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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
[X]ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 For the fiscal year ended September 30, 1996
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-27234
PHOTON DYNAMICS, INC.
(Exact name of small business issuer as specified in its charter)
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<S> <C>
CALIFORNIA 94-3007502
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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6325 SAN IGNACIO
SAN JOSE, CA 95119
(Address of principal executive offices)
(408) 226 9900
(Issuer's telephone number)
Securities registered under Section 12(b) of the Exchange Act:
NONE
Securities registered under Section 12(g) of the Exchange Act:
COMMON STOCK
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the last 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. YES [X] NO
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B is not contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-
KSB or any amendment to this Form 10-KSB. [_]
Revenue for the year ended September 30, 1996 was $24,763,000.
The aggregate market value of the voting stock held by non-affiliates of the
Registrant, based on the closing price of the Common Stock on December 27,
1996, as reported on the Nasdaq National Market was approximately $43,361,000
Shares of Common Stock held by each officer and director and by each person
who owns 5% or more of the outstanding Common Stock have been excluded from
this computation in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive
determination for other purposes.
As of December 27, 1996 the Registrant had outstanding 6,955,037 shares of
Common Stock.
Transitional small business Disclosure Format (check one) Yes No X [X]
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for its 1997 Annual Meeting of
Shareholders and the Registrants Annual Report to Shareholders for its fiscal
year ended September 30, 1996 are incorporated by reference in Part I, II and
III of this Form 10-KSB report.
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PART I
ITEM 1: DESCRIPTION OF BUSINESS
THE COMPANY
Photon Dynamics, Inc. is a leading worldwide supplier of test, inspection
and repair systems for the flat panel display ("FPD") industry. The Company's
systems are used to control, monitor and refine the manufacturing process to
increase the yield of FPDs, to reduce materials loss, to transition new FPD
designs from research and development to commercial production and to assist
in the rapid start-up of new FPD manufacturing facilities. While certain
aspects of the manufacturing processes for FPDs are similar to manufacturing
processes for semiconductor devices, materials costs represent a substantially
higher percentage of the cost of an FPD as compared with semiconductor
devices. As a result, the need for test and inspection of FPDs goes beyond the
need to improve yields as FPD manufacturers seek to identify defects early in
the manufacturing process to either avoid investment of further materials cost
or to repair the defect before further manufacturing steps make it less
accessible. The Company believes that more of its systems have been used by
manufacturers of active matrix liquid crystal displays ("AMLCDs") and other
advanced FPDs to test, inspect and repair more VGA and other higher resolution
FPDs than any other currently available competitive system and that this
experience has enabled it to become a leading technical innovator of test,
inspection and repair equipment for advanced FPD manufacturers.
Photon Dynamics offers a suite of products to inspect virtually all current
types of FPDs and to address all key areas of AMLCD test, inspection and
repair throughout all major stages of the manufacturing life cycle, from
research and development to commercial production. The Company's test products
include array test systems that locate, count and characterize electrical
array faults, contamination and other defects on partially completed flat
panel display substrates. The Company's repair product performs array laser
cut and weld repair functions based upon information generated by its test and
inspection products. Its inspection products perform flat panel cell and
module inspection to detect and locate optical defects in FPDs. All of the
Company's product lines interface with one another through software systems
used to store data and generate reports and other information used by FPD
manufacturers to increase their yields.
The Company's products incorporate proprietary technologies that provide FPD
manufacturers with the ability to obtain information critical to yield
improvement and management of manufacturing processes that had not previously
been readily available to FPD manufacturers. The Company's proprietary Voltage
Imaging(TM) and N-Aliasing(TM) technologies, in conjunction with its
proprietary software programs, permit non-contact, full characterization and
image evaluation of virtually all commercially produced FPD displays,
regardless of panel size or the FPD technology employed. All of the Company's
product lines are currently being used with VGA and SVGA displays and are
designed for use with next generation XGA and SXGA displays.
PRODUCTS
Photon Dynamics offers a suite of products to inspect virtually all types of
FPDs. All of the Company's systems use similar software based controls,
processing and graphical user interfaces. Products can be networked together
so FPD defect data can be stored, analyzed and used throughout the
manufacturing process. All of the Company's systems are capable of providing
fully automated functionality through robotics incorporated into the systems
by Photon Dynamics or purchased from third party vendors.
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The following table lists the Company's products:
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FIRST
COMMERCIAL COMPATIBLE FPD
PRODUCT SHIPMENT FUNCTION TECHNOLOGY STATE OF FPD MANUFACTURE
------- ---------- -------- -------------- ------------------------
<C> <C> <C> <C> <S>
IPT-E 1994 Array test AMLCD Research and development
Pre-production
IPT-MPS 1995 Array test AMLCD Research and development
Pre-production
Production
FIS-200* 1993 VGA inspection ALL Research and development
Pre-production
Production
FIS-250 1995 SVGA inspection ALL Research and development
Pre-production
Production
FIS-300 1995 XGA inspection ALL Research and development
Pre-production
Production
ILW(TM) 1993 Repair AMLCD and Production
passive matrix LCD
</TABLE>
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* Superseded by the FIS-250
In-Process Test Systems (IPT Systems)
The Company's In-Process Test (IPT) systems use the Company's proprietary
Voltage Imaging(TM) technology to detect, locate, quantify and characterize
electrical, contamination and other defects in AMLCD arrays after the
completion of the first major step of production, the construction of the
transistor array on the glass substrate. The systems incorporate a computer
workstation and proprietary image processing software to display pixel images
and information which not only allows manufacturers to determine whether
individual pixels or lines of pixels are functional, but also allows them to
find more subtle defects such as individual pixel voltage variations early in
the production process. In addition, these systems generate point and line
defect data files specifying the exact location of each defect, which data can
then be used for statistical process control or downloaded to the Company's
ILW(TM) system to effect repairs. The systems also perform key procedures
involved in the testing process, including running test sequences and loading,
unloading and sorting substrates. The IPT systems can be adapted to test
different panel sizes in less than three hours, as compared with systems using
probe card technology which the Company estimates can require up to 16 hours.
The currently available IPT-MPS system is an enhanced version of the IPT
system that uses optimized processing software, graphical user interface and
materials transport features. These features have been designed to enable the
IPT-MPS system to achieve throughput rates that are comparable to conventional
probe card based systems while providing the same functionality, flexibility
and cost-efficient features of the earlier IPT system.
Flat Panel Inspection Systems (FIS Systems)
The Company's Flat Panel Inspection (FIS) systems use the Company's
proprietary N-Aliasing(TM) technology to inspect virtually any type and size
of commercially available FPD panel for optical defects after the completion
of the second major stage of production, the construction of color cells
comprising individual pixels. FIS systems are also designed to perform
inspection after final module assembly of FPD panels. The systems use a single
high-resolution camera and workstation driven by the Company's N-Aliasing(TM)
software to quantitatively measure critical optical qualities such as
contrast, luminance and color balance and to precisely
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locate mura, line, cluster and individual pixel defects. Test data generated
by the systems is displayed on a video monitor to provide immediate visual
interpretation and can be stored or sent to a repair system to effect repairs.
FIS systems comprise a family of products that offer different levels of
resolution and flexibility to suit customers needs. The FIS-250 and the FIS-
300 test FPD panels with VGA, SVGA and XGA resolution, respectively. They can
currently be configured to perform as many as 100 individual tests and are
adaptable to panel sizes ranging from 0.75 to 15 inches. The systems are
available either as stand-alone units or as modular systems designed to be
integrated with manufacturers' material handling equipment.
Integrated Laser Weld System (ILWS(TM) System)
The Company's Integrated Laser Weld (ILW(TM)) system uses a laser to repair
opens and shorts in AMLCD and passive LCD panels. The ILW(TM) can use defect
files downloaded from the Company's IPT or FIS systems to automatically locate
the defects in the panel so that the operator can decide whether or not to
repair them. This capability saves operator time searching for the defects
among the hundreds of thousands of pixels on a display. The ILW(TM) repairs
shorts by cutting away excess material and opens by welding a new connection
to a recovery ring. New model ILW(TM) systems shipped in 1996 featured unique
BeamBlender(TM) laser technology. The feature allows manufacturers to blend
two laser frequencies in certain ratios for cutting or welding new materials
used in low-temperature polysilicon thin-film transistors.
INTELLECTUAL PROPERTY
The Company has been issued over 21 U.S. patents with respect to its FPD
test, inspection and repair technologies and has certain U.S. and foreign
applications pending. The Company has a number of U.S. patents related to its
Voltage Imaging(TM) technology and has applied for U.S., Japanese and Korean
patents related to this technology as well as its N-Aliasing(TM) technology.
No patents are scheduled to expire before 2010, subject to payment of
applicable maintenance fees. In addition, Photon Dynamics and IHI have jointly
filed patent applications in Japan relating to certain aspects of the IPT
systems.
The Company frequently reviews its inventions and attempts to determine
which inventions will provide substantial differentiation between the
Company's products and those of its competitors. In certain cases, the Company
may also choose to keep an invention or a process as a trade secret. Trade
secrets are routinely employed in the Company's manufacturing processes. The
Company has entered into non-disclosure agreements to protect its proprietary
technology with its employees and consultants, and in some instances with its
suppliers, its customers and IHI. Because of rapid technological developments
in the electronics and FPD industries and the broad and rapidly developing
patent coverage in such industries, the patent position of any manufacturer,
including the Company, is subject to uncertainties and may involve complex
legal and factual issues. Consequently, although the Company holds certain
patents and is currently prosecuting additional patent applications, there can
be no assurance that patents will issue from any pending applications or that
claims allowed by any existing or future patents will issue from any pending
applications or that claims allowed by any existing or future patents issued
to the Company will not be challenged, invalidated, or circumvented, or that
any rights granted thereunder will provide adequate protection to the Company.
Furthermore, there can be no assurance that others will not develop
technologies that are similar or superior to the Company's technology,
duplicate the Company's technology or design around the patents owned by the
Company. In addition, effective copyright and trade secret protection may be
unavailable or limited in certain foreign countries. There can be no assurance
that the steps taken by the Company will prevent misappropriation of its
technology. In addition, litigation may be necessary in the future to enforce
the Company's patents and other intellectual property rights, to protect the
Company's trade secrets, to determine the validity and scope of the
proprietary rights of others or to defend against claims of infringement or
invalidity. Such litigation could result in substantial costs and diversion of
resources and could have a material adverse effect on the Company's results of
operations or financial condition. Moreover, the Company may be required to
participate in interference proceedings to determine the priority of
inventions, which also could result in substantial cost to the Company. See
"Factors That May Affect Future Results."
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RESEARCH AND DEVELOPMENT
The market for FPD test, inspection and repair systems is characterized by
rapid and continuous technological development and product innovation. The
Company believes that continued and timely development of new products and
enhancements to existing products is necessary to maintain its competitive
position. Accordingly, the Company devotes a significant portion of its
personnel and financial resources to research and development programs and
seeks to maintain close relationships with customers to remain responsive to
their product needs. Photon Dynamics' current research and development efforts
are directed to increasing the performance of its flat panel inspection and
test systems and expanding the application of its inspection systems for use
in other related markets. Because the software incorporated by the Company
into its products represents a significant portion of the value added by these
products, over one-third of the Company's research and development personnel
are focused on software development.
The Company's research and development expenses were $4.0 million and $1.7
million in fiscal 1996 and fiscal 1995, respectively, or 16.1% and 9.1% of
revenue, respectively. Research and development expenses consist primarily of
salaries, project materials and other costs associated with the Company's
ongoing efforts. In addition to research and development expenses incurred for
product development, the Company spent $1.0 million in fiscal 1996 and $4.6
million in fiscal 1995 in performance of its obligations under development
contracts.
The Company has obtained substantial development funding from IHI with
respect to the Company's IPT systems. IHI has provided funding for initial
feasibility studies and development of the first prototypes of the IPT
systems, and since 1990 IHI has provided to the Company in excess of $6.3
million in research and development funding with respect to the IPT systems.
At present, the Company and IHI are parties to a development agreement
pursuant to which IHI is providing up to $1.5 million to Photon Dynamics to
fund continuing development and improvement of the IPT-MPS systems. Under
these agreements IHI is granted certain licenses and joint ownership rights to
the developed technology, which rights are consistent with IHI's manufacturing
and sales rights under the Company's existing agreements with IHI.
The Company has entered into contracts from the U.S. government and private
companies including IHI, to develop products which Photon Dynamics is then
able to sell with certain restrictions. Photon Dynamics generally owns all of
the intellectual property developed under these contracts, although the
Company has licensed certain rights to its IPT technology to the U.S.
government which may transfer its license to a third party for use in products
sold to U.S. customers in the event the Company becomes unable to delivery IPT
systems to U.S. customers.
CUSTOMERS, SALES AND SERVICE
The Company sells its products to leading FPD manufacturers worldwide. Sales
to Sharp Corp. represented 5% and 25% of revenue in fiscal 1996 and fiscal
1995. Sales to LG Electronics, Inc represented 19% and 24% of revenue in
fiscal 1996 and fiscal 1995. Overall, the Company's top six customers
contributed 78% of revenue in fiscal 1996. International sales accounted for
88% and 63% of revenue in fiscal 1996 and 1995, respectively.
Under its agreements with IHI, the Company has granted certain exclusive
sales rights to IHI with respect to its IPT systems, including the IPT-MPS,
for Japan, Korea and a number of other Asian countries. These exclusive rights
continue until June 1997 and may be renewed by IHI and the Company for
subsequent periods. In the event these exclusive sales and marketing rights of
IHI are not renewed, IHI will retain a non-exclusive right to manufacture and
sell IPT systems in the IHI territory. The sales and marketing provisions of
the Company's relationship with IHI provide that IHI is entitled to sell IPT
systems in Japan, Korea and the rest of the IHI territory and that the Company
will assist IHI in a sales agent capacity in exchange for a commission. At
present, IHI and Photon Dynamics share sales responsibility for Photon
Dynamics manufactured IPT systems in Japan, and Photon Dynamics is directly
selling all IPT systems outside Japan, which IHI has contractually agreed to
allow Photon Dynamics to do through December 31, 1996. IHI performs all
support and service for system
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units in Japan, while Photon Dynamics provides support and service in the
balance of the IHI territory. To the extent IHI determines in the future to
exercise fully its contractual rights to manufacture and sell these systems
for the IHI territory, such action would reduce revenue of the Company
attributable to these IHI manufactured IPT systems and may have an adverse
effect on the Company's results of operations. In the event IHI should
determine to reduce its internal budgets, staffing levels, research and
development funding or other allocations of its resources for development,
manufacture, sale and support of IPT systems in its territory, such action by
IHI could have a material adverse effect on the Company's ability to compete
in these markets and on the Company's results of operations.
The Company primarily sells its products directly to end users, other than
sales through IHI. Photon Dynamics believes that using a direct sales force
provides it with a significant competitive advantage as well as control over
pricing and customer satisfaction. In Taiwan, Photon Dynamics sells through a
direct sales force supported by an independent sales representative. In the
U.S., the Company sells direct. Sales in Europe are supported from the
Company's U.S. offices.
In the U.S., the Company maintains its sales and service office at its
headquarters in San Jose, California. In Asia, the Company has subsidiaries in
Tokyo, Japan and Seoul, Korea that provide direct sales and service support.
The Asian sales and service operations are staffed by direct marketing, sales
and service personnel located in Japan and Korea. In addition, in Japan the
Company's IPT systems are serviced by IHI.
The Company generally sells its products on net 30-day terms to its
customers, with a small portion held back until final acceptance. However, a
substantial portion of its customers, primarily foreign, remit payments on
significantly longer terms. The Company generally warrants its products for a
period of one year from acceptance by customers within 30 days of installation
for material and labor to repair the product. Installation is generally
included in the price of the product. The Company's field engineers provide
customers with repair and maintenance services. Customers may enter into
repair and maintenance service contracts covering the Company's products. The
Company provides customer training for a fee to enable its customers to
perform routine service and provides telephone consultation services generally
free of charge. The Company does not consider its business to be seasonal in
nature, but it may become cyclical with respect to the capital equipment
procurement practices of major FPD manufacturers.
MANUFACTURING AND SUPPLIERS
The Company's principal manufacturing activities take place in San Jose,
California and consist primarily of assembling and testing components and
subassemblies which are acquired from third party vendors and then integrated
into Photon Dynamics finished products. Certain of the components and
subassemblies included in the Company's systems are obtained from a single
source or a limited group of suppliers. For example, the Company has obtained
all of the high speed image processing systems, materials handling platforms
and ultra-high resolution cameras used in its products from single source
suppliers, including Kodak Corporation and Anorad Corporation. The Company has
not entered into any formal agreements with such suppliers, other than long
term purchase orders and, in some cases, volume pricing agreements. The
partial or complete loss of such suppliers could increase the Company's
manufacturing costs or delay product shipments while the Company qualifies a
new supplier, could require redesigning the Company's products and could
therefore have an adverse effect on the Company's results of operations and
damage customer relationships. Further, a significant increase in the price of
one or more of the components supplied by such suppliers could adversely
affect the Company's results of operations.
The Company schedules production based upon firm customer commitments and
anticipated orders during the planning cycle. The Company generally expects to
be able to accept a customer order, build the required machinery and ship to
the customer within 16 weeks. Quality control is maintained through incoming
inspection of components, in-process inspection during equipment assembly and
final inspection and operation of all manufactured equipment prior to
shipment. The Company works in close collaboration with its employees,
customers and suppliers and trains all of its employees in basic quality
skills and regularly participates in quality
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sharing meetings with other equipment manufacturers and customer quality
audits of procedures and personnel. The Company conducts final testing of its
systems and assembles certain components under limited clean room conditions,
but most manufacturing is done in standard manufacturing space. The Company
believes that additional manufacturing space to respond to higher demand is
therefore readily available.
The Company has granted certain exclusive rights to IHI to manufacture IPT
systems, including the IPT-MPS, for Japan, Korea and the rest of the IHI
territory. Under the terms of the Company's agreements with IHI, Photon
Dynamics retains the right to manufacture certain critical components for the
IPT systems and to sell these components to IHI at prices that are established
annually, and IHI has the right to manufacture and assemble the balance of the
IPT systems to be sold in its territories. To date, IHI has allowed Photon
Dynamics to manufacture all IPT systems for IHI, which has acted as a
distributor in Japan and performed customization of the IPT systems for the
Japanese market and its individual customers in that market. To the extent IHI
determines in the future to exercise fully its contractual right to
manufacture and sell these systems for the IHI territory, such action would
reduce revenue of the Company attributable to these IHI manufactured IPT
systems and may have a material adverse effect on the Company's results of
operations.
BACKLOG
As of September 30, 1996, the Company's backlog was approximately $4.9
million as compared to approximately $5.4 million as of September 30, 1995. In
addition, approximately 82% of the Company's backlog at fiscal 1996 year-end
was comprised of orders from three customers. The Company's backlog consists
of those customer orders for which it has accepted purchase orders and
assigned shipment dates within the next 12 months. All orders are subject to
delay or cancellation with limited or no penalty. Because of possible changes
in product delivery schedules and cancellation of product orders, because
orders received by the Company in any particular quarter may vary
significantly and because the Company's sales will often reflect orders
shipped in the same quarter they are received, the Company's backlog may vary
significantly and at any particular date is not necessarily indicative of
actual sales for any succeeding period.
COMPETITION
The FPD equipment industry is highly competitive. The Company faces the
prospect of substantial future competition from established companies, some of
which are expected to be larger companies, or parts thereof, some of which are
expected to have greater financial, engineering and manufacturing resources
than the Company and some of which are expected to have larger service
organizations and long-standing customer relationships with major FPD
manufacturers. In the event that the Company's agreements with IHI are not
extended in 1997, IHI may compete with the Company selling the Company's IPT
systems in Japan, Korea and the rest of the IHI territory. The Company also
expects it may face additional competition from new entrants into the FPD
equipment industry and from competitors utilizing new technologies. The
Company's competitors can be expected to continue to improve the design and
performance of their products and to introduce new products with competitive
price/performance characteristics. In addition, the Company's customers may
choose to develop proprietary technology and FPD equipment which may obviate
or lessen their need to purchase the Company's products. The Company's
customers may also use multiple technologies and solutions, including
competitors' products, to replicate the functionality of the Company's
systems. Competitive pressures may necessitate price reductions which could
adversely affect the Company's results of operations. Although the Company
believes that it has certain technological and other advantages over its
competitors, realizing and maintaining such advantages will require a
continued high level of investment by the Company in engineering, research and
development, marketing and customer service and support. There can be no
assurance that the Company will have sufficient resources to continue to make
such investments or that the Company will be able to make the technological
advances necessary to maintain such competitive advantages.
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EMPLOYEES
As of September 30, 1996, the Company employed 104 persons, all full time.
Many of the Company's employees are highly skilled, and the Company's success
will depend in part upon its ability to attract and retain such employees, who
are in great demand. The Company has never had a work stoppage or strike and
no employees are represented by a labor union or covered by a collective
bargaining agreement. The Company considers its employee relations to be good.
FACTORS THAT MAY AFFECT FUTURE RESULTS
FACTORS AFFECTING EARNINGS AND STOCK PRICE
The statements contained in this report on Form 10-KSB that are not purely
historical are forward looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934, including statements regarding the Company's expectations, hopes,
intentions or strategies regarding the future. All forward looking statements
included in this document are based on information available to the Company on
the date hereof, and the Company assumes no obligation to update any such
forward looking statements. It is important to note that the Company's actual
results could differ materially from those in such forward looking statements.
You should consult the risk factors listed from time to time in the Company's
reports on Form 10-QSB, and annual reports to shareholders. Among the factors
that could cause actual results to differ materially are the following risk
factors:
VARIABILITY OF QUARTERLY RESULTS OF OPERATIONS; LIMITED HISTORY OF
PROFITABILITY
The Company has experienced and expects to continue to experience
significant fluctuations in its quarterly results of operations. The Company
derives substantially all of its revenue from the sale of a relatively small
number of systems, which typically range in price from $400,000 to $1,500,000.
As a result, the timing of the sale of a single system could have a
significant impact on the Company's quarterly revenue and results of
operations. The failure to receive anticipated orders or delays in shipments
in a particular quarter, due, for example, to unanticipated shipment
reschedulings, cancellations by customers or unexpected manufacturing
difficulties, may cause revenue for that quarter to fall significantly below
the Company's expectations, which would have a material adverse effect on the
Company's results of operations for such quarter. The Company's backlog at the
beginning of each quarter is not necessarily indicative of actual sales for
any succeeding period. All orders are subject to delay or cancellation with
limited or no penalty. The Company's sales will often reflect orders shipped
in the same quarter that they are received. Other factors which may have an
influence on the Company's results of operations in a particular quarter
include the volume, mix and timing of the receipt of orders from major
customers, competitive pricing pressures, costs of components and subsystems,
the Company's ability to design, manufacture and introduce new products on a
cost effective and timely basis, the delay between incurrence of expenses to
further develop marketing and service capabilities and realization of benefits
from such improved capabilities, fluctuations in foreign exchange rates, the
timing of recognition of revenue under development contracts, the introduction
and announcement of new products by the Company's competitors and changing
conditions in the FPD ( "Flat Panel Display")market worldwide. In particular,
due to substantial differences in gross margin for the Company's products,
changes in the mix of products sold could result in substantial fluctuations
in the Company's gross margin. Accordingly, the Company's results of
operations are subject to significant variability from quarter to quarter.
DEPENDENCE ON RECENTLY INTRODUCED AND NEW PRODUCTS
The markets for the Company's products are characterized by rapidly changing
technologies, extensive research and new product introductions. The Company
believes that its future success will depend in part upon its ability to
continue to enhance its existing products and to develop and manufacture new
products. As a result, the Company expects to continue to make a significant
investment in engineering, research and development. There can be no assurance
that the Company will be successful in the introduction, marketing and cost
effective
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manufacture of any of its new or recently introduced products or that the
Company will be able to develop and introduce new products or enhancements to
its existing products and processes in a timely manner which satisfy customer
needs, achieve market acceptance or address technological changes in the FPD
industry. In order to develop new products successfully, the Company is
dependent upon close relationships with its customers and the willingness of
those customers to share information with the Company. The failure to develop
products and introduce them successfully and in a timely manner could
adversely affect the Company's competitive position and results of operations.
The Company's future results of operations are highly dependent on the
continuing market introduction, marketing and cost-effective manufacture of
its In-Process Test Mass Production System (IPT-MPS), which first shipped in
September 1995. The Company continues to perform research and development work
with respect to the IPT-MPS system to attain additional throughput levels
requested by the Company's customers and other performance parameters sought
by manufacturers of active matrix liquid crystal displays ("AMLCDs") for their
volume production environments. The Company has experienced delays in
implementing the software necessary to achieve throughput rates. No assurance
can be given that development efforts related to other performance parameters
will be successful. The Company believes that future orders of IPT-MPS systems
will be dependent on its ability to attain requested throughput levels and
other performance parameters. The Company has experienced delays in obtaining
final acceptance and final payment on some products. If products have
performance, reliability or quality problems or shortcomings, then the Company
may experience reduced orders, higher manufacturing costs, continued delays in
collecting accounts receivable and additional warranty and service expenses
which may have an adverse effect on the Company's results of operations. In
addition, future growth in sales of the Company's products will depend upon
the acceptance of the Company's IPT or FIS technologies by a broader group of
customers, including additional international customers and FPD manufacturers
who currently do not perform the type of FPD test or inspection offered by the
Company's products or utilize alternative technologies for, or methods of,
inspection, such as "open/short" testing and human visual inspection. Because
of the large capital commitment involved in the construction and operation of
an FPD manufacturing facility, the decision by an FPD manufacturer to purchase
the Company's IPT or FIS systems involves a significant technological and
financial commitment as compared to current alternatives such as human
inspection and open/short testers. While the Company is actively promoting the
acceptance of these technologies, there can be no assurance that the Company
will be successful in obtaining broader acceptance of its IPT or FIS
technologies. Failure to achieve broader acceptance would have an adverse
effect on the Company's results of operations.
DEPENDENCE ON PRINCIPAL CUSTOMERS
The FPD industry is extremely concentrated, with virtually all major FPD
manufacturers and many of the Company's principal customers located in Asia.
Although the composition of the Company's largest customers has changed from
year to year, direct sales to the Company's top six in fiscal 1996 and top
four in fiscal 1995 end user customers accounted for approximately 78% and
71%, respectively, of the Company's total revenue. The Company currently has
no long-term purchase commitments with any of its customers and sales are
generally made pursuant to purchase orders. All orders are subject to delay or
cancellation with limited or no penalty. A reduction, delay, or cancellation
of orders from one or more of its significant customers, or the loss of one or
more of such customers, could have a material adverse effect on the Company's
results of operations.
DEPENDENCE ON SINGLE OR LIMITED SUPPLIERS
Certain of the components and subassemblies included in the Company's
systems are obtained from a single source or a limited group of suppliers. For
example, the Company has obtained all of the high speed image processing
systems, materials handling platforms and ultra-high resolution cameras used
in its products from single source suppliers, including Kodak Corporation and
Anorad Corporation. The Company has not entered into any formal agreements
with such suppliers, other than long term purchase orders and, in some cases,
volume pricing agreements. The partial or complete loss of such suppliers
could increase the Company's manufacturing costs or delay product shipments
while the Company qualifies a new supplier, could require redesigning the
9
<PAGE>
Company's products and could therefore have an adverse effect on the Company's
results of operations and damage customer relationships. Further, a
significant increase in the price of one or more of the components supplied by
such suppliers could adversely affect the Company's results of operations.
RELATIONSHIP WITH IHI
The Company has granted certain exclusive manufacturing and sales rights to
Ishikawajima-Harima Heavy Industries Co., Ltd. ("IHI") with respect to its IPT
systems, including the IPT-MPS, for Japan, Korea, a number of other Asian
countries, Saudi Arabia, Australia, New Zealand, India and Sri Lanka. Under
the terms of this relationship the Company reserves the rights to manufacture
certain critical components and to sell the components to IHI for inclusion in
IPT systems to be sold by IHI in its territory. The agreements between IHI and
the Company further provide for the Company to assist IHI in its sales efforts
in these countries in exchange for a commission. This relationship continues
on an exclusive basis for the IHI territory until June 1997, and, if such
exclusivity is not renewed, IHI will have non-exclusive manufacturing and
sales rights in its territory in periods thereafter. In exchange for these
rights, IHI has provided and continues to provide significant funding for
development of the IPT systems, which funding substantially enhanced the
Company's ability to complete development of these systems in a timely
fashion. To date, IHI has allowed Photon to manufacture all IPT systems sold
by IHI in the IHI territory, and the Company expects that many, if not all, of
the IPT systems that will be sold in IHI's territory will be manufactured by
the Company. At present, IHI and Photon share sales responsibility for Photon
manufactured IPT systems in Japan, and IHI has agreed to allow Photon to sell
directly all IPT systems outside Japan through December 31, 1996. IHI performs
all support and service for system units in Japan, while Photon provides
support and service in the balance of the IHI territory. To the extent IHI
determines in the future to exercise fully its contractual rights to
manufacture and sell these systems in the IHI territory, such action would
reduce revenue of the Company attributable to these IHI manufactured IPT
systems and may have a material adverse effect on the Company's results of
operations. Given the concentration of FPD manufacturers in the IHI territory,
the Company is highly dependent on IHI and the success of the Company's
relationship with IHI to market and sell the IPT systems, including the IPT-
MPS, in these critical markets. In the event IHI should determine to reduce
its internal budgets, staffing levels, research and development funding or
other allocations of its resources for the development, manufacture, sale and
support of IPT systems in its territory, such action by IHI could have a
material adverse effect on the Company's ability to compete in these markets
and on the Company's results of operations. While the Company believes that
both it and IHI have obtained significant mutual benefit from their continuing
relationship, no assurance can be given that the IHI relationship will
continue to provide such benefits to the Company or that the Company's results
of operations will not be adversely impacted in the future based on its
dependency on IHI for the manufacture, sales and support of IPT systems in
Japan and other important Asian markets in the IHI territory.
INTERNATIONAL OPERATIONS
Approximately 88% of the Company's total revenue for fiscal 1996 was
attributable to sales outside the U.S. The Company expects that international
sales will continue to represent a significant portion of its total sales.
Sales to customers outside the U.S. are subject to risks, including the
imposition of governmental controls, the need to comply with a wide variety of
foreign and U.S. export laws, political and economic instability, trade
restrictions, changes in tariffs and taxes, longer payment cycles typically
associated with international sales, and the greater difficulty of
administering business overseas as well as general economic conditions.
Although substantially all of the Company's direct international sales are
denominated in U.S. dollars, both direct sales by the Company and sales
through IHI may be affected by changes in demand resulting from fluctuations
in interest and currency exchange rates. To the extent the Company's sales are
denominated in foreign currency, the Company's revenue and results of
operations may also be directly affected by fluctuations in foreign currency
exchange rates. Furthermore, although the Company endeavors to meet technical
standards established by foreign regulatory bodies, there can be no assurance
that the Company will be able to comply with changes in foreign standards in
the future. The inability of the Company to design products to comply with
foreign standards could have a material adverse effect on the Company. In
addition, the laws of certain foreign countries may not protect the Company's
intellectual property to the same extent as do the laws of the U.S.
10
<PAGE>
DEPENDENCE ON JAPANESE MARKET
The future performance of the Company will be dependent, in part, upon its
ability to continue to compete successfully in the Japanese market, one of the
largest markets for FPD test, inspection and repair equipment. The Company's
ability to compete in this market in the future is dependent upon continuing
free trade between Japan and the U.S., the continuing ability of the Company
to develop products in a timely manner that meet the technical requirements of
its Japanese customers and the continuing ability of the Company to maintain
satisfactory relationships with leading companies in the Japanese FPD
industry. The Company believes that the Japanese companies with which it
competes may have a competitive advantage in Japan because of the preference
of some Japanese customers for Japanese equipment suppliers because such
customers may have longer standing or closer business relationships with such
competitors. The Company's sales to Japan and results of operations will also
be affected by the overall health of the Japanese economy, including the
effects of currency exchange rate fluctuations on the global competitiveness
of Japanese FPD manufacturers.
RAPID AND FUNDAMENTAL TECHNOLOGICAL CHANGE
The FPD industry is an evolving industry characterized by extensive research
and development which has and is expected to continue to lead to rapid
technological change. The development by others of new or improved products or
technologies may make the Company's current or proposed products obsolete or
less competitive. Although the Company devotes significant efforts and
financial resources to further develop and enhance its existing products,
there can be no assurance that advances in other or alternative technologies
will not make the Company's products obsolete or less competitive. Currently,
the predominant technology used in the FPD industry is liquid crystal display
("LCD") technology. Although the Company has installed its products or has
entered into discussions with manufacturers utilizing virtually all of the
alternative FPD technologies which the Company believes are commercially
viable FPD technologies, its revenue is derived primarily from sales of
products related to a variant of LCD technology used in a substantial portion
of all FPDs, AMLCD technology. An industry shift away from AMLCD technology or
the emergence of new competing technologies could have a material adverse
effect on the Company's business and results of operations.
COMPETITION
The FPD equipment industry is highly competitive. The Company faces the
prospect of substantial future competition from established companies, some of
which are expected to be larger companies, or parts thereof, some of which are
expected to have greater financial, engineering and manufacturing resources
than the Company and some of which are expected to have larger sales and
service organizations and long-standing customer relationships with major FPD
manufacturers. In the event that the Company's agreements with IHI are not
extended in 1997, IHI may compete with the Company in selling the Company's
IPT systems in Japan, Korea and the rest of the IHI territory. The Company
also expects it may face additional competition from new entrants into the FPD
equipment industry and from competitors utilizing new technologies. The
Company's competitors can be expected to continue to improve the design and
performance of their products and to introduce new products with competitive
price/performance characteristics. In addition, the Company's customers may
choose to develop proprietary technology and FPD equipment which may obviate
or lessen their need to purchase the Company's products. The Company's
customers may also use multiple technologies and solutions, including
competitors' products, to provide the functionality of the Company's systems.
Competitive pressures may necessitate price reductions which could adversely
affect the Company's results of operations. Although the Company believes that
it has certain technological and other advantages over its competitors,
realizing and maintaining such advantages will require a continued high level
of investment by the Company in engineering, research and development,
marketing and customer service and support. There can be no assurance that the
Company will have sufficient resources to continue to make such investments or
that the Company will be able to make the technological advances necessary to
maintain such competitive advantages.
11
<PAGE>
FLAT PANEL DISPLAY INDUSTRY DOWNTURNS OR SLOWDOWNS
The Company's business depends in large part upon the capital equipment
expenditures of FPD manufacturers, which in turn depend on the current and
anticipated market demand for FPDs and products utilizing FPDs. For example,
the Company believes that historical shortages of supplies of semiconductor
components may have in the past temporarily limited the quantities of laptop
computers that were manufactured, which in turn may have reduced demand from
laptop computer manufacturers for certain FPDs. Should these conditions have
continued for an extended period, the resulting reduced long-term demand for
FPDs suitable for laptop computers could adversely affect the level of capital
expenditure by FPD manufacturers. Although to date the FPD industry has had a
relatively steady growth rate, the FPD industry may, like the semiconductor
industry, become highly cyclical and experience periodic downturns or
slowdowns in growth, which may have a material adverse effect on capital
equipment expenditures by FPD manufacturers and in turn adversely affect the
Company's results of operations. No assurance can be given that the Company's
results of operations would not be adversely affected if such downturns or
slowdowns in the FPD industry were to occur in the future. In addition, the
need for continued investment in engineering, research and development and
marketing required to penetrate targeted foreign markets and maintenance of
extensive worldwide customer service and support capabilities will limit the
Company's ability to reduce expenses during downturns or slowdowns in growth
in the FPD industry.
PATENTS AND PROPRIETARY RIGHTS
The Company's future success and competitive position are dependent in part
upon its proprietary technology, and the Company relies on patent, trade
secret, trademark and copyright law to protect its intellectual property.
There can be no assurance that any patent owned or licensed by the Company
will not be invalidated, circumvented, challenged or licensed to others, that
the rights granted thereunder will provide competitive advantages to the
Company or that any of the Company's pending or future patent applications
will be issued with the scope of the claims sought by the Company, if at all.
Furthermore, there can be no assurance that others will not develop
technologies that are similar or superior to the Company's technology,
duplicate the Company's technology or design around the patents owned by the
Company. In addition, effective copyright and trade secret protection may be
unavailable or limited in certain foreign countries. There can be no assurance
that the steps taken by the Company will prevent misappropriation of its
technology. In addition, litigation may be necessary in the future to enforce
the Company's patents and other intellectual property rights, to protect the
Company's trade secrets, to determine the validity and scope of the
proprietary rights of others or to defend against claims of infringement or
invalidity. Such litigation could result in substantial costs and diversion of
resources and could have a material adverse effect on the Company's results of
operations.
Competitors in both the U.S. and foreign countries, many of which have
substantially greater resources and have made substantial investments in
competing technologies, may have applied for or obtained, or may in the future
apply for and obtain, patents that will prevent, limit or interfere with the
Company's ability to manufacture and sell its products. The Company has not
conducted an independent review of patents issued to third parties. Although
the Company believes that its products do not infringe the patents or other
proprietary rights of third parties, there can be no assurance that other
third parties will not assert infringement claims against the Company or that
such claims will not be successful. Even successful defense of patent suits
are both costly and time-consuming. An adverse outcome in the defense of a
patent suit could subject the Company to significant liabilities to third
parties, require disputed rights to be licensed from third parties or require
the Company to cease selling its products.
MANAGEMENT OF GROWTH
The Company has recently experienced and may continue to experience growth
in the number of its employees and the scope of its operations, resulting in
increased responsibilities for management personnel. To manage recent and
potential future growth effectively, the Company will need to continue to
implement and improve its operational, financial and management information
systems and to hire, train, motivate and manage
12
<PAGE>
a growing number of employees. The future success of the Company also will
depend on its ability to attract and retain qualified technical, marketing and
management personnel, particularly highly skilled software engineers, for whom
competition is intense. In particular, the current availability of qualified
engineers is limited, and competition among companies for skilled and
experienced engineering personnel is very strong. The Company is currently
attempting to hire a number of engineering personnel and has experienced
delays in filling such positions. The Company expects to experience continued
difficulty in filling its needs for qualified engineers and other personnel.
There can be no assurance that the Company will be able to achieve or manage
effectively any such growth, and failure to do so could delay product
development cycles or otherwise have a material adverse effect on the
Company's results of operations.
DEPENDENCE ON KEY EMPLOYEES
The future success of the Company is dependent, in part, on its ability to
retain certain key personnel. The Company also needs to attract additional
skilled personnel in all areas of its business to continue to grow. While many
of the Company's current employees have many years of service with the
Company, there can be no assurance that the Company will be able to retain its
existing personnel or attract additional qualified employees in the future.
POSSIBLE VOLATILITY OF COMMON STOCK PRICE
Many factors such as, but not limited to, announcements of technological
innovations or new products by the Company, its competitors or third parties,
as well as quarterly variations in the Company's actual or anticipated results
of operations, may cause the market price of the Company's Common Stock to
fluctuate significantly. Furthermore, the stock market has experienced extreme
price and volume fluctuations, which have particularly affected the market
prices of many high technology companies and which have often been unrelated
to the operating performance of such companies. These broad market
fluctuations may adversely affect the market price of the Company's Common
Stock.
ITEM 2: DESCRIPTION OF PROPERTY.
The Company's main headquarters, located in San Jose, California consists of
a 50,000 square foot facility. The current monthly base rental under the lease
for the facility is approximately $49,000. The lease expires in 2001. The
Company also leases office space for its sales and service operations in
Seoul, Korea and Tokyo, Japan.
ITEM 3: LEGAL PROCEEDINGS.
The Company is not a party to any material litigation.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of security holders during the fourth
quarter ended September 30, 1996.
13
<PAGE>
PART II
ITEM 5: MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The information required by this Item is incorporated by reference from page
24 of the Company's 1996 Annual Report to Stockholders.
ITEM 6: MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The information required by this Item is incorporated by reference from
pages 6-10 of the Company's 1996 Annual Report to Stockholders.
ITEM 7: FINANCIAL STATEMENTS.
The information required by this Item is incorporated by reference from
pages 11-22 of the Company's 1996 Annual Report to Stockholders.
ITEM 8: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
Not applicable
14
<PAGE>
PART III
Certain information required by Part III is omitted from this Report in that
the Registrant will file a definitive proxy statement within 120 days after
the end of its fiscal year pursuant to Regulation 14A (the "Proxy Statement")
for its 1997 Annual Meeting of Stockholders to be held February 12, 1997 and
the information included therein is incorporated herein by reference.
ITEM 9: DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT.
The information required by this Item is incorporated by reference from the
Company's Proxy Statement for the 1997 Annual Meeting of Stockholders under
the Heading "Management
ITEM 10: EXECUTIVE COMPENSATION.
The information required by this Item is incorporated by reference from the
Company's Proxy Statement for the 1997 Annual Meeting of Stockholders under
the Heading "Management
ITEM 11: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this Item is incorporated by reference from the
Company's Proxy Statement for the 1997 Annual Meeting of Stockholders under
the Heading "Security Ownership Of Certain Beneficial Owners And Management"
ITEM 12: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this Item is incorporated by reference from the
Company's Proxy Statement for the 1997 Annual Meeting of Stockholders under
the Heading "Certain Relationships And Related Transactions"
ITEM 13: EXHIBITS AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this Form 10-KSB Report:
(1) Financial Statements
(2) Exhibits: See index to Exhibits. The Exhibits listed in the
accompanying Index to Exhibits are filed as incorporated by
references as part of this report.
(b) Reports on Form 8-K. No reports on Form 8-K were filed during the
fourth quarter of 1996.
15
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities and Exchange Act of
1932 as amended (the "Exchange Act"), the registrant caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
PHOTON DYNAMICS, INC.
Date: December 30, 1996 /s/ Vincent Sollitto
---------------------------------------
Vincent Sollitto
Chief Executive Officer and Director
(Principal Executive Officer)
KNOW ALL PERSONS BY THESE PRESENTS, THAT EACH PERSON WHOSE SIGNATURE APPEARS
BELOW CONSTITUTES AND APPOINTS VINCENT F. SOLLITTO JR. AND HOWARD M. BAILEY,
AND EACH OF THEM, ACTING INDIVIDUALLY, AS HIS OR HER ATTORNEY-IN-FACT, EACH
WITH FULL POWER OF SUBSTITUTION AND RESUBSTITUTION, FOR HIM AND IN HIS NAME,
PLACE AND STEAD, IN ANY AND ALL CAPACITIES, TO SIGN ANY AND ALL AMENDMENTS TO
THIS ANNUAL REPORT ON FORM 10-KSB, AND TO FILE THE SAME, WITH ALL EXHIBITS
THERETO, AND OTHER DOCUMENTS IN CONNECTION THEREWITH, WITH THE SECURITIES AND
EXCHANGE COMMISSION, GRANTING UNTO SAID ATTORNEYS-IN-FACT AND AGENTS, AND EACH
OF THEM, FULL POWER AND AUTHORITY TO DO AND PERFORM EACH AND EVERY ACT AND
THING REQUISITE AND NECESSARY TO BE DONE IN CONNECTION THEREWITH AND ABOUT THE
PREMISES, AS FULLY TO ALL INTENTS AND PURPOSES AS HE MIGHT OR COULD DO IN
PERSON, HEREBY RATIFYING AND CONFIRMING ALL THAT SAID ATTORNEYS-IN-FACT AND
AGENTS, OR ANY OF THEM, OR THEIR OR HIS SUBSTITUTE OR SUBSTITUTES, MAY
LAWFULLY DO OR CAUSE TO BE DONE BY VIRTUE HEREOF.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1932, THIS ANNUAL
REPORT ON FORM 10-KSB HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE
CAPACITIES AND ON THE DATES INDICATED:
<TABLE>
<S> <C> <C>
December 30, 1996 Chief Executive Officer and /s/ Vincent Sollitto
Director (Principal Executive _________________________________
Officer) Vincent Sollitto
</TABLE>
<TABLE>
<S> <C> <C>
December 30, 1996 Chief Financial Officer and /s/ Howard Bailey
Secretary (Principal Financial _________________________________
and Accounting Officer) Howard Bailey
</TABLE>
<TABLE>
<S> <C> <C>
December 30, 1996 Chief Technical Officer, /s/ Francois Henley
Director _________________________________
Francois Henley
</TABLE>
<TABLE>
<S> <C> <C>
December 30, 1996 Chairman of the Board /s/ E. Floyd Kvamme
_________________________________
E. Floyd Kvamme
</TABLE>
<TABLE>
<S> <C> <C>
December 30, 1996 Director /s/ Barry Cox
_________________________________
Barry Cox
</TABLE>
<TABLE>
<S> <C> <C>
December 30, 1996 Director /s/ Michael Kim
_________________________________
Michael Kim
</TABLE>
<TABLE>
<S> <C> <C>
December 30, 1996 Director /s/ Dr. Malcolm J. Thompson
_________________________________
Dr. Malcolm J. Thompson
</TABLE>
<TABLE>
<S> <C> <C>
December 30, 1996 Director /s/ Steve Krausz
_________________________________
Steve Krausz
</TABLE>
16
<PAGE>
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
NUMBER EXHIBIT REFERENCE
------ ------- ---------
<C> <S> <C>
3.1 Form of Amended and Restated Articles of Incorporation of A
the Registrant.
3.2 Bylaws of the Registrant and amendments thereto. A
4.1 Reference is made to Exhibits 3.1 and 3.2. A
10.1 First Amended and Restated Investor Rights Agreement A
between Registrant and the shareholders set forth therein
dated May 11, 1994.
l0.2 Fourth Amended Shareholders Agreement for Photon Dynamics, A
Inc. between the Registrant and the shareholders set forth
therein dated May 11, 1994.
10.3 Form of Indemnification Agreement between the Registrant A
and each of its executive officers and directors.
10.4 1987 Stock Option Plan and Form of Stock Option Agreement. A,B
10.5 1995 Stock Option Plan and Forms of Stock Option A,B
Agreements.
10.6 1995 Employee Stock Purchase Plan. A,B
10.7 Lease agreement between Berg & Berg Developers and Photon
Dynamics, Inc. Dated August 6, 1996.
10.8 Sales Agent Agreement between the Registrant, K.K. Photon A
Dynamics and Ishikawajima-Harima Heavy Industries Co., Ltd.
dated June 1, 1992, the amendment thereto dated November
17, 1993 and the modification agreement related thereto
dated January 1, 1995.
10.9 License Agreement between the Registrant and Ishikawajima- A
Harima Heavy Industries Co., Ltd. dated June 1, 1992 and
the addendum thereto dated November 11, 1993.
10.10 Commercialization Agreement between the Registrant and A
Ishikawaima-Harima Heavy Industries Co., Ltd. dated June 1,
1992 and the amendment thereto dated November 17, 1993.
10.11 Form of Agreements Regarding Change of Control between the A,B
Registrant and each of Francois J. Henley, Howard M.
Bailey, Jeffrey Hawthome and Alan Nolet.
10.12 Agreement Regarding Change of Control between the
Registrant Donald Jerome dated July 1, 1996.
10.13 Form of Amendment to First Amended and Restated Investor A
Rights Agreement.
10.14 Agreement Regarding Change of Control between the
Registrant and Vincent Sollitto dated July 1, 1996.
11.1 Statement re: computation of earnings per share.
13.1 Registrants Annual Report to Stockholders for the year
ended September 30, 1996 (only such portions as necessary
to satisfy Form 10-KSB requirements).
2l.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP, Independent Auditors
27.1 Financial Data Schedules
Key to Exhibits:
(A) Incorporated by reference to Registrants' Registration
Statement on Form SB-2 filed with the Securities and
Exchange Commission on November 15, 1995
(B) Management contract or compensatory plan or arrangements
required to filed as an exhibit to this report on Form 10-
KSB pursuant to Item 13(a)
of this report.
</TABLE>
<PAGE>
EXHIBIT 10.7
STANDARD FORM LEASE
PARTIES: This Lease, executed in duplicate at Cupertino, California, on August
____, 1996, by and between Berg & Berg Developers, a California General
Partnership, and Photon Dynamics, Inc., a California Corporation, hereinafter
called respectively Lessor and Lessee, without regard to number or gender.
USE: Witnesseth: That Lessor hereby leases to Lessee, and Lessee hires from
----------
Lessor, for the purpose of conducting therein office, research and development,
light manufacturing, and warehouse activities, and any other legal activity; and
for no other purpose without obtaining the prior written consent of Lessor.
PREMISES: The real property with appurtenances as shown on Exhibit A. 1,
composed of 4 buildings, (the "Premises") situated in the City of San Jose,
County of Santa Clara, State of California, and more particularly described as
follows:
Lessee's portion of the building is 52,000 square feet including all
improvements thereto as outlined in red (tile "Building") as shown on
Exhibit A.2 including the right to use up to 182 unreserved parking spaces
at the Premises. The address for the leased portion of file Premises is
6325 San Ignacio, San Jose, California. Lessee's pro-rata share of the
building is 51%.
TERM: The term shall be for sixty (60) months unless extended pursuant to
Section 35 of this Lease (the "Lease Term"), commencing on the Commencement Date
as defined in Section 1), and ending on the day sixty (60) months thereafter.
RENT: Base rent shall be payable in monthly installments as follows:
Base rent Estimated CAC Total
--------- ------------- -----
Months 1 through 12 $46,540 $8,320* $54,860
Monthly base rent shall increase by 3% on the annual anniversary of the
Commencement Date each year during the Lease Term over the prior year's rent.
* CAC charges to be adjusted per Common Area Charges Section below.
Base rent as scheduled above shall be payable in advance on or before the first
day of each calendar month during the Lease Term. The term "Rent," as used
herein, shall be deemed to be and to mean the base monthly rent and all other
sums required to be paid by Lessee pursuant to the terms of this Lease. Rent
shall be paid in lawful money of the United States of America, without offset or
deduction, and shall be paid to Lessor at such place or places as may be
designated from time to time by Lessor. Rent for any period less than a calendar
month shall be a pro rata portion of the monthly installment. Upon execution of
this Lease, Lessee shall deposit with Lessor the first month's rent.
SECURITY DEPOSIT: Lessee shall deposit with Lessor in trust the sum of Fifty-
Four Thousand Eight Hundred Sixty Dollars ($54,860) (the "Security Deposit").
The Security Deposit shall be held by Lessor as security for the faithful
performance by Lessee of all of the terms, covenants, and conditions of this
Lease applicable to Lessee. If Lessee commits a default as provided for herein,
including but not limited to a default with respect to the provisions contained
herein relating to the condition of the Premises, Lessor may (but shall not be
required to) use, apply or retain all or any part of the Security Deposit for
the payment of any amount which Lessor may spend by reason of default by Lessee.
If any portion of the Security Deposit is so used or applied, Lessee shall,
within ten days after
<PAGE>
written demand therefor, deposit cash with Lessor in an amount sufficient to
restore the Security Deposit to its original amount. Lessee's failure to do so
shall be a default by Lessee. Any attempt by Lessee to transfer or encumber
its interest in the Security Deposit shall be null and void. Upon execution of
this Lease, Lessee shall deposit with Lessor the Security Deposit.
LATE CHARGES: Lessee hereby acknowledges that a late payment made by Lessee to
Lessor of Rent and other sums due hereunder 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 on Lessor
according to the terms of any mortgage or trust deed covering the Premises.
Accordingly, if any installment of Rent or any other sum due from Lessee is not
received by Lessor or Lessor's designee within ten (10) days after such amount
is due, Lessee shall pay to Lessor a late charge equal to five (5%) percent of
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
payments made by Lessee. Acceptance of such late charges by Lessor shall in no
event constitute a waiver of Lessee's default with respect to such overdue
amount, nor shall it prevent Lessor from exercising any of the other rights and
remedies granted hereunder. Notwithstanding the above, Lessee shall not be
required to pay a late charge if it is the result of a non-recurring unusual
event such as a accounting error.
QUIET ENJOYMENT: Lessor covenants and agrees with Lessee that upon Lessee paying
Rent and performing its covenants and conditions under this Lease, Lessee shall
and may peaceably and quietly have, hold and enjoy the Premises for the Lease
Term, subject, however, to the rights reserved by Lessor hereunder.
COMMON AREA CHARGES: Lessee shall pay to Lessor, as additional Rent, an amount
equal to Lessee's pro-rata share of the total common area charges of the
Premises and the total common area charges for the Building as defined below
(the common area charges for the Premises and the common area charges for the
Building collectively referred to herein as ("CAC")). Lessee shall pay to Lessor
as Rent, on or before the first day of each calendar month during the Lease
Term, subject to adjustment and reconciliation as provided hereinbelow, the sum
of Eight Thousand Three Hundred Twenty Dollars ($8,320), said sum representing
Lessee's estimated monthly payment of Lessee's percentage share of CAC. It is
understood and agreed that Lessee's obligation under this paragraph shall be
prorated to reflect the Commencement Date and the end of the Lease Term.
Lessee's estimated monthly payment of CAC payable by Lessee during the calendar
year in which the Lease commences is set forth above. At or prior to the
commencement of each succeeding calendar year term (or as soon as practical
thereafter), Lessor shall provide Lessee with Lessee's estimated monthly payment
for CAC which Lessee shall pay to Lessor as Rent. Within 120 days of the end of
the calendar year and the end of the Lease Term, Lessor shall provide Lessee a
statement of actual CAC incurred including capital reserves for the preceding
year or other applicable period in the case of a termination year. If such
statement shows that Lessee has paid less than its actual percentage, then
Lessee shall on demand pay to Lessor the amount of such deficiency. If such
statement shows that Lessee has paid more than its actual percentage, then
Lessor shall, at its option, promptly refund such excess to Lessee or credit the
amount thereof to the Rent next becoming due from Lessee. Lessor reserves the
right to revise any estimate of CAC if the actual or projected CAC show an
increase or decrease in excess of 10% from an earlier estimate for the same
period. In such event, Lessor shall provide a revised estimate to Lessee,
together with an explanation of the reasons therefor, and Lessee shall revise
its monthly payments accordingly. Lessor's and Lessee's obligation with respect
to adjustments at the end of the Lease Term or earlier expiration of this Lease
shall survive the Lease Term or earlier expiration.
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As used in this Lease, CAC shall include, but are not limited to (i) items
specified as CAC items in Paragraphs 5(b), 6, 16 and 31; (ii) utility costs
related to the common areas of the Premises as shown on Exhibit A.1 (iii) all
costs and expenses including but not limited to supplies, materials, equipment
and tools used or required in connection with the operation and maintenance of
the Premises; (iv) licenses, permits and inspection fees; (v) all other costs
incurred by Lessor in maintaining and operating the Premises; (vi) all reserves
for capital replacements; and (vii) an amount equal to five percent (5%) of the
aggregate of all CAC, as compensation for Lessor's accounting and processing
services. Lessee shall have the right to review the CAC applicable to this Lease
annually.
COMMENCEMENT DATE MEMORANDUM: When the actual Commencement Date is determined,
the parties shall execute a Commencement Date Memorandum setting forth the
Commencement Date, the expiration date of the Lease Term and any required
adjustments to base rent as provided in this Lease, but failure to do so shall
not affect the continuing validity and enforceability of this Lease, which shall
remain in full force and effect.
IT IS FURTHER MUTUALLY AGREED BETWEEN THE PARTIES AS FOLLOWS:
1. POSSESSION: Possession shall be deemed tendered and the term shall commence
upon the first to occur of the following (the "Commencement Date"): (i) the
Lessee Interior Improvements are Substantially Complete or (ii) Lessee occupies
the Building and commences to conduct business operations or (iii) if Lessor is
prevented from or delayed in completing its work under Section 2 of this Lease
due to Lessee Delays, such work will be deemed Substantially Complete as of the
date on which it would have been Substantially Complete had it not been for such
Lessee Delays. It is the intention of Lessee and Lessor that November 1, 1996
shall be the Commencement Date.
"Substantially Complete" shall mean that: (i) Lessor has tendered possession of
Building to Lessee, (ii) Lessor has met all legal requirements for occupancy,
(iii) The Lessee Interior improvements are materially complete per the approved
plans, exclusive of telephone or other communication systems, punchlist items
and there remains no incomplete or defective items of work which would
materially adversely affect Lessee's intended use of the Premises and (iv) said
interior of the building is in a "broom clean" condition.
2. LESSEE'S IMPROVEMENTS: The "Lessee Interior Improvements" shall be defined as
all items as shown on attached Exhibit B and shall be constructed by independent
contractors to be employed by and under the supervision of Lessor, in accordance
with complete plans and specifications prepared by Lessor and approved by Lessee
("Lessee Improvement Plans"), to be attached hereto as Exhibit B.1. Lessee and
its designated representatives, shall at all times during the construction of
the Lessee Interior Improvements have access to the Building to monitor the
progress of construction and Lessor's compliance with its obligation hereunder;
provided however, that such access shall not unreasonably interfere with the
activities of Lessor or its contractors. If Lessor notifies Lessee that any
fittings, finishes or other materials included in the specifications for the
Lessee Interior Improvements cannot be obtained within fifteen (15) days after
placing an order therefor for fittings, finishes, or other materials specified
by Lessee, Lessee shall be responsible for selecting alternative fittings,
finishes or other materials which can be obtained within said fifteen (15) day
period, or, if Lessee does not specify any alternative, Lessee shall be
responsible for any delay beyond said fifteen (15) day period including Rent for
each day of delay.
Lessor shall be responsible for ensuring that the Lessee Interior Improvements
conform to the approved plans and all applicable statutes, rules, regulations,
ordinances, and San Jose Building Department interpretations necessary for
occupancy.
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For any contract to be entered into between Lessor and any contractor furnishing
labor or materials in connection with the construction of the Lessee Interior
Improvements where the payment due under such contract is estimated by Lessor to
be in excess of One Hundred Thousand Dollars $100,000, Lessor shall request bids
from at least three (3) qualified contractors selected by Lessor for bidding.
Lessor will accept the lowest qualified bid. Lessee shall have the opportunity
to review the qualified bidders list and may select a bidder of their choice for
any bid provided the bidder meets Lessor's reasonable requirements.
Lessor shall be responsible for and shall pay the cost of the Lessee Interior
Improvements up to the amount of Six Hundred Ninety Thousand Dollars ($690,000)
(the "TI Allowance"). In the event the cost of the Lessee Interior Improvements
is less than the TI Allowance, the monthly base rent under the Lease shall be
reduced by $15.83 per month for every $1,000 dollars the costs are less than the
TI Allowance. Costs in excess of the TI Allowance, if ally, and the cost of
clean room estimated at $280,000 will not be incurred without advance approval
of Lessee. Any approved cost over the TI Allowance shall be paid for by Lessee
in cash within fifteen (15) days after Lessor has provided Lessee with evidence
that the work approved is complete.
Lessor shall be entitled to a construction management fee covering its overhead
and profit on the TI work of six percent (6%). All costs for Lessee Interior
Improvements shall be documented and subject to verification by Lessee.
Notwithstanding Lessor's responsibility for the TI Allowance, if at any time
after the execution of the Lease and upon the first occurrence only, Lessee's
cash position falls below One Million Five Hundred Thousand Dollars
($1,500,000), Lessee shall immediately reduce the principal amount of the TI
Allowance by paying to Lessor cash, the amount of which shall be determined with
reference to the following months of the Lease Term:
Months 1 through 12 $300,000
Months 13 through 24 250,000
Months 25 through 36 200,000
Months 37 through 48 100,000
After receipt of any required payments from Lessee to reduce the principal
amount of the TI Allowance, Lessor shall provide Lessee with a recalculation of
rent for the balance of the Lease Term.
Lessor shall use its best efforts to cause the Commencement Date of the initial
term to occur not later than November 1, 1996. If the Commencement Date has not
occurred by December 1, 1996, Lessee shall receive one day of base rent
abatement for each day after December 1, 1996 until the Commencement Date.
Lessor and Lessee agree that having a Commencement Date after December 1, 1996
will cause Lessee and Lessor to incur costs not contemplated by this Lease, the
exact amount of which will be extremely difficult to ascertain. Accordingly, the
parties hereby agree that Lessee's right to the abatement of base rent specified
herein represents a fair and reasonable settlement for both parties and neither
party shall have further liability to the other for any damages. If the
Commencement Date has not occurred by December 1, 1996, Lessee may at its sole
option, by written notice to Lessor, have the right to terminate this Lease at
any time after December 1, 1996 until the Commencement Date. Notwithstanding
anything to the contrary herein, all dates stated herein shall be extended for
the number of days Lessor is unable to Substantially Complete the Building as a
result of delays (i) due to governmental actions (other than governmental action
of refusing to approve work which fails to comply with the law or the building
permit) which occurs after receipt of normal building permits, (ii) due to acts
of God, (iii) due to circumstances beyond Lessor's control, (iv) after thirty
(30) days that the City of San Jose requires to issue a building permit after
plan submittal by Lessor, and (v) due to Lessee Delays. "Lessee Delays" means a
delay in Substantial Completion
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resulting from (a) Lessee's failure to meet Lessee's deadlines for approval as
shown on Exhibit E, (b) delays due to change orders, (c) delays due to
Lessee's failure to meet the deadlines for approving any plans or change
orders, and (d) delays because of the inability to obtain any product,
materials, design, color, fitting, or finish pursuant to this Section 2.
Lessee shall have a minimum of 3 business days to approve or disapprove any
preliminary plans or change orders and a minimum of 10 business days to
approve or disapprove any final plans. If Lessee does not disapprove any plans
or change orders within the time period set forth herein in writing, Lessor
may proceed on the basis that the plans or change orders are approved by
Lessee. If plans or change orders are disapproved, Lessee shall state the
reason for disapproval and Lessor and Lessee shall act in good faith to
resolve any issues. Lessor shall charge Lessee $250 per change order after the
fifth (5th) change order for processing.
2.1 ACCEPTANCE OF PREMISES AND COVENANTS TO SURRENDER: Lessor represents that
the Premises shall be in good order and repair, and shall comply with all
requirements for occupancy as of the Commencement Date. Lessee agrees on the
last day of the Lease Term, or on the sooner termination of this Lease, to
surrender the Building to Lessor in Good Condition and Repair. Good Condition
and Repair ("Good Condition and Repair") shall not mean original condition, but
shall mean that the Building are in a commercially acceptable condition suitable
for occupancy by a reasonable lessee. The interior walls of all office and
warehouse areas, the floors of all office and warehouse areas, all suspended
ceilings and any carpeting are to be cleaned and in Good Condition and Repair.
Lessee also agrees to surrender unto Lessor all alterations, additions, and
improvements which may have been made in, to, or on the Building by Lessee,
except that Lessee shall ascertain from Lessor, within (30) days before the end
of the Lease Term or earlier termination of this Lease, whether Lessor desires
to have the Building or any part or parts thereof restored to their condition as
of the Commencement Date of this Lease; if Lessor shall so desire, then Lessee
shall restore said Building or such part or parts thereof before the end of the
Lease Term or earlier termination of this Lease at Lessee's sole cost and
expense. Lessee, on or before the end of the Lease Term or sooner termination of
this Lease, shall remove all its personal property and trade fixtures from the
Building, and all such property not so removed shall be deemed to be abandoned
by Lessee. Lessee shall reimburse Lessor for all disposition costs incurred by
Lessor relative to Lessee's abandoned property. If the Building are not
surrendered at the end of the Lease Term or earlier termination of this Lease,
Lessee shall indemnify Lessor against loss or liability resulting from any delay
caused by Lessee in surrendering the Building including, without limitation, any
claims made by any succeeding Lessee founded on such delay.
3. USES PROHIBITED: Lessee shall not commit, or suffer to be committed, any
waste upon the Premises, or any nuisance, or other act or thing which may
disturb the quiet enjoyment of any other tenant in or around the buildings in
which the subject Premises are located or allow any sale by auction upon the
Premises, or allow the Premises to be used for any improper, immoral, unlawful
or objectionable purpose, or place any loads upon the floor, walls, or ceiling
which may endanger the structure, or use any machinery or apparatus which will
in any manner vibrate or shake the Building, or place any harmful liquids in the
drainage system of the building. No waste materials or refuse shall be dumped
upon or permitted to remain upon any part of the Premises outside of the
building proper. No materials, supplies, equipment, finished products or semi-
finished products, raw materials or articles of any nature shall be stored upon
or permitted to remain on any portion of the Premises outside of the building
structure, unless approved by the local, state federal or other applicable
governing authority. Lessor consents to Lessee's use of materials which are
incidental to the normal, day-to-day operations of any office user, such as
copier fluids, cleaning materials, etc., but this does not relieve Lessee of any
of its obligations not to contaminate the Premises or related real property or
violated any Hazardous Materials Laws.
4. ALTERATIONS AND ADDITIONS: Lessee shall not make, or suffer to be
made, any alteration or addition to the Building, or any part thereof, without
the express, advance written consent of Lessor; any addition or alteration to
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said Building, except movable furniture and trade fixtures, shall become at once
a part of the realty and belong to Lessor at the end of the Lease Term or
earlier termination of this Lease. Alterations and additions which are not
deemed as trade fixtures shall include HVAC systems, lighting systems,
electrical systems, partitioning, carpeting, or any other installation which has
become an integral part of the Building. Lessee agrees that it will not proceed
to make such alterations or additions until all required government permits have
been obtained and after having obtained consent from Lessor to do so, until five
(5) days from the receipt of such consent, so that Lessor may post appropriate
notices to avoid any liability to contractors or material suppliers for payment
for Lessee's improvements. Lessee shall at all times permit such notices to be
posted and to remain posted until the completion of work. At the end of the
Lease Term or earlier termination of this Lease, Lessee shall remove and shall
be required to remove its special tenant improvements and all related equipment
installed by Lessee at or during the Lease Term and Lessee shall return the
Building to the condition that existed before the installation of the special
tenant improvements. Notwithstanding the above, Lessor agrees to allow any
reasonable alterations and improvements and will use its best efforts to notify
Lessee at the time of approval if such improvements or alterations are to be
removed at the end of the Lease Term or earlier termination of this Lease.
5. MAINTENANCE OF PREMISES:
(a) Lessee shall at its sole cost and expense keep and maintain the interior of
the Building, including, but not limited to, all lighting systems, temperature
control systems, clean room systems other than base HVAC units and plumbing
systems, in Good Condition and Repair, including any required replacements.
Lessee shall maintain all wall surfaces and floor coverings in Good Condition
and Repair, free of holes, gouges, or defacements.
(b) Lessor shall keep and maintain in Good Condition and Repair including
replacements, at Lessee's expense, based on a pro-rata share of cost based on
square footage or costs directly related to Lessee's use of the Premises the
following, which shall be included in the monthly CAC:
1. The exterior of the building, any appurtenances and every part
thereof, including but not limited to, glazing, sidewalks, parking areas,
electrical systems, HVAC systems, roof membrane, and painting of exterior
walls.
2. The HVAC by a service contract with a licensed air conditioning and
heating contractor which contract shall provide for a minimum of quarterly
maintenance of all air conditioning and heating equipment at the Building
including HVAC repairs or replacements which are either excluded from such
service contract or any existing equipment warranties.
3. The landscaping by a landscape contractor to water, maintain, trim and
replace, when necessary, any shrubbery and landscaping at the Premises.
4. The roof membrane by a service contract with a licensed reputable
roofing contractor which contract shall provide for a minimum of semi-
annual maintenance, cleaning of storm gutters, drains, removing of debris
and trimming overhanging trees, repair of the roof and application of a
finish coat every five years at the Building.
5. Extermination services.
6. Fire monitoring services.
(c) Lessee hereby waives any and all rights to make repairs at the expense of
Lessor as provided in Section 1942 of the Civil Code of the State of
California, and all rights provided for by Section 1941 of said Civil Code.
(d) Lessor shall be responsible for the repair of any structural defects in the
Building including the roof structure (not membrane), exterior walls and
foundation during the Lease Term.
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6. HAZARD INSURANCE: Lessee shall not use, or permit said Premises, or any part
thereof, to be used, for any purpose other than that for which said Premises are
hereby leased; and no use shall be made or permitted to be made of the Premises,
nor acts done, which may cause a cancellation of any insurance policy covering
said building, or any part thereof, nor shall Lessee sell or permit to be kept,
used or sold, in or about said Premises, any article which may be prohibited by
a standard form fire insurance policy. Lessee shall, at its sole cost and
expense, comply with any and all requirements, pertaining to said Premises, of
any insurance organization or company, necessary for the maintenance of
reasonable fire and general liability insurance, covering said building and
appurtenances. Lessor agrees to purchase and keep in force fire and extended
coverage insurance covering loss or damage to the Premises in amounts not to
exceed the full replacement cost of said Premises as determined by Lessor, with
proceeds payable to Lessor. Lessee acknowledges that the insurance referenced
above does not include coverage for Lessee's personal property. In the event of
a loss per the insurance provisions of this paragraph, Lessee shall be
responsible for deductibles up to a maximum of $5,000 per occurrence. Lessee
agrees to pay to the Lessor as additional Rent, on demand, the full cost of said
insurance as evidenced by insurance billings to the Lessor which shall be
included in Lessee's monthly CAC. If said insurance billings cover the
Premises, and Lessee does not occupy the entire Premises, the insurance premiums
and deductibles shall be allocated to the portion of the Premises occupied by
Lessee on a pro-rata square footage or other equitable basis, as determined by
Lessor. It is understood and agreed that Lessee's obligation under this
paragraph will be prorated to reflect the Commencement Date and the end of the
Lease Term.
Lessor and Lessee hereby waive any rights each may have against the other
related to any loss or damage caused to Lessor or Lessee as the case may be, or
to the Premises, the Building, or its contents, and which may arise from any
risk generally covered by fire and extended coverage insurance. The parties
shall provide that their respective insurance policies insuring the property or
the personal property include a waiver of any right of subrogation which said
insurance company may have against Lessor or Lessee, as the case may be. Lessor
shall maintain in full force and effect, a policy of rental loss insurance, in
an amount equal to the amount of Rent payable by Lessee commencing on the date
of loss during the next ensuing one (1) year, as reasonably determined by Lessor
with proceeds payable to Lessor ("Loss of Rents Insurance"). Lessee shall
reimburse Lessor for the full cost of said rental loss insurance coverage.
7. ABANDONMENT: Lessee shall not vacate or abandon the Building at any time
during the Lease Term; and if Lessee shall abandon, vacate or surrender the
Building, or be dispossessed by process of law, or otherwise, any personal
property belonging to Lessee and left on the Building shall be deemed to be
abandoned, at the option of Lessor. Notwithstanding the above, the Building
shall not be considered vacated or abandoned if Lessee maintains the Building in
Good Condition and Repair, provides security and is not in default.
8. FREE FROM LIENS: Lessee shall keep the subject Premises and the property in
which the subject Premises are situated, free from any and all liens including
but not limited to liens arising out of any work performed, materials furnished,
or obligations incurred by Lessee. However, the Lessor shall allow Lessee to
contest a lien claim, so long as the claim is discharged prior to any
foreclosure proceeding being initiated against the property and provided Lessee
provides Lessor a bond if the lien exceeds $5,000.
9. COMPLIANCE WITH GOVERNMENTAL REGULATIONS: Lessee shall, at its sole cost and
expense, comply with all of the requirements of all local, municipal, state and
federal authorities now in force, or which may hereafter be in force, pertaining
to Lessee's use and occupancy of the said Premises, and shall faithfully observe
in the use of the Premises all local and municipal ordinances and state and
federal statutes now in force or which may hereafter be in force.
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10. LESSEE'S INSURANCE: Lessee, as a material part of the consideration to be
rendered to Lessor, hereby waives all claims against Lessor and Lessor's Agents
for damages to goods, wares and merchandise, and all other personal property in,
upon or about said Premises, and for injuries to persons in, upon or about said
Premises, from any cause arising at any time, and Lessee will hold Lessor and
Lessor's Agents exempt and harmless from any damage or injury to any person, or
to the goods, wares and merchandise and all other personal property of any
person, arising from the use or occupancy of the Premises by Lessee, or from the
failure of Lessee to keep the Building in good condition and repair, as herein
provided. Lessee shall secure and keep in force a standard policy of commercial
general liability insurance and property damage policy covering the Premises,
including parking areas, insuring the Lessee. A certificate of said policy
naming Lessor as an additional insured shall be delivered to Lessor and will
have a combined single limit for both bodily injury, death and property damage
in an amount not less than five million dollars ($5,000,000.00). The limits of
said insurance shall not, however, limit the liability of Lessee hereunder.
Lessee shall obtain a written obligation on the part of the insurer to notify
Lessor 30 days in advance in writing before any cancellation thereof Lessee
shall obtain, at Lessee's sole cost and expense, a policy of fire and extended
coverage insurance including coverage for direct physical loss special form, and
a sprinkler leakage endorsement insuring the personal property of Lessee. The
proceeds from any personal property damage policy shall be payable to Lessee.
Lessee shall, at its sole cost and expense, comply with all of the insurance
requirements of all local, municipal, state and federal authorities now in
force, or which may hereafter be in force, pertaining to Lessee's use and
occupancy of the said Premises.
11. ADVERTISEMENTS AND SIGNS: Lessee shall not place or permit to be placed,
in, upon or about the Premises any unusual or extraordinary signs, or any
signs not approved by the city, local, state, federal or other applicable
governing authority. Lessee shall not place, or permit to be placed upon the
Premises, any signs, advertisements or notices without the written consent of
the Lessor, and such consent shall not be unreasonably withheld. A sign so
placed on the Premises shall be so placed upon the understanding and agreement
that Lessee will remove same at the end of the Lease Term or earlier
termination of this Lease and repair any damage or injury to the Premises
caused thereby, and if not so removed by Lessee, then Lessor may have the same
removed at Lessee's expense.
12. UTILITIES: Lessee shall pay for all water , gas , heat, light, power,
telephone and other utilities supplied to the Building. Any charges for sewer
usage or related fees shall be the obligation of Lessee and paid for by Lessee.
If any such services are not separately metered to Lessee, Lessee shall pay a
reasonable proportion of all charges which are jointly metered, the
determination to be made by Lessor acting reasonably and on any equitable basis.
Lessor shall not be liable to Lessee for any disruption in any of the utility
services to the Building or Premises.
13. ATTORNEY'S FEES: In case suit should be brought for the possession of the
Building or Premises, for the recovery of any sum due hereunder, or because of
the breach of any other covenant herein, the losing party shall pay to the
prevailing party reasonable attorney's fee which shall be deemed to have accrued
on the commencement of such action and shall be enforceable whether or not such
action is prosecuted to judgment.
14.1 DEFAULT: The occurrence of any of the following shall constitute a
default and breach of this Lease by Lessee: a) Any failure by Lessee to pay Rent
or to make any other payment required to be made by Lessee hereunder when due if
not cured within ten (10) days after written notice thereof by Lessor to Lessee;
b) The abandonment or vacation of the Premises by Lessee except as provided in
Section 7; c) A failure by Lessee to observe and perform any other provision of
this Lease to be observed or performed by Lessee, where such failure continues
for thirty days after written notice thereof by Lessor to Lessee; provided,
however, that if the nature of such default is such that the same cannot be
reasonably cured within such thirty (30) day period, Lessee shall not be deemed
to be in
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default if Lessee shall, within such period, commence such cure and thereafter
diligently prosecute the same to completion; d) The making by Lessee of any
general assignment for the benefit of creditors; the filing by or against
Lessee of a petition to have Lessee adjudged a bankrupt or of a petition for
reorganization or arrangement under any law relating to bankruptcy; e) the
appointment of a trustee or receiver to take possession of substantially all
of Lessee's assets or Lessee's interest in this Lease, or 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.
14.2 SURRENDER OF LEASE: In the event of any such default by Lessee, then in
addition to any other remedies available to Lessor at law or in equity, Lessor
shall have the immediate option to terminate this Lease before the end of the
Lease Term and all rights of Lessee hereunder, by giving written notice of
such intention to terminate. In the event that Lessor terminates this Lease
due to a default of Lessee, then Lessor may recover from Lessee: a) the worth
at the time of award of any unpaid Rent which had been earned at the time of
such termination; plus b) the worth at the time of award of unpaid Rent which
would have been earned after termination until the time of award exceeding the
amount of such rental loss that the Lessee proves could have been reasonably
avoided; plus c) the worth at the time of award of the amount by which the
unpaid Rent for the balance of the Lease Term after the time of award exceeds
the amount of such rental loss that the Lessee proves could have been
reasonably avoided; plus d) any other amount necessary to compensate Lessor
for all the detriment proximately caused by Lessee's failure to perform his
obligations under this Lease or which in the ordinary course of things would
be likely to result therefrom; and e) at Lessor's election, such other amounts
in addition to or in lieu of the foregoing as may be permitted from time to
time by applicable California law. As used in (a) and (b) above, the "worth at
the time of award" is computed by allowing interest at the rate of Wells
Fargo's prime rate plus two percent (2%) per annum. As used in (c) above, the
"worth at the time of award" is computed by discounting such amount at the
discount rate of the Federal Reserve Bank of San Francisco at the time of
award plus one percent (1%).
14.3 RIGHT OF ENTRY AND REMOVAL: In the event of any such default by Lessee,
Lessor shall also have the right, with or without terminating this Lease, to re-
enter the Building and remove all persons and property from the Building; such
property may be removed and stored in a public warehouse or elsewhere at the
cost of and for the account of Lessee.
14.4 ABANDONMENT: In the event of the vacation or abandonment, except as
provided in Section 7, of the Building by Lessee or in the event that Lessor
shall elect to re-enter as provided in paragraph 14.3 above or shall take
possession of the Premises pursuant to legal proceeding or pursuant to any
notice provided by law, and Lessor does not elect to terminate this Lease as
provided in paragraph 14.2 above, then Lessor may from time to time, without
terminating this Lease, either recover all Rent as it becomes due or relet the
Building or any part thereof for such term or terms and at such rental rates and
upon such other terms and conditions as Lessor, in its sole discretion, may deem
advisable with the right to make alterations and repairs to the Building. In the
event that Lessor elects to relet the Building, then Rent received by Lessor
from such reletting shall be applied; first, to the payment of any indebtedness
other than Rent due hereunder from Lessee to Lessor; second, to the payment of
any cost of such reletting; third, to the payment of the cost of any alterations
and repairs to the Building; fourth, to the payment of Rent due and unpaid
hereunder; and the residue, if any, shall be held by Lessor and applied to the
payment of future Rent as the same may become due and payable hereunder. Should
that portion of such Rent received from such reletting during any month, which
is applied by the payment of Rent hereunder according to the application
procedure outlined above, be less than the Rent payable during that month by
Lessee hereunder, then Lessee shall pay such deficiency to Lessor immediately
upon demand therefor by Lessor. Such deficiency shall be calculated and paid
monthly. Lessee shall also pay to Lessor, as soon as ascertained, any costs and
expenses incurred by
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Lessor in such reletting or in making such alterations and repairs not covered
by the rentals received from such reletting.
14.5 NO IMPLIED TERMINATION: No re-entry or taking possession of the Building by
Lessor pursuant to 14.3 or 14.4 of this Article 14 shall be construed as an
election to terminate this Lease unless a written notice of such intention is
given to Lessee or unless the termination thereof is decreed by a court of
competent jurisdiction. Notwithstanding any reletting without termination by
Lessor because of any default by Lessee, Lessor may at any time after such
reletting elect to terminate this Lease for any such default.
15. SURRENDER OF LEASE: The voluntary or other surrender of this Lease by
Lessee, or a mutual cancellation thereof, shall not work a merger, and shall, at
the option of Lessor, terminate all or any existing subleases or sub tenancies,
or may, at the option of Lessor, operate as an assignment to him of any or all
such subleases or sub tenancies.
16. TAXES: Lessee shall pay and discharge punctually and when the same shall
become due and payable without penalty, all real estate taxes, personal
property taxes, taxes based on vehicles utilizing parking areas in the
Premises, taxes computed or based on rental income (other than federal, state
and municipal net income taxes), Environmental Surcharges, privilege taxes,
excise taxes, business and occupation taxes, school fees or surcharges, gross
receipts taxes, sales and/or use taxes, employee taxes, occupational license
taxes, water and sewer taxes, assessments (including, but not limited to,
assessments for public improvements or benefit), assessments for local
improvement and maintenance districts, and all other governmental impositions
and charges of every kind and nature whatsoever, regardless of whether now
customary or within the contemplation of the parties hereto and regardless of
whether resulting from increased rate and/or valuation, or whether
extraordinary or ordinary, general or special, unforeseen or foreseen, or
similar or dissimilar to any of the foregoing (all of the foregoing being
hereinafter collectively called "Tax" or "Taxes") which, at any time during
the Lease Term, shall be applicable or against the Premises, or shall become
due and payable and a lien or charge upon the Premises under or by virtue of
any present or future laws, statutes, ordinances, regulations, or other
requirements of any governmental authority whatsoever. The term "Environmental
Surcharge" shall include any and all expenses, taxes, charges or penalties
imposed by the Federal Department of Energy, Federal Environmental Protection
Agency, the Federal Clean Air Act, or any regulations promulgated thereunder,
or any other local, state or federal governmental agency or entity now or
hereafter vested with the power to impose taxes, assessments or other types of
surcharges as a means of controlling or abating environmental pollution or the
use of energy (i) generally imposed on similar properties in a wide geographic
area without regard to whether the properties are subject to the tax are
contaminated by Hazardous Materials and which is part of a comprehensive plan
imposed by a governmental unit or (ii) imposed with respect to the Premises as
the result of presence of Hazardous Materials for which Lessee is required to
indemnify Lessor under Section 33. The term "Tax" shall include, without
limitation, all taxes, assessments, levies, fees, impositions or charges
levied, imposed, assessed, measured, or based in any manner whatsoever (i) in
whole or in part on the Rent payable by Lessee under this Lease, (ii) upon or
with respect to the use, possession, occupancy, leasing, operation or
management of the Premises, (iii) upon this transaction or any document to
which Lessee is a party creating or transferring an interest or an estate in
the Premises, (iv) upon Lessee's business operations conducted at the
Premises, (v) upon, measured by or reasonably attributable to the cost or
value of Lessee's equipment, furniture, fixtures and other personal property
located on the Premises or the cost or value of any leasehold improvements
made in or to the Premises by or for Lessee, regardless of whether title to
such improvements shall be in Lessor or Lessee, or (vi) in lieu of or
equivalent to any Tax set forth in this Section 16. In the event any such
Taxes are payable by Lessor and it shall not be lawful for Lessee to reimburse
Lessor for such Taxes, then the Rent payable thereunder shall be increased to
net Lessor the same net rent after imposition of any such Tax upon Lessor as
would have been payable to Lessor prior to the imposition of any
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such Tax. It is the intention of the parties that Lessor shall be free from
all such Taxes and all other governmental impositions and charges of every
kind and nature whatsoever. However, nothing contained in this Section 16
shall require Lessee to pay any Federal or State income, franchise, estate,
inheritance, succession, transfer or excess profits tax imposed upon Lessor.
If any general or special assessment is levied and assessed against the
Premises, Lessor agrees to use its best reasonable efforts to cause the
assessment to become a lien on the Premises securing repayment of a bond sold
to finance the improvements to which the assessment relates which is payable
in installments of principal and interest over the maximum term allowed by
law. It is understood and agreed that Lessee's obligation under this paragraph
will be prorated to reflect the Commencement Date and the end of the Lease
Term. It is further understood that if Taxes cover the Premises and Lessee
does not occupy the entire Premises, the Taxes will be allocated to the
portion of the Premises occupied by Lessee based on a pro-rata square footage
or other equitable basis. Taxes billed by Lessor to Lessee shall be included
in the monthly CAC.
Subject to any limitations or restrictions imposed by any deeds of trust or
mortgages now or hereafter covering or affecting the Premises, Lessee shall have
the right to contest or review the amount or validity of any Tax by appropriate
legal proceedings but which is not to be deemed or construed in any way as
relieving, modifying or extending Lessee's covenant to pay such Tax at the time
and in the manner as provided in this Section 16. However, as a condition of
Lessee's right to contest, if such contested Tax is not paid before such contest
and if the legal proceedings shall not operate to prevent or stay the collection
of the Tax so contested, Lessee shall, before instituting any such proceeding,
protect the Premises and the interest of Lessor and of the beneficiary of a deed
of trust or the mortgagee of a mortgage affecting the Premises against any lien
upon the Premises by a surety bond, issued by an insurance company acceptable to
Lessor and in an amount equal to one and one-half (1 1/2) times the amount
contested or, at Lessor's option, the amount of the contested Tax and the
interest and penalties in connection therewith. Any contest as to the validity
or amount of any Tax, whether before or after payment, shall be made by Lessee
in Lessee's own name, or if required by law, in the name of Lessor or both
Lessor and Lessee. Lessee shall defend, indemnify and hold harmless Lessor from
and against any and all costs or expenses, including attorneys' fees, in
connection with any such proceedings brought by Lessee, whether in its own name
or not. Lessee shall be entitled to retain any refund of any such contested Tax
and penalties or interest thereon which have been paid by Lessee. Nothing
contained herein shall be construed as affecting or limiting Lessor's right to
contest any Tax at Lessor's expense.
17. NOTICES: Unless otherwise provided for in this Lease, any and all
written notices or other communication (the "Communication") to be given in
connection with this Lease shall be given in writing and shall be given by
personal delivery, facsimile transmission or by mailing by registered or
certified mail with postage thereon or recognized overnight courier, fully
prepaid, in a sealed envelope addressed to the intended recipient as follows:
(a) to the Lessor at: 10050 Bandley Drive
Cupertino, California 95014
Attention: Carl E. Berg
Fax No: (408) 725-1 626
(b) to the Lessee at: 6325 San lgnacio
San Jose, California
Attention: CFO
Fax No:
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or such other addresses, facsimile number or individual as may be designated by
a Communication given by a party to the other parties as aforesaid. Any
Communication given by personal delivery shall be conclusively deemed to have
been given and received on a date it is so delivered at such address provided
that such date is a business day, otherwise on the first business day following
its receipt, and if given by registered or certified mail, on the day on which
delivery is made or refused or if given by recognized overnight courier, on the
first business day following deposit with such overnight courier and if given by
facsimile transmission, on the day on which it was transmitted provided such day
is a business day, failing which, on the next business day thereafter.
18. ENTRY BY LESSOR: Lessee shall permit Lessor and its agents to enter into
the Building at all reasonable times using the minimum amount of interference
and inconvenience to Lessee and Lessee's business, subject to any security
regulations of Lessee, for the purpose of inspecting the same or for the
purpose of maintaining the Building, or for the purpose of making repairs,
alterations or additions to any other portion of said Building, including the
erection and maintenance of such scaffolding, canopies, fences and props as
may be required, without any rebate of Rent and without any liability to
Lessee for any loss of occupation or quiet enjoyment of the Premises; and
shall permit Lessor and his agents, at any time within ninety (90) days prior
to the end of the Lease Term, to place upon said Premises any usual or
ordinary "For Sale" or "For Lease" signs and exhibit the Premises and the
Building to prospective tenants at reasonable hours.
19. DESTRUCTION OF PREMISES: In the event of a partial destruction of the said
Premises during the Lease Term from any cause which is covered by Lessor's
property insurance, Lessor shall forthwith repair the same, provided such
repairs can be made within ninety (90) days under the laws and regulations of
State, Federal, County, or Municipal authorities, but such partial destruction
shall in no way annul or void this Lease, except that Lessee shall be entitled
to a proportionate reduction of Rent while such repairs are being made to the
extent of payments received by Lessor under its Loss of Rents Insurance
coverage. With respect to any partial destruction which Lessor is obligated to
repair or may elect to repair under the terms of this paragraph, the provision
of Section 1932, Subdivision 2, and of Section 1933, Subdivision 4, of the
Civil Code of the State of California are waived by Lessee. In the event that
the Building is destroyed to all extent greater than thirty-three and one-
third (33 1/3%) of the replacement cost thereof, Lessor may, at its sole
option, elect to terminate this Lease, whether the subject Premises is insured
or not. A total destruction of the Building shall terminate this Lease.
Notwithstanding the above, Lessor is only obligated to repair or rebuild to
the extent of available insurance proceeds including any deductible amount.
Should Lessor determine that insufficient or no insurance proceeds are
available for repair or reconstruction of Premises, Lessor, at its sole
option, may terminate the Lease. Lessee shall have the option of continuing
this Lease by agreeing to pay all repair costs to the subject Premises.
20. ASSIGNMENT AND SUBLETTING: Lessee shall not assign this Lease, or any
interest therein, and shall not sublet the said Building or any part thereof, or
any right or privilege appurtenant thereto, or cause any other person or entity
(a bona fide subsidiary or affiliate of Lessee excepted) to occupy or use the
Building, or any portion thereof, without the advance written consent of Lessor.
Any such assignment or subletting without such consent shall he void, and shall,
at the option of the Lessor, terminate this Lease. This Lease shall not, or
shall an)' interest therein, be assignable, as to the interest of Lessee, by
operation of law, without the written consent of Lessor. Notwithstanding
Lessor's obligation to provide reasonable approval, Lessor reserves the right to
withhold its consent for any proposed sublessee or assignee of Lessee if the
proposed sublessee or assignee is a user or generator of Hazardous Materials. If
Lessee desires to assign its rights under this Lease or to sublet, all or a
portion of the subject Building to a party other than a bona fide subsidiary or
affiliate of Lessee, Lessee shall first notify Lessor of the proposed terms and
conditions of such assignment or subletting. Lessor shall have the right of
first refusal to enter into a direct Lessor-Lessee relationship with such party
under such proposed terms and conditions, in which
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event Lessee shall be relieved of its obligations hereunder to the extent of
the Lessor-lessee relationship entered into between Lessor and such third
party. Notwithstanding the foregoing, Lessee may assign this Lease to a
successor in interest, whether by merger or acquisition, provided there is no
substantial reduction in the net worth of the resulting entity and the
resulting entity is not a user or generator of Hazardous Materials. Whether or
not Lessor's consent to a sublease or assignment is required, in the event of
any sublease or assignment, Lessee shall be and shall remain primarily liable
for the performance of all conditions, covenants, and obligations of Lessee
hereunder and, in the event of a default by an assignee or sublessee, Lessor
may proceed directly against the original Lessee hereunder and/or any other
predecessor of such assignee or sublessee without the necessity of exhausting
remedies against said assignee or sublessee.
21. CONDEMNATION: If any part of the Building shall be taken for any public or
quasi-public use, under any statute or by right of eminent domain or private
purchase in lieu thereof, and a part thereof remains which is susceptible of
occupation hereunder, this Lease shall as to the part so taken, terminate as of
the date title vests in the condemnor or purchaser, and the Rent payable
hereunder shall be adjusted so that the Lessee shall be required to pay for the
remainder of tile Lease Term only that portion of Rent as the value of the part
remaining. The rental adjustment resulting will be computed at the same Rental
rate for the remaining part not taken; however, Lessor shall have the option to
terminate this Lease as of the date when title to the part so taken vests in the
condemnor or purchaser. If all of the Building, or such part thereof be taken so
that there does not remain a portion susceptible for occupation hereunder, this
Lease shall thereupon terminate. If a part or all of the Building be taken, all
compensation awarded upon such taking shall be payable to the Lessor. Lessee may
file a separate claim and be entitled to any award granted to Lessee.
22. EFFECTS OF CONVEYANCE: The term "Lessor" as used in this Lease, means only
the owner for the time being of the land and building constituting the
Premises, so that, in the event of any sale of said land or building, or in
the event of a Lease of said building, Lessor shall be and hereby is entirely
freed and relieved of all covenants and obligations of Lessor hereunder, and
it shall be deemed and construed, without further agreement between the
parties and the purchaser of any such sale, or the Lessor of the building,
that the purchaser or lessor of the building has assumed and agreed to carry
out any and all covenants and obligations of the Lessor hereunder. If any
security is given by Lessee to secure the faithful performance of all or any
of the covenants of this Lease on the part of Lessee, Lessor may transfer and
deliver the security, as such, to the purchaser at any such sale of the
building, and thereupon the Lessor shall be discharged from any further
liability.
23. SUBORDINATION: This Lease, in the event Lessor notifies Lessee in writing,
shall be subordinate to any ground lease, deed of trust, or other
hypothecation for security now or hereafter placed upon the real property at
which the Premises are a part and to any and all advances made on the security
thereof and to renewals, modifications, replacements and extensions thereof.
Lessee agrees to promptly execute any documents which may be required to
effectuate such subordination. Notwithstanding such subordination, if Lessee
is not in default and so long as Lessee shall pay the Rent and observe and
perform all of the provisions and covenants required under this Lease,
Lessee's right to quiet possession of the Premises shall not be disturbed or
effected by any subordination.
24. WAIVER: The waiver by Lessor of any breach of any term, covenant or
condition, herein contained shall not be construed to be a waiver of such term,
covenant or condition or any subsequent breach of the same or any other term,
covenant or condition therein contained. The subsequent acceptance of Rent
hereunder by Lessor shall not be deemed to be a waiver of Lessee's breach of any
term, covenant, or condition of the Lease.
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25. HOLDING OVER: Any holding over after the end of the Lease Term requires
Lessor's written approval prior to the end of the Lease Term, which,
notwithstanding any other provisions of this Lease, Lessor may withhold and
shall be construed to be a tenancy at sufferance from month to month. Lessee
shall pay to Lessor monthly base rent equal to one and one-half (1.5) times the
monthly base rent installment due in the last month of the Lease Term and all
other additional rent and all other terms and conditions of the Lease shall
apply, so far as applicable. Holding over by Lessee without written approval of
Lessor shall subject Lessee to the liabilities and obligations provided for in
this Lease and by law, including, but not limited to those in Section 2.1 of
this Lease. Lessee shall indemnify and hold Lessor harmless against any loss or
liability resulting from any delay caused by Lessee in surrendering the
Building, including without limitation, any claims made or penalties incurred by
any succeeding lessee or by Lessor. No holding over shall be deemed or construed
to exercise any option to extend or renew this Lease in lieu of full and timely
exercise of any such option as required hereunder.
26. SUCCESSORS AND ASSIGNS: The covenants and conditions herein contained
shall, subject to the provisions as to assignment, apply to and bind the
heirs, successors, executors, administrators and assigns of all of the parties
hereto; and all of the parties hereto shall be jointly and severally liable
hereunder.
27. ESTOPPEL CERTIFICATES: Lessee shall at any time during the Lease Term,
upon not less than ten (10) days prior written notice from Lessor, execute and
deliver to Lessor a statement in writing certifying that, this Lease is
unmodified and in full force and effect (or, if modified, stating the nature
of such modification) and the dates to which the Rent and other charges have
been paid in advance, if any, and acknowledging that there are not, to
Lessee's knowledge, any uncured defaults on the part of Lessor hereunder or
specifying such defaults if they are claimed. Any such statement may be
conclusively relied upon by any prospective purchaser or encumbrancer of the
Premises. Lessee's failure to deliver such a statement within such time shall
be conclusive upon the Lessee that (a) this Lease is in full force and effect,
without modification except as may be represented by Lessor, (b) there are 110
uncured defaults in Lessor's performance.
28. TIME: Time is of the essence of the Lease.
29. CAPTIONS: The headings on titles to the paragraphs of this Lease are not a
part of this Lease and shall have no effect upon the construction or
interpretation of any part thereof. This instrument contains all of the
agreements and conditions made between the parties hereto and may not be
modified orally or in any other manner than by an agreement in writing signed
by all of the parties hereto or their respective successors in interest.
30. PARTY NAMES: Landlord and Tenant may be used in various places in this
Lease as a substitute for Lessor and Lessee respectively.
31. EARTHQUAKE INSURANCE: As a condition of Lessor agreeing to waive the
requirement for earthquake insurance, Lessee agrees that it will pay, as
additional Rent, which shall be included in the monthly CAC, an amount not to
exceed twenty thousand eight hundred dollars ($20,800) per year for earthquake
insurance if Lessor desires to obtain some form of earthquake insurance in the
future, if and when available, on terms acceptable to Lessor.
32. HABITUAL DEFAULT: Notwithstanding anything to the contrary contained in
Section 14 herein, Lessor and Lessee agree that if Lessee shall have defaulted
in the payment of Rent for three or more times during any twelve month period
during the Lease Term, then such conduct shall, at the option of the Lessor,
represent a separate event of default which cannot be cured by Lessee. Lessee
acknowledges that the purpose of this provision is to prevent
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repetitive defaults by the Lessee under the Lease, which constitute a hardship
to the Lessor and deprive the Lessor of the timely performance by the Lessee
hereunder.
33. HAZARDOUS MATERIALS
33.1 DEFINITIONS: As used in this Lease, the following terms shall have the
following meaning:
a. The term "Hazardous Materials" shall mean (i) polychlorinated
biphenyls; (ii) radioactive materials and (iii) any chemical, material or
substance now or hereafter defined as or included in the definitions of
"hazardous substance" "hazardous water", "hazardous material", "extremely
hazardous waste", "restricted hazardous waste" under Section 25115, 25117
or 15122.7, or listed pursuant to Section 25140 of the California Health
and Safety Code, Division 20, Chapter 6.5 (Hazardous Waste Control Law),
(ii) defined as "hazardous substance" under Section 25316 of the California
Health and Safety Code, Division 20, Chapter 6.8 (Carpenter-Presley-Tanner
Hazardous Substances Account Act), (iii) defined as "hazardous material",
"hazardous substance", or "hazardous waste" under Section 25501 of the
California Health and Safety Code, Division 20, Chapter 6.95 (Hazardous
Materials Release, Response, Plans and Inventory), (iv) defined as a
"hazardous substance" tinder Section 25181 of the California Health and
Safety Code, Division 201, Chapter 6.7 (Underground Storage of Hazardous
Substances), (v) petroleum, (vi) asbestos, (vii) listed under Article 9 or
defined as "hazardous" or "extremely hazardous" pursuant to Article II of
Title 22 of the California Administrative Code, Division 4, Chapter 20,
(viii) defined as "hazardous substance" pursuant to Section 311 of the
Federal Water Pollution Control Act, 33 U.S.C. 1251 et seq. or listed
pursuant to Section 1004 of the Federal Water Pollution Control Act (33
U.S.C. 1317), (ix) defined as a "hazardous waste", pursuant to Section 1004
of the Federal Resource Conservation and Recovery Act, 42 U.S.C. 6901 et
seq., (x) defined as "hazardous substance" pursuant to Section 101 of the
Comprehensive Environmental Responsibility Compensations, and Liability
Act, 42 U.S.C. 9601 et seq., or (xi) regulated under the Toxic Substances
Control Act, 156 U.S.C. 2601 et seq.
b. The term "Hazardous Materials Laws" shall mean any local, state and
federal laws, rules, regulations, or ordinances relating to the use,
generation, transportation, analysis, manufacture, installation, release,
discharge, storage or disposal of Hazardous Material.
c. The term "Lessor's Agents" as used herein shall mean Lessor's agents,
representatives, employees, contractors, subcontractors, directors,
officers and partners.
d. The term "Lessee's Agents" as used herein shall mean Lessee's agents,
representatives, employees, contractors, subcontractors, directors,
officers, partners, invitees or any other person in or about the Premises.
33.2 LESSEE'S RIGHT TO INVESTIGATE: Lessee shall be entitled to cause such
inspection, soils and ground water tests, and other evaluations to be made of
the Premises as Lessee deems necessary regarding (i) the presence and use of
Hazardous Materials in or about the Premises, and (ii) the potential for
exposure to Lessee's employees and other persons to any Hazardous Materials
used and stored by previous occupants in or about the Premises. Lessee shall
provide Lessor with copies of all inspections, tests and evaluations. Lessee
shall indemnify, defend and hold Lessor harmless from any cost, claim or
expense arising from such entry by Lessee or from the performance of any such
investigation by such Lessee.
33.3 LESSOR'S REPRESENTATIONS: Lessor hereby represents and warrants to the
best of Lessor's knowledge that the Premises are, as of the date of this
Lease, in compliance with all Hazardous Material Laws.
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33.4 LESSEE'S OBLIGATION TO INDEMNIFY: Lessee, at its sole cost and expense,
shall indemnify, defend, protect and hold Lessor and Lessor's Agents harmless
from and against any and all cost or expenses, including those described under
subparagraphs i, ii and iii herein below set forth, arising from or caused in
whole or in part, directly or indirectly by:
a. Lessee's or Lessee's Agents' use, analysis, storage, transportation,
disposal, release, threatened release, discharge or generation of Hazardous
Material to, in, on, under, about or from the Premises; or
b. Lessee's or Lessee's Agents failure to comply with Hazardous Material
laws; or
c. Any release of Hazardous Material to, in, on, under, about, from or
onto the Premises caused by Lessee or Lessee's Agents, except ground water
contamination from other parcels where the source is from off the Premises
not arising from or caused by Lessee or Lessee's Agents.
The cost and expenses indemnified against include, but are not limited to the
following:
i. Any and all claims, actions, suits, proceedings, losses, damages,
liabilities, deficiencies, forfeitures, penalties, fines, punitive damages,
cost or expenses;
ii. Any claim, action, suit or proceeding for personal injury (including
sickness, disease, or death), tangible or intangible property damage,
compensation for lost wages, business income, profits or other economic
loss, damage to the natural resources of the environment, nuisance,
pollution, contamination, leaks, spills, release or other adverse effects
on the environment;
iii. The cost of any repair, clean-up, treatment or detoxification of the
Premises necessary to bring the Premises into compliance with all Hazardous
Material Laws, including the preparation and implementation of any closure,
disposal, remedial action, or other actions with regard to the Premises,
and expenses (including, without limitation, reasonable attorney's fees and
consultants fees, investigation and laboratory fees, court cost and
litigation expenses).
33.5 LESSEE'S OBLIGATION TO REMEDIATE CONTAMINATION: Lessee shall, at its sole
cost and expense, promptly take any and all action necessary to remediate
contamination of the Premises by Hazardous Materials arising or occurring as a
result of acts or omissions of Lessee or Lessee's Agents during the Lease
Term.
33.6 OBLIGATION TO NOTIFY: Lessor and Lessee shall each give written notice to
the other as soon as reasonably practical of (i) any communication received
from any governmental authority concerning Hazardous Material which related to
the Premises and (ii) any contamination of the Premises by Hazardous Materials
which constitutes a violation of any Hazardous Material Laws.
33.7 SURVIVAL: The obligations of Lessee under this Section 33 shall survive
the Lease Term or earlier termination of this Lease.
33.8 CERTIFICATION AND CLOSURE: On or before the end of the Lease Term or
earlier termination of this Lease, Lessee shall deliver to Lessor a
certification executed by Lessee stating that, to the best of Lessee's
knowledge, there exists no violation of Hazardous Material Laws resulting from
Lessee's obligation in Paragraph 33. If pursuant to local ordinance, state or
federal law, Lessee is required, at the expiration of the Lease Term, to
submit a closure plan for the Premises to a local, state or federal agency,
then Lessee shall furnish to Lessor a copy of such plan.
33.9 PRIOR HAZARDOUS MATERIALS: Notwithstanding anything contained to the
contrary herein, Lessee shall have no obligation to clean up or to hold Lessor
harmless or make any payment with respect to, any Hazardous Material or wastes
discovered on the Premises which were not introduced into, in, on, about, from
or under the Premises
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during the Lease Term or ground water contamination from other parcels where
the source is from off the Premises not arising from or caused by Lessee or
Lessee's Agents.
34. BROKERS: Lessor and Lessee represent that they have not utilized or
contacted a real estate broker or finder with respect to this Lease other than
Cornish & Carey ("C&C") and Lessee agrees to indemnify and hold Lessor
harmless against any claim, cost, liability or cause of action asserted by any
broker or finder claiming through Lessee other than C&C. Lessor shall at its
sole cost and expense pay the brokerage commission per Lessor's standard
commission schedule to C&C in connection with this transaction. Lessor
represents and warrants that it has not utilized or contacted a real estate
broker or finder with respect to this Lease other than C&C and Lessor agrees
to indemnify and hold Lessee harmless against any claim, cost, liability or
cause of action asserted by any broker or finder claiming through Lessor.
35. OPTION TO EXTEND
A. Option: Lessor hereby grants to Lessee one (1) option to extend the Lease
------
Term, with the extended term to be for a period of five (5) years, on the
following terms and conditions:
(i) Lessee shall give Lessor written notice of its exercise of its option
to extend no earlier than twenty-four (24) calendar months, nor later than
six (6) calendar months before the Lease Term would end but for said
exercise. Time is of the essence.
(ii) Lessee may not extend the Lease Term pursuant to any option granted by
this section 35 if Lessee is in default as of the date of the exercise of
its option. If Lessee has committed a default by Lessee as defined in
Section 14 or 32 that has not been cured or waived by Lessor in writing by
the date that any extended term is to commence, then Lessor may elect not
to allow the Lease Tern' to be extended, notwithstanding any notice given
by Lessee of an exercise of this option to extend.
(iii) All terms and conditions of this Lease shall apply during the
extended term, except that the base rent and rental increases for each
extended term shall be determined as provided in Section 35 (B) below
(iv) Once Lessee delivers a notice of exercise of its options to extend the
Lease Term, Lessee may not withdraw such exercise and subject to the
provisions of this Section 35, such notice shall operate to extend the
Lease Term. Upon any extension of the Lease Term pursuant to this Section
35, the term "Lease Term" as used in this Lease shall thereafter include
the then extended term.
(v) The option rights of Photon Dynamics, Inc. granted under this Section
35 are granted for Photon Dynamics, Inc.'s personal benefit and may not be
assigned or transferred by Photon Dynamics, Inc. or exercised if Photon
Dynamics, Inc. is not occupying the Building at the time of exercise.
B. Extended Term Rent - Option Period: The monthly Rent for the Building
----------------------------------
during the extended term shall equal to ninety-five percent (95%) of the fair
market monthly Rent for the Building as of the commencement date of the
extended term, but in no case, less than the Rent during the last month of the
prior Lease term. Promptly upon Lessee's exercise of the option to extend,
Lessee and Lessor shall meet and attempt to agree on the fair market monthly
Rent for the Building as of the commencement date of the extended term. In the
event the parties fail to agree upon the amount of the monthly Rent for the
extended term prior to commencement thereof, the monthly Rent for the extended
term shall be determined by appraisal in the manner hereafter set forth;
provided, however, that in no event shall the monthly Remit for the extended
term be less than in the immediate preceding period.
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Annual base rent increases during the extended term shall be three percent
(3%) per year. In the event it becomes necessary under this paragraph to
determine the fair market monthly Rent of the Building by appraisal, Lessor
and Lessee each shall appoint a real estate appraiser who shall be a member of
the American Institute of Real Estate Appraiser ("AIREA") and such appraisers
shall each determine the fair market monthly Rent for the Building taking into
account the value of the Premises and the amenities provided by the outside
areas, the common areas, and the Building, and prevailing comparable Rentals
in the area. Such appraisers shall, within twenty (20) business days after
their appointment, complete their appraisals and submit their appraisal
reports to Lessor and Lessee. If the fair market monthly Rent of the Building
established in the two (2) appraisals varies by five percent (5%) or less of
the higher Rent, the average of the two shall be controlling. If said fair
market monthly Rent varies by more than five percent (5%) of the higher
Rental, said appraisers, within ten (10) days after submission of the last
appraisal, shall appoint a third appraiser who shall be a member of the AIREA
and who shall also be experienced in the appraisal of Rent values and
adjustment practices for commercial properties in the vicinity of the
Building. Such third appraiser shall, within twenty (20) business days after
his appointment, determine by appraisal the fair market monthly Rent of the
Building taking into account the same factors referred to above, and submit
his appraisal report to Lessor and Lessee. The fair market monthly Rent
determined by the third appraiser for the Building shall be controlling,
unless it is less than that set forth in the lower appraisal previously
obtained, in which case the value set forth in said lower appraisal shall be
controlling, or unless it is greater than that set forth in the higher
appraisal previously obtained in which case the Rent set for in said higher
appraisal shall be controlling. If either Lessor or Lessee fails to appoint an
appraiser, or if an appraiser appointed by either of them fails, after his
appointment to submit his appraisal within the required period in accordance
with the foregoing, the appraisal submitted by the appraiser properly
appointed and timely submitting his appraisal shall be controlling. If the two
appraisers appointed by Lessor and Lessee are unable to agree upon a third
appraiser within the required period in accordance with the foregoing,
application shall be made within twenty (20) days thereafter by either Lessor
or Lessee to AIREA, which shall appoint a member of said institute willing to
serve as appraiser. The cost of all appraisals under this subparagraph shall
be borne equally be Lessor and Lessee.
36. APPROVALS: Whenever in this Lease the Lessor's or Lessee's consent is
required, such consent shall not be unreasonably or arbitrarily withheld or
delayed. In the event that the Lessor or Lessee does not respond to a request
for any consents which may be required of it in this Lease within ten business
days of the request of such consent in writing by the Lessee or Lessor, such
consent shall be deemed to have been given by the Lessor or Lessee.
37. AUTHORITY: Each party executing this Lease represents and warrants that he
or she is duly authorized to execute and deliver the Lease. If executed on
behalf of a corporation, that the Lease is executed in accordance with the by-
laws of said corporation (or a partnership that the Lease is executed in
accordance with the partnership agreement of such partnership), that no other
party's approval or consent to such execution and delivery is required, and
that the Lease is binding upon said individual, corporation (or partnership)
as the case may be in accordance with its terms.
38. (a) INDEMNIFICATION OF LESSEE: Lessor shall indemnify and hold Lessee
harmless for the negligent acts amid willful misconduct of Lessor and Lessor's
Agents in not performing Lessor's obligations under the Lease provided Lessee
has given Lessor written notice with adequate time to cure of any obligations
which it believes Lessor has not performed per the terms of the Lease.
Notwithstanding this indemnification, Lessor shall have no liability nor
obligation for consequential damages, including but not limited to, damages
for loss of use or profits.
(b) INDEMNIFICATION OF LESSOR: Except to the extent caused by the sole
negligence or willful misconduct of Lessor or Lessor's Agents, Lessee shall
defend, indemnify and hold Lessor harmless from and against any amid all
obligations, losses, costs, expenses, claims, demands, attorney's fees ,
investigation costs or liabilities on account
PAGE 18
<PAGE>
of, or arising out of the use, condition or occupancy of the Premises or any
act or omission to act of Lessee or Lessee's Agents or any occurrence in,
upon, about or at the Premises, including, without limitation, any of the
foregoing provisions arising out of the use, generation, manufacture,
installation, release, discharge, storage, or disposal of Hazardous Materials
by Lessee or Lessee's Agents. It is understood that Lessee is and shall be in
control and possession of the Premises and that Lessor shall in no event be
responsible or liable for any injury or damage or injury to any person
whatsoever, happening on, in, about, or in connection with the Premises, or
for any injury or damage to the Premises or any part thereof This Lease is
entered into on the express condition that Lessor shall not be liable for, or
suffer loss by reason of injury to person or property, from whatever cause,
which in any way may be connected with the use, condition or occupancy of the
Premises or personal property located herein. The provisions of this Lease
permitting Lessor to enter and inspect the Premises are for the purpose of
enabling Lessor to become informed as to whether Lessee is complying with the
terms of this Lease and Lessor shall be under no duty to enter, inspect or to
perform any of Lessee's covenants set forth in this Lease. Lessee shall
further indemnify, defend and hold harmless Lessor from and against any and
all claims arising from any breach or default in the performance of any
obligation to Lessee's part to be performed under the terms of this Lease. The
provisions of Section 38 shall survive the Lease Term or earlier termination
of this Lease with respect to any damage, injury or death occurring during the
Lease Term.
39. LESSOR'S LIABILITY: If Lessee should recover a money judgment against
Lessor arising in connection with this Lease, the judgment shall be satisfied
only out of the Lessor's interest in the Building and neither Lessor or any of
its partners shall be liable personally for any deficiency.
40. MISCELLANEOUS PROVISIONS: All rights and remedies hereunder are cumulative
and not alternative to the extent permitted by law and are in addition to all
other rights or remedies in law and in equity.
41. CHOICE OF LAW: This lease shall be construed and enforced in accordance
with the substantive laws of the State of California. The language of all
parts of this lease shall in all cases be construed as a whole according to
its fair meaning and not strictly for or against either Lessor or Lessee.
42. ENTIRE AGREEMENT: This Lease is the entire agreement between the parties,
and there are no agreements or representations between the parties except as
expressed herein. Except as otherwise provided for herein, no subsequent
change or addition to this Lease shall be binding unless in writing and signed
by the parties hereto.
IN WITNESS WHEREOF, Lessor and Lessee have executed these presents, the day and
year first above written.
LESSOR LESSEE
BERG & BERG DEVELOPERS PHOTON DYNAMICS, INC.
By: ________________________________ By:__________________________________
signature of authorized representative signature of authorized representative
______________________________________ __________________________________
printed name printed name
______________________________________ __________________________________
title title
PAGE 19
<PAGE>
______________________________________ __________________________________
date date
PAGE 20
<PAGE>
Exhibit E
Lessee Approval Deadlines
Lease signed 08/05/96
Approval of preliminary floor plan, single line 08110196
Final selection of all material and interior finishes
for construction such as carpet, ceramic tile, paint
and any other lessee selected materials & finishes 08/15/96
Lessee shall not unreasonably withhold approval of final shell or interior plans
if they conform in general to the preliminary site plan, preliminary elevation,
and floor plans.
The Commencement Date shall be extended one day for each day Lessee does not
meet each deadline set forth on this Exhibit E.
PAGE 21
<PAGE>
[MAP APPEARS HERE]
<PAGE>
[MAP APPEARS HERE]
<PAGE>
[CHART APPEARS HERE]
<PAGE>
[CHART APPEARS HERE]
<PAGE>
AGREEMENT REGARDING CHANGE OF CONTROL
-------------------------------------
This Agreement is entered into as of this 1st day of July 1996 by and
between Photon Dynamics, Inc., a California corporation (the "Company"), and
Donald Jerome ("Executive").
RECITALS
--------
Executive is employed by the Company and is a valued officer of the
Company. As an inducement to Executive to remain in the employ of the Company,
the Company wishes to provide for certain rights in favor of Executive to
severance payments and other benefits in the event of a Change of Control (as
defined below) of the Company upon the terms herein provided.
NOW THEREFORE, in consideration of the foregoing and the mutual promises
herein contained, the parties agree as follows:
AGREEMENT
---------
Section 1. Definitions
- ----------------------
For purposes of this Agreement, the following definitions shall apply:
"Alternative Employment" shall mean any employment, consulting or other
relationship pursuant to which Executive provides in excess of 20 hours of
service per week for compensation following any Protection Termination of his
employment with the Company.
"Change of Control" shall mean the occurrence of one or more of the
following with respect to the Company: (i) the sale or exchange of more than 50%
of the outstanding shares of Common Stock (treating any Preferred Stock on a
fully converted basis) in a single transaction or series of related
transactions; (ii) a merger or consolidation in which the Company is not the
surviving entity, except for a transaction the principal purpose of which is to
change the state of the Company's incorporation; or (iii) any reverse merger in
which the Company is the surviving entity but in which securities representing
more than fifty percent (50%) of the total combined voting power of the
Company's outstanding securities are transferred to holder different from those
who held such securities immediately prior to such merger.
"Closing Date" shall mean the date of the first closing of the transactions
constituting a Change of Control.
"Common Stock" shall mean no par value, Common Stock of the Company.
"Constructive Termination" shall mean any of the following actions taken by
the Company with respect to the position or compensation or other material terms
and conditions of Executive's employment with the Company: (A) unless approved
in writing in advance by Executive, the assignment to Executive of any duties
materially inconsistent with his position,
1
<PAGE>
duties, responsibilities, authority and status, or the removal of any material
duties, responsibilities or authority from such position, except to the extent
necessary in connection with a disability that would qualify under the
Company's existing disability plan, if any, but for any requirement in such
plan that the disability continue for any period of time, for the period of
such disability; (B) a reduction in Executive's annual base salary in effect
at the time any determination thereof is to be made; or (C) unless approved in
writing in advance by Executive, the Company's requiring the Executive to
work, apart from reasonable business trips, more than 100 miles from the
location at which Executive was working on the Closing Date.
"Executive's Stock Options" shall mean those options to purchase Common
Stock held by Executive that have been issued to Executive prior to the date
hereof pursuant to the Photon Dynamics, Inc. 1987 and 1995 Stock Option Plan and
that are set forth in Exhibit A attached hereto.
"Protected Termination" shall mean any termination of Executive's
employment with the Company (including, without limitation, a Constructive
Termination as provided in Section 2.5 below) other than: (i) a voluntary
termination of such employment by Executive other than as a result of a
Constructive Termination; or (ii) a termination by the Company of such
employment for cause, which shall mean, for purposes of this Section 1, a
termination of Executive's employment by the Company as a result of the
occurrence of one or more of the following with respect to Executive: (w)
chronic alcoholism or drug addiction, to the extent discharge therefor is
permitted by applicable law; (x) misappropriation of any money or other assets
or properties of the Company or any subsidiary of the Company; (y) the
conviction of Executive of any felony, or of any lesser crime or offense
materially and adversely affecting the property, reputation or goodwill of the
Company or any of its subsidiaries; or (z) willful or gross neglect by Executive
of his duties, or willful misconduct by Executive in connection with the
performance of his duties, which neglect or misconduct shall have an adverse
effect on the Company or one of its subsidiaries and which shall remain
unremedied for thirty (30) days after written notice (indicating with reasonable
specificity the events of neglect and/or misconduct) given to Executive by the
Company through its Board of Directors.
"Severance Payments and Benefits" shall mean Executive's base salary and
non-discretionary bonuses (as measured at the then effective rates), plus
medical, health and other insurance benefits that are in effect as of the
Closing Date.
Section 2. Severance Payments
- -----------------------------
2.1 In the event of and following a Change of Control and in the further
event that Executive is an employee of the Company as of the Closing Date of
such Change of Control, the Company agrees that Executive shall be entitled to
the Severance Payments and Benefits and other consideration in accordance with
this Section 2 in the event Executive's employment with the Company terminates
as a result of a Protected Termination (or is deemed to terminate as a result of
a Constructive Termination as provided in Section 2.5 below) within the nine (9)
month period following the Closing Date.
2.2 Subject to Section 2.1 above and in the event that Executive's
employment with the Company is to be terminated as of the Closing Date as a
result of a Protected Termination (or
2
<PAGE>
is deemed to terminate as a result of a Constructive Termination as provided in
Section 2.5 below), Executive shall be paid or otherwise provided by the Company
Severance Payments and Benefits for a period of six (6) months following the
Closing Date; provided that if Executive has not obtained Alternative Employment
upon the expiration of said six (6) month period, Executive's right pursuant to
this Section 2.2 to receive Severance Payments and Benefits shall be extended
for an additional three (3) months. To the extent that Executive shall obtain
Alternative Employment at a compensation rate or for benefits that are less in
any material respect than the Severance Payments and Benefits that Executive
would otherwise be entitled to receive pursuant to this Section 2.2, said three
(3) month extension shall apply, and Executive be entitled to continue to
receive the Severance Payments and Benefits for the Company until expiration of
said three (3) month period, less those credits against such obligation which
the Company is allowed pursuant to Section 3.1 below.
2.3 Subject to Section 2.1 above and in the event that Executive remains
an employee of the Company at any time following the Closing Date and his
employment is terminated as a result of a Protected Termination (or is deemed to
terminate as a result of a Constructive Termination pursuant to Section 2.5
below) within nine (9) months following the Closing, Executive shall be paid or
otherwise provided by the Company Severance Payments and Benefits from the date
of such termination of employment until six (6) months from such termination
date.
2.4 Subject to Section 2.1 above, the Company agrees that the right of
Executive to exercise the Executive's Stock Options shall be accelerated as of
the Closing Date of a Change of Control as follows: (i) if Executive's
employment with the Company is to be terminated as of the Closing Date in the
manner described in Section 2.2 above, Executive's Stock Options shall become
fully exercisable as of the Closing Date as to all shares of the Company's
Common Stock subject thereto; and (ii) if Executive is to remain an employee of
the Company at any time following the Closing Date as described in Section 2.3
above, Executive's Stock Options shall become exercisable as to that number of
shares of Common Stock (in addition to that number of shares of Common Stock for
which the Executive's Stock Option is then otherwise exercisable) for which the
Executive's Stock Options would be exercisable upon the expiration of two (2)
years following the Closing Date (assuming that Executive was then employed by
the Company). As a condition to an acceleration of the Executive's Stock Options
as provided in this Section 2.4, Executive agrees that the Executive's Stock
Options shall terminate as of the Closing Date to the extent unexercised as of
such Closing Date if the terms and conditions of such Change of Control require
that all employee stock options terminate as of such Closing Date. In no event
shall this Section 2.4 be interpreted to cause the Executive's Stock Options to
be exercisable for a greater number of shares of Common Stock than were subject
to the Executive's Stock Options immediately prior to the Closing Date.
2.5 In the event of a Constructive Termination, Executive shall have the
option to give notice to the Company within ten (10) business days of the
effective date of such Constructive Termination that Executive elects to
terminate his employment with the Company, in which case Executive's employment
with the Company shall be deemed to have been terminated as a result of a
Protected Termination, and Executive shall be entitled to the appropriate
Severance Payments and Benefits as provided in Section 2.2 or 2.3 above. In the
event Executive does not elect to resign his employment with the Company in
accordance with the preceding sentence
3
<PAGE>
following a Constructive Termination and notwithstanding any proposed term of
employment related to such Constructive Termination, Executive shall remain
entitled to the same level of base salary compensation and non-discretionary
bonuses (which are then in effect) and medical, health and other insurance
benefits that were in effect as of the Closing Date until the first to occur
of: (i) the expiration of fifteen (15) months following the Closing Date, or
(ii) the termination of Executive's employment with the Company (in which case
Executive shall retain those rights described in Section 2 hereof as to such
termination).
Section 3. Alternative Employment: Payment of Severance Payments and Benefits
- --------------------------------------------- -------------------------------
3.1 In the event Executive shall obtain Alternative Employment during any
period in which Executive is entitled to Severance Payments and Benefits
pursuant to Section 2.2 or 2.3 above (other than the initial six (6) month
period described in Section 2.2 or 2.3), Executive shall promptly give notice to
the Company of such Alternative Employment, which notice shall describe the
following with respect to such Alternative Employment: (i) the salary,
commission, bonus and other monetary compensation payable to Executive; (ii) the
medical, health and other insurance benefits to be provided to Executive and
(iii) any other consideration payable to or otherwise be provided to Executive.
The Company shall be credited for any compensation payable or benefits provided
with respect to such Alternative Employment against the Company's obligation to
pay and or provide Severance Payments and Benefits for any period (other than
the Initial six (6) month period described in Section 2.2 or 2.3) pursuant to
Section 2 hereof so that: (A) the monetary portion of the Severance Payments
and Benefits shall be reduced for any cash compensation payable to Executive
for such period with respect to such Alternative Employment; and (B) the
Company shall cease to be obligated to provide any medical, health or other
insurance benefit to the extent an equivalent benefit is provided to Executive
in connection with such Alternative Employment. Following a Protected
Termination of Executive's employment with the Company, Executive shall use
reasonable efforts to obtain Alternative Employment, provided, that nothing
contained herein shall be deemed to obligate Executive to accept Alternative
Employment that: (1) involves duties, responsibility, authority and status
that are less in any material respect that applied to Executive's position
with the Company as of the Closing Date; (2) involves a reduction in
Executive's annual base salary that Executive was receiving as of the Closing
Date; or (iii) requires Executive to work more than 100 miles from the
location at which Executive was working on the Closing Date.
3.2 During any period in which Executive is entitled to Severance
Payments and Benefits, the Company shall (i) pay the salary and bonus component
thereof in accordance with the Company's then effective payroll payment
policies; and (ii) provide Executive with the same or equivalent medical, health
and other insurance policies or, at the Company's option, reimburse Executive
for premiums payable with respect to equivalent policies to be obtained directly
by Executive.
4
<PAGE>
Section 4. No Employment Agreement Employment at Will
- -----------------------------------------------------
Except as previously herein provided, Executive and the Company each
acknowledge and agree that: (i) this Agreement does not provide for the terms
and conditions of Executive's employment with the Company and does not require
or obligate Executive to provide services to the Company or the Company to
continue to employ Executive; and (ii) Executive's employment with the Company
remains an employment relationship terminable at will by either Executive or the
Company.
Section 5. Release of the Company and Its Affiliates
- --------------------- ------------------------------
5.1 Upon a termination of Executive's employment with the Company
following a Change of Control for which Executive is entitled to payments or
other benefits pursuant to Section 2 above and subject to full performance by
the Company of its obligations hereunder, Executive hereby forever and
completely releases and discharges the following (and each of them); (i) the
Company; (ii) any entity which is controlled by, or under common control with,
the Company (including, without limitation, any entity or entities or persons
acquiring control of the Company through the Change of Control); and (iii) any
past, present or future agents, attorneys, directors, officers, shareholders,
employees, affiliates, predecessors and successors of any of the foregoing
individuals or entities under clauses (i) and (ii) above, of and from any and
all claims and demands of every kind and nature, in law, equity or otherwise,
known or unknown, suspected or unsuspected, disclosed or undisclosed, including
but not limited to all claims and demands of every kind and nature, known or
unknown, suspected or unsuspected, disclosed or undisclosed, for damages actual,
consequential or exemplary, past, present and future, arising out of or in any
way related to Executive's employment with the Company.
5.2 Notwithstanding anything to the contrary set forth in Section 5.1
above, the releases set forth in said Section 5.1 shall not apply to any claims
or demands that: (i) do not arise in connection with Executive's employment with
the Company or a termination thereof; or (ii) are for salary or other benefits
for periods prior to such termination that have not been paid or otherwise
provided by the Company prior to the date of such termination.
Section 6. Notices
- ------------------
All notices or other communications required or permitted hereunder shall
be made in writing and shall be deemed to have been duly given if delivered by
hand or mailed, postage prepaid, by certified or registered mail, return receipt
requested, and addressed to the Company at:
Photon Dynamics, Inc.
1504 McCarthy Blvd.
Milpitas, CA 95035
Attention: Chairman
5
<PAGE>
or to the Executive at:
__________________________________
__________________________________
__________________________________
Notice of change of address shall be effective only when done in accordance with
this Section.
Section 7. Successors
- ---------------------
This Agreement shall be binding upon and shall inure to the benefit of the
parties hereto and their respective heirs, executors, administrators, successors
and assigns.
Section 8. California Law
- -------------------------
The interpretation, performance and enforcement of this Agreement shall be
governed by the laws of the State of California.
IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as
of the date first above written.
PHOTON DYNAMICS, INC., EXECUTIVE:
a California corporation
By: /s/ E. Floyd Kvamme /s/ Donald Jerome
___________________________________ ____________________________________
E. Floyd Kvamme Donald Jerome
Title: Chairman
6
<PAGE>
EXHIBIT A
Executive's Stock Options
-------------------------
7
<PAGE>
AGREEMENT REGARDING CHANGE OF CONTROL
-------------------------------------
This Agreement is entered into as of this 1st day of July 1996 by and
between Photon Dynamics, Inc., a California corporation (the "Company"), and
Vincent F. Sollitto, Jr. ("Executive").
RECITALS
--------
Executive is employed by the Company and is a valued officer of the
Company. As an inducement to Executive to remain in the employ of the Company,
the Company wishes to provide for certain rights in favor of Executive to
severance payments and other benefits in the event of a Change of Control (as
defined below) of the Company upon the terms herein provided.
NOW THEREFORE, in consideration of the foregoing and the mutual promises
herein contained, the parties agree as follows:
AGREEMENT
---------
Section 1. Definitions
- ----------------------
For purposes of this Agreement, the following definitions shall apply:
"Alternative Employment" shall mean any employment, consulting or other
relationship pursuant to which Executive provides in excess of 20 hours of
service per week for compensation following any Protection Termination of his
employment with the Company.
"Change of Control" shall mean the occurrence of one or more of the
following with respect to the Company: (i) the sale or exchange of more than 50%
of the outstanding shares of Common Stock (treating any Preferred Stock on a
fully converted basis) in a single transaction or series of related
transactions; (ii) a merger or consolidation in which the Company is not the
surviving entity, except for a transaction the principal purpose of which is to
change the state of the Company's incorporation; or (iii) any reverse merger in
which the Company is the surviving entity but in which securities representing
more than fifty percent (50%) of the total combined voting power of the
Company's outstanding securities are transferred to holder different from those
who held such securities immediately prior to such merger.
"Closing Date" shall mean the date of the first closing of the transactions
constituting a Change of Control.
"Common Stock" shall mean no par value, Common Stock of the Company.
"Constructive Termination" shall mean any of the following actions taken by
the Company with respect to the position or compensation or other material terms
and conditions of Executive's employment with the Company: (A) unless approved
in writing in advance by
1
<PAGE>
Executive, the assignment to Executive of any duties materially inconsistent
with his position, duties, responsibilities, authority and status, or the
removal of any material duties, responsibilities or authority from such
position, except to the extent necessary in connection with a disability that
would qualify under the Company's existing disability plan, if any, but for
any requirement in such plan that the disability continue for any period of
time, for the period of such disability; (B) a reduction in Executive s annual
base salary in effect at the time any determination thereof is to be made; or
(C) unless approved in writing in advance by Executive, the Company's
requiring the Executive to work, apart from reasonable business trips, more
than 100 miles from the location at which Executive was working on the Closing
Date.
"Executive's Stock Options" shall mean those options to purchase Common
Stock held by Executive that have been issued to Executive prior to the date
hereof pursuant to the Photon Dynamics, Inc. 1995 Stock Option Plan and that are
set forth in Exhibit A attached hereto.
"Protected Termination" shall mean any termination of Executive's
employment with the Company (including, without limitation, a Constructive
Termination as provided in Section 2.5 below) other than: (i) a voluntary
termination of such employment by Executive other than as a result of a
Constructive Termination; or (ii) a termination by the Company of such
employment for cause, which shall mean, for purposes of this Section 1, a
termination of Executive's employment by the Company as a result of the
occurrence of one or more of the following with respect to Executive: (w)
chronic alcoholism or drug addiction, to the extent discharge therefor is
permitted by applicable law; (x) misappropriation of any money or other assets
or properties of the Company or any subsidiary of the Company; (y) the
conviction of Executive of any felony, or of any lesser crime or offense
materially and adversely affecting the property, reputation or goodwill of the
Company or any of its subsidiaries; or (z) willful or gross neglect by Executive
of his duties, or willful misconduct by Executive in connection with the
performance of his duties, which neglect or misconduct shall have an adverse
effect on the Company or one of its subsidiaries and which shall remain
unremedied for thirty (30) days after written notice (indicating with reasonable
specificity the events of neglect and/or misconduct) given to Executive by the
Company through its Board of Directors.
"Severance Payments and Benefits" shall mean Executive's base salary and
non-discretionary bonuses (as measured at the then effective rates), plus
medical, health and other insurance benefits that are in effect as of the
Closing Date.
Section 2. Severance Payments
- -----------------------------
2.1 In the event of and following a Change of Control and in the further
event that Executive is an employee of the Company as of the Closing Date of
such Change of Control, the Company agrees that Executive shall be entitled to
the Severance Payments and Benefits and other consideration in accordance with
this Section 2 in the event Executive's employment with the Company terminates
as a result of a Protected Termination (or is deemed to terminate as a result of
a Constructive Termination as provided in Section 2.5 below) within the fifteen
(15) month period following the Closing Date.
2.2 Subject to Section 2.1 above and in the event that Executive's
employment with the Company is to be terminated as of the Closing Date as a
result of a Protected Termination (or
2
<PAGE>
is deemed to terminate as a result of a Constructive Termination as provided
in Section 2.5 below), Executive shall be paid or otherwise provided by the
Company Severance Payments and Benefits for a period of six (6) months
following the Closing Date; provided that Executive's right pursuant to this
Section 2.2 to receive Severance Payments and Benefits shall be extended for
up to three (3) additional three (3) month periods as provided in this Section
2.2. In the event that Executive shall not have obtained Alternative
Employment by the expiration of the initial six (6) month period, Executive's
right to Severance Benefits and Payments shall be extended for one (1) three
(3) month extension period. In the further event that Executive shall not have
obtained Alternative Employment by the expiration of such initial three (3)
month extension period, Executive's right to receive Severance Benefits and
Payments shall be continued for one (1) additional three month extension
period following expiration of such initial extension period, and if Executive
shall not have obtained Alternative Employment by the expiration of the second
three (3) month extension period, Executive's right to receive Severance
Benefits and Payments shall be continued for one (1) additional three month
extension period following expiration of such second extension period. Any
right of Executive to Severance Payments and Benefits pursuant to this Section
2.2 shall cease and terminate fifteen (15) months from the Closing Date. To
the extent Executive shall obtain Alternative Employment at a compensation
rate or for benefits that are less in any material respect than the Severance
Payments and Benefits that Executive would otherwise be entitled to receive
pursuant to this Section 2.2, Executive's right to receive Severance Payments
and Benefits from the Company shall continue to be extended as provided above
in this Section 2.2, provided that the Company shall be allowed a credit as
provided in Section 3.1 below on the basis of such Alternative Employment with
respect to its obligation to pay and provide such extended Severance Payments
and Benefits.
2.3 Subject to Section 2.1 above and in the event that Executive remains
an employee of the Company at any time following the Closing Date and his
employment is terminated as a result of a Protected Termination (or is deemed to
terminate as a result of a Constructive Termination pursuant to Section 2.5
below) within fifteen (15) months following the Closing, Executive shall be paid
or otherwise provided by the Company Severance Payments and Benefits from the
date of such termination of employment until six (6) months from the date of
such termination.
2.4 Subject to Section 2.1 above, the Company agrees that the right of
Executive to exercise the Executive's Stock Options shall be accelerated as of
the Closing Date of a Change of Control as follows: (i) if Executive's
employment with the Company is to be terminated as of the Closing Date in the
manner described in Section 2.2 above, Executive's Stock Options shall become
fully exercisable as of the Closing Date as to all shares of the Company's
Common Stock subject thereto; and (ii) if Executive is to remain an employee of
the Company at any time following the Closing Date as described in Section 2.3
above, Executive's Stock Options shall become exercisable as to that number of
shares of Common Stock (in addition to that number of shares of Common Stock for
which the Executive's Stock Option is then otherwise exercisable) for which the
Executive's Stock Options would be exercisable upon the expiration of two (2)
years following the Closing Date (assuming that Executive was then employed by
the Company). As a condition to an acceleration of the Executive's Stock Options
as provided in this Section 2.4, Executive agrees that the Executive's Stock
Options shall terminate as of the Closing Date to the extent unexercised as of
such Closing Date if the terms and conditions of such Change of Control require
that all employee stock options terminate as of such Closing Date. In
3
<PAGE>
no event shall this Section 2.4 be interpreted to cause the Executive's Stock
Options to be exercisable for a greater number of shares of Common Stock than
were subject to the Executive's Stock Options immediately prior to the Closing
Date.
2.5 In the event of a Constructive Termination, Executive shall have the
option to give notice to the Company within ten (10) business days of the
effective date of such Constructive Termination that Executive elects to
terminate his employment with the Company, in which case Executive's employment
with the Company shall be deemed to have been terminated as a result of a
Protected Termination, and Executive shall be entitled to the appropriate
Severance Payments and Benefits as provided in Section 2.2 or 2.3 above. In the
event Executive does not elect to resign his employment with the Company in
accordance with the preceding sentence following a Constructive Termination and
notwithstanding any proposed term of employment related to such Constructive
Termination, Executive shall remain entitled to the same level of base salary
compensation and non-discretionary bonuses (which are then in effect) and
medical, health and other insurance benefits that were in effect as of the
Closing Date until the first to occur of: (i) the expiration of fifteen (15)
months following the Closing Date, or (ii) the termination of Executive's
employment with the Company (in which case Executive shall retain those rights
described in Section 2 hereof as to such termination).
Section 3. Alternative Employment: Payment of Severance Payments and Benefits
- --------------------------------------------- -------------------------------
3.1 In the event Executive shall obtain Alternative Employment during any
period in which Executive is entitled to Severance Payments and Benefits
pursuant to Section 2.2 or 2.3 above (other than the initial six (6) month
period described in Section 2.2 or 2.3), Executive shall promptly give notice to
the Company of such Alternative Employment, which notice shall describe the
following with respect to such Alternative Employment: (i) the salary,
commission, bonus and other monetary compensation payable to Executive; (ii) the
medical, health and other insurance benefits to be provided to Executive and
(iii) any other consideration payable to or otherwise be provided to Executive.
The Company shall be credited for any compensation payable or benefits provided
with respect to such Alternative Employment against the Company's obligation to
pay and or provide Severance Payments and Benefits for any period (other than
the initial six (6) month period provided in Section 2.2 or 2.3) pursuant to
Section 2 hereof so that: (A) the monetary portion of the Severance Payments
and Benefits shall be reduced for any cash compensation payable to Executive
for such period with respect to such Alternative Employment; and (B) the
Company shall cease to be obligated to provide any medical, health or other
insurance benefit to the extent an equivalent benefit is provided to Executive
in connection with such Alternative Employment. Following a Protected
Termination of Executive's employment with the Company, Executive shall use
reasonable efforts to obtain Alternative Employment provided that nothing
contained herein shall be deemed to obligate Executive to accept Alternative
Employment that: (1) involves duties, responsibility, authority and status
that are less in any material respect that applied to Executive's position
with the Company as of the Closing Date; (2) involves a reduction in
Executive's annual base salary that Executive was receiving as of the Closing
Date; or (iii) requires Executive to work more than 100 miles from the
location at which Executive was working on the Closing Date.
3.2 During any period in which Executive is entitled to Severance
Payments and Benefits, the Company shall (i) pay the salary and bonus component
thereof in accordance with
4
<PAGE>
the Company's then effective payroll payment policies; and (ii) provide
Executive with the same or equivalent medical, health and other insurance
policies or, at the Company's option, reimburse Executive for premiums payable
with respect to equivalent policies to be obtained directly by Executive.
Section 4. No Employment Agreement, Employment at Will
- ------------------------------------------------------
Except as previously herein provided, Executive and the Company each
acknowledge and agree that: (i) this Agreement does not provide for the terms
and conditions of Executive's employment with the Company and does not require
or obligate Executive to provide services to the Company or the Company to
continue to employ Executive; and (ii) Executive's employment with the Company
remains an employment relationship terminable at will by either Executive or the
Company.
Section 5. Release of the Company and Its Affiliates
- --------------------- ------------------------------
5.1 Upon a termination of Executive's employment with the Company
following a Change of Control for which Executive is entitled to payments or
other benefits pursuant to Section 2 above and subject to full performance by
the Company of its obligations hereunder, Executive hereby forever and
completely releases and discharges the following (and each of them); (i) the
Company; (ii) any entity which is controlled by, or under common control with,
the Company (including, without limitation, any entity or entities or persons
acquiring control of the Company through the Change of Control); and (iii) any
past, present or future agents, attorneys, directors, officers, shareholders,
employees, affiliates, predecessors and successors of any of the foregoing
individuals or entities under clauses (i) and (ii) above, of and from any and
all claims and demands of every kind and nature, in law, equity or otherwise,
known or unknown, suspected or unsuspected, disclosed or undisclosed, including
but not limited to all claims and demands of every kind and nature, known or
unknown, suspected or unsuspected, disclosed or undisclosed, for damages actual,
consequential or exemplary, past, present and future, arising out of or in any
way related to Executive's employment with the Company.
5.2 Notwithstanding anything to the contrary set forth in Section 5.1
above, the releases set forth in said Section 5.1 shall not apply to any claims
or demands that: (i) do not arise in connection with Executive's employment with
the Company or a termination thereof; or (ii) are for salary or other benefits
for periods prior to such termination that have not been paid or otherwise
provided by the Company prior to the date of such termination.
Section 6. Notices
- ------------------
All notices or other communications required or permitted hereunder shall
be made in writing and shall be deemed to have been duly given if delivered by
hand or mailed, postage prepaid, by certified or registered mail, return receipt
requested, and addressed to the Company at:
5
<PAGE>
Photon Dynamics, Inc.
1504 McCarthy Blvd.
Milpitas, CA 95035
Attention: Chairman
or to the Executive at:
_____________________________________
_____________________________________
_____________________________________
Notice of change of address shall be effective only when done in accordance with
this Section.
Section 7. Successors
- ---------------------
This Agreement shall be binding upon and shall inure to the benefit of the
parties hereto and their respective heirs, executors, administrators, successors
and assigns.
Section 8. California Law
- -------------------------
The interpretation, performance and enforcement of this Agreement shall be
governed by the laws of the State of California.
IN WITNESS WHEREOF, the parties hereto have duly executed this Agreement as
of the date first above written.
PHOTON DYNAMICS, INC., EXECUTIVE:
a California corporation
By: /s/ E. Floyd Kvamme /s/ Vincent F. Sollitto, Jr.
___________________________________ ____________________________________
E. Floyd Kvamme Vincent F. Sollitto, Jr.
Title: Chairman
6
<PAGE>
EXHIBIT A
Executive's Stock Options
-------------------------
7
<PAGE>
EXHIBIT 11.1
PHOTON DYNAMICS, INC.
STATEMENT RE COMPUTATION OF EARNINGS PER SHARE
(In thousands, except per share data)
Primary and Fully Diluted Earnings Per Share
<TABLE>
<CAPTION>
YEAR ENDED
SEPTEMBER
30,
-----------
1996 1995
----- -----
<S> <C> <C>
Net income..................................................... $ 854 $ 377
Reduction of interest expense related to modified treasury
stock method................................................... -- 26
----- -----
Adjusted net income............................................ $ 854 $ 403
Computation of weighted average common and common equivalent
shares outstanding:
Common stock................................................. 7,387 963
Convertible preferred shares................................. -- 3,482
Options and warrants......................................... -- 518
Shares related to SAB No. 55, 64, and 83..................... -- 462
----- -----
Total weighted average common and common equivalent shares
outstanding.................................................... 7,387 5,425
----- -----
Net income per share........................................... $0.12 $0.07
===== =====
</TABLE>
<PAGE>
EXHIBIT 13.1
COMPANY PROFILE
The flat panel display (FPD) industry has grown significantly in recent years
due to expanding applications made possible by improvements in size, resolution,
and power utilization. Flat panel display manufacturing is a complex, materials
intensive process. Fast, accurate testing of FPDs is a critical step in
successful manufacturing. Early defect detection can eliminate the investment of
further materials and labor, and allows for repair prior to final assembly,
providing a substantial savings in manufacturing costs.
Photon Dynamics is a leading worldwide supplier of test, inspection and repair
systems for the flat panel display industry. Photon Dynamics' products
incorporate technologies that are designed to provide FPD manufacturers with the
ability to obtain information critical to yield improvement and manufacturing
processes insights. Our systems are used to control, monitor and refine the
manufacturing process in order to increase yields, reduce materials loss,
transition new designs from R & D to commercial production, and to assist in the
rapid start-up of new manufacturing facilities.
Photon Dynamics offers a suite of products to inspect virtually all types of
FPDs and to address the key areas of active matrix liquid crystal display
(AMLCD) test, inspection and repair, from research and development through
commercial production. Photon Dynamics' In Process Test Systems (IPT) locate,
count and characterize electrical defects, contamination and other defects at
the active array stage. Flat Panel Inspection Systems (FIS) perform cell and
module inspection to detect and locate optical defects. Review stations with
Integrated Laser Cut and Weld (ILW) repair defects based on precise location
information generated by the IPT and the FIS. Patented technologies, such as
Voltage Imaging and N-Aliasing, work in conjunction with proprietary software
programs to permit low cost, non-contact, full characterization and image
evaluation.
Photon Dynamics has been issued over 21 U.S. patents for flat panel display
test, inspection and repair technologies, and has other U.S. and foreign
applications pending. As the only company with systems addressing all key areas
of AMLCD test, inspection and repair, Photon Dynamics is positioned to provide
an integrated yield and cost management solution for FPD manufacturing.
Customer Commitment
Photon Dynamics' expertise in flat panel test, inspection, and repair comes from
many years of production experience with the worlds leading FPD manufacturers.
Our philosophy is to develop our technologies through close interaction with our
customers in order to provide the most efficient, cost-effective solutions
throughout the world. We are dedicated to maximizing value to our customers, and
cooperating with them to achieve lower costs, higher quality products, and
increased production levels.
Worldwide Presence
Photon Dynamics' main headquarters, located in San Jose, California, is home to
our manufacturing and research and development facilities. In order to meet our
customer' needs throughout the world, Photon Dynamics also maintains offices in
Japan and Korea, and is represented in Taiwan. With systems installed throughout
the world, we are committed to serving our customer base with the highest level
of support possible. Our customer support network
<PAGE>
allows us to meet our customer satisfaction goals, and helps us to stay in close
contact with the issues that impact their success.
Training and Service
The relationships we have with our customers continue long after our systems are
installed at their facilities. Our trained technical support and service staff
is available to maintain the high standard of performance that our customers
expect from our systems. In addition, Photon Dynamics offers a full range of
customer training courses for all of our products, covering maintenance, basic
operation, test design and applications. These courses provide our customers
with the latest theory of operation, methodology, and technological
enhancements. Our service and training teams are dedicated to providing
customized solutions for the specific needs of each of our customers.
SHAREHOLDERS' LETTER
Fiscal 1996 marked an important year of growth for the flat panel display
industry and Photon Dynamics. In the first quarter, we became a publicly traded
company, and reported record revenue and earnings, which earned us a spot as one
of Silicon Valley's 50 fastest growing companies. We have developed new versions
of our test, inspection, and repair systems, added key management and
engineering people, and recently moved into a new 50,000 sq. ft. corporate
office and manufacturing facility in San Jose, Ca. In addition, we have added
several new customers throughout the world, and have seen repeat business from
some of the worlds' largest flat panel display manufacturers that make up our
existing customer base.
Flat panel displays are one of the fastest growing segments of the electronics
industry, with excellent potential for growth throughout the next decade. We are
very excited about the opportunities for flat panel displays, led by the growth
of the notebook computer market. Today, flat panel displays are also being used
for other markets which are potentially much larger than notebook computers. We
are beginning to see flat panel displays replacing the cathode ray tube (CRT) in
the desktop monitor market, and the technology for a flat television screen that
hangs on the wall is now a reality. Other emerging flat panel display
applications include on-board vehicle navigation, personal information devices,
and projection systems. These visual delivery technologies are key components of
today's multi-media information age.
To be a leader in these industries, companies must be proficient in two key
technologies for the 21st Century: machine vision and image processing. These
technologies are Photon Dynamics' core competency, and represent the future of
our Company's technological development.
The thrust of our business is to offer integrated, software driven, capital
equipment solutions that apply machine vision technology to flat panel display
manufacturing.
In the future, we plan to broaden our machine vision and image processing
technology to include new applications and new product opportunities.
1997 will present challenges as well as opportunities for Photon Dynamics.
In order to reduce deadline pressures and to help smooth out periods of
fluctuating revenue, as seen in the fourth quarter of fiscal year 1996, we are
committed to building up our backlog to a significant level. As the flat panel
industry matures and expands, so does the sophistication of the manufacturing
process, which has been gradually gearing up towards mass production to meet
increasing demand. Our challenge is to continue to move the
<PAGE>
use of machine vision systems from a research and development stage to the mass
production lines of all of our strategic customers. To achieve this, we must
improve our throughput to match the high level of performance our systems offer.
We must also continue to raise our level of worldwide service and applications
to meet our customers' requirements, while continuing to develop new
technologies that lead the industry.
We believe that fiscal 1997 will bring more industry growth, more product
development, and more technology advances for Photon Dynamics than any other
period of time in our Company's history. We are focused on the challenges that
face us, and look forward to the tremendous opportunities that lie ahead.
Vincent F. Sollitto Jr.
Chief Executive Officer
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Consolidated Statements of Operations
In thousands except per share data
For the Years Ended September 30, 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
Revenue $24,763 $18,447 $10,587 $10,312 $ 5,721
Gross margin 11,507 6,756 3,902 3,066 756
Operating income (loss) 563 710 (2,048) (3,109) (4,802)
Net income (loss) $ 854 $ 377 $(2,105) $(3,070) $(4,607)
Net income per share (pro forma for $0.12 $0.07
1995)
Shares used in computing net income per 7,387 5,425
share
</TABLE>
<TABLE>
<CAPTION>
Consolidated Balance Sheet Data
In thousands September 30, 1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
Working capital (deficit) $17,290 $ 709 $ 408 $ (857) $ 2,064
Total assets 24,958 10,519 6,567 4,948 5,006
Total shareholders' equity 19,770 1,857 1,435 132 3,204
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Unaudited Quarterly Consolidated Financial Data
In thousands
Fiscal Quarters Ended December 31, 1995 March 31, 1996 June 30, 1996 September 30, 1996
<S> <C> <C> <C> <C>
Revenue $ 6,205 $ 6,308 $ 7,709 $ 4,541
Gross margin 2,804 2,975 3,599 2,129
Net income (loss)1 563 751 825 (1,285)
<CAPTION>
Fiscal Quarters Ended December 31, 1994 March 31, 1995 June 30, 1995 September 30, 1995
1995
<S> <C> <C> <C> <C>
Revenue $ 2,963 $ 4,448 $ 4,857 $ 6,179
Gross margin 1,192 1,453 1,778 2,333
Net income 25 32 110 210
</TABLE>
1. Net loss for the fourth quarter of fiscal 1996 includes a $844,000 charge for
the write down of assets related to a product line disposal, see Note 3 to the
consolidated financial statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The following table sets forth certain operating data as a percentage of total
revenue:
<TABLE>
<CAPTION>
Years Ended September 30, 1996 1995
<S> <C> <C>
Revenue:
Product sales 94.4% 75.4%
Development contracts 5.6 24.6
100.0 100.0
Cost of revenue:
Product sales 49.6 38.6
Development contracts 3.9 24.8
53.5 63.4
Gross margin 46.5 36.6
Operating expenses:
Research and development 16.1 9.1
Selling, general and administrative 24.7 23.7
Asset write-off related to product line 3.4 -
disposal
Total operating expenses 44.2 32.8
Operating income 2.3 3.8
Other income (expense), net 1.3 (1.7)
Income before provision for income taxes 3.6 2.1
Provision for income taxes 0.2 0.1
Net income 3.4% 2.0%
</TABLE>
<PAGE>
To the extent that this annual report discusses financial projections,
information or expectations about products or markets of Photon Dynamics Inc.
(the Company), all such forward looking statements are based on information
available to the Company on the date hereof, and the Company assumes no
obligation to update any such forward looking statements. It is important to
note that the Company's actual results could differ materially y from those in
such forward looking statements. The Company's results will be affected,
particularly when measured on a quarterly basis, by the volume, composition and
timing of orders for capital equipment by Flat Panel Display (FPD)
manufacturers.
Other uncertainties include, acceptance of new products, timing of orders
received, costs associated with new product introductions and managing growth.
For a further discussion of the Company's business, please refer t= o the
Company's 1996 Annual Report on Form 10-KSB.
Overview
Photon Dynamics develops, manufactures and markets on a worldwide basis a suite
of products to inspect virtually all types of FPDs and to address all key areas
of AMLCD test, inspection and repair throughout all major stages of the
manufacturing life cycle, from research and development to commercial
production. The Company's revenue is derived primarily from the sale of products
and, to a lesser extent, from revenue under development contracts. In fiscal
1996 and 1995, revenue under development contracts accounted for 6% and 25% of
total revenue, respectively.
The Company expects revenue under development contracts to decline on an
absolute dollar basis in 1997. The Company does not expect that service revenue
for continuing maintenance of its products will be a significant part of its
revenue in the near term.
Results of Operations
Revenue
Revenue increased 34% from $18.4 million in fiscal 1995 to $24.8 million in
fiscal 1996. Revenue from product sales increased 68% from $13.9 million to
$23.4 million over the same period. The increase in product sales was primarily
attributable to the introduction of the In-Process Test Mass Production System
(IPT-MPS) in late fiscal 1995, which sold into both new and existing customer
plants, and the continued penetration of the Japanese and Korean markets.
International sales accounted for $21.6 million and $11.6 million of revenue in
fiscal 1996 and 1995, respectively. Sales to Japan increased to $9.3 million in
fiscal 1996 from $5.2 million in fiscal 1995, and sales to Korea increased to
$10.6 million in fiscal 1996 from $4.5 million in fiscal 1995.
Gross Margin
Gross margin as a percent of revenue increased to 46.5% in fiscal 1996 from
36.6% in 1995. This increase in gross margins was due to the relative decrease
in development contract revenue, with associated lower gross margins, as a
percentage of total revenue. The gross margin for product sales decreased to
47.4% in fiscal 1996 from 48.8% in fiscal 1995. The decrease was the result of
lower foreign exchange rates on Yen denominated sales and a less favorable
product mix year to year. Overall product gross margins will fluctuate on a
quarterly basis as the Company's product mix fluctuates. The Company expects to
add to its infrastructure by hiring additional personnel and increasing its
<PAGE>
capital expenditures for new facilities and equipment which is expected to
modestly reduce gross margins at the start of 1997.
The increase in gross margin attributable to development contracts was primarily
due to the ending of two lower margin contracts with government agencies.
Research and Development
The Company increased its research and development expenses on an absolute
dollar basis to $4.0 million in fiscal 1996, or 16% of revenue, from $1.7
million in fiscal 1995, or 9% of revenue. In addition to these research and
development expenses incurred for product development, the Company spent $1.0
million in fiscal 1996 and $4.6 million in fiscal 1995 in performance of its
obligations under third party development contracts. The combination of research
and development expenses and costs incurred on development contracts was $4.9
million, or 20% of revenue, in fiscal 1996 and $6.3 million, or 34% of revenue,
in fiscal 1995. The Company expects that these combined product development
expenses will increase in absolute dollar amounts in fiscal 1997 with continued
emphasis on Company spending and lower spending under third party development
contracts.
Selling, General and Administrative
Selling, general and administrative expenses increased to $6.1 million, or 25%
of revenue, in fiscal 1996 from $4.4 million, or 24% of revenue, in fiscal 1995.
The increase reflects an overall increase in revenue and the associated
incremental selling costs as well the administration costs associated with being
a public company. Selling, general and administrative expenses may increase in
absolute dollar amounts in fiscal 1997 and in future periods depending on
factors including the level of the Company's revenue and other operations.
Selling expenses may also fluctuate based on the Company's product and territory
sales mix, which have different sales channels and associated cost structures.
In September, 1996, the Company ceased operations of its Defect Monitoring Tool
(DMT) product line. The DMT product group had been working exclusively on a
single customer project not in the flat panel display market. As a result of the
cancellation of this project, the associated inventory and assets of this
product line which can not be transferred to other products will be disposed of.
The Company recorded a $844,000 charge to write down the inventory and assets
associated with the product line.
Interest income/expense
Interest income in fiscal 1996 increased to $646,000 from the fiscal 1995 level
of $16,000 as a result of interest received on the proceeds from the Company's
Initial Public Offering (IPO) in November 1995. Interest expense was $263,000
and $194,000 in fiscal 1996 and 1995 respectively, because of increases in
borrowings under the Company's revolving bank line s of credit which were repaid
in the first quarter of fiscal 1996, as well as borrowing under a term loan
which was repaid in late fiscal 1996.
Provision for Income Taxes
Provisions for income taxes in fiscal 1995 and 1996 were minimal due to
utilization of loss carryforwards. As of September 30, 1996 the Company had
available federal and state net operating loss carryforwards of approximately
$12.5 million and $3.0 million, respectively. The Company also had federal and
state research and development tax credit carryforwards of approximately
<PAGE>
$698,000 and $341,000, respectively. The net operating loss and credit
carryforwards will expire at various times beginning in 1998 through 2011 if not
utilized. As of September 30, 1996, the Company had deferred tax assets of
approximately $7.8 million, for which no benefit has been recorded on the
Company's financial statements, and which consist primarily y of net operating
loss carryforwards. This deferred tax asset will be recognized in future periods
as taxable income is realized and consistent profits are reported.
Under certain provisions of the Internal Revenue Code of 1986, as amended, the
availability of the Company's operating loss and credit carryforwards may be
subjected to limitation if it should be determined that there has been a change
of ownership of more than 50% of the value of the Company's stock within any
three year period. See Note 7 to Consolidated Financial Statements.
Liquidity and Capital Resources
Working capital increased from $709,000 as of September 30, 1995 to $17.3
million at September 30, 1996, of which $5.1 million was cash or cash
equivalents. In November 1995, the Company completed its IPO of 2,932,500 shares
of Common Stock, of which 2,127,661 shares were issued and sold by the Company
and 804,839 shares were sold by stockholders. The IPO raised approximately $17.8
million before deducting offering expenses.
Cash used by operating activities was $3.8 million for the year. Working capital
items that significantly impacted cash balances were accounts receivable and
inventory. The Company's accounts receivable balance increased $3.4 million to
$8.7 million. The factors affecting the accounts receivable balance include, the
Company's credit terms to customers which typically have a small portion of the
payment extended for a period of months after shipment resulting in a larger
accounts receivable balance, especially when combined with the growth in product
sales in fiscal 1996 compared fiscal 1995 as well as the near quarter end timing
of such product shipments. Inventory levels increased $1.1 million reflecting
the increased production levels in fiscal 1996.
Capital expenditures in fiscal 1996 and fiscal 1995 were $1.2 million and
$1.0 million, respectively. The increase is the result of the capitalization of
engineering and demonstration equipment related to the Company's latest
products. In the first quarter of fiscal 1997 the Company relocated to a new
facility and expects to spend approximately $700,000 in leasehold improvements
and related costs.
The Company believes that cash and cash equivalents, income from operations and
the proceeds from the Offering will be sufficient to satisfy working capital
requirements and capital equipment needs for the next 12 months. As of September
30, 1996, the Company had no material outstanding commitments to purchase or
lease capital equipment.
The Company believes that success in its industry requires substantial capital
in order to maintain the flexibility to take advantage of opportunities as they
may arise. The Company may, from time to time, invest in or acquire
complementary businesses, products or technologies. The Company may effect
additional equity or debt financing to fund such activities. The sale of
additional equity or convertible debt could result in additional dilution to the
Company's shareholders.
Other Factors Affecting Company Results
The Company has experienced, (see unaudited quarterly consolidated financial
data, page 5), and expects to continue to experience significant fluctuations
<PAGE>
in its quarterly results of operations. The Company derives substantially all of
its revenue from the sale of a relatively small number of systems, which
typically range in price from $400,000 to $1,500,000. As a result, the timing of
the sale of a single system could have a significant impact on the Company's
quarterly revenue and results of operations. The failure to receive anticipated
orders or delays in shipments in a particular quarter, due, for example, to
unanticipated shipment reschedulings or cancellations by customers or unexpected
manufacturing difficulties, may cause revenue for that quarter to fall
significantly below the Company's expectations, which would have a material
adverse effect on the Company's results of operations for such quarter.
The Company's backlog at the beginning of each quarter is not necessarily
indicative of actual sales for any succeeding period. All orders are subject to
delay or cancellation with limited or no penalty. The Company's sales will often
reflect orders shipped in the same quarter that they are received.
Other factors which may have an influence on the Company's results of operations
in a particular quarter include the volume, mix and timing of the receipt of
orders from major customers, competitive pricing pressures, costs of components
and subsystems, the Company's ability to design, manufacture and introduce new
products on a cost effective and timely basis, the delay between incurrence of
expenses to further develop marketing and service capabilities and realization
of benefits from such improved capabilities, fluctuations in foreign exchange
rates, the timing of recognition of revenue under development contracts, the
introduction and announcement of new products by the Company's competitors and
changing conditions in the FPD market worldwide. In particular, due to
substantial differences in gross margin for the Company's products, changes in
the mix of products sold could result in substantial fluctuations in the
Company's gross margin. Accordingly, the Company's results of operations are
subject to significant variability from quarter to quarter.
<TABLE>
<CAPTION>
CONSOLIDATED BALANCE SHEETS
In thousands, except share amounts
Years Ended September 30, 1996 1995
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 5,108 $ 298
Short term investments 4,066 -
Accounts receivable, net of allowance for doubtful 8,652 5,280
accounts of $629 ($224 in 1995); including $1,220
receivable from related parties ($1,907 in 1995)
Inventories 4,125 2,986
Prepaid expenses and other current assets 518 219
Total current assets 22,469 8,783
Property, equipment, and leasehold improvements, net 1,849 1,418
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C>
Other assets 640 318
Total assets $ 24,958 $10,519
Liabilities and shareholders' equity
Current liabilities:
Accounts payable $ 2,743 $ 1,684
Accrued expenses and other liabilities 2,067 2,368
Customer deposits and deferred revenue 353 1,251
Line of credit and other short-term debt - 2,407
Current portion of long-term debt 16 364
Total current liabilities 5,179 8,074
Noncurrent portion of long-term debt 9 588
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value, issuable in series: - 17,935
13,000,000 authorized, convertible shares issued and
outstanding - 9,822,826 in 1995
Preferred Stock, no par value, 5,000,000 authorized, - -
none issued and outstanding
Common stock, no par value, 20,000,000 authorized, 38,064 3,008
shares issued and outstanding - 6,888,032 and
1,155,782 in 1996 and 1995
Accumulated deficit (18,201) (19,055)
Foreign currency translation adjustment and other (7) 104
Notes receivable from shareholders (86) (135)
Total shareholders' equity 19,770 1,857
Total liabilities and shareholders' equity $ 24,958 $ 10,519
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
In thousands, except share amounts
Years Ended September 30, 1996 1995
<S> <C> <C>
Revenue
Product sales $ 23,381 $ 13,906
Development contracts 1,382 4,541
24,763 18,447
Cost of revenue:
Product sales 12,294 7,114
Development contracts 962 4,577
13,256 11,691
Gross margin 11,507 6,756
Operating expenses
Research and development 3,982 1,676
Selling, general, and administrative 6,118 4,370
Asset write-off related to product line disposal 844 -
Total operating expenses 10,944 6,046
Operating income 563 710
Interest income 646 16
Interest expense (263) (194)
Foreign exchange loss (53) (142)
Income before provision for income taxes 893 390
Provision for income taxes 39 13
Net income $ 854 $ 377
Net income per share (pro forma for 1995) $ 0.12 $ 0.07
Shares used in computing net income per share 7,387 5,425
</TABLE>
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
In thousands
Years Ended September 30, 1996 1995
<S> <C> <C>
Operating activities
Net income $ 854 $ 377
Adjustments to reconcile net
income to net cash used in
operating activities:
Depreciation and amortization 723 451
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C>
Changes in operating assets and liabilities:
Accounts receivable (3,372) (2,615)
Inventories (1,139) (1,433)
Prepaid expenses and other current assets (299) (167)
Other assets (418) (173)
Accounts payable 1,044 (109)
Accrued expenses and other liabilities (301) 117
Customer deposits and deferred revenue (898) 293
Net cash used in operating activities (3,806) (3,259)
Investing activities
Acquisition of property and equipment (1,154) (975)
Acquisition of short term investments (10,554) -
Maturities of short term investments 6,488 -
Net cash used in investing activities (5,220) (975)
Financing activities
Borrowings under lines of credit - 2,325
Proceeds from issuance of note payable - 1,000
Proceeds from issuance of short term debt - 41
Repayment of lines of credit (2,325) -
Principal payments under capital leases (30) (50)
Issuance of common stock 226 83
Proceeds from initial public offering, net 16,895 -
Repayment of notes receivable from shareholders 49 -
Payment of notes payable (979) (103)
Net cash provided by financing activities 13,836 3,296
Net increase (decrease) in cash and cash equivalents 4,810 (938)
Cash and cash equivalents at beginning of period 298 1,236
Cash and cash equivalents at end of period $ 5,108 $ 298
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Convertible Common Stock
Preferred
Stock
Shares Amount Shares Amount
In thousands
<S> <C> <C> <C> <C>
Balance at September 30, 1994 9,823 $ 17,935 860 $ 2,790
Issuance of common stock - - 98 83
Issuance of common stock for - - 198 135
notes receivable
Foreign currency translation - - - -
adjustment
Net Income - - - -
Balance at September 30, 1995 9,823 $ 17,935 1,156 $ 3,008
Issuance of common stock - - 122 226
Conversion of preferred (9,823) (17,935) 3,482 17,935
stock to common stock
Initial public offering, net - - 2,128 16,895
of offering costs
Foreign currency translation - - - -
adjustment
Repayment of notes receivable - - - -
Net Income - - - -
Balance at September 30, 1996 - - 6,888 $38,064
<CAPTION>
Accumulated Foreign Notes Total
Deficit Currency Receivable Shareholders'
Translation From Equity
Adjustment Shareholders'
and other
In thousands
<S> <C> <C> <C> <C>
Balance at September 30, 1994 $(19,432) $ 142 $ - $ 1,435
Issuance of common stock - - - 83
Issuance of common stock for - - (135) -
notes receivable
Foreign currency translation - (38) - (38)
adjustment
Net Income 377 - - 377
Balance at September 30, 1995 $(19,055) $ 104 (135) $ 1,857
Issuance of common stock - - - 226
Conversion of preferred - - - -
stock to common stock
Initial public offering, net - - - 16,895
of offering costs
Foreign currency translation - (111) - (111)
adjustment
Repayment of notes receivable - - 49 49
Net Income 854 - - 854
Balance at September 30, 1996 $(18,201) $ (7) $(86) $19,770
</TABLE>
<PAGE>
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE I Summary of Significant
Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries after elimination of all material intercompany
balances and transactions. Photon Dynamics, Inc. is a manufacturer of test
inspection and repair systems for the flat panel display industry.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts in the financial statements and accompanying notes. Actual
results could differ from those estimates.
Initial Public Offering
In November 1995, the Company completed an initial public offering (IPO)
of 2,932,500 share of Common Stock, of which 2,127,661 shares were issued and
sold by the Company and 804,439 shares were sold by stockholders. The
IPO raised approximately $17.8 million before deducting offering expenses.
Reverse Stock Split
In November 1995, the Company effected a one-for-three reverse stock split of
the Company's common stock. All references in the accompanying financial l
statements to numbers of common shares and per share amounts have been
retroactively restated to reflect the reverse stock split.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with a maturity of
three months or less on the date of purchase to be cash equivalents.
Short Term Investments
Effective October 1, 1994, the Company adopted Statement of Financial Accounting
Standards No. 115 Accounting for Investments in Certain Debt and Equity
securities (FAS 115), which requires investment securities to be classified as
either held to maturity, trading or available for sale.
The Company has classified its investment portfolio as available for sale. Under
FAS 115, investments classified as available for sale are required to be
recorded at fair value and any temporary difference between an investment's cost
and its fair value is recorded as a separate component o= f shareholders'
equity.
At September 30, 1996, short term investments consisted of commercial paper and
fixed rate notes. The cost of these securities approximated the fair value and
the amount of unrealized gains or losses was not significant. These securities
mature through May 1997.
Inventories
Inventories are stated at the lower of cost or market, with cost being
determined on a first-in, first-out basis.
<PAGE>
<TABLE>
<CAPTION>
September 30, 1996 1995
Inventories comprise
(in thousands):
<S> <C> <C>
Raw materials $1,970 $1,322
Work-in-progress 1,247 461
Finished goods 908 1,203
$4,125 $2,986
</TABLE>
Property, Equipment and Leasehold Improvements
Property and equipment are recorded at cost. Depreciation is computed using the
straight-line method based upon the estimated useful lives of the assets,
generally three to five years.
Equipment recorded under capital leases is amortized using the straight-line
method over the lesser of the lease terms or the lives of the related assets.
<TABLE>
<CAPTION>
September 30, 1996 1995
<S> <C> <C>
Property and equipment comprise
(in thousands):
Equipment $ 3,553 $ 2,390
Office furniture and fixtures 265 268
Leasehold improvements 459 458
4,277 3,116
Less accumulated depreciation and (2,428) (1,698)
amortization
$ 1,849 $ 1,418
</TABLE>
Foreign Currency Translation
Assets and liabilities of the Company's foreign subsidiary are translated into
U.S. dollars at year-end exchange rates and revenues and expenses are translated
at average rates prevailing during the year. Translation adjustments are
included in a separate component of shareholders' equity.
Foreign currency transaction gains and losses are included in results of
operations.
Revenue Recognition
The Company generally recognizes revenue from product sales at the time of
shipment. The Company also sells one-year service contracts, for which revenue
is recognized ratably over the contract period. Revenue under cost reimbursement
type development contracts is recorded as costs are incurred.
Applicable estimated profits are included in revenue in the same proportion that
incurred costs bear to total estimated costs. Certain fixed-price contracts that
require substantial performance over a long period of time before deliveries
begin are accounted for under the percentage-of-completion method. Under all
other contracts, sales are recorded at delivery or on completion of specified
tasks, as applicable, and estimated contract profits are taken into earnings in
proportion to recorded sales.
Concentrations of Credit Risk
The Company markets its products primarily to a limited number of customers in
the Far East. The Company has development contracts primarily with the U.S.
government and companies in the Far East.
The Company is subject to economic conditions affecting its customers and the
countries in which it operates. The Company believes its credit evaluation and
<PAGE>
monitoring process mitigates this credit risk. In 1996, sales to two
unaffiliated and one affiliated customer accounted for 30%,14% and 19%
respectively. In 1995, sales to two unaffiliated and one affiliated customer
represented 25%, 24%, and 24% of total revenue. International sales accounted
for 88% and 63% of total revenue in 1996 and 1995, respectively.
Warranty and Installation
The Company generally warrants its systems for a period of 12 months from
installation for material and labor to repair and service the system. A
provision for the estimated cost of installation and warranty is recorded upon
shipment.
Net Income Per Share
Except as noted below, net income per share is computed using the weighted
average number of shares of common stock and dilutive common stock equivalents
from stock options and warrants (using the treasury stock method). Pursuant to
Securities and Exchange Commission Staff Accounting Bulletins, common and common
stock equivalent shares issued by the Company at prices below the initial
offering price during the 12-month period prior to the offering in 1995 have
been included in the calculation as if they were outstanding for all periods
presented regardless of whether they are dilutive (using the treasury stock
method and the initial public offering price).
The net income per share for the year ended September 30, 1995 is pro forma and
is computed using the same method described above and also gives effect to
common equivalent shares from convertible preferred stock using the if-converted
method.
Impact of Recently Issued Accounting Standards
In March 1995, the FASB issued Statement of Financial Accounting Standards
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long Lived
Assets to be Disposed Of (FAS 121), effective for fiscal years beginning after
December 15, 1995. The Company will adopt FAS 121 in the first quarter of fiscal
1997 and, based on current circumstances, does not believe the effect of
adoption will be material. In October 1995, the FASB issued Statement of
Financial Accounting Standards No. 123, Accounting for Stock Based compensation
(FAS 123), effective for fiscal years beginning after December 15, 1995. The
Company will adopt the FAS 123 disclosure method of reporting in its fiscal 1997
financial statements.
NOTE 2 =F1 Related Parties
During 1996 and 1995 the Company sold approximately $4,651,000 and
$4,482,000 of its systems to LG. Electronics, Inc. LG. Electronics owns
approximately 8% of the Company's common stock, and warrants to purchase
28,333 shares of Common Stock at an exercise price of $0.60 per share. The
Company believes its sales to LG. Electronics were made on terms no less
favorable than would have been obtained from unaffiliated parties.
NOTE 3 =F1 Asset Write-off Related to Product line Disposal
In September, 1996, the Company ceased operations of its Defect Monitoring Tool
(DMT) product line. The DMT product group had been working exclusively on a
single customer project not in the flat panel display market. As a result of the
cancellation of this project, the associated inventory and assets of this
<PAGE>
product line which can not be transferred to other products will be disposed of.
The Company recorded a $844,000 charge to write down the inventory and assets
associated with the product line.
NOTE 4 =F1 Lease Obligations and Commitments
The Company leases certain equipment under capital leases. Total capitalized
costs and related accumulated amortization for equipment under capital leases
was $215,000 and $175,000, respectively, as of September 30, 1996 and $215,000
and $150,000, respectively, as of September 30, 1995.
The Company leases its main facility under a noncancelable operating lease
agreement that expires in fiscal 1997. In late fiscal 1996 the Company entered
into a new noncancelable operating lease on a facility which commences in
November 1996 and expires in fiscal 2002.
Total future minimum lease obligations are as follows:
<TABLE>
<CAPTION>
In thousands Operating Leases
<S> <C>
1997 $512
1998 574
1999 591
2000 609
2001 627
2002 52
</TABLE>
Rental expense for the years ended September 30, 1996 and 1995 was $352,000 and
$404,000, respectively.
NOTE 5 =F1 Shareholders' Equity Preferred Stock
At September 30, 1995 the Company had 9,822,826 shares of Convertible
Preferred Stock outstanding which automatically converted into Common Stock upon
the closing of the Company's initial public offering in November 1995=
=2E
Additionally, in November 1995, the Board of Directors approved an amendment of
the Company's Articles of Incorporation to authorize 5,000,00=
0 shares of preferred stock, no par value, none of which are outstanding.
In 1995, the Company issued two sets of warrants to purchase 177,777 shares of
Series E preferred stock, which are currently exercisable in exchange for 59,259
shares of common stock at $5.50 per share. The warrants expire from 2000 to
2002.
Warrants to Purchase Common Stock
In connection with bridge financing in 1994, the Company issued warrants to
purchase a total of 160,856 shares of common stock at $0.60 per share.
These warrants expire in 1999.
Stock Reserved for Future Issuance
As of September 30, 1996, the Company has reserved 1,732,506 shares of common
stock for future issuance.
Stock Option and Purchase Plans
Under the Company's stock option plans, the Board of Directors may, at its
discretion, grant incentive or nonqualified stock options to employees and
directors. Options may be granted for a period not to exceed ten years from the
date of grant, at prices at least equal to the fair market value of common
<PAGE>
stock at the grant date, and become exercisable generally over a period of four
years.
The following table summarizes activity under the Plans:
<TABLE>
<CAPTION>
Shares Under Option Exercise Price
<S> <C> <C>
Balance at Sept. 30, 1994 615,956
Granted 616,678 $0.60 - $ 7.20
Exercised (293,383) $0.60 - $ 7.20
Canceled (119,671) $0.60 - $ 1.20
Balance at Sept. 30, 1995 819,580
Granted 591,900 $6.75 - $11.00
Exercised (91,905) $0.60 - $ 7.20
Canceled (217,056) $0.60 - $11.00
Balance at Sept. 30, 1996 1,102,519
</TABLE>
Options to purchase 409,872 shares of common stock are available for grant as of
September 30, 1996. Options to purchase 67,328 shares of common stock have been
granted subject to shareholder approval by the Board of Directors. Compensation
related to such options will not be measured until approved. Options for 354,119
shares are currently exercisable (options for 223,872 shares at September 30,
1995).
The Company has reserved 100,000 shares of common stock to be issued under the
1995 Employee Stock Purchase Plan. The plan permits eligible employees to
purchase common stock, through payroll deductions, at 85% of the lower of the
fair market value of the common stock on the date at the beginning of the two-
year offering period or the last day of the purchase period.
Substantially all employees are eligible to participate in the plan. At
September 30, 1996 81,884 shares were available for issuance under the plan.
NOTE 6 =F1 Notes Receivable From Shareholders
The notes receivable from shareholders arose from certain employees exercising
their stock options. The notes bear interest at 6.83% per annum, and are secured
by the shares of common stock.
NOTE 7 =F1 Income Taxes
The provision for income taxes for the year ended September 30, 1996 consists of
the following:
<TABLE>
<CAPTION>
In thousands
Year Ended September 30, 1996 1995
<S> <C> <C>
Federal - current $ 29 $ 10
State - current 10 3
Total $ 39 $ 13
</TABLE>
The provisions for taxes on income differed from the provisions calculated by
applying the federal statutory rate to income before taxes as follows:
<TABLE>
<CAPTION>
In thousands
Years ended September 30, 1996 1995
<S> <C> <C>
Expected provision (benefit) at $ 313 $ 137
statutory rate
Alternative minimum taxes 39 13
Benefit of operating loss carryforwards (313) (137)
$ 39 $ 13
</TABLE>
<PAGE>
As of September 30, 1996, the Company has federal and state net operating loss
carryforwards of approximately $12,500,000 and $3,000,000, respectively. The
Company also has federal and state research and development tax credit
carryforwards of approximately $698,000 and $341,000, respectively. The net
operating loss and credit carryforwards will expire at various times beginning
in 1998 through 2011, if not utilized.
Under certain provisions of the Internal Revenue Code of 1986, as amended, the
availability of the Company's net operating loss and tax credit carryforwards
may be subject to limitation if it should be determined that there has been a
change in ownership of more than 50% of the value of the Company's stock. Such
determination could limit the utilization of net operating loss and tax credit
carryforwards. Deferred tax assets reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes, net operating
loss and credit carryforwards.
Significant components of the Company's deferred tax assets are as follows:
<TABLE>
<CAPTION>
In thousands
Years Ended September 30, 1996 1995
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 4,712 $ 4,955
Research credit carryforwards 920 794
Capitalized research costs 335 338
Inventory valuation 771 584
Deferred revenue 103 534
Other individually immaterial items 960 755
Total deferred tax assets 7,801 7,960
Valuation allowance (7,801) (7,960)1
Net deferred tax assets $ - $ -
</TABLE>
1The valuation allowance increased by $201,000 in 1995.
NOTE 8 - Statements of Cash Flows Data
<TABLE>
<CAPTION>
In thousands 1996 1995
Supplemental disclosure of cash flow information
<S> <C> <C>
Interest paid $ 272 $ 124
Income taxes paid $ 110 $ 13
</TABLE>
Supplemental disclosure of noncash investing and financing activities
<TABLE>
<S> <C> <C>
Equipment purchased under capital leases $ - $ 16
Common stock issued for notes $ - $ 135
Conversion of Preferred Stock to Common $17,935 $ -
Stock
</TABLE>
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Photon Dynamics, Inc.
We have audited the accompanying consolidated balance sheets of Photon Dynamics,
Inc. as of September 30, 1996 and 1995, and the related consolidated statements
of operations, shareholders' equity, and cash flow s for the years then ended.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion. In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Photon
Dynamics, Inc. as of September 30, 1996 and 1995, and the consolidated results
of its operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.
San Jose California
October 25, 1996
CORPORATE OFFICERS AND DIRECTORS
Directors
E. Floyd Kvamme - Chairman
Partner
Kleiner Perkins Caufield & Byers
Barry Cox
Private Investor
Michael Kim
Executive Director - New Business Development
LG Electronics, Inc.
Dr. Malcolm J. Thompson
Chief Executive Officer dpiX
Francois Henley
Chief Technical Officer
Photon Dynamics, Inc.
<PAGE>
Steve Krausz
General Partner
U.S. Venture Partners
Vincent F. Sollitto Jr.
Chief Executive Officer
Photon Dynamics, Inc.
Officers
Vincent F. Sollitto Jr.
Chief Executive Officer
Francois Henley
Chief Technical Officer
Howard Bailey
Chief Financial Officer
Jeff Hawthorne
Vice President - Development
Alan Nolet
Senior Vice President - Sales
Donald Jerome
Vice President - Operations
C.J. Meurell
Vice President - Marketing and Technology
Dr. William Pratt
Chief Technical Officer - Software
CORPORATE INFORMATION
Independent Auditors
Ernst and Young LLP
San Jose, CA
Legal Counsel
Morrison and Foerster LLP
San Francisco, CA
Registrar and Transfer Agent
Bank of Boston
Boston, MA
Investor Information
Additional Copies of this report, as well as copies of SEC Form 10-KSB, for the
year ended September 30, 1996, may be obtained from the Company without charge
by contacting Investor Relations at Photon Dynamics Corporate Office.
The Company's common stock is traded on the Nasdaq National Market under the
symbol PHTN.
<PAGE>
<TABLE>
<CAPTION>
FISCAL 1996
High Low
<S> <C>
1st Quarter 12 1/4 6 7/8
2nd Quarter 10 1/2 6 3/4
3rd Quarter 13 1/2 7
4th Quarter 10 1/4 5
</TABLE>
The preceding table sets forth the high and low sales prices as reported on the
Nasdaq National Market since the IPO in November 1995.
Corporate Office
Photon Dynamics, Inc.
6325 San Ignacio Avenue
San Jose, CA 95119-1202 telephone: (408) 226-9900 facsimile: (408) 226-9910
Subsidiaries
K.K. Photon Dynamics
No. 2 SVAX Hamamatsucho Building
Minato-ku, Tokyo 105
Japan telephone: (03) 5472-6147 facsimile: (03) 5472-6138
Photon Dynamics, Korea
7th Floor Taejin Building
14-2 Yangjae-Dong
Soecho-Ku, Seoul, Korea telephone: (02) 575-3443 facsimile: (02) 575-3446
<PAGE>
EXHIBIT 21.1
PHOTON DYNAMICS, INC.
The Company has two subsidiaries, K.K. Photon Dynamics, which is incorporated
in Japan and Photon Dynamics, Korea which is incorporated in Korea.
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-8 Nos. 33-98232-LA and 333-05283) pertaining to the 1995 Employee
Stock Purchase Plan, the 1987 Stock Option Plan and the 1995 Stock Option Plan
of Photon Dynamics, Inc. of our report dated October 25, 1996, with respect to
the consolidated financial statements of Photon Dynamics, Inc. incorporated by
reference in the Annual Report (Form 10-KSB) for the year ended September 30,
1996.
Ernst & Young LLP
San Jose, California
December 23, 1996
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> SEP-30-1996 SEP-30-1995
<PERIOD-START> OCT-01-1995 OCT-01-1994
<PERIOD-END> SEP-30-1996 SEP-30-1995
<CASH> 5,108 298
<SECURITIES> 4,066 0
<RECEIVABLES> 9,281 5,504
<ALLOWANCES> (629) (224)
<INVENTORY> 4,125 2,986
<CURRENT-ASSETS> 22,469 8,783
<PP&E> 4,277 3,116
<DEPRECIATION> (2,428) (1,698)
<TOTAL-ASSETS> 24,958 10,519
<CURRENT-LIABILITIES> 5,197 8,074
<BONDS> 0 0
0 0
0 17,935
<COMMON> 38,064 3,008
<OTHER-SE> (18,294) (19,086)
<TOTAL-LIABILITY-AND-EQUITY> 24,958 10,519
<SALES> 23,381 13,906
<TOTAL-REVENUES> 24,763 18,447
<CGS> (12,294) (7,114)
<TOTAL-COSTS> (13,256) (11,691)
<OTHER-EXPENSES> (10,944) (6,046)
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 383 (178)
<INCOME-PRETAX> 893 390
<INCOME-TAX> (39) (13)
<INCOME-CONTINUING> 854 377
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 854 377
<EPS-PRIMARY> .12 .07
<EPS-DILUTED> 0 0
</TABLE>
