-----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, JDQJsR7Jp8TQEpjOQ26Q6KoZknB6JsQj92Vas+j7xzwy+JYmWvg+Z0ETZnnxvW2z KJrL6/qbOEO1MBh0weqs5A== 0000912057-00-008153.txt : 20000225 0000912057-00-008153.hdr.sgml : 20000225 ACCESSION NUMBER: 0000912057-00-008153 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000224 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SILICON STORAGE TECHNOLOGY INC CENTRAL INDEX KEY: 0000855906 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 770225590 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-26944 FILM NUMBER: 551912 BUSINESS ADDRESS: STREET 1: 1171 SONORA CT CITY: SUNNYVALE STATE: CA ZIP: 94086 BUSINESS PHONE: 4087359110 MAIL ADDRESS: STREET 1: 1171 SONORA COURT CITY: SUNNYVALE STATE: CA ZIP: 94086 10-K405 1 FORM 10-K405 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES 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 DECEMBER 31, 1999. 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 0-26944 ------------------------ SILICON STORAGE TECHNOLOGY, INC. (Exact name of Registrant as specified in its charter) CALIFORNIA 77-0225590 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 1171 SONORA COURT, SUNNYVALE, CA 94086 (Address of principal executive offices) (Zip code) Company's telephone number, including area code: (408) 735-9110
------------------------ Securities registered pursuant to Section 12(b) of the Act:
TITLE OF CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED - -------------- ----------------------------------------- None. None.
Securities registered pursuant to Section 12(g) of the Act: Common Stock, no par value. ------------------------ Indicate by check mark whether SST (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 SST 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 Company's knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes /X/ No / /. Aggregate market value of the voting stock held by non-affiliates of SST as of January 31, 2000: $820,375,898 based on the closing price of SST's Common Stock as reported on the Nasdaq National Market. Number of shares outstanding of SST's Common Stock, no par value, as of January 31, 2000: 25,071,223. Documents incorporated by reference: Exhibits previously filed as noted on page 34. Part III--A portion of the Registrant's definitive proxy statement for the Registrant's Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SILICON STORAGE TECHNOLOGY, INC. FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999 TABLE OF CONTENTS PART I Item 1. Business.................................................... 3 Item 2. Properties.................................................. 11 Item 3. Legal Proceedings........................................... 11 Item 4. Submission of Matters to a Vote of Security Holders......... 12 PART II Item 5. Market for Registrant's Common Stock and Related Shareholder Matters................................................... 13 Item 6. Selected Consolidated Financial Data........................ 14 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................................. 15 Item 7A. Quantitative and Qualitative Disclosures about Market Risk...................................................... 30 Item 8. Consolidated Financial Statements and Supplementary Data.... 30 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................. 32 PART III Item 10. Directors and Executive Officers of the Registrant.......... 33 Item 11. Executive Compensation...................................... 33 Item 12. Security Ownership of Certain Beneficial Owners and Management................................................ 33 Item 13. Certain Relationships and Related Transactions.............. 33 PART IV Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K.................................................. 34 Index to Exhibits........................................................... 34 Signatures.................................................................. 36 Index to Consolidated Financial Statements.................................. 39
2 PART I ITEM 1. BUSINESS OVERVIEW We are a leading supplier of flash memory semiconductor devices for the digital consumer, networking, wireless communication and Internet computing markets. Flash memory is nonvolatile memory that does not lose data when the power source is removed and is capable of electrically erasing selected blocks of data. We believe our proprietary flash memory technology, SuperFlash, offers superior performance to other flash memory solutions. We further believe that the benefits of SuperFlash include high reliability, fast write performance, ability to be scaled to a smaller size and a low-cost manufacturing process. We offer over 40 products based on our SuperFlash design and manufacturing process technology. We also offer mass storage products that are used for storing images, music and other data in devices such as digital cameras and MP3 players. Our customers include 3Com, Acer, Apple, Compaq, Diamond Multimedia, FIC, Hyundai, Intel, IBM, LG, Lucent, Motorola, Panasonic, Samsung, Sanyo, Siemens and Sony. In addition, we have recently added Cisco and Nortel as new customers. We also license our SuperFlash technology to leading semiconductor companies including Analog Devices, ATMI, IBM, ISD, Motorola, Samsung, Sanyo, Seiko-Epson and TSMC to embed in semiconductor devices that integrate flash memory with other functions on a single chip. Our products are manufactured at leading wafer foundries and semiconductor manufacturers including Samsung Electronics, Sanyo, Seiko-Epson, TSMC and UMC. We also work with IBM, Samsung Electronics, Sanyo, Seiko-Epson and TSMC to develop new technology for manufacturing our products. INDUSTRY BACKGROUND Semiconductor integrated circuits are critical components used in an increasingly wide variety of applications, such as computers and computer systems, communications equipment, consumer products and industrial automation and control systems. As integrated circuit performance has increased and size and cost have decreased, the use of semiconductors in these applications has grown significantly. According to the Semiconductor Industry Association, or SIA, worldwide semiconductor device revenue will grow from $125.6 billion in 1998 to $215.7 billion in 2002. Historically, the demand for semiconductors has been driven by the personal computer, or PC, market. The demand for PCs has grown in recent years, in part due to increased use of PCs for Internet access. The PC market grew from 80 million units shipped in 1997 to 100 million units shipped in 1998 to 115 million units shipped in 1999, according to Dataquest. In recent years, growth in demand for semiconductors relating to PCs has been outpaced by growth in demand for semiconductors in digital electronic devices for communication and consumer applications. Communications applications include digital subscriber line modems, cable modems, wireless local area network devices, cellular phones and pagers. Consumer-oriented digital electronic devices include digital cameras, DVD players, MP3 players, personal digital assistants, set-top boxes, CD-ROM drives and GPS navigation systems. In order to function correctly, PCs and other digital electronic devices require program code. The program code defines how devices function and affects how they are configured. In PCs, this program code, or BIOS, initiates the loading of the PC's operating system, which is then read from the disk drive. In the case of other digital electronic devices, the program code is stored in its entirety in nonvolatile memory, mostly in flash memory. As a result, virtually all complex electronic systems that use a processor or controller for computing, consumer, communications, and industrial applications require nonvolatile memory. 3 System manufacturers generally prefer nonvolatile memory devices that can be reprogrammed efficiently in the system in order to achieve several important advantages. With reprogrammable memory, manufacturers can cost effectively change program code in response to faster product cycles and changing market specifications. This in turn greatly simplifies inventory management and manufacturing processes. Reprogrammable memory also allows the manufacturer to reconfigure or update a system either locally or through a network connection. In addition, in-system reprogrammable devices can be used for data storage functions, such as storage of phone numbers for speed dialing in a cellular phone. Flash memory is the predominant reprogrammable nonvolatile memory device used to store program codes. Flash memory can electrically erase select blocks of data on the chip much faster and more simply than with alternative solutions, such as Erasable Programmable Read-Only Memory, or EPROM. Moreover, flash memory is significantly less expensive than other reprogrammable solutions, such as Electrically Erasable Programmable Read-Only Memory, or EEPROMs. As a result, the demand for flash memory has grown dramatically. This growth has been fueled by the need for code sharing and other storage functions in a wide array of digital devices. According to SIA, worldwide flash memory revenue was $4.6 billion in 1999, a 83% increase over 1998. According to Dataquest, as a result of newly emerging applications, worldwide flash revenue is projected to reach $8.0 billion by 2003. OUR SOLUTION We are a leading supplier of flash memory semiconductor devices addressing the needs of high volume electronic applications. We believe our proprietary flash memory technology, SuperFlash, offers superior performance to other flash memory solutions. In addition, we believe SuperFlash's benefits include high reliability, fast write performance, ability to be scaled to a smaller size and a low-cost manufacturing process. Many leading technology companies use our technology in their products including 3Com, Acer, Apple, Compaq, Diamond Multimedia, FIC, Hyundai, Intel, IBM, LG, Lucent, Motorola, Panasonic, Samsung, Sanyo, Siemens and Sony. New customers include Cisco and Nortel. We offer over 40 products based on our proprietary SuperFlash design and manufacturing process technology. These products are produced to meet the needs of a wide range of digital consumer, networking, wireless communication and Internet computing markets. Our product offerings include standard flash products, application specific memory products, standard embedded controllers and mass storage products. Our memory devices have densities ranging from 256 Kbit to 16 Mbit and are generally used for the storage of program code. Our flash embedded microcontrollers support concurrent flash read-while-write operations using In-Application Programming, or IAP. Our mass storage products are used for storing images, music and other data in devices such as digital cameras and MP3 players. Our products are manufactured at leading wafer foundries and semiconductor manufacturers including Samsung Electronics, Sanyo, Seiko-Epson, TSMC and UMC. We also work with IBM, Samsung Electronics, Sanyo, Seiko-Epson and TSMC to develop new technology for manufacturing our products. We license our SuperFlash technology to leading semiconductor companies including Analog Devices, ATMI, IBM, ISD, Motorola, Samsung, Sanyo, Seiko-Epson and TSMC to embed in semiconductor devices that integrate flash memory with other functions on a single chip. OUR STRATEGY Our objective is to be the leading worldwide supplier of flash memory devices and intellectual property for program code storage applications. In addition, we intend to leverage our SuperFlash technology to penetrate the high density mass storage markets. We intend to achieve our objectives by: 4 MAINTAINING A LEADING POSITION IN THE PROGRAM CODE STORAGE MARKET. We believe that program code storage is an attractive segment of the flash memory market for a number of reasons. While experiencing continued growth in all densities, solutions for program code storage applications benefit from the increasing number and variety of digital electronic applications, longer product lives and lower density requirements relative to mass data storage applications. We believe that our proprietary SuperFlash technology is a superior product for program code storage applications because it offers reliability and high performance at a low cost. CONTINUING TO ENHANCE OUR LEADING FLASH MEMORY TECHNOLOGY. We believe that our proprietary SuperFlash technology is less complicated, more reliable, more scalable and more cost-effective than competing flash memory technologies. Our ongoing research and development efforts are focused on enhancing our leading flash memory technology. We are working with IBM, Samsung, Sanyo, Seiko Epson and TSMC to develop new process technologies for SuperFlash. INTRODUCING NEW PRODUCTS BASED ON SUPERFLASH. We intend to introduce new and different application specific products. We are currently developing ComboMemory, a new class of devices for wireless and portable applications that combine volatile and nonvolatile memory on a single monolithic silicon chip or in a common package with optimized performance. We are also developing a new reprogrammable microcontroller family and new mass storage products. In addition, we plan to introduce 1, 2 and 4 Mbit serial flash, 2, 4 and 8 Mbit firmware hubs and 8, 16, 32 and 64 Mbit concurrent flash. ComboMemory and concurrent flash are designed to address the memory needs of wireless communications devices, such as cellular phones, wireless modems and pagers. MAINTAINING A LEADING POSITION IN LICENSING EMBEDDED FLASH TECHNOLOGY. We believe that SuperFlash technology is well-suited for embedded memory applications, which integrate flash memory and other functions onto a single chip. We intend to continue to license SuperFlash technology to semiconductor manufacturers for use in embedded flash applications and to enhance our technology to facilitate integration at higher densities and higher levels of complexity. PENETRATING THE HIGH DENSITY MASS STORAGE MARKET. Many digital electronic devices currently being introduced, such as MP3 players, digital cameras and PDAs, require high density flash memory for storing music, pictures and other data that require mass storage capacities. We believe that the market for high density flash memory is attractive based on its potential growth. We further believe that SuperFlash technology can readily scale to address this market growth. We intend to leverage our leading technology and strong manufacturing partnerships to introduce high density mass storage flash products and to compete effectively in this market. OUR FLASH PRODUCTS STANDARD FLASH MEMORY PRODUCTS. Currently, we offer low and medium density devices that target a broad range of existing and emerging applications in the digital consumer, networking, wireless communication and Internet computing markets. Our products are differentiated based upon attributes such as density, voltage, access speed, packaging and predicted endurance. We have three Standard Flash Memory product families: the Small-Sector Flash, or SSF, family, the Multi-Purpose Flash, or MPF, family, and the Many-Time Programmable, or MTP, family. These families allow us to produce products optimized for cost and functionality to support the broad range of applications that use nonvolatile memory products. Among the three product families, SSF provides the highest functionality. MPF is a lower cost flash solution because it eliminates much of the peripheral circuitry of SSF products while retaining many of the benefits of the SuperFlash core--high reliability, faster write performance, geometric scalability and a low-cost manufacturing process. Both SSF and MPF address mainstream flash applications that require In System Programming, or ISP. MTP devices are our lowest cost flash 5 products. Our MTP products provide an electrically-erasable alternative to EPROM and other low-end flash products that do not require ISP. APPLICATION-SPECIFIC MEMORY PRODUCTS. Our application-specific memory products consist of ComboMemory, FlashBank, Serial Flash and Firmware Hub, or FWH. These products are designed to address specific applications such as cellular phones, pagers, PDAs, set-top boxes, hard disk drives and PC BIOS applications. FLASH EMBEDDED CONTROLLERS. Our flash embedded controllers include the FlashFlex51 microcontroller product family, which features products that are both software and pin compatible with industry standard 8051 microcontroller products. This family is designed with two banks of program memory to support concurrent read and write operations using IAP. It also contains SoftLock security features allowing IAP while preventing software piracy. These products target the 8-bit microcontroller market segment with products addressing the emerging applications for in-system reprogrammable microcontrollers. MASS STORAGE PRODUCTS. Our mass storage products, including the CompactFlash Card product family, address digital cameras, digital cellular phones, PDAs, MP3 players and other types of mass data storage applications. Our mass storage products leverage our patented ATA controller technology and flash memory design expertise to offer favorable read/write data transfer rates to the flash memory, which allows significant speed advantages for applications such as digital cameras. TECHNOLOGY LICENSING We license our SuperFlash technology to semiconductor manufacturers for use in embedded flash applications. We intend to increase our market share by entering into additional license agreements for our process and SuperFlash memory cell technology with leading wafer foundries and semiconductor manufacturers. We expect to continue to receive licensing fees and royalties from these agreements. We design our products using patented memory cell technology and fabricate them using patented process technology. We own 22 patents in the United States relating to certain aspects of our products and processes, and have filed for several more. In addition, we hold two patents in Europe, one patent in Germany and additional foreign patent applications have been filed in Europe, Japan, Taiwan and Canada. CUSTOMERS We provide high-performance flash memory solutions to customers in four major markets: digital consumer, networking, wireless communications and Internet computing. Our customers benefit by obtaining products that we believe are highly reliable, technologically advanced and that have an attractive cost structure. As a result of these highly desirable benefits, we have developed relationships with many of the industry's leading companies. In digital consumer products, we provide memory components for consumer companies including Canon, Datel, Freetron, GSL, IDT, Panasonic, Sanyo, Siemens, Sony, TiVo and Xerox. In networking, we provide memory components for 3Com, E-tech, Intel, Nortel and Xircom. In wireless communications, we provide products for companies including Kirks, Lucent, Maxon, RTX, Siemens and VTech. In Internet computing, we provide a wide array of memory components for companies including Acer, Apple, Asustek, Compal, Dell, FIC, Gigabyte, Mitac, NEC and Quanta. 6 The following tables illustrate the geographic regions in which our customers or licensees operate based on the country to which the product is shipped or license revenue is generated.
YEAR ENDED DECEMBER 31, ------------------------------ 1997 1998 1999 -------- -------- -------- United States................................... $10,032 $ 5,099 $ 13,644 Europe.......................................... 3,381 6,929 7,347 Japan........................................... 17,878 13,739 16,396 Korea........................................... 4,203 3,756 11,750 Taiwan.......................................... 22,027 19,134 33,541 China (including Hong Kong)..................... 11,863 14,104 28,776 Other Asian countries........................... 5,890 6,119 9,340 Rest of world................................... 48 531 4,000 ------- ------- -------- $75,322 $69,411 $124,794 ======= ======= ========
SALES AND DISTRIBUTION We sell a majority of our products to customers in Asia through manufacturers' representatives. We also sell and distribute our products in North America and Europe through a direct sales organization supported primarily by manufacturers' representatives and distributors. Our manufacturer representative and distributor relationships are generally cancellable by us or the other parties with reasonable notice. APPLICATIONS As the Internet, communications and consumer electronics industries continue to expand and diversify, new applications are likely to be developed. We believe our products are designed to address this expanding set of applications:
WIRELESS INTERNET DIGITAL CONSUMER NETWORKING COMMUNICATIONS COMPUTING - ---------------------------------------------- ---------------------- ---------------------- ---------------------- TV Replayer Set-top Box DSL Modem Cellular Phone Network PC Digital TV CD-ROM Drive Cable Modem Data Pager Notebook PC Digital Camera CD-RW Drive V.90/56K Modem Cordless Telephone Palm PC DVD Player DVD-ROM Drive Wireless LAN Cellular Phone GPS X-PC VCD Player DVD-RAM Drive Network Interface Card Bluetooth Applications Server MP3 Player DVD-RW Drive Router PC Firmware Hub Video Game Web Browser Graphics Card PDA Hand Held GPS Printer Electronic Book Digital Camcorder Copier/Scanner Memory Cards Electronic Toys Bar Code Scanner
MANUFACTURING We purchase wafers and sorted die from semiconductor manufacturing foundries, have this product shipped directly to subcontractors for packaging, testing, and finishing, and then ship the final product to our customers. Virtually all of our subcontractors are located in Asia. WAFER AND SORTED DIE. We have manufacturing arrangements with Samsung, Sanyo, Seiko-Epson, TSMC and UMC. As of December 31, 1999, our major wafer fabrication foundries were TSMC, Sanyo and Samsung. In 1999, wafer sort, which is the process of taking silicon wafers and separating them into individual die, was performed at Sanyo, TSMC, Seiko-Epson, Samsung and KYE. Although capacity is not guaranteed, under these arrangements we generally receive preferential treatment regarding wafer pricing and capacity. 7 In order to obtain, on an ongoing basis, an adequate supply of wafers, we have considered and will continue to consider various possible options, including equity investments in foundries in exchange for guaranteed production volumes, the formation of joint ventures to own and operate foundries and the licensing of our proprietary technology. PACKAGING, TESTING AND FINISHING. In the assembly process, the individual die are assembled into packages. Following assembly, the packaged devices require testing and finishing to segregate conforming from nonconforming devices and to identify devices by performance levels. Currently, all devices are tested and inspected pursuant to our quality assurance program at our test facilities in Sunnyvale, California or at other domestic or international subcontracted facilities. Finishing operations are performed at our Sunnyvale facility or at other domestic or international subcontracted facilities before shipment to customers. Certain facilities currently perform consolidated assembly, packaging, test and finishing operations at one location. During 1999, the two facilities performing the substantial majority of consolidated operations were Lingsen in Taiwan and Amkor's facility in Korea. For newly released products, most of the test and finishing activities are performed at our Sunnyvale facility. RESEARCH AND DEVELOPMENT We believe that our future success will depend in part on the development of next generation technologies with reduced feature size. During 1999, 1998 and 1997, we spent $18.2 million, $14.5 million and $8.7 million, respectively, on research and development. Our research efforts are focused on process development and product development. Our research strategy is to collaborate with our partners to advance our technologies. We work simultaneously with several partners on the development of multiple generations of technologies. In addition, we allocate our resources and personnel into category-specific teams to focus on new product development. From time to time we invest in, jointly develop with or license or acquire technology from other companies in the course of developing products. For example, in June 1999, we acquired Linvex Technology, Corp., a privately held, memory design company located in Sunnyvale, California. COMPETITION The semiconductor industry is intensely competitive and has been characterized by price erosion, rapid technological change and product obsolescence. We compete with major domestic and international semiconductor companies, many of whom have substantially greater financial, technical, marketing, distribution, manufacturing and other resources than us. Our low to medium density memory products, sales of which presently account for substantially all of our revenues, compete against products offered by Intel Corporation, Advanced Micro Devices, Inc., Atmel Corporation, STMicroelectronics, Inc., Winbond Electronics Corporation, and Macronix, Inc. Our high density memory products compete with products offered by Intel, Advanced Micro Devices, Atmel, Fujitsu Limited, Sharp Electronics Corporation, Samsung, Mitsubishi Corporation and Toshiba Corporation. In addition, competition may come from alternative technologies such as ferroelectric random access memory device, or FRAM, technology. The competition in the existing markets for our new products such as the FlashFlex51 microcontroller product family and the CompactFlash product family is extremely intense. We compete principally with major companies such as Philips Electronics, Atmel, Intel, and Microchip Technology Inc. in the microcontroller market and with SanDisk Corporation and Hitachi Corporation in the memory card market. We may, in the future, also experience direct competition from our foundry partners. We have licensed to each foundry the right to fabricate certain products based on our proprietary technology and circuit design, and to sell such products worldwide, subject to royalty payments back to us. 8 We compete principally on price, reliability, functionality and the ability to offer timely delivery to customers. During the extreme currency devaluations in Asia in 1997-1998, we were severely impaired in our ability to compete on the basis of price. While we believe that our medium density products currently compete favorably on the basis of reliability and functionality, it is important to note that our principal competitors have a significant advantage over us in terms of greater financial, technical and marketing resources. Our long-term ability to compete successfully in the evolving flash memory market will depend on factors both within and beyond our control, including access to advanced process technologies at competitive prices, successful and timely product development, wafer supply, product pricing, actions of our competitors and general economic conditions. EMPLOYEES As of December 31, 1999, we employed 277 individuals on a full-time basis, all but five of whom reside in the United States. Two employees reside in Japan and one employee resides in each of England, Denmark and Taiwan. Of these 277 employees, 65 were employed in manufacturing support, 141 in engineering, 45 in sales and marketing and 26 in administration and finance. No employees are represented by a collective bargaining agreement, nor have we ever experienced any work stoppage related to strike activity. We believe that our relationship with our employees is good. EXECUTIVE OFFICERS AND DIRECTORS The following table lists the names, ages and positions of our executive officers and directors as of December 31, 1999. There are no family relationships between any of our directors or executive officers. Executive officers serve at the discretion of the board of directors.
NAME AGE POSITION - ---- ---- ------------------------------------------------- Bing Yeh(1)(4)............................ 49 President and Chief Executive Officer and Director Yaw Wen Hu................................ 50 Senior Vice President, Operations and Process Development and Director Derek Best................................ 49 Vice President, Sales and Marketing Michael Briner............................ 52 Vice President, Products Isao Nojima............................... 55 Vice President, Advanced Development Paul Lui.................................. 49 Vice President and General Manager of the Linvex Product Line Jeffrey L. Garon.......................... 39 Chief Financial Officer and Vice President, Finance and Administration and Secretary Tsuyoshi Taira(1)(2)(3)................... 61 Director Yasushi Chikagami(1)(2)(3)................ 61 Director Ronald Chwang(1)(2)(3).................... 51 Director
- ------------------------ (1) Member of Compensation Committee (2) Member of Audit Committee (3) Member of Stock Option Committee (4) Sole Member of Non-Officer Stock Option Committee BING YEH, one of our co-founders, has served as our President and Chief Executive Officer and been a member of our board of directors since our inception in 1989. Prior to that, Mr. Yeh served as a senior research and development manager of Xicor, Inc., a nonvolatile memory semiconductor company. From 1981 to 1984, Mr. Yeh held program manager and other positions at Honeywell Inc. 9 From 1979 to 1981, Mr. Yeh was a senior development engineer of EEPROM technology of Intel Corporation. He was a Ph.D. candidate in Applied Physics and earned an Engineer degree at Stanford University. Mr. Yeh holds an M.S. and a B.S. in Physics from National Taiwan University. YAW WEN HU, Ph.D., joined us in 1993 as Vice President, Technology Development. In 1997, he was given the additional responsibility of wafer manufacturing and, in August 1999, he became Vice President, Operations and Process Development. In January 2000, he was promoted to Senior Vice President, Operations and Process Development. Dr. Hu has been a member of our board of directors since September 1995. From 1990 to 1993, Dr. Hu served as deputy general manager of technology development of Vitelic Taiwan Corporation. From 1988 to 1990, he served as FAB engineering manager of Integrated Device Technology, Inc. From 1985 to 1988, he was the director of technology development at Vitelic Corporation. From 1978 to 1985 he worked as a senior development engineer in Intel Corporation's Technology Development group. Mr. Hu holds a B.S. in Physics from National Taiwan University and an M.S. in Computer Engineering and a Ph.D. in Applied Physics from Stanford University. DEREK BEST joined us in June 1997 as Vice President of Sales and Marketing. Prior to that, he worked for Micromodule Systems, a manufacturer of high density interconnect technology, as vice president marketing and sales world wide from 1992 to 1996. From 1987 to 1992, he owned his own company, Mosaic Semiconductor, a semiconductor company. Mr. Best holds an Electrical Engineering degree from Portsmouth University in England. MICHAEL BRINER joined us as Vice President, Design Engineering in November 1997 and became Vice President, Products during 1999. From 1993 to 1997, he served as vice president of design engineering for Micron Quantum Devices, Inc., a subsidiary of Micron Technology, Inc., chartered to develop and manufacture flash memory products. From 1986 through 1992, he served as director of design engineering for the Nonvolatile Division of Advanced Micro Devices, Inc. In this position, he was instrumental in helping AMD become a major nonvolatile memory manufacturer. Mr. Briner holds a B.S. in Electrical Engineering from the University of Cincinnati. ISAO NOJIMA has served as our Vice President, Advanced Development since July 1997. From March 1993 to June 1997, he served as our Vice President, Memory Design and Product Engineering. From 1990 to 1993, Mr. Nojima served as director of design engineering of Pioneer Semiconductor Corporation, now called Pericom, a manufacturer of semiconductors. From 1980 to 1990, he served as design manager of Xicor Inc., a nonvolatile semiconductor company. From 1977 to 1980, he served as a senior design engineer for Intel Corporation. From 1969 to 1976, he was a senior researcher at Toshiba's R&D Center in Japan. Mr. Nojima holds a B.S. and an M.S. in Electrical Engineering from Osaka University in Japan. PAUL LUI joined us as Vice President and General Manager of the Linvex Product Line in June 1999. From 1994 to 1999, he was the president and founder of Linvex Technology, Corporation. From 1987 to 1994, he was the president and chief executive officer of Macronix, Inc.. From 1981 to 1985, he served as group general manager at VLSI Technology, Inc. where he was responsible for transferring that company's technology to Korea. In addition, Mr. Lui has held senior engineering positions at the Synertek Division of Honeywell and McDonnell Douglas. Mr. Lui holds an M.S.E.E. degree from University of California, Berkeley and a B.S. degree in Electrical Engineering and Mathematics from California Polytechnic State University, San Luis Obispo. JEFFREY L. GARON joined us as Chief Financial Officer and Vice President, Finance and Administration and Secretary in March 1998. Prior to that, Mr. Garon served as president and senior operating officer of The Garon Financial Group, Inc., a venture capital and venture consulting firm specializing in start-ups, turnarounds and restarts, from 1994 to 1998. From 1993 to 1994, he served as a vice president and chief financial officer of Monster Cable Products, Inc., a leading provider of audio cables and supplies to consumers and the consumer electronic retail channel. Prior to this, Mr. Garon 10 held senior financial positions with Visual Edge Technology, Inc., a provider of large format digital imaging systems, Oracle Corporation, Ashton-Tate Corporation and Teledyne Microelectronics. Mr. Garon holds a B.S. in Business Administration Finance from California State University, Northridge and a M.B.A. from Loyola Marymount University. TSUYOSHI TAIRA has been a member of our board of directors since July 1993. Mr. Taira served as a member of the board of directors of Atmel Corporation from 1987 to 1992. Mr. Taira served as president of Sanyo Semiconductor Corporation from 1986 to 1993. Mr. Taira was chairman of the Sanyo Semiconductor Corporation from 1993 to 1996. Mr. Taira left the Sanyo Semiconductor Corporation in August 1996. Mr. Taira currently owns and runs a marketing and management consulting company, Tazan International, Inc. Mr. Taira holds a B.S. from Tokyo Metropolitan University. YASUSHI CHIKAGAMI has been a member of our board of directors since September 1995. Mr. Chikagami has been chairman of Keian Corporation, a personal computer and PC peripheral distributor, since 1993. Mr. Chikagami has also served as director of GVC Corporation and Trident Microsystems, Inc. since 1993. Mr. Chikagami holds a B.S. in Agricultural Engineering from Taiwan University and a M.S. in engineering from University of Tokyo. RONALD CHWANG, PH.D., has been a member of our board of directors since June 1997. Dr. Chwang is the president of Acer Capital America and managing general partner of Acer Technology Venture Fund. Previously, Dr. Chwang was president and chief executive officer of Acer America, a subsidiary of Acer Group, a worldwide computer, component and semiconductor manufacturer, from 1992 to 1997, and has been with Acer in various capacities since 1986. Dr. Chwang has previously held development and management positions at Intel Corporation and Bell Northern Research. Dr. Chwang holds a B.S. in Engineering from McGill University and a Ph.D. in Electrical Engineering from the University of Southern California. ITEM 2. PROPERTIES As of January 31, 2000, we occupy four leased facilities totaling approximately 86,000 square feet in Sunnyvale, California in which our executive offices, manufacturing, engineering, research and development and testing facilities are located. The lease on one facility expires in May, 2003, and the leases on the other three facilities expire in April, 2005. We believe these facilities are adequate to meet our needs for at least the next 12 months. ITEM 3. LEGAL PROCEEDINGS ATMEL LITIGATION On January 3, 1996, Atmel sued us in the U.S. District Court for the Northern District of California. Atmel's complaint alleged that we willfully infringed on five U.S. patents owned or exclusively licensed to Atmel. Atmel later amended its complaint to allege infringement of a sixth patent. Regarding each of these six patents, Atmel sought a judgment that we infringed the patent, an injunction prohibiting future infringement, and treble damages, as well as attorney's fees and expenses. On two of these six patents, the District Court granted in our favor a summary judgment that we did not infringe. Two of the other patents were invalidated by another U.S. District Court in a proceeding to which we were not a party, but this decision was reversed by the Federal Circuit. Thus, four patents remain at issue in Atmel's District Court case against us. That case has been stayed, and Atmel has not requested a trial date. On February 17, 1997, Atmel filed an action with the International Trade Commission, or ITC, against two suppliers of our parts, involving five of the six patents that Atmel alleged that we infringed in the District Court case above. We intervened as a party in that action. Pursuant to indemnification 11 agreements with these suppliers, we are obligated to indemnify both to the extent provided in those agreements. As to two of these five patents, Atmel's claims were withdrawn because of the summary judgment granted by the District Court above. As to another two patents, the Administrative Law Judge, or ALJ, which makes recommendations to the ITC, has ruled that we did not infringe. This ruling has yet to be confirmed by the ITC, which is free to adopt or reject the ALJ's findings. As to the fifth patent, the ALJ held a hearing, which concluded on February 17, 2000, to determine if it was invalid due to failure to name an inventor, and whether or not Atmel committed inequitable conduct in its dealings with the Patent and Trademark Office when it attempted to add a co-inventor. We expect that the ALJ will rule on this issue sometime in April, and make a recommendation to the ITC. Any final decisions by the ITC will not be dispositive because Atmel can still pursue its claims in the District Court action. Any decisions by the ITC are not binding on the District Court. We intend to defend ourselves vigorously against these actions. WINBOND LITIGATION On July 31, 1998, we filed suit against Winbond Electronics Corporation in the U.S. District Court for the Northern District of California, San Jose Division. Winbond has answered the complaint and has counter-claimed. Since then, the parties have amended the complaint and the answer and counterclaim. As of February 24, 2000, we have asserted eight causes of action, including breach of contract, misappropriation of trade secrets, and other contractual and tortious claims. Our suit seeks damages and equitable remedies to prevent Winbond from using any of our technology. Winbond has answered and asserted counter-claims for a declaration that it is not in material breach of the agreement, breach of the agreement, breach of the covenant of good faith and fair dealing, interference with prospective economic advantage, unlawful business practice in violation of state law, common law unfair competition, a declaration that Winbond is not obligated to pay us under the agreement and/or they own or jointly own the technology embodied in their products, misappropriation of Winbond's trade secrets, unfair competition in violation of the Federal Lanham Act, and common law fraud and misrepresentation. Winbond seeks, in part, restitution of the payments made, and other damages, and an injunction. We have replied by denying these charges. We believe that the substantive allegations in the Winbond counter-claims are without merit and we intend to defend ourselves vigorously against the action. From time to time, we are also involved in other legal actions arising in the ordinary course of business. While we have accrued certain amounts for the estimated legal costs associated with defending these matters, there can be no assurance the Atmel complaint, the Winbond complaint or other third party assertions will be resolved without costly litigation, in a manner that is not adverse to our financial position, results of operations or cash flows or without requiring royalty payments in the future which may adversely impact gross margins. No estimate can be made of the possible loss or possible range of loss associated with the resolution of these contingencies. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted during the fourth quarter to a vote of security holders. 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS PRICE RANGE OF COMMON STOCK The principal U.S. market for our Common Stock is The Nasdaq Stock Market's National Market. The only class of our securities that is traded is our Common Stock. Our Common Stock has traded on The Nasdaq Stock Market's National Market since November 21, 1995, under the symbol SSTI. The following table sets forth the quarterly high and low closing sales prices of the Common Stock for the period indicated as reported by The Nasdaq Stock Market. These prices do not include retail mark-ups, mark-downs, or commissions. The closing sales price of our Common Stock on December 31, 1999, the last trading day in 1999, was $41.250.
1998: HIGH CLOSE LOW CLOSE - ----- ---------- --------- First Quarter: January 1 - March 31, 1998 $ 3.750 $ 2.938 Second Quarter: April 1 - June 30, 1998 3.688 2.656 Third Quarter: July 1 - September 30, 1998 4.250 2.031 Fourth Quarter: October 1 - December 31, 1998 2.750 1.313
1999: HIGH CLOSE LOW CLOSE - ----- ---------- --------- First Quarter: January 1 - March 31, 1999 $ 4.063 $ 2.406 Second Quarter: April 1 - June 30, 1999 7.500 3.625 Third Quarter: July 1 - September 30, 1999 17.875 7.094 Fourth Quarter: October 1 - December 31, 1999 46.125 14.125
2000: HIGH CLOSE LOW CLOSE - ----- ---------- --------- First Quarter: January 1 - February 22, 2000 $58.625 $29.563
APPROXIMATE NUMBER OF EQUITY SECURITY HOLDERS As of December 31, 1999, there were approximately 5,800 record holders of our Common Stock. DIVIDENDS We have never paid a cash dividend on our Common Stock and we intend to continue to retain earnings, if any, to finance future growth. Accordingly, we do not anticipate the payment of cash dividends to holders of Common Stock in the foreseeable future. In addition, our line of credit does not permit the payment of dividends. 13 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following selected consolidated financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and the notes thereto included elsewhere in this report. The statements of operations data for the years ended December 31, 1997, 1998 and 1999 and the balance sheet data at December 31, 1998 and 1999 are derived from, and should be read in conjunction with, the audited consolidated financial statements and notes thereto included elsewhere in this report. The statements of operations data for the year ended December 31, 1995 and 1996 and the balance sheet data at December 31, 1995, 1996 and 1997 are derived from audited financial statements not included in this report. The results of operations are not necessarily indicative of the results to be expected for future periods.
YEAR ENDED DECEMBER 31 ---------------------------------------------------- 1995 1996 1997 1998 1999 -------- -------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Net revenues: Product revenues........................... $38,283 $90,638 $73,796 $ 66,875 $118,242 License revenues........................... 1,245 2,652 1,526 2,536 6,552 ------- ------- ------- -------- -------- Total net revenues....................... 39,528 93,290 75,322 69,411 124,794 Cost of revenues............................. 26,360 59,494 62,747 62,703 94,652 ------- ------- ------- -------- -------- Gross profit................................. 13,168 33,796 12,575 6,708 30,142 ------- ------- ------- -------- -------- Operating expenses: Research and development................... 4,058 6,948 8,744 14,527 18,199 Sales and marketing........................ 2,455 5,292 6,587 7,290 10,576 General and administrative................. 1,464 3,370 9,479 4,592 3,800 In-process research and development........ -- -- -- -- 2,011 ------- ------- ------- -------- -------- Total operating expenses................. 7,977 15,610 24,810 26,409 34,586 ------- ------- ------- -------- -------- Income (loss) from operations................ 5,191 18,186 (12,235) (19,701) (4,444) Interest and other income, net............... 517 1,763 2,146 1,573 730 Interest expense............................. (273) -- -- (31) (214) ------- ------- ------- -------- -------- Income (loss) before provision for (benefit from) income taxes......................... 5,435 19,949 (10,089) (18,159) (3,928) Provision for (benefit from) income taxes.... (594) 7,598 (3,165) (571) 88 ------- ------- ------- -------- -------- Net income (loss)............................ $ 6,029 $12,351 $(6,924) $(17,588) $ (4,016) ======= ======= ======= ======== ======== Net income (loss) per share--basic........... $ 0.70 $ 0.54 $ (0.30) $ (0.77) $ (0.17) ======= ======= ======= ======== ======== Net income (loss) per share--diluted......... $ 0.32 $ 0.49 $ (0.30) $ (0.77) $ (0.17) ======= ======= ======= ======== ======== BALANCE SHEET DATA: Total assets................................. $66,403 $80,914 $82,539 $ 56,138 $ 88,806 ======= ======= ======= ======== ======== Long-term obligations........................ $ 76 $ 71 $ 66 $ 663 $ 446 ======= ======= ======= ======== ======== Shareholders' equity......................... $52,172 $64,788 $55,889 $ 38,030 $ 41,015 ======= ======= ======= ======== ========
14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE FOLLOWING DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO US ON THE DATE HEREOF, AND WE ASSUME NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE DISCUSSED. FACTORS THAT COULD CAUSE OR CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED BELOW UNDER THE HEADING "BUSINESS RISKS", AS WELL AS THOSE DISCUSSED ELSEWHERE IN THIS REPORT. OVERVIEW We are a leading supplier of flash memory semiconductor devices for the digital consumer, networking, wireless communication and Internet computing markets. Historically, the semiconductor industry has been cyclical, alternately experiencing periods of over supply and increased demand. During 1999, the semiconductor industry transitioned from a period of over-supply to a period of increased demand against the available capacity, resulting in an industry-wide shortage of flash memory product. From late 1996 through mid-1999, selling prices of our products declined significantly. Selling prices of semiconductor products have generally declined over time and are expected to continue to decline over the long term, principally due to increased market competition. Specifically, during 1999 and 1998, industry over-capacity resulted in higher than normal price declines in our markets, which unfavorably impacted our revenues, gross margins, and profitability. During the second half of 1999, we were able to increase the selling price of some of our products as the industry shifted to a period of industry-wide shortage. This trend may not continue and prices may not remain stable. In addition, the current market environment may constrain our ability to obtain wafers to manufacture our products, which may also impair our profitability. We derived 81% of our product revenues during 1999 from product shipments to Asia. Additionally, our major wafer suppliers and packaging and testing subcontractors are all located in Asia. During 1998 and 1997, several Asian countries where we do business, including Japan, Taiwan and Korea, experienced severe currency fluctuation and economic deflation, which negatively impacted our revenues and our ability to collect payments from these customers. In September 1999, Taiwan experienced a major earthquake. The resulting disruption to the manufacturing operations in the wafer foundries and assembly and testing subcontractors that we use in Taiwan negatively impacted our revenues and operating results during the fourth and third quarter of 1999. Our product sales are made primarily using short-term cancelable purchase orders. The quantities actually purchased by the customer, as well as shipment schedules, are frequently revised to reflect changes in the customer's needs and in our supply of product. Accordingly, our backlog of open purchase orders at any given time is not a meaningful indicator of future sales. Changes in the amount of our backlog do not necessarily reflect a corresponding change in the level of actual sales. Direct sales to customers are recognized upon shipment of product net of an allowance for estimated returns. Sales to distributors are made primarily under arrangements allowing price protection and the right of stock rotation on merchandise unsold to customers. Because of the uncertainty associated with pricing concessions and future returns, we defer recognition of such revenues, related costs of revenues and related gross margin until we are notified by the distributor that merchandise is sold by the distributor. Most of our technology licenses provide for the payment of up-front license fees and continuing royalties based on product sales. For license and other arrangements for technology that we are continuing to enhance and refine and under which we are obligated to provide unspecified enhancements, revenue is recognized over the lesser of the estimated period we have historically enhanced and developed refinements to the technology, generally three years, the upgrade period, or the remaining portion of the upgrade period from the date of delivery, provided all specified 15 technology and documentation has been delivered, the fee is fixed and determinable and collection of the fee is probable. From time to time, we reexamine the estimated upgrade period relating to license technology to determine if a change in the estimate upgrade period is needed. Revenue from license or other technology arrangements where we are not continuing to enhance and refine the technology or are not obligated to provide unspecified enhancements is recognized upon delivery, if the fee is fixed and determinable and collection of the fee is probable. We recognize royalties received under these arrangements during the upgrade period as revenue based on the ratio of the elapsed portion of the upgrade period to the estimated upgrade period. We recognize the remaining portion of the royalties ratably over the remaining portion of the upgrade period. We recognize royalties received after the upgrade period has elapsed when reported to us, which generally coincides with the receipt of payment. In 1999, Silicon Technology, a company located in Japan, and Actron Technology, Ltd., a company located in Hong Kong, China, accounted for 8.1% and 11.8%, respectively, of our net revenues. In 1998, Silicon Technology and Actron, accounted for 14.7% and 10.8%, respectively, of our net revenues. In 1997, Silicon Technology accounted for 15.4% of our net revenues. We own a 14% interest in Silicon Technology. RESULTS OF OPERATIONS: YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 NET REVENUES Net revenues were $124.8 million in 1999 compared to $69.4 million in 1998 and $75.3 million in 1997. The increase from 1998 to 1999 was due to increased shipment volume of new and existing products and due to our ability to raise prices slightly in the second half of 1999. The decrease from 1997 to 1998 was a result of a decline in selling prices for our products. PRODUCT REVENUES. Product revenues were $118.2 million in 1999, $66.9 million in 1998 and $73.8 million in 1997. The increase from 1998 to 1999 was primarily due to shipments of over 30 new products that we introduced in the second half of 1998 and the first half of 1999. The decrease from 1997 to 1998 was primarily the result of a decline in selling prices due to industry over-supply. LICENSE REVENUES. Revenues from license fees and royalties were $6.6 million in 1999, $2.5 million in 1998 and $1.5 million in 1997. The increase from 1998 to 1999 was primarily due to recognition of up-front fees paid by licensees and an increase in the number of licensees from 1998. We anticipate that license revenues will fluctuate significantly in the future. GROSS PROFIT Gross profit was $30.1 million, or 24.2% of net revenues, in 1999, $6.7 million, or 10% of net revenues, in 1998 and $12.6 million, or 17% of net revenues, in 1997. Gross profit increased from 1998 to 1999 due to increased unit shipments from existing cost-reduced products and from increased shipments of new, higher margin products. The decrease from 1997 to 1998 was primarily due to declines in selling prices in 1998. OPERATING EXPENSES Our operating expenses consist of research and development, sales and marketing, general and administrative expenses, and, in 1999, the charge for in-process research and development related to an acquisition. Operating expenses were $34.6 million, or 28% of net revenues, in 1999, $26.4 million, or 38% of net revenues, in 1998, and $24.8 million, or 33% of net revenues, in 1997. The increase in absolute dollars in each year was due to hiring additional personnel, the development of new products and, in 1999, the charge for in-process research and development related to an acquisition. We anticipate that we will continue to devote substantial resources to research and development, sales and 16 marketing and to general and administrative, and that these expenses will continue to increase in absolute dollar amounts. RESEARCH AND DEVELOPMENT. Research and development expenses include costs associated with the development of new products, enhancements to existing products and quality assurance activities. These costs consist primarily of employee salaries, benefits and the cost of outside resources that supplement the internal development team. Research and development expenses were $18.2 million, or 15% of net revenues, in 1999, $14.5 million, or 21% of net revenues, in 1998 and $8.7 million, or 12% of net revenues, in 1997. These increases were primarily due to the hiring of additional personnel, depreciation expenses related to purchases of additional test equipment, increased prototyping and product qualification costs associated with our product and process development efforts, and increases in the use of outside resources. We expect research and development expenses to increase in absolute dollars. SALES AND MARKETING. Sales and marketing expenses consist of salaries, commissions to manufacturers representatives, travel and entertainment and promotional expenses. Sales and marketing expenses were $10.6 million, or 8% of net revenues, in 1999, $7.3 million, or 11% of net revenues, in 1998, and $6.6 million, or 9% of net revenues, in 1997. The increase from 1998 to 1999 was due to increased commissions as a result of higher product revenues. The increase from 1997 to 1998 was primarily due to the hiring of additional sales personnel. We expect sales and marketing expenses to increase in absolute dollars as we continue to expand our sales and marketing efforts and as our revenues increase. GENERAL AND ADMINISTRATIVE. General and administrative expenses consist of salaries for administrative, executive and finance personnel, recruiting costs, information systems costs, professional service fees and allowances for doubtful accounts. General and administrative expenses were $3.8 million, or 3% of net revenues, in 1999, $4.6 million, or 7% of net revenues, in 1998, and $9.5 million, or 13% of net revenues, in 1997. General and administrative expenses during 1998 included a one-time charge of $500,000 for the termination of a land purchase agreement and in 1999 these expenses were offset by the reversal of $1.2 million in legal accruals associated with the settlement of the Intel lawsuit in the second quarter. The high level of general and administrative expenses during 1997 was primarily due to legal expenses associated with pending lawsuits. We anticipate that general and administrative expenses will continue to increase in absolute dollar amount as we scale our facilities, infrastructure, and head count to support our overall expected growth. We expect to incur additional expenses in connection with the Winbond litigation and may incur additional expenses in connection with the Atmel litigation. For further information on this litigation see "Legal Proceedings." IN-PROCESS RESEARCH AND DEVELOPMENT CHARGE. A charge of $2.0 million, or 2% of net revenues, in 1999, relates to the expense for in-process research and development incurred during the acquisition of Linvex. Refer also to Note 6 of Notes to the Consolidated Financial Statements. The fair value of Linvex' core technology, existing products, and the technology currently under development was determined by an independent appraiser using the income approach, which discounts expected future cash flows to present value. The discount rates used in the present value calculations were derived from a weighted average cost of capital analysis, adjusted upward by a premium of 5% to reflect additional risks inherent in the development life cycle. We believe that the pricing model related to this acquisition is consistent within the high-technology industry. We do not expect to achieve a material amount of expense reductions or synergies as a result of integrating the acquired in-process technology. Therefore the valuation assumptions do not include anticipated cost savings. In process research and development valued at $2.0 million consisted of a single project to combine flash and SRAM memory on a single chip, the ComboMemory chip. At the time of the acquisition the estimated cost to complete the ComboMemory chip was $1.1 million and the chip was approximately 42% complete. The risk adjusted discount rate relating to in-process technology was 40%. 17 We expect that the ComboMemory chip will be completed and begin to generate cash flows within 3 to 6 months. However, development of the ComboMemory chip remains a significant risk due to the remaining effort to achieve technical viability, rapidly changing customer markets, uncertain standards for new products and significant competitive threats from numerous companies. The nature of the efforts to develop the ComboMemory chip into a commercially viable product consists principally of planning, designing and testing activities necessary to determine that the ComboMemory chip can meet market expectations, including functionality and technical requirements. Failure to bring the ComboMemory chip to market in a timely manner could result in a lost opportunity to capitalize on emerging markets. Failure to achieve the expected levels of revenues and net income from the ComboMemory chip will negatively impact the return on investment expected at the time of the acquisition and potentially result in impairment of other assets related to the development activities. Recent actions and comments regarding other companies from the Securities and Exchange Commission have indicated that they are reviewing the current valuation methodology of purchased in-process research and development relating to acquisitions. The Commission is concerned that some companies are writing off more of the value of an acquisition than is appropriate. We believe that we are in compliance with all of the rules and related guidance as they currently exist. However, the Commission may seek to reduce the amount of purchased in-process research and development we have previously expensed. This would result in the restatement of our previously filed financial statements and could have a material negative impact on the financial results for the period subsequent to the acquisition. INTEREST AND OTHER INCOME. Interest and other income was approximately $730,000, or 1% of net revenues, in 1999, $1.6 million, or 2% of net revenues, in 1998, and $2.1 million, or 3% of net revenues, in 1997. Interest income decreased over these years as cash, cash equivalents and short-term investments decreased. INTEREST EXPENSE. Interest expense for 1999 was approximately $214,000 and interest expense for 1998 was approximately $31,000. Interest expense increased during 1999 due to interest charges incurred as we borrowed against our line of credit. There was no interest expense in 1997. PROVISION FOR (BENEFIT FROM) INCOME TAXES The provision for (benefit from) income taxes was approximately $88,000 in 1999, approximately ($571,000) in 1998, and ($3.2) million in 1997. The benefit in 1997 and 1998 related to our loss position for those years and related future tax benefits. The provision for income taxes in 1999 related to foreign taxes paid on foreign license revenues offset by an income tax refund received during the year. During 1998, we determined that our cumulative net operating losses incurred exceeded the amount of tax carry back available. For this reason, in the third quarter of 1998, we recorded a full valuation allowance against the deferred tax asset. We will provide a full valuation against our deferred tax asset until such time as evidence shows that the deferred tax asset is more likely than not to be recovered. SEGMENT REPORTING Our business has two segments: flash products and technology licensing. Flash products comprise our standard flash memory products, our application-specific memory products, flash embedded controllers and mass storage products. Technology licensing comprises design service fees, technical consultation fees, license fees and royalties earned through technology agreements that we have with wafer foundries and manufacturers for non-competing applications. 18 The table below presents information about reported segments for the three years ended December 31:
TECHNOLOGY FLASH PRODUCTS LICENSING TOTAL -------------- --------------- -------- (IN THOUSANDS) 1999: Revenues................................................ $118,242 $6,552 $124,794 Gross profit............................................ $ 23,590 $6,552 $ 30,142 1998: Revenues................................................ $ 66,875 $2,536 $ 69,411 Gross profit............................................ $ 4,172 $2,536 $ 6,708 1997: Revenues................................................ $ 73,796 $1,526 $ 75,322 Gross profit............................................ $ 11,049 $1,526 $ 12,575
RECENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Boards issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 established a new model for accounting for derivative and hedging activities. In July, 1999 the Financial Accounting Standards Boards issued SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133" (SFAS 133). SFAS 137 deferred the effective date of SFAS 133 until the first quarter beginning after June 15, 2000. The impact of SFAS 133 on our consolidated financial statements has not yet been determined. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin: No. 101 "Revenue Recognition in Financial Statements" (SAB 101). SAB 101 summarizes certain of the Staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. We have until the first quarter of 2000 to comply with the guidance in SAB 101. The impact of SAB 101 on our consolidated financial statements has not yet been determined. LIQUIDITY AND CAPITAL RESOURCES Cash used in operations was $35.8 million in 1999 and relates primarily to the increase in accounts receivable and accounts receivable from related parties by $26.4 million due to increased sales in the third and fourth quarters and also relates to the increase in inventories of $24.7 million due to the production ramp, offset in part by an $8.4 million increase in trade accounts payable. Cash used in operating activities was $18.2 million during 1998 and primarily resulted from a net loss of $17.6 and a decrease in accounts payable of $8.6 million offset by a decrease in net deferred income taxes of $3.7 million, a decrease in net inventory of $3.6 million and depreciation and amortization of $4.2 million. Cash provided by operations was $13.2 million during 1997 and primarily resulted from a decrease in accounts receivable and accounts receivable from related parties of $2.1 million, an increase in accounts payable of $8.5 million and an increase in accrued expenses of $2.7 million offset by a net loss of $6.9 million. In September 1998, we signed a credit agreement with Foothill Capital Corporation, which provides for up to $25.0 million of borrowings through September 2001. We must pay an unused line fee at the annual rate of one-quarter of one percent and we are required to maintain a minimum level of tangible net worth. The line of credit is collateralized by substantially all our assets and availability under the line is limited to 80% of eligible world-wide accounts receivable. At December 31, 1999 the borrowing base was approximately $28.0 million of which approximately $8.7 million was unused at that date. Interest is payable at one-half of one percent above the bank's base rate (8.5% at December 31, 1999). On September 30, 1999 a new agreement was signed to increase our line of credit to 19 $35.0 million immediately, increasing to $50.0 million from January 1, 2000 through March 30, 2000, dropping back down to $40.0 million from April 1, 2000 through May 31, 2000, thereafter returning to $25.0 million until September 2002. The funds in excess of $25.0 million are available only if certain profitability covenants are met. At December 31, 1999, we had borrowed $19.3 million against this agreement and met the profitability covenants. In January 2000 we amended the agreement to include a sub-line to cover the issuance of letters of credit to a vendor from whom we purchase wafers. We made capital expenditures of $7.9 million in 1999, $3.8 million in 1998, and $2.8 million in 1997. These expenditures were primarily for the purchase of test equipment, design and engineering tools, computer equipment and the enterprise resource planning and supply chain management system software. During 1997, we resold certain equipment to a subcontractor for proceeds of $2.6 million. Management estimates that gross expenditures for capital equipment will be $3.8 million in 2000. In the second quarter of 1998, we terminated an agreement to purchase a 14 acre plot of land located in San Jose, California. The costs associated with the termination of the agreement were approximately $500,000 and are included in general and administrative expenses. In January 1998, our board of directors authorized a stock repurchase program whereby 1,000,000 shares of our common stock could be repurchased on the open market at prevailing market prices. The repurchase program ended June 1998. Approximately 449,000 shares were repurchased under this authorization during the six months ended June 1998 for an aggregate purchase price of approximately $1.6 million. Purchase prices ranged from $3.19 to $3.78 per share. No shares were repurchased during 1999. In February 1998, we agreed to purchase technology from a product development partner for $1.8 million, payable upon the completion of certain product development milestones over the next eighteen months. During 1998, we paid approximately $295,000 pursuant to this agreement. During 1999, the agreement was terminated and we expensed $50,000 as a result of this termination. In addition, we incurred $1.0 million in expenses related to a project to jointly develop new products with another development partner. As of December 31, 1999, our principal sources of liquidity included cash and cash equivalents of $1.2 million. As of December 31, 1999, we had an open line of credit of up to $25.0 million to secure sufficient working capital to finance growth in operations and new product development efforts. As noted above, the credit line increased to $50.0 million on January 1, 2000. We believe that our cash balances, together with funds expected to be generated from operations and the line of credit availability, will be sufficient to meet our projected working capital and other cash requirements through at least the next twelve months. However, there can be no assurance that future events will not require us to seek additional borrowings or capital and, if so required, that such borrowings or capital will be available on acceptable terms. YEAR 2000 STATE OF READINESS We have completed all Year 2000 readiness work and did not experience disruption in our business related to the Year 2000 Issue. However, we cannot provide any assurance that no Year 2000 issues will impact our systems, products or other aspects of our business in the future. Our key suppliers have not experienced disruptions in their businesses related to the Year 2000 issue. However, we cannot provide any assurance that no Year 2000 issue will effect our suppliers in the future. 20 COSTS The total cost of our Year 2000 readiness program is estimated to be approximately $750,000. All costs were charged to expense as incurred, and did not include potential costs related to any customers or other claims or the cost of internal software or hardware replaced in the normal course of business. RISKS/CONTINGENCY PLANS We have taken appropriate steps to assess and address the Year 2000 issues. We completed the implementation of our contingency plan prior to December 31, 1999. BUSINESS RISKS RISKS RELATED TO OUR BUSINESS OUR OPERATING RESULTS FLUCTUATE SIGNIFICANTLY, AND AN UNANTICIPATED DECLINE IN REVENUE MAY DISAPPOINT SECURITIES ANALYSTS OR INVESTORS AND RESULT IN A DECLINE IN OUR STOCK PRICE. Our recent growth rate may not be sustainable and you should not use our past financial performance to predict future operating results. We have incurred net losses for the past three fiscal years. Our recent quarterly and annual operating results have fluctuated, and will continue to fluctuate, due to the following factors, all of which are difficult to forecast and many of which are out of our control: - the availability, timely deliverability and cost of wafers from our suppliers; - competitive pricing pressures and related changes in selling prices; - fluctuations in manufacturing yields and significant yield losses which affect our ability to fulfill orders; - new product announcements and introductions for competing products by us or our competitors; - product obsolescence; - lower of cost or market inventory adjustments; - unpredictability of changes in demand for, or in the mix of, our products; - the gain or loss of significant customers; - market acceptance of products utilizing our SuperFlash technology; - changes in the channels through which our products are distributed and the timeliness of receipt of distributor resale information; - exchange rate fluctuations; - general economic, political and environmental-related conditions, such as natural disasters; - difficulties in forecasting, planning and management of inventory levels; - unanticipated research and development expenses associated with new product introductions; and - the timing of significant orders and of license and royalty revenue. A downturn in the market for consumer products such as personal computers and cellular telephones that incorporate our products can also harm our operating results. 21 We typically receive and fulfill a majority of our orders within the quarter, with a substantial portion occurring during the last month of the quarter. One reason for this is that our products are primarily sold to large manufacturers, which, typically place orders at or near the end of a quarter. As a result, we may not learn of revenue shortfalls until late in a quarter and may not be able to predict future revenues with accuracy. Additionally, our costs consist of salaries for personnel and materials that must be ordered several months in advance. These costs are based in part on our expectations for future revenues and are relatively fixed in the short term. As a result, any revenue shortfall below expectations could harm our business. WE DEPEND ON A LIMITED NUMBER OF FOREIGN FOUNDRIES TO MANUFACTURE OUR PRODUCTS, AND THESE FOUNDRIES MAY NOT BE ABLE TO SATISFY OUR MANUFACTURING REQUIREMENTS WHICH COULD CAUSE OUR REVENUES TO DECLINE. We outsource all of our manufacturing with the exception of limited testing activities. We currently buy all of our wafers, and sorted die, from a limited number of suppliers. During 1999, substantially all of our products were manufactured by two foundries, Sanyo Electric Co., Ltd. in Japan and Taiwan Semiconductor Manufacturing Co., Ltd., or TSMC, in Taiwan. We anticipate that these foundries will continue to manufacture the majority of our products in 2000. If these suppliers fail to satisfy our requirements on a timely basis and at competitive prices we could suffer manufacturing delays, a possible loss of revenues or higher than anticipated costs of revenues, any of which could seriously harm our operating results. Given the current constraints on worldwide semiconductor manufacturing capacity, our revenues for the next several quarters will largely be determined by our ability to obtain adequate wafer supplies from our foundries. We are currently unable to meet all of the demand for our products, and have in the past failed to meet scheduled shipment dates, due to our inability to obtain a sufficient supply of wafers and sorted die from our foundries. The foundries with which we currently have arrangements, together with any additional foundry at which capacity might be obtained, may not be willing or able to satisfy all of our manufacturing requirements on a timely basis at favorable prices. In addition, we have encountered delays in qualifying new products and in ramping new product production and could experience these delays in the future. We are also subject to the risks of service disruptions, raw material shortages and price increases by the foundries. Such disruptions, shortages and price increases could seriously harm our operating results. IF WE ARE UNABLE TO INCREASE OUR MANUFACTURING CAPACITY, OUR REVENUES MAY DECLINE. In order to grow, we need to increase our present manufacturing capacity. Events that we have not foreseen could arise which would limit our capacity. In addition, we have not secured adequate capacity beyond this year. If we cannot satisfactorily increase our manufacturing capacity, our ability to grow will be severely impaired and this may harm our operating results. OUR COST OF REVENUES MAY INCREASE IF WE ARE REQUIRED TO PURCHASE MANUFACTURING CAPACITY IN THE FUTURE. To obtain additional manufacturing capacity, we may be required to make deposits, equipment purchases, loans, joint ventures, equity investments or technology licenses in or with wafer fabrication companies. These transactions could involve a commitment of substantial amounts of our capital and technology licenses in return for production capacity. We may be required to seek additional debt or equity financing if we need substantial capital in order to secure this capacity and we cannot assure you that we will be able to obtain such financing. 22 IF OUR FOUNDRIES FAIL TO ACHIEVE ACCEPTABLE WAFER MANUFACTURING YIELDS, WE WILL EXPERIENCE HIGHER COSTS OF REVENUES AND REDUCED PRODUCT AVAILABILITY. The fabrication of our products requires wafers to be produced in a highly controlled and ultra-clean environment. Semiconductor companies that supply our wafers sometimes have experienced problems achieving acceptable wafer manufacturing yields. Semiconductor manufacturing yields are a function of both our design technology and the foundry's manufacturing process technology. Low yields may result from marginal design or manufacturing process drift. Yield problems may not be identified until the wafers are well into the production process, which often makes them difficult, time consuming and costly to correct. Furthermore we rely on independent foreign foundries for our wafers which increases the effort and time required to identify, communicate and resolve manufacturing yield problems. If our foundries fail to achieve acceptable manufacturing yields, we will experience higher costs of revenues and reduced product availability, which would harm our operating results. IF OUR FOUNDRIES DISCONTINUE THE MANUFACTURING PROCESSES NEEDED TO MEET OUR DEMANDS, OR FAIL TO UPGRADE THE TECHNOLOGIES NEEDED TO MANUFACTURE OUR PRODUCTS, WE MAY FACE PRODUCTION DELAYS AND LOWER REVENUES. Our wafer and product requirements typically represent a small portion of the total production of the foundries that manufacture our products. As a result, we are subject to the risk that a foundry will cease production on an older or lower-volume manufacturing process that it uses to produce our parts. Additionally, we cannot be certain our foundries will continue to devote resources to advance the process technologies on which the manufacturing of our products is based. Each of these events could increase our costs and harm our ability to deliver our products on time. OUR DEPENDENCE ON THIRD-PARTY SUBCONTRACTORS TO ASSEMBLE AND TEST OUR PRODUCTS SUBJECTS US TO A NUMBER OF RISKS, INCLUDING AN INADEQUATE SUPPLY OF PRODUCTS AND HIGHER COSTS OF MATERIALS. We depend on independent subcontractors to assemble and test our products. Our reliance on these subcontractors involves the following significant risks: - reduced control over delivery schedules and quality; - the potential lack of adequate capacity during periods of strong demand; - difficulties selecting and integrating new subcontractors; - limited warranties on products supplied to us; - potential increases in prices due to capacity shortages and other factors; and - potential misappropriation of our intellectual property. These risks may lead to increased costs, delayed product delivery or loss of competitive advantage which would harm our profitability and customer relationships. OUR GROWTH DEPENDS UPON OUR ABILITY TO COMMERCIALIZE PRODUCTS FOR COMMUNICATIONS AND CONSUMER ELECTRONICS APPLICATIONS. In 1998 and 1999, the majority of our revenues came from PC BIOS and PC peripheral applications. However, communications and consumer electronics applications are central to our growth strategy. We believe that products for these applications will encounter intense competition and be highly price sensitive. While we are currently developing and introducing new products for these applications, we cannot assure you that these products will reach the market on time, will satisfactorily address customer needs, will be sold in high volume, or will be sold at profitable margins. 23 OUR OPERATING EXPENSES ARE RELATIVELY FIXED, AND WE ORDER MATERIALS IN ADVANCE OF ANTICIPATED CUSTOMER DEMAND. THEREFORE, WE HAVE LIMITED ABILITY TO REDUCE EXPENSES QUICKLY IN RESPONSE TO ANY REVENUE SHORTFALLS. Our operating expenses are relatively fixed, and we therefore have limited ability to reduce expenses quickly in response to any revenue shortfalls. Consequently, our operating results will be harmed if our revenues do not meet our revenue projections. We may experience revenue shortfalls for the following reasons: - significant pricing pressures that occur because of declines in selling prices over the life of a product; - sudden shortages of raw materials or fabrication, test or assembly capacity constraints that lead our suppliers to allocate available supplies or capacity to other customers which, in turn, harm our ability to meet our sales obligations; and - the reduction, rescheduling or cancellation of customer orders. In addition, we typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially. From time to time, in response to anticipated long lead times to obtain inventory and materials from our outside suppliers and foundries, we may order materials in advance of anticipated customer demand. This advance ordering may result in excess inventory levels or unanticipated inventory write-downs if expected orders fail to materialize. BECAUSE OUR FLASH MEMORY PRODUCTS TYPICALLY HAVE LENGTHY SALES CYCLES, WE MAY EXPERIENCE SUBSTANTIAL DELAYS BETWEEN INCURRING EXPENSES RELATED TO RESEARCH AND DEVELOPMENT AND THE GENERATION OF REVENUES. Due to the flash memory product cycle we usually require more than nine months to realize volume shipments after we first contact a customer. We first work with customers to achieve a design win, which may take three months or longer. Our customers then complete the design, testing and evaluation process and begin to ramp up production, a period which typically lasts an additional six months or longer. As a result, a significant period of time may elapse between our research and development efforts and our realization of revenue, if any, from volume purchasing of our products by our customers. WE FACE INTENSE COMPETITION FROM COMPANIES WITH SIGNIFICANTLY GREATER FINANCIAL, TECHNICAL AND MARKETING RESOURCES THAT COULD ADVERSELY AFFECT OUR ABILITY TO INCREASE SALES OF OUR PRODUCTS. We compete with major domestic and international semiconductor companies, many of which have substantially greater financial, technical, marketing, distribution, and other resources than we do. Many of our competitors have their own facilities for the production of semiconductor memory components and have recently added significant capacity for such production. Our memory products, which presently account for substantially all of our revenues, compete principally against products offered by Intel, Advanced Micro Devices, Atmel, STMicroelectronics, Sanyo, Winbond Electronics and Macronix. If we are successful in developing our high density products, these products will compete principally with products offered by Intel, Advanced Micro Devices, Fujitsu, Sharp, Samsung Semiconductor, SanDisk and Toshiba, as well as any new entrants to the market. In addition, we may in the future experience direct competition from our foundry partners. We have licensed to our foundry partners the right to fabricate products based on our technology and circuit design, and to sell such products worldwide, subject to our receipt of royalty payments. Competition may also come from alternative technologies such as ferroelectric random access memory, or FRAM, or other developing technologies. 24 OUR MARKETS ARE SUBJECT TO RAPID TECHNOLOGICAL CHANGE AND, THEREFORE, OUR SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP AND INTRODUCE NEW PRODUCTS. The markets for our products are characterized by: - rapidly changing technologies; - evolving and competing industry standards; - changing customer needs; - frequent new product introductions and enhancements; - increased integration with other functions; and - rapid product obsolescence. To develop new products for our target markets, we must develop, gain access to and use leading technologies in a cost-effective and timely manner and continue to expand our technical and design expertise. In addition, we must have our products designed into our customers' future products and maintain close working relationships with key customers in order to develop new products that meet their changing needs. In addition, products for communications applications are based on continually evolving industry standards. Our ability to compete will depend on our ability to identify and ensure compliance with these industry standards. As a result, we could be required to invest significant time and effort and incur significant expense to redesign our products and ensure compliance with relevant standards. We cannot assure you that we will be able to identify new product opportunities successfully, develop and bring to market new products, achieve design wins or respond effectively to new technological changes or product announcements by our competitors. In addition, we may not be successful in developing or using new technologies or in developing new products or product enhancements that achieve market acceptance. Our pursuit of necessary technological advances may require substantial time and expense. Failure in any of these areas could harm our operating results. OUR FUTURE SUCCESS DEPENDS IN PART ON THE CONTINUED SERVICE OF OUR KEY DESIGN ENGINEERING, SALES, MARKETING AND EXECUTIVE PERSONNEL AND OUR ABILITY TO IDENTIFY, RECRUIT AND RETAIN ADDITIONAL PERSONNEL. We are highly dependent on Bing Yeh, our President and Chief Executive Officer, as well as the other principal members of our management and engineering staff. There is intense competition for qualified personnel in the semiconductor industry, in particular the highly skilled design, applications and test engineers involved in the development of flash memory technology. Competition is especially intense in Silicon Valley, where our corporate headquarters is located. We may not be able to continue to attract and retain engineers or other qualified personnel necessary for the development of our business or to replace engineers or other qualified personnel who may leave our employ in the future. Our anticipated growth is expected to place increased demands on our resources and will likely require the addition of new management and engineering personnel and the development of additional expertise by existing management personnel. The failure to recruit and retain key design engineers or other technical and management personnel could harm our business. OUR ABILITY TO COMPETE SUCCESSFULLY WILL DEPEND, IN PART, ON OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, WHICH WE MAY NOT BE ABLE TO PROTECT. We rely on a combination of patent, trade secrets, copyright and mask work production laws and rights, nondisclosure agreements and other contractual provisions and technical measures to protect our intellectual property rights. Policing unauthorized use of our products, however, is difficult, especially in foreign countries. Litigation may continue to be necessary in the future to enforce our intellectual 25 property rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Litigation could result in substantial costs and diversion of resources and could harm our business, operating results and financial condition regardless of the outcome of the litigation. For example, in 1998, we filed suit against Winbond Electronics Corporation alleging breach of contract and breach of covenant of good faith and fair dealing and are seeking an injunction prohibiting Winbond from using any of our licensed technology. Winbond has responded by denying the claims and asserting counterclaims. We own 22 patents in the United States relating to our products and processes, and have filed for several more. In addition, we hold two patents in Europe, one patent in Germany and additional foreign patent applications have been filed in Europe, Japan, Taiwan and Canada. We cannot assure you that any pending patent application will be granted. Our operating results could be seriously harmed by the failure to protect our intellectual property. IF WE ARE ACCUSED OF INFRINGING THE INTELLECTUAL PROPERTY RIGHTS OF OTHER PARTIES WE MAY BECOME SUBJECT TO TIME-CONSUMING AND COSTLY LITIGATION. IF WE LOSE, WE COULD SUFFER A SIGNIFICANT IMPACT ON OUR BUSINESS AND BE FORCED TO PAY DAMAGES. Third parties may assert that our products infringe their proprietary rights, or may assert claims for indemnification resulting from infringement claims against us. Any such claims may cause us to delay or cancel shipment of our products or pay damages which could seriously harm our business, financial condition and results of operations. In addition, irrespective of the validity or the successful assertion of such claims, we could incur significant costs in defending against such claims. Over the past three years we were sued both by Atmel Corporation and Intel Corporation regarding patent infringement issues and by Winbond Electronics Corporation regarding our contractual relationship with them. Significant management time and financial resources have been devoted to defending these lawsuits. We settled with Intel in May 1999 and the Atmel and Winbond litigation is ongoing. In addition to the Atmel, Intel and Winbond actions, we receive from time to time letters or communications from other companies stating that such companies have patent rights which involve our products. Since the design of all of our products is based on SuperFlash technology, any legal finding that the use of our SuperFlash technology infringes the patent of another company would have a significantly negative effect on our entire product line and operating results. Furthermore, if such a finding were made, there can be no assurance that we could license the other company's technology on commercially reasonable terms or that we could successfully operate without such technology. Moreover, if we are found to infringe, we could be required to pay damages to the owner of the protected technology and could be prohibited from making, using, selling, or importing into the United States any products that infringe the protected technology. In addition, the management attention consumed by and legal cost associated with any litigation could have a negative effect on our operating results. PUBLIC ANNOUNCEMENTS MAY HURT OUR STOCK PRICE. During the course of lawsuits there may be public announcements of the results of hearings, motions, and other interim proceedings or developments in the litigation. If securities analysts or investors perceive these results to be negative, it could have a substantial negative effect on the trading price of our stock. OUR LITIGATION MAY BE EXPENSIVE, MAY BE PROTRACTED AND CONFIDENTIAL INFORMATION MAY BE COMPROMISED. Whether or not we are successful in our lawsuits with Winbond and Atmel, we expect this litigation to consume substantial amounts of our financial and managerial resources. At any time Winbond or Atmel may file additional claims against us, which could increase the risk, expense and duration of the litigation. Further, because of the substantial amount of discovery required in connection with this type 26 of litigation, there is a risk that some of our confidential information could be compromised by disclosure. OUR BUSINESS MAY SUFFER DUE TO RISKS ASSOCIATED WITH INTERNATIONAL SALES AND OPERATIONS. During 1997, 1998, and 1999, our export product and licensing revenues accounted for approximately 87%, 93%, and 86% of our net revenues, respectively. Our international business activities are subject to a number of risks, each of which could impose unexpected costs on us that would have an adverse effect on our operating results. These risks include: - difficulties in complying with regulatory requirements and standards; - tariffs and other trade barriers; - costs and risks of localizing products for foreign countries; - reliance on third parties to distribute our products; - longer accounts receivable payment cycles; - potentially adverse tax consequences; - limits on repatriation of earnings; and - burdens of complying with a wide variety of foreign laws. We derived 81% of our product revenue from Asia during 1999. Additionally, our major wafer suppliers and assembly and packaging subcontractors are all located in Asia. Any kind of economic, political or environmental instability in this region of the world can have a severe negative impact on our operating results due to the large concentration of our production and sales activities in this region. For example, during 1998 and 1997, several Asian countries where we do business, such as Japan, Taiwan and Korea, experienced severe currency fluctuation and economic deflation, which negatively impacted our total revenues and also negatively impacted our ability to collect payments from these customers. During this period, the lack of capital in the financial sectors of these countries made it difficult for our customers to open letters of credit or other financial instruments that are guaranteed by foreign banks. Finally, the economic situation in this period exacerbated a decline in selling prices for our products as our competitors reduced product prices to generate needed cash. It should be also be noted that we are greatly impacted by the political, economic and military conditions in Taiwan. Taiwan and China are continuously engaged in political disputes and both countries have recently conducted military exercises in or near the other's territorial waters and airspace. Such disputes may continue and even escalate, resulting in an economic embargo, a disruption in shipping or even military hostilities. This could severely harm our business by interrupting or delaying production or shipment of our products. Any kind of activity of this nature or even rumors of such activity could severely negatively impact our operations, revenues, operating results, and stock price. BECAUSE A SMALL NUMBER OF CUSTOMERS HAVE ACCOUNTED FOR, AND ARE LIKELY TO CONTINUE TO ACCOUNT FOR, A SUBSTANTIAL PORTION OF OUR REVENUES, OUR REVENUES COULD DECLINE DUE TO THE LOSS OF ONE OF THESE CUSTOMERS. More than half of our revenues come from a small number of customers. For example, product sales to our top 10 customers accounted for approximately 62%, 66%, and 57%, respectively, of our product revenues for 1997, 1998, and 1999. One customer accounted for 16% and 15% of product sales in 1997 and 1998. Another customer accounted for 11% and 12% of product sales in 1998 and 1999. If we were to lose any of these customers or experience any substantial reduction in orders from these 27 customers, our revenues and operating results would suffer. In addition, the composition of our major customer base changes from year to year as the market demand for our customers' products change. WE DO NOT HAVE LONG-TERM CONTRACTS WITH OUR CUSTOMERS AND THE LOSS OF A MAJOR CUSTOMER COULD SERIOUSLY HARM OUR BUSINESS. We do not typically enter into long-term contracts with our customers, and we cannot be certain as to future order levels from our customers. When we do enter into a long-term contract, the contract is generally terminable at the convenience of the customer. An early termination by one of our major customers would harm our financial results as it is unlikely that we would be able to rapidly replace that revenue source. OUR BACKLOG MAY NOT RESULT IN FUTURE REVENUE WHICH WOULD SERIOUSLY HARM OUR BUSINESS. Due to possible customer changes in delivery schedules and cancellations of orders, our backlog at any particular date is not necessarily indicative of actual sales for any succeeding period. A reduction of backlog during any particular period, or the failure of our backlog to result in future revenue, could harm our business. IF AN EARTHQUAKE OR OTHER NATURAL DISASTER STRIKES OUR MANUFACTURING FACILITY OR THOSE OF OUR SUPPLIERS, WE WOULD BE UNABLE TO MANUFACTURE OUR PRODUCTS FOR A SUBSTANTIAL AMOUNT OF TIME AND WE WOULD EXPERIENCE LOST REVENUES. Our corporate headquarters are located in California near major earthquake faults. In addition, some of our suppliers are located near fault lines. In the event of a major earthquake or other natural disaster near our headquarters, our operations could be harmed. Similarly, a major earthquake or other natural disaster near one or more of our major suppliers, like the one that occurred in Taiwan in September 1999, could disrupt the operations of those suppliers, which could limit the supply of our products and harm our business. IF WE DID NOT ADEQUATELY PREPARE FOR THE TRANSITION TO YEAR 2000, OUR BUSINESS COULD BE HARMED. We have executed a plan designed to make our computer systems, applications, computer and manufacturing equipment and facilities year 2000 compliant. To date, none of our systems, applications, equipment or facilities have experienced any difficulties from the transition to year 2000. However, it is possible that significant difficulties could be discovered or could arise. We cannot guarantee that our year 2000 readiness plan has been successfully implemented, and actual results could still differ substantially from our plan. In addition, we have communicated with our critical suppliers to determine the extent to which we may be vulnerable to such parties' failure to resolve their own year 2000 issues. Where practicable, we have attempted to mitigate our risks with respect to the failure of these entities to be year 2000 compliant. The effect, if any, on our results of operations from any failure of such parties to be year 2000 compliant cannot yet be determined. WE MAY REQUIRE ADDITIONAL CAPITAL IN ORDER TO BRING NEW PRODUCTS TO MARKET, AND THE ISSUANCE OF NEW EQUITY SECURITIES WILL DILUTE YOUR INVESTMENT IN OUR COMMON STOCK. To implement our strategy of diversified product offerings, we need to bring new products to market. Bringing new products to market and ramping up production requires significant working capital. We have in place a credit agreement with Foothill Capital Credit Corporation to provide up to $50 million of additional capital to support potential on-going working capital requirements. As of December 31, 1999, we had borrowed $19.3 million under this facility. We anticipate that we will continue to borrow under this credit facility for some time. We may also sell additional shares of our stock or seek additional borrowings or outside capital infusions. We cannot assure you that such 28 financing options will be available on terms acceptable to us, if at all. In addition, if we issue shares of our common stock, our shareholders will experience dilution with respect to their investment. WE DEPEND ON MANUFACTURERS' REPRESENTATIVES AND DISTRIBUTORS TO GENERATE A MAJORITY OF OUR REVENUES. We rely on manufacturers' representatives and distributors to sell our products and these entities could discontinue selling our products at any time. Two of our manufacturers' representatives are responsible for substantially all of our sales in Taiwan, which accounted for 28% of our product revenues during 1999. One manufacturers' representative accounted for substantially all of our sales in China, including Hong Kong, during 1999, which accounted for 24% of our total 1999 product revenues. The loss of any of these manufacturers' representatives, or any other significant manufacturers' representative or distributor could seriously harm our operating results by impairing our ability to sell our products. OUR GROWTH CONTINUES TO PLACE A SIGNIFICANT STRAIN ON OUR MANAGEMENT SYSTEMS AND RESOURCES AND IF WE FAIL TO MANAGE OUR GROWTH, OUR ABILITY TO MARKET AND SELL OUR PRODUCTS AND DEVELOP NEW PRODUCTS MAY BE HARMED. Our business is experiencing rapid growth which has strained our internal systems and will require us to continuously develop sophisticated information management systems in order to manage the business effectively. We expect to complete the implementation of an Oracle enterprise resource planning and management system for our operations during the first quarter of 2000. We also plan to implement a supply-chain management system and a vendor electronic data interface system during this year. There is no guarantee that we will be able to implement these new systems in a timely fashion, that in themselves they will be adequate to address our expected growth, or that management will be able to foresee in a timely manner other infrastructure needs before they arise. Our success depends on the ability of our executive officers to effectively manage our growth. If we are unable to manage our growth effectively, our results of operations will be seriously harmed. If we fail to successfully implement the Oracle enterprise resource planning and management system, our business may suffer severe inefficiencies that may adversely impact the results of our operations. RISKS RELATED TO OUR INDUSTRY OUR SUCCESS IS DEPENDENT ON THE GROWTH AND STRENGTH OF THE FLASH MEMORY MARKET. All of our products, as well as all new products currently under design, are stand-alone flash memory devices or devices embedded with flash memory. A memory technology other than SuperFlash may be adopted as an industry standard. Our competitors are generally in a better financial and marketing position than we are from which to influence industry acceptance of a particular memory technology. In particular, a primary source of competition may come from alternative technologies such as FRAM devices if such technology is commercialized for higher density applications. To the extent our competitors are able to promote a technology other than SuperFlash as an industry standard, our business will be seriously harmed. THE SELLING PRICES FOR OUR PRODUCTS ARE EXTREMELY VOLATILE AND HAVE HISTORICALLY DECLINED. IN ADDITION, THE CYCLICAL NATURE OF THE SEMICONDUCTOR INDUSTRY COULD CREATE FLUCTUATIONS IN OUR OPERATING RESULTS, AS WE EXPERIENCED IN 1997 AND 1998. The semiconductor industry has historically been cyclical, characterized by wide fluctuations in product supply and demand. From time to time, the industry has also experienced significant downturns, often in connection with, or in anticipation of, maturing product cycles and declines in general economic conditions. Downturns of this type occurred in 1997 and 1998. These downturns have been characterized by diminished product demand, production over-capacity and accelerated decline of 29 average selling prices, and in some cases have lasted for more than a year. Our business could be harmed by industry-wide fluctuations in the future. The flash memory products portion of the semiconductor industry, from which we derived substantially all of our revenues in 1998, continued to suffer from excess capacity in 1998, which resulted in greater than normal price declines in our markets, which unfavorably impacted our revenues, gross margins and profitability. While these conditions improved in 1999, if they were to resume our growth and operating results would be harmed. THERE IS SEASONALITY IN OUR BUSINESS AND IF WE FAIL TO CONTINUE TO INTRODUCE NEW PRODUCTS THIS SEASONALITY MAY BECOME MORE PRONOUNCED. Sales of our products in the consumer electronics applications market are subject to seasonality. As a result, sales of these products are impacted by seasonal purchasing patterns with higher sales generally occurring in the second half of each year. In 1998 and 1999 this seasonality was partially offset by the introduction of new products as we continued to diversify our product offerings. If we fail to continue to introduce new products, our business may suffer and the seasonality of a portion of our sales may become more pronounced. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to risks associated with foreign exchange rate fluctuations due to our international manufacturing and sales activities. These exposures may change over time as business practices evolve and could negatively impact our operating results and financial condition. All of our sales are denominated in U.S. dollars. An increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive and therefore reduce the demand for our products. Such a decline in the demand could reduce revenues and/or result in operating losses. In addition, a downturn in the Japanese economy could impair the value of our investment in our Japanese affiliate. If we consider the value of Silicon Technology, in which we have a 14% interest, to be impaired, we would write off, or expense, some or all of our approximately $939,000 investment. At any time, fluctuations in interest rates could affect interest earnings on our cash, cash equivalents and short-term investments or increase any interest expense owed on the line of credit facility. We believe that the effect, if any, of reasonably possible near term changes in interest rates on our financial position, results of operations and cash flows would not be material. Currently, we do not hedge these interest rate exposures. ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements, together with the report thereon of PricewaterhouseCoopers LLP, independent accountants, dated January 17, 2000, except for Note 4, which is as of February 24, 2000, are included in a separate section of this report. SUPPLEMENTARY DATA: SELECTED CONSOLIDATED QUARTERLY DATA The following table presents our unaudited consolidated statements of operations data for each of the eight quarters in the period ended December 31, 1999. In our opinion, this information has been presented on the same basis as the audited consolidated financial statements included in a separate section of this report, and all necessary adjustments, consisting only of normal recurring adjustments, have been included in the amounts stated below to present fairly the unaudited quarterly results when read in conjunction with the audited consolidated financial statements and related notes. The operating results for any quarter should not be relied upon as necessarily indicative of results for any future 30 period. We expect our quarterly operating results to fluctuate in future periods due to a variety of reasons, including those discussed in "Business Risks."
QUARTER ENDED --------------------------------------------------------------------------------------- MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31 1998 1998 1998 1998 1999 1999 1999 1999 -------- -------- --------- -------- -------- -------- --------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net revenues: Product revenues............ $15,754 $16,422 $17,333 $17,366 $17,793 $20,433 $32,508 $47,508 License revenues............ 611 402 806 717 535 2,558 2,639 820 ------- ------- ------- ------- ------- ------- ------- ------- Total net revenues........ 16,365 16,824 18,139 18,083 18,328 22,991 35,147 48,328 Gross profit (loss)........... 1,975 3,418 1,902 (587) 1,349 4,966 9,206 14,621 Income (loss) from operations.................. (3,866) (3,513) (5,373) (6,949) (6,788) (3,831) 773 5,402 Net income (loss)............. (2,325) (1,242) (7,273) (6,748) (6,577) (3,630) 448 5,743 Net income (loss) per share-- basic....................... $ (0.10) $ (0.05) $ (0.32) $ (0.29) $ (0.28) $ (0.15) $ 0.02 $ 0.23 Net income (loss) per share-- diluted..................... $ (0.10) $ (0.05) $ (0.32) $ (0.29) $ (0.28) $ (0.15) $ 0.02 $ 0.21
QUARTERLY DISCUSSION NET REVENUES. During 1999, units shipped continued to increase and new products began to ship at high volume levels from the second quarter of 1998 to the fourth quarter of 1999. Net revenues increased during 1998 as the volume of units shipped increased each quarter for our existing products. The slow quarter to quarter percentage increase in revenue in early 1998 and the flat growth from the third quarter of 1998 through the first quarter of 1999 was due to declining selling prices offsetting the increased numbers of units shipped. License revenues as a portion of net revenues fluctuated from quarter to quarter. The increase in license revenues in the second and third quarters of 1999 is primarily related to the recognition of up-front license fees. GROSS PROFIT. Gross margin increased in 1999 from quarter to quarter due to the recovery of margin on our existing products in the first half of 1999 and the volume shipment of new products with improved gross margin in the second half of 1999 as we returned to profitability in the third quarter. Overall, gross margin decreased in 1998 despite increased unit shipment activity due to an approximate 14% decrease in weighted selling prices from quarter to quarter, due to industry over capacity. Gross margin increased from the first quarter of 1998 to the second quarter as a result of renegotiated die prices and increased unit shipment activity. The decreases in gross margin and gross profit during the fourth and third quarters of 1998 were due to continued price erosion. INCOME (LOSS) FROM OPERATIONS. Net loss from operations decreased in the first half of 1999 and net income from operations increased in the second half of 1999 as we returned to profitability in the third quarter. This has been due to the overall increases in units shipped for both new and existing products and due to selling prices increases on our existing products in the second half of 1999. Net loss from operations increased from the first quarter of 1998 through the first quarter of 1999 because declining selling prices outpaced manufacturing cost reductions. NET INCOME (LOSS). Net loss decreased in the first half of 1999 and net income increased in the second half of 1999 as we returned to profitability in the third quarter. This resulted from overall increases in units shipped for both new and existing products and from selling price increases on existing products in the second half of 1999. Net loss decreased from the first quarter to the second quarter of 1998 due to an increase in the tax benefit rate from 30% to 44%. Net loss increased during the last two quarters of 1998 due to declining gross margins and a $2.2 million charge in the third 31 quarter to provide a full valuation allowance against the carrying value of our deferred tax asset as a result of cumulative net operating losses. NET INCOME (LOSS) PER SHARE. Net loss per share decreased in the first half of 1999 and net income per share increased in the second half of 1999 as we returned to profitability in the third quarter. This was primarily due to overall increases in units shipped for both new and existing products, selling prices increase and cost reduction on existing products in the second half of 1999. Net loss per share decreased from the first quarter to the second quarter of 1998 due to an increase in the tax benefit rate from 30% to 44%. Net loss per share increased during the second half of 1998 due to declining gross margins and a $2.2 million charge to the provision for income taxes in the third quarter to provide a full valuation allowance against the carrying value of our deferred tax asset as a result of cumulative net operating losses. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 32 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item will be contained in our definitive Proxy Statement with respect to our Annual Meeting of Stockholders under the captions "Election of Directors--Nominees," and "Security Ownership of Certain Beneficial Owners and Management--Compliance with the Reporting Requirement of Section 16(a)," and is incorporated by reference into this report. The information relating to our executive officers and directors is contained in Part I, Item 1 of this report. ITEM 11. EXECUTIVE COMPENSATION The information required by this item will be contained in our definitive Proxy Statement with respect to our Annual Meeting of Stockholders under the caption "Executive Compensation," and is incorporated by reference into this report. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item will be contained in our definitive Proxy Statement with respect to our Annual Meeting of Stockholders under the captain "Security Ownership of Certain Beneficial Owners and Management," and is incorporated by reference into this report. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item will be contained in the our definitive Proxy Statement with respect to our Annual Meeting of Stockholders under the caption "Certain Transactions," and is incorporated by reference into this report. 33 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K. (a) (1) CONSOLIDATED FINANCIAL STATEMENTS. The index to the consolidated financial statements is found on page 39 of this Report. (2) FINANCIAL STATEMENT SCHEDULE. Financial statement schedule Number II is included. (3) EXHIBITS. See Exhibit Index in part (c), below. (b) REPORTS ON FORM 8-K. No reports on Form 8-K were filed during the last quarter of the period covered by this report. (c) INDEX TO EXHIBITS.
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT --------------------- ----------------------- 3.2 + Bylaws of SST. 3.4 + Form of Restated Articles of Incorporation of SST to be effective upon the closing of the offering, dated November 3, 1995. 4.1 + Reference is made to Exhibits 3.2. 10.1 + Equity Incentive Plan and related agreements. 10.2 + 1990 Stock Option Plan and related agreements. 10.3 + Employee Stock Purchase Plan. 10.4 + 1995 Non-Employee Directors' Stock Option Plan. 10.5 + Profit Sharing Plan. 10.6 + Lease Agreement between SST and Sonora Court Properties, dated March 15, 1993, as amended. 10.7 + Lease Agreement between SST and Coast Properties, dated May 4, 1995, as amended. 10.8 + License Agreement between SST and Winbond Electronics Corporation, dated July 30, 1990, as amended on September 14, 1990, August 27, 1992, December 15, 1992 and December 1, 1993. 10.9 + License Agreement between SST and Sanyo Electric Co., Ltd., dated April 7, 1993, as clarified by two letters each dated April 8, 1993. 10.10+ Manufacturing Agreement between SST and Sanyo Electric Co., Ltd., dated December 10, 1994. 10.11+ License and Technical Assistance Agreement between SST and Rockwell International Corporation, Digital Communications Division, dated September 1993, as amended on March 29, 1995. 10.13++ Documents relating to investment in Japanese company. 10.15++ License Agreement between SST and Seiko Epson Corporation dated March 31, 1996. 10.16++ License Agreement between SST and Taiwan Semiconductor Manufacturing Co., Ltd. dated February 26, 1997. 10.17++ Lease amendment, dated March 4, 1998, between SST and Sonora Court Properties. 10.18++ Lease amendment, dated March 4, 1998, between SST and Coast Properties.
34
EXHIBIT NUMBER DESCRIPTION OF DOCUMENT --------------------- ----------------------- 10.19++ Loan and Security Agreement between SST and Foothill Capital Corporation, dated September 22, 1998. 10.20++ Loan and Security Agreement amendment between SST and Foothill Capital Corporation dated December 8, 1998. 10.21++ 0.25 Micron Agreement between SST and Motorola, Inc., dated May 5, 1999. 10.22++ Loan and Security Agreement amendment between SST and Foothill Capital Corporation, dated September 30, 1999. 10.23 Second Amendment to Lease, dated September 13, 1999, between SST and Coast Properties. 10.24 Lease Agreement between SST and Bhupinder S. Lehga and Rupinder K. Lehga, dated November 15, 1999. 10.25 Lease Agreement between SST and The Irvine Company, dated November 22, 1999. 10.26* Agreement between SST and Samsung Electronic Co. Ltd., dated March 19, 1998. 23.1 Consent of PricewaterhouseCoopers LLP, independent accountants. 27.1 Financial Data Schedule.
- ------------------------ + Previously filed as an Exhibit to the Registration Statement filed on Form S-1 (33-97802) and incorporated by reference herein. ++ Previously filed as an Exhibit to Form 10-K or Form 10-Q and incorporated by reference herein. * Confidential treatment has been requested for portions of this exhibit. 35 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Sunnyvale, County of Santa Clara, State of California, on the 24th day of February, 2000. SILICON STORAGE TECHNOLOGY, INC. By: /s/ BING YEH ----------------------------------------- Bing Yeh PRESIDENT AND CHIEF EXECUTIVE OFFICER
Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of SST and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ BING YEH President, Chief Executive Officer ------------------------------------ and Director (PRINCIPAL February 24, 2000 Bing Yeh EXECUTIVE OFFICER) Vice President Finance & /s/ JEFFREY L. GARON Administration, Chief Financial ------------------------------------ Officer and Secretary (PRINCIPAL February 24, 2000 Jeffrey L. Garon FINANCIAL AND ACCOUNTING OFFICER) /s/ YAW WEN HU Senior Vice President, Operations ------------------------------------ and Process Development and February 24, 2000 Yaw Wen Hu Director /s/ TSUYOSHI TAIRA ------------------------------------ Director February 24, 2000 Tsuyoshi Taira /s/ RONALD CHWANG ------------------------------------ Director February 24, 2000 Ronald Chwang /s/ YASUSHI CHIKAGAMI ------------------------------------ Director February 24, 2000 Yasushi Chikagami
36 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Board of Directors of Silicon Storage Technology, Inc. and Subsidiaries: Our audits of the consolidated financial statements referred to in our report dated January 17, 2000, except for Note 4, which is as of February 24, 2000, appearing on page 40 of this Annual Report on Form 10-K also included an audit of the financial statement schedule listed in Item 14(a)(2) of this Form 10-K. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. /s/ PRICEWATERHOUSECOOPERS LLP PricewaterhouseCoopers LLP San Jose, California January 17, 2000 37 SCHEDULE II SILICON STORAGE TECHNOLOGY, INC. VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS)
BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND WRITE-OFF OF END OF DESCRIPTION OF PERIOD EXPENSES ACCOUNTS/OTHER PERIOD - ----------- ---------- ---------- -------------- ---------- Year ended December 31, 1997 Allowance for doubtful accounts................ $ 350 $ 400 $ 30 $ 720 Allowance for sales returns.................... $1,456 $ (759) $ 28 $ 669 Allowance for excess and obsolete inventories.................................. $2,718 $ 4,175 $3,160 $ 3,733 Valuation allowance on net deferred tax assets....................................... $ -- $ -- $ -- $ -- Year ended December 31, 1998 Allowance for doubtful accounts................ $ 720 $ 13 $ 170 $ 563 Allowance for sales returns.................... $ 669 $ (609) $ -- $ 60 Allowance for excess and obsolete inventories.................................. $3,733 $ 2,740 $5,051 $ 1,422 Valuation allowance on net deferred tax assets....................................... $ -- $ 9,607 $ -- $ 9,607 Year ended December 31, 1999 Allowance for doubtful accounts................ $ 563 $ 32 $ 60 $ 535 Allowance for sales returns.................... $ 60 $ 144 $ 163 $ 41 Allowance for excess and obsolete inventories.................................. $1,422 $ 3,293 $4,565 $ 150 Valuation allowance on net deferred tax assets....................................... $9,607 $ 3,092 $ -- $12,699
38 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE -------- Report of Independent Accountants........................... 40 Consolidated Balance Sheets................................. 41 Consolidated Statements of Operations....................... 42 Consolidated Statements of Shareholders' Equity............. 43 Consolidated Statements of Cash Flows....................... 44 Notes to the Consolidated Financial Statements.............. 45
39 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders Silicon Storage Technology, Inc. and Subsidiaries In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Silicon Storage Technology, Inc. and Subsidiaries at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PRICEWATERHOUSECOOPERS LLP PricewaterhouseCoopers LLP San Jose, California January 17, 2000, except for Note 4, which is as of February 24, 2000 40 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS) ASSETS
DECEMBER 31, ------------------- 1998 1999 -------- -------- Current assets: Cash and cash equivalents................................. $ 23,007 $ 1,223 Short-term investments.................................... 851 -- Accounts receivable, net of allowance for doubtful accounts of $563 in 1998 and $535 in 1999............... 9,249 33,285 Accounts receivable from related parties.................. 2,838 5,573 Inventories, net.......................................... 8,297 29,766 Other current assets...................................... 2,615 3,341 -------- -------- Total current assets.................................... 46,857 73,188 Equipment, furniture and fixtures, net...................... 6,847 11,131 Other assets................................................ 2,434 4,487 -------- -------- Total assets............................................ $ 56,138 $ 88,806 ======== ======== LIABILITIES Current liabilities: Borrowings under line of credit facility.................. $ -- $ 19,287 Trade accounts payable.................................... 10,309 19,207 Accrued expenses.......................................... 5,309 4,707 Deferred revenue.......................................... 1,827 4,144 -------- -------- Total current liabilities............................... 17,445 47,345 Other liabilities........................................... 663 446 -------- -------- Total liabilities....................................... 18,108 47,791 -------- -------- Commitments and contingencies (Note 4) SHAREHOLDERS' EQUITY Preferred Stock, no par value Authorized: 7,000 shares Series A Junior Participating Preferred Stock, no par value Designated: 450 shares Issued and outstanding: none............................ -- -- Common stock, no par value: Authorized: 45,000 shares Issued and outstanding: 23,086 shares (1998) and 24,946 shares (1999).................................... 53,601 60,570 Deferred stock compensation................................. (32) -- Accumulated deficit......................................... (15,539) (19,555) -------- -------- Total shareholders' equity.............................. 38,030 41,015 -------- -------- Total liabilities and shareholders' equity.............. $ 56,138 $ 88,806 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 41 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, ------------------------------ 1997 1998 1999 -------- -------- -------- Net revenues: Product revenues--non related parties..................... $ 57,696 $ 51,611 $ 99,769 Product revenues--related parties......................... 16,100 15,264 18,473 License revenues.......................................... 1,526 2,536 6,552 -------- -------- -------- Total net revenues...................................... 75,322 69,411 124,794 Cost of revenues............................................ 62,747 62,703 94,652 -------- -------- -------- Gross profit................................................ 12,575 6,708 30,142 -------- -------- -------- Operating expenses: Research and development.................................. 8,744 14,527 18,199 Sales and marketing....................................... 6,587 7,290 10,576 General and administrative................................ 9,479 4,592 3,800 In-process research and development....................... -- -- 2,011 -------- -------- -------- Total operating expenses................................ 24,810 26,409 34,586 -------- -------- -------- Loss from operations........................................ (12,235) (19,701) (4,444) Interest income............................................. 2,146 1,542 714 Interest expense............................................ -- (31) (214) Other income, net........................................... -- 31 16 -------- -------- -------- Loss before provision for (benefit from) income taxes....... (10,089) (18,159) (3,928) Provision for (benefit from) income taxes................... (3,165) (571) 88 -------- -------- -------- Net loss.................................................... $ (6,924) $(17,588) $ (4,016) ======== ======== ======== Net loss per share--basic and diluted....................... $ (0.30) $ (0.77) $ (0.17) ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 42 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
COMMON STOCK ------------------- DEFERRED STOCK RETAINED EARNINGS/ SHARES AMOUNT COMPENSATION (ACCUMULATED DEFICIT) TOTAL -------- -------- -------------- --------------------- -------- Balances, December 31, 1996........ 23,225 $54,312 $(100) $ 10,576 $ 64,788 Repurchase of shares of common stock.......................... (725) (1,682) -- (1,053) (2,735) Issuance of shares of common stock under employees' stock purchase and option plans...... 607 599 -- -- 599 Tax benefit from exercise of stock options.................. -- 127 -- -- 127 Amortization of deferred stock compensation................... -- -- 34 -- 34 Net loss......................... -- -- -- (6,924) (6,924) ------ ------- ----- -------- -------- Balances, December 31, 1997........ 23,107 53,356 (66) 2,599 55,889 Repurchase of shares of common stock.......................... (449) (1,034) -- (550) (1,584) Issuance of shares of common stock under employees' stock purchase and option plans...... 428 572 -- -- 572 Tax benefit from exercise of stock options.................. -- 707 -- -- 707 Amortization of deferred stock compensation................... -- -- 34 -- 34 Net loss......................... -- -- -- (17,588) (17,588) ------ ------- ----- -------- -------- Balances, December 31, 1998........ 23,086 53,601 (32) (15,539) 38,030 Issuance of shares for acquisition of Linvex Technology Corporation......... 895 5,146 -- 5,146 Issuance of shares of common stock under employees' stock purchase and option plans...... 965 1,823 -- -- 1,823 Amortization of deferred stock compensation................... -- -- 32 -- 32 Net loss......................... -- -- -- (4,016) (4,016) ------ ------- ----- -------- -------- Balances, December 31, 1999........ 24,946 $60,570 $ -- $(19,555) $ 41,015 ====== ======= ===== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 43 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED DECEMBER 31, ------------------------------- 1997 1998 1999 --------- -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss.................................................. $ (6,924) $(17,588) $ (4,016) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization........................... 4,206 4,235 4,613 Provision for doubtful accounts receivable.............. 400 13 32 Provision for excess and obsolete inventories and write down of inventory to market........................... 4,175 2,740 3,293 Amortization of deferred stock compensation............. 34 34 32 Loss on sale of equipment............................... 7 1 3 Deferred income taxes................................... (127) 3,747 -- Purchased in-process research and development........... -- -- 2,011 Changes in operating assets and liabilities (in 1999, net of effects of acquisition): Accounts receivable................................... 1,084 (944) (23,745) Accounts receivable from related parties.............. 1,000 (714) (2,735) Inventories........................................... (2,121) 872 (24,662) Other current and noncurrent assets................... 361 (1,219) (321) Trade accounts payable................................ 8,470 (8,648) 8,385 Accrued expenses...................................... 2,690 (1,287) (881) Deferred revenue...................................... (104) 527 2,205 --------- -------- -------- Net cash provided by (used in) operating activities........................................ 13,151 (18,231) (35,786) --------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Acquisition of equipment, furniture and fixtures.......... (2,777) (3,758) (7,928) Proceeds from sale of equipment........................... 2,614 -- -- Purchases of available-for-sale investments............... (101,659) (25,167) -- Sales and maturities of available-for-sale investments.... 107,143 44,792 851 Cash acquired in acquisition.............................. -- -- 110 Other..................................................... -- (1,000) -- --------- -------- -------- Net cash provided by (used in) investing activities........................................ 5,321 14,867 (6,967) --------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings under line of credit facility.................. -- -- 42,150 Repayments under line of credit facility.................. -- -- (22,863) Tax benefit from exercise of stock options................ 127 707 -- Issuance of shares of common stock........................ 599 572 1,823 Repurchase of common stock................................ (2,735) (1,584) -- Other..................................................... -- (67) (141) --------- -------- -------- Net cash provided by (used in) financing activities........................................ (2,009) (372) 20,969 --------- -------- -------- Net increase (decrease) in cash and cash equivalents....................................... 16,463 (3,736) (21,784) Cash and cash equivalents at beginning of period............ 10,280 26,743 23,007 --------- -------- -------- Cash and cash equivalents at end of period.................. $ 26,743 $ 23,007 $ 1,223 ========= ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for interest.................. $ -- $ 31 $ 213 Net cash paid (received) during the period for income taxes................................................... $ 130 $ 95 $ (1,652) Common stock issued in relation to the acquisition of Linvex.................................................. $ -- $ -- $ 5,146 Write-off of fully depreciated equipment, furniture and fixtures................................................ $ -- $ -- $ 11,847
The accompanying notes are an integral part of these consolidated financial statements. 44 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: NATURE OF OPERATIONS: Silicon Storage Technology, Inc. ("SST" or "the Company") supplies flash memory semiconductor devices for digital consumer, networking, wireless communication and Internet computing markets. Flash memory is nonvolatile memory that does not lose data when the power source is removed and is capable of electrically erasing selected blocks of data. The Company licenses its SuperFlash technology to other companies for non-competing applications. Substantially all of the Company's product revenues to date have been derived from the sale of four products: 512Kbit, 1Mbit, 2Mbit and 4Mbit memory devices used in personal computers, personal computer peripheral devices and consumer electronics and communications devices. The products are sold to manufacturers located primarily in Asia. USE OF ESTIMATES IN PREPARATION OF THE FINANCIAL STATEMENTS: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RISKS AND UNCERTAINTIES: SST's sales are concentrated in the nonvolatile memory class of the semiconductor memory industry, which is highly competitive and rapidly changing. Significant technological changes in the industry, changes in customer requirements, changes in product costs and selling prices, or the emergence of competitor products with new capabilities or technologies could affect SST's operating results adversely. SST currently buys all of its wafers and sorted die, an integral component of its products, from outside suppliers and is dependent on third party subcontractors to assemble and test products. During 1999, substantially all of SST's wafers and sorted die were supplied by two foundries and substantially all its products were assembled and tested by two subcontractors. If these suppliers and subcontractors fail to satisfy SST's requirements on a timely basis and at competitive prices SST could suffer manufacturing delays, a possible loss of revenues, or higher than anticipated cost of revenues any of which could severely adversely affect operating results. Most of SST's sales are made through manufacturers' representatives and distributors. These manufacturers' representatives and distributors can discontinue selling SST's products at any time. Two of the manufacturers' representatives are responsible for substantially all sales into Taiwan, which accounted for approximately 28% of SST's product revenues during 1999. One manufacturer representative accounted for substantially all sales in China, including Hong Kong, during 1999, which counted for 24% of SST's product revenues during 1999. The loss of any of the manufacturers' representatives or any other significant manufacturers' representatives or distributors could have a material adverse effect on SST's operating results. A majority of SST's product revenue came from sales to customers in the personal computer and computer peripherals industries. A decline in demand in these industries could have a material adverse affect on SST's operating results and financial condition. SST derived 81% of product revenue from Asia during 1999. Additionally, SST major wafer suppliers and assembly and packaging subcontractors are all located in Asia. Any kind of economic, 45 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) political or environmental instability in this region of the world can have a severe negative impact on SST's operating results due to the large concentration of SST's production and sales activities in this region. For example, during 1998 and 1997, several Asian countries where SST does business, such as Japan, Taiwan and Korea, experienced severe currency fluctuation and economic deflation, which negatively impacted SST's total revenues and also negatively impacted SST's ability to collect payments from these customers. During this period, the lack of capital in the financial sectors of these countries made it difficult for SST's customers to open letters of credit or other financial instruments that are guaranteed by foreign banks. Finally, the economic situation in this period exacerbated a decline in selling prices for SST's products as SST's competitors reduced product prices to generate needed cash. It should be noted that SST may be greatly impact by the political, economic and military conditions in Taiwan. Taiwan and China are continuously engaged in political disputes and both countries have recently conducted military exercises in or near the other's territorial waters and airspace. Such disputes may continue and even escalate, resulting in an economic embargo, a disruption in shipping or even military hostilities. This could severely harm SST's business by interrupting or delaying production or shipment of SST's product. Any kind of activity of this nature or even rumors of such activity could severely and negatively impact SST's operations, revenues, operating results, and stock price. SST's corporate headquarters are located in California near major earthquake faults. In addition, some of SST's suppliers are located near fault lines. In the event of a major earthquake or other natural disaster near SST's headquarters, SST's operations could be harmed. Similarly, a major earthquake or other natural disaster near one or more of SST's major suppliers, like the one that occurred in Taiwan in September 1999, could disrupt the operations of those suppliers, which could limit the supply of SST's products and harm SST's business. BASIS OF CONSOLIDATION: The consolidated financial statements include the accounts of SST and its wholly-owned subsidiaries after elimination of intercompany balances and transactions. FINANCIAL INSTRUMENTS AND CONCENTRATIONS: Cash equivalents are highly liquid investments with original or remaining maturities of three months or less as of the dates of purchase. Highly liquid investments included in cash equivalents are classified as available for sale and are carried at cost which approximates fair value. Cash equivalents present insignificant risk of changes in value because of interest rate changes. SST maintains substantially all of its cash balances with several major financial and/or brokerage institutions domiciled in the United States and has not experienced any material losses relating to these investment instruments. Short-term investments, which are comprised of corporate bonds and United States government securities, are classified as available-for-sale and carried at fair value, based on quoted market prices, with the unrealized gains or losses, net of tax, reported in shareholders' equity. Gross unrealized holding gains and losses have not been material. The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, both of which are included in interest income. Realized gains and losses are recorded on the specific identification method. As of December 31, 1998, 46 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) the fair value of available for sale securities included in cash equivalents and short-term investments approximated cost as follows:
UNREALIZED AMORTIZED GAIN FAIR COST (LOSS) VALUE --------- ---------- -------- As of December 31, 1998: Government bonds and notes.................... $ 6,436 $ -- $ 6,436 Corporate bonds and notes..................... 5,432 -- 5,432 -------- ---------- -------- 11,868 -- 11,868 Less amounts classified as cash equivalents... (11,017) -- (11,017) -------- ---------- -------- Short-term investments........................ $ 851 $ -- $ 851 ======== ========== ======== Contractual maturity dates less than 1 year... $ 851 ========
The carrying amounts reported for cash and cash equivalents, accounts receivable, accounts payable and accrued expenses are considered to approximate fair values based upon the short maturities of those financial instruments. The carrying amount of borrowing under the line of credit are also considered to approximate fair values as the interest rate on the borrowing adjusts to the banks reference rate. Financial instruments that potentially subject SST to concentrations of credit risks comprise, principally, cash, investments and trade accounts receivable. SST invests its excess cash in accordance with its investment policy which is approved by the Board of Directors and reviewed periodically. SST performs credit evaluations of new customers and requires those without positive, established histories to pay in advance, upon delivery or through letters of credit. Otherwise, SST does not require collateral of its customers, and maintains allowances for potential credit losses which have historically not been material. One customer represented 11% of SST's accounts receivable at December 31, 1999. Another customer represented 18% of SST's accounts receivable at December 31, 1998. At December 31, 1999 and 1998 no other customers exceed 10% of SST's accounts receivable. In 1999, 1998 and 1997 sales to SST's top 10 customers accounted for approximately 57%, 66% and 62% of product revenues. SST acquired a 14% interest in a privately held Japanese company in January, 1996 (see Note 8). The investment is carried at its original cost and when a decline in value is other than temporary the securities are reduced to their net realized value. Dividends and other distributions of earnings from the investee, if any, are included in income when declared. INVENTORIES: Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market value. SST's inventories include high technology parts and components that are specialized in nature or subject to rapid technological obsolescence. While SST has programs to minimize the required inventories on hand and considers technological obsolescence when estimating allowances for potentially excess and obsolete inventories and those required to reduce recorded amounts to market values, it is reasonably possible that such estimates could change in the near term. 47 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) EQUIPMENT, FURNITURE AND FIXTURES: Furniture, fixtures and equipment are stated at cost and depreciated using the straight-line method over estimated useful lives of three to seven years (see Note 3). INTANGIBLE ASSETS: Intangible assets include technology acquired in the acquisition of Linvex Technology Corporation (see Note 6) and technology acquired under licensing arrangements. These amounts are included in other assets and amortized over estimated lives of three years. LONG-LIVED ASSETS: Long-lived assets include furniture, fixtures and equipment and intangibles assets. Whenever events or changes in circumstances indicate that the carrying amounts of long-lived assets may not be recoverable, SST estimates the future cash flows, undiscounted and without interest charges, expected to result from the use of those assets and their eventual cash position. If the sum of the expected future cash flows is less then the carrying amount of those assets, SST recognizes an impairment loss based on the excess of the carrying amount over the fair value of the assets. WARRANTIES: SST's products are generally subject to warranty and SST provides for the estimated future costs of repair, replacement or customer accommodation upon shipment of the product in the accompanying statements of operations. REVENUE RECOGNITION: Direct sales to customers are recognized upon shipment of product net of an allowance for estimated returns. Sales to distributors are made primarily under arrangements allowing price protection and the right of stock rotation on merchandise unsold to distributors. Because of the uncertainty associated with pricing concessions and future returns, SST defers recognition of such revenues, related costs of revenues and related gross profit until the merchandise is sold by the distributor to the end user. For license and other arrangements for technology that SST is continuing to enhance and refine and under which we are obligated to provide unspecified enhancements, revenue is recognized over the lessor of the estimated period SST has historically enhanced and developed refinements to the technology, generally three years (the upgrade period), or the remaining portion of the upgrade period from the date of delivery, provided all specified technology and documentation has been delivered, the fee is fixed and determinable and collection of the fee is probable. From time to time, SST reexamines the estimated upgrade period relating to license technology to determine if a change in the estimate upgrade period is needed. Revenue from license or other technology arrangements where SST is not continuing to enhance and refine the technology or is not obligated to provide unspecified enhancements is recognized upon delivery, if the fee is fixed and determinable and collection of the fee is probable. 48 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) Royalties received under these arrangements during the upgrade period are recognized as revenue based on the ratio of the elapsed portion of the upgrade period to the estimated upgrade period. The remaining portion of the royalties are recognized ratably over the remaining portion of the upgrade period. Royalties received after the upgrade period has elapsed are recognized when reported to SST, which generally coincides with the receipt of payment. RESEARCH AND DEVELOPMENT: Research and development expenses are charged to operations as incurred. INCOME TAXES: Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized. COMPUTATION OF NET LOSS PER SHARE: SST has computed and presented net loss per share under two methods, basic and diluted. Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period. Diluted net loss per share is computed by dividing loss by the sum of the weighted average number of common shares outstanding and potential common shares (when dilutive). STOCK COMPENSATION: SST accounts for stock-based compensation using the intrinsic value method. SST calculates the fair value of stock-based compensation and discloses the pro forma impact of the value on net loss and net loss per share in the footnotes to the financial statements. COMPREHENSIVE INCOME: There was no material difference between SST's net loss and its total comprehensive loss for the periods reported in these financial statements. RECENT ACCOUNTING PRONOUNCEMENTS: In June, 1998, the Financial Accounting Standards Boards issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133 established a new model for accounting for derivative and hedging activities. In July, 1999 the Financial Accounting Standards Boards issued SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133" (SFAS 137). SFAS 137 deferred the effective date of SFAS 133 until the first fiscal quarter beginning after June 15, 2000. The impact of the implementation of SFAS 133 on the consolidated financial statements of SST has not yet been determined. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements" (SAB 101). SAB 101 summarizes certain of 49 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) the Staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. SST has until the first quarter of 2000 to comply with the guidance in SAB 101. The implementation of SAB 101 on the consolidated financial statements of SST has not yet been determined. 2. INVENTORIES (IN THOUSANDS):
DECEMBER 31, ------------------- 1998 1999 -------- -------- Raw materials.............................................. $ 311 $ 6,855 Work in process............................................ 4,717 19,338 Finished goods............................................. 3,269 3,573 ------ ------- $8,297 $29,766 ====== =======
3. EQUIPMENT, FURNITURE AND FIXTURES, NET (IN THOUSANDS):
DECEMBER 31, ------------------- ESTIMATED 1998 1999 USEFUL LIVES -------- -------- ------------ Equipment.................................... $13,325 $ 7,932 Four years Design hardware.............................. 3,559 2,540 Three years Software..................................... 2,131 2,478 Four years Furniture and fixtures....................... 804 1,109 Seven years ------- ------- 19,819 14,059 Less accumulated depreciation................ 12,972 4,859 ------- ------- 6,847 9,200 Construction in progress..................... -- 1,931 ------- ------- $ 6,847 $11,131 ======= =======
Depreciation expense was $3,676,000, $4,134,000 and $4,206,000 for 1999, 1998 and 1997, respectively. Construction in progress relates to software and consulting costs incurred to implement our enterprise resource planning system and our supply chain management system. These costs will be depreciated over three years beginning during the month that each system is fully functional. It is anticipated that both systems will be fully functional by the end of the first half of 2000. 4. COMMITMENTS AND CONTINGENCIES: SST leases its corporate facilities under noncancelable operating leases that expire in 2003 and 2005. The leases require escalating monthly payments over their terms and, therefore, periodic rent expense is being recognized on a straight-line basis. Under the terms of the leases, SST is responsible for maintenance costs, including real property taxes, utilities and other costs. Rent expense was $1,107,000, $749,000 and $421,000 in 1999, 1998 and 1997 respectively. 50 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 4. COMMITMENTS AND CONTINGENCIES: (CONTINUED) Future minimum rental payments at December 31, 1999 are as follows (IN THOUSANDS): 2000........................................................ $1,610 2001........................................................ 1,804 2002........................................................ 1,872 2003........................................................ 1,427 2004........................................................ 1,549 Thereafter.................................................. 365 ------ $8,627 ======
In February 1998, SST agreed to purchase technology from a product development partner for $1.8 million, payable upon the completion of certain product development milestones over the next eighteen months. During 1998, SST paid $275,000 pursuant to this agreement. During 1999, the agreement was terminated. No future payments are required of SST under this agreement. LINE OF CREDIT: On September 30, 1999, SST signed an agreement with Foothill Capital Corporation to increase SST's line of credit, which provided for borrowings up to $25 million. The new agreement allows SST to borrow up to $35 million, increasing to $50 million from January 1, 2000 through March 31, 2000, declining to $40 million from April 1, 2000 through May 31, 2000 and thereafter, returning to $25 million until September, 2002. Borrowing is limited to 80% of eligible world-wide accounts receivable and is collateralized by subtantially all the assets of SST. At December 31, 1999 the borrowing base was approximately $28 million of which approximately $8.7 million was unused at that date. The funds in excess of $25 million are available only if certain profitability covenants are met. SST is required to maintain specified levels of tangible net worth. Under the agreement SST is not permitted to pay a dividend, is restricted to capital expenditures of $15 million per annum, and is not permitted to make any debt or equity investments if those investments are funded from borrowings. The line bears interest at a rate of the bank's reference rate (8.5% at December 31, 1999) plus 0.5%. There is a minimum interest rate of 6.0%. SST must pay an unused line fee at the annual rate of one quarter of one percent on the unused portion. As of December 31, 1999, SST had borrowed approximately $19,287,000 under the line of credit and met the profitability covenant. LEGAL CONTINGENCIES: On January 3, 1996, Atmel sued SST in the U.S. District Court for the Northern District of California. Atmel's complaint alleged that SST willfully infringed on five U.S. patents owned or exclusively licensed to Atmel. Atmel later amended its complaint to allege infringement of a sixth patent. Regarding each of these six patents, Atmel sought a judgment that SST infringed the patent, an injunction prohibiting future infringement, and treble damages, as well as attorney's fees and expenses. On two of these six patents, the District Court granted in SST's favor a summary judgment that SST did not infringe. Two of the other patents were invalidated by another U.S. District Court in a proceeding to which SST was not a party, but this decision was reversed by the Federal Circuit. Thus, four patents remain at issue in Atmel's District Court case against SST. That case has been stayed, and Atmel has not requested a trial date. 51 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 4. COMMITMENTS AND CONTINGENCIES: (CONTINUED) On February 17, 1997, Atmel filed an action with the International Trade Commission, or ITC, against two suppliers of SST parts, involving five of the six patents that Atmel alleged that SST infringed in the District Court case above. SST intervened as a party in that action. Pursuant to indemnification agreements with these suppliers, SST is obligated to indemnify both to the extent provided in those agreements. As to two of these five patents, Atmel's claims were withdrawn because of the summary judgment granted by the District Court above. As to another two patents, the Administrative Law Judge, or ALJ, which makes recommendations to the ITC, has ruled that SST did not infringe. This ruling has yet to be confirmed by the ITC, which is free to adopt or reject the ALJ's findings. As to the fifth patent, the ALJ held a hearing, which concluded on February 17, 2000, to determine if it was invalid due to failure to name an inventor, and whether or not Atmel committed inequitable conduct in its dealings with the Patent and Trademark Office when it attempted to add a co-inventor. SST expects that the ALJ will rule on this issue sometime in April, and make a recommendation to the ITC. Any final decisions by the ITC will not be dispositive because Atmel can still pursue its claims in the District Court action. Any decisions by the ITC are not binding on the District Court. SST management intends to vigorously defend SST against these actions. On September 14, 1998, Intel sued SST in the U.S. District Court for the Northern District of California, San Jose Division. Intel's complaint alleged that, by making, using and selling devices, SST was willfully infringing four U.S. patents owned by Intel. Regarding each of these four patents, Intel sought: (1) a judgment that SST infringed on the patent; (2) an injunction prohibiting further infringement; and (3) an accounting of all damages caused by the alleged infringement, treble the amount of damages caused by the alleged infringement and attorney's fees, costs and expenses. SST denied infringement of any of the Intel patents and counter-claimed for invalidity and non-infringement of the Intel patents. Through neutral mediation, a settlement of the pending litigation was reached on May 13, 1999. The terms of the settlement were immaterial to SST's financial statements. However, as a result of the settlement an accrual for legal costs of $1.2 million was reversed to the statement of operations. On July 31, 1998, SST filed suit against Winbond Electronics Corporation in the U.S. District Court for the Northern District of California, San Jose Division. Winbond has answered the complaint and has counter-claimed. Since then, the parties have amended the complaint and the answer and counterclaim. As of February 24, 2000, SST has asserted eight causes of action, including breach of contract, misappropriation of trade secrets, and other contractual and tortious claims. SST's suit seeks damages and equitable remedies to prevent Winbond from using any of SST's technology. Winbond has answered and asserted counter-claims for a declaration that it is not in material breach of the agreement, breach of the agreement, breach of the covenant of good faith and fair dealing, interference with prospective economic advantage, unlawful business practice in violation of state law, common law unfair competition, a declaration that Winbond is not obligated to pay SST under the agreement and/or they own or jointly own the technology embodied in their products, misappropriation of Winbond's trade secrets, unfair competition in violation of the Federal Lanham 52 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 4. COMMITMENTS AND CONTINGENCIES: (CONTINUED) Act, and common law fraud and misrepresentation. Winbond seeks, in part, restitution of the payments made, and other damages, and an injunction. SST has replied by denying these charges. SST management believes that the substantive allegations in the Winbond counter-claims are without merit and intends to vigorously defend SST against the action. From time to time, SST is also involved in other legal actions arising in the ordinary course of business. While SST has accrued certain amounts for the estimated legal costs associated with defending these matters, there can be no assurance the Atmel complaint, the Winbond complaint or other third party assertions will be resolved without costly litigation, in a manner that is not adverse to SST's financial position, results of operations or cash flows or without requiring royalty payments in the future which may adversely impact gross margins. No estimate can be made of the possible loss or possible range of loss associated with the resolution of these contingencies. 5. SHAREHOLDERS' EQUITY: AUTHORIZED CAPITAL SHARES: SST's authorized capital shares consist of 45,000,000 shares of common stock and 7,000,000 shares of preferred stock. Of the preferred stock, 450,000 shares has been designated as series A junior participating preferred stock. All of SST's capital shares have no par value. SHARE PURCHASE RIGHTS PLAN: In May 1999, SST adopted a Share Purchase Rights Plan in which preferred stock rights were distributed as a rights dividend at a rate of one right for each share of common stock held as of the close of business on May 27, 1999. Preferred stock rights will also be issued with any new issuance of common shares. Each Right entitles the registered holder under certain circumstances to purchase from SST one one-hundredth of a share of series A junior participating preferred stock. Until the occurrence of certain events the preferred stock rights will be transferable with and only with the Common Shares. The effect will be to discourage acquisitions of more than 15 percent of SST's common stock without negotiations with the Board of Directors. The rights expire May 3, 2009. NET LOSS PER SHARE: A reconciliation of the numerator and the denominator of basic and diluted loss per share is as follows:
1997 1998 1999 -------- -------- -------- Numerator--Basic and Diluted: Net loss....................................... $(6,924) $(17,588) $(4,016) ======= ======== ======= Denominator--Basic and Diluted: Weighted average common stock outstanding...... 23,166 22,958 24,059 ======= ======== ======= Basic and Diluted net loss per share............. $ (0.30) $ (0.77) $ (0.17) ======= ======== =======
53 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 5. SHAREHOLDERS' EQUITY: (CONTINUED) Stock options to purchase 3,206,000, 3,095,000 and 2,886,000 shares of common stock were outstanding at December 31, 1999, 1998 and 1997, but were not included in the computation of diluted loss per share because SST had a net loss in 1999, 1998 and 1997. REPURCHASE OF COMMON STOCK: In January 1998, the Board of Directors approved a stock repurchase program whereby up to an aggregate of 1,000,000 shares of SST's common stock may be repurchased on the open market at prevailing market prices. The repurchase program ended June 1998. Approximately 449,000 shares were repurchased under this authorization during the period ended June 1998 for an aggregate purchase price of $1,584,000 at prices ranging from $3.19 to $3.78 per share. In July 1997 the Board of Directors authorized a stock repurchase program whereby 1,000,000 shares of SST's common stock may be repurchased on the open market at prevailing market prices. The repurchase program ended December 1997. Approximately 233,000 shares were repurchased under this authorization during the period ended December 1997 for an aggregate purchase price of $872,000 at prices ranging from $3.62 to $3.78 per share. In February 1997 the Board of Directors approved a stock repurchase program whereby up to an aggregate of 1,000,000 shares of SST's common stock may be repurchased on the open market at prevailing market prices. The repurchase program ended June 1997. Approximately 492,000 shares were repurchased under this authorization during the quarter ended June 1997 for an aggregate purchase price of $1,863,000 at prices ranging from $3.69 to $3.88 per share. EQUITY INCENTIVE PLAN: In 1990, SST adopted a combined incentive and supplemental stock option plan (the Option Plan) under which the Board of Directors could issue options to purchase up to 4,000,000 shares of common stock to employees and directors of and consultants to SST and its affiliates. In November 1995, SST amended the Option Plan, restated it as the Equity Incentive Plan and reserved an additional 2,000,000 shares of common stock for issuance under the plan. In July 1998 and 1999, SST amended the Equity Incentive Plan and reserved an additional 750,000 and 1,000,000 shares, respectively, of common stock for issuance under the plan. Under the Equity Incentive Plan, the Board of Directors has the authority to determine to whom options will be granted, the number of shares under option, the option term and the exercise price. The options generally are exercisable beginning one year from date of grant and thereafter become exercisable ratably over four or five years from the date of grant. During 1999, options were issued to employees that begin to be exercisable three years from the date of grant and are fully exercisable four years from the date of grant. The term of any options issued under either plan may not exceed ten years from the date of grant. At December 31, 1999, options to purchase approximately 1,217,000 shares of common stock were exercisable at a weighted average exercise price of $1.88. At December 31, 1998, options to purchase approximately 1,343,000 shares of common stock were exercisable at a weighted average exercise price of $1.25. At December 31, 1997, options to purchase approximately 1,132,000 shares of common stock were exercisable at a weighted average exercise price of $0.67. 54 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 5. SHAREHOLDERS' EQUITY: (CONTINUED) DIRECTORS' OPTION PLAN: In October 1995, SST adopted the Non-Employee Directors' Stock Option Plan (the "Directors' Plan") which became effective upon the effective date of SST's initial public offering. The Directors' Plan provided for the automatic grant of options to purchase 24,000 shares of SST's common stock to non-employee directors of SST upon the initial public offering. It also provides for automatic grants upon new non-employee directors being elected to the Board of Directors. The Directors' Plan also provides for the grant of options to purchase up to an additional 6,000 shares annually thereafter. Options under the Directors' Plan vest over 48 months and the exercise price of options granted must equal or exceed the fair market value of SST's common stock on the date of grant. The options expire ten years after the date of grant. In July 1999, SST amended the Directors' Plan to change the vesting terms from ratably over four years to upon date of grant, decreased the initial grant amount of options from 24,000 to 15,000 shares, and increased the aggregate number of share authorized by 50,000 shares to 200,000 shares. At December 31, 1999, 90,000 options were exercisable at a weighted-average exercise price of $9.17 per share. At December 31, 1998, 52,000 options were exercisable at a weighted-average exercise price of $7.30 per share. At December 31, 1997, 29,000 options were exercisable at a weighted-average exercise price of $6.52 per share. Activity under the Equity Incentive Plan and Directors' Plan follows: (IN THOUSANDS, EXCEPT PER SHARE DATA):
OPTIONS OUTSTANDING ----------------------------------------------------- AVAILABLE PRICE WEIGHTED AVERAGE FOR GRANT SHARES PER SHARE AMOUNT EXERCISE PRICE --------- -------- ------------ -------- ---------------- Balances, December 31, 1996........... 1,798 2,396 $0.15-$16.50 $ 4,700 $1.96 Granted............................. (2,307) 2,307 3.13-6.00 8,755 3.79 Exercised........................... -- (493) 0.15-3.13 (167) 0.34 Terminated.......................... 1,105 (1,105) 0.15-9.63 (5,355) 4.77 ------ ------ ------------ ------- ----- Balances, December 31, 1997........... 596 3,105 0.15-16.50 7,933 2.56 Granted............................. (888) 888 1.31-3.00 2,335 2.63 Exercised........................... -- (268) 0.15-3.13 (155) 0.58 Terminated.......................... 607 (607) 0.25-6.00 (2,797) 3.17 Authorized.......................... 750 -- -- -- -- ------ ------ ------------ ------- ----- Balances, December 31, 1998........... 1,065 3,118 0.15-16.50 7,316 2.35 Granted............................. (1,019) 1,019 2.41-24.88 7,990 7.84 Exercised........................... -- (712) 0.15-6.00 (1,117) 1.57 Terminated.......................... 219 (219) 0.33-13.25 (643) 2.36 Authorized.......................... 1,050 -- -- -- -- ------ ------ ------------ ------- ----- Balances, December 31, 1999........... 1,315 3,206 $0.15-$24.88 $13,546 $4.23 ====== ====== =======
On April 23, 1997, the Board of Directors approved an offer to employees of SST to reprice outstanding options granted prior to that date with an exercise price above $3.125 per share (the "1997 Repricing Program"). Under the 1997 Repricing Program, as of April 28, 1997, 845,000 option grants were converted into repriced option grants with an exercise price of $3.125 (based on the closing price as reported on the Nasdaq National Stock Market on such date). As consideration for the grant of 55 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 5. SHAREHOLDERS' EQUITY: (CONTINUED) repriced options, optionees are prohibited from exercising the repriced options for a period of three months following the initial vest date of such repriced options. The 1997 Repricing Program terminated on April 28, 1997. EMPLOYEE STOCK PURCHASE PLAN: In October 1995, SST adopted the Employee Stock Purchase Plan (the "Purchase Plan") which became effective upon the effective date of SST's initial public offering. A total of 850,000 shares of common stock were reserved for issuance under the Purchase Plan. The Purchase Plan provides for eligible employees to purchase shares of common stock at a price equal to 85% of the fair market value of SST's common stock on the date of the option grant by withholding up to 10 percent of their annual base earnings. In July 1999 the Purchase Plan was amended to increase the aggregate number of shares of common stock authorized for issuance by 350,000 shares to 1,200,000 shares. At December 31, 1999, shares available for purchase under this plan were 649,000. Shares issued under the Purchase Plan in 1999, 1998 and 1997 were 253,000, 160,000 and 114,000, respectively. STOCK COMPENSATION: SST has adopted the disclosure-only provisions of SFAS 123. Had compensation cost for the Equity Incentive Plan, the Directors' Plan or the Purchase Plan been determined based on the fair value at the grant date for the awards consistent with the provisions of SFAS 123, SST's net loss and net loss per share for 1999, 1998 and 1997 would have been increased to the pro forma amounts indicated below (IN THOUSANDS):
1997 1998 1999 -------- -------- -------- Pro forma net loss............................... $(8,939) $(19,316) $(6,479) Pro forma net loss per share--basic and diluted........................................ $ (0.39) $ (0.84) $ (0.26)
The fair value of each option grant for both the Directors' Plan and the Equity Incentive Plan is estimated on the date of grant using the Black-Scholes multiple options pricing model with the following weighted average assumptions by year:
1997 1998 1999 -------- -------- -------- Risk-free interest rate....................... 5.5-6.0% 4.1-5.8% 4.6-5.9% Expected term of option....................... 2 years 2 years 2 years Expected volatility........................... 92% 92% 92% Expected dividend yield....................... 0% 0% 0%
The weighted average fair value of options granted under the Equity Incentive Plan and the Directors' Option Plan during 1999, 1998 and 1997 was $7.79, $2.64 and $3.14, respectively, per share. 56 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 5. SHAREHOLDERS' EQUITY: (CONTINUED) The fair value of each stock purchase right granted under the Purchase Plan is estimated using the Black-Scholes model with the following weighted average assumptions by year:
1997 1998 1999 -------- -------- -------- Risk-free interest rate....................... 5.7% 5.3-5.5% 4.6-5.3% Expected term of option....................... 1/2 year 1/2 year 1/2 year Expected volatility........................... 92% 92% 92% Expected dividend yield....................... 0% 0% 0%
The risk-free interest rate range represents the low and high end of the range used at different points during the year. The weighted average valuation of right grants under the Purchase Plan during 1999, 1998 and 1997 was $1.34, $1.32 and $2.03, respectively, per share. The options outstanding and currently exercisable by exercise price under the Equity Incentive Plan and the Directors' Plan at December 31, 1999, are as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------- ------------------------------ WEIGHTED-AVERAGE RANGE OF NUMBER REMAINING WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE OUTSTANDING EXERCISE PRICE - --------------- ----------- ---------------- ---------------- ----------- ---------------- $0.150-$0.200............ 445,000 3.64 $ 0.156 445,000 $ 0.156 $0.250-$0.400............ 86,000 5.29 0.264 86,000 0.264 $0.500-$1.313............ 32,000 8.32 1.192 11,000 0.975 $1.813-$2.656............ 245,000 8.82 2.154 54,000 2.167 $2.844-$4.063............ 1,467,000 7.98 3.080 594,000 3.129 $4.375-$6.000............ 252,000 8.91 5.074 36,000 5.992 $6.250-$9.000............ 400,000 9.07 7.357 52,000 8.861 $10.688-$16.688.......... 253,000 9.58 13.910 29,000 12.280 $23.625-$24.875.......... 26,000 9.89 24.243 -- 0.000 --------- --------- $0.150-$24.875........... 3,206,000 7.72 $ 4.226 1,307,000 $ 2.377 ========= =========
6. ACQUISITION On June 4, 1999, SST purchased all of the outstanding capital stock of Linvex Technology, Corp. (Linvex), a privately held, memory design company located in Sunnyvale, California, in exchange for 789,000 shares of SST common stock with a fair market value of $4.7 million. The purchase price of $4.8 million, which includes acquisition costs of $0.1 million, was accounted for using the purchase method of accounting, which means that the purchase price was allocated to the assets acquired and liabilities assumed based on the estimated fair values at the date of the acquisition. The results of operations of Linvex have been included with those of SST since June 4, 1999, the date that the acquisition was consummated. 57 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 6. ACQUISITION (CONTINUED) The fair value of the assets of Linvex, which was determined through established valuation techniques used by an independent appraiser, and a summary of the consideration exchanged for these assets is as follows (in thousands): Total purchase price........................................ $ 4,794 ======= Assets acquired: Tangible assets, primarily cash, accounts receivable, and computer software....................................... $ 701 Core technology........................................... 2,827 Completed products........................................ 163 Workforce................................................. 272 Purchased in-process research and development............. 2,011 Liabilities assumed......................................... (1,180) ------- $ 4,794 =======
The amount allocated to the core technology, the completed products, for which technological feasibility had been established at the acquisition date, and the workforce is amortized on a straight line basis over three years. At December 31, 1999, accumulated amortization related to these items was $634,000. The amount of the purchase price allocated to purchased in-process research and development, which had no alternative future use and relates to a product for which technological feasibility had not been established, was expensed at the acquisition date. In addition, after the purchase, notes payable and deferred salary payable to shareholders and employees of $476,000 were converted into an additional 106,000 shares of SST's common stock. Summarized below are the unaudited pro forma results of SST as though Linvex had been acquired at the beginning of periods presented. Adjustments have been made for the estimated increases in amortization related to the purchase of core technology, completed products and workforce, and other appropriate pro forma adjustments.
1998 1999 -------- -------- Net revenues............................................ $ 70,515 $125,311 Net loss................................................ $(19,495) $ (3,146) Net loss per share--basic and diluted................... $ (0.82) $ (0.13)
The above amounts are based upon certain assumptions and estimates which we believe are reasonable and do not reflect any benefit from economies which might be achieved from combined operations. The pro forma financial information presented above is not necessarily indicative of either the results of operations that would have occurred had the acquisition taken place at the beginning of the periods presented or of future results of operations of the combined companies. The charge for purchased in process research and development has not been included in the pro forma results above because it is nonrecurring and directly related to the acquisition. 58 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 7. INCOME TAXES: The components of the provision for (benefit from) income taxes reflected in the statements of operations are as follows (IN THOUSANDS):
DECEMBER 31, ------------------------------ 1997 1998 1999 -------- -------- -------- Current: Federal......................................... $(2,693) $(4,445) $ (489) State........................................... (471) 1 248 Foreign......................................... 126 126 329 ------- ------- ------- (3,038) (4,318) 88 ------- ------- ------- Deferred: Federal......................................... 240 -- -- State........................................... (367) -- -- Change in valuation allowance................... -- 3,747 -- ------- ------- ------- (127) 3,747 -- ------- ------- ------- $(3,165) $ (571) $ 88 ======= ======= =======
Substantially all of SST's revenue is taxable in the United States. The principal items accounting for the difference between income taxes computed at the U.S. statutory rate and the provision for income taxes reflected in the statements of operations are as follows:
DECEMBER 31, ------------------------------------ 1997 1998 1999 -------- -------- -------- United States statutory rate....................... (34.0)% (35.0)% (35.0)% State taxes, net of federal benefit................ (3.0) 4.3 6.3 Foreign taxes, net................................. 1.0 -- 8.4 Net operating losses not utilized.................. -- 9.3 21.5 Change in valuation allowance...................... -- 20.6 -- Other.............................................. 4.6 (2.3) 1.1 ----- ----- ----- (31.4)% (3.1)% 2.3% ===== ===== =====
The tax effects of temporary differences that give rise to significant portions of the net deferred tax asset are as follows (IN THOUSANDS):
DECEMBER 31, ------------------- 1998 1999 -------- -------- Accrued expenses and allowances.......................... $ 2,754 $ 2,599 Net operating loss carry-forwards........................ 3,530 4,992 Credits.................................................. 3,742 5,431 ------- -------- Total.................................................. 10,026 13,022 Depreciation............................................. (419) (323) Valuation Allowance...................................... (9,607) (12,699) ------- -------- Net deferred tax asset................................... $ -- $ -- ======= ========
59 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 7. INCOME TAXES: (CONTINUED) Due to the uncertainties surrounding the realization of the deferred tax assets resulting from SST's accumulated losses and net losses in 1999, 1998 and 1997, SST has provided a full valuation allowance and, therefore, no benefit has been recognized for the operating loss and other deferred tax assets. SST evaluates positive and negative evidence about the recoverablity of its net deferred tax asset each quarter and will record the net deferred tax asset when it is more likely than not that it will be recovered. At December 31, 1999, SST had available approximately $12,100,000 for federal and approximately $11,500,000 for state net operating loss carry-forwards. These net operating losses, if not utilized, expire between 2003 and 2019. At December 31, 1999, SST also had available research and development credit carry-forwards for federal and state income tax purposes of approximately $2,951,000 and $1,328,000, respectively. These credit carry-forwards expire between 2016 and 2019. In addition, SST has approximately $846,000 of foreign tax credit carry-forwards which expire between 2000 and 2004. At December 31, 1999, SST also had available manufacturer's investment credits for state income tax purposes of $306,000 that expire between 2005 and 2007. 8. SEGMENT AND RELATED PARTY REPORTING: SST's business has two reportable segments: Flash Products and Technology Licensing based on SST's method of internal reporting. The table below presents information about reported segments:
1999 (IN THOUSANDS): -------------------------------- FLASH TECHNOLOGY PRODUCTS LICENSING TOTAL -------- ---------- -------- Revenues...................................... $118,242 $6,552 $124,794 Gross profits................................. $ 23,590 $6,552 $ 30,142 1998 (IN THOUSANDS): -------------------------------- FLASH TECHNOLOGY PRODUCTS LICENSING TOTAL -------- ---------- -------- Revenues...................................... $ 66,875 $2,536 $ 69,411 Gross profits................................. $ 4,172 $2,536 $ 6,708 1997 (IN THOUSANDS): -------------------------------- FLASH TECHNOLOGY PRODUCTS LICENSING TOTAL -------- ---------- -------- Revenues...................................... $ 73,796 $1,526 $ 75,322 Gross profits................................. $ 11,049 $1,526 $ 12,575
SST does not allocate operating expenses, interest income or expense, other income net, or the provision for (benefits from) income taxes to these segments for internal reporting purposes. 60 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 8. SEGMENT AND RELATED PARTY REPORTING: (CONTINUED) The Flash Products segment comprises four product groups, standard flash memory products, application-specific memory products, flash embedded controllers and mass storage products. Revenues were as follows:
1997 1998 1999 -------- -------- -------- Standard flash memory products.................. $73,796 $66,845 $111,675 All other....................................... -- 30 6,567 ------- ------- -------- Total flash product segment revenue............. $73,796 $66,875 $118,242 ======= ======= ========
Due to the low volume of the new products relative to the volume of Standard Flash Memory Products it is not practicable to report gross margin by product group for the Flash Products segment. The Technology Licensing segment comprises license fees and royalties earned through technology agreements that we have with wafer foundries and manufacturers for non-competing applications. SST's revenues are all denominated in U.S. dollars and are summarized as follows (in thousands):
YEAR ENDED DECEMBER 31, ------------------------------ 1997 1998 1999 -------- -------- -------- United States................................... $10,032 $ 5,099 $ 13,644 Europe.......................................... 3,381 6,929 7,347 Japan........................................... 17,878 13,739 16,396 Korea........................................... 4,203 3,756 11,750 Taiwan.......................................... 22,027 19,134 33,541 China (including Hong Kong)..................... 11,863 14,104 28,776 Other Asian countries........................... 5,890 6,119 9,340 Rest of world................................... 48 531 4,000 ------- ------- -------- $75,322 $69,411 $124,794 ======= ======= ========
Foreign revenue is based on the country to which the product is shipped. The locations and net book value of long lived assets follows:
DECEMBER 31, ------------------------------ 1997 1998 1999 -------- -------- -------- United States..................................... $ 7,018 $8,251 $13,921 Taiwan............................................ 1,554 924 1,655 Malaysia.......................................... -- -- 42 Philippines....................................... -- 106 -- ------- ------ ------- $ 8,572 $9,281 $15,618 ======= ====== =======
On January 31, 1996, SST acquired a 14% interest in a Japanese company for approximately $939,000 paid in cash, which interest is carried at cost in the other noncurrent assets category in the accompanying balance sheet. The president of the Japanese company is a shareholder of SST. In 1999, 61 SILICON STORAGE TECHNOLOGY, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS: (CONTINUED) 8. SEGMENT AND RELATED PARTY REPORTING: (CONTINUED) 1998 and 1997 this customer accounted for 8.1%, 14.7% and 15.4% respectively or approximately $10,032,000, $10,180,000 and $11,598,000, respectively, of net revenues. In 1997, no other customer accounted for more than 10% of net revenues for SST. In both 1999 and 1998, only one other customer accounted for more than 10% of net revenues for SST. This customer accounted for 11.8% and 10.8%, or approximately $14,700,000 and $7,187,000 of net revenues in 1999 and 1998, respectively. In June 1997, Dr. Ronald Chwang became a member of the Board of Directors. Dr. Chwang is the president of Acer Capital America and managing general partner of Acer Technology Venture Fund. Related Acer entities, Acer Corporation, Acer Peripherals and Acer Technologies are customers of SST. In 1999, 1998 and 1997 the combined Acer entities accounted for 6.3%, 7.3% and 6.0%, respectively, or $7,900,000, $5,084,000 and $4,502,000 of net revenues. In 1999, SST added Ocean Automation Ltd. and related entities as a customer. Mr. Yasushi Chikagami, a member of the SST Board of Directors, is also a member of the Board of Directors of Ocean. During 1999, Ocean accounted for 0.4% or $541,000 of net revenues. 9. EMPLOYEE BENEFIT PLANS: PROFIT SHARING PLAN: In April 1995, the Board adopted the Profit Sharing Plan under which employees may collectively earn up to 10% of SST's operating profit, provided that both net earnings before interest income (expense), net and provision for (benefit from) income taxes and operating profit are greater than 10% of sales. For purposes of the Profit Sharing Plan, "operating profit" is product revenues less cost of revenues and less operating expenses. The sum paid to any particular employee as profit sharing is a function of the employee's length of service, performance and salary. SST plans to pay profit sharing sums, when available, to employees twice a year. No profit sharing was paid in 1999, 1998 or 1997. 401(k) PLAN: In 1995, SST adopted the SST 401(k) Tax Sheltered Savings Plan and Trust (the Plan), as amended, which is intended to qualify under Section 401 of the Internal Revenue Code of 1986. The Plan covers essentially all employees. Each eligible employee may elect to contribute to the Plan, through payroll deductions, up to 15% of their compensation, subject to certain limitations. SST, at its discretion, may make additional contributions on behalf of employees. All employee contributions are 100% vested. No employer contributions were made in 1999, 1998 or 1997. 62 EX-10.23 2 EXHIBIT 10.23 Exhibit 10.23 SECOND AMENDMENT TO LEASE I. PARTIES AND DATE. This Amendment to Lease ("Second Amendment") dated as of September 13, 1999 is entered into by and between Coast Properties ("Landlord"), and Silicon Storage Technology, Inc. ("Tenant"). II. RECITALS. A. Landlord and Tenant entered into that certain Lease dated as of April 6, 1995 as amended by an amendment dated March 4, 1998 (as amended, the "Lease"), concerning a certain premises ("Premises") referred herein as "Initial Premises" located at 1156 Sonora Court, Sunnyvale California. The capitalized terms used and not otherwise defined herein shall have the same definitions as set forth in the Lease. B. Landlord and Tenant desire to modify the Lease to extend the term and to expand the Premises to include the additional 19,748 gross square feet of space located at 1154 Sonora Court, more particularly shown on Exhibit "A" attached hereto and incorporated herein by reference ("Additional Space"), which modifications shall be deemed effective as of the commencement date of this Second Amendment. III. MODIFICATIONS. Landlord and Tenant hereby agree that the Lease shall be modified and/or supplemented as follows: A. EXPANDED PREMISES. Landlord hereby leases the Additional Space to Tenant, and Tenant hereby leases the Additional Space from Landlord, on the same terms and conditions as are set forth in the Lease, as supplemented hereby, from and after the date hereof, the Premises (as defined in the Lease) shall consist of the Premises described in the Lease, together with the Additional Space described in Exhibit "A" to this Second Amendment. B. TENANT'S SHARE. Tenant's Share shall be increased to One Hundred percent (100%). Such increase shall take effect as of the Additional Space Commencement Date. 1. C. RENT/COMMENCEMENT DATE. Commencing on the earliest to occur of: (i), the date the Additional Space Improvements are substantially completed, or (ii) the date Tenant commences occupancy of the Additional Space (such earliest date being hereinafter referred to as the "Additional Space Commencement Date"), Monthly Rent payable by Tenant to Landlord shall be increased to the amount of:
ADDITIONAL SPACE RENT TOTAL RENT MONTHS PER MO. PER MO. ---------- --------------------- ---------- 1-12 $33,769 $55,568 13-24 $35,151 $57,822 25-36 $36,533 $60,111 37-48 $37,916 $62,437 49-* $39,496 $64,998 *April 5, 2005
D. LANDLORD'S WORK - ADDITIONAL SPACE IMPROVEMENTS: Prior to Tenant's occupancy of the Additional Space, Landlord, at Landlord's sole cost and expense, shall perform the following work to the Additional Space including related cost associated with architecture, construction drawings, and building permits: a. Repaint the interior, with a color mutually agreed upon by Tenant and Landlord; b. Replace all carpeting and v.c.t floor coverings (except areas to remain v.c.t), selection of the floor covering subject to mutual approval of Tenant and Landlord; c. Install new HVAC units servicing the Additional Space; d. Repair, re-seal and re-stripe the entire parking lot; e. Create two (double door size) opening between 1154 and 1156 Sonora Court-placement to be mutually agreeable; f. Landlord is responsible for the cost of any code compliance work as required by the City of Sunnyvale relating to Landlord's Work; Any subsequent work could trigger additional code compliance work; Tenant would be responsible for those costs associated with any subsequent work and any related code compliance work. g. Tenant to choose between the floor plans attached in Exhibit "B" and Exhibit "C" by September 30, 1999. E. LANDLORD'S WORK - INITIAL PREMISES: Landlord has no obligation to improve or modify the Initial Premises pursuant to the terms of this Second Amendment. Landlord has fully performed all of Landlord's obligations to improve or modify the Initial Premises in accordance with the terms of the Lease; Tenant shall continue in possession of the Initial Premises "As-Is". F. ADDITIONAL SPACE SECURITY DEPOSIT. Concurrently with its execution of this Second Amendment, Tenant shall deposit an additional Thirty-Seven Thousand Dollars ($37,000.00). with Landlord as an increase in the Security Deposit. With payment of the aforementioned amount, Tenant's Security Deposit held by landlord the Security Deposit held by Landlord will total $45,984.16. The Security Deposit paid by Tenant, as so increased, shall be held and applied as set forth in the Lease. 2. G. TERM-ADDITIONAL SPACE: Approximately sixty-two (62) months. The anticipated commencement date shall be February 1, 2000 and the Lease Termination date shall be April 5, 2005. TERM-INITIAL PREMISES: The lease term of the Initial Premises is hereby extended to be coterminous with the expiration of the Additional Space. The amended expiration of the Initial Premises is hereby extended to April 5, 2005 H. TERMINATION: Landlord grants Tenant the one time right to terminate the obligations of the Second Amendment. If Casto Travel fails to vacate by January 31, 2000, Tenant, by providing written notice to Landlord on or before the close of business February 4, 2000, may elect to terminate the obligation of the Second Amendment. In the event Tenant does exercise the aforementioned termination right, all deposits Landlord by Tenant for the Additional Space shall be returned and all rights between the parties for the Additional Space shall be null and void, however, all terms and conditions of the Initial Premises shall remain in full force and effect. I. ACCESS DURING CONSTRUCTION: Provided Tenant does not interfere with Landlord's Work described in paragraph E and provided Tenant furnishes Landlord with proof of Tenant's insurance for the Additional Space, Tenant shall be permitted to enter the Additional Space for the purpose of preparing the space for Tenant's occupancy. J. BROKERS: Tenant and Landlord acknowledge that Colliers International (Broker) is acting solely as the agent for the Tenant in this transaction and that CPS is acting, solely as the agent for Landlord, and that neither broker represents the other's client. Landlord shall pay a commission to CPS per CPS's standard schedule. K. PARKING/SIGNAGE: Upon the Commencement of the Additional Space, Tenant shall be entitled to the exclusive right to all parking and signage that belong to the Premises. L. OPTION TO RENEW-ARBITRATED RENT: Tenant is given the option to extend the term of both 1154 and 1156 Sonora Court subject to an the provisions contained in this Second Amendment for a period of five (5) years ("extended term") following, the expiration of the existing term by giving notice of exercise of the option ("option notice") to Landlord at least six (6) months, but not more than (9) nine months before the expiration of the existing term. Provided that, if Tenant is in default at the date of giving, the option notice, the option notice shall be totally ineffective, or if the Tenant is in default on the date the extended term is to commence, Landlord may elect that the extended term shall not commence and this lease shall expire at the end of the existing term. Base monthly rent for the option period is to be set at 100% of the then market rent for the Premises. However, in no event will the option rent be less than the rent during, the last period of the existing term. The parties shall have thirty (30) days after Landlord receives the option notice in which to agree on a base monthly rent during the extended term. If the parties agree on the base monthly rent for the extended term during, that period, they shall immediately execute an amendment to this lease stating the base monthly rent for the extended term. 3. If the parties are unable to agree on a base monthly rent for the extended term within that period, then ten (10) days after the expiration of that period each party, at it's cost, and by giving notice to the other party, shall appoint a real estate appraiser or broker with at least five (5) years full-time commercial appraisal or brokerage experience in the area in which the Premises are located, to appraise and set the base monthly rent for the extended term. If a party does not appoint an appraiser or broker within ten (10) days after the other party has given notice of the name of its appraiser or broker, this single appraiser or broker appointed shall be the sole appraiser or broker and shall set the base monthly rent for the extended term. If the two appraisers or brokers are appointed by the parties as stated in this paragraph, they shall meet promptly and attempt to set the base monthly rent for the extended term. If they are unable to agree within ten (10) days after the second appraiser or broker has been appointed, they shall attempt to elect a third appraiser or broker meeting the qualifications stated in this paragraph within five (5) days after the last day the two appraisers or brokers are given to set the base monthly rent. If they are unable to agree on the third appraiser or broker, either of the parties to this lease, by giving ten (10) days notice to the other party, can apply to the then president of the County Real Estate Board of Santa Clara County, or the presiding judge of the Superior Court of that county for the selection of a third appraiser or broker who meets the qualifications stated in this paragraph. Each of the parties shall bear one half of the cost of appointing a third appraiser or broker and paying for the third appraiser or broker's fee. The third appraiser or broker, however selected, shall be a person who has not previously acted in any capacity for either party or for either party's broker. Within twenty (20) days after the selection of the third appraiser or broker, a majority of the appraisers/brokers shall set the base monthly rent for the extended term. If the appraisers/brokers are unable to set a base monthly rent within the stipulated time, the two closest appraisers shall be added together and divided by two; the resulting quotient shall be the base monthly rent for the Premises during the extended term. The third broker's value, which is farthest apart, shall be disregarded. In all appraisals referred to herein, the property is to be appraised based on comparable buildings in the Sunnyvale area as close as possible to the Premises, with similar tenant improvements and Tenant credit worthiness. The option shall be personal to Tenant and shall be non-assignable, and non-transferable. IV. GENERAL. A. EFFECT OF SECOND AMENDMENT, RATIFICATION. Except to the extent the Lease is modified by this Second Amendment, the terms and provisions of the Lease shall remain unmodified and in full force and effect. In the event of conflict between the terms of the Lease and the terms of this Second Amendment, the terms of this Second Amendment shall prevail. B. ATTORNEYS' FEES. The provisions of the Lease respecting payment of attorney's fees shall also apply to this Second Amendment. 4. C. COUNTERPARTS. If this Second Amendment is executed in counterparts, each counterpart shall be deemed an original. D. AUTHORITY TO EXECUTE SECOND AMENDMENT. Each individual executing this Second Amendment on behalf of a corporation or partnership represents that he or she is duly authorized to execute and deliver this Second Amendment on behalf of the corporation or partnership and that this Second Amendment is binding upon the corporation or partnership in accordance with its terms. E. GOVERNING LAW. This Second Amendment and any enforcement of the agreements and modifications set forth above shall be governed by and construed in accordance with the laws of the State of California. "LANDLORD" COAST PROPERTIES, a California General Partnership By: /s/ illegible ------------------------------------ Its: Managing Partner ----------------------------------- "TENANT" SILICON STORAGE TECHNOLOGY, INC. a California Corporation By: /s/ Jeffrey L. Garon ------------------------------------ Its: Vice President and Chief Financial Officer ----------------------------------- By: /s/ Humberto Chacon ------------------------------------ Its: Manager, Human Resources ----------------------------------- 5. EXHIBIT A 1154-1156 SONORA COURT SUNNYVALE [Schematic of Premises] EXHIBIT B 1154-1156 SONORA COURT SUNNYVALE [Schematic of Premises] EXHIBIT C 1154-1156 SONORA COURT SUNNYVALE [Schematic of Premises] EX-10.24 3 EXHIBIT 10.24 EXHIBIT 10.24 AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION STANDARD INDUSTRIAL/COMMERCIAL SINGLE-TENANT LEASE - NET (DO NOT USE THIS FORM FOR MULTI-TENANT BUILDINGS) 1. BASIC PROVISIONS ("Basic Provisions"). 1.1 PARTIES: This Lease ("Lease"), dated for reference purposes only, November 15, 1999, is made by and between BHUPINDER S. LEHGA & RUPINDER K. LEHGA ("Lessor") and SILICON STORAGE TECHNOLOGY INC. ("Lessee"), (collectively, the "Parties," or individually a "Party"). (a) PREMISES: That certain real property, including all improvements therein or to be provided by Lessor under the terms of this Lease, and commonly known AS 1159 Sonora Court, Sunnyvale, located in the County of Santa Clara, State of California, and generally described as (describe briefly the nature of the property and, if applicable, the "Project". If the property is located within a Project) 13,534 square foot industrial building ("Premises"). (See also Paragraph 2) 1.2 TERM: Five (5) years and five (5) months ("Original Term") commencing November 15, 1999 ("Commencement Date") and ending April 4, 2005 ("Expiration Date"). (See also Paragraph 3). 1.3 EARLY POSSESSION: N/A ("Early Possession Date"). (See also Paragraphs 3.2 and 3.3) 1.4 BASE RENT: $ SEE ADDENDUM per month ("Base Rent"), payable on the First Day of Month day of each month commencing November 15, 1999. (See also Paragraph 4) /X/ if this box is check, there are provisions in this Lease for the Base Rent to be adjusted. 1.5 BASE RENT PAID UPON EXECUTION: $22,737.12, as Base Rent for the period [SEE ADDENDUM]. 1.6 SECURITY DEPOSIT: $22,737.12 ("Security Deposit"). (See also Paragraph 5) 1.7 AGREED USE: Any legally permitted use. (See also Paragraph 6) 1.8 INSURING PARTY: Lessor is the "Insuring Party" unless otherwise stated herein. (See also Paragraph 8) 1.9 REAL ESTATE BROKERS: (See also Paragraph 15) (a) REPRESENTATION: The following real estate brokers (collectively, the "Brokers") and brokerage relationships exist in this transaction (check applicable box(es)): / / N/A represents Lessor exclusively ("Lessor's Broker's); / / N/A represents Lessee exclusively ("Lessee's Broker"); or / / Represents both Lessor and Lessee ("Dual Agency"). (b) PAYMENT TO BROKERS: Upon execution and delivery of this Lease by both Parties, Lessor shall pay to the Broker the fee agreed to in this separate written agreement (or if there is no such agreement, the sum of N/A % of the total Base Rent for the brokerage services rendered by said Broker). INITIALS: ___________ __________ Page 1 of 27 1.10 GUARANTOR. The obligations of the Lessee under this Lease are to be guaranteed by None ("Guarantor"). (See also Paragraph 37). 1.11 ADDENDA AND EXHIBITS. Attached hereto is an Addendum or Addenda consisting of Paragraphs _______ and through ______ and Exhibits ____________, all of which constitute a part of this Lease. 2. PREMISES. 2.1 LETTING. Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor, the Premises, for the term, at the rental, and upon all of the terms covenants and conditions set forth in this Lease. Unless otherwise provided herein, any statement of size set forth in this Lease, or that may have been used in calculating rental, is an approximation which the Parties agree is reasonable and the rental based thereon is not subject to revision whether or not the actual size is more or less. 2.2 CONDITION. Lessor shall deliver the Premises to Lessee broom clean and free of debris on the Commencement Date or the Early Possession Date, whichever first occurs ("Start Date"), and, so long as the required service contracts described in Paragraph 7.1(b) below are obtained by Lessee within thirty (30) days following the Start Date, warrants that the existing electrical, plumbing, firs sprinkler, lighting, heating, ventilating and air conditioning systems ("HVAC"), loading doors, if any, and all other such elements in the Premises, other than those constructed by Lessee, shall be in good operating condition on said date and that the structural elements of the roof, bearing walls and foundation of any buildings on the Premises (the "Building") shall be free of material defects. If a non-compliance with said warranty exists as of the Start Date, Lessor shall, as Lessor's sole obligation with respect to such matter, except as otherwise provided in this Lease, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, rectify same at Lessor's expense. If, after the Start Date, Lessee does not give Lessor written notice of any non-compliance with this warranty within: (i) one year as to the surface of the roof and the structural portions of the roof, foundations and bearing walls, (ii) six (6) months as to the HVAC systems, (iii) one hundred eighty (180) days as to the remaining systems and other elements of the Building, correction of such non-compliance shall be the obligation of Lessee at Lessee's sole cost and expense. 2.3 COMPLIANCE. Lessor warrants that the improvements on the Premises comply with all applicable laws, covenants or restrictions of record, building codes, regulations and ordinances ("Applicable Requirements") in effect on the Start Date. Said warranty does not apply to the use to which Lessee will put the Premises or to any Alternations or Utility Installations (as defined in Paragraph 7.3(a)) made or to be made by Lessee. NOTE: Lessee is responsible for determining whether or not the zoning is appropriate for Lessee's intended use, and acknowledges that past uses of the Premises may no longer be allowed. If the Premises do not comply with said warranty, Lessor shall, except as otherwise provided, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, rectify the same at Lessor's expense. If the Applicable Requirements are hereafter changed (as opposed to being in existence at the Start Date, which is addressed in Paragraph 6.2(e) below) so as to require during the term of this Lease the construction of an addition to or an alteration of the Building, the remediation of any Hazardous Substance, or the reinforcement or other physical modification of the Building ("Capital Expenditure"), Lessor and Lessee shall allocate the cost of such work as follows: (a) Subject to Paragraph 2.3(c) below, if such Capital Expenditures are required as a result of the specific and unique use of the Premises by Lessee as compared with uses by tenants in general, Lessee shall be fully responsible for the cost thereof, provided, however that if such Capital Expenditure is required during the last two (2) years of this Lease and the cost thereof exceeds six (6) months' Base Rent, Lessee may instead terminate this Lease unless Lessor notifies Lessee, in writing, within ten (10) days after receipt of Lessee's termination notice that Lessor has elected to pay the difference between the actual cost thereof and the amount equal to six (6) months' Base Rent. If Lessee elects termination, Lessee shall immediately cease the use of the Premises which requires such Capital Expenditure and deliver to Lessor written notice specifying a termination date at least ninety (90) days thereafter. Such termination date shall, however, in no event be earlier than the last day that Lessee could legally utilize the Premises without commencing such Capital Expenditure. INITIALS: ___________ __________ Page 2 of 27 (b) If such Capital Expenditure is not the result of the specific and unique use of the Premises by Lessee (such as, governmentally mandated seismic modifications), then Lessor and Lessee shall allocate the obligation to pay for such costs pursuant to the provisions of Paragraph 7.1(c), provided, however, that if such Capital Expenditure is required during the last two years of this Lease or if Lessor reasonably determines that it is not economically feasible to pay its share thereof, Lessor shall have the option to terminate this Lease upon ninety (90) days prior written notice to Lessee unless Lessee notifies Lessor, in writing within ten (10) days after receipt of Lessor's termination notice that Lessee will pay for such Capital Expenditure. If Lessor does not elect to terminate, and fails to tender its share of any such Capital Expenditure, Lessee may advance such funds and deduct same, with interest, from Rent until Lessor's share of such costs have been fully paid. If Lessee is unable to finance Lessor's share, or if the balance of the Rent due and payable for the remainder of this Lease is not sufficient to fully reimburse Lessee on an offset basis, Lessee shall have the right to terminate this Lease upon thirty (30) days written notice to Lessor. (c) Notwithstanding the above, the provisions concerning Capital Expenditures are intended to apply only to non-voluntary, unexpected, and new Applicable Requirements. If the Capital Expenditures are instead triggered by Lessee as a result of an actual or proposed change in use, change in intensity of use, or modification to the Premises then, and in that event, Lessee shall be fully responsible for the cost thereof, and Lessee shall not have any right to terminate this Lease. 2.4 ACKNOWLEDGEMENTS. Lessee acknowledges that: (a) it has been advised by Lessor and/or Brokers to satisfy itself with respect to the condition of the Premises (including but not limited to electrical, HVAC and fire sprinkler systems, security, environmental aspects and compliance with Applicable Requirements), and their suitability for Lessee's intended use; (b) Lessee has made such Investigation as it deems necessary with reference to such matters and assumes all responsibility therefor as the same related to its occupancy of the Premises; and (c) neither Lessor, Lessor's agents, nor any Broker has made any oral or written representations or warranties with respect to said matters other than as set forth in this Lease. Lessor acknowledges that (a) Broker has made no representations, promises or warranties concerning Lessee's ability to honor the Lease or suitability to occupy the Premises; and (b) it is Lessor's sole responsibility to investigate the financial capability and/or suitability of all proposed tenants. 2.5 LESSEE AS PRIOR OWNER/OCCUPANT. The warranties made by Lessor in Paragraph 2 shall be of no force or effect if immediately prior to the Start Date Lessee was the owner or occupant to the Premises. In such event, Lessee shall be responsible for any necessary corrective work. 3. TERM. 3.1 TERM. The Commencement Date, Expiration Date and Original Term of this Lease are as specified in Paragraph 1.3. 3.2 EARLY POSSESSION. If Lessee totally or partially occupies the Premises prior to the Commencement Date, the obligation to pay Base Rent shall be abated for the period of such early possession. All other terms of this Lease (including, but not limited to, the obligations to pay Real Property Taxes and Insurance premiums and to maintain the Premises) shall, however, be in effect during such period. Any such early possession shall not affect the Expiration Date. 3.3 DELAY IN POSSESSION. Lessor agrees to use its best commercially reasonable efforts to deliver possession of the Premises to Lessee by the Commencement Date. If, despite said efforts, Lessor is unable to deliver possession as agreed, Lessor shall not be subject to any liability therefor, nor shall such failure affect the validity of this Lease. Lessee shall not, however, be obligated to pay Rent or perform its other obligations until it receives possession of the Premises. If possession is not delivered within sixty (60) days after the Commencement Date, Lessee may , at its option, by notice in writing within ten (10) days after the end of such sixty (60) day period, cancel this Lease, in which event the Parties shall be discharged from all obligations hereunder. If such written notice is not received by Lessor within said ten (10) day period, Lessee's right to cancel shall terminate. Except as otherwise provided, if possession is not tendered to Lessee by the Start Date and Lessee does not terminate this Lease, as aforesaid, any period of rent abatement that Lessee would otherwise have enjoyed shall run from the date of delivery of possession and continue for a period equal to what Lessee would otherwise have enjoyed under the INITIALS: ___________ __________ Page 3 of 27 terms hereof, but minus any days of delay caused by the acts of omissions of Lessee. If possession of the Premises is not delivered within four (4) months after the Commencement Date, this Lease shall terminate unless other agreements are reached between Lessor and Lessee, in writing. 3.4 LESSEE COMPLIANCE. Lessor shall not be required to tender possession of the Premises to Lessee until Lessee complies with its obligation to provide evidence of insurance (Paragraph 8.5). Pending delivery of such evidence, Lessee shall be required to perform all of its obligations under this Lease from and after the Start Date, including the payment of Rent, notwithstanding Lessor's election to withhold possession pending receipt of such evidence of insurance. Further, if Lessee is required to perform any other conditions prior to or concurrent with the Start Date, the Start Date shall occur but Lessor may elect to withhold possession until such conditions are satisfied. 4. RENT. 4.1 RENT DEFINED. All monetary obligations of Lessee to Lessor under the terms of this Lease (except for the Security Deposit) are deemed to be rent ("Rent"). 4.2 PAYMENT. Lessee shall cause payment of Rent to be received by Lessor in lawful money of the United States, without offset or deduction (except as specifically permitted in this Lease), on or before the day on which it is due. Rent for any period during the term hereof which is for less than one (1) full calendar month shall be prorated based upon the actual number of days of said month. Payment of Rent shall be made to Lessor at its address stated herein or to such other persons or place as Lessor may from time to time designated in writing. Acceptance of payment which is less than the amount then due shall not be a waiver of Lessor's rights to the balance of such Rent, regardless of Lessor's endorsement of any check so stating. 5. SECURITY DEPOSIT. Lessee shall deposit with Lessor upon execution hereof the Security Deposit as security for Lessee's faithful performance of its obligations under this Lease. If Lessee fails to pay Rent, or otherwise Defaults under this Lease, Lessor may use, apply or retain all or any portion of said Security Deposit for the payment of any amount due Lessor or to reimburse or compensate Lessor for any liability, expense, loss or damage which Lessor may suffer or incur by reason hereof. If Lessor uses or applies all or any portion of said Security Deposit, Lessee shall within ten (10) days after written request thereof deposit monies with Lessor sufficient to restore said Security Deposit to the full amount required by this lease. If the Base Rent increases during the term of this Lease, Lessee shall upon written request from Lessor, deposit additional monies with Lessor so that the total amount of the Security Deposit shall at all times bear the same portion to the increase Base Rent as the initial Security Deposit bore to the initial Base Rent. Should the Agreed Use be amended to accommodate a material change in the business of Lessee or to accommodate a sublessee or assignee, Lessor shall have the right to increase the Security Deposit to the extent necessary, in Lessor' reasonable judgement, to account for any increased wear and tear that the Premises may suffer as a result thereof. If a change in control of Lessee occurs during the Lease and following such change the financial condition of Lessee is, in Lessor's reasonable judgement, significantly reduced, Lessee shall deposit such additional monies with Lessor as shall be sufficient to cause the Security Deposit to be at a commercially reasonable level based on said change in financial condition. Lessor shall not be required to keep the Security Deposit separate from its general accounts. Within fourteen (14) days after the expiration or termination of this Lease, if Lessor elects to apply the Security Deposit only to unpaid Rent, and otherwise within thirty (30) days after the Premises have been vacated pursuant to Paragraph 7.4(c) below, Lessor shall return that portion of the Security Deposit not used or applied by Lessor. No part of the Security Deposit shall be considered to be held in trust, to bear interest or to be prepayment for any monies to be paid by Lessee under Lease. 6. USE. 6.1 USE. Lessee shall use and occupy the Premises only for the Agreed Use, or any other legal use which is reasonably comparable thereto, and for no other purpose. Lessee shall not use or permit the use of the Premises in a manner that is unlawful, creates damage, waste or a nuisance, or that disturbs owners and/or occupants of, or causes damage to neighboring properties. Lessor shall not unreasonably withhold or delay its consent to any written request for a modification of the Agreed Use, so long as the same will not impair the structural integrity of the improvements on the Premises or the mechanical or electrical systems therein, is not significantly more burdensome to the Premises. If Lessor elects to withhold consent, Lessor shall within five (5) business days after INITIALS: ___________ __________ Page 4 of 27 such request give written notification of same, which notice shall include an explanation of Lessor's objections to the change in use. 6.2 HAZARDOUS SUBSTANCES. (a) REPORTABLE USE REQUIRE CONSENT. The term "Hazardous Substance" as used in this Lease shall mean any product, substance, or waste whose presence, use, manufacture, disposal, transportation, or release, either by itself or in combination with other materials expected to be on the Premises, is either (i) potentially injurious to the public health, safety or welfare, the environment or the Premises, (ii) regulated or monitored by any government authority, or (iii) a basis for potential liability of Lessor to any government agency or authorized agent under any applicable statute or common law theory. Hazardous Substances shall include, but not be limited to, hydrocarbons, petroleum, gasoline, and/or crude oil or any products or products or fractions thereof. Lessee shall not engage in any activity in or on the Premises which constitutes a Reportable Use of Hazardous Substances without the express prior written consent of Lessor and timely compliance (at Lessee's expense) with all Applicable Requirements. "Reportable Use" shall mean (i) the installation or use of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance that requires a permit from or with respect to which a report notice, registration or business plan is required to be filed with, any governmental authority, and/or (iii) the presence at the Premises of a Hazardous Substance with respect to which any Applicable Requirements requires that a notice be given to persons entering or occupying the Premises or neighboring properties. Notwithstanding the foregoing, Lessee may use any ordinary and customary materials reasonably required to be used in the normal course of the Agreed Use, as long as such use is in compliance with all Applicable Requirements, is not a Reportable Use, and does not expose the Premises or neighboring property to any meaningful risk of contamination or damage or expose Lessor to any liability therefor. In addition, Lessor may condition its consent to any Reportable Use upon receiving such additional assurances as Lessor reasonably deems necessary to protect itself, the public, the Premises and/or the environment against damage, contamination, injury and/or liability, including, but not limited to, the installation (and removal on or before Lease expiration or termination) of protective modifications (such as concrete encasements) and /or increasing the Security Deposit. (b) DUTY TO INFORM LESSOR. If Lessee knows, or has reasonable cause to believe, that a Hazardous Substance has come to be located in, on, under or about the Premises, other than as previously consented to by Lessor, Lessee shall immediately give written notice of such fact to Lessor, and provide Lessor with a copy of any report, notice, claim or other documentation with it has concerning the presence of such Hazardous Substance. (c) LEASE REMEDIATION. Lessee shall not cause or permit any Hazardous Substance to be spilled or released in, on, under, or about the Premises (including through the plumbing or sanitary sewer system) and shall promptly, at Lessee' expense, take all investigatory and/or remedial action reasonably recommended, whether or not formally ordered or required, for the cleanup of any contamination of, and for the maintenance, security and/or monitoring of the Premises or neighboring properties, that was caused or materially contributed to be Lessee, or pertaining to or involving any Hazardous Substance brought onto the Premises during the term of this Lease, by or for Lessee, or any authorized agent. (d) LESSEE INDEMNIFICATION. Lessee shall indemnify, defend and hold Lessor, its agents, employees, lenders and ground lessor, if any, harmless from and against any and all loss of rents and/or damages, liabilities, judgements, claims, expenses, penalties, and attorney's and consultants' fees arising out of or involving any Hazardous Substances brought onto the Premises by or for Lessee, or any third party (provided, however, that Lessee shall have no liability under this Lease with respect to underground migration of any Hazardous Substance under the Premises from adjacent properties). Lessee's obligations shall include, but not limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Lessee, and the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. No termination, cancellation or release agreement entered into by Lessor and Lessee shall release Lessee from its obligations under this Lease with respect to Hazardous Substances, unless specifically so agreed by Lessor in writing at time of such agreement. (e) LESSOR INDEMNIFICATION. Lessor and its successors and assigns shall indemnify, defend, reimburse and hold Lessee, its employees and lenders, harmless from and against any and all environmental damages, including the cost of remediation, which existed as a result of Hazardous Substances on the Premises prior INITIALS: ___________ __________ Page 5 of 27 to the Start Date or which are caused by the gross negligence or willful misconduct of Lessor, its agents or employees. Lessor's obligations, as and when required by the Applicable Requirements, shall include, but not limited to, the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. (f) INVESTIGATIONS AND REMEDIATIONS. Lessor shall retain the responsibility and pay for investigations or remediation measures required by governmental entities having jurisdiction with respect to the existence of Hazardous Substances on the Premises prior to the Start Date, unless such remediation measure is required as a result of Lessee's use (including "Alterations", as defined in Paragraph 7.3(a) below) of the Premises. In which event Lessee shall be responsible for such payment. Lessee shall cooperate fully in any such activities at the request of Lessor, including allowing Lessor and Lessor's agents to have reasonable access to the Premises at reasonable times in order to carry out Lessor's investigative and remedial responsibilities. (g) LESSOR TERMINATION OPTION. If a Hazardous Substance Condition occurs during the term of this Lease, unless Lessee is legally responsible therefor (in which case Lessee shall make the Investigation and remediation thereof required by the Applicable Requirements and this Lease shall continue in full force and effect, but subject to Lessors' rights under Paragraph 6.2(d) and Paragraph 13), Lessor may at Lessor's option, either (i) investigate and remediate such Hazardous Substance Condition, if required as soon as reasonably possible at lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) if the estimated cost to remediate such condition exceeds twelve (12) times the then monthly Base Rent or $100,00, whichever is greater, give written notice to Lessee, within thirty (30) days after receipt by Lessor of knowledge of the occurrence of such Hazardous Substance Condition, of Lessor's desire to terminate this Lease as of the date sixty (60) days following the date of such notice. In the event Lessor elects to give a termination notice, Lessee may, within ten (10) days thereafter, give written notice to Lessor of Lessee's commitment to pay the amount by which the cost of the remediation of such Hazardous Substance Condition exceeds an amount equal to twelve (12) times the then monthly Base Rent of $100,000, whichever is greater. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within thirty (30) days following such commitment. In such event, this Lease shall continue in full force and effect, and Lessor shall proceed to make such remediation as soon as reasonably possible after the required funds are available. If Lessee does not give such notice and provide the required funds or assurance thereof within the time provided, this Lease shall terminate as of the date specified in Lessor's notice of termination. 6.3 LESSEE'S COMPLIANCE WITH APPLICABLE REQUIREMENTS. Except as otherwise provided in this Lease, Lessee shall, at Lessee's sole expense, fully, diligently and in a timely manner, materially comply with all Applicable Requirements, the requirements of any applicable fire insurance underwriter or rating bureau, and the recommendations of Lessor's engineers and/or consultants which relate to the tenant's use of the Premises, without regard to whether said requirements are now in effect or become effective after the Start Date. Lessee shall, within ten (10) days after receipt of Lessor's written request, provide Lessor with copies of all permits and other documents, and other information evidencing Lessee's compliance with any Applicable Requirements specified by Lessor, and shall immediately upon receipt, notify Lessor in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving the failure of Lessee or the Premises to comply with any Applicable Requirements. 6.4 INSPECTION; COMPLIANCE. Lessor and Lessor's "Lender" (as defined under Paragraph 30 below) and consultants shall have the right to enter into Premises at any time, in the case of an emergency, and otherwise at reasonable times, for the purpose of inspecting the condition of the Premises and for verifying compliance by Lessee with this Lease. The cost of any such inspections shall be paid by Lessor, unless a violation of Applicable Requirements, or a contamination is found to exist or be imminent, or the inspection is requested or ordered by a governmental authority. In such case, Lessee shall upon request reimburse lessor for the cost of such inspections, so long as such Inspection is reasonably related to the violation or contamination. INITIALS: ___________ __________ Page 6 of 27 7. MAINTENANCE; REPAIRS, UTILITY INSTALLATIONS; TRADE FIXTURES AND ALTERATIONS. 7.1 LESSEE'S OBLIGATIONS. (a) IN GENERAL. Subject to the provisions of Paragraph 2.2 (Condition), 2.3 (Compliance), 6.3 (Lessee's Compliance with Applicable Requirements), 7.2 (Lessor's Obligations), 9 (Damage or Destruction), and 14 (Condemnation), Lessee shall, at Lessee's sole expense, keep the Premises, Utility Installations, and Alterations in good order, condition and repair (whether or not the portion of the Premises requiring repairs, or the means of repairing the same, are reasonably or readily accessible to Lessee, and whether or not the need for such repairs occurs as a result of Lessee's use, any prior use, the elements or the age of such portion of the Premises), including, but not limited to, all equipment or facilities, such as electrical, lighting, facilities, boilers, pressure vessels, fire protection systems, fixtures, walls (interior and exterior), ceilings, floors, windows, doors, plate glass, skylights, landscaping, fences, retaining walls, signs, sidewalks and parkways located in, on or adjacent to the Premises. Lessee, in keeping the Premises in good order, condition and repair, shall exercise and perform good maintenance practices, specifically including the procurement and maintenance of the service contracts required by Paragraph 7.1(b) below. Lessee's obligations shall include restorations, replacements or renewals when necessary to keep the Premises and all improvements thereon or a part hereof in good order, condition and state of repair. Lessee shall, during the term of this Lease, keep the exterior appearance of the Building in a first-class condition consistent with the exterior appearance of other similar facilities of comparable age and size in the vicinity, including, when necessary, the exterior repainting of the Building. (b) SERVICE CONTRACTS. Lessee shall, at Lessee's sole expense, procure and maintain contracts, with copies to Lessor, in customary form and substance for, and with contractors specializing in maintenance of the following equipment and improvements, if any, if and when installed on the Premises (i) HVAC equipment, (ii) boiler and pressure vessels, (iii) fire extinguishing systems, including fire alarm and/or smoke detection, (iv) landscaping and irrigation systems, (v) roof covering and drains, (vi) driveways and parking lots, (vii) clarifiers, (viii) basic utility feed to the perimeter of the Building, and (ix) any other equipment, if reasonably required by Lessor. (c) REPLACEMENT. Subject to Lessee's Indemnification of Lessor as set forth in Paragraph 8.7 below, and without relieving Lessee of liability resulting from Lessee's failure to exercise and perform good maintenance practices. If the Basic Elements described in Paragraph 7.1(b) cannot be repaired other than at a cost which is in excess of 50% of the cost of replacing such Basic Elements, then such Basic Elements shall be replaced by Lessor, and the cost thereof shall be prorated between the Parties and Lessee shall only be obligated to pay, each month during the remainder of the term of this Lease, on the date on which Base Rent is due, an amount equal to the product of multiplying the cost of such replacement by a fraction, the numerator of which is one, and the denominator of which is the number of months of the useful life of such replacement as such useful life is specified pursuant to Federal Income tax regulations or guidelines for depreciation thereof (including interest on the unamortized balance as is then commercially reasonable in the judgement of Lessor's accounant(s), with Lessee reserving the right to prepay its obligation at any time. 7.2 LESSOR'S OBLIGATIONS. (a) Subject to the provisions of Paragraphs 2.2 (Condition), 2.3 (Compliance), 9 (Damage or Destruction) and 14 (Condemnation), it is intended by the Parties hereto that Lessor have no obligation, in any manner whatsoever, to repair and maintain the Premises, or the equipment therein, all of which obligations are intended to be that of the Lessee. It is the intention of the Parties that the terms of this Lease govern the respective obligations of the Parties as to maintenance and repair of the Premises, and they expressly waive the benefit of any statute now or hereinafter in effect to the extent it is inconsistent with the terms of this Lease. 7.3 UTILITY INSTALLATIONS; TRADE FIXTURES; ALTERATIONS. (a) DEFINITIONS; CONSENT REQUIRED. The term "UTILITY INSTALLATIONS" refers to all floor and window coverings, air lines, power panels, electrical distribution, security and fire protection systems, communication systems, lighting fixtures, HVAC equipment, plumbing, and fencing in or on the Premises. The term "TRADE FIXTURES" shall mean Lessee's machinery and equipment that can be removed without doing material INITIALS: ___________ __________ Page 7 of 27 damage to the Premises. The term "ALTERATIONS" shall mean any modification of the Improvements, other than Utility Installations or Trade Fixtures, whether by addition or deletion. "LESSEE OWNED ALTERATIONS AND/OR UTILITY INSTALLATIONS" are defined as Alterations and/or Utility Installations made by Lessee that are not yet owned by Lessor pursuant to Paragraph 7.4(a). Lessee shall not make any Alterations or Utility Installations to the Premises without Lessor's prior written consent. Lessee may, however, make non-structural Utility Installations to the interior of the Premises (excluding the roof) without Lessor's such consent but upon notice to Lessor, as long as they are not visible from the outside, do not involve puncturing, relocating or removing the roof or any existing walls, and the cumulative cost thereof during this Lease as extended does not exceed $50,000 in the aggregate or $10,000 in any one year. (b) CONSENT. Any Alterations or Utility Installations that Lessee shall desire to make and which require the consent of the Lessor shall be presented to Lessor in written form with detailed plans. Consent shall be deemed conditioned upon: (i) acquiring all applicable governmental permits, (ii) furnishing Lessor with copies of both the permits and the plans and specifications prior to commencement of the work, and (iii) compliance with all conditions of said permits and other Applicable Requirements in a prompt and expeditious manner. Any Alterations or Utility Installations shall be performed in a workmanlike manner with good and sufficient materials. Lessee shall promptly upon completion furnish Lessor with as-built plans and specifications. For work which costs an amount equal to the greater of one month's Base Rent, or $10,000, Lessor may condition its consent upon Lessee providing a lien and completion bond in an amount equal to the greater of one month's Base Rent, or $10,000, Lessor may condition its consent upon Lessee providing a lien and completion bond in an amount equal to one and one-half times the estimated cost of such Alteration or Utility Installation and/or upon Lessee's posting an additional Security Deposit with Lessor. (c) INDEMNIFICATION. Lessee shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Lessee at or for use on the Premises, which claims are or may be secured by any mechanics' or materialmen's lien against the Premises or any interest therein. Lessee shall give Lessor not less than ten (10) days' notice prior to the commencement of any work in, on or about the Premises, and Lessor shall have the right to post notices of non-responsibility. If Lessee shall contest the validity of any such lien, claim or demand, then Lessee shall, at its sole expense defend and protect itself, Lessor and the Premises against the same and shall pay and satisfy any such adverse judgment that may be rendered thereon before the enforcement thereof. If Lessor shall require, Lessee shall furnish a surety bond in an amount equal to one and one-half times the amount of such contested lien, claim or demand, indemnifying Lessor against liability for the same. If Lessor elects to participate in any such action, Lessee shall pay Lessor's attorneys' fees and costs. 7.4 OWNERSHIP; REMOVAL; SURRENDER; AND RESTORATION. (a) OWNERSHIP. Subject to Lessor's right to require removal or elect ownership as hereinafter provided, all Alterations and Utility Installations made by Lessee shall be the property of Lessee, but considered a part of the Premises. Unless otherwise instructed per subparagraph 7.4(b) hereof, all Lessee Owned Alterations and Utility Installations shall, at the expiration or termination of this Lease, become the property of Lessor and be surrendered by Lessee with the Premises. (b) REMOVAL. By delivery to Lessee of written notice from Lessor not earlier than ninety (90) and not later than thirty (30) days prior to the end of the term of this Lease, Lessor may require that any or all Lessee Owned Alterations or Utility Installations be removed by the expiration or termination of this Lease. Lessor may require the removal at any time of all or any part of any Lessee Owned Alterations or Utility Installations made without the required consent. Lessor will advise Lessee at the time of approval of any Installation if a removal may be required. (c) SURRENDER/RESTORATION. Lessee shall surrender the Premises by the Expiration Date or any earlier termination date, with all of the improvements, parts and surfaces thereof broom clean and free of debris and in good operating order, condition and state of repair, ordinary wear and tear excepted. "ORDINARY WEAR AND TEAR" shall not include any damage or deterioration that would have been prevented by good maintenance practice. Lessee shall repair any damage occasioned by the installation, maintenance or removal of Trade Fixtures, Lessee Owned Alterations and/or Utility Installations, furnishings, and equipment as well as the removal of any storage tank installed by or for Lessee, and the removal, replacement, or remediation of any soil, material or groundwater INITIALS: ___________ __________ Page 8 of 27 contaminated by Lessee. Trade Fixtures shall remain the property of Lessee and shall be removed by Lessee. The failure by Lessee to timely vacate the Premises pursuant to this Paragraph 7.4(c) without the express written consent of Lessor shall constitute a holdover under the provisions of Paragraph 26 below. 8. INSURANCE; INDEMNITY. 8.1 PAYMENT FOR INSURANCE. Lessee shall pay for all insurance required under Paragraph 8 except to the extent of the cost attributable to liability insurance carried by Lessor under Paragraph 8.2(b) in excess of $2,000,000 per occurrence. Premiums for policy periods commencing prior to or extending beyond the Lease term shall be prorated to correspond to the Lease term. Payment shall be made by Lessee to Lessor within ten (10) days following receipt of an invoice. 8.2 LIABILITY INSURANCE. (a) CARRIED BY LESSEE. Lessee shall obtain and keep in force a Commercial General Liability policy of insurance protecting Lessee and Lessor against claims for bodily injury, personal injury and property damage based upon or arising out of the ownership, use, occupancy or maintenance of the Premises and all areas appurtenant thereto. Such insurance shall be on an occurrence basis providing single limit coverage in an amount not less than $2,000,000 per occurrence with an "Additional Insured-Managers or Lessors of Premises Endorsement" and contain the "Amendment of the Pollution Exclusion" for damage caused by heat, smoke or fumes from a hostile fire. The policy shall not contain any intra-insured exclusions as between insured persons or organizations, but shall include coverage for liability assumed under this Lease as an "insured contract" for the performance of Lessee's indemnity obligations under this Lease. The limits of said insurance shall not, however, limit the liability of Lessee nor relieve Lessee of any obligation hereunder. All insurance to be carried by Lessee shall be primary to and not contributory with any similar insurance carried by Lessor, whose insurance shall be considered excess insurance only. (b) CARRIED BY LESSOR. Lessor shall maintain liability insurance as described in Paragraph 8.2(a), in addition to, and not in lieu of, the insurance required to be maintained by Lessee. Lessee shall not be named as an additional insured therein. 8.3 PROPERTY INSURANCE - BUILDING, IMPROVEMENTS AND RENTAL VALUE. (a) BUILDING AND IMPROVEMENTS. The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor, with loss payable to Lessor, any groundlessor, and to any Lender(s) insuring loss or damage to the Premises. The amount of such insurance shall be equal to the full replacement cost of the Premises, as the same shall exist from time to time, or the amount required by Lenders, but in no event more than the commercially reasonable and available insurable value thereof. If Lessor is the Insuring Party, however, Lessee Owned Alterations and Utility Installations, Trade Fixtures and Lessee's personal property shall be insured by Lessee under Paragraph 8.4 rather than by Lessor. If the coverage is available and commercially appropriate, such policy or policies shall insure against all risks of direct physical loss or damage (except the perils of flood and/or earthquake unless required by a Lender), including coverage for debris removal and the enforcement of any Applicable Requirements requiring the upgrading, demolition, reconstruction or replacement of any portion of the Premises as the result of a covered loss. Said policy or policies shall also contain an agreed valuation provision in lieu of any coinsurance clause, waiver of subrogation, and inflation guard protection causing an increase in the annual property insurance coverage amount by a factor of not less than the adjusted U.S. Department of Labor Consumer Price Index for All Urban Consumers for the city nearest to where the Premises are located. If such insurance coverage has a deductible clause, the deductible amount shall not exceed $1,000 per occurrence, and lessee shall be liable for such deductible amount in the event of an Insured Loss. (b) RENTAL VALUE. The Insuring Party shall obtain and keep in force a policy or policies in the name of Lessor with loss payable to Lessor and any Lender, insuring the loss of the full Rent for one (1) year. Said insurance shall provide that in the event the Lease is terminated by reason of an insured loss, the period of indemnity for such coverage shall be extended beyond the date of the completion of repairs or replacement of the Premises, to provide for one full year's loss of Rent from the date of any such loss. Said insurance shall contain an agreed valuation provision in lieu of any coinsurance clause, and the amount of coverage shall be adjusted annually INITIALS: ___________ __________ Page 9 of 27 to reflect the projected Rent otherwise payable by Lessee, for the next twelve (12) month period. Lessee shall be liable for any deductible amount in the event of such loss. (c) ADJACENT PREMISES. If the Premises are part of a larger building, or of a group of buildings owned by Lessor which are adjacent to the Premises, the Lessee shall pay for any increase in the premiums for the property insurance of such building or buildings if said increase is caused by Lessee's acts, omissions, use or occupancy of the Premises. 8.4 LESSEE'S PROPERTY/BUSINESS INTERRUPTION INSURANCE. (a) PROPERTY DAMAGE. Lessee shall obtain and maintain insurance coverage on all of Lessee's personal property, Trade Fixtures, and Lessee Owned Alterations and Utility Installations. Such insurance shall be full replacement cost coverage with a deductible selected by Lessee. The proceeds from any such insurance shall be used by Lessee for the replacement of personal property, Trade Fixtures and Lessee Owned Alterations and Utility Installations. Lessee shall provide Lessor with written evidence that such insurance is in force. (b) BUSINESS INTERRUPTION. Lessee shall obtain and maintain loss of income and extra expense insurance in amounts as will reimburse Lessee for direct or indirect loss of earnings attributable to all perils commonly insured against by prudent lessees in the business of Lessee or attributable to prevention of access to the Premises as a result of such perils. (c) NO REPRESENTATION OF ADEQUATE INSURANCE. Lessor makes no representation that the limits or forms of coverage of insurance specified herein are adequate to cover Lessee's property, business operations or obligations under this Lease. 8.5 INSURANCE POLICIES. Insurance required herein shall be by companies duly licensed or admitted to transact business in the state where the Premises are located, and maintaining during the policy term a "General Policyholders Rating" of at least B+, V, as set forth in the most current issue of "Best's Insurance Guide," or such other rating as may be required by a Lender. Lessee shall not do or permit to be done anything which invalidates the insurance policies. Lessee shall, prior to the Start Date, cause to be delivered to Lessor certified copies of policies of such insurance or certificates evidencing the existence and amounts of the required insurance. No such policy shall be cancelable or subject to modification except after thirty (30) days prior written notice to Lessor. Lessee shall, at least thirty (30) days prior to the expiration of such policies, furnish Lessor with evidence of renewals or "insurance binders" evidencing renewal thereof, or Lessor may order such insurance and charge the cost thereof to Lessee, which amount shall be payable by Lessee to Lessor upon demand. Such policies shall be for a term of at least one year, or the length of the remaining term of this Lease, whichever is less. If either Party shall fail to procure and maintain the insurance required to be carried by it, the other Party may, but shall not be required to, procure and maintain the same. 8.6 WAIVER OF SUBROGATION. Without affecting any other rights or remedies, Lessee and Lessor each hereby release and relieve the other, and waive their entire right to recover damages against the other, for loss of or damage to its property arising out of or incident to the perils required to be insured against herein. The effect of such releases and waivers is not limited by the amount of insurance carried or required, or by any deductibles applicable hereto. The Parties agree to have their respective property damage insurance carriers waive any right to subrogation that such companies may have against Lessor or Lessee, as the case may be, so long as the insurance is not invalidated thereby. 8.7 INDEMNITY. Except for Lessor's gross negligence or willful misconduct, Lessee shall indemnify, protect, defend and hold harmless, the Premises, Lessor and its agents, Lessor's master or ground lessor, partners and Lenders, from and against any and all claims, loss of rents and/or damages, liens, judgments, penalties, permits, attorney's and consultant's fees, expenses and/or liabilities arising out of, involving, or in connection with, the use and/or occupancy of the Premises by Lessee. If any action or proceeding is brought against Lessor by reason of any of the foregoing matters, Lessee shall upon notice from Lessor defend the same at Lessee's expense by counsel reasonably satisfactory to Lessor and Lessor shall cooperate with Lessee in such defense. Lessor need not have first paid any such claim in order to be defended or indemnified. INITIALS: ___________ __________ Page 10 of 27 8.8 EXEMPTION OF LESSOR FROM LIABILITY. Lessor shall not be liable for injury or damage to the person or goods, wares, merchandise or other property of Lessee, Lessee's employees, contractors, invitees, customers, or any other person in or about the Premises, whether such damage or injury is caused by or results from fire, steam, electricity, gas, water or rain, or from the breakage, leakage, obstruction or other defects of pipes, fire sprinklers, wires, appliances, plumbing, HVAC or lighting fixtures, or from any other cause, whether the said injury or damage results from conditions arising from the Premises or upon other portions of the building of which the Premises are a part, or from other sources or places. Lessor shall not be liable for any damages arising from any act or neglect of any other tenant of Lessor. Notwithstanding Lessor's negligence or breach of this Lease, Lessor shall under no circumstances be liable for injury to Lessee's business or for any loss of income or profit therefrom. 9. DAMAGE OR DESTRUCTION. 9.1 DEFINITIONS. (a) "PREMISES PARTIAL DAMAGE" shall mean damage or destruction to the improvements on the Premises, other than Lessee Owned Alterations and Utility Installations, which can reasonably be repaired in six (6) months or less from the date of the damage or destruction. Lessor shall notify Lessee in writing within thirty (30) days from the date of the damage or destruction as to whether or not the damage is Partial or Total. (b) "PREMISES TOTAL DESTRUCTION" shall mean damage or destruction to the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which cannot reasonably be repaired in six (6) months or less from the date of the damage or destruction. Lessor shall notify Lessee in writing within thirty (30) days from the date of the damage or destruction as to whether or not the damage is Partial or Total. (c) "INSURED LOSS" shall mean damage or destruction to improvements on the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which was caused by an event required to be covered by the insurance described in Paragraph 8.3(a), irrespective of any deductible amounts or coverage limits involved. (d) "REPLACEMENT COST" shall mean the cost to repair or rebuild the improvements owned by Lessor at the time of the occurrence to their condition existing immediately prior thereto, including demolition, debris removal and upgrading required by the operation of Applicable Requirements, and without deduction for depreciation. (e) "HAZARDOUS SUBSTANCE CONDITION" shall mean the occurrence or discovery of a condition involving the presence of, or a contamination by, a Hazardous Substance as defined in Paragraph 6.2(a), in, on, or under the Premises. 9.2 PARTIAL DAMAGE - INSURED LOSS. If a Premises Partial Damage that is an Insured Loss occurs, then Lessor shall, at Lessor's expense, repair such damage (but not Lessee's Trade Fixtures or Lessee Owned Alterations and Utility Installations) as soon as reasonably possible and this Lease shall continue in full force and effect; provided, however, that Lessee shall, at Lessor's election, make the repair of any damage or destruction the total cost to repair of which is $10,000 or less, and, in such event, Lessor shall make any applicable insurance proceeds available to Lessee on a reasonable basis for that purpose. Notwithstanding the foregoing, if the required insurance was not in force or the insurance proceeds are not sufficient to effect such repair, the Insuring Party shall promptly contribute the shortage in proceeds (except as to the deductible which is Lessee's responsibility) as and when required to complete said repairs. In the event, however, such shortage was due to the fact that, by reason of the unique nature of the improvements, full replacement cost insurance coverage was not commercially reasonable and available, Lessor shall have no obligation to pay for the shortage in insurance proceeds or to fully restore the unique aspects of the Premises unless Lessee provides Lessor with the funds to cover same, or adequate assurance thereof, within ten (10) days following receipt of written notice of such shortage and request therefor. If Lessor receives said funds or adequate assurances thereof within said ten (10) day period, the party responsible for making the repairs shall complete them as soon as reasonably possible and this Lease shall remain in full force and effect. If such funds or assurance are not received, Lessor may nevertheless elect by written notice to Lessee within ten (10) days thereafter to: (i) make such restoration and repair as is commercially reasonable with Lessor paying any shortage in proceeds, in which case this Lease shall remain in full force and effect, or have this Lease terminate INITIALS: ___________ __________ Page 11 of 27 thirty (30) days thereafter. Lessee shall not be entitled to reimbursement of any funds contributed by Lessee to repair any such damage or destruction. Premises Partial Damage due to flood or earthquake shall be subject to Paragraph 9.3, notwithstanding that there may be some insurance coverage, but the net proceeds of any such insurance shall be made available for the repairs if made by either Party. 9.3 PARTIAL DAMAGE - UNINSURED LOSS. If a Premises Partial Damage that is not an Insured Loss occurs, unless caused by a negligent or willful act of Lessee (in which event Lessee shall make the repairs at Lessee's expense), Lessor may either: (i) repair such damage as soon as reasonably possible at Lessor's expense, in which event this Lease shall continue in full force and effect, or (ii) terminate this Lease by giving written notice to Lessee within thirty (30) days after receipt by Lessor of knowledge of the occurrence of such damage. Such termination shall be effective sixty (60) days following the date of such notice. In the event Lessor elects to terminate this Lease, Lessee shall have the right within ten (10) days after receipt of notice to give written notice to Lessor of Lessee's commitment to pay for the repair of such damage without reimbursement from Lessor. Lessee shall provide Lessor with the required funds or satisfactory assurance thereof within thirty (30) days after making such commitment. In such event this Lease shall continue in full force and effect, and Lessor shall proceed to make such repairs as soon as reasonably possible after the required funds are available. If Lessee does not make the required commitment, this Lease shall terminate as of the date specified in the termination notice. 9.4 TOTAL DESTRUCTION. Notwithstanding any other provision hereof, if a Premises Total Destruction occurs, this Lease shall terminate sixty (60) days following such Destruction. If the damage or destruction was caused by the gross negligence or willful misconduct of Lessee, Lessor shall have the right to recover Lessor's damages from Lessee, except as provided in Paragraph 8.6. 9.5 DAMAGE NEAR END OF TERM. If at any time during the last six (6) months of the term of this Lease there is damage for which the cost to repair exceeds one (1) month's Base Rent, whether or not an Insured Loss, Lessor may terminate this Lease effective sixty (60) days following the date of occurrence of such damage by giving written notice to Lessee within thirty (30) days after the date of occurrence of such damage. Notwithstanding the foregoing, if Lessee at that time has an exercisable option to extend this Lease or to purchase the Premises, then Lessee may preserve this Lease by, (a) exercising such option and (b) providing Lessor with any shortage in insurance proceeds (or adequate assurance thereof) needed to make the repairs on or before the earlier of (i) the date which is ten days after Lessee's receipt of Lessor's written notice purporting to terminate this Lease, or (ii) the day prior to the date upon which such option expires. If Lessee duly exercises such option during such period and provides Lessor with funds (or adequate assurance thereof) to cover any shortage in insurance proceeds, Lessor shall, at Lessor's commercially reasonable expense, repair such damage as soon as reasonably possible and this Lease shall continue in full force and effect. If Lessee fails to exercise such option and provide such funds or assurance during such period, then this Lease shall terminate on the date specified in the termination notice and Lessee's option shall be extinguished. 9.6 ABATEMENT OF RENT; LESSEE'S REMEDIES. (a) ABATEMENT. In the event of Premises Partial Damage or Premises Total Destruction or a Hazardous Substance Condition for which Lessee is not responsible under this Lease, the Rent payable by Lessee for the period required for the repair, remediation or restoration of such damage shall be abated in proportion to the degree to which Lessee's use of the Premises is impaired, but not to exceed the proceeds received from the Rental Value Insurance. All other obligations of Lessee hereunder shall be performed by Lessee, and Lessor shall have no liability for any such damage, destruction, remediation, repair or restoration except as provided herein. (b) REMEDIES. If Lessor shall be obligated to repair or restore the Premises and does not commence, in a substantial and meaningful way, such repair or restoration within ninety (90) days after such obligation shall accrue, Lessee may, at any time prior to the commencement of such repair or restoration, give written notice to Lessor and to any Lenders of which Lessee has actual notice, of Lessee's election to terminate this Lease on a date not less than sixty (60) days following the giving of such notice. If Lessee gives such notice and such repair or restoration is not commenced within thirty (30) days thereafter, this Lease shall terminate as of the date specified in said notice. If Lessee gives such notice and such repair or restoration is commenced within said thirty (30) days, this Lease shall continue in full force and effect. "COMMENCE" shall mean either the unconditional INITIALS: ___________ __________ Page 12 of 27 authorization of the preparation of the required plans, or the beginning of the actual work on the Premises, whichever first occurs. 9.7 TERMINATION - ADVANCE PAYMENTS. Upon termination of this Lease pursuant to Paragraph 9, an equitable adjustment shall be made concerning advance Base Rent and any other advance payments made by Lessee to Lessor. Lessor shall, in addition, return to Lessee so much of Lessee's Security Deposit as has not been, or is not then required to be, used by Lessor. 9.8 WAIVE STATUTES. Lessor and Lessee agree that the terms of this Lease shall govern the effect of any damage to or destruction of the Premises with respect to the termination of this Lease and hereby waive the provisions of any present or future statute to the extent inconsistent herewith. 10. REAL PROPERTY TAXES. 10.1 DEFINITION OF "REAL PROPERTY TAXES." As used herein, the term "REAL PROPERTY TAXES" shall include any form of assessment; real estate, general, special, ordinary or extraordinary, or rental levy or tax (other than inheritance, personal income or estate taxes), improvement bond, and/or license fee imposed upon or levied against any legal or equitable interest of Lessor in the Premises, Lessor's right to other income therefrom, and/or Lessor's business of leasing, by any authority having the direct or indirect power to tax and where the funds are generated with reference to the Building address and where the proceeds so generated are to be applied by the city, county or other local taxing authority of a jurisdiction within which the Premises are located. The term "REAL PROPERTY TAXES" shall also include any tax, fee, levy, assessment or charge, or any increase therein, imposed by reason of events occurring during the term of this Lease, including but not limited to, a change in the ownership of the Premises. 10.2 (a) PAYMENT OF TAXES. Lessee shall pay the Real Property Taxes applicable to the Premises during the term of this Lease. Subject to Paragraph 10.2(b), all such payments shall be made at least ten (10) days prior to the delinquency date. Lessee shall promptly furnish Lessor with satisfactory evidence that such taxes have been paid. If any such taxes cover any period of time prior to or after the expiration or termination of this Lease, Lessee's share of such taxes shall be prorated to cover only that portion of the tax bill applicable to the period that this Lease is in effect, and Lessor shall reimburse Lessee therefor upon demand. If Lessee shall fail to pay any required Real Property Taxes, Lessor shall have the right to pay the same, and Lessee shall reimburse Lessor therefor upon demand. (b) ADVANCE PAYMENT. In the event Lessee incurs a late charge on any Rent payment, Lessor may, at Lessor's option, estimate the current Real Property Taxes, and require that such taxes be paid in advance to Lessor by Lessee, either: (i) in a lump sum amount equal to the installment due, at least twenty (20) days prior to the applicable delinquency date, or (ii) monthly in advance with the payment of the Base Rent. If Lessor elects to require payment monthly in advance, the monthly payment shall be an amount equal to the amount of the estimated installment of taxes divided by the number of months remaining before the month in which said installment becomes delinquent. When the actual amount of the applicable tax bill is known, the amount of such equal monthly advance payments shall be adjusted as required to provide the funds needed to pay the applicable taxes. If the amount collected by Lessor is insufficient to pay such Real Property Taxes when due, Lessee shall pay Lessor, upon demand, such additional sums as are necessary to pay such obligations. All monies paid to Lessor under this Paragraph may be intermingled with other monies of Lessor and shall not bear interest. In the event of a Breach by Lessee in the performance of its obligations under this Lease, then any balance of funds paid to Lessor under the provisions of this Paragraph may, at the option of Lessor, be treated as an additional Security Deposit. 10.3 JOINT ASSESSMENT. If the Premises are not separately assessed, Lessee's liability shall be an equitable proportion of the Real Property Taxes of all of the land and improvements included within the tax parcel assessed, such proportion to be conclusively determined by Lessor from the respective valuations assigned in the assessor's work sheets or such other information as may be reasonably available. INITIALS: ___________ __________ Page 13 of 27 10.4 PERSONAL PROPERTY TAXES. Lessee shall pay, prior to delinquency, all taxes assessed against and levied upon Lessee Owned Alterations, Utility Installations, Trade Fixtures, furnishings, equipment and all personal property of Lessee. When possible, Lessee shall cause such property to be assessed and billed separately from the real property of Lessor. If any of Lessee's said personal property shall be assessed with Lessor's real property, Lessee shall pay Lessor the taxes attributable to Lessee within ten (10) days after receipt of a written statement. 11. UTILITIES. Lessee shall pay for all water, gas, heat, light, power, telephone, trash disposal and other utilities and services supplied to the Premises, together with any taxes thereon. If any such services are not separately metered to Lessee, Lessee shall pay a reasonable proportion, to be determined by Lessor, if all charges jointly metered. 12. ASSIGNMENT AND SUBLETTING. 12.1 LESSOR'S CONSENT REQUIRED. (a) Lessee shall not voluntarily or by operation of law assign, transfer, mortgage or encumber (collectively, "ASSIGN or ASSIGNMENT") or sublet all or any part of Lessee's interest in this Lease or in the Premises without Lessor's prior consent. (b) A change in the control of Lessee shall constitute an assignment requiring consent. The transfer, on a cumulative basis, of twenty-five percent (25%) or more of the voting control of Lessee shall constitute a change in control for this purpose. (c) The involvement of Lessee or its assets in any transaction, or series of transactions (by way of merger, sale, acquisition, financing, transfer, leveraged buy-out or otherwise), whether or not a formal assignment or hypothecation of this Lease or Lessee's assets occurs, which results or will result in a reduction of the Net Worth of Lessee by an amount greater than twenty-five percent (25%) of such Net Worth as it was represented at the time of the execution of this Lease or at the time of the most recent assignment to which Lessor has consented, or as it exists immediately prior to said transaction or transactions constituting such reduction, whichever was or is greater, shall be considered an assignment of this Lease to which Lessor may withhold its consent. "NET WORTH OF LESSEE" shall mean the net worth of Lessee (excluding any guarantors) established under generally accepted accounting principles. (d) An assignment or subletting without consent shall, at Lessor's option, be a Default curable after notice per Paragraph 13.1(c), or a noncurable Breach without the necessity of any notice and grace period. If Lessor elects to treat such unapproved assignment or subletting as a noncurable Breach, Lessor may either: (i) terminate this Lease, or (ii) upon thirty (30) days written notice, increase the monthly Base Rent to one hundred ten percent (110%) of the Base Rent then in effect. Further, in the event of such Breach and rental adjustment, (i) the purchase price of any option to purchase the Premises held by Lessee shall be subject to similar adjustment to one hundred ten percent (110%) of the price previously in effect, and (ii) all fixed and non-fixed rental adjustments scheduled during the remainder of the Lease term shall be increased to One Hundred Ten Percent (110%) of the scheduled adjusted rent. (e) Lessee's remedy for any breach of Paragraph 12.1 by Lessor shall be limited to compensatory damages and/or injunctive relief. 12.2 TERMS AND CONDITIONS APPLICABLE TO ASSIGNMENT AND SUBLETTING. (a) Regardless of Lessor's consent, any assignment or subletting shall not: (i) be effective without the express written assumption by such assignee or sublessee of the obligations of Lessee under this Lease, (ii) release Lessee of any obligations hereunder, or (iii) alter the primary liability of Lessee for the payment of Rent or for the performance of any other obligations to be performed by Lessee. (b) Lessor may accept Rent or performance of Lessee's obligations from any person other than Lessee pending approval or disapproval of an assignment. Neither a delay in the approval or disapproval of INITIALS: ___________ __________ Page 14 of 27 such assignment nor the acceptance of any Rent or performance shall constitute a waiver or estoppel of Lessor's right to exercise its remedies for Lessee's Default or Breach. (c) Lessor's consent to any assignment or subletting shall not constitute a consent to any subsequent assignment or subletting. (d) In the event of any Default or Breach by Lessee, Lessor may proceed directly against Lessee, any Guarantors or anyone else responsible for the performance of the Lessee's obligations under this Lease, including any assignee or sublessee, without first exhausting Lessor's remedies against any other person or entity responsible therefor to Lessor, or any security held by Lessor. (e) Each request for consent to an assignment or subletting shall be in writing, accompanied by information relevant to Lessor's determination as to the financial and operational responsibility and appropriateness of the proposed assignee or sublessee, including but not limited to the intended use and/or required modification of the Premises, if any, together with a fee of $1,000 or ten percent (10%) of the current monthly Base Rent applicable to the portion of the Premises which is the subject of the proposed assignment or sublease, whichever is greater, as consideration for Lessor's considering and processing said request. Lessee agrees to provide Lessor with such other or additional information and/or documentation as may be as reasonably requested. (f) Any assignee of, or sublessee under, this Lease shall, by reason of accepting such assignment or entering into such sublease, be deemed to have assumed and agreed to conform and comply with each and every term, covenant, condition and obligation herein to be observed or performed by Lessee during the term of said assignment or sublease, other than such obligations as are contrary to or inconsistent with provisions of an assignment or sublease to which Lessor has specifically consented in writing. 12.3 ADDITIONAL TERMS AND CONDITIONS APPLICABLE TO SUBLETTING. The following terms and conditions shall apply to any subletting by Lessee of all or any part of the Premises and shall be deemed included in all subleases under this Lease whether or not expressly incorporated therein: (a) Lessee hereby assigns and transfers to Lessor all of Lessee's interest in all Rent payable on any sublease, and Lessor may collect such Rent and apply same toward Lessee's obligations under this Lease; provided, however, that until a Breach shall occur in the performance of Lessee's obligations Lessee may collect said Rent. Lessor shall not, by reason of this or any other assignment of such sublease, nor by reason of the collection of the Rent, be deemed liable to the sublessee for any failure of Lessee to perform and comply with any of Lessee's obligations to such sublessee. Lessee hereby irrevocably authorizes and directs any such sublessee, upon receipt of a written notice from Lessor stating that a Breach exists in the performance of Lessee's obligations under this Lease, to pay to Lessor all Rent due and to become due under the sublease. Sublessee shall rely upon any such statement and notice from Lessor and shall pay all Rents to Lessor without any obligation or right to inquire as to whether such Breach exists, and notwithstanding any claim from Lessee to the contrary. (b) In the event of a Breach by Lessee, Lessor may, at its option, require sublessee to attorn to Lessor, in which event Lessor shall undertake the obligations of the sublessor under such sublease from the time of the exercise of said option to the expiration of such sublease; provided, however, Lessor shall not be liable for any prepaid rents or security deposit paid by such sublessee to such sublessor for any other prior Defaults or Breaches of such subleasor. (c) Any matter requiring the consent of the sublessor under a sublease shall also require the consent of Lessor. (d) No sublessee shall further assign or sublet all or any part of the Premises without Lessor's prior written consent. (e) Lessor shall deliver a copy of any notice of Default or Breach by Lessee to the sublessee, who shall have the right to cure the Default of Lessee within the grace period, if any, specified in such notice. The INITIALS: ___________ __________ Page 15 of 27 sublessee shall have a right to reimbursement and offset from and against Lessee for any such Defaults cured by the sublessee. 13. DEFAULT; BREACH; REMEDIES. 13.1 DEFAULT; BREACH. A "DEFAULT" is defined as a failure by the Lessee to comply with or perform any of the terms, covenants, conditions or rules under this Lease. A "BREACH is defined as the occurrence of any one or more of the following Defaults, and the failure by Lessee to cure such Default within any applicable grace period: (a) The abandonment of the Premises; or the vacating of the Premises without providing a commercially reasonable level of security, or where the coverage of the property insurance described in Paragraph 8.3 is jeopardized as a result thereof, or without providing reasonable assurances to minimize potential vandalism. (b) The failure of Lessee to make any payment of Rent or any Security Deposit required to be made by Lessee hereunder, whether to Lessor or to a third party, when due, to provide reasonable evidence of insurance or surety bond, or to fulfill any obligation under this Lease which endangers or threatens life or property, where such failure continues for a period of three (3) business days following written notice to Lessee. (c) The failure by Lessee to provide (i) reasonable written evidence of compliance with Applicable Requirements, (ii) the service contracts, (iii) the rescission of an unauthorized assignment or subletting, (iv) a Tenancy Statement, (v) a requested subordination, (vi) evidence concerning any guaranty and/or Guarantor, (vii) any document requested under Paragraph 42 (easements), or (viii) any other documentation or information which Lessor may reasonably require of Lessee under the terms of this Lease, where any such failure continues for a period of ten (10) days following written notice to Lessee. (d) A Default by Lessee as to the terms, covenants, conditions or provisions of this Lease, or of the rules adopted under Paragraph 40 hereof, other than those described in subparagraphs 13.1(a), (b) or (c) above, where such Default continues for a period of thirty (30) days after written notice; provided, however, that if the nature of Lessee's Default is such that more than thirty (30) days are reasonably required for its cure, then it shall not be deemed to be a Breach if Lessee commences such cure within said thirty (30) day period and thereafter diligently prosecutes such cure to completion. (e) The occurrence of any of the following events: (i) the making of any general arrangement or assignment for the benefit of creditors; (ii) Lessee's becoming a "debtor" as defined in 11 U.S.C. Section 101 or any successor statute thereto (unless, in the case of a petition filed against Lessee, the same is dismissed within sixty (60) days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where possession is not restored to Lessee within thirty (30) days; or (iv) the attachment, execution or other judicial seizure of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease, where such seizure is not discharged within thirty (30) days; provided, however, in the event that any provision of this subparagraph 13.1(e) is contrary to any applicable law, such provision shall be of no force or effect, and not affect the validity of the remaining provisions. (f) The discovery that any financial statement of Lessee or any Guarantor given to Lessor was materially false. (g) If the performance of Lessee's obligations under this Lease is guaranteed: (i) the death of a Guarantor; (ii) the termination of a Guarantor's liability with respect to this Lease other than in accordance with the terms of such guaranty; (iii) a Guarantor's becoming insolvent or the subject of a bankruptcy filing; (iv) a Guarantor's refusal to honor the guaranty; or (v) a Guarantor's breach of its guaranty obligation on an anticipatory basis, and Lessee's failure, within sixty (60) days following written notice of any such event, to provide written alternative assurance or security, which, when coupled with the then existing resources of Lessee, equals or exceeds the combined financial resources of Lessee and the Guarantors that existed at the time of execution of this Lease. INITIALS: ___________ __________ Page 16 of 27 13.2 REMEDIES. If Lessee fails to perform any of its affirmative duties or obligations, within ten (10) days after written notice (or in the case of an emergency, without notice), Lessor may, at its option, perform such duty or obligation on Lessee's behalf, including but not limited to the obtaining of reasonably required bonds, insurance policies, or governmental licenses, permits or approvals. The costs and expenses of any such performance by Lessor shall be due and payable by Lessee upon receipt of invoice therefor. If any check given to Lessor by Lessee shall not be honored by the bank upon which it is drawn, Lessor, at its option, may require all future payments to be made by Lessee to be by cashier's check. In the event of a Breach, Lessor may, with or without further notice or demand, and without limiting Lessor in the exercise of any right or remedy which Lessor may have by reason of such Breach: (a) Terminate Lessee's right to possession of the Premises by any lawful means, in which case this Lease and the term hereof shall terminate and Lessee shall immediately surrender possession to Lessor. In such event Lessor shall be entitled to recover from Lessee: (i) unpaid Rent which had been earned at the time of termination; (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that the Lessee proves could have been reasonably avoided; (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the term after the time of award exceeds the amount of such rental loss that the Lessee proves could be reasonably avoided; and (iv) any other amount necessary to compensate Lessor for all the detriment proximately caused by the Lessee's failure to perform it obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including but not limited to the cost of recovering possession of the Premises, expenses of reletting, including necessary renovation and alteration of the Premises, reasonable attorneys' fees, and that portion of the leasing commission paid by Lessor in connection with the this Lease applicable to the unexpired term of this Lease. The worth at the time of award of the amount referred to in provision (iii) of the immediately preceding sentence shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of the District within which the Premises are located at the time of award plus one percent (1%). Efforts by Lessor to mitigate damages caused by Lessee's Breach of this Lease shall not waive Lessor's right to recover damages under Paragraph 12. If termination of this Lease is obtained through the provisional remedy of unlawful detainer, Lessor shall have the right to recover in such proceeding the unpaid Rent and damages as are recoverable therein, or Lessor may reserve therein the right to recover all or any part thereof in a separate suit. If a notice and grace period required under Paragraph 13.1 was not previously given, a notice to pay rent or quit, or to perform or quit given to Lessee under the unlawful detainer statute shall also constitute the notice required by Paragraph 13.1. In such case, the applicable grace period required by Paragraph 13.1 and under unlawful detainer statute shall run concurrently, and the failure of Lessee to cure the Default within the greater of the two such grace periods shall constitute both an unlawful detainer and a Breach of this Lease entitling Lessor to the remedies provided for in this Lease and/or by said statute. (b) Continue the Lease and Lessee's right to possession and recover the Rent as it becomes due, in which event Lessee may sublet or assign, subject only to reasonable limitations. Acts of maintenance, efforts to relet, and/or the appointment of a receiver to protect the Lessor's interests, shall not constitute a termination of the Lessee's right to possession. (c) Pursue any other remedy now or hereafter available under the laws of judicial decisions of the state wherein the Premises are located. The expiration or termination of this Lease and/or the termination of Lessee's right to possession shall not relieve Lessee from liability under any indemnity provisions of this Lease as to matters occurring or accruing during the term hereof or by reason of Lessee's occupancy of the Premises. 13.3 INDUCEMENT RECAPTURE. Any agreement for free or abated rent or other charges, or for the giving or paying by Lessor to or for Lessee of any cash or other bonus, inducement or consideration for Lessee's entering into this Lease, all of which concessions are hereinafter referred to as "INDUCEMENT PROVISIONS," shall be deemed conditioned upon Lessee's full and faithful performance of all of the terms, covenants and conditions of this Lease. Upon Breach of this Lease by Lessee, any such Inducement Provision shall automatically be deemed deleted from this Lease and of no further force or effect, and any rent, other charge, bonus, inducement or consideration theretofore abated, given or paid by Lessor under such an Inducement Provision shall be immediately due and payable by Lessee to Lessor, notwithstanding any subsequent cure of said Breach by Lessee. The acceptance by Lessor of Rent or the cure of the Breach which initiated the operation of this paragraph shall not be deemed a waiver INITIALS: ___________ __________ Page 17 of 27 by Lessor of the provisions of this paragraph unless specifically so stated in writing by Lessor at the time of such acceptance. 13.4 LATE CHARGES. Lessee hereby acknowledges that late payment by Lessee of Rent will cause Lessor to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges which may be imposed upon Lessor. Accordingly, if any Rent shall not be received by Lessor within five (5) days after such amount shall be due, then, without any requirement for notice to Lessee, Lessee shall pay to Lessor a one-time late charge equal to five percent (5%) of each such overdue amount. The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Lessor will incur by reason of late payment. Acceptance of such late charge by Lessor shall in no event constitute a waiver of Lessee's Default or Breach with respect to such overdue amount, nor prevent the exercise of any of the other rights and remedies granted hereunder. In the event that a late charge is payable hereunder, whether or not collected, for three (3) consecutive installments of Base Rent, then notwithstanding any provision of this Lease to the contrary, Base Rent shall, at Lessor's option, become due and payable quarterly in advance. 13.5 INTEREST. Any monetary payment due Lessor hereunder, other than late charges, not received by Lessor, when due as to scheduled payments (such as Base Rent) or within thirty (30) days following the date on which it was due for a non-scheduled payment, shall bear interest from the date when due, as to scheduled payments, or the thirty-first (31st) day after it was due as to non-scheduled payments. The interest ("INTEREST") charged shall be equal to the prime rate reported in The Wall Street Journal as published closest prior to the date when due plus four percent (4%), but shall not exceed the maximum rate allowed by law. Interest is payable in addition to the potential late charge provided for in Paragraph 13.4. 13.6 BREACH BY LESSOR. (a) NOTICE OF BREACH. Lessor shall not be deemed in breach of this Lease unless Lessor fails within a reasonable time to perform an obligation required to be performed by Lessor. For purposes of this Paragraph, a reasonable time shall in no event be less than thirty (30) days after receipt by Lessor, and any Lender whose name and address shall have been furnished Lessee in writing for such purpose, of written notice specifying wherein such obligation of Lessor has not been performed; provided, however, that if the nature of Lessor's obligation is such that more than thirty (30) days are reasonably required for its performance, then Lessor shall not be in breach if performance is commenced within such thirty (30) day period and thereafter diligently pursued to completion. (b) PERFORMANCE BY LESSEE ON BEHALF OF LESSOR. In the event that neither Lessor nor Lender cures said breach within thirty (30) days after receipt of said notice, or if having commenced said cure they do not diligently pursue it to completion, then Lessee may elect to cure said breach at Lessee's expense and offset from Rent an amount equal to the greater of one months' Base Rent or the Security Deposit, and to pay an excess of such expense under protest, reserving Lessee's right to reimbursement from Lessor. Lessee shall document the cost of said cure and supply said documentation to Lessor. 14. CONDEMNATION. If the Premises or any portion thereof are taken under the power of eminent domain or sold under the threat of the exercise of said power (collectively "CONDEMNATION"), this Lease shall terminate as to the part taken as of the date the condemning authority takes title or possession, whichever first occurs. If more than ten percent (10%) of any building portion of the Premises, or more than twenty-five percent (25%) of the land area portion of the Premises not occupied by any building, is taken by Condemnation, Lessee may, at Lessee's option, to be exercised in writing within ten (10) days after Lessor shall have given Lessee written notice of such taking (or in the absence of such notice, within ten (10) days after the condemning authority shall have taken possession) terminate this Lease as of the date the condemning authority takes such possession. If Lessee does not terminate this Lease in accordance with the foregoing, this Lease shall remain in full force and effect as to the portion of the Premises remaining, except that the Base Rent shall be reduced in proportion to the reduction in utility of the Premises caused by such Condemnation. Condemnation awards and/or payments shall be the property of Lessor, whether such award shall be made as compensation for diminution in value of the leasehold, the value of the part taken, or for severance damages; provided, however, that Lessee shall be entitled to any compensation for Lessee's relocation expenses, loss of business goodwill and/or Trade Fixtures, without regard to whether or not this Lease is INITIALS: ___________ __________ Page 18 of 27 terminated pursuant to the provisions of this Paragraph. All Alterations and Utility Installations made to the Premises by Lessee, for purposes of Condemnation only, shall be considered the property of the Lessee and Lessee shall be entitled to any and all compensation which is payable therefor. In the event that this Lease is not terminated by reason of the Condemnation, Lessor shall repair any damage to the Premises caused by such Condemnation. 15. BROKER'S FEE. 15.1 ADDITIONAL COMMISSION. In addition to the payments owed pursuant to Paragraph 1.10 above, and unless Lessor and the Brokers otherwise agree in writing, Lessor agrees that: (a) if Lessee exercises any Option, (b) if Lessee acquires any rights to the Premises or other premises owned by Lessor and located within the same Project, if any, within which the Premises is located, (c) if Lessee remains in possession of the Premises, with the consent of Lessor, after the expiration of this Lease, or (d) if Base Rent is increased, whether by agreement or operation of an escalation clause herein, then, Lessor shall pay Brokers a fee in accordance with the schedule of said Brokers in effect at the time of the execution of this Lease. 15.2 ASSUMPTION OF OBLIGATIONS. Any buyer or transferee of Lessor's interest in this Lease shall be deemed to have assumed Lessor's obligation hereunder. Each Broker shall be a third party beneficiary of the provisions of Paragraphs 1.10, 15, 22 and 31. If Lessor fails to pay to a Broker any amounts due as and for commissions pertaining to this Lease when due, then such amounts shall accrue interest. In addition, if Lessor fails to pay any amounts to Lessee's Broker when due, Lessee's Broker may send written notice to Lessor and Lessee of such failure and if Lessor fails to pay such amounts within ten (10) days after said notice, Lessee shall pay said monies to its Broker and offset such amounts against Rent. In addition, Lessee's Broker shall be deemed to be a third party beneficiary of any commission agreement entered into by and/or between Lessor and Lessor's Broker. 15.3 REPRESENTATIONS AND INDEMNITIES OF BROKER RELATIONSHIPS. Lessee and Lessor each represent and warrant to the other that it has had no dealings with any person, firm, broker or finder (other than the Brokers, if any) in connection with this Lease, and that no one other than said named Brokers is entitled to any commission or finder's fee in connection herewith. Lessee and Lessor do each hereby agree to indemnify, protect, defend and hold the other harmless from and against liability for compensation or charges which may be claimed by any such unnamed broker, finder or other similar party by reason of any dealings or actions of the Indemnifying Party, including any costs, expenses, and/or attorneys' fees reasonably incurred with respect thereto. 16. ESTOPPEL CERTIFICATES. (a) Each Party (as "RESPONDING PARTY") shall within the (10) days after written notice from the other Party (the "REQUESTING PARTY") execute, acknowledge and deliver to the Requesting Party a statement in writing in form similar to the then most current "Estoppel Certificate" form published by the American Industrial Real Estate Association, plus such additional information, confirmation and/or statements as may be reasonably requested by the Requesting Party. (b) If the Responding Party shall fail to execute or deliver the Estoppel Certificate within such ten day period, the Requesting Party may execute an Estoppel Certificate stating that: (i) the Lease is in full force and effect without modification except as may be represented by the Requesting Party, (ii) there are no uncured defaults in the Requesting Party's performance, and (iii) if Lessor is the Requesting Party, not more than one month's Rent has been paid in advance. Prospective purchasers and encumbrancers may rely upon the Requesting Party's Estoppel Certificate, and the Responding Party shall be estopped from denying the truth of the facts contained in said Certificate. (c) If Lessor desires to finance, refinance, or sell the Premises, or any part thereof, Lessee and all Guarantors shall deliver to any potential lender or purchaser designated by Lessor such financial statements as may be reasonably required by such lender or purchaser, including, but not limited to, Lessee's financial statements for the past three (3) years. All such financial statements shall be received by Lessor and such lender or purchaser in confidence and shall be used only for the purposes herein set forth. INITIALS: ___________ __________ Page 19 of 27 17. DEFINITION OF LESSOR. The term "LESSOR" as used herein shall mean the owner or owners at the time in question of the fee title to the Premises, or, if this is a sublease, of the Lessee's interest in the prior lease. In the event of a transfer of Lessor's title or interest in the Premises or this Lease, Lessor shall deliver to the transferee or assignee (in cash or by credit) any unused Security Deposit held by Lessor. Except as provided in Paragraph 15, upon such transfer or assignment and delivery of the Security Deposit, as aforesaid, the prior Lessor shall be relieved of all liability with respect to the obligations and/or covenants under this Lease thereafter to be performed by the Lessor. Subject to the foregoing, the obligations and/or covenants in this Lease to be performed by the Lessor shall be binding only upon the Lessor as hereinabove defined. Notwithstanding the above, and subject to the provisions of Paragraph 20 below, the original Lessor under this Lease, and all subsequent holders of the Lessor's Interest in this Lease shall remain liable and responsible with regard to the potential duties and liabilities of Lessor pertaining to Hazardous Substances as outlined in Paragraph 6 above. 18. SEVERABILITY. The invalidity of any provision of this Lease, as determined by a court of competent jurisdiction, shall in no way affect the validity of any of the provision hereof. 19. DAYS. Unless otherwise specifically indicated to the contrary, the word "DAYS" as used in this Lease shall mean and refer to calendar days. 20. LIMITATION ON LIABILITY. Subject to the provisions of Paragraph 17 above, the obligations of Lessor under this Lease shall not constitute personal obligations of Lessor, the individual partners of Lessor or its or their individual partners, directors, officers or shareholders, and Lessee shall look to the Premises, and to no other assets of Lessor, for the satisfaction of any liability of Lessor with respect to this Lease, and shall not seek recourse against the individual partners of Lessor, or its or their individual partners, directors, officers or shareholders, or any of their personal assets for such satisfaction. 21. TIME OF ESSENCE. Time is of the essence with respect to the performance of all obligations to be performed or observed by the Parties under this Lease. 22. NO PRIOR OR OTHER AGREEMENTS; BROKER DISCLAIMER. This Lease contains all agreements between the Parties with respect to any mater mentioned herein, and no other prior or contemporaneous agreement or understanding shall be effective. Lessor and Lessee each represents and warrants to the Brokers that it has made, and is relying solely upon, its own investigation as to the nature, quality, character and financial responsibility of the other Party to this Lease and as to the nature, quality and character of the Premises. Brokers have no responsibility with respect thereto or with respect to any default or breach hereof by either Party. The liability (including court costs and Attorneys' fees), of any Broker with respect to negotiation, execution, delivery or performance by either Lessor or Lessee under this Lease or any amendment or modification hereto shall be limited to an amount up to the fee received by such Broker pursuant to this Lease; provided, however, that the foregoing limitation on each Broker's liability shall not be applicable to any gross negligence or willful misconduct of such Broker. 23. NOTICES. 23.1 NOTICE REQUIREMENTS. All notices required or permitted by this Lease shall be in writing and may be delivered in person (by hand or by courier) or may be sent by regular, certified or registered mail or U.S. Postal Service Express Mail, with postage prepaid, or by facsimile transmission, and shall be deemed sufficiently given if served in a manner specified in this Paragraph 23. The addresses noted adjacent to a Party's signature on this Lease shall be that Party's address for delivery or mailing of notices. Either Party may by written notice to the other specify a different address for notice, except that upon Lessee's taking possession of the Premises, the Premises shall constitute Lessee's address for notice. A copy of all notices to Lessor shall be concurrently transmitted to such party or parties at such addresses as Lessor may from time to time hereafter designate in writing. 23.2 DATE OF NOTICE. Any notice sent by registered or certified mail, return receipt requested, shall be deemed given on the date of delivery shown on the receipt card, or if no delivery date is shown, the postmark thereon. If sent by regular mail the notice shall be deemed given forty-eight (48) hours after the same is addressed as required herein and mailed with postage prepaid. Notices delivered by United States Express Mail or overnight courier that guarantee next day delivery shall be deemed given twenty-four (24) hours after delivery of the same to the Postal Service or courier. Notices transmitted by facsimile transmission or similar means shall be deemed INITIALS: ___________ __________ Page 20 of 27 delivered upon telephone confirmation of receipt, provided a copy is also delivered via delivery or mail. If notice is received on a Saturday, Sunday or legal holiday, it shall be deemed received on the next business day. 24. WAIVERS. No waiver by Lessor of the Default or Breach of any term, covenant or condition hereof by Lessee, shall be deemed a waiver of any other term, covenant or condition hereof, or of any subsequent Default or Breach by Lessee of the same or of any other term, covenant or condition hereof. Lessor's consent to, or approval of, any act shall not be deemed to render unnecessary the obtaining of Lessor's consent to, or approval of, any subsequent or similar act by Lessee, or be construed as the basis of an estoppel to enforce the provision or provisions of this Lease requiring such consent. The acceptance of Rent by Lessor shall not be a waiver of any Default or Breach by Lessee. Any payment by Lessee may be accepted by Lessor on account of monies or damages due Lessor, notwithstanding any qualifying statements or conditions made by Lessee in connection therewith, which such statements and/or conditions shall be of no force or effect whatsoever unless specifically agreed to in writing by Lessor at or before the time of deposit of such payment. 25. RECORDING. Either Lessor or Lessee shall, upon request of the other, execute, acknowledge and deliver to the other a short form memorandum of this Lease for recording purposes. The Party requesting recordation shall be responsible of repayment of any fees or taxes applicable thereto. 26. NO RIGHT TO HOLDOVER. Lessee has no right to retain possession of the Premises or any part thereof beyond the expiration or earlier termination of this Lease. In the event that Lessee holds over, then the Base Rent shall be increased to one hundred fifty percent (150%) of the Base Rent applicable during the month immediately preceding the expiration or termination. Nothing contained herein shall be construed as consent by Lessor to any holding over by Lessee. 27. CUMULATIVE REMEDIES. No remedy or election hereunder shall be deemed exclusive but shall, wherever possible, be cumulative with all of the remedies at law or in equity. 28. COVENANTS AND CONDITIONS; CONSTRUCTION OF AGREEMENT. All provisions of this Lease to be observed or performed by Lessee are both covenants and conditions. In construing this Lease, all headings and titles are for the convenience of the Parties only and shall not be considered a part of this Lease. Whenever required by the context, the singular shall include the plural and vice versa. This Lease shall not be construed as if prepared by one of the Parties, but rather according to its fair meaning as a whole, as if both Parties had prepared it. 29. BINDING EFFECT; CHOICE OF LAW. This Lease shall be binding upon the parties, their personal representatives, successors and assigns and be governed by the laws of the State in which the Premises are located. Any litigation between the Parties hereto concerning this Lease shall be initiated in the county in which the Premises are located. 30. SUBORDINATION; ATTORNMENT; NON-DISTURBANCE. 30.1 SUBORDINATION. This Lease and any Option granted hereby shall be subject and subordinate to any ground lease, mortgage, deed of trust, or other hypothecation or security device (collectively, "SECURITY DEVICE"), now or hereafter placed upon the Premises, to any and all advances made on the security thereof, and to all renewals, modifications, and extensions thereof. Lessee agrees that the holders of any such Security Devices (in this Lease together referred to as "LESSOR'S LENDER") shall have no liability or obligation to perform any of the obligations of Lessor under this Lease. Any Lender may elect to have this Lease and/or any Option granted hereby superior to the lien of its Security Device by giving written notice thereof to Lessee, whereupon this Lease and such Options shall be deemed prior to such Security Device, notwithstanding the relative dates of the documentation or recordation thereof. 30.2 ATTORNMENT. Subject to the non-disturbance provisions of Paragraph 30.3, Lessee agrees to attorn to a Lender of any other party who acquires ownership of the Premises by reason of a foreclosure of a Security Device, and that in the event of such foreclosure, such new owner shall not: (i) be liable for any act or omission of any prior lessor or with respect to events occurring prior to acquisition of ownership, (ii) be subject to any offsets or INITIALS: ___________ __________ Page 21 of 27 defenses which Lessee might have against any prior lessor, or (iii) be bound by prepayment of more than one (1) month's rent. 30.3 NON-DISTURBANCE. With respect to Security Devices entered into by Lessor after the execution of this Lease, Lessee's subordination of this Lease shall be subject to receiving a commercially reasonable non-disturbance agreement (a "NON-DISTURBANCE AGREEMENT") from the Lender which Non-Disturbance Agreement provides that Lessee's possession of the Premises, and this Lease, including any options to extend the term hereof, will not be disturbed so long as Lessee is not in Breach hereof and attorns to the record owner of the Premise. Further, within sixty (60) days after the execution of this Lease, Lessor shall use its commercially reasonable efforts to obtain a Non-Disturbance Agreement from the holder of any pre-existing Security Device which is secured by the Premises. In the event that Lessor is unable to provide the Non-Disturbance Agreement within said sixty (60) days, then Lessee may, at Lessee's option, directly contact Lessor's lender and attempt to negotiate for the execution and delivery of a Non-Disturbance Agreement. 30.4 SELF-EXECUTING. The agreements contained in this Paragraph 30 shall be effective without the execution of any further documents; provided, however, that, upon written request from Lessor or a Lender in connection with a sale, financing or refinancing of the Premises, Lessee and Lessor shall execute such further writings as may be reasonably required to separately document any subordination, attornment and/or Non-Disclosure Agreement provided for herein. 31. ATTORNEY'S FEES. If any Party or Broker brings an action or proceeding involving the Premises to enforce the terms hereof or to declare rights hereunder, the Prevailing Party (as hereafter defined) in any such proceeding, action, or appeal thereon, shall be entitled to reasonable attorneys' fees. Such fees may be awarded in the same suit or recovered in a separate suit, whether or not such action or proceeding is pursued to decision or judgment. The term, "PREVAILING PARTY," shall include, without limitation, a Party or Broker who substantially obtains or defeats the relief sought, as the case may be, whether by compromise, settlement, judgment, or the abandonment by the other Party or Broker of its claim or defense. The attorneys' fees award shall not be computed in accordance with any court fee schedule, but shall be such as to fully reimburse all attorneys' fees reasonably incurred. In addition, Lessor shall be entitled to attorneys' fees, costs and expense incurred in the preparation and service of notices of Default and consultations in connection therewith, whether or not a legal action is subsequently commenced in connection with such Default or resulting Breach. 32. LESSOR'S ACCESS; SHOWING PREMISES; REPAIRS. Lessor and Lessor's agents shall have the right to enter the Premises at any time, in the case of an emergency, and otherwise at reasonable times for the purpose of showing the same to prospective purchasers, lenders, or lessees, and making such alterations, repairs, improvements or additions to the Premises as Lessor may deem necessary. All such activities shall be without abatement of rent or liability to Lessee. Lessor may at any time place on the Premises any ordinary "For Sale" signs and Lessor may during the last six (6) months of the term hereof place on the Premises any ordinary "For Lease" signs. Lessee may at any time place on or about the Premises any ordinary "For Sublease" sign. 33. AUCTIONS. Lessee shall not conduct, nor permit to be conducted, any auction upon the Premises without Lessor's prior written consent. Lessor shall not be obligated to exercise any standard of reasonableness in determining whether to permit an auction. 34. SIGNS. Except for ordinary "For Sublease" signs, Lessee shall not place any sign upon the Premises without Lessor' prior written consent. All signs must comply with all Applicable Requirements. 35. TERMINATION; MERGER. Unless specifically stated otherwise in writing by Lessor, the voluntary or other surrender of this Lease by Lessee, the mutual termination or cancellation hereof, or a termination hereof by Lessor for Breach by Lessee, shall automatically terminate any sublease or lesser estate in the Premises; provided, however, that Lessor may elect to continue any one or all existing subtenancies. Lessor's failure within ten (10) days following any such event to elect to the contrary by written notice to the holder of any such lesser interest, shall constitute Lessor's election to have such event constitute the termination of such interest. INITIALS: ___________ __________ Page 22 of 27 36. CONSENTS. Except as otherwise provided herein, wherever in this Lease the consent of a Party is required to act by or for the other Party, such consent shall not be unreasonably withheld or delayed. Lessor's actual reasonable costs and expenses (including, but not limited to, architects', attorneys', engineers' and other consultants' fees) incurred in the consideration of, or response to, a request by Lessee for any Lessor consent, including, but not limited to, consents to an assignment, a subletting or the presence or use of a Hazardous Substance, shall be paid by Lessee upon receipt of an invoice and supporting documentation therefor. Lessor's consent to any act, assignment or subletting shall not constitute an acknowledgement that no Default or Breach by Lessee of this Lease exists, nor shall such consent be deemed a waiver of any then existing Default or Breach, except as may be otherwise specifically stated in writing by Lessor at the time of such consent. The failure to specify herein any particular condition to Lessor's consent shall not preclude the imposition by Lessor at the time of consent of such further or other conditions as are then reasonable with reference to the particular matter for which consent is being given. In the event that either Party disagrees with any determination made by the other hereunder and reasonably requests the reasons for such determination, the determining party shall furnish its reasons in writing and in reasonable detail within ten (10) business days following such request. 37. GUARANTOR. 37.1 EXECUTION. The Guarantors, if any, shall each execute a guaranty in the form most recently published by the American Industrial Real Estate Association, and each such Guarantor shall have the same obligations as Lessee under this Lease. 37.2 DEFAULT. It shall constitute a Default of the Lessee if any Guarantor fails or refuses, upon request to provide: (a) evidence of the execution of the guaranty, including the authority of the party signing on Guarantor's behalf to obligate Guarantor, and in the case of a corporate Guarantor, a certified copy of a resolution of its board of directors authorizing the making of such guaranty, (b) current financial statements, (c) a Tenancy Statement, or (d) written confirmation that the guaranty is still in effect. 38. QUIET POSSESSION. Subject to payment by Lessee of the Rent and performance of all of the covenants, conditions and provisions on Lessee's part to be observed and performed under this Lease, Lessee shall have quiet possession and quiet enjoyment of the Premises during the term hereof. 39. OPTIONS. 39.1 DEFINITION. "OPTION" shall mean: (a) the right to extend the term of or renew this Lease or to extend or renew any lease that Lessee has on other property of Lessor; (b) the right of first refusal or first offer to lease either the premises or other property of Lessor; (c) the right to purchase or the right of first refusal to purchase the Premises or other property of Lessor. 39.2 OPTIONS PERSONAL TO ORIGINAL LESSEE. Each Option granted to Lessee in this Lease is personal to the original Lessee, and cannot be assigned or exercised by anyone other than said original Lessee and only while the original Lessee is in full possession of the Premises. 39.3 MULTIPLE OPTIONS. In the event that Lessee has any multiple Options to extend or renew this Lease, a later Option cannot be exercised unless the prior Options have been validly exercised. 39.4 EFFECT OF DEFAULT ON OPTIONS. (a) Lessee shall have no right to exercise an Option: (i) during the period commencing with the giving of any notice of Default and continuing until said Default is cured, (ii) during the period of time any Rent is unpaid (without regard to whether notice thereof is given Lessee), (iii) during the time Lessee is in Breach of this Lease, or (iv) in the event that Lessee has been given three (3) or more notices of separate Default, whether or not the Defaults are cured, during the twelve (12) month period immediately preceding the exercise of the Option. (b) The period of time within which an Option may be exercised shall not be extended or enlarged by reason of Lessee's inability to exercise an Option because of the provisions of Paragraph 39.4(a). INITIALS: ___________ __________ Page 23 of 27 (c) An Option shall terminate and be of no further force or effect, notwithstanding Lessee's due and timely exercise of the Option, if, after such exercise and prior to the commencement of the extended term, (i) Lessee fails to pay Rent for a period of thirty (30) days after such Rent becomes due (without any necessity of Lessor to give notice thereof), (ii) Lessor gives to Lessee three (3) or more notices of separate Default during any twelve (12) month period, whether or not the Defaults are cured, or (iii) if Lessee commits a Breach of this Lease. 40. MULTIPLE BUILDINGS. If the Premises are a part of a group of buildings controlled by Lessor, Lessee agrees that it will observe all reasonable rules and regulations which Lessor may make from time to time for the management, safety, and care of said properties, including the care and cleanliness of the grounds and including the parking, loading and unloading of vehicles, and that Lessee will pay its fair share of common expenses incurred in connection therewith. 41. SECURITY MEASURES. Lessee hereby acknowledges that the rental payable to Lessor hereunder does not include the cost of guard service or the security measures, and that Lessor shall have no obligation whatsoever to provide same. Lessee assumes all responsibility for the protection of the Premises, Lessee, its agents and invitees and their property from the acts of third parties. 42. RESERVATIONS. Lessor reserves to itself the right, from time to time, to grant, without the consent or joinder of Lessee, such easements, rights and dedications that Lessor deems necessary, and to cause the recordation of parcel maps and restrictions, so long as such easements, rights, dedications, maps and restrictions do not unreasonably interfere with the use of the Premises by Lessee. Lessee agrees to sign any documents reasonably requested by Lessor to effectuate any such easement rights, dedication, map or restrictions. 43. PERFORMANCE UNDER PROTEST. If at any time a dispute shall arise as to any amount or sum of money to be paid by one Party to the other under the provisions hereof, the Party against whom the obligation to pay the money is asserted shall have the right to make payment "under protest" and such payment shall not be regarded as a voluntary payment and there shall survive the right on the part of said Party to institute suit for recovery of such sum. If it shall be adjudged that there was no legal obligation on the part of said Party to pay such sum or any part thereof, said Party shall be entitled to recover such sum or so much thereof as it was not legally required to pay. 44. AUTHORITY. If either Party hereto is a corporation, trust, limited liability company, partnership or similar entity, each individual executing this Lease on behalf of such entity represents and warrants that he or she is duly authorized to execute and deliver this Lease on its behalf. Each Party shall, within thirty (30) days after request, deliver to the other Party satisfactory evidence of such authority. 45. CONFLICT. Any conflict between the printed provisions of this Lease and the typewritten or handwritten provisions shall be controlled by the typewritten or handwritten provisions. 46. OFFER. Preparation of this Lease by either Party or their agent and submission of same to the other Party shall not be deemed an offer to lease to the other Party. This Lease is not intended to be binding until executed and delivered by all Parties hereto. 47. AMENDMENTS. This Lease may be modified only in writing, signed by the Parties in interest at the time of the modification. 48. MULTIPLE PARTIES. If more than one person or entity is named herein as either Lessor or Lessee, such multiple Parties shall have joint and several responsibility to comply with the terms of this Lease. 49. MEDIATION AND ARBITRATION DISPUTES. An Addendum requiring the Mediation and/or the Arbitration of all disputes between the Parties and/or Brokers arising out of this Lease / / is /X/ is not attached to this Lease. INITIALS: ___________ __________ Page 24 of 27 LESSOR AND LESSEE HAVE CAREFULLY READ AND REVIEWED THIS LEASE AND EACH TERM AND PROVISION CONTAINED HEREIN, AND BY THE EXECUTION OF THIS LEASE SHOW THEIR INFORMED AND VOLUNTARY CONSENT THERETO. THE PARTIES HEREBY AGREE THAT, AT THE TIME THIS LEASE IS EXECUTED, THE TERMS OF THIS LEASE ARE COMMERCIALLY REASONABLE AND EFFECTUATE THE INTENT AND PURPOSE OF LESSOR AND LESSEE WITH RESPECT TO THE PREMISES. INITIALS: ___________ __________ Page 25 of 27 - ------------------------------------------------------------------------------- ATTENTION: NO REPRESENTATION OR RECOMMENDATION IS MADE BY THE AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION OR BY ANY BROKER AS TO THE LEGAL SUFFICIENCY, LEGAL EFFECT, OR TAX CONSEQUENCES OF THIS LEASE OR THE TRANSACTION TO WHICH IT RELATES. THE PARTIES ARE URGED TO: 1. SEEK ADVICE OF COUNSEL AS TO THE LEGAL AND TAX CONSEQUENCES OF THIS LEASE. 2. RETAIN APPROPRIATE CONSULTANTS TO REVIEW AND INVESTIGATE THE CONDITION OF THE PREMISES. SAID INVESTIGATION SHOULD INCLUDE BUT NOT BE LIMITED TO: THE POSSIBLE PRESENCE OF HAZARDOUS SUBSTANCES, THE ZONING OF THE PREMISES, THE STRUCTURAL INTEGRITY, THE CONDITION OF THE ROOF AND OPERATING SYSTEMS, AND THE SUITABILITY OF THE PREMISES FOR LESSEE'S INTENDED USE. WARNING: IF THE PREMISES IS LOCATED IN A STATE OTHER THAN CALIFORNIA, CERTAIN PROVISIONS OF THE LEASE MAY NEED TO BE REVISED TO COMPLY WITH THE LAWS OF THE STATE IN WHICH THE PREMISES IS LOCATED. - ------------------------------------------------------------------------------- The parties hereto have executed this Lease at the place on the dates specified above to their respective signatures. Executed at 3043 Summerhill Court, Executed at 1171 Sonora Court, San Jose, CA, on November 5, 1999 Sunnyvale, CA on November 5, 1999 by LESSOR: BHUPINDER S. LEHGA. by LESSEE: SILICON STORAGE RUPINDER K. LEHGA TECHNOLOGY, INC. By: /s/ Bhupinder S. Lehga By /s/ Jeffrey L. Garon Name Printed: BHUPINDER S. LEHGA Name Printed: JEFFREY L. GARON Title: ___________________________________ Title: Vice President, Chief Financial Officer By: /s/ Rupinder K. Lehga By: /s/ Humberto Chacon Name Printed: RUPINDER K. LEHGA Name Printed: HUMBERTO CHACON Title: ___________________________________ Title: Manager, Human Resources Address: _________________________________ Address: 1171 Sonora Court __________________________________________ Sunnyvale, CA 94086 Telephone: (408) 238-0454 / (408) 524-8630 Telephone: (408) 523-7705 Facsimile: (408) 524-8631 Facsimile: (408) 523-7707 Federal ID No. : _________________________ Federal ID No.:__________________ NOTE: These forms are often modified to meet the changing requirements of law and industry needs. Always write or call to make sure you are utilizing the most current form: AMERICAN INDUSTRIAL REAL ESTATE ASSOCIATION, 700 So. Flower Street, Suite l600, Los Angeles, California 90017, (213) 687-8777, Fax No. (213) 687-8616. INITIALS: ___________ __________ Page 26 of 27 ADDENDUM - 1 ADDENDUM TO THAT CERTAIN STANDARD INDUSTRIAL/COMMERCIAL SINGLE- TENANT LEASE - NET DATED: NOVEMBER 15, 1999 BY AND BETWEEN BHUPINDER S. LEHGA & RUPINDER K. LEHGA ("LESSOR") AND SILICON STORAGE TECHNOLOGY, INC. ("LESSEE") FOR THE PROPERTY LOCATED AT 1159 SONORA COURT, SUNNYVALE, CALIFORNIA. 1. Monthly rent shall be as follows: Month 1 Nov. 15 to Nov. 30, 1999 $ 5684.28 Months 2 $ 11368.56 Months 3-12 $ 22737.12 Months 13-24 $ 23646.60 Months 25-36 $ 24592.47 Months 37-48 $ 25576.17 Months 49-60 $ 26599.22 Months 61-64 $ 27663.18
2. Lessee shall have first right of refusal to expand into the adjacent "Wave Systems" space within said Property. Lessor to serve written notice to Lessee regarding said first right of refusal and Lessee to respond in writing within five (5) calendar days. (Exhibit A) 3. Lessee to one (1) five (5) year option to extend lease at the then fair market fair lease rate. 4. Lessor will also install condensation outlets from all existing air conditioners on the roof. By: /s/ BHUPINDER LEHGA Date: November 5, 1999 ------------------------------- -------------------------------- Lessor By: /s/ RUPINDER LEHGA Date: November 9, 1999 ------------------------------- -------------------------------- Lessor By: /s/ JEFFREY L. GARON Date: November 6, 1999 ------------------------------- -------------------------------- Lessee By: /s/ HUMBERTO CHACON Date: November 5, 1999 ------------------------------- -------------------------------- Lessee EX-10.25 4 EXHIBIT 10.25 EXHIBIT 10.25 INDUSTRIAL LEASE (SINGLE TENANT: NET; STAND-ALONE) BETWEEN THE IRVINE COMPANY AND SILICON STORAGE TECHNOLOGY, INC. TABLE OF CONTENTS
PAGE ARTICLE 1 BASIC LEASE PROVISIONS . . . . . . . . . . . . . . . . . . . . . . . . . .1 ARTICLE 2 PREMISES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2 Section 2.1 LEASED PREMISES. . . . . . . . . . . . . . . . . . . . . . . . .2 Section 2.2 ACCEPTANCE OF PREMISES . . . . . . . . . . . . . . . . . . . . .2 Section 2.3 BUILDING NAME AND ADDRESS. . . . . . . . . . . . . . . . . . . .2 Section 2.4 LANDLORD'S RESPONSIBILITIES. . . . . . . . . . . . . . . . . . .2 ARTICLE 3 TERM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 Section 3.1 GENERAL. . . . . . . . . . . . . . . . . . . . . . . . . . . . .3 Section 3.2 RIGHT TO EXTEND THIS LEASE . . . . . . . . . . . . . . . . . . .3 ARTICLE 4 RENT AND OPERATING EXPENSES. . . . . . . . . . . . . . . . . . . . . . . .4 Section 4.1 BASIC RENT . . . . . . . . . . . . . . . . . . . . . . . . . . .4 Section 4.2 OPERATING EXPENSES . . . . . . . . . . . . . . . . . . . . . . .4 Section 4.3 SECURITY DEPOSIT . . . . . . . . . . . . . . . . . . . . . . . .6 ARTICLE 5 USES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 Section 5.1 USE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6 Section 5.2 SIGNS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7 Section 5.3 HAZARDOUS MATERIALS. . . . . . . . . . . . . . . . . . . . . . .7 ARTICLE 6 SERVICES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 Section 6.1 UTILITIES AND SERVICES . . . . . . . . . . . . . . . . . . . . .9 Section 6.2 PARKING. . . . . . . . . . . . . . . . . . . . . . . . . . . . .9 ARTICLE 7 MAINTAINING THE PREMISES . . . . . . . . . . . . . . . . . . . . . . . . 10 Section 7.1 TENANT'S MAINTENANCE AND REPAIR. . . . . . . . . . . . . . . . 10 Section 7.2 LANDLORD'S MAINTENANCE AND REPAIR. . . . . . . . . . . . . . . 10 Section 7.3 ALTERATIONS. . . . . . . . . . . . . . . . . . . . . . . . . . 11 Section 7.4 MECHANIC'S LIENS . . . . . . . . . . . . . . . . . . . . . . . 11 Section 7.5 ENTRY AND INSPECTION . . . . . . . . . . . . . . . . . . . . . 12 ARTICLE 8 TAXES AND ASSESSMENTS ON TENANT'S PROPERTY . . . . . . . . . . . . . . . 12 ARTICLE 9 ASSIGNMENT AND SUBLETTING. . . . . . . . . . . . . . . . . . . . . . . . 12 Section 9.1 RIGHTS OF PARTIES. . . . . . . . . . . . . . . . . . . . . . . 12 Section 9.2 EFFECT OF TRANSFER . . . . . . . . . . . . . . . . . . . . . . 14 Section 9.3 SUBLEASE REQUIREMENTS. . . . . . . . . . . . . . . . . . . . . 14 Section 9.4 CERTAIN TRANSFERS. . . . . . . . . . . . . . . . . . . . . . . 14 ARTICLE 10 INSURANCE AND INDEMNITY . . . . . . . . . . . . . . . . . . . . . . 15 Section 10.1 TENANT'S INSURANCE . . . . . . . . . . . . . . . . . . . . . . 15 i. TABLE OF CONTENTS (CONTINUED) PAGE Section 10.2 LANDLORD'S INSURANCE . . . . . . . . . . . . . . . . . . . . . 15 Section 10.3 TENANT'S INDEMNITY . . . . . . . . . . . . . . . . . . . . . . 15 Section 10.4 LANDLORD'S NONLIABILITY. . . . . . . . . . . . . . . . . . . . 15 Section 10.5 WAIVER OF SUBROGATION. . . . . . . . . . . . . . . . . . . . . 16 ARTICLE 11 DAMAGE OR DESTRUCTION . . . . . . . . . . . . . . . . . . . . . . . 16 Section 11.1 RESTORATION. . . . . . . . . . . . . . . . . . . . . . . . . . 16 Section 11.2 LEASE GOVERNS. . . . . . . . . . . . . . . . . . . . . . . . . 17 ARTICLE 12 EMINENT DOMAIN. . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Section 12.1 TOTAL OR PARTIAL TAKING. . . . . . . . . . . . . . . . . . . . 17 Section 12.2 TEMPORARY TAKING . . . . . . . . . . . . . . . . . . . . . . . 17 Section 12.3 TAKING OF PARKING AREA . . . . . . . . . . . . . . . . . . . . 17 ARTICLE 13 SUBORDINATION; ESTOPPEL CERTIFICATE; FINANCIALS . . . . . . . . . . 18 Section 13.1 SUBORDINATION. . . . . . . . . . . . . . . . . . . . . . . . . 18 Section 13.2 ESTOPPEL CERTIFICATE . . . . . . . . . . . . . . . . . . . . . 18 Section 13.3 FINANCIALS.. . . . . . . . . . . . . . . . . . . . . . . . . . 18 ARTICLE 14 DEFAULTS AND REMEDIES . . . . . . . . . . . . . . . . . . . . . . . 19 Section 14.1 TENANT'S DEFAULTS. . . . . . . . . . . . . . . . . . . . . . . 19 Section 14.2 LANDLORD'S REMEDIES. . . . . . . . . . . . . . . . . . . . . . 19 Section 14.3 LATE PAYMENTS. . . . . . . . . . . . . . . . . . . . . . . . . 21 Section 14.4 RIGHT OF LANDLORD TO PERFORM . . . . . . . . . . . . . . . . . 21 Section 14.5 DEFAULT BY LANDLORD. . . . . . . . . . . . . . . . . . . . . . 21 Section 14.6 EXPENSES AND LEGAL FEES. . . . . . . . . . . . . . . . . . . . 21 Section 14.7 WAIVER OF JURY TRIAL . . . . . . . . . . . . . . . . . . . . . 22 Section 14.8 SATISFACTION OF JUDGMENT . . . . . . . . . . . . . . . . . . . 22 Section 14.9 LIMITATION OF ACTIONS AGAINST LANDLORD . . . . . . . . . . . . 22 ARTICLE 15 END OF TERM . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Section 15.1 HOLDING OVER . . . . . . . . . . . . . . . . . . . . . . . . . 22 Section 15.2 MERGER ON TERMINATION. . . . . . . . . . . . . . . . . . . . . 22 Section 15.3 SURRENDER OF PREMISES; REMOVAL OF PROPERTY . . . . . . . . . . 23 ARTICLE 16 PAYMENTS AND NOTICES. . . . . . . . . . . . . . . . . . . . . . . . 23 ARTICLE 17 RULES AND REGULATIONS . . . . . . . . . . . . . . . . . . . . . . . 23 ARTICLE 18 BROKER'S COMMISSION . . . . . . . . . . . . . . . . . . . . . . . . 23 ARTICLE 19 TRANSFER OF LANDLORD'S INTEREST . . . . . . . . . . . . . . . . . . 24 ARTICLE 20 INTERPRETATION. . . . . . . . . . . . . . . . . . . . . . . . . . . 24 ii. TABLE OF CONTENTS (CONTINUED) PAGE Section 20.1 GENDER AND NUMBER. . . . . . . . . . . . . . . . . . . . . . . 24 Section 20.2 HEADINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Section 20.3 JOINT AND SEVERAL LIABILITY. . . . . . . . . . . . . . . . . . 24 Section 20.4 SUCCESSORS . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Section 20.5 TIME OF ESSENCE. . . . . . . . . . . . . . . . . . . . . . . . 24 Section 20.6 CONTROLLING LAW. . . . . . . . . . . . . . . . . . . . . . . . 24 Section 20.7 SEVERABILITY . . . . . . . . . . . . . . . . . . . . . . . . . 24 Section 20.8 WAIVER AND CUMULATIVE REMEDIES . . . . . . . . . . . . . . . . 24 Section 20.9 INABILITY TO PERFORM . . . . . . . . . . . . . . . . . . . . . 25 Section 20.10 ENTIRE AGREEMENT . . . . . . . . . . . . . . . . . . . . . . . 25 Section 20.11 QUIET ENJOYMENT. . . . . . . . . . . . . . . . . . . . . . . . 25 Section 20.12 SURVIVAL . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 ARTICLE 21 EXECUTION AND RECORDING . . . . . . . . . . . . . . . . . . . . . . 25 Section 21.1 COUNTERPARTS . . . . . . . . . . . . . . . . . . . . . . . . . 25 Section 21.2 CORPORATE AND PARTNERSHIP AUTHORITY. . . . . . . . . . . . . . 25 Section 21.3 EXECUTION OF LEASE; NO OPTION OR OFFER . . . . . . . . . . . . 25 Section 21.4 RECORDING. . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Section 21.5 AMENDMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Section 21.6 EXECUTED COPY. . . . . . . . . . . . . . . . . . . . . . . . . 26 Section 21.7 ATTACHMENTS. . . . . . . . . . . . . . . . . . . . . . . . . . 26 ARTICLE 22 MISCELLANEOUS . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Section 22.1 NONDISCLOSURE OF LEASE TERMS . . . . . . . . . . . . . . . . . 26 Section 22.2 GUARANTY . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Section 22.3 CHANGES REQUESTED BY LENDER. . . . . . . . . . . . . . . . . . 26 Section 22.4 MORTGAGEE PROTECTION . . . . . . . . . . . . . . . . . . . . . 26 Section 22.5 COVENANTS AND CONDITIONS . . . . . . . . . . . . . . . . . . . 26 Section 22.6 SECURITY MEASURES. . . . . . . . . . . . . . . . . . . . . . . 26 Section 22.7 EXPIRATION OF EXISTING LEASE . . . . . . . . . . . . . . . . . 27 Section 22.8 JAMS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
iii. INDUSTRIAL LEASE (SINGLE TENANT; NET; STAND-ALONE) THIS LEASE is made as of the 22nd day of November, 1999, by and between The Irvine Company, hereafter called "Landlord," and SILICON STORAGE TECHNOLOGY, INC., a California corporation hereinafter called "Tenant." ARTICLE I BASIC LEASE PROVISIONS Each reference in this Lease to the "Basic Lease Provisions" shall mean and refer to the following collective terms, the application of which shall be governed by the provisions in the remaining Articles of this Lease. 1. Premises: The Premises are more particularly described in Section 2.1. 2. Address of Building: 1175 Sonora Court, Sunnyvale, CA 94086 3. Use of Premises: General office, research and development, storage, distribution and testing of computer flash memory products. 4. Estimated Commencement Date: April 6, 2000 5. Lease Term: The Term of this Lease shall expire at midnight on April 5, 2005. 6. Basic Rent: Thirty Four Thousand Dollars ($34,000.00) per month, based on $1.70 per rentable square foot. Basic Rent is subject to adjustment as follows: Commencing April 1, 2001, the Basic Rent shall be Thirty Five Thousand Dollars ($35,000.00) per month, based on $1.75 per rentable square foot. Commencing April 1, 2002, the Basic Rent shall be Thirty Six Thousand Dollars ($36,000.00) per month, based on $1.80 per rentable square foot. Commencing April 1, 2003, the Basic Rent shall be Thirty Seven Thousand Two Hundred Dollars ($37,200.00) per month, based on $1.86 per rentable square foot. Commencing April 1, 2004, the Basic Rent shall be Thirty Eight Thousand Two Hundred Dollars ($38,200.00) per month, based on $1.91 per rentable square foot. 7. Guarantor(s): None 8. Floor Area of Premises: approximately 20,000 rentable square feet 9. Security Deposit: $21,000.00 10. Broker(s): Colliers International 11. Additional Insureds: Insignia\ESG of California, Inc. 12. Address for Payments and Notices: 1. LANDLORD TENANT INSIGNIA\ESG OF CALIFORNIA, INC. SILICON STORAGE TECHNOLOGY, INC. 160 Santa Clara Street, Suite 1350 1171 Sonora Court San Jose, CA 95113 Sunnyvale, CA 94086 with a copy of notices to: IRVINE INDUSTRIAL COMPANY P.O. Box 6370 Newport Beach, CA 92658-6370 Attn: Vice President, Industrial Operations
13. Tenant's Liability Insurance Requirement: $2,000,000.00 14. Vehicle Parking Spaces: See Section 6.2 ARTICLE II PREMISES SECTION 2.1 LEASED PREMISES. Landlord leases to Tenant and Tenant leases from Landlord the premises shown in EXHIBIT A (the "Premises"), including the building identified in Item 2 of the Basic Lease Provisions (which together with the underlying real property, is called the "Building"), and containing approximately the floor area set forth in Item 8 of the Basic Lease Provisions. The Building is located on the site (the "Site") shown on EXHIBIT A-1 attached hereto. SECTION 2.2 ACCEPTANCE OF PREMISES. Tenant acknowledges that neither Landlord nor any representative of Landlord has made any representation or warranty with respect to the Premises or the Building or the suitability or fitness of either for any purpose, including without limitation any representations or warranties regarding zoning or other land use matters. Tenant further acknowledges that neither Landlord nor any representative of Landlord has agreed to undertake any alterations or additions or construct any improvements to the Premises except as expressly provided in this Lease. Tenant is currently in possession of the Premises pursuant to a separate lease agreement with Landlord that will expire on the day before the Commencement Date of this Lease (the "Existing Lease"). Tenant shall take possession of the premises as of the Commencement Date of the Lease in an "as-is" condition without further obligation on Landlord's part as to improvements whatsoever, except that Landlord shall make repairs to the mechanical system at a cost not to exceed Twenty Three Thousand Dollars ($23,000.00). SECTION 2.3 BUILDING NAME AND ADDRESS. Tenant shall not utilize any name selected by Landlord from time to time for the Building as any part of Tenant's corporate or trade name. Landlord shall have the right to change the name, address, number or designation of the Building without liability to Tenant. SECTION 2.4 LANDLORD'S RESPONSIBILITIES. Notwithstanding the provisions of Section 7.2 of this Lease, during the Term of this Lease, Landlord agrees to repair and/or replace, at its sole cost and expense and not as a "Building Cost", the structural components of the roof, the load-bearing walls and the foundations and footings of the Building. Notwithstanding the foregoing, Landlord's obligation contained in this Section 2.4 to bear such costs and expenses shall not apply: (i) to the costs and expenses of periodic maintenance of the roof, walls, foundations and footings of the Building, nor (ii) to the extent of the negligence or willful misconduct by Tenant, its employees, agents, contractors, licensees or invitees (in which case Tenant shall be responsible for the reasonable costs of such repairs and/or replacements). The repairs or replacements required of Landlord pursuant to this Section 2.4(a) shall be made promptly following notice from Tenant of the need for such repairs or replacements. 2. ARTICLE III TERM SECTION 3.1 GENERAL. The Term shall be for the period shown in Item 5 of the Basic Lease Provisions. The Term shall commence ("Commencement Date") on the date set forth in Item 4 of the Basic Lease Provisions and shall expire on the corresponding date (the "Expiration Date") of the expiration of the Term. SECTION 3.2 RIGHT TO EXTEND THIS LEASE. Provided that Tenant is not in default under any provision of this Lease, either at the time of exercise of the extension right granted herein or at the time of the commencement of such extension, and provided further that Tenant is occupying the Premises and has not assigned its interest in this Lease, Tenant may extend the Term of this Lease for one (1) period of sixty (60) months. Tenant shall exercise its right to extend the Term by and only by delivering to Landlord, not less than nine (9) months or more than twelve (12) months prior to the expiration date of the Term, Tenant's irrevocable written notice of its commitment to extend (the "Commitment Notice"). The Basic Rent payable under the Lease during any extension of the Term shall be determined as provided in the following provisions. If Landlord and Tenant have not by then been able to agree upon the Basic Rent for the extension of the Term, then within one hundred twenty (120) and ninety (90) days prior to the expiration date of the Term, Landlord shall notify Tenant in writing of the Basic Rent that would reflect the prevailing market rental rate for a 60-month renewal of comparable space in the area of the Premises (together with any increases thereof during the extension period) as of the commencement of the extension period ("Landlord's Determination"). Should Tenant disagree with the Landlord's Determination, then Tenant shall, not later than twenty (20) days thereafter, notify Landlord in writing of Tenant's determination of those rental terms ("Tenant's Determination"). In no event, however, shall Landlord's Determination or Tenant's Determination be less than the Basic Rent payable by Tenant during the final month of the initial Term. Within ten (10) days following delivery of the Tenant's Determination, the parties shall attempt to agree on an appraiser to determine the fair market rental. If the parties are unable to agree in that time, then each party shall designate an appraiser within ten (10) days thereafter. Should either party fail to so designate an appraiser within that time, then the appraiser designated by the other party shall determine the fair market rental. Should each of the parties timely designate an appraiser, then the two appraisers so designated shall appoint a third appraiser who shall, acting alone, determine the fair market rental for the Premises. Any appraiser designated hereunder shall have an MAI certification with not less than five (5) years experience in the valuation of commercial industrial buildings in Santa Clara County, California. Within thirty (30) days following the selection of the appraiser and such appraiser's receipt of the Landlord's Determination and the Tenant's Determination, the appraiser shall determine whether the rental rate determined by Landlord or by Tenant more accurately reflects the fair market rental rate for the 60-month renewal of the Lease for the Premises, as reasonably extrapolated to the commencement of the extension period. Accordingly, either the Landlord's Determination or the Tenant's Determination shall be selected by the appraiser as the fair market rental rate for the extension period. In making such determination, the appraiser shall consider rental comparables for similarly improved space in thc area of the Premises with appropriate adjustment for location and quality of project, but the appraiser shall not attribute any factor for market tenant improvement allowances or brokerage commissions in making its determination of the fair market rental rate. At any time before the decision of the appraiser is rendered, either party may, by written notice to the other party, accept the rental terms submitted by the other party, in which event such terms shall be deemed adopted as the agreed fair market rental. The fees of the appraiser(s) shall be borne entirely by the party, whose determination of the fair market rental rate was not accepted by the appraiser. Within twenty (20) days after the determination of the fair market rental, Landlord shall prepare an appropriate amendment to this Lease for the extension period, and Tenant shall execute and return same to Landlord within twenty (20) days. Should the fair market rental not be established by the commencement of the extension period, then Tenant shall continue paying rent at the rate in effect during the last month of the initial Term, and a lump sum adjustment shall be made promptly upon the determination of such new rental. 3. If Tenant fails to timely comply with any of the provisions of this paragraph, Tenant's right to extend the Term shall be extinguished and the Lease shall automatically terminate as of the expiration date of the Term, without any extension and without any liability to Landlord. Any attempt to assign or transfer any right or interest created by this paragraph shall be void from its inception. Tenant shall have no other right to extend the Term beyond the single sixty (60) month extension period created by this paragraph. Unless agreed to in a writing signed by Landlord and Tenant, any extension of the Term, whether created by an amendment to this Lease or by a holdover of the Premises by Tenant, or otherwise, shall be deemed a part of, and not in addition to, any duly exercised extension period permitted by this paragraph. ARTICLE IV RENT AND OPERATING EXPENSES SECTION 4.1 BASIC RENT. From and after the Commencement Date, Tenant shall pay to Landlord without deduction or offset, Basic Rent for the Premises in the total amount shown (including subsequent adjustments, if any) in Item 6 of the Basic Lease Provisions. Any rental adjustment shown in Item 6 shall be deemed to occur on the specified monthly anniversary of the Commencement Date. The rent shall be due and payable in advance commencing on the Commencement Date (as prorated for any partial month) and continuing thereafter on the first day of each successive calendar month of the Term. No demand, notice or invoice shall be required for the payment of Basic Rent. SECTION 4.2 OPERATING EXPENSES. (a) Tenant shall pay to Landlord, as additional rent, "Building Costs" and "Property Taxes," as those terms are defined below, incurred by Landlord in the operation of the Building. For convenience of reference, Property Taxes and Building Costs shall be referred to collectively as "Operating Expenses". (b) Commencing prior to the start of the first full "Expense Recovery Period" (as defined below) of the Lease, and prior to the start of each full or partial Expense Recovery Period thereafter, Landlord shall give Tenant a written estimate of the amount of Operating Expenses for the Expense Recovery Period. Tenant shall pay the estimated amounts to Landlord in equal monthly installments, in advance, with Basic Rent. If Landlord has not furnished its written estimate for any Expense Recovery Period by the time set forth above, Tenant shall continue to pay cost reimbursements at the rates established for the prior Expense Recovery Period, if any; provided that when the new estimate is delivered to Tenant, Tenant shall, at the next monthly payment date, pay any accrued cost reimbursements based upon the new estimate. For purposes hereof, "Expense Recovery Period" shall mean every twelve month period during the Term (or portion thereof for the first and last lease years) commencing July 1 and ending June 30. (c) Within one hundred twenty (120) days after the end of each Expense Recovery Period, Landlord shall furnish to Tenant a statement showing in reasonable detail the actual or prorated Operating Expenses incurred by Landlord during the period, and the parties shall within thirty (30) days thereafter make any payment or allowance necessary to adjust Tenant's estimated payments, if any, to Tenant's actual owed amounts as shown by the annual statement. Any delay or failure by Landlord in delivering any statement hereunder shall not constitute a waiver of Landlord's right to require Tenant to pay Operating Expenses pursuant hereto. Any amount due Tenant shall be credited against installments next coming due under this Section 4.2, and any deficiency shall be paid by Tenant together with the next installment. If Tenant has not made estimated payments during the Expense Recovery Period, any amount owing by Tenant pursuant to subsection (a) above shall be paid to Landlord in accordance with Article XVI. Should Tenant fail to object in writing to Landlord's determination of actual Operating Expenses within sixty (60) days following delivery of Landlord's expense statement, Landlord's determination of actual Operating Expenses for the applicable Expense Recovery Period shall be conclusive and binding on the parties and any future claims to the contrary shall be barred. Provided Tenant is not then in default of any monetary covenant of this Lease (including, without limitation, the obligation to pay Basic Rent and/or Tenant's Share of Operating Expenses), or any material non-monetary covenant, following written notice and the expiration of the applicable cure period, then Tenant shall have 4. the right to have Tenant's financial officer or a certified public accountant audit Landlord's Operating Expenses, subject to the terms and conditions hereof. In no event, however, shall such auditor be compensated by Tenant on a "contingency" basis, or on any other basis tied to the results of said audit. Tenant shall give written notice to Landlord of Tenant's intent to audit, if at all, within sixty (60) days following delivery of Landlord's expense statement for each of the Expense Recovery Periods. Following at least ten (10) business days notice to Landlord, such audit shall be conducted at a mutually agreeable time during normal business hours at the office of Landlord or its management agent where the records are maintained. Landlord agrees to make such personnel available to Tenant as is reasonably necessary for Tenant's employees and agents, to conduct such audit. Landlord shall make such records available to Tenant's employees and agents, for inspection during normal business hours. Tenant's employees and agents shall be entitled to make photostatic copies of such records, provided Tenant bears the expense of such copying, and further provided that Tenant keeps such copies in a confidential manner and does not discuss, display or distribute such copies to any other third party. If Tenant's audit determines that actual Operating Expenses have been overstated by more than five percent (5%), then subject to Landlord's right to review and/or contest the audit results, Landlord shall reimburse Tenant for the reasonable out-of-pocket costs of such audit. Tenant's Basic Rent shall be appropriately adjusted to reflect any overstatement in Operating Expenses. In the event or a dispute between Landlord and Tenant regarding the results of such audit, such dispute shall be submitted to and resolved by JAMS as provided in Section 22.7 of this Lease. All of the information obtained by Tenant and/or its auditor in connection with such audit. as well as any compromise, settlement, or adjustment reached between Landlord and Tenant as a result thereof, shall be held in strict confidence and, except as may be required pursuant to litigation, shall not be disclosed to any third party, directly or indirectly, by Tenant or its auditor or any of their officers, agents or employees. Landlord may require Tenant and its auditor to execute a separate confidentiality agreement as a condition precedent to any audit. (d) Even though the Lease has terminated and the Tenant has vacated the Premises, when the final determination is made of Operating Expenses for the Expense Recovery Period in which the Lease terminates, Tenant shall upon notice pay the entire increase due over the estimated expenses paid. Conversely, any overpayment made in the event expenses decrease shall be rebated by Landlord to Tenant. (e) If, at any time during any Expense Recovery Period, any one or more of the Operating Expenses are increased to a rate(s) or amount(s) in excess of the rate(s) or amount(s) used in calculating the estimated expenses for the year, then the estimate of Operating Expenses shall be increased for the month in which such rate(s) or amount(s) becomes effective and for all succeeding months by an amount equal to the increase. Landlord shall give Tenant written notice of the amount or estimated amount of the increase, the month in which the increase will become effective, and the month for which the payments are due. Tenant shall pay the increase to Landlord as a part of Tenant's monthly payments of estimated expenses as provided in paragraph (b) above, commencing with the month in which effective. (f) The term "Building Costs" shall include all expenses of operation and maintenance of the Building and all landscaping, walkways, parking areas and lighting of the Site to the extent such expenses are not billed to and paid directly by Tenant, and shall include the following charges by way of illustration but not limitation: water and sewer charges; insurance premiums or reasonable premium equivalents should Landlord elect to self-insure any risk that Landlord is authorized to insure hereunder; license, permit, and inspection fees; heat; light; power; air conditioning; supplies; materials; equipment; tools; the cost of any environmental, insurance, tax or other consultant utilized by Landlord in connection with the Building; costs incurred in connection with compliance of any laws or changes in laws applicable to the Building; the cost of any capital investments (other than tenant improvements for specific tenants) to the extent of the amortized amount thereof over the useful life of such capital investments calculated at a market cost of funds, all as determined by Landlord, for each such year of useful life during the Term; labor; reasonably allocated wages and salaries, fringe benefits, and payroll taxes for administrative and other personnel directly applicable to the Building, including both Landlord's personnel and outside personnel; any expense incurred pursuant to Sections 6.1, 6.2, 7.2, and 10.2; and a reasonable overhead/management fee for the professional operation of the Building. Notwithstanding anything to the contrary contained herein, the amount of such overhead/management fee to be charged to Tenant shall be determined by multiplying the actual fee charged (which from time to time may be with respect to the Building only or the Building together with other properties owned by Landlord and/or its affiliates) by a fraction, the numerator of which is the floor area of the Premises (as set forth in Item No. 8 of the Basic Lease Provisions) and the denominator of which is the total square footage of space 5. charged with such fee actually leased to tenants (including Tenant). It is understood that Building Costs shall include competitive charges for direct services provided by any subsidiary or division of Landlord, and may include the Building's or the Site's proportionate share of the cost of maintenance or repair contracts which cover the Building and/or the Site and other buildings and/or projects in Landlord's portfolio, as reasonably allocated by Landlord. (g) The term "Property Taxes" as used herein shall include the following: (i) all real estate taxes or personal property taxes, as such property taxes may be reassessed from time to time; and (ii) other taxes, charges and assessments which are levied with respect to this Lease, to the Building or to the Site, and any improvements, fixtures and equipment and other property, of Landlord located in the Building or on the Site, except that general net income and franchise taxes imposed against Landlord shall be excluded; and (iii) all assessments and fees for public improvements, services, and facilities and impacts thereon, including without limitation arising out of any Community Facilities Districts, "Mello Roos" districts, similar assessment districts, and any traffic impact mitigation assessments or fees; and (iv) any tax, surcharge or assessment which shall be levied in addition to or in lieu of real estate or personal property taxes, other than taxes covered by Article VIII; and (v) costs and expenses incurred in contesting the amount or validity of any Property Tax by appropriate proceedings. SECTION 4.3 SECURITY DEPOSIT. Concurrently with Tenant's delivery of this Lease, Tenant shall deposit with Landlord the sum, if any, stated in Item 9 of the Basic Lease Provisions, to be held by Landlord as security for the full and faithful performance of Tenant's obligations under this Lease (the "Security Deposit"). Subject to the last sentence of this Section, the Security Deposit shall be understood and agreed to be the property of Landlord upon Landlord's receipt thereof, and may be utilized by Landlord in its discretion towards the payment of all prepaid expenses by Landlord for which Tenant would be required to reimburse Landlord under this Lease, including without limitation brokerage commissions and Tenant Improvement costs. Upon any default by Tenant, including specifically Tenant's failure to pay rent or to abide by its obligations under Sections 7.1 and 15.3 below, whether or not Landlord is informed of or has knowledge of the default, the Security Deposit shall be deemed to be automatically and immediately applied, without waiver of any rights Landlord may have under this Lease or at law or in equity as a result of the default, as a setoff for full or partial compensation for that default. If any portion of the Security Deposit is applied after a default by Tenant, Tenant shall within five (5) days after written demand by Landlord deposit cash with Landlord in an amount sufficient to restore the Security Deposit to its original amount. Landlord shall not be required to keep this Security Deposit separate from its general funds, and Tenant shall not be entitled to interest on the Security Deposit. If Tenant fully performs its obligations under this Lease, the Security Deposit or any balance thereof shall be returned to Tenant (or, at Landlord's option, to the last assignee of Tenant's interest in this Lease) after the expiration of the Term, provided that Landlord may retain the Security Deposit to the extent and until such time as all amounts due from Tenant in accordance with this Lease have been determined and paid in full. Tenant hereby authorizes Landlord to retain any remaining balance of the security deposit funded to Landlord under the Existing Lease (as defined in Section 22.7), which balance shall be applied by Landlord to offset the sums owing under this Section 4.3. ARTICLE V USES SECTION 5.1 USE. Tenant shall use the Premises only for the purposes stated in Item 3 of the Basic Lease Provisions, all in accordance with applicable laws and restrictions and pursuant to approvals to be obtained by Tenant from all relevant and required governmental agencies and authorities. The parties agree that any contrary use shall be deemed to cause material and irreparable harm to Landlord and shall entitle Landlord to injunctive relief in addition to any other available remedy. Tenant, at its expense, shall procure, maintain and make available for Landlord's inspection throughout the Term, all governmental approvals, licenses and permits required for the proper and lawful conduct of Tenant's permitted use of the Premises. Tenant shall not use or allow the Premises to be used for any unlawful purpose, nor shall Tenant permit any nuisance or commit any waste in the Premises. Tenant shall not do or permit to be done anything which will invalidate or increase the cost of any insurance policy(ies) covering the Building or its contents, and shall comply with all applicable insurance underwriters rules and the requirements of the Pacific Fire Rating Bureau or any other organization performing a similar function. Tenant shall comply at its expense with all present and future laws, ordinances, restrictions, regulations, orders, rules and requirements of all governmental authorities that pertain to Tenant or its use of the Premises, including without limitation all federal and 6. state occupational health and safety requirements, whether or not Tenant's compliance will necessitate expenditures or interfere with its use and enjoyment of the Premises. Tenant shall comply at its expense with all present and future covenants, conditions, easements or restrictions now or hereafter affecting or encumbering the Building, and any amendments or modifications thereto, including without limitation the payment by Tenant of any periodic or special dues or assessments charged against the Premises or Tenant which may be allocated to the Premises or Tenant in accordance with the provisions thereof. Tenant shall promptly upon demand reimburse Landlord for any additional insurance premium charged by reason of Tenant's failure to comply with the provisions of this Section, and shall indemnify Landlord from any liability and/or expense resulting from Tenant's noncompliance. SECTION 5.2 SIGNS. Except for Tenant's existing signage on or about the Premises or the Building (which existing signage is hereby approved by Landlord), Tenant shall not have the right to install new signage on or about the Premises or the Building visible from the exterior of the Building, without Landlord's approval. The size, design, graphics, material, style, color and other physical aspects of any such new signage shall be subject to Landlord's written approval prior to installation (which approval may be withheld in Landlord's discretion), any covenants, conditions or restrictions encumbering the Premises, Landlord's signage program, if any, as in effect from time to time ("Signage Criteria"), and any applicable municipal or other governmental permits and approvals. Tenant acknowledges having received and reviewed a copy of the current Signage Criteria, if applicable. Tenant shall be responsible for the cost of any permitted sign, including the fabrication, installation, maintenance and removal thereof. If Tenant fails to maintain its sign, or if Tenant fails to remove same upon termination of this Lease and repair any damage caused by such removal, Landlord may do so at Tenant's expense. SECTION 5.3 HAZARDOUS MATERIALS. (a) For purposes of this Lease, the term "Hazardous Materials" includes (i) any "hazardous materials" as defined in Section 25501(n) of the California Health and Safety Code, (ii) any other substance or matter which results in liability to any person or entity from exposure to such substance or matter under any statutory or common law theory, and (iii) any substance or matter which is in excess of permitted levels set forth in any federal, California or local law or regulation pertaining to any hazardous or toxic substance, material or waste. (b) Tenant shall not cause or permit any Hazardous Materials to be brought upon, stored, used, generated, released or disposed of on, under, from or about the Premises or the Site (including without limitation the soil and groundwater thereunder) without the prior written consent of Landlord. Notwithstanding the foregoing, Tenant shall have the right, without obtaining prior written consent of Landlord: (A) to utilize within the Premises standard office products that may contain Hazardous Materials (such as photocopy toner, "White Out," and the like), provided, however, that (i) Tenant shall maintain such products in their original retail packaging, shall follow all instructions on such packaging with respect to the storage, use and disposal of such products, and shall otherwise comply with all applicable laws with respect to such products, and (ii) all of the other terms and provisions of this Section 5.3 shall apply with respect to Tenant's storage, use and disposal of all such products, and (B) to utilize those Hazardous Materials in kind and quantity as set forth on Tenant's Environmental Questionnaire delivered to Landlord prior to the execution of this Lease, provided that all of the terms and provisions of this Section 5.3 shall apply with respect to Tenant's storage, use and disposal of such Hazardous Materials. Landlord may, in its sole discretion, place such conditions as Landlord deems appropriate with respect to any Hazardous Materials other than those described in the preceding sentence, and may further require that Tenant demonstrate that any such Hazardous Materials are necessary or useful to Tenant's business and will be generated, stored, used and disposed of in a manner that complies with all applicable laws and regulations pertaining thereto and with good business practices. Tenant understands that Landlord may utilize an environmental consultant to assist in determining conditions of approval in connection with the storage, generation, release, disposal or use of Hazardous Materials by Tenant on or about the Premises, and/or to conduct periodic inspections of the storage, generation, use, release and/or disposal of such Hazardous Materials by Tenant on and from the Premises, and Tenant agrees that any reasonable costs incurred by Landlord in connection therewith shall be reimbursed by Tenant to Landlord as additional rent hereunder upon demand, provided Tenant has been the cause of the contamination justifying the use of the environmental consultant. (c) Prior to the execution of this Lease, Tenant shall complete, execute and deliver to Landlord an Environmental Questionnaire and Disclosure Statement (the "Environmental Questionnaire") in the form of Exhibit B attached hereto. The completed Environmental Questionnaire shall be deemed incorporated into 7. this Lease for all purposes, and Landlord shall be entitled to rely fully on the information contained therein. On each anniversary of the Commencement until the termination of this Tenant shall disclose to Landlord in writing the names and amounts of all Hazardous Materials which were stored, generated, used, released and/or disposed of on, under or about the Premises for the twelve-month period prior thereto, and which Tenant desires to store, generate, use, release and/or dispose of on, under or about the Premises for the succeeding twelve-month period. In addition, to the extent Tenant is permitted to utilize Hazardous Materials upon the Premises, Tenant shall promptly provide Landlord with complete and legible copies of all the following environmental documents relating thereto: reports filed pursuant to any self-reporting requirements; permit applications, permits, monitoring reports, workplace exposure and community exposure warnings or notices and all other reports, disclosures, plans or documents (even those which may be characterized as confidential) relating to water discharges, air pollution, waste generation or disposal, and underground storage tanks for Hazardous Materials; orders, reports, notices, listings and correspondence (even those which may be considered confidential) of or concerning the release, investigation of, compliance, cleanup, remedial and corrective actions, and abatement of Hazardous Materials; and all complaints, pleadings and other legal documents filed by or against Tenant related to Tenant's use, handling, storage, release and/or disposal of Hazardous Materials. (d) Landlord and its agents shall have the right, but not the obligation, to inspect, sample and/or monitor the Premises, the Site and/or the soil or groundwater thereunder at any time to determine whether Tenant is complying with the terms of this Section 5.3, and in connection therewith Tenant shall provide Landlord with full access in all relevant facilities, records and personnel. If Tenant is not in compliance with any of the provisions of this Section 5.3, or in the event or a release of any Hazardous Material on, under or about the Premises and/or the Site caused or permitted by Tenant, its agents, employees, contractors, licensees or invitees, Landlord and its agents shall have the right, but not the obligation, without limitation upon any of Landlord's other rights and remedies under this Lease, to immediately enter upon the Premises and/or the Site without notice and to discharge Tenant's obligations under this Section 5.3 at Tenant's expense, including without limitation the taking of emergency or long-term remedial action. Landlord and its agents shall endeavor to minimize interference with Tenant's business in connection therewith, but shall not be liable for any such interference. In addition, Landlord, at Tenant's expense, shall have the right, but not the obligation, to join and participate in any legal proceedings or actions initiated in connection with any claims arising out of the storage, generation, use, release and/or disposal by Tenant or its agents, employees, contractors, licensees or invitees of Hazardous Materials on, under, from or about the Premises and/or the Site. (e) If the presence of any Hazardous Materials on, under, from or about the Premises and/or the Site caused or permitted by Tenant or its agents, employees, contractors, licensees or invitees results in (i) injury to any person, (ii) injury to or any contamination of the Premises and/or the Site, or (iii) injury to or contamination of any real or personal property wherever situated, Tenant, at its expense, shall promptly take all actions necessary to return the Premises, the Site and any other affected real or personal property, owned by Landlord to the condition existing prior to the introduction of such Hazardous Materials and to remedy or repair any such injury or contamination, including without limitation, any cleanup, remediation, removal, disposal, neutralization or other treatment of any such Hazardous Materials. Notwithstanding the foregoing, Tenant shall not, without Landlord's prior written consent, take any remedial action in response to the presence of any Hazardous Materials on, under or about the Premises, the Site or any other affected real or personal property owned by Landlord or enter into any similar agreement, consent, decree or other compromise with any governmental agency with respect to any Hazardous Materials claims; provided however, Landlord's prior written consent shall not be necessary in the event that the presence of Hazardous Materials on, under or about the Premises, the Site or any other affected real or personal property owned by Landlord (i) imposes an immediate threat to the health, safety or welfare of any individual or (ii) is of such a nature that an immediate remedial response is necessary and it is not possible to obtain Landlord's consent before taking such action. To the fullest extent permitted by law, Tenant shall indemnify, hold harmless, protect and defend (with attorneys acceptable to Landlord) Landlord and any successors to all or any portion of Landlord's interest in the Premises, the Site and any other real or personal property owned by Landlord from and against any and all liabilities, losses, damages, diminution in value, judgments, fines, demands, claims, recoveries, deficiencies, costs and expenses (including without limitation attorneys' fees, court costs and other professional expenses), whether foreseeable or unforeseeable, arising directly or indirectly out of the use, generation, storage, treatment, release, on or off-site disposal or transportation of Hazardous Materials on, into, from, under or about the Premises, the Site and any other real or personal property owned by Landlord caused or permitted by Tenant, its agents, employees, contractors, licensees or invitees, specifically including without 8. limitation the cost of any required or necessary, repair, restoration, cleanup or detoxification of the Premises, the Site and any other real or personal property, owned by Landlord, and the preparation of any closure or other required plans, whether or not such action is required or necessary during the Term or after the expiration of this Lease. If Landlord at any time discovers that Tenant or its agents, employees, contractors, licensees or invitees may have caused or permitted the release of a Hazardous Material on, under, from or about the Premises, the Site or any other real or personal property owned by Landlord, Tenant shall, at Landlord's request, immediately prepare and submit to Landlord a comprehensive plan, subject to Landlord's approval, specifying the actions to be taken by Tenant to return the Premises, the Site or any other real or personal property owned by Landlord to the condition existing prior to the introduction of such Hazardous Materials. Upon Landlord's approval of such cleanup plan, Tenant shall, at its expense, and without limitation of any rights and remedies of Landlord under this Lease or at law or in equity, immediately implement such plan and proceed to cleanup such Hazardous Materials in accordance with all applicable laws and as required by such plan and this Lease. The provisions of this subsection (e) shall expressly survive the expiration or sooner termination of this Lease. (f) Landlord hereby discloses to Tenant, and Tenant hereby acknowledges, certain facts relating to Hazardous Materials at the Project known by Landlord to exist as of the date of this Lease, as more particularly described in EXHIBIT C attached hereto. Tenant shall have no liability or responsibility with respect to the Hazardous Materials facts described in EXHIBIT C, nor with respect to any Hazardous Materials which were not caused or permitted by Tenant, its agents, employees, contractors, licensees or invitees. Landlord shall take responsibility, at its sole cost and expense, for any governmentally-ordered clean-up, remediation, removal, disposal, neutralization or other treatment of Hazardous Materials conditions described in this Section 5.3(f). The foregoing obligation on the part of Landlord shall include the reasonable costs (including, without limitation, reasonable attorney's fees) of defending Tenant (with attorneys reasonably acceptable to Tenant) from and against any legal action or proceeding instituted by any governmental agency in connection with such clean-up, remediation, removal, disposal, neutralization or other treatment of such conditions, provided that Tenant promptly tenders such defense to Landlord. Tenant agrees to notify its agents, employees, contractors, licensees, and invitees of any exposure or potential exposure to Hazardous Materials at the Premises that Landlord brings to Tenant's attention. SECTION 5.4 In the event of any foreclosure of a mortgage or deed of trust encumbering the Building and/or the Project, the obligations on the part of Landlord contained in Section 5.3(f) above shall be personal to Landlord and shall not be binding on nor inure against any lender acquiring the Building and/or the Project by foreclosure of its mortgage or deed of trust or deed in lieu of foreclosure, or any successor in interest to such lender. ARTICLE VI SERVICES SECTION 6.1 UTILITIES AND SERVICES. Tenant shall be responsible for and shall pay promptly, directly to the appropriate supplier, all charges for water, gas, electricity, sewer, heat, light, power, telephone, refuse pickup, janitorial service, interior landscape maintenance and all other utilities, materials and services furnished directly to Tenant or the Premises or used by Tenant in, on or about the Premises during the Term, together with any taxes thereon. Landlord shall not be liable for damages or otherwise for any failure or interruption of any utility or other service furnished to the Premises, and no such failure or interruption shall be deemed an eviction or entitle Tenant to terminate this Lease or withhold or abate any rent due hereunder. Landlord shall at all reasonable times have free access to all electrical and mechanical installations of Landlord. SECTION 6.2 PARKING. Tenant shall be entitled to the vehicle parking spaces on the Site which are designated by Landlord for parking. Tenant shall not permit or allow any vehicles that belong to or are controlled by Tenant or Tenant's employees, suppliers, shippers, Customers or invitees to be loaded, unloaded or parked in areas other than those designated by Landlord for such activities. If Tenant permits or allows any of the prohibited activities described above, then Landlord shall have the right, without notice, in addition to such other rights and remedies that Landlord may have, to remove or tow away the vehicle involved and charge the costs to Tenant. Parking shall be limited to striped parking stalls, and no parking shall be permitted in any driveways, access ways or in any similar area. Nothing contained in this Lease shall be deemed to create liability upon Landlord for any damage to motor vehicles of visitors or employees, for any loss of property from within those motor vehicles, or for 9. any injury to Tenant, its visitors or employees, unless ultimately determined to be caused by the sole active negligence or willful misconduct of Landlord, its agents, servants and employees. Landlord shall have the right to establish, and from time to time amend, and to enforce against all users all reasonable rules and regulations (including the designation of areas for employee parking) that Landlord may deem necessary and advisable for the proper and efficient operation and maintenance of parking. Landlord shall have the right to construct, maintain and operate lighting facilities within the parking areas; to change the area, level, location and arrangement of the parking areas and improvements therein; and to do and perform such other acts in and to the parking areas and improvements therein as, in the use of good business judgment, Landlord shall determine to be advisable. Parking areas shall be used only for parking vehicles. Washing, waxing, cleaning or servicing of vehicles, or the storage of vehicles for 24-hour periods, is prohibited unless otherwise authorized by Landlord. Tenant shall be liable for any damage to the parking areas caused by Tenant or Tenant's employees, suppliers, shippers, customers or invitees, including without limitation damage from excess oil leakage. Tenant shall have no right to install any fixtures, equipment or personal property in the parking areas. ARTICLE VII MAINTAINING THE PREMISES SECTION 7.1 TENANT'S MAINTENANCE AND REPAIR. Tenant at its sole expense shall comply with all applicable laws and governmental regulations governing the Premises and make all repairs necessary to keep the Premises in the condition as existed on the Commencement Date (or on any later date that the improvements may have been installed), excepting ordinary wear and tear, including without limitation the electrical and mechanical systems, any air conditioning, ventilating or heating equipment which serves the Premises, all walls, glass, windows, doors, door closures, hardware, fixtures, electrical, plumbing, fire extinguisher equipment and other equipment. Any damage or deterioration of the Premises shall not be deemed ordinary wear and tear if the same could have been prevented by good maintenance practices by Tenant. As part of its maintenance obligations hereunder, Tenant shall, at Landlord's request, provide Landlord with copies of all maintenance schedules, reports and notices prepared by, for or on behalf of Tenant. Tenant shall obtain preventive maintenance contracts from a licensed heating and air conditioning contractor to provide for regular inspection and maintenance of the heating, ventilating and air conditioning systems servicing the Premises, all subject to Landlord's approval. All repairs shall be at least equal in quality to the original work, shall be made only by a licensed contractor approved in writing in advance by Landlord and shall be made only at the time or times approved by Landlord. Any contractor utilized by Tenant shall be subject to Landlord's standard requirements for contractors, as modified from time to time. Landlord shall have the right at all times to inspect Tenant's maintenance of all equipment (including without limitation air conditioning, ventilating and heating equipment), and may impose reasonable restrictions and requirements with respect to repairs, as provided in Section 7.3, and the provisions of Section 7.4 shall apply to all repairs. Alternatively, Landlord may elect to make any repair or maintenance required hereunder on behalf of Tenant and at Tenant's expense, and Tenant shall promptly reimburse Landlord for all costs incurred upon submission of an invoice. SECTION 7.2 LANDLORD'S MAINTENANCE AND REPAIR. Subject to Section 7.1 and Article XI, Landlord shall provide service, maintenance and repair with respect to the roof, foundations, and footings of the Building, all landscaping, walkways, parking areas, exterior lighting of the Site, and the exterior surfaces of the exterior walls of the Building, except that Tenant at its expense shall make all repairs which Landlord deems reasonably necessary as a result of the act or negligence of Tenant, its agents, employees, invitees, subtenants or contractors. Landlord shall have the right to employ or designate any reputable person or firm, including any employee or agent of Landlord or any of Landlord's affiliates or divisions, to perform any service, repair or maintenance function. Landlord need not make any other improvements or repairs except as specifically required under this Lease, and nothing contained in this Section shall limit Landlord's right to reimbursement from Tenant for maintenance, repair costs and replacement costs as provided elsewhere in this Lease. Tenant understands that it shall not make repairs at Landlord's expense or by rental offset. Tenant further understands that Landlord shall not be required to make any repairs to the roof, foundations or footings unless and until Tenant has notified Landlord in writing of the need for such repair and Landlord shall have a reasonable period of time thereafter to commence and complete said repair, if warranted. Except for Landlord's repair and/or replacement obligations contained in Sections 2.2 and 2.4 of this Lease, all costs of any maintenance and repairs on the part of Landlord provided hereunder shall be considered part of Building Costs. 10. SECTION 7.3 ALTERATIONS. Tenant shall make no alterations, additions or improvements to the Premises without the prior written consent of Landlord, which consent may be given or withheld in Landlord's sole discretion. Notwithstanding the foregoing, Landlord shall not unreasonably withhold its consent to any alterations, additions or improvements to the Premises which cost less than One Dollar ($1.00) per square foot of the improved portions of the Premises (excluding warehouse square footage) and do not (i) affect the exterior of the Building or outside areas (or be visible from adjoining sites), or (ii) affect or penetrate any of the structural portions of the Building, including but not limited to the roof, or (iii) require any change to the basic floor plan of the Premises, any change to any structural or mechanical systems of the Premises, or any governmental permit as a prerequisite to the construction thereof, or (iv) interfere in any manner with the proper functioning of or Landlord's access to any mechanical, electrical, plumbing or HVAC systems, facilities or equipment located in or serving the Building, or (v) diminish the value of the Premises. Landlord may impose, as a condition to its consent, any requirements that Landlord in its discretion may deem reasonable or desirable, including but not limited to a requirement that all work be covered by a lien and completion bond satisfactory to Landlord and requirements as to the manner, time, and contractor for performance of the work. Tenant shall obtain all required permits for the work and shall perform the work in compliance with all applicable laws, regulations and ordinances, all covenants, conditions and restrictions affecting the Premises, and the Rules and Regulations (hereafter defined). If any governmental entity requires, as a condition to any proposed alterations, additions or improvements to the Premises by Tenant, that improvements be made to the outside areas, and if Landlord consents to such improvements to the outside areas, then Tenant shall, at Tenant's sole expense, make such required improvements to the outside areas in such manner, utilizing such materials, and with such contractors (including, if required by Landlord, Landlord's contractors) as Landlord may require in its sole discretion. Under no circumstances shall Tenant make any improvement which incorporates any Hazardous Materials, including without limitation asbestos-containing construction materials into the Premises. Any request for Landlord's consent shall be made in writing and shall contain architectural plans describing the work in detail reasonably satisfactory to Landlord. Unless Landlord otherwise agrees in writing, all alterations, additions or improvements affixed to the Premises (excluding moveable trade fixtures and furniture) shall become the property of Landlord and shall be surrendered with the Premises at the end of the Term, except that Landlord may, as provided in the next succeeding paragraph of this Section 7.3, require Tenant to remove by the Expiration Date, or sooner termination date of this Lease, all or any alterations, decorations, fixtures, additions, improvements and the like installed either by Tenant or by Landlord at Tenant's request and to repair any damage to the Premises arising from that removal. Except as otherwise provided in this Lease or in any Exhibit to this Lease, should Landlord make any alteration or improvement to the Premises for Tenant, Landlord shall be entitled to prompt reimbursement from Tenant for all costs incurred. As of the Expiration Date or earlier termination of the Term, Landlord shall have the right to require Tenant to remove any alterations, additions or improvements made by Tenant to the Premises, whether or not Landlord's consent was required therefor. Notwithstanding the foregoing, if at the time of requesting Landlord's consent to any such alterations, improvements or additions to the Premises, Tenant shall request in writing whether or not Landlord shall require the removal thereof as of the Expiration Date or earlier termination of this Lease, then Landlord's right to require Tenant to so remove such alterations, improvements or additions shall be exercised, if at all, at the time of Landlord's consent thereto. Any such removal by Tenant shall be subject to the provisions of Section 15.3 of this Lease. SECTION 7.4 MECHANIC'S LIENS. Tenant shall keep the Premises free from any liens arising out of any work performed, materials furnished, or obligations incurred by or for Tenant. Upon request by Landlord, Tenant shall promptly cause any such lien to be released by posting a bond in accordance with California Civil Code Section 3143 or any successor statute. In the event that Tenant shall not, within thirty (30) days following the imposition of any lien, cause the lien to be released of record by payment or posting or a proper bond, Landlord shall have, in addition to all other available remedies, the right to cause the lien to be released by any means it deems proper, including payment of or defense against the claim giving rise to the lien. All expenses so incurred by Landlord, including Landlord's attorneys' fees, and any consequential or other damages incurred by Landlord arising out of such lien, shall be reimbursed by Tenant promptly following Landlord's demand, together with interest from the date of payment by Landlord at the maximum rate permitted by law until paid. Tenant shall give Landlord no less than twenty (20) days' prior notice in writing before commencing construction of any kind on the Premises so that Landlord may post and maintain notices of nonresponsibility on the Premises. 11. SECTION 7.5 ENTRY AND INSPECTION. Landlord shall at all reasonable times, upon written or oral notice (except in emergencies, when no notice shall be required) have the right to enter the Premises to inspect them, to supply services in accordance with this Lease, to protect the interests of Landlord in the Premises, and to submit the Premises to prospective or actual purchasers or encumbrance holders (or, during the last one hundred and eighty (180) days of the Term or when an uncured Tenant default exists, to prospective tenants), all without being deemed to have caused an eviction of Tenant and without abatement of rent except as provided elsewhere in this Lease. Except in cases of emergency, Landlord, at Tenant's election, shall be accompanied by Tenant's representative in connection with any such entry. Landlord shall have the right, if desired, to retain a key which unlocks all of the doors in the Premises, excluding Tenant's vaults and safes, and Landlord shall have the right to use any and all means which Landlord may deem proper to open the doors in an emergency in order to obtain entry to the Premises, and any entry to the Premises obtained by Landlord shall not under any circumstances be deemed to be a forcible or unlawful entry into, or a detainer of, the Premises, or any eviction of Tenant from the Premises. ARTICLE VIII TAXES AND ASSESSMENTS ON TENANT'S PROPERTY Tenant shall be liable for and shall pay, at least ten (10) days before delinquency, all taxes and assessments levied against all personal property of Tenant located in the Premises, and against any alterations, additions or like improvements made to the Premises by or on behalf of Tenant. When possible Tenant shall cause its personal property and alterations to be assessed and billed separately from the real property of which the Premises form a part. If any taxes on Tenant's personal property and/or alterations are levied against Landlord or Landlord's property and if Landlord pays the same, or if the assessed value of Landlord's property is increased by the inclusion of a value placed upon the personal property and/or alterations of Tenant and if Landlord pays the taxes based upon the increased assessment, Tenant shall pay to Landlord the taxes so levied against Landlord or the proportion of the taxes resulting from the increase in the assessment. In calculating what portion of any tax bill which is assessed against Landlord separately, or Landlord and Tenant jointly, is attributable to Tenant's alterations and personal property, Landlord's reasonable determination shall be conclusive. ARTICLE IX ASSIGNMENT AND SUBLETTING SECTION 9.1 RIGHTS OF PARTIES. (a) Notwithstanding any provision of this Lease to the contrary, Tenant will not, either voluntarily or by operation of law, assign, sublet, encumber, or otherwise transfer all or any part of Tenant's interest in this lease, or permit the Premises to be occupied by anyone other than Tenant, without Landlord's prior written consent, which consent shall not unreasonably be withheld in accordance with the provisions of Section 9.1(b). No assignment (whether voluntary, involuntary or by operation of law) and no subletting shall be valid or effective without Landlord's prior written consent and, at Landlord's election, any such assignment or subletting or attempted assignment or subletting shall constitute a material default of this Lease. Landlord shall not be deemed to have given its consent to any assignment or subletting by any other course of action, including its acceptance of any name for listing in the Building directory. To the extent not prohibited by provisions of the Bankruptcy Code, 11 U.S.C. Section 101 et seq. (the "Bankruptcy Code"), including Section 365(f)(1), Tenant on behalf of itself and its creditors, administrators and assigns waives the applicability of Section 365(e) of the Bankruptcy Code unless the proposed assignee of the Trustee for the estate of the bankrupt meets Landlord's standard for consent as set forth in Section 9.1(b) of this Lease. If this Lease is assigned to any person or entity pursuant to the provisions of the Bankruptcy Code, any and all monies or other considerations to be delivered in connection with the assignment shall be delivered to Landlord, shall be and remain the exclusive property of Landlord and shall not constitute property of Tenant or of the estate of Tenant within the meaning of the Bankruptcy Code. Any person or entity to which this Lease is assigned pursuant to the provisions of the Bankruptcy Code shall be deemed to have assumed all of the obligations arising under this Lease on and after the date of the assignment, and shall upon demand execute and deliver to Landlord an instrument confirming that assumption. 12. (b) If Tenant desires to transfer an interest in this Lease, it shall first notify Landlord of its desire and shall submit in writing to Landlord: (i) the name and address of the proposed transferee; (ii) the nature of any proposed subtenant's or assignee's business to be carried on in the Premises; (iii) the terms and provisions of any proposed sublease or assignment, including a copy of the proposed assignment or sublease form; (iv) evidence of insurance of the proposed assignee or subtenant complying with the requirements of Exhibit D hereto; (v) a completed Environmental Questionnaire from the proposed assignee or subtenant; and (vi) any other information requested by Landlord and reasonably related to the transfer. Except as provided in Subsection (e) of this Section, Landlord shall not unreasonably withhold its consent, provided: (1) the use of the Premises will be consistent with the provisions of this Lease; (2) the proposed assignee or subtenant has not been required by any prior landlord, lender or governmental authority to take remedial action in connection with Hazardous Materials contaminating a property arising out of the proposed assignee's or subtenant's actions or use of the property in question and is not subject to any enforcement order issued by any governmental authority in connection with the use, disposal or storage of a Hazardous Material; (3) at Landlord's election, insurance requirements shall be brought into conformity with Landlord's then current leasing practice; (4) any proposed subtenant or assignee demonstrates that it is financially responsible by submission to Landlord of all reasonable information as Landlord may request concerning the proposed subtenant or assignee, including, but not limited to, a balance sheet of the proposed subtenant or assignee as or a date within ninety (90) days of the request for Landlord's consent and statements of income or profit and loss of the proposed subtenant or assignee for the two-year period preceding the request for Landlord's consent, and/or a certification signed by the proposed subtenant or assignee that it has not been evicted or been in arrears in rent at any other leased premises for the 3-year period preceding the request for Landlord's consent; (5) any proposed subtenant or assignee demonstrates to Landlord's reasonable satisfaction a record of successful experience in business; and (6) the proposed transfer will not impose additional burdens or adverse tax effects on Landlord. If Tenant has any exterior sign rights under this Lease, such rights are personal to Tenant and may not be assigned or transferred to any assignee of this Lease or subtenant of the Premises without Landlord's prior written consent, which may be withheld in Landlord's sole and absolute discretion. If Landlord consents to the proposed transfer, Tenant may within ninety (90) days after the date of the consent effect the transfer upon the terms described in the information furnished to Landlord; provided that any material change in the terms shall be subject to Landlord's consent as set forth in this Section. Landlord shall approve or disapprove any requested transfer within fifteen (15) business days following receipt of Tenant's written request, the information set forth above, and the fee set forth below. (c) Notwithstanding the provisions of Subsection (b) above, in lieu of consenting to a proposed assignment of the Lease or to any proposed subletting of the entire floor area of the Premises for more than fifty percent (50%) of the then-remaining Term of this Lease, Landlord may elect to (i) sublease the Premises or take an assignment of Tenant's interest in this Lease, upon the same terms as offered to such proposed subtenant or assignee (excluding terms relating to the purchase of personal property, the use of Tenant's name or the continuation of Tenant's business), or (ii) terminate this Lease effective on the date that such proposed sublease or assignment would have become effective, Landlord may thereafter, at its option, assign or re-let any space so recaptured to any third party, including without limitation the proposed transferee of Tenant. (d) Tenant agrees that fifty percent (50%) of any amounts paid by the assignee or subtenant, however described, in excess of (i) the Basic Rent payable by Tenant hereunder, or in the case or a sublease or a portion of the Premises, in excess of the Basic Rent reasonably allocable to such portion, plus (ii) Tenant's direct out-of-pocket costs which Tenant certifies to Landlord have been paid to provide occupancy related services to such assignee or subtenant of a nature commonly provided by landlords of similar space, shall be the property of Landlord and such amounts shall be payable directly to Landlord by the assignee or subtenant or, at Landlord's option, by Tenant. At Landlord's request, a written agreement shall be entered into by and among Tenant, Landlord and the proposed assignee or subtenant confirming the requirements of this subsection. (e) Tenant shall pay to Landlord a fee of Five Hundred Dollars ($500.00) if and when any transfer hereunder is requested by Tenant. Such fee is hereby acknowledged as a reasonable amount to reimburse Landlord for its costs of review and evaluation or a proposed assignee/sublessee, and Landlord shall not be obligated to commence such review and evaluation unless and until such fee is paid. 13. SECTION 9.2 EFFECT OF TRANSFER. No subletting or assignment, even with the consent of Landlord, shall relieve Tenant of its obligation to pay rent and to perform all its other obligations under this Lease. Moreover, Tenant shall indemnify and hold Landlord harmless, as provided in Section 10.3, for any act or omission by an assignee or subtenant. Each assignee, other than Landlord, shall be deemed to assume all obligations of Tenant under this Lease and shall be liable jointly and severally with Tenant for the payment of all rent, and for the due performance of all of Tenant's obligations, under this Lease. No transfer shall be binding on Landlord unless any document memorializing the transfer is delivered to Landlord and both the assignee/subtenant and Tenant deliver to Landlord an executed consent to transfer instrument prepared by Landlord and consistent with the requirements of this Article. The acceptance by Landlord of any payment due under this Lease from any other person shall not be deemed to be a waiver by Landlord of any provision of this Lease or to be a consent to any transfer. Consent by Landlord to one or more transfers shall not operate as a waiver or estoppel to the future enforcement by Landlord of its rights under this Lease. SECTION 9.3 SUBLEASE REQUIREMENTS. The following terms and conditions shall apply to any subletting by Tenant of all or any part of the Premises and shall be deemed included in each sublease: (a) Each and every provision contained in this Lease (other than with respect to the payment of rent hereunder) is incorporated by reference into and made a part of such sublease, with "Landlord" hereunder meaning the sublandlord therein and "Tenant" hereunder meaning the subtenant therein. (b) Tenant hereby irrevocably assigns to Landlord all of Tenant's interest in all rentals and income arising from any sublease of the Premises, and Landlord may collect such rent and income and apply same toward Tenant's obligations under this Lease; provided, however, that until a default occurs in the performance of Tenant's obligations under this Lease, Tenant shall have the right to receive and collect the sublease rentals. Landlord shall not, by reason of this assignment or the collection of sublease rentals, be deemed liable to the subtenant for the performance of any of Tenant's obligations under the sublease. Tenant hereby irrevocably authorizes and directs any subtenant, upon receipt of a written notice from Landlord stating that an uncured default exists in the performance of Tenant's obligations under this Lease, to pay to Landlord all sums then and thereafter due under the sublease. Tenant agrees that the subtenant may rely on that notice without any duty of further inquiry and notwithstanding any notice or claim by Tenant to the contrary. Tenant shall have no right or claim against the subtenant or Landlord for any rentals so paid to Landlord. (c) In the event of the termination of this Lease, Landlord may, at its sole option, take over Tenant's entire interest in any sublease and, upon notice from Landlord, the subtenant shall attorn to Landlord. In no event, however, shall Landlord be liable for any previous act or omission by Tenant under the sublease or for the return of any advance rental payments or deposits under the sublease that have not been actually delivered to Landlord, nor shall Landlord be bound by any sublease modification executed without Landlord's consent or for any advance rental payment by the subtenant in excess of one month's rent. The general provisions of this Lease, including without limitation those pertaining to insurance and indemnification, shall be deemed incorporated by reference into the sublease despite the termination of this Lease. SECTION 9.4 CERTAIN TRANSFERS. The sale of all or substantially all of Tenant's assets (other than bulk sales in the ordinary course of business) or, if Tenant is a corporation, an unincorporated association, or a partnership, the transfer, assignment or hypothecation of any stock or interest in such corporation, association, or partnership in the aggregate of twenty-five percent (25%) (except for publicly traded shares of stock constituting a transfer of twenty-five percent (25%) or more in the aggregate, so long as no change in the controlling interest of Tenant occurs as a result thereof) shall be deemed an assignment within the meaning and provisions of this Article. Notwithstanding the foregoing, Landlord's consent shall not be required for the assignment of this Lease as a result of a merger by Tenant with or into another entity, so long as (i) the net worth of the successor entity after such merger is at least equal to the greater of the net worth of Tenant as of the execution of this Lease by Landlord or the net worth of Tenant immediately prior to the date of such merger, evidence of which, satisfactory to Landlord, shall be presented to Landlord prior to such merger, (ii) Tenant shall provide to Landlord, prior to such merger, written notice of such merger and such assignment documentation and other information as Landlord may request in connection therewith, and (iii) all of the other terms and requirements of this Article shall apply with respect to such assignment. 14. ARTICLE X INSURANCE AND INDEMNITY SECTION 10.1 TENANT'S INSURANCE. Tenant, at its sole cost and expense, shall provide and maintain in effect tile insurance described in Exhibit D. Evidence of that insurance must be delivered to Landlord prior to the Commencement Date. SECTION 10.2 LANDLORD'S INSURANCE. Landlord may, at its election, provide any or all of the following types of insurance, with or without deductible and in amounts and coverages as may be determined by Landlord in its discretion: "all risk" property insurance, subject to standard exclusions, covering the Building, and such other risks as Landlord or its mortgagees may from time to time deem appropriate, including leasehold improvements made by Landlord, and commercial general liability coverage. Landlord shall not be required to carry insurance of any kind on Tenant's property, including leasehold improvements, trade fixtures, furnishings, equipment, plate glass, signs and all other items of personal property, and shall not be obligated to repair or replace that property should damage occur. All proceeds of insurance maintained by Landlord upon the Building shall be the property of Landlord, whether or not Landlord is obligated to or elects to make any repairs. At Landlord's option, Landlord may self-insure all or any portion of the risks for which Landlord elects to provide insurance hereunder. SECTION 10.3 TENANT'S INDEMNITY. To the fullest extent permitted by law, and except to the extent of the sole active negligence of Landlord, its employees or authorized agents, Tenant shall defend, indemnify, protect, save and hold harmless Landlord, its agents, and any and all affiliates of Landlord, including, without limitation, any corporations or other entities controlling, controlled by or under common control with Landlord, from and against any and all claims, liabilities, costs or expenses arising either before or after the Commencement Date from Tenant's use or occupancy of the Premises or the Building, or from the conduct of its business, or from any activity, work, or thing done, permitted or suffered by Tenant or its agents, employees, invitees or licensees in or about the Premises or the Building, or from any default in the performance of any obligation on Tenant's part to be performed under this Lease, or from any act or negligence of Tenant or its agents, employees, visitors, patrons, guests, invitees or licensees. Landlord may, at its option, require Tenant to assume Landlord's defense in any action covered by this Section through counsel satisfactory to Landlord. The provisions of this Section shall expressly survive the expiration or sooner termination of this Lease. SECTION 10.4 LANDLORD'S NONLIABILITY. Except to the extent of the sole active negligence of Landlord, its employees or authorized agents, Landlord shall not be liable to Tenant, its employees, agents and invitees, and Tenant hereby waives all claims against Landlord for loss of or damage to any property or personal injury, or any other loss, cost, damage, injury or liability whatsoever resulting from fire, explosion, falling plaster, steam, gas, electricity, water or rain which may leak or flow from or into any part of the Premises or from the breakage, leakage, obstruction or other defects of the pipes, sprinklers, wires, appliances, plumbing, air conditioning, electrical works or other fixtures in the Building, whether the damage or injury results from conditions arising in the Premises or in other portions of the Building. It is understood that any such condition may require the temporary evacuation or closure of all or a portion of the Building. Notwithstanding any provision of this Lease to the contrary, including, without limitation, the negligence of Landlord, its employees and/or agents, Landlord shall in no event be liable to Tenant, its employees, agents, and invitees, and Tenant hereby waives all claims against Landlord, for loss or interruption of Tenant's business or income (including, without limitation, any consequential damages and lost profit or opportunity costs), or any other loss, cost, damage, injury or liability resulting from, but not limited to, Acts of God (except with respect to restoration obligations pursuant to Article XI below), acts of civil disobedience or insurrection, acts or omissions (criminal or otherwise) of any third parties (other than Landlord's employees or authorized agents), including without limitation, any other tenants within the Project or their agents, employees, contractors, guests or invitees. Except as provided in Sections 11.1 and 12.1 below, there shall be no abatement of rent and no liability of Landlord by reason of any injury to or interference with Tenant's business (including without limitation consequential damages and lost profit or opportunity costs) arising from the making of any repairs, alterations or improvements to any portion of the Building, including repairs to the Premises, nor shall any related activity by Landlord constitute an actual or constructive eviction; provided, however, that in making repairs, alterations or improvements, Landlord shall interfere as little as reasonably practicable with the conduct of Tenant's business in the Premises. Neither Landlord nor its agents shall be liable for interference 15. with light or other similar intangible interests. Tenant shall immediately notify Landlord in case of fire or accident in the Premises or the Building and of defects in any improvements or equipment. SECTION 10.5 WAIVER OF SUBROGATION. Landlord and Tenant each hereby waives all rights of recovery against the other and the other's agents on account of loss and damage occasioned to the property of such waiving party to the extent only that such loss or damage is required to be insured against under any "all risk" property insurance policies required by this Article X; provided however, that (i) the foregoing waiver shall not apply to the extent of Tenant's obligations to pay deductibles under any such policies and this Lease, and (ii) if any loss is due to the act, omission or negligence or willful misconduct of Tenant or its agents, employees, contractors, guests or invitees, Tenant's liability insurance shall be primary and shall cover all losses and damages prior to any other insurance hereunder. By this waiver it is the intent of the parties that neither Landlord nor Tenant shall be liable to any insurance company (by way of subrogation or otherwise) insuring the other party for any loss or damage insured against under any "all risk" property insurance policies required by this Article, even though such loss or damage might be occasioned by the negligence of such party, its agents, employees, contractors, guests or invitees. The provisions of this Section shall not limit the indemnification provisions elsewhere contained in this Lease. ARTICLE XI DAMAGE OR DESTRUCTION SECTION 11.1 RESTORATION. (a) If the Building is damaged, Landlord shall repair that damage as soon as reasonably possible, at its expense, unless: (i) Landlord reasonably determines that the cost of repair is not covered by Landlord's fire and extended coverage insurance plus such additional amounts Tenant elects, at its option, to contribute, excluding however the deductible (for which Tenant shall be responsible for Tenant's proportionate share); (ii) Landlord reasonably determines that the Premises cannot, with reasonable diligence, be fully repaired by Landlord (or cannot be safely repaired because of the presence of hazardous factors, including without limitation Hazardous Materials, earthquake faults, and other similar dangers) within two hundred seventy (270) days after the date of the damage; (iii) an event of default by Tenant has occurred and is continuing at the time of such damage; or (iv) the damage occurs during the final twelve (12) months of the Term. Should Landlord elect not to repair the damage for one of the preceding reasons, Landlord shall so notify Tenant in writing within sixty (60) days after the damage occurs and this Lease shall terminate as of the date of that notice. (b) Unless Landlord elects to terminate this Lease in accordance with subsection (a) above, this Lease shall continue in effect for the remainder of the Term; provided that so long as Tenant is not in default under this Lease, if the damage is so extensive that Landlord reasonably determines that the Premises cannot, with reasonable diligence, be repaired by Landlord (or cannot be safely repaired because of the presence of hazardous factors, earthquake faults, and other similar dangers) so as to allow Tenant's substantial use and enjoyment of the Premises within two hundred seventy (270) days after the date of damage, then Tenant may elect to terminate this Lease by written notice to Landlord within the sixty (60) day period stated in subsection (a). (c) Commencing on the date of any damage to the Building, and ending on the sooner of the date the damage is repaired or the date this Lease is terminated, the rental to be paid under this Lease shall be abated in the same proportion that the floor area of the Building that is rendered unusable by the damage from time to time bears to the total floor area of the Building, but only to the extent that any business interruption insurance proceeds are received by Landlord therefor from Tenant's insurance described in Exhibit D. (d) Notwithstanding the provisions of subsections (a), (b) and (c) of this Section, and subject to the provisions of Section 10.5 above, the cost of any repairs shall be borne by Tenant, and Tenant shall not be entitled to rental abatement or termination rights, if the damage is due to the fault or neglect of Tenant or its employees, subtenants, invitees or representatives. In addition, the provisions of this Section shall not be deemed to require Landlord to repair any improvements or fixtures that Tenant is obligated to repair or insure pursuant to any other provision of this Lease. 16. (e) Tenant shall fully cooperate with Landlord in removing Tenant's personal property and any debris from the Premises to facilitate all inspections of the Premises and the making of any repairs. Notwithstanding anything to the contrary contained in this Lease, if Landlord in good faith believes there is a risk of injury to persons or damage to property from entry into the Building or Premises following any damage or destruction thereto, Landlord may restrict entry into the Building or the Premises by Tenant, its employees, agents and contractors in a non-discriminatory manner, without being deemed to have violated Tenant's rights of quiet enjoyment to, or made an unlawful detainer of, or evicted Tenant from, the Premises. Upon request, Landlord shall consult with tenant to determine if there are safe methods of entry into the Building or the Premises solely in order to allow Tenant to retrieve files, data in computers, and necessary inventory, subject however to all indemnities and waivers of liability from Tenant to Landlord contained in this Lease and any additional indemnities and waivers of liability which Landlord may require. SECTION 11.2 LEASE GOVERNS. Tenant agrees that the provisions of this Lease, including without limitation Section 11.1, shall govern any damage or destruction and shall accordingly supersede any contrary statute or rule of law. ARTICLE XII EMINENT DOMAIN SECTION 12.1 TOTAL OR PARTIAL TAKING. If all or a material portion of the Premises is taken by any lawful authority by exercise of the right of eminent domain, or sold to prevent a taking, either Tenant or Landlord may terminate this Lease effective as of the date possession is required to be surrendered to the authority. In the event title to a portion of the Premises is taken or sold in lieu of taking, and if Landlord elects to restore the Premises in such a way as to alter the Premises materially, either party may terminate this Lease, by written notice to the other party, effective on the date of vesting of title. In the event neither party has elected to terminate this Lease as provided above, then Landlord shall promptly, after receipt of a sufficient condemnation award, proceed to restore the Premises to substantially their condition prior to the taking, and a proportionate allowance shall be made to Tenant for the rent corresponding to the time during which, and to the pan of the Premises of which, Tenant is deprived on account of the taking and restoration. In the event of a taking, Landlord shall be entitled to the entire amount of the condemnation award without deduction for any estate or interest of Tenant; provided that nothing in this Section shall be deemed to give Landlord any interest in, or prevent Tenant from seeking any award against the taking authority for, the taking of personal property and fixtures belonging to Tenant or for relocation or business interruption expenses recoverable from the taking authority. SECTION 12.2 TEMPORARY TAKING. No temporary taking of the Premises shall terminate this Lease or give Tenant any right to abatement of rent, and any award specifically attributable to a temporary taking of the Premises shall belong entirely to Tenant. A temporary taking shall be deemed to be a taking of the use or occupancy of the Premises for a period of not to exceed one hundred eighty (180) days. SECTION 12.3 TAKING OF PARKING AREA. In the event there shall be a taking of the parking area such that Landlord can no longer provide sufficient parking to comply with this Lease, Landlord may substitute reasonably equivalent parking in a location reasonably close to the Building; provided that if Landlord fails to make that substitution within ninety (90) days following the taking and if the taking materially impairs Tenant's use and enjoyment of the Premises, Tenant may, at its option, terminate this Lease by written notice to Landlord. If this Lease is not so terminated by Tenant, there shall be no abatement of rent and this Lease shall continue in effect. ARTICLE XIII SUBORDINATION; ESTOPPEL CERTIFICATE; FINANCIALS SECTION 13.1 SUBORDINATION. At the option of Landlord, this Lease shall be either superior or subordinate to all ground or underlying leases, mortgages and deeds of trust, if any, which may hereafter affect the Premises, and to all renewals, modifications, consolidations, replacements and extensions thereof; provided, that so long as Tenant is not in default under this Lease, this Lease shall not be terminated or Tenant's quiet enjoyment of 17. the Premises is disturbed in the event of termination of any such ground or underlying lease, or the foreclosure of any such mortgage or deed of trust, to which Tenant has subordinated this Lease pursuant to this Section. In the event of a termination or foreclosure, Tenant shall become a tenant of and attorn to the successor-in-interest to Landlord upon the same terms and conditions as are contained in this Lease, and shall execute any instrument reasonably required by Landlord's successor for that purpose. Tenant shall also, upon written request of Landlord, execute and deliver all instruments as may be required from time to time to subordinate the rights of Tenant under this Lease to any ground or underlying lease or to the lien of any mortgage or deed of trust (provided that such instruments include the nondisturbance and attornment provisions set forth above), or, if requested by Landlord, to subordinate, in whole or in part, any ground or underlying lease or the lien of any mortgage or deed of trust to this Lease. SECTION 13.2 ESTOPPEL CERTIFICATE. (a) Tenant shall, at any time upon not less than ten (10) days prior written notice from Landlord, execute, acknowledge and deliver to Landlord, in any form that Landlord may reasonably require, a statement in writing (i) certifying that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of the modification and certifying that this Lease, as modified, is in full force and effect) and the dates to which the rental, additional rent and other charges have been paid in advance, if any, and (ii) acknowledging that, to Tenant's knowledge, there are no uncured defaults on the part of Landlord, or specifying each default if any are claimed, and (iii) setting forth all further information that Landlord may reasonably require. Tenant's statement may be relied upon by any prospective purchaser or encumbrancer of the Premises. (b) Notwithstanding any other rights and remedies of Landlord, Tenant's failure to deliver any estoppel statement within the provided time shall be conclusive upon Tenant that (i) this Lease is in full force and effect, without modification except as may be represented by Landlord, (ii) there are no uncured defaults in Landlord's performance, and (iii) not more than one month's rental has been paid in advance. SECTION 13.3 FINANCIALS. (a) Tenant shall deliver to Landlord, prior to the execution of this Lease and thereafter at any time upon Landlord's request, Tenant's current tax returns and financial statements, certified true, accurate and complete by the chief financial officer of Tenant, including a balance sheet and profit and loss statement for the most recent prior year (collectively, the "Statements"), which Statements shall accurately and completely reflect the financial condition of Tenant. Landlord agrees that it will keep the Statements confidential, except that Landlord shall have the right to deliver the same to any proposed purchaser or encumbrancer of the Premises. Notwithstanding the foregoing, so long as Tenant is a publicly-traded corporation whose stock is traded on a nationally recognized exchange or on NASDAQ, the "Statements" shall consist of Tenant's most recently publicly disclosed financial statements. (b) Tenant acknowledges that Landlord is relying on the Statements in its determination to enter into this Lease, and Tenant represents to Landlord, which representation shall be deemed made on the date of this Lease and again on the Commencement Date, that no material change in the financial condition of Tenant, as reflected in the Statements, has occurred since the date Tenant delivered the Statements to Landlord. The Statements are represented and warranted by Tenant to be correct and to accurately and fully reflect Tenant's true financial condition as of the date of submission by any Statements to Landlord. ARTICLE XIV DEFAULTS AND REMEDIES SECTION 14.1 TENANT'S DEFAULTS. In addition to any other event of default set forth in this Lease, the occurrence of any one or more of the following events shall constitute a default by Tenant: (a) The failure by Tenant to make any payment of rent or additional rent required to be made by Tenant, as and when due, where the failure continues for a period of three (3) days after written notice from 18. Landlord to Tenant; provided, however, that any such notice shall be in lieu of, and not in addition to, any notice required under California Code of Civil Procedure Section 1161 and 1161(a) as amended. For purposes of these default and remedies provisions, the term "additional rent" shall be deemed to include all amounts of any type whatsoever other than Basic Rent to be paid by Tenant pursuant to the terms of this Lease. (b) Assignment, sublease, encumbrance or other transfer of the Lease by Tenant, either voluntarily or by operation of law, whether by judgment, execution, transfer by intestacy or testacy, or other means, without the prior written consent of Landlord. (c) The discovery by Landlord that any financial statement provided by Tenant, or by any affiliate, successor or guarantor of Tenant, was materially false. (d) The failure of Tenant to timely and fully provide any subordination agreement, estoppel certificate or financial statements in accordance with the requirements of Article XIII. (e) The failure or inability by Tenant to observe or perform any of the express or implied covenants or provisions of this Lease to be observed or performed by Tenant, other than as specified in any other subsection of this Section, where the failure continues for a period of thirty (30) days after written notice from Landlord to Tenant or such shorter period as is specified in any other provision of this Lease; provided, however, that any such notice shall be in lieu of, and not in addition to, any notice required under California Code of Civil Procedure Section 1161 and 1161(a) as amended. However, if the nature of the failure is such that more than thirty (30) days are reasonably required for its cure, then Tenant shall not be deemed to be in default if Tenant commences the cure within thirty (30) days, and thereafter diligently pursues the cure to completion. (f) (i) The making by Tenant of any general assignment for the benefit of creditors; (ii) the filing by or against Tenant or a petition to have Tenant adjudged a Chapter 7 debtor under the Bankruptcy Code or to have debts discharged or a petition for reorganization or arrangement under any law relating to bankruptcy (unless, in the case or a petition filed against Tenant, the same is dismissed within thirty (30) days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, if possession is not restored to Tenant within thirty (30) days; (iv) the attachment, execution or other judicial seizure of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, where the seizure is not discharged within thirty (30) days; or (v) Tenant's convening of a meeting of its creditors for the purpose of effecting a moratorium upon or composition of its debts. Landlord shall not be deemed to have knowledge of any event described in this subsection unless notification in writing is received by Landlord, nor shall there be any presumption attributable to Landlord of Tenant's insolvency. In the event that any provision of this subsection is contrary to applicable law, the provision shall be of no force or effect. SECTION 14.2 LANDLORD'S REMEDIES. (a) In the event of any default by Tenant, or in the event of the abandonment of the Premises by Tenant, then in addition to any other remedies available to Landlord, Landlord may exercise the following remedies: (i) Landlord may terminate Tenant's right to possession of the Premises by any lawful means, in which case this Lease shall terminate and Tenant shall immediately surrender possession of the Premises to Landlord. Such termination shall not affect any accrued obligations of Tenant under this Lease. Upon termination, Landlord shall have the right to reenter the Premises and remove all persons and property. Landlord shall also be entitled to recover from Tenant: 1. The worth at the time of award of the unpaid rent and additional rent which had been earned at the time of termination; 2. The worth at the time of award of the amount by which the unpaid rent and additional rent which would have been earned after termination until the time of award exceeds the amount of such loss that Tenant proves could have been reasonably avoided; 19. 3. The worth at the time of award of the amount by which the unpaid rent and additional rent for the balance of the Term after the time of award exceeds the amount of such loss that Tenant proves could be reasonably avoided; 4. Any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result from Tenant's default, including, but not limited to, the cost of recovering possession of the Premises, refurbishment of the Premises, marketing costs, commissions and other expenses of reletting, including necessary, repair, the unamortized portion of any tenant improvements and brokerage commissions funded by Landlord in connection with this Lease, reasonable attorneys' fees, and any other reasonable costs; and 5. At Landlord's election, all other amounts in addition to or in lieu of the foregoing as may be permitted by law. The term "rent" as used in this Lease shall be deemed to mean the Basic Rent and all other sums required to be paid by Tenant to Landlord pursuant to the terms of this Lease. Any sum, other than Basic Rent, shall be computed on the basis of the average monthly amount accruing during the twenty-four (24) month period immediately prior to default, except that if it becomes necessary to compute such rental before the twenty-four (24) month period has occurred, then the computation shall be on the basis of the average monthly amount during the shorter period. As used in subparagraphs (1) and (2) above, the "worth at the time of award" shall be computed by allowing interest at the rate often percent (10%) per annum. As used in subparagraph (3) above, the "worth at the time of award" shall be computed by discounting the amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). (ii) Landlord may elect not to terminate Tenant's right to possession of the Premises, in which event Landlord may continue to enforce all of its rights and remedies under this Lease, including the right to collect all rent as it becomes due. Efforts by the Landlord to maintain, preserve or relet the Premises, or the appointment or a receiver to protect the Landlord's interests under this Lease, shall not constitute a termination of the Tenant's right to possession of the Premises. In the event that Landlord elects to avail itself of the remedy provided by this subsection (ii), Landlord shall not unreasonably withhold its consent to an assignment or subletting of the Premises subject to the reasonable standards for Landlord's consent as are contained in this Lease. (b) Landlord shall be under no obligation to observe or perform any covenant of this Lease on its part to be observed or performed which accrues after the date of any default by Tenant unless and until the default is cured by Tenant, it being understood and agreed that the performance by Landlord of its obligations under this Lease are expressly conditioned upon Tenant's full and timely performance of its obligations under this Lease. The various rights and remedies reserved to Landlord in this Lease or otherwise shall be cumulative and, except as otherwise provided by California law, Landlord may pursue any or all of its rights and remedies at the same time. (c) No delay or omission of Landlord to exercise any right or remedy shall be construed as a waiver of the right or remedy or of any default by Tenant. The acceptance by Landlord of rent shall not be a (i) waiver of any preceding breach or default by Tenant of any provision of this Lease, other than the failure of Tenant to pay the particular rent accepted, regardless of Landlord's knowledge of the preceding breach or default at the time of acceptance of rent, or (ii) a waiver of Landlord's right to exercise any remedy available to Landlord by virtue of the breach or default. The acceptance of any payment from a debtor in possession, a trustee, a receiver or any other person acting on behalf of Tenant or Tenant's estate shall not waive or cure a default under Section 14.1. No payment by Tenant or receipt by Landlord of a lesser amount than the rent required by this Lease shall be deemed to be other than a partial payment on account of the earliest due stipulated rent, nor shall any endorsement or statement on any check or letter be deemed an accord and satisfaction and Landlord shall accept the check or payment without prejudice to Landlord's right to recover the balance of the rent or pursue any other remedy available to it. No act or thing done by Landlord or Landlord's agents during the Term shall be deemed an acceptance of a surrender of the Premises, and no agreement to accept a surrender shall be valid unless in writing and signed by Landlord. No employee of Landlord or of Landlord's agents shall have any power to accept the keys to the Premises prior to the termination of this Lease, and the delivery of the keys to any employee shall not operate as a termination of the Lease or a surrender of the Premises. 20. SECTION 14.3 LATE PAYMENTS. (a) Any rent due under this Lease that is not received by Landlord within five (5) days of the date when due shall bear interest at the maximum rate permitted by law from the date due until fully paid. The payment of interest shall not cure any default by Tenant under this Lease. In addition, Tenant acknowledges that the late payment by Tenant to Landlord of rent will cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult and impracticable to ascertain. Those costs may include, but are not limited to, administrative, processing and accounting charges, and late charges which may be imposed on Landlord by the terms of any ground lease, mortgage or trust deed covering the Premises. Accordingly, if any rent due from Tenant shall not be received by Landlord or Landlord's designee within five (5) days after the date due, then Tenant shall pay to Landlord, in addition to the interest provided above, a late charge in a sum equal to the greater of five percent (5%) of the amount overdue or Two Hundred Fifty Dollars ($250.00) for each delinquent payment. Acceptance of a late charge by Landlord shall not constitute a waiver of Tenant's default with respect to the overdue amount, nor shall it prevent Landlord from exercising any of its other rights and remedies. (b) Following each second consecutive installment of rent that is not paid within five (5) days following notice of nonpayment from Landlord. Landlord shall have the option (i) to require that beginning with the first payment of rent next due, rent shall no longer be paid in monthly installments but shall be payable quarterly three (3) months in advance and/or (ii) to require that Tenant increase the amount, if any, of the Security Deposit by one hundred percent (100%). Should Tenant deliver to Landlord, at any time during the Term, two (2) or more insufficient cheeks, the Landlord may require that all monies then and thereafter due from Tenant be paid to Landlord by cashier's check. SECTION 14.4 RIGHT OF LANDLORD TO PERFORM. All covenants and agreements to be performed by Tenant under this Lease shall be performed at Tenant's sole cost and expense and without any abatement of rent or right of set-off. If Tenant fails to pay any sum of money, other than rent, or fails to perform any other act on its part to be performed under this Lease, and the failure continues beyond any applicable grace period set forth in Section 14.1, then in addition to any other available remedies, Landlord may, at its election make the payment or perform the other act on Tenant's part. Landlord's election to make the payment or perform the act on Tenant's part shall not give rise to any responsibility of Landlord to continue making the same or similar payments or performing the same or similar acts. Tenant shall, promptly upon demand by Landlord, reimburse Landlord for all sums paid by Landlord and all necessary incidental costs, together with interest at the maximum rate permitted by law from the date of the payment by Landlord. Landlord shall have the same rights and remedies if Tenant fails to pay those amounts as Landlord would have in the event of a default by Tenant in the payment of rent. SECTION 14.5 DEFAULT BY LANDLORD. Landlord shall not be deemed to be in default in the performance of any obligation under this Lease unless and until it has failed to perform the obligation within thirty (30) days after written notice by Tenant to Landlord specifying in reasonable detail the nature and extent of the failure; provided, however, that if the nature of Landlord's obligation is such that more than thirty (30) days are required for its performance, then Landlord shall not he deemed to be in default if it commences performance within the thirty (30) day period and thereafter diligently pursues the cure to completion. SECTION 14.6 EXPENSES AND LEGAL FEES. All sums reasonably incurred by Landlord in connection with any event of default by Tenant under this Lease or holding over of possession by Tenant after the expiration or earlier termination of this Lease, including without limitation all costs, expenses and actual accountants, appraisers, attorneys and other professional fees, and any collection agency or other collection charges, shall be due and payable by Tenant to Landlord on demand, and shall bear interest at the rate of ten percent (10%) per annum. Should either Landlord or Tenant bring any action in connection with this Lease, the prevailing party shall be entitled to recover as a part of the action its reasonable attorneys' fees, and all other costs. The prevailing party for the purpose of this paragraph shall be determined by the trier of the facts. SECTION 14.7 WAIVER OF JURY TRIAL. LANDLORD AND TENANT EACH ACKNOWLEDGES THAT IT IS AWARE OF AND HAS HAD THE ADVICE OF COUNSEL OF ITS CHOICE WITH RESPECT TO ITS RIGHTS TO TRIAL BY JURY, AND EACH PARTY DOES HEREBY EXPRESSLY AND KNOWINGLY WAIVE AND RELEASE ALL SUCH RIGHTS TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM BROUGHT BY EITHER PARTY HERETO AGAINST THE OTHER 21. (AND/OR AGAINST ITS OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, OR SUBSIDIARY OR AFFILIATED ENTITIES) ON ANY MATTERS WHATSOEVER ARISING OUT OF OR IN ANY WAY CONNECTED WITH THIS LEASE, TENANT'S USE OR OCCUPANCY OF THE PREMISES, AND/OR ANY CLAIM OF INJURY OR DAMAGE. SECTION 14.8 SATISFACTION OF JUDGMENT. The obligations of Landlord do not constitute the personal obligations of the individual partners, trustees, directors, officers or shareholders of Landlord or its constituent partners. Should Tenant recover a money judgment against Landlord, such judgment shall be satisfied only out of the proceeds of sale received upon execution of such judgment and levied thereon against the right, title and interest of Landlord in the Building and out of the rent or other income from such property receivable by Landlord or out of consideration received by Landlord from the sale or other disposition of all or any part of Landlord's right, title or interest in the Building, and no action for any deficiency may be sought or obtained by Tenant. SECTION 14.9 LIMITATION OF ACTIONS AGAINST LANDLORD. Any claim, demand or right of any kind by Tenant which is based upon or arises in connection with this Lease shall be barred unless Tenant commences an action thereon within twelve (12) months after the date that the act, omission, event or default upon which the claim, demand or right arises, has occurred. ARTICLE XV END OF TERM SECTION 15.1 HOLDING OVER. This Lease shall terminate without further notice upon the expiration of the Term, and any holding over by Tenant after the expiration shall not constitute a renewal or extension of this Lease, or give Tenant any rights under this Lease, except when in writing signed by both parties. If Tenant holds over for any period after the expiration (or earlier termination) of the Term without the prior written consent of Landlord, such possession shall constitute a tenancy at sufferance only; such holding over with the prior written consent of Landlord shall constitute a month-to-month tenancy commencing on the first (1st) day following the termination of this Lease. In either of such events, possession shall be subject to all of the terms of this Lease, except that the monthly Basic Rent shall be the greater of(a) one hundred fifty, percent (150%) of the Basic Rent for the month immediately preceding the date of termination or (b) the then currently scheduled Basic Rent for comparable space in the Building. If Tenant fails to surrender the Premises upon the expiration of this Lease despite demand to do so by Landlord, Tenant shall indemnify and hold Landlord harmless from all loss or liability, including without limitation, any claims made by any succeeding tenant relating to such failure to surrender. Acceptance by Landlord of rent after the termination shall not constitute a consent to a holdover or result in a renewal of this Lease. The foregoing provisions of this Section are in addition to and do not affect Landlord's right of re-entry or any other rights of Landlord under this Lease or at law. SECTION 15.2 MERGER ON TERMINATION. The voluntary or other surrender of this Lease by Tenant, or a mutual termination of this Lease, shall terminate any or all existing subleases unless Landlord, at its option, elects in writing to treat the surrender or termination as an assignment to it of any or all subleases affecting the Premises. SECTION 15.3 SURRENDER OF PREMISES; REMOVAL OF PROPERTY. Upon the Expiration Date or upon any earlier termination of this Lease, Tenant shall quit and surrender possession of the Premises to Landlord in as good order, condition and repair as when received or as hereafter may be improved by Landlord or Tenant, reasonable wear and tear and repairs which are Landlord's obligation excepted, and shall, without expense to Landlord, remove or cause to be removed from the Premises all personal property and debris, except for any items that Landlord may by written authorization allow to remain. Tenant shall repair all damage to the Premises resulting from the removal, which repair shall include the patching and filling of holes and repair of structural damage, provided that Landlord may instead elect to repair any structural damage at Tenant's expense. If Tenant shall fail to comply with the provisions of this Section, Landlord may effect the removal and/or make any repairs, and the cost to Landlord shall be additional rent payable by Tenant upon demand. If Tenant fails to remove Tenant's personal property from the Premises upon the expiration of the Term, Landlord may remove, store, dispose of and/or retain 22. such personal property, at Landlord's option, in accordance with then applicable laws, all at the expense of Tenant. If requested by Landlord, Tenant shall execute, acknowledge and deliver to Landlord an instrument in writing releasing and quitclaiming to Landlord all right, title and interest of Tenant in the Premises. ARTICLE XVI PAYMENTS AND NOTICES All sums payable by Tenant to Landlord shall be paid, without deduction or offset, in lawful money of the United States to Landlord at its address set forth in Item 12 of the Basic Lease Provisions, or at any other place as Landlord may designate in writing. Unless this Lease expressly provides otherwise, as for example in the payment of rent pursuant to Section 4.1, all payments shall be due and payable within ten (10) days after demand. All payments requiring proration shall be prorated on the basis of a thirty (30) day month and a three hundred sixty (360) day year. Any notice, election, demand, consent, approval or other communication to be given or other document to be delivered by either party to the other may be delivered in person or by courier or overnight delivery service to the other party, or may be deposited in the United States mail, duly registered or certified, postage prepaid, return receipt requested, and addressed to the other party at the address set forth in Item 12 of the Basic Lease Provisions, or if to Tenant, at that address or, from and after the Commencement Date, at the Premises (whether or not Tenant has departed from, abandoned or vacated the Premises), or may be delivered by telegram, telex or telecopy, provided that receipt thereof is telephonically confirmed. Either party may, by written notice to the other, served in the manner provided in this Article, designate a different address. If any notice or other document is sent by mail, it shall be deemed served or delivered twenty-four (24) hours after mailing. If more than one person or entity is named as Tenant under this Lease, service of any notice upon any one of them shall be deemed as service upon all of them. ARTICLE XVII RULES AND REGULATIONS Tenant agrees to observe faithfully and comply strictly with the Rules and Regulations, attached as Exhibit E, and any reasonable and nondiscriminatory amendments, modifications and/or additions as may be adopted and published by written notice to tenants by Landlord for the safety, care, security, good order, or cleanliness of the Premises. Landlord shall not be liable to Tenant for any violation of the Rules and Regulations or the breach of any covenant or condition in any lease by any other tenant or such tenant's agents, employees, contractors, guests or invitees. One or more waivers by Landlord of any breach of the Rules and Regulations by Tenant or by any other tenant(s) shall not be a waiver of any subsequent breach of that rule or any other. Tenant's failure to keep and observe the Rules and Regulations shall constitute a default under this Lease. In the case of any conflict between the Rules and Regulations and this Lease, this Lease shall be controlling. ARTICLE XVIII BROKER'S COMMISSION The parties recognize as the broker(s) who negotiated this Lease the firm(s), if any, whose name(s) is (are) stated in item 10 of the Basic Lease Provisions, and agree that Landlord shall be responsible for the payment of brokerage commissions to those broker(s) unless otherwise provided in this Lease. Tenant warrants that it has had no dealings with any other real estate broker or agent in connection with the negotiation of this Lease, and Tenant agrees to indemnify and hold Landlord harmless from any cost, expense or liability (including reasonable attorneys' fees) for any compensation, commissions or charges claimed by any other real estate broker or agent employed or claiming to represent or to have been employed by Tenant in connection with the negotiation of this Lease. The foregoing agreement shall survive the termination of this Lease. ARTICLE XIX TRANSFER OF LANDLORD'S INTEREST 23. In the event of any transfer of Landlord's interest in the Premises, the transferor shall be automatically relieved of all obligations on the part of Landlord accruing under this Lease from and after the date of the transfer, provided that any funds held by the transferor in which Tenant has an interest shall be turned over, subject to that interest, to the transferee and Tenant is notified of the transfer as required by law. No holder or a mortgage and/or deed of trust to which this Lease is or may be subordinate, and no landlord under a so-called sale-leaseback, shall be responsible in connection with the Security Deposit, unless the mortgagee or holder of the deed of trust or the landlord actually receives the Security Deposit. It is intended that the covenants and obligations contained in this Lease on the part of Landlord shall, subject to the foregoing, be binding on Landlord, its successors and assigns, only during and in respect to their respective successive periods of ownership. ARTICLE XX INTERPRETATION SECTION 20.1 GENDER AND NUMBER. Whenever the context of this Lease requires, the words "Landlord" and "Tenant" shall include the plural as well as the singular, and words used in neuter, masculine or feminine genders shall include the others. SECTION 20.2 HEADINGS. The captions and headings of the articles and sections of this Lease are for convenience only, are not a part of this Lease and shall have no effect upon its construction or interpretation. SECTION 20.3 JOINT AND SEVERAL LIABILITY. If more than one person or entity is named as Tenant, the obligations imposed upon each shall be joint and several and the act of or notice from, or notice or refund to, or the signature of, any one or more of them shall be binding on all of them with respect to the tenancy of this Lease, including, but not limited to, any renewal, extension, termination or modification of this Lease. SECTION 20.4 SUCCESSORS. Subject to Articles IX and XIX, all rights and liabilities given to or imposed upon Landlord and Tenant shall extend to and bind their respective heirs, executors, administrators, successors and assigns. Nothing contained in this Section is intended, or shall be construed, to grant to any person other than Landlord and Tenant and their successors and assigns any rights or remedies under this Lease. SECTION 20.5 TIME OF ESSENCE. Time is of the essence with respect to the performance of every provision of this Lease. SECTION 20.6 CONTROLLING LAW. This Lease shall be governed by and interpreted in accordance with the laws of the State of California. SECTION 20.7 SEVERABILITY. If any term or provision of this Lease, the deletion of which would not adversely affect the receipt of any material benefit by either party or the deletion of which is consented to by the party adversely affected, shall be held invalid or unenforceable to any extent, the remainder of this Lease shall not be affected and each term and provision of this Lease shall be valid and enforceable to the fullest extent permitted by law. SECTION 20.8 WAIVER AND CUMULATIVE REMEDIES. One or more waivers by Landlord or Tenant of any breach of any term, covenant or condition contained in this Lease shall not be a waiver of any subsequent breach of the same or any other term, covenant or condition. Consent to any act by one of the parties shall not be deemed to render unnecessary, the obtaining of that party's consent to any subsequent act. No breach by Tenant of this Lease shall be deemed to have been waived by Landlord unless the waiver is in a writing signed by Landlord. The rights and remedies of Landlord under this Lease shall be cumulative and in addition to any and all other rights and remedies which Landlord may have. SECTION 20.9 INABILITY TO PERFORM. In the event that either party shall be delayed or hindered in or prevented from the performance of any work or in performing any act required under this Lease by reason of any cause beyond the reasonable control of that party, then the performance of the work or the doing of the act shall be excused for the period of the delay and the time for performance shall be extended for a period equivalent to the 24. period of the delay. The provisions of this Section shall not operate to excuse Tenant from the prompt payment of rent or from the timely performance of any other obligation under this Lease within Tenant's reasonable control. SECTION 20.10 ENTIRE AGREEMENT. This Lease and its exhibits and other attachments cover in full each and every agreement of every kind between the parties concerning the Premises and the Building, and all preliminary negotiations, oral agreements, understandings and/or practices, except those contained in this Lease, are superseded and of no further effect. Tenant waives its rights to rely on any representations or promises made by Landlord or others which are not contained in this Lease. No verbal agreement or implied covenant shall be held to modify the provisions of this Lease, any statute, law, or custom to the contrary notwithstanding. SECTION 20.11 QUIET ENJOYMENT. Upon the observance and performance of all the covenants, terms and conditions on Tenant's part to be observed and performed, and subject to the other provisions of this Lease. Tenant shall peaceably and quietly hold and enjoy the Premises for the Term without hindrance or interruption by Landlord or any other person claiming by or through Landlord. SECTION 20.12 SURVIVAL. All covenants of Landlord or Tenant which reasonably would be intended to survive the expiration or sooner termination of this Lease, including without limitation any warranty or indemnity hereunder, shall so survive and continue to be binding upon and inure to the benefit of the respective parties and their successors and assigns. ARTICLE XXI EXECUTION AND RECORDING SECTION 21.1 COUNTERPARTS. This Lease may be executed in one or more counterparts, each of which shall constitute an original and all of which shall be one and the same agreement. SECTION 21.2 CORPORATE AND PARTNERSHIP AUTHORITY. If Tenant is a corporation or partnership, each individual executing this Lease on behalf of the corporation or partnership represents and warrants that he is duly authorized to execute and deliver this Lease on behalf of the corporation or partnership, and that this Lease is binding upon the corporation or partnership in accordance with its terms. Tenant shall, at Landlord's request, deliver a certified copy of its board of directors' resolution or partnership agreement or certificate authorizing or evidencing the execution of this Lease. SECTION 21.3 EXECUTION OF LEASE; NO OPTION OR OFFER. The submission of this Lease to Tenant shall be for examination purposes only, and shall not constitute an offer to or option for Tenant to lease the Premises. Execution of this Lease by Tenant and its return to Landlord shall not be binding upon Landlord, notwithstanding any time interval, until Landlord has in fact executed and delivered this Lease to Tenant, it being intended that this Lease shall only become effective upon execution by Landlord and delivery of a fully executed counterpart to Tenant. SECTION 21.4 RECORDING. Tenant shall not record this Lease without the prior written consent of Landlord. Tenant, upon the request of Landlord, shall execute and acknowledge a "short form" memorandum of this Lease for recording purposes. SECTION 21.5 AMENDMENTS. No amendment or termination of this Lease shall be effective unless in writing signed by authorized signatories of Tenant and Landlord, or by their respective successors in interest. No actions, policies, oral or informal arrangements, business dealings or other course of conduct by or between the parties shall be deemed to modify, this Lease in any respect. SECTION 21.6 EXECUTED COPY. Any fully executed photocopy or similar reproduction of this Lease shall be deemed an original for all purposes. SECTION 21.7 ATTACHMENTS. All exhibits, amendments, riders and addenda attached to this Lease are hereby incorporated into and made a part of this Lease. 25. ARTICLE XXII MISCELLANEOUS SECTION 22.1 NONDISCLOSURE OF LEASE TERMS. Tenant acknowledges and agrees that the terms of this Lease are confidential and constitute proprietary information of Landlord. Disclosure of the terms could adversely affect the ability of Landlord to negotiate other leases and impair Landlord's relationship with other tenants. Accordingly, Tenant agrees that it, and its partners, officers, directors, employees and attorneys, shall not intentionally and voluntarily disclose the terms and conditions of this Lease to any other tenant or apparent prospective tenant of the Landlord, either directly or indirectly, without the prior written consent of Landlord. provided, however, that Tenant may disclose the terms to prospective subtenants or assignees under this Lease. SECTION 22.2 GUARANTY. As a condition to the execution of this Lease by Landlord, the obligations, covenants and performance of the Tenant as herein provided shall be guaranteed in writing by the Guarantor(s) listed in Item 7 of the Basic Lease Provisions, if any, on a form of guaranty provided by Landlord. SECTION 22.3 CHANGES REQUESTED BY LENDER. If, in connection with obtaining financing for the Building, the lender shall request reasonable modifications in this Lease as a condition to the financing, Tenant will not unreasonably withhold or delay its consent, provided that the modifications do not materially increase the obligations of Tenant or materially and adversely affect the leasehold interest created by this Lease. SECTION 22.4 MORTGAGEE PROTECTION. No act or failure to act on the part of Landlord which would otherwise entitle Tenant to be relieved of its obligations hereunder or to terminate this Lease shall result in such a release or termination unless (a) Tenant has given notice by registered or certified mail to any beneficiary or a deed of trust or mortgage covering the Premises whose address has been furnished to Tenant and (b) such beneficiary is afforded a reasonable opportunity to cure the default by Landlord (which in no event shall be less than sixty (60) days), including, if necessary to effect the cure, time to obtain possession of the Premises by power of sale or judicial foreclosure provided that such foreclosure remedy is diligently pursued. Tenant agrees that each beneficiary or a deed of trust or mortgage covering the Premises is an express third party beneficiary hereof, Tenant shall have no right or claim for the collection of any deposit from such beneficiary or from any purchaser at a foreclosure sale unless such beneficiary or purchaser shall have actually received and not refunded the deposit, and Tenant shall comply with any written directions by any beneficiary to pay rent due hereunder directly to such beneficiary without determining whether an event of default exists under such beneficiary's deed of trust. SECTION 22.5 COVENANTS AND CONDITIONS. All of the provisions of this Lease shall be construed to be conditions as well as covenants as though the words specifically expressing or imparting covenants and conditions were used in each separate provision. SECTION 22.6 SECURITY MEASURES. Tenant hereby acknowledges that Landlord shall have no obligation whatsoever to provide guard service or other security measures for the benefit of the Premises. Tenant assumes all responsibility for the protection of Tenant, its agents, invitees and property from acts of third parties, Nothing herein contained shall prevent Landlord, at its sole option, from providing security protection for the Premises or any part thereof, in which event the cost thereof shall be included within the definition of Building Costs. SECTION 22.7 EXPIRATION OF EXISTING LEASE. It is understood that Tenant is presently leasing the Premises pursuant to a Lease Agreement dated March 5, 1996 executed by Landlord's predecessor-in-interest, Aetna Life Insurance Company, (the "Existing Lease"). The parties agree that the Existing Lease shall expire in accordance with its terms as &the day preceding the Commencement Date of this Lease, provided that such termination shall not relieve Tenant of (a) any accrued obligation or liability under the Existing Lease as of said termination date, or (b) any obligation under the Existing Lease which was reasonably intended to survive the expiration or termination thereof. SECTION 22.8 JAMS. 26. (a) All claims or disputes between Landlord and Tenant arising out of, or relating to the Lease which either party is expressly authorized by a provision hereof to submit to arbitration, shall be decided by the JAMS/ENDISPUTE, or its successor, in San Jose, California ("JAMS"), unless the parties mutually agree otherwise. Within ten (10) business days following submission to JAMS, JAMS shall designate three arbitrators and each party may, within five (5) business days thereafter, veto one of the three persons so designated. If two different designated arbitrators have been vetoed, the third arbitrator shall hear and decide the matter. Any arbitration pursuant to this Section 22.8 shall be decided within thirty (30) days of submission of JAMS. The decision of the arbitrator shall be final and binding on the parties. All costs associated with arbitration shall be awarded to the prevailing party as determined by the arbitrator. (b) Notice of the demand for arbitration by either party to the Lease shall be filed in writing with the other party to the Lease and with JAMS and shall be made within a reasonable time after the dispute has arisen. The award rendered by the arbitrators shall be final, and judgment may be entered upon it in accordance with applicable law in any court having jurisdiction thereof. Except by written consent of the person or entity sought to be joined, no arbitration arising out of or relating to the Lease shall include, by consolidation, joinder or in any other manner, any person or entity not a party to the Lease under which such arbitration is filed unless (1) such person or entity is substantially involved in a common question of fact or law, (2) the presence of such person or entity is required if complete relief is to be accorded in the arbitration, or (3) the interest or responsibility of such person or entity, in the matter is not insubstantial. (c) The agreement herein among the parties to the Lease and any other written agreement to arbitrate referred to herein shall be specifically enforceable under prevailing law. LANDLORD TENANT: THE IRVINE COMPANY SILICON STORAGE TECHNOLOGY, INC. a California corporation By: /s/ Robert E. Williams, Jr. By: /s/ Bing Yeh --------------------------------- ----------------------------------- Robert E. Williams, Jr., Name: Bing Yeh President -------------------------- Irvine Industrial Company, Title: President and Chief A division of The Irvine Executive Officer Company ------------------------- By: Nancy E. Trujillo By: /s/ Jeffrey L. Garon --------------------------------- ----------------------------------- Nancy E. Trujillo Name: Jeffrey L. Garon Assistant Secretary -------------------------- Title: Vice President, Chief Finance Officer ------------------------- 27. EX-10.26 5 EXHIBIT 10.26 AGREEMENT THIS AGREEMENT is entered into as of the Effective Date, between SAMSUNG ELECTRONIC CO. LTD. with a principal place of business located at San #24 Nongseo-Ri, Kiheung-Eup Yongin-City, Kyungki-Do, KOREA 449-900 ("SEC"), and SILICON STORAGE TECHNOLOGY, INC. located at 1171 Sonora Court, Sunnyvale, California, U.S.A. ("SST"). WHEREAS, SST has designed and developed SST Technology (as defined hereinafter), WHEREAS, SST is the owner of SST Intellectual Property Rights (as defined hereinafter), WHEREAS, SEC desires to obtain from SST a non-exclusive, personal, non-transferable, world-wide license to use, make, sell, and distribute the products containing SST Technology for design of Embedded Products (as defined hereinafter); SST agrees to grant to SEC such nonexclusive, world-wide license to SEC in accordance with the terms and conditions set forth in this Agreement, WHEREAS, SST's grant of right to use SST Technology by SEC's ASIC customers shall be limited to design of the Embedded Product (as defined hereinafter) by SEC for such ASIC customers for manufacture by SEC, and such right prohibit transfer of technology, or any part of SST Intellectual Property Rights to any third party, WHEREAS, SST desires to purchase from SEC high density NAND flash memory IC and SEC desires to supply SST with such products. WHEREAS, SST desires to obtain foundry capacity for SST Products (as defined hereinafter) and SEC agrees to provide such capacity to SST. NOW THEREFORE, the parties hereto agree as follows: ARTICLE I DEFINITIONS 1.0 "SST Technology" shall mean [ * ], including but not limited to [ * ], - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 1. [ * ]. 1.1 In the evolution of the product designs and the manufacturing process that incorporate elements of the SST Technology, there may be modifications made, after the execution of this Agreement, which are improvements of the original SST Technology. These incremental improvements or modifications made to the SST Technology by SEC, shall be known as "SEC Improvement." 1.2 In the evolution of the product designs and the manufacturing process that incorporate elements of the SST Technology, there may be modifications made, after the execution of this Agreement, which are improvements of the original SST Technology. These incremental improvements or modifications made to the SST Technology by SST, shall be known as "SST Improvement." 1.3 SEC Improvement and SST Improvement shall be collectively called "Improvements." 1.4 The "Embedded Product" shall mean a product having one or more Flash Cells which was designed by SEC or its authorized subcontractor under non-disclosure agreement with SEC to safeguard SST, for SEC or according to the SEC's customer specification, and incorporate substantial elements of the SST Technology and its improvements. This product shall not include memory only products, i.e. the sole purpose or function of which is for the storage and retrieval of data or information and used as standalone memory products. Embedded Product shall be ASIC or microcontroller type product with SST Technology presented to the SEC customers only in a form of specifications. GDSII layout data base, circuit designs, schematics and related data of SST Technology shall not be disclosed to Embedded Product customers' nor to SEC Subcontractors' SEC agrees to enter into a non- disclosure agreement with ASIC customers, to maintain in confidence the SST Intellectual Property Rights. The right to enforce the non-disclosure agreement is assigned to SST. The percentage of the Flash Area relative to Embedded Product area shall not exceed [ * ] - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 2. [ * ]. 1.5 The "SST Product" shall mean standalone memory products or a logic product with embedded SST Technology designed by SST or for SST by a third party incorporating SST Technology, or an Embedded Product designed for SST by SEC. 1.6 "Flash Cell" shall mean a nonvolatile memory cell for storage of single bit based upon the SST Technology. 1.7 "Flash Area" shall mean the total area of the embedded SST Technology. The Flash Area shall include Flash Cell array, addressing, decoding, sensing, charge pump, and all related circuits required for the operation of the embedded block. 1.8 "SST Intellectual Property Rights" shall mean all patents, copyrights, mask work rights, and trade secrets subsisting in or covering the SST Technology, which are owned by SST or to which SST has the right to grant the rights and license granted herein, now or hereafter during the term of the Agreement. SST Intellectual Property Rights include, but is not limited to, patents covering Flash Cells and memory circuits, and methods of operation and manufacturing thereof, mask work rights in the layout of the Flash Cells and memory circuits, copyrights in the net list, and confidential information in cell design layout, design rules, and process flow architecture. 1.9 "Selling Price" shall mean actual price billed to end-user customer by SEC for Embedded Product sold less amount for authorized returned material. This price is different from list price, marketing and sales quoted price, etc. which may not be the actual price billed to the customer. 1.10 "Proprietary Information" shall mean any information controlled by a party hereto identified as proprietary and/or confidential and disclosed to the other party according to this Agreement. Written Proprietary Information shall be clearly marked "CONFIDENTIAL" or "PROPRIETARY". All oral disclosures of Proprietary Information shall be identified as such prior to disclosure and confirmed - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 3. in writing, or email, by the disclosing party within thirty (30) days of the oral disclosure. In case of disagreement, the receiving party must make a written objection thereto within thirty (30) days after receipt of the information. The Proprietary Information shall not include information that: (1) is now or subsequently in the public domain or otherwise becomes available to the public other than by breach of this Agreement by the receiving party; (2) has been rightfully in the receiving party's possession prior to receipt from the disclosing party with the receiving party having the burden of proof; (3) is rightfully received by the receiving party from a third party; or (4) is independently developed by the receiving party without use of any proprietary information or trade secrets of disclosure with the receiving party having the burden of proof. 1.11 "Effective Date" shall mean either the date when this Agreement is signed by both parties, or the date when SEC and SST receive all necessary approvals for this Agreement from their respective governments, whichever is later. 1.12 "Subsidiary (ies)" shall mean any corporation, company or other entity controlled by, controlling, or under common control with, either party hereto. As used herein, the term "control" means ownership or control, direct or indirect, now or hereafter during the term of this Agreement, of more than fifty percent (50%) of the outstanding shares of interest entitled to vote for the election of directors (other than any shares or stock whose voting rights are subject to restriction) of such corporation, company or other entity. Any corporation, company or other entity which would at any time be a Subsidiary of SST or SEC, as the case may be, by reason of the foregoing shall be considered a Subsidiary for the purpose of this Agreement only so long as such control exists. A list of Subsidiary(ies) is attached in Exhibit "C" hereto. - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 4. ARTICLE II GRANT 2.0 Subject to the terms and conditions of this Agreement, and during the term of such Agreement SST grants SEC and SEC's Subsidiary under SST Intellectual Property Rights, a world wide, non- exclusive, personal, non-transferable license and right (without the right to sublicense) to design (for itself or for its customers) and have designed by SEC Subcontractors Embedded Products, manufacture at SEC owned wafer manufacturing plants such designed Embedded Products, sell the manufactured Embedded Products. Use of the license granted herein, shall not constitute a right to sublicense the technology to any party for manufacturing of Embedded Products, or any other products using SST Technology outside of SEC's foundry sites. 2.1 In consideration of the license set forth in paragraph 2.0, SEC shall pay license fee and royalty described in Article (III). In further consideration of the license granted herewith, [ * ] as described in paragraph 4.0 and [ * ] as described in paragraph 4.1. 2.2 SEC shall not use a minimum Flash Cell size for its Embedded Products less than the minimum Flash Cell size used in SST Product manufactured at SEC. The number of Flash Cells in each Embedded Product shall not exceed [ * ] unless a waiver letter is obtained from SST. [ * ]. 2.3 SEC further agrees to assume responsibility for material costs of developing [ * ] SST Technologies, including [ * ]. 2.4 This agreement is only for [ * ] generation of SST Technology. For development and licensing of technology geometry below [ * ], both parties shall negotiate in good faith to reach a separate agreement. 2.5 SST and SEC shall negotiate in good faith the right - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 5. for SEC to provide foundry capacity for licensees of SST Technology [ * ]. 2.6 SEC shall [ * ] provide SST with layout design data base, schematics of circuit designs, specifications of SST Technology embedded ASIC blocks, and provide documentation relating to SEC Improvements as soon as possible, in order to keep SST informed of latest SST Technology based blocks for Embedded Products and to allow SST to use such material in SST Products. 2.7 Both parties agree that the objective of establishing SST Technology for both [ * ] geometry would be to yield similar design rules and device specification to allow SST to keep the same design (GDSII data base) manufactured at both SEC and SST's other foundries. If any process incompatibility should develop that would cause the original working design to require modifications, SEC has agreed to make process changes necessary to make the same design manufacturable at SEC, without any added cost to SST. 2.8 Both Parties agree to negotiate, in good faith, extending the relationship to include [ * ]. 2.9 SST shall provide-SEC with the deliverables and technical assistance as specified in Exhibits A and B. ARTICLE III LICENSE FEE AND ROYALTY 3.0 SEC shall pay SST a license fee of [ * ] total, net of taxes from Korean government, in two equal payments of [ * ] each. The first payment shall be due upon signing the Agreement and clearance from Korean government, which is not expected to take more than thirty (30) days. The second payment shall be due upon meeting certain milestone described in Exhibit "A". Unless otherwise specified, payment will be due and payable - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 6. by SEC within thirty (30) days after the satisfaction of the applicable milestone and the receipt of the corresponding invoice from SST. 3.1 SEC shall pay SST a royalty for the licenses granted herein, which royalty shall be a certain percentage of Selling Price of any Embedded Product sold by SEC, in accordance with the schedule below; A) [ * ] B) [ * ] 3.2 In the event that as a result of embedding high density of SST Technology in Embedded Products a significant direct competition to SST's memory product business is created, both parties agree to negotiate in good faith for reaching an equitable solution. 3.3 Royalty payments shall be made semi-annually within thirty (30) days after close of each calendar six months, and shall be accompanied by a report setting [ * ]. In connection with this royalty, the sales records of SEC shall be available for inspection by SST's internal or independent auditors during usual business hours for the sole purpose of verifying said reports at SST's expenses provided such audit takes place during normal business hours. In the event any such audit shall disclose that such-royalty has been underpaid by more than [ * ] SEC shall bear the cost of that audit. - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 7. ARTICLE IV FOUNDRY AND MASS STORAGE In consideration of the license granted herein, the following relationships shall be established between SST and SEC: 4.0 SEC shall provide guaranteed wafer foundry capacity for SST Products in accordance with schedule below. [ * ] [ * ] [ * ] [ * ] [ * ] ------------------------------------------------------------------ [ * ] [ * ] [ * ] [ * ] [ * ] [ * ] [ * ] [ * ] [ * ] [ * ] [ * ] SEC further agrees to [ * ] . [ * ]. 4.1 [ * ]. ARTICLE V CROSS LICENSE 5.0 Title to all intellectual property rights relating to SST Improvements under this Agreement shall be owned by SST, and all expenses incurred in obtaining and maintaining such rights shall be borne by SST. 5.1 SEC will receive, as soon as possible, updated SST Improvement and improvements that SST is entitled to grant from other licensing agreements associated with the SST Technology without additional fee or royalty. SST and SST's Subsidiaries will receive a paid up, unrestricted license including the right to - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 8. grant sublicenses to all SEC Improvement. 5.2 Title to all intellectual property rights relating to SEC Improvements under this Agreement shall be owned by SEC, and all expenses incurred in obtaining and maintaining such rights shall be borne by SEC. Subject to the limitation on SEC's sublicense under the Agreement, either party has the right to license such SEC Improvement to third parties. In case SEC elects not to seek or maintain legal protection for any such invention or improvement in any particular country or territory, SST shall have the right to seek protection at its sole expenses and for its sole benefit and shall have full control over the prosecution and maintenance thereof, provided that SST shall grant to SEC [ * ]. ARTICLE VI WARRANTY 6.0 SST warrants and represents that it has the right and authority to convey and grant the license as set forth herein. 6.1 SST represents that the SST Technology including the deliverables provided hereunder to SEC is, and shall be kept accurate, updated technology available to SST. 6.2 SST represents that to the best of its knowledge the SST Technology provided by SST under this Agreement does not infringe upon any third party's patents, copyrights, or trade secrets and that it has not been duly notified by any patent holders of any assertion of patent infringement by using SST Technology, [ * ]. 6.3 SST agrees to indemnify, hold harmless and defend SEC from and against any and all equitable actions, damages, costs and expenses incurred by SEC in connection with a claim which, if true, would constitute a breach of SST's warranty set forth - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 9. under Sub-Section 6.0 hereof, provided SST has been given prompt notification and reasonable assistance from SEC, and SST has sole control over legal action. [ * ] under the law of the United States or any copyright, trade secret right of the United States or any other jurisdiction, SST may, at its sole option and expense (up to the limit set forth in paragraph 6.4 hereof), procure for SEC the right to continued use of SST Technology as provided hereunder, or modify the allegedly infringing item such that it is no longer infringing, or replace the allegedly infringing item, within sixty (60) days after adjudication, provided however, that such equitable actions, damages, cost and expense is not incurred by SEC Technology. 6.4 Neither party shall be liable to the other for any incidental, indirect or consequential damages arising out of or in connection with this Agreement. In no event shall either party be liable to the other for damages, in the aggregate, greater than [ * ]. Furthermore, SEC agrees to hold SST harmless from any-cause of action arising out of, as a result of, or in connection with, any dispute between SEC and its customers, except to the extent such dispute arises from a breach by SST of its contractual obligation to SEC under this Agreement, including a breach by SST of its warranty under Sub-Section 6.0, and provided that SST fulfills its obligation under Sub-Section 6.3. 6.5 SEC shall provide SST with SEC's standard warranties on NAND flash memory and Embedded Products sold to SST. Such warranties shall include, warranty that the NAND product is free from infringement of patents under the laws of the United States, or copyright, trade secret right of any party in the United States or any other jurisdiction. SEC further warrants that if any third party asks SST for royalty for the compensation of using such third party's patents alleging the infringement by the NAND flash memory integrated circuits sold by SEC to SST, SEC shall be responsible for such royalty. - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 10. Above warranty is limited to the NAND flash memory integrated circuits only provided by SEC. In the event SEC flash memory integrated circuits provided by SEC to SST are combined with other products such as controller which is not provided by SEC, SEC is not responsible for the patent claims or legal actions based on patent infringement by any third party [ * ] relating to such combination. In any event SEC's whole responsibility shall not exceed prices of such NAND flash memory integrated circuits paid by SST to SEC. 6.6 SEC agrees to indemnify, hold harmless and defend SST from and against any and all equitable actions, damages, costs and expenses incurred by SST in connection with the design of the Embedded Product, the manufacturing of the Embedded Product, the sale of the Embedded Product and the use thereof by SEC customers, provided however, that such equitable actions, damages, cost and expense is not incurred by breach of SST Technology. 6.7 SEC agrees to indemnify, hold harmless and defend SST from and against any and all equitable actions, damages, costs and expenses incurred by SST in connection with a claim which, if true, would constitute a breach of SEC's warranty set forth under Sub-Sections 6.5 hereof, provided SEC has been given prompt notification and reasonable assistance from SST, and SEC has sole control over the legal action. ARTICLE VII TERM AND TERMINATION 7.0 This Agreement shall remain in full force and effect for [ * ] years from the Effective Date, unless earlier terminated as provided elsewhere herein. Both parties shall negotiate in good faith for renewed terms and conditions at least six (6) months prior to the expiration of this Agreement. If neither of the parties hereto gives six (6) months prior notice before the expiration date of this Agreement, then this Agreement shall be extended for one (1) year each time. Upon termination, all tangible Proprietary Information shall be returned - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 11. or destroyed according to the instruction of the disclosing party. 7.1 This Agreement may be terminated by either party if the other party (1) breaches any material provision of this Agreement and does not cure or remedy such breach within thirty (30) days after receipt of the notice of breach from the other party; (2) becomes the subject of a voluntary or involuntary petition in bankruptcy or any proceeding relating to insolvency, receivership, liquidation, or composition for the benefit of creditors if such petition or proceeding is not dismissed with prejudice within sixty (60) days after filing. Termination of this Agreement shall be effective 30 days after issuance of a written notice of termination to the other party by the non-defaulting party. In the event SST becomes bankrupt, or a trustee is otherwise appointed for SST, SEC shall have the right to maintain the rights and licenses provided for in this Agreement, provided it continues to make the royalty payments provided for herein. 7.2 After effective termination of this Agreement by either party in accordance with Section VII hereof, SEC shall cease and desist all use of the license except for the performance of its obligations to customers, which are incurred before termination of this Agreement. The obligation and duties of both parties under this Agreement for existing products at the time of termination shall survive the termination of this Agreement. 7.3 Upon the breach by either party to this Agreement of any provision of this Agreement, the non-breaching party shall have the right to pursue all available remedies at law or in equity it may elect, in order to obtain the benefits provided pursuant to this Agreement, or to obtain adequate resource or compensation. 7.4 The termination of the license granted under this Agreement, by expiration or otherwise, shall not release one party from any of its obligations or liabilities therefore incurred, or rescind or give any rights to rescind, anything done or any payment - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 12. made or other consideration given theretofore to the other party under this Agreement, provided that SEC will have such rights, under such license, after any such termination or expiration, as are necessary for SEC to (a) supply replacement products for any defective Embedded Product units sold by SEC on or prior to the date of such termination or expiration, and (b) supply Embedded Products under, and pursuant to the terms of, commitments of SEC to third parties, for a period of one year thereafter, and (c) dispose of inventory of Embedded Products under SEC's control as of the date of such termination or expiration. In no event shall SEC have the right to commit to supply Embedded Products to new product design, for the purpose of sub-paragraph(c) herein, new product designs do not include products which have been taped out, masking plates have been made for them, and such proof of existence is provided by SEC to SST no later than thirty (30) days after termination of the Agreement. SEC will provide SST a statement of inventory at this point in time, as well as an estimate of time required to dispose of said inventory. SEC shall cause to be issued an irrevocable letter of credit issued by a commercial bank equal to the amount of royalty based upon the inventory. SEC will fulfill all royalty obligations for material described in (a), (b) and (c). No failure or delay on the part of non-breaching party in exercising its right to terminate for any one or more default shall be construed to prejudice its rights of termination for such or for any other or subsequent default. 7.5 The provisions of [ * ] shall survive any termination or expiration of this Agreement for any reason. ARTICLE VIII MISCELLANEOUS 8.0 SEC and SST shall schedule management review meetings twice a year to assess the progress of the relationship, deal with any unresolved problems, and develop strategic plans for continued joint effort. Specific areas of discussion are to include: [ * ] - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 13. [ * ]; 6) other topics as required and proposed by either party toward the continued achievement of the business objectives represented by this Agreement. 8.1 SEC shall put a label or writing which reads "This product incorporates SuperFlash-Registered Trademark- technology licensed from Silicon Storage Technology, Inc. (SST)," for all Embedded Products sold by SEC, having font, size and layout solely determined by SEC but shall be readable with a naked eye of a typical person, at a prominent location on the data sheet, product brochure and promotion material of all Embedded Products. 8.2 Neither party shall be responsible for any failure to perform under this Agreement if such failure is caused by unforeseen circumstances or due to causes beyond its control, including but not limited to acts of God, riot, labor stoppages, acts of civil and military authorities, fire, floods or accidents. 8.3 This Agreement shall be governed by and construed in accordance with the laws of the state of California. In the event of any dispute arising out of or in connection with this Agreement which cannot be amicably settled by the parties hereto, the parties agree to submit any such dispute to binding arbitration to be conducted in California in accordance with the then prevailing rules for the commercial arbitration of American Arbitration Association, and the decision of the arbitration panel shall be final and binding and may be entered as a judgment by a court of competent jurisdiction. All information relating to or disclosed by any party in connection with the arbitration shall be treated by the parties and the arbitration panel as confidential information and no disclosure of such information shall be made by either party or the arbitration panel without the prior written consent of the disclosing party. Each party shall equally bear the cost of the arbitration. 8.4 No modification, alteration or amendment of this Agreement shall be effective unless in writing and duly signed by both parties. The terms and - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 14. conditions of this Agreement constitutes the entire agreement and understanding of the parties with respect to the subject matter hereof, and supersede all previous communication, agreement, understanding, whether oral or written, between the parties regarding the same. 8.5 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. 8.6 Neither party can assign this Agreement without the prior written consent of the other party. 8.7 This Agreement shall not be construed as creating a partnership between the parties hereto or to create any other form of legal association which would impose liability upon one party for the act or failure to act of the other party. 8.8 No remedy conferred by any of the specific provisions of this Agreement is intended to be exclusive of any other remedy, and each and every remedy shall be cumulative and shall be in addition to every other remedy given hereunder or now or hereafter existing at law or in equity or by statue or otherwise. The election of one or more remedies by either party shall not constitute a waiver of the right to pursue other available remedies. 8.9 If any clause or provision of this Agreement is declared illegal, invalid or unenforceable under present or future laws effective during the term hereof, it is the intention of the parties hereto that the remainder of this Agreement shall not be affected hereby and shall remain in force and effect. 8.10 The parties understand and acknowledge the violation of the respective covenants and agreements contained herein may cause the other irreparable harm and damage, which may not be recovered by law, and each agrees that the other's remedies for a breach hereof may be in equity by way of injunctive relief, as well as for damages and any other relief available - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 15. to the non-breaching party, whether in law or in equity. 8.11 SEC agrees to comply with all laws relating to export control with regard to all goods and information transferred by SST to SEC hereunder, including but not limited to the information transferred pursuant to Exhibit "A" hereof, and agrees to hold SST harmless and indemnify it from any breach thereof. SST agrees to comply with all laws relating to export control with regard to all goods and information transferred by SEC to SST hereunder, including but not limited to the information relating to the SEC Improvement, and agrees to hold SEC harmless and indemnify it from any breach thereof. 8.12 Any notice between the parities shall be made, by fax or mail, to the correspondent as follows: to SEC: [ * ] Address: [ * ] [ * ] Telephone: [ * ] Fax: [ * ] to SST: [ * ] Address: [ * ] Telephone: [ * ] Fax: [ * ] ARTICLE IX PROPRIETARY INFORMATION 9.0 Except that SEC exercises its license and rights hereunder, both parties agree to maintain Proprietary Information in confidence, not to make use thereof other than for the performance of this Agreement, to release it only to employees or SEC customers who have a reasonable need to know the same, and not to release or disclose it to any third party, without the prior written consent of the disclosing party. 9.1 All Proprietary Information and any copies thereof - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 16. shall remain the property of the disclosing party. Upon expiration or termination of this Agreement, the receiving party shall return the original and all copies of tangible Proprietary Information at the request of the disclosing party. 9.2 This Section shall survive the termination or expiration of this Agreement for a period of five (5) years. 9.3 The terms and conditions of the Non-disclosure Agreement dated July 10, 1997 between the parties shall remain effective. In the event the terms and conditions conflicts with this Agreement, this Agreement shall prevail. IN WITNESS WHEREOF, the parties have caused this Letter of Intent to be executed by respective duly authorized representatives as the date and year hereinabove written above. Signed: SAMSUNG ELECTRONIC CO. LTD. SILICON STORAGE TECHNOLOGY, INC. By: /s/ illegible By: /s/ Bing Yeh ------------------------------------ ---------------------------------- Title: General Manager of Asia Business Title: President and CEO --------------------------------- ------------------------------- Date: March 19, 1998 Date: March 19, 1998 ---------------------------------- -------------------------------- - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. 17. EXHIBIT "A" [ * ] - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. EXHIBIT "B" A) At SEC's request and subject to agreement of the parties on a mutually convenient date, SST will provide an initial technical consultation to SEC at SEC's facility, to be attended by appropriate engineering teams for each company, and designed to provide an overview of the SST Technology. [ * ]. B) [ * ]; a. [ * ] b. [ * ] c. [ * ] d. [ * ] e. [ * ] f. [ * ] g. [ * ] h. [ * ] i. [ * ] j. [ * ] k. [ * ] l. [ * ] (c) Beginning with the manufacturing release for the Embedded Product, SST shall provide [*] at SST or SEC (to be agreed by working groups) free of charge. Additional consultation, if required, shall be billed by SST to SEC on the basis of [ * ]. Each party will bear the expenses of its travel to the other's facility incurred in the course of such additional technical supporting and training. - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. EXHIBIT "C" List of SEC Subsidiaries: 1. None Listed 2. 3. 4. 5. List of SST Subsidiaries 1. None Listed 2. 3. 4. 5. - ------------------- *Certain confidential information contained in this document, marked by brackets, has been omitted and filed separately with the Securities Exchange Commission pursuant to rule 24B-2 of the Securities Exchange Act of 1934, as amended. EX-23.1 6 CONSENT OF INDEPENDENT ACCOUNTANTS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 (No. 333-83981) and Form S-8 (No. 0-26944) of Silicon Storage Technology, Inc. of our report dated January 17, 2000, except for Note 4, which is as of February 24, 2000, relating to the financial statements, which appears in this Form 10-K. We also consent to the incorporation by reference of our report dated January 17, 2000 relating to the financial statement schedule, which appears in this Form 10-K. /s/ PRICEWATERHOUSECOOPERS LLP PricewaterhouseCoopers LLP San Jose, California February 24, 2000 EX-27.1 7 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONDENSED CONSOLIDATED BALANCE SHEETS AND THE CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOUND IN THE COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 1,223 0 39,393 535 29,766 73,188 15,990 4,859 88,806 47,345 0 0 0 60,570 (19,555) 88,806 118,242 124,794 94,652 129,238 0 0 214 (3,928) 88 (4,016) 0 0 0 (4,016) (0.17) (0.17)
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