be deemed a trustee of the Security Deposit, may use the Security Deposit in business, and shall not be required to segregate it from its general accounts. Tenant shall not be entitled to any interest on the Security Deposit. If Landlord transfers the Premises during the Lease Term, Landlord may pay the Security Deposit to any transferee of Landlord's interest in conformity with the provisions of California Civil Code Section 1950.7 and/or any successor statute, in which event the transferring Landlord will be released from all liability for the return of the Security Deposit. 11 ARTICLE 4 USE OF PREMISES 4.1 LIMITATION ON USE: Tenant shall use the Premises solely for the Permitted Use specified in SECTION N of the Summary. Any change in use shall be subject to the prior written consent of Landlord, which will not be unreasonably withheld. Tenant shall not do anything in or about the Premises which will (i) cause structural injury to the Building, or (ii) cause damage to any part of the Building except to the extent reasonably necessary for the installation of Tenant's Trade Fixtures and Tenant's Alterations, and then only in a manner which has been first approved by Landlord in writing. Tenant shall not operate any equipment within the Premises which will (i) materially damage the Building or the Common Area, (ii) overload existing electrical systems or other mechanical equipment servicing the Building, (iii) impair the efficient operation of the sprinkler system or the heating, ventilating or air conditioning ("HVAC") equipment within or servicing the Building, or (iv) damage, overload or corrode the sanitary sewer system. Tenant shall not attach, hang or suspend anything from the ceiling, roof, walls or columns of the Building or set any load on the floor in excess of the load limits for which such items are designed nor operate hard wheel forklifts within the Premises. Any dust, fumes, or waste products generated by Tenant's use of the Premises shall be contained and disposed so that they do not (i) create an unreasonable fire or health hazard, (ii) damage the Premises, or (iii) result in the violation of any Law. Except as approved by Landlord, Tenant shall not change the exterior of the Building or install any equipment or antennas on or make any penetrations of the exterior or roof of the Building. Tenant shall not commit any waste in or about the Premises, and Tenant shall keep the Premises in a neat, clean, attractive and orderly condition, free of any nuisances. If Landlord designates a standard window covering for use throughout the Building, Tenant shall use this standard window covering to cover all windows in the Premises. Tenant shall not conduct on any portion of the Premises or the Project any sale of any kind, including any public or private auction, fire sale, going-out-of-business sale, distress sale or other liquidation sale. 4.2 COMPLIANCE WITH REGULATIONS: Tenant shall not use the Premises in any manner which violates any Laws or Private Restrictions which affect the Premises. Tenant shall abide by and promptly observe and comply with all Laws and Private Restrictions. Tenant shall not use the Premises in any manner which will cause a cancellation of any insurance policy covering Tenant's Alternations or any improvements installed by Landlord at its expense or which poses an unreasonable risk of damage or injury to the Premises. Tenant shall not sell, or permit to be kept, used, or sold in or about the Premises any article which may be prohibited by the standard form of fire insurance policy. Tenant shall comply with all reasonable requirements of any insurance company, insurance underwriter, or Board of Fire Underwriters which are necessary to maintain the insurance coverage carried by either Landlord or Tenant pursuant to this Lease. 4.3 OUTSIDE AREAS: No materials, supplies, tanks or containers, equipment, finished products or semi-finished products, raw materials, inoperable vehicles or articles of any nature shall be stored upon or permitted to remain outside of the Premises except in fully fenced and screened areas outside the Building which have been designed for such purpose and have been approved in writing by Landlord for such use by Tenant. 4.4 SIGNS: Tenant shall not place on any portion of the Premises any sign, placard, lettering in or on windows, banner, displays or other advertising or communicative material which is visible from the exterior of the Building without the prior written approval of Landlord. All such approved signs shall strictly conform to all Laws, Private Restrictions, and Landlord's sign criteria then in effect, and shall be installed at the expense of Tenant. Tenant shall maintain such signs in good condition and repair. 12 As of the date hereof, there exists a monument sign by Devcon Drive with Tenant's name located thereon. In lieu of using such existing monument sign, Tenant shall have the right to have installed as part of the Tenant Improvements a new monument sign by the corner of Devcon Drive and Zanker Road, subject to the reasonable approval of Landlord and compliance by Tenant at its expense with Landlord's signage criteria and all governmental ordinances and requirements. Tenant acknowledges and agrees that it may only use one monument sign and may not have rights to use the foregoing new monument sign and the existing monument sign. As part of the Tenant Improvements, Tenant may also have a sign installed on the Building by its Premises which is consistent with the identification signs in the Project and subject to the reasonable approval of Landlord and compliance by Tenant at its expense with Landlord's signage criteria and all governmental ordinances and requirements. At its expense, Tenant shall be responsible for removing such signs and repairing any damage by the expiration or earlier termination of this Lease. 4.5 PARKING: Tenant is allocated and shall have the non-exclusive right to use free of charge not more than the number of Tenant's Allocated Parking Stalls contained within the Project described in SECTION H of the Summary for its use and the use of Tenant's Agents, the location of which may be designated from time to time by Landlord. Tenant shall not at any time use more parking spaces than the number so allocated to Tenant or park its vehicles or the vehicles of others in any portion of the Project not designated by Landlord as a non-exclusive parking area. Tenant shall not have the exclusive right to use any specific parking space. If Landlord grants to any other tenant the exclusive right to use any particular parking space(s), Tenant shall not use such spaces. Landlord reserves the right, after having given Tenant reasonable notice, to have any vehicles owned by Tenant or Tenant's Agents utilizing parking spaces in excess of the parking spaces allowed for Tenant's use to be towed away at Tenant's cost. All trucks and delivery vehicles shall be (i) parked at the rear of the Building, (ii) loaded and unloaded in a manner which does not interfere with the businesses of other occupants of the Project, and (iii) permitted to remain on the Project only so long as is reasonably necessary to complete loading and unloading. In the event Landlord elects or is required by any Law to limit or control parking in the Project, whether by validation of parking tickets or any other method of assessment, Tenant agrees to participate in such validation or assessment program under such reasonable rules and regulations as are from time to time established by Landlord. So long as Tenant is in occupancy at the Leased Premises (other than for any subleases entered into in the space described in section 14.1G), Landlord agrees not to grant another tenant in the Project an exclusive right to parking in the portion of the areas that are in front of the Building facing Zanker Road and Devcon Drive as outlined in EXHIBIT A attached hereto, nor shall Landlord require Tenant to park in any specific areas in the Project. 4.6 RULES AND REGULATIONS: Landlord may from time to time promulgate reasonable and nondiscriminatory rules and regulations applicable to all occupants of the Project for the care and orderly management of the Project and the safety of its tenants and invitees. Such rules and regulations shall be binding upon Tenant upon delivery of a copy thereof to Tenant, and Tenant agrees to abide by such rules and regulations. If there is a conflict between the rules and regulations and any of the provisions of this Lease, the provisions of this Lease shall prevail. Landlord shall not be responsible for the violation by any other tenant of the Project of any such rules and regulations. 13 ARTICLE 5 TRADE FIXTURES AND ALTERATIONS 5.1 TRADE FIXTURES: Throughout the Lease Term, Tenant may provide and install, and shall maintain in good condition, any Trade Fixtures required in the conduct of its business in the Premises. All Trade Fixtures shall remain Tenant's property. 5.2 TENANT'S ALTERATIONS: Construction by Tenant of Tenant's Alterations shall be governed by the following: A. Tenant shall not construct any of Tenant's Alterations or otherwise alter the Premises without Landlord's prior written approval. Landlord approves of the Future Alteration Work to the extent the Construction Plans approved by Landlord in accordance with Exhibit B attached hereto include the Future Alteration Work. Tenant shall be entitled, without Landlord's prior approval, to make Tenant's Alterations (i) which do not affect the structural or exterior parts or water tight character of the Building, and (ii) the reasonably estimated cost of which, plus the original cost of any part of the Premises removed or materially altered in connection with such Tenant's Alterations, together do not exceed the Permitted Tenant Alterations Limit specified in SECTION O of the Summary for each work of improvement. In the event Landlord's approval for any Tenant's Alterations is required, Tenant shall not construct the Leasehold Improvement until Landlord has approved in writing the plans and specifications therefor, and such Tenant's Alterations shall be constructed substantially in compliance with such approved plans and specifications by a licensed contractor first approved by Landlord. All Tenant's Alterations constructed by Tenant shall be constructed by a licensed contractor approved by Landlord and otherwise in accordance with all Laws using new materials of good quality. B. Tenant shall not commence construction of any Tenant's Alterations until (i) all required governmental approvals and permits have been obtained, (ii) all requirements regarding insurance imposed by this Lease have been satisfied, (iii) Tenant has given Landlord at least five days' prior written notice of its intention to commence such construction, and (iv) if reasonably requested by Landlord, Tenant has obtained contingent liability and broad form builders' risk insurance in an amount reasonably satisfactory to Landlord if there are any perils relating to the proposed construction not covered by insurance carried pursuant to Article 9. C. All Tenant's Alterations shall remain the property of Tenant during the Lease Term but shall not be altered or removed from the Premises. At the expiration or sooner termination of the Lease Term, all Tenant's Alterations shall be surrendered to Landlord as part of the realty and shall then become Landlord's property, and Landlord shall have no obligation to reimburse Tenant for all or any portion of the value or cost thereof; provided, however, that if Landlord requires Tenant to remove any Tenant's Alterations, Tenant shall so remove such Tenant's Alterations prior to the expiration or sooner termination of the Lease Term. Notwithstanding the foregoing, Tenant shall not be obligated to remove any Tenant's Alterations with respect to which the following is true: (i) Tenant was required, or elected, to obtain the approval of Landlord to the installation of the Leasehold Improvement in question; (ii) at the time Tenant requested Landlord's approval, Tenant requested of Landlord in writing that Landlord inform Tenant of whether or not Landlord would require Tenant to remove such Leasehold Improvement at the expiration of the Lease Term; and (iii) at the time Landlord granted its approval, it did not inform Tenant that it would require Tenant to remove such Leasehold Improvement at the expiration of the Lease Term. 14 5.3 ALTERATIONS REQUIRED BY LAW: Tenant shall make any alteration, addition or change of any sort to the Premises that is required by any Law because of (i) Tenant's particular use or change of use of the Premises; (ii) Tenant's application for any permit or governmental approval, excluding, however, any application for a permit for construction of the Tenant Improvements pursuant to EXHIBIT B attached hereto, including without limitation any Future Alteration Work, which additional work shall be considered part of the Tenant Improvements and the cost included as part of the Constructions Costs under EXHIBIT B attached hereto; or (iii) Tenant's construction or installation of any Tenant's Alterations or Trade Fixtures. Any other alteration, addition, or change required by Law which is not the responsibility of Tenant pursuant to the foregoing shall be made by Landlord (subject to Landlord's right to reimbursement from Tenant specified in P. 5.4). As provided in Exhibit B attached hereto, the Tenant Improvements to be constructed by Landlord's contractor shall be completed in a manner to comply with all Laws as the same exist and apply as of the date hereof. 5.4 AMORTIZATION OF CERTAIN CAPITAL IMPROVEMENTS: Tenant shall pay its proportionate share, as Additional Rent, of the following amortized costs as provided in paragraph A below, in the event Landlord reasonably elects or is required to make any of the following kinds of capital improvements to the Project: (i) capital improvements required to be constructed in order to comply with any Law (excluding any Hazardous Materials Law) not in effect or applicable to the Project as of the Effective Date; (ii) modification of existing or construction of additional capital improvements or building service equipment for the purpose of reducing the consumption of utility services or Common Operating Expenses of the Project; and (iii) replacement of capital improvements or building service equipment existing as of the Effective Date when required because of normal wear and tear. The amount of Additional Rent Tenant is to pay with respect to each such capital improvement shall be determined as follows: A. All costs paid by Landlord to construct such improvements (including financing costs) shall be amortized over the useful life of such improvement (as reasonably determined by Landlord in accordance with generally accepted accounting principles) with interest on the unamortized balance at the then prevailing market rate Landlord would pay if it borrowed funds to construct such improvements from an institutional lender, and Landlord shall inform Tenant of the monthly amortization payment required to so amortize such costs, and shall also provide Tenant with the information upon which such determination is made. B. As Additional Rent, Tenant shall pay at the same time the Base Monthly Rent is due an amount equal to Tenant's Share of that portion of such monthly amortization payment fairly allocable to the Building (as reasonably determined by Landlord) for each month after such improvements are completed until the first to occur of (i) the expiration of the Lease Term (as it may be extended), or (ii) the end of the term over which such costs were amortized. 5.5 MECHANIC'S LIENS: Tenant shall keep the Project free from any liens and shall pay when due all bills arising out of any work performed, materials furnished, or obligations incurred by Tenant or Tenant's Agents relating to the Project. If any claim of lien is recorded (except those caused by Landlord or Landlord's Agents), Tenant shall bond against or discharge the same within 10 days after Tenant's receipt of actual notice that the same has been recorded against the Project. Should any lien be filed against the Project or any action be commenced affecting title to the Project, the party receiving notice of such lien or action shall immediately give the other party written notice thereof. 5.6 TAXES ON TENANT'S PROPERTY: Tenant shall pay before delinquency any and all taxes, assessments, license fees and public charges levied, assessed or imposed against Tenant or Tenant's estate in this Lease or the property of Tenant situated within the Premises which become due during the Lease Term. If any tax or other charge is assessed by any governmental agency because of the execution of this Lease, such tax shall be paid by Tenant. On demand by Landlord, Tenant shall furnish Landlord with satisfactory evidence of these payments. 15 ARTICLE 6 REPAIR AND MAINTENANCE 6.1 TENANT'S OBLIGATION TO MAINTAIN: Except as otherwise provided in P. 6.2, P. 11.1, and P. 12.3, Tenant shall be responsible for the following during the Lease Term: A. Tenant shall clean and maintain in good order, condition, and repair and replace when necessary the Premises and every part thereof, through regular inspections and servicing, including, but not limited to: (i) all plumbing and sewage facilities (including all sinks, toilets, faucets and drains), and all ducts, pipes, vents or other parts of the HVAC or plumbing system; (ii) all fixtures, interior walls, floors, carpets and ceilings; (iii) all windows, doors, entrances, plate glass, showcases and skylights (including cleaning both interior and exterior surfaces); (iv) all electrical facilities and all equipment (including all lighting fixtures, lamps, bulbs, tubes, fans, vents, exhaust equipment and systems); and (v) any automatic fire extinguisher equipment in the Premises. B. With respect to utility facilities serving the Premises (including electrical wiring and conduits, gas lines, water pipes, and plumbing and sewage fixtures and pipes), Tenant shall be responsible for the maintenance and repair of any such facilities which serve only the Premises, including all such facilities that are within the walls or floor, or on the roof of the Premises, and any part of such facility that is not within the Premises, but only up to the point where such facilities join a main or other junction (e.g., sewer main or electrical transformer) from which such utility services are distributed to other parts of the Project as well as to the Premises. Tenant shall replace any damaged or broken glass in the Premises (including all interior and exterior doors and windows) with glass of the same kind, size and quality. Tenant shall repair any damage to the Premises (including exterior doors and windows) caused by vandalism or any unauthorized entry. C. Tenant shall (i) maintain, repair and replace when necessary all HVAC equipment which services only the Premises, and shall keep the same in good condition through regular inspection and servicing, and (ii) maintain continuously throughout the Lease Term a service contract for the maintenance of all such HVAC equipment with a licensed HVAC repair and maintenance contractor approved by Landlord, which contract provides for the periodic inspection and servicing of the HVAC equipment at least once every 60 days during the Lease Term. Notwithstanding the foregoing, Landlord may elect at any time to assume responsibility for the maintenance, repair and replacement of such HVAC equipment which serves only the Premises. Tenant shall maintain continuously throughout the Lease Term a service contract for the washing of all windows (both interior and exterior surfaces) in the Premises with a contractor approved by Landlord, which contract provides for the periodic washing of all such windows at least once every 60 days during the Lease Term. Tenant shall furnish Landlord with copies of all such service contracts, which shall provide that they may not be changed without at least 30 days' prior written notice to Landlord. 16 If the cost to replace in the future the HVAC system for the Leased Premises, other than in connection with or as part of the Tenant Improvements to be constructed pursuant to the Constructions Plans in accordance with Exhibit B attached hereto, will be more than $5,000.00, then Landlord shall arrange to perform and pay for such work, and the cost thereof shall be amortized over the useful life, together with interest as provided in sections 5.4A. During the Lease Term, Tenant shall pay for such amortized cost, with interest, as provided in section 5.4A. If the cost of such work is $5,000.00 or less, Tenant shall perform the work at its expense, or if Landlord elects in its sole discretion to perform such work, then Tenant shall reimburse Landlord for the total amount of such expense. D. All repairs and replacements required of Tenant shall be promptly made with new materials of like kind and quality. If the work affects the structural parts of the Building or if the estimated cost of any item of repair or replacement is in excess of the Permitted Tenant's Alterations Limit, then Tenant shall first obtain Landlord's written approval of the scope of the work, plans therefor, materials to be used, and the contractor. E. Tenant currently occupies the Devcon Drive Space and is familiar with its condition. In connection with the Tenant Improvements to be constructed in the Premises, Landlord agrees to partially assign to Tenant upon request any warranties for such work that Landlord receives from its contractor and any supplier in order for Tenant to pursue at its expense any claim for work done in the Premises that may be covered under any such warranty. At no additional expense to Landlord, Landlord agrees to cooperate with Tenant in enforcing such warranty. The failure of Tenant to collect or enforce any such warranty shall not change Tenant's repair and maintenance obligations under this Lease. 6.2 LANDLORD'S OBLIGATION TO MAINTAIN: Landlord shall repair, maintain and operate the Common Area and repair and maintain the roof, exterior and structural parts of the building(s), including interior load bearing walls, located on the Project so that the same are kept in good order and repair. If there is central HVAC or other building service equipment and/or utility facilities serving portions of the Common Area and/or both the Premises and other parts of the Building, Landlord shall maintain and operate (and replace when necessary) such equipment. Landlord shall not be responsible for repairs required by an accident, fire or other peril or for damage caused to any part of the Project by any act or omission of Tenant or Tenant's Agents except as otherwise required by Article 11. Landlord may engage contractors of its choice to perform the obligations required of it by this Article, and the necessity of any expenditure to perform such obligations shall be at the sole discretion of Landlord. 6.3 CONTROL OF COMMON AREA: Landlord shall at all times have exclusive control of the Common Area. Landlord shall have the right, without the same constituting an actual or constructive eviction and without entitling Tenant to any abatement of rent, to: (i) close any part of the Common Area to whatever extent required in the opinion of Landlord's counsel to prevent a dedication thereof or the accrual of any prescriptive rights therein; (ii) temporarily close the Common Area to perform maintenance or for any other reason deemed sufficient by Landlord; (iii) change the shape, size, location and extent of the Common Area; (iv) eliminate from or add to the Project any land or improvement, including multi-deck parking structures; (v) make changes to the Common Area including, without limitation, changes in the location of driveways, entrances, passageways, doors and doorways, elevators, stairs, restrooms, exits, parking spaces, parking areas, sidewalks or the direction of the flow of traffic and the site of the Common Area; (vi) remove unauthorized persons from the Project; and/or (vii) change the name or address of the Building or Project. Tenant shall keep the Common Area clear of all obstructions created or permitted by Tenant. If in the opinion of Landlord unauthorized persons are using any of the Common Area by reason of the presence of Tenant in the Building, Tenant, upon demand of Landlord, shall restrain such unauthorized use by appropriate proceedings. In exercising any such rights regarding the Common Area, (i) Landlord shall make a reasonable effort to minimize any disruption to Tenant's business, and (ii) Landlord shall not exercise its rights to control the Common Area in a manner that would materially interfere with Tenant's use of the Premises without first obtaining Tenant's consent, which shall not be unreasonably withheld. Landlord shall have no obligation to provide guard services or other security measures for the benefit of the Project. Tenant assumes all responsibility for the protection of Tenant and Tenant's Agents from acts of third parties; provided, however, that nothing contained herein shall prevent Landlord, at its sole option, from providing security measures for the Project. 17 ARTICLE 7 WASTE DISPOSAL AND UTILITIES 7.1 WASTE DISPOSAL: Tenant shall store its waste either inside the Premises or within outside trash enclosures that are fully fenced and screened in compliance with all Private Restrictions, and designed for such purpose. All entrances to such outside trash enclosures shall be kept closed, and waste shall be stored in such manner as not to be visible from the exterior of such outside enclosures. Tenant shall cause all of its waste to be regularly removed from the Premises at Tenant's sole cost. Tenant shall keep all fire corridors and mechanical equipment rooms in the Premises free and clear of all obstructions at all times. 7.2 HAZARDOUS MATERIALS: Landlord and Tenant agree as follows with respect to the existence or use of Hazardous Materials on the Project: A. Any handling, transportation, storage, treatment, disposal or use of Hazardous Materials by Tenant and Tenant's Agents after the Effective Date in or about the Project shall strictly comply with all applicable Hazardous Materials Laws. Tenant shall indemnify, defend upon demand with counsel reasonably acceptable to Landlord, and hold harmless Landlord from and against any liabilities, losses, claims, damages, lost profits, consequential damages, interest, penalties, fines, monetary sanctions, attorneys' fees, experts' fees, court costs, remediation costs, investigation costs, and other expenses which result from or arise in any manner whatsoever out of the use, storage, treatment, transportation, release, or disposal of Hazardous Materials on or about the Project by Tenant or Tenant's Agents after the Effective Date. B. If the presence of Hazardous Materials on the Project caused or permitted by Tenant or Tenant's Agents after the Effective Date results in contamination or deterioration of water or soil resulting in a level of contamination greater than the levels established as acceptable by any governmental agency having jurisdiction over such contamination, then Tenant shall promptly take any and all action necessary to investigate and remediate such contamination if required by Law or as a condition to the issuance or continuing effectiveness of any governmental approval which relates to the use of the Project or any part thereof. Tenant shall further be solely responsible for, and shall defend, indemnify and hold Landlord and its agents harmless from and against, all claims, costs and liabilities, including attorneys' fees and costs, arising out of or in connection with any investigation and remediation required hereunder to return the Project to its condition existing prior to the appearance of such Hazardous Materials. C. Landlord and Tenant shall each give written notice to the other as soon as reasonably practicable of (i) any communication received from any governmental authority concerning Hazardous Materials which relates to the Project, and (ii) any contamination of the Project by Hazardous Materials which constitutes a violation of any Hazardous Materials Law. Tenant may use small quantities of household chemicals such as adhesives, lubricants, and cleaning fluids in order to conduct its business at the Premises and such other Hazardous Materials as are necessary for the operation of Tenant's business of which Landlord receives notice prior to such Hazardous Materials being brought onto the Premises and which Landlord consents in writing in its sole and absolute discretion may be brought onto the Premises. At any time during the Lease Term, Tenant shall, within five days after written request therefor received from Landlord, disclose in writing all Hazardous Materials that are being used by Tenant on the Project, the nature of such use, and the manner of storage and disposal. D. Landlord may cause testing wells to be installed on the Project, and may cause the ground water to be tested to detect the presence of Hazardous Material by the use of such tests as are then customarily used for such purposes. If Tenant so requests, Landlord shall supply Tenant with copies of such test results. The cost of such tests and of the installation, maintenance, repair and replacement of such wells shall be paid by Tenant if such tests disclose the existence of facts which give rise to liability of Tenant pursuant to its indemnity given in P. 7.2A and/or P. 7.2B. 18 E. As used herein, the term "Hazardous Material," means any hazardous or toxic substance, material or waste which is or becomes regulated by any local governmental authority, the State of California or the United States Government. The term "Hazardous Material," includes, without limitation, petroleum products, asbestos, PCB's, and any material or substance which is (i) listed under Article 9 or defined as hazardous or extremely hazardous pursuant to Article 11 of Title 22 of the California Administrative Code, Division 4, Chapter 20, (ii) defined as a "hazardous waste" pursuant to Section 1004 of the Federal Resource Conservation and Recovery Act, 42 U.S.C. 6901 et seq. (42 U.S.C. 6903), or (iii) defined as a "hazardous substance" pursuant to Section 101 of the Comprehensive Environmental Response; Compensation and Liability Act, 42 U.S.C. 9601 et seq. (42 U.S.C. 9601). As used herein, the term "Hazardous Material Law" shall mean any statute, law, ordinance, or regulation of any governmental body or agency (including the U.S. Environmental Protection Agency, the California Regional Water Quality Control Board, and the California Department of Health Services) which now of in the future regulates the use, storage, release or disposal of any Hazardous Material. F. The obligations of Landlord and Tenant under this P. 7.2 shall survive the expiration or earlier termination of the Lease Term. The rights and obligations of Landlord and Tenant with respect to issues relating to Hazardous Materials are exclusively established by this P. 7.2. In the event of any inconsistency between any other part of this Lease and this P. 7.2, the terms of this P. 7.2 shall control. 7.3 UTILITIES: Tenant shall promptly pay, as the same become due, all charges for water, gas, electricity, telephone, sewer service, waste pick-up and any other utilities, materials or services furnished directly to or used by Tenant on or about the Premises during the Lease Term, including, without limitation, (i) meter, use and/or connection fees, hook-up fees, or standby fee (excluding any connection fees or hook-up fees which relate to making the existing electrical, gas, and water service available to the Premises as of the Commencement Date), and (ii) penalties for discontinued or interrupted service. If any utility service is not separately metered to the Premises, then Tenant shall pay its pro rata share of the cost of such utility service with all others served by the service not separately metered. However, if Landlord determines that Tenant is using a disproportionate amount of any utility service not separately metered, then Landlord at its election may (i) periodically charge Tenant, as Additional Rent, a sum equal to Landlord's reasonable estimate of the cost of Tenant's excess use of such utility service, or (ii) install a separate meter (at Tenant's expense) to measure the utility service supplied to the Premises. 7.4 COMPLIANCE WITH GOVERNMENTAL REGULATIONS: Landlord and Tenant shall comply with all rules, regulations and requirements promulgated by national, state or local governmental agencies or utility suppliers concerning the use of utility services, including any rationing, limitation or other control. Tenant shall not be entitled to terminate this Lease nor to any abatement in rent by reason of such compliance. ARTICLE 8 COMMON OPERATING EXPENSES 8.1 TENANT'S OBLIGATION TO REIMBURSE: As Additional Rent, Tenant shall pay Tenant's Share (specified in SECTION G of the Summary) of all Common Operating Expenses; provided, however, if the Project contains more than one building, then Tenant shall pay Tenant's Share of all Common Operating Expenses fairly allocable to the Building, including (i) all Common Operating Expenses paid with respect to the Building, and (ii) a proportionate share (based on the Building Gross Leasable Area as a percentage of the Project Gross Leasable Area) of all Common Operating Expenses which relate to the Project in general are not fairly allocable to any one building that is part of the Project. Tenant shall pay such share of the actual Common Operating Expenses incurred or paid by Landlord but not theretofore billed to Tenant within 10 days after receipt of a written bill therefor from Landlord, on such periodic basis as Landlord shall designate, but in no event more frequently than once a month. Alternatively, Landlord may from time to time require that Tenant pay Tenant's Share of Common Operating Expenses in advance in estimated monthly installments, in accordance with the following: (i) Landlord shall deliver to Tenant Landlord's reasonable estimate of the Common Operating expenses it anticipates will be paid or incurred for the Landlord's fiscal year in question; 19 (ii) during such Landlord's fiscal year Tenant shall pay such share of the estimated Common Operating Expenses in advance in monthly installments as required by Landlord due with the installments of Base Monthly Rent; and (iii) within 180 days after the end of each Landlord's fiscal year, Landlord shall furnish to Tenant a statement in reasonable detail of the actual Common Operating Expenses paid or incurred by Landlord during the just ended Landlord's fiscal year and thereupon there shall be an adjustment between Landlord and Tenant, with payment to Landlord or credit by Landlord against the next installment of Base Monthly Rent, as the case may require, within 10 days after delivery by Landlord to Tenant of said statement, so that Landlord shall receive the entire amount of Tenant's Share of all Common Operating Expenses for such Landlord's fiscal year and no more. Tenant shall have the right at its expense, exercisable upon reasonable prior written notice to Landlord, to inspect at Landlord's office during normal business hours Landlord's books and records as they relate to Common Operating Expenses. Such inspection must be within 90 days of Tenant's receipt of Landlord's annual statement for the same, and shall be limited to verification of the charges contained in such statement. Tenant may not withhold payment of such bill pending completion of such inspection. 8.2 COMMON OPERATING EXPENSES DEFINED: The term "Common Operating Expenses" shall mean the following: A. All costs and expenses paid or incurred by Landlord in doing the following (including payments to independent contractors providing services related to the performance of the following): (i) maintaining, cleaning, repairing and resurfacing the roof (including repair of leaks) and the exterior surfaces (including painting) of all buildings located on the Project; (ii) maintenance of the liability, fire, property damage, earthquake and other insurance covering the Project carried by Landlord pursuant to P. 9.2 (including the prepayment of premiums for coverage of up to one year); (iii) maintaining, repairing, operating and replacing when necessary HVAC equipment, utility facilities and other building service equipment, subject to section 5.4 regarding the amortization of certain capital improvements; (iv) providing utilities to the Common Area (including lighting, trash removal and water for landscaping irrigation); (v) complying with all applicable Laws and Private Restrictions; (vi) operating, maintaining, repairing, cleaning, painting, restriping and resurfacing the Common Area; (vii) replacement or installation of lighting fixtures, directional or other signs and signals, irrigation systems, trees, shrubs, ground cover and other plant materials, and all landscaping in the Common Area; and (viii) providing security (provided, however, that Landlord shall not be obligated to provide security and if it does, Landlord may discontinue such service at any time and in any event Landlord shall not be responsible for any act or omission of any security personnel); and (ix) capital improvements as provided in P. 5.4 hereof; B. The following costs: (i) Real Property Taxes as defined in P. 8.3; (ii) the amount of any "deductible" paid by Landlord with respect to damage caused by any Insured Peril up to $10,000.00 for each claim; and (iii) that portion of all compensation (including benefits and premiums for workers' compensation and other insurance) paid to or on behalf of employees of Landlord but only to the extent they are involved in the performance of the work described by P. 8.2A that is fairly allocable to the Project; C. Fees for management services rendered by either Landlord or a third party manager engaged by Landlord (which may be a party affiliated with Landlord), except that the total amount charged for management services and included in Tenant's Share of Common Operating Expenses shall not exceed the monthly rate of four percent (4%) of the Base Monthly Rent. D. All additional costs and expenses incurred by Landlord with respect to the operation, protection, maintenance, repair and replacement of the Project which would be considered a current expense (and not a capital expenditure) pursuant to generally accepted accounting principles; provided, however, that Common Operating Expenses shall not include any of the following: (i) payments on any loans or ground leases affecting the Project; (ii) depreciation of any buildings or any major systems of building service equipment within the Project; (iii) leasing commissions; (iv) the cost of tenant improvements installed or performed for the exclusive use of other tenants of the Project and the cost of any special services for a particular tenant that is not available or offered to Tenant; and (v) any cost incurred in complying with Hazardous Materials Laws, which subject is governed exclusively by P. 7.2. 20 Since the Project consists of multiple buildings, certain Common Area Expenses may pertain to a particular building(s) and other Common Area Expenses to the Project as a whole (such as Common Area Expenses for the Common Areas of the Project). Common Area Expenses applicable to any particular building within the Project shall be charged to the building in question whose tenants shall be responsible for payment of their respective proportionate shares in the pertinent building and other Common Area Expenses applicable to the Project (such as the Common Areas of the Project) shall be charged to each building in the Project (including the Building) with the tenants in each such building being responsible for paying their respective proportionate shares in such building of such costs. Landlord shall in good faith attempt to allocate such Common Area Expenses to the buildings (including the Building) and such allocation shall be binding on Tenant. Any contrary provision contained in this Section 8.2 or Section 5.4 or elsewhere in this Lease notwithstanding, for purposes of calculating Common Operating Expenses, in no event shall such Common Operating Expenses include (i) costs of correcting structural defects in the structural portions of the Building, which for purposes hereof shall mean the roof, foundation and load bearing walls, (ii) legal fees, space planners' fees, and advertising and promotional expenses incurred in connection with and incidental to the development or leasing of the Building or other space in the Project, or (iii) any legal fees and costs of Landlord (including, but not limited to, those incurred in connection with any litigation or other proceedings between Landlord and any other tenant) except those legal fees and costs incurred in the normal course of Landlord's business. 8.3 REAL PROPERTY TAXES DEFINED: The term "Real Property Taxes" shall mean all taxes, assessments, levies, and other charges of any kind or nature whatsoever, general and special, foreseen and unforeseen (including all installments of principal and interest required to pay any existing or future general or special assessments for public improvements, services or benefits, and any increases resulting from reassessments resulting from a change in ownership, new construction, or any other cause), now or hereafter imposed by any governmental or quasi-governmental authority or special district having the direct or indirect power to tax or levy assessments, which are levied or assessed against, or with respect to the value, occupancy or use of all or any portion of the Project (as now constructed or as may at any time hereafter be constructed, altered, or otherwise changed) or Landlord's interest therein, the fixtures, equipment and other property of Landlord, real or personal, that are an integral part of and located on the Project, the gross receipts, income, or rentals from the Project, or the use of parking areas, public utilities, or energy within the Project, or Landlord's business of leasing the Project. If at any time during the Lease Term the method of taxation or assessment of the Project prevailing as of the Effective Date shall be altered so that in lieu of or in addition to any Real Property Tax described above there shall be levied, assessed or imposed (whether by reason of a change in the method of taxation or assessment, creation of a new tax or charge, or any other cause) an alternate or additional tax or charge (i) on the value, use or occupancy of the Project or Landlord's interest therein, or (ii) on or measured by the gross receipts, income or rentals from the Project, on Landlord's business of leasing the Project, or computed in any manner with respect to the operation of the Project, then any such tax or charge, however designated, shall be included within the meaning of the term "Real Property Taxes" for purposes of this Lease. If any Real Property Tax is based upon property or rents unrelated to the Project, then only that part of such Real Property Tax that is fairly allocable to the Project shall be included within the meaning of the term "Real Property Taxes". Notwithstanding the foregoing, the term "Real Property Taxes" shall not include estate, inheritance, transfer, gift or franchise taxes of Landlord or the federal or state net income tax imposed on Landlord's income from all sources. ARTICLE 9 INSURANCE 9.1 TENANT'S INSURANCE: Tenant shall maintain insurance complying with all of the following: A. Tenant shall procure, pay for and keep in full force and effect the following: (1) Commercial general liability insurance, including property damage, against liability for personal injury, bodily injury, death and damage to property occurring in or about, or resulting from an occurrence in or about, the Premises with combined single limit coverage of not less than the amount of Tenant's Liability Insurance Minimum specified in SECTION P of the Summary, which insurance shall contain a "contractual liability" endorsement insuring Tenant's performance of Tenant's obligation to indemnify Landlord contained in P. 10.3; 21 (2) Fire and property damage insurance in so-called "all risk" form insuring Tenant's Trade Fixtures and Tenant's Alterations for the full actual replacement cost thereof; (3) Business interruption insurance with limits of liability representing at least approximately six months of income, business auto liability covering owned, non-owned and hired vehicles with a limit of not less than $1,000,000 per accident, insurance protecting against liability under workers' compensation laws with limits at least as required by statute, insurance for all plate glass in the Premises, and such other insurance that is either (i) required by any Lender, or (ii) reasonably required by Landlord and customarily carried by tenants of similar property in similar businesses. Notwithstanding the foregoing, the original party signing this Lease as Tenant, and its transferees under a Permitted Transfer, shall have the right to self insure for the risks covered under business interruption insurance and plate glass insurance, provided that no such self-insurance shall diminish the rights and privileges to which Landlord would otherwise have been entitled under the terms of the Lease had there been a third party insurer, including, without limitation, the waiver of subrogation B. Where applicable and required by Landlord, each policy of insurance required to be carried by Tenant pursuant to this P. 9.1: (i) shall name Landlord and such other parties in interest as Landlord reasonably designates as additional insured; (ii) shall be primary insurance which provides that the insurer shall be liable for the full amount of the loss up to and including the total amount of liability set forth in the declarations without the right of contribution from any other insurance coverage of Landlord; (iii) shall be in a form satisfactory to Landlord; (iv) shall be carried with companies reasonably acceptable to Landlord; (v) shall provide that such policy shall not be subject to cancellation, lapse or change except after at least 30 days prior written notice to Landlord so long as such provision of 30 days notice is reasonably obtainable, but in any event not less than 10 days prior written notice; (vi) shall not have a "deductible" in excess of such amount as is reasonably approved by Landlord; (vii) shall contain a cross liability endorsement; and (viii) shall contain a "severability" clause. If Tenant has in full force and effect a blanket policy of liability insurance with the same coverage for the Premises as described above, as well as other coverage of other premises and properties of Tenant, or in which Tenant has some interest, such blanket insurance shall satisfy the requirements of this P. 9.1. C. A copy of each paid-up policy evidencing the insurance required to be carried by Tenant pursuant to this P. 9.1 (appropriately authenticated by the insurer) or a certificate of the insurer, certifying that such policy has been issued, providing the coverage required by this P. 9.1, and containing the provisions specified herein, shall be delivered to Landlord prior to the time Tenant or any of its Agents enters the Premises and upon renewal of such policies, but not less than 5 days prior to the expiration of the term of such coverage. Landlord may, at any time, and from time to time, inspect and/or copy any and all insurance policies required to be procured by Tenant pursuant to this P. 9.1. If any Lender or insurance advisor reasonably determines at any time that the amount of coverage required for any policy of insurance Tenant is to obtain pursuant to this P. 9.1 is not adequate, then Tenant shall increase such coverage for such insurance to such amount as such Lender or insurance advisor reasonably deems adequate, not to exceed the level of coverage for such insurance commonly carried by comparable businesses similarly situated. 9.2 LANDLORD'S INSURANCE: Landlord shall have the following obligations and options regarding insurance: A. Landlord shall maintain a policy or policies of fire and property damage insurance in so-called "all risk" form insuring Landlord (and such others as Landlord may designate) against loss of rents for a period of not less than 12 months and from physical damage to the Project with coverage of not less than the full replacement cost thereof. Landlord may so insure the Project separately, or may insure the Project with other property owned by Landlord which Landlord elects to insure together under the same policy or policies. Landlord shall have the right, but not the obligation, in its sole and absolute discretion, to obtain insurance for such additional perils that Landlord deems appropriate, including, without limitation, coverage for damage by earthquake and/or flood. All such coverage shall contain "deductibles" which Landlord deems appropriate, which in the case of earthquake and flood insurance, may be up to 10% of the replacement value of the property insured or such higher amount as is then commercially reasonable. Landlord shall not be required to cause such insurance to cover any Trade Fixtures or Tenant's Alterations of Tenant. 22 B. Landlord may maintain a policy or policies of commercial general liability insurance insuring Landlord (and such others as are designated by Landlord) against liability for personal injury, bodily injury, death and damage to property occurring or resulting from an occurrence in, on or about the Project, with combined single limit coverage in such amount as Landlord from time to time determines is reasonably necessary for its protection. C. If Landlord's insurance rates for the Building are increased at any time during the Lease Term as a result of the nature of Tenant's use of the Premises, Tenant shall reimburse Landlord for the full amount of such increase immediately upon receipt of a bill from Landlord therefor. 9.4 RELEASE AND WAIVER OF SUBROGATION: The parties hereto release each other, and their respective agents and employees, from any liability for injury to any person or damage to property that is caused by or results from any risk insured against under any valid and collectible insurance policy carried by either of the parties which contains a waiver of subrogation by the insurer and is in force at the time of such injury or damage; subject to the following limitations: (i) the foregoing provision shall not apply to the commercial general liability insurance described by subparagraphs P. 9.1A and P. 9.2B; (ii) such release shall apply to liability resulting from any risk insured against or covered by self-insurance maintained or provided by Tenant to satisfy the requirements of P. 9.1 to the extent permitted by this Lease; and (iii) the parties shall not be released from any such liability to the extent any damages resulting from such injury or damage are not covered (other than the deductible amounts and amounts not covered due to a party not having replacement cost insurance or due to any co-insurance requirements) by the recovery obtained by the other party from such insurance (or which would have been obtained had the party carried insurance required under this Lease or had not self-insured), but only if the insurance in question permits such partial release in connection with obtaining a waiver of subrogation from the insurer. This release shall be in effect only so long as the applicable insurance policy contains a clause to the effect that this release shall not affect the right of the insured to recover under such policy. Each party shall cause each insurance policy obtained by it to provide that the insurer waives all right of recovery by way of subrogation against the other party and its agents and employees in connection with any injury or damage covered by such policy. However, if any insurance policy cannot be obtained with such a waiver of subrogation, or if such waiver of subrogation is only available at additional cost and the party for whose benefit the waiver is to be obtained does not pay such additional cost, then the party obtaining such insurance shall notify the other party of that fact and thereupon shall be relieved of the obligation to obtain such waiver of subrogation rights from the insurer with respect to the particular insurance involved unless the other party pays the additional cost. ARTICLE 10 LIMITATION ON LANDLORD'S LIABILITY AND INDEMNITY 10.1 LIMITATION ON LANDLORD'S LIABILITY: Landlord shall not be liable to Tenant, nor shall Tenant be entitled to terminate this Lease or to any abatement of rent (except as expressly provided otherwise herein), for any injury to Tenant or Tenant's Agents, damage to the property of Tenant or Tenant's Agents, or loss to Tenant's business resulting from any cause, including without limitation any: (i) failure, interruption or installation of any HVAC or other utility system or service; (ii) failure to furnish or delay in furnishing any utilities or services when such failure or delay is caused by fire or other peril, the elements, labor disturbances of any character, or any other accidents or other conditions beyond the reasonable control of Landlord; (iii) limitation, curtailment, rationing or restriction on the use of water or electricity, gas or any other form of energy or any services or utility serving the Project; (iv) vandalism or forcible entry by unauthorized persons or the criminal act of any person; or (v) penetration of water into or onto any portion of the Premises or the Building through roof leaks or otherwise. Notwithstanding the foregoing but subject to P. 9.4, Landlord shall be liable for any such injury, damage or loss which is proximately caused by Landlord's or Landlord's Agents willful misconduct or gross negligence of which Landlord has actual notice and a reasonable opportunity to cure but which it fails to so cure. 10.2 LIMITATION ON TENANT'S RECOURSE: If Landlord is a corporation, trust, partnership, joint venture, unincorporated association or other form of business entity: (i) the obligations of Landlord shall not constitute personal obligations of the officers, directors, trustees, partners, joint venturers, members, owners, stockholders, or other principals or representatives of such business entity; and (ii) Tenant shall not have recourse to the assets of such officers, directors, trustees, partners, joint venturers, members, owners, stockholders, principals or representatives except to the extent of their interest in the Project. Tenant shall have recourse only to the interest of 23 Landlord in the Project for the satisfaction of the obligations of Landlord and shall not have recourse to any other assets of Landlord for the satisfaction of such obligations. 10.3 INDEMNIFICATION OF LANDLORD: Subject to section 9.4 and to the extent not covered by Landlord's insurance but only after resorting to Tenant's insurance as the primary insurance, Tenant shall hold harmless, indemnify and defend Landlord, and its employees, agents and contractors, with competent counsel reasonably satisfactory to Landlord (and Landlord agrees to accept counsel that any insurer requires be used), from all liability, penalties, losses, damages, costs, expenses, causes of action, claims and/or judgments arising by reason of any death, bodily injury, personal injury or property damage resulting from (i) any cause or causes whatsoever (other than the willful misconduct or gross negligence of Landlord of which Landlord has had notice and a reasonable time to cure, but which Landlord has failed to cure) occurring in or about or resulting from an occurrence in or about the Premises during the Lease Term, (ii) the negligence or willful misconduct of Tenant or its agents, employees and contractors, wherever the same may occur, or (iii) an Event of Tenant's Default. The provisions of this P. 10.3 shall survive the expiration or sooner termination of this Lease. ARTICLE 11 DAMAGE TO PREMISES 11.1 LANDLORD'S DUTY TO RESTORE: If the Premises are damaged by any peril after the Effective Date, Landlord shall restore the Premises unless the Lease is terminated by Landlord pursuant to P. 11.2 or by Tenant pursuant to P. 11.3. All insurance proceeds available from the fire and property damage insurance carried by Landlord pursuant to P. 9.2 shall be paid to and become the property of Landlord. If this Lease is terminated pursuant to either P. 11.2 or P. 11.3, then all insurance proceeds available from insurance carried by Tenant which covers loss to property that is Landlord's property or would become Landlord's property on termination of this Lease shall be paid to and become the property of Landlord. If this Lease is not so terminated, then upon receipt of the insurance proceeds (if the loss is covered by insurance) and the issuance of all necessary governmental permits, Landlord shall commence and diligently prosecute to completion the restoration of the Premises, to the extent then allowed by Law, to substantially the same condition in which the Premises were immediately prior to such damage. Landlord's obligation to restore shall be limited to the Premises and interior improvements constructed by Landlord as they existed as of the Commencement Date, excluding any Tenant's Alterations, Trade Fixtures and/or personal property constructed or installed by Tenant in the Premises. Tenant shall forthwith replace or fully repair all Tenant's Alterations and Trade Fixtures installed by Tenant and existing at the time of such damage or destruction, and all insurance proceeds received by Tenant from the insurance carried by it pursuant to P. 9.1A(2) shall be used for such purpose. 11.2 LANDLORD'S RIGHT TO TERMINATE: Landlord shall have the right to terminate this Lease in the event any of the following occurs, which right may be exercised only by delivery to Tenant of a written notice of election to terminate within 30 days after the date of such damage: A. The Building is damaged by an Insured Peril to such an extent that the estimated cost to restore exceeds 33% of the then actual replacement cost thereof; B. The Building is damaged by an Uninsured Peril to such an extent that the estimated cost to restore exceeds 2% of the then actual replacement cost thereof; provided, however, that Landlord may not terminate this Lease pursuant to this P. 11.2B if one or more tenants of the Project agree in writing to pay the amount by which the cost to restore the damage exceeds such amount and subsequently deposit such amount with Landlord within 30 days after Landlord has notified Tenant of its election to terminate this Lease; C. The Premises are damaged by any peril within 12 months of the last day of the Lease Term to such an extent that the estimated cost to restore equals or exceeds an amount equal to six times the Base Monthly Rent then due; provided, however, that Landlord may not terminate this Lease pursuant to this P. 11.2C if Tenant, at the time of such damage, has a then valid express written option to extend the Lease Term and Tenant exercises such option to extend the Lease Term within 15 days following the date of such damage; or 24 D. Either the Project or the Building is damaged by any peril and, because of the Laws then in force, (i) cannot be restored at reasonable cost to substantially the same condition in which it was prior to such damage, or (ii) cannot be used for the same use being made thereof before such damage if restored as required by this Article. E. As used herein, the following terms shall have the following meanings: (i) the term "Insured Peril" shall mean a peril actually insured against for which the insurance proceeds actually received by Landlord are sufficient (except for any "deductible" amount specified by such insurance) to restore the Project under then existing building codes to the condition existing immediately prior to the damage; and (ii) the term "Uninsured Peril" shall mean any peril which is not an Insured Peril. Notwithstanding the foregoing, if the "deductible" for earthquake or flood insurance exceeds 2% of the replacement cost of the improvements insured, such peril shall be deemed an "Uninsured Peril". 11.3 TENANT'S RIGHT TO TERMINATE: If the Premises are damaged by any peril and Landlord does not elect to terminate this Lease or is not entitled to terminate this Lease pursuant to P. 11.2, then as soon as reasonably practicable, Landlord shall furnish Tenant with the written opinion of Landlord's architect or construction consultant as to when the restoration work required of Landlord may be completed. Tenant shall have the right to terminate this Lease in the event any of the following occurs, which right may be exercised only by delivery to Landlord of a written notice of election to terminate within 7 days after Tenant receives from Landlord the estimate of the time needed to complete such restoration. A. The Premises are damaged by any peril and, in the reasonable opinion of Landlord's architect or construction consultant, the restoration of the Premises cannot be substantially completed within 180 days after the date of such damage; or B. The Premises are damaged by any peril within 12 months of the last day of the Lease Term and, in the reasonable opinion of Landlord's architect or construction consultant, the restoration of the Premises cannot be substantially completed within 90 days after the date of such damage and such damage renders unusable more than 30% of the Premises; or C. If Landlord's insurance proceeds for the restoration of the Premises are insufficient and the Premises are not restored to substantially the same condition prior to such damage (except for Tenant's Alterations and Tenant's Fixtures) and the Premises as restored materially impair Tenants ability to use the Premises for the permitted use, as reasonably determined prior to commencement of such restoration work by Landlord. 11.4 ABATEMENT OF RENT: In the event of damage to the Premises which does not result in the termination of this Lease, the Base Monthly Rent and the Additional Rent shall be temporarily abated during the period of restoration in proportion to the degree to which Tenant's use of the Premises is impaired by such damage. Tenant shall not be entitled to any compensation or damages from Landlord for loss of Tenant's business or property or for any inconvenience or annoyance caused by such damage or restoration. Tenant hereby waives the provisions of California Civil Code Sections 1932(2) and 1933(4) and the provisions of any similar law hereinafter enacted. ARTICLE 12 CONDEMNATION 12.1 LANDLORD'S TERMINATION RIGHT: Landlord shall have the right to terminate this Lease if, as a result of a taking by means of the exercise of the power of eminent domain (including a voluntary sale or transfer by Landlord to a condemnor under threat of condemnation), (i) all or any part of the Premises is so taken, (ii) more than 10% of the Building Leasable Area is so taken, or (iii) more than 50% of the Common Area is so taken. Any such right to terminate by Landlord must be exercised within a reasonable period of time, to be effective as of the date possession is taken by the condemnor. 25 12.2 TENANT'S TERMINATION RIGHT: Tenant shall have the right to terminate this Lease if, as a result of any taking by means of the exercise of the power of eminent domain (including any voluntary sale or transfer by Landlord to any condemnor under threat of condemnation), (i) 10% or more of the Premises is so taken and that part of the Premises that remains cannot be restored within a reasonable period of time not to exceed ninety (90) days and thereby made reasonably suitable for the continued operation of the Tenant's business, or (ii) there is a taking affecting the Common Area and, as a result of such taking, Landlord cannot provide parking spaces within reasonable walking distance of the Premises equal in number to at least 80% of the number of spaces allocated to Tenant by P. 2.1, whether by rearrangement of the remaining parking areas in the Common Area (including construction of multi-deck parking structures or restriping for compact cars where permitted by Law) or by alternative parking facilities on other land. Tenant must exercise such right within a reasonable period of time, to be effective on the date that possession of that portion of the Premises or Common Area that is condemned is taken by the condemnor. 12.3 RESTORATION AND ABATEMENT OF RENT: If any part of the Premises or the Common Area is taken by condemnation and this Lease is not terminated, then Landlord shall restore the remaining portion of the Premises and Common Area and interior improvements constructed by Landlord as they existed as of the Commencement Date, excluding any Tenant's Alterations, Trade Fixtures and/or personal property constructed or installed by Tenant. Thereafter, except in the case of a temporary taking, as of the date possession is taken the Base Monthly Rent shall be reduced in the same proportion that the floor area of that part of the Premises so taken (less any addition thereto by reason of any reconstruction) bears to the original floor area of the Premises. 12.4 TEMPORARY TAKING: If any portion of the Premises is temporarily taken for one year or less, this Lease shall remain in effect. If any portion of the Premises is temporarily taken by condemnation for a period which exceeds one year or which extends beyond the natural expiration of the Lease Term, and such taking materially and adversely affects Tenant's ability to use the Premises for the Permitted Use, then Tenant shall have the right to terminate this Lease, effective on the date possession is taken by the condemnor. 12.5 DIVISION OF CONDEMNATION AWARD: Any award made as a result of any condemnation of the Premises or the Common Area shall belong to and be paid to Landlord, and Tenant hereby assigns to Landlord all of its right, title and interest in any such award; provided, however, that Tenant shall be entitled to receive any condemnation award that is made directly to Tenant for the following so long as the award made to Landlord is not thereby reduced: (i) for the taking of personal property or Trade Fixtures belonging to Tenant, (ii) for the interruption of Tenant's business or its moving costs, (iii) for loss of Tenant's goodwill; or (iv) for any temporary taking where this Lease is not terminated as a result of such taking. The rights of Landlord and Tenant regarding any condemnation shall be determined as provided in this Article, and each party hereby waives the provisions of California Code of Civil Procedure Section 1265.130 and the provisions of any similar law hereinafter enacted allowing either party to petition the Superior Court to terminate this Lease in the event of a partial taking of the Premises. ARTICLE 13 DEFAULT AND REMEDIES 13.1 EVENTS OF TENANT'S DEFAULT: Tenant shall be in default of its obligations under this Lease if any of the following events occurs (an "Event of Tenant's Default"): A. Tenant shall have failed to pay Base Monthly Rent or Additional Rent when due; provided, however, that not more frequently than twice each calendar year, Tenant shall not be in default for failure to pay rent or any other sum unless Tenant fails to make such payment within five (5) days after receipt of written notice of such failure from Landlord; or B. Tenant shall have failed to perform any term, covenant, or condition of this Lease except those requiring the payment of Base Monthly Rent or Additional Rent, and Tenant shall have failed to cure such breach within 30 days after written notice from Landlord specifying the nature of such breach where such breach could reasonably be cured within said 30 day period, or if such breach could not be reasonably cured within said 30 day period, Tenant shall have failed to commence such cure within said 30 day period and thereafter continue with due diligence to prosecute such cure to completion within such time period as is reasonably needed; or C. Tenant shall have sublet the Premises or assigned its interest in the Lease in violation of the provisions contained in Article 14; or 26 D. The occurrence of the following: (i) the making by Tenant of any general arrangements or assignments for the benefit of creditors; (ii) Tenant becomes a "debtor" as defined in 11 USC ss.101 or any successor statute thereto (unless, in the case of a petition filed against Tenant, the same is dismissed within 60 days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, where possession is not restored to Tenant within 60 days; or (iv) the attachment, execution or other judicial seizure of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, where such seizure is not discharged within 60 days; provided, however, in the event that any provision of this Section 13.1E is contrary to any applicable Law, such provision shall be of no force or effect; or E. Tenant shall have failed to deliver documents required of it pursuant to P. 15.4 or P. 15.6 within the time periods specified therein; or 13.2 LANDLORD'S REMEDIES: If an Event of Tenant's Default occurs, Landlord shall have the following remedies, in addition to all other rights and remedies provided by any Law or otherwise provided in this Lease, to which Landlord may resort cumulatively or in the alternative: A. Landlord may keep this Lease in effect and enforce by an action at law or in equity all of its rights and remedies under this Lease, including (i) the right to recover the rent and other sums as they become due by appropriate legal action, (ii) the right to make payments required of Tenant or perform Tenant's obligations and be reimbursed by Tenant for the cost thereof with interest at the Agreed Interest Rate from the date the sum is paid by Landlord until Landlord is reimbursed by Tenant, and (iii) the remedies of injunctive relief. Notwithstanding anything contained in this Lease, in the event of a breach of an obligation by Tenant which results in a condition which poses an imminent danger to safety of persons or damage to property, an unsightly condition visible from the exterior of the Building, or a threat to insurance coverage, then if Tenant does not cure such breach within 3 days after delivery to it of written notice from Landlord identifying the breach, Landlord may cure the breach of Tenant and be reimbursed by Tenant for the actual and reasonable cost thereof with interest at the Agreed Interest Rate from the date the sum is paid by Landlord until Landlord is reimbursed by Tenant. B. Landlord may enter the Premises and release them to third parties for Tenant's account for any period, whether shorter or longer than the remaining Lease Term. Tenant shall be liable immediately to Landlord for all commercially reasonable and actual costs Landlord incurs in releasing the Premises, including brokers' commissions, expenses of altering and preparing the Premises required by the releasing. Tenant shall pay to Landlord the rent and other sums due under this Lease on the date the rent is due, less the rent and other sums Landlord received from any releasing. No act by Landlord allowed by this subparagraph shall terminate this Lease unless Landlord notifies Tenant in writing that Landlord elects to terminate this Lease. Notwithstanding any releasing without termination, Landlord may later elect to terminate this Lease because of the default by Tenant. C. Landlord may terminate this Lease by giving Tenant written notice of termination, in which event this Lease shall terminate on the date set forth for termination in such notice. Any termination under this P. 13.2C shall not relieve Tenant from its obligation to pay sums then due Landlord or from any claim against Tenant for damages or rent previously accrued or then accruing. In no event shall any one or more of the following actions by Landlord, in the absence of a written election by Landlord to terminate this Lease, constitute a termination of this Lease: (i) appointment of a receiver or keeper in order to protect Landlord's interest hereunder; (ii) consent to any subletting of the Premises or assignment of this Lease by Tenant, whether pursuant to the provisions hereof or otherwise; or (iii) any other action by Landlord or Landlord's Agents intended to mitigate the adverse effects of any breach of this Lease by Tenant, including without limitation any action taken to maintain and preserve the Premises or any action taken to relet the Premises or any portions thereof to the extent such actions do not affect a termination of Tenant's right to possession of the Premises. D. In the event Tenant breaches this Lease and abandons the Premises, this Lease shall not terminate unless Landlord gives Tenant written notice of its election to so terminate this Lease. No act by or on behalf of Landlord intended to mitigate the adverse effect of such breach, including those described by P. 13.C, shall constitute a termination of Tenant's right to possession unless Landlord gives Tenant written notice of termination. Should Landlord not terminate this Lease by giving Tenant written notice, Landlord may enforce all its rights and remedies under this Lease, including the right to recover the rent as it becomes due under the Lease as provided in California Civil Code Section 1951.4. 27 E. In the event Landlord terminates this Lease, Landlord shall be entitled, at Landlord's election, to damages in an amount as set forth in California Civil Code Section 1951.2 as in effect on the Effective Date. For purposes of computing damages pursuant to California Civil Code Section 1951.2, (i) an interest rate equal to the Agreed Interest Rate shall be used where permitted, and (ii) the term "rent" includes Base Monthly Rent and Additional Rent. Such damages shall include: (1) The worth at the time of award of the amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that Tenant proves could be reasonably avoided, computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%); and (2) Any other amount necessary to compensate Landlord for all detriment proximately caused by Tenant's failure to perform Tenant's obligations under this Lease, or which in the ordinary course of things would be likely to result therefrom, including the following: (i) expenses for cleaning, repairing or restoring the Premises; (ii) expenses for altering, remodeling or otherwise improving the Premises for the purpose of reletting, including installation of leasehold improvements (whether such installation be funded by a reduction of rent, direct payment or allowance to a new tenant, or otherwise); (iii) broker's fees, advertising costs and other expenses of reletting the Premises; (iv) costs of carrying the Premises, such as taxes, insurance premiums, utilities and security precautions; (v) expenses in retaking possession of the Premises; and (vi) reasonable attorneys' fees and court costs incurred by Landlord in retaking possession of the Premises and in releasing the Premises or otherwise incurred as a result of Tenant's default. F. Nothing in this P. 13.2 shall limit Landlord's right to indemnification from Tenant as provided in P. 7.2 and P. 10.3. Any notice given by Landlord in order to satisfy the requirements of P. 13.1A or P. 13.1B above shall also satisfy the notice requirements of California Code of Civil Procedure Section 1161 regarding unlawful detainer proceedings. 13.3 WAIVER: One party's consent to or approval of any act by the other party requiring the first party's consent or approval shall not be deemed to waive or render unnecessary the first party's consent to or approval of any subsequent similar act by the other party. The receipt by Landlord of any rent or payment with or without knowledge of the breach of any other provision hereof shall not be deemed a waiver of any such breach unless such waiver is in writing and signed by Landlord. No delay or omission in the exercise of any right or remedy accruing to either party upon any breach by the other party under this Lease shall impair such right or remedy or be construed as a waiver of any such breach theretofore or thereafter occurring. The waiver by either party of any breach of any provision of this Lease shall not be deemed to be a waiver of any subsequent breach of the same or of any other provisions herein contained. 13.4 LIMITATION ON EXERCISE OF RIGHTS: At any time that an Event of Tenant's Default has occurred and remains uncured, (i) it shall not be unreasonable for Landlord to deny or withhold any consent or approval requested of it by Tenant which Landlord would otherwise be obligated to give, and (ii) Tenant may not exercise any option to extend, right to terminate this Lease, or other right granted to it by this Lease which would otherwise be available to it. 13.5 WAIVER BY TENANT OF CERTAIN REMEDIES: Tenant waives the provisions of Sections 1932(1), 1941 and 1942 of the California Civil Code and any similar or successor law regarding Tenant's right to terminate this Lease or to make repairs and deduct the expenses of such repairs from the rent due under this Lease. Tenant hereby waives any right of redemption or relief from forfeiture under the laws of the State of California, or under any other present or future law, including the provisions of Sections 1174 and 1179 of the California Code of Civil Procedure. ARTICLE 14 ASSIGNMENT AND SUBLETTING 14.1 TRANSFER BY TENANT: The following provisions shall apply to any assignment, subletting or other transfer by Tenant or any subtenant or assignee or other successor in interest of the original Tenant (collectively referred to in this P. 14.1 as "Tenant"): 28 A. Tenant shall not do any of the following (collectively referred to herein as a "Transfer"), whether voluntarily, involuntarily or by operation of law, without the prior written consent of Landlord, which consent shall not be unreasonably withheld: (i) sublet all or any part of the Premises or allow it to be sublet, occupied or used by any person or entity other than Tenant; (ii) assign its interest in this Lease; (iii) mortgage or encumber the Lease (or otherwise use the Lease as a security device) in any manner; or (iv) materially amend or modify an assignment, sublease or other transfer that has been previously approved by Landlord. Tenant shall reimburse Landlord for all reasonable costs and attorneys' fees incurred by Landlord in connection with the evaluation, processing, and/or documentation of any requested Transfer, whether or not Landlord's consent is granted. Landlord's reasonable costs shall include the cost of any review or investigation performed by Landlord or consultant acting on Landlord's behalf of (i) Hazardous Materials (as defined in Section 7.2E of this Lease) used, stored, released, or disposed of by the potential Subtenant or Assignee, and/or (ii) violations of Hazardous Materials Law (as defined in Section 7.2E of this lease) by the Tenant or the proposed Subtenant or Assignee. Any Transfer so approved by Landlord shall not be effective until Tenant has delivered to Landlord an executed counterpart of the document evidencing the Transfer which (i) is in a form reasonably approved by Landlord, (ii) contains the same terms and conditions as stated in Tenant's notice given to Landlord pursuant to P. 14.1B, and (iii) in the case of an assignment of the Lease, contains the agreement of the proposed transferee to assume all obligations of Tenant under this Lease arising after the effective date of such Transfer and to remain jointly and severally liable therefor with Tenant. Any attempted Transfer without Landlord's consent shall constitute an Event of Tenant's Default and shall be voidable at Landlord's option. Landlord's consent to any one Transfer shall not constitute a waiver of the provisions of this P. 14.1 as to any subsequent Transfer or a consent to any subsequent Transfer. No Transfer, even with the consent of Landlord, shall relieve Tenant of its personal and primary obligation to pay the rent and to perform all of the other obligations to be performed by Tenant hereunder. The acceptance of rent by Landlord from any person shall not be deemed to be a waiver by Landlord of any provision of this Lease nor to be a consent to any Transfer. B. At least 30 days before a proposed Transfer is to become effective, Tenant shall give Landlord written notice of the proposed terms of such Transfer and request Landlord's approval, which notice shall include the following: (i) the name and legal composition of the proposed transferee; (ii) the latest annual and quarterly report of the transferee if the transferee is a public company, otherwise a current financial statement of the transferee and financial statements of such transferee covering the preceding three years if the same exist, and (if available) an audited financial statement of the transferee for a period ending not more than one year prior to the proposed effective date of the Transfer, all of which statements are prepared in accordance with generally accepted accounting principles; (iii) the nature of the proposed transferee's business to be carried on in the Premises; (iv) all consideration to be given on account of the Transfer; (v) a current financial statement of Tenant; and (vi) an accurately filled out response to Landlord's standard hazardous materials questionnaire. Tenant shall provide to Landlord such other information as may be reasonably requested by Landlord within seven days after Landlord's receipt of such notice from Tenant. Landlord shall respond in writing to Tenant's request for Landlord's consent to a Transfer within the later of (i) 30 days of receipt of such request together with the required accompanying documentation, or (ii) 15 days after Landlord's receipt of all information which Landlord reasonably requests within seven days after it receives Tenant's first notice regarding the Transfer in question. If Landlord fails to respond in writing within said period, then Tenant shall provide a second written notice to Tenant requesting such consent and if Landlord fails to respond within 7 days after receipt of such second notice, then Landlord will be deemed to have consented to such Transfer. Tenant shall immediately notify Landlord of any modification to the proposed terms of such Transfer, which shall also be subject Landlord's consent in accordance with the same process for obtaining Landlord's initial consent to such Transfer. C. Except for a Permitted Transfer under section 14.1F or a Transfer described in section 14.1G, in the event that Tenant seeks to make any Transfer, Landlord shall have the right to terminate this Lease or, in the case of a sublease of less than all of the Premises, terminate this Lease as to that part of the Premises proposed to be so sublet, either (i) on the condition that the proposed transferee immediately enter into a direct lease of the Premises with Landlord (or, in the case of a partial sublease, a lease for the portion proposed to be so sublet) on the same terms and conditions contained in Tenant's notice, or (ii) so that Landlord is thereafter free to lease the Premises (or, in the case of a partial sublease, the portion proposed to be so sublet) to whomever it pleases on whatever terms are acceptable to Landlord. In the event Landlord elects to so terminate this Lease, then 29 (i) if such termination is conditioned upon the execution of a lease between Landlord and the proposed transferee, Tenant's obligations under this Lease shall not be terminated until such transferee executes a new lease with Landlord, enters into possession and commences the payment of rent, and (ii) if Landlord elects simply to terminate this Lease (or, in the case of a partial sublease, terminate this Lease as to the portion to be so sublet), the Lease shall so terminate in its entirety (or as to the space to be so sublet) fifteen (15) days after Landlord has notified Tenant in writing of such election. Upon such termination, Tenant shall be released from any further obligation under this Lease if it is terminated in its entirety, or shall be released from any further obligation under the Lease with respect to the space proposed to be sublet in the case of a proposed partial sublease. In the case of a partial termination of the Lease, the Base Monthly Rent and Tenant's Share shall be reduced to an amount which bears the same relationship to the original amount thereof as the area of that part of the Premises which remains subject to the Lease bears to the original area of the Premises. Landlord and Tenant shall execute a cancellation and release with respect to the Lease to effect such termination. D. If Landlord consents to a Transfer proposed by Tenant, Tenant may enter into such Transfer, and if Tenant does so, the following shall apply: (1) Tenant shall not be released of its liability for the performance of all of its obligations under the Lease. However, Tenant shall not be liable for any obligation that accrues during any extension of this Lease beyond the initial Lease Term, unless Tenant was a party to any such extension or the Transfer was a Permitted Transfer. (2) If Tenant assigns its interest in this Lease, then Tenant shall pay to Landlord 50% of all Subrent (as defined in P. 14.1D(5)) received by Tenant over and above (i) the assignee's agreement to assume the obligations of Tenant under this Lease, and (ii) all Permitted Transfer Costs related to such assignment. In the case of assignment, the amount of Subrent owed to Landlord shall be paid to Landlord on the same basis, whether periodic or in lump sum, that such Subrent is paid to Tenant by the assignee. All Permitted Transfer Costs shall be amortized on a straight line basis over the term of such sublease (excluding any extension options) for purposes of calculating the amount due Landlord hereunder. (3) If Tenant sublets any part of the Premises, then with respect to the space so subleased, Tenant shall pay to Landlord 50% of the positive difference, if any, between (i) all Subrent paid by the subtenant to Tenant, less (ii) the sum of all Base Monthly Rent and Additional Rent allocable to the space sublet and all Permitted Transfer Costs related to such sublease. Such amount shall be paid to Landlord on the same basis, whether periodic or in lump sum, that such Subrent is paid to Tenant by its subtenant. All Permitted Transfer Costs shall be amortized on a straight line basis over the term of such sublease (excluding any extension options) for purposes of calculating the amount due Landlord hereunder. (4) Tenant's obligations under this P. 14.1D shall survive any Transfer, and Tenant's failure to perform its obligations hereunder shall be an Event of Tenant's Default. At the time Tenant makes any payment to Landlord required by this P. 14.1D, Tenant shall deliver an itemized statement of the method by which the amount to which Landlord is entitled was calculated, certified by Tenant as true and correct. Landlord shall have the right at reasonable intervals to inspect Tenant's books and records relating to the payments due hereunder. Upon request therefor, Tenant shall deliver to Landlord copies of all bills, invoices or other documents upon which its calculations are based. Landlord may condition its approval of any Transfer upon obtaining a certification from both Tenant and the proposed transferee of all Subrent and other amounts that are to be paid to Tenant in connection with such Transfer. (5) As used in this P. 14.1D, the term "Subrent" shall mean any consideration of any kind received, or to be received, by Tenant as a result of the Transfer, if such sums are related to Tenant's interest in this Lease or in the Premises, including payments from or on behalf of the transferee (in excess of the book value thereof) for Tenant's assets, fixtures, leasehold improvements, inventory, accounts, goodwill, equipment, furniture, and general intangibles. As used in this P. 14.1D, the term "Permitted Transfer Costs" shall mean (i) all reasonable leasing commissions paid to third parties not affiliated with Tenant in order to obtain the Transfer in question, and (ii) all reasonable attorneys' fees incurred by Tenant with respect to the Transfer in question, and (iii) the unamortized cost of the Tenant Improvements (as defined in Exhibit B attached hereto) to the extent the cost for such Tenant Improvements were in excess of Landlord's Allowances (as defined in Exhibit B attached hereto). 30 E. If Tenant is a corporation, the following shall be deemed a voluntary assignment of Tenant's interest in this Lease: (i) any dissolution, merger, consolidation, or other reorganization of or affecting Tenant, whether or not Tenant is the surviving corporation; and (ii) if the capital stock of Tenant is not publicly traded, the sale or transfer to one person or entity (or to any group of related persons or entities) stock possessing more than 50% of the total combined voting power of all classes of Tenant's capital stock issued, outstanding and entitled to vote for the election of directors. If Tenant is a partnership, limited liability company or other entity any withdrawal or substitution (whether voluntary, involuntary or by operation of law, and whether occurring at one time or over a period of time) of any partner, member or other party owning 25% or more (cumulatively) of any interest in the capital or profits of the partnership, limited liability company or other entity or the dissolution of the partnership, limited liability company or other entity, shall be deemed a voluntary assignment of Tenant's interest in this Lease. F. Notwithstanding anything contained in P. 14.1, so long as Tenant otherwise complies with the provisions of P. 14.1 Tenant may enter into any of the following transfers (a "Permitted Transfer") without Landlord's prior written consent, and Landlord shall not be entitled to terminate the Lease pursuant to P. 14.1C or to receive any part of any Subrent resulting therefrom that would otherwise be due it pursuant to P. 14.1D: (1) Tenant may sublease all or part of the Premises or assign its interest in this Lease to any corporation which controls, is controlled by, or is under common control with the original Tenant to this Lease by means of an ownership interest of more than 50%; (2) Tenant may assign its interest in the Lease to a corporation which results from a merger, consolidation or other reorganization in which Tenant is not the surviving corporation, so long as the surviving corporation has a net worth at the time of such assignment that is equal to or greater than the net worth of Tenant immediately prior to such transaction; and (3) Tenant may assign this Lease to a corporation which purchases or otherwise acquires all or substantially all of the assets of Tenant, so long as such acquiring corporation has a net worth at the time of such assignment that is equal to or greater than the net worth of Tenant immediately prior to such transaction. G. Notwithstanding anything to the contrary, the merger of All American Semiconductor, Inc. (the parent corporation of Tenant) with a wholly owned subsidiary of Reptron Electronics, Inc. during the first year following the Commencement Date, shall not constitute a Transfer requiring the Landlord's consent or be subject to the bonus rent provisions of section 14.1D(2) and (3) or the recapture provisions of section 14.1C, or similar provisions under the Devcon Lease. In addition, so long as Tenant otherwise complies with the provisions of P. 14.1, the recapture provisions of section 14.1C shall not apply to a sublease by Tenant to another party for any portion of the space located in front of the Zanker Road Space consisting of approximately 6,000 square feet of space, as outlined in Exhibit B-1 attached to the Work Letter attached hereto as Exhibit B. 14.2 TRANSFER BY LANDLORD: Landlord and its successors in interest shall have the right to transfer their interest in this Lease and the Project at any time and to any person or entity. In the event of any such transfer, the Landlord originally named herein (and, in the case of any subsequent transfer, the transferor) from the date of such transfer, shall be automatically relieved, without any further act by any person or entity, of all liability for the performance of the obligations of the Landlord hereunder which may accrue after the date of such transfer. After the date of any such transfer, the term "Landlord" as used herein shall mean the transferee of such interest in the Premises. 31 ARTICLE 15 GENERAL PROVISIONS 15.1 LANDLORD'S RIGHT TO ENTER: Landlord and its agents may enter the Premises at any reasonable time after giving at least 24 hours' prior notice to Tenant (and immediately in the case of emergency) for the purpose of: (i) inspecting the same; (ii) posting notices of non-responsibility; (iii) supplying any service to be provided by Landlord to Tenant; (iv) showing the Premises to prospective purchasers, mortgagees or tenants; (v) making necessary alterations, additions or repairs; (vi) performing Tenant's obligations when Tenant has failed to do so after written notice from Landlord; (vii) placing upon the Premises ordinary "for lease" signs or "for sale" signs; and (viii) responding to an emergency. Landlord shall have the right to use any and all means Landlord may deem necessary and proper to enter the Premises in an emergency. Any entry into the Premises obtained by Landlord in accordance with this P. 15.1 shall not be a forcible or unlawful entry into, or a detainer of, the Premises, or an eviction, actual or constructive, of Tenant from the Premises. 15.2 SURRENDER OF THE PREMISES: Upon the expiration or sooner termination of this Lease, Tenant shall vacate and surrender the Premises to Landlord in the same condition as existed at the Commencement Date, except for (i) reasonable wear and tear, (ii) damage caused by any peril or condemnation, and (iii) contamination by Hazardous Materials for which Tenant is not responsible pursuant to P. 7.2A or P. 7.2B. In this regard, normal wear and tear shall be construed to mean wear and tear caused to the Premises by the natural aging process which occurs in spite of prudent application of the best standards for maintenance, repair and janitorial practices, and does not include items of neglected or deferred maintenance. In any event, Tenant shall cause the following to be done prior to the expiration or the sooner termination of this Lease: (i) all interior walls shall be cleaned or if necessary painted to appear in good condition, reasonable wear and tear excepted; (ii) all tiled floors shall be cleaned and waxed; (iii) all carpets shall be cleaned and shampooed; (iv) all broken, marred, stained or nonconforming acoustical ceiling tiles shall be replaced; (v) all exterior and interior windows shall be washed; (vi) the HVAC system shall be serviced by a reputable and licensed service firm and left in good operating condition and repair as so certified by such firm; and (vii) the plumbing and electrical systems and lighting shall be placed in good order and repair (including replacement of any burned out, discolored or broken light bulbs, ballasts, or lenses). If Landlord so requests, Tenant shall, prior to the expiration or sooner termination of this Lease, (i) remove any Tenant's Alterations which Tenant is required to remove pursuant to P. 5.2 and repair all damage caused by such removal, and (ii) return the Premises or any part thereof to its original configuration existing as of the time the Premises were delivered to Tenant with the Tenant Improvements completed, except for any portion of the Tenant Improvements that Landlord notifies Tenant at the time Landlord approves of the Construction Plans for the Tenant Improvements must be removed by Tenant at or prior to the expiration or earlier termination of this Lease. If the Premises are not so surrendered at the termination of this Lease, Tenant shall be liable to Landlord for all costs incurred by Landlord in returning the Premises to the required condition, plus interest on all costs incurred at the Agreed Interest Rate. Tenant shall indemnify Landlord against loss or liability resulting from delay by Tenant in so surrendering the Premises, including, without limitation, any claims made by any succeeding tenant or losses to Landlord due to lost opportunities to lease to succeeding tenants only if there is a delay of more than thirty (30) days in completing such work. 32 15.3 HOLDING OVER: This Lease shall terminate without further notice at the expiration of the Lease Term. Any holding over by Tenant after expiration of the Lease Term shall not constitute a renewal or extension of the Lease or give Tenant any rights in or to the Premises except as expressly provided in this Lease. Any holding over after such expiration with the written consent of Landlord shall be construed to be a tenancy from month to month on the same terms and conditions herein specified insofar as applicable except that Base Monthly Rent shall be increased to an amount equal to 150% of the greater of (a) the Base Monthly Rent payable during the last full calendar month of the Lease Term, or (b) the then prevailing fair market rent. 15.4 SUBORDINATION: The following provisions shall govern the relationship of this Lease to any Security Instrument: A. The Lease is subject and subordinate to all Security Instruments existing as of the Effective Date. However, if any Lender so requires, this Lease shall become prior and superior to any such Security Instrument. B. At Landlord's election, this Lease shall become subject and subordinate to any Security Instrument created after the Effective Date. Notwithstanding such subordination, Tenant's right to quiet possession of the Premises shall not be disturbed so long as Tenant is not in default and performs all of its obligations under this Lease, unless this Lease is otherwise terminated pursuant to its terms. C. Tenant shall upon request execute any document or instrument required by any Lender to make this Lease either prior or subordinate to a Security Instrument, which may include such other matters as the Lender customarily and reasonably requires in connection with such agreements, including provisions that the Lender not be liable for (i) the return of any security deposit unless the Lender receives it from Landlord, and (ii) any defaults on the part of Landlord occurring prior to the time the Lender takes possession of the Project in connection with the enforcement of its Security Instrument, except that such Lender shall be responsible for correcting any continuing default in the nature of the failure of Landlord to repair the Building or Common Areas for which Tenant has previously provided Landlord and such Lender with notice of default. Tenant's failure to execute any such document or instrument within 15 days after written demand therefor shall constitute an Event of Tenant's Default. Landlord shall request the beneficiary (or its servicer) of the deed of trust that encumbers the Project as of the date hereof issue its subordination, non-disturbance and attornment agreement ("SNDA"), pursuant to which such beneficiary agrees to recognize this Lease in the event of default under such deed of trust or sale under such deed of trust, so long as Tenant is not in default hereunder beyond the expiration of any applicable cure period. The failure of such beneficiary to issue its SNDA shall not be grounds to terminate this Lease or afford Tenant any right or remedy against Landlord. Tenant shall be responsible for paying any legal fees or charges required by beneficiary to issue such SNDA. 15.5 MORTGAGEE PROTECTION AND ATTORNMENT: In the event of any default on the part of the Landlord, Tenant will use reasonable efforts to give notice by certified mail to any Lender whose name has been provided to Tenant and shall offer such Lender a reasonable opportunity to cure the default, including time to obtain possession of the Premises by power of sale or judicial foreclosure or other appropriate legal proceedings, if such should prove necessary to effect a cure. Tenant shall attorn to any purchaser of the Premises at any foreclosure sale or private sale conducted pursuant to any Security Instrument encumbering the Premises, or to any grantee or transferee designated in any deed given in lieu of foreclosure. 15.6 ESTOPPEL CERTIFICATES AND FINANCIAL STATEMENTS: At all times during the Lease Term, each party agrees, following any request by the other party, promptly to execute and deliver to the requesting party within 15 days following delivery of such request an estoppel certificate: (i) certifying that this Lease is unmodified and in full force and effect or, if modified, stating the nature of such modification and certifying that this Lease, as so modified, is in full force and effect, (ii) stating the date to which the rent and other charges are paid in advance, if any, (iii) acknowledging that there are not, to the certifying party's knowledge, any uncured defaults on the part of any party hereunder or, if there are uncured defaults, specifying the nature of such defaults, and (iv) certifying such other factual information about the Lease as may be reasonably required by the requesting party. A failure to deliver an estoppel certificate within 15 days after delivery of a request therefor shall be a conclusive admission that, as of the date of the request for such statement: (i) this Lease is unmodified except as may be represented by the requesting party in said request and is in full force and effect, (ii) there are no uncured defaults in the requesting party's performance, and (iii) no rent has been paid more than 30 days in advance. At any time during the Lease Term Tenant shall, upon 15 days' prior written notice from Landlord, provide Tenant's most recent annual and quarterly reports if Tenant is a public company, otherwise a current financial statement and financial statements covering the 24 month period prior to the date of such most recent financial statement to any existing Lender or to any potential Lender or buyer of the Premises. 33 15.7 INTENTIONALLY DELETED. 15.8 NOTICES: Any notice required or desired to be given regarding this Lease shall be in writing and may be given by personal delivery, by facsimile, by courier service, or by mail. A notice shall be deemed to have been given (i) when delivered if given by personal delivery, including overnight courier service, and (ii) in all other cases when actually received at the party's Address for Notices or on date delivery is refused. Either party may change its address by giving notice of the same in accordance with this P. 15.8, provided, however, that any address to which notices may be sent must be a California address. 15.9 ATTORNEYS' FEES: In the event either Landlord or Tenant shall bring any action or legal proceeding for an alleged breach of any provision of this Lease, to recover rent, to terminate this Lease or otherwise to enforce, protect or establish any term or covenant of this Lease, the prevailing party shall be entitled to recover as a part of such action or proceeding, or in a separate action brought for that purpose, reasonable attorneys' fees, court costs, and experts' fees as may be fixed by the court. 15.10 CORPORATE AUTHORITY: If Tenant is a corporation (or partnership), each individual executing this Lease on behalf of Tenant represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of such corporation in accordance with the by-laws of such corporation (or partnership in accordance with the partnership agreement of such partnership) and that this Lease is binding upon such corporation (or partnership) in accordance with its terms. Each of the persons executing this Lease on behalf of a corporation does hereby covenant and warrant that the party for whom it is executing this Lease is a duly authorized and existing corporation, that it is qualified to do business in California, and that the corporation has full right and authority to enter into this Lease. 15.11 MISCELLANEOUS: Should any provision of this Lease prove to be invalid or illegal, such invalidity or illegality shall in no way affect, impair or invalidate any other provision hereof, and such remaining provisions shall remain in full force and effect. Time is of the essence with respect to the performance of every provision of this Lease in which time of performance is a factor. The captions used in this Lease are for convenience only and shall not be considered in the construction or interpretation of any provision hereof. Any executed copy of this Lease shall be deemed an original for all purposes. This Lease shall, subject to the provisions regarding assignment, apply to and bind the respective heirs, successors, executors, administrators and assigns of Landlord and Tenant. "Party" shall mean Landlord or Tenant, as the context implies. If Tenant consists of more than one person or entity, then all members of Tenant shall be jointly and severally liable hereunder. This Lease shall be construed and enforced in accordance with the laws of the State of California. The language in all parts of this Lease shall in all cases be construed as a whole according to its fair meaning, and not strictly for or against either Landlord or Tenant. When the context of this Lease requires, the neuter gender includes the masculine, the feminine, a partnership or corporation or joint venture, and the singular includes the plural. The terms "shall", "will" and "agree" are mandatory. The term "may" is permissive. When a party is required to do something by this Lease, it shall do so at its sole cost and expense without right of reimbursement from the other party unless a provision of this Lease expressly requires reimbursement. Landlord and Tenant agree that (i) the gross leasable area of the Premises includes any atriums, depressed loading docks, covered entrances or egresses, and covered loading areas, (ii) each has had an opportunity to determine to its satisfaction the actual area of the Project and the Premises, (iii) all measurements of area contained in this Lease are conclusively agreed to be correct and binding upon the parties, even if a subsequent measurement of any one of these areas determines that it is more or less than the amount of area reflected in this Lease, and (iv) any such subsequent determination that the area is more or less than shown in this Lease shall not result in a change in any of the computations of rent, improvement allowances, or other matters described in this Lease where area is a factor. Where a party hereto is obligated not to perform any act, such party is also obligated to restrain any others within its control from performing said act, including the Agents of such party. Landlord shall not become or be deemed a partner or a joint venturer with Tenant by reason of the provisions of this Lease. 15.12 TERMINATION BY EXERCISE OF RIGHT: If this Lease is terminated pursuant to its terms by the proper exercise of a right to terminate specifically granted to Landlord or Tenant by this Lease, then this Lease shall terminate 30 days after the date the right to terminate is properly exercised (unless another date is specified in that part of the Lease creating the right, in which event the date so specified for termination shall prevail), the rent and all other charges due hereunder shall be prorated as of the date of termination, and neither Landlord nor Tenant shall have any further rights or obligations under this Lease except for those that have accrued prior to the date of termination or those obligations which this Lease specifically provides are to survive termination. This P. 15.12 does not apply to a termination of this Lease by Landlord as a result of an Event of Tenant's Default. 34 15.13 BROKERAGE COMMISSIONS: Each party hereto (i) represents and warrants to the other that it has not had any dealings with any real estate brokers, leasing agents or salesmen, or incurred any obligations for the payment of real estate brokerage commissions or finder's fees which would be earned or due and payable by reason of the execution of this Lease, other than to the Retained Real Estate Brokers described in SECTION S of the Summary, and (ii) agrees to indemnify, defend, and hold harmless the other party from any claim for any such commission or fees which result from the actions of the indemnifying party. Landlord shall be responsible for the payment of any commission owed to the Retained Real Estate Brokers if there is a separate written commission agreement between Landlord and the Retained Real Estate Brokers for the payment of a commission as a result of the execution of this Lease. 15.14 FORCE MAJEURE: Any prevention, delay or stoppage due to strikes, lock-outs, inclement weather, labor disputes, inability to obtain labor, materials, fuels or reasonable substitutes therefor, governmental restrictions, regulations, controls, action or inaction, civil commotion, fire or other acts of God, and other causes beyond the reasonable control of Landlord or Tenant (except financial inability) shall excuse the performance by Landlord or Tenant, for a period equal to the period of any said prevention, delay or stoppage, of any obligation hereunder, except Tenant shall not be excused form the payment of rent or any other sum under this Lease. 15.15 ENTIRE AGREEMENT: This Lease constitutes the entire agreement between the parties, and there are no binding agreements or representations between the parties except as expressed herein. Tenant acknowledges that neither Landlord nor Landlord's Agents has made any legally binding representation or warranty as to any matter except those expressly set forth herein, including any warranty as to (i) whether the Premises may be used for Tenant's intended use under existing Law, (ii) the suitability of the Premises or the Project for the conduct of Tenant's business, or (iii) the condition of any improvements. There are no oral agreements between Landlord and Tenant affecting this Lease, and this Lease supersedes and cancels any and all previous negotiations, arrangements, brochures, agreements and understandings, if any, between Landlord and Tenant or displayed by Landlord to Tenant with respect to the subject matter of this Lease. This instrument shall not be legally binding until it is executed by both Landlord and Tenant. No subsequent change or addition to this Lease shall be binding unless in writing and signed by Landlord and Tenant. 15.16 WAIVER OF LANDLORD'S LIEN. Landlord agrees to waives its "landlord's lien" or any other statutory lien, contractual lien or security interest given by law or this Lease to Landlord in any equipment, furniture, trade fixtures, inventory, supplies or personal property of Tenant now or hereafter placed in or upon the Premises. Upon Tenant's request, Landlord agrees to cooperate with Tenant's third party lender's request in executing a consent to such financing and removal of such furniture, trade fixtures and equipment, provided such form of consent (a) does not require the delivery to such lender of notice of any default by Tenant, (b) does not permit any auction, bulk sale or similar sale at the Premises or Project, (c) provides for an indemnity by such lender to Landlord for any injury to any person or damage to any property, including, without limitation, the Project caused by such lender or its agents, consultants or contractors and (d) is acceptable to Landlord in its good faith discretion. 15.17 LANDLORD'S REPRESENTATIONS. Landlord represents and warrants to Tenant that as of the date hereof: (a) Landlord is the sole owner of fee simple title to the Project, subject to all liens, encumbrances, rights of way, easements, restrictions and other matters of record; and (b) Landlord has full power and authority, and has taken all necessary action, to execute, deliver and perform under this Lease. IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease with the intent to be legally bound thereby, to be effective as of the Effective Date. LANDLORD: TENANT: By: SAN JOSE TECHNOLOBY PROPERTIES, LLC By: ALL AMERICAN SEMICONDUCTOR a Delaware limited liability company OF NORTHERN CALIFORNIA, INC. a California corporation By: Divco West Group, LLC, a Delaware limited By: /s/ BRUCE M. GOLDBERG liability company ----------------------- Its Manager Name: BRUCE M. GOLDBERG Title: PRES. & CEO By: /s/ SCOTT SMITHERS ---------------------------- Name: Scott Smithers Its: President 35 ADDENDUM NO. 1 This ADDENDUM NO. 1 (this "Addendum") is made in connection with and is a part of that certain Lease, dated as of October 1, 1998, by and between ALL AMERICAN SEMICONDUCTOR OF NORTHERN CALIFORNIA, INC., a California corporation, as Tenant, and SAN JOSE TECHNOLOGY PROPERTIES, LLC, a Delaware limited liability company, as Landlord (the "Lease"). 1. DEFINITIONS AND CONFLICT. All capitalized terms referred to in this Addendum shall have the same meaning as provided in the Lease, except as expressly provided to the contrary in this Addendum. In case of any conflict between any term or provision of the Lease and any exhibits attached thereto and this Addendum, this Addendum shall control. 2. OPTION TO EXTEND AND RENT DURING THE EXTENDED PERIOD: Tenant shall have one (1) option to extend the term of the Lease for a period of five (5) years (the period shall be referred to as the "Extension Period") by giving written notice of exercise of such option ("Extension Option Notice") at least one hundred eighty (180) days, but not more than three hundred sixty-five (365) days, prior to the expiration of the initial Lease Term. The Extension Period shall commence, if at all, immediately following the expiration of the initial Lease Term. If Tenant is in default (after notice and the expiration of the applicable cure period) under any term or provision of the Lease on the date of giving an Extension Option Notice, or if Tenant is in default (after notice and the expiration of the applicable cure period) under any term or provision of the Lease on the date of the applicable Extension Period is to commence, the Extension Period at the option of Landlord shall not commence and the Lease shall expire at the end of initial Lease Term. The Extension Period shall be upon all of the terms and provisions of the Lease, except that the Base Monthly Rent during such Extension Period shall be one hundred percent (100%) of then Fair Market Rent. Tenant may not rescind, cancel, terminate or modify its Extension Option Notice once given. 2.1 FAIR MARKET RENT. The term "Fair Market Rent" for purposes of determining Base Monthly Rent during the Extension Period shall mean the greater of (i) the Base Monthly Rent payable during the last month prior to the commencement of the Extension Period, or (ii) the base monthly rent generally applicable to similar leases in like buildings with annual increases in base monthly rent for space of comparable size, age, quality of the Premises in the San Jose, California area within the boundaries of Highways 237, 880 and 101, projected as of the first day of the Extension Period by giving due consideration for the quality of the Building and improvements therein (including the quality of the then existing improvements in the Premises), for a term comparable to the Extension Period at the time the commencement of the Extension Period is scheduled to commence, without any deduction for amortization or cost of Tenant improvements or commissions whether or not incurred by Landlord, and otherwise subject to the terms and conditions of this Lease that will be applicable during the Extension Period. 2.2 PROCEDURE TO DETERMINE FAIR MARKET RENT. Landlord shall notify Tenant in writing of Landlord's determination of the Fair Market Rent ("Landlord's FMR") after receipt of the Extension Option Notice. Within thirty (30) days after receipt of such written notice of Landlord's FMR, Tenant shall have the right either to: (i) accept Landlord's FMR, or (ii) elect to have the Fair Market Rent determined in accordance with the appraisal procedure set forth below. The failure of Tenant to provide written notice of its election under the preceding sentence shall be deemed an acceptance of Landlord's FMR. The election (or deemed election ) by Tenant under this section shall be non-revocable and binding on the parties. 36 2.3 APPRAISERS. If Tenant has elected to have the Fair Market Rent determined by an appraisal, then within ten (10) days after receipt of Tenant's written notice of such an election, each party, by giving written notice to the other party, shall appoint an appraiser to render a written opinion of the Fair Market Rent for the Extension Period. Each appraiser must be a member of the Appraisal Institute of America (MAI) for at least five years and with at least five years experience in the appraisal of rental rates of similar commercial buildings in the area in which the Building is located and otherwise unaffiliated with either Landlord or Tenant. The two appraisers shall render their written opinion of the Fair Market Rent for the Extension Period to Landlord and Tenant within thirty (30) days after the appointment of the second appraiser. If the Fair Market Rent of each appraiser is within five percent (5%) of each other, then the average of the two appraisals of Fair Market Rent shall be the Base Monthly Rent for the Extension Period. If one party does not appoint its appraiser as provided above, then the one appointed shall determine the Fair Market Rent. The Fair Market Rent so determined under this section shall be binding on Landlord and Tenant. 2.4 THIRD APPRAISER. If the Fair Market Rent determined by the appraisers is more than five percent (5%) apart, then the two appraisers shall pick a third appraiser within ten (10) days after the two appraisers have rendered their opinions of Fair Market Rent as provided above. If the two appraisers are unable to agree on the third appraiser within said ten (10) day period, Landlord and Tenant shall mutually agree on the third appraiser within ten (10) days thereafter. The third appraiser shall be a person who has not previously acted in any capacity for either party and must meet the qualifications stated above. 2.5 IMPARTIAL APPRAISAL. Within thirty (30) days after its appointment, the third appraiser shall render its written opinion of the Fair Market Rent for the Extension Period ("Third Opinion"). If the Fair Market Rent set forth in the Third Opinion is equidistant from the Fair Market Rent made by Landlord's or Tenant's appraiser, then the Fair Market Rent contained in the Third Opinion shall be the Fair Market Rent during the Extension Period. Otherwise, the Fair Market Rent of Landlord's or Tenant's appraiser that is closest to the Fair Market Rent of the Third Opinion shall be averaged with the Fair Market Rent of Third Option to determine the Fair Market Rent during the Extension Period. 2.6 APPRAISAL COSTS. Each party shall bear the cost of its own appraiser and one-half (1/2) the cost of the third appraiser. 2.7 ACKNOWLEDGMENT OF RENT. After the Fair Market Rent for the Extension Period has been established in accordance with the foregoing procedure, Landlord and Tenant shall promptly execute an amendment to the Lease to reflect the Base Monthly Rent for the Extension Period. 2.8 OPTION PERSONAL. The option to extend under this Addendum is applicable only for the original party signing the Lease as "Tenant" as of the date of the Lease and such Tenant's transferee under a Permitted Transfer as defined in sections 14.1F or 14.1G of the Lease, but may not be relied upon or exercise by any other assignee, sublessee, transferee under a Transfer or any other successor to Tenant. 37 EX-10.18 3 EXHIBIT 10.18 Exhibit 10.18 AMENDMENT NO. 4 TO LOAN AND SECURITY AGREEMENT March 23, 1999 All American Semiconductor, Inc. 16115 Northwest 52nd Avenue Miami, Florida 33014 Attention: Chief Financial Officer Ladies and Gentlemen: Reference is made to the Loan and Security Agreement dated as of May 3, 1996 among Harris Trust and Savings Bank, as a Lender and as Administrative Agent for the Lenders, American National Bank and Trust Company of Chicago, as a Lender and as Collateral Agent for the Lenders and the other Lenders party thereto and All American Semiconductor, Inc., as amended to date (the "Loan Agreement"). Unless defined herein, capitalized terms used herein shall have the meanings provided for such terms in the Loan Agreement. Borrower has requested that Requisite Lenders agree to amend the Loan Agreement in order to modify certain financial covenants contained in the Loan Agreement and certain related definitions. Requisite Lenders have agreed to the foregoing on the terms and pursuant to the conditions provided herein. Therefore, the parties hereto hereby agree as follows: 1. AMENDMENTS TO LOAN AGREEMENT. The Loan Agreement is hereby amended, as follows: (a) SECTION 1.1. The definition of the term "Debt Service Coverage Ratio" contained in Section 1.1 of the Loan Agreement is hereby amended and restated, as follows: " 'DEBT SERVICE COVERAGE RATIO' shall mean, with respect to the Designated Companies for any period, the ratio of (a) the sum of (i) Net Income from continuing and discontinued operations before interest expense and taxes, PLUS (ii) depreciation and amortization expenses, MINUS (iii) tax payments, MINUS (iv) capital expenditures, to the extent not financed, MINUS (v) dividends paid, and PLUS (vi) with respect only to calculations made for the testing periods ending on each of December 31, 1998, March 31, 1999, June 30, 1999 and September 30, 1999, charges taken in the 1998 fiscal year and associated with the proposed Reptron Merger, to (b) the sum of (i) all interest payments in respect of the Revolving Loans PLUS (ii) all payments of principal and interest in respect of capitalized leases and other long-term indebtedness of the Designated Companies, including without limitation the Junior Debt (but specifically excluding principal payments in respect of the Revolving Loans), all determined for such period on a consolidated basis and in accordance with GAAP." (b) SECTION 8.12. Clause (ii) of Section 8.12 of the Loan Agreement is hereby amended and restated in its entirety, as follows: "(ii) Five Million Dollars ($5,000,000) for the 1999 fiscal year or any fiscal year thereafter." (c) SECTION 8.17. The table contained in Section 8.17 of the Loan Agreement is hereby amended and restated in its entirety, as follows: "PERIOD AMOUNT ------- ------ December 31, 1998 through and including $24,400,000 December 30, 1999 December 31, 1999 through and including $26,000,000 December 30, 2000 December 31, 2000 through and including $27,600,000 December 30, 2001 December 31, 2001 through and including $29,200,000" May 3, 2002 (d) SCOPE. This Amendment No. 4 to Loan and Security Agreement shall have the effect of amending the Loan Agreement and the other Financing Agreements as appropriate to express the agreements contained herein. In all other respects, the Loan Agreement and the other Financing Agreements shall remain in full force and effect in accordance with their respective terms. 2. CONDITIONS TO EFFECTIVENESS. This Amendment No. 4 to Loan and Security Agreement shall be effective immediately upon the execution hereof by Requisite Lenders, the acceptance hereof by each Borrower and each Guarantor, and the delivery hereof to the Administrative Agent, at 111 West Monroe Street, Chicago, Illinois 60603, Attention: Mr. William Kane, Vice President, on or before March 23, 1999. Very truly yours, HARRIS TRUST AND SAVINGS BANK, as Administrative Agent and a Lender Pro Rata Share: 25% By: /s/ WILLIAM J. KANE ------------------------------------- Its: Vice President ------------------------------------- AMERICAN NATIONAL BANK AND TRUST COMPANY OF CHICAGO, as Collateral Agent and a Lender Pro Rata Share: 25% By: /s/ M. MARTHA GASKIN ------------------------------------- Its: Vice President ------------------------------------- -2- FLEET BUSINESS CREDIT CORPORATION, formerly known as SANWA BUSINESS CREDIT CORPORATION, as a Lender Pro Rata Share: 12.5% By: /s/ DANIEL J. MANELLA ------------------------------------- Its: Vice President ------------------------------------- MERCANTILE BUSINESS CREDIT, INC., as a Lender Pro Rata Share: 12.5% By: ------------------------------------- Its: ------------------------------------- BNY FINANCIAL CORPORATION, as a Lender Pro Rata Share: 12.5% By: /s/ A. VIOLA ------------------------------------- Its: Vice President ------------------------------------- NATIONSBANK, N.A., successor by merger to NATIONSBANK OF TEXAS, N.A., as a Lender Pro Rata Share: 12.5% By: ------------------------------------- Its: ------------------------------------- Acknowledged and agreed to as of this 23rd day of March, 1999. ALL AMERICAN SEMICONDUCTOR, INC. By: /s/ HOWARD L. FLANDERS --------------------------------- Its: EVP & CFO --------------------------------- -3- ACKNOWLEDGMENT AND ACCEPTANCE OF GUARANTORS Each of the undersigned, in its capacity as a Guarantor of the Liabilities of Borrowers to Agents and Lenders under the Loan Agreement, hereby acknowledges receipt of the foregoing Amendment No. 4 to Loan and Security Agreement, accepts and agrees to be bound by the terms thereof, ratifies and confirms all of its obligations under the Master Corporate Guaranty executed by it and agrees that such Master Corporate Guaranty shall continue in full force and effect as to it, notwithstanding such amendment. Dated: March 23, 1999 Each of the Subsidiaries of All American Semiconductor, Inc. By: /s/ HOWARD L. FLANDERS ----------------------------- Its: EVP & CFO ----------------------------- -4- EX-11.1 4 EXHIBIT 11.1
ALL AMERICAN SEMICONDUCTOR, INC. AND SUBSIDIARIES EXHIBIT 11.1 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS (UNAUDITED) YEARS ENDED DECEMBER 31 1998 1997 1996 - ------------------------------------------------------------------------------------------------------------------- BASIC EARNINGS (LOSS) PER SHARE: Net Income (Loss)............................................ $ 831,000 $ 3,250,000 $ (9,920,000) =============== =============== ================ Weighted Average Shares Outstanding.......................... 19,685,106 19,672,559 19,742,849 =============== =============== ================ Basic Earnings (Loss) Per Share.............................. $ .04 $ .17 $ (.50) ====== ====== ======= DILUTED EARNINGS (LOSS) PER SHARE: Net Income (Loss)............................................ $ 831,000 $ 3,250,000 $ (9,920,000) =============== =============== ================ Weighted Average and Dilutive Shares: Weighted average shares outstanding........................ 19,685,106 19,672,559 19,742,849 Dilutive shares............................................ 308,903 112,278 362,912 --------------- --------------- ---------------- 19,994,009 19,784,837 20,105,761 =============== =============== ================ Diluted Earnings (Loss) Per Share............................ $ .04 $ .16 $ (.49) ====== ====== ======
EX-21.1 5 EXHIBIT 21.1 ALL AMERICAN SEMICONDUCTOR, INC. EXHIBIT 21.1 LIST OF SUBSIDIARIES NAME JURISDICTION OF INCORPORATION Access Micro Products, Inc. Delaware All American Added Value, Inc. California All American A.V.E.D., Inc. Colorado All American Semiconductor of Atlanta, Inc. Georgia All American Semiconductor of Canada, Inc. Canada All American Semiconductor of Chicago, Inc. Illinois All American Semiconductor of Florida, Inc. Florida All American Semiconductor of Huntsville, Inc. Alabama All American Semiconductor of Massachusetts, Inc. Massachusetts All American Semiconductor of Michigan, Inc. Michigan All American Semiconductor of Minnesota, Inc. Minnesota All American Semiconductor of New York, Inc. New York All American Semiconductor of Ohio, Inc. Ohio All American Semiconductor of Philadelphia, Inc. New Jersey All American Semiconductor of Phoenix, Inc. Arizona All American Semiconductor of Portland, Inc. Oregon All American Semiconductor of Rockville, Inc. Maryland All American Semiconductor of Salt Lake, Inc. Utah All American Semiconductor of Texas, Inc. Texas All American Semiconductor-Northern California, Inc. California All American Semiconductor of Washington, Inc. Washington All American Semiconductor of Wisconsin, Inc. Wisconsin All American Technologies, Inc. Florida All American Transistor of California, Inc. California Aved Industries, Inc. California Palm Electronics Manufacturing Corp. Florida EX-23.1 6 EXHIBIT 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS EXHIBIT 23.1 All American Semiconductor, Inc. We hereby consent to the incorporation in the Company's previously filed Registration Statement on Form S-8 of our report dated March 5, 1999, except as to Note 14, the date of which is March 17, 1999 and Note 7, the date of which is March 23, 1999, relating to the consolidated financial statements of All American Semiconductor, Inc. and Subsidiaries included in this Form 10-K for the fiscal year ended December 31, 1998 and to the reference to our firm under the caption "Experts" in such Registration Statement. /s/ LAZAR LEVINE & FELIX LLP - ---------------------------- Lazar Levine & Felix LLP New York, New York March 31, 1999 EX-27.1 7 FINANCIAL DATA SCHEDULE
5 The schedule contains summary financial information from the Registrant's consolidated financial statements as of and for the year ended December 31, 1998, and is qualified in its entirety by reference to such consolidated financial statements. 0000818074 ALL AMERICAN SEMICONDUCTOR, INC. 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 473 0 39,233 1,412 69,063 109,931 10,120 5,614 118,957 41,739 50,709 0 0 199 26,310 118,957 250,044 250,044 194,599 194,599 46,089 791 4,313 1,392 561 831 0 0 0 831 .04 .04
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