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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM
--------------- TO
--------------- .
COMMISSION FILE NUMBER: 0-28734
ADVANCED FIBRE COMMUNICATIONS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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DELAWARE 68-0277743
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
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ONE WILLOW BROOK COURT
PETALUMA, CALIFORNIA 94954
(707) 794-7700
(ADDRESS, INCLUDING ZIP CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES
AND 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, $0.01
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 [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of the Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 9, 1998, 73,837,502 shares of Advanced Fibre Communications,
Inc. Common Stock, $.01 par value, were outstanding, and the aggregate market
price of the shares held by non-affiliates was $1,827,634,350. (Solely for the
purposes of calculating the preceding amount, all directors and officers of the
registrant are deemed to be affiliates.)
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Annual Report to Stockholders for the year ended
December 31, 1997 are incorporated by reference in Parts II and IV of this
report.
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ADVANCED FIBRE COMMUNICATIONS, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 31, 1997
TABLE OF CONTENTS
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PART I
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 16
Item 3. Legal Proceedings........................................... 16
Item 4. Submission of Matters to a Vote of Security Holders......... 18
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 19
Item 6. Selected Consolidated Financial Data........................ 20
Item 7. Management's Discussion and Analysis of Financial Condition
and
Results of Operations....................................... 20
Item 8. Financial Statements and Supplementary Data................. 20
Item 9. Changes in and Disagreements with Accountants and Financial
Disclosure.................................................. 20
PART III
Item 10. Directors, Executive Officers and Key Employees of the
Registrant.................................................. 21
Item 11. Executive Compensation...................................... 24
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 28
Item 13. Certain Relationships and Related Transactions.............. 29
PART IV
Item 14. Exhibits, Financial Statement Schedule and Reports on Form
8-K......................................................... 31
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PART I.
Except for the historical financial information contained herein, the
following discussion may contain "forward-looking statements" that have been
made pursuant to the provisions of the Private Securities Litigation Reform Act
of 1995. Such statements include declarations regarding the intent, belief or
current expectations of the Company and its management. Any such forward-looking
statements are not guarantees of future performance and involve a number of
risks and uncertainties. Actual results could differ materially from those
indicated by such forward-looking statements. Among the important factors that
could cause actual results to differ materially from those indicated by such
forward-looking statements are those set forth below in "Certain Factors That
Might Affect Future Operating Results," as well as those noted in the documents
incorporated herein by reference. Unless required by law, the Company undertakes
no obligations to update publicly any forward-looking statements, whether as a
result of new information, future events or otherwise. However, readers should
carefully review the risk factors set forth in other reports or documents the
Company files from time to time with the Securities and Exchange Commission,
particularly the Quarterly Reports on Form 10-Q and any current reports on Form
8-K.
ITEM 1. BUSINESS
OVERVIEW
Advanced Fibre Communications, Inc. ("the Company") designs, develops,
manufactures, markets and supports the Universal Modular Carrier 1000(TM) (the
"UMC system"), a cost-effective, multi-feature digital loop carrier system
developed to serve small line-size markets. The Company's UMC system is designed
to enable telephone companies and other service providers to connect subscribers
to the central office switch for voice and data communications over copper wire,
fiber optic cable and analog radio networks. The UMC system meets the service
needs of domestic and international subscribers, including analog services such
as plain old telephone service ("POTS"), universal voice grade service ("UVG"),
high speed digital data service, and integrated services digital network
("ISDN") compatibility.
The UMC system is easily scalable from six to 672 lines through the
addition of plug-in components. Utilizing a single platform and a variety of
line cards supporting specific services, the UMC system is capable of providing
a range of voice and data services. In addition, the UMC system can be installed
in a variety of network configurations to support the varying geographic
distribution of subscriber bases. The Company has designed the UMC system to
require a minimum number of common control units to support transmission over a
variety of media and the delivery of more advanced services and features by
telephone companies. Thus, the UMC system offers a cost-effective solution to
the small line-size market with a wide variety of features and advanced
services.
The UMC system has been sold to more than 600 independent telephone
companies in the United States. The UMC system is currently deployed by
Ameritech, Pacific Bell, Sprint and GTE. The Company has also sold the UMC
system to telephone companies in China, Brazil, France, Mexico, Canada, South
Africa, Hong Kong, Panama, Venezuela and the Philippines. The UMC system is
distributed and serviced worldwide through a direct sales force in the United
States and through direct sales, distributors and agents in international
markets.
The Company was incorporated in California in May 1992 and reincorporated
in Delaware in September 1995. The Company's principal executive offices are
located at One Willow Brook Court, Petaluma, California 94954, and the telephone
number at that address is (707) 794-7700.
The Company operates on a 13-week fiscal quarter, comprised of four, four
and five week months ending on the last Saturday of the last week of the
five-week month. For presentation purposes only, the Company has shown its first
three fiscal quarters as ending on March 31, June 30, and September 30, and its
fourth fiscal quarter and fiscal year as ending on December 31.
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INDUSTRY BACKGROUND
Much of the existing local loop, which connects the subscriber to the
central office switch, was designed to provide analog voice communications, or
POTS, over copper. As a transmission medium, copper suffers from significant
signal degradation, particularly when transmitting signals beyond 10,000 feet.
In addition, the traditional copper infrastructure was designed to support low
speed telecommunications services and offers relatively poor transmission
quality, especially in data communications applications. Before the 1970s,
various solutions were implemented to address these concerns; however, these
solutions were generally costly to maintain and resulted in complex
architectures. In the early 1970s, to decrease the cost and complexity of
extending service beyond 10,000 feet from the central office, telephone
companies began to deploy digital loop carriers ("DLCs"), which convert analog
signals into digital bit streams for transmission to and from the central
office. The resulting improved signal quality enabled telephone companies to
increase transmission distances from the central office to the customer.
Advancements in digital technology have enabled central office switches to
increase by tenfold the number of lines served. While these advancements have
permitted greater centralization of switch resources, they have also resulted in
increased distances between the central office and the subscribers. Rapid
deployment of DLCs was necessary to effectively transmit signals over these
greater distances. However, the copper infrastructures supported by traditional
DLCs lacked the bandwidth for additional lines and the transmission quality for
high speed telecommunications. In response to these limitations as well as the
deterioration of the existing copper infrastructure, telephone companies began
installing fiber in high density urban markets in the late 1980s. Next
generation DLCs ("NGDLCs") were designed and introduced to the market in the
early 1990s to support telecommunications services over fiber-only networks in
densely populated urban markets with 600 to 2,000 lines within the serviceable
area of the NGDLC (i.e., large line-size markets). NGDLCs address certain of the
limitations inherent in DLCs. However, NGDLCs have high installation costs and
complex, support-intensive characteristics and are optimized for fiber-only
networks and large line-size markets.
THE AFC SOLUTION
The Company has developed the UMC system to provide cost-effective,
multi-feature local loop systems for the small line-size market, incorporating a
modular architecture that supports copper, fiber and wireless and the evolution
from one transmission media to another. The Company believes that the UMC system
is optimized to operate simultaneously and economically over a variety of
transmission media and line sizes. The UMC system is easily scalable from six to
672 lines through the addition of plug-in components. Utilizing a single
platform and a variety of line cards supporting specific services, the UMC
system is capable of providing a range of voice and data services. In addition,
the UMC system can be installed in a variety of network configurations to
support the varying geographic distribution of subscriber bases. The Company has
designed the UMC system to require a minimum number of common control units to
support transmission over a variety of media and the delivery of more advanced
services and features by telephone companies. Thus, the UMC system offers a
cost-effective solution for the small line-size market with a wide variety of
features and advanced services.
RECENT DEVELOPMENTS
In May 1997, the Company introduced the UMC 1000 Third Generation Digital
Loop Carrier(TM) ("3GDLC"). This enhanced version of the UMC is designed to
accommodate the bandwidth and connectivity requirements of current and future
local loop applications. The 3GDLC has the capability to connect simultaneously
to time division multiplexing ("TDM"), cell (asynchronous transfer mode ("ATM")
and frame), and high speed serial (SONET) network architectures, delivering
voice or data access from 64 Kbps to 155 Mbps to any subscriber from a single
channel bank assembly ("CBA"). The Company has designed the 3GDLC to support 6.2
Gbps bandwidth, making it capable of delivering broadband and narrowband
technology and services anywhere in the local loop from a single platform. The
GR-303 interface capability has been added to the 3GDLC and allows a remote DLC
terminal to connect directly to a telephone company
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switch. The concentration feature in a fully configured 3GDLC system allows the
switch to concentrate subscriber access in ratios of up to 4:1.
The Company seeks to enhance its products and technology by forming
alliances with companies whose products are complimentary with and integrate
into the UMC system. The Company has entered into agreements with 3Com
Corporation and Aware, Inc. concentrating on asymmetric digital subscriber line
("ADSL") technology, and has entered into agreements with ADTRAN, Inc. and
Pairgain Technologies, Inc. to collaborate on high speed digital subscriber line
("HDSL") transport.
MARKETS AND CUSTOMERS
To date, the UMC system has been deployed primarily in the U. S. rural and
suburban markets served by independent telephone companies. The Company
continues to pursue customers in the U. S. small line-size market as well as
other markets including regional full service communications providers,
international telecommunications service providers and competitive local
exchange carriers.
Domestic Small Line-Size Markets. The domestic small line-size markets for
telecommunications services are generally located in rural and suburban areas
and are served by approximately 1,200 independent telephone companies and the
five Regional Bell Operating Companies ("RBOCs"). The independent telephone
companies range from rural companies with as few as 125 subscribers to GTE with
approximately 20 million subscribers. The Company's current RBOC customers,
Ameritech and Pacific Bell, have approximately 20 million and 16 million
customers, respectively. The Company has segmented the domestic telephone
company market into the following: (i) small independents that use consulting
engineering firms to provide network design for service expansion and
modernization; (ii) medium-size independents that perform the network design
internally; (iii) large independents, such as Sprint and GTE, that have
engineering committees that approve equipment for standardization and may
require testing and equipment modifications to meet their specific network
requirements, and (iv) RBOCs requiring cost-effective solutions to their small
line-size requirements. The Company has targeted each of these segments as
sources of potential customers and to date over 600 independents have purchased
the Company's products.
The RBOCs, formed by the 1984 breakup of AT&T, are large corporations
providing communications services over sophisticated networks. The Company has
increased its efforts to expand its presence in the RBOC market by reorganizing
its sales force and aligning itself with the RBOCs. The reorganized sales force
includes experienced RBOC-trained representatives proficient in developing and
managing strategic relationships with the RBOCs. Product and technology
alliances formed with companies such as 3Com, Efficient Networks, Pairgain and
ADTRAN help the Company to provide a total solution for the RBOCs for such
applications as high speed services.
International Markets. The international telephone market is segmented into
developing countries requiring basic telecommunication services, or POTS, and
developed countries which, in addition to POTS, have requirements for more
advanced telecommunication services and which have barriers to entry in the form
of standards or unique domestic network specifications. In most of these
international markets, a single telephone company, which is typically highly
regulated and government-owned, provides service throughout the country.
Typically, these companies are striving to install technology that offers the
opportunity in the future for advanced services, with ease of installation and
servicing at an attractive price. In addition, these companies are striving to
optimize existing facilities, which typically consist of copper, for a growing
subscriber base. The Company is pursuing selected opportunities to develop these
markets primarily through its direct sales force, local distributors and
strategic relationships.
In 1997, the Company's international revenues grew 162%. The UMC system is
currently undergoing lab testing and field trials in Japan and the Philippines.
In 1996, the Company was awarded contracts with France Telecom and Hong Kong
Telecommunications Limited, and the Company continued to supply product under
these contracts in 1997. The Company was also awarded contracts with South
Africa, Panama, Venezuela and Brazil during 1997.
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SALES, MARKETING AND CUSTOMER SUPPORT
The Company markets the UMC system worldwide directly to telephone
companies and indirectly through original equipment manufacturers, distributors,
sales representatives, and joint ventures to accommodate specific markets and
customer support requirements. The Company's sales force consists of two groups,
one focusing on U.S. and Canadian telephone companies, and the other group
focusing on international markets.
The Company's North American sales force focuses on developing
relationships with independent telephone companies, regional full service
providers and the RBOCs in the U.S. and Canada, and on understanding their
network deployment strategies and cost requirements. As of December 31, 1997,
the Company's domestic sales organization consisted of 30 direct salespeople,
one domestic sales vice president, one sales and marketing vice president and
technical support personnel. The RBOCs make up the largest segment of the U.S.
telecommunications equipment market and serve over 80% of all U.S. telephone
customers, primarily in urban areas. To date, Ameritech and Pacific Bell have
purchased the UMC system and currently deploy the system in their networks.
The Company also has sales personnel dedicated to specific customer
accounts, such as Ameritech, Pacific Bell, GTE and Sprint. In addition to direct
calls on telephone companies, sales to customers often involve marketing through
consulting engineers who are retained by small independent telephone companies
for engineering, specifications and installation services.
In international markets, the Company employs a direct sales force
consisting of five salespersons and one vice president. The primary tasks of the
international sales force include marketing the UMC system directly to
international telephone companies and selecting, training and managing local
distributors. Sales to international customers are primarily fulfilled through
the Company's distributors and agents. The Company currently has offices in Hong
Kong and Shanghai, China. In 1997, the Company expanded its international
organizational infrastructure to add dedicated international business
development, product management, and customer support personnel. In doing so,
the Company significantly increased the number of employees dedicated to
international markets and added new distribution channels in all major
international regions.
The domestic and international sales organizations receive support from the
Company's marketing department, which is responsible for, among other things,
product marketing, advertising and marketing communications. The marketing
department works closely with telephone companies' planning and engineering
departments in order to provide product proposals that are optimal in terms of
both performance and cost for specific network configurations.
The Company's customer support organization is responsible for servicing
the Company's products and assisting the Company's sales personnel. In addition
to its own field technical service engineers, the Company uses Point To Point
Communications, Inc., a third-party support organization, which provides
around-the-clock first-line support for the Company's customers through a
toll-free number and provides installation services on a subcontract basis for
the Company. The Company maintains a training organization dedicated to
developing training curriculums and materials that are made available to the
customer either through student training or train-the-trainer programs. The
Company provides international customer support either directly, or through
authorized distributors or joint venture partners. The Company's products
generally have a warranty period of 24 months.
RESEARCH AND DEVELOPMENT
The Company's research and development efforts have been focused on
developing local loop products with advanced features for small line-size and
large line-size markets. The Company has developed a modular software and
hardware platform that can be configured and adapted to particular customer
requirements. In addition, development efforts include extensive attention to
ease of installation and use by the customer as evidenced in the menu driven
software approach as well as the compact and efficient hardware design
demonstrated in its printed circuit board assemblies ("PCBAs"). The Company's
research and development personnel work closely with sales and marketing
personnel to ensure development efforts are targeted at
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customer needs. The Company's development efforts have focused on developing
enhancements to the UMC system, such as a higher bandwidth backplane, new line
cards, and spread spectrum radio ("SSR").
The industry in which the Company operates is characterized by rapidly
changing technological and market conditions which may shorten product life
cycles. The Company's future competitive position will depend not only upon
successful production and sales of the UMC system, but also upon its ability to
develop and produce, on a timely basis, new features and services to meet
existing and anticipated industry demands. The Company is currently engaged in
the development of several new features for the UMC system. During the product
development process, the Company invests a substantial amount of resources in
products which often require extensive field testing and evaluation prior to
introduction to market.
The Company's research and development costs charged to expense were $25.7
million, $14.4 million and $5.7 million for 1997, 1996, and 1995, respectively.
As a percentage of total revenues, research and development costs represented
9.6% in 1997, 11.1% in 1996 and 10.6% in 1995. The Company considers its
research and development efforts vital to its future success and anticipates
that research and development expenditures as a percentage of revenues will
remain significant for the foreseeable future. As of December 31, 1997, the
Company's research and development staff consisted of 176 employees as compared
with 124 employees in 1996.
MANUFACTURING
Manufacturing, system integration and certain testing operations are
performed at the Company's headquarters in Petaluma, California. The Company's
manufacturing operations consist primarily of the final assembly and testing of
product, primarily printed circuit boards purchased from third parties, and
cabinets assembled internally. The Company monitors quality at each stage of the
production process, including the selection of component suppliers, warehouse
procedures, the assembly of finished goods and final testing, packaging and
shipping. The Company also performs functional, environmental and systems
testing and other quality assurance related activities on the subassemblies
incorporated into the UMC system.
The Company relies on a limited number of independent contractors to
manufacture subassemblies to the Company's specifications for use in the UMC
system. In particular, the Company relies on: (i) Flextronics International
Ltd., Solectron, Inc., Tanon Manufacturing, Inc. (a division of Electronic
Associates, Inc.), and Shanghai Lucent Technologies Transmission Equipment Co.,
Ltd., to manufacture the Company's PCBAs, (ii) Paragon, Inc. and Tyco Printed
Circuit Group Inc. to manufacture backplanes and CBAs, (iii) AMI American
Microsystems, Inc. for application specific integrated circuits ("ASICs") and
(iv) Sonoma Metal Products, Inc. and Cowden Metal San Jose, Inc. to manufacture
external housing cabinets. The Company believes that it has good relations with
each of its suppliers. As the demand for the UMC system has increased, the
Company has begun a program to identify, and potentially qualify at a future
date, additional suppliers to manufacture key product subassemblies. While the
Company believes that the subassemblies manufactured by any of the suppliers
could be procured from alternate suppliers, in the event that the Company's
subcontractors were to experience financial, operational, production, or quality
assurance difficulties that resulted in a reduction or interruption in supply to
the Company or otherwise failed to meet the Company's manufacturing
requirements, the Company's business, financial condition and results of
operations would be adversely affected until the Company established sufficient
manufacturing supply from alternative sources. There can be no assurance that
the Company's current or alternative manufacturers will be able to meet the
Company's future requirements or that such manufacturing services will continue
to be available to the Company at favorable prices.
Certain components used in the Company's products, including the Company's
proprietary ASICs, codec components, certain surface mount technology components
and other components, are only available from a single source or limited number
of suppliers. Some of the Company's sole-source suppliers are companies which
from time to time allocate parts to telephone equipment manufacturers due to
market demand for telecommunication components and equipment. Many of the
Company's competitors are much larger and may be able to obtain priority
allocations from these shared suppliers, thereby limiting or making unreliable
the sources of supply for these components. The Company has encountered supply
delays for codecs
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in the past, which resulted in delayed shipments of the UMC system, and there
can be no assurance that similar shortages will not occur in the future or will
not result in the Company having to pay a higher price for components. If the
Company is unable to obtain sufficient quantities of these or any other
components, delays or reductions in manufacturing or product shipments could
occur which would have a material adverse effect on the Company's business,
financial condition and results of operations.
In February 1998, the Company moved its domestic manufacturing and
distribution operations into a new facility to accommodate growth, double
capacity and increase efficiency. Although the Company attempted to move its
operations in an orderly manner, there can be no assurance that there will not
be an interruption of business, or that any such interruption will not have a
material adverse effect on the Company's business, manufacturing and
distribution functions.
COMPETITION
The market for equipment for local telecommunications networks is extremely
competitive. The Company's competitors range from small companies, both domestic
and international, to large multinational corporations. The Company's
competitors include: Alcatel Alsthom Compagnie Generale d'Electricite, DSC
Communications Corporation, ECI Telecom, Ltd., E/O Networks, Fujitsu America,
Inc., Hitron Technology, Inc., Lucent Technologies, Inc., NEC America, Inc.,
Northern Telecom Ltd., Opnet Technologies Co. Ltd., RELTEC Corporation, Seiscor
Technologies Inc., Siemens Corporation, Teledata Communications, Ltd., UT
Starcom and Vidar SMS Co. Ltd. Many of these competitors have more extensive
financial, marketing and technical resources than the Company and enjoy superior
name recognition in the market. In addition, the Company has entered into
agreements with the Industrial Technology Research Institute ("ITRI") to jointly
develop products based on the UMC system. ITRI is a Taiwanese
government-sponsored research and development organization in the
telecommunications field. Such agreements grant ITRI and certain of its member
companies certain rights to manufacture and sell the European Telecommunications
Standards Institute ("ETSI") version of the UMC system outside of North America.
Such entities currently compete with the Company in international markets,
primarily in China. In addition, upon termination of the agreements with ITRI in
2002, ITRI will have a worldwide, non-exclusive, royalty-free, irrevocable
license to use the ETSI version of the UMC technology and, consequently, such
member companies will be able to compete with the Company worldwide at such
time. There is an ongoing dispute subject to litigation between the Company and
ITRI and such member companies as to whether, among other things, ITRI possesses
the right to grant such rights to manufacture and sell the ETSI version of the
UMC system to new member companies. See "Item 3 -- Legal Proceedings" in this
Annual Report on Form 10-K.
Depending upon the outcome of this dispute, the Company may face
competition from new member companies for the ETSI version of the UMC system.
Such companies may possess substantially greater financial, marketing and
technical resources than the Company. The Company may also face competition from
new market entrants. The principal competitive factors in the segment of the
telecommunications equipment industry in which the Company operates are total
cost of solution, product quality and performance, scalability, flexibility of
configuration and range of system capabilities available. The Company believes
that it competes favorably with respect to these factors, and that the ability
of the UMC system to offer voice and data communications over a variety of
transmission media in a cost-effective package provides a competitive advantage
in the small line-size market. There can be no assurance that the Company will
be able to compete successfully in the future.
COMPLIANCE WITH REGULATORY AND INDUSTRY STANDARDS
The UMC system is required to comply with a large number of voice and data
regulations and standards, which vary between domestic and international
markets, and may vary by the specific international regional carriers to which
the Company sells its products. The standards in the U.S. are determined by the
Federal Communications Commission ("FCC"), Underwriters Laboratories, Bell
Communications Research ("Bellcore"), other independent third-party testing
organizations, and by independent telephone companies. The UMC technology is
certified by Underwriters Laboratories. In international markets, the Company's
products must comply with recommendations issued by the Consultative Committee
on International
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Telegraph and Telephony and individual regional carriers' network operating
system requirements and specifications. The Company's products must also comply
with standards issued by the European Telecommunications Standards Institute.
These standards are implemented and enforced by the Telecommunications
Regulatory Authority of each European nation. Standards for new services
continue to evolve, and the Company will be required to modify its products or
develop and support new versions of its products to meet these standards. These
risks are discussed in "Certain Factors That Might Affect Future Operating
Results" set forth below in this Annual Report on Form 10-K. In addition, the
Company will need to ensure that its products are easily integrated with the
carriers' network management systems. The RBOCs, representing a large segment of
the U.S. telecommunications market, in many cases require that equipment
integrated into their networks to be tested by Bellcore, indicating that the
products are interoperable with the operations, administration, maintenance and
provisioning systems used by the RBOCs in managing their networks. Bellcore
testing requires significant investments in resources to achieve compliance.
These risks are discussed in "Certain Factors That Might Affect Future Operating
Results" set forth below in this Annual Report on Form 10-K.
The Company has successfully completed the Bellcore Operations Systems
Modifications for the Integration of Network Elements ("OSMINE") process on
LFACS, TIRKS, SWITCH, and NMA interoperability. LFACS and TIRKS are operational
support systems ("OSS") which allow RBOCs' operating systems to identify the
UMC's bandwidth and equipment type and capabilities. SWITCH is an OSS designed
to inventory and assign telecommunications equipment. NMA adds the ability to
retrieve UMC alarms through the RBOCs' operating systems and generate trouble
tickets online. The Company has also completed switch compliance testing on
GR-303 with Lucent Technologies on the Lucent 5ESS switch, and with Northern
Telecom on the DMS-100 switch. GR-303 compliance testing with Bellcore is
currently in process. Integration with OPS/INE to allow through provisioning of
the UMC through Bellcore operating systems is currently in process with
Bellcore.
In October 1997, Underwriters Laboratories officially registered the
Company as ISO 9001, ANSI/ ASQC Q9001, compliant which assures quality in
design, development, production, installation and servicing. The ISO 9001
international standard consists of all elements which define a quality system
aimed primarily at achieving customer satisfaction by preventing nonconformity
at all stages from design through servicing.
The U.S. Congress recently passed new regulations that affect
telecommunications services, including changes to pricing, access by competitive
suppliers and many other broad changes to the data and telecommunications
networks and services. These changes will have a major impact on the pricing of
existing services, and may affect the deployment of future services. These risks
are discussed in "Certain Factors That Might Affect Future Operating Results"
set forth below in this Annual Report on Form 10-K.
ENVIRONMENTAL MATTERS
The Company's operations and manufacturing processes are subject to certain
federal, state, local and foreign environmental protection laws and regulations.
These laws and regulations relate to the Company's use, handling, storage,
discharge and disposal of certain hazardous materials and wastes, the
pre-treatment and discharge of process waste waters and the control of process
air pollutants. The Company believes that it is in compliance in all material
respects with applicable environmental regulations. Such laws and regulations,
however, may become more stringent over time and there can be no assurances that
the Company's failure to comply with either present or future regulations would
not subject the Company to significant compliance expenses, production
suspensions or delay, restrictions on expansion at its present locations or the
acquisition of costly equipment.
PROPRIETARY RIGHTS AND LICENSES
The Company attempts to protect its technology through a combination of
copyrights, trade secret laws, contractual obligations and patents. The Company
does not presently hold any patents for its existing products but has one patent
application pending. There can be no assurance that the Company's intellectual
property protection measures will be sufficient to prevent misappropriation of
the Company's technology or that the
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Company's competitors will not independently develop technologies that are
substantially equivalent or superior to the Company's technology. In addition,
the laws of many foreign countries do not protect the Company's intellectual
property rights to the same extent as the laws of the U.S. These risks are
discussed in "Certain Factors That Might Affect Future Operating Results" set
forth below in this Annual Report on Form 10-K.
The increasing dependence of the telecommunications industry on proprietary
technology has resulted in frequent litigation based on allegations of the
infringement of patents and other intellectual property. In 1996, the Company
settled litigation with DSC Communications Corporation ("DSC") under which DSC
had claimed proprietary rights in the UMC technology. See "Note 10 of Notes to
Consolidated Financial Statements" on page 37 through 38 of the Company's 1997
Annual Report to Stockholders, which information is incorporated herein by
reference and is filed herewith as Exhibit 13.3. In addition, DSC filed a
lawsuit on January 22, 1998, that includes allegations of patent infringement by
the Company. This pending litigation with DSC is discussed in "Item 3 -- Legal
Proceedings" included in this Annual Report on Form 10-K. In the future the
Company may be subject to additional litigation to defend against claimed
infringements of the rights of others or to determine the scope and validity of
the proprietary rights of others. Future litigation also may be necessary to
enforce and protect trade secrets and other intellectual property rights owned
by the Company. Any such litigation could be costly and cause diversion of
management's attention, either of which could have a material adverse effect on
the Company's business, financial condition and results of operations. Adverse
determination in such litigation could result in the loss of the Company's
proprietary rights, subject the Company to significant liabilities, require the
Company to seek licenses from third parties, or prevent the Company from
manufacturing or selling its products, any one of which could have a material
adverse effect on the Company's business, financial condition and results of
operations. Furthermore, there can be no assurance that any necessary licenses
will be available on reasonable terms.
In 1992, the Company entered into agreements (the "ITRI Agreements") with
ITRI to jointly develop products based on the ETSI version of the UMC system.
Under the ITRI Agreements, ITRI has the exclusive right in Taiwan to use and
develop the ETSI version of the UMC technology, and to manufacture and sell such
version of the UMC system through certain of ITRI's member companies (the
"Member Companies"), but does not have the right to manufacture and sell the
Company's proprietary application specific integrated circuits ("ASICs") except
in circumstances where the Company has failed to provide the ASICs as required.
The ASIC designs were placed in escrow in order to be available to ITRI and the
Member Companies should the right to manufacture ASICs become effective. ITRI
and the Member Companies also have a non-exclusive right to sell or lease the
ETSI version of the UMC system in all countries outside of North America. The
ITRI Agreements require ITRI to pay the Company a royalty on sales or leases of
the UMC system made through September 2002, at which time the license becomes
fully paid, and ITRI will have a worldwide, non-exclusive, royalty free,
irrevocable license to use the ETSI version of the UMC technology. ITRI's Member
Companies currently compete with the Company in international markets, primarily
in China. The Company is currently involved in litigation with ITRI and certain
of its Member Companies arising out of disputes over, among other things,
payment of royalties and the supply of ASICs. See "Certain Factors That Might
Affect Future Operating Results -- Competition" and "Item 3 -- Legal Proceedings
- - ITRI".
EMPLOYEES
As of December 31, 1997, the Company employed 660 people. None of the
Company's employees are covered by collective bargaining agreements, and the
Company has never experienced a work stoppage, strike or labor dispute. The
Company believes relations with its employees are good.
CERTAIN FACTORS THAT MIGHT AFFECT FUTURE OPERATING RESULTS
In addition to the other information in this Annual Report on Form 10-K,
the following are important factors that should be considered in evaluating the
Company and its business.
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Limited History of Operations and Profitability. The Company was
incorporated in May 1992 and was in the initial startup and development phase
through December 1993. The Company began shipping the UMC system in January 1994
and, accordingly, has a limited operating history. The Company has incurred
substantial expenditures related to the development, manufacturing startup and
marketing of the UMC system. Although the Company first achieved profitability
in the second quarter of 1995, it recorded a net loss in the second quarter of
1996 due to charges associated with the settlement of litigation with DSC. There
can be no assurance that the Company will sustain or increase its profitability
in the future.
Potential Fluctuations in Future Operating Results and Seasonality. The
Company's operating results have been, and will continue to be, affected by a
wide variety of factors, some of which are outside of the Company's control,
that could have a material adverse effect on revenues and results of operations
during any particular period. These factors include: the mix between domestic
and international sales; the customer mix; the timing and size of orders which
are received and can be shipped in a quarter; the availability of adequate
supplies of key components and assemblies and the adequacy of manufacturing
capacity; the Company's ability to introduce new products and technologies on a
timely basis; the timing of new product introductions or announcements by the
Company or its competitors; price competition; and unit volume.
The UMC system is sold primarily to telephone companies that install the
UMC system as part of their access networks. Additions to those networks
represent complex engineering projects which can require from three to twelve
months from project conceptualization to completion. The UMC system typically
represents only a portion of a given project and, therefore, the timing of
product shipment and revenue recognition is often difficult to forecast. In
developing countries, delays and reductions in the planned project deployment
can be caused by additional factors, including reductions in capital
availability due to declines in the local economy, currency fluctuations,
priority changes in the government's budget and delays in receiving government
approval for deployment of the UMC system in the local loop.
The Company's customers normally install a portion of the UMC system in
outdoor locations. Shipments of the UMC system are subject to the effects of
seasonality, with fewer installation projects scheduled for the winter months.
Accordingly, the Company believes that over time this seasonality will cause its
revenues in the quarter ended March 31 to be lower than revenues in the
preceding quarter ended December 31. In particular, the Company currently
believes that revenues for the quarter ended March 31, 1998, may be lower than
the revenues in the quarter ended December 31, 1997.
The Company's expenditures for research and development, marketing and
sales, and general and administrative functions are based in part on future
revenue projections and in the near term are relatively fixed. The Company may
be unable to adjust spending in a timely manner in response to any unanticipated
declines in revenues. Accordingly, any significant decline in demand for the UMC
system relative to planned levels could have a material adverse effect on the
Company's business, financial condition and results of operations in that
quarter or subsequent quarters.
All of the above factors are difficult to forecast, and these or other
factors could materially adversely affect the Company's business, financial
condition and results of operations. As a result, the Company believes that
period-to-period comparisons are not necessarily meaningful and should not be
relied upon as indications of future performance. Fluctuations in the Company's
operating results may cause volatility in the price of the Company's Common
Stock. Further, it is likely that in some future quarter the Company's revenues
or operating results will be below the expectations of public market analysts or
investors. In such event, the market price of the Company's Common Stock would
likely be materially adversely affected.
Dependence on Telecommunications Industry and Small Line-Size Market. The
Company's customers are concentrated in the public carrier telecommunications
industry. Accordingly, the Company's future success depends upon the capital
spending patterns of such customers and the continued demand by such customers
for the UMC system. The target markets for the UMC system are the small
line-size markets of the U.S. and developing countries.
Historically, these markets have had little access to the advanced services
that can be made available through the UMC system and, accordingly, there can be
no assurance that potential customers will consider
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the near term value of these advanced services to be sufficient to influence
their purchase decisions. Furthermore, there can be no assurance that the UMC
system will find widespread acceptance among the telephone companies and other
potential customers in small line-size markets or that such customers and
potential customers will not adopt alternative architectures or technologies
that are incompatible with the UMC technology, which would have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, there can be no assurance that telephone companies,
foreign governments or other customers will pursue infrastructure upgrades that
will necessitate the implementation of advanced products such as the UMC system.
Infrastructure improvements requiring the Company's or similar technology may be
delayed or prevented by a variety of factors, including cost, regulatory
obstacles, the lack of consumer demand for advanced telecommunications services
and alternative approaches to service delivery.
Concentrated Product Line, New Products and Rapid Technological Change. The
Company currently derives substantially all of its revenues from the UMC system
and expects that this concentration will continue in the foreseeable future. As
a result, any decrease in the overall level of sales of, or the prices for, the
UMC system due to product enhancements, introductions or announcements by the
Company's competitors, a decline in the demand for the UMC system, product
obsolescence or any other reason could have a material adverse effect on the
Company's business, financial condition and results of operations.
The telecommunications equipment market is characterized by rapidly
changing technology, evolving industry standards, changes in end-user
requirements, and frequent new product introductions and enhancements. The
introduction of products embodying new technologies or the emergence of new
industry standards can render existing products obsolete or unmarketable. The
Company's success will depend upon its ability to enhance the UMC technology and
to develop and introduce, on a timely basis, new products and feature
enhancements that keep pace with technological developments and emerging
industry standards and address changing customer requirements in a
cost-effective manner. There can be no assurance that the Company will be
successful in identifying, developing, manufacturing, and marketing product
enhancements or new products that respond to technological change or evolving
industry standards, that the Company will not experience difficulties that could
delay or prevent the successful development, introduction and marketing of these
products, or that its new products and product enhancements will adequately meet
the requirements of the marketplace and achieve market acceptance. Furthermore,
from time to time, the Company may announce new products or product
enhancements, services or technologies that have the potential to replace or
shorten the life cycle of the UMC system and that may cause customers to defer
purchasing the UMC system. There can be no assurance that future technological
advances in the telecommunications industry will not diminish market acceptance
of the UMC system or render the UMC system obsolete and, thereby, materially
adversely affect the Company's business, financial condition and results of
operations.
The Company has experienced delays in completing development and
introduction of new products, product variations and feature enhancements, and
there can be no assurance that such delays will not continue or recur in the
future. Furthermore, the UMC system contains a significant amount of complex
hardware and software that may contain undetected or unresolved errors as
products are introduced or as new versions are released. The Company has in the
past discovered technical difficulties in certain UMC system installations.
There can be no assurance that despite significant testing by the Company,
hardware or software errors will not be found in the UMC system after
commencement of shipments, resulting in delays in, or cancellation of, customer
orders or in the loss of market acceptance, any of which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Dependence on Sole-Source and Other Key Suppliers. Certain components used
in the Company's products, including the Company's proprietary application
specific integrated circuits ("ASICs"), codec components, certain surface mount
technology components and other components, are only available from a single
source or limited number of suppliers. Some of the Company's sole-source
suppliers are companies which from time to time allocate parts to telephone
equipment manufacturers due to market demand for telecommunications components
and equipment. Many of the Company's competitors are much larger and may be able
to obtain priority allocations from these shared suppliers, thereby limiting or
making unreliable the sources of supply for these components. The Company
encountered supply delays for codecs in the second
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quarter of 1994 which resulted in delayed shipments of the UMC system, and there
can be no assurance that similar shortages will not occur in the future or will
not result in the Company having to pay a higher price for components. If the
Company is unable to obtain sufficient quantities of these or any other
components, delays or reductions in manufacturing or product shipments could
occur which would have a material adverse effect on the Company's business,
financial condition and results of operations.
Dependence on Limited Number of Third Party Manufacturers and Support
Organizations. The Company relies on a limited number of independent contractors
to manufacture the subassemblies to the Company's specifications for use in the
Company's products. In particular, the Company relies on: (i) Flextronics
International Ltd., Solectron Inc., Tanon Manufacturing, Inc. (a division of
Electronic Associates, Inc.), and Shanghai Lucent Technologies Transmission
Equipment Co., Ltd., to manufacture the Company's PCBAs, (ii) Paragon, Inc., and
Tyco Printed Circuit Group Inc. to manufacture backplanes and CBAs, (iii) AMI
American Microsystems, Inc. for ASICs and (iv) Sonoma Metal Products, Inc., and
Cowden Metal San Jose, Inc., to manufacture the external housing cabinets. In
the event that the Company's subcontractors were to experience financial,
operational, production, or quality assurance difficulties that resulted in a
reduction or interruption in supply to the Company or otherwise failed to meet
the Company's manufacturing requirements, the Company's business, financial
condition and results of operations would be adversely affected until the
Company established sufficient manufacturing supply from alternative sources.
There can be no assurance that the Company's current or alternative
manufacturers will be able to meet the Company's future requirements or that
such manufacturing services will continue to be available to the Company at
favorable prices, or at all.
The Company also relies on Point To Point Communications, Inc. ("Point To
Point"), a third-party support organization, to provide first line technical
assistance and post-sales support to the Company's customers. There can be no
assurance that Point To Point will be able to provide the level of customer
support demanded by the Company's existing or potential customers. The Company
is in the process of bringing its 24-hour on-line technical support services in
house to improve quality and responsiveness of service, while Point To Point
will continue to provide field support. There can be no assurance that this
transition will not adversely affect current technical and post sales support
functions.
Competition. The market for equipment for local telecommunications networks
is extremely competitive. The Company's competitors range from small companies,
both domestic and international, to large multinational corporations. The
Company's competitors include Alcatel Alsthom Compagnie Generale d'Electricite,
DSC Communication Corporation, ECI Telecom, Inc., E/O Networks, Fujitsu America,
Inc., Hitron Technology, Inc., Lucent Technologies, Inc., NEC America, Inc.,
Northern Telecom Ltd., Opnet Technologies Co. Ltd., RELTEC Corporation, Seiscor
Technologies Inc., Siemens Corporation, Teledata Communications Ltd., UT
Starcom, Inc. and Vidar-SMS Co. Ltd. Many of these competitors have more
extensive financial, marketing and technical resources than the Company and
enjoy superior name recognition in the market. In addition, the Company has
entered into agreements with the Industrial Technology Research Institute
("ITRI") to jointly develop products based on the UMC system. ITRI is a
Taiwanese government-sponsored research and development organization in the
telecommunications field. Such agreements grant ITRI and certain of its member
companies certain rights to manufacture and sell the European Telecommunications
Standards Institute ("ETSI") version of the UMC system outside of North America.
Such entities currently compete with the Company in international markets,
primarily in China. In addition, upon termination of the agreements with ITRI in
2002, ITRI will have a worldwide, non-exclusive, royalty-free, irrevocable
license to use the ETSI version of the UMC technology and, consequently, such
member companies will be able to compete with the Company worldwide at such
time. There is an ongoing dispute subject to litigation between the Company and
ITRI and such member companies as to, among other things, whether ITRI possesses
the right to grant such rights to manufacture and sell the ETSI version of the
UMC system to new member companies and whether the Company has terminated or may
terminate such agreements and the rights, if any, of the member companies
thereunder. Depending on the outcome of this dispute, the Company may face
competition from new member companies for the ETSI version of the UMC system.
Such companies may possess substantially greater financial, marketing and
technical resources than
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the Company. The Company may also face competition from new market entrants.
There can be no assurance that the Company will be able to compete successfully
in the future.
Risks Associated with Pending Litigation. The Company is a party to certain
legal proceedings as described in "Item 3 -- Legal Proceedings." The Company is
unable to predict the ultimate outcome of these proceedings or determine the
total expense or possible loss, if any, that may ultimately be incurred in the
resolution of these proceedings. Regardless of the ultimate outcome of these
proceedings, they could result in significant diversion of time by the Company's
management. See "Item 3 -- Legal Proceedings".
Limited Protection of Proprietary Technology; Risk of Third-Party Claims of
Infringement. The Company attempts to protect its technology through a
combination of copyrights, trade secret laws, contractual obligations and
patents. The Company does not presently hold any patents for its existing
products but has one patent application pending. There can be no assurance that
the Company's intellectual property protection measures will be sufficient to
prevent misappropriation of the Company's technology or that the Company's
competitors will not independently develop technologies that are substantially
equivalent or superior to the Company's technology. In addition, the laws of
many foreign countries do not protect the Company's intellectual property rights
to the same extent as the laws of the U.S. The failure of the Company to protect
its proprietary information could have a material adverse effect on the
Company's business, financial condition and results of operations.
The increasing dependence of the telecommunications industry on proprietary
technology has resulted in frequent litigation based on allegations of the
infringement of patents and other intellectual property. In June 1996, the
Company settled litigation with DSC under which DSC had claimed proprietary
rights to the UMC technology. In January 1998, DSC filed a lawsuit against the
Company alleging, among other things, that the Company's 3GDLC product infringes
a DSC patent. See "Item 3 -- Legal Proceedings." In the future, the Company may
be subject to additional litigation to defend against claimed infringements of
the rights of others or to determine the scope and validity of the proprietary
rights of others. Future litigation also may be necessary to enforce and protect
trade secrets and other intellectual property rights owned by the Company. Any
such litigation could be costly and cause diversion of management's attention,
either of which could have a material adverse effect on the Company's business,
financial condition and results of operations. Adverse determinations in such
litigation could result in the loss of the Company's proprietary rights, subject
the Company to significant liabilities, require the Company to seek licenses
from third parties, or prevent the Company from manufacturing or selling its
products, any one of which could have a material adverse effect on the Company's
business, financial condition and results of operations. Furthermore, there can
be no assurance that any necessary licenses will be available on reasonable
terms.
Risk of Failure to Manage Expanding Operations. The Company has experienced
a period of rapid growth, which has placed and could continue to place, a
significant strain on the Company's management, operational, financial and other
resources. The members of the Company's management team have limited experience
in the management of rapidly growing companies. To effectively manage the recent
growth as well as any future growth, the Company will need to recruit, train,
assimilate, motivate and retain qualified managers and employees. Management of
potential future growth required the Company to implement a new management and
accounting system. Management evaluated and purchased a new management and
accounting system and implemented the system effective November 1997.
Information systems expansion or replacement can be a complex, costly and
time-consuming process, and there can be no assurance that the Company's system
transition and further implementation can be accomplished without disruption of
the Company's business. Any business disruption or other system transition
difficulties could have a material adverse effect on the Company's business,
financial condition and results of operations. The failure of the Company to
effectively manage its domestic and international operations or any current or
future growth could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company's results of
operations will be adversely affected if revenues do not increase sufficiently
to compensate for the increase in operating expenses resulting from any
expansion.
Expanding Operations. Effective February 1998, the Company moved its
domestic manufacturing and distribution operations into a new facility to
accommodate growth, double capacity and increase efficiency.
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Although the Company attempted to move its operations in an orderly manner,
there can be no assurance there will not be an interruption of business, or that
such interruption will not have a material adverse effect on the Company's
business, manufacturing and distribution functions.
Year 2000. Many computer operating systems and software applications in use
today were designed and developed using two-digit fields to identify the year.
Such systems and applications will recognize the year 2000 as "00", or 1900,
causing failures in the systems and/or applications or creating erroneous
results by or in the year 2000. The Company believes that it has adequately
addressed the year 2000 issue by utilizing operating systems and software
applications that were designed and developed to properly reflect the year 2000
and subsequent years' data. Although the Company believes that its products and
systems are year 2000 compliant, the Company's manufacturing suppliers may
utilize equipment or software that is not year 2000 compliant. The failure on
the part of any supplier to adequately address its own year 2000 compliance
issues could lead to delays on the part of the supplier in the delivery of
subassemblies for use in the Company's products, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Customer Concentration. For the year ended December 31, 1997, approximately
19% of the Company's revenues were derived from sales to GTE Communication
Systems Corporation. No other customer accounted for 10% or more of revenues in
1997. No single customer accounted for 10% or more of revenues in 1996. For the
years ended December 31, 1997 and 1996, the Company's five largest customers
accounted for approximately 38% and 28% of revenues, respectively. Although the
Company's largest customers have varied from period to period, the Company
anticipates that its results of operations in any given period will continue to
depend to a significant extent upon sales to a small number of customers. None
of the Company's customers has entered into an agreement requiring it to
purchase a minimum amount of product from the Company. There can be no assurance
that the Company's principal customers will continue to purchase product from
the Company at current levels, if at all. The loss of one or more major
customers could have a material adverse effect on the Company's business,
financial condition and results of operations.
Risks Associated with International Markets. International sales
constituted 27% and 21% of the Company's total revenues for the years ended
December 31, 1997 and 1996, respectively. International sales have fluctuated in
absolute dollars and as a percentage of revenues, and are expected to continue
to fluctuate in future periods. The Company relies on a number of third-party
distributors and agents to market and sell the UMC system outside of North
America. There can be no assurance that such distributors or agents will provide
the support and effort necessary to service international markets effectively.
The Company intends to expand its existing international operations and enter
new international markets, which will demand significant management attention
and financial commitment. The Company's management has limited experience in
international operations, and there can be no assurance that the Company will
successfully expand its international operations. In addition, a successful
expansion by the Company of its international operations and sales in certain
markets may depend on the Company's ability to establish and maintain productive
strategic relationships. To date, the Company has formed three joint ventures to
pursue international markets, two of which have been or are in the process of
being terminated or liquidated due to differences with the joint venture
partners. There can be no assurance that the Company will be able to identify
suitable parties for joint ventures or strategic relationships or, even if such
parties are identified, that successful joint ventures or strategic
relationships will result. Moreover, there can be no assurance that the Company
will be able to increase international sales of the UMC system through strategic
relationships or joint ventures. The failure to do so could significantly limit
the Company's ability to expand its international operations and could adversely
affect the Company's business, financial condition and results of operations.
International telephone companies are in many cases owned or strictly
regulated by local authorities. Access to such markets is often difficult due to
the established relationships between a government owned or controlled telephone
company and its traditional indigenous suppliers of telecommunications
equipment. In addition, the Company's bids for business in certain international
markets typically will require the Company to post bid and performance bonds and
to incur contract penalties should the Company fail to meet production and
delivery time schedules on large orders. The failure of the Company to meet
these schedules could result in the loss of collateral posted for the bonds or
financial penalties which could adversely affect the Company's business,
financial condition and results of operations.
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Currently, the Company's international sales are primarily U.S.
dollar-denominated. As a result, an increase in the value of the U.S. dollar
relative to foreign currencies could make the Company's products less
competitive in international markets. For example, increases in the value of the
U.S. dollar relative to the Mexican peso in late 1994 resulted in a significant
decrease in sales of the UMC system to Telefonos de Mexico for 1995.
Additionally, the Asia Pacific region's economy has deteriorated recently
resulting in the devaluation of currencies in certain of the countries of this
region. As a result of the Company's U.S. dollar-denominated contracts, the
economic downturn in the Asia Pacific region has not had a material effect to
date on the Company's financial condition. Furthermore, operating in
international markets subjects the Company to certain additional risks,
including unexpected changes in regulatory requirements, political and economic
conditions, tariffs or other barriers, difficulties in staffing and managing
international operations, exchange rate fluctuations, potential exchange and
repatriation controls on foreign earnings, potentially negative tax
consequences, longer sales and payment cycles and difficulty in accounts
receivable collection. In addition, any inability to obtain local regulatory
approval could delay or prevent entrance into international markets, which could
materially impact the Company's business, financial condition and results of
operations. In order to compete in international markets, the Company will need
to comply with various regulations and standards.
Dependence on Key Personnel. The Company's success depends to a significant
extent upon key technical and management employees. The loss of the services of
any of these key employees of the Company could have a material adverse effect
on the Company's business, financial condition and results of operations. The
Company does not have employment agreements with, or key person life insurance
for, any of its employees. Competition for highly qualified employees is intense
and the process of locating key technical and management personnel with the
combination of skills and attributes required to execute the Company's strategy
is often lengthy. There can be no assurance that the Company will be successful
in retaining its existing key personnel or in attracting and retaining the
additional employees it may require.
Compliance with Regulations and Industry Standards. The UMC system is
required to comply with a large number of voice and data regulations and
standards, which vary between domestic and international markets, and may vary
by the specific international market into which the Company sells its products.
Standards setting and compliance verification in the U.S. are determined by the
Federal Communications Commission ("FCC"), Underwriters Laboratories, Bell
Communications Research ("Bellcore"), other independent third-party testing
organizations, and by independent telephone companies. In international markets,
the Company's products must comply with recommendations issued by the
Consultative Committee on International Telegraph and Telephony and individual
regional carriers' network operating system requirements and specifications. In
addition, the Company's products must comply with standards issued by the
European Telecommunications Standards Institute and implemented and enforced by
the Telecommunications Regulatory Authority of each European nation. Standards
for new services continue to evolve, and the Company will be required to modify
its products or develop and support new versions of its products to meet these
standards. The failure of the Company's products to comply, or delays in meeting
compliance, with the evolving standards both in its domestic and international
markets could have a material adverse effect on the Company's business,
financial condition and results of operations.
In addition, the Company will need to ensure that its products are easily
integrated with the carriers' network management systems. The Regional Bell
Operating Companies ("RBOCs"), which represent a large segment of the U.S.
telecommunications market, in many cases require equipment integrated into their
networks to be tested by Bellcore, indicating that the products are
interoperable with the operations, administration, maintenance and provisioning
systems used by the RBOCs to manage their networks. Bellcore testing requires
significant investments in resources to achieve compliance. The failure to
maintain such compliance or to obtain it on new features released in the future
could have a material adverse effect on the Company's business, financial
condition and results of operations.
In October 1997, Underwriters Laboratories officially registered the
Company to ISO 9001, ANSI/ASQC Q9001 which assures quality in design,
development production, installation and servicing. The ISO 9001 international
standard consists of all elements which define a quality system aimed primarily
at achieving customer satisfaction by preventing nonconformity at all stages
from design through servicing. There can be no assurance that the Company will
maintain such certification. The failure to maintain such
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certification may preclude the Company from selling the UMC system in certain
markets and could materially adversely affect the Company's ability to compete
with other suppliers of telecommunications equipment.
The U.S. Congress recently passed new regulations that affect
telecommunications services, including changes to pricing, access by competitive
suppliers and many other broad changes to the data and telecommunications
networks and services. These changes will have a major impact on the pricing of
existing services, and may affect the deployment of future services. These
changes could cause greater consolidation in the telecommunications industry,
which in turn could disrupt existing customer relationships and have a material
adverse effect on the Company's business, financial condition and results of
operations. There can be no assurance that any regulatory changes will not have
a material adverse effect on the demand for the UMC system. Uncertainty
regarding future policies combined with emerging new competition may also affect
the demand for telecommunications products such as the UMC system.
ITEM 2. PROPERTIES
The Company's administrative, sales and marketing, and product development
headquarters are located in Petaluma, California, where the Company leases six
buildings. In addition to its headquarters, the Company leases property at the
following locations: Petaluma, California (manufacturing and distribution),
Fremont, California (research and design), Buffalo Grove, Illinois and Shanghai,
China (engineering and marketing), and Hong Kong, China (sales). The Company
believes its facilities are adequate for its current needs and for its needs in
the foreseeable future.
The Company believes that each building is suitable to its operational use,
and its facilities, other than its new Manufacturing and Distribution facility
in Petaluma, are fully utilized. The Company believes its new Manufacturing and
Distribution facility is 65% utilized as of February 1998.
ITEM 3. LEGAL PROCEEDINGS
ITRI. In September 1992, the Company entered into agreements (the "ITRI
Agreements") with the Industrial Technology Research Institute ("ITRI"), a
Taiwanese government-sponsored research and development organization, that
granted to ITRI certain license rights to the European Telecommunications
Standards Institute ("ETSI") version of the UMC system. In 1995, a dispute arose
among the Company, ITRI, and certain of ITRI's member companies (the "Member
Companies") in which the Company claimed that ITRI and the Member Companies
were, among other things, failing to pay royalties when due under the ITRI
Agreements. In reliance upon certain provisions of the ITRI Agreements, in April
1996, the Company ceased delivering to the Member Companies certain proprietary
application specific integrated circuits ("ASICs") used in manufacturing the UMC
system.
Pursuant to agreements with ITRI reached in 1994, the design documentation
for these ASICs are held in a trust account, with directions that the designs
can be made available to ITRI on the occurrence of specified conditions. On July
9, 1996, the trustee-custodian of the ASIC designs filed suit against the
Company in the United States District Court, Eastern District of New York,
alleging that the Company had not supplied all required documentation to the
trustee, and wrongfully discontinued the sale of the ASICs to the Member
Companies. Among other things, the complaint seeks unspecified damages on behalf
of the trustee, and a determination that the trustee can release the ASIC
designs to ITRI. On July 31, 1996, the Company filed a counterclaim against the
trustee claiming, among other things, that the trustee improperly disclosed the
design documentation to third parties. Discovery in the case commenced in
October 1996, and was ongoing into December 1997. At a hearing held December 15,
1997, the court stayed the case pending resolution of the arbitration
proceedings described on the following page.
On July 30, 1996, the Company filed suit against ITRI and others in the
United States District Court, Northern District of California, for breach of the
ITRI Agreements, breach of covenants of good faith, trade secret
misappropriation, tortious interference, and related claims. The complaint
alleges that ITRI breached the ITRI Agreements, among other things, by failing
to collect royalties owed to the Company, by developing UMC-based products not
shared with the Company, by transferring UMC technology to an unauthorized
company, and by misappropriating the Company's trade secrets and that the ITRI
Agreements have been
16
<PAGE> 18
terminated. The Company seeks recovery for lost profits and unjust enrichment,
punitive damages, and declaratory and injunctive relief. On September 13, 1996,
ITRI filed a demand for arbitration of the dispute and claimed, among other
things, that the Company had breached the ITRI Agreements and is liable for
unspecified royalties and punitive damages, and claiming proprietary rights in
certain UMC technology. On September 30, 1996, the Company amended the complaint
in its suit against ITRI to add the Member Companies and Taiwan-based Acer
Netxus, Inc. as parties to the suit.
On August 27, 1996, the Member Companies filed suit against the Company in
United States District Court, Northern District of California, alleging breach
of contract and unfair competition based on the Company's discontinuation of
ASICs sales and alleged failure to provide certain other UMC technology to the
Member Companies. The complaint filed by the Member Companies alleges that the
Company lacked justification to discontinue the sale of ASICs and that its
failure to sell ASICs to the Member Companies constituted unfair competition.
The complaint seeks court-ordered arbitration, unspecified damages, punitive
damages and an injunction requiring further sales of the ASICs to the Member
Companies. On September 6, 1996, the court granted a temporary restraining order
pursuant to which the Company was required to supply the Member Companies with a
specified number of ASICs during the ensuing two month period on the terms and
conditions set forth in the ITRI Agreements. The court's order was granted as an
interim measure to preserve the status quo pending adjudication on the merits.
The Company believes that compliance with the court's order will not have a
material adverse effect on the Company's business, financial condition and
results of operations. On September 16, 1996, the Company filed counterclaims
seeking declaratory and injunctive relief and damages against Member Companies
for, among other things, breach of contract, fraud and misappropriation of trade
secrets. On September 23, 1996, the Member Companies filed a demand for
arbitration of the dispute and claimed, among other things, actual damages in
excess of $60 million, legal fees and expenses and punitive damages.
A hearing on ITRI's motion for a preliminary injunction to require the
Company to continue supplying ASICs and ITRI's motion to compel arbitration was
held on November 22, 1996. On January 23, 1997, the court granted the ITRI
parties' motion to compel arbitration, and granted, in part, the Member
Companies' motion for a preliminary injunction. Under the court's order, the
case was directed to arbitration under the auspices of the American Arbitration
Association, the litigation was stayed, and the Company was directed to continue
supplying ASICs to the Member Companies as under the prior temporary restraining
order.
On or about April 8, 1997, ITRI and the Member Companies filed amended
demands for arbitration with the American Arbitration Association. On April 28,
1997, the Company filed an answer and counterclaim in the arbitration proceeding
against ITRI, the Member Companies, and Acer Netxus, Inc., to which ITRI
purportedly assigned member company rights under the ITRI Agreements without the
Company's consent.
During January 1998, the Company, ITRI, the Member Companies and the
trustee agreed to a tentative settlement that, if finalized, will resolve all
claims among the Company, ITRI, the Member Companies and the trustee. The
tentative settlement does not affect the Company's claims against Acer Netxus,
Inc. The Company is currently working to finalize the settlement; however, there
can be no assurances that the settlement will be finalized.
The Company believes that it has meritorious defenses to the claims
asserted by the trustee, ITRI and the Member Companies and, if the settlement is
not finalized, the Company intends to continue to defend the litigation and to
prosecute its affirmative claims vigorously. Moreover, the Company believes that
the damages claims of the trustee, ITRI, and the Member Companies are without
merit. The Company further believes that its claims against Acer Netxus, Inc.
are meritorious and intends to pursue these claims vigorously. However, due to
the nature of the claims, the Company cannot determine the total expense or
possible loss, if any, that may ultimately be incurred either in the context of
a trial, arbitration or as a result of a negotiated settlement. Regardless of
the ultimate outcome of the proceedings, it could result in significant
diversion of time by the Company's management. After consideration of the nature
of the claims and the facts relating to the proceedings, the Company believes
that the resolution of these matters will not have a material adverse effect on
the Company's business, financial condition and results of operations; however,
the results of these proceedings, including any potential settlement, are
uncertain and there can be no assurance to that effect.
17
<PAGE> 19
DSC. On December 22, 1997, the Company filed a lawsuit in Sonoma County
Superior Court in California against DSC Communications Corporation ("DSC")
related to its hiring of a former employee of DSC, to become the Company's Vice
President, Product Planning. The Company's complaint seeks a declaratory
judgement that its hiring of the former DSC employee was lawful.
On January 22, 1998, DSC filed a lawsuit against the Company and the former
DSC employee in the United States District Court, Eastern District of Texas,
alleging "inevitable" trade secret misappropriation and related claims. DSC also
asserted a separate claim against the Company for patent infringement alleging
that the Company's 3GDLC product infringes a DSC patent. DSC's complaint seeks
unspecified damages, injunctions relating to the alleged misappropriation and
patent infringement, attorneys' fees and other relief. On February 5, 1998, the
United States District Court, Eastern District of Texas granted the Company's
motion to dismiss all non-patent claims in this lawsuit.
On February 18, 1998, DSC filed a motion in the lawsuit filed by the
Company in Sonoma County Superior Court to allege the "inevitable" trade secret
misappropriation and related claims, seeking unspecified damages, injunctions
relating to the alleged misappropriation, attorneys' fees and other relief. A
hearing is set for June 22, 1998.
The Company believes that all of DSC's misappropriation and other claims
related to the hiring of the former DSC employee are without merit, and the
Company intends to defend the lawsuit vigorously. Based on the Company's
preliminary review of the patent claim, the Company believes that the Company's
3GDLC product does not infringe the DSC patent, and that the Company has
meritorious defenses to such claim. The Company intends to vigorously defend the
litigation against DSC and prosecute its declaratory judgement action. However,
the Company cannot predict the ultimate outcome of these lawsuits. In addition,
patent litigation is highly complex and can extend for a protracted period of
time, which can divert the attention of the Company's management and technical
personnel and require the Company to incur substantial costs and expenses. If
the patent claim were to be resolved against the Company, this could have a
material adverse effect on the Company's business, results of operations and
financial condition.
RELTEC Corporation. On November 26, 1997, the Company filed a lawsuit in
Sonoma County Superior Court in California against RELTEC Corporation, alleging
trade secret misappropriation, tortious interference with a contract, and
related claims. The case involves RELTEC's acquisition of the Company's
technology through the Company's Taiwan-based licensee, Vidar-SMS Co., Ltd. On
January 21, 1998, the Company filed for and obtained an order to show cause, and
a preliminary injunction hearing is scheduled for April 8, 1998.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1997, no matters were submitted to a vote of
security holders through the solicitation of proxies or otherwise.
18
<PAGE> 20
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market using
the symbol "AFCI". The Company's Common Stock prices are listed daily in the
Wall Street Journal and other publications under the Nasdaq National Market
listing with the abbreviation "AdvFibComm".
In September 1997, the Company's stockholders approved an increase in the
number of authorized shares of common stock from 100,000,000 to 200,000,000. On
September 22, 1997, the Company effected a two-for-one stock split to
stockholders of record as of August 29, 1997. All share, per share and common
stock amounts herein have been restated to reflect the effect of this split.
The following table lists the high and low closing sales prices for the
Company's Common Stock as reported by the Nasdaq National Market for each full
quarterly period beginning with October 1, 1996, the date of the Company's
initial public offering :
<TABLE>
<CAPTION>
HIGH LOW
------- -------
<S> <C> <C>
FISCAL 1996:
Fourth Quarter (through December 28)...................... $ 30.63 $ 22.25
</TABLE>
<TABLE>
<CAPTION>
HIGH LOW
------- -------
<S> <C> <C>
FISCAL 1997:
First Quarter (through March 29).......................... $ 27.81 $ 14.50
Second Quarter (through June 28).......................... 30.44 14.50
Third Quarter (through September 27)...................... 38.00 29.88
Fourth Quarter (through December 27)...................... 42.50 23.88
</TABLE>
On March 9, 1998, the last reported sale price of the Company's Common
Stock on the Nasdaq National Market was $30.00 per share. As of December 31,
1997, there were approximately 293 stockholders of record of the Company's
Common Stock.
DIVIDEND POLICY
The Company has never declared or paid cash dividends on its capital stock.
The Company currently intends to utilize all of its earnings, if any, for use in
its business and does not anticipate the payment of cash dividends in the
foreseeable future. In addition, the Company's revolving line of credit
agreement requires consent from the bank prior to payment of dividends.
ISSUANCE OF UNREGISTERED SECURITIES
Between October 1, 1997 and December 31, 1997, the Company issued and sold
the following securities which were not registered under the Securities Act of
1933 ("Securities Act"): the Company issued and sold an aggregate of 114,947
shares of common stock upon the net exercise of warrants to three persons or
entities for aggregate consideration of 357 shares of common stock.
The sales and issuances of securities in the transactions described above
were deemed to be exempt from registration under the Securities Act in reliance
upon Section 4(2) of the Securities Act, or Regulation D promulgated thereunder,
or Rule 701 promulgated under Section 3(b) of the Securities Act, as
transactions by an issuer not involving any public offering or transactions
pursuant to compensatory benefit plans and contracts relating to compensations
as provided under Rule 701.
USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
The Company completed its initial public offering in October 1996, in which
it issued and sold 10,350,000 shares of Common Stock for aggregate proceeds to
the Company of $120.3 million. The Registration Statement Commission File No.
333-8921 for the offering was effective for October 1, 1996. The
19
<PAGE> 21
offering closed on October 4, 1996. The Managing underwriters for the offering
were: Morgan Stanley & Co. Incorporated, Merrill Lynch & Co., Cowen & Company
and Hambrecht & Quist. Of the aggregate proceeds received in the offering, $2.2
million was used to defray costs and expenses related to the offering, resulting
in net proceeds of approximately $118.1 million. Of the net proceeds, $14.8
million was used to reduce debt. The remainder is invested in cash equivalents
and marketable securities.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The information required by this item is set forth on page 17 of the
Company's 1997 Annual Report to Stockholders, which information is incorporated
herein by reference and is filed herewith as Exhibit 13.1.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this item is set forth in the text on pages 18
through 23 of the Company's 1997 Annual Report to Stockholders, which
information is incorporated herein by reference and is filed herewith as Exhibit
13.2.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is set forth in the text on pages 24
through 39 of the Company's 1997 Annual Report to Stockholders, which
information is incorporated herein by reference and is filed herewith as Exhibit
13.3.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
None.
20
<PAGE> 22
PART III.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND KEY EMPLOYEES OF THE REGISTRANT
Executive officers are selected annually and serve at the discretion of the
Board of Directors. No family relationships exist between any of the executive
officers or directors of the Company. The following table sets forth certain
information with respect to each person who is an executive officer, key
employee or director of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
EXECUTIVE OFFICERS
Donald Green................................. 66 Chairman of the Board
Carl J. Grivner.............................. 44 President, Chief Executive Officer and
Director
Peter A. Darbee.............................. 45 Vice President, Chief Financial
Officer, Treasurer and Secretary
Karen L. Godfrey............................. 43 Vice President, Corporate Controller
and Assistant Secretary
Glenn Lillich................................ 50 Vice President, Sales and Marketing
KEY EMPLOYEES
James Hoeck.................................. 36 Vice President, Corporate Technologist
John Webley.................................. 39 Vice President, Corporate Technologist
David Arnold................................. 47 Vice President, Development Engineering
Catherine Millet............................. 45 Vice President, Product Planning
Gregory Peters............................... 36 Vice President, International
Operations
Greg Steele.................................. 36 Vice President, Operations
Rich Stanfield............................... 41 Vice President, Domestic Sales
OUTSIDE DIRECTORS
B.J. Cassin(1)............................... 64 Director
Clifford H. Higgerson(1)(2).................. 58 Director
Dan Rasdal(2)................................ 64 Director
Alex Sozonoff................................ 58 Director
</TABLE>
- ---------------
(1) Member of the Audit Committee
(2) Member of the Compensation Committee
DONALD GREEN was a co-founder of the Company and has been the Company's
Chairman of the Board since May 1992. From May 1992 to June 1997, he was also
the Company's Chief Executive Officer. Mr. Green founded Optilink Corporation in
1987, where he was the President and Chief Executive Officer, until its
acquisition by DSC in 1990. From 1990 until the founding of the Company, Mr.
Green was Vice President and General Manager of the Access Products division of
DSC Communications Corporation.
CARL J. GRIVNER has been the Company's President since December 1995 and
its Chief Executive Officer since June 1997. From July 1995 to June 1997 he was
the Company's Chief Operating Officer, and he has been a Director since May
1996. Prior to joining the Company, Mr. Grivner was President of Enhanced
Business Services of Ameritech, an RBOC, from September 1994 to July 1995. From
1986 to September 1994, Mr. Grivner held various management positions at
Ameritech, including President of Ameritech's Advertising Services Unit.
PETER A. DARBEE has been the Company's Vice President, Chief Financial
Officer, Treasurer and Secretary since June 1997. Prior to joining the Company,
Mr. Darbee was the Vice President, Chief Financial Officer and Controller of
Pacific Bell, an RBOC, from 1994 through June 1997. From 1989 through 1994, he
was Vice President and co-head of Goldman Sachs' Global Energy and
Telecommunications Group.
21
<PAGE> 23
KAREN L. GODFREY has been the Company's Corporate Controller since May 1994
and its Assistant Secretary since February 1995. Ms. Godfrey was made a Vice
President of the Company in May 1997. From September 1992 to May 1994, Ms.
Godfrey was self-employed as a financial management consultant. Ms. Godfrey was
the Chief Financial Officer of Fortune's Almanac, Inc., a catalog company, from
September 1991 to September 1992 and the Chief Financial Officer and Vice
President of Operations of Paracomp, Inc., a software company, from 1989 to
September 1991.
GLENN LILLICH has been the Company's Vice President, Sales and Marketing
since June 1996. From February 1993 to June 1996, Mr. Lillich was the Company's
Vice President, Sales. Prior to joining the Company, Mr. Lillich served as the
Western Region Director of Sales for the Telecom Division of Stratus Computer,
Inc., a manufacturer of computer systems, from January 1992 to February 1993.
JAMES HOECK was a co-founder of the Company and has served as Vice
President, Corporate Technologist since November 1997. From May 1992 through
January 1995, he served as Vice President, Engineering. From February 1995
through October 1997, he served as Vice President, Advanced Development.
JOHN WEBLEY was a co-founder of the Company and has served as Vice
President, Corporate Technologist since November 1997. From May 1992 through
January 1995, he served as Vice President, Engineering. From February 1995
through October 1997, he served as Vice President, Advanced Development.
DAVID ARNOLD has been the Company's Vice President, Development Engineering
since April 1996. Prior to joining the Company, Mr. Arnold was the Senior
Director of Telephony Products Research at Ericsson Raynet, a provider of
telecommunications equipment, from November 1993 to November 1995. From 1989 to
November 1993, Mr. Arnold served as Engineering Director at Alcatel Network
Systems, a provider of telecommunications equipment.
CATHERINE MILLET has been the Company's Vice President, Product Planning
since December 1997. Prior to joining the Company, Ms. Millet was Vice
President, Advanced Planning and Senior Director, Systems Engineering with DSC
Communications Corporation from September 1994 to December 1997. From 1993
through August 1994, Ms. Millet was the Senior Director, Engineering with
Alcatel Network Systems.
GREGORY PETERS has been the Company's Vice President, International
Operations since June 1997. Prior to joining the Company, Mr. Peters was the
Vice President, International Operations of ADTRAN, Inc., a company that designs
and develops digital modem and HDSL equipment, from 1996 to June 1997. From
January 1993 to 1996, he served as Executive Vice President of Connell
Communications Company, a company that invests in international
telecommunications projects. Mr. Peters participated in the Management
Development Program with AT&T's Network Systems Division from 1986 through 1992.
GREG STEELE has been the Company's Vice President, Operations since April
1995. From November 1994 to March 1995, Mr. Steele was the Company's Director of
Operations. Prior to joining the Company, from 1990 to November 1994, Mr. Steele
held various positions at DSC Communications Corporation, including Director of
Account Marketing and Senior Manager of Manufacturing.
RICH STANFIELD has been the Company's Vice President, Domestic Sales since
December 1994. Prior to joining the Company, from 1986 through December 1994,
Mr. Stanfield held various management positions with Stratus Computer, Inc.,
including Western Region Director of Sales.
B.J. CASSIN has been a Director of the Company since January 1993. Since
1979, he has been a private venture capitalist. Mr. Cassin is also a Director of
Cerus Corporation, Symphonix Devices, Inc. and six private companies.
CLIFFORD H. HIGGERSON has been a Director of the Company since January
1993. Mr. Higgerson has been a general partner of Vanguard Venture Partners, a
venture capital firm and a stockholder of the Company, since July 1991 and
managing partner of Communications Ventures, a venture capital firm since 1987.
Mr. Higgerson is also a Director of Digital Microwave Corporation, Ciena
Corporation and nine private companies.
22
<PAGE> 24
DAN RASDAL has been a Director of the Company since February 1993. Mr.
Rasdal has been Chairman of the Board of SymmetriComm, Inc., a
telecommunications company, since July 1989, and the President and Chief
Executive Officer of SymmetriComm since 1985. Mr. Rasdal is also a director of
Celeritek, Inc., a semiconductor manufacturer.
ALEX SOZONOFF has been a Director of the Company since October 1997. Mr.
Sozonoff has been Vice President of Hewlett-Packard Company, an electronics
equipment and computer company, and General Manager of the Marketing and
Operations Group for Hewlett-Packard's Computer Organization since 1997. From
1994 to 1997 he was the Sales and Marketing General Manager for
Hewlett-Packard's Computer Organization and was elected Vice President in 1995.
In 1994 he was named General Manager of Hewlett-Packard's Computer Products
Sales and Distribution Organization in Europe. From 1990 to 1994 he was
Hewlett-Packard's European Business Unit Manager for Personal Computers and
Personal Peripherals.
The current directors, other than Messrs. Grivner, Higgerson, and Sozonoff,
were elected pursuant to the terms of the Company's certificate of incorporation
and a voting agreement among certain stockholders of the Company, whereby
holders of the Company's Series A and Series B Preferred Stock had the right to
elect three directors in the aggregate and the parties to the voting agreement
agreed to vote for a director designated in accordance with the voting
agreement. Such arrangements terminated and all such shares of Preferred Stock
converted into shares of Common Stock, upon closing of the initial public
offering of the Company's Common Stock in October 1996. The Company's
certificate of incorporation provides for a classified Board of Directors
composed of seven directors. Accordingly, the terms of the office of the Board
of Directors are divided into three classes. Class I will expire at the annual
meeting of the stockholders to be held in 2000; Class II will expire at the
annual meeting of the stockholders to be held in 1998; and Class III will expire
at the annual meeting of the stockholders to be held in 1999. At each annual
meeting of the stockholders, the successors to directors whose terms will then
expire will be elected to serve from the time of election and qualification
until the third annual meeting following election and until their successors
have been duly elected and qualified, or until their earlier resignation or
removal, if any. Carl Grivner, Clifford Higgerson and Alex Sozonoff have been
designated Class I directors. B.J. Cassin has been designated as a Class II
director. Donald Green and Dan Rasdal have been designated as Class III
directors. Brian Jackman, who resigned from the Board effective February 19,
1998, was a Class II director. To the extent there is an increase in the number
of directors, additional directorships resulting therefrom will be distributed
among the three classes so that, as nearly as possible, each class will consist
of an equal number of directors.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's directors and executive officers, and persons who own more than
ten percent of a registered class of the Company's equity securities, to file
with the Securities and Exchange Commission initial reports of ownership and
reports of changes in ownership of Common Stock and other equity securities of
the Company. Executive officers, directors and greater than ten percent
stockholders are required by Securities and Exchange Commission regulations to
furnish the Company with copies of all Section 16(a) reports they file.
Based solely upon review of the copies of Section 16(a) reports received by
the Company and written representations that no other reports were required, the
Company believes that there was compliance for the 1997 fiscal year with all
Section 16(a) filing requirements applicable to the Company's officers,
directors and greater than ten percent stockholders except that (i) Mr. Grivner
inadvertently filed one Form 4 late reporting one transaction; (ii) Mr. Green
inadvertently filed one Form 4 late reporting seven transactions and (iii) Mr.
Cassin inadvertently filed one Form 4 late reporting eight transactions.
23
<PAGE> 25
ITEM 11. EXECUTIVE COMPENSATION
Summary of Cash and Other Compensation. The following table sets forth the
compensation earned by (i) the Company's former Chief Executive Officer, (ii)
the Company's Chief Executive Officer, (iii) the other three most highly
compensated executive officers of the Company serving as such as of the end of
the last fiscal year, and (iv) one former executive officer of the Company (the
"Named Executive Officers"), each of whose total salary and bonus for the year
ended December 31, 1997 was in excess of $100,000 for services rendered in all
capacities to the Company for such fiscal year.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
ANNUAL COMPENSATION ------------
---------------------------------- SECURITIES
FISCAL OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION OPTIONS (#) COMPENSATION
--------------------------- ------ -------- -------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Donald Green(1)................ 1997 $295,769 $225,993 $ -- 63,200 $ --
Chairman of the Board and 1996 275,000 138,903 -- 369,804 --
former Chief Executive 1995 185,000 115,625 -- 50,000 --
Officer
Carl J. Grivner(2)............. 1997 284,231 208,296 73,583(3) 302,310 --
President, Chief Executive 1996 235,000 106,349 74,080(3) -- --
Officer and Director 1995 102,115 48,894 -- 424,000 --
Glenn Lillich.................. 1997 177,028 101,116 -- 72,450 --
Vice President, 1996 170,000 51,868 -- -- --
Sales and Marketing 1995 160,000 54,400 -- 24,000 --
Peter A. Darbee(4)............. 1997 125,000 71,827 -- 300,000 --
Vice President, 1996 -- -- -- -- --
Chief Financial Officer, 1995 -- -- -- -- --
Treasurer and Secretary
Karen L. Godfrey............... 1997 115,500 63,383 -- 8,630 --
Vice President, Corporate 1996 105,000 25,077 -- -- --
Controller and Assistant 1995 101,016 28,935 -- 20,400 --
Secretary
Dan E. Steimle(5).............. 1997 148,605 60,460 -- 21,300 50,346(6)
former Vice President, 1996 170,000 51,868 -- -- --
Chief Financial Officer, 1995 160,000 54,400 -- 24,000 --
Treasurer and Secretary
</TABLE>
- ---------------
(1) Mr. Green served as Chief Executive Officer until June 1997.
(2) Mr. Grivner joined the Company in July 1995 and became Chief Executive
Officer in June 1997.
(3) Represents relocation expenses paid by the Company for 1997: $36,003; and
for 1996: $34,377. Also includes forgiveness of principal and interest on a
note payable to the Company for 1997: $37,580; and for 1996: $39,703. See
"Item 13 -- Certain Relationships and Related Transactions".
(4) Mr. Darbee joined the Company on June 30, 1997.
(5) Mr. Steimle resigned as Chief Financial Officer on June 30, 1997, and
resigned from the Company on September 30, 1997.
(6) Represents payments pursuant to a termination agreement between Mr. Steimle
and the Company.
24
<PAGE> 26
Stock Option Grants to Named Executives. The following table sets forth
certain information regarding stock option grants made to each of the Named
Executive Officers in 1997. No stock appreciation rights were granted to the
Named Executive Officers during such year.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS(1)
--------------------------------------------------- POTENTIAL REALIZABLE VALUE AT
NUMBER OF PERCENT OF ASSUMED ANNUAL RATES OF
SECURITIES TOTAL OPTIONS EXERCISE STOCK PRICE APPRECIATION FOR
UNDERLYING GRANTED TO OR BASE OPTION TERM(2)
OPTIONS EMPLOYEES IN PRICE PER EXPIRATION -----------------------------
NAME GRANTED FISCAL YEAR SHARE(3) DATE 5% 10%
---- ---------- ------------- --------- ---------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Donald Green............... 63,200 1.8% $26.50 01/17/07 $1,053,273 $ 2,669,200
Carl J. Grivner............ 102,310 2.9 26.50 01/17/07 1,705,068 4,320,978
200,000 5.6 33.00 07/24/07 4,150,705 10,518,700
Glenn Lillich.............. 22,450 0.6 26.50 01/17/07 374,145 948,157
50,000 1.4 35.25 09/19/07 1,108,427 2,808,971
Peter A. Darbee............ 300,000 8.4 22.50 05/19/07 4,245,039 10,757,762
Karen L. Godfrey........... 8,630 0.2 26.50 01/17/07 143,825 364,481
Dan E. Steimle............. 21,300 0.6 26.50 12/31/97 26,877 53,695
</TABLE>
- ---------------
(1) In general, twenty five percent of the option shares shown in this table
vest upon optionee's completion of one year of service measured from the
vesting date, and the balance vests in successive equal monthly installments
over the next 36 months of service thereafter. All such option shares will
immediately vest in the event the Company is acquired by merger or asset
sale, unless the options are assumed by the acquiring entity.
(2) Realizable values are reported net of the option exercise price. The dollar
amounts under these columns are the result of calculations based upon stock
price appreciation at the assumed 5% and 10% compounded annual rates (as
applied to the estimated fair market value of the option shares on the date
of grant, not the current fair market value of those shares) and are not
intended to forecast any actual or potential future appreciation, if any, in
the value of the Company's stock price. Actual gains, if any, on stock
option exercises will be dependent upon the future performance of the Common
Stock as well as the option holder's continued employment through the
vesting period. The potential realizable value calculation assumes that the
option holder waits until the end of the option term to exercise the option.
(3) The exercise price for the shares of Common Stock subject to option grants
made under the Company's 1996 Stock Incentive Plan may be paid in cash or in
shares of Common Stock valued at fair market value on the exercise date. The
option may also be exercised through a same-day sale program without any
cash outlay by the optionee. In addition, the Plan Administrator may provide
financial assistance to one or more optionees in the exercise of their
outstanding options by allowing such individuals to deliver a full-
recourse, interest-bearing promissory note in payment of the exercise price
and any associated withholding taxes incurred in connection with such
exercise.
25
<PAGE> 27
Option Exercises and Holdings. The following table sets forth certain
information with respect to the Named Executive Officers concerning their option
exercises during 1997 and their option holdings as of December 27, 1997. None of
the Named Executive Officers held any stock appreciation rights at the end of
that fiscal year.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION
VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED IN-
SHARES OPTIONS AS OF THE-MONEY OPTIONS AS OF
ACQUIRED DECEMBER 27, 1997(2)(3) DECEMBER 27, 1997(4)
ON VALUE --------------------------- ---------------------------
NAME EXERCISE REALIZED(1) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- -------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Donald Green............ -- $ -- 459,237 183,767 $9,239,205 $2,760,169
Carl J. Grivner......... 66,000 2,207,367 88,410 478,568 1,061,299 5,396,025
Glenn Lillich........... 202,000 5,901,305 226,835 139,615 5,381,925 1,855,950
Peter A. Darbee......... -- -- 60,000 240,000 135,000 540,000
Karen L. Godfrey........ 90,000 2,340,556 23,082 45,948 515,215 963,235
Dan E. Steimle.......... 104,000 1,957,517 3,766 4,709 -- --
</TABLE>
- ---------------
(1) Based upon the difference between the exercise price and the fair market
value of the Company's Common Stock on the date of exercise.
(2) Certain of these options were granted under the Company's 1996 Stock
Incentive Plan ("the 1996 Plan"). In general, twenty five percent of such
option shares vest upon optionee's completion of one year of service
measured from the vesting date, and the balance vests in successive equal
monthly installments over the next 36 months of service thereafter. All such
option shares will immediately vest in the event the Company is acquired by
merger or asset sale, unless the options are assumed by the acquiring
entity. Accordingly, the table reflects such vested option shares in the
"exercisable" column as follows: Mr. Green -- 15,217; Mr. Grivner -- 44,809;
Mr. Lillich -- 8,569; Mr. Darbee -- 60,000; Ms. Godfrey -- 2,122 and Mr.
Steimle -- 3,766. In addition, the table reflects such unvested option
shares in the "unexercisable" column as follows: Mr. Green -- 47,983; Mr.
Grivner -- 257,501; Mr. Lillich -- 63,881; Mr. Darbee -- 240,000; Ms.
Godfrey -- 6,508 and Mr. Steimle -- 4,709.
(3) Certain of these options were granted under the predecessor equity incentive
plan to the 1996 Plan (the "Predecessor Plan"). The terms of these options
provide that each option is immediately exercisable for all the option
shares, but any shares purchased under the options are subject to repurchase
by the Company, at the exercise price paid per share, in the event the
optionee terminates employment prior to vesting in those shares. Twenty
percent of such option shares vest upon optionee's completion of one year of
service measured from the vesting date, and the balance vests in successive
equal monthly installments over the next 48 months of service thereafter
(other than Mr. Green's options granted under the Predecessor Plan which
vest in successive equal monthly installments over 24 months measured from
the date of grant). All such options will immediately vest in the event the
Company is acquired by merger or asset sale, unless the options are assumed
by the acquiring entity. Accordingly, the table reflects such vested option
shares for which the rights of repurchase have lapsed in the "exercisable"
column as follows: Mr. Green -- 444,020; Mr. Grivner -- 43,601; Mr.
Lillich -- 218,266; Mr. Darbee -- 0; Ms. Godfrey -- 20,960 and Mr.
Steimle -- 0. In addition, the table reflects such unvested option shares
for which the right of repurchase has not lapsed in the "unexercisable"
column as follows: Mr. Green -- 135,784; Mr. Grivner -- 221,067; Mr.
Lillich -- 75,734; Mr. Darbee -- 0; Ms. Godfrey -- 39,440 and Mr.
Steimle -- 0.
(4) Based on the last reported sale price of the Company's Common Stock on
December 26, 1997 ($24.75 per share) less the exercise price payable for
such shares.
Director Compensation. Non-employee Board members do not receive any cash
fees for their service on the Board or any Board committee, but they are
entitled to reimbursement of all reasonable out-of-pocket expenses incurred in
connection with their attendance at Board and Board committee meetings. In
addition,
26
<PAGE> 28
non-employee Board members receive stock options pursuant to the Automatic
Option Grant Program in effect under the 1996 Plan.
Under the Automatic Option Grant Program, each individual who first joins
the Board after June 30, 1996 as a non-employee Board member will receive a
non-qualified stock option grant for 40,000 shares of Common Stock at the time
of his or her commencement of board service, provided such individual has not
otherwise been in the prior employ of the Company. In addition, at each annual
meeting of stockholders, each individual who is to continue to serve as a
non-employee Board member will receive a non-qualified stock option grant to
purchase 12,000 shares of Common Stock, whether or not such individual has been
in the prior employ of the Company and whether or not such individual first
joined the Board after June 30, 1996, provided that such individual has served
as a non-employee Board member for at least six months. Messrs. Cassin,
Higgerson and Jackman each waived their right to receive such options at the
1997 Annual Meeting of Stockholders.
Each automatic grant will have an exercise price equal to the fair market
value per share of Common Stock on the grant date and will have a maximum term
of 10 years, subject to earlier termination following the optionee's cessation
of Board service. Each automatic option will be immediately exercisable;
however, any shares purchased upon exercise of the option will be subject to
repurchase, at the option exercise price paid per share, should the optionee's
service as a non-employee Board member cease prior to vesting in the shares.
Each automatic option grant will vest in a series of installments over the
optionee's period of Board service as follows: one-third of the option shares
upon completion of one year of Board service, and the balance in twenty-four
(24) successive equal monthly installments upon the optionee's completion of
each additional month of Board service thereafter. However, each outstanding
option will immediately vest upon (i) certain changes in the ownership or
control of the Company or (ii) the death or disability of the optionee while
serving as a Board member.
Employment Contracts, Termination of Employment and Changes in Control
Agreements. The Compensation Committee as Plan Administrator of the 1996 Plan
has the authority to provide for the accelerated vesting of the shares of Common
Stock subject to outstanding options held by the Chief Executive Officer and the
Company's other executive officers or any unvested shares actually held by those
individuals under the 1996 Plan or the Predecessor Plan, in the event the
Company is acquired by merger or asset sale or there is a hostile change in
control effected by a successful tender or exchange offer for more than 50% of
the Company's outstanding voting securities or a change in the majority of the
Board as a result of one or more contested elections for board membership.
Alternatively, the Compensation Committee may condition such accelerated vesting
upon the individual's termination of service within a designated period
following the acquisition or hostile change in control.
Dan E. Steimle, the Company's former Vice President, Chief Financial
Officer, Treasurer and Secretary resigned from the Company effective September
30, 1997. In connection with his resignation, Mr. Steimle and the Company
entered into a Termination Agreement and General Release, pursuant to which the
Company agreed to pay Mr. Steimle (i) bi-weekly payments of $7,192.30 through
July 20, 1998 for an aggregate total of $155,353.68, less applicable taxes and
withholding and (ii) the pro-rata portion of his year-end bonus, as determined
by the Board of Directors, based upon services rendered from January 1, 1997
through July 20, 1997.
The Company and Mr. Steimle also entered into a Consulting Agreement
pursuant to which (i) Mr. Steimle agreed to assist with the orderly transition
of his responsibilities to the Company's new Vice President and Chief Financial
Officer for the period commencing October 1, 1997 through July 20, 1998 and (ii)
the Company agreed to continue to vest a total of 4,709 Nonqualified Stock
Options through July 20, 1998 and permit Mr. Steimle to exercise such vested
stock options during the period beginning on July 20, 1998 through October 17,
1998. In the event Mr. Steimle breaks any terms of the Termination Agreement and
General Release or Consulting Agreement, the bi-weekly payments will cease and
the additional vesting of Mr. Steimle's options will be cancelled.
Compensation Committee Interlocks and Insider Participation. The Board of
Directors established a Compensation Committee in May 1994. The Compensation
Committee consists of Messrs. Higgerson and
27
<PAGE> 29
Rasdal. Mr. Rasdal replaced Mr. Jackman as a member of the Compensation
Committee in May 1997. None of these individuals has served at any time as an
officer or employee of the Company. Prior to the establishment of the
Compensation Committee, all decisions relating to executive compensation were
made by the Company's Board of Directors. No executive officer of the Company
serves as a member of the board of directors or compensation committee of any
entity which has one or more executive officers serving as a member of the
Company's Board of Directors or Compensation Committee.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Security Ownership. The following table sets forth certain information
regarding the beneficial ownership of the Company's Common Stock as of March 2,
1998 by: (i) each person (or group of affiliated persons) who is known by the
Company to own beneficially more than five percent of the outstanding shares of
the Common Stock of the Company; (ii) each director of the Company; (iii) each
executive officer of the Company (including the Named Executive Officers); and
(iv) all directors and executive officers of the Company as a group.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED AS OF
MARCH 2, 1998(1)
------------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENTAGE
------------------------ ---------- ----------
<S> <C> <C>
FMR Corporation(2)................................... 8,877,500 12.0%
82 Devonshire Street
Boston, MA 02109
Tellabs, Inc.(3)..................................... 6,340,234 8.5
4951 Indiana Avenue
Lisle, IL 60532
B.J. Cassin(4)....................................... 1,699,106 2.3
Donald Green(5)...................................... 2,524,621 3.4
Carl J. Grivner(6)................................... 352,643 *
Clifford H. Higgerson................................ 343,446 *
Dan Rasdal(7)........................................ 126,000 *
Alex Sozonoff........................................ 400 *
David Arnold(8)...................................... 113,297 *
Peter A. Darbee(9)................................... 65,551 *
Karen Godfrey(10).................................... 120,597 *
James Hoeck(11)...................................... 1,991,198 2.7
Glenn Lillich(12).................................... 352,635 *
Gregory Peters....................................... 2,691 *
Richard Stanfield(13)................................ 121,128 *
Greg Steele(14)...................................... 115,149 *
John Webley(15)...................................... 1,243,750 1.7
Dan E. Steimle(16)................................... 475,399 *
All executive officers and directors as a group (16
persons)(17)....................................... 15,554,378 20.3%
</TABLE>
- ---------------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to securities. Shares of Common Stock subject
to options and warrants currently exercisable within 60 days are deemed to
be outstanding for computing the percentage of the person holding such
options or warrants but are not deemed outstanding for computing the
percentage of any other person. Except as indicated by footnote, and
subject to community property laws where applicable, the persons named in
the table have sole voting and investment power with respect to all shares
of Common Stock shown as beneficially owned by them.
28
<PAGE> 30
(2) Based on a Schedule 13G filed on January 10, 1998 by FMR Corporation.
(3) Includes 600,000 shares which may be acquired upon exercise of a warrant.
(4) Includes 174,106 shares held in trust by the Robert S. Cassin Charitable
Trust. Also includes 100,000 shares held in trust by The Cassin Foundation
and 125,000 shares held in trust by the Cassin 1997 Charitable Trust UTA
dated 1/28/97. The remaining shares are held in trust by B.J. Cassin and
Isabel B. Cassin, Trustees of the Cassin Family Trust U/D/T, dated January
31, 1996.
(5) Includes 603,054 shares issuable upon exercise of options held by Mr.
Green, 542,903 of which shares will be vested as of 60 days from March 2,
1998. Also includes 50,000 shares held by the Donald and Maureen Green
Foundation.
(6) Includes 307,362 shares issuable upon exercise of options held by Mr.
Grivner, 114,562 of which shares will be vested as of 60 days from March 2,
1998.
(7) Includes 126,000 shares issuable upon exercise of options held by Mr.
Rasdal, 107,500 of which shares will be vested as of 60 days from March 2,
1998.
(8) Includes 66,650 shares issuable upon exercise of options held by Mr.
Arnold, 10,650 of which shares will be vested as of 60 days from March 2,
1998. Also includes 11,250 shares subject to a right of repurchase by the
Company, and 716 shares held by Mr. Arnold's spouse.
(9) Includes 60,000 shares issuable upon exercise of options held by Mr.
Darbee, all of which shares will be vested as of 60 days from March 2,
1998.
(10) Includes 24,820 shares issuable upon exercise of options held by Ms.
Godfrey, 5,273 of which shares will be vested as of 60 days from March 2,
1998. Also includes 6,675 shares subject to a right of repurchase by the
Company.
(11) Includes 187,683 shares issuable upon exercise of options held by Mr.
Hoeck, 174,349 of which shares will be vested as of 60 days from March 2,
1998.
(12) Includes 259,589 shares issuable upon exercise of options held by Mr.
Lillich, 206,256 of which shares will be vested as of 60 days from March 2,
1998.
(13) Includes 87,355 shares issuable upon exercise of options held by Mr.
Stanfield, 16,421 of which shares will be vested as of 60 days from March
2, 1998.
(14) Includes 107,825 shares issuable upon exercise of options held by Mr.
Steele, 45,425 of which shares will be vested as of 60 days from March 2,
1998.
(15) Includes 187,683 shares issuable upon exercise of options held by Mr.
Webley, 174,349 of which shares will be vested as of 60 days from March 2,
1998. Also includes 190,000 shares held by Mr. Webley's spouse.
(16) Includes 8,000 shares held by Mr. Steimle's spouse.
(17) Includes 18,195 shares subject to a right of repurchase by the Company.
Also includes 2,018,021 shares issuable upon exercise of options, 1,457,688
of which shares will be vested as of 60 days from March 2, 1998, and
620,000 shares which may be acquired upon exercise of warrants.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In October 1995, the Company loaned Carl Grivner, the Company's President
and Chief Executive Officer, the sum of $100,000 to assist him in relocating to
Northern California. Such loan bears interest at the rate of 6.37% per annum,
with accrued interest due and payable annually on July 19 of each year, and the
principal of such loan due and payable in three equal installments on July 19 of
1996, 1997 and 1998. In August 1996, the Company forgave one-third of the
principal balance and interest accrued through July 19, 1996. In August 1997,
the Company forgave one-third of the principal balance and interest accrued
through July 19, 1997. As of December 27, 1997, one-third of the principal
balance of this loan remained outstanding.
In June 1997, the Company issued 4,968 shares of restricted Common Stock at
$30.1875 per share to Peter Darbee, the Company's Vice President, Chief
Financial Officer, Treasurer and Secretary in connection with Mr. Darbee's
commencement of employment. Mr. Darbee issued a note payable to the Company in
the
29
<PAGE> 31
amount of $149,972 as consideration for the shares. The note is secured by
shares of Common Stock owned by Mr. Darbee. Such note bears interest at the rate
of 6.8% per annum with the entire principal balance of the note, together with
all accrued or unpaid interest, due and payable on July 1, 2002.
The Company and Tellabs Operations, Inc. ("Tellabs Operations"), a
subsidiary of Tellabs, Inc., a stockholder of the Company entered into a License
and Marketing Agreement and an OEM Agreement on December 23, 1996. Under the
License and Marketing Agreement, the Company granted to Tellabs Operations a
license to use the UMC technology in the development, manufacture, and
distribution of coaxial systems for specified markets. In return, the Company
will receive royalties from the sale of these systems. Under the OEM Agreement,
the Company agreed to manufacture the UMC products for Tellabs Operations. The
License and Marketing Agreement was terminated on February 20, 1998.
The Company has granted options to certain of its directors and executive
officers. See "Item 11 -- Executive Compensation" and "Item 12 -- Security
Ownership of Certain Beneficial Owners and Management."
The Company believes that all of the transactions set forth above were made
on terms no less favorable to the Company than could have been obtained from
unaffiliated third parties. The Company intends that all future transactions,
including loans, between the Company and its officers, directors, principal
stockholders and their affiliates be approved by a majority of the Board of
Directors, including a majority of the independent and disinterested outside
directors on the Board of Directors, and be on terms no less favorable to the
Company than could be obtained from unaffiliated third parties.
30
<PAGE> 32
PART IV.
ITEM 14.EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
The following is a list of the consolidated financial statements and the
financial statement schedules which are included in this Form 10-K or which are
incorporated herein by reference:
1. FINANCIAL STATEMENTS:
As of December 31, 1997 and 1996:
-- Consolidated Balance Sheets
For the Years Ended December 31, 1997, 1996, and 1995:
-- Consolidated Statements of Operations
-- Consolidated Statements of Redeemable Convertible Preferred Stock
and Stockholders' Equity (Deficit)
-- Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Independent Auditors' Report
Quarterly Results of Operations (Unaudited)
2. FINANCIAL STATEMENT SCHEDULE:
-- Schedule II -- Valuation Accounts
All other financial statements and financial statement schedules have been
omitted because they are not applicable, or the required information is included
in the consolidated financial statements or notes thereto.
3(A). EXHIBITS:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------- --------------------
<S> <C>
3.3.1 Fifth Amended and Restated Certificate of Incorporation of
the Registrant.(4)
3.5 Amended and Restated Bylaws of the Registrant.(3)
4.1 Specimen Certificate of Common Stock.(1)
4.2 Series E Preferred Stock Purchase Agreement, dated September
29, 1995, between the Registrant and certain purchasers of
the Registrant's Series E Preferred Stock.(1)
4.3 Certificate of Incorporation of the Registrant (included in
Exhibit 3.3.1).
10.1 Form of Warrant Issued In Connection with the Sale of the
Registrant's Series A Preferred Stock on January 6, 1993.(1)
10.2 Form of Warrant Issued In Connection with the Sale of the
Registrant's Series B Preferred Stock on October 5, 1993.(1)
10.3 Form of Warrant Issued in Connection with the Sale of the
Registrant's Series C Preferred Stock on March 16, 1994.(1)
10.4 Form of Performance Warrant Issued in Connection with the
Sale of the Registrant's Series C Preferred Stock on March
16, 1994 and May 4, 1994.(1)
10.4.1 Form of Amendment to Warrants and Performance Warrants.(1)
10.5 Warrant Issued in Connection with the Sale of the
Registrant's Series E Preferred Stock on September 29,
1995.(1)
10.6 Restricted Stock Issuance Agreement, dated May 19, 1995,
between the Registrant, Donald Green and Maureen Green.(1)
10.7 Compensation Agreement, dated May 19, 1995, between the
Registrant and Donald Green.(1)
10.8 Promissory Note Secured by Pledge Agreement, dated May 31,
1995, by Donald Green in favor of the Registrant.(1)
10.9 Stock Pledge Agreement, dated June 16, 1995, between the
Registrant and Donald Green.(1)
</TABLE>
31
<PAGE> 33
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------- --------------------
<S> <C>
10.10 Promissory Note issued by Carl Grivner, dated October 5,
1995, in favor of the Registrant.(1)
10.11 Shareholder and Joint Venture Agreement, dated December 28,
1995, between the Registrant and Harris Corporation, acting
for the purposes of the agreement through its Digital
Telephone Systems Division.(1)+
10.13 License, Joint Development, Supply and Authorized
Manufacturing Agreement, dated September 25, 1992, between
the Registrant and Industrial Technology Research Institute
of the Republic of China.(1)+
10.14 Hangzhou Aftek Communication Registrant Ltd. Contract, dated
June 18, 1994, between Advanced Fibre Technology
Communication (Hong Kong) Limited and Hangzhou Communication
Equipment Factory of the MPT., HuaTong Branch.(1)+
10.15 1445 & 1455 McDowell Boulevard North Net Lease, dated
February 1, 1993, between the Registrant and G & W/ Redwood
Associates Joint Venture, for the premises located at 1445
McDowell Boulevard North.(1)
10.16 Redwood Business Park Net Lease, dated July 9, 1995, between
the Registrant and G & W/ Redwood Associates Joint Venture,
for the premises located at 1455 McDowell Boulevard
North.(1)
10.17 Redwood Business Park Net Lease, dated July 10, 1995,
between the Registrant and G & W/ Redwood Associates Joint
Venture, for the premises located at 1440 McDowell Boulevard
North.(1)
10.18 Redwood Business Park Net Lease, dated June 3, 1996, between
the Registrant and G & W/ Redwood Associates Joint Venture,
for the premises located at Buildings 1 & 9 of Willow Brook
Court.(1)
10.19 Second Amended and Restated Loan and Security Agreement,
dated December 7, 1995, between the Registrant and Bank of
the West.(1)
10.20 Form of Indemnification Agreement for Executive Officers and
Directors of the Registrant.(1)
10.21 The Registrant's 1993 Stock Option/Stock Issuance Plan, as
amended (the "1993 Plan").(1)
10.22 Form of Stock Option Agreement pertaining to the 1993
Plan.(1)
10.23 Form of Notice of Grant of Stock Option pertaining to the
1993 Plan.(1)
10.24 Form of Stock Purchase Agreement pertaining to the 1993
Plan.(1)
10.25 The Registrant's 1996 Stock Incentive Plan (the "1996
Plan").(1)
10.26 Form of Stock Option Agreement pertaining to the 1996
Plan.(1)
10.26.1 Form of Automatic Stock Option Agreement pertaining to the
1996 Plan.(1)
10.27 Form of Notice of Grant of Stock Option pertaining to the
1996 Plan.(1)
10.27.1 Form of Notice of Grant of Non-Employee Director Automatic
Stock Option pertaining to the 1996 Plan.(1)
10.28 Form of Stock Issuance Agreement pertaining to the 1996
Plan.(1)
10.29 The Registrant's Employee Stock Purchase Plan.(1)
10.30 Termination Agreement of Joint Venture and Partnership
Agreement, dated December 23, 1996, between the Registrant
and Tellabs Operations, Inc.(2)
10.31 License and Marketing Agreement, dated December 23, 1996,
between the Registrant and Tellabs Operations, Inc.(2)
10.32 OEM Agreement, dated December 23, 1996, between the
Registrant and Tellabs Operations, Inc.(2)
10.33 Stock Issuance Agreement, dated June 30, 1997, between the
Registrant and Peter A. Darbee.(3)
10.34 Note secured by Stock Pledge Agreement, dated June 30, 1997,
by Peter A. Darbee in favor of the Registrant.(3)
10.35 Stock Pledge Agreement, dated June 30, 1997, between the
Registrant and Peter A. Darbee.(3)
10.36 Consulting Agreement, dated May 19, 1997, between the
Registrant and Peter A. Darbee.(3)
10.37 Cypress Center Net Lease, dated October 9, 1997, between the
Registrant and RNM Lakeville L.P., for the premises located
at 2210 South McDowell Boulevard.
</TABLE>
32
<PAGE> 34
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------- --------------------
<S> <C>
10.38 Termination Agreement and General Release, dated December
22, 1997, between the Registrant and Dan E. Steimle.
10.39 Consulting Agreement, dated December 22, 1997, between the
Registrant and Dan E. Steimle.
13.1 Five Year Summary of Selected Consolidated Financial Data
from the 1997 Annual Report to Stockholders (for EDGAR
filing purposes only).
13.2 Management's Discussion and Analysis of Financial Condition
and Results of Operations from the 1997 Annual Report to
Stockholders (for EDGAR filing purposes only).
13.3 Financial Statements and Supplementary Data from the 1997
Annual Report to Stockholders (for EDGAR filing purposes
only).
21.1 Subsidiaries of the Registrant.(1)
23.1 Consent of KPMG Peat Marwick LLP, Independent Auditors.
27.1 Financial data schedule.
</TABLE>
- ---------------
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (no. 333-8921) filed with the Securities and Exchange Commission on
July 26, 1996, as amended, and declared effective September 30, 1996.
(2) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (no. 333-20369) filed with the Securities and Exchange Commission
on January 24, 1997, as amended, and declared effective February 12, 1997.
(3) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997, filed with the Securities and
Exchange Commission on August 8, 1997.
(4) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997, filed with the Securities and
Exchange Commission on November 7, 1997.
+ Portions of this Exhibit have been granted Confidential Treatment.
3(B). REPORTS ON FORM 8-K
None.
33
<PAGE> 35
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.
ADVANCED FIBRE COMMUNICATIONS, INC.
(Registrant)
By: /s/ CARL J. GRIVNER
------------------------------------
Carl J. Grivner
President, Chief Executive Officer
and Director
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE AND TITLE DATE
------------------- ----
<S> <C>
/s/ DONALD GREEN March 23, 1998
- --------------------------------------------------
Donald Green
Chairman of the Board
/s/ CARL J. GRIVNER March 23, 1998
- --------------------------------------------------
Carl J. Grivner
President, Chief Executive Officer and Director
/s/ B. J. CASSIN March 23, 1998
- --------------------------------------------------
B. J. Cassin
Director
/s/ CLIFFORD H. HIGGERSON March 23, 1998
- --------------------------------------------------
Clifford H. Higgerson
Director
/s/ DAN RASDAL March 23, 1998
- --------------------------------------------------
Dan Rasdal
Director
/s/ ALEX SOZONOFF March 23, 1998
- --------------------------------------------------
Alex Sozonoff
Director
/s/ PETER A. DARBEE March 23, 1998
- --------------------------------------------------
Peter A. Darbee
Vice President, Chief Financial Officer,
Treasurer and Secretary (Principal Financial
Officer)
/s/ KAREN L. GODFREY March 23, 1998
- --------------------------------------------------
Karen L. Godfrey
Vice President, Corporate Controller and
Assistant Secretary
(Principal Accounting Officer)
</TABLE>
34
<PAGE> 36
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------- --------------------
<S> <C>
3.3.1 Fifth Amended and Restated Certificate of Incorporation of
the Registrant.(4)
3.5 Amended and Restated Bylaws of the Registrant.(3)
4.1 Specimen Certificate of Common Stock.(1)
4.2 Series E Preferred Stock Purchase Agreement, dated September
29, 1995, between the Registrant and certain purchasers of
the Registrant's Series E Preferred Stock.(1)
4.3 Certificate of Incorporation of the Registrant (included in
Exhibit 3.3.1).
10.1 Form of Warrant Issued In Connection with the Sale of the
Registrant's Series A Preferred Stock on January 6, 1993.(1)
10.2 Form of Warrant Issued In Connection with the Sale of the
Registrant's Series B Preferred Stock on October 5, 1993.(1)
10.3 Form of Warrant Issued in Connection with the Sale of the
Registrant's Series C Preferred Stock on March 16, 1994.(1)
10.4 Form of Performance Warrant Issued in Connection with the
Sale of the Registrant's Series C Preferred Stock on March
16, 1994 and May 4, 1994.(1)
10.4.1 Form of Amendment to Warrants and Performance Warrants.(1)
10.5 Warrant Issued in Connection with the Sale of the
Registrant's Series E Preferred Stock on September 29,
1995.(1)
10.6 Restricted Stock Issuance Agreement, dated May 19, 1995,
between the Registrant, Donald Green and Maureen Green.(1)
10.7 Compensation Agreement, dated May 19, 1995, between the
Registrant and Donald Green.(1)
10.8 Promissory Note Secured by Pledge Agreement, dated May 31,
1995, by Donald Green in favor of the Registrant.(1)
10.9 Stock Pledge Agreement, dated June 16, 1995, between the
Registrant and Donald Green.(1)
10.10 Promissory Note issued by Carl Grivner, dated October 5,
1995, in favor of the Registrant.(1)
10.11 Shareholder and Joint Venture Agreement, dated December 28,
1995, between the Registrant and Harris Corporation, acting
for the purposes of the agreement through its Digital
Telephone Systems Division.(1)+
10.13 License, Joint Development, Supply and Authorized
Manufacturing Agreement, dated September 25, 1992, between
the Registrant and Industrial Technology Research Institute
of the Republic of China.(1)+
10.14 Hangzhou Aftek Communication Registrant Ltd. Contract, dated
June 18, 1994, between Advanced Fibre Technology
Communication (Hong Kong) Limited and Hangzhou Communication
Equipment Factory of the MPT., HuaTong Branch.(1)+
10.15 1445 & 1455 McDowell Boulevard North Net Lease, dated
February 1, 1993, between the Registrant and G & W/ Redwood
Associates Joint Venture, for the premises located at 1445
McDowell Boulevard North.(1)
10.16 Redwood Business Park Net Lease, dated July 9, 1995, between
the Registrant and G & W/ Redwood Associates Joint Venture,
for the premises located at 1455 McDowell Boulevard
North.(1)
10.17 Redwood Business Park Net Lease, dated July 10, 1995,
between the Registrant and G & W/ Redwood Associates Joint
Venture, for the premises located at 1440 McDowell Boulevard
North.(1)
10.18 Redwood Business Park Net Lease, dated June 3, 1996, between
the Registrant and G & W/ Redwood Associates Joint Venture,
for the premises located at Buildings 1 & 9 of Willow Brook
Court.(1)
10.19 Second Amended and Restated Loan and Security Agreement,
dated December 7, 1995, between the Registrant and Bank of
the West.(1)
10.20 Form of Indemnification Agreement for Executive Officers and
Directors of the Registrant.(1)
10.21 The Registrant's 1993 Stock Option/Stock Issuance Plan, as
amended (the "1993 Plan").(1)
</TABLE>
<PAGE> 37
EXHIBIT INDEX (Continued)
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------- --------------------
<S> <C>
10.22 Form of Stock Option Agreement pertaining to the 1993
Plan.(1)
10.23 Form of Notice of Grant of Stock Option pertaining to the
1993 Plan.(1)
10.24 Form of Stock Purchase Agreement pertaining to the 1993
Plan.(1)
10.25 The Registrant's 1996 Stock Incentive Plan (the "1996
Plan").(1)
10.26 Form of Stock Option Agreement pertaining to the 1996
Plan.(1)
10.26.1 Form of Automatic Stock Option Agreement pertaining to the
1996 Plan.(1)
10.27 Form of Notice of Grant of Stock Option pertaining to the
1996 Plan.(1)
10.27.1 Form of Notice of Grant of Non-Employee Director Automatic
Stock Option pertaining to the 1996 Plan.(1)
10.28 Form of Stock Issuance Agreement pertaining to the 1996
Plan.(1)
10.29 The Registrant's Employee Stock Purchase Plan.(1)
10.30 Termination Agreement of Joint Venture and Partnership
Agreement, dated December 23, 1996, between the Registrant
and Tellabs Operations, Inc.(2)
10.31 License and Marketing Agreement, dated December 23, 1996,
between the Registrant and Tellabs Operations, Inc.(2)
10.32 OEM Agreement, dated December 23, 1996, between the
Registrant and Tellabs Operations, Inc.(2)
10.33 Stock Issuance Agreement, dated June 30, 1997, between the
Registrant and Peter A. Darbee.(3)
10.34 Note secured by Stock Pledge Agreement, dated June 30, 1997,
by Peter A. Darbee in favor of the Registrant.(3)
10.35 Stock Pledge Agreement, dated June 30, 1997, between the
Registrant and Peter A. Darbee.(3)
10.36 Consulting Agreement, dated May 19, 1997, between the
Registrant and Peter A. Darbee.(3)
10.37 Cypress Center Net Lease, dated October 9, 1997, between the
Registrant and RNM Lakeville L.P., for the premises located
at 2210 South McDowell Boulevard.
10.38 Termination Agreement and General Release, dated December
22, 1997, between the Registrant and Dan E. Steimle.
10.39 Consulting Agreement, dated December 22, 1997, between the
Registrant and Dan E. Steimle.
13.1 Five Year Summary of Selected Consolidated Financial Data
from the 1997 Annual Report to Stockholders (for EDGAR
filing purposes only).
13.2 Management's Discussion and Analysis of Financial Condition
and Results of Operations from the 1997 Annual Report to
Stockholders (for EDGAR filing purposes only).
13.3 Financial Statements and Supplementary Data from the 1997
Annual Report to Stockholders (for EDGAR filing purposes
only).
21.1 Subsidiaries of the Registrant.(1)
23.1 Consent of KPMG Peat Marwick LLP, Independent Auditors.
27.1 Financial data schedule.
</TABLE>
- ---------------
(1) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (no. 333-8921) filed with the Securities and Exchange Commission on
July 26, 1996, as amended, and declared effective September 30, 1996.
(2) Incorporated by reference from the Registrant's Registration Statement on
Form S-1 (no. 333-20369) filed with the Securities and Exchange Commission
on January 24, 1997, as amended, and declared effective February 12, 1997.
(3) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarter ended June 30, 1997, filed with the Securities and
Exchange Commission on August 8, 1997.
(4) Incorporated by reference from the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1997, filed with the Securities and
Exchange Commission on November 7, 1997.
+ Portions of this Exhibit have been granted Confidential Treatment.
<PAGE> 1
EXHIBIT 10.37
CYPRESS CENTER
LEASE AGREEMENT
by and between
RNM LAKEVILLE, L.P.,
a California Limited Partnership
("Landlord")
and
ADVANCED FIBRE COMMUNICATIONS, INC.,
a Delaware corporation
("Tenant")
<PAGE> 2
TABLE OF CONTENTS
1. Parties.............................................................1
2. Demise of Premises..................................................1
3. Lease Term..........................................................1
4. Rent................................................................3
5. Use of Premises.....................................................6
6. Taxes and Assessments...............................................6
7. Insurance...........................................................8
8. Utilities and Other Services.......................................10
9. Repairs and Maintenance............................................10
10. Alterations........................................................11
11. Condition of and Acceptance of the Premises........................12
12. Default............................................................13
13. Destruction........................................................16
14. Condemnation.......................................................18
15. Subleasing and Assignment..........................................19
16. Mechanics Liens....................................................20
17. Inspection of the Premises.........................................21
18. Compliance with Laws...............................................21
19. Subordination......................................................21
20. Signs..............................................................22
21. Option to Extend...................................................23
22. Right of First Offer...............................................24
23. Surrender of the Premises..........................................25
24. Holding Over.......................................................25
25. Notices............................................................25
26. Attorneys' Fees....................................................26
27. Successors.........................................................26
28. Mortgagee Protection...............................................26
29. Estoppel Certificate...............................................27
30. Surrender of Lease Not Merger......................................27
31. Waiver.............................................................27
32. General............................................................27
33. Authority..........................................................29
34. CC&R's.............................................................29
35. Brokers............................................................29
36. Limitation on Landlord's Liability.................................29
37. Hazardous Material.................................................30
38. Integration........................................................31
i
<PAGE> 3
CYPRESS CENTER
LEASE AGREEMENT
1. Parties. This Lease, dated for reference purposes as of September
19, 1997, is made by and between RNM LAKEVILLE, L.P., a California Limited
Partnership ("Landlord"), and ADVANCED FIBRE COMMUNICATIONS, INC., a Delaware
corporation ("Tenant").
2. Demise of Premises. Landlord hereby leases to Tenant and Tenant
hereby leases from Landlord, upon the terms and conditions hereinafter set
forth, those certain premises commonly known as 2210 South McDowell Boulevard
(the "Premises"), located on that certain parcel of real property more
particularly described in Exhibit A attached hereto (the "Property") situated in
Petaluma, County of Sonoma, State of California, described as follows:
A. That certain single story building shell (the "Building")
constructed in accordance with the plans and specifications listed on Exhibit B
attached hereto.
B. The improvements (the "Tenant Improvements") to be constructed
in and about the Building in accordance with the provisions of the Tenant
Improvement Agreement attached hereto as Exhibit C (the "Improvement
Agreement"). The Building and the Tenant Improvements are collectively referred
to in this Lease as the "Improvements".
C. Notwithstanding the foregoing, until the Expansion Date (as
defined in Paragraph 3.C below), Tenant shall lease approximately 140,000 square
feet of the Building outlined as Phases I and II on Exhibit D and the
Improvements contained therein (the "Initial Premises") and the rights to use
the Property for parking and ingress and egress to the Initial Premises in
common with any Temporary Tenant (as defined in Paragraph 4.F below). On the
Expansion Date, Tenant shall lease the entire Premises, including approximately
45,841 square feet outlined as Phase III on Exhibit D (the "Expansion
Premises"). Where the term "Premises" is used in this Lease relative to the time
prior to the Expansion Date, such term shall be deemed to refer only to the
Initial Premises.
3. Lease Term.
A. Lease Term. The term of this Lease ("Lease Term") shall be for
twelve (12) years commencing on the Commencement Date and ending twelve (12)
1
<PAGE> 4
years thereafter unless sooner terminated pursuant to any provision hereof or
unless extended pursuant to Paragraph 21 below.
B. Commencement Date. As used in this Lease, the term
"Commencement Date" shall mean the date of Substantial Completion of the Tenant
Improvements in the Initial Premises in accordance with the provisions of the
Improvement Agreement.
C. Expansion Date. As used in this Lease, the "Expansion Date"
shall mean the later of (i) January 1, 1999, or (ii) the date when all of the
following have occurred:
(i) Substantial Completion of the Tenant Improvements in the
Expansion Premises substantially similar in construction quality to, and with
utilities which are compatible with, the Tenant Improvements in the Initial
Premises (except for minor punchlist items which do not substantially interfere
with Tenant's use of the Expansion Premises), and;
(ii) Any Temporary Tenant(s) of the Expansion Premises shall
have vacated the Expansion Premises.
D. Acceleration of Expansion Date. Notwithstanding the terms set
forth above, Tenant, at its option, may accelerate the Expansion Date by
delivering written notice to Landlord not less than sixty (60) days prior to the
requested accelerated Expansion Date. Landlord shall use its best efforts to
delivery the Expansion Premises to Tenant in the condition set forth in
Subparagraph 3.C by the requested accelerated Expansion Date. Following
Landlord's delivery of the Expansion Premises to Tenant, the Monthly Installment
of Rent shall increase by $0.75 per square foot of the Expansion Premises for
the period between the accelerated Expansion Date and January 1, 1999. Tenant's
right to accelerate the Expansion Date shall be subject to the rights of any and
all Temporary Tenants of the Expansion Premises.
E. Early Entry. Tenant may enter the Initial Premises during the
four (4) weeks prior to the Commencement Date to install fixtures and equipment
therein, and Tenant may enter the Expansion Premises during the four (4) weeks
prior to the Expansion Date to install fixtures and equipment therein: provided,
in each case, Tenant obtains Landlord's prior, written approval, which shall not
be unreasonably withheld or delayed. In addition, Tenant may enter approximately
20,000 square feet of the Premises outlined as Phase I on Exhibit D prior to the
Commencement Date but following Substantial Completion of the Tenant
Improvements in Phase I. All entries shall be subject to all of the terms and
conditions of this Lease, excepting only the obligation to pay the Monthly
Installment of rent or Additional Rent (as defined in
2
<PAGE> 5
paragraph 4.D below) shall not commence until the Commencement Date. Tenant
shall coordinate its entry onto the Premises with Landlord and the contractors
and other personnel employed by Landlord. Tenant shall at all times while
exercising its right of entry, refrain from interfering with the construction
activities of Landlord's personnel. In any case, Tenant shall repair any damage
to the Improvements constructed by Landlord resulting from the entry upon the
Premises by Tenant or Tenant's Agents prior to the Commencement Date or the
Expansion Date, as appropriate, or caused by the installation of fixtures and
equipment by Tenant or Tenant's Agents. If the entry by Tenant or Tenant's
Agents upon the Premises prior to the Commencement Date or the Expansion Date
interferes with Landlord's construction activities, then Landlord shall give
Tenant written notice requesting that Tenant cease such interference. If Tenant
does not immediately comply with such notice from Landlord requesting that
Tenant cease interference with Landlord's construction activities, and if the
entry by Tenant prior to the Commencement Date or the Expansion Date causes a
delay in completing the construction of the Tenant Improvements, then the
Commencement Date or the Expansion Date shall be deemed to have occurred on the
date the Tenant Improvements would have been completed had there been no such
delay caused by Tenant or its Agents. If Tenant does not immediately comply with
notice from Landlord requesting that Tenant cease any interference with
Landlord's construction activities, then Tenant shall be required to vacate the
Premises and shall have no further right to enter the Premises until the
Commencement Date or the Expansion Date.
4. Rent.
A. Time of Payment. Commencing on the Commencement Date, Tenant
shall pay to Landlord as rent for the Premises the respective sums specified in
Subparagraph 4.B below (the "Monthly Installment") each month in advance on the
first day of each calendar month, without deduction or offset, prior notice or
demand, together with such Additional Rent as is payable by Tenant to Landlord
under the terms of this Lease. The Monthly Installment for any period during the
Lease Term which is less than one (1) full month shall be a pro rata portion of
the Monthly Installment based upon a thirty (30) day month.
B. Monthly Installment. The Monthly Installment of rent shall be
the following respective amounts during the following respective time periods:
<TABLE>
<CAPTION>
LEASE MONTH MONTHLY INSTALLMENT
----------- -------------------
<S> <C>
Year 1
Month 1 0
Months 2-4 $ 22,333
Months 5-8 $ 45,000
Months 9-12 $ 67,500
</TABLE>
3
<PAGE> 6
Year 2
Months 1-6 90,000
Months 7-9 $112,500
Months 10-12 $139,381
Year 3 $167,257
Year 4 $167,257
Year 5 $167,257
Year 6 $167,257
Year 7 $167,257
Year 8 $167,257
Year 9 $176,549
Year 10 $176,549
Year 11 $176,549
Year 12 $176,549
C. Late Charge. Tenant acknowledges that late payment by Tenant
to Landlord of rent and other sums due hereunder will cause Landlord to incur
costs not contemplated by this Lease, the exact amount of which will be
extremely difficult to ascertain. Such costs include, but are not limited to,
processing and accounting charges, and late charges which may be imposed on
Landlord by the terms of any mortgage or deed of trust covering the Premises.
Accordingly, if any installment of rent or any other sum due from Tenant shall
not be received by Landlord within ten (10) days after written notice from
Landlord, then Landlord may impose, as Additional Rent, a late charge equal to
six percent (6%) of such overdue amount. The parties hereby agree that such late
charge represents a fair and reasonable estimate of the costs Landlord will
incur by reason of late payment by Tenant. Acceptance of such late charge by
Landlord shall in no event constitute a waiver of Tenant's default with respect
to such overdue amount, nor prevent Landlord from exercising any of its other
rights and remedies granted hereunder.
D. Additional Rent. All other payments due from Tenant to
Landlord hereunder, including without limitation taxes, insurance premiums,
maintenance and repair costs, payments of the Tenant Improvement Loan,
Management Fees, late charges, costs, and expenses, together with all interest
and penalties that may accrue thereon in the event of Tenant's failure to pay
such amounts, and all reasonable damages, costs, and attorneys' fees and
expenses which Landlord may incur by reason of any default of Tenant or failure
on Tenant's part to comply with the terms of this Lease, shall be deemed to be
additional rent ("Additional Rent") and shall be paid in addition to the Monthly
Installment of rent, and, in the event of nonpayment by Tenant,
4
<PAGE> 7
Landlord shall have all of the rights and remedies with respect thereto as
Landlord has for the nonpayment of the Monthly Installment of rent.
E. Management Fee. With each payment of the Monthly Installment
of rent, Tenant shall pay to Landlord a monthly management fee equal to $2,000
per month, increasing, at the option by of the Landlord, by up two and
one-half percent (2 1/2%) on each anniversary of the Commencement Date.
F. Temporary Tenants. Landlord reserves the right to lease all or
any portion of the Expansion Premises to any other tenant or tenants ("Temporary
Tenant") under the following conditions: (i) Tenant shall approve (which
approval shall not be unreasonably withheld or delayed) the identity of the
Temporary Tenant, the location of its premises, and any improvement required for
such Temporary Tenant, (ii) Tenant shall not be liable for any costs or expenses
associated with any lease to any Temporary Tenant, including construction or
cleanup costs, (iii) any such lease terminates prior to the Expansion Date, and
(iv) during the term of any lease to a Temporary Tenant(s) Tenant's share of
Property Taxes, reimbursement of insurance premiums and reimbursement of
operating expenses shall be decreased in proportion to the total square footage
of the Building, being leased to the Temporary Tenant(s).
G. Place of Payment. Rent shall be payable in lawful money of the
United States of America to Landlord at 135 Main Street, San Francisco,
California 94105 or to such other person(s) or at such other place(s) as
Landlord may designate in writing.
H. Advance Payment. Concurrently with the execution of this
Lease, Tenant shall pay to Landlord the sum of One Hundred, Thirty-Nine Thousand
Three Hundred Eighty-One Dollars ($139,381) to be applied to the Monthly
Installment of rent due for the twenty-second (22nd) month following the
Commencement Date.
I. Interest on Past Due Obligations. Any Monthly Installment of
rent due from Tenant, or any other sum due under this Lease from Tenant, which
is received by Landlord after the date ten (10) days after the date due, shall
bear interest from said due date until paid, at an annual rate equal to the
lower of (the "Permitted Rate"): (1) twelve percent (12%); or (2) five percent
(5%) plus the rate established by the Federal Reserve Bank of San Francisco, as
of the twenty-fifth (25th) day of the month immediately preceding the due date,
on advances to member Banks. Payment of such interest shall not excuse or cure
any default by Tenant.
5
<PAGE> 8
5. Use of Premises.
A. Restrictions on Use. Tenant shall use the Premises only in
conformance with the CC&R's (as defined below) and applicable governmental Laws,
regulations, rules and ordinances for the purpose of manufacturing of
telecommunications equipment and related and ancillary office uses and for no
other purpose without the consent of Landlord, which shall not be unreasonably
withheld. Tenant shall not commit or suffer to be committed, any waste upon the
Premises, or any nuisance, or other acts or things which may disturb the quiet
enjoyment of any tenant or user of the buildings adjacent to the Premises, or
allow any sale by auction upon the Premises, or allow the Premises to be used
for any unlawful purpose, or place any loads upon the floor, walls or ceiling
which would endanger the structure, or place any harmful liquids in the drainage
system of the Premises. No waste materials or refuse shall be dumped upon or
permitted to remain upon any part of the Premises outside of the Building,
except in trash containers placed inside exterior enclosures designated for that
purpose by Landlord. No materials, supplies, equipment, finished products or
semifinished products, raw materials or articles of any nature shall be stored
upon or permitted to remain on any portion of the property outside of the
Building. Tenant shall strictly comply with the provisions of Paragraph 37
below.
6. Taxes and Assessments.
A. Tenant's Property. Tenant shall pay before delinquency any and
all taxes and assessments, license fees and public charges levied, assessed or
imposed upon or against Tenant's fixtures, equipment, furnishings, furniture,
appliances and personal property installed or located on or within the Premises.
Tenant shall use its best efforts to cause said fixtures, equipment,
furnishings, furniture, appliances and personal property to be assessed and
billed separately from the real property of Landlord. If any of Tenant's said
personal property shall be assessed with Landlord's real property, Tenant shall
pay Landlord the taxes attributable to Tenant within ten (10) days after receipt
of a written statement from Landlord setting forth the taxes applicable to
Tenant's property.
B. Property Taxes. Tenant shall pay, as Additional Rent, one
hundred percent (100%) of all Property Taxes levied or assessed with respect to
the Improvements, Building, Property and the Premises which become due or accrue
during the term of this Lease. Tenant shall pay such Property Taxes to Landlord
not later than (i) ten (10) days prior to the delinquency date of such Property
Taxes, or (ii) twenty (20) days after receipt of billing, whichever is later. If
Tenant fails to do so, Tenant shall reimburse Landlord, on demand, for all
interest, late fees and penalties that the taxing authority charges Landlord.
Tenant's liability hereunder shall be prorated to reflect the Commencement Date
and termination dates of this Lease.
6
<PAGE> 9
C. Property Taxes Defined. For the purpose of this Lease,
"Property Taxes" means and includes all taxes, assessments (including, but not
limited to, assessments for all public improvements or benefits, taxes based on
vehicles utilizing parking areas, taxes based or measured by the rent paid,
payable or received under this Lease, taxes on the value, use, or occupancy of
the Premises, the Building and/or the Property, and all other governmental
impositions and charges of every kind and nature whatsoever, whether or not
customary or within the contemplation of the parties hereto and regardless of
whether the same shall be extraordinary or ordinary, general or special,
unforeseen or foreseen, or similar or dissimilar to any of the foregoing which,
at any time during the Lease Term, shall be applicable to the Premises, the
Building and/or the Property or assessed, levied or imposed upon the Premises,
the Building and/or the Property, or become due and payable and a lien or charge
upon the Premises, the Building and/or the Property, or any part thereof, under
or by virtue of any present or future Laws, statutes, ordinances, regulations or
other requirements of any governmental authority whatsoever. The term "Property
Taxes" shall not include any federal, state or local net income, estate, gift or
inheritance tax imposed on Landlord.
D. Other Taxes. Tenant shall, as Additional Rent, pay or
reimburse Landlord for any tax based upon, allocable to, or measured by the area
of the Premises or the Building or the Property; or by the rent paid, payable or
received under this Lease; any tax upon or with respect to the possession,
leasing, operation, management, maintenance, alteration, repair, use or
occupancy of the Premises or any portion thereof, any privilege tax, excise tax,
business and occupation tax, gross receipts tax, sales and/or use tax, water
tax, sewer tax, employee tax occupational license tax imposed upon Landlord or
Tenant with respect to the Premises, any tax upon this transaction or any
document to which Tenant is a party creating or transferring an interest or an
estate in the Premises.
E. Tenant's Right to Contest. Tenant shall have the right, by
appropriate proceedings, to protest or contest any assessment, reassessment or
allocation of Property Taxes or any change therein. In the contest or
proceedings, Tenant may act in its own name and/or the name of Landlord and
Landlord will, at Tenant's request and expense, cooperate with Tenant in any way
Tenant may reasonably require in connection with such contest. Tenant must pay
all Property Taxes as and when required by Paragraph 6.B, even those which are
the subject of such protest or contest, but Tenant may sue to recover
overpayments of Property Taxes as part of any such contest. With respect to any
contest of Property Taxes, Tenant shall indemnify and hold Landlord and the
Premises harmless from any liens or damage arising out of such protest or
contest and shall pay any judgment that may be rendered for which Tenant would
otherwise be liable under this Lease without such contest or protest. Any
contest conducted by Tenant under this paragraph shall be at Tenant's expense
and if interest
7
<PAGE> 10
or late charges become payable as a result of such contest or protest, Tenant
shall pay the same.
7. Insurance.
A. Indemnity. Tenant agrees to indemnify, protect and defend
Landlord against and hold Landlord harmless from any and all claims, causes of
action, judgments, obligations or liabilities, and all reasonable expenses
incurred in investigating or resisting the same (including reasonable attorneys'
fees), on account of, or arising out of, the operation, maintenance, use or
occupancy of the Premises by Tenant and/or its Agents (except for the sole
negligence or willful misconduct of Landlord or its Agents). This Lease is made
on the express understanding that Landlord shall not be liable for, or suffer
loss by reason of, injury to person or property, from whatever cause (except for
the sole negligence or willful misconduct of Landlord or its Agents), which in
any way may be connected with the operation, maintenance, use or occupancy of
the Premises by Tenant and/or its Agents specifically including, without
limitation, any liability for injury to the person or property of Tenant or its
Agents.
B. Liability Insurance. Tenant shall, at Tenant's expense, obtain
and keep in force during the term of this Lease a policy of comprehensive public
liability insurance insuring Landlord and Tenant against claims and liabilities
arising out of the operation, maintenance, use, or occupancy of the Premises.
Such insurance shall provide combined single limit coverage of not less than Two
Million Dollars ($2,000,000.00) per occurrence with a Ten Million Dollar
($10,000,000) umbrella coverage. Landlord shall have the right to require Tenant
to increase the amount of coverage of such public liability insurance to the
extent reasonably necessary to bring such insurance coverage into conformity
with the level of coverage commonly carried by similar businesses in California.
The insurance shall be provided by companies with a Best's Insurance Guide
rating of at least A or otherwise approved by Landlord. Tenant shall deliver to
Landlord, prior to possession, and at least thirty (30) days prior to the
expiration of coverage, a certificate of insurance evidencing the existence of
the policy required hereunder and such certificate shall certify that the policy
(1) names Landlord and Landlord's property manager as an additional insured, (2)
shall not be canceled or altered without thirty (30) days prior written notice
to Landlord, (3) insures performance of the indemnity set forth in Subparagraph
7.A above, (4) the coverage is primary and any coverage by Landlord is in excess
thereto and (5) contains a cross liability endorsement.
Landlord shall maintain a policy or policies of comprehensive general
liability insurance insuring Landlord (and such others as are designated by
Landlord), against liability for personal injury, bodily injury, death and
damage to property occurring or resulting from an occurrence in, on or about the
Premises, with such limits of coverage
8
<PAGE> 11
as Landlord may from time to time determine are reasonably necessary for its
protection but in no event less than Two Million Dollars ($2,000,000) per
occurrence with a Ten Million Dollar ($10,000,000 umbrella coverage. Tenant
shall, as Additional Rent, reimburse Landlord for the cost of any such insurance
policy within ten (10) days after receipt of billing.
C. Property Insurance. Landlord shall, at Tenant's expense,
obtain and keep in force during the Lease Term a policy of insurance covering
loss or damage to the Building and Tenant Improvements, in the amount of at
least eighty percent (80%) of the full replacement value thereof with Agreed
Amount Endorsement, providing protection against those perils included within
the classification of "all risk" insurance, flood insurance, earthquake
insurance, Plus a policy of rental abatement income insurance in the amount of
one hundred percent (100%) of twelve (12) months' rent (including, without
limitation, sums payable as Additional Rent), and any other coverages which may
be required from time to time by Landlord's Lender. Landlord shall have the
right to procure the foregoing coverage by means of a blanket policy provided
that the coverage allocated under such blanket policy with respect to the
Premises is at least equivalent to the coverage that Landlord is obligated to
provide under this Paragraph 7.C. Tenant shall, as Additional Rent, reimburse
Landlord for the full cost of such insurance within ten (10) days after receipt
of billing.
D. Tenant's Personal Property Insurance. Tenant, at Tenant's own
expense, shall maintain in full force and effect on all of its fixtures,
equipment and personal property in the Premises, a policy of "All Risk" coverage
insurance to the extent of at least eighty percent (80%) of the insurable value.
Tenant assumes all risk, and Landlord shall have no liability for any insured or
uninsured loss or damage to Tenant's personal property, trade fixtures or
improvements, except to the extent such loss or damage is attributable to
Landlord's intentional misconduct or failure of Landlord to comply with its
obligations under Subparagraph 9.A. If Tenant desires to pursue a claim for
damage to Tenant's personal property due to latent structural defects in
construction or design of the Premises against the design and construction
professionals who constructed and designed the Premises, then Landlord shall
cooperate reasonably in pursuing Tenant's claim against such parties.
E. Mutual Waiver of Subrogation. Tenant and Landlord hereby
mutually waive their respective rights of recovery against each other of any
loss of or damage to the property of either party, to the extent such loss or
damage is insured by any insurance policy required to be maintained by this
Lease or otherwise in force at the time of such loss or damage. Each party shall
obtain any special endorsements, if required by the insurer, whereby the insurer
waives its right of subrogation against the other party hereto. The provisions
of this Subparagraph 7.E shall not apply in those
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instances in which the waiver of subrogation would cause either party's
insurance coverage to be voided or otherwise made uncollectible.
8. Utilities and Other Services. Tenant shall pay for all water, gas,
light, heat, power, electricity, telephone, trash pick-up, sewer charges,
janitorial charges, and all other services supplied to or consumed on the
Premises, Building, and Property and all taxes and surcharges thereon.
9. Repairs and Maintenance.
A. Landlord's Repairs. Subject to the provisions of Paragraph 13,
Landlord shall, at its sole cost and expense, repair and replace the structural
elements and exterior walls of the Building including the roof structure and
roof membrane (the "Structural Elements") in compliance with all applicable
Laws. Landlord shall not, however, be required to perform routine maintenance on
the Structural Elements or to maintain, repair or replace the interior surface
of exterior walls, nor shall Landlord be required to maintain, repair or replace
windows, doors, skylights, plate glass, roofing, caulking, waterproofing,
flooring, gutters, down spouts, the electrical, plumbing, lighting, heating,
ventilating and air conditioning systems and equipment, and all areas outside
the Building (including all landscaping, irrigation systems, paving, driveways,
parking areas, sidewalks, fences, sips and exterior lighting). If Landlord
elects to perform such routine maintenance, repair and replacement, then Tenant
shall reimburse Landlord therefor as Additional Rent; provided, however, that
Tenant shall be entitled to participate actively and reasonably in the selection
by Landlord of contractors to perform such tasks. Landlord shall have no
obligation to commence repairs under this Subparagraph 9.A until at least thirty
(30) days after receipt of written notice from Tenant of the need for such
repairs.
B. Tenant's Repairs. Except as expressly provided in Subparagraph
9.A above and Paragraph 13 below, Tenant shall, at its sole cost, keep and
maintain (or reimburse Landlord for its costs required to do so) the entire
Premises, and every part thereof, including without limitation, the windows,
window frames, plate glass, glazing, skylights, truck doors, doors and all door
hardware, the interior walls and partitions, interior surfaces of exterior
walls, carpets, flooring, gutters, down spouts, the electrical, plumbing,
lighting, heating, ventilating and air conditioning systems and equipment, and
all areas outside the Building (including all landscaping, irrigation systems,
paving, roofing, driveways, parking areas, sidewalks, fences, signs and exterior
lighting) and the Structural Elements in good order, condition and repair,
ordinary wear and tear excepted. The term "repairs" shall include replacements,
restorations and/or renewals when necessary as well as painting. Tenant's
obligation shall extend to all alterations, additions and improvements to the
Premises, and all fixtures and appurtenances therein and thereto. Should Tenant
fail to commence to make repairs required of Tenant
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hereunder within ten (10) days after notice from Landlord or should Tenant fail
thereafter to diligently complete the repairs, Landlord, in addition to all
other remedies available hereunder or by Law and without waiving any alternative
remedies, may make the same, and in that event, Tenant shall reimburse Landlord
as Additional Rent for the cost of such maintenance or repairs within ten (10)
days of written demand by Landlord.
C. Lease Controls. Landlord shall have no maintenance or repair
obligations whatsoever with respect to the Premises except as expressly provided
in Subparagraph 9.A and Paragraph 13. Tenant hereby expressly waives the
provisions of Subsection 1 of Section 1932 and Sections 1941 and 1942 of the
Civil Code of California and all rights to make repairs at the expense of
Landlord as provided in Section 1942 of said Civil Code.
10. Alterations.
A. Limitations. Tenant shall not make, or suffer to be made, any
alterations, improvements or additions in, on, about or to the Premises or any
part thereof, without the prior written consent of Landlord (which consent shall
not be unreasonably withheld) and without all applicable building permits issued
by the appropriate governmental authority; provided, however, Landlord's consent
shall not be required for interior non-structural alterations which cost less
than Twenty Thousand Dollars ($20,000) in any twelve (12) month period. As a
condition to, and concurrently with, the giving of such consent Landlord may
require that Tenant agree to remove any such alterations, improvements or
additions at the termination of this Lease, and to restore the Premises to their
prior condition. Unless Landlord requires that Tenant remove any such
alteration, improvement or addition, any alteration, addition or improvement to
the Premises, except movable furniture and trade fixtures not affixed to the
Premises, shall become the property of Landlord upon termination of the Lease
and shall remain upon and be surrendered with the Premises at the termination of
this Lease. Without limiting the generality of the foregoing, all heating,
lighting, electrical (including all wiring, conduit, outlets, drops, buss ducts,
main and subpanels), air conditioning, partitioning, drapery, and carpet
installations made by Tenant regardless of how affixed to the Premises, together
with all other additions, alterations and improvements that have become an
integral part of the Building, shall be and become the property of the Landlord
upon termination of the Lease, and shall not be deemed trade fixtures, and shall
remain upon and be surrendered with the Premises at the termination of this
Lease.
B. Alterations Required By Law. If, during the term hereof, any
alteration, addition or change of any sort to all or any portion of the Premises
(other than those portions of the Premises which Landlord is obligated to
maintain and repair
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pursuant to Paragraph 9.A) is required by Law for Tenant's occupancy of the
Premises, then Tenant shall promptly make the same at its sole cost and expense.
If, during the term hereof, any Law requires for Tenant's lawful occupancy of
the Premises any alteration, addition or change of any sort to the portion of
the Premises which Landlord is obligated to maintain and repair pursuant to
Paragraph 9.A, then Landlord shall promptly make the same and shall charge
Tenant for the cost thereof as provided in Paragraph 9.A.
11. Condition of and Acceptance of the Premises.
A. Compliance. To the best of Landlord's current actual
knowledge, Landlord hereby represents and warrants that the Premises do now and
at the delivery of possession to Tenant shall, comply with all current laws,
regulations, design guidelines and the CC&R's. Landlord hereby agrees to
indemnity, protect, defend and hold Tenant harmless against any loss, expense,
damage, attorneys' fees or liability arising out of Landlord's breach of the
representation and warranty set forth above, subject to the following
limitations: (i) prior to enforcing any claim against Landlord with respect to
design or construction matters, Tenant shall first seek to enforce such warranty
rights and remedies as may be available to Tenant against the architects,
contractors and others involved in the design and construction of the Premises,
and (ii) Tenant makes any claims against Landlord under this Section within one
year following the Commencement Date (or within one year following the Expansion
Date with respect to the Expansion Premises).
B. Acceptance of the Premises, Assignment of Warranties. Subject
to the provisions of Section 11.A, by entry and taking possession of the
Premises pursuant to this Lease, Tenant accepts the Premises as being in good
and sanitary order, condition and repair and accepts the Premises in their
condition existing as of the date of such entry and Tenant further accepts the
Tenant Improvements to be constructed by Landlord, if any, as being completed in
accordance with the plans and specifications for such Tenant Improvements,
except for punchlist items. Tenant shall prepare the punchlist with Architect
within five (5) business days (sixty (60) days for latent defects) after the
Commencement Date (or the Expansion Date with respect to the Expansion
Premises), and Landlord shall use good faith efforts to complete each punchlist
item, at its sole cost, within thirty (30) business days following notice of the
punchlist item. As of the Commencement Date (or the Expansion Date with 'respect
to the Improvements within the Expansion Premises), Landlord assigns to Tenant
Landlord's warranties and guaranties relating to the Improvements and the Tenant
Improvements.
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12. Default.
A. Events of Default. A breach of this Lease by Tenant shall
exist if any of the following events (hereinafter referred to as "Event of
Default") shall occur:
(1) Default in the payment when due of any installment of
rent or other payment required to be made by Tenant hereunder, where such
default shall not have been cured within three (3) days after written notice of
such default is given to Tenant;
(2) Tenant's failure to perform any other material term,
covenant or condition contained in this Lease where such failure shall have
continued for twenty (20) days after written notice of such failure is given to
Tenant; provided, however, Tenant shall not be deemed in default if Tenant
commences to cure such failure within said twenty (20) day period and thereafter
diligently prosecutes such cure to completion;
(3) Tenant's abandonment of the Premises;
(4) Tenant's assignment of its assets for the benefit of its
creditors;
(5) The sequestration of, attachment of, or execution on,
any substantial part of the property of Tenant or on any property essential to
the conduct of Tenant's business shall have occurred and Tenant shall have
failed to obtain a return or release of such property within thirty (30) days
thereafter, or prior to sale pursuant to such sequestration, attachment or levy,
whichever is earlier;
(6) Tenant or any guarantor of Tenant's obligations
hereunder shall commence any case, proceeding or other action seeking
reorganization, arrangement, adjustment, liquidation, dissolution or composition
of it or its debts under any Law relating to bankruptcy, insolvency,
reorganization or relief of debtors, or seek appointment of a receiver,
trustee, custodian, or other similar official for it or for all or any
substantial part of its property;
(7) Tenant or any such guarantor shall take any corporate
action to authorize any of the actions set forth in Clause (6) above; or
(8) Any case, proceeding or other action against Tenant or
any guarantor of Tenant's obligations hereunder shall be commenced seeking to
have an order for relief entered against it as debtor, or seeking
reorganization, arrangement, adjustment, liquidation, dissolution or composition
of it or its debts under any Law relating to bankruptcy, insolvency,
reorganization or relief of debtors, or seeking
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appointment of a receiver, trustee, custodian or other similar official for it
or for all or any substantial part of its property, and such case, proceeding or
other action (i) results in the entry of an order for relief against it which is
not fully stayed within seven (7) business days after the entry thereof or (ii)
remains undismissed for a period of sixty (60) days.
B. Remedies. Upon any Event of Default, Landlord shall have the
following remedies, in addition to all other rights and remedies provided by
Law, to which Landlord may resort cumulatively, or in the alternative:
(1) Recovery of Tenant Improvement Investment. The parties
acknowledge that as consideration for Tenant's performance of all its
obligations under this Lease, Landlord is investing the Tenant Allowance and
additional costs into the Premises and paying significant broker's commissions.
Should an Event of Default occur under the Lease, then, the parties agree that
Landlord shall be entitled to recover from Tenant a portion of said investment
equal to (A) $1,000,000, less (B) $7,000 per month for each full month between
the Commencement Date and the Event of Default.
(2) Recovery of Rent. Landlord shall be entitled to keep
this Lease in full force and effect in accordance with California Civil Code
Section 1951.4 (whether or not Tenant shall have abandoned the Premises) and to
enforce all of its rights and remedies under this Lease, including the right to
recover rent and other sums as they become due, plus interest at the Permitted
Rate from the due date of each installment of rent or other sum until paid,
subject to the provisions of Section 12.B(4) below.
(3) Termination. Upon an Event of Default, Landlord may
terminate this Lease by giving Tenant not less than five (5) days prior, written
notice of termination. Upon the giving of the notice, all of Tenant's rights in
the Premises shall terminate. Upon the giving of the notice, Tenant shall
surrender and vacate the Premises in the condition required by Paragraph 23, and
Landlord may re-enter and take possession of the Premises and all the remaining
Improvements or property and eject Tenant or any of Tenants subtenants,
assignees or other person or persons claiming any right under or through Tenant
or eject some and not others or eject none. This Lease may also be terminated by
a judgment specifically providing for termination. Any termination under this
paragraph shall not release Tenant from the payment of any sum then due Landlord
or from any claim for damages or rent previously accrued or then accruing
against Tenant. In no event shall any one or more of the following actions by
Landlord constitute a termination of this Lease:
(a) maintenance and preservation of the Premises;
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(b) efforts to relet the Premises;
(c) appointment of a receiver in order to protect
Landlord's interest hereunder;
(d) consent to any subletting of the Premises or
assignment of this Lease by Tenant, whether pursuant to provisions hereof
concerning subletting and assignment or otherwise; or
(e) any other action by Landlord or Landlord's Agents
intended to mitigate the adverse effects from any breach of this Lease by
Tenant.
(4) Damages. In the event this Lease is terminated pursuant
to Subparagraph 12.B(2) above, or otherwise, Landlord shall be entitled to
damages in the following sums:
(a) the worth at the time of award of the unpaid rent
which has been earned at the time of termination; plus
(b) the worth at the time of award of the amount by
which the unpaid rent which would have been earned after termination until the
time of award exceeds the amount of such rental loss which could have been
reasonably avoided; plus
(c) the worth at the time of award of the amount by
which the unpaid rent for the balance of the term after the time of award
exceeds the amount of such rental loss which could be reasonably avoided; and
(d) any other amount necessary to compensate Landlord
for all detriment proximately caused by Tenant's failure to perform Tenant's
obligations under this Lease, or which in the ordinary course of things would be
likely to result therefrom including, without limitation, the following: (i)
expenses for cleaning, repairing or restoring the Premises; (ii) real estate
broker's fees, advertising costs and other expenses of reletting the Premises
which are reasonably incurred by Landlord; (iii) reasonable costs of carrying
the Premises such as taxes and insurance premiums thereon, utilities and
security precautions; (iv) expenses in retaking possession of the Premises; and
(v) reasonable attorneys' fees and court costs arising from the Event of
Default.
(e) The "worth at the time of award" of the amounts
referred to in Subparagraphs (a) and (b) of this Paragraph 12.B(4), is computed
by allowing interest at the Permitted Rate. The "worth at the time of award" of
the amounts referred to in Subparagraph (c) of this Paragraph 12.B(4) is
computed by
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discounting such amount at the discount rate of the Federal Reserve Board of San
Francisco at the time of award plus one percent (1%). The term "rent" as used in
this Paragraph 12 shall include all sums required to be paid by Tenant to
Landlord pursuant to the terms of this Lease.
13. Destruction.
A. Landlord's Duty to Restore. If the Improvements are damaged by
any peril after the Commencement Date of this Lease, Landlord shall restore the
Premises unless the Lease is terminated by Landlord pursuant to Paragraph 13.B
or by Tenant pursuant to Paragraph 13.C. If this Lease is terminated pursuant to
either Paragraphs 13.B or 13.C, then all insurance proceeds available from
insurance carried by Tenant which covers loss to property that is Landlord's
property or would become Landlord's property on the termination of this Lease
shall be paid to and become the property of Landlord. If this Lease is not so
terminated, then upon receipt of the insurance proceeds (if the loss is covered
by insurance) and the issuance of all necessary governmental permits, Landlord
shall commence and diligently prosecute to completion the restoration of the
Premises, to the extent then allowed by Law, to substantially the same condition
in which the Premises were immediately prior to such damage. Landlord's
obligation to restore shall be limited to the Building and Tenant Improvements
constructed by Landlord as they existed as of the Commencement Date or the
Expansion Date, excluding any trade fixtures and/or personal property and/or
alterations constructed or installed by Tenant in the Premises. Tenant shall
forthwith replace or fully repair all trade fixtures installed by Tenant and
existing at the time of such damage or destruction.
B. Landlord's Right to Terminate. Landlord shall have the option
to terminate this Lease in the event any of the following occurs, which option
may be exercised only by delivery to Tenant of a written notice of election to
terminate within thirty (30) days after the date of such damage:
(1) The Improvements are damaged by any peril to such an
extent that the estimated restoration cost exceeds fifty percent (50%) of the
then actual replacement cost thereof.
(2) The Improvements are damaged by any peril not covered by
valid and collectible insurance carried by Landlord and in force at the time of
such damage or destruction, to such an extent that the estimated restoration
cost exceeds five percent (5%) of the then actual replacement cost thereof;
provided, however, that Landlord may not terminate this Lease pursuant to this
subparagraph if Tenant agrees in writing to pay the amount by which the
restoration cost exceeds five percent (5%) of the replacement cost of the
Improvements and deposits with Landlord an amount
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equal to the estimated amount of such excess within thirty (30) days after
Landlord has notified Tenant of its election to terminate this Lease pursuant to
this subparagraph.
(3) The improvements are damaged by any peril during the
last twelve (12) months of the Lease Term to such an extent that the estimated
cost to restore equals or exceeds an amount equal to six (6) times the Monthly
Installment of rent then due; provided, however, that Landlord may not terminate
this Lease pursuant to this subparagraph if Tenant, at the time of such damage,
has an express written option to further extend the term of this Lease and
Tenant exercises such option to so further extend the Lease Term within fifteen
(15) days following the date of such damage.
(4) The Improvements are damaged by any peril and, because
of the Laws then in force, (i) may not be restored at reasonable costs to
substantially the same condition in which it was prior to such damage, or (ii)
if restored, may not be used for the same use being made thereof before such
damage.
C. Tenant's Right to Terminate. If the Improvements are damaged
by any peril and Landlord does not elect to terminate this Lease or is not
entitled to terminate this Lease pursuant to Paragraph 13.B, then as soon as
reasonably practicable, Landlord shall furnish Tenant with the written opinion
of Landlord's architect or construction consultant as to when the restoration
work required of Landlord be completed. Tenant shall have the option to
terminate this Lease in the event any of the following occurs, which option may
be exercised only by delivery to Landlord of a written notice of election to
terminate within fifteen (15) days after Tenant receives from Landlord the
estimate of the time needed to complete such restoration:
(1) The Improvements are damaged by any peril and, in the
reasonable opinion of Landlord's architect or construction consultant, the
restoration of the Premises cannot be substantially completed within one hundred
twenty (120) days after the issuance of necessary building permits for such
restoration.
(2) The Improvements are damaged by any peril within twelve
(12) months of the last day of the Lease Term, and, in the reasonable opinion of
Landlord's architect or construction consultant, the restoration of the Premises
cannot be substantially completed within ninety (90) days after the date of
such damage.
D. Abatement of Rent. In the event of damage to the Premises
which does not result in the termination of this Lease, the Monthly Installment
of rent and Additional Rent shall be temporarily abated during the period of
restoration in proportion to the degree to which Tenant's use of the Premises is
impaired by such damage. Tenant shall not be entitled to any compensation from
Landlord for loss of Tenant's property or loss to Tenant's business caused by
such damage or restoration.
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Tenant hereby waives the provisions of Section 1932, Subdivision 2, and Section
1933, Subdivision 4, of the California Civil Code, and the provisions of any
similar Law. hereinafter enacted
14. Condemnation.
A. Definition of Terms. For the purposes of this Lease, the term
(1) "Taking" means a taking of the Premises or damage to the Premises related to
the exercise of the power of eminent domain and includes a voluntary conveyance,
in lieu of court proceedings, to any agency, authority, public utility, person
or corporate entity empowered to condemn property; (2) "Total Taking" means the
Taking of the entire Premises or so much of the Premises as to prevent or
substantially impair the use thereof by Tenant for the uses herein specified;
(3) "Partial Taking" means a Taking which does not constitute a Total Taking;
(4) "Date of Taking" means the date upon which the title to the Premises, or a
portion thereof, passes to and vests in the condemner or the effective date of
any order for possession if issued prior to the date title vests in the
condemner; and (5) "Award" means the amount of any award made, consideration
paid, or damages ordered as a result of a Taking.
B. Rights. The parties agree that in the event of a Taking all
rights between them or in and to an Award shall be as set forth herein and
Tenant shall have no right to any Award except as set forth herein.
C. Total Taking. In the event of a Total Taking during the term
hereof (1) the rights of Tenant under the Lease and the leasehold estate of
Tenant in and to the Premises shall cease and terminate as of the Date of
Taking; (2) Landlord shall refund to Tenant any prepaid rent and any unapplied
Security Deposit; (3) Tenant shall pay Landlord any rent or charges due Landlord
under the Lease, each prorated as of the Date of Taking; (4) Tenant shall
receive from the Award those portions of the Award attributable specifically to
trade fixtures of Tenant and for moving expenses of Tenant; and (5) the
remainder of the Award shall be paid to and be the property of Landlord. Tenant
may make a separate claim against the condemning authority so long as such
separate claim does not reduce the amount of the Award which would otherwise be
available to Landlord and so long as such separate claim is not a claim for the
value of Tenant's leasehold.
D. Partial Taking. In the event of a Partial Taking during the
term hereof (1) the rights of Tenant under the Lease and the leasehold estate of
Tenant in and to the portion of the Premises taken shall cease and terminate as
of the Date of Taking; (2) from and after the Date of Taking the Monthly
Installment of rent shall be an amount equal to the product obtained by
multiplying the Monthly Installment of rent immediately prior to the Taking by a
fraction, the numerator of which is the number of
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square feet contained in the Building after the Taking and the denominator of
which is the number of square feet contained in the Building prior to the
Taking; (3) Tenant shall receive from the Award the portions of the Award
attributable specifically to trade fixtures of Tenant; and (4) the remainder of
the Award shall be paid to and be the property so Landlord. Tenant may make a
separate claim against the condemning authority so long as such separate claim
does not reduce the amount of the Award which would otherwise be available to
Landlord and so long as such separate claim is not a claim for the value of
Tenant's leasehold.
15. Subleasing and Assignment.
A. Landlord's Consent Required. Tenant shall not assign its
interest in this Lease by operation of Law or otherwise, sublet the Premises,
transfer any interest of Tenant therein or permit any use of the Premises by
another party, without the prior written consent of Landlord to each such
assignment, subletting, transfer or use, which consent Landlord agrees not to
withhold or delay unreasonably. A consent to one assignment, subletting,
occupancy or use by another party shall not be deemed to be a consent to any
subsequent assignment, subletting, occupancy or use by another party. Any
assignment or subletting without such consent shall be void and shall, at the
option of Landlord, terminate this Lease. Landlord's waiver or consent to any
assignment or subletting hereunder shall not relieve Tenant from any obligation
under this Lease.
B. Transferee Information Required. If Tenant desires to assign
its interest in this Lease or sublet the Premises, or transfer any interest of
Tenant therein, or permit the use of the Premises by another party (hereinafter
collectively referred to as a "Transfer"), Tenant shall give Landlord at least
fifteen (15) business days prior written notice of the proposed Transfer and of
the terms of such proposed Transfer, including, but not limited to, the name and
legal composition of the proposed transferee, a financial statement of the
proposed transferee, the nature of the proposed transferee's business to be
carried on in the Premises (including a list of the type and quantities of all
Hazardous Materials to be used by the Transferee on the Premises), the payment
to be made or other consideration to be given to Tenant on account of the
Transfer, and such other pertinent information as may be requested by Landlord,
all in sufficient detail to enable Landlord to evaluate the proposed Transfer
and the prospective transferee.
C. Landlord's Rights. It is the intent of the parties hereto that
this Lease shall confer upon Tenant only the right to use and occupy the
Premises, and to exercise such other rights as are conferred upon Tenant by this
Lease. The parties agree that this Lease is not intended to have a bonus value
nor to serve as a vehicle whereby Tenant may profit by a future Transfer of this
Lease or the right to use or occupy the Premises as a result of any favorable
terms contained herein, or future changes in the market for leased space. It is
the intent of the parties that any such bonus value that
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may attach to this Lease shall be and remain the exclusive property of Landlord.
In the event Tenant seeks to Transfer its interest in this Lease or the
Premises, Landlord shall have the following options, which may be exercised at
its sole choice without limiting Landlord in the exercise of any other right or
remedy which Landlord may have by reason of such proposed Transfer:
(1) Landlord may consent to the proposed Transfer on the
condition that Tenant agrees to pay to Landlord, as Additional Rent, any and all
rents or other consideration received by Tenant from the Transferee by reason of
such Transfer in excess of the rent payable by Tenant to Landlord under this
Lease (less any brokerage commissions, attorneys' fees, advertising expenses,
and tenant improvement costs incurred by Tenant in connection with the
Transfer). Tenant expressly agrees that the foregoing is a reasonable condition
of obtaining Landlord's consent to any Transfer; or
(2) Landlord may reasonably withhold its consent to the
proposed Transfer.
D. Permitted Transfers. Notwithstanding the foregoing, Tenant
may, without Landlord's prior written consent, assign its interest in the Lease
or sublet the Premises or a portion thereof to (i) a subsidiary, affiliate,
division or corporation controlled by or under common control with Tenant; (ii)
a successor corporation related to Tenant by merger, consolidation,
nonbankruptcy reorganization or government action; or (iii) a purchaser of
substantially all of the Tenant's assets; provided that, in each instance
described above, (a) the transferee assumes the obligations of the Tenant under
this Lease in a written instrument delivered to Landlord; (b) the transferor
Tenant remains liable as a primary obligor for the obligations of Tenant under
this Lease; and (c) the financial strength of the transferee Tenant is no less
than Tenant's financial strength as of the Commencement Date or the date of such
Transfer, whichever is greater.
16. Mechanics Liens. Tenant shall (A) pay for all labor and services
performed, or materials used by or furnished to, Tenant or any contractor
employed by Tenant with respect to the Premises; (B) indemnify, defend, protect
and hold Landlord and the Premises harmless and free from any liens, claims,
liabilities, demands, encumbrances, or judgments created or suffered by reason
of any labor or services performed for, materials used by or furnished to,
Tenant or any contractor employed by Tenant with respect to the Premises; (C)
give notice to Landlord in writing five (5) days prior to employing any laborer
or contractor to perform services related to, or receiving materials for use
upon the Premises; and (D) permit Landlord to post a notice of nonresponsibility
in accordance with the statutory requirements of California Civil Code Section
3094 or any amendment thereof In the event Tenant is required to post an
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improvement bond with a public agency in connection with the above, Tenant
agrees to include Landlord as an additional obligee.
17. Inspection of the Premises. Tenant shall permit Landlord and its
Agents to enter the Premises at any reasonable time, during standard business
hours, and subject to Tenant's standard security requirements, for the purpose
of inspecting the same, performing Landlord's maintenance and repair
responsibilities (upon 24 hour prior notice except in an emergency), posting a
notice of non-responsibility for alterations, additions or repairs and at any
time within three hundred sixty-five (365) days prior to expiration of this
Lease, to place upon the Premises, ordinary "For Lease" or "For Sale" signs and
show the Premises to prospective tenants without interfering with Tenant's use
of the Premises.
18. Compliance with Laws. Tenant shall, at its own cost, comply with all
of the requirements of all municipal, county, state and federal authorities now
in force, or which may hereafter be in force, pertaining to Tenant's use and
occupancy of the Premises, and shall faithfully observe all municipal, county,
state and federal Law, statutes or ordinances now in force or which may
hereafter be in force pertaining to Tenant's use and occupancy of the Premises.
The judgment of any court of competent jurisdiction or the admission of Tenant
in any action or proceeding against Tenant, whether Landlord be a party thereto
or not, that Tenant has violated any such ordinance or statute in the use and
occupancy of the Premises shall be conclusive of the fact that such violation by
Tenant has occurred. Tenant shall indemnify, protect, defend, and hold Landlord
harmless against any loss, expense, damage, attorneys' fees or liability arising
out of the failure of Tenant to comply with the CC&R's and any applicable Law.
19. Subordination. The following provisions shall govern the
relationship of this Lease to any underlying lease, mortgage or deed of trust
which now or hereafter affects the Premises or Landlord's interest or estate
therein and any renewal, modification, consolidation, replacement, or extension
thereof (a "Security Instrument").
A. Priority. This Lease is subject and subordinate to all
Security Instruments existing as of the Commencement Date. However, if any
Lender so requires, this Lease shall become prior and superior to any such
Security Instrument.
B. Subsequent Security Instruments. At Landlord's election, this
Lease shall become subject and subordinate to any Security Instrument created
after the Commencement Date provided that the Lender holding such Security
Agreement agrees that in the event of foreclosure of the Security Instrument in
question, such Lender shall recognize the tenancy of Tenant on the terms and
conditions contained in this Lease so long as Tenant is not in default under
this Lease. Notwithstanding such subordination,
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Tenant's right to quiet possession of the Premises shall not be disturbed so
long as Tenant is not in default and performs all of its obligations under this
Lease, unless this Lease is otherwise terminated pursuant to its terms.
C. Documents. Tenant shall execute any reasonable document or
instrument required by Landlord or any Lender to make this Lease either prior or
subordinate to a Security Instrument, which may include such other matters as
the Lender customarily requires in connection with such agreements, including
provisions that the Lender not be liable for (1) the return of any prepaid rent
unless the Lender receives it from Landlord, (2) any defaults on the part of
Landlord occurring prior to the time that the Lender takes possession of the
Premises in connection with the enforcement of its Security Instrument, or (3)
any obligations to construct Tenant Improvements. Tenant's failure to execute
any reasonable document or instrument within ten (10) days after written demand
therefor shall constitute a default by Tenant. Tenant's obligation to execute
and deliver any subordination agreement to any future Lender shall be
conditioned upon such Lender agreeing that in the event of foreclosure of the
mortgage or termination of the ground lease in question, such Lender shall
recognize the tenancy of Tenant on the terms and conditions contained in this
Lease so long as Tenant is not in default under this Lease.
D. Tenant's Attornment. Tenant shall attorn (1) to any purchaser
of the Premises at any foreclosure sale or private sale conducted pursuant to
any Security Instrument encumbering the Premises; (2) to any grantee or
transferee designated in any deed given in lieu of foreclosure; or (3) to the
lessor under any underlying ground lease should such ground lease be terminated.
20. Signs. Landlord and Tenant shall use good faith efforts to agree on
the design and specifications for a monument sign to be located on the Property,
containing space for Tenant's sign. The monument sign shall be designed and
installed by Landlord as part of the Improvements. The Tenant's sign on the
monument shall be designed and installed by Tenant at Tenant's cost, subject to
Landlord's consent, which shall not be unreasonably withheld. Neither party
shall post any signs on the Building, except that Landlord may post for-sale or
for-lease signs thereon to aid in marketing efforts. Tenant, upon written notice
by Landlord, shall immediately remove any sign or decoration that Tenant has
placed or permitted to be placed on the Property or the exterior of the Building
without the prior written consent of Landlord, and if Tenant fails to so remove
such sign or decoration within five (5) days after Landlord's written notice,
Landlord may enter upon the Premises and remove said sign or decoration and
Tenant agrees to pay Landlord, as Additional Rent upon demand, the cost of such
removal. At the termination of this Lease, Tenant shall remove any sign which it
has placed on the Property or Building and shall repair any damage caused by the
installation or removal of such sign.
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21. Option to Extend.
A. Exercise of Option. Provided that Tenant is not in default
under this Lease at the time of exercise of any of the hereinafter described
option or at the time of termination of the term of this Lease, Tenant shall
have one (1) option to extend the term of this Lease for one (1) period of ten
(10) years (the "Option Term"). The option shall be exercised only by written
notice delivered to Landlord not later than the eleventh (11th) anniversary of
the Commencement Date. In all respects, the terms, covenants and conditions of
this Lease shall remain unchanged during the Option Term, except that the
Monthly Installment of rent payable during the Option Term shall be determined
in accordance with Paragraph 21.B and, except that there shall be no further
option to extend the term of this Lease at the end of the Option Term.
B. Monthly Installment of Rent. The Monthly Installment of rent
during the Option Term shall be ninety-five (95%) of the Fair Market Rental of
the Premises during the Option Term, determined as follows but in no event less
than the Monthly Installment of Rent during the last month of the Lease Term.
Promptly following exercise of either option, the parties shall meet and
endeavor to agree upon the Fair Market Rental of the Premises for the Option
Term (which shall include both the Fair Market Rental as of the first day of the
Option Term together with provisions for periodic rental increases, if
applicable). In determining the Fair Market Rental for the Premises, the
Premises shall be compared only to buildings of a similar quality and size and
with similar improvements and amenities in Petaluma occupied by companies of
similar financial strength as Tenant. If within thirty (30) days after the
exercise of the option for the Option Term, the parties cannot agree upon the
Fair Market Rental for the Premises, the parties shall submit the matter to
binding appraisal in accordance with the following procedure:
Within sixty (60) days after exercise of the option, the parties shall
either (i) jointly appoint an appraiser for this purpose (the determination of
such jointly appointed appraiser shall be binding and conclusive upon the
parties) or (ii) failing this joint action, each separately designate a
disinterested appraiser. No person shall be appointed or designated an appraiser
unless he or she has at least five (5) years experience in appraising major
commercial property in Northern Marin and Sonoma Counties and is a member of a
recognized society of real estate appraisers. If, within thirty (30) days' after
the appointment, the two appraisers reach agreement on the Fair Market Rental
for the Premises, that value shall be binding and conclusive upon the parties.
If the two appraisers thus appointed cannot reach agreement on the question
presented within thirty (30) days after their appointment, then the appraisers
thus appointed shall, within fifteen (15) days appoint a third disinterested
appraiser having like qualifications. If within thirty (30) days after the
appointment of the third
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appraiser, a majority of the appraisers agree on the Fair Market Rental of the
Premises, that value shall be binding and conclusive upon the parties. If within
thirty (30) days after the appointment of the third appraiser, a majority of the
appraisers cannot reach agreement on the question presented, then the three
appraisers shall each submit their independent appraisal to the parties, and the
appraisal farthest from the median of the three appraisals shall be disregarded
and the mean average of the remaining two appraisals shall be deemed to be the
Fair Market Rental of the Premises and shall be binding and conclusive upon the
parties. Each party shall pay the fees and expenses of the appraiser appointed
by it and shall share equally the fees and expenses of the third appraiser or
the single appraiser if only one appraiser is jointly appointed. The appraisal
procedure shall be completed within thirty (30) days after the last of the
appraisers is appointed (whether one, two or three appraisers are appointed). If
the two appraisers appointed by the parties cannot agree on the appointment of
the third appraiser, they or either of them shall give notice of such failure to
agree to the parties and if the parties fail to agree upon the selection of such
third appraiser within ten (10) days after the appraisers appointed by the
parties give such notice, then either of the parties, upon notice to the other
party may request such appointment by the American Arbitration Association, or
on its failure, refusal or inability to act, may apply for such appointment to
the presiding judge of the Superior Court of Sonoma County, California. When the
Monthly Installment of rent for the Option Term is determined, the parties shall
execute an amendment to Lease reflecting the Monthly Installment of rent for the
Option Term.
22. Right of First Offer. During the initial Lease Term (but not the
Option Term), Landlord shall not offer to sell the Property to any unrelated
third party without first offering to sell the Property to Tenant, subject to
the terms and conditions set forth below (the "Right of First Offer"). Landlord
shall notify Tenant in writing ("Offer Notice") of its intention to offer the
Property for sale. If Tenant wishes to exercise its Right of First Offer, then,
within fifteen (15) days following the date of the Offer Notice, Tenant must
deliver to Landlord its written offer ("Tenant's Offer") to purchase the
Property, including price, contingencies, and other relevant conditions. If
Tenant fails to deliver Tenant' Offer to Landlord within said fifteen (15) day
period, then the Right of First Offer shall lapse in its entirety. If Tenant
provides Tenant's Offer to Landlord, Landlord shall not be bound to accept the
terms and conditions set forth therein, but the parties shall negotiate in good
faith to finalize and execute a definitive Purchase and Sale Agreement with
respect to the Property within sixty (60) days following the date of the Offer
Notice. The closing thereof shall occur no later than ninety (90) days following
execution of the Purchase and Sale Agreement by the parties. Should the parties
fail to execute a definitive Purchase and Sale Agreement or should Tenant fail
to close the purchase in the time periods set forth above, then this Right of
First Offer shall lapse in its entirety, and the Landlord shall be free to offer
sell the Property to any buyer, at any price and on any terms and conditions,
including those
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more favorable to the buyer than had been offered by Tenant, In the event Tenant
acquires the Property upon exercise of its Right of First Offer, then Landlord
shall pay to Meridian Commercial, Inc. a sales commission equal to one percent
(1%) of the purchase price.
23. Surrender of the Premises. On the last day of the term hereof, or on
the sooner termination of this Lease, Tenant shall surrender the Premises to
Landlord in their condition existing as of the Commencement Date of this Lease,
ordinary wear and tear excepted, with all originally painted interior walls
washed, and other interior walls cleaned, and repaired or replaced, all floors
cleaned and waxed, all to the reasonable satisfaction of Landlord. Tenant shall
remove all of Tenant's personal property and trade fixtures from the Premises,
and all property not so removed shall be deemed abandoned by Tenant. Tenant, at
its sole cost, shall repair any damage to the Premises caused by the removal of
Tenant's personal property, machinery and equipment, which repair shall include,
without limitation, the patching and filling of holes and repair of structural
damage. If the Premises are not so surrendered at the termination of this Lease,
Tenant shall indemnify, defend, protect and hold Landlord harmless from and
against loss or liability resulting from delay by Tenant in so surrendering the
Premises including without limitation, any claims made by any succeeding tenant
or losses to Landlord due to lost opportunities to lease to succeeding tenants.
24. Holding Over. This Lease shall terminate without further notice at
the expiration of the Lease Term. Any holding over by Tenant after expiration
without the consent of Landlord shall not constitute a renewal or extension or
give Tenant any rights in or to the Premises, and the monthly rental value of
the Premises shall be deemed to be two hundred percent (200%) of the monthly
rent for the last month of the Lease term, plus Additional Rent. Any holding
over after the expiration with the consent of Landlord shall be construed to be
a tenancy from month to month, at a monthly rate agreed upon by Landlord and
Tenant, and shall otherwise be on the terms and conditions herein specified
insofar as applicable.
25. Notices. Any notice required or desired to be given under this Lease
shall be in writing with copies directed as indicated below and shall be
personally served or given by mail. Any notice given by mail shall be deemed to
have been given when seventy-two (72) hours have elapsed from the time such
notice was deposited in the United States Mail, certified and postage prepaid,
return receipt requested, addressed to the party to be served with a copy as
indicated herein at the last address given by that party to the other party
under the provisions of this paragraph. At the date of execution of this Lease,
the address of Landlord is:
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RNM Lakeville, L.P.
135 Main Street, 1lth Floor
San Francisco, CA 94105
Attn: John R. McNulty
with a copy to:
Springs Rivin Detwiler Dudnick & Stikker
351 California Street, 15th Floor
San Francisco, CA 94104
Attn: Jonathan Rivin, Esq.
and the address of Tenant is:
Advanced Fibre Communications, Inc.
One Willowbrook Court
Petaluma, CA 94954
Attn: Buck Hudkins
with a copy to:
Advanced Fibre Communications, Inc.
One Willowbrook Court
Petaluma, CA 94954
Attn: Legal Department
26. Attorneys' Fees. In the event either party shall bring any action or
legal proceeding for damages for any alleged breach of any provision of this
Lease, to recover rent or possession of the Premises, to terminate this Lease,
or to enforce, protect or establish any term or covenant of this Lease or right
or remedy of either party, the prevailing party shall be entitled to recover as
a part of such action or proceeding, reasonable attorneys' fees and court costs,
including attorneys' fees and costs for appeal, as may be fixed by the court or
jury. The term "prevailing party" shall mean the party who received
substantially the relief requested, whether by settlement, dismissal, summary
judgment, judgment, or otherwise.
27. Successors. The covenants and agreements contained in this Lease
shall be binding on the parties hereto and on their respective heirs, successors
and assigns (to the extent the Lease is assignable).
28. Mortgagee Protection. In the event of any default on the part of
Landlord, Tenant will give notice by registered or certified mail to any
beneficiary of a deed of
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trust or mortgage of a mortgage encumbering the Premises, whose address shall
have been previously furnished to Tenant. So long as such beneficiary or
mortgagee is making reasonable efforts to cure the default, including, but not
limited to, obtaining possession of the Premises by power of sale or judicial
foreclosure, if such should prove necessary to effect a cure, Tenant shall not
have the fight to terminate this Lease.
29. Estoppel Certificate. Tenant agrees within ten (10) days following
request by Landlord to (A) execute and deliver to Landlord any documents,
including estopped certificates presented to Tenant by Landlord, (1) certifying
that this Lease is unmodified and in full force and effect and the date to which
the rent and other charges are paid in advance, if any, and (2) acknowledging
that there are not, to Tenant's knowledge, any uncured defaults on the pail of
Landlord hereunder, or specifying the defaults, if any, and (3) evidencing the
status of the Lease as may be required either by a Lender making a loan to
Landlord to be secured by a deed of trust or mortgage covering the Premises or a
purchaser of the Premises from Landlord and (B) to deliver to Landlord the
financial statements of Tenant with an opinion by a certified public accountant,
including a balance sheet and profit and loss statement, for the last completed
fiscal year, all prepared in accordance with generally accepted accounting
principles consistently applied. Tenant's failure to deliver an estopped
certificate within ten (10) days following such request shall be an Event of
Default under this Lease.
30. Surrender of Lease Not Merger. The voluntary or other surrender of
this Lease by Tenant, or a mutual cancellation thereof, shall not work a merger
and shall, at the option of Landlord, terminate all or any existing subleases or
subtenants, or operate as an assignment to Landlord of any or all such subleases
or subtenants.
31. Waiver. The waiver by Landlord or Tenant of any breach of any term,
covenant or condition herein contained shall not be deemed to be a waiver of
such term, covenant or condition or any subsequent breach of the same or any
other term, covenant or condition herein contained. Any waiver shall be in
writing and signed by both Landlord and Tenant.
32. General.
A. Captions. The captions and paragraph headings used in this
Lease are for the purposes of convenience only. They shall not be construed to
limit or extend the meaning of any part of this Lease, or be used to interpret
specific sections. The word(s) enclosed in quotation marks shall be construed as
defined terms for purposes of this Lease. As used in this Lease, the masculine,
feminine and neuter and the singular or plural number shall each be deemed to
include the other whenever the context so requires.
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B. Definition of Landlord. The term "Landlord" as used in this
Lease, so far as the covenants or obligations on the part of Landlord are
concerned, shall be limited to mean and include only the owner at the time in
question of the fee title of the Premises, and in the event of any transfer or
transfers of the title of such fee, the Landlord herein named (and in case of
any subsequent transfers or conveyances, the then grantor) shall be
automatically freed and relieved of all liability with respect to performance of
any covenants or obligations on the part of Landlord contained in this Lease to
be performed after the date-of such transfer or conveyance; provided that any
funds in the hands of Landlord or the then grantor at the time of such transfer,
in which Tenant has an interest, shall be turned over to the grantee. It is
intended that the covenants and obligations contained in this Lease on the part
of Landlord shall, subject as aforesaid, be binding upon each Landlord, its
heirs, personal representatives, successors and assigns only during its
respective period of ownership.
C. Time of Essence. Time is of the essence for the performance of
each term, covenant and condition of this Lease.
D. Severability, California Law. In case any one or more of the
provisions contained herein, except for the payment of rent, shall for any
reason be held to be invalid, illegal or unenforceable in any respect, such
invalidity, illegality or unenforceability shall not affect any other provision
of this Lease, but this Lease shall be construed as if such invalid, illegal or
unenforceable provision had not been contained herein. This Lease shall be
construed and enforced in accordance with the Laws of the State of California
other than laws relating to conflicts of law.
E. Quiet Environment. Upon Tenant paying the rent for the
Premises and observing and performing all of the covenants, conditions and
provisions on Tenant's part to be observed and performed hereunder, Tenant shall
have quiet possession of the Premises for the entire term hereof subject to all
of the provisions of this Lease.
F. Law. As used in this Lease, the term "Law" or "Laws" shall
mean any judicial decision, statute, constitution, ordinance, resolution,
regulation, rule, administrative order, or other requirement of any government
agency or authority having jurisdiction over the parties to this Lease or the
Premises or both, in effect at the Commencement Date of this Lease or any time
during the Lease Term, including, without limitation, any regulation, order, or
policy of any quasi-official entity or body (e.g. board of fire examiners,
public utility or special district).
G. Agent. As used in this Lease, the term "Agent" shall mean,
with respect to either Landlord or Tenant, its respective agents, employees,
contractors (and their subcontractors), and invitees (and in the case of Tenant
or its subtenants).
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H. Lender. As used in this Lease, the term "Lender" shall mean
any beneficiary, mortgagee, secured party or other holder of any deed of trust,
mortgage or other written security device or agreement affecting Landlord's
interest in the Premises.
33. Authority. The undersigned parties hereby warrant that they have
proper authority and are empowered to execute this Lease on behalf of Landlord
and Tenant, respectively.
34. CC&R's. This Lease is made subject to all matters of public record
affecting title to the property of which the Premises are a part. Tenant shall
abide by and comply with all private conditions, covenants and restrictions of
public record now or hereafter affecting the Premises and any amendment thereof,
including, but not limited to, the First Amended and Restated Declaration of
Restrictions of Oakmead-Northbay Industrial Park dated as of February 17, 1984
and recorded on May 10, 1985 as instrument no. 85029124, a copy of which has
been delivered to Tenant.
All assessments and charges which are imposed, levied or assessed against
the Premises pursuant to the above-described covenants, conditions and
restrictions shall be paid by Tenant as Additional Rent.
35. Brokers, Tenant represents and warrants to Landlord that it has not
dealt with any broker respecting this transaction other than Meridian
Commercial, Inc. ("Broker") and hereby agrees to indemnify and hold Landlord
harmless from and against any brokerage commission or fee, obligation, claim or
damage (including attorneys' fees) paid or incurred respecting any other broker
claiming through Tenant or with which/whom Tenant has dealt. Landlord agrees to
pay Meridian Commercial, Inc., a leasing commission in connection with this
Lease pursuant to the terms of a separate Exclusive Leasing Agreement. Landlord
shall not be required to pay any brokerage commission upon the exercise of
Tenant's option to extend under Paragraph 21.
36. Limitation on Landlord's Liability Tenant, for itself and its
successors and assigns (to the extent this Lease is assignable), hereby agrees
that in the event of any actual, or alleged, breach or default by Landlord under
this Lease that:
A. Tenant's sole and exclusive remedy and recourse against
Landlord shall be as against Landlord's interest in the Premises and shall be
further limited to thirty percent (30%) of the value of the Premises (as if the
Premises were subject to a loan of eighty percent (70%) of the value thereof);
B. No partner of Landlord shall be sued or named as a party in a
suit or action (except as may be necessary to secure jurisdiction of the
partnership);
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C. No service of process shall be made against any partner of
Landlord (except as may be necessary to secure jurisdiction of the partnership);
D. No partner of Landlord shall be required to answer or
otherwise plead to any service of process;
E. No judgment will be taken against any partner of Landlord;
F. Any judgment taken against any partner of Landlord may be
vacated and set aside at any time nunc pro tunc;
G. No writ of execution will ever be levied against the assets of
any partner of Landlord; and
H. The covenants and agreements of Tenant set forth in this
Paragraph 36 shall be enforceable by Landlord and any partner of Landlord.
37. Hazardous Material.
A. Use Restrictions. Tenant shall not use, generate, manufacture,
produce, store, release, discharge or dispose of, on, under or about the
Premises, or transport to or from the Premises, any Hazardous Materials or allow
its employees, Agents, contractors, invitees or any other person or entity to do
so except in full compliance with all Federal, state and local Laws, regulations
and ordinances. The term "Hazardous Materials" shall include without limitation:
(1) Those substances included within the definitions of "hazardous substances",
"hazardous materials", "toxic substances" or "solid waste" under CERCLA, RCRA
and the Hazardous Materials Transportation Act, 49 U.S.C. Sections 1801, et seq.
and in the regulations promulgated pursuant to said Laws; (2) Those substances
defined as "hazardous wastes" in Section 25117 of the California Health & Safety
Code, or as "hazardous substances" in Section 25316 of the California Health &
Safety Code, and in the regulations promulgated pursuant to said Laws; (3) Those
substances listed in the United States Department of Transportation Table (49
CFR 172.101 and amendments thereto) or designated by the Environmental
Protection Agency (or any successor agency) as hazardous substances; (4) Such
other substances, materials and wastes which are or become regulated under
applicable local, state or federal Law or the United States government, or which
are or become classified as hazardous or toxic under federal, state or local
Laws or regulations; and (5) Any material, waste or substance which is (i)
petroleum, (ii) asbestos, (iii) polychlorinated biphenyls, (iv) designated as a
"hazardous substance" pursuant to Section 311 of the Clean Water Act of 1977, 33
U.S.C. Sections 1251, et seq. (33 U.S.C. Section 1321) or listed pursuant to
Section 307 of the Clean Water Act
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of 1977 (33 U.S.C. Section 1317), (v) flammable explosives, or (vi) radioactive
materials.
B. Tenant's Indemnity. Tenant shall be liable to Landlord for and
indemnify and hold Landlord harmless against all damages (including
investigation and remedial costs), liabilities and claims arising out of
Tenant's and Tenant's Agents' activities associated with Hazardous Materials,
including all costs and expenses incurred by Landlord in remediating, cleaning
up, investigating or responding to any governmental or third party claims,
demands, orders or enforcement actions. In the event Tenant and/or Tenant's
Agents' activities with Hazardous Materials create a contamination problem or.
or adjacent to the Premises, Tenant shall promptly commence investigation and
remedial activities to fully clean up the problem. If appropriate or required by
Law, these activities shall be conducted in conjunction with Federal, state and
local oversight and approvals.
C. Assignment and Subletting. It shall not be unreasonable for
Landlord to withhold its consent to any proposed assignment or subletting if (i)
the proposed assignee's or subtenant's anticipated use of the Premises involves
the storage, generation, discharge, transport, use or disposal of any Hazardous
Material in a greater intensity and scope than Tenant's then-existing use, or
(ii) the proposed assignee or subtenant has been required by any prior landlord,
Lender or governmental authority to " clean-up" or remediate any Hazardous
Material and has failed to do so, or (iii) the proposed assignee or subtenant is
subject to a criminal investigation or enforcement order or proceeding by any
government authority in connection with the use, generation, discharge,
transport, disposal or storage of any Hazardous Material.
D. List of Hazardous Materials. Upon request of Landlord, Tenant
shall provide Landlord with a list of Hazardous Materials (and the quantities
thereof) which Tenant uses or stores (or intends to use or store) on the
Premises, which list shall be attached to this Lease as Exhibit E.
E. Provisions Survive Termination. The provisions of this
Paragraph 37 shall survive the expiration or termination of this Lease.
38. Integration. Tenant acknowledges that neither the Landlord nor
Landlord's Agents has made any representation or warranty as to the suitability
of the Premises to the conduct of Tenant's business. Any agreements, warranties
or representations not expressly contained herein shall in no way bind either
Landlord or Tenant, and Landlord and Tenant expressly waive all claims for
damages by reason of any statement representation, warranty, promise or
agreement, if any, not contained in this Lease. This Lease constitutes the
entire understanding between the parties hereto and no
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addition to, or modification of, any term or provision of this Lease shall be
effective until set forth in a writing signed by both Landlord and Tenant.
IN WITNESS WHEREOF, the parties have entered this Lease Agreement on the
date set forth below.
LANDLORD TENANT
RNM LAKEVILLE, L.P., a California ADVANCED FIBRE
Limited Partnership COMMUNICATIONS, INC., a
Delaware corporation
By RNM PETALUMA, INC., a
California corporation, its
Managing General Partner By: /s/ PETER DARBEE
-------------------------------------
Peter Darbee, Chief Financial
By: /s/ JOHN R. MCNULTY Officer
--------------------------
John R. McNulty, President
Date: October 9, 1997
-----------------------------------
Date: October 9, 1997
------------------------
List of Exhibits
A - Property Description
B - List of Building Plans and Specifications
C - Improvement Agreement
D - Premises
E - List of Hazardous Materials
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EXHIBIT A
THE "PROPERTY"
LEGAL DESCRIPTION
Real property located in Sonoma County, California and legally described as
follows:
PARCEL ONE:
LOTS 5 AND 6, AS NUMBERED AND DESIGNATED UPON THE MAP OF OAKMEAD-NORTH BAY PARK
UNIT NO. 2, FILED FOR RECORD IN THE OFFICE OF THE COUNTY RECORDER ON
DECEMBER 1, 1983 IN BOOK 351 OF MAPS AT PAGES 44 AND 45, SONOMA COUNTY RECORDS.
RESERVING THEREFROM AN EASEMENT FOR PRIVATE DRAINAGE PURPOSES, AS SHOWN AND
DELINEATED UPON THE MAP OF "OAKMEAD-NORTH BAY PARK UNIT NO. 2" RECORDED ON
DECEMBER 1, 1983 IN BOOK 351 OF MAPS AT PAGE 44, SONOMA COUNTY RECORDS. SAID
EASEMENT IS APPURTENANT TO LOTS 1, 2, 3 AND 4 OF SAID SUBDIVISION AND LOCATED
OVER THE SOUTHEASTERLY 10 FEET OF LOTS 2, 3, 4 AND 6 AND OVER THE NORTHEASTERLY
10 FEET OF THE SOUTHEASTERLY 475 FEET OF LOT 2.
PARCEL TWO:
ALL OF LOT 4 AND A PORTION OF LOT 3 AS SHOWN ON THE MAP ENTITLED,
"OAKMEAD-NORTH BAY PARK UNIT 2 - PETALUMA, CALIFORNIA" RECORDED IN BOOK 351 OF
MAPS AT PAGES 44 THROUGH 45, SONOMA COUNTY RECORDS, SAID PROPERTY BEING MORE
PARTICULARLY DESCRIBED AS FOLLOWS:
BEGINNING AT THE MOST NORTHERLY CORNER OF SAID LOT 3 ON THE SOUTHWESTERLY
RIGHT-OF-WAY LINE OF SOUTH McDOWELL EXTENSION, FROM WHICH POINT A FOUND
3/4-INCH IRON PIPE AND TAG RCE 13677 AT THE MOST NORTHERLY CORNER OF LOT 2
BEARS NORTH 35 DEGREES 28' 06" EAST, A DISTANCE OF 350.00 FEET; THENCE ALONG
SAID SOUTHWESTERLY RIGHT-OF-WAY LINE SOUTH 35 DEGREES 28' 06" WEST, A
DISTANCE OF 75.00 FEET TO THE TRUE POINT OF BEGINNING; THENCE LEAVING SAID
SOUTHWESTERLY RIGHT-OF-WAY LINE SOUTH 54 DEGREES 31' 54" EAST, A
DISTANCE OF 618.87 FEET TO A POINT ON THE SOUTHWESTERLY LINE OF LANDS KNOWN AS
OAKMEAD-NORTH BAY PARK UNIT 3; THENCE ALONG SAID LANDS SOUTH 35 DEGREES 28' 06"
WEST, A DISTANCE OF 195.00 FEET TO THE EASTERLY CORNER OF SAID LOT 3 AND LOT 4;
THENCE LEAVING SAID LANDS AND ALONG THE NORTHWESTERLY BOUNDARY OF SAID LOT 4
NORTH 54 DEGREES 31' 54" WEST, A DISTANCE OF 618.87 FEET TO THE WESTERLY CORNER
OF SAID LOT 3 AND LOT 4 ON THE SOUTHWESTERLY RIGHT-OF-WAY LINE OF SOUTH
McDOWELL EXTENSION. THENCE ALONG SAID RIGHT-OF-WAY LINE NORTH 35 DEGREES 28'
06" EAST, A DISTANCE OF 195.00 FEET TO THE TRUE POINT OF BEGINNING AS DESCRIBED
IN THAT CERTAIN LOT LINE ADJUSTMENT/PARCEL MERGER RECORDED DECEMBER 23, 1994,
INSTRUMENT NO. 1994 0140339 AND THAT CERTAIN DEED RECORDED DECEMBER 23, 1994,
INSTRUMENT NO. 1994 0140340, SONOMA COUNTY RECORDS.
RESERVING THEREFROM AN EASEMENT FOR PRIVATE DRAINAGE PURPOSES, AS SHOWN AND
DELINEATED UPON THE MAP OF "OAKMEAD-NORTH BAY PARK UNIT NO. 2" RECORDED ON
DECEMBER 1, 1983 IN BOOK 351 OF MAPS AT PAGE 44, SONOMA COUNTY RECORDS. SAID
EASEMENT IS APPURTENANT TO LOTS 1, 2, 3 AND 4 OF SAID SUBDIVISION AND LOCATED
OVER THE SOUTHEASTERLY 10 FEET OF LOTS 2, 3, 4 AND 6 AND OVER THE NORTHEASTERLY
10 FEET OF THE SOUTHEASTERLY 475 FEET OF LOT 2.
<PAGE> 36
EXHIBIT B
LIST OF BUILDING SHELL
PLANS AND SPECIFICATIONS
Specifications by Greg LeDoux & Associates, Inc.
Division I through 16, dated January 21, 1997
Drawings by Greg LeDoux & Associates, Inc.:
T1 Dated February, 1997
Al through A19 Dated February, 1997
S1 through S7 Dated February, 1997
(MKM and Associates)
S9 through S-20 Dated February, 1997
S8 Dated May, 1997
HI through H2 Dated February, 1997
El Dated April 10, 1997
Pi Dated February, 1997
L1, L2, L3 L4 Dated December, 1996
(Dave Hazelwood)
L5 Dated January 10, 1997
L6, L7, L8 Dated October, 1996
Drawings by Carlenzoli and Associates:
Cl, C3, C10 Dated January 20, 1997
C2, C5, C6, C7, C8, C9 Dated December 10, 1996
C4 Dated April 4, 1997
Addenda:
One Dated March 26, 1997 (regarding finish
dates and grading scope of work)
Two Dated March 27, 1997 (clarification of
expansion joint and overhead door G)
Three Dated April 1, 1997 (electrical main
service deletion ballast
clarification)
Four Dated April 1, 1997 (revised bid form)
Soils Report: Giblin and Associates
<PAGE> 37
EXHIBIT C
CYPRESS CENTER
2210 SOUTH McDOWELL
TENANT IMPROVEMENT AGREEMENT
RECITALS
A. Tenant and Landlord are parties to that certain Lease relating to
the Premises at 2210 South McDowell in Petaluma, California (the "Premises").
Unless otherwise defined herein, all capitalized terms have the meanings
assigned to them in the Lease.
B. In connection with the Lease, Landlord shall construct the Tenant
Improvements consisting of approximately 30,000 square feet of office space and
approximately 155,841 square feet of manufacturing space, pursuant to the terms
and conditions set forth herein.
C. Construction of the Tenant Improvements shall be performed in four
phases outlined on Exhibit D of the Lease. Landlord shall construct
approximately 20,000 square feet of office space in Phase I and use its best
commercial efforts to deliver Phase I to Tenant prior to the Commencement Date.
Phase II, approximately 120,000 square feet of manufacturing space, shall be
improved and delivered to Tenant on the Commencement Date. Phase III,
approximately 45,841 square feet of manufacturing space, shall be improved and
delivered to Tenant on the Expansion Date. Following the Expansion Date, the
Landlord shall construct up to 10,000 square feet of offices in Phase IV at such
time as is agreed to by the parties.
THEREFORE THE PARTIES AGREE AS FOLLOWS:
1. DEFINITIONS.
a. "Approved Plans" shall mean the Preliminary Space Plan, the
Final Space Plan and the Working Drawings as approved by Landlord and Tenant.
b. "Cost of Improvements" shall mean the total of all hard and
soft costs associated with or caused by the construction of the Tenant
Improvements, including but not limited to:
(i) All architectural and engineering fees and expenses,
including those of a sound engineer;
(ii) the costs and expenses of installing telephone/data
wires and cables to and within the Premises;
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<PAGE> 38
(iii) Ail contractor and construction manager costs and fees;
(iv) All governmental fees and taxes (including permit fees);
and
(v) All construction costs, including the costs of
performing any alterations to other portions of the Building that are
required as a result of construction of the Tenant Improvements, including
both structural alterations or Building system modifications that are
necessary to accommodate the Tenant Improvements and any structural or
nonstructural alterations required by any law, ordinance or regulation to
the extent such requirement is triggered by construction of the Tenant
Improvements or use of the Building.
c. "Final Space Plan" shall mean a drawing of the Premises
showing, in addition to the items shown on the Preliminary Space Plan, locations
of electrical, data and telephone outlets, plumbing, millwork, furniture and
equipment.
d. "Preliminary Space Plan" shall mean a drawing of the Premises
clearly showing the layout and relationship of all rooms or other divisions of
the Premises, depicting partitions, door locations and swings, special equipment
locations and requirements, rentable and usable area calculations.
e. "Space Planner" shall mean TSH Architects.
f. "Tenant Allowance" shall mean the amount necessary to
construct the Tenant Improvements but in no case in excess of $3,716,820, which
allowance shall be paid by Landlord toward the Cost of Improvements and
Landlord's overhead and third party costs for supervising such construction, but
in no case more than five percent (5%) of the Cost of Improvements shall be paid
on account of such supervision.
g. "Tenant Improvements" shall mean all improvements to be
constructed by Landlord for Tenant in the Premises.
h. "Tenant Loan" shall mean an amount of up to $929,205 which
Landlord may lend to Tenant for the purposes of being applied to the Cost of
Improvements and which shall be repaid in accordance with the provisions of
Section 7 of this Improvement Agreement.
i. "Working Drawings" shall mean documents detailing the Tenant
Improvements, as shown on the Final Space Plan, and conforming to applicable
building and planning codes, complete in form and content and containing
sufficient information and detail to allow for competitive bidding or negotiated
pricing.
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<PAGE> 39
Other terms are defined in this Improvement Agreement. In addition,
terms defined in the Lease have the same meanings where used herein, unless the
context otherwise requires.
2. DESIGN AND CONSTRUCTION. The preparation of the Preliminary and
Final Space Plans, the Working Drawings and the construction of the Tenant
Improvements shall be performed by designers, engineers, contractors and
subcontractors selected and engaged by Landlord, subject to Tenant's approval
which shall not be unreasonably withheld or delayed.
3. SCHEDULE OF TENANT IMPROVEMENT ACTIVITIES.
a. Landlord shall submit the Preliminary Space Plan to Tenant for
its review. Tenant shall review and approve or disapprove in writing the
Preliminary Space Plan within five (5) business days following delivery. If
Tenant disapproves the Preliminary Space Plan or any portion thereof, it shall
include with its disapproval a statement of the revisions Tenant requests in
order to approve the Preliminary Space Plan. Within five (5) business days
thereafter Landlord shall submit to Tenant a revised Preliminary Space Plan
incorporating the revisions requested by Tenant,
b. After approval of the Preliminary Space Plan, Landlord shall
forthwith cause its architect to prepare the Final Space Plan and upon its
completion shall forward it to Tenant for review. Within five (5) business days
following Landlord's submission of the Final Space Plan, Tenant shall review and
approve or disapprove in writing the Final Space Plan. If Tenant disapproves the
Final Space Plan or any portion thereof, Tenant shall include with its notice of
disapproval a statement of the revisions Tenant requests in order to approve the
Final Space Plan. Within five (5) business days following the date of Tenant's
notice, Landlord shall submit to Tenant a revised Final Space Plan incorporating
the revisions requested by Tenant.
c. Following Tenant's approval of the Final Space Plan, Landlord
shall proceed immediately with preparation of the Working Drawings, and upon
their completion shall submit the Working Drawings to Tenant for review. Within
five (5) business days following Tenant's receipt of the Working Drawings,
Tenant shall review and approve or disapprove in writing the Working Drawings.
If Tenant disapproves the Working Drawings, or any portion thereof, Tenant shall
include with its notice of disapproval a statement of the revisions Tenant
requests in order to approve the Working Drawings. Within five (5) business days
after the date of Tenant's notice, Landlord shall submit to Tenant revised
Working Drawings incorporating the revisions requested by Tenant.
d. Upon Tenant's approval of the Working Drawings, Landlord shall
cause application to be made to the appropriate governmental or
quasi-governmental authorities for necessary approvals and building permits.
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<PAGE> 40
e. Notwithstanding the five (5) business day limitations for
Landlord's response (i) if any changes to the Building structure or systems are
proposed which would require structural or mechanical engineering analysis, the
time periods for approval shall be extended to ten (10) business days, and (ii)
Landlord may, not more than two (2) times during design and construction of the
Tenant Improvements, extend Landlord's response time by five (5) additional
business days by notifying Tenant by telephone. Tenant shall be considered to
have approved the Preliminary Space Plan, Final Space Plan, Working Drawings or
Additional Tenant Work if Tenant has not given Landlord written notice of
disapproval specifying the grounds for disapproval within the time specified
herein.
4. TENANT IMPROVEMENT CONSTRUCTION.
a. All Tenant Improvements to be constructed or installed in the
Premises shall be performed by South Bay Construction in accordance with the
Approved Plans (subject to such changes as may be required by any governmental
agency). Existing improvements in the Premises, if any, may be used or
incorporated in the Tenant Improvements on a strictly AS IS basis. Landlord
shall not be required to commence work until the Approved Plans are filed with
the governmental agencies having jurisdiction thereof and all required building
permits have been obtained. Landlord may cause the Approved Plans to be changed
as may be required by any governmental agency, or as may be required due to
structural or unanticipated field conditions. Landlord shall notify Tenant
concerning any such changes promptly after Landlord becomes aware that they are
required.
b. If Tenant desires any change in the Approved Plans or any work
in addition to the Tenant Improvements in accordance with the Approved Plans to
be performed in the Premises ("Additional Tenant Work"), Tenant, at Tenant's
expense, shall cause plans and specifications for such work to be prepared by
arranging therefor with Space Planner. All plans and specifications for
Additional Tenant Work shall be subject to review and approval by Landlord
(which shall not be unreasonably delayed or withheld) to insure, among other
things, that the work is compatible with all other construction and all
electrical and mechanical systems within the Building. Upon such written request
and approval of same by Landlord, Landlord shall submit to Tenant, for approval,
a field order describing the change, a cost proposal and a Tenant Improvement
Construction Schedule Adjustment. Tenant shall approve the change order, in
writing, within two (2) business days following receipt thereof Landlord may
refuse to make any changes (and proceed with the work in accordance with the
Approved Plans) until Tenant so approves in writing the description of the
change, the cost proposal and a Tenant Improvement Construction Schedule
Adjustment. If Tenant does not approve the change order, then Landlord may elect
(i) to agree to the change order on Tenant's behalf, (ii) to withdraw the change
request on Tenant's behalf, or (iii) to proceed with the Tenant Improvement work
in accordance with the Approved Plans, but delaying any portion as reasonably
necessary to accommodate the change request. Any time consumed for changes or
delays pursuant to
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<PAGE> 41
clause (iii) above, shall be considered a Tenant Delay and shall not delay the
Commencement Date of the Lease. Tenant shall pay to Landlord upon demand all
costs actually and reasonably incurred by Landlord in connection with Landlord's
review and processing of Tenant's change request (including, without limitation,
the fees of space planners, architects, engineers), regardless of whether the
requested change is ultimately incorporated in the Tenant Improvements.
c. Following the Expansion Date, the parties shall agree as to
the scope of work and scheduling of the Tenant Improvements to be constructed in
Phase IV as outlined in Exhibit D of the Lease. Landlord shall construct such
Tenant Improvements in Phase IV in accordance with the terms of this Improvement
Agreement, and Landlord shall apply any unused Tenant Allowance and Tenant Loan
to the Cost of Improvements for Phase IV.
5. COMPLETION. The work to be performed by Landlord under this
Improvement Agreement shall be deemed substantially completed ("Substantial
Completion") on the date on which Landlord delivers to Tenant a certification
from Space Planner stating that the Premises are substantially complete and
ready for occupancy in accordance with the Approved Plans (modified as provided
herein) and that the final building inspection required for subsequent issuance
of a temporary certificate of occupancy for the Premises has been completed, or
that any remaining work fully described by Space Planner or other representative
on a punchlist can reasonably be expected to be completed with due diligence by
the Landlord's contractor within sixty (60) days and will not materially
adversely affect Tenant's ability to occupy and conduct Tenant's business in the
Premises.
6. COMMENCEMENT DATE.
a. The Commencement Date shall be the earliest of (a) the
Substantial Completion of the work pursuant to paragraph 5 above, (b) the date
Tenant takes possession of the Premises, or (c) the date such Substantial
Completion would have occurred but for delays caused by Tenant or its
representatives, agents or employees ("Tenant Delays"), including, without
limitation, delays caused by (i) any failure of Tenant to comply with the
schedule set forth in Section 3 above; (ii) any Additional Tenant Work; (iii)
any changes initiated by reason of Tenant's disapproval of cost proposals or
resulting in the preparation of revised cost proposals; (iv) field changes to
construction work requested or required by Tenant; (v) the delivery,
installation or completion of any Tenant cabling or finish work performed by
Tenant's employees or agents; (vi) Tenant's failure timely to make any payment
as required under this Improvement Agreement or the Lease; (vii) Tenant's
requirement for materials, components, finishes or improvements which are not
available within a commercially reasonable time; or (viii) any other act or
omission of Tenant, its agents or employees.
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<PAGE> 42
b. Notwithstanding any provision contained herein, if an Event of
Default occurs under the Lease or this Improvement Agreement at any time prior
to Substantial Completion of the Tenant Improvements, then, in addition to all
other rights and remedies set forth in the Lease, Landlord shall have the right
to cease design and construction of the Tenant Improvements, and such delay
shall be deemed a Tenant Delay.
c. If, for any reason other than Tenant Delays, Landlord fails to
deliver possession of the Premises to Tenant on the Commencement Date, or
perform any other covenant contained in this Improvement Agreement or in the
Lease related to the work described in this Improvement Agreement, this Lease
shall not be void or violable, nor shall such failure affect the obligations of
Tenant hereunder, except that all rent shall be abated during the period between
the Commencement Date and the time when Landlord delivers possession following
Substantial Completion of the Premises; provided, however that Tenant may
terminate this Lease by written notice to Landlord in the event the Commencement
Date has not occurred on or before the date which is ninety (90) days after the
Commencement Date (except for reasons attributable to Tenant Delays or causes
outside Landlord's control, which shall extend such period proportionately), if
such notice of termination is given within five (5) days after expiration of
such ninety (90) day period.
7. TENANT LOAN.
a. If the Cost of Improvements exceeds the Tenant Allowance, then
the Landlord shall advance the Tenant Loan to Tenant to the Cost of
Improvements. The entire amount advanced by Landlord as a Tenant Loan shall be
amortized over the initial Lease Term with any and all outstanding balance
accruing interest at a rate of twelve percent (12%) per annum from the date of
the advance. Tenant shall repay to Landlord the Tenant Loan, plus interest in
equal monthly installments commencing on the Commencement Date and continuing
until the first day of the last month of the initial Lease Term. If this Lease
is terminated for any reason prior to the expiration of the initial Lease Term,
then the Tenant Loan shall become due and payable in full on the last day of the
Lease. If the Cost of Improvements exceeds the Tenant Allowance and the Tenant
Loan, Tenant shall reimburse Landlord for such excess within ten (10) days
following Landlord's written demand. If Landlord completes the Tenant
Improvements without spending the entire Tenant Allowance, then all of such
savings shall be for Landlord's benefit, and Tenant shall have no right to any
rebate, credit or reimbursement for any portion of such savings.
b. Any failure by Tenant to pay any amounts due hereunder shall
have the same effect under the Lease as a failure to pay rent. Any such failure,
or failure by Landlord or Tenant to perform any of its other obligations
hereunder, shall constitute an Event of Default under the Lease entitling the
other party to all of its remedies under the Lease, at law and in equity.
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<PAGE> 43
8. GENERAL.
a. All drawings, space plans, plans and specifications for any
improvements or installations in the Premises are expressly subject to
Landlord's prior written approval. Any approval by Landlord or Landlord's
architects or engineers of any drawings, plans or specifications prepared on
behalf of Tenant shall not in any way bind Landlord or constitute a
representation or warranty by Landlord as to the adequacy or sufficiency of such
drawings, plans or specifications, or the improvement to which they relate, but
such approval shall merely evidence the consent of Landlord to Tenant's
drawings, plans or specifications.
b. Landlord hereby assigns to Tenant all warranties and
guaranties relating to the Improvements and the Tenant Improvements, and Tenant
hereby waives any and all claims it may have against Landlord relating to or
arising out of the construction of the Improvements and Tenant Improvements
except as expressly set forth in the Lease.
c. Tenant hereby designates Buck Hudkins as its sole
representative with respect to the matters set forth in this Improvement
Agreement, who, until further written notice to Landlord from Tenant, shall have
full authority and responsibility to act of behalf of Tenant as required in the
Improvement Agreement.
IN WITNESS WHEREOF, the parties have executed this Tenant Improvement
Agreement as of September 19, 1997.
LANDLORD TENANT
RNM LAKEVILLE, L.P., a California ADVANCED FIBRE
Limited Partnership COMMUNICATIONS, INC., a Delaware
corporation
By RNM PETALUMA, INC., a
California corporation, its
Managing General Partner
By: /s/ PETER DARBEE
-------------------------------------
Peter Darbee, Chief Financial Officer
By: /s/ JOHN R. MCNULTY
---------------------------------
John R. McNulty, President
Date: October 9, 1997
-------------------------------
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<PAGE> 44
EXHIBIT D
PREMISES
[MAP OF PREMISE]
<PAGE> 45
EXHIBIT E
LIST OF HAZARDOUS MATERIALS
<PAGE> 46
BROKER DISCLOSURE STATEMENT
PROPERTY: Cypress Center, 2210 S. McDowell Blvd., Petaluma, California
AMERICANS WITH DISABILITIES ACT: On July 26, 1991, the federal legislation known
as the Americans with Disabilities Act (ADA) was signed into law. The purpose of
the ADA is to integrate persons with disabilities into the economic and social
mainstream of American life. Title III of the ADA applies to landlords and
tenants of "places of public accommodation" and "commercial facilities," and
requires that places of public accommodation undertake "readily achievable"
removal of communication and access barriers to the disabled. This requirement
of Title III of the ADA became effective January 26, 1992. Landlord and Tenant
should seek expert advice regarding the implications of the Act as it affects
this agreement.
HAZARDOUS MATERIALS WARNING: Current and future federal, state and local laws
and regulations may require the clean-up of such toxic, hazardous or undesirable
materials at the expense of those persons who in the past, present or future
have had any interest in the Property including, but, not limited to, current,
past and future owners and users of the Property, Landlord and Tenant are
advised to consult with independent legal counsel of their choice or other
experts, to determine their potential liability.
LIABILITY RELEASE: Meridian Commercial, Inc., and its salespeople in this
transaction have no expertise regarding the Americans with Disabilities Act or
hazardous materials. Landlord and Tenant agree that they shall each individually
release Meridian Commercial, Inc., and its salespeople from any claim,
liability, or expense regarding the ADA or hazardous materials.
BROKER: Meridian Commercial, Inc. is the only real estate broker in this
transaction and both Landlord and Tenant consent thereto.
"Landlord" "Tenant"
RNM LAKEVILLE LP, INC. ADVANCED FIBRE COMMUNICATIONS,
By: RNM Petaluma Inc. INC.,
Its: Managing General Partner a Delaware corporation
By /s/ JOHN R. MCNULTY By /s/ PETER DARBEE
------------------------------ ---------------------------------
John R. McNulty Peter Darbee
Its: President Its: Chief Financial Officer
Date Date
Executed October 9, 1997 Executed October 9, 1997
----------------------- --------------------------
<PAGE> 1
EXHIBIT 10.38
[AFC LETTERHEAD]
CONFIDENTIAL
TERMINATION AGREEMENT AND GENERAL RELEASE
THIS TERMINATION AGREEMENT AND GENERAL RELEASE (the "AGREEMENT") is made
and entered into by and between Daniel E. Steimle (the "Employee") and Advanced
Fibre Communications, Inc., its predecessors, successors, affiliates,
subsidiaries, employees, agents, officers, directors, etc., (the "Company").
The Employee and the Company enter into this Agreement for the purpose
of concluding and resolving all matters relating to the Employee's employment
with the Company, the terms and conditions of that employment, and the
termination of that employment.
The Employee acknowledges that he possesses sufficient education and
experience to fully understand the terms of this Agreement as it has been
written, the legal and binding effect of the Agreement, and the exchange of
benefits and payments for promises hereunder.
The Employee and the Company agree that the Company has no prior legal
obligation to make the payments which are exchanged for promises herein. The
Employee understands and agrees that the Company's obligation to perform under
this Agreement is conditioned upon the Employee's performance of all agreements,
releases and covenants to the Company as set forth herein.
In consideration of the promises and mutual promises herein, it is
agreed as follows:
1. The Employee served the Company at the will of the Company. This
Agreement shall not in any way be construed as an admission by the Company of
any alleged wrongful acts of any kind or nature whatsoever. This Agreement is
not an admission of liability, and furthermore, the Company specifically
disclaims any liability or wrongdoing whatsoever.
2. The Employee's termination date will be September 30, 1997.
<PAGE> 2
3. The Company agrees that Employee will receive regular bi-weekly
payments of $7,192.30 through July 20, 1998 for a total of $155,353.68, minus
lawful taxes and withholding. Employee will also receive a pro-rata portion of
the year-end bonus provided by the Company, based on services rendered from
January 1, 1997 through July 20, 1997.
4. The Company agrees to conditional continued vesting of certain of
Employee's unvested stock options through July 20, 1998 (see Attachment A of the
Exhibit A). The options that will continue to vest, however, will not be
exercisable until July 20, 1998 provided Employee has complied with all
provisions of this Agreement and of the consulting agreement attached hereto as
Exhibit A. In the event Employee breaches any terms of this Agreement or Exhibit
A, the payments referred to in paragraph 3 will cease, and the additional
vesting referred to in this paragraph will be cancelled.
5. Employee agrees to enter into and comply with the consulting
agreement attached hereto as Exhibit A which is incorporated herein.
6. The payments made to, or on behalf of Employee, by the Company as
stated in paragraph 3 and 4 are not in the nature of severance pay and are
provided to the Employee on the basis of the specific facts and circumstances of
the Employee's situation and only in exchange for the mutual promises made in
this Agreement.
For and in consideration of these special payments and for other good
and valuable consideration paid by the Company, the receipt and sufficiency of
which is hereby acknowledged, the Employee does for himself, his heirs, personal
representatives, administrators and anyone claiming by or through him, forever
unconditionally and irrevocably release, acquit and discharge the Company and
all of its past and present directors, officers, supervisors, employees,
representatives, successors, assigns, subsidiaries, affiliates, benefit plans,
divisions and parent and insurers (hereinafter collectively "the Releasees")
from any and all claims and causes of action, suits, obligations, promises,
agreements, controversies, damages, debts and demands, liabilities and losses of
every kind, character, and nature, including third party claims for indemnity or
contribution, against the Company and any other cause of action ("claim" or
"claims") that the Employee has ever had or now has, now known or unknown, or
that any person or entity claiming through the Employee may have or claim to
have against the Releasees. This Agreement specifically, without limitation,
releases the Releasees from any and all obligations arising out of the
Employee's employment with the Company, including but not limited to claims for
tort, contract, wrongful termination, discrimination, under Title VII of the
Civil Rights Act of 1964 ("Title VII"), as amended, the California Fair
Employment and Housing Act, or the Age Discrimination in Employment Act ("ADEA")
or violation of any state or federal statute, and any other employment benefit
or compensation.
2
<PAGE> 3
7. The Employee represents that the Employee has not filed nor will he
file any complaint or charge against the Company with the Equal Opportunity
Commission ("EEOC"), the California Fair Employment and Housing Commission, the
Federal or California Department of Labor, or with any other local, state or
federal agency or court, that the Employee will not do so at any time hereafter,
and that if any such agency or court assumes jurisdiction of any complaint, the
Employee will request such agency or court to withdraw from the matter.
8. The Employee expressly waives and relinquishes any claims, rights and
benefits, whether actually known or not, including those afforded to him by
Title VII, the ADEA, the California Fair Employment and Housing Act, Section
1542 of the Civil Code of California, which is quoted below, or any other local,
state or federal acts dealing with employment discrimination.
CIVIL CODE SECTION 1542: "A general release does not extend to claims
which the creditor does not know or suspect to exist in his favor at
the time of executing the release which if known by him must have
materially affected his settlement with the debtor."
9. The Employee shall return all Company property, including but not
limited to, keys, equipment, manuals, drawings, notes, etc. to the Company
immediately upon execution of this Agreement. In addition, any monies owed to
the Company by the Employee, whether with respect to loans, travel advances, or
otherwise, must be immediately repaid by the Employee. If the Employee has any
travel or business expenses which have not been submitted for approval, the
Employee will submit such items within two weeks following the date of this
Agreement.
10. This Agreement shall be binding upon the Employee and upon the
Employee's heirs, administrators, representatives, executors, successors and
assigns, and shall inure to the benefit of the Releasees.
11. The Employee represents that no inducements, statements or
representations have been made that are not set forth in this Agreement and that
he did not rely on any inducements, statements or representations not set forth
herein. The Employee further represents that he is of sound mind and body to
enter into this Agreement, he has had an opportunity and was encouraged to
discuss the legal significance and ramifications of this Agreement with his
independent attorneys if he so desired and he enters into this Agreement freely
and voluntarily. Moreover, the Employee understands he has seven (7) days to
revoke this Agreement and acknowledges he has received at least 21 days to
decide whether or not to accept this Agreement.
3
<PAGE> 4
12. The Employee will not disclose any confidential or proprietary
information acquired while an employee of the Company, nor will the Employee
make any disparaging remarks about the Company. Employee agrees to abide by the
terms of the Proprietary Information and Inventions Agreement executed on
February 5, 1996. Information acquired by Employee concerning litigation of any
kind involving the Company is considered confidential and/or proprietary
information and is within the scope of the prohibitions contained in this
paragraph and the Proprietary Information and Inventions Agreement. Further,
Employee agrees not encourage or solicit, directly, indirectly or through
others, any present or future AFC employee to leave the Company for any reason
for a period of two years from the date of execution of this Agreement.
13. The Employee shall not disclose the terms of this Agreement, or its
existence, to anyone other than his immediate family or professional advisors
and shall instruct them on the duty to maintain its confidentiality.
14. The Employee will cooperate with the Company to assure an orderly
transition of work responsibilities and covenants that he will not take any
action , or omit to act, to the detriment of Company or its operations. The
Employee agrees that during the period he continues to be employed, and
thereafter, at the Company's expense, he will assist the Company in any
litigation against the Company brought by third parties relating to the
Employee's work product, or the business of the Company, whether now pending or
brought in the future.
15. This Agreement constitutes the complete understanding between the
Employee and the Company with respect to the subject matter of the Agreement and
supersedes any prior or contemporaneous oral and/or written agreements or
representations, if any, between the parties. This Agreement may not be orally
amended, modified or changed and may be amended, modified or changed only by
written instrument or instruments signed by the Employee and the duly authorized
officers of the Company.
16. This Agreement is made and entered into in the State of California,
and shall in all respects be interpreted, enforced and governed, under the laws
of California. The language of all parts of this Agreement shall in all cases be
construed as a whole, according to its fair meaning, and not strictly for or
against any of the parties.
17. In the event the Employee breaches the agreements set forth in this
Agreement by making a claim or bringing an action of any kind against the
Company in violation of this Agreement, the Employee shall be required to pay
the Company's litigation costs (including attorney's fees) associated with
defending against such claim or action.
4
<PAGE> 5
18. Should any provision of this Agreement be declared or be determined
by any court to be illegal or invalid, the validity of the remaining parts,
terms or provisions shall not be affected thereby and said illegal or invalid
part, term or provision shall be deemed not to be a part of this Agreement.
19. As used in this Agreement, the singular or plural shall be deemed to
include the other whenever the context so indicates or requires.
PLEASE READ CAREFULLY. THIS TERMINATION AGREEMENT
AND GENERAL RELEASE INCLUDES A RELEASE OF ALL KNOWN AND
UNKNOWN CLAIMS.
BY EXECUTING THIS AGREEMENT BELOW, EMPLOYEE
ACKNOWLEDGES
THAT HE HAS READ THIS TERMINATION AGREEMENT AND GENERAL
RELEASE
AND THAT HE WAS GIVEN TWENTY ONE (21) DAYS TO CONSIDER ITS
TERMS AND
HAS ENTERED INTO THIS AGREEMENT FREELY AND VOLUNTARILY.
Executed at Cupertino, California, this 22ND day of December, 1997
/s/ DANIEL E. STEIMLE
- -------------------------------------
Daniel E. Steimle
Executed at Petaluma, California, this ___ day of __________, 1997.
ADVANCED FIBRE COMMUNICATIONS, INC.
BY: /s/ CARL GRIVNER
---------------------------------
Carl Grivner
President and CEO
<PAGE> 1
EXHIBIT 10.39
EXHIBIT A
CONSULTING AGREEMENT
This Agreement is entered into as of the date set forth below between
Advanced Fibre Communications, Inc. ("AFC") and the consultant named below
("Contractor").
In consideration of the mutual covenants set forth herein, AFC hereby
retains Contractor on the terms set forth below:
1. SERVICES TO BE RENDERED. Contractor will perform services as
described in Attachment A.
2. PAYMENT FOR CONTRACTOR'S SERVICES. AFC will pay Contractor according
to the terms specified in the Termination Agreement and General Release and as
detailed in Attachment A hereof.
3. LOCATION OF WORK. Contractor's principal place of work shall be
determined by contractor, except that it will not be at the offices of AFC.
4. CONTRACTOR'S INDEPENDENT CONTRACTOR STATUS. Contractor will provide
services as an independent contractor, and is not authorized to act as AFC's
agent. Contractor will not be an employee of AFC, and will not be entitled to
Workmen's Compensation Coverage, Unemployment Insurance or any other type of
insurance or benefit normally provided by AFC to its employees. AFC will not
withhold income or Social Security taxes from Contractor's fee. AFC shall have
no financial liability to Contractor as a result of this Agreement, except as
provided in paragraph one above.
5. EXPENSES. Expenses incurred by Contractor in connection with
performing services to be provided herein shall be borne exclusively by
Contractor and will not be reimbursed by AFC, except as may be set forth herein.
6. OTHER SERVICES. This Agreement shall not be construed to preclude or
limit Contractor from performing services similar to those provided to AFC to
other persons or entities, provided the confidentiality provisions set forth
below are complied with, and provided such other services do not present a
conflict of interest.
6
<PAGE> 2
7. CONFIDENTIAL INFORMATION OF OTHERS. Contractor represents that he
will not use, disclose to AFC, or induce AFC to use any confidential information
or documents belonging to others, which he has in his possession. Contractor
represents that this Agreement will not cause Contractor to violate any
copyright or other intellectual property right of any third party.
8. DEFINITION OF PROPRIETARY INFORMATION. As used herein, the term
"Proprietary Information" refers to any and all information of a confidential,
proprietary or secret nature which is or may be either applicable to, or related
in any way to (i) the business, present or future, of AFC, (ii) the research and
development or investigations of AFC, or (iii) the business of any customer of
AFC. Proprietary Information includes, for example and without limitation, trade
secrets, processes, formulae, data, algorithms, source codes, object codes,
know-how, improvements, inventions, techniques, marketing plans and strategies,
information concerning volume of sales, profits and losses, and any information
regarding current or potential customers. Proprietary Information shall also
include all information of a like nature owned by any other person and furnished
to AFC by such other person pursuant to an undertaking by AFC to maintain the
same in confidence.
9. PROPRIETARY INFORMATION TO BE KEPT IN CONFIDENCE. Contractor
acknowledges that Proprietary Information is a special, valuable and unique
asset of AFC and/or its customers or licensors, and Contractor agrees at all
times during the period of this Agreement, and thereafter, to keep in confidence
and trust all Proprietary Information. Contractor agrees that during the period
of this Agreement and thereafter, Contractor will not directly or indirectly use
the Proprietary Information other than in the course of performing duties for
AFC, nor will Contractor directly or indirectly disclose any Proprietary
Information or anything relating thereto to any person or entity, except in the
course of performing services under this Agreement and with the consent of AFC.
Contractor will abide by AFC's policies and regulations as may be established
from time to time for the protection of its Proprietary Information.
10. RETURN OF MATERIALS. At the request of AFC or in the event of any
termination of this Agreement for whatever reason, Contractor will promptly
deliver to
7
<PAGE> 3
AFC all documents, data, records and other information pertaining to
this Agreement, including information created by Contractor as a result of this
Agreement. Contractor shall not take with him any documents or data, or any
reproductions or excerpt of any document or data, containing or pertaining to
any Proprietary Information.
11. DISCLOSURE TO AFC; INVENTIONS AS SOLE PROPERTY OF AFC. Contractor
agrees promptly to disclose to AFC any and all inventions, discoveries,
improvements, trade secrets, copyrights, formulae, techniques, processes and
know-how, whether or not patentable or whether or not reduced to practice,
conceived or learned by Contractor during the period of his work on behalf of
AFC, either alone or jointly with others, which relate to or result from the
actual or anticipated scope of this Agreement, or which result, to any extent,
from use of AFC's premises or property (the work being hereinafter collectively
referred to as the "Inventions").
Contractor acknowledges and agrees that all such Inventions shall be the
sole property of AFC and/or any other person or entity designated by it, and
Contractor hereby assigns to AFC his entire right and interest in and to all
Inventions; provided, however, that such assignment does not apply to any
invention which qualifies for protection under California Labor Code Section
2870. Upon request by AFC, Contractor shall execute any required documents and
furnish all reasonable assistance to AFC in order to vest all rights to the
Inventions in AFC. All data and reports prepared as a result of this Agreement
shall be the exclusive property of AFC and shall be used by Contractor solely in
his work for AFC. If any preexsisting materials are contained in the deliverable
items, Contractor hereby grants a royalty free license to AFC to use such
materials.
12. INJUNCTION. Contractor agrees that it would be difficult to measure
damage to AFC from any breach by Contractor of the agreements set forth in
Paragraphs 6, 7, 8 and 9 herein, and that injury to AFC from any such breach
would be impossible to calculate, and that money damages would therefore be an
inadequate remedy. Accordingly, Contractor agrees that if he should breach any
provision of Paragraphs 6, 7, 8 and 9, or any of them, AFC shall be entitled, in
addition to all other remedies it may have, to an injunction or other
appropriate
8
<PAGE> 4
orders to restrain any such breach by Contractor without showing or proving any
actual damage sustained by AFC.
13. TERM OF THIS AGREEMENT. Either party may terminate this Agreement
with no further obligation for unperformed work ten (10) days after written
notice is mailed or given to the other party.
14. INDEMNIFICATION. Contractor agrees to indemnify and defend AFC and
its employees from any liability for claims arising as a result of services
performed under this Agreement, except for liability occasioned by the
negligence of AFC or its employees.
15. OTHER OBLIGATIONS. Contractor is not currently obligated, nor will
Contractor assume any obligations which interfere with or are inconsistent with
the services to be performed under this Agreement.
16. GENERAL.
(a) To the extent that any of the promises set forth herein,
or any word, phrase, clause, or sentence thereof shall be found to be illegal or
unenforceable for any reason, such agreement, word, clause, phrase or sentence
shall be modified or deleted in such manner so as to make the agreement as
modified legal and enforceable under applicable laws, and the balance of the
agreement, or parts thereof, shall not be affected thereby, the balance being
construed as severable and independent.
(b) This Agreement shall be binding upon Contractor and his
heirs, executors, assigns, and administrators and shall inure to the benefit of
AFC, its successors and assigns and any Subsidiary or Parent of AFC.
(c) This Agreement shall be governed by and construed in
accordance with the laws of the State of California.
(d) This Agreement may be signed in counterparts, each of
which shall be deemed an original and which together shall constitute one
instrument.
(e) The use of the singular in this Agreement includes the
plural, as appropriate.
9
<PAGE> 5
(f) This Agreement and Attachment A represent the entire
agreement between Contractor and AFC with respect to the subject matter hereof,
superseding all previous oral or written communications, representations or
agreements. This Agreement may be modified only by a duly authorized and
executed writing, signed by Contractor and the Manager and approved by the
President.
Dated: 12/22/97 Dated:
---------------------------- --------------------------------
Contractor: ADVANCED FIBRE COMMUNICATIONS, INC.
By: /s/ DANIEL E. STEIMLE By: /s/ CARL GRIVNER
------------------------------- -----------------------------------
Daniel E. Steimle Carl Grivner
President and CEO
SS or ER ID#
10
<PAGE> 6
ATTACHMENT A
Contractor will assist, as requested, with the orderly transition of his
responsibilities as the former Vice President, Chief Financial Officer to the
new Vice President, Chief Financial Officer. Contractor agrees to be available
for telephone consultations as needed for the period commencing October 1, 1997
through July 20, 1998. AFC will pay for all of Contractor's reasonable out of
pocket expenses related to providing consulting services hereunder.
In exchange for such services, AFC will compensate Contractor by continuing to
vest the following stock options held by him through July 20, 1998:
<TABLE>
<CAPTION>
NQSO Shares to Vest
Grant Date Shares Granted 10/1/97 - 7/20/98 Price
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
January 17, 1997 1,300 542 $26.50
January 17, 1997 20,000 4167 $26.50
</TABLE>
Contractor will be permitted to exercise the "shares to vest" (totaling 4709
NQSOs) for a period of ninety (90) days after July 20, 1998.
11
<PAGE> 1
EXHIBIT 13.1
FIVE-YEAR SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1997 1996(1) 1995 1994 1993
-------- -------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Revenues....................................... $267,858 $130,193 $54,287 $18,802 $ 620
Cost of revenues............................... 145,933 73,950 33,469 14,124 2,574
-------- -------- ------- ------- -------
Gross profit (loss).......................... 121,925 56,243 20,818 4,678 (1,954)
-------- -------- ------- ------- -------
Operating expenses:
Research and development..................... 25,726 14,413 5,730 2,867 2,044
Selling, general and administrative.......... 42,653 21,188 9,660 5,051 2,509
DSC litigation costs......................... -- 18,947 1,623 4,551 784
-------- -------- ------- ------- -------
Total operating expenses............. 68,379 54,548 17,013 12,469 5,337
-------- -------- ------- ------- -------
Operating income (loss)........................ 53,546 1,695 3,805 (7,791) (7,291)
Gain on dissolution (equity in loss) of joint
venture, net................................. -- 1,516 (1,516) -- --
Other income, net.............................. 4,866 872 149 26 --
-------- -------- ------- ------- -------
Income (loss) before income taxes.............. 58,412 4,083 2,438 (7,765) (7,291)
Income taxes (benefit)......................... 21,612 (3,154) 97 -- --
-------- -------- ------- ------- -------
Net income (loss).............................. $ 36,800 $ 7,237 $ 2,341 $(7,765) $(7,291)
======== ======== ======= ======= =======
Basic net income (loss) per share(2)........... $ 0.52 $ 0.30 $ 0.27 $ (1.27) $ (1.21)
======== ======== ======= ======= =======
Shares used in basic per share computations.... 70,131 24,146 8,746 6,093 6,006
======== ======== ======= ======= =======
Diluted net income (loss) per share(2)......... $ 0.48 $ 0.11 $ 0.05 $ (1.27) $ (1.21)
======== ======== ======= ======= =======
Shares used in diluted per share
computations................................. 77,469 68,048 50,684 6,093 6,006
======== ======== ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------
1997 1996 1995 1994 1993
-------- -------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities................................... $105,196 $108,430 $11,118 $ 3,858 $ 450
Working capital................................ 193,640 145,338 18,770 6,809 466
Total assets................................... 273,293 175,679 36,680 14,884 3,787
Redeemable convertible preferred stock......... -- -- 37,777 23,546 9,152
Stockholders' equity (deficit)................. 223,720 158,023 (15,765) (15,706) (7,952)
</TABLE>
- ---------------
(1) Includes a charge of $15.8 million to reflect a cash payment of $10.1
million and the issuance of 1,451,574 shares of Common Stock to DSC in
settlement of outstanding litigation. See "Note 10 of Notes to Consolidated
Financial Statements." Without this charge, operating income for the year
ended December 31, 1996 would have been $17.5 million.
(2) See "Note 1 of Notes to Consolidated Financial Statements" for an
explanation of the determination of the number of shares used in computing
basic and diluted net income per share.
<PAGE> 1
EXHIBIT 13.2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Except for the historical financial information contained herein, the
following discussion and analysis may contain "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Such statements
include declarations regarding the intent, belief or current expectations of the
Company and its management. Prospective investors are cautioned that any such
forward-looking statements are not guarantees of future performance and involve
a number of risks and uncertainties; actual results could differ materially from
those indicated by such forward-looking statements. Among the important factors
that could cause actual results to differ materially from those indicated by
such forward-looking statements, as set forth in "Certain Factors That Might
Affect Future Operating Results," are: (i) the limited history of operations and
profitability of the Company, (ii) potential fluctuations in future operating
results and seasonality, (iii) dependence on the telecommunications industry and
small line-size market, (iv) risks associated with a concentrated product line,
new products and rapid technological change, (v) dependence on sole-source and
other key suppliers, (vi) dependence on a limited number of third party
manufacturers and support organizations, (vii) risks associated with
competition, (viii) risks associated with pending litigation, (ix) risks
associated with limited protection of proprietary technology and risk of
third-party claims of infringement, (x) risk of failure to manage expanding
operations, (xi) impact of the year 2000 on operating systems, (xii) customer
concentration, (xiii) risks associated with international markets, including
currency and economic risks, (xiv) dependence on key personnel, (xv) compliance
with regulations and industry standards and (xvi) other risks identified from
time to time in the Company's reports and registration statements filed with the
Securities and Exchange Commission.
OVERVIEW
The Company designs, develops, manufactures, markets and supports the UMC
system, a cost-effective multi-feature digital loop carrier system developed to
serve small line-size markets. The Company's UMC system is designed to enable
telephone companies, cable companies and other service providers to connect
subscribers to the central office switch for voice and data communications over
copper, fiber and analog radio networks. The Company was incorporated in May
1992 and was in the initial startup and development phase through December 1993.
The Company began shipping the UMC in January 1994 and, accordingly, has a
limited operating history.
The Company has incurred substantial expenditures related to the
development, manufacturing startup and marketing of the UMC system. As a result
of these expenditures, combined with $25.9 million of expenses and settlement
amounts recorded in connection with certain litigation with DSC which was
settled in June 1996, the Company had a year-end accumulated deficit of $6.2
million as of December 31, 1996. Although the Company achieved profitability for
each year beginning in 1995, there can be no assurance that the Company will
sustain or increase its profitability in the future. The Company currently
derives substantially all of its revenues from the UMC system and expects that
this concentration will continue in the foreseeable future. As a result, any
decrease in the overall level of sales of, or the prices for, the UMC system due
to product enhancements, introductions or announcements by the Company's
competitors, a decline in the demand for the UMC system, product obsolescense or
any other reason would have a material adverse effect on the Company's business,
financial condition and results of operations. The Company derives a minor
amount of revenue from royalties generated from the Company's various strategic
relationships. Support revenues to date have been negligible.
The Company sells its products worldwide, primarily through its direct
sales force in the domestic market, and through its direct sales force,
distributors and agents in international markets. The Company's wholly owned,
Hong Kong-based subsidiary markets the UMC system throughout the Asia Pacific
region. The Asia Pacific region's economy has deteriorated recently resulting in
the devaluation of currencies in
1
<PAGE> 2
certain of the countries of this region. The Company sells the UMC system in
this region under U.S. Dollar denominated contracts; primarily in China. As a
result, the economic downturn in the Asia Pacific region has not had a material
adverse effect on the Company's financial condition to date. However, there can
be no assurances that the economic downturn in the Asia Pacific region will not
have an adverse effect on the Company's financial results in the future.
The Company's customers normally install a portion of the UMC system in
outdoor locations. Shipments of the UMC system are subject to the effects of
seasonality, with fewer installation projects scheduled for the winter months.
Accordingly, the Company believes that over time this seasonality will cause its
revenues in the quarter ended March 31 to be lower than revenues in the
preceding quarter ended December 31. In particular, the Company currently
believes that revenues in the quarter ended March 31, 1998, may be lower than
revenues in the quarter ended December 31, 1997. See "Quarterly Results of
Operations".
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
of revenues represented by certain items reflected in the Company's consolidated
statements of operations:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996(1) 1995
------ --------- ------
<S> <C> <C> <C>
Revenues.................................................... 100.0% 100.0% 100.0%
Cost of revenues............................................ 54.5 56.8 61.7
------ ----- ------
Gross profit.............................................. 45.5 43.2 38.3
------ ----- ------
Operating expenses:
Research and development.................................. 9.6 11.1 10.6
Selling, general and administrative....................... 15.9 16.3 17.8
DSC litigation costs...................................... -- 14.5 3.0
------ ----- ------
Total operating expenses............................... 25.5 41.9 31.3
------ ----- ------
Operating income............................................ 20.0 1.3 7.0
Gain on dissolution (equity in loss) of joint venture,
net....................................................... -- 1.2 (2.8)
Other income, net........................................... 1.8 0.6 0.3
------ ----- ------
Income before income taxes.................................. 21.8 3.1 4.5
Income taxes (benefit)...................................... 8.1 (2.4) 0.2
------ ----- ------
Net income.................................................. 13.7% 5.5% 4.3%
====== ===== ======
</TABLE>
- ---------------
(1) Includes a charge of $15.8 million to reflect a cash payment of $10.1
million and the issuance of 1,451,574 shares of Common Stock to DSC in
settlement of outstanding litigation. See "Note 10 of the Notes to
Consolidated Financial Statements". Without this charge, operating income as
a percentage of revenues for the year ended December 31, 1996 would have
been 13.4%.
1997 COMPARED WITH 1996
Revenues Revenues for the year ended December 31, 1997 were $267.9 million
compared with $130.2 million for 1996, an increase of $137.7 million or 106%.
International revenues were $70.9 million for 1997 compared with $27.1 million
for 1996, an increase of $43.8 million or 162%. The increase in revenues for
1997 was primarily due to continued growth in the independent telephone market,
an increase in international revenues arising from expanded marketing and
targeting efforts, the introduction of the 3GDLC and other new features of the
UMC system, and the expansion of the Company's customer base. For the year ended
December 31, 1997, GTE Communication Systems Corporation ("GTE") accounted for
19% of total revenues. No other single customer accounted for 10% or more of
total revenues in 1997. For the year ended December 31, 1996, no single customer
accounted for 10% or more of total revenues. Although the Company's largest
customers have varied from period to period, the Company anticipates that its
results of operations in
2
<PAGE> 3
any given period will continue to depend to a significant extent upon sales to a
small number of customers. There can be no assurance that the Company's
principal customers will continue to purchase product from the Company at
current levels, if at all. The loss of one or more major customers could have a
material adverse effect on the Company's business, financial condition and
results of operations.
Gross Profit For the year ended December 31, 1997, gross profit was $121.9
million or 45.5% of revenues compared with $56.2 million or 43.2% of revenues
for 1996, an increase of $65.7 million or 117%. The improvement in gross profit,
as a percentage of revenues, from 1996 to 1997 resulted from greater
efficiencies achieved in the purchasing and manufacturing activities associated
with higher unit volume, engineering design improvements, and the lower cost of
inventory manufactured in China. In the future, gross profit may fluctuate due
to a wide variety of factors, including: the mix between domestic and
international sales; the customer mix; the timing and size of orders which are
received and can be shipped in a quarter; the availability of adequate supplies
of key components and assemblies; the adequacy of manufacturing capacity; the
Company's ability to introduce new products and technologies on a timely basis;
the timing of new product introductions or announcements by the Company or its
competitors; price competition and unit volume.
Research and Development For the year ended December 31, 1997, research and
development expenses were $25.7 million compared with $14.4 million for 1996, an
increase of $11.3 million or 78%. Research and development expenses were 9.6%
and 11.1% of revenues for 1997 and 1996, respectively.
The increase in research and development expenses from 1996 to 1997 was
primarily due to the addition of personnel hired to develop technology, the use
of outside services for certain development and testing efforts, and the higher
costs for material and test equipment used to develop and test new products and
features. As of December 31, 1997, the number of employees in research and
development was 176 compared with 124 in 1996, an increase of 42%. The Company
expects that research and development expenditures generally will continue to
increase in absolute dollars to support the continued development of new
products and features and the efforts to reduce product costs. All research and
development costs have been expensed as incurred.
Selling, General and Administrative For the year ended December 31, 1997,
selling, general and administrative expenses were $42.7 million compared with
$21.2 million for 1996, an increase of $21.5 million or 101%. Selling, general
and administrative expenses were 15.9% and 16.3% of revenues for 1997 and 1996,
respectively.
The increase in sales and marketing expenses from 1996 to 1997 was
attributed primarily to the effect of higher revenue levels on commissions
earned by the Company's sales force and by international distributors,
additional sales and marketing personnel including the growth of the Company's
infrastructure for international operations, increased advertising and trade
show participation, and increased travel and entertainment expenses. Additional
employees, expenses related to the conversion of management and accounting
systems, higher facility costs, and legal costs associated with the ITRI
litigation predominately accounted for the increase in general and
administrative expenses from 1996 to 1997. Selling, general and administrative
headcount increased 82% to 259 as of 1997 from 142 as of the end of the prior
year.
DSC Litigation From July 1993 until June 1996 the Company was involved in
litigation with DSC Communications Corporation ("DSC"). DSC alleged, among other
things, that the Company's UMC technology contained or was derived from trade
secrets and other proprietary technology of DSC. The parties entered into a
Settlement Agreement and Mutual Releases dated as of June 24, 1996 (the
"Settlement Agreement") pursuant to which the litigation was terminated. Under
the terms of the Settlement Agreement, the Company paid DSC $3.0 million in June
1996 and $7.1 million in July 1996, and issued 1,451,574 shares of Common Stock
to DSC. The full settlement amount was recorded during the second quarter of
1996 as a charge of $15.8 million. Under the terms of the Settlement Agreement,
the Company maintains all rights to the UMC technology free and clear of any
claim by DSC.
Other Income, Net For the year ended December 31, 1997, net other income
was $4.9 million compared with $2.4 million in 1996 (including a $1.5 million
gain on dissolution of joint venture), an increase of
3
<PAGE> 4
$2.5 million or 104%. The increase in 1997 was primarily due to investment
income from the investment of a portion of the proceeds of the Company's IPO in
October 1996.
Income Taxes (Benefit) For the year ended December 31, 1997, the Company
recorded income taxes at an effective rate that approximated the combined
federal and state statutory rates. For the year ended December 31, 1996, an
income tax benefit of $3.2 million was recorded to reflect the benefit of the
DSC litigation settlement and the decrease in the valuation allowance recorded
against the Company's deferred tax assets.
1996 COMPARED WITH 1995
Revenues Revenues for 1996 increased 140% to $130.2 million compared with
$54.3 million for 1995. International revenues for 1996 increased 277% to $27.1
million compared with $7.2 million in 1995 and represented 21% and 13% of total
revenues, respectively. ALLTEL Supply, Inc., an affiliate of ALLTEL, a major
independent domestic telephone company, accounted for 16% of total revenues in
1995, and was the only customer accounting for 10% or more of total revenues in
that year. No customer accounted for 10% or more of total revenues in 1996.
International and domestic revenues increased as a result of expansion of
the Company's customer base and the introduction of new features in the UMC
system. The increase in international revenues was partially due to higher sales
levels in China resulting from the acquisition in April 1996 of the shares of
the Company's Hong Kong-based subsidiary not previously owned by the Company
(which resulted in the consolidation for financial reporting purposes of the
Company's China-based operations) as well as increased levels of sales activity
in China. The increase in international revenues was also attributable to sales
to France Telecom, Hong Kong Telecom and Promon Electronics (Brazil).
Gross Profit Gross profit for 1996 increased 170% to $56.2 million compared
with $20.8 million in 1995. Gross profit, as a percent of revenues, was 43.2% in
1996 and 38.3% in 1995. The improvement in gross profit was attributable to
greater efficiencies in purchasing and manufacturing activities resulting from
higher unit volumes. Also, the Company realized lower product costs as a result
of engineering design improvements. Gross profit was negatively impacted in 1996
by the increased sales level in China which generally have lower gross profit
due to the higher cost of distribution and price sensitivity as compared with
other markets.
Research and Development Expenses relating to research and development
activities for 1996 increased 152% to $14.4 million compared with $5.7 million
in 1995. As a percentage of revenues, research and development expenses
increased to 11.1% for 1996 from 10.6% in 1995. The increase resulted primarily
from the hiring of additional personnel, the higher costs for material and test
equipment, and the use of outside services for certain development efforts
during 1996. The number of employees in research and development increased from
63 as of December 31, 1995 to 124 as of December 31, 1996.
Selling, General and Administrative Selling, general and administrative
expenses for 1996 increased 119% to $21.2 million from $9.7 million in 1995. As
a percentage of revenues, selling, general and administrative expenses decreased
from 17.8% in 1995 to 16.3% in 1996. Costs in the sales and marketing area
increased significantly from period to period reflecting the hiring of new
employees, and commissions earned by the Company's sales force and outside
international sales representatives as a result of higher revenue levels. The
Company also increased its advertising and trade show participation in 1996.
General and administrative expenses increased as a result of the expansion of
the administrative staff in 1996, the legal costs incurred for the ITRI
litigation and the additional costs associated with being a public company.
Selling, general and administrative headcount increased 129% to 142 employees as
of December 31, 1996.
DSC Litigation Costs Litigation expenses incurred in connection with the
DSC litigation increased to $18.9 million for 1996 from $1.6 million for 1995.
The increase is attributable to the $15.8 million charge recorded in the second
quarter of 1996 in connection with the final settlement of the DSC litigation.
See "Note 10 of Notes to the Consolidated Financial Statements."
4
<PAGE> 5
Gain on Dissolution (Equity in Loss) of Joint Venture, Net In 1996 and
1995, the Company made advances to a joint venture in which the Company had a
50% ownership interest. In April 1995, the Company made a loan of $1.0 million
to the joint venture. During 1995 and the first quarter of 1996, the Company
recorded its proportionate share of the joint venture's losses to the extent of
the loan and advances. As a result, the loan and intercompany receivables were
reduced to zero on the Company's balance sheet as of December 31, 1995. On
December 23, 1996, the Company and the joint venture partner entered into an
agreement to terminate the joint venture. In connection with the dissolution,
the joint venture partner reimbursed the Company approximately $1.7 million for
all loans and advances made by the Company to date. The reimbursement was
recorded as a gain in the fourth quarter of 1996 and is reflected in gain on
dissolution (equity in loss) of joint venture, net.
Other Income, Net Net other income increased to $872,000 in 1996 from
$149,000 in 1995 and consisted primarily of interest income from the Company's
cash and investments in marketable securities, net of interest expense on the
Company's bank line of credit and short-term bank loan.
Income Taxes (Benefit) An income tax benefit of $3.2 million was recorded
for 1996 to reflect the benefit of the DSC litigation settlement and the
decrease in the valuation allowance recorded against the Company's deferred tax
assets. As of December 31, 1996, the Company did not reflect a valuation
allowance against its deferred tax assets because management believed such
assets were realizable. For the second half of 1996, the Company recorded income
taxes at an effective rate that approximates the combined federal and state
statutory rates.
LIQUIDITY AND CAPITAL RESOURCES
The components of the Company's capital resources and liquidity at December
31, 1997 and 1996 were as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Cash and cash equivalents................................... $ 9,053 $24,942
Marketable securities....................................... 96,143 83,488
Non-debt working capital, excluding cash and cash
equivalents and marketable securities..................... 88,444 36,908
</TABLE>
As of December 31, 1997, the Company's cash and marketable securities
amounted to $105.2 million compared with $108.4 million at December 31, 1996.
Pursuant to its IPO on October 1, 1996, the Company issued 10,350,000
shares of its common stock which generated approximately $118.1 million in net
proceeds. These proceeds were used to reduce debt of approximately $14.8 million
in 1996 and the balance was invested in cash equivalents and marketable
securities.
In February 1997, the Company completed a secondary offering of 4,000,000
shares of Common Stock, 3,600,000 of which were sold by certain stockholders and
400,000 of which were sold by the Company, generating approximately $7.8 million
of net proceeds to the Company.
Net cash of $7.2 million was generated from operating activities in 1997.
This was primarily the result of increased earnings and a tax benefit generated
from the exercise of stock options, offset by an increase in receivables due to
higher sales volume and an increase in inventory in anticipation of expected
customer demand for the Company's products. Days sales outstanding were 78 days
at the end of 1997 and 68 days at the end of 1996. Net cash of $33.4 million was
used in investing activities in 1997, including the net purchases of marketable
securities, purchases of property and equipment, and an equity investment in a
development stage telecommunications company. The Company continues to invest in
capital equipment to support its employee and facility growth, its
implementation of a new management and accounting system, and its research and
development and manufacturing activities.
5
<PAGE> 6
The Company has a $12.0 million bank line with an interest rate of prime
plus 0.5%, or 9% at December 31, 1997. The line of credit expires in June 1998.
The Company intends to review and increase its line in the future. The amount
available to the Company for borrowing under the current line is based upon the
balance of eligible domestic accounts receivable at the time of borrowing. As
part of the bank line, the bank may issue letters of credit up to $10.0 million
and foreign exchange contracts up to $5.0 million on behalf of the Company. The
bank line requires the Company to comply with certain debt and financial
covenants. As of December 31, 1997 and 1996, no borrowings were outstanding
under the bank line, and the Company was in compliance with the covenants
contained in the agreement. At December 31, 1997 and 1996, $140,000 and
$1,300,000, respectively, were reserved under the line for letters of credit and
$2,900,000 and $352,000, respectively, were reserved for foreign exchange
contracts under the line.
The Company has lease lines totaling $11.8 million that are used for
equipment and furniture purchases. As of December 31, 1997, $3.1 million
remained available under the lease lines.
The Company believes that its existing cash and short-term investments,
available credit facilities, and cash flows from operating and financing
activities will be adequate to support the Company's financial resource needs,
including working capital requirements, capital expenditures and operating lease
obligations for the next twelve months.
6
<PAGE> 1
EXHIBIT 13.3
FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 9,053 $ 24,942
Marketable securities..................................... 96,143 83,488
Accounts receivable, less allowances of $2,729 in 1997.... 79,098 32,779
Inventories............................................... 52,073 17,349
Other current assets...................................... 6,090 3,631
-------- --------
Total current assets.............................. 242,457 162,189
Property and equipment, net................................. 24,506 9,589
Other assets................................................ 6,330 3,901
-------- --------
Total assets...................................... $273,293 $175,679
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 18,475 $ 8,799
Accrued liabilities....................................... 30,342 8,052
-------- --------
Total current liabilities......................... 48,817 16,851
Long-term liabilities....................................... 756 805
Commitments and contingencies...............................
Stockholders' equity:
Preferred stock, $0.01 par value; 5,000,000 shares
authorized, no shares issued and outstanding........... -- --
Common stock, $0.01 par value; 200,000,000 shares
authorized in 1997 and 1996; 72,626,370 and 65,299,214
shares issued and outstanding in 1997 and 1996,
respectively........................................... 726 653
Additional paid-in capital................................ 193,183 163,675
Notes receivable from stockholders........................ (835) (151)
Retained earnings (deficit)............................... 30,646 (6,154)
-------- --------
Total stockholders' equity........................ 223,720 158,023
-------- --------
Total liabilities and stockholders' equity........ $273,293 $175,679
======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
1
<PAGE> 2
ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
-------- -------- -------
<S> <C> <C> <C>
Revenues.................................................... $267,858 $130,193 $54,287
Cost of revenues............................................ 145,933 73,950 33,469
-------- -------- -------
Gross profit.............................................. 121,925 56,243 20,818
-------- -------- -------
Operating expenses:
Research and development.................................. 25,726 14,413 5,730
Selling, general and administrative....................... 42,653 21,188 9,660
DSC litigation costs...................................... -- 18,947 1,623
-------- -------- -------
Total operating expenses.......................... 68,379 54,548 17,013
Operating income.......................................... 53,546 1,695 3,805
Other income (expense):
Gain on dissolution (equity in loss) of joint venture,
net.................................................... -- 1,516 (1,516)
Other income, net......................................... 4,866 872 149
-------- -------- -------
Income before income taxes........................ 58,412 4,083 2,438
Income taxes (benefit)...................................... 21,612 (3,154) 97
-------- -------- -------
Net income........................................ $ 36,800 $ 7,237 $ 2,341
======== ======== =======
Basic net income per share.................................. $ 0.52 $ 0.30 $ 0.27
-------- -------- -------
Shares used in basic per share computations................. 70,131 24,146 8,746
-------- -------- -------
Diluted net income per share................................ $ 0.48 $ 0.11 $ 0.05
-------- -------- -------
Shares used in diluted per share computations............... 77,469 68,048 50,684
-------- -------- -------
</TABLE>
See accompanying notes to consolidated financial statements.
2
<PAGE> 3
ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF REDEEMABLE
CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
REDEEMABLE
CONVERTIBLE PREFERRED NOTES TOTAL
STOCK COMMON STOCK ADDITIONAL RECEIVABLE RETAINED STOCKHOLDERS'
---------------------- ------------------- PAID-IN FROM EARNINGS EQUITY
SHARES AMOUNT SHARES AMOUNT CAPITAL STOCKHOLDERS (DEFICIT) (DEFICIT)
----------- -------- ---------- ------ ---------- ------------ --------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances as of December 31,
1994..................... 30,865,816 $ 23,546 6,185,448 $ 62 $ (36) $ -- $(15,732) $(15,706)
Issuance of preferred
stock.................... 4,387,080 14,539 -- -- -- -- -- --
Repurchase of preferred
stock.................... (1,230,488) (308) -- -- (3,848) -- -- (3,848)
Sale of common stock for
notes receivable......... -- -- 1,127,200 11 165 (176) -- --
Exercise of common stock
options and warrants..... -- -- 2,717,688 27 1,421 -- -- 1,448
Net income................. -- -- -- -- -- -- 2,341 2,341
----------- -------- ---------- ---- -------- ----- -------- --------
Balances as of December 31,
1995..................... 34,022,408 37,777 10,030,336 100 (2,298) (176) (13,391) (15,765)
Issuance of preferred
stock.................... 440,000 1,540 -- -- -- -- -- --
Issuance of common stock in
settlement of
litigation............... -- -- 1,451,574 15 8,978 -- -- 8,993
Exercise of common stock
options and warrants..... -- -- 6,032,378 60 82 -- -- 142
Initial public offering of
common stock............. -- -- 10,350,000 104 117,970 -- -- 118,074
Conversion of preferred
stock to common stock.... (34,462,408) (39,317) 37,434,926 374 38,943 -- -- 39,317
Payment of notes receivable
from stockholder......... -- -- -- -- -- 25 -- 25
Net income................. -- -- -- -- -- -- 7,237 7,237
----------- -------- ---------- ---- -------- ----- -------- --------
Balances as of December 31,
1996..................... -- -- 65,299,214 653 163,675 (151) (6,154) 158,023
Exercise of common stock
options and warrants..... -- -- 6,940,978 69 2,446 -- -- 2,515
Secondary public offering
of common stock.......... -- -- 400,000 4 7,839 -- -- 7,843
Sale of common stock for
notes receivable......... -- -- 25,378 3 684 (684) -- 3
Repurchase of common
stock.................... -- -- (39,200) (3) (10) -- -- (13)
Tax benefit from option
exercises................ -- -- -- -- 18,549 -- -- 18,549
Net income................. -- -- -- -- -- -- 36,800 36,800
----------- -------- ---------- ---- -------- ----- -------- --------
Balances as of December 31,
1997..................... -- $ -- 72,626,370 $726 $193,183 $(835) $ 30,646 $223,720
=========== ======== ========== ==== ======== ===== ======== ========
</TABLE>
See accompanying notes to consolidated financial statements.
3
<PAGE> 4
ADVANCED FIBRE COMMUNICATIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
--------- -------- -------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................... $ 36,800 $ 7,237 $ 2,341
Adjustments to reconcile net income to net cash provided
from (used in) operating activities:
Tax benefit from option exercises..................... 18,549 -- --
Noncash portion of litigation settlement.............. -- 12,807 --
Deferred income taxes................................. (826) (3,679) --
Depreciation and amortization......................... 2,850 956 547
Equity in loss (gain on dissolution) of joint venture,
net................................................. -- (1,149) 1,516
Changes in operating assets and liabilities:
Accounts receivable................................. (46,319) (21,403) (5,802)
Inventories......................................... (34,724) (5,714) (5,529)
Other current assets................................ (1,063) (588) (169)
Accounts payable.................................... 9,676 1,602 4,516
Other liabilities, including accrued liabilities.... 22,040 3,442 1,626
Long-term liabilities............................... 193 258 (17)
--------- -------- -------
NET CASH PROVIDED FROM (USED IN) OPERATING
ACTIVITIES..................................... 7,176 (6,231) (971)
--------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Net purchases of marketable securities................... (12,655) (83,488) --
Acquisition of technology license........................ -- -- (1,000)
Investment in development-stage company.................. (3,000) -- --
Purchase of property and equipment....................... (17,767) (8,367) (1,084)
Reimbursement of loans (advances) to joint venture....... -- 1,516 (1,516)
Business acquisition, net of cash acquired............... -- (783) --
--------- -------- -------
NET CASH USED IN INVESTING ACTIVITIES............ (33,422) (91,122) (3,600)
--------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from bank borrowings............................ -- 16,806 1,550
Repayment of bank borrowings............................. -- (16,806) (1,550)
Repayment of long-term portion of litigation
settlement............................................ -- (7,064) --
Proceeds from initial public offering of common stock.... -- 118,074 --
Proceeds from secondary offering of common stock......... 7,843 -- --
Proceeds from issuance of redeemable convertible
preferred stock....................................... -- -- 14,539
Repurchase of redeemable convertible preferred stock..... -- -- (4,156)
Proceeds from exercise of common stock options and
warrants.............................................. 2,514 167 1,448
--------- -------- -------
NET CASH PROVIDED FROM FINANCING ACTIVITIES...... 10,357 111,177 11,831
--------- -------- -------
INCREASE IN CASH AND CASH EQUIVALENTS...................... (15,889) 13,824 7,260
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR............... 24,942 11,118 3,858
--------- -------- -------
CASH AND CASH EQUIVALENTS, END OF YEAR..................... $ 9,053 $ 24,942 $11,118
NONCASH FINANCING AND INVESTING ACTIVITIES:
Issuance of common stock for notes receivable............ $ 684 $ -- $ 176
Deferred portion of technology license fee............... -- -- 1,500
Issuance of preferred stock for business acquisition..... -- 1,540 --
CASH PAID:
Interest................................................. -- 398 37
Income taxes............................................. 442 265 --
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Advanced Fibre Communications, Inc. (the "Company") operates in one
business segment and designs, develops, manufactures, markets, and supports the
Universal Modular Carrier 1000(TM) (the "UMC system"), a cost-effective,
multi-feature digital loop carrier system developed to serve small line-size
markets. The Company's UMC system is designed to enable telephone companies,
cable companies, and other service providers to connect subscribers to the
central office switch for voice and data communications over copper wire, fiber
optic cable and analog radio networks.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant intercompany balances and transactions
have been eliminated. The Company's investments in 50% or less owned joint
ventures are accounted for under the equity method, and an investment in a less
than 20% owned company is accounted for using the cost method.
Cash and Cash Equivalents
The Company considers all highly liquid investments with original
maturities of three months or less to be cash equivalents. Cash and cash
equivalents are generally invested in money market funds, are classified as
available-for-sales securities and their cost approximates their market value.
Marketable Securities
All marketable securities are classified as available-for-sale and are
stated at estimated fair value. Unrealized gains and losses and realized gains
and losses were immaterial for all years presented.
Inventories
Inventories are valued at the lower of first-in, first-out cost or market.
Property and Equipment
Property and equipment are recorded at cost. Depreciation is computed using
the straight-line method over the estimated useful lives, generally five to
seven years, of the related assets.
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of
The Company adopted the provisions of Statement of Financial Accounting
Standards No. 121, Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to be Disposed Of, effective January 1996. This statement
requires long-lived assets to be evaluated for impairment whenever events or
changes in circumstances indicate that the carrying amount of the asset may not
be recoverable. Adoption of this statement did not have a material effect on the
Company's consolidated financial position or results of operations.
Revenue Recognition
Revenue is generally recognized when products are shipped. An allowance for
uncollectible accounts and a reserve for estimated returns have been
established, although uncollectible accounts and product returns have been
insignificant to date.
Warranty
The Company provides for estimated warranty costs at the time of sale.
5
<PAGE> 6
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Income Taxes
The Company accounts for income taxes using the asset and liability method
of accounting. Under this method, deferred tax assets and liabilities are
recognized based on the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. The measurement of deferred tax
assets is reduced, if necessary, by a valuation allowance for any tax benefits
that are not expected to be realized.
Equity-Based Compensation Plans
The Company accounts for equity-based compensation plans using the
intrinsic value method.
Net Income Per Share
The Company adopted the provisions of Statement of Financial Accounting
Standards (SFAS) No. 128, Earnings Per Share, effective December 15, 1997. SFAS
128 requires the presentation of basic net income per share and, for companies
with complex capital structures, diluted net income per share. Basic net income
per share is computed using the weighted average number of shares of common
stock outstanding. Diluted net income per share is computed using the weighted
average number of shares of common stock and redeemable convertible preferred
stock outstanding, on an as-if converted basis, and common equivalent shares
from options and warrants to purchase common stock using the treasury stock
method, when dilutive. In accordance with certain Securities and Exchange
Commission Staff Accounting Bulletins ("SAB"), such computations included all
common and common equivalent shares issued within the 12 months preceding the
Company's initial public offering ("IPO") date as if they were outstanding for
all prior periods presented using the treasury stock method and the estimated
IPO price. The provisions of SAB No. 98, issued in February 1998, have also been
adopted, and accordingly, shares previously presented under the guidance of SAB
No. 83 have been omitted from both basic and diluted per share computations.
Concentration of Credit Risk
Financial instruments potentially exposing the Company to concentrations of
credit risk consist primarily of cash and cash equivalents and trade accounts
receivable. The Company manufactures and sells its products principally to
telephone companies in the United States and to telephone companies and
distributors in international markets. To reduce credit risk, the Company
performs ongoing credit evaluations of its customers' financial condition. The
Company does not generally require collateral. For international shipments, the
Company generally requires prepayment or letters of credit.
Use of Estimates
The Company has made a number of estimates and assumptions that affect the
reported amount of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of revenues and expenses during the reporting period. Actual results could
differ from these estimates.
Reclassifications
Certain prior year amounts have been reclassified to conform with the
current year's presentation.
NOTE 2. JOINT VENTURES
Advanced Access Labs
During fiscal 1994, the Company entered into a joint venture partnership,
Advanced Access Labs, with a stockholder. The joint venture designed and
developed a product to allow telephone services to be provided
6
<PAGE> 7
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. JOINT VENTURES (CONTINUED)
over existing cable TV coaxial systems as well as other transmission media. The
Company contributed the right to use its technology in exchange for a 50%
ownership in the joint venture partnership. During 1996 and 1995, the Company
made loans and other advances to the joint venture totaling $167,000 and
$1,516,000, respectively. The Company has recorded its proportionate share of
the joint venture's losses to the extent of the Company's loans and advances
therein.
On December 23, 1996, the Company and the joint venture partner entered
into an agreement to terminate the partnership. In connection with the
dissolution, the joint venture partner reimbursed the Company $1,683,000 for all
loans and advances made by the Company to date. The reimbursement was recorded
as a gain and is reflected in gain on dissolution (equity in loss) of joint
venture, net in the accompanying consolidated financial statements.
AFTEK Hong Kong
On April 11, 1996, the Company acquired all of the outstanding shares of
AFTEK Hong Kong, of which the Company had previously been a 49% stockholder.
AFTEK Hong Kong is a holding company that owns 60% of a joint venture, AFTEK
Hangzhou, that was licensed to manufacture and sell the Company's
telecommunications equipment in China. Total consideration consisted of the
following (in thousands):
<TABLE>
<S> <C>
Issuance of Series F preferred stock........................ $1,540
Cash paid to retire note payable............................ 939
Acquisition costs incurred.................................. 79
------
Total consideration......................................... $2,558
======
</TABLE>
The acquisition has been accounted for using the purchase method of
accounting, and, accordingly, the purchase price has been allocated to the
assets purchased and the liabilities assumed based upon their fair values at the
date of acquisition. The excess of the purchase price over the fair values of
the net assets acquired was $932,000 and has been recorded as goodwill, which is
being amortized on a straight-line basis over 5 years.
On August 10, 1996, AFTEK Hong Kong and its joint venture partner agreed to
liquidate AFTEK Hangzhou. The partners appointed a liquidation committee to
facilitate the liquidation procedures and to ensure that the liquidation is
completed in accordance with the relevant stipulations contained in the joint
venture agreement. The Company has recorded a provision of approximately $59,000
in 1997 and $383,000 in 1996 reflecting the reduction in the net realizable
value of AFTEK Hong Kong's interest in the joint venture's net assets to be
distributed upon liquidation, which is pending governmental approval from the
Peoples Republic of China.
Historical results of AFTEK Hong Kong and pro forma results of operations
giving effect to the acquisition have not been presented because such
information is immaterial in relation to the Company's results of operations.
The Company had sales to AFTEK Hong Kong of $2,020,000 in 1995.
7
<PAGE> 8
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3. MARKETABLE SECURITIES
Marketable securities are valued at fair market value and are comprised of
the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Municipal debt securities........................ $94,143 $61,488
Corporate debt securities........................ 2,000 22,000
------- -------
Total marketable securities...................... $96,143 $83,488
======= =======
</TABLE>
The fair value of securities maturing in one year or less and those
maturing between one year and five years was $42,850,000 and $53,293,000,
respectively, as of December 31, 1997.
NOTE 4. INVENTORIES
The major components of inventories are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Raw materials.................................... $17,369 $ 7,631
Work-in-progress................................. 666 155
Finished goods................................... 34,038 9,563
------- -------
Total inventories................................ $52,073 $17,349
======= =======
</TABLE>
NOTE 5. PROPERTY AND EQUIPMENT
A summary of property and equipment follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Furniture and fixtures........................... $ 2,572 $ 1,266
Computer and office equipment.................... 11,726 4,306
Engineering equipment............................ 14,395 5,508
------- -------
28,693 11,080
Less: accumulated depreciation................... 4,187 1,491
------- -------
Property and equipment, net...................... $24,506 $ 9,589
======= =======
</TABLE>
NOTE 6. ACCRUED LIABILITIES
A summary of accrued liabilities follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1997 1996
------- ------
<S> <C> <C>
Outside services.................................. $ 9,522 $ 188
Income and sales taxes............................ 5,223 769
Warranty.......................................... 4,929 2,550
Salaries and benefits............................. 4,715 1,817
Other............................................. 5,953 2,728
------- ------
Total accrued liabilities......................... $30,342 $8,052
======= ======
</TABLE>
8
<PAGE> 9
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. INCOME TAXES
A summary of the components of income taxes (benefit) follows (in
thousands):
<TABLE>
<CAPTION>
CHARGE IN
LIEU OF
CURRENT DEFERRED INCOME(1) TOTAL
------- -------- --------- -------
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
Federal................................... $3,142 $(1,052) $16,017 $18,107
State..................................... 747 226 2,532 3,505
------ ------- ------- -------
Income taxes (benefit)...................... $3,889 $ (826) $18,549 $21,612
====== ======= ======= =======
Year ended December 31, 1996:
Federal................................... $ 523 $(2,764) $ -- $(2,241)
State..................................... 2 (915) -- (913)
------ ------- ------- -------
Income taxes (benefit)...................... $ 525 $(3,679) $ -- $(3,154)
====== ======= ======= =======
Year ended December 31, 1995:
Federal................................... $ 82 $ -- $ -- $ 82
State..................................... 15 -- -- 15
------ ------- ------- -------
Income taxes (benefit)...................... $ 97 $ -- $ -- $ 97
====== ======= ======= =======
</TABLE>
- ---------------
(1) Charge in lieu of income taxes from tax benefit of stock option exercises.
Income taxes (benefit) differs from the amount computed by applying the
U.S. federal statutory rate of 34% to income before income taxes as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- ------- -----
<S> <C> <C> <C>
Income taxes at statutory rate.......................... $19,860 $ 1,388 $ 829
Current losses and temporary differences for which no
benefit was recognized................................ 95 476 --
Foreign sales corporation benefit....................... (179) -- --
Utilization of credits.................................. (304) -- --
Tax exempt interest..................................... (407) -- --
Alternative minimum tax................................. -- -- 82
State taxes, net of federal benefit..................... 2,258 (167) 15
Change in valuation allowance........................... -- (4,687) (847)
Other................................................... 289 (164) 18
------- ------- -----
Income taxes (benefit).................................. $21,612 $(3,154) $ 97
======= ======= =====
</TABLE>
9
<PAGE> 10
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.................... $ -- $ -- $ 3,316
DSC settlement costs................................ 784 1,257 --
Allowances and accruals............................. 4,191 1,618 1,914
Research tax credit carryforwards................... 896 588 --
Other............................................... 66 216 6
------- ------- -------
5,937 3,679 5,236
Deferred tax liability:
Investment in joint venture......................... -- -- (549)
Net book value over net tax value................... (1,866) -- --
------- ------- -------
4,071 3,679 4,687
Less valuation allowance.............................. -- -- (4,687)
------- ------- -------
Net deferred tax asset.............................. $ 4,071 $ 3,679 $ --
======= ======= =======
</TABLE>
Management believes that a valuation allowance is not required as of
December 31, 1997 and 1996, based upon current and projected profitability of
the Company. The Tax Reform Act of 1986 and the California Conformity Act of
1987 impose restrictions on the utilization of tax credit carryforwards, for tax
purposes, in the event of an "ownership change" as defined by the Internal
Revenue Code. As of December 31, 1997, the Company had research credit
carryforwards for federal income tax return purposes of approximately $896,000
available to reduce future income subject to income taxes. The federal research
tax credit carryforwards expire in 2012. The Company also has minimum tax credit
carryforwards for federal income tax return purposes of approximately $33,000,
which carry forward indefinitely until utilized. The Company also has
manufacturing investment credit carryforwards for California income tax return
purposes of approximately $50,000, which will expire in 2005.
NOTE 8. BANK BORROWINGS
The Company has a $12.0 million bank line with an interest rate of prime
plus 0.5%, or 9% at December 31, 1997. The line of credit expires in June 1998.
The amount available to the Company for borrowing under the current line is
based upon the balance of eligible domestic accounts receivable at the time of
borrowing. As part of the bank line, the bank may issue letters of credit up to
$10.0 million and foreign exchange contracts up to $5.0 million on behalf of the
Company. The bank line requires the Company to comply with certain debt and
financial covenants. As of December 31, 1997 and 1996, no borrowings were
outstanding under the bank line, and the Company was in compliance with the
covenants contained in the agreement. At December 31, 1997 and 1996, $140,000
and $1,300,000, respectively, were reserved under the line for letters of credit
and $2,900,000 and $352,000, respectively, were reserved for foreign exchange
contracts under the line.
In July 1996, the Company borrowed approximately $7,106,000 under a
six-month term loan bearing interest at 5.75%. The proceeds from the loan were
used to pay the remaining obligations under the DSC litigation settlement (See
Note 10). The loan had a $4.0 million compensating balance requirement. The loan
was repaid in October 1996 with a portion of the proceeds from the Company's
initial public offering.
10
<PAGE> 11
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
IPO
In October 1996, the Company issued 10,350,000 shares of its common stock
pursuant to the IPO, which generated approximately $118,074,000 of net proceeds
to the Company. In conjunction with the IPO, 34,462,408 shares of outstanding
redeemable convertible preferred stock were converted into a total of 37,434,926
shares of common stock. Prior to the IPO, the Company had six series of
redeemable convertible preferred stock outstanding.
Secondary Offering
In February 1997, the Company completed a secondary offering of 4,000,000
shares of common stock, 3,600,000 of which were sold by certain stockholders and
400,000 of which were sold by the Company, generating approximately $7,843,000
of net proceeds to the Company.
Common Stock Split
In August 1996, the Company's Board of Directors approved and effected a
two-for-one stock split. The following year, on September 22, 1997, the Company
effected a two-for-one stock split to stockholders of record as of August 29,
1997. All share, per share, and common stock amounts herein have been restated
to reflect the effect of these splits. In September 1997, the stockholders
approved an increase in the Company's authorized shares of common stock from
100,000,000 to 200,000,000.
Common Stock Options
The Company's 1996 Stock Incentive Plan (the "1996 Plan") is intended to
serve as the successor equity incentive program to the Company's 1993 Stock
Option/Stock Issuance Plan (the "Predecessor Plan"). As of December 31, 1997, a
total of 19,138,074 shares of common stock were authorized for issuance under
the 1996 Plan. This share reserve is comprised of (i) the shares which remained
available for issuance under the Predecessor Plan, including the shares subject
to outstanding options thereunder, plus (ii) an additional increase of 2,000,000
shares. In addition, the share reserve will automatically be increased on the
first trading day of each calendar year, beginning with the 1997 calendar year,
by an amount equal to 3% of the number of shares of common stock outstanding on
the last trading day of the immediately preceding calendar year. Options issued
prior to 1997 generally vest 20% on the first anniversary date and ratably over
the following 48 months. Options issued subsequent to January 1, 1997, generally
vest 25% on the first anniversary date and ratably over the following 36 months
for employees who have been with the Company for less than one year, and ratably
over 48 months for employees with over one year of service. The options expire
10 years from the date of grant and are normally canceled three months after
termination of employment.
11
<PAGE> 12
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(CONTINUED)
A summary of the Company's stock option plan activity is presented below:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
1997 1996 1995
--------------------- -------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS SHARES PRICE SHARES PRICE SHARES PRICE
------- ---------- -------- --------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year.......... 8,627,088 $ 1.66 7,780,032 $0.18 5,468,560 $0.07
Granted................................... 3,603,646 27.42 2,166,164 6.17 2,548,072 0.41
Exercised................................. (3,050,793) 0.38 (832,852) 0.09 (107,304) 0.11
Canceled.................................. (876,681) 14.64 (486,256) 0.61 (129,296) 0.12
---------- ------ --------- ----- ---------- -----
Outstanding at end of year................ 8,303,260 $11.92 8,627,088 $1.66 7,780,032 $0.18
Options exercisable at end of year........ 2,611,424 3,411,318 2,378,804
Weighted average fair value of options
granted during the year................. $17.29 $2.95 $0.11
</TABLE>
The following table summarizes information about stock options outstanding
as of December 31, 1997:
<TABLE>
<CAPTION>
WEIGHTED
RANGE AVERAGE WEIGHTED
OF REMAINING AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER
PRICES OUTSTANDING LIFE PRICE EXERCISABLE
-------- ----------- ----------- -------- -----------
<S> <C> <C> <C> <C>
$ 0.01 1,010,187 5.3 year $ 0.01 915,057
0.13 - 0.16 1,203,199 6.9 0.15 518,893
0.31 682,966 7.7 0.31 148,583
0.38 - 0.75 1,198,186 8.0 0.75 332,290
2.35 - 12.50 858,615 8.6 6.86 382,194
14.75 - 25.63 910,575 9.4 21.08 66,821
25.88 - 26.13 218,000 9.9 26.10 --
26.50 870,181 8.9 26.50 175,263
26.63 - 33.00 915,520 9.5 30.89 58,863
33.53 - 42.38 435,831 9.7 35.65 13,460
</TABLE>
Employee Stock Purchase Plan
Under the 1996 Employee Stock Purchase Plan (the "Purchase Plan") adopted
on July 12, 1996, the Company is authorized to issue up to 3,000,000 shares of
common stock to eligible employees of the Company and participating
subsidiaries. The Purchase Plan will be implemented in a series of successive
offering periods, each with a maximum duration of 24 months. The initial
offering period commenced on October 4, 1996 and ends on the last business day
in July 1998. Under the terms of the Purchase Plan, eligible employees on the
start date of any offering period can enter the Purchase Plan on that start
date, or on any subsequent semi-annual entry date. Individuals who become
eligible after the start date may join the Purchase Plan on any subsequent
semi-annual entry date within that period. Employees may have up to 10 percent
of their base salary withheld through payroll deductions to purchase the
Company's common stock. The purchase price of the stock is the lower of 85
percent of (i) the fair market value of the common stock on the participant's
entry date into the offering period or (ii) the fair market value on the
semi-annual purchase date. Under the Purchase Plan, the purchase dates are
January 31 and July 31 of each year, and the first purchase was made on January
31, 1997. Purchases under the Plan through January 31, 1998 and estimated for
July 31, 1998, based on current contribution rates, totaled 309,915 shares of
common stock. The weighted average fair value of
12
<PAGE> 13
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(CONTINUED)
stock purchased was $11.76 per share. At December 31, 1997, 2,874,486 shares
remained available for issuance under the Purchase Plan.
Common Stock Warrants
Warrants to purchase shares of common stock were issued to investors as
part of the preferred stock agreements. The warrants expire through the year
2000 and are summarized as follows:
<TABLE>
<CAPTION>
NUMBER EXERCISE
OF SHARES PRICE PER SHARE
---------- ---------------
<S> <C> <C> <C>
Warrants outstanding as of December 31, 1995.............. 10,442,160 $0.02 - $3.50
Exercised............................................... (5,199,526) 0.02 - 0.59
Retired................................................. (95,082) 0.02 - 0.59
----------
Warrants outstanding as of December 31, 1996.............. 5,147,552 0.01 - 3.50
Exercised............................................... (38,000) 0.01
Retired................................................. (3,819,808) 0.01 - 0.58
----------
Warrants outstanding as of December 31, 1997.............. 1,289,744 $0.01 - $3.50
==========
</TABLE>
Pro Forma Fair Value Information
The Company applies the intrinsic value method of accounting for its
stock-based compensation plans. If compensation cost for the Company's
stock-based compensation plans had been determined in accordance with the fair
value approach set forth in SFAS No. 123, Accounting for Stock-Based
Compensation, the Company's net income and earnings per share would have been
reduced to the pro forma amounts as follows (in thousands except per share
data):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------ ------
<S> <C> <C> <C>
Net income:
As reported........................................... $36,800 $7,237 $2,341
Pro forma............................................. 26,404 6,638 2,328
Basic net income per share:
As reported........................................... $ 0.52 $ 0.30 $ 0.27
Pro forma............................................. 0.38 0.27 0.27
Diluted net income per share:
As reported........................................... $ 0.48 $ 0.11 $ 0.05
Pro forma............................................. 0.34 0.10 0.05
</TABLE>
The fair value of option grants prior to the IPO was estimated on the date
of grant using the minimum value method with the following weighted average
assumptions: no dividend yield, risk-free interest rates of 6.24%, and an
expected life of 5 years. The fair value of option grants from the IPO through
December 31, 1996, was estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted average assumptions; no
dividend yield, expected volatility of 55%, risk-free interest rate of 6.32%,
and an expected life of five years. The fair value of option grants made during
1997 was estimated on the date of grant using the Black-Scholes option-pricing
model with the following weighted average assumptions: no dividend yield,
expected volatility of 71%, risk-free interest rate of 6.23%, and an expected
life of five years. Compensation costs related to the Purchase Plan were
recognized for the fair value of the employees' purchase rights, which were
purchased, or will be purchased, under the Purchase Plan for the semi-annual
purchase dates January 1997 through July 1998 as of the date of purchase using
the Black-Scholes option-pricing
13
<PAGE> 14
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
(CONTINUED)
model. The following weighted average assumptions were used: no dividend yield,
expected volatility of 71%, risk free interest rate of 5.8%, and an expected
life of 14 months based on plan entry dates and purchase dates.
Net Income Per Share
The Financial Accounting Standards Board recently issued Statement of
Financial Accounting Standards (SFAS) No. 128, Earnings Per Share. SFAS No. 128
requires the presentation of basic net income per share and, for companies with
complex capital structures, diluted net income per share. In conjunction with
the Company's adoption of SFAS No. 128, the provisions of Staff Accounting
Bulletin ("SAB") No. 98, issued in February 1998, have also been adopted and,
accordingly, shares previously presented under the guidance of SAB No. 83 have
been omitted from both basic and diluted per share amounts calculated below.
The following tables set forth the computations of shares and net income
used in the calculation of basic and diluted net income per share for the years
ended December 31, 1997, 1996, and 1995 (in thousands, except share data):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Basic net income per share:
Net income.......................................... $36,800 $ 7,237 $ 2,341
======= ======= =======
Actual weighted average common shares outstanding
for the period................................... 70,131 24,146 8,746
======= ======= =======
Basic net income per share............................ $ 0.52 $ 0.30 $ 0.27
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Diluted net income per share:
Net income.......................................... $36,800 $ 7,237 $ 2,341
======= ======= =======
Actual weighted average common shares outstanding
for the period................................... 70,131 24,146 8,746
Weighted average number of shares upon conversion of
redeemable convertible preferred stock........... -- 27,994 34,896
Weighted average number of shares upon exercise of
dilutive options and warrants.................... 7,338 15,908 7,042
------- ------- -------
Shares used in per share calculations............... 77,469 68,048 50,684
======= ======= =======
Diluted net income per share.......................... $ 0.48 $ 0.11 $ 0.05
======= ======= =======
</TABLE>
14
<PAGE> 15
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. COMMITMENTS AND CONTINGENCIES
Leases
The Company leases office space and certain equipment under operating
leases. Future minimum payments under operating leases with an initial term of
more than one year as of December 31, 1997 are summarized as follows (in
thousands):
<TABLE>
<S> <C>
1998....................................................... $ 6,343
1999....................................................... 6,729
2000....................................................... 7,939
2001....................................................... 7,927
2002....................................................... 7,152
Thereafter................................................. 53,321
-------
Total minimum lease payments............................... $89,411
=======
</TABLE>
Total rent expense for all operating leases was $5,318,000, $3,030,000, and
$887,000 for the years ended December 31, 1997, 1996, and 1995, respectively.
Employee Benefit Plan
The Company has a 401(k) plan under which employees may contribute a
portion of their compensation on a tax-deferred basis to the plan. The Company,
at its discretion, may contribute to the plan on a matching basis up to a
maximum of $4,750 per employee per year. The Company is the plan administrator.
During 1997 and 1996, the Company contributed $785,000 and $466,000,
respectively, to the plan.
Litigation
ITRI:
In September 1992, the Company entered into agreements (the "ITRI
Agreements") with the Industrial Technology Research Institute ("ITRI"), a
Taiwanese government-sponsored research and development organization, that
granted to ITRI certain license rights to the European Telecommunications
Standards Institute ("ETSI") version of the UMC system. In 1995, a dispute arose
among the Company, ITRI, and certain of ITRI's member companies (the "Member
Companies") in which the Company claimed that ITRI and the Member Companies
were, among other things, failing to pay royalties when due under the ITRI
Agreements. In reliance upon certain provisions of the ITRI Agreements, in April
1996, the Company ceased delivering to the Member Companies certain proprietary
application specific integrated circuits ("ASICs") used in manufacturing the UMC
system.
Pursuant to agreements with ITRI reached in 1994, the design documentation
for these ASICs is held in a trust account, with directions that the designs can
be made available to ITRI on the occurrence of specified conditions. On July 9,
1996, the trustee-custodian of the ASIC designs filed suit against the Company
in the United States District Court, Eastern District of New York, alleging that
the Company had not supplied all required documentation to the trustee, and
wrongfully discontinued the sale of the ASICs to the Member Companies. Among
other things, the complaint seeks unspecified damages on behalf of the trustee,
and a determination that the trustee can release the ASIC designs to ITRI. On
July 31, 1996, the Company filed a counterclaim against the trustee claiming,
among other things, that the trustee improperly disclosed the design
documentation to third parties. Discovery in the case commenced in October 1996,
and was ongoing into December 1997. At a hearing held December 15, 1997, the
court stayed the case pending resolution of the arbitration proceedings
described below.
15
<PAGE> 16
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
On July 30, 1996, the Company filed suit against ITRI and others in the
United States District Court, Northern District of California, for breach of the
ITRI Agreements, breach of covenants of good faith, trade secret
misappropriation, tortious interference, and related claims. The complaint
alleges that ITRI breached the ITRI Agreements, among other things, by failing
to collect royalties owed to the Company, by developing UMC-based products not
shared with the Company, by transferring UMC technology to an unauthorized
company, and by misappropriating the Company's trade secrets and that the ITRI
Agreements have been terminated. The Company seeks recovery for lost profits and
unjust enrichment, punitive damages, and declaratory and injunctive relief. On
September 13, 1996, ITRI filed a demand for arbitration of the dispute and
claimed, among other things, that the Company had breached the ITRI Agreements
and is liable for unspecified royalties and punitive damages, and claiming
proprietary rights in certain UMC technology. On September 30, 1996, the Company
amended the complaint in its suit against ITRI to add the Member Companies and
Taiwan-based Acer Netxus, Inc., as parties to the suit.
On August 27, 1996, the Member Companies filed suit against the Company in
United States District Court, Northern District of California, alleging breach
of contract and unfair competition based on the Company's discontinuation of
ASIC sales and alleged failure to provide certain other UMC technology to the
Member Companies. The complaint filed by the Member Companies alleges that the
Company lacked justification to discontinue the sale of ASICs and that its
failure to sell ASICs to the Member Companies constituted unfair competition.
The Complaint seeks court-ordered arbitration, unspecified damages, punitive
damages and an injunction requiring further sales of the ASICs to the Member
Companies. On September 6, 1996, the court granted a temporary restraining order
pursuant to which the Company will be required to supply the Member Companies
with a specified number of ASICs during the ensuing two month period on the
terms and conditions set forth in the ITRI Agreements. The court's order was
granted as an interim measure to preserve the status quo pending adjudication on
the merits. The Company believes that compliance with the court's order will not
have a material adverse effect on the Company's business, financial condition
and results of operations. On September 16, 1996, the Company filed
counterclaims seeking declaratory and injunctive relief and damages against
Member Companies for, among other things, breach of contract, fraud and
misappropriation of trade secrets. On September 23, 1996, the Member Companies
filed a demand for arbitration of the dispute and claimed, among other things,
actual damages in excess of $60 million, legal fees and expenses and punitive
damages.
A hearing on ITRI's motion for a preliminary injunction to require the
Company to continue supplying ASICs and ITRI's motion to compel arbitration was
held on November 22, 1996. On January 23, 1997, the Court granted the ITRI
parties' motion to compel arbitration, and granted, in part, the Member
Companies' motion for a preliminary injunction. Under the Court's order, the
case was directed to arbitration under the auspices of the American Arbitration
Association, the litigation was stayed, and the Company was directed to continue
supplying ASICs to the Member Companies as under the prior temporary restraining
order.
On or about April 8, 1997, ITRI and the Member Companies filed amended
demands for arbitration with the American Arbitration Association. On April 28,
1997, the Company filed an answer and counterclaim in the arbitration proceeding
against ITRI, the Member Companies, and ACER Netxus, Inc., to which ITRI
purportedly assigned member company rights under the ITRI Agreements without the
Company's consent.
During January 1998, the Company, ITRI, the Member Companies and the
trustee agreed on a tentative settlement that, if finalized, will resolve all
claims among the Company, ITRI, the Member Companies and the trustee. The
tentative settlement does not affect the Company's claims against Acer Netxus,
Inc. The Company is currently working to finalize the settlement, however, there
can be no assurances that the settlement will be finalized.
16
<PAGE> 17
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company believes that it has meritorious defenses to the claims
asserted by the trustee, ITRI and the Member Companies and, if the settlement is
not finalized, the Company intends to continue to defend the litigation and to
prosecute its affirmative claims vigorously. Moreover, the Company believes that
the damages claims of the trustee, ITRI, and the Member Companies are without
merit. The Company further believes that its claims against Acer Netxus Inc. are
meritorious and intends to pursue these claims vigorously. However, due to the
nature of the claims, the Company cannot determine the total expense or possible
loss, if any, that may ultimately be incurred either in the context of a trial,
arbitration or as a result of a negotiated settlement. Regardless of the
ultimate outcome of the proceedings, it could result in significant diversion of
time by the Company's management. After consideration of the nature of the
claims and the facts relating to the proceedings, the Company believes that the
resolution of these matters will not have a material adverse effect on the
Company's business, financial condition, results of operations, and cash flows;
however, the results of these proceedings, including any potential settlement,
are uncertain and there can be no assurance to that effect.
DSC:
From July 1993 until June 1996 the Company was involved in litigation with
DSC Communications Corporation ("DSC"). DSC alleged, among other things, that
the Company's UMC system technology contained or was derived from trade secrets
and other proprietary technology of DSC. The parties entered into a Settlement
Agreement and Mutual Releases dated as of June 24, 1996 (the "Settlement
Agreement") pursuant to which the litigation was terminated. Under the terms of
the Settlement Agreement, the Company paid DSC $3,000,000 in June 1996 and
$7,106,000 in July 1996, and issued 1,451,574 shares of common stock to DSC. The
settlement amount was recorded during the first six months of 1996 as a charge
of $15,807,000. Under the terms of the Settlement Agreement, the Company
maintains all rights to the UMC technology free and clear of any claim by DSC.
On December 22, 1997, the Company filed a lawsuit in Sonoma County Superior
Court in California against DSC related to its hiring of a former employee of
DSC, as the Company's Vice President, Product Planning. The Company's complaint
seeks a declaratory judgement that its hiring of the former DSC employee was
lawful.
On January 22, 1998, DSC filed a lawsuit against the Company and the former
DSC employee in the United States District Court, Eastern District of Texas,
alleging "inevitable" trade secret misappropriation and related claims. DSC also
asserted a separate claim against the Company for patent infringement alleging
that the Company's 3GDLC product infringes on a DSC patent. DSC's complaint
seeks unspecified damages, injunctions relating to the alleged misappropriation
and patent infringement, attorneys' fees and other relief.
On February 5, 1998, the United States District Court, Eastern District of
Texas granted the Company's motion to dismiss all non-patent claims in this
lawsuit.
On February 18, 1998, DSC filed a motion in the lawsuit filed by the
Company in Sonoma County Superior Court to allege the "inevitable" trade secret
misappropriation and related claims, seeking unspecified damages, injunctions
relating to the alleged misappropriation, attorneys' fees and other relief. A
hearing is set for April 20, 1998.
The Company believes that all of DSC's misappropriation and other claims
related to the hiring of the former DSC employee are without merit, and the
Company intends to defend the lawsuit vigorously. Based on the Company's
preliminary review of the patent claim, the Company believes that the Company's
3GDLC product does not infringe the DSC patent, and that the Company has
meritorious defenses to such claim. The Company intends to vigorously defend the
litigation against DSC and prosecute its declaratory judgement action. However,
the Company cannot predict the ultimate outcome of these lawsuits. In addition,
patent
17
<PAGE> 18
ADVANCED FIBRE COMMUNICATIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. COMMITMENTS AND CONTINGENCIES (CONTINUED)
litigation is highly complex and can extend for a protracted period of time,
which can divert the attention of the Company's management and technical
personnel and require the Company to incur substantial costs and expenses. If
the patent claim were to be resolved against the Company, this could have a
material adverse effect on the Company's business, results of operations and
financial condition.
RELTEC Corporation:
On November 26, 1997, the Company filed a lawsuit in Sonoma County Superior
Court in California against RELTEC Corporation, alleging trade secret
misappropriation, tortious interference with a contract, and related claims. The
case involves RELTEC's acquisition of the Company's technology through the
Company's Taiwan-based licensee, Vidar-SMS Co., Ltd. On January 21, 1998, the
Company filed for and obtained an order to show cause, and a preliminary
injunction hearing is scheduled for March 18, 1998.
NOTE 11. COMPANY INFORMATION AND CERTAIN CONCENTRATIONS
During 1997, one customer accounted for 19% of total revenues. No single
customer accounted for 10% or more of total revenues in 1996, and during 1995,
one customer accounted for 16% of total revenues. International sales
constituted 27%, 21% and 13% during 1997, 1996 and 1995, respectively.
The Company currently derives substantially all of its revenue from the UMC
system, and expects that this concentration will continue for the foreseeable
future. As a result, any factor adversely affecting the demand for, or pricing
of, the UMC system could have a material adverse effect on the Company's
business and results of operations.
The Company's manufacturing operations consist of the final assembly and
testing of finished goods from components and custom-made subassemblies
purchased from third parties. Although the Company's product designs employ
primarily industry standard hardware, certain components are only available
through limited sources of supply. The Company's proprietary ASICs, codec
components, and some surface mount technology components and other components
are available from limited sources. If the Company cannot obtain essential
components as required, the Company may be unable to meet demand for its
products, thereby adversely affecting its operating results. In addition,
scarcity of such components could result in cost increases that adversely affect
the Company's gross profit.
The Company's printed circuit board assemblies and channel bank assemblies
are provided by a limited number of outside turnkey suppliers. In the event
operations of these turnkey suppliers are impaired or they are unable to support
the manufacturing requirements of the Company, the Company's operating results
could be adversely affected.
18
<PAGE> 19
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Advanced Fibre Communications, Inc.:
We have audited the accompanying consolidated balance sheets of Advanced
Fibre Communications, Inc. and subsidiaries as of December 31, 1997 and 1996,
and the related consolidated statements of operations, redeemable convertible
preferred stock and stockholders' equity (deficit) and cash flows for each of
the years in the three-year period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Advanced
Fibre Communications, Inc. and subsidiaries as of December 31, 1997 and 1996,
and the results of its operations and its cash flows for each of the years in
the three-year period ended December 31, 1997, in conformity with generally
accepted accounting principles.
KPMG PEAT MARWICK LLP
San Francisco, California
January 28, 1998
19
<PAGE> 20
QUARTERLY RESULTS OF OPERATIONS
Selected quarterly financial data is summarized below (unaudited):
<TABLE>
<CAPTION>
QUARTER ENDED (IN THOUSANDS)
----------------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1996 1996(1) 1996 1996 1997 1997 1997 1997
-------- -------- --------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues....................... $24,121 $ 29,651 $35,012 $41,409 $44,405 $61,207 $76,790 $85,456
Cost of revenues............... 14,101 16,957 19,737 23,155 24,977 33,535 41,472 45,949
------- -------- ------- ------- ------- ------- ------- -------
Gross profit................... 10,020 12,694 15,275 18,254 19,428 27,672 35,318 39,507
------- -------- ------- ------- ------- ------- ------- -------
Operating expenses:
Research and development..... 2,619 3,275 4,141 4,378 4,850 6,440 7,205 7,231
Selling, general and
administrative............. 3,545 4,356 5,608 7,679 7,798 9,830 12,297 12,728
DSC litigation costs......... 691 18,256 -- -- -- -- -- --
------- -------- ------- ------- ------- ------- ------- -------
Total operating expenses... 6,855 25,887 9,749 12,057 12,648 16,270 19,502 19,959
------- -------- ------- ------- ------- ------- ------- -------
Operating income (loss)........ 3,165 (13,193) 5,526 6,197 6,780 11,402 15,816 19,548
Other income (expense):
Gain on dissolution (equity
in loss) of joint venture,
net........................ (167) -- -- 1,683 -- -- -- --
Other income (expense),
net........................ 84 (18) (338) 1,144 996 1,385 1,313 1,172
------- -------- ------- ------- ------- ------- ------- -------
Income (loss) before income
taxes........................ 3,082 (13,211) 5,188 9,024 7,776 12,787 17,129 20,720
Income taxes (benefit)......... 910 (9,498) 1,984 3,450 2,877 4,731 6,338 7,666
------- -------- ------- ------- ------- ------- ------- -------
Net income (loss).............. $ 2,172 $ (3,713) $ 3,204 $ 5,574 $ 4,899 $ 8,056 $10,791 $13,054
======= ======== ======= ======= ======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
AS A PERCENTAGE OF REVENUES
----------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues....................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Costs of revenues.............. 58.5 57.2 56.4 55.9 56.2 54.8 54.0 53.8
------- -------- ------- ------- ------- ------- ------- -------
Gross profit................... 41.5 42.8 43.6 44.1 43.8 45.2 46.0 46.2
------- -------- ------- ------- ------- ------- ------- -------
Operating expenses:
Research and development..... 10.9 11.0 11.8 10.6 10.9 10.5 9.4 8.5
Selling, general and
administrative............. 14.7 14.7 16.0 18.5 17.6 16.1 16.0 14.9
DSC litigation costs......... 2.9 61.6 -- -- -- -- -- --
------- -------- ------- ------- ------- ------- ------- -------
Total operating expenses... 28.4 87.3 27.8 29.1 28.5 26.6 25.4 23.4
------- -------- ------- ------- ------- ------- ------- -------
Operating income (loss)........ 13.1 (44.5) 15.8 15.0 15.3 18.6 20.6 22.9
Other income (expense):
Gain on dissolution (equity
in loss) of joint venture,
net........................ (0.7) -- -- 4.1 -- -- -- --
Other income (expense),
net........................ 0.3 (0.1) (1.0) 2.7 2.2 2.3 1.7 1.4
------- -------- ------- ------- ------- ------- ------- -------
Income (loss) before income
taxes........................ 12.8 (44.6) 14.8 21.8 17.5 20.9 22.3 24.2
Income taxes (benefits)........ 3.8 (32.1) 5.6 8.3 6.5 7.7 8.3 9.0
------- -------- ------- ------- ------- ------- ------- -------
Net income (loss).............. 9.0% (12.5)% 9.2% 13.5% 11.0% 13.2% 14.1% 15.3%
======= ======== ======= ======= ======= ======= ======= =======
</TABLE>
- ---------------
(1) Includes a charge of $15.8 million in the quarter ended June 30, 1996 to
reflect a cash payment of $3.0 million paid in June 1996, additional cash
payments of $7.1 million paid in July and the issuance of 1,451,574 shares
of Common Stock to DSC in settlement of outstanding litigation. See "Note 10
of the Notes to Consolidated Financial Statements." Without this charge,
operating income for the quarter ended June 30, 1996 would have been $2.6
million, and as a percentage of revenues would have been 8.8%.
See accompanying notes to consolidated financial statements
20
<PAGE> 1
EXHIBIT 23.1
REPORT ON SCHEDULE
AND
CONSENT OF KPMG PEAT MARWICK LLP
The audits referred to in our report dated January 28, 1998, included the
related financial statement schedule for the year ended December 31, 1997,
included in the annual report on Form 10-K of Advanced Fibre Communications,
Inc. This financial statement schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion on this financial
statement schedule based on our audits. In our opinion, such financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
We consent to incorporation by reference in the registration statements
(No.s 333-15651 and 333-44645) on Form S-8 of Advanced Fibre Communications,
Inc. of our reports dated January 28, 1998, relating to the consolidated balance
sheets of Advanced Fibre Communications, Inc. as of December 31, 1997 and 1996,
and the related consolidated statements of operations, redeemable convertible
preferred stock and stockholders' equity (deficit) and cash flows for each of
the years in the three-year period ended December 31, 1997, and the related
schedule, which reports appear, or are incorporated by reference, in the
December 31, 1997 annual report on Form 10-K of Advanced Fibre Communications,
Inc.
KPMG PEAT MARWICK LLP
San Francisco, California
March 23, 1998
1
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 9,053
<SECURITIES> 96,143
<RECEIVABLES> 81,827
<ALLOWANCES> (2,729)
<INVENTORY> 52,073
<CURRENT-ASSETS> 242,457
<PP&E> 28,693
<DEPRECIATION> (4,187)
<TOTAL-ASSETS> 273,293
<CURRENT-LIABILITIES> 48,817
<BONDS> 0
<COMMON> 726
0
0
<OTHER-SE> 223,029
<TOTAL-LIABILITY-AND-EQUITY> 273,293
<SALES> 266,388
<TOTAL-REVENUES> 267,858
<CGS> 137,216
<TOTAL-COSTS> 145,933
<OTHER-EXPENSES> 67,906
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 58,412
<INCOME-PRETAX> 21,612
<INCOME-TAX> 36,800
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 36,800
<EPS-BASIC> 0.52
<EPS-DILUTED> 0.48
</TABLE>
