-----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, M8HyOV0taY4+NTU65Tq2UWuNy+Q3OzuJKbaMJj6DPyCT4pzKXxb8FYqJB7dbzfdw eFhhVDFv5vBUKasbALLbJQ== 0000891618-96-002953.txt : 19970825 0000891618-96-002953.hdr.sgml : 19970825 ACCESSION NUMBER: 0000891618-96-002953 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961202 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTEGRATED SILICON SOLUTION INC CENTRAL INDEX KEY: 0000854701 STANDARD INDUSTRIAL CLASSIFICATION: 3674 IRS NUMBER: 770199971 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-23084 FILM NUMBER: 96674996 BUSINESS ADDRESS: STREET 1: 680 ALMANOR DR CITY: SUNNYVALE STATE: CA ZIP: 94086 BUSINESS PHONE: 4087334774 MAIL ADDRESS: STREET 1: 680 ALMANOR AVE CITY: SUNNYVALE STATE: CA ZIP: 94086 10-K 1 FORM 10-K 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, 1996 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 Identification No.) incorporation or organization) 680 ALMANOR AVENUE, SUNNYVALE, CALIFORNIA 94086 (Address of principal executive offices) zip code Registrant's telephone number, including area code (408) 733-4774 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 nonaffiliates of the registrant, based upon the closing price of such stock on November 22, 1996, as reported by the Nasdaq National Market, was approximately $174.6 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 November 22, 1996 was 17,610,773. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Registrant's 1997 Annual Meeting of Stockholders to be held February 4, 1997 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................................................................... 8 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 11 Operations................................................................... 11 Item 8. Financial Statements and Supplementary Data.................................. 19 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................................................................... 40 PART III Item 10. Directors and Executive Officers of the Registrant........................... 40 Item 11. Executive Compensation....................................................... 40 Item 12. Security Ownership of Certain Beneficial Owners and Management............... 40 Item 13. Certain Relationships and Related Transactions............................... 40 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.............. 40 SIGNATURES............................................................................ 43
3 Part I ITEM 1. BUSINESS GENERAL Integrated Silicon Solution, Inc. ("ISSI" or the "Company") designs, develops and markets high performance static random access memory ("SRAM") and nonvolatile memory ("NVM") integrated circuits. The Company's memory devices are used in networking applications, telecommunications, personal computers ("PC"), disk drives, data communications, office automation, instrumentation and consumer products. SRAM products include both asynchronous and synchronous devices ranging in densities from 64K to 1 megabit. Nonvolatile memory products include EPROMs (erasable programmable read only memories), EEPROMs (electrically erasable programmable read only memories) and FLASH memories. The Company has its headquarters in Sunnyvale, California and markets its products on a worldwide basis. The primary function of SRAMs is to improve overall system performance 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 addition, when designing systems with SRAMs, customers 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 and be able to implement design improvements, such as reduced geometries, quickly through short product design cycles. 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 differentiate it from traditional fabless companies and allow it to secure 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 and nonvolatile memories. The Company also has a collaborative program with Chartered Semiconductor Manufacturing ("Chartered") in Singapore and with Belling Semiconductor ("Belling") in the People's Republic of China. In addition, the Company has a manufacturing program with United Microelectronics Corporation ("UMC") in Taiwan. The Company has made an equity investment in a joint venture with TSMC and an equity investment in a joint venture with UMC. The Company has its headquarters in Sunnyvale, California. This facility focuses on research and development, product definition, quality assurance and marketing and sales. The Company has a wholly owned subsidiary in Taiwan. This subsidiary, located in the Hsinchu Science-Based Industrial Park, focuses on manufacturing coordination, quality assurance, product test and regional sales in the Asian market. The Company also has smaller subsidiaries in Hong Kong and China. PRODUCTS The Company designs and markets a family of high performance, low cost SRAMs, as well as NVM products, including high speed EPROMS, serial EEPROMs, FLASH and Voice EPROMs. The Company began shipping its initial SRAM products in 1990 and its first NVM product in 1992. To date the Company has derived substantially all of its revenues from the sale of SRAM products. 1 4 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 1 megabit (128K x 8 and 32K x 32). The Company produces both asynchronous SRAMs and synchronous SRAMs. Synchronous SRAMs are designed to operate at a clock speed synchronized to the microprocessor clock speed to increase speed performance. The Company's 1 megabit 32K x 32 synchronous SRAM currently achieves 5 nanosecond access time. 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 a 9 nanosecond access time. In late 1994, the Company introduced its first 3.3 volt SRAM product, a 256K configuration. Currently, the Company's 3.3 volt SRAMs are produced in the 32K x 8 asynchronous and 32K x 32 synchronous version and are generally used in PC cache applications. The Company's 5 volt SRAMs are used in applications such as modems, LANs, telecommunications, bridges, routers, multimedia products and industrial instrumentation. Additional SRAM products are under development and are expected to include higher density products and alternative configurations allowing for wider bus widths. NONVOLATILE MEMORY PRODUCTS The Company's NVM products include high performance FLASH, EPROMS, serial EEPROMs and voice recording chips. FLASH and EPROMs are typically used in electronic systems which require permanent storage of data or program control code. The Company's EPROM development program focuses on high speed products. In this regard, the Company's 1 megabit EPROM achieves a read cycle of 30 nanoseconds. In December 1995, the Company entered into a cross license agreement for FLASH technology with Intel. This enables the Company to design its own FLASH products and FLASH process technology with Intel-compatible architecture. The Company produces a high speed 45 nanosecond 1 megabit FLASH and a 55 nanosecond 2 megabit FLASH. FLASH memory combines the low cost and high density benefits of EPROMs with the in-system programmability of EEPROMs. High speed EPROM and FLASH applications include modems, printers, digital phones and industrial instrumentation. The Company introduced its first serial EEPROM product in 1993. Serial EEPROMs are used in applications that require nonvolatile storage of data or code and which also 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 also produces a Voice EPROM product in which voice algorithm technology is embedded in its EPROM. Initial applications for Voice EPROM products are in consumer electronics such as voice recorded greeting cards. DESIGN AND PROCESS TECHNOLOGY The Company's process technology development efforts concentrate on process flow architecture, process modules, memory core cell development and manufacturing yield enhancement. 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, to develop new process technologies, refine existing process technologies, and to reduce the circuit geometries of its products. During 1996, the Company and TSMC developed 0.35 micron, 3.3 volt high speed SRAM process technology. The Company currently has several development programs with TSMC, including a program based on a 0.25 micron design for advanced SRAM applications and a 0.5 micron design for a high speed FLASH memory product. The Company's collaborative efforts with Chartered focus on 0.35 micron SRAM process technology. In 1995, both TSMC and Chartered began shipping 8" wafers which employed the Company's SRAM design and process technology. The Company's collaborative efforts with Belling focus on EEPROM design and process technology. 2 5 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 develop products in related memory areas including memory embedded into other functions such as the voice recording chip. In addition, the Company has developed proprietary product test software that allows it to test products accurately and cost effectively in high volumes. MANUFACTURING The Company has adopted a fabless manufacturing strategy with the objective of establishing collaborative manufacturing relationships with selected semiconductor wafer manufacturers. As memory products are particularly well suited for the development of advanced process technology, the Company targets partners with which it can actively participate in developing and refining the process technology used to manufacture its specific products and apply the technology on an accelerated basis to bring new products to market rapidly. The Company believes that its fabless strategy enables it to introduce high performance memory products quickly and at low cost. To date, the Company's principal manufacturing relationship has been with TSMC, whereby the Company provides TSMC with design and process expertise in return for access to advanced process technology and committed wafer capacity at TSMC's wafer fabrication facilities. The Company also has a collaborative manufacturing relationship with Chartered for SRAM and FLASH products. In 1995, the Company entered into a manufacturing joint venture agreement with UMC that is expected to result in the delivery of wafers to the Company beginning in late 1997 until 2005. The joint venture agreement requires an equity investment by the Company of approximately $30 million of which approximately $7.0 million had been paid as of September 30, 1996. In 1996, the Company entered into a joint venture agreement with Altera Inc., Analog Devices Inc. and TSMC wherein TSMC, as the general partner, will 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, 0.25 and 0.18 micron process technology. The joint venture, named WaferTech LLC, is expected to reach full production in approximately 1999/2000. The joint venture agreement requires an equity investment by the Company of $31.2 million of which, at September 30, 1996, $9.4 million had been paid. The Company has a technology transfer program with Belling Semiconductor in China. The Company has assisted Belling with certain EEPROM process technology and has begun to receive a limited supply of low cost wafers from Belling. The manufacturing of the Company's products is coordinated 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. The Science Park location provides certain advantages, including preferential tax treatment, streamlined customs administration and government-subsidized development grants. After receiving wafers from its independent wafer foundries, the Company performs its own wafer probe testing, laser repair, and final testing in its product test facility at ISSI-Taiwan, which operates on a multiple shift basis. The Company's U.S. headquarters includes a smaller scale, duplicate product test facility used primarily to develop test programs and test procedures and to supplement product test capacity 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 and the Company's Taiwan facility has received certification under ISO 9002 standards. 3 6 Each of the Company's wafer suppliers also fabricates for other integrated circuit companies, including certain of the Company's competitors. In addition, UMC manufactures integrated circuits, including SRAMs, for its own account. During 1995, the semiconductor industry, including the Company, experienced wafer capacity shortages. In 1996, the industry, including the Company, experienced a general oversupply of wafers. Although the Company has written commitments for increasing capacity on a year-to-year basis, the Company would currently have little or no recourse if a wafer supplier chose to prioritize capacity for other use or reduce or eliminate deliveries to the Company. The equity investment arrangements and related purchase agreements by the Company with TSMC and UMC will provide the Company with guaranteed capacity, and thus will mitigate this risk in the future. However, these fabrication facilities are not yet operational. Although currently there is a general oversupply of wafer capacity, there can be no assurance that the Company's foundries 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. In addition, since the construction of a wafer fabrication facility is a lengthy and complex endeavor, there can be no assurance that the TSMC joint venture fabrication facility or the UMC joint venture fabrication facility will be successfully completed and successfully enter into production. 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 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, 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 in the future, which could materially and adversely affect the Company's business and operating results. The Company has certain minimum wafer purchasing commitments to its foundry partners in exchange for wafer capacity commitments. The Company agreed to make certain annual payments to TSMC for capacity increases. Additional required payments to TSMC totaling approximately $31.2 million over the next four years represent annual increases in capacity which must be purchased by the Company. The Company has minimum purchase obligations for its joint venture with UMC and WaferTech LLC. 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 original equipment manufacturers ("OEM") and PC motherboard manufacturers. The Company's SRAM products are used primarily in high speed modems, local area networks, bridges and routers, PC cache, disk drives, cellular phones and adaptor cards. The Company's nonvolatile memory products have a wide range of memory applications, including high speed modems, local area networks, adaptor cards, cellular telephones and electronic games. In fiscal 1996, one customer, U.S. Robotics, a manufacturer of modems, networking equipment and access hardware for internet service providers, accounted for approximately 22% of the Company's net sales. In fiscal 1995 and 1994, no customer accounted for more than 10% of the Company's net sales. In the United States, the Company markets its products through a direct sales force and independent sales representatives. The Company engaged a U.S. distributor in 1995, and added a second U.S. distributor in 1996. The Company is continuing to expand its marketing and sales activity in Europe. 4 7 The Company 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. In addition, the Company is in the process of expanding its sales and distribution efforts in other Asian countries, in particular Japan, Hong Kong, Singapore, Korea and the People's Republic of China. The Company markets and distributes its products on a worldwide basis. In fiscal 1996, approximately 53% of the Company's net sales were attributable to customers located in the United States, 10% was attributable to customers located in Europe and 37% was attributable to customers located in Asia. In fiscal 1995, approximately 35% of the Company's net sales were attributable to customers located in the United States, 9% was attributable to customers located in Europe and 56% was attributable to customers located in Asia. In fiscal 1994, approximately 34% of the Company's net sales were attributable to customers located in the United States, 1% was attributable to customers located in Europe and 65% was attributable to customers located in Asia. In fiscal 1996, 1995, and 1994, international sales (sales by ISSI-Taiwan and export sales by ISSI-U.S.) comprised approximately 47%, 65% and 68% of the Company's net sales, respectively. See Note 11 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. The Company's Taiwan subsidiary employs over one-half of the Company's total work force. 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 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. Although the Company's business and results of operations have not been materially and adversely impacted by exchange rate fluctuations, 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. Sales are generally made pursuant to standard purchase orders, which can be revised during the agreement term to reflect changes in the customer's requirements. The Company has also entered into master purchase agreements with certain of its OEM customers. These agreements do not require the OEMs to purchase minimum quantities of the Company's products. Product deliveries are scheduled upon the Company's receipt of purchase orders under the related OEM agreements. Generally, these 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 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 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 and performance, successful and timely product development, wafer supply and 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 5 8 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 Alliance Semiconductor, Cypress Semiconductor, Integrated Device Technology ("IDT"), Micron Technology, Motorola, Samsung, Sony, Toshiba, UMC and Winbond. The Company also competes with new and emerging companies 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 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. The Company believes that the principal competitive factor in the market for EPROM and EEPROM is price and speed, respectively. In the area of FLASH memory, the Company faces competition from companies that have already established FLASH memory products, particularly Intel and AMD. 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 rights 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 its high performance memory products and jointly develops advanced process technology with its manufacturing partners from its headquarters in Sunnyvale, California. The Company's Taiwan and Hong Kong subsidiaries are responsible for the development of application-specific products, such as the Voice EPROM. The Company is currently designing new SRAM and nonvolatile products. SRAM products under development include both 3.3 volt and 5 volt designs. Nonvolatile memory programs include the development of higher density FLASH products. Several new product families are also under development. The Company's technology and product development expenditures in fiscal 1996, 1995 and 1994 were $21.4 million, $14.9 million and $8.8 million, respectively. 6 9 PATENTS As of September 30, 1996, the Company held four U.S. patents and has a fifth patent allowed but not yet issued. This fifth patent was subsequently issued on October 22, 1996. These patents expire between 2010 and 2013. The Company expects to continue to file patent applications where appropriate to protect its proprietary technologies; however, 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 may from time to time continue to be notified of claims that it may be infringing patents, maskwork rights or copyrights owned by third parties. In this regard, the Company has been notified by several companies that it may be infringing certain patents with respect to its products and underlying process technology. Although none of these companies have pursued a claim against the Company, there is no assurance that these or 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 which may be necessary to 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. EMPLOYEES As of September 30, 1996, the Company had approximately 380 employees, of which 219 were based in Taiwan, 149 in the U.S., 7 in the People's Republic of China and 5 in Hong Kong. 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, 1996 are as follows:
Name Age Position Jimmy S.M. Lee 41 Chairman, Chief Executive Officer, President, and Director Kong-Yeu Han 41 Executive Vice President, Office of the President, General Manager-Taiwan and Director Gary L. Fischer 45 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 Chief Financial Officer since June 1993. He also served as Vice President, Finance and Administration from December 1993 to April 1995 and as Vice President, Finance from June 1993 to December 1993. 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. ITEM 2. PROPERTIES The Company's U.S. headquarters occupies two leased facilities, totaling approximately 43,000 square feet, in Sunnyvale, California in which its executive offices, technology and product development groups and some testing facilities are located. The leases on these facilities expire in May 1997. ISSI-Taiwan occupies two leased facilities totaling approximately 48,000 square feet in the Hsinchu Science-Based Industrial Park in Hsinchu, Taiwan. These leases expire in October and November 1997 and are 8 11 subject to annual renewal. The Company also leases sales offices in five states, Taipei, Taiwan and China and engineering offices in Hong Kong. The Company entered into a ten year lease effective December 1, 1996 for a facility in Santa Clara, California totaling 93,000 square feet. The lease expires in February 2007. The Company intends to sublease approximately 23,000 square feet of this space to a third party. The Company plans to vacate its two leased facilities in Sunnyvale, California and relocate to the Santa Clara facility in late December 1996. The Company needs additional space in Taiwan to accommodate its growth. In this regard, the Company has begun the construction of a building of approximately 225,000 square feet in the Hsinchu Science-Based Industrial Park to house its Taiwan operation at a cost of approximately $18 million. Occupancy is expected to begin in late 1997. ITEM 3. LEGAL PROCEEDINGS On December 13, 1995, a securities class action lawsuit was filed in the United States District Court for the Northern District of California against the Company, certain of its officers and directors, and the co-lead underwriters for the company's initial public offering and secondary offering, on behalf of all persons who purchased the Company's common stock between February 3, 1995, and December 5, 1995 (the "Lawsuit"). The Lawsuit asserts claims under Section 11 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934, and Rule 10b-5 promulgated thereunder. The Lawsuit seeks damages in an unspecified amount. The Company believes it has meritorious defenses to the Lawsuit and intends to defend the case vigorously. 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 1996. 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 on February 3, 1995 at $13.00 per share. 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.
Fiscal Year ending September 30, 1996 High Low ------- ------- Fourth quarter $13.375 $ 8.00 Third quarter 19.125 10.625 Second quarter 18.75 11.375 First quarter 38.00 15.00
Fiscal Year ending September 30, 1995 High Low ------ ------ Fourth quarter $73.25 $31.50 Third quarter 58.25 31.75 Second quarter (from February 3, 1995) 43.50 16.75
HOLDERS OF RECORD As of November 22, 1996, there were approximately 321 stockholders of record for 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 9 of Notes to Consolidated Financial Statements. 10 13 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Fiscal Year Ended September 30, 1996 1995 1994 1993 1992 --------- -------- ------- ------- ------- (in thousands, except per share data) Net sales $ 132,039 $123,201 $60,836 $52,662 $29,140 Gross margin 31,855 62,252 20,553 15,671 6,084 Operating income (loss) (4,683) 34,476 4,994 5,755 494 Net income 1,015 29,653 4,612 5,782 555 Net income per share (1) 0.06 1.79 0.34 -- -- Working capital 107,929 120,839 16,648 11,957 7,404 Total assets 178,039 204,441 33,243 28,883 21,435 Total long-term obligations, notes payable, and current portion of long-term obligations 14,534 33,888 1,526 2,963 2,940 Stockholders' equity 142,435 139,909 21,187 15,963 10,615 Dividends paid -- -- -- -- --
- - --------------------- (1) See Note 1 of Notes to Consolidated Financial Statements for an explanation of the basis used to calculate net income per share. Prior to 1994, Statements of Income omit the historical net income per share as it was not presented in the Company's initial public offering registration statement. 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 FISCAL YEAR ENDED SEPTEMBER 30, 1996 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30, 1995 Net Sales. Net sales consist principally of total product sales less estimated sales returns. Net sales increased by 7% to $132.0 million in fiscal 1996 from $123.2 million in fiscal 1995. The Company's SRAM product family accounted for a substantial majority of total net sales in fiscal 1996 and 1995. During fiscal 1996, there was a significant drop in the average selling prices of SRAM products due to worldwide over capacity. Although the Company increased its unit shipments of SRAM products in fiscal 1996 from fiscal 1995, this increase in unit shipments was generally offset by lower average selling prices. The increase in total sales of approximately 7% was primarily attributable to growth in the Company's NVM product line sales which more than doubled in fiscal 1996 compared to fiscal 1995. During fiscal 1996 and 1995, the Company's 256K SRAM products accounted for a majority of its net sales. Although the Company anticipates that its 256K SRAM products will continue to account for a significant portion of sales, the proportion of such sales is expected to decline as demand shifts to higher density products, particularly the 512K and 1 megabit products. The Company believes that the average selling prices of its existing products will continue to decline for the next several quarters. There can be no assurance that such declines will be offset by higher volumes or by higher prices on newer products. See "Certain Factors - Quarterly Fluctuations and Declines in Average Selling Prices". Gross Profit. The Company's cost of revenues includes die cost from the wafers acquired from foundries, subcontracted package and assembly costs and costs associated with in-house product testing and quality assurance. Gross profit decreased 49% to $31.9 million in fiscal 1996 from $62.3 million in fiscal 1995. As a percentage of net sales, gross profit decreased to 24.1% for fiscal 1996 from 50.5% for fiscal 1995. The decline in gross margin includes a $15.0 million write-down of inventory recorded in the June 1996 quarter. There can be no assurance that additional inventory write-downs will not be needed in the future and such write-downs could have a material adverse affect on the Company's future operating 11 14 results. The general decrease in gross profit was primarily the result of lower average selling prices for the Company's SRAM products in fiscal 1996 compared to fiscal 1995. The Company experienced a significant drop in the average selling prices of its SRAM products in fiscal 1996 and, to a lesser extent, a decline in the average selling prices of its NVM products. Although product costs were also generally lower in fiscal 1996, the significant drop in average selling prices resulted in lower gross margins. 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. The Company has product cost reduction programs in place and believes that the excess wafer capacity at its suppliers will result in reduced wafer costs. However, there can be no assurance that product cost reductions will occur or that such possible reductions will be sufficient to offset the expected declines in average selling prices. Research and Development. Research and development expenses increased by 44% to $21.4 million in fiscal 1996 from $14.9 million in fiscal 1995. As a percentage of net sales, research and development expenses increased to 16.2% in fiscal 1996, from 12.1% in fiscal 1995. The increase 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 1996, the Company's development efforts principally focused on geometry reductions for its memory products, synchronous SRAMs, wider bus width SRAMs such as 64K x 32 and 32K x 16 configurations, Flash memories, Voice EPROMs, and other memory related products. The Company anticipates that its research and development expenses will increase in absolute dollars in future periods, although such expenses may fluctuate as a percentage of net sales. Selling, General and Administrative. Selling, general and administrative expenses increased by 18% to $15.2 million in fiscal 1996 from $12.9 million in fiscal 1995. As a percentage of net sales, selling, general and administrative expenses increased to 11.5% in fiscal 1996, from 10.5% in fiscal 1995. The increase was primarily the result of the addition of marketing and sales personnel, payroll related expenses and increased selling commissions. The Company expects its selling, general and administrative expenses to increase in absolute dollars in future periods as it continues to expand its sales and marketing efforts, although such expenses may fluctuate as a percentage of net sales. Interest and other income, Net. Interest and other income, net increased to $4.5 million in fiscal 1996 from $2.5 million in fiscal 1995, primarily due to increased net interest earnings as a result of higher cash and short-term investment balances. Benefit for Income Taxes. The Company recorded a tax benefit of $1,158,000 for fiscal year 1996 which was primarily attributable to a net loss before income taxes, the Company's Taiwan tax exemption and investment tax credits earned in Taiwan. As a result of its location in the Hsinchu Science-Based Industrial Park in Taiwan, ISSI-Taiwan receives a significant tax exemption for taxable income from October 1, 1992 through September 30, 1997. 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. For fiscal 1996, the Company was able to reduce current taxes payable by approximately $1,510,000 ($0.08 per share) related to this exemption. In addition, the Company recognized benefits from investment tax credits in Taiwan of approximately $1,018,000 in the current fiscal year. 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. 12 15 The Company has established a valuation allowance covering a portion of the gross deferred tax assets based on management's expectations of future taxable income and the actual taxable income during the three years ended September 30, 1996. Approximately $1,832,000 of the valuation allowance at September 30, 1996 is attributable to tax benefits of stock option deductions which will be credited to paid in capital when realized. FISCAL YEAR ENDED SEPTEMBER 30, 1995 COMPARED TO FISCAL YEAR ENDED SEPTEMBER 30, 1994 Net Sales. Net sales increased by 103% to $123.2 million in fiscal 1995 from $60.8 million in fiscal 1994. The increase in sales was principally due to increased unit shipments of SRAM products and, to a lesser extent, nonvolatile memory products, changes in product mix to lower voltage (3.3v) and higher density products, and higher average selling prices for the Company's SRAM products. The increased units were a result of increased wafer allocation from the Company's primary outside foundry, TSMC, and design improvements which resulted in more die per wafer. The Company generally experienced increasing average selling prices for its SRAM products in fiscal 1995 compared to fiscal 1994 due to a general shortage of wafer capacity in the industry. Gross Profit. Gross profit increased 203% to $62.3 million in fiscal 1995 from $20.6 million in fiscal 1994. As a percentage of net sales, gross profit increased to 50.5% for fiscal 1995 from 33.8% for fiscal 1994. This change was a result of increased shipments in fiscal 1995 of higher margin products such as the 3.3 volt 256K SRAM and the higher density 512K and 1 Meg SRAMs, higher average selling prices for SRAM products in general, and reduced die costs as a result of advances in design geometries from 0.64 and 0.60 micron to 0.5 micron for the Company's primary products. Research and Development. Research and development expenses increased by 70% to $14.9 million in fiscal 1995 from $8.8 million in fiscal 1994. As a percentage of net sales, research and development expenses decreased to 12.1% in fiscal 1995 from 14.4% in fiscal 1994. The increase in absolute dollars was primarily the result of an increase in engineering personnel, including the establishment of an engineering group in the People's Republic of China, and increased expenses related to the development of new products. Selling, General and Administrative. Selling, general and administrative expenses increased by 90% to $12.9 million in fiscal 1995 from $6.8 million in fiscal 1994. As a percentage of net sales, selling, general and administrative expenses decreased to 10.5% in fiscal 1995 from 11.2% in fiscal 1994. The increase in absolute dollars was primarily the result of increased sales commissions as the Company expanded its network of manufacturing representatives and added marketing and sales personnel. Interest and other income, Net. Interest and other income, net increased to $2.5 million in fiscal 1995 from $0.4 million in fiscal 1994, primarily due to increased net interest income as a result of higher cash and short-term investment balances. Provision for Income Taxes. As a result of its location in the Hsinchu Science-Based Industrial Park in Taiwan, ISSI-Taiwan receives a significant tax exemption for taxable income from October 1, 1992 through September 30, 1997. For fiscal 1995, the Company recognized a tax benefit of approximately $5.0 million ($0.30 per share) related to this exemption. For fiscal 1995, the Company increased its provision for income taxes to 20% of income before income taxes and minority interest as compared to 15% for fiscal 1994, primarily reflecting increased operating income attributable to the Company's U.S. operations. The Company's consolidated effective tax rate for any given period is calculated by dividing the total provision for income taxes incurred by the Company and each of its subsidiaries by consolidated pre-tax income before minority interest in net loss of consolidated subsidiary. Losses incurred by one subsidiary generally are not deductible by another subsidiary in calculation of their respective taxes. Therefore, the relative earnings of the Company and its subsidiaries would affect the Company's consolidated effective tax rate. 13 16 LIQUIDITY AND CAPITAL RESOURCES As of September 30, 1996, the Company's principal sources of liquidity included cash, cash equivalents, restricted cash and short-term investments of approximately $81.5 million, of which approximately $6.5 million are held by ISSI-Taiwan. Approximately $7.0 million of the cash held by the Company is restricted as of September 30, 1996 for purposes of securing available short-term lines of credit and letters of credit. During fiscal 1996, operating activities utilized cash of approximately $13.6 million. Cash utilized by operations was primarily due to increases in inventory and prepaid and other assets and decreases in accounts payable, partially offset by decreases in accounts receivable and net income adjusted for non-cash items. In addition, the Company received net proceeds from borrowings under short-term and long-term lines of credit of $11.8 million. The Company made capital expenditures of approximately $20.4 million in fiscal 1996, primarily for the purchase of test equipment and design and engineering tools. The Company expects to spend approximately $6 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 commenced construction, in July 1996, of an $18.0 million facility in the Hsinchu Science-Based Industrial Park to house its Taiwan operations. The building is expected to be completed in late 1997. In June 1996, the Company entered into a joint venture "WaferTech, LLC" with TSMC, Altera, Analog Devices, and private investors to build a wafer fabrication facility in Camas, Washington. The Company will invest $31.2 million for a 4% equity interest in the venture and as of September 30, 1996, $9.4 million had been paid by the Company to WaferTech in this regard. The next payments by the Company of $9.4 million and $12.4 million are expected to be made in December 1996 and November 1997, respectively. In fiscal 1995, the Company entered into an agreement with TSMC pursuant to which the Company agreed to acquire specified wafer capacity through 2001. In exchange for wafer capacity commitments by TSMC, the Company agreed to make certain annual payments to TSMC which commenced in June 1995. The first payment in June 1995 was approximately $2.4 million and is being credited towards the purchase of wafers in 1996. The additional required payments totaling approximately $31.2 million over the next four years represent annual increases in capacity which must be purchased by the Company, a portion of which is secured by a letter of credit for $4.8 million. Additionally, in fiscal 1995, the Company entered into a manufacturing agreement and joint venture agreement with UMC. Under the terms of these agreements, the Company received a supply of wafers from UMC beginning with the December 1995 quarter and the Company agreed to invest approximately $30 million for a 5% equity interest in a joint manufacturing venture of which UMC retains 55% ownership. As of September 30, 1996, approximately $7.0 million has been paid by the Company to UMC for the joint venture. Based on the completion of certain milestones, the Company is committed to future payments to UMC of approximately $23.0 million. The next payments of approximately $15.0 million and $8.0 million are expected to be made in January 1997 and July 1997, respectively, subject to certain milestone completions. The Company has $23.8 million available through a number of short-term lines of credit with various financial institutions in Taiwan. As of September 30, 1996, the Company had borrowings of approximately $3.6 million under these short-term lines of credit. The Company has a number of long-term lines of credit with the Bank of Communication in Taiwan to finance the purchase of machinery, equipment and building construction in Taiwan. Total obligations related to these borrowings as of September 30, 1996 were $10.9 million, of which $0.7 million is included in the current portion of long-term obligations. These obligations bear interest at rates of from 6.50% to 6.625% and are payable in quarterly installments through 2003. As of September 30, 1996, the Company had available long-term lines of credit of approximately $13.3 million of which approximately $10.9 million is for construction financing for the Company's new facility in the Hsinchu Science-Based Industrial Park. 14 17 The Company believes that its existing funds will satisfy the Company's anticipated working capital and other cash requirements through at least the next 12 months. The Company may also use bank borrowings and capital leases depending on the terms available. 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 financings to fund such activities and, in certain circumstances, to provide product or technology rights. 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 QUARTERLY FLUCTUATIONS AND DECLINES IN AVERAGE SELLING PRICES 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 and fluctuations in manufacturing yield. 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 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, the Company experienced quarterly sequential declines in revenue in the quarters ending March, June and September, 1996 principally due to declines in the average selling prices of its products and the inability to offset these declines by sufficient increases in unit shipments. There can be no assurance that the Company will not experience further declines in quarterly revenue. Such revenue declines have had a material adverse impact on the Company's gross profit and net income. 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 addition, there can be no assurance that the markets for the Company's products, which are highly cyclical, will continue to grow. Competitive pricing pressures resulted in significant price decreases for the Company's products during 1996. 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 to introduce and sell new products which compensate for the anticipated declines in the average selling prices of its products. Declining average selling prices will also adversely affect the Company's gross margins and profits unless the Company is able to 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. Shifts in industry-wide wafer capacity from shortages to oversupply or from oversupply to shortages may also result in significant fluctuations in the Company's quarterly or annual operating results. Excess capacity may result in declining average selling prices or write downs in the value of inventory due to excess inventory or inventory values that exceed selling prices. In this regard, in the June 1996 quarter, the Company recorded a $15 million write-down of inventory. 15 18 PRODUCT CONCENTRATION AND DEPENDENCE ON PERSONAL COMPUTER INDUSTRY In fiscal 1996, substantially all of the Company's net sales were derived from the sale of SRAM products, primarily 256K products. Substantially all of the Company's products are incorporated into computer and computer-peripheral products such as modems, disk drives and networks. In recent periods, the PC industry has experienced strong unit sales growth, which has increased demand for integrated circuits, including memory products offered by the Company. 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 PC or PC peripherals industry. CUSTOMER CONCENTRATION The Company's sales are concentrated within a limited customer base. In fiscal 1996, one customer accounted for approximately 22% of net sales. 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 adopted a fabless manufacturing strategy with the objective of establishing collaborative manufacturing relationships with selected semiconductor manufacturers. To date, the Company's principal manufacturing relationship has been with TSMC, and in fiscal 1996, the Company obtained a substantial majority of its wafers from TSMC. 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 increasing wafer quantities, the Company would have little or no recourse if its wafer suppliers experienced manufacturing failures or yield shortfalls, chose to prioritize capacity for other use or reduced or eliminated deliveries to the Company. 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 agreed to certain minimum wafer purchase commitments with its foundry partners in exchange for wafer capacity commitments. The Company also agreed to make certain annual payments to TSMC for capacity increases. Additional required payments to TSMC totaling approximately $31.2 million over the next four years represent annual increases in capacity which must be purchased by the Company. The Company also has minimum purchase obligations for its joint venture with UMC and WaferTech LLC. 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 would be materially and adversely affected. 16 19 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 may from time to time continue 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 is no assurance that these or other companies will not in the future pursue claims against the Company with respect to the alleged infringement. 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 result in protracted, costly litigation and 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 effect the Company's business and operating results. MANAGEMENT OF GROWTH The Company has grown rapidly over the last several years. This growth has resulted in a significant increase in responsibilities for existing management which has placed, and may continue to place, a significant strain on the Company's limited personnel and other resources. The Company's ability to manage its growth effectively will require it to continue to improve its operational, financial and management systems, to successfully attract new employees and to properly train, motivate and manage its employees. If the Company's management is unable to manage growth effectively, the Company's business and operating results could be materially and adversely affected. RISK OF INCREASED TAXES The Company's tax rate could increase 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 holiday 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. It is not the Company's intention to cause ISSI-Taiwan to distribute dividends. 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 accumulating cash and other passive assets in excess of 25% of its total assets; 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. If cash is accumulated through operations and not otherwise invested in non-passive assets such as capital equipment, such amounts in excess of 25% of total assets would cause the Company's effective tax rate to increase. 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. 17 20 VOLATILITY OF STOCK PRICE The trading price of the Common Stock increased substantially after the Company's initial public offering in February 1995, subsequently declined, and could be subject to wide fluctuations in response to quarter-to-quarter variations in operating results, future announcements by the Company or its competitors, increases or decreases in wafer capacity, general conditions in the semiconductor or computer industries, governmental regulations, 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. 18 21 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Consolidated Financial StatementS Page Report of Independent Auditors.................................... 20 Financial Statements: Consolidated Statements of Income for Fiscal Years Ended September 30, 1996, September 30, 1995, and September 30, 1994................ 21 Consolidated Balance Sheets as of September 30, 1996, and September 30, 1995.......... 22 Consolidated Statements of Stockholders' Equity for Fiscal Years Ended September 30, 1996, September 30, 1995, and September 30, 1994................ 23 Consolidated Statements of Cash Flows for Fiscal Years Ended September 30, 1996, September 30, 1995, and September 30, 1994................ 24 Notes to Consolidated Financial Statements.................... 25 19 22 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, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended September 30, 1996. 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, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended September 30, 1996, 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 28, 1996 20 23 Integrated Silicon Solution, Inc. Consolidated Statements of Income (In thousands, except per share data)
Years Ended September 30, ------------------------------------ 1996 1995 1994 --------- --------- -------- Net sales $ 132,039 $ 123,201 $ 60,836 Cost of sales (other than item below) 85,184 60,949 40,283 Inventory write-down 15,000 -- -- --------- --------- -------- Total cost of sales 100,184 60,949 40,283 --------- --------- -------- Gross profit 31,855 62,252 20,553 --------- --------- -------- Operating expenses: Research and development 21,350 14,852 8,750 Selling, general and administrative 15,188 12,924 6,809 --------- --------- -------- Total operating expenses 36,538 27,776 15,559 --------- --------- -------- Operating income (loss) (4,683) 34,476 4,994 Interest and other income 4,803 2,631 605 Interest expense (335) (88) (218) --------- --------- -------- Income (loss) before income taxes and minority interest (215) 37,019 5,381 Provision (benefit) for income taxes (1,158) 7,404 807 --------- --------- -------- Income before minority interest 943 29,615 4,574 Minority interest in net loss of consolidated subsidiary (72) (38) (38) --------- --------- -------- Net income $ 1,015 $ 29,653 $ 4,612 ========= ========= ======== Net income per share $ 0.06 $ 1.79 $ 0.34 ========= ========= ======== Shares used in per share calculation 18,356 16,534 13,747 ========= ========= ========
See the accompanying notes to consolidated financial statements 21 24 Integrated Silicon Solution, Inc. Consolidated Balance Sheets (In thousands, except per share data)
September 30, ----------------------- 1996 1995 --------- --------- ASSETS Current assets: Cash and cash equivalents $ 12,237 $ 29,452 Restricted cash 7,023 986 Short-term investments 62,200 80,300 Accounts receivable, net of allowance for doubtful accounts of $2,002 in 1996 and $1,297 in 1995 11,316 18,746 Inventories 22,469 11,114 Other current assets 13,777 11,822 --------- --------- Total current assets 129,022 152,420 Property, equipment, and leasehold improvements, net 31,129 17,946 Other assets 17,888 34,075 ========= ========= Total assets $ 178,039 $ 204,441 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable $ 3,617 $ -- Accounts payable 8,912 15,370 Accrued compensation and benefits 3,994 5,632 Accrued expenses 3,298 1,719 Income tax payable 550 3,535 Current portion of long-term obligations 722 5,325 --------- --------- Total current liabilities 21,093 31,581 Income tax payable - noncurrent 4,298 4,298 Long-term obligations 10,195 28,563 Minority interest in consolidated subsidiary 18 90 Stockholders' equity: Convertible preferred stock, $0.0001 par value: Authorized shares - 5,000 in 1996 and 1995. No shares outstanding -- -- Common stock, $0.0001 par value: Authorized shares - 70,000 in 1996 and 35,000 in 1995. Issued and outstanding shares - 17,607 in 1996 and 17,225 in 1995 2 2 Additional paid-in capital 104,788 102,376 Retained earnings 39,952 38,937 Cumulative translation adjustment (2,246) (1,302) Unearned compensation (61) (104) --------- --------- Total stockholders' equity 142,435 139,909 ========= ========= Total liabilities and stockholders' equity $ 178,039 $ 204,441 ========= =========
See the accompanying notes to consolidated financial statements 22 25 Integrated Silicon Solution, Inc. Consolidated Statements of Stockholders' Equity (In thousands)
Convertible Preferred Stock Common Stock Additional ------------------- ----------------- Paid-In Retained Shares Amount Shares Amount Capital Earnings ------------------------------------------------------------------------- Balance at September 30, 1993 31,314 $ 3 4,669 $- $ 11,731 $ 4,672 Stock options exercised -- -- 123 - 52 -- Issuance of common stock -- -- 5 - 20 -- Unearned compensation -- -- -- - 35 -- Translation adjustment -- -- -- - -- -- Net income -- -- -- - -- 4,612 ------------------------------------------------------------------------- Balance at September 30, 1994 31,314 3 4,797 - 11,838 9,284 Stock options exercised -- -- 517 - 1,008 -- Issuance of common stock in public offering and exercise of warrant -- -- 4,082 1 85,979 -- Conversion to common stock (31,314) (3) 7,829 1 2 -- Unearned compensation -- -- -- - 131 -- Amortization of unearned compensation -- -- -- - -- -- Cancellation of stock options -- -- -- - (30) -- Tax benefits from sale of common stock -- -- -- - 3,448 -- Translation adjustment -- -- -- - -- -- Net income -- -- -- - -- 29,653 ------------------------------------------------------------------------- Balance at September 30, 1995 -- -- 17,225 2 102,376 38,937 Stock options exercised -- -- 253 - 952 -- Shares issued under stock purchase plan -- -- 129 - 1,357 -- Amortization of unearned compensation -- -- -- - -- -- Tax benefits from sale of common stock -- -- -- - 103 -- Translation adjustment -- -- -- - -- -- Net income -- -- -- - -- 1,015 ========================================================================= Balance at September 30, 1996 -- $-- 17,607 $2 $ 104,788 $39,952 ========================================================================= Cumulative Total Translation Unearned Stockholders' Adjustment Compensation Equity ---------------------------------------- Balance at September 30, 1993 $ (443) $ -- $ 15,963 Stock options exercised -- -- 52 Issuance of common stock -- -- 20 Unearned compensation -- (35) -- Translation adjustment 540 -- 540 Net income -- -- 4,612 ---------------------------------------- Balance at September 30, 1994 97 (35) 21,187 Stock options exercised -- -- 1,008 Issuance of common stock in public offering and exercise of warrant -- -- 85,980 Conversion to common stock -- -- -- Unearned compensation -- (131) -- Amortization of unearned compensation -- 32 32 Cancellation of stock options -- 30 -- Tax benefits from sale of common stock -- -- 3,448 Translation adjustment (1,399) -- (1,399) Net income -- -- 29,653 ---------------------------------------- Balance at September 30, 1995 (1,302) (104) 139,909 Stock options exercised -- -- 952 Shares issued under stock purchase plan -- -- 1,357 Amortization of unearned compensation -- 43 43 Tax benefits from sale of common stock -- -- 103 Translation adjustment (944) -- (944) Net income -- -- 1,015 ======================================== Balance at September 30, 1996 $(2,246) $ (61) $ 142,435 ========================================
See the accompanying notes to consolidated financial statements 23 26 Integrated Silicon Solution, Inc. Consolidated Statements of Cash Flows (In thousands)
Years Ended September 30, ------------------------------------ 1996 1995 1994 --------- --------- -------- Cash flows from operating activities: Net income $ 1,015 $ 29,653 $ 4,612 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 7,586 3,816 2,436 Provision for losses on accounts receivable 714 1,185 1,333 Net foreign currency transaction (gains) losses (311) 225 50 Minority interest in net loss of consolidated subsidiary (72) (38) (38) Changes in operating assets and liabilities: Accounts receivable 6,581 (11,694) (2,436) Inventories (11,592) (3,725) (1,040) Other assets (7,710) (10,641) (948) Accounts payable (6,721) 7,288 (360) Accrued expenses (3,104) 13,367 805 --------- --------- -------- Net cash provided by (used in) operating activities (13,614) 29,436 4,414 Cash flows from investing activities: Acquisition of property, equipment, and leasehold improvements (20,423) (17,411) (2,843) Purchases of available-for-sale securities (197,800) (184,650) -- Sales of available-for-sale securities 215,900 104,350 -- Investment in WaferTech, LLC (9,360) -- -- --------- --------- -------- Net cash used in investing activities (11,683) (97,711) (2,843) Cash flows from financing activities: Proceeds from issuance of stock 2,352 87,020 72 Borrowings under notes payable and long-term obligations 28,018 4,317 11,178 Principal payments of notes payable and long-term obligations (16,172) (3,155) (12,650) Proceeds from joint venture partner -- -- 166 Decrease (increase) in restricted cash (6,037) 355 1,078 --------- --------- -------- Net cash provided by (used in) financing activities 8,161 88,537 (156) Effect of exchange rate changes on cash and cash equivalents (79) (226) 376 --------- --------- -------- Net increase (decrease) in cash and cash equivalents (17,215) 20,036 1,791 Cash and cash equivalents at beginning of year 29,452 9,416 7,625 ========= ========= ======== Cash and cash equivalents at end of year $ 12,237 $ 29,452 $ 9,416 ========= ========= ========
See the accompanying notes to consolidated financial statements 24 27 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, 1996 and 1995, 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, 1996 and 1995, 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, 1996 and 1995. 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 to 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. 25 28 Notes to Consolidated Financial Statements 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. REVENUE RECOGNITION The Company recognizes revenue to non-distributor customers upon shipment. The Company provides for estimated sales returns on sales to these customers. A portion of the Company's sales is made to distributors under terms allowing certain rights of return and price protection on unsold merchandise held by the distributor. These agreements can be canceled by either party upon written notice, at which time the Company would repurchase unsold inventory. Accordingly, recognition of sales to these distributors has been deferred until the merchandise is resold. 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 nonvolatile memory 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 1994, the Company incurred a specific write-off of approximately $1.0 million as a result of the bankruptcy proceeding of one of its principal customers. In fiscal year 1996, sales to one customer were $29,021,000, or 22% of total net sales. In fiscal years 1995 and 1994, no customer exceeded 10% of total net sales. The Company maintains cash, cash equivalents, and short-term investments with various financial institutions. The Company's 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. 26 29 Notes to Consolidated Financial Statements SEMICONDUCTOR INDUSTRY RISKS To date the Company has derived substantially all of its revenues from the sale of SRAM products. The Company is undertaking efforts to diversify into other product areas such as NVM 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 and fluctuations in manufacturing yield. Other factors include potential inventory write-downs, changes in product mix, 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 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. NET INCOME PER SHARE Net income per share is computed using the weighted average number of shares of common stock and common equivalent shares, when dilutive, from convertible preferred stock (using the if-converted method) and from stock options and warrants (using the treasury stock method). Pursuant to the Securities and Exchange Commission Staff Accounting Bulletins, common equivalent shares issued by the Company at prices below the initial public offering price of the Company's common stock during the twelve-month period prior to the Company's initial public offering in February 1995, have been included in the calculation as if they were outstanding for all periods presented prior to the initial public offering (using the treasury stock method at the initial public offering price). IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (FAS 123), "Accounting for Stock-Based Compensation," which provides an alternative to APB Opinion No. 25, "Accounting for Stock Issued to Employees," in accounting for stock-based compensation issued to employees. FAS 123 allows for a fair value-based method of accounting for employee stock options and similar equity instruments. However, for companies that continue to account for employee stock-based compensation arrangements under APB Opinion No. 25, FAS 123 requires disclosures of the pro forma effect on net income and earnings per share of its fair value-based accounting for those arrangements. These disclosure requirements are effective for fiscal years beginning after December 15, 1995. The Company plans to continue to account for employee stock-based compensation under APB Opinion No. 25. 27 30 Notes to Consolidated Financial Statements In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (FAS 121), which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets carrying amounts. FAS 121 also addresses the accounting for long-lived assets that are expected to be disposed of. The Company will adopt FAS 121 in the first quarter of fiscal 1997 and, based on current circumstances, does not believe the effect of this adoption will have a material impact on its financial condition or results of operations. 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:
1996 1995 -------- -------- (In thousands) Cash $ 9,989 $ 9,275 Money market instruments 3,189 4,698 Certificates of deposit 6,082 16,465 Auction preferred stock 42,500 66,800 Municipal bonds due in more than 3 years 19,700 13,500 -------- -------- Total $ 81,460 $110,738 ======== ========
NOTE 3. INVENTORIES Inventories consisted of the following at September 30:
1996 1995 ------- ------- (In thousands) Purchased components $10,123 $ 3,993 Work-in-process 2,826 4,305 Finished goods 9,520 2,816 ------- ------- $22,469 $11,114 ======= =======
During the third quarter of fiscal 1996, the Company recorded an inventory write-down of $15.0 million. 28 31 Notes to Consolidated Financial Statements NOTE 4. OTHER CURRENT ASSETS AND OTHER ASSETS Other current assets and other assets consisted of the following at September 30:
1996 1995 ------- ------- (In thousands) Advance payment TSMC (see note 6) $ 2,326 $ 7,200 Deferred tax asset 4,615 3,029 Other 6,836 1,593 ------- ------- $13,777 $11,822 ======= ======= Advance payment TSMC (see note 6) $ -- $26,400 Capacity investment UMC (see note 12) 6,821 7,500 Investment WaferTech LLC. (see Note 12) 9,360 -- Other 1,707 175 ------- ------- $17,888 $34,075 ======= =======
NOTE 5. PROPERTY, EQUIPMENT, AND LEASEHOLD IMPROVEMENTS Property, equipment, and leasehold improvements consisted of the following at September 30:
1996 1995 ------- ------- (In thousands) Machinery and equipment $43,209 $24,038 Furniture and fixtures 1,174 845 Leasehold improvements 1,763 1,470 Construction in progress 334 -- ------- ------- 46,480 26,353 Less accumulated depreciation and amortization 15,351 8,407 ======= ======= $31,129 $17,946 ======= =======
NOTE 6. NOTES PAYABLE AND LONG-TERM OBLIGATIONS At September 30, 1996, ISSI-Taiwan had short-term lines of credit with various financial institutions whereby it could borrow in aggregate up to approximately $23,751,000 denominated in a combination of U.S. and New Taiwan dollars. As of September 30, 1996, the Company had borrowings of approximately $3,617,000 outstanding under these lines of credit. These lines of credit expire at various times through July 1997. These lines of credit are secured by time deposits of approximately $2,223,000, which are recorded as restricted cash. Commitment fees relating to these lines are not material. At September 30, 1996, the weighted average interest rate on borrowing under these lines was 6.7%. In fiscal 1995, the Company's primary foundry partner, TSMC, committed to provide the Company with annual wafer capacity increases for each year through 2001. For wafer increases over 1994, the base year, the Company is obligated to pay a portion of the cost for the increased number of wafers even if the allocated annual increase is not purchased in that year. At September 30, 1995, this obligation was evidenced by approximately $31.2 million in promissory notes and a prepayment of $2.4 million. To the extent these obligations were recorded, an offsetting short-term and long-term asset was recorded. During fiscal 1996, the promissory notes were canceled (which also led to the elimination of the corresponding 29 32 Notes to Consolidated Financial Statements asset), however, the Company's future commitments for the years 1997-2001 remained at approximately $31.2 million and the Company has established a letter of credit for $4.8 million covering the next capacity increase. At September 30, 1996, the Company's $2.4 million prepayment remained in short-term assets. Long-term obligations consisted of the following at September 30:
1996 1995 ------- ------- (In thousands) Capitalized lease obligations $ -- $ 6 Notes payable to bank, due in quarterly installments through 2000 with interest at 6.5% to 6.625% and secured by the Company's property and equipment 10,917 2,682 Notes payable to TSMC for additional capacity -- 31,200 ------- ------- 10,917 33,888 Less current portion 722 5,325 ------- ------- $10,195 $28,563 ======= =======
At September 30, 1996, future minimum principal payments on notes payable and long-term obligations were as follows (in thousands): 1997 $ 722 1998 1,978 1999 2,249 2000 1,781 2001 1,675 Thereafter 2,512 ----------------- Total $10,917 =================
Interest of $235,000, $136,000 and $0 was capitalized in 1996, 1995 and 1994, respectively, and is included in fixed assets. NOTE 7. CAPITAL STOCK The Company's Restated Certificate of Incorporation provides for 70,000,000 authorized shares of Common Stock and 5,000,000 shares of authorized but unissued preferred stock, the terms of which 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. 30 33 Notes to Consolidated Financial Statements NOTE 8. 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 791,000 shares, 432,000 shares and 525,000 shares were exercisable as of September 30, 1996, 1995, and 1994, 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. `The following table summarizes activity under the Plan:
Options Outstanding --------------------------------------------------------- Options Number Aggregate Available of Price Exercise For Grant Shares Per Share Price ----------------- --------------------------------------------------------- (In thousands, except per share data) Balance at September 30, 1993 1,200 1,333 $ 0.12 - $ 4.00 $ 2,574 Granted (767) 767 $ 4.00 3,068 Exercised -- (123) $ 0.12 - $ 1.60 (52) Canceled 213 (213) $ 0.20 - $ 4.00 (554) ----------------- --------------------------------------------------------- Balance at September 30, 1994 646 1,764 $ 0.12 - $ 4.00 5,036 Granted (929) 929 $ 5.00 - $59.50 28,458 Exercised -- (517) $ 0.12 - $ 9.00 (1,008) Canceled 125 (125) $ 0.20 - $13.00 (570) Authorized 500 -- - -- ----------------- ----------------- ------------------- ----------------- Balance at September 30, 1995 342 2,051 $ 0.20 - $59.50 31,916 Granted (1,599) 1,599 $9.625 - $26.00 29,986 Exercised -- (253) $ 0.20 - $13.00 (952) Canceled 907 (907) $ 0.28 - $59.50 (30,316) Authorized 1,000 -- - -- ----------------- ----------------- ------------------- ----------------- Balance at September 30, 1996 650 2,490 $ 0.20 - $27.50 $ 30,634 ================= ================= =================== =================
31 34 Notes to Consolidated Financial Statements For certain options granted in 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 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 $43,000, $32,000 and $0 was recognized for the years ending September 30, 1996, 1995, and 1994, respectively. 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 deduction. The shares can be 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 450,000 shares of common stock are reserved for issuance under the plan, of which 129,000 had been issued as of September 30, 1996. 1995 DIRECTOR STOCK OPTION PLAN The Board of Directors and stockholders approved the 1995 Director Stock Option Plan ("Director Plan") in December 1994 and January 1995, 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. At September 30, 1996, 10,000 options (5,800 of which were vested) with an exercise price of $14.50 were outstanding. NOTE 9. 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, 1996, such restricted equity amounted to approximately $4,119,000. 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. 32 35 Notes to Consolidated Financial Statements NOTE 10. INCOME TAXES The provision (benefit) for income taxes consisted of the following for the years ended September 30:
1996 1995 1994 -------- -------- -------- (In thousands) Current: Federal $ 3,137 $ 7,989 $ 781 State 335 1,411 11 Foreign 200 693 355 -------- -------- -------- Total Current 3,672 10,093 1,147 Deferred: Federal (3,062) (2,257) (340) State (614) (432) -- Foreign (1,154) -- -- -------- -------- -------- Total Deferred (4,830) (2,689) (340) -------- -------- -------- Total Provision (Benefit) $ (1,158) $ 7,404 $ 807 ======== ======== ========
Pretax income from foreign operations was approximately $153,000, $28,320,000 and $6,330,000 for 1996, 1995, and 1994, respectively. A reconciliation of the income tax provision (benefit) at the U.S. federal statutory rate (35%) to the income tax provision (benefit) at the effective tax rate is as follows for the years ended September 30:
1996 1995 1994 -------- -------- -------- (In thousands) Income taxes computed at the U.S. federal statutory rate $ (75) $ 12,957 $ 1,883 Operating losses with no current benefit -- 89 -- Valuation of U.S. temporary differences 1,104 (1,242) 165 Lower effective income tax rate of Taiwan (1,006) (4,392) (1,248) Tax exempt interest income (694) (470) -- State tax (net of federal effect) (184) 636 7 Other individually immaterial items (303) (174) -- -------- -------- -------- $ (1,158) $ 7,404 $ 807 ======== ======== ========
33 36 Notes to Consolidated Financial Statements The components of deferred taxes consisted of the following at September 30:
1996 1995 -------- -------- (In thousands) Deferred tax assets: Depreciation $ 321 $ 142 Inventory and other valuation reserves 6,319 1,957 Accrued expenses 2,509 784 Taiwan - investment tax credit carryforwards 3,516 -- Other, net 525 146 -------- -------- Total deferred tax assets 13,190 3,029 Valuation allowance (7,163) -- -------- -------- Net deferred tax assets $ 6,027 $ 3,029 ======== ========
The Company has established a valuation allowance covering a portion of the gross deferred tax assets based on management's expectations of future taxable income and the actual taxable income during the three years ended September 30, 1996. The valuation allowance for deferred tax assets increased by $7,163,000 during fiscal 1996. Approximately $1,832,000 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 receives a significant tax exemption for taxable income from October 1, 1992 through September 30, 1997. The precise amount of the tax 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. For fiscal 1996, the Company was able to reduce current taxes payable by approximately $1,510,000 ($0.08 per share) related to this exemption. In addition, the Company recognized benefits from investment tax credits in Taiwan of approximately $1,018,000 in fiscal 1996. Cumulative net undistributed earnings of ISSI-Taiwan for which no income taxes have been provided aggregated approximately $13,000,000 at September 30, 1996. These earnings are considered to be permanently invested in non-U.S. operations. Upon distribution of those 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. In the event that ISSI-Taiwan's retained earnings, after deducting the legal reserve as described in Note 9, exceeds 200% of its capital, this excess retained earnings amount, if not distributed, is subject to a 10% tax. At September 30, 1996, ISSI-Taiwan's retained earnings, less the legal reserve, was approximately $49,700,000 below the amount represented by 200% of its capital. 34 37 Notes to Consolidated Financial Statements NOTE 11. GEOGRAPHIC AND SEGMENT INFORMATION The Company operates in one business segment, which is to design, develop, and market a broad range of high-performance SRAM and nonvolatile memory integrated circuits. The following table summarizes the Company's operations in different geographic areas:
Year Ended September 30, 1996 ----------------------------------------------------------- United States Taiwan Adjustments/ 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 ========= ========= ========== =========
Year Ended September 30, 1995 ----------------------------------------------------------- United States Taiwan Adjustments/ Eliminations Consolidated ----------------------------------------------------------- (In thousands) Sales to unaffiliated customers $ 59,677 $ 63,524 $ -- $ 123,201 Transfers between geographic areas 1,648 35,487 (37,135) -- --------- --------- ---------- --------- Total net sales $ 61,325 $ 99,011 $ (37,135) $ 123,201 ========= ========= ========== ========= Operating income (loss) $ 10,462 $ 24,470 $ (456) $ 34,476 ========= ========= ========== ========= Identifiable assets $ 116,604 $ 98,286 $ (10,449) $ 204,441 ========= ========= ========== ========= Cash, cash equivalents, restricted cash and short-term investments $ 93,083 $ 17,655 $ -- $ 110,738 ========= ========= ========== ========= Accounts receivable from third-party customers $ 11,220 $ 7,526 $ -- $ 18,746 ========= ========= ========== =========
35 38 Notes to Consolidated Financial Statements
Year Ended September 30, 1994 --------------------------------------------------------- United States Taiwan Adjustments/ Eliminations Consolidated --------------------------------------------------------- (In thousands) Sales to unaffiliated customers $ 25,168 $35,668 $ -- $60,836 Transfers between geographic areas 946 17,571 (18,517) -- -------- ------- -------- ------- Total net sales $ 26,114 $53,239 $(18,517) $60,836 ======== ======= ======== ======= Operating income (loss) $ (864) $ 5,967 $ (109) $ 4,994 ======== ======= ======== ======= Identifiable assets $ 12,125 $32,661 $(11,543) $33,243 ======== ======= ======== ======= Cash, cash equivalents and restricted cash $ 2,415 $ 8,342 $ -- $10,757 ======== ======= ======== ======= Accounts receivable from third-party customers $ 3,214 $ 5,195 $ -- $ 8,409 ======== ======= ======== =======
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, liabilities, and net income for ISSI-Taiwan amounted to approximately $81,521,0000, $31,580,000 and $3,521,000, respectively, at September 30, 1996. Included in the assets and liabilities of ISSI-Taiwan were intercompany receivables amounting to approximately $5,678,000 at September 30, 1996. Export sales by the U.S. operating company were approximately $15,741,000, $17,854,000, and $5,761,000 for the years ended September 30, 1996, 1995, and 1994, respectively. Net foreign currency transaction gains (losses) of approximately $311,000, $(225,000) and $(50,000) for the years ended September 30, 1996, 1995 and 1994, respectively, were primarily the result of the settlement of intercompany transactions and are included in the determination of net income. NOTE 12. 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 may from time to time continue to be notified of claims that it may be infringing patents, maskwork rights or copyrights owned by third parties. In this regard, the Company has been notified by several companies that it may be infringing certain patents with respect to its products and underlying process technology. 36 39 Notes to Consolidated Financial Statements Although none of these companies have pursued a claim against the Company, there is no assurance that these or 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 which may be necessary to protect patents or other intellectual property rights of the Company. While the Company cannot accurately predict the eventual outcome of these or any other such infringement matters, management believes that the likelihood of an outcome resulting in a material adverse effect on the Company's consolidated financial position, results of operations, or cash flows is remote. LITIGATION On December 13, 1995, a securities class action lawsuit was filed in the United States District Court for the Northern District of California against the Company, certain of its officers and directors, and the co-lead underwriters for the company's initial public offering and secondary offering, on behalf of all persons who purchased the Company's common stock between February 3, 1995, and December 5, 1995 (the "Lawsuit"). The Lawsuit asserts claims under Section 11 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934, and Rule 10b-5 promulgated thereunder. The Lawsuit seeks damages in an unspecified amount. The Company believes it has meritorious defenses to the Lawsuit and intends to defend the case vigorously. The Company believes that the ultimate resolution of this matter will not have a material adverse effect on its financial position, results of operations or cash flow. LEASES The Company leases its facilities and the land upon which it is constructing its new Taiwan facility under operating lease agreements that expire at various dates through 2116. The Company has entered into a ten year lease effective December 1, 1996 for its headquarters facility in Santa Clara, California. The Company anticipates that it will sublease a portion of this space, but as of November 1, 1996 has not yet done so. Minimum rental commitments under these leases are as follows (in thousands):
1997 $ 1,072 1998 1,306 1999 1,269 2000 1,294 2001 1,359 Thereafter 9,118 -------- Total minimum rental commitments $ 15,418 ========
Total rental expense for the years ended September 30, 1996, 1995, and 1994 was approximately $637,000, $620,000 and $391,000, respectively. 37 40 Notes to Consolidated Financial Statements COMMITMENTS TO WAFER FABRICATION FACILITIES In June 1996, the Company entered into a joint venture "WaferTech, LLC" with TSMC, Altera, Analog Devices and private investors for the construction of a wafer fabrication facility in Camas, Washington. Under the terms of the agreement, the Company will invest $31.2 million for a 4% equity interest in the venture and will receive access to wafers manufactured using advanced process technology. As of September 30, 1996, $9.4 million had been paid by the Company to WaferTech. The next payments by the Company of $9.4 million and $12.4 million are expected to be made in December 1996 and November 1997, respectively. The Company is accounting for this investment on the cost basis. In 1995, the Company entered into a manufacturing agreement and joint venture agreement with United Microelectronics Corporation ("UMC"). Under the terms of these agreements, the Company receives a supply of wafers from UMC beginning with the December 1995 quarter and the Company agreed to invest $30 million in cash for a 5% equity interest in a joint manufacturing venture of which UMC retains 55% ownership. As of September 30, 1996, approximately $7.0 million has been paid to UMC for the joint venture. Based on the completion of certain milestones, the Company is committed to future payments to UMC of approximately an additional $23.0 million. The next payments of approximately $15.0 million and $8.0 million are expected to be made in January 1997 and July 1997, respectively, subject to certain milestone completions. The Company is accounting for this investment on the cost basis. On December 31, 1995, the Company entered into a technology development and wafer purchasing agreement with SubMicron Technology. Under the terms of the agreement, the Company intended to assist SubMicron Technology in process development and prepay $9 million for the purchase of wafers. The Company has subsequently informed SubMicron Technology that the process technology proposed by SubMicron Technology is not competitive and is therefore unacceptable. The Company considers SubMicron Technology to be in violation of the agreement and will, therefore, not make any prepayment nor proceed in the joint technology development. NOTE 13. 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 $9,500 for 1996. The Company elected to make no contributions during the years ended September 30, 1996, 1995 and 1994. Administrative expenses relating to the plan are insignificant. NOTE 14. SUPPLEMENTAL CASH FLOW INFORMATION
Years Ended September 30, 1996 1995 1994 ---- ---- ---- (In thousands) Cash paid for interest $ 478 $ 214 $216 Cash paid for income taxes 8,603 7 511 Notes payable issued for other assets (31,200) 31,200 -- Tax benefit from sale of common stock 103 3,448 --
38 41 Notes to Consolidated Financial Statements NOTE 15. RELATED PARTY TRANSACTIONS For the years ended September 30, 1996, 1995, and 1994, the Company sold approximately $0, $605,000, and $456,000, respectively, of SRAM products to Wearnes Automation and Wearnes affiliates, whose vice chairman is a member of the Company's Board of Directors. At September 30, 1996, 1995, and 1994, the Company had a trade receivables balance from Wearnes and its affiliates of approximately $0, $49,000, and $290,000, respectively. For the years ended September 30, 1996, 1995, and 1994, the Company purchased approximately $1,342,000, $2,985,000 and $2,989,000, respectively, of services from Taicera Electronics Company, an assembly plant that is an affiliate of the Fu Sheng Industrial Group, whose chairman is a member of the Company's Board of Directors. At September 30, 1996, 1995, and 1994, the Company owed Taicera Electronics Company approximately $0, $558,000 and $512,000, respectively. NOTE 16. SUBSEQUENT EVENT Effective October 18, 1996, the Company's Board of Directors approved a Nonstatutory stock option plan for employees of the Company. A total of 300,000 shares have been reserved for issuance under this plan. NOTE 17. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) The following is a summary of the quarterly results of operations for the years ended September 30, 1996 and 1995.
Dec. 31 Mar. 31 June 30 Sept. 30 ------- ------- ------- -------- (In thousands, except per share data) (unaudited) 1996 Net sales $45,051 $36,353 $ 27,579 $ 23,056 Gross profit (loss) 21,128 14,963 (5,756) 1,520 Operating income (loss) 12,149 5,662 (14,994) (7,500) Net income (loss) 10,294 5,064 (10,550) (3,793) Net income (loss) per share $ 0.56 $ 0.28 $ (0.60) $ (0.22) 1995 Net sales $19,102 $25,043 $ 35,458 $ 43,598 Gross profit 8,062 12,220 18,510 23,460 Operating income 5,088 5,807 10,665 14,424 Net income 2,557 5,394 9,242 12,460 Net income per share (1) $ 0.18 $ 0.34 $ 0.52 $ 0.67
(1) See Note 1 of Notes to Consolidated Financial Statements for an explanation of the basis used to calculate net income (loss) per share. Net income for the first quarter of fiscal 1995 is presented on a pro forma basis. 39 42 ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III Certain information required by Part III is omitted from this Report on Form 10-K in that the Registrant will file its definitive Proxy Statement for its Annual Meeting of Stockholders to be held on February 4, 1997, 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. 40 43 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 Income 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 ------ ----------------------- ++3.1 Restated Certificate of Incorporation of Registrant. +3.3 Bylaws of Registrant. +4.2 Form of Common Stock Certificate. +10.1 Form of Indemnification Agreement. +10.2*** Form of 1993 Employee Stock Purchase Plan, as amended, and form of Subscription Agreement. +10.3*** Form of 1989 Stock Plan, as amended, and form of Stock Option Agreements. +10.4 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* Letter Agreement dated September 14, 1994 between Taiwan Semiconductor Manufacturing Company, Ltd. ("TSMC") and the Registrant. +10.6 Industrial Lease dated November 7, 1989 between Aetna Life Insurance Company and the Registrant related to premises at 680 Almanor Avenue, as amended by First Addendum dated November 7, 1989 and First Amendment dated February 9,1993. +10.7* Joint Development Contract between TSMC and the Registrant dated February 5, 1993. +10.8* Joint Development Contract between TSMC and the Registrant dated October , 1992. +10.9* Agreement for Contract Manufacturing dated July 12, 1993 between Mitsui Plastics Inc., Rohm Co., Ltd. and the Registrant. +10.10 Lease for ISSI-Taiwan facilities at No. 10 Prosperity dated November 8, 1993. +10.11 Facility Lease Agreement for second ISSI-Taiwan facility located at No. 9 Prosperity I Road, Hsinchu, Taiwan. +10.12 Wafer Production Agreement between TSMC and the Registrant dated November 8, 1993. +10.13* Joint Development Contract of 0.45u process between TSMC and the Registrant dated November 15, 1994. 41 44 +10.14* Joint Development Contract between Chartered Semiconductor Manufacturing Pte. Ltd. and the Registrant dated July 21, 1994. +10.15 Office Lease for facilities located at 675 Almanor Avenue, Sunnyvale, California. +10.16 Subscription and Shareholders Agreement Relating to Valery Limited dated March 30, 1994. +10.17 Long term line of credit between Bank of Communication and Registrant. +10.18 Short term line of credit between International Commercial Bank of China and Registrant. +10.19*** 1995 Director Stock Option Plan. ++10.20* Option I Agreement between the Registrant and TSMC dated April 21, 1995. ++10.21* Option II Agreement between the Registrant and TSMC dated April 21, 1995. +++10.22** UMC/ISSI-Taiwan Foundry Venture Agreement dated August 31, 1995. +++10.23** UMC/ISSI-Taiwan Fabven Foundry Capacity Agreement dated August 31, 1995. ++++10.24** Amended and Restated Limited Liability Company Agreement of WaferTech, LLC, dated as of August 9, 1996. ++++10.25** Purchase Agreement by and between Taiwan Semiconductor Manufacturing Corporation, as Seller, and Analog Devices, Inc., Altera Corporation and Integrated Silicon Solution, Inc., as Buyers. 10.26** Amendment to Option I and Option II Agreement between the Company and TSMC dated September 23, 1996. 10.27 Sublease Agreement for facility located at 2231 Lawson Lane, Santa Clara, California. 11.1 Calculation of Earnings Per Share +21.1 Subsidiaries of the Registrant 23.1 Consent of Ernst & Young LLP, Independent Auditors 24.1 Power of Attorney (see page 43). 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. + Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (file no. 33-72960). ++ Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (file no. 33-91520). +++ Incorporated by reference to the Company's Annual Report on Form 10-K for the period ended September 30, 1995. ++++ Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1996. (b) Reports on Form 8-K The registrant did not file any Reports on Form 8-K during the quarter ended September 30, 1996. (c) Exhibits See (a) above (d) Financial statement schedules See (a) above 42 45 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 Sunnyvale, State of California, on the 2nd day of December, 1996. 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 attorney-in-fact, each with full power of substitution, for him 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 by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date - - ----------------------------- -------------------------------------------------- ---------------- /s/ Jimmy S.M. Lee Chairman of the Board, Chief Executive Officer, December 2, 1996 - - ----------------------------- and President (Principal Executive Officer) (Jimmy S.M. Lee) /s/ Kong-Yeu Han Executive Vice President, Office of the President, December 2, 1996 - - ----------------------------- General Manager Taiwan and Director (Kong-Yeu Han) /s/ Gary L. Fischer Executive Vice President, Office of the President December 2, 1996 - - ----------------------------- and Chief Financial Officer (Principal Financial (Gary L. Fischer) and Accounting Officer) /s/ Diosdado P. Banatao Director December 2, 1996 - - ----------------------------- (Diosdado P. Banatao) /s/ Hou-Teng Lee Director December 2, 1996 - - ----------------------------- (Hou-Teng Lee) /s/ Lip-Bu Tan Director December 2, 1996 - - ----------------------------- (Lip-Bu Tan) /s/ Chun Win Wong Director December 2, 1996 - - ----------------------------- (Chun Win Wong)
43 46 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, 1994: Allowance for doubtful accounts................. $274 $ 1,333 $ (1,103)(1) $ 504 Sales returns reserve........................... 378 199 (32) 545 Year ended September 30, 1995: Allowance for doubtful accounts ................ 504 1,185 (392)(1) 1,297 Sales returns reserve........................... 545 2,851 (695) 2,701 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
(1) Uncollectible accounts written off, net of recoveries 44 EX-10.26 2 AMENDMENT TO OPTION I AND OPTION II 1 EXHIBIT 10.26 Amendment to Option I Agreement This Amendment, made to Option I Agreement between Integrated Silicon Solution (Taiwan), Inc. and Taiwan Semiconductor Manufacturing Co, Ltd., dated April 21, 1995 (the "Option Agreement"), is effective as of September 23, 1996 (the "Effective Date") by and between Integrated Silicon Solution (Taiwan), Inc., a company organized under the laws of the R.O.C, with its registered address at IF, No. 10, Prosperity Rd. 11, Science-Based Industrial Park, Hsinchu, Taiwan, R.O.C ("Customer"), and Taiwan Semiconductor Manufacturing Co., Ltd., a company organized under the laws of the R.O.C., with its registered address at No. 121, Park Ave. 3, Science-Based Industrial Park, Hsinchu, Taiwan, R.O.C ("TSMC"). In consideration of mutual covenants and condition, both parties agree to amend the Option Agreement as follows: I. Defined terms to be used herein but not defined herein shall have the meaning set forth in the Option Agreement. II. Amend Sections 1 (d), 5, 6, 12 and 16 as follows: l(d). "Option Fee"** 5. The Option Fee is set forth in Exhibit D.** To guarantee Customer's commitment to purchase the Option Capacity, Customer shall cause to be delivered by Integrated Silicon Solution Inc. ("ISSI"), with its principal office at 680 Almanor Ave., Sunnyvale, CA 94086-9513, an irrevocable standby L/C to TSMC covering the yearly Option Fee for the years from and after 1997. The standby L/C shall be issued before every November 1, covering 18 months starting from every November 1, by an internationally reputable bank mutually agreed upon by the parties in the amount of the Option Fee for the subsequent calendar year, and promptly submitted to TSMC for approval. Customer shall cause ISSI to make the standby L/C in the form and substance as attached hereto as Exhibit F.** In the event Customer fails to pay the foregoing Option Fee within 30 days of receiving TSMC's notice of payment, TSMC has the right to draw on the applicable standby L/C the foregoing Option Fee. 6. Upon TSMC's acceptance of the standby L/C from Customer for 1997 Option Fee, TSMC will return to Customer all the promissory notes already made to TSMC pursuant to this Agreement. **Confidential treatment requested for certain portions of this exhibit. 2 12. This Agreement, including Exhibits A-F and the Amendment, constitutes the entire agreement between the parties with respect to the subject matter hereof, and supersedes and replaces all prior or contemporaneous understanding, agreements, dealings and negotiations, oral or written, regarding the subject matter hereof. In the event, any provision of this Agreement conflicts with the Amendment, the Amendment shall govern with respect to the subject matter therein. No modification, alteration or amendment of this Agreement shall be effective unless made in writing and signed by both parties. No waiver of any breach or failure by either party to enforce any provision of this Agreement shall be deemed a waiver of any other or subsequent breach, or a waiver of future enforcement of that or any other provision. 16. Both parties shall keep in strict confidence the existence and contents of this Agreement and the Amendment, and take best precaution possible to prevent any Unauthorized disclosure or use thereof. Both parties agree, that no disclosure of this Agreement, the Amendment or any matters relating hereto may be made without the disclosing party first providing the proposed disclosure to the other party two weeks in advance for consent and reasonable changes. In the event disclosure is required by laws or governmental regulations, the disclosing party shall provide the other party two weeks prior written notice and give the other party the opportunity to protest, participate in preparing disclosure or make reasonable changes thereto. III. Add New Section 18: 18. Within forty (40) days upon expiration or termination of the Customer/TSMC Wafer Production Agreement dated November 8, 1993, both parties agree to use their best efforts to negotiate and enter into a new wafer production agreement or to renew the above Agreement. Both parties agree to apply such agreement to all purchase of wafers by Customer from TSMC under this Agreement, except that the provisions of this Agreement will supersede the above Agreement or any similar agreement to the subject matter hereof. IV. Delete Section 8(b) and Renumber Original Sections 8(c) and 8(d) as Sections 8(b) and 8(c). V. Add to the End of New Section 8(c): "In no event shall either party liable for indirect, consequential, or special damage arising from this Agreement or its performance." 3 VI. Replace Original Exhibit D with New Exhibit D. Integrated Silicon Solution (Taiwan), Inc. Taiwan Semiconductor Manufacturing Co., Ltd. /s/ K.Y. Han /s/ Donald Brooks - - ------------ ----------------- K.Y. Han Donald Brooks President President 4 EXHIBIT D OPTION FEE
- - -------------------------------------------------------------------------------------------------------------- Year Option Capacity Option Fee Standby L/C (Unit: Wafer Equivalent) (US$) for Standby L/C Due Date - - -------------------------------------------------------------------------------------------------------------- 1996 ** ** Paid - - -------------------------------------------------------------------------------------------------------------- 1997 ** ** Amendment Effective Date - - -------------------------------------------------------------------------------------------------------------- 1998 ** ** November 1, 1997 - - -------------------------------------------------------------------------------------------------------------- 1999 ** ** November 1, 1998 - - --------------------------------------------------------------------------------------------------------------
** Confidential treatment requested for certain portions of this exhibit 5 Amendment to Option II Agreement This Amendment, made to Option II Agreement between Integrated Silicon Solution (Taiwan), Inc. and Taiwan Semiconductor Manufacturing Co. Ltd., dated April 21, 1995 (the "Option Agreement"), is effective as of September 23, 1996 (the "Effective Date") by and between Integrated Silicon Solution (Taiwan), Inc., a company organized under the laws of the R.O.C., with its registered address at IF, No. 10, Prosperity Rd. II, Science-Based Industrial Park, Hsinchu, Taiwan, R.O.C. ("Customer"), and Taiwan Semiconductor Manufacturing Co., Ltd., a company organized under the laws of the R.O.C. with its registered address at No. 121, Park Ave. 3, Science-Based Industrial Parkway, Hsinchu, Taiwan, R.O.C ("TSMC"). In consideration of mutual covenants and conditions, both parties agree to amend the Option Agreement as follows: I. Defined terms used herein but not defined herein shall have the meaning set forth in the Option Agreement. II. Amend Sections 1(d), 5 , 6, 12 and 16 as follows: 1(d). "Option Fee" ** 5. The Option Fee is set forth in Exhibit D.** To guarantee Customer's commitment to purchase the Option Capacity, Customer shall cause to be delivered by Integrated Silicon Solution, Inc. ("ISSI"), with its principal office at 680 Almanor Ave., Sunnyvale, CA 94086-9513, an irrevocable standby L/C to TSMC covering the yearly Option Fee for the years from and after 1997. The standby L/C shall be issued before every November 1, covering 18 months starting from every November 1, by an internationally reputable bank mutually agreed upon by the parties in the amount of the Option Fee for the subsequent calendar year, and promptly submitted to TSMC for approval. Customer shall cause ISSI to make the standby L/C in the form and substance as attached hereto as Exhibit F.** In the event Customer fails to pay the foregoing Option Fee within 30 days of receiving TSMC's notice of payment, TSMC has the right to draw on the applicable standby L/C the foregoing Option Fee- 6. Upon TSMC's acceptance of the standby L/C. from Customer for 1997 Option Fee, TSMC will return to Customer all the promissory notes already made to TSMC pursuant to this Agreement. ** Confidential treatment requested for certain portions of this exhibit. 6 12. This Agreement, including Exhibits A-F, and the Amendment, constitutes the entire agreement between the parties with respect to the subject matter hereof, and supersedes and replaces all prior or contemporaneous understanding, agreements, dealings and negotiations, oral or written, regarding the subject matter hereof. In the event, any provision of this Agreement conflicts with the Amendment, the Amendment shall govern with respect to the subject matter therein. No modification, alteration or amendment of this Agreement shall be effective unless made in writing and signed by both parties. No waiver of any breach or failure by either party to enforce any provision of this Agreement shall be deemed a waiver of any other or subsequent breach or a waiver of future enforcement of that or any other provision. 16. Both parties shall keep in strict confidence the existence and contents of this Agreement and the Amendment, and take best precaution possible to prevent any unauthorized disclosure or use thereof. Both parties agree that no disclosure of this Agreement, the Amendment or any matters relating hereto may be made without the disclosing party first providing the opposed disclosure to the other party two weeks in advance for consent and reasonable changes. In the event disclosure is required by laws or governmental regulations, the disclosing party shall provide the other party two weeks prior written notice and give the other party the opportunity to protest, participate in preparing disclosure or make reasonable changes thereto. 111. Add New Section 18: 18. Within forty (40) days upon expiration or termination of the Customer/TSMC Wafer Production Agreement dated November 8, 1993, both parties agree to use their best efforts to negotiate and enter into a new wafer production agreement or to renew the above Agreement. Both parties agree to apply such agreement to all purchase of wafers by Customer from TSMC under this Agreement, except that the provisions of this Agreement will supersede the above Agreement or any similar agreement with respect to the subject matter hereof IV. Delete Section 8(b) and Remember Original Sections 8(c) and 8(d) as Sections 8(b) and 8(c). V. Add to the End of New Section 8(c): "In no event shall either party be liable for indirect, consequential, or special damage arising from this Agreement or its performance." VI. Replace Original Exhibit D with New Exhibit D. 7 Integrated Silicon Solution (Taiwan), Inc. Taiwan Semiconductor Manufacturing Co., Ltd., /s/K.Y. Han /s/Donald Brooks - - ----------- ---------------- K.Y. Han Donald Brooks President President Date: September 23, 1996 EX-10.27 3 SUBLEASE AGREEMENT FOR FACILITY 1 EXHIBIT 10.27 SUBLEASE AGREEMENT I. DEFINED TERMS Base Rent: MONTHS MONTHLY BASE RENT 1-12 $ 56,160 13-24 $ 74,880 25-36 $ 93,600 37-48 $102,960 49-60 $107,640 61-72 $112,320 73-84 $117,000 85-96 $121,680 97-108 $126,360 109-120 $131,040 121-123 $135,720 Broker: Sublessor's Broker: Grubb & Ellis Company Commercial Real Estate Services (Bruce M. Horton) and Colliers Parrish International Sublessee's Broker: MacMillan, Moore & Buchanan (Dave Gray) Commencement Date: December 1, 1996 Effective Date: September __, 1996. 1. 2 Expiration Date: February 28, 2007. Landlord: Sobrato Interests II, a California general partnership Master Lease: That certain Lease dated October 30, 1986 between Landlord, as landlord, and Sublessor, as tenant. Permitted Uses: General office use, developing, assembling, operating and selling computers and computer parts, accessories, manuals and software and ancillary uses. Premises: That certain real property described in Exhibit A attached hereto, together with the approximately 93,600 square foot building (the "Building") thereon known as 2231 Lawson Lane in Santa Clara, California Security Deposit: $135,720 Sublessee: INTEGRATED SILICON SOLUTION, INC., a Delaware corporation Sublessee's Address: prior to the Commencement Date: 680 Almanor Avenue Sunnyvale, California 94086 Attn: Mr. Gary Fischer Executive Vice President and Chief Financial Officer Phone: (408) 774-4612 Fax: (408) 749-1977 as of the Commencement Date: 2231 Lawson Lane 2. 3 Santa Clara, California Attn: Mr. Gary L. Fischer Executive Vice President and Chief Financial Officer Phone: (408) 774-4612 Fax: (408) 749-1977 Sublessor: AMDAHL CORPORATION, a Delaware corporation Sublessor's Address: 1250 East Arques Avenue Mail Stop 110 P.O. Box 3470 Sunnyvale, California 94088-3470 Attn: Director, Corporate Real Estate Phone: (408) 746-6639 Fax: (408) 746-6100 Term: One Hundred Twenty-Three (123) Months Exhibits: Exhibit A - Premises Legal Description Exhibit B - Master Lease Exhibit C - Work Letter Exhibit D - Permitted Hazardous Materials Schedules: Schedule 1 - Electrical Equipment II. THIS SUBLEASE AGREEMENT ("Sublease") is entered as of the Effective Date by and between Sublessor and Sublessee. THE PARTIES ENTER this Sublease on the basis of the following facts, understandings and intentions: A. Sublessor is presently a lessee of the Premises pursuant to the Master Lease by and between Landlord and Sublessor. A copy of the Master Lease, together with all exhibits and addenda thereto is attached hereto as Exhibit B. B. Sublessor desires to sublease the Premises to Sublessee and Sublessee desires to sublease the Premises from 3. 4 Sublessor on all of the terms, covenants and conditions hereinafter set forth. C. All of the terms and definitions in the Defined Terms section are incorporated herein by this reference. NOW, THEREFORE, IN CONSIDERATION of the mutual covenants and promises of the parties, the parties hereto agree as follows: 1. SUBLEASE OF PREMISES. 2. 1.1 SUBLEASE. As of the Commencement Date, Sublessor shall sublease to Sublessee, and Sublessee shall sublease from Sublessor, the Premises for the Term upon all of the terms, covenants and conditions herein contained. In addition, Sublessor shall lease to Sublessee, and Sublessee shall lease from Sublessor, any and all permanent improvements ("Improvements") on the Premises constructed and/or owned by Sublessor, along with any and all mechanical and electrical equipment (the "Electrical Equipment") located in the Premises as of the Commencement Date of the Lease (which Electrical Equipment shall, in any event, include those items listed on Schedule 1 attached hereto) upon all of the terms, covenants and conditions herein contained. As used herein, "Premises" shall include the Premises, Improvements and Equipment. 1.2 DELAY IN DELIVERY OF PREMISES. If Sublessor, for any reason whatsoever, cannot deliver possession of the Premises to Sublessee on or before the Commencement Date, this Sublease shall not be void or voidable nor shall Sublessor be liable to Sublessee for any resulting loss or damage. However, Sublessee shall not be liable for any Rent and the Commencement Date shall not occur until the Premises are Substantially Complete (as defined in the Work Letter), except that if Sublessor's failure to Substantially Complete the Premises by the Commencement Date is attributable to any action or inaction by Sublessee (including without limitation any Sublessee Delay described in the Work Letter attached this Sublease), then the Commencement Date shall not be advanced to the date on which possession of the Premises is tendered to Sublessee, and Sublessor shall be entitled to full performance by Sublessee (including the payment of Rent) from the date the Premises would have been Substantially Complete but for such Sublessee Delays. Notwithstanding the foregoing, in the event that (a) Sublessee is not then in default under the terms of this Sublease beyond any applicable cure period, (b) the Premises are not Substantially Complete on or before January 31, 1997, as such date may be 4. 5 extended for events of "Sublessee Delay" (as defined in the Work Letter) (the "Drop Dead Date"), then Sublessee, as its sole and exclusive remedy (except as provided for below), shall be entitled to terminate this Sublease by providing Sublessor with written notice thereof no later than February 15, 1997; provided that such written notice shall be null and void, and this Sublease shall continue to be in full force and effect, if Sublessor Substantially Completes the Premises within ten (10) business days of the date Sublessor receives such written notice from Sublessee. If Sublessee shall terminate this Sublease pursuant to this Section 1.2 then Sublessor shall return the Security Deposit, any prepaid Rent and any other sums previously paid by Sublessee to Sublessor in connection with this Sublease, to Sublessee within twenty (20) days thereof and any and all obligations, rights and liabilities of the parties hereto shall terminate and be forever null and void. Notwithstanding the foregoing, if the Premises are not Substantially Complete on the Drop Dead Date and Sublessee does not terminate this Sublease as provided for above, then interest will accrue from the date such amounts were delivered to Sublessor to the date the Premises are Substantially Complete at a rate equal to eight percent (8%) per annum on an amount equal to the sum of the first month's Base Rent, the Security Deposit and the Cash Payment (as defined in Section 5.a. of the Work Letter), and the Sublessee's obligation to pay the next installment of Base Rent coming due hereunder shall be credited by the amount of such interest. If Sublessee does terminate this Sublease based on the failure of Sublessor to deliver the Premises to Sublessee by the Drop Dead Date, Sublessor shall pay Sublessee interest on all sums previously paid by Sublessee to Sublessor in connection with the Sublease from the date delivered to Sublessor until the date Sublessor returns such previously paid sums to Sublessee with interest thereon as required hereunder. 1.3 EARLY ENTRY. Notwithstanding anything to the contrary herein, provided that the written consent of Landlord to this Sublease has been received by Sublessor and Sublessee, Sublessee shall have the right to occupy the Premises five (5) business days prior to the Commencement Date for the purpose of installing furniture, cabling and personal property on the Premises and Sublessee's contractor shall be allowed to enter the Premises fifteen (15) business days prior to the Commencement Date for the purpose of installing data and telephone lines, provided that: (i) Sublessee's early entry shall not interfere with any of Sublessor's activities on the Premises during such period; (ii) Sublessee shall give Sublessor written notice of such entry at least five (5) days in advance; (iii) such entry on the Premises shall be of the terms of this Sublease, except that Sublessee shall not be required to pay any monthly Base Rent 5. 6 hereunder during any period of early entry if Sublessee is not conducting Sublessee's business on the Premises; (iv) during the last five (5) business days of early occupancy, Tenant shall arrange to have all utilities services, including but not limited to storm and sanitary sewer service, gas, electric, domestic and irrigation water and trash billed directly to Sublessee for payment or, at Landlord's option, reimburse Sublessor for the cost thereof (provided that, if Sublessor continues to occupy the Premises during the last five (5) business days prior to the Commencement Date, then the cost of such utilities during such five (5) business day period shall be equitably proportioned between Sublessor and Sublessee, acting in good faith, in proportion to the proportionate use of such utilities between the parties); and (v) Sublessee shall provide Sublessor before such early entry with certificates of the insurance required of Sublessee pursuant to the terms of this Sublease. 1 CONDITION OF PREMISES. 2.1 PHYSICAL CONDITION. As of the Effective Date, Sublessee acknowledges that Sublessee shall have conducted Sublessee's own investigation of the Premises and the physical condition thereof, including accessibility and location of utilities, improvements, existence of hazardous materials, including but not limited to asbestos, asbestos containing materials, polychlorinated biphenyls (PCB) and earthquake preparedness, which in Sublessee's judgment affect or influence Sublessee's use of the Premises and Sublessee's willingness to enter this Sublease. Sublessee recognizes that Sublessor would not sublease the Premises except on an "as is" basis and acknowledges that Sublessor has made no representations of any kind in connection with improvements or physical conditions on, or bearing on, the use of the Premises. Sublessee shall rely solely on Sublessee's own inspection and examination of such items and not on any representations of Sublessor, express or implied. Sublessee further recognizes and agrees that neither Sublessor nor Landlord shall be required to perform any work of construction, alteration or maintenance of or to the Premises, except as is provided for in this Sublease or in Exhibit C attached hereto. The foregoing is not intended to and shall not limit or affect any maintenance or repair or restoration obligations of Landlord under the Master Lease. Notwithstanding anything to the contrary herein, the cost of any repairs or replacements other than normal maintenance ("Special Repair Costs") necessary for the four (4) existing air conditioning units on the Premises shall be dealt with in the following manner: (i) any portion of such Special Repair Costs equal to or less than Thirty Thousand Dollars in any calendar year shall be the responsibility of Sublessee and shall be paid by Sublessee to 6. 7 Sublessor as additional rent at the next time Base Rent is due hereunder, and (ii) if any portion of Such Special Repair Costs exceeds Thirty Thousand Dollars ($30,000) in any calendar year, then Sublessee shall be responsible only for the portion of such excess cost equal to Sublessee's Share (as defined below), which amount shall be paid by Sublessee to Sublessor as additional rent at the next time Base Rent is due hereunder. The remaining portion of such excess cost shall be paid by Sublessor. "Sublessee's Share" shall be calculated by multiplying the portion of such Special Repair Costs in excess of Thirty Thousand Dollars ($30,000) by a fraction, the numerator of which is the number of months remaining in the Term of this Sublease at the time the Special Repair Cost is incurred and the denominator of which shall be 240. 2.2 FURTHER INSPECTION. Sublessee represents and warrants to Sublessor that as of the Effective Date Sublessee shall examine and inspect all matters with respect to taxes, income and expense data, insurance costs, bonds, permissible uses, the Master Lease, zoning, covenants, conditions and restrictions and all other matters which in Sublessee's judgment bear upon the value and suitability of the Premises for Sublessee's purposes. Sublessee has and will rely solely on Sublessee's own inspection and examination of such items and not on any representations of Sublessor, express or implied. Nothing in this Section 2.2 is meant to diminish in any way Sublessee's rights under the Work Letter to review the Sublessee Improvements (as defined in the Work Letter) and create a "punch list" of non-conforming items or the obligation of Sublessor to correct such non-conforming items. 1 SUBLEASE SUBJECT TO MASTER LEASE. 3.1 INCLUSIONS. It is expressly understood, acknowledged and agreed by Sublessee that all of the other terms, conditions and covenants of this Sublease shall be those stated in the Master Lease except as excluded in Section 3.b herein. Sublessee shall be subject to, bound by and comply with all of said Articles and Sections of the Master Lease with respect to the Premises and shall satisfy all applicable terms and conditions of the Master Lease relating to the Premises for the benefit of both Sublessor and Landlord, it being understood and agreed that wherever in the Master Lease the word "Tenant" appears, for the purposes of this Sublease, the word "Sublessee" shall be substituted, and wherever the word "Landlord" appears, for the purposes of this Sublease, the word "Sublessor" shall be substituted; and that upon the breach of any of said terms, conditions or covenants of the Master Lease by Sublessee or upon the failure of Sublessee to pay Rent (as hereinafter defined) or 7. 8 comply with any of the provisions of this Sublease, Sublessor may exercise any and all rights and remedies granted to Landlord by the Master Lease. In the event of any conflict between this Sublease and the Master Lease, the terms of this Sublease shall control between Sublessor and Sublessee. It is further understood and agreed that Sublessor has no duty or obligation to Sublessee under the aforesaid Articles and Sections of the Master Lease other than to perform the obligations of Sublessor as lessee under the Master Lease during the Term of this Sublease. Whenever the provisions of the Master Lease incorporated as provisions of this Sublease require the written consent of Landlord, said provisions shall be construed to require the written consent of both Landlord and Sublessor, except as expressly provided to the contrary herein. Sublessee hereby acknowledges that it has read and is familiar with all the terms of the Master Lease, and agrees that this Sublease is subordinate and subject to the Master Lease and that any termination thereof not due to a default by Sublessor thereunder shall likewise terminate this Sublease. The terms of the Work Letter attached hereto as Exhibit C are hereby incorporated herein by reference hereto. 3.2 EXCLUSIONS. The terms and provisions of the following Sections and portions of the Master Lease are not incorporated into this Sublease: the initial paragraphs entitled "Parties," "Grant," "Premises," "Use," "Term," "Late Charge," 1, the first sentence of Section 2 of the Master Lease, the last sentence of Section 3, the clause " ..., IN THE EVENT LANDLORD SHALL FAIL TO RESPOND WITHIN SUCH PERIOD, SUCH ALTERATIONS OR ADDITIONS WILL BE DEEMED TO HAVE BEEN CONSENTED TO BY LANDLORD" on the ninth, tenth and eleventh lines of Section 4, the second and the last sentence of Section 4, the third sentence of the first paragraph of Section 6, Section 10, the second sentence of Section 12, 19, the second sentence of Section 20, 21, the fourth sentence of Section 22, 23, Section 25, 30, 31, 32, 33 and the fifth sentence of Section 35. 3.3 TIME FOR NOTICE. The time limits provided for in the provisions of the Master Lease for the giving of notice, making of demands, performance of any act, condition or covenant, or the exercise of any right, remedy or option, are amended for the purposes of this Sublease by lengthening or shortening the same in each instance by five (5) days, as appropriate, so that notices may be given, demands made, or any act, condition or covenant performed, or any right, remedy or option hereunder exercised, by Sublessor or Sublessee, as the case may be, within the time limit relating thereto contained in the Master Lease. If the Master Lease allows only five (5) days or less for Sublessor to perform any act, or to undertake to 8. 9 perform such act, or to correct any failure relating to the Premises or this Sublease, then Sublessee shall nevertheless be allowed three (3) business days to perform such act, undertake such act and/or correct such failure. 1 LANDLORD'S OBLIGATIONS. It shall be the obligation of Landlord to (i) provide all services to be provided by Landlord under the terms of the Master Lease and (ii) to satisfy all obligations and covenants of Landlord made in the Master Lease. Sublessee acknowledges that Sublessor shall be under no obligation to provide any such services or satisfy any such obligations or covenants to the extent such obligations or covenants are not expressly assumed by Sublessor hereunder; provided, however, Sublessor, upon written request of Sublessee, shall diligently attempt to enforce all obligations of Landlord under the Master Lease. If, after receipt of written request from Sublessee, Sublessor shall fail or refuse to take action for the enforcement of Sublessor's rights against Landlord with respect to the portion of the Premises then occupied by Sublessee ("Action"), Sublessee shall have the right to take such Action in its own name and at Sublessee's own expense, and for that purpose and only to such extent, all of the rights of Sublessor as tenant under the Master Lease are hereby conferred upon and assigned to Sublessee, and Sublessee shall be subrogated to such rights to the extent that the same shall apply to the portion of the Premises then occupied by Sublessee. If any Action against Landlord in Sublessee's name shall be barred by reason of lack of privity, nonassignability or otherwise, Sublessee may take such Action in Sublessor's name but at Sublessee's expense; provided that Sublessee has obtained the prior written consent of Sublessor, which consent shall not be unreasonably withheld; and provided, further, that Sublessee shall indemnify, protect, defend by counsel reasonably satisfactory to Sublessor and hold Sublessor harmless from and against any and all claims, demands, actions, suits, proceedings, liabilities, obligations, losses, damages, judgments, costs and expenses (including, without limitation, reasonable attorneys' fees) which Sublessor may incur or suffer by reason of such Action, except to the extent incurred or suffered by reason of Sublessor's negligent acts or omissions. Sublessor hereby agrees to perform its obligations as tenant under the Master Lease if and to the extent those obligations are not assumed by Sublessee pursuant to the terms of this Sublease. If a default by Landlord under the terms of the Master Lease, or any of the terms of the Master Lease (including but not limited to Section 20 thereof) shall result in the excuse of Sublessor from the performance of any of its obligations to be performed under the Master Lease or result in any reduction or abatement in the base rent or additional rent to be paid by Sublessor thereunder, then Sublessee shall be excused from the performance .9 10 of a corresponding obligation and/or shall be entitled to a corresponding reduction in or abatement of the Rent to be paid by Sublessee hereunder. All provisions of the Master Lease incorporated into this Sublease which contain obligations or covenants of Landlord shall be deemed to have been expressly assumed by Sublessor and shall be obligations and covenants of Sublessor under this Sublease. 2 RENT. 5.1 BASE RENT. Upon execution hereof, Sublessee shall deliver the first month's Base Rent to Sublessor, to be applied against Sublessee's first obligation to pay Base Rent hereunder. Sublessee shall pay to Sublessor the Base Rent in advance on the first day of each month of the Term, commencing on the Commencement Date without being invoiced by Sublessor. In the event the first day of the Term shall not be the first day of a calendar month or the last day of the Term is not the last day of the calendar month, the Base Rent shall be appropriately prorated based on a thirty (30) day month. All installments of Base Rent shall be delivered to Sublessor's Address, or at such other place as may be designated in writing from time to time by Sublessor, in lawful money of the United States and without deduction or offset for any cause whatsoever. 5.2 NET RENTAL. Sublessee shall be responsible for Sublessee's Share of all costs and expenses of every kind and nature which may be imposed, at any time, on Sublessor pursuant to the Master Lease (except for Base Rent, as defined in the Master Lease) including, but not limited to, additional rent, operating costs, and tax costs, all as defined in the Master Lease ", but excluding any late payment charges or other costs, expenses or liabilities which Sublessor incurs under the Master Lease (i) as a result of Sublessor's breach of, or default under, the Master Lease or Sublessor's failure to perform its obligations under the Master Lease in a timely manner or (ii) which arise as a result of or in connection with Sublessor's indemnifications given under the Master Lease or Sublessor's obligation to pay attorneys' fees under the Master Lease or (iii) which are caused by or arise from the negligence or misconduct of Sublessor or its employees, agents, contractors or invitees, except to the extent that such otherwise excluded costs and expenses identified in immediately preceding clauses (i), (ii) and (iii) are caused by Sublessee's breach of, or default under, this Sublease or Sublessee's failure to perform its obligations under this Sublease in a timely manner or the negligence or misconduct of Sublessee or its employees, agents, contractors or invitees." As hereinafter used, "Rent" shall 10. 11 include Base Rent and all additional charges to be paid by Sublessee pursuant to this Section 5.2 5.3 LATE PAYMENT CHARGES AND INTEREST. Any payment of Rent or other amount from Sublessee to Sublessor in this Sublease which is not paid within ten (10) days of the date due shall accrue interest from the date due until the date paid at an annual rate of ten percent (10%) (the "Interest Rate"). If any installment of Rent is not paid promptly within ten (10) days of the first of the month, or the date such amount is otherwise due, Sublessee shall pay to Sublessor a late payment charge equal to five percent (5%) of the amount of such delinquent payment of Rent, in addition to the installment of Rent then owing. This Section 5 shall not relieve Sublessee of Sublessee's obligation to pay any amount owing hereunder at the time and in the manner provided. 1 SECURITY DEPOSIT. Upon execution hereof, Sublessee shall deposit the Security Deposit with Sublessor. The Security Deposit shall secure Sublessee's obligations under this Sublease to pay Base Rent and other monetary amounts, to maintain the Premises and repair damages thereto, to surrender the Premises to Sublessor in clean condition and repair upon termination of this Sublease and to discharge Sublessee's other obligations hereunder. Sublessor may use and commingle the Security Deposit with other funds of Sublessor. If Sublessee fails to perform Sublessee's obligations hereunder, Sublessor may, but without any obligation to do so, apply all or any portion of the Security Deposit towards fulfillment of Sublessee's unperformed obligations. If Sublessor does so apply any portion of the Security Deposit, Sublessee's failure to remit to Sublessor a sufficient amount in cash to restore the Security Deposit to the original amount within five (5) days after receipt of Sublessor's written demand to do so shall constitute an event of default. Upon termination of this Sublease, if Sublessee is not then in default beyond any applicable cure period in all of Sublessee's obligations hereunder, Sublessor shall return the entire Security Deposit to Sublessee; if Sublessee is in default of one or more provisions of the Sublease beyond any applicable cure period(s), then Sublessor shall return whatever amount remains of the Security Deposit after Sublessor applied all or a portion of the Security Deposit to cure such default(s), to Sublessee, in both cases, without payment of interest and in accordance with the terms of California Civil Code Section 1950.7 or any successor statute thereto. 2 USE. The Premises is to be used for the Permitted Uses, and for no other purpose or business without the prior written consent of Sublessor. In no event shall the Premises 11. 12 be used for a purpose or use prohibited by the Master Lease. 3 ALTERATIONS. Sublessee shall not make or suffer to be made any alterations, additions or improvements (collectively "Alterations") in, on, or to the Premises without the prior written consent of Sublessor which consent shall not be unreasonably withheld; provided, however, that Sublessor agrees not to withhold Sublessor's consent to any Alteration which has already been consented to in writing by Landlord. Sublessor will not respond to Sublessee's request for approval of an Alteration until Sublessor has sought and received Landlord's approval or disapproval of such Alteration (if Landlord's consent to such Alteration is required under the Master Lease). Notwithstanding the foregoing, Sublessee shall have the right, without need for the prior written consent of Sublessor, to make non-structural Alterations which do not affect the Building systems and cost less than Fifteen Thousand Dollars ($15,000) each to build and install, provided that such Alterations are otherwise installed in accordance with the terms of this Section 8. Any Alterations Sublessee is permitted to make shall be made by Sublessee at Sublessee's sole cost and expense, and Sublessee shall notify Sublessor at least five (5) business days in advance of the same so that Sublessor may post appropriate notices of nonresponsibility. Upon the expiration or sooner termination of this Sublease, Sublessee shall, at Sublessee's sole cost and expense, forthwith and with all due diligence, at Sublessee's sole cost and expense, repair and restore the Premises to their condition as of the Commencement Date of this Sublease, together with any Alterations which are not required to be removed by Sublessor pursuant to the terms of this Sublease, ordinary wear and tear, Hazardous Materials not caused by Sublessee, changes to the Premises due to Condemnation thereof and damage to the Premises by an act of God or casualty excepted. In addition, upon the expiration or earlier termination of this Sublease, to the extent only that: (i) Landlord has required the removal of an Alteration and Landlord has the right under the Master Lease to require such removal or (ii) (a) Sublessor has exercised any right Sublessor may now or hereafter possess to reoccupy the Premises after the expiration or earlier termination of this Lease (and provided Sublessee with written evidence of a binding obligation to do so), and (b) Sublessor informed Sublessee in writing at the time consent for such Alteration was given or written notice thereof was received by Sublessor that removal of such Alteration would be required in the event of (a), then Sublessee shall, at Sublessee's sole expense, forthwith and with due diligence, remove any such Alteration from the Premises upon the expiration or earlier termination of this Sublease. Nothing in this Section 8 shall be deemed to require Sublessee to remove any Alterations which were made to the Premises by a party other 12. 13 than Sublessee or a Sublessee Party prior to the Commencement Date of this Sublease. Under no circumstances shall Sublessee be required to remove the improvements constructed and/or installed in the Premises pursuant to the Work Letter attached as Exhibit C attached hereto. Sublessor and Sublessee agree to cooperate with each other in good faith to minimize the costs of restoration of the Premises at the expiration or earlier termination of this Sublease. 9. DAMAGE AND DESTRUCTION. 9.1 TERMINATION OF MASTER LEASE. If the Premises is damaged or destroyed and Landlord exercises any option it may have to terminate the Master Lease, this Sublease shall terminate as of the date of the termination of the Master Lease. If Sublessor has the option to terminate the Master Lease due to an event of damage or destruction to the Premises and Sublessee is not then in default (following Sublessor's notice to Sublessee and the expiration without cure of the applicable cure period provided for in Section 15 of the Master Lease, which has been incorporated herein) hereunder, then Sublessor shall promptly give Sublessee notice of such option and shall exercise such option only if so directed by Sublessee within ten (10) business days of receipt thereof, subject to the relevant provisions of the Master Lease; provided, however, that in the event that the Master Lease shall be terminable by Sublessor pursuant to its terms, yet Sublessee shall direct Sublessor to refrain from terminating the Master Lease, Sublessor shall nonetheless have the right to terminate the Master Lease and this Sublease and all of the obligations of Sublessor under both if Landlord has agreed in writing to (i) release Sublessor from all obligations and liabilities under the Master Lease; and (ii) continue this Sublease in full force and effect as a direct lease between Landlord and Sublessee upon and subject to all of the terms, covenants and conditions of this Sublease for the balance of the Term hereof. If Landlord so consents, Sublessee shall (a) attorn to Landlord in connection with any such voluntary termination and shall execute an attornment agreement in such form as may reasonably be requested by Landlord; provided, however, that the attornment agreement does not materially adversely affect the use by Sublessee of the Premises in accordance with the terms of this Sublease, materially increase Sublessee's obligations under this Sublease or materially decrease Sublessee's rights under this Sublease, and (b) release Sublessor from all obligations and liabilities under this Sublease arising from and after the termination of the Master Lease and Sublessor shall return to Sublessee the Security Deposit and any unearned amounts prepaid to Sublessor by Sublessee pursuant to this Sublease. 13. 14 9.2 CONTINUATION OF SUBLEASE. If the Master Lease is not terminated following any damage or destruction as provided above, this Sublease shall remain in full force and effect; provided, however, that the Rent due hereunder shall be abated to the extent and in proportion to the reduction in base rent and additional rent due under the Master Lease pursuant to the terms thereof. Sublessee shall be obligated to repair its Alterations to substantially the condition they were in prior to such damage or destruction, and Sublessor shall diligently enforce any obligation of Landlord to rebuild the Premises in accordance with the Master Lease. 10. EMINENT DOMAIN. 10.1 TOTAL CONDEMNATION. If all of the Premises is condemned by eminent domain, inversely condemned or sold in lieu of condemnation, for any public or a quasi-public use or purpose ("Condemned" or "Condemnation"), this Sublease shall terminate as of the date of title vesting in such proceeding, and Rent shall be adjusted to the date of termination. 10.2 PARTIAL CONDEMNATION. If any portion of the Premises is Condemned, and Landlord exercises any option to terminate the Master Lease, this Sublease shall automatically terminate as of the date of the termination of the Master Lease. If Sublessor has the option to terminate the Master Lease and Sublessee is not then in default (following Sublessor's notice to Sublessee and the expiration without cure of the applicable cure period provided for in Section 15 of the Master Lease, which has been incorporated herein) hereunder, Sublessor shall promptly give Sublessee notice of such option and shall exercise such option only if so directed by Sublessee within ten (10) business days of receipt thereof, subject to the relevant provisions of the Master Lease and further provided that such partial condemnation renders the Premises unusable for Sublessee's business, as reasonably determined by Sublessor and Sublessee. Sublessor and Sublessee agree to cooperate with each other to determine in good faith if the remaining portion of the Premises is suitable for the continued conduct of Sublessee's business therein. In the event that the Master Lease shall be terminable by Sublessor pursuant to its terms, yet Sublessee shall direct Sublessor to refrain from terminating the Master Lease, Sublessor shall nonetheless have the right to terminate the Master Lease and this Sublease and all of the obligations of Sublessor under both if Landlord has agreed in writing to (i) release Sublessor from all obligations and liabilities under the Master Lease; and (ii) continue this Sublease in full force and effect as a direct lease between Landlord and Sublessee upon and subject to all of the terms, covenants and conditions of this Sublease for the 14. 15 balance of the Term hereof. If Landlord so consents, Sublessee shall (a) attorn to Landlord in connection with any such voluntary termination and shall execute an attornment agreement in such form as may reasonably be requested by Landlord; provided, however, that the attornment agreement does not materially adversely affect the use by Sublessee of the Premises in accordance with the terms of this Sublease, materially increase Sublessee's obligations under this Sublease or materially decrease Sublessee's rights under this Sublease, and (b) release Sublessor from all obligations and liabilities under this Sublease arising from and after the termination of the Master Lease and return to Sublessee the Security Deposit and any unearned amounts prepaid to Sublessor by Sublessee pursuant to this Sublease. If this Sublease is not terminated following any such Condemnation, this Sublease shall remain in full force and effect and Sublessor shall diligently enforce any rights under the Master Lease to require Landlord to rebuild the Premises. Base Rent shall be equitably adjusted to take into account interference with Sublessee's ability to conduct its operations on the Premises as a result of the Premises being Condemned. Sublessee hereby waives the provisions of California Code of Civil Procedure Section 1265.130 permitting a court of law to terminate this Sublease. 10.3 SUBLESSEE'S AWARD. Subject to the provisions of the Master Lease, Sublessee shall have the right to recover from the condemning authority, but not from Sublessor, such compensation as may be separately awarded to Sublessee in connection with Sublessee's trade fixtures, Alterations, and any reasonable structures and improvements created by Sublessee upon the Premises which Sublessee is entitled to remove upon the expiration of the Term hereof. Sublessee shall also be entitled to any and all expenses paid or to be paid by the condemnor for moving Sublessee's equipment, Alterations and furniture. 11. INSURANCE. 11.1 ADDITIONAL INSUREDS. All insurance policies required to be carried by Sublessee, pursuant to the Master Lease, shall contain a provision whereby Sublessor and Landlord are each named as additional insureds under such policies. 11.2 INSURANCE PROCEEDS. Whenever provisions in the Master Lease which have been incorporated into this Sublease limit some obligation of Sublessor if Landlord would have insurance proceeds available, the term "Landlord" shall be deemed to refer to both Landlord and Sublessor, notwithstanding any provision to the contrary in this Sublease. 15. 16 11.3 WAIVER OF SUBROGATION. To the extent agreed to by Landlord in Landlord's consent to this Sublease, the waiver of subrogation provision incorporated into the Sublease by reference, which is set forth in the third grammatical paragraph of Section 6 of the Master Lease, commencing with the second sentence and continuing through the end of the third grammatical paragraph, shall supersede any conflicting provision in the Master Lease and/or this Sublease. Notwithstanding the foregoing, as between Sublessor and Sublessee such waiver of subrogation shall supersede any conflicting provision in the Master Lease and/or the Sublease except in a circumstance in which Sublessor incurs loss, cost, expense or damage under the Master Lease because of the failure of the waiver to subrogation to supersede inconsistent provisions in the Master Lease. The waiver of subrogation that is contained in the Master Lease, as expanded hereunder, will run between the Landlord and the Sublessee, as well as between the Landlord and the Sublessor. Landlord, by its execution of the consent following this Sublease, specifically consents to the foregoing provision concerning the waiver of subrogation. 12. BROKERAGE COMMISSION. 12.1 SUBLESSOR'S OBLIGATIONS. Sublessor shall pay a brokerage commission to Sublessor's Broker for Sublessee's subletting of the Premises as provided for in a separate agreement between Sublessor and Sublessor's Broker. Sublessor warrants for the benefit of Sublessee that its sole contact with Sublessee in connection with this transaction has been directly with Sublessee, Sublessor's Broker and Sublessee's Broker. Sublessor further warrants for the benefit of Sublessee that no other broker or finder can properly claim a right to a commission or a finder's fee based upon contacts between the claimant and Sublessor with respect to the other party or the Premises. Sublessor shall indemnify, defend by counsel acceptable to Sublessee and hold Sublessee harmless from and against any loss, cost or expense, including, but not limited to, attorneys' fees and court costs, resulting from any claim through Sublessor for a fee or commission by any broker or finder, other than any claims by Sublessor's Broker, in connection with the Premises and this Sublease. 12.2 SUBLESSEE'S REPRESENTATIONS AND WARRANTIES AND INDEMNITY. Sublessee warrants for the benefit of Sublessor that its sole contact with Sublessor or the Premises in connection with this transaction has been directly with Sublessor, Sublessor's Broker and Sublessee's Broker. Sublessee further warrants for the benefit of Sublessor that no other broker or finder can properly claim a right to a commission or a 16. 17 finder's fee based upon contacts between the claimant and Sublessee with respect to the other party or the Premises. Sublessee shall indemnify, defend by counsel acceptable to Sublessor and hold Sublessor harmless from and against any loss, cost or expense, including, but not limited to, attorneys' fees and court costs, resulting from any claim through Sublessee for a fee or commission by any broker or finder, other than any claims by Sublessee's Broker, in connection with the Premises and this Sublease. 13. SUBLESSEE'S INDEMNITY. Except to the extent caused by the negligence or willful misconduct or breach of this Sublease or the Master Lease of Sublessor or Sublessor's Parties, Sublessee shall defend, indemnify and hold harmless Sublessor, its partners, employees, and agents, and Landlord, from and against any and all claims, liabilities, suits, judgments, awards, damages, losses, fines, penalties, costs and expenses, including reasonable attorney's fees, that Sublessor, its partners, employees and agents, and Landlord may suffer, incur or be liable for by reason of or arising out of or related to the breach by Sublessee of any of the duties, obligations, liabilities or covenants applicable to Sublessee hereunder. This indemnification shall survive termination of this Sublease. 14. RIGHT TO CURE SUBLESSEE'S DEFAULTS. If Sublessee shall at any time fail to make any payment or perform any other obligation of Sublessee hereunder, then Sublessor shall have the right, but not the obligation, after the lesser of five (5) days' notice to Sublessee or the time within which Landlord may act on Sublessor's behalf under the Master Lease, or without notice to Sublessee in the case of any emergency, and without waiving or releasing Sublessee from any obligations of Sublessee hereunder, to make such payment or perform such other obligation of Sublessee in such manner and to such extent as Sublessor shall deem necessary, and in exercising any such right, to pay any incidental costs and expenses, employ attorneys and other professionals, and incur and pay attorneys' fees and other costs reasonably required in connection therewith. Sublessee shall pay to Sublessor upon demand all sums so paid by Sublessor and all incidental costs and expenses of Sublessor in connection therewith, together with interest thereon at the Interest Rate. 15. HAZARDOUS MATERIALS. 15.1 DEFINITIONS. (a) "HAZARDOUS MATERIALS". As used herein, "Hazardous Materials" means any chemical, substance, material, controlled substance, object, condition, waste, living organism 17. 18 or combination thereof which is or may be hazardous to human health or safety or to the environment due to its radioactivity, ignitability, corrosivity, reactivity, explosivity, toxicity, carcinogenicity, mutagenicity, phytotoxicity, infectiousness or other harmful or potentially harmful properties or effects, including, without limitation, petroleum and petroleum products, asbestos, radon, polychlorinated biphenyls (PCBs) and all of those chemicals, substances, materials, controlled substances, objects, conditions, wastes, living organisms or combinations thereof which are now or become in the future listed, defined or regulated in any manner by any Environmental Law based upon, directly or indirectly, such properties or effects. (b) ENVIRONMENTAL LAWS. As used herein, "Environmental Laws" means any and all federal, state or local environmental, health and/or safety-related laws, regulations, standards, decisions of courts, ordinances, rules, codes, orders, decrees, directives, guidelines, permits or permit conditions, currently existing and as amended, enacted, issued or adopted in the future which are or become applicable to Sublessee or the Premises. 15.2 SUBLESSEE'S COVENANT. Sublessee shall not cause, or allow any of Sublessee's employees, agents, customers, visitors, invitees, licensees, contractors, assignees or subtenants (collectively, "Sublessee's Parties") to cause any Hazardous Materials to be brought upon, stored, manufactured, generated, blended, handled, recycled, treated, disposed or used on, under or about the Premises, except for routine office and janitorial supplies in usual and customary quantities stored, used and disposed of in accordance with all applicable Environmental Laws. Notwithstanding the foregoing, Sublessee shall have the right, without need for consent from Sublessor, to use on the Premises the types of Hazardous Materials described in Exhibit D attached hereto or as hereafter consented to by Sublessor, pursuant to the terms of this Section 15.2 ("Permitted Hazardous Materials"), provided that: (i) no Permitted Hazardous Materials shall be used on the Premises in amounts in excess of the quantity thereof described in Exhibit D attached hereto, (ii) all such Permitted Hazardous Materials shall be used in compliance with all applicable Environmental Laws and in compliance with all of the terms of this Sublease (except for the need for Sublessee's consent thereto), (iii) such Permitted Hazardous Materials shall be used in a self-contained, state-of- the-art enclosed system and (iv) to the extent Sublessee wishes to use Hazardous Materials on the Premises other than the Permitted Hazardous Materials or wishes to use Permitted Hazardous Materials in quantities in excess of the amounts thereof described in Exhibit D, all such uses shall require the 18. 19 prior written consent of Sublessor, which consent shall not be unreasonably withheld if such Permitted Hazardous Materials are incidental to the conduct of Sublessee's customary activities on the Premises. Sublessee and Sublessee's Parties shall comply with all (to the extent Sublessee has actual knowledge of such presence) Environmental Laws with respect to Hazardous Materials brought upon, stored, manufactured, generated, blended, handled, recycled, treated, disposed or used on, under or about the Premises by Sublessee or Sublessee's Parties and promptly notify Sublessor of the presence of any Hazardous Materials, other than Permitted Hazardous Materials or office and janitorial supplies as permitted above, on the Premises or any violation (to the extent Sublessee has actual knowledge of such violation) of any Environmental Law. Sublessor shall have the right to inspect the Premises and to conduct tests and investigations to determine whether Sublessee is in compliance with the foregoing provisions provided that in each instance: (i) Sublessor gives Sublessee prior written notice of such inspection at least seventy-two (72) hours in advance, (except in cases of emergency, in which case no notice shall be necessary) and (ii) Sublessor and Sublessor's agents, contractors and representatives conduct such investigation in a manner reasonably designed to limit interference to Sublessee and Sublessee's use of the Premises. If such tests indicate the presence of any environmental condition caused by Sublessee or Sublessee's Parties, Sublessee shall reimburse Sublessor for the cost of conducting such tests. The phrase "environmental condition" shall mean any adverse condition relating to any Hazardous Materials or the environment, including surface water, groundwater, drinking water supply, land, surface or subsurface strata or the ambient air and includes air, land and water pollutants, noise, vibration, light and odors. In the event that Sublessee or Sublessee's Parties have caused Hazardous Materials to be released, stored, disposed of or introduced to the Premises in a manner or in amounts in violation of Environmental Laws, Sublessee shall promptly take any and all steps necessary to rectify the same or shall, at Sublessee's election, reimburse Sublessor, upon demand, for the cost to Sublessor of performing rectifying work. In the event that Sublessee shall elect to rectify such violation of Environmental Law but fail to commence to do so within the time periods required by relevant governmental authorities or within a time period specified by Sublessor, in Sublessor's reasonable discretion, Sublessor shall have the right to perform such rectifying work, and Sublessee shall reimburse Sublessor for the cost thereof upon demand therefor. Nothing in this Section 15.2 shall be deemed to create a liability for or an obligation of Sublessee to remediate Hazardous Materials released or stored on the Premises prior to the Commencement Date or at any time by parties other than Sublessee or Sublessee's Parties. 19. 20 15.3 SUBLESSEE'S INDEMNIFICATION. Sublessee shall indemnify, protect, defend (by counsel reasonably acceptable to Sublessor) and hold harmless Sublessor and its partners, directors, officers, employees, shareholders, lenders, agents, contractors and each of their respective successors and assigns from and against any and all claims, judgments, causes of action, damages, penalties, fines, taxes, costs, liabilities, losses and expenses arising at any time during or after the Term as a result (directly or indirectly) of or in connection with Hazardous Materials caused to be present on, under or about the Premises by Sublessee or Sublessee's Parties. This indemnity shall include the cost of any required or necessary repair, cleanup or detoxification, and the preparation of any closure or other required plans, whether such action is required or necessary prior to or following the termination of this Sublease. Neither the written consent by Sublessor to the presence of Hazardous Materials on, under or about the Premises nor the strict compliance by Sublessee with all Environmental Laws shall excuse Sublessee from Sublessee's obligation of indemnification pursuant hereto. Sublessee's obligations pursuant to the foregoing indemnity shall survive the termination of this Sublease. 15.4 SUBLESSOR'S INDEMNIFICATION. Sublessor shall indemnify, protect, defend (by counsel reasonably acceptable to Sublessee) and hold harmless Sublessee and its partners, directors, officers, employees, shareholders, lenders, agents, contractors and each of their respective successors and assigns from and against any and all claims, judgments, causes of action, damages, penalties, fines, taxes, costs, liabilities, losses and expenses arising at any time during or after the Term as a result (directly or indirectly) of or in connection with the presence of Hazardous Materials on, under or about the Premises or other properties as a result (directly or indirectly) of Sublessor's and/or Sublessor's Parties' activities in connection with the Premises. This indemnity shall include the cost of any required or necessary repair, cleanup or detoxification, and the preparation of any closure or other required plans, whether such action is required or necessary prior to or following the termination of this Sublease. Neither the written consent by Sublessee to the presence of Hazardous Materials on, under or about the Premises nor the strict compliance by Sublessor with all Environmental Laws shall excuse Sublessor from Sublessor's obligation of indemnification pursuant hereto. Sublessor's obligations pursuant to the foregoing indemnity shall survive the termination of this Sublease. 16. COVENANT OF QUIET ENJOYMENT. Subject to the termination of this Sublease due to a termination of the Master 20. 21 Lease for reasons other than a default by Sublessor as the tenant thereunder, Sublessee shall have, hold and enjoy the Premises, subject to the terms and conditions of this Sublease, provided that Sublessee pays all rent imposed hereunder and otherwise performs all of Sublessee's covenants and agreements contained herein. The obligations of Sublessor under this Section 16 are conditioned on the receipt by Sublessor and Sublessee of the prior written consent of Landlord to this Sublease and the terms and conditions thereof. 17. MISCELLANEOUS. 17.1 SUBLESSOR'S REPRESENTATIONS AND WARRANTIES. To the best of Sublessor's knowledge, Sublessor represents and warrants that the Master Lease is in full force and effect, and there exists under the Master Lease no default or event of default by either Landlord or Sublessor, nor has there occurred any event which, with the giving of notice or passage of time or both, could constitute such a default or event of default. Sublessor further represents and warrants that the copy of the Master Lease attached to this Sublease as Exhibit B is a true and complete copy of the Master Lease and that there are no addenda, amendments, exhibits or modifications to the Master Lease except which are attached hereto as part of Exhibit B. As used herein, "the best of Sublessor's knowledge" shall mean the actual knowledge of Jonathan Anderson as of the Effective Date, without the obligation to perform any research, investigation, due diligence or inquiry whatsoever. 17.2 COVENANTS OF SUBLESSOR. Sublessor shall not amend, terminate (except as provided for in Sections 9 and 10 hereof) or explicitly waive in writing any provisions under the Master Lease without receiving the prior written consent of Sublessee, which consent shall not be unreasonably withheld or delayed. 17.3 NOTICES. Any notice or report required or desired to be given regarding this Sublease shall be in writing, may be given (i) by personal delivery, (ii) by facsimile, (iii) by courier service or (iv) by certified mail, return receipt requested. Any notice or report addressed to Sublessor or Sublessee at the address set froth for each in Article I of this Sublease shall be deemed to have been given (i) when delivered, if given by personal delivery, (ii) instantaneously upon confirmation of receipt of facsimile, (iii) on the business day following deposit, cost prepaid, with Federal Express or similar private carrier, (iv) on the date the U.S. Post Office certifies delivery or refusal of delivery if such notice or report was deposited in the United States mail, certified, postage prepaid, 21. 22 and (v) in all other cases when actually received. Either party may change its address by giving notice of the same in accordance with this Section 17.3. The term "business day" shall mean a day on which the carrier used (Federal Express or other private carrier, or the U.S. Postal Service, as applicable) delivers, whether by special request or in the ordinary course of operations. 17.4 ENTIRE AGREEMENT. This Sublease contains all of the covenants, conditions and agreements between the parties concerning the Premises, and shall supersede all prior correspondence, agreements and understandings concerning the Premises, both oral and written. No addition or modification of any term or provision of this Sublease shall be effective unless set forth in writing and signed by both Sublessor and Sublessee. 17.5 CAPTIONS. All captions and headings in this Sublease are for the purposes of reference and convenience and shall not limit or expand the provisions of this Sublease. 17.6 LANDLORD'S CONSENT. This Sublease is conditioned upon Landlord's written approval of this Sublease within thirty (30) days after the Effective Date. If Landlord refuses to consent to this Sublease, or if the thirty (30) day consent period expires, this Sublease shall terminate and neither party shall have any continuing obligation to the other with respect to the Premises; provided Sublessor shall return the Deposit, any prepaid Rent and any other sums previously paid by Sublessee to Sublessor in connection with this Sublease, if previously delivered to Sublessor, to Sublessee. 17.7 AUTHORITY. Each person executing this Sublease on behalf of a party hereto represents and warrants that he or she is authorized and empowered to do so and to thereby bind the party on whose behalf he or she is signing. 17.8 ATTORNEYS' FEES. In the event either party shall bring any action or proceeding for damages or for an alleged breach of any provision of this Sublease to recover rents, or to enforce, protect or establish any right or remedy hereunder, the prevailing party shall be entitled to recover reasonable attorneys' fees and court costs as part of such action or proceeding. 17.9 SUBLESSOR'S RIGHT TO MATCH BIDS FOR, AND PERFORM, PROPERTY MANAGEMENT SERVICES. On or before November 1, 1996, Sublessee shall solicit bids (the "Property management Bids") from up to three (3) property management companies reasonably satisfactory to Sublessor for the performance of the 22. 23 property management and repair obligations of Sublessee (the "Management Obligations") during the Term of this Sublease. Sublessee shall promptly submit all of the Property Management Bids, together with written notice of Sublessee's proposed winning bid (the "Winning Bid") to Sublessor upon Sublessee's receipt thereof. Within five (5) business days after receipt of the Property Management Bids, Sublessor shall, at Sublessor's sole discretion, either (i) approve Sublessee's use of the property management company submitting the Winning Bid for the performance of the Management Obligations, which consent shall not be unreasonably withheld, or (ii) elect instead to perform the Property Management Obligations itself (or through a subsidiary of Sublessor, Amdahl Corporate Facilities) throughout the Term of the Sublease on the terms and conditions of the Winning Bid. Should Sublessor elect option (i) above, Sublessee shall provide Sublessor with a fully-executed copy of the management agreement entered into with the entity submitting the Winning Bid promptly upon execution thereof. If Sublessor shall select option (ii) above, Sublessor and Sublessee shall promptly enter into an agreement upon terms reasonably satisfactory to both parties (including without limitation a provision that Sublessee may terminate such agreement upon thirty (30) days' written notice if Sublessor or Amdahl Corporate Facilities, as relevant, fails to perform such Property Management Obligations in a manner reasonably acceptable (at, or above the facility maintenance industry average) to Sublessee) whereby Sublessor shall perform the Property Management Obligations for Sublessee throughout the Term of this Sublease. 17.10 ASSIGNMENT OF RIGHTS. Sublessor hereby assigns to Sublessee, without representation or warranty, all warranties given and indemnities made by Landlord to Sublessor under the Master Lease which would reduce Sublessee's obligations hereunder, to the extent such warranties and indemnities are assignable. 17.11 CONSENTS. Whenever the consent of either Sublessor or Sublessee is required under the terms of this Sublease, such consent shall not be unreasonably withheld or delayed unless expressly provided to the contrary herein. 17.12 EXHIBITS. All exhibits attached hereto are incorporated herein and made a part hereof. IN WITNESS WHEREOF, the parties hereto have executed one (1) or more copies of this Sublease, dated as of the Effective Date. "SUBLESSOR" 23. 24 IN WITNESS WHEREOF, the parties hereto have executed one (1) or more copies of this Sublease, dated as of the Effective Date. "SUBLESSOR" AMDAHL CORPORATION, a Delaware corporation By: /s/ Edward S. Hartford ---------------------------------- Name: Edward S. Hartford Title: Vice President, Corporate Facilities "SUBLESSEE" INTEGRATED SILICON SOLUTION, INC., a Delaware corporation By: /s/ Gary L. Fischer ---------------------------------- Name: Gary L. Fischer Title: Executive Vice President and Chief Financial Officer By: _______________________________ Name: _____________________________ Title: ____________________________ 24. EX-11.1 4 CALCULATION OF EARNINGS PER SHARE 1 Exhibit 11.1 INTEGRATED SILICON SOLUTION, INC. STATEMENTS OF COMPUTATION OF EARNINGS PER SHARE (In thousands, except per share data)
Years Ended September 30, 1996 1995 1994 ------- -------------- ------- Net income ................................. $ 1,015 $29,653 $ 4,612 ======= ======= ======= Computation of weighted average common and common equivalent shares outstanding: Weighted average common shares outstanding ............................ 17,457 12,128 4,778 Common equivalent shares from dilutive preferred stock ........................ -- 2,805 7,829 Common equivalent shares from dilutive common stock options and warrants ...... 899 1,470 616 Common equivalent shares from stock and stock options granted during the twelve- month period prior to the Company's initial public offering ................ -- 131 524 ------- ------- ------- Shares used in per share calculations ...... 18,356 16,534 13,747 ======= ======= ======= Net income per share ....................... $ 0.06 $ 1.79 $ 0.34 ======= ======= =======
EX-23.1 5 CONSENT OF ERNST & YOUNG LLP 1 Exhibit 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement on Form S-8 (including registration of shares for resale by means of a Form S-3 prospectus) Nos. 33-95282 and 333-3438 pertaining to the 1993 Employee Stock Purchase Plan, the 1995 Director Stock Purchase Plan and the 1989 Stock plan of Integrated Silicon Solution, Inc. of our report dated October 28, 1996 with respect to the consolidated financial statements and schedule of Integrated Silicon Solution, Inc. included in the Annual Report (Form 10-K) for the year ended September 30, 1996. ERNST & YOUNG LLP San Jose, California December 2, 1996 EX-27.1 6 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from (a) the audited financial statements and is qualified in its entirety by reference to such (b) audited financial statements for the year ending September 30, 1996. 1,000 U.S. DOLLARS YEAR SEP-30-1996 OCT-01-1995 SEP-30-1996 1 19,260 62,200 13,318 2,002 11,316 129,022 46,480 15,351 178,039 21,093 10,195 0 0 2 142,433 178,039 132,039 132,039 100,184 100,184 0 0 335 (215) (1,158) 1,015 0 0 0 1,015 0.06 0.06
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