SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
Annual Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 31, 1996
Commission File Number 1-4373
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THREE-FIVE SYSTEMS, INC.
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(Name of Issuer Specified in Its Charter)
Delaware 86-0654102
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
1600 North Desert Drive, Tempe, Arizona 85281
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(Address of Principal Executive Offices)
(602) 389-8600
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(Issuer's Telephone Number, Including Area Code)
Securities registered under Section 12(b) of the Exchange Act:
Title of Each Class Name of Each Exchange on Which Registered
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Common Stock, Par Value $.01 Per Share New York Stock Exchange
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Securities registered under Section 12(g) of the Exchange Act: None
Check whether the issuer (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for
such shorter period that the registrant was required to file such reports) and
(2) has been subject to such filing requirements for the past 90 days.
Yes X No
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Check if there is no disclosure of delinquent filers pursuant to Item
405 of Regulation S-K contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [X]
State issuer's revenues for its most recent fiscal year: $60,713,000
As of March 6, 1997, the aggregate market value of the voting stock
held by non-affiliates of the issuer, computed by reference to the price at
which stock was sold as of such date in the stock market as reported on the New
York Stock Exchange, was $87,942,085. 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 conclusive
and does not constitute an admission of affiliate status.
As of March 6, 1997, there were 7,759,629 shares of the issuer's Common
Stock outstanding.
Documents incorporated by reference: Portions of the issuer's
definitive Proxy Statement for the 1997 Annual Meeting of Stockholders are
incorporated by reference into Part III hereof.
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THREE-FIVE SYSTEMS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1996
TABLE OF CONTENTS
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PART I
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ITEM 1. DESCRIPTION OF BUSINESS.........................................................................1
ITEM 2. DESCRIPTION OF PROPERTY........................................................................15
ITEM 3. LEGAL PROCEEDINGS..............................................................................15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................15
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.......................................16
ITEM 6. SELECTED FINANCIAL DATA .......................................................................17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS............................................................18
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA....................................................24
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE............................................................24
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS ..............................................................24
ITEM 11. EXECUTIVE COMPENSATION.........................................................................24
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.....................................................................................24
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................................24
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K....................................................................................25
SIGNATURES.......................................................................................................27
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ITEM 1. DESCRIPTION OF BUSINESS
Introduction
The Company designs and manufactures a wide range of user interface
devices for operational control and informational display functions required in
the end products of original equipment manufacturers ("OEMs"). Most of the
Company's sales consist of custom devices developed in close collaboration with
its customers. Devices designed and manufactured by the Company find application
in cellular telephones and other wireless communication devices as well as in
medical equipment, office automation equipment, industrial process controls,
instrumentation, consumer electronic products, automotive equipment, and
industrial and military control products. The Company currently specializes in
liquid crystal display ("LCD") and light emitting diode ("LED") components and
technology in providing its design and manufacturing services for its customers.
The Company markets its services primarily in North America, Europe, and Asia
through direct technical sales persons and, to a much lesser extent, through an
independent sales and distribution network.
The Company experienced substantial growth from 1993 through 1995 with
net sales increasing from $38.0 million in 1993 to $91.6 million in 1995. The
Company's growth during that period, however, depended primarily upon the
Company's participation in the substantial growth of the wireless communications
market and sales to a single major customer in that industry. In 1996, the
Company's sales declined to $60.7 million, largely as the result of the
phase-out by that major customer of a significant family of programs in early
1996, and the Company reported a loss in 1996 as a result of that phase-out and
the significant inventory reserve taken during the third quarter. The growth
that occurred during the period from 1993 through 1995 allowed the Company to
complete construction of the highest volume passive matrix LCD glass production
facility in North America, which will enable the Company to produce a
substantial portion of its LCD glass requirements, as well as to attract key
personnel, expand its research and development efforts, and build its
infrastructure. The Company also has undertaken substantial efforts to diversify
its business, broaden its customer base, and expand its markets.
The Company believes that it is positioned to resume its growth as a
result of its efforts in expanding its customer base and the markets it serves
as well as its strength in designing, prototyping, and producing, on a timely
and cost-efficient basis, a wide range of innovative, distinctive, and
high-quality user interface devices required in the end products of OEMs. The
Company also believes that its research and development capabilities will allow
it to develop display technologies and manufacturing processes that will be of
benefit to its current and future customers. The Company's design processes
utilize advanced computer-aided design software to provide custom solutions for
customers' products in time frames and on cost-bases that it believes are
competitive. The Company utilizes advanced, flexible manufacturing systems that
can accommodate low-volume production runs or highly sophisticated applications
in Arizona and high-volume, price sensitive runs in Manila, the Philippines.
The Company maintains its principal executive offices at 1600 North
Desert Drive, Tempe, Arizona 85281, and its telephone number is (602) 389-8600.
Unless the context indicates otherwise, all references to the "Company" refer to
Three-Five Systems, Inc., its subsidiaries and predecessors.
Technology
Since the commercial introduction of the first light emitting diodes in
the 1960s and twisted nematic liquid crystal displays in the 1970s, the use of
LCD and LED indicators has become widespread in industrial and consumer
electronic products. Prior to these innovations, the most common displays or
indicators had substantial limitations as to their use, especially in terms of
size, life, and power consumption. LCD and LED technologies were developed in
order to overcome these limitations.
An LCD modifies light that passes through or is reflected by it, rather
than emitting light like an LED. An LCD generally consists of a layer of liquid
crystalline material suspended between two glass plates. The crystals align
themselves in a predictable manner, and this alignment changes when stimulated
electrically. This changed alignment produces a visual representation of the
information desired when used in conjunction with a polarizer and either natural
ambient light or an external light source.
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An LED chip produces light as the result of the application of direct
current at a low voltage. Different wavelengths (colors) can be produced in a
product depending upon the manufacturing process and the dopant (impurity) added
to the basic chip material, usually gallium arsenide or gallium phosphide. These
wavelengths can be visible or non-visible. In the visible range, LED chips
produce red, yellow, green, and recently, blue and white colors. In the
non-visible range (infrared), the Company's devices utilize 880 nanometer
wavelength or 940 nanometer wavelength chips.
Industry Overview
The Company has benefitted from the determination by certain OEMs in
the electronics industry to outsource the design and production of certain
components included in the end products of those OEMs. The Company believes that
the following factors have contributed to this growing trend among OEMs:
o As technology has become increasingly sophisticated and
complex, it has become more difficult for even the leading
OEMs to maintain the necessary technology, expertise,
personnel, and equipment to design and produce internally all
of the various components necessary for their products.
o Advanced design and manufacturing processes require
increasingly greater investments for research and development,
personnel, and equipment.
o Competitive market conditions require OEMs to reduce the
period of time from product conception to delivery, to
differentiate their products from those of their competitors,
to improve user friendliness, and to continually enhance
product performance and reduce product cost during the life
cycle of the product.
OEMs often design their products to contain user interface devices
(including those relating to operational control and informational display) as a
highly cost-effective means of differentiating their products from competing
products. OEMs then make the decision of whether to use standard devices, to
design and produce the devices in-house, or to outsource with a third party for
design and production. In making this decision, companies often recognize that
their greatest strengths consist of consumer recognition of brand names, market
research and product development expertise, and highly developed sales and
distribution channels. OEMs also recognize that the desired devices often cannot
be obtained "off-the-shelf" and that time constraints and limitations on
available resources often preclude them from maintaining the specialized
in-house expertise and equipment necessary to design and manufacture the desired
devices. OEMs often conclude that the logical solution is to focus their
resources on those areas (such as marketing and distribution) where they possess
the greatest leverage and to outsource the production of devices and components
in which they lack the requisite technology and expertise.
Outsourcing enables OEMs to obtain the following desired benefits:
o To gain access to specialized design and manufacturing
technology and expertise.
o To accelerate the design process and to reduce design and
manufacturing costs by utilizing the specialized personnel,
equipment, and facilities of the supplier.
o To reduce their own investment in personnel, equipment, and
facilities necessary for specialized design and production
capabilities.
o To streamline their own operations by concentrating their
resources on the design, production, and distribution of their
core products.
By eliminating the duplication and overlap of investment and resources,
outsourcing permits the Company and the OEMs to work together and grow at a
faster rate than would otherwise be possible. Outsourcing greatly reduces the
Company's need to devote time and resources on market development for specific
products and allows
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the Company to concentrate on the development of its display technologies and
their applications to a multitude of products.
Products and Services
The Company currently emphasizes custom designed user interface devices
for operational control and informational display functions. The Company
believes that custom devices represent the source of its greatest profits and
growth potential. For each custom device, the Company works directly with its
customer to develop and produce the original design and to manufacture the
device in accordance with the customer's specifications. The Company also
designs and produces standard or "off-the-shelf" devices, which involve designs
that are adaptable to various fixed end uses without modification.
The Company pursues a strategy designed to enable it to enhance its
position as a major, worldwide supplier of custom-designed and manufactured user
interface devices for products of leading OEMs in various high growth
industries. The Company attempts to identify industries that present the
greatest long-term potential for growth at any given time. The Company's
research and development activities then focus upon technological developments
that attempt to meet the current and future requirements of those industries.
The Company seeks to establish strong and long-lasting customer relationships by
aligning its prospects with those of its customers and by seeking to make its
engineering and advanced manufacturing functions seamless extensions of the
product design and production departments of its customers. The Company engages
in a careful customer selection process because it recognizes that its own
growth and development will be closely aligned with the growth and development
of the customers it serves. The Company's strategy currently involves
concentrating its efforts on providing design and production services to leading
companies in five primary industries: cellular telephones and other wireless
communications, data collection, office automation, medical devices, and
industrial process controls.
Custom Devices
LCD and LED custom displays currently account for approximately 91
percent of the Company's revenue. A manufacturer of a complete system or product
requiring a specific type of visual display (such as a cellular telephone,
medical instrument, business machine, or hand-held data collection device)
represents a typical buyer for a custom device.
The Company has developed a sophisticated design process to meet the
specific needs of its customers' applications. Each design project normally
involves a cross-functional team of Company engineers who are assigned to a
customer program. The team consults with the customer's engineers throughout the
design phase, prototype development, and manufacturing process. The Company
continues to supply value-added engineering support after the design solution
has been developed and integrated into the manufacturing process in an ongoing
effort to provide customers with product performance enhancements and
cost-reduction opportunities.
Standard Devices
Standard devices encompass a wide variety of LCD and LED devices having
varied applications. "Visible" LCD and LED standard devices include (i) solid
state lamps used for indicators, status lights, on-board circuit monitors, and
instrumentation; (ii) multi-digit numerical displays used for calculators,
industrial controls, data terminals, instrumentation timers, hand-held
instruments, event counters, and PCB diagnostics; (iii) integrated displays
(with on-board integrated circuit drivers) and alpha numeric displays used for
hand-held terminals, minicomputers, telecommunications, and instrumentation word
processors; (iv) bar graph displays used for power meters in stereo systems, Ham
and CB radio meters, VU meters in tape recorders, process control meters, and
replacements for edge meters; and (v) multi-digit numeric displays used for
industrial controls, data terminals, test equipment, point of sale,
mini-computer readout, and home consumer applications.
Standard infrared devices include (a) infrared emitters and silicon
detectors used for TV remote controls, disk drives, tape drives, printers,
encoders, solid state relays, photoelectric controls, slotted switches,
reflective
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switches, intrusion alarms, touch screens, wireless data entry and positioning
sensors; and (b) optocouplers used for AC power controls, DC power controls,
solid state relays, logic to power interfaces, and power supplies.
Manufacturing Services
The Company has geographically organized its manufacturing capabilities
in a manner that optimizes the combination of technology and human resources.
This enables the Company to compete solely on the basis of cost, if necessary,
with suppliers of similar products and services throughout the world. Advanced
manufacturing techniques include surface mount technologies, chip-on-board,
chip-on-flex, flip-chip, tape automated bonding, and sophisticated testing
systems throughout the process. The Company maintains at each of its facilities
quality systems and processes that meet or exceed the demanding standards set by
leading OEMs in targeted industries.
The Company seeks to increase its value to its customers by providing
responsive, flexible, total manufacturing services. To date, manufacturing
services have been concentrated toward the manufacture of LCDs and assembly of
Company-designed user interface module assemblies. However, the Company has
recognized an increased demand for extended manufacturing services beyond these
core services. These extended services may include adding additional components,
such as a keypad, microphone, card reader, product housing, or non-display
electronic sub-assembly, or the turn-key manufacture of a complete OEM product.
The Company intends to pursue extended manufacturing opportunities in those
instances when the Company believes it will be profitable to do so.
Manufacturing Facilities
The Company currently conducts manufacturing operations in Tempe,
Arizona and in Manila, the Philippines. The Company completed the construction
of its new principal U.S. facility in March 1995. The Arizona facility houses a
Class 1000 "clean room" and LCD fabrication and prototyping operation. The
Company utilizes the facility primarily to conduct LCD research and development,
to produce prototype and pre-production runs of devices for customer approval,
to conduct full production runs of low-volume devices, and to develop advanced
manufacturing processes that can be applied in Manila during full-scale
production. In addition, the facility has the largest LCD glass production
capacity in North America. Now fully operational, this highly automated line
enables the Company to reduce its dependence on foreign suppliers of LCD glass.
Facility personnel include a team of experts ranging from LCD research
scientists to specialized engineers with backgrounds in electronics, mechanics,
chemistry, physics, and manufacturing. The Company maintains a complete array of
state- of-the-art testing and quality control equipment at the facility.
The Company is a party to an agreement (the "Sub-Assembly Agreement")
with Technology Electronic Assembly and Management Pacific Corporation ("TEAM"),
pursuant to which TEAM manufactures, assembles, and tests user interface devices
for the Company at a facility owned by TEAM located in Manila, the Philippines.
The Company is also party to a lease agreement (the "Lease Agreement") with TEAM
pursuant to which TEAM leases space to the Company for those manufacturing
operations performed by TEAM under the Sub-Assembly Agreement. TEAM
manufactures, assembles, and tests devices designed by the Company in the space
leased to the Company and pursuant to procedures set forth in the Sub-Assembly
Agreement in accordance with specifications supplied by the Company. The Company
owns the manufacturing, assembling, and testing equipment (including automated
die attach and wire bond equipment with automatic pattern recognition features
for die and wire placement for LED die) as well as the processes and
documentation used by TEAM at the Manila facility. Pursuant to the
Sub-Assembly Agreement, the Company supplies all direct materials to TEAM that
are necessary to meet forecasted production levels specified by the Company. The
Company pays TEAM for the sub-assembly of the Company's devices based upon a
negotiated hourly rate. The Company also employs professional personnel,
including an Operations Manager, with a support staff consisting of
manufacturing, quality, and process engineers, and logistics personnel at the
Manila facility.
The Sub-Assembly Agreement and Lease Agreement between the Company and
TEAM extend through December 31, 1999 and from year to year thereafter. The
Sub-Assembly Agreement requires minimum production levels to be maintained. The
termination of the Lease Agreement or Sub-Assembly Agreement or the inability of
TEAM to fulfill its requirements under the Sub-Assembly Agreement would require
the Company to acquire
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additional manufacturing facilities or to contract for additional manufacturing
services. The Philippines has been subject to volcanic eruptions, typhoons, and
substantial civil disturbances, including attempted military coups against the
government. These circumstances could affect the Company's ability to obtain
products pursuant to the SubAssembly Agreement, although there has not been any
material interruption of operations to date. The termination of or the inability
of the Company to obtain products pursuant to the Sub-Assembly Agreement, even
for a relatively short period, would have a material adverse effect on the
operations and profitability of the Company.
The Company has implemented an aggressive quality control program. The
program is based upon Statistical Process Control, which advocates continual
quantitative measurements of crucial parameters and uses those measurements in a
closed-loop feedback system to control the manufacturing process. Product life
testing is performed to help ensure long-term product reliability. The results
of life tests are analyzed and actions taken to refine the manufacturing process
or enhance the product design.
Sales and Marketing
The Company markets its services primarily in North America, Europe,
and Asia through direct technical sales persons and, to a much lesser extent,
through an independent sales and distribution network. This network includes two
franchised distributors in approximately 96 sales offices. A staff of in-house,
Arizona-based sales and marketing personnel directs and aids the franchised
distributors. The Company also has sales offices in Arlington Heights, Illinois;
Flemington, New Jersey; and Tempe, Arizona.
The Company's sales to customers in Europe represented approximately 46
percent of net sales in 1996. In addition to a direct technical sales force, the
Company distributes products in Europe through a network of distributors,
augmented in some regions by marketing representatives. This network receives
support from the marketing, customer service, and support staff employed by the
Company's subsidiary, Three-Five Systems Limited, located in Swindon, England.
The European staff and network of distributors provide marketing, consulting,
and product design input locally for customers throughout Western Europe.
Customers
The Company's strategy involves concentrating its efforts on providing
design and production services to leading companies in five primary industries:
cellular telephones and other wireless communications, data collection, office
automation, medical devices, and industrial process controls. As a result, the
Company generally derives its revenue from services provided to a limited number
of customers. The Company's largest customer is Motorola, Inc. ("Motorola").
Sales to Motorola are made through 12 buyers operating in five separate product
divisions. The Company currently designs and manufactures user interface devices
used in approximately 42 individual product programs for Motorola. During 1996,
the five largest of these programs accounted for 9.6 percent, 7.5 percent, 6.6
percent, 4.9 percent, and 2.5 percent, respectively, of the Company's total
revenue, and the remaining product programs in the aggregate accounted for
approximately 34 percent of the Company's total revenue. Devices that are used
in cellular telephones accounted for substantially all of the Company's sales to
Motorola in 1996. See "Special Considerations - Substantial Reliance on Certain
Customers" contained in Item 1 of this Report.
Backlog
As of December 31, 1996, the Company had a backlog of orders of
approximately $17.9 million, all of which orders are believed to be firm and all
of which are expected to be filled during fiscal 1997. The backlog of orders at
December 31, 1995 was approximately $21.3 million. The Company's business has
not been seasonal to date.
Patents and Trademarks
The Company's business does not depend on patent or trademark
protection. The Company has recently received a patent on a technology, which
the Company refers to as LCiD(TM) or liquid crystal intense display. This is a
type of LCD that incorporates a proprietary approach to designing a dot matrix
LCD.
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Raw Materials
The principal raw materials used in producing the Company's displays
consist of gallium arsenide and gallium phosphorous wafers and die, LCD glass,
driver die, circuit boards, molded plastic parts, lead frames, wire, chips, and
packaging materials. The Company's procurement strategy provides alternative
sources of supplies for the majority of these materials. Many of such materials,
however, must be obtained from foreign suppliers, which subjects the Company to
the risks inherent in obtaining materials from foreign sources, including supply
interruptions and currency fluctuations. The Company's suppliers currently are
meeting the requirements of the Company, and strategic supplier alliances have
further strengthened relations with offshore suppliers. The Company's ability to
produce a significant percentage of its requirements of LCD glass in its new
facility is expected to reduce the Company's dependence on foreign suppliers.
See "Special Considerations - Shortage of Raw Materials and Supplies" contained
in Item 1 of this Report.
Competition
The Company believes that Optrex America, Inc., Seiko-Epson, Seiko
Instruments, Vikay Industrial Pte. Limited, PCI Limited, and Philips Components
B.V. constitute the principal competitors for the Company's LCD devices.
Hewlett-Packard, Rohm Co., Ltd., LiteOn, Inc., Siemens, Inc., Stanley Electric
Company, Ltd., and Quality Technologies Corp. constitute its principal
competitors for its LED devices. Most of these competitors are large companies
that have greater financial, technical, marketing, manufacturing, and personnel
resources than the Company. The revenue, profitability, and success of the
Company depend substantially upon its ability to compete with other providers of
user interface devices. No assurance can be given that the Company will continue
to be able to compete successfully with such organizations.
The Company currently competes principally on the basis of the
technical innovation and performance of its product solutions, including their
ease of use and reliability, as well as on their cost, timely design, and
manufacturing and delivery schedules. The Company's competitive position could
be adversely affected if one or more of its customers, particularly Motorola,
determine to design and manufacture their user interface devices internally or
secure them from other parties. See "Special Considerations - Competition"
contained in Item 1 of this Report.
Research and Development
The Company conducts an active and ongoing research, development, and
engineering program that focuses on advancing technology, developing improved
design and manufacturing processes, and improving the overall quality of the
products and services that the Company provides. Research and development
personnel concentrate on LCD technology, especially improving performance of
current products and expanding the technology to serve new markets. Research and
development also is conducted in manufacturing processes, including those
associated with efficient, high-volume production and electronic packaging.
Environmental Regulation
The operations of the Company result in the creation of small amounts
of hazardous waste, including various epoxies, gases, inks, solvents, and other
wastes. The amount of hazardous waste produced by the Company may increase in
the future depending on changes in the Company's operations. The disposal of
hazardous waste has received increasing focus from federal, state, local, and
international governments and agencies and has been subject to increasing
regulation. See "Special Considerations - Environmental Regulation" contained in
Item 1 of this Report.
In 1991, the Company received a notice of potential liability at the
Barkhamsted-New Hartford Landfill Site in Barkhamsted, Connecticut from the
United States Environmental Protection Agency ("EPA"). No further administrative
action was taken against the Company and the Company has recently been advised
by a representative of the EPA that the Company will have no liability with
respect to this matter.
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In a separate matter, the Company conducted a clean-up of limited
chemical contamination at its former property located in Barkhamsted,
Connecticut. The contamination was caused by the previous owner of the property,
and not as a result of any of the Company's operations. The Company has
contracted with an environmental consulting firm for assistance with the
clean-up process and has complied with the requests and recommendations of the
Connecticut Environmental Protection Agency throughout the process. The Company
believes that the source of the contamination has been removed from the property
and that the clean-up has been completed. Four monitoring wells have been
installed to permit periodic chemical analysis to be made at the property. The
property was sold on June 25, 1995, subject to the Company making its best
efforts to obtain from either the Connecticut or federal Environmental
Protection Agency documentation to the effect that the property is clean and
that there is no actionable contamination in the vicinity of the property.
Employees
As of December 31, 1996, the Company employed a total of 195 persons.
This number includes 148 full-time and approximately 26 temporary employees at
its principal U.S. facility in Tempe, Arizona. The Company considers its
relationship with its employees to be good, and none of its employees currently
are represented by a union in collective bargaining with the Company.
TEAM provides the personnel engaged in the assembly of the Company's
devices in Manila pursuant to the Sub-Assembly Agreement between the Company and
TEAM. See "Description of Business - Manufacturing Facilities" contained in Item
1 of this Report. As of December 31, 1995, approximately 1,150 persons performed
direct and indirect labor operations at the Manila facility through the
Sub-Assembly Agreement with TEAM.
Executive Officers
The following table sets forth information concerning each of the
executive officers of the Company:
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David R. Buchanan 64 Chairman of the Board, President, and Chief Executive Officer
Vincent C. Hren 46 Vice President - Operations
Dan J. Schott 57 Vice President - Research and Development
James F. Bowser 55 Vice President - New Product Development
Bruce E. Sedlak 43 Vice President - Sales
Jeffrey D. Buchanan 41 Vice President - Finance, Administration, and Legal;
Chief Financial Officer; Secretary; and Treasurer
Elizabeth A. Sharp 35 Vice President - Corporate Relations
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David R. Buchanan has been Chairman of the Board, President, Chief
Executive Officer, and a Director of the Company since its formation in February
1990. Mr. Buchanan served as Treasurer of the Company from May 1990 until
January 1994 and as Chairman of the Board, Chief Executive Officer, President,
and a Director of one of the predecessors of the Company from October 1986,
February 1987, and November 1985, respectively, until the predecessor's merger
into the Company in May 1990.
Vincent C. Hren has been Vice President - Operations of the Company
since August 1996 and served as Vice President - Manufacturing Operations from
January 1996 to August 1996. Mr. Hren served as Vice President - Worldwide
Automotive of Graco Inc. from 1994 to 1995. Mr. Hren served as Vice President -
Worldwide Operations for Fisher-Rosemount Systems, Inc. from 1993 to 1994,
General Manager of Rosemount Analytical, Inc. from 1992 to 1993, and held
various management positions with Fisher-Rosemount, Inc. from 1974 to 1992.
Dan J. Schott has been Vice President - Research and Development of the
Company since January 1994. From 1988 to January 1994, Mr. Schott was an
Associate Director with Honeywell Inc., where his responsibilities included flat
panel display research and development. From 1981 until 1987, he held various
engineering management and program management positions with Sperry Rand Corp.
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James F. Bowser has been Vice President - New Product Development of
the Company since March 1997 and has served in a variety of executive positions
with the Company since August 1990, including as the Company's Vice President -
Sales and Marketing and Vice President - Manufacturing Operations. From January
1985 until August 1990, he held a variety of executive positions with National
Computer Systems, Inc.
Bruce E. Sedlak has served as Vice President - Sales of the Company
since February 1997. Mr. Sedlak served as Regional Sales Manager of Auspex
Systems, Inc. from August 1994 until February 1997. From January 1993 to January
1995, Mr. Sedlak served as President and Chief Executive Officer of Summit
Solutions, Inc. and from March 1991 to January 1993 he served as Vice President
and General Manager of VERSYSS Southwest, Inc. Mr. Sedlak held various
management positions with UNISYS Corporation (formerly Burroughs) from September
1975 until March 1991, including serving as Regional Manager, Western Region
from April 1989 until March 1991.
Jeffrey D. Buchanan has been Vice President - Finance, Administration,
and Legal, Chief Financial Officer, and Treasurer of the Company since June 1996
and Vice President - Administration and Legal and Secretary of the Company since
May 1996. Mr. Buchanan served as a Senior Partner of O'Connor, Cavanagh,
Anderson, Killingsworth & Beshears from June 1986 until May 1996, where he
practiced as a business lawyer with an emphasis on mergers and acquisitions,
joint ventures, and taxation. Mr. Buchanan was associated with the international
law firm of Davis Wright Tremaine from 1984 to 1986, and he was a senior staff
person at Deloitte & Touche from 1982 to 1984. Mr. Buchanan is a member of the
Arizona and Washington state bars and passed the certified public accounting
examination in 1983. Mr. Buchanan is the son of David R. Buchanan.
Elizabeth A. Sharp has been Vice President - Corporate Relations of the
Company since May 1996. Ms. Sharp served as Director of Human Resources of the
Company from May 1992 until May 1996, as Corporate Administrator of the Company
from April 1988 until May 1992, as Personnel Manager from April 1987 until April
1988, and as Administrative Assistant to the President and Chief Financial
Officer of the Company from May 1986 until April 1987. From December 1981 until
March 1986, Ms. Sharp held a variety of management positions with Concept
Communications Corporation.
SPECIAL CONSIDERATIONS
Certain Factors Affecting Operating Results
The Company's operating results are affected by a wide variety of
factors which could adversely impact its net sales and profitability. These
factors, many of which are beyond the control of the Company, include the
Company's ability to identify industries which have significant growth potential
and to establish strong and long- lasting relationships with companies in those
industries; the Company's ability to provide significant design and
manufacturing services for those companies on a timely and cost-effective basis;
the Company's success in maintaining customer satisfaction with its design and
manufacturing services; market acceptance of products of its customers
incorporating devices designed and manufactured by the Company; the level and
timing of orders placed by customers which the Company can complete in a
quarter; customer order patterns; changes in order mix; the performance and
reliability of devices designed and manufactured by the Company; the life cycles
of its customers' products; the availability and utilization of manufacturing
capacity; fluctuations in manufacturing yield and productivity; the availability
and cost of raw materials, equipment, and supplies; the timing of expenditures
in anticipation of orders; the cyclical nature of the industries and the markets
served by the Company; technological changes; and competition and competitive
pressures on prices.
The Company's ability to increase its design and manufacturing capacity
to meet customer demand and maintain satisfactory delivery schedules will be an
important factor in its long-term prospects. Although the Company's product
solutions are incorporated into a wide variety of communications, consumer,
medical, office automation, and industrial products, a majority of its sales in
1996 were display modules for cellular products. A slowdown in demand for
customer products, particularly cellular products, which utilize the Company's
products, as a result of economic or other conditions in the United States or
worldwide markets served by the Company or other broadbased factors would
adversely affect the Company's operating results.
8
<PAGE>
Dependence on New Products and Technologies
The Company operates in fast changing industries. Technological
advances, the introduction of new products, and new design and manufacturing
techniques could adversely affect the Company's operations unless the Company is
able to adapt to the resulting changing conditions. As a result, the Company
will be required to expend substantial funds for and commit significant
resources to the conduct of continuing research and development activities, the
engagement of additional engineering and other technical personnel, the purchase
of advanced design, production and test equipment, and the enhancement of design
and manufacturing processes and techniques.
The Company's future operating results will depend to a significant
extent on its ability to continue to provide design and manufacturing services
for new products that compare favorably on the basis of time to introduction,
cost, and performance with the design and manufacturing capabilities of OEMs and
other third-party suppliers. The success of new design and manufacturing
services depends on various factors, including proper customer selection,
utilization of advances in technology, innovative development of new solutions
for customer products, efficient and cost-effective services, timely completion
and delivery of new product solutions, and market acceptance of customers' end
products. Because of the complexity of the Company's design and manufacturing
services, the Company may experience delays from time to time in completing the
design and manufacture of new product solutions. In addition, there can be no
assurance that any new product solutions will receive or maintain customer or
market acceptance. If the Company were unable to design and manufacture
solutions for new products of its customers on a timely and cost-effective
basis, its future operating results would be adversely affected. See
"Description of Business - Products and Services" contained in Item 1 of this
Report.
Finally, even when a design and manufacturing solution is
satisfactorily completed, circumstances outside of the Company's control may
result in the loss of expected revenue. For example, a customer may terminate or
delay its own program for any number of reasons unrelated to the Company,
including problems with other suppliers to the program or lack of market
acceptance of the customer's product. In such instances, the future operating
results of the Company could be adversely affected.
Substantial Reliance on Certain Customers
In the past few years, the Company has generated most of its revenue
from sales to a few significant customers. The Company's largest customer is
Motorola, which accounted for 65 percent of the Company's revenue in 1996 and 81
percent of the Company's revenue in 1995. Sales to Motorola are made through 12
buyers operating in five separate product divisions. The Company currently
designs and manufactures user interface devices for use in approximately 42
individual product programs for Motorola. During 1996, the five largest of these
programs accounted for 9.6 percent, 7.5 percent, 6.6 percent, 4.9 percent, and
2.5 percent, respectively, of the Company's total revenue, and the remaining
product programs in the aggregate accounted for approximately 34 percent of the
Company's total revenue. Devices that are used in cellular telephones accounted
for substantially all of the Company's sales to Motorola in 1996. Although the
percentage of sales to Motorola declined in 1996, and is expected to decline
further in 1997, the Company expects that a recent new customer could account
for as much as 20 percent of the Company's revenue in 1997.
The Company does not have long-term supply contracts with any
customers, and customers also generally do not commit to long-term production
schedules. In addition, customer orders generally can be cancelled and volume
levels changed or delayed. The timely replacement of cancelled, delayed, or
reduced orders cannot be assured. The Company's operating results have been
materially and adversely affected in the past by the failure of anticipated
orders to be realized and by deferrals or cancellations of orders as a result of
changes in customer requirements. Cancelled, delayed, or reduced commitments
from any of the Company's major customers, particularly Motorola or the recent
new customer referred to above, would have a material adverse effect on the
Company's results of operations.
9
<PAGE>
Manufacturing Operations in the Philippines
The Company has maintained its primary manufacturing facility in
Manila, the Philippines since 1986. TEAM, a third party subcontractor, owns the
facility, which is located on land it leases from the Philippine government.
TEAM operates the facility under the Sub-Assembly Agreement and the Lease
Agreement with the Company, utilizing equipment, processes, and documentation
owned by the Company and supervisory personnel employed by the Company. TEAM
provides production personnel under the Sub-Assembly Agreement and leases space
to the Company under the Lease Agreement. TEAM also utilizes other space in the
facility to produce products for other entities unrelated to the Company. The
Sub-Assembly Agreement and the Lease Agreement have current terms extending
through December 31, 1999 and from year to year thereafter. Since 1994, the
Company has made advance payments to TEAM to assist it in meeting its working
capital needs while it negotiates new financing arrangements. Advances, net of
amounts payable to TEAM, totalled approximately $119,000 at December 31, 1996
and are secured by future payments for sub-assembly services to be provided to
the Company as well as other assets of TEAM.
The Company has made cumulative capital investments in the Philippines
amounting to approximately $10.6 million through December 31, 1996. The
Company's reliance on personnel and facilities in the Philippines and its
maintenance of inventories abroad expose the Company to certain economic and
political risks, including the business and financial condition of the
subcontractor, political instability and expropriation, supply disruption,
currency controls, and exchange fluctuations as well as changes in tax laws,
tariffs, and freight rates. The Company has not experienced any significant
interruptions in its business operations in the Philippines to date despite the
fact that the Philippines has been subject to volcanic eruptions, typhoons, and
substantial civil disturbances, including attempted military coups against the
government. The Company believes that its manufacturing operations in the
Philippines constitute one of the Company's most important resources and that it
would be difficult for it to replace the low-cost, high-performance facility or
the high-quality and hardworking production staff if its manufacturing
operations in the Philippines were disrupted or terminated. As a result, the
Company's operations would be adversely affected if operations in the
Philippines or air transportation with the Philippines were disrupted or
terminated, even for a relatively short period of time. See "Description of
Business - Manufacturing Facilities" contained in Item 1 of this Report.
International Trade and Currency Exchange
Approximately 46 percent of the Company's net sales in 1996 were
international sales. In addition, the Company purchases a substantial portion of
its raw materials and equipment from foreign suppliers and incurs labor costs in
foreign locations. The foreign sale of products and the purchase of raw
materials and equipment from foreign suppliers may be adversely affected by
political and economic conditions abroad. Protectionist trade legislation in
either the United States or foreign countries, such as a change in the current
tariff structures, export compliance laws, or other trade policies, could
adversely affect the Company's ability to sell devices in foreign markets and
purchase materials or equipment from foreign suppliers.
A small portion of the Company's foreign transactions are denominated
in currencies other than the U.S. dollar. Such transactions expose the Company
to exchange rate fluctuations for the period of time from inception of the
transaction until it is settled. For example, the Company's Sub-Assembly
Agreement and Lease Agreement with TEAM are based on a fixed conversion rate,
exposing the Company to exchange rate fluctuations with the Philippine peso.
Although the Company has not incurred any material exchange gains or losses to
date, there can be no assurance that fluctuations in the currency exchange rates
in the future will not have an adverse effect on the Company's operations. The
Company has entered and from time to time will enter into hedging transactions
in order to minimize its exposure to currency rate fluctuations.
Manufacturing Yields and Capacity
The design and manufacture of user interface devices are highly complex
processes that are sensitive to a wide variety of factors, including the level
of contaminants in the manufacturing environment, impurities in the materials
used, and the performance of the design and production personnel and equipment.
As is typical in the
10
<PAGE>
industry, the Company from time to time has experienced lower than anticipated
manufacturing yields and lengthening of delivery schedules. This may be
particularly true as the Company ramps up its new high-volume LCD line to
greater production levels in 1997. The Company continually reviews its processes
to increase its manufacturing productivity, achieve higher manufacturing yields,
and reduce design and manufacturing errors. In addition, the Company maintains
ongoing procedures to assure its ability to meet delivery schedules to satisfy
increased business. The Company's operating results would be adversely affected
if it were unable to maintain high levels of productivity or to maintain
satisfactory delivery schedules in either its Manila manufacturing plant or its
Arizona high-volume LCD line.
Manufacturing yields and delivery schedules also may be affected as the
Company increases its use of the capacity of the Manila manufacturing facility.
Other companies in the industry have experienced difficulty in expanding
manufacturing output and capacity, with such difficulty resulting in reduced
yields or delays in product deliveries. No assurance can be given that the
Company will not experience manufacturing yield or delivery problems in the
future. Such problems could materially affect the Company's operating results.
See "Description of Business - Manufacturing Facilities" contained in Item 1 of
this Report.
Utilization of New Facility
The Company has made substantial expenditures in constructing and
equipping its new headquarters facility in Tempe, Arizona, including a
high-volume LCD manufacturing line. The high-volume line was placed in service
in 1996, although the Company committed a significant amount of time and
resources in 1996 to the development of manufacturing processes on the line. The
Company intends to utilize the high-volume line to produce a substantial portion
of its own requirements for LCD glass. The successful utilization of the LCD
glass line will require the Company (i) to produce LCD glass on a timely and
cost-effective basis at quality levels at least equal to the LCD glass available
from independent suppliers and (ii) to utilize the LCD glass it produces in
devices it designs and manufactures in a manner satisfactory to its customers.
The Company experienced some delays in fully implementing its LCD glass
manufacturing operations in 1996, and no assurance can be given that the Company
will not experience problems or delays in the future in conducting its LCD glass
manufacturing operations. Any such problems could result in the lengthening of
the Company's delivery schedules, reductions in the quality or performance of
the Company's design and manufacturing services, and reduced customer
satisfaction. Such problems also could require the Company to purchase its LCD
glass requirements from third parties and result in the inability of the Company
to recover its investment in the high-volume LCD line.
Management of Growth
The Company's revenue expanded substantially during the period from
1993 through 1995, but declined significantly in 1996 as a result of the
discontinuation of a few significant programs from its major customer. During
the last half of 1996, however, the Company increased the number of its
manufacturing and design programs and the Company plans to further expand the
number and diversity of its programs in the future. At the end of 1996, the
Company had 69 manufacturing and design programs versus 47 at the end of 1995.
The Company's ability to manage its planned growth effectively will require it
to enhance its operational, financial, and management systems, to expand its
facilities and equipment, and to successfully hire, train, and motivate
additional employees, including the technical personnel necessary to operate its
new LCD glass production facility in Arizona. The failure of the Company to
manage its growth on an effective basis could have a material adverse effect on
the Company's operations.
The Company may be required to increase staffing and other expenses as
well as its expenditures on capital equipment and leasehold improvements in
order to meet the anticipated demand of its customers. Customers, however,
generally do not commit to firm production schedules for more than a short time
in advance. The Company's profitability would be adversely affected if the
Company increases its expenditures in anticipation of future orders that do not
materialize. Customers also may require rapid increases in design and production
services that place an excessive short-term burden on the Company's resources.
11
<PAGE>
Dependence on Key Personnel
The Company's development and operations depend substantially on the
efforts and abilities of its senior management and technical personnel,
including David R. Buchanan, who has served as the Chairman of the Board since
1986 and as President and Chief Executive Officer of the Company since 1987. The
competition for qualified management and technical personnel is intense. The
loss of services of one or more of its key employees or the inability to add key
personnel (including those required for its new LCD glass production facility)
could have a material adverse effect on the Company. See "Description of
Business - Executive Officers" contained in Item 1 of this Report. The Company
does not have an employment agreement with, or key person life insurance
covering, any officer or employee. The Company, however, maintains
noncompetition and nondisclosure agreements with its key personnel.
Possible Volatility of Stock Price
The market price of the Company's Common Stock increased dramatically
during the three-year period ended December 31, 1994, but declined significantly
during 1995 and 1996. See "Market for Common Equity and Related Stockholder
Matters" contained in Item 5 of this Report. The trading price of the Company's
Common Stock in the future could continue to be subject to wide fluctuations in
response to various factors, including quarterly variations in operating results
of the Company, actual or anticipated announcements of technical innovations or
new product developments by the Company or its competitors, changes in analysts'
estimates of the Company's financial performance, general conditions in the
electronics industry, worldwide economic and financial conditions, and other
events or factors. In addition, the stock market has experienced extreme price
and volume fluctuations which have particularly affected the market prices for
many high technology companies and which often have been unrelated to the
operating performance of such companies. These broad market fluctuations and
other factors may adversely affect the market price of the Company's Common
Stock.
Competition
The industries which the Company serves are intensely competitive and
have been characterized by price erosion, rapid technological change, and
foreign competition. The Company competes with major domestic and international
companies, many of which have greater market recognition and substantially
greater financial, technical, marketing, distribution, and other resources than
the Company possesses. Emerging companies also may increase their participation
in the user interface device market. The ability of the Company to compete
successfully depends on a number of factors both within and outside its control,
including the quality, performance, reliability, features, ease of use, pricing,
and diversity of its product solutions; foreign currency fluctuations, which may
cause a foreign competitor's products to be priced significantly lower than the
Company's products; the quality of its customer services; its ability to address
the needs of its customers; its success in designing and manufacturing new
product solutions, including those implementing new technologies; the
availability of adequate sources of raw materials and other supplies at
acceptable prices; its efficiency of production; the rate at which customers
incorporate the Company's user interface devices into their own products;
product solution introductions by the Company's competitors; the number, nature,
and success of its competitors in a given market; and general market and
economic conditions. The Company currently competes principally on the basis of
the technical innovation and performance of its user interface devices,
including their ease of use and reliability, as well as on cost and timely
design, manufacturing, and delivery schedules. The Company's competitive
position could be adversely affected if one or more of these customers increase
their own capacity and decide to design and manufacture their own user interface
devices, to use standard devices, or to outsource with a competitor. There is no
assurance that the Company will continue to be able to compete successfully in
the future. See "Description of Business - Competition" contained in Item 1 of
this Report.
Shortage of Raw Materials and Supplies
The principal raw materials used in producing the Company's product
solutions consist of gallium arsenide and gallium phosphorous wafers and die,
LCD glass, driver die, circuit boards, molded plastic parts, lead frames,
12
<PAGE>
wire, chips, and packaging materials, most of which are acquired from Asian
sources. The Company does not have long-term contracts with its suppliers.
The Company believes that there are alternative sources of supplies for
most of these materials. Many of such materials, however, must be obtained from
foreign suppliers, which subjects the Company to certain risks, including supply
interruptions and currency price fluctuations. Purchasers of these materials,
including the Company, experience difficulty from time to time in obtaining such
materials. The Company's suppliers currently are adequately meeting the
requirements of the Company, and the Company's ability to produce a substantial
portion of its own requirements for LCD glass in its new facility is expected to
reduce the Company's dependence on foreign suppliers of LCD glass.
The Electronics Industry: Cyclicity and Capital Requirements
The electronics industry has experienced significant economic downturns
at various times, characterized by diminished product demand, accelerated
erosion of average selling prices, and production over-capacity. In addition,
the electronics industry has been characterized by cyclicity. The Company has
sought to reduce its exposure to industry downturns and cyclicity by providing
design and production services for leading companies in rapidly expanding
segments of the electronics industry. However, the Company may experience
substantial period-to-period fluctuations in future operating results because of
general industry conditions or events occurring in the general economy. There is
no assurance that the Company will continue to experience increased demand.
To remain competitive, the Company must continue to make significant
investments in research and development, equipment, and facilities. As a result
of the increase in fixed costs and operating expenses related to these capital
expenditures, the Company's operating results may be adversely affected if its
net sales do not increase sufficiently to offset the increased costs. The
Company from time to time may seek additional equity or debt financing to
provide for the capital expenditures required to maintain or expand the
Company's design and production facilities and equipment. The timing and amount
of any such capital requirements cannot be predicted at this time. There can be
no assurance that any such financing will be available on acceptable terms. If
such financing is not available on satisfactory terms, the Company may be unable
to expand its business or develop new customers at the rate desired and its
operating results may be adversely affected. Debt financing increases expenses
and must be repaid regardless of operating results. Equity financing could
result in additional dilution to existing stockholders. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources" contained in Item 7 of this Report.
Environmental Regulation
The operations of the Company result in the creation of small amounts
of hazardous waste, including various epoxies, gases, inks, solvents, and other
wastes. The Company, therefore, is subject to federal, state, and local
governmental regulations related to the use, storage, discharge, and disposal of
toxic, volatile, or otherwise hazardous chemicals used in its design and
manufacturing processes. The amount of hazardous waste produced by the Company
may increase in the future depending on changes in the Company's operations. The
failure by the Company to comply with present or future environmental
regulations could result in fines being imposed on the Company, suspension of
production, or a cessation of operations. Compliance with such regulations could
require the Company to acquire costly equipment or to incur other significant
expenses. Any failure by the Company to control the use of, or adequately
restrict the discharge of, hazardous substances could subject it to future
liabilities.
In January 1991, the Company received a notice of potential liability
respecting a landfill site near the Company's former property in Barkhamsted,
Connecticut from the United States Environmental Protection Agency. No further
administrative action was taken against the Company and the Company has recently
been advised by a representative of the EPA that the Company will have no
liability with respect to this matter. In a separate matter, the Company has
removed contamination and continues to conduct periodic chemical monitoring at
the Company's former Connecticut property. There can be no assurance that other
environmental problems will not be discovered in the future which could subject
the Company to future costs or liabilities. See "Description of Business -
Environmental Regulation" contained in Item 1 of this Report.
13
<PAGE>
Change in Control Provisions
The Company's Restated Certificate of Incorporation (the "Restated
Certificate") and the Delaware General Corporation Law (the "Delaware GCL")
contain provisions that may have the effect of making more difficult or delaying
attempts by others to obtain control of the Company, even when these attempts
may be in the best interests of stockholders. The Restated Certificate also
authorizes the Board of Directors, without stockholder approval, to issue one or
more series of Preferred Stock which could have voting and conversion rights
that adversely affect or dilute the voting power of the holders of Common Stock.
The Delaware GCL also imposes conditions on certain business combination
transactions with "interested stockholders" (as defined therein).
Rights to Acquire Shares
At December 31, 1996, 9,000 shares of Common Stock were reserved for
issuance upon exercise of options previously granted under the Company's 1994
Automatic Stock Option Plan; 197,000 shares of Common Stock were reserved for
issuance upon exercise of options previously granted under the Company's 1993
Stock Option Plan; and 345,776 shares of Common Stock were reserved for issuance
upon exercise of options previously granted under the Company's 1990 Stock
Option Plan. The weighted average exercise price of those shares is $6.92 per
share. During the terms of such options, the holders thereof will have an
opportunity to profit from an increase in the market price of Common Stock with
resulting dilution in the interests of holders of Common Stock. The existence of
such stock options may adversely affect the terms on which the Company can
obtain additional financing, and the holders of such options can be expected to
exercise such options at a time when the Company, in all likelihood, would be
able to obtain additional capital by offering shares of its Common Stock on
terms more favorable to the Company than those provided by the exercise of such
options.
Repurchase of Common Stock
In August 1996, the Board of Directors authorized the repurchase from
time to time of up to one million shares of the Company's Common Stock on the
open market or in negotiated transactions, depending on market conditions and
other factors. The repurchase of shares by the Company would reduce the
Company's capital. If the Company obtains financing from other sources for such
repurchases, the liabilities of the Company would increase. The reduction in
capital or increase in liabilities could adversely affect the Company's ability
to expand its business or commit resources to needed expenditures. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resources" contained in Item 7 of this
Report. A significant reduction in the number of shares outstanding on the open
market could also increase the volatility of the stock as a result of the
reduced supply of available shares on the open market.
Shares Eligible for Future Sale; Potential Depressive Effect on Stock Price
Currently, Rule 144 under the Securities Act of 1933, as amended (the
"Securities Act"), provides that each person who beneficially owns restricted
securities with respect to which at least two years has elapsed since the later
of the date the shares were acquired from the Company or an affiliate of the
Company may, every three months, sell in ordinary brokerage transactions or to
market makers an amount of shares equal to the greater of 1 percent of the
Company's then-outstanding Common Stock or the average weekly trading volume for
the four weeks prior to the proposed sale of such shares. An aggregate of
741,262 shares of Common Stock held by an officer and director of the Company
currently are available for sale under Rule 144. Sales of substantial amounts of
Common Stock by stockholders of the Company or even the potential for such
sales, are likely to have a depressive effect on the market price of the Common
Stock and could impair the Company's ability to raise capital through the sale
of its equity securities.
Dividends
The Company has never paid any cash dividends on its Common Stock and
does not anticipate that it will pay cash dividends in the near term. Instead,
the Company intends to apply any earnings to the expansion and development of
its business. See "Market for Common Equity and Related Stockholder Matters"
contained in Item 5 of this Report.
14
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Cautionary Statement Regarding Forward-Looking Statements
Certain statements and information contained in this Report under the
headings "Business," "Special Considerations," and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" concerning future,
proposed, and anticipated activities of the Company, certain trends with respect
to the Company's revenue, operating results, capital resources, and liquidity or
with respect to the markets in which the Company competes or the electronics
industry in general, and other statements contained in this Report regarding
matters that are not historical facts are forward-looking statements, as such
term is defined in the Securities Act. Forward- looking statements, by their
very nature, include risks and uncertainties, many of which are beyond the
Company's control. Accordingly, actual results may differ, perhaps materially,
from those expressed in or implied by such forward-looking statements. Factors
that could cause actual results to differ materially include those discussed
elsewhere under this Item 1, "Business - Special Considerations."
ITEM 2. DESCRIPTION OF PROPERTY
During 1995, the Company completed the construction of its new
principal facility to house its U.S.-based manufacturing operations; its
research, development, engineering, design, and corporate functions; and the
largest LCD glass manufacturing operations in North America. The facility
contains 97,000 square feet of space located on a 5.7 acre site in the Papago
Park Center in Tempe, Arizona. The Company entered into a ground lease through
December 31, 2069, subject to renewal and purchase options as well as early
termination provisions. Costs to construct, furnish, and equip the new facility
were approximately $24.0 million.
The Company leases approximately 3,500 square feet of office space in
Swindon, United Kingdom, where it maintains its European administrative and
executive offices.
The Company leases approximately 60,000 square feet of manufacturing
space in Manila, the Philippines. Approximately 40,000 square feet is subject to
a lease which expires on December 31, 1999, and the remaining 20,000 square feet
is subject to a lease which expires on March 31, 1997, with renewal options for
two additional years.
ITEM 3. LEGAL PROCEEDINGS
There are no legal proceedings to which the Company is a party or to
which any of its properties are subject, other than routine litigation incident
to the Company's business which is covered by insurance or an indemnity or which
are not expected to have a material adverse effect on the Company. It is
possible, however, that the Company could incur claims for which it is not
insured or that exceed the amount of its insurance coverage.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
15
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PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been listed on the New York Stock
Exchange ("NYSE") under the symbol "TFS" since December 29, 1994. The Company's
Common Stock was listed on the American Stock Exchange ("AMEX") from January 28,
1993 through December 28, 1994. The Company's Common Stock was listed on the
AMEX Emerging Company Marketplace from March 18, 1992 until January 27, 1993,
and on the Nasdaq National Market system from May 1, 1990 until March 17, 1992.
The following table sets forth the quarterly high and low prices of the
Company's Common Stock for the periods indicated, adjusted to reflect the
two-for-one split of the Common Stock effected as a stock dividend in May 1994.
<TABLE>
<CAPTION>
High Low
---- ---
<S> <C> <C>
1993:
First Quarter................................................................. $ 3 7/8 $ 1 3/4
Second Quarter................................................................ 8 3 7/16
Third Quarter................................................................. 12 1/16 6 3/8
Fourth Quarter................................................................ 17 5/8 10 7/8
1994:
First Quarter................................................................. $ 30 7/8 $ 16 9/16
Second Quarter................................................................ 29 15/16 20
Third Quarter................................................................. 46 1/2 26 1/4
Fourth Quarter................................................................ 50 28 3/4
1995:
First Quarter................................................................. $ 38 3/8 $ 20 5/8
Second Quarter................................................................ 38 7/8 22 3/8
Third Quarter................................................................. 36 3/4 24 1/4
Fourth Quarter................................................................ 26 1/2 16
1996:
First Quarter................................................................. $ 21 7/8 $ 11 5/8
Second Quarter................................................................ 14 1/8 9 1/8
Third Quarter................................................................. 13 8 3/4
Fourth Quarter................................................................ 14 10 5/8
1997:
First Quarter (through March 6, 1997)......................................... $ 16 1/8 $ 12 1/4
</TABLE>
As of March 6, 1997, there were approximately 1,200 holders of record
of the Company's Common Stock.
The present policy of the Company is to retain earnings to provide
funds for the operation and expansion of its business. The Company has not paid
dividends on its Common Stock and does not anticipate that it will do so in the
near term. Furthermore, the Company's line of credit with Wells Fargo Bank does
not permit the payment of dividends without the consent of Wells Fargo Bank. The
payment of dividends in the future will depend on the Company's growth,
profitability, financial condition, and other factors which the directors may
deem relevant.
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ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes certain selected consolidated financial
data of the Company and is qualified in its entirety by the more detailed
consolidated financial statements and notes thereto appearing elsewhere herein.
The data have been derived from the consolidated financial statements of the
Company audited by Arthur Andersen LLP, independent public accountants. All
share amounts and per share data have been adjusted to reflect the two-for-one
split of the Company's Common Stock effected as a stock dividend in May 1994.
<TABLE>
<CAPTION>
1996 1995 1994 1993(1) 1992
---- ---- ---- ------- ----
<S> <C> <C> <C> <C> <C>
Consolidated Statements of Income (Loss): (in thousands, except per share amounts)
Net sales.................................................. $60,713 $91,585 $85,477 $38,002 $20,833
------- ------- ------- ------- -------
Costs and expenses:
Cost of sales............................................ 58,321 70,481 59,409 26,725 15,388
Selling, general and administrative...................... 5,351 5,386 4,867 3,853 3,469
Research and development................................. 4,065 2,396 1,270 857 468
------- ------- ------- ------- -------
67,737 78,263 65,546 31,435 19,325
------- ------- ------- ------- -------
Operating income (loss).................................... (7,024) 13,322 19,931 6,567 1,508
------- ------- ------- ------- -------
Other income (expense)
Interest, net............................................ 412 765 859 (117) (179)
Other, net............................................... (139) (122) (135) (277) (160)
------- ------- ------- ------- -------
273 643 724 (394) (339)
------- ------- ------- ------- -------
Income (loss) before provision for (benefit from)
income taxes and cumulative effect of
accounting change........................................ (6,751) 13,965 20,655 6,173 1,169
Provision for (benefit from) income taxes.................. (2,920) 5,548 8,109 2,043 147
------- ------- ------- ------- -------
Income (loss) before cumulative effect of
accounting change........................................ (3,831) 8,417 12,546 4,130 1,022
Cumulative effect of accounting change..................... -- -- -- 924 --
------- ------- ------- ------- -------
Net income (loss).......................................... $(3,831) $ 8,417 $12,546 $ 5,054 $ 1,022
======= ======= ======= ======= =======
Earnings (loss) per common share and common share equivalent:
Income (loss) before cumulative effect of
accounting change...................................... $ (0.49) $ 1.04 $ 1.59 $ 0.59 $ 0.14
Cumulative effect of accounting change................... -- -- -- 0.13 --
------- ------- ------- ------- -------
Net income (loss).......................................... $ (0.49) $ 1.04 $ 1.59 $ 0.72 $ 0.14
======= ======= ======= ======= =======
Weighted average number of common
shares and common share equivalents outstanding.......... 7,766 8,084 7,882 7,040 7,225
Consolidated Balance Sheet Data
(at end of period):
Working capital............................................ $21,513 $22,400 $37,638 $ 7,427 $ 4,450
Total assets............................................... 62,569 63,780 56,280 17,470 9,811
Notes payable to banks and long-term debt.................. -- 3,000 182 223 2,184
Stockholders' equity....................................... 51,184 55,224 46,561 10,202 4,661
</TABLE>
- -----------------
(1) The Company adopted Statement of Financial Accounting Standards No.
109, "Accounting for Income Taxes," effective January 1, 1993. The
presentation above includes the cumulative effect of the change in
accounting principle which increased net income by $924,000, or $0.13
per share, for the year ended December 31, 1993.
17
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations
Annual Table: Percentages of Net Sales
The following table sets forth, for the periods indicated, the
percentage of net sales of certain items in the Consolidated Financial
Statements of the Company. The table and the discussion below should be read in
conjunction with the Consolidated Financial Statements and Notes thereto.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Net sales.................................................................. 100.0% 100.0% 100.0%
----- ----- -----
Costs and expenses
Cost of sales............................................................ 96.1 77.0 69.5
Selling, general, and administrative..................................... 8.8 5.9 5.7
Research and development................................................. 6.7 2.6 1.5
----- ----- -----
111.6 85.5 76.7
Operating income (loss).................................................... (11.6) 14.5 23.3
Other income (expense)
Interest, net............................................................ 0.7 0.8 1.0
Other, net............................................................... (0.2) (0.1) (0.1)
----- ----- -----
0.5 0.7 0.9
----- ----- -----
Income (loss) before provision for (benefit from) income taxes............. (11.1) 15.2 24.2
Provision for (benefit from) income taxes.................................. (4.8) 6.1 9.5
----- ----- -----
Net income (loss).......................................................... (6.3)% 9.1% 14.7%
====== ===== =====
</TABLE>
Year Ended December 31, 1996 Compared with Year Ended December 31,1995
Net sales were $60.7 million for 1996, a decrease of 33.7 percent
compared with net sales of $91.6 million for 1995. The sales decrease was
primarily a result of lower order rates from the Company's major customer for
existing product programs. During the first quarter of 1996, that customer,
which is in the wireless communications industry, informed the Company that it
had made an unexpected decision to begin phasing out certain of its cellular
products that used display modules which comprised the Company's highest volume,
longest running programs. Subsequently, the phase-out of those programs occurred
even more quickly than the Company had anticipated or its customer had initially
indicated. The sudden and unexpected reduction of those programs was the
greatest contributor to the reduced revenue in 1996. The long product
development time in the custom business prevented the Company from quickly
replacing the phased-out programs. In 1996, the Company's largest customer
accounted for net sales of $39.5 million compared with net sales of $73.7
million to that customer for 1995, for an overall decrease of 46.4 percent. The
Company's major customer accounted for approximately 65.1 percent of the net
sales for 1996 compared with approximately 80.5 percent for 1995. All other
customers accounted for net sales of $21.2 million for 1996 compared with net
sales of $17.9 million for 1995.
Cost of sales, as a percentage of net sales, increased to 96.1 percent
for 1996 as compared with 77 percent for 1995. The corresponding decline in the
gross margin was the result of a number of factors, including increased
provisions for excess and obsolete inventory, manufacturing variances occurring
as a result of decreased manufacturing volume and material purchases, and sales
of low-margin products. In the third quarter of 1996, the Company took a special
one-time provision for excess and obsolete inventory related primarily to
end-of-life programs for which the majority of shipments, expected to occur in
the latter part of 1996, never materialized. Furthermore, the Company was
required to make significant design modifications to a new product, which also
18
<PAGE>
resulted in obsolete inventory. The Company has since implemented procedures
that attempt to balance the benefits of responsiveness to customer needs against
the risks of purchasing inventory too soon by discussing, allocating, and
sharing inventory risk with its customers. Without the provision for excess and
obsolete inventory taken in the third quarter, the cost of sales, as a
percentage of net sales, would have been 84.5 percent for 1996.
Selling, general, and administrative expense was $5.4 million for 1996,
the same as in 1995. As a result of reduced revenue in 1996, however, selling,
general, and administrative expense rose to 8.8 percent of net sales from 5.9
percent of net sales in 1995.
Research and development expense totaled $4.1 million, or 6.7 percent
of net sales, for 1996 as compared with $2.4 million, or 2.6 percent of net
sales, for 1995. Research and development expense consists principally of
salaries and benefits to scientists and other personnel, related facilities
costs, including certain expenses associated with the start-up and continued
operations of the LCD line in Tempe, Arizona, and various expenses for projects.
Research and development expense has increased as the Company has invested in
new technologies and manufacturing processes, developed new potential products,
and continued its in-house process development efforts related to the
high-volume manufacturing LCD line. The Company believes that continued
investments in research and development relating to manufacturing processes and
new display technology are necessary to remain competitive in the marketplace,
as well as to provide opportunities for growth.
Interest income (net) for 1996 was $412,000, down from $765,000 for
1995. The decrease in interest income was the result of investing lower average
cash balances during the year. Other expenses (net) increased to $139,000 for
1996 from $122,000 for 1995. An increase in closed facilities expenses and
foreign exchange losses in 1996 was partially offset by decreased net losses on
the sale of assets.
There was a benefit from income taxes of $2.9 million for 1996, as
compared to a provision for income taxes of $5.5 million for 1995. This resulted
primarily from having a loss in 1996 as compared with reporting net income in
1995. The reported tax rate for the Company in the fourth quarter of 1996 was
lower than normal because of an adjustment related to the difference between
1995 tax accruals and taxes actually incurred. This adjustment was $371,000 and
was reflected in the reduced tax provision in the fourth quarter of 1996.
Overall, the tax rate for the Company for 1996 was 43.3 percent as compared to
39.7 percent for 1995. The Company expects that the tax rate for 1997 will
approximate 40 percent.
For 1996, the Company reported a net loss of $3.8 million, or $0.49 per
share, as compared to net income of $8.4 million, or $1.04 per share, for 1995.
Without the provision for excess and obsolete inventory taken in the third
quarter, the Company would have reported net income of $158,000, or $0.02 per
share in 1996.
Year Ended December 31, 1995 Compared with Year Ended December 31,1994
Net sales were $91.6 million during 1995, an increase of 7.1 percent
compared with net sales of $85.5 million during 1994. The sales increase in 1995
was primarily a result of higher order rates from a major wireless
communications customer for existing as well as new product programs. The rate
of sales growth decreased significantly in 1995 as compared with 1994, primarily
as a result of the Company's inability to bring two new major programs into
production during the period, as well as the loss of sales from other older
programs that were being phased out of production.
Cost of sales, as a percentage of net sales, increased to 77 percent in
1995 as compared with 69.5 percent in 1994. This increase was primarily due to
manufacturing inefficiencies from design delays, new program introductions, and
product mix.
Selling, general, and administrative expense increased to $5.4 million
during 1995 from $4.9 million during 1994. The 10.2 percent increase resulted
primarily from expenses related to expanding the Company's sales force,
19
<PAGE>
offset by decreased bonus accruals. Selling, general, and administrative expense
increased as a percentage of net sales to 5.9 percent for 1995 from 5.7 percent
for 1994.
Research and development expense totaled $2.4 million, or 2.6 percent
of net sales, in 1995 as compared with $1.3 million, or 1.5 percent of net
sales, in 1994. The increase in research and development expense represented
in-house development efforts related to the LCD laboratory and the high-volume
manufacturing line located in Tempe, Arizona.
Interest income (net) for 1995 was $765,000, down from $859,000 for
1994. The decrease in interest income was the result of investing lower average
cash balances during the year. Other expense (net) decreased to $122,000 for
1995 from $135,000 for 1994. The decrease was due primarily to decreased net
foreign exchange losses and decreased net losses on dispositions of fixed
assets.
The provision for income taxes decreased to $5.5 million in 1995 from
$8.1 million in 1994. This resulted primarily from lower pre-tax income in 1995
as compared with 1994.
Net income decreased to $8.4 million, or $1.04 per share, in 1995 from
$12.5 million, or $1.59 per share, in 1994.
Quarterly Results of Operations
The following table presents unaudited consolidated financial results
for each of the eight quarters in the period ended December 31, 1996. The
Company believes that all necessary adjustments have been included to present
fairly the quarterly information when read in conjunction with the Consolidated
Financial Statements. The operating results for any quarter are not necessarily
indicative of the results for any subsequent quarter.
<TABLE>
<CAPTION>
Quarters Ended
-------------------------------------------------------------------------------------------
1996 1995
------------------------------------------- -------------------------------------------
Mar 31 June 30 Sept 30 Dec 31 Mar 31 June 30 Sept 30 Dec 31
------- ------- ------- ------- ------- ------- ------- -------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net sales............................ $18,082 $14,457 $13,118 $15,056 $24,483 $22,105 $24,217 $20,780
------- ------- ------- ------- ------- ------- ------- -------
Costs and expenses:
Cost of sales....................... 14,401 11,944 19,798 12,178 17,582 16,138 19,790 16,971
Selling, general, and administrative 1,459 1,471 1,316 1,105 1,272 1,213 1,419 1,482
Research and development............ 1,010 820 1,074 1,161 405 401 770 820
------- ------- ------- ------- ------- ------- ------- -------
16,870 14,235 22,188 14,444 19,259 17,752 21,979 19,273
------- ------- ------- ------- ------- ------- ------- -------
Operating income (loss).............. 1,212 222 (9,070) 612 5,224 4,353 2,238 1,507
Other income (expense):
Interest, net....................... 19 133 90 170 342 279 120 24
Other, net.......................... (27) (72) (17) (23) (42) 27 (14) (93)
------- ------- ------- ------- ------- ------- ------- -------
Income before provision for
(benefit from) income taxes....... 1,204 283 (8,997) 759 5,524 4,659 2,344 1,438
Provision for (benefit from)
income taxes...................... 482 113 (3,519) 4 2,210 1,840 961 537
------- ------- ------- ------- ------- ------- ------- -------
Net income (loss).................... $ 722 $ 170 $ (5,478) $ 755 $ 3,314 $ 2,819 $ 1,383 $ 901
===== ===== ======== ====== ======= ======= ======= =====
Earnings (loss) per common share
and common share equivalent....... $0.09 $0.02 $(0.70) $0.09 $0.41 $0.35 $0.17 $0.11
===== ===== ======= ====== ======= ======= ======= =====
Weighted average number of
common shares and common
share equivalents outstanding...... 8,040 8,032 7,779 8,049 8,086 8,094 8,088 8,053
</TABLE>
20
<PAGE>
Liquidity and Capital Resources
During 1996, the Company generated $12.2 million in cash flow from
operations as compared with $1.3 million during 1995. The increase in cash flow
from operations with substantially lower earnings was primarily due to the
significant increase in the Company's depreciation expense and inventory reserve
provisions, as well as the substantial reduction of its accounts receivable and
inventory and an increase in its accounts payable and accrued liabilities. The
increase in depreciation expense was as a result of the start-up of the
high-volume LCD manufacturing line in Tempe, Arizona. The high-volume LCD
manufacturing line is depreciated on a units-of- production method based on
units started. It is anticipated that depreciation will rise in 1997 as a result
of an expected higher number of starts for the high-volume LCD manufacturing
line in 1997 versus 1996, as well as having additional capital expenditures in
1997. The increase in accrued liabilities primarily relates to compensation and
customs obligations. The Company's working capital was $21.5 million at December
31, 1996, down slightly from the $22.4 million that it had at December 31, 1995.
The Company's current ratio at December 31, 1996 was 3.2-to-1 as compared with a
current ratio of 4.0-to-1 at December 31, 1995. Including its cash and loan
commitments, the Company had over $32 million in readily available funds on
December 31, 1996.
During 1996, the Company's primary financing activity was to repay with
cash flow from operations $3 million of debt that was outstanding under the
revolving line of credit at December 31, 1995. In August 1996, the Company
modified its $15 million unsecured revolving line of credit, which matures May
31, 1997, with its primary lender, Wells Fargo Bank (formerly, First Interstate
Bank of Arizona). At December 31, 1996, no borrowings were outstanding under
this credit facility. Advances under the revolving line may be made as Prime
Rate Advances, which accrue interest payable monthly at the bank's prime lending
rate, or as LIBOR Rate Advances which bear interest at 150 basis points in
excess of the LIBOR Base Rate. The Company's subsidiary, Three-Five Systems
Limited, has established an annually renewable credit facility with a United
Kingdom bank, Barclays Bank PLC, in order to fund its working capital
requirements. The facility provides $350,000 of borrowing capacity secured by
accounts receivable of Three-Five Systems Limited. Advances are based on
accounts receivable, as defined. Advances under the credit facility accrue
interest, which is payable quarterly, at the bank's base rate plus 200 basis
points. The United Kingdom credit facility matures June 20, 1997. Three-Five
Systems Limited had no borrowings outstanding under this line of credit at
December 31, 1996.
On Monday, August 19, 1996, the Board of Directors authorized the
repurchase from time to time of up to one million shares of the Company's Common
Stock on the open market or in negotiated transactions, depending on market
conditions and other factors. The closing price of the Company's Common Stock on
Friday, August 16, 1996, was $8.75. In October 1996, the Company entered into a
new $5 million non-revolving line of credit/term loan with Wells Fargo Bank to
provide financing for the acquisition of any treasury shares (the "Treasury
Stock Loan"). The Treasury Stock Loan is available for advances until October
24, 1997, followed by a three-year amortization period in which principal will
be payable quarterly in equal installments. Advances under the Treasury Stock
Loan will be made as either Prime Rate Advances, which accrue interest payable
monthly, at the bank's prime lending rate, or as LIBOR Rate Advances, which bear
interest at 225 basis points in excess of the LIBOR Base Rate. At maturity of
the draw period, the Company may choose either a fixed rate at 250 basis points
in excess of the Treasury Rate or a variable rate of either the Prime Rate or
LIBOR Rate. The Treasury Stock Loan is secured by all equipment located in the
state of Arizona and a non-filed negative pledge on the Company's real estate
located in Tempe, Arizona. The Company must apply all proceeds from the sale of
any treasury stock to the outstanding principal balance of the Treasury Stock
Loan. As of December 31, 1996, 22,500 treasury shares had been purchased by the
Company at a total cost of $253,000, but the Company had no borrowings
outstanding under the Treasury Stock Loan.
Capital expenditures during 1996 were approximately $948,000, as
compared with $27.1 million during 1995. Capital expenditures for 1996 consisted
primarily of manufacturing and office equipment for the Company's operations in
Manila and Arizona and laboratory equipment for research and development.
Expenditures for 1995 consisted primarily of payments to complete its new
manufacturing and headquarters facility in Tempe, Arizona as well as equipment
for its operations in Manila and Arizona. The Company anticipates that it will
increase its capital
21
<PAGE>
expenditures during 1997, although those capital expenditures should not have a
significant effect on the Company's liquidity because the expenditures should
not be in excess of its 1997 depreciation expense. Those expenditures will
primarily relate to advanced manufacturing processes, the high-volume LCD line,
and necessary manufacturing equipment.
The Company anticipates that accounts receivable and inventory will
rise in 1997 if revenue levels increase as currently anticipated. The Company
believes that its existing capital and anticipated cash flow from operations
will provide adequate sources to fund operations and planned expenditures
throughout 1997 without any need for borrowings. Should the Company purchase a
significant amount of treasury shares or encounter unexpected additional cash
requirements, however, the Company believes that its existing loan commitments
of $20 million will be adequate. The Company also expects that its existing
capital, anticipated cash flow from operations, and existing loan commitments
will provide adequate sources for its long-term liquidity and capital
requirements, such as expansion of its manufacturing facilities oversees. The
Company does not anticipate such expansion for two to three years.
Effects of Inflation and Foreign Currency Exchange Fluctuations
The results of operations of the Company for the periods discussed have
not been significantly affected by inflation or foreign currency fluctuations.
The Company generally sells its products and services and negotiates purchase
orders with its foreign suppliers in United States dollars. An exception is the
Company's sub-assembly agreement in the Philippines, which is based on a fixed
conversion rate, exposing the Company to exchange rate fluctuations with the
Philippine peso. Although the Company has not incurred any material exchange
gains or losses to date, there can be no assurance that fluctuations in currency
exchange rates in the future will not have an adverse effect on the Company's
operations. The Company from time to time may enter into hedging transactions in
order to minimize its exposure to currency rate fluctuations.
Business Outlook and Risk Factors
The Company intends to continue its efforts to expand and diversify its
sales base in 1997, an area in which the Company believes that it already has
made significant strides. The Company's major customer, which had accounted for
as much as 80 percent of the Company's business in past years, accounted for
only 53 percent of the Company's business in the fourth quarter of 1996. The
current business plan of the Company targets that customer to account for no
more than 40 percent of its revenue in 1997. This percentage reduction in 1997
is expected to occur for two reasons. First, although the number of programs
that the Company has with its major customer have continued to increase, the
average selling price of the products sold to that customer have declined.
Second, the business plan of the Company calls for a substantial increase in
sales to other customers. In 1997, the Company expects that all communication
products will account for less than 50 percent of its revenue with a strong
growth in office automation products. The Company also is planning to introduce
more standard product lines late in 1997 in order to mitigate the risks
associated with custom design modules. Using the last half of 1996 as a
baseline, the Company is planning for modest revenue growth during the first
half of 1997 and a more rapid growth in the last half of the year. Although
increased competition in the display module industry from Asian suppliers,
partially as a result of a strong dollar, have reduced margins, the Company
expects that a variety of factors, including a more diverse product mix,
proprietary products, and greater manufacturing efficiencies as a result of
increased production, should enable the Company over time to increase its gross
margins to the low- or mid-twenties as a percentage of revenue.
As the Company expands and diversifies its product and customer base,
it will have to increase its selling and administrative expenses. Serving a
myriad of customers with complex and differing issues requires increased
personnel committed to those customers. As a result, the actual dollar amount of
the selling, general, and administrative expenses in 1997 should be 10 to 25
percent greater than in 1996, although SG&A expenditures should decrease in 1997
as a percent of net sales.
22
<PAGE>
The Company will also continue its research and development efforts. In
1996, the Company expanded and intensified its research and development to focus
on proprietary display products rather than just manufacturing process
improvements. Use of the LCD manufacturing line in Tempe, Arizona is the key to
the development of these products, some of which will be proprietary and not
available from other display manufacturers. This focus will continue in 1997.
The Company believes that the key to its future is to be a leader in the
development of new passive matrix display technology. As a result, the actual
dollar amount of such expenditures in 1997 should be 10 to 15 percent greater
than in 1996, although R & D expenditures should decrease in 1997 as a
percentage of net sales.
The Company's future operating results may be affected by various
trends, developments, and factors that the Company must successfully manage in
order to achieve its goals. In addition, there are trends, developments, and
factors beyond the Company's control that may affect its operations. The
cautionary statements and risk factors set forth below and elsewhere in this
document, and in the Company's other filings with the Securities and Exchange
Commission, identify important trends, factors, and currently known developments
that could cause actual results to differ materially from those in any
forward-looking statements contained in this report and in any written or oral
statements of the Company. Forward-looking statements in this report include
revenue, margin, expense, and earnings analysis for 1997 as well as the
Company's expectations relating to future design and production orders.
As noted previously, one customer is currently responsible for a
majority of the Company's business. Although that customer is expected to
account for only 40 percent of the Company's revenue in 1997, the majority of
the Company's business in 1997 will still likely come from a core customer base.
For example, it is expected that one of the Company's recent new customers could
account for as much as 20 percent of the Company's revenue in 1997. Thus, any
material delay, cancellation, or reduction of orders from one or more of those
core customers could have a material adverse effect on the Company's operations.
Although the trend of the Company is to enter into more manufacturing
contracts with its customers, the principal benefit of these contracts is to
clarify order lead times, inventory risk allocation, and similar matters and not
to provide firm, long-term volume purchase commitments. The Company has no firm
long-term volume purchase commitments from its customers. Thus, customer
commitments can be canceled, and expected volume levels can be changed or
delayed. The timely replacement of canceled, delayed, or reduced commitments
cannot be assured and, among other things, could result in the Company holding
excess and obsolete inventory or having manufacturing variances as a result of
under-absorption. These risks are exacerbated because a majority of the
Company's expected sales will be to customers in the retail electronics
industry, which is subject to severe competitive pressures, rapid technological
change, and obsolescence.
Another risk, which is inherent in custom manufacturing, is the
satisfactory completion of design services and securing of production orders.
Completion of the design is dependent on the customer's changing needs and not
every design is successful in meeting those needs. In addition, some designs
test new theories or applications and may not meet the desired results. Failure
of a design order to achieve the customer's desired results could result in a
material adverse effect on the Company's operations if the expected production
order for that product was significant. Finally, even when a design is
satisfactorily completed, the customer may terminate or delay the program as a
result of marketing or other pressures. It is expected that a significant
portion of the Company's anticipated revenue for 1997 will come from programs
still in the design or pilot production stage at the end of 1996.
The Company designs and manufactures products based on firm quotes.
Thus, the Company bears the risk of component price increases, which could
adversely affect the Company's gross margins. In addition, the Company depends
on certain suppliers, and the unavailability or shortage of materials could
cause delays or lost orders, either of which could have a material adverse
effect on the Company.
Finally, the Company's success, especially in penetrating new markets
and increasing its OEM customer base, depends to a large extent upon the efforts
and abilities of key managerial and technical employees. The loss
23
<PAGE>
of services of certain key personnel could have a material adverse effect on the
Company. The Company's business also depends upon its ability to continue to
attract and retain senior managers and skilled employees. Failure to do so could
adversely affect the Company's operations.
As a result of the foregoing and other factors, the Company's stock
price may be subject to significant volatility, particularly on a quarterly
basis. Any shortfall in revenue or earnings from levels expected by investors,
analysts, and brokers could have an immediate and significant adverse effect on
the trading price of the Company's Common Stock in any given period.
Additionally, the Company may not learn of such shortfalls until late in a
fiscal quarter, which could result in an even more immediate and adverse effect
on the trading price of the Company's Common Stock. Finally, other factors,
which generally affect the market for stocks of high technology companies, could
cause the price of the Company's Common Stock to fluctuate substantially over
short periods for reasons unrelated to the Company's performance.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to the financial statements, the report thereon, the
notes thereto and the supplementary data commencing at page F-1 of this Report,
which financial statements, report, notes and data are incorporated herein by
reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information required by this Item relating to directors of the
Company is incorporated by reference to the definitive Proxy Statement filed
pursuant to Regulation 14A of the Exchange Act for the Company's 1997 Annual
Meeting of Stockholders. The information required by this Item relating to
executive officers of the Company is included in "Description of Business -
Executive Officers" contained in Item 1 of this Report.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement filed pursuant to Regulation 14A of
the Exchange Act for the Company's 1997 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item is incorporated herein by
reference to the definitive Proxy Statement filed pursuant to Regulation 14A of
the Exchange Act for the Company's 1997 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
24
<PAGE>
PART IV
ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K
(a) Financial Statements and Financial Statement Schedule
(1) Financial Statements are listed in the Index to Financial
Statements on page F-1 of this Report.
(2) Financial Statement Schedule:
Schedule II Valuation and Qualifying Accounts and Reserves is
set forth on page S-1 of this Report.
Other schedules are omitted because they are not applicable, not
required or because required information is included in the consolidated
financial statements or notes thereto.
(b) Reports on Form 8-K
Not applicable.
(c) Exhibits
Exhibit
Number Exhibits
- ------ --------
2 Amended and Restated Agreement and Plan of Reorganization(1)
3(a) Restated Certificate of Incorporation of the Company(2)
3(b) Bylaws of the Company(1)
10(a) 1990 Incentive Stock Option Plan(1)
10(b) Line of Credit Agreements between the Company and First
Interstate Bank of Arizona, N.A.(3)
10(c) Line of Credit Agreement between Three-Five Systems Limited
and Barclays Bank, PLC(1)
10(d) Sub-Assembly Agreement between Three-Five Systems, Inc. and
TEAM Pacific Corporation dated February 22, 1995(3)
10(g) Form of Three-Five Systems, Inc. Distributor Franchise
Agreement(4)
10(h) Form of Three-Five Systems, Inc. Sales Representative
Agreement(4)
10(j) 1993 Stock Option Plan(4)
10(k) 1994 Automatic Stock Option Plan(5)
10(l) Lease Agreement between Technology Electronic Assembly and
Management (T.E.A.M.) Pacific Corporation and Three-Five
Systems Pacific, Inc.(6)
10(m) Lease Agreement between Regent Apparel Corporation and
Three-Five Systems Pacific, Inc.(6)
10(n) Second Modification Agreement between First Interstate Bank,
N.A. and Three-Five Systems, Inc., together with Revolving
Promissory Note for $15,000,000(6)
10(o) Lease dated April 1, 1994, between Papago Park Center, Inc.
and Three-Five Systems, Inc.
10(p) Third Modification Agreement dated August 5, 1996, between
Wells Fargo Bank of Arizona, National Association (formerly
First Interstate Bank of Arizona, N.A.) and Three-Five
Systems, Inc.)
0(q) Fourth Modification Agreement dated October 24, 1996, between
Wells Fargo Bank of Arizona, National Association (formerly
First Interstate Bank of Arizona, N.A.) and Three-Five
Systems, Inc.)
10(r) Promissory Note dated October 24, 1996, in the principal
amount of $5,000,000 issued by Three- Five Systems, Inc., as
Maker, to Wells Fargo Bank, National Association, as Payee.
25
<PAGE>
Exhibit
Number Exhibits
- ------ --------
10(s) Security Agreement dated October 24, 1996, between Three-Five
Systems, Inc. and Wells Fargo Bank, National Association.
11 Statement re: Computation of Per Share Earnings
21 List of Subsidiaries(6)
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule
- -------------
(1) Incorporated by reference to the Registration Statement on Form S-4 of
TF Consolidation, Inc. (Registration No. 33-33944) as filed March 27,
1990 and declared effective March 27, 1990.
(2) Incorporated by reference to the Registrant's Form 10-QSB for the
quarter ended March 31, 1994, as filed with the Commission on or about
May 12, 1994.
(3) Incorporated by reference to the Registrant's Form 10-KSB for the
fiscal year ended December 31, 1994 filed with the Commission on March
22, 1995, as amended by Form 10-KSB/A as filed with the Commission on
April 28, 1995.
(4) Incorporated by reference to the Registration Statement on Form S-1
(Registration No. 33-74788) as filed on February 3, 1994, and declared
effective March 15, 1994.
(5) Incorporated by reference to the Registration Statement on Form S-8
(Registration No. 33-88706) as filed on January 24, 1995.
(6) Incorporated by reference to the Registrant's Form 10-K for the fiscal
year ended December 31, 1995, as filed with the Commission on March 13,
1996.
26
<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.
THREE-FIVE SYSTEMS, INC.
Date: March 12, 1997 By /s/ David R. Buchanan
------------------------------------------
David R. Buchanan, Chairman of the Board,
President, and Chief Executive Officer
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>
Name Title Date
---- ----- ----
<S> <C> <C>
/s/ David R. Buchanan Chairman of the Board, President, March 12, 1997
- --------------------------------------- and Chief Executive Officer
David R. Buchanan (Principal Executive Officer)
/s/ Jeffrey D. Buchanan Vice President - Finance, Administration, and March 12, 1997
- --------------------------------------- Legal; Chief Financial Officer; Secretary;
Jeffrey D. Buchanan and Treasurer (Principal Financial and
Accounting Officer)
/s/ David C. Malmberg Director March 12, 1997
- ---------------------------------------
David C. Malmberg
/s/ Burton E. McGillivray Director March 12, 1997
- ---------------------------------------
Burton E. McGillivray
/s/ Jeffrey A. Wilson Director March 12, 1997
- ---------------------------------------
Jeffrey A. Wilson
/s/ Gary R. Long Director March 12, 1997
- ---------------------------------------
Gary R. Long
/s/ Kenneth M. Julien Director March 12, 1997
- ---------------------------------------
Kenneth M. Julien
</TABLE>
27
<PAGE>
THREE-FIVE SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Public Accountants .............................. F-2
Consolidated Balance Sheets as of December 31, 1996 and 1995 .......... F-3
Consolidated Statements of Income (Loss) for the years ended
December 31, 1996, 1995 and 1994.....................................F-4
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1996, 1995 and 1994.........................F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994.................................... F-6
Notes to Consolidated Financial Statements .............................F-7
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Three-Five Systems, Inc.:
We have audited the accompanying consolidated balance sheets of THREE-FIVE
SYSTEMS, INC. (a Delaware corporation) and subsidiaries as of December 31, 1996
and 1995, and the related consolidated statements of income (loss),
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits 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 financial statements referred to above present fairly, in
all material respects, the financial position of Three-Five Systems, Inc. and
subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules listed in the index of
financial statements are presented for purposes of complying with the Securities
and Exchange Commission's rules and are not part of the basic financial
statements. These schedules have been subjected to the auditing procedures
applied in the audits of the basic financial statements and, in our opinion,
fairly state in all material respects the financial data required to be set
forth therein in relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
Phoenix, Arizona,
January 17, 1997.
F-2
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
<TABLE>
<CAPTION>
ASSETS
December 31,
-----------------------
1996 1995
---------- ----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 12,580 $ 4,551
Accounts receivable, net (Note 2) 6,830 9,346
Inventories, net (Note 2) 4,606 13,703
Deferred tax asset (Note 7) 5,930 1,826
Other current assets 1,384 491
---------- ----------
Total current assets 31,330 29,917
PROPERTY, PLANT AND EQUIPMENT, net (Note 2) 30,913 33,493
COST IN EXCESS OF NET ASSETS ACQUIRED, net (Note 2) 130 170
OTHER ASSETS (Note 2) 196 200
---------- ----------
$ 62,569 $ 63,780
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 4,289 $ 3,199
Accrued liabilities (Note 2) 4,524 1,318
Current maturities of long-term debt (Note 3) - 3,000
Current taxes payable (Note 7) 1,004 -
---------- ---------
Total current liabilities 9,817 7,517
---------- ----------
DEFERRED TAX LIABILITY (Note 7) 1,568 1,039
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 8)
STOCKHOLDERS' EQUITY (Notes 4 and 5):
Preferred stock, $.01 par value; 1,000,000 shares authorized - -
Common stock, $.01 par value; 15,000,000 shares authorized, 7,779,829 shares
issued, 7,757,329 shares outstanding at December 31, 1996; 7,735,745 shares
issued and outstanding at December 31, 1995 78 77
Additional paid-in capital 32,329 32,286
Retained earnings 19,016 22,847
Cumulative translation adjustment 14 14
Less- Treasury stock, at cost (22,500 shares) (253) -
---------- ----------
Total stockholders' equity 51,184 55,224
---------- ----------
$ 62,569 $ 63,780
========== ==========
</TABLE>
The accompanying notes are an integral
part of these consolidated balance sheets.
F-3
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(in thousands, except share amounts)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------
1996 1995 1994
---------- ---------- ---------
<S> <C> <C> <C>
NET SALES (Notes 2, 6 and 9) $ 60,713 $ 91,585 $ 85,477
---------- ---------- ---------
COSTS AND EXPENSES:
Cost of sales 58,321 70,481 59,409
Selling, general and administrative 5,351 5,386 4,867
Research and development 4,065 2,396 1,270
---------- ---------- ---------
67,737 78,263 65,546
---------- ---------- ---------
Operating income (loss) (7,024) 13,322 19,931
---------- ---------- ---------
OTHER INCOME (EXPENSE):
Interest, net 412 765 859
Other, net (139) (122) (135)
---------- ---------- ---------
273 643 724
---------- ---------- ---------
INCOME (LOSS) BEFORE PROVISION FOR
(BENEFIT FROM) INCOME TAXES (6,751) 13,965 20,655
Provision for (benefit from) income taxes (Note 7) (2,920) 5,548 8,109
---------- ---------- ---------
NET INCOME (LOSS) $ (3,831) $ 8,417 $ 12,546
==========- ========== =========
EARNINGS (LOSS) PER COMMON SHARE AND
COMMON SHARE EQUIVALENT (Notes 2 and 4):
Net income (loss) $ (0.49) $ 1.04 $ 1.59
======= ======== =======
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES AND COMMON SHARE EQUIVALENTS
OUTSTANDING (Notes 2 and 4) 7,765,838 8,083,551 7,882,011
========== ========== =========
</TABLE>
The accompanying notes are an
integral part of these consolidated statements.
F-4
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(in thousands, except share amounts)
<TABLE>
<CAPTION>
Common Stock
--------------------------- Additional
Shares Paid-in Retained
Issued Amount Capital Earnings
------------ ------ ------------- -----------------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1993 6,641,944 $ 66 $ 8,243 $ 1,884
Stock options exercised 49,580 1 64 -
Tax benefit from early disposition
of incentive stock options (Note 5) - - 500 -
Sale of common stock, net 1,000,000 10 23,245 -
Net income - - - 12,546
Translation adjustment - - - -
------------ ------ ---------- ----------
BALANCE, December 31, 1994 7,691,524 77 32,052 14,430
Stock options exercised 44,221 - 32 -
Tax benefit from early disposition
of incentive stock options (Note 5) - - 202 -
Net income - - - 8,417
Translation adjustment - - - -
------------ ------ ---------- ----------
BALANCE, December 31, 1995 7,735,745 77 32,286 22,847
Stock options exercised 44,084 1 11 -
Tax benefit from early disposition
of incentive stock options (Note 5) - - 32 -
Net loss - - - (3,831)
Translation adjustment - - - -
Purchase of treasury stock - - - -
------------ ------ ---------- ----------
BALANCE, December 31, 1996 7,779,829 $ 78 $ 32,329 $ 19,016
============ ====== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
Cumulative
Translation Treasury
Adjustment Stock Total
---------------- -------------- ----------
<S> <C> <C> <C>
BALANCE, December 31, 1993 $ 9 $ - $ 10,202
Stock options exercised - - 65
Tax benefit from early disposition
of incentive stock options (Note 5) - - 500
Sale of common stock, net - - 23,255
Net income - - 12,546
Translation adjustment (7) - (7)
--------- --------- -----------
BALANCE, December 31, 1994 2 - 46,561
Stock options exercised - - 32
Tax benefit from early disposition
of incentive stock options (Note 5) - - 202
Net income - - 8,417
Translation adjustment 12 - 12
--------- --------- -----------
BALANCE, December 31, 1995 14 - 55,224
Stock options exercised - - 12
Tax benefit from early disposition
of incentive stock options (Note 5) - 32
Net loss - - (3,831)
Translation adjustment - - -
Purchase of treasury stock - (253) (253)
--------- --------- -----------
BALANCE, December 31, 1996 $ 14 $ (253) $ 51,184
========= ========= ===========
</TABLE>
The accompanying notes are an
integral part of these consolidated statements.
F-5
<PAGE>
THREE-FIVE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Years Ended December 31,
-----------------------------------------
1996 1995 1994
---------- --------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (3,831) $ 8,417 $ 12,546
Adjustments to reconcile net income to net cash provided
by operating activities-
Depreciation and amortization 3,551 2,278 1,215
Provision (recovery) of accounts receivable valuation reserves 47 (1) 205
Provision for inventory valuation reserves 4,015 1,218 857
Loss on disposal of assets 12 24 54
Changes in assets and liabilities-
(Increase) decrease in accounts receivable 2,469 (624) (3,609)
(Increase) decrease in inventories 5,082 (5,264) (3,406)
Increase in other assets (1,070) (32) (225)
Increase (decrease) in accounts payable and accrued liabilities 4,296 (3,170) 1,788
Increase (decrease) in taxes payable, net (2,358) (1,568) 1,065
---------- --------- ----------
Net cash provided by operating activities 12,213 1,278 10,490
---------- --------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (948) (27,051) (7,412)
Proceeds from sale of property, plant and equipment 5 326 5
---------- --------- ----------
Net cash used for investing activities (943) (26,725) (7,407)
---------- --------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from (payments on) notes payable to banks (3,000) 3,000 (17)
Principal payments on and retirement of long-term debt - (182) (24)
Stock options exercised 12 32 65
Proceeds from sale of common stock, net (Note 4) - - 23,255
Purchase of treasury stock (253) - -
---------- --------- ----------
Net cash provided by (used for) financing activities (3,241) 2,850 23,279
---------- --------- ----------
Effect of exchange rate changes on cash - 12 (7)
---------- --------- ----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 8,029 (22,585) 26,355
CASH AND CASH EQUIVALENTS, beginning of year 4,551 27,136 781
---------- --------- ----------
CASH AND CASH EQUIVALENTS, end of year $ 12,580 $ 4,551 $ 27,136
========== ========= ==========
SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid $ 60 $ 12 $ 21
========== ========= ==========
Income taxes paid $ 1,832 $ 7,296 $ 7,103
========== ========= ==========
</TABLE>
The accompanying notes are an
integral part of these consolidated statements.
F-6
<PAGE>
THREE-FIVE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996, 1995 AND 1994
(1) ORGANIZATION:
Three-Five Systems, Inc. (the Company) was incorporated under the laws of the
state of Delaware on February 13, 1990, under the name of TF Consolidation, Inc.
On February 14, 1990, the Company entered into an amended and restated agreement
and plan of reorganization providing for the merger of Electronic Research
Associates, Inc. (ERA; a New Jersey corporation) and Three-Five Systems, Inc. (a
privately owned Delaware corporation) into the Company. The merger became
effective May 1, 1990, following stockholder approval. The Company was the
surviving corporation; the separate corporate existences of ERA and Three-Five
Systems, Inc. ceased; and the Company changed its corporate name to Three-Five
Systems, Inc.
The Company designs and manufactures a wide range of user interface devices for
operational control and informational display functions required in the end
products of original equipment manufacturers. Most of the Company's sales
consist of custom user interface devices developed in close collaboration with
its customers. The Company maintains its primary manufacturing facility in
Manila, the Philippines. A third-party subcontractor operates the facility under
a sub-assembly agreement with the Company utilizing equipment, processes and
documentation owned by the Company. The sub-assembly agreement has a current
term extending through December 31, 1999, and from year to year thereafter, but
may be terminated by either party upon 180 days written notice. The termination
of or the inability of the Company to obtain products pursuant to the
sub-assembly agreement, even for a relatively short period, would have a
material adverse effect on the operations and profitability of the Company.
Since December 1994, the Company has made advances totaling approximately $1.7
million to the subcontractor to help the subcontractor in meeting its working
capital needs. The balance of the advances outstanding in excess of amounts
payable to the subcontractor at December 31, 1996, was $119,000. These advances
are secured by future payments for subcontracting services to be provided to the
Company as well as other assets of the subcontractor.
Three-Five Systems Limited (Limited), a wholly owned subsidiary of the Company,
is incorporated in the United Kingdom. Limited sells and distributes the
Company's products to customers on the European continent.
During 1994, the Company dissolved its wholly owned subsidiary, Certified
Electronics Ltd. (CEL). CEL, a Taiwan corporation, had procured materials from
Taiwanese vendors. This function is now performed directly by the Company.
F-7
<PAGE>
During 1995, the Company formed a wholly owned subsidiary, Three-Five Systems
Pacific, Inc. (Pacific). Pacific, a Philippines corporation, procures supplies
primarily from Philippine vendors.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation and Preparation of Financial Statements
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All material intercompany transactions have been
eliminated.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Cash and Cash Equivalents
For purposes of the statements of cash flows, all highly liquid investments with
a maturity of three months or less at the time of purchase are considered to be
cash equivalents. Cash equivalents consist primarily of United States government
agencies' obligations classified as held-to-maturity in accordance with
Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for
Certain Investments in Debt and Equity Securities. Cash equivalents were
$11,243,000 and $114,000 at December 31, 1996 and December 31, 1995,
respectively.
Inventories
Inventories are stated at the lower of cost (first-in, first-out) or net
realizable value. Reserves are established against Company-owned inventories for
excess, slow-moving and obsolete items and for items where the net realizable
value is less than cost. The reserve for obsolete inventory totaled $6,782,000
and $2,767,000 at December 31, 1996 and December 31, 1995, respectively.
Inventories at December 31 consist of the following:
1996 1995
--------- ----------
(in thousands)
Raw materials $ 3,147 $ 9,257
Work-in-process 780 2,002
Finished goods 679 2,444
--------- ----------
$ 4,606 $ 13,703
========= ==========
Revenue Recognition
The Company recognizes revenues upon shipment. The Company's distributor
agreements provide for stock (inventory) rotation and price protection. Reserves
are provided for each of these programs based on past return experience. These
reserves are established at the time of shipment and reduce gross sales to
arrive at net sales as presented in the accompanying
F-8
<PAGE>
consolidated statements of income (loss). These reserves are reflected as a
reserve against accounts receivable from sales to distributors and totaled
$89,000 and $140,000 at December 31, 1996 and 1995, respectively. The Company's
distributors generally offset any returns and allowances against payments on
accounts receivable. The Company also provides reserves for uncollectible
accounts receivable. These reserves totaled $560,000 and $463,000 at December
31, 1996 and 1995, respectively. The Company performs ongoing credit evaluations
of all of its customers and considers various factors in establishing its
allowance for doubtful accounts.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost and is generally depreciated
using the straight-line method over the estimated useful lives of the respective
assets, which range from 3 to 39 years. During 1996, the Company placed into
service a high-volume LCD glass manufacturing line in its Tempe, Arizona
manufacturing facility. The Company is depreciating the LCD glass line using the
units of production method. Depreciation expense recorded using this method may
be subject to significant fluctuation from year to year resulting from changes
in actual production levels and ongoing analysis of the capacity of the
equipment. Property, plant and equipment at December 31 consist of the
following:
1996 1995
---------- -----------
(in thousands)
Building and improvements $ 10,431 $ 10,375
Furniture and equipment 28,776 27,971
---------- -----------
39,207 38,346
Less-accumulated depreciation (8,294) (4,853)
---------- -----------
$ 30,913 $ 33,493
========== ===========
The Company intends to utilize a significant portion of the high-volume LCD
glass manufacturing line facility to produce a substantial portion of its own
requirements for LCD glass. The successful utilization of the manufacturing
facility will require the Company (i) to produce LCD glass on a timely and
cost-effective basis at quality levels at least equal to the LCD glass available
from independent suppliers and (ii) to utilize the LCD glass it produces in
devices it designs and manufactures in a manner satisfactory to its customers.
Although management believes that the manufacturing facility will be
successfully utilized, no assurance can be given that the Company will not
experience problems or delays in implementing or conducting its LCD glass
manufacturing operations. Such problems could require the Company to continue to
purchase its LCD glass requirements from third parties and result in the
inability of the Company to recover its investment in the manufacturing
facility.
During 1996, the Company entered into a transaction, in which it conveyed its
Tempe, Arizona facility and certain improvements to the City of Tempe as
consideration for a rent-free 75-year lease. The Company has the option to
repurchase the facility for $1,000 after ten years.
F-9
<PAGE>
Accrued Liabilities
Accrued liabilities includes accrued compensation of approximately $988,000 and
$441,000 at December 31, 1996 and 1995, respectively.
Foreign Currency Translation
Financial information relating to the Company's foreign subsidiaries is reported
in accordance with SFAS No. 52, Foreign Currency Translation. The gain or loss
resulting from the translation of the subsidiaries' financial statements has
been included as a separate component of stockholders' equity. The net foreign
currency transaction loss in 1996, 1995 and 1994 was $46,000, $32,000 and
$41,000, respectively, and has been included in other expenses in the
accompanying statements of income (loss).
Earnings (Loss) Per Common Share
Earnings (loss) per share is computed by dividing net earnings (loss) by the
weighted average number of common shares and common share equivalents assumed
outstanding during the year. For the year ended December 31, 1996, no common
share equivalents were considered in the calculation of loss per share as the
effect was antidilutive. For all other periods presented common share
equivalents have been included in the calculation of earnings per share. Fully
diluted earnings (loss) per share is considered equal to primary earnings (loss)
per share in all periods presented.
Recently Issued Accounting Standards
The Financial Accounting Standards Board issued SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,
which established a new accounting principle for accounting for the impairment
of certain loans, certain investments in debt and equity securities, long-lived
assets that will be held and used including certain identifiable intangibles and
goodwill related to those assets, and long-lived assets and certain identifiable
intangibles to be disposed of. The implementation of SFAS 121 did not have a
material impact on the Company's financial position or results of operations.
F-10
<PAGE>
(3) LONG-TERM DEBT:
Long-term debt at December 31 consists of the following:
<TABLE>
<CAPTION>
1996 1995
--------- ---------
(in thousands)
<S> <C> <C>
$15,000,000 revolving line of credit, interest due monthly at the
bank's prime rate (8.25% at December 31, 1996) or at the LIBOR base
rate (5.5% to 5.6% at December 31, 1996) plus 1.50%, unpaid balance due
May 31, 1997 $ - $ 3,000
$5,000,000 non-revolving line of credit/term loan, interest due monthly
at the bank's prime rate (8.25% at December 31, 1996) or at the LIBOR
base rate (5.5% to 5.6% at December 31, 1996) plus 2.25%, principal
payable in equal installments commencing October 1997, unpaid balance
due October 2000, secured by all equipment located in the State of
Arizona - -
$350,000 United Kingdom credit facility, interest due quarterly at the
bank's base rate (6.00% at December 31, 1996) plus 2%, unpaid balance
due June 20, 1997, secured by United Kingdom accounts receivable - -
--------- ---------
- 3,000
Less- current maturities - (3,000)
--------- ---------
$ - $ -
========= =========
</TABLE>
In August 1996, the Company modified its $15.0 million unsecured revolving line
of credit which matures May 31, 1997. The weighted average interest rate on
borrowings outstanding under the line of credit during 1996 was 7.31%. The
Company paid down the outstanding balance under the line of credit during fiscal
1996 and had classified the balance as current on the accompanying balance
sheets as of December 31, 1995.
In October 1996, the Company entered into a $5.0 million non-revolving line of
credit/term loan to provide financing for the acquisition of treasury shares.
The amount of the term loan is available for advances until October 24, 1997,
followed by a three-year amortization period in which principal will be payable
quarterly in equal installments. Advances under the term loan will be made as
either Prime Rate Advances, which accrue interest payable monthly, at the bank's
prime lending rate, or as LIBOR Rate Advances which bear interest at 225 basis
points in excess of the LIBOR Base Rate. At the end of the draw period, the
Company may choose either a fixed rate at 250 basis points in excess of the
Treasury Rate or a variable rate of either the Prime Rate or LIBOR Rate. The
term loan will be secured by all equipment located in the State of Arizona. The
Company must apply all proceeds from the sale of any treasury stock to the
outstanding principal balance of the term loan.
F-11
<PAGE>
The lines of credit contain certain restrictive covenants which include, among
other things, restrictions on the declaration or payment of dividends and the
amount of capital expenditures. The lines also require the Company to maintain a
specified net worth, as defined, to maintain a required debt to equity ratio and
to maintain certain other financial ratios.
Advances under the United Kingdom credit facility are based on accounts
receivable, as defined. Management intends to renew the United Kingdom credit
facility and does not anticipate any material changes to the existing terms.
(4) STOCKHOLDERS' EQUITY:
During 1994, the Company's Board of Directors declared a two-for-one stock split
effected in the form of a 100 percent stock dividend whereby the number of
common shares outstanding was increased from 3,824,622 to 7,649,244. The
3,824,622 additional shares of common stock were distributed on May 4, 1994, to
holders of record on April 22, 1994. All share amounts and per share data have
been restated for all periods presented to reflect this split. In addition,
during 1994, the Company's stockholders approved an amendment to the Certificate
of Incorporation which increased the authorized shares of common stock, par
value $.01 per share, from 5,000,000 to 15,000,000 and eliminated the
authorization to issue shares of Class A Preferred stock, par value $.01 per
share, Class B Preferred stock, no par value, and Class C Preferred stock, par
value $.01 per share. The Company's authorized capital stock also includes
1,000,000 shares of serial preferred stock, par value $.01 per share.
In March 1994, the Company completed a public offering of 2,120,000 shares, of
which 1,000,000 shares of common stock were sold by the Company and 1,120,000
were sold by a selling stockholder. Net proceeds to the Company totaled
approximately $23.3 million, net of issuance costs of $1,745,000.
(5) BENEFIT PLANS:
The Company has three stock option plans, the 1994 Non-Employee Directors Stock
Option Plan (1994 Plan), the 1993 Stock Option Plan (1993 Plan), and the 1990
Stock Option Plan (1990 Plan).
1994 Non-Employee Directors Stock Option Plan
The Non-Employee Directors Stock Option Plan (1994 Plan) provides for the
automatic grant of stock options to non-employee directors to purchase up to
100,000 shares. Under the 1994 Plan, options to acquire 500 shares of common
stock will be automatically granted to each non-employee director at the meeting
of the Board of Directors held immediately after each annual meeting of
stockholders, with such options to vest in a series of 12 equal and successive
monthly installments commencing one month after the annual automatic grant date.
In addition, each non-employee director serving on the Board of Directors on the
date the 1994 Plan was approved by the Company's stockholders received an
automatic grant of options to acquire 1,000 shares of common stock and each
subsequent newly elected non-employee member of the Board of Directors will
receive an automatic grant of options to acquire 1,000 shares of common stock on
the date of their first appointment or election to the Board of Directors. Those
options become exercisable and vest in a series of three equal and successive
F-12
<PAGE>
annual installments, with the first such installment becoming exercisable 13
months after the automatic grant date. A non-employee member of the Board of
Directors is not eligible to receive the 500 share automatic option grant if
that option grant date is within 30 days of such non-employee member receiving
the 1,000 share automatic option grant. The exercise price per share of common
stock subject to options granted under the 1994 Plan will be equal to 100% of
the fair market value of the Company's common stock on the date such options are
granted. There were outstanding options to acquire 9,000 shares of the Company's
common stock under the 1994 Plan at December 31, 1996.
1993 Stock Option Plan
The 1993 Stock Option Plan (1993 Plan) provides for the granting of options to
purchase up to 385,454 shares of the Company's common stock (which includes
85,454 shares previously reserved for issuance under the Company's 1990 Stock
Option Plan), the direct granting of common stock (stock awards), the granting
of stock appreciation rights (SARs) and the granting of other cash awards (cash
awards) (stock awards, SARs and cash awards are collectively referred to herein
as Awards). Under the 1993 Plan, options and Awards may be issued to key
personnel and others providing valuable services to the Company and its
subsidiaries. The options issued may be incentive stock options or nonqualified
stock options. If any option or SAR terminates or expires without having been
exercised in full, stock not issued under such option or SAR will again be
available for the purposes of the 1993 Plan. There were outstanding options to
acquire 197,000 shares of the Company's common stock under the 1993 Plan at
December 31, 1996.
To the extent that granted options are incentive stock options, the terms and
conditions of those options must be consistent with the qualification
requirement set forth in the Internal Revenue Code of 1986. The expiration date,
maximum number of shares purchasable and the other provisions of the options
will be established at the time of grant. Options may be granted for terms of up
to ten years and become exercisable in whole or in one or more installments at
such time as may be determined by the plan administrator upon grant of the
options. The exercise prices of options will be determined by the plan
administrator, but may not be less than 100 percent (110 percent if the option
is granted to a stockholder who at the time the option is granted owns stock
representing more than ten percent of the total combined voting power of all
classes of stock of the Company) of the fair market value of the common stock at
the time of the grant. The 1993 Plan will remain in force until February 24,
2003.
1990 Stock Option Plan
In conjunction with the 1990 merger with ERA, the Three-Five Systems, Inc. 1987
Incentive Stock Option Plan (1987 Plan) was replaced with a new Incentive Stock
Option Plan ("1990 Plan"). Options issued under the 1987 Plan were assumed under
the 1990 Plan. Under the 1990 Plan, there are 345,776 options issued but
unexercised as of December 31, 1996. In conjunction with stockholder approval of
the 1993 Plan, the Board terminated the 1990 Plan with respect to unissued
options to purchase 85,454 shares of common stock which remained and were
unissued as of the date the 1993 Plan was adopted. The 1990 Plan will remain in
force through May 1, 2000.
F-13
<PAGE>
The expiration date, maximum number of shares purchasable, and the other
provisions of the options granted under the 1990 Plan were established at the
time of grant. Options were granted for terms of up to ten years and become
exercisable in whole or in one or more installments at such times as were
determined by the Board of Directors upon grant of the options.
The exercise price of incentive stock options granted and assumed under the 1990
Plan range from $0.255 to $1.595 per share. These exercise prices are not less
than 100% (110% if the option was granted to a stockholder who at the time the
option was granted owned stock representing more than 10% of the total combined
voting power of all classes of stock of the Company) of the closing price the
day before the date of original grant.
Tax benefits from early disposition of common stock by optionees under the 1993
and 1990 Plans and from the exercise of non-qualified options are credited to
additional paid-in capital.
Pursuant to the provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, the Company accounts for transactions with its employees pursuant
to Accounting Principles Board Opinion No. 25, Accounting for Stock-Issued to
Employees, under which no compensation cost has been recognized. Had
compensation cost for these plans been determined consistent with SFAS No. 123,
the Company's net income (loss) and earnings (loss) per share would have been as
follows (in thousands, except per share data):
1996 1995
----------- -----------
Net income (loss): As reported $ (3,831) $ 8,417
Pro forma (4,076) 8,327
Earnings (loss)
per share: As reported $ (0.49) $ 1.04
Pro forma (0.52) 1.03
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions for grants in 1996 and 1995, respectively: risk-free interest rates
of 6.31% for all Plans for both years; expected dividend yields of zero;
expected lives of 6.1 and 5.7 years for all Plans options; expected volatility
(a measure of the amount by which a price has fluctuated or is expected to
fluctuate during a period) of 61.9% and 58.7%.
Because the SFAS No. 123 method of accounting has not been applied to options
granted prior to January 1, 1995, the resulting pro forma compensation cost may
not be representative of that to be expected in future years. The weighted
average fair value of shares sold in 1996 was $11.66.
F-14
<PAGE>
A summary of the status of the Company's three stock option plans at December
31, 1996 and 1995 and changes during the years then ended is presented in the
table and narrative below:
<TABLE>
<CAPTION>
1996 1995
----------------------------- ------------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
------------- ----------- ------------- -------------
<S> <C> <C> <C> <C>
Outstanding at beginning of year 539,576 $ 8.06 465,326 $ 4.68
Granted 250,100 $ 11.89 178,000 $ 22.15
Exercised (44,900) $ 0.49 (44,250) $ 0.75
Expired (193,000) $ 18.04 (59,500) $ 29.24
------------- -------------
Outstanding at end of year 551,776 $ 6.92 539,576 $ 8.06
------------- -------------
Exercisable at end of year 294,982 $ 2.40 308,940 $ 1.31
============= =============
Weighted average fair value of
options granted $ 7.57 $ 13.19
========= =========
</TABLE>
Of the 551,776 options outstanding at December 31, 1996, 268,276 have exercise
prices between $0.25 and $9.00, with a weighted average exercise price of $1.01
and a weighted average remaining contractual life of 3.8 years. Of these
options, 267,776 are exercisable with a weighted average exercise price of
$1.01. Of the 551,776 options outstanding at December 31, 1996, 277,000 have
exercise prices between $9.00 and $20.00, with a weighted average exercise price
of $12.15 and a weighted average remaining contractual life of 8.2 years. Of
these options, 22,374 are exercisable with a weighted average exercise price of
$13.54. Of the 551,776 options outstanding at December 31, 1996, 6,500 have
exercise prices between $20.00 and $34.38, with a weighted average exercise
price of $27.89 and a weighted average remaining contractual life of 7.6 years.
Of these options, 4,832 are exercisable with a weighted average exercise price
of $27.56. No dividends were declared during the periods used in the option
pricing method.
401(k) Profit Sharing Plan
Effective September 1, 1990, the Company adopted a profit sharing plan (401(k)
Plan) pursuant to Section 401(k) of the Internal Revenue Code of 1986. The
401(k) Plan covers substantially all full-time employees who meet the
eligibility requirements and provides for a discretionary profit sharing
contribution by the Company and an employee elective contribution with a
discretionary Company matching provision. The Company expensed discretionary
contributions pursuant to the 401(k) Plan in the amount of $65,000, $0, and
$94,000 for the years ended December 31, 1996, 1995, and 1994, respectively.
(6) MAJOR CUSTOMERS:
The Company's strategy involves concentrating its efforts on providing design
and production services to leading companies in a limited number of fast growing
industries. Sales to the Company's largest customer are made through 12 buyers
operating in five separate product
F-15
<PAGE>
divisions. During 1996, the Company manufactured approximately 42 individual
products for this customer. The percentage of net sales to this customer were
65%, 81% and 84% during the fiscal years ended December 31, 1996, 1995 and 1994,
respectively.
The significant amount of sales to a single customer results in certain
concentrations of credit risk for the Company. The Company's accounts receivable
balance, including the accounts receivable of the Company's largest customer, is
comprised of a large number of customers, primarily in the cellular phone,
computer hardware and other electronic products industries. These customers are
located primarily in the United States and Europe.
(7) INCOME TAXES:
SFAS No. 109, Accounting for Income Taxes, requires the use of an asset and
liability approach in accounting for income taxes. Deferred tax assets and
liabilities are recorded based on the differences between the financial
statement and tax bases of assets and liabilities and the tax rates in effect
when these differences are expected to reverse.
The provision for income taxes for the years ended December 31 consists of the
following:
<TABLE>
<CAPTION>
1996 1995 1994
---------- ---------- --------
(in thousands)
<S> <C> <C> <C>
Current, net of operating loss carryforwards
and tax credits utilized
Federal, net of tax benefit from early
termination of incentive stock options $ 556 $ 2,775 $ 5,102
State 58 790 1,389
Foreign 9 1,681 1,403
---------- ---------- --------
623 5,246 7,894
Deferred provision (benefit) (3,575) 100 (285)
Tax benefit from early termination of incentive
stock options, reflected in stockholders' equity 32 202 500
---------- ---------- --------
Provision (benefit) for income taxes $ (2,920) $ 5,548 $ 8,109
========== ========== ========
</TABLE>
In accordance with SFAS No. 109, a tax benefit for net operating losses of
approximately $102,000, $67,000, and $363,000 and tax credits of approximately
$938,000, $1,478,000, and $537,000 utilized in 1996, 1995 and 1994,
respectively, are included as a reduction of the provision for income taxes in
the consolidated statements of income.
F-16
<PAGE>
The components of deferred taxes at December 31 are as follows:
<TABLE>
<CAPTION>
1996 1995
--------- --------
(in thousands)
<S> <C> <C>
Net long-term deferred tax liabilities:
Accelerated tax depreciation $ 1,535 $ 1,002
Other 33 37
--------- --------
$ 1,568 $ 1,039
========= ========
Net short-term deferred tax assets:
Tax effect of regular U.S. net operating loss carryforward $ 189 $ 212
Inventory reserve 3,755 1,080
Uniform capitalization 1,868 456
Allowance for doubtful accounts 196 159
Other 76 101
--------- --------
6,084 2,008
Valuation allowance (154) (182)
--------- --------
$ 5,930 $ 1,826
========= ========
</TABLE>
SFAS No. 109 requires the reduction of deferred tax assets by a valuation
allowance if, based on the weight of available evidence, it is more likely than
not that some or all of the deferred tax assets will not be realized. As a
result of certain limitations on the use of net operating loss carryforwards
acquired in the ERA acquisition, a valuation allowance has been established for
those net operating losses not likely to be realized.
A reconciliation of the U.S. federal statutory rate to the Company's effective
tax rate is as follows:
1996 1995 1994
------ ------ ----
Statutory federal rate 34% 34% 35%
Effect of foreign operations - - 4
Effect of state taxes 6 6 7
Effect of tax credits - - (7)
Other 3 - -
------ ------ -----
43% 40% 39%
====== ====== =====
Net operating loss carryforwards for federal tax purposes totaled approximately
$557,000 at December 31, 1996. The use of these carryforwards is limited to
$67,000 per year and they expire through 2003.
(8) COMMITMENTS AND CONTINGENCIES:
In March 1995, the Company entered into a non-cancelable operating lease for its
primary manufacturing facility in Manila, the Philippines. The lease expires
December 31, 1999. In April 1995, the Company entered into a non-cancelable
operating lease for an additional manufacturing facility in Manila, the
Philippines. The lease expires March 31, 1997.
F-17
<PAGE>
Rent expense was approximately $477,000, $683,000 and $280,000 for the years
ended December 31, 1996, 1995, and 1994, respectively.
In April 1994, the Company entered into a ground lease (with purchase options)
on a 5.7 acre site in Tempe, Arizona. Annual lease payments under the ground
lease, which will expire on March 31, 2069, subject to renewal and purchase
options as well as termination provisions, will average approximately $100,000
over the term of the lease subject to certain escalation provisions. A new
design, manufacturing, and corporate headquarters facility containing
approximately 97,000 square feet was completed on the land in 1995 at a cost of
approximately $10.4 million.
The Company's future lease commitments under the non-cancelable operating leases
as of December 31, 1996, are as follows:
1997 $ 377,000
1998 357,000
1999 357,000
2000 100,000
2001 100,000
Thereafter 6,725,000
-------------
$ 8,016,000
=============
On January 24, 1991, the Company received from the United States Environmental
Protection Agency (EPA) a notice of potential liability at the Barkhamsted-New
Hartford Landfill site in Barkhamsted, Connecticut. The notice was to notify the
Company of its potential liability with respect to the site and request the
Company's voluntary participation in undertaking cleanup activities at the site.
On January 9, 1992, the Company received an additional 104(e) questionnaire
which was completed and submitted during 1992. This matter is still in discovery
and therefore, the Company and its consultants are unable to determine the
outcome or potential range of loss, if any.
The Company is involved in certain administrative proceedings arising in the
normal course of business. In the opinion of management, the Company's potential
exposure under the pending administrative proceedings is adequately provided for
in the accompanying financial statements.
F-18
<PAGE>
(9) GEOGRAPHIC SEGMENTS:
Sales by geographic area and identifiable assets for the years ended December
31, 1996, 1995, and 1994 were as follows:
<TABLE>
<CAPTION>
North
America Europe Taiwan Pacific Rim Eliminations Consolidated
-------- --------- --------- -------- ---------- --------
(in thousands)
<S> <C> <C> <C> <C> <C> <C>
December 31, 1996
Net sales $ 32,899 $ 27,814 $ - $ - $ - $ 60,713
Transfers to Europe 25,810 - - - (25,810) -
Transfers to North America - - - 1,494 (1,494) -
-------- --------- --------- -------- ---------- --------
Total revenue $ 58,709 $ 27,814 $ - $ 1,494 $ (27,304) $ 60,713
======== ========= ========= ======== ========== =========
Net income $ (4,005) $ 19 $ - $ 12 $ 143 $ (3,831)
======== ========= ========= ======== ========== =========
Identifiable assets $ 52,951 $ 3,824 $ - $ 6,164 $ (370) $ 62,569
======== ========= ========= ======== ========== =========
December 31, 1995:
Net sales $ 24,235 $ 67,350 $ - $ - $ - $ 91,585
Transfers to Europe 60,361 - - - (60,361) -
Transfers to North America - - - 1,437 (1,437) -
-------- --------- --------- -------- ---------- --------
Total revenue $ 84,596 $ 67,350 $ - $ 1,437 $ (61,798) $ 91,585
======== ========= ========= ======== ========== =========
Net income (loss) $ 5,093 $ 3,353 $ - $ (46) $ 17 $ 8,417
======== ========= ========= ======== ========== =========
Identifiable assets $ 50,779 $ 8,491 $ - $ 7,789 $ (3,279) $ 63,780
======== ========= ========= ======== =========== =========
December 31, 1994:
Net sales $ 33,774 $ 51,703 $ - $ - $ - $ 85,477
Transfers to Europe 46,813 - - - (46,813) -
Transfers to North America - - 1,750 - (1,750) -
-------- --------- --------- -------- ---------- --------
Total revenue $ 80,587 $ 51,703 $ 1,750 $ - $ (48,563) $ 85,477
======== ========= ========= ======== ========== =========
Net income (loss) $ 12,668 $ (457) $ 637 $ - $ (302) $ 12,546
======== ========= ========= ======== ========== =========
Identifiable assets $ 48,743 $ 7,912 $ 2 $ 4,292 $ (4,669) $ 56,280
======== ========= ========= ======== ========== =========
</TABLE>
F-19
<PAGE>
THREE-FIVE SYSTEMS, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
<TABLE>
<CAPTION>
Balance at Charged to Charged to Balance
Beginning Costs and Other at End
of Period Expenses Accounts Other of Period
--------- -------- -------- ----- ---------
(in thousands)
Allowance for doubtful
accounts and sales
returns and allowances:
- -----------------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996 $603 14 32 (1) -- $649
Year ended December 31, 1995 $604 (36) 35 (1) -- $603
Year ended December 31, 1994 $399 248 (60) (1) 17 (2) $604
Inventory Reserve:
- ------------------
Year ended December 31, 1996 $2,767 5,939 142 (4) (2,066) (3) $6,782
Year ended December 31, 1995 $1,548 1,563 391 (4) (735) (3) $2,767
Year ended December 31, 1994 $691 1,855 78 (4) (1,076) (3) $1,548
</TABLE>
- -----------------------
(1) Actual return activity
(2) Accounts written off
(3) Obsolete inventory written off
(4) Inventory adjustments
S-1
PAPAGO PARK CENTER
GROUND SUBLEASE
BETWEEN
PAPAGO PARK CENTER, INC.
an Arizona corporation
AND
THREE-FIVE SYSTEMS, INC.
a Delaware Corporation
DATED April 1, 1994
<PAGE>
TABLE OF CONTENTS
Page
----
ARTICLE 1 DEFINITIONS...................................................... 1
Section 1.1. Definitions.......................................... 1
ARTICLE 2 DEMISE OF THE PREMISES; TERM..................................... 5
Section 2.1. Premises............................................. 5
Section 2.2. Term................................................. 5
Section 2.3. Commencement Date; Possession........................ 5
Section 2.4. Title Insurance...................................... 5
Section 2.5. Nondisturbance and Attornment Agreement.............. 6
ARTICLE 3 RENT............................................................. 6
Section 3.1. Rent................................................. 6
Section 3.2. Rent Absolutely Net.................................. 9
Section 3.3. Option to Purchase................................... 10
Section 3.4. Nonsubordination..................................... 12
ARTICLE 4 ADDITIONAL RENT.................................................. 13
Section 4.1. "Additional Rent" and "Impositions" Defined.......... 13
Section 4.2. Payments............................................. 14
Section 4.3. Contest.............................................. 14
Section 4.4. Assessment Reduction................................. 14
Section 4.5. Hold Harmless........................................ 14
ARTICLE 5 INSURANCE........................................................ 15
Section 5.1. Tenant Obligations to Insure......................... 15
Section 5.2. Policies and Companies............................... 16
Section 5.3. Policy Delivery, Payment Evidence.................... 16
Section 5.4. Blanket Insurance.................................... 16
Section 5.5. Expiration of Term................................... 16
Section 5.6. Risk of Loss......................................... 17
Section 5.7. Failure to Maintain Insurance........................ 17
Section 5.8. Availability of Insurance............................ 17
ARTICLE 6 SURRENDER........................................................ 17
Section 6.1. Surrender--Removable Property........................ 17
Section 6.2. Waste................................................ 18
Section 6.3. Title................................................ 18
<PAGE>
TABLE OF CONTENTS
(Continued)
Page
----
Section 6.4. Initial Environmental Site Assessment................ 18
Section 6.5. Interim Site Assessments............................. 18
Section 6.6. Final Phase I........................................ 19
Section 6.7. Tenant's Failure to Obtain the Final Phase I......... 19
Section 6.8. Survival of Provisions............................... 19
ARTICLE 7 LANDLORD'S PERFORMANCE FOR TENANT................................ 20
Section 7.1. Cures--Rights, Costs, and Damages.................... 20
ARTICLE 8 USE AND MAINTENANCE OF PREMISES.................................. 20
Section 8.1. Absence of Warranties................................ 20
Section 8.2. Permitted Uses....................................... 21
Section 8.3. Maintenance and Repairs.............................. 21
Section 8.4. Performance by Landlord.............................. 21
Section 8.5. Alterations.......................................... 21
ARTICLE 9 COMPLIANCE....................................................... 22
Section 9.1. Tenant Obligations................................... 22
Section 9.2. Certificate of Occupancy............................. 22
ARTICLE 10 CONSTRUCTION OF BUILDINGS AND LANDSCAPING....................... 22
Section 10.1. General Requirements................................ 22
Section 10.2. Approval of Final Plans............................. 23
Section 10.3. Government Approval................................. 23
Section 10.4. Construction Standards.............................. 23
Section 10.5. Ownership of Buildings and Improvements............. 23
Section 10.6. Requirement of Construction Contract................ 24
Section 10.7. Application of This Article......................... 25
ARTICLE 11 IMPAIRMENT OF LANDLORD'S TITLE.................................. 25
Section 11.1. No Liens............................................ 25
Section 11.2. Discharge........................................... 25
Section 11.3. No Implied Consent.................................. 26
ARTICLE 12 INSPECTION...................................................... 26
Section 12.1. Inspection and Entry................................ 26
ARTICLE 13 INDEMNIFICATION................................................. 27
ii
<PAGE>
TABLE OF CONTENTS
(Continued)
Page
----
Section 13.1. Indemnification of Landlord......................... 27
Section 13.2. Indemnification of Tenant........................... 29
ARTICLE 14 DAMAGE OR DESTRUCTION........................................... 30
Section 14.1. Tenant's Election to Restore, Rebuild or Raze....... 30
Section 14.2. Lease Obligations Continue.......................... 30
Section 14.3. Election to Terminate............................... 30
ARTICLE 15 CONDEMNATION.................................................... 31
Section 15.1. Total or Substantial Takings........................ 31
Section 15.2. Partial Taking...................................... 32
Section 15.3. Rights of Participation............................. 32
Section 15.4. Notice of Proceeding................................ 32
ARTICLE 16 SUBTENANT NON-DISTURBANCE....................................... 33
Section 16.1. Agreement for Non-Disturbance of Subtenants......... 33
ARTICLE 17 ASSIGNMENT, SUBLETTING, MORTGAGE................................ 34
Section 17.1. Prior Consent; Permitted Assignments............... 34
Section 17.2. Permitted Subleases................................ 35
Section 17.3. Rent From Assignee................................. 36
Section 17.4. Continuing Liability............................... 36
Section 17.5. Assignee Bound..................................... 37
Section 17.6. Consent Limited.................................... 37
Section 17.7. Permitted Mortgages--Definition.................... 37
Section 17.8. Permitted Mortgages--Further Provisions............ 38
Section 17.9. Notice to Permitted Mortgagees..................... 39
Section 17.10. Right to Cure...................................... 39
Section 17.11. Conditions of Cure................................. 40
Section 17.12. New Lease with Mortgagee........................... 40
Section 17.13. Priority of New Lease.............................. 41
Section 17.14. Assignment of Subleases............................ 41
Section 17.15. Grace Period....................................... 41
Section 17.16. Modifications...................................... 41
Section 17.17. Initial Assignment................................. 42
ARTICLE 18 DEFAULT BY TENANT............................................... 42
Section 18.1. Events of Default.................................. 42
iii
<PAGE>
TABLE OF CONTENTS
(Continued)
Page
----
Section 18.2. Notice and Termination.............................. 43
Section 18.3. No Implied Waivers.................................. 43
Section 18.4. Remedies Cumulative................................. 43
Section 18.5. Late Charge......................................... 43
ARTICLE 19 SAVING PROVISION................................................ 44
ARTICLE 20 NOTICES......................................................... 44
Section 20.1. Notices............................................. 44
Section 20.2. Notice to Permitted Mortgagees of Record Only....... 45
ARTICLE 21 QUIET ENJOYMENT................................................. 45
Section 21.1. Quiet Enjoyment..................................... 45
ARTICLE 22 ESTOPPEL........................................................ 45
Section 22.1. Estoppel Certificates............................... 45
ARTICLE 23 CONSENTS........................................................ 46
Section 23.1. Parties and Notice.................................. 46
Section 23.2. No Unreasonable Withholding or Delay................ 46
ARTICLE 24 ADJOINING EXCAVATION............................................ 46
Section 24.1. Entry and Repairs................................... 46
ARTICLE 25 LIMITATION ON RECOURSE.......................................... 47
ARTICLE 26 EASEMENTS, DEDICATIONS AND OTHER MATTERS........................ 47
ARTICLE 27 TRADE FIXTURES, MACHINERY AND EQUIPMENT......................... 48
ARTICLE 28 LEASEHOLD MORTGAGEE FURTHER ASSURANCES.......................... 48
ARTICLE 29 MISCELLANEOUS................................................... 49
Section 29.1. Choice of Law....................................... 49
Section 29.2. Memorandum.......................................... 49
Section 29.3. Entire Agreement.................................... 49
Section 29.4. Captions............................................ 49
Section 29.5. Execution and Delivery.............................. 50
iv
<PAGE>
TABLE OF CONTENTS
(Continued)
Page
----
Section 29.6. Singular and Plural, Gender......................... 50
Section 29.7. Multiple Parties.................................... 50
Section 29.8. Construction........................................ 50
Section 29.9. Declaration......................................... 50
Section 29.10.Nondisturbance - Improvement District.............. 50
ARTICLE 30 INUREMENT....................................................... 51
Section 30.1. Covenants Bind and Inure............................ 51
ARTICLE 31 ATTORNEYS' FEES................................................. 52
Section 31.1. Prevailing Party to Recover Attorneys' Fees......... 52
v
<PAGE>
PAPAGO PARK CENTER
GROUND SUBLEASE
---------------
THIS SUBLEASE ("Lease"), dated effective as of the 1st day of April,
1994, by and between PAPAGO PARK CENTER, INC., an Arizona corporation
(hereinafter "Landlord"), and THREE-FIVE SYSTEMS, INC. a Delaware corporation
(hereinafter "Tenant").
WITNESSETH:
WHEREAS, Landlord is the ground lessee of certain real property located
in the City of Tempe, Arizona, known as the "Papago Park Center"; and
WHEREAS, Landlord plans to develop and maintain the Papago Park Center
as an integrated real estate development project for the benefit of Landlord;
and
WHEREAS, Tenant desires to lease from Landlord and Landlord is willing
to lease to Tenant a portion of the Papago Park Center on the terms and subject
to the conditions hereinafter set forth.
NOW, THEREFORE, in consideration of these premises and of the mutual
covenants and agreements hereinafter set forth, Landlord and Tenant have agreed
and hereby agree as follows:
ARTICLE 1
---------
DEFINITIONS
-----------
Section 1.1. Definitions. For the purposes of this Lease, the following
words shall have the meanings hereafter set forth:
"Additional Rent": As defined in Section 4.1.
"Adjustment Date": As defined in Section 3.1.B.
"Buildings": Any and all structures or improvements to be
constructed pursuant to Article 10, together with all future additions thereto
and alterations thereof, other than Landscaping.
"City": The City of Tempe, a municipal corporation.
<PAGE>
"City Lease": That certain so-called "Improvements Lease" to
be executed between the City and Tenant pursuant to that certain "Agreement for
the Conveyance and Leaseback of Improvements", regarding the lease of the
Buildings and Landscaping from the City to Tenant.
"Commencement Date": As defined in Section 2.3.
"Declaration": Any instrument affecting the Papago Park Center
or any portion thereof which is now or may hereafter be duly recorded within the
records of Maricopa County, Arizona, together with all amendments thereto, and
which contains conditions, covenants, restrictions, liens, easements or similar
provisions running with the land, including without limitation any rules,
regulations, Papago Park Center Design Guidelines, Architectural and Development
Guidelines and procedures for obtaining approvals or for other purposes
contained therein or promulgated pursuant thereto; provided that any such
instrument (including amendments) hereafter recorded or adopted which contains
provisions having a non-uniform or materially adverse affect on the Premises,
shall not be effective against Tenant or any Person claiming by, through or
under Tenant and shall not be considered a "Declaration" hereunder without
Tenant's prior written consent, which shall not be unreasonably withheld or
delayed.
"Environmental Laws": Any one or all of the following: the
Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C.
ss. 9601 et seq.; the Resource Conservation and Recovery Act, 42 U.S.C. ss. 6941
et seq.; the Toxic Substances Control Act, 15 U.S.C. ss. 2601 et seq.; the Safe
Drinking Water Act, 42 U.S.C. ss. 300h et seq.; the Clean Water Act, 33 U.S.C.
ss. 1251 et seq.; the Clean Air Act, 42 A.R.S. ss. 49-921 et seq.; the Arizona
Environmental Quality Act, Laws 1986, Ch. 368; Laws 1987, Ch. 317; A.R.S. ss.
49-1001 et seq.; rules and regulations under any of the foregoing; and any other
applicable laws and regulations of the United States of America, the State of
Arizona or any political subdivision thereof now in effect or hereafter enacted
that deal with the regulation or protection of the environment, including the
ambient air, ground water, surface water or land use.
"Event of Default": As defined in Section 18.1.
"First Permitted Mortgage of Record": As defined in Section
17.8.A.
"Impositions": As defined in Section 4.1.
"Institutional Lender": As defined in Section 4.3.
"Insurance Requirements": All terms and provisions of each
insurance policy, whether procured by or covering Landlord, City, Tenant or any
Subtenant, covering or applicable to all or any part of the Premises and all
requirements of the issuers of any such
2
<PAGE>
policies which are applicable to or affect all or any part of the Premises or
any use or condition thereof, at the time then relevant.
"Landlord": Papago Park Center, Inc., an Arizona corporation,
and its successors and assigns.
"Landscaping": All grading, drainage and site preparation or
improvements, landscaping, planting materials, hardscaping, outdoor decorative
or beautification features and watering systems and related improvements to be
installed on or in the Premises by Tenant pursuant to Article 10.
"Lease Term": As defined in Section 2.2.
"Legal Requirements": All statutes, codes, laws, acts,
ordinances, orders, judgments, decrees, injunctions, rules, regulations,
permits, licenses, authorizations, directions and requirements of all federal,
state, county, municipal, and other governments, departments, commissions,
boards, courts, authorities, officials and officers of every nature and
description, all terms and conditions of the City Lease, and all covenants,
conditions, restrictions or other requirements duly and validly imposed by or
pursuant to any Declaration (subject to the limitations contained in the
definition of "Declaration") which may at any time be applicable to the
Landlord, the Tenant or any Subtenant or to the Premises or any part thereof,
including without limitation Environmental Laws.
"Lessor under the Master Ground Lease": Salt River Project
Agricultural Improvement and Power District, its successors and assigns, with
respect to the Lessor's interest under the Master Ground Lease.
"Master Ground Lease": That certain Papago Park Center Ground
Lease dated March 6, 1989, between Salt River Project Agricultural Improvement
and Power District, as Lessor, and Papago Center, Inc., as Lessee, and subject
to the provisions of Section 2.5 below, all amendments thereto and modifications
thereof, to which this Lease is and shall be subject and subordinate.
"Minimum Rent": As defined and described in Section 3.1.
"Mortgage": Any mortgage, deed of trust, security agreement,
contract to convey, pledge, assignment or other transfer for the purpose of
securing any debt or other obligation of or which creates any lien or
encumbrance upon all or any portion of the right, title or interest of Tenant
under this Lease, the leasehold estate hereby created or the Premises.
"Mortgagee": The holder, trustee or beneficiary of any
Mortgage.
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"Papago Park Center": As defined in the Recitals.
"Papago Park Center Design Guidelines" or "Manual": Synonymous
with the Papago Park Center Architectural and Development Guidelines, being
detailed guidelines adopted and amended from time to time pursuant to the
Declaration (subject to the limitation on amendments and other adopted
instruments set forth in the definition of "Declaration" above) pertaining to
the location, design and construction of improvements within the Papago Park
Center.
"Permitted Assignee": As defined in Section 17.1.
"Permitted Assignment": As defined in Section 17.1.
"Permitted Mortgage": As defined in Section 17.7.
"Permitted Sublease": As defined in Section 17.2.
"Person": Any natural person, corporation, partnership, trust,
political subdivision, limited liability company or other person or entity
permitted by law to own real property in the State of Arizona.
"Premises": As defined in Section 2.1.
"Prohibited Use": Any of the following uses or occupancies:
any unlawful use or use in violation of any Legal Requirements; any business or
use that emits offensive odors, fumes, dust or vapors; any business or use that
is a public or private nuisance; any so-called "head shop"; massage parlor;
tatoo parlor; adult bookstore or store selling or exhibiting pornographic
materials; pornographic adult theater; adult lodging rented for periods of less
than twenty-four hours; and any display of nude or semi-nude male or female
dancers or entertainers or a so-called "strip-tease" establishment.
"Sublease": Any agreement, written or oral, by which Tenant
gives any Person the use or occupancy of or any benefit flowing from the
Premises or any portion thereof, including without limitation any permit,
license or concession.
"Subtenant": Any person having the use or occupancy of or any
benefit flowing from the Premises or any portion thereof pursuant to a Sublease.
"Tenant": The Tenant named herein and its successors and
assigns.
"Year": Unless otherwise specified, a 12-month period
commencing on the Commencement Date, unless the Commencement Date is other than
the first day of a
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calendar month, in which event the first Lease Year (and each subsequent Lease
Year) shall commence on the first day of the calendar month following the
Commencement Date.
ARTICLE 2
---------
DEMISE OF THE PREMISES; TERM
----------------------------
Section 2.1. Premises. Landlord hereby leases to Tenant and Tenant
hereby leases from Landlord, upon and in consideration of the terms and subject
to the conditions contained herein, that certain parcel of real property located
in the City of Tempe, County of Maricopa, State of Arizona, more particularly
described in Exhibit "A" attached hereto and incorporated herein by this
reference, which real property together with the Buildings and Landscaping to be
constructed thereon (as hereinafter provided) is hereinafter referred to as the
"Premises"; subject, however, to the Master Ground Lease, all Legal Requirements
and all matters now of record, including but not limited to those matters which
are listed and disclosed in Exhibit "B" attached hereto and incorporated herein
by this reference, and any other matters hereafter placed of record pursuant to
the provisions of the Declaration and/or the provisions of Article 26 hereof. It
is acknowledged that the City will own the Buildings and Landscaping while the
City Lease is in effect, but Tenant shall remain responsible for the entire
Premises as set forth in this Lease.
Section 2.2. Term. The term of this Lease (the "Lease Term") shall be
approximately seventy-five (75) years commencing on the Commencement Date, and
expiring at 12:00 midnight on the last day of March, 2069, unless this Lease is
sooner terminated as hereinafter provided.
Section 2.3. Commencement Date; Possession. The initial Lease Term
shall commence upon full execution of this Lease (the "Commencement Date").
Notwithstanding such commencement, Tenant shall not have possession of the
Premises or be permitted to commence any construction until after the last to
occur of: (a) Landlord's receipt of Tenant's grading plans for Tenant's
contemplated construction, marked to show approval by the Architectural
Committee of the Papago Park Center Association, (b) Landlord's receipt of
evidence that the bond called for in Section 10.6 is in effect (unless such
requirement has been waived as hereinafter provided), and (c) Tenant's delivery
to Landlord of evidence of the insurance called for in subparts (A) and (C) of
Section 5.1 below.
Section 2.4. Title Insurance. Tenant shall be entitled to
order a leasehold title insurance policy insuring the leasehold interest of
Tenant or its assignee R & K (as defined in Section 6.4 below) for an amount
equal to $3.72 per net square foot of real property included within the
Premises. Landlord shall pay the one-time cost of a standard owner's leasehold
title insurance policy, and Tenant shall pay the additional premium for any
extended coverage, endorsements, lenders' policy, survey or any other title
insurance
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requirements of Tenant or Tenant's title insurer. Landlord will use reasonable
efforts, at no expense to Landlord, to comply with any reasonable requirements
of the title insurer regarding the issuance of a title insurance policy to
Tenant. Tenant's ability to obtain extended coverage title insurance, lender's
title insurance or any particular title insurance endorsements, however, shall
not be a condition to the effectiveness of this Lease.
Section 2.5. Nondisturbance and Attornment Agreement. Prior to
the execution of this Lease, Landlord shall use reasonable efforts to cause the
Lessor under the Master Ground Lease to execute, have acknowledged and deliver
to Tenant, for its benefit and the benefit of any assignee pursuant to a
Permitted Assignment (as defined in Section 17.1.A below), a Nondisturbance and
Attornment Agreement substantially in the form attached to this Lease as Exhibit
"C", pursuant to which, among other things, the Lessor under the Master Ground
Lease shall (i) consent to and agree to be bound by the option to purchase set
forth in Section 3.3 below and the condemnation provisions set forth in Article
15 below, (ii) (intentionally omitted), (iii) certify that the Master Ground
Lease is free from default and that this Lease constitutes a Permitted Sublease
under the terms of the Master Ground Lease, (iv) agree that notwithstanding any
breach or default by Landlord under the Master Ground Lease, it will honor this
Lease and not disturb the rights of Tenant hereunder, provided that there is not
then in existence an Event of Default, and (v) agree that Tenant shall not be
bound by any amendment or modification made to the Master Ground Lease which
materially and adversely affects Tenant or the Premises if such amendment or
modification is made without the prior written consent of Tenant. If Landlord is
unable to obtain said Nondisturbance and Attornment Agreement, or if said
Nondisturbance and Attornment Agreement is delivered but deviates from the
requirements of Exhibit "C" in some material respect (as determined by Tenant),
Tenant may either (i) waive strict conformance with this Section 2.5 and execute
this Lease, whereupon the other provisions of the Lease shall have full force
and effect, or (ii) refuse to execute this Lease, whereupon this Lease shall
have no force or effect and neither Landlord nor Tenant shall have any liability
one to the other.
ARTICLE 3
---------
RENT
----
Section 3.1. Rent. Tenant shall pay rent throughout the Lease Term as
follows:
A. Minimum Rent and Adjustments. Tenant shall pay to
Landlord in such United States coin or currency as at
the time of payment shall be legal tender for the
payment of public and private debts at the addresses
specified or furnished pursuant to Section 20.1
during the Lease Term a minimum annual rental (which
as adjusted from time to time, as
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hereinafter provided, is herein referred to as the
"Minimum Rent") as follows:
(1) During the first two (2) Years of the Lease Term,
a minimum rental of Twelve Dollars ($12.00) per annum, payable in equal monthly
installments in advance on or before the first (1st) day of each month;
(2) During Years three (3) through five (5) inclusive
of the Lease Term, a minimum rental of $79,868.16 per annum (based on $.32 per
net square foot), payable in equal monthly installments in advance on or before
the first (1st) day of each month;
(3) During Years six (6) through ten (10) inclusive
of the Lease Term, a minimum rental of $87,355.80 per annum (based on $.35 per
net square foot), payable in equal monthly installments in advance on or before
the first (1st) day of each month;
(4) During Years eleven (11) through fifteen (15)
inclusive of the Lease Term, a minimum rental of $99,835.20 per annum (based on
$.40 per net square foot), payable in equal monthly installments in advance on
or before the first (1st) day of each month;
(5) Minimum Rent shall be payable in advance without
notice in equal monthly installments on the first (1st) day of each and every
month, except that, if the Commencement Date is not the first day of a month,
the Minimum Rent for the month during which the Commencement Date occurs shall
be due and payable on the Commencement Date.
The foregoing rental amounts are based upon the assumption
that the real property described in Exhibit "A" contains a total of 249,588 net
square feet. In the event Tenant, at its own cost and expense, prior to the
Commencement Date commissions a survey by an Arizona licensed surveyor
reasonably acceptable to Landlord (the "Survey"), and such Survey establishes
that there are more or less than 249,588 net square feet contained within such
real property, the rental amounts set forth in subparagraphs (2) through (4)
above shall be adjusted to equal the actual net square footage contained in such
real property times the applicable per net square foot dollar amount set forth
in each subparagraph. For the purposes of this Section 3.1, net square footage
shall be calculated by excluding any portion of the Premises located within the
beds of any existing roads, streets, alleyways, access easements (excluding,
however, landscape easements and utility easements) or rights-of-way, whether or
not of record.
B. Minimum Rent Adjustments Commencing Year Sixteen
(16). After the fifteenth (15th) Year of the Lease
Term, the Minimum Rent shall
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be subject to adjustment for the remaining Lease Term
in accordance with the formula set forth below.
In applying the formula, the following definitions shall
prevail:
(a) "Price Index" means the Metropolitan
Phoenix Consumer Price Index compiled quarterly by
the Center for Business Research of the College of
Business of Arizona State University or, if such
Price Index is discontinued, a reasonably equivalent
index selected by Landlord which includes the
Phoenix, Arizona, metropolitan area.
(b) "Average Price Index" means the average
of the Price Indices issued for the most recent four
(4) quarters prior to the date on which the Average
Price Index is to be determined for which Price
Indices have previously been announced.
(c) "Base Index" is the average of the Price
Indices for the four (4) quarters prior to the first
day of the calendar quarter of the 11th Year.
On the first day of the sixteenth (16th) Year of the Lease
Term and on the first day of each five (5) Year period thereafter (an
"Adjustment Date"), the Minimum Rent shall be adjusted to equal the Minimum Rent
for the eleventh (11th) Year of the Lease Term multiplied by a fraction, the
numerator of which is the Average Price Index applicable on the date of such
adjustment and the denominator of which is the Base Index; provided, however,
that in no event shall the Minimum Rent determined by such calculation be less
than the Minimum Rent for the immediately preceding Year. In no event shall any
five-year increase be greater than 20%; provided, however, in no event shall the
escalation of Minimum Rent on any Adjustment Date result in an adjusted annual
Minimum Rent which exceeds ten percent (10%) of the then fee simple value of the
Premises, exclusive of the value of the Buildings and Landscaping. Within three
(3) months prior to the applicable Adjustment Date, Landlord shall notify Tenant
of Landlord's calculation of the adjusted Minimum Rent. If Tenant believes such
calculation exceeds the ten percent (10%) of fee value limitation set forth
above, Tenant shall immediately notify Landlord and shall submit Tenant's
proposed fee simple value of the Premises (excluding the value of the Buildings
and Landscaping). If Landlord disagrees with such proposed value, Landlord shall
notify Tenant and the parties will engage in good faith negotiations to
determine the applicable fee simple value of the Premises exclusive of the
Buildings and Landscaping. If Landlord and Tenant are unable to agree upon such
value within thirty (30) days, Landlord and Tenant within ten (10) business days
thereafter shall appoint an arbitrator who is mutually acceptable to both
parties. Such arbitrator shall be a member of the American Institute of Real
Estate Appraisers (or any successor organization) with a then current senior
designation of MAI, who possesses no conflict of interest or relationship with
either party that would impair
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impartiality, and at least ten (10) years experience in appraising commercial
properties in Maricopa County, Arizona. If the parties are unable to agree on
the appointment of such an arbitrator within such ten (10) day period, then upon
the request of either party, a qualified arbitrator meeting such qualifications
shall be appointed by the president of the Maricopa County Board of Realtors (or
any organization successor thereto), or, in such president's failure to act by
the presiding judge of the Superior Court of Maricopa County. Within five (5)
business days after appointment of the arbitrator, Landlord and Tenant shall
each submit to the arbitrator its respective proposed value. The arbitrator
shall determine the fee simple value of the Premises, exclusive of the Buildings
and Landscaping, by reviewing the two submitted values and selecting the one of
the two submitted values which most closely approximates the arbitrator's
independent opinion of the fee simple value of the Premises, exclusive of the
Buildings and Landscaping. The arbitrator shall not propose a third amount for
the value, nor propose a modification to the two amounts submitted by the
parties; instead, the arbitrator must choose one of the two values submitted by
the parties. In determining such value, the arbitrator may consult such
evidence, experts, consultants, or authorities as he or she deems necessary, or
such evidence, experts, consultants, or authorities as may be offered by either
Landlord or Tenant, provided such consultation takes place in the presence of
both Landlord and Tenant and each party has the right to cross-examine any
person so consulted. The arbitrator will use his or her best effort to render a
decision determining such value within twenty (20) days, but in no event later
than forty-five (45) days, after the receipt by the arbitrator of the proposals
submitted by Landlord and Tenant. The decision shall be rendered in writing
executed by the arbitrator and delivered to each of the parties and shall be
final. If for any reason the arbitrator fails, refuses, or is unable to act, a
successor shall be appointed in the same manner as provided herein. Until such
time as the fee simple value of the Premises is agreed upon by Landlord and
Tenant or otherwise determined by the arbitrator, Tenant shall continue to pay
the Minimum Rent at the rate calculated by Landlord. If the Minimum Rent
calculated and collected by Landlord is determined to exceed the ten percent
(10%) of fee value limitation set forth above, Landlord shall rebate the excess
to Tenant. The expense and fees of the arbitrator shall be borne equally by
Landlord and Tenant; however, all consultation costs, expert fees and expenses,
including attorneys' fees, incurred by each party shall be borne by the party
incurring the same.
Once the Minimum Rent is determined and adjusted effective as of the Adjustment
Date, the annual Minimum Rent so determined shall be the applicable annual
Minimum Rent for each Year thereafter until the next Adjustment Date occurs.
Section 3.2. Rent Absolutely Net. Landlord and Tenant hereby expressly
covenant and agree that all rent and other sums payable hereunder shall be
absolutely net to Landlord so that this Lease shall yield to Landlord the
Minimum Rent herein specified each Year during the Lease Term, free of any
charges, assessments, Impositions, or deductions of any kind charged, assessed
or imposed on or against Tenant or the Premises without abatement, diminution,
deduction or setoff by the Tenant, except as hereinafter specifically
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provided. Except for Mortgages imposed by or on behalf of the Lessor under the
Master Ground Lease or Landlord for their own respective account(s), for which
such Lessor or Landlord, as applicable, shall be responsible, or except as
otherwise herein expressly set forth, Landlord shall not be required to pay any
such charge, assessment or Imposition concerning the Premises and all other
costs, expenses, and obligations of any kind relating to the ownership,
maintenance and operation of the Premises, including all construction,
alterations, repairs, reconstruction and replacements as hereinafter provided,
if any, and all liabilities which may arise or become due during the Term hereof
shall be paid by Tenant, and Landlord shall be indemnified and saved harmless by
Tenant from and against any or all such costs, expenses and obligations. In no
event shall Landlord be responsible for any personal property taxes of Tenant or
any Person claiming by, through or under Tenant, water or sewer rents, rates or
charges, charges for other private or public utilities, excises, levies, license
or permit fees, expenditures for improvements imposed or required by or as a
result of any Legal Requirements, or any other charges arising out of any use or
occupation of the Premises. In no event shall Tenant be responsible for the
ground rent amounts payable under the Master Ground Lease.
Section 3.3. Option to Purchase.
A. Tenant shall have an option (the "Option") to
purchase the real property which constitutes a part
of the Premises at the end of each of Years ten (10)
through fifteen (15) as follows:
Year Purchase Price
---- --------------
10 $1,622,322.00 ($6.50 per net square foot)
11 $1,634,801.40 ($6.55 per net square foot)
12 $1,647,280.80 ($6.60 per net square foot)
13 $1,659,760.20 ($6.65 per net square foot)
14 $1,672,239.60 ($6.70 per net square foot)
15 $1,684,719.00 ($6.75 per net square foot)
Each Purchase Price figure set forth above is based upon the assumption that the
real property which constitutes a part of the Premises contains 249,588 net
square feet. If the Survey establishes that there are more or less than 249,588
net square feet, the pertinent Purchase Price shall be adjusted to equal the
actual net square footage contained in such real property times the applicable
per net square foot dollar amount for the pertinent Year set forth above.
B. Tenant may exercise the Option at the end of each of Years
ten (10) through fifteen (15) by delivering written notice of such exercise
("the Purchase Notice") in accordance with the notice provisions of this Lease.
The Purchase Notice shall be delivered (i) no earlier than one hundred fifty
(150) days prior to the end (i.e., the last day of February) of the pertinent
Year, and (ii) no later than sixty (60) days prior to the end of
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such pertinent Year, for the Year in which the Option is to be exercised. When
and if Tenant exercises the Option as provided herein, the purchase and sale
shall be conducted as follows:
(1) The Purchase Price shall be a net price (i.e.,
exclusive of the items in subparagraph [5] below) and shall be paid to Landlord
in immediately available funds at the closing.
(2) The closing shall be conducted by an Arizona
licensed escrow agent reasonably acceptable to Landlord and Tenant and located
in Phoenix, Arizona, and shall occur on or before December 31 of the Year in
which the Option is exercised.
(3) The real property shall be conveyed "AS IS"
without representation or warranty whatsoever, by special warranty deed subject
to (i) the deed restriction referred to in Section 8.2, (ii) all matters
affecting title as of the date of this Lease (excluding the Master Ground
Lease), (iii) all matters subsequently placed of record by Landlord pursuant to
the Declaration, and (iv) matters created by or with the consent of Tenant
(excluding, however, Mortgages imposed by or on behalf of Landlord or Lessor
under the Master Ground Lease for their own respective account(s), if any, and
also excluding the lien imposed by Tempe Improvement District No. 166, which
Mortgages and improvement lien shall be released or otherwise removed at the
closing). With respect to the lien of Tempe Improvement District No. 166, Lessor
under the Master Ground Lease and Landlord shall have the option, in lieu of
obtaining a release of said lien, to provide other continuing financial
assurances or arrangements insuring that Tenant, its successors and assigns, its
Permitted Mortgagees, future purchasers of the Premises and the Premises shall
not be held financially responsible for the lien imposed by Tempe Improvement
District No. 166 or, if reasonably commercially available at a reasonable cost,
Lessor under the Master Ground Lease or Landlord may obtain title insurance
endorsements insuring Tenant, its successor and assigns, its Permitted
Mortgagees and future purchasers of the Premises against loss as a result of the
existence of said lien. The Master Ground Lease shall be amended to delete said
real property therefrom at the closing.
(4) At closing, Lessor under the Master Ground Lease,
Landlord and Tenant, as appropriate, shall execute and deliver such other
reasonable and customary documents as may be required by the escrow agent or any
title insurer in order to consummate closing, including, without limitation,
escrow instructions, FIRPTA and property value affidavits.
(5) Costs of title insurance, escrow fees, recording
fees and other expenses of sale shall be paid by Tenant.
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(6) Upon closing, this Lease shall terminate. Neither
Landlord nor the Lessor under the Master Ground Lease shall have any continuing
indemnity obligations of any kind with respect to the real property for matters
occurring after closing.
(7) Until closing, Tenant shall remain liable for
Minimum Rent, Additional Rent and all other charges imposed upon Tenant under
this Lease.
C. The parties acknowledge that Tenant intends to avail itself
of the partial tax abatement provided in A.R.S. ss. 42-685(C) with respect to
the possessory interest tax on the Buildings and Landscaping. Landlord does not
guarantee that Tenant will obtain such partial tax abatement and Tenant's
ability to obtain such partial tax abatement shall not be a condition to this
Lease. However, if Tenant does not obtain such partial tax abatement or if
Tenant loses such partial tax abatement, during the first eight (8) years
following the initial issuance of a certificate of occupancy on any Building
(the "Relevant Eight years") because of the repeal or amendment of A.R.S. ss.
42-685(C), then Tenant shall be entitled to a one-time reduction in the Purchase
Price if the Option is exercised and closed in Year ten (10) of this Lease, in
accordance with the following provisions:
Under current law, the parties acknowledge that the
maximum period for which the partial tax abatement could be obtained covers the
entire Relevant Eight Years. For each year of the Relevant Eight Years that
Tenant does not have the benefit of the partial tax abatement because of the
repeal or amendment of A.R.S. ss. 42-685(C), the Purchase Price in Lease Year
ten (10) shall be reduced by a factor of $.125 per net square foot. Thus, for
example, if Tenant loses the partial tax abatement during the eighth year of the
Relevant Eight Years, the Purchase Price shall be reduced by $.125 per net
square foot; if the Tenant loses the partial tax abatement during the seventh
year of the Relevant Eight Years, the Purchase Price shall be reduced by $.25
per net square foot; if the Tenant loses the partial tax abatement during the
sixth year of the Relevant Eight Years, the Purchase Price shall be reduced by
$.375 per net square foot; if the Tenant loses the partial tax abatement during
the fifth year of the Relevant Eight Years, the Purchase Price shall be reduced
by $.50 per net square foot; if the Tenant loses the partial tax abatement
during the fourth year of the Relevant Eight Years, the Purchase Price shall be
reduced by $.625 per net square foot; if the Tenant loses the partial tax
abatement during the third year of the Relevant Eight Years, the Purchase Price
shall be reduced by $.75 per net square foot; if the Tenant loses the partial
tax abatement during the second year of the Relevant Eight Years, the Purchase
Price shall be reduced by $.875 per net square foot; and if the Tenant loses or
fails to obtain the partial tax abatement during the first year of the Relevant
Eight Years, the Purchase Price shall be reduced by $1.00 per net square foot.
For purpose of this Section 3.3.C, each year within the Relevant Eight Years
shall be measured from the anniversary date of the initial issuance of a
certificate of occupancy on any Building. Further, if Tenant is entitled to the
benefit of such partial tax abatement for the period of six (6) or more months
in any such year, Tenant shall be deemed to have obtained the partial tax
abatement benefit for the entire such year for purposes of calculating the
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Purchase Price adjustment, and there shall be no proration of the Purchase Price
adjustment to account for any loss of the partial tax abatement for the
remaining part of such year. Nothing herein shall be construed to entitle Tenant
to any Purchase Price adjustment resulting from Tenant's failure to meet the
requirements in A.R.S. ss. 42-685(B), which requirements are a condition
precedent to obtaining the partial tax abatement under A.R.S. ss. 42-685(C), or
Tenant's failure to obtain such partial tax abatement for any reason other than
the repeal or amendment of A.R.S. ss. 42-685(C).
Section 3.4. Nonsubordination. Except with respect to the Option,
neither this Lease nor any of Landlord's right, title or interest hereunder
shall be subject or subordinate to any Mortgage or other liens or encumbrances
of any nature or description hereafter affecting Tenant's interest in this
Lease.
ARTICLE 4
---------
ADDITIONAL RENT
---------------
Section 4.1. "Additional Rent" and "Impositions" Defined. Following the
Commencement Date, Tenant shall pay as "Additional Rent" during the Lease Term,
without notice (except as specifically provided) and without abatement,
deduction or setoff (except as hereinafter provided in Section 4.3), before any
fine, penalty, interest, or cost may be added thereto, or become due or be
imposed by operation of law for the nonpayment thereof, all "Impositions" as
defined below:
"Impositions" mean all real property taxes or required
payments in lieu thereof and any taxes on rents or other payments hereunder
whether levied on Landlord or Tenant, general assessments (but not assessments
levied or imposed by Tempe Improvement District No. 166, which shall be the
responsibility of Landlord), fees, assessments or other charges pursuant to any
Declaration, and any other governmental or quasi-governmental charges, general
and special, ordinary and extraordinary, foreseen and unforeseen, of any kind
and nature whatsoever which at any time during the Term hereof may be assessed
and, if not paid, could become a lien on the Premises or any part thereof or
could become a charge against Landlord; provided, however, that:
A. If, by law, any Imposition may at the option of the
taxpayer be paid in installments (whether or not interest shall accrue on the
unpaid balance of such Imposition), Tenant may exercise the option to pay the
same (and any accrued interest on the unpaid balance of such Imposition) in
installments and in such event, shall pay such installments as they become due
during the Lease Term before any fine, penalty, further interest or cost may be
added thereto; and
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B. Any Imposition (including Impositions which have been
converted into installment payments by Tenant, as referred to in Subpart A
above) relating to a fiscal period of the taxing authority, a part of which
period is included within the Lease Term and a part of which is included in the
period of time after the expiration of the Lease Term (whether or not such
Imposition shall be assessed, levied, confirmed, imposed upon or become a lien
upon the Premises, or shall become payable, during the Lease Term) shall be
adjusted between Landlord and Tenant as of the expiration of the Lease Term, so
that Tenant shall pay that portion of such Imposition attributable to the Lease
Term and Landlord shall pay the remainder thereof.
C. "Impositions" shall not include, and Tenant shall not be
liable or responsible for, any estate, inheritance, succession, transfer, gift,
franchise, income or excess profits tax levied or imposed upon Landlord, its
affiliates, or their respective successors and assigns.
Section 4.2. Payments. Tenant shall pay to Landlord, with and in
addition to the rental payments, all taxes imposed by any governmental unit on
the rentals received by Landlord pursuant to the terms of this Lease, if any.
Tenant shall pay all other Impositions directly to the taxing authority or other
Persons to whom such payment is due.
Section 4.3. Contest. Tenant, if it shall so desire, may contest the
validity or amount of any Imposition, in which event, Tenant may defer the
payment thereof during the pendency of such contest; provided, however, that
Tenant shall give Landlord prior notice of any such contest and, upon request by
Landlord at any time after the same shall have become due, Tenant shall deposit
with the Landlord an amount sufficient to pay such contested item together with
the interest and penalties thereon (as reasonably estimated by Landlord), which
amount shall be applied to the payment of such item when the amount thereof
shall be finally fixed and determined, or Tenant shall provide other security
reasonably acceptable to Landlord. Nothing herein contained, however, shall be
construed so as to allow such item to remain unpaid for a length of time that
permits the Premises or any part thereof to be sold for the nonpayment of the
same. If the amount so deposited shall exceed the amount of such payment, the
excess shall be paid to Tenant or, in case there shall be any deficiency, the
amount of such deficiency shall be promptly paid by Tenant to Landlord together
with all interest, penalties or other charges accruing thereon. At any time that
the Tenant hereunder is an Institutional Lender, the requirements for deposits
set forth in this Section shall be waived by Landlord. For purposes of this
Lease, an "Institutional Lender" shall means a bank, savings and loan
association, insurance company, trust company, pension fund, mutual fund,
retirement fund, eleemosynary, education or other financial institution.
Section 4.4. Assessment Reduction. Tenant may, if it shall so desire,
without expense to Landlord, endeavor at any time to obtain a reduction of the
assessed valuation upon the Premises for the purpose of reducing taxes thereon.
Tenant shall be authorized
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to collect any tax refund payable as a result of any proceeding Tenant may
institute for that purpose, and any such tax refund shall be the property of
Tenant if and to the extent that such refund is based on a payment made by
Tenant.
Section 4.5. Hold Harmless. Landlord shall not be required to join in
any action or proceeding referred to in Section 4.3 or 4.4 unless required by
law or any rule or regulation in order to make such action or proceeding
effective, in which event any such action or proceeding shall be subject to
Landlord's prior written consent, which shall not be unreasonably withheld.
Landlord's reasonable costs and expenses in appearing or joining in any action
or proceeding referred to in Section 4.3 or 4.4 shall be reimbursed by Tenant;
and where practicable, Tenant shall be permitted to hire the attorney
representing Landlord's interests in any such action or proceeding. Tenant
hereby agrees to save Landlord harmless from all costs, expenses, claims, loss
or damage by reason of, in connection with, on account of, growing out of or
resulting from any such action or proceeding.
ARTICLE 5
---------
INSURANCE
---------
Section 5.1. Tenant Obligations to Insure. Tenant shall, at its own
cost and expense, keep and maintain or cause to be kept and maintained, for the
benefit of the Landlord, Tenant and, where applicable, City, the following
policies of insurance:
A. During Construction of the Buildings. Builders Risk
Completed Value Insurance during the course of the construction of the
Buildings.
B. After the Completion of the Buildings. Following completion
of any Buildings, Tenant shall at all times maintain or cause to be maintained
insurance on the Buildings against loss or damage by risks of fire, windstorm,
malicious mischief and other risks normally covered by a "special form" or
extended coverage policy in amounts sufficient to prevent Landlord or Tenant
from becoming a co-insurer under the terms of the applicable policies, but in
any event not less than the then full insurable value of the Buildings. The term
"full insurable value" shall mean actual replacement value without depreciation.
Such "full insurable value" shall be determined from time to time (but not less
frequently than once in any twenty-four (24) calendar months) by the insurer or,
at the option of the Tenant, by an appraiser, engineer, architect, or contractor
employed by Tenant. Tenant shall submit to Landlord a copy of each such
appraisal when received.
C. Liability. Tenant, throughout the Term of this Lease, shall
procure and maintain in effect, or cause to be procured and maintained in
effect, general commercial liability insurance against damage or loss because of
or on account of bodily injuries to or
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the death of any person or the destruction of or damage to the property of any
person, occurring in, on, or about the Premises, or due in any way to the use,
occupancy, maintenance, or operation thereof or of any building or improvement
upon the Premises, or of the sidewalks adjoining the same. During the initial
construction of the Buildings and Landscaping, said policy or policies shall
provide insurance having limits of not less than Five Million Dollars
($5,000,000.00). Upon issuance of a certificate of occupancy upon any Buildings
within the Premises, said policy or policies shall provide insurance having
limits of not less than Five Million Dollars ($5,000,000.00) combined single
limit, or such higher limits as may be required under the City Lease. The
minimum policy limits set forth above shall be subject to increase as of every
fifth anniversary of the Commencement Date to an amount equal to the greater of:
(a) $5,000,000.00; or (b) the product of $5,000,000.00 multiplied by a fraction,
the numerator of which is the Consumer Price Index -- All Items -- All
Consumers--U.S. Cities Average--(1982-1984 = 100) published by the United States
Department of Labor, Bureau of Labor Statistics (the "CPI") for the month which
is three months prior to such fifth anniversary and the denominator of which is
the CPI for the month which is three months prior to the Commencement Date,
provided such increased amount is commercially available, and further provided
that in no event shall such insurance fall below the $5,000,000.00 limit once a
certificate of occupancy has been issued for any Building. In the event the CPI
is discontinued or substantially modified, Landlord shall substitute an
alternative price index, published by the United States Government or other
generally accepted source for such information, reconciled to December, 1993.
Tenant agrees that provisions of this paragraph as to maintenance of insurance
shall not be construed as limiting in any way the extent to which Tenant may be
held responsible for the payment of damages to persons or property resulting
from Tenant's activities, or the activities of its invitees and sublessees or
the activities of any other person or persons for which Lessee is otherwise
responsible.
Section 5.2. Policies and Companies. All insurance provided under
Sections 5.1(A), (B) and (C) shall be effected under standard form policies,
issued by stock or mutual company insurers of recognized responsibility
authorized to do business in the State of Arizona which are well rated by
national rating organizations and reasonably approved by Landlord and City. Any
such policy of insurance shall specifically provide that it is primary coverage
and name Landlord and Salt River Project Agricultural Improvement and Power
District as additional insureds. All policies of insurance shall provide that
they may not be modified or canceled without thirty (30) days prior written
notice to Landlord.
Section 5.3. Policy Delivery, Payment Evidence. Concurrently with the
execution and delivery of this Lease and not less than thirty (30) days prior to
the expiration dates of any policies of insurance furnished pursuant to this
Article 5, Tenant shall deliver to Landlord evidence of the payment of
applicable premiums together with a copy of the policy of insurance. Landlord's
failure to request copies or revision of insurance levels shall in no way
relieve Tenant of its obligation to maintain all insurance required in this
Article 5.
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Section 5.4. Blanket Insurance. Nothing in this Article 5 shall prevent
Tenant from obtaining insurance of a kind and in the amount provided for under
this Article 5 under a blanket insurance policy or policies which cover other
properties owned or operated by Tenant or a Subtenant as well as the Premises;
provided, however, that any such policy of blanket insurance of the kind
provided for by Section 5.1 shall specify therein, or Tenant shall furnish
Landlord a written statement from the insurers under such policies specifying,
the amount of the total insurance allocated to the Premises, which amount shall
be not less than the amounts required herein. No blanket policy shall contain
any clause that would result in any insured thereunder being required or
permitted to carry insurance with respect to the property covered thereby in an
amount less than the full insurable value of such property in order to prevent
the insured therein named from becoming a co-insurer of any loss with the
insurer under such policy.
Section 5.5. Expiration of Term. If Landlord desires to assume existing
insurance coverage at the expiration of the Lease Term, all policies (except
blanket policies) shall be transferred to Landlord free of all right, title and
interest of Tenant and those claiming under Tenant, and Landlord shall pay to
Tenant an amount equal to the unearned premiums apportioned as of such
expiration date. If Landlord does not desire to assume existing policies of
insurance at the expiration of the term hereof, all existing policies shall be
canceled at no expense to Landlord, and Tenant shall be entitled to any refund
of premium.
Section 5.6. Risk of Loss. At no time during the Lease Term hereof, will
Landlord be required to carry any insurance covering or affecting the Premises.
Tenant assumes the risk of any loss or damage to or claims arising out of or
concerning the Premises throughout the Lease Term, except loss or damage
resulting from the negligence or willful misconduct of Landlord, its agents,
servants, contractors or employees.
Section 5.7. Failure to Maintain Insurance. If Tenant fails or refuses
to provide a copy of the required insurance policies, together with evidence of
payment of premiums therefor as required by Section 5.3 herein, or otherwise
fails or refuses to procure or maintain insurance as required by this Lease,
Landlord shall have the right, at Landlord's election, and after fifteen (15)
days written notice to Tenant and Tenant's failure to cure, in addition to any
other right or remedy, to procure and maintain such insurance. However, Tenant's
right to receive notice and an opportunity to cure is conditioned upon Landlord
timely receiving actual notice of Tenant's default with respect to insurance,
and in the event Landlord fails to receive at least thirty (30) days prior
actual notice of any expiration, cancellation, modification or failure to obtain
or maintain any of such insurance, Landlord shall not be required to give Tenant
any notice or opportunity to cure prior to Landlord's obtaining such insurance.
In any such event, the premiums paid by Landlord shall be due and payable by
Tenant to Landlord on the first day of the month following the date on which the
premiums were paid, together with interest as provided in Section 7.1. Landlord
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shall give prompt notice of the payment of such premiums, stating the amounts
paid and the name(s) of the insured(s).
Section 5.8. Availability of Insurance. Notwithstanding anything to the
contrary contained herein, in the event that any of the insurance required above
is not commercially available at commercially reasonable rates to Tenant through
insurance brokers located in the Metropolitan Phoenix area, such that it is not
reasonably possible for Tenant to provide the exact type(s) or amounts of
coverage called for herein, then Landlord and Tenant shall negotiate and modify
this Lease as necessary to permit Tenant to obtain and maintain alternative
coverages that are commercially available at commercially reasonable rates so
long as such alternative coverages approximate as closely as reasonably possible
the types and amounts of insurance specified above.
ARTICLE 6
---------
SURRENDER
---------
Section 6.1. Surrender--Removable Property. Subject to the rights of
the City with respect to the Buildings under the City Lease, upon the expiration
of the Lease Term or on the sooner termination thereof, Tenant shall peaceably
and quietly leave, surrender and yield up to the Landlord all of the Premises
broom-clean and free of occupants and shall repair all material damage to the
Premises caused by or resulting from the removal of any removable property of
Tenant or of Subtenants. Any property of Tenant or any Subtenant which shall
remain in any Building after the expiration of the Lease Term or sooner
termination thereof shall be deemed to have been abandoned and may, subject to
Article 27 hereof and to the rights of the City under the City Lease, either be
retained by Landlord as its property or disposed of in such manner as Landlord
may see fit. If such property or any part thereof shall be sold by Landlord,
Landlord shall receive and retain the proceeds of such sale. Tenant shall be
liable to Landlord for any and all costs of removal and the repair of any and
all material damages caused thereby.
Section 6.2. Waste. Tenant shall not commit or suffer to be committed
any waste of the Premises.
Section 6.3. Title. Subject to the provisions of Section 10.5 hereof,
at the end of the Lease Term or any earlier termination thereof, title to the
Buildings and Landscaping shall, at the election of Landlord, automatically vest
in Landlord without the requirement of any deed, conveyance or bill of sale
thereon. However, if Landlord should require any such document in confirmation
thereof, Tenant shall execute, acknowledge and deliver the same.
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Section 6.4. Initial Environmental Site Assessment. Prior to the date
of this Lease, Landlord shall procure a phase I environmental site assessment of
the Premises from Western Technologies, Inc. (the "Engineer"), the report of
which shall be certified to Landlord, Tenant, First Interstate Bank of Arizona,
NA ("FIB"), and R&K Development, LLC ("R&K") and shall be attached hereto as
Exhibit "D" and incorporated herein by this reference (the "Initial Phase I").
Landlord shall indemnify, defend, protect and hold Tenant, R&K, FIB and their
respective successors and assigns harmless for, from and against any and all
liability, obligation, claims, actions, costs and expenses (including reasonable
attorneys' fees and costs) arising out of or in connection with the existence of
any condition on, under or about the Premises existing prior to the date of this
Lease which violates any Environmental Laws, except to the extent arising out of
any condition on, under or about the Premises existing prior to the date of this
Lease which is caused by any act, omission or negligence of Tenant, Subtenants,
their employees, agents, licensees, guests or invitees. Further, if and to the
extent Landlord fails to so indemnify Tenant, R&K, FIB and their respective
successors and assigns, Tenant, R&K, FIB and their respective successors and
assigns shall be subrogated to Landlord's rights with respect to the indemnity
provided by the Lessor under the Master Ground Lease in Section 2.09.3 of the
Master Ground Lease.
Section 6.5. Interim Site Assessments. At any time Tenant desires to
assign its interest under this Lease in accordance with Section 17.1 hereof
(other than the Initial Assignment contemplated by Section 17.17 below), Tenant
shall commission a phase I environmental site assessment meeting the
requirements of the Final Phase I (defined below), which phase I environmental
site assessment shall be dated no earlier than six (6) months prior to the date
of such proposed assignment (an "Interim Site Assessment"). If the Interim Site
Assessment reveals the existence or potential existence of any adverse
environmental condition, Landlord shall not be required to accept such Interim
Site Assessment, and Landlord shall promptly cause a separate phase II
environmental report to be prepared, at Tenant's expense. If such separate
report indicates any condition on, under or about the Premises arising
subsequent to the date of this Lease which violates any Environmental Laws,
Tenant shall indemnify, defend, protect and hold Landlord and the Lessor under
the Master Ground Lease harmless for, from and against any and all liability,
obligation, claims, actions, costs and expenses (including, but not limited to,
costs of remediation and reasonable attorneys' fees and costs), except to the
extent arising out of any condition on, under or about the Premises which is
caused by any act, omission or negligence of Landlord, Lessor under the Master
Ground Lease, their respective employees, agents, licensees, guests or invitees.
Section 6.6. Final Phase I. Within three (3) months immediately
preceding the expiration of the Term or within two (2) months after any earlier
termination of the Lease, Tenant shall cause a phase I environmental site
assessment of the Premises to be conducted by the Engineer or another qualified
engineer licensed in the State of Arizona acceptable to Landlord, and cause a
final report to be issued and certified to Landlord in connection therewith
(collectively, the "Final Phase I"). The Final Phase I shall be conducted
pursuant
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to a scope of work that is equal to or in excess of the scope of work pursuant
to which the Initial Phase I was conducted and shall include, without
limitation, a report on the Buildings and/or any other existing improvements.
Tenant shall indemnify, defend, protect and hold Landlord and the Lessor under
the Master Ground Lease harmless for, from and against any and all liability,
obligation, claims, actions, costs and expenses (including, but not limited to,
costs of remediation and reasonable attorneys' fees and costs) arising out of or
in connection with the existence of any condition on, under or about the
Premises arising subsequent to the date of this Lease which violates any
Environmental Laws, except to the extent caused by any act, omission or
negligence of Landlord, Lessor under the Master Ground Lease, their respective
employees, agents, licensees, guests or invitees. Tenant's indemnity shall
include but not be limited to, the full correction of the violation of law and
the restoration of the Premises, at Tenant's expense.
Section 6.7. Tenant's Failure to Obtain the Final Phase I. Should
Tenant fail to deliver to Landlord a Final Phase I showing the Premises to be
free of adverse environmental conditions, then Landlord may cause a separate
environmental report or reports to be prepared to like effect (including, if
necessary, any phase II or subsequent reports) and Tenant shall be liable to
Landlord for the actual cost of such separate report(s).
Section 6.8. Survival of Provisions. The provisions of this Article 6
shall survive the expiration or any termination of this Lease.
ARTICLE 7
---------
LANDLORD'S PERFORMANCE FOR TENANT
---------------------------------
Section 7.1. Cures--Rights, Costs, and Damages. If Tenant shall fail to
pay any Imposition or make any other payment required to be made under this
Lease or shall default in the performance of any other covenant, agreement,
term, provision, limitation or condition herein contained, Landlord, without
being under any obligation to do so and without thereby waiving such Event of
Default, may make such payment and/or remedy or correct such other default for
the account and at the expense of Tenant. Except as otherwise specifically set
forth herein, Landlord shall give Tenant thirty (30) days prior written notice
before taking any such action; provided, however, Landlord may take sooner
action as provided in Section 5.7 with respect to Tenant's failure to obtain or
maintain the required insurance hereunder, and may take immediate action without
notice to Tenant in the event of an emergency, or if the possibility of a lien
against the Premises is imminent. Bills for any reasonable expense incurred by
Landlord in connection therewith, and bills for all such reasonable expenses and
disbursements of every kind and nature whatsoever, including reasonable
attorneys' fees and reasonable out-of-pocket expenses, involved in collection or
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endeavoring to collect the rent or additional rent or any part thereof or
enforcing or endeavoring to enforce any other right against Tenant under or in
connection with this Lease or pursuant to law, including without limitation any
such cost, expense and disbursements involved in instituting and prosecuting
summary proceedings, as well as bills for any property, material, labor or
services provided, furnished or rendered or caused to be furnished or rendered
by Landlord to Tenant with respect to the Premises and other equipment and
construction work done for the account of the Tenant pursuant to Sections 8.4
and/or 8.5 hereof, together with interest at the rate per annum equal to four
percent (4%) over the prime rate then published in the Wall Street Journal or a
reasonably equivalent rate selected by Landlord (eg., if the "prime rate" is 4%,
then the rate hereunder shall be 4% higher; in other words, 8%) from the
respective dates of the Landlord's making of each such payment or incurring of
each such cost or expense until paid in full hereunder may be sent by Landlord
to Tenant immediately or at any time at Landlord's option and shall be due and
payable in full to Landlord immediately upon demand.
ARTICLE 8
---------
USE AND MAINTENANCE OF PREMISES
-------------------------------
Section 8.1. Absence of Warranties. Tenant has leased the Premises
after a full and complete examination of the physical condition thereof as well
as the title thereto and knowledge of its presently permitted uses. Tenant
accepts the same in the condition or state in which they now exist without any
representation or warranty, express or implied in fact or by law, by Landlord
and without recourse to Landlord as to the title or access thereto, the nature,
condition or usability thereof (except as otherwise provided in Section 6.4
above) or the use or uses to which the Premises or any part thereof may be put.
Except as otherwise provided in Section 6.4 above, Landlord shall not be
required to furnish any services or facilities or to make any repairs or
alterations in or to the Premises throughout the Lease Term. Tenant hereby
assumes the full and sole responsibility for the condition, construction,
operation, repair, demolition, replacement, maintenance and management of the
Premises.
Section 8.2. Permitted Uses. Subject to the Declaration, applicable
Insurance Requirements and Legal Requirements, and the other requirements of
this Lease, the Premises may be used for any lawful purpose permitted by each of
the following: I-1 Zoning as defined by City of Tempe in the year that this
Lease is executed; and the Planned Area Development for Papago Park Center, and
for no other purpose without the prior written consent of Landlord. Landlord
shall not undertake or seek any zoning changes or any change to the Planned Area
Development with respect to the Premises that would materially and adversely
affect the Premises or Tenant's rights or obligations with respect thereto
without Tenant's consent. The Premises shall be used at all times solely in
compliance with all Legal Requirements. Under no circumstances shall the
Premises be used for any Prohibited Use. Further, should Tenant elect to
purchase the Premises, the
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Tenant agrees to accept in the deed a restriction and covenant that runs with
the land that no Prohibited Use shall ever be permitted on the Premises.
Section 8.3. Maintenance and Repairs. Tenant shall take reasonable care
of the Premises consistent with the requirements of the Declaration and any
Legal Requirements. Tenant shall also keep the sidewalks and gutters in front of
the Premises free and clear from rubbish and shall not obstruct the same or
allow the same to be obstructed in any manner.
Section 8.4. Performance by Landlord. In the event Tenant fails to
maintain and repair the Premises in the condition required by Section 8.3
hereof, and subject to the terms of the City Lease with respect to the
Buildings, Landlord, without being under any obligation to do so and without
thereby waiving any default, may after thirty (30) days written notice to Tenant
and Tenant's failure to cure (or, in the event of an emergency or a threat to
safety, immediately and without notice to Tenant), perform or have performed any
and all such work as Landlord, in its reasonable discretion, deems necessary to
maintain or restore the Premises to the required condition. Any and all work
performed by or for Landlord pursuant to this Section 8.4 shall be deemed to
have been undertaken for and at the expense of Tenant. All reasonable costs
incurred by Landlord in undertaking such work shall be subject to the provisions
of Section 7.1 hereof.
Section 8.5. Alterations. Except as provided in Article 10 hereof,
Tenant shall not erect any structures, make any improvements or do any other
construction work on the Premises or alter, modify, or make additions,
improvements or repairs to or replacements of any structure now existing or
built at any time during the Lease Term or install any fixtures (other than
trade fixtures removable without injury to the Premises) which would (i) affect
the structural integrity of the Buildings, (ii) interfere with or affect utility
systems on the Premises (other than heating, ventilating, and air conditioning
systems installed by Tenant) or (iii) require filing of plans with, or other
approval by, any governmental authority having jurisdiction thereof, except in
accordance with the provisions of the Declaration.
ARTICLE 9
---------
COMPLIANCE
----------
Section 9.1. Tenant Obligations. Tenant shall assume and perform any
and all obligations of Landlord under any Declaration or other covenants,
easements and agreements now affecting the title to the Premises or hereafter
placed of record pursuant to the Declaration and/or Article 26 hereof, and shall
diligently comply with, at its own expense during the Lease Term, all Legal
Requirements and Insurance Requirements, the intention of the parties being that
Tenant during the Lease Term shall discharge and perform all obligations of
Landlord with regard to the Premises (other than obligations of Landlord
expressly agreed by Landlord herein to be performed by Landlord), as well as all
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obligations of Tenant, pertaining to the Premises, and shall save Landlord
harmless therefrom, so that at all times the rent and other sums payable
hereunder shall be net to the Landlord without reduction on account of any such
matter.
Section 9.2. Certificate of Occupancy. Tenant shall obtain and keep in
full force and effect at all times any Building is occupied a certificate of
occupancy with respect to the Premises as may at any time be required by any
governmental agency having jurisdiction thereof. If at any time any of the
Buildings are unoccupied, Tenant may allow the certificate of occupancy for any
unoccupied Building to lapse; provided Tenant shall continue to maintain, keep
safe and insure the Premises during such time, and further provided that Tenant
shall obtain a new or renewed certificate of occupancy at the time such Building
is re-occupied.
ARTICLE 10
----------
CONSTRUCTION OF BUILDINGS AND LANDSCAPING
-----------------------------------------
Section 10.1. General Requirements. Landlord acknowledges Tenant
intends to construct Buildings on the real property which is subject to this
Lease, and convey title to such Buildings to the City upon completion of the
Buildings. Landlord further acknowledges that Tenant intends to lease back the
Buildings from the City under the City Lease. The Buildings and Landscaping
shall be constructed by Tenant in accordance with the requirements of the City
Lease and this Article 10. The initial Buildings and Landscaping shall be
completed by June 30, 1995, subject to Force Majeure delays. As used in this
Lease, the term "Force Majeure" shall mean war, fire, earthquake, flood,
unavailability of materials and court orders (provided the unavailability of
materials or court orders do not result from the conduct of the party claiming
the delay). Tenant shall notify Landlord in writing of any Force Majeure event
within fifteen (15) business days after it occurs. In the event of a Force
Majeure delay, the period for performance shall be extended for a period equal
to the Force Majeure delay; provided, such performance shall not be extended for
any Force Majeure period occurring more than fifteen (15) business days prior to
the date notice of such Force Majeure is given by Tenant to Landlord.
Section 10.2. Approval of Final Plans. Before commencing any
construction, Tenant will submit to Landlord and obtain Landlord's approval of
all final construction plans and specifications for construction of the
Buildings and Landscaping. In like manner, Tenant shall submit to Landlord and
obtain Landlord's approval of all amendments to said final construction plans
and specifications at least seven (7) days prior to giving effect thereto.
Within ninety (90) days following completion of the Buildings and Landscaping,
Tenant shall deliver to Landlord true and complete copies, in duplicate, of the
final "as built" plans and specifications. The right of Landlord to approve the
final plans and specifications and any amendment thereto is for the sole benefit
of Landlord and may be waived by Landlord in its sole and unfettered discretion.
Landlord's rights hereunder are for the sole benefit of
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Landlord, and approval by Landlord shall not constitute an opinion or
representation by Landlord as to the sufficiency thereof or impose any present
or future liability or responsibility upon the Landlord.
Section 10.3. Government Approval. Prior to commencement of any
construction, Tenant will obtain the approval of the final construction plans
and specifications by the City and any and all federal, state, municipal, and
other governmental authorities, offices, and departments having jurisdiction in
the matter, and provide conformed copies of executed approvals to Landlord, and
will obtain all necessary building permits.
Section 10.4. Construction Standards. Tenant will construct the
Buildings and the Landscaping in a good, careful, proper and workmanlike manner,
in substantial accordance with the final construction plans and specifications,
and otherwise in strict accordance with the Architectural and Development
Guidelines and all Legal Requirements. Upon completion, Tenant shall provide to
Landlord a certificate of substantial completion in a form and executed by an
architect reasonably satisfactory to Landlord certifying that the Buildings and
the Landscaping have been substantially completed as above provided.
Section 10.5. Ownership of Buildings and Improvements. During the
existence of the City Lease, title to all Buildings and Landscaping constructed
or installed on the Premises by Tenant shall be in the City. In the event Tenant
exercises its option to purchase such Buildings and Landscaping from the City
pursuant to the option to purchase contained in the City Lease, title to such
Buildings and Landscaping shall thereafter be in the Tenant during the Lease
Term. In the event this Lease expires or is terminated for any reason prior to
the expiration or termination of the City Lease, Tenant's right to exercise the
option to purchase the Buildings and Landscaping under the City Lease shall
automatically be transferred to Landlord and Landlord shall be entitled to
exercise the same by payment of the option purchase price to the City as
provided in the City Lease, without further act or deed of Tenant and without
the payment of compensation to Tenant. Unless such Buildings and Landscaping are
then owned by the City, on the expiration or sooner lawful termination of this
Lease, all Buildings and Landscaping which constitute a part of the Premises,
exclusive of removable trade fixtures and personal property of Tenant and
Subtenants, shall, at the election of Landlord, without the payment of
compensation to Tenant or others, automatically and without further act or deed
become the property of Landlord free and clear of all claims and encumbrances.
Notwithstanding the foregoing, after the expiration or termination of this
Lease, Tenant shall upon request of Landlord execute such further documents or
instruments as may be necessary or appropriate to transfer to Landlord any and
all rights, interests and claims of Tenant to the Buildings and Landscaping.
Additionally, Tenant shall assign to Landlord, and Landlord shall be entitled to
the benefit of, any licenses, warranties or guarantees applicable to equipment,
systems, fixtures or personal property conveyed or otherwise transferred to or
for the benefit of Landlord under this Lease.
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Section 10.6. Requirement of Construction Contract. All improvements
which Tenant is required or permitted to construct upon the Premises pursuant to
this Lease shall be constructed pursuant to written construction contracts,
copies of which, and of all amendments thereto, shall be provided to Landlord
prior to the commencement of construction. All such contracts shall contain a
provision to the effect that no lien for labor, materials or supplies may be
filed against the interests of the Landlord or the Lessor under the Master
Ground Lease, nor shall Landlord or the Lessor under the Master Ground Lease
have responsibility or liability therefor, and such contracts shall require the
parties thereto to inform subcontractors and material suppliers of such
non-responsibility and non-liability. The provisions of the immediately
preceding sentence shall not, however, be applicable with respect to the
construction of the Buildings and Landscaping so long as such Buildings and
Landscaping are constructed and/or installed, as the case may be, by Sun State
Builders. Unless waived by Landlord as provided below, prior to the commencement
of construction, Tenant shall, or shall cause the contractor to provide to
Tenant a performance bond, with endorsements naming Landlord and Salt River
Project Agricultural Improvement and Power District as additional obligees under
such bond, in the full amount of the cost of such work in form and substance and
issued by a bonding company satisfactory to Landlord sufficient to assure the
completion of such work. Tenant also shall cause a labor and material payment
bond conforming to the requirements of A.R.S. Section 33-1003 and a copy of the
contract to which it relates to be recorded in the office of the County Recorder
of Maricopa County, Arizona, prior to the performance of any labor or furnishing
of any materials, machinery, fixtures or tools contemplated by such contract and
shall take any and all other actions as may be necessary under A.R.S. Section
33-1003 in order to prevent mechanics' or materialmen's liens from attaching to
the Premises or any portion thereof. Tenant shall provide Landlord with true and
accurate copies of such bonds and endorsements. Notwithstanding the bond
requirements set forth above, in the event that the Master Ground Lease is
amended to permit alternatives to such bonds prior to commencement of
construction, Landlord may waive the bond requirements set forth above and
alternatively may require alternative forms of collateralization and/or
contractual security reasonably acceptable to Landlord. In connection with the
construction of the initial Buildings and Landscaping, Landlord shall accept, as
an alternative to such bonds, a security deposit in the amount of Fifty Thousand
and NO/100 Dollars ($50,0000.00) subject to and in accordance with the further
terms and provisions of this section. On or before the commencement of
construction of the initial Buildings and Landscaping, Tenant shall deliver to
Landlord a sum of Fifty Thousand and NO/100 Dollars ($50,000.00) as assurance of
Tenant's full and faithful performance of its construction and other obligations
under this Lease during the period from the commencement of such construction
through and including the date (the "Release Date") which is the later of (i)
one hundred twenty (120) days after Tenant opens for business within the
Premises, (ii) ninety (90) days after Tenant records (or causes to be recorded)
a notice of completion with respect to the construction of the initial Buildings
and Landscaping, or (iii) ninety (90) days after completion of construction of
the initial Buildings and Landscaping. If prior to the Release Date, Tenant
commits a Event of Default, Landlord may use, apply or retain all or part of the
security deposit for the payment of any
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amount which Landlord may spend or become obligated to spend because of Tenant's
committing an Event of Default or to compensate Landlord for any other loss or
damage which Landlord may suffer as a result thereof. On the Release Date, as
long as there is not then in existence an Event of Default, Landlord shall
release the security deposit (less any amounts previously used, applied or
retained as permitted herein) to Tenant. Tenant shall not be entitled to any
interest earned on the security deposit.
Section 10.7. Application of this Article. Except with respect to the
provisions of this Article which are expressly limited to the construction of
the initial Buildings and Landscaping, the provisions of this Article 10 are
applicable to the construction of not only the initial Buildings and
Landscaping, but any future Buildings and/or Landscaping.
ARTICLE 11
----------
IMPAIRMENT OF LANDLORD'S TITLE
------------------------------
Section 11.1. No Liens. Tenant shall not create or suffer to be created
or to remain, and shall within thirty (30) days after notice of the filing
thereof pay in full and discharge or provide bonding sufficient to obtain the
release of any mechanic's, laborer's or materialman's lien which might be or
become a lien, encumbrance or charge upon the Premises or any part thereof or
the income therefrom, and Tenant will not suffer any other matter or thing
arising out of Tenant's use and occupancy of the Premises whereby the estate,
rights and interests of Landlord in the Premises or any part thereof might be
impaired.
Section 11.2. Discharge. If any mechanic's, laborer's or materialman's
lien shall at any time be filed against the Premises or any part thereof,
Tenant, within thirty (30) days after notice of the filing thereof, shall cause
such lien to be discharged of record by payment, deposit, bond, order of court
of competent jurisdiction or otherwise. Tenant shall immediately notify Landlord
in writing of any such lien which might attach or be claimed at any time and of
its action to either satisfy or obtain the release of the lien. If Tenant shall
fail to cause such lien to be released or discharged within the period
aforesaid, then, in addition to any other right or remedy, Landlord may, but
shall not be obligated to, discharge the same either by paying the amount
claimed to be due or by procuring the release of such lien by bonding or other
means, and any amount so paid by Landlord and reasonable costs and expenses
incurred by Landlord in connection therewith shall constitute additional rent
payable by Tenant to Landlord on demand.
Section 11.3. No Implied Consent. Nothing contained in this Lease shall
be deemed or construed in any way as constituting Landlord's expressed or
implied authorization, consent or request to any contractor, subcontractor,
laborer or materialman, architect or consultant for the construction or
demolition of any improvement, the performance of any
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labor or services or the furnishing of any materials for any improvements,
alterations to or repair of the Premises or any part thereof.
ARTICLE 12
----------
INSPECTION
----------
Section 12.1. Inspection and Entry. Landlord shall have the right at
any time and from time to time during Tenant's or any Subtenant's normal
business hours to enter upon the Premises, or any part thereof, at any time
during the Lease Term for the purposes of inspecting any work under
construction, ascertaining the condition of the Premises and determining whether
Tenant is observing and performing all of its obligations under this Lease, or
of showing the Premises to any prospective Mortgagees (and during the last two
(2) years of the Lease Term, to any prospective purchaser or lessee), all with
or without cause and without hindrance or molestation from Tenant, provided that
Landlord shall give Tenant at least twenty-four (24) hours notice prior to any
inspection of any building interior and further provided Tenant may require
Landlord to be escorted throughout the Premises, but Landlord shall nonetheless
have full access. The notice and escort requirements provided for in this
paragraph shall not be required if and to the extent that Landlord has
reasonable cause to believe that an emergency exists requiring immediate
attention. Any inspection or entry by Landlord onto the Premises shall be
conducted, to the extent reasonably practicable, in a manner so as to minimize
disruption and/or interference with construction activities or the conduct of
business on the Premises
ARTICLE 13
----------
INDEMNIFICATION
---------------
Section 13.1. Indemnification of Landlord.
A. Tenant shall indemnify and save Landlord and all of its
directors, officers, employees, shareholders, agents or other persons liable by,
through or under Landlord harmless from and against any and all liabilities,
suits, obligations, fines, damages, penalties, claims, costs, charges and
expenses, including property damage, personal injury and wrongful death and
further including, without limitation, architects' and attorneys' fees and
disbursements, which may be imposed upon or incurred by or asserted against
Landlord or any such indemnified Person by reason of any of the following
occurring during the Lease Term or at any time when Tenant or any Subtenant is
in possession of the Premises or any portion thereof, unless caused by any
breach by Landlord of its obligations under this Lease or by the negligent
actions or willful misconduct of Landlord, its agents, servants, contractors or
employees:
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(1) construction of the Buildings or Landscaping or
any other work or thing done in, on or about the Premises or any part thereof,
by Tenant or its agents or any contractor employed by it or any work performed
by or for Landlord pursuant to Article 7 hereof and any other work or
construction required under this Lease, including activities related to the bid
process therefor;
(2) any use, non-use, possession, occupation,
alteration, repair, condition, operation, maintenance or management of the
Premises or any improvements thereon at any time or any nuisance made or
suffered thereon or any failure by Tenant to keep the Premises or improvements
or any part thereof in a safe condition;
(3) any acts or omissions of the Tenant or any
Subtenant or any of its or their respective agents, contractors, servants,
employees or licensees;
(4) any fire, accident, injury (including death) or
damage to any person or property occurring in, on or about the Premises or
improvements or any part thereof;
(5) any lien or claim which may be alleged to have
arisen against or on the Premises or improvements or any part thereof or any of
the assets of, or funds appropriated to, Landlord or any liability which may be
asserted against Landlord with respect thereto to the extent arising, in each
such case, out of the acts or omissions of Tenant, its contractors, agents,
servants, guests, employees, licensees, invitees or Subtenants;
(6) any failure on the part of Tenant to keep,
observe, comply with and perform any of the terms, covenants, agreements,
provisions, conditions or limitations contained in any Subleases or other
contracts and agreements affecting the Premises or improvements or any part
thereof on Tenant's part to be kept, observed or performed; and
(7) any Imposition or tax, including any tax
attributable to the execution, delivery or recording of this Lease or payment of
Rent or other sums hereunder with respect to events occurring during the Term of
this Lease, except for any tax imposed on the net income of Landlord or excluded
from the definition of Impositions under Section 4.1.C above.
The provisions of this indemnity shall survive the expiration or
earlier termination of this Lease for any reason. However, the provisions of
this indemnity shall apply to Tenant only with respect to liabilities, suits,
obligations, fines, damages, penalties, claims, costs, charges and expenses,
arising out of or relating to events occurring prior to the occurrence of a
Permitted Assignment as defined in Section 17.1 and the receipt by Landlord of
the Permitted Assignee's covenant of assumption as provided in Section 17.5;
thereafter, the Permitted Assignee shall have the indemnity obligations for
events occurring from and after its assumption of Tenant's obligations
hereunder.
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B. Tenant will hold all goods, materials, furniture, fixtures,
equipment, machinery and other property whatsoever on the Premises and
improvements at the sole risk of Tenant and save the Landlord harmless from any
loss or damage thereto by any cause whatsoever, except to the extent caused by
the grossly negligent actions or willful misconduct of Landlord, its agents,
servants, contractors or employees.
C. The obligations of Tenant under this Section shall not in
any way be affected by the absence in any case of covering insurance or by the
failure or refusal of any insurance carrier to perform any obligation on its
part to be performed under insurance policies affecting the Premises.
D. If any claim, action or proceeding is made or brought
against Landlord or its directors, officers, employees, shareholders, agents or
other Persons claiming by, through or under Landlord by reason of any event for
which Tenant is liable under this Article, then, upon demand by Landlord,
Tenant, at its sole cost and expense, shall resist or defend such claim, action
or proceeding in Landlord's name, if necessary, by such attorneys as Landlord
shall reasonably approve, which may be the attorneys for Tenant's insurance
carrier, if such claim, action or proceeding is covered by insurance. Landlord
agrees that Tenant shall have the right to contest the validity of any and all
claims and defend, settle and compromise any and all such claims of any kind or
character or by whomsoever claimed, in the name of Landlord, as Tenant may deem
necessary, provided that the expenses thereof shall be paid by Tenant, and
further provided that Landlord shall be fully indemnified.
Section 13.2. Indemnification of Tenant.
A. Landlord shall indemnify and save Tenant and all of its
directors, officers, employees, shareholders, agents or other persons liable by,
through or under Tenant harmless from and against any and all liabilities,
suits, obligations, fines, damages, penalties, claims, costs, charges and
expenses, including property damage, personal injury and wrongful death and
further including, without limitation, architects' and attorneys' fees and
disbursements, which may be imposed upon or incurred by or asserted against
Tenant or any such indemnified Person by reason of the negligence, recklessness
or willful misconduct of Landlord, its agents, servants, contractors, employees
or licensees or caused by any breach by Landlord of its obligations under this
Lease.
B. If any claim, action or proceeding is made or brought
against Tenant or its directors, officers, employees, shareholders, agents or
other Persons claiming by, through or under Tenant by reason of any event for
which Landlord is liable under this Article, then, upon demand by Tenant,
Landlord, at its sole cost and expense, shall resist or defend such claim,
action or proceeding in Tenant's name, if necessary, by such attorneys as Tenant
shall reasonably approve, which may be the attorneys for Landlord's insurance
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carrier, if such claim, action or proceeding is covered by insurance. Tenant
agrees that Landlord shall have the right to contest the validity of any and all
claims and defend, settle and compromise any and all such claims of any kind or
character or by whomsoever claimed, in the name of Tenant, as Landlord may deem
necessary, provided that the expenses thereof shall be paid by Landlord, and
further provided that Tenant shall be fully indemnified.
ARTICLE 14
----------
DAMAGE OR DESTRUCTION
---------------------
Section 14.1. Tenant's Election to Restore, Rebuild or Raze. If at any
time during the Lease Term the Premises or any improvements thereon shall be
damaged or destroyed in whole or in part by fire or other occurrence of any kind
or nature, ordinary or extraordinary, foreseen or unforeseen, Tenant shall
restore, rebuild, raze or otherwise secure the Premises in a neat, safe and
sightly condition, in compliance with any Legal Requirements and the
requirements of any Declaration. All proceeds from the insurance procured by
Tenant pursuant to Article 5 that are released or paid on account of such damage
or destruction shall belong to Tenant. Any restoration or rebuilding undertaken
by Tenant shall comply with all requirements of Articles 10 and 11 pertaining to
the construction of the Buildings and Landscaping as if such provisions were set
forth in full herein.
Section 14.2. Lease Obligations Continue. In no event shall Tenant be
entitled to any abatement, allowance, reduction or suspension of rent because
part or all of the Premises shall be untenable due to the partial or total
destruction thereof. No such damage or destruction shall affect in any way the
obligation of Tenant to pay the Minimum Rent, Additional Rent and other charges
herein reserved or required to be paid or release Tenant of or from any
obligations imposed upon Tenant hereunder.
Section 14.3. Election to Terminate. Notwithstanding Sections 14.1 and
14.2 above, if the Buildings or any parts thereof are damaged or destroyed by
fire or other casualty at any time during the Lease Term:
A. Tenant's Elections. Tenant may elect to rebuild, restore,
raze or otherwise secure the Premises as set forth in Section 14.1 above and
keep this Lease in effect; or Tenant may elect to terminate this Lease after
such damage or destruction in accordance with the following: If Tenant elects to
terminate, it will give Landlord written notice of its intention to so terminate
within ninety (90) days after the occurrence of such damage or destruction.
Landlord shall, within thirty (30) additional days after receiving Tenant's
notice, inform Tenant in writing that Landlord either will (a) accept the
surrender of the Premises in its damaged condition, or (b) require Tenant to
completely raze and clear
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the property within the next sixty (60) days. In the latter event, Tenant shall
completely raze and clear the property in a commercially reasonable manner
within said sixty-day (60) period. Upon either (i) Landlord's written election
to accept the surrender of the Premises in its damaged condition, or (ii) the
completion of the razing and clearing of the property, this Lease shall
terminate and all of Tenant's obligations hereunder shall cease with the
exception of any provisions hereto which expressly survive the termination of
this Lease.
B. Adjustment of Additional Rent. Upon Landlord's acceptance
of the surrender of the Premises in its damaged condition or the completion of
the razing and clearing of the property as provided in subparagraph A, this
Lease shall cease and terminate on the date of such completion with the same
force and effect as if such date were the date originally fixed for the
termination hereof. With respect to any items of Additional Rent which are
payable to Landlord in the event of such termination or which have accrued but
are not yet payable at the date of termination, but which are not then capable
of ascertainment, Tenant shall pay to Landlord an amount reasonably computed by
Landlord, who will hold such payment as trust funds until such Additional Rent
becomes determined. Upon determination of the Additional Rent due, if there is a
surplus in such trust account, Landlord will promptly refund the surplus to
Tenant. If there is a deficit in such account, Tenant will promptly pay the
amount of such deficit to Landlord. If as a result of any action or proceeding
to obtain a reduction of Impositions, Tenant shall be entitled to a refund, the
amount of such refund (less the cost and expense of collection including
reasonable attorneys' fees) when collected by Landlord shall be paid by Landlord
to Tenant, unless there remains at the time a deficit in the trust account or
unless Tenant shall be otherwise in default under the terms hereof. The
covenants and agreements with respect to the adjustment and payment of these
items of Additional Rent shall survive the termination hereof.
ARTICLE 15
----------
CONDEMNATION
------------
Section 15.1. Total or Substantial Takings. If at any time during the
term of this Lease, title to the whole or substantially all of the Premises
shall be taken in condemnation proceedings or by any right of eminent domain or
by agreement in lieu of such proceedings, or a substantial portion of the
Premises are so taken and the remainder of the Premises cannot feasibly be used
or converted for use by Tenant for the uses set forth in Section 8.2 hereof,
this Lease shall terminate on the date of such taking and the Minimum Rent and
Additional Rent provided for herein shall be apportioned and paid to the date of
such taking. In the event of the termination of this Lease as a result of any
such taking, each of Landlord and Tenant shall be entitled to make and pursue or
to settle, compromise and adjust and to receive any award or proceeds payable on
account of its own separate claim
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for the value of the rights and interests so taken as if this Lease would have
remained in effect for the full Lease Term but for such taking.
Section 15.2. Partial Taking. In the event that title to or any
interest in the Premises shall be taken in condemnation proceedings or by right
of eminent domain or by agreement in lieu thereof, and such taking is not
subject to Section 15.1 hereof, the following provisions shall apply:
A. Awards. Each of Landlord and Tenant shall be entitled to
make and pursue or to settle, compromise and adjust its own separate claim for
the value of the rights and interests so taken as if this Lease would have
remained in effect as to the portion of the property so taken for the full Lease
Term but for such taking. Landlord shall be entitled to retain any amount
awarded for the taking of any right, title or interest of Landlord free of any
right or claim of Tenant or any Mortgage. Tenant shall be entitled to retain any
amount awarded for the taking of any right, title or interest of Tenant
hereunder, subject to the provisions of this Section and subject to the rights
of any Mortgagees.
B. Tenant's Elections. In the event of a partial taking,
Tenant shall have the same elections as provided in Section 14.1 in the case of
damage or destruction, In the event of a partial taking occurring during the
last five (5) years of the Lease Term, Tenant shall have the elections set forth
in Section 14.3.
C. Lease Obligations Continue. Unless this Lease is terminated
pursuant to the provisions of this Article 15, Tenant shall be entitled to a
reduction in the Minimum Rent based upon the percentage that the square footage
of land lost because of a partial taking bears to the total square footage of
land in the Premises prior to such partial taking; however, no such partial
taking shall otherwise affect in any way the obligation of Tenant to pay the
Additional Rent applicable to the remaining portion of the Premises or the other
charges herein reserved or required to be paid or release Tenant of or from any
other obligations imposed upon Tenant hereunder.
Section 15.3. Rights of Participation. Each of Landlord and Tenant
shall have the right, at its own expense, to appear in any condemnation
proceeding and participate in any and all hearings, trials and appeals therein.
Section 15.4. Notice of Proceeding. In the event that either Landlord
or Tenant shall receive notice of any proposed or pending condemnation
proceedings affecting the Premises or any part thereof, the party receiving such
notice shall promptly notify the other party of such notice and contents
thereof.
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ARTICLE 16
----------
SUBTENANT NON-DISTURBANCE
-------------------------
Section 16.1. Agreement for Non-Disturbance of Subtenants. Landlord
hereby covenants and agrees, for the benefit of any Subtenant, that, in the
event that this Lease shall for any reason terminate prior to the end of the
Lease Term, Landlord shall attorn to and shall recognize the rights of each
Subtenant under its Sublease as if the Landlord were the sublessor thereunder,
subject to the following terms and conditions: (a) such Sublease is a Permitted
Sublease; (b) such Subtenant has previously provided Landlord with its current
notice address; (c) at the time of the termination of this Lease, no default
exists (after the expiration of any applicable notice and cure periods) under
such Sublease which would then permit the landlord thereunder to terminate the
same or to exercise any default remedy provided for therein; and (d) Landlord
shall deliver to the Subtenant (at the notice address previously provided by
Subtenant to Landlord) within thirty (30) days following termination of this
Lease an instrument which the Subtenant shall execute within fifteen (15) days
after such delivery, confirming the agreement of such Subtenant to attorn to
Landlord and to pay all rent and other sums payable under such Sublease directly
to Landlord and to recognize Landlord as such Subtenant's landlord under its
Sublease, which instrument shall also provide that neither Landlord nor any of
its officers, employees, agents or other Persons responsible by, through or
under Landlord shall be:
A. Liable for any act or omission of any prior landlord
(including, without limitation, the then defaulting landlord), or
B. Subject to any offsets or defenses which the Subtenant may
have against any prior landlord (including, without limitation, the then
defaulting landlord), or
C. Bound by any payment of rent which the Subtenant might have
paid for more than the current month to any prior landlord (including, without
limitation, the then defaulting landlord), or
D. Bound by any covenant to undertake or complete any
construction of the Premises or any portion thereof demised by said Sublease, or
E. Bound by any obligation to make any payment to the
Subtenant, or
F. Bound by any modification of the Sublease made without the
written consent of Landlord.
Notwithstanding that Landlord shall not be liable for any act or
omission of any prior landlord, nor subject to any offsets or any defenses which
Subtenant may have against any prior landlord, and notwithstanding that Landlord
shall not have any obligation to construct
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or complete any portion of the Premises, Subtenant shall have the right to set
off against the rent otherwise payable to Landlord under the Permitted Sublease
(subject to the limitation on setoff set forth below) the amounts necessary to
reimburse Subtenant for any amounts actually and reasonably expended and any
costs and expenses actually and reasonably incurred by Subtenant (but not for
lost profits or consequential damages incurred by Subtenant) as a result of any
breach or default under the Permitted Sublease by any landlord, including any
continuing default and including any failure of the Landlord or any prior
landlord to construct, complete, service, maintain or repair any improvements on
the Premises if and as provided in such Permitted Sublease; provided, however,
that the amount of rent to be paid to Landlord each month by the Subtenant
without setoff shall equal or exceed the monthly rent payable for that month
under this Lease.
ARTICLE 17
----------
ASSIGNMENT, SUBLETTING, MORTGAGE
--------------------------------
Section 17.1. Prior Consent; Permitted Assignments. Tenant may assign,
mortgage, pledge, encumber, sublease or transfer this Lease or any part thereof
or interest therein, with or without the prior written consent of Landlord in
each instance, provided no such action shall release Tenant of its continuing
obligations hereunder unless it meets the requirements of a "Permitted
Assignment" as hereinafter defined, and further provided that a Permitted
Assignment which is also the Initial Assignment shall not in any event act to
release the Tenant named in the first paragraph of this Lease of any of the
Tenant's obligations or liabilities under this Lease.
A. A "Permitted Assignment" shall be (i) the Initial
Assignment described in Section 17.17 below, and (ii) any other assignment of
Tenant's interest in this Lease which meets the following requirements:
(1) The assignment shall be an assignment of the
entire interest of Tenant for the remainder of the Term, and a partial
assignment shall not be permitted.
(2) Prior to such assignment the proposed assignee
shall submit to Landlord a financial statement together with reasonable
supporting documentation (but not including new appraisals) establishing that
such proposed assignee, either by itself or in combination with a guarantor
willing to guaranty such proposed assignee's obligations under this Lease, will
have at the time of the assignment a net worth (defined as the then current
market value of its assets less its liabilities) at least equal to the greater
of (i) $4,000,000 in 1993 dollars adjusted by the CPI index referred to in
Article 5 for inflation to the time of the proposed assignment, or (ii) the then
current fair market value of Premises (including the real property, Buildings
and Landscaping, if any) as if held in fee simple and in single ownership. The
fair market value of the Premises shall be established either through mutual
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agreement between Landlord and Tenant, or, if they cannot agree upon a value, by
appraisal conducted by an MAI appraiser experienced in valuing similar
properties, with the expense of such appraisal being borne by Tenant.
(3) The proposed assignee's occupation and use of the
Premises will not violate Section 8.2 hereof.
(4) The proposed assignee's occupancy will not
require a variation in the terms of this Lease.
(5) Landlord is provided with an Interim Site
Assessment indicating no adverse environmental condition in, on, under or about
the Premises caused by Tenant or anyone claiming by, through or under Tenant.
B. Notwithstanding the foregoing requirements, so long as the
Premises or any portion thereof are owned by or under lease to Papago Park
Center, Inc., Salt River Project Agricultural Improvement and Power District, or
any affiliate or subsidiary thereof, Tenant may request Landlord's consent to an
assignment which does not meet all of the foregoing requirements, and any such
assignment with the consent of Landlord shall also be considered a "Permitted
Assignment." Further, in the event and at such time that none of Papago Park
Center, Inc., Salt River Project Agricultural Improvement and Power District, or
any affiliate or subsidiary thereof have any ownership interest (leasehold or
otherwise) in the Premises, Tenant shall have the right to assign its entire
interest under this Lease without meeting the requirements set forth above and
without obtaining the then Landlord's consent, and such assignment shall also be
considered a "Permitted Assignment."
C. An assignment which meets requirements of subpart A or B
above is herein called a "Permitted Assignment" and the assignee under a
Permitted Assignment is herein called a "Permitted Assignee". Upon the
occurrence of a Permitted Assignment and the Permitted Assignee's delivery to
Landlord of the assumption instrument referred to in Section 17.5 below, the
prior Tenant (except as otherwise provided in Section 17.17 below) shall be
released from liabilities and obligations under this Lease accruing thereafter,
and the Permitted Assignee shall be and become and remain liable for the payment
of all rents and other sums payable hereunder and for the due performance of all
the covenants, agreements, terms and provisions hereof on Tenant's part to be
performed throughout the remainder of the Lease Term, from and after the
Permitted Assignment. The provisions hereof shall be operative for and apply to
each subsequent Permitted Assignment.
Section 17.2. Permitted Subleases. Tenant may sublease portions of the
Premises with or without the prior consent of Landlord. However, the Subtenant
under any Sublease made without Landlord's consent shall not have the
protections of Article 16 and Landlord shall not be required to recognize or
attorn to such Subtenant, unless such Sublease meets the following requirements
for a "Permitted Sublease":
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A. Such Sublease shall be subject and subordinate to this
Lease and the rights of Landlord hereunder and the rights of any Permitted
Mortgagee, as provided herein.
B. Such Sublease shall provide that, in the event the Lease is
terminated, the Subtenant will attorn to Landlord as provided in Article 16
hereof.
C. Such Sublease shall contain a provision to the effect that,
in the event this Lease is terminated and all of the Buildings within the
Premises are not operating at a total occupancy level of at least forty percent
(40%) or Landlord is not then receiving rents under all of the Subleases which
result in Landlord realizing the net amount of the Minimum Rent then due under
this Lease after considering all expenses of holding, operating and managing the
Buildings, then notwithstanding any agreement on the part of Landlord to
recognize such Sublease, Landlord shall have the right to terminate the Sublease
at any time after the first nine (9) years under the Sublease upon the giving of
one (1) year's prior notice and Landlord's making termination payment equal to
the annual Sublease rent then in effect upon such termination.
D. Such Sublease shall require the payment of minimum rent
thereunder which will represent throughout the term of such Sublease a
reasonable share of the Minimum Rent payable hereunder based on the Building
square footage leased by the subtenant relative to the square footage all of
Buildings within the Premises.
E. Such Sublease is otherwise entered into upon terms and
conditions which are reasonably satisfactory to Landlord. Tenant may satisfy
this condition E by obtaining Landlord's prior approval of a standard form of
Sublease and using such form without substantial deviation.
F. Notwithstanding anything to the contrary contained in this
Lease, provided it conforms with the form previously reviewed and approved by
Landlord, when executed the City Lease shall be approved as a Permitted
Sublease.
Section 17.3. Rent From Assignee. If this Lease is assigned, whether or
not in violation of the provisions hereof, Landlord may and hereby is empowered
to collect rent directly from the assignee. In such event, Landlord may apply
the net amount received by it to the rent and other sums payable hereunder. No
such collection shall be deemed a waiver of the covenant herein regarding
assignment or an acceptance of the assignee as a Tenant under this Lease or a
release of Tenant from the further performance of the covenants herein contained
on the part of Tenant.
Section 17.4. Continuing Liability. Except as provided herein in the
case of a Permitted Assignment, the making of any assignment in whole or in part
without Landlord's prior reasonable consent, shall not operate to relieve Tenant
from its obligations under this Lease and, notwithstanding any such assignment,
Tenant shall remain liable for the payment
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of all rent and other sums payable hereunder and for the due performance of all
the covenants, agreements, terms and provisions of this Lease throughout the
Lease Term. However, in the event of a Permitted Assignment of all of Tenant's
rights and obligations under this Lease to a Permitted Assignee, upon such
Permitted Assignee's delivery to Landlord of the assumption instrument referred
to be in Section 17.5 below, Tenant thereafter shall only be liable for
obligations arising prior to such assignment, and the Permitted Assignee shall
be liable for all obligations arising from and after such assignment, provided
such Permitted Assignee has executed an instrument expressly assuming all such
obligations, as provided in Section 17.5 below.
Section 17.5. Assignee Bound. Subject to the provisions of Section
17.1.C above, every assignee, whether as assignee or as successor in interest of
any assignee of Tenant herein named, or as successor in interest of any
assignee, including any purchaser of the Lease under a foreclosure of any
Permitted Mortgage, shall be and become and remain liable for the payment of all
rent and other sums payable hereunder and for the due performance of all the
covenants, agreements, terms and provisions hereof on Tenant's part to be
performed throughout the Lease Term, and every provision of this Lease
applicable to Tenant shall apply to and bind every such assignee and purchaser
with the same force and effect as though such assignee or purchaser were the
Tenant named in this Lease. No transfer to such assignee or to such purchaser
shall be binding upon Landlord or act to release any assignor or prior Tenant
unless such assignee or purchaser shall deliver to the Landlord a recordable
instrument which contains a covenant of assumption by said assignee or purchaser
to such effect, but the failure or refusal of such assignee or purchaser to
deliver such instrument shall not release or discharge such assignee or
purchaser from its obligations and liability as above set forth.
Section 17.6. Consent Limited. Any consent by Landlord to any
assignment or Sublease shall apply only to the specific transaction approved.
Such consent shall not be construed as a waiver of the duty of Tenant or its
successors or assigns to obtain from the Landlord a consent to any other or
subsequent assignment or Sublease, if applicable, or as a modification or
limitation of the right of Landlord with respect to the foregoing covenant.
Section 17.7. Permitted Mortgages--Definition. Tenant from time to time
during the Term of this Lease may make one or more Permitted Mortgages. A
"Permitted Mortgage" shall mean a Mortgage in which the following conditions are
satisfied:
A. Such Permitted Mortgage shall encumber no interests in the
Premises other than Tenant's interest therein (including the Option) and any
Subleases;
B. Tenant or the holder of such Permitted Mortgage shall
promptly deliver to Landlord in the manner herein provided for the giving of
notices a true copy of the Permitted Mortgage and of any assignments thereof and
shall provide Landlord with the current notice address of the holder of such
Permitted Mortgage; and
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C. The holder of such Permitted Mortgage shall expressly
accept and agree for itself and its successors and assigns, including any
purchaser at any foreclosure sale, to be bound by the provisions of Section 17.5
hereof, but only for the period of time that the holder of such Permitted
Mortgage is the Subtenant under the Sublease.
Section 17.8. Permitted Mortgages--Further Provisions. The following
provisions shall apply to any Permitted Mortgage:
A. For purposes of the notice requirements of this Article,
the term "Permitted Mortgagee" shall mean only the holder of an outstanding
Permitted Mortgage recorded in the office of the Maricopa County Recorder who
has provided Landlord with a current address for the delivery of notices (herein
sometimes called a "Permitted Mortgagee of Record"). Further, Landlord may rely
upon the certificate of any title insurance company authorized to do business in
the State of Arizona in order to determine which Permitted Mortgage is first and
prior to all others recorded in the office of said Maricopa County Recorder
(herein sometimes called the "First Permitted Mortgage of Record").
B. For the purpose of this Article, the making of a Permitted
Mortgage shall not be deemed to constitute an assignment or transfer of this
Lease, nor shall any holder of a Permitted Mortgage, as such, be deemed an
assignee or transferee of this Lease or of the leasehold estate hereby created
so as to require such holder of a Permitted Mortgage to assume the performance
of any of the terms, covenants or conditions on the part of Tenant to be
performed hereunder; but the purchaser at any sale of this Lease in any
proceedings for the foreclosure of any Permitted Mortgage, or the assignee or
transferee of this Lease under any instrument of assignment or transfer in lieu
of the foreclosure of any Permitted Mortgage (including any such holder of a
Permitted Mortgage, if it becomes such a purchaser or assignee), shall be deemed
to be an assignee or transferee within the meaning of this Section and shall be
deemed to have assumed the performance of all the terms, covenants, and
conditions on the part of Tenant to be performed hereunder, but only from and
after the date of such purchase and assignment. In no event shall a Permitted
Mortgagee (or any purchaser at a foreclosure sale) be liable or responsible for
or be deemed to have assumed liability or be obligated to indemnify Landlord for
any prior actions, omissions, defaults, breaches or other events caused by or
related to any prior tenant (including Tenant) and such Permitted Mortgagee (or
any purchaser at a foreclosure sale) shall only be responsible for acts,
omissions, defaults, breaches or events occurring from and after it becomes the
Tenant, but the prior Tenant(s) shall not be released from liability for prior
occurrences for which any such Tenant(s) may be liable under this Lease.
Notwithstanding the foregoing, upon the Permitted Mortgagee (or any purchaser at
a foreclosure sale) becoming the Tenant hereunder, such Permitted Mortgagee (or
purchaser at a foreclosure sale) shall be responsible to cure any defaults which
may then exist which are reasonably susceptible to cure, in accordance with the
provisions of Section 17.11 below.
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C. Notwithstanding the provisions of Article 15 to the
contrary, any award or other proceeds of or from a taking in condemnation
proceedings or by any right of eminent domain or by agreement in lieu of such
proceedings, relating to the Buildings and Landscaping or any portion thereof,
shall first be utilized to pay off and discharge all Permitted Mortgages (with
such award or proceeds to first be utilized to pay off and discharge the First
Permitted Mortgage of Record and thereafter, in order of lien priority of the
Permitted Mortgages) before either Landlord or Tenant shall have rights or
claims thereto under Article 15 below or otherwise.
Section 17.9. Notice to Permitted Mortgagees. So long as any Permitted
Mortgage shall remain a lien on Tenant's leasehold estate hereunder, Landlord
agrees, simultaneously with the giving of any notice to Tenant (i) of default or
(ii) of termination hereof or (iii) of any matter on which a default may be
predicated or claimed or (iv) of any condition which if continued may lead to a
default or termination hereof or the exercise of any other remedies hereunder,
to give duplicate copies thereof or of any process in any action or proceeding
brought to terminate or to otherwise in any way affect this Lease, to each
Permitted Mortgagee of Record, and no such notice to Tenant or process shall be
effective against the holder of a Permitted Mortgage unless a copy of such
notice is given to such Permitted Mortgagee in the manner herein provided.
Concurrently with Tenant, the holder of a Permitted Mortgage will have the same
period, if any, after receipt of the aforesaid notice to remedy the default or
cause the same to be remedied plus twenty (20) additional days thereafter, and
Landlord agrees to accept performance by the holder of a Permitted Mortgage as
though the same had been done or performed by Tenant. Notwithstanding the
foregoing, if Landlord elects to obtain insurance pursuant to Section 5.7, the
additional grace period for Permitted Mortgagees set forth above shall be
reduced from twenty (20) days to ten (10) days.
Section 17.10. Right to Cure. Any provision hereof to the contrary
notwithstanding, Landlord will not terminate this Lease by reason of any default
without first giving to each Permitted Mortgagee a period of ninety (90) days
after the occurrence of such a default within which either (i) to obtain
possession of the Premises (including possession by a receiver) and thereafter
to cure such default, or (ii) to commence foreclosure proceedings in order to
acquire Tenant's interest under this Lease and thereafter prosecutes the same
with diligence and without unreasonable delay or substantial interruption. If
the holder of a Permitted Mortgage is prohibited from commencing or prosecuting
foreclosure or other appropriate proceedings in the nature thereof by any
process or injunction issued by any court or by reason of any action by any
court having jurisdiction of any bankruptcy or insolvency proceeding involving
Tenant, the ninety (90) day period set forth above for commencing or prosecuting
foreclosure or other proceedings shall be extended for the period of the
prohibition. Nothing herein shall preclude Landlord from exercising any other
rights or remedies under this Lease with respect to any default by Tenant during
any period of such forbearance. Upon a Permitted Mortgagee of Record acquiring
title or possession of the Premises, as provided above, such Permitted Mortgagee
of Record shall thereafter
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proceed to cure any then existing defaults under this Lease, subject to and in
the manner set forth in Section 17.11 below.
Section 17.11. Conditions of Cure. The provisions of Section 17.10 are
subject to the conditions that, within forty-five (45) days after receipt of any
notice pursuant to Section 17.10, the holder of a Permitted Mortgage shall:
A. Notify Landlord of its election to proceed with due
diligence promptly to acquire possession of the Premises or to foreclose the
Permitted Mortgage or otherwise to extinguish Tenant's interest in this Lease;
and
B. Deliver to Landlord an instrument in writing duly executed
and acknowledged wherein such Mortgagee agrees that:
(1) During the period that such Mortgagee shall be in possession of
the Premises and so long as it remains in possession it will pay or cause to be
promptly paid to Landlord all Minimum Rent and Impositions that are then
currently due or that may, from time to time, become due hereunder; and
(2) If such Mortgagee shall obtain possession of the Premises, whether
voluntarily or pursuant to any foreclosure or other proceedings, such Mortgagee
shall, promptly following delivery of possession, perform all the covenants and
agreements herein contained on Tenant's part to be performed and also pay all
past due Minimum Rent and Impositions to the extent that Tenant shall have
failed to pay the same to the date of delivery of possession.
Section 17.12. New Lease with Mortgagee. In the event of the
termination of this Lease prior to its stated expiration date, Landlord agrees
that it will give the holder of the First Permitted Mortgage of Record notice of
such termination and will enter into a new lease of the Premises with such
Mortgagee or, at the request of such Mortgagee, with its assignee, designee or
nominee for the remainder of the Lease Term, effective as of the date of such
termination, upon all of the same covenants, agreements, terms, provisions and
limitations as are herein contained, if and only if (i) such Mortgagee makes
written request upon Landlord for such new lease within sixty (60) days after
the Landlord gives notice that this Lease has been terminated, and (ii) such
Mortgagee pays or causes to be paid to Landlord at the time of the execution and
delivery of such new lease any and all Minimum Rent and Impositions which would
at the time of the execution and delivery thereof be due under this Lease but
for such termination and pays or causes to be paid any and all expenses,
including reasonable attorneys' fees, court costs, and costs and disbursements
incurred by Landlord in connection with any such termination and in connection
with the execution and delivery of such new lease, less the net income from the
Premises collected by Landlord subsequent to the date of the termination of this
Lease and prior to the execution and delivery of such new lease. The provisions
of this Section shall survive the
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termination of this Lease and shall continue in full force and effect thereafter
to the same extent as if this Section were a separate and independent contract
between Landlord and the holder of the First Permitted Mortgage of Record.
Section 17.13. Priority of New Lease. Notwithstanding anything to the
contrary express or implied in this Lease, any new lease made pursuant to the
preceding Section shall have the same priority as this Lease with respect to any
mortgage, deed of trust, or other lien, charge, or encumbrance on the fee of the
Premises, and any Sublease under this Lease shall be a Sublease under the new
lease (except to the extent the Mortgagee's foreclosure, if any, has eliminated
such Sublease and the Mortgagee does not require or permit attornment) and shall
not be deemed to have been terminated by the termination of this Lease.
Section 17.14. Assignment of Subleases. Tenant hereby assigns to
Landlord, effective upon the occurrence of any Event of Default hereunder, and
so long as such Default remains uncured, as collateral security for the
performance of all obligations of Tenant under this Lease, any Sublease created
by Tenant and each and every amendment, modification or extension thereof. In no
event shall such assignment impose upon Landlord any duty or obligation to
perform any of the obligations of Tenant as landlord under any such Sublease,
subject to Section 17.2. After default by Tenant, Landlord may collect the rents
and other payments from any and all Subtenants and apply the net amount
collected to the rent and other sums payable hereunder, and may enforce the
provisions of any such Sublease directly against the Subtenant thereunder in the
name of Landlord or of Tenant but for Landlord's sole benefit. No such
collection or enforcement by Landlord will be deemed to be a waiver of any
agreement, term, covenant or condition of this Lease by Landlord or the
acceptance by Landlord of any Subtenant. The assignment in this Section shall be
subordinate to any assignment of rents to a Permitted Mortgagee. Although the
provisions of the immediately preceding sentence are intended to be
self-operative, Landlord shall execute, have acknowledged and shall deliver such
instruments of subordination respecting said assignment of rents as any
Permitted Mortgagee may reasonably require. Once such default has been cured,
Tenant thereafter shall have the right to collect future rents and other
payments from any and all Subtenants and otherwise enforce the provisions of the
Sublease.
Section 17.15. Grace Period. Unless and until Landlord has received
notice from the holder of the First Permitted Mortgage of Record that such
holder elects not to demand a new lease as provided in Section 17.12 or until
the sixty (60) day period therefor has expired, Landlord shall not cancel or
agree to the termination or surrender of any existing Subleases or enter into
any new leases or subleases with respect to the Premises without the prior
written consent of the holder of the First Permitted Mortgage of Record.
Section 17.16. Modifications. Notwithstanding anything to the contrary
contained herein, so long as there is any Permitted Mortgage of Record, no
consensual act or
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agreement between or on the part of Landlord or Tenant to cancel, terminate,
surrender, or modify this Lease or Tenant's right to possession shall be binding
upon or effective against a Permitted Mortgagee of Record without its prior
written consent.
Section 17.17. Initial Assignment. Tenant has informed Landlord that
concurrently with (or shortly following) the execution and delivery of this
Lease, Tenant intends to assign this Lease and its rights hereunder to R&K,
subject to and in accordance with the terms, covenants and provisions of an
Addendum to Escrow Instructions and Agreement to Purchase and Sell Improved Real
Property (the "Initial Assignment"). Throughout the term of the Initial
Assignment, the obligations of R&K shall be guaranteed by the Chamberlain Family
Trust dated September 21, 1979 pursuant to a Guarantee of Lease in a form
reasonably acceptable to Landlord. Notwithstanding anything to the contrary
contained in Section 17.4, Section 17.16, or any other contrary provision of
this Lease, the Initial Assignment shall not relieve the Tenant named in the
first paragraph of this Lease of its agreements, liabilities, covenants and
obligations hereunder during the period that R&K holds the Tenant's interest
hereunder; provided, however, R&K shall be released from any future obligation
or liability arising under this Lease following the acquisition of the Buildings
and Landscaping by Tenant and the re-assignment of this Lease by R&K back to the
Tenant named in the first paragraph of this Lease, it being understood that the
reassignment of this Lease by R&K back to the Tenant named in the first
paragraph of this Lease shall not operate to release R&K or any guarantor from
any obligation or liability incurred during the term of the Initial Assignment.
ARTICLE 18
----------
DEFAULT BY TENANT
-----------------
Section 18.1. Events of Default. The happening of any one of the
following events (herein called "Events of Default") shall be considered a
material breach and default by Tenant under this Lease.
A. Rent Payment. If default shall be made in the due and punctual
payment of any rent or sums required to be paid by Tenant hereunder within
twenty (20) days after notice thereof from Landlord to Tenant; or
B. Continuing Default. If default shall be made by Tenant in the
performance of or compliance with any of the covenants, agreements, terms,
limitations or conditions hereof other than those referred to in the foregoing
subsection A, and such default shall continue for a period of thirty (30) days
after written notice thereof from Landlord to Tenant (provided, however, that if
Tenant proceeds with due diligence during such thirty (30) day period to cure
such default and is unable by reason of the nature of the work involved to cure
the same within such period, but such default is reasonably susceptible of
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being
cured by Tenant, such period shall be extended by the time reasonably necessary
to cure the same, as reasonably determined by Landlord).
Section 18.2. Notice and Termination. Upon the occurrence of one or
more of the Events of Default listed in Section 18.1, subject to the rights of
any Permitted Mortgagees, the terms and provisions of Sections 17.7 to 17.16,
inclusive, above, and the expiration of any cure, grace or other time period set
forth herein which are conditions precedent to Landlord's right of termination,
then Landlord at any time thereafter unless and until such Event of Default has
been cured may give written notice ("Second Notice") to Tenant specifying such
Event(s) of Default and stating that this Lease shall expire and terminate on
the date specified in such Second Notice, which shall be at least fifteen (15)
days after the giving of such Second Notice, and upon the date specified in such
Second Notice, subject to the provisions of Article 17, this Lease and all
rights of Tenant herein under shall terminate, cease and be null and void.
Section 18.3. No Implied Waivers. No failure by Landlord to insist upon
the strict performance of any covenant, agreement, term or condition hereof or
to exercise any right or remedy consequent upon a breach hereof, and no
acceptance of full or partial rent during the continuance of any such breach,
shall constitute a waiver of any such breach or of such covenant, agreement,
term or condition. No covenant, agreement, term or condition hereof to be
performed or complied with by Landlord or Tenant, and no breach thereof, shall
be waived, altered or modified, except by a written instrument executed by the
party to be charged therewith. No waiver of any breach shall affect or alter
this Lease, but each and every covenant, agreement, term, limitation and
condition hereof shall continue in full force and effect with respect to any
other then existing or subsequent breach hereof.
Section 18.4. Remedies Cumulative. In the event of any breach by Tenant
of any of the covenants, agreements, terms or conditions hereof, Landlord, in
addition to any and all other rights, shall be entitled to enjoin such breach
and shall have the right to invoke any right and remedy allowed at law or in
equity or by statute or otherwise for such breach as though re-entry, summary
proceedings, and other remedies were not provided for in this Lease. In the
event of Tenant's failure to pay rent or any other sums within five (5) days
after the date when due hereunder (without regard to any notice or grace periods
set forth in Section 18.1), then Tenant shall pay Landlord interest on any such
overdue payments and associated late charges at a per annum interest rate equal
to four percent (4%) over the prime rate then published in the Wall Street
Journal or a reasonably equivalent rate selected by Landlord (e.g., if the
"prime rate" is 4%, the rate hereunder shall be 4% higher; in other words 8%)
but in no event an amount greater than permitted by law, in addition to any
other right or remedy of Landlord resulting from any such breach or default by
Tenant.
Section 18.5. Late Charge. In the event that any payment required to be
made by Tenant to Landlord under the terms of this Lease is not received within
five (5) days after
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the due date thereof (without regard to any notice or grace periods set forth in
Section 18.1), a late charge shall without notice become immediately due and
payable in an amount equal to two and one-half percent (2.5%) of the late
payment or $500.00, whichever is greater. The late charge shall be in addition
to the interest charges pursuant to Section 18.4.
ARTICLE 19
----------
SAVING PROVISION
----------------
If any term or provision hereof or the application thereof to any
person or circumstances shall, to any extent, be invalid or unenforceable, the
remainder of this Lease, or the application of such term or provision to persons
or circumstances other than those as to which it is held invalid or
unenforceable, shall not be affected thereby, and each term and provision hereof
shall be valid and be enforced to the fullest extent permitted by law.
ARTICLE 20
----------
NOTICES
-------
Section 20.1. Notices. Any notice, request, demand, statement, or
consent herein required or permitted to be given by either party to the other
hereunder shall be in writing signed by or on behalf of the party giving the
notice and addressed to the other at the address as set forth below:
Landlord Papago Park Center, Inc.
Post Office Box 52025
Phoenix, AZ 85012
Attn: Development Manager
Tenant Three-Five Systems, Inc.
Attn: Mr. Thomas Schoenbeck
10230 South 50th Place
Phoenix, AZ 85044
with a copy to: David L. Lansky, Esq.
O'Connor Cavanagh
One East Camelback Road
Suite 1100
Phoenix, AZ 85016
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Each party may by notice in writing change its address for the purpose
of this Lease, which address shall thereafter be used in place of the former
address. Each notice, demand, request, or communication which shall be mailed to
any of the aforesaid shall be deemed sufficiently given, served, or sent for all
purposes hereunder two (2) business days after it shall be mailed by United
States registered or certified mail, postage prepaid, in any post office or
branch post office regularly maintained by the United States Government.
Section 20.2. Notice to Permitted Mortgagees of Record Only. When,
under the terms of this Lease, any notice is required or permitted to be given
to a Permitted Mortgagee, it is the intention of the parties that such notice
shall be required to be given only to Permitted Mortgagee(s) of Record who have
provided Landlord with a current notice address. This provision takes precedence
over any other provisions of this Lease that might impose a greater notice
requirement upon Landlord.
ARTICLE 21
----------
QUIET ENJOYMENT
---------------
Section 21.1. Quiet Enjoyment. Subject to all of the conditions, terms,
and provisions contained in this Lease, Landlord covenants that Tenant, upon
paying the rent and other sums when due hereunder and observing and keeping all
terms, covenants, agreements, limitations and conditions hereof on the part of
Tenant to be kept, shall have and may quietly enjoy the possession of the
Premises during the term hereof, without hindrance or molestation by Landlord,
and Landlord shall not affirmatively authorize any hindrance or molestation of
Tenant by others.
ARTICLE 22
----------
ESTOPPEL
--------
Section 22.1. Estoppel Certificates. Landlord may request of Tenant or
any Subtenant, and Tenant may request of Landlord, at any time and from time to
time a certificate addressed to Landlord or Tenant, as applicable, or any Person
designated by Landlord or Tenant, as applicable, as having any interest or
proposed interest in the Premises or any portion thereof evidencing whether:
A. The Lease is in full force and effect;
B. The Lease has not been modified or amended in any respect or
describing such modifications or amendments, if any;
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C. There are no existing defaults under the Lease to the knowledge of
the party executing the certificate or specifying the nature of such defaults,
if any; and
D. Such other factual matters pertaining to the Lease and the Premises
as may be reasonably requested.
Any such requested certificate shall be delivered, without charge, to the
requesting party within fourteen (14) days after the request has been made in
writing.
ARTICLE 23
----------
CONSENTS
--------
Section 23.1. Parties and Notice. Whenever any consent, approval,
election or similar action is required under this Lease, the same shall not be
effective unless it is in writing and delivered to all parties in the manner
hereinabove provided for the giving of notices.
Section 23.2. No Unreasonable Withholding or Delay. Wherever in this
Lease the consent or approval of any party is required, such consent or approval
shall not be unreasonably withheld nor delayed, except where otherwise
specifically provided.
ARTICLE 24
----------
ADJOINING EXCAVATION
--------------------
Section 24.1. Entry and Repairs. Tenant shall allow any person,
municipality or agency authorized by law and desiring to excavate upon land or
streets adjacent to the Premises to enter the Premises and shore up any walls
during such excavation to the extent required. Tenant shall, at Tenant's own
expense, repair or cause to be repaired, any damage caused to any part of the
Premises because of any excavation, construction work or other work of a similar
nature which may be done on any property or street adjoining or adjacent to the
Premises, and Landlord hereby assigns to Tenant any and all rights to sue for or
recover against any parties causing such damages, the amounts expended or
incurred by Tenant because of the provisions hereof requiring Tenant to repair
any damages sustained by such excavation work or other work.
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ARTICLE 25
----------
LIMITATION ON RECOURSE
----------------------
In the event of a material breach and default by Tenant under this
Lease, after Landlord regains possession of the Premises, Tenant shall have no
personal liability for the payment of future Minimum Rent or Additional Rent or
other obligations accruing after Landlord regains possession of the Premises.
The foregoing limitation on Landlord's recourse shall not apply, however, and
Tenant shall have full, personal and continuing liability, for:
(1) Claims arising out of failure prior to Tenant's surrender of
the Premises to pay Impositions, taxes, assessments, labor or
material charges, or other charges that can create liens
against the Premises;
(2) Claims arising out of waste of the Premises or any portion
thereof occurring prior to Tenant's surrender of the Premises;
(3) Claims arising out of failure to comply with any Legal
Requirement or any requirement of the Declaration related to
the Premises occurring prior to Tenant's surrender of the
Premises;
(4) Claims arising out of any use, generation, storage or disposal
by Tenant or any Person responsible by, through or under
Tenant, of hazardous materials, hazardous substances, toxic
substances, or other regulated substances causing
environmental damage or liability;
(5) Claims arising out of or related to Tenant's indemnity
obligations under Article 13 hereof; and
(6) Claims arising out of Tenant's failure to comply with the
provisions of Section 14.3.
ARTICLE 26
----------
EASEMENTS, DEDICATIONS AND OTHER MATTERS
----------------------------------------
At the request of Tenant, when Tenant is not in default hereunder
(notice thereof having been given and any applicable cure period having expired,
where notice and/or grace is required hereunder), Landlord shall make reasonable
dedications to public use of roads, alleys or easements and convey any portion
so dedicated to the appropriate governmental authority, join in granting any
reasonable easements requested by Tenant for the Premises,
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and execute and deliver (in recordable form where appropriate) all other
instruments and perform all other acts reasonably necessary or appropriate to
the development, construction, razing, redevelopment or reconstruction of the
Premises; however, Landlord shall not be required to cooperate in any rezoning.
Landlord's cooperation and consent to any of the foregoing shall be within
Landlord's reasonable discretion, to be given or withheld after Tenant's
submission of written requests and other information reasonably required by
Landlord. Landlord's cooperation, consent and actions under this Article shall
be at no cost to Landlord. Tenant shall save Landlord harmless from all costs,
expenses, claims, loss or damage by reason of, in connection with, on account
of, growing out of or resulting from any such cooperation, consent or action.
ARTICLE 27
----------
TRADE FIXTURES, MACHINERY AND EQUIPMENT
---------------------------------------
Landlord agrees that all trade fixtures, machinery, equipment,
furniture or other personal property of whatever kind and nature kept or
installed on the Premises by Tenant or Subtenants may be removed by Tenant or
Subtenants, or their agents and employees, in their discretion, at any time and
from time to time during the Term or upon expiration of this Lease. Tenant
agrees that in the event of material damage to the Premises due to such removal,
Tenant will repair or restore the same. Upon request of Tenant or any Subtenant,
Landlord shall execute and deliver any reasonable consent or waiver forms
submitted by any vendors, lessors, chattel mortgagees or holders or owners of
any trade fixtures, machinery, equipment, furniture or other personal property
of any kind and description kept or installed on the Premises by Tenant or any
Subtenant, setting forth the fact that Landlord waives, in favor of such vendor,
lessor, chattel mortgagee, holder or owner, any lien, claim, interest or other
right therein superior to that of such vendor, lessor, chattel mortgagee, owner
or holder. Landlord shall further acknowledge that the property covered by such
consent or waiver forms is personal property and is not to become a part of the
realty no matter how affixed thereto and that such property may be removed from
the Premises by the vendor, lessor, chattel mortgagee, owner or holder at any
time upon default by the Tenant or Subtenant, pursuant to the terms of such
chattel mortgage or other similar documents, provided that any damage to the
Premises due to such material removal will be repaired or restored by such
vendor, lessor, chattel mortgagee, owner or holder.
ARTICLE 28
----------
LEASEHOLD MORTGAGEE FURTHER ASSURANCES
--------------------------------------
Landlord and Tenant shall cooperate in including in this Lease by
suitable amendment from time to time any reasonable provision which may be
reasonably requested
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by any proposed Permitted Mortgagee for the purposes of (i) implementing the
mortgagee-protection provisions contained in this Lease, (ii) allowing that
Permitted Mortgagee reasonable means to protect or preserve the lien of its
Permitted Mortgage upon the occurrence of a default under the terms of this
Lease, and (iii) confirming the elimination of the ability by Tenant to modify,
terminate or waive this Lease or any of its provisions without the prior written
approval of the Permitted Mortgagee. Landlord and Tenant each agree to execute
and deliver (and to acknowledge, if necessary, for recording purposes) any
agreement reasonably necessary to effect any such amendment; provided, however,
that any such amendment shall not in any way affect the term or rent under this
Lease nor otherwise in any material respect modify the provisions hereof or
adversely affect any rights of Landlord under this Lease. Landlord's cooperation
shall be limited to review and comment on any proposed amendments and eventual
approval by Landlord of any such amendments reasonably acceptable to Landlord.
Any reasonable costs and expenses incurred by Landlord in connection with its
cooperation under this Article 28 shall be reimbursed by Tenant.
ARTICLE 29
----------
MISCELLANEOUS
-------------
Section 29.1. Choice of Law. This Lease shall be construed and enforced
in accordance with the laws of the State of Arizona.
Section 29.2. Memorandum. Landlord and Tenant agree that at the request
of either, each will execute a short form memorandum of this Lease in a form
satisfactory for recording in the Office of the County Recorder, Maricopa
County, Arizona.
Section 29.3. Entire Agreement. This Lease together with the Exhibits
hereto contains the entire agreement between Landlord and Tenant and supersedes
all prior negotiations or agreements. Any agreement hereafter made between
Landlord and Tenant shall be ineffective to change, modify, waive, release,
discharge, terminate or effect an abandonment of this Lease, in whole or in
part, unless such agreement is in writing and signed by the party against whom
enforcement thereof is sought.
Section 29.4. Captions. The captions of Articles and Sections in this
Lease and its Table of Contents are inserted only as a convenience and for
reference and they in no way define, limit, or describe the scope of this Lease
or the intent of any provision thereof. References to Articles and Section
numbers are to those in this Lease unless otherwise noted.
49
<PAGE>
Section 29.5. Execution and Delivery. This Lease shall bind Tenant upon
its execution thereof. Landlord shall be bound only after it executes and
delivers the Lease to Tenant.
Section 29.6. Singular and Plural, Gender. If two or more persons,
firms, corporations, or other entities constitute either the Landlord or the
Tenant, the word "Landlord" or the word "Tenant" shall be construed as if it
reads "Landlords" or "Tenants" and the pronouns "it", "he", and "him" appearing
herein shall be construed to be the singular or plural, masculine, feminine, or
neuter gender as the context in which it is used shall require.
Section 29.7. Multiple Parties. If at any time Landlord, Tenant, any
Permitted Mortgagee (Landlord, Tenant or any such Mortgagee being in this
Section referred to as a "party") is other than one individual, partnership,
firm, corporation, or other entity, the act of, or notice, demand, request, or
other communication from or to, or payment or refund from or to, or signature of
any one of the individuals, partnerships, firms, corporations, or other entities
then constituting such party with respect to such party's estate or interest in
the Premises or this Lease shall bind all of them as if all of them so had
acted, or so had given or received such notice, demand, request, or other
communication, or so had given or received such payment or refund, or so had
signed.
Section 29.8. Construction. This Lease has been fully negotiated by
both parties with the assistance of legal counsel and shall be construed
impartially in light of all pertinent facts and circumstances and not narrowly
against any party.
Section 29.9. Declaration. Landlord, as the Declarant under the
Declaration, acknowledges and agrees that Tenant shall be entitled to exercise
all voting rights applicable to the Premises under the Declaration and that
Tenant, by leasing the Premises pursuant to this Lease, shall be considered the
lessee of the Premises for all purposes under the Declaration, including any
period of time during which the Buildings are owned by the City of Tempe,
Arizona, pursuant to the City Lease.
Section 29.10. Nondisturbance - Improvement District. Prior to the
execution of this Lease, and as a condition precedent to the obligations of
Tenant hereunder, Landlord shall (i) use reasonable efforts to cause the Tempe
Improvement District No. 166 to execute, have acknowledged and delivered to
Tenant a Nondisturbance and Attornment Agreement in a form reasonably acceptable
to Tenant, pursuant to which the Tempe Improvement District No. 166 agrees that
notwithstanding any default by Landlord and/or the Lessor under the Master
Ground Lease under the terms and conditions of the agreements and documents
secured by a lien against the Premises, that so long as there is not in
existence an Event of Default hereunder, the Tempe Improvement District No. 166
will honor this Lease and not disturb Tenant's rights hereunder, or (ii) provide
other continuing financial assurances or arrangements insuring that Tenant, its
successors and assigns, its Permitted
50
<PAGE>
Mortgagees, future purchasers of the Premises and the Premises shall not be held
financially responsible for the lien imposed by Tempe Improvement District No.
166 or, if reasonably commercially available at a reasonable cost, Lessor under
the Master Ground Lease or Landlord shall obtain title insurance endorsement(s)
insuring Tenant, its successors and assigns, its Permitted Mortgagees and future
purchasers of the Premises against loss as a result of the existence of said
lien. If Landlord is unable to deliver the financial assurances or arrangements
for such title insurance endorsement(s) or is unable to obtain said
Nondisturbance and Attornment Agreement, Tenant may either (i) waive strict
conformance with this Section 29.10 and execute this Lease, whereupon the other
provisions of the Lease shall have full force and effect, or (ii) refuse to
execute this Lease, whereupon this Lease shall have no force or effect and
neither Landlord nor Tenant shall have any liability one to the other.
ARTICLE 30
----------
INUREMENT
---------
Section 30.1. Covenants Bind and Inure. The covenants and agreements
herein contained shall bind and inure to the benefit of Landlord and Tenant and
their respective heirs, legal representatives, successors and assigns, except as
otherwise provided herein.
51
<PAGE>
ARTICLE 31
----------
ATTORNEYS' FEES
---------------
Section 31.1. Prevailing Party to Recover Attorneys' Fees.
In the event of any suit, arbitration, or other adversarial proceeding between
the parties in any court or other forum of competent jurisdiction, the
prevailing party shall be entitled, in addition to any other remedy, to recover
its reasonable attorneys' fees and costs of such proceeding.
The parties have caused this instrument to be duly executed the day and
year first above written.
LANDLORD:
PAPAGO PARK CENTER, INC.,
An Arizona corporation
By /s/ John R. Lassen
----------------------------
Its President
-------------------------
TENANT:
THREE-FIVE SYSTEMS, INC., a
Delaware corporation
By David R. Buchanan
----------------------------
Its President
-------------------------
52
<PAGE>
STATE OF ARIZONA )
)ss.
County of Maricopa )
On this, the 1st day of April, 1994, before me, the undersigned Notary
Public, personally appeared John R. Lassen, who acknowledged himself to be the
President of PAPAGO PARK CENTER, INC., an Arizona corporation, whose name is
subscribed to the foregoing instrument, and acknowledged that he executed the
same for the purposes therein contained in such capacity.
IN WITNESS WHEREOF, I have hereunto set my hand and official seal.
/s/ Terril A. Lonon
-------------------------------
Notary Public
My Commission Expires: OFFICIAL SEAL
April 29, 1995 TERRILL A. LONON
- ---------------------- Notary Public - State of Arizona
MARICOPA COUNTY
STATE OF ARIZONA ) My Comm. Expires April 29, 1995
)ss.
County of Maricopa )
On this, the 1st day of April, 1994, before me, the undersigned Notary
Public, personally appeared David R. Buchanan, who acknowledged himself to be
the President of THREE-FIVE SYSTEMS, INC., a Delaware corporation, whose name is
subscribed to the foregoing instrument, and acknowledged that he executed the
same for the purposes therein contained in such capacity.
IN WITNESS WHEREOF, I have hereunto set my hand and official seal.
/s/ Jeanne A. Gargus
-------------------------------
Notary Public
My Commission Expires:
December 12, 1995
- ----------------------
53
THIRD MODIFICATION AGREEMENT
BY THIS THIRD MODIFICATION AGREEMENT (the "Agreement"), made and
entered into as of the 5th day of August, 1996, WELLS FARGO BANK OF ARIZONA,
NATIONAL ASSOCIATION, formerly known as FIRST INTERSTATE BANK OF ARIZONA, N.A.,
whose address is Post Office Box 29742, Phoenix, Arizona 85038-9742, Corporate
Banking Division (hereinafter called "Lender"), and THREE-FIVE SYSTEMS, INC., a
Delaware corporation, whose address is 1600 North Desert Drive, Tempe, Arizona
85281-1212 (hereinafter called "Borrower"), in consideration of the mutual
covenants herein contained and other good and valuable consideration, the
receipt and sufficiency of which is hereby acknowledged, hereby confirm and
agree as follows:
SECTION 1. RECITALS.
1.1 Borrower and Lender entered into a Loan Agreement dated July 11,
1994 (the "Loan Agreement"), which provided for a revolving line of credit by
Lender to Borrower in the amount of $5,000,000.00 (the "Revolving Commitment
Amount") upon the terms and conditions contained therein (the "Revolving Credit
Loan").
1.2 The Loan was evidenced by a Revolving Promissory Note dated July
11, 1994, executed by Borrower, payable to the order of Lender, in the principal
amount of $5,000,000.00 (the "Revolving Note"). (Hereinafter the Loan Agreement
and the Revolving Note are referred to as the "Loan Documents.")
1.3 Lender and Borrower have executed and delivered previously a
Modification Agreement dated as of June 28, 1995 and a Second Modification
Agreement dated as of ________________ (together, the "Modifications") modifying
the terms of the Loan Documents. Hereinafter, "Revolving Note," and "Loan
Agreement" shall mean such documents as modified in the Modifications.
1.4 Borrower and Lender desire to modify the Loan Documents as set
forth herein.
1.5 All undefined capitalized terms used herein shall have the meaning
given them in the Loan Agreement.
SECTION 2. REVOLVING NOTE.
As of the date hereof, prior to the effect of the modifications
contained herein, the outstanding principal balance of the Revolving Note is
$___________.
SECTION 3. LOAN AGREEMENT.
3.1 The Loan Agreement is hereby amended as follows:
(a) Section 7.4 of the Loan Agreement is amended to read as
follows:
<PAGE>
Section 7.4 Declare or pay any cash dividend or
purchase any treasury stock greater than $8,000,000.00.
(b) Section 7.8 of the Loan Agreement is amended to read as
follows:
Section 7.8 Permit its Tangible Net Worth to be: (a)
less than $41,606,000.00 as of September 30, 1996; and (b) on
each subsequent Quarterly End Date, less than $41,606,000.00
plus fifty percent (50%) of the aggregate of Borrower's
positive net income of each subsequent quarterly period, with
no deduction for any quarterly period net loss.
(c) Section 7.12 of the Loan Agreement is amended to read as
follows:
Section 7.12 Permit the ratio of Borrower's Current
Assets to its Current Liabilities at the end of any fiscal
quarter to be less than 2.0 to 1.0 with both Current Assets
and Current Liabilities determined in accordance with
generally accepted accounting principles, except that Current
Liabilities shall include all amounts outstanding under the
RLC including without limitation amounts due and payable
beyond a year.
SECTION 4. OTHER MODIFICATIONS, RATIFICATIONS AND AGREEMENTS.
4.1 All references to the Loan Agreement in the Revolving Note are
hereby amended to refer to the Loan Agreement as hereby amended.
4.2 Borrower acknowledges that the indebtedness evidenced by the
Revolving Note is just and owing, that the balance thereof is correctly shown in
the records of Lender as of the date hereof, and Borrower agrees to pay the
indebtedness evidenced by the Revolving Note according to the terms thereof, as
herein modified.
4.3 Borrower hereby reaffirms to Lender each of the representations,
warranties, covenants and agreements of Borrower set forth in the Revolving Note
and the Loan Agreement, with the same force and effect as if each were
separately stated herein and made as of the date hereof.
4.4 Borrower hereby ratifies, reaffirms, acknowledges, and agrees that
the Revolving Note and the Loan Agreement, represent valid, enforceable and
collectible obligations of Borrower, and that there are no existing claims,
defenses, personal or otherwise, or rights of setoff whatsoever with respect to
any of these documents or instruments. In addition, Borrower hereby expressly
waives, releases and absolutely and forever discharges Lender and its present
and former shareholders, directors, officers, employees and agents, and their
separate and respective heirs, personal representatives, successors and assigns,
from any and all liabilities, claims, demands, damages, action and causes of
action, whether known or unknown and whether contingent or matured, that
Borrower may now have,
2
<PAGE>
or has had prior to the date hereof, or that may hereafter arise with respect to
acts, omissions or events occurring prior to the date hereof and, without
limiting the generality of the foregoing, from any and all liabilities, claims,
demands, damages, actions and causes of action, known or unknown, contingent or
matured, arising out of, or in any way connected with, the RLC. Borrower further
acknowledges and represents that no event has occurred and no condition exists
that, after notice or lapse of time, or both, would constitute a default under
this Agreement, the Revolving Note or the Loan Agreement.
4.5 All terms, conditions and provisions of the Revolving Note and the
Loan Agreement are continued in full force and effect and shall remain
unaffected and unchanged except as specifically amended hereby. The Revolving
Note and the Loan Agreement, as amended hereby, are hereby ratified and
reaffirmed by Borrower, and Borrower specifically acknowledges the validity and
enforceability thereof.
SECTION 5. GENERAL.
5.1 This Agreement in no way acts as a release or relinquishment of
those rights securing payment of the RLC. Such rights are hereby ratified,
confirmed, renewed and extended by Borrower in all respects.
5.2 The modifications contained herein shall not be binding upon Lender
until Lender shall have received all of the following:
(a) An original of this Agreement fully executed by the
Borrower.
(b) Such resolutions or authorizations and such other
documents as Lender may require relating to the existence and good
standing of the Borrower and the authority of any person executing this
Agreement or other documents on behalf of the Borrower.
5.3 Borrower shall execute and deliver such additional documents and do
such other acts as Lender may reasonably require to fully implement the intent
of this Agreement.
5.4 Borrower shall pay all costs and expenses, including, but not
limited to, reasonable attorneys' fees incurred by Lender in connection
herewith, whether or not all of the conditions described in Paragraph 5.2 above
are satisfied. Lender, at its option, but without any obligation to do so, may
advance funds to pay any such costs and expenses that are the obligation of the
Borrower, and all such funds advanced shall bear interest at the highest rate
provided in the Revolving Note and shall be due and payable upon demand.
5.5 Notwithstanding anything to the contrary contained herein or in any
other instrument executed by Borrower or Lender, or in any other action or
conduct undertaken by Borrower or Lender on or before the date hereof, the
agreements, covenants and provisions contained herein shall constitute the only
evidence of Lender's consent to modify the terms and provisions of the Revolving
Note or the Loan Agreement. Accordingly, no express or implied consent to any
further modifications involving any of the matters set forth in this Agreement
or otherwise shall be inferred or implied by Lender's execution of this
Agreement. Further, Lender's execution of this Agreement shall not constitute a
waiver (either express or implied) of the requirement that any further
modification of the RLC or of
3
<PAGE>
the Revolving Note or the Loan Agreement, shall require the express written
approval of Lender; no such approval (either express or implied) has been given
as of the date hereof.
5.6 Time is hereby declared to be of the essence hereof of the RLC, of
the Revolving Note and of the Loan Agreement, and Lender requires, and Borrower
agrees to, strict performance of each and every covenant, condition, provision
and agreement hereof, of the Revolving Note and the Loan Agreement.
5.7 This Agreement shall be binding upon, and shall inure to the
benefit of, the parties hereto and their heirs, personal representatives,
successors and assigns.
5.8 This Agreement is made for the sole protection and benefit of the
parties hereto, and no other person or entity shall have any right of action
hereon.
5.9 This Agreement shall be governed by and construed according to the
laws of the State of Arizona.
IN WITNESS WHEREOF, these presents are executed as of the date
indicated above.
WELLS FARGO BANK OF ARIZONA, NATIONAL
ASSOCIATION, formerly known as FIRST
INTERSTATE BANK OF ARIZONA, N.A.
By:____________________________________
Name:__________________________________
Its:___________________________________
LENDER
THREE-FIVE SYSTEMS, INC., a Delaware
corporation
By:____________________________________
Name:__________________________________
Its:___________________________________
BORROWER
4
FOURTH MODIFICATION AGREEMENT
BY THIS FOURTH MODIFICATION AGREEMENT (the "Agreement"), made and
entered into as of the 24th day of October, 1996, WELLS FARGO BANK, NATIONAL
ASSOCIATION, as successor in interest to FIRST INTERSTATE BANK OF ARIZONA, N.A.,
whose address is Post Office Box 29742, Phoenix, Arizona 85038-9742, Corporate
Banking Division (hereinafter called "Lender"), and THREE-FIVE SYSTEMS, INC., a
Delaware corporation, whose address is 1600 North Desert Drive, Tempe, Arizona
85281-1212 (hereinafter called "Borrower"), in consideration of the mutual
covenants herein contained and other good and valuable consideration, the
receipt and sufficiency of which is hereby acknowledged, hereby confirm and
agree as follows:
SECTION 1. RECITALS.
1.1 Borrower and Lender entered into a Loan Agreement dated July 11,
1994 (the "Loan Agreement"), which provided for a revolving line of credit by
Lender to Borrower in the subsequently amended amount of $15,000,000.00 (the
"RLC Commitment Amount") upon the terms and conditions contained therein (the
"RLC").
1.2 The RLC is evidenced by a Revolving Promissory Note dated December
21, 1995, executed by Borrower, payable to the order of Lender, in the principal
amount of $15,000,000.00 (the "RLC Note"). (Hereinafter the Loan Agreement and
the RLC Note are referred to as the "Loan Documents.")
1.3 Lender and Borrower have executed and delivered previously a
Modification Agreement dated as of June 28, 1995, a Second Modification
Agreement dated as of December 22, 1995 and a Third Modification Agreement dated
as of August 5, 1996 (collectively, the "Modifications") modifying the terms of
the Loan Documents. Hereinafter, "RLC Note" and "Loan Agreement" shall mean such
documents as modified in the Modifications.
1.4 Borrower and Lender desire to modify the Loan Documents as set
forth herein.
1.5 All undefined capitalized terms used herein shall have the meaning
given them in the Loan Agreement.
SECTION 2. RLC NOTE.
As of the date hereof, prior to the effect of the modifications
contained herein, the outstanding principal balance of the RLC Note is $0.
-1-
<PAGE>
SECTION 3. LOAN AGREEMENT.
3.1 The following definitions in Section 2.1 of the Loan Agreement are
amended to read as follows:
"Advance" means either an RLC Advance or a Term Advance.
"Convert," "Conversion" and "Converted" each refers to a
conversion of an Advance of one Type into an Advance of another Type.
"Eurodollar Reserve Percentage" for the Interest Period for
each LIBOR Rate Advance means the reserve percentage applicable two (2)
Business Days before the first day of such Interest Period under
regulations issued from time to time by the Board of Governors of the
Federal Reserve System (or any successor) for determining the maximum
reserve requirement (including, but not limited to, any emergency,
supplemental, or other marginal reserve requirement) for a member Bank
of the Federal Reserve System in San Francisco with respect to
liabilities or assets consisting of or including Eurocurrency
Liabilities (or with respect to any other category of liabilities which
includes deposits by reference to which the interest rate on LIBOR Rate
Advances is determined) having a term equal to such Interest Period.
"Financial Covenants" means those financial covenants
specified in Sections 7.8 through 7.13.
"Interest Period" means, for each LIBOR Rate Advance, the
period commencing on the date of such LIBOR Rate Advance or the date of
the Conversion of any Advance into such a LIBOR Rate Advance and ending
on the last day of the period selected by the Borrower pursuant to the
provisions herein and, thereafter, each subsequent period commencing on
the day after the last day of the immediately preceding Interest Period
and ending on the last day of the period selected by the Borrower
pursuant to the provisions herein. With respect to LIBOR Rate Advances,
the duration of each such Interest Period shall be (a) 30, 60, 90, or
180 days, or (b) as to the Term Loan after the Term Termination Date,
30, 60 or 90 days, as the Borrower may select; provided, however, that:
(i) Interest Periods commencing on the same date for
the same Type of Advances shall be of the same duration;
(ii) Whenever the last day of any Interest Period
would otherwise occur on a day other than a Business Day, the
last day of such Interest Period shall be extended to occur on
the next succeeding Business Day, provided that if such
extension would cause the last day of such Interest Period to
occur in the next following calendar
-2-
<PAGE>
month, the last day of such Interest Period shall occur on the
next preceding Business Day; and
(iii) No Interest Period with respect to any RLC
Advance shall extend beyond the RLC Maturity Date or with
respect to any Term Advance shall extend beyond the Term
Maturity Date.
"LIBOR Base Rate" means, for the Interest Period for each
LIBOR Rate Advance, an interest rate per annum equal to the rate of
interest per annum obtained by dividing (i) the rate of interest
determined by Lender, based on Telerate System reports or such other
source selected by Lender, to be the "London Interbank Offered Rate" at
which deposits in U.S. dollars are offered by major banks in London,
England, two (2) Business Days before the first day of such Interest
Period by (ii) a percentage equal to one hundred percent (100%) minus
the Eurodollar Reserve Percentage for the period equal to such Interest
Period.
3.2 Section 2.1 of the Loan Agreement is amended by the addition of the
following definitions:
"Fixed Rate" means an interest rate per annum equal to two and
one-half percent (2.5%) in excess of the Treasury Rate.
"LIBOR Rate Advance" means either a LIBOR Rate RLC Advance or
a LIBOR Rate Term Advance.
"LIBOR Rate Term Advance" means a Term Advance that bears
interest at the applicable Term LIBOR Rate.
"Loans," each a "Loan," means the RLC and the Term Loan.
"Notes," each a "Note," means the RLC Note and the Term Note.
"Notice of Term Advance": See Section 3A.3(b).
"Obligations" means all obligations of Borrower under this
Agreement, the Notes, the Security Agreement and any other documents
delivered by Borrower to Lender with respect to the Loans.
"Prime Rate Term Advance" means a Term Advance that bears
interest at the Prime Rate.
"Security Agreement": See Section 3A.9(a).
"Term Advance" means prior to the Term Termination Date an
advance by Lender to the Borrower under the Term Loan pursuant to
Section 3A.3 and includes a Prime Rate Term Advance or a LIBOR Rate
Term Advance (each of which shall be a "Type" of Term
-3-
<PAGE>
Advance), and after the Term Termination Date, it means the Term Loan.
"Term Commitment Amount" means $5,000,000.00.
"Term LIBOR Rate" means an interest rate per annum equal to
two and one-quarter percent (2.25%) in excess of the LIBOR Base Rate,
rounded upward, if necessary, to the nearest 1/16 of 1%.
"Term Loan" means that Loan evidenced by the Term Note made
pursuant to Section 3A.1 hereof by Lender to Borrower.
"Term Maturity Date" means October 24, 2000.
"Term Note" means that Promissory Note dated as of October 24,
1996 in the face amount equal to the Term Commitment Amount made by
Borrower payable to the order of Lender, evidencing the Term Loan, and
extensions, modifications and renewals thereof.
"Term Payment Date" means:
(a) As to each Prime Rate Term Advance, the last day
of each month;
(b) As to each LIBOR Rate Term Advance, the earlier
of the last day of the Interest Period or the ninetieth (90th)
day after the beginning of the Interest Period; and
(c) As to the Term Loan should it accrue interest at
the Fixed Rate, the Quarterly End Date.
"Term Termination Date" means October 24, 1997.
"Treasury Rate" means the yield in percent per annum as shown
for three (3) year United States Treasury constant maturities on the
Federal Reserve statistical release H.15 (519) for the most recent week
prior to the Term Termination Date.
3.3 The Loan Agreement is amended by the addition of the following
Article 3A:
ARTICLE 3A
----------
TERM LOAN
---------
Section 3A.1 Term Commitment Amount. Subject to the conditions
set forth herein, Lender, from time to time, shall make Term Advances
as Borrower may request, as provided below, provided that the
outstanding principal balance shall not exceed the Term Commitment
-4-
<PAGE>
Amount. Until the Term Termination Date, the Term Loan shall be a line
of credit, against which Term Advances may be made to Borrower,
provided that (i) Borrower is not in default under any provision of
this Agreement, and (ii) no Term Advance shall be made that would cause
the outstanding principal balance of the Term Loan to exceed the Term
Commitment Amount. The Term Loan is not a revolving line of credit and
once a Term Advance is disbursed and repaid, it may not be reborrowed
again. On and after the Term Termination Date, no further Term Advances
shall be made to Borrower under the Term Loan.
Section 3A.2 Term Note. The Term Loan shall be evidenced by
the Term Note, in the form approved by Lender, payable to the order of
Lender upon the terms and conditions therein contained.
Section 3A.3 Term Advances.
(a) Unless otherwise specifically approved in writing
by Lender, the proceeds of the Term Loan shall be used only to
purchase treasury stock or, so long as the aggregate amount of
Term Advances shall not exceed the aggregate amount of
Borrower's purchase of treasury stock, to reimburse Borrower
for prior purchases of treasury stock.
(b) Lender may from time to time make Term Advances
in such sums as Borrower shall request. Each such Term Advance
shall be in the minimum amount of $100,000.00.
(c) The Borrower shall give Lender written notice, or
telephonic notice confirmed immediately in writing, of the
request for any Term Advances under this Agreement, which
notice (the "Notice of Term Advance") shall be received by
Lender not later than 11:00 A.M. (Phoenix, Arizona local time)
on the same Business Day in the case of a Prime Rate Advance,
and in the case of a LIBOR Rate Term Advance not later than
2:00 p.m. (Phoenix, Arizona local time) on the second Business
Day before the date of the proposed Term Advance. Each such
Notice of Term Advance shall specify: (i) the date of the
proposed Term Advance, (ii) the amount of such Term Advance,
(iii) the Type of Term Advance, and (iv) in the case of a
LIBOR Rate Term Advance, the Interest Period. Each Notice of
Term Advance shall be irrevocable and binding on the
-5-
<PAGE>
Borrower. Anything herein to the contrary notwithstanding, no
LIBOR Rate Term Advance shall be less than $50,000.00.
(d) In the case of any Term Advance which the related
Notice of Term Advance specifies that it is to be a LIBOR Rate
Term Advance, the Borrower shall indemnify Lender on demand
for, from, and against any loss or expense incurred by Lender
as a result of any failure by Borrower to fulfill on or before
the date specified in such Notice of Term Advance for such
Term Advance the applicable conditions set forth in Section
4.2, including, without limitation, any loss, including, other
losses, costs, and expenses incurred by Lender by reason of
liquidation or reemployment of deposits or other funds
acquired by Lender to fund the LIBOR Rate Term Advance to be
made by Lender when such LIBOR Rate Term Advance, as a result
of such failure, is not made on such date.
Section 3A.4 Conversion of Term Advances.
(a) The Borrower may, upon written notice to and
received by the Lender (i) not later than 2:00 p.m. (Phoenix,
Arizona local time) on the second Business Day before the
requested Conversion, in the case of any Conversion of Prime
Rate Term Advances into LIBOR Rate Term Advances, and (ii) not
later than 11:00 A.M. (Phoenix, Arizona local time) on the
same Business Day as the Conversion, in the case of any
Conversion of LIBOR Rate Term Advances into Prime Rate Term
Advances, subject to the provisions of this Section 3A.4,
Convert any Term Advances of one Type into Term Advances of
another Type; provided, however, that any Conversion of LIBOR
Rate Term Advances made on other than the last day of said
Term Advances's Interest Period shall be made only on
condition that Borrower pays all amounts specified in
connection therewith in Section 3A.8(e). Each such notice of a
Conversion shall be irrevocable and binding on the Borrower.
Each such notice of a Conversion shall, within the
restrictions specified above, specify (w) the date of such
Conversion (x) the Term Advances to be Converted, (y) the Type
of Term Advances into which the Term Advances are to be
Converted,
-6-
<PAGE>
and (z) if such Conversion is into LIBOR Rate Term Advances,
the duration of the Interest Period for each such Term
Advance.
(b) If the Borrower should fail to give the Lender
any notice of Conversion upon the termination of the Interest
Period for a LIBOR Rate Term Advance, such Term Advance, upon
the termination of the Interest Period, shall automatically
become a Prime Rate Term Advance.
Section 3A.5 Term Loan Payments.
(a) Until the Term Termination Date, interest on the
Term Loan shall accrue on the principal balance of the Term
Loan from time to time outstanding under the Term Note as
follows:
(i) At the Prime Rate if it is a Prime Rate
Term Advance.
(ii) At the applicable Term LIBOR Rate if it
is a LIBOR Rate Term Advance.
(b) After the Term Termination Date, interest on the
Term Loan shall accrue as follows:
(i) At the Fixed Rate if Borrower shall have
elected by written notice to Lender by no later than
11:00 a.m. (Phoenix, Arizona local time) on the Term
Termination Date that interest should accrue at the
Fixed Rate, commencing the next day, at the Fixed
Rate. Borrower's right to elect that interest accrue
at the Fixed Rate shall terminate at 11:00 a.m.
(Phoenix, Arizona local time) on the Term Termination
Date.
(ii) Otherwise at either the Prime Rate or
the Term LIBOR Rate as Borrower shall elect from time
to time; provided that at any one time after the Term
Termination Date interest shall accrue on the entire
Term Loan at either the Prime Rate or the then
applicable Term LIBOR
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<PAGE>
Rate based on a single Interest Period.
(c) All accrued interest shall be due and payable on
the Term Payment Date.
(d) Principal payments shall be made in equal amounts
on each Quarterly End Date commencing on the first Quarterly
End Date after the Term Termination Date, sufficient to fully
amortize the Term Loan balance outstanding on the Term
Termination Date on the Term Maturity Date.
(e) The entire outstanding principal balance of the
Term Note, all accrued and unpaid interest and all other sums
which may have become payable thereunder shall be due and
payable in full on the Term Maturity Date.
Section 3A.6 Term Loan Prepayments. Borrower shall have the
option to prepay the Term Loan, in full or in part at any time, subject
to payment of the following:
(a) With respect to any LIBOR Rate Term Advance, all
amounts specified in Section 3A.8(a).
(b) In the event the Term Loan is accruing interest
at the Fixed Rate, an amount equal to a prepayment premium
computed as follows:
1% of the outstanding principal balance if
the outstanding principal balance is less than
$50,000.00, and if the outstanding principal balance
is equal to or more than $50,000.00, an amount equal
to [the present value of the remaining cash flows
calculated with an interest rate assuming that a
Determination of Taxability had occurred discounted
at the Treasury Constant Yield (TCY) + 100 basis
points] - outstanding principal. The TCY is
calculated as the interpolated constant maturity
Treasury rate with a maturity matching the remaining
average term of the Term Note to the Term Maturity
Date. Rate data is obtained, at the time of
prepayment,
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from the most recent Federal Reserve statistical
release H.15 (519).
Section 3A.7 Term Loan Commitment Fee. Borrower agrees to pay
to Lender an upfront commitment fee equal to 30 basis points of the
Term Commitment Amount upon the closing of the Term Loan.
Section 3A.8 Additional Provisions for LIBOR Rate Term
Advances.
(a) Unavailability of Deposits or Inability to Ascertain the
Rates. Notwithstanding any other provision of this Agreement, if prior
to the commencement of any Interest Period, Lender shall determine (i)
that United States dollar deposits in the amount of any LIBOR Rate Term
Advance to be outstanding during such Interest Period are not readily
available to Lender in the London interbank market, or (ii) by reason
of circumstances affecting the London interbank market, adequate and
reasonable means do not exist for ascertaining the LIBOR Base Rate,
then Lender shall promptly give notice thereof to the Borrower and the
obligation of Lender to create, or effect by conversion any LIBOR Rate
Term Advance in such amount and for such Interest Period shall
terminate until United States dollar deposits in such amount and for
the Interest Period selected by the Borrower shall again be readily
available in the market and adequate and reasonable means exist for
ascertaining the LIBOR Base Rate.
(b) Increased Costs. (i) If, due to any Regulatory Change,
there shall be any increase in the cost to Lender of agreeing to make
or making, funding or maintaining LIBOR Rate Term Advances (including,
without limitation, any increase in any applicable reserve
requirement), then the Borrower shall from time to time, upon demand by
Lender, pay to Lender such amounts as Lender may reasonably determine
to be necessary to compensate Lender for any additional costs which it
reasonably determines are attributable to such Regulatory Change; (ii)
if Lender determines (in its reasonable discretion) that, as a result
of any Regulatory Change, the amount of capital required or expected to
be maintained by Lender is increased by or based upon the existence of
Lender's commitment to lend hereunder, then, upon demand by Lender, the
Borrower shall immediately pay to Lender such amounts as Lender may
reasonably determine to be necessary to compensate Lender for any
additional costs which it reasonably determines are attributable to the
maintenance by Lender of capital in respect of Lender's commitment to
lend hereunder; and (iii) Lender will
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<PAGE>
notify the Borrower of any Regulatory Change that will entitle Lender
to compensate pursuant to this paragraph (b) as promptly as
practicable, but in any event within 90 days after Lender obtains
knowledge thereof; provided, however, that if Lender fails to give such
notice within 90 days after it obtains knowledge of such a Regulatory
Change, Lender shall, with respect to compensation payable in respect
of any costs resulting from such Regulatory Change, only be entitled to
payment for costs incurred from and after the date that Lender has
given such notice. Lender will furnish to Borrower a certificate
setting forth in reasonable detail the basis for the amount of each
request by Lender for compensation. Determination by Lender of the
amounts required by compensate Lender shall be made on a reasonable
basis. Lender shall be entitled to compensation in connection with any
Regulatory Change only for costs actually incurred by such Lender. Upon
receipt of notice of any such Regulatory Change from Lender, Borrower
shall have the option to prepay or Convert any Term Advances adversely
affected by any Regulatory Change within seven (7) days of receipt of
such notice, without the obligation to pay to Lender with respect to
such prepayment or Conversion any amount or amounts otherwise payable
to Lender by Borrower pursuant to Section 3A.8(e).
(c) Illegality. Notwithstanding any other provision of this
Agreement, if Lender shall notify the Borrower that as a result of a
Regulatory Change it is unlawful for Lender to perform its obligations
hereunder to make LIBOR Rate Term Advances or to fund or maintain LIBOR
Rate Term Advances hereunder (i) the obligation of Lender to make, or
to Convert Term Advances into, a LIBOR Rate Term Advances shall be
suspended until Lender shall notify Borrower that the circumstances
causing such suspension no longer exist and (ii) in the event such
Regulatory Change makes the maintenance of LIBOR Rate Term Advances
hereunder unlawful, the Borrower shall forthwith prepay in full all
LIBOR Rate Term Advances then outstanding, together with interest
accrued thereon and all amounts in connection with such prepayment
specified in Section 3A.8(e), unless the Borrower, within five (5)
Business Days of notice from Lender, Converts all LIBOR Rate Term
Advances then outstanding into Prime Rate Term Advances in accordance
with Section 3A.4 and pays all amounts in connection with such
prepayments specified in Section 3.8(e).
(d) Discretion of Lender as to Manner of Funding.
Notwithstanding any provision of this Agreement to the contrary, Lender
shall be entitled to fund and maintain
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<PAGE>
its funding of all or any part of any Term Advance in any manner it
sees fit; provided, however, that for the purposes of this Agreement,
all determinations hereunder shall be made as if Lender had actually
funded and maintained each LIBOR Rate Term Advance during the Interest
Period therefor through the purchase of deposits having a maturity
corresponding to the last day of the Interest Period and bearing an
interest rate equal to the Term LIBOR Rate for such Interest Period.
(e) Funding Loss Indemnification. Borrower shall pay to Lender
such amount of amounts as shall be sufficient to compensate for any
losses (including without limitation loss of anticipated profit), costs
or expenses which Lender may reasonably incur as a result of payment or
Conversion of any LIBOR Rate Term Advance other than on the last
Business Day of the Interest Period for such Term Advance, whether due
to prepayment, Conversion, illegality (pursuant to Section 3A.8(c)
above), acceleration of the Term Maturity Date or for any other reason.
Section 3A.9 Security. So long as the Term Loan remains
outstanding Borrower agrees as follows:
(a) To secure its obligations with respect to the
Term Loan by granting to Lender a security interest in all of
Borrower's equipment located in the State of Arizona pursuant
to a security agreement (the "Security Agreement") delivered
by Borrower to Lender;
(b) Not to create or suffer to be created or to exist
any mortgages, pledges, security interests, encumbrances or
other liens on its real property located at 1600 North Desert
Drive, Phoenix, Arizona at any time that in the aggregate
exceed $100,000.00; and
(c) To apply immediately all proceeds from the sale
of any treasury stock to the outstanding principal balance of
the Term Loan.
3.4 All references in Articles 5, 6, 7, 8, 9 and 10 of the Loan
Agreement:
(a) to "RLC Note" are hereby amended to read "Note"
or "Notes", as applicable;
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<PAGE>
(b) to "RLC" are hereby amended to read "Loan" or
"Loans", as applicable; and
(c) to "RLC Advances" are hereby amended to read
"Advance" or "Advances", as applicable.
3.5 Section 7.2 of the Loan Agreement is hereby amended to read as
follows:
Section 7.2. Create or suffer to be created or to exist any
mortgages, pledges, security interests, encumbrances or other liens
that at any time in the aggregate exceed $100,000.00:
(a) on its real property; or
(b) on its accounts receivable.
3.6 Section 7.4 of the Loan Agreement is amended to read as follows:
Section 7.4 Declare or pay any cash dividend or purchase any
treasury stock greater than $10,000,000.00.
3.7 The first paragraph of Section 7.8 of the Loan Agreement is amended
to read as follows:
Section 7.8 Permit its Tangible Net Worth to be as of each
Quarterly End Date:
(a) less than $42,500,000 plus fifty percent (50%) of
the aggregate of Borrower's positive net income of each
quarterly period, beginning June 30, 1996, with no deduction
for any quarterly period net loss, plus (b) any additional
paid-in equity capital.
3.8 Section 7.10 of the Loan Agreement is amended by the addition of
the following:
Notwithstanding anything herein to the contrary, for purposes
of the calculation of "cash flow", the inventory reserve taken in the
third fiscal quarter of 1996 (the "1996 Adjustment") shall not be
considered in the calculation of net income for the relevant period.
3.9 Section 7.11 of the Loan Agreement is amended to read as follows:
Section 7.11 Permit its annual capital expenditures to exceed
the sum of $5,000,000.00.
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<PAGE>
3.10 Article 7 of the Loan Agreement is amended by the addition of the
following Section 7.13:
Section 7.13 Permit, in fiscal year 1997 and thereafter, (i)
its annual operating net result to be negative, or (ii) its operating
net result to be negative for two or more consecutive quarterly fiscal
periods.
3.11 Section 8.1(h) of the Loan Agreement is amended to read as
follows:
(h) The occurrence of any default under (i) any Note
or any document or instrument given by Borrower in connection
with any other indebtedness of Borrower to Lender or any
affiliate thereof and the expiration of any grace period
provided therein, or (ii) any other indebtedness in excess of
$1,000,000 of Borrower to any other creditor and the
expiration of any grace period provided therein;
3.12 Exhibit "B" to the Loan Agreement is amended to read as attached
hereto.
SECTION 4. OTHER MODIFICATIONS, RATIFICATIONS AND AGREEMENTS.
4.1 All references to the Loan Agreement in the RLC Note are hereby
amended to refer to the Loan Agreement as hereby amended.
4.2 Borrower acknowledges that the indebtedness evidenced by the RLC
Note is just and owing, that the balance thereof is correctly shown in the
records of Lender as of the date hereof, and Borrower agrees to pay the
indebtedness evidenced by the RLC Note according to the terms thereof, as herein
modified.
4.3 Borrower hereby reaffirms to Lender each of the representations,
warranties, covenants and agreements of Borrower set forth in the RLC Note and
the Loan Agreement, with the same force and effect as if each were separately
stated herein and made as of the date hereof.
4.4 Borrower hereby ratifies, reaffirms, acknowledges, and agrees that
the RLC Note and the Loan Agreement, represent valid, enforceable and
collectible obligations of Borrower, and that there are no existing claims,
defenses, personal or otherwise, or rights of setoff whatsoever with respect to
any of these documents or instruments. In addition, Borrower hereby expressly
waives, releases and absolutely and forever discharges Lender and its present
and former shareholders, directors, officers, employees and agents, and their
separate and respective heirs, personal
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<PAGE>
representatives, successors and assigns, from any and all liabilities, claims,
demands, damages, action and causes of action, whether known or unknown and
whether contingent or matured, that Borrower may now have, or has had prior to
the date hereof, or that may hereafter arise with respect to acts, omissions or
events occurring prior to the date hereof and, without limiting the generality
of the foregoing, from any and all liabilities, claims, demands, damages,
actions and causes of action, known or unknown, contingent or matured, arising
out of, or in any way connected with, the RLC. Borrower further acknowledges and
represents that no event has occurred and no condition exists that, after notice
or lapse of time, or both, would constitute a default under this Agreement, the
RLC Note or the Loan Agreement.
4.5 All terms, conditions and provisions of the RLC Note and the Loan
Agreement are continued in full force and effect and shall remain unaffected and
unchanged except as specifically amended hereby. The RLC Note and the Loan
Agreement, as amended hereby, are hereby ratified and reaffirmed by Borrower,
and Borrower specifically acknowledges the validity and enforceability thereof.
SECTION 5. GENERAL.
5.1 This Agreement in no way acts as a release or relinquishment of
those rights securing payment of the RLC. Such rights are hereby ratified,
confirmed, renewed and extended by Borrower in all respects.
5.2 The modifications contained herein shall not be binding upon Lender
until Lender shall have received all of the following:
(a) An original of this Agreement fully executed by the
Borrower.
(b) Such resolutions or authorizations and such other
documents as Lender may reasonably require relating to the existence
and good standing of the Borrower and the authority of any person
executing this Agreement or other documents on behalf of the Borrower.
(c) The Security Agreement fully executed by the Borrower.
(d) The Term Note fully executed by the Borrower.
(e) A UCC-1 Financing Statement fully executed by the
Borrower.
(f) A commitment fee with respect to the Term Loan in the
amount of $15,000.00.
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<PAGE>
5.3 Borrower shall execute and deliver such additional documents and do
such other acts as Lender may reasonably require to fully implement the intent
of this Agreement.
5.4 Borrower shall pay all costs and expenses, including, but not
limited to, reasonable attorneys' fees incurred by Lender in connection
herewith, whether or not all of the conditions described in Paragraph 5.2 above
are satisfied. Lender, at its option, but without any obligation to do so, may
advance funds to pay any such costs and expenses that are the obligation of the
Borrower, and all such funds advanced shall bear interest at the highest rate
provided in the RLC Note and shall be due and payable upon demand.
5.5 Notwithstanding anything to the contrary contained herein or in any
other instrument executed by Borrower or Lender, or in any other action or
conduct undertaken by Borrower or Lender on or before the date hereof, the
agreements, covenants and provisions contained herein shall constitute the only
evidence of Lender's consent to modify the terms and provisions of the RLC Note
or the Loan Agreement. Accordingly, no express or implied consent to any further
modifications involving any of the matters set forth in this Agreement or
otherwise shall be inferred or implied by Lender's execution of this Agreement.
Further, Lender's execution of this Agreement shall not constitute a waiver
(either express or implied) of the requirement that any further modification of
the RLC or of the RLC Note or the Loan Agreement, shall require the express
written approval of Lender; no such approval (either express or implied) has
been given as of the date hereof.
5.6 Time is hereby declared to be of the essence hereof of the RLC, of
the RLC Note and of the Loan Agreement, and Lender requires, and Borrower agrees
to, strict performance of each and every covenant, condition, provision and
agreement hereof, of the RLC Note and the Loan Agreement.
5.7 This Agreement shall be binding upon, and shall inure to the
benefit of, the parties hereto and their heirs, personal representatives,
successors and assigns.
5.8 This Agreement is made for the sole protection and benefit of the
parties hereto, and no other person or entity shall have any right of action
hereon.
5.9 This Agreement shall be governed by and construed according to the
laws of the State of Arizona.
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<PAGE>
IN WITNESS WHEREOF, these presents are executed as of the date
indicated above.
WELLS FARGO BANK, NATIONAL
ASSOCIATION, as successor in
interest to FIRST
INTERSTATE BANK OF ARIZONA, N.A.
By:_____________________________________
Name:___________________________________
Its:____________________________________
LENDER
THREE-FIVE SYSTEMS, INC., a Delaware
corporation
By:_____________________________________
Name:___________________________________
Its:____________________________________
BORROWER
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PROMISSORY NOTE
$5,000,000.00 Phoenix, Arizona
October 24, 1996
FOR VALUE RECEIVED, the undersigned THREE-FIVE SYSTEMS, INC., a
Delaware corporation ("Maker"), promises to pay to the order of WELLS FARGO
BANK, NATIONAL ASSOCIATION (the "Payee"; Payee and each subsequent transferee
and/or owner of this Note, whether taking by endorsement or otherwise, are
herein successfully called "Holder") at Post Office Box 29742, Phoenix, Arizona
85038-9742, or at such other place as Holder may from time to time designate in
writing, the principal sum of FIVE MILLION AND NO/100 DOLLARS ($5,000,000.00) or
so much thereof as Holder may advance to or for the benefit of maker plus
interest calculated on a daily basis (based on a 360-day year) from the date
hereof on the principal balance from time to time outstanding as hereinafter
provided, principal, interest and all other sums payable hereunder to be paid in
lawful money of the United States of America as follows:
A. Until the Term Termination Date, interest shall accrue on the
principal balance hereunder as follows:
1. At the Prime Rate if it is a Prime Rate Term Advance.
2. At the applicable Term LIBOR Rate if it is a LIBOR Rate
Term Advance.
B. After the Term Termination Date, interest shall accrue hereunder as
follows:
1. At the Fixed Rate if Maker shall have elected by written
notice to Holder by no later than 11:00 a.m. (Phoenix, Arizona local
time) on the Term Termination Date that interest should accrue at the
Fixed Rate, commencing the next day, at the Fixed Rate. Maker's right
to elect that interest accrue at the Fixed Rate shall terminate at
11:00 a.m. (Phoenix, Arizona local time) on the Term Termination Date.
2. Otherwise at either the Prime Rate or the Term LIBOR Rate
as Maker shall elect from time to time, provided that at any one time
after the Term Termination Date interest shall accrue on the entire
Term Loan at either the Prime Rate or the then applicable Term LIBOR
Rate based on a single Interest Period.
C. All accrued interest hereunder shall be due and payable on the Term
Payment Date.
D. Principal payments shall be made in equal amounts on each Quarterly
End Date commencing the first Quarterly End Date after the Term Termination
Date, sufficient to fully
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<PAGE>
amortize the balance outstanding hereunder on the Term Termination Date on the
Term Maturity Date.
E. The entire outstanding principal balance of this Note, all accrued
and unpaid interest and all other sums which may have become payable thereunder
shall be due and payable in full on the Term Maturity Date.
F. The capitalized terms used and not otherwise defined herein shall
have the same meanings as defined in the Loan Agreement.
From the date hereof until the Term Termination Date, the principal balance of
this Note represents a line of credit all or any part of which may be advanced
by Maker, from time to time, subject to the terms hereof and the conditions, if
any, contained in the Loan Agreement, and provided that the principal balance
outstanding at any one time shall not exceed the face amount hereof. Commencing
on the Term Termination Date no further disbursements shall be made to Maker
under this Note.
Maker agrees to an effective rate of interest that is the rate stated
above plus any additional rate of interest resulting from any other charges in
the nature of interest paid or to be paid by or on behalf of Maker, or any
benefit received or to be received by Holder, in connection with this Note.
If any payment required under this Note is not paid within five (5)
Business Days of when due; then, at the option of Holder, Maker shall pay a
"late charge" equal to three percent (3%) of the amount of that payment to
compensate Holder for administrative expenses and other costs of delinquent
payments. This late charge may be assessed without notice, shall be immediately
due and payable and shall be in addition to all other rights and remedies
available to Holder.
All payments on this Note shall be applied first to the payment of any
costs, fees or other charges incurred in connection with the indebtedness
evidenced hereby, next to the payment of accrued interest and then to the
reduction of the principal balance.
This Note is issued pursuant to that Loan Agreement (as amended from
time to time, the "Loan Agreement") dated as of July 11, 1994, between Maker and
Payee, and is secured by, among other things, that Security Agreement of even
date herewith, by and between Maker, as debtor and Payee, as secured party (the
"Security Agreement"), encumbering the personal property described therein. Such
Security Agreement and all other documents or instruments securing the
indebtedness evidenced by this Note or executed or delivered in connection with
this Note are herein called the "Security Documents."
Time is of the essence of this Note. At the option of Holder, the
entire unpaid principal balance, all accrued and unpaid interest and all other
amounts payable hereunder shall become immediately due and payable without
notice upon the failure to pay any sum due and owing hereunder as provided
herein or upon the occurrence of any event of default under the Loan Agreement
or any Security Document.
After maturity, including maturity upon acceleration, the unpaid
principal balance, all
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<PAGE>
accrued and unpaid interest and all other amounts payable hereunder shall bear
interest at that rate that is five percent (5%) above the rate that would
otherwise be payable under the terms hereof. Maker shall pay all costs and
expenses, including reasonable attorneys' fees and court costs, incurred in the
collection or enforcement of all or any part of this Note. Such court costs and
attorneys' fees shall be set by the court and not by jury, shall be included in
any judgement obtained by Holder and shall be secured by the Security Documents.
Maker shall have the option to prepay this Note, in full or in part, at
any time as provided in the Loan Agreement. All prepayments shall be applied in
the inverse order of maturity.
Failure of Holder to exercise any option hereunder shall not constitute
a waiver of the right to exercise the same in the event of any subsequent
default or in the event of continuance of any existing default after demand for
strict performance hereof.
Maker and all sureties, guarantors and/or endorsers hereof (or of any
obligation hereunder) and accommodation parties hereon (severally each
hereinafter called a "Surety") each: (a) agree that the liability under this
Note of all parties hereto is joint and several; (b) severally waive any and all
formalities in connection with this Note to the maximum extent allowed by law,
including (but not limited to) demand, diligence, presentment for payment,
protest and demand, and notice of extension, dishonor, protest, demand and
nonpayment of this Note; and (c) consent that Holder may extend the time of
payment or otherwise modify the terms of payment of any part or the whole of the
debt evidenced by this Note, at the request of any other person liable hereon,
and such consent shall not alter nor diminish the liability of any person
hereon.
In addition, each Surety waives and agrees not to assert: (a) any right
to require Holder to proceed against Maker or any other Surety, to proceed
against or exhaust any security for the Note, to pursue any other remedy
available to Holder, or to pursue any remedy in any particular order or manner;
(b) the benefit of any statute of limitations affecting its liability hereunder
or the enforcement hereof; (c) the benefits of any legal or equitable doctrine
or principle of marshalling; (d) notice of the existence, creation or incurring
of new or additional indebtedness of Maker to Holder; (e) the benefits of any
statutory provision limiting the liability of a surety, including without
limitation the provisions of Sections 12-1641, et seq., of the Arizona Revised
Statutes; and (f) any defense arising by reason of any disability or other
defense of Maker or by reason of the cessation from any cause whatsoever (other
than payment in full) of the liability of Maker for payment of the Note. Until
payment in full of the Note, no Surety shall have any right of subrogation and
each hereby waives any right to enforce any remedy which Holder now has, or may
hereafter have, against Maker or any other Surety, and waives any benefit of,
and any right to participate in, any security now or hereafter held by Holder.
Maker agrees that to the extent Maker or any Surety makes any payment
to Holder in connection with the indebtedness evidenced by this Note, and all or
any part of such payment is subsequently invalidated, declared to be fraudulent
or preferential, set aside or required to be repaid by Holder or paid over to a
trustee, receiver or any other entity, whether under any bankruptcy act or
otherwise (any such payment is hereinafter referred to as a "Preferential
Payment"), then the indebtedness of Maker under this Note shall continue or
shall be reinstated, as the case may be, and, to the extent of such payment or
repayment by Holder, the indebtedness
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<PAGE>
evidenced by this Note or part thereof intended to be satisfied by such
Preferential Payment shall be revived and continued in full force and effect as
if said Preferential Payment had not been made.
Without limiting the right of Holder to bring any action or proceeding
against Maker or any Surety or against any property of Maker or any Surety (an
"Action") arising out of or relating to this Note or any indebtedness evidenced
hereby in the courts of other jurisdictions, Maker and each Surety hereby
irrevocably submit to the jurisdiction, process and venue of any Arizona State
or Federal court sitting in Phoenix, Arizona, and hereby irrevocably agree that
any Action may be heard and determined in such Arizona State court or in such
Federal court. Maker and all Sureties each hereby irrevocably waives, to the
fullest extent it may effectively do so, the defenses of lack of jurisdiction
over any person, inconvenient forum or improper venue, to the maintenance of any
Action in any jurisdiction.
This Note shall be binding upon Maker and its successors and assigns
and shall inure to the benefit of Payee, and any subsequent holders of this
Note, and their successors and assigns.
All notices required or permitted in connection with this Note shall be
given at the place and in the manner provided in the Loan Agreement for the
giving of notices.
This Note shall be construed according to the laws of the State of
Arizona.
IN WITNESS WHEREOF, this Promissory Note has been executed as of the
date first written above.
THREE-FIVE SYSTEMS, INC., a Delaware
corporation
By_____________________________________
Its_______________________________
MAKER
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SECURITY AGREEMENT
THIS SECURITY AGREEMENT (the "Agreement") is made and entered into as
of the 24th day of October, 1996, by THREE-FIVE SYSTEMS, INC., a Delaware
corporation (hereinafter called "Debtor"), whose chief executive office is
located at 1600 North Desert Drive, Tempe, Arizona 85281-1212, in favor of WELLS
FARGO BANK, NATIONAL ASSOCIATION, and its successors and assigns (hereinafter
called "Secured Party"), whose address is Post Office Box 29742, Phoenix,
Arizona 85038-9742.
1. SECURITY INTEREST
Debtor hereby grants to Secured Party a security interest (hereinafter
called the "Security Interest") in all of Debtor's right, title and interest in
and to the personal property (the "Collateral") described on Schedule A attached
hereto and by this reference incorporated herein.
2. OBLIGATION SECURED
The Security Interest shall secure, in such order of priority as
Secured Party may elect:
(a) Payment of the sum of $5,000,000.00 with interest thereon,
extension and other fees, late charges, prepayment premiums and
attorneys' fees, according to the terms of that Promissory Note dated
of even date herewith, made by Debtor, payable to the order of Secured
Party, and all extensions, modifications, renewals or replacements
thereof (hereinafter called the "Note");
(b) Payment, performance and observance by Debtor of each
covenant, condition, provision and agreement contained herein and of
all monies expended or advanced by Secured Party pursuant to the terms
hereof, or to preserve any right of Secured Party hereunder, or to
protect or preserve the Collateral or any part thereof; and
(c) Payment, performance and observance by Debtor of each
covenant, condition, provision and agreement contained in that Loan
Agreement dated July 11, 1994, by and between Debtor and Secured Party
as successor-in-interest to First Interstate Bank of Arizona, N.A. (as
amended from time to time, hereinafter called the "Loan Agreement") and
in any other document or instrument related to the indebtedness
described in subparagraph (a) above (the "Term Loan") and of all monies
expended or advanced by Secured Party pursuant to the terms thereof
with respect to the Term Loan only, and not with respect to the RLC (as
defined in the Loan Agreement), or to preserve any right of Secured
Party thereunder.
All of the indebtedness and obligations secured by this Agreement are
hereinafter collectively called the "Obligation."
3. USE; LOCATION; MANILA EQUIPMENT
3.1 The Collateral is or will be used or produced primarily for
business purposes.
<PAGE>
3.2 The Collateral will be kept at Debtor's address set forth at the
beginning of this Agreement; provided that, notwithstanding anything herein to
the contrary, Collateral ("Manila Equipment") may be removed from the State of
Arizona without the consent of the Secured Party only to the extent it is
designated by Debtor in the ordinary course of business to be sent to Debtor's
facility in Manila, P.I. ("Manila Facility"). Upon the shipment of any such
Manila Equipment to the Manila Facility and its departure from the State of
Arizona, the Security Interest of the Secured Party shall be automatically
released from such Manila Equipment.
3.3 Debtor's records concerning the Collateral will be kept at Debtor's
address set forth at the beginning of this Agreement.
4. REPRESENTATIONS AND WARRANTIES OF DEBTOR
Debtor hereby represents and warrants that:
4.1 Debtor (i) is duly organized, validly existing and in good standing
under the laws of the state in which it is organized; (ii) is qualified to do
business and is in good standing under the laws of the state in which the
Collateral is located and in each state in which it is doing business; (iii) has
full power and authority to own its properties and assets and to carry on its
businesses as now conducted; and (iv) is fully authorized and permitted to
execute and deliver this Agreement and to enter into any transactions evidenced
by any portion of the Collateral. The execution, delivery and performance by
Debtor of this Agreement and all other documents and instruments relating to the
Obligation will not result in any breach of the terms and conditions or
constitute a default under any agreement or instrument under which Debtor is a
party or is obligated. Debtor is not in default in the performance or observance
of any covenants, conditions or provisions of any such agreement or instrument.
4.2 Subject to Section 7.2 of the Loan Agreement, Debtor is the owner
of the Collateral free of all security interests or other encumbrances except
the Security Interest and no financing statement covering the Collateral is
filed or recorded in any public office.
4.3 The Collateral is, and is intended to be, used, produced or
acquired by Debtor for use primarily for business purposes. The address of
Debtor set forth at the beginning of this Agreement is the chief executive
office of Debtor. If a portion of the Collateral is or will become a fixture, it
will be affixed to the real property as described above.
5. COVENANTS OF DEBTOR
5.1 Except as permitted in Paragraph 3.2 hereof with respect to the
Manila Equipment, Debtor shall not sell, transfer, assign or otherwise dispose
of any Collateral or any interest therein (except as permitted herein) without
obtaining the prior written consent of Secured Party and, subject to Section 7.2
of the Loan Agreement, shall keep the Collateral free of all security interests
or other encumbrances except the Security Interest; provided however that Debtor
may sell, transfer, assign or otherwise dispose of any Collateral ("Disposed
Collateral") or any interest thereon without obtaining the prior written consent
of Secured Party so long as (i) Debtor is doing so in the ordinary course of
business, (ii) the book value of any such Disposed Collateral does not exceed
$5,000.00, and (iii) the aggregate book value of all such Disposed Collateral
does not exceed $100,000.00 in any fiscal year. Although proceeds of Collateral
are covered by this Agreement, this shall not be construed to mean that Secured
Party consents to any sale of the Collateral.
2
<PAGE>
5.2 Debtor shall keep and maintain the Collateral in good condition and
repair and shall not use the Collateral in violation of any provision of this
Agreement or any applicable statute, ordinance or regulation or any policy of
insurance insuring the Collateral.
5.3 Debtor shall provide and maintain insurance insuring the Collateral
against risks, with coverage and in form and amount satisfactory to Secured
Party. At Secured Party's request, Debtor shall deliver to Secured Party the
original policies of insurance containing endorsements naming Secured Party as a
loss payee.
5.4 Subject to Section 7.2 of the Loan Agreement, Debtor shall pay when
due all taxes, assessments and other charges which may be levied or assessed
against the Collateral.
5.5 Debtor shall prevent any portion of the Collateral that is not a
fixture from being or becoming a fixture and shall prevent any portion of the
Collateral from being or becoming an accession to other goods that are not part
of the Collateral.
5.6 Debtor shall give Secured Party immediate written notice of any
change in the location of: (i) Debtor's chief executive office; (ii) except as
permitted in Paragraph 3.2 hereof with respect to the Manila Equipment, the
Collateral or any part thereof; or (iii) Debtor's records concerning the
Collateral.
5.7 After reasonable notice by Secured Party to Debtor, Secured Party
or its agents may inspect the Collateral at reasonable times and may enter into
any premises where the Collateral is or may be located. Debtor shall keep
records concerning the Collateral in accordance with generally accepted
accounting principles and, if requested in writing by Secured Party, shall mark
its records and the Collateral to indicate the Security Interest. Secured Party
shall have free and complete access to Debtor's records and shall have the right
to make extracts therefrom or copies thereof. Upon request of Secured Party from
time to time, Debtor shall submit up-to-date schedules of the items comprising
the Collateral in such detail as Secured Party may require.
5.8 Debtor, at its reasonable cost and expense, shall protect and
defend this Agreement, all of the rights of Secured Party hereunder, and the
Collateral against all claims and demands of other parties. Debtor shall pay all
claims and charges that in the opinion of Secured Party might prejudice, imperil
or otherwise affect the Collateral or the Security Interest. Debtor shall
promptly notify Secured Party of any levy, distraint or other seizure by legal
process or otherwise of any part of the Collateral and of any threatened or
filed claims or proceedings that might in any way affect or impair the terms of
this Agreement.
5.9 Subject to Section 7.2 of the Loan Agreement, the Security
Interest, at all times, shall be perfected and shall be prior to any other
interests in the Collateral. Debtor shall act and perform as necessary and shall
execute and file all security agreements, financing statements, continuation
statements and other documents requested by Secured Party to establish, maintain
and continue the perfected Security Interest. Debtor, on demand, shall promptly
pay all reasonable costs and expenses of filing and recording, including the
costs of any searches, deemed reasonably necessary by Secured Party from time to
time to establish and determine the validity and the continuing priority of the
Security Interest.
3
<PAGE>
5.10 If Debtor shall fail, subject to Section 7.2 of the Loan
Agreement, to pay any taxes, assessments, expenses or charges, to keep all of
the Collateral free from other security interests, encumbrances or claims, to
keep the Collateral in good condition and repair, to procure and maintain
insurance thereon, or to perform otherwise as required herein, Secured Party may
advance the monies necessary to pay the same, to accomplish such repairs, to
procure and maintain such insurance or to so perform; after reasonable notice by
Secured Party to Debtor, Secured Party is hereby authorized to enter upon any
property in the possession or control of Debtor for such purposes.
5.11 All rights, powers and remedies granted Secured Party herein, or
otherwise available to Secured Party, are for the sole benefit and protection of
Secured Party, and Secured Party may exercise any such right, power or remedy at
its option and in its sole and absolute discretion without any obligation to do
so. In addition, if under the terms hereof, Secured Party is given two or more
alternative courses of action, Secured Party may elect any alternative or
combination of alternatives at its option and in its sole and absolute
discretion. All monies advanced by Secured Party under the terms hereof and all
amounts paid, suffered or incurred by Secured Party in exercising any authority
granted herein, including reasonable attorneys' fees, shall be added to the
Obligation, shall be secured by the Security Interest, shall bear interest at
the highest rate payable on any of the Obligation until paid, and shall be due
and payable by Debtor to Secured Party immediately without demand.
6. COLLATERAL IN THE POSSESSION OF SECURED PARTY
6.1 Secured Party shall use such reasonable care in handling,
preserving and protecting the Collateral in its possession as it uses in
handling similar property for its own account. Secured Party, however, shall
have no liability for the loss, destruction or disappearance of any Collateral
unless there is affirmative proof of a lack of due care; the lack of due care
shall not be implied solely by virtue of any loss, destruction or disappearance.
7. EVENTS OF DEFAULT; REMEDIES
7.1 The occurrence of any of the following events or conditions shall
constitute and is hereby defined to be an "Event of Default":
(a) Any failure or neglect to perform or observe any of the
terms, provisions, or covenants of this Agreement, and such failure or
neglect either (i) cannot be remedied, (ii) can be remedied within
fifteen (15) days by prompt and diligent action, but it continues
unremedied for a period of fifteen (15) days after notice thereof to
Debtor, or (iii) can be remedied, although not within fifteen (15) days
even by prompt and diligent action, but such remedy is not commenced
within fifteen (15) days after notice thereof to Debtor or is not
diligently prosecuted to completion within a total of forty-five (45)
days from the date of such notice.
(b) Any warranty, representation or statement contained in
this Agreement that shall be or shall prove to have been false when
made or furnished.
(c) Any levy or execution upon, or judicial seizure of, any
portion of the Collateral or any other collateral or security for the
Obligation.
4
<PAGE>
(d) Any attachment or garnishment of, or the existence or
filing of any lien or encumbrance against, any portion of the
Collateral or any other collateral or security for the Obligation that
is not removed and released within fifteen (15) days after its
creation.
(e) The institution of any legal action or proceedings to
enforce any lien or encumbrance upon any portion of the Collateral or
any other collateral or security for the Obligation, that is not
dismissed within sixty (60) days after its institution.
(f) The abandonment by Debtor of all or any part of the
Collateral.
(g) The loss, theft or destruction of, or any substantial
damage to, any portion of the Collateral or any other collateral or
security for the Obligation, that is not adequately covered by
insurance.
(h) The occurrence of any event of default under the Loan
Agreement.
7.2 Upon the occurrence of any Event of Default and at any time while
such Event of Default is continuing, Secured Party shall have the following
rights and remedies and may do one or more of the following:
(a) Declare all or any part of the Obligation to be
immediately due and payable, and the same, with all reasonable costs
and charges, shall be collectible thereupon by action at law.
(b) Without further notice or demand and without legal
process, take possession of the Collateral wherever found and, for this
purpose, enter upon any property occupied by or in the control of
Debtor. Debtor, upon demand by Secured Party, shall assemble the
Collateral and deliver it to Secured Party or to a place designated by
Secured Party that is reasonably convenient to both parties.
(c) Pursue any legal or equitable remedy available to collect
the Obligation, to enforce its title in and right to possession of the
Collateral and to enforce any and all other rights or remedies
available to it.
(d) Upon obtaining possession of the Collateral or any part
thereof, after notice to Debtor as provided in Paragraph 7.4 herein,
sell such Collateral at public or private sale either with or without
having such Collateral at the place of sale. The proceeds of such sale,
after deducting therefrom all reasonable expenses of Secured Party in
taking, storing, repairing and selling the Collateral (including
reasonable attorneys' fees) shall be applied to the payment of the
Obligation, and any surplus thereafter remaining shall be paid to
Debtor or any other person that may be legally entitled thereto. In the
event of a deficiency between such net proceeds from the sale of the
Collateral and the total amount of the Obligation, Debtor, upon demand,
shall promptly pay the amount of such deficiency to Secured Party.
5
<PAGE>
7.3 Secured Party, so far as may be lawful, may purchase all or any
part of the Collateral offered at any public or private sale made in the
enforcement of Secured Party's rights and remedies hereunder.
7.4 Any demand or notice of sale, disposition or other intended action
hereunder or in connection herewith, whether required by the Uniform Commercial
Code or otherwise, shall be deemed to be commercially reasonable and effective
if such demand or notice is given to Debtor at least ten (10) days prior to such
sale, disposition or other intended action, in the manner provided herein for
the giving of notices.
7.5 Debtor shall pay all costs and expenses, including without
limitation costs of Uniform Commercial Code searches, court costs and reasonable
attorneys' fees, incurred by Secured Party in enforcing payment and performance
of the Obligation or in exercising the rights and remedies of Secured Party
hereunder. All such costs and expenses shall be secured by this Agreement and by
all deeds of trust and other lien and security documents securing the
Obligation. In the event of any court proceedings, court costs and attorneys'
fees shall be set by the court and not by jury and shall be included in any
judgment obtained by Secured Party.
7.6 In addition to any remedies provided herein for an Event of
Default, Secured Party shall have all the rights and remedies afforded a secured
party under the Uniform Commercial Code and all other legal and equitable
remedies allowed under applicable law. No failure on the part of Secured Party
to exercise any of its rights hereunder arising upon any Event of Default shall
be construed to prejudice its rights upon the occurrence of any other or
subsequent Event of Default. No delay on the part of Secured Party in exercising
any such rights shall be construed to preclude it from the exercise thereof at
any time while that Event of Default is continuing. Secured Party may enforce
any one or more rights or remedies hereunder successively or concurrently. By
accepting payment or performance of any of the Obligation after its due date,
Secured Party shall not thereby waive the agreement contained herein that time
is of the essence, nor shall Secured Party waive either its right to require
prompt payment or performance when due of the remainder of the Obligation or its
right to consider the failure to so pay or perform an Event of Default.
8. MISCELLANEOUS PROVISIONS
8.1 The acceptance of this Agreement by Secured Party shall not be
considered a waiver of or in any way to affect or impair any other security that
Secured Party may have, acquire simultaneously herewith, or hereafter acquire
for the payment or performance of the Obligation, nor shall the taking by
Secured Party at any time of any such additional security be construed as a
waiver of or in any way to affect or impair the Security Interest; Secured Party
may resort, for the payment or performance of the Obligation, to its several
securities therefor in such order and manner as it may determine.
8.2 Without notice or demand, without affecting the obligations of
Debtor hereunder or the personal liability of any person for payment or
performance of the Obligation, and without affecting the Security Interest or
the priority thereof, Secured Party, from time to time, may: (i) extend the time
for payment of all or any part of the Obligation, accept a renewal note
therefor, reduce the payments thereon, release any person liable for all or any
part thereof, or otherwise change the terms of all or any part of the
Obligation; (ii) take and hold other security for the payment or performance of
the Obligation and enforce, exchange, substitute, subordinate, waive or release
any such security; (iii) join in any extension or subordination agreement; or
(iv) release any part of the Collateral from the Security Interest.
6
<PAGE>
8.3 Debtor waives and agrees not to assert: (i) any right to require
Secured Party to proceed against any guarantor, to proceed against or exhaust
any other security for the Obligation, to pursue any other remedy available to
Secured Party, or to pursue any remedy in any particular order or manner; (ii)
the benefits of any legal or equitable doctrine or principle of marshalling;
(iii) the benefits of any statute of limitations affecting the enforcement
hereof; (iv) demand, diligence, presentment for payment, protest and demand, and
notice of extension, dishonor, protest, demand and nonpayment, relating to the
Obligation; and (v) any benefit of, and any right to participate in, any other
security now or hereafter held by Secured Party.
8.4 The terms herein shall have the meanings in and be construed under
the Uniform Commercial Code. This Agreement shall be governed by and construed
according to the laws of the State of Arizona. Each provision of this Agreement
shall be interpreted in such manner as to be effective and valid under
applicable law, but if any provision of this Agreement is held to be void or
invalid, the same shall not affect the remainder hereof which shall be effective
as though the void or invalid provision had not been contained herein.
8.5 No modification, rescission, waiver, release or amendment of any
provision of this Agreement shall be made except by a written agreement executed
by Debtor and a duly authorized officer of Secured Party.
8.6 This is a continuing Agreement which shall remain in full force and
effect until actual receipt by Secured Party of written notice of its revocation
as to future transactions and shall remain in full force and effect thereafter
until all of the Obligation with respect to the Term Loan incurred before the
receipt of such notice, and all of the Obligation incurred thereafter under
commitments extended by Secured Party before the receipt of such notice with
respect to the Term Loan, shall have been paid and performed in full. Once the
Term Loan has been fully paid, Secured Party agrees to terminate this Security
Agreement and release its Security Interest with respect to the Collateral.
8.7 No setoff or claim that Debtor now has or may in the future have
against Secured Party shall relieve Debtor from paying or performing the
Obligation.
8.8 Time is of the essence hereof. All liability hereunder shall be
joint and several. This Agreement shall be binding upon, and shall inure to the
benefit of, the parties hereto and their heirs, personal representatives,
successors and assigns. The term "Secured Party" shall include not only the
original Secured Party hereunder but also any future owner and holder, including
pledgees, of note or notes evidencing the Obligation. The provisions hereof
shall apply to the parties according to the context thereof and without regard
to the number or gender of words or expressions used.
8.9 All notices required or permitted to be given hereunder shall be in
writing and may be given in person or by United States mail, by delivery service
or by electronic transmission. Any notice directed to a party to this Agreement
shall become effective upon the earliest of the following: (i) actual receipt by
that party; (ii) delivery to the designated address of that party, addressed to
that party; or (iii) if given by certified or registered United States mail,
twenty-four (24) hours after deposit with the United States Postal Service,
postage prepaid, addressed to that party at its designated address. The
designated address of a party shall be the address of that party shown at the
beginning of this Agreement or such other address as that party, from time to
time, may specify by notice to the other parties.
7
<PAGE>
8.10 A carbon, photographic or other reproduced copy of this Agreement
and/or any financing statement relating hereto shall be sufficient for filing
and/or recording as a financing statement.
IN WITNESS WHEREOF, these presents are executed as of the date
indicated above.
THREE-FIVE SYSTEMS, INC., a Delaware
corporation
By:____________________________________
Name:__________________________________
Its:___________________________________
DEBTOR
-9-
<PAGE>
SCHEDULE "A"
COLLATERAL
----------
(a) All equipment now owned or hereafter acquired, including all
furniture, fixtures, furnishings, vehicles (whether titled or non-titled),
machinery, materials and supplies, wherever located in the State of Arizona,
together with all parts, accessories, attachments, additions thereto or
replacements therefor;
(b) Together with (i) all policies or certificates of insurance
covering any of the foregoing property, and all awards, loss payments, proceeds
and premium refunds that may become payable with respect to such policies; and
(ii) all proceeds of any of the foregoing property, whether due or to become due
from any sale, exchange or other disposition thereof, whether cash or non-cash
in nature, and whether represented by checks, drafts, notes or other instruments
for the payment of money, including, without limitation, all property, whether
cash or non-cash in nature, derived from tort, contractual or other claims
arising in connection with any of the foregoing property.
EXHIBIT 11
THREE-FIVE SYSTEMS, INC.
STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
<TABLE>
<CAPTION>
FOR THE YEAR ENDED
DECEMBER 31,
------------------------------------------------
1996 1995 1994
------------- ------------ -------------
<S> <C> <C> <C>
Common shares outstanding beginning of period 7,735,745 7,691,524 6,641,944
Effect of weighting shares:
Employee stock options exercised 31,999 24,472 23,824
Employee stock options outstanding -- 367,555 418,983
Purchase of treasury stock (1,906) -- --
Issuance of common stock -- -- 797,260
------------- ------------ -------------
Primary 7,765,838 8,083,551 7,882,011
============= ============ =============
Common shares outstanding beginning of period 7,735,745 7,691,524 6,641,944
Effect of weighting shares:
Employee stock options exercised 31,999 24,472 23,824
Employee stock options outstanding -- 367,567 427,443
Purchase of treasury stock (1,906) -- --
Issuance of common stock -- -- 797,260
------------- ------------ -------------
Fully diluted 7,765,838 8,083,563 7,890,471
============= ============ =============
Net income (loss) $ (3,831,000) $ 8,417,000 $ 12,546,000
============= ============ =============
NET INCOME (LOSS) PER COMMON AND
COMMON EQUIVALENT SHARES:
Net income (loss) per share
Primary $ (0.49) $ 1.04 $ 1.59
============= ============ =============
Fully diluted $ (0.49) $ 1.04 $ 1.59
============= ============ =============
</TABLE>
As independent public accountants, we hereby consent to the incorporation of our
report included in this Form 10-K, into the Company's previously filed
Registration Statement File No's 33-77600, 33-76090, 33-36968, and 33-88706.
/s/ Arthur Andersen LLP
Phoenix, Arizona,
March 11, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1996 AND THE RELATED CONSOLIDATED
STATEMENTS OF INCOME AND OF CASH FLOWS FOR THE TWELVE MONTHS ENDED DECEMBER 31,
1996 OF THREE-FIVE SYSTEMS, INC. AND ITS SUBSIDIARIES AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. THIS EXHIBIT SHALL NOT BE
DEEMED FILED FOR PURPOSES OF SECTION 11 OF THE SECURITIES ACT OF 1933 AND
SECTION 18 OF THE SECURITIES EXCHANGE ACT OF 1934, OR OTHERWISE SUBJECT TO THE
LIABILITY OF SUCH SECTIONS, NOR SHALL IT BE DEEMED A PART OF ANY OTHER FILING
WHICH INCORPORATES THIS REPORT BY REFERENCE, UNLESS SUCH OTHER FILING EXPRESSLY
INCORPORATES THIS EXHIBIT BY REFERENCE.
</LEGEND>
<MULTIPLIER> 1000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<EXCHANGE-RATE> 1
<CASH> 12,580
<SECURITIES> 0
<RECEIVABLES> 7,479
<ALLOWANCES> 649
<INVENTORY> 4,606
<CURRENT-ASSETS> 31,330
<PP&E> 39,207
<DEPRECIATION> 8,294
<TOTAL-ASSETS> 62,569
<CURRENT-LIABILITIES> 9,817
<BONDS> 0
0
0
<COMMON> 78
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 62,569
<SALES> 60,713
<TOTAL-REVENUES> 60,713
<CGS> 58,321
<TOTAL-COSTS> 67,737
<OTHER-EXPENSES> 139
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (6,751)
<INCOME-TAX> (2,920)
<INCOME-CONTINUING> (3,831)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,831)
<EPS-PRIMARY> (0.49)
<EPS-DILUTED> (0.49)
</TABLE>
