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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 0-24507
PILOT NETWORK SERVICES, INC.
(Exact name of registrant as specified in its charter)
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<S> <C>
Delaware 94-3305774
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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1080 MARINA VILLAGE PARKWAY
ALAMEDA, CA 94501
(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (510) 433-7800
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.001
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period than the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES [X] NO [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $106.7 million as of June 1, 1999, based upon the
closing sale price on the Nasdaq National Market reported for such date.
Shares of Common Stock held by each officer and director and by each person
who owns 10% or more of the outstanding Common Stock have been excluded in
that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
There were 13,544,702 shares of the registrant's Common Stock issued and
outstanding as of June 1, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the definitive proxy
statement for the Annual Meeting of Stockholders to be held on September 16,
1999.
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Forward Looking Statements
In addition to historical information, this Annual Report contains forward-
looking statements. These forward-looking statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from those reflected in these forward-looking statements. Factors that might
cause such a difference include, but are not limited to, those discussed in
the section entitled "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Factors That May Affect Future Results
and Market Price of Stock." Readers are cautioned not to place undue reliance
on these forward-looking statements, which reflect management's opinions only
as of the date hereof. The Company undertakes no obligation to revise or
publicly release the results of any revision to these forward-looking
statements. Readers should carefully review the risk factors described in
other documents the Company files from time to time with the Securities and
Exchange Commission, including the Quarterly Reports on Form 10-Q to be filed
by the Company in fiscal year 2000.
PART I
Item 1. Business.
Overview
Pilot Network Services, Inc. (the "Company") provides a wide range of secure
Internet services that incorporate high-bandwidth connectivity and enable
secure electronic business over the Internet. The services are offered for a
fixed monthly fee on an annual subscription-basis. The Company's services
include secure hosting and Internet connectivity services that enable secure
connectivity between a corporate network and the Internet and secure virtual
private networking services that enable remote users and wide-area networks to
securely communicate enterprise-wide and over the Internet. The Company offers
a scalable solution that allows customers to quickly deploy and expand
electronic business capabilities by subscribing to Pilot's secure Internet
services.
Pilot's subscription-based secure Internet services allow customers to avoid
the risks associated with traditional approaches to Internet security.
Customers can also avoid extensive costs associated with implementing an in-
house solution, including set-up costs for security and systems design,
hardware, software, Internet access services provided by Internet Service
Providers ("ISPs") and labor, and ongoing costs for telecommunications,
staffing, maintenance and upgrades.
The foundation of Pilot's solution is its Heuristic Defense Infrastructure,
an Internet security approach developed by Pilot to continuously manage and
monitor Internet traffic to and from customer networks in order to respond in
real-time to security threats. The Heuristic Defense Infrastructure consists
of a multi-layered defensive architecture and around-the-clock security
operations delivered through geographically dispersed Pilot customer centers
called Network Security Centers that are connected to customer networks via
dedicated, high-speed data lines. The Pilot solution aggregates the experience
gained from protecting each customer against attacks and leverages such
experience for the collective benefit of all customers. The Heuristic Defense
Infrastructure offers benefits over other security approaches by eliminating
single points of failure, enhancing attack detection, delivering real-time
defenses, and adapting continuously to external conditions. Customers can
concentrate on their core business because the secure infrastructure for
electronic commerce is provided by Pilot.
The Company was incorporated in California on August 6, 1992 and was
reincorporated in Delaware on August 4, 1998. Unless the context otherwise
requires, the term "Company" or "Pilot" refers to Pilot Network Services,
Inc., a Delaware corporation, and its California predecessor. The Company
maintains its executive offices and principal facilities at 1080 Marina
Village Parkway, Alameda, CA 94501. Its telephone number is (510) 433-7800.
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Industry Background
Over the past several years, the Internet has become an increasingly
important means of communications. International Data Corporation (IDC)
estimates that the number of World Wide Web ("Web") users was approximately 69
million at the end of 1997 and will grow to 320 million users by the end of
2002. The explosive growth of the Internet is being driven not only by its
global reach, easy accessibility and use of open standards, but also by its
promise to greatly improve the cost efficiency and quality of communications.
To date, Internet growth has been fueled primarily by the use of general
applications such as electronic mail, chat and Web browsing. The Internet's
potential for more cost-efficient and higher quality communications has made
it an increasingly attractive platform for complex business applications such
as marketing and sales, contract negotiations and customer support. As a
result, an increasing number of businesses seek to use the Internet as a means
for extending their traditional business activities. Business activities over
the Internet involve not only commercial transactions, but also general
business communications. These communications include running mission-critical
applications across geographically dispersed facilities, exchanging highly
sensitive information and linking customers, remote employees and business
partners in extended business networks.
These business activities have become known as electronic commerce and
electronic business. Use of the Internet for electronic commerce is expected
to grow substantially. For example, IDC estimates that the value of electronic
commerce will grow from $12 billion in 1997 to $900 billion in 2003.
Despite the advantages of conducting business on the Internet, lack of
Internet security is a significant inhibitor to the adoption and growth of
electronic commerce. The Internet is inherently vulnerable to security
breaches due to its easy accessibility, use of open standards and lack of
centralized management. As the Internet has developed into an increasingly
complex computing environment with multiple hardware, operating systems,
networking protocols and applications supplied by different vendors, it has
become even more vulnerable to security breaches. Although losses due to
computer crime and security breaches are difficult to estimate, independent
industry sources estimate such losses were between $3 billion and $5 billion
in 1997. These intrusions draw unwelcome attention from the press and
financial community. As a result of security concerns, businesses are
investing substantial amounts of money in security technology.
The Pilot Solution
Pilot offers services designed to combine the highest level of commercially
available security with high bandwidth connectivity to enable secure
electronic commerce over the Internet. The foundation of Pilot's solution is
its Heuristic Defense Infrastructure, consisting of a multi-layered defensive
architecture and security operations 24 hours a day, 7 days a week (24x7)
delivered through geographically dispersed Network Security Centers. This
infrastructure allows Pilot to continuously manage and monitor Internet
traffic to and from customer networks in order to respond in real-time to
security threats. The Pilot solution aggregates the experience gained from
protecting each customer against attacks and leverages such experience for the
collective benefit of all customers. The Heuristic Defense Infrastructure
offers benefits over other security approaches by eliminating single points of
failure, enhancing attack detection, delivering real-time defenses, and
adapting continuously to external conditions.
The Company provides a wide range of secure network services for a fixed
monthly fee on an annual subscription-basis. The Company's services include
secure hosting and Internet connectivity services that enable secure
connectivity between a corporate network and the Internet and secure virtual
private networking services that enable remote users and wide-area networks to
securely communicate over the Internet with a local network. The Company
offers a scalable solution that enables customers to quickly deploy and expand
electronic commerce capabilities by subscribing to Pilot's secure Internet
services. As a result, companies avoid costs associated with implementing an
in-house solution, including set-up costs for security and systems design,
hardware, software, ISP services and labor, and ongoing costs for
telecommunications, staffing, maintenance and
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upgrades. Pilot's services enable customers to concentrate on their core
business because the secure infrastructure for electronic commerce is provided
by Pilot. The Company's strategy is to become the leading supplier of secure
electronic business services for companies worldwide. Key elements of the
Company's strategy include:
Services
The Company offers two primary categories of services: secure hosting and
Internet connectivity services and secure virtual private networking services.
Customers subscribe to the Company's services for an initial installation fee
and a fixed monthly fee. The Company's contracts with its customers are
generally based on a one-year term with renewal periods. Service fees vary
according to the services selected by the customer. The minimum first-year
commitment consists of an installation fee of $12,000 followed by a recurring
fee of $5,000 per month upon the completed installation of the services. In
fiscal 1999, the average new customer first-year commitment was $134,000.
Secure Hosting and Internet Connectivity Services. The Company provides
secure access services that enable secure connectivity between a corporate
network and the Internet. Services range from access to electronic mail
gateways and Web servers to securing electronic businesses. Secure hosting and
electronic business services integrate high-throughput data transmission
(10Mbps and higher) with around-the-clock host and network security.
Secure Virtual Private Networking Services. The Company provides secure
virtual private networking services that combine security and bandwidth to
enable remote users and wide-area networks to communicate securely enterprise-
wide and over the Internet. These services include encryption, authentication
and access control technologies to protect both the information in transit as
well as the security of the network.
See "Item 7--Risks Associated with the Emerging Market for Outsourced
Network Security Services."
Pilot Heuristic Defense Infrastructure
The Pilot Heuristic Defense Infrastructure consists of a multi-layered
defensive architecture that learns from experience and 24x7 security
operations provided through geographically dispersed Network Security Centers.
Proprietary Architecture
Proprietary Security Processes. The Company has developed a set of
technology-based processes, including secure networking, a layered defense,
real-time data collection and analysis, and a feedback loop that continuously
updates a database of security threats and responses. ISPs typically permit
all traffic that is not explicitly restricted, while Pilot's secure network
blocks all traffic that is not explicitly permitted, greatly reducing the risk
of an attack. Legitimate inbound traffic from the Internet passes through a
number of increasingly protective defensive layers on its way to a customer.
Each layer provides a different type of protection, and combined with
customer-specific security policies creates a secure environment for
electronic business transactions and networks. The layered defense enables the
Company to detect, analyze, plan and defend, thereby reducing the probability
of and minimizing the potential damage from an attack. Data collection and
analysis processes include security logging, monitoring and analysis and
authentication. The data from these processes is then analyzed by proprietary
software that applies policy rules and statistical analysis to identify
patterns which could signal an attack in progress. This data along with
ongoing research into current attack methods is continuously used to update
the Company's defense databases and processes, resulting in a system that
learns from its experiences and adapts defenses to respond to emerging attack
techniques. This process allows the Company to aggregate the experience gained
from protecting each individual customer and leverage such experience for the
collective benefit of all customers.
Multi-Layered, Distributed Architecture. Pilot's multi-layered defense
distributes specific functions across separate devices. This adds isolation,
in which the breach of one device does not compromise another; detectability,
in which the time required to attack (and the time available to detect an
attack) is increased; and performance, in which the performance and
measurability of each device can be tailored for its particular
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purpose. In contrast, a traditional firewall software package requires many
services, such as electronic mail, telnet, DNS, and FTP, to pass through a
single device. This complexity makes it difficult to rule out inadvertent
interactions between one type of service and another within the same device.
Pilot's distributed defense eliminates these interactions and simplifies
attack detection by distributing each function across separate devices. In
addition, the Company continuously evaluates new technologies to ensure that
it incorporates best-of-breed hardware and software into its infrastructure.
Security Operations, Investigation and Development
Trained Security Personnel. Pilot's security team includes expert engineers
with significant security experience. The Security Team consists of three
groups: (i) Security Operations, which handles the day-to-day management of
the Pilot Heuristic Defense Infrastructure, manages incident investigation and
response, and applies standard procedures regarding changes to Pilot's systems
and services, (ii) Security Investigation, which is responsible for incident
analysis and escalation, attack pattern research, defense design, and service
extension, (iii) Security Development, which is responsible for the creation
of new automated methodologies, the acquisition and maintenance of security
tools and the development of internal tools, advanced research and development
as well as defining new services that may be introduced to customers.
Dynamic 24x7 Monitoring and Management. The Pilot Heuristic Defense
Infrastructure provides a flexible, dynamic and rapid response capability, 24
hours per day, seven days per week, through its Security Team and the
monitoring and management methods illustrated below. All systems within the
Pilot Heuristic Defense Infrastructure log their status and activities in
detail. Using advanced display and analysis tools developed by Pilot, the
Security Team detects and stores patterns indicative of an attack and blocks
attackers from further attempts. Patterns of attack attempts are collected in
a centralized security database. Pilot's monitoring and management methods
allow it to protect customers by blocking new attacks on a real-time basis and
rapidly adapting and automating its security defenses.
Third-Party Audits. Pilot regularly engages independent third-party security
experts to audit its Heuristic Defense Infrastructure. Such auditors prepare a
detailed technical report for Pilot's internal use, and an executive summary
available to Pilot's current and potential customers. The most recent audit
was conducted by Trident Data Systems in April 1998. In May 1999, the Company
engaged Trident Data Systems to conduct another review of Pilot's security.
The May 1999 audit is scheduled for completion in September 1999.
Network Infrastructure
Network Security Centers. The Company provides its services to customers by
connecting their networks to the Internet through its regional Network
Security Centers via dedicated, high-speed data lines. The Company currently
has major Network Security Centers located in the San Francisco, Los Angeles,
New York, Chicago, and London metropolitan areas, with smaller Network
Security Centers in the Boston, and Washington D.C. metropolitan areas. Each
Network Security Center establishes interconnections with other global and
local Internet service providers. The Company currently connects directly to
the Internet at four major network access points: Pacific Bell and Palo Alto
Exchanges in Northern California; Sprint in New York; Ameritech in Chicago;
and the London Internet Exchange (LINX) in London. Additionally, Pilot
benefits from approximately 64 private Internet peering agreements. (A
"peering" agreement allows private Internet carriers to provide mutually
beneficial Internet traffic balancing with each other.) The Company also
maintains private connections from each Network Security Center to Cable and
Wireless, Sprint and UUNET. Each Network Security Center is also connected to
Pilot's Secure Asynchronous Transfer Mode (ATM) Backbone. As a result,
customer connectivity to various Internet sites can be improved by routing
traffic through Pilot's Secure ATM Backbone in addition to
direct Internet interconnections.
The distributed design of the Company's secure network infrastructure allows
Pilot to scale security and electronic business services differently than
other industry providers. Additional servers, telecommunications capacity and
Pilot services can easily be added to meet customer demand. In the event of
equipment failure,
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operations are disrupted only for the components involved, and not across all
services. Because of Pilot's standardized operations, internal monitoring and
backup equipment, a failure can be detected and a replacement operation
scheduled rapidly, minimizing downtime. Each Network Security Center is
staffed by technical, sales and customer support personnel, and operates as a
physically secured facility for Pilot and customer equipment.
Pilot Secure ATM Backbone. In addition to bandwidth management, the Pilot
Secure ATM Backbone is used for Pilot-specific traffic, such as security
management and monitoring, and customer-specific traffic, such as secured
traffic between multiple Pilot customers. Unlike backbone networks of most
other providers, this network blocks all traffic except for traffic that is
specifically allowed. The Pilot Secure ATM Backbone also supports a wide
variety of encryption options, so that traffic between customers can be
secured at multiple levels.
The operation and expansion of the Company's secure network infrastructure
is subject to a number of risks, including those set forth in "Item 7--Risks
Associated with Security Breaches," "--Risks of Business Expansion and
Management Growth," "--Risks of System Failure," "--Dependence Upon
Scalability of the Company's Network" and "--Dependence on Third-Party Network
Infrastructure Providers."
Customers
The Company's customers span a diverse range of industries. The Company's
services are suitable for any organization building or maintaining Internet-
based connectivity for their networks or applications at or above the
Company's minimum bandwidth requirements. The following is a representative
list of customers who as of March 31, 1999 have entered into annual
commitments to purchase more than $60,000 of services from the Company. No
single customer accounted for more than 5% of the Company's total revenues for
the year ended March 31, 1999.
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Consumer, Entertainment,
Financial and Professional Services High-Technology Education and Media
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A.M. Best Company Altera Corporation 20th Century Fox, Inc.
American Bar Association Computer Adaptive Technology American Stores Company
American Medical Association E-Stamp, Inc. The Good Guys, Inc.
C.E. Unterberg, Towbin Co. Lucent Technologies Los Angeles Times
First Data Corporation Neopost, Inc. Newsweek, Inc.
Gibson, Dunn & Crutcher LLP PeopleSoft, Inc. PR Newswire, Inc.
Graham & James, LLP Xilinx, Inc. Rainbow Media Holdings, Inc.
Memorial Health Services Saban Entertainment, Inc.
Morrison & Foerster, LLP Wilson Sporting Goods Co.
Troop Meisinger Steuber & Pasich, LLP Industrial and Manufacturing Ziff-Davis Comdex & Forums
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Baxter Healthcare Corp.
Continental Grain Company
General Electric Company
Global Marine, Inc.
JM Huber Corporation
Kaiser Aluminum & Chemical
Corporation
Pacific Enterprises (parent of
Southern California Gas)
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Sales and Marketing
The Company's sales and marketing efforts are designed to achieve broad
market penetration by targeting enterprises that depend upon the Internet for
electronic commerce and business communications. The Company also builds its
recurring revenue base from such enterprises by continuing to provide value-
added services and through active customer account management.
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As of March 31, 1999, the Company had 42 employees in sales and marketing.
The Company's sales force is organized into separate groups consisting of
field sales (new customers), customer account management (customer retention
and expansion), partnerships and alliances (channel and OEM sales), strategic
accounts and pre-sales engineering support. Each of these groups is further
divided into geographical regions. The Company's sales staff is primarily
located in the San Francisco, Los Angeles, New York, Chicago, Washington D.C.,
Boston and London metropolitan areas.
To date, most of the Company's sales have been derived directly through the
efforts of its sales force. The Company is actively seeking to increase its
sales and marketing capabilities and coverage in the United States and to
expand internationally as new Network Security Centers are established outside
of the United States. See "Item 7--Risks of Business Expansion and Management
of Growth."
A key element of the Company's sales and marketing strategy is to strengthen
relationships with partners in order to generate an increasing percentage of
total sales through partners. Pilot has established a distribution
relationship with GE Capital Information Technology Solutions, Inc. ("GE
Capital ITS") for the sale of Pilot's services through the GE Capital ITS
sales force. Additionally, the Company is building joint-marketing
relationships with strategic partners, such as Arthur Andersen LLP, electronic
commerce vendors, such as BroadVision, Open Market and VeriSign, technology
vendors, such as Cisco Systems, Inc., Sun Microsystems, VPNet Technologies,
IPass, and TrendMicro and selected telecommunications partners. See "Item 7--
Dependence on Other Third-Party Relationships."
The Company's marketing organization is responsible for new service
introductions, public relations and marketing communications. New service
introductions include strategy, definition, pricing, competitive analysis,
launches, and partner program management. The Company stimulates demand for
its services through a broad range of marketing communications and public
relations activities, including co-marketing programs with the Company's
marketing partners. Primary marketing communications vehicles include Web
banner and direct mail promotions, telemarketing, trade shows and seminars,
event sponsorship and management of the Company's Web site. Public relations
focuses on cultivating industry analyst and media relationships with the goal
of obtaining media coverage and public recognition of the Company's leadership
position in the market for secure electronic commerce and business
communications services.
The Company regularly conducts account reviews internally with customers to
measure satisfaction. Pilot's customer base provides revenue growth
opportunities in the form of referrals, recurring revenue, and new services.
Customers generally enter into one-year agreements with the Company, with
renewal periods. However, there can be no assurance that the Company's
customers will continue or renew their commitments to use the Company's
services.
Competition
The market served by the Company is new, rapidly evolving, highly
competitive and largely undefined. There are few general barriers to entry,
and the Company expects that it will face additional competition from existing
competitors and new market entrants in the future. The Company believes that
this market is characterized by a limited period of time during which
participants must grow rapidly and achieve a significant presence in the
market in order to compete effectively. The Company also believes its
Heuristic Defense Infrastructure provides the Company with a competitive
advantage in the marketplace. The principal competitive factors in this market
include Internet services and security engineering expertise, customer
service, network and security capabilities, reliability, quality and
scalability of service, broad geographic presence, brand name, technical
expertise and functionality, the variety of services offered, the ability to
maintain and expand distribution channels, customer support, price, the timing
of introductions of new services, financial resources and conformity with
industry standards. There can be no assurance that the Company will have the
resources or expertise to compete successfully in the future.
The Company competes with a broad range of products and services. The
Company's competitors include companies providing security, electronic
commerce, and secure Internet networking products that are offered as
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stand-alone product solutions. Companies offering stand-alone software
products include providers of firewall software, such as Check Point Software
Technologies and AXENT Technologies (formerly Raptor Systems), security
monitoring software, such as ISS Group, and electronic commerce products. The
security and electronic commerce products provided by these companies are
typically implemented and managed by internal MIS departments of enterprises.
In addition, internal corporate MIS departments increasingly rely on third
party consultants or system integrators to manage the integration and
implementation of multiple stand-alone products from different vendors.
The Company also competes with third party service providers that offer
Internet hosting and access services, including (i) providers of server
hosting services, such as Exodus Communications and PSI Net; (ii) national and
regional ISPs such as Concentric Network Corp., UUNET (part of MCI WorldCom),
certain subsidiaries of GTE Corporation and Global Center, which was acquired
by Frontier Corporation; and (iii) global, regional and local
telecommunications companies such as Sprint and MCI WorldCom, and regional
bell operating companies. The Company also competes with information
technology service firms providing either outsourcing or systems integration
services such as International Business Machines Corporation and Electronic
Data Systems. Although these third party service providers often add security
features to their service offerings, either through internal development
efforts or through the incorporation of products purchased from vendors of
stand-alone point solutions, the Company believes that generally these
competitors do not offer the same level of security in their services as the
Company. However, the Company expects perceived competition to intensify as
third party service providers incorporate a broader range of security,
electronic commerce and secure Internet networking services and products into
their service offerings. Furthermore, the Company may face competition from
its vendors and other partners. The Company's agreements with its vendors and
other partners generally do not limit or restrict those parties from selling
similar products and services directly to the Company's customers or its
competitors, thereby enabling such parties to compete against the Company.
There can be no assurance that such vendors or other partners will not compete
with the Company in the future.
Many of the Company's competitors have substantially greater financial,
technical and marketing resources, larger customer bases, longer operating
histories, greater name recognition and more established relationships in the
industry than the Company. As a result, certain of these competitors may be
able to develop and expand their network infrastructures and service offerings
more quickly, adapt to new or emerging technologies and changes in customer
requirements more quickly, take advantage of acquisition and other
opportunities more readily, devote greater resources to the marketing and sale
of their products and adopt more aggressive pricing policies than the Company.
In addition, these competitors have entered, and will likely continue to
enter, into joint ventures or consortiums to provide additional services
competitive with those provided by the Company. Certain of the Company's
competitors may be able to provide customers with additional benefits in
connection with their Internet system and network management solutions,
including reduced communications costs, which could reduce the overall costs
of their services relative to the Company's. There can be no assurance that
the Company will be able to offset the effects of any resulting price
reductions. In addition, the Company believes that the businesses in which the
Company competes are likely to encounter consolidation in the near future,
which could result in increased price and other competition that could have a
material adverse effect on the Company's business, results of operations and
financial condition.
Intellectual Property Rights
The Company relies on a combination of copyright, trademark, service mark
and trade secret laws and contractual restrictions to establish and protect
certain proprietary rights in technology underlying its services. The Company
has applied for three separate patents in the U.S. and Europe and intends to
continue to seek patents on its inventions when appropriate, although the
Company currently has no patented technology that would preclude or inhibit
competitors from entering the Company's market. There can be no assurance that
patents will issue from currently pending or any future applications, or that
any patents that may be issued will be sufficient in scope or strength to
provide meaningful protection or any commercial advantage to the Company. The
Company has three separate trademark applications pending in the United States
and counterparts in certain
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foreign jurisdictions for distinct marks, including its distinctive Pilot
logo; however, there can be no assurance that such trademarks will be granted.
The laws of certain foreign countries may not protect the Company's products,
services or intellectual property rights to the same extent as do the laws of
the United States.
The Company has entered into confidentiality and invention assignment
agreements with its employees and contractors, and nondisclosure agreements
with its suppliers, distributors and appropriate customers in order to limit
access to and disclosure of its proprietary information. There can be no
assurance that these contractual arrangements or the other steps taken by the
Company to protect its intellectual property will prove sufficient to prevent
infringement of or misappropriation of the Company's technology or to deter
independent third-party development of similar technologies. Any such
infringement or misappropriation, should it occur, could have a material
adverse effect on the Company's business, results of operations and financial
condition. Furthermore, litigation may be necessary to enforce the Company's
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 business, results of operations and
financial condition.
To date, the Company has not been notified that the Company's services
infringe the proprietary rights of third parties, but there can be no
assurance that third parties will not claim infringement or indemnification by
the Company with respect to current or future services. The Company expects
that participants in its markets will be increasingly subject to infringement
claims as the number of products and competitors in the Company's industry
segment grows. Any such claim, whether meritorious or not, could be time-
consuming, result in costly litigation, cause product installation delays,
prevent the Company from using important technologies or methods, subject the
Company to substantial damages, or require the Company to enter into royalty
or licensing agreements. Such royalty or licensing agreements might not be
available on terms acceptable to the Company or at all. As a result, any such
claim could have a material adverse effect upon the Company's business,
results of operations and financial condition.
Government Regulation and Legal Uncertainties
There is currently only a small body of laws and regulations directly
applicable to access to or commerce on the Internet, other than regulations
applicable to businesses generally and regulations applicable to certain
encryption technologies incorporated into products provided by certain of the
Company's vendors. However, because the Internet has recently emerged, there
is significant uncertainty as to the application of existing laws and
regulations with respect to the Internet, covering issues such as user
privacy, freedom of expression, pricing, characteristics and quality of
products and services, taxation, advertising, intellectual property rights,
information security and the convergence of traditional telecommunications
services with Internet communications. Moreover, a number of laws and
regulations have been proposed and are currently being considered by federal,
state and foreign legislatures with respect to such issues. The nature of any
new laws and regulations and the manner in which existing and new laws and
regulations may be interpreted and enforced cannot be fully determined.
Therefore, such laws and regulations could decrease the growth of the
Internet, decrease demand for the Company's services, restrict the Company's
activities, impose taxes or other costly technical requirements, subject the
Company and/or its customers to potential liability or otherwise adversely
affect the Company or its customers, each of which could have a material
adverse effect on the Company's business, results of operations and financial
condition. For example, because the Company's services are available over the
Internet in multiple states and foreign countries, and as the Company
facilitates sales by its customers to end users located in such states and
foreign countries, such jurisdictions may claim that the Company is required
to qualify to do business as a foreign corporation in each such state or
foreign country, which could have a material adverse effect on the Company's
business, results of operations and financial condition.
A number of governments have imposed controls, export license requirements
and restrictions on the export of encryption technologies provided by certain
of the Company's vendors. To the extent the Company or its vendors are
required to export products incorporating certain encryption technology
developed in the United States in support of services provided to the
Company's customers located outside of the United States, the
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Company and its vendors will need to comply with United States export
controls. In particular, all cryptographic products require either
qualification under appropriate licensing exemptions or export licenses from
either the U.S. State Department, acting under the authority of the
International Traffic in Arms Regulation, or the U.S. Commerce Department,
acting under the authority of the Export Administration Regulations.
Furthermore, if the Company is unable to comply with such export controls, it
may not be able to obtain on commercially reasonable terms encryption
technologies developed outside the United States for its international
services that provide for encryption as strong as those developed in the
United States. There can be no assurance that U.S. export restrictions will be
changed to allow stronger encryption for international delivery, that the
Company or its vendors will be able to comply with such restrictions, or that
such factors will not have a material adverse effect on the Company's
business, operating results and financial condition.
Employees
As of March 31, 1999, the Company had 149 full-time employees, including 74
people in security implementation, customer support and operations, 16 people
in security engineering, 42 people in sales, marketing, customer account
management and pre-sales engineering support and 17 people in finance and
administration. The Company's success depends to a significant degree upon the
continued contribution of its executive management and security operations and
engineering teams. See "Item 7--Dependence on Key Personnel" and "--Risks of
Business Expansion and Management of Growth."
Item 2. Properties.
Facilities
The Company's executive, sales and administrative offices are located in
Alameda, California. The Company's Network Security Centers are located in the
San Francisco, Los Angeles, New York, Chicago, Washington D.C., Boston and
London metropolitan areas. The Company's leases for its executive, sales and
administrative offices and its Network Security Centers expire from June 2000
to February 2009 (excluding options to renew), and cover an aggregate of
approximately 69,450 gross square feet.
Most of the Company's leases provide for a renewal option upon the
expiration of the initial term. The Company believes that these existing
facilities are adequate to meet its current foreseeable requirements or that
suitable additional or substitute space will be available on commercially
reasonable terms. Pilot plans to expand its Network Security Centers both
nationally and internationally.
Item 3. Legal Proceedings.
The Company is currently not a party to any material legal proceedings.
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
10
<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Company's Common Stock has been traded on the NASDAQ National Market
since the Company's initial public offering in August of 1998. According to
records of the Company's transfer agent, the Company had approximately 78
stockholders of record as of March 31, 1999. Because many of such shares are
held by brokers and other institutions on behalf of stockholders, the Company
is unable to estimate the total number of stockholders represented by these
record holders. The following table sets forth the low and high sale price as
of the close of the market for the Company's common stock in each of the
Company's last three fiscal quarters:
<TABLE>
<CAPTION>
Low Closing Price High Closing Price
------------------ ------------------
<S> <C> <C>
Fiscal 1999:
Fourth Quarter..................... $8.063 $15.500
Third Quarter...................... 4.000 9.500
Second Quarter (August 10-September
31)............................... 4.625 14.500
</TABLE>
The Company has not yet made any earnings, and intends to reinvest any
possible future earnings to fund future growth. Accordingly, the Company has
not paid dividends and does not anticipate declaring dividends on its common
stock in the foreseeable future.
In June 1998, the Company issued 150,000 warrants to purchase common stock
to certain lending institutions at an exercise price of $11.20 per share as
partial consideration for $6.0 million of short-term financing. All 150,000
warrants remain outstanding as of March 31, 1999. The foregoing purchases and
sales were exempt from registration under Section 4(2) of the Securities Act
of 1933 on the basis that the transactions did not involve public offerings.
From April 1, 1998 through August 10, 1998, the Company granted stock
options to purchase 681,000 shares of common stock, with exercise prices
ranging from $3.00 to $6.00 per share, to employees and officers pursuant to
its 1994 Stock Plan and stock options to purchase 106,900 shares of common
stock at an exercise price of $13.00 per share to employees and a director of
the Company pursuant to its 1998 Stock Plan. From April 1, 1998, through
August 10, 1998, options to purchase 397,568 shares of common stock were
exercised at prices that ranged from $0.035 to $2.00. The sales and issuances
of these securities were exempt from registration under either Rule 701 of the
Securities Act of 1933 on the basis that these options were offered and sold
either pursuant to a written compensatory benefit plan or pursuant to a
written contract, as provided by Rule 701, or under Section 4(2) of the
Securities Act of 1933 on the basis that the transactions did not involve a
public offering.
Use of Proceeds
The Company filed a registration statement on Form S-1, File No. 333-57453,
for an initial public offering of Common Stock which was declared effective by
the Securities and Exchange Commission on August 10, 1998. In that offering,
the Company sold an aggregate of 3,110,000 shares of its Common Stock with net
offering proceeds of approximately $39.4 million. As of March 31, 1999, the
Company had used approximately $20.0 million of those proceeds as follows:
<TABLE>
<S> <C>
Construction of plant, building and
facilities:............................. $2.7 million
Purchase and installation of machinery
and equipment:.......................... $4.2 million
Purchases of real estate:................ None
Acquisition of other businesses:......... None
Repayment of indebtedness:............... $3.4 million
Working capital:......................... $1.2 million
Repurchase of Common Stock:.............. $2.7 million
Cash loss from operations:............... $5.8 million
</TABLE>
11
<PAGE>
The foregoing amounts represent the Company's best estimate of its use of
proceeds for the period indicated. No payments were made to directors or
officers of the Company or their associates, holders of 10% or more of any
class of equity securities of the Company or to affiliates of the Company,
other than compensation paid in the ordinary course of business.
Item 6. Selected Financial Data.
The selected financial data set forth below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations," the consolidated financial statements and the notes thereto
and the other information contained in this Form 10-K. The selected statements
of operations data for the years ended March 31, 1997, 1998 and 1999 and the
selected balance sheet data as of March 31, 1998 and 1999, are derived from,
and are qualified by reference to, the audited financial statements of the
Company appearing elsewhere in this Form 10-K. The selected statements of
operations data for the years ended March 31, 1995 and 1996 and the selected
balance sheet data as of March 31, 1995, 1996 and 1997, are derived from
audited financial statements of the Company not included herein. The
historical results are not necessarily indicative of future results.
<TABLE>
<CAPTION>
Year Ended March 31,
-------------------------------------------
1995 1996 1997 1998 1999
------ ------- ------- ------- --------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Service revenues................. $ 800 $ 2,525 $ 6,300 $11,317 $ 17,522
Cost of service revenues......... 322 1,424 4,181 9,825 20,072
------ ------- ------- ------- --------
Gross margin..................... 478 1,101 2,119 1,492 (2,550)
Operating expenses:
Sales and marketing............. 579 1,792 3,109 4,306 9,627
Engineering and development..... 93 162 275 799 1,642
General and administrative...... 253 766 1,064 1,551 2,903
------ ------- ------- ------- --------
Total operating expenses........ 925 2,720 4,448 6,656 14,172
------ ------- ------- ------- --------
Operating loss................... (447) (1,619) (2,329) (5,164) (16,722)
Interest expense, net............ (1) (131) (323) (471) (1,373)
------ ------- ------- ------- --------
Net loss......................... $ (448) $(1,750) $(2,652) $(5,635) $(18,095)
Accretion on redeemable
convertible preferred stock..... (80) (263) (478) (1,069) (488)
------ ------- ------- ------- --------
Net loss attributable to common
stockholders.................... $ (528) $(2,013) $(3,130) $(6,704) $(18,583)
====== ======= ======= ======= ========
Basic and diluted net loss per
share(1)........................ $(0.39) $ (1.07) $ (1.58) $ (3.31) $ (1.94)
====== ======= ======= ======= ========
Shares used in computing basic
and diluted net loss per
share(1)........................ 1,350 1,889 1,982 2,025 9,568
====== ======= ======= ======= ========
Pro forma basic and diluted net
loss per share(1)............... $ (0.60) $ (1.47)
======= ========
Shares used in computing pro
forma basic and diluted net loss
per share(1).................... 9,355 12,328
======= ========
</TABLE>
<TABLE>
<CAPTION>
March 31,
-------------------------------------------
1995 1996 1997 1998 1999
------ ------ ------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and short-
term investments................. $1,149 $ 420 $ 3,081 $ 1,447 $ 23,012
Total current assets.............. 1,329 1,056 3,927 2,786 27,233
Total assets...................... 1,711 2,945 7,439 8,922 42,115
Total current liabilities......... 333 1,695 3,291 5,749 12,650
Capital lease obligations, net of
current portion.................. 205 908 1,946 3,444 4,830
Total stockholders' equity
(deficit)........................ (766) (2,762) (5,882) (12,414) 24,635
</TABLE>
- --------
(1) See Notes 1 and 5 of Notes to Consolidated Financial Statements for an
explanation of the determination of the number of shares used in computing
per share amounts.
12
<PAGE>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The following discussion and analysis should be read in conjunction with the
"Selected Financial Data" and the Company's Consolidated Financial Statements
and Notes thereto included elsewhere in this Form 10-K. In addition to
historical information, this Annual Report contains forward-looking
statements. These forward-looking statements are subject to certain risks and
uncertainties that could cause actual results to differ materially from those
reflected in these forward-looking statements. Factors that might cause such a
difference include, but are not limited to, those discussed in the section
entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Factors That May Affect Future Results and Market Price
of Stock." Readers are cautioned not to place undue reliance on these forward-
looking statements, which reflect management's opinions only as of the date
hereof. The Company undertakes no obligation to revise or publicly release the
results of any revision to these forward-looking statements. Readers should
carefully review the risk factors described in other documents the Company
files from time to time with the Securities and Exchange Commission, including
the Quarterly Reports on Form 10-Q to be filed by the Company in fiscal year
2000.
OVERVIEW
Pilot provides comprehensive security services that incorporate high
bandwidth connectivity and enable secure electronic commerce over the
Internet. Pilot's services include secure access and gateway services, secure
hosting and electronic commerce services, and secure extranet and virtual
private networking services. The Company delivers its services from
geographically dispersed Network Security Centers that are connected through
its secure high performance Internet backbone.
The Company was incorporated in August 1992 and commenced operations in
1993. The Company opened its first Network Security Center in the San
Francisco metropolitan area in 1994, followed by three additional centers in
the Los Angeles, New York and Chicago metropolitan areas in 1995. The Company
has since commenced operations at Network Security Centers in the Boston,
Minneapolis, Washington, D.C. and London metropolitan areas.
Customers subscribe to the Company's services for an initial setup fee plus
a fixed monthly fee. The Company's contracts with its customers are generally
based on a one-year term with renewal periods. The minimum first-year
commitment consists of an installation fee of $12,000 followed by a recurring
fee of $5,000 per month upon the completed installation of the services.
Service fees vary according to the services selected by the customer. In
fiscal 1999, the average new customer commitment for the first year of service
was $134,000. Installation fees are typically recognized as revenue over the
installation period, which is generally under 60 days. The ongoing monthly
fees are billed one month in advance for the following month and recognized as
revenue when earned in the following month.
The Company has recently expanded and expects to continue to expand its
operating capacity, sales and marketing activities and the development of new
services by making significant investments in new and existing Network
Security Centers. This subjects the Company to relatively large increments of
fixed expenses in advance of potential future revenues. As a result, the
Company has incurred and expects to incur substantially higher costs of
revenues during these periods. The Company has and anticipates that it will
continue to add customers over time to utilize this planned capacity
expansion. However, because its services are offered on a subscription basis
rather than for an up front fee, revenues from any additional customers
increase gradually. As a result, although the planned capacity expansion may
potentially increase the Company's revenue and profitability over the long
term, the Company experienced a decline in gross margin and an increase in net
loss in fiscal 1999 and expects to continue to experience significant net
losses on a quarterly and annual basis for the foreseeable future, including a
negative gross margin at least through fiscal 2000.
Since the Company's inception, it has experienced operating losses and
negative cash flows from operations in each quarterly and annual period. As of
March 31, 1999, the Company had an accumulated deficit of
13
<PAGE>
approximately $31.3 million. The revenue and income potential of the Company's
business and market is unproven, and the Company's limited operating history
makes an evaluation of the Company and its prospects difficult. The Company
and its prospects must be considered in light of the risks, expenses and
difficulties encountered by companies in the new and rapidly evolving market
for Internet system and network management solutions. To address these risks,
among other things, the Company must market its brand name effectively,
continue to advance its security leadership in the marketplace, provide
scalable, reliable and cost-effective services, continue to grow its
infrastructure to accommodate new Network Security Centers and increased
bandwidth utilization of its network, expand its channels of distribution,
retain and motivate qualified personnel and continue to respond to competitive
developments. Failure of the Company to achieve market acceptance of its
services would have a material adverse effect on the Company's business,
results of operations and financial condition. There can be no assurance that
the Company will ever achieve profitability on a quarterly or an annual basis
or will sustain profitability if achieved. See "Item 7--Limited Operating
History; History of Losses."
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship of certain items from the Company's statements of operations to
service revenues. This information has been derived from our audited
consolidated financial statements included in this Form 10-K. This information
should be read in conjunction with the consolidated financial statements and
the notes thereto.
<TABLE>
<CAPTION>
Year Ended March
31,
----------------------
1997 1998 1999
----- ----- ------
<S> <C> <C> <C>
Service revenues....................................... 100.0 % 100.0 % 100.0 %
Cost of service revenues............................... 66.4 86.8 114.5
----- ----- ------
Gross margin........................................... 33.6 13.2 (14.5)
Operating expenses:
Sales and marketing.................................. 49.3 38.1 54.9
Engineering and development.......................... 4.4 7.1 9.4
General and administrative........................... 16.9 13.6 16.6
----- ----- ------
Total operating expenses........................... 70.6 58.8 80.9
----- ----- ------
Operating loss......................................... (37.0) (45.6) (95.4)
Interest expense, net.................................. (5.1) (4.2) (7.9)
----- ----- ------
Net loss............................................... (42.1)% (49.8)% (103.3)%
===== ===== ======
</TABLE>
FISCAL YEARS ENDED MARCH 31, 1997, 1998 AND 1999
Service revenues. Service revenues consist of monthly fees for installation,
recurring services and, to a lesser extent, one-time fees for management and
consulting services such as security audits. The Company's service revenues
increased 80% from $6.3 million in fiscal 1997 to $11.3 million in fiscal 1998
and increased an additional 55% to $17.5 million in fiscal 1999. The growth in
the Company's service revenues over this period resulted primarily from an
increase in the number of customers and to a lesser extent from increases in
the number of service offerings and in service revenues per customer. To date,
a substantial majority of the Company's revenues have been derived from its
secure hosting and Internet connectivity services.
Cost of service revenues. The Company's cost of service revenues is
comprised primarily of the Company's costs for network bandwidth, equipment
costs and salaries and benefits for the Company's customer service and
operations personnel, including its network engineers, backbone engineers,
network management and systems and installation personnel. Network bandwidth
consists of costs for access to and use of third-party communications
networks.
Cost of service revenues increased from $4.2 million in fiscal 1997 to $9.8
million in fiscal 1998 and to $20.1 million in fiscal 1999. The Company's cost
of service revenues as a percentage of service revenues
14
<PAGE>
increased from 66.4% in fiscal 1997 to 86.8% in fiscal 1998, and to 114.5% in
fiscal 1999. The increases in cost of service revenues in absolute dollars and
as a percentage of service revenues were due to ATM-backbone network upgrade
and expansion, increased costs associated with the build-out and operation of
the Company's Network Security Centers, including increased costs for its
network bandwidth, equipment costs and salaries and benefits for its customer
service and operations personnel. The Company expects the cost of service
revenues to increase on an absolute basis as a result of expected customer
expansion in the Company's Network Security Centers.
Sales and marketing. The Company's marketing and sales expenses are
comprised primarily of salaries, commissions and benefits for the Company's
marketing and sales personnel and marketing expenses for items such as public
relations, tradeshows and product literature. The Company's sales and
marketing expenses increased from $3.1 million in fiscal 1997 to $4.3 million
in fiscal 1998 and to $9.6 million in fiscal 1999. These increases were
primarily the result of hiring additional marketing and sales personnel and
expanding marketing programs such as public relations, in connection with the
Company's expansion of its operations. The Company expects that marketing and
sales expenses will continue to increase in absolute dollars.
Engineering and development. The Company's engineering and development
expenses are comprised primarily of salaries and benefits for its engineering
and development personnel and fees paid to consultants. These individuals work
on day-to-day security operations, development of new processes and
methodologies, and integration of best-of-breed components into the Company's
secure operating environment. The Company's engineering and development
expenses increased from $275,000 in fiscal 1997 to $799,000 in fiscal 1998 and
to $1.6 million in fiscal 1999. The Company's security and services
development expenses grew between the comparison periods primarily due to the
addition of engineering personnel required to support the Company's expanded
service offerings. The Company expects that engineering and development
expenses will continue to increase in absolute dollars as the Company makes
additional investments in developing its secure electronic commerce services.
General and administrative. The Company's general and administrative
expenses are comprised primarily of salaries and benefits for the Company's
general management and administrative personnel as well as fees paid for
professional services. The Company's general and administrative expenses
increased from $1.1 million in fiscal 1997 to $1.6 million in fiscal 1998 and
to $2.9 million in fiscal 1999. These increases were primarily the result of
increased hiring of general and administrative personnel, and costs for
consultants and professional services providers. These increased expenses
reflected the Company's need for additional general and administrative
personnel to handle the expansion of the Company's operations. General and
administrative costs are expected to increase in absolute dollars to the
extent the Company expands its operations and incurs full-year costs
associated with being a public company.
Interest expense, net. The Company's net interest expense increased from
$323,000 in fiscal 1997 to $471,000 in fiscal 1998 and to $1.4 million in
fiscal 1999. The increases in net interest expense between the most recent
fiscal periods were primarily due to the amortization of non-cash loan fees
associated with a bridge loan consummated in June 1998 amounting to $1.1
million in additional expense in fiscal 1999. To a lesser extent, the
increases in interest expense between the comparison periods were due to
increased borrowings as the Company entered into equipment loans and lease
agreements to finance the construction of its Network Security Centers offset
by an increase in earned interest income.
Income tax benefit. There has been no provision for income taxes in fiscal
1997, 1998 and 1999 due to the Company's net losses. As of March 31, 1999, the
Company has approximately $27.4 million of operating loss carryforwards for
federal tax purposes. These expire at various periods through the year 2019.
Because of the uncertainties surrounding the Company's ability to utilize
those tax losses in future periods, the Company does not carry a corresponding
net deferred tax asset in its consolidated financial statements.
Net loss attributable to common stockholders. Net loss per share reflects a
charge for accretion on redeemable convertible preferred stock of $478,000 in
fiscal 1997, $1.1 million in fiscal 1998 and $488,000 in fiscal 1999. The
Company no longer records a charge for accretion on redeemable convertible
preferred stock
15
<PAGE>
due to the conversion of all outstanding Preferred Stock of the Company at the
closing of the public offering in fiscal 1999.
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain unaudited statements of operations
data of the Company for each of the eight quarters in the period ended March
31, 1999 expressed as a percentage of the Company's net revenues. This
information has been derived from the Company's unaudited consolidated
financial statements, which, in management's opinion, have been prepared on
substantially the same basis as the audited consolidated financial statements
and include all adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the financial information for the
quarters presented. This information should be read in conjunction with the
consolidated financial statements and notes thereto included elsewhere in this
Form 10-K. The operating results in any quarter are not necessarily indicative
of the results for any future period.
<TABLE>
<CAPTION>
Quarter Ended
---------------------------------------------------------------------------------------
June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31,
1997 1997 1997 1998 1998 1998 1998 1999
-------- --------- -------- -------- -------- --------- -------- --------
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Service revenues........ $ 2,461 $ 2,774 $ 2,977 $ 3,105 $ 3,720 $ 3,770 $ 4,480 $ 5,552
Cost of service
revenues............... 1,745 2,290 2,623 3,167 4,023 4,581 5,263 6,205
------- -------- -------- -------- -------- -------- -------- --------
Gross margin............ 716 484 354 (62) (303) (811) (783) (653)
Operating expenses:
Sales and marketing.... 867 850 1,082 1,507 2,134 2,134 2,724 2,635
Engineering and
development........... 143 184 243 229 299 386 386 571
General and
administrative........ 341 390 435 385 688 728 722 765
------- -------- -------- -------- -------- -------- -------- --------
Total operating
expenses.............. 1,351 1,424 1,760 2,121 3,121 3,248 3,832 3,971
------- -------- -------- -------- -------- -------- -------- --------
Operating loss.......... (635) (940) (1,406) (2,183) (3,424) (4,059) (4,615) (4,624)
Interest expense, net... (83) (94) (145) (149) (208) (1,031) (47) (87)
------- -------- -------- -------- -------- -------- -------- --------
Net loss................ $ (718) $ (1,034) $ (1,551) $ (2,332) $ (3,632) $ (5,090) $ (4,662) $ (4,711)
======= ======== ======== ======== ======== ======== ======== ========
As a Percentage of
Revenues:
Service revenues........ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of service
revenues............... 70.9 82.6 88.1 102.0 108.1 121.5 117.5 111.7
------- -------- -------- -------- -------- -------- -------- --------
Gross margin............ 29.1 17.4 11.9 (2.0) (8.1) (21.5) (17.5) (11.7)
Operating expenses:
Sales and marketing.... 35.3 30.6 36.3 48.5 57.4 56.6 60.8 47.5
Engineering and
development........... 5.7 6.6 8.2 7.4 8.0 10.2 8.6 10.3
General and
administrative........ 13.9 14.1 14.6 12.4 18.5 19.3 16.1 13.8
------- -------- -------- -------- -------- -------- -------- --------
Total operating
expenses.............. 54.9 51.3 59.1 68.3 83.9 86.1 85.5 71.6
------- -------- -------- -------- -------- -------- -------- --------
Operating loss.......... (25.8) (33.9) (47.2) (70.3) (92.0) (107.6) (103.0) (83.3)
Interest expense, net... (3.4) (3.4) (4.9) (4.8) (5.6) (27.4) (1.0) (1.6)
------- -------- -------- -------- -------- -------- -------- --------
Net loss................ (29.2)% (37.3)% (52.1)% (75.1)% (97.6)% (135.0)% (104.0)% (84.9)%
======= ======== ======== ======== ======== ======== ======== ========
</TABLE>
Service revenues. The Company's revenues increased sequentially each
quarter. This growth in revenues resulted primarily from increases in the
number of customers and to a lesser extent increases in the number of service
offerings and in revenues per customer.
Cost of service revenues. The Company's cost of service revenues increased
in absolute dollars and as a percentage of revenues sequentially each quarter.
These increases in cost of service revenues in absolute dollars and as a
percentage of service revenues were primarily the result of costs associated
with expanding the Company's network to provide both broader geographic
coverage as well as increased types of services. Additionally, the Company
incurred higher than usual expenses in the quarter ended March 31, 1998 and
throughout fiscal 1999 due to the conversion of its backbone network from a
"frame relay" network to an ATM
16
<PAGE>
network. This new protocol will allow the Company to more efficiently and cost
effectively expand its communications bandwidth. The increases in costs for
the fiscal 1999 quarters also resulted from increased costs for salaries,
telecommunications, recruiting, temporary help and depreciation associated
with preparations to open three new Network Security Centers.
Sales and marketing. Sales and marketing expenses as a percentage of total
revenues fluctuated from quarter to quarter primarily due to increases in
personnel, the timing of sales compensation and the timing of promotional
activities. The increase in sales and marketing expenses in the four quarters
for the period ended March 31, 1999 is largely the result of an increase in
sales and marketing personnel from 31 to 42 people during that period.
Engineering and development. Engineering and development expenses have
increased in absolute dollars and as a percentage of revenue as a result of
continuing the development of new security methodologies, enhancement of
current technologies, integration of best-of-breed third-party technologies to
support the Company's security and add new service offerings.
General and administrative. General and administrative expenses have
increased primarily as a result of additional personnel, and professional
fees. The increase in costs for the four quarters ended March 31, 1999
resulted from increases in professional fees, business taxes, salaries and
amortization of deferred compensation. The Company expects that general and
administrative expenses will continue to increase in absolute dollars.
LIQUIDITY AND CAPITAL RESOURCES
At March 31, 1999, the Company's cash, cash equivalents and short-term
investments totaled $23.0 million as compared to of $1.4 million at March 31,
1998. The Company completed an initial public offering of 3,250,000 shares of
common stock, including 3,110,000 shares sold by the Company and 140,000
shares sold by selling stockholders, on August 10, 1998 at $14.00 per share
resulting in net proceeds to the Company of $39.4 million. Immediately prior
to the initial public offering, common stock options and warrants to purchase
shares of Series F Preferred Stock convertible to 600,000 shares of common
stock were exercised resulting in additional net proceeds to the Company of
$3.8 million.
As of March 31, 1999, the Company had an $8.0 million equipment line of
credit and lease facility for financing of equipment purchases at interest
rates of approximately 15%. Borrowing under the financing is repayable in
monthly installments of principal and interest over 48 months and is secured
by a lien on the financed equipment. As of March 31, 1999, the Company had
borrowed an aggregate of $7.0 million under these lines of credit and lease
facilities.
On May 11, 1998, the Company negotiated a line of credit with a financial
institution for an aggregate amount of $1.5 million. The line of credit
currently bears interest of 9.75% per annum and is secured by assets of the
Company. At March 31, 1999, $61,000 of this debt facility was available.
On June 30, 1998, the Company completed a borrowing arrangement with two
lenders providing $6.0 million of short term financing. The loans expire in
June 1999 and bear interest at 13.5% per annum. The loans contain various pre-
payment options available after the Company's initial public offering date of
August 10, 1998. As additional consideration, the Company issued 150,000
warrants to purchase common stock at $11.20 per share. The Company calculated
a fair value of the warrants of $1.2 million which amount was capitalized and
amortized over the expected terms of the loans. One of the lenders exercised
its option for repayment of $3.0 million which was repaid in October 1998.
On October 19, 1998, the Company announced an open-market common stock
repurchase program under which the Company would repurchase up to 1.5 million
shares of its Common Stock. As of March 31, 1999, 450,936 shares had been
repurchased, at an aggregate cost to the Company of approximately $2.7
million. The Company does not anticipate making any additional repurchases
under this program.
17
<PAGE>
The Company's working capital and capital requirements will depend upon
numerous factors including plans to incur substantial additional capital
expenditures primarily for additions to and expansions of its Network Security
Centers, developing, acquiring or licensing new applications and technologies,
and the level of resources that the Company devotes to its sales and marketing
activities. The Company believes that its existing capital resources and
available equipment lease financing arrangements will be adequate to fund its
current operations for at least the next 12 months. However, there can be no
assurance that the Company will be successful in generating anticipated levels
of cash from operations or borrowings. If the Company is unable to generate
sufficient cash flow from operations or additional borrowings, it may be
required to sell assets, scale down its operations and expansion plans,
refinance all or a portion of its existing indebtedness or obtain other
sources of financing earlier than planned, any of which could have a material
adverse impact on the Company's business, results of operations and financial
condition. There can be no assurance that any such refinancing would be
available on commercially reasonable terms, or at all, or that any other
financing could be obtained.
YEAR 2000 RISKS
The Company has established procedures for evaluating and managing the risks
and costs associated with the Year 2000 problem and believes that the internal
computer systems that the Company has developed are currently Year 2000
compliant. To date, the Company has not incurred significant incremental costs
in order to comply with Year 2000 requirements and does not believe it will
incur significant incremental costs in order to comply with Year 2000
requirements in the foreseeable future. In the quarter ended December 31,
1998, the Company formed a group of its technical staff on a project to
upgrade and standardize hardware, operating systems and application software
versions on most of the Company's production equipment. The Company believes
that this project is required for general consistency and operating
efficiencies. However, a by-product of this effort will be a greater level of
assurance that the Company is Year 2000 compliant. The project is currently
estimated to last at least through September 1999.
Despite the Company's belief that its internal computer systems are
currently Year 2000 compliant, many of the Company's customers maintain their
Internet operations on commercially available operating systems, which may be
impacted by Year 2000 complications. In addition, the Company relies on third
party vendors for certain equipment, which may contain embedded instructions,
and software included within the Company's services, which may not be Year
2000 compliant. The Company is conducting an audit of its third-party
suppliers as to the Year 2000 compliance of their systems. However, the
failure to correct or discover a material Year 2000 problem could result in an
interruption in, or a failure of, certain normal business activities or
operations. Such failures could materially and adversely affect the Company's
results of operations, liquidity and financial condition. Due to the general
uncertainty inherent in the Year 2000 problem resulting in part from the
uncertainty of the Year 2000 readiness of third-party suppliers and customers,
the Company is unable to determine at this time whether the consequences of
Year 2000 failures will have a material impact on the Company's results of
operations, liquidity or financial condition. The Company does not have a
contingency plan if it is unable to reach Year 2000 readiness prior to
December 31, 1999. However, the Company intends to develop such a plan as it
completes the remainder of its readiness efforts. The Company believes this
plan will be in place prior to December 1999.
The dates on which the Company believes its audit of third party suppliers
and its overall Year 2000 readiness will be completed is based on the
Company's management's best estimates, which were derived utilizing numerous
assumptions of future events, including the continued availability of certain
resources, third-party cooperation and modification plans, and other factors.
However, there can be no guarantee that these estimates will be achieved, or
that there will not be a delay in, or increased costs associated with, the
implementation of Year 2000 compliant solutions. Specific factors that might
cause differences between the estimates and actual results include, but are
not limited to, the availability and cost of personnel trained in these areas,
the ability to locate and correct all relevant computer code, timely responses
to and corrections by third-parties and suppliers, the ability to implement
interfaces between the new systems and the systems not being replaced, and
similar uncertainties. Due to the general uncertainty inherent in the Year
2000 problem, resulting
18
<PAGE>
in part from the uncertainty of the Year 2000 readiness of third-parties and
the interconnection of global businesses, the Company cannot ensure its
ability to timely and cost-effectively resolve problems associated with the
Year 2000 issue and is unable to determine at this time whether the
consequences of Year 2000 failures will have a material impact on the
Company's results of operations, liquidity or financial condition. The Company
operates a number of servers on behalf of its customers. The Company has
limited control over most of the software and applications that are running on
such servers and believes that it bears no responsibility for the Year 2000
compliance of such servers. The Company is unable to determine what costs, if
any, it may have to incur to the extent that such customers are unable to
complete their own Year 2000 compliance on such servers. Although the Company
believes that it is not obligated to make such upgrades and believes that any
costs incurred should be billable to its customers, Year 2000 problems on such
customer servers may force the Company to make significant, unplanned
allocations of limited technical and financial resources. Any significant
unplanned allocations could have a material and adverse impact on the
Company's results of operations, liquidity and financial condition.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND MARKET PRICE OF STOCK
The Company operates in a rapidly changing environment that involves
numerous risks, some of which are beyond the Company's control. The following
discussion highlights some of these risks.
Limited Operating History; History of Losses
The Company began operations in 1993, and has experienced operating losses
and negative cash flows from operations in each quarterly and annual period.
As of March 31, 1999, the Company had an accumulated deficit of approximately
$31.3 million. The revenue and income potential of the Company's business and
market is unproven, and the Company's limited operating history makes an
evaluation of the Company and its prospects difficult. The Company has
recently made and expects to continue making significant investments in
security technologies, new and existing Network Security Centers, sales and
marketing activities, and the development of new services. As a result, the
Company experienced a decline in gross margin and an increase in net loss in
fiscal 1998 and fiscal 1999 and expects to continue experiencing significant
net losses on a quarterly and annual basis for the foreseeable future,
including a negative gross margin at least for the next nine months. Failure
of the Company's services to achieve market acceptance would have a material
adverse effect on the Company's business, results of operations and financial
condition. There can be no assurance that the Company will ever achieve
profitability on a quarterly or an annual basis or will sustain profitability
if achieved.
Potential Fluctuations in Results of Operations
The Company derives revenue from its customers primarily through initial
setup fees and ongoing monthly service charges. For each new customer, the
Company must incur costs in anticipation of the customer's decision to use the
Company's services and in advance of the receipt of sufficient revenues to
repay these costs and provide a return on the Company's investment. As a
result, a relatively large portion of the Company's expenditures are fixed in
the short-term, and the Company's success is substantially dependent on the
continued growth in its customer base and the retention of its customers for
sufficient periods to provide returns on the Company's investment. There can
be no assurance that the Company's customers will maintain or renew their
commitments to use the Company's services. The Company typically experiences a
lengthy sales cycle for its services, particularly given the importance to
customers of adequately securing Internet connectivity for electronic commerce
and the need to educate them regarding the requirements for effective network
security. Changes in the rate of growth in the Company's customer base,
customer renewal rates and the sales cycle for the Company's services, have
caused, or are expected in the future to cause, significant fluctuations in
the Company's results of operations on a quarterly and an annual basis.
For these and other reasons, in some future quarters, the Company's results
of operations may fall below the expectations of securities analysts or
investors, which could have a material adverse effect on the market price of
the Company's Common Stock.
19
<PAGE>
Risks Associated with Security Breaches
The Company's success is substantially dependent on the continued confidence
of its current and future customers that the Company provides superior network
security protection. Despite the Company's focus on Internet security, there
can be no assurance that the Company will be able to stop unauthorized
attempts, whether made unintentionally or by computer "attackers," to gain
access to or disrupt the network operations of the Company's customers. The
Company's Heuristic Defense Infrastrucure delivered through its Network
Security Centers is designed to prevent unauthorized access to customers'
networks from the Internet. Any failure by the Company to stop unauthorized
access from the Internet or disruptions to related Internet operations of its
customers could materially adversely affect such customers and the Company.
Although the Company generally limits warranties and liabilities relating to
security in its customer contracts, the Company's customers may seek to hold
the Company responsible for any losses suffered by the customer as a result of
unauthorized access to customers' network systems from the Internet. This
could result in liability to the Company, which could have a material adverse
effect upon its business, operating results and financial condition. Moreover,
computer attackers from the Internet could infiltrate the Company's network
and seek to sabotage its network or services by creating bugs or viruses or
through other means. In addition, any adverse publicity resulting from any
such unauthorized access could deter future customers from using the Company's
services and could cause current customers to cease using the Company's
services, which could have a material adverse effect upon the Company's
business, operating results and financial condition.
Risks Associated with The Emerging Market for Outsourced Network Security
Services
The market for Internet security monitoring, detection and defense services
in general is new and rapidly evolving. If the market for such services fails
to grow or grows more slowly than the Company currently anticipates, the
Company's business, operating results and financial condition would be
materially and adversely affected.
Risks of Business Expansion and Management of Growth
The Company intends to expand domestically and internationally by adding
Network Security Centers in new locations and expanding Network Security
Centers in existing locations. The Company's inability to manage effectively
its expansion, including any disruption of service to current customers, would
have a material adverse effect upon the Company's business, results of
operations and financial condition.
In addition, the Company will be required to expend substantial resources
for leases and improvements of facilities, purchases of equipment,
implementation of multiple telecommunications connections and hiring of
network, administrative, customer support, and sales and marketing personnel.
Furthermore, any problems encountered in connection with the expansion of
existing Network Security Centers may cause the interruption of service to
current customers.
The Company has recently hired large numbers of new employees. This growth
has placed and may continue to place a significant strain on the Company's
financial, management, operational and other resources. If the Company's
executives were unable to manage growth effectively, the Company's business,
results of operations and financial condition would be materially adversely
affected.
Competition
The market served by the Company is new, rapidly evolving, highly
competitive and largely undefined. There are few general barriers to entry,
and the Company expects that it will face additional competition from existing
competitors and new market entrants in the future. There can be no assurance
that the Company will have the resources or expertise to compete successfully
in the future.
The Company competes with a broad range of products and services. Many of
the Company's competitors have substantially greater financial, technical and
marketing resources, larger customer bases, longer operating
20
<PAGE>
histories, greater name recognition and more established relationships in the
industry than the Company. As a result, certain of these competitors may be
able to develop and expand their network infrastructures and service offerings
more quickly, adapt to new or emerging technologies and changes in customer
requirements more quickly, take advantage of acquisition and other
opportunities more readily, devote greater resources to the marketing and sale
of their products and adopt more aggressive pricing policies than the Company.
In addition, the Company believes that the businesses in which the Company
competes are likely to encounter consolidation in the near future, which could
result in increased price and other competition that could have a material
adverse effect on the Company's business, results of operations and financial
condition.
Risk of System Failure
The Company's success depends on the excellence of security protection and
uninterrupted operation of its network infrastructure. Despite existing and
planned precautions by the Company, the occurrence of a natural disaster or
other unanticipated problems at one or more of the Company's Network Security
Centers could result in interruptions in the services provided by the Company.
Any damage to or failure of the Company's systems or those of its service
providers could result in reductions in, or terminations of, services supplied
to the Company's customers. Such reductions or terminations in service could
materially and adversely impact the Company's customers, which could have a
material adverse effect on the Company's business, results of operations and
financial condition.
Future Capital Needs
The Company expects to incur significant expenditures as part of its planned
expansion, including expenditures for new security technologies, new and
expanded Network Security Centers, increases in sales and marketing activities
and the development of new services. There can be no assurance that the
Company will be successful in generating anticipated levels of cash from
operations or borrowings. If the Company is not successful, it may be required
to sell assets, scale down its operations and expansion plans, seek to
refinance all or a portion of its existing indebtedness or seek to obtain
other financing earlier than planned, any of which could have a material
adverse effect on the Company's business, results of operations and financial
condition. There can be no assurance that any such refinancing would be
available on commercially reasonable terms, or at all, or that any other
financing could be obtained or would not result in significant dilution to the
Company's stockholders.
Risks Associated With International Operations
A key component of the Company's long-term strategy is to expand into
international markets. If revenue generated by any international Network
Security Center is not adequate to offset the expense of establishing and
maintaining any such international operation, the Company's business, results
of operations and financial condition could be materially adversely affected.
In addition, the Company faces certain risks inherent in conducting business
internationally, any of which could adversely affect the Company's
international operations.
Dependence Upon Scalability of The Company's Network
The Company must continue to expand and adapt its network infrastructure as
the number of customers and the amount of information they wish to transmit
increases, and as customer requirements change. The expansion and adaptation
of the Company's telecommunications infrastructure will require substantial
financial, operational and management resources. Due to the limited deployment
of the Company's services to date, the ability of the Company's network to
connect and manage a substantially larger number of customers at high
transmission speeds is as yet unknown, and the Company faces risks related to
the network's ability to operate with higher customer levels while maintaining
superior performance. The Company's failure to achieve or maintain high
capacity data transmission could significantly reduce customer demand for its
services and have a material adverse effect on its business, results of
operations and financial condition. There can be no assurance that the
21
<PAGE>
Company will be able to expand or adapt its telecommunications infrastructure
to meet additional demand or its customers' changing requirements.
Dependence Upon Third Party Network Infrastructure Providers
The Company's success will depend upon third party network infrastructure
providers. In addition, the Company relies on a number of public and private
peering interconnections (i.e., arrangements among access providers to carry
traffic of each other) to deliver its services. If the carriers that operate
the Internet exchange points ("IXPs") were to discontinue their support of the
peering points or to refuse to offer services to the Company and no
alternative providers were to emerge, or such alternative providers were to
increase the cost of utilizing the IXPs, the transmission of network traffic
by the Company would be significantly constrained. If the Company were unable
to access on a cost- effective basis alternative networks to distribute its
customers' content or pass through any additional costs of utilizing these
networks to its customers, the Company's business, results of operations and
financial condition could be materially adversely affected.
Dependence on Other Third-Party Relationships
The Company is dependent on other companies to supply certain key components
of its telecommunications infrastructure and system and network management
solutions that, in the quantities and quality demanded by the Company, are
available only from sole or limited sources. Any failure to obtain required
components or software on a timely basis and at an acceptable cost would have
a material adverse effect on the Company's business, results of operations and
financial condition. The Company also intends to develop alternative
distribution and lead generation channel partners for the Company's services,
such as systems integration firms and bandwidth providers. Any failure by the
Company to develop these channel partners could materially and adversely
impact the ability of the Company to generate increased revenues, which could
have a material adverse effect on the Company's business, results of
operations and financial condition.
Rapid Technological Change; Evolving Industry Standards
The Company's future success will depend, in part, on its ability to offer
services that incorporate leading technology, address the increasingly
sophisticated and varied needs of its current and prospective customers and
respond to technological advances and emerging industry standards and
practices on a timely and cost-effective basis. The market for the Company's
services is characterized by rapidly changing and unproven technology,
evolving industry standards, changes in customer needs, emerging competition
and frequent new service introductions. There can be no assurance that future
advances in technology will be beneficial to, or compatible with, the
Company's business or that the Company will be able to incorporate such
advances on a cost-effective and timely basis into its business. The Company
believes that its ability to compete successfully is also dependent upon the
continued compatibility and interoperability of its services with products,
services and architectures offered by various vendors as part of the Company's
services. There can be no assurance that such products will be compatible with
the Company's infrastructure or that such products will adequately address
changing customer needs. In addition, there can be no assurance that products,
services or technologies developed by others will not render the Company's
services uncompetitive or obsolete.
Dependence On Key Personnel
The Company's success depends in significant part upon the continued
services of its key technical, sales and senior management personnel,
including the Company's President and Chief Executive Officer, Marketta
Silvera, and the Company's Vice President, Engineering and Development, Thomas
Wadlow. Any officer or employee of the Company can terminate his or her
relationship with the Company at any time. The loss of the services of one or
more of the Company's key employees or the Company's failure to attract
additional qualified personnel could have a material adverse effect on the
Company's business, results of operations and financial condition.
22
<PAGE>
Risks Associated With Information Disseminated Through The Company's Network
The law relating to the liability of on-line services companies and Internet
access providers for information carried on or disseminated through their
networks is currently unsettled. It is possible that claims could be made
against on-line services companies and Internet access providers under both
United States and foreign law for defamation, negligence, copyright or
trademark infringement, or other theories based on the nature and content of
the materials disseminated through their networks. The imposition upon the
Company and other Internet network providers of potential liability for
information carried on or disseminated through their systems could require the
Company to implement measures to reduce its exposure to such liability, which
may require the expenditure of substantial resources, or to discontinue
certain service or product offerings.
Protection and Enforcement of Intellectual Property Rights
The Company relies on a combination of copyright, trademark, patent, service
mark and trade secret laws and contractual restrictions to establish and
protect certain proprietary rights in technology underlying its services.
There can be no assurance that patents or trademarks will be issued or granted
from currently pending or any future applications, or that any patents or
trademarks that may be issued or granted will be sufficient in scope or
strength to provide meaningful protection or any commercial advantage to the
Company. The laws of certain foreign countries may not protect the Company's
products, services or intellectual property rights to the same extent as do
the laws of the United States.
There can be no assurance that contractual arrangements or other steps taken
by the Company to protect its intellectual property will prove sufficient to
prevent infringement of or misappropriation of the Company's technology or to
deter independent third-party development of similar technologies. Any such
infringement or misappropriation, should it occur, could have a material
adverse effect on the Company's business, results of operation and financial
condition.
To date, the Company has not been notified that the Company's products
infringe the proprietary rights of third parties, but there can be no
assurance that third parties will not claim infringement or indemnification by
the Company with respect to current or future products. Any such claim,
whether meritorious or not, could be time-consuming, result in costly
litigation, cause product installation delays, prevent the Company from using
important technologies or methods, subject the Company to substantial damages,
or require the Company to enter into royalty or licensing agreements. As a
result, any such claim could have a material adverse effect upon the Company's
business, results of operations and financial condition.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Company has limited exposure to financial market risks, including
changes in interest rates. The fair value of Pilot's investment portfolio or
related income would not be significantly impacted by a 100 basis point
increase or decrease in interest rates due mainly to the short-term nature of
the major portion of the Company's investment portfolio. An increase or
decrease in interest rates would not significantly increase or decrease
interest expense on debt obligations due to the fixed nature of the Company's
debt obligations. Pilot's foreign operations are limited in scope and thus the
Company is not materially exposed to foreign currency fluctuations.
Item 8. Financial Statements and Supplementary Data.
The index to the audited consolidated financial statements, financial
schedules and the report of the independent auditors appears in Part IV of
this Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
23
<PAGE>
PART III
Item 10. Directors and Executive Officers of the Company
The information regarding directors and executive officers required by Item
10 is incorporated by reference from the Company's definitive proxy statement
for its annual stockholders' meeting to be held on September 16, 1999.
Item 11. Executive Compensation
The information required by Item 11 is incorporated by reference from the
Company's definitive proxy statement for its annual stockholders' meeting to
be held on September 16, 1999. The information specified in Item 402 (k) and
(l) of Regulation S-K and set forth in the Company's definitive proxy
statement for its annual stockholders' meeting to be held on September 16,
1999 is not incorporated herein by reference.
Item 12. Security Ownership Of Certain Beneficial Owners And Management
The information required by Item 12 is incorporated by reference from the
Company's definitive proxy statement for its annual stockholders' meeting to
be held on September 16, 1999.
Item 13. Certain Relationships and Related Transactions
The information required by Item 13 is incorporated by reference from the
Company's definitive proxy statement for its annual stockholders' meeting to
be held on September 16, 1999.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) The following documents are filed as part of this report:
(1) Report of KPMG LLP.
(2) Consolidated Financial Statements
(3) Financial Statement Schedule
(4) Exhibits (numbered in accordance with Item 601 of Regulation S-K)
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<C> <S>
3.2(1) Bylaws of the Company.
Restated Certificate of Incorporation of the Company, dated September
3.3(2) 29, 1998.
4.1(1) Form of the Company's Common Stock Certificate.
10.1(1) Form of Indemnification Agreement.
10.2(1) 1994 Stock Plan, as amended, including form of stock agreements.
10.3(1) 1998 Stock Option Plan, including form of stock option agreement
1998 Directors' Stock Option Plan, including form of stock option
10.4(1) agreement.
1998 Employee Stock Purchase Plan, including form of subscription
10.5(1) agreement.
10.6(1) Amended and Restated Investors' Rights Agreement dated March 31, 1997,
as amended, between the Company and certain holders of the Company's
securities.
10.7(1) (a) Sublease dated April 25, 1995, between the Company and Computer
Associates International, Inc.; (b) Lease dated June 26, 1992 between
Alameda Real Estate Investments and ASK Computers Systems, Inc.
</TABLE>
24
<PAGE>
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<C> <S>
10.8(1) (a) Sublease dated March 17, 1998 between the Company and TCSI
Corporation; (b) Sublease between TCSI Corporation and Computer
Associates International, Inc.; (c) Lease dated June 26, 1992 between
Alameda Real Estate Investments and ASK Computers Systems, Inc.
(included in Exhibit 10.7(b)).
Industrial Complex Lease dated July 11, 1997 between the Company and
10.9(1) Great Oak, L.L.C.
10.10(1) Standard Office Lease dated January 14, 1998 between the Company and
Pacific Corporate Towers LLC., as amended February 1998.
10.11(1) (a) Sublease dated October 25, 1995, as amended, between the Company
and RFG Co., Ltd.; (b) Master Lease dated June 14, 1988 between
Newport Office Center I Co., and Recruit U.S.A., Inc.
</TABLE>
<TABLE>
<C> <S>
10.12(1) (a) Sublease dated April 30, 1997 between Nippon Travel Agency
Pacific, Inc. and the Company; (b) Sublease dated January 23, 1992
between the Newport Office Services and Nippon Travel Agency Pacific,
Inc.; (c) Master Lease dated June 14, 1988 between Newport Office
Center I Co., and Recruit U.S.A., Inc. (included in Exhibit
10.11(b)).
10.13(1) Loan and Security Agreement dated May 11, 1998 between the Company
and Transamerica Business Credit Union.
10.14(1) Master Loan and Security Agreement dated September 1, 1997 between
the Company and Transamerica Business Credit Corporation, as amended.
10.17(1) Management Bonus Plan.
10.18(1) Stock Purchase and Restriction Agreement dated January 28, 1994, as
amended, between the Company, Marketta Silvera and certain of the
Company's stockholders.
10.19(1) Stock Purchase and Restriction Agreement dated March 14, 1995,
between the Company, Marketta Silvera and certain of the Company's
stockholders.
10.20(1) Stock Purchase and Restriction Agreement dated June 15, 1996 between
the Company, Marketta Silvera and certain of the Company's
stockholders.
10.21(1) Stock Option Agreement dated May 20, 1998 between the Company and
William C. Leetham.
10.22(1) Loan and Security Agreement dated June 30, 1998 between the Company,
MMC/GATX Partnership No. 1 and Transamerica Business Credit
Corporation, including related secured promissory notes and warrants.
10.23 Office Lease dated October 27, 1998 between the Company and Lincoln-
Whitehall Realty, LLC.
23.1 Consent of Independent Auditors.
27.1 Financial Data Schedule.
</TABLE>
- --------
(1) Incorporated by reference to the Company's Form S-1 Registration
Statement filed August 10, 1998, File No. 33-57453.
(2) Incorporated by reference to the Company's report on Form 10-Q, filed for
the quarter ending September 30, 1998.
(b) Reports on Form 8-K
None.
25
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
PILOT NETWORK SERVICES, INC.
/s/ M. Marketta Silvera
By: _________________________________
M. Marketta Silvera
President and Chief Executive
Officer
Date: June 29, 1999
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints M. Marketta Silvera and William C. Leetham,
jointly and severally, his or her attorneys-in-fact, each with the power of
substitution, for her or him in any and all capacities, to sign any amendments
to this Report on Form 10-K, and to file the same, with exhibits thereto and
other documents in connection therewith with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of said attorneys-
in-fact, or his or her substitute or substitutes may do or cause to be done by
virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ M. Marketta Silvera President, Chief Executive June 29, 1999
____________________________________ Officer and Director
M. Marketta Silvera (Principal Executive
Officer)
/s/ William C. Leetham Senior Vice President, June 29, 1999
____________________________________ Finance and Administration,
William C. Leetham Chief Financial Officer,
Treasurer and Secretary
(Principal Financial and
Accounting Officer)
/s/ Shanda Bahles Director June 29, 1999
____________________________________
Shanda Bahles
/s/ Thomas Kelly Director June 29, 1999
____________________________________
Thomas Kelly
/s/ K. Flynn McDonald Director June 29, 1999
____________________________________
K. Flynn McDonald
/s/ Thomas O'Rourke Director June 29, 1999
____________________________________
Thomas O'Rourke
</TABLE>
26
<PAGE>
PART IV
PILOT NETWORK SERVICES, INC.
INDEX TO FINANCIAL PAGES
<TABLE>
<S> <C>
Independent Auditors' Report.............................................. F-2
Consolidated Balance Sheets as of March 31, 1998 and 1999................. F-3
Consolidated Statements of Operations for the years ended March 31, 1997,
1998 and 1999............................................................ F-4
Consolidated Statements of Comprehensive Loss for the years ended March
31, 1997, 1998 and 1999.................................................. F-5
Consolidated Statements of Stockholders' Equity (Deficit) for the years
ended March 31, 1997, 1998 and 1999...................................... F-6
Consolidated Statements of Cash Flows for the years ended March 31, 1997,
1998 and 1999............................................................ F-7
Notes to Consolidated Financial Statements................................ F-8
Schedule II--Valuation and Qualifying Accounts............................ S-1
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Boards of Directors
Pilot Network Services, Inc.:
We have audited the accompanying consolidated financial statements of Pilot
Network Services, Inc. and subsidiary (the "Company") as listed in the
accompanying index. In connection with our audits of the consolidated
financial statements, we have also audited the financial statement schedule as
listed in the accompanying index. These consolidated financial statements and
the financial statement schedule are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements and the financial statement schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Pilot
Network Services, Inc. as of March 31, 1999 and 1998, and the results of their
operations and their cash flows for each of the years in the three-year period
ended March 31, 1999, in conformity with generally accepted accounting
principles. Also in our opinion, the related financial statement schedule,
when considered in relation to the basic consolidated financial statements
taken as a whole, present fairly, in all material respects, the information
set forth therein.
/s/ KPMG LLP
San Francisco, California
April 28, 1999
F-2
<PAGE>
PILOT NETWORK SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
<TABLE>
<CAPTION>
March March 31,
31, 1998 1999
-------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................................... $ 1,447 $ 10,660
Short-term investments....................................... -- 12,352
Trade receivables, less allowance for doubtful accounts of
$111,000 and $157,000 as of March 31, 1998 and 1999,
respectively................................................ 1,066 3,438
Prepaid and other current assets............................. 273 783
-------- --------
Total current assets....................................... 2,786 27,233
Property and equipment, net.................................... 5,994 14,184
Other assets................................................... 142 698
-------- --------
$ 8,922 $ 42,115
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable............................................. $ 2,057 $ 2,334
Accrued expenses............................................. 601 1,675
Line of credit............................................... -- 1,439
Term loan.................................................... -- 3,000
Current portion of capital lease obligation.................. 1,549 2,175
Deferred revenue............................................. 1,542 2,027
-------- --------
Total current liabilities.................................. 5,749 12,650
Capital lease obligations, net of current portion.............. 3,444 4,830
-------- --------
Total liabilities.......................................... 9,193 17,480
Redeemable convertible preferred stock, $0.001 par value;
7,432,810 shares authorized; 6,363,030
issued and outstanding as of March 31, 1998................... 12,143 --
Stockholders' equity (deficit):
Convertible Series A preferred stock, $0.001 par value;
1,400,000 shares authorized, issued and outstanding as of
March 31, 1998.............................................. 1 --
Common stock, $0.001 par value; 40,000,000 shares authorized;
2,050,536 and 13,913,024 shares issued and outstanding as of
March 31, 1998 and March 31, 1999, respectively............. 2 14
Additional paid-in capital................................... 1,169 59,563
Accumulated other comprehensive income....................... -- 127
Deferred stock compensation.................................. (891) (1,097)
Accumulated deficit.......................................... (12,695) (31,278)
Treasury stock, 450,936 shares of common stock at cost as of
March 31, 1999.............................................. -- (2,694)
-------- --------
Total stockholders' equity (deficit)....................... (12,414) 24,635
-------- --------
$ 8,922 $ 42,115
======== ========
</TABLE>
See accompanying notes to consolidated financial statements
F-3
<PAGE>
PILOT NETWORK SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended March 31,
-------------------------------
1997 1998 1999
-------- -------- ---------
<S> <C> <C> <C>
Service revenues............................ $ 6,300 $ 11,317 $ 17,522
Cost of service revenues.................... 4,181 9,825 20,072
-------- -------- ---------
Gross margin................................ 2,119 1,492 (2,550)
Operating expenses:
Sales and marketing....................... 3,109 4,306 9,627
Engineering and development............... 275 799 1,642
General and administrative................ 1,064 1,551 2,903
-------- -------- ---------
Total operating expenses................ 4,448 6,656 14,172
-------- -------- ---------
Operating loss.............................. (2,329) (5,164) (16,722)
Interest expense, net....................... (323) (471) (1,373)
-------- -------- ---------
Net loss.................................... $ (2,652) $ (5,635) $ (18,095)
Accretion on redeemable convertible
preferred stock............................ (478) (1,069) (488)
-------- -------- ---------
Net loss attributable to common
stockholders............................... $ (3,130) $ (6,704) $ (18,583)
======== ======== =========
Basic and diluted net loss per share........ $ (1.58) $ (3.31) $ (1.94)
======== ======== =========
Shares used in computing basic and diluted
net loss per share......................... 1,982 2,025 9,568
======== ======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE>
PILOT NETWORK SERVICES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(in thousands)
<TABLE>
<CAPTION>
Year Ended March 31,
-----------------------------
1997 1998 1999
-------- -------- ---------
<S> <C> <C> <C>
Net loss........................................ $ (2,652) $ (5,635) $ (18,095)
Other comprehensive income, net of income tax:
Unrealized holding gain from marketable
securities................................... -- -- 126
Foreign currency translation.................. -- -- 1
-------- -------- ---------
Comprehensive loss.............................. $ (2,652) $ (5,635) $ (17,968)
======== ======== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE>
PILOT NETWORK SERVICES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Years Ended March 31, 1997, 1998 and 1999
(in thousands, except number of shares)
<TABLE>
<CAPTION>
Series A
Convertible Accumulated
Preferred stock Common stock Additional Deferred Other Treasury stock
------------------ ------------------ Paid-in Stock Comprehensive -----------------
Shares Amount Shares Amount capital Compensation Income Shares Amount
---------- ------ ---------- ------ ---------- ------------ ------------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance March 31, 1996.. 1,400,000 $ 1 1,959,640 $ 2 $ 96 $ -- $ -- -- $ --
Issuance of
common stock.... -- -- 96,916 -- 15 -- -- -- --
Repurchase of
common stock.... -- -- (54,834) -- (5) -- -- -- --
Accretion on
Series B, C, D,
E, and F
redeemable
convertible
preferred
stock........... -- -- -- -- -- -- -- -- --
Net loss........ -- -- -- -- -- -- -- -- --
---------- ----- ---------- ---- -------- -------- ----- -------- -------
Balance March 31,
1997............. 1,400,000 $ 1 2,001,722 $ 2 $ 106 $ -- $ -- -- $ --
Issuance of
common stock.... -- -- 72,706 -- 9 -- -- -- --
Repurchase of
common stock.... -- -- (23,892) -- (1) -- -- -- --
Accretion on
Series B, C, D,
E, and F
redeemable
convertible
preferred
stock........... -- -- -- -- -- -- -- -- --
Deferred
compensation
related to grant
of common stock
options......... -- -- -- -- 1,055 (1,055) -- -- --
Amortization of
deferred
compensation.... -- -- -- -- -- 164 -- -- --
Net loss........ -- -- -- -- -- -- -- -- --
---------- ----- ---------- ---- -------- -------- ----- -------- -------
Balance March 31,
1998............. 1,400,000 $ 1 2,050,536 $ 2 $ 1,169 $ (891) $ -- -- $ --
Issuance of
common stock,
net of issuance
costs........... 3,603,625 4 39,721 -- -- -- --
Repurchase of
common stock.... -- -- (104,167) -- (70) -- -- (450,936) (2,694)
Accretion on
Series B, C, D,
E, and F
redeemable
convertible
preferred
stock........... -- -- -- -- 2,390 -- -- -- --
Issuance of
common stock
Warrants in
connection with
Bridge
financing....... -- -- -- -- 1,200 -- -- -- --
Conversion of
Series A, B, C,
D, E, and F
convertible
preferred stock
to common
stock........... (1,400,000) $ (1) 8,363,030 8 13,834 -- -- -- --
Deferred
compensation
related to grant
of common stock
options......... -- -- -- -- 2,175 (2,175) -- -- --
Amortization of
deferred
compensation.... -- -- -- -- -- 1,113 -- -- --
Forfeiture of
stock options
with deferred
compensation.... -- -- -- -- (856) 856 -- -- --
Unrealized gain
on short-term
investments..... -- -- -- -- -- -- 127 -- --
Net loss........ -- -- -- -- -- -- -- -- --
---------- ----- ---------- ---- -------- -------- ----- -------- -------
Balance March 31,
1999............. -- $ -- 13,913,024 $ 14 $ 59,563 $ (1,097) $ 127 (450,936) $(2,694)
---------- ----- ---------- ---- -------- -------- ----- -------- -------
<CAPTION>
Total
Accumulated Stockholders'
deficit Equity (Deficit)
----------- ----------------
<S> <C> <C>
Balance March 31, 1996.. $ (2,861) $ (2,762)
Issuance of
common stock.... -- 15
Repurchase of
common stock.... -- (5)
Accretion on
Series B, C, D,
E, and F
redeemable
convertible
preferred
stock........... (478) (478)
Net loss........ (2,652) (2,652)
----------- ----------------
Balance March 31,
1997............. $ (5,991) $ (5,882)
Issuance of
common stock.... -- 9
Repurchase of
common stock.... -- (1)
Accretion on
Series B, C, D,
E, and F
redeemable
convertible
preferred
stock........... (1,069) (1,069)
Deferred
compensation
related to grant
of common stock
options......... -- --
Amortization of
deferred
compensation.... -- 164
Net loss........ (5,635) (5,635)
----------- ----------------
Balance March 31,
1998............. $ (12,695) $ (12,414)
Issuance of
common stock,
net of issuance
costs........... -- 39,725
Repurchase of
common stock.... -- (2,764)
Accretion on
Series B, C, D,
E, and F
redeemable
convertible
preferred
stock........... (488) 1,902
Issuance of
common stock
Warrants in
connection with
Bridge
financing....... -- 1,200
Conversion of
Series A, B, C,
D, E, and F
convertible
preferred stock
to common
stock........... -- 13,841
Deferred
compensation
related to grant
of common stock
options......... -- --
Amortization of
deferred
compensation.... -- 1,113
Forfeiture of
stock options
with deferred
compensation.... -- --
Unrealized gain
on short-term
investments..... -- 127
Net loss........ (18,095) (18,095)
----------- ----------------
Balance March 31,
1999............. $ (31,278) $ 24,635
----------- ----------------
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
PILOT NETWORK SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year Ended March 31,
--------------------------
1997 1998 1999
------- ------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss......................................... $(2,652) $(5,635) $(18,095)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization................... 1,222 2,274 4,050
Amortization of deferred compensation........... -- 164 1,113
Amortization of loan fee........................ -- -- 1,050
Changes in operating assets and liabilities:
Trade receivables.............................. (238) (341) (2,372)
Prepaid and other assets....................... 78 (261) (922)
Accounts payable............................... 353 1,475 277
Accrued expenses............................... 198 122 1,074
Deferred revenue............................... 528 284 485
------- ------- --------
Net cash used in operating activities........ (511) (1,918) (13,340)
------- ------- --------
Cash flows from investing activities:
Capital expenditures............................. (651) (1,470) (8,225)
Purchases of short-term investments.............. -- -- (12,352)
Unrealized gain from marketable securities....... -- -- 127
------- ------- --------
Net cash used in investing activities........ (651) (1,470) (20,450)
------- ------- --------
Cash flows from financing activities:
Net proceeds from issuance of redeemable
convertible preferred stock..................... 4,501 2,990 --
Net proceeds from issuance of common stock....... 15 9 43,325
Repurchase of common stock....................... (5) (1) (70)
Treasury stock purchases......................... -- -- (2,694)
Proceeds from working capital line of credit..... -- -- 1,439
Proceeds from term loan.......................... -- -- 6,000
Payments of term loan............................ -- -- (3,000)
Principal payments of obligations under capital
leases.......................................... (688) (1,244) (1,997)
------- ------- --------
Net cash provided by financing activities.... 3,823 1,754 43,003
------- ------- --------
Net increase (decrease) in cash and cash
equivalents..................................... 2,661 (1,634) 9,213
Cash and cash equivalents at beginning of year... 420 3,081 1,447
------- ------- --------
Cash and cash equivalents at end of year......... $ 3,081 $ 1,447 $ 10,660
======= ======= ========
Supplemental disclosure of cash flow information:
Cash paid for interest........................... $ 330 $ 568 $ 1,432
======= ======= ========
Noncash financing activities:
Assets acquired under capital lease obligations.. $ 2,245 $ 3,319 $ 4,008
======= ======= ========
Accretion of redeemable preferred stock.......... $ 478 $ 1,069 $ 488
======= ======= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE>
PILOT NETWORK SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description of Business
Pilot Network Services, Inc. (the Company) was originally incorporated in
California on August 6, 1992, then reincorporated in Delaware on August 4,
1998. The Company provides comprehensive security services that incorporate
high-bandwidth connectivity and enable secure electronic commerce over the
Internet.
Consolidation
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiary. All material intercompany
balances and transactions have been eliminated in consolidation.
Revenue Recognition
Revenues consist primarily of monthly fees for secure access and hosting
services, installation and management services. Secure access and hosting
service fees are recognized ratably over the term of the contract, generally
one year. Installation fees are recognized over the installation period,
generally up to 60 days. Management services, which include security audits
and consulting arrangements, are recognized as the service is performed.
Cash Equivalents and Short-term Investments
The Company considers all highly liquid instruments with original maturities
of 90 days or less at the date of purchase to be cash equivalents. The Company
has classified all short-term investments as available-for-sale in accordance
with Statement of Financial Accounting Standards (SFAS) No. 115, Accounting
for Certain Investments in Debt and Equity Securities.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method based on estimated useful lives, generally over three
years. Depreciation expense includes amortization of assets recorded under
capital lease. Equipment held under capital leases is amortized over the
shorter of the lease term or the estimated useful life of the asset.
Software Development Costs
Software development costs are expensed as incurred until the technological
feasibility of the related product has been established. After technological
feasibility is established, any additional software development costs would be
capitalized in accordance with SFAS No. 86, Capitalization of Software
Development Costs. Through March 31, 1999, the Company's process for
developing software was essentially completed concurrently with the
establishment of technological feasibility in the form of a working model,
and, accordingly, no software costs have been capitalized to date. Software
development costs incurred prior to achieving technological feasibility are
charged to engineering and development expense as incurred.
Income Taxes
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between financial statement carrying
amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in
F-8
<PAGE>
PILOT NETWORK SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
the years that those differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
Accounting for Stock-Based Compensation
The Company uses the intrinsic value method to account for its stock-based
employee compensation plans. Compensation expense, if any, is amortized on an
accelerated basis over the vesting period of the individual options, generally
four years.
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of
The Company evaluates the recoverability of its identifiable tangible assets
under SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of. This statement requires identifiable
assets to be evaluated for impairment whenever events or changes in
circumstances indicate that the carrying value of an asset may not be
recoverable. If an asset is considered to be impaired, the carrying amount of
that asset is reduced to its fair value, resulting in a charge to income.
Assets to be disposed of are reported at the lower of the carrying amounts or
fair value less costs to sell. As of March 31, 1999, the Company did not
consider any of its assets to be impaired.
Advertising
Advertising costs are expensed as incurred and are included in sales and
marketing expense. The Company had no advertising expense for the year ended
March 31, 1997 and approximately $24,000 and $71,000 for the years ended March
31, 1998 and 1999, respectively.
Net Loss Per Share
Basic net loss per share is computed using the weighted average number of
common shares outstanding during the year. Diluted net loss per share is
computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the year, using either the as-if-
converted method for convertible preferred stock or the treasury stock method
for options and warrants. The effect of including convertible preferred stock,
options and warrants would have been anti-dilutive during all periods
presented and, as a result, such effect has been excluded from the computation
of diluted net loss per share.
Excluded from the computation of diluted earnings per share for the years
ended March 31, 1997, 1998 and 1999 are options to acquire 461,958, 1,125,312,
and 1,870,350 shares of common stock, respectively, with weighted-average
exercise prices of $0.23, $0.68 and $5.14, respectively, because their effects
would be anti-dilutive. Also excluded from the computation of diluted earnings
per share are common share equivalents resulting from the conversion of the
Series A, B, C, D, E and F preferred stock upon completion of the Company's
initial public offering (IPO) because their effects would be anti-dilutive.
F-9
<PAGE>
PILOT NETWORK SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Had the outstanding shares of redeemable convertible preferred stock and the
Series A Preferred Stock converted to common stock as of April 1, 1997 or the
date of issuance, if later, pro forma basic and diluted loss per share would
have been as follows (dollars in thousands, except per share data):
<TABLE>
<CAPTION>
Years ended
March 31, 1997, 1998 and
1999
---------------------------
Weighted
Average Per
Net Loss Shares Share
-------- ---------- ------
<S> <C> <C> <C>
March 31, 1997
Basic and diluted loss per share.............. $ (3,130) 1,982,422 $(1.58)
Pro forma adjustment for accretion and
conversion of preferred stock................ 478 6,320,693 --
-------- ---------- ------
Pro forma basic and diluted loss per share.... $ (2,652) 8,303,115 $(0.32)
======== ========== ======
March 31, 1998
Basic and diluted loss per share.............. $ (6,704) 2,025,470 $(3.31)
Pro forma adjustment for accretion and
conversion of preferred stock................ 1,069 7,329,696 --
-------- ---------- ------
Pro forma basic and diluted loss per share.... $ (5,635) 9,355,166 $(0.60)
======== ========== ======
March 31, 1999
Basic and diluted loss per share.............. $(18,583) 9,567,901 $(1.94)
Pro forma adjustment for accretion and
conversion of preferred stock................ 488 2,760,188 --
-------- ---------- ------
Pro forma basic and diluted loss per share.... $(18,095) 12,328,089 $(1.47)
======== ========== ======
</TABLE>
Comprehensive Income
During fiscal year ended March 31, 1999, the Company adopted SFAS No. 130,
Reporting Comprehensive Income, which requires entities to report, by major
component and in total, all changes in equity from non-owner sources. The
Company's net loss was equal to comprehensive loss for the fiscal years ended
March 31, 1997 and 1998. The tax impact of comprehensive income was not
material.
Concentration of Credit Risk
The Company provides its services throughout the United States to a wide
user base. During the years presented no single customer accounted for greater
than 5% of total service revenue. The Company performs credit evaluations of
its customers' financial condition and, generally, does not require collateral
from its customers. Management makes estimates as to its credit losses and to
date its estimates have not differed materially from actual results. Overall,
credit risk is limited due to the large number of customers in differing
industries and geographic areas.
The Company purchases its network management hardware from a limited number
of suppliers.
Fair Value of Financial Instruments
The carrying value of cash, cash equivalents, accounts receivable, accounts
payable and accrued liabilities approximate fair value due to the short
maturity of those instruments.
F-10
<PAGE>
PILOT NETWORK SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the
consolidated financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. This statement
establishes standards for derivative instruments and hedging activities. The
Company is required to adopt SFAS No. 133 in the first quarter of fiscal year
2001. The Company does not anticipate that SFAS No. 133 will have a material
impact on its consolidated financial statements.
(2) PROPERTY AND EQUIPMENT
Property and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
Year Ended
March 31,
--------------
1998 1999
------ -------
<S> <C> <C>
Network and computer equipment............................... $8,274 $14,232
Furniture and fixtures....................................... 457 1,102
Purchased software........................................... 577 1,225
Leasehold improvements....................................... 718 5,697
------ -------
10,026 22,256
Less: accumulated depreciation and amortization.............. 4,032 8,072
------ -------
$5,994 $14,184
====== =======
</TABLE>
The gross amount of capitalized leased assets included in property and
equipment was approximately $7,873,000 and $11,881,000 and related accumulated
amortization was approximately $3,182,000 and $6,364,000 as of March 31, 1998
and 1999, respectively.
(3) SHORT-TERM DEBT
On May 11, 1998, the Company negotiated a line of credit with a financial
institution for an aggregate amount of $1.5 million. The line of credit
currently bears interest of 9.75% per annum and is secured by assets of the
Company. At March 31, 1999, $61,000 of this debt facility was available.
On June 30, 1998, the Company completed a borrowing arrangement with two
lenders providing $6.0 million of short term financing. The loans expire in
June 1999 and bear interest at 13.5% per annum. The loans contain various pre-
payment options available after the Company's initial public offering date of
August 10, 1998. As additional consideration, the Company issued 150,000
warrants to purchase common stock at $11.20 per share. The Company calculated
a fair value of the warrants of $1.2 million which amount was capitalized and
amortized over the expected terms of the loans. One of the lenders exercised
its option for repayment of $3.0 million which was repaid in October 1998.
F-11
<PAGE>
PILOT NETWORK SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(4) COMMITMENTS
Leases
The Company has entered into equipment leases with various leasing
institutions providing for financing of equipment purchases of up to
$5,000,000 at varying interest rates. Borrowings under the leases are
generally repayable in monthly installments over periods ranging from 36 to 48
months with a mandatory buyout at the end of the lease term, and are secured
by a lien on the leased equipment.
The Company is obligated under certain non-cancelable operating leases for
office space and equipment expiring at various dates through 2001. Rent
expense for the years ended March 31, 1997, 1998 and 1999 was approximately
$465,000, $636,000 and $1,078,000, respectively.
The following is a schedule of future minimum payments required under
capital and operating leases that have initial or remaining non-cancelable
lease terms in excess of one year as of March 31, 1999 (in thousands):
<TABLE>
<CAPTION>
Capital Operating
leases leases
------- ---------
<S> <C> <C>
Year Ending March 31, 1999
2000..................................................... $3,056 $ 2,594
2001..................................................... 2,587 2,010
2002..................................................... 2,068 1,348
2003..................................................... 1,039 722
2004..................................................... 29 650
Thereafter............................................... -- 2,908
------ -------
8,779 $10,232
Less: amount representing interest (at rates ranging from
14.5% to 14.7%)......................................... 1,774
------
7,005
Less current portion of capital lease obligations........ 2,175
------
Capital lease obligations, net of current portion........ $4,830
======
</TABLE>
Agreement
On June 18, 1996, the Company entered into an agreement with AmeriData
Technologies Inc. (subsequently purchased by GE Capital Information
Technologies Solutions, Inc.) (AmeriData) whereby the Company granted
AmeriData options to purchase 200,000 shares of the Company's common stock at
$2.00 per share and AmeriData agreed to sell the Company's secure internet
services to AmeriData customers in exchange for a commission on the monthly
recurring revenue received in the first two years of these new customer
contracts. The commissions incurred through March 31, 1999 have not been
material. The fair value of the options granted to AmeriData was immaterial
using the Black-Sholes option pricing model and the following assumptions: no
dividend yield; risk free interest rate of 6.5%; volatility of 60%; expected
life for the options of five years; and a fair value of common stock of $0.40.
401(k) Retirement Plan
Effective July 1, 1995, the Company established a 401(k) defined
contribution retirement plan (Retirement Plan) covering all full-time
employees with greater than one months' service. The Retirement Plan provides
for voluntary employee contributions from 1% to 15% of annual compensation,
subject to a maximum limit allowed by Internal Revenue Service guidelines. The
Company may contribute such amounts to the accounts of participants in the
Retirement Plan as determined by the Board of Directors. However, to date, the
Company has not made any contributions to the Retirement Plan.
F-12
<PAGE>
PILOT NETWORK SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(5) INCOME TAXES
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities are presented below (in
thousands):
<TABLE>
<CAPTION>
March 31,
---------------
1998 1999
------ -------
<S> <C> <C>
Deferred tax assets (liabilities):
Net operating loss carryforwards.......................... $3,522 $10,348
Property and equipment---depreciation differences......... 49 (42)
Research credit carryforwards............................. 34 211
Other reserves and accruals............................... 200 437
------ -------
Total gross deferred tax assets......................... 3,805 10,954
Less valuation allowance.................................. (3,805) (10,954)
------ -------
Net deferred tax assets................................. $ -- $ --
====== =======
</TABLE>
The net increase in the valuation allowance was approximately $1,795,000 and
$7,149,000 for the years ended March 31, 1998 and 1999, respectively. Due to
recent operating losses the Company believes that sufficient uncertainty
exists with respect to future realization of these deferred tax assets;
therefore, it has established a valuation allowance against all net deferred
tax assets. The Company has net operating loss carryforwards for federal
income tax return purposes of approximately $27,418,000 which can be used to
reduce future taxable income. These carryforwards expire in 2008 through 2019.
As of March 31, 1999, the Company had California operating loss carryforwards
of approximately $12,859,000 available to offset future income subject to
California franchise tax. The difference between the federal loss
carryforwards and the California loss carryforwards results primarily from a
50% limitation on California loss carryforwards, and certain research and
development costs that were deferred for California tax purposes. The
California net operating loss carryforwards expire in various amounts from
1999 through 2004. The Company also has federal and California tax credit
carryforwards of approximately $117,000 and $82,000, respectively, as of March
31, 1999. These tax credits expire through 2019. Under the Tax Reform Act of
1986, the amounts of any benefit from net operating losses and credits that
can be carried forward may be limited in the event of an ownership change as
defined in the Internal Revenue Code, Section 382.
(6) STOCKHOLDERS' EQUITY (DEFICIT)
Convertible Preferred Stock and Redeemable Convertible Preferred Stock
As of March 31, 1998, the Company had outstanding six series of preferred
stock: Series A, B, C, D, E and F. Each share of preferred stock was
convertible, at the option of the holder, into fully paid shares of common
stock. The conversion rate was one-for-one, subject to adjustments for stock
dividends, stock splits and capital reorganizations and dilution.
In January 1994, the Company issued 1,661,646 shares of Series B redeemable
convertible preferred stock at $0.365 per share. In March 1995, the Company
issued 1,488,200 shares of Series D redeemable convertible preferred stock at
$0.875 per share. In December 1995 and January 1996, the Company issued
1,210,068 shares of Series C redeemable convertible preferred stock at $0.73
per share upon the exercise of warrants outstanding. In July 1996, the Company
issued 783,118 shares of Series E redeemable convertible preferred stock at
$2.00 per share. From March 1997 through February 1998, the Company issued
1,220,000 shares of Series F redeemable convertible preferred stock and
warrants to purchase 600,000 shares of Series F preferred stock for $5.00 per
share and an exercise price on the warrants of $6.00 per share, all of which
was exercised on August 11, 1998.
F-13
<PAGE>
PILOT NETWORK SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Convertible preferred stock issued and outstanding as of March 31, 1998 was
as follows:
<TABLE>
<CAPTION>
March 31,
---------
1998
---------
<S> <C>
Series A........................................................ 1,400,000
Series B........................................................ 1,661,644
Series C........................................................ 1,210,068
Series D........................................................ 1,488,200
Series E........................................................ 783,118
Series F........................................................ 1,220,000
---------
7,763,030
=========
</TABLE>
Warrants
In connection with lease financings, the Company has outstanding warrants
for the purchase of 19,588 and 115,786 shares of Series B and Series D
redeemable preferred stock, at weighted average exercise prices of $0.365 and
$1.53, respectively. During the years ended March 31, 1997 and 1998, the
Company issued warrants to purchase 600,000 shares of Series F redeemable
preferred stock to the purchases of Series F redeemable preferred stock at an
exercise price of $6.00 per share in conjunction with the issuance of the
Series F redeemable preferred stock. The fair value of all warrant issuances
calculated using the Black-Scholes option pricing model was not material,
using the following assumptions: dividend yield--none; expected life--
contractual term; risk free interest rate--6%; volatility--60%.
Stock-Based Compensation Plans
During fiscal 1995, the Company adopted its 1994 Stock Option Plan and the
1994 Restricted Stock Purchase Plan. On April 17, 1997, the plans were merged
into a single plan (the "1994 Plan") and the authorized shares were increased
resulting in an aggregate 1,200,000 shares reserved for issuance. The plan, as
amended, allows the Board of Directors to issue nonqualified stock options,
incentive stock options or restricted stock to employees, officers, directors,
advisors or contractors of the Company.
The plan expires 10 years from the date of adoption. Options and restricted
stock are granted at fair market value at date of grant for incentive stock
options or no less than 85% of fair market value at the date of grant for
nonqualified options. Options and restricted stock generally vest over 4
years, with 25% vesting after one year and monthly thereafter, and expire 10
years from grant date.
As of March 31, 1999, 51,667 shares of restricted common stock held by
management were subjected to repurchase by the Company at prices ranging from
$0.20 to $0.75 per share.
During fiscal 1999, the Company increased the shares reserved under the 1994
Plan by 1,000,000 shares and adopted its 1998 Stock Option Plan (the "1998
Plan"). The 1998 Plan reserves 1,000,000 shares plus annual increases limited
to the lesser of 500,000 shares, 3% of the Company's outstanding common stock,
or the number determined by the Board of Directors. Also during fiscal 1999,
the Company adopted the 1998 Directors Stock Option Plan which reserves
200,000 shares of common stock and a 1998 Employee Stock Purchase Plan
("Purchase Plan") which reserves 200,000 shares of common stock. The Purchase
Plan provides for automatic annual increases of the lesser 100,000 shares,
1/2% of the Company's outstanding common stock or an amount determined by the
Board of Directors. The Purchase Plan permits eligible employees to purchase
common stock through payroll deductions, which may not exceed 10% of an
employee's compensation, at a price equal to the lower of 85% of the fair
market value of the Company's common stock at the beginning of each offering
period
F-14
<PAGE>
PILOT NETWORK SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
or at the end of each purchase period. At March 31, 1999, options for 40,000
shares were issued and outstanding under the 1998 Directors Stock Option Plan
and no shares were issued or outstanding under the 1998 Employee Stock
Purchase Plan.
The following table summarizes stock option and restricted stock activity as
if all the plans had been combined at the beginning of the periods presented:
<TABLE>
<CAPTION>
Weighted
Available Average
for grant Outstanding Exercise price
---------- ----------- --------------
<S> <C> <C> <C>
Balances, March 31, 1996............. 393,804 316,416 $0.09
Granted............................ (412,000) 412,000 0.31
Exercised.......................... -- (96,916) 0.16
Canceled........................... 169,542 (169,542) 0.22
Repurchased........................ 54,834 -- 0.09
---------- --------- -----
Balances, March 31, 1997............. 206,180 461,958 0.23
Authorized......................... 830,140 -- --
Granted............................ (1,020,000) 1,020,000 0.82
Exercised.......................... -- (72,706) 0.12
Canceled........................... 283,940 (283,940) 0.57
Repurchased........................ 23,892 -- 0.08
---------- --------- -----
Balances, March 31, 1998............. 324,152 1,125,312 0.68
Authorized......................... 2,200,000 -- --
Granted............................ (1,601,400) 1,601,400 6.98
Exercised.......................... -- (393,625) 0.57
Canceled........................... 462,737 (462,737) 4.59
Repurchased........................ 104,167 -- 0.67
---------- --------- -----
Balances, March 31, 1999............. 1,489,656 1,870,350 $5.14
========== ========= =====
Exercisable as of March 31, 1999..... 304,258 $1.96
========= =====
</TABLE>
The following table summarizes information about fixed stock options
outstanding at March 31, 1999:
<TABLE>
<CAPTION>
Weighted
Average
Remaining Number of
Number of Contractual Shares
Exercise Prices shares Life Exerciseable
--------------- --------- ----------- ------------
<S> <C> <C> <C>
$ 0.09 -$ 1.50............................ 530,617 7.53 242,719
3.00 - 6.00............................ 800,833 9.22 41,539
8.50 - 9.813........................... 355,000 9.79 0
12.375- 14.125........................... 183,900 8.62 20,000
--------- -------
$ 0.09 -$14.125........................... 1,870,350 304,258
========= =======
</TABLE>
The Company accounts for the plan using the intrinsic value method. As such,
compensation expense is recorded if on the date of grant the current fair
value per share of the underlying stock exceeds the exercise price per share.
With respect to certain options granted during fiscal 1998 and the first
quarter of fiscal 1999, the Company recorded deferred compensation of
$1,055,000 and $2,175,000, respectively, for the difference at the grant date
between the exercise price per share and the fair value per share, based upon
management's estimate of the fair value of the Company's stock on the various
grant dates of the common stock underlying the options.
F-15
<PAGE>
PILOT NETWORK SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
Had compensation cost for the Company's stock-based compensation plans been
determined consistent with SFAS No. 123, the Company's net loss would have
increased to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
Year ended March 31,
----------------------------------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Net loss attributable to common
stockholders
(in thousands):
As reported........................... $ (3,130) $ (6,704) $ (18,583)
Pro forma............................. (3,132) (6,727) (19,596)
Net loss per share:
As reported basic and diluted net loss
per share............................ $ (1.58) $ (3.31) $ (1.94)
Pro forma basic and diluted net loss
per share............................ $ (1.58) $ (3.32) $ (2.05)
Shares used in computing reported and
pro forma basic and diluted net loss
per share............................ 1,982,422 2,025,470 9,567,901
</TABLE>
Under SFAS No. 123 the fair value of each option grant is estimated on the
date of grant using minimum value method in 1997 and 1998 and the Black-
Scholes option pricing model in 1999 with the following weighted average
assumptions; no dividend yield; expected risk free interest rate of 6.5% for
1997 and 1998 and 5.0% for 1999; expected volatility of 85% for 1999; and
expected life for the options of five years and for the shares in the Purchase
Plan an expected life of one year. The weighted average fair value of stock
options and purchase rights granted under the plans during 1999 was $4.71 per
share for options granted and $2.36 per share for purchase rights granted. The
fair value stock options granted in 1997 and 1998 was not material.
(7) Segment Information
The Company has adopted the provisions of SFAS No. 131, Disclosures About
Segments of an Enterprise and Related Information. SFAS No. 131 establishes
standards for the reporting by public business enterprises of information
about operating segments, products and services, geographic areas, and major
customers. The method for determining what information to report is based on
the way that management organizes the operating segments within the Company
for making operating decisions and assessing financial performance.
The Company's chief operating decision maker is considered to be the
Company's President and Chief Executive Officer (CEO). The President and CEO
reviews financial information presented on a consolidated basis for purposes
of making operating decisions and assessing financial performance. The
consolidated financial information reviewed by the President and CEO is
comparable with the information presented in the accompanying consolidated
statement of operations. The Company operates in a single operating segment:
providing comprehensive security services that incorporate high-bandwidth
connectivity and enable secure electronic commerce over the Internet. No
single customer accounted for greater than 10% of revenues in any period
presented and the Company does not have any significant international
operations or export revenues.
F-16
<PAGE>
PILOT NETWORK SERVICES, INC.
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
Balance at Balance at
Beginning End
Classification of Year Additions Deductions of Year
- -------------- ---------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts:
Year ended March 31, 1997......... $ 0 $ 12 $ 0 $ 12
Year ended March 31, 1998......... 12 179 (80) 111
Year ended March 31, 1999......... 111 445 (399) 157
</TABLE>
S-1
<PAGE>
EXHIBIT 10.23
LEASE AGREEMENT
(NNN R&D)
Basic Lease Information
Lease Date: October 27, 1998
Landlord: LINCOLN-WHITEHALL REALTY, LLC. a Delaware limited
liability company
Landlord's Address: c/o Legacy Partners Commercial. Inc. 101 Lincoln
Centre Drive, Fourth Floor Foster City, California
94404-1167
Tenant: Pilot Network Services, Inc., a Delaware
corporation
Tenant's Address: 1080 Marina Village Parkway Alameda, California
94501
Premises: Approximately 31.200 rentable square feet as shown
on Exhibit A
---------
Premises Address: 2450 Mariner Square Loop
Alameda, California 94501
Building (Building C): Approximately 31,200
rentable square feet
Lot: APN 74-905-34
Park (Lincoln
Alameda Center): Approximately 62,400
rentable square feet
Term: The date ("Commencement Date") that is the earlier
of(i) the date that the Tenant Improvements (as
such term is defined in Exhibit B hereto) are
---------
Substantially Complete (as such term is defined in
Exhibit B hereto), or (ii) February, 15, 1999.
---------
subject to the provisions of Sections 6 and 7 of
Exhibit B hereto: through February 14. 2009
---------
("Expiration Date").
Base Rent ((P)3): See Addendum 1 for monthly Base Rent schedule
Security Deposit ((P)4): Initially a Security Deposit of One Hundred Fifty
Thousand Dollars ($150,000.00), which Security
Deposit may be decreased in amounts as set forth in
Section 4 hereof
*Tenant's Share of Operating Expenses ((P)6.1): 50% of the Park
*Tenant's Share of Tax Expenses ((P)6.2): 50% of the Park
*Tenant's Share of Common Area Utility Costs ((P)7): 50% of the Park
*Tenant's Share of Utility Expenses ((P)7): 100% of the Building
*The amount of Tenant's Share of the expenses as referenced above shall be
subject to modification as set forth in this Lease.
Permitted Uses ((P)9): Data and operations center, including associated
office and data center functions, but only to the
extent permitted by the City of Alameda and all
agencies and governmental authorities having
jurisdiction thereof
Unreserved
Parking Spaces: One hundred seven (107)non-exclusive and non-
designated spaces subject to the provisions of
Sections 24 and 41 hereof
Broker ((P)38): Sam Swan - Cushman Realty (for Tenant and Landlord)
Exhibits: Exhibit 4 - Premises, Building, Lot and or Park
Exhibit B - Tenant Improvements
Exhibit B-1 - Insurance Requirements
Exhibit B-2 - Building Standards
Exhibit C - Rules and Regulations
Exhibit D - Intentionally Omitted
Exhibit E - Hazardous Materials Disclosure
Certificate -Example
Exhibit F - Change of Commencement Date - Example
Exhibit G - Tenant's Initial Hazardous Materials
Disclosure Certificate
Exhibit H - Intentionally Omitted
Addenda: Addendum 1: Monthly Base Rent Schedule
Addendum 2: Options to Extend the Lease Term
Addendum 3: Right of First Refusal
1
<PAGE>
TABLE OF CONTENTS
-----------------
<TABLE>
<CAPTION>
SECTION PAGE
- ------- ----
<S> <C>
1. PREMISES........................................................ 3
2. COMMENCEMENT DATE; CONDITION OF THE PREMISES.................... 3
3. RENT............................................................ 3
4. SECURITY DEPOSIT................................................ 4
5. TENANT IMPROVEMENTS............................................. 4
6. ADDITIONAL RENT................................................. 4
7. UTILITIES....................................................... 8
8. LATE CHARGES.................................................... 10
9. USE OF PREMISES................................................. 10
10. ALTERATIONS AND ADDITIONS; AND SURRENDER OF PREMISES............ 11
11. REPAIRS AND MAINTENANCE......................................... 12
12. INSURANCE....................................................... 13
13. WAIVER OF SUBROGATION........................................... 14
14. LIMITATION OF LIABILITY AND INDEMNITY........................... 15
15. ASSIGNMENT AND SUBLEASING....................................... 15
16. AD VALOREM TAXES................................................ 17
17. SUBORDINATION................................................... 17
18. RIGHT OF ENTRY.................................................. 17
19. ESTOPPEL CERTIFICATE............................................ 18
20. TENANT'S DEFAULT................................................ 18
21. REMEDIES FOR TENANT'S DEFAULT................................... 19
22. HOLDING OVER.................................................... 20
23. LANDLORD'S DEFAULT.............................................. 20
24. PARKING......................................................... 20
25. SALE OF PREMISES................................................ 20
26. WAIVER.......................................................... 20
27. CASUALTY DAMAGE................................................. .21
28. CONDEMNATION.................................................... 21
29. ENVIRONMENTAL MATTERS/HAZARDOUS MATERIALS....................... 21
30. FINANCIAL STATEMENTS............................................ 22
31. GENERAL PROVISIONS.............................................. 24
32. SIGNS........................................................... 26
33. MORTGAGEE PROTECTION............................................ 26
34. MODIFICATIONS FOR LENDER........................................ 26
35. WARRANTIES OF TENANT............................................ 26
36. COMPLIANCE WITH AMERICANS WITH DISABILITIES ACT................. 26
37. BROKERAGE COMMISSION............................................ 27
38. QUIET ENJOYMENT................................................. 27
39. LANDLORD'S ABILITY TO PERFORM TENANT'S UNPERFORMED OBLIGATIONS.. 28
40. EXTERIOR ENCLOSURE.............................................. 28
41. EARLY TERMINATION OPTION........................................ 28
</TABLE>
2
<PAGE>
LEASE AGREEMENT
DATE: This Lease is made and entered into as of the Lease Date set forth on
Page 1. The Basic Lease Information set forth on Page 1 and this Lease
are and shall be construed as a single instrument.
1. Premises: Landlord hereby leases the Premises to Tenant upon the terms and
--------
conditions contained herein. Landlord hereby grants to Tenant a license for the
right to use, on a non-exclusive basis, parking areas and ancillary facilities
located within the Common Areas of the Park, subject to the terms of this Lease.
Landlord and Tenant hereby agree that for purposes of this Lease, as of the
Lease Date, the rentable square footage area of the Premises, the Building, the
Lot and the Park shall be deemed to be the number of rentable square feet as set
forth in the Basic Lease Information on Page 1. Tenant hereby acknowledges that
the rentable square footage of the Premises may include a proportionate share of
certain areas used in common by all occupants of the Building and/or the Park
(for example an electrical room or telephone room).
2. Commencement Date; Condition of the Premises:
--------------------------------------------
2.1 Landlord shall deliver possession of the Premises to Tenant initially
for the purpose of Tenant constructing the Tenant Improvements (as such term is
defined in Exhibit B hereto) upon full execution of this Lease and satisfaction
---------
of the conditions set forth in Section 2.2 below. The word "Term" whenever used
herein refers to the initial term of this Lease and any extension thereof. The
Term shall commence upon the Commencement Date, which shall not be subject to
extension, delay or adjustment for any reason whatsoever, except as otherwise
expressly set forth in Section 6 and Section 7 of Exhibit B hereto. By taking
---------
possession of the Premises, Tenant shall be deemed to have accepted the Premises
in good condition and state of repair. Tenant hereby acknowledges and agrees
that neither Landlord nor Landlord's agents or representatives has made any
representations or warranties as to the suitability, safety or fitness of the
Premises for the conduct of Tenant's business, Tenant's intended use of the
Premises or for any other purpose, except as expressly otherwise provided in
this Section 2. Landlord hereby represents to Tenant that, as of the Lease Date:
(i) Landlord has no actual (not constructive) knowledge that the shell
improvements presently existing on the Lot (excluding the Tenant Improvements
(as such term is defined in Exhibit B hereto) and any other alterations or
---------
additions to the Premises made by Tenant after the Lease Date) are presently in
violation of any applicable Laws, as such Laws are presently in effect as of the
Lease Date, and (ii)except as set forth or otherwise disclosed in that certain
Phase I Environmental Site Assessment, Project No. 81182.0013, dated October 8,
1996, prepared by ATC Environmental, Inc. (the "Phase I Report"), Landlord has
no actual (not constructive) knowledge of the presence of any Hazardous
Materials (defined in Section 29 hereof) in, on or under the Premises in
violation of applicable Laws, as such Laws are presently in effect as of the
Lease Date. Tenant hereby acknowledges and agrees that it has received and had
the opportunity to review and approve the Phase I Report prior to the execution
of this Lease. Tenant hereby further acknowledges and agrees that the
representations made by Landlord in this Section 2 are made to Landlord's actual
(not constructive) knowledge, without any duty to inquire or investigate and
without imputation of any knowledge from any third party.
2.2 Landlord shall permit Tenant to occupy the Premises after Tenant's
execution and delivery of this Lease to Landlord but prior to the Commencement
Date for purposes of planning and construction of the Tenant Improvements as
well as for purposes of installing in, on or about the Premises, Tenant's
personal property, equipment, fixtures, furnishings and any improvements not
included in the definition of the Tenant Improvements. Such pre-Commencement
Date occupancy shall be at Tenant's sole risk and subject to all the provisions
of this Lease other than the payment of Rent, including, but not limited to (a)
the requirement that Tenant obtain the insurance required pursuant to this Lease
and to deliver insurance certificates as required herein, and (b) the
requirement that Tenant pay to Landlord the Advance Rent and Security Deposit,
as required under Section 3 of this Lease. In addition to the foregoing,
Landlord shall have the right to impose such reasonable additional conditions on
Tenant's early entry as Landlord shall deem reasonably appropriate.
3. Rent: On the date that Tenant executes this Lease, Tenant shall deliver to
----
Landlord the original executed Lease, the amount of Forty-Seven Thousand Seven
Hundred Thirty-Six Dollars ($47,736.00) (the "Advance Rent") (which Advance Rent
shall be applied against the Rent payable by Tenant for the first month(s)
Tenant is required to commence paying Base Rent and Additional Rent), the
Security Deposit, and all insurance certificates evidencing the insurance
required to be obtained by Tenant under Section 12 of this Lease. Tenant agrees
to pay Landlord, without prior notice or demand, or abatement, offset, deduction
or claim, the Base Rent specified in the Basic Lease Information, payable in
advance at Landlord's address
3
<PAGE>
specified in the Basic Lease Information on the Commencement Date and thereafter
on the first (1st) day of each month throughout the balance of the Term of the
Lease. In addition to the Base Rent set forth in the Basic Lease Information,
Tenant shall pay Landlord in advance on the Commencement Date and thereafter on
the first (lst) day of each month throughout the balance of the Term of this
Lease, as Additional Rent, Tenant's Share of Operating Expenses, Tax Expenses,
Common Area Utility Costs and Utility Expenses. Tenant shall also pay to
Landlord as Additional Rent hereunder, immediately on Landlord's demand,
therefor, any and all reasonable costs and expenses incurred by Landlord to
enforce the provisions of this Lease, including, but not limited to, costs
associated with the delivery of notices, delivery and recordation of notice(s)
of default, reasonable attorneys' fees, expert fees, court costs and filing fees
(collectively, the "Enforcement Expenses"). The term "Rent" whenever used herein
refers to the aggregate of all these amounts. If Landlord permits Tenant to
occupy the Premises without requiring Tenant to pay rental payments for a period
of time, the waiver of the requirement to pay rental payments shall only apply
to waiver of the Base Rent and Tenant shall otherwise perform all other
obligations of Tenant required hereunder. The Rent for any fractional part of a
calendar month at the commencement or termination of the Lease term shall be a
prorated amount of the Rent for a full calendar month based upon a thirty (30)
day month. The prorated Rent shall be paid on the Commencement Date and the
first day of the calendar month in which the date of termination occurs, as the
case may be.
4. Security Deposit: Upon Tenant's execution of this Lease, Tenant shall
----------------
deliver to Landlord, as a Security Deposit for the performance by Tenant of its
obligations under this Lease, One Hundred Fifty Thousand Dollars ($150,000.00)
cash, in immediately available funds. So long as (i) there has not occurred any
default by Tenant during the first thirty-five (35) months of the initial Term,
and (ii) Tenant's total shareholder equity (as shown on Tenant's most recent
annual report) ("Shareholder Equity'") is at least Thirty Million Dollars
($30,000,000.00) for the prior three (3) fiscal quarters preceding the date on
which the following described reduction may be made, then on the fifteenth
(15/~h) /day of the thirty-sixth (36th) month of the initial Term, a portion of
the Security Deposit in the amount of Fifty Thousand Dollars ($50,000.00) plus
accrued interest on such amount shall be returned to Tenant by Landlord.
Additionally, so long as (i) there has not occurred any default by Tenant during
the first fifty-nine (59) months of the initial Term, and (ii) Tenant's
Shareholder Equity is at least Thirty-Five Million Dollars ($35,000,000.00) for
the prior three (3) fiscal quarters preceding the date on which the following
described reduction may be made, then on the fifteenth (15th) day of the
sixtieth (60th) month of the initial Term, another portion of the Security
Deposit in the amount of Fifty Thousand Dollars ($50,000.00) plus accrued
interest on such amount shall be returned to Tenant by Landlord. If Tenant is in
default, Landlord may, but without obligation to do so, use the Security
Deposit, or any portion thereof, to cure the default or to compensate Landlord
for all damages sustained by Landlord resulting from Tenant's default,
including, but not limited to, the Enforcement Expenses. Tenant shall, within
ten (10) days of Landlord's written demand, pay to landlord a sum equal to the
portion of the Security Deposit so applied or used so as to replenish the amount
of the Security Deposit held to increase such deposit to the amount required to
be on deposit with Landlord at the time of the default. Within thirty (30) days
after the termination of this Lease, Landlord shall return the portion of the
Security Deposit then being held by Landlord to Tenant, with accrued interest
thereon, less the amounts as are reasonably necessary to remedy Tenant's
default(s) hereunder or to otherwise restore the Premises to a clean and safe
condition, reasonable wear and tear excepted. If the cost to restore Premises
exceeds the amount of the portion of the Security Deposit then being held by
Landlord, Tenant shall promptly deliver to Landlord any and all of such excess
sums as reasonably determined by Landlord. Landlord shall keep the Security
Deposit separate from all other funds in an account which shall allow the
Security Deposit to earn interest at a rate equivalent to the then applicable
money market rate offered by Sanwa Bank or a comparable financial institution,
from time to time. In no event or circumstance shall Tenant have the right to
any use of the Security Deposit, and, specifically, Tenant may not use the
Security Deposit as a credit or to otherwise offset any payments required
hereunder, including, but not limited to, Rent or any portion thereof.
5. Tenant Improvements: Tenant shall install and construct the Tenant
-------------------
Improvements in accordance with the terms, conditions, criteria and provisions
set forth in Exhibit B. Landlord and Tenant hereby agree to and shall be bound
---------
by the terms, conditions and provisions of Exhibit B. Except for the work to be
---------
done by Tenant pursuant to Exhibit B, Tenant hereby accepts the Premises as
---------
suitable for Tenant's intended use and as being in good operating order,
condition and repair, and acknowledges and agrees that except as expressly
otherwise provided in Section 2 hereinabove, neither Landlord nor any of
Landlord's agents, representatives or employees has made any representations as
to the suitability, fitness or condition of the Premises for the conduct of
Tenant's business. Any exception to the foregoing provisions must be made by
express written agreement by both parties.
6. Additional Rent: It is intended by Landlord and Tenant that this Lease be
---------------
a "triple net lease." The costs and expenses described in this Section 6 and all
other sums, charges, costs and expenses specified in
4
<PAGE>
this Lease other than Base Rent are to be paid by Tenant to Landlord as
additional rent (collectively, "Additional Rent").
6.1 Operating Expenses: In addition to the Base Rent set forth in Section
3, Tenant shall pay Tenant's Share, which is specified in the Basic Lease
Information, of all Operating Expenses as Additional Rent. The term "Operating
Expenses" as used herein shall mean the total amounts paid or payable by
Landlord in connection with the ownership, maintenance, repair and operation of
the Premises, the Building and the Lot, and where applicable, of the Park
referred to in the Basic Lease Information. These Operating Expenses may
include, but are not limited to:
6.1.1 Landlord's cost of repairs to, and maintenance of, the roof,
the roof membrane (subject to Section 6.1.4 below) and the exterior walls
of the Building;
6.1.2 Landlord's cost of maintaining the outside paved area,
landscaping and other common areas for the Park. The term "Common Areas"
shall mean all areas and facilities within the Park exclusive of the
Premises and the other portions of the Park leasable exclusively to other
tenants. The Common Areas include, but are not limited to, interior
lobbies, mezzanines, parking areas, access and perimeter roads, sidewalks,
rail spurs, landscaped areas and similar areas and facilities;
6.1.3 Landlord's annual cost of insurance insuring against fire and
extended coverage (including, if Landlord elects, "all risk" or "special
purpose" coverage) and all other insurance, including, but not limited to,
earthquake, flood and/or surface water endorsements for the Building, the
Lot and the Park (including the Common Areas), rental value insurance
against loss of Rent in an amount equal to the amount of Rent for a period
of at least six (6) months commencing on the date of loss, and subject to
the provisions of Section 27 below, any deductible;
6.1.4 Landlord's cost off (i) modifications and/or new improvements
to the Building, the Common Areas and/or the Park occasioned by any rules,
laws or regulations effective subsequent to the date on which the Building
was originally constructed; (ii) reasonably necessary replacement
improvements to the Building, the Common Areas and the Park after the Lease
Date (including the Building roof membrane); and (iii) new improvements to
the Building, the Common Areas and/or the Park that reduce operating costs
or improve life/safety conditions, all as reasonably determined by
Landlord, in its sole discretion; provided, however, if any of the
foregoing are in the nature of capital improvements, then the cost of such
capital improvements shall be amortized on a straight-line basis over a
reasonable period, which shall not be less than the reasonably estimated
useful life of such modifications, new improvements or replacement
improvements in question (at an interest rate as reasonably determined by
Landlord), and Tenant shall pay Tenant's Share of the monthly amortized
portion of such costs (including interest charges) as part of the Operating
Expenses herein;
6.1.5 If Landlord elects to so procure, Landlord's cost of
preventative maintenance, and repair contracts including, but not limited
to, contracts for elevator systems and heating, ventilation and air
conditioning systems, lifts for disabled persons, and trash or refuse
collection;
6.1.6 Landlord's cost of security and fire protection services for
the Building and/or the Park, as the case may be, if in Landlord's sole
discretion such services are provided;
6.1.7 Landlord's establishment of reasonable reserves for
replacements and/or repairs of Common Area improvements, equipment and
supplies, and upon expiration or earlier termination of this Lease, Tenant
shall be appropriately credited for any such reserves to the extent
Landlord has not actually drawn upon such reserves;
6.1.8 Landlord's cost for the maintenance and repair of any licenses,
easements or other similar undertakings;
6.1.9 Landlord's cost of supplies, equipment, rental equipment and
other similar items used in the operation and/or maintenance of the Park;
6.1.10 Landlord's cost for the repairs and maintenance items set
forth in Section 11.2 below; and
6.1.11 Landlord's cost for the management and administration of the
Premises, the Building, the Common Areas and the Park, including without
limitation, a property management fee, accounting, auditing, billing, salaries
for clerical and supervisory employees (whether located within the
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Park or off-site) and all fees, licenses and permits related to the ownership,
operation and management of any portion of the Park.
Notwithstanding the foregoing, for purposes of this Lease, the term
"Operating Expenses" shall not include the following:
(i) interest, principal, points, fees and other financing costs on debt
(except in connection with the financing of items which may be included in
the definition of Operating Expenses herein) or amortization on any
mortgage or mortgages or any other debt instrument .made by Landlord
encumbering the Premises and/or Building (including the Lot on which the
Building is situated) or payments on any ground lease;
(ii) marketing costs, including leasing commissions, attorneys' fees in
connection with the negotiation and preparation of letters, deal memos,
letters of intent, leases, subleases and/or assignments, space planning
costs, and other costs and expenses incurred in connection with lease,
sublease and/or assignment negotiations and transactions with present or
prospective tenants or other occupants of the Building, including bad debt
expenses, attorneys' fees and other costs and expenditures incurred in
connection with disputes with present or prospective tenants or other
occupants of the Building;
(iii) real estate brokers' leasing commissions;
(iv) costs, including permit, license and inspection costs, incurred
with respect to the installation of other tenants' or occupants'
improvements made for tenants or other occupants in the Park or incurred in
renovating or otherwise improving, painting or redecorating space for
tenants or other occupants in the Park;
(v) the cost of providing any service directly to any tenant in the
Park which is reimbursed by that tenant;
(vi) any items for which Landlord is actually reimbursed by insurance
proceeds or by direct reimbursement by any other tenant of the Building or
Park;
(vii) costs of repairs or other work necessitated by fire, windstorm or
other casualty (excluding any commercially reasonable deductibles) and/or
costs of repair or other work necessitated by the exercise of the right of
eminent domain to the extent insurance proceeds or a condemnation award, as
applicable, is actually received by Landlord for such purposes; provided
such costs of repairs or other work shall be paid by the parties in
accordance with the provisions of Sections 27 and 28 below;
(viii) costs incurred by Landlord due to the violation solely by Landlord
or any tenant of the terms and conditions of any lease of space in the
Park;
(ix) overhead and profit increment paid to Landlord or to subsidiaries
or affiliates of Landlord for goods and/or services in the Building to the
extent the same exceeds the costs of such by unaffiliated third parties on
a competitive basis; or any costs included in Operating Expenses
representing an amount paid to a person, firm, corporation or other entity
related to Landlord which is in excess of the amount which would have been
paid in the absence of such relationship;
(x) Landlord's general corporate overhead and general administrative
expenses, including, but not limited to, salaries of officers and
executives of Landlord (other than any such costs and expenses to be paid
as part of the management fee referred to in Section 6.1.11 above);
(xi) advertising and promotional expenditures, and costs of signs
identifying the owner of the Building or other tenants' signs;
(xii) utility costs for which any tenant directly contracts with the
local public service company;
(xiii) costs associated with the investigation and/or remediation of
Hazardous Materials (hereafter defined) present in, on or about, the
Premises, the Building or the Park, unless such costs and expenses are the
responsibility of Tenant as provided in Section 29 of this Lease, in which
event such costs and expenses shall be paid solely by Tenant in accordance
with the provisions of Section 29 of this Lease;
(xiv) legal and accounting fees for preparation of Landlord's business
documents, including the preparation of any and all tax returns;
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(xv) any payments under a ground lease or master lease;
(xvi) costs which are actually paid and/or reimbursed to Landlord by any
contractor, manufacturer or supplier under any warranty;
(xvii) costs and expenses incurred by Landlord to perform its obligations
under Section 11.3 of this Lease;
(xviii) expenses resulting directly from the willful misconduct or gross
negligence of Landlord;
(xix) costs of purchasing, installing and replacing artwork, excluding
repair and maintenance required as a result of normal wear and tear, to the
extent properly capitalized under generally accepted accounting and
management practices; and
(xx) costs of repairs to the Building resulting solely and directly from
Landlord's failure to construct the Building in compliance with
governmental regulations, ordinances and laws effective at the time of
original construction of the Building to the extent such regulations,
ordinances and laws were made applicable to such construction.
6.2 Tax Expenses: In addition to the Base Rent set forth in Section 3,
Tenant shall pay its share, which is specified in the Basic Lease Information,
of all real property taxes applicable to the land and improvements included
within the Lot on which the Premises are situated and one hundred percent (100%)
of all personal property taxes now or hereafter assessed or levied against the
Premises or Tenant's personal property. Tenant shall also pay one hundred
percent (100%) of any increase in real property taxes attributable, in
Landlord's sole discretion, to any and all alterations, Tenant Improvements or
other improvements of any kind, which are above standard improvements
customarily installed for similar buildings located within the Building or the
Park (as applicable), whatsoever placed in, on or about the Premises for the
benefit of, at the request of, or by Tenant. The term "Tax Expenses" shall mean
and include, without limitation, any form of tax and assessment (general,
special, supplemental, ordinary or extraordinary), commercial rental tax,
payments under any improvement bond or bonds, license fees, license tax,
business license fee, rental tax, transaction tax, levy, or penalty imposed by
authority having the direct or indirect power of tax (including any city,
county, state or federal government, or any school, agricultural, lighting,
drainage or other improvement district thereof) as against any legal or
equitable interest of Landlord in the Premises, the Building, the Lot or the
Park, as against Landlord's right to rent, or as against Landlord's business of
leasing the Premises or the occupancy of Tenant or any other tax, fee, or
excise, however described, including, but not limited to, any value added tax,
or any tax imposed in substitution (partially or totally) of any tax previously
included within the definition of real property taxes, or any additional tax the
nature of which was previously included within the definition of real property
taxes. The term "Tax Expenses" shall not include any franchise, estate,
inheritance, net income, or excess profits tax imposed upon Landlord.
6.3 Payment of Expenses: Landlord shall estimate Tenant's Share of the
Operating Expenses and Tax Expenses for the calendar year in which the Lease
commences. Commencing on the Commencement Date, one-twelfth (1/12th)of this
estimated amount shall be paid by Tenant to Landlord, as Additional Rent, and
thereafter on the first (lst) day of each month throughout the remaining months
of such calendar year. Thereafter, Landlord may estimate such expenses as of the
beginning of each calendar year during the Term of this Lease and Tenant shall
pay one-twelfth (1/12th) of such estimated amount as Additional Rent hereunder
on the first (lst) day of each month during such calendar year and for each
ensuing calendar year throughout the Term of this Lease. Tenant's obligation to
pay Tenant's Share of Operating Expenses and Tax Expenses accrued during
Tenant's tenancy under this Lease shall survive the expiration or earlier
termination of this Lease.
6.4 Annual Reconciliation: By May 15/u' /of each calendar year, Landlord
shall endeavor to furnish Tenant with an accounting of actual Operating Expenses
and Tax Expenses. Within thirty (30) days of Landlord's delivery of such
accounting, Tenant shall pay to Landlord the amount of any underpayment.
Notwithstanding the foregoing, failure by Landlord to give such accounting by
such date shall not constitute a waiver by Landlord of its fight to collect any
of Tenant's underpayment at any time. Landlord shall credit the amount of any
overpayment by Tenant toward the next estimated monthly installment(s) falling
due, or where the Term of the Lease has expired, refund the amount of
overpayment to Tenant. If the Term of the Lease expires prior to the annual
reconciliation of expenses Landlord shall have the right to reasonably estimate
Tenant's Share of such expenses, and if Landlord determines that an underpayment
is due, Tenant hereby agrees that, if Tenant fails to pay to Landlord .the
amount of any underpayment within ten (10) days after the termination of this
Lease, Landlord shall be entitled to deduct such underpayment from Tenant's
Security Deposit. If Landlord reasonably determines that an overpayment has been
made by Tenant, Landlord shall refund said overpayment to Tenant within sixty
(60) days thereafter. Notwithstanding the
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foregoing, failure of Landlord to accurately estimate Tenant's Share of such
expenses or to otherwise perform such reconciliation of expenses shall not
constitute a waiver of Landlord's right to collect any of Tenant's underpayment
at any time during the Term of the Lease or at any time after the expiration or
earlier termination of this Lease.
6.5 Audit: After delivery to Landlord of at least thirty (30) days' prior
written notice, Tenant, at its sole cost and expense through any accountant or
other representative designated by it, shall have the right to examine and/or
audit the books and records evidencing such costs and expenses for the previous
one (1) calendar year, during Landlord's reasonable business hours but not more
frequently than once during any calendar year. Any such accounting firm
designated by Tenant may not be compensated on a contingency fee basis. The
results of any such audit (and any negotiations between the parties related
thereto) shall be maintained strictly confidential by Tenant and its accounting
firm or other representative and shall not be disclosed, published or otherwise
disseminated to any other party other than to Landlord and its authorized
agents. Landlord and Tenant shall use their best efforts to cooperate in such
negotiations and to promptly resolve any discrepancies between Landlord and
Tenant in the accounting of such costs and expenses. If through such audit it is
determined that there is a discrepancy of more than seven percent (7%) in the
amount of actual Operating Expenses, then Landlord shall reimburse Tenant for
the reasonable out-of- pocket accounting costs and expenses incurred by Tenant
in performing such audit, including Tenant's outside auditors or accountants.
However, if through such audit it is determined that there is a discrepancy of
four percent (4%) or less in the amount of actual Operating Expenses, then
Tenant shall reimburse Landlord for the reasonable staff and accounting costs
and expenses associated with Landlord's costs and expenses recurred by Landlord
in connection with Tenant performing such audit, including, without limitation,
those reasonable costs and expenses incurred by Landlord for any outside
accounting firms or auditors in connection with such audit.
7. Utilities:
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7.1 Additional Rent. Utility Expenses, Common Area Utility Costs and all other
sums or charges set forth in this Section 7 are considered part of Additional
Rent. In addition to the Base Rent set forth in Section 3 hereof, Tenant shall
pay the cost of all water, sewer use, sewer discharge fees and sewer connection
fees, gas, heat, electricity, refuse pickup, janitorial service, telephone and
other utilities billed or metered separately to the Premises and/or Tenant.
Tenant shall also pay Tenant's Share of any assessments or charges for utility
or similar purposes included within any tax bill for the Lot on which the
Premises are situated, including, without limitation, entitlement fees,
allocation unit fees, and/or any similar fees or charges, and any penalties
related thereto. For any such utility fees or use charges that are not billed or
metered separately to Tenant, including without limitation, water and refuse
pick up charges, Tenant shall pay to Landlord, as Additional Rent, without prior
notice or demand, on the Commencement Date and thereafter on the first (lst) day
of each month throughout the balance of the Term of this Lease the amount which
is attributable to Tenant's use of the utilities or similar services, as
reasonably estimated and determined by Landlord based upon factors such as size
of the Premises and intensity of use of such utilities by Tenant such that
Tenant shall pay the portion of such charges reasonably consistent with Tenant's
use of such utilities and similar services ("Utility Expenses"). If Tenant
disputes any such estimate or determination, then Tenant shall either pay the
estimated amount or cause the Premises to be separately metered at Tenant's sole
expense. In addition, Tenant shall pay to Landlord Tenant's Share of any Common
Area utility costs, fees, charges or expenses ("Common Area Utility Costs").
Tenant shall pay to Landlord one-twelfth (1/12th) of the estimated amount of
Tenant's Share of the Common Area Utility Costs on the Commencement Date and
thereafter on the first (1st) day of each month throughout the balance of the
Term of this Lease and any reconciliation thereof shall be substantially in the
same manner as specified in Section 6.4 above. Tenant acknowledges that the
Premises may become subject to the rationing of utility services or restrictions
on utility use as required by a public utility company, governmental agency or
other similar entity having jurisdiction thereof. Notwithstanding any such
rationing or restrictions on use of any such utility services, Tenant
acknowledges and agrees that its tenancy and occupancy hereunder shall be
subject to such rationing restrictions as may be imposed upon Landlord, Tenant,
the Premises, the Building or the Park, and Tenant shall in no event be excused
or relieved from any covenant or obligation to be kept or performed by Tenant by
reason of any such rationing or restrictions. Tenant further agrees to timely
and faithfully pay, prior to delinquency, any amount, tax, charge, surcharge,
assessment or imposition levied, assessed or imposed upon the Premises, or
Tenant's use and occupancy thereof. Landlord does not warrant that any of the
services referred to above will be free from interruption, and Tenant
acknowledges that any one or more of such services may be suspended by reason of
accident, repairs, inspections, alterations or improvements necessary to be
made, or by strikes or lockouts, or by reason of operation of law, or causes
beyond the reasonable control of Landlord. Any interruption or discontinuance of
service shall not be deemed an eviction or disturbance of Tenant's use and
possession of the Premises, or any part thereof. Landlord shall, however,
exercise reasonable diligence to restore any service so interrupted. Where the
cause of a service interruption is within the control of a public utility or
other public or quasi-public entity outside Landlord's control, notification to
such utility or entity of the service interruption and
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request to remedy the interruption shall constitute "reasonable diligence" by
Landlord to restore the interrupted service. Tenant shall be permitted to abate
its Base Rent after ten (10) consecutive business days of service interruption
until such service is restored, unless such service interruption is due to any
of the following, in which case there shall not be any abatement: Tenant's
failure to perform any of its obligations under this Lease or due to any
casualty or force majeure delays (which delays include without limitation,
delays in obtaining service from any public utility or other public or quasi-
public entity outside Landlord's control, governmental delays or moratoriums,
inclement weather and similar events outside of the reasonable control of
Landlord), or due to any failure by a Tenant's ASP (as set forth in Section 7.3
hereinbelow).
7.2 Notwithstanding anything to the contrary contained herein, if
permitted by applicable Laws, Landlord shall have the right at any time and from
time to time during the Term of this Lease to either contract for service from a
different company or companies (each such company shall be referred to herein as
an "Alternate Service Provider") other than the company or companies presently
providing electricity service for the Building or the Park (the "Electric
Service Provider") or continue to contract for service from the Electric Service
Provider, at Landlord's sole discretion. Tenant hereby agrees to cooperate with
Landlord, the Electric Service Provider, and any Alternate Service Provider at
all times and, as reasonably necessary, shall allow Landlord, the Electric
Service Provider, and any Alternate Service Provider reasonable access to the
Building's electric lines, feeders, risers, wiring, and any other machinery
within the Premises.
7.3 Tenant's ASP.
a. Landlord Approval Required. In the event that Tenant wishes
Landlord to utilize services of a particular Alternate Service Provider
("Tenant's ASP") for the Building (but not for any of the Common Areas),
Landlord shall give due consideration to approval of such Tenant's ASP, which
approval shall not be unreasonably withheld.
b. Conditions to Approval. Unless all of the following conditions are
satisfied to Landlord's satisfaction in a written agreement between the Tenant's
ASP and Landlord or by any other means acceptable to Landlord, it shall be
reasonable for Landlord to refuse its approval:
(i) No Start-Up Expense to Landlord. Landlord shall incur no
start-up expense whatsoever with respect to any aspect of Tenant's ASP's
provision of its services, including without limitation, the cost of
installation, hook-up charges, installation of meters and the like;
(ii) Tenant's ASP Supplies Insurance and Financial
Verification. Prior to commencement of any work in or about the Premises and/or
Building by Tenant's ASP, Tenant's ASP shall supply Landlord with verification
that, in Landlord's sole judgment, Tenant's ASP is (A) properly insured, and (B)
financially capable of covering any uninsured damage;
(iii) Tenant's ASP Will Follow Building Rules. Prior to the
commencement of any work in or about the Building by Tenant's ASP, Tenant's ASP
shall agree in writing to abide by such rules and regulations, job site rules,
and such other requirements as reasonably determined by Landlord to be necessary
to protect the Building and the interest of the Landlord;
(iv) Sufficient Space for Equipment and Materials. Landlord
reasonably determines that there is sufficient space in the Building for the
placement of all Tenant's ASP's equipment and materials, including, without
limitation, in any electrical risers;
(v) Tenant's ASP in Good Standing. Tenant's ASP is, in
Landlord's sole judgment, licensed, reputable and reliable, as shown in
documents acceptable to Landlord;
(vi) Compensation for Space. Tenant's ASP agrees, in a license
agreement signed by Landlord and Tenant's ASP, to compensate Landlord the amount
determined by Landlord for (A) space used in the Building for the storage and
maintenance of Tenant's ASP's equipment ("Tenant's ASP's Space"); and (B) all
costs that may be incurred by Landlord in arranging for access by Tenant's ASP's
personnel, security for Tenant's ASP's equipment, and any other such costs as
Landlord may incur;
(vii) Tenant's ASP Subject to Landlord's Supervision. Tenant's
ASP agrees that Landlord shall have the right to supervise Tenant's ASP's
performance of any work on or about the Building, including, without limitation,
any installations or repairs;
(viii) Tenant's ASP Must Give Landlord Access. Tenant's ASP
agrees that Landlord shall have the right to enter Tenant's ASP's Space at any
time in the event of an emergency and at all reasonable times and upon
reasonable notice for the purpose of (A) inspecting same; (B) making
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repairs to Tenant's ASP's Space and performing work therein as may be necessary,
in Landlord's judgment; or (C) exhibiting Tenant's ASP's Space for purposes of
sale, lease ground lease, or financing.
c. Approval Not a Landlord Warranty. Landlord's approval under this
Section shall not be deemed any kind of warranty or representation by Landlord,
including without limitation, as to the suitability or competence of Tenant's
ASP.
d. Tenant Responsible for Service Interruptions. Tenant acknowledges
and agrees that to the extent service by Tenant's ASP is interrupted, curtailed
or discontinued for whatever reason, Landlord shall have no obligation or
liability with respect thereto, including for abatement of rent under Section
7.1 hereinabove.
e. Tenant's ASP Indemnifies Landlord. Tenant's ASP shall indemnify,
protect, defend and hold harmless Landlord for all losses, claims, demands,
expenses, and judgments against Landlord caused by or arising out of, either
directly or indirectly, any acts or omissions by Tenant's ASP.
f. Landlord's Withholding of Approval. Notwithstanding any provision
herein to the contrary, the refusal of Landlord to give its approval to any
prospective Tenant's ASP shall not be deemed a default or breach by Landlord of
its obligations under this Lease unless and until Landlord is adjudicated in a
final and unappealable court decision to have acted recklessly or maliciously
with respect to its refusal.
g. Right to Terminate Tenant's ASP. Notwithstanding anything to the
contrary herein, Landlord shall have right at any time and from time to time
during the Term to terminate any contract or agreement for electrical service
with Tenant's ASP for any reasonable cause, including failure of the Tenant's
ASP to provide services of the quality and reliability anticipated, billing
discrepancies, or rate increases.
8. Late Charges: Any and all sums or charges set forth in this Section 8 are
------------
considered part of Additional Rent. Tenant acknowledges that late payment (the
fifth business day of each month or any time thereafter) by Tenant to Landlord
of Base Rent, Tenant's Share of Operating Expenses, Tax Expenses, Common Area
Utility Costs, and Utility Expenses or other sums due hereunder, will cause
Landlord to incur costs not contemplated by this Lease, the exact amount of such
costs being extremely difficult and impracticable to fix. Such costs include,
without limitation, processing and accounting charges, and late charges that may
be imposed on Landlord by the terms of any note secured by any encumbrance
against the Premises, and late charges and penalties due to the late payment of
real property taxes on the Premises. Therefore, if any installment of Rent or
any other sum due from Tenant is not received by Landlord when due, Tenant shall
promptly pay to Landlord all of the following, as applicable: (a) an additional
sum equal to six percent (6%) of such delinquent amount plus interest on such
delinquent amount at the rate equal to the prime rate for the time period such
payments are delinquent as a late charge for every month or portion thereof that
such sums remain unpaid, and (b) the amount of fifty dollars ($50) relating to
checks for which there are not sufficient funds. If Tenant delivers to Landlord
a check for which there are not sufficient funds, Landlord may, at its sole
option, require Tenant to replace such check with a cashier's check for the
amount of such check and all other charges payable hereunder. The parties agree
that this late charge and the other charges referenced above represent a fair
and reasonable estimate of the costs that Landlord will incur by reason of late
payment by Tenant. Acceptance of any late charge or other charges shall not
constitute a waiver by Landlord of Tenant's default with respect to the
delinquent amount, nor prevent Landlord from exercising any of the other fights
and remedies available to Landlord for any other breach of Tenant under this
Lease. If a late charge or other charge becomes payable for any three (3)
installments of Rent within any twelve (12) month period, then Landlord, at
Landlord's sole option, can either require the Rent be paid quarterly in
advance, or be paid monthly in advance by cashier's check or by electronic funds
transfer.
9. Use of Premises:
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9.1 Compliance with Laws, Recorded Matters, and Rules and Regulations: The
Premises are to be used solely for the purposes and uses specified in the Basic
Lease Information and for no other uses or purposes without Landlord's prior
written consent, which consent shall not be unreasonably withheld or delayed so
long as the proposed use (~i) does not involve the use of Hazardous Materials
other than as expressly permitted under the provisions of Section 29 below, (ii)
does not require any additional parking in excess of the parking spaces already
licensed to Tenant pursuant to the provisions of Section 24 of this Lease, and
(iii) is compatible and consistent with the other uses then being made in the
Park and in other similar types of buildings in the vicinity of the Park, as
reasonably determined by Landlord. The use of the Premises by Tenant and its
employees, representatives, agents, invitees, licensees, subtenants, customers
or contractors (collectively, "Tenant's Representatives") shall be subject to,
and at all times in
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compliance with, (a) any and all applicable laws, ordinances, statutes, orders
and regulations as same exist from time to time (collectively, the "Laws"), (b)
any and all documents, matters or instruments, including without limitation, any
declarations of covenants, conditions and restrictions, and any supplements
thereto, each of which has been or hereafter is recorded in any official or
public records with respect to the Premises, the Building, the Lot and/or the
Park, or any portion thereof (collectively, the "Recorded Matters"), and (c) any
and all rules and regulations set forth in Exhibit C, attached to and made a
---------
part of this Lease, and any other reasonable rules and regulations promulgated
by Landlord now or hereafter enacted relating to parking and the operation of
the Premises, the Building and the Park (collectively, the "Rules and
Regulations"). Tenant agrees to, and does hereby, assume full and complete
responsibility to ensure that the Premises are adequate to fully meet the needs
and requirements of Tenant's intended operations of its business within the
Premises, and Tenant's use of the Premises and that same are in compliance with
all applicable Laws throughout the Term of this Lease. Additionally, Tenant
shall be solely responsible for the payment of all costs, fees and expenses
associated with any modifications, improvements or alterations to the Premises,
Building, the Common Areas and/or the Park occasioned by the enactment of, or
changes to, any Laws arising from Tenant's particular use of the Premises or
alterations, improvements or additions made to the Premises regardless of when
such Laws became effective.
9.2 Prohibition on Use: Tenant shall not use the Premises or permit
anything to be done in or about the Premises nor keep or bring anything therein
which will in any way conflict with any of the requirements of the Board of Fire
Underwriters or similar body now or hereafter constituted or in any way increase
the existing rate of or affect any policy of fire or other insurance upon the
Building or any of its contents, or cause a cancellation of any insurance
policy. No auctions may be held or otherwise conducted in, on or about the
Premises, the Building, the Lot or the Park without Landlord's written consent
thereto, which consent may be given or withheld in Landlord's sole discretion.
Tenant shall not do or permit anything to be done in or about the Premises which
will in any way obstruct or interfere with the fights of Landlord, other tenants
or occupants of the Building, other buildings in the Park, or other persons or
businesses in the area, or injure or annoy other tenants or use or allow the
Premises to be used for any unlawful purpose, for the benefit, quiet enjoyment
and use by Landlord and all other tenants or occupants of the Building or other
buildings in the Park; nor shall Tenant cause, maintain or permit any private or
public nuisance in, on or about the Premises, Building, Park and/or the Common
Areas, including, but not limited to, any offensive odors, noises, fumes or
vibrations. Tenant shall not damage or deface or otherwise commit or suffer to
be committed any waste in, upon or about the Premises. Tenant shall not place or
store, nor permit any other person or entity to place or store, any property,
equipment, materials, supplies, personal property or any other items or goods
outside of the Premises for any period of time. Tenant shall not permit any
animals, including, but not limited to, any household pets (but excluding
seeing-eye dogs and other service animals when accompanied by their owners), to
be brought or kept in or about the Premises. Tenant shall place no loads upon
the floors, walls, or ceilings in excess of the maximum designed load permitted
by the applicable Laws, including the Uniform Building Code, or which may damage
the Building or outside areas; nor place any harmful liquids in the drainage
systems; nor dump or store waste materials, refuse or other such materials, or
allow such to remain outside the Building area, except for any non-hazardous or
non-harmful materials which may be stored in refuse dumpsters or in any enclosed
trash areas provided. Tenant shall honor the terms of all Recorded Matters
relating to the Premises, the Building, the Lot and/or the Park. Tenant shall
honor the Rules and Regulations.
10. Alterations and Additions; and Surrender of Premises:
----------------------------------------------------
10.1 Alterations and Additions: Tenant shall not install any signs,
fixtures, improvements, nor make or permit any other alterations or additions to
the Premises without the prior written consent of Landlord. If any such
alteration or addition is expressly permitted by Landlord, Tenant shall deliver
at least twenty (20) days prior notice to Landlord, from the date Tenant intends
to commence construction, sufficient to enable Landlord to post a Notice of Non-
Responsibility. In all events, Tenant shall obtain all permits or other
governmental approvals prior to commencing any of such work and deliver a copy
of same to Landlord. All alterations and additions shall be installed by a
licensed contractor approved by Landlord, at Tenant's sole expense in compliance
with all applicable Laws (including, but not limited to, the ADA as defined
herein), Recorded Matters, and Rules and Regulations. Tenant shall keep the
Premises and the property on which the Premises are situated free from any liens
arising out of any work performed, materials furnished or obligations incurred
by or on behalf of Tenant. As a condition to Landlord's consent to the
installation of any fixtures, additions or other improvements, Landlord may
require Tenant to post and obtain a completion and indemnity bond for ~p to one
hundred fifty percent (150%) of the cost of the work. Notwithstanding the above,
Landlord hereby acknowledges that Tenant intends to expand its data center
periodically throughout the Term, and Landlord agrees not to unreasonably
withhold its consent to such expansions, provided that each such expansion shall
comply with all applicable Laws and all requirements of this Lease, and shall
not affect the structural integrity of the Building.
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10.2 Surrender of Premises: Upon the termination of this Lease, whether by
forfeiture, lapse of time or otherwise, or upon the termination of Tenant's
fight to possession of the Premises, Tenant will at once surrender and deliver
up the Premises, together with the fixtures (other than trade fixtures),
alterations, additions and improvements which Landlord has notified Tenant, in
writing, that Landlord will require Tenant not to remove, to Landlord in good
condition and repair (including, but not limited to, replacing all light bulbs
and ballasts not in good working condition) and in the condition in which the
Premises existed as of the Commencement Date, except for reasonable wear and
tear. Reasonable wear and tear shall not include any damage or deterioration to
the floors of the Premises arising from the use of forklifts in, on or about the
Premises (including, without limitation, any marks or stains of any portion of
the floors), and any damage or deterioration that would have been prevented by
proper maintenance by Tenant or Tenant otherwise performing all of its
obligations under this Lease. Within ten (10) business days of Landlord's
receipt of Tenant's written notice of any item comprising fixtures (other than
trade fixtures), alterations, additions and improvements, together with Tenant's
request that Landlord notify Tenant, in writing, whether or not Landlord will
require Tenant to remove such item from the Premises upon the expiration or
earlier termination of this Lease, Landlord shall so notify Tenant. Upon such
termination of this Lease, Tenant shall remove all tenant signage, trade
fixtures, furniture, furnishings, personal property, additions, alterations,
data center improvements and equipment (including but not limited to the
Exterior Enclosure (as defined in Section 41), and any and all generators,
raised flooring, racks, drop wiring to racks, and other equipment, but excluding
data center HVAC and electric lines) and other improvements unless Landlord had
previously notified Tenant, in writing, that Tenant would be required not to
remove such fixtures (other than trade fixtures), alterations, additions or
improvements installed by, or on behalf of Tenant or situated in or about the
Premises. If Tenant did not request the notice described above in this Section
10.2 with request to any fixtures (other than trade fixtures), alterations,
additions or improvements, then by the date which is twenty (20) days prior to
such termination of this Lease, Landlord shall notify Tenant in writing of those
fixtures (other than trade fixtures), alterations, additions and other
improvements which Landlord shall require Tenant not to remove from the
Premises. Tenant shall repair any damage caused by the installation or removal
of such signs, trade fixtures, furniture, furnishings, fixtures, additions and
improvements which are to be removed from the Premises by Tenant hereunder. If
Tenant did not request the notice described above in this Section 10.2 with
request to any fixtures (other than trade fixtures), alterations, additions or
improvements, and if Landlord fails to so notify Tenant at least twenty (20)
days prior to such termination of this Lease, then Tenant shall remove all
tenant signage, alterations, furniture, furnishings, trade fixtures, additions
and other improvements (other than the Tenant Improvements) installed in or
about the Premises by, or on behalf of Tenant. Tenant shall ensure that the
removal of such items and the repair of the Premises will be completed prior to
such termination of this Lease.
11. Repairs and Maintenance:
------------------------
11.1 Tenant's Repairs and Maintenance Obligations: Except for those
portions of the Building to be maintained by Landlord, as provided in Sections
11.2 and 11.3 below, Tenant shall, at Tenant's sole cost and expense, keep and
maintain the Premises and the adjacent dock and staging areas in good, clean and
safe condition and repair to the reasonable satisfaction of Landlord including,
but not limited to, repairing any damage caused by Tenant or Tenant's
Representatives and replacing any property so damaged by Tenant or Tenant's
Representatives. Without limiting the generality of the foregoing, Tenant shall
be solely responsible for maintaining, repairing and replacing (a), all
mechanical systems, heating, ventilation and air conditioning systems
exclusively serving the Premises, (b) all plumbing, electrical wiring and
equipment serving the Premises, (c) all interior lighting (including, without
limitation, light bulbs and/or ballasts) and exterior lighting serving the
Premises, (d) all glass, windows, window frames, window casements, skylights,
interior and exterior doors, door frames and door closers, (e) all roll-up
doors, ramps and dock equipment, including without limitation, dock bumpers,
dock plates, dock seals, dock levelers and dock lights, (f) all tenant signage,
(g) lifts for disabled persons serving the Premises, (h) sprinkler systems, fire
protection systems and security systems serving the Premises, (i) all
partitions, fixtures, equipment, interior painting, and interior walls and
floors of the Premises and every part thereof (including, without limitation,
any demising walls contiguous to any portion of the Premises).
11.2 Reimbursable Repairs and Maintenance Obligations: Subject to the
provisions of Sections 6 and 9 of this Lease and except for (i) the obligations
of Tenant set forth in Section 11.1 above, (ii) the obligations of Landlord set
forth in Section 11.3 below, and (iii) the repairs rendered necessary by the
intentional or negligent acts or omissions of Tenant or any of Tenant's
Representatives, Landlord agrees, at Landlord's expense, subject to
reimbursement pursuant to Section 6 above, to keep in good repair the plumbing
and mechanical systems exterior to the Premises, any rail spur and rail
crossing, the roof (including the roof membrane, the amortized cost of the
replacement of which shall be subject to reimbursement by Tenant as set forth in
Section 6..1.4 above), exterior walls of the Building, signage (exclusive of
tenant signage), and exterior electrical wiring and equipment, exterior
lighting, exterior glass, exterior doors/entrances and door closers, exterior
window casements, exterior painting of the Building (exclusive of the Premises),
and underground utility and sewer pipes outside the exterior walls of the
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Building. For purposes of this Section 11.2, the term "exterior" shall mean
outside of and not exclusively serving the Premises. Unless otherwise notified
by Landlord, in writing, that Landlord has elected to procure and maintain the
following described contract(s), Tenant shall procure and maintain (a) the
heating, ventilation and air conditioning systems preventative maintenance and
repair contract(s); such contract(s) to be on a bi-monthly or quarterly basis,
as reasonably determined by Landlord, and (b) the fire and sprinkler protection
services and preventative maintenance and repair contract(s) (including, without
limitation, monitoring services); such contract(s) to be on a bi-monthly or
quarterly basis, as reasonably determined by Landlord. Landlord reserves the
right, but without the obligation to do so, to procure and maintain (i) the
heating, ventilation and air conditioning systems preventative maintenance and
repair contract(s), and/or (ii) the fire and sprinkler protection services and
preventative maintenance and repair contract(s) (including, without limitation,
monitoring services). If Landlord so elects to procure and maintain any such
contract(s), Tenant will reimburse Landlord for the cost thereof in accordance
with the provisions of Section 6 above. If Tenant procures and maintains any of
such contract(s), Tenant will promptly deliver to Landlord a true and complete
copy of each such contract and any and all renewals or extensions thereof, and
each service report or other summary received by Tenant pursuant to or in
connection with such contract(s).
11.3 Landlord's Repairs and Maintenance Obligations: Except for repairs
rendered necessary by the intentional or negligent acts or omissions of Tenant
or any of Tenant's Representatives, Landlord agrees, at Landlord's sole cost and
expense, to (a) keep in good repair the structural portions of the floors,
foundations and exterior perimeter walls of the Building (exclusive of glass and
exterior doors), and (b) replace the structural portions of the roof of the
Building (excluding the roof membrane, the amortized cost of the replacement of
which shall be subject to reimbursement by Tenant as set forth in Section 6.1.4
above) as, and when, Landlord reasonably determines such replacement to be
necessary in Landlord's sole discretion.
11.4 Tenant's Failure to Perform Repairs and Maintenance Obligations:
Except for normal maintenance and repair of the items described above, Tenant
shall have no fight of access to or fight to install any device on the roof of
the Building nor make any penetrations of the roof of the Building without the
express prior written consent of Landlord. If Tenant refuses or neglects to
repair and maintain the Premises and the adjacent areas properly as required
herein and to the reasonable satisfaction of Landlord, Landlord may, but without
obligation to do so, at any time make such repairs and/or maintenance without
Landlord having any liability to Tenant for any loss or damage that may accrue
to Tenant's merchandise, fixtures or other property, or to Tenant's business by
reason thereof, except to the extent any damage is caused by the willful
misconduct or gross negligence of Landlord or its authorized agents and
representatives; provided, however, that except in the event of a failure to
repair or maintain that creates an emergency, Landlord shall give Tenant notice
and an opportunity to cure, as set forth in Section 20.3 below, before Landlord
shall make such repairs and/or maintenance. In the event Landlord makes such
repairs and/or maintenance, upon completion thereof Tenant shall pay to
Landlord, as additional rent, the Landlord's costs for making such repairs
and/or maintenance, plus ten percent (10%) for overhead, upon presentation of a
bill therefor, plus any Enforcement Expenses. The obligations of Tenant
hereunder accrued during Tenant's tenancy under this Lease shall survive the
expiration of the Term of this Lease or the earlier termination thereof. Tenant
hereby waives any fight to repair at the expense of Landlord under any
applicable Laws now or hereafter in effect respecting the Premises.
12. Insurance:
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12.1 Types of Insurance: Tenant shall maintain in full force and effect at
all times during the Term of this Lease, at Tenant's sole cost and expense, for
the protection of Tenant and Landlord, as their interests may appear, policies
of insurance issued by a career or carriers reasonably acceptable to Landlord
and its lender(s) which afford the following coverages: (i) worker's
compensation: statutory limits; (ii) employer's liability, as required by law,
with a minimum limit of $100,000 per employee and $500,000 per occurrence; (iii)
commercial general liability insurance (occurrence form) providing coverage
against any and all claims for bodily injury and property damage occurring in,
on or about the Premises arising out of Tenant's and Tenant's Representatives'
use and/or occupancy of the Premises. Such insurance shall include coverage for
blanket contractual liability, fire damage, premises, personal injury, completed
operations, products liability, personal and advertising, and a plate-glass
rider to provide coverage for all glass in, on or about the Premises including,
without limitation, skylights. Such insurance shall have a combined single limit
of not less than One Million Dollars ($1,000,000) per occurrence with a Two
Million Dollar ($2,000,000) aggregate limit and excess/umbrella insurance in the
amount of Two Million Dollars ($2,000,000). If Tenant has other locations which
it owns or leases, the policy shall include an aggregate limit per location
endorsement. If necessary, as reasonably determined by Landlord, Tenant shall
provide for restoration of the aggregate limit; (iv) comprehensive automobile
liability insurance' a combined single limit of not less than $2,000,000 per
occurrence and insuring Tenant against liability for claims arising out of the
ownership, maintenance, or use of any owned, hired or non-owned automobiles; (v)
"all risk" or "special purpose" property insurance, including without
limitation, sprinkler leakage, boiler and machinery
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comprehensive form, if applicable, covering damage to or loss of any personal
property, trade fixtures, inventory, fixtures and equipment located in, on or
about the Premises, and in addition, coverage for earthquake sprinkler leakage
and business interruption of Tenant, together with, if the property of Tenant's
invitees is to be kept in the Premises, warehouser's legal liability or bailee
customers insurance for the full replacement cost of the property belonging to
invitees and located in the Premises. Such insurance shall be written on a
replacement cost basis (without deduction for depreciation) in an amount equal
to one hundred percent (100%) of the full replacement value of the aggregate of
the items referred to in this subparagraph (v); and (vi) such other insurance as
Landlord deems reasonably necessary and prudent or as may otherwise be required
by any of Landlord's lenders or joint venture partners.
12.2 Insurance Policies: Insurance required to be maintained by Tenant
shall be written by companies (i) licensed to do business in the State of
California, (ii) domiciled in the United States of America, and (iii) having a
"General Policyholders Rating" of at least A:X (or such higher rating as may be
required by a lender having a lien on the Premises) as set forth in the most
current issue of "A.M. Best's Rating Guides." Any deductible amounts under any
of the insurance policies required hereunder shall not exceed One Thousand
Dollars ($1,000). Tenant shall deliver to Landlord certificates of insurance and
true and complete copies of any and all endorsements required herein for all
insurance required to be maintained by Tenant hereunder at the time of execution
of this Lease by Tenant. Tenant shall, at least thirty (30) days prior to
expiration of each policy, furnish Landlord with certificates of renewal or
"binders" thereof. Each certificate shall expressly provide that such policies
shall not be cancelable or otherwise subject to modification except after thirty
(30) days prior written notice to the parties named as additional insureds as
required in this Lease (except for cancellation for nonpayment of premium, in
which event cancellation shall not take effect until at least ten (10) days'
notice has been given to Landlord). Tenant shall have the right to provide
insurance coverage which it is obligated to carry pursuant to the terms of this
Lease under a blanket insurance policy, provided such blanket policy expressly
affords coverage for the Premises and for Landlord as required by this Lease.
12.3 Additional Insureds and Coverage: Landlord, any property management
company and/or agent of Landlord for the Premises, the Building, the Lot or the
Park, and any lender(s) of Landlord having a lien against the Premises, the
Building, the Lot or the Park shall be named as additional insureds under all of
the policies required in Section 12.1(iii) above. Additionally, such policies
shall provide for severability of interest. All insurance to be maintained by
Tenant shall, except for workers' compensation and employer's liability
insurance, be primary, without fight of contribution from insurance maintained
by Landlord. Any umbrella/excess liability policy (which shall be in "following
form") shall provide that if the underlying aggregate is exhausted, the excess
coverage will drop down as primary insurance. The limits of insurance maintained
by Tenant shall not limit Tenant's liability under this Lease. It is the
parties' intention that the insurance to be procured and maintained by Tenant as
required herein shall provide coverage for any and all damage or injury arising
from or related to Tenant's operations of its business and/or Tenant's or
Tenant's Representatives' use of the Premises and/or any of the areas within the
Park, whether such events occur within the Premises (as described in Exhibit A
---------
hereto) or in any other areas of the Park. It is not contemplated or anticipated
by the parties that the aforementioned risks of loss be borne by Landlord's
insurance carriers, rather it is contemplated and anticipated by Landlord and
Tenant that such risks of loss be borne by Tenant's insurance carriers pursuant
to the insurance policies procured and maintained by Tenant as required herein.
12.4 Failure of Tenant to Purchase and Maintain Insurance: In the event
Tenant does not purchase the insurance required in this Lease or keep the same
in full force and effect throughout the Term of this Lease (including any
renewals or extensions), Landlord may, but without obligation to do so, purchase
the necessary insurance and pay the premiums therefor. If Landlord so elects to
purchase such insurance, Tenant shall promptly pay to Landlord as Additional
Rent, the amount so paid by Landlord, upon Landlord's demand therefor. In
addition, Landlord may recover from Tenant and Tenant agrees to pay, as
Additional Rent, any and all Enforcement Expenses and damages which Landlord may
sustain by reason of Tenant's failure to obtain and maintain such insurance. If
Tenant fails to maintain any insurance required in this Lease, Tenant shall be
liable for all losses, damages and costs resulting from such failure.
13. Waiver of Subrogation: Landlord and Tenant hereby mutually waive their
---------------------
respective rights of recovery against each other for any loss of, or damage to,
either parties' property to the extent that such loss or damage is insured by an
insurance policy required to be in effect at the time of such loss or damage.
Each party shall obtain any special endorsements, if required by its insurer
whereby the insurer waives its rights of subrogation against the other party.
This provision is intended to waive fully, and for the benefit of the parties
hereto, any rights and/or claims which might give rise to a right of subrogation
in favor of any insurance carrier. The coverage obtained by Tenant pursuant to
Section 12 of this Lease shall include, without limitation, a waiver of
subrogation endorsement attached to the certificate of insurance. The provisions
of this Section 13 shall not apply in those instances in which such waiver of
subrogation would
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invalidate such insurance coverage or would cause either party's insurance
coverage to be voided or otherwise uncollectible.
14. Limitation of Liability and Indemnity: Except to the extent of damage
-------------------------------------
resulting from the gross negligence or willful misconduct of Landlord or its
authorized representatives, Tenant agrees to protect, defend (with counsel
acceptable to Landlord) and hold Landlord and Landlord's lenders, partners,
members, property management company (if other than Landlord), agents,
directors, officers, employees, representatives, contractors, shareholders,
successors and assigns and each of their respective partners, members,
directors, employees, representatives, agents, contractors, shareholders,
successors and assigns (collectively, the "Indemnitees") harmless and indemnify
the Indemnitees from and against all liabilities, damages, claims, losses,
judgments, charges and expenses (including reasonable attorneys' fees, costs of
court and expenses necessary in the prosecution or defense of any litigation
including the enforcement of this provision) arising from or in any way related
to, directly or indirectly, (i) Tenant's or Tenant's Representatives' use of the
Premises, Building and/or the Park, (ii) the conduct of Tenant's business, (iii)
from any activity, work or thing done, permitted or suffered by Tenant in or
about the Premises, (iv) any liability for injury to person or property of
Tenant, Tenant's Representatives, or third party persons, and/or (v) Tenant's
failure to perform any covenant or obligation of Tenant under this Lease. Tenant
agrees that the obligations of Tenant herein accrued during Tenant's tenancy
under this Lease shall survive the expiration or earlier termination of this
Lease.
Except to the extent of damage resulting from the gross negligence or
willful misconduct of Landlord or its authorized representatives, to the fullest
extent permitted by law, Tenant agrees that neither Landlord nor any of
Landlord's lender(s), partners, members, employees, representatives, legal
representatives, successors or assigns shall at any time or to any extent
whatsoever be liable, responsible or in any way accountable for any loss,
liability, injury, death or damage to persons or property which at any time may
be suffered or sustained by Tenant or by any person(s) whomsoever who may at any
time be using, occupying or visiting the Premises, the Building or the Park,
including, but not limited to, any acts, errors or omissions by or on behalf of
any other tenants or occupants of the Building and/or the Park. Tenant shall
not, in any event or circumstance, be permitted to offset or otherwise credit
against any payments of Rent required herein for matters for which Landlord may
be liable hereunder. Landlord and its authorized representatives shall not be
liable for any interference with light or air, or for any latent defect in the
Premises or the Building.
15. Assignment and Subleasing:
-------------------------
15.1 Prohibition: Except as otherwise set forth below in Section 15.4 with
respect to a Related Entity, Tenant shall not assign, mortgage, hypothecate,
encumber, grant any license or concession, pledge or otherwise transfer this
Lease (collectively, "assignment"), in whole or in part, whether voluntarily or
involuntarily or by operation of law, nor sublet or permit occupancy by any
person other than Tenant of all or any portion of the Premises without first
obtaining the prior written consent of Landlord, which consent shall not be
unreasonably withheld. Tenant hereby agrees that Landlord may withhold its
consent to any proposed sublease or assignment if the proposed sublessee or
assignee or its business is subject to compliance with additional requirements
of the ADA (defined below) and/or Environmental Laws (defined below) beyond
those requirements which are applicable to Tenant, unless the proposed sublessee
or assignee shall (a) first deliver plans and specifications for complying with
such additional requirements and obtain Landlord's written consent thereto, and
Co) comply with all Landlord's conditions for or contained in such consent,
including without limitation, requirements for security to assure the lien-free
completion of such improvements. If Tenant seeks to sublet or assign all or any
portion of the Premises, Tenant shall deliver to Landlord at least thirty (30)
days prior to the proposed commencement of the sublease or assignment (the
"Proposed Effective Date") the following: (i) the name of the proposed assignee
or sublessee; (ii) such information as to such assignee's or sublessee's
financial responsibility and standing as Landlord may reasonably require; and
(iii) the aforementioned plans and specifications, if any. Within five (5)
business days after Landlord's receipt of a written request from Tenant that
Tenant seeks to sublet or assign all or any portion of the Premises, Landlord
shall deliver to Tenant a copy of Landlord's standard form of sublease or
assignment agreement (as applicable), which instrument shall be utilized for
each proposed sublease or assignment (as applicable), and such instrument shall
include a provision whereby the assignee or sublessee assumes all of Tenant's
obligations hereunder and agrees to be bound by the terms hereof. As Additional
Rent hereunder, Tenant shall reimburse Landlord for actual legal and other
expenses incurred by Landlord in connection with any actual or proposed
assignment or subletting. In the event the sublease or assignment (1) by itself
or taken together with prior sublease(s) or partial assignment(s) covers or
totals, as the case may be, more than one-third (1/3) of the rentable square
feet of the Premises or (2) is for a term which by itself or taken together with
prior or other subleases or partial assignments either (x) is greater than fifty
percent (50%) of the period remaining in the Term of this Lease as of the time
of the Proposed Effective Date, or (y) extends through all or substantially all
of the Term through the Termination Date (as defined in Section
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41 hereinbelow) then Landlord shall have the right, to be exercised by giving
written notice to Tenant, to recapture the space described in the sublease or
assignment. If such recapture notice is given, it shall serve to terminate this
Lease with respect to the proposed sublease or assignment space, or, if the
proposed sublease or assignment space covers all the Premises, it shall serve to
terminate the entire term of this Lease in either case, as of the Proposed
Effective Date. However, no termination of this Lease with respect to part or
all of the Premises shall become effective without the prior written consent,
where necessary, of the holder of each deed of trust encumbering the Premises or
any part thereof. If this Lease is terminated pursuant to the foregoing with
respect to less than the entire Premises, the Rent shall be adjusted on the
basis of the proportion of square feet retained by Tenant to the square feet
originally demised and this Lease as so amended shall continue thereafter in
full force and effect. Each permitted assignee of sublessee shall assume and be
deemed to assume this Lease and shall be and remain liable jointly and severally
with Tenant for payment of Rent and for the due performance of, and compliance
with all the terms, covenants, conditions and agreements herein contained on
Tenant's part to be performed or complied with, for the term of this Lease. No
assignment or subletting shall affect the continuing primary liability of Tenant
(which, following assignment, shall be joint and several with the assignee), and
Tenant shall not be released from performing any of the terms, covenants and
conditions of this Lease. Tenant hereby acknowledges and agrees that it
understands that Landlord's accounting department may process and accept Rent
payments without verifying that such payments are being made by Tenant, a
permitted sublessee or a permitted assignee in accordance with the provisions of
this Lease. Although such payments may be processed and accepted by such
accounting department personnel, any and all actions or omissions by the
personnel of Landlord's accounting department shall not be considered as
acceptance by Landlord of any proposed assignee or sublessee nor shall such
actions or omissions be deemed to be a substitute for the requirement that
Tenant obtain Landlord's prior written consent to any such subletting or
assignment, and any such actions or omissions by the personnel of Landlord's
accounting department shall not be considered as a voluntary relinquishment by
Landlord of any of its rights hereunder nor shall any voluntary relinquishment
of such rights be inferred therefrom. For purposes hereof, in the event Tenant
is a corporation, partnership, joint venture, trust or other entity other than a
natural person, any change in the direct or indirect ownership of Tenant
(whether pursuant to one or more transfers) which results in a change of more
than fifty percent (50%) in the direct or indirect ownership of Tenant shall be
deemed to be an assignment within the meaning of this Section 15 and shall be
subject to all the provisions hereof; provided, however, if such change occurs
due to Tenant's issuance of additional shares of common stock for purposes of
raising additional capital, such change shall not be deemed an assignment under
this Section 15. Any and all options, first rights of refusal, tenant
improvement allowances and other similar rights granted to Tenant in this Lease,
if any, shall not be assignable by Tenant unless expressly authorized in writing
by Landlord.
15.2 Excess Sublease Rental or Assignment Consideration: In the event of
any sublease or assignment of all or any portion of the Premises where the rent
or other consideration provided for in the sublease or assignment either
initially or over the term of the sublease or assignment exceeds the Rent or pro
rata portion of the Rent, as the case may be, for such space reserved in the
Lease, Tenant shall pay the Landlord monthly, as Additional Rent, at the same
time as the monthly installments of Rent are payable hereunder, seventy-five
percent (75%) of the excess of each such payment of rent or other consideration
in excess of the Rent called for hereunder, after deduction of customarily
market-based leasing commissions actually paid for said sublease and costs and
expenses actually paid by Tenant for reasonable attorneys' fees.
15.3 Waiver: Notwithstanding any assignment or sublease, or any
indulgences, waivers or extensions of time granted by Landlord to any assignee
or sublessee, or failure by Landlord to take action against any assignee or
sublessee, Tenant agrees that Landlord may, at its option, proceed against
Tenant without having taken action against or joined such assignee or sublessee,
except that Tenant shall have the benefit of any indulgences, waivers and
extensions of time granted to any such assignee or sublessee.
15.4 Related Entities: Notwithstanding anything to the contrary contained
in this Section 15, so long as Tenant delivers to Landlord (1) at least thirty
(30) days prior written notice of its intention to assign or sublease the
Premises to any Related Entity, which notice shall set forth the name of the
Related Entity, (2) a copy of the proposed agreement pursuant to which such
assignment or sublease shall be effectuated, and (3) such other information
concerning the Related Entity as Landlord may reasonably require, including
without limitation, information regarding any change in the proposed use of any
portion of the Premises and any financial information with respect to such
Related Entity, and so long as (i) any change in the proposed use of the subject
portion of the Premises is in conformance with the uses permitted to be made
under this Lease and do not involve the use or storage of any Hazardous
Materials (other than nominal amounts of ordinary household cleaners, office
supplies and janitorial supplies which are not regulated by any Environmental
Laws), and (ii) at the time of the proposed assignment or sublease, the net
profits and financial condition of the Related Entity is reasonably adequate and
sufficient in relation to the then remaining obligations of Tenant under this
Lease, then Tenant may assign this Lease or sublease any portion of the Premises
(X) to any Related Entity, or (Y) in connection with any merger, consolidation
or sale of substantially all of the assets of Tenant, without having to obtain
the prior written consent of Landlord thereto. For purposes of this Lease the
term "Related Entity" shall mean and refer to any corporation or entity which
controls, is controlled by or is under common control with Tenant, as all of
such
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terms are customarily used in the industry. Notwithstanding anything to the
contrary of the foregoing, any Related Entity must have a Shareholder Equity of
at least Thirty-Five Million Dollars ($35,000,000,00) for the prior three (3)
fiscal quarters preceding the effective date of such assignment or sublease.
16. Ad Valorem Taxes: Prior to delinquency, Tenant shall pay all taxes and
----------------
assessments levied upon trade fixtures, alterations, additions, improvements,
inventories and personal property located and/or installed on or in the Premises
by, or on behalf of, Tenant; and if requested by Landlord, Tenant shall promptly
deliver to Landlord copies of receipts for payment of all such taxes and
assessments. To the extent any such taxes are not separately assessed or billed
to Tenant, Tenant shall pay the amount thereof as invoiced by Landlord.
17. Subordination: Without the necessity of any additional document being
-------------
executed by Tenant for the purpose of effecting a subordination, and at the
election of Landlord or any bona fide mortgagee or deed of trust beneficiary
with a lien on all or any portion of the Premises or any ground lessor with
respect to the land of which the Premises are a part, the rights of Tenant under
this Lease and this Lease shall be subject and subordinate at all times to: (i)
all ground leases or underlying leases which may now exist or hereafter be
executed affecting the Building or the land upon which the Building is situated
or both, and (ii) the lien of any mortgage or deed of trust which may now exist
or hereafter be executed in any amount for which the Building, the Lot, ground
leases or underlying leases, or Landlord's interest or estate in any of said
items is specified as security. Notwithstanding the foregoing, Landlord or any
such ground lessor, mortgagee, or any beneficiary shall have the fight to
subordinate or cause to be subordinated any such ground leases or underlying
leases or any such liens to this Lease. Landlord shall use commercially
reasonable and diligent efforts to obtain from any such ground lessor,
mortgagee, or beneficiary a non-disturbance agreement for the benefit of Tenant,
on a form reasonably acceptable to Landlord, the subject ground lessor,
mortgagee, or beneficiary, and Tenant. If any ground lease or underlying lease
terminates for any reason or any mortgage or deed of trust is foreclosed or a
conveyance in lieu of foreclosure is made for any reason, Tenant shall,
notwithstanding any subordination and upon the request of such successor to
Landlord, attorn to and become the Tenant of the successor in interest to
Landlord, provided such successor in interest will not disturb Tenant's use,
occupancy or quiet enjoyment of the Premises and will recognize Tenant's fights
under this Lease, so long as Tenant is not in default of the terms and
provisions of this Lease. The successor in interest to Landlord following
foreclosure, sale or deed in lieu thereof shall not be (a) liable for any act or
omission of any prior lessor or with respect to events occurring prior to
acquisition of ownership; (b) subject to any offsets or defenses which Tenant
might have against any prior lessor; (c) bound by prepayment of more than one
(1) month's Rent, except in those instances when Tenant pays Rent quarterly in
advance pursuant to Section 8 hereof, then not more than three months' Rent; or
(d) liable to Tenant for any Security Deposit not actually received by such
successor in interest to the extent any portion or all of such Security Deposit
has not already been forfeited by, or refunded to, Tenant. Landlord shall be
liable to Tenant for all or any portion of the Security Deposit not forfeited
by, or refunded to Tenant, until and unless Landlord transfers such Security
Deposit to the successor in interest. Tenant covenants and agrees to execute
(and acknowledge if required by Landlord, any lender or ground lessor) and
deliver, within ten (10) days of a demand or request by Landlord and in a form
reasonably acceptable to Landlord, such ground lessor or lender, and Tenant, any
additional documents evidencing the priority or subordination of this Lease with
respect to any such ground leases or underlying leases or the lien of any such
mortgage or deed of trust. Tenant's failure to timely execute and deliver such
additional documents shall at Landlord's option, constitute a material default
hereunder. It is further agreed that Tenant shall be liable to Landlord, and
shall indemnify Landlord from and against any loss, cost, damage or expense,
incidental, consequential, or otherwise, arising or accruing directly or
indirectly, from any failure of Tenant to execute or deliver to Landlord any
such additional documents, together with any and all Enforcement Expenses.
18. Right of Entry: Tenant grants Landlord or its agents the right to enter the
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Premises at all reasonable times (upon twenty-four (24) hours' advance notice,
except in the event of an emergency) for purposes of inspection, exhibition,
posting of notices, repair or alteration, provided that, except in the event of
an emergency, Tenant shall have the fight to require that Landlord and its
agents be accompanied by a designated representative of Tenant, and if Tenant
shall so require Tenant shall make such designated representative reasonably
available). At Landlord's option, Landlord shall at all times have and retain a
key with which to unlock all the doors in, upon and about the Premises,
excluding Tenant's vaults, safes and data center. It is further agreed that
Landlord shall have the fight to use any and all means Landlord deems necessary
to enter the Premises in an emergency) Landlord shall have the right to place
"for rent" or "for lease" signs on the outside of the Premises, the Building and
in the Common Areas. Landlord shall also have the fight to place "for sale"
signs on the outside of the Building and in the Common Areas. Tenant hereby
waives any claim from damages or for any injury or inconvenience to or
interference with Tenant's business, or any other loss occasioned thereby except
for any claim for any of the foregoing arising out of the gross negligence or
willful misconduct of Landlord or its authorized representatives.
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19. Estoppel Certificate: Tenant shall execute (and acknowledge if required by
--------------------
any lender or ground lessor) and deliver to Landlord, within ten (10) days after
Landlord provides such to Tenant, a statement in writing certifying that this
Lease is unmodified and in full three and effect (or, if modified, stating the
nature of such modification), the date to which the Rent and other charges are
paid in advance, if any, acknowledging that there are not, to Tenant's
knowledge, any uncured defaults on the part of Landlord hereunder or specifying
such defaults as are claimed, and such other matters as Landlord may reasonably
require. Any such statement may be conclusively relied upon by Landlord and any
prospective purchaser or encumbrancer of the Premises. Tenant's failure to
deliver such statement within such time shall be conclusive upon the Tenant that
(a) this Lease is in full force and effect, without modification except as may
be represented by Landlord; (b) there are no uncured defaults in Landlord's
performance; and (c) not more than one month's Rent has been paid in advance,
except in those instances when Tenant pays Rent quarterly in advance pursuant to
Section 8 hereof, then not more than three month's Rent has been paid in
advance. Failure by Tenant to so deliver such certified estoppel certificate
shall be a material default of the provisions of this Lease. Tenant shall be
liable to Landlord, and shall indemnify Landlord from and against any loss,
cost, damage or expense, incidental, consequential, or otherwise, arising or
accruing directly or indirectly, from any failure of Tenant to execute or
deliver to Landlord any such certified estoppel certificate, together with any
and all Enforcement Expenses.
20. Tenant's Default: The occurrence of any one or more of the following events
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shall, at Landlord's option, constitute a material default by Tenant of the
provisions of this Lease:
20.1 The abandonment of the Premises by Tenant or the vacation of the
Premises by Tenant which would cause any insurance policy to be invalidated or
otherwise lapse. Tenant agrees to notice and service of notice as provided for
in this Lease;
20.2 The failure by Tenant to make any payment of Rent, Additional Rent or
any other payment required hereunder within five (5) days of the date said
payment is due. Tenant agrees to notice and service of notice as provided for in
this Lease;
20.3 The failure by Tenant to observe, perform or comply with any of the
conditions, covenants or provisions of this Lease (except failure to make any
payment of Rent and/or Additional Rent) and such failure is not cured within (i)
thirty (30) days of the date on which Landlord delivers written notice of such
failure to Tenant for all failures other than with respect to obtaining and
providing evidence of insurance as required under Section 12 hereof, and other
than with respect to Hazardous Materials (defined in Section 29 hereof), and
(ii) ten (10) days of the date on which Landlord delivers written notice of such
failure to Tenant for all failures in any way related to obtaining and providing
evidence of insurance or related to Hazardous Materials. However, Tenant shall
not be in default of its obligations hereunder if such failure cannot reasonably
be cured within such thirty (30) or ten (10) day period, as applicable, and
Tenant promptly commences, and thereafter diligently proceeds with same to
completion, all actions necessary to cure such failure as soon as is reasonably
possible, but in no event shall the completion of such cure be later than
seventy-five (75) days after the date on which Landlord delivers to Tenant
written notice of such failure, unless Landlord, acting reasonably and in good
faith, otherwise expressly agrees in writing to a longer period of time based
upon the circumstances relating to such failure as well as the nature of the
failure and the nature of the actions necessary to cure such failure;
20.4 The making of a general assignment by Tenant for the benefit of
creditors, the filing of a voluntary petition by Tenant or the filing of an
involuntary petition by any of Tenant's creditors seeking the rehabilitation,
liquidation, or reorganization of Tenant under any law relating to bankruptcy,
insolvency or other relief of debtors and, in the case of an involuntary action,
the failure to remove or discharge the same within sixty (60) days of such
filing, the appointment of a receiver or other custodian to take possession of
substantially all of Tenant's assets or this leasehold, Tenant's insolvency or
inability to pay Tenant's debts or failure generally to pay Tenant's debts when
due, any court entering a decree or order directing the winding up or
liquidation of Tenant or of substantially all of Tenant's assets, Tenant taking
any action toward the dissolution or winding up of Tenant's affairs, the
cessation or suspension of Tenant's use of the Premises, or the attachment,
execution or other judicial seizure of substantially all of Tenant's assets or
this leasehold; or
20.5 Tenant's use or storage of Hazardous Materials in, on or about the
Premises, the Building, the Lot and/or the Park other than as expressly
permitted by the provisions of Section 29 below.
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21. Remedies for Tenant's Default:
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21.1 Landlord's Rights: In the event of Tenant's material default under
this Lease, Landlord may terminate Tenant's right to possession of the Premises
by any lawful means in which case upon delivery of written notice by Landlord
this Lease shall terminate on the date specified by Landlord in such notice and
Tenant shall immediately surrender possession of the Premises to Landlord. In
addition, the Landlord shall have the immediate right of re-entry whether or not
this Lease is terminated, and if this right of re-entry is exercised following
abandonment of the Premises by Tenant, Landlord may consider any personal
property belonging to Tenant and left on the Premises to also have been
abandoned. No re-entry or taking possession of the Premises by Landlord pursuant
to this Section 21 shall be construed as an election to terminate this Lease
unless a written notice of such intention is given to Tenant. If Landlord relets
the Premises or any portion thereof, (i) Tenant shall be liable immediately to
Landlord for all reasonable costs Landlord incurs in reletting the Premises or
any part thereof, including, without limitation, broker's commissions, expenses
of cleaning the Premises and other similar costs (collectively, the "Reletting
Costs"), and (ii) the rent received by Landlord from such reletting shall be
applied to the payment of, first, any indebtedness from Tenant to Landlord other
than Base Rent, Operating Expenses, Tax Expenses, Common Area Utility Costs, and
Utility Expenses; second, all costs including maintenance, incurred by Landlord
in reletting; and, third, Base Rent, Operating Expenses, Tax Expenses, Common
Area Utility Costs, Utility Expenses, and all other sums due under this Lease.
Any and all of the Reletting Costs shall be fully chargeable to Tenant and shall
not be prorated or otherwise amortized in relation to any new lease for the
Premises or any portion thereof. After deducting the payments referred to above,
any sum remaining from the rental Landlord receives from reletting shall be held
by Landlord and applied in payment of future Rent as Rent becomes due under this
Lease. In no event shall Tenant be entitled to any excess rent received by
Landlord. Reletting may be for a period shorter or longer than the remaining
term of this Lease. No act by Landlord other than giving written notice to
Tenant shall terminate this Lease. Acts of maintenance, efforts to relet the
Premises or the appointment of a receiver on Landlord's initiative to protect
Landlord's interest under this Lease shall not constitute a termination of
Tenant's fight to possession. So long as this Lease is not terminated, Landlord
shall have the fight to remedy any default of Tenant, to maintain or improve the
Premises, to cause a receiver to be appointed to administer the Premises and new
or existing subleases and to add to the Rent payable hereunder all of Landlord's
reasonable costs in so doing, with interest at the maximum rate permitted by law
from the date of such expenditure.
21.2 Damages Recoverable: If Tenant breaches this Lease and abandons the
Premises before the end of the Term, or if Tenant's right to possession is
terminated by Landlord because of a breach or default under this Lease, then in
either such case, Landlord may recover from Tenant all damages suffered by
Landlord as a result of Tenant's failure to perform its obligations hereunder,
including, but not limited to, the cost of any Tenant Improvements constructed
by or on behalf of Tenant pursuant to Exhibit B hereto, the portion of any
---------
broker's or leasing agent's commission incurred with respect to the leasing of
the Premises to Tenant for the balance of the Term of the Lease remaining after
the date on which Tenant is in default of its obligations hereunder, and all
Reletting Costs, and the worth at the time of the award (computed in accordance
with paragraph (3) of Subdivision (a) of Section 1951.2 of the California Civil
Code) of the amount by which the Rent then unpaid hereunder for the balance of
the Lease Term exceeds the amount of such loss of Rent for the same period which
Tenant proves could be reasonably avoided by Landlord and in such case, Landlord
prior to the award, may relet the Premises for the purpose of mitigating damages
suffered by Landlord because of Tenant's failure to perform its obligations
hereunder; provided, however, that even though Tenant has abandoned the Premises
following such breach, this Lease shall nevertheless continue in full force and
effect for as long as Landlord does not terminate Tenant's right of possession,
and until such termination, Landlord shall have the remedy described in Section
1951.4 of the California Civil Code (Landlord may continue this Lease in effect
after Tenant's breach and abandonment and recover Rent as it becomes due, if
Tenant has the fight to sublet or assign, subject only to reasonable
limitations) and may enforce all its fights and remedies under this Lease,
including the fight to recover the Rent from Tenant as it becomes due hereunder.
The "worth at the time of the award" within the meaning of Subparagraphs (a)(1)
and (a)(2) of Section 1951.2 of the California Civil Code shall be computed by
allowing interest at the rate of ten percent (10%) per annum. Tenant waives
redemption or relief from forfeiture under California Code of Civil Procedure
Sections 1174 and 1179, or under any other present or future law, in the event
Tenant is evicted or Landlord takes possession of the Premises by reason of any
default of Tenant hereunder.
21.3 Rights and Remedies Cumulative: The foregoing fights and remedies of
Landlord are not exclusive; they are cumulative in addition to any rights and
remedies now or hereafter existing at law, in equity by statute or otherwise, or
to any equitable remedies Landlord may have, and to any remedies Landlord may
have under bankruptcy laws or laws affecting creditor's rights generally. In
addition to all remedies set forth above, if Tenant materially defaults beyond
any applicable notice and cure period under this Lease, any and all Base Rent
waived by Landlord under Section 3 above shall be immediately due and payable to
Landlord and all options granted to Tenant hereunder shall automatically
terminate, unless otherwise expressly agreed to in writing by Landlord.
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22. Holding Over: If Tenant holds possession of the Premises after the
------------
expiration of the Term of this Lease with Landlord's consent, Tenant shall
become a tenant from month-to-month upon the terms and provisions of this Lease,
provided the monthly Base Rent during such hold over period shall be 125% of the
Base Rent due on the last month of the Lease Term two (2) months of such hold
over period, and thereafter 150% of the Base Rent due on the last month of the
Lease Term, in either case payable in advance on or before the first day of each
month. Acceptance by Landlord of the monthly Base Rent without the additional
fifty percent (50%) increase of Base Rent shall not be deemed or construed as a
waiver by Landlord of any of its fights to collect the increased amount of the
Base Rent as provided herein at any time. Such month-to-month tenancy shall not
constitute a renewal or extension for any further term. All options, if any,
granted under the terms of this Lease shall be deemed automatically terminated
and be of no force or effect during said month-to-month tenancy. Tenant shall
continue in possession until such tenancy shall be terminated by either Landlord
or Tenant giving written notice of termination to the other party at least
thirty (30) days prior to the effective date of termination. This paragraph
shall not be construed as Landlord's permission for Tenant to hold over.
Acceptance of Base Rent by Landlord following expiration or termination of this
Lease shall not constitute a renewal of this Lease.
23. Landlord's Default: Landlord shall not be deemed in breach or default of
------------------
this Lease unless Landlord fails within a reasonable time to perform an
obligation required to be performed by Landlord hereunder. For purposes of this
provision, a reasonable time shall not be less than thirty (30) days after
receipt by Landlord of written notice specifying the nature of the obligation
Landlord has not performed; provided, however, that if the nature of Landlord's
obligation is such that more than thirty (30) days, after receipt of written
notice, is reasonably necessary for its performance, then Landlord shall not be
in breach or default of this Lease if performance of such obligation is
commenced within such thirty (30) day period and thereafter diligently pursued
to completion.
24. Parking: Tenant shall have a license to use at no charge the number of non-
-------
designated and non-exclusive parking spaces specified in the Basic Lease
Information. Landlord shall exercise reasonable efforts to ensure that such
parking spaces are available to Tenant for its use, but Landlord shall not be
required to enforce Tenant's fight to use the same. Notwithstanding the
foregoing or anything contained herein to the contrary, the actual number of
parking spaces available for use by Tenant shall be reduced by the actual number
of parking spaces used by Tenant in connection with, and for, the Exterior
Enclosure (as defined in Section 41).
25. Sale of Premises: In the event of any sale of the Premises by Landlord or
----------------
the cessation otherwise of Landlord's interest therein, Landlord shall be and is
hereby entirely released from any and all of its obligations to perform or
further perform under this Lease and from all liability hereunder accruing from
or after the date of such sale; and the purchaser, at such sale or any
subsequent sale of the Premises shall be deemed, without any further agreement
between the parties or their successors in interest or between the parties and
any such purchaser, to have assumed and agreed to carry out any and all of the
covenants and obligations of the Landlord under this Lease. For purposes of this
Section 25, the term "Landlord" means only the owner and/or agent of the owner
as such parties exist as of the date on which Tenant executes this Lease. A
ground lease or similar long term lease by Landlord of the entire Building, of
which the Premises are a part, shall be deemed a sale within the meaning of this
Section 25. Tenant agrees to attorn to such new owner provided such new owner
does not disturb Tenant's use, occupancy or quiet enjoyment of the Premises so
long as Tenant is not in default of any of the provisions of this Lease.
26. Waiver: No delay or omission in the exercise of any right or remedy of
------
Landlord on any default by Tenant shall impair such a right or remedy or be
construed as a waiver. The subsequent acceptance of Rent by Landlord after
default by Tenant of any covenant or term of this Lease shall not be deemed a
waiver of such default, other than a waiver of timely payment for the particular
Rent payment involved, and shall not prevent Landlord from maintaining an
unlawful detainer or other action based on such breach. No payment by Tenant or
receipt by Landlord of a lesser amount than the monthly Rent and other sums due
hereunder shall be deemed to be other than on account of the earliest Rent or
other sums due, nor shall any endorsement or statement on any check or
accompanying any check or payment be deemed an accord and satisfaction; and
Landlord may accept such check or payment without prejudice to Landlord's fight
to recover the balance of such Rent or other sum or pursue any other remedy
provided in this Lease. No failure, partial exercise or delay on the part of the
Landlord in exercising any fight, power or privilege hereunder shall operate as
a waiver thereof.
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27. Casualty Damage: If the Premises or any part thereof shall be damaged by
---------------
fire or other casualty, Tenant shall give prompt written notice thereof to
Landlord. In case the Building shall be so damaged by fire or other casualty
that substantial alteration or reconstruction of the Building shall, in
Landlord's sole opinion, be required (whether or not the Premises shall have
been damaged by such fire or other casualty), Landlord may, at its option,
terminate this Lease by notifying Tenant in writing of such termination within
ninety (90) days after the date of such damage, in which event the Rent shall be
abated as of the date of such damage. In addition to the foregoing, if the
Premises or any part thereof shall be damaged by fire or other casualty such
that the reparation of such damage or casualty shall, in Landlord's reasonable
judgment, require more than one hundred fifty (150) days to complete (subject to
extension for 90 days for force majeure delays (which delays include without
limitation, delays in obtaining permits, delaying in processing of any insurance
claim, governmental delays or moratoriums, inclement weather and similar events
outside of the reasonable control of Landlord), and extension for delays
attributable to Tenant's or any of Tenant's Representatives' acts or omissions),
then either Tenant or Landlord may terminate this Lease by notifying the other
party of such election to terminate this Lease within thirty (30) days after the
date of Landlord's determination of the extent of such damage (which
determination shall be made within ninety (90) days after the date of such
damage), in which event the Rent shall be abated as of the date of such damage.
If neither party exercises its rights to so elect to terminate this Lease in
accordance with the aforesaid provisions, and provided insurance proceeds and
any contributions from Tenant, if necessary, are available to fully repair the
damage, Landlord shall within one hundred twenty (120) days after the date of
such damage commence to repair and restore the Building and shall proceed with
reasonable diligence to restore the Building (except that Landlord shall not be
responsible for delays outside its control) to substantially the same condition
in which it was immediately prior to the happening of the casualty; provided,
Landlord shall not be required to rebuild, repair, or replace any part of
Tenant's furniture, furnishings, fixtures and/or equipment removable by Tenant
or any improvements, alterations or additions installed by or for the benefit of
Tenant under the provisions of this Lease. Landlord shall not in any event be
required to spend for such work an amount in excess of the insurance proceeds
(excluding any deductible) and any contributions from Tenant, if necessary,
actually received by Landlord as a result of the fire or other casualty.
Landlord shall not be liable for any inconvenience or annoyance to Tenant,
injury to the business of Tenant, loss of use of any part of the Premises by the
Tenant or loss of Tenant's personal property resulting in any way from such
damage or the repair thereof, except that, subject to the provisions of the next
sentence, Landlord shall allow Tenant a fair diminution of Rent during the time
and to the extent the Premises are unfit for occupancy. Notwithstanding anything
to the contrary contained herein, if the Premises or any other portion of the
Building be damaged by fire or other casualty resulting from the intentional or
negligent acts or omissions of Tenant or any of Tenant's Representatives, (i)
the Rent shall not be diminished during the repair of such damage, (ii) Tenant
shall not have any fight to terminate this Lease due to the occurrence of such
casualty or damage, and (iii) Tenant shall be liable to Landlord for the cost
and expense of the repair and restoration of all or any portion of the Building
caused thereby (including, without limitation, any deductible) to the extent
such cost and expense is not covered by insurance proceeds. In the event the
holder of any indebtedness secured by the Premises requires that the insurance
proceeds be applied to such indebtedness, then Landlord shall have the right to
terminate this Lease by delivering written notice of termination to Tenant
within thirty (30) days after the date of notice to Tenant of any such event,
whereupon all rights and obligations shall cease and terminate hereunder except
for those obligations expressly intended to survive any such termination of this
Lease. Except as otherwise provided in this Section 27, Tenant hereby waives the
provisions of Sections 1932(2.), 1933(4.), 1941 and 1942 of the California Civil
Code.
28. Condemnation: If twenty-five percent (25%) or more of the Premises is
------------
condemned by eminent domain, inversely condemned or sold in lieu of condemnation
for any public or quasi-public use or purpose ("Condemned"), then Tenant or
Landlord may terminate this Lease as of the date when physical possession of the
Premises is taken and title vests in such condemning authority, and Rent shall
be adjusted to the date of termination. Tenant shall not because of such
condemnation assert any claim against Landlord or the condemning authority for
any compensation because of such condemnation, and Landlord shall be entitled to
receive the entire amount of any award without deduction for any estate of
interest or other interest of Tenant; provided, however, the foregoing
provisions shall not preclude Tenant, at Tenant's sole cost and expense, from
obtaining any separate award to Tenant for loss of or damage to Tenant's trade
fixtures and removable personal property or for damages for cessation or
interruption of Tenant's business, provided such award is separate from
Landlord's award and provided further such separate award does not diminish or
impair the award otherwise payable to Landlord. In addition to the foregoing,
Tenant shall be entitled to seek compensation for the costs recoverable by
Tenant pursuant to the provisions of California Government Code Section 7262. If
neither party elects to terminate this Lease, Landlord shall, if necessary,
promptly proceed to restore the Premises or the Building to substantially its
same condition prior to such partial condemnation, allowing for the reasonable
effects of such partial condemnation, and a proportionate allowance shall be
made to Tenant, as solely determined by Landlord, for the Rent corresponding to
the time during which, and to the part of the Premises of which, Tenant is
deprived on account of such partial
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condemnation and restoration. Landlord shall not be required to spend funds for
restoration in excess of the amount received by Landlord as compensation
awarded.
29. Environmental Matters/Hazardous Materials:
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29.1 Hazardous Materials Disclosure Certificate: Prior to executing this
Lease, Tenant has completed, executed and delivered to Landlord Tenant's initial
Hazardous Materials Disclosure Certificate (the "Initial HazMat Certificate"), a
copy of which is attached hereto as Exhibit G and incorporated herein by this
---------
reference. Tenant covenants, represents and warrants to Landlord that the
information on the Initial HazMat Certificate is true and correct and accurately
describes the use(s) of Hazardous Materials which will be made and/or used on
the Premises by Tenant. Tenant shall commencing with the date which is one year
from the Commencement Date and continuing every year thereafter, complete,
execute, and deliver to Landlord, a Hazardous Materials Disclosure Certificate
(the "HazMat Certificate") describing Tenant's present use of Hazardous
Materials on the Premises, and any other reasonably necessary documents as
requested by Landlord. The HazMat Certificate required hereunder shall be in
substantially the form as that which is attached hereto as Exhibit E.
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29.2 Definition of Hazardous Materials: As used in this Lease, the term
Hazardous Materials shall mean and include (a) any hazardous or toxic wastes,
materials or substances, and other pollutants or contaminants, which are or
become regulated by any Environmental Laws; (b) petroleum, petroleum by
products, gasoline, diesel fuel, crude oil or any fraction thereof; (c) asbestos
and asbestos containing material, in any form, whether friable or non-friable;
(d) polychlorinated biphenyls; (e) radioactive materials; (f) lead and lead-
containing materials; (g) any other material, waste or substance displaying
toxic, reactive, ignitable or corrosive characteristics, as all such terms are
used in their broadest sense, and are defined or become defined by any
Environmental Law (defined below); or (h) any materials which cause or threatens
to cause a nuisance upon or waste to any portion of the Premises, the Building,
the Lot, the Park or any surrounding property; or poses or threatens to pose a
hazard to the health and safety of persons on the Premises or any surrounding
property.
29.3 Prohibition; Environmental Laws: Tenant shall not be entitled to use
nor store any Hazardous Materials on, in, or about the Premises, the Building,
the Lot and the Park, or any portion of the foregoing, without, in each
instance, obtaining Landlord's prior written consent thereto. If Landlord
consents to any such usage or storage, then Tenant shall be permitted to use
and/or store only those Hazardous Materials that are necessary for Tenant's
business and to the extent disclosed in the HazMat Certificate and as expressly
approved by Landlord in writing, provided that such usage and storage is only to
the extent of the quantities of Hazardous Materials as specified in the then
applicable HazMat Certificate as expressly approved by Landlord and provided
further that such usage and storage is in full compliance with any and all
local, state and federal environmental, health and/or safety-related laws,
statutes, orders, standards, courts' decisions, ordinances, roles and
regulations (as interpreted by judicial and administrative decisions), decrees,
directives, guidelines, permits or permit conditions, currently existing and as
amended, enacted, issued or adopted in the future which are or become applicable
to Tenant or all or any portion of the Premises (collectively, the
"Environmental Laws"). Tenant agrees that any changes to the type and/or
quantities of Hazardous Materials specified in the most recent HazMat
Certificate may be implemented only with the prior written consent of Landlord,
which consent may be given or withheld in Landlord's sole discretion. Tenant
shall not be entitled nor permitted to install any tanks under, on o(about the
Premises for the storage of Hazardous Materials without the express written
consent of Landlord, which may be given or withheld in Landlord's sole
discretion. Landlord shall have the right at all times during the Term of this
Lease to (i) inspect the Premises, (ii) conduct tests and investigations to
determine whether Tenant is in compliance with the provisions of this Section
29, and (iii)request lists of all Hazardous Materials used, stored or otherwise
located on, under or about any portion of the Premises and/or the Common Areas.
The cost of all such inspections, tests and investigations shall be
proportionately borne by Tenant commensurate with the extent of Hazardous
Materials revealed by any such inspection, test or investigation (such
determination to be made by one or more environmental consultants jointly
selected by Landlord and Tenant) to be present in, on or about the Premises
and/or the Common Areas due to the acts or omissions of Tenant or any of
Tenant's Representatives and all other costs and expenses shall be borne by
parties other than Tenant. The aforementioned rights granted herein to Landlord
and its representatives shall not create (a) a duty on Landlord's part to
inspect, test, investigate, monitor or otherwise observe the Premises or the
activities of Tenant and Tenant's Representatives with respect to Hazardous
Materials, including without limitation, Tenant's operation, use and any
remediation related thereto, or (b) liability on the part of Landlord and its
representatives for Tenant's use, storage, disposal or remediation of Hazardous
Materials, it being understood that Tenant shall be solely responsible for all
liability in connection therewith.
29.4 Tenant's Environmental Obligations: Tenant shall give to Landlord
immediate verbal and follow-up written notice of any spills, releases,
discharges, disposals, emissions, migrations, removals or transportation of
Hazardous Materials on, under or about any portion of the Premises or in any
Common
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Areas of which Tenant has knowledge. Tenant, at its sole cost and expense,
covenants and warrants to promptly investigate, clean up, remove, restore and
otherwise remediate (including, without limitation, preparation of any
feasibility studies or reports and the performance of any and all closures) any
spill, release, discharge, disposal, emission, migration or transportation of
Hazardous Materials arising from or related to the intentional or negligent acts
or omissions of Tenant or Tenant's Representatives such that the affected
portions of the Park and any adjacent property are returned to the condition
existing prior to the appearance of such Hazardous Materials. Any such
investigation, clean up, removal, restoration and other remediation shall only
be performed after Tenant has obtained Landlord's prior written consent, which
consent shall not be unreasonably withheld so long as such actions would not
potentially have a material adverse long-term or short-term effect on any
portion of the Premises, the Building, the Lot or the Park. Notwithstanding the
foregoing, Tenant shall be entitled to respond immediately to an emergency
without first obtaining Landlord's prior written consent. Tenant, at its sole
cost and expense, shall conduct and perform, or cause to be conducted and
performed, all closures as required by any Environmental Laws or any agencies or
other governmental authorities having jurisdiction thereof. If Tenant fails to
so promptly investigate, clean up, remove, restore, provide closure or otherwise
so remediate, Landlord may, but without obligation to do so, take any and all
steps necessary to rectify the same and Tenant shall promptly reimburse
Landlord, upon demand, for all costs and expenses to Landlord of performing
investigation, clean up, removal, restoration, closure and remediation work. All
such work undertaken by Tenant, as required herein, shall be performed in such a
manner so as to enable Landlord to make full economic use of the Premises, the
Building, the Lot and the Park after the satisfactory completion of such work.
29.5 Tenant's Environmental Indemnity: In addition to Tenant's obligations
as set forth hereinabove but subject to the provisions of Section 29.8 below,
Tenant agrees to, and shall, protect, indemnify, defend (with counsel acceptable
to Landlord) and hold Landlord and the other Indemnitees harmless from and
against any and all claims, judgments, damages, penalties, fines, liabilities,
losses (including, without limitation, diminution in value of any portion of the
Premises, the Building, the Lot or the Park, damages for the loss of or
restriction on the use of rentable or usable space, and from any adverse impact
of Landlord's marketing of any space within the Building and/or Park), suits,
administrative proceedings and costs (including, but not limited to, reasonable
attorneys' and consultant fees and court costs) arising at any time during or
after the Term of this Lease in connection with or related to, directly or
indirectly, the use, presence, transportation, storage, disposal, migration,
removal, spill, release or discharge of Hazardous Materials on, in or about any
portion of the Premises, the Common Areas, the Building, the Lot or the Park as
a result (directly or indirectly) of the intentional or negligent acts or
omissions of Tenant or any of Tenant's Representatives. Neither the written
consent of Landlord to the presence, use or storage of Hazardous Materials in,
on, under or about any portion of the Premises, the Building, the Lot and/or the
Park, nor the strict compliance by Tenant with all Environmental Laws shall
excuse Tenant from its obligations of indemnification pursuant hereto. Tenant
shall not be relieved of its indemnification obligations under the provisions of
this Section 29.5 due to Landlord's status as either an "owner" or "operator"
under any Environmental Laws.
29.6 Landlord's Environmental Indemnity: In addition to the provisions of
Section 29.8 below, Landlord agrees to, and shall, protect, indemnify, defend
(with counsel reasonably acceptable to Tenant) and hold Tenant and Tenant's
partners, members, agents, directors, officers, employees, representatives,
contractors, shareholders, successors and assigns and each of their respective
partners, members, directors, employees, representatives, agents, contractors,
shareholders, successors and assigns Tenant's Indemnities harmless from and
against any and all claims, judgments, damages, penalties, fines, liabilities,
losses, suits, administrative proceedings and costs (including reasonable
attorneys' and consultant fees and court costs) (collectively, "Costs") arising
at any time during or after the Term of this Lease as a result of the presence
of pre-existing Hazardous Materials situated on, in or about any portion of the
Premises, the Building or the Lot to the extent said Hazardous Materials are
present in, on or under any of the foregoing prior to the Lease Date; provided,
however, such indemnity shall not include Costs to the extent attributable to
the acts or omissions of Tenant or any of Tenant's Representatives contributing
to the presence of such Hazardous Materials, or to the extent Tenant and/or any
of Tenant's Representatives exacerbates the pre-existing conditions caused by
such pre-existing Hazardous Materials, including, but not limited to, by
Tenant's failure to comply in full with all Environmental Laws with respect to
the Premises, the Building, the Lot, the Common Areas and the Park.
29.7 Survival: Tenant's obligations and liabilities pursuant to the
provisions of this Section 29 and Landlord's obligations pursuant to the
provisions of Section 29.6 which have accrued during Tenant's tenancy under this
Lease shall survive the expiration or earlier termination of this Lease. If it
is determined by Landlord, based upon advice from Landlord's environmental
consultants, that the condition of all or any portion of the Premises, the
Building, the Lot and/or the Park is not in compliance with the provisions of
this Lease with respect to Tenant's obligations regarding Hazardous Materials,
including without limitation all Environmental Laws at the expiration or earlier
termination of this Lease, Tenant shall return the Premises to Landlord in the
condition in which the Premises existed as of the Lease Date and prior to the
appearance of such Hazardous Materials except for reasonable wear and tear,
including without limitation,
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the conduct or performance of any closures as required by any Environmental
Laws. For purposes hereof, the term "reasonable wear and tear" shall not include
any deterioration in the condition or diminution of the value of any portion of
the Premises, the Building, the Lot and/or the Park in any manner whatsoever
related to directly, or indirectly, Hazardous Materials.
29.8 Exculpation of Tenant: Tenant shall not be liable to Landlord for nor
otherwise obligated to Landlord under any provision of the Lease with respect to
the following: (i)any claim, remediation, obligation, investigation, obligation,
liability, cause of action, attorney's fees, consultants' cost, expense or
damage resulting from any Hazardous Materials present in, on or about the
Premises or the Building to the extent not caused nor otherwise permitted,
directly or indirectly, by Tenant or Tenant's Representatives; or (ii) the
removal, investigation, monitoring or remediation of any Hazardous Material
present in, on or about the Premises or the Building directly caused by any
source, including third parties, other than Tenant or Tenant's Representatives;
provided, however, Tenant shall be fully liable for and otherwise obligated to
Landlord under the provisions of this Lease for all liabilities, costs, damages,
penalties, claims, judgments, expenses (including without limitation, attorneys'
and experts' fees and costs) and losses to the extent (a) Tenant or any of
Tenant's Representatives contributes to the presence of such Hazardous
Materials, or Tenant and/or any of Tenant's Representatives exacerbates the
conditions caused by such Hazardous Materials, or (b) Tenant and/or Tenant's
Representatives allows or permits persons over which Tenant or any of Tenant's
Representatives has control, and/or for which Tenant or any of Tenant's
Representatives are legally responsible for, to cause such Hazardous Materials
to be present in, on, under, through or about any portion of the Premises, the
Common Areas, the Building or the Park, or (c) Tenant and/or any of Tenant's
Representatives does not take all reasonably appropriate actions to prevent such
persons over which Tenant or any of Tenant's Representatives has control and/or
for which Tenant or any of Tenant's Representatives are legally responsible from
causing the presence of Hazardous Materials in, on, under, through or about any
portion of the Premises, the Common Areas, the Building or the Park.
30. Financial Statements: Tenant and any Related Entity of Tenant, for the
--------------------
reliance of Landlord, any lender holding or anticipated to acquire a lien upon
the Premises, the Building or the Park or any portion thereof, or any
prospective purchaser of the Building or the Park or any portion thereof, within
ten (10) days after Landlord's request therefor, but not more often than once
annually so long as Tenant or any Related Entity of Tenant, as the case may be,
is not in default of this Lease, shall deliver to Landlord the then current
audited financial statements of Tenant or any Related Entity of Tenant, as the
case may be, (including interim periods following the end of the last fiscal
year for which annual statements are available) which statements shall be
prepared or compiled by a certified public accountant and shall present fairly
the financial condition of Tenant or any Related Entity of Tenant, as the case
may be, at such dates and the result of its operations and changes in its
financial positions for the periods ended on such dates. If an audited financial
statement has not been prepared, Tenant or any Related Entity of Tenant, as the
case may be, shall provide Landlord with an unaudited financial statement and/or
such other information, the type and form of which are acceptable to Landlord in
Landlord's reasonable discretion, which reflects the financial condition of
Tenant or any Related Entity of Tenant, as the Case may be. If Landlord so
requests, Tenant or any Related Entity of Tenant, as the case may be, shall
deliver to Landlord an opinion of a certified public accountant, including a
balance sheet and profit and loss statement for the most recent prior year, all
prepared in accordance with generally accepted accounting principles
consistently applied. Any and all options granted to Tenant or any Related
Entity of Tenant, as the case may be, hereunder shall be subject to and
conditioned upon Landlord's reasonable approval of Tenant's or any Related
Entity's, as the case may be, financial condition at the time of Tenant's or any
Related Entity's, as the case may be, exercise of any such option.
31. General Provisions:
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31.1 Time. Time is of the essence in this Lease and with respect to each
and all of its provisions in which performance is a factor.
31.2 Successors and Assigns. The covenants and conditions herein
contained, subject to the provisions as to assignment, apply to and bind the
heirs, successors, executors, administrators and assigns of the parties hereto.
31.3 Recordation. Tenant shall not record this Lease or a short form
memorandum hereof without the prior written consent of the Landlord.
31.4 Landlord's Personal Liability. The liability of Landlord (which, for
purposes of this Lease, shall include Landlord and the owner of the Building if
other than Landlord) to Tenant for any default by Landlord under the terms of
this Lease shall be limited to the actual interest of Landlord and its present
or furore partners or members in the Premises, the Building or the Park, and
Tenant agrees to look
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solely to the Premises for satisfaction of any liability and shall not look to
other assets of Landlord nor seek any recourse against the assets of the
individual partners, members, directors, officers, shareholders, agents or
employees of Landlord (including without limitation, any property management
company of Landlord); it being intended that Landlord and the individual
partners, members, directors, officers, shareholders, agents and employees of
Landlord (including without limitation, any property management company of
Landlord) shall not be personally liable in any manner whatsoever for any
judgment or deficiency. The liability of Landlord under this Lease is limited to
its actual period of ownership of title to the Building, and Landlord shall be
automatically released from further performance under this Lease upon transfer
of Landlord's interest in the Premises or the Building.
31.5 Separability. Any provisions of this Lease which shall prove to be
invalid, void or illegal shall in no way affect, impair or invalidate any other
provisions hereof and such other provision shall remain in full force and
effect.
31.6 Choice of Law. This Lease shall be governed by, and construed in
accordance with, the laws of the State of California.
31.7 Attorneys' Fees. In the event any dispute between the parties results
in litigation or other proceeding, the prevailing party shall be reimbursed by
the party not prevailing for all reasonable costs and expenses, including,
without limitation, reasonable attorneys' and experts' fees and costs incurred
by the prevailing party in connection with such litigation or other proceeding,
and any appeal thereof. Such costs, expenses and fees shall be included in and
made a part of the judgment recovered by the prevailing party, if any.
31.8 Entire Agreement. This Lease supersedes any prior agreements,
representations, negotiations or correspondence between the parties, and
contains the entire agreement of the parties on matters covered. No other
agreement, statement or promise made by any party, that is not in writing and
signed by all parties to this Lease, shall be binding.
31.9 Warranty of Authority. On the date that Tenant executes this Lease,
Tenant shall deliver to Landlord an original certificate of stares for Tenant
issued by the California Secretary of State or statement of partnership for
Tenant recorded in the county in which the Premises are located, as applicable,
and such other documents as Landlord may reasonably request with regard to the
lawful existence of Tenant. Each person executing this Lease on behalf of a
party represents and warrants that (1) such person is duly and validly
authorized to do so on behalf of the entity it purports to so bind, and (2) if
such party is a partnership, corporation or trustee, that such partnership,
corporation or trustee has full right and authority to enter into this Lease and
perform all of its obligations hereunder. Tenant hereby warrants that this Lease
is valid and binding upon Tenant and enforceable against Tenant in accordance
with its terms.
31.10 Notices. Any and all notices and demands required or permitted to be
given hereunder to Landlord shall be in writing and shall be sent: (a) by United
States mail, certified and postage prepaid; or (b) by personal delivery; or (c)
by overnight courier, addressed to Landlord at 101 Lincoln Centre Drive, Fourth
Floor, Foster City, California 94404-1167. Any and all notices and demands
required or permitted to be given hereunder to Tenant shall be in writing and
shall be sent: (i) by United States mail, certified and postage prepaid; or (ii)
by personal delivery to any employee or agent of Tenant over the age of eighteen
(18) years of age; or (iii) by overnight courier, all of which shall be
addressed to Tenant at the Tenant's address set forth in the Basic Lease
Information. Notice and/or demand shall be deemed given upon the earlier of
actual receipt or the third day following deposit in the United States mail. Any
notice or requirement of service required by any statute or law now or hereafter
in effect, including, but not limited to, California Code of Civil Procedure
Sections 1161, 1161.1, and 1162 (including any amendments, supplements or
substitutions thereof), is hereby waived by Tenant to the extent permitted by
law.
31.11 Joint and Several. If Tenant consists of more than one person or
entity, the obligations of all such persons or entities shall be joint and
several.
31.12 Covenants and Conditions. Each provision to be performed by Tenant
hereunder shall be deemed to be both a covenant and a condition.
31.13 Waiver of Jury Trial. The parties hereto shall and they hereby do
waive trial by jury in any action, proceeding or counterclaim brought by either
of the parties hereto against the other on any matters whatsoever arising out of
or in any way related to this Lease, the relationship of Landlord and Tenant,
Tenant's use or occupancy of the Premises, the Building or the Park, and/or any
claim of injury, loss or damage.
31.14 Merger. The voluntary or other surrender of this Lease by Tenant,
the mutual termination or cancellation hereof by Landlord and Tenant, or a
termination of this Lease by Landlord for a material
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default by Tenant hereunder, shall not work a merger, and. at the sole option of
Landlord, (i) shall terminate all or any existing subleases or subtenancies, or
(ii) may operate as an assignment to Landlord of any or all of such subleases or
subtenancies. Landlord's election of either or both of the foregoing options
shall be exercised by delivery by Landlord of written notice thereof to Tenant
and all known subtenants under any sublease.
32. Signs: All signs and graphics of every kind visible in or from public view
-----
or corridors or the exterior of the Premises shall be subject to Landlord's
prior written approval and shall be subject to any applicable governmental laws,
ordinances, and regulations and in compliance with Landlord's sign criteria as
same may exist from time to time. Landlord acknowledges and agrees that Tenant
shall be permitted to install, at Tenant's sole cost and expense, signage on two
sides of one of the monument signs presently existing at the Park and on the
exterior of the Building, so long as such signage complies with all applicable
Laws and is consistent with existing signage in the Park and Landlord's sign
criteria. Tenant shall remove all such signs and graphics prior to the
termination of this Lease. Such installations and removals shall be made in a
manner as to avoid damage or defacement of the Premises; and Tenant shall repair
any damage or defacement, including without limitation, discoloration caused by
such installation or removal. Landlord shall have the right, at its option, to
deduct from the Security Deposit such sums as are reasonably necessary to remove
such signs, including, but not limited to, the costs and expenses associated
with any repairs necessitated by such removal. Notwithstanding the foregoing, in
no event shall any: (a) neon, flashing or moving sign(s) or (b) sign(s) which
shall interfere with the visibility of any sign, awning, canopy, advertising
matter, or decoration of any kind of any other business or occupant of the
Building or the Park be permitted hereunder. Tenant further agrees to maintain
any such sign, awning, canopy, advertising matter, lettering, decoration or
other thing as may be approved in good condition and repair at all times.
33. Mortgagee Protection: Upon any default on the part of Landlord, Tenant will
--------------------
give written notice to any beneficiary of a deed of trust or mortgagee of a
mortgage coveting the Premises who has provided Tenant with notice of their
interest together with an address for receiving notice, and shall offer such
beneficiary or mortgagee a reasonable opportunity to cure the default (which, in
no event shall be less than ninety (90) days), including time to obtain
possession of the Premises by power of sale or a judicial foreclosure, if such
should prove necessary to effect a cure. If such default cannot be cured within
such time period, then such additional time as may be necessary will be given to
such beneficiary or mortgagee to effect such cure so long as such beneficiary or
mortgagee has commenced the cure within the original time period and thereafter
diligently pursues such cure to completion, in which event this Lease shall not
be terminated while such cure is being diligently pursued. Tenant agrees that
each lender to whom this Lease has been assigned by Landlord is an express third
party beneficiary hereof. Tenant shall not make any prepayment of Rent more than
one (1) month in advance without the prior written consent of each such lender,
except if Tenant is required to make quarterly payments of Rent in advance
pursuant to the provisions of Section 8 above. Tenant waives the collection of
any deposit from such lender(s) or any purchaser at a foreclosure sale of such
lender(s)' deed of trust unless the lender(s) or such purchaser shall have
actually received and not refunded the deposit. Tenant agrees to make all
payments under this Lease to the lender with the most senior encumbrance upon
receiving a direction, in writing, to pay said amounts to such lender. Tenant
shall comply with such written direction to pay without determining whether an
event of default exists under such lender's loan to Landlord.
34. Modifications for Lender: If, in connection with obtaining financing for
------------------------
the Premises or any portion thereof, Landlord's lender shall request reasonable
modification(s) to this Lease as a condition to such financing, Tenant shall not
unreasonably withhold, delay or defer its consent thereto, provided such
modifications do not materially adversely affect Tenant's rights hereunder or
the use, occupancy or quiet enjoyment of Tenant hereunder.
35. Warranties of Tenant: Tenant hereby warrants and represents to Landlord,
--------------------
for the express benefit of Landlord, that Tenant has undertaken a complete and
independent evaluation of the risks inherent in the execution of this Lease and
the operation of the Premises for the use permitted hereby, and that, based upon
said independent evaluation, Tenant has elected to enter into this Lease and
hereby assumes all risks with respect thereto. Tenant hereby further warrants
and represents to Landlord, for the express benefit of Landlord, that in
entering into this Lease, Tenant has not relied upon any statement, fact,
promise or representation (whether express or implied, written or oral) not
specifically set forth herein in writing and that any statement, fact, promise
or representation (whether express or implied, written or oral) made at any time
to Tenant, which is not expressly incorporated herein in writing, is hereby
waived by Tenant.
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36. Compliance with Americans with Disabilities Act: Landlord and Tenant hereby
-----------------------------------------------
agree and acknowledge that the Premises, the Building and/or the Park may be
subject to the requirements of the Americans with Disabilities Act, a federal
law codified at 42 U.S.C. 12101 et seq, including, but not limited to Title III
thereof, all regulations and guidelines related thereto, together with any and
all laws, rules, regulations, ordinances, codes and statutes now or hereafter
enacted by local or state agencies having jurisdiction thereof, including all
requirements of Title 24 of the State of California, as the same may be in
effect on the date of this Lease and may be hereafter modified, amended or
supplemented (collectively, the "ADA"). The Tenant Improvements to be
constructed hereunder shall be in compliance with the requirements of the ADA,
and all costs incurred for purposes of compliance therewith shall be a part of
and included in the costs of the Tenant Improvements. Tenant shall be solely
responsible for conducting its own independent investigation of this matter and
for ensuring that the design of all Tenant Improvements strictly comply with all
requirements of the ADA. Subject to reimbursement pursuant to Section 6 of the
Lease, if any barrier removal work or other work is required to the Building,
the Common Areas or the Park under the ADA, then such work shall be the
responsibility of Landlord; provided, if such work is required under the ADA as
a result of Tenant's use of the Premises or any work or alteration made to the
Premises by or on behalf of Tenant, then such work shall be performed by
Landlord at the sole cost and expense of Tenant. Landlord shall and hereby
agrees to protect, defend (with counsel reasonably acceptable to Tenant) and
hold Tenant harmless and indemnify Tenant from and against all liabilities,
damages, claims, losses, penalties, judgments, charges and expenses (including
reasonable attorneys' fees, costs of court and expenses necessary in the
prosecution or defense of any litigation including the enforcement of this
provision) arising from or in any way related to, directly or indirectly,
Landlord's or Landlord's Representatives' violation or alleged violation of
Landlord's obligations with respect to the Common Areas of the Park under the
ADA pursuant to this Section 36. Except as otherwise expressly provided in this
provision, Tenant shall be responsible at its sole cost and expense for fully
and faithfully complying with all applicable requirements of the ADA, including
without limitation, not discriminating against any disabled persons in the
operation of Tenant's business in or about the Premises, and offering or
otherwise providing auxiliary aids and services as, and when, required by the
ADA. Within ten (10) days after receipt, Landlord and Tenant shall advise the
other party in writing, and provide the other with copies of (as applicable),
any notices alleging violation of the ADA relating to any portion of the
Premises or the Building; any claims made or threatened in writing regarding
noncompliance with the ADA and relating to any portion of the Premises or the
Building; or any governmental or regulatory actions or investigations instituted
or threatened regarding noncompliance with the ADA and relating to any portion
of the Premises or the Building. Tenant shall and hereby agrees to protect,
defend (with counsel acceptable to Landlord) and hold Landlord and the other
Indemnitees harmless and indemnify the Indemnitees from and against all
liabilities, damages, claims, losses, penalties, judgments, charges and expenses
(including reasonable attorneys' fees, costs of court and expenses necessary in
the prosecution or defense of any litigation including the enforcement of this
provision) arising from or in any way related to, directly or indirectly,
Tenant's or Tenant's Representatives' violation or alleged violation of Tenant's
obligations with respect to the ADA pursuant to this Section 36. Tenant agrees
that the obligations of Tenant herein accrued during Tenant's tenancy under this
Lease shall survive the expiration or earlier termination of this Lease.
37. Brokerage Commission: Landlord and Tenant each represents and warrants for
--------------------
the benefit of the other that it has had no dealings with any real estate
broker, agent or finder in connection with the Premises and/or the negotiation
of this Lease, except for the Broker (as set forth on Page 1), and that it knows
of no other real estate broker, agent or finder who is or might be entitled to a
real estate brokerage commission or finder's fee in connection with this Lease
or otherwise based upon contacts between the claimant and Tenant. Each party
hereby acknowledges that the Broker is acting in a dual capacity and hereby
consents to such dual capacity. Each party shall indemnify and hold harmless the
other from and against any and all liabilities or expenses arising out of claims
made for a fee or commission by any real estate broker, agent or finder in
connection with the Premises and this Lease other than Broker, if any, resulting
from the actions of the indemnifying party. Any real estate brokerage commission
or finder's fee payable to the Broker in connection with this Lease shall be
payable by Landlord; however, such commission or fee shall only be payable and
applicable to the extent of the initial Term of the Lease and to the extent of
the Premises as same exist as of the date on which Tenant executes this Lease.
Unless expressly agreed to in writing by Landlord and Broker, no real estate
brokerage commission or finder's fee shall be owed to, or otherwise payable to,
the Broker for any renewals or other extensions of the initial Term of this
Lease or for any additional space leased by Tenant other than the Premises as
same exists as of the date on which Tenant executes this Lease. Tenant further
represents and warrants to Landlord that Tenant will not receive (i) any portion
of any brokerage commission or finder's fee payable to the Broker in connection
with this Lease or (ii) any other form of compensation or incentive from the
Broker with respect to this Lease.
38. Quiet Enjoyment: Landlord covenants with Tenant, upon the paying of Rent
---------------
and observing and keeping the covenants, agreements and conditions of this Lease
on its part to be kept, and during the periods that Tenant is not otherwise in
default of any of the terms or provisions of this Lease, and subject to the
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rights of any of Landlord's lenders, (i) that Tenant shall and may peaceably and
quietly hold, occupy and enjoy the Premises and the Common Areas during the Term
of this Lease, and (ii) neither Landlord, nor any successor or assign of
Landlord, shall disturb Tenant's occupancy or enjoyment of the Premises and the
Common Areas.
39. Landlord's Ability to Perform Tenant's Unperformed Obligations:
--------------------------------------------------------------
Notwithstanding anything to the contrary contained in this Lease, if Tenant
shall fail to perform any of the terms, provisions, covenants or conditions to
be performed or complied with by Tenant pursuant to this Lease after any
applicable notice and cure period, and/or if the failure of' Tenant relates to a
matter which 'in Landlord's judgment reasonably exercised is of an emergency
nature and such failure shall remain uncured for a period of time commensurate
with such emergency, then Landlord may, at Landlord's option without any
obligation to do so, and in its sole discretion as to the necessity therefor,
perform any such term, provision, covenant, or condition, or make any such
payment and Landlord by reason of so doing shall not be liable or responsible
for any loss or damage thereby sustained by Tenant or anyone holding under or
through Tenant. If Landlord so performs any of Tenant's obligations hereunder,
the full amount of the cost and expense entailed or the payment so made or the
amount of the loss so sustained shall immediately be owing by Tenant to
Landlord, and Tenant shall promptly pay to Landlord upon demand, as Additional
Rent, the full amount thereof with interest thereon from the date of payment at
the greater of (i) ten percent (10%) per annum, or (ii) the highest rate
permitted by applicable law and Enforcement Expenses.
40. Exterior Enclosure: Landlord acknowledges that in connection with Tenant's
------------------
operations Tenant requires an enclosed area outside of the Building in the
portion of parking lot adjacent to the Building (the "Exterior Enclosure") for
purposes of installing, storing and maintaining, at Tenant's sole cost and
expense, one or more generators. The Exterior Enclosure shall be limited in size
to be situated within six (6) parking spaces (from the number of parking spaces
otherwise permitted to be used by Tenant hereunder as specified in Section 24
hereof) in the portion of the parking lot depicted as the cross-hatched area in
Exhibit A hereto. Tenant shall submit any and all plans for the design of the
- ---------
Exterior Enclosure to Landlord for Landlord's prior written approval and shall
otherwise comply with the provisions of Section 10 with respect thereto. Tenant
shall be responsible for ensuring that the Exterior Enclosure complies in all
respects with any and all applicable Laws imposed by the City of Alameda and/or
the County of Alameda, and any other governmental entity having jurisdiction
thereof. Tenant, at its sole cost and expense, (i) shall be solely responsible
for the installation, construction, maintenance and, upon expiration or earlier
termination of this Lease, the removal of the Exterior Enclosure and restoration
of the portion of the parking lot upon which said Exterior Enclosure is located,
and (ii) throughout the Term of this Lease, shall maintain the Exterior
Enclosure in good and safe condition and repair.
41. Early Termination Option. During only the initial term of this Lease
(exclusive of any Extended Terms), Tenant shall have a one (1) time option (the
"Termination Option") to terminate this Lease prior to the Expiration Date, such
termination to be effective on September 30, 2004 (the "Termination Date").
41.1 The Termination Option is granted subject to the following terms and
conditions:
41.1.1 Notice. Tenant delivers to Landlord a written notice of
Tenant's election to exercise the Termination Option, which notice must be given
no later than one hundred eighty (180) days prior to the Termination Date; and
41.1.2 No Default. Tenant has not at any time been in default beyond
any applicable notice and cure period of its obligations under this Lease and
Tenant is not in default under this Lease either on the date that Tenant
exercises the Termination Option, or unless waived in writing by Landlord, on
the Termination Date; and
41.1.3 Termination Fee. Tenant pays to Landlord on or before the
Termination Date a cash lease termination fee (the "Fee") equal to the aggregate
of (i) the then remaining unamortized portion of the brokerage commission paid
by Landlord for this Lease and the Tenant Improvement Allowance paid by Landlord
for this Lease, plus (ii) the monthly Base Rent otherwise payable by Tenant
----
during the months of October, November, and December of the year 2004.
41.2 Terms. If Tenant timely and properly exercises the Termination
Option, (i) all Rent payable under this Lease shall be paid through and
apportioned as of the Termination Date (in addition to payment by Tenant of the
Fee); (ii) neither party shall have any rights, estates, liabilities, or
obligations under this Lease for the period accruing after the Termination Date,
except those which, by the provisions of this Lease, expressly survive the
expiration or termination of this Lease; (iii) Tenant shall surrender and
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vacate the Premises and deliver possession thereof to Landlord on or before the
Termination Date in the condition required under this Lease for surrender of the
Premises; and (iv) Landlord and Tenant shall enter into a written agreement
reflecting the termination of this Lease upon the terms provided for herein,
which agreement shall be executed within thirty (30) days after Tenant exercises
the Termination Option and delivers to Landlord the written notice required in
Section 41.1.1 above. It is the parties' intention that nothing contained herein
shall impair, diminish or otherwise prevent Landlord from recovering from Tenant
such additional sums as may be necessary for payment of Tenant's Share of the
Operating Expenses, Tax Expenses, Common Area Utility Costs, Utility Expenses
and any other sums due and payable under this Lease, including without
limitation, any sums required to repair any damage to the Premises and/or
restore the Premises to the condition required under the provisions of this
Lease.
41.3 Termination. The Termination Option shall automatically terminate and
become null and void upon the earlier to occur of (i) the default by Tenant
beyond any applicable notice and cure period of any of the terms of this Lease;
(ii) the termination of Tenant's right to possession of the Premises; (iii) the
assignment by Tenant of this Lease, in whole or in part, regardless of whether
Landlord consents to such assignment, except an assignment to a Related Entity;
(iv) the sublease by Tenant of all or any part of the Premises demised under
this Lease, regardless of whether Landlord consents to such sublease, which
sublease by itself or taken together with prior sublease(s) covers or totals, as
the case may be, more than one-third (1/3) of the rentable square feet of the
Premises; or (v) the failure of Tenant to timely or properly exercise the
Termination Option as contemplated herein or to pay the Fee as required in
Section 41.1.3 above. This Termination Option is personal to Tenant and not be
assigned, voluntarily or involuntarily, separate from or as part of the Lease.
The period of time within which this Termination Option may be exercised shall
not be extended nor enlarged for any reason.
IN WITNESS WHEREOF, this Lease is executed by the parties as of the Lease
Date referenced on Page 1 of this Lease.
TENANT:
Pilot Network Services, Inc.,
a Delaware corporation
By: /s/ M. Marketta Silvera
----------------------------
Its: CEO
---------------------------
By: /s/ William C. Leetham
----------------------------
Its: CFO
---------------------------
LANDLORD:
LINCOLN-WHITEHALL REALTY, LLC,
a Delaware limited liability company
By: Legacy Partners Commercial, Inc.,
as manager and agent for LINCOLN-WHITEHALL REALTY, LLC
By: /s/ Mark Laney
----------------------------
Senior Vice President
29
<PAGE>
EXHIBIT A- PREMISES
This exhibit, entitled "Premises", is and shall constitute EXHIBIT A to that
certain Lease Agreement dated October 27, 1998 (the "Lease"), by and between
LINCOLN-WHITEHALL REALTY, LLC, a Delaware limited liability company
("Landlord'") and Pilot Network Services, Inc., a Delaware corporation
("Tenant") for the leasing of certain premises located in the Lincoln Alameda
Center at Building C, 2450 Manner Square Loop, Alameda, California (the
"Premises").
The Premises consist of the rentable square footage of space specified in the
Basic Lease Information and has the address specified in the Basic Lease
Information. The Premises are a part of and are contained in the Building
specified in the Basic Lease Information. The cross-hatched area depicts the
Premises within the Project:
[FLOOR PLAN APPEARS HERE]
30
<PAGE>
Exhibit B to Lease Agreement
Tenant Improvements
This exhibit, entitled "Tenant Improvements", is and shall constitute Exhibit B
---------
to that certain Lease Agreement dated for reference purposes as of October 27,
1998 (the "Lease"), by and between LINCOLN-WHITEHALL REALTY, LLC, a Delaware
limited liability company ("Landlord"), and Pilot Network Services, Inc., a
Delaware corporation ("Tenant"), for the leasing of certain premises located at
2450 Mariner Square Loop, Building C, Alameda, California (the "Premises"). The
terms, conditions and provisions of this Exhibit B are hereby incorporated into
---------
and are made a part of the Lease. Any capitalized terms used herein and not
otherwise defined herein shall have the meaning ascribed to such terms as set
forth in the Lease.
1. Tenant To Construct Tenant Improvements. Subject to the provisions below,
Tenant shall be solely responsible for the planning, design, construction and
completion of the interior tenant improvements ("Tenant Improvements") to the
Premises in accordance with the terms and conditions of this Exhibit B. The
---------
Tenant Improvements shall expressly not include (a) any work or materials which
is in excess of the Building Standards described herein, and/or (b) any of
Tenant's trade fixtures, equipment, furniture, furnishings, telephone equipment,
other personal property or similar items. The Tenant Improvements shall
expressly include any work and costs associated with the provision of greater
electrical and fire sprinkler services. No portion of the Tenant Improvement
Allowance (defined below) is to be available to Tenant or otherwise used for any
work or materials which is in excess of the Building Standards described herein.
2. Tenant Improvement Plans.
A. Preliminary Plans and Specifications. Promptly after execution of this
Lease, Tenant shall retain a licensed and insured architect ("Architect") to
prepare preliminary working architectural and engineering plans and
specifications ("Preliminary Plans and Specifications") for the Tenant
Improvements. Tenant shall deliver the Preliminary Plans and Specifications to
Landlord. The Preliminary Plans and Specifications shall be in sufficient detail
to show locations, types and requirements for all heat loads, people loads,
floor loads, power and plumbing, regular and special HVAC needs, telephone
communications, telephone and electrical outlets, lighting, lighting fixtures
and related power, and electrical and telephone switches. Landlord shall
reasonably approve or disapprove the Preliminary Plans and Specifications within
five (5) business days after Landlord receives the Preliminary Plans and
Specifications and, if disapproved, Landlord shall return the Preliminary Plans
and Specifications to Tenant, who shall make all necessary revisions within ten
(10) days after Tenant's receipt thereof. This procedure shall be repeated until
Landlord approves the Preliminary Plans and Specifications. The approved
Preliminary Plans and Specifications, as modified, shall be deemed the "Final
Preliminary Plans and Specifications".
B. Final Plans and Specifications. After the Final Preliminary Plans and
Specifications are approved by Landlord and are deemed to be the Final
Preliminary Plans and Specifications, Tenant shall cause the Architect to
prepare, for the Tenant Improvements, in twenty (20) days following Landlord's
approval of the Final Preliminary Plans and Specifications the final working
architectural and engineering plans, specifications and drawings ("Final Plans
and Specifications") for the Tenant Improvements. Tenant shall then deliver the
Final Plans and Specifications to Landlord. Landlord shall reasonably approve or
disapprove the Final Plans and Specifications within five (5) business days
after Landlord receives the Final Plans and Specifications and, if disapproved,
Landlord shall return the Final Plans and Specifications to Tenant who shall
make all necessary revisions within ten (10) days after Tenant's receipt
thereof. This procedure shall be repeated until Landlord approves, in writing,
the Final Plans and Specifications. The approved Final Plans and Specifications,
as modified, shall be deemed the "Construction Documents."
C. Miscellaneous. All deliveries of the Preliminary Plans and
Specifications, the Final Preliminary Plans and Specifications, the Final Plans
and Specifications, and the Construction Documents shall be delivered by
messenger service, by personal hand delivery or by overnight parcel service.
While Landlord has the right to approve the Preliminary Plans and
Specifications, the Final Preliminary Plans and Specifications, the Final Plans
and Specifications, and the Construction Documents, Landlord's interest in doing
so is to protect the Premises, the Building and Landlord's interest therein.
Accordingly, Tenant shall not rely upon Landlord's approvals and Landlord shall
not be the guarantor of, nor responsible for, the adequacy and correctness or
accuracy of the Preliminary Plans and Specifications, the Final Preliminary
Plans and Specifications, the Final Plans and Specifications, and the
Construction Documents, or the compliance thereof with applicable Laws, and
Landlord shall incur no liability of any kind by reason of granting such
approvals. Tenant agrees to, and does hereby, assume full, sole and complete
responsibility to ensure that the Final Preliminary Plans and Specifications,
the Final Plans and Specifications, and the Construction Documents are adequate
to fully meet the needs and requirements of Tenant's intended operations of its
business within the Premises and Tenant's use of the Premises.
1
<PAGE>
D. Building Standard Work. The Construction Documents shall provide that
the Tenant Improvements to be constructed in accordance therewith must be at
least equal to or better, in quality, to Landlord's building standard materials,
quantities and procedures then in use by Landlord ("Building Standards")
attached hereto as Exhibit B-2, provided, however, that the Building Standards
-----------
shall not apply to those portions of the Tenant Improvements to be constructed
and used as the data center, network operations center and customer service
center (although all Tenant Improvements, including the data center, network
operations center and customer service center, shall be subject to Landlord's
approval, such approval not to be unreasonably withheld); and, except as
otherwise expressly approved by Landlord, such approval not to be unreasonably
withheld, shall consist of improvements which are generic in nature.\\
E. Construction Agreements. Tenant hereby covenants and agrees that a
provision shall be included in each and every agreement made with the Architect
and the Contractor with respect to the Tenant Improvements specifying that
Landlord shall be a third party beneficiary thereof, including without
limitation, a third party beneficiary of all covenants, representations,
indemnities and warranties made by the Architect and/or Contractor.
3. Permits. Tenant at its sole cost and expense (subject to the provisions of
Paragraph 5 below) shall obtain all governmental approvals of the Construction
Documents to the full extent necessary for the issuance of a building permit for
the Tenant Improvements based upon such Construction Documents. Tenant at its
sole cost and expense shall also cause to be obtained all other necessary
approvals and permits from all governmental agencies having jurisdiction or
authority for the construction and installation of the Tenant Improvements in
accordance with the approved Construction Documents. Tenant at its sole cost and
expense (subject to the provisions of Paragraph 5 below) shall undertake all
steps necessary to ensure that the construction of the Tenant Improvements is
accomplished in strict compliance with all statutes, laws, ordinances, codes,
roles, and regulations applicable to the construction of the Tenant Improvements
and the requirements and standards of any insurance underwriting board,
inspection bureau or insurance career insuring the Premises and/or the Building.
4. Construction.
A. Tenant shall be solely responsible for the construction, installation
and completion of the Tenant Improvements in accordance with the Construction
Documents approved by Landlord and is solely responsible for the payment of all
amounts when payable in connection therewith without any cost or expense to
Landlord, except for Landlord's obligation to contribute the Tenant Improvement
Allowance in accordance with the provisions of Paragraph 5 below. Tenant shall
diligently proceed with the construction, installation and completion of the
Tenant Improvements in accordance with the Construction Documents and the
completion schedule reasonably approved by Landlord. No material changes shall
be made to the Construction Documents and the completion schedule approved by
Landlord without Landlord's prior written consent, which consent shall not be
unreasonably withheld.
B. Tenant and Landlord shall confer, cooperate and jointly select a
licensed, insured and bonded general contractor reasonably acceptable to both
parties (the "Contractor"), and after selection of the Contractor, Tenant shall
employ the Contractor to construct the Tenant Improvements in accordance with
the Construction Documents. The construction contracts between Tenant and the
Contractor and between the Contractor and subcontractors shall be subject to
Landlord's prior written approval, which approval shall not be unreasonably
withheld. Proof that the Contractor is licensed in California, is bonded as
required under California law, and has the insurance specified in Exhibit B-l,
-----------
attached hereto and incorporated herein by this reference, shall be provided to
Landlord at the time that Tenant requests approval of the Contractor from
Landlord. Tenant shall comply with or cause the Contractor to comply with all
other terms and provisions of Exhibit B- 1.
------------
C. Prior to the commencement of the construction and installation of the
Tenant Improvements, Tenant shall provide the following to Landlord, all of
which shall be to Landlord's reasonable satisfaction and approval:
(i) An estimated budget and cost breakdown for the Tenant
Improvements.
(ii) An estimated completion schedule for the Tenant Improvements.
(iii) Copies of all required approvals and permits from governmental
agencies having jurisdiction or authority for the construction and installation
of the Tenant Improvements; provided, however, if prior to commencement of the
construction and installation of Tenant Improvements Tenant has not received the
electrical, plumbing or mechanical permits, Tenant shall only be required to
provide Landlord with evidence that Tenant has made application therefor, and,
upon receipt by Tenant of such permits, Tenant shall promptly provide Landlord
with copies thereof.
2
<PAGE>
(iv) Evidence of Tenant's procurement of insurance required to be
obtained pursuant to the provisions of Paragraphs 4.B and 4.G.
D. Landlord shall at all reasonable times have a right to inspect the
Tenant Improvements (provided Landlord shall use commercially reasonable efforts
to minimize any interference with the work being performed by the Contractor or
its subcontractors) and Tenant shall immediately cease work upon written notice
from Landlord if the Tenant Improvements are not in compliance with the
Construction Documents approved by Landlord. If Landlord shall give notice of
faulty construction or any other deviation from the Construction Documents,
Tenant shall cause the Contractor to make corrections promptly. However, neither
the privilege herein granted to Landlord to make such inspections, nor the
making of such inspections by Landlord, shall operate as a waiver of any rights
of Landlord to require good and workmanlike construction and improvements
constructed in accordance with the Construction Documents.
E. Subject to Landlord complying with its obligations in Paragraph 5
below, Tenant shall pay and discharge promptly and fully all claims for labor
done and materials and services furnished in connection with the Tenant
Improvements. The Tenant Improvements shall not be commenced until Tenant shall
have given Landlord five (5) business days' notice stating the date the
construction of the Tenant Improvements is to commence so that Landlord can post
and record any appropriate Notice of Non-Responsibility; provided that if
Landlord shall have completed the posting and recording requirements prior to
the expiration of such five business day period, Landlord shall so notify
Tenant, and Tenant may immediately commence construction of the Tenant
Improvements.
F. Tenant shall maintain, and cause to be maintained, during the
construction of the Tenant Improvements, at its sole cost and expense, insurance
of the types and in the amounts specified in Exhibit B-1 and in the applicable
-----------
provisions of the Lease, together with builders' risk insurance for the amount
of the completed value of the Tenant Improvements on an all-risk non-reporting
form coveting all improvements under construction, including building materials,
and other insurance in amounts and against such risks as the Landlord shall
reasonably require in connection with the Tenant Improvements.
G. No materials, equipment or fixtures shall be delivered to or installed
upon the Premises pursuant to any agreement by which another party has a
security interest or rights to remove or repossess such items, without the prior
written consent of Landlord, which consent shall not be unreasonably withheld.
H. Landlord reserves the right to establish reasonable rules and
regulations for the use of the Building during the course of construction of the
Tenant Improvements, including, but not limited to, construction parking,
storage of materials, hours of work, use of elevators, and clean-up of
construction related debris.
I. Upon completion of the Tenant Improvements, Tenant shall deliver to
Landlord the following, all of which shall be to Landlord's reasonable
satisfaction:
(i) Any certificates (or the equivalent thereof) required for
occupancy, including a permanent and complete Certificate of Occupancy issued by
the City of Alameda.
(ii) A Certificate of Completion signed by the Architect who prepared
the Construction Documents, reasonably approved by Landlord.
(iii) A cost breakdown itemizing all expenses for the Tenant
Improvements, together with invoices and receipts for the same or other evidence
of payment.
(iv) Final and unconditional mechanic's lien waivers for all the
Tenant Improvements.
(v) A Notice of Completion for execution by Landlord, which
certificate once executed by Landlord shall be recorded by Tenant in the
official records of the County of Alameda, and Tenant shall then deliver to
Landlord a true and correct copy of the recorded Notice of Completion.
(vi) A tree and complete copy of all as-built plans and drawings for
the Tenant Improvements.
5. Tenant Improvement Allowance; Tenant Improvement Costs.
A. Subject to Tenant's compliance with the provisions of this Exhibit B,
---------
Landlord shall provide an allowance for the planning and construction of the
Tenant Improvements to be performed in the Premises, as described in the Final
Plans and Specifications and the Construction Documents, in the amount of One
Million Ninety-Two Thousand Dollars ($1,092,000) (the "Tenant Improvement
Allowance") based
3
<PAGE>
upon an allowance of Thirty-Five Dollars ($35.00) per rentable square foot for
31,200 rentable square feet of the Premises to be improved, as described in the
Final Plans and Specifications and the Construction Documents. Tenant shall not
be entitled to any credit, abatement or payment from Landlord in the event that
the amount of the Tenant shall not be entitled to any credit, abatement or
payment from Landlord in the event that the amount of the Tenant Improvement
Allowance specified above exceeds the actual Tenant Improvement Costs (defined
below). The Tenant Improvement Allowance shall only be used for tenant
improvements typically installed by Landlord in office/R&D buildings. The Tenant
Improvement Allowance shall be the maximum contribution by Landlord for the
Tenant Improvement Costs. The Tenant Improvement Allowance shall be used to
design, prepare, plan, obtain the approval of, construct and install the Tenant
Improvements and for no other purpose. Except as otherwise expressly provided
herein, Landlord shall have no obligation to contribute the Tenant Improvement
Allowance unless and until the Construction Documents have been approved by
Landlord, and Tenant has compiled with all requirements set forth in Paragraph
4.C. of this Exhibit B. The costs to be paid out of the Tenant Improvement
---------
Allowance shall include all reasonable costs and expenses associated with the
design, preparation, approval, planning, construction and installation of the
Tenant Improvements (collectively, the "Tenant Improvement Costs"), including
all of the following:
(i) All costs of the Preliminary Plans and Specifications. the
Final Plans and Specifications, and the Construction Documents, and engineering
costs associated with completion of the State of California energy utilization
calculations under Title 24 legislation:
(ii) All costs of obtaining building permits and other necessary
authorizations from local governmental authorities:
(iii) All costs of interior design and finish schedule plans and
specifications including as-built drawings, if applicable:
(iv) All direct and indirect costs of procuring, constructing and
installing the Tenant Improvements in the Premises, including, but not limited
to. the construction fee for overhead and profit and the cost of all on-site
supervisory and administrative staff, office, equipment and temporary services
rendered by the Contractor in connection with the construction of the Tenant
Improvements' provided, however, that the construction fee for overhead and
profit, the cost of all on-site supervision and administrative staff; office,
equipment and temporary, services shall not exceed amounts which are reasonable
and customary for such items in the local construction industry:
(v) All fees payable to the Architect and any engineer if they are
required to redesign any portion of the Tenant Improvements following Tenant's
and Landlord's approval of the Construction Documents;
(vi) Utility connection fees:
(vii) Inspection fees and filing fees payable to local governmental
authorities, if any:
(viii) All costs of all permanently affixed equipment and non-trade
fixtures provided for in the Construction Documents, including the cost of
installation: and.
(ix) A construction management fee (the "CM Fee") payable to
Landlord in the amount of Thirty-Two Thousand Seven Hundred Sixty Dollars
(S32,760.00).
(xx) A fee for review of the Preliminary Plans and Specifications.
Final Plans and Specifications and Construction Documents (the "Plan Review
Fee") payable to Landlord in the amount of Seven Thousand Eight Hundred Dollars
($7,800).
The Tenant Improvement Allowance shall be the sole and maximum contribution by
Landlord for the Tenant Improvement Costs, and the disbursement of the Tenant
Improvement Allowance shall be in the manner specified herein and shall be
subject to the terms and provisions contained hereinbelow. The CM Fee and the
Plan Review Fee shall be the only lees payable to. and imposed by, Landlord for
any oversight. plan review, or other work or services provided by or on behalf
of Landlord or its representatives.
Except for payment of the CM Fee and the Plan Review Fee. Landlord will make
payments to Tenant from the Tenant Improvement Allowance to reimburse Tenant for
the Tenant Improvement Costs paid or incurred by Tenant (as invoiced by third
parties). Payment of the CM Fee and the Plan Review Fee shall be the first
payment from the Tenant Improvement Allowance and shall be made by means of a
deduction or credit against the Tenant Improvement Allowance. All other payments
of the Tenant Improvement Allowance shall be by progress payments not more
frequently than once per month and only after satisfaction of the following
conditions precedent: (a) receipt by Landlord of conditional mechanics' lien
releases for the work completed and to be paid by said process payment,
conditioned only on the payment of the sums set forth in the mechanics' lien
release, executed by the Contractor and all subcontractors, labor
4
<PAGE>
suppliers and materialmen; (b) receipt by Landlord of unconditional mechanics'
lien releases from the Contractor and all subcontractors, labor suppliers and
materialmen for all work other than that being paid by the current progress
payment previously completed by the Contractor, subcontractors, labor suppliers
and materialmen and for which Tenant has received funds from the Tenant
Improvement Allowance to pay for such work; (c) receipt by Landlord of any and
all documentation reasonably required by Landlord detailing the work that has
been completed and the materials and supplies used as of the date of Tenant's
request for the progress payment, including, without limitation, invoices,
bills, or statements for the work completed and the materials and supplies used;
and (d) completion by Landlord or Landlord's agents of any inspections of the
work completed and materials and supplies used as deemed reasonably necessary by
Landlord (Landlord hereby agrees to cause such inspections to be done, if at
all, within five (5) business days after Landlord's receipt of a request from
Tenant for the then applicable progress payment). Except for the CM Fee and the
Plan Review Fee payment (credit), Tenant Improvement Allowance progress payments
shall be paid to Tenant within twenty-one (21) days from the satisfaction of the
conditions set forth in the immediately preceding sentence. The preceding
notwithstanding, all Tenant Improvement Costs paid or incurred by Tenant prior
to Landlord's approval of the Construction Documents in connection with the
design and planning of the Tenant Improvements by Architect shall be paid from
the Tenant Improvement Allowance, without any retention, within twenty-one (21)
days following Landlord's receipt of invoices, bills or statements from
Architect evidencing such costs. Notwithstanding the foregoing to the contrary,
Landlord shall be entitled to withhold and retain five percent (5%) of the
Tenant Improvement Allowance or of any Tenant Improvement Allowance progress
payment until the earlier to occur of Landlord's receipt of all unconditional
and final lien waivers and releases (with no notation therein of sums being
disputed) or the lien-free expiration of the time for filing of any mechanics'
liens claimed or which might be filed on account of any work ordered by Tenant
or the Contractor or any subcontractor in connection with the construction and
installation of the Tenant Improvements.
B. Landlord shall not be obligated to pay any Tenant Improvement Allowance
progress payment or the Tenant Improvement Allowance retention if on the date
Tenant is entitled to receive the Tenant Improvement Allowance progress payment
or the Tenant Improvement Allowance retention Tenant is in default of any of the
provisions of the Lease beyond any applicable notice and cure period. Such
payments shall resume upon Tenant completely, timely and satisfactorily curing
any such default within the time periods which may be provided for in the Lease.
C. Except as otherwise expressly provided in Paragraph 5.A. above, if the
total and actual cost of designing, planning, constructing and installing the
Tenant Improvements is less than the Tenant Improvement Allowance, the Tenant
Improvement Allowance shall be automatically reduced to the amount which is
equal to said actual Tenant Improvement Costs.
6. Substantial Completion. The Tenant Improvements shall be deemed
substantially complete on the date that the Contractor issues a notice of
substantial completion, or the date that the building officials of the
applicable governmental agency(s) issues final approval of the construction of
the Tenant Improvements whether in the form of the issuance of a final permit,
certificate of occupancy or the v, written approval evidencing its final
inspection on the building permit(s), or the date on which Tenant first takes
occupancy of the Premises, whichever first occurs ("Substantial Completion", or
"Substantially Completed", or "Substantially Complete"). Tenant hereby
acknowledges and agrees that neither the term "Substantial Completion" nor
"Substantially Completed" nor "Substantially Complete" as used herein will
include any work associated with Tenant's data center improvements or Exterior
Enclosure requirements (including, without limitation, any requirements of
governmental and regulatory agencies). If the Tenant Improvements are not deemed
to be Substantially Complete on or before February 15, 1999, (i) the Lease shall
remain in full force and effect, (ii) Landlord shall not be deemed to be in
breach or default of the Lease or this Exhibit B as a result thereof, and (iii)
---------
except in the event of any Landlord Delays (as such term is defined in Section 7
below), which will extend the Commencement Date and the Expiration Date on a
day-for-day basis without any other penalty or liability to Landlord, and
notwithstanding anything to the contrary contained in the Lease, the
Commencement Date and the Expiration Date of the term of the Lease (as defined
in Section 2 of the Lease) shall not be extended by the amount of time
attributable to force majeure delays or any other reason. In the event the
Commencement Date of this Lease is other than February 15, 1999, Landlord and
Tenant shall execute a written amendment to this Lease, substantially in the
form of Exhibit F hereto, wherein the parties shall specify the actual
---------
Commencement Date and the Expiration Date.
7. Landlord Delays. There shall be no extension of the scheduled Commencement
Date or Expiration Date of the term of the Lease if the Tenant Improvements have
not been Substantially Completed by February 15, 1999, except that the
Commencement Date and the Expiration Date shall be extended on a day-for-day
basis to the extent any delay is attributable to Landlord's failure to perform
any of Landlord's obligations under any provision of this Exhibit B in the time
---------
period provided, including without limitation Landlord's failure to approve or
disapprove the Preliminary Plans and Specifications and. if disapproved, to
return the Preliminary Plans and Specifications to Tenant within the time period
required under Section 2.A above, or to approve or disapprove the Final Plans
and Specifications and. if disapproved, to
5
<PAGE>
return the Final Plans and Specifications to Tenant within the time period
required under Section 2.B above (collectively, "Landlord Delays"). Any delays
in the construction of the Tenant Improvements due to any cause other than any
Landlord Delays shall in no way extend or affect the date on which Tenant is
required to commence paying Rent under the terms of the Lease.
8. Termination. If the Lease is terminated prior to the date on which the
Tenant Improvements are completed, for any reason due to the default of Tenant
hereunder, in addition to any other remedies available to Landlord under the
Lease, Tenant shall pay to Landlord as Additional Rent under the Lease, within
five (5) days of receipt of a statement therefor, any and all costs incurred by
Landlord and not reimbursed or otherwise paid by Tenant through the date of
termination in connection with the Tenant Improvements to the extent planned,
installed and/or constructed as of such date of termination, including, but not
limited to, any costs related to the removal of all or any portion of the Tenant
Improvements and restoration costs related thereto. Subject to the provisions of
the Lease regarding surrender of the Premises, upon the expiration or earlier
termination of the Lease, Tenant shall not be required to remove the Tenant
Improvements it being the intention of the parties that the Tenant Improvements
are to be considered incorporated into the Building.
9. Lease Provisions; Conflict. The terms and provisions of the Lease, insofar
as they are applicable, in whole or in part, to this Exhibit B, are hereby
---------
incorporated herein by reference, and specifically including all of the
provisions of Section 31 of the Lease. In the event of any conflict between the
terms of the Lease and this Exhibit B, the terms of this Exhibit B, shall
--------- ---------
prevail. Any amounts payable by Tenant to Landlord hereunder shall be deemed to
be Additional Rent under the Lease and, upon any default (beyond any applicable
notice and cure period) in the payment of same, Landlord shall have all rights
and remedies available to it as provided for in the Lease.
6
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Pilot Network Services, Inc.:
We consent to the incorporation by reference in the registration statement
(No. 333-61187) on Form S-8 of Pilot Network Services, Inc. of our report
dated April 28, 1999, relating 1998 to the consolidated balance sheets of
Pilot Network Services, Inc. and subsidiary as of March 31, 1998 and 1999 and
the related consolidated statements of operations, comprehensive loss,
stockholders' equity (deficit) and cash flows for each of the years in the
three-year period ended march 31, 1999, and related schedule, which report
appears in the March 31 ,1999, annual report on Form 10-K of Pilot Network
Services, Inc.
/s/ KPMG LLP
San Francisco, California
June 29, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE PILOT
NETWORK SERVICES, INC. FORM 10-K FOR THE PERIOD ENDED MARCH 31, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAR-31-1999
<PERIOD-START> APR-01-1998
<PERIOD-END> MAR-31-1999
<CASH> 10,660
<SECURITIES> 12,352
<RECEIVABLES> 3,595
<ALLOWANCES> 157
<INVENTORY> 0
<CURRENT-ASSETS> 27,233
<PP&E> 22,256
<DEPRECIATION> 8,072
<TOTAL-ASSETS> 42,115
<CURRENT-LIABILITIES> 12,650
<BONDS> 4,830
0
0
<COMMON> 14
<OTHER-SE> 24,621
<TOTAL-LIABILITY-AND-EQUITY> 42,115
<SALES> 17,522
<TOTAL-REVENUES> 17,522
<CGS> 20,072
<TOTAL-COSTS> 20,072
<OTHER-EXPENSES> 14,172
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (1,373)
<INCOME-PRETAX> (18,095)
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
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<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (18,095)
<EPS-BASIC> (1.94)
<EPS-DILUTED> (1.94)
</TABLE>
