<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 0-20045
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WATSON PHARMACEUTICALS, INC.
(Exact name of Registrant as specified in its charter)
NEVADA 95-3872914
(State or other jurisdiction of (I.R.S Employer
incorporation or organization) Identification No.)
311 BONNIE CIRCLE
CORONA, CA 91720
(Address of principal executive offices) (Zip Code)
(909) 270-1400
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $.0033 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
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Indicated by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
AGGREGATE MARKET VALUE, AS OF FEBRUARY 28, 1997, OF COMMON STOCK HELD
BY NON-AFFILIATES OF THE REGISTRANT: $1,471,847,385 BASED ON THE LAST REPORTED
SALE PRICE ON THE NASDAQ NATIONAL MARKET SYSTEM.
NUMBER OF SHARES OF COMMON STOCK OUTSTANDING ON FEBRUARY 28, 1997: 40,506,503
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a definitive Proxy Statement pursuant to
Regulation 14A within 120 days after the end of the fiscal year ended December
31, 1996. Portions of such Proxy Statement are incorporated by reference in Part
III of this report.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Watson Pharmaceuticals, Inc. ("Watson" or the "Company"), incorporated
in 1985, is engaged in the research and development, production, marketing and
distribution of off-patent and proprietary pharmaceutical products. The Company
pursues a balanced strategy of generating revenue through its long-established
off-patent pharmaceutical business, capitalizing on its proven capabilities to
support the development of off-patent and proprietary products. The Company's
objective is to become a fully integrated pharmaceutical company which (i)
develops and markets off-patent pharmaceuticals and (ii) develops proprietary
and off-patent products and markets such products worldwide through
pharmaceutical companies, joint ventures and its own marketing efforts. The
Company regularly reviews potential opportunities to acquire or invest in
technologies, products or product rights and businesses compatible with its
existing business.
Since inception, and prior to the merger with Circa Pharmaceuticals,
Inc. ("Circa"), the Company derived a substantial portion of its revenues from
the sale of off-patent pharmaceutical products. While this continues to be the
primary revenue source, certain developments have occurred which have augmented
the Company's revenue mix resulting in a decreased emphasis upon sales of
off-patent products. Management expects this change in the mix of revenues to
continue. Product sales of off-patent medications accounted for approximately
99% of total revenues in 1994. In 1995 and 1996, sales of off-patent products
accounted for approximately 86% of total revenues and royalty income accounted
for approximately 14% of total revenues. A portion of the Company's income is
included in other income, as a result of its joint ventures and investments, and
is not reflected in its consolidated revenue category.
At February 28, 1997, the Company, had received 88 Abbreviated New Drug
Applications ("ANDAs") for 33 off-patent products and one New Drug Application
("NDA") for one brand product. These 34 products are approved in 97 separate
dosage strengths. The Company currently manufactures and markets 29 off-patent
products in 77 dosages and one brand product in one dosage. On February 14,
1997, the Company announced FDA approval of its second brand product,
Norco(TM), the highest single tablet dose of Hydrocodone Bitartrate with the
lowest level of Acetaminophen indicated for the relief of moderate to moderately
severe pain. The Company launched Norco(TM) in the first quarter of 1997. As
of February 28, 1997, the Company had eight ANDAs representing six drugs pending
before the FDA and has several drugs under development. The Company intends to
continue to develop off-patent pharmaceutical products based upon market
potential, competition, target indications and other considerations. The number
of products under development may vary from time to time depending on these
factors. The Company also seeks to develop difficult-to-duplicate formulations
of both off-patent drugs and proprietary products which employ its drug delivery
systems.
The foregoing product information relating to the Company, and all
other information contained in this Form 10-K relating to the Company, unless
otherwise expressly provided, excludes information relating to Oclassen
Pharmaceuticals, Inc. ("Oclassen") and Royce Laboratories, Inc. ("Royce")
(as discussed below).
RECENT MERGER
On September 25, 1996, the Company entered into a definitive Agreement
and Plan of Merger, as amended effective November 14, 1996 and as further
amended effective December 31, 1996, (collectively, the "Oclassen Merger
Agreement") with Oclassen. Pursuant to the Oclassen Merger Agreement, effective
February 27, 1997, Oclassen was merged with a subsidiary of the Company created
for the purpose of the merger, with Oclassen surviving the merger as a wholly
owned subsidiary of the Company.
Oclassen develops specialty prescription pharmaceuticals to prevent and
treat skin diseases, and markets these products to dermatologists. Oclassen
in-licenses pharmaceutical products, which have been developed beyond the
initial discovery phase, from domestic and foreign pharmaceutical companies and
from universities and research institutions. Oclassen completes the product
formulation and any preclinical development, conducts clinical trials and brings
products through the required regulatory approval process and into the market.
Oclassen markets its products through its 60-person nationwide direct sales
force. Oclassen believes that its in-licensing, development and marketing
strategy reduces the time, risks and costs associated with product development
and marketing.
On February 26, 1997, the stockholders of Oclassen approved the merger
and under the terms of the Oclassen Merger Agreement, Oclassen stockholders are
expected to receive 0.37 of a share of the Company's common stock for each
Oclassen common stock. Accordingly, the Company issued approximately 3.3 million
shares of its common stock for all of the outstanding common stock of Oclassen.
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The Company believes that the merger qualifies as a tax-free
reorganization and has been accounted for as a pooling of interests. See
Watson's Form S-4 Registration Statement, as amended (Registration No.
333-16275) for a further description of the terms of the Oclassen merger.
PENDING MERGER
On December 24, 1996, the Company entered into a definitive Agreement
and Plan of Merger, as amended effective March 4, 1997, collectively, (the
"Royce Merger Agreement") with Royce. Pursuant to the Royce Merger Agreement,
Royce agreed to merge with a subsidiary of the Company created for the purpose
of the merger, with Royce surviving the merger as a wholly owned subsidiary of
the Company.
Royce develops, manufactures and markets off-patent prescription drugs
in solid dosage forms (tablets and capsules). At present, Royce manufactures and
markets 20 off-patent prescription drugs in 42 dosage strengths and has received
approval for an additional drug in 3 dosage strengths that it has not yet
commenced manufacturing or marketing. In addition, Royce has ANDAs pending with
the FDA for 9 new products in 15 dosage strengths.
At the effective time of the Royce Merger, Royce stockholders will
receive an aggregate of up to approximately 2.6 million shares of the Company's
common stock. Consummation of the Royce Merger is subject to the satisfaction of
certain conditions, including, without limitation, approval of the Royce Merger
Agreement by the Royce stockholders. It is intended that the Royce Merger will
qualify as a pooling of interests for accounting purposes and a tax-free
reorganization for federal income tax purposes. The Royce Merger Agreement may
be terminated and the Royce Merger abandoned if the merger has not occurred by
April 30, 1997. The Royce stockholders' meeting is scheduled for April 16, 1997,
and if approved, the merger is expected to close the next day. See Watson's Form
S-4 Registration Statement (Registration No. 333-20029) for a further
description of the terms of the merger.
1995 MERGER WITH CIRCA
In July 1995, a wholly owned subsidiary of the Company merged with
Circa Pharmaceuticals, Inc. ("Circa") in a transaction accounted for as a
pooling of interests for accounting purposes and a tax-free exchange for federal
income tax purposes. The merger strengthened and diversified the Company's
revenue base, enhanced its manufacturing capabilities and increased its product
development program, particularly in the area of proprietary products. Following
the merger, Dr. Melvin Sharoky, the president of Circa, became president of the
Company. Dr. Allen Chao, who had been president, became chief executive officer
and subsequently, Chairman of the Company. Dr. Sharoky is also the president of
Somerset Pharmaceuticals, Inc. ("Somerset"), a brand pharmaceutical company in
which the Company owns a 50-percent interest. See "--Partnership and Joint
Venture Activities."
PARTNERSHIP AND JOINT VENTURE ACTIVITIES
A significant portion of the Company's net income is derived from joint
ventures and a royalty arrangement. In addition, the Company is involved in
developing controlled-release technology primarily through a joint venture. The
Company does not have control of these joint ventures, which involve several
partners, or the commercial exploitation of the licensed products they
manufacture. Further, there can be no assurance that such joint ventures will be
profitable. In certain of these arrangements, products developed or marketed by
the Company may be competitive with products developed by such joint ventures or
the joint venture partners. The Company's joint venture arrangement with
Rhone-Poulenc Rorer, Inc. ("RPR") has certain restrictions which may limit the
development or marketing of future products competitive with the Dilacor XR(R)
product line as stated in the agreement. To the extent any such restrictions are
enforced, such restrictions could affect future revenues.
In 1989, the Company and RPR formed a partnership to develop and market
Dilacor XR(R), a pharmaceutical product used for the treatment of hypertension
and angina. Through an amended partnership agreement with RPR, the Company earns
royalties on sales of Dilacor XR(R). Royalty income is determined based upon
market demand for the product, as evidenced by prescriptions written, as defined
in the partnership agreement. Revenues under this royalty agreement were $27.2
million in 1996, $22.2 million in 1995 and $1.2 million in 1994. Pursuant to the
contract, the royalty percentage earned by the Company on RPR's sales of Dilacor
XR(R) in 1994 was 1%, whereas in 1995 and 1996 it was 20%. The royalty rate
increases in 1997 to 22%, and is reduced to 3% after 2000. Royalties are
remitted to the Company on a quarterly basis. Dilacor XR(R) lost exclusivity in
May 1995. The loss of exclusivity did not have a significant impact on 1995 and
1996 sales of the product because competitors have not introduced competitive
off-patent products. However, if competitors introduce off-patent versions of
this drug, sales of Dilacor XR(R) are likely to decrease, resulting in a
corresponding decrease in the Company's royalty income. It is the Company's
intention to launch an off-patent Dilacor XR(R) product, as competition
intensifies. The costs and profits from the off-patent product will be shared
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equally by the Company and RPR. However, actual revenues, costs and profits, if
any, from any future collaboration cannot be determined at this time.
The Company has made substantial investments in pharmaceutical joint
ventures and plans to continue this method of investment in the future. The
Company owns a 50% interest in the outstanding common stock of Somerset.
Somerset manufactures and markets the product Eldepryl(R), which is used in the
treatment of Parkinson's disease. The Company recognized equity in the earnings
of Somerset of $20.1 million, $24.8 million and $25.1 million for the years
ended December 31, 1996, 1995 and 1994, respectively. Orphan drug exclusivity
expired for Eldepryl(R) in June 1996. During 1996, the Company experienced a
decrease in earnings from Somerset due to increased competition for Eldepryl(R)
and increased research and development spending. Management anticipates that the
Company's equity in earnings from Somerset will be substantially reduced in 1997
from prior year levels due to increased competition and due to Somerset's
anticipated increased expenditures on research and development in connection
with the development of several new products.
On March 7, 1997, Somerset received notice from taxing authorities
that it may be subject to approximately $9.0 million (50% of which would be
Watson's share) of additional income tax and interest charges that have not
been accrued as of December 31, 1996. Management of Somerset believes that it
has complied with all relevant tax laws and intends to vigorously defend its
position on this matter. Any adverse outcome of this matter may effectively
reduce Watson's equity in earnings from joint ventures during 1997.
In October 1995, the Company increased its investment in Andrx, then a
privately held corporation involved in the development of controlled-release
drug delivery systems for certain orally administered drugs. This $15.6 million
investment increased the Company's total ownership to 19.5% of the Andrx common
stock outstanding. On June 14, 1996, Andrx completed an initial public offering
of its securities, effectively reducing the Company's ownership interest in
Andrx to approximately 15.6% at December 31, 1996. As of December 31, 1996, the
Company recorded an unrealized gain of $7.2 million (net of applicable income
taxes of $4.8 million) on its investment in Andrx.
In connection with the increased investment, the Company and Andrx
amended their joint venture agreement and made the parties equal partners in the
ANCIRC joint venture. ANCIRC, formed in July 1994, is conducting research and
development activities in the area of controlled-release technology. In the
future, the Company expects certain controlled-release products to emerge from
ANCIRC that, subject to FDA approval, will contribute to the Company's long-term
growth.
In March 1996, Watson's wholly owned subsidiary, Watson Pharmaceuticals
(Asia) Ltd. ("Watson (Asia)") entered into an agreement to form two joint
ventures with China-based Changzhou No. 4 Pharmaceutical Factory ("Changzhou").
The first joint venture, Changzhou Watson Pharmaceuticals Co. Ltd. ("Joint
Venture A") will establish a manufacturing facility in China for the production,
marketing and sales of pharmaceuticals and related products. A second joint
venture will be known as Changzhou Siyao Pharmaceuticals Co. Ltd. ("Joint
Venture B"). Joint Venture B will provide the raw materials to Joint Venture A.
Joint Venture A is 87.5% owned by Watson (Asia) and 12.5% owned by Changzhou,
and Joint Venture B is owned 25% by Watson (Asia) and 75% by Changzhou. The
total investment by Watson (Asia) in Joint Ventures A and B is expected to be
approximately $9 million. Construction of the manufacturing facility for Joint
Venture A began during 1996, and is expected to be operational by late 1997. The
Company invested approximately $3.5 million in Watson (Asia) during 1996.
Management anticipates that the operations of Joint Venture A will commence in
late 1997.
RESEARCH RELATED ACTIVITIES
In 1991, the Company acquired Zetachron, Inc. ("Zetachron"), a
research and development organization, specializing in the development of
advanced drug delivery systems. Zetachron was merged into Watson Laboratories,
Inc. ("Watson Labs"), the Company's principal operating subsidiary on June 30,
1995, and certain of Zetachron's research and development activities were
terminated shortly thereafter. The Company is developing certain proprietary
drug products that utilize its drug delivery systems, each of which, if and when
developed, will require FDA approval of a NDA prior to marketing. Based on data
gathered during clinical studies, during 1995 the Company focused its efforts on
two products that utilize its proprietary drug delivery systems.
Progesterone/Vaginal Insert and Estradiol/Vaginal Insert, which will be used for
hormone replacement therapy, are currently in Phase II/III clinical studies.
There can be no assurance that any of these proprietary products, if and when
fully developed, will contribute materially to the Company's revenues in the
future.
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The Company is also involved in the development of a gum-delivery
technology and has been working on two prescription pharmaceutical products in
this area. In 1994, an application was filed with the FDA for a generic version
of Nicorette(R), a nicotine gum product developed and marketed by Smith Kline
Beecham ("SKB"). In February 1996, SKB's Nicorette(R) was approved by the FDA as
an over the counter product, and exclusivity of Nicorette(R) was extended to
1999.
In 1993, the Company acquired the rights to manufacture and market a
product under a NDA for a widely-used cardiovascular agent. In November 1994,
the Company filed a NDA seeking approval for this product, which it believes
will fill a need for clinicians working in the cardiovascular field. This
product was approved in December 1996 and is now marketed under the brand name,
Microzide(TM).
Oclassen is developing a variety of new products, as well as new
indications and formulations of its current products, for the treatment of
genital warts, acne, psoriasis, vitiligo, skin infections and dermatoses.
Extensions to the current product lines include a gel formulation of
Condylox(R) for current and expanded indications, and cream, gel and
emollient cream formulations of Cormax(TM) for inflammatory skin dermatoses.
Development of a psoralen-based phototherapy product for use in PUVA therapy for
indications in psoriasis and vitiligo is currently underway. Oclassen believes
that this product will reduce the side effects characteristic of current
psoralen therapy. Additionally, Oclassen is developing a topical anti-microbial
product line based upon proprietary technology utilizing the active form of
iodine. These products are intended to minimize irritation and microbial
resistance while maintaining a high activity level against a variety of
pathogens.
The Company continues to devote significant resources to the research
and development of off-patent and proprietary products. However, there can be no
assurance that any of the Company's products currently in preclinical or
clinical trials will ever receive the required regulatory approvals from the
FDA.
PRODUCT DEVELOPMENT STRATEGY
The Company intends to pursue a balanced strategy of developing
off-patent and proprietary products. Over the next few years, patents on a
relatively large number of branded drugs will expire, thereby providing
additional off-patent product opportunities. The Company is developing a wide
variety of off-patent products, including those with small but specialized or
growing markets as well as products whose brand name equivalents have U.S. sales
of over $100 million.
Off-Patent Pharmaceuticals
The Company has invested significantly in off-patent product
development and is developing a wide variety of products, including therapeutic
equivalents of solid, liquid and sustained release products. Each product is
chosen based on the patent expiration date, market size and potential,
anticipated competition, availability of active ingredients and other
considerations. The Company seeks to be among the first companies to offer such
products. The Company has also focused its development efforts on technically
difficult-to-duplicate products or products that require advanced manufacturing
technology, and the Company believes that such products will experience limited
competition. Of the 77 off-patent dosages currently marketed by the Company, it
received the first ANDA approval for 38 products. As of February 28, 1997, the
Company believed it held the only ANDA approval for 15 of these products. The
Company expects to significantly increase its production of off-patent
pharmaceuticals in 1997 following the acquisition of Royce.
The Company targets difficult-to-produce niche off-patent
pharmaceuticals thereby minimizing competition with traditional
commodity-oriented off-patent pharmaceutical companies. The Company's sales of
off-patent drugs have increased significantly in recent years. The Company
believes that this growth is attributable to a number of factors, including (i)
modification of certain state laws to permit or mandate substitution of
off-patent drugs by pharmacists, (ii) the enactment of abbreviated procedures
for obtaining FDA approval to manufacture off-patent prescription drugs, (iii)
changes in government and third-party payor healthcare reimbursement policies to
encourage cost containment by health care providers and consumers, (iv)
increased acceptance of off-patent drugs by physicians, pharmacists and
consumers, and (v) the increasing number of formerly patented drugs which have
become available to off-patent competition.
Proprietary Pharmaceuticals
The Company is developing proprietary products through a combination of
internal and collaborative programs, including joint ventures. The Company may
internally develop these proprietary products through all stages of development,
including final manufacturing and commercialization. In addition, the Company
may choose to acquire developed products for marketing and distribution
purposes. The Company may also choose to enter into collaborative or licensing
agreements with various parties at various stages of product development.
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The Company believes that its merger with Oclassen will significantly
expand the Company's breadth of proprietary products. Oclassen's product
development efforts are directed to the development and regulatory approval of
new pharmaceuticals for the treatment of skin diseases. These products typically
have been initially researched by other pharmaceutical companies, universities
and research institutions and have been the subject of at least limited human
clinical trials. Oclassen focuses its development efforts on selected product
candidates that it believes, based on its market research and technical
evaluation, have a high probability of commercial success. Oclassen's
development group also seeks to identify additional indications for and create
new formulations of previously in-licensed products. Where appropriate, Oclassen
may sub-contract with third parties for certain phases of its development
activities.
Oclassen's technical development unit is responsible for the design,
formulation and scale-up to production of dosage forms, the analytical
development of testing methods and specifications, and quality control/quality
assurance of clinical supplies and marketed products. Oclassen's clinical
research group has responsibility for the design, conduct, monitoring and
evaluation of clinical trials in support of its development projects. Oclassen's
regulatory affairs team organizes the data developed for presentation to the FDA
and maintains contact with the appropriate authorities through the preclinical
development and approval stages of Oclassen's regulatory submissions.
Drug Delivery Systems
The Company continues to evaluate the specific application of injection
molding technology in the area of progesterone vaginal insert and estradiol
vaginal insert products.
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PRODUCTS
The following table lists the off-patent products for which the Company
holds approved ANDAs:
<TABLE>
<CAPTION>
PRODUCT NAME(1) NUMBER OF DOSAGES THERAPEUTIC CATEGORY BRAND NAME
--------------- ----------------- -------------------- ----------
<S> <C> <C> <C>
CENTRAL NERVOUS SYSTEM
Amoxapine 4 Anti-depressant Asendin(R)
Clorazepate Dipotassium 3 Anti-anxiety Tranxene(R)
Lorazepam 3 Anti-anxiety Ativan(R)
Loxapine Succinate 4 Anti-psychotic Loxitane(R)
Maprotiline Hydrochloride 3 Anti-depressant Ludiomil(R)
Carbidopa-Levodopa 3 Anti-Parkinsons Sinemet(R)
Clomipramine 3 Anti-psychotic Anafranil(R)
CARDIOVASCULAR
Acebutolol Hydrochloride 2 Anti-hypertensive Sectral(R)
Furosemide 3 Anti-hypertensive Lasix(R)
Gemfibrozil 1 Anti-cholesterol Lopid(R)
Guanabenz Acetate 2 Anti-hypertensive Wytensin(R)
Guanfacine Hydrochloride 2 Anti-hypertensive Tenex(R)
Indapamide 2 Anti-hypertensive Lozol(R)
Methyldopa
& Hydrochlorothiazide 4 Anti-hypertensive Aldoril(R)
Metoprolol Tartrate 2 Anti-hypertensive Lopressor(R)
Mexilitene Hydrochloride 3 Anti-hypertensive Mexitil(R)
Propranolol Hydrochloride 6 Anti-hypertensive Inderal(R)
Triamterene &
Hydrochlorothiazide 2 Anti-hypertensive Maxzide(R)
Maxzide 25(R)
Verapamil Hydrochloride 3 Anti-hypertensive Calan(R)
Isoptin(R)
ORAL CONTRACEPTIVE
Ethynodiol Diacetate &
Ethinyl Estradiol 4 Oral contraceptive Demulen(R)
Norethindrone &
Ethinyl Estradiol 6 Oral contraceptive Modicon(R)
Brevicon(R)
Ortho-Novum(R)
Norinyl(R)
Norethindrone & Mestranol 2 Oral contraceptive Ortho-Novum(R)
Norinyl(R)
ANALGESIC
Butalbital, Aspirin,
Caffeine and Codeine Phosphate 1 Analgesic Fiorinal(R) with Codeine
Fenoprofen Calcium 3 Anti-inflammatory Nalfon(R)
Hydrocodone Bitartrate &
Acetaminophen 8 Analgesic Vicodin(R)
Lortab(R)
Indomethacin 2 Anti-inflammatory Indocin(R)
HORMONE/HORMONE REGULATOR
Estradiol 3 Hormone replacement Estrace(R)
Estropipate 4 Hormone replacement Ogen(R)
OTHER
Albuterol Sulfate 3 Asthma Proventil(R)
Ventolin(R)
Cyclobenzaprine Hydrochloride 1 Muscle spasm relief Flexeril(R)
Glipizide 2 Anti-diabetic Glucotrol(R)
Metoclopramide Hydrochloride 1 Pro-motility Reglan(R)
Loperamide Hydrochloride 1 Anti-diarrheal Imodium(R) A-D
</TABLE>
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(1) The Company has not marketed four of the products for which it holds
approved ANDAs.
In addition, the Company holds an approved NDA for Microzide(TM)
(hydrochlorothiazide) which is manufactured and marketed in a single dosage.
Oclassen Products
Oclassen currently markets the following five commercial prescription
brands in the United States:
Condylox(R) (podofilox 0.5%) Topical Solution was introduced in the
United States by Oclassen in April 1991 and was the first patient-applied
topical therapy approved by the FDA for the treatment of external genital warts,
the most common viral sexually transmitted disease. Oclassen in-licensed
Condylox(R) in 1985, conducted the preclinical studies and clinical trials
necessary to file a NDA and, in December 1990, obtained FDA approval. Oclassen
believes Condylox(R) therapy is a less invasive and more cost-effective
alternative to most other genital wart treatments, such as cryosurgery, laser
surgery, caustic topical agents, intralesional injections and excision.
Condylox(R) Topical Solution is promoted to dermatologists and urologists by the
Oclassen sales force.
Monodox(R) (doxycycline monohydrate), available in 50 mg and 100 mg
capsules, was introduced in the United States by Oclassen in March 1991. In
1990, Oclassen in-licensed the rights to distribute this FDA-approved broad
spectrum oral antibiotic in the United States and Canada. In 1995, Oclassen
purchased the NDA for Monodox(R). Monodox(R) is promoted primarily for the
treatment of acne. Doxycycline, the active component of Monodox(R), has been
shown in clinical trials to be as effective as minocycline with an alternative
side effect profile. Minocycline is the leading oral antibiotic for acne.
Cordran(R) (flurandrenolide) is a topical steroid used for the
treatment of the inflammatory and pruritic manifestations of
corticosteroid-responsive dermatoses. Oclassen commenced sales of Cordran(R)
topical steroid products in September 1992 after Oclassen in-licensed the
exclusive United States and Canadian distribution rights to this product line
through an agreement with Eli Lilly and Company ("Lilly"). The Cordran(R)
formulations include Cordran(R) Cream, Ointment and Lotion as well as
Cordran(R) Tape, the only fluorinated steroid-impregnated tape available in
the United States. Topical steroids are used for the treatment of skin
inflammation and are among the drugs most commonly prescribed by dermatologists.
Cinobac(R) (cinoxacin) is an oral quinolone anti-infective,
available in 250 mg and 500 mg capsules, indicated in the treatment of
uncomplicated urinary tract infections. Oclassen commenced sales of
Cinobac(R) Capsules in the United States in September 1992, under an
agreement with Lilly granting Oclassen exclusive United States and Canadian
distribution rights. Oclassen promotes Cinobac(R) primarily to urologists for
the outpatient treatment of initial and recurrent urinary tract infections and
prophylaxis.
Cormax(TM) (clobetasol propionate) is a highly potent topical steroid
used for the short-term treatment of inflammatory and pruritic manifestations of
moderate to severe corticosteroid-responsive dermatoses. Oclassen introduced
Cormax(TM) Scalp Application in March 1996 and Cormax(TM) Ointment in June
1996 after in-licensing the U.S. marketing and distribution rights.
Marketing, Distribution and Joint Venture Revenues
The Company markets its products to drug distributors, pharmaceutical
wholesalers, chain drug stores, hospitals, health maintenance organizations and
other drug companies. The Company sells its products under the "Watson
Laboratories" brand name and intends to increase the percentage of products sold
under such brand name in the future. During 1996, six dosages in the hydrocodone
bitartrate/acetaminophen product group sold by the Company accounted for
approximately 37% of total revenues. In 1995, five dosages in the hydrocodone
bitartrate/acetaminophen product group accounted for approximately 44% of the
Company's total revenues. In 1994, three dosages in the hydrocodone
bitartrate/acetaminophen product group accounted for approximately 52% of the
Company's total revenues. For the same period, the loxapine succinate product
group accounted for approximately 11% of total revenues. Due to FDA approval of
products that will compete with the Company's hydrocodone products group,
management anticipates increased price competition with respect to the
hydrocodone product line and consequently the Company may experience a reduction
in future sales of such products. The Company's primary supplier of raw
materials for the hydrocodone product line has been selling finished products at
lower prices than the Company's product sales prices. Management is unable to
predict whether such sales could have a material adverse effect on the sales of
the Company's hydrocodone products.
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The Company's equity in the earnings of Somerset was generated from the
sale of one product, Eldepryl(R). Exclusivity on Eldepryl(R) expired in June
1996. Currently, competitors have introduced off-patent products to compete with
Eldepryl(R). Management anticipates that the Company's equity in earnings from
Somerset will be substantially reduced in 1997 from prior year levels due to
increased competition for Eldepryl(R) increased expenditures on research and
development in connection with the development of several new products. Somerset
is developing an Eldepryl(R) transdermal patch and is currently in Phase III
clinical trials on this product. In addition, Somerset is committed to the
development of other pharmaceutical products. The loss of exclusivity with
respect to these products, and/or the introduction by other companies of
additional competitive products, could have a material adverse effect on the
operating results and financial condition of the Company. See "Business --
Competition."
The Company ships products pursuant to purchase orders and does not
have any supply agreements with its customers. The Company's business does not
experience any significant seasonal variation. No single customer accounted for
more than 10% of the Company's total 1996 product sales revenues.
The Company's newly created brand division has approximately 70 sales
and marketing professionals focusing its direct sales efforts on primary care
physicians and certain specialized doctors. The sales force markets
Microzide(R), Norco(TM) and Zovia(TM) product lines. Microzide(R) is
used for the treatment of mild-to-moderate hypertension; Norco(TM) is used for
relief of moderate to moderately severe pain; and Zovia(TM) is a branded
generic of Demulen(R), an oral contraceptive.
Oclassen focuses its direct sales efforts on dermatologists. There are
an estimated 7,000 dermatologists in the United States and Oclassen believes
that these physicians can be effectively reached by a highly focused and
experienced sales force. Dermatologists located in areas not covered by an
Oclassen field representative are serviced by an in-house telemarketing team.
Although Oclassen markets its products to physicians, it distributes its
products through major drug wholesalers who supply local pharmacies that fill
physician prescriptions.
Royalty income from RPR's sales of Dilacor XR(R) represented 14.0% of
the Company's total revenues in 1996, 14.5% in 1995 and 1.3% in 1994. Royalty
income is recognized based on prescriptions written, as defined in the
partnership agreement, for the product Dilacor XR(R). Dilacor XR(R) is used for
the treatment of hypertension and angina. Revenues under the royalty agreement
were $27.2 million in 1996, $22.2 million in 1995 and $1.2 million in 1994. As
contractually specified, the royalty percentage earned by Watson in 1994 was 1%,
whereas in 1995 and 1996 it was 20%. Dilacor XR(R) lost exclusivity in May 1995.
The loss of exclusivity did not have a significant impact on the 1995 and 1996
sales of the product. However, if competitors introduce off-patent versions of
this drug, sales of Dilacor XR(R) are likely to decrease, resulting in a
corresponding decrease in the Company's royalty income. The Company and RPR
intend to launch an off-patent Dilacor XR(R) product, as considered
appropriate. The costs and profits from the off-patent product are to be shared
equally by the Company and RPR. Actual revenues, costs and profits, from future
collaboration, if any, cannot be determined at this time. The Company's
agreement with RPR has certain restrictions which may limit the development or
marketing of the existing or future products of the Company. To the extent any
such restrictions are enforced, such restrictions could affect future revenues.
Marketing Collaborations
Oclassen has entered into and, when appropriate, intends to pursue,
collaborative marketing relationships to address market opportunities not
efficiently reached by a focused sales force. Such relationships may include
co-promotion and co-marketing arrangements to broaden marketing efforts within
the United States to larger physician groups, such as obstetricians,
gynecologists and primary care physicians, to market products internationally
and to market Oclassen's current products for therapeutic applications outside
Oclassen's focus. Such co-promotion arrangements may require Oclassen to pay
commissions on sales over certain thresholds and make certain minimum payments
for promotion and advertising.
Other Activities
In 1995, the Company entered into a co-marketing agreement with
Creighton Products Corporation ("Creighton"), a division of Sandoz
Pharmaceuticals, Inc. This co-marketing agreement was expected to expand the
Company's distribution channels by providing Creighton with certain of the
Company's off-patent pharmaceutical products for distribution into Creighton's
managed care channels. Creighton provided the Company with products for
distribution into the Company's wholesaler and distributor channels. This
contract was terminated during 1996 in conjunction with the merger of Sandoz
Pharmaceuticals, Inc. with Ciba-Geigy, Inc. The Company does not believe the
termination of this contract will result in a material loss of income.
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SUBSIDIARIES
The Company's wholly owned subsidiaries include Watson Labs , Circa,
Watson (Asia), and Corona Pharmaceuticals, Inc. (currently inactive) and as of
February 27, 1997, Oclassen. Upon the anticipated closing of the Royce merger,
Royce will become a wholly owned subsidiary. Watson (Asia) owns an 87.5%
interest in Changzhou Watson Pharmaceutical Co., Ltd. (Joint Venture A), which
is consolidated for financial reporting purposes.
PATENTS AND PROPRIETARY RIGHTS
The Company believes that protection of its patents, proprietary
products, technologies, processes and know-how is important to its business. The
Company maintains an active patent program to protect its technologies. To date,
15 United States patents have been issued: five covering compositions of matter
for the oral delivery systems (which patents expire in 2003), five covering
aspects of the Company's buccal systems (which expire between 2005 and 2010),
two covering aspects of mucosal tissue drug delivery (which expire in 2007 and
2008), one covering the Company's microencapsulation composition used in its
sustained release oral potassium chloride product (expiring in 2006), one
covering a chlorhexidine compound (expiring in 2007) and one covering cutaneous
therapeutic devices (expiring in 2009). The Company maintains an aggressive
patent program, has three additional United States patents pending and has
several patent applications at different stages of development. Recent changes
to the patent law resulting from passage of the Uruguay Round Agreements Act
("URAA") will lengthen the term of some granted patents. Generally, patents have
terms that are the longer of 17 years from patent grant or 20 years from patent
application. The Company also seeks patent protection in major foreign
pharmaceutical markets, and has numerous foreign patents and patents pending.
There can be no assurance that the Company's patents or those of its competitors
would be held valid by a court of competent jurisdiction. Any litigation or
proceedings with respect to patents or proprietary rights could result in
substantial cost to the Company.
The Company does not know whether any of its developing applications
will result in the issuance of any patents or whether any issued patents will
provide proprietary protection or be circumvented or invalidated. The Company
may be required or may desire to obtain licenses from others to develop,
manufacture and market commercially viable products. There can be no assurance
that such licenses would be obtainable on commercially reasonable terms or that
any licensed patents or proprietary rights would be valid and enforceable.
The Company also relies upon unpatented trade secrets, and no assurance
can be given that others will not independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to the Company's
trade secrets or disclose such technology, or that the Company can meaningfully
protect its right to unpatented trade secrets. It is Company policy to require
its key employees, consultants and other advisors to execute confidentiality
agreements. There can be no assurance, however, that these agreements will
provide meaningful protection or adequate remedies for the Company's trade
secrets in the event of unauthorized use or disclosure of such information.
REGULATION
The research and development, manufacture and marketing of the
Company's products and systems are subject to regulation by the FDA in the
United States and by comparable authorities in other countries. These national
authorities and other federal, state and local entities regulate, among other
things, research and development activities and the testing, manufacture,
labeling, storage, record keeping, advertising and promotion of the Company's
products.
The Federal Food, Drug and Cosmetic Act, the Public Health Service Act,
the Controlled Substance Act and other federal statutes and regulations govern
or influence all aspects of the Company's business. Noncompliance with
applicable requirements can result in fines and other judicially imposed
sanctions, including product seizures, injunction actions and criminal
prosecutions. In addition, administrative remedies can involve the forced
voluntary recall of products as well as the refusal of the government to approve
pending applications or supplements to approved applications. The FDA also has
the authority to withdraw approval of drugs in accordance with statutory due
process procedures, and has significant additional authority under the Generic
Drug Enforcement Act of 1992, which is discussed below.
FDA approval is required before any dosage form of any new drug,
including an off-patent equivalent of a previously approved drug, can be
marketed. All applications for FDA approval must contain information relating to
product formulation, stability, manufacturing processes, packaging, labeling and
quality control. To obtain FDA approval for a new drug not previously approved
by the FDA, a prospective manufacturer must also provide substantial evidence of
safety and efficacy of the drug product. Finally, the manufacturer must
establish that the methods, facilities, and controls used in connection with the
production, processing, packaging, and storage of the drug meet FDA requirements
embodied in FDA regulations and guidelines generally referred to as the current
good manufacturing practice ("cGMP") requirements. Compliance with cGMP is
required at all times during the manufacture and processing of drugs. Such
compliance requires considerable Company time and resources in the areas of
production and quality control.
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There are generally two types of applications for FDA approval that
would be applicable to the Company's products:
New Drug Application ("NDA")
Generally, with respect to drugs with active ingredients and/or with a
dosage form, dosage strength or delivery system of an active ingredient not
previously approved by the FDA, a prospective manufacturer must submit to the
FDA complete reports of preclinical, clinical and laboratory studies performed
to establish that the drug will be safe and effective for its intended uses.
Substantially all of the Company's products employing its proprietary delivery
systems are expected to require approval under the NDA procedures.
The FDA approval process for a previously approved drug having a novel
dosage form or drug delivery system may involve the completion of preclinical
studies. Preclinical studies involve laboratory evaluation of product
characteristics and animal studies to assess the safety and potential efficacy
of the product, and proof that the product delivers sufficient quantities of the
drug to the bloodstream to produce the desired therapeutic result. The results
of these studies are submitted to the FDA as part of an Investigational New Drug
Application ("IND"). The IND requests authorization to initiate studies of the
new drug in humans based on the demonstrated safety and potential efficacy of
the compound in the preclinical studies. Once the IND becomes effective, human
clinical trials may commence.
Abbreviated New Drug Application ("ANDA")
The Drug Price Competition and Patent Term Restoration Act of 1984 (the
"1984 Amendments") established a statutory procedure for submission of ANDAs to
the FDA. Under the ANDA procedure, the FDA waives the requirement of submitting
complete reports of preclinical and clinical studies of safety and efficacy and
instead requires bioavailability data illustrating that the off-patent drug
formulation is bioequivalent to a previously approved drug. Bioavailability
measures the rate and extent of absorption of a drug's active ingredient and its
availability at the site of drug action, typically measured through blood
levels. An off-patent drug is bioequivalent to the previously approved drug if
the rate and extent of absorption of the off-patent drug are not significantly
different from that of the previously approved drug. All of the Company's
off-patent drug products, including products employing its proprietary drug
delivery systems, are subject to the NDA or ANDA approval procedures.
The 1984 Amendments protect certain drugs approved under NDA procedures
from immediate competition from ANDA-approved drugs. First, the effective date
of approval of an ANDA-approved drug will ordinarily be delayed until the
expiration of patents, if any, covering the NDA-approved drug, or, in the event
of a challenge to the validity or infringement of an existing patent, until a
court has determined the patent to be invalid or not infringed by the
ANDA-approved drug. Second, under the 1984 Amendments, existing product or use
patents on NDA-approved drugs may be extended for up to five years to compensate
the patent holder for the reduction of the effective patented marketing life of
the drug due to the federal regulatory review period. Finally, with respect to
NDA-approved drugs not covered by existing patents, the FDA awards periods of
three or five years exclusivity, depending on the nature of the NDA-approved
drug and the type of data submitted in the NDA. During a three-year exclusivity
period, the FDA will accept for evaluation an ANDA that refers to the
NDA-approved drug as a basis for approval, but the FDA will not make effective
any approval of such an ANDA before expiration of the three-year period of
exclusivity granted to the NDA-approved drug. During a five-year exclusivity
period, the FDA will not accept for evaluation an ANDA that refers to such an
NDA-approved drug as a basis for approval before expiration of the five-year
period of market exclusivity. Because FDA review preceding ANDA approval
ordinarily requires from one year to two years, the five-year exclusivity period
effectively grants the NDA-approved drug marketing exclusivity for a period of
six or more years.
Human clinical trials are typically conducted in three sequential
phases, but the phases may overlap. Phase I trials consist of testing the
product in a small number of patients, primarily for safety, at one or more
dosages. In Phase II, in addition to safety, the efficacy of the product is
evaluated in a patient population somewhat larger than Phase I trials. Phase III
trials typically involve additional testing for safety and clinical efficacy and
an expanded population at geographically dispersed test sites. A clinical plan,
or "protocol," accompanied by the approval of the institution participating in
the trials, must be submitted to the FDA prior to the commencement of each
clinical trial. All patients involved in the clinical trials must provide
informed consent prior to their participation. The FDA may order the temporary
or permanent discontinuation of a clinical trial at any time. The results of the
clinical trials are submitted to the FDA as part of the NDA to establish the
safety and effectiveness of the drug for its intended indications.
The FDA may not approve an NDA or ANDA if applicable regulatory
criteria, including compliance with cGMP, are not satisfied. The FDA may require
additional clinical testing or other types of testing, or manufacturing or
quality control changes. Even if such data are submitted or such changes are
made, the FDA may ultimately decide that the NDA or ANDA does not satisfy the
criteria for approval. Following approval of an NDA or ANDA, the FDA expects the
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applicant to conduct extensive in-process and finished product testing on
consecutive batches made in the initial manufacturing campaign to validate the
reliability of all critical processes during full-scale commercial production.
This is commonly referred to in the industry as the pre-shipment validation
process. Only after all processes have been shown through test data to produce
consistent results within quality specifications will the FDA authorize
commercial distribution. Accordingly, following the approval of an ANDA, several
weeks or months ordinarily are required to complete testing and the FDA
pre-shipment validation process. Product approvals may be withdrawn by the FDA
if compliance with regulatory standards is not maintained or if new evidence
demonstrating that the drug is unsafe or lacks efficacy for its intended uses
becomes known after the product reaches the market. The FDA may require testing
and surveillance programs to monitor the effect of proprietary drug delivery
systems which have been commercialized, and has the power to prevent or limit
further marketing of the product based on the results of these post-marketing
programs.
In recent years, the FDA's approval process of ANDA off-patent products
has become more rigorous, time consuming and costly, and the Company cannot
predict the extent to which it may be affected by legislative and regulatory
developments concerning its products, operations or the healthcare field
generally. The URAA, which became effective June 8, 1994, lengthens the term of
existing and future patents by changing the patent term from 17 years, based on
the date of patent grant, to 20 years, based on the date of patent application.
These URAA changes could postpone approval eligibility of some ANDAs. Regulatory
compliance issues or regulatory changes affecting the Company's operations or
the approval or shipment of products could have a material adverse effect upon
the Company's business.
Each domestic drug product manufacturing establishment must be
registered with, and achieve a satisfactory inspection from, the FDA. Drug
product manufacturing establishments located in California and New York also
must be licensed by each of these states. Establishments handling controlled
substances must be licensed by the United States Drug Enforcement Administration
("DEA"). Domestic manufacturing establishments are routinely subject to
inspection by the FDA prior to the approval of an NDA or ANDA and to biennial
inspections by the FDA for cGMP compliance after an NDA or ANDA has been
approved. The Prescription Drug User Fee Act of 1992, enacted to expedite drug
approval by providing the FDA with resources to hire additional medical
reviewers, imposes three kinds of user fees on manufacturers of NDA-approved
prescription drugs. Applicants submitting only ANDAs and most other off-patent
drug manufacturers, including the Company, are not currently subject to any of
the three user fees. If the Company submits NDAs for products employing its
proprietary drug delivery systems, the Company will be subject to user fees.
The Generic Drug Enforcement Act of 1992 establishes penalties for
wrongdoing in connection with the development or submission of an ANDA by
authorizing the FDA to permanently or temporarily debar companies or individuals
from submitting or assisting in the submission of an ANDA, and to temporarily
deny approval and suspend applications to market off-patent drugs. The FDA must
debar companies or individuals convicted of a federal felony for conduct
relating to the development or approval of an ANDA, and may debar persons
convicted of other misconduct. In addition to debarment, the FDA may refuse to
approve an ANDA (for up to 18 months) if the applicant is under active federal
criminal investigation for (i) bribery or (ii) making material false statements
in connection with any ANDA, and if a significant question has been raised
regarding the integrity of the approval process or the reliability of the data
in the ANDA. The FDA may also suspend the distribution of all drugs approved or
developed in connection with certain wrongful conduct. The FDA also has
authority to withdraw approval of an ANDA under certain circumstances and seek
civil penalties. The FDA can also significantly delay the approval of any
pending NDA or ANDA under the "Fraud, Untrue Statements of Material Facts,
Bribery, and Illegal Gratuities Policy."
The methods of reimbursement and fixing of reimbursement levels under
Medicare, Medicaid and other reimbursement programs are under active review by
federal, state and local government entities as well as by private third-party
reimbursers. In addition, Medicaid legislation requires that all pharmaceutical
manufacturers rebate to individual states a percentage of their revenues arising
from Medicaid-reimbursed drug sales. The required rebate for off-patent drug
manufacturers is currently 11%. In addition, political pressure to contain
health care costs at the federal and state levels is increasing.
Political, economic and regulatory influences are subjecting the health
care industry in the United States to fundamental change. The Clinton
Administration previously proposed comprehensive programs to reform the health
care system and has expressed its commitment to increase access to health care
for the presently uninsured, control the continued escalation of health care
expenditures and use health care reimbursement policy to help control the
federal deficit. All potential approaches are under consideration, including
mandated basic health care benefits, controls on health care spending through
limitation on the growth of private health insurance premiums and Medicare and
Medicaid spending, price discounts from drug manufacturers and the creation of
large insurance purchasing groups. In addition, some of the states in which the
Company operates are considering various health care reform proposals. The
Company anticipates that Congress and state legislatures will continue to review
and assess alternative health care delivery systems and payment methodologies
and public debate of these issues will continue in the future. Due to
uncertainties regarding the ultimate features of reform initiatives and their
enactment and implementation, the Company cannot predict which, if any, of such
reform proposals will be adopted, when they may be adopted or what impact they
may have on the Company.
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Sales of pharmaceutical products outside the United States are subject
to regulatory requirements governing human clinical trials, post-approval
inspection and marketing approval for drugs and drug delivery systems. These
requirements vary widely from country to country. The Company is also subject to
regulation under federal, state and local regulations regarding work place
safety, environmental protection and hazardous substance controls, among others.
The Company believes that it is in substantial compliance with all such laws.
With respect to any product currently being developed by the Company or
its subsidiaries internally or with joint venture partners, or any product for
which an NDA, ANDA, IND or patent application has been filed, there can be no
assurance that such applications will be approved, or if approved, that any such
product will contribute materially to the Company's future operating results.
SUPPLIERS AND MATERIALS
The principal components used in the Company's business are active and
inactive pharmaceutical ingredients and certain packaging materials. Some of
these components are available only from sole source suppliers. In addition,
sources for materials for the Company's products must be approved by the FDA,
and in many instances only one source has been approved for certain materials in
the Company's products. Development and approval of the Company's
pharmaceuticals are dependent upon the Company's ability to procure active
ingredients and certain packaging materials from FDA-approved sources. FDA
approval of a new supplier would be required if, for example, active ingredients
or such packaging materials were no longer available from the initially approved
supplier. The qualification of a new supplier would delay the manufacture of the
drug involved. Arrangements with foreign suppliers are subject to certain
additional risks, including the availability of governmental clearances, export
duties, political instability, currency fluctuations and restrictions on the
transfer of funds.
Although to date no significant difficulty has been encountered in
obtaining materials required for products and sources of supply are considered
adequate, there can be no assurance that the Company will continue to be able to
obtain materials as required or at reasonable prices.
Oclassen contracts for the manufacture of its current products for
commercial purposes and intends to do so for future products. This manufacturing
strategy enables Oclassen to direct its financial resources to product
in-licensing and acquisition, product development and sales and marketing
efforts. The manufacturers of Oclassen's products are required by the Federal
Food, Drug and Cosmetic Act and by FDA regulations to follow current Good
Manufacturing Practices ("cGMP"). Accordingly, Oclassen is dependent upon its
contract manufacturers to comply with such requirements or similar standards
imposed by foreign regulators. To ensure such compliance, Oclassen quality
assurance staff audits Oclassen's contract manufacturing sites and batch records
to determine whether products are manufactured in compliance with cGMP
requirements and to Oclassen's specifications. The FDA conducts regular
inspections and audits of fims subject to cGMP requirements. Although Oclassen
has taken all actions that it believes are necessary to assure that it and its
contract manufacturers are in compliance with these requirements, there can be
no assurance that the FDA or a foreigh regulator would not take action against
Oclassen or a supplier or a contract manufacturer for alleged violations of cGMP
guidelines or similar standards.
COMPETITION
The Company competes with off-patent drug manufacturers, brand-name
pharmaceutical companies that manufacture or market off-patent drugs, the
original manufacturers of brand-name drugs that continue to produce such drugs
after patent expirations or introduce generic versions of their branded
products, and manufacturers of new drugs that may compete with the Company's
off-patent drugs. The Company's proprietary drugs compete with products
developed by numerous pharmaceutical and biotechnology companies. The Company's
competitors vary depending upon product categories and, within each product
category, upon dosage strengths. Such competitors include the major brand name
and off-patent manufacturers of pharmaceuticals doing business in the United
States. Many competitors have been in business for a longer period of time than
the Company, have a greater number of products on the market and have greater
financial and other resources.
The principal competitive factors in the off-patent pharmaceutical
market are the ability to be among the first to introduce products after a
patent expires, price, quality, methods of distribution, reputation, customer
service (including maintenance of inventories for timely delivery) and breadth
of product line. Approvals for new products may have a synergistic effect on a
company's entire product line since orders for new products are frequently
accompanied by, or bring about, orders for other products available from such
company. The Company believes that price is a significant competitive factor,
particularly as the number of off-patent manufacturers which produce a
particular product increases.
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As competition from other manufacturers intensifies, selling prices typically
decline. The Company pursues the development of products which occupy market
niches and should therefore be less subject to competitive price erosion.
The Company expects its proprietary products approved for sale to
compete primarily on the basis of product efficacy, safety, patient convenience,
reliability, availability, price and patent position. There can be no assurance
that product introductions or developments by others will not render the
Company's products or technologies noncompetitive or obsolete.
Oclassen competes with numerous pharmaceutical companies and research
groups engaged in the research and development of products targeted at diseases
or conditions addressed by Oclassen's current and potential products. There can
be no assurance that such competitors will not complete the development and
regulatory process sooner and, therefore, market their products earlier than
Oclassen. Watson and Oclassen believes that key competitive factors include
Oclassen's continued ability to attract and retain skilled and experienced
personnel, to develop and secure the rights to pharmaceutical products and
compounds and to exploit these products and compounds commercially prior to the
development of competitive products by others. Intense competition for highly
qualified scientific, technical and managerial personnel is expected to
continue in the pharmaceutical industry.
PERSONNEL
As of December 31, 1996, the Company had 515 full-time employees,
including 14 employees who hold Ph.D.s or M.D.s. Of the Company's employees, 78
are engaged in research and development (including 9 with Ph.D.s), 237 in
manufacturing, 106 in quality assurance and quality control (including 2 with
Ph.D.s) and 94 in administration, marketing, finance and human resources
(including 2 with Ph.D.'s and 1 M.D.). As of December 31, 1996, Oclassen had 106
full-time employees (including 4 with Ph.D.'s). No employee is represented by a
union, and the Company and Oclassen have never experienced a work stoppage.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
The Company cautions readers that certain important factors may affect
the Company's actual results and could cause such results to differ materially
from forward-looking statements which may be deemed to have been made in this
Report, or which are otherwise made by or on behalf of the Company. Such factors
include, but are not limited to, changing market conditions; the availability
and cost of raw materials; the timely development, FDA approval and market
acceptance of the Company's products; the products producing royalties for the
Company; the products being developed and marketed by the Company's joint
ventures; and other risks detailed herein or detailed from time to time in the
Company's Securities and Exchange Commission filings. In addition, the U.S.
off-patent drug industry is highly competitive, with pricing determined by many
factors including the number and timing of product introductions. Although the
price of an off-patent product generally declines over time as competitors
introduce additional versions of the product, the actual degree and timing of
price competition is not predictable.
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ITEM 2. PROPERTIES
The Company's manufacturing facilities and quality control laboratories
(excluding oral contraceptives) are located in an approximately 165,000 square
foot building located at 132 Business Center Drive in Corona, California. The
production and packaging of oral contraceptives and certain other products are
located in a 30,000 square foot building at 100 Business Center Drive in Corona,
California, which is leased by the Company pursuant to a long-term lease from an
entity controlled by affiliates of the Company. The Company leases from an
independent lessor approximately 26,000 square feet for a warehouse facility in
a third building at 341 Bonnie Circle, Corona, California. In addition, it has
leased for approximately one year from an independent lessor, an industrial
building consisting of approximately 21,971 square feet used as a warehouse
facility at 137 N. Vander Street, Corona, California.The Company also owns an
approximately 100,000 square foot building at 311 Bonnie Circle, Corona,
California which is used as the Company's research and development facility, a
warehouse/distribution facility and as its principal executive offices. The
Company's manufacturing facilities comply with cGMP standards. The Company has
received licenses from the California Department of Health and Human Services
and the DEA for the manufacture of drug products.
The Company has leased for approximately one year from an independent
lessor, 3,141 square feet used for sales and marketing offices at Glenpointe
Centre West, 500 Frank W. Burr Boulevard, Teaneck, New Jersey. The Company has
also leased for approximately one year from an independent lessor, 480 square
feet used for sales offices at 2340 East Trinity Mills Road, Carrollton, Texas.
The Company also owns manufacturing, warehouse and office facilities
occupying approximately 162,000 square feet in Copiague, New York. The Company
has a 60% interest in a company that owns a 26,000 square foot
microencapsulation facility which is located outside of Dayton, Ohio.
In connection with the Oclassen Merger Agreement, the Company assumed
Oclassen's lease of its main facility which occupies approximately 23,800
square feet at 100 Pelican Way, San Rafael, California. The lease continues
through December 2002 and contains a renewal option of five years.
In conjunction with the Company's joint ventures with Changzhou, the
Company has commenced construction and development of a 90,000 square foot
manufacturing facility to be completed during 1997 in Changzhou City, People's
Republic of China.
The Company maintains current permits and licenses with various
regulatory bodies for the operation of these facilities.
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ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various disputes and litigation matters
which arise in the ordinary course of business. The litigation process is
inherently uncertain and it is possible that the resolution of these disputes
and lawsuits may adversely effect the Company. Management believes, however,
that the ultimate resolution of such matters will not have a material adverse
impact on the Company's financial position or results of operations.
Settlement of Reeves Litigation
In January 1995, Circa received a complaint naming it as a defendant in
an action captioned Lela Reeves V. Circa Pharmaceuticals, Inc., No. 94-436678
(Circuit Court, Wayne County, Michigan). This action was brought as a putative
class action pursuant to Michigan State law. Plaintiff alleged that she was a
consumer of a generic version of Hydergine manufactured by Circa under the
generic name Ergoloid Mesylates, and that between 1987 and 1991 she was induced
to purchase Ergoloid Mesylates tablets that were not validly approved by the FDA
and/or not manufactured in accordance with FDA approvals, and which were neither
safe nor effective. Predicated on these allegations, plaintiff sought recovery
for herself and on behalf of a purported class consisting of all persons who
purchased Ergoloid Mesylates, by asserting causes of action for common-law
fraud, breach of contract, illegality of contract, constructive trust, and
exemplary damages. Plaintiff sought damages in the form of (i) reimbursement for
prescription expenses incurred in purchasing Ergoloid Mesylates, (ii) an
accounting of all profits, (iii) other, unspecified economic damages, and (iv)
exemplary damages. This matter was settled by the payment of $425,000 by Circa
pursuant to an order and final judgment that was issued on February 12, 1997,
dismissing all claims against Circa.
Pending Litigation
In October 1995, a putative class action complaint captioned Jimmy
Jackson v. Circa Pharmaceuticals, Inc., et al., was filed against Circa,
Lawrence Raisfeld and Robert Shulman, former presidents of Circa, and Roger
Jordan, president of Vitarine Pharmaceuticals ("Vitarine") in the Circuit Court
of Tallapoosa County, Alabama. The action was filed individually and on behalf
of a class comprised of all residents of the State of Alabama who (a) purchased
Dyazide that was manufactured by Circa or Vitarine during the period 1988 to
1989; (b) purchased Dyazide from a vendor other than Circa or Vitarine; and (c)
purchased the Dyazide for resale purposes only. The action alleges that the
defendants conspired and combined to fix the price of Dyazide during 1988 and
1989. In April 1996, the court denied Circa's motion to dismiss and, over
Circa's objection, granted class certification of a group of Alabama retail
pharmacists. The parties to this action are presently conducting discovery.
Circa intends to vigorously defend this action.
In August 1996, Somerset, filed a complaint against the FDA entitled
Somerset Pharmaceuticals, Inc. v. Donna Shalala, et. al. in the United States
District Court for the District of Delaware. The complaint requested injunctive
and declaratory relief and a review of agency action, and Somerset
simultaneously requested a temporary restraining order ("TRO") in connection
with the approval by the FDA of three tablet-form competitors to Somerset's
Eldepryl(R) capsule product. Somerset maintains that such approval should not
have been granted by the FDA because the tablets were not approved in accordance
with law. The District Court denied Somerset's request for a TRO and scheduled a
hearing on the preliminary injunction for February 18, 1997 that was
subsequently continued pending the receipt by the court of additional
information from the parties. Novopharm Limited, the maker of one of the
approved tablets, filed a motion with the District Court to intervene in the
action, which motion was denied.
Based on the information currently available and through consultation
with outside counsel, the Company does not believe that the resolution of any of
these pending matters will have a material adverse effect on the Company's
future operations or consolidated financial position.
16
<PAGE> 17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of the Company's fiscal year ended December 31, 1996.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
Principal Occupation and Position
Name Age and Office with Registrant
- ---- --- --------------------------
<S> <C> <C>
Allen Chao, Ph.D. 51 Chairman of the Company since May 1996, Chief
Executive Officer of the Company since
1983, and is a co-founder of the Company.
Melvin Sharoky, M.D. 46 President of the Company since July 1995, Chief
Executive Officer and President of Circa since
1993 and President of Somerset since July 1995.
David C. Hsia, Ph.D. 52 Senior Vice President of Scientific Affairs, has
served as a Vice President of the Company since
1984, and is a co-founder of the Company.
</TABLE>
The executive officers of the Company are elected annually by the Board
of Directors, hold office until their successors are chosen and qualify, and may
be removed at any time by the affirmative vote of a majority of the Board. The
Company has employment agreements with each of the executive officers. David C.
Hsia is the brother-in-law of Allen Chao. There are no other family
relationships between any director or executive officer of the Company.
17
<PAGE> 18
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock trades on the Nasdaq National Market tier of
The Nasdaq Stock Market under the symbol "WATS." The following table sets forth
the range of quarterly high and low price information for the indicated periods
of the years ended December 31, 1996 and 1995:
<TABLE>
<CAPTION>
Fiscal 1996 High Low
- ----------- ------- -------
<S> <C> <C>
First $49.500 $37.000
Second $48.500 $36.500
Third $40.000 $26.000
Fourth $46.000 $31.750
Fiscal 1995
- -----------
First $33.250 $20.000
Second $40.250 $28.500
Third $44.500 $32.380
Fourth $50.500 $39.500
</TABLE>
As of February 28, 1997, there were 1,993 stockholders of record.
A wholly owned subsidiary of the Company paid a cash dividend in 1990.
The Company has never paid cash dividends on its common stock and does not
anticipate paying dividends in the foreseeable future. The declaration and
payment of dividends and the amount paid, if any, will be subject to the
discretion of the Company's Board of Directors and will necessarily be dependent
on the earnings and financial condition of the Company and any other factors the
Board of Directors may consider relevant.
18
<PAGE> 19
ITEM 6. SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
SELECTED CONSOLIDATED FINANCIAL DATA (1)
(In Thousands, Except Earnings Per Share)
For the Years Ended December 31, (1)
------------------------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- -------- -------- ---------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Product sales $ 166,958 $ 130,688 $ 93,649 $ 70,838 $ 34,773
Royalty income 27,162 22,247 1,209
--------- --------- -------- -------- ---------
Total revenues 194,120 152,935 94,858 70,838 34,773
--------- --------- -------- -------- ---------
Cost of revenues 77,039 64,996 48,972 39,207 23,291
Research and development 16,490 18,573 18,980 15,085 8,217
Selling, general and administrative 17,882 17,030 13,342 15,682 14,944
Merger expenses (2) 13,939
--------- --------- -------- -------- ---------
Total operating expenses 111,411 114,538 81,294 69,974 46,452
--------- --------- -------- -------- ---------
Operating income 82,709 38,397 13,564 864 (11,679)
Equity in earnings of joint ventures 17,909 22,766 24,968 24,688 20,712
Investment and other income (3) 8,555 11,594 6,542 16,879 2,871
Gain from (provision for) legal settlements (4) 2,299 (6,297)
Partnership loss (5) (7,644) (15,598)
--------- --------- -------- -------- ---------
26,464 34,360 33,809 27,626 7,985
--------- --------- -------- -------- ---------
Income (loss) before provision (benefit)
for income taxes 109,173 72,757 47,373 28,490 (3,694)
Provision (benefit) for income taxes (6) 35,875 24,867 10,828 (21,927) 2,396
--------- --------- -------- -------- ---------
Net income (loss) $ 73,298 $ 47,890 $ 36,545 $ 50,417 $ (6,090)
========= ========= ======== ======== =========
PER SHARE DATA: (7)
Earnings (loss) per common and common
equivalent share $ 1.95 $ 1.29 $ 1.00 $ 1.42 $ (0.18)
========= ========= ======== ======== =========
Weighted average number of common and common
equivalent shares outstanding 37,664 37,143 36,515 35,504 32,938
========= ========= ======== ======== =========
</TABLE>
<TABLE>
<CAPTION>
December 31, (1)
-----------------------------------------------------------------
1996 1995 1994 1993 1992
--------- --------- -------- -------- ---------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Current assets $ 279,597 $ 197,634 $172,912 $155,025 $ 57,118
Working capital 258,243 168,812 154,661 131,943 31,534
Total assets 419,597 322,121 262,316 235,672 130,516
Long-term debt and capitalized lease obligations 2,904 3,577 5,058 2,143 3,991
Deferred tax liabilities 12,226
Deferred partnership liability 14,033 15,242 7,598
Total stockholders' equity 382,712 289,035 223,370 185,081 77,872
</TABLE>
(1) The Company merged with Circa in July 1995. The transaction was
accounted for as a pooling of interests, and accordingly, the
consolidated financial data presented includes the accounts of Circa
for all periods presented.
(2) The costs associated with the merger of Circa resulted in a one-time
charge of approximately $13.9 million during 1995.
(3) Included in investment and other income for the years ended December
31, 1995, 1994, 1993 and 1992 were gains from the sales of the common
stock of Marsam Pharmaceuticals, Inc. ("Marsam") of $6.2 million, $3.2
million, $14.5 million and $1.1 million, respectively. The Company
disposed of its investment in Marsam during 1995.
(4) The gain from and (provision for) legal settlements resulted from the
settlements of and reserve for various lawsuits in which the Company
was a defendant. The majority of these now-settled lawsuits were
initiated during 1990 and 1991.
(5) See Note 6 of the Company's Notes to Consolidated Financial Statements.
(6) In 1993, as a result of the Company's 1995 merger with Circa, an income
tax benefit of $29.8 million was recorded which was the result of the
reduction in the valuation allowance related to net deferred tax
assets. These net deferred tax assets resulted principally from net
operating loss carryforwards and tax credit carryforwards generated by
Circa prior to its merger with the Company. Previously, these net
deferred tax assets were fully reserved by Circa.
(7) The merger between the Company and Circa resulted in the exchange of
0.86 of a share of the Company common stock for each share of Circa
common stock. The computation of earnings (loss) per share is based on
the weighted average number of common shares outstanding, including the
dilutive effect of the assumed exercise of all outstanding stock
options and warrants. The weighted average number of common shares
outstanding was adjusted to reflect the merger exchange ratio. Fully
diluted earnings per share is not materially different from primary
earnings per share.
19
<PAGE> 20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Safe Harbor Statement Under the Private Securities Litigation Reform Act of
1995. The Company cautions readers that certain important factors may affect the
Company's actual results and could cause such results to differ materially from
forward-looking statements which may be deemed to have been made in this Report,
or which are otherwise made by or on behalf of the Company. Such factors
include, but are not limited to, changing market conditions; the availability
and cost of raw materials; the timely development, FDA approval and market
acceptance of the Company's products; the products producing royalties for the
Company; the products being developed and marketed by the Company's joint
ventures; and other risks detailed herein or detailed from time to time in the
Company's Securities and Exchange Commission filings. In addition, the U.S.
off-patent drug industry is highly competitive, with pricing determined by many
factors including the number and timing of product introductions. Although the
price of an off-patent product generally declines over time as competitors
introduce additional versions of the product, the actual degree and timing of
price competition is not predictable.
GENERAL
The Company has historically derived its revenues from the manufacture
and sale of off-patent pharmaceutical products. While sales of off-patent
products continue to be the primary revenue source, certain developments have
occurred which have augmented the Company's revenue mix. Product sales of
off-patent medications accounted for approximately 98.7% of total revenues in
1994; 85.5% in 1995; and 86.0% in 1996. The significant change in the revenue
mix from 1994 to 1995 and 1996 was largely due to an increase in the contractual
royalty rate from 1% in 1994 to 20% in 1995 and 1996 earned by the Company on
sales of Dilacor XR(R) by Rhone-Poulenc Rorer Inc. ("RPR"). Dilacor XR(R) lost
patent exclusivity in May 1995. Although the Company's royalty revenue in 1995
and 1996 was not significantly impacted by this event, royalty revenue may
decline in the future as competitors introduce off-patent versions of this drug
into the marketplace. It is the Company's intention to launch an off-patent
version of Dilacor XR(R) as competition intensifies. Any future off-patent
Dilacor XR(R) profits are expected to be shared equally by the Company and RPR.
Actual revenues, costs and profits, however, from future collaboration, if any,
cannot be determined at this time. The Company's joint venture arrangement with
RPR has certain restrictions which may limit the development or marketing of
future products competitive with the Dilacor XR(R) product line as stated in the
agreement. To the extent any such restrictions are enforced, such restrictions
could affect future revenues.
In July 1995, the Company completed its merger with Circa
Pharmaceuticals, Inc. ("Circa"). The merger, accounted for as a pooling of
interests for accounting purposes and a tax-free reorganization for income tax
purposes, augmented the Company's revenue base, enhanced the Company's
manufacturing capabilities and increased its product development program,
particularly in the area of proprietary products.
In 1989, Circa and RPR were partners in the development of Dilacor
XR(R). In connection with the Dilacor XR(R) development, Circa incurred a
liability to the partnership reflecting the Company's share of development and
operating costs. At December 31, 1993, the liability to the partnership was
$15.2 million. The partnership agreement was amended in April 1993, so that
after September 1993, the Company earns a royalty from RPR's sales of Dilacor
XR(R). The amended partnership agreement also provides that all royalties earned
will be used first to offset the partnership liability and royalties in
excess of the partnership liability will be remitted to the Company. As
royalties were earned in 1994 and 1995, the partnership liability was reduced
per the terms of this agreement. This liability was eliminated in 1995. At
December 31, 1996 and 1995 the Company had recorded royalty receivables of
$5,554 and $8,205, respectively.
Dilacor XR(R) is used for the treatment of hypertension and angina. The
amended agreement with RPR also provides that royalty income be determined based
upon market demand for the product, as evidenced by prescriptions written, as
defined. Revenues under this royalty agreement were $27.2 million in 1996, $22.2
million in 1995 and $1.2 million in 1994. The Company's royalty income from
RPR's sales of Dilacor XR(R) represented 14.0% of total revenues in 1996, 14.5%
in 1995 and 1.3% in 1994. As contractually specified, the royalty percentage
earned by the Company in 1994 on RPR's sales of Dilacor XR(R) was 1%, whereas in
1995 and 1996, it was 20%. The royalty rate increases in 1997 to 22% and is
reduced to 3% after 2000. Royalties are remitted to the Company on a quarterly
basis.
The Company owns a 50% equity interest in Somerset Pharmaceuticals,
Inc. ("Somerset"), which markets Eldepryl(R) for the treatment of Parkinson's
disease. The Company recorded equity in earnings from this joint venture of
20
<PAGE> 21
$20.1 million in 1996, $24.8 million in 1995, and $25.1 million in 1994. Orphan
drug exclusivity expired for Eldepryl(R) in June 1996. During 1996, the Company
experienced a decrease in earnings from Somerset due to increased competition
for Eldepryl(R) and increased research and development spending. Management
anticipates that the Company's equity in earnings from Somerset will be reduced
by approximately 30% to 50% in 1997 from prior year levels due to increased
competition for Eldepryl(R) and Somerset's increased expenditures on research
and development in connection with the development of several new products.
In July 1994, the Company and Andrx formed a joint venture, ANCIRC, to
develop off-patent pharmaceutical products utilizing Andrx's controlled-release
technology. During 1995, the terms of the ANCIRC joint venture agreement were
amended whereby the Company and Andrx became equal partners in the sharing of
costs and profits in the ANCIRC joint venture. Previously, the Company was
responsible for 40% of the costs and profits of ANCIRC. The Company utilizes the
equity method to account for this joint venture and recognized losses from
ANCIRC of approximately $2.0 million, $1.7 million and $0.2 million in 1996,
1995, and 1994 respectively.
The Company continues to expand its research and development efforts in
the area of proprietary product development through joint ventures, product
acquisitions and strategic alliances. The Company also continues to seek
opportunities to broaden its technology platform and to invest in new products,
technologies or businesses that are consistent with its strategy to focus on
niche or technically difficult to duplicate products. This strategy was
evidenced by the Company's increased investment in Andrx. In October 1995, the
Company purchased additional Andrx common stock for approximately $15.6 million,
increasing its ownership to 19.5% of the total outstanding common stock of
Andrx. On June 14, 1996, Andrx completed its initial public offering of common
stock effectively reducing the Company's ownership interest to approximately
15.6% at December 31, 1996.
The foregoing management's discussion and analysis of financial
condition and results of operations relating to the Company, and all other
information contained in this Form 10-K relating to the Company, unless
otherwise expressly provided, excludes information relating to Oclassen
Pharmaceuticals, Inc. ("Oclassen") and Royce Laboratories, Inc. ("Royce")
(as discussed below).
Recent Developments
On September 25, 1996, Watson entered into the Oclassen merger
agreement, as amended effective November 14, 1996 and December 31, 1996.
Pursuant to the Oclassen merger agreement, effective February 27, 1997, Oclassen
was merged with a subsidiary of Watson created for the purpose of effectuating
the merger, with Oclassen surviving as a wholly owned subsidiary of Watson.
Oclassen develops and markets specialty prescription pharmaceuticals to prevent
and treat skin diseases and markets these products to dermatologists. Oclassen
in-licenses pharmaceutical products, which have been developed beyond the
initial discovery phase from domestic and foreign pharmaceutical companies and
from universities and research institutions. Oclassen completes the product
formulation and any preclinical development, conducts clinical trials and brings
dermatological products through the required regulatory approval process and
into the market. Oclassen markets its products through its 60-person nationwide
direct sales force. The Company and Oclassen believe that its in-licensing,
development and marketing strategy reduces the time, risks and costs associated
with product development and marketing.
The merger was consummated on February 27, 1997. To consummate the
transaction, Watson exchanged approximately 3.3 million shares of common stock
for all of the outstanding common stock of Oclassen. The Company will account
for the Oclassen merger as a pooling of interests for accounting purposes and
believes that the merger qualifies as a tax-free reorganization for federal
income tax purposes.
On December 24, 1996, Watson entered into the Royce merger agreement.
Pursuant to the Royce merger agreement, Royce agreed to merge with a subsidiary
of Watson created for the purpose of effectuating the merger, with Royce
surviving as a wholly owned subsidiary of Watson. Royce develops, manufactures
and markets off-patent prescription drugs in solid dosage forms (tablets and
capsules). At present, Royce manufactures and markets 20 off-patent prescription
drugs in 42 dosage strengths and has received approvals on an additional drug in
3 dosage strengths that it has not yet commenced manufacturing and marketing.
Additionally, Royce has ANDAs pending with the FDA for 9 new products in 15
dosage strengths.
At the effective time of the Royce merger, Royce stockholders will
receive an aggregate of up to approximately 2.6 million shares of Watson common
stock in exchange for all of the outstanding common stock of Royce. It is
intended that the Royce merger will qualify as a pooling of interests for
accounting purposes and a tax-free reorganization for federal income tax
purposes. The Royce merger agreement may be terminated and the Royce merger
abandoned if the Royce merger has not occurred by April 30, 1997. The Royce
stockholders' meeting has been scheduled for April 16, 1997, and if approved,
the Royce merger will close the next day.
21
<PAGE> 22
On March 7, 1997, Somerset received notice from taxing authorities
that it may be subject to approximately $9.0 million (50% of which would be
Watson's share) of additional income tax and interest charges that have not
been accrued as of December 31, 1996. Management of Somerset believes that it
has complied with all relevant tax laws and intends to vigorously defend its
position on this matter. Any adverse outcome of this matter may effectively
reduce Watson's equity in earnings from joint ventures during 1997.
The Company's future results of operations will depend to a significant
extent upon its ability to introduce new off-patent and proprietary
pharmaceutical products. Future operating results may vary significantly on an
annual or quarterly basis depending on the timing of, and the Company's ability
to obtain, FDA approvals of ANDAs and NDAs for such products and FDA approvals
for shipment of such products. Newly introduced off-patent products with limited
or no off-patent competition are typically sold at higher prices, often
resulting in increased gross profit margins. As competition from other
manufacturers intensifies, selling prices typically decline. The Company's
future operating results may also be affected by a variety of additional
factors, including customer purchasing practices and changes in the degree of
competition affecting the Company's products. The loss of exclusivity with
respect to Eldepryl(R) and Dilacor XR(R) and/or the introduction by other
companies of additional competitive products, could have a material adverse
effect on the operating results and financial condition of the Company.
QUARTERLY FLUCTUATIONS
The Company's results of operations on a quarterly basis have
fluctuated in the past, and may continue to fluctuate. The Company believes such
fluctuations are primarily due to new product introductions and to a variety of
additional factors including, without limitation, purchasing practices of the
Company's customers and changes in the degree of competition regarding the
Company's products.
22
<PAGE> 23
RESULTS OF OPERATIONS
The following table represents selected components of the Company's
results of operations, in thousands of dollars and as percentages of revenues.
The table reflects the Company's merger with Circa for all periods presented.
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------------
1996 1995 1994
-------------------- -------------------- -------------------
$ % $ % $ %
-------- ------- -------- ------- ------- -------
Revenues:
<S> <C> <C> <C> <C> <C> <C>
Product sales $166,958 86.0% $130,688 85.5% $93,649 98.7%
Royalty income 27,162 14.0% 22,247 14.5% 1,209 1.3%
-------- ------- -------- ------- ------- -------
Total revenues 194,120 100.0% 152,935 100.0% 94,858 100.0%
-------- ------- -------- ------- ------- -------
Operating expenses:
Cost of revenues 77,039 39.7% 64,996 42.5% 48,972 51.6%
Research and development 16,490 8.5% 18,573 12.1% 18,980 20.0%
Selling, general and administrative 17,882 9.2% 17,030 11.1% 13,342 14.1%
Merger expenses 13,939 9.1%
-------- ------- -------- ------- ------- -------
Total operating expenses 111,411 57.4% 114,538 74.8% 81,294 85.7%
-------- ------- -------- ------- ------- -------
Operating income 82,709 42.6% 38,397 25.2% 13,564 14.3%
Other income:
Equity in earnings of joint ventures 17,909 9.2% 22,766 14.9% 24,968 26.3%
Investment and other income 8,555 4.4% 11,594 7.6% 6,542 6.9%
Gain from legal settlements 2,299 2.4%
-------- ------- -------- ------- ------- -------
Total other income, net 26,464 13.6% 34,360 22.5% 33,809 35.6%
-------- ------- -------- ------- ------- -------
Income before provision for income taxes 109,173 56.2% 72,757 47.7% 47,373 49.9%
Provision for income taxes 35,875 18.5% 24,867 16.3% 10,828 11.4%
-------- ------- -------- ------- ------- -------
Net income $ 73,298 37.7% $ 47,890 31.4% $36,545 38.5%
======== ======= ======== ======= ======= =======
</TABLE>
YEARS ENDED DECEMBER 31, 1996 AND 1995
Revenues for the year ended December 31, 1996 were $194.1 million
compared to $152.9 million for the year ended December 31, 1995, an increase of
$41.2 million or 26.9%. The increase in revenues was composed of a $36.3 million
increase in product sales and a $4.9 million increase in royalty income. The
increase in product sales was due to (i) sales of products introduced in 1996
which totaled $26.1 million; (ii) a $24.9 million increase in sales relating to
products introduced during the fourth quarter of fiscal 1995, and (iii) a net
increase in sales of the Company's other core products, defined generally as
products available in the market place for at least twelve months. These
increases were partially offset by decreased sales of certain strengths of
Hydrocodone products.
Royalty income increased 22.1% in 1996 as compared with 1995 due to
increased demand for Dilacor XR(R), which lost its exclusivity in May 1995. The
loss of exclusivity did not have a significant impact on 1996 and 1995 sales of
Dilacor XR(R). However, if competitors introduce generic versions of this drug,
sales of Dilacor XR(R) are likely to decrease, resulting in a corresponding
decrease in the Company's royalty income. The royalty percentage on RPR's sales
of Dilacor XR(R) will increase to 22% of sales, as defined, in the years ending
December 31, 1997 through 2000 and decline to 3% thereafter.
Cost of revenues increased $12.0 million, or 18.5% to $77.0 million for
the year ended December 31, 1996 from $65.0 million for the year ended December
31, 1995. Cost of revenues were 46.1% of product sales in 1996 compared to 49.7%
in 1995. Gross profit margins increased to 53.9% in 1996 from 50.3% in 1995.
This favorable increase was due to higher than average gross margins earned on
the sales of certain core products and new products introduced during 1996.
Research and development expenses decreased slightly from $18.6 million
in 1995 to $16.5 million in 1996. Following the merger with Circa, the Company
integrated the two research and development departments of Watson and Circa into
one, eliminating duplication and therefore achieving a focused strategy. The
Company expects that 1997 research and development expenses will be higher than
1996 research and development expenses as the Company pursues the development of
off-patent and proprietary pharmaceutical products.
23
<PAGE> 24
Selling, general and administrative expenses were consistent with the
prior year increasing slightly from $17.0 million in 1995 to $17.9 million in
1996. As a percentage of revenues, these costs decreased from 11.1% to 9.2% from
1995 to 1996, respectively, which reflected management's efforts to control
costs and the fact that the Company's growth in revenues outpaced the growth in
selling, general and administrative expenses.
The Company expects that 1997 selling, general and administrative
expenses will be significantly higher than those incurred in 1996 as a result of
the Company receiving FDA approval to manufacture and market two brand products.
These products represent the Company's first internally manufactured and
marketed brand products. The marketing and selling of brand products calls for
significantly different tactics than those employed solely for off-patent
products. In anticipation of this, Watson formed a brand marketing and sales
division in 1996. The Company has hired approximately 70 sales and marketing
personnel, the majority during the fourth quarter of 1996 and through the first
quarter of 1997.
In connection with the merger with Circa, the Company recorded a
one-time $13.9 million charge for costs incurred related to the merger in 1995.
These costs included investment banking fees and other costs related to the
consolidation of operations between the two companies. No such expenses were
recorded in 1996.
Equity in earnings from joint ventures decreased $4.9 million or 21.3%
to $17.9 million in 1996 compared to $22.8 million in 1995. The two most
significant ventures included in this earnings amount are Somerset and ANCIRC.
Equity in earnings from Somerset decreased from $24.8 million in 1995 to $20.1
million in 1996 in part due to the loss of exclusivity for Eldepryl(R) in June
1996, and in part to increased research and development expenditures in support
of the Phase III clinical trials on a transdermal Eldepryl(R) patch. During
1996, three competitors introduced generic tablets to compete with Eldepryl(R)
capsules. The loss of exclusivity with respect to this product, and/or the
introduction by other companies of additional competitive products, could have a
material adverse effect on the operating results and financial condition of the
Company. The Company's portion of ANCIRC's losses increased slightly from $1.7
million in 1995 to $2.0 million in 1996.
Investment and other income decreased $3.0 million or 26.2% to $8.6
million in 1996 from $11.6 million in 1995. This decrease was due to the
recognition of a $6.2 million gain from the sale of Marsam Pharmaceuticals, Inc.
("Marsam") common stock, a stock held for investment purposes in 1995, partially
offset by an increase in interest income in 1996 which resulted from higher
short-term interest rates on a larger base of invested cash.
The provision for income taxes increased to $35.9 million in 1996,
compared to $24.9 million in 1995. The effective income tax rates were 32.9% and
34.2% for the years ended December 31, 1996 and 1995, respectively. The decrease
in the Company's effective income tax rate was due primarily to the
non-deductibility of a significant portion of merger expenses recognized in
1995.
Net income increased to $73.3 million in 1996 from $47.9 million in
1995. As a percentage of revenues, net income increased to 37.7% in 1996 from
31.4% in 1995 principally due to (1) revenue growth and continued cost control
efforts during 1996 and (2) the one-time merger expenses related to the merger
with Circa in 1995.
YEARS ENDED DECEMBER 31, 1995 AND 1994
Revenues for the year ended December 31, 1995 were $152.9 million
compared to $94.9 million for the year ended December 31, 1994, an increase of
$58.0 million or 61.2%. The increase in revenues was composed of a $37.0 million
increase in product sales and a $21.0 million increase in royalty income. The
increase in product sales was due primarily to increased sales of the Company's
core products, defined as products available in the marketplace for one year or
longer. In addition, the Company introduced eight products during 1995 which
accounted for $12.9 million in sales, or 9.9% of total 1995 product sales.
The increase in royalty income was attributable to an increase in
market demand for Dilacor XR(R) and to the increase in the royalty percentage on
sales of Dilacor XR(R) from 1% in 1994 to 20% in 1995. The royalty percentage on
Dilacor XR(R) will increase to 22% in the years ending December 31, 1997 through
2000 and then decline to 3% thereafter.
Cost of revenues increased $16.0 million to $65.0 million for the year
ended December 31, 1995 (an increase of 32.7%). Cost of revenues were 49.7% of
product sales in 1995 compared to 52.3% in 1994. This favorable decrease was due
to a combination of higher than average gross margins earned on certain core
products and new products introduced during 1995.
Research and development expenses were consistent with the prior year,
decreasing slightly from $19.0 million in 1994 to $18.6 million in 1995, despite
increasing research and development efforts in the area of proprietary
24
<PAGE> 25
pharmaceuticals. Following the merger with Circa, the Company began integrating
the two research and development departments into one, eliminating duplication
and therefore achieving a focused strategy.
Selling, general and administrative expenses increased 27.6% to $17.0
million for 1995 from $13.3 million in 1994. The increase in such expenses is
largely attributable to increased marketing and selling expenses associated with
new product introductions and an increase in administrative support due to the
overall growth of the Company. As a percentage of revenues, these costs
decreased from 14.1% to 11.1% from 1994 to 1995, respectively, which reflected
management's efforts to control costs and the fact that the Company's growth in
revenues outpaced the growth in selling, general and administrative expenses.
In connection with the merger with Circa, the Company recorded a
one-time $13.9 million charge in 1995 for costs incurred related to the merger.
These costs included investment banking fees and other costs related to the
consolidation of operations between the two companies.
Equity in earnings from joint ventures decreased 8.8% (or $2.2 million)
to $22.8 million in 1995 compared to $25.0 million in 1994. The two most
significant ventures included in this earnings amount are Somerset and ANCIRC.
Equity in earnings from Somerset decreased slightly from $25.1 million in 1994
to $24.8 million in 1995. The Company's portion of ANCIRC's losses increased
from $220,000 in 1994 to $1.7 million in 1995. In October 1995, the Company
amended its joint venture agreement with Andrx and became equal partners in
ANCIRC. Previously, the Company recognized 40% of the costs and profits from
ANCIRC.
Included in investment and other income in 1995 was a $6.2 million gain
from the sale of Marsam common stock, as compared to a $3.2 million gain in
1994. During 1995, the Company disposed of its remaining investment in Marsam
common stock. In addition, during 1994, the Company recognized a one-time gain
from legal settlements of $2.3 million. The balance of the increase in
investment and other income in 1995 as compared to 1994, was due to higher
short-term interest rates on a larger base of invested cash.
The provision for income taxes increased to $24.9 million in 1995,
compared to $10.8 million in 1994. The effective income tax rates for the years
ended December 31, 1995 and 1994 were 34.2% and 22.9%, respectively. This
increase was primarily attributable to increased taxable income and the
non-deductibility of a significant portion of merger expenses recognized in
1995.
Net income increased to $47.9 million in 1995 from $36.5 million in
1994. As a percentage of revenues, net income decreased to 31.4% in 1995 from
38.5% principally due to the one-time merger expenses related to the merger with
Circa and the higher effective income tax rate in 1995. Exclusive of
non-recurring merger expenses of $13.9 million, a third quarter gain of $6.2
million from the gain on sale of Marsam common stock and the income tax effect
of such items, net income for 1995 would have been $57.0 million or $1.54 per
share.
25
<PAGE> 26
LIQUIDITY AND CAPITAL RESOURCES
As the Company has grown during the last three years, its overall
liquidity requirements have increased. The significant increase in accounts
receivable, inventories, and investment in property and equipment have been
financed primarily by cash flows from operating activities and from the
Company's public offerings in 1993. The net proceeds from these offerings were
used primarily for working capital and investments in Andrx and other joint
ventures. The balance was invested in short-term marketable securities during
1994, 1995 and 1996.
The Company has experienced a significant increase in accounts
receivable balances over the last three years. This growth has been caused
primarily by increased product sales. The Company performs ongoing credit
evaluations of its customers and maintains reserves for potentially
uncollectible accounts. Actual losses have been within management's
expectations.
The Company's working capital increased from $168.8 million at December
31, 1995 to $258.2 million at December 31, 1996. This $89.4 million increase was
primarily due to increased cash flow from operations. Net cash provided by all
sources in 1996 was $56.0 million compared to $21.0 million in 1995. The
increase was primarily attributable to the Company's 1996 net income of $73.3
million, proceeds from exercise of stock options of $5.2 million, offset by
capital expenditures of $10.2 million and net purchases of marketable securities
of $37.4 million.
The Company expects to invest approximately $12.7 million in capital
expenditures in 1997.
At December 31, 1996, the Company had a note payable outstanding of
approximately $3.6 million. This is comprised of a single, unsecured term loan
with interest at a fixed rate of 8.1% and payments due monthly through August
2001. In addition, a credit facility of $36.0 million is currently available to
the Company, comprised of (i) a $20.0 million revolving, unsecured line of
credit, (ii) a $6.0 million revolving, unsecured equipment line of credit with a
term repayment option and (iii) a $10.0 million non-revolving, line of credit
with a term repayment option. The Company has made no borrowings against this
credit facility.
The Company's cash and marketable securities totaled $211.0 million at
December 31, 1996. The Company anticipates that its current cash and amounts
available under its bank financing agreement will be sufficient to fund its
short-term working capital requirements and enable the Company to continue its
operations on long-term basis. To the extent that additional capital resources
are required, such capital may be raised through bank borrowings, equity
offerings, or other means.
The Company regularly reviews potential opportunities to acquire or
invest in technologies, products or product rights. The Company also regularly
reviews potential acquisitions, investments or combinations involving businesses
compatible with its existing business. The Company could use sources other than
cash, such as issuance of debt or equity securities, to finance any such
acquisition or investment. If such an acquisition or investment was completed,
the Company's operating results and financial condition could change materially
in future periods.
Management believes inflation does not have, and has not had, a
significant impact on the Company's revenues or operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is contained in the financial
statements set forth in Item 14(a) under the caption "Consolidated Financial
Statements" as a part of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on
accounting or financial disclosure matters during the Company's fiscal years
ended December 31, 1996, 1995 and 1994.
26
<PAGE> 27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS
The information concerning directors of the Company required under this
Item is incorporated herein by reference to the Company's definitive proxy
statement pursuant to Regulation 14A, filed with the Commission not later than
120 days after the close of the Company's fiscal year ended December 31, 1996.
EXECUTIVE OFFICERS
The information concerning executive officers of the Company required
under this Item is provided under Item 4 A.
ITEM 11. EXECUTIVE COMPENSATION
The information required under this Item is incorporated herein by
reference to the Company's definitive proxy statement pursuant to Regulation
14A, filed with the Commission not later than 120 days after the close of the
Company's fiscal year ended December 31, 1996.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this Item is incorporated herein by
reference to the Company's definitive proxy statement pursuant to Regulation
14A, filed with the Commission not later than 120 days after the close of the
Company's fiscal year ended December 31, 1996.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required under this Item is incorporated herein by
reference to the Company's definitive proxy statement pursuant to Regulation
14A, filed with the Commission not later than 120 days after the close of the
Company's fiscal year ended December 31, 1996.
27
<PAGE> 28
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. CONSOLIDATED FINANCIAL STATEMENTS
The following are included herein under Item 8:
Reports of Independent Accountants.
Consolidated Balance Sheets as of December 31, 1996 and 1995.
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1996.
Consolidated Statements of Stockholders' Equity for each of
the three years in the period ended December 31, 1996.
Consolidated Statements of Cash Flows for each of the three
years in the period ended December 31, 1996.
Notes to Consolidated Financial Statements.
(a) 2. FINANCIAL STATEMENT SCHEDULES:
II. Valuation and Qualifying Accounts
All other schedules are omitted because they are not applicable or the
required information is included in the Consolidated Financial Statements or
notes thereto.
28
<PAGE> 29
EXHIBIT
NO. DESCRIPTION
- --------------------------------------------------------------------------------
2.1 Agreement and Plan of Merger among the Company, Gum Acquisition Corp.
and Circa Pharmaceuticals, Inc., filed as Exhibit 2.1 to the Company's
Registration Statement on Form S-4 Reg. No. 33-60211 ("33-60211") and
hereby incorporated by reference.
2.2 Agreement and Plan of Merger among the Company, Opalacq Co. and
Oclassen Pharmaceuticals, Inc. dated as of September 25, 1996, as
amended effective November 14, 1996, and as amended effective December
31, 1996, filed as Exhibit 2.1 to the Company's Registration Statement
on Form S-4 Reg. No. 333-16275 ("333-16275") and hereby incorporated by
reference.
2.2 Agreement and Plan of Merger among the Company, Dolphins Acquisition
Corp. and Royce Laboratories, Inc. dated as of December 24, 1996, filed
as Exhibit 2.1 to the Company's Registration Statement on Form S-4 Reg.
No. 333-20029 ("333-20029") and hereby incorporated by reference.
3.1 Articles of Incorporation of the Company and all amendments thereto,
filed as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1995 and Exhibit 3.1(A) to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 1996 and
hereby incorporated by reference.
3.2 Bylaws of the Company, as amended as of July 18, 1995, filed as Exhibit
3.2 to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1995 and hereby incorporated by reference.
4.1 Loan Agreement between the Company, its subsidiaries and Bank of
America NT & SA dated August 19, 1994, filed as Exhibit 4.1 to the
Company's Quarterly Report on Form 10-Q for the quarter ended September
30, 1994 and hereby incorporated by reference.
4.1(a) Amendment to loan agreement between the Company, its subsidiaries and
Bank of America NT & SA dated as of February 26, 1996, filed as Exhibit
4.1 to the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1995, and hereby incorporated by reference.
4.1(b) Amendment to loan agreement between the Company, its subsidiaries and
Bank of America NT & SA dated as of December 31, 1996.
10.1 Lease between Westgate Associates and the Company dated October 1991
and addendums thereto, filed as Exhibit 10.5 to the Company's
Registration Statement on Form S-1 Reg. No. 33-46229 ("33-46229") and
hereby incorporated by reference.
10.2 Industrial Real Estate Lease, as amended, dated August 8, 1995, between
Hsi-Hsiung Hsu Hwa Chao (Chao Family) Trust I and the Company, filed as
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1995 and hereby incorporated by reference.
10.3 Lease and Option Termination Agreement between Watson Laboratories,
Inc. and Research Property Associates dated January 31, 1997.
10.4 Lease between Bayview Associates and Oclassen Pharmaceuticals, Inc.
dated November 15, 1998.
10.4(a) Amendment to lease between Limar Realty Corporation #11 (successor in
interest to Bayview Associates) and Oclassen Pharmaceuticals, Inc.,
dated October 10, 1995.
10.5 Grant of Option to Purchase Real Estate by and between Dr. Alec Keith,
Mr. Wallace C. Snipes and Zetachron, Incorporated dated July 1, 1987,
filed as Exhibit 10.8 to 33-46229 and hereby incorporated by reference.
*10.6 The Company's 1985 Stock Incentive Plan, filed as Exhibit 10.11 to
33-46229 and hereby incorporated by reference.
*10.7 1991 Stock Option Plan of the Company as revised, filed as Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1995 and hereby incorporated by reference.
29
<PAGE> 30
EXHIBIT
NO. DESCRIPTION
- --------------------------------------------------------------------------------
*10.7(a) Amendment to the 1991 Stock Option Plan of the Company, filed
as Exhibit 10.6(a) to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1996 and hereby
incorporated by reference.
*10.8 1995 Non-Employee Directors' Stock Option Plan, as amended,
filed as Exhibit 10.2 to the Company's Quarterly Report on
Form 10-Q for the quarter ended June 30, 1995 and hereby
incorporated by reference.
10.9 Form of the Company's Employee Invention, Confidential
Information Agreement, filed as Exhibit 10.22 to 33-46229 and
hereby incorporated by reference.
10.10 Purchase Agreement relating to the Company's purchase of 132
Business Center Drive property, filed as Exhibit 10.15 to the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1993, and hereby incorporated by
reference.
10.11 Purchase and Sale Agreement between the Company, its
subsidiaries and AETNA Real Estate Associates dated October
18, 1994 regarding the acquisition of 311 Bonnie Circle,
Corona, California, filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September
30, 1994 and hereby incorporated by reference.
*10.12 Senior Executive Employment Agreement dated as of May 29,
1995 between the Company and Allen Chao, filed as Exhibit
10.1 to 33-60211 and hereby incorporated by reference.
*10.13 Form of Senior Executive Employment Agreement dated as of May
29, 1995 between the Company and David C. Hsia, filed as
Exhibit 10.2 to 33-60211 and hereby incorporated by
reference.
10.14 Release, Exit and Consulting Agreement between Alec D. Keith
Ph.D. and the Company, dated July 18, 1996, filed as Exhibit
10.15 to the Company's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996 and hereby incorporated by
reference.
10.15 Intellectual Property Agreement between Alec D. Keith, Ph.D.
and the Company dated as of July 18, 1996.
*10.16 Employment Agreement with Dr. Melvin Sharoky dated April 26,
1991 as amended January 19, 1993 and July 17, 1995, filed as
Exhibit 10.3 to the Company's Quarter Report on Form 10-Q for
the quarter ended June 30, 1995 and hereby incorporated by
reference.
*10.16(a) Amendment to the Employment Agreement with Dr. Melvin Sharoky
dated February 12, 1997.
*10.17 Form of Employment Agreement between the Company, Oclassen
Pharmaceuticals, Inc., and Glenn A. Olcassen, filed as
Exhibit 10.1 to 333-16275 and hereby incorporated by
reference.
*10.18 Form of Employment Agreement between the Company, Oclassen
Pharmaceuticals, Inc. and Terry L. Johnson, filed as Exhibit
10.2 to 333-16275 and hereby incorporated by reference.
*10.19 Form of Employment Agreement between the Company, Oclassen
Pharmaecuticals, Inc. and Anthony A. DiTonno, filed as Exhibit
10.3 to 333-16275 and hereby incorporated by reference.
*10.20 Form of Employment Agreement between Royce Laboratories, Inc.
and Patrick J. McEnany, filed as Exhibit 10.1 to Royce
Laboratories, Inc.'s Current Report on Form 8-K dated January
8, 1997 and hereby incorporated by reference.
22.1 Subsidiaries of the Company.
23.1 Consent of Price Waterhouse LLP.
30
<PAGE> 31
EXHIBIT
NO. DESCRIPTION
- --------------------------------------------------------------------------------
23.2 Consent of Deloitte & Touche LLP.
23.3 Consent of Coopers & Lybrand L.L.P.
27.1 Financial Data Schedule (EDGAR version only).
99.1 Consolidated Financial Statements of Somerset
Pharmaceuticals, Inc. and Subsidiaries for the years ended
December 31, 1996, 1995 and 1994.
- ------------------------------
*Compensation Plan or Agreement
(b) REPORTS ON FORM 8-K: On October 3, 1996, the Company filed a Form 8-K Report
to disclose the execution of the Oclassen Merger Agreement. On January 9,
1997, the Company filed a Form 8-K Report to disclose the execution of the
Royce Merger Agreement. On March 14, 1997, the Company filed a Form 8-K
Report to disclose the consummation of the Oclassen Merger.
31
<PAGE> 32
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.
WATSON PHARMACEUTICALS, INC.
(Registrant)
By: /s/ ALLEN CHAO, Ph.D.
--------------------------------------
Allen Chao, Ph.D.
Chairman and Chief Executive Officer
(Principal Executive and Financial Officer)
By: /s/ CHATO ABAD
--------------------------------------
Chato Abad
Vice President-Corporate Controller
(Principal Accounting Officer)
Date: March 28, 1997
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.
Signature Title Date
- ----------------------------- ----------------------- ---------------
/s/ Allen Chao, Ph.D. Chairman and March 28, 1997
- ----------------------------- Chief Executive Officer
Allen Chao, Ph.D.
/s/ Melvin Sharoky, M.D. President and Director March 28, 1997
- -----------------------------
Melvin Sharoky, M.D.
/s/ Michel J. Feldman Secretary and Director March 28, 1997
- -----------------------------
Michel J. Feldman
/s/ Michael Fedida Director March 28, 1997
- -----------------------------
Michael Fedida
/s/ Albert F. Hummel Director March 28, 1997
- -----------------------------
Albert F. Hummel
/s/ Alec D. Keith, Ph.D. Director March 28, 1997
- -----------------------------
Alec D. Keith, Ph.D.
/s/ Ronald R. Taylor Director March 28, 1997
- -----------------------------
Ronald R. Taylor
32
<PAGE> 33
<TABLE>
<CAPTION>
INDEX TO FINANCIAL STATEMENTS PAGE
----
<S> <C>
REPORTS OF INDEPENDENT ACCOUNTANTS ................................................................ F-2
CONSOLIDATED BALANCE SHEETS
as of December 31, 1996 and 1995 .......................................................... F-5
CONSOLIDATED STATEMENTS OF INCOME
for each of the three years in the period ended December 31, 1996 ......................... F-6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
for each of the three years in the period ended December 31, 1996 ........................ F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS
for each of the three years in the period ended December 31, 1996 ......................... F-8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ........................................................ F-10
FINANCIAL STATEMENT SCHEDULE:
II. Valuation and Qualifying Accounts ..................................................... F-25
</TABLE>
All other schedules are omitted because they are not applicable or the required
information is included in the Consolidated Financial Statements or notes
thereto.
<PAGE> 34
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Watson Pharmaceuticals, Inc.
In our opinion, based upon our audits and the reports of other auditors,
the consolidated financial statements in the accompanying index on page F-1
present fairly, in all material respects, the financial position of Watson
Pharmaceuticals, Inc. and its subsidiaries at 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. 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 did not audit the financial
statements of Somerset Pharmaceuticals, Inc. (Somerset), an entity which is 50%
owned by the Company. The Company's investment in Somerset aggregated
$24,653,000 and $25,741,000 at December 31, 1996 and 1995, respectively, and its
equity in the earnings of Somerset totaled $20,100,000, $24,800,000, and
$25,100,000 for the years ended December 31, 1996, 1995, and 1994, respectively.
In addition, we did not audit the financial statements of Circa Pharmaceuticals,
Inc. (Circa), a wholly owned subsidiary, for the year ended December 31, 1994,
which statements reflect net income of $17,259,000 (includes equity in the
earnings of Somerset of $25,100,000). Those financial statements were audited by
other auditors whose reports thereon have been furnished to us, and our opinion
expressed herein, insofar as it relates to the amounts included for Somerset and
Circa, is based solely on the reports of each of the respective other auditors.
We conducted our audits of the consolidated financial statements of Watson
Pharmaceuticals, Inc. in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits and the respective
reports of other auditors provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Costa Mesa, California
February 7, 1997, except as to Note 2,
which is as of February 27, 1997
F-2
<PAGE> 35
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Somerset Pharmaceuticals, Inc.:
We have audited the accompanying consolidated balance sheets of Somerset
Pharmaceuticals, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Somerset Pharmaceuticals, 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.
Deloitte & Touche LLP
Pittsburgh, Pennsylvania
February 6, 1997, except for Note 12,
as to which the date is March 7, 1997
F-3
<PAGE> 36
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Circa Pharmaceuticals, Inc.
We have audited the consolidated statements of operations and cash flows of
Circa Pharmaceuticals, Inc. and Subsidiaries (the "Company") for the year ended
December 31, 1994. 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 did not audit the financial
statements of Somerset Pharmaceuticals, Inc. ("Somerset"), an entity which is
50% owned by the company. In 1994, the Company has recorded income from Somerset
of $25,089,000. Those statements were audited by other auditors whose report has
been furnished to us, and our opinion, insofar as it relates to the amounts
included for Somerset, is based solely on the report of other auditors.
We conducted our audit 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 statements presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, based on our audit and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated results of operations and cash flows of
Circa Pharmaceuticals, Inc. and Subsidiaries for the year ended December 31,
1994, in conformity with generally accepted accounting principles.
Coopers & Lybrand L.L.P.
Melville, New York
February 7, 1995.
F-4
<PAGE> 37
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1996 1995
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents (Note 1) $ 148,231 $ 92,214
Marketable securities (Note 1) 62,817 26,038
Accounts receivable, net of allowances for doubtful accounts of
$1,419 and $1,320 (Note 1) 27,156 25,081
Royalty receivable (Note 6) 5,554 8,205
Inventories (Note 3) 23,216 22,637
Prepaid expenses and other current assets 2,816 2,344
Deferred tax assets (Note 7) 9,807 21,115
--------- --------
Total current assets 279,597 197,634
Property and equipment, net (Note 3) 73,594 69,999
Investments in joint ventures and other long-term investments
(Note 4) 61,164 49,355
Other assets 5,242 5,133
--------- --------
Total assets $ 419,597 $322,121
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses (Note 3) $ 20,208 $ 25,215
Income taxes payable (Note 7) 473 2,985
Current portion of long-term debt (Note 5) 673 622
--------- --------
Total current liabilities 21,354 28,822
Long-term debt (Note 5) 2,904 3,577
Deferred tax liabilities (Note 7) 12,226
Other liabilities 687
--------- --------
Total liabilities 36,484 33,086
--------- --------
Commitments and contingencies (Note 10)
Minority interests (Note 1) 401
--------- --------
Stockholders' equity:
Preferred stock; no par; 2,500,000 shares authorized; none outstanding
(Note 8)
Common stock; par value of $.0033; 100,000,000 shares
authorized; 36,832,801 and 36,368,725 shares
issued and outstanding, respectively (Note 8) 122 120
Additional paid-in capital 159,392 146,439
Retained earnings 216,009 142,711
Unrealized holding gain on available-for-sale securities 7,189 621
Unearned compensation - stock awards (Note 1) (856)
--------- --------
Total stockholders' equity 382,712 289,035
--------- --------
Total liabilities and stockholders' equity $ 419,597 $322,121
========= ========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 38
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
-------- -------- -------
<S> <C> <C> <C>
Revenues:
Product sales $166,958 $130,688 $93,649
Royalty income (Note 6) 27,162 22,247 1,209
-------- -------- -------
Total revenues 194,120 152,935 94,858
-------- -------- -------
Operating expenses:
Cost of revenues (Note 9) 77,039 64,996 48,972
Research and development (Note 9) 16,490 18,573 18,980
Selling, general and administrative (Note 9) 17,882 17,030 13,342
Merger expenses (Note 2) 13,939
-------- -------- -------
Total operating expenses 111,411 114,538 81,294
-------- -------- -------
Operating income 82,709 38,397 13,564
Other income:
Equity in earnings of joint ventures (Note 4) 17,909 22,766 24,968
Investment and other income 8,555 11,594 6,542
Gain from legal settlements 2,299
-------- -------- -------
Total other income, net 26,464 34,360 33,809
-------- -------- -------
Income before provision for income taxes 109,173 72,757 47,373
Provision for income taxes (Note 7) 35,875 24,867 10,828
-------- -------- -------
Net income $ 73,298 $ 47,890 $36,545
======== ======== =======
Per share data:
Earnings per share (Note 1) $ 1.95 $ 1.29 $ 1.00
======== ======== =======
Weighted average number of common and common
equivalent shares outstanding (Note 1) 37,664 37,143 36,515
======== ======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 39
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
Unrealized Holding
Common Stock Additional Receivable Gain (Loss)
-------------- Paid-in Retained from on Available-for-Sale
Shares Amount Capital Earnings Stockholders Securities
------ ------ ---------- -------- ------------ ---------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 35,550 $117 $130,805 $ 58,276 $ (40)
Exercise of options/warrants 213 1 425
Collection of note receivable from stockholders 40
Tax benefit related to exercise of options 659
Common stock issued to employees 26 326
Cancellation of common stock issued to employees (6) (100)
Amortization of unearned compensation
Adjustment for unrealized holding loss on investment $ (870)
Net income 36,545
------ ---- -------- -------- ------ -------
Balance at December 31, 1994 35,783 118 132,115 94,821 (870)
Exercise of options 586 2 7,516
Tax benefit related to exercise of options 6,808
Amortization of unearned compensation
Adjustment for unrealized holding gain on investment 1,491
Net income 47,890
------ ---- -------- -------- ------ -------
Balance at December 31, 1995 36,369 120 146,439 142,711 621
Exercise of options 464 2 5,201
Tax benefit related to exercise of options 7,752
Amortization of unearned compensation
Adjustment for unrealized holding gain on investment 6,568
Net income 73,298
------ ---- -------- -------- ------ -------
Balance at December 31, 1996 36,833 $122 $159,392 $216,009 $ 7,189
====== ==== ======== ======== ====== =======
</TABLE>
<TABLE>
<CAPTION>
Unearned Total
Compensation- Stockholders'
Stock Awards Equity
------------- -------------
<S> <C> <C>
Balance at December 31, 1993 $ (4,079) $ 185,079
Exercise of options/warrants 426
Collection of note receivable from stockholders 40
Tax benefit related to exercise of options 659
Common stock issued to employees 326
Cancellation of common stock issued to employees 80 (20)
Amortization of unearned compensation 1,185 1,185
Adjustment for unrealized holding loss on investment (870)
Net income 36,545
----------- -----------
Balance at December 31, 1994 (2,814) 223,370
Exercise of options 7,518
Tax benefit related to exercise of options 6,808
Amortization of unearned compensation 1,958 1,958
Adjustment for unrealized holding gain on investment 1,491
Net income 47,890
----------- -----------
Balance at December 31, 1995 (856) 289,035
Exercise of options 5,203
Tax benefit related to exercise of options 7,752
Amortization of unearned compensation 856 856
Adjustment for unrealized holding gain on investment 6,568
Net income 73,298
----------- -----------
Balance at December 31, 1996 $ 382,712
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE> 40
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
------------------------------------------
1996 1995 1994
--------- --------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 73,298 $ 47,890 $ 36,545
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 6,256 5,243 4,447
Amortization of unearned compensation-stock awards 856 1,958 1,491
Amortization of deferred income and bond premium (917) (146)
Decrease in deferred partnership liability (14,033) (1,209)
Dividends received from Somerset 18,000 18,000 18,000
Equity in earnings of joint ventures (14,684) (19,067) (20,945)
Gain on sale of Marsam stock (6,243) (3,180)
Gain on settlement with former officers (2,299)
Provision for doubtful accounts 1,234 417 119
Deferred income tax provision (benefit) 20,399 8,215 (597)
Tax benefit related to stock option plan 7,752 6,808 659
Changes in assets and liabilities:
Increase in accounts receivable (3,309) (9,371) (7,262)
(Increase) decrease in royalty receivable 2,651 (8,205)
Increase in inventories (579) (6,276) (3,715)
(Increase) decrease in prepaid expenses and other current assets (472) 24 420
(Increase) decrease in other assets (1,557) 82 49
Increase (decrease) in accounts payable and accrued expenses (5,007) 7,605 1,931
Increase (decrease) in income taxes payable (2,512) 3,263
Decrease in accrual for legal settlements (10,881)
Decrease in other liabilities (687)
--------- --------- --------
Total adjustments 28,341 (12,497) (23,118)
--------- --------- --------
Net cash provided by operating activities 101,639 35,393 13,427
--------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (10,209) (22,588) (21,484)
Disposals of property and equipment 460 1,463 104
Purchases of marketable securities (838,543) (386,502) (19,164)
Proceeds from maturities of marketable securities 801,179 396,725 45,324
Proceeds from sale of Marsam stock 7,005 3,869
Proceeds from sale of a joint venture 7,992
Investment in Andrx (15,645) (6,000)
Increase in investment in other joint ventures (3,090) (818) (1,518)
--------- --------- --------
Net cash provided by (used in) investing activities $ (50,203) $ (20,360) $ 9,123
--------- --------- --------
</TABLE>
See accompanying notes to consolidated financial statements.
F-8
<PAGE> 41
WATSON PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------
1996 1995 1994
-------- -------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt $ 5,000
Principal payments on long-term debt $ (622) $ (1,502) (1,938)
Proceeds from exercise of stock options 5,203 7,518 426
Net collections of notes receivable from stockholders 40
--------- -------- --------
Net cash provided by financing activities 4,581 6,016 3,528
--------- -------- --------
Net increase in cash and cash equivalents 56,017 21,049 26,078
Cash and cash equivalents at beginning of year 92,214 71,165 45,087
--------- -------- --------
Cash and cash equivalents at end of year $ 148,231 $ 92,214 $ 71,165
========= ======== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for
Interest $ 318 $ 446 $ 901
Income taxes $ 10,332 $ 6,765 $ 10,082
</TABLE>
See accompanying notes to consolidated financial statements.
F-9
<PAGE> 42
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Description of business and principles of consolidation
Watson Pharmaceuticals, Inc. ("Watson" or the "Company") is engaged in
the research and development, production, marketing and distribution of
off-patent and proprietary pharmaceutical products. The consolidated financial
statements include the accounts of wholly owned and majority owned subsidiaries
after elimination of intercompany accounts and transactions.
The Company's wholly owned subsidiaries include Watson Laboratories,
Inc. ("Watson Labs"), Circa Pharmaceuticals, Inc. ("Circa"), Watson
Pharmaceuticals (Asia) Ltd. ("Watson (Asia)") and Corona Pharmaceuticals, Inc.
(currently inactive). Changzhou Watson Pharmaceuticals Co. Ltd. is the Company's
only majority owned subsidiary. During 1995, all of the assets of Zetachron
Inc., a wholly owned subsidiary, were merged into Watson Labs or disposed of for
an immaterial loss.
Investments are accounted for under the equity method of accounting
where the Company can exert significant influence and ownership does not exceed
50%. All investments in which the Company holds less than a 20% interest and
does not exert significant influence are accounted for under the cost method of
accounting. The Company's investments accounted for under the equity method of
accounting include Somerset Pharmaceuticals, Inc., ANCIRC and Changzhou Siyao
Pharmaceuticals Co. Ltd. The Company's investment in Andrx Corporation is
accounted for under the cost method of accounting. See Note 4 for further
discussion.
Cash and cash equivalents
Cash and cash equivalents include time deposits and readily marketable
securities with original maturities of three months or less.
Fair value of financial instruments
The Company values financial instruments as required by Statement of
Financial Accounting Standards No. 107, "Disclosures about Fair Values of
Financial Instruments" ("SFAS 107"). The carrying amounts of cash and cash
equivalents, marketable securities, accounts and other receivables, inventories,
accounts payable, accrued expenses and debt approximate fair value.
F-10
<PAGE> 43
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Marketable securities
The Company's investment portfolio consists of fixed income securities,
equity securities and money market funds, all of which are included in the
Company's cash and cash equivalents or marketable securities. In 1994, the
Company adopted Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities" ("SFAS 115"). Under SFAS
115, all of the Company's investments are classified as "available-for-sale"
securities and are reported at fair market value. Any unrealized holding gains
or losses are reported, net of applicable income taxes, as a separate component
of stockholders' equity. Realized gains and losses are determined on the
specific identification method and are reported in income. Maturity dates on
fixed income securities ranged from 1997 to 2009.
The following table includes the Company's cash equivalents and the
amortized cost and fair market values of all marketable securities (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1996
------------------------------------------------------
GROSS GROSS FAIR
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUES
---------- ---------- ---------- ------
<S> <C> <C> <C> <C>
Fixed income securities:
U.S. government and
Government agency securities $ 55,052 $ 150 $ (91) $ 55,111
State-issued securities 3,405 3,405
Corporate bonds 12,825 2 (30) 12,797
Commercial paper 107,273 4 (1) 107,276
Equity securities 17,545 1 17,546
Money market funds 14,913 14,913
-------- -------- --------- --------
$211,013 $ 157 $ (122) $211,048
======== ======== ========= ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1995
------------------------------------------------------
GROSS GROSS FAIR
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUES
---------- ---------- ---------- ------
<S> <C> <C> <C> <C>
Fixed income securities:
U.S. government and
Government agency securities $ 36,741 $ 463 $ (54) $ 37,150
State-issued securities 4,400 4,400
Corporate bonds 9,444 232 9,676
Commercial paper 46,197 (48) 46,149
Equity securities 6,624 28 6,652
Money market funds 14,225 14,225
-------- -------- --------- --------
$117,631 $ 723 $ (102) $118,252
======== ======== ========= ========
</TABLE>
The Company disposed of its investment in common stock of Marsam
Pharmaceuticals, Inc. ("Marsam") during 1995. Realized gains from the sales of
Marsam common stock were $6.2 million and $3.2 million for the years ended
December 31, 1995 and 1994, respectively. Realized gains and losses from the
sales of other marketable securities were not material for the three years in
the period ended December 31, 1996.
F-11
<PAGE> 44
WATSON PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Inventories
Inventories are stated at the lower of cost (first-in, first-out
method) or market.
Property and equipment
Property and equipment are stated at cost. Major renewals and
improvements are capitalized, while normal maintenance and repairs are expensed
as incurred. At the time properties are retired from service, the cost and
accumulated depreciation are removed from the respective accounts and gains or
losses are reflected in income.
Depreciation expense is computed principally on a straight-line basis,
over the estimated useful lives of two to ten years for furniture, fixtures and
equipment and thirty years for buildings and building improvements. Leasehold
improvements and assets recorded under capital leases are amortized on a
straight-line basis over the terms of the respective leases.
Accounting for long-lived assets
Effective January 1, 1996, the Company adopted Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of" ("SFAS 121") which requires
the Company to periodically review the recoverability of long-lived assets based
on the related undiscounted future cash flows. The adoption of SFAS 121 did not
have a material impact on the Company's financial condition or results of
operations.
Minority interest
Minority interest represents third party capital contributions received
or receivable by the Company.
Unearned compensation
Prior to its merger with the Company (Note 2), Circa maintained stock
award plans (the "stock awards") for key employees and officers. The stock
awards contained certain vesting provisions which required unearned compensation
to be recorded for the fair market value of the shares issued. Concurrent with
the merger with Circa, the stock awards were converted to equivalent common
shares in the Company pursuant to the merger exchange ratio specified in the
merger agreement. Compensation expense was charged on a straight-line basis to
selling, general and administrative expense over the related vesting periods. At
December 31, 1996, unearned compensation related to the stock awards had been
fully amortized.
Revenue recognition
Revenues from product sales are recognized upon shipment and are net of
returns and adjustments. Royalty income is recognized as earned pursuant to the
terms of the Company's amended agreement with Rhone-Poulenc Rorer, Inc. (Note
6).
Product sales to major customers
In 1996 and 1995, no individual customers accounted for more than 10%
of the Company's product sales. In 1994, two customers accounted for 25% of
product sales, 13% and 12% individually.
Research and development activities
The costs associated with the development, testing and approval of
pharmaceutical products are expensed as incurred.
F-12
<PAGE> 45
Income taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standard No. 109, "Accounting for Income Taxes" ("SFAS
109"). Under the liability method specified by SFAS 109, the deferred tax assets
and liabilities are measured each year based on the difference between the
financial statement and income tax bases of assets and liabilities at the
applicable enacted income tax rates. The deferred tax provision is the result of
changes in the deferred tax assets and liabilities.
Earnings per share
The computation of earnings per share is based on the weighted average
number of common shares outstanding. The weighted average number of shares
includes the dilutive effect of the assumed exercise of all outstanding stock
options and warrants described in Note 8.
Accounting for stock-based compensation
The Company adopted Statement of Financial Accounting Standards No.
123, "Accounting for Stock-Based Compensation" ("SFAS 123"), in 1996. As
permitted by SFAS 123, the Company continues to measure compensation cost in
accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", but provides pro forma disclosures of net income and
earnings per share as if the fair value method (as defined in SFAS 123) had been
applied beginning in 1995.
Use of estimates by management
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make certain
estimates and assumptions. These estimates and assumptions are reflected in the
reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at December 31, 1996 and 1995. Management's estimates and
assumptions are also reflected in the revenues and expenses for the three years
in the period ended December 31, 1996.
Concentration of credit risk
The Company is potentially subject to a concentration of credit risk
with respect to its trade receivable balance, all of which are due from service
providers, distributors, wholesalers and chain drug stores in the health care
and pharmaceutical industries. The Company performs ongoing credit evaluations
of its customers and maintains reserves for potential uncollectible accounts.
Actual losses from uncollectible accounts have been within management's
expectations.
Reclassifications
Certain amounts in the 1994 and 1995 financial statements have been
reclassified to conform with the 1996 presentation. These reclassifications had
no effect on net income or retained earnings.
2. MERGERS
Merger with Circa
On July 17, 1995, the stockholders of the Company and Circa approved
the merger which resulted in Circa becoming a wholly owned subsidiary of the
Company. Under the terms of the merger agreement, Circa stockholders received
0.86 of a share of the Company's common stock for each Circa share. Accordingly,
the Company issued approximately 18.7 million shares of its common stock for all
of the outstanding common shares of Circa.
The merger qualified as a tax-free reorganization and was accounted for
as a pooling of interests. The Company's financial statements have been
retroactively restated to include the results of Circa for all periods
presented. A one-time charge of $13.9 million for merger-related expenses was
recorded during the quarter ended September 30, 1995. These expenses included
investment banking fees and other costs related to the consolidation of
operations between the two companies.
Recent merger
F-13
<PAGE> 46
On September 25, 1996, Watson entered into a definitive Agreement and
Plan of Merger, as amended effective November 14, 1996 and as further amended
December 31. 1996, (collectively, the "Oclassen Merger Agreement") with Oclassen
Pharmaceuticals, Inc. ("Oclassen"). Pursuant to the Oclassen Merger Agreement,
Oclassen agreed to merge with a subsidiary of Watson created for the purpose of
the Oclassen merger, with Oclassen surviving as a wholly owned subsidiary of
Watson.
Oclassen develops specialty prescription pharmaceuticals to prevent and
treat skin diseases, and markets these products to dermatologists. The merger
was consummated on February 27, 1997 and Watson issued approximately 3.3 million
shares of Watson common stock for all of the outstanding common shares of
Oclassen. The Company believes that the merger qualifies as a tax-free
reorganization for federal income tax purposes and has been accounted for as a
pooling of interests.
The following table sets forth unaudited pro forma combined financial
information of the Company as if the merger with Oclassen had been consummated
on January 1, 1996:
<TABLE>
<CAPTION>
Pro Forma
Watson Oclassen Adjustments Combined
--------- --------- ------------ ----------
<S> <C> <C> <C> <C>
Net revenues $194,120 $34,364 $228,484
Net income 73,298 4,458 77,756
Total assets 419,597 35,900 455,497
Total liabilities 36,484 8,864 45,348
Minority interest 401 401
Mandatorily redeemable
preferred stock 39,389 (39,389)
Total stockholders' equity (deficit) 382,712 (12,353) 39,389 409,748
</TABLE>
In connection with the Oclassen merger, the Company expects to record a one-time
charge of approximately $8.5 million for merger-related expenses in the first
quarter of 1997. These expenses include investment banking fees and other costs
related to the merger.
Pending merger
On December 24, 1996, Watson entered into a definitive Agreement and
Plan of Merger, as amended effective March 4, 1997 (collectively the "Royce
Merger Agreement") with Royce Laboratories, Inc. ("Royce"). Pursuant to the
Royce Merger Agreement, Royce agreed to merge with a subsidiary of Watson
created for the purpose of the merger, with Royce surviving as a wholly owned
subsidiary of Watson.
Royce develops, manufactures and markets off-patent prescription drugs
in solid dosage forms (tablets and capsules). At present, Royce manufactures and
markets 20 off-patent prescription drugs in 42 dosage strengths and had received
approval on an additional drug in 3 dosage strengths that it has not yet
commenced manufacturing and marketing. Additionally, Royce has ANDAs pending
with the FDA for 9 new products in 15 dosage strengths.
At the effective time of the Royce merger, Royce stockholders will
receive an aggregate of up to approximately 2.6 million shares of Watson common
stock in exchange for all of the outstanding common stock of Royce. It is
intended that the Royce merger will qualify as a pooling of interests for
accounting purposes and a tax-free reorganization for federal income tax
purposes. The Royce Merger Agreement may be terminated and the Royce merger
abandoned if the Royce merger has not occurred by April 30, 1997. The Royce
stockholders' meeting is scheduled for April 16, 1997, and if approved, the
Royce merger will close the next day.
F-14
<PAGE> 47
3. BALANCE SHEET COMPONENTS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1996 1995
----------- -----------
(IN THOUSANDS)
INVENTORIES:
<S> <C> <C>
Raw materials $ 10,075 $ 11,483
Work-in-process 5,874 5,112
Finished goods 7,267 6,042
--------- --------
$ 23,216 $ 22,637
========= ========
PROPERTY AND EQUIPMENT:
Buildings and improvements $ 37,859 $ 22,457
Leaseholds improvements 7,302 7,396
Land and land improvements 4,937 4,937
Machinery and equipment 45,292 41,403
Research and laboratory equipment 9,474 9,020
Furniture and fixtures 2,796 2,667
--------- --------
107,660 87,880
Less accumulated depreciation and amortization (37,726) (32,647)
--------- --------
69,934 55,233
Construction in progress 3,660 14,766
--------- --------
$ 73,594 $ 69,999
========= ========
ACCOUNTS PAYABLE AND ACCRUED EXPENSES:
Trade accounts payable $ 13,986 $ 16,824
Reserve for litigation settlement 2,839
Accrued payroll and benefits 2,218 2,716
Reserve for sales coupons 1,101 1,783
Other accrued expenses 2,903 1,053
--------- --------
$ 20,208 $ 25,215
========= ========
</TABLE>
4. INVESTMENTS IN JOINT VENTURES AND OTHER LONG-TERM INVESTMENTS
Joint Ventures
Somerset Pharmaceuticals, Inc. ("Somerset")
The Company maintains a 50% interest in the outstanding common stock of
Somerset and utilizes the equity method to account for this investment. Somerset
markets the product Eldepry(R), which is used in the treatment of Parkinson's
disease. Income recognized from Somerset was approximately $20.1 million, $24.8
million, and $25.1 million for the years ended December 31, 1996, 1995, and
1994, respectively. Income includes 50% of Somerset's earnings, ongoing
management fees and amortization of deferred income, offset by amortization of
goodwill. The net excess cost of this investment over its net assets was $7.4
million and $8.4 million at December 31, 1996 and 1995 respectively, and is
being amortized on a straight-line basis over 15 years.
Orphan drug exclusivity expired for Eldepry(R) in June 1996. During
1996, the Company experienced a decrease in earnings from Somerset due to
increased competition for Eldepry(R) and increased research and development
spending. Management anticipates that the Company's equity in earnings from
Somerset will be substantially reduced in 1997 from prior year levels due to
increased competition for Eldepry(R) and anticipated increased research and
development expenditures in connection with the development of several new
products.
F-15
<PAGE> 48
Condensed income statements and balance sheets of Somerset are as
follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1996 1995 1994
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Net revenues $101,512 $107,365 $124,566
Costs and expenses 46,895 42,812 59,557
Income taxes 18,815 20,200 20,900
-------- -------- --------
Net income $ 35,802 $ 44,353 $ 44,109
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1996 1995
------- -------
(IN THOUSANDS)
<S> <C> <C>
Current assets $45,871 $43,993
Other assets 7,006 7,127
------- -------
Total assets $52,877 $51,120
======= =======
Current liabilities $19,075 $17,057
Other liabilities -- 63
Stockholders' equity 33,802 34,000
------- -------
Total liabilities and stockholders' equity $52,877 $51,120
======= =======
</TABLE>
ANCIRC
In July 1994, the Company and Andrx Corporation ("Andrx") formed a
joint venture, ANCIRC, to develop off-patent pharmaceutical products utilizing
Andrx's controlled-release technology. During 1995, the terms of the ANCIRC
joint venture agreement were amended whereby the Company and Andrx became equal
partners in the sharing of costs and profits in the ANCIRC joint venture.
Previously, the Company was responsible for 40% of the costs and profits of
ANCIRC. The Company utilizes the equity method to account for this joint venture
and recognized losses from ANCIRC of approximately $2.0 million, $1.7 million
and $0.2 million for the years ended December 31, 1996, 1995 and 1994,
respectively.
F-16
<PAGE> 49
Combined Results for Unconsolidated Investments in Joint Ventures
The following aggregate financial information is provided for
unconsolidated investments in joint ventures accounted for using the equity
method:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1996 1995 1994
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Net revenues $101,512 $107,365 $126,726
======== ======== ========
Gross profit $ 88,840 $ 93,748 $109,979
======== ======== ========
Net income $ 31,564 $ 41,099 $ 44,409
======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1996 1995
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Current assets $ 46,572 $ 44,078
Other assets 10,342 7,127
-------- --------
Total assets $ 56,914 $ 51,205
======== ========
Current liabilities $ 20,123 $ 18,422
Other liabilities 63
Stockholders' equity 36,791 32,720
-------- --------
Total liabilities and stockholders' equity $ 56,914 $ 51,205
======== ========
</TABLE>
China Ventures
In 1996, Watson (Asia) entered into an agreement to form two ventures
with China-based Changzhou No. 4 Pharmaceuticals Factory ("Changzhou"). The
initial joint venture, Changzhou Watson Pharmaceuticals, Co. Ltd ("Joint Venture
A") will be engaged in the production, marketing and distribution of
pharmaceutical products in China. Joint Venture A is 87.5% owned by the Company
and 12.5% owned by Changzhou. The second joint venture, Changzhou Siyao
Pharmaceuticals Co. Ltd. ("Joint Venture B") will provide the raw materials to
Joint Venture A. Joint Venture B is 25% owned by the Company and 75% owned by
Changzhou. The earnings and losses of Joint Venture B operations will be shared
according to each partner's respective ownership percentage. As of December 31,
1996, neither joint venture had commenced operations.
American Triumvirate Insurance Company ("ATIC")
Prior to December 31, 1994, the Company had a 50% ownership interest
with another pharmaceutical company in ATIC, a captive insurance company, which
underwrote product liability insurance for Circa, Somerset and the joint venture
partner. The investment was accounted for under the equity method of accounting.
The Company recognized $759,000 as its equity in ATIC's earnings for the year
ended December 31, 1994. On December 31, 1994, the Company sold its 50% interest
in ATIC to the other joint venture partner. The selling price was $8.2 million,
which was equal to 50% of ATIC's stockholders' equity at December 31, 1994. The
Company received approximately $8.0 million in cash and established a receivable
for the balance. For financial reporting purposes, the sale of ATIC did not
result in a gain or loss to the Company.
F-17
<PAGE> 50
Other Long-Term Investments
Andrx Corporation
Andrx develops advanced controlled-release drug delivery systems and
distributes certain off-patent pharmaceutical products manufactured by others.
On October 30, 1995, the Company invested an additional $15.6 million in Andrx,
bringing its ownership to 19.5% of Andrx's total outstanding common shares. The
Company utilizes the cost method to account for its investment in Andrx. On June
14, 1996, Andrx completed an initial public offering of its securities,
effectively reducing the Company's ownership interest in Andrx to approximately
15.6% at December 31, 1996. At December 31, 1996, the Company recorded an
unrealized gain of $7.2 million (net of applicable income taxes of
$4.8 million) on its investment in Andrx.
5. DEBT
In 1994, the Company entered into an agreement, which was subsequently
amended as of December 31, 1996, with a bank (the "financing agreement") that
provided for several financing facilities. Under the terms of a facility in this
agreement, $5.0 million was borrowed in 1994. A seven-year note payable was
established, with monthly payments due through August 2001.
The facilities available to the Company under the financing agreement
are comprised of (i) a $20.0 million revolving, unsecured line of credit which
expires on August 1, 1998, (ii) a $6.0 million revolving, unsecured equipment
line of credit which expires on August 1, 1997, and (iii) a $10.0 million
non-revolving, unsecured line of credit which expires on August 1, 1997. At
August 1, 1997, the Company has the option of converting any outstanding
balances under the $6.0 million and $10.0 million lines of credit into five and
seven year notes payable, respectively. The financing agreement provides for (a)
variable interest rates, which would initially range from the bank's Reference
Rate (8.25% at December 31, 1996) minus one-quarter of a percentage point and
(b) fixed interest rate options. The Company must maintain specified financial
ratios and must comply with certain restrictive covenants. At December 31, 1996,
the Company was in compliance with all of the ratios and covenants. Except for
the note payable discussed in the preceding paragraph, no borrowings have been
made under this financing agreement.
Long-term debt is summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1996 1995
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Note payable to bank, unsecured, at a fixed rate of 8.105%, payable in
monthly installments of $78, including interest, due August 2001 $3,577 $4,199
Less current portion (673) (622)
------ ------
Long-term debt $2,904 $3,577
====== ======
</TABLE>
At December 31, 1996, annual maturities of long-term debt consisted of
the following:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31, (IN THOUSANDS)
- -------------------------------- --------------
<S> <C>
1997 $ 673
1998 730
1999 791
2000 858
2001 525
------
$3,577
======
</TABLE>
6. PARTNERSHIP WITH RHONE-POULENC RORER INC. ("RPR")
F-18
<PAGE> 51
In 1989, the Company and RPR formed a partnership (the "Partnership")
to develop and market Dilacor XR(R), a pharmaceutical product used in the
treatment of hypertension and angina. In connection with the development of
Dilacor XR(R), the Company incurred a liability to the Partnership reflecting
the Company's share of development and operating costs. At December 31, 1993,
the liability to the Partnership was $15.2 million. The Partnership agreement
was amended in April 1993, so that after September 1, 1993, the Company earned a
royalty from RPR's sales of Dilacor XR(R). The amended agreement also provided
that all royalties earned would be used first to offset the Partnership
liability and that any royalties in excess of the Partnership liability would be
remitted to the Company. As royalties were earned in 1994 and 1995, the
Partnership liability was fully eliminated in 1995 pursuant to the terms of this
agreement. Subsequent to the elimination of the partnership liability, royalties
earned are remitted to the Company on a quarterly basis.
In a subsequent amendment, effective January 1, 1995, it was agreed
that royalty income would be determined by prescriptions written, as defined,
for Dilacor XR(R). The royalty rates established under the agreement were 1% in
1994, 20% in 1995 and 1996, 22% from 1997 to 2000, and 3% thereafter. For the
years ended December 31, 1996, 1995 and 1994, the Company earned royalties of
$27.2 million, $22.2 million and $1.2 million, respectively and recorded a
royalty receivable balance of $5.6 million and $8.2 million at December 31, 1996
and 1995, respectively. Dilacor XR(R) lost exclusivity in May 1995. The loss of
exclusivity for Dilacor XR(R) did not have a significant impact on 1995 and 1996
sales of the product.
7. INCOME TAXES
The provision for income taxes is summarized as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
------- ------- --------
Taxes currently payable: (IN THOUSANDS)
<S> <C> <C> <C>
Federal $ 4,359 $ 6,623 $ 8,400
State 3,363 3,336 2,372
------- ------- --------
Total current 7,722 9,959 10,772
Deferred provision (benefit):
Federal 17,364 7,622 (592)
State 3,035 478 (11)
------- ------- --------
Total deferred 20,399 8,100 (603)
Exercise of stock options not treated as a reduction
of income tax expense 7,754 6,808 659
------- ------- --------
Total provision for
income taxes $35,875 $24,867 $ 10,828
======= ======= ========
</TABLE>
The exercise of stock options represents a tax benefit reflected as a
reduction of taxes currently payable, with a corresponding increase to the
additional paid-in capital account. Income taxes have been provided for the
possible distribution of approximately $17.0 million of undistributed earnings
related to the Company's investments in joint ventures.
F-19
<PAGE> 52
The income tax provision differs from the amount computed by applying
the federal income tax rate to income as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
-----------------------------------
1996 1995 1994
----------- -------- --------
<S> <C> <C> <C>
Expected tax at federal statutory rate 35% 35% 35%
State income tax, net of federal benefit 5 5 6
Research tax credits and other credits (1) (1) (2)
Dividends received deduction (4) (7) (11)
Non-deductible merger expenses 3
Other (2) (1) (4)
Reduction of valuation allowance related to
deferred tax assets (1)
--- --- ---
33% 34% 23%
=== === ===
</TABLE>
Deferred tax assets and liabilities are measured based on the
difference between the financial statement and tax bases of assets and
liabilities at the applicable enacted tax rates. Deferred tax assets and
liabilities are the results of the following temporary differences:
<TABLE>
<CAPTION>
December 31,
------------------------
1996 1995
------- --------
(in thousands)
<S> <C> <C>
Benefits from net operating loss carryforwards $ 390 $ 18,122
Difference in accounting for inventory and receivables 6,191 4,019
Benefits from tax credits and carryforward credits 875 2,965
Difference in depreciation for book and tax purposes (5,650) (4,998)
Difference in investment basis for book and tax (6,005) (116)
Other 1,780 2,788
------- --------
Net deferred tax (liabilities) assets $(2,419) $ 22,780
======= ========
</TABLE>
The Company had net operating loss ("NOL") carryforwards at December
31, 1996 of approximately $1.1 million for federal and New York state income tax
purposes. In the year ended December 31, 1996, the Company utilized NOL
carryforwards of approximately $46.7 million and $8.5 million to offset federal
and New York state income, respectively. The utilization of the New York NOL
carryforward is generally limited to the federal NOL carryforward amount. The
Company's NOL carryforwards will begin to expire in 2006. The Company has
approximately $0.9 million in federal alternative minimum tax credits which have
no expiration date. These credits are available to directly offset future
federal income taxes.
F-20
<PAGE> 53
8. STOCKHOLDERS' EQUITY
Preferred stock
In 1992, the Company authorized 2.5 million shares of no par preferred
stock. The Board of Directors has the authority to fix the rights, preferences,
privileges and restrictions, including dividend rates, conversion and voting
rights, terms and prices of redemptions and liquidation preferences without vote
or action by the stockholders. At December 31, 1996, no preferred stock was
issued.
Stock option plans
The Company has adopted several stock option plans that authorize the
granting of options to employees and directors to purchase the Company's common
stock subject to certain conditions. The options are granted at the fair market
value of the shares underlying the options at the date of the grant, become
exercisable over a five year period and expire in ten years. In conjunction with
the merger with Circa, certain stock option plans were assumed (the "assumed
options") by the Company. The assumed options were adjusted by the exchange
ratio as specified in the merger agreement. No additional options will be
granted under any of the assumed options plans.
F-21
<PAGE> 54
As discussed in Note 1, the Company has applied the disclosure-only
provision SFAS 123. Had compensation cost been determined based on the fair
value at the grant date consistent with the provisions of SFAS 123, the
Company's net income and earnings per share would have been reduced to the pro
forma amounts indicated below:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------
1996 1995
------- -------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<S> <C> <C>
Net income As reported $73,298 $47,890
======= =======
Pro forma $67,733 $42,938
======= =======
Earnings per share As reported $ 1.95 $ 1.29
======= =======
Pro forma $ 1.80 $ 1.16
======= =======
</TABLE>
The weighted-average fair value of each option has been estimated on
the date of grant using the Black-Scholes options-pricing model with the
following weighted-average assumptions used for grants in 1996 and 1995,
respectively: no dividend yield; expected volatility of 51% and 55%; risk-free
interest rate of 6.18% and 6.43%; and expected terms ranging from approximately
three to seven years. Weighted averages are used because of varying assumed
exercise dates.
A summary of the status of the Company's stock option plans as of
December 31, 1996, 1995 and 1994, and for the years then ended is presented
below (shares in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------
1996 1995 1994
------------------ ------------------ -------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ --------- ------ -------- -------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 3,138 $22 2,221 $11 1,762 $ 8
Granted 509 38 1,573 34 741 17
Exercised (464) 11 (585) 13 (112) 7
Canceled (297) 34 (71) 27 (170) 11
----- --- ------ --- ----- ---
Outstanding at end of year 2,886 $25 3,138 $22 2,221 $11
===== ====== =====
Options exercisable at year end 1,450 1,278 1,016
===== ====== =====
Weighted-average fair value of options
granted during the year $17.62 $16.26 $8.23
====== ====== =====
</TABLE>
F-22
<PAGE> 55
The following table summarizes information about stock options
outstanding at December 31, 1996 (shares in thousands):
<TABLE>
<CAPTION>
Weighted Average Weighted Average
Weighted Average Exercise Price Exercise Price
Range of Shares Remaining of Shares Shares of Shares
Exercise Prices Outstanding Contractual Life Outstanding Exercisable Exercisable
- --------------- ----------- ---------------- ---------------- ------------ ----------------
<S> <C> <C> <C> <C> <C>
$ 4 to $ 9 726 2.3 $ 6 682 $ 6
$ 9 to $28 746 6.9 $ 19 441 $ 18
$28 to $37 1,058 8.7 $ 36 298 $ 36
$38 to $48 356 9.1 $ 42 29 $ 39
----- --- ---- ----- ------
$ 4 to $48 2,886 6.7 $ 25 1,450 $ 16
</TABLE>
9. RELATED PARTIES
The Company leases a portion of its facilities from related parties.
The aggregate rent expense for 1996, 1995 and 1994 was $432,000, $432,000 and
$550,000, respectively, and was allocated to cost of revenues, research and
development and selling, general and administrative expenses.
In 1989, the Company assigned its purchase rights under a lease for
office and manufacturing facilities to a partnership in which the Chief
Executive Officer and certain family members are the general partners. The
partnership purchased the facilities and assumed the lease with the Company. In
April 1994, the Company acquired the manufacturing and office facilities from
the family partnership for a purchase price of $3.6 million which approximated
the fair market value at the time of sale.
At December 31, 1996, a receivable of approximately $2.4 million was
due from the President of the Company. This receivable arose from an agreement
whereby the Company makes the payment of applicable income taxes due from the
grant of restricted stock to the President. When the restricted stock vests and
is eligible to be sold, the receivable balance will be repaid.
10. COMMITMENTS AND CONTINGENCIES
Facility and equipment leases
The Company has entered into operating leases for certain of its
facilities and equipment. The terms of the operating leases for the Company's
facilities require the Company to pay property taxes, normal maintenance
expenses and maintain minimum insurance coverage. Total rental expense for
operating leases was approximately $631,000 for the years ended December 31,
1996 and 1995, respectively, and approximately $1.1 million for the year ended
December 31, 1994.
F-23
<PAGE> 56
At December 31, 1996, future minimum lease payments under all
noncancelable operating leases consisted of the following:
YEARS ENDED DECEMBER 31, (IN THOUSANDS)
- ---------------------------------------
1997 $ 804
1998 509
1999 445
2000 470
2001 137
------
$2,365
======
Employee retirement plan
The Company maintains a 401(k) retirement plan covering substantially
all employees. Monthly contributions are made by the Company based upon the
employee contributions to the plan. The Company contributed approximately
$340,000, $190,000 and $161,000 to the retirement plan for the years ended
December 31, 1996, 1995, and 1994, respectively.
Legal matters
In July 1995, Circa initiated discussions with the United States
Department of Justice as to the possible resolution of a long-standing open
inquiry with regard to possible violations of the False Claims Act in respect
of drugs sold prior to cessation of these product sales in 1990. Through these
discussions, the parties entered into a settlement agreement in March 1996.
Under the terms of this agreement, in March 1996 the Company paid $2.7 million
in settlement of all outstanding claims. The Company had established a reserve
at December 31, 1995 for the full amount of the settlement.
In November 1994, Circa settled its litigation with a former President,
who resigned in 1990. Under the terms of the agreement, the former President,
through an escrow agent, sold all of the 528,108 shares of Circa's common stock
owned by him. The proceeds from the sale of a substantial portion of such
shares, after payment of expenses and various taxes, were utilized to settle
Circa's claim that his conduct damaged Circa and also to reimburse Circa for
legal expenses paid on his behalf in past years. Circa recognized a gain on
settlement of $2.3 million. In addition, in 1994, Circa made cash settlement
payments aggregating $8.9 million, which amounts had been provided for in prior
years. Such payments related to civil anti-trust claims settled in 1994 and
other claims settled in prior years.
The Company is involved in various disputes the litigation matters
which arise in the ordinary course of business. The litigation process is
inherently uncertain and it is possible that the resolution of these disputes
and lawsuits may adversely affect the Company. Management believes, however,
that the ultimate resolution of such matters will not have a material adverse
impact on the Company's financial position or results of operations.
F-24
<PAGE> 57
WATSON PHARMACEUTICALS, INC.
SCHEDULE II -- VALUATION & QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGE TO BALANCE AT
BEGINNING COSTS AND DEDUCTIONS/ END OF
OF PERIOD EXPENSES OTHER PERIOD
---------- --------- ------------ ----------
<S> <C> <C> <C> <C>
YEAR END 1996:
Allowance for doubtful accounts $ 1,320 $ 1,234 $ (1,135) $ 1,419
YEAR END 1995:
Allowance for doubtful accounts $ 903 $ 417 $ 1,320
YEAR END 1994:
Allowance for doubtful accounts $ 574 $ 579 $ (250) $ 903
</TABLE>
F-25
<PAGE> 58
WATSON PHARMACEUTICALS, INC.
EXHIBIT INDEX
1996 FORM 10-K
<TABLE>
<CAPTION>
Exhibit
No. Description
- ------- -----------
<S> <C>
4.1(b) Amendment to loan agreement between the Company, its subsidiaries and
Bank of America NT & SA dated as of December 31, 1996.
10.3 Lease and Option Termination Agreement between Watson Laboratories,
Inc. and Research Property Associates dated January 31, 1997.
10.4 Lease between Bayview Associates and Oclassen Pharmaceuticals, Inc.
dated November 15, 1988.
10.4(a) Amendment to lease between Limar Realty Corporation #11 (successor
in interest to Bayview Associates) and Oclassen Pharmaceuticals, Inc.
dated October 10, 1995.
10.15 Intellectual Property Agreement between Alec D. Keith, Ph.D. and the
Company dated as of July 18, 1996.
*10.16(a) Amendment to the Employment Agreement with Dr. Melvin Sharoky dated
February 12, 1997.
22.1 Subsidiaries of the Company.
23.1 Consent of Price Waterhouse LLP.
23.2 Consent of Deloitte & Touche LLP.
23.3 Consent of Coopers & Lybrand L.L.P.
27.1 Financial Data Schedule (EDGAR version only).
99.1 Consolidated Financial Statements of Somerset Pharmaceuticals, Inc.
and Subsidiaries for the years ended December 31, 1996, 1995 and 1994.
</TABLE>
- ---------------
*Compensation Plan or Agreement
<PAGE> 1
EXHIBIT 4.1 (b)
AMENDMENT NO. 7 TO BUSINESS LOAN AGREEMENT
This Amendment No. 7 (the "Amendment") dated as of December 31, 1996 is
among Bank of America National Trust and Savings Association (the "Bank"),
WATSON PHARMACEUTICALS, INC. ("WPI"), WATSON LABORATORIES, INC. ("WLI") and
CIRCA PHARMACEUTICALS, INC. ("CPI") (WPI, WLI and CPI are sometimes referred to
collectively as the "Borrowers" and individually as the "Borrower").
RECITALS
A. The Bank and the Borrowers entered into a certain Business Loan
Agreement dated as of June 30, 1994 as previously amended (the
"Agreement").
B. The Bank and the Borrowers desire to further amend the Agreement.
AGREEMENT
1. DEFINITIONS. Capitalized terms used but not defined in this Amendment
shall have the meaning given to them in the Agreement.
2. AMENDMENTS. The Agreement is hereby amended as follows:
2.1 In subparagraph (a) of Paragraph 1.1 of the
Agreement, the AMOUNT "TWENTY MILLION DOLLARS
($20,000,000)" is substituted for the amount "TEN
MILLION DOLLARS ($10,000,000)".
2.2 In Paragraph 1.2 of the Agreement, the date "AUGUST
1, 1998" is substituted for the date "NOVEMBER 1,
1996".
2.3 Subparagraph (a) of Paragraph 1.3 of the Agreement is
amended in its entirety and shall read as follows:
"(a) Unless the Borrowers elect an optional interest
rate as described below, the interest rate is the
Bank's Reference Rate minus one-quarter (.25) of a
percentage point."
2.4 Subparagraph (a) of Paragraph 1.6 of the Agreement is
amended in its entirety and shall read as follows:
"(a) 'SHORT TERM FIXED RATE' means the Short Term
Base Rate plus eighty-five hundredths (.85) of a
percentage point."
2.5 The first sentence in Paragraph 1.7 of the Agreement
is amended in its entirety and shall read as follows:
"OFFSHORE RATE. The Borrowers may elect to have all
or portions of the principal balance of the line of
credit bear interest at the Offshore Rate plus
eighty-five hundredths (.85) of a percentage point."
<PAGE> 2
2.6 In Paragraph 2.2 of the Agreement, the date is
"AUGUST 1, 1997" substituted for the date "JUNE 1,
1996".
2.7 In subparagraph (b) of Paragraph 2.6 of the
Agreement, the date "SEPTEMBER 1, 1997" is
substituted for the date "JULY 1, 1996" and "AUGUST
1, 2002" is substituted for the date "JUNE 1, 2002".
2.8 Article 4 and its subsequent paragraphs are deleted
in their entirety.
2.9 In Paragraph 4A.4 of the Agreement, the date "AUGUST
1, 1997" is substituted for the date "JUNE 1, 1996".
2.10 In subparagraph (b) of Paragraph 4A.4 of the
Agreement, the date "JULY 1, 2004" is substituted for
the date "MAY 1, 2003".
2.11 The first phrase in Paragraph 9. 1 of the Agreement
is amended as follows:
"To use the proceeds of Facility No. 1 only for the
Borrowers' general corporate purposes and joint
venture investments;"
2.12 Subparagraph (a) of Paragraph 9.2 of the Agreement is
amended in its entirety and shall read as follows:
"(a) Copies of WPI's Form 10-K Annual Report and
Form 10-Q Quarterly Report within 30 days after the
date of filing with the Securities and Exchange
Commission."
2.13 Subparagraphs (b), (c), (d), (e) and (h) of Paragraph
9.2 of the Agreement are deleted in their entirety.
2.14 Paragraph 9.3 of the Agreement is deleted in its
entirety.
2.15 Paragraph 9.4 of the Agreement is amended in its
entirety and shall read as follows:
"9.4 TANGIBLE NET WORTH. With respect to WPI, to
maintain on a consolidated basis, tangible net worth
equal to at least the following:
(1) From and including the date hereof to but
excluding the Oclassen Merger Date, the sum
of:
(a) Three Hundred Twenty Five Million
Dollars ($325,000,000); plus
(b) the sum of 50% of net income after
income taxes (without subtracting
losses) earned in each quarterly
accounting period commencing
December 31, 1996.
<PAGE> 3
(2) On and after the Oclassen Merger Date, the
sum of:
(a) Three Hundred Fifty Million Dollars
($350,000,000); plus
(b) the sum of 50% of net income after
income taxes (without subtracting
losses) earned in each quarterly
accounting period commencing March
31, 1997.
'Oclassen Merger Date' means the date on which
Oclassen Pharmaceuticals, Inc. becomes a wholly-owned
subsidiary of WPI; 'tangible net worth' means the
gross book value of WPI's assets (excluding goodwill,
patents, trademarks, trade names, organization
expense, treasury stock, unamortized debt discount
and expense, deferred research and development costs,
deferred marketing expenses, and other like
intangibles, and monies due from affiliates,
officers, directors or shareholders of WPI) plus debt
subordinated to the Bank in a manner acceptable to
the Bank (using the Bank's standard form) less total
liabilities, including but not limited to accrued and
deferred income taxes, and any reserves against
assets.'
2.16 Paragraph 9.6 of the Agreement is amended in its
entirety and shall read as follows:
'9.6 CASH FLOW COVERAGE RATIO. With respect to
WPI, to maintain on a consolidated basis, cash flow
coverage ratio of at least 2.0:1.0.
'Cash flow coverage ratio' means the sum of net
income after taxes, plus depreciation and other
non-cash charges, plus interest expense minus
dividends and non-financed capital expenditures
divided by the sum of interest expense, plus the
current portion of capital leases and the current
portion of long-term debt. This ratio will be
calculated at the end of each fiscal quarter. The
current portion of long term debt and the current
portion of capital leases will be measured as of the
last day of the preceding fiscal quarter."
2.17 Subparagraph (e) of Paragraph 9.8 of the Agreement is
amended in its entirety to read as follows:
"(e) Additional debts and lease obligations of
Borrowers for business purposes."
2.18 Subparagraph (d) of Paragraph 9.9 of the Agreement is
amended in its entirety to read as follows:
"(d) Additional purchase money security interest in
personal and non-personal property acquired by the
Borrowers or any one of them."
2.19 Paragraph 9.10 of the Agreement is deleted in its
entirety.
2.20 In Paragraph 9.11 of the Agreement, the definition of
"Line year" is amended in its entirety to read as
follows:
" 'Line year' means the period between August 1, 1996
and July 31, 1997, and each subsequent one-year
period (if any)."
<PAGE> 4
2.21 In subparagraph (a) of Paragraph 9.12 of the
Agreement, the amount "One Million Dollars
($1,000,000)" is substituted for the amount "One
Hundred Thousand Dollars ($100,000)".
2.22 Subparagraph (f) of Paragraph 9.20 of the Agreement
is amended in its entirety to read as follows:
"(f) make any loans or advances to or
investments in any person or entity in
excess of an aggregate amount at any time
exceeding twenty percent (20%) of the
Borrowers' tangible net worth, as of the
period beginning January 1, 1997, subject to
the Borrowers being in compliance with all
other terms and conditions."
2.23 In Paragraphs 11.5 of the Agreement, the amount "Two
Million Five Hundred Thousand Dollars ($2,500,000)"
is substituted for the amount "One Million Dollars
($1,000,000)".
2.24 In Paragraphs 11.6 of the Agreement, the amount "Two
Million Five Hundred Thousand Dollars ($2,500,000)"
is substituted for the amount "Seven Hundred Fifty
Thousand Dollars ($750,000)".
2.25 Paragraph 11.9 of the Agreement is amended in its
entirety to read as follows:
"11.9 CROSS-DEFAULT. Any default occurs under one or
more agreements of any Borrower (or any guarantor),
including without limitation, agreements obtaining
credit, guaranties, and supplier agreements, where
the aggregate amount of obligations thereunder exceed
Five Million Dollars ($5,000,000)."
3. CONDITIONS. This Amendment will be effective when the Bank
receives the following items, in form and content acceptable
to the Bank:
3.1 PERIODIC FEE. (FACILITY NO. 1) The Borrowers agree to
pay (i) a fee in the amount of Five Thousand Eight
Hundred Thirty-Three and 33/100 Dollars ($5,833.33)
payable on or before the date of this Amendment
covering the period from January 1, 1997 through July
31, 1997; and (ii) a fee in the amount of Ten
Thousand Dollars ($10,000) payable on August 1, 1997
covering the period from August 1, 1997 through July
31, 1998.
3.2 A Corporate Resolution to Obtain Credit executed by
each Borrower in an amount not less than Forty
Million Dollars ($40,000,000).
4. EFFECT OF AMENDMENT. Except as provided in this Amendment, all
of the terms and conditions of the Agreement shall remain in
full force and effect.
<PAGE> 5
This Amendment is executed as of the date stated at the beginning of
this Amendment.
BANK OF AMERICA WATSON PHARMACEUTICALS, INC.
National Trust and Savings Association
X /s/ Curt L. McCombs X /s/ Allen Chao
- ------------------------- ---------------------------------------
By: Curt L. McCombs, Vice President By: Allen Chao, Chairman and Chief
Executive Officer
X /s/ Michel J. Feldman
---------------------------------------
By: Michel J. Feldman, Secretary
WATSON LABORATORIES, INC.
X /s/ Allen Chao
---------------------------------------
By: Allen Chao, President
X /s/ Chato Abad
---------------------------------------
By: Chato Abad, Vice President of
Finance
CIRCA PHARMACEUTICALS, INC.
X /s/ Allen Chao
---------------------------------------
By: Allen Chao, Chairman of the Board
X /s/ Michel J. Feldman
---------------------------------------
By: Michel J. Feldman, Secretary
<PAGE> 1
EXHIBIT 10.3
LEASE AND OPTION TERMINATION AGREEMENT
This Lease and Option Termination Agreement is effective as of the 31st
day of January, 1997, between Watson Laboratories, Inc., a Nevada corporation
with offices at 311 Bonnie Circle, Corona, California 91718 ("Lessee"), and
Research Properties Associates, a partnership with a mailing address at P.O. Box
339, State College, Pennsylvania 16801 ("Lessor"). All capitalized terms not
defined herein shall have the meaning ascribed to them in that certain Lease
dated as of February 1, 1983 between Lessor and Zetachron, Incorporated, a
Pennsylvania corporation ("Zetachron"), as such lease was amended by that
certain Supplemental Agreement dated as of February 23, 1984 and by that certain
Modification of Lease dated as of January 1, 1985 (as so amended, the "Lease").
Lessee became a party to the Lease by virtue of the merger of Zetachron into
Lessee.
WHEREAS, pursuant to the Lease, Lessee leased from Lessor the premises
identified in the Lease and commonly known as Building #1, 100 N. Science Park
Road, Ferguson Township, Centre County, Pennsylvania (the "Premises");
WHEREAS, pursuant to a Grant of Option to Purchase Real Estate dated as
of July 1, 1987 (the "Option Agreement"), Lessor granted to Lessee an option to
purchase the Premises; and
WHEREAS, Lessee and Lessor now mutually desire to terminate the Lease
and the Option Agreement, as provided below.
NOW, THEREFORE, for good and valuable consideration, the receipt and
sufficiency of which are hereby acknowledged, the parties agree as follows:
1. Termination of Lease and Option Agreement. The Lease and the Option
Agreement are hereby terminated as of the date first written above.
2. Termination Payment. Concurrently with the execution of this
Agreement, Lessee shall deliver to Lessor by wire transfer to an account
designated by Lessor an amount equal to One Hundred Fifty-Eight Thousand Eight
Hundred Dollars ($158,800) (the "Termination Payment"), in full satisfaction of
all of Lessee's duties under the Lease and in exchange for Lessor's agreements
set forth below. Lessor has provided Lessee with written wire transfer
instructions.
3. Sale of Equipment. In consideration of Lessor's termination of the
Lease, Lessee hereby sells, transfers, conveys, assigns and delivers to Lessor,
its successors and assigns forever, all of Lessee's right, title and interest in
and to all of Lessee's personal property and equipment located on and in the
Premises.
4. General Release. In consideration of Lessee's payment of the
Termination Payment to Lessor, Lessor, on its own behalf and on behalf of its
successors and assigns, hereby releases and forever discharges Lessee, its
parent, their subsidiaries and affiliates, and their respective directors,
officers, employees and agents from any and all obligations, debts, claims,
actions, suits at law or in equity, sums of money, accounts, or demands arising
out of or in connection with the Lease of the Premises.
5. Indemnification. In consideration of Lessee's payment of the
Termination Payment to Lessor, Lessor hereby agrees to indemnify and hold
harmless Lessee, its parent, their subsidiaries and affiliates, and their
respective directors, officers, employees and agents from and against any and
all obligations, debts, claims or actions, suits at law or in equity, sums of
money, accounts, judgments or demands arising out of or in connection with
Lessee's guaranty of that certain $500,000 note (the "Note") issued by the
Centre County Industrial Development Corporation to the Pennsylvania Industrial
Development Authority ("PIDA"), and any additional guarantees by Lessee of the
repayment of indebtedness to finance the acquisition, construction, maintenance
or expansion of the Premises, including, without limitation, any indebtedness to
PIDA, SEDA-COG Local Development Corporation or the Pennsylvania Capital Loan
Fund.
<PAGE> 2
6. Counterparts. This Agreement may be executed in multiple
counterparts, each of which shall be deemed to be an original, and all such
counterparts shall constitute but one instrument.
IN WITNESS WHEREOF, the parties, intending to be legally bound, have
executed this Lease and Option Termination Agreement to be effective as of the
day and year first above written.
WATSON LABORATORIES, INC. RESEARCH PROPERTIES ASSOCIATES
/s/ Chato Abad /s/ Alec D. Keith
- ----------------------------------- -----------------------------------
Chato Abad Alec D. Keith, Partner
Vice President - Finance /s/ Wallace C. Snipes
- ----------------------------------- -----------------------------------
Printed Name and Title Wallace C. Snipes, Partner
<PAGE> 1
EXHIBIT 10.4
INDUSTRIAL LEASE
between
BAYVIEW ASSOCIATES, as Landlord
and
OCLASSEN PHARMACEUTICALS, INC., as Tenant
for
Building E
BAYVIEW BUSINESS PARK
SAN RAFAEL, CALIFORNIA
<PAGE> 2
Basic Lease Information
INDUSTRIAL LEASE
<TABLE>
<S> <C>
Lease Date: November 15, 1988
Landlord: BAYVIEW ASSOCIATES,
a California joint venture
Address of 100 Pelican Way, Suite 140
Landlord: San Rafael, California 94912
Tenant: OCLASSEN PHARMACEUTICALS, INC.,
a California corporation
Address of 201 Tamal Vista Boulevard
Tenant: Corte Madera, California 94925
Contact: Daniel K. Turner
Telephone: (415) 924-2000
Section 1.1 Premises: All of Building E (See Schedule 1)
Park: Bayview Business Park
Section 1.3 Parking Spaces: 2.5 per 1,000 sq. ft. of rentable area of
Premises -- 71 upon takedown of all of Building E
Section 2.1 Term: Eight years (96 months)
Commencement Date: January 15, 1989
Expiration Date: January 14, 1997
Section 3.1 Rent: See Schedule 2
Section 3.2 Periodic Rent Increase Dates:Each anniversary of the
Commencement Date
Section 4.1 Rentable Area of Total Premises: 28,344 rentable sq. ft.
Tenant's Share of Building and Park: See Schedule 2
Section 6.1 Use: General office and warehouse; and laboratory, research and
development, and manufacturing for pharmaceutical purposes
Section 25.1 Security Deposit: $16,000
Section 27.1 Broker: Grubb & Ellis Company (Landlord and Tenant)
Section 36 Option to Extend: One extension option for five (5) years
</TABLE>
The Basic Lease Information and the Lease are and shall be construed as a
single instrument. Each reference in this Lease to any of the terms and
information set forth in the Basic Lease Information shall mean the respective
terms and information hereinabove set forth, which terms and information shall
be incorporated into and made a part of the particular Lease section pertaining
to such Basic Lease Information.
<PAGE> 3
<TABLE>
<CAPTION>
BAYVIEW ASSOCIATES, OCLASSEN PHARMACEUTICALS, INC.,
a California Joint Venture a California corporation
<S> <C>
By: Bayview Partners, By: Dan K. Turner
a California limited partnership Its: Vice President - Finance and administration
Its: General Partner
By: Reid Corporation, By: /s/ Glenn A. Oclassen
a California corporation Its: President
Its: General Partner
By: /s/ L.C. Tolomei "TENANT"
----------------
L.C. Tolomei
President
"LANDLORD"
</TABLE>
<PAGE> 4
Table of Contents
<TABLE>
<CAPTION>
Page
Articles Description Number
- -------- ----------- ------
<S> <C> <C>
1 Premises and Common Areas 1
2 Term 2
3 Rent; Consumer Price Index; Additional Charges 2
4 Additional Charges for Taxes and Common Expenses 4
5 Improvement of the Premises 9
6 Conduct of Business by Tenant 11
7 Alterations and Tenant's Property 12
8 Repairs 14
9 Liens 15
10 Compliance with Laws and Insurance Requirements 15
11 Subordination 16
12 Inability to Perform; Right to Cure 17
13 Destruction 18
14 Eminent Domain 21
15 Assignment and Subletting 23
16 Utilities 26
17 Default 26
18 Insolvency or Bankruptcy 29
19 Fees and Expenses; Indemnity 29
20 Access to Premises 31
21 Notices 31
22 No Waiver; No Oral Modification 32
23 Tenant's Certificates 33
24 Tax on Tenant's Personal Property 33
25 Security Deposit 34
26 Authority 34
27 Broker 34
28 Liability of Landlord 35
29 Attorneys' Fees 35
30 Surrender and Holding Over 35
31 Quiet Enjoyment 35
32 Tenant's Insurance 36
33 Short Form of Lease 37
34 Hazardous Materials 37
35 Miscellaneous 40
36 Option to Extend 41
37 Option to Expand -- Building B 43
38 Expansion Option -- Building C 47
39 Right of First Refusal 49
</TABLE>
Schedule 1 - Delivery of Premises to Tenant
Schedule 2 - Rent Schedule
Exhibit A - Site Plan of Park
Exhibit B - Improvement of the Premises
Annex 1 - Initial Space Plan
<PAGE> 5
INDUSTRIAL LEASE
THIS LEASE is made and entered into as of the Lease Date by and between
BAYVIEW ASSOCIATES, a California Joint venture ("Landlord"), and OCLASSEN
PHARMACEUTICALS, INC., a California corporation ("Tenant").
WITNESSETH:
Landlord and Tenant hereby covenant and agree as follows:
1. Premises and Common Areas
1.1 Upon and subject to the terms, covenants and conditions
hereinafter set forth, Landlord hereby leases to Tenant and Tenant hereby hires
from Landlord the building located at 100 Pelican Way, San Rafael, California,
said building being Building E of the Bayview Business Park as more particularly
shown in the site plan for the Park set forth in Exhibit A attached hereto
(hereinafter called the "Building'). Landlord and Tenant acknowledge and agree
that the Building shall be delivered by Landlord to Tenant in phases as more
particularly specified in Schedule 1 attached hereto, and Tenant shall accept
such portions of the Building and shall have the right of occupancy with respect
thereto in accordance with the schedule set forth in said Schedule 1. As used
herein, the term "Premises" shall mean those portions of the Building that are
subject to the terms of this Lease, as and when such portions become subject to
the terms hereof in accordance with the schedule set forth in said Schedule 1.
Landlord and Tenant further acknowledge and agree that certain portions of the
Building are and/or may be leased by Landlord to third parties for the period(s)
prior to which such portions are to be delivered to Tenant as provided in said
Schedule 1.
1.2 Tenant shall have the right, for the benefit of Tenant and its
employees, suppliers, shippers, customers and invitees, to the use of all areas
and facilities serving the Premises that are within the site area for said
Building E, as such site area is outlined on Exhibit A attached hereto (the
"Building E Site"). Tenant shall also have the right, for the benefit of Tenant
and its employees, customers and invitees, to the non-exclusive use of all areas
and facilities within the exterior boundaries of the Park that are provided and
designated by Landlord from time to time for the general non-exclusive use of
Landlord, Tenant and the other tenants of the Park and their respective
employees, suppliers, shippers, customers and invitees, including drives,
walkways, roadways, trash areas and landscaped areas (herein called "Common
Areas").
1.3 Tenant shall have the right, for the benefit of Tenant and its
employees, customers and invitees, to the use of the number of vehicle parking
spaces specified in the Basic Lease Information, such parking spaces to be
within the area shown on Exhibit A as the parking area for Building E.
2. Term
2.1 This Lease shall be for the Term to commence on the Commencement
Date and end on the Expiration Date, unless the Term shall sooner terminate as
hereinafter provided.
2.2 If, on or prior to the Commencement Date, Landlord fails to
deliver possession of that portion of the Premises to be initially delivered to
Tenant as set forth in Schedule 1, then the following provisions shall apply:
(i) the Term shall not commence on the Commencement Date set forth in the Basic
Lease Information but shall, instead, commence on the date that Landlord
delivers possession of said portion of the Premises to Tenant; (ii) neither the
validity of this Lease nor the obligations of Tenant under this Lease shall be
affected thereby, except that the Term shall begin as provided in clause (i)
above; (iii) Tenant shall have no claim against Landlord because of Landlord's
failure to deliver possession of said portion of the Premises on the date
originally fixed therefor; and (iv) the Expiration Date shall be the date that
is eight (8) years after the revised Commencement Date. Promptly following the
Commencement Date, if the Commencement Date occurs on a date other than as
specified in the Basic Lease Information, the parties shall forthwith enter into
a supplementary agreement identifying the Commencement Date and the Expiration
Date of this Lease.
<PAGE> 6
2.3 In the event permission is given to Tenant to enter or occupy a
portion of the Building prior to the Commencement Date, such occupancy shall be
subject to all the terms and conditions of this Lease.
2.4 It is agreed that by occupying each portion of the Premises as a
tenant, Tenant formally accepts same and acknowledges that the same are in the
condition provided for hereunder, subject, however, to the completion of
punchlist items for Landlord's Work (as defined in Article 5).
3. Rent; Consumer Price Index; Additional Charges
3.1 Tenant shall pay to Landlord during the Term monthly rent ("Rent")
at the rates specified in Schedule 2 attached hereto on or before the first day
of each month, in advance, at the address specified for Landlord in the Basic
Lease Information, or such other place as Landlord shall designate, without any
prior demand therefor and without any abatement, in deduction or setoff
whatsoever. If the Commencement Date (or the date upon which any additional
portion of the Premises is delivered to Tenant) should occur on a day other than
the first day of a calendar month, or the Expiration Date should occur on a day
other than the last day of a calendar month, then the rental for such fractional
month shall be prorated on a daily basis based upon a thirty (30) day calendar
month.
3.2 On each of the Periodic Rent Increase Dates, the monthly rental
rates initially allocated and chargeable to each portion of the Premises as
specified in Schedule 2 (whether or not such portion of the Premises has yet
been delivered to Tenant) shall be increased to an amount determined by
multiplying the initial monthly rental rate for each portion of the Premises as
specified in Schedule 2 by a fraction, the denominator of which shall be the
most recent Consumer Price Index (as hereinafter defined) figure published prior
to the Commencement Date, and the numerator of which shall be the most recent
Consumer Price Index figure published prior to the date of such adjustment;
provided, however, in no event shall the rental rate for any month for any
portion of the Premises be less than the rental rate for the immediately
preceding month for such portion; and provided further that no Rent shall
actually be payable hereunder for any portion of the Premises that is not yet
subject to the terms of this Lease in accordance with the schedule set forth in
Schedule 1. As used herein, the term "Consumer Price Index" shall mean the
United States Department of Labor's Bureau of Labor Statistics' Consumer Price
Index, All Urban Wage Earners and Clerical Workers, All Items, for the San
Francisco-Oakland Area (1982-1984 equals 100). Should Landlord lack sufficient
data to make the determination specified in this Section 3.2 on the date of any
such adjustment, Tenant shall continue to pay Rent at the monthly rental rate
for each portion of the Premises that was applicable immediately prior to such
adjustment date. As soon as Landlord obtains the necessary data, it shall
determine the monthly rental rate for each portion of the Premises that is
applicable from and after such adjustment date and notify Tenant of the
adjustment in writing. Should the monthly Rent for the period following such
adjustment date exceed the amount previously paid by Tenant for such period,
Tenant shall forthwith pay the difference to Landlord. If the Consumer Price
Index is changed so that the base year differs from that used as of the month
immediately preceding the Commencement Date, the Consumer Price Index shall be
converted in accordance with the conversion factor published by the United
States Department of Labor's Bureau of Labor Statistics. If the Consumer Price
Index is discontinued or revised during the Term, such other government index or
computation with which it is replaced shall be used in order to obtain
substantially the same result as would be obtained if the Consumer Price Index
had not been discontinued or revised.
3.3 Tenant shall pay to Landlord all charges and other amounts
whatsoever as provided in this Lease (herein called "Additional Charges")
including, without limitation, any increase in the Rent resulting from the
provisions of Article 4. All such amounts and charges shall be payable to
Landlord at the place where the Rent is payable. Landlord shall have the same
remedies for a default in the payment of Additional Charges as for a default in
the payment of Rent.
3.4 Notwithstanding any other provisions of this Lease, including
Section 17.1, if Tenant shall fail to pay any Rent or Additional Charges within
ten (10) days after the date same are due and payable, such unpaid amounts shall
be subject to a late payment charge equal to six percent (6%) of such unpaid
amounts in each instance to cover Landlord's additional administrative costs
resulting from Tenant's failure.
<PAGE> 7
Such late payment charge has been agreed upon by Landlord and Tenant, after
negotiation, as a reasonable estimate of the additional administrative costs and
detriment to Landlord's ability to meet its own obligations relating to the
Building in a timely manner that will be incurred by Landlord as a result of any
such failure by Tenant, the actual cost thereof in each instance being extremely
difficult, if not impossible, to determine. Such late payment charge shall
constitute liquidated damages to compensate Landlord for its damages resulting
from such failure to pay and shall be paid to Landlord together with such unpaid
amounts; provided, however, that the payment of such charges shall not
constitute a waiver of any default by Tenant hereunder.
3.5 Notwithstanding any other provisions of this Lease, including
Section 17.1, any installment of Rent or Additional Charges not paid to Landlord
when due hereunder shall bear interest from the date due or from the date of
expenditure by Landlord for the account of Tenant, until the same have been
fully paid, at a rate (the "Default Rate") that is equal to the lesser of (i)
two percent (2%) above the rate of interest established by Bank of America N.T.&
S.A. at its San Francisco headquarters as its "Reference Rate" (or the successor
rate thereto), adjusted monthly on the first day of each month, such adjustment
to be effective for the following month, or (ii) the highest rate permitted by
law. The payment of such interest shall not constitute a waiver of any default
by Tenant hereunder.
4. Additional Charges for Taxes and Expenses
4.1 For purposes of this Article 4, the following terms shall have the
meanings hereinafter set forth:
(a) "Computation Year" shall mean each twelve (12) consecutive month
period commencing January 1 of each year or partial year during the
Term, provided that Landlord, upon notice to Tenant, may change the
Computation Year from time to time to any other twelve (12)
consecutive month period and, in the event of any such change,
Tenant's Share of Taxes and Expenses (as hereinafter defined) shall
be equitably adjusted for the Computation Years involved in any such
change.
(b) "Tenant's Shares" shall mean the percentage figures for Tenant's
Share of Building E and Tenant's Share of the Park as specified in
Schedule 2. Tenant's Share of the Park has been computed by dividing
the Rentable Area of the Premises by the total Rentable Area of the
Park and, in the event that either the Rentable Area of the Premises
or the total Rentable Area of the Park is changed, Tenant's Share of
the Park will be appropriately adjusted by Landlord, which
adjustment shall be conclusive and binding on Tenant and, as to the
Computation Year in which such change occurs, for purposes of this
Article 4, Tenant's Share shall be determined on the basis of the
number of days during such Computation Year at each such percentage.
(c) "Taxes" shall mean all taxes, assessments and charges levied
upon or with respect to the Building and the Building E Site as well
as the Common Areas of the Park, or any personal property of
Landlord used in the operation thereof, or Landlord's interest in
the Building, the Building E Site, the Common Areas of the Park or
such personal property. Taxes shall include, without limitation, all
general real property taxes and general and special assessments,
charges, fees or assessments for transit, housing, police, fire or
other governmental services or purported benefits to the Park,
service payments in lieu of taxes, and any tax, fee or excise on the
act of entering into this Lease or any other lease of space in the
Park, or on the use or occupancy of the Building or the Common Areas
of the Park or any part thereof, or on the rent payable under any
lease or in connection with the business of renting space in the
Park that are now or hereafter levied or assessed against Landlord
by the United States of America, the State of California, or any
political subdivision, public corporation, district or other
political or public entity, and shall also include any other tax,
fee or other excise, however described, that may be levied or
assessed as a substitute for or as an addition to, as a whole or in
part, any other Taxes, whether or not now customary or in the
contemplation of the parties on the date of this Lease. Taxes shall
not include franchise, transfer, inheritance or capital stock taxes
or income taxes
<PAGE> 8
measured by the net income of Landlord from all sources, unless, due
to a change in the method of taxation, any of such taxes is levied
or assessed against Landlord as a substitute for or as an addition
to, as a whole or in part, any other tax that would otherwise
constitute a Tax. Further, Taxes shall not include any special
assessment levied against the Building after the Lease Date if such
special assessment is levied for the purpose of constructing any
offsite improvements specifically serving the Building, which
improvements were required to be constructed as part of the initial
approval of the construction of the Building by the City of San
Rafael. Taxes shall also include reasonable legal fees, costs and
disbursements incurred in connection with proceedings to contest,
determine or reduce Taxes. If any Taxes are specially assessed by
reason of the occupancy or activities of one or more tenants and not
the occupancy or activities of the tenants as a whole, such Taxes
shall be allocated by Landlord to the tenant or tenants whose
occupancy or activities brought about such assessment. Except as
shown on the tax bill for the Building for the 1988-89 fiscal year,
Landlord has not received notice of any special assessment
proceedings that have been instituted which affect the Building;
provided, however, that Landlord is aware that there has been public
discussion of the possible formation of a special assessment
district for the construction of intersection improvements and other
traffic mitigation measures in the vicinity of the Park.
(d) "Expenses" shall mean the aggregate amount of (i) the total
costs and expenses paid or incurred by Landlord in connection with
the operation, repair and maintenance of the Common Areas, the
Building, the Building E Site and the Park, including, without
limitation parking areas, loading and unloading areas, trash areas,
roadways, driveways, walkways, landscaped areas, striping, bumpers,
lighting facilities, fences and gates, and window washing, (ii) the
cost of fire, extended coverage, boiler, sprinkler, public
liability, property damage, rent, earthquake and other insurance
obtained by Landlord in connection with the Building and/or the
Common Areas of the Park and the deductible portion of any insured
loss otherwise covered by such insurance, (provided, however, that
Landlord shall include the cost of any earthquake insurance
maintained by Landlord as an item of Expenses only if such insurance
is commonly carried by prudent owners of property similar to the
Park or if such insurance is commonly required by institutional
lenders financing projects similar to the Park; and, provided
further that the deductible amount under any casualty insurance
policy on the Building or the Park that is maintained by Landlord
shall not exceed $10,000 per occurrence, or, if such insurance can
only be obtained from reputable insurers with a higher deductible
amount, then Landlord shall obtain such insurance which, in
Landlord's good faith judgment, provides for a satisfactory
deductible amount after taking into account the amount of the policy
premium for such insurance and the reputation of the insurer), (iii)
the cost of trash disposal services, (iv) the cost of maintaining
tenant directories, (v) the cost of operating, repairing and
maintaining life safety systems, including, without limitation,
sprinkler systems, (vi) the cost of security services, if provided
by Landlord, (vii) the cost of water, electricity, gas and any other
utilities used in connection with the operation, maintenance and
repair of the Common Areas, (viii) permits, licenses and
certificates necessary to operate the Park, (ix) legal, accounting
and consulting fees and expenses directly related to the use and
operation of the Building and the Park, but excluding any such fees
and expenses incurred in connection with disputes with any tenants
of the Park or any other third parties, (x) managerial fees and
administrative expenses related to the Common Areas of the Park and
to the Building (if such fees and expenses are not charged
separately to the Common Areas and the Building, the Landlord shall
make a reasonable allocation thereto from gross fees and expenses
charged, and in any event any management fee charged with respect to
the Common Areas shall not exceed ten percent (10%) of the Expenses
incurred in connection with the Common Areas and any management fee
charged with respect to the Building shall not exceed ten percent
(10%) of the Expenses incurred in connection with the Building),
(xi) the cost of any capital improvements made to the Building as a
labor-saving device or to effect other economies in the operation or
maintenance of the Building, or made to the Park or the Building
after the date of this Lease that are required under any
governmental law or regulation that was not applicable to the Park
or the Building at the time that permits for
<PAGE> 9
the construction thereof were obtained, any such cost to be
amortized over the reasonable useful life of any such improvement,
together with interest on the unamortized balance at the rate of ten
percent (10%) per annum or such higher rate as may have been paid by
Landlord on funds borrowed for the purpose of constructing such
capital improvements, and (xii) the cost of any other service
generally provided to the tenants of the Park by Landlord.
"Expenses" shall not include any of the following items: any items
of repair caused by the negligence or misconduct of Landlord or any
other tenant of the Park or their respective agents, employees or
contractors, any item of expense for which Landlord is entitled to
reimbursement by any third party, the cost of correcting any defects
in the original construction of the Building or any portion of the
Park or any defects in the installation of any tenant improvements
in the Premises installed by Landlord (as opposed to defects in the
design of such tenant improvements, which shall be the
responsibility of Tenant), the cost of complying with the
requirements of any insurance underwriter (to the extent such
requirements are generally applicable to buildings in the vicinity
of the Park and are not related to Tenant's particular use of the
Premises), fees, commissions, attorneys' fees and other costs
incurred in connection with the leasing of the Park, including
advertising and promotional costs, depreciation of the Building or
the Park, and debt service payments on any mortgage and rental owing
under any ground or underlying lease; and, further, "Expenses" shall
not include any reserves that may be established by Landlord from
time to time for the maintenance and repair of the Building or the
Park. The computation of Expenses shall be made in accordance with
generally accepted accounting principles. Landlord shall be entitled
to reasonably allocate any items of Expense that are incurred
commonly for the Building and any other building(s) in the Park.
4.2 Tenant shall pay to Landlord as Additional Charges one twelfth
(1/12) of Tenant's Share of the Taxes for each Computation Year on or before the
first day of each month during such Computation Year, in advance, in an amount
reasonably estimated by Landlord and billed by Landlord to Tenant; provided that
Landlord shall have the right initially to determine monthly estimates and to
revise such estimates from time to time. With reasonable promptness after
Landlord has received the tax bills for any Computation Year, Landlord shall
furnish Tenant with a statement (herein called "Landlords Tax Statement")
setting forth the amount of Taxes for such Computation Year, and Tenant's Share
of such Taxes. If the actual Taxes for such Computation Year exceed the
estimated Taxes paid by Tenant for such Computation Year, Tenant shall pay to
Landlord the difference between the amount paid by Tenant and the actual Taxes
within thirty (30) days after the receipt of Landlord's Tax Statement, and if
the total amount paid by Tenant for any such Computation Year shall exceed the
actual Taxes for such Computation Year, such excess shall be credited against
the next installments of Taxes due from Tenant to Landlord hereunder. Upon the
written request of Tenant, Landlord shall provide Tenant with copies of the tax
bills that form the basis of Landlord's Tax Statement for any Computation Year.
4.3 Tenant shall pay to Landlord as Additional Charges one twelfth
(1/12) of Tenant's Share of the Expenses for each Computation Year on or before
the first day of each month of such Computation Year, in advance, in an amount
reasonably estimated by Landlord and billed by Landlord to Tenant; provided that
Landlord shall have the right initially to determine monthly estimates and to
review such estimates from time to time. With reasonable promptness after the
expiration of each Computation Year, Landlord shall furnish Tenant with a
statement (herein called "Landlord's Expense Statement"); certified by Landlord,
setting forth in reasonable detail the Expenses for such Computation Year, and
Tenant's Share of such Expenses. If the actual Expenses for such Computation
Year exceed the estimated Expenses paid by Tenant for such Computation Year,
Tenant shall pay to Landlord the difference between the amount paid by Tenant
and Tenant's share of the actual Expenses within thirty (30) days after the
receipt of Landlord's Expense Statement, and if the total amount paid by Tenant
for any such Computation Year shall exceed the actual Expenses for such
Computation Year, such excess shall be credited against the next installments of
the estimated Expenses due from Tenant to Landlord hereunder. Upon the written
request of Tenant, Landlord shall provide Tenant with copies of invoices or
other reasonable evidence of Landlord's determination of Expenses for any
Computation Year.
4.4 If the Commencement Date shall occur on a date other than the
first day of a Computation Year, Tenant's Share of Taxes and Expenses for the
Computation Year in which the
<PAGE> 10
Commencement Date occurs shall be determined so as to include only that portion
of the Taxes and Expenses for such Computation Year that are fairly attributable
to the period from and after the Commencement Date, as reasonably determined by
Landlord. Similarly, if the Expiration Date shall occur on a date other than the
last day of a Computation Year, Tenant's Share of Taxes and Expenses for the
Computation Year in which the Expiration Data occurs shall be determined so as
to include only that portion of the Taxes and Expenses for such Computation Year
that are fairly attributable to the period through the Expiration Date, as
reasonably determined by Landlord. Notwithstanding the foregoing, Landlord may,
pending the determination of the amount of Taxes and Expenses for such partial
Computation Year, furnish Tenant with statements of estimated Taxes, estimated
Expenses, and Tenant's Share of each thereof for such partial Computation Year.
Within fifteen (15) days after receipt of such estimated statement, Tenant shall
remit to Landlord, as Additional Charges, the amount of Tenant's Share of such
Taxes and Expenses. With respect to the Computation Year in which the Expiration
Date occurs, if the Expiration Date shall occur on a date other than the last
day of such Computation Year, Tenant shall pay Tenant's Share of the estimated
Taxes and estimated Expenses for such Computation Year as provided in Sections
4.2 and 4.3 hereof, respectively, until the Expiration Date; and,
notwithstanding the occurrence of the Expiration Date, after Taxes and Expenses
for such Computation Year have been finally determined and Landlord's Tax
Statement and Landlord's Expense Statement have been furnished to Tenant
pursuant to Sections 4.2 and 4.3 hereof, respectively, (a) if there shall have
been an underpayment of Tenant's Share of Taxes or Expenses for such Computation
Year, Tenant shall remit the amount of such underpayment to Landlord within
thirty (30) days after receipt of such statements, and (b) if there shall have
been an overpayment, Landlord shall remit the amount of any such overpayment to
Tenant within thirty (30) days after the issuance of such statements.
5. Improvement of the Premises
5.1 Prior to the Commencement Date or any subsequent date on which any
additional portion of the Premises is to be delivered to Tenant and included as
part of the Premises under the terms of this Lease (an "Inclusion Date"),
Landlord will perform the work and make the installations required to be made by
Landlord in the portion of the Premises initially to be delivered to Tenant or
to such additional portion of the Premises, as the case may be, substantially as
set forth in Exhibit B attached hereto (such work and installations being herein
called "Landlord's Work.). Landlord's obligation to perform Landlord's Work
shall not require Landlord to incur overtime costs and expenses and shall be
subject to unavoidable delays due to acts of God, governmental restrictions,
strikes, labor disturbances, shortages of material and supplies, and due to any
other cause or event beyond Landlord's reasonable control. Landlord shall, when
construction progress so permits, notify Tenant in advance of the approximate
date on which any such Landlord's Work will be substantially completed in
accordance with Exhibit B and will notify Tenant when Landlord's Work is in fact
so completed, which latter notice shall constitute delivery of possession of
such portion of the Premises to Tenant. If any dispute shall arise as to whether
the initial portion of the Premises or any additional portion thereof is
substantially completed and ready for Tenant's occupancy, a certificate
furnished by Landlord's architect certifying the date of substantial completion
shall be conclusive of that fact and date and shall be binding upon Landlord and
Tenant. It is understood and agreed by Tenant that any minor changes from any
plans or from said Exhibit B that may be necessary during construction of any
portion of the Premises shall not affect or change this Lease or invalidate
same. Except for the adjustment of the Commencement Date as provided in Section
2.2 with respect to the initial portion of the Premises to be delivered to
Tenant, failure of Landlord to deliver possession of any portion of the Premises
within the time and in the condition provided for in this Lease will not give
rise to any claim for damages by Tenant against Landlord or Landlord's
contractor.
5.2 The manner in which the Common Areas are maintained and operated
and the expenditures therefor shall be at the sole discretion of Landlord
provided that Landlord shall at all times maintain such Common Areas in a
first-class appearance and condition. The use of such areas and facilities shall
be subject to such rules and regulations, including, without limitation, the
provisions of any covenants, conditions and restrictions affecting the Park, as
Landlord shall make from time to time. Landlord shall not be responsible for the
nonperformance of any such rules and regulations or covenants, conditions and
restrictions by any other tenant or occupant of the Park.
<PAGE> 11
5.3 Landlord hereby reserves the right, at any time and from time to
time, to (a) make alterations in or additions to the Park and the Common Areas,
including, without limitation, constructing new buildings, changes in the
location, size, shape and number of driveways, entrances, parking spaces,
parking areas, loading and unloading areas, landscaped areas and walkways, (b)
close temporarily any of the Common Areas for maintenance purposes as long as
reasonable access to the Premises remains available, (c) designate property
outside the Park to be part of the Common Areas, (d) add additional buildings
and improvements to the Park and Common Areas, (e) use the Common Areas while
engaged in making alterations in or additions or repairs to the Park, and (f)
change the arrangement and location of entrances or passageways, corridors,
stairs, toilets and other public parts of the Building; provided, however, that
Landlord shall not make changes to the parking areas of the Building E Site so
as to substantially (other than on a temporary basis) reduce the number of
parking spaces provided within the area of the Building E Site without the prior
approval of Tenant, and provided further that Landlord shall not make
alterations to the Common Areas that shall materially (other than on a temporary
basis) interfere with Tenant's access to the Premises or with Tenant's business
operation therein. Tenant agrees that no diminution of light, air or view by any
structure that may be erected in the Park after the Lease Date shall entitle
Tenant to any reduction of Rent or result in any liability of Landlord to
Tenant.
5.4 Landlord reserves the right, from time to time, to grant such
easements, rights and dedications as Landlord deems necessary or desirable, and
to cause the recordation of parcel maps and covenants, conditions and
restrictions affecting the Park, as long as such easements, rights, dedications,
maps and covenants, conditions and restrictions do not unreasonably interfere
with the use of the Premises by Tenant. At Landlord's request, Tenant shall join
in the execution of any of the aforementioned documents. The Building and the
Park may be known by any name that Landlord may choose, which name may be
changed from time to time in Landlord's sole discretion.
5.5 Tenant hereby acknowledges that Landlord shall have no obligation
whatsoever to provide guard services or other security measures for the benefit
of the Premises or the Park, and Landlord shall have no responsibility
whatsoever for the protection of Tenant, its employees, suppliers, shippers,
customers and invitees and the property of Tenant and of Tenant's employees,
suppliers, shippers, customers and invitees from acts of third parties. Nothing
herein contained shall prevent Landlord, at Landlord's sole option, from
providing security protection for the Park or any part thereof, in which event
the cost thereof shall be included within the definition of Expenses, as set
forth in Section 4.1(d).
6. Conduct of Business by Tenant
6.1 Tenant shall use and occupy the Premises during the Term of this
Lease solely for the use specified in the Basic Lease Information and for no
other use or uses without the prior written consent of Landlord, which consent
shall not be unreasonably withheld so long as any such other use is a lawfully
permitted use that is consistent with the character of the Park and the other
tenancies therein.
6.2 In the event that Tenant vacates the Premises or any portion
thereof at any time during the Term, Tenant shall continue to be responsible
therefor and shall provide and maintain at all times adequate security services
to protect the Premises, and Tenant shall be responsible for any increase in
insurance costs as a consequence of such vacation of the Premises by Tenant.
6.3 Tenant shall not use or occupy, or permit the use or occupancy of,
the Premises or any part thereof for any use other than the use specifically set
forth in Section 6.1. Tenant shall not do or permit anything to be done in or
about the Premises which will in any way obstruct or interfere with the rights
of other tenants of the Park, or injure them, or use or allow the Premises to be
used for any unlawful purpose or in violation of any conditions, covenants and
restrictions affecting the Premises and/or the Park, nor shall Tenant cause,
maintain or permit any nuisance in, on or about the Premises or commit or suffer
to be committed any waste in, on, or about the Premises.
6.4 The parking spaces to be provided to Tenant pursuant to Section
1.3 shall be used for parking only by vehicles no larger than full-sized
passenger automobiles or pick-up trucks. Tenant shall not
<PAGE> 12
permit or allow any vehicles or trucks that belong to or are controlled by
Tenant or Tenant's employees, suppliers, shippers, customers or invitees to be
loaded or parked in areas other than those areas within the Building E Site that
are designated by Landlord for such activities. If Tenant permits or allows any
of the prohibited activities described in this Section 6.4, Landlord shall have
the right, in addition to all other rights and remedies that it may have under
this Lease, to remove or tow away the vehicle involved without prior notice to
Tenant, and the cost thereof shall be paid to Landlord as Additional Charges
within ten (10) days after delivery to Tenant of bills therefor.
6.5 Tenant shall not store any property in the Common Areas without
the prior written consent of Landlord. In the event that any unauthorized
storage shall occur, Landlord shall have the right, in addition to all other
rights and remedies that Landlord may have under this Lease, to remove the
property after three (3) days' prior notice to Tenant, and the cost thereof
shall be paid by Tenant to Landlord within ten (10) days after delivery to
Tenant of bills therefor.
7. Alterations and Tenant's Property
7.1 Tenant shall make no alterations, installations, additions or
improvements whether structural or nonstructural (herein collectively called
"Alterations") in or to the Premises without Landlord's prior written consent,
which consent shall not be unreasonably withheld; except that Landlord's prior
consent shall not be required in the case of any nonstructural Alteration that
does not affect or change any waste line serving the Building or any materials
or waste to be deposited in any such waste line, if the total cost of such
Alteration is less than $5,000, but, in any such case, Tenant must give Landlord
prior written notice of such Alteration together with complete copies of the
plans and specifications therefor. Tenant shall submit such information as
Landlord may require, including without limitation, (i) plans and specifications
for the Alterations, (ii) payment and performance bonds for any Alterations
costing $10,000 or more, and (iii) evidence of builder's all-risk, comprehensive
general liability, and workers compensation insurance, as well as any other
insurance required by any lender or by law, in such types and amounts and from
such insurers as Landlord deems satisfactory. All Alterations shall be done at
Tenant's expense, at such times and in such manner as Landlord may reasonably
designate, and only by such contractors or mechanics as are approved by
Landlord, which approval shall not be unreasonably withheld; and all Alterations
must be performed in accordance with all applicable laws, ordinances and codes
pursuant to validly issued building permits, copies of which must be delivered
to Landlord prior to the commencement of construction of any such Alterations.
In no event shall any Alterations affect the structure of the Building or its
exterior appearance.
7.2 Except for items of Tenant's Property (as defined below), all
appurtenances, fixtures, improvements, additions and other property attached to
or installed in the Premises, whether by Landlord or by or on behalf of Tenant,
and whether at Landlord's expense or Tenant's expense, or at the joint expense
of Landlord and Tenant, shall be and remain the property of Landlord; provided,
however, that if, at the time Landlord consents to the installation of any
Alterations or promptly after receipt of Tenant's notice of any Alterations that
are permitted to be made without Landlord's prior approval, Landlord notifies
Tenant that any such Alterations must be removed by Tenant on or prior to the
termination of this Lease, then Tenant, at its sole cost and expense, shall
remove any such Alterations so designated by Landlord on or prior to the
termination of this Lease, and Tenant shall repair any damage to the Premises
resulting from such removal and shall restore such portion of the Premises to
substantially the same condition existing prior to the making of any such
Alterations. Any furnishings and personal property installed in the Premises
that are removable without material damage to the Building or the Premises
(including, without limitation, any laboratory equipment and cabinets installed
by Tenant as well as Tenant's telephone and computer systems), whether the
property of Tenant or leased by Tenant, are herein sometimes called "Tenant's
Property." Any replacements of any property of Landlord, whether made at
Tenant's expense or otherwise, shall be and remain the property of Landlord.
Tenant shall not install any machines or equipment which cause vibration, noise,
heat or cold that may be transmitted to the structure of the Building or any
other premises therein without Landlord's prior written consent, which consent
may be conditioned upon such terms as Landlord may require.
7.3 Any of Tenant's property remaining on the Premises at the
expiration of the Term shall be removed by Tenant at Tenant's cost and expense,
and Tenant shall, at its cost and expense, repair any
<PAGE> 13
damage to the Premises caused by such removal. Any of Tenant's Property not
removed from the Premises prior to the expiration of the Term shall, at
Landlord's option, become the property of Landlord, or Landlord may remove such
Tenant's Property, and Tenant shall pay to Landlord Landlord's cost of removal
within ten (10) days after delivery of a bill therefor.
7.4 Landlord shall have the right at all times to post and keep posted
on the Premises any notices permitted or required by law, or that Landlord shall
deem proper, for the protection of Landlord, the Building, the Premises, and any
other party having an interest therein, from mechanics' and materialmen's liens,
and Tenant shall give to Landlord at least ten (10) business days' prior notice
of commencement of any construction on the Premises.
8. Repairs
8.1 Except for damage caused by any negligent or intentional act or
omission of Tenant or any person claiming through or under Tenant, or any of
their employees, suppliers, shippers, customers or invitees, in which event
Tenant shall repair the damage (except to the extent that the cost of any such
repair is covered by insurance maintained by Landlord), Landlord, at Landlord's
cost and expense, subject to reimbursement pursuant to Article 4 for items of
ordinary repair and maintenance, shall keep in good condition and repair the
foundations, exterior walls, structural condition of interior bearing walls, and
roof of the Premises, as well as the parking lots, walkways, driveways,
landscaping, fences, signs and utility installations of the Common Areas.
Landlord shall not, however, be obligated to paint the exterior or interior
surface of exterior walls, nor shall Landlord be required to maintain, repair or
replace windows, doors, or plate glass of the Premises. Landlord shall not be
liable for, and, except as provided in Article 13 hereof, there shall be no
abatement of Rent with respect to, any injury to or interference with Tenant's
business arising from any repair, maintenance, alteration or improvement in or
to (a) any portion of the Park or the Premises, or (b) the fixtures,
appurtenances and equipment therein; provided, however, that Landlord shall be
liable for any damage to Tenant's Property caused by the negligence or willful
misconduct of Landlord, its agents, employees or contractors (except to the
extent any such damage is covered by insurance maintained by Tenant). Tenant
hereby waives and releases its right to make repairs at Landlord's expense under
Sections 1941 and 1942 of the California Civil Code or under any similar law,
statute or ordinance now or hereafter in effect.
8.2 Subject to the provisions of Section 8.1, Tenant, at Tenant's cost
and expense, shall make all repairs and replacements as and when Landlord deems
necessary to preserve in good working order and condition the Premises and every
part thereof, including, without limitation, all plumbing, heating, ventilating,
and air conditioning systems, electrical and lighting facilities and equipment
within the Premises, fixtures, interior walls, interior surfaces of exterior
walls, ceiling, windows, doors, plate glass and skylights located within the
Premises. At Landlord's option, either Tenant shall procure and maintain, at
Tenant's expense, a ventilating and air conditioning system maintenance contract
satisfactory to Landlord, or Landlord shall procure and maintain a ventilating
and air conditioning system maintenance contract. If Landlord elects to procure
and maintain the ventilating and air conditioning system maintenance contract,
Tenant shall pay to Landlord from time to time, within ten (10) days after
delivery of a statement therefor, the cost of such contract. In either case,
such contract shall provide for the regular maintenance and servicing of the
ventilating and air conditioning system serving the Premises. The foregoing
notwithstanding, Tenant shall not be responsible for repairs and replacements to
the Premises to the extent that the same are necessitated by or arise as a
consequence of (a) the acts or omissions of Landlord, (b) any defect in the
construction of the Building or the installation of any tenant improvements in
the Premises installed by Landlord (as opposed to defects in the design of such
tenant improvements, which shall be the responsibility of Tenant), (c) the
noncompliance of the Building with any laws or covenants, conditions and
restrictions or underwriters requirements applicable thereto as of the Lease
Date, (d) acts or conditions for which Landlord receives reimbursement from any
third party, or (e) any casualty to the extent that the same is covered by
insurance maintained by Landlord.
8.3 All repairs and replacements made by or on behalf of Tenant or any
person claiming through or under Tenant shall be made and performed (a) at
Tenant's cost and expense and at such time and in such manner as Landlord may
designate, (b) by contractors or mechanics approved by Landlord, (c) so that
<PAGE> 14
same shall be at least equal in quality, value, and utility to the original work
or installation, and (d) in accordance with the rules and regulations for the
Park adopted by Landlord from time to time and in accordance with all applicable
laws and regulations of governmental authorities having jurisdiction over the
Premises and the Park.
9. Liens
9.1 Tenant shall keep the Premises free from any liens arising out of
any work performed, material furnished or obligation incurred by or for Tenant
or any person or entity claiming through or under Tenant. In the event that
Tenant shall not, within thirty (30) days following the imposition of any such
lien, cause same to be released of record by payment or posting of a proper
bond, Landlord shall have, in addition to all other remedies provided herein and
by law, the right but not the obligation to cause such lien to be released by
such means as it shall deem proper, including payment of the claim giving rise
to such lien. All such sums paid by Landlord and all expenses incurred by it in
connection therewith shall be payable to it by Tenant with interest at the
Default Rate from the date of payment and shall be due and payable to Landlord
by Tenant on demand.
10. Compliance with Laws and Insurance Requirements
10.1 Tenant, at Tenant's cost and expense, shall comply with all laws,
orders and regulations of federal, state, county and municipal authorities, and
with all directions, pursuant to law, of all public officers, that shall impose
any duty upon Landlord or Tenant with respect to the Premises or the use or
occupancy thereof, except that Tenant shall not be required to make any
structural Alterations in order to comply unless such Alterations shall be
necessitated or occasioned, as a whole or in part, by the act, omission or
negligence of Tenant or any person claiming through or under Tenant, or any of
their employees, suppliers, shippers, customers or invitees, or by the use or
occupancy or manner of use or occupancy of the Premises by Tenant or any such
person. Any work or installation made or performed by or on behalf of Tenant or
any person claiming through or under Tenant pursuant to the provisions of this
Article 10 shall be made in conformity with, and subject to the provisions of,
Section 8.3. The foregoing notwithstanding, Landlord shall be responsible for
the correction of any noncompliance of the Building with any laws or covenants,
conditions and restrictions or underwriters requirements applicable thereto as
of the Lease Date; and Tenant shall have no responsibility with respect thereto.
10.2 Tenant shall not do anything, or permit anything to be done, in
or about the Premises that shall (a) invalidate or be in conflict with the
provisions of any fire or other insurance policies covering the Premises, or the
Park or any property located therein, (b) result in a refusal by fire insurance
companies of good standing to insure the Premises or the Park or any such
property in amounts reasonably satisfactory to Landlord, (c) subject Landlord to
any liability or responsibility for injury to any person or property by reason
of any business operation being conducted in or about the Premises, (d) cause
any increase in the fire insurance rates applicable to the Premises or property
located therein at the beginning of the Term or at any time thereafter, or (e)
be in violation of any certificate of occupancy or use permit for the Premises.
Tenant, at Tenant's expense, shall comply with all rules, orders, regulations
and requirements of the American Insurance Association (formerly the National
Board of Fire underwriters) and of any similar body that shall hereafter perform
the function of such Association.
11. Subordination
11.1 Without the necessity of any additional document being executed
by Tenant for the purpose of effecting a subordination, Tenant agrees that this
Lease shall be subject and subordinate at all times to (a) all ground leases or
underlying leases that may now exist or hereafter be executed affecting the
Premises or the Park or both, and (b) the lien of any mortgage or deed of trust
that may now exist or hereafter be executed in any amount for which the
Building, the Park, any ground leases or underlying leases, or Landlord's
interest or estate in any of said items is specified as security; provided that,
so long as Tenant is not then in default hereunder, the mortgagees or
beneficiaries named in said mortgages or deeds of trust and any ground or
underlying lessor under such ground or underlying leases shall agree to
recognize the rights and interest of
<PAGE> 15
Tenant under this Lease in the event of foreclosure of any such mortgage or deed
of trust or termination of any ground or underlying lease. Notwithstanding the
foregoing, Landlord shall have the right to subordinate or cause to be
subordinated to this Lease any such ground leases or underlying leases or any
such liens. In the event that any ground lease or underlying lease terminates
for any reason or any mortgage or deed of trust is foreclosed or a conveyance in
lieu of foreclosure is made for any reason, Tenant shall, notwithstanding any
subordination to this Lease of any ground lease, underlying lease or lien,
attorn to and become the Tenant of the successor in interest to Landlord at the
option of such successor in interest. Tenant covenants and agrees to execute and
deliver, upon demand by Landlord and in the form requested by Landlord, any
additional documents evidencing the priority or subordination of this Lease with
respect to any such ground leases or underlying leases or the lien of any such
mortgage or deed of trust, provided that such documents acknowledge the rights
of Tenant under this Section 11.1.
12. Inability to Perform; Right to Cure
12.1 If, for any reason beyond the reasonable control of Landlord,
Landlord is unable to furnish or is delayed in furnishing any utility or service
required to be furnished by Landlord under the provisions of this Lease or of
any collateral instrument, or is unable to perform or make or is delayed in
performing or making any installations, repairs, alterations, additions or
improvements, whether required to be performed or made under this Lease or under
any collateral instrument, or is unable to fulfill or is delayed in fulfilling
any of Landlord's other obligations under this Lease or any collateral
instrument, no such inability or delay shall constitute an actual or
constructive eviction, as a whole or in part, or entitle Tenant to any abatement
or diminution of Rent or Additional Charges, or relieve Tenant from any of its
obligations under this Lease, or impose any liability upon Landlord or its
agents by reason of inconvenience or annoyance to Tenant or by reason of injury
to or interruption of Tenants business, or otherwise. Tenant hereby waives and
releases its right to terminate this Lease under Section 1932(1) of the
California Civil Code or under any similar law, statute or ordinance now or
hereafter in effect.
12.2 Landlord shall not be deemed to be in default in the performance
of any obligation required to be performed by it hereunder unless and until it
has failed to perform such obligation within thirty (30) days after written
notice by Tenant to landlord specifying the nature of Landlord's failure to
perform such obligation; provided, however, that if the nature of Landlord's
obligation is such that more than thirty (30) days are required for its
performance, then Landlord shall not be deemed to be in default if it shall
commence such performance within such thirty (30) day period and thereafter
shall prosecute the same to completion. Notwithstanding the foregoing, however,
so long as Tenant promptly notifies Landlord of any condition affecting the
Building that Tenant becomes aware of that Landlord is obligated to repair, if
Landlord is required to perform any obligation hereunder and such obligation
arises in the context of an emergency that materially interferes with Tenant's
ability to conduct its business operations in the Premises, Landlord shall
commence the performance of such obligation as soon as reasonably possible under
the circumstances and shall diligently pursue the performance of such obligation
to completion; and if Landlord fails to act with reasonable promptness under the
circumstances, Tenant shall have the right after notice to Landlord that is
reasonable under the circumstances, to take reasonable steps to abate such
emergency and Landlord shall reimburse Tenant for any costs and expenses
reasonable incurred by Tenant in connection therewith within twenty (20) days
after receipt of satisfactory evidence of such costs and expenses so incurred by
Tenant (but in no event shall Tenant have any right to withhold any Rent or
Additional Charges hereunder or to offset any such costs and expenses against
the Rent and/or Additional Charges owing hereunder). All rights to cure provided
to Landlord under this Section 12.2 shall also be accorded to any mortgagee or
beneficiary under a deed of trust encumbering the Premises, and, if Tenant shall
have been notified of the name and address of any such mortgagee or beneficiary,
Tenant shall send a copy of any notice of default by Landlord to any such
mortgagee or beneficiary and no such notice of default shall be effective
against Landlord unless and until a copy of the same is sent to any such
mortgagee or beneficiary. Landlord shall not be liable for any injury or damage
to persons or property resulting from loss, theft, fire, explosion, falling
plaster, cessation or variation or shortage or interruption of services or
utilities, steam, gas, electricity, earthquake, acts of God, rain or water or
dampness from any source or any other cause whatsoever; except, however, to the
extent that such injury or damage is caused by the negligence or willful
misconduct of Landlord or Landlord's agents, employees or contractors, and then
only to the extent such injury or damage is not covered by any insurance
required to be maintained by Tenant hereunder; and in the event that Landlord is
so liable to Tenant hereunder, Landlord shall be liable for the reasonably
foreseeable
<PAGE> 16
expense incurred by Tenant as a consequence of the negligence or willful
misconduct giving rise to such liability and then only to the extent of such
negligence or willful misconduct of Landlord, or Landlord's agents, employees or
contractors (and not to the extent of the negligence or willful misconduct of
any third party). Notwithstanding the foregoing, however, in no event shall
Landlord be liable for damages by reason of loss of profits, business
interruptions or other consequential damages.
13. Destruction
13.1 If the Premises shall be damaged by fire or other casualty
insured against by Landlord's fire and extended coverage insurance policy
covering the Building, and if Tenant shall give prompt notice to Landlord of
such damage, Landlord, at Landlord's expense, shall repair such damage and
restore the Premises (including any tenant improvements installed by Landlord)
to substantially the condition it was in prior to such fire or casualty;
provided, however, that Landlord shall have no obligation to repair any damage
to or to replace Tenant's Property, Alterations or any other property or effects
of Tenant. Except as otherwise provided in this Article 13, if the entire
Premises shall be rendered untenantable by reason of any such damage, Rent and
Additional Charges shall abate for the period from the date of such damage to
the date when such damage to the Premises shall have been repaired, and if only
a part of the Premises shall be rendered untenantable, Rent and Additional
Charges shall be equitably abated for such period taking into account the nature
of the portions of the Premises that are rendered untenantable; provided,
however, if, prior to the date when all of such damage shall have been repaired,
any part of the Premises so damaged shall be rendered tenantable or shall be
used or occupied by Tenant or any person or persons claiming through or under
Tenant, then the amount by which Rent and Additional Charges shall abate shall
be equitably apportioned for the period from the date of any such use or
occupancy to the date when all such damage shall have been repaired.
13.2 Notwithstanding the provisions of Section 13.1, if, prior to or
during the Term, the Building or the Premises shall be so damaged by fire or
other casualty that, in Landlord's reasonable judgment, such damage cannot be
repaired within ninety (90) days, if such damage occurs more than eighteen (18)
months prior to the Expiration Date, or within sixty (60) days, if such damage
occurs less than eighteen (18) months prior to the Expiration Date, then
Landlord, at Landlord's option, may give to Tenant, within thirty (30) days
after such fire or other casualty, thirty (30) days' notice of termination of
this Lease and, in the event such notice is given, this Lease and the Term shall
terminate upon the expiration of such thirty (30) days with the same effect as
if the date of expiration of such thirty (30) days were the Expiration Date; and
Rent and Additional Charges shall be apportioned as of such date and any prepaid
portion of Rent or Additional Charges for any period after such date shall be
refunded by Landlord to Tenant. Further, if the Premises shall be so damaged by
fire or other casualty that, in Landlord's reasonable judgment, such damage
cannot be repaired within 180 days if such damage occurs more than eighteen (18)
months prior to the Expiration Date, or within ninety (90) days, if such damage
occurs less than eighteen (18) months prior to the Expiration Date, then Tenant,
at Tenant's option, may give to Landlord, within fifteen (15) days after receipt
of Landlord's notice stating the period of time that will be required, in
Landlord's opinion, to repair the Premises, thirty (30) days' notice of
termination of the Lease and, in the event such notice is given, this Lease and
the Term shall terminate as provided hereinabove. If any party having the right
to terminate this Lease as provided hereinabove elects not to so exercise such
right, Landlord shall proceed to repair the Premises as provided in this Article
13, and this Lease shall remain in full force and effect.
13.3 Notwithstanding anything contained in this Article 13 to the
contrary, in no event shall Landlord be required to spend for any repair,
replacement or reconstruction of the Premises an amount greater than the
insurance proceeds actually received by Landlord as a result of the fire or
other casualty causing such loss, damage or destruction.
13.4 Notwithstanding anything set forth herein to the contrary,
Landlord waives any and all rights of recovery against Tenant for or arising out
of damage to or destruction of any portion of the Premises or the Building from
causes then included under standard fire and extended coverage insurance
policies or endorsements, whether or not such damage or destruction shall have
been caused by the negligence of Tenant, its agents, contractors, employees,
subtenants, licensees, invitees or visitors, but only to the extent that
Landlord's insurance policies then in force permit such waiver; and Tenant
waives any and all rights of
<PAGE> 17
recovery against Landlord for or arising out of damage to or destruction of any
property of Tenant from causes then included under the insurance policies and
endorsements required to be maintained by Tenant hereunder, whether or not such
damage or destruction shall have been caused by the negligence of Landlord, its
agents, contractors, employees, licensees, invitees or -visitors, but only to
the extent that Tenant's insurance policies then in force permit such waiver.
Landlord and Tenant hereby represent that their present insurance policies now
in force permit such waiver. If at any time during the term of this Lease either
party shall give no less than ten (10) days' prior notice to the other
certifying that any insurance carrier which shall have issued any such policy
covering any of the property above mentioned shall refuse to consent to the
aforesaid waiver of subrogation, or such carrier shall revoke a consent
previously given or shall cancel or threaten to cancel any policy previously
issued and then in force and effect, because of such waiver of subrogation,
then, in any of such events, the waiver set forth herein shall thereupon be of
no further force or effect as to the loss, damage or destruction covered by such
policy; but in any such event, the party receiving such notice shall have the
right to identify an alternative insurance carrier willing to consent to such
waiver and, if such alternate insurance carrier is reasonably acceptable to the
party maintaining such insurance, such party shall obtain such insurance from
such alternate insurer. The cost of obtaining any such waiver shall be deemed a
cost of such policy. Landlord and Tenant each shall indemnify the other against
any loss or expense, including reasonable attorneys' fees and costs, resulting
from the failure to obtain any such waiver, provided the same is available.
13.5 Except to the extent expressly provided in Section 13.4, nothing
contained in this Lease shall relieve Tenant of any liability to Landlord or to
its insurance carriers that Tenant may have under law or under the provisions of
this Lease in connection with any damage to the Premises or the Building by fire
or other casualty.
13.6 Notwithstanding the provisions of Section 13.1, if any such
damage is due to the fault or neglect of Tenant, any person claiming through or
under Tenant, or any of their employees, suppliers, shippers, customers or
invitees, then there shall be no abatement of Rent or Additional Charges by
reason of such damage, except to the extent that Landlord is reimbursed for such
abatement of Rent or Additional Charges pursuant to a rental insurance policy,
which policy shall be maintained by Landlord covering not less than six (6)
months' rental payments owing hereunder and the cost of which shall be included
in Expenses under Section 4.1(d) above.
13.7 The provisions of this Lease, including this Article 13,
constitute an express agreement between Landlord and Tenant with respect to any
and all damage to, or destruction of, all or any part of the Premises, the
Building or any other portion of the Park, and any statute or regulation of the
State of California, including, without limitation, Sections 1932(2) and 1933(4)
of the California Civil Code, with respect to any rights or obligations
concerning damage or destruction in the absence of an express agreement between
the parties, and any similar statute or regulation, now or hereafter in effect,
shall have no application to this Lease or to any damage to or destruction of
all or any part of the Premises, the Building or any other portion of the Park.
13.8 Landlord shall obtain and keep in force during the Term of this
Lease a current policy or policies of insurance covering loss or damage to the
Premises, in the amount of the full replacement value thereof (exclusive of any
Alterations and Tenant's Property) providing protection against all perils
included within the standard policy of fire and extended coverage casualty
insurance, as well as rent loss insurance in favor of Landlord insuring Landlord
against any loss of rental from damage or destruction of the Premises covered by
such casualty policy for a period of at least six (6) months from the date of
such damage or destruction. Landlord may also obtain (but shall not be obligated
to do so) such other insurance as may be required by the holder(s) of a mortgage
or deed of trust on the Premises or by prudent property management practices.
14. Eminent Domain
14.1 If all or substantially all of the Premises is condemned or taken
in any manner for public or quasi-public use, including but not limited to a
conveyance or assignment in lieu of a condemnation
<PAGE> 18
or taking, this Lease shall automatically terminate as of the earlier of the
date of the vesting of title or the date of dispossession of Tenant as a result
of such condemnation or other taking. If less than all or substantially all of
the Premises is so condemned or taken, this Lease shall automatically terminate
only as to the portion of the Premises so taken as of the earlier of the date of
the vesting of title or the date of dispossession of Tenant as a result of such
condemnation or taking. If such portion of the Building or Park is condemned or
otherwise taken so as to require, in the opinion of Landlord, a substantial
alteration or reconstruction of the remaining portions thereof, this Lease may
be terminated by Landlord, as of the earlier of the date of the vesting of title
or the date of dispossession of Tenant as a result of such condemnation or
taking, by written notice to Tenant within sixty (60) days following notice to
Landlord of the date on which said vesting or dispossession will occur.
14.2 Landlord shall be entitled to the entire award in any
condemnation proceeding or other proceeding for taking for public or
quasi-public use, including, without limitation, any award made for the value of
the leasehold estate created by this Lease. No award for any partial or entire
taking shall be apportioned, and Tenant hereby assigns to Landlord any award
that may be made in such condemnation or other taking, together with any and all
rights of Tenant now or hereafter arising in or to same or any part thereof;
provided, however, that nothing contained herein shall be deemed to give
Landlord any interest in, or to require Tenant to assign to Landlord, any award
made to Tenant specifically for its relocation expenses, the taking of personal
property and fixtures belonging to Tenant, or the interruption of or damage to
Tenant's business if such award is made separately to Tenant and not as part of
the damages recoverable by Landlord.
14.3 In the event of a partial condemnation or other taking that does
not result in a termination of this Lease as to the entire Premises pursuant to
Section 14.1, the Rent and Additional Charges shall be equitably abated taking
into account the nature of the portions of the Premises so taken.
14.4 If all or any portion of the Premises is condemned or otherwise
taken for public or quasi-public use for a limited period of time, this Lease
shall remain in full force and effect and Tenant shall continue to perform all
terms, conditions and covenants of this Lease. Tenant shall be entitled to
receive the entire award made in connection with any such temporary condemnation
or other taking.
14.5 Landlord may, without any obligation to Tenant, agree to sell
and/or convey to the condemnor the Premises or any portion thereof sought by the
condemnor, free from this Lease and the rights of Tenant hereunder, without
first requiring that any action or proceeding be instituted or, if instituted,
pursued to a judgment.
14.6 In the event that any of the parking spaces allocated to Tenant
hereunder shall be taken, Landlord shall provide alternate parking spaces for
Tenant within the Park or in the vicinity thereof.
15. Assignment and Subletting
15.1 Tenant shall not directly or indirectly, voluntarily or by
operation of law, sell, assign, encumber, pledge or otherwise transfer or
hypothecate all or any part of the Premises or Tenant's leasehold estate
hereunder (collectively, "Assignment"), or permit the Premises to be occupied by
anyone other than Tenant or sublet the Premises (collectively, "Sublease") or
any portion thereof without Landlord's prior written consent in each instance,
which consent, subject to the provisions of Section 15.3 and 15.4 below, shall
not be unreasonably withheld.
15.2 If Tenant desires at any time to enter into an Assignment of this
Lease or a Sublease of the Premises or any portion thereof, it shall first give
written notice to Landlord of its desire to do so, which notice shall contain
(a) the name of the proposed assignee, subtenant or occupant, (b) the nature of
the proposed assignee's, subtenants or occupant's business to be carried on in
the Premises, (c) the terms and provisions of the proposed Assignment or
Sublease, and (d) such financial information as Landlord may reasonably request
concerning the proposed assignee, subtenant or occupant. Tenant shall reimburse
Landlord for Landlord's
<PAGE> 19
reasonable counsel fees incurred in connection with the processing and
documentation of any requested Assignment of this Lease or Sublease of the
Premises.
15.3 At any time within twenty (20) days after Landlord's receipt of
the notice specified in Section 15.2, Landlord may by written notice to Tenant
elect to (a) terminate this Lease as to the portion (including all) of the
Premises that is specified in Tenant's notice, with a proportionate abatement in
the Rent taking into account the nature of the portion of the Premises as to
which this Lease is terminated and a similar proportionate reduction in parking,
(b) consent to the Sublease or Assignment, or (c) disapprove the Sublease or
Assignment. In the event Landlord elects the option set forth in subsection (a)
above, with respect to a portion of the Premises, Tenant shall at all times
provide reasonable and appropriate access to such portion of the Premises and
use of any common facilities, and Landlord shall have the right to use such
portion of the`Premises for any legal purpose in its sole discretion. If
Landlord consents to the Sublease or Assignment within said twenty (20) day
period, Tenant may thereafter within ninety (90) days after Landlord's consent,
but not later than the expiration of said ninety (90) days, enter into such
Assignment or Sublease of the Premises or portion thereof, but only upon the
terms and conditions set forth in the notice furnished by Tenant to Landlord
pursuant to Section 15.2. In the event of any such Assignment or Sublease,
seventy-five percent (75%) of any rent or other consideration received or to be
received by or on behalf of Tenant as a result of such assignment or subletting
in excess of the Rent and Additional Charges which Tenant is obligated to pay
Landlord under this Lease (prorated to reflect obligations allocable to that
portion of the Premises subject to such sublease), shall be payable to Landlord
as additional rent under this Lease without affecting or reducing any other
obligation of Tenant hereunder; provided, however, that Tenant shall first be
entitled to recoup from any such excess rent the reasonable cost of such
subletting or assignment incurred by Tenant for broker's commission, attorneys'
fees and the cost of any tenant improvements required to be constructed by
Tenant.
15.4 If Tenant complies with the provisions of paragraph 15.2 above,
and Landlord does not exercise its option set forth in subsection (a) of Section
15.3 above, Landlord's consent to a proposed Assignment or Sublease shall not be
unreasonably withheld. Without limiting the other instances in which it may be
reasonable for Landlord to withhold its consent to an Assignment or Subletting,
Landlord and Tenant acknowledge that it shall be reasonable for Landlord to
withhold its consent in the following instances:
(a) in Landlord's reasonable judgment, the use of the Premises
by the proposed assignee or sublessee would be in violation of
Article 6 of this Lease;
(b) in Landlord's reasonable judgment, the financial worth of the
proposed assignee or sublessee does not meet the credit standards
applied by Landlord for other tenants under leases with comparable
terms;
(c) in Landlord's reasonable Judgment, the proposed assignee or
sublessee does not have a good reputation or record as a tenant
of property;
(d) Landlord has experienced previous defaults by or is in
litigation with the proposed assignee or subtenant;
(e) the use of the Premises by the proposed assignee or subtenant
will violate any applicable law, ordinance or regulation, or any use
permit issued for the use and occupancy of the Premises; or
(f) the proposed assignee or subtenant is a person with whom
Landlord is actively negotiating to lease space in the Park.
15.5 No consent by Landlord to any Assignment or Sublease by Tenant
shall relieve Tenant of any obligation to be performed by Tenant under this
Lease, whether arising before or after the Assignment or Sublease. The consent
by Landlord to any Assignment or Sublease shall not relieve Tenant of the
obligation to
<PAGE> 20
obtain Landlord's express written consent to any other Assignment or Sublease.
Any Assignment or Sublease that is not in compliance with this Article 15 shall
be void and, at the option of Landlord, shall constitute a material default by
Tenant under this Lease. The acceptance of Rent or Additional Charges by
Landlord from a proposed assignee or sublessee shall not constitute the consent
by Landlord to such Assignment or Sublease.
15.6 Any sale or other transfer, including transfer by consolidation,
merger or reorganization, of a majority of the voting stock of Tenant in any
single transaction or series of related transactions, if Tenant is a
corporation, or any sale or other transfer of a majority of the partnership
interests in Tenant, if Tenant is a partnership, shall be an Assignment for
purposes of this Article 15. As used in this Section 15.6, the term "Tenant"
shall also mean any entity that has guaranteed Tenant's obligations under this
Lease, and the prohibition hereof shall be applicable to any sales or transfers
of the stock or partnership interests of said guarantor. Notwithstanding the
foregoing, any of the following with respect to the original Tenant hereunder
shall not be deemed an Assignment of this Lease or a Sublease hereunder, and
shall not require the prior consent of Landlord: (i) any assignment or sublease
to any wholly-owned subsidiary of Tenant or to any entity wholly-owned by any
entity that owns a majority of the voting stock of Tenant, or (ii) the transfer
of a majority of the voting stock of Tenant to a corporation resulting from any
merger, consolidation or non-bankruptcy reorganization of Tenant or from any
governmental action or by virtue of the sale of the voting stock of Tenant on a
public stock exchange, or (iii) any transfer of this Lease to an entity which
acquires all or substantially all the assets as a going concern of the business
of Tenant, so long as in each of the foregoing cases the transferee of the Lease
or any portion of the Premises, as the case may be, has a net worth equal to or
greater than the net worth of Tenant as set forth on the regularly prepared
financial statement of Tenant for the closest 12-month financial reporting
period of Tenant prior to the Lease Date; but in any of the foregoing cases,
Tenant shall notify Landlord not less than twenty (20) days in advance thereof.
15.7 Each assignee, sublessee, or other transferee, other than
Landlord, shall assume, as provided in this Section 15.7, all obligations of
Tenant under this Lease and shall be and remain liable jointly and severally
with Tenant for the payment of Rent and Additional Charges, and for the
performance of all the terms, covenants, conditions and agreements herein
contained on Tenant's part to be performed for the Term; provided, however, that
the assignee, sublessee, or other transferee shall be liable to Landlord for
rent only in the amount set forth in the Assignment or Sublease. No Assignment
shall be binding on Landlord unless the assignee or Tenant shall deliver to
Landlord a counterpart of the Assignment and an instrument in recordable form
that contains a covenant of assumption by the assignee satisfactory in substance
and form to Landlord, consistent with the requirements of this Section 15.7, but
the failure or refusal of the assignee to execute such instrument of assumption
shall not release or discharge the assignee from its liability as set forth
above.
16. Utilities
16.1 Tenant shall pay for all water, gas, heat, light, power,
telephone and other utilities and services supplied for the Premises (including
the Building E Site), including all costs related to the delivery and repair of
the same, and for trash disposal service for the Premises, which shall be
arranged and paid for by Tenant. Landlord makes no representation with respect
to the adequacy or fitness of the air conditioning or ventilation equipment in
the Building to maintain temperatures that may be required for, or because of,
any equipment of Tenant other than normal fractional horsepower office
equipment, and Landlord shall have no liability for loss or damage in connection
therewith.
16.2 In the event any governmental entity promulgates or revises any
statute, ordinance or building, fire or other code or imposes mandatory or
voluntary controls or guidelines on Landlord or the Park or any part thereof,
relating to the use or conservation of energy, water, gas, light or electricity
or the reduction of automobile or other emissions or the provision of any other
utility or service provided with respect to this Lease, or in the event Landlord
is required or elects to make alterations to the Building or any other part of
the Park in order to comply with such mandatory or voluntary controls or
guidelines, Landlord may, in its sole discretion, require Tenant to comply with
such mandatory or voluntary controls or guidelines or Landlord may, in its sole
discretion, make such alterations to the Building or any other part of the Park
related thereto. All costs incurred by Landlord in connection with such laws,
ordinances, guidelines or controls, including alterations to the Building or
other portions of the Park, shall be an Expense and assessed to the tenants of
the
<PAGE> 21
Park. Such compliance and the making of such alterations shall in no event
entitle Tenant to any damages, relieve Tenant of the obligation to pay the full
Rent and Additional Charges reserved hereunder or constitute or be construed as
a constructive or other eviction of Tenant.
17. Default
17.1 The failure of Tenant to perform or honor any covenant, condition
or representation made under this Lease shall constitute a default hereunder by
Tenant upon the expiration of the appropriate grace period hereinafter provided.
Tenant shall have a period of three (3) days from the date of written notice
from Landlord within which to cure any default in the payment of Rent or
Additional Charges; provided, however, that the obligation of Tenant to pay a
late charge pursuant to Section 3.4 or interest pursuant to Section 3.5 shall
commence as of the dates set forth in said Sections. Tenant shall have a period
of thirty (30) days from the date of written notice from Landlord within which
to cure any other default under this Lease; provided, however, that with respect
to any default other than the payment of Rent or Additional Charges that cannot
reasonably be cured within thirty (30) days, the default shall not be deemed to
be uncured if Tenant commences to cure within ten (10) days from Landlord's
notice and continues to prosecute diligently the curing thereof to completion
within a reasonable time.
17.2 Upon the occurrence of a default by Tenant that is not cured by
Tenant within the grace periods specified in Section 17.1 hereof, Landlord shall
have the following rights and remedies in addition to all other rights and
remedies available to Landlord at law or in equity:
(a) The rights and remedies provided by California Civil Code
Section 1951.4 to recover from Tenant upon termination of the Lease:
(i) the worth at the time of award of the unpaid Rent
which had been earned at the time of termination;
(ii) the worth at the time of aware of the amount by which the
unpaid Rent which would have been earned after termination
until the time of award exceeds the amount of such rental loss
that Tenant proves could have been reasonably avoided;
(iii) subject to Subdivision (c) of California Civil Code
Section 1951.2, the worth at the time of award of the amount
by which the unpaid Rent for the balance of the Term after the
time of award exceeds the amount of rental loss that tenant
proves could be reasonably avoided; and
(iv) any other amount necessary to compensate Landlord for all
the detriment proximately caused by Tenant's failure to
perform its obligations under this Lease or which in the
ordinary course of things would be likely to result therefrom.
The "worth" at the time of award of the amounts referred to in
clauses (i) and (ii) of this Section 17.2(a) shall be computed
by allowing interest at the Prime Rate. The worth at the time
of the award of the amount referred to in clause (iii) of this
Section 17.2(a) shall be computed by discounting such amount
at the discount rate of the Federal Reserve Bank of San
Francisco at the time of award plus 1%.
(b) The rights and remedies provided by California Civil Code
Section 1951.4, which allows Landlord to continue this Lease in
effect and to enforce all of its rights and remedies under this
Lease, including the right to recover Rent and Additional Charges as
they become due, for as long as Landlord does not terminate Tenant's
right to possession; provided, however, if Landlord elects to
exercise its remedies described in this subsection (b) and Landlord
does not terminate this Lease, and if Tenant requests Landlord's
consent to an assignment of this Lease or a sublease of the Premises
at such time as Tenant is in default,
<PAGE> 22
Landlord shall not unreasonably withhold its consent to such assignment
or sublease. Acts of maintenance or preservation, efforts to relet the
Premises or the appointment of a receiver upon Landlord's initiative to
protect its interest under the Lease shall not constitute a termination
of Tenant's right to possession.
(c) The right to terminate this Lease by giving notice to Tenant in
accordance with applicable law.
(d) The right and power, as attorney-in-fact for Tenant, to enter the
Premises and remove therefrom all persons and property, to store such
property in a public warehouse or elsewhere at the cost of and for the
account of Tenant, and to sell such property and apply the proceeds
therefrom pursuant to applicable California law. Landlord, as
attorney-in-fact for Tenant, may from time to time sublet the Premises
or any part thereof for such term or terms (which may extend beyond the
Term) and at such rent and such other terms as Landlord in its sole
discretion may deem advisable, with the right to make alterations in
and repairs to the Premises. Upon each such subletting, (i) Tenant
shall be immediately liable for payment to Landlord of, in addition to
Rent and Additional Charges due hereunder, the cost of such subletting
and such alterations and repairs incurred by Landlord and the amount,
if any, by which the Rent and Additional Charges for the period of such
subletting (to the extent such period does not exceed the Term) exceed
the amount to be paid as Rent and Additional Charges for the Premises
for such period, or (ii) at the option of Landlord, rents received from
such subletting shall be applied, first, to payment of any indebtedness
other than Rent and Additional Charges due hereunder from Tenant to
Landlord; second, to payment of any costs of such subletting and of
such alterations and repairs; third, to payment of Rent and Additional
Charges due and unpaid hereunder; and the residue, if any, shall be
held by Landlord and applied in payment of future Rent and Additional
Charges as the same become due hereunder. If Tenant has been credited
with any rent to be received by such subletting under clause (i) and
such rent shall not be promptly paid to Landlord by the subtenant(s),
or if such rentals received from such subletting under clause (ii)
during any month are less than those to be paid during that month by
Tenant hereunder, Tenant shall pay any such deficiency to Landlord.
Such deficiency shall be calculated and paid monthly. For all purposes
set forth in this Section 17.2(d), Landlord is hereby irrevocably
appointed attorney-in-fact for Tenant, with power of substitution. No
taking possession of the Premises by Landlord, as attorney-in-fact for
Tenant, shall be construed as an election on Landlord's part to
terminate this Lease unless a written notice of such intention is given
to Tenant. Notwithstanding any such subletting without termination,
Landlord may at any time thereafter elect to terminate this Lease for
such previous breach.
(e) The right to have a receiver appointed for Tenant, upon application
by Landlord, to take possession of the Premises and to apply any rental
collected from the Premises and to exercise all other rights and
remedies granted to Landlord as attorney-in-fact for Tenant pursuant to
Section 17.2(d).
18. Insolvency or Bankruptcy
18.1 The appointment of a receiver to take possession of all or
substantially all of the assets of Tenant, or an assignment by Tenant for the
benefit of creditors, or any action voluntarily taken by or instituted against
Tenant under any insolvency, bankruptcy, reorganization, moratorium or other
debtor relief act or statute, whether now existing or hereafter amended or
enacted, or if Tenant shall admit in writing its inability to pay its debts or
shall generally not be paying its debts as they mature, shall at Landlord's
option constitute a breach of this Lease by Tenant. Upon the happening of any
such event or at any time thereafter, this Lease shall terminate five (5) days
after written notice of termination from Landlord to Tenant. In no event shall
this Lease be assigned or assignable by operation of law or by voluntary or
involuntary bankruptcy proceedings or otherwise, and in no event shall this
Lease or any rights or privileges hereunder be an asset of Tenant under any
bankruptcy, insolvency, reorganization or other debtor relief proceedings.
<PAGE> 23
19. Fees and Expenses; Indemnity
19.1 If Tenant shall default in the performance of its obligations
under this Lease, Landlord, at any time thereafter and without notice, may
remedy such default for Tenant's account and at Tenant's expense, without
thereby waiving any other right or remedies of Landlord with respect to such
default.
19.2 Tenant agrees to indemnify Landlord against and save Landlord
harmless from any and all loss, cost, liability, damage and expense, including,
without limitation, penalties, fines and counsel fees, incurred in connection
with or arising from any cause whatsoever (except, however, to the extent caused
by the negligence or willful misconduct of Landlord or Landlord's agents,
employees or contractors or by any default by Landlord hereunder) in, on or
about the Premises, including, without limiting the generality of the foregoing,
(a) any default by Tenant in the observance or performance of any of the terms,
covenants or conditions of this Lease on Tenant's part to be observed or
performed, (b) the use or occupancy or manner of use or occupancy of the
Premises by Tenant or any person claiming through or under Tenant, (c) the
condition of the Premises (other than those portions of the Premises required to
be maintained by Landlord) or any occurrence or happening on the Premises from
any cause whatsoever, or (d) any act, omission or negligence of Tenant or any
person claiming through or under Tenant, or of the employees, suppliers,
shippers, customers or invitees of Tenant or any such person, in, on or about
the Premises or the Park, whether prior to, during, or after the expiration of
the Term including, without limitation, any act, omission or negligence in the
making or performing of any Alterations. Tenant further agrees to indemnify
Landlord, Landlord's agents, and the lessor or lessors under all ground or
underlying leases, against and hold them harmless from any and all loss, cost,
liability, damage and expense including, without limitation, counsel fees,
incurred in connection with or arising from any claims by any persons by reason
of injury to persons or damage to property occasioned by any use, occupancy,
condition, occurrence, happening, act, omission or negligence referred to in the
preceding sentence.
19.3 Landlord shall not be responsible for or liable to Tenant for any
loss or damage that may be occasioned by or through the acts or omissions of
persons occupying adjoining premises or any part of the premises adjacent to or
connected with the Premises or any part of the Park or for any loss or damage
resulting to Tenant or its property from burst, stopped or leaking water, gas,
sewer or steam pipes or for any damage to or loss of property within the
Premises from any causes whatsoever, including theft, except to the extent that
such loss or damage is caused by the negligence or willful misconduct of
Landlord or Landlord's agents, employees or contractors or by any default by
Landlord hereunder, and then only to the extent that such loss or damage is not
covered by Tenant's insurance, but in no event shall Landlord be liable for any
consequential damages whatsoever.
19.4 Except where a longer or shorter period is specifically provided
for in this Lease for a particular expenditure, Tenant shall pay to Landlord,
within ten (10) days after delivery by Landlord to Tenant of bills or statements
therefor: (a) sums equal to all expenditures made and monetary obligations
incurred by Landlord including, without limitation, expenditures made and
obligations incurred for reasonable counsel fees, in connection with the
remedying by Landlord for Tenant's account pursuant to the provisions of Section
19.1; (b) sums equal to all losses, costs, liabilities, damages and expenses
referred to in Section 19.2; and (c) sums equal to all expenditures made and
monetary obligations incurred by Landlord, including, without limitation,
expenditures made and obligations incurred for reasonable counsel fees, in
collecting or attempting to collect the Rent, any Additional Charges or any
other sum of money accruing under this Lease or in enforcing or attempting to
enforce any rights of Landlord under this Lease or pursuant to law. Tenant's
obligations under this Section 19.4 shall survive the expiration or sooner
termination of the Term.
20. Access to Premises
20.1 Landlord reserves and shall at all times have the right to enter
the Premises at all reasonable times and upon reasonable prior notice (except in
an emergency) under the circumstances, which notice need not be written, to
inspect same, to supply any service to be provided by Landlord to Tenant
hereunder, to show the Premises to prospective purchasers, mortgagees or
tenants, to post notices of nonresponsibility, and to alter, improve or repair
the Premises and any portion of the Park, without abatement
<PAGE> 24
of Rent or Additional Charges, and may for that purpose erect, use and maintain
scaffolding, pipes, conduits and other necessary structures in and through the
Premises where reasonably required by the character of the work to be
performance, provided that the entrance to the Premises shall not be blocked
thereby, and further provided that the business of Tenant shall not be
interfered with unreasonably and in the course of any such entry upon the
Premises Landlord shall comply with Tenant's reasonable security procedures.
Tenant hereby waives any claim for damages for any injury or inconvenience to or
interference with Tenant's business, any loss of occupancy or quiet enjoyment of
the Premises or any other loss occasioned thereby (except for any damage to
Tenant's Property caused by the negligence or willful misconduct of Landlord or
Landlord's agents, employees or contractors, and then only to the extent that
such damage is not covered by Tenant's insurance). For each of the aforesaid
purposes, Landlord shall at all times have and retain a key with which to unlock
all doors in, upon and about the Premises, excluding Tenant's vaults and safes
or special security areas (designated in advance), and Landlord shall have the
right to use any and all means that Landlord may deem necessary or proper to
open said doors in an emergency, in order to obtain entry to any portion of the
premises, and any entry to the Premises or portions thereof obtained by Landlord
by any of said means, or otherwise, shall not under any circumstances be
construed or deemed to be a forcible or unlawful entry into, or a detainer of,
the Premises, or an eviction, actual or constructive, of Tenant from the
Premises or any portion thereof.
21. Notices
21.1 Except as otherwise expressly provided in this Lease, any bills,
statements, notices, demands, requests or other communications given or required
to be given under this Lease shall be effective only if rendered or given in
writing, sent by registered or certified mail or prepaid overnight courier, or
delivered personally, (a) to Tenant (i) at Tenant's address set forth in the
Basic Lease Information, if sent prior to Tenant's taking possession of the
Premises, or (ii) at the Premises if sent subsequent to Tenant's taking
possession of the Premises, or (iii) at any place where Tenant or any agent or
employee of Tenant may be found if sent subsequent to Tenant's vacating,
deserting, abandoning or surrendering the Premises, or (b) to Landlord at
Landlord's address set forth in the Basic Lease Information, or (c) to such
other address as either Landlord or Tenant may designate as its new address for
such purpose by notice given to the other in accordance with the provisions of
this Section 21.1. Any such bill, statement, notice, demand, request or other
communication shall be deemed to have been rendered or given upon receipt
thereof (or refusal to accept delivery) if sent by registered or certified mail
or prepaid overnight courier, or upon the date personal delivery is made (or
attempted to be made, if Tenant refuses to accept such delivery). If Tenant is
notified of the identity and address of Landlord's mortgagee or beneficiary
under a deed of trust, or ground or underlying lessor, Tenant shall give to such
mortgagee, beneficiary or ground or underlying lessor notice of any default by
Landlord under the terms of this Lease in writing sent by registered or
certified mail or prepaid overnight courier, and such mortgagee, beneficiary or
ground or underlying lessor shall be given a reasonable opportunity to cure such
default prior to any termination of this Lease by Tenant.
22. No Waiver; No Oral Modification
22.1 No failure by Landlord to insist upon the strict performance of
any obligation of Tenant under this Lease or to exercise any right, power or
remedy consequent upon a breach thereof, no acceptance of full or partial Rent
or Additional Charges during the continuance of any such breach, and no
acceptance of the keys to or possession of the Premises prior to the termination
of the Term by any employee of Landlord shall constitute a waiver of any such
breach or of such term, covenant or condition or operate as a surrender of this
Lease. No payment by Tenant or receipt by Landlord of a lesser amount than the
aggregate of all Rent and Additional Charges then due under this Lease shall be
deemed to be other than on account of the first items of such Rent and
Additional Charges then accruing or becoming due, unless Landlord elects
otherwise; and no endorsement or statement on any check, no letter accompanying
any check or other payment of Rent or Additional Charges in any such lesser
amount and no acceptance of any such check or other such payment by Landlord
shall constitute an accord and satisfaction, and Landlord may accept such check
or payment without prejudice to Landlord's right to recover the balance of such
Rent or Additional Charges or to pursue any other legal remedy.
<PAGE> 25
22.2 Neither this Lease nor any term or provision hereof may be
changed, waived, discharged or terminated orally, and no breach thereof shall be
waived, altered or modified, except by a written instrument signed by the party
against which the enforcement of the change, waiver, discharge or termination is
sought. No waiver of any breach shall affect or alter this Lease, but each and
every term, covenant and condition of this Lease shall continue in full force
and effect with respect to any other then existing or subsequent breach thereof.
22.3 The review, approval, inspection or examination by Landlord of
any item to be reviewed, approved, inspected or examined by Landlord under the
terms of this Lease or the exhibits attached hereto shall not constitute the
assumption of any responsibility by Landlord for either the accuracy or
sufficiency of any such item or the quality or suitability of such item for its
intended use. Any such review, approval, inspection or examination by Landlord
is for the sole purpose of protecting Landlord's interests in the Park and under
this Lease, and no third parties, including, without limitation, tenant or any
person or entity claiming through or under Tenant, or the contractors, agents,
servants, employees, visitors or licensees of Tenant or any such person or
entity, shall have any rights hereunder.
23. Tenant's Certificates
23.1 Tenant, at any time and from time to time upon not less than ten
(10) business days prior written notice from Landlord, will execute, acknowledge
and deliver to Landlord and, at Landlord's request, to any prospective
purchaser, ground or underlying lessor, beneficiary under a deed of trust or
mortgagee of any part of the Park, a certificate of Tenant stating: (a) that
Tenant has accepted the Premises (or, if Tenant has not done so, that Tenant has
not accepted the premises and specifying the reasons therefor, (b) the
Commencement and Expiration Dates of this Lease, (c) that this Lease is
unmodified and in full force and effect (or, if there have been modifications,
that same is in full force and effect as modified and stating the
modifications), (d) whether or not there are then existing any defenses against
the enforcement of any of the obligations of Tenant under this Lease (and, if
so, specifying same), (e) whether or not there are then existing any defaults by
Landlord in the performance of its obligations under this Lease (and, if so,
specifying same), (f) the dates, if any, to which the Rent and Additional
Charges and other charges under this Lease have been paid, and (g) any other
information that may reasonably be required by any of such persons. It is
intended that any such certificate of Tenant delivered pursuant to this Section
23.1 may be relied upon by Landlord and any prospective purchaser, ground or
underlying lessor, beneficiary or mortgagee of any part of the Park.
24. Tax on Tenant's Personal Property
24.1 At least ten (10) days prior to delinquency, Tenant shall pay all
taxes levied or assessed upon Tenant's equipment, furniture, fixtures and other
personal property located in or about the Premises. If the assessed value of
Landlord's property is increased by the inclusion therein of a value placed upon
Tenant's equipment, furniture, fixtures or other personal property, Tenant shall
pay to Landlord, upon and written demand, the taxes so levied against Landlord,
or the proportion thereof resulting from said increase in assessment. The
portion of real estate taxes payable by Tenant pursuant to this Section 24.1 and
by other tenants of the Park pursuant to similar provisions in their leases
shall be excluded from Taxes for purposes of computing the Additional Charges to
be paid pursuant to Article 4.
25. Security Deposit
25.1 By execution of this Lease, Landlord acknowledges receipt of
Tenant's Security Deposit for the faithful performance of all terms, covenants
and conditions of this Lease. Tenant agrees that Landlord may, without waiving
any of Landlord's other rights and remedies under this Lease upon the occurrence
of any of the events of default described in Article 17, apply the Security
Deposit to remedy any failure by Tenant to pay any Rent, Additional Charges or
other sum owing hereunder, to repair or maintain the Premises or to perform any
other terms, covenants or conditions contained herein. If Tenant has kept and
performed all terms, covenants and conditions of this Lease during the Term,
Landlord will within thirty (30) days following the termination hereof return
said sum to Tenant or the last permitted assignee of Tenant's interest hereunder
at the expiration of the Term. Should Landlord use any portion of the Security
Deposit to cure any default by Tenant hereunder, Tenant shall replace the
Security Deposit to the original amount within
<PAGE> 26
ten (10) days after notice. Landlord shall not be required to keep the security
deposit separate from its general funds, and Tenant shall not be entitled to
interest on any such deposit. Upon any sale or transfer of its interest in the
Building, Landlord may transfer the Security Deposit to its successor in
interest and thereupon Landlord shall be released from any liability or
obligation with respect thereto.
26. Authority
26.1 If Tenant signs as a corporation or a partnership, each of the
persons executing this Lease on behalf of Tenant does hereby covenant and
warrant that Tenant is a duly authorized and existing entity, that Tenant has
and is 'qualified to do business in California, that Tenant has full right and
authority to enter into this Lease, and that each and every person signing on
behalf of Tenant is authorized to do so. Upon Landlord's request, Tenant shall
provide Landlord with evidence satisfactory to Landlord confirming the foregoing
covenants and warranties.
27. Broker
27.1 Tenant represents and warrants that the broker specified in the
Basic Lease Information was the sole broker who negotiated and brought about the
consummation of this Lease, and that no discussions or negotiations were had
with any other broker concerning the leasing of the Premises. Based on the
foregoing representation and warranty, Landlord has agreed to pay any and all
commission or compensation due to said broker in connection with the
consummation of this Lease. Tenant agrees to indemnify and defend Landlord
against and hold Landlord harmless from any claims for brokerage commissions
arising out of any discussions or negotiations allegedly had by Tenant with any
other broker.
28. Liability of Landlord
28.1 The liability of Landlord hereunder or in connection with the
Premises shall be limited to its interest in the Building, and in no event shall
any other assets of Landlord or any constituent partner of Landlord be subject
to any claim arising out of or in connection with the Lease.
29. Attorneys' Fees
29.1 In the event that either Landlord or Tenant fails to perform any
of its obligations under this Lease or in the event a dispute arises concerning
the meaning or interpretation of any provision of this Lease, the basis of the
dispute shall be settled by judicial proceeding and the defaulting party or the
party not prevailing in such dispute, as the case may be, shall pay any and all
costs and expenses incurred by the other party in enforcing or establishing its
rights hereunder, including without limitation, court costs and attorneys' fees.
30. Surrender and Holding Over
30.1 Upon the expiration or sooner termination of the Term, Tenant
will quietly and peacefully surrender to Landlord the Premises in the condition
in which they are required to be kept as provided in Article 8, ordinary wear
and tear and the provisions of Article 13 excepted.
30.2 Any holding over after the expiration of the Term with the
consent of Landlord shall be construed to be a tenancy from month to month at
one hundred fifty percent (150%) of the Rent herein specified (prorated on a
monthly basis), unless Landlord shall specify a different rent in its sole
discretion, together with an amount estimated by Landlord for the monthly
Additional Charges payable under this Lease, and shall otherwise be on the terms
and conditions herein specified as far as applicable. Any holding over without
Landlord's consent shall constitute a default by Tenant and shall entitle
Landlord to reenter the Premises as provided in Article 17 hereof.
<PAGE> 27
31. Quiet Enjoyment
31.2 Upon Tenant's paying the Rent and Additional Charges and
performing all of Tenant's obligations under this Lease, Tenant may peacefully
and quietly enjoy the Premises during the Term as against all persons or
entities lawfully claiming by or through Landlord; subject, however, to the
provisions of this Lease and to any mortgages, deeds of trust or ground or
underlying leases referred to in Article 11.
32. Tenant's Insurance
32.1 Tenant shall carry at its expense and maintain in force during
the Term the following insurance:
(a) Comprehensive General Liability Insurance (including protective
liability coverage on operations of independent contractors engaged
in construction and also blanket contractual liability insurance) on
an "occurrence" basis for the benefit of Tenant and Landlord as
named insured against claims for "personal injury" liability,
including, without limitation, bodily injury, death or property
damage liability. Until such time as Tenant has commenced its
manufacturing operations in the Premises, the limit under such
liability insurance shall be not less than One Million Dollars
($1,000,000) in the event of "personal injury" to any number of
persons or of damage to property arising out of any one
"occurrence;" and from and after the date Tenant commences any
manufacturing operations in the Premises, the limit under such
liability insurance shall be increased to not less than Three
Million Dollars ($3,000,000) per such occurrence. Such insurance may
be furnished under a "primary" policy and an "umbrella" policy,
provided that it is primary insurance and not excess over or
contributory with any insurance in force for Landlord, and such
insurance policy shall contain a cross-liability endorsement. The
required liability limit of such insurance may be reasonably
increased by Landlord from time to time by giving written notice to
Tenant of such adjustment in the required liability limit.
(b) Insurance against loss or damage by fire and such other risks
and hazards as are insurable under present and future standard "all
risk" forms of fire and extended coverage insurance policies with
vandalism and malicious mischief endorsements, to the personal
property, furniture, furnishings and fixtures belonging to Tenant
located in the Premises for not less than 100% of the actual
replacement value thereof.
(c) Full coverage plate glass insurance covering all plate and
crystal glass situated in the Premises (provided, however, that
Tenant, but not any assignee or sublessee, may elect to self-insure
against breakage or damage to plate and crystal glass in the
Premises, and in such case, Tenant shall notify Landlord of such
election in writing).
32.2 All such insurance shall name Landlord as additional insured,
shall be effected under policies issued by insurers qualified and admitted to do
business in the State of California and having a Best's rating of not less than
A:X, shall be for amounts approved by Landlord and shall provide that Landlord
shall receive thirty (30) days' written notice from the insurer prior to any
cancellation or change of coverage.
32.3 Tenant shall deliver certificates of such insurance to Landlord
on or before the Commencement Date, and thereafter at least ten (10) days before
the expiration dates of expiring policies; and, in the event Tenant shall fail
to procure such insurance, or to deliver such certificates, Landlord may, at its
option, procure same for the account of Tenant, and the cost thereof shall be
paid to Landlord as Additional Charges within ten (10) days after delivery to
Tenant of bills therefor. Upon Landlord's request therefor, Tenant shall deliver
to Landlord a copy of any such insurance policy required to be maintained by
Tenant hereunder. Nothing contained in this Article 32 shall in any way limit
the extent of Tenant's liability under any of the other provisions of this
Lease.
<PAGE> 28
33. Short Form of Lease
33.1 Tenant agrees to execute, deliver and acknowledge, at the request
of Landlord, a short form of this Lease satisfactory to counsel for Landlord,
and Landlord may in its sole discretion record this Lease or such short form in
the County where the Premises are located. Tenant shall not record this Lease,
or a short form of this Lease, without Landlord's prior written consent.
34. Hazardous Materials
34.1 For purposes of this Lease, the term "Hazardous Material" means
any hazardous, toxic or radioactive substance or material the storage, use,
generation or disposal of which is or becomes regulated by any local
governmental authority, the State of California or the United States Government.
The term "Hazardous Material" includes, without limitation, any material or
substance which is (i) defined as a "hazardous waste," under Sections 25115,
25117 or 25122.7, or listed pursuant to Section 25140, of the California Health
and Safety Code, Division 20, Chapter 6.5 (Hazardous Waste Control Law), (ii)
defined as a "hazardous substance" under Section 25316 of the California Health
and Safety Code, Division 20, Chapter 6.8 (Carpenter-Presley-Tanner Hazardous
Substance Account Act), (iii) defined as a "hazardous material," hazardous
substance," or "hazardous waste" under Section 25501 of the California Health
and Safety Code, Division 20, Chapter 6.95 (Hazardous Materials Release Response
Plans and Inventory), (iv) defined as a "hazardous substance" under Section
25281 of the California Health and Safety Code, Division 20, Chapter 6.7
(Underground Storage of Hazardous Substances), (v) petroleum, (vi) asbestos,
(vii) listed under Article 9 or defined as hazardous or extremely hazardous
pursuant to Article 11 of Title 22 of the California Administrative Code,
Division 4, Chapter 20, (vii) designated as a "hazardous substance" pursuant to
Section 311 of the Federal Water Pollution Control Act (33 U.S.C. Section 1317),
(ix) defined as a "hazardous waste" pursuant to Section 1004 of the Federal
Resource Conservation and Recover Act, 42 U.S.C. Section 6901 et seq. (42 U.S.C.
Section 6903), or (x) defined as a "hazardous substance" pursuant to Section 101
of the Comprehensive Environmental Response, Compensation and Liability Act, 42
U.S.C. Section 9601 et seq. (42 U.S.C. Section 9601), or (xi) listed or defined
as "hazardous waste," or "hazardous substance," or "toxic substance," or other
similar designation by any regulatory scheme of the State of California or the
United States Government.
34.2 If, as a necessary component of Tenant's conduct of its business
on the Premises, Tenant intends to store, use, generate or dispose of any
Hazardous Materials on the Premises, Tenant shall notify Landlord, in writing at
least thirty (30) days prior to their first appearance on the Premises, of
Tenant's proposed activity and the specific Hazardous Materials to be stored,
used, generated or disposed of on the Premises. Tenant shall not store, use,
generate or dispose of any Hazardous Materials on the Premises other than as a
necessary component of Tenant's conduct of its business on the Premises. Tenant,
at its sole cost, shall comply with all laws and regulations relating to the
storage, use, generation and disposal of Hazardous Materials. Tenant shall be
solely responsible for and shall defend, indemnify and hold Landlord, and
Landlord's successors, assigns and agents, harmless from and against all claims,
demands, damages, costs and liabilities, including attorneys' fees and
costs, arising out of or in connection with the storage, use, generation or
disposal of Hazardous Materials by Tenant, its agents, employees, or
contractors.
34.3 If the presence of Hazardous Materials on the Premises and/or
Park caused or permitted by Tenant, its agents, employees, contractors or
subtenants results in contamination or deterioration of water or soil resulting
in a level of contamination greater than the levels established by any
governmental agency having jurisdiction over such contamination, or if any
investigation of conditions or any clean up, remedial removal or restoration
work is required by any federal, state or local governmental agency or political
subdivision ("Governmental Agency") because of the level of Hazardous Material
in the soil or ground water or on the Premises or the Park caused or permitted
by Tenant, its agents, employees, contractors, or subtenants, then Tenant shall
promptly, and at its sole cost and expense, take any and all action as required
by any applicable Governmental Agency concerning the investigation or clean-up
of such Hazardous Materials caused or permitted by Tenant, its agents,
employees, contractors or subtenants. Tenant shall further be solely responsible
for, and shall defend, indemnify and hold Landlord and Landlord's successors,
assigns and agents harmless from and against, all claims, demands, damages,
costs and liabilities, including attorneys' fees and
<PAGE> 29
costs, arising out of or in connection with any removal, clean-up and
restoration work and materials required hereunder to return the Premises and the
Park and any other property to substantially their condition existing prior to
the introduction of any Hazardous Materials in the Premises or the Park caused
or permitted by Tenant, its agents, employees, contractors or subtenants, but in
any event to a condition deemed satisfactory by any Governmental Agency
exercising jurisdiction with respect thereto. Tenant's obligations under this
Article 34 shall survive the termination of this Lease; provided, however, that
Tenant shall have the right prior to the termination of this Lease to request
that the Building E Site and the Park be tested to determine whether or not
there exist any Hazardous Materials caused or permitted by Tenant, its agents,
employees, contractors or subtenants. In the event Tenant so requests that such
testing be undertaken, Landlord and Tenant shall select a mutually acceptable
independent certified pollution control engineer who shall determine the
appropriate testing methodology and procedures and the extent and timing of such
testing, in order to make the foregoing determination based upon then current
standards of good engineering practice given the nature of Tenant's use of the
Premises. Such testing shall be performed at Tenant's sole cost and expense, and
Landlord may require that Tenant deposit with Landlord in advance the full
amount of the cost of any such testing. If on the basis of such testing, it can
be determined to Landlord's satisfaction, in Landlord's good faith judgment,
that no such contamination has occurred for which Tenant is responsible
hereunder, Landlord shall so indicate in writing to Tenant and thereafter Tenant
shall have no further obligations under this Article 34.
34.4 Notwithstanding anything contained in this Article 34 to the
contrary, Tenant shall have no obligation to clean up, to comply with any law
regarding, or to indemnify, defend or hold Landlord harmless with respect to,
any Hazardous Materials which were not stored, used, generated or disposed of
within the Park by Tenant or its agents, employees, contractors, or subtenants.
34.5 Landlord hereby represents and warrants to Tenant that, as of the
Lease Date, Landlord is not aware of any violation within the boundaries of the
Park of any local, state or federal law regulating the use, storage,
transportation or disposal of Hazardous Materials ("Hazardous Materials Laws").
Tenant hereby acknowledges that Landlord has disclosed to Tenant the fact that
the Park has been built upon a former landfill site and that methane gas is
known to form in the ground beneath the Park. As a consequence of the foregoing,
the Building and other buildings in the Park were required by applicable
governmental authorities to be constructed, and have been constructed, with
methane barriers. Further, in order to monitor the presence of Hazardous
Materials that may exist in the groundwater passing through the site of the
Park, Landlord was required by applicable governmental authorities to install
and maintain, and has installed and does maintain, five (5) groundwater
monitoring wells in the vicinity of the Building; and the cost of maintenance of
such monitoring wells after the Commencement Date of the Lease shall be an item
of "Expenses" under Section 4.1(d) above. Landlord has not received notice of
any litigation pending, and has no knowledge of any threatened litigation,
regarding the actual or alleged presence of Hazardous Materials within the Park
or any disposal, release or threatened release of Hazardous Materials in or from
the Park, nor has Landlord previously entered into any settlements of any such
litigation with any governmental entity or private party; provided, however,
that Tenant hereby acknowledges that Landlord has disclosed to Tenant the fact
that Landlord did previously agree to move a sewer lateral serving one of the
buildings in the Park at the request of the City of San Rafael because of the
presence of methane gas in the sewer line operated by the City of San Rafael to
which such sewer lateral is connected.
35. Miscellaneous
35.1 Use of Terms
The words "Landlord" and "Tenant" as used herein all include the
plural as well as the singular. Words used in the neuter gender include the
masculine and feminine. If there is more than one Tenant, the obligations under
this Lease imposed on Tenant shall be joint and several. The captions preceding
the articles of this Lease have been inserted solely as a matter of convenience,
and such captions in no way define or limit the scope or intent of any provision
of this Lease.
<PAGE> 30
35.2 Binding Effect
The terms, covenants and conditions contained in this Lease shall
bind and inure to the benefit of Landlord and Tenant and, except as otherwise
provided herein, their respective personal representatives and successors and
assigns; provided, however, upon the sale, assignment or transfer by Landlord
(or by any subsequent landlord) of its interest in the Building as owner or
lessee, including any transfer by operation of law, Landlord (or subsequent
landlord) shall be relieved of all obligations or liabilities under this Lease,
and all obligations or liabilities shall be binding upon the grantee, assignee
or other transferee of such interest, and any such grantee, assignee or
transferee, by accepting such interest, shall be deemed to have assumed such
obligations and liabilities; and provided, further, that at any time after the
Lease Date, whether or not in connection with a sale of the Building, Landlord's
responsibilities hereunder with respect to the maintenance and operation of the
Common Areas of the Park may be performed by one or more successors to Landlord
with respect to one or more buildings in the Park or an owner's association
comprised of one or more owners of buildings in the Park. A lease of the entire
Building to a person other than for occupancy thereof shall be deemed a transfer
within the meaning of this Section 35.2.
35.3 Severability
If any provision of this Lease or the application thereof to any
person or circumstance shall, to any extent, be invalid or unenforceable, and in
Landlord's opinion such invalid or unenforceable provision does not affect a
material benefit or right hereunder, the remainder of this Lease, for the
application of such provision to persons or circumstances other than those as to
which it is invalid or unenforceable, shall not be affected thereby, and each
provision of this Lease shall be valid and be enforced to the full extent
permitted by law.
35.4 California Law
This Lease shall be construed and enforced in accordance with the
laws of the State of California.
35.5 Execution by Landlord
Submission of this instrument for examination or signature by Tenant
does not constitute a reservation of or an option for lease, and it is not
effective as a lease or otherwise until execution and delivery by both Landlord
and Tenant.
35.6 Merger
This instrument, including the exhibits hereto, which are made a
part of this Lease, contains the entire agreement between the parties, and all
prior negotiations and agreements are merged herein. Neither Landlord nor
Landlord's agents have made any representations or warranties with respect to
the Premises, the Building, the Park, or this Lease except as expressly set
forth herein, and no rights, easements or licenses are or shall be acquired by
Tenant by implication or otherwise unless expressly set forth herein.
35.7 Signs
Subject to Landlords approval of the design and location of such
sign, which approval shall not be unreasonably withheld, Tenant shall be
permitted to erect a monument sign within the Building E Site identifying the
Premises. Under no circumstances shall Tenant place a sign on the roof of the
Building.
<PAGE> 31
36. Option to Extend
36.1 Landlord hereby grants Tenant an option to extend the term of
this Lease (the "Option to Extend") for one additional period of five (5) years
(the "Option Term") commencing immediately after the expiration of the initial
Term, upon the same material terms and conditions contained herein, except that
(i) the Rent for the Premises (including, if applicable, Building B or C, if
either of such buildings shall become a part of this Lease pursuant to the
exercise of Tenant's expansion options under Articles 37 or 38 below) during the
Option Term shall be equal to the fair market rent for the Premises determined
in the manner set forth in Section 36.2 below, (ii) Tenant shall continue to be
responsible for the payment of all Additional Charges as provided for in this
Lease, (iii) Tenant shall accept the Premises in an "as is" condition without
any obligation of Landlord to repaint, remodel, repair, improve or alter the
Premises, and (iv) there shall be no further options to extend the term of this
Lease. Tenant's notice of its election to exercise the Option to Extend must be
given to Landlord in writing no later than twelve (12) months prior to
expiration of the initial Term of this Lease. If Tenant properly exercises the
Option to Extend, references in this Lease to the Term shall be deemed to mean
the Option Term unless the context clearly provides otherwise.
36.2 If Tenant properly exercises the Option to Extend, the Rent for
the Premises during the Option Term shall be determined in the following manner.
The Rent shall be increased to an amount equal to the fair market rent for the
Premises as of the commencement of the Option Term for a term equal to the
Option Term, including any interim CPI or other adjustments as may constitute
such fair market rent, as specified by Landlord by notice to Tenant not less
than thirty (30) days prior to commencement of the Option Term, subject to
Tenant's right of arbitration as set forth below. If Tenant believes that the
fair market rent specified by Landlord exceeds the actual fair market rent for
the Premises as of the commencement of the Option Term, than Tenant shall so
notify Landlord within five (5) business days following receipt of Landlord's
notice. If Tenant fails to so notify Landlord within said five (5) business
days, Landlord's determination of the fair market rent for the Premises shall be
final and binding upon the parties. If the parties are unable to agree upon the
fair market rent for the Premises within ten (10) days after Landlord's receipt
of notice of Tenant's objection, the Rent for the Option Term shall be
determined as follows:
(a) Within 20 days after receipt of Landlord's notice specifying
fair market rent, Tenant, at its sole expense, shall obtain and
deliver in writing to Landlord a determination of the fair market
rent for the Premises for a term equal to the Option Term from a
broker (Tenant broker") licensed in the State of California and
engaged in the commercial brokerage business in the City of San
Rafael for at least the immediately preceding five (5) years. If
Landlord accepts such determination, the Rent for the Option Term
shall be increased to an amount equal to the amount determined by
Tenant's broker.
(b) If Landlord does not accept such determination, with 15 days
after receipt of the determination of Tenant's broker, Landlord
shall designate a broker ("Landlord's broker") licensed in the State
of California and engaged in the commercial brokerage business in
the City of San Rafael for at least the immediately preceding five
(5) years. Landlord's broker and Tenant's broker shall name a third
broker, similarly qualified, within five (5) days after the
appointment of Landlord's broker. Each of said three brokers shall
determine the fair market rent for the Premises as of the
commencement of the Option Term for a term equal to the Option Term
of the Lease within 15 days after the appointment of the third
broker. The Rent payable by Tenant effective as of the commencement
of the Option Term shall be increased to an amount equal to the
arithmetic average of such three determinations; provided, however,
that if any such broker's determination deviates more than 10% from
the median of such determinations, the Rent payable shall be an
amount equal to the average of the two closest determinations.
(c) Landlord shall pay the costs and fees of Landlord's broker in
connection with any determination hereunder, and Tenant shall pay
the costs and fees of Tenant's broker in connection with such
determination. The costs and fees of any third broker shall be paid
one-half by Landlord and one-half by Tenant.
<PAGE> 32
If the amount of the fair market rent is not known as of the
commencement of the Option Term, then Tenant shall continue to pay
the Rent in effect at the expiration of the initial Term until the
amount of the fair market rent is determined. When such
determination is made Tenant shall pay any deficiency to Landlord
upon demand.
36.3 Notwithstanding anything to the contrary contained herein, all
option rights of Tenant pursuant to this Article 36 shall automatically
terminate without notice and shall be of no further force and effect, whether or
not Tenant has timely exercised the Option to Extend granted in this Article 36,
if (i) Tenant is in default (as defined in Article 17 above) at the time of
exercise of said option or at the time of commencement of the Option Term, or
(ii) Landlord has rightfully given Tenant three (3) or more notices respecting a
default on the part of Tenant during the initial Term of this Lease, whether or
not any such default was subsequently cured.
37. Option to Expand -- Building B
37.1 Grant of Option. Landlord hereby grants to Tenant the option to
lease the entirety of Building B of the Park as identified in Exhibit A, upon
and subject to the terms and conditions of this Article 37 (the "Building B
Expansion Option"). Landlord and Tenant acknowledge that Building B is currently
occupied by the Loric Corporation ("Loric") under a lease (the "Loric Lease")
scheduled to terminate on August 25, 1991. Loric has an option to extend the
term of the Loric Lease for an additional two (2) years following the expiration
of the initial term of the Loric Lease. The Building B Expansion Option shall be
subject to the occupancy rights of the tenant under the Loric Lease.
37.2 Notice of Exercise.
37.2.1 If Loric Fails to Extend. If Loric does not exercise its
option to extend the Loric Lease, the term of the Loric Lease shall
expire as of August 25, 1991, and Loric must notify Landlord of its
exercise of Loric's option to extend the term of the Loric Lease on
or before December 25, 1990. In the event that Loric does not
exercise its right to extend the Loric Lease, Landlord shall
promptly notify Tenant of such failure to exercise. The Building B
Expansion Option shall then be exercised, if at all, by written
notice from Tenant to Landlord given at any time following Landlords
notice of Loric's failure to so extend the term of the Loric Lease
and prior to March 1, 1991. Time is of the essence with respect to
Tenant's delivery to Landlord of the notice of exercise of the
Building B Expansion Option, and if Tenant fails to deliver such
notice of exercise prior to March 1, 1991, the Building B Expansion
Option shall expire and shall be of no further force or effect.
37.2.2 If Loric Exercises Extension Option. If Loric exercises its
option to extend the Loric Lease, the term of the Loric Lease shall
expire as of August 25, 1993. In the event that Loric exercises its
right to extend the Loric Lease, Landlord shall promptly notify
Tenant of such exercise. The Building B Expansion Option shall then
be exercised, if at all, by written notice from Tenant to Landlord
given at any time following Landlord's notice of Loric's exercise of
Loric's option to extend the Loric Lease and prior to February 28,
1992. Time is of the essence with respect to Tenant's delivery to
Landlord of the notice of exercise of the Building B Expansion
Option, and if Tenant fails to deliver such notice of exercise prior
to February 28, 1992, the Building B Expansion Option shall expire
and shall be of no further force or effect.
37.3 Conditions to Exercise of Expansion Option. Tenant shall not be
entitled to exercise the Building B Expansion Option at any time that Tenant is
in default under any of the terms or conditions of this Lease or at any time
that there exists any circumstance or condition which with the passage of time
would cause Tenant to be in material default hereunder; and any notice of
exercise of the Building B Expansion Option given by Tenant to Landlord at any
such time shall be void. Further, if at any time after Tenant's delivery of the
notice of exercise of the Building B Expansion Option and prior to Tenant's
occupancy of
<PAGE> 33
Building B Tenant shall be in default under any of the terms or conditions of
this Lease or there shall exist any circumstance or condition which with the
passage of time would cause Tenant to be in material default hereunder, Landlord
shall have, in addition to any and all of the other rights and remedies of
Landlord under this Lease, the right to terminate Tenant's exercise of the
Building B Expansion Option by notice to Tenant of such termination.
37.4 Commencement Date. The Commencement Date for Building B for
purposes of this Lease shall be the date that is ten (10) business days after
the date on which the Loric Lease expires (the "Building B Commencement Date").
If, on or prior to the stated Building B Commencement Date, Landlord fails to
deliver possession of Building B. then the following provisions shall apply: (i)
the Building B Initial Term (as defined below) shall not commence on the
Building B Commencement Date set forth above but shall, instead, commence on the
date that Landlord delivers possession of Building B to Tenant; (ii) neither the
validity of this Lease nor the obligations of Tenant under this Lease shall be
affected thereby, except that the Building B Initial Term shall begin as
provided in clause (i) above; and (iii) Tenant shall have no claim against
Landlord because of Landlord's failure to deliver possession of Building B on
the date originally fixed therefor. From and after the Building B Commencement
Date, all references in the Lease to the Premises shall be deemed to include
Building B as a part thereof, Tenant shall lease and occupy Building B upon all
of the terms and conditions contained in the Lease, including, without
limitation, Tenant's obligation to pay Additional Charges pursuant to Section
3.3 above as well as all other items payable by Tenant under the Lease, and
Tenant's Share of Taxes and Expenses charges shall be increased pursuant to the
terms of Article 4 above. Notwithstanding the foregoing, Tenant's obligation to
pay Rent for its occupancy of Building B shall be as set forth in Section 37.5
below.
37.5 Rent for Building B. The Rent payable by Tenant for Building B
shall be the fair market rent for Building B as of the Building B Commencement
Date for a term equal to the remainder of the initial Term of this Lease (the
"Building B Initial Term") as such fair market rent is specified by Landlord by
notice to Tenant not less than thirty (30) days prior to the Building B
Commencement Date, subject to Tenant's right of arbitration as set forth below.
If Tenant believes that the fair market rent specified by Landlord exceeds the
actual fair market rent for Building B as of Building s Commencement Date, then
Tenant shall so notify Landlord within ten (10) days following receipt of
Landlord's notice. If Tenant fails to so notify Landlord within said ten (10)
days, Landlord's determination of the fair market rent for Building B shall be
final and binding upon the parties. If the parties are unable to agree upon the
fair market rent for Building B within ten (10) days after Landlord's receipt of
notice of Tenant's objection, the Rent payable for Tenant's occupancy of
Building B as of the Building B Commencement Date shall be determined as
follows:
(a) Within 20 days after receipt of Landlord's notice specifying
fair market rent, Tenant, at its sole expense, shall obtain and
deliver in writing to Landlord a determination of the fair market
rent for Building B for a term equal to the Building B Initial Term
from a broker ("Tenant's Broker") licensed in the State of
California and engaged in the commercial brokerage business in the
City of San Rafael for at least the immediately preceding five (5)
years. If Landlord accepts such determination by written notice
within ten (10) days of receiving Tenant's Broker's determination,
the Rent for the Building B Initial Term shall be the amount
determined by Tenant's Broker.
(b) If Landlord does not so accept such determination, within
fifteen (15) days after receipt of the determination of Tenant's
Broker, Landlord shall designate a broker ("Landlord's Broker")
licensed in the State of California and engaged in the commercial
brokerage business in the City of San Rafael for at least the
immediately preceding five (5) years. Landlord's Broker and Tenant's
Broker shall name a third broker, similarly qualified, within five
(5) days after the appointment of Landlord's Broker. Each of said
three brokers shall determine the fair market rent for Building B as
of the Building B Commencement Date for a term equal to the Building
B Initial Term within 15 days after the appointment of the third
broker. The Rent payable by Tenant effective as of the Building B
Commencement Date shall be an amount equal to the arithmetic average
of such three determinations; provided, however, that if any
<PAGE> 34
such broker's determination deviates more than 10% from the median
of such determination, the Rent payable shall be an amount equal to
the average of the two closest determinations.
(c) Landlord shall pay the costs and fees of Landlord's Broker in
connection with any determination hereunder, and Tenant shall pay
the costs and fees of Tenant's Broker in connection with such
determination. The costs and fees of any third broker shall be paid
one-half by Landlord and one-half by Tenant.
(d) As used in this Lease with reference to the Building B Initial
Term, the "fair market rent" means the effective fair market rental
per annum for Building B for the period constituting the Building B
Initial Term as determined herein. The fair market rental shall not
be subject to the Rent Formula set forth in Schedule 2 attached to
the Lease, but shall be subject to annual CPI adjustments.
(e) If the amount of the fair market rent is not known as of the
Building B Commencement Date, then Tenant shall pay the Rent
specified by Landlord in Landlord's notice of its initial
determination of the fair market rent for Building B until the
amount of the fair market rent is determined. When such
determination is made, Tenant shall pay any deficiency to Landlord
upon demand. In the event the fair market rent as determined
pursuant to this Section 37.5 is less than the fair market rent
initially specified by Landlord, Landlord shall provide Tenant with
a credit against the next installments of Rent for Building B in the
amount of the difference.
37.6 "As Is" Basis. Tenant acknowledges that Tenant's occupancy of
Building B following the exercise of the Building B Expansion Option shall be on
an "as is" basis and that Landlord shall have no obligation to build out or
alter Building B or construct any tenant improvements therein.
38. Expansion option -- Building C
38.1 Grant of Option. Landlord hereby grants to Tenant the option to
lease the entirety of Building C of the Park as identified in Exhibit A, upon
and subject to the terms and conditions of this Article 38 (the "Building C
Expansion Option").
38.2 Availability of Option. The Building C Expansion Option shall be
available to Tenant only if (i) Loric fails to exercise its right to extend the
term of the Loric Lease, and (ii) Tenant does not thereafter exercise the
Building B Expansion Option pursuant to the terms of Section 37.2.1 above. In
the event that Loric exercises its right to extend the Loric Lease or Tenant
exercises the Building B Expansion Option pursuant to Section 37.2.1 above, the
Building C Expansion option granted in this Article 38 shall terminate and be of
no further force or effect.
38.3 Notice of Exercise. The Building C Expansion Option shall be
exercised, if at all, by written notice from Tenant to Landlord given at any
time following Landlord's notice that Loric did not exercise its option to
extend the Loric Lease and prior to June 30, 1992. Time is of the essence with
respect to Tenant's delivery to Landlord of the notice of exercise of the
Building C Expansion Option, and if Tenant fails to deliver such notice of
exercise prior to June 30, 1992, the Building C Expansion option shall expire
and shall be of no further force or effect.
38.4 Conditions to Exercise of Expansion Option. Tenant shall not be
entitled to exercise the Building C Expansion Option at any time that Tenant is
in default under any of the terms or conditions of this Lease or at any time
that there exists any circumstance or condition which with the passage of time
would cause Tenant to be in material default hereunder; and any notice of
exercise of the Building C Expansion Option given by Tenant to Landlord at any
such time shall be void. Further, if any time after Tenant's delivery of the
notice exercise of the Building C Expansion Option and prior to Tenant's
occupancy of Building C
<PAGE> 35
Tenant shall be in default under any of the terms or conditions of this Lease or
there shall exist any circumstance or condition which with the passage of time
would cause Tenant to be in material default hereunder, Landlord shall have, in
addition to any and all of the other rights and remedies of Landlord under this
Lease, the right to terminate Tenant's exercise of the Building C Expansion
Option by notice to Tenant of such termination.
38.5 Commencement Date. The Commencement Date for Building C for
purposes of this Lease shall be the date that is five years after the original
Commencement Date of this Lease as provided for in Section 2.2 above (the
"Building C Commencement Date"). If, on or prior to the stated Building C
Commencement Date, Landlord fails to deliver possession of Building C, then the
following provisions shall apply: (i) the Building C Initial Term (as defined
below) shall not commence on the Building C Commencement Date set forth above
but shall, instead, commence on the date that Landlord delivers possession of
Building C to Tenant; (ii) neither the validity of this Lease nor the
obligations of Tenant under this Lease shall be affected thereby, except that
the Building C Initial Term shall begin as provided in clause (i) above; and
(iii) Tenant shall have no claim against Landlord because of Landlord's failure
to deliver possession of Building C on the date originally fixed therefor. From
and after the Building C Commencement Date, all references in the Lease to the
Premises shall be deemed to include Building C as a part thereof, Tenant shall
lease and occupy Building C upon all of the terms and conditions contained in
this Lease, including, without limitation, Tenant's obligation to pay Additional
Charges pursuant to Section 3.3 above as well as all other items payable by
Tenant under the Lease, and Tenant's Share of Taxes and Expenses charges shall
be increased pursuant to the terms of Article 4 above. Notwithstanding the
foregoing, Tenant's obligation to pay Rent for its occupancy of Building C shall
be as set forth in Section 38.6 below.
38.6 Rent for Building C. The Rent payable by Tenant for Building C
shall be the fair market rent for Building C as of the Building C Commencement
Date for a term equal to the remainder of the initial Term of this Lease (the
"Building C Initial Term") as such fair market rent is specified by Landlord by
notice to Tenant not less than thirty (30) days prior to the Building C
Commencement Date. Tenant shall have a right of arbitration with regard to
Landlord's determination of the fair market rental for Building C identical to
the arbitration procedure set forth in Section 37.5 above. In any challenge to
Landlord's initial determination of the fair market rent for Building C, Tenant
shall be bound by the terms and notice procedures set forth in Section 37.5.
Such fair market rent shall not be subject to the Rent Formula set forth in
Schedule 2 attached to the Lease, but shall be subject to annual CPI
adjustments.
38.7 "As Is" Basis. Tenant acknowledges that Tenant's occupancy of
Building C following the exercise of the Building C Expansion Option shall be on
an "as is" basis and that Landlord shall have no obligation to build out or
alter Building C or construct any tenant improvements therein.
39. Right of First Refusal.
If during the Term of this Lease, including the Option Term, Landlord
determines to transfer, sell, or otherwise convey only Building E (and/or
Building B or Building C, if Tenant shall have exercised its Expansion Option
for either of those Buildings and is in full occupancy thereof) [but not, for
example, if Landlord determines to transfer the Park, or several buildings in
the Park including Building E (or Building B or C, if applicable) or any
interest in the entity owning Building E (or Building B or C, if applicable) or
the Park] to an unaffiliated third party (a "Third Party") Landlord shall first
notify Tenant in writing of the material terms upon which Landlord intends to
offer any such Building for sale ("Landlord's Sale Notice"). If Tenant, within
twenty-five (25) days after receipt of Landlord's Sale Notice, indicates in
writing its agreement to purchase such Building on the terms stated in
Landlord's Sale Notice, Landlord shall sell and convey such Building to Tenant
on the terms stated in Landlord's Sale Notice. If Tenant does not indicate its
agreement within said twenty-five (25) days, Landlord thereafter shall have the
right to sell and convey such Building to a Third Party; provided that if
Landlord receives an offer to purchase such Building from a Third Party for a
gross price that is less than ninety-five percent (95%) of the price stated in
Landlord's Sale Notice (without regard for any difference in payment terms), and
Landlord determines to accept such offer, Landlord shall notify Tenant of such
determination in writing ("Landlord's Notice of Revised Prices), including in
its notice such other material terms as are included in the Third Party's offer.
If Tenant, within five (5) days after receipt
<PAGE> 36
of such notice from Landlord, indicates in writing its agreement to purchase
such Building at the price and payment terms stated in such notice, Landlord
shall sell and convey such Building to Tenant at such price and upon such terms.
If Tenant does not indicate its agreement within said five (5) days, Landlord
thereafter shall have the right to sell and convey such Building to the Third
Party pursuant to said Third Party's offer. If Landlord does not thereafter sell
and convey such Building to the Third Party at a price at least equal to the
price stated in Landlord's Notice of Revised Price and on substantially similar
payment terms, any further transaction shall be deemed to be a new determination
by Landlord to sell and convey such Building and the provisions of this Article
39 shall be applicable. If Tenant purchases the Building, this Lease shall
terminate on the date title vests in Tenant, and Landlord shall remit to Tenant
all prepaid and unearned Rent, and all Additional Charges shall be prorated as
of such date. Tenant's rights as set forth in this Article 39 shall apply only
to the first sale of any such Building by Landlord; and such rights shall
terminate and be of no further force or effect upon the consummation of the
first sale of any such Building. In the event that Tenant does not elect to
exercise its right to purchase any such Building as provided in this Article 39,
within three (3) days after written request therefor from Landlord, Tenant shall
deliver to Landlord an instrument in form and substance satisfactory to Landlord
and any Third Party that acknowledges that Tenant has not elected to exercise
such right.
IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease as
of the Lease Date.
BAYVIEW ASSOCIATES, OCLASSEN PHARMACEUTICALS, INC., a
a California Joint Venture California corporation
By: Bayview Partners, a California By: Dan K. Turner
--------------------------------- --------------------------------
limited partnership
Its: General Partner
---------------------- Its: Vice President - Finance and
-------------------------------
Administration
-------------------------------
By: Reid Corporation a
------------------------- By: /s/ Glenn A. Oclassen
California --------------------------------
Its: General Partner Its: President
--------------------- -------------------------------
By: /s/ L.C. Tolomei "TENANT"
---------------------
L.C. Tomolei
President
"LANDLORD"
<PAGE> 37
Schedule 1
DELIVERY OF PREMISES TO TENANT
1. General. The Premises shall be built out in phases and delivered to
Tenant over the first five (5) years of the Term of the Lease in accordance with
the schedule set forth in paragraph 2 below (the "Delivery Schedule"). In order
to accommodate the various needs of Tenant, the Premises shall be built out so
as to include office, warehouse, manufacturing and laboratory space. Initially,
Landlord and Tenant anticipate that the Premises, when completely built out,
will contain the following square footages of rentable areas of each such type
of space:
<TABLE>
<S> <C>
(i) Office = 13,684 sq. ft.
(ii) Warehouse = 2,520 sq. ft.
(iii) Manufacturing = 6,160 sq. ft.
(iv) Laboratory = 1,452 sq. ft.
(v) Undesignated = 4,528 sq. ft. (Microage - see below)
</TABLE>
The respective areas of each such type of space may be adjusted over time as
requested by Tenant; provided, however, that the amount of space to be built out
for warehouse purposes cannot exceed 2,520 rentable square feet and Tenant must
take down at the commencement of each lease year at least that amount of space
specified in the Delivery Schedule for such lease year.
2. Delivery of Premises.
(a) Delivery Schedule. Portions of the Premises shall be
delivered to Tenant in accordance with the Delivery Schedule set
forth below:
(i) Initial Premises. The portion of the Premises to be
delivered at the Commencement Date shall consist of the following
contiguous space as indicated in the attached Exhibit A-1:
<TABLE>
<S> <C>
Office = 6,908 sq. ft.
Warehouse = 2,520 sq. ft.
Laboratory = 1,452 sq. ft.
Vacant = 8,536 sq. ft. (see below)
</TABLE>
(ii) Subsequent Space. The balance of the Premises shall be
delivered to Tenant as follows:
a. Commencement of Lease Year Two -- additional 1,936
sq. ft. of office space, such space to be taken from the vacant
space originally delivered by Landlord.
b. Commencement of Lease Year Three -- additional 1,936
sq. ft. of office space; and October 1, 1991 -- 6,160 sq. ft. of
manufacturing space; such space to be taken in part from the
vacant space originally delivered by Landlord and in part from
the Reid Corporation space (see below).
c. Lease Year Four -additional 2,904 sq. ft. of office
space, such space to be the balance of the vacant space
originally delivered by Landlord and the Reid Corporation space.
d. Lease Year Five -- 4,528 sq. ft. of space that is
currently Undesignated, such space being the Microage space (see
below).
(b) Undesignated Space (Microage). The portion of the Premises
consisting of 4,528 so. ft. that is to be delivered to Tenant in the fifth
lease year is shown on Exhibit A-1 to the Lease. Such space has not yet been
designated by Tenant for use as office, manufacturing or laboratory space;
and such designation shall be made by Tenant no later than the commencement
of the fourth lease year.
<PAGE> 38
Such space is currently under lease to Microage Corporation, and
Tenant acknowledges that it is anticipated that such space will continue to be
so occupied until such time as such space is scheduled to be delivered to
Tenant. If, however, Tenant desires to take down such space prior to the
commencement of the fifth lease year, Landlord agrees to use reasonable efforts
to assist Tenant in negotiating with Microage for the early termination or
buy-out of its lease; but Tenant shall be responsible for all costs and expense
of any such negotiations and for any payments to be made for the early
termination or buy-out of the Microage lease.
(c) Reid Corporation Space. Reid Corporation will occupy 4,400 sq.
ft. of space in Building E, as shown on Exhibit A-1 to the Lease. Such space is
to be delivered to Tenant in two stages - 2,464 sq. ft. of manufacturing space
(the "Reid Manufacturing Space") at the commencement of lease year three and
1,936 sq. ft. of office space (the "Reid Office Space") at the commencement of
lease year four. Tenant shall have the right to take down all of the Reid
Manufacturing Space (but not a portion thereof) or all of the Reid Office Space
(but not a portion thereof), or both the Reid Manufacturing Space and the Reid
Office Space,.any time prior to the third lease year by providing Landlord with
one hundred twenty (120) days advance written notice of such election and
submitting to Landlord the Plans and Specifications for the Reid Corporation
space to be taken down together with the Plans and Specifications for the other
space to be added to the Premises at the commencement of such lease year.
(d) Vacant Space. Initially, the Premises shall include 8,536 sq.
ft. of vacant space as shown on Exhibit A-1 to the Lease, which vacant space
shall not have been built out by Landlord with any tenant improvements at the
Commencement Date. Tenant shall pay rent on such vacant space as provided in
Schedule 2 and shall have the right, if lawfully permitted under applicable
governmental laws and regulations, to use such vacant space for purposes of
storage.
A portion of the vacant space consisting of 3,696 sq. ft. as shown
on Exhibit A-1 to the Lease shall be available for lease by Landlord to a third
party (the "vacant Space Available for Lease"). From and after the Lease Date,
Landlord shall attempt in good faith to lease to a third party the vacant Space
Available for Lease for a period not to extend beyond August 30, 1990. Tenant
shall have the right to approve the term of any such lease in order to preserve
its opportunity to take down the vacant Space Available for Lease prior to the
commencement of the third lease year. Until the vacant Space Available for Lease
has been built out with tenant improvements for occupancy by Tenant, Tenant
shall pay Rent and Additional Charges on the Vacant Space Available for Lease
only until the earlier of (i) six months after the Commencement Date of the
Lease, or (ii) the date that Landlord has entered into a lease with a third
party for such space; provided, however, that if Tenant disapproves the term of
any proposed lease with a third party, Tenant shall thereupon be obligated to
pay Rent and Additional Charges for the Vacant Space Available for Lease for the
period from such disapproval until August 30, 1990.
3. Improvement Allowances. Landlord shall provide Tenant with an
Improvement Allowance for the varying portions of the Premises based upon the
type of space to be built out therein. Such Improvement Allowance, subject to
the exceptions below regarding the Microage space and the Reid Corporation
space, shall be as follows:
<TABLE>
<S> <C>
(i) Office = $22.00 per sq. ft.
(ii) Warehouse = $ 3.50 per sq. ft.
(iii) Manufacturing = $45.00 per sq. ft.
(iv) Laboratory = $85.00 per sq. ft.
</TABLE>
The Rent for each such portion of the Premises shall depend upon the
type of space built out therein, as set forth in Schedule 2.
With respect to Office Space and Warehouse Space, the Improvement
Allowance set forth above shall be applied to the cost of obtaining all
necessary permits for the build-out as well as all "hard costs" such as
construction costs, insurance, and contractors' fees, but the Improvement
Allowance shall not be applied to architectural fees and costs or engineering
fees and costs associated with such build-out, which fees and costs shall be
paid for by Tenant. With respect to Manufacturing Space and Laboratory Space,
the Improvement Allowance set forth above may be applied to architectural fees
and costs and engineering fees and
<PAGE> 39
costs associated with the build-out, as well as "hard costs" and the costs of
obtaining necessary permits for the build-out.
With respect to those portions of the Premises currently occupied by
Reid Corporation and Microage, the Improvement Allowance for the renovation of
such space for use by Tenant shall be $4.00 per square foot, regardless of the
type of build out that Tenant requests for such space. The foregoing reflects
the fact that such space is "second generation" space; such space having been
already built out with tenant improvements.
4. Tenant's Share.
(a) Rentable Areas. Landlord and Tenant agree that the rentable area
of the entire Premises (i.e., all of Building E) is 28,344 rentable square feet
and that, as of the Lease Date, the rentable area of the Park (consisting of
Buildings B. C and E) is 79,356 rentable square feet. The rentable area of the
Park shall be adjusted over time as and when additional buildings are completed
therein.
(b) Tenant Is Share. Tenant's Share of the Building and the Park for
purposes of Article 4 of the Lease shall be determined on the basis of the
square footage area of the Premises on which Tenant is then paying Rent pursuant
to the Delivery Schedule and Schedule 2. Assuming that Tenant takes down the
Premises strictly in accordance with the Delivery Schedule set forth in
paragraph 2(a)' Tenant's Share would be as follows:
(i) Lease Year 1 (taking into account the vacant Space Available for
Lease):
<TABLE>
<S> <C>
a. First 6 months --
Building E = 69%
Park = 24.5%
b. Second 6 months
Building E = 56%
Park = 20%
(ii) Lease Year 2:
Building E = 56%
Park = 20%
(iii) Lease Year 3:
Building E = 78%
Park = 27%
(iv) Lease Year 4:
Building E = 84%
Park = 30%
(v) Lease Years 5 through 8:
Building E = 100%
Park = 35.5%
</TABLE>
<PAGE> 40
Schedule 2
RENT SCHEDULE
1. General. Rent for the Premises shall be determined on the basis of the
square footage areas of the Premises that are built out for various purposes
noted in Schedule 1. The initial rate applicable to each such area of the
Premises in lease year one (the "Base Rate") is set forth in paragraph 2 below.
As provided in Section 3.2 of the Lease, each such Base Rate shall be adjusted
for each lease year during the Term to reflect increases in the CPI (each such
Base Rate as so adjusted is called an "Adjusted Rate"). Further, an adjustment
factor specified in paragraph 3 below (the "Adjustment Factor") shall be applied
during each lease year to each Base Rate (for the first lease year) and to each
Adjusted Rate (for each subsequent lease year) to determine the Rent actually
payable (the "Pay Rate") for each portion of the Premises during each lease
year.
2. Base Rates. The Base Rates for the various portions of the Premises
during the first lease year are as follows:
<TABLE>
<S> <C>
(i) Office = $1.10 per sq. ft. per month
(ii) Manufacturing = $1.51 per sq. ft. per month
(iii) Laboratory = $1.94 per sq. ft. per month
(iv) Warehouse = $0.45 per sq. ft. per month
(v) vacant = $0.35 per sq. ft. per month
(vi) Microage = $1.10 per sq. ft. per month
</TABLE>
3. Adjustment Factor. The Adjustment Factor to be applied to the Base
Rates (during the first lease year) and to the Adjusted Rates (for each subject
lease year) are as follows:
<TABLE>
<S> <C>
Lease Year 1 = .50
Lease Year 2 = .61
Lease Year 3 = 1.15
Lease Year 4 = 1.20
Lease Years 5-8 = 1.30
</TABLE>
The Adjustment Factor for the Microage space shall be 1.00 at all
times during the initial term of the Lease.
4. Rent Formula. The Rent for each portion of the Premises in any lease
year, as generally described in paragraph 1, is expressed by the following
formula:
Pay Rate = Base Rate or Adjusted Rate (as applicable)
x Applicable Adjustment Factor
As an illustration of the application of this formula:
(i) the monthly Rent for office space in the third lease year, assuming a
total increase in the CPI equal to 12% from commencement through the second
lease year, would be determined as follows:
Adjusted Rate = $1.10 [Base Rate] x 1.12 [CPI] = $1.23
$1.23 [Adjusted Rate] x 1.15 [Adjustment Factor for third lease year] =
$1.42 [Pay Rate on office space during third lease year]
(ii) the monthly Rent for manufacturing space would be derived in the same
manner, i.e. when such space is delivered at the commencement of lease year
three, assuming such a 12% increase in the CPI the rent would be determined as
follows:
Adjusted Rate = $1.51 [Base Rate] x 1.12 [CPI] = $1.69
<PAGE> 41
$1.69 [Adjusted Rate] x 1.15 [Adjustment Factor for third lease
year] = $1.94 [Pay Rate on office space during third lease year]
Landlord shall $5.00 per sq.
5. Alternative Rent for Manufacturing Space. The Delivery Schedule
provides for the delivery of 6,160 sq. ft. of manufacturing space to Tenant
at the commencement of lease year three. The Improvement Allowance for such
space is $45.00 per sq. ft. Tenant may, by notice to Landlord given not less
than 18 months prior to the commencement of lease year three, elect to build
out such manufacturing space itself. In such case, provide an Improvement
Allowance for such space of ft. and the Base Rate for such space shall be
reduced from $1.51 per sq. ft. per month to $0.65 per sq. ft. per month. Such
Base Rate would then be used to determine the Adjusted Rate (based upon
increases in the CPI), which would in turn be multiplied by the applicable
Adjustment Factor to determine the Pay Rate for such manufacturing space for
each lease year.
<PAGE> 42
EXHIBIT B
WORK LETTER
IMPROVEMENT OF PREMISES
Prior to the execution of the Lease, Landlord completed construction of
the shell portion of Building E and Tenant has had the opportunity to inspect
such construction and the extent of the work constituting the Building E shell.
The provisions of this Work Letter apply to all of the work to be undertaken in
Building E from and after the Lease Date in order to make the various portions
of the Premises-ready for Tenant's occupancy under the Lease. All work
undertaken in Building E pursuant to the Lease and this Work Letter shall be
charged to the applicable Improvement Allowances provided for in Schedule 1 to
the Lease.
1. Use Permit(s).
(a) Prior to the execution of the Lease, Landlord submitted to the
City of San Rafael (the "City") an application on behalf of
Landlord and Tenant for a use permit ("Use Permit") for Tenant's
proposed use of the Premises. The parties shall cooperate and
shall diligently endeavor to obtain approval of such Use Permit
on terms and conditions acceptable to both Landlord and Tenant as
soon as possible. The parties acknowledge that the anticipated
date for the City's review and approval of such Use Permit
application is November 16, 1988. If such Use Permit application
has not been finally approved by the City on or before February
28, 1989, then either party shall have the right to terminate the
Lease by notice to the other party given within five (5) days
after such date. If neither party elects to terminate the Lease
in such case, the parties shall diligently continue in their
efforts to obtain the Use Permit. If, thereafter, the Use Permit
has not been approved within an additional thirty (30) day
period, each party shall again have the right to terminate the
Lease; and this process shall continue until either the Use
Permit is finally approved by the City or the Lease has been
terminated as provided above.
(b) The parties further acknowledge that Schedule 1 of the Lease
contemplates the delivery of the Premises to Tenant in phases
over the first five (5) years of the Term of the Lease, and that
the City may not agree to grant a Use Permit at the time of the
making of the Lease that encompasses all of Tenant's proposed
uses or Tenant's ultimate occupancy of the entire Building.
Instead, the City may agree only to issue a Use Permit applicable
to the initial build out of the Premises and the initial use
thereof by Tenant (the initial Use Permit"). If such is the
case, then in each succeeding Lease Year during the Term in which
Tenant is required to take down an additional portion of the
Premises, Landlord shall submit to the City an application on
behalf of Landlord and Tenant for a Use Permit for Tenant's
proposed use of each additional portion of the Premises (each, a
"Subsequent Use Permit") promptly upon the delivery by Tenant to
Landlord of Tenant's space plan for such portion as provided by
paragraph 5 below. The parties shall cooperate and shall
diligently endeavor to obtain approval of each such Subsequent
Use Permit on terms and conditions acceptable to both Landlord
and Tenant as soon as possible; provided, however, that the
provisions set forth above regarding the termination of the Lease
shall only apply with respect to the issuance of the Initial Use
Permit and shall not be applicable with regard to the issuance of
any Subsequent Use Permit.
2. Landlord's Work.
Landlord, through a general contractor selected by Landlord or a general
contractor selected by Tenant and approved by Landlord (which approval
shall not be unreasonably withheld), as provided below, shall furnish and
install within the Premises those items of general construction (the
"Improvements") shown on the Plans and Specifications for each portion of
the Premises as prepared by Tenant and approved by Landlord pursuant to
paragraph 5 below. With respect to the construction of each portion of the
Improvements, Landlord shall obtain from its general contractor a price
quote for the construction of such Improvements on a unit price basis.
Landlord shall submit such price quote to Tenant and Tenant shall have
five (5) business days after receipt thereof in which to review and
approve such price quote. If Tenant fails to notify Landlord within such
five (5) day period of Tenant's
<PAGE> 43
disapproval thereof, Tenant shall be deemed to have approved such price
quote from Landlord's general contractor. If Tenant disapproves such price
quote, Tenant shall request bids for the construction of such Improvements
from one or more general contractors, each of which must be acceptable to
Landlord in Landlord's reasonable judgment, such bids to be based upon an
eight (8) week construction schedule for such Improvements. Landlord may,
in its reasonable judgment, condition its approval of the contractor
selected by Tenant upon the requirement that such contractor provide, for
the benefit of Landlord and Tenant, payment and performance bonds in an
amount and issued by a surety acceptable to Landlord. If Tenant
disapproves Landlord's contractor's price quote and elects to obtain bids
from other contractors, Tenant shall select a contractor for the
construction of such Improvements no later than two (2) weeks after the
issuance of the building permit for such construction; and any delay
beyond such two (2) week period in selecting such contractor shall be
deemed a Tenant Delay for purposes of determining the Commencement Date of
the Lease or any Inclusion Date, as the case may be; provided, however,
that with respect to the build out of the initial Premises to be occupied
by Tenant, any such delay shall only be deemed a Tenant Delay to the
extent that such portion of the Premises is not completed and ready for
Tenant's occupancy by March 1, 1989.
3. Delivery of Premises.
(a) The Premises shall be built out and delivered to Tenant in
accordance with the Delivery Schedule set forth in Schedule 1 to
the Lease. The Initial Premises (as referred to in said Schedule
1) are to be delivered to Tenant on the Commencement Date, and
each Subsequent Space (as referred to in said Schedule 1) is to
be delivered to Tenant at the commencement of the Lease Year
specified in the Delivery Schedule (each such date being referred
to as an "Inclusion Date"). The term "Lease Year" shall mean a
period of twelve (12) consecutive calendar months during the Term
of the Lease, and the first Lease Year shall begin on the
Commencement Date if the Commencement Date occurs on the first
day of a calendar month or, if the Commencement Date is not the
first day of a calendar month, the first Lease Year shall
commence on the first day of the calendar month next following
the Commencement Date and shall be deemed to include the partial
month between the Commencement Date and the first day of such
calendar month.
(b) The Term of the Lease shall commence on the Commencement Date as
provided in Article 2 of the Lease. Tenant's obligation to pay Rent
for each Subsequent Space shall commence on the Inclusion Date for
each such Subsequent Space or on such earlier date as Tenant shall
first occupy any such Subsequent Space.
In addition to the terms of Section 2.2 of the Lease with regard to
delivery of possession of the Initial Premises, if, on or prior to
the Inclusion Date for any Subsequent Space, Landlord fails to
deliver possession of such Subsequent Space (but subject to the
terms of paragraph 10 below regarding Tenant Delays)' then the
following provisions shall apply: (i) the Inclusion Date for such
Subsequent Space shall be the date that Landlord delivers possession
of such Subsequent Space to Tenant; (ii) neither the validity of the
Lease nor the obligations of Tenant under the Lease shall be
affected thereby, except that payment of Rent for such Subsequent
Space shall commence on the Inclusion Date therefor; (iii) Tenant
shall have no claim against Landlord because of Landlord's failure
to deliver possession of such Subsequent Space on the date
originally fixed therefor; and (iv) the Expiration Date of the Lease
shall not be modified as a consequence of any delay in the delivery
of any Subsequent Space.
4. Plans and Specifications.
(a) Tenant, through its architects and engineers and at Tenant's sole
cost and expense (except as otherwise provided in Schedule 1 with
respect to Manufacturing Space and Laboratory Space), shall
furnish all architectural and engineering plans and
specifications (the "Plans and specifications") required for the
construction of the Improvements for each portion of the
Premises. In the event that in any Lease Year Tenant desires to
take down more space for any particular use of the Premises than
Tenant is required to take down in said Lease Year under the
terms of the Delivery Schedule set forth in Schedule 1 to the
Lease, Tenant shall provide
<PAGE> 44
Landlord with prompt notice of such determination together with
complete the Plans and Specifications for such space in accordance
with paragraph 5 below.
(b) All Plans and Specifications referred to herein are subject to
Landlord's or Landlord's representative's approval, which
Landlord agrees shall not be unreasonably withheld. All such
Plans and Specifications must be prepared by duly licensed
architects and engineers and must comply with all applicable
laws, building codes, fire codes (including the City of San
Rafael's interpretation thereof) and other governmental
requirements.
(c) Any architectural or engineering services for Tenant's Work referred
to in paragraph 9 below or interior design services such as
selection of colors, finishes, fixtures, furnishings or floor
coverings shall be at Tenant's sole cost.
(d) Promptly following Landlord's approval of the Plans and
Specifications for each portion of the Improvements, Landlord
shall deliver a copy thereof to Landlord's general contractor for
pricing. In the event that the price for construction of such
Improvements exceeds the amount of the Improvement Allowance
applicable thereto, Tenant shall have the opportunity to revise
such Plans and Specifications in order to reduce such
constructions costs. Any such revisions shall be subject to
Landlord's review and approval.
(e) Promptly following Landlord's approval of the final Plans and
Specifications for each portion of the Improvements, Tenant (or
its architects and/or engineers) shall submit to the City of San
Rafael an application on behalf of Landlord and Tenant for a
building permit ("Building Permit") for the construction of such
Improvements, and the cost of such Building Permit and any fees
charged in connection therewith or related thereto (such as
inspection fees and utility hook-up charges) shall be included
within the cost of such Improvements. Tenant shall cooperate with
Landlord in obtaining final approval of each Building Permit
application as soon as possible after the submission of the
application therefor.
5. Progress Schedule.
(a) Initial Build Out. Landlord and Tenant acknowledge that the approved
space plan for the Improvements to be constructed in the Initial
Premises is attached as Annex 1 to this Work Letter. With regard to
the preparation of the final Plans and Specifications for the build
out of the Initial Premises, Landlord and Tenant shall maintain the
following progress schedule, with dates and times of performance for
actions as follows:
<TABLE>
<CAPTION>
Action Date Due Responsible Party
------ -------- -----------------
<S> <C> <C>
Working Drawings November 9, 1988 Tenant
Delivery Date
Working Drawings November 16, 1988 Landlord
Review Date
Resubmittal Date November 20, 1988 Tenant
</TABLE>
(b) Build Out of Remaining Non-Manufacturing Space. With regard to the
build out of each Subsequent Space to be taken down by Tenant during
the Term of the Lease other than manufacturing space, Landlord shall
deliver to Tenant approximately seven (7) months prior to the
delivery date for such Subsequent Space as set forth in the Delivery
Schedule a progress schedule for the preparation of the Plans and
Specifications for such space and the construction of the
Improvements therein. Such progress schedule shall provide for at
least two (2) weeks for Landlord's review and approval of Tenant's
proposed working drawings for such Improvements, four (4) weeks for
the issuance of a Building Permit, and a three (3) month
construction period. Each such progress schedule submitted by
Landlord shall be subject to Tenant's review and approval, which
approval shall not be unreasonably withheld or unduly delayed.
<PAGE> 45
(c) Build Out of All Manufacturing Space. During any Lease Year in which
Tenant shall take down manufacturing space, Landlord and Tenant
shall agree upon a progress schedule as provided in subparagraph (b)
above; provided, however, that if Tenant elects to construct the
Improvements in such space as provided in Schedule 2 to the Lease,
Tenant shall establish its own schedule for such construction and
the Inclusion Date for such space shall not be later than October 1,
1991, regardless of when such space is actually completed. Such
schedule established by Tenant for the build out of any such
manufacturing space shall include a period of not less than five (5)
business days for Landlord's review and approval of Tenant's
complete working drawings for such space and a period of not less
than five (5) business days for Landlord's review and approval of
the general contractor proposed by Tenant for such construction. The
October 1, 1991 Inclusion Date for such space shall be extended by
one day for each day that Landlord delays its review and approval or
disapproval of such working drawings and/or general contractor
beyond the period provided therefor in Tenant's build out schedule
for such manufacturing space.
6. Construction of Improvements.
(a) Following the issuance of the Use Permit, and the Building Permit
for each portion of the Premises to be built out by Landlord,
Landlord, through the general contractor selected pursuant to
paragraph 2, shall commence construction of the Improvements in such
portion of the Premises as promptly as reasonably possible and shall
diligently prosecute the construction of the Improvements therein
substantially in accordance with the Plans and Specifications for
such portion of the Premises. Landlord shall use its reasonable
efforts to obtain the final building inspection by the City of the
Initial Premises by January 15, 1989, and of each Subsequent Space
by the Inclusion Date stated therefor in the Delivery Schedule, and
Tenant shall fully cooperate with Landlord in this regard.
(b) Landlord's Work shall be deemed substantially complete and
possession of each portion the Premises delivered to Tenant at such
time as the Improvements in such portion have been completed to such
an extent that utility services to the portion have been connected
and metered and said portion of the Premises may be lawfully
occupied for the conduct of Tenant's regular business, the air
conditioning, mechanical, plumbing and other building systems
serving said portion are operational, and the walls, ceilings, light
fixtures, flooring, painting and other work set forth in the Plans
and Specifications for such portion have been substantially
completed such that Tenant's business operations can reasonably be
conducted in such portion. Within ten (10) days following
substantial completion of each portion of the Premises to be
occupied by Tenant, Landlord and Tenant together with Landlords
architect and the general contractor shall prepare a "punch list" of
items of unfinished or corrective work required to be completed and
such items of work shall thereafter be completed by Landlord with
reasonable diligence.
7. Cost of the Improvements.
With respect to the build out of the Improvements for each portion of the
Premises, Landlord shall provide an Improvement Allowance as set forth in
Schedule 1 to the Lease. The cost of such Improvements shall include all
costs and expenses incurred in connection with the construction of such
Improvements, including, without limitation, all permit application and
inspection fees (except that the inspection fees for the subsurface
inspection of the methane barrier under the Building shall be paid by
Landlord and shall not be charged against the Improvement Allowance),
utility hook-up charges, contractor's payment and performance bonds,
payments to the general contractor for such Improvements, the cost of any
change orders approved by Landlord and Tenant, and any changes to the
final Plans and Specifications required by any governmental authority
provided, however, that such costs shall not include (i) charges and
expenses for changes to the final Plans and Specifications that have not
been approved by Tenant, except to the extent that any such changes are
required by any governmental authority, (ii) additional costs and expenses
incurred by Landlord on account of any contractors' or subcontractors'
fault or construction defects (as opposed to defects in the design of the
Improvements, which shall be paid for by Tenant), (iii) management and
overhead cost of Landlord except as expressly provided in this Exhibit B,
and (iv) costs for which Landlord has a right to
<PAGE> 46
reimbursement from a third party. Further, in order to accommodate
Tenant's space plan for the Premises, Landlord has incurred costs in
constructing the second staircase in the Initial Premises to be occupied
by Tenant in excess of the costs that Landlord would have otherwise
incurred for the construction of such staircase; and such additional cost,
as reasonably documented by Landlord, shall be charged against the
Improvement Allowance allocable to the initial portion of the Premises. In
the event that the cost of the Improvements for any portion of the
Premises as submitted by Landlords general contractor and accepted by
Landlord after consultation with Tenant will exceed the Improvement
Allowance applicable thereto, Tenant shall be responsible for all such
excess costs and shall deposit such excess amount in the Grubb & Ellis
trust account prior to the commencement of construction of such
Improvements; and such funds deposited by Tenant shall be the first funds
utilized to make progress payments to the contractor during the course of
construction of the Improvements. In the event that the final cost of such
Improvements exceeds the amount of the Improvement Allowance applicable
thereto as well as any payments therefor made by Tenant prior to the
completion thereof, Tenant shall pay to Landlord such excess amount within
twenty (20) days after receipt of Landlord's invoice therefor. To the
extent that the final cost of such Improvements is less than the
Improvement Allowance applicable thereto, Tenant may apply any such
balance to the cost of any fixtures required by Tenant or any movable
property such as cabinetry, so long as Landlord approves such items in its
reasonable judgment, and any such items shall be and remain the property
of Landlord.
8. Changes.
Tenant may request changes in any final Plans and Specifications by
submitting a signed change request accompanied by revised Working Drawings
showing such requested changes. Any such requested change must conform to
all applicable governmental requirements and building codes and to the Use
Permit for Tenant's use of the Premises. Landlord shall promptly review
any such requested change and upon approval thereof (which approval shall
not be unreasonably withheld) shall submit such change to the general
contractor for pricing and for the contractor's determination of the
effect of such requested change on the estimated date for substantial
completion of the portion of the Improvements affected thereby. Landlord
shall thereafter notify Tenant of the cost of such change, which cost
shall include a 15% supervision charge by Landlord, and the effect thereof
on the estimated date of substantial completion of such Improvements.
Within three (3) days of receipt of Landlord's notice, Tenant shall notify
Landlord in writing whether Tenant approves such change and the impact
thereof on the construction schedule, and at the time of such approval by
Tenant, Tenant must deposit either with the contractor or in the Grubb &
Ellis trust account payment for the cost of such change, to the extent
that the costs of the Improvements as so changed exceeds the Improvement
Allowance allocable thereto. If Tenant does not approve such change within
such three (3) day period, construction of the Improvements shall proceed
in accordance with the original final Plans and Specifications therefor.
Notwithstanding the foregoing provision regarding the payment by Tenant of
the cost of any change orders, if the amount of such change order shall
exceed $10,000, Tenant may elect to have the amount of such change order
over $10,000 advanced by Landlord and amortized over the balance of the
initial Term of the Lease. In such case, the amount so advanced by
Landlord shall be payable in equal monthly installments with interest on
the unamortized balance at the rate of ten percent (10%) per annum. The
first such monthly installment shall be due and payable on the
Commencement Date (in the case of the initial space to be occupied by
Tenant) or the applicable Inclusion Date, as the case may be, and any
unpaid balance plus accrued but unpaid interest shall be due and payable
upon the expiration or earlier termination of the Lease. All such amounts
shall be payable as additional rent subject to and in accordance with all
of the terms and conditions of the Lease, and in the event of any default
by Tenant under the Lease the unpaid balance of any such advances by
Landlord plus any accrued but unpaid interest thereon shall immediately
become due and payable, without notice or demand by Landlord.
9. Tenant's Work.
(a) Tenant shall be responsible for the installation of Tenant's trade
fixtures, furnishings, personal property and equipment in the
Premises, including, without limitation, the Tenant's computer and
telephone equipment as well as the wiring therefor Tenant's Work");
and all such Tenant's
<PAGE> 47
Work must conform to the requirements of the Building Permit with
respect thereto. Landlord shall inform Tenant from time to time of
the progress of Landlord's Work in order to permit Tenant to arrange
for the installation of Tenant's Work. Tenant and Tenant's
contractor shall be permitted to enter upon the Premises at such
times as Landlord shall designate based upon the contractor's
schedule for construction of the Improvements for the purpose of
performing Tenant's Work and any such entry shall be subject to all
of the terms and conditions of the Lease except for the provisions
regarding the payment of Rent.
(b) The performance of Tenant's Work shall be subject to Landlord's
policies and schedules and shall be conducted in such a way as not
to hinder, cause any disharmony with or delay Landlord's Work.
Tenant's suppliers, contractors, workmen and mechanics shall be
subject to reasonable approval by Landlord prior to the commencement
of their work and shall be subject to Landlord's administrative
control while performing their work. Tenant shall cause its
suppliers and contractors to engage only labor that is harmonious
and compatible with other labor working in the Premises and the
Park. In the event of any labor disturbance caused by persons
employed by Tenant or Tenant's contractor, Tenant shall immediately
take all actions necessary to eliminate such disturbance. At any
time any supplier, contractor, workman or mechanic performing
Tenant's Work hinders or delays any other work of improvement in the
Premises or the Park, or performs any work which may or does impair
the quality, integrity or performance of any portion of the
Premises, Tenant shall cause such supplier, contractor, workman or
mechanic to leave the Premises and remove all his tools, equipment
and materials and Tenant shall reimburse Landlord for any repairs or
corrections of any of Landlord's Work caused by or resulting from
the work of any such supplier, contractor, workman or mechanic with
whom Tenant contracts.
10. Commencement Date and Inclusion Date.
It is agreed that (i) notwithstanding the provisions of the Basic Lease
Information setting forth the Commencement Date of the Lease, the Term of
the Lease shall not commence until Landlord has substantially completed
Landlord's Work in the Initial Premises as provided in paragraph 6(b)
above, and (ii) notwithstanding the provisions of Schedule 1 of the Lease
setting forth the Inclusion Date for each Subsequent Space shall not occur
until Landlord has substantially completed Landlord's Work in such
Subsequent Space as provided in paragraph 6(b) above; provided, however,
that if Landlord shall be delayed in substantially completing said work in
the Initial Premises or any such Subsequent Space as a result of:
(a) Any changes requested by Tenant to the final Plans and
Specifications for such portion of the Premises or any hindrance or
disruption of Landlord's Work in such portion of the Premises
resulting from Tenant's Work therein or caused by Tenant or Tenant's
contractors, employees or agents, or
(b) Tenant's failure to furnish any items required to be provided by
Tenant in accordance with the progress schedules set forth in
paragraph 5 above, or
(c) Tenants selection of materials, finishes or installations that are
not readily available through building material suppliers in the
vicinity of San Rafael or that must be special ordered or that
require special fabrication prior to installation,
then the Commencement Date of the Term of the Lease or the Inclusion Date
for any Subsequent Space, as applicable, shall be advanced by the number
of days of such delay (each, a "Tenant Delay"). With respect to any Tenant
Delay arising as a consequence of any hindrance or disruption of
Landlord's Work resulting from Tenant's Work, Landlord shall promptly
notify Tenant as to the occurrence, cause and extent of such Tenant Delay.
<PAGE> 48
11. Payment.
Any amounts due from Tenant to Landlord under the terms of this Exhibit B
shall constitute additional rent owing under the Lease, and the provisions
of Section 3.5 of the Lease shall apply with respect to interest payable
on amounts not paid when due.
IN WITNESS WHEREOF, the parties have executed this Exhibit B as of
the Lease Date.
<TABLE>
<S> <C>
TENANT: LANDLORD:
OCLASSEN PHARMACEUTICALS, INC., BAYVIEW ASSOCIATES,
a California corporation a California joint venture
By: /s/ Dan K. Turner By: Bayview Partners,
-------------------- a California limited partnership,
Its: Vice President - Finance and Administration General Partner
---------------------------------------------
By: Reid Corporation,
By: /s/ Glenn A. Oclassen a California corporation
------------------------ General Partner
Its: President
----------- By: /s/ L. C. Tolomei
--------------------
L. C. Tolomei
President
</TABLE>
<PAGE> 1
EXHIBIT 10.4(a)
FIRST AMENDMENT TO LEASE
This First Amendment to Lease to that certain Lease by and between Limar Realty
Corp. #11, successor in interest to Bayview Associates, a California joint
venture (hereinafter called "Landlord"), and Oclassen Pharmaceuticals, Inc., a
California corporation (hereinafter called "Tenant"), dated November 15,1988
("Lease") for the Premises located at 100 Pelican Way, San Rafael, California
("Premises"), is entered into as of the 10th day of October 1995.
RECITALS
This First Amendment to Lease is made with reference to and in reliance upon the
following facts:
A. On November 15, 1988, Landlord's predecessor in interest leased to
Tenant the Premises consisting of one (1) building containing a
total building area of approximately twenty-eight thousand three
hundred forty-four (28,344) rentable square feet, for a Term
expiring February 5,1997 ("Original Term").
B. Tenant and Landlord desire to amend the Lease to further extend the
Term, to define the Rent for the new Extension Period, and to add
certain other terms and conditions.
THEREFORE, for valuable consideration, the receipt and sufficiency of which are
hereby acknowledged, the parties hereto agree as follows:
1. EXTENSION OF LEASE:
The Term of the Lease shall be extended so as to end on December 31,
2002. The period from February 6, 1997 through December 31, 2002
(inclusive) shall be known as the "Extension Period". The Expiration
Date of the Extension Period shall be December 31, 2002.
2. RENT:
The Rent (as defined in the Lease) payable during the Extension
Period shall be $28,791.35 ("Base Rent") subject to adjustment in
accordance with changes in the Consumer Price Index ("CPI") as such
index is defined in Paragraph 3.2. The Rent shall be adjusted upon
the commencement of the Extension Period and upon each annual
anniversary thereof (each such adjustment point in time being
referred to herein as an "Adjustment Date") by multiplying the Base
Rent of $28,791.25 by a fraction the numerator of which shall be the
CPI published for the month which immediately precedes the
Adjustment Date and the denominator of which shall be the CPI for
the month of September, 1995, provided that in no event shall any
such adjustment cause the Rent to be decreased below the amount
existing immediately prior to said Adjustment Date.
3. OPTION TO EXTEND:
The Lease contains one (1) five-year Option to Extend (Paragraph
36). Effective with this First Amendment to Lease, the Option to
Extend shall remain available to Tenant. If, and only if, proper
written notice of the exercise of the Option is delivered to
Landlord by December 31, 2001, the Lease will be further extended
through December 31, 2007, with the Rent for such further extension
period to be determined in accordance with Paragraph 36.2 of the
Lease.
4. NET RENTABLE AREA:
The Net Rentable Area of the Premises is agreed to be 28,344 square
feet comprised of 20,311 square feet of office/lab area and 8,033
square feet of warehouse area.
<PAGE> 2
5. EXPENSES:
Expenses, as defined by Paragraph 14.1(d) of the Lease, shall
specifically include the cost of monitoring the groundwater of
Bayview Business Park ("Park") and the cost of methane gas
monitoring of the Park and buildings in the Park.
6. ADDITIONAL CHARGES LIMIT:
A new subparagraph 4.5 is added to the Lease as follows:
"4.5 The total Additional Charges for Taxes and Expenses
payable by Tenant for any Computation Year commencing
with the year of 1996 shall not exceed the Adjusted
Additional Charges Limit (as defined below) for the
subject year. The Additional Charges Limit shall be set
at $112,778.00 for 1995. For each year subsequent to
1995 the Additional Charges Limit shall be increased by
five percent (5%) of the previous years' Additional
Charges Limit ("Adjusted Additional Charges Limit"). At
Landlord's option, the Additional Charges Limit and the
Adjusted Additional Charges Limit will not apply to
property tax increases resulting from the sale of the
Premises or if Proposition 13 (Jarvis/Gann) is repealed
or modified to affect commercial properties. In the
event of increased taxes due to such a sale or
modification of Proposition 13, at Landlord's option,
the Additional Charges Limit and the Adjusted Additional
Charges Limit will be modified to remove property taxes.
In the case of such a modification, the Additional
Charges Limit and the Adjusted Additional Charges Limit
will apply to all Expenses except property taxes and
Tenant will be responsible for its full Tenant's Share
of property taxes. In all cases, if actual charge for
Taxes and Expenses for a given year are less than the
Adjusted Additional Charges Limit for the same year,
Tenant will pay only the actual charges."
7. TRAFFIC TRIPS:
The City of San Rafael allocates "Traffic Trips" to the Park and to
each Tenant at Park. There are currently fifty-five (55) Traffic
Trips allocated to Tenant. Landlord agrees to transfer four (4) of
the Traffic Trips it has for the Park to Tenant, bringing Tenant's
total to fifty-nine (59) Traffic Trips.
8. IMPROVEMENT ALLOWANCE:
There is currently 6,464 square feet of area of Reid Corp. and
MicroAge space within the Premises that has been taken over by
Tenant but not yet improved. Per the Lease, Tenant is due a $4.00
per square foot improvement allowance for this space. The
improvement allowance for this 6,464 square feet is hereby increased
to $10.00 per square foot for a total improvement allowance of
$64,640.00. To be entitled to the Allowance, Tenant must provide
Landlord with satisfactory evidence that it has spent a minimum of
$25.00 per square foot to improve the 6,464 square feet of space.
9. TREES:
Landlord agrees to plant at its expense a row of twenty (20) trees
along the fence line of the MMWD (subject to written MMWD approval,
since the trees will be on MMWD land, which approval has been
verbally given to Landlord's landscaper). Those trees will be
24-inch box size with an initial height of approximately 11 to 15
feet and a canopy of approximately 3 to 5 feet and will be planted
approximately 15 feet on center. The existing bushes will be
retained to provide a low screen. Subsequent to the initial
planting, the cost to care for the trees will be an Expense and
billed to Tenant.
<PAGE> 3
10. VALENTINE CORPORATION:
Landlord agrees to use its absolute "Best Efforts" to cause
Valentine Corporation to comply with the building code regarding the
appearance of their site.
11. LEASE COMMISSION:
There shall be no real estate brokerage commission payable by
Landlord to any real estate broker which may claim to have
represented Tenant.
All other terms and conditions of said Lease shall remain in full force and
effect.
IN WITNESS WHEREOF, Landlord and Tenant have executed this First Amendment to
Lease as of the date first written above.
LANDLORD TENANT
LIMAR REALTY CORP. #11 OCLASSEN PHARMACEUTICALS, INC.
/s/ Terry L. Johnson
/s/ Theodore H. Kruttschnitt ------------------------------
- ------------------------------------ Print Name: Terry L. Johnson
Print Name: Theodore H. Kruttschnitt Its: President and CEO
Its: President
<PAGE> 1
EXHIBIT 10.15
INTELLECTUAL PROPERTY AGREEMENT
This Intellectual Property Agreement (this "Agreement") is made and
entered into as of this 18th day of July, 1996, among Alec D. Keith, Ph.D.
("Keith") and Watson Pharmaceuticals, Inc. ("Watson").
Whereas Watson and Keith have entered into a Release, Exit and
Consulting Agreement (the "Consulting Agreement") dated as of even date
herewith;
Whereas prior to the effective date of the Consulting Agreement Keith
served as Chairman of the Board of Watson, was an employee of Watson and/or its
affiliates including without limitation Watson Laboratories, Inc. and Circa
Pharmaceuticals, Inc.;
Whereas in connection with such employment, on or about December 21,
1992, Keith executed Watson's Employee Invention and Confidential Information
Agreement ("EICI Agreement") which obligates Keith to disclose and assign
Inventions (as that term is defined in the EICI Agreement) conceived or reduced
to practice by Keith;
Whereas during the term of Keith's employment, Keith conducted research
in the field of a High Density Dosage Form designed to pass through the GI Tract
slower than is generally expected (such High Density Dosage Form is referred to
herein as "HDDF");
Whereas an invention using the research in the field of HDDF has been
reduced to practice (the "HDDF Invention") and is now the subject of a U.S.
Patent Application (attached hereto as Exhibit A and incorporated herein by this
reference); and
Whereas Watson wishes to assign to Keith all of Watson's rights with
respect to the HDDF Invention on the terms and subject to the conditions
contained in this Agreement;
NOW THEREFORE, for good and valuable consideration, the receipt and
sufficiency of which is hereby acknowledged, the parties agree as follows:
1. Assignment: Watson on behalf of itself and all its affiliates hereby assigns
to Keith all of Watson's interest in Keith's research in the field of HDDF (the
"HDDF Research") and Watson's and all its affiliates's interest in the HDDF
Invention.
2. Formation of Corporation: Keith shall organize and incorporate a corporation
pursuant to the laws of the state of Delaware. Such corporation and any and all
other corporation(s), partnership(s) or other entity(s) that Keith may establish
or utilize, either directly or indirectly, alone or with others, which is (are)
based upon, which exploits, or which utilizes the HDDF Research or the HDDF
Invention is referred to herein as the "Corporation". The purposes of the
Corporation shall include:
(i) the development, commercialization, manufacture, and marketing
of products and services based on the HDDF Research or the HDDF Invention
or any improvements, enhancements or additions thereto or modifications or
derivations thereof;
(ii) the filing, prosecution, holding, licensing and enforcement of
patents based on the HDDF Research or the HDDF Invention or any
improvements, enhancements or additions thereto or modifications or
derivations thereof; and
(iii) the performing of other acts reasonably necessary for the
profitable exploitation of the HDDF Research or the HDDF Invention or any
improvements, enhancement or additions thereto or modifications or
derivations thereof.
4. Distribution of Shares to Watson: In consideration of Watson's assignment
hereunder, the parties hereby agree that upon incorporation of the Corporation,
Watson shall receive, without further consideration, a nineteen and ninety-nine
one hundredths percent (19.99%) ownership interest in the Corporation. Such
<PAGE> 2
ownership by Watson in the Corporation may, if so requested by Watson, be
subject to a shareholder's agreement reasonably acceptable to the parties.
Watson's ownership interest shall be subject to dilution to reflect future
issuances for value of shares in any Keith Corporation. In the event that no
Corporation is established by Keith, then Watson shall nonetheless have a
nineteen and ninety-nine one hundredths percent (19.99%) ownership interest in
the HDDF Research and HDDF Invention. Collectively Keith and Corporation are
referred to herein as Keith Corporation. The obligations of Keith Corporation
shall be jointly and severally the obligations of Keith and Corporation.
5. Ratification: Upon the incorporation of the Corporation, the Corporation
shall, by resolution of its board of directors, ratify, adopt and become a party
to this Agreement, and shall thereupon cause to be issued the shares of stock to
be issued to Watson hereunder and to perform such other acts as may be required
to effect the provisions of this Agreement.
6. License to Watson: Keith hereby grants to Watson, and hereby represents and
warrants that Corporation will grant to Watson, the exclusive, unlimited,
worldwide right and license to develop, manufacture, have manufactured, use,
market, have marketed, sell and have sold (2) Products (as herein defined) using
the HDDF Invention and selected by Watson as provided in Section 7. All
differing strengths and dosages and country-specific variations of a particular
drug entity or entities shall constitute one Product. Watson's right and license
includes the right to grant sublicenses to third parties on such terms as are
consistent with the provisions of this Agreement. The right and license granted
herein shall apply to all inventions, improvements, patent applications and
letters patent, which Keith Corporation now owns or controls, or hereafter may
own or control, and which relate to the HDDF Invention. "Product" as used in
this Agreement shall mean any drug entity or entities incorporated into a dosage
form that has completed the necessary registration and approvals by a drug
regulatory agency of a recognized government.
7. Watson to be Kept Informed: Not less than once per calendar quarter, Keith
Corporation shall keep the CEO of Watson apprised of suitable drug entities that
can successfully be incorporated into the HDDF Invention and the general
findings of the research relating to the HDDF Invention and HDDF Research.
Watson shall have the sole right to select the two (2) Products contemplated by
Section 6 from the drug entities by providing written notice to Keith.
8. Patent Filing, Maintenance and Extension
A. Keith Corporation shall (i) prosecute all patent applications
constituting the HDDF Invention at Keith Corporation's sole cost and
expense, (ii) keep Watson fully and promptly informed of the status
of the prosecution of such applications.
B. During the term of this Agreement, Keith Corporation shall take
all steps and pay all expenses necessary to maintain the patents on
the HDDF Research and HDDF Invention for the full lives thereof.
C. Watson shall have the right, upon consultation with Keith
Corporation, to file on behalf of and as agent for Watson, all
applications and to take all actions necessary (i) to obtain the
benefits under the Drug Price Competition and Patent Term
Restoration Act of 1984 and any amendments thereof and (ii) to
extend the lives of the patents on the HDDF Invention to the extent
permitted by any other law through, among other things, applications
for patent extension certificates. Keith Corporation agrees to
execute and deliver such further authorizations and instruments and
to take such further actions as may be requested by Watson to
implement the foregoing.
9. Watson to Pursue Development of Selected Products without Delay: For any
Product selected by Watson, Watson agrees to undertake the developmental process
to pursue the development of the Product without undue loss of time. If Watson
shall not make any progress or not devote any attention to the Product for a
period of three years, then Watson shall forfeit its exclusive rights to that
selected Product, but such selected Product shall still count as a selected
Product for purposes of Sections 6 and 7.
<PAGE> 3
10. Royalties: In the event Watson completes the development of a selected
Product and markets said Product, then Watson shall pay to Keith Corporation ten
percent (10%) of net sales. If Watson licenses the Product to a third party,
then Watson shall pay to Keith Corporation twenty five percent (25%) of any
payments or royalties received by Watson pursuant to such agreement. Payments of
royalties from Watson to Keith Corporation shall be made on a quarterly basis,
within 30 days of the end of each quarter in which royalties have accrued.
All royalties due hereunder shall be paid in U.S. Dollars. All royalties
for an accounting period computed in other currencies shall be converted into
U.S. Dollars at the buying rate for the transfer of such other currencies to
U.S. Dollars as quoted by Bank of America on the last day of such accounting
period, or the business day thereafter if such last day shall be a Saturday,
Sunday or holiday.
11. Books and Records: Watson agrees that it will keep complete, true and
correct books of account containing a current record of sales and licenses and
other data in sufficient detail to enable the royalties payable under this
Agreement to be computed and verified. Watson further agrees to permit Keith
Corporation, its duly authorized agents or an independent certified public
accountant to have access, upon reasonable notice, for the inspection and/or to
make copies of said books of account at reasonable intervals during business
hours.
12. Right of First Negotiation for Future Projects: In addition to the rights
granted pursuant to Section 12, Keith Corporation agrees to offer Watson the
first opportunity to negotiate with Keith Corporation for the exclusive right to
develop, manufacture, have manufactured, use, market, have marketed, sell, and
have sold any products or technology, other than products or technology based
upon HDDF Research, initiated during Keith's tenure at Watson and developed by
Keith Corporation ("Future Projects"). Keith Corporation will notify Watson of
each Future Project such that Watson shall have at least fifteen (15) days
during which time to consider whether Watson wishes to pursue such Future
Project. Within fifteen (15) days after receipt of notice of a Future Project,
Watson shall, if it desires to pursue negotiations with respect to such Future
Project, notify Keith Corporation of such desire. Keith Corporation shall then
refrain from negotiating such Future Project with any entity other than Watson
for a period of sixty (60) days. During such sixty (60) day period the parties
shall engage in exclusive, good faith negotiations regarding the Future Project.
If such negotiations do not result in a definitive agreement within the sixty
(60) day period, the exclusive negotiation period shall terminate and Keith
Corporation shall be entitled to pursue negotiations with respect to the Future
Projects with third parties.
13. Term: This Agreement shall remain and continue in full force and effect for
a period of 5 years from the date first above written or if letters patent issue
on the HDDF Invention then for the full life of the last to expire of such
letters patent, whichever is later; provided, however, the rights and licenses
granted to Watson hereunder shall continue for the full term thereof, but
subject to the following:
A. If Watson shall commit a breach of any duty to be performed or
observed by it hereunder and shall not remedy such breach within
sixty (60) days after written notice to do so is given to it by
Keith Corporation, or if Watson assigns or make any disposition of
its assets for the benefit of its creditors, becomes insolvent, goes
into liquidation or becomes bankrupt, whether by voluntary or
involuntary action, or if all or a substantial part of Watson's
business or assets is assigned or becomes subject to judicial or
governmental management, then and in any one of such events Keith
Corporation by notice in writing to Watson may terminate forthwith
this Agreement. If Watson terminates this Agreement pursuant to this
Section 13.A., the license granted to Watson hereunder shall survive
the termination of this Agreement.
B. If Keith Corporation shall commit a breach of any duty to be
performed or observed by it hereunder and shall not remedy such
breach within sixty (60) days after written notice to do so is given
to it by Watson, or assigns or makes any disposition of its assets
for the benefit of its creditors, becomes insolvent, goes into
liquidation or becomes bankrupt, whether by voluntary or involuntary
action, or if all or a substantial part of Keith Corporation's
business or assets is voluntarily or involuntarily assigned or
becomes subject to judicial or governmental management, then and in
any one of such events Watson by notice in writing to Keith
Corporation may terminate forthwith this Agreement, however, the
assignment made pursuant to Section 1 shall survive such
termination.
<PAGE> 4
14. Ownership of Patents: All patents resulting from Keith Corporation
inventions, developments, discoveries, improvements or ideas shall be the sole
and exclusive property of Keith Corporation, subject to the license granted
pursuant to this Agreement. Keith Corporation shall, upon demand, execute and
deliver to Watson such documents as may be deemed necessary or advisable by
counsel for Watson for filing in the appropriate patent offices to evidence the
granting of the license granted hereunder.
15. New Inventions: If during the term of this Agreement, Keith Corporation
makes any further improvements in the HDDF Invention or the mode of using it, or
becomes the owner(s) of any new improvement(s) in the HDDF Invention either
through patent(s) or otherwise, then Keith Corporation shall communicate such
improvement(s) to Watson and Watson shall have the right to include the same in
this Agreement without additional compensation.
16. Representations of Keith: Keith represents the following:
A. That the HDDF Invention is secret and has not been revealed to
anyone, except Watson, current Watson employees and Keith's patent
attorney;
B. That upon execution of this Agreement Keith is the exclusive owner
of all rights to the HDDF Invention; and
C. That Keith has at no time filed, or caused to be filed, patent
applications other than the Application attached as Exhibit A, or
obtained in his name, or caused to be obtained in the name of
others, any letters patent in the United States or elsewhere, based
on or relating to the HDDF Invention or the HDDF Research.
D. That Keith knows of no statutory bars or prior art which would
prevent the HDDF Invention from being the subject of one or more
United States Letters Patent.
17. Representations of Watson: Watson represents the following:
That neither Watson nor any of its affiliates have made any previous
assignment of Watson's interest in the HDDF Research and HDDF Invention.
18. Most Favored Nations Clause: In the event that Keith Corporation enters into
an agreement with a third party granting a licensee comparable business terms to
the license granted to Watson herein but containing royalty terms more favorable
to the third party than those contained herein, the Keith Corporation shall
notify Watson of such grant and such more favorable royalty terms and Watson
shall have the right to elect to replace the royalty terms contained herein with
such more favorable royalty terms.
19. Infringement: Keith Corporation shall defend, at its own expense, all
infringement suits that may be brought against Watson or its sublicensees based
on or related to the manufacture, use or sale of the Products based on or using
the HDDF Invention. In the event any information is brought to the attention of
Keith Corporation that others without benefit of a license are infringing any of
the rights granted pursuant to this Agreement, Keith Corporation shall, at its
own expense, diligently prosecute all such infringers. In any of the foregoing
suits, Watson may, at Watson's expense, be represented by counsel of its own
choice.
20. Indemnification: During the course of this Agreement, Keith Corporation
shall indemnify and hold Watson harmless from any and all liabilities, claims,
damages and expenses (including attorneys' fees) arising out of the HDDF
Research, HDDF Invention or Products; provided, however, that Keith Corporation
shall not so indemnify Watson for product liability claims from manufacturing
defects or testing deficiencies in the Products resulting from Watson's
negligence or intentional wrong-doing. During the course of this Agreement,
Watson shall indemnify and hold Keith Corporation harmless from any and all
liabilities, claims, damages and expenses (including attorneys' fees) for
product liability claims resulting from Watson's negligence or intentional
wrong-doing with respect to the Products.
In the event either party incurs, or expects to incur any liabilities,
expenses, damages or claims for which it intends to seek indemnification
from the other party, the party claiming indemnification
<PAGE> 5
("Indemnitee") shall promptly so notify the other party ("Indemnitor") in
writing. The omission so to notify the Indemnitor will not relieve the
Indemnitor from any liability which it may otherwise have to the Indemnitee
unless such Indemnitor is materially prejudiced by the failure to give such
notice. Upon such notification, the Indemnitor will be entitled to participate
in any such claim or suit and to assume the defense and settlement thereof, with
counsel of its own choice. After notice from the Indemnitor to the Indemnitee of
the Indemnitor's election to assume such defense, the Indemnitor shall not be
liable to the Indemnitee under this Section 20 for any legal fees subsequently
incurred by the Indemnitee in connection with such defense. The Indemnitee will
permit the Indemnitor, at the Indemnitor's sole discretion, to settle any such
claim or suit; provided, however, that the Indemnitor, without the written
consent of the Indemnitee, may not settle any such claim or suit, which
settlement would have an adverse effect on the Indemnitee. The Indemnitee, its
employees and agents, shall cooperate fully with the Indemnitor and its legal
representatives in the investigation and defense of any claims or suits covered
by the indemnification provisions of this Section 19.
Notwithstanding the provisions set forth in this Section 19, the
Indemnitor hereunder shall not have any liability or obligation to indemnify or
hold harmless the Indemnitee to the extent that the Indemnitee has received
payment under an insurance policy for any liabilities, claims, damages and
expenses (including attorneys' fees). In the event that the Indemnitee has been
indemnified by the Indemnitor hereunder against any liabilities for which such
Indemnitee subsequently receives payment under an insurance policy, such
Indemnitee shall apply the proceeds received by it from such insurance payment
to repay to such Indemnitor all amounts paid by such Indemnitor for any
liabilities described herein.
20. Keith Corporation's Continued Responsibility: Keith Corporation's
responsibility under this Agreement includes the requirement to continue to
provide special expertise relative to the development of the Products, as
required, in order to assist in the objective of developing commercially viable
Products for Watson.
21. Notice:
A. All notices pursuant to this Agreement shall be in writing and
shall be delivered personally or sent postage prepaid by registered
or certified mail, return receipt requested, or by telefacsimile or
by a nationally recognized overnight courier such as Federal Express
and addressed to the other party as follows:
If to Watson: Watson Pharmaceuticals, Inc.
311 Bonnie Circle
Corona, CA 91720
Attn: President
fax: 909-270-1429
If to Keith or Corporation:
Dr. Alec Keith
12930 Thunderbird Road
El Mirage, AZ 85335
B. All properly addressed notices shall be deemed given on the date
of delivery (or the next business day if delivered on a weekend or
holiday) if delivered personally or by confirmed telefacsimile, and
shall be deemed given on the date three (3) business days after the
postmark date if delivered by U.S. mail or one (1) business day
after being sent by overnight courier. Any notice of change of
address shall be prospective only.
22. Assignment: Except for the assignment of the HDDF Invention and HDDF
Research by Keith to the Corporation as contemplated herein, Keith Corporation
shall not have the right to assign this Agreement or any rights granted to Keith
Corporation hereunder without the prior written consent of Watson which shall
not be unreasonably withheld. This Agreement and the rights and licenses granted
to Watson hereunder may be assigned only to a successor in interest of the
entire or of a substantial portion of the business of Watson.
<PAGE> 6
23. General Provisions:
A. This Agreement sets forth the entire agreement between the
parties with respect to the subject matter hereof.
B. There are no representations or covenants, express or
implied, or other than those set forth herein.
C. This Agreement may be amended or modified only by a writing
signed by both parties.
D. This Agreement shall be binding upon the parties hereto and
their respective successors and assigns and shall inure to the benefit
of the parties hereto and their respective successors and assigns.
E. If any provision of this Agreement is adjudicated by a
court of competent jurisdiction as void, invalid or inoperative, such
decision shall not affect any other provision hereof, and the remainder
of this Agreement shall be effective as though such void, invalid or
inoperative provision had not been contained herein.
F. Nothing contained herein shall create a partnership, agency
or joint venture between the parties. Neither party to this Agreement
may bind the other party by its actions except as expressly provided
herein.
G. This Agreement shall not be deemed to give any right or
remedy to any third party whatsoever unless specifically set forth in
this Agreement.
H. In the event of any action, suit or proceeding arising from
or based upon this Agreement brought by either party hereto against the
other, the prevailing party shall be entitled to recover from the other
its reasonable attorneys' fees in connection therewith in addition to
the costs of that action, suit or proceeding.
I. The paragraph headings herein are solely for the purpose of
convenience and shall be disregarded in the interpretation of this
Agreement or any of its terms.
IN WITNESS WHEREOF, the parties have executed this Agreement as of the
date first written above.
WATSON PHARMACEUTICALS, INC. ALEC D. KEITH, Ph.D.
By: /s/ Allen Chao By: /s/ Alec D. Keith
---------------- --------------------------------
Title: CEO and Chairman Alec. D. Keith, Ph.D.
<PAGE> 1
EXHIBIT 10.16(a)
March 11,1997
Dr. Melvin Sharoky
c/o Somerset Pharmaceuticals, Inc.
P.O. Box 30706
Tampa, Florida 33630
Re: Continued Employment
Dear Dr. Sharoky:
This letter confirms our discussions regarding your continued
employment pursuant to the Employment Agreement between Bolar Pharmaceutical
Co., Inc. (now Circa Pharmaceuticals, Inc.) dated on or about April 26, 1991, as
amended by: a) an Amendment dated as of January 19, 1993, and b) a letter dated
July 17, 1995 with Exhibit A as an attachment ("July 17 Assumption") by which
certain obligations relating to your employment were assumed by Watson
Pharmaceuticals, Inc. ("Watson") (such agreement as amended is hereinafter
referred to as the "Agreement"). Except as specifically provided below, the
terms and conditions of the Agreement shall remain unchanged and in full force
and effect:
1. Term. Regarding Section 1 of the Agreement, the Term of your
employment under the Agreement shall be extended for a period of one year, up to
and including January 31, 1998, unless sooner terminated or further extended as
provided in the Agreement.
2. Somerset. The parties acknowledge that you presently are serving as
the President and a director of Somerset Pharmaceuticals, Inc. ("Somerset") and
that a substantial portion of your business time and attention is being devoted
to duties on behalf of Somerset.
3. Base Compensation. Section 4(a) of the Agreement is amended to raise
your minimum annual base compensation to $375,000. It is contemplated but not
required that Somerset will agree to reimburse Watson for $300,000 of your
annual base compensation in a manner acceptable to Watson.
4. Bonuses and Incentive Compensation. Section 4(b) of the Agreement is
amended by adding the following at the end of the Section:
The bonus or incentive compensation to be paid to Employee under the
Agreement for the 1997 fiscal year shall be the following:
<PAGE> 2
(A) You shall receive a bonus in the event that Watson's earnings-per-share
equals or exceed $2.20 for the 1997 fiscal year in accordance with the
following chart:
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
EARNINGS PER SHARE GROSS AMOUNT OF BONUS
- -------------------------------------------------------------------------------
<S> <C>
Less than $2.20 $0
- -------------------------------------------------------------------------------
$2.20 - $2.24 $20,000
- -------------------------------------------------------------------------------
$2.25 - $2.29 $40,000
- -------------------------------------------------------------------------------
$2.30 - $2.34 $100,000
- -------------------------------------------------------------------------------
$2.35 - $2.39 $110,000
- -------------------------------------------------------------------------------
$2.40 - $2.44 $120,000
- -------------------------------------------------------------------------------
$2.45 - $2.49 $130,000
- -------------------------------------------------------------------------------
$2.50 and up $140,000
- -------------------------------------------------------------------------------
</TABLE>
All earnings per share figures will be based upon Watson's year-end
audited financial statements as approved by Watson's Board of Directors
calculated on a pooling-of-interest basis, but will exclude any one-time charges
resulting from past or future corporate mergers, reorganizations or other
transactions.
(B) In addition, Employee may receive an additional bonus based on the
performance of Somerset, such bonus to be determined in the sole discretion of
the board of directors of Somerset (or its compensation committee) and to be
paid solely by Somerset. In lieu of such bonus or in combination with a cash
bonus, Somerset may award additional compensation to Employee in the form or
stock ownership or other equity based compensation (e.g., stock options).
Watson's board of directors and/or its compensation committee, in its sole
discretion, may pay Employee an additional bonus based on Somerset's performance
and its review of the amount of any bonus paid or the value of any equity
interest transferred to Employee by Somerset.
(C) All bonus payments referred to above shall be reduced by all deductions
required by law and shall be paid as soon as reasonably practicable after the
Company has completed the closing of its books for the 1997 fiscal year.
5. Termination for Good Reason. Section 16 of the Agreement is
modified by adding the following language after the end of subsection 16(e):
Employee acknowledges that if he terminates his employment with
Watson and within one year thereafter accepts full time employment with
Somerset, such termination shall not constitute a termination for Good
Reason under the Agreement. Employee further acknowledges and agrees that
in the event that he receives and accepts equity based compensation from
Somerset (whether stock, stock options or similar form of compensation),
including the receipt of such compensation as a bonus, Employee will
resign from Watson as an employee and officer and such resignation shall
not constitute
<PAGE> 3
a termination for Good Reason under the Agreement. In the event of either
of the occurrences as described in the foregoing two sentences, Employee
shall not be entitled to the Severance Benefits described in Section 17 of
the Agreement or any other benefits to which he may be entitled related to
a termination for Good Reason and Employee shall only be entitled to any
amounts as set forth in Section 12(b) relating to a termination by
Employee for other than Good Reason; provided however, that such
resignation shall not effect Employee's rights with regards to any then
unvested portion of the options for 300,000 shares of Watson stock as
provided in the July 17 Assumption.
6. Severance Benefits. Section 17 (c) is replaced in its entirety by
the following:
(c) In lieu of any further salary payments to the Employee for
periods subsequent to the Date of Termination, Watson shall pay as
severance to the Employee the lump sum amount of $1,350,000; provided
however that if such termination shall occur in connection with a Change
in Control of Watson occurring after the date hereof and such other
requirements as necessary for payment of Severance Benefits are met, then
in lieu of any further salary payments to the Employee for periods
subsequent to the Date of Termination, Watson shall pay as severance to
the Employee a lump sum equal to two and ninety-nine one-hundredths (2.99)
times the Employee's Base Salary either:
(i) As of the Date of Termination;
(ii) As of the date the Change in Control occurred; or
(iii) During the twelve (12) months preceding the date of
Notice of Termination, whichever is greatest, plus an amount equal
to two and ninety-nine one-hundredths (2.99) times the amount earned
by the Employee under any Incentive Plans in the calendar year
ending as of December 31st immediately preceding the Date of
Termination or the date the Change in Control of Watson occurs,
whichever is greater.
For purposes of this Agreement, a "Change in Control of Watson" shall mean
the occurrence of any of the following events during the Term of this
extension of the Agreement:
i. The acquisition by any individual, entity or group (within
the meaning of Section 13(d)(3) or 14(d)(2) of the securities
Exchange Act of 1934, as amended [the "Exchange Act"])
(collectively, a "person") of Beneficial ownership (as such term is
defined in Rule 13d-3 promulgated under the Exchange Act), directly
or indirectly, of twenty (20%) percent or more of the then
outstanding shares of common stock of Company (collectively, the
"Outstanding Common Stock"); provided, however, that the following
shall not constitute a Change of Control:
<PAGE> 4
(1) Any acquisition directly from Company (excluding an
acquisition by virtue of the exercise of a conversion
privilege);
(2) Any acquisition by an Underwriter (as such term is defined in
Section 2(11) of the Securities Act of 1933, as amended) for
the purpose of making a public offering;
(3) Any acquisition by Company; or
(4) Any acquisition by any employee benefit plan (or related
trust) sponsored or maintained by Company or any corporation
controlled by Company;
ii. The liquidation of all or substantially all
of the assets of Company; or
iii. If within two (2) years of:
(1) The completion of a tender offer or exchange offer for the
voting stock of Company (other than a tender offer or exchange
offer by Company) or a proxy contest in connection with the
election of members of the Board;
(2) A merger, consolidation, transfer or sale of twenty percent
(20%) of the book value of the gross assets of Company
measured at the time of such merger, consolidation, transfer
or sale in one (1) or more transactions;
(3) The acquisition by any person, directly or indirectly, of the
Beneficial Ownership of securities of Company representing
twenty percent (20%) of the Outstanding Common Stock; or
(4) Any combination of the foregoing;
Dr. Allen Chao is not a member of the Board and a majority of
the Board shall not consist of:
(a) Persons who were directors of Company on the
effective date of the CIRCA Merger; or
(b) Persons who were elected or nominated for election as
directors with the approval of a majority of the
persons referred to in subsection (iii)(D)(I) of this
paragraph or persons theretofore elected in
accordance with this subsection (iii)(D)(II) of this
paragraph.
7. Andrx. The parties acknowledge that you currently serve as a
director of Andrx Corporation ("Andrx") as Watson's designee. Watson agrees that
you may retain any fees or other compensation which you receive for serving as a
director of Andrx. You agree that you will resign such directorship as Watson's
designee at the written request of Watson's Board of Directors.
8. Effective Date. The amendments to the Agreement contained in
this letter are effective February 1, 1997.
<PAGE> 5
9. Notice of Termination. The time period referred to in
Section 12(a)(ii) of the Agreement, which was modified to one (1) day by letter
agreement dated December 27, 1996, is hereby changed to fifteen (15) days.
If this letter is consistent with our agreement regarding your
continued employment, please execute four copies of this letter in the space
provided below, retain two copies for your files, and return two fully executed
copies to Watson to the attention of the undersigned.
Very truly yours,
CIRCA PHARMACEUTICALS, INC.
By: /s/ Melvin Sharoky
-----------------------------------------
Title: President and CEO
--------------------------------------
WATSON PHARMACEUTICALS, INC.
By: /s/ Allen Chao
-----------------------------------------
Title: CEO and Chairman
--------------------------------------
ACCEPTED:
/s/ Melvin Sharoky
- ---------------------
Dr. Melvin Sharoky
<PAGE> 1
EXHIBIT 22.1
WATSON PHARMACEUTICALS, INC.
SUBSIDIARIES OF THE COMPANY
<TABLE>
<CAPTION>
Name Country Or State Of Incorporation
- ---------------------------------------- -----------------------------------
<S> <C>
Watson Laboratories, Inc. Nevada
Watson Pharmaceuticals (Asia) Ltd. British Virginia Islands
Corona Pharmaceuticals, Inc. Nevada
Circa Pharmaceuticals, Inc. New York
Oclassen Pharmaceuticals, Inc. Delaware
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (Nos. 33-70878, 33-94350 and 333-05737) and on Form S-4
(Nos. 333-16275 and 333-20029) of Watson Pharmaceuticals, Inc. of our report
dated February 7, 1997 except as to Note 2, which is as of February 27, 1997
appearing on page F-2 of the Watson Pharmaceuticals, Inc. Annual Report on Form
10-K for the year ended December 31, 1996.
Price Waterhouse LLP
Costa Mesa, California
March 28, 1997
<PAGE> 1
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in Registration Statement Nos.
33-70878, 33-94350 and 333-05737 on Form S-8 and Nos. 333-16275 and 333-20029 on
Form S-4 of Watson Pharmaceuticals, Inc. of our report dated February 6, 1997,
except for Note 12, as to which the date is March 7, 1997 (relating to the
consolidated financial statements of Somerset Pharmaceuticals, Inc. and
subsidiaries) appearing in this Annual Report on Form 10-K of Watson
Pharmaceuticals, Inc. for the year ended December 31, 1996.
/s/ Deloitte & Touche LLP
Pittsburgh, Pennsylvania
March 28, 1997
<PAGE> 1
EXHIBIT 23.3
CONSENT OF COOPERS & LYBRAND L.L.P.
We consent to the incorporation by reference in the registration statement of
Watson Pharmaceuticals, Inc. on Form S-8 (No. 333-05737) and on Form S-4 (Nos.
333-16275 and 333-20029) of our report dated February 7, 1995, on our audit of
the consolidated financial statements and financial statement schedule of Circa
Pharmaceuticals, Inc. for the year ended December 31, 1994.
COOPERS & LYBRAND L.L.P.
Melville, New York
March 27, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 148,231
<SECURITIES> 62,817
<RECEIVABLES> 34,129
<ALLOWANCES> 1,419
<INVENTORY> 23,216
<CURRENT-ASSETS> 279,597
<PP&E> 111,320
<DEPRECIATION> 37,726
<TOTAL-ASSETS> 419,597
<CURRENT-LIABILITIES> 21,354
<BONDS> 2,904
0
0
<COMMON> 122
<OTHER-SE> 382,590
<TOTAL-LIABILITY-AND-EQUITY> 419,597
<SALES> 166,958
<TOTAL-REVENUES> 194,120
<CGS> 77,039
<TOTAL-COSTS> 34,372
<OTHER-EXPENSES> (26,464)
<LOSS-PROVISION> 1,234
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 109,173
<INCOME-TAX> 35,875
<INCOME-CONTINUING> 73,298
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 73,298
<EPS-PRIMARY> 1.95
<EPS-DILUTED> 1.95
</TABLE>
<PAGE> 1
EXHIBIT 99.1
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS FOR THE
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994, AND
INDEPENDENT AUDITORS' REPORT
<PAGE> 2
INDEPENDENT AUDITORS' REPORT
To the Board of Directors of
Somerset Pharmaceuticals, Inc.:
We have audited the accompanying consolidated balance sheets of Somerset
Pharmaceuticals, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended 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, such consolidated financial statements present fairly, in all
material respects, the financial position of Somerset Pharmaceuticals, 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.
/s/ Deloitte & Touche LLP
- --------------------------
February 6, 1997, except for Note 12,
as to which the date is March 7, 1997
<PAGE> 3
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------
ASSETS 1996 1995
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 33,477,000 $ 21,315,000
Investment securities 1,008,000 180,000
Accounts receivable (net of allowance for
doubtful accounts of $100,000) 6,172,000 13,875,000
Inventories 1,704,000 6,551,000
Prepaid expenses and other current assets 3,510,000 2,072,000
Total current assets 45,871,000 43,993,000
PROPERTY AND EQUIPMENT - Net 4,891,000 5,496,000
INTANGIBLE ASSETS - Net 1,259,000 1,451,000
OTHER ASSETS 856,000 180,000
$ 52,877,000 $ 51,120,000
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY 1996 1995
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable $ 651,000 $ 1,512,000
Royalty payable 1,626,000 4,676,000
Medicaid payable 1,039,000 1,004,000
Other accrued expenses 2,034,000 849,000
Accrued research and development 4,578,000 1,921,000
Income taxes payable 6,032,000 4,390,000
Accrued compensation 1,494,000 630,000
Amounts due to related parties 1,621,000 2,075,000
Total current liabilities 19,075,000 17,057,000
DEFERRED REVENUE - 63,000
STOCKHOLDERS' EQUITY:
Common stock, $.01 par value; 13,719
shares authorized, 11,297 shares issued - -
Retained earnings 34,254,000 34,452,000
Less treasury stock, 644 shares at cost (452,000) (452,000)
Total stockholders' equity 33,802,000 34,000,000
$ 52,877,000 $ 51,120,000
</TABLE>
-2-
<PAGE> 4
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------
1996 1995 1994
<S> <C> <C> <C>
NET SALES $101,512,000 $107,365,000 $124,566,000
------------ ------------ ------------
COSTS AND EXPENSES:
Cost of sales 12,672,000 13,617,000 16,399,000
Marketing 6,263,000 4,862,000 23,457,000
Research and development 20,118,000 17,904,000 10,424,000
Administrative 9,574,000 8,601,000 9,845,000
------------ ------------ ------------
48,627,000 44,984,000 60,125,000
------------ ------------ ------------
52,885,000 62,381,000 64,441,000
OTHER INCOME - NET 1,732,000 2,172,000 568,000
------------ ------------ ------------
INCOME BEFORE INCOME TAXES 54,617,000 64,553,000 65,009,000
PROVISION FOR INCOME TAXES 18,815,000 20,200,000 20,900,000
------------ ------------ ------------
NET INCOME $ 35,802,000 $ 44,353,000 $ 44,109,000
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
-3-
<PAGE> 5
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------
COMMON STOCK TREASURY STOCK RETAINED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT EARNINGS EQUITY
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1993 11,297 $ -- 644 $(452,000) $ 17,990,00 $ 17,538,000
Net income -- -- -- -- 44,109,000 44,109,000
Dividends -- -- -- -- (36,000,000) (36,000,000)
------ ---- --- --------- ----------- ------------
BALANCE, DECEMBER 31, 1994 11,297 -- 644 (452,000) 26,099,000 25,647,000
Net income -- -- -- -- 44,353,000 44,353,000
Dividends -- -- -- -- (36,000,000) (36,000,000)
------ ---- --- --------- ----------- ------------
BALANCE, DECEMBER 31, 1995 11,297 -- 644 (452,000) 34,452,000 34,000,000
Net income -- -- -- -- 35,802,000 35,802,000
Dividends -- -- -- -- (36,000,000) (36,000,000)
------ ---- --- --------- ----------- ------------
BALANCE, DECEMBER 31, 1996 11,297 $ -- 644 $(452,000) $ 34,254,000 $ 33,802,000
====== ==== === ========= =========== ============
</TABLE>
See notes to consolidated financial statements.
-4-
<PAGE> 6
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
1996 1995 1994
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 35,802,000 $ 44,353,000 $ 44,109,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,048,000 847,000 587,000
Deferred tax expense (benefit) (736,000) 283,000 862,000
Deferred revenue (63,000) (229,000) (166,000)
Changes in operating assets and liabilities:
Accounts receivable 7,703,000 6,778,000 (4,558,000)
Inventories 4,847,000 (1,258,000) (1,473,000)
Prepaid expenses and other current assets (1,438,000) (398,000) (375,000)
Accounts payable (861,000) 1,220,000 87,000
Royalty payable (3,050,000) (1,174,000) 1,070,000
Accrued marketing costs -- (11,000,000) 1,900,000
Accrued research and development 2,657,000 20,000 (145,000)
Other accrued expenses 2,084,000 (350,000) 763,000
Income taxes payable 1,642,000 (627,000) 2,117,000
Amounts due to related parties (454,000) (243,000) 255,000
------------ ------------ ------------
Net cash provided by operating activities 49,181,000 38,222,000 45,033,000
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in investment securities (828,000) 3,158,000 132,000
Purchase of property and equipment (251,000) (1,884,000) (1,898,000)
Decrease in other assets 60,000 290,000 234,000
------------ ------------ ------------
Net cash (used in) provided by investing activities (1,019,000) 1,564,000 (1,532,000)
------------ ------------ ------------
(Continued)
</TABLE>
-5-
<PAGE> 7
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------
1996 1995 1994
<S> <C> <C> <C>
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid on common stock $(36,000,000) $(36,000,000) $(36,000,000)
Net decrease in note payable -- -- (253,000)
------------ ------------ ------------
Net cash used in financing activities (36,000,000) (36,000,000) (36,253,000)
------------ ------------ ------------
NET INCREASE IN CASH AND CASH
EQUIVALENTS 12,162,000 3,786,000 7,248,000
CASH AND CASH EQUIVALENTS,
BEGINNING OF YEAR 21,315,000 17,529,000 10,281,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS,
END OF YEAR $ 33,477,000 $ 21,315,000 $ 17,529,000
============ ============ ============
SUPPLEMENTAL DISCLOSURES OF
CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ -- $ -- $ 7,000
============ ============ ============
Income taxes $ 20,409,000 $ 22,074,000 $ 17,683,000
============ ============ ============
</TABLE>
See notes to consolidated financial statements.
-6-
<PAGE> 8
SOMERSET PHARMACEUTICALS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
- --------------------------------------------------------------------------------
1. PRINCIPLES OF CONSOLIDATION AND OPERATIONS
The consolidated financial statements include the accounts of Somerset
Pharmaceuticals, Inc. (the "Company") and its wholly owned subsidiaries,
Somerset Pharmaceuticals Holding Company and Somerset Caribe, Inc. The
Company is jointly owned by Mylan Laboratories, Inc. and Watson
Pharmaceuticals, Inc., with each owning 50% of the outstanding common
stock of the Company. All significant intercompany accounts and
transactions have been eliminated in consolidation. The Company,
incorporated in February 1986, is engaged in the development, testing
and marketing of drugs to be used in the treatment of various human
disorders. Currently, the Company manufactures (at its facility in
Puerto Rico), markets and sells Eldepryl, which is used as a treatment
for Parkinson's Disease. The Company had exclusivity relating to the
chemical compound Eldepryl for use as a treatment for late stage
Parkinson's Disease through June of 1996. In May 1996, the Company
received approval from the Food and Drug Administration for Eldepryl
capsules and withdrew the tablet form from the marketplace. Competitors
entered the marketplace with a generic version of the tablet in August
1996. The loss of exclusivity and the introduction of competitive
products could have a material impact on the Company's future operating
results.
The Company is party to an exclusive 14-year agreement (through November
22, 2003) with Chinoin Pharmaceutical Company ("Chinoin") of Budapest,
Hungary under which Eldepryl and other new potential drugs resulting
from Chinoin research are made available for licensing by the Company.
The license agreement required the Company to pay royalties equal to 7%
of net sales of Eldepryl including sub-license revenues. During 1996,
the license agreement was amended to reduce the Eldepryl royalties to
3.5% of net sales subsequent to May 31, 1996. The Company incurred
royalty expense of approximately $5,917,000, $8,473,000 and $9,983,000
for the years ended December 31, 1996, 1995 and 1994, respectively. The
license agreement also requires the Company to purchase the main raw
material used in the manufacture of Eldepryl from Chinoin through 1999.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Cash and Cash Equivalents - The Company generally considers debt
instruments purchased with a maturity of three months or less and
investments in money market accounts to be cash equivalents.
b. Investment Securities - The Company accounts for investment
securities in accordance with Statement of Financial Accounting
Standards ("SFAS") No. 115, "Accounting for Certain Investments
in Debt and Equity Securities." At December 31, 1996 and 1995,
the investment securities were available-for-sale, and there were
no material unrealized gains or losses. There were no sales or
maturities of investments in 1996. Proceeds from sales and
maturities of investments were $4,898,000 and $70,000 in 1995,
and $797,000 and $750,000 in 1994, respectively, and realized
gains or losses were not material in either year. The gain or
loss on sale is based on the specific identification method.
c. Inventories - Inventories are stated at the lower-of-cost or
market, with cost determined on a first-in, first-out basis.
-7-
<PAGE> 9
d. Property and Equipment - Property and equipment are stated at
cost. Depreciation is provided over the estimated useful lives of
the assets by the straight-line method. Estimated useful lives
are five to seven years for machinery and equipment and furniture
and fixtures and 35 years for the building.
e. Intangible Assets - Intangible assets are amortized on a
straight-line basis over 14 years.
f. Research and Development - Research and development costs are
expensed as incurred.
g. Concentration of Credit Risk - The Company's product is sold
throughout the United States principally to distributors and
wholesalers in the pharmaceutical industry. The Company performs
ongoing credit evaluation of its customers' financial condition
and generally requires no collateral from its customers.
h. Use of Estimates in the Preparation of Financial Statements - The
preparation of financial statements in conformity with generally
accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets
and liabilities at the date of the financial statements, as well
as the reported amounts of income and expenses during the
reporting period.
i. New Accounting Standard - The Company adopted SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to be Disposed Of" during 1996. The adoption of
this standard did not have a material impact on the financial
statements.
3. INVENTORIES
Inventory consists of the following at December 31, 1996 and 1995:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Raw material $ 1,083,000 $ 5,091,000
Work in process 373,000 163,000
Finished goods 248,000 1,297,000
------------- -------------
Total $ 1,704,000 $ 6,551,000
============= =============
</TABLE>
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31, 1996 and
1995:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Land $ 300,000 $ 300,000
Building 2,255,000 2,255,000
Machinery and equipment 4,281,000 4,048,000
Furniture and fixtures 153,000 146,000
---------- ----------
6,989,000 6,749,000
Less accumulated depreciation 2,098,000 1,253,000
---------- ----------
Property and equipment - net $4,891,000 $5,496,000
========== ==========
</TABLE>
-8-
<PAGE> 10
5. SUB-LICENSE OF RIGHTS
On February 9, 1988, the Company granted a sub-license to its exclusive
right and license to use its technology to Draxis Health Inc. (formerly
Deprenyl Research Limited) to commercialize certain drugs in Canada for
15 years. The Company receives a royalty of 11% of Draxis Health Inc.'s
net sales over the license period.
Royalty income, net of related royalty expense payable to Chinoin,
included in other income for the years ended December 31, 1996, 1995 and
1994 was approximately $175,000, $197,000 and $199,000, respectively.
6. INTANGIBLE ASSETS
Intangible assets primarily represent the cost of a modification to the
terms of the Chinoin Agreement, less accumulated amortization of
$1,446,000 and $1,254,000 at December 31, 1996 and 1995, respectively.
7. CO-PROMOTIONAL AGREEMENT
Effective October 1, 1990, the Company entered into an agreement with
Sandoz Pharmaceuticals Corporation ("Sandoz") to co-promote the product
Eldepryl. Under the terms of the agreement, the Company was required to
make certain payments to Sandoz in the event sales of Eldepryl exceed
certain predefined minimums. The agreement required Sandoz, among other
things, to expend, at a minimum, a predetermined amount for advertising
during each year of the agreement. Once the predetermined levels of
sales were exceeded, the Company was required to pay Sandoz for
advertising expenditures made on behalf of the Company. After Sandoz's
advertising expenses were reimbursed, any additional amounts were shared
by Sandoz and the Company based upon the terms of the agreement.
In December 1994, the Company amended its co-promotional agreement with
Sandoz. The amended agreement eliminated certain residual period
payments to Sandoz, shortened the term to March 31, 1996, eliminated
certain sales force detail requirements and required certain payments to
be made to the Company if a predetermined level of sales was not
achieved.
During 1995 the Company entered into an agreement with CoCensys, Inc.
("CoCensys") for the promotion of Elderpryl. The agreement was effective
January 1, 1996 and had an initial term of two years. Under the terms of
the original agreement, the Company would have compensated CoCensys,
based on a predetermined formula that considered both the number of new
prescriptions written and the net sales dollars achieved in each
quarter. During 1996, the agreement was modified with respect to term,
new prescriptions and detail calls. The Company and CoCensys are
currently renegotiating a new agreement.
During 1996, 1995 and 1994, the Company expensed (net of any payments
required to be made to the Company by Sandoz) $1,230,000, $5,304,000 and
$22,360,000, respectively, pursuant to the agreements. Additionally,
certain co-promotional fees paid by Sandoz at the commencement of the
1990 agreement were recognized ratably by the Company during the term of
the agreement (six years, expiring on March 31, 1996), and certain costs
associated with the procurement, negotiating and execution of the
agreement by the owners of the Company were incurred by the Company in
approximately the same amount.
-9-
<PAGE> 11
8. INCOME TAXES
The income tax provision consists of the following for the years ended
December 31, 1996, 1995 and 1994:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Current tax expense:
Federal $ 15,257,000 $15,625,000 $15,025,000
State 4,194,000 4,177,000 4,899,000
Foreign 100,000 115,000 114,000
------------ ----------- -----------
19,551,000 19,917,000 20,038,000
------------ ----------- -----------
Deferred tax expense (benefit):
Federal (669,000) 256,000 754,000
State (67,000) 27,000 108,000
------------ ----------- -----------
(736,000) 283,000 862,000
------------ ----------- -----------
Total provision for income taxes $ 18,815,000 $20,200,000 $20,900,000
============ =========== ===========
</TABLE>
Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax
purposes. The tax effects of significant items comprising the Company's
deferred taxes (which are included in "Other Assets" in the balance
sheet) as of December 31, 1996 and 1995 are as follows:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Deferred tax assets:
Deferred compensation $ 557,000 $122,000
Inventory valuation allowance 230,000 --
Chargeback allowance 216,000 148,000
Other 37,000 60,000
---------- --------
1,040,000 330,000
Deferred tax liabilities - different methods of accounting
between financial and income tax reporting for amortization 220,000 246,000
---------- --------
Net deferred tax assets $ 820,000 $ 84,000
========== ========
</TABLE>
-10-
<PAGE> 12
The statutory federal income tax rate is reconciled to the effective tax
rate as follows for the years ended December 31, 1996, 1995 and 1994:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Tax at statutory rate 35.0% 35.0% 35.0%
State income tax (net of federal benefit) 3.6 2.8 3.5
Tax credits (9.5) (9.4) (9.9)
Tollgate tax 4.0 3.9 3.9
Other 1.3 (1.0) (.4)
---- ---- ----
Effective tax rate 34.4% 31.3% 32.1%
==== ==== ====
</TABLE>
Tax credits result principally from operations in Puerto Rico. See Note
12.
9. RELATED PARTY TRANSACTIONS
The Company incurs expenses for ongoing management services and over a
six year period (which ended March 31, 1996) for specific services
related to the procurement, negotiation and execution of the original
co-promotion agreement by the owners of the Company. The Company also
has other transactions with one or both of its owners as detailed below
for the years ended December 31, 1996, 1995 and 1994:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Management fees $5,076,000 $5,370,000 $6,228,000
Research and development 1,250,000 -- 1,020,000
Inventory handling and distribution fees 519,000 415,000 650,000
Rent - equipment and facilities 1,217,000 1,416,000 1,065,000
Product liability insurance -- -- 618,000
Purchase of raw materials -- 450,000 --
</TABLE>
10. SIGNIFICANT CUSTOMERS
The Company had sales to certain customers which individually exceeded
10% of sales. In 1996 sales to three major customers were $23,200,000,
$21,259,000 and $18,692,000, respectively. In 1995 sales to four major
customers were of $23,986,000, $23,467,000, $15,733,000 and $13,111,000,
respectively. In 1994 sales to three customers were $30,090,000,
$23,479,000 and $17,991,000, respectively.
11. EMPLOYEE BENEFIT PLANS
The Company has a defined contribution profit sharing plan covering
substantially all employees. Contributions are made at the discretion of
the Board of Directors. Additionally, during 1994, the Company initiated
a deferred compensation plan for certain key employees. During 1996,
1995 and 1994, the Company recorded expense of $954,000, $83,000 and
$755,000 for these plans, respectively.
-11-
<PAGE> 13
12. SUBSEQUENT EVENT
In connection with an examination of the Company's Federal tax returns
for the three years ended December 31, 1995, representatives of the
Internal Revenue Service (the "Service"), on March 7, 1997, have
reviewed with the Company a draft "Notice of Proposed Adjustments" that
contains a proposed adjustment to the Company's use of tax credits under
Internal Revenue Code section 936.
Under the proposed adjustment, the Company could be subject to
approximately $9 million of additional income tax and interest charges
that have not been accrued as of December 31, 1996.
Management believes that the Company has met all of the requirements to
qualify for the tax credits available under Internal Revenue Code
section 936, and intends to vigorously defend its position on this
matter.
* * * * * *
-12-
