-----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, JNmH+n397j4LF3qDDAx+Wv3AvsdXFryz4MSQ5QOTQPYOqgTW08bdYQPiUxQYARwv gJ8urpeeDqx1Psh3adYa/w== 0000891618-98-005361.txt : 19981217 0000891618-98-005361.hdr.sgml : 19981217 ACCESSION NUMBER: 0000891618-98-005361 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981216 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTEGRATED SILICON SOLUTION INC CENTRAL INDEX KEY: 0000854701 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 770199971 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-23084 FILM NUMBER: 98770763 BUSINESS ADDRESS: STREET 1: 2231 LAWSON LANE CITY: SANTA CLARA STATE: CA ZIP: 95054-3311 BUSINESS PHONE: 4085880800 MAIL ADDRESS: STREET 1: 680 ALMANOR AVE CITY: SUNNYVALE STATE: CA ZIP: 94086 10-K405 1 FORM 10-K FOR THE YEAR ENDED SEPTEMBER 9, 1998 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended _____September 30, 1998_____ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934] For the transition period from ______________________ to ______________________ Commission file number 0-23084 INTEGRATED SILICON SOLUTION, INC. ------------------------------------------------------ (Exact name of Registrant as specified in its charter) DELAWARE 77-0199971 ------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2231 Lawson Lane, Santa Clara, California 95054. ----------------------------------------- -------- (Address of principal executive offices) zip code Registrant's telephone number, including area code (408) 588-0800 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered COMMON STOCK, PAR VALUE $0.0001 PER SHARE NASDAQ NATIONAL MARKET ----------------------------------------- ----------------------
Securities registered pursuant to Section 12(g) of the Act: NONE ------------------------------ (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing price of such stock on November 28, 1997, as reported by the Nasdaq National Market, was approximately $159.5 million. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. The number of outstanding shares of the registrant's Common Stock on December 1, 1998 was 19,417,827. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Registrant's 1998 Annual Meeting of Stockholders to be held on January 29, 1999 are incorporated by reference in Part III of this Form 10-K. 2 TABLE OF CONTENTS PART I Item 1. Business................................................................................1 Item 2. Properties..............................................................................9 Item 3. Legal Proceedings.......................................................................9 Item 4. Submission of Matters to a Vote of Security Holders.....................................9 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters...............10 Item 6. Selected Consolidated Financial Data....................................................11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..............................................................................11 Item 8. Financial Statements and Supplementary Data.............................................22 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure..............................................................................44 PART III Item 10. Directors and Executive Officers of the Registrant......................................44 Item 11. Executive Compensation..................................................................44 Item 12. Security Ownership of Certain Beneficial Owners and Management..........................44 Item 13. Certain Relationships and Related Transactions..........................................44 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.........................44 SIGNATURES.........................................................................................47
3 When used in this Report, the words "expects," "anticipates," "believes," "estimates" and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements, which include statements concerning the timing of new product introductions; the functionality and availability of products under development; trends in the networking, telecommunications, personal computer and instrumentation markets, in particular as they may affect demand for or pricing of the Company's products; the percentage of export sales and sales to strategic customers; the percentage of revenue by product line; and the availability and cost of products from the Company's suppliers; are subject to risks and uncertainties, including those set forth in Item 1 of Part I and in Item 7 of Part II hereof entitled "Certain Factors Which May Affect the Company's Business or Future Operating Results" and elsewhere in this Report, that could cause actual results to differ materially from those projected in the forward-looking statements. These forward-looking statements speak only as of the date of this Report. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the Company's expectations with regard thereto or to reflect any change in events, conditions or circumstances on which any such forward-looking statement is based, in whole or in part. PART I ITEM 1. BUSINESS GENERAL Integrated Silicon Solution, Inc. ("ISSI" or the "Company") designs, develops and markets high performance memory devices including static random access memory ("SRAM"), specialty dynamic random access memory ("DRAM"), and nonvolatile memory ("NVM"). The Company also designs, develops and markets embedded memory devices which include voice recording chips and certain microcontroller devices. The Company's memory devices are used in networking applications, telecommunications, personal computers ("PC"), disk drives and other peripherals, data communications, office automation, instrumentation and consumer products. SRAM products include both asynchronous and synchronous devices ranging in densities from 64K to 4 megabit. DRAM products focus on high speed, low density devices with densities of 2, 4, and 16 megabits. Nonvolatile memory products include Flash memories, EEPROMs (electrically erasable programmable read only memories), and EPROMs (erasable programmable read only memories). The Company has its headquarters in Santa Clara, California and markets its products on a worldwide basis. The primary function of high performance SRAMs is to improve the overall performance of an electronic system by compensating for the disparity in the speeds of other integrated circuits within the system architecture. As a result, speed is a key performance characteristic for SRAMs. In many mobile or portable applications the need for low power is also a key performance characteristic. Customers also regard cost as a critical factor. For these reasons, in order to continually improve product performance and reduce costs, the Company must have access to state-of-the-art process technology for wafer manufacturing and be able to implement design improvements, such as reduced geometries, on a consistent basis. The Company leverages its SRAM design and advanced complimentary metal oxide semiconductor ("CMOS") process technology expertise to establish collaborative manufacturing relationships with Asian semiconductor manufacturers which use the Company's memory products as a vehicle for the development of advanced process technology. The Company believes that these relationships assist in securing access to leading edge process technology and a committed source for wafer processing. The Company's principal collaborative manufacturing relationship is with Taiwan Semiconductor Manufacturing Corporation ("TSMC"), with which it jointly develops process technology for producing the Company's SRAMs. The Company also has a collaborative program with Chartered Semiconductor Manufacturing ("Chartered") in Singapore. In addition, the Company has a manufacturing program with United Microelectronics Corporation ("UMC") in Taiwan. To further strengthen its manufacturing relationships, the Company has made an equity investment in a business venture with TSMC and an equity investment in a business venture with UMC. ISSI was founded in 1988. The Company has its headquarters in Santa Clara, California. This facility focuses on research and development, product definition, quality assurance and marketing and sales. The Company has majority ownership of a subsidiary in Taiwan ("ISSI-Taiwan"). ISSI-Taiwan focuses on manufacturing coordination, quality assurance, product test and regional sales in the Asian market. See "Recent Developments". 1 4 The Company also has a subsidiary in Hong Kong that primarily focuses on research and development and a subsidiary in China which focuses mainly on marketing. RECENT DEVELOPMENTS In June 1998, the Company sold approximately 46% of ISSI-Taiwan to a group of private investors. Cash proceeds from the transaction totaled $35.5 million net of withholding and transaction taxes. The Company intends to continue to use ISSI-Taiwan for the majority of its manufacturing coordination, testing of wafers, and testing of its memory devices. However, the Company believes that, in the next decade, more cost efficient testing services may become available in countries such as China or Vietnam, and could be used by the Company. The Company expects to sell up to an additional 18% of its interest in ISSI-Taiwan in fiscal 1999 and, as a result, the Company's ownership interest in ISSI-Taiwan will be less than 50%. At such time, the Company's financial statements will not consolidate the results of ISSI-Taiwan but will account for ISSI-Taiwan on the equity basis and will include its percentage share of ISSI-Taiwan's financial results. At such time as the Company's consolidated results no longer include ISSI-Taiwan, there will be a significant decline in the Company's consolidated revenue, a decline in operating expenses, and there may be an increase in the Company's effective tax rate. See Note 13 of Notes to Consolidated Financial Statements. In October 1998, the Company transferred its Flash memory business to a newly formed company, NexFlash Technologies, Inc. ("NexFlash"). The Company presently owns approximately 32% of NexFlash, ISSI-Taiwan owns approximately 17%, and private investors and management own approximately 51% of NexFlash. The Company and NexFlash jointly own related Flash intellectual property. The Company intends that future development of Flash products and the sale of such products will be done through NexFlash. In fiscal 1999, the Company's financial results will not consolidate the results of NexFlash, as the Company's ownership of NexFlash is less than 50%. The Company will account for NexFlash on the equity basis and will include in its financial statements its percentage share of NexFlash's financial results. This change is expected to have a minimal effect on the Company's consolidated revenue and will result in a decrease in the Company's consolidated research and development expenses. See Note 19 of Notes to Consolidated Financial Statements. PRODUCTS The Company designs and markets a family of high performance, low cost SRAMs, high speed, low density DRAMs, as well as NVM products, including serial EEPROMs, high speed EPROMS, and Voice EPROMs. Flash products are developed and marketed by a minority owned company, NexFlash. See "Recent Developments". To date the Company has derived substantially all of its revenues from the sale of SRAM products. SRAMS The Company offers a family of CMOS SRAMs in various densities, speeds and packaging configurations. SRAM densities include 64K (8K x 8), 256K (32K x 8), 512K (64K x 8 and 32K x 16), 1 megabit (128K x 8, 64K x 16, 32K x 32), 2 megabit (64K x 32), and 4 megabit (64K x 64 and 128K x 32). The Company produces both asynchronous SRAMs and synchronous SRAMs. The Company's 2 megabit 64K x 32 synchronous SRAM currently achieves clock speeds of 166MHz. Leading speeds for the Company's asynchronous SRAMs vary according to density. The 1 megabit 128K x 8 SRAM currently achieves 12 nanoseconds. The 256K SRAM achieves as low as an 8 nanosecond access time. The Company's asynchronous SRAMs are used in applications such as LANs, telecommunications, bridges, routers, modems, multimedia products, and industrial instrumentation. Additional SRAM products are under development and are expected to include performance-leading features in speed, configuration, power levels, density and packaging. The Company's synchronous SRAMs are used primarily in networking applications. The Company is also developing embedded memory products, which will combine certain logic functions with SRAM. DRAMS The Company's DRAM products focus on very high speed and low to medium density devices. The Company currently offers 2, 4, 8, and 16 megabit Fast Page Mode (FPM), Extended Memory Out (EDO), SDRAM and SGRAM. Applications for such devices currently include 3D graphics, disk drives, networking, modems, 2 5 telecommunications base stations, and set top box applications. Such devices are not targeted at the main memory DRAM market. NONVOLATILE MEMORY PRODUCTS The Company's NVM products include high performance serial EEPROMs and EPROMS. The Company's selection of serial EEPROM devices are used in applications that require nonvolatile storage of data or code and allow the information to be modified during system operation. Applications for serial EEPROMs include pagers, networking systems, modems, telephone sets, security systems, smart cards, video games and other consumer products. The Company's EPROM product offerings include 256K, 512K, 1 megabit, and 2 megabit devices. EPROM applications include modems, printers, digital phones, and instrumentation. Flash memory business, which was transferred to NexFlash, includes Serial Flash, Parallel Flash and Embedded Flash. The Serial Flash family includes Serial Flash Memory products ranging in density from 1M-bit to 16M-bit, and Serial Flash Module products (removable Flash cards) ranging in density from 128K-byte to 4M-byte. Ultra-low-power Serial Flash devices are designed for storing voice, images or data in applications such as voice recorders, digital cameras, hand-held terminals, internet appliances, and data loggers. The Parallel Flash line includes a 1M-bit Flash memory that is the first in a family of high performance, industry compatible devices used in modems, graphics cards, and industrial systems. Embedded Flash includes high density Flash memory blocks that, in conjunction with Foundry partners, are licensed for use in Embedded Flash applications such as microcontrollers, digital signal processors, and ASIC controllers. The Company has also developed a memory intensive 8051 microcontroller. Microcontrollers are used in a broad array of electronic equipment for the command and control logic of appliances, toys or cellular phones. The Company also produces a voice-recording chip that combines voice algorithm technology in a Flash based recording chip. Initial applications for this device are in consumer electronics such as voice recorded greeting cards. Revenue from both of these products has been immaterial. DESIGN AND PROCESS TECHNOLOGY The Company has invested in advanced process technology that allows it to design at leading edge geometries such as 0.18 micron for SRAMs. Memory products are particularly well suited for the development of advanced process technology. The Company's technology development engineers work closely with the Company's design engineers and manufacturing partners, such as TSMC and Chartered Semiconductor, to develop new process technologies, refine existing process technologies and to reduce the circuit geometries of its products. During 1998, the Company and TSMC began development of 0.18 micron, 3.3-volt high speed SRAM process technology. In addition, the Company has developed a six transistor cell SRAM for low power applications. SRAMs that do not require low power typically use four transistor cell structures. The Company's design efforts focus on product specification, memory cell and array structure, logic and circuit design, simulation and layout. The Company has invested in advanced computer aided design ("CAD") systems to ensure that the design team has state-of-the-art design tools and employs innovative and rigorous design methodologies. The Company leverages its memory expertise to design embedded memory products that combine memory and logic. MANUFACTURING The Company combines its process technology expertise, foundry partnership strategy and equity investment arrangements with TSMC and UMC to form a hybrid of the fab and fabless business models which it calls Fab-Lite(TM). The Company does not own or operate its own wafer foundry but because memory products are particularly well suited for the development of advanced process technology, the Company actively participates in developing and refining the process technology used to manufacture many of its products. The Company believes that this strategy enables it to achieve the early introduction of advanced geometries for its high performance memory products, which results in increased performance and lower manufacturing costs. To date, the Company's principal manufacturing relationship has been with TSMC. The Company also has a collaborative technology development relationship with Chartered Semiconductor in Singapore. 3 6 In 1995, the Company entered into a business venture, United Integrated Circuits Corp ("UICC") with UMC and other investors to build a wafer fabrication facility in Hsinchu, Taiwan. The Company currently has an investment in UICC of approximately $16.5 million and no additional investment payments are due. The UICC facility was severely damaged by fire in October 1997. It is the Company's understanding that the damage was covered by insurance. UICC has undertaken a clean up of the facility, but reconstruction has not commenced as an alternative site is being evaluated. A decision as to whether to build on the existing site or the alternative site has not yet been made. The Company believes that its investment of $16.5 million is recoverable. In 1996, the Company entered into a business venture agreement with Altera Inc., Analog Devices Inc. and TSMC wherein TSMC, as the general partner, would construct a wafer fabrication facility in the state of Washington. The fabrication facility is intended to be a very advanced process technology facility capable of 0.35, 0.30, 0.25 and 0.18 micron process technology. The joint venture, named WaferTech LLC, began production in 1998 and is expected to increase production levels in 1999 and 2000. The Company currently has an investment in the business venture of $31.2 million and no additional investment payments are due. In December 1998, the Company agreed to sell approximately 33% of its investment in WaferTech to TSMC for approximately $10.0 million. The transaction is expected to close in January 1999. Upon completion of the transaction, the Company will have a 2.67% interest in WaferTech. The manufacturing of the Company's products is coordinated primarily by ISSI-Taiwan, which is located in close proximity to TSMC and UMC in the Hsinchu Science-Based Industrial Park, a government-sponsored technology development zone. After receiving wafers from its independent wafer foundry partners, ISSI-Taiwan performs wafer probe testing, laser repair, and final testing. The Company's U.S. headquarters develops and debugs test programs and tests procedures used in Taiwan. Both the Taiwan and U.S. facilities have clean rooms that are equipped for the wafer probe segment of the testing process. Packaging and assembly operations are performed by subcontractors, principally in Taiwan. A comprehensive quality control program is in place in both facilities. The Company has adopted ISO 9000 as its quality management standard. The Company's U.S. facility has received certification under ISO 9001 standards. ISSI-Taiwan has received certification under ISO 9002 standards. Each of the Company's wafer suppliers also fabricates for other integrated circuit companies, including certain of the Company's competitors. In addition, UMC subsidiaries manufacture integrated circuits, including SRAMs, for their own account. Although the Company has written commitments specifying wafer capacities, if a wafer supplier chose to prioritize capacity for other use or reduce or eliminate deliveries to the Company, there can be no assurance that the Company could enforce fulfillment of the delivery commitments. The equity investment arrangements and related purchase agreements by the Company with TSMC and UMC will provide the Company with guaranteed capacity, and thus are expected to mitigate this delivery risk in the future. However, since the construction of a wafer fabrication facility is a lengthy and complex endeavor, there can be no assurance that the TSMC business venture fabrication facility or the UMC business venture fabrication facility will be capable of meeting their commitments. In this regard, the UMC business venture facility was severely damaged by fire in October 1997 resulting in a delay in wafer production. There can be no assurance that the foundries used by the Company will not encounter construction or production difficulties or that they will allocate sufficient wafer capacity to satisfy the Company's wafer requirements, especially in times of wafer capacity shortages. Moreover, there can be no assurance that the Company would be able to qualify additional manufacturing sources for existing or new products in a timely manner or that such additional manufacturing sources would be able to produce an adequate supply of wafers. If the Company were unable to obtain an adequate supply of wafers from its current or any alternative sources in a timely manner, its business and operating results would be materially and adversely affected. Although the Company's policy is to work closely with its manufacturing sources there are certain risks associated with the use of independent foundries, including the absence of a controlled source of supply, or delays in obtaining adequate wafer supplies. In addition, the manufacture of integrated circuits is a highly complex and technically demanding process. Production yields and device reliability can be affected by a large number of factors. As is typical in the semiconductor industry, the Company's outside foundries have from time to time experienced lower than anticipated manufacturing yields and device reliability problems, particularly in connection with the introduction of new products and changes in such foundry's processing steps. There can be no assurance that the Company's foundries will not experience lower than expected manufacturing yields or device reliability problems in the future, which could materially and adversely affect the Company's business and operating results. 4 7 The Company has certain minimum wafer purchasing commitments to its foundry partners in exchange for wafer capacity commitments. Although the Company has rights to re-schedule or assign capacity to another party, there can be no assurance that such re-schedule or assignment would be successfully accomplished. Should the Company fail to re-schedule or assign unneeded capacity, the Company's business and operating results could be adversely affected. CUSTOMERS AND MARKETING The Company's customers include a broad range of electronic system manufacturers such as Cisco Systems, Compaq Computer, 3Com, IBM, Motorola, and Seagate. The Company's SRAM products are used primarily in high-speed modems, local area networks, bridges and routers, PC cache, disk drives, cellular phones, base stations, and adapter cards. The Company's NVM products have a wide range of memory applications including high-speed modems, local area networks, adapter cards, cellular telephones and electronic games. In fiscal 1998, 1997, and 1996, one customer, 3Com/U.S. Robotics, accounted for approximately 19%, 19%, and 22% of the Company's net sales, respectively. In the United States, the Company markets its products through a direct sales force and independent sales representatives. In addition, the Company has four distributors in North America. The Company is continuing to expand its marketing and sales activity in Europe. The Company has sales offices in the United States, Europe, Japan, Hong Kong, Taiwan and the Peoples Republic of China. ISSI-Taiwan has a direct sales and marketing organization based in Taipei, Taiwan that is primarily responsible for the Asian market. To date, a majority of the Company's Asian sales have been to Taiwan customers. The Company markets and distributes its products on a worldwide basis. In fiscal 1998, approximately 43% of the Company's net sales were attributable to customers located in the United States, 18% were attributable to customers located in Europe and 39% were attributable to customers located in Asia. In fiscal 1997, approximately 45% of the Company's net sales were attributable to customers located in the United States, 13% were attributable to customers located in Europe, and 42% were attributable to customers located in Asia. In fiscal 1996, approximately 53% of the Company's net sales were attributable to customers located in the United States, 10% were attributable to customers located in Europe, and 37% were attributable to customers located in Asia. In fiscal 1998, 1997, and 1996, international sales (sales by ISSI-Taiwan and export sales by ISSI-U.S.) comprised approximately 57%, 55%, and 47% of the Company's net sales, respectively. See Note 13 of Notes to Consolidated Financial Statements. The Company is subject to the risks of conducting business internationally, including economic conditions in Asia, particularly Taiwan, changes in trade policy and regulatory requirements, tariffs and other trade barriers and restrictions, the burdens of complying with foreign laws and, possibly, political instability. The Company anticipates that sales to international customers will continue to represent a significant percentage of net sales. Substantially all of the Company's foundries and assembly and test operations are located in Asia. The Company transacts business predominately in U.S. and New Taiwan ("NT") dollars. Such transactions expose the Company to the risk of exchange rate fluctuations. The Company periodically monitors its exposure to foreign currency fluctuations, and has from time to time taken action to hedge against such exposure, but has not to date adopted any formal hedging strategy. There can be no assurance that exchange rate fluctuations will not materially and adversely affect its business and operating results in the future. The Company manufactures and markets primarily standard products and sales are generally made pursuant to standard purchase orders, which can be revised to reflect changes in the customer's requirements. Generally, purchase orders and OEM agreements allow customers to reschedule delivery dates and cancel purchase orders without significant penalties. For these reasons, the Company believes that its backlog, while useful for scheduling production, is not necessarily a reliable indicator of future revenues. COMPETITION The semiconductor memory market is intensely competitive and has been characterized by an oversupply of product, price erosion, rapid technological change, short product life cycles, cyclical market patterns and heightened foreign and domestic competition. The ability of the Company to compete successfully in the high performance memory market depends on factors both within and outside of its control, including imbalances in supply and demand, product pricing, the rate at which OEM customers incorporate the Company's products into their systems, 5 8 access to advance process technologies at competitive prices, product functionality, performance, and reliability, successful and timely product development, wafer supply, wafer costs, achievement of acceptable yields of functional die, the gain or loss of significant customers, the nature of its competitors and general economic conditions. There can be no assurance that the Company will be able to compete successfully in the future as to any of these factors. The failure of the Company to compete successfully in these or other areas could materially and adversely affect the Company's business and operating results. In addition, the Company is vulnerable to technology advances utilized by competitors to manufacture higher performance or lower cost products. The high performance SRAM market is generally a fragmented market and specific competitors and competitive factors vary based on geographic regions and market segments. In the high performance SRAM market, the Company competes with several major domestic and international semiconductor companies including Cypress Semiconductor, Integrated Device Technology ("IDT"), Mitsubishi, Motorola, Samsung, Sony, Toshiba, UMC and Winbond. The Company also competes with new and emerging companies, such as Galvantech and Giga Semiconductor, which have recently entered or may in the future enter the market. The Company also may face significant competition from other domestic and foreign integrated circuit manufacturers, which have advanced technological capabilities but have not previously participated in the SRAM market sector. There can be no assurance that the Company will be able to compete successfully against any of these competitors. In the high speed DRAM area, the Company competes primarily with Silicon Magic, E-toon, and G-Link. Other main memory DRAM companies could potentially enter the high-speed market in the future. In the low to medium density DRAM area, where speed is not the critical factor, the Company competes with Mosel-Vitelic, Vanguard and Oki. There can be no assurance that the Company will be able to compete successfully against any of these competitors. In the nonvolatile memory market, the Company's primary competitors include Advanced Micro Devices ("AMD"), Atmel, Intel and SGS-Thomson Microelectronics. The Company also competes with many small to medium-sized companies in one or more segments of the market. Certain of the Company's competitors offer broader product lines and have greater financial, technical, marketing, distribution and other resources than the Company. There can be no assurance that the Company will be able to compete successfully against any of these competitors. The process technology used by the Company's manufacturing sources, including process technology that the Company has developed with its foundries, can be used by such manufacturers to produce products for other companies, including the Company's competitors. Although the Company believes that its participation in the development of the processes provides it the advantage of early access to such processes, there can be no assurance that the knowledge of the manufacturer will not be used to benefit the Company's competitors. PRODUCT WARRANTY Consistent with semiconductor memory industry practice, the Company generally provides a limited warranty that its semiconductor memory devices are in compliance with specifications existing at the time of delivery. Liability for a stated warranty period is usually limited to replacement of defective items or return of amounts paid. RESEARCH AND DEVELOPMENT Rapid technological change and continuing price competition require research and development efforts on both new products and advanced processes employing smaller geometries. The Company's research and development activities are focused primarily on the development of advanced process technologies and new memory circuit designs. The Company currently designs most of its high performance memory products and jointly develops advanced process technology with its manufacturing partners from its headquarters in Santa Clara, California. The Company's Taiwan and Hong Kong subsidiaries are responsible for the development of the Company's microcontroller products, voice products and certain EEPROM products. The Company is currently designing new SRAM, DRAM, Embedded Memory and NVM products. SRAM products under development include low power SRAMs and additional memory configurations. DRAM products under development include synchronous graphics DRAMs. Nonvolatile memory products include the development of additional EEPROM devices and, through NexFlash, Serial Flash products. The Company's research and development expenditures in fiscal 1998, 1997 and 1996 were $36.9 million, $31.9 million, and $21.4 million, respectively. 6 9 PATENTS As of September 30, 1998, the Company held 27 U.S. patents, of which 13 were acquired with the acquisition of Nexcom Technology, Inc. ("Nexcom"). These patents expire between 2010 and 2018. The Company has approximately 41 additional patent applications pending and expects to continue to file patent applications where appropriate to protect its proprietary technologies. Although patents are an important element of the Company's intellectual property, the Company believes that its continued success depends primarily on factors such as the technological skills and innovation of its personnel rather than on its patents. The process of seeking patent protection can be expensive and time consuming. There can be no assurance that patents will be issued from pending or future applications or that, if patents are issued, they will not be challenged, invalidated or circumvented, or that rights granted thereunder will provide meaningful protection or other commercial advantage to the Company. Moreover, there can be no assurance that any patent rights will be upheld in the future or that the Company will be able to preserve any of its other intellectual property rights. In the semiconductor industry it is typical for companies to receive notices from time to time alleging infringement of patents or other intellectual property rights of others. The Company has been, and from time-to-time expects to be, notified of claims that it may be infringing patents, maskwork rights or copyrights owned by third parties. Although none of these companies have pursued a claim against the Company, there can be no assurance that other companies will not in the future pursue claims against the Company with respect to the alleged infringement of patents, maskwork rights, copyrights or other intellectual property owned by third parties. If it appears necessary or desirable, the Company may seek licenses under patents that it is alleged to be infringing. Although patent holders commonly offer such licenses, there is no assurance that any licenses will be offered or that the terms of any offered licenses will be acceptable to the Company. The failure to obtain a license under a key patent or intellectual property right from a third party for technology used by the Company could cause the Company to incur substantial liabilities and to suspend the manufacture of the products utilizing the invention or to attempt to develop non-infringing products, any of which could materially and adversely affect the Company's business and operating results. Furthermore, there can be no assurance that the Company will not become involved in protracted litigation regarding the alleged infringement by the Company of third party intellectual property rights or litigation to assert and protect patents or other intellectual property rights of the Company. Any litigation relating to patent infringement or other intellectual property matters could result in substantial cost and diversion of resources by the Company which could materially and adversely affect the Company's business and operating results. ACQUISITION OF NEXCOM TECHNOLOGY, INC. In December 1997, the Company completed its acquisition of Nexcom in exchange for the issuance of 772,693 shares of Common Stock, $0.5 million in cash, and the assumption of $1.2 million of net liabilities (total consideration of approximately $8.5 million). Nexcom was formed in 1990 and has been engaged primarily in the research and development of non-volatile flash memory technology. As a result of the merger, the Company acquired 13 patents which were held by Nexcom. This Flash memory business has been transferred to NexFlash. See "Recent Developments". EMPLOYEES As of September 30, 1998, the Company had approximately 150 employees in the U.S. (of which 30 were transferred to NexFlash), 8 in the People's Republic of China and 14 in Hong Kong. ISSI-Taiwan had approximately 270 employees at September 30, 1998. The Company's future success will largely be dependent on its ability to attract, retain and motivate highly qualified technical and management personnel. The employment market for such personnel is extremely competitive and there can be no assurance that the Company will successfully staff all necessary positions. The Company's employees are not represented by any collective bargaining agreements and the Company has never experienced a work stoppage. The Company believes that its employee relations are good. 7 10 EXECUTIVE OFFICERS The executive officers of the Company and their ages as of September 30, 1998 are as follows:
Name Age Position Jimmy S.M. Lee 43 Chairman, Chief Executive Officer, President, and Director Kong-Yeu Han 43 Executive Vice President, Office of the President, General Manager-Taiwan and Director Gary L. Fischer 47 Executive Vice President, Office of the President and Chief Financial Officer
BACKGROUND OF EXECUTIVE OFFICERS Jimmy S.M. Lee has served as Chief Executive Officer, President and a director of the Company since he co-founded the Company in October 1988. He has also served as a director of ISSI-Taiwan since September 1990. From 1985 to 1988, Mr. Lee was engineering manager at International CMOS Technology, Inc., a semiconductor company, and from 1983 to 1985, he was a design manager at Signetics Corporation, a semiconductor company. Prior thereto, Mr. Lee was a project manager at Toshiba Semiconductor Corporation and a design engineer at National Semiconductor Corporation. Mr. Lee holds an M.S. degree in electrical engineering from Texas Tech University and a B.S. degree in electrical engineering from National Taiwan University. Kong-Yeu Han has served as the Company's Executive Vice President since April 1995, as General Manager, ISSI-Taiwan since September 1990 and as a director of the Company since he co-founded the Company in October 1988. He has also served as a director of ISSI-Taiwan since September 1990. From October 1988 to September 1990, he also served as Vice President, Engineering of the Company. From 1985 to 1988, Mr. Han was design engineering manager at Vitelic Corporation, a semiconductor company, and from 1984 to 1985 he was a staff engineer at Signetics Corporation. From 1980 to 1984, Mr. Han was a senior engineer at AMD and its subsidiary Monolithic Memories, Inc. ("MMI"), both of which are semiconductor companies. Mr. Han holds an M.S. degree in electrical engineering from the University of California, Santa Barbara and a B.S. degree in electrical engineering from National Taiwan University. Gary L. Fischer has served as the Company's Executive Vice President since April 1995 and as Vice President and Chief Financial Officer since June 1993. He also served as Vice President, Finance and Administration from December 1993 to April 1995. From December 1992 to April 1993, Mr. Fischer was Vice President, Finance and Chief Financial Officer of Shaman Pharmaceuticals, Inc., a pharmaceutical company. From January 1989 to December 1992, Mr. Fischer was Chief Financial Officer of Synergy Semiconductor Corporation, a manufacturer of high performance SRAM and logic integrated circuits. Mr. Fischer holds an M.B.A. degree from the University of Santa Clara and a B.A. degree from the University of California, Santa Barbara. Officers serve at the discretion of the Board and are appointed annually. There are no family relationships between the directors or officers of the Company. 8 11 ITEM 2. PROPERTIES The Company's U.S. headquarters occupy a two story building, totaling approximately 93,400 square feet, in Santa Clara, California in which its executive offices, marketing, technology, product development groups and some R&D testing facilities are located. The Company's minority owned business, NexFlash, is located within this facility. The lease on this building expires in February 2007. The Company subleases approximately 24,000 square feet to a third party. The sublease expires in March 2000. ISSI-Taiwan occupies approximately 145,000 square feet of a newly constructed 500,000 square feet facility in the Hsin-Chu Science-Based Industrial Park, which is owned by ISSI-Taiwan. Approximately 155,000 square feet is leased to other tenants. ITEM 3. LEGAL PROCEEDINGS On April 22, 1998, the U.S. Department of Commerce ("DOC") published an amended antidumping duty order on imports of SRAMs from Taiwan from where the Company currently imports a majority of its SRAMs. As a consequence of this antidumping duty order, the Company is required to post a cash deposit on imports of Taiwan fabricated SRAM wafers or devices, at the ad valorem rate of 7.56%. The cash deposits subsequently could be returned to the Company or, alternatively, the Company could forfeit amounts deposited and owe duties and interest in addition to the amounts deposited. The outcome is dependent on whether the DOC conducts an administrative review of imports entered after the imposition of the antidumping order, and if so, on the results of the DOC review. The decision on whether to conduct a review will be made in 1999 and the results of the review will be issued in the year 2000. The Company has retained legal counsel to defend and assist in its interests in the antidumping proceedings. In addition, certain aspects of the antidumping determination are being challenged in federal court proceedings by some of the respondents to the investigation, and these proceedings could result in the termination of this antidumping case. Duties calculated and assessed by the government could have a material adverse affect on the Company's gross margins and profits. There can be no assurance that any reviews or proceedings will mitigate or eliminate antidumping duties. On October 22, 1998, Micron Technology filed an anti-dumping petition against DRAMs fabricated in Taiwan. Currently, the Company's DRAM products are fabricated in Taiwan. The case is expected to take from 12 to 18 months to complete. If the petition is upheld, the Company could face DRAM duties, unless it is able to secure DRAM from outside of Taiwan. Currently, DRAM accounts for less than 10% of the Company's revenue. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of fiscal 1998. 9 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS MARKET FOR COMMON STOCK The Company's common stock has been quoted on the Nasdaq National Market under the symbol ISSI since the Company's initial public offering in February 1995. Prior to such date, there was no public market for the common stock. The following table sets forth, for the fiscal quarters indicated, the high and low sale prices per share for the Common Stock as reported on the Nasdaq National Market. These prices are over-the-counter market quotations which reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
Fiscal Year ending September 30, 1998 High Low ------------- ------------ Fourth quarter $ 7.125 $ 2.75 Third quarter 10.75 6.656 Second quarter 12.25 7.313 First quarter 14.50 7.00 Fiscal Year ending September 30, 1997 High Low ------------- ------------ Fourth quarter $ 16.375 $ 7.563 Third quarter 9.875 6.50 Second quarter 10.625 8.031 First quarter 12.375 8.00
HOLDERS OF RECORD As of December 1, 1998, there were approximately 13,900 beneficial holders of the Company's common stock. DIVIDENDS The Company has never declared or paid cash dividends. The Company currently intends to retain any earnings for use in its business and does not anticipate paying any cash dividends on its capital stock in the foreseeable future. The Company is subject to legal restrictions related to distribution of earnings of its Taiwan subsidiary. See Note 10 of Notes to Consolidated Financial Statements. RECENT SALES OF UNREGISTERED SECURITIES On December 3, 1997, in connection with the merger of Nexcom with and into the Company, the Company issued an aggregate of 772,693 shares of its Common Stock to the Nexcom shareholders. The shares were issued pursuant to Section 4(2) and Rule 506 of Regulation D promulgated under the Securities Act of 1933, as amended. 10 13 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Fiscal Year Ended September 30, 1998 1997 1996 1995 1994 --------- --------- --------- --------- --------- (in thousands, except per share data) Net sales $ 131,132 $ 108,261 $ 132,039 $ 123,201 $ 60,836 Gross margin 4,338 32,156 31,855 62,252 20,553 Operating income (loss) (53,053) (10,776) (4,683) 34,476 4,994 Net income (loss) (43,933) (7,686) 1,015 29,653 4,612 Basic income (loss) per share(1) (2.32) (0.43) 0.06 1.98 0.37 Diluted income (loss) per share(1) (2.32) (0.43) 0.06 1.80 0.34 Working capital 32,549 75,544 107,929 120,839 16,648 Total assets 202,168 195,596 178,039 204,441 33,243 Total long-term obligations, notes payable, and current portion of long-term obligations 33,791 20,101 14,534 33,888 1,526 Stockholders' equity 90,920 134,567 142,435 139,909 21,187 Dividends paid -- -- -- -- --
- ---------- (1) See Note 1 of Notes to Consolidated Financial Statements for an explanation of the basis used to calculate net income (loss) per share. Pro forma income per share is presented for fiscal 1994. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS The Company's financial results for fiscal 1998 are presented on a consolidated basis and include the results of the operations which were transferred to NexFlash and as well as those of ISSI-Taiwan. In fiscal 1999, the Company's financial results will not consolidate the results of NexFlash, as the Company's ownership of NexFlash is less than 50%. The Company will account for NexFlash on the equity basis and will include in its financial statements its percentage share of NexFlash's financial results. This change is expected to have a minimal effect on the Company's consolidated revenue and will result in a decrease in the Company's consolidated research and development expenses. The Company expects to sell up to an additional 18% of its interest in ISSI-Taiwan in fiscal 1999 and, as a result, the Company's ownership interest in ISSI-Taiwan will be less than 50%. At such time, the Company's financial statements will not consolidate the results of ISSI-Taiwan but will account for ISSI-Taiwan on the equity basis and will include its percentage share of ISSI-Taiwan's financial results. At such time as the Company's consolidated results no longer include ISSI-Taiwan, there will be a significant decline in the Company's consolidated revenue, a decline in operating expenses, and there may be an increase in the Company's effective tax rate. See Note 13 of Notes to Consolidated Financial Statements. FISCAL YEAR ENDED SEPTEMBER 30, 1998 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30, 1997 Net Sales. Net sales consist principally of total product sales less estimated sales returns. Net sales increased by 21% to $131.1 million in fiscal 1998 from $108.3 million in fiscal 1997. The increase in sales was principally due to shipments of the Company's newer products, specifically its 64K x 16, 64K x 32, and 64K x 64 SRAMs and its 256K x 16 DRAM. Additionally, shipments of the Company's more mature 128K x 8 SRAM product increased, more than offsetting the lower average selling price for such product and shipments of the more mature 32K x32 SRAM increased while its average selling price increased. Shipments of certain of the Company's NVM products, principally its EPROMs and EEPROMs, declined significantly in fiscal 1998 compared to fiscal 1997. The Company anticipates that the average selling prices of substantially all of its existing products will continue to decline although the rate of decline may fluctuate for certain products. There can be no assurance that such declines will be offset by higher volumes or by higher prices on newer products. See "Certain Factors - Declines in Average Selling Prices". Sales to 3Com/U.S. Robotics accounted for approximately 19% of total net 11 14 sales for both fiscal 1998 and fiscal 1997. As sales to this customer are executed pursuant to purchase orders and no purchasing contract exists, the customer can cease doing business with the Company at any time. Gross Profit. The Company's cost of sales includes die cost from the wafers acquired from foundries, subcontracted package and assembly costs, costs associated with in-house product testing, quality assurance and import duties. Gross profit decreased 87% to $4.3 million in fiscal 1998 from $32.2 million in fiscal 1997. As a percentage of net sales, gross profit decreased to 3.3% in fiscal 1998 from 29.7% in fiscal 1997. In fiscal 1998, the Company recorded inventory write-downs of $23.0 million, including $9.6 million in the September quarter. The inventory write-downs were predominately for lower of cost or market issues on certain of the Company's products, primarily SRAMs. The September 1998 quarter included a $2.9 million write-down of certain Flash inventories due to obsolescence resulting from the decision to spin off the Company's Flash product business to form NexFlash. In addition, in the December 1997 quarter, the Company wrote-off $0.8 million worth of a specific DRAM product, for which the Company's six month forecast showed minimal demand at December 31, 1997 and for which the Company has had minimal sales to date. It is the Company's practice to write-down to zero carrying value inventory on hand in excess of six months estimated sales volumes to cover estimated exposures unless adjustments are made to the forecast based on management's judgments for newer products, end of life products or planned inventory increases. Management's judgments take into account the product life cycles which can range from 6 to 24 months, the maturity of the product as to whether it is newly introduced or is approaching its end of life, the impact of competitor announcements and product introductions on the Company's products and purchasing opportunities due to excess wafer capacity. The Company believes that six months is an appropriate period for sales forecasts and inventory exposure calculations because it is difficult to accurately forecast for a specific product beyond this time frame due to potential introduction of products by competitors, technology obsolescence or fluctuations in demand. The policy has resulted in inventory write-downs of approximately $5.4 million, $0, and $15 million for fiscal year 1998, 1997 and 1996, respectively, and recoveries of written-down inventory of approximately $0, $13.9 million, and $0.3 million in fiscal 1998, 1997 and 1996, respectively. Excluding the inventory write-downs of $23.0 million for fiscal 1998, the decrease in gross profit dollars was primarily the result of a continuing decline in the average selling prices of the Company's products without a commensurate decline in product cost, particularly in the second half of the fiscal year. The Company believes that the average selling price of its products will continue to decline and, unless the Company is able to reduce its cost per unit to the extent necessary to offset such declines, the decline in average selling prices will result in a material decline in the Company's gross margin. Although the Company has product cost reduction programs in place for certain products that involve efforts to reduce internal costs and supplier costs, there can be no assurance that product costs will be reduced or that such reductions will be sufficient to offset the expected declines in average selling prices. The Company does not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of its products or the level of service provided by the Company. Research and Development. Research and development expenses increased by 22% to $31.9 million in fiscal 1998 from $26.2 million in fiscal 1997. As a percentage of net sales, research and development expenses increased to 24.3% in fiscal 1998 from 24.2% in fiscal 1997. The increase in absolute dollars was primarily the result of an increase in engineering personnel and payroll related expenses and increased expenses related to the development of new products. During fiscal 1998, the Company's development efforts principally focused on wider width SRAMs such as the 64K x 64, 64K x 32, 64K x 36 and 128K x 64 configurations, specialty EDO DRAMs, specialty DSP support SRAMs, serial Flash and other memory related devices. The Company anticipates that its research and development expenses will decline in fiscal 1999 primarily as a result of its transfer of Flash development efforts to NexFlash, as well as its expense reduction efforts, which include a reduction in force, salary cuts, and limitations on discretionary spending, although such expenses may fluctuate as a percentage of net sales. Selling, General and Administrative. Selling, general and administrative expenses increased by 10% to $18.4 million in fiscal 1998 from $16.8 million in fiscal 1997. As a percentage of net sales, selling, general and administrative expenses decreased to 14.0% in fiscal 1998, from 15.5% in fiscal 1997. The increase in absolute dollars was primarily the result of increased payroll related expenses from the addition of marketing and sales personnel and increased selling commissions associated with higher revenues partially offset by decreases in bad debt expenses and legal expenses associated with antidumping proceedings. The Company expects its selling, general and administrative expenses will decline in fiscal 1999 as a result of its expense reduction efforts, although such expenses may fluctuate as a percentage of net sales. 12 15 In-process Technology. In December 1997, the Company completed its acquisition of Nexcom in exchange for the issuance of 772,693 shares of Common Stock, $0.5 million in cash, and the assumption of $1.2 million of net liabilities (total consideration of approximately $8.5 million). In addition, the Company incurred approximately $400,000 in other costs related to this transaction. The transaction was accounted for as a purchase and resulted in an in-process technology charge of $7.1 million in the Company's December 31, 1997 quarter. Gain on sale of investment. In June 1998, the Company sold approximately 46% of ISSI-Taiwan to a group of private investors. The price was privately negotiated between the parties. Cash proceeds from the transaction totaled $35.5 million net of withholding and transaction taxes. The transaction resulted in a pre-tax gain of $17.2 million which is recorded in the Company's June 30, 1998 quarter. Interest and other income (loss), Net. Other income (loss), net decreased to $(3.5) million in fiscal 1998 from $1.9 million in fiscal 1997, primarily due to exchange losses as well as decreased interest earnings as a result of lower cash and short-term investment balances and increased interest expense as a result of increased short-term and long-term borrowings. Provision (benefit) for Income Taxes. The income tax provision for fiscal 1998 is comprised mainly of foreign withholding taxes related to the sale of ISSI-Taiwan stock and a reversal of previously recorded federal deferred tax assets which management has now determined should be subject to a valuation allowance based on historical and future earnings trends. The income tax benefit for fiscal 1997 was the result of losses which were carried back for refunds of prior federal taxes paid and Taiwan tax credits offset by a partial valuation allowance set up for U.S. deferred tax assets. As a result of its Hsinchu Science-Based Industrial Park in Taiwan, ISSI-Taiwan has received a significant tax exemption for taxable income beginning October 1, 1992. This tax exemption is extended each time ISSI-Taiwan expands its capital assets and uses the capital to purchase qualified machinery. The precise amount of the exemption is calculated annually based upon the extent of ISSI-Taiwan's net operating taxable income and measured by certain factors, including use of qualified manufacturing equipment, self-manufacturing costs and qualified sales revenue. The portion of ISSI-Taiwan's taxable income which is not subject to exemption is taxed at a flat 20% tax rate. There can be no assurances that the Company's current tax status in Taiwan will not change in the future due to changes in the regulatory environment, the inability to qualify for exempt status or other factors. Under Statement of Financial Accounting Standards No. 109 (FAS 109), deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Management has established a valuation allowance covering the U.S. portion of the gross deferred tax assets based on management's belief that the realization of the U.S. deferred tax assets is not realizable on a more likely than not basis. Management has determined, based on ISSI-Taiwan's history of prior operating earnings and its expectation of future taxable income, that a partial valuation allowance for ISSI-Taiwan's deferred tax assets should be provided. Although realization of the ISSI-Taiwan deferred tax assets is not assured, management believes that it is more likely than not that the deferred tax asset will be realized. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. Fiscal Year Ended September 30, 1997 Compared to Fiscal Year Ended September 30, 1996 Net Sales. Net sales decreased by 18% to $108.3 million in fiscal 1997 from $132.0 million in fiscal 1996. The decrease in sales was principally due to significant deterioration in the average selling prices of the Company's SRAM and NVM products. The decreased revenue resulting from lower average selling prices was partially offset by increased unit shipments of SRAM products, specifically the Company's 256K, 512K, 1024K products, cache module products, and NVM products. Sales to one customer, 3Com/U.S. Robotics, accounted for approximately 19% and 22% of total net sales for fiscal 1997 and fiscal 1996, respectively. Gross Profit. Gross profit increased 1% to $32.2 million in fiscal 1997 from $31.9 million in fiscal 1996. As a percentage of net sales, gross profit increased to 29.7% in fiscal 1997, from 24.1% in fiscal 1996. Fiscal 1996 included a $15.0 million write down of inventory during the June quarter related to various SRAM products (primarily 8Kx8, 32Kx8 and 128Kx8) as well as some NVM products (EPROM and EEPROM) that the Company anticipated as being non-salable based on its six month sales forecast. Excluding the $15.0 million inventory write- 13 16 down, gross profit was $46.9 million or 35.5% of net sales in fiscal 1996. Excluding the inventory write-down in the 1996 period, the decrease in the fiscal 1997 gross profit was primarily the result of significantly lower average selling prices for the Company's SRAM and NVM products in fiscal 1997 compared to fiscal 1996. Although product unit costs were lower in fiscal 1997 compared to fiscal 1996, such reductions did not offset the declines in average selling prices, resulting in lower gross margins. Gross profit for fiscal 1997 reflects a $13.9 million benefit related to inventory sold during 1997 that had been written-down in June 1996. Gross margin would have been $18.2 million or 16.8 % without the benefit from the sale of the previously written down product. Late in the first quarter of fiscal 1997, the Company began to realize that, due to changes in industry conditions, its estimate of the June 30, 1996 sales forecast and inventory write-down may not have been accurate. Sales continued to decline in the September 1996 quarter, but thereafter the Company experienced sequential quarterly revenue growth throughout fiscal 1997 moving from $23.1 million for the September 1996 quarter to $32.3 million for the September 1997 quarter. The sales forecast used to estimate the June 1996 quarter write-down changed on a quarterly basis throughout fiscal 1997 as demand for the written-down products strengthened or was extended. This change was not attributable to any single event, but rather an overall strengthening of demand in the industry. Revenues for the product categories that were written down in June 1996, totaled approximately $80.3 million in fiscal 1997 compared to approximately $118.7 million in fiscal 1996. The Company continued to sell these product categories throughout fiscal 1997, but at prices that declined significantly during the quarters. Research and Development. Research and development expenses increased by 23% to $26.2 million in fiscal 1997 from $21.4 million in fiscal 1996. As a percentage of net sales, research and development expenses increased to 24.2% in fiscal 1997 from 16.2% in fiscal 1996. These increases were primarily the result of an increase in engineering personnel, increased payroll related expenses and increased expenses related to the development of new products and, to a lesser extent, the write-off of obsolete engineering equipment and software. During fiscal 1997, the Company's development efforts principally focused on wider bus width SRAMs such as the 64K x 32, 64K x 16 and 32K x 16 configurations, 2 megabit Flash memory, geometry reductions for its memory products, EPROMs, and other memory related devices. In this regard, the Company developed its initial DRAM devices, specialty high speed 4 megabit and 2 megabit DRAMs during fiscal 1997. Selling, General and Administrative. Selling, general and administrative expenses increased by 10% to $16.8 million in fiscal 1997 from $15.2 million in fiscal 1996. As a percentage of net sales, selling, general and administrative expenses increased to 15.5% in fiscal 1997 from 11.5% in fiscal 1996. These increases were primarily the result of increases in legal expenses associated with antidumping proceedings and increased payroll related expenses from the addition of marketing and sales personnel, partially offset by decreased selling commissions associated with lower revenues. Interest and other income, Net. Interest and other income, net decreased to $1.9 million in fiscal 1997 from $4.5 million in fiscal 1996, primarily due to decreased net interest earnings as a result of lower cash and short-term investment balances. Benefit for Income Taxes. The Company recorded a tax benefit of $1.1 million for fiscal year 1997 which was primarily attributable to investment tax credits generated by ISSI-Taiwan during the year ended September 30, 1997. The Company recorded a tax benefit of $1.2 million for fiscal year 1996 which was primarily attributable to lower than expected profit before income taxes and tax benefits relating to tax-exempt interest income and the dividends deduction. In addition, ISSI-Taiwan generated significant investment tax credits during the year ended September 30, 1996. LIQUIDITY AND CAPITAL RESOURCES As of September 30, 1998, the Company's principal sources of liquidity included cash, cash equivalents, restricted cash and short-term investments of approximately $35.9 million, of which approximately $5.0 million was held by ISSI-Taiwan. Approximately $0.3 million of the cash held by the Company is restricted as of September 30, 1998 for purposes of securing available short-term lines of credit and letters of credit. During fiscal 1998, operating activities used cash of approximately $34.5 million. Cash used by operations was primarily due to net loss adjusted for the gain on the partial sale of ISSI-Taiwan, depreciation, in-process technology charge and other non-cash items and increases in inventory partially offset by increases in accounts payable and decreases in other assets. 14 17 Inventory increased to $46.5 million at September 30, 1998 from $40.7 million at September 30, 1997. The increase in inventory was predominately due to increases in the Company's newer SRAM products earlier in the year in anticipation of stronger future demand that did not materialize and increases in the inventory of wafers purchased by the Company. Accounts payable increased to $40.6 million at September 30, 1998 from $23.1 million at September 30, 1997. The increase in accounts payable is principally related to increases in inventory. In fiscal 1998, the Company was provided with $18.1 million from investing activities compared to $5.6 million in fiscal 1997. The cash provided from investing activities was primarily the result of $37.6 million from the partial sale of ISSI-Taiwan and $17.8 million from the sale of available-for-sale securities offset by $19.2 million used for the acquisition of fixed assets, $12.5 million invested in WaferTech, and $4.7 million invested in UICC. The Company made capital expenditures of approximately $19.2 million in fiscal 1998, of which approximately $11.2 million was for the construction of ISSI-Taiwan's new facility and $8.0 million was for the purchase of test equipment and design and engineering tools. The Company expects to spend approximately $7.0 million to purchase capital equipment during the next twelve months, principally for the purchase of additional test equipment, design and engineering tools, and computer hardware and software. Additionally, the Company expects to spend approximately $5.0 million during the next twelve months for the completion of construction of the ISSI-Taiwan facility. A portion of this construction cost is expected to be financed through loans. Although construction is still continuing, ISSI-Taiwan took occupancy of the building in August 1998. In June 1998, the Company sold approximately 46% of ISSI-Taiwan to a group of private investors. The price was privately negotiated between the parties. Cash proceeds from the transaction totaled $35.5 million net of withholding and transaction taxes. The transaction resulted in a pre-tax gain of $17.2 million which is recorded in the Company's June 30, 1998 quarter. The Company expects to sell up to an additional 18% of its interest in ISSI-Taiwan during fiscal 1999. In June 1996, the Company entered into a business venture "WaferTech, LLC" with TSMC, Altera, Analog Devices, and private investors to build a wafer fabrication facility in Camas, Washington. The Company agreed to invest $31.2 million for a 4% equity interest in the venture and as of September 30, 1998 all of this amount had been paid. The last scheduled payment to WaferTech by the Company of $12.5 million was made in November 1997. In December 1998, the Company agreed to sell approximately 33% of its investment in WaferTech to TSMC for approximately $10.0 million. The transaction is expected to close in January 1999. Upon completion of the transaction, the Company will have a 2.67% interest in WaferTech. The Company has also agreed to certain minimum wafer purchase commitments with its foundry partners in exchange for wafer capacity commitments. In fiscal 1995, the Company entered into an agreement with TSMC pursuant to which the Company agreed to acquire specified wafer capacity through 2001. The Company also agreed to make certain annual payments totaling approximately $19.2 million through 2001 to TSMC for additional capacity above the annual base capacity. Wafer purchases in any given year are first applied to the base capacity and then to the Company's $19.2 million obligation. As a result, the $19.2 million may be subject to forfeiture if the Company does not purchase the base capacity and additional capacity for which it has contracted. The Company also has minimum purchase obligations to TSMC related to WaferTech LLC. The Company is obligated to purchase from WaferTech or TSMC a minimum of 3.4% of WaferTech's installed capacity. Initial wafer outs occurred in the second half of calendar 1998. Additionally, in fiscal 1995, the Company entered into a business venture "United Integrated Circuits Corp" ("UICC") with UMC and other investors to build a wafer fabrication facility in Hsinchu, Taiwan. The Company has invested approximately $16.5 million (subject to fluctuations in the New Taiwanese Dollar) for a 4% equity interest in the venture of which UMC retains 55% ownership. The final payment of approximately $4.7 million was made to UICC in December 1997. The UICC facility was severely damaged by fire in October 1997. It is the Company's understanding that the damage was covered by insurance. UICC has undertaken a clean up of the facility but reconstruction has not commenced as an alternative site is being evaluated. A decision as to whether to build on the existing site or the alternative site has not yet been made. The Company believes that its investment of $16.5 million is recoverable. The Company was provided $23.9 million from financing activities during fiscal 1998, as compared to $9.2 million in fiscal 1997, of which $15.9 million was for net borrowings under short-term and long-term lines of credit, $4.8 million resulted from the decrease in restricted cash and $3.1 million was for proceeds from the issuance of common stock under stock option and stock purchase plans. The Company has $23.5 million available through a 15 18 number of short-term lines of credit with various financial institutions in Taiwan. As of September 30, 1998, the Company had outstanding borrowings of approximately $18.2 million under these short-term lines of credit. ISSI-Taiwan has a number of long-term lines of credit with various financial institutions in Taiwan to finance the purchase of machinery, equipment and building construction in Taiwan. Total obligations related to these borrowings as of September 30, 1998 were $15.5 million, of which $3.4 million is included in the current portion of long-term obligations. These obligations bear interest at rates from 6.82% to 8.82% and are payable in quarterly installments through 2004. As of September 30, 1998, the Company had available long-term lines of credit of approximately $7.0 million of which approximately $2.8 million is for the construction financing of the Company's new facility in the Hsinchu Science-Based Industrial Park. On April 22, 1998, the U.S. Department of Commerce ("DOC") published an amended antidumping duty order on imports of SRAMs from Taiwan from where the Company currently imports a majority of its SRAMs. As a consequence of this antidumping duty order, the Company is required to post a cash deposit on imports of Taiwan fabricated SRAM wafers or devices, at the ad valorem rate of 7.56%. The cash deposits subsequently could be returned to the Company or, alternatively, the Company could forfeit amounts deposited and owe duties and interest in addition to the amounts deposited, depending on whether the DOC conducts an administrative review of imports entered after the imposition of the antidumping order, and if so, on the results of the DOC review. The decision on whether to conduct a review will be made in 1999, and the results of the review would be issued in the year 2000. The Company has retained legal counsel to defend and assist in its interests in the antidumping proceedings. In addition, certain aspects of the antidumping determination are being challenged in federal court proceedings by some of the respondents to the investigation, and these proceedings could result in the termination of this antidumping case. Duties calculated and assessed by the government could have a material adverse affect on the Company's gross margins and profits. There can be no assurance that any reviews or proceedings will mitigate or eliminate antidumping duties. On October 22, 1998, Micron Technology filed an antidumping petition against DRAMs fabricated in Taiwan. Currently, the Company's DRAM products are fabricated in Taiwan. The case is expected to take from 12 to 18 months to complete. If the petition is upheld, the Company could face DRAM duties, unless it is able to secure DRAM from outside of Taiwan. Currently, DRAM accounts for less than 10% of the Company's revenue. The Company believes that its existing funds together with available financing will satisfy the Company's anticipated working capital and other cash requirements through the next 12 months. The Company may evaluate actions to further increase its cash position such as bank borrowings, sales of additional shares of ISSI-Taiwan, the disposition of certain assets, equity financing, and debt financing. The Company, from time to time, evaluates potential acquisitions and equity investments complementary to its memory expertise and market strategy. To the extent the Company pursues such transactions, any such transactions could require the Company to seek additional equity or debt financing to fund such activities. There can be no assurance that any such additional financing could be obtained on terms acceptable to the Company, if at all. CERTAIN FACTORS WHICH MAY AFFECT THE COMPANY'S BUSINESS OR FUTURE OPERATING RESULTS DEPENDENCE ON SRAM PRODUCTS; DECLINE IN AVERAGE SELLING PRICES FOR SRAM PRODUCTS A substantial majority of the Company's net sales are derived from the sale of SRAM products, which are subject to unit volume fluctuations and declines in average selling prices. For example, in the June 1998 quarter, the Company's net sales decreased by 38% to $25.0 million from $40.7 million in the March 1998 quarter, principally due to a decrease in unit shipments of the Company's SRAM products. In fiscal 1997, the Company's net sales decreased by 18% to $108.3 million from $132.0 million in fiscal 1996. This decrease in sales was principally due to significant deterioration in the average selling prices of the Company's SRAM and NVM products. The Company anticipates that the average selling prices of its existing products will continue to decline over time, although the rate of decline may fluctuate for certain products. There can be no assurance that such declines will be offset by higher volumes or by higher prices on newer products. 16 19 QUARTERLY FLUCTUATIONS IN OPERATING RESULTS The Company's future quarterly and annual operating results are subject to fluctuations due to a wide variety of factors, many of which are outside of its control, including declines in average selling prices of the Company's products, oversupply of memory products in the market, failure to introduce new products and to implement technologies on a timely basis, the timing and announcement of new product introductions by the Company and its competitors, market acceptance of the Company's and its customers' products, the failure to anticipate changing customer product requirements, fluctuations in manufacturing yields, disruption in delivery and order fulfillment, and disruption in the supply of wafers or assembly services. Other factors include changes in product mix, seasonal fluctuations in customer demand for the Company's products, the timing of significant orders, increased expenses associated with new product introductions or process changes, the ability of customers to make payments to the Company, increases in material costs, increases in antidumping duties, increases in costs associated with the expansion of sales channels, increases in general and administrative expenses, and certain production and other risks associated with using independent manufacturers. In this regard, in the June 1998 quarter, the Company's net sales decreased by 38% to $25.0 million from $40.7 million in the March 1998 quarter principally due to a decrease in unit shipments of the Company's SRAM products. In addition, in fiscal 1997, the Company's net sales decreased by 18% to $108.3 million from $132.0 million in fiscal 1996. This decrease in sales was principally due to significant deterioration in the average selling prices of the Company's SRAM and NVM products. In fiscal 1998, approximately 43% of the Company's net sales were attributable to customers located in the United States, 18% was attributable to customers located in Europe and 39% was attributable to customers located in Asia. In fiscal 1997, approximately 45% of the Company's net sales were attributable to customers located in the United States, 13% was attributable to customers located in Europe and 42% was attributable to customers located in Asia. In fiscal 1998 and 1997, international sales (sales by ISSI-Taiwan and export sales by ISSI-U.S.) comprised approximately 57% and 55% of the Company's net sales, respectively. Accordingly, the Company's future operating results will also depend in part on general economic conditions in Asia, the United States and its other markets. In this regard, since late 1997 many Asian countries, including Korea, Japan and Thailand, have experienced significant economic downturns and significant declines in the value of their currencies relative to the U.S. dollar. The Company is unable to predict what future effect, if any, these factors will have on its ability to maintain or increase its sales in these markets. In addition, there can be no assurance that the markets for the Company's products, which are highly cyclical, will continue to grow. DECLINES IN AVERAGE SELLING PRICES Competitive pricing pressures due to an industry-wide oversupply of wafer capacity resulted in significant price decreases for the Company's products during 1996, 1997 and 1998. Historically, average selling prices for semiconductor memory products have declined and the Company expects that average selling prices will decline in the future. Accordingly, the Company's ability to maintain or increase revenues will be highly dependent upon its ability to increase unit sales volume of existing products and introduce and sell new products which compensate for the anticipated declines in the average selling prices of its existing products. Declining average selling prices will also adversely affect the Company's gross margins and profits unless the Company is able to introduce new products with higher margins or reduce its cost per unit to offset declines in average selling prices. There can be no assurance that the Company will be able to increase unit sales volumes, introduce and sell new products or reduce its cost per unit. In this regard, the Company has a cost reduction program in place, which involves efforts to reduce internal costs and supplier costs, in an effort to reduce its cost per unit for certain products. The Company does not believe that such cost reduction efforts are likely to have a material adverse impact on the quality of its products or the level of service provided by the Company. RISK OF INVENTORY WRITE-DOWNS Shifts in industry-wide capacity from shortages to oversupply or from oversupply to shortages may result in significant fluctuations in the Company's quarterly or annual operating results. The semiconductor industry is highly cyclical and is subject to significant downturns resulting from excess capacity, overproduction, reduced demand or technological obsolescence. These factors can result in a decline in average selling prices and the stated value of inventory. In fiscal 1998, the Company recorded inventory write-downs of $23.0 million, including $9.6 million in the September quarter. The inventory write-downs were predominately for lower of cost or market issues on certain of the Company's products, primarily SRAMs. The September 1998 quarter included a $2.9 million write-down of certain of the Company's Flash inventories due to obsolescence resulting from the Company's 17 20 decision to spin off the Flash product business to form NexFlash. In addition, in the December 1997 quarter, the Company wrote-off $0.8 million worth of a specific DRAM product, for which the Company's six month forecast showed minimal demand at December 31, 1997 and for which the Company has had minimal sales to date. It is the Company's practice to write-down to zero carrying value inventory on hand in excess of six months estimated sales volumes to cover estimated exposures unless adjustments are made to the forecast based on management's judgments for newer products, end of life products or planned inventory increases. Management's judgments take into account the product life cycles which can range from 6 to 24 months, the maturity of the product as to whether it is newly introduced or is approaching its end of life, the impact of competitor announcements and product introductions on the Company's products and purchasing opportunities due to excess wafer capacity. The Company believes that six months is an appropriate period because it is difficult to accurately forecast for a specific product beyond this time frame due to potential introduction of products by competitors, technology obsolescence or fluctuations in demand. In this regard, in the June 1996 quarter, the Company recorded a $15 million write-down for various SRAM and NVM products that the Company's forecast indicated would not be sold in the next six months. The Company did not expect to sell the excess inventory at the time because the volume and price declines from the December 1995 quarter to the June 1996 quarter resulted in a decrease in revenues of 38%. During this period, market conditions were extremely uncertain. Furthermore, during the fourth fiscal quarter of 1996 the Company experienced a continued decline in revenue of 16% from the June 1996 quarter. While the Company continued to focus on the selling of this product, sales reached a bottom in its decline in the September 1996 quarter and stayed relatively flat in the December 1996 quarter. Subsequently, as market conditions improved in the latter part of the December 1996 quarter, the Company was able to sell certain of these products. As a result of improving market conditions during fiscal 1997, the Company was able to sell $13.9 million of the written-off product. However, the Company considers such sales unusual and there can be no assurance that in the future written-off inventory can be sold. Historically, the Company has consistently applied this practice in valuing inventory and, until the events that transpired in the first through third quarters of fiscal 1996, had never recorded material write-downs or recoveries. The Company believes that based on the factors noted above, its six month write-off policy is still appropriate as a method to identify and estimate inventory exposure. There can be no assurance that in the future additional inventory write-downs will not occur. PRODUCT CONCENTRATION AND DEPENDENCE ON PERSONAL COMPUTER INDUSTRY A majority of the Company's products are incorporated into products such as modems, networking equipment, disk drives and PC cache. The PC and PC peripherals industry has from time to time experienced cyclical, depressed business conditions, often in connection with, or in anticipation of, a decline in general economic conditions. Such industry downturns have resulted in reduced product demand and declining average selling prices. The Company's business and operating results would be materially and adversely affected by any future downturns in the peripherals industry or in PCs. CUSTOMER CONCENTRATION The Company's sales are concentrated within a limited customer base. In both fiscal 1998 and fiscal 1997, one customer, 3COM, accounted for approximately 19% of net sales. As sales to this customer are executed pursuant to purchase orders and no purchasing contract exists, the customer can cease doing business with the Company at any time. The Company expects a significant portion of its future sales to remain concentrated within a limited number of strategic customers. There can be no assurance that the Company will be able to retain its strategic customers or that such customers will not otherwise cancel or reschedule orders, or in the event of canceled orders, that such orders will be replaced by other sales. In addition, sales to any particular customer may fluctuate significantly from quarter to quarter. The occurrence of any such events could have a material adverse effect on the Company's business and operating results. DEPENDENCE ON INDEPENDENT WAFER FOUNDRIES The Company has combined its fabless manufacturing strategy with technology partnerships and equity investments. This hybrid approach, which the Company calls "Fab-Lite(TM)", has provided advanced process technology and a committed wafer supply. To date, the Company's principal manufacturing relationship has been with TSMC, from which the Company has obtained a substantial majority of its wafers. The Company also receives wafers from Chartered Semiconductor and UMC. Each of the Company's wafer suppliers also fabricates for other integrated circuit companies, including certain of the Company's competitors. Although the Company has written commitments specifying wafer capacities from its suppliers, if these suppliers experience manufacturing failures or 18 21 yield shortfalls, choose to prioritize capacity for other use or reduce or eliminate deliveries to the Company there can be no assurance that the Company could enforce fulfillment of the delivery commitments. There can be no assurance that the Company would be able to qualify additional manufacturing sources for existing or new products in a timely manner or that such additional manufacturing sources would agree to deliver an adequate supply of wafers. If the Company were unable to obtain an adequate supply of wafers from its current or any alternative sources in a timely manner, its business and operating results would be materially and adversely affected. The Company has certain minimum wafer purchase commitments with its foundry partners in exchange for wafer capacity commitments. The Company has agreed to make certain annual purchases totaling, in aggregate, approximately $19.2 million through 2001 from TSMC for additional capacity above the annual base capacity. Wafer purchases in any given year are first applied to the base capacity and then to the Company's $19.2 million obligation. As a result, the $19.2 million may be subject to forfeiture if the Company does not purchase the base capacity and additional capacity for which it has contracted. The Company has minimum purchase obligations to TSMC related to WaferTech LLC, a business venture in which the Company is an investor. The Company is obligated to purchase from WaferTech or TSMC a minimum of 3.4% of WaferTech's installed capacity. Although the Company has rights to re-schedule or assign capacity to another party, there can be no assurance that such re-schedule or assignment would be successfully accomplished. Should the Company fail to re-schedule or assign unneeded capacity, the Company will be required to make payments for the unused capacity and its business and operating results would be materially and adversely affected. INTERNATIONAL OPERATIONS The Company is subject to the risks of conducting business internationally, including economic conditions in Asia, particularly Taiwan, changes in trade policy and regulatory requirements, tariffs and other trade barriers and restrictions, the burdens of complying with foreign laws, and possibly, political instability. The Company anticipates that sales to international customers will continue to represent a significant percentage of net sales. In addition, substantially all of the Company's foundries and assembly and test operations are located in Asia. The Company transacts business predominately in U.S. and New Taiwan ("NT") dollars. Such transactions expose the Company to the risk of exchange rate fluctuations. The Company monitors its exposure to foreign currency fluctuations, and has from time to time taken action to hedge against such exposure, but has not to date adopted any formal hedging strategy. The Company's business and results of operations have been negatively impacted by exchange rate fluctuations in the past and there can be no assurance that exchange rate fluctuations will not materially and adversely affect its business and operating results in the future. COMPETITION The semiconductor memory market is intensely competitive and has been characterized by an oversupply of product, price erosion, rapid technological change, short product life cycles, cyclical market patterns and heightened foreign and domestic competition. The ability of the Company to compete successfully in the high performance memory market depends on factors both within and outside of its control, including imbalances in supply and demand, product pricing, the rate at which OEM customers incorporate the Company's products into their systems, access to advance process technologies at competitive prices, product functionality, performance, and reliability, successful and timely product development, wafer supply, wafer costs, achievement of acceptable yields of functional die, the gain or loss of significant customers, the nature of its competitors and general economic conditions. There can be no assurance that the Company will be able to compete successfully in the future as to any of these factors. The failure of the Company to compete successfully in these or other areas could materially and adversely affect the Company's business and operating results. In addition, the Company is vulnerable to technology advances utilized by competitors to manufacture higher performance or lower cost products. CLAIMS REGARDING INTELLECTUAL PROPERTY In the semiconductor industry it is typical for companies to receive notices from time to time alleging infringement of patents or other intellectual property rights of others. The Company has been, and from time-to-time expects to be, notified of claims that it may be infringing patents, maskwork rights or copyrights owned by third parties. Although none of these companies have pursued a claim against the Company, there can be no assurance that other companies will not in the future pursue claims against the Company with respect to the alleged infringement of patents, maskwork rights, copyrights or other intellectual property owned by third parties. If it appears necessary or desirable, the Company may seek licenses under patents that it is alleged to be infringing. 19 22 Although patent holders commonly offer such licenses, there is no assurance that any licenses will be offered or that the terms of any offered licenses will be acceptable to the Company. The failure to obtain a license under a key patent or intellectual property right from a third party for technology used by the Company could cause the Company to incur substantial liabilities and to suspend the manufacture of the products utilizing the invention or to attempt to develop non-infringing products, any of which could materially and adversely affect the Company's business and operating results. RISK OF INCREASED TAXES The Company's tax rate could fluctuate for a number of reasons. For example, if the proportions of taxable income shifted such that a greater proportion of taxable income is earned by U.S. operations, the Company's effective tax rate may increase. It is possible that the Taiwan tax exemption applicable to the earnings of ISSI-Taiwan could be modified by changes in law or otherwise reduced. In addition, the Company's taxes would increase if all or a portion of the earnings of ISSI-Taiwan were to become subject to U.S. tax as the result of actual dividends or through U.S. rules for taxing controlled foreign corporations. Further, if profits of ISSI-Taiwan are distributed to the Company as dividends they become subject to Taiwan withholding tax as well as U.S. tax (with an offset for underlying Taiwan taxes paid) and the tax rate would increase. ISSI-Taiwan is a controlled foreign corporation ("CFC") for U.S. income tax purposes. Under U.S. rules for taxing CFCs, all or a portion of the earnings of ISSI-Taiwan may become subject to U.S. tax as inclusions in the U.S. taxable income of the Company (with a credit for foreign taxes paid by ISSI-Taiwan) if one or more of a number of events occur. Such events include, but are not limited to, ISSI-Taiwan lending funds to the Company or otherwise investing in certain proscribed assets and ISSI-Taiwan engaging in various types of transactions defined in the Subpart F provisions of the U.S. Internal Revenue Code. The Company believes that its existing plans will minimize the impact of the CFC rules for the immediate future, subject to such changes in U.S. tax laws as may occur. However, over time the CFC rules may cause the Company's tax rate to increase. YEAR 2000 ISSUES The Company is aware of the issues associated with computer systems as the Year 2000 approaches. The Year 2000 issues are the result of common computer programming techniques that result in systems that do not function properly when manipulating dates later than December 31, 1999. The problem may affect internal information technology (IT) systems used by the Company for product design, product test, accounting, distribution and planning. The problem may also affect non-IT systems such as security systems, communication equipment and other equipment. The Company has done an initial assessment of its critical IT systems and has identified at least one area (accounting software) that is not Year 2000 compliant. The Company is currently evaluating alternative software packages and intends to have implementation completed by October 1999. However, there can be no assurance that there will not be a delay in the implementation of such systems. It is estimated that the cost of implementing the new software will range between $0.1 million to $0.5 million. With respect to critical non-IT systems, the Company has assessed the compliance of these systems and believes that these systems are Year 2000 compliant. There can be no assurance that the Company has successfully identified all its internal Year 2000 issues. The failure to identify and address internal Year 2000 issues in a timely fashion could have a material adverse affect on the Company's business and results of operations. The Company could possibly be adversely impacted by Year 2000 issues faced by major suppliers, subcontractors, and customers. The Company is in the process of determining the potential impact on its operations as a result of the Year 2000 readiness of these third parties. Their failure to address Year 2000 issues could have an impact on the Company's operations and financial results. The extent of this impact, if any, is not known at this time. The above discussion regarding costs, risks and estimated completion dates for the Year 2000 is based on the Company's best estimates given information that is currently available, and is subject to change. As the Company proceeds with this project, it may discover that actual results will differ materially from these estimates. 20 23 VOLATILITY OF STOCK PRICE The trading price of the Company's Common Stock has been subject to wide fluctuations in response to quarter-to-quarter variations in operating results, announcements by the Company or its competitors, increases or decreases in wafer capacity, general conditions in the semiconductor or computer industries, governmental regulations, trade laws and import duties, litigation, new or revised earnings estimates, comments or recommendations issued by analysts who follow the Company, its competitors or the semiconductor industry and other events or factors. In addition, stock markets have experienced extreme price and trading volume volatility in recent years. This volatility has had a substantial effect on the market prices of securities of many high technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. 21 24 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Consolidated Financial StatementS Report of Independent Auditors...............................................23 Financial Statements: Consolidated Statements of Operations For Fiscal Years Ended September 30, 1998, September 30, 1997, and September 30, 1996......................24 Consolidated Balance Sheets As of September 30, 1998, and September 30, 1997................25 Consolidated Statements of Stockholders' Equity For Fiscal Years Ended September 30, 1998, September 30, 1997, and September 30, 1996......................26 Consolidated Statements of Cash Flows For Fiscal Years Ended September 30, 1998.......................27 September 30, 1997, and September 30, 1996 Notes to Consolidated Financial Statements............................28
22 25 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Stockholders Integrated Silicon Solution, Inc. We have audited the accompanying consolidated balance sheets of Integrated Silicon Solution, Inc. as of September 30, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended September 30, 1998. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Integrated Silicon Solution, Inc. at September 30, 1998 and 1997, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 1998, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. ERNST & YOUNG LLP San Jose, California October 23, 1998 23 26 Integrated Silicon Solution, Inc. Consolidated Statements of Operations (In thousands, except per share data)
Years Ended September 30, --------------------------------------------- 1998 1997 1996 --------- --------- --------- Net Sales $ 131,132 $ 108,261 $ 132,039 Cost of sales (other than item below) 103,794 76,105 85,184 Inventory write-down 23,000 -- 15,000 --------- --------- --------- Total cost of sales 126,794 76,105 100,184 --------- --------- --------- Gross profit 4,338 32,156 31,855 --------- --------- --------- Operating expenses Research and development 31,911 26,179 21,350 Selling, general and administrative 18,402 16,753 15,188 In-process technology charge 7,078 -- -- --------- --------- --------- Total operating expenses 57,391 42,932 36,538 --------- --------- --------- Operating loss (53,053) (10,776) (4,683) Interest and other income (expense) (1,697) 2,535 4,803 Interest expense (1,795) (607) (335) Gain on sale of investment 17,168 -- -- --------- --------- --------- Loss before income taxes and minority interest (39,377) (8,848) (215) Provision (benefit) for income taxes 4,668 (1,144) (1,158) --------- --------- --------- Income (loss) before minority interest (44,045) (7,704) 943 Minority interest in net loss of consolidated subsidiary (112) (18) (72) --------- --------- --------- Net income (loss) $ (43,933) $ (7,686) $ 1,015 ========= ========= ========= Basic income (loss) per share $ (2.32) $ (0.43) $ 0.06 ========= ========= ========= Shares used in basic per share calculation 18,940 17,748 17,457 ========= ========= ========= Diluted income (loss) per share $ (2.32) $ (0.43) $ 0.06 ========= ========= ========= Shares used in diluted per share calculation 18,940 17,748 18,356 ========= ========= =========
See the accompanying notes to consolidated financial statements 24 27 Integrated Silicon Solution, Inc. Consolidated Balance Sheets (In thousands, except per share data)
September 30, --------------------------- 1998 1997 --------- --------- ASSETS Current assets: Cash and cash equivalents $ 27,776 $ 22,334 Restricted cash 333 5,202 Short-term investments 7,800 25,600 Accounts receivable, net of allowance for doubtful accounts of $1,804 in 1998 and $2,268 in 1997 19,069 18,478 Inventories 46,484 40,730 Other current assets 4,938 7,472 --------- --------- Total current assets 106,400 119,816 Property, equipment, and leasehold improvements, net 44,316 27,693 Construction in progress -- 6,343 Other assets 51,452 41,744 --------- --------- Total assets $ 202,168 $ 195,596 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable $ 18,325 $ 6,152 Accounts payable 40,642 23,138 Accrued compensation and benefits 2,945 3,424 Accrued expenses 8,036 8,725 Income tax payable 524 582 Current portion of long-term obligations 3,379 2,251 --------- --------- Total current liabilities 73,851 44,272 Income tax payable - noncurrent 4,996 5,059 Long-term obligations 12,087 11,698 Minority interest in consolidated subsidiary 20,314 -- Commitments and contingencies Stockholders' equity: Preferred stock, $0.0001 par value: Authorized shares - 5,000 in 1998 and 1997. No shares outstanding -- -- Common stock, $0.0001 par value: Authorized shares - 70,000 in 1998 and 1997. Issued and outstanding shares - 19,417 in 1998 and 17,938 in 1997 2 2 Additional paid-in capital 116,199 106,769 Retained earnings (accumulated deficit) (11,667) 32,266 Cumulative translation adjustment (13,461) (4,248) Unearned compensation (153) (222) --------- --------- Total stockholders' equity 90,920 134,567 --------- --------- Total liabilities and stockholders' equity $ 202,168 $ 195,596 ========= =========
See the accompanying notes to consolidated financial statements 25 28 Integrated Silicon Solution, Inc. Consolidated Statements of Stockholders' Equity (In thousands)
Retained Total Common Stock Additional Earnings Cumulative Stock- ----------------------- Paid-In (Accumulated Translation Unearned holders' Shares Amount Capital Deficit) Adjustment Compensation Equity --------- --------- ---------- ------------ ----------- ------------ --------- Balance at September 30, 1995 17,225 $ 2 $ 102,376 $ 38,937 $ (1,302) $ (104) $ 139,909 Stock options exercised 253 -- 952 -- -- -- 952 Shares issued under stock purchase plan 129 -- 1,357 -- -- -- 1,357 Amortization of unearned compensation -- -- -- -- -- 43 43 Tax benefits from sale of common stock -- -- 103 -- -- -- 103 Translation adjustment -- -- -- -- (944) -- (944) Net income -- -- -- 1,015 -- -- 1,015 --------- --------- --------- --------- --------- --------- --------- Balance at September 30, 1996 17,607 2 104,788 39,952 (2,246) (61) 142,435 Stock options exercised 197 -- 665 -- -- -- 665 Shares issued under stock purchase plan 134 -- 1,112 -- -- -- 1,112 Unearned compensation -- -- 204 -- -- (204) -- Amortization of unearned compensation -- -- -- -- -- 43 43 Translation adjustment -- -- -- -- (2,002) -- (2,002) Net loss -- -- -- (7,686) -- -- (7,686) --------- --------- --------- --------- --------- --------- --------- Balance at September 30, 1997 17,938 2 106,769 32,266 (4,248) (222) 134,567 Stock options exercised 461 -- 1,674 -- -- -- 1,674 Shares issued under stock purchase plan 245 -- 1,379 -- -- -- 1,379 Amortization of unearned compensation -- -- -- -- -- 69 69 Shares issued for purchase of Nexcom Technology, Inc. 773 -- 6,377 -- -- -- 6,377 Translation adjustment -- -- -- -- (9,213) -- (9,213) Net loss -- -- -- (43,933) -- -- (43,933) --------- --------- --------- --------- --------- --------- --------- Balance at September 30, 1998 19,417 $ 2 $ 116,199 $ (11,667) $ (13,461) $ (153) $ 90,920 ========= ========= ========= ========= ========= ========= =========
See the accompanying notes to consolidated financial statements 26 29 Integrated Silicon Solution, Inc. Consolidated Statements of Cash Flows (In thousands)
Years Ended September 30, --------------------------------------- 1998 1997 1996 --------- --------- --------- Cash flows from operating activities: Net income (loss) $ (43,933) $ (7,686) $ 1,015 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 9,065 11,408 7,586 In-process technology charge 7,078 -- -- Gain on partial sale of ISSI-Taiwan (17,168) -- -- Provision for losses on accounts receivable -- 675 714 Net foreign currency transaction (gains) losses 3,188 17 (311) Minority interest in net loss of consolidated subsidiary (112) (18) (72) Changes in operating assets and liabilities: Accounts receivable (386) (8,007) 6,581 Inventories (13,515) (19,446) (11,592) Other assets 7,458 4,328 (7,710) Accounts payable 16,350 13,939 (6,721) Accrued expenses (2,553) 227 (3,104) --------- --------- --------- Net cash used in operating activities (34,528) (4,563) (13,614) Cash flows from investing activities: Acquisition of property, equipment, and leasehold improvements (19,218) (13,985) (20,423) Purchases of available-for-sale securities (42,750) (174,400) (197,800) Sales of available-for-sale securities 60,550 211,000 215,900 Investment in WaferTech, LLC (12,480) (9,360) (9,360) Investment in United Integrated Circuits Corp. (4,730) (12,983) -- Investment in Nexcom Technology, Inc. (869) -- -- Partial sale of ISSI-Taiwan 37,594 -- -- Proceeds from employees for UICC shares -- 5,345 -- --------- --------- --------- Net cash provided by (used in) investing activities 18,097 5,617 (11,683) Cash flows from financing activities: Proceeds from issuance of stock 3,122 1,820 2,352 Borrowings under notes payable and long-term obligations 81,816 28,659 28,018 Principal payments of notes payable and long-term obligations (65,884) (23,092) (16,172) Decrease (increase) in restricted cash 4,800 1,821 (6,037) --------- --------- --------- Net cash provided by financing activities 23,854 9,208 8,161 Effect of exchange rate changes on cash and cash equivalents (1,981) (165) (79) --------- --------- --------- Net increase (decrease) in cash and cash equivalents 5,442 10,097 (17,215) Cash and cash equivalents at beginning of year 22,334 12,237 29,452 ========= ========= ========= Cash and cash equivalents at end of year $ 27,776 $ 22,334 $ 12,237 ========= ========= =========
See the accompanying notes to consolidated financial statements 27 30 Notes to Consolidated Financial Statements NOTE 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION Integrated Silicon Solution, Inc. (the "Company") was incorporated in California on October 27, 1988 and reincorporated in Delaware on August 9, 1993. BASIS OF PRESENTATION The accompanying consolidated financial statements include the accounts of Integrated Silicon Solution, Inc. and its majority owned subsidiaries, after elimination of all significant intercompany accounts and transactions. CASH EQUIVALENTS AND SHORT -TERM INVESTMENTS The Company considers all highly liquid investments with a maturity of three months or less at the date of purchase to be cash equivalents. Under Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" all affected debt securities must be classified as held-to-maturity, trading, or available-for-sale and equity securities must be classified as trading or available-for-sale. Management determines the appropriate classification of debt and equity securities at the time of purchase and reevaluates such designation as of each balance sheet date. At September 30, 1998 and 1997, all debt and equity securities were designated as available-for-sale. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of tax, reported in a separate component of stockholders' equity. The amortized cost for available-for-sale debt securities is adjusted for the amortization of premiums and accretion of discounts to maturity. Such amortization is included in investment income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in investment income. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income. At September 30, 1998 and 1997, the cost of these securities approximated the fair value and the amount of unrealized gain or loss was not significant. There were no gains or losses on the sale of securities for the twelve months ended September 30, 1998 and 1997. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out) or market. The Company's inventory valuation process is done on a part-by-part basis. Lower of cost or market adjustments, specifically identified on a part-by-part basis, reduce the carrying value of the related inventory and take into consideration reductions in sales prices, excess inventory levels and obsolete inventory. Once established, these adjustments are considered permanent and are not reversed until the related inventory is sold or disposed. PROPERTY, EQUIPMENT, AND LEASEHOLD IMPROVEMENTS Property, equipment, and leasehold improvements are stated at cost. Equipment under capital leases is stated at the present value of minimum lease payments at the beginning of the lease term. Depreciation and amortization are computed using the straight-line method, based upon the shorter of the estimated useful lives ranging from three to seven years, or the lease term of the respective assets, if applicable, except the building in Taiwan which is being depreciated over fifty years. 28 31 Notes to Consolidated Financial Statements REVENUE RECOGNITION The Company recognizes revenue to non-distributor customers upon shipment. The Company provides for estimated sales returns on sales to these customers. Sales made to distributors, under terms allowing certain rights of return and price protection on unsold merchandise held by the distributor, are deferred until the merchandise is sold by the distributor. FOREIGN CURRENCY TRANSLATION The Company uses the local currency as its functional currency for all foreign subsidiaries. Translation adjustments, which result from the process of translating foreign currency financial statements into U.S. dollars, are included as a separate component of stockholders' equity. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. CONCENTRATION OF CREDIT RISK The Company operates in one business segment, which is to design, develop, and market high performance SRAM and NVM integrated circuits. The Company markets and distributes its products on a worldwide basis, primarily to original equipment manufacturers and personal computer motherboard manufacturers. The Company performs ongoing credit evaluations of its customers' financial condition and generally requires no collateral. In fiscal 1998, 1997 and 1996, one customer accounted for approximately 19%, 19% and 22% of net sales, respectively. The Company maintains cash, cash equivalents, and short-term investments with various financial institutions. The Company's investment policy is designed to limit exposure to any one institution. The Company performs periodic evaluations of the relative credit standing of those financial institutions that are considered in the Company's investment strategy. To date, the Company has not incurred losses related to these investments. SEMICONDUCTOR INDUSTRY RISKS To date the Company has derived substantially all of its revenues from the sale of SRAM products. The Company has diversified into other product areas such as specialty DRAMs, NVM products, and embedded memories, but a substantial majority of the Company's revenue is still derived from SRAM products. If the market for SRAM products should decline and the Company has not successfully diversified, such decline would have a material adverse affect on the Company's financial performance. The semiconductor industry is characterized by rapid technological change, intense competitive pressure and cyclical market patterns. The Company's results of operations are affected by a wide variety of factors, including declines in average selling prices of the Company's products, oversupply of memory products in the market, failure to introduce new products and to implement technologies on a timely basis, the timing and announcement of new product introductions by the Company and its competitors, market acceptance of the Company's and its customers' products, the failure to anticipate changing customer product requirements, fluctuations in manufacturing yields, disruption in delivery and order fulfillment, and disruption in the supply of wafers or assembly services. Other factors include changes in product mix, seasonal fluctuations in customer demand for the Company's products, the timing of significant orders, increased expenses associated with new product introductions or process changes, the ability of customers to make payments to the Company, increases in material costs, increases in antidumping duties, increases in costs associated with the expansion of sales channels, increases in general and administrative expenses, and certain production and other risks associated with using independent manufacturers. As a result, the Company may experience substantial period-to-period fluctuations in future operating results due to the factors mentioned above or other factors. 29 32 Notes to Consolidated Financial Statements NET INCOME (LOSS) PER SHARE Basic income per share is computed using the weighted number of common shares outstanding during the period. Diluted income per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of the shares issuable upon the exercise of stock options under the treasury stock method. Basic and diluted loss per share is computed using the weighted average number of shares of common stock outstanding during the period. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board issued Statement No. 130, "Reporting Comprehensive Income" (FAS No. 130) and Statement No. 131 "Disclosures About Segments of An Enterprise and Related Information" (FAS No. 131). FAS No. 130 establishes rules for reporting and displaying comprehensive income. FAS No. 131 will require the Company to use the "management approach" in disclosing segment information. Both statements are effective for the Company during fiscal 1999. The Company does not believe that the adoption of either FAS No. 130 or FAS No. 131 will have a material impact on the Company's results of operations, cash flows, or financial position. However, comprehensive income will differ from net income. RECLASSIFICATION OF PRIOR YEAR BALANCES Certain reclassifications have been made to prior year's financial statements to conform to the current year presentation. NOTE 2. CASH, CASH EQUIVALENTS, RESTRICTED CASH AND SHORT-TERM INVESTMENTS Cash, cash equivalents, restricted cash, and short-term investments consisted of the following at September 30:
1998 1997 ------- ------- (In thousands) Cash $23,893 $21,953 Money market instruments 195 480 Certificates of deposit 4,021 5,103 Auction preferred stock 1,000 13,200 Municipal bonds due in more than 3 years 6,800 12,400 ------- ------- Total $35,909 $53,136 ======= =======
NOTE 3. INVENTORIES Inventories consisted of the following at September 30:
1998 1997 ------- ------- (In thousands) Purchased components $ 5,447 $10,444 Work-in-process 14,868 10,199 Finished goods 26,169 20,087 ======= ======= $46,484 $40,730 ======= =======
In fiscal 1998, the Company recorded inventory write-downs of $23.0 million, including $9.6 million in the September quarter. The inventory write-downs were predominately for lower of cost or market issues on certain of the Company's products, primarily SRAMs. 30 33 Notes to Consolidated Financial Statements NOTE 4. OTHER ASSETS Other assets consisted of the following at September 30:
1998 1997 ------- ------- (In thousands) Investment in United Integrated Circuits Corp. (see Note 14) $16,486 $19,012 Investment in WaferTech LLC. (see Notes 14 and 20) 31,200 18,720 Other 3,766 4,012 ======= ======= $51,452 $41,744 ======= =======
NOTE 5. PROPERTY, EQUIPMENT, AND LEASEHOLD IMPROVEMENTS Property, equipment, and leasehold improvements consisted of the following at September 30:
1998 1997 ------- ------- (In thousands) Machinery and equipment $52,462 $49,463 Furniture and fixtures 1,969 1,409 Building and improvements 19,205 2,050 ------- ------- 73,636 52,922 Less accumulated depreciation and amortization 29,320 25,229 ======= ======= $44,316 $27,693 ======= =======
NOTE 6. ACCRUED EXPENSES Accrued liabilities consisted of the following at September 30:
1998 1997 ------ ------ (In thousands) UICC shares due employees $ -- $5,345 Other 8,036 3,380 ====== ====== $8,036 $8,725 ====== ======
The Company has an equity investment of approximately $16 million (subject to fluctuations in the New Taiwanese Dollar) in UICC, a wafer fabrication business venture led by UMC. In fiscal 1997, the Company elected to re-sell a portion of this investment to its employees at cost, which approximated fair value, generating a cash inflow to the Company of approximately $5,345,000. The UICC shares were transferred to the employees in fiscal 1998 after final approval by UICC and the government of the Republic of China. NOTE 7. NOTES PAYABLE AND LONG-TERM OBLIGATIONS At September 30, 1998, ISSI-Taiwan had short-term lines of credit with various financial institutions whereby it could borrow in aggregate up to approximately $23,510,000 denominated in a combination of U.S. and New Taiwan dollars. As of September 30, 1998, the Company had borrowings of approximately $18,225,000 outstanding under these lines of credit. These lines of credit expire at various times through September 1999. These lines of credit are secured by time deposits of approximately $333,000, which are recorded as restricted cash, as well as approximately $5.8 million at cost of UICC stock. Commitment fees relating to these lines are not material. At September 30, 1998, the weighted average interest rate on borrowing under these lines was 8.4%. 31 34 Notes to Consolidated Financial Statements Long-term obligations consisted of the following at September 30:
1998 1997 ------- ------- (In thousands) Notes payable to bank, due in quarterly installments through 2004 with interest at 6.82% to 8.82% and secured by the Company's property and equipment $15,466 $13,949 Less current portion 3,379 2,251 ------- ------- $12,087 $11,698 ======= =======
At September 30, 1998, future minimum principal payments on notes payable and long-term obligations were as follows (in thousands): 1999 3,379 2000 3,077 2001 3,077 2002 3,077 2003 2,290 Thereafter 566 ------- Total $15,466 =======
Interest of $913,000, $280,000, and $235,000 was capitalized in 1998, 1997, and 1996, respectively, and is included in fixed assets. NOTE 8. CAPITAL STOCK The Company's Restated Certificate of Incorporation provides for 70,000,000 authorized shares of Common Stock and 5,000,000 authorized shares of preferred stock. The terms of the preferred stock may be fixed by the Board of Directors, who have the right to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders of the Company. The rights of the holders of common stock are subject to, and may be adversely affected by, the rights of the holders of any preferred stock that may be issued in the future. NOTE 9. STOCK PLANS 1989 STOCK OPTION PLAN During 1989, the Company adopted a stock option plan (the "Plan") that provides for incentive stock options for employees and nonstatutory stock options for employees, consultants and nonemployee directors of the Company. Incentive stock options and nonstatutory options granted under the Plan have five or ten-year terms. All incentive stock option grants and nonstatutory stock option grants must be at prices of at least 100% and 85%, respectively, of the fair market value of the stock on the date of grant, as determined by the Board of Directors. The options are exercisable as determined by the Board of Directors. Generally, the stock options vest ratably over a four-year period. The options expire upon the earlier of five or ten years from the date of grant or 30 days following termination of employment. Options to purchase 1,120,000 shares, 1,164,000 shares, and 791,000 shares were exercisable as of September 30, 1998, 1997, and 1996, respectively. In the event of certain changes in control of the Company, the Plan requires that each outstanding option be assumed or an equivalent option substituted by the successor corporation; however, if such successor refuses to assume the then outstanding options, the Plan provides for the full acceleration of the exercisability of all outstanding options. 32 35 Notes to Consolidated Financial Statements 1996 STOCK OPTION PLAN On October 18, 1996, the Company adopted a stock option plan (the "1996 Plan") that provides for non-statutory stock options for non-executive employees and consultants of the Company. Under the terms of the plan, the exercise price and exercise period of non-statutory stock option grants is determined by the Board of Directors on the date of grant. Generally, the stock options vest ratably over a four year period. The options expire upon the earlier of ten years from the date of grant or 30 days following termination of employment or consultancy. Options to purchase 430,000 shares and 33,000 shares were exercisable as of September 30, 1998 and 1997, respectively. In the event of certain changes in control of the Company, the 1996 Plan requires that each outstanding option be assumed or an equivalent option substituted by the successor corporation; however, if such successor refuses to assume the then outstanding options, the 1996 Plan provides for the full acceleration of the exercisability of all outstanding options. 1995 DIRECTOR STOCK OPTION PLAN The Board of Directors and stockholders approved the 1995 Director Stock Option Plan ("Director Plan") in December 1995 and January 1996, respectively. Under the terms of the Plan, 50,000 shares of Common Stock were authorized for issuance. Each director who has been a non-employee director for at least six months will automatically receive a non-statutory option to purchase 2,500 shares of Common Stock upon such director's annual reelection to the Board by the stockholders. Options to purchase 26,000 shares, 13,000 shares and 6,000 shares were exercisable at September 30, 1998, 1997 and 1996, respectively. The following table summarizes activity of the 1989, 1996 and Director Plans:
Options Outstanding ------------------------------------------------- Options Number Weighted- Available Of Price Average For Grant Shares Per Share Exercise Price --------- ------ --------------- -------------- (In thousands, except per share data) Balance at September 30, 1995 342 2,051 $0.20 - $59.50 $15.56 Authorized 1,050 -- -- -- Granted (1,609) 1,609 $9.625- $26.00 18.73 Exercised -- (253) $0.20 - $13.00 3.76 Canceled 907 (907) $0.28 - $59.50 33.42 ----------------------------------------------------------------- Balance at September 30, 1996 690 2,500 $0.20 - $27.50 12.31 Authorized 775 -- -- -- Granted (2,340) 2,340 $5.00 - $10.125 8.72 Exercised -- (197) $0.20 - $12.25 3.37 Canceled 1,095 (1,095) $0.20 - $27.50 19.98 ----------------------------------------------------------------- Balance at September 30, 1997 220 3,548 $0.28 - $26.00 8.07 Authorized 2,218 -- -- -- Granted (1,463) 1,463 $3.00 - $11.00 8.08 Exercised -- (461) $0.28 - $10.48 3.63 Canceled 1,254 (1,254) $3.00 - $26.00 8.39 ----------------------------------------------------------------- Balance at September 30, 1998 2,229 3,296 $3.00 - $14.50 $ 8.57 -----------------------------------------------------------------
For certain options granted in 1997, 1995 and 1994, the Company recognized as unearned compensation the excess of the deemed value for accounting purposes of the common stock issuable upon exercise of such options over the aggregate exercise price of such options. The deemed value for accounting purposes represents the fair value at the date of grant. The compensation expense is being amortized ratably over the vesting period of the option. Compensation expense amounting to $69,000, $43,000 and $43,000 was recognized for the years ending September 30, 1998, 1997, and 1996, respectively. 33 36 Notes to Consolidated Financial Statements Outstanding and exercisable options presented by price range at September 30, 1998 are as follows:
Options Outstanding Options Exercisable ------------------------------------------------ ------------------------------- Number of Wtd. Average Number of Range of Options Remaining Life Wtd. Average Options Wtd. Average Exercise Prices Outstanding (Years) Exercise Price Exercisable Exercise Price - --------------------- ------------- -------------- -------------- ------------- --------------- $ 3.00 - 7.59 589,000 7.81 $ 5.53 307,000 $ 4.56 7.75 - 8.00 775,000 9.06 7.92 129,000 7.85 8.56 - 9.13 381,000 8.66 8.86 159,000 8.91 9.25 - 9.25 867,000 8.37 9.25 538,000 9.25 9.38 - 12.25 614,000 7.87 10.69 391,000 10.74 12.75 - 14.50 70,000 7.05 13.02 52,000 13.09 ========================================================================================================== $ 3.00 - 14.50 3,296,000 8.34 $ 8.57 1,576,000 $ 8.68 ==========================================================================================================
EMPLOYEE STOCK PURCHASE PLAN In March 1993, the Company adopted an Employee Stock Purchase Plan ("Purchase Plan") under Section 423 of the Internal Revenue Code. Under the Company's Purchase Plan, eligible employees may purchase shares of the Company's common stock through payroll deductions. The shares are purchased at a price equal to 85% of the lesser of the fair value of the Company's common stock as of the first day of the 24-month offering period or the last day of each six-month purchase period. A total of 1,450,000 shares of common stock is reserved for issuance under the plan, of which 508,000 had been issued as of September 30, 1998. STOCK-BASED COMPENSATION As permitted under FAS 123, the Company has elected to follow APB 25 and related Interpretations, in accounting for stock-based awards to employees. Under APB 25, the Company generally recognized no compensation expense with respect to such awards. Pro forma information regarding net income (loss) and earnings (loss) per share is required by FAS 123 for awards granted or modified after September 30, 1995 as if the Company had accounted for its stock-based awards to employees under the fair value method of FAS 123. The fair value of the Company's stock-based awards to employees was estimated using a Black-Scholes option pricing model. The Black-Scholes model requires the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock-based awards to employees have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards to employees. The fair value of the Company's stock-based awards to employees was estimated assuming no expected dividends and the following weighted-average assumptions:
STOCK OPTIONS ESPP ------------------------------------- ------------------------------------- 1998 1997 1996 1998 1997 1996 ------- ------- ------- ------- ------- ------- Expected life (years) 5.0 5.0 5.0 0.5 0.5 0.5 Expected volatility .76 .70 .70 .72 .53 .73 Risk-free interest rate 5.50 6.43 6.11 5.33 5.50 5.34
The weighted-average fair value of options granted at market value during fiscal 1998, 1997 and 1996 was $3.81, $4.02 and $9.75 per share, respectively. The weighted-average fair value of employee stock purchase rights during fiscal 1998, 1997 and 1996 was $3.89, $5.33 and $5.20 per share, respectively. 34 37 Notes to Consolidated Financial Statements For pro forma purposes, the estimated fair value of the Company's stock-based awards to employees is amortized over the options' vesting period (for options) and the six-month purchase period (for stock purchases under the ESPP). The Company's pro forma information for the years ended September 30, is as follows (in thousands, except for income (loss) per share information):
1998 1997 1996 ---------- ---------- ---------- Net income (loss) As reported $ (43,933) $ (7,686) $ 1,015 Pro forma $ (48,890) $ (14,814) $ (4,754) Basic and diluted income (loss) per share As reported $ (2.32) $ (0.43) $ 0.06 Pro forma $ (2.58) $ (0.83) $ (0.27)
Because FAS 123 is applicable only to awards granted subsequent to September 30, 1995, its pro forma effect will not be fully reflected until fiscal 1999 and is not expected to be indicative of the effects on net income (loss) and net income (loss) per share in future years. NOTE 10. STOCKHOLDERS' EQUITY The Company is subject to legal restrictions related to its distribution of ISSI-Taiwan earnings. In accordance with the Corporate Law of the Republic of China, before ISSI-Taiwan declares any part of net income as dividends and/or bonuses, ISSI-Taiwan must transfer 10% of its statutory net income to a legal reserve until such reserve is equal to ISSI-Taiwan's capital. At September 30, 1998, such restricted equity amounted to approximately $5,022,000. The legal reserve is not available for distribution; however, when the reserve exceeds 50% of ISSI-Taiwan's capital, 50% of the legal reserve in excess of 50% of ISSI-Taiwan's capital may be distributed in the form of stock. The reserve may be utilized at any time to offset a deficit. In addition, any distribution of equity of ISSI-Taiwan must allocate 1% of the related distribution to employees of ISSI-Taiwan. NOTE 11. INCOME TAXES The provision (benefit) for income taxes consisted of the following for the years ended September 30:
1998 1997 1996 ------- ------- ------- (In thousands) Current: Federal $ 114 $(2,558) $ 3,137 State 36 1 335 Foreign 2,377 116 200 ------- ------- ------- Total current $ 2,527 $(2,441) $ 3,672 Deferred: Federal 2,289 2,584 (3,062) State -- -- (614) Foreign (148) (1,287) (1,154) ------- ------- ------- Total deferred 2,141 1,297 (4,830) ------- ------- ------- Total provision (benefit) $ 4,668 $(1,144) $(1,158) ======= ======= =======
Pretax income from foreign operations was approximately $200,000, $9,207,000, and $153,000 for 1998, 1997 and 1996, respectively. 35 38 Notes to Consolidated Financial Statements The Company's provision (benefit) for income taxes differs from the amount computed by applying the U.S. federal statutory rate (35%) to income before taxes and minority interest as follows for the years ended September 30:
1998 1997 1996 -------- -------- -------- (In thousands) Income taxes computed at the U.S. federal statutory rate $(13,782) $ (3,097) $ (75) Valuation of deferred tax assets 11,105 6,546 1,104 Net operating loss utilized (2,898) -- -- Foreign earnings taxed at lower than U.S. rate (62) (4,368) (1,006) Foreign withholding taxes 2,373 -- -- Tax exempt interest income (93) (328) (694) Gain on sale of ISSI-Taiwan stock 5,554 -- -- In-process research and development 2,477 -- -- Other individually immaterial items (6) 103 (487) ======== ======== ======== Total provision (benefit) $ 4,668 $ (1,144) $ (1,158) ======== ======== ========
As of September 30, 1998 the Company has federal net operating loss carryforwards of approximately $9,000,000. The Company has federal research and development credit carryforwards, foreign tax credits and alternative minimum tax credit carryforwards of approximately $2,600,000, $2,500,000 and $500,000, respectively. The Company also has state research and manufacturers' investment tax credit carryforwards of approximately $900,000 and $250,000. The net operating losses, research credit carryforwards, foreign tax credit carryforwards and state manufacturers' investment tax credit carryforwards will expire at various dates beginning in 2003 through 2013, if not utilized. In addition, ISSI-Taiwan has investment tax credit carryforwards of approximately $5,000,000 that will expire at various dates beginning in 1999 through 2002, if not utilized. Utilization of the net operating loss carryforwards and credits may be subject to a substantial annual limitation due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization. Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amount used for income tax purposes. Significant components of deferred taxes consisted of the following at September 30:
1998 1997 -------- -------- (In thousands) Deferred tax assets: Depreciation $ 577 $ 607 Reserves and write-downs not currently deductible 11,961 3,159 Accrued expenses 2,983 2,053 Taiwan - investment tax credit carryforwards 5,383 4,480 Federal and state credit carryforwards 6,548 2,040 Federal and state net operating loss carryforwards 3,204 6,236 Other, net 1,185 13 -------- -------- Total deferred tax assets 31,841 18,588 Valuation allowance (29,667) (13,858) -------- -------- Net deferred tax assets $ 2,174 $ 4,730 ======== ========
Management has established a valuation allowance for the U.S. portion of the gross deferred tax assets based on management's belief that the realization of the U.S. deferred tax assets is not realizable on a more likely than not basis. Management has determined, based on ISSI-Taiwan's history of prior operating earnings and its expectation of future taxable income, that a partial valuation allowance for ISSI-Taiwan's deferred tax assets should be provided. Although realization of the ISSI-Taiwan deferred tax assets is not assured, management believes that it is more likely than not that the deferred tax asset will be realized. The amount of the deferred tax asset considered 36 39 Notes to Consolidated Financial Statements realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. The valuation allowance for deferred tax assets increased by $15,809,000 and $6,695,000 during 1998 and 1997, respectively. Approximately, $2,450,000 of the valuation allowance is attributable to tax benefits of stock option deductions, which will be credited to paid in capital when recognized. As a result of its location in the Hsinchu Science-Based Industrial Park in Taiwan, ISSI-Taiwan has received a tax exemption for taxable income beginning October 1, 1992. ISSI-Taiwan continuously extends this 4-year exemption each time it expands its capital assets and uses the capital to purchase qualified machinery. The precise amount of the exemption is calculated annually based upon the extent of ISSI-Taiwan's net operating taxable income and measured by certain factors, including use of qualified manufacturing equipment, self-manufacturing costs and qualified sales revenue. The portion of ISSI-Taiwan's taxable income which is not subject to exemption is taxed at a flat 20% tax rate. Cumulative net undistributed earnings of ISSI-Taiwan for which no residual U.S. taxes have been provided aggregate approximately $28,000,000 at September 30, 1998. These earnings are considered to be permanently invested in non-U.S. operations. Upon distribution of these earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes and withholding tax payable to the foreign country. Determination of the amount of unrecognized deferred U.S. tax liability is not practical because of the complexities associated with its hypothetical calculation. However, a U.S. foreign tax credit for the withholding tax payable on the distribution would be available to reduce U.S. taxes. NOTE 12. PER SHARE DATA The calculations of basic and diluted income (loss) per share for each of the three years ended September 30, 1998 are as follows:
Years Ended September 30, 1998 1997 1996 -------- -------- -------- In thousands, except per share data Net income (loss) $(43,933) $ (7,686) $ 1,015 ======== ======== ======== Denominator for basic income (loss) per share: Weighted average common shares outstanding 18,940 17,748 17,457 Denominator for basic income (loss) per share 18,940 17,748 17,457 -------- -------- -------- Dilutive stock options -- -- 899 -------- -------- -------- Denominator for diluted income (loss) per share 18,940 17,748 18,356 ======== ======== ======== Basic income (loss) per share $ (2.32) $ (0.43) $ 0.06 ======== ======== ======== Diluted income (loss) per share $ (2.32) $ (0.43) $ 0.06 ======== ======== ========
The above diluted calculation for the years ended September 30, 1998, 1997 and 1996, does not include approximately 2,497,000, 1,418,000 and 797,000 shares attributable to options as of September 30, 1998, 1997 and 1996, respectively, as their impact would be anti-dilutive. 37 40 Notes to Consolidated Financial Statements NOTE 13. GEOGRAPHIC AND SEGMENT INFORMATION The Company operates in one business segment, which is to design, develop, and market high-performance SRAM and NVM integrated circuits. The following table summarizes the Company's operations in different geographic areas:
Year Ended September 30, 1998 ------------------------------------------------------------------- Adjustments/ United States Taiwan Eliminations Consolidated ------------- ---------- ------------ ----------- (In thousands) Sales to unaffiliated customers $ 83,223 $ 47,909 $ -- $ 131,132 Transfers between geographic areas 2,155 69,495 (71,650) -- ---------- ---------- ---------- ---------- Total net sales $ 85,378 $ 117,404 $ (71,650) $ 131,132 ========== ========== ========== ========== Operating income (loss) $ (56,374) $ 3,266 $ 55 $ (53,053) ========== ========== ========== ========== Identifiable assets $ 84,399 $ 128,115 $ (10,346) $ 202,168 ========== ========== ========== ========== Cash, cash equivalents, restricted cash and short-term investments $ 30,072 $ 5,837 $ -- $ 35,909 ========== ========== ========== ========== Accounts receivable from third-party customers $ 10,170 $ 8,899 $ -- $ 19,069 ========== ========== ========== ==========
Year Ended September 30, 1997 ------------------------------------------------------------------- Adjustments/ United States Taiwan Eliminations Consolidated ------------- ---------- ------------ ------------ (In thousands) Sales to unaffiliated customers $ 63,247 $ 45,014 $ -- $ 108,261 Transfers between geographic areas 3,586 69,795 (73,381) -- ---------- ---------- ---------- ---------- Total net sales $ 66,833 $ 114,809 $ (73,381) $ 108,261 ========== ========== ========== ========== Operating loss $ (20,504) $ 8,995 $ 733 $ (10,776) ---------- ---------- ---------- ---------- Identifiable assets $ 115,477 $ 123,676 $ (43,557) $ 195,596 ========== ========== ========== ========== Cash, cash equivalents, restricted cash and short-term investments $ 40,737 $ 12,399 $ -- $ 53,136 ========== ========== ========== ========== Accounts receivable from third-party customers $ 10,705 $ 7,773 $ -- $ 18,478 ========== ========== ========== ==========
38 41 Notes to Consolidated Financial Statements
Year Ended September 30, 1996 ----------------------------------------------------------------------- Adjustments/ United States Taiwan Eliminations Consolidated ------------- ----------- ------------ ----------- (In thousands) Sales to unaffiliated customers $ 85,676 $ 46,363 $ -- $ 132,039 Transfers between geographic areas 6,250 70,450 (76,700) -- ----------- ----------- ----------- ----------- Total net sales $ 91,926 $ 116,813 $ (76,700) $ 132,039 =========== =========== =========== =========== Operating loss $ (3,751) $ (615) $ (317) $ (4,683) ---------- ---------- ---------- ---------- Identifiable assets $ 115,331 $ 76,976 $ (14,268) $ 178,039 =========== =========== =========== =========== Cash, cash equivalents, restricted cash and short-term investments $ 74,498 $ 6,962 $ -- $ 81,460 =========== =========== =========== =========== Accounts receivable from third-party customers $ 6,910 $ 4,406 $ -- $ 11,316 =========== =========== =========== ===========
Transfers between geographic areas are accounted for at amounts which are generally above cost and consistent with rules and regulations of governing tax authorities. Such transfers are eliminated in the consolidated financial statements. Identifiable assets by geographic area are those assets used in the Company's operations in each area. Total assets and liabilities for ISSI-Taiwan amounted to approximately $128,115,000 and $84,089,000, respectively, at September 30, 1998. Included in the assets and liabilities of ISSI-Taiwan were intercompany receivables amounting to approximately $2,697,000 at September 30, 1998. Pre-tax income for ISSI-Taiwan for the year ended September 30, 1998 was approximately $195,000. Export sales by the U.S. operating company were approximately $26,393,000, $14,125,000, and $15,741,000, for the years ended September 30, 1998, 1997, and 1996, respectively. Net foreign currency transaction gains (losses) of approximately $(3,188,000), $(17,000), and $311,000 for the years ended September 30, 1998, 1997 and 1996, respectively, were primarily the result of the settlement of intercompany transactions and are included in the determination of net income. NOTE 14. COMMITMENTS AND CONTINGENCIES PATENTS AND LICENSES In the semiconductor industry it is typical for companies to receive notices from time to time alleging infringement of patents or other intellectual property rights of others. The Company has been, and from time-to-time expects to be, notified of claims that it may be infringing patents, maskwork rights or copyrights owned by third parties. Although none of these companies have pursued a claim against the Company, there can be no assurance that other companies will not in the future pursue claims against the Company with respect to the alleged infringement of patents, maskwork rights, copyrights or other intellectual property owned by third parties. If it appears necessary or desirable, the Company may seek licenses under patents that it is alleged to be infringing. Although patent holders commonly offer such licenses, there is no assurance that any licenses will be offered or that the terms of any offered licenses will be acceptable to the Company. The failure to obtain a license under a key patent or intellectual property right from a third party for technology used by the Company could cause the Company to incur substantial liabilities and to suspend the manufacture of the products utilizing the invention or to attempt to develop non-infringing products, any of which could materially and adversely affect the Company's 39 42 Notes to Consolidated Financial Statements business and operating results. Furthermore, there can be no assurance that the Company will not become involved in protracted litigation regarding the alleged infringement by the Company of third party intellectual property rights or litigation to assert and protect patents or other intellectual property rights of the Company. Any litigation relating to patent infringement or other intellectual property matters could result in substantial cost and diversion of resources by the Company which could materially and adversely affect the Company's business and operating results. LITIGATION On April 22, 1998, the U.S. Department of Commerce ("DOC") published an amended antidumping duty order on imports of SRAMs from Taiwan from where the Company currently imports a majority of its SRAMs. As a consequence of this antidumping duty order, the Company is required to post a cash deposit on imports of Taiwan fabricated SRAM wafers or devices, at the ad valorem rate of 7.56%. The cash deposits subsequently could be returned to the Company or, alternatively, the Company could forfeit amounts deposited and owe duties and interest in addition to the amounts deposited. The outcome is dependent on whether the DOC conducts an administrative review of imports entered after the imposition of the antidumping order, and if so, on the results of the DOC review. The decision on whether to conduct a review will be made in 1999 and the results of the review will be issued in the year 2000. The Company has retained legal counsel to defend and assist in its interests in the antidumping proceedings. In addition, certain aspects of the antidumping determination are being challenged in federal court proceedings by some of the respondents to the investigation, and these proceedings could result in the termination of this antidumping case. Duties calculated and assessed by the government could have a material adverse affect on the Company's gross margins and profits. There can be no assurance that any reviews or proceedings will mitigate or eliminate antidumping duties. On October 22, 1998, Micron Technology filed an anti-dumping petition against DRAMs fabricated in Taiwan. Currently, the Company's DRAM products are fabricated in Taiwan. The case is expected to take from 12 to 18 months to complete. If the petition is upheld, the Company could face DRAM duties, unless it is able to secure DRAM from outside of Taiwan. Currently, DRAM accounts for less than 10% of the Company's revenue. LEASES The Company leases its facilities and the land upon which ISSI-Taiwan is constructing its new Taiwan facility under operating lease agreements that expire at various dates through 2016. The Company entered into a ten year lease effective December 1, 1996 for its headquarters facility in Santa Clara, California. The Company has subleased approximately 25% of the Santa Clara facility and the sublease expires in March 2000. Minimum rental commitments under these leases are as follows (in thousands): 1999 (net of sublease income of $501) $ 1,045 2000 (net of sublease income of $285) 1,231 2001 1,367 2002 1,423 2003 1,479 Thereafter 6,247 ------- Total minimum rental commitments $12,792 =======
Total rental expense for the years ended September 30, 1998, 1997, and 1996 was approximately $1,078,000 (net of sublease income of $375,000), $1,372,000 (net of sublease income of $148,000), and $637,000, respectively. 40 43 Notes to Consolidated Financial Statements COMMITMENTS TO WAFER FABRICATION FACILITIES In June 1996, the Company entered into a business venture "WaferTech, LLC" with TSMC, Altera, Analog Devices, and private investors to build a wafer fabrication facility in Camas, Washington. The Company agreed to invest $31.2 million for a 4% equity interest in the venture and as of September 30, 1998 all of this amount had been paid. The last scheduled payment to WaferTech by the Company of $12.5 million was made in November 1997. The Company is accounting for this investment on the cost basis. In December 1998, the Company agreed to sell approximately 33% of its investment in WaferTech to TSMC for approximately $10.0 million. The transaction is expected to close in January 1999. Upon completion of the transaction, the Company will have a 2.67% interest in WaferTech. The Company has also agreed to certain minimum wafer purchase commitments with its foundry partners in exchange for wafer capacity commitments. In fiscal 1995, the Company entered into an agreement with TSMC pursuant to which the Company agreed to acquire specified wafer capacity through 2001. The Company also agreed to make certain annual payments totaling approximately $19.2 million through 2001 to TSMC for additional capacity above the annual base capacity. Wafer purchases in any given year are first applied to the base capacity and then to the Company's $19.2 million obligation. As a result, the $19.2 million may be subject to forfeiture if the Company does not purchase the base capacity and additional capacity for which it has contracted. To date, the Company has never forfeited any amounts under this agreement. The Company also has minimum purchase obligations to TSMC related to WaferTech LLC. The Company is obligated to purchase from WaferTech or TSMC a minimum of 3.4% of WaferTech's installed capacity. Initial wafer outs occurred in the second half of calendar 1998. Although the Company has rights to re-schedule or assign capacity to another party, there can be no assurance that such re-schedule or assignment would be successfully accomplished. Should the Company fail to re-schedule or assign unneeded capacity, the Company's business and operating results could be adversely affected. In fiscal 1995, the Company entered into a business venture "United Integrated Circuits Corp" ("UICC") with UMC and other investors to build a wafer fabrication facility in Hsinchu, Taiwan. The Company has invested approximately $16.5 million (subject to fluctuations in the New Taiwanese Dollar) for a 4% equity interest in the venture of which UMC retains 55% ownership. The final payment of approximately $4.7 million was made to UICC in December 1997. The Company is accounting for this investment on the cost basis. The UICC facility was severely damaged by fire in October 1997. It is the Company's understanding that the damage was covered by insurance. UICC has undertaken a clean up of the facility, but reconstruction has not commenced as an alternative site is being evaluated. A decision as to whether to build on the existing site or the alternative site has not yet been made. The Company believes that its investment of $16.5 million is recoverable. NOTE 15. EMPLOYEE BENEFIT PLAN In August 1992, the Company established a defined contribution retirement plan with 401(k) plan features. The plan covers all United States employees 18 years and older. Employees may make contributions by a percentage reduction in their salaries, up to $10,000 for 1998. The Company elected to make no contributions during the years ended September 30, 1998, 1997 and 1996. Administrative expenses relating to the plan are insignificant. NOTE 16. SUPPLEMENTAL CASH FLOW INFORMATION
Years Ended September 30, 1998 1997 1996 -------- -------- -------- (In thousands) Cash paid for interest $ 2,896 $ 1,431 $ 478 Cash paid (refunded) for income taxes 2,561 (5,004) 8,603 Notes payable issued for other assets -- -- (31,200) Tax benefit from sale of common stock -- -- 103 Fixed assets acquired for accounts payable 4,440 -- -- Stock issued in acquisition of Nexcom 6,377 -- -- Assets acquired from Nexcom 2,515 -- -- Liabilities assumed from Nexcom 3,762 -- --
41 44 Notes to Consolidated Financial Statements NOTE 17. TRANSACTIONS On December 3, 1997, the Company completed its acquisition of Nexcom Technology, Inc. ("Nexcom") in exchange for the issuance of 772,693 shares of Common Stock, $0.5 million in cash, and the assumption of $1.2 million of net liabilities (total consideration of approximately $8.5 million). The transaction was accounted for as a purchase and resulted in an in-process technology charge of approximately $7.1 million in the Company's December 31, 1997 quarter. Nexcom was formed in 1990 and has been engaged primarily in the research and development of non-volatile flash memory technology. On June 29, 1998, the Company sold approximately 46% of ISSI-Taiwan to a group of private investors. The price was privately negotiated between the parties. Cash proceeds from the transaction totaled $35.5 million net of withholding and transaction taxes. The transaction resulted in a pre-tax gain of $17.2 million which is recorded in the Company's June 30, 1998 quarter. NOTE 18. RELATED PARTY TRANSACTIONS For the year ended September 30, 1996, the Company purchased approximately $1,342,000 of services from Taicera Electronics Company, an assembly plant that is an affiliate of the Fu Sheng Industrial Group, whose chairman was a member of the Company's Board of Directors until April 1997. At September 30, 1996, the Company had no balance due to Taicera Electronics Company. NOTE 19. SPIN-OFF OF NEXFLASH TECHNOLOGIES, INC. Effective October 1, 1998, the Company transferred certain employees and joint ownership of certain patents and related Flash technology to a newly formed company, NexFlash Technologies, Inc. The Company and NexFlash jointly own existing Flash related patents and NexFlash will continue development of Flash products. The Company owns approximately 32% of NexFlash, and ISSI-Taiwan owns approximately 17%, which includes approximately 6% of NexFlash purchased for $1,000,000. The Company's President is the acting Chief Executive Officer of NexFlash. In connection with the NexFlash transaction, the Company issued warrants to purchase an aggregate of 981,659 shares of ISSI Common Stock at an exercise price of $3.76 per share to the NexFlash investors. The warrants expire on November 4, 2000. NOTE 20. SUBSEQUENT EVENTS (UNAUDITED) 1998 ISSI-TAIWAN STOCK PLAN On October 29, 1998, the Company adopted the 1998 ISSI-Taiwan Stock Plan "Taiwan Stock Plan" that provides for non-statutory stock options in the common stock of ISSI-Taiwan for employees, consultants, and directors of the Company. Upon exercise, if any, the Company would sell its shares in ISSI-Taiwan to the optionee. Under terms of the Taiwan Stock Plan, the maximum aggregate number of shares of ISSI-Taiwan stock which may be optioned and sold is twelve million. This represents approximately 10% of the outstanding shares of ISSI-Taiwan. Under the terms of the plan, the exercise price, which is deemed to be fair value, and the exercise period of the non-statutory stock option grants are determined by the Board of Directors on the date of grant. Generally, the stock options vest one-third annually on the anniversary of the date of grant. The options expire upon the earlier of ten years from the date of grant or 30 days following termination of employment or consultancy. In the event of an optionee's termination of status as an employee or consultant of the Company, without cause, within twelve months of certain changes of control of the Company, the Taiwan Stock Plan provides for full acceleration of the exercisability of all outstanding options. 42 45 Notes to Consolidated Financial Statements PARTIAL SALE OF INVESTMENT IN WAFERTECH In December 1998, the Company agreed to sell approximately 33% of its investment in WaferTech to TSMC for approximately $10.0 million. The transaction is expected to close in January 1999. Upon completion of the transaction, the Company will have a 2.67% interest in WaferTech. REPRICE OF STOCK OPTIONS On December 2, 1998, the Board of Directors approved the repricing of certain options outstanding previously granted to employees of the Company. Approximately 2,007,000 shares with an aggregate exercise price of approximately $17.3 million were repriced to an exercise price of $3.1562 per share. In connection with the repricing, certain vesting and exercise rights were surrendered. 43 46 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III Certain information required by Part III is omitted from this Report on Form 10-K in that the Registrant will file its definitive Proxy Statement for its Annual Meeting of Stockholders to be held on January 29, 1999, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended (the "Proxy Statement"), not later than 120 days after the end of the fiscal year covered by this Report, and certain information included in the Proxy Statement is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Executive Officers - See the section entitled "Executive Officers" in Part I, Item 1 hereof. (b) Directors - The information required by this Item is incorporated by reference to the section entitled "Election of Directors" in the Proxy Statement The disclosure required by Item 405 of Regulation S-K is incorporated by reference to the section entitled "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to the sections entitled "Compensation of Executive Officers" and "Compensation of Directors" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference to the sections entitled "Principal Share Ownership" and "Security Ownership of Management" in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated by reference to the section entitled "Certain Transactions" in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) List of documents filed as part of this Report. 44 47 1. FINANCIAL STATEMENTS The following consolidated financial statements of Integrated Silicon Solution, Inc. are contained in Part II, Item 8 of this Report on Form 10-K: Report of Ernst & Young LLP, Independent Auditors Consolidated Statements of Operations Consolidated Balance Sheets Consolidated Statements of Cash Flows Consolidated Statements of Stockholders' Equity Notes to Consolidated Financial Statements 2. FINANCIAL STATEMENT SCHEDULE The following financial statement schedule of Integrated Silicon Solution, Inc. is contained in Part IV, Item 14(d) of this report on Form 10-K: Schedule II-Valuation and Qualifying Accounts All other schedules for which provision is made in the Applicable Accounting Regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. 3. EXHIBITS
Exhibit Number Description of Document ------ ----------------------- 2.1(6) Agreement and Plan of Reorganization dated November 5, 1997 by and among the Company, Nexcom Technology, Inc. and certain shareholders of Nexcom Technology, Inc. 3.1(2) Restated Certificate of Incorporation of Registrant. 3.3(1) Bylaws of Registrant. 4.2(1) Form of Common Stock Certificate. 10.1(1) Form of Indemnification Agreement. 10.2(1)*** Form of 1993 Employee Stock Purchase Plan, as amended, and form of Subscription Agreement. 10.3(1)*** Form of 1989 Stock Plan, as amended, and form of Stock Option Agreements. 10.4(1) Information and Registration Rights Agreement dated as of March 17, 1993 among the Registrant and certain holders of the Registrant's Common Stock, as amended. 10.5(1)* Letter Agreement dated September 14, 1994 between Taiwan Semiconductor Manufacturing Company, Ltd. ("TSMC") and the Registrant. 10.6(1)* Joint Development Contract between Chartered Semiconductor Manufacturing Pte.Ltd. and the Registrant dated July 21, 1994. 10.7(1) Subscription and Shareholders Agreement Relating to Valery Limited dated March 30, 1994. 10.8(1) Long term line of credit between Bank of Communication and Registrant. 10.9(1) Short term line of credit between International Commercial Bank of China and Registrant. 10.10(1)*** 1995 Director Stock Option Plan. 10.11(2)* Option I Agreement between the Registrant and TSMC dated April 21, 1995. 10.12(2)* Option II Agreement between the Registrant and TSMC dated April 21, 1995. 10.13(3)* UMC/ISSI-Taiwan Foundry Venture Agreement dated August 31, 1995. 10.14(3)* UMC/ISSI-Taiwan Fabven Foundry Capacity Agreement dated August 31, 1995. 10.15 Second Amended and Restated Limited Liability Company Agreement of WaferTech, LLC, a Delaware limited liability company, dated as of October 28, 1997.
45 48 10.16(4)** Purchase Agreement by and between Taiwan Semiconductor Manufacturing Corporation, as Seller, and Analog Devices, Inc., Altera Corporation and Integrated Silicon Solution, Inc., as Buyers. 10.17(5)* Amendment to Option I and Option II Agreement between the Company and TSMC dated September 23, 1996. 10.18(5) Sublease Agreement for facility located at 2231 Lawson Lane, Santa Clara, California. 10.19(7)*** Nonstatutory Stock Plan 10.20*** 1998 ISSI-Taiwan Stock Plan 21.1(1) Subsidiaries of the Registrant 23.1 Consent of Ernst & Young LLP, Independent Auditors 24.1 Power of Attorney (see page 47). 27.1 Financial Data Schedule
- ---------- * Confidential treatment granted for certain portions of this exhibit. ** Confidential treatment requested for certain portions of this exhibit. The portions of this exhibit for which confidential treatment is being requested have been blacked out in the copies filed with the related report and the confidential portions so omitted have been filed separately with the Securities and Exchange Commission. *** Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Report on Form 10-K pursuant to form 14(c) of this report. (1) Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (file no. 33-72960). (2) Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (file no. 33-91520). (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the period ended September 30, 1995. (4) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1996. (5) Incorporated by reference to the Company's Annual Report on Form 10-K for the period ended September 30, 1996. (6) Incorporated by reference to the Company's Annual Report on Form 10-K for the period ended September 30, 1997. (7) Incorporated by reference to the Company's Registration Statement on Form S-8 filed April 30, 1997. (b) Reports on Form 8-K On July 14, 1998, the Company filed a Form 8-K for the purpose of disclosing the sale of certain shares of ISSI-Taiwan to a group of private investors. (c) Exhibits See (a) above (d) Financial statement schedules See (a) above 46 49 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized in the City of Santa Clara, State of California, on the 11th day of December, 1998. INTEGRATED SILICON SOLUTION, INC. By /s/ Gary L. Fischer -------------------- Gary L. Fischer Executive Vice President, Office of the President and Chief Financial Officer POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below hereby constitutes and appoints Jimmy S.M. Lee and Gary L. Fischer, and each of them acting individually, as his or her attorney-in-fact, each with full power of substitution, for him or her in any and all capacities, to sign any and all amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming our signatures as they may be signed by our said attorney to any and all amendments to said Report. Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below on December 11, 1998 by the following persons on behalf of the Registrant and in the capacities indicated.
Signature Title - ------------------------------- -------------------------------------------------- /s/ Jimmy S.M. Lee Chairman of the Board, Chief Executive Officer, - ------------------------------- and President (Principal Executive Officer) (Jimmy S.M. Lee) /s/ Kong-Yeu Han Executive Vice President, General Manager, - ------------------------------- Taiwan and Director (Kong-Yeu Han) /s/ Gary L. Fischer Executive Vice President, Office of the President - ------------------------------- and Chief Financial Officer (Principal Financial (Gary L. Fischer) and Accounting Officer) /s/ Pauline L. Alker Director - ------------------------------- (Pauline L. Alker) /s/ Lip-Bu Tan Director - ------------------------------- (Lip-Bu Tan) /s/ Hide Tanigami Director - ------------------------------- (Hide Tanigami) /s/ Chun Win Wong Director - ------------------------------- (Chun Win Wong)
47 50 ITEM 14(d). FINANCIAL STATEMENT SCHEDULE INTEGRATED SILICON SOLUTION, INC. SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (In thousands)
Addition Balance at Charged to Balance Beginning Costs and at End of Period Expenses Deductions of Period --------- ----------- ---------- -------- Year ended September 30, 1996: Allowance for doubtful accounts ........... 1,297 714 (9)(1) 2,002 Sales returns reserve ..................... 2,701 665 (1,133) 2,233 Year ended September 30, 1997: Allowance for doubtful accounts ........... 2,002 675 (409)(1) 2,268 Sales returns reserve ..................... 2,233 1,713 (1,510) 2,436 Year ended September 30, 1998: Allowance for doubtful accounts ........... 2,268 -- (464)(1) 1,804 Sales returns reserve ..................... 2,436 858 (1,419) 1,875
(1) Uncollectible accounts written off, net of recoveries 48 51 INDEX TO EXHIBITS
Exhibit Number Description of Document ------ ----------------------- 2.1(6) Agreement and Plan of Reorganization dated November 5, 1997 by and among the Company, Nexcom Technology, Inc. and certain shareholders of Nexcom Technology, Inc. 3.1(2) Restated Certificate of Incorporation of Registrant. 3.3(1) Bylaws of Registrant. 4.2(1) Form of Common Stock Certificate. 10.1(1) Form of Indemnification Agreement. 10.2(1)*** Form of 1993 Employee Stock Purchase Plan, as amended, and form of Subscription Agreement. 10.3(1)*** Form of 1989 Stock Plan, as amended, and form of Stock Option Agreements. 10.4(1) Information and Registration Rights Agreement dated as of March 17, 1993 among the Registrant and certain holders of the Registrant's Common Stock, as amended. 10.5(1)* Letter Agreement dated September 14, 1994 between Taiwan Semiconductor Manufacturing Company, Ltd. ("TSMC") and the Registrant. 10.6(1)* Joint Development Contract between Chartered Semiconductor Manufacturing Pte.Ltd. and the Registrant dated July 21, 1994. 10.7(1) Subscription and Shareholders Agreement Relating to Valery Limited dated March 30, 1994. 10.8(1) Long term line of credit between Bank of Communication and Registrant. 10.9(1) Short term line of credit between International Commercial Bank of China and Registrant. 10.10(1)*** 1995 Director Stock Option Plan. 10.11(2)* Option I Agreement between the Registrant and TSMC dated April 21, 1995. 10.12(2)* Option II Agreement between the Registrant and TSMC dated April 21, 1995. 10.13(3)* UMC/ISSI-Taiwan Foundry Venture Agreement dated August 31, 1995. 10.14(3)* UMC/ISSI-Taiwan Fabven Foundry Capacity Agreement dated August 31, 1995. 10.15 Second Amended and Restated Limited Liability Company Agreement of WaferTech, LLC, a Delaware limited liability company, dated as of October 28, 1997.
52
10.16(4)** Purchase Agreement by and between Taiwan Semiconductor Manufacturing Corporation, as Seller, and Analog Devices, Inc., Altera Corporation and Integrated Silicon Solution, Inc., as Buyers. 10.17(5)* Amendment to Option I and Option II Agreement between the Company and TSMC dated September 23, 1996. 10.18(5) Sublease Agreement for facility located at 2231 Lawson Lane, Santa Clara, California. 10.19(7)*** Nonstatutory Stock Plan. 10.20*** 1998 ISSI-Taiwan Stock Plan. 21.1(1) Subsidiaries of the Registrant. 23.1 Consent of Ernst & Young LLP, Independent Auditors. 24.1 Power of Attorney (see page 47). 27.1 Financial Data Schedule.
- ---------- * Confidential treatment granted for certain portions of this exhibit. ** Confidential treatment requested for certain portions of this exhibit. The portions of this exhibit for which confidential treatment is being requested have been blacked out in the copies filed with the related report and the confidential portions so omitted have been filed separately with the Securities and Exchange Commission. *** Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Report on Form 10-K pursuant to form 14(c) of this report. (1) Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (file no. 33-72960). (2) Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (file no. 33-91520). (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the period ended September 30, 1995. (4) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1996. (5) Incorporated by reference to the Company's Annual Report on Form 10-K for the period ended September 30, 1996. (6) Incorporated by reference to the Company's Annual Report on Form 10-K for the period ended September 30, 1997. (7) Incorporated by reference to the Company's Registration Statement on Form S-8 filed April 30, 1997. EX-10.15 2 2ND AMENDED/RESTATED LTD. LIABILITY COMPANY AGMT. 1 EXHIBIT 10.15 SECOND AMENDED AND RESTATED LIMITED LIABILITY COMPANY AGREEMENT OF WAFERTECH, LLC A DELAWARE LIMITED LIABILITY COMPANY DATED AS OF OCTOBER 28, 1997 ------------------------------------------------------------ 2 TABLE OF CONTENTS
Page ---- ARTICLE 1 DEFINITIONS AND RULES OF CONSTRUCTION........................................1 1.1 DEFINITIONS..................................................................1 1.2 RULES OF CONSTRUCTION.......................................................10 ARTICLE 2 ORGANIZATIONAL MATTERS......................................................10 2.1 FORMATION OF COMPANY........................................................10 2.2 NAME........................................................................10 2.3 FICTITIOUS BUSINESS NAME STATEMENT; OTHER CERTIFICATES......................10 2.4 PRINCIPAL EXECUTIVE OFFICE; OTHER OFFICES...................................11 2.5 AGENTS FOR SERVICE OF PROCESS...............................................11 2.6 BUSINESS AND PURPOSE OF THE COMPANY.........................................11 2.7 TERM OF THE COMPANY.........................................................12 2.8 INITIAL MEMBERS; STATUS OF MEMBERS..........................................12 2.9 LIABILITY OF MEMBERS........................................................12 2.10 COMPETITION; CONFLICT OF INTEREST...........................................12 2.11 BUSINESS PLAN...............................................................13 2.12 MEMBER INTELLECTUAL PROPERTY................................................13 2.13 FORMATION AUTHORIZATION.....................................................15 2.14 REIMBURSEMENT OF TSMC EXPENSES..............................................15 ARTICLE 3 AUTHORIZED CAPITAL; CAPITAL CONTRIBUTIONS...................................15 3.1 AUTHORIZED CAPITAL..........................................................15 3.1 INITIAL CAPITAL CONTRIBUTIONS...............................................16 3.3 ADDITIONAL CAPITAL CONTRIBUTION.............................................17 3.4 CONSEQUENCES OF FAILURE TO CONTRIBUTE.......................................17 3.5 CAPITAL ACCOUNTS............................................................22 3.6 TRANSACTIONS BETWEEN MEMBERS AND THE COMPANY; COMPANY LOANS AND GUARANTEES..................................................................23 3.7 RIGHTS WITH RESPECT TO CAPITAL..............................................24 ARTICLE 4 DISTRIBUTIONS...............................................................25 4.1 CASH AVAILABLE FOR DISTRIBUTION.............................................25 4.2 TAX DISTRIBUTIONS...........................................................26 4.3 DISCRETIONARY DISTRIBUTIONS.................................................26 4.4 AMOUNTS WITHHELD............................................................26 ARTICLE 5 ALLOCATION OF PROFITS AND LOSSES............................................27 5.1 ALLOCATION OF NET PROFIT AND LOSS...........................................27 5.2 RESIDUAL ALLOCATIONS........................................................28 5.3 OTHER ALLOCATION RULES......................................................28
3 5.4 TAX ALLOCATIONS.............................................................28 ARTICLE 6 MANAGEMENT OF THE COMPANY...................................................28 6.1 MANAGEMENT BY DIRECTORS.....................................................28 6.2 NUMBER AND DESIGNATION OF DIRECTORS; OBSERVER OF THIRD PARTY INVESTORS......29 6.3 MEETINGS OF DIRECTORS.......................................................29 6.4 POWERS OF DIRECTORS.........................................................30 6.5 ANNUAL INFORMATIONAL MEETING OF MEMBERS.....................................32 6.6 COMPENSATION COMMITTEE......................................................32 6.7 EXPENSE REIMBURSEMENT.......................................................33 6.8 INSURANCE...................................................................33 6.9 OFFICERS....................................................................33 6.10 MEMBER CONSENTS.............................................................35 6.11 BEST INTEREST OF THE COMPANY................................................35 ARTICLE 7 MEMBER REPRESENTATIONS AND WARRANTIES.......................................35 7.1 NATURE OF MEMBER'S INTEREST.................................................36 7.2 MEMBER REPRESENTATIONS AND WARRANTIES.......................................36 ARTICLE 8 RESTRICTIONS ON TRANSFER; PREEMPTIVE RIGHT; ADMISSION OF NEW MEMBERS; RIGHT OF FIRST REFUSAL......................................................37 8.1 RESTRICTIONS ON TRANSFER....................................................37 8.2 GENERAL TRANSFER PROVISIONS.................................................38 8.3 PREEMPTIVE RIGHTS...........................................................40 8.4 ADMISSION OF NEW MEMBERS....................................................41 8.5 RIGHT OF FIRST REFUSAL......................................................41 8.6 SPECIAL TRANSFER PROVISION..................................................42 8.7 SPECIAL RIGHT OF MANAGING MEMBERS OTHER THAN TSMC TO PURCHASE...............43 ARTICLE 9 BOOKS, RECORDS, REPORTS AND BANK ACCOUNTS...................................43 9.1 MAINTENANCE OF BOOKS AND RECORDS............................................43 9.2 INSPECTION RIGHTS...........................................................44 9.3 RIGHTS TO RECEIVE COPIES OF DOCUMENTS.......................................45 9.4 BANK ACCOUNTS...............................................................45 9.5 TAX MATTERS HANDLED BY TAX MATTERS PARTNER..................................45 9.6 FEDERAL INCOME TAX ELECTIONS MADE BY TAX MATTERS PARTNER....................46 9.7 OBLIGATIONS OF MEMBERS TO REPORT ALLOCATIONS................................46 ARTICLE 10 EVENT OF DEFAULT; TERMINATION OF MEMBERSHIP.................................46 10.1 EVENT OF DEFAULT............................................................46 10.2 TERMINATION OF MEMBER.......................................................48 10.3 PURCHASE RIGHT..............................................................48
-ii- 4 10.4 NOTICE OF INTENT TO PURCHASE................................................48 10.5 ELECTION TO PURCHASE LESS THAN ALL OF THE TERMINATED MEMBER'S INTEREST......49 10.6 PAYMENT OF PURCHASE PRICE...................................................49 10.7 CLOSING OF PURCHASE OF TERMINATED MEMBER'S INTEREST.........................50 ARTICLE 11 TERMINATION AND DISSOLUTION.................................................50 11.1 TERMINATION.................................................................50 11.2 DISSOLUTION.................................................................50 11.3 WINDING UP..................................................................51 11.4 DISTRIBUTION OF ASSETS......................................................52 11.5 TIME FOR WINDING UP.........................................................53 11.6 FINAL ACCOUNTING; CERTIFICATES OF CANCELLATION..............................53 ARTICLE 12 INCENTIVE PLANS.............................................................53 12.1 AUTHORIZATION OF INCENTIVE PLANS............................................53 12.2 ADMISSION OF PLAN PARTICIPANTS..............................................53 ARTICLE 13 TSMC LAND OPTION; NEW VENTURE RIGHTS........................................54 13.1 LAND OPTION.................................................................54 13.2 NEW FAB VENTURE RIGHT OF FIRST REFUSAL......................................54 13.3 FURTHER ASSURANCES..........................................................54 ARTICLE 14 CHANGE OR CONVERSION TO A GENERAL CORPORATION...............................54 14.1 MERGER OR CONSOLIDATION TO A GENERAL CORPORATION............................54 14.2 REGISTRATION RIGHTS.........................................................55 14.3 VOTING ARRANGEMENTS.........................................................55 14.4 OPTIONS.....................................................................55 ARTICLE 15 STANDARD OF CARE; INDEMNIFICATION...........................................57 15.1 STANDARD OF CARE............................................................57 15.2 INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND AGENTS................57 15.3 EXPENSES....................................................................57 15.4 INDEMNIFICATION RIGHTS NON-EXCLUSIVE........................................58 15.5 ERRORS AND OMISSIONS INSURANCE..............................................58 15.6 ASSETS OF THE COMPANY.......................................................58 ARTICLE 16 AMENDMENTS..................................................................58 16.1 AMENDMENT, ETC. OF LIMITED LIABILITY COMPANY AGREEMENT......................58 16.2 AMENDMENT, ETC..............................................................58 ARTICLE 17 CONDITIONS PRECEDENT........................................................58 17.1 CONDITIONS TO MEMBERS' PERFORMANCE..........................................58 17.2 CONDITIONS TO TSMC'S PERFORMANCE............................................59
-iii- 5 17.3 CONDITIONS TO ADI'S PERFORMANCE.............................................59 17.4 CONDITIONS TO ALTERA'S PERFORMANCE..........................................60 17.5 CONDITIONS TO ISSI'S PERFORMANCE............................................60 17.6 CONDITIONS TO THE THIRD PARTY INVESTORS' PERFORMANCE........................60 ARTICLE 18 CONFIDENTIALITY.............................................................61 18.1 EXCHANGE OF INFORMATION AND NONDISCLOSURE...................................61 18.2 CONFIDENTIALITY AGREEMENTS FOR VISITORS AND EMPLOYEES.......................61 18.3 THIRD PARTY REQUEST FOR INFORMATION.........................................61 18.4 REPORTING LOSS, THEFT OR MISAPPROPRIATION...................................62 18.5 BREACH OF CONFIDENTIALITY...................................................62 ARTICLE 19 ANCILLARY AGREEMENTS........................................................62 19.1 EXECUTION AND DELIVERY......................................................62 19.2 TERMINATION OF MANUFACTURING AGREEMENT; FUTURE PURCHASE AGREEMENT...........63 ARTICLE 20 DISPUTE RESOLUTION; ARBITRATION.............................................63 20.1 NEGOTIATION BETWEEN EXECUTIVES..............................................63 20.2 MEDIATION...................................................................63 20.3 CLAIMS SUBJECT TO ARBITRATION...............................................64 ARTICLE 21 LIMITATION ON DAMAGES; CONTRACTUAL LIMITATIONS PERIOD.......................66 21.1 LIMITATION ON DAMAGES.......................................................66 21.2 CONTRACTUAL LIMITATIONS PERIOD..............................................67 ARTICLE 22 FORCE MAJEURE...............................................................67 22.1 FORCE MAJEURE...............................................................67 22.2 NOTIFICATION................................................................67 22.3 RESPONSE TO FORCE MAJEURE...................................................67 22.4 LIMITATIONS ON APPLICABILITY OF FORCE MAJEURE...............................68 ARTICLE 23 GENERAL PROVISIONS..........................................................68 23.1 SEVERABILITY................................................................68 23.2 NEUTRAL INTERPRETATION; WAIVER..............................................68 23.3 NOTICES.....................................................................68 23.4 TIME OF THE ESSENCE.........................................................69 23.5 GOVERNING LAW...............................................................69 23.6 ENTIRE AGREEMENT............................................................69 23.7 WAIVER......................................................................69 23.8 COOPERATION.................................................................69 23.9 COUNTERPARTS................................................................69 23.10 EXHIBITS AND SCHEDULES......................................................69
-iv- 6 23.11 ATTORNEYS' FEES.............................................................69 23.12 DATE OF PERFORMANCE.........................................................70 23.13 SURVIVAL....................................................................70 23.14 SURVIVAL OF RIGHTS..........................................................70 23.15 THIRD-PARTY BENEFICIARIES...................................................70 23.16 PARTITION...................................................................70 23.17 GOVERNING LANGUAGE OF AGREEMENT.............................................70 23.18 CONSENT TO JURISDICTION AND SERVICE OF PROCESS..............................70 23.19 LIQUIDATED DAMAGES..........................................................71 23.20 AUTHORIZED REPRESENTATIVES..................................................71 23.21 REMEDIES CUMULATIVE, CONCURRENT AND NON-EXCLUSIVE...........................72 23.22 WAIVER OF CONFLICT OF INTEREST..............................................72 23.23 AMENDMENT AND RESTATEMENT...................................................72
-v- 7 LIST OF EXHIBITS Exhibit A - Capital Contributions Exhibit B - Certificate of Formation Exhibit C - Confidentiality Agreements (1) Visitor Confidentiality Agreement (2) Employee Invention Assignment and Confidentiality Agreement Exhibit D - Description of Real Property Exhibit E - Possible Future Restructuring Exhibit F - Future Purchase Agreement Exhibit G Allocation Rules Exhibit H Senior Executive Incentive Plan Exhibit I Employee Incentive Plan -vi- 8 SECOND AMENDED AND RESTATED LIMITED LIABILITY COMPANY AGREEMENT OF WAFERTECH, LLC THIS SECOND AMENDED AND RESTATED LIMITED LIABILITY COMPANY AGREEMENT (the "Agreement") is dated as of October 28, 1997 by and among TSMC Development, Inc., a Delaware corporation ("TSMC"), Analog Devices, Inc., a Massachusetts corporation ("ADI"), Altera Corporation, a Delaware corporation ("ALTERA"), Integrated Silicon Solutions, Inc., a Delaware corporation ("ISSI") and each of the other Persons identified on the signature page hereof as a Member (as hereinafter defined) hereunder. WHEREAS, TSMC, ADI, ALTERA, ISSI and the Third Party Investors (as hereinafter defined) as of June 25, 1996 (the "EFFECTIVE DATE") formed a limited liability company organized under the laws of the State of Delaware in the United States of America, pursuant to that certain Limited Liability Company Agreement by and among TSMC, ADI, Altera, ISSI and the Third Party Investors, dated as of June 25, 1996 (the "ORIGINAL AGREEMENT"), the purpose of which is to construct a foundry which shall provide foundry services for the manufacture of IC wafers in accordance with the terms of this Agreement. WHEREAS, TSMC, ADI, ALTERA, ISSI and the Third Party Investors as of August 9, 1996 amended and restated the Original Agreement. WHEREAS, TSMC, ADI, ALTERA, ISSI and the Third Party Investors wish to further amend and restate the Original Agreement as herein amended and restated; NOW, THEREFORE, in consideration of the mutual promises hereinafter set forth and other good and valuable consideration had and received, each of the parties hereto agrees as follows: ARTICLE 1 DEFINITIONS AND RULES OF CONSTRUCTION 1.1 DEFINITIONS. In addition to the terms defined elsewhere in this Agreement, the following words and expressions shall have the meanings set forth below: 1.1.1 "AAA" means the American Arbitration Association. 1.1.2 "ACT" means the Delaware Limited Liability Company Act set forth in Title 6, Sections 18-101 through 18-1109 of the Delaware Code, as amended from time to time. Any reference to the Act shall automatically include a reference to any subsequent or successor limited liability company law in Delaware. 9 1.1.3 "ADDITIONAL CAPITAL CONTRIBUTION" is defined in Section 3.2. 1.1.4 "ADVANCED PROCESS AGREEMENT" means that certain Advanced Process License Agreement dated as of April 10, 1996, between TSMC and TSMC International Investment Ltd., a British Virgin Islands corporation ("TSMC IIL"), whereby TSMC has been granted a license to certain future processes and know-how of TSMC IIL which Advanced Process Agreement has been assigned by TSMC to the Company as described in Section 3.1.1. 1.1.5 "AFFILIATE" means, when used with reference to a specified Person: (i) With respect to any corporation, limited liability company, partnership or other business enterprise: (a) which owns or controls, directly or indirectly, fifty percent (50%) or more of the voting rights with respect to the election of directors or managers, or which has practical control directly or indirectly, of any party to this Agreement; (b) of which fifty percent (50%) or more of the voting rights with respect to the election of directors or managers is owned or controlled, directly or indirectly, by, or which is under the practical control directly or indirectly of, any party to this Agreement; or (c) of which fifty percent (50%) or more of the total voting rights with respect to the election of directors or managers is owned or controlled, directly or indirectly, by, or which is under the practical control directly or indirectly of, any corporation, limited liability company, partnership or other business enterprise qualifying under subsections (a) or (b) above; and (ii) With respect to any natural person, any relative of such Person or such Person's spouse, whether by blood, marriage or adoption. 1.1.6 "AGREEMENT" means this Amended and Restated Limited Liability Company Agreement, including all Exhibits (which are hereby incorporated into and made a part of this Agreement by this reference), as originally executed and as amended from time to time, as the context requires. 1.1.7 "APPROVAL OF MEMBERS HOLDING A MAJORITY IN PERCENTAGE INTEREST" means the written consent by, or approval at a meeting of Preferred Members by, a Preferred Member singularly owning, or Preferred Members collectively owning, more than fifty percent (50%) of the Percentage Interests owned by all of the Preferred Members. 1.1.8 "APPROVAL OF MEMBERS HOLDING NOT LESS THAN 71% IN PERCENTAGE INTEREST" OR "APPROVED BY MEMBERS HOLDING NOT LESS THAN 71% IN PERCENTAGE INTEREST" means the written consent by, or approval at a meeting of Preferred Members by, Preferred Members owning 71% or more of the Percentage Interests owned by all of the Preferred Members. 1.1.9 "APPROVAL OF MEMBERS HOLDING NOT LESS THAN 87% IN PERCENTAGE INTEREST" means the written consent by, or approval at a meeting of Preferred Members by, Preferred Members owning 87% or more of the Percentage Interests owned by all of the Preferred Members. -2- 10 1.1.10 "ANCILLARY AGREEMENTS" mean (i) the Confidentiality Agreements, (ii) the Manufacturing Agreement, (iii) the Technology License and Assistance Agreement, (iv) the Advanced Process Agreement, (v) the Assignments of each of the Manufacturing Agreement, the Technology License and Assistance Agreement and the Advanced Process Agreement, (vi) the Registration Rights Agreement, (vii) the Purchase Agreement, (viii) the TSMC Land Option and (ix) the Future Purchase Agreement. 1.1.11 "BOARD OF DIRECTORS" is defined in Section 6.1. 1.1.12 "BUSINESS DAY" means a day on which banking institutions are open for business in Seattle, Washington and San Jose, California other than a Saturday or Sunday. 1.1.13 "BUSINESS PLAN" is defined in Section 2.11. 1.1.14 "CAPITAL ACCOUNT" is defined in Section 3.5. 1.1.15 "CAPITAL CONTRIBUTION" means the total amount of cash and the agreed fair market value (net of liabilities) of other property contributed to the Company by a particular Member, as contemplated in Section 3.2, plus any subsequent contributions of cash and the agreed fair market value (net of liabilities) of any other property subsequently contributed to the Company by that Member as an Additional Capital Contribution. 1.1.16 "CASH AVAILABLE FOR DISTRIBUTION" is defined in Section 4.1.2. 1.1.17 "CERTIFICATE OF FORMATION" means the certificate to be filed with the Office of the Delaware Secretary of State for the purpose of forming the Company, attached hereto as Exhibit B. 1.1.18 "CODE" means the Internal Revenue Code of 1986, as amended (or any corresponding provision or provisions of any succeeding law). 1.1.19 "COMMON MEMBER" means any Member who owns Common Shares. 1.1.20 "COMMON SHARES" means one or more of the 13.5 million shares authorized by Section 3.1 and having the rights and privileges as stated in Section 3.1.1. 1.1.21 "COMPANY" means WaferTech, LLC. 1.1.22 "COMPANY LOANS" means any loans or advances made by any Member to the Company as contemplated in Section 3.6.2. 1.1.23 "CONFIDENTIAL INFORMATION" means confidential or secret information, including information protected under the Confidentiality Agreements or confidential or secret information protected under any of the Ancillary Agreements, including but not limited to Trade -3- 11 and Industrial Secrets (as defined in the Technology License and Assistance Agreement) and Proprietary Information (as defined in the Manufacturing Agreement). 1.1.24 "CONFIDENTIALITY AGREEMENTS" mean that certain Member's Confidentiality Agreement dated May 25, 1996 executed by the Company and each Member and the Visitor Confidentiality Agreements executed by the Company and each Visitor (as provided in Article 18) substantially in the form attached hereto as Exhibit C(1). 1.1.25 "DEFAULTING MEMBER" means (1) a Preferred Member who fails to make such Preferred Member's Second Part Capital Contribution or Third Part Capital Contribution hereunder or an Additional Capital Contribution under the circumstances described in Section 3.4.2.2, and (2) a Member who otherwise breaches this Agreement in a manner that constitutes an Event of Default. 1.1.26 "DELAWARE CORPORATION" is defined in Section 14.1. 1.1.27 "DEPRECIATION" means, for each Fiscal Year, an amount equal to the depreciation, amortization, or other cost recovery deduction allowable as determined for book purposes under GAAP. 1.1.28 "DILUTION EVENT" means an event resulting in reduction of a Member's Percentage Interest in the Company as contemplated in Section 3.4.2.1 or Section 3.6.4 of this Agreement if the Additional Capital Contribution or guaranteed debt which the Member did not provide or guarantee, as the case may be, was used for purposes other than the completion of the Foundry in accordance with the Business Plan. 1.1.29 "DIRECTOR" is defined in Section 6.2.1, and includes voting and nonvoting Directors. 1.1.30 "DISSOLUTION DATE" shall mean the first date on which one of the events set forth in Section 11.2 shall occur. 1.1.31 "ECONOMIC INTEREST" means a Person's right to share in the Net Profit, Net Loss or similar items of, and to receive distributions from, the Company, resulting from the assignment or other transfer of Preferred or Common Shares where the assignee or transferee thereof is not admitted as a Member pursuant to Article 8. An Economic Interest does not include any other rights of a Member including, without limitation, the right to vote or to participate in the management of the Company, or, except as provided in Sections 9.2 and 9.3, any right to information concerning the business and affairs of the Company. 1.1.32 "EVENT OF DEFAULT" is defined in Section 10.1. 1.1.33 "FISCAL YEAR" means each twelve (12) month period commencing January 1 and through and including December 31 and including as the first Fiscal Year, the period from the Effective Date to and including December 31, 1996. -4- 12 1.1.34 "FORCE MAJEURE" means any one or more of the following: acts of war declared or undeclared, nationalization, expropriation, civil unrest or other public disturbance, fire, storm, floods, typhoon, tidal wave, hurricane, cyclone or other severe weather conditions, earthquake, or other Acts of God, legal restraints, governmental or like interference, judicial action, accidental damage to equipment, as well as any other cause outside the reasonable control of a Member. "Force Majeure" also includes the failure to obtain such license(s) and other approvals, including export licenses, as are required by United States law or other applicable law for the equipment, technical information, software, technology and Proven Products to be provided pursuant to the terms of this Agreement, the Technology License and Assistance Agreement or the Advanced Process Agreement. 1.1.35 "FUTURE PURCHASE AGREEMENT" is defined in Section 19.2. 1.1.36 "FOUNDRY" is defined in Section 2.6.1. 1.1.37 "GAAP" means generally accepted accounting principles in the United States of America. 1.1.38 "GOVERNMENTAL INTERVENTION" means (i) any action taken by any government or agency thereof, subsequent to the formation of the Company, which is material and adverse to any Member, or (ii) any recommendations by any government or agency thereof to the Members or any of them individually, requiring directly or indirectly, formally or informally, alteration or modification of any term or condition of this Agreement or of the Ancillary Agreements, or of the performance of the Members under this Agreement or the Ancillary Agreements in a manner which is material and adverse to one Member. 1.1.39 "IC" means integrated circuit. 1.1.40 "INCENTIVE PLAN" means the Senior Executive Incentive Plan and Employee Incentive Plan and includes any other incentive plan (1) approved by the Board of Directors and (2) Approved by Members holding not less than 71% in Percentage Interest. 1.1.41"INDEMNITEE" is defined in Section 15.1 hereof. 1.1.42 "INITIAL CAPITAL CONTRIBUTION" means the Capital Contribution of a Member as of the date hereof. "TOTAL INITIAL CAPITAL CONTRIBUTION" means the sum of the "Initial Capital Contributions," of all of the Members, as of the date hereof. 1.1.43 "INTELLECTUAL PROPERTY RIGHTS" means (a) all patent rights and all right, title and interest in and to all letters patent and applications for letters patent, and all other government-issued or -granted indicia of invention ownership, including any reissue, division, term extensions, continuation or continuation-in-part applications; (b) all copyrights and all other literary property and author rights, and all right, title and interest in and to all copyrights, copyright registrations, certificates of copyrights and copyrighted interests; (c) all trademarks, -5- 13 trade names and service marks, and all rights, title and interest in and to all applications, certifications and registrations therefor; (d) all mask work rights, mask work applications, and mask work registrations; (e) all rights, title and interest in and to all trade secrets and trade secret rights; and (f) any licenses or license rights with respect to the foregoing. 1.1.44 "INTEREST" means either (i) a Membership Interest, or (ii) an Economic Interest, as the case may be. Each Member's Interest shall be represented by Common and Preferred Shares; provided, however, that the Company's stock records shall in the absence of manifest error be conclusive as to any Member's ownership of Common and Preferred Shares. At such time as any Interest of any Member is changed, the appropriate number of Shares held by such Member shall also be deemed transferred to reflect such change. Subject to the requirements of Article 8 with respect to transfers of Interests, the Company shall issue additional Share certificates to the Members to reflect ownership of additional Shares and shall, upon surrender of Share certificates or delivery of an affidavit of lost certificate together with appropriate indemnity, issue new Share certificates to reflect transfers, reductions or other adjustments to the ownership of Shares. 1.1.45 "IPO" means an underwritten initial public offering of securities made pursuant to an effective Registration Statement under the Securities Act of 1933, as amended, and the Rules and Regulations of the Securities and Exchange Commission thereunder. 1.1.46 "LAND" is defined in Section 1.1.78. 1.1.47 "MANAGING MEMBERS" means TSMC, ADI, Altera and ISSI. 1.1.48 "MANUFACTURING AGREEMENT" means that certain Manufacturing Agreement dated as of February 16, 1996, by and between TSMC and Taiwan Semiconductor Manufacturing Co. Ltd. of Taiwan ("TSMC Taiwan"), pursuant to which TSMC Taiwan has agreed to purchase all IC wafers manufactured by TSMC for the time and on the terms therein specified, which Manufacturing Agreement has been assigned by TSMC to the Company as described in Section 3.1.1. 1.1.49 "MEMBER" means a Person who: (i) Has been admitted to the Company as a member in accordance with the Certificate of Formation or this Agreement, or an assignee of an Interest who has become a Member pursuant to Article 8, or has exercised an Option granted pursuant to Article 12 and has complied in all respects with the requirements for exercising such Option; and (ii) Has not resigned, withdrawn or been expelled as a Member or, if other than an individual, been dissolved. Reference to a "Member" shall be to any one of the Members. Reference to an "Initial Member" shall be to any one of the Members who are such on the Effective Date. -6- 14 1.1.50 "MEMBERSHIP INTEREST" means ownership by a Member of (i) one or more Preferred Shares; or (ii) one or more Common Shares. 1.1.51 "NET PROFIT" and "NET LOSS" mean, for each Fiscal Year or other period, an amount equal to the Company's taxable income or loss for such year or period, as the case may be, determined in accordance with Code Section 703(a) (for this purpose, all items of income, gain, loss or deduction required to be stated separately pursuant to Code Section 703(a)(1) shall be included in taxable income or loss), with the following adjustments: (i) Any income of the Company that is exempt from U.S. federal income tax and not otherwise taken into account in computing Net Profit or Net Loss shall be added to such taxable income or loss; (ii) Any expenditures of the Company described in Code Section 705(a)(2)(B) or treated as Code Section 705(a)(2)(B) expenditures pursuant to Regulations Section 1.704-1(b)(2)(iv)(i) and not otherwise taken into account in computing Net Profit or Net Loss shall be subtracted from such taxable income or loss; (iii) Gain or loss resulting from any disposition of Property with respect to which gain or loss is recognized for U.S. Federal income tax purposes shall be computed in accordance with the Section 704(b) Regulations by reference to the book basis and fair market value of the Property disposed of, notwithstanding that the adjusted tax basis of such Property differs from its book basis and fair market value; (iv) In lieu of depreciation, amortization, and other cost recovery deductions taken into account in computing such taxable income or loss, there shall be taken into account depreciation as determined for book purposes in accordance with the Section 704(b) Regulations for such Fiscal Year or other period; and (v) Notwithstanding any other provision of this subsection, any items of income, gain, loss or deduction which are specifically allocated to any Member shall not be taken into account in computing Net Profit or Net Loss. 1.1.52 "NON-DEFAULTING MEMBERS" means each Preferred Member who has made such Member's Second Part Capital Contribution or Third Part Capital Contribution or an Additional Capital Contribution under the circumstances described in Section 3.4.2.2 hereunder, and is not otherwise in breach of this Agreement in a manner that constitutes an Event of Default. 1.1.53 "OFFERING NOTICE" is defined in Section 8.5.1 1.1.54 "OFFICER" means an officer of the Company. 1.1.55 "OPTION" means a stock option granted pursuant to an Incentive Plan. -7- 15 1.1.56 "PERCENTAGE INTEREST" means the Interest of a Member or the holder of an Economic Interest in the Company, expressed as a percentage of the Interests of all of the Members and holders of an Economic Interest. The Percentage Interests shall initially be as set forth on Exhibit A and shall be adjusted from time to time as herein provided. Notwithstanding the foregoing, however, for the purpose only of determining the Percentage Interest required for any vote or approval, including, but not limited to, the approvals contemplated by Sections 3.6.1, 6.4.2, 6.4.3, 8.1.1, 8.1.2, 11.2 and Article 16, the Percentage Interest shall be calculated without counting the Common Shares and without giving effect to the issuance of options or grant of any equity interest in the Company pursuant to any Incentive Plan. 1.1.57 "PERSON" means a natural person, partnership (whether general or limited), limited liability company, trust, estate, association, corporation, custodian, nominee or any other individual or entity in its own or any representative capacity, in each case whether domestic or foreign. 1.1.58 "PREFERRED MEMBER" means any Member who owns Preferred Shares. 1.1.59 "PREFERRED SHARES" means one or more of the 225 million shares authorized by Section 3.1 and having the rights and privileges as stated in Section 3.1.2. 1.1.60 "PRODUCTS" is defined in the Manufacturing Agreement. 1.1.61 "PROHIBITED PERSON" means a Person (i) who is in the business of providing foundry services (other than TSMC or any Affiliate thereof, and other than as permitted pursuant to the last two sentences of Section 2.10.1), or (ii) whose admission as a Member could reasonably be economically inimical to the interests of the Company or to any Member. The Board of Directors and the Members pursuant to Section 6.4.2 shall determine who is a Prohibited Person. 1.1.62 "PROPERTY" means the assets of the Company, both tangible and intangible, or any portion thereof. 1.1.63 "PROJECT" is defined in Section 2.6.1. 1.1.64 "PROVEN PRODUCTS" is defined in the Manufacturing Agreement. 1.1.65 "PURCHASE AGREEMENT" means that certain Purchase Agreement dated as of the Effective Date by and between TSMC Taiwan, Altera, ADI and ISSI, pursuant to which each of Altera, ADI and ISSI commit to purchase a designated amount of IC wafers from TSMC Taiwan. 1.1.66 "REGISTRATION RIGHTS AGREEMENT" means the Registration Rights Agreement dated as of the Effective Date by, between and among the Company and each Member. -8- 16 1.1.67 "REGULATIONS" means the U.S. Federal income tax regulations promulgated by the Treasury Department under the Code, as such regulations may be amended from time to time. All references herein to a specific Section of the Regulations shall be deemed also to refer to any corresponding provisions of succeeding Regulations. 1.1.68 "REMAINING MEMBER" is defined in Section 10.2.3. 1.1.69 "SECRETARY OF STATE" means the Office of the Secretary of State of the State of Delaware. 1.1.70 "SECTION 704(B) REGULATIONS" means the final or temporary income tax regulations under Section 704(b) of the Code relating to the determination of a partner's distributive share of partnership income, gain, loss, deduction or credit (or item thereof), and to the extent not inconsistent with any final or temporary regulations, any outstanding proposed income tax regulations under Section 704(b) of the Code. All references to Section 704(b) Regulations shall be deemed also to refer to any corresponding provisions of any succeeding regulations to such Section 704(b) of the Code. 1.1.71 "SELLING MEMBER" is defined in Section 8.5.1. 1.1.72 "TAX MATTERS PARTNER" means the person designated as such in Section 9.5. 1.1.73 "TECHNOLOGY LICENSE AND ASSISTANCE AGREEMENT" means that certain Technology License and Assistance Agreement dated as of February 20, 1996, by and between TSMC Technology, Inc. and TSMC, providing for TSMC Technology, Inc. to provide certain services to TSMC and granting a license to use certain technology to TSMC, which Technology License and Assistance Agreement has been assigned by TSMC to the Company as described in Section 3.1.1. 1.1.74 "TERMINATED MEMBER" is defined in Section 10.2.3. 1.1.75 "THIRD PARTY INVESTORS" means the persons signing this Agreement other than TSMC, ADI, ALTERA, ISSI and participants in the Incentive Plans who become Members. 1.1.76 "TRANSFER" is defined in Section 8.1.1. 1.1.77 "TSMC LAND OPTION" means that certain Option Agreement dated as of the Effective Date between the Company and TSMC whereby the Company granted an option to TSMC to purchase all or part of the Land (as defined therein), hereinafter the "Land". 1.1.78 "UNPAID CAPITAL PREFERENCE" means, with respect to any Preferred Member, such Member's Capital Contribution reduced by distributions to such Member pursuant to Section 4.3.1 hereof. -9- 17 1.1.79 "WASHINGTON ACT" means the Washington Limited Liability Act, codified at Title 25, Chapter 25.15 of the Revised Code of Washington. Any reference to the Washington Act shall automatically include a reference to any subsequent or successor limited liability law in Washington. 1.2 RULES OF CONSTRUCTION. For purposes of this Agreement: 1.2.1 GENERAL. Unless the context otherwise requires, (i) "or" is not exclusive; (ii) words in the singular include the plural and vice versa; (iii) words in the masculine include the feminine and neuter and vice versa; and (iv) words such as "herein," "hereinafter," "hereto," "hereby," and "hereunder," when used in this Agreement, refer to this Agreement as a whole, unless the context otherwise requires. 1.2.2 ARTICLES AND SECTIONS; HEADINGS. References to Articles and Sections are to Articles and Sections of this Agreement unless stated otherwise. Article and Section headings used in this Agreement are for convenience of reference only and shall not be used in construing or interpreting this Agreement. 1.2.3 OTHER AGREEMENTS. References herein to any agreement, schedule or other instrument, including, without limitation, any other Ancillary Agreement shall, unless the context otherwise requires (or the definition thereof otherwise specifies), be deemed references to the same as it may from time to time be amended, modified or extended. ARTICLE 2 ORGANIZATIONAL MATTERS 2.1 FORMATION OF COMPANY. The parties have formed the Company pursuant to the provisions of the Act by filing the Certificate of Formation with the Secretary of State. 2.2 NAME. The name of the Company is "WaferTech, LLC". 2.3 FICTITIOUS BUSINESS NAME STATEMENT; OTHER CERTIFICATES. The Directors have registered the Company as a foreign limited liability company in the State of Washington and shall from time to time register the Company as a foreign limited liability company and file on behalf of the Company such fictitious or trade name statements or certificates in such other jurisdictions and offices as the Directors consider necessary, convenient or appropriate. From time to time, the Directors shall file such certificates of amendment, certificates of cancellation, or other certificates as the Directors reasonably deem necessary, convenient or appropriate under the Act, under the Washington Act or under the laws of any jurisdiction in which the Company is doing business to establish and continue the Company as a limited liability company or to protect the limited liability of the Members. 2.4 PRINCIPAL EXECUTIVE OFFICE; OTHER OFFICES. The Company shall maintain its principal executive office, which shall be its principal place of business in the -10- 18 State of Washington, at Camas, or any other location determined by the Directors. The Company shall also maintain a registered office in Delaware, which shall be at the business office of the Company's agent for service of process in Delaware. The Company may maintain such other offices as determined by the Directors. 2.5 AGENTS FOR SERVICE OF PROCESS. The name and address of the Company's agent for service of process in Washington is the Corporation Service Company, c/o 600 First Avenue, Suite 500, Seattle, Washington 98104. The name and address of the Company's agent for service of process in Delaware is The Corporation Service Company, 1013 Centre Road, Wilmington, Delaware 19805. 2.6 BUSINESS AND PURPOSE OF THE COMPANY. 2.6.1 GENERAL CHARACTER OF BUSINESS. The general character of the business to be conducted by the Company shall be to provide foundry services for the manufacture of IC wafers in North America to meet the specifications of the purchasers of such IC wafers in accordance with the terms and conditions of this Agreement and the Ancillary Agreements. In addition, the Company may provide testing services, tooling services, ASIC design services, computer assisted design services, maintain a design library, or provide other related services for integrated circuits. The Company shall purchase, develop and improve a portion of certain real property located in Camas, Washington that is the subject of option agreements for the benefit of TSMC, as described in Exhibit D hereto (which, subject to the TSMC Land Option, is referred to herein as the "REAL PROPERTY"). The Company shall construct and manage a foundry, or "FAB" (the "FOUNDRY") on the Real Property, subject to the TSMC Land Option, to manufacture and produce IC wafers (subsumed in the definition of "PROVEN PRODUCTS") (collectively, the "PROJECT") and to conduct any other activities, operations or business (including the borrowing of money, the encumbering of the Company's assets for security and the entry into contracts) directly and reasonably related to the Project and its use and development. In accordance with Section 3.1.1, TSMC has assigned the Manufacturing Agreement to the Company, so that during the Manufacturing Agreement's term, TSMC Taiwan shall have an obligation to purchase not less than 85% of Calculated Installed Capacity (as defined in the Manufacturing Agreement) but shall have a right to purchase up to 100% of Calculated Installed Capacity and TSMC has assigned the Technology License and Assistance Agreement and Advanced Process Agreement to the Company so that specified technical services and technology shall be provided to the Company. The Managing Members shall order and take or pay for Products from TSMC Taiwan as contemplated in the Purchase Agreement. The Managing Members shall cause the Company to conduct the business of the Company in compliance with all material laws and regulations. 2.6.2 OTHER PURPOSES. Subject to Section 2.6.1, the Company may carry on any lawful business, purpose or activity, in accordance with this Agreement, but the Company shall not engage in the business of granting policies of insurance or assuming insurance risks or banking. The Company shall possess and may exercise all the powers and privileges granted by the Act or by any other law or by this Agreement, together with any powers incidental thereto, so -11- 19 far as such powers and privileges are necessary or convenient to the conduct, promotion or attainment of the business, purposes or activities of the Company as set forth in Section 2.6.1. 2.7 TERM OF THE COMPANY. The Company was established and commenced on the Effective Date. The Company shall dissolve on the Dissolution Date. Notwithstanding the foregoing, the Company may be dissolved prior to the Dissolution Date as provided in this Agreement or pursuant to the Act. 2.8 INITIAL MEMBERS; STATUS OF MEMBERS. 2.8.1 INITIAL MEMBERS. The Initial Members shall be those Persons listed as Members on Exhibit A. 2.8.2 STATUS OF MEMBERS. The Initial Members and any additional or substituted Members shall be "members" of the Company, as that term is used in the Act, subject to the terms and provisions of this Agreement. The Managing Members shall have authority as specified herein. 2.9 LIABILITY OF MEMBERS. No Member shall be obligated personally for any debt, obligation or liability of the Company, whether arising in contract, tort or otherwise, solely by reason of being a Member. 2.10 COMPETITION; CONFLICT OF INTEREST. 2.10.1 MEMBER COMPETITION. Subject to the provisions of the Confidentiality Agreements, and except as hereinafter provided, any Member may engage in, acquire or possess an interest or interests in other business ventures of any nature or description, independently or with others and neither the Company not any Member shall have any rights in or to such independent ventures or the income or profits derived therefrom. Notwithstanding the foregoing, each Member acknowledges, understands and agrees that pursuant to Section 3.1.1, TSMC has contributed to the Company proprietary, trade secret, know-how and other Confidential Information and that TSMC would not have entered into this Agreement with a Prohibited Person. Further, each Member acknowledges, understands and agrees that monetary compensation would not be an adequate inducement for TSMC to enter into this Agreement with a Prohibited Person. Accordingly, each Member except TSMC agrees that so long as such Member shall be a Member and for a period of two years thereafter, such Member shall not acquire or possess a controlling interest, directly or indirectly, by operation of law or otherwise, in any venture (an "OTHER VENTURE") (not including TSMC or an Affiliate thereof) that has as one of its primary purposes the provision of foundry services for the manufacture of IC wafers for sale to third-parties not affiliated with such Other Venture and not for the Member's own use or the use of other parties affiliated with the Other Venture. This restriction shall not limit the existing ventures of any Member, or future ventures in which any Member has a non-controlling minority interest, from selling IC wafers to third parties not affiliated with such Other Venture. This Section shall not limit the ability of TSMC or any of its Affiliates to enter into any Other Venture or subject to Section 13.2, to construct any other foundry. -12- 20 2.10.2 CONFLICT OF INTEREST. Subject to Section 3.6, the fact that a Person is employed by or is directly or indirectly interested in or connected with any Person employed by the Company to render any service or from whom the Company may buy merchandise shall not prohibit the Company from employing or dealing with such Person; provided, however, that any contract, employment or other arrangement with such Person shall be on an arm's-length basis and in accordance with competitive rates and other terms prevailing throughout the industry for similar goods or services. 2.11 BUSINESS PLAN. On the Effective Date each Initial Member received a preliminary annual operating budget and business plan of the Company for Fiscal Years 1996 through 2002, which was prepared by TSMC and its Affiliates in good faith for planning purposes and is incorporated herein by this reference (as it may be amended from time to time, the "BUSINESS PLAN"). Each Managing Member agrees to use reasonable commercial efforts in accordance with the terms of this Agreement to facilitate the implementation of the Business Plan by the Company. Notwithstanding the foregoing, the Members acknowledge that the Business Plan is a projection only and, as a forward looking statement, reflects certain anticipated goals, which may not be realized. The Members further acknowledge that the Business Plan does not constitute an assurance, representation, warranty or agreement by any Member or the Company for any purpose, including but not limited to, the purpose of determining whether to enter into this Agreement. Any material change or amendment to the Business Plan shall require the Approval of Members holding not less than 71% in Percentage Interest, as provided in Section 6.4.2. 2.12 MEMBER INTELLECTUAL PROPERTY. 2.12.1 GRANT OF LICENSES. Each Member, including TSMC and its Affiliates to the extent not provided for pursuant to the Technology License and Assistance Agreement or the Advanced Process Agreement, shall grant or extend to the Company the rights, licenses or cross licenses from third parties obtained or held by such Member as the same are related to and required for the manufacture of IC wafers by the Company, to the extent that any such action is not in conflict with such Member's agreements with third parties. In case any third party agreement requires the payment of fees or royalties to a third party in the event of such grant or extension, the Company shall be offered the option to accept the grant or extension and to pay such fees or royalties. 2.12.2 SHARING OF TECHNOLOGY. Any Managing Member (other than TSMC or its Affiliates, to which the terms of the Technology License and Assistance Agreement and Advanced Process License Agreement will apply), which has knowledge or know-how relating to the manufacture of IC wafers may offer to provide such knowledge or know-how to the Company in consideration for the right to use the knowledge or know-how developed by the Company relating to that knowledge or know-how provided by such Member. The terms and conditions of any such exchange of knowledge or know-how shall be determined by mutual agreement between the applicable Managing Member and the Company. Notwithstanding the foregoing, any such Managing Member (other than TSMC or its Affiliates) shall not use the -13- 21 knowledge or know-how developed by the Company to manufacture any products competitive with the Products produced for any other Managing Member (other than TSMC or its Affiliates). 2.12.3 CO-DEVELOPMENTS. In the event personnel of the Company and any Managing Member co-develop (i.e. both parties substantially and significantly contribute to the development) devices, ICs, processes or apparatus relating to the subject matter of this Agreement, the Manufacturing Agreement, the Purchase Agreement, or the Future Purchase Agreement, then the Intellectual Property Rights created by such co-development shall be jointly owned by the Company and the applicable Managing Member without accounting to each other, both parties having the right under the Intellectual Property Rights obtained with respect to such co-development to make, have made, use, modify, lease, sell, or otherwise dispose of products and to license (with a right to sub-license) such Intellectual Property Rights, subject to the other party's rights therein but without the necessity of obtaining the consent of the other party. The Company and applicable Managing Member shall cooperate in applying for, prosecuting and maintaining patents and copyright and mask work registrations for such co-developments and shall equally divide the expenses thereof. Notwithstanding the preceding sentence, either the Company or the applicable Managing Member may elect not to share the expenses of any such applications in any or all countries, in which case the other party may file and/or prosecute at its own expense and shall have sole control and ownership of such applications and any patents, copyright or mask work registrations issuing thereon, subject to a non-exclusive non-transferable, paid-up and royalty-free, worldwide license under such patents, copyright and mask right registrations in favor of the non-electing party to make, have made, use, modify, lease, sell, or otherwise dispose of products to the extent of the rights granted by such patents and registrations (with the right to sublicense only to Affiliates). The Company or the applicable Managing Member, as the case may be, shall be obligated to share the expenses referred to in the preceding sentence unless such party provides written notice of its election not to do so to the other party within thirty (30) days of a written request from such other party. An election not to share expenses shall be irrevocable. 2.13 FORMATION AUTHORIZATION. Each of the Members ratifies and approves the acts of TSMC prior to the date of this Agreement taken to (i) handle matters with respect to the formation and establishment of the Company, (ii) commit to the acquisition of the Real Property including the grant of the TSMC Land Option, (iii) commit to the construction of the Foundry, and (iv) commit to the purchase of such equipment as is required by the Company to commence the Project (collectively, the "ORGANIZATIONAL MATTERS"). Each Member authorizes TSMC to continue to implement the Organizational Matters in accordance with this Agreement. TSMC will attempt to obtain favorable terms for such Organizational Matters, and the Members will cooperate to discuss and resolve any issues in connection therewith. 2.14 REIMBURSEMENT OF TSMC EXPENSES. By execution and delivery of this Agreement, the Members agree that the following out-of-pocket expenses incurred by TSMC, or its Affiliates, upon presentation by TSMC to the Company of an itemization of such expenses, shall be reimbursed by the Company. Such expenses may include the following: -14- 22 2.14.1 Any and all reasonable expenses incurred for the acquisition of the Real Property including but not limited to those incurred in the site selection and permitting activities; 2.14.2 Any and all reasonable fees and expenses incurred to commit to construction of the Foundry; 2.14.3 Any and all fees and expenses charged by the counsel, consultants and specialists retained in connection with the formation of the Company, the acquisition of the Real Property and the construction of the Foundry; and 2.14.4 Any and all other fees and expenses incurred in handling the matters authorized in Section 2.13 or this Section 2.14. An estimate of such expenses as of the Effective Date was delivered to each Initial Member on the Effective Date. ARTICLE 3 AUTHORIZED CAPITAL; CAPITAL CONTRIBUTIONS 3.1 AUTHORIZED CAPITAL. The Company shall have the authority to issue up to TWO HUNDRED TWENTY FIVE MILLION (225,000,000) Preferred Shares and up to THIRTEEN MILLION FIVE HUNDRED THOUSAND (13,500,000) Common Shares. To acknowledge and reflect the relative Capital Contributions previously made and to be made by the Members, the Company shall issue to each Member that number of Preferred Shares and/or Common Shares specified on the attached Exhibit A as amended from time to time in accordance with this Agreement. The Company shall maintain stock records reflecting such ownership. Shares may be transferred, to the extent permitted by the terms of this Agreement, solely by submitting to the Company a written power of attorney to assign and transfer the Shares on the stock records of the Company. Unless otherwise authorized by the Board of Directors, no certificates will be issued reflecting such ownership. 3.1.1 Except as otherwise provided in this Agreement or the Act, the Common Shares shall have no right to vote or manage the business and affairs of the Company and shall have solely the rights and privileges provided by this section. 3.1.1.1 The Common Shares shall have the right to participate in distributions as provided by Article 4 and Section 11.4. 3.1.1.2 The Common Shares shall have the right to information concerning the business and affairs of the Company, as provided in this Agreement and under the Act. 3.1.1.3 The Common Shares shall, upon issuance thereof in exchange for the consideration specified by the terms of the option grant, be fully paid and non-assessable and shall have no obligation for Additional Capital Contributions. -15- 23 3.1.2 The Preferred Shares shall have the rights and privileges provided by this Agreement, including without limitation the following: 3.1.2.1 The Preferred Shares shall have the right to vote as provided by Section 6.4.2 and other provisions requiring the Approval of Members holding not less than 71% in Percentage Interest, Approval of Members holding not less than 87% in Percentage Interest and the Approval of Members holding a Majority in Percentage Interest. 3.1.2.2 The Preferred Shares shall have the distribution and liquidation preferences as provided by Article 4 and Section 11.4. 3.1.2.3 The Preferred Shares shall have the sole right to manage the business and affairs of the Company. 3.2 INITIAL CAPITAL CONTRIBUTIONS. 3.2.1 FIRST PART CAPITAL CONTRIBUTION. Subject to the satisfaction or waiver of the conditions precedent set forth in Article 17, on the Effective Date (sometimes referred to herein as the "FIRST CONTRIBUTION DATE") each Initial Member contributed to the Company in good same day funds an amount of cash equal to the cash contribution set forth opposite such Initial Member's name on Exhibit A under the column "FIRST PART CAPITAL CONTRIBUTION" and in addition TSMC contributed to the Company (i) the Manufacturing Agreement, the Technology License and Assistance Agreement and the Advanced Process Agreement, by assigning such agreements to the Company, and (ii) all rights and interests of TSMC in the Real Property, the Foundry and all equipment purchased by TSMC ("FIRST PART CAPITAL CONTRIBUTION"). 3.2.2 SECOND PART CAPITAL CONTRIBUTION. On November 30, 1996 (the "SECOND CONTRIBUTION DATE"), each Initial Member contributed to the Company an amount of cash equal to the cash contribution set forth opposite such Initial Member's name on Exhibit A under the column "Second Part Capital Contribution" (the "SECOND PART CAPITAL CONTRIBUTION"). 3.2.3 THIRD PART CAPITAL CONTRIBUTION. On November 3, 1997 (the "THIRD CONTRIBUTION DATE"), each Initial Member shall contribute to the Company an amount of cash equal to the cash contribution set forth opposite such Initial Member's name on Exhibit A under the column "Third Part Capital Contribution" (the "THIRD PART CAPITAL CONTRIBUTION"). 3.2.4 PERCENTAGE INTEREST. Upon making each such Capital Contribution, each Initial Member shall be credited for its Capital Contribution and shall have the Percentage Interest in the Company as set forth with respect to such Initial Member on Exhibit A. -16- 24 3.3 ADDITIONAL CAPITAL CONTRIBUTION. No Member shall be obligated to or shall make any additional capital contribution to the Company in excess of such Member's portion of the Initial Capital Contribution provided for in Section 3.2 ("ADDITIONAL CAPITAL CONTRIBUTION") except that the Board of Directors may approve and require Preferred Members to make Additional Capital Contributions. The Board of Directors shall send to each Preferred Member written notice of the Additional Capital Contribution including a description of the purpose of the Additional Capital Contribution, a statement of the potential benefits to the Company and to Members who make such Additional Capital Contribution and a statement of the potential impact upon each Member pursuant to Section 3.4.1 if such Member does not make the Additional Capital Contribution (the "Additional Capital Contribution Notice"). If a proposed Additional Capital Contribution, together with all prior Additional Capital Contributions, exceeds in the aggregate an amount equal to 15% of the Total Initial Capital Contribution, as set forth on Exhibit A hereto, such Additional Capital Contribution must also be Approved by Members holding not less than 71% in Percentage Interest as provided in Section 6.4.2. Following approval as set forth above and subject to Section 3.4.2.1., all Preferred Members shall contribute their Additional Capital Contributions to the Company in proportion to their respective Percentage Interests promptly at such time or times as may be so established by the Board of Directors for the payment thereof. 3.4 CONSEQUENCES OF FAILURE TO CONTRIBUTE. 3.4.1 DEFAULT ON SECOND PART OR THIRD PART CAPITAL CONTRIBUTION. In the event any Preferred Member fails to pay its Second Part Capital Contribution or its Third Part Capital Contribution as contemplated in this Agreement, such Defaulting Member shall pay to the Non-Defaulting Members which have made their required Second Part Capital Contributions or Third Part Capital Contributions, as the case may be, as a partial liquidated payment for damages suffered by the Company and the Non-Defaulting Members as a result of such failure to pay, a cash payment equal to 10% of the Second Part Capital Contribution or Third Part Capital Contribution, as the case may be, of the Defaulting Member. Such cash payment shall be distributed among the Non-Defaulting Members according to their respective Percentage Interests. Such Defaulting Member's Membership Interest thereupon and without more shall be terminated and the following procedures shall apply: 3.4.1.1 MISSING CAPITAL CONTRIBUTION. The Non-Defaulting Members shall have the right, but not the obligation to, subject to the provisions of Section 8.6, contribute that portion of the Capital Contribution to have been funded by the Defaulting Member ("MISSING CAPITAL") in proportion to the respective Percentage Interest of each electing Non-Defaulting Member. If any Non-Defaulting Member elects to contribute none or less than all of such Non-Defaulting Member's pro rata share of the Missing Capital, then the other Non-Defaulting Members may elect to contribute the remaining portion of the Missing Capital in proportion to their respective Percentage Interests. If less than all of the Missing Capital is contributed by Non-Defaulting Members, subject to the provisions of Section 8.6, one or more new Preferred Members, if approved pursuant to Section 8.4, may be admitted as a Preferred Member or Members to contribute any remaining Missing Capital to the Company. If the entire Missing Capital is not contributed, the Initial Capitalization of the Company shall be reduced -17- 25 accordingly. Following such process, the Percentage Interest of all Preferred Members shall, subject to the last sentence of Section 3.4.1.4, be adjusted so that each Preferred Member's Percentage Interest (including that of any new Preferred Member) shall be determined by multiplying (1) the aggregate Percentage Interests of all of the Preferred Members times (2) a fraction, the numerator of which is the aggregate amount of such Preferred Member's Capital Contributions and the denominator of which is the sum of all Preferred Member's Capital Contributions (including that of any new Preferred Member) and each Preferred Member's Capital Account Balance shall be adjusted accordingly. As used in the preceding sentence, Capital Contributions shall include those portions of Capital Contributions made by a Defaulting Member or a Terminated Member that are credited to the Capital Account Balances of Non-Defaulting Members or Remaining Members following a transfer of part of the Defaulting Member's Interest or Terminated Member's Interest under clause (ii) of either of Section 3.4.1.4 or Section 10.5. For purposes of the remainder of this Section 3.4, any reference to a Non-Defaulting Member shall include any new Preferred Member admitted in connection with a failure to contribute Capital described in Section 3.4.1.1. 3.4.1.2 PURCHASE RIGHT. Upon termination of a Defaulting Member's Membership Interest pursuant to this Section and after giving effect to Section 3.4.1.1, subject to the provisions of Section 8.6, the Non-Defaulting Members shall have the right to purchase and the Defaulting Member shall have the obligation to sell, the Defaulting Member's Interest in the Company in the manner contemplated in Sections 3.4.1.3 through 3.4.1.6, inclusive. The purchase price for such Interest shall be an amount equal to 50% of the cash Capital Contributions of the Defaulting Member as of the termination date of the Defaulting Member. Such reduction in value shall constitute partial compensation for damages suffered by the Company and the Non-Defaulting Members as a result of the failure by the Defaulting Member to contribute the Second Capital Contribution or Third Capital Contribution, as the case may be. The Board of Directors shall give notice to all Non-Defaulting Members of such purchase price. 3.4.1.3 OPTION OF NON-DEFAULTING MEMBERS TO PURCHASE. Each Non-Defaulting Member shall have the right, but not the obligation, to elect to purchase a portion of the Defaulting Member's Interest, as hereinafter provided. Any Non-Defaulting Member so electing shall notify the Directors in writing within thirty (30) days after the notice from the Directors referred to in Section 3.4.1.2 above, of such Non-Defaulting Member's desire to purchase a portion of the Defaulting Member's Interest. The failure of any Non-Defaulting Member to submit such notice within the applicable period shall constitute an election on the part of the Non-Defaulting Member not to purchase any of the Defaulting Member's Interest. Each Non-Defaulting Member so electing to purchase shall be entitled to purchase a portion of the Defaulting Member's Interest in the same proportion that the Percentage Interest of the Non-Defaulting Member bears to the aggregate of the Percentage Interest of all of the Non-Defaulting Members electing to purchase a portion of the Defaulting Member's Interest. 3.4.1.4 ELECTION TO PURCHASE LESS THAN ALL OF THE DEFAULTING MEMBER'S INTEREST. If any Non-Defaulting Member elects to purchase none or less than all of such Non-Defaulting Member's pro rata share of the remaining Defaulting Member's Interest, then subject to the provisions of Section 8.6, the other Non-Defaulting Members may elect to -18- 26 purchase that Interest remaining in proportion to their respective Percentage Interests. Each Non-Defaulting Member who purchases part of the Defaulting Member's Interest shall succeed to a pro rata share of the Defaulting Member's Unpaid Capital Preference and Capital Account Balance. If the Non-Defaulting Members do not purchase the entire Interest of the Defaulting Member, then subject to the provisions of Section 8.6, one or more new Members, if approved pursuant to Section 8.4, may be admitted as a Member and purchase the remaining Defaulting Member's Interest by paying for such Interest in cash. If the entire remaining Interest has not been purchased, with respect to all or any remaining share of the Defaulting Member's Interest, the Defaulting Member shall have only an Economic Interest, and without limiting the generality of the foregoing, shall not be a Managing Member, shall not be entitled to designate a Director hereunder and any current Director or Directors appointed by such Member shall be deemed to be removed and the number of Directors on the Board of Directors shall be reduced accordingly. In such event, as partial compensation for damages suffered by the Company and the Non-Defaulting Members, (i) the Defaulting Member's remaining Interest shall be reduced by fifty percent (50%) and the Non-Defaulting Members' Interests shall be increased pro rata accordingly, (ii) the Defaulting Member's Capital Account Balance and Unpaid Capital Preference shall be reduced by 50%, and the difference shall be added to the Capital Account Balances and Unpaid Capital Preferences of the Non-Defaulting Members, pro rata according to their Interests, and (iii) solely for purposes of determining the Managing Members' and a Defaulting Member's rights and obligations to purchase the output of the Foundry under the Purchase Agreement or Future Purchase Agreement (which rights and obligations shall be a function, to be specified in each of those agreements, of the Managing Members' and Defaulting Member's Percentage Interests), effect shall not be given to any increase or decrease in a Managing Member's or Defaulting Member's Percentage Interest attributable to (A) the operation of clause (i), or (B) any reduction (x) in the Capital Contribution of the Defaulting Member due to (I) that portion of the Missing Capital that is not contributed by any other Person or (II) that portion of the Missing Capital contributed by a Person other than a Managing Member or a new Member who will become a party to the Purchase Agreement or Future Purchase Agreement (a "NEW BUYER") or (y) in the total Capital Contributions of Members due to that portion of the Missing Capital that is not contributed by any Person. 3.4.1.5 PAYMENT OF PURCHASE PRICE. The purchase price shall be paid by the electing Non-Defaulting Members by either of the following methods, each of which may be selected separately by the electing Non Defaulting Members in their respective sole discretion: (i) The Non-Defaulting Members shall at the consummation of the purchase of the Defaulting Member's Interest ("CLOSING") pay in cash the total purchase price for the Defaulting Member's Interest; or (ii) The Non-Defaulting Members shall pay at the Closing one-fifth (1/5) of the purchase price in cash and the balance of the purchase price shall be paid in four equal annual principal installments, plus accrued interest, and be payable each year on the anniversary date of the Closing. The unpaid principal balance shall accrue interest at the current applicable U.S. Federal rate as provided in the Code for the month in which the initial payment is made, but the Non-Defaulting Members shall have the right to prepay in full or in part at any -19- 27 time without penalty. The obligation of each purchasing Non-Defaulting Member to pay its portion of the balance due shall be evidenced by a separate promissory note executed by the respective Non-Defaulting Member. Each such promissory note shall be in an original principal amount equal to the portion owed by the respective purchasing Non-Defaulting Member. The promissory note executed by each purchasing Non-Defaulting Member shall be secured by a pledge of that portion of the Defaulting Member's Interest purchased by such Non-Defaulting Member. 3.4.1.6 CLOSING OF PURCHASE OF DEFAULTING MEMBER'S INTEREST. The Closing for the sale of a Defaulting Member's Interest pursuant to this Section 3.4 shall be held at 10:00 a.m. at the principal office of Company no later than sixty (60) days after the determination of the purchase price. At the Closing, the Defaulting Member or such Defaulting Member's legal representative shall deliver to the electing Non-Defaulting Members an instrument of transfer (containing warranties of title and no encumbrances) conveying the Defaulting Member's Interest free and clear of all liens, charges and encumbrances whatsoever, except as permitted by the purchaser thereof. The Defaulting Member or such Defaulting Member's legal representative, the Company and the Non-Defaulting Members shall do all things and execute and deliver all documents as may be necessary or convenient to consummate such sale and purchase in accordance with the terms and provisions of this Agreement. Without limiting the generality of the foregoing, each Defaulting Member hereby appoints each Non-Defaulting Member as its attorney-in-fact and agent, with full power and authority to take all actions and execute and deliver all agreements, deeds, leases, releases, assignments, bills of sale, security instruments and any other document which, in the sole judgment of such Non-Defaulting Member, is necessary or convenient to consummate such sale and purchase. 3.4.2 FAILURE TO PAY ADDITIONAL CAPITAL CONTRIBUTION. 3.4.2.1 FAILURE TO PAY ADDITIONAL CAPITAL CALL NOT APPROVED BY NON-PAYING MEMBER. The provisions of this Section 3.4.2.1 shall apply in the event a Member fails to make an Additional Capital Contribution: (i) requiring the Approval of Members holding not less than 71% in Percentage Interest as provided in Section 6.4.2.5, if such non-paying Member did not consent to such Additional Capital Contribution, or (ii) not requiring the consent of Members pursuant to Section 6.4.2.5 and (x) not approved by such Member's representative on the Board of Directors if such Member has a representative on the Board of Directors, or (y) if such Member does not have a representative on the Board of Directors. Such a Member shall be referred to in this Section as a "NON-PAYING MEMBER." In such event, the other Members who have made the Additional Capital Contribution (the "PAYING MEMBERS") shall have the right, but not the obligation, subject to the provisions of Section 8.6, to contribute that portion of the Additional Capital Contribution to have been funded by the Non-Paying Member ("MISSING ADDITIONAL CAPITAL") in proportion to the respective Percentage Interests of each electing Paying Member. If any Paying Member elects to contribute none, or less than all of such Paying Member's pro-rata share of the Missing Additional Capital, then the other Paying Members may elect to contribute the remaining portion in proportion to their respective Percentage Interests. If less than all of the Missing Additional Capital is contributed by the Paying Members, one or more new investors, approved as provided in Section 8.4, may be admitted as a Preferred -20- 28 Member to pay to the Company the remaining Missing Additional Capital. (Such a new Member shall be treated as a Paying Member for purposes of the remainder of this Section 3.4.2.1.) The failure of the Non-Paying Member to make an Additional Capital Contribution under the circumstances specified in this Section shall not constitute an Event of Default under this Agreement, but the Percentage Interests of all Preferred Members shall be adjusted so that each Preferred Member's Percentage Interest (including that of the new Member, if any), shall be determined by multiplying (1) the aggregate Percentage Interests of all of the Preferred Members times (2) a fraction, the numerator of which is the aggregate amount of each Preferred Member's Capital Contributions and the denominator of which is the sum of all Preferred Members' Capital Contributions (including that of the new Member, if any). As used in the preceding sentence, Capital Contributions shall include those portions of Capital Contributions made by a Defaulting Member or a Terminated Member that are credited to the Capital Account Balances of Non-Defaulting Members or Remaining Members following a transfer of part of the Defaulting Member's or Terminated Member's Interest to such Members under clause (ii) of either of Section 3.4.1.4 or Section 10.5. Notwithstanding the foregoing, if the Board of Directors in its reasonable discretion determines that the fair market value of the Company as of the date immediately prior to the requested Additional Capital Contribution is less than total Capital Contributions made to such date, the Preferred Members' Percentage Interests (including that of the new Member, if any), shall be adjusted to reflect a fraction, the numerator of which is (A) the fair market value of the Company multiplied by the Percentage Interest of each Preferred Member as of such date, plus (B) the Additional Capital Contribution made by such Member (if any), and the denominator of which is such fair market value of the Company as of such date plus the total Additional Capital Contributions of all Members (including that of the new Member, if any). The Board of Directors in its reasonable discretion shall determine the fair market value of the Company except that any Director who was elected by a Non-Paying Member shall not vote or otherwise participate in any such determination. Each Member's Capital Account shall be adjusted as provided in Section 3.4. If the failure to make the Additional Capital Contribution is a Dilution Event, each Managing Member's right to receive and obligation to take the output of the Foundry pursuant to the Purchase Agreement and the Future Purchase Agreement shall be adjusted contemporaneously to give effect to the changes in Members' Percentage Interests. If the failure to make the Additional Capital Contribution is not a Dilution Event each Managing Member's right to receive and obligation to take the output of the Foundry pursuant to the Purchase Agreement and Future Purchase Agreement shall not be affected in which case the provisions of Section 8.6 with respect to an increase in the obligations of new Members or Members acquiring an additional Percentage Interest pursuant to such agreements shall not apply. Additionally, a Non-Paying Member shall not be entitled to acquire directly or indirectly any Products of the Company, the production of which has been funded, enabled or otherwise facilitated by such Additional Capital Contribution made by the Paying Members, and the production of which was described in the Additional Capital Contribution Notice. 3.4.2.2 DEFAULT FOLLOWING MEMBERS APPROVAL OF ADDITIONAL CAPITAL CONTRIBUTION. This Section 3.4.2.2 shall apply in the event a Member fails to make an Additional Capital Contribution or any installment payment of an Additional Capital Contribution that has been: (i) approved by such Defaulting Member, if the Additional Capital -21- 29 Contribution is one requiring Approval of Members holding not less than 71% in Percentage Interest as provided in Section 6.4.2.5, or (ii) approved by such Member's representative on the Board of Directors (if such Defaulting Member has a representative on the Board of Directors) if the Additional Capital Contribution is not one requiring Approval of Members holding not less than 71% in Percentage Interest as provided in Section 6.4.2.5. In either circumstance, the Defaulting Member's Membership Interest shall be terminated and the procedures set forth in Sections 3.4.1.1 through 3.4.1.6 inclusive, shall apply. 3.5 CAPITAL ACCOUNTS. The Capital Accounts of the Members shall be determined and maintained throughout the full term of the Company in accordance with the capital account rules of Section 1.704-1(b)(2)(iv) of the Section 704(b) Regulations (relating to maintenance of capital accounts). 3.5.1 Each Member shall have a capital account ("CAPITAL ACCOUNT") which shall be credited (increased) by: 3.5.1.1 the amount of such Member's cash capital contributions to the Company and the agreed net fair market value of property other than cash contributed to the Company by such Member (net of liabilities secured by such contributed property that the Company is considered to have assumed or taken subject to for purposes of Section 752 of the Code); 3.5.1.2 the amount of Net Profits and items thereof allocated to it pursuant to Article 5 hereof; and 3.5.1.3 any other increase required to be made to the Capital Account of the Member by the Section 704(b) Regulations, to the extent not otherwise provided for herein. 3.5.2 Each Member's Capital Account shall be debited (decreased) by: 3.5.2.1 the amount of Net Losses and items thereof allocated to such Member pursuant to Article 5 hereof; 3.5.2.2 all amounts paid, distributed or deemed distributed to it pursuant to Article 4 hereof, and the fair market value of property distributed to it (in each case, net of liabilities securing such distributed property that such Member is considered to have assumed or taken subject to under Section 752 of the Code); and 3.5.2.3 any other reductions in the Capital Account of the Member required by the Section 704(b) Regulations, to the extent not otherwise provided for herein. 3.5.3 In the discretion of the Board of Directors, the capital accounts may be adjusted to reflect a revaluation of Company property to the extent permitted by the Section 704(b) Regulations in connection with capital contributions to the Company by new or existing Members resulting in a change of Percentage Interests held by the Members, or in -22- 30 connection with distributions by the Company to a retiring or continuing Member as consideration for an Interest in the Company. 3.6 TRANSACTIONS BETWEEN MEMBERS AND THE COMPANY; COMPANY LOANS AND GUARANTEES. 3.6.1 TRANSACTIONS BETWEEN MEMBERS AND THE COMPANY. With the written approval of the Board of Directors, and the written consent of Preferred Members with no economic interest in the transaction in question ("DISINTERESTED MEMBERS") holding a majority of the Percentage Interests of Disinterested Members, a Member or an Affiliate of a Member may transact business or contract with the Company so long as the terms of any such transaction are at fair market value and are comparable to those that could be obtained between independent parties negotiating at arm's-length. The representatives of the contracting Member on the Board of Directors shall not be prohibited from participating in the decision made to enter into any such transaction. All Members agree that the terms of the Ancillary Agreements and the Incentive Plans satisfy the standard set forth in this Section 3.6.1, that such documents are deemed to have been approved by the Board of Directors and the Members and that no further action or approval by the Board of Directors or the Members to approve such instruments or transactions is required. 3.6.2 LOANS TO THE COMPANY. With the approval of the Board of Directors, and the consent of the Members contemplated in Section 6.4.2, a Member may lend money to, act as a surety, guarantor or endorser for, or guarantee or assume one or more specific obligations of, or provide collateral for the Company (collectively, "COMPANY LOANS"), and, subject to applicable law, has the same rights and obligations with respect to any Company Loan as a Person who is not a Member; provided, however, that each Managing Member shall have the option to participate in any such Company Loan pro rata in accordance with such Managing Member's Percentage Interest. Unless otherwise agreed to in writing by the Board of Directors, Company Loans shall not be considered capital contributions or be reflected in the balance of any Capital Account. Each Company Loan shall be a debt due from the Company to the lending Member, shall bear interest at the rate agreed to between such Member and the Company and, except as otherwise expressly provided in this Agreement or agreed between such Member and the Company at the time such funds are advanced, shall be repaid as soon as practicable to such Member. 3.6.3 PROHIBITION ON LOANS TO MEMBERS. The Company shall not lend money to, act as a surety, guarantor or endorser for, or guaranty or assume any obligations of any Member (other than, with respect to Common Members, such loans as may be approved by the Board of Directors). 3.6.4 GUARANTEES. To the extent a Member guarantee is required by an institutional lender to the Company, the Board of Directors shall send to each Preferred Member written notice of the required guarantee including a description of the purpose of the loan the Members are being asked to guarantee, a statement of the potential benefits of the loan to the Company and the Members who guarantee the loan and a statement of the potential impact upon -23- 31 each Member pursuant to this Section if such Member does not guarantee the loan (the "GUARANTEE NOTICE"). The Preferred Members agree to provide, to a maximum aggregate amount of US$250 Million, a several guarantee of the Company's debt according to their respective Percentage Interests. If any Preferred Member fails to provide, in whole or in part, a guarantee as specified above, such failure shall not constitute an Event of Default under this Agreement, but the Percentage Interests of the Preferred Members shall be adjusted so that each Preferred Member's Percentage Interest shall be determined by multiplying (1) the aggregate Percentage Interests of all of the Preferred Members times (2) a fraction, the numerator of which represents the aggregate amount of each Preferred Member's Capital Contribution plus any amount such Member guaranteed as provided for above, and the denominator of which represents the sum of all Preferred Members' Capital Contributions (other than Common Members) plus the total amount guaranteed by the Members. In addition, the Unpaid Capital Preference and Capital Account of the Preferred Member who fails to approve in whole or in part a guarantee, as specified above, shall be adjusted in substantially the same manner as Percentage Interests. The Preferred Shares owned by each Preferred Member shall be adjusted accordingly to reflect such adjustments in each Preferred Member's Percentage Interest. As used in the preceding sentence, Capital Contributions shall include those portions of Capital Contributions made by a Defaulting Member or Terminated Member that are credited to the Capital Account Balances of Non-Defaulting Members or Remaining Members following a transfer of part of the Defaulting Member's or Terminated Member's Interest to such Members under clause (ii) of either of Section 3.4.1.4 or Section 10.5. If the failure to guarantee the Company's debt is not a Dilution Event each Member's right to receive and obligation to take the output of the Foundry pursuant to the Purchase Agreement and Future Purchase Agreement shall not be affected. However, if such failure is a Dilution Event, the Members' right to receive and obligation to take the output of the Foundry pursuant to the Purchase Agreement and the Future Purchase Agreement shall be adjusted contemporaneously to reflect the change in Percentage Interests. Additionally, if a Member fails to provide a guarantee as specified above, such Member shall not be entitled to acquire directly or indirectly any Products of the Company, the production of which has been funded, enabled or otherwise facilitated by the proceeds of any Company debt such Member failed to guarantee, the production of which was described in the Guarantee Notice. 3.7 RIGHTS WITH RESPECT TO CAPITAL. 3.7.1 CAPITAL. No Member shall have the right to withdraw all or any part of its Capital Contribution. No Member shall have any right to the return of all or any part of its Capital Contribution except through distributions as provided in this Agreement. 3.7.2 NO INTEREST ON CAPITAL CONTRIBUTIONS. Except as expressly provided in this Agreement, no Capital Contribution of any Member shall bear any interest or otherwise entitle the contributing Member to any compensation for use of the contributed capital. 3.7.3 DISTRIBUTION IN KIND. Except as provided in Article 19, no Member shall have the right to demand and receive any distribution in any form other than cash, -24- 32 regardless of the nature of its Capital Contribution. No Member shall be compelled to accept a distribution of any asset in kind to the extent that the percentage of the asset distributed to such Member exceeds a percentage of that asset that is equal to the percentage in which such Member shares in distributions from the Company. ARTICLE 4 DISTRIBUTIONS 4.1 CASH AVAILABLE FOR DISTRIBUTION. Cash Available for Distribution shall be distributed to the Members in accordance with the following: 4.1.1 DETERMINATION. The Company shall distribute, from time to time, pursuant to Sections 4.1.3, 4.2 and 4.3 as determined by the Board of Directors and approved by the Members as provided in Section 6.4.2, Cash Available For Distribution, if any, to the Members as provided in this Article 4. 4.1.2 DEFINITION OF CASH AVAILABLE FOR DISTRIBUTION. For purposes of this Agreement, "Cash Available For Distribution" means the cash available for distribution to Members after giving effect to the following: (i) projected cash available from operations of the Company as determined by the Board of Directors; (ii) cash on hand of the Company; (iii) a prudent level of reserves for the Company, as determined by the Board of Directors; (iv) projected cash needed for operations of the Company including for payment of debt and for future Special Tax Distributions to Members, as such are determined by the Board of Directors; and ( v) the anticipated total project costs for any new foundry to be developed by the Company or retrofit of the Foundry which have been approved by the Members in accordance with Section 6.4.2. 4.1.3 FINAL SALE. Notwithstanding the foregoing provisions, all distributions and proceeds resulting from a final sale or other event causing a dissolution of the Company shall be applied in the manner set forth in Section 11.4 and not in the manner set forth in this Section 4.1. 4.2 TAX DISTRIBUTIONS. For each Fiscal Year, the Company shall distribute to its Members in accordance with the amount of Net Profit allocated to them in such Fiscal Year and to the extent available from the cash resources of the Company (including borrowings), before calculation of Cash Available for Distribution, within ninety (90) days after the end of each Fiscal Year (a "SPECIAL TAX DISTRIBUTION"), an aggregate amount of cash equal to the excess of (i) the product of (A) the Company's aggregate amount of Net Profit for the Fiscal Year determined for this purpose only without regard to the adjustments set forth in clauses (iii) and (iv) of Section 1.1.52 and (B) the highest applicable composite marginal rate borne by any Initial Member for U.S. Federal, state and local taxes for such Fiscal Year over (ii) the aggregate net cash distributions previously made to the Members with respect to such Fiscal Year pursuant to this Section 4.2. All amounts withheld under Section 4.4 shall be deemed to be distributions to the respective Members for purposes of this Section 4.2. -25- 33 4.3 DISCRETIONARY DISTRIBUTIONS The Board of Directors, following the approval of the Members pursuant to Section 6.4.2, may make additional distributions ("DISCRETIONARY DISTRIBUTIONS") of Cash Available for Distribution (as defined in Section 4.1.2) as it deems appropriate at any time prior to the commencement of the liquidation of the Company. 4.3.1 REDUCTION OF UNPAID CAPITAL PREFERENCE. All Discretionary Distributions shall be made solely to the Preferred Members in proportion to their respective Unpaid Capital Preferences at the time of distribution until each Preferred Member's Unpaid Capital Preference equals zero. 4.3.2 RESIDUAL DISTRIBUTIONS. The balance, if any, of any Discretionary Distributions shall be made to the Members pro rata in accordance with their respective Percentage Interests. 4.4 AMOUNTS WITHHELD. All amounts withheld pursuant to the Code or any provision of any state or local tax law with respect to any payment, distribution or allocation to the Company or the Members shall be treated for all purposes under this Agreement as amounts distributed to the Members pursuant to this Article 4. The Board of Directors is authorized to withhold from distributions, or with respect to allocations, to the Members and to pay over to any U.S. Federal, state, or local government any amounts required to be so withheld pursuant to the Code or any provisions of any other U.S. Federal, state or local law and shall allocate such amounts to the Members with respect to which such amount was withheld. ARTICLE 5 ALLOCATION OF PROFITS AND LOSSES 5.1 ALLOCATION OF NET PROFIT AND LOSS. In each fiscal period Net Profit and Net Loss of the Company shall be allocated among the Members (consistent with and subject to the rules stated in Exhibit G) as follows: 5.1.1 NET LOSS. 5.1.1.1. Net Loss shall be allocated first, to each Member with a positive Capital Account balance, in the amount of such positive balance; provided, however, that if the amount of Net Loss to be allocated is less than the sum of the Capital Account balances of all Members having positive Capital Account balances, then the Net Loss shall be allocated to the Members in such proportions and in such amounts as would result in the Capital Account balance of each Member equaling, as nearly as possible, the amount such Member would be distributed if the Company (i) sold all of its assets at their respective adjusted tax bases (or, if different, their book values as determined pursuant to Treasury Regulation Section 1.704-1(b)(2)), (ii) paid all of its liabilities in accordance with their terms and (iii) distributed the balance of the proceeds from such sale in accordance with Section 4.3 hereof; and -26- 34 5.1.1.2 Thereafter, Net Loss shall be allocated among the Members in proportion to their respective Percentage Interests. 5.1.2 NET PROFIT. 5.1.2.1 Net Profit shall be allocated first, to any Members having negative Capital Account balances, in proportion to and to the extent of such negative balances. 5.1.2.2 Thereafter, Net Profit shall be allocated to the Members in such proportions and in such amounts as would result in the Capital Account balance of each Member equaling, as nearly as possible, the amount such Member would be distributed if the Company (i) sold all of its assets at their respective adjusted tax bases (or, if different, their book values as determined pursuant to Treasury Regulation Section 1.704-1(b)(2)), (ii) paid all of its liabilities in accordance with their terms and (iii) distributed the balance of the proceeds from such sale in accordance with Section 4.3 hereof. 5.1.3 CAPITAL ACCOUNT ADJUSTMENTS. Adjustments to the Capital Accounts pursuant to Sections 3.5.1.3 and 3.5.2.3 shall be allocated among the Capital Accounts of the Partners in the same manner as Net Profit and Net Loss. 5.2 RESIDUAL ALLOCATIONS. Except as otherwise provided in this Agreement, all items of Company income, gain, loss, deduction, and any other allocations not otherwise provided for shall be divided among the Members in the same proportions as they share Net Profit or Net Losses, as the case may be, for the Fiscal Year, consistent with the rules stated in Exhibit G. 5.3 OTHER ALLOCATION RULES. 5.3.1 The Members are aware of the income tax consequences of the allocations made by this Article 5 and agree to be bound by the provisions of this Article 5 in reporting their shares of Company income and loss for income tax purposes. 5.3.2 For purposes of determining the Net Profits, Net Losses, or any other items allocable to any period, Net Profits, Net Losses, and any such other items shall be determined on a daily, monthly, or other basis, as determined by the Board of Directors using any permissible method under Code Section 706 and the Regulations thereunder. 5.4 TAX ALLOCATIONS. 5.4.1 Except as otherwise provided in this Section 5.4, for income tax purposes each item of income, gain, loss and deduction (collectively, "TAX ITEMS") shall be allocated among the Members in the same manner as its correlative item of "book" income, gain, loss or deduction is allocated pursuant to Sections 5.1 - 5.2. -27- 35 5.4.2 Notwithstanding Section 5.4.1, Tax Items with respect to Property that is contributed to the Company by a Member shall be shared among the Members for income tax purposes in accordance with the "traditional method" pursuant to Regulations promulgated under Section 704(c) of the Code, so as to take into account the variation, if any, between the book and tax basis of the Property contributed to the Company. 5.4.3 Any elections or other decisions relating to such allocations shall be made by the Directors in a manner that reasonably reflects the purpose and intention of this Agreement. Allocations pursuant to this Section 5.4 are solely for purposes of U.S. Federal, state, and local taxes and shall not affect, or in any way be taken into account in computing, any Person's Capital Account or share of Net Profits, Net Losses, other items, or distributions pursuant to any provisions of this Agreement. ARTICLE 6 MANAGEMENT OF THE COMPANY 6.1 MANAGEMENT BY DIRECTORS. Subject to the provisions of the Certificate of Formation and this Agreement relating to actions required to be approved by the Members, the business, property and affairs of the Company shall be managed and all powers of the Company shall be exercised by or under the direction of the Managing Members who shall act through their designated representatives as the Board of Directors ("BOARD OF DIRECTORS"). Subject to the foregoing, the Members are the "MANAGERS" of the Company as such term is defined under the Act. Notwithstanding Section 18402 of the Act, the powers of the Members and the Board of Directors to bind the Company are as set forth in this Agreement. 6.2 NUMBER AND DESIGNATION OF DIRECTORS; OBSERVER OF THIRD PARTY INVESTORS. 6.2.1 BOARD OF DIRECTORS. The Company shall have a board of seven (7) directors ("DIRECTORS"). TSMC shall designate four (4) of the Directors, one (1) of whom shall be voting and three (3) of whom shall be non-voting. Each of Altera, ADI and ISSI shall designate one (1) voting Director. Each Director shall serve at the pleasure of the Member who designated such Director. Only the Member who originally designated a Director may remove such Director, except that one or more Members holding a Majority in Interest may remove any Director appointed by a Terminated Member. Any Director may resign upon written notice to the Member who designated such Director. The resignation shall take effect upon receipt of such notice, or at such later time as shall be specified in such notice. Any vacancy occurring for any reason in the number of Directors shall be filled by the Member who originally designated the Director whose position has become vacant. 6.2.2 OBSERVER. The Third Party Investors may from time to time designate one representative, approved by TSMC, who shall serve in an advisory capacity to the Board of Directors, with no other rights, duties or authority (the "OBSERVER"). TSMC may revoke its approval of a designated Observer at any time, following which the Third Party Investors shall select an alternative Observer approved by TSMC. The Observer shall be entitled to attend such -28- 36 meetings of the Board of Directors as he is invited by the Board of Directors to attend, and to receive all materials distributed to the Directors for such meetings. The initial Observer shall be Mr. Quintin Wu. 6.3 MEETINGS OF DIRECTORS. 6.3.1 MEETINGS. Meetings of the Directors shall be held at least once each calendar quarter and may be called by the Chairman/Chief Executive Officer ("CEO") of the Company. All meetings shall be held upon seven (7) days notice by mail or four (4) days notice (or upon such shorter notice period if necessary under the circumstances) delivered personally or by telephone, e-mail or facsimile. A notice need not specify the purpose of any meeting. Notice of a meeting need not be given to any Director who signs a waiver of notice or a consent to holding the meeting (which waiver or consent need not specify the purpose of the meeting) or an approval of the minutes thereof, whether before or after the meeting, or who attends the meeting without protesting, prior to its commencement, the lack of notice to such Director. All such waivers, consents and approvals shall be filed with the Company records or made a part of the minutes of the meeting. A majority of the Directors present, whether or not a quorum is present, may adjourn any meeting to another time and place. If the meeting is adjourned for more than twenty-four (24) hours, notice of any adjournment shall be given prior to the time of the adjourned meeting to the Directors who are not present at the time of the adjournment. Meetings of the Directors may be held at any place which has been designated in the notice of the meeting or at such place as may be approved by the Directors. Directors may participate in a meeting through use of conference telephone or similar communications equipment, so long as all Directors participating in such meeting can hear one another. Participation in a meeting in such manner constitutes a presence in person at such meeting. 6.3.2 QUORUM; ACTION OF THE DIRECTORS. Directors elected by one or more Members holding a Majority in Interest, present at a meeting shall constitute a quorum of Directors for the transaction of business. Every action or resolution done or made by Directors holding a majority of the Director Votes (as defined below) at a meeting at which a quorum is present is the action of the Directors. Each voting Director shall hold the same number of votes as the Percentage Interest held by the Member who designated such Director ("DIRECTOR VOTES"). If the voting Director of TSMC shall not be present at a meeting, such voting Director may delegate in writing such Director's voting authority to one of the non-voting Directors nominated by TSMC. TSMC shall designate which of its Director nominees shall be its voting Director. 6.3.3 ACTION BY WRITTEN CONSENT. Any action required or permitted to be taken by the Directors may be taken by the Directors without a meeting, if Directors holding all Director Votes consent in writing to such action. Such action by written consent shall have the same force and effect as a unanimous vote of such Directors. 6.4 POWERS OF DIRECTORS. -29- 37 6.4.1 POWERS OF DIRECTORS. Without limiting the generality of Section 6.1, but subject to Sections 3.6, 6.4.2 and 6.4.3, and to any express limitations set forth elsewhere in this Agreement, the Board of Directors shall have all powers necessary or convenient to manage and carry out the purposes, business, property and affairs of the Company, including, without limitation, the power to: 6.4.1.1 approve the annual budget; 6.4.1.2 provide for capital increase and capacity expansion of the Company; 6.4.1.3 sell, transfer, mortgage or dispose of property of the Company; 6.4.1.4 borrow, guarantee or incur long term debt; 6.4.1.5 amend the Certificate of Formation of the Company or this Agreement; 6.4.1.6 voluntarily dissolve the Company or merge the Company with another entity; 6.4.1.7 dissolve, liquidate, wind up, reorganize the Company, or any similar action; or 6.4.1.8 convert or exchange the Interests of the Members into or for, as the case may be, an interest in the Delaware Corporation as contemplated in Article 14. Subject to applicable laws and regulations, all actions of the Board of Directors shall be taken as provided in Section 6.3.2 and 6.3.3. 6.4.2 LIMITATIONS ON RIGHTS AND POWERS; APPROVAL OF MEMBERS HOLDING NOT LESS THAN 71% IN PERCENTAGE INTEREST. In addition to any affirmative vote of the Board of Directors or Members otherwise required by law or this Agreement, each of the following actions shall require the Approval of Members holding not less than 71% in Percentage Interest: 6.4.2.1 borrow, guarantee or incur long term debt in any way greater than the amount of US $25 Million in the aggregate; 6.4.2.2 determine that a Member or an Affiliate of a Member is a Prohibited Person; 6.4.2.3 convert or exchange the Interest of the Members into or for, as the case may be, an interest in the Delaware Corporation if such conversion or exchange does not occur contemporaneously with an IPO of the Delaware Corporation; -30- 38 6.4.2.4 reduce the Company's capital; 6.4.2.5 authorize or call for any Additional Capital Contribution in an amount exceeding 15% of the Total Initial Capital Contribution as set forth on Exhibit A hereto; 6.4.2.6 determine if Cash Available For Distribution exists to be distributed to the Members; 6.4.2.7 engage legal counsel to the Company or engage certified public accountants to audit and certify the financial statements of the Company; 6.4.2.8 construct another foundry or retrofit the Foundry; 6.4.2.9 create any Incentive Plan, except for the Senior Executive Incentive Plan and Employee Incentive Plan provided for in Article 12, or amend an Incentive Plan in any manner that increases the maximum aggregate awards thereunder; 6.4.2.10 make any material change or amendment to the Business Plan including, but not limited to, the capacity ramp up schedule incorporated therein; or 6.4.2.11 admit any new Member other than a participant in an Incentive Plan. 6.4.3 LIMITATIONS ON RIGHTS AND POWERS; APPROVAL OF MEMBERS HOLDING NOT LESS THAN 87% IN PERCENTAGE INTEREST. In addition to any affirmative vote of the Board of Directors or Members otherwise required by law or this Agreement, each of the following actions shall require, in addition to the approval of the Board of Directors, the Approval of Members holding not less than 87% in Percentage Interest: 6.4.3.1 Except for any action taken pursuant to Section 6.4.2.8, discontinue a material part of, add materially to or materially change the business of the Company as it is described in Section 2.6.1; 6.4.3.2 Transfer in a single transaction or in a series of related transactions, all or substantially all of the Company's business and assets; 6.4.3.3 subject to Article 16, amend, restate or alter the Certificate of Formation or this Agreement (other than an Incentive Plan or the Business Plan, which may be changed or amended as contemplated in Section 6.4.2.9 or 6.4.2.10, respectively); 6.4.3.4 merge or consolidate the Company, other than as provided in Article 14; or -31- 39 6.4.3.5 dissolve, liquidate, place into bankruptcy, wind up or reorganize the Company or any similar event, if such action does not occur contemporaneously with an IPO of the Delaware Corporation. 6.5 ANNUAL INFORMATIONAL MEETING OF MEMBERS. The Members shall hold an annual informational meeting concerning the affairs of the Company. All Members of the Company shall be entitled to attend the annual informational meeting. The annual informational meeting shall be held in the first quarter of each year with the exact time and date of the meeting to be determined by the Chairman/CEO. Notice of the annual informational meeting shall be given to all Members at least ten (10) days before the scheduled meeting. At such meeting, the Members may take any action that pursuant to this Agreement, would otherwise be taken by written consent. 6.6 COMPENSATION COMMITTEE. The Board of Directors shall appoint a Compensation Committee composed of the Directors designated by Altera and ADI and the voting Director designated by TSMC pursuant to Section 6.2.1. The Compensation Committee shall serve in an advisory capacity only to the Board of Directors and may make non-binding recommendations to the Board of Directors regarding the compensation of employees of the Company and the administration of any Incentive Plan. 6.7 EXPENSE REIMBURSEMENT. The Company shall reimburse the Members for any expenses paid by them that properly are to be borne by the Company, as approved from time to time by the Board of Directors. 6.8 INSURANCE. The Company shall maintain adequate types and amounts of insurance as determined from time to time by the Board of Directors including worker's compensation, comprehensive general liability, product liability, and fire and extended coverage, considering the risks of conducting the Company's business and the replacement value of the Project. 6.9 OFFICERS. 6.9.1 APPOINTMENT OF OFFICERS. The Officers of the Company shall include a Chairman/CEO, a Vice Chairman, a President/Chief Operating Officer ("COO"), one or more Vice Presidents, a Secretary, and a Chief Financial Officer, each of whom shall be appointed by the Board of Directors. If deemed necessary by the Board of Directors, the Company shall have such additional Officers as the Board of Directors may from time to time approve. The Officers shall serve at the pleasure or the Directors, subject to all rights, if any, of an Officer under any contract of employment with the Company. Any individual may hold any number of offices. A Member's officers, directors, members or employees, as the case may be, may serve as Officers of the Company if elected by the Directors. The Officers shall exercise such powers and perform such duties as specified in this Agreement and as shall be determined from time to time by the Directors. Notwithstanding the foregoing, no Officer shall have the power or authority to implement any of the matters specifically enumerated in Section 6.4.1, without the explicit approval of the Board of Directors. -32- 40 6.9.2 REMOVAL, RESIGNATION AND FILLING OF VACANCY OF OFFICERS. Any Officer may be removed, either with or without cause, by the Directors at any time. Any Officer may resign at any time by giving written notice to the Directors. Any resignation shall take effect at the date of the receipt of such notice or at any later time specified in such notice, and, unless otherwise specified in such notice, the acceptance of the resignation shall not be necessary to make it effective. Any resignation is without prejudice to the rights, if any, of the Company under any contract to which such Officer is a party. A vacancy in any office because of death, resignation, removal, disqualification or any other cause shall be filled in the manner prescribed in this Agreement for regular appointments to that office. 6.9.3 DUTIES AND POWERS OF THE CHAIRMAN/CEO. The Chairman/CEO shall be the chief executive officer of the Company and, if present, shall preside at all meetings of the Members and at all meetings of the Directors. The Chairman/CEO shall have the general powers and duties of management usually vested in the office of chief executive officer of a Delaware general corporation and shall have general and active management of the business of the Company and shall see that all orders and resolutions of the Members and Directors are carried into effect. The Chairman/CEO shall have such other duties and responsibilities as may be assigned to the Chairman/CEO by the Board of Directors and which he shall accept. 6.9.4 DUTIES AND POWERS OF THE VICE CHAIRMAN. The Vice Chairman shall in the absence or disability of the Chairman/CEO perform the duties and exercise the powers of the Chairman/CEO and shall perform such other duties and have such other powers as the Directors by resolution may from time to time determine. 6.9.5 DUTIES AND POWERS OF THE PRESIDENT/COO. Subject to such supervisory powers, if any, as may be assigned by the Directors to the Chairman/CEO and Vice Chairman, the President/COO shall assist the Chairman/CEO and Vice Chairman with the general and active management of the business of the Company. The President/COO shall have authority to execute bonds, mortgages and other contracts except where required or permitted by law to be otherwise signed and executed, and except where the signing and execution thereof shall be expressly delegated by the unanimous action of the Directors to some other officer or agent of the Company. The President/COO shall perform such other duties and have such other powers as the Directors by resolution may from time to time determine. 6.9.6 DUTIES AND POWERS OF VICE-PRESIDENT. The Vice-President, or if there shall be more than one, the Vice-Presidents in the order determined by a resolution of the Directors, shall, in the absence or disability of the President, perform the duties and exercise the powers of the President and shall perform such other duties and have such other powers as the Directors by resolution may from time to time determine. 6.9.7 DUTIES AND POWERS OF SECRETARY. -33- 41 6.9.7.1 The Secretary shall attend all meetings of the Directors and all meetings of the Members, and shall record all the proceedings of the meetings in a book to be kept for that purpose, and shall perform like duties for the standing committees when required. The Secretary shall give, or cause to be given, notice of all meetings of the Members and all meetings of the Directors and shall perform such other duties as may be determined by the Directors. The Secretary shall have custody of the seal, if any, and the Secretary shall have authority to affix the same to any instrument requiting it, and when so affixed, it may be attested by the Secretary's signature. The Directors may give general authority to any other officer to affix the seal of the Company, if any, and to attest the affixing by his or her signature. 6.9.7.2 The Secretary shall keep, or cause to be kept, at the principal executive office or at the office of the Company's transfer agent or registrar, as determined by resolution of the Directors, a register, or a duplicate register, showing the names of all Members and their addresses and their Percentage Interests. The Secretary shall also keep all documents described in Section 9.1 and such other documents as may be required under the Act. The Secretary shall perform such other duties and have such other authority as may be prescribed elsewhere in this Agreement or from time to time by the Directors. The Secretary shall have the general duties, powers and responsibilities of a secretary of a Delaware general corporation. 6.9.8 DUTIES AND POWERS OF CHIEF FINANCIAL OFFICER. 6.9.8.1 The Chief Financial Officer shall keep and maintain, or cause to be kept and maintained, adequate and correct books and records of accounts of the properties and business transactions of the Company, including accounts of its assets, liabilities, receipts, disbursements, gains, losses, capital, Membership Interests and Economic Interests. The books of account shall at all reasonable times be open to inspection by any Director. 6.9.8.2 The Chief Financial Officer shall have the custody of the funds and securities of the Company, and shall keep full and accurate accounts of receipts and disbursements in books belonging to the Company, and shall deposit all moneys and other valuable effects in the name and to the credit of the Company in such depositories as may be designated by the Directors. 6.9.8.3 The Chief Financial Officer shall disburse the funds of the Company as may be ordered by the Directors, taking proper vouchers for such disbursements, and shall render to the CEO and the Directors, at their regular meetings, or when Members so require, at a meeting of the Members an account of all his or her transactions as treasurer and of the financial condition of the Company. 6.9.8.4 The Chief Financial Officer shall perform such other duties and shall have such other responsibility and authority as may be prescribed elsewhere in this Agreement or from time to time by the Directors. The Chief Financial Officer shall have the general duties, powers and responsibility of a Chief Financial Officer of a Delaware general corporation, and shall be the chief financial and accounting officer of the Company. -34- 42 6.10 MEMBER CONSENTS. Except for actions approved by unanimous written consent of all Preferred Members, no action requiring written consent of the Preferred Members shall become effective until five (5) Business Days after all Preferred Members have been notified of such action in accordance with Section 23.3. 6.11 BEST INTEREST OF THE COMPANY. In managing the affairs of the Company the Members and the Board of Directors will take into account, among other things, the best interests of the Company and the best interests of the Members as a whole, and will endeavor not to take any action prejudicial to any Member unless, in the sole determination of the Board of Directors, such action is in the best interests of the Company or the best interests of the Members as a whole. ARTICLE 7 MEMBER REPRESENTATIONS AND WARRANTIES 7.1 NATURE OF MEMBER'S INTEREST. The Interest of each Member constitutes personal property of such Member. No Member has any interest in the Property. 7.2 MEMBER REPRESENTATIONS AND WARRANTIES. 7.2.1 POWER AND AUTHORITY. Each Member (other than natural persons) represents and warrants that such Member has full corporate power and authority to enter into this Agreement and to consummate and perform the transactions contemplated hereby. Each Member (other than natural persons) further represents and warrants that this Agreement has been duly authorized by it. 7.2.2 GOOD STANDING. Each Member (other than natural persons) represents and warrants that it is duly incorporated or formed, validly existing and in good standing under the laws of the jurisdiction of its incorporation or formation. 7.2.3 EXECUTION. Each Member represents and warrants that the execution and delivery of this Agreement and the consummation of the transactions contemplated hereby will not conflict with or violate its charter documents or any law, rule, regulation, court order, contract, agreement, judgment or decree binding upon or applicable to such Member or by which the property of such Member is bound or affected in a manner that would materially and adversely affect such Member's performance hereunder and thereunder. 7.2.4 INVESTMENT REPRESENTATIONS. 7.2.4.1 KNOWLEDGE. Each Member (other than Participants in the Incentive Plans) represents and warrants that such Member (i) has such knowledge, skill and experience in business and financial matters, that such Member is capable of evaluating the merits and risks of an investment in the Company and the suitability thereof as an investment for such Member, (ii) has sufficient net worth to sustain a loss of all such Member's interest in the Company without economic hardship if such a loss should occur and can bear the economic risk -35- 43 of such Member's investment in the Company, (iii) understands that an investment in the Company involves a considerable degree of risk of loss by such Member, (iv) has reviewed this Agreement and each of the Ancillary Agreements and has received such other documents and information as such Member has requested and has had an opportunity to ask questions of and receive satisfactory answers from the Company concerning the terms and conditions of the investment contemplated under this Agreement, and based thereon believes that such Member can make an informed investment decision, and (v) (if not a natural person) was not formed for the specific purpose of making an investment in the Company. 7.2.4.2 INVESTMENT INTENT. Each Member represents and warrants that such Member is acquiring such Member's Interest for investment for such Member's own account and not with a view to, or for resale in connection with, any distribution thereof, subject, nevertheless, to the condition that, except as otherwise provided herein, the disposition of the property of each Member shall at all times be within such Member's control. By execution of this Agreement, each Member represents and warrants that, except as otherwise permitted by this Agreement, such Member has no agreement, contract, or understanding with any person or entity to sell, transfer, or grant rights in any of such Member's Interest. 7.2.5 SECURITIES LAWS. EACH MEMBER REPRESENTS AND WARRANTS THAT SUCH MEMBER UNDERSTANDS THAT SUCH MEMBER'S INTEREST HAS NOT BEEN AND WILL NOT BE REGISTERED UNDER APPLICABLE U.S. FEDERAL OR STATE SECURITIES LAWS BY REASON OF CERTAIN EXEMPTIONS FROM THE REGISTRATION PROVISIONS THEREOF WHICH DEPEND UPON, AMONG OTHER THINGS, THE BONA FIDE NATURE OF SUCH MEMBER'S REPRESENTATIONS AND INVESTMENT INTENT AS EXPRESSED HEREIN, AND UNDERSTANDS THAT NO PUBLIC MARKET NOW EXISTS, OR MAY EVER EXIST, FOR THE INTERESTS. 7.2.6 STATEMENTS IN BUSINESS PLAN. EACH MEMBER REPRESENTS AND WARRANTS THAT SUCH MEMBER UNDERSTANDS THAT THE STATEMENTS CONTAINED IN THE BUSINESS PLAN THAT ARE NOT HISTORICAL STATEMENTS ARE FORWARD LOOKING STATEMENTS. THESE FORWARD LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, INCLUDING BUT NOT LIMITED TO THE RISK THAT ACTUAL RESULTS OF OPERATIONS MAY NOT MATCH THOSE PRESENTED THEREIN. 7.2.7 ACCREDITED INVESTOR. Each Initial Member represents and warrants that it is an institutional investor or accredited investor meeting the standards of sophistication normally expected of an investor in a transaction exempt from the registration provisions of the United States Securities Act of 1933, as amended, under Section 4(2) thereof or as defined in Regulation D promulgated thereunder, with respect to the purchase of the Interests. 7.2.8 NO COMMISSIONS. Each Member represents and warrants that no person has or will have, as a result of the transactions contemplated by this Agreement, any rights, interest or valid claim against or upon the Company or any other party hereto for any -36- 44 commission, fee or other compensation as a finder or broker because of any act or omission by such Member or any agent of such Member. Each Member agrees to indemnify and hold the Company and each other party hereto harmless against any and all costs and liabilities as a result of any such claim arising from any such act or omission by such Member. ARTICLE 8 RESTRICTIONS ON TRANSFER; PREEMPTIVE RIGHT; ADMISSION OF NEW MEMBERS; RIGHT OF FIRST REFUSAL 8.1 RESTRICTIONS ON TRANSFER. 8.1.1 NO TRANSFER WITHOUT CONSENT. Until the fifth anniversary of the Effective Date, except with the prior unanimous consent of the Preferred Members or as provided in Sections 3.4.1, 3.4.2.2, 8.1.2, or 10.3 through 10.7, inclusive, no Preferred Member may sell, convey, transfer, assign, mortgage, pledge, hypothecate or otherwise encumber in any way ("TRANSFER") all or any portion of such Member's Interest. In addition, the Transfer of Common Shares by a Participant in an Incentive Plan shall be subject to the restrictions provided in such Incentive Plan. As used in this Agreement, a Transfer shall not include a reincorporation or merger not entered into for the purpose of, and not having the effect of, changing or influencing the control of such Member. From and after the fifth anniversary of the Effective Date, no Member may Transfer all or any portion of such Member's Interest except (i) with the prior written consent of other Preferred Members holding not less than a majority of the Percentage Interests held by such other Preferred Members and (ii) in compliance with Section 8.5. This Section 8.1.1 shall not apply to a Transfer by a Member to its wholly-owned subsidiary, or to a Transfer pursuant to Section 14.1. 8.1.2 TRANSFER FOLLOWING APPROVAL OF NEW FOUNDRY. Notwithstanding the provisions of Section 8.1.1, a Preferred Member may Transfer such Member's Interest if (i) such Transfer follows the approval of the construction of a new foundry by the Company by the Board of Directors and the Preferred Members as provided in Section 6.4.2.8 and the Preferred Member proposing to Transfer its Interest did not consent to the construction of such new foundry by the Company, and (ii) the provisions of Section 8.5 have been complied with. A Transfer pursuant to this Section 8.1.2 shall be limited to a Preferred Member's Economic Interest if the Board of Directors of the Company in its reasonable discretion determines that a Transfer of the Preferred Member's Membership Interest will jeopardize the Company's treatment as a partnership for federal or state tax purposes. 8.1.3 NO TRANSFER TO COMPETITOR. Without the prior unanimous written consent of the Managing Members, no Transfer may be made by a Member of such Member's Interest to a Prohibited Person. 8.1.4 TRANSFER IN VIOLATION VOID. Any attempted Transfer not permitted hereunder shall be null and void ab initio. If, notwithstanding the foregoing, a Transfer not permitted hereunder is determined by a court of competent jurisdiction to be valid, any transferee taking pursuant thereto shall receive only the Economic Interest of the transferring -37- 45 Member. Any Member who Transfers or purports or attempts to Transfer an Interest in violation of Section 8.1 shall promptly pay over and be liable to the non-breaching Members, according to their respective Percentage Interests, for the total transfer price of such Interest, received and to be received, in addition to, and not in lieu of, any other right or remedy which the non-breaching Members may have, at law or in equity, or pursuant to Article 10, all subject to Article 21. 8.2 GENERAL TRANSFER PROVISIONS. Notwithstanding any other provisions of this Agreement: 8.2.1 NO VIOLATION OF LAW. No portion of, or interest in, an Interest may be the subject of a Transfer without assurances to the Company that are satisfactory to non-transferring Preferred Members that the proposed Transfer does not violate any law applicable to the Company. The nontransferring Preferred Members may, among other things, require (i) a written opinion addressed to the Company, in form and substance satisfactory to the non-transferring Preferred Members, of legal counsel acceptable to the non-transferring Preferred Members, to the effect that the proposed Transfer is exempt from registration under the Securities Act of 1933, as amended (or a "no action" letter from the staff of the Securities and Exchange Commission satisfactory to the non-transferring Preferred Members, to the effect that such Transfer is exempt from such registration); (ii) registration under applicable state securities laws or a written opinion addressed to the Company, in form and substance satisfactory to the non-transferring Preferred Members, of legal counsel acceptable to the Company, to the effect that such Transfer is exempt under applicable state securities laws; (iii) a written opinion addressed to the Company, in form and substance satisfactory to the non-transferring Preferred Members, of legal counsel acceptable to the non-transferring Preferred Members, to the effect that any such contemplated Transfer will not require the Company to register under the Investment Company Act of 1940, require that the Company or any Member register as an investment adviser under the Investment Advisers Act of 1940, or cause the Company to lose its partnership status for U.S. Federal income tax purposes; and (iv) representations and warranties concerning the facts and circumstances establishing the basis for the availability of exemptions from registration under the Securities Act of 1933, the Investment Company Act of 1940, the Investment Advisers Act of 1940, and other reasonable assurances relating to any other applicable laws, from the proposed substituted or proposed transferee Member. 8.2.2 TRANSFEREE TO BE BOUND BY THIS AGREEMENT. In addition to any other requirements contained in this Agreement pertaining to a Transfer of Interests, as a condition precedent to any Transfer, the prospective transferee shall, for the express benefit of the Company and each non-transferring Member, agree to be bound by all of the terms of this Agreement and to make such reasonable representations and warranties as the Preferred Members may request. 8.2.3 DELAY IN TRANSFER. Except as may occur upon conversion of the Company or upon transfers of Interest to a corporation pursuant to Section 14.1, if, in the determination of the non-transferring Preferred Members, a proposed Transfer would, alone or in conjunction with one or more other Transfers cause the Company to lose its partnership status or terminate its partnership existence for U.S. Federal income tax purposes, such Transfer (if -38- 46 otherwise permitted) shall be delayed in whole or in part until the earliest time as determined by the non-transferring Preferred Members that such Transfer may occur without causing the Company to lose its partnership status or to terminate for U.S. Federal income tax purposes. If at any time more than one Transfer is being delayed under this Section 8.2.3, such Transfers shall be made in the order in which the Company received written notice of the proposed Transfers under this Section. 8.2.4 LIABILITY OF TRANSFEROR. Except as may occur upon conversion of the Company or upon Transfers of Interest to a corporation pursuant to Section 14.1, any Member who voluntarily Transfers or attempts to Transfer any portion of or interest in its Interest, if such a Transfer causes or would cause the Company to lose its partnership status or terminate its partnership existence for U.S. Federal income tax purposes, shall be liable to the Company and promptly shall pay for any incremental costs, taxes, fines, penalties, damages or losses which may be due from the Company or the Members or suffered by the Company or the Members, including costs of enforcement of the Company's power to void or otherwise prohibit such Transfer or attempted Transfer. 8.2.5 NO RELEASE. No Transfer of all or any portion of, or interest in, an Interest, whether or not in compliance with this Article 8 and even if it results in the substitution of the transferee as a new Member, shall release the transferor from those liabilities to the Company which survive such Transfer. 8.3 PREEMPTIVE RIGHTS. 8.3.1 PREEMPTIVE RIGHT. Subject to Section 8.6, if the Company shall propose to issue, sell or distribute any Membership Interest or any option, warrant or right to acquire, or any security convertible into or exchangeable for any of the foregoing, each Preferred Member shall, subject to the provisions of Section 8.6, have a right of first refusal to participate in such issuance, sale or distribution on a pro rata basis in accordance with the respective Percentage Interest held by each Preferred Member so that following such issuance, sale or distribution each Preferred Member would acquire or have the right to acquire, if each Preferred Member had elected to acquire such Preferred Member's pro rata portion, the same Percentage Interest in the Company as each Preferred Member had by reasons of such Preferred Member's Percentage Interest prior to such issuance, sale or distribution. 8.3.2 PROCEDURE. The Company shall provide each Preferred Member with notice of any such proposed issuance which notice shall specify the nature of the proposed issuance, the consideration to be received therefor, the identity of the proposed purchaser, and the terms upon which such issuance shall be undertaken. Each Preferred Member shall have the right to elect to purchase from the Company a portion of the Interest referred to in the notice at the same price and on the same terms as specified in the notice for a period of sixty (60) days after the giving of the notice but not thereafter. A Preferred Member shall exercise this right by delivering in writing to the Company notice of such Preferred Member's intent to purchase such Preferred Member's pro rata share along with the purchase price therefore. If any Preferred Member shall elect to purchase none, or less than all of the offered Interest, the other Preferred -39- 47 Members shall have the right to purchase the pro rata share of the Preferred Member who has declined to purchase the offered Interest, according to each purchasing Preferred Member's pro rata share of such Interest, for a successive period of thirty (30) days thereafter. All or any portion of the Interest not so purchased may be issued as specified in the notice within a period of forty-five (45) days after the expiration of such ninety (90) day period specified above. 8.3.3 LIMITATION. Notwithstanding the foregoing, the provisions of this Section 8.3 shall not apply to any of the following: (i) any issuance, sale or distribution in connection with the conversion of each Member's Interest in the Company to an interest in the Delaware Corporation as provided for in Article 14, (ii) the transactions contemplated by Sections 3.4.1, 3.4.2, 3.6.4 or 10.5, or (iii) the sale, issuance or grant of any Shares, options, warrants or other rights to Officers, Directors or employees of the Company pursuant to any Incentive Plan. 8.4 ADMISSION OF NEW MEMBERS. A new Member may be admitted to the Company only if Section 8.3 has been complied with and upon the Approval of Members holding not less than 71% in Percentage Interest (without consideration of the Percentage Interest of any Defaulting Member, Selling Member, Terminated Member or Non-Paying Member). Prior to any new Member acquiring the Interest of a Managing Member, the Managing Member proposing to Transfer its Interest shall disclose to the other Preferred Members, whether it is proposed that the new Member shall, following the Transfer, designate such Managing Member's representative on the Board of Directors, and hold the decision making authority of the Managing Member for decisions which pursuant to this Agreement require the consent of the Managing Members. Any Transfer approved pursuant to the first sentence of this Section shall then be an approval of the Transfer of the rights specified in the disclosure notice. 8.4.1 CAPITAL CONTRIBUTION. The type and amount of Capital Contribution which must be made by a new Member shall be determined by the Approval of Members holding not less than 71% in Percentage Interest (without consideration of the Percentage Interest of any Defaulting Member, Selling Member, Terminated Member or Non-Paying Member). 8.4.2 TIME OF ADMISSION. A new Member shall not be deemed admitted into the Company until the Capital Contribution required of such Person shall have been made and such Person has become a party to this Agreement. 8.4.3 ADJUSTMENT OF INTERESTS. Upon admission of a new Member, the Percentage Interests of all previously existing Members shall be adjusted to reflect the addition of such new Member and such new Member's Capital Contribution. 8.5 RIGHT OF FIRST REFUSAL. 8.5.1 If any Preferred Member ("SELLING MEMBER") intends to Transfer its Interest or any part thereof (the "OFFERED INTEREST") (except to a wholly-owned subsidiary), it shall notify the Company and the other Preferred Members of its intention to do so ("OFFERING -40- 48 NOTICE"). The Offering Notice shall specify the nature of the Transfer, the consideration to be received therefor, the identity of the proposed purchaser (or lender, as the case may be), and the terms upon which such Member intends to undertake such Transfer. Within thirty (30) days after receipt of the Offering Notice, the Preferred Members other than the Selling Member shall have the right, but not the obligation, subject to Section 8.6, to elect to purchase from the Selling Member a portion of the Offered Interest referred to in the Offering Notice at the same price and on the same terms as specified in the Offering Notice for a period of thirty (30) days after the giving of the Offering Notice (or make the loan, if the same involves an encumbrance, hypothecation or mortgage, upon the same terms on which said loan was to be made therefor) by delivering in writing to the Company an offer to purchase (or loan) a portion of the Offered Interest of the Selling Member. Each Preferred Member so electing to purchase shall be entitled to purchase a portion of such Offered Interest in the same proportion that such Preferred Member's Percentage Interest bears to the aggregate of the Percentage Interests of all of the Preferred Members electing to purchase the Offered Interest. In the event any Preferred Member elects to purchase less than all of such Preferred Member's pro rata share of such Offered Interest ("SHORTFALL"), subject to Section 8.6, the other Preferred Members may elect to purchase their pro rata share of the Shortfall. Within sixty (60) days after the election notice of the Preferred Members who so elect, the purchase shall be consummated on the terms and conditions set forth in the Offering Notice of the Selling Member (or if the same involves a mortgage, encumbrance or other hypothecation, the loan shall be consummated upon the terms and conditions of the loan set forth in the Offering Notice). 8.5.2 If none of the other Preferred Members elect to purchase the Offered Interest (or elect to make the loan specified), or the election is made for less than all of the Offered Interest, then the Selling Member, subject to Section 8.6, within thirty (30) days after the expiration of said sixty (60) day period, may undertake and complete the Transfer to any Person the identity of which was disclosed in the Offering Notice for that portion of the Offered Interest not undertaken to be purchased by the other Preferred Members provided, however, that the proposed transferee has been approved by the other Preferred Members as specified in Sections 8.1.1, 8.1.3, and 8.4, as such Sections may be applicable to the Transfer, and the provisions of Section 8.6 have been complied with. The Transfer shall not be undertaken at a lower price or upon more favorable terms than specified in the Offering Notice. If the Selling Member does not then consummate the original proposed Transfer within ninety (90) days after the date of the Offering Notice, or within the time scheduled for closing by the purchasing person, firm or corporation, whichever is later, then all restrictions of this Section shall apply as though no Offering Notice had been given. 8.6 SPECIAL TRANSFER PROVISION. Any Managing-Member who elects pursuant to Sections 3.4, 8.1, 8.5 or 10.3 of this Agreement to acquire an additional Interest in the Company (which Interest was previously held by or was to be held by a Managing Member) shall at the time such Member's Percentage Interest is increased also have an increase in such Member's rights and obligations to purchase the output of the Foundry pursuant to the Purchase Agreement or Future Purchase Agreement corresponding to the additional Percentage Interest being acquired. Any New Buyer which acquires pursuant to Section 3.4, 8.1, 8.5 or 10.3 hereof an Interest that was previously held by a Managing Member or other Person holding rights and -41- 49 obligations to purchase the output of the Foundry pursuant to the Purchase Agreement or Future Purchase Agreement shall at the time of such acquisition acquire rights and obligations to purchase the output of the Foundry corresponding to the Percentage Interest being acquired. If at any time (a) a Member's or other Person's Percentage Interest changes as a result of (i) a Transfer in accordance herewith, (ii) a failure to pay a Second Part Capital Contribution, Third Part Capital Contribution, or Additional Capital Contribution, (iii) a failure to guarantee a loan to the Company in accordance herewith, (iv) an Event of Default, or (v) any other provision hereunder and (b) in the reasonable opinion of the Board of Directors, such change, in conjunction with the provisions herein and in the Purchase Agreement or Future Purchase Agreement for adjusting the Managing Members' purchase rights or obligations under such agreements, produces an inequitable or unintended result, then the Board of Directors, with the concurrence of all Managing Members that are parties to the Purchase Agreement or Future Purchase Agreement, may adjust the purchase rights and obligations of such Members in such manner as the Board of Directors determines in good faith is equitable under the circumstances. 8.7 SPECIAL RIGHT OF MANAGING MEMBERS OTHER THAN TSMC TO PURCHASE. This Section shall apply if pursuant to Sections 3.4, 8.3, 8.5, or 10.3 of this Agreement, TSMC provides notice to the Company of its intention to acquire an additional Interest in the Company which, after the Percentage Interests of all Members are adjusted in connection with such transaction, would result in TSMC having a Percentage Interest which, when combined with the Percentage Interest of the Third Party Investors', would equal or exceed a 71% Percentage Interest of all Preferred Members. Prior to the completion of any such transaction, the Board of Directors shall provide written notice to each Managing Member of this provision and the option of such Managing Members (other than TSMC and excluding any Managing Member whose Interest is being offered pursuant to Sections 3.4, 8.5 or 10.3 of this Agreement (the "SUBJECT INTEREST")) to purchase, in addition to their pro rata portion of the Subject Interest, a pro rata portion of the Excess Subject Interest (including the right to purchase a pro rata portion of any shortfall resulting from another Member's election to purchase less than its entire pro rata allocation). As used in this Section 8.7, the term "EXCESS SUBJECT INTEREST" means the portion of the Subject Interest which TSMC has elected to purchase which would cause TSMC and the Third Party Investors to jointly hold a Percentage Interest equal to or exceeding 71% of all Preferred Members. Each such Managing Member shall have the right to purchase its pro rata share of the Excess Subject Interest by giving notice within thirty (30) days of the notice received from the Board of Directors pursuant to this Section of such Member's intent to acquire its pro rata share of the Excess Subject Interest. If such Managing Members do not elect to purchase all of the Excess Subject Interest, TSMC may proceed with its acquisition of any portion of the Excess Subject Interest not so acquired. ARTICLE 9 BOOKS, RECORDS, REPORTS AND BANK ACCOUNTS 9.1 MAINTENANCE OF BOOKS AND RECORDS. The Company shall cause books and records of the Company to be maintained in accordance with GAAP (except for the Capital Accounts which shall be maintained in accordance with the Regulations as provided in Section 3.5), and shall give reports to the Members in accordance with prudent business practices -42- 50 and the Act. The annual accounting period of the Company shall be the Fiscal Year. The books and records of the Company shall be audited annually by a certified public accounting firm nationally recognized in the United States, selected by the Board of Directors and approved by the Members as provided for in Section 6.4.2.7. The Company shall promptly upon receipt make available to the Managing Members all preliminary drafts of financial statements that it receives from the Company's certified public accountants. Not less than five (5) days before the financial statements of the Company become final, the Company shall provide each of the Managing Members with a copy of the draft of the financial statements of the Company and during this period, shall provide each of the Managing Members with the opportunity to comment on such financial statements. The initial firm of certified public accountants is Arthur Andersen & Co. LLP. There shall be kept at the principal business office of the Company specified in Section 2.4 the following Company documents: 9.1.1 A current list of the full name and last known business or residence address of each Member and each holder of an Economic Interest, set forth in alphabetical order, together with the amount of cash and a description and statement of the agreed value of any other property or services that were Capital Contributions of each Member and that each Member has agreed to contribute to the Company in the future, the date on which each Member became a Member, and the share in Net Profit and Net Loss of each Member and holder of an Economic Interest; 9.1.2 A copy of the Certificate of Formation and any amendments thereto, together with any powers of attorney pursuant to which the Certificate of Formation and any amendments thereto were executed; 9.1.3 Copies of the Company's U.S. Federal, state, local and other income tax or information returns and reports, if any, for the six most recent taxable years; 9.1.4 A signed counterpart of this Agreement and any amendments hereto, together with any powers of attorney pursuant to which this Agreement and any amendments hereto were executed; 9.1.5 Copies of the financial statements of the Company, if any, for the six (6) most recent Fiscal Years; 9.1.6 The Company's books and records as they relate to internal affairs of the Company for at least the current and past four (4) Fiscal Years; 9.1.7 Any other information necessary to provide true and full information regarding the status of the business and financial condition of the Company; and 9.1.8 Other information regarding the affairs of the Company as is reasonable or prudent. -43- 51 9.2 INSPECTION RIGHTS. Each Member and each holder of an Economic Interest has the right upon reasonable request, for purposes reasonably related to the interest of that Person as a Member or holder of an Economic Interest, to inspect and copy during normal business hours any of the books and records required to be maintained in accordance with Section 9.1. Such right may be exercised by such Person or by that Person's agent or attorney. 9.3 RIGHTS TO RECEIVE COPIES OF DOCUMENTS. Upon the request of a Member or holder of an Economic Interest, for purposes reasonably related to the interest of that Person as a Member or holder of an Economic Interest, the Member who has custody of the following documents shall promptly deliver to the Member or holder of an Economic Interest, at the expense of the Company, a copy of this Agreement and a copy of the documents listed in Sections 9.1.1 and 9.1.3 of this Agreement. 9.4 BANK ACCOUNTS. The bank accounts of the Company shall be maintained in such banking institutions as the Board of Directors shall determine. 9.5 TAX MATTERS HANDLED BY TAX MATTERS PARTNER. 9.5.1 TSMC is hereby designated the "TAX MATTERS PARTNER" (as defined in Code Section 6231), and is authorized and required to represent the Company (at the Company's expense) in connection with all examinations of the Company's affairs by tax authorities, including administrative and judicial proceedings, and to expend Company funds for professional services and costs associated therewith. The Tax Matters Partner will control all decisions with respect to such proceedings, but will keep the Board of Directors and other Managing Members reasonably informed with respect to such proceedings and will provide the other Managing Members the opportunity to offer comments and suggestions with respect to such proceedings to the extent practicable. Each Member agrees to cooperate with the Tax Matters Partner and to do or refrain from doing any or all things reasonably requested by the Tax Matters Partner with respect to the conduct of such proceedings. The Tax Matters Partner shall arrange for the preparation and timely filing of all returns required to be filed by the Company. Any Member receiving advice that the Internal Revenue Service or any state or foreign revenue service intends to examine any income tax return of the Company shall promptly notify the Tax Matters Partner. 9.5.2 The Tax Matters Partner shall exert commercially reasonable efforts to adopt positions and make elections for tax purposes which (i) minimize the sum of the current taxable income and gain, and (ii) maximize the sum of the current taxable losses, deductions, and credits, to the Managing Members as a group. In addition, notwithstanding any other provision of this Agreement, the Tax Matters Partner shall cause all Company tax returns and other related tax filings to be prepared in such manner as to reflect that any income, gain, loss, or deduction recognized by the Company as the result of an adjustment, reallocation or recharacterization by any tax authority of the tax treatment of any transaction between the Company and a Member or an Affiliate of a Member as originally reported on any tax return filed for the Company shall be specially allocated to such Member for the taxable year of the adjustment, reallocation or recharacterization and for each taxable year thereafter so that the tax consequences to the other -44- 52 Members shall, to the extent possible, have the same cumulative aggregate tax consequences as if no such adjustment, reallocation or recharacterization had occurred. No such adjustment shall be reflected in the Capital Accounts of the Members. Not less than thirty (30) days before actual filing, the Tax Matters Partner shall provide to all of the other Managing Members a copy of each of the final returns and other administrative or judicial filings of the Company relating to income taxation, and during this period, shall provide the other Managing Members with the opportunity to comment on such returns and filings. The Members agree that, except as otherwise approved in advance by the Board of Directors, no Member shall take any position in any such administrative proceeding inconsistent with the tax returns filed by the Company, provided such tax returns are prepared in a manner consistent with this Agreement. Nothing in this Agreement shall be construed to provide the Tax Matters Partner with rights, powers or privileges relating to tax administrative proceedings in excess of the minimum rights, powers and privileges provided to the Tax Matters Partner by Code Sections 6221, et. seq., and the Treasury Regulations thereunder. 9.6 FEDERAL INCOME TAX ELECTIONS MADE BY TAX MATTERS PARTNER. Except as otherwise provided herein, the Tax Matters Partner on behalf of the Company may make all elections for U.S. Federal, state and local income tax purposes, including but not limited to, the following: 9.6.1 USE OF ACCELERATED DEPRECIATION METHODS. To the extent permitted by applicable law and regulations, the Company may elect to use an accelerated depreciation method on any depreciable unit of the assets of the Company. 9.6.2 ADJUSTMENT OF BASIS OF ASSETS. In case of a transfer of all or part of the Interest of any Member, the Company may elect, pursuant to Sections 734, 743, and 754 of the Code, to adjust the basis of the assets of the Company. 9.7 OBLIGATIONS OF MEMBERS TO REPORT ALLOCATIONS. The Members are aware of the income tax consequences of the allocations made by this Agreement and hereby agree to be bound by the provisions of this Agreement in reporting their shares of the Company income and loss for income tax purposes in a manner consistent with the tax returns filed by the Company, provided such tax returns are prepared in a manner consistent with this Agreement. ARTICLE 10 EVENT OF DEFAULT; TERMINATION OF MEMBERSHIP 10.1 EVENT OF DEFAULT. The occurrence of any one or more of the following events shall be a breach and a default ("EVENT OF DEFAULT") hereunder: 10.1.1 A Member shall fail to perform a material obligation of this Agreement or of any of the Ancillary Agreements and, (except for breaches contemplated in Sections 10.1.5 or 10.1.6 of this Agreement, which provide for no opportunity to cure, and except for breaches for which another cure period is specified herein), does not cure or remedy the default within sixty -45- 53 (60) days thereafter. Notwithstanding the foregoing, the breach or failure to perform any of the following Sections shall not be, or be deemed to be, an Event of Default: Sections 3.4.1, 3.4.2, and 3.6.4 (each of which shall be treated as provided in such Sections). 10.1.2 Any representation, warranty or statement made by a Member under or pursuant to this Agreement or any Ancillary Agreement or under any affidavit, certificate or other instrument executed in connection with any of the foregoing, shall be false or misleading in any material respect as of the Effective Date or shall become so at any time prior to the Dissolution Date, and such Member does not cure the same within thirty (30) days written notice thereof. 10.1.3 A Member shall (i) be adjudicated as bankrupt or insolvent; (ii) make a general assignment for the benefit of its creditors; (iii) file a petition, answer or consent seeking, or have entered against it (or fail reasonably to contest the material allegations of any petition for) an order for relief (or any similar remedy) under any provision of Title 11 of the United States Code or any other U.S. Federal or state law relating to insolvency, bankruptcy, rehabilitation, liquidation or reorganization, or consent to the institution of any proceedings thereunder; (iv) convene a general meeting of its creditors, or any class thereof, for the purpose of effecting a general moratorium upon or general extension or composition of its debts; (v) fail to pay such Member's debts as they mature; (vi) admit in writing that such Member is generally not able to pay its debts as they mature; or (vii) apply for or consent to the appointment of a receiver, trustee, custodian, liquidator or other similar official of all or a substantial portion of such Member's assets. 10.1.4 Any one or more of the following occurs: (i) a petition is filed or any case or proceeding described in Section 10.1.3 above is commenced against any Member or against the assets thereof, unless such petition and the case or proceeding initiated thereby is dismissed within sixty (60) days from the date of the filing; (ii) an answer is filed by any Member admitting the allegations of any such petition; or (iii) a court of competent jurisdiction enters an order, judgment or decree appointing, without the consent of any Member, a custodian, trustee, agent or receiver of it, or for all or a substantial part of its property, or authorizing the taking possession by a custodian, trustee, agent or receiver of it, or of all or a substantial part of its property unless such appointment is vacated or dismissed or such possession is terminated within sixty (60) days from the date of such appointment or commencement of such possession, but not later than 5 days before the proposed sale of any assets of such Member by such custodian, trustee, agent or receiver. 10.1.5 A Member files a certificate of dissolution or otherwise dissolves, terminates or liquidates, or is merged with or is consolidated into any other corporation, limited liability company, partnership, or other entity other than an Affiliate of such Member, except for a merger or consolidation not entered into for the purpose of and not having the effect of changing or influencing the control of the Member. 10.1.6 A Member becomes a Prohibited Person or an Affiliate of a Prohibited Person. -46- 54 10.2 TERMINATION OF MEMBER. If an Event of Default occurs and is not cured within the applicable time period (if any) specified in Section 10.1, the defaulting Member shall be terminated as a Member, and all rights and privileges of such former Member under this Agreement shall be adjusted and disposed of as follows: 10.2.1 If the Event of Default is as provided or described in any of Section 10.1.1, Section 10.1.2 or Section 10.1.5, the Member shall be terminated as a Member upon the vote of the non-defaulting Preferred Members with a majority of the Preferred Shares owned by non-defaulting Members. 10.2.2 For all other Events of Default, termination of Membership shall occur immediately following the elapse of the specified cure period, if any. 10.2.3 Notwithstanding any other provision of this Agreement and subject to Section 11.2.3, the termination of a Member ("TERMINATED MEMBER") as contemplated in this Section 10.2 shall not affect the rights of any other Member under this Agreement. The Company shall promptly notify a Terminated Member of such termination, but the failure to give such notice shall not affect such termination or create any rights in the Terminated Member. 10.3 PURCHASE RIGHT. Unless provided otherwise in this Agreement, upon termination of a Terminated Member as contemplated in Section 10.2, the remaining Preferred Members (a "REMAINING MEMBER") shall have the right to purchase and the Terminated Member shall have the obligation to sell, the Terminated Member's Interest as provided in Sections 10.3 through 10.7, inclusive. The purchase price for such Interest shall be an amount equal to 50% of the lesser of (i) the Terminated Member's Percentage Interest in the book value of the Company as of such termination date, or (ii) the fair market value of the Terminated Member's Interest as of such termination date as determined in the reasonable discretion of the Board of Directors, not including any Director appointed by the Terminated Member. Such reduction in value shall constitute partial compensation for damages suffered by the Remaining Members as a result of the act, omission or condition which resulted in the termination of the Terminated Member, and subject to Article 21, shall be in addition to, and not in lieu of any other right or remedy which the Remaining Members may have, at law or in equity, or pursuant to this Agreement. The Directors shall give notice to all Remaining Members of such purchase price. 10.4 NOTICE OF INTENT TO PURCHASE. Within thirty (30) days after the Directors have determined and notified the Remaining Members as to the purchase price of the Terminated Member's Interest determined in accordance with Section 10.3, each Remaining Member shall have the right, but not the obligation, to elect to purchase a portion of the Terminated Member's Interest. Any Remaining Member so electing shall notify the Directors in writing within thirty (30) days after the notice from the Directors of such Remaining Member's desire to purchase a portion of the Terminated Member's Interest. The failure of any Remaining Member to submit such notice within the applicable period shall constitute an election on the part of the Remaining Member not to purchase any of the Terminated Member's Interest. Each -47- 55 Remaining Member so electing to purchase shall be entitled to purchase a portion of the Terminated Member's Interest in the same proportion that the Percentage Interest of the Remaining Member bears to the aggregate of the Percentage Interest of all of the Remaining Members electing to purchase the Terminated Member's Interest. 10.5 ELECTION TO PURCHASE LESS THAN ALL OF THE TERMINATED MEMBER'S INTEREST. If any Remaining Member elects to purchase none or less than all of such Remaining Member's pro rata share of the Terminated Member's Interest ("SHORTFALL AMOUNT"), then subject to the provisions of Section 8.6, the other Remaining Members may elect to purchase the Shortfall Amount in proportion to their respective Percentage Interests. Each Remaining Member who purchases part of the Terminated Member's Interest shall succeed to a pro rata share of the Terminated Member's Capital Account balance. If the Remaining Members do not purchase the entire Interest of the Terminated Member, then subject to the provisions of Section 8.6, with respect to all or any remaining share of the Terminated Member's Interest, one or more new Members, if approved pursuant to Section 8.4, may be admitted as a Member or Members and purchase the Terminated Member's remaining Interest by paying for the Interest in cash. If the entire Interest of the terminated Member is not purchased, the Terminated Member shall have only an Economic Interest, and without limiting the generality of the foregoing, shall not be a Managing Member, shall not be entitled to designate a Director hereunder and any current Director or Directors appointed by such Terminated Member shall be deemed to be removed and the number of Directors on the Board of Directors shall be reduced accordingly. In such event as partial compensation for damages suffered by the Company and the Remaining Members, (i) the Terminated Member's remaining Interest shall be reduced by fifty percent (50%) and the Remaining Members' Interests shall be increased pro rata accordingly, (ii) the Terminated Member's Capital Account Balance following the purchase of any Remaining Member, if any, shall be reduced by 50%, and the difference shall be added to the Capital Account Balances of the Remaining Members, pro rata according to their Interests, and (iii) solely for purposes of determining the Managing Members' and a Terminated Member's rights and obligations to purchase the output of the Foundry under the Purchase Agreement or Future Purchase Agreement (which rights and obligations shall be a function, to be specified in each of those agreements, of the Managing Members' and Terminated Member's Percentage Interests), effect shall not be given to any increase or decrease in a Managing Member's or Terminated Member's Percentage Interest attributable to the operation of clause (i). 10.6 PAYMENT OF PURCHASE PRICE. The purchase price shall be paid by the electing Remaining Members by either of the following methods, each of which may be selected separately by the electing Remaining Members in their respective sole discretion: 10.6.1 The Remaining Members shall at the consummation of the purchase of the Terminated Member's Interest ("CLOSING") pay in cash the total purchase price for the Terminated Member's Interest; or 10.6.2 The Remaining Members shall pay at the Closing one-fifth (1/5) of the purchase price in cash and the balance of the purchase price shall be paid in four equal annual principal installments, plus accrued interest, and be payable each year on the anniversary date of -48- 56 the Closing. The unpaid principal balance shall accrue interest at the current applicable U.S. Federal rate as provided in the Code for the month in which the initial payment is made, but the Remaining Members shall have the right to prepay in full or in part at any time without penalty. The obligation of each purchasing Remaining Member to pay its portion of the balance due shall be evidenced by a separate promissory note executed by the respective Remaining Member. Each such promissory note shall be in an original principal amount equal to the portion owed by the respective purchasing Remaining Member. The promissory note executed by each purchasing Remaining Member shall be secured by a pledge of that portion of the Terminated Member's Interest purchased by such Remaining Member. 10.7 CLOSING OF PURCHASE OF TERMINATED MEMBER'S INTEREST. The Closing for the sale of a Terminated Member's Interest pursuant to this Article 10 shall be held at 10:00 a.m. at the principal office of Company no later than sixty (60) days after the determination of the purchase price. At the Closing, the Terminated Member or such Terminated Member's legal representative shall deliver to the electing Remaining Members an instrument of transfer (containing warranties of title and no encumbrances) conveying the Terminated Member's Interest free and clear of all liens, charges and encumbrances whatsoever, except as permitted by the purchaser thereof. The Terminated Member or such Terminated Member's legal representative, the Company and the Remaining Members shall do all things and execute and deliver all documents as may be necessary or convenient to consummate such sale and purchase in accordance with the terms and provisions of this Agreement. Without limiting the generality of the foregoing, each Member hereby appoints each Remaining Member as its attorney-in-fact and agent, with full power and authority to take all actions and execute and deliver all agreements, deeds, leases, releases, assignments, bills of sale, security instruments and any other document which, in the sole judgment of such Remaining Member, is necessary or convenient to consummate such sale and purchase. ARTICLE 11 TERMINATION AND DISSOLUTION 11.1 TERMINATION. This Agreement shall terminate on the first to occur of (i) the Dissolution Date or (ii) the unanimous written consent of the Preferred Members or (iii) upon consummation of the Company's merger or consolidation as contemplated in Article 14. 11.2 DISSOLUTION. The Company shall be dissolved upon the first to occur of the following events: 11.2.1 The Approval of Members holding not less than 87% in Percentage Interest if the dissolution does not occur contemporaneously with an IPO of the Delaware Corporation; 11.2.2 The action of the Board of Directors if such action occurs contemporaneously with an IPO of the Delaware Corporation; -49- 57 11.2.3 The death, retirement, insanity, incapacity, resignation, expulsion, bankruptcy or dissolution of a Managing Member, or the occurrence of any other event which terminates a Managing Member's continued membership in the Company, unless the business of the Company is continued with the written consent of other Members holding a Majority in Interest of such other Members within ninety (90) days following the occurrence of such event; 11.2.4 The appointment of a receiver, trustee or liquidator of the Project which appointment is not vacated within thirty (30) days; or the attachment, execution or other judicial seizure of the Project where such seizure is not discharged within ten (10) days thereafter; or 11.2.5 The entry of a decree of judicial dissolution under Section 18-802 of the Act; or 11.2.6 Following an act of Governmental Intervention, if written request shall be made by one Managing Member to the other Managing Members within sixty (60) days from said Governmental Intervention and the Managing Members hereto shall have entered into good faith negotiations with the objective of restructuring the relationship among the Members in a manner such that the adverse effect of said alteration or modification of this Agreement will be minimized and following which, the Managing Members cannot unanimously reach a reasonably acceptable modification to this Agreement, within six (6) months from the date of dispatch of said written request, or within such longer period of time as mutually agreed upon by the unanimous consent of the Managing Members. 11.2.7 On the thirtieth (30th) anniversary of the date of the filing of the Certificate of Formation of the Company. 11.3 WINDING UP. Upon the dissolution of the Company, TSMC (or if TSMC is no longer a Member, a liquidating trustee appointed by a Majority in Interest of the remaining Members) shall wind up the affairs of the Company (such Person or Persons herein collectively called the "LIQUIDATING PERSON"). Upon dissolution of the Company and until the filing of the certificates of cancellation pursuant to Section 11.6, the Liquidating Person may, in the name of, and on behalf of, the Company, prosecute and defend suits, whether civil, criminal or administrative, gradually settle and close the Company's business, dispose of and make reasonable provision for the Company's liabilities, and distribute to the members any remaining assets of the Company, all without affecting the liability of the Members and without imposing liability on a liquidating trustee. The Liquidating Person shall be entitled to reimbursement for out-of-pocket expenses incurred and reasonable compensation for services rendered in connection with the winding up and liquidation of the Company, as agreed by the Members. Such reimbursement shall be paid as an expense of the Company after all debts to third parties have been repaid or adequately provided for but before any repayment of loans or advances by Members. 11.4 DISTRIBUTION OF ASSETS. The Members shall continue to divide Net Profit and Net Loss and Cash Available For Distribution during the winding-up period in the -50- 58 same manner and the same priorities as provided for in Articles 4 and 5 hereof. The proceeds from the liquidation of Property shall be applied in the following order: 11.4.1 To the payment of creditors, including Members who are creditors, in satisfaction of liabilities of the Company (whether by payment of the making or reasonable provision for payment thereof) other than liabilities for which reasonable provision for payment has been made and liabilities to Members for distributions pursuant to Article 4; 11.4.2 To set up reasonable reserves for contingent or unforeseen liabilities of the Company, to be maintained in a regular trust fund account; 11.4.3 To repay pro rata all loans or advances made by the Members to the Company, but in the event the amount available for such repayment shall be insufficient, then pro rata on account thereof; 11.4.4 The balance if any, to the Members in accordance with the provisions of Section 4.3 hereof; except, if the Company shall be dissolved prior to the expiration of the period beginning on the Effective Date and ending five years from the date of Commencement of Production, as defined in the Purchase Agreement (the "SUBORDINATION PERIOD") and if such dissolution is as a result of an event of Force Majeure or a major economic or business event or condition such that the economic or business assumptions underlying the Business Plan have changed to the extent that it is economically impracticable to substantially implement the Business Plan (including, but not limited to, major claims or litigation against the Company, failure to operate the Foundry on an economically viable basis, a change in technology rendering the business of the Company obsolete, or a major economic recession), and the Board has determined to dissolve the Company with the approval of the Members as provided in Section 11.2.1, then the Manufacturing Agreement, the Technology License and Assistance Agreement, and the Advanced Process Agreement (collectively and together with the other property listed as contributed by TSMC on Exhibit A, the "TSMC CONTRIBUTED PROPERTY") shall each be terminated and the balance of the proceeds from the liquidation of Property shall be paid or distributed to the Members as follows: (i) first, to the Members in reverse chronological order (last in, first out), until the entire Cash Contribution of each is returned to each Member, without any interest, and (ii) the rest, residue and remainder, if any, to the Members in accordance with each Member's Percentage Interest. For purposes of the preceding sentence, TSMC shall be treated as if it had contributed pursuant to the First Part Capital Contribution described in Section 3.1.1 hereof, an amount of cash ("PROPERTY CASH"), in addition to the cash contribution of TSMC described in such Section 3.1.1, equal to the product of (x) the initial agreed value of the TSMC Contributed Property as shown on Exhibit A and (y) the Permitted Percentage. For purposes of this Section 11.4.4, the term "PERMITTED PERCENTAGE" shall be and mean zero percent (0%) on and before the Commencement of Production, increasing daily thereafter at an annual rate of twenty percent (20%) until the Permitted Percentage is one hundred percent (100%) on the last day of the Subordination Period. -51- 59 Where the distribution pursuant to this Section 11.4 consists both of cash (or cash equivalents) and non-cash property, the cash (or cash equivalents) shall first be distributed, in a descending order, to fully satisfy each category starting with the most preferred category above. To the maximum extent practicable consistent with the foregoing, non-cash property shall be returned to the Member which has contributed it. 11.5 TIME FOR WINDING UP. A reasonable time shall be allowed for the orderly liquidation of assets of the Company and the discharge or other provision of liabilities to creditors so as to enable the Liquidating Person to minimize any losses attendant upon a liquidation. 11.6 FINAL ACCOUNTING; CERTIFICATES OF CANCELLATION. Each of the Members shall be furnished with a statement, prepared by the Company's independent certified public accountant, setting forth the assets and liabilities of the Company as of the date of the complete liquidation. Upon the compliance by the Liquidating Person with the foregoing distribution plan, the Members shall cease to be such, and the Liquidating Person shall execute and cause to be filed any and all documents necessary with respect to the termination and cancellation of the Company, including, without limitation, a certificate of cancellation under Section 18-203 of the Act. ARTICLE 12 INCENTIVE PLANS 12.1 AUTHORIZATION OF INCENTIVE PLANS. The Company shall have a Senior Executive Incentive Plan and an Employee Incentive Plan (each an "INCENTIVE PLAN" and, collectively, the "INCENTIVE PLANS") in the forms attached as Exhibits H and I. The Incentive Plans shall be administered by the Board in accordance with their terms. In no event shall the aggregate rights awarded under the Incentive Plans exceed 13.5 million Common Shares. 12.2 ADMISSION OF PLAN PARTICIPANTS. Upon exercise of an option or payment of an award for Common Shares, payment of any applicable purchase price in connection with such option or award, and execution of a counterpart of this Agreement, a participant shall be admitted as a Member. Such participant shall have an initial Capital Account equal to the purchase price paid for such Common Shares, plus the amount of any income recognized on such acquisition (if any); and such Capital Account shall thereafter be determined in accordance with Section 3.5. ARTICLE 13 TSMC LAND OPTION; NEW VENTURE RIGHTS 13.1 LAND OPTION. By execution of this Agreement, the Members agree and acknowledge that as part of the Initial Capital Contribution of TSMC, and as a convenience and accommodation to the Company, TSMC has arranged for option agreements covering the Real Property to be assigned to the Company, which option agreements cover real property in excess -52- 60 of that amount necessary to construct the Foundry. On the Effective Date, the Company with the approval of the Members granted to TSMC the TSMC Land Option, whereby TSMC has the option to purchase the Land from the Company, for the Purchase Price (as defined in the TSMC Land Option). 13.2 NEW FAB VENTURE RIGHT OF FIRST REFUSAL. On the Effective Date and until the tenth (10th) anniversary of the Effective Date, TSMC has granted and hereby grants a right of first refusal to each of the Managing Members to participate in any venture controlled by TSMC or its Affiliates to construct another foundry on the Land which is the subject of the TSMC Land Option, or anywhere else in North America in proportion to their respective Percentage Interests in the Company. TSMC agrees to meet and confer with the Managing Members prior to exercise of TSMC's rights under the TSMC Land Option, in order to discuss the participation of the Managing Members in any venture related thereto. 13.3 FURTHER ASSURANCES. The Members, from time to time and as requested by a Managing Member, shall, and shall cause the Company to, execute and deliver such additional documents, give such further assurances and take any additional actions as may be necessary or appropriate to effectuate, carry out and perform all of the terms, provisions and conditions of this Article 13. ARTICLE 14 CHANGE OR CONVERSION TO A GENERAL CORPORATION 14.1 MERGER OR CONSOLIDATION TO A GENERAL CORPORATION. Subject to the approval required by Section 6.4.2.3, each Member by execution and delivery of this Agreement agrees to vote, and hereby votes, in favor of the reincorporation, merger or consolidation of the Company, pursuant to Section 18-209 of the Act, or otherwise, to change or convert the Company into a Delaware general corporation or a parent or a subsidiary of a Delaware corporation, at such time, in such manner and on such basis as the Board of Directors shall determine is in the best interests of the Company. Such change or conversion to a Delaware general corporation may be accomplished by a direct merger into a corporation, by one of the methods illustrated in Exhibit E, or by any other method the Board of Directors determines is desirable, provided, however, that each Member shall have the right to participate in proportion to its Percentage Interest in whichever method is selected by the Board of Directors. As used herein "DELAWARE CORPORATION" shall mean any corporation which through one transaction or a series of transactions involves the conversion or exchange of the Interests of those Members who choose to participate in such transaction into an interest in or the stock of such corporation in proportion to a Member's Interest in the Company as adjusted to reflect the participation of the other Members. Additionally, by execution and delivery of this Agreement, each Member agrees to take any and all actions necessary to consummate such a change or conversion, including, but not limited to, the execution and delivery of an Agreement of Merger or Consolidation and filing of a Certificate of Merger or Consolidation with the Office of the Secretary of State, in such form and on such basis as the Board of Directors may determine. -53- 61 14.2 REGISTRATION RIGHTS. In the event the Delaware Corporation undertakes an IPO, the Preferred Members shall have the registration rights provided for in the Registration Rights Agreement. At the time the Member's Interests are converted into or exchanged for an interest or shares in the Delaware Corporation, each of the Members shall use its best efforts to cause the Delaware Corporation to assume all rights, duties and obligations ascribed to it in the Registration Rights Agreement. In the event any Preferred Member's shares of the Delaware Corporation are included for sale in the initial public offering, each Preferred Member shall be entitled to include such Preferred Member's shares of the Delaware Corporation in such initial public offering on a pro rata basis. 14.3 VOTING ARRANGEMENTS. 14.3.1 CONVERSION CONTEMPORANEOUSLY WITH IPO. Each Preferred Member agrees that if the conversion or exchange of each Preferred Member's Interest into an interest in the Delaware Corporation occurs contemporaneously with an IPO of the Delaware Corporation, then such Member shall execute and deliver a voting agreement or other arrangement with a term and on such terms as may be specified by TSMC, whereby TSMC shall have authority to designate the majority of the board of directors of the Delaware Corporation. Each Member shall take any and all actions necessary and execute any and all documents necessary to give TSMC such authority. 14.3.2 CONVERSION NOT CONTEMPORANEOUSLY WITH IPO. Each Member agrees that if the conversion or exchange of each Member's Interest into an interest in the Delaware Corporation is not contemporaneous with an IPO of the Delaware Corporation, then the Articles, Bylaws, Stockholder's Agreement, and other governing documents of the Delaware Corporation shall provide for corporate governance substantially equivalent to that of the Company as set forth in this Agreement. 14.4 OPTIONS. In the event that each Member's Interest is converted or exchanged into an interest in or shares of the Delaware Corporation, any outstanding options, warrants or right to securities of the Company shall be changed or converted into similar securities of the Delaware Corporation on the same basis as a Member's Interest is changed or converted to an interest in or shares of the Delaware Corporation. 14.5 CONVERSION OF COMMON SHARES AND PREFERRED SHARES. In the event of a conversion pursuant to Section 14.1 of the Company into a Delaware corporation contemporaneously with an IPO, each Common Share and each Preferred Share shall be converted into common stock (the "COMMON STOCK") of the Delaware Corporation as hereinafter provided. 14.5.1 Each Common Share shall be convertible into one fully paid and nonassessable share of Common Stock. -54- 62 14.5.2 The Board of Directors shall have the discretion to determine the class or classes of securities of the Delaware Corporation into which all or part of each Preferred Share shall be convertible. 14.5.3 Unless otherwise approved by the Board of Directors, each Preferred Share shall be convertible into one fully paid and nonassessable share of Common Stock. ARTICLE 15 STANDARD OF CARE; INDEMNIFICATION 15.1 STANDARD OF CARE. Each Director, Officer, employee and agent shall perform its, his or her duties to the Company in good faith, in a manner he, she or it reasonably believes to be in or not opposed to the best interests of the Company, and with the care that a prudent person in a similar position would use under similar circumstances. Each Director, Officer, employee and agent of the Company and any Liquidating Person (individually, an "Indemnitee" and collectively, the "Indemnitees") acting in such capacity shall be fully protected in relying in good faith on information, opinions, reports or statements, including financial statements, books of account and other financial data, if prepared or presented by (i) one or more Directors, Officers or employees of the Company who the Indemnitee reasonably believes are reliable and competent in the matters prepared or presented, or (ii) legal counsel, certified public accountants or other persons as to matters that the Indemnitee reasonably believes are within the person's professional or expert competence. No Indemnitee shall be liable for damages to the Company or any present or former Member with respect to claims relating to its conduct for or on behalf of the Company, except to the extent that there is a final judicial determination based on clear and convincing evidence that (a) its action or failure to act involved an act or omission undertaken with deliberate intent to cause injury to the Company or undertaken with reckless disregard for the best interests of the Company, or (b) with respect to any criminal action, proceeding or investigation, it had no reasonable cause to believe its conduct was unlawful. 15.2 INDEMNIFICATION OF DIRECTORS, OFFICERS, EMPLOYEES AND AGENTS. The Company shall indemnify, defend and hold harmless each Indemnitee from and against any and all claims, demands, causes of action, loss, liability, cost, or expense (including reasonable attorneys' fees and disbursements), judgments, fines, settlements and other amounts arising from any and all claims, demands, actions, suits or proceedings, whether civil, criminal, administrative or investigative, in which the Indemnitee was involved or may be involved, or threatened to be involved, as a party or otherwise, arising out of or incidental to the business of the Company, excluding liabilities to any Member, regardless of whether the Indemnitee is or continues to be a Director, Officer, employee, or agent of the Company, or a Liquidating Person at the time any such liability or expense is paid or incurred, to the fullest extent permitted by the Act and all other applicable laws. 15.3 EXPENSES. Expenses incurred by an Indemnitee in defending any claim, demand, action, suit or proceeding subject to Section 15.2 shall, from time to time, be advanced by the Company prior to the final disposition of such claim, demand, action, suit or proceeding -55- 63 upon receipt by the Company of an undertaking by or on behalf of the Indemnitee to repay such amount if it shall be determined that such Person is not entitled to be indemnified as authorized in Section 15.2. 15.4 INDEMNIFICATION RIGHTS NON-EXCLUSIVE. The indemnification provided by Section 15.2 shall be in addition to any other rights to which those indemnified may be entitled under any agreement, action of the Board of Directors, vote of the Members, as a matter of law or equity or otherwise, both as to action in the Indemnitee's capacity as an Officer, Director, employee, or agent of the Company or as a Liquidating Person and as to any action in another capacity, and shall continue as to an Indemnitee who has ceased to serve in such capacity and shall inure to the benefit of the heirs, successors, assigns and administrators of the Indemnitee. 15.5 ERRORS AND OMISSIONS INSURANCE. The Company may purchase and maintain insurance, at the Company's expense, on behalf of the Directors and Officers and such other Persons as the Directors shall determine, against any liability that may be asserted against, or any expense that may be incurred by, such Person in connection with the activities of the Company, regardless of whether the Company would have the power to indemnify such Person against such liability under the provisions of this Agreement. 15.6 ASSETS OF THE COMPANY. Any indemnification pursuant to Section 15.2 shall be satisfied solely out of the assets of the Company. No Member shall be subject to personal liability or required to fund or to cause to be funded any obligation by reason of these indemnification provisions. ARTICLE 16 AMENDMENTS 16.1 AMENDMENT, ETC. OF LIMITED LIABILITY COMPANY AGREEMENT. Except as provided in Sections 6.4.2.9 and 6.4.2.10 and except to admit a new Member approved as contemplated in Section 6.4.2.11, this Agreement may be amended, or repealed and a new agreement may be adopted, only by (i) action of the Directors, and (ii) the Approval of Members holding not less than 87% in Percentage Interest. 16.2 AMENDMENT, ETC. OF CERTIFICATE OF FORMATION. The Certificate of Formation may be amended only by (i) action of the Directors, and (ii) the Approval of Members holding not less than 87% in Percentage Interest. ARTICLE 17 CONDITIONS PRECEDENT 17.1 CONDITIONS TO MEMBERS' PERFORMANCE. Notwithstanding anything to the contrary contained herein, on the Effective Date each of the following conditions had been satisfied: -56- 64 17.1.1 Expiration of any waiting periods that are required by the laws of the U.S. or Taiwan to expire, and obtaining all requisite governmental and other approvals, prior to the consummation of such transactions, including, but not limited to, any waiting period required under the U.S. Hart Scott Rodino Antitrust Improvement Act of 1976, as amended. 17.1.2 The execution and delivery by the Company of all Ancillary Agreements that this Agreement contemplates the Company shall execute. 17.1.3 The Certificate of Formation shall have been filed with the Office of the Delaware Secretary of State. 17.2 CONDITIONS TO TSMC'S PERFORMANCE. In addition to the conditions set forth in Section 17.1, notwithstanding anything to the contrary contained herein, on the Effective Date each of the following conditions were deemed satisfied by TSMC: 17.2.1 The truth and accuracy as of the Effective Date of each of the representations and warranties set forth in Section 7.2 made by each other Initial Member. 17.2.2 The execution and delivery by each other Initial Member of each of the Ancillary Agreements that this Agreement contemplates such Initial Member shall execute. 17.2.3 The performance by each other Initial Member of all obligations and covenants set forth in this Agreement and required to be performed on the date hereof, including without limitation, that each other Initial Member shall have made its respective First Part Capital Contribution. 17.2.4 Receipt of any necessary approval by the Taiwan Ministry of Economic Affairs of the investment in the Company by TSMC as contemplated hereby. 17.3 CONDITIONS TO ADI'S PERFORMANCE. In addition to the conditions set forth in Section 17.1, notwithstanding anything to the contrary contained herein, on the Effective Date each of the following conditions were deemed satisfied by ADI: 17.3.1 The truth and accuracy as of the Effective Date of each of the representations and warranties set forth in Section 7.2 made by each other Initial Member. 17.3.2 The execution and delivery by each other Initial Member of each of the Ancillary Agreements that this Agreement contemplates such Initial Member shall execute. 17.3.3 The performance by each other Initial Member of all obligations and covenants set forth in this Agreement and required to be performed on the date hereof, including without limitation, that each other Initial Member shall have made its respective First Part Capital Contribution. -57- 65 17.4 CONDITIONS TO ALTERA'S PERFORMANCE. In addition to the conditions set forth in Section 17.1, notwithstanding anything to the contrary contained herein, on the Effective Date each of the following condition were deemed satisfied by Altera: 17.4.1 The truth and accuracy as of the Effective Date of each of the representations and warranties set forth in Section 7.2 made by each other Initial Member. 17.4.2 The execution and delivery by each other Initial Member of each of the Ancillary Agreements that this Agreement contemplates such Initial Member shall execute. 17.4.3 The performance by each other Initial Member of all obligations and covenants set forth in this Agreement and required to be performed on the date hereof, including without limitation, that each other Initial Member shall have made its respective First Part Capital Contribution. 17.5 CONDITIONS TO ISSI'S PERFORMANCE. In addition to the conditions set forth in Section 17.1, notwithstanding anything to the contrary contained herein, on the Effective Date each of the following conditions were deemed satisfied by ISSI: 17.5.1 The truth and accuracy as of the Effective Date of each of the representations and warranties set forth in Section 7.2 made by each other Initial Member. 17.5.2 The execution and delivery by each other Initial Member of each of the Ancillary Agreements that this Agreement contemplates such Initial Member shall execute. 17.5.3 The performance by each other Initial Member of all obligations and covenants set forth in this Agreement and required to be performed on the date hereof, including without limitation, that each other Initial Member shall have made its respective First Part Capital Contribution. 17.6 CONDITIONS TO THE THIRD PARTY INVESTORS' PERFORMANCE. In addition to the conditions set forth in Section 17.1, notwithstanding anything to the contrary contained herein, on the Effective Date each of the following conditions were deemed satisfied by the Third Party Investors: 17.6.1 The truth and accuracy as of the Effective Date of each of the representations and warranties set forth in Section 7.2 made by each other Initial Member. 17.6.2 The execution and delivery by each other Initial Member of each of the Ancillary Agreements that this Agreement contemplates such Initial Member shall execute. 17.6.3 The performance by each other Initial Member of all obligations and covenants set forth in this Agreement and required to be performed on the date hereof, including without limitation, that each other Initial Member shall have made its respective First Part Capital Contribution. -58- 66 17.6.4 Receipt of any necessary approval by the Taiwan Ministry of Economic Affairs of the investment in the Company by a Third Party Investor as contemplated hereby. ARTICLE 18 CONFIDENTIALITY 18.1 EXCHANGE OF INFORMATION AND NONDISCLOSURE. In furtherance of this Agreement, or pursuant to the Ancillary Agreements the Members may from time to time come into possession of certain information and data, including business plans, fabrication techniques, processes, technology, financial information and other compilations of information, which relate to the business of the Members. Prior to the execution of this Agreement, each Initial Member has executed, and each new Member shall sign and become a party to, the Member's Confidentiality Agreement relating to such information. 18.2 CONFIDENTIALITY AGREEMENTS FOR VISITORS AND EMPLOYEES. Any employee, contractor, subcontractor or guest of TSMC, ADI, Altera or ISSI who visit the Foundry ("VISITOR") shall execute and deliver a copy of the Confidentiality Agreement in the form of Exhibit C(1). Visitors shall not be permitted to: make or compile any notes, documentation or other information, or make any photographs, drawings, tapes, films or other graphic representations. Each employee of the Company at the time of employment shall execute and deliver a copy of the Employee Invention Assignment and Confidentiality Agreement in the form of Exhibit C(2). 18.3 THIRD PARTY REQUEST FOR INFORMATION. Except as otherwise provided in this Agreement and except for private requests in the ordinary course of business for non-Confidential Information relating to the Proven Products, a Member shall immediately notify the other Preferred Members of any private or governmental request for Confidential Information or any other information or documents relating to the Proven Products or this Agreement. Each Preferred Member shall have the right to participate in any other Member's response to any such request. In the event that a Member receives any subpoena or other legal process requiring the production of information, documents, data, work papers, reports, or other materials relating to this Agreement, that Member shall: 18.3.1 give the other Preferred Members, if possible, the opportunity to participate in quashing, modifying or otherwise responding to any compulsory process in an appropriate and timely manner; and 18.3.2 cooperate fully with the other Preferred Member's efforts to narrow the scope of any such compulsory process, to obtain a protective order limiting the use or disclosure of the information sought, or in any other lawful way to obtain continued protection of the Confidential Information. Notwithstanding the foregoing, a private request to a Member from a third party for Design Rules (as defined in the Purchase Agreement) and reliability results may be disclosed -59- 67 without prior notice to the other Preferred Members if such third party executes a Confidentiality Agreement in the form of Exhibit L to the Purchase Agreement and the other Preferred Members are promptly provided with notice of the disclosure after the disclosure is made. 18.4 REPORTING LOSS, THEFT OR MISAPPROPRIATION. If any Member becomes aware of the loss, theft or misappropriation of Confidential Information which is in its possession or control, it shall notify the other Preferred Members in writing within five (5) days of its discovery of such loss, theft or misappropriation. 18.5 BREACH OF CONFIDENTIALITY. Each Member acknowledges that a breach of this Article 18 or a breach of either of the Confidentiality Agreements will result in irreparable injury to the party whose Confidential Information has been disclosed and such party shall be entitled to temporary, preliminary and permanent injunctive relief or to a protective order for any threatened or actual violation of the provisions of this Article. Each Member agrees and consents to the entry of an injunction or protective order by any court of competent jurisdiction upon a showing by the party whose Confidential Information has been disclosed that its Confidential Information is being used or disclosed contrary to the terms of this Article 18 or the Confidentiality Agreements. The foregoing provisions are in addition to, and not in limitation of, the remedies of specific performance, damages, and any other remedies at law, in equity or otherwise that the Members may have upon breach. The Members stipulate that the arbitration provisions of Article 20 shall not apply to any temporary restraining order, preliminary injunctive relief or other provisional remedy sought to prohibit a breach or threatened breach of the provisions of this Article or the Confidentiality Agreements. ARTICLE 19 ANCILLARY AGREEMENTS 19.1 EXECUTION AND DELIVERY. On or before the Effective Date, the following documents were executed and delivered by the parties thereto, and the Company executed and delivered each such document: the Confidentiality Agreements, the Registration Rights Agreement, and the Assignments of the Manufacturing Agreement, the Technology License and Assistance Agreement and the Advanced Process Agreement. 19.2 TERMINATION OF MANUFACTURING AGREEMENT; FUTURE PURCHASE AGREEMENT. Following the expiration or termination of the Manufacturing Agreement (and consequently, the termination of the Purchase Agreement), until the useful life of the Foundry has ended, the Managing Members shall enter into the Future Purchase Agreement, the form of which is attached hereto as Exhibit F, whereby the Managing Members shall have the right and obligation to purchase the output of the Foundry as provided for in the Future Purchase Agreement. Notwithstanding the foregoing, the Members agree that if the Company constructs an additional foundry on the Real Property, any rights or obligations to purchase the output of such additional foundry shall be negotiated at that time and shall not be covered by the provisions of the Purchase Agreement or the Future Purchase Agreement. ARTICLE 20 -60- 68 DISPUTE RESOLUTION; ARBITRATION 20.1 NEGOTIATION BETWEEN EXECUTIVES. Each of the Members and the Company shall attempt in good faith to resolve any dispute, controversy or claim ("Dispute") arising out of or relating to this Agreement promptly by negotiations between executives who have authority to settle the Dispute. Any Member or the Company may give the other Preferred Members and the Company written notice of any Dispute not resolved in the normal course of business. Within twenty (20) days after delivery of such a notice, executives of the Members and the Company involved in the Dispute who have authority to settle the Dispute shall meet at a mutually acceptable time and place, and thereafter as often as they reasonably deem necessary, to attempt to resolve the Dispute. If the matter has not been resolved within thirty (30) days after such notice, unless extended by the agreement of the parties involved in the Dispute in writing (the "Negotiation Period"), the matter shall be subject to mediation as provided in Section 20.2. If a Member or the Company intends to be accompanied at a meeting by an attorney, the other involved parties shall be given at least three (3) Business Days' notice of such intention and may also be accompanied by an attorney. All negotiations pursuant to this provision are confidential and shall be treated as compromise and settlement negotiations for purpose of the United States Federal Rules of Evidence and state rules of evidence. 20.2 MEDIATION. Any Dispute not settled pursuant to Section 20.1 shall be submitted to mediation administered by the American Arbitration Association under its Commercial Mediation Rules (such mediation, "MEDIATION"), before resorting to arbitration as hereinafter provided. The Mediation shall be completed within forty-five (45) days of its initiation pursuant to the Commercial Mediation Rules, unless all the parties involved in the Dispute otherwise agree. Executives of all parties involved in the Dispute with authority to resolve the Dispute shall participate in the Mediation. The Mediation shall take place in San Jose, California. The parties shall attempt in good faith to reach agreement on the appointment of a mediator. If they cannot so agree, the mediator shall be appointed pursuant to the Commercial Mediation Rules; provided, however, that the mediator appointed shall have a background in the semiconductor industry. The parties involved in the Dispute shall each pay their own expenses of Mediation, including attorney's fees, and shall share equally the mediator's fees and expenses. 20.3 CLAIMS SUBJECT TO ARBITRATION. Except as otherwise specified below, any Dispute arising out of or relating to this Agreement, or the breach or termination thereof, and not resolved pursuant to Section 20.1 or Section 20.2 shall be resolved by binding arbitration in accordance with the Federal Arbitration Act, 9 U.S.C. Section 1 et seq. (the "FAA"), and the Commercial Arbitration Rules and, where the amount in controversy exceeds $1,000,000, the Supplementary Procedures for Large Complex Disputes, of the AAA (collectively, the "RULES"). In the event of a conflict between the FAA and the Rules, the Rules shall govern. In the event of a conflict between this Article 20 and the FAA or the Rules, the provisions of this Article 20 shall govern. A court of competent jurisdiction, upon application from any party to the Dispute, may relieve the parties of their duty to arbitrate Disputes in whole or in part, or may stay any arbitration hereunder in whole or in part, if ongoing litigation between one or more of the parties and a third party (or parties) involves issues of fact or law common -61- 69 with those subject to arbitration hereunder and there exists the possibility of inconsistent judgments if such relief is not granted. Each party involved in a Dispute also reserves the right to file with a court of competent jurisdiction an application for temporary or preliminary injunctive relief, a protective order or other appropriate provisional remedy on grounds that (a) the arbitration award to which the applicant may be entitled may be rendered ineffectual in the absence of such relief; or (b) in the event of a breach or threatened breach of Article 18 hereof or the Confidentiality Agreements. 20.3.1 VENUE. The venue for such arbitration proceeding will be San Jose, California. 20.3.2 SELECTION OF ARBITRATOR AND DETERMINATION OF CONTROVERSIES. 20.3.2.1 Any Dispute subject to arbitration shall be submitted to a single neutral arbitrator, who, unless otherwise agreed by all parties involved in the Dispute, shall be a retired judge or other lawyer who is a member of the arbitration panel of the Judicial Arbitration and Mediation Service ("JAMS") or the national panel of arbitrators of the AAA and who has substantial experience in the area of the Dispute. The parties involved in the 'Dispute shall confer concerning the selection of the AAA or JAMS with the objective of selecting one or the other within thirty (30) days of the conclusion of the Mediation; provided, however, that if all parties to the Dispute do not agree on one or the other within such thirty (30) day period, the Dispute initially will be submitted simultaneously to both the AAA and JAMS for the sole purpose of picking the arbitrator. If the parties to the Dispute select the arbitrator from the JAMS panel, then the term "RULES" as used herein shall mean the then-prevailing JAMS rules. The AAA (or JAMS, as the case may be) simultaneously shall submit to each party involved in the Dispute an identical list of five proposed qualified arbitrators drawn from the applicable panel of commercial arbitrators. If the parties involved in the Dispute are unable to agree upon an arbitrator within thirty (30) days from the date that the AAA (or JAMS, as the case may be) submits such list to the parties involved in the Dispute, then the AAA (or JAMS, as the case may be) shall simultaneously submit to each party involved in the Dispute a second identical list of five additional proposed qualified arbitrators drawn from the applicable panel of commercial arbitrators. If for any reason, the appointment of an arbitrator cannot be made from either list, the AAA (or JAMS, as the case may be) may make the appointment from among other qualified members of the panel without the submission of additional lists to the parties involved in the Dispute. If the Dispute is initially submitted to both the AAA and JAMS for the purpose of picking the arbitrator, then both the AAA and JAMS simultaneously shall submit to each party lists of five proposed qualified arbitrators drawn from the applicable panel (with each party receiving the identical list from AAA and the identical list from JAMS), and if the parties are unable to agree upon an arbitrator within thirty (30) days from the date that both the AAA and JAMS submit the first such lists to each party, then the AAA and JAMS simultaneously shall submit to each party second lists of five additional proposed qualified arbitrators (with each party receiving an identical second list from AAA and an identical second list from JAMS). If the parties for any reason are unable to select an arbitrator from the first and second lists submitted by the AAA and JAMS, then a majority of the parties shall select to arbitrate with either the -62- 70 AAA or JAMS, and the arbitration organization so selected shall make the appointment from among other qualified members of the arbitration panel of that organization without the submission of additional lists to the parties. Where the parties have initially submitted the Dispute to both the AAA and JAMS, then once an arbitrator has been appointed, the arbitration proceeding will be terminated with the arbitration organization that has not been selected and the parties shall equally share the costs and fees of the arbitration organization so terminated. If for any reason the parties to the Dispute have not selected an arbitrator within ninety (90) days of the conclusion of the Mediation, then the arbitration shall be conducted with the AAA. No matter how selected, the arbitrator shall have no prior or existing affiliation or relationship with any party involved in the Dispute or its counsel, and shall sign an oath of impartiality upon appointment. 20.3.2.2 The parties involved in the Dispute shall be entitled to obtain pre-hearing discovery through depositions and requests for the inspection and copying of documents and other items upon reasonable notice and to obtain the issuance of a subpoena duces tecum therefor in accordance with applicable law, including without limitation 9 U.S.C. Section 7 and (notwithstanding Section 1297.17 of the California Code of Civil Procedure) Section 1283.05 of the California Code of Civil Procedure; provided that depositions shall not be taken unless leave to do so is first granted by the arbitrator. As between the parties involved in the Dispute, the arbitrator shall have the power to enforce the rights, remedies, procedures, duties, liabilities and obligations of discovery by the imposition of the same terms, conditions, consequences, sanctions and penalties as may be imposed in like circumstances in a civil action by a U.S. Federal court. 20.3.3 ARBITRATION AWARD AND JUDICIAL REVIEW. The arbitrator, in deciding any Dispute, shall base his or her decision on the record and in accordance with this Agreement and applicable law. In no event shall the arbitrator make any ruling, finding or award that does not conform to the terms and conditions of this Agreement, is not supported by the weight of the evidence, or is contrary to statute, administrative regulations or established judicial precedents. The arbitration award shall be a factually detailed, reasoned opinion stating the arbitrator's findings of fact and conclusions of law. Unless the arbitrator for good cause determines otherwise, the final award shall include attorneys' fees, costs and expenses of the prevailing party, including expert and non-expert witness fees and the prevailing party's share of the administrative fee and the arbitrator's fees and expenses, if any. Notwithstanding any other provisions of this Agreement, the arbitrator shall have no jurisdiction to award damages in contravention of Article 21 hereof. The arbitration award shall be subject to judicial review in accordance with 9 U.S.C. Sections 10-12; provided, however, that the arbitration award shall also be vacated to the extent that the arbitrator exceeds his or her authority as set forth in this Section 20.3.3, and, on balance, the party seeking vacation of the award has been materially and adversely affected thereby. Judgment may be entered on the award by the United States District Court in accordance with 9 U.S.C. Section 9. 20.3.4 DERIVATIVE ACTION. Pursuant to Section 20.3, a Member may initiate and pursue in the right of the Company any Dispute arising out of or relating to -63- 71 a transaction which is the subject matter of Section 2.10.2 or Section 3.6.1. The parties to any such Dispute shall first attempt to resolve the Dispute pursuant to Section 20.1 or 20.2. ARTICLE 21 LIMITATION ON DAMAGES; CONTRACTUAL LIMITATIONS PERIOD 21.1 LIMITATION ON DAMAGES. 21.1.1 WITH THE EXCEPTION OF ANY LOSS, LIABILITY, DAMAGE OR OBLIGATION ARISING OUT OF OR RELATING TO DISCLOSURE OF CONFIDENTIAL INFORMATION IN VIOLATION OF ARTICLE 18, NO MEMBER SHALL BE LIABLE FOR ANY INDIRECT, SPECIAL, INCIDENTAL OR CONSEQUENTIAL LOSS OR DAMAGE (INCLUDING, WITHOUT LIMITATION, LOSS OF PROFITS OR LOSS OF USE) SUFFERED BY ANY OTHER MEMBER ARISING FROM OR RELATING TO A MEMBER'S PERFORMANCE, NON-PERFORMANCE, BREACH OF OR DEFAULT UNDER A COVENANT, WARRANTY, REPRESENTATION, TERM OR CONDITION HEREOF. EXCEPT AS SPECIFICALLY PROVIDED IN THE PRECEDING SENTENCE, EACH MEMBER WAIVES AND RELINQUISHES CLAIMS FOR INDIRECT, SPECIAL, INCIDENTAL OR CONSEQUENTIAL DAMAGES. NOTWITHSTANDING SUCH WAIVER AND RELINQUISHMENT, WITH RESPECT TO ANY LOSS, LIABILITY, DAMAGE OR OBLIGATION ARISING OUT OF OR RELATING TO DISCLOSURE OF CONFIDENTIAL INFORMATION IN VIOLATION OF ARTICLE 18, A MEMBER SHALL BE LIABLE FOR ANY INDIRECT, SPECIAL, INCIDENTAL OR CONSEQUENTIAL DAMAGE (INCLUDING WITHOUT LIMITATION, LOSS OF PROFITS OR LOSS OF USE) SUFFERED BY ANY OTHER MEMBER ARISING FROM OR RELATING TO A MEMBER'S PERFORMANCE, NON-PERFORMANCE, BREACH OF OR DEFAULT UNDER SAID ARTICLE 18. 21.1.2 NO MEMBER SHALL HAVE THE RIGHT TO RECOVER PUNITIVE DAMAGES FROM THE OTHER MEMBER, AND EACH MEMBER HEREBY WAIVES AND RELINQUISHES ANY AND ALL PUNITIVE DAMAGE CLAIMS. 21.1.3 THE LIMITATIONS ON LIABILITY AND DAMAGES SET FORTH IN SECTIONS 21.1.1 AND 21.1.2 APPLY TO ALL CAUSES OF ACTION THAT MAY BE ASSERTED HEREUNDER, WHETHER SOUNDING IN BREACH OF CONTRACT, BREACH OF WARRANTY, TORT, PRODUCT LIABILITY, NEGLIGENCE OR OTHERWISE. 21.2 CONTRACTUAL LIMITATIONS PERIOD. Any arbitration, litigation, judicial reference or other legal proceeding involving the parties shall be commenced within two (2) years after the accrual of the cause of action, except for arbitration, litigation, judicial reference or other legal proceedings in respect to claims for indemnification under the provisions of this Agreement, which indemnification claims shall be commenced within the statutory limitations period provided by applicable law. -64- 72 ARTICLE 22 FORCE MAJEURE 22.1 FORCE MAJEURE. Subject to the limitations set forth in Section 22.4, should any Member be prevented from performing such Member's contractual obligations under this Agreement due to the cause or causes of Force Majeure, that Member shall not be liable to any other Member for any delay or failure of performance caused by any Force Majeure events; nor shall that Member be deemed to have committed an Event of Default hereunder. Notwithstanding the foregoing, a Force Majeure event shall not excuse a Member's obligation to pay money. However, a monetary obligation shall be suspended until cessation of such Force Majeure event if, and only if, the Force Majeure event actually and directly renders physically impossible a Member's payment of money due under this Agreement. 22.2 NOTIFICATION. The Member prevented or delayed by a Force Majeure event in the performance of any obligation hereunder shall promptly notify the other Members of the occurrence of any Force Majeure event in writing by cable, telex or telecopier. 22.3 RESPONSE TO FORCE MAJEURE. Should the delay caused by any events of Force Majeure continue for more than ninety (90) days, the Members shall settle all questions of further performance of this Agreement through good faith negotiations as soon as possible with the objective of restructuring the relationship among them such that the effects of such events of Force Majeure are minimized. If the Members do not agree in writing on a mutually acceptable solution within six (6) months of a Member's request for such negotiations, the Board of Directors shall have the authority to deem the Member subject to the Force Majeure event to have committed an Event of Default at which time, the Member shall become a Terminated Member, without necessity for a vote of the Members, and, without limitation, shall be subject to the provisions of Sections 10.3 through 10.7, inclusive. 22.4 LIMITATIONS ON APPLICABILITY OF FORCE MAJEURE. This Article 22 shall be void and inapplicable to any Member (i) if such Member fails to use reasonable diligence to remedy any Force Majeure event that prevents or delays that Member's performance hereunder by continuously pursuing such actions as that Member reasonably can take under the circumstances; and (ii) in the event of a strike, lockout or other labor disruption, if the Member is found by the National Labor Relations Board or other governmental agency having jurisdiction to have caused such strike, lockout or labor disruption or if such Member refuses to enter into bargaining with respect to such strike, lockout or labor disruption. ARTICLE 23 GENERAL PROVISIONS 23.1 SEVERABILITY. If any provision of this Agreement is, or becomes or is deemed invalid, illegal or unenforceable in any jurisdiction, such provision shall be deemed amended to conform to applicable laws so as to be valid and enforceable or, if it cannot be so amended without materially altering the intention of the Members, it shall be stricken and the remainder of this Agreement shall remain in full force and effect. -65- 73 23.2 NEUTRAL INTERPRETATION; WAIVER. Each party hereto has received independent legal advice from its attorneys with respect to the advisability of executing this Agreement and the meaning of the provisions hereof. Each party hereto waives any real, apparent, possible or inchoate conflict in connection with, arising out of or resulting from the representation of any Member and its Affiliates, and the Company by the same law firm. The provisions of this Agreement shall be construed as to their fair meaning, and not for or against any party hereto based upon any attribution to such party as the source of the language in question. 23.3 NOTICES. Any notices, demands, requests, waivers or other communications required or permitted to be given to a party hereunder shall be in writing in the English language and shall be delivered or sent to such party at its address set forth on Exhibit A hereto, or such other address as such party may hereafter specify, and shall be deemed given (i) when personally delivered to such party, (ii) when transmitted by facsimile and receipt of such transmission is confirmed by facsimile, (iii) 24 hours after dispatch via an established overnight courier service, or (iv) three (3) days after mailing by prepaid first class, certified mail with return receipt requested. 23.4 TIME OF THE ESSENCE. Time is of the essence with respect to each provision of this Agreement. 23.5 GOVERNING LAW. This Agreement shall be governed by and construed in accordance with the laws of the State of Delaware, United States of America, without regard to conflicts of laws principles. 23.6 ENTIRE AGREEMENT. Except as provided in Section 23.23, this Agreement, the Ancillary Agreements, the Incentive Plans and that certain letter from TSMC Taiwan to the Initial Members dated as of the Effective Date (the "LETTER OF ASSURANCES") constitute and contain the entire agreement of the Members, and supersede any and all prior or contemporaneous negotiation, correspondence, understandings, representations, warranties and agreements between the Members, written or oral, respecting the subject matter hereof or thereof. Other than as contained herein and as provided in Section 23.23, in the Ancillary Agreements or in the Letter of Assurances, no representation, warranty, statement, or condition is binding on the parties hereto or thereto, or has any force or effect whatsoever. 23.7 WAIVER. No waiver of any provision of this Agreement shall be effective unless and until made in writing and signed by each party hereto. No waiver, forbearance or failure by any party hereto of its right to enforce any provision of this Agreement shall constitute a waiver or estoppel of such party's right to enforce any other provision of this Agreement or a continuing waiver by such party of compliance with any provision. 23.8 COOPERATION. Each party hereto shall cooperate with each other party hereto and shall take such further action and shall execute and deliver such further documents as may be necessary or desirable in order to carry out the provisions and purposes of this -66- 74 Agreement. Each party, recognizing that there may be drafting errors in and among this Agreement, the Ancillary Agreements and the Letter of Assurances, agrees that it will cooperate with each other party to exercise good faith efforts to correct any such drafting errors. 23.9 COUNTERPARTS. This Agreement may be executed in one or more counterparts, each of which shall be deemed to be an original, but all of which together shall constitute one and the same instrument. 23.10 EXHIBITS AND SCHEDULES. All Exhibits and Schedules to which reference is made in this Agreement are deemed to be incorporated by reference into this Agreement, whether or not actually attached hereto. 23.11 ATTORNEYS' FEES. In the event of any arbitration, mediation, litigation or other proceeding involving the parties to this Agreement to enforce any provision of this Agreement, to enforce any remedy available upon default under this Agreement, or seeking a declaration of the rights of a party under this Agreement, the prevailing party shall be entitled to recover from the other such attorneys' fees and costs as may be reasonably incurred, including the cost of reasonable investigation, preparation and professional or expert consultation incurred by reason of such litigation. Notwithstanding the foregoing, (a) in an arbitration proceeding the award of attorneys' fees shall be governed by the provisions of Section 20.3.3, and (b) in a mediation each party shall pay its own attorneys' fees in accordance with Section 20.2. 23.12 DATE OF PERFORMANCE. If the date on which any performance required hereunder is other than a Business Day, then such performance shall be required as of the next following Business Day. 23.13 SURVIVAL. Following early termination or the elapse or expiration of this Agreement, the provisions of Article 1, Section 7.2, Article 9, Article 14, Article 15, Article 16, Article 20, Article 21 and Article 23 shall survive and remain in full force and effect in accordance with their terms. 23.14 SURVIVAL OF RIGHTS. This Agreement shall be binding upon, and, as to permitted or accepted successors, transferees and assigns, inure to the benefit of the Members and the Company and their respective heirs, legatees, legal representatives, successors, transferees and assigns, in all cases whether by the laws of descent and distribution, merger, reverse merger, consolidation, sale of assets, other sale, operation of law or otherwise. 23.15 THIRD-PARTY BENEFICIARIES. There are no third-party beneficiaries of this Agreement except Indemnitees. 23.16 PARTITION. Each Member hereby irrevocably waives any and all rights, duties, obligations and benefits with respect to any action for partition of Company Property or to compel any sale or appraisal thereof or of any deceased Member's interest therein. Further, all rights, duties, benefits and obligations including inventory and appraisal of the Company assets or sale of a deceased Member's interest therein, provision for which is made in the law of -67- 75 Delaware, or on account of the operation of any other role or law of any other jurisdiction to compel any sale or appraisal of Company assets or sale or appraisal of a deceased Member's interest therein, are hereby irrevocably waived and dispensed with. The Interest of a deceased Member shall be subject to the provisions of this Agreement. 23.17 GOVERNING LANGUAGE OF AGREEMENT. This Agreement is in the English language only, which language shall be controlling in all respects, and all other versions thereof in any other language shall be for accommodation only and shall not be binding upon each party hereto. All communications to be made or given pursuant to this Agreement shall be in the English language. 23.18 CONSENT TO JURISDICTION AND SERVICE OF PROCESS. Each party hereto irrevocably Consents to the jurisdiction of the courts located in San Jose, California, agrees, subject to the provisions of Article 20 and Article 21, that any action, suit or proceeding by or among the Members (or any of them) or the Company and any Member may be brought in any such court sitting in San Jose, California and waives any objection which the Member may now or hereafter have concerning jurisdiction and venue, whether based on considerations of personal jurisdiction, forum non conveniens or on any other ground. Each party hereto hereby irrevocably designates, appoints and empowers the Secretary of State of California to receive for and on behalf of such party service of process in the State of California and further irrevocably consents to the service of process outside of the territorial jurisdiction of said courts by mailing copies thereof by registered or certified United States mail, postage prepaid, to such party's last known address- as shown in the records of the Company with the same effect as if such party were a resident of the State of California and had been lawfully served in such state. Nothing in this Agreement shall affect the right to service of process in any other manner permitted by law. Any process served on the California Secretary of State in accordance with the preceding sentence shall also be noticed to the served party's last known address established in accordance with Section 23.3, in a manner permitted by such Section 23.3. Each party hereto further agrees that final judgment against it in any such action or proceeding shall be conclusive and may be enforced in any other jurisdiction within or outside the State of California by suit on the judgment, a certified or exemplified copy of which shall be conclusive evidence of the fact and the amount of such judgment. 23.19 LIQUIDATED DAMAGES. All provisions of this Agreement, including without limitation those relating to the valuation of a Member's Interest or adjustments in Percentage Interests, have been negotiated by the parties hereto at arm's-length, and each party affirms that all such provisions are fair, just and equitable. Without limiting the generality of the foregoing, the provisions of Sections 3.4, 3.6.4, 8.1.4, 8.2.4, 10.3, 10.5 and 22.3 reflect the parties' best estimates of liquidated compensatory damages and do not constitute a penalty, and no party shall make any claim or allegation to the contrary. 23.20 AUTHORIZED REPRESENTATIVES. Until changed by a party hereto by written notice to each of the other parties, the following individuals, and only such individuals, are authorized to act on behalf of the party so designating them as its authorized representative -68- 76 with full power and authority to speak for and bind such Member in connection with all matters arising under this Agreement or relating to the business of the Company: TSMC ---------------------------------- ALTERA Rodney Smith ---------------------------------- ADI Rob Marshall ---------------------------------- ISSI Jimmy Lee ---------------------------------- COMPANY Kenneth Smith ---------------------------------- The Third Party Investors pursuant to a Power of Attorney and Proxy contained in Subscription Agreements dated as of June 5, 1996 have designated Donald W. Brooks as their attorney-in-fact and authorized representative, who shall be their only representative authorized to act on their behalf, with full power and authority to vote, speak for and bind such Third Party Investors in connection with all matters arising under this Agreement or relating to the business of the Company. 23.21 REMEDIES CUMULATIVE, CONCURRENT AND NON-EXCLUSIVE. The parties hereto shall have all rights, remedies and recourse granted in this Agreement, in any other agreements entered into between the parties hereto and available at law or in equity, and except as otherwise provided in this Agreement or the Ancillary Agreements the same (i) shall be cumulative and concurrent; (ii) may be pursued separately, successively or concurrently; (iii) may be exercised as often as occasion therefore shall arise, it being agreed that the exercise or failure to exercise any right, remedy or recourse shall in no event be construed as a waiver or release thereof; and (iv) are intended to be, and shall be, non-exclusive. 23.22 WAIVER OF CONFLICT OF INTEREST. EACH OF THE MEMBERS HAS BEEN REPRESENTED BY SEPARATE COUNSEL IN CONNECTION WITH THIS AGREEMENT AND THE ANCILLARY AGREEMENTS. SUCH COUNSEL HAS NOT REPRESENTED THE COMPANY PRIOR TO THE EFFECTIVE DATE. THE ATTORNEYS, ACCOUNTANTS AND OTHER EXPERTS WHO HAVE PERFORMED SERVICES FOR THE MEMBERS IN THE PAST MAY PERFORM SERVICES FOR THE COMPANY AND MAY CONTINUE TO ALSO PERFORM SERVICES FOR THE SEPARATE MEMBERS IN THE FUTURE. TO THE EXTENT THAT SUCH DUAL REPRESENTATION CONSTITUTES A CONFLICT OF INTEREST, THE COMPANY AND THE MEMBERS HEREBY EXPRESSLY WAIVE ANY SUCH CONFLICT OF INTEREST WITH RESPECT TO ANY SUCH DUAL REPRESENTATION RELATIVE TO THE NEGOTIATION AND EXECUTION OF THIS AGREEMENT AND THE ANCILLARY AGREEMENTS. -69- 77 23.23 AMENDMENT AND RESTATEMENT. This Agreement amends, restates and supersedes the Original Agreement. The operative effect of this Agreement and the rights and obligations of each Member hereunder relate back to the Effective Date. [THE REMAINDER OF THIS PAGE IS INTENTIONALLY LEFT BLANK.] -70- 78 [SIGNATURE PAGE TO SECOND AMENDED AND RESTATED LIMITED LIABILITY COMPANY AGREEMENT] IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first written above. TSMC DEVELOPMENT, INC. By /s/ MORRIS CHANG ------------------------------------- Name Morris Chang ----------------------------------- Its ------------------------------------ ANALOG DEVICES, INC. By /s/ JOSEPH E. MCDONOUGH ------------------------------------- Name Joseph E. McDonough ----------------------------------- Its Vice President, Finance & CFO ------------------------------------ ALTERA CORPORATION By /s/ RODNEY SMITH ------------------------------------- Name Rodney Smith ----------------------------------- Its President & CEO ------------------------------------ INTEGRATED SILICON SOLUTIONS, INC. By /s/ JIMMY LEE ------------------------------------- Name Jimmy Lee ----------------------------------- Its President & CEO ------------------------------------ -71- 79 EXHIBIT G The allocation provisions below are included in this agreement to satisfy certain provisions of the Treasury Regulations issued pursuant to Section 704 of the Internal Revenue Code. Notwithstanding any other provision of this Agreement, these provisions shall be taken into account in allocating items of income, gain, loss, and deduction among the Members so that, to the extent possible, the net amount of such allocations of any items to each Member shall be equal to the net amount that would have been allocated to each such Member if these provisions had not been applicable. To the extent that allocations taking into account the provisions below vary from those which would have occurred in the absence of such provisions, items of income, gain and loss shall be allocated to the Preferred Members in later years to minimize or eliminate the effect of such provisions as the Preferred Members shall deem appropriate. Income Offset. No loss shall be allocated to a Member if such allocation causes or increases a deficit balance in such Member's Capital Account. In determining the extent to which the previous sentence is satisfied, each Member's Capital Account also shall be adjusted, solely for purposes of this requirement, to take into account the items and adjustments required by Treas. Reg. Section 1.704-1(b)(2)(ii)(d) as modified by Treas. Reg. Section 1.704-2(g)(1) and 1.704-2(i)(5). Allocations pursuant to this provision shall be offset by other allocations (consistent with this Agreement) as soon as possible so that net allocations to the Members of losses shall be the same as if no allocations had been made pursuant to this Section. This provision is intended to comply with the requirements of Treas. Reg. Section 1.704-1 (b)(2)(ii)(d)-and shall be interpreted in accordance therewith. Minimum Gain Chargeback. If for any Fiscal Year there is a net decrease in Company minimum gain as defined in Treas. Reg. Section 1.704-1(b)(2), each Member shall be specially allocated items of Company gross income and gross gain for such year (and, if necessary, for succeeding years) in an amount equal to such Member's share of the net decrease in Company Minimum Gain, determined in accordance with Regulations Section 1.704-2(g), except as otherwise provided in Regulations Section 1.704-2(f)(2), 1.704-2(f)(3), 1.704-(2)(f)(4), and 1.704-2(0(5). Allocations pursuant to the previous sentence shall be made in proportion to the respective amounts required to be allocated to each Member pursuant thereto. The items to be so allocated shall be determined in accordance with Regulations Section 1.704-2(f)(6). This provision is intended to comply with the minimum gain chargeback requirement of Regulations Section 1.704-2(f) and shall be interpreted consistently therewith. Member Minimum Gain Chargeback. If during a fiscal year there is a net decrease in member nonrecourse debt minimum gain, each Member who has a share of that member nonrecourse debt minimum gain (determined in accordance with Regulations Section 1.704-2(i)(5)) as of the beginning of such year shall be specially allocated items of Company income and gain for such year (and, if necessary, for succeeding years) in an amount equal to such Member's share of the 80 net decrease in member nonrecourse debt minimum gain, determined in accordance with Regulations Section 1.704-2(i)(4) (and taking into account the exceptions provided therein). Allocations pursuant to the previous sentence shall be made in proportion to the respective amounts required to be allocated to each Member pursuant thereto. The items to be so allocated shall be determined in accordance with Regulations Section 1.704-2(i)(4). This provision is intended to comply with the minimum gain chargeback requirement in Regulations Section 1.704-2(i)(4) and shall be interpreted consistently therewith. Member Nonrecourse Deductions. Any member nonrecourse deductions, determined in accordance with Treas. Reg. Section 1.704-2(i)(1) for any fiscal year or other period shall be specially allocated to the Member who bears the economic risk of loss with respect to the member nonrecourse debt to which such member nonrecourse deductions are attributable in accordance with Regulations Section 1.704-2(i). Deemed Capital Account Balance. Solely for purposes of Section 5.1.1.1 and Section 5.1.2.2, the Capital Account balance of each Member shall be determined by increasing the amount in such Member's Capital Account by the amount such Member is deemed obligated to restore to the Company under Treasury Regulation Section 1.704-1(b)(2)(ii)(d) as a result of the application of Treasury Regulation Sections 1.704-2(g)(1) and 1.704-2(i)(5). -2- EX-10.20 3 1998 IIS-TAIWAN STOCK PLAN 1 EXHIBIT 10.20 INTEGRATED SILICON SOLUTION, INC. 1998 ISSI-TAIWAN STOCK PLAN 1. Purposes of the Plan. The purposes of this Plan are to attract and retain the best available personnel for positions of substantial responsibility to provide additional incentive to Employees and Consultants of the Company and its Subsidiaries and to promote the success of the Company's business. Only nonstatutory stock options for shares of Integrated Silicon Solution (Taiwan), Inc. ("ISSI-Taiwan") may be granted under the Plan. 2. Definitions. As used herein, the following definitions shall apply: (a) "Administrator" means the Board or any of its Committees appointed pursuant to Section 4 of the Plan. (b) "Applicable Laws" means the requirements relating to the administration of stock option plans under U.S. state corporate laws, U.S. federal and state securities laws, the Code, the laws of the Republic of China applicable to ISSI-Taiwan, any stock exchange or quotation system on which the Common Stock is listed or quoted and the applicable laws of any other country or jurisdiction where Options are granted under the Plan. (c) "Board" means the Board of Directors of the Company. (d) "Code" means the Internal Revenue Code of 1986, as amended. (e) "Committee" means the Committee appointed by the Board of Directors in accordance with paragraph (a) of Section 4 of the Plan. (f) "Common Stock" means the Common Stock of Integrated Silicon Solution (Taiwan), Inc., a company formed under the laws of the Republic of Taiwan. (g) "Company" means Integrated Silicon Solution, Inc., a Delaware corporation. (h) "Consultant" means any person, including an advisor, who is engaged by the Company or any parent, subsidiary or affiliate to render services, and any director of the Company whether compensated for such services or not. (i) "Continuous Status as an Employee or Consultant" means the absence of any interruption or termination of service as an Employee or Consultant. Continuous Status as an Employee or Consultant shall not be considered interrupted in the case of: (i) sick leave; (ii) military leave; (iii) any other leave of absence approved by the Company; (iv) transfer between locations of -1- 2 the Company or between the Company, its subsidiaries, successors or affiliates; or (v) change in status from Employee to Consultant or Consultant to Employee. (j) "Employee" means any person, including officers and directors, employed by the Company or any parent, subsidiary or affiliate of the Company. The payment of a director's fee by the Company shall not be sufficient to constitute "employment" by the Company. (k) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (l) "Fair Market Value" means, as of any date, the value of Common Stock determined as follows: (i) If the Common Stock is listed on any established stock exchange or a national market system including without limitation the National Market System of the National Association of Securities Dealers, Inc. Automated Quotation ("NASDAQ") System, its Fair Market Value shall be the closing sales price for such stock (or the closing bid, if no sales were reported, as quoted on such system or exchange, for the last market trading day prior to the time of determination) as reported in the Wall Street Journal or such other source as the Administrator deems reliable; (ii) If the Common Stock is quoted on the NASDAQ System (but not on the National Market System thereof) or regularly quoted by a recognized securities dealer but selling prices are not reported, its Fair Market Value shall be the mean between the high and low asked prices for the Common Stock or; (iii) In the absence of an established market for the Common Stock, the Fair Market Value thereof shall be determined in good faith by the Administrator. (m) "Option" means a nonstatutory stock option granted pursuant to the Plan. Such option is not intended to qualify as an incentive stock option within the meaning of Section 422 of the Code. (n) "Optioned Stock" means the Common Stock subject to an Option. (o) "Optionee" means an Employee or Consultant who receives an Option. (p) "Parent" means a "parent corporation," whether now or hereafter existing, as defined in Section 424(e) of the Code. (q) "Plan" means this Nonstatutory Stock Plan. (r) "Share" means a share of the Common Stock, as adjusted in accordance with Section 12 of the Plan. -2- 3 (s) "Subsidiary" means a "subsidiary corporation," whether now or hereafter existing, as defined in Section 424(f) of the Code. 3. Stock Subject to the Plan. Subject to the provisions of Section 12 of the Plan, the maximum aggregate number of shares which may be optioned and sold under the Plan is Twelve Million (12,000,000) shares of Common Stock. The shares may be authorized, but unissued, or reacquired Common Stock. If an Option should expire or become unexercisable for any reason without having been exercised in full, the unpurchased Shares which were subject thereto shall, unless the Plan shall have been terminated, become available for future grant under the Plan. 4. Administration of the Plan. (a) Administration. The Plan shall be administered by (i) the Board or (ii) a Committee designated by the Board, which Committee shall be constituted to satisfy Applicable Laws. Once appointed, such Committee shall serve in its designated capacity until otherwise directed by the Board. The Board may increase the size of the Committee and appoint additional members, remove members (with or without cause) and substitute new members, fill vacancies (however caused), and remove all members of the Committee and thereafter directly administer the Plan, all to the extent permitted by Applicable Laws. (b) Powers of the Administrator. Subject to the provisions of the Plan and in the case of a Committee, the specific duties delegated by the Board to such Committee, the Administrator shall have the authority, in its discretion: (i) to determine the Fair Market Value of the Common Stock; (ii) to select the Consultants and Employees to whom Options may from time to time be granted hereunder; (iii) to determine whether and to what extent Options, are granted hereunder; (iv) to determine the number of shares of Common Stock to be covered by each such award granted hereunder; (v) to approve forms of agreement for use under the Plan; (vi) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any award granted hereunder (including, but not limited to, the share price and any restriction or limitation, or any vesting acceleration or waiver of forfeiture restrictions regarding any Option and/or the shares of Common Stock relating thereto, based in each case on such factors as the Administrator shall determine, in its sole discretion); -3- 4 (vii) to determine whether and under what circumstances an Option may be settled in cash under Section 9(e) instead of Common Stock; (viii) to determine whether, to what extent and under what circumstances Common Stock and other amounts payable with respect to an award under this Plan shall be deferred either automatically or at the election of the participant (including providing for and determining the amount, if any, of any deemed earnings on any deferred amount during any deferral period); and (ix) to reduce the exercise price of any Option to the then current Fair Market Value if the Fair Market Value of the Common Stock covered by such Option shall have declined since the date the Option was granted. (c) Effect of Administrator's Decision. All decisions, determinations and interpretations of the Administrator shall be final and binding on all Optionees and any other holders of any Options. 5. Eligibility. (a) Options may be granted to Employees or Consultants. (b) The Plan shall not confer upon any Optionee any right with respect to continuation of employment or consulting relationship with the Company, nor shall it interfere in any way with his right or the Company's right to terminate his employment or consulting relationship at any time, with or without cause. 6. Term of Plan. The Plan shall become effective upon its adoption by the Board of Directors. It shall continue in effect for a term of ten (10) years unless sooner terminated under Section 14 of the Plan. 7. Term of Option. The term of each Option shall be the term stated in the Option Agreement; provided, however, that the term shall be no more than ten (10) years from the date of grant thereof. 8. Option Exercise Price and Consideration. (a) The per share exercise price for the Shares to be issued pursuant to exercise of an Option shall be no less than 85% of the Fair Market Value per Share on the date of grant; provided, however, that Shares granted to an Employee or Consultant who, at the time of grant of such option, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the exercise price shall be no less than 110% of the Fair Market Value per Share on the date of grant. (b) The consideration to be paid for the Shares to be issued upon exercise of an Option, including the method of payment, shall be determined by the Administrator and may consist -4- 5 entirely of (1) cash, (2) check, (3) promissory note, (4) delivery of a properly executed exercise notice together with such other documentation as the Administrator and the broker, if applicable, shall require to effect an exercise of the Option and delivery to the Company of the sale or loan proceeds required to pay the exercise price; (5) any combination of the foregoing methods of payment, (6) or such other consideration and method of payment for the issuance of Shares to the extent permitted under Applicable Laws. 9. Exercise of Option. (a) Procedure for Exercise; Rights as a Stockholder. Any Option granted hereunder shall be exercisable at such times and under such conditions as determined by the Board, including performance criteria with respect to the Company and/or the Optionee, and as shall be permissible under the terms of the Plan. Except in the case of Options granted to Officers and Consultants, Options shall become exercisable at a rate of no less than 20% per year over five (5) years from the date the Options are granted. Unless the Administrator provides otherwise, vesting of Options granted hereunder to Officers shall be tolled during any unpaid leave of absence. An Option may not be exercised for a fraction of a Share. An Option shall be deemed to be exercised when written notice of such exercise has been given to the Company in accordance with the terms of the Option by the person entitled to exercise the Option and full payment for the Shares with respect to which the Option is exercised has been received by the Company. Full payment may, as authorized by the Board, consist of any consideration and method of payment allowable under Section 8(b) of the Plan. Until the issuance (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent for ISSI-Taiwan) of the stock certificate evidencing such Shares, no right to vote or receive dividends or any other rights as a stockholder shall exist with respect to the Optioned Stock, notwithstanding the exercise of the Option. The Company shall issue (or cause ISSI-Taiwan or its transfer agent to issue) such stock certificate promptly upon exercise of the Option. No adjustment will be made for a dividend or other right for which the record date is prior to the date the stock certificate is issued, except as provided in Section 12 of the Plan. Exercise of an Option in any manner shall result in a decrease in the number of Shares which thereafter may be available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised. (b) Termination of Employment. In the event of termination of an Optionee's Continuous Status as an Employee or Consultant, such Optionee may, but only within thirty (30) days (or within such longer period of time as is determined by the Board), after the date of such termination (but in no event later than the expiration date of the term of such Option as set forth in the Option Agreement), exercise his Option to the extent that Optionee was entitled to exercise it at the date of such termination. To the extent that Optionee was not entitled to exercise the Option at the date of such termination, or if Optionee does not exercise such Option to the extent so entitled within the time specified herein, the Option shall terminate. -5- 6 (c) Disability of Optionee. Notwithstanding the provisions of Section 9(b) above, in the event of termination of an Optionee's Continuous Status as an Employee or Consultant as a result of his total and permanent disability (as defined in Section 22(e)(3) of the Code), Optionee may, but only within twelve (12) months from the date of such termination (but in no event later than the expiration date of the term of such Option as set forth in the Option Agreement), exercise the Option to the extent otherwise entitled to exercise it at the date of such termination. To the extent that Optionee was not entitled to exercise the Option at the date of termination, or if Optionee does not exercise such Option to the extent so entitled within the time specified herein, the Option shall terminate. (d) Death of Optionee. Notwithstanding the provisions of Section 9(b) above, in the event of the death of an Optionee while Optionee is an Employee or Consultant, the Option may be exercised at any time within twelve (12) months following the date of death (but in no event later than the expiration date of the term of such Option as set forth in the Option Agreement), by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent the Optionee was entitled to exercise the Option at the date of death. To the extent that Optionee was not entitled to exercise the Option at the date of termination, or if Optionee does not exercise such Option to the extent so entitled within the time specified herein, the Option shall terminate. (e) Buyout Provisions. The Administrator may at any time offer to buy out for a payment in cash or Shares, an Option previously granted, based on such terms and conditions as the Administrator shall establish and communicate to the Optionee at the time that such offer is made. 10. Non-Transferability of Options. Unless otherwise provided for by the Administrator, the Option may not be sold, pledged, assigned, hypothecated, transferred, or disposed of in any manner other than by will or by the laws of descent or distribution and may be exercised, during the lifetime of the Optionee, only by the Optionee. 11. Stock Withholding to Satisfy Withholding Tax Obligations. At the discretion of the Administrator, Optionees may satisfy withholding obligations as provided in this paragraph. When an Optionee incurs tax liability in connection with an Option, which tax liability is subject to tax withholding under applicable tax laws, and the Optionee is obligated to pay the Company an amount required to be withheld under applicable tax laws, the Optionee may satisfy the withholding tax obligation by electing to have the Company withhold from the Shares to be issued upon exercise of the Option, if any, that number of Shares having a Fair Market Value equal to the amount required to be withheld. The Fair Market Value of the Shares to be withheld shall be determined on the date that the amount of tax to be withheld is to be determined (the "Tax Date"). All elections by an Optionee to have Shares withheld for this purpose shall be made in writing in a form acceptable to the Administrator and shall be subject to the following restrictions: (a) the election must be made on or prior to the applicable Tax Date; -6- 7 (b) once made, the election shall be irrevocable as to the particular Shares of the Option as to which the election is made; (c) all elections shall be subject to the consent or disapproval of the Administrator; In the event the election to have Shares withheld is made by an Optionee and the Tax Date is deferred under Section 83 of the Code because no election is filed under Section 83(b) of the Code, the Optionee shall receive the full number of Shares with respect to which the Option is exercised but such Optionee shall be unconditionally obligated to tender back to the Company the proper number of Shares on the Tax Date. 12. Adjustments Upon Changes in Capitalization, Dissolution, Merger or Asset Sale. (a) Changes in Capitalization. Subject to the Company having the number of shares of ISSI-Taiwan owned by the Company adjusted, the number of shares of Common Stock covered by each outstanding Option, and the number of shares of Common Stock which have been authorized for issuance under the Plan but as to which no Options have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Option, as well as the price per share of Common Stock covered by each such outstanding Option, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by ISSI-Taiwan; provided, however, that conversion of any convertible securities of ISSI-Taiwan shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by ISSI-Taiwan of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Option. (b) Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, the Board shall notify the Optionee at least fifteen (15) days prior to such proposed action. To the extent it has not been previously exercised, the Option will terminate immediately prior to the consummation of such proposed action. (c) Merger or Asset Sale. (i) In the event an Optionee's Continuous Status as an Employee or Consultant is terminated by the Company without cause (as determined by the Administration) within 12 months following (i) a merger of the Company with or into another corporation, or (ii) the sale of substantially all of the assets of the Company, the Optionee shall fully vest in and have the right to exercise the Option as to all of the Optioned Stock, including Shares as to which the Optionee would not otherwise be vested or exercisable. If the Option becomes fully vested and exercisable, the Administrator shall notify the Optionee in writing or electronically that the Option shall be fully vested -7- 8 and exercisable for a period of fifteen (15) days from the date of such notice. For the purposes of this paragraph, the Option shall be considered assumed if, following the merger or sale of assets, the option confers the right to purchase or receive, for each Share of Optioned Stock subject to the Option immediately prior to the merger or sale of assets, the consideration (whether stock, cash, or other securities or property) received in the merger or sale of assets by holders of Common Stock for each Share held on the effective date of the transaction (and if holders were offered a choice of consideration, the type of consideration chosen by the holders of a majority of the outstanding Shares); provided, however, that if such consideration received in the merger or sale of assets is not solely common stock of the successor corporation or its parent, the Administrator may, with the consent of the successor corporation, provide for the consideration to be received upon the exercise of the Option, for each Share or Optioned Stock subject to the Option, to be solely common stock of the successor corporation or its parent equal in fair market value to the per share consideration received by holders of Common Stock in the merger or sale of assets. (ii) In the event of (i) a merger of ISSI-Taiwan with or into another corporation where ISSI-Taiwan is not the surviving corporation, or (ii) the sale of substantially all of the assets of ISSI-Taiwan, the Option shall be exercisable (in accordance with the terms of the Option Agreement, including the vesting schedule) for the consideration (whether stock, cash, or other securities or property) received in the merger or sale of assets by holders of Common Stock on the effective date of the transaction (and if holders were offered a choice of consideration, the type of consideration chosen by the Company, or if the Company is not a holder at such time, by the holders of a majority of the outstanding Shares); provided, however, that if such consideration received in the merger or sale of assets is not solely common stock of the successor corporation or its Parent, the Administrator may, with the consent of the successor corporation, provide for the consideration to be received upon the exercise of the Option, for each Share of Optioned Stock subject to the Option, to be solely common stock of the successor corporation or its Parent equal in fair market value to the per share consideration received by holders of Common Stock in the merger or sale of assets. 13. Time of Granting Options. The date of grant of an Option shall, for all purposes, be the date on which the Administrator makes the determination granting such Option, or such other date as is determined by the Board. Notice of the determination shall be given to each Employee or Consultant to whom an Option is so granted within a reasonable time after the date of such grant. 14. Amendment and Termination of the Plan. (a) Amendment and Termination. The Board may at any time amend, alter, suspend or discontinue the Plan, but no amendment, alteration, suspension or discontinuation shall be made which would impair the rights of any Optionee under any grant theretofore made, without his or her consent. (b) Shareholder Approval. The Board shall obtain shareholder approval of any Plan amendment to the extent necessary and desirable to comply with Applicable Laws. -8- 9 (c) Effect of Amendment or Termination. Any such amendment or termination of the Plan shall not affect Options already granted and such Options shall remain in full force and effect as if this Plan had not been amended or terminated, unless mutually agreed otherwise between the Optionee and the Board, which agreement must be in writing and signed by the Optionee and the Company. 15. Conditions Upon Issuance of Shares. Shares shall not be issued pursuant to the exercise of an Option unless the exercise of such Option and the issuance and delivery of such Shares pursuant thereto shall comply with all relevant provisions of law, including, without limitation, the Securities Act of 1933, as amended (the "Securities Act"), the Exchange Act, the rules and regulations promulgated thereunder, the requirements of any stock exchange upon which the Shares may then be listed and any laws or regulations then applicable to ISSI-Taiwan, and shall be further subject to the approval of counsel for the Company and ISSI-Taiwan with respect to such compliance. As a condition to the exercise of an Option, the Company or ISSI-Taiwan may require the person exercising such Option to represent and warrant at the time of any such exercise that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares if, in the opinion of counsel for the Company or ISSI-Taiwan, such a representation is required by any of the aforementioned relevant provisions of law. 16. Reservation of Shares. The Company, during the term of this Plan, will at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan. The inability of the Company or ISSI-Taiwan to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company's counsel or counsel for ISSI-Taiwan to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained. 17. Agreements. Options shall be evidenced by written agreements in such form as the Board shall approve from time to time. 18. Rule 701. The issuer of the securities under this Plan within the meaning of Rule 701 under the Securities Act is ISSI-Taiwan. 19. Shareholder Approval. The Plan shall be subject to approval by the shareholders of ISSI-Taiwan within twelve (12) months after the date the Plan is adopted. Such shareholder approval shall be obtained in the degree and manner required under Applicable Laws. 20. Information to Optionees. The Company shall provide to each Optionee and to each individual who acquires Shares pursuant to the Plan, not less frequently than annually during the period such Optionee or purchaser has one or more Options outstanding, and, in the case of an -9- 10 individual who acquires Shares pursuant to the Plan, during the period such individual owns such Shares, copies of annual financial statements. The Company shall not be required to provide such statements to key employees whose duties in connection with the Company assure their access to equivalent information. -10- EX-23.1 4 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS 1 EXHIBIT 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements on Form S-3 No. 333-42245 pertaining to shares issued in connection with the acquisition of Nexcom Technology, Inc., and Form S-8 (including registration of shares for resale by means of a Form S-3 prospectus) Nos. 333-95282, 333-3438, 333-21635, and 333-50679 pertaining to the 1993 Employee Stock Purchase Plan, the 1995 Director Stock Option Plan, the 1989 Stock Plan and the Nonstatutory Stock Plan of Integrated Silicon Solution, Inc. of our report dated October 23, 1998, with respect to the consolidated financial statements and schedule of Integrated Silicon Solution, Inc. included in its Annual Report (Form 10-K) for the year ended September 30, 1998. /s/ ERNST & YOUNG LLP San Jose, California December 16, 1998 EX-27.1 5 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE AUDITED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH AUDITED FINANCIAL STATEMENTS FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1998. 1,000 YEAR SEP-30-1998 OCT-01-1997 SEP-30-1998 28,109 7,800 20,873 1,814 46,484 106,400 73,636 29,320 202,168 73,851 12,087 0 0 2 90,918 202,168 131,132 131,132 126,794 126,794 0 0 1,795 (39,377) 4,668 (43,933) 0 0 0 (43,933) (2.32) (2.32)
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