-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, OqB/Mt7VNoOanbvF9/RtjT5F7mi+DHZP1B+gor4GdTDbXTC3VITN3lHm6V95uzNJ H3tTqZix+3ESxpkoZWmKQw== 0000892569-98-002693.txt : 19981002 0000892569-98-002693.hdr.sgml : 19981002 ACCESSION NUMBER: 0000892569-98-002693 CONFORMED SUBMISSION TYPE: S-1 PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 19980930 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: BROADCOM CORP CENTRAL INDEX KEY: 0001054374 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 330480482 FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1 SEC ACT: SEC FILE NUMBER: 333-65117 FILM NUMBER: 98718956 BUSINESS ADDRESS: STREET 1: 16251 LAGUNA CANYON RD CITY: IRVINE STATE: CA ZIP: 92618 BUSINESS PHONE: 7144508700 MAIL ADDRESS: STREET 1: 16251 LAGUNA CANYON RD CITY: IRVINE STATE: CA ZIP: 92618 S-1 1 FORM S-1 REGISTRATION STATEMENT 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 30, 1998 REGISTRATION NO. 333- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 BROADCOM CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 3674 33-0480482 (STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) CLASSIFICATION NUMBER) IDENTIFICATION NO.)
16251 LAGUNA CANYON ROAD IRVINE, CALIFORNIA 92618 (949) 450-8700 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) HENRY T. NICHOLAS, III, PH.D. CO-CHAIRMAN AND CHIEF EXECUTIVE OFFICER BROADCOM CORPORATION 16251 LAGUNA CANYON ROAD IRVINE, CALIFORNIA 92618 (949) 450-8700 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) COPIES TO: BRUCE R. HALLETT, ESQ. LARRY W. SONSINI, ESQ. ELLEN S. BANCROFT, ESQ. JAMES N. STRAWBRIDGE, ESQ. SUE L. COLLINS, ESQ. JOSE F. MACIAS, ESQ. BROBECK, PHLEGER & HARRISON LLP WILSON SONSINI GOODRICH & ROSATI 38 TECHNOLOGY DRIVE PROFESSIONAL CORPORATION IRVINE, CALIFORNIA 92618 650 PAGE MILL ROAD (949) 790-6300 PALO ALTO, CALIFORNIA 94304-1050 (650) 493-9300
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this Registration Statement becomes effective. If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ] If delivery of the Prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] CALCULATION OF REGISTRATION FEE
- ---------------------------------------------------------------------------------------------------------------------- - ---------------------------------------------------------------------------------------------------------------------- TITLE OF EACH CLASS AMOUNT PROPOSED MAXIMUM PROPOSED MAXIMUM OF SECURITIES TO BE OFFERING PRICE AGGREGATE AMOUNT OF TO BE REGISTERED REGISTERED(1) PER SHARE(2) OFFERING PRICE(2) REGISTRATION FEE - ---------------------------------------------------------------------------------------------------------------------- Class A Common Stock, $.0001 par value............ 3,450,000 $77.00 $265,650,000 $78,367 - ---------------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------------
(1) Includes 450,000 shares that the Underwriters have the option to purchase solely to cover over-allotments, if any. (2) Estimated solely for the purpose of computing the registration fee pursuant to Rule 457(a). Based on the last sale price of the Class A Common Stock on September 29, 1998, as reported on the Nasdaq National Market. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES IN ANY JURISDICTION IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR TO THE REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH JURISDICTION. PROSPECTUS (Subject to Completion) Issued September 30, 1998 3,000,000 Shares BROADCOM LOGO CLASS A COMMON STOCK ------------------------ OF THE 3,000,000 SHARES OF CLASS A COMMON STOCK OFFERED HEREBY, 392,500 SHARES ARE BEING SOLD BY THE COMPANY AND 2,607,500 SHARES ARE BEING SOLD BY THE SELLING SHAREHOLDERS. SEE "PRINCIPAL AND SELLING SHAREHOLDERS." THE COMPANY WILL NOT RECEIVE ANY OF THE PROCEEDS FROM THE SALE OF SHARES BY THE SELLING SHAREHOLDERS. THE COMPANY HAS TWO CLASSES OF COMMON STOCK: CLASS A COMMON STOCK AND CLASS B COMMON STOCK (COLLECTIVELY, THE "COMMON STOCK"). THE SHARES OF COMMON STOCK ARE SUBSTANTIALLY IDENTICAL EXCEPT THAT THE HOLDERS OF CLASS A COMMON STOCK ARE ENTITLED TO ONE VOTE PER SHARE, AND THE HOLDERS OF CLASS B COMMON STOCK ARE ENTITLED TO TEN VOTES PER SHARE, ON MATTERS SUBMITTED TO A VOTE OF THE SHAREHOLDERS. EACH SHARE OF CLASS B COMMON STOCK IS CONVERTIBLE AT THE OPTION OF THE HOLDER INTO ONE SHARE OF CLASS A COMMON STOCK, AND GENERALLY WILL AUTOMATICALLY CONVERT INTO ONE SHARE OF CLASS A COMMON STOCK UPON TRANSFER OF THE CLASS B COMMON STOCK FROM ITS ORIGINAL HOLDER. SEE "DESCRIPTION OF CAPITAL STOCK." THE COMPANY'S CLASS A COMMON STOCK IS LISTED ON THE NASDAQ NATIONAL MARKET UNDER THE SYMBOL "BRCM." ON SEPTEMBER 29, 1998, THE LAST SALE PRICE OF THE CLASS A COMMON STOCK AS REPORTED ON THE NASDAQ NATIONAL MARKET WAS $77 PER SHARE. SEE "PRICE RANGE OF THE CLASS A COMMON STOCK." ------------------------ THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" COMMENCING ON PAGE 5 HEREOF. ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------------ PRICE $ A SHARE ------------------------
UNDERWRITING PROCEEDS TO PRICE TO DISCOUNTS AND PROCEEDS TO SELLING PUBLIC COMMISSIONS(1) COMPANY(2) SHAREHOLDERS -------- -------------- ----------- ------------ Per Share................. $ $ $ $ Total(3).................. $ $ $ $
- --------------- (1) The Company and the Selling Shareholders have agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. See "Underwriters." (2) Before deducting expenses payable by the Company estimated at $500,000. (3) The Company and certain Selling Shareholders have granted the Underwriters an option, exercisable within 30 days from the date hereof, to purchase up to an aggregate of 450,000 additional Shares at the price to public less underwriting discounts and commissions for the purpose of covering over-allotments, if any. If the Underwriters exercise such option in full, the total price to public, underwriting discounts and commissions, proceeds to Company and proceeds to Selling Shareholders will be $ , $ , $ , and $ , respectively. See "Underwriters." ------------------------ The Shares are offered, subject to prior sale, when, as and if accepted by the Underwriters named herein and subject to approval of certain legal matters by Wilson Sonsini Goodrich & Rosati, counsel for the Underwriters. It is expected that delivery of the Shares will be made on or about , 1998 at the office of Morgan Stanley & Co. Incorporated, New York, N.Y., against payment therefor in immediately available funds. ------------------------ MORGAN STANLEY DEAN WITTER BT ALEX. BROWN CREDIT SUISSE FIRST BOSTON HAMBRECHT & QUIST MERRILL LYNCH & CO. , 1998 3 CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE CLASS A COMMON STOCK. SPECIFICALLY, THE UNDERWRITERS MAY OVER-ALLOT IN CONNECTION WITH THE OFFERING AND MAY BID FOR, AND PURCHASE, SHARES OF THE CLASS A COMMON STOCK IN THE OPEN MARKET. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITERS." ------------------------ IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS AND SELLING GROUP MEMBERS (IF ANY) OR THEIR RESPECTIVE AFFILIATES MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE CLASS A COMMON STOCK ON THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "UNDERWRITERS." 2 4 PROSPECTUS SUMMARY The following summary is qualified in its entirety by the more detailed information and Financial Statements and Notes thereto appearing elsewhere in this Prospectus. THE COMPANY Broadcom Corporation (the "Company" or "Broadcom") is a leading developer of highly integrated silicon solutions that enable broadband digital data transmission to the home and within the business enterprise. The Company's products enable the high-speed transmission of data over existing communications infrastructures, most of which were not originally intended for digital data transmission. Using proprietary technologies and advanced design methodologies, the Company has designed and developed integrated circuits for some of the most significant broadband communications markets, including the markets for cable set-top boxes, cable modems, high-speed networking, direct broadcast satellite and terrestrial digital broadcast, and xDSL. Although the communications infrastructures of these markets are very different, the Company has leveraged its core technologies and introduced silicon solutions for each market that deliver the cost and performance levels necessary to enable the widespread deployment of broadband transmission services. The Company's broadband transmission products consist primarily of high-performance digital signal processing circuits that implement complex communications algorithms, surrounded by precision high-speed analog-to-digital and digital-to-analog converter circuits. The Company's products integrate comprehensive systems solutions into single chips or chip-sets, thereby eliminating costly external components, reducing board space, simplifying the customer's manufacturing process, lowering the customer's system costs and enabling higher performance. Customers currently shipping broadband communications equipment incorporating the Company's products include 3Com, Bay Networks (a division of Northern Telecom), Cisco Systems, General Instrument, Motorola and Scientific-Atlanta. The Company was incorporated in California in August 1991. The Company's executive offices are located at 16251 Laguna Canyon Road, Irvine, California 92618, and its telephone number is (949) 450-8700. THE OFFERING Class A Common Stock offered............................... 3,000,000 shares, including 392,500 shares by the Company and 2,607,500 shares by the Selling Shareholders Common Stock to be outstanding after this offering Class A Common Stock (one vote per share)................ 7,839,750 shares(1) Class B Common Stock (ten votes per share)............... 36,270,699 shares(1) Total.............................................. 44,110,449 shares(1) Use of proceeds............................................ General corporate purposes, including working capital and acquisition of capital equipment. See "Use of Proceeds." Nasdaq National Market symbol.............................. BRCM
SUMMARY FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
SIX MONTHS ENDED YEARS ENDED DECEMBER 31, JUNE 30, ------------------------------------------------ ------------------ 1993 1994 1995 1996 1997 1997 1998 ------ ------ ------ ------- ------- ------- ------- STATEMENT OF OPERATIONS DATA: Total revenue............................................ $1,138 $3,636 $6,107 $21,370 $36,955 $10,426 $80,512 Gross profit............................................. 1,138 2,929 4,709 13,510 22,029 5,616 46,300 Total operating expense.................................. 1,127 2,690 4,822 9,208 24,267 8,746 23,941 Income (loss) from operations............................ 11 239 (113) 4,302 (2,238) (3,130) 22,359 Net income (loss)........................................ 12 237 4 3,016 (1,173) (1,841) 15,379 Diluted earnings (loss) per share(2)..................... $ .00 $ .01 $ .00 $ .09 $ (.04) $ (.07) $ .35
JUNE 30, 1998 -------------------------- ACTUAL AS ADJUSTED(3) -------- -------------- BALANCE SHEET: Cash and cash equivalents................................... $ 64,711 $ 93,149 Total assets................................................ 148,101 176,539 Total debt.................................................. 134 134 Total shareholders' equity.................................. 128,682 157,120
- --------------- (1) Based on the number of shares outstanding as of June 30, 1998. Excludes (i) 714,550 shares of Class A Common Stock and 7,970,103 shares of Class B Common Stock issuable upon the exercise of options outstanding as of June 30, 1998 and (ii) 8,038,660 shares of Common Stock available for issuance under the Company's employee benefit plans. See Notes 9 and 10 of Notes to Financial Statements. (2) See Note 1 of Notes to Financial Statements for an explanation of the calculation of diluted earnings (loss) per share. (3) Adjusted to reflect the sale of 392,500 shares of Class A Common Stock offered by the Company hereby at the assumed public offering price of $77.00 per share and the application of the net proceeds therefrom. See "Use of Proceeds." 3 5 NO PERSON IS AUTHORIZED IN CONNECTION WITH THIS OFFERING TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN AS CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, BY ANY SELLING SHAREHOLDER OR BY ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY BY ANY PERSON IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL FOR SUCH PERSON TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, IMPLY THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF. ------------------------ TABLE OF CONTENTS
PAGE ---- Prospectus Summary....................... 3 Risk Factors............................. 5 Use of Proceeds.......................... 16 Dividend Policy.......................... 16 Price Range of Class A Common Stock...... 16 Capitalization........................... 17 Selected Financial Data.................. 18 Management's Discussion and Analysis of Financial Condition and Results of Operations............................. 19 Business................................. 28
PAGE ---- Management............................... 47 Certain Transactions..................... 57 Principal and Selling Shareholders....... 59 Description of Capital Stock............. 60 Shares Eligible for Future Sale.......... 62 Underwriters............................. 64 Legal Matters............................ 66 Experts.................................. 66 Available Information.................... 66 Glossary of Technical Terms.............. 67 Index to Financial Statements............ F-1
------------------------ Broadcom(R) and QAMLink(TM) are trademarks of the Company. This Prospectus also includes trademarks of companies other than the Company. ------------------------ Except as otherwise noted herein, information in this Prospectus assumes (i) no exercise of outstanding options, of which options to purchase an aggregate of 714,550 shares of Class A Common Stock and 7,970,103 shares of Class B Common Stock were outstanding as of June 30, 1998, and (ii) no exercise of the Underwriters' over-allotment option. 4 6 RISK FACTORS In addition to the other information in this Prospectus, the following factors should be considered carefully in evaluating an investment in the Class A Common Stock offered hereby. This Prospectus contains forward-looking statements that involve risks and uncertainties. The Company's actual results may differ materially from the results discussed in the forward-looking statements. The factors that may cause such a difference include, but are not limited to, those discussed below in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business." Fluctuations in Results of Operations. The Company's quarterly results of operations have fluctuated significantly in the past and may continue to fluctuate in the future based on a number of factors, many of which are not in the Company's control, including, but not limited to, the volume of product sales and pricing concessions on volume sales; the timing, rescheduling or cancellation of significant customer orders; the gain or loss of a significant customer; the timing of customer qualification and industry interoperability certification of new products; the rate of adoption by customers and end users of new and emerging technologies in the high-speed data networking, cable set-top box, cable modem, direct broadcast satellite ("DBS") and terrestrial digital broadcast, and digital subscriber line ("xDSL") markets; the rate of adoption and acceptance of new industry standards in the foregoing markets; the Company's ability to specify, develop, introduce and market new products and technologies on a timely basis; the qualification, availability and pricing of competing products and technologies from other vendors; fluctuations in manufacturing yields and other problems or delays in the fabrication, assembly, testing or delivery of products; uncertainties associated with international operations; the Company's ability to retain and hire key executives, technical personnel and other employees in the numbers and with the capabilities needed to implement its business and product plans; problems or delays in migrating product designs to smaller geometry processes and achieving higher levels of design integration; intellectual property disputes; changes in product and customer mix; the amount and timing of recognition of development revenue; general business conditions in the semiconductor industry and the broadband communications markets; availability of foundry capacity and raw materials; the quality of the Company's products; the timing of investments in, and the results of, research and development; the Company's ability to expand and implement its sales and marketing programs; the level of orders received that can be shipped in a quarter; the effects on operations and management of facility relocations; currency fluctuations; and general economic conditions. The Company intends to continue to increase its operating expenses in 1998 and 1999. Because a large portion of the Company's operating expense, including rent, salaries and capital lease expenses, is fixed and difficult to reduce or modify, if total revenue does not meet the Company's expectations, the effect of any revenue shortfall will be magnified by the fixed nature of these operating expenses. Based on the foregoing or other factors, it is possible that in some future periods the Company's reported or anticipated operating results will fail to meet or exceed the expectations of analysts or investors. In such event, the price of the Company's Class A Common Stock would likely be materially and adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Customer Concentration. A relatively small number of customers have accounted for a significant portion of the Company's total revenue to date, and the Company expects that this trend will continue for the foreseeable future. In particular, sales to General Instrument and 3Com (including sales to their respective manufacturing subcontractors) accounted for approximately 31.8% and 35.9%, respectively, of total revenue in the six months ended June 30, 1998 and 31.9% and 14.6%, respectively, of total revenue in 1997. Moreover, sales to the Company's five largest customers (including sales to their respective manufacturing subcontractors) represented approximately 80.9% and 61.7% of the Company's total revenue in the six months ended June 30, 1998 and in 1997, respectively. Accordingly, the Company's future results of operations will continue to be substantially dependent on the success of its largest customers and on the Company's success in selling its existing and future products to those customers in significant quantities. Any reduction or delay in sales of the Company's products to one or more of these key customers could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will retain its largest customers or that it will be able to obtain additional key customers. The loss of one or more of the Company's largest customers or the inability of the Company to successfully develop 5 7 relationships with additional key customers could have a material adverse effect on the Company's business, financial condition and results of operations. Most of the Company's customers can cease incorporating the Company's products in their own products with limited notice to the Company and with little or no penalty. The Company's agreements with its customers typically do not require minimum purchases. In addition, certain of the Company's customers offer or may offer products (designed by themselves or third parties) that compete with those offered by the Company. Many of the Company's customers have pre-existing relationships with current or potential competitors of the Company, which may affect such customers' purchasing decisions. In addition, the Company's longstanding relationship with certain of its larger customers may affect the purchasing decisions of other potential customers who compete with these customers. The Company's customers face intense competition from other manufacturers that do not use the Company's products. Further, some of the Company's customers have "most favored nation" pricing arrangements which could materially and adversely affect the Company's average selling prices and gross margins in the event of product pricing decisions that trigger such arrangements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Customers and Strategic Relationships." Rapid Technological Change; Dependence on Emerging Markets and Evolving Standards. The semiconductor industry and the broadband communications markets are characterized by rapidly changing technology, frequent new product introductions and evolving industry standards. Substantially all of the Company's current product revenue is derived from sales of products for the high-speed networking, cable set-top box and cable modem markets. These markets are characterized by intense competition, rapid technological change and short product life cycles. In particular, the high-speed networking, cable set-top box and cable modem markets continue to undergo a period of rapid growth and consolidation. The Company's business, financial condition and results of operations would be materially and adversely affected in the event of a significant slowdown in any of these or other broadband communications markets. The Company's success will depend on the ability of its customers to develop new products and enhance existing products for the broadband communications markets and to successfully introduce and promote such products. There can be no assurance that the broadband communications markets will develop to the extent or in the timeframes anticipated by the Company. The failure of new markets to develop as anticipated or the failure of the Company's products in these markets to gain widespread acceptance could have a material adverse effect on the Company's business, financial condition and results of operations. Products for broadband communications applications are generally based on industry standards, which are continually evolving. The emergence of new industry standards could render products of the Company or its customers unmarketable or obsolete and may require the Company to incur substantial unanticipated costs to comply with any such new standards. Moreover, the Company's past sales and profitability have resulted, to a significant extent, from its ability to anticipate changes in technology and industry standards and to develop and introduce new and enhanced products. The Company's continued ability to adapt to such changes and to anticipate future standards, and the rate of adoption and acceptance of those standards, will be a significant factor in maintaining or improving the Company's competitive position and its prospects for growth. The Company has in the past invested substantial resources in emerging technologies, such as 100Base-T4 for high-speed networking, for which the market did not ultimately meet the Company's expectations. There can be no assurance that the Company will be able to anticipate the evolving standards in the semiconductor industry and, in particular, the broadband communications markets, or that the Company will be able to successfully develop and introduce new products into such markets. The failure of the Company to anticipate technological change and introduce new products that achieve market acceptance could materially and adversely affect the Company's business, financial condition and results of operations. See "Business -- Markets" and "-- Core Technologies." Dependence on Development of New Products. The Company's future success will depend upon its ability to develop new silicon solutions for existing and new markets, introduce such products in a timely and cost-effective manner and have such products selected for design into new products of leading equipment manufacturers ("design wins"). The development of these new devices is highly complex, and from time to time the Company has experienced delays in completing the development and introduction of new products. Successful product development and introduction depends on a number of factors, including, among other 6 8 things, accurate prediction of market requirements and evolving standards; accurate new product definition; timely completion and introduction of new product designs; timely qualification and industry interoperability certification of the Company's products and the products into which the Company's products will be incorporated; availability of foundry capacity; achievement of high manufacturing yields; and market acceptance of the Company's and its customers' products. Furthermore, there can be no assurance that the Company will be able to introduce new products in a timely and cost-effective manner or in sufficient quantities to meet customer demand or that such products will satisfy customer requirements or achieve market acceptance. The Company's quarterly results have in the past been, and are expected in the future to continue to be, dependent upon the introduction of a relatively small number of new products and the timely completion and delivery of those products to customers. The Company's or its customers' failure to develop and introduce new products successfully and in a timely manner would materially and adversely affect the Company's business, financial condition and results of operations. The Company's new products are generally incorporated into customers' products or systems at the design stage. Achieving a design win often requires significant expenditures by the Company without any assurance of success. Moreover, design wins frequently precede the generation of volume sales, if any, by six to nine months or more. The value of any design win largely depends upon the commercial success of the customer's product and on the extent to which the design of the customer's electronic system accommodates components manufactured by the Company's competitors. There can be no assurance that the Company will continue to achieve design wins or that the products for which the Company achieves design wins will be commercially successful. See "Business -- Strategy," "-- Products" and "-- Research and Development." Dependence on Key Personnel. The Company's success depends to a significant extent upon the continued service of its executive officers and other key management and technical personnel and on its ability to continue to attract, retain and motivate qualified personnel, particularly experienced mixed-signal circuit designers and systems applications engineers. The competition for such employees is intense, and the Company may not be able to attract as many qualified new personnel as it was able to employ prior to its initial public offering. The loss of the services of one or more of the Company's key employees or the Company's failure to attract, retain and motivate qualified personnel could have a material adverse effect on the Company's business, financial condition and results of operations. In particular, the loss of the services of Dr. Henry T. Nicholas, III, the co-founder, President and Chief Executive Officer of the Company, or Dr. Henry Samueli, the co-founder, Vice President of Research and Development and Chief Technical Officer of the Company, could materially and adversely affect the Company. The Company does not have any employment contracts with its employees. See "Business -- Employees" and "Management -- Executive Officers, Key Employees and Directors." Competition. The broadband communications markets and semiconductor industries are intensely competitive and are characterized by rapid technological change, evolving standards, short product life cycles and price erosion. The Company competes with a number of major domestic and international suppliers of equipment in the markets for cable set-top boxes, cable modems, high-speed networking, DBS and terrestrial digital broadcast, and xDSL. This competition has resulted and may continue to result in declining average selling prices for the Company's products. The Company currently competes in the cable television set-top box market with Fujitsu, LSI Logic, Philips Electronics, Rockwell International and VLSI Technology for communication devices and with ATI Technologies, C-Cube, LSI Logic, Motorola and STMicroelectronics (formerly SGS-THOMSON) in the MPEG/graphics segment. The Company expects other major semiconductor manufacturers to enter the market as the digital broadcast television and other digital cable television markets become more established. A number of companies, including Hitachi, Libit Signal Processing, LSI Logic, Rockwell International, Stanford Telecommunications, Inc. ("STI") and Toshiba have announced that they are developing and plan to introduce MCNS/DOCSIS compliant products in 1998, which could result in significant competition in the cable modem market. In the high-speed networking market, the Company principally competes with established suppliers including Level One Communications, Lucent Technologies, National Semiconductor and Texas Instruments. The Company's principal competitors in the DBS/terrestrial broadcast market include LSI Logic, Lucent Technologies, Philips Electronics, Rockwell International, Sony, STMicroelectronics and VLSI Technology. The Company's principal competitors in the xDSL market include Alcatel, Analog Devices, Globespan, Motorola, Rockwell International and Texas 7 9 Instruments. The Company also may face competition from suppliers of products based on new or emerging technologies. Many of the Company's competitors operate their own fabrication facilities and have longer operating histories and presence in key markets, greater name recognition, access to larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than the Company. As a result, such competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the promotion and sale of their products than the Company. Current and potential competitors have established or may establish financial or strategic relationships among themselves or with existing or potential customers, resellers or other third parties. Accordingly, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. In addition, existing or new competitors may in the future develop technologies that more effectively address the transmission of digital information through existing analog infrastructures at a lower cost. There can be no assurance that the Company will be able to compete successfully against current or potential competitors, or that competition will not have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Competition." Management of Growth. The Company has experienced a period of rapid growth, expanding from 164 employees in June 1997 to 376 employees (including temporary and contract employees) in June 1998. This expansion has placed, and continues to place, significant strain on the Company's resources. To accommodate this growth, the Company will be required to implement a variety of new and upgraded operational and financial systems, procedures and controls, including the improvement of its accounting and other internal management systems, all of which may require substantial management effort. There can be no assurance that such efforts can be accomplished successfully. The Company's rapid growth and expansion, as well as its product development and selling, general and administrative activities, have necessitated the increase in the number of employees as well as increased responsibilities for the Company's management. To support its growth, the Company recently entered into a new lease for larger facilities and is in the process of improving these facilities. These new facilities will allow all of the Company's Irvine employees and operations to be centralized on one campus. This relocation of the Company's headquarters and Irvine operations could result in a temporary disruption of the Company's operations or a temporary diversion of management attention and resources. From time to time, the Company engages in other relocations of employees or operations. If the Company sustains its growth in the future, it will need to continue to implement and improve its operational, financial and management information systems and to hire, train, motivate and manage its expanding employee base. There can be no assurance that the Company's systems, procedures and controls will be adequate to support the Company's operations. Any difficulties resulting from relocation of employees or operations or any failure to improve the Company's operational, financial and management information systems, or to hire, train, motivate or manage its employees could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Dependence on Independent Foundries. The Company does not own or operate a fabrication facility, and substantially all of its semiconductor device requirements are currently supplied by two outside foundries, Taiwan Semiconductor Manufacturing Corporation ("TSMC") in Taiwan and Chartered Semiconductor Manufacturing ("Chartered") in Singapore. There are significant risks associated with the Company's reliance on outside foundries, including the lack of ensured wafer supply; limited control over delivery schedules, quality assurance and control, manufacturing yields and production costs; and the unavailability of or delays in obtaining access to key process technologies. In addition, the manufacture of integrated circuits ("ICs") is a highly complex and technologically demanding process. Although the Company works closely with its foundries to minimize the likelihood of reduced manufacturing yields, the Company's foundries have from time to time experienced lower than anticipated manufacturing yields, particularly in connection with the introduction of new products and the installation and start-up of new process technologies. The Company provides its foundries with rolling forecasts of its production requirements; however, the ability of each foundry to provide semiconductor devices to the Company is limited by the foundry's available capacity. Although the Company has entered into contractual commitments to supply specified levels of products to certain of its customers, the Company does not have a long-term volume purchase agreement or a guaranteed level of 8 10 production capacity with TSMC or Chartered because the Company believes excess foundry capacity is currently available. The Company places its orders on a purchase order basis, and these foundries may allocate capacity to the production of other companies' products while reducing deliveries to the Company on short notice. In particular, foundry customers that are larger and better financed than the Company or that have long-term agreements with the Company's foundries may cause such foundries to reallocate capacity in a manner adverse to the Company. In addition, if the Company chooses to use a new foundry, several months are typically required to complete the qualification process before the Company can begin shipping products from the new foundry. Although the Company primarily utilizes two independent foundries, most of the Company's components are not manufactured at both foundries at any given time. Any inability of one of the foundries to provide the necessary components could result in significant delays and could have a material adverse effect on the Company's business, financial condition and results of operations. In the event either foundry experiences financial difficulties (whether as a result of the Asian economic crisis or otherwise) or suffers any damage or destruction to its respective facilities, or in the event of any other disruption of foundry capacity, the Company may not be able to qualify alternative manufacturing sources for existing or new products in a timely manner. Even the Company's current outside foundries would need to have certain manufacturing processes qualified in the event of disruption at another foundry, which the Company may not be able to accomplish in a timely enough manner to prevent an interruption in supply of the affected products. There can be no assurance that any existing or new foundries would be able to produce ICs with acceptable manufacturing yields. Furthermore, there can be no assurance that the Company's foundries will continue to deliver sufficient quantities of semiconductor devices on a timely basis, will not experience lower than expected manufacturing yields in the future, or will continue to have excess capacity, any of which events could materially and adversely affect the Company's business, financial condition and results of operations. See "Business -- Manufacturing." Dependence on Third-Party Subcontractors for Assembly and Test. Substantially all of the Company's products are assembled and tested by one of two third-party subcontractors, ASAT Ltd. ("ASAT") in Hong Kong and ST Assembly Test Services ("STATS") in Singapore. The Company does not have long-term agreements with either of these suppliers and typically procures services from such suppliers on a per order basis. The availability of assembly and testing services from these subcontractors could be adversely affected in the event either subcontractor experiences financial difficulties (whether as a result of the Asian economic crisis or otherwise) or suffers any damage or destruction to its respective facilities, or in the event of any other disruption of assembly and testing capacity. As a result of this reliance on third-party subcontractors for assembly and testing of its products, the Company cannot directly control product delivery schedules, which has in the past, and could in the future, result in product shortages or quality assurance problems that could increase the costs of manufacture, assembly or testing of the Company's products. Due to the amount of time normally required to qualify assemblers and testers, if the Company is required to find alternative manufacturing assemblers or testers of its components, shipments could be delayed. Any problems associated with the delivery, quality or cost of the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Manufacturing." Risks Associated with Potential Acquisitions. As part of its business strategy, the Company expects to review acquisition prospects that would complement its existing product offerings, augment its market coverage or enhance its technological capabilities. Although the Company has no current understandings or agreements with respect to any material acquisitions, the Company may make acquisitions of businesses, products or technologies in the future. However, there can be no assurance that the Company will be able to locate suitable acquisition opportunities or to consummate any such acquisitions on terms and conditions acceptable to the Company. Future acquisitions by the Company could result in potentially dilutive issuances of equity securities, large one-time write-offs, the incurrence of debt and contingent liabilities or amortization expenses related to goodwill and other intangible assets, any of which could materially adversely affect the Company's results of operations or the price of the Company's Class A Common Stock. Furthermore, acquisitions entail numerous risks, including difficulties in the assimilation and integration of operations, personnel, technologies, products and the information systems of the acquired companies, diversion of management's attention from other business concerns, risks of entering geographic or business markets in which the Company has no or limited prior experience and the potential loss of key employees. Since the Company has not made any material acquisitions in the past, no assurance can be given as to the ability of the 9 11 Company to successfully integrate any businesses, products, technologies or personnel that might be acquired in the future, and the failure of the Company to do so could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Strategy." Risks Associated with Expansion of International Business Activities. The Company currently procures substantially all of its manufacturing, assembly and test services from suppliers located outside the United States and may expand its manufacturing activities abroad. Approximately 13.1% of the Company's total revenue in the six months ended June 30, 1998 was derived from sales to independent customers based outside the United States. In 1997, approximately 15.4% of the Company's total revenue was derived from sales to independent customers based outside of the United States. In addition, the Company often ships products to its domestic customers' international manufacturing divisions and subcontractors. Accordingly, the Company is subject to risks inherent in international operations, which include, but are not limited to, political, social and economic instability, trade restrictions, the imposition of governmental controls, exposure to different legal standards (particularly with respect to intellectual property), burdens of complying with a variety of foreign laws, import and export license requirements, future import and export restrictions, unexpected changes in regulatory requirements, foreign technical standards, changes in tariffs, difficulties in staffing and managing operations, difficulties in collecting receivables and potentially adverse tax consequences. In particular, certain Asian countries have recently experienced significant economic difficulties, including currency devaluation and instability, business failures and a generally depressed business climate, particularly in the semiconductor industry. In view of the Company's reliance on Asian foundries and assemblers, and the Company's expanded international operations, the Asian economic crisis may have a material adverse effect on the Company's business, financial condition and results of operations. In addition, certain of the Company's products contain encryption or other features that are subject to various government export regulations, pursuant to which the Company has applied for export licenses. If such licenses are not granted, the Company may be unable to manufacture such products at its foreign foundries or to ship such products to certain customers located outside the United States. There can be no assurance that the Company will obtain such licenses or any licenses applied for in the future or that the failure to obtain such licenses will not have a material adverse effect on the Company's business, financial condition and results of operations. Moreover, demand for the Company's products could be adversely affected by seasonality of international sales and economic conditions in the Company's primary overseas markets. All of the Company's international sales to date have been denominated in U.S. dollars. 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. There can be no assurance that the risks associated with the Company's international operations will not materially adversely affect the Company's business, financial condition and results of operations in the future or require the Company to modify significantly its current business practices. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Reliance on Strategic Relationships. The Company has relied on in the past, and intends to continue to form in the future, strategic relationships with certain of its customers who are technology leaders in the Company's target markets. These relationships often involve the proposed development by the Company of new products involving significant technological challenges. Since the proposed product under development may offer potential competitive advantages to the strategic partner, considerable pressure is frequently placed on the limited resources of the Company to meet development schedules. While an essential element of the Company's strategy involves establishing such relationships, these projects utilize substantial amounts of the Company's limited resources, and could materially detract from or delay the completion of other important development projects. Delays in development could impair the relationship between the Company and its strategic partners. Moreover, there can be no assurance that customers of the Company will not develop their own solutions for products currently supplied by the Company, which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Customers and Strategic Relationships." Transition to Smaller Geometry Process Technologies. The Company continuously evaluates the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies in order to reduce costs and has commenced migration of certain products to smaller geometry processes. The Company 10 12 believes that the transition of its products to increasingly smaller geometries will be important for the Company to remain competitive. The Company has in the past experienced difficulty in migrating to new manufacturing processes, which has resulted and could continue to result in reduced yields, delays in product deliveries and increased expense levels. Moreover, the Company is dependent on its relationships with its foundries to migrate to smaller geometry processes successfully. No assurance can be given that the Company's future process migrations will be achieved without difficulties, delays or increased expenses. The Company's business, financial condition and results of operations could be materially and adversely affected if any such transition is substantially delayed or inefficiently implemented. As smaller geometry processes become more prevalent, the Company expects to integrate higher levels of customer and third-party intellectual property into its products. No assurance can be given that higher levels of integration will not adversely affect the Company's ability to deliver new integrated products on a timely basis, or at all. See "Business -- Manufacturing." Risks Associated with Intellectual Property Protection. The Company's success and future revenue growth will depend, in part, on its ability to protect its intellectual property. The Company relies primarily on patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods to protect its proprietary technologies and processes. There can be no assurance that such measures will provide meaningful protection for the Company's proprietary technologies and processes. The Company has been issued three United States patents and has filed 13 United States patent applications. There can be no assurance that any patent will issue as a result of these applications or future applications or, if issued, that any claims allowed will be sufficiently broad to protect the Company's technology. In addition, there can be no assurance that any existing or future patents will not be challenged, invalidated or circumvented, or that any right granted thereunder would provide meaningful protection to the Company. The failure of any patents to provide protection to the Company's technology would make it easier for the Company's competitors to offer similar products. In connection with its participation in the development of various industry standards, the Company may be required to agree to license certain of its patents to other parties, including its competitors, that develop products based upon the adopted standards. The Company also generally enters into confidentiality agreements with its employees and strategic partners, and generally controls access to and distribution of its documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's products, services or technology without authorization, develop similar technology independently or design around the Company's patents. In addition, effective copyright, trademark and trade secret protection may be unavailable or limited in certain foreign countries. Certain of the Company's customers have entered into agreements with the Company pursuant to which such customers have the right to use the Company's proprietary technology in the event the Company defaults in its contractual obligations, including product supply obligations, and fails to cure the default within a specified period of time. Moreover, the Company often incorporates the intellectual property of its strategic customers into its designs, and the Company has certain obligations with respect to the non-use and non-disclosure of such intellectual property. There can be no assurance that the steps taken by the Company to prevent misappropriation or infringement of the intellectual property of the Company or its customers will be successful. Moreover, litigation may be necessary in the future to enforce the Company's intellectual property rights, to protect the Company's trade secrets or to determine the validity and scope of proprietary rights of others, including its customers. Such litigation could result in substantial costs and diversion of management's efforts and other Company resources and could have a material adverse effect on the Company's business, financial condition and results of operations. The semiconductor industry is characterized by vigorous protection of and pursuit of intellectual property rights. From time to time, the Company has received, and may continue to receive in the future, notices of claims of infringement, misappropriation or misuse of other parties' proprietary rights. The Company has received a letter from counsel for BroadCom, Inc. asserting rights in the "Broadcom" trademark and demanding that the Company cease and desist from any further use of the Broadcom name. The Company and BroadCom, Inc. have exchanged correspondence outlining their respective positions on the matter. In addition, the Company is currently involved in litigation with STI concerning the alleged infringement of one of STI's patents by several of the Company's modem products and with Sarnoff Corporation and Sarnoff Digital Communications, Inc. (collectively, "Sarnoff") concerning the alleged misappropriation and misuse of 11 13 certain Sarnoff trade secrets by the Company. There can be no assurance that the Company will prevail in these actions, or that other actions alleging infringement by the Company of third-party patents, misappropriation or misuse by the Company of third-party trade secrets or the invalidity of one or more patents held by the Company will not be asserted or prosecuted against the Company, or that any assertions of infringement, misappropriation or misuse or prosecutions seeking to establish the invalidity of Company-held patents will not materially and adversely affect the Company's business, financial condition and results of operations. For example, in a patent or trade secret action, an injunction could be issued against the Company requiring that the Company withdraw certain products from the market or necessitating that certain products offered for sale or under development be redesigned. The Company has also entered into certain indemnification obligations in favor of its customers and strategic partners that could be triggered upon an allegation or finding of the Company's infringement, misappropriation or misuse of other parties' proprietary rights. Irrespective of the validity or successful assertion of such claims, the Company would likely incur significant costs and diversion of its management and personnel resources with respect to the defense of such claims, which could also have a material adverse effect on the Company's business, financial condition and results of operations. If any claims or actions are asserted against the Company, the Company may seek to obtain a license under a third party's intellectual property rights. There can be no assurance that under such circumstances a license would be available on commercially reasonable terms, if at all. See "Business -- Intellectual Property" and "-- Legal Proceedings." Lengthy Sales Cycle. The Company's sales cycle involves test and evaluation of its products by the potential customer and design of the customer's equipment to incorporate the Company's products. The sales cycle for the test and evaluation of the Company's products can range from three to six months or more, and it can take an additional six to nine months or more before a customer commences volume production of equipment that incorporates the Company's products. Because of this lengthy sales cycle, the Company may experience a delay between increasing expenses for research and development, sales and marketing, and general and administrative efforts, as well as increasing investments in inventory, and the generation of revenues, if any, from such expenditures. In addition, the delays inherent in such lengthy sales cycle raise additional risks of customer decisions to cancel or change product plans, which could result in the loss of anticipated sales by the Company. Achieving a design win provides no assurance that such customer will ultimately ship products incorporating the Company's products. The Company's business, financial condition and results of operations could be materially adversely affected if a significant customer curtails, reduces or delays orders during the Company's sales cycle or chooses not to release products employing the Company's products. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Sales and Marketing." Order and Shipment Uncertainties. The Company's sales are generally made pursuant to individual purchase orders that may be canceled or deferred by customers on short notice without significant penalty. Cancellation or deferral of product orders could result in the Company holding excess inventory, which could have a material adverse effect on the Company's profit margins and restrict its ability to fund its operations. The Company recognizes revenue upon shipment of products to the customer. Refusal of customers to accept shipped products or delays or difficulties in collecting accounts receivable could result in significant charges against income, which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Product Complexity. Products as complex as those offered by the Company frequently contain errors, defects and bugs when first introduced or as new versions are released. The Company has in the past experienced such errors, defects and bugs. Delivery of products with production defects or reliability, quality or compatibility problems could significantly delay or hinder market acceptance of such products, which could damage the Company's reputation and adversely affect the Company's ability to retain its existing customers and to attract new customers. Moreover, such errors, defects or bugs could cause problems, interruptions, delays or a cessation of sales to the Company's customers. Alleviating such problems may require significant expenditures of capital and resources by the Company. There can be no assurance that, despite testing by the Company, its suppliers or its customers, errors, defects or bugs will not be found in new products after 12 14 commencement of commercial production, resulting in additional development costs, loss of, or delays in, market acceptance, diversion of technical and other resources from the Company's other development efforts, product repair or replacement costs, claims by the Company's customers or others against the Company, or the loss of credibility with the Company's current and prospective customers. Any such event could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Core Technologies" and "-- Manufacturing." Cyclicality of the Semiconductor Industry. The Company provides semiconductor devices to the broadband communications markets. The semiconductor industry is highly cyclical and subject to rapid technological change and has been subject to significant economic downturns at various times, characterized by diminished product demand, accelerated erosion of average selling prices and production overcapacity. The semiconductor industry also periodically experiences increased demand and production capacity constraints. As a result, the Company may experience substantial period-to-period fluctuations in future results of operations due to general semiconductor industry conditions, overall economic conditions or other factors. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Limited Operating History. The Company was incorporated in August 1991 but did not begin shipping products until 1994. Accordingly, the Company has a limited operating history upon which investors may evaluate the Company and its prospects. The Company's recent revenue growth may not be sustainable and should not be considered indicative of future revenue growth, if any. There can be no assurance that the Company will be profitable in any future period. The Company's prospects must be considered in light of the risks, challenges and difficulties frequently encountered by companies in their early stage of development, particularly companies in intensely competitive and rapidly evolving markets such as the semiconductor industry and the broadband communications markets. To address these risks, the Company must, among other things, successfully increase the scope of its operations, respond to competitive and technological developments, continue to attract, retain and motivate qualified personnel and continue to commercialize products incorporating innovative technologies. There can be no assurance that the Company will be successful in addressing these risks and challenges. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Risks Associated with Government Regulation. The Federal Communications Commission (the "FCC") has broad jurisdiction over each of the Company's target markets. Although the Company's products are not directly subject to current regulations of the FCC or any other federal or state communications regulatory agency, much of the equipment into which the Company's products are incorporated is subject to direct government regulation. Accordingly, the effects of regulation on the Company's customers or the industries in which they operate may, in turn, adversely impact the Company's business, financial condition and results of operations. FCC regulatory policies affecting the ability of cable operators or telephone companies to offer certain services and other terms on which these companies conduct their businesses may impede sales of the Company's products. For example, the Company has in the past experienced delays when products incorporating its chips failed to comply with FCC emissions specifications. In addition, the Company's business, financial condition and results of operations may also be adversely affected by the imposition of certain tariffs, duties and other import restrictions on components that the Company obtains from non-domestic suppliers or by the imposition of export restrictions on products that the Company sells internationally. The Company may also be subject to regulation by countries other than the United States. Changes in current laws or regulations or the imposition of new laws and regulations in the United States or elsewhere, could materially and adversely affect the Company's business, financial condition and results of operations. Control by Directors, Executive Officers and Their Affiliates. As of June 30, 1998, the Company's directors and executive officers beneficially owned approximately 54.5% of the outstanding Common Stock and 60.3% of the total voting control of the Company. In particular, as of June 30, 1998, the two founders of the Company, Dr. Henry T. Nicholas, III and Dr. Henry Samueli, beneficially owned an aggregate of approximately 49.5% of the outstanding Common Stock and 54.8% of the total voting control of the Company. Accordingly, such persons will have sufficient voting power to control the outcome of matters (including the election of a majority of the Board of Directors, and any merger, consolidation or sale of all or substantially all 13 15 of the Company's assets) submitted to the Company's shareholders for approval and will also have control over the management and affairs of the Company. As a result of such control, certain transactions may not be possible without the approval of such shareholders. These transactions include proxy contests, mergers involving the Company, tender offers, open market purchase programs or other purchases of Class A Common Stock that could give shareholders of the Company the opportunity to realize a premium over the then prevailing market price for their shares of Class A Common Stock. See "Principal and Selling Shareholders." Year 2000 Compliance. Many existing computer systems and applications, and other control devices, use only two digits to identify a year in the date field, without considering the impact of the upcoming change in the century. Others do not correctly process "leap year" dates. As a result, such systems and applications could fail or create erroneous results unless corrected so that they can correctly process data related to the year 2000 and beyond, but there can be no assurance that such upgrades will be completed on a timely basis or without incurring substantial costs. The Company has evaluated each of its products for material year 2000 compliance and believes that each is substantially year 2000 compliant. However, management believes that it is not possible to determine whether all of its customers' products that incorporate the Company's products will be year 2000 compliant because the Company has little or no control over the design, production and testing of its customers' products. There can be no assurance, however, that the Company will make any such changes or that any of the Company's products are or will be year 2000 compliant. The Company relies on its systems, applications and devices in operating and monitoring all major aspects of its business, including financial systems (such as general ledger, accounts payable and payroll modules), customer services, infrastructure, embedded computer chips, networks and telecommunications equipment and end products. Although the Company is in the process of upgrading its software to address the year 2000 issue, there can be no assurance that such upgrades will be completed on a timely basis at reasonable costs, or that such upgrades will be able to anticipate all of the problems triggered by the actual impact of the year 2000. The Company also relies, directly and indirectly, on external systems of suppliers for the management and control of fabrication, assembly and testing of substantially all of the Company's products and of business enterprises such as customers, suppliers, creditors, financial organizations, and of governmental entities, both domestic and international, for accurate exchange of data. The Company could be affected through disruptions in the operation of the enterprises with which the Company interacts or from general widespread problems or an economic crisis resulting from noncompliant year 2000 systems. Despite the Company's efforts to address the year 2000 impact on its internal systems and business operations, there can be no assurance that such impact will not result in a material disruption of its business or have a material adverse effect on the Company's business, financial condition or results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Year 2000." Future Capital Needs; Uncertainty of Additional Funding. The Company believes that the aggregate net proceeds from this offering, together with the net proceeds of the Company's initial public offering and cash generated from its operations will be sufficient to meet its capital requirements for at least the next twelve months. Nonetheless, the Company may elect to sell additional equity securities or obtain additional credit facilities. The Company's future capital requirements will depend on many factors, including, but not limited to, the levels at which the Company maintains inventory, the market acceptance of the Company's products, the levels of promotion and advertising required to launch such products and attain a competitive position in the marketplace, the extent to which the Company invests in new technology and improvements to its existing technology, potential acquisitions, the response of competitors to products based on the Company's technology and other factors. To the extent the Company's existing resources and any future earnings are insufficient to fund the Company's activities, the Company may need to raise additional funds through public or private financing. No assurance can be given that additional financing will be available or that if available, any such financing can be obtained on terms favorable to the Company and its shareholders. If adequate funds are not available, the Company may be required to curtail its operations significantly or to obtain funds through arrangements with strategic partners or others that may require the Company to relinquish rights to certain of its technologies or potential markets. If additional funds are raised through the issuance of equity securities, the percentage ownership of the then existing shareholders of the Company would be reduced. Such equity securities may have rights, preferences or privileges senior to those of the holders of the Company's Common 14 16 Stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." Stock Price Volatility. The trading price of the Company's Class A Common Stock has been and will likely continue to be subject to wide fluctuations in response to quarter to quarter variations in results of operations, announcements of technological innovations or new products by the Company, its competitors or its customers, general conditions in the semiconductor, telecommunications and data communications equipment markets, changes in earnings estimates or investment recommendations by analysts, investor perceptions and expectations regarding the products, plans and strategic position of the Company, its competitors and its customers, or other events or factors. For example, since the Company's initial public offering, the Company's Class A Common Stock has traded as low as $47.00 and as high as $89.75 per share. In addition, the public stock markets have experienced extreme price and trading volume volatility, particularly in high technology sectors of the market. This volatility has significantly affected the market prices of securities of many technology companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations may adversely affect the market price of the Company's Class A Common Stock. There can be no assurance that the market price of the Company's Class A Common Stock will not decline below the offering price. Potential Effect of Anti-Takeover Provisions. The Company's Articles of Incorporation and Bylaws contain provisions that may discourage or prevent certain types of transactions involving an actual or potential change in control of the Company, including transactions in which the shareholders might otherwise receive a premium for their shares over then current market prices, and may limit the ability of the shareholders to approve transactions that they may deem to be in their best interests. In addition, the Company has outstanding Class B Common Stock, which entitles each holder thereof to ten votes per share on all matters presented for a shareholder vote. The Board of Directors also has the authority to fix the rights and preferences of shares of the Company's Preferred Stock and to issue such shares without a shareholder vote. It is possible that the provisions in the Company's Articles of Incorporation and Bylaws, the existence of super voting rights held by insiders and the ability of the Board of Directors to issue Preferred Stock may have the effect of delaying, deferring or preventing a change of control of the Company without further action by the shareholders, may discourage bids for the Company's Class A Common Stock at a premium over the market price of the Class A Common Stock and may adversely affect the market price of the Class A Common Stock and the voting and other rights of the holders of Class A Common Stock. Shares Eligible for Future Sale. Sales of substantial amounts of Class A Common Stock in the public market after this offering could adversely affect the market price of the Class A Common Stock. See "Shares Eligible for Future Sale." Broad Management Discretion in Use of Proceeds. While the Company expects to use the net proceeds of this offering for general corporate purposes, the Company has not yet identified specific uses for such net proceeds. Accordingly, the Company's management will retain broad discretion as to the allocation of the net proceeds of this offering. There can be no assurance that the proceeds will be utilized in a manner that the shareholders deem optimal, or that the proceeds can or will be invested to yield a significant return. See "Use of Proceeds." 15 17 USE OF PROCEEDS The net proceeds to the Company from the sale of the 392,500 shares of Class A Common Stock offered by the Company hereby, at the assumed public offering price of $77 per share and after deducting estimated underwriting discounts and commissions and offering expenses payable by the Company are estimated to be $28.4 million ($34.2 million if the Company sells an additional 77,500 shares as a result of the Underwriters' over-allotment option being exercised in full). The balance of the net proceeds will be used for general corporate purposes, including working capital and capital purchases such as test equipment, design tools and leasehold improvements associated with the Company's planned facilities expansion. Pending such uses, the Company intends to invest its net proceeds of this offering in investment-grade, interest-bearing securities. Management of the Company will have broad discretion concerning the allocation and use of all of the net proceeds of this offering to be received by the Company. The Company may use a portion of the net proceeds of this offering for the acquisition of businesses, products and technologies. As of the date of this Prospectus, the Company has no current understandings or agreements regarding any material acquisition. The Company will not receive any proceeds from the sale of Class A Common Stock by the Selling Shareholders. DIVIDEND POLICY The Company has never declared or paid cash dividends on shares of its capital stock. The Company currently intends to retain future earnings, if any, for use in its business, and does not anticipate paying any cash dividends in the foreseeable future. PRICE RANGE OF CLASS A COMMON STOCK The Company's Class A Common Stock is quoted on the Nasdaq National Market under the symbol "BRCM." The following table sets forth, for the periods indicated, the high and low sales prices of the Class A Common Stock as reported by the Nasdaq National Market since the Company's initial public offering in April 1998. The Company's Class A Common Stock was initially sold to the public at a price of $24 per share.
HIGH LOW Year Ending December 31, 1998 ---- --- Second Quarter (beginning April 17, 1998)............ $76 5/8 $47 Third Quarter (through September 29, 1998)........... 89 3/4 47
The last sale price of the Class A Common Stock on September 29, 1998, as reported by the Nasdaq National Market, was $77 per share. As of September 29, 1998, there were approximately 56 and 350 holders of record of the Company's Class A Common Stock and Class B Common Stock, respectively. 16 18 CAPITALIZATION The following table sets forth the capitalization of the Company as of June 30, 1998 on an actual basis, and as adjusted basis to give effect to the sale of 392,500 shares of Class A Common Stock by the Company in this offering at an assumed public offering price of $77 per share and after deducting estimated underwriting discounts and commissions and offering expenses payable by the Company. This table should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Financial Statements included elsewhere in this Prospectus.
JUNE 30, 1998 ----------------------- ACTUAL AS ADJUSTED -------- ----------- (IN THOUSANDS) Long-term debt, less current portion(1)..................... $ 45 $ 45 -------- -------- Shareholders' equity: Preferred Stock, $.0001 par value; 10,000,000 shares authorized; no shares issued and outstanding, actual and as adjusted............................................... -- -- Class A Common Stock, $.0001 par value; 200,000,000 shares authorized; 4,839,750 shares issued and outstanding, actual; 7,839,750 shares issued and outstanding, as adjusted(2)............................................... -- 1 Class B Common Stock, $.0001 par value; 100,000,000 shares authorized; 38,878,199 shares issued and outstanding, actual; 36,270,699 shares issued and outstanding, as adjusted(2)............................................... 4 4 Additional paid-in capital.................................. 120,621 149,058 Notes receivable from employees............................. (3,464) (3,464) Deferred compensation....................................... (5,956) (5,956) Retained earnings........................................... 17,477 17,477 -------- -------- Total shareholders' equity.................................. 128,682 157,120 -------- -------- Total capitalization.............................. $128,727 $157,165 ======== ========
- --------------- (1) See Note 3 of Notes to Financial Statements. (2) Based on the number of shares outstanding as of June 30, 1998. Excludes (i) 714,550 shares of Class A Common Stock and 7,970,103 shares of Class B Common Stock issuable upon the exercise of options outstanding as of June 30, 1998 and (ii) 8,038,660 shares of Common Stock available for issuance under the Company's employee benefit plans. 17 19 SELECTED FINANCIAL DATA The selected financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Financial Statements and Notes thereto included elsewhere in this Prospectus. The balance sheet data as of December 31, 1996 and 1997 and the statement of operations data for the years ended December 31, 1995, 1996 and 1997 have been derived from the audited financial statements of the Company included elsewhere in this Prospectus. The balance sheet data as of December 31, 1994 and 1995 and the statement of operations data for the year ended December 31, 1994 have been derived from audited financial statements of the Company not included herein. The balance sheet data as of June 30, 1998 and the statement of operations data for the six months ended June 30, 1997 and 1998 have been derived from unaudited financial statements included elsewhere in this Prospectus. The balance sheet data as of December 31, 1993 and the statement of operations data for the year ended December 31, 1993 have been derived from unaudited financial statements not included herein. The unaudited financial statements of the Company were prepared by management of the Company on the same basis as the audited financial statements included elsewhere herein and, in the opinion of the Company, include all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the information set forth below. Results for the six month period ended June 30, 1998 are not necessarily indicative of results that may be expected for the year ended December 31, 1998.
SIX MONTHS ENDED YEARS ENDED DECEMBER 31, JUNE 30, -------------------------------------------- ------------------ 1993 1994 1995 1996 1997 1997 1998 ------ ------ ------ ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Revenue: Product revenue..................... $ -- $1,554 $4,317 $18,981 $31,668 $ 8,169 $78,493 Development revenue................. 1,138 2,082 1,790 2,389 5,287 2,257 2,019 ------ ------ ------ ------- ------- ------- ------- Total revenue......................... 1,138 3,636 6,107 21,370 36,955 10,426 80,512 Cost of revenue....................... -- 707 1,398 7,860 14,926 4,810 34,212 ------ ------ ------ ------- ------- ------- ------- Gross profit.......................... 1,138 2,929 4,709 13,510 22,029 5,616 46,300 Operating expense: Research and development............ 875 1,746 2,687 5,662 16,204 6,205 14,619 Selling, general and administrative.................... 252 944 2,135 3,546 8,063 2,541 9,322 ------ ------ ------ ------- ------- ------- ------- Total operating expense............... 1,127 2,690 4,822 9,208 24,267 8,746 23,941 ------ ------ ------ ------- ------- ------- ------- Income (loss) from operations......... 11 239 (113) 4,302 (2,238) (3,130) 22,359 Interest and other income, net........ 12 41 120 213 290 63 1,301 Net loss on sale of investments....... (8) (42) -- -- -- -- -- ------ ------ ------ ------- ------- ------- ------- Income (loss) before income taxes..... 15 238 7 4,515 (1,948) (3,067) 23,660 Provision (benefit) for income taxes............................... 3 1 3 1,499 (775) (1,226) 8,281 ------ ------ ------ ------- ------- ------- ------- Net income (loss)..................... $ 12 $ 237 $ 4 $ 3,016 $(1,173) $(1,841) $15,379 ====== ====== ====== ======= ======= ======= ======= Basic earnings (loss) per share(1).... $ .00 $ .01 $ .00 $ .12 $ (.04) $ (.07) $ .45 ====== ====== ====== ======= ======= ======= ======= Diluted earnings (loss) per share (1)................................. $ .00 $ .01 $ .00 $ .09 $ (.04) $ (.07) $ .35 ====== ====== ====== ======= ======= ======= =======
DECEMBER 31, -------------------------------------------- JUNE 30, 1993 1994 1995 1996 1997 1998 ----- ------ ------ ------- ------- -------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents...................... $ 49 $ 100 $1,990 $ 4,657 $22,116 $ 64,711 Working capital................................ (223) 1,958 2,247 5,529 26,262 86,409 Total assets................................... 473 3,144 4,509 14,367 45,244 148,101 Long-term debt, including current portion...... 61 85 49 216 2,693 134 Convertible preferred stock.................... -- 2,161 3,150 6,084 28,617 -- Total shareholders' equity..................... 24 2,474 3,475 9,770 33,392 128,682
- --------------- (1) See Note 1 of Notes to Financial Statements for an explanation of the calculation of earnings (loss) per share. 18 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the Financial Statements and Notes thereto included elsewhere in this Prospectus. This Prospectus contains forward-looking statements that involve risks and uncertainties. The Company's actual results could differ significantly from those projected in the forward-looking statements as a result of certain factors, including those discussed in "Risk Factors," "Business" and elsewhere in this Prospectus. The Company assumes no obligation to update the forward-looking statements or such factors. OVERVIEW The Company is a leading developer of highly integrated silicon solutions that enable broadband digital data transmission to the home and within the business enterprise. The Company's products enable the high-speed transmission of data over existing communications infrastructures, most of which were not originally intended for digital data transmission. Using proprietary technologies and advanced design methodologies, the Company has designed and developed ICs for some of the most significant broadband communications markets including cable set-top boxes, cable modems, high-speed networking, DBS and terrestrial digital broadcast, and xDSL. From the Company's inception in 1991 through 1994, it was primarily engaged in product development and the establishment of strategic customer and foundry relationships. During this period, the Company generated the majority of its total revenue from development work performed for key customers. The Company began shipping its products in 1994, and subsequently the Company's total revenue has grown predominately through sales of its semiconductor products. The Company intends to continue to enter into development contracts with key customers, but expects development revenue will constitute a decreasing percentage of its total revenue. The Company also generates a small percentage of its product revenue from sales of its system level reference designs. The Company recognizes product revenue at the time of shipment. Provision is concurrently made for estimated product returns, which have been immaterial prior to the fourth quarter of 1997. The Company's products typically carry a one year warranty. In the fourth quarter of 1997, the Company experienced product returns in excess of $500,000 due to packaging defects. Such defects were caused by one of the Company's assemblers, which reimbursed the Company for such expenses. Development revenue is recognized when earned. Approximately 15.4% and 13.1% of the Company's total revenue in 1997 and in the six months ended June 30, 1998, respectively, were derived from independent customers located outside of the United States. All of the Company's revenue to date has been denominated in U.S. dollars. See Note 8 of Notes to Financial Statements. From time to time, the Company's key customers have placed large orders causing quarterly revenue to fluctuate significantly, which fluctuations are likely to continue in the future. For example, in the fourth quarter of 1997, sales of the Company's networking products increased to approximately $7.6 million from $759,000 in the previous quarter. More than half of this increase was attributable to sales to a single customer. Sales to the Company's largest five customers (including sales to their respective manufacturing subcontractors) accounted for 61.7%, 67.7% and 80.9% of the Company's total revenue for 1997, 1996 and the six months ended June 30, 1998, respectively. The Company expects that these five customers will continue to account for a significant portion of the Company's total revenue for 1998. See "Risk Factors -- Customer Concentration" and "Business -- Customers and Strategic Relationships." Various factors have in the past affected and may continue in the future to affect the Company's gross margin, including, but not limited to, the Company's product mix, the position of the Company's products in their respective life cycles and the mix of the Company's product revenue and development revenue. For example, newly-introduced products generally have higher average selling prices and gross margins, both of which typically decline over product life cycles due to competitive pressures and volume pricing agreements. The Company's gross margin and operating results in the future may continue to fluctuate as a result of these and other factors. See "-- Quarterly Results of Operations" and "Risk Factors -- Fluctuations in Results of Operations." 19 21 The sales cycle for the test and evaluation of the Company's products can range from three to six months or more, with an additional three to six months or more before a customer commences volume production of equipment incorporating the Company's products. Due to such lengthy sales cycles, the Company may experience a delay between increasing expenses for research and development and selling, general and administrative efforts, and the generation of corresponding revenue, if any. Furthermore, in 1998 and 1999, the Company intends to increase its investment in research and development, selling, general and administrative functions and inventory as it expands its operations. The Company anticipates that the rate of new orders may vary significantly from month to month. Consequently, if anticipated sales and shipments in any quarter do not occur when expected, expenses and inventory levels could be disproportionately high, and the Company's operating results for that quarter and, potentially, future quarters would be materially and adversely affected. "See Risk Factors -- Fluctuations in Results of Operations" and "-- Lengthy Sales Cycle." RECENT PRELIMINARY OPERATING RESULTS On September 30, 1998, the Company announced estimated preliminary results for the third quarter ending September 30, 1998, subject to final review and confirmation. For the quarter ending September 30, 1998, the Company expects to report total revenue of approximately $52.0 million to $52.5 million. The Company expects to report diluted earnings per share for the quarter of approximately $.16 to $.17. This information regarding expected revenue and earnings per share for the three months ending September 30, 1998 constitutes forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Actual final results for the three months ending September 30, 1998 could differ materially as a result of a number of factors, including, but not limited to, accounting adjustments made during the course of closing the quarter. For a more detailed discussion of factors that affect the Company's operating results, see "Risk Factors." RESULTS OF OPERATIONS The following table sets forth certain statement of operations data expressed as a percentage of total net sales for the periods indicated.
SIX MONTHS YEAR ENDED DECEMBER 31, ENDED JUNE 30, ----------------------- -------------- 1995 1996 1997 1997 1998 ----- ----- ----- ----- ----- Revenue: Product revenue.................................. 70.7% 88.8% 85.7% 78.4% 97.5% Development revenue.............................. 29.3 11.2 14.3 21.6 2.5 ----- ----- ----- ----- ----- Total revenue...................................... 100.0 100.0 100.0 100.0 100.0 Cost of revenue.................................... 22.9 36.8 40.4 46.1 42.5 ----- ----- ----- ----- ----- Gross profit....................................... 77.1 63.2 59.6 53.9 57.5 Operating expense: Research and development......................... 44.0 26.5 43.9 59.5 18.1 Selling, general and administrative.............. 35.0 16.6 21.8 24.4 11.6 ----- ----- ----- ----- ----- Total operating expense............................ 79.0 43.1 65.7 83.9 29.7 ----- ----- ----- ----- ----- Income (loss) from operations...................... (1.9) 20.1 (6.1) (30.0) 27.8 Interest and other income, net..................... 2.0 1.0 .8 .6 1.6 ----- ----- ----- ----- ----- Income (loss) before income taxes.................. .1 21.1 (5.3) (29.4) 29.4 Provision (benefit) for income taxes............... -- 7.0 (2.1) (11.7) 10.3 ----- ----- ----- ----- ----- Net income (loss).................................. .1% 14.1% (3.2)% (17.7)% 19.1% ===== ===== ===== ===== =====
SIX MONTHS ENDED JUNE 30, 1998 AND 1997 Total Revenue. Total revenue consists of product revenue generated principally by sales of the Company's semiconductor products and development revenue generated under development contracts with the Company's customers. Total revenue for the six months ended June 30, 1998 was $80.5 million, an increase of $70.1 million or 672.2% from total revenue of $10.4 million in the six months ended June 30, 1997. The increase in total revenue was derived mainly from an increase in volume of shipments of ICs for digital cable set-top boxes and for the high-speed networking market and, to a lesser extent, for the cable modem market. 20 22 Gross Profit. Gross profit represents total revenue less the cost of revenue. Cost of revenue includes the cost of purchasing the finished silicon wafers processed by independent foundries, and costs associated with assembly, test and quality assurance for those products, as well as costs of personnel and equipment associated with manufacturing support and contracted development work. Gross profit for the six months ended June 30, 1998 was $46.3 million or 57.5% of total revenue, an increase of $40.7 million or 724.4% from gross profit of $5.6 million or 53.9% of total revenue in the six months ended June 30, 1997. The increase in gross profit was mainly attributable to the significant increase in the volume of product shipments. It is expected that gross profit, as a percentage of total revenue, will decline in future periods as volume-pricing agreements and competitive pricing strategies continue to take effect. In addition, the Company's gross margin may be affected by the introduction in the future of certain lower margin products. Research and Development Expense. Research and development expense consists primarily of salaries and related costs of employees engaged in research, design and development activities, as well as related subcontracting costs. Research and development expense for the six months ended June 30, 1998 was $14.6 million or 18.1% of total revenue, an increase of $8.4 million or 135.6% from research and development expense of $6.2 million or 59.5% of total revenue for the six months ended June 30, 1997. The increase in absolute dollars was primarily due to the addition of personnel for the development of new products and the enhancement of existing products. The decline in research and development expense as a percentage of total revenue reflected a significant increase in total revenue during the six months ended June 30, 1998. The Company expects that research and development expense in absolute dollars will continue to increase for the foreseeable future. Selling, General and Administrative Expense. Selling, general and administrative expense consists primarily of personnel-related expenses, professional fees, trade show expenses and facilities expenses. Selling, general and administrative expense for the six months ended June 30, 1998 was $9.3 million or 11.6% of total revenue, an increase of $6.8 million or 266.9% from $2.5 million or 24.4% of total revenue for the six months ended June 30, 1997. The increase in absolute dollars reflected higher personnel related costs resulting from the hiring of sales and marketing personnel, senior management and administrative personnel, and increased occupancy, legal and other professional fees, including increased expenses for litigation. The decline in selling, general and administrative expense as a percentage of total revenue reflected a significant increase in total revenue during the six months ended June 30, 1998. The Company expects that selling, general and administrative expense in absolute dollars will continue to increase in the near term to support the planned expansion of the Company's operations. Deferred Compensation. In the six months ended June 30, 1998, the Company recorded approximately $5.4 million of net deferred compensation in connection with the grant of employee stock options to purchase an aggregate of 1,298,050 shares of Class B Common Stock in late March 1998 (in addition to approximately $1.1 million of deferred compensation recorded in 1997). The deferred compensation represents the difference between the deemed value of the Class B Common Stock for accounting purposes and the option exercise price of such options at the date of grant. Such amount has been presented as a reduction of shareholders' equity and is being amortized ratably to expense over the vesting period of the applicable options. The Company amortized an aggregate of $503,000 of deferred compensation in the six months ended June 30, 1998. The remaining balance of total deferred compensation will be amortized at a rate of approximately $406,000 (pre-tax) per quarter through September 2001 and approximately $338,000 (pre-tax) for the quarters ending December 31, 2001 and March 31, 2002. Interest and Other Income, Net. Interest and other income, net reflects interest earned on average cash and cash equivalents and investment balances, less interest on the Company's long-term debt and capital lease obligations. Interest and other income, net for the six months ended June 30, 1998 was $1.3 million, compared to $63,000 in the six months ended June 30, 1997. This increase was principally due to increased cash balances available to invest resulting from consummation of the Company's initial public offering and sale of shares to Cisco Systems in April 1998. Provision (Benefit) for Income Taxes. The Company accrues a provision for federal and state income tax at applicable statutory rates. The Company's effective tax rates were approximately 35% and 40% for the 21 23 six months ended June 30, 1998 and 1997, respectively. The difference between the Company's effective tax rates and the federal statutory tax rate of 34% was primarily related to the effect of state income taxes and research and development tax credits. YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 Total Revenue. Total revenue for 1997 was $37.0 million, an increase of $15.6 million or 72.9% from 1996. Total revenue for 1996 was $21.4 million, an increase of $15.3 million or 249.9% from $6.1 million in 1995. In each year, the increase was primarily due to the introduction of new products and to a higher volume of shipments of existing products to manufacturers of cable set-top boxes and networking customers selling Fast Ethernet hubs and switches. In particular, the majority of the increase in total revenue in 1997 was derived from sales of new products, including the Company's Fast Ethernet Quad transceivers for the high-speed networking market and its QAM receivers for digital cable set-top boxes. Gross Profit. Gross profit for 1997 was $22.0 million or 59.6% of total revenue, an increase of $8.5 million or 63.1% from 1996. Gross profit in 1996 was $13.5 million or 63.2% of total revenue, an increase of $8.8 million or 186.9% from $4.7 million or 77.1% of total revenue in 1995. In each year, the increase in absolute dollars was largely due to higher total revenue. Gross margin declined in 1997 from 1996 primarily due to volume pricing concessions made in 1997 for cable set-top box products. Gross margin declined in 1996 from 1995 largely due to a decline in higher margin development revenue as a percentage of total revenue in 1996. Research and Development Expense. Research and development expense for 1997 was $16.2 million or 43.9% of total revenue, an increase of $10.5 million or 186.2% from 1996. Research and development expense for 1996 was $5.7 million or 26.5% of total revenue, an increase of $3.0 million or 110.7% from 1995 expense of $2.7 million or 44.0% of total revenue in 1995. In each year, the increase in absolute dollars was primarily due to the addition of personnel for the development of new products and the enhancement of existing products, as well as payments to outside consultants where specific resources were needed in the development process. Research and development expense in absolute dollars increased at a fairly steady rate for each quarter between 1995 and 1997 after taking into consideration the $1.2 million or non-recurring engineering expense paid to General Instrument in the third quarter of 1997 for development support services with respect to the Company's MPEG development program. Such services included the engagement of several engineers from General Instrument on a contract basis and the development of high level descriptions and related documentation. The decline in research and development expense as a percentage of total revenue reflects a significant increase in total revenue during that period. Selling, General and Administrative Expense. Selling, general and administrative expense for 1997 was $8.1 million or 21.8% of total revenue, an increase of $4.5 million or 127.4% from 1996. Selling, general and administrative expense for 1996 was $3.5 million or 16.6% of total revenue, an increase of $1.4 million or 66.1% from $2.1 million or 35.0% of total revenue in 1995. In each year, the increase in absolute dollars principally reflected higher personnel related costs resulting from a net increase in sales and marketing personnel to address each of the Company's target markets. These increases were also due in part to the hiring of senior level management and administrative personnel and increased occupancy, legal and other professional fees. The decline in selling, general and administrative expense as a percentage of total revenue reflects a significant increase in total revenue during that period. As the Company's infrastructure expanded in 1997, selling, general and administrative expense as a percentage of total revenue increased at a more rapid rate than total revenue. Deferred Compensation. In connection with the grant of certain stock options to employees during 1997, the Company recorded aggregate deferred compensation of approximately $1.1 million, representing the difference between the deemed value of the Class B Common Stock for accounting purposes and the option exercise price of such options at the date of grant. Such amount is presented as a reduction of shareholders' equity and amortized ratably over the vesting period of the applicable options. Amortization of deferred compensation recorded in 1997 was $66,000 (pre-tax). 22 24 Interest and Other Income, Net. Interest and other income, net reflects interest earned on average cash, cash equivalents and short-term investment balances, less interest on the Company's term loan. Interest and other income, net for 1997 was $290,000, an increase of $77,000 or 36.2% from 1996. Interest and other income, net for 1996 was $213,000, an increase of $93,000 or 77.5% from $120,000 in 1995. In each year, the increase was primarily due to interest earned on higher levels of short-term investments and cash balances, partially offset by interest expense incurred on higher average debt balances. Provision (Benefit) for Income Taxes. The Company accrues a provision for federal and state income tax at applicable statutory rates. The Company's effective tax rates were approximately 40%, 33% and 43% for 1997, 1996 and 1995, respectively. In each year, the difference between the Company's effective tax rate and the federal statutory tax rate of 34% was primarily related to state income taxes and research and development tax credits. The Company utilizes the liability method of accounting for income taxes as set forth in Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. See Note 2 of Notes to Financial Statements. QUARTERLY RESULTS OF OPERATIONS The following table presents selected quarterly financial information for each of the eight quarters through June 30, 1998. This information is unaudited but, in the opinion of the Company's management, reflects all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for a fair presentation of this information in accordance with generally accepted accounting principles. Such quarterly results are not necessarily indicative of future results of operations.
SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, 1996 1996 1997 1997 1997 1997 1998 1998 --------- -------- -------- -------- --------- -------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenue: Product revenue.................... $4,590 $6,134 $ 3,959 $ 4,210 $ 8,096 $15,403 $35,225 $43,268 Development revenue................ 1,000 600 1,072 1,185 1,159 1,871 119 1,900 ------ ------ ------- ------- ------- ------- ------- ------- Total revenue........................ 5,590 6,734 5,031 5,395 9,255 17,274 35,344 45,168 Cost of revenue...................... 2,215 1,916 2,534 2,276 4,047 6,069 13,832 20,380 ------ ------ ------- ------- ------- ------- ------- ------- Gross profit......................... 3,375 4,818 2,497 3,119 5,208 11,205 21,512 24,788 Operating expense: Research and development........... 1,449 2,309 2,686 3,519 5,503 4,496 5,952 8,667 Selling, general and administrative................... 1,041 1,110 1,142 1,399 2,670 2,852 3,989 5,333 ------ ------ ------- ------- ------- ------- ------- ------- Total operating expense.............. 2,490 3,419 3,828 4,918 8,173 7,348 9,941 14,000 ------ ------ ------- ------- ------- ------- ------- ------- Income (loss) from operations........ 885 1,399 (1,331) (1,799) (2,965) 3,857 11,571 10,788 Interest and other income (expense), net................................ 45 97 60 3 (41) 268 218 1,083 ------ ------ ------- ------- ------- ------- ------- ------- Income (loss) before income taxes.... 930 1,496 (1,271) (1,796) (3,006) 4,125 11,789 11,871 Provision (benefit) for income taxes.............................. 309 497 (508) (718) (1,202) 1,653 4,126 4,155 ------ ------ ------- ------- ------- ------- ------- ------- Net income (loss).................... $ 621 $ 999 $ (763) $(1,078) $(1,804) $ 2,472 $ 7,663 $ 7,716 ====== ====== ======= ======= ======= ======= ======= ======= Basic earnings (loss) per share (1)................................ $ .02 $ .04 $ (.03) $ (.04) $ (.07) $ .09 $ .27 $ .19 ====== ====== ======= ======= ======= ======= ======= ======= Diluted earnings (loss) per share (1)................................ $ .02 $ .03 $ (.03) $ (.04) $ (.07) $ .06 $ .19 $ .16 ====== ====== ======= ======= ======= ======= ======= =======
- --------------- (1) See Note 1 of Notes to Financial Statements for an explanation of the calculation of earnings (loss) per share. 23 25 The following table sets forth, for the periods indicated, the percentage of total revenue represented by each item in the Company's statement of operations.
THREE MONTHS ENDED ---------------------------------------------------------------------------------------- SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, 1996 1996 1997 1997 1997 1997 1998 1998 --------- -------- -------- -------- --------- -------- --------- -------- Revenue: Product revenue...................... 82.1% 91.1% 78.7% 78.0% 87.5% 89.2% 99.7% 95.8% Development revenue.................. 17.9 8.9 21.3 22.0 12.5 10.8 .3 4.2 ----- ----- ----- ----- ----- ----- ----- ----- Total revenue.......................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Cost of revenue........................ 39.6 28.5 50.4 42.2 43.7 35.1 39.1 45.1 ----- ----- ----- ----- ----- ----- ----- ----- Gross profit........................... 60.4 71.5 49.6 57.8 56.3 64.9 60.9 54.9 Operating expense: Research and development............. 26.0 34.3 53.4 65.2 59.5 26.0 16.8 19.2 Selling, general and administrative..................... 18.6 16.4 22.7 25.9 28.8 16.6 11.3 11.8 ----- ----- ----- ----- ----- ----- ----- ----- Total operating expense................ 44.6 50.7 76.1 91.1 88.3 42.6 28.1 31.0 ----- ----- ----- ----- ----- ----- ----- ----- Income (loss) from operations.......... 15.8 20.8 (26.5) (33.3) (32.0) 22.3 32.8 23.9 Interest and other income expense, net.................................. .8 1.4 1.2 -- (.5) 1.6 .6 2.4 ----- ----- ----- ----- ----- ----- ----- ----- Income (loss) before income taxes...... 16.6 22.2 (25.3) (33.3) (32.5) 23.9 33.4 26.3 Provision (benefit) for income taxes... 5.5 7.4 (10.1) (13.3) (13.0) 9.6 11.7 9.2 ----- ----- ----- ----- ----- ----- ----- ----- Net income (loss)...................... 11.1% 14.8% (15.2)% (20.0)% (19.5)% 14.3% 21.7% 17.1% ===== ===== ===== ===== ===== ===== ===== =====
Total Revenue. Quarterly revenue increased throughout the second half of 1996 as a result of the introduction of new products and higher unit shipments of the Company's existing products in the cable set-top box, cable modem and high-speed networking markets and generally reflected higher revenue from development programs. The Company anticipates that development revenue will continue to vary from quarter to quarter as contract milestones are met. The decrease in total revenue from $6.7 million in the fourth quarter of 1996 to $5.0 million in the first quarter of 1997 was primarily due to a reduction of unit shipments of 100Base-T4 high-speed networking products and pricing concessions to a major customer for cable set-top boxes. The increase in total revenue to $9.3 million in the third quarter of 1997 largely resulted from the introduction of new products and increased unit shipments of existing cable set-top box and cable modem products. The increase in total revenue to $17.3 million in the fourth quarter of 1997 was primarily due to the first significant volume shipments of the Company's 100Base-TX high-speed networking products, as well as $2.5 million of revenue from a take or pay contract with a significant customer. The increase in total revenue to $35.3 million in the first quarter of 1998 was primarily the result of the continuation of significant volume shipments of the Company's networking products. The increase in total revenue to $45.2 million in the second quarter of 1998 was attributed to increased unit shipments of existing cable set-top box and cable modem products, offset by a reduction in unit shipments of networking products. Gross Profit. As a percentage of total revenue, gross profit increased to 71.5% in fourth quarter 1996 as a result of a favorable product mix and a significant increase in the volume of product shipments over the previous quarters, which allowed fixed manufacturing costs to be spread over a larger product base. In the first quarter of 1997, gross profit decreased to 49.6% of total revenue as a result of an unfavorable product mix and pricing concessions to a major customer for cable set-top boxes. Gross profit increased to 64.9% of total revenue in the fourth quarter of 1997 as a result of volume shipments of high-speed networking products and a significant increase in the volume of product shipments generally. During the first and second quarters of 1998, gross profit decreased to 60.9% and 54.9%, respectively, of total revenue due to volume-pricing agreements and competitive pricing strategies. Operating Expense. Research and development expense increased in absolute dollars through the third quarter of 1997 to facilitate the expansion of introduction of new products by the Company. Research and development expense in the third quarter of 1997 included a substantial non-recurring engineering expense, which consisted of approximately $1.2 million paid to General Instrument for engineering support related to the development of the Company's MPEG technology and, as a result, research and development expense in the fourth quarter of 1997 was lower than in the prior quarter. The increase in research and development 24 26 expense in the first and second quarter of 1998 was primarily due to the addition of personnel for the development of new products and the enhancement of existing products. Selling, general and administrative expense has also increased in absolute dollars as the Company has expanded its infrastructure to accommodate the Company's expanding operations. In the third and fourth quarters of 1997, the Company also incurred significant legal expenses in conjunction with pending litigation and the negotiation of large customer contracts. The increase in selling, general and administrative expense during the first and second quarter of 1998 reflected higher personnel related costs resulting from the hiring of sales and marketing personnel, senior management and administrative personnel, and increased occupancy, legal and other professional fees, including increased expenses for litigation. See "Business -- Legal Proceedings." The Company's quarterly results of operations have fluctuated significantly in the past and may continue to fluctuate in the future based on a number of factors, not all of which are in the Company's control. In particular, the Company's results of operations have fluctuated in the past due to, among other things, competitive pressures on selling prices; the volume of product sales; the timing and cancellation of significant customer orders; lengthy sales cycles; pricing concessions on volume sales; fluctuations in manufacturing yields; changes in product mix; intellectual property disputes; the Company's ability to develop, introduce and market new products and technologies on a timely basis; introduction of products and technologies by the Company's competitors; market acceptance of the Company's and its customers' products; and the amount and timing of recognition of development revenue. The Company's results of operations may also fluctuate in the future based on a number of factors, including, but not limited to those listed above, as well as general business conditions in the semiconductor industry and the broadband communications markets; availability of foundry capacity and raw materials; the quality of the Company's products; the timing of investments in research and development; the Company's ability to expand and implement its sales and marketing programs; the level of orders received that can be shipped in a quarter; currency fluctuations; and general economic conditions. As a result of the foregoing factors, the Company believes period to period comparisons are not necessarily meaningful and should not be relied upon as indicative of future results. LIQUIDITY AND CAPITAL RESOURCES Since its inception, the Company has financed its operations through a combination of sales of equity securities and cash generated by operations. At June 30, 1998, the Company had $86.4 million in working capital and $67.3 million in cash and cash equivalents, and short-term investments. In addition, at June 30, 1998, the Company had long-term investments of $25.1 million. The Company's operating activities provided cash of $4.2 million in the six months ended June 30, 1998, primarily as a result of net income and a growth in accounts payable, partially offset by increases in accounts receivable and inventory. The Company's operating activities used cash in the amount of $2.6 million in fiscal 1997, and generated cash in the amount of $3.2 million and $1.1 million in fiscal 1996 and fiscal 1995, respectively. Cash used in operating activities in 1997 was primarily attributable to a net loss, growth in accounts receivable and inventory and a decrease in income taxes payable, which more than offset growth in accounts payable and the non-cash impact of depreciation and amortization. Cash provided by operating activities in fiscal 1996 was primarily attributable to net income and growth in accounts payable and income taxes payable, partially offset by growth in accounts receivable. Cash provided by operating activities in 1995 was primarily attributable to a decrease in accounts receivable, growth in accounts payable, and the non-cash impact of depreciation and amortization. The Company's investing activities used cash in the amount of $27.7 million in the six months ended June 30, 1998, for the purchase of held-to-maturity investments and $10.7 million for the purchase of capital equipment to support its expanding operations. The Company's investing activities used cash of $7.1 million in fiscal 1997, $3.7 million in fiscal 1996 and $116,000 in fiscal 1995, primarily for the purchase of capital equipment. Cash provided by financing activities was $76.8 million for the six months ended June 30, 1998, primarily from the aggregate net proceeds of $79.2 million from the Company's initial public offering and the 25 27 Company's sale of Class A Common Stock to Cisco Systems described below, partially offset by the repayment of $2.5 million outstanding under a bank term loan. Cash provided by financing activities was $27.1 million in 1997, $3.2 million in 1996 and $949,000 in 1995, primarily from the sale of convertible preferred stock and, in 1997, from the establishment of a revolving credit facility and term loan. As of June 30, 1998, the Company had material commitments of $5.4 million consisting of the purchase of workstation software and hardware. The Company also plans to spend approximately $17.0 million through the end of 1998 for additional workstation software and hardware, test equipment, design tools and leasehold improvements. See Notes 3 and 4 of Notes to Financial Statements. In April 1998, the Company completed its initial public offering of Class A Common Stock. Of the 4,025,000 shares of Class A Common Stock offered, the Company sold 3,120,000 shares, and selling shareholders sold 905,000 shares, at a price of $24.00 per share. In addition, the Company sold 500,000 shares to Cisco Systems in a concurrent, non-underwritten registered offering at a price of $22.32 per share. The Company received net aggregate proceeds from the initial public offering and the sale of shares to Cisco Systems of approximately $79.2 million in cash (net of underwriting discounts and commissions and estimated offering costs). Approximately $2.3 million of the Company's net proceeds were used to retire all outstanding indebtedness under a term loan in April 1998. The Company believes that the net proceeds from this offering, its initial public offering and sale of shares to Cisco Systems, together with cash generated from its operations will be sufficient to meet the Company's capital requirements for at least the next twelve months. Nonetheless, the Company may elect to sell additional equity securities or to obtain credit facilities. The Company's future capital requirements may vary materially from those now planned and will depend on many factors, including, but not limited to, the levels at which the Company maintains inventory and accounts receivable; the market acceptance of the Company's products; the levels of promotion and advertising required to launch such products and attain a competitive position in the marketplace; volume pricing concessions; the Company's business, product, capital expenditure and research and development plans and technology roadmap; capital improvements to new and existing facilities; technological advances; the response of competitors to the Company's products; and the Company's relationships with suppliers and customers. In addition, the Company may require an increase in the level of working capital to accommodate planned growth, hiring, infrastructure and facility needs, including the Company's recently executed lease of new facilities to centralize all Irvine employees and operations on one campus. Additional capital may be required for consummation of any acquisitions of businesses, products or technologies. To the extent that the funds generated by this offering, together with existing resources and cash generated from operations, are insufficient to fund the Company's future activities, the Company may need to raise additional funds through public or private financings or increased borrowings. No assurance can be given that additional financing will be available or that, if available, such financing can be obtained on terms favorable to the Company and its shareholders. During the second half of 1998, the Company may use approximately $25.0 million to purchase additional capital equipment to support its expanding operations, of which the Company has used approximately $13.0 million as of September 30, 1998. The Company may finance these purchases from the proceeds of this offering, the proceeds of its initial public offering, cash generated from its operations, or a combination thereof. YEAR 2000 The Company is aware of problems associated with computer systems as the year 2000 approaches. Many existing computer systems and applications, and other control devices, use only two digits to identify a year in the date field, without considering the impact of the upcoming change in the century. Others do not correctly process "leap year" dates. As a result, such systems and applications could fail or create erroneous results unless corrected so that they can correctly process data related to the year 2000 and beyond. These problems are expected to increase in frequency and severity as the year 2000 approaches, and are commonly referred to as the "Year 2000 Problem." 26 28 The Company is continuing to assess the impact that the Year 2000 Problem may have on its operations and has identified the following four key areas of its business that may be affected: Products. The Company has evaluated each of its products and believes that each is substantially year 2000 compliant. However, management believes that it is not possible to determine whether all of its customers' products that incorporate the Company's products will be year 2000 compliant because the Company has little or no control over the design, production and testing of its customers' products. Internal Infrastructure. The Year 2000 Problem could affect the systems, transaction processing computer applications and devices used by the Company to operate and monitor all major aspects of its business, including financial systems (such as general ledger, accounts payable and payroll), customer services, infrastructure, materials requirement planning, master production scheduling, networks and telecommunications systems. The Company believes that it has identified substantially all of the major systems, software applications and related equipment used in connection with its internal operations that must be modified or upgraded in order to minimize the possibility of a material disruption to its business. The Company is currently in the process of modifying and upgrading all affected systems and expects to complete this process by the end of 1998. Because most of the software applications used by the Company are recent versions of vendor supported, commercially available products, the Company has not incurred, and does not expect in the future to incur, significant costs to upgrade these applications as year 2000 compliant versions are released by the respective vendors. Third-Party Suppliers. The Company relies, directly and indirectly, on external systems utilized by its suppliers for the management and control of fabrication, assembly and testing of substantially all of the Company's products. The Company has sent questionnaires to the two independent foundries that fabricate substantially all of its semiconductor devices, TSMC and Chartered, and to the two subcontractors that assemble and test substantially all of its products, ASAT and STATS, to identify and, to the extent possible, resolve issues involving the Year 2000 Problem. In addition, certain of the Company's key employees have scheduled on-site visits at the facilities of each of these suppliers in late 1998 to evaluate the systems and remediation efforts employed by each of them. The Company expects to resolve any significant Year 2000 Problems with its suppliers; however, there can be no assurance that these suppliers will resolve any or all Year 2000 Problems with their systems in a timely manner. Any failure of these third parties to resolve their Year 2000 Problems in a timely manner could result in the material disruption to the business of the Company. Any such disruption could have a material adverse effect on the Company's business, financial condition and results of operations. Facility and Laboratory Related Systems. Systems such as heating, sprinklers, elevators, test equipment and security systems at the Company's facilities and labs may also be affected by the Year 2000 Problem. The Company is currently assessing the potential effect of and costs of remediating the Year 2000 Problem on its facility and lab related systems. The Company estimates that the total cost to the Company of completing any required modifications, upgrades or replacements of these systems will not have a material adverse effect on the Company's business or results of operations. The Company presently estimates that the total cost of addressing its year 2000 issues will be approximately $500,000. This estimate was derived utilizing numerous assumptions, including the assumption that the Company has already identified its most significant year 2000 issues and that the plans of its third party suppliers will be fulfilled in a timely manner without cost to the Company. However, there can be no guarantee that these assumptions are accurate, and actual results could differ materially from those anticipated. The Company is currently developing contingency plans to address the year 2000 issues that may pose a significant risk to its on-going operations. Such plans could include accelerated replacement of affected equipment or software, temporary use of back-up equipment or software or the implementation of manual procedures to compensate for system deficiencies. However, there can be no assurance that any contingency plans implemented by the Company would be adequate to meet the Company's needs without materially impacting its operations, that any such plan would be successful or that the Company's results of operations would not be materially and adversely affected by the delays and inefficiencies inherent in conducting operations in an alternative manner. 27 29 BUSINESS Broadcom is a leading developer of highly integrated silicon solutions that enable broadband digital data transmission to the home and within the business enterprise. The Company's products enable the high-speed transmission of data over existing communications infrastructures, most of which were not originally intended for digital data transmission. Using proprietary technologies and advanced design methodologies, the Company has designed and developed ICs for some of the most significant broadband communications markets, including the markets for cable set-top boxes, cable modems, high-speed networking, DBS and terrestrial digital broadcast, and xDSL. Although the communications infrastructures of these markets are very different, the Company has leveraged its core technologies and introduced silicon solutions for each market that deliver the cost and performance levels necessary to enable the widespread deployment of broadband transmission services. The Company's broadband transmission products consist primarily of high-performance digital signal processing ("DSP") circuits that implement complex communications algorithms, surrounded by precision high-speed analog-to-digital and digital-to-analog converter circuits. The Company's products integrate comprehensive systems solutions into single chips or chip-sets, thereby eliminating costly external components, reducing board space, simplifying the customer's manufacturing process, lowering the customer's system costs and enabling higher performance. Customers currently shipping broadband communications equipment incorporating the Company's products include 3Com, Bay Networks, Cisco Systems, General Instrument, Motorola and Scientific-Atlanta. INDUSTRY BACKGROUND In recent years, there has been a dramatic increase in business and consumer demand for high-speed access to multimedia information and entertainment content, consisting of data, voice and video. This demand is being driven by the growth of desirable information and entertainment content accessible via the Internet and cable and data networks. Demand has also been stimulated by the improved availability and affordability of access devices such as set-top boxes, PCs and other consumer appliances. Computer processor speeds over the last decade have increased dramatically and, as a result, significantly improved the rate at which multimedia data can be processed. However, the rate at which such data can be transmitted has not kept pace. This disparity has become known as the "bandwidth gap" and has frustrated users and challenged solutions providers in a number of markets. The bandwidth gap has emerged in a variety of commercial and consumer applications. Businesses are constantly seeking new ways to access and analyze larger amounts of information to improve the quality of management decisions and enhance customer and employee communications. Many businesses have deployed local area networks ("LANs") which are principally based upon 10Base-T Ethernet technology. The proliferation of LAN usage within corporate networks has resulted in volumes of electronic traffic that are rapidly outgrowing the ability of legacy LAN technologies and infrastructures to readily transmit the traffic and has exacerbated the bandwidth gap for businesses. As such, much of the installed base of Ethernet ports will require upgrading to higher speeds as the infrastructure continues to grow. Individuals are also increasingly using their home PCs to access the Internet and to telecommute. Consumer online usage is expected to increase rapidly with the availability and market acceptance of low cost PCs (sub $1,000) and the increased availability and improving quality of content. In addition, the increasing number of next generation television set-top boxes, PCs and other devices that feature integrated Internet access will contribute to the surging demand for rapid access to information. International Data Corporation ("IDC") estimates that between 1995 and 1997 the number of devices that had access to the Internet grew from approximately 15.4 million to 64.4 million and anticipates that the number of such devices will grow to over 331.3 million by 2001. Similarly, the available content on the Internet is also increasing rapidly. IDC estimates that the number of web pages for Internet devices to access grew from approximately 18.1 million in 1995 to approximately 250.5 million in 1997, and is expected to increase to 4.4 billion by 2001. As the volume of traffic continues to grow, consumers are becoming increasingly frustrated with the low performance of "last mile" remote access connections that are typically limited to data rates of only 28.8 kbps to 56 kbps and require several minutes or hours to download large multimedia intensive files. 28 30 Business and residential PC users have not been the only ones affected by the bandwidth gap. Cable television subscribers seeking more entertainment options including Internet access, and cable service providers seeking higher revenue services beyond basic cable, have generally been frustrated by the limited amount of programming that can be provided over the existing cable infrastructure, as well as the inability of that infrastructure to deliver interactive multimedia content. With the advent of digital television and digital compression technologies such as MPEG, the conversion from analog transmission to digital transmission enables a dramatic increase in the number of channels available to the subscriber. In late 1996, cable television service providers began offering expanded services, including digital programming through new digital set-top boxes as well as high-speed Internet access and telecommuting through cable modems. Dataquest estimates that approximately 3.2 million digital cable set-top boxes will be shipped worldwide in 1998 and that approximately 14.3 million will be shipped in 2002. In order to satisfy customer demand for increased programming and other entertainment options, and to capitalize on the revenue growth opportunities associated with these expanded services, service providers will have to deploy a new generation of digital set- top boxes and headend equipment. Much of the bandwidth gap is a result of the existing last mile communications infrastructure, which was originally designed for lower speed analog transmission rather than high-speed digital transmission. This infrastructure consists primarily of copper twisted pair wiring, coaxial cable and wireless communication connections. Copper twisted pair wiring was originally intended for the transmission of narrowband analog voice while coaxial cable was intended for delivery of one-way analog video signals. These analog infrastructures have numerous impairments, including limited spectrum, noise, dispersion and multipath reflections, which make broadband transmission (greater than 1.5 Mbps) of digital data very difficult. Because it is impractical to replace these communications infrastructures with entirely new infrastructures that are optimized for digital data transmission, the fundamental challenge for service and equipment providers is to enable broadband communications over existing infrastructures. These providers are in a race to introduce new cost-effective technologies and products into the broadband communications marketplace. The principal segments that define this marketplace include: Cable Set-Top Boxes. Cable operators are deploying digital cable set-top boxes to facilitate high-speed digital communications between a subscriber's television and the cable network. Cable set-top boxes are currently able to support downstream (to the subscriber) transmission speeds of up to 43 Mbps (North American standard) or 56 Mbps (international standard), and several hundred MPEG-2 compressed digital television channels to be delivered to the consumer. Additional applications for digital cable set-top boxes are expected to include Internet access, interactive television, high definition television ("HDTV") and cable telephony. Cable Modems. Cable modems connect PCs to the cable network and have been designed to achieve downstream transmission speeds of up to 43 Mbps (North American standard) or 56 Mbps (international standard), and upstream (to the network) transmission speeds of up to 10 Mbps. These transmission rates are almost 1,000 times faster than the fastest analog telephone modems (56 kbps downstream and 28.8 kbps upstream) currently available. The high speeds of cable modems should enable an entirely new generation of multimedia-rich content over the Internet, make telecommuting a productive and effective means for work at home and allow cable operators to offer expanded services such as cable telephony. High-Speed Networking. As communications bottlenecks have appeared in corporate LANs, technologies such as Fast Ethernet (100 Mbps) and Gigabit Ethernet (1,000 Mbps) are being employed to replace older technologies such as 10Base-T Ethernet (10 Mbps) and Token Ring (16 Mbps). As desktop connections continue to migrate to Fast Ethernet, the Company believes that Gigabit Ethernet will emerge as the predominant backbone and server communications technology, and will eventually migrate to the desktop. Direct Broadcast Satellite and Terrestrial Digital Broadcast. DBS is the primary alternative to cable for providing digital television programming and can be used to transmit information at speeds of up to 90 Mbps. DBS broadcasts video and audio data from satellites directly to set-top boxes in the home via 29 31 dish antennas. Other broadband wireless technologies include (i) terrestrial digital broadcast television, the upgrade of analog broadcast television to digital which enables the delivery of HDTV, (ii) Multichannel Multipoint Distribution Systems ("MMDS"), which use microwave frequencies (2.5 GHz) to transmit digital video signals over terrestrial digital broadcast channels to digital set-top boxes, and (iii) Local Multipoint Distribution Systems ("LMDS"), which use even higher microwave frequencies (28 to 38 GHz) to transmit video and data to digital set-top boxes over a shorter distance via a cellular-like network. Digital Subscriber Lines (xDSL). xDSL represents a family of newer broadband technologies which use the copper twisted pair wiring in the existing telephone local loops to deliver transmission speeds ranging from 128 kbps to 52 Mbps depending on the distance between the central office and the subscriber. These data rates are expected to enable a wide range of new services including high-speed Internet access and digital television. The desire by equipment manufacturers and service providers to develop these markets has created the need for new generations of semiconductor solutions. Broadband transmission of digital information over existing infrastructures requires highly integrated mixed-signal semiconductor solutions to perform critical systems functions such as complex signal processing and converting digital data to and from analog signals. Broadband communications equipment requires substantially higher levels of system performance in terms of both speed and precision that typically cannot be adequately addressed by traditional IC solutions developed for low speed transmission applications. Moreover, solutions that are based on multiple discrete analog and digital ICs generally cannot achieve the cost-effectiveness, performance and reliability required by the broadband communications markets. These requirements are best addressed by new generations of highly integrated mixed-signal devices that combine complex analog and digital functions with high performance DSP circuitry that can be manufactured in high volumes using cost-effective semiconductor technologies. THE BROADCOM SOLUTION The Company is a leading developer of highly integrated silicon solutions that enable broadband digital data transmission to the home and within the business enterprise. Using its proprietary communications algorithms and protocols, unique DSP architectures, silicon compiler design methodologies and full-custom, mixed-signal circuit design techniques, the Company has designed and developed ICs for some of the most significant broadband communications markets, which include cable set-top boxes, cable modems, high-speed networking, DBS and terrestrial digital broadcast, and xDSL. The Company's expertise in communications algorithms and its detailed understanding of transmission media enable the implementation of complex systems incorporating signal processing functions such as digital demodulation, adaptive equalization and error correction in a single device. In addition, the Company's comprehensive knowledge of advanced communications protocols enables the Company to design protocol processing ICs that seamlessly interface its mixed-signal transceiver ICs with higher-level networking layers for communications applications. Finally, the Company's systems level communications expertise has enabled it to establish a viable long-term product roadmap that permits its customers to achieve rapid time-to-market over multiple generations of equipment. All of the Company's products are implemented in low-cost, highly-manufacturable CMOS technologies that enable the integration of comprehensive systems solutions into single-chip ICs, thereby eliminating costly external components, reducing board space, simplifying the customer's equipment manufacturing process, lowering customer system costs and enabling higher performance. The Company's proprietary technology and advanced design methodologies result in a high likelihood of first pass silicon success, accelerated time-to-market, and ease of porting to multiple foundries. The Company's design methodologies also allow it to rapidly and cost-effectively incorporate proprietary features or intellectual property from its key strategic customers into products that are exclusive to those customers, thereby enabling them to differentiate their products. Customers currently shipping broadband communications equipment that incorporates the Company's products include 3Com, Bay Networks, Cisco Systems, General Instrument, Motorola and Scientific-Atlanta. 30 32 STRATEGY The Company's objective is to be the leading provider of highly integrated silicon solutions to the worldwide broadband communications markets. Key elements of the Company's strategy include the following: Target Multiple High-Growth Broadband Communications Markets. The Company's strategy is to identify rapidly growing broadband digital communications markets and to develop highly integrated silicon solutions for applications in those markets. The Company's initial products were designed for the cable set-top box, cable modem and high-speed networking markets, which require high-performance, feature-rich and highly integrated semiconductor solutions. The Company has recently leveraged the core technologies it developed for these markets to design and develop semiconductor solutions for the DBS and terrestrial digital broadcast, and xDSL markets, which it believes have significant growth potential. Strengthen and Expand Strategic Relationships with Industry Leaders. The Company has established strategic relationships with key equipment manufacturers, including 3Com, Bay Networks, Cisco Systems, General Instrument, Motorola and Scientific-Atlanta, which are market and technology leaders within the broadband communications markets. While the Company designs products that can be used by multiple customers, the Company's proprietary design methodologies allow it to rapidly design custom features based on either the Company's or its customers' intellectual property. This capability enables the Company's customers to improve their time-to-market, differentiate their products and address new market opportunities. The Company believes that these strategic relationships are essential to its continued growth and to further development and acceptance of its technologies. Extend Technology Leadership and Achieve Rapid Time-to-Market. The Company is aggressively building on its technology leadership by investing substantial development resources in all of its key technology areas. The Company works closely with leading communications systems companies to develop new and enhanced algorithms that address next generation broadband market opportunities. The Company's strategy is to continue to implement these algorithms in highly integrated, full-custom ICs using DSP architectures that optimize performance, efficiency and cost. During product development, the Company leverages its silicon compiler technologies and proprietary circuit libraries and layouts of high- performance analog and digital IC building blocks, thereby accelerating time-to-market for new products. The silicon solutions for each of these markets benefit from the same underlying core technologies, providing the Company significant leverage in its ability to address a diverse set of end user markets with a relatively focused investment in research and development. Drive Industry Standards. The Company participates actively in the formulation of critical standards for the broadband communications markets. The Company believes such participation provides it with several significant benefits, including (i) accelerating and expanding the development of markets for the Company's products by encouraging all market participants to focus their efforts on developing products compliant with the standards, and (ii) providing valuable insight and relationships, which assist the Company in being early to market with products incorporating the standards. The Company has established strategic relationships with major networking equipment and cable modem vendors and was a principal participant in formulating and writing the Multimedia Cable Network Systems Data Over Cable Services Interface Specifications ("MCNS/DOCSIS") for the end-to-end delivery of high-speed data services over hybrid fiber coax ("HFC") networks, which facilitate the development of interoperable networking products, including cable modems. The Company's active participation in this process enabled it to be the first provider of transmission and protocol ICs to equipment manufacturers developing MCNS/DOCSIS compliant products. The Company is also currently participating in the formulation and evolution of standards for Fast Ethernet, Gigabit Ethernet and xDSL systems. Focus on Highly Integrated Solutions. The Company believes its analog mixed-signal technology and advanced design methodologies enable it to offer silicon solutions that are more highly integrated than competitive alternatives. High levels of integration and aggressive product development roadmaps allow the Company to enhance the value-added benefits of its products in its customers' systems. Integration, which reduces the total component count in the system, provides many fundamental benefits for the 31 33 Company's customers, including streamlining their production flow, improving yields, saving board space, shortening time-to-market, reducing production costs and improving performance and reliability. These benefits have often enabled the Company's customers to achieve faster and broader penetration within their respective markets. MARKETS The increased demand for the high-speed delivery of data and video services is forcing equipment vendors and service providers to race to provide solutions to close the bandwidth gap. The Company's silicon solutions address the bandwidth gap in multiple communications markets. While the communication infrastructures of these markets are very different, the Company has been able to leverage many of its core technologies across multiple markets in various product implementations. Many industry analysts project high growth rates for the markets served by the Company's products even though such markets are at different phases in their evolution. High-speed networking is an established market that is currently going through an upgrade; cable and DBS set-top boxes are, on a global basis, in an early growth phase, and the cable modem and xDSL markets are emerging. Cable Set-Top Boxes The last decade has seen rapid growth in the quantity and diversity in television programming. Despite ongoing efforts to upgrade the existing cable infrastructure, an inadequate number of channels exist to provide the content demanded by consumers. In an effort to increase the number of channels and to provide picture quality that is comparable to DBS, cable service providers began offering digital programming in 1996 through new digital cable set-top boxes. Paul Kagan Associates, Inc. ("Kagan") estimates that in 1998 only 1.1 million of the 65 million cable subscribing homes in the United States will install digital cable set-top boxes. Dataquest estimates that approximately 3.2 million digital cable set-top boxes will be shipped worldwide in 1998, and that approximately 14.3 million will be shipped in 2002. General Instrument, in particular, recently announced its agreement to provide leading multiple cable system operators with an aggregate of 15 million digital cable set-top boxes over the next three to five years. The Company believes a new generation of digital cable set-top boxes will be introduced in the near future to facilitate television Internet access and to support HDTV. Cable Modems Cable television operators are upgrading their coaxial cable trunk systems (backbones) to fiber to create HFC networks. These upgraded networks are able to support two-way communications, high-speed Internet access and telecommuting through the use of a cable modem. High-speed Internet access services, including @Home, RoadRunner and HighwayOne (the predecessor to MediaOne), were introduced in 1996 in conjunction with several cable system operators. Kagan estimates that high-speed Internet service was available to 9.5 million homes in 1997 and predicts that this service will be extended to 51.8 million homes in the United States by 2002. Forrester Research, Inc. estimates that the number of cable modems subscribers in the United States will increase from 100,000 in 1997 to 13.6 million by 2001. The cable industry's adoption of the MCNS/DOCSIS specifications in 1997 for the end-to-end delivery of high-speed data services is anticipated to enable interoperability between different manufacturers' cable modems and headend equipment across different cable networks. This interoperability should facilitate the creation of a retail market for cable modems. High-Speed Networking The high-speed networking equipment market is undergoing a rapid transition from 10Base-T Ethernet to Fast Ethernet (100Base-T) transceivers, with Gigabit Ethernet (1000Base-T) anticipated to be introduced in 1998. Dell'Oro Group estimates that the number of 100Base-T repeater/hub ports sold worldwide is expected to grow from 5.0 million in 1997 to 49.5 million by 2001, and the number of switch ports is expected to grow from 5.3 million to 133.7 million during the same period. Dataquest predicts the number of 100Base-T network interface cards ("NIC") sold worldwide will grow from 20.0 million units in 1997 to 48.4 million units by 2001. As the networking market transitions to Fast Ethernet and Gigabit Ethernet, it is anticipated 32 34 that a significant portion of the installed base of 10Base-T repeater/hub ports, switches and NICs will be upgraded to the faster technologies. Direct Broadcast Satellite and Terrestrial Digital Broadcast Due to the ability of DBS to provide television programming where no cable infrastructure is in place, it is expected that the U.S. market for DBS may eventually be surpassed by the international market where the cable infrastructure is generally less extensive. Dataquest estimates that approximately 6.3 million digital satellite set-top boxes were shipped worldwide in 1997 and that approximately 22.3 million will be shipped in 2002. Other wireless offerings such as MMDS and LMDS are currently being tested in limited deployments. These new networks, which are able to provide programming in areas that do not have cable, will also require a digital set-top box. Beginning in 1999, the FCC has mandated that the top four affiliated television stations begin digital broadcasting and has required that all current television broadcasters and their affiliates return the old analog spectrum by the year 2006 for FCC auction. ABC, CBS and NBC have announced that they will begin transmitting HDTV before the end of 1998. This conversion to digital broadcasting will also require new set-top boxes and television receivers. Digital Subscriber Lines (xDSL) xDSL is a family of technologies for high-speed data transmission over existing copper twisted pair wiring in the telephone local loops. Several Regional Bell Operating Companies ("RBOCs"), including Southwestern Bell, Bell Atlantic, Bell South and U S West, and several international telephone companies, including Bell Canada, British Telecom and Deutsche Telekom, have conducted field trials, deployed or announced plans to conduct trials or deploy xDSL services in select markets for high-speed Internet access and telecommuting. Certain Internet service providers are also embracing xDSL technologies. In January 1998, Compaq, Intel, Microsoft and several RBOCs announced they would coordinate their efforts to create an interoperable xDSL standard for 1.5 Mbps transmission. Dataquest estimates that the number of xDSL lines in North America will increase from 47,800 in 1998 to 3.1 million in 2002. Asymmetric DSL ("ADSL"), which can provide transmission at speeds of up to 8 Mbps, and Very-high-bit-rate DSL ("VDSL"), which can provide transmission at speeds of up to 52 Mbps, represent the xDSL technologies that have recently attracted the most interest from the service providers. 33 35 CUSTOMERS AND STRATEGIC RELATIONSHIPS The Company sells its products to leading manufacturers of data communications equipment in each of the Company's target markets. Because the Company leverages its technology across different markets, certain of the Company's ICs may be incorporated into equipment used in several different markets. Equipment manufacturers from which the Company recognized aggregate revenue of at least $100,000 in 1998 included, among others:
- ---------------------------------------------------------------------------------------------- MARKETS CUSTOMERS - ---------------------------------------------------------------------------------------------- Cable Set-Top Boxes General Instrument Italtel Scientific-Atlanta - ---------------------------------------------------------------------------------------------- Cable Modems 3Com Bay Networks Cisco Systems Com21 General Instrument Hybrid Networks Intel Motorola Samsung - ---------------------------------------------------------------------------------------------- High-Speed Networking 3Com Accton Technology Adaptec Bay Networks Cabletron Cisco Systems Digital Equipment Corporation D-Link Hewlett-Packard Run Top Samsung - ---------------------------------------------------------------------------------------------- DBS and Terrestrial Digital Broadcast Access Media DIRECTV Italtel Samsung - ---------------------------------------------------------------------------------------------- xDSL Next Level Communications Nortel - ----------------------------------------------------------------------------------------------
As part of its business strategy, the Company periodically establishes strategic relationships with certain key customers. In September 1997, the Company entered into a Development, Supply and License Agreement with General Instrument, pursuant to which the Company agreed to develop ICs for General Instrument's digital cable set-top boxes and supply such ICs to General Instrument for four years. Pursuant to this agreement, General Instrument agreed to purchase from the Company 100% of its requirements for components containing transmission, communications or video decompression (MPEG) functions for its digital cable set-top box subscriber products in the first year of this agreement, subject to the Company's good faith efforts to maintain its competitive position with respect to such components. The percentage of its product requirements that General Instrument must purchase from the Company declines each year over the term of the agreement to 45% of General Instrument's requirements in 2001. General Instrument also granted the Company a royalty-bearing, perpetual, nonexclusive, worldwide license to use its MPEG and related technology. 34 36 From time to time, the Company has also entered into development agreements with 3Com, Cisco Systems, Nortel, Sony, Bay Networks and DirecTV, pursuant to which the Company has worked closely with these customers to co-develop products for these customers. A small number of customers have historically accounted for a substantial portion of the Company's total revenue. Sales to General Instrument and 3Com (including sales to their respective manufacturing subcontractors) accounted for approximately 31.9% and 14.6%, respectively, of the Company's total revenue in 1997. Sales to General Instrument and 3Com (including sales to their respective manufacturing subcontractors) represented approximately 31.8% and 35.9%, respectively, of the Company's total revenue in the six months ended June 30, 1998. Sales to the Company's five largest customers represented approximately 61.7% and 71.5% of the Company's total revenue in 1997 and the fourth quarter of 1997, respectively. The loss of any key customer could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Customer Concentration." PRODUCTS The Company's five primary product lines encompass: (i) high-speed communications and MPEG video/audio/graphics devices for the cable television set-top box market, (ii) high-speed data transmission and media access control devices for the cable modem market, (iii) 10/100/1000Base-T Ethernet transceivers and repeater controllers for the high-speed networking market, (iv) receivers and MPEG video/audio/graphics devices for the DBS and terrestrial digital broadcast markets, and (v) broadband twisted pair transceivers for the xDSL market. The Company also develops and sells reference platforms designed around its IC products that represent application examples for incorporation into its customers' equipment. By providing these reference platforms, the Company can assist its customers in achieving easier and faster transitions from initial prototype designs through final production releases. These reference platforms significantly enhance the customer's confidence that the Company's products will meet their market requirements and product introduction schedules. Cable Set-Top Boxes The Company offers a suite of silicon solutions for digital cable set-top boxes and cable headends which encompass the high-speed transmission, reception and decompression of digital audio and video multimedia signals. These products are also applicable to the terrestrial digital broadcast markets. The Company's QAMLink transmission products integrate the core functionality required of advanced communications transceiver devices including modulators and demodulators for quadrature amplitude modulation ("QAM") and quadrature phase shift keying ("QPSK"), adaptive equalization, forward error correction and high-speed analog-to-digital and digital-to-analog conversion. These products have been designed to meet both international and North American communications standards for cable networks. Several of these products also incorporate additional set-top box functionality such as cable network protocol processing for entitlement and tiered programming access and input/output device control. The Company introduced its first single-chip MPEG multimedia device in the second quarter of 1998 that incorporates all of the processing capabilities necessary to decode and decompress an MPEG-2 digital television data stream and subsequently reconstruct an analog studio quality television signal that can be displayed on a standard television receiver. This IC integrates MPEG-2 video decompression, Dolby AC3 audio decompression, MPEG-2 transport processing, on-screen display, analog video reconstruction and other necessary MPEG related functions required to deliver video and audio to a television. The Company believes this combination of the Company's transmission and MPEG silicon solutions and licensed MIPS microprocessor cores will provide all of the significant silicon functionality of most existing digital cable set-top boxes with the exception of the security functions and memory. Cable Modems The Company has leveraged its core transmission technologies that were developed for the cable set-top box market and adapted them to the development of a family of products that enable digital data to be 35 37 delivered over an HFC cable network at downstream speeds of up to 56 Mbps and upstream speeds of up to 10 Mbps. These products incorporate similar modulation, adaptive equalization and error correction technologies as the set-top box products and thereby achieve robust and reliable transmission, especially in the noisy and interference prone upstream direction. The cable modem product family also includes both a headend and a subscriber media access controller ("MAC") device that controls the upstream and downstream data flow over the HFC network. In September 1998, the Company introduced the BCM3300, which integrates the upstream and downstream physical layers with the MCNS/DOCSIS MAC functions. This device allows cable modems to provide telephony over the cable network using the Internet Protocol ("IP"). The Company's cable modem products have been designed to conform to the MCNS/DOCSIS specifications. The combination of the transmission and MAC ICs provides a complete end-to-end silicon platform for the Company's customers to build headend systems and subscriber modems. With the integration of the MIPS microprocessor cores, the Company believes it has all of the silicon functionality necessary to eventually reduce the cable data modem into a single chip with the exception of the memory. The Company's principal products for cable set-top boxes and cable modems include the following:
- ------------------------------------------------------------------------------------------- PRODUCT FUNCTION INTRODUCTION DATE - ------------------------------------------------------------------------------------------- BCM3033 Universal headend QAM modulator First Quarter 1997 - ------------------------------------------------------------------------------------------- BCM3036 Universal QPSK/QAM burst modulator. Fourth Quarter 1996 - ------------------------------------------------------------------------------------------- BCM3037 Universal QPSK/QAM burst modulator for MCNS/DOCSIS Fourth Quarter 1997 applications - ------------------------------------------------------------------------------------------- BCM3115 Downstream QAM receiver for North American set-top box Fourth Quarter 1995 applications. Includes QPSK control channel receiver. - ------------------------------------------------------------------------------------------- BCM3116 Downstream QAM receiver for North American set-top box Fourth Quarter 1997 and MCNS/DOCSIS applications. - ------------------------------------------------------------------------------------------- BCM3118 Downstream QAM receiver for international applications. Fourth Quarter 1996 - ------------------------------------------------------------------------------------------- BCM3120 Universal set-top box transceiver for both North Second Quarter 1998 American and international applications. Includes QAM receiver, QPSK control channel receiver, peripheral device interfaces and QPSK/QAM transmitter. - ------------------------------------------------------------------------------------------- BCM3137 Headend QPSK/QAM burst receiver for MCNS/DOCSIS Second Quarter 1998 applications. - ------------------------------------------------------------------------------------------- BCM3210 Headend MCNS/DOCSIS MAC for downstream and upstream Second Quarter 1998 traffic flow. Includes data encryption and decryption. - ------------------------------------------------------------------------------------------- BCM3220 Subscriber MCNS/DOCSIS cable modem MAC for downstream Fourth Quarter 1997 and upstream traffic flow. Includes data encryption and decryption. - ------------------------------------------------------------------------------------------- BCM3300 Single chip MCNS/DOCSIS cable modem. Includes receiver, Third Quarter 1998 transmitter and MAC. - ------------------------------------------------------------------------------------------- BCM3900 Downstream QAM receiver for North American set-top box First Quarter 1997 applications. Includes QPSK control channel receiver and peripheral device interfaces. - ------------------------------------------------------------------------------------------- BCM7010 MPEG system on a chip. Integrates MPEG-2 video Second Quarter 1998 decompression, Dolby AC3 audio decompression, MPEG transport, on-screen display, analog video reconstruction and other MPEG related functions for delivering video and audio to a television. - -------------------------------------------------------------------------------------------
36 38 High-Speed Networking The Company's networking products provide the core functionality required for building Fast Ethernet adapter cards, repeater/hubs and switches which support both the Ethernet (10Base-T) and Fast Ethernet (100Base-T) standards. The Company's transceivers, which are the basic elements required for implementing a high-speed Ethernet port, incorporate the Company's embedded DSP algorithms combined with high-speed analog-to-digital and digital-to-analog converters to create highly-integrated mixed-signal solutions. In addition to the DSP-based architecture, features of the 10/100Base-T transceiver products include low power and low voltage operation (3.3 Volts) making them suitable for high port density switches and hubs, as well as PCI2.2 compliant adapter cards and computer motherboards. The Company also offers a variety of repeater and switch controller devices, thereby providing a broad suite of Fast Ethernet products to meet the demands of the adapter card, repeater/hub, switch, network peripheral and router markets. The Company's principal networking products include the following:
- ------------------------------------------------------------------------------------------- PRODUCT FUNCTION INTRODUCTION DATE - ------------------------------------------------------------------------------------------- BCM5012 100Base-T managed repeater controller. Incorporates Fourth Quarter 1995 13 repeater ports, MAC port, microprocessor port, and a port for stacking hubs. Interfaces to external transceivers. - ------------------------------------------------------------------------------------------- BCM5020 100Base-T network management processor. Second Quarter 1997 Incorporates statistical analysis of network traffic to enable control of repeating hubs by network management software. - ------------------------------------------------------------------------------------------- BCM5100 Single-channel 10/100Base-T4 transceiver. Fourth Quarter 1996 Incorporates a 10Base-T and 100Base-T4 transceiver for Category 3, 4 and 5 twisted pair cabling. - ------------------------------------------------------------------------------------------- BCM5201/5202 Single-channel 3.3/5 Volt 10/100Base-TX First Quarter 1998 transceiver. Incorporates a 10Base-T and 100Base-TX transceiver for Category 5 twisted pair cabling. - ------------------------------------------------------------------------------------------- BCM5203 Quad 100Base-TX transceiver. Contains four Second Quarter 1997 100Base-TX Fast Ethernet transceivers. - ------------------------------------------------------------------------------------------- BCM5205 Quad 100Base-TX integrated repeater. Incorporates Second Quarter 1997 four 100Base-TX transceivers, MII port, repeater controller and repeater management functions. - ------------------------------------------------------------------------------------------- BCM5208 Quad 10/100Base-T transceiver. Integrates four Third Quarter 1997 10Base-T/ 100Base-TX transceivers. 100Base-FX is also supported at each port through an external fiber optic transceiver. - ------------------------------------------------------------------------------------------- BCM5216 Hex 10/100Base-T transceiver. Integrates six 10 Third Quarter 1998 Base-T/ 100Base-TX transceivers. - ------------------------------------------------------------------------------------------- BCM5308 Nine port 10/100Base-T switch. Integrates eight Fourth Quarter 1998* 10/100 Base-TX transceivers, nine MACs and switching fabric. - ------------------------------------------------------------------------------------------- BCM5903 Single chip 10/100Base-T transceiver with Second Quarter 1998 integrated MAC - -------------------------------------------------------------------------------------------
- --------------- * Estimated date of initial commercial sampling. Direct Broadcast Satellite and Terrestrial Digital Broadcast The Company's products for the DBS market are designed to meet the needs of satellite set-top box providers and incorporate the functionality necessary to receive, demodulate and decode a broadband QPSK signal, including advanced forward error correction. These products can be programmed to accommodate satellite standards such as DSS (DIRECTV), DVB (international) and Primestar, and can operate at any 37 39 data rate from 2 to 90 Mbps. The Company's MPEG system on a chip (BCM7010) will employ the MPEG-2 standard, which enables it to be used in either cable set-top boxes or DBS set-top boxes. The Company's principal DBS and terrestrial digital broadcast products include the following:
- ------------------------------------------------------------------------------------------- PRODUCT FUNCTION INTRODUCTION DATE - ------------------------------------------------------------------------------------------- BCM4200 QPSK receiver for DSS (DIRECTV) and DVB (international) First Quarter 1997 digital satellite reception. Accommodates data rates from 2 to 90 Mbps. - ------------------------------------------------------------------------------------------- BCM4201 Universal QPSK receiver for DSS, DVB and Primestar Third Quarter 1998 digital satellite reception. Accommodates data rates from 2 to 90 Mbps. - ------------------------------------------------------------------------------------------- BCM7010 MPEG system on a chip. Integrates MPEG-2 video Second Quarter 1998 decompression, Dolby AC3 audio decompression, MPEG transport, on-screen display, analog video reconstruction and other MPEG related functions for delivering video and audio to a television. - -------------------------------------------------------------------------------------------
Digital Subscriber Lines (xDSL) The Company's product for xDSL transmission incorporates the functionality to enable data to be transmitted and received at high speed over the existing copper twisted pair wiring in the telephone local loops. The Company believes it currently offers the industry's only single-chip silicon solution that can be configured to operate at data rates spanning ISDN (128 kbps) to VDSL (52 Mbps), thereby accommodating the needs of a wide variety of xDSL market segments in a single IC. This solution offers network operators the ability to initially install high-speed ADSL data services on the existing local loop plant and subsequently offer higher data rates for video related services on an upgraded plant. The Company has leveraged its mixed-signal and digital signal processing design expertise developed for cable television and wireless products to develop the following QAM transceiver product for the xDSL market.
- ------------------------------------------------------------------------------------------- PRODUCT FUNCTION INTRODUCTION DATE - ------------------------------------------------------------------------------------------- BCM6010 Scalable xDSL QAM transceiver for twisted-pair Third Quarter 1997 applications. Incorporates ATM Utopia interface and programmable rate transmitter and receiver. Can accommodate data rates from 128 kbps to 52 Mbps in either a symmetric or asymmetric configuration. - -------------------------------------------------------------------------------------------
The Company's future success will depend upon its ability to develop new silicon solutions for existing and new markets, introduce such products in a timely and cost-effective manner, and achieve design wins. There can be no assurance that the Company will be able to develop or introduce new products in a timely and cost-effective manner or in sufficient quantities to meet customer demand or that such products will satisfy customer requirements or achieve market acceptance. See "Risk Factors -- Dependence on Development of New Products." CORE TECHNOLOGIES The Company believes that one of its key competitive advantages is its broad base of core technologies encompassing the complete design space from systems to silicon. The Company has developed and continues to build on four primary technology foundations: (i) proprietary communications systems algorithms and protocols, (ii) advanced DSP hardware architectures, (iii) silicon compiler design methodologies and advanced cell library development for both standard cell and full-custom IC design, and (iv) high performance analog and mixed-signal circuit design using industry standard CMOS processes. 38 40 Communications Algorithms and Protocols The Company was an innovator in integrating a high-speed QAM digital demodulator with adaptive equalization and forward error correction into a single IC. In addition, the Company has continued to make system advances in the areas of FEC, QAM and QPSK modulation and demodulation, variable rate transmitters and receivers, digital clock and carrier recovery techniques and adaptive equalization algorithms. The Company has also designed and deployed fully integrated, DSP-based transceiver chips for Fast Ethernet LAN applications. The Company has developed a compact core transceiver module that employs high performance 125 MBaud digital equalizers and high-speed analog-to-digital converters and clock recovery circuits. This core module has been used in a number of the Company's single channel and quad transceiver products for Fast Ethernet (100Base-TX) applications including NICs, switches and repeaters. This DSP transceiver expertise is now being extended and applied to the development of a Gigabit copper twisted pair transceiver. In addition to data transmission algorithms, the Company has developed significant expertise in networking protocols which it has applied to the development of MAC devices for cable modems and interactive set-top box applications as well as repeaters/hub, switch and MAC controllers for Fast Ethernet applications. The Company has introduced the industry's first MCNS/DOCSIS physical layer and MAC ICs for cable modems. Digital Signal Processing Hardware Architectures The Company has developed cost-effective, single-chip broadband transceivers by mapping complex communications algorithms into low-complexity DSP hardware architectures. The Company is a technology leader in the area of low-complexity, high-performance "silicon embedded algorithms" whereby the communications algorithms are individually implemented in full-custom logic rather than the conventional approach of running all of the algorithms in firmware on a single general purpose programmable DSP architecture. This design approach is combined with silicon compiler based design methodologies which generate the custom logic functions. This results in ICs that are less complex and less expensive to manufacture than conventional implementations. One particular area where the Company has developed leading DSP technology is in digital adaptive equalization. Equalizers are key components in all of the Company's transceiver products. The Company believes that the speed and density of its equalizers help to distinguish its products in the marketplace. The Company is currently developing a single-chip, mixed-signal adaptive DSP transceiver for Gigabit Ethernet, which the Company expects will perform in excess of 100 billion operations per second. Silicon Compiler Design Methodologies The Company has developed proprietary silicon compiler technologies that enable designers to implement ICs using a high level of abstraction yet produce area-efficient IC layouts and achieve short design cycles. The cells that are synthesized from this process can be individually optimized for functionality, performance, topology, electrical characteristics and manufacturing process portability. The Company has designed compilers for standard cells, arithmetic processing, memories and analog building blocks. In addition, the Company has created compilers to manage the implementation of higher level functions such as digital filters, adaptive equalizers, modulators, demodulators and numerically controlled oscillators/direct digital frequency synthesizers. The Company believes that these silicon compiler capabilities accelerate time-to-market by improving designer productivity and by providing functional blocks that can be reused in multiple products. In addition, these compiler techniques significantly reduce errors, thereby frequently resulting in first pass silicon success. The Company has also developed, and continues to improve and expand its own proprietary set of circuit and layout libraries for both standard-cell and full-custom ICs. Full-Custom Analog and Mixed-Signal Circuit Design The Company has developed significant analog and mixed-signal circuit expertise. The Company has achieved a level of circuit performance in standard CMOS process technologies that is normally associated with more expensive special purpose silicon fabrication technologies. All of the Company's high-performance analog building blocks are implemented in the same low-cost CMOS technologies as the digital IC circuitry. In addition to achieving very high performance, the Company's analog-to-digital and digital-to-analog 39 41 converters are among the lowest die area devices in the industry, which makes them well suited for integration into high volume mixed-signal products. The Company's 10-bit, 50 Msample/sec analog-to-digital converter received the Best Paper Award of the 1997 International Solid State Circuits Conference, a prestigious semiconductor conference. This converter was integrated onto the same die as the Company's broadband QAM receiver, which the Company believes was the first such mixed-signal QAM receiver product ever demonstrated (BCM3118). The Company has also developed very high-speed 125 MHz analog-to-digital converters for Fast Ethernet transceivers and 200 MHz digital-to-analog converters for cable modulator applications. All of these data converters were designed for integration with high-speed digital circuits in conventional CMOS technologies. The Company has also evaluated experimental IC designs and is in the development phase of producing other analog functions such as low noise RF amplifiers, linear high-gain RF amplifiers, RF mixers, frequency synthesizers, RF phase-locked loops and other building blocks to enable higher levels of system integration. RESEARCH AND DEVELOPMENT The Company has assembled a core team of experienced engineers and technologists, many of whom are leaders in their particular field or discipline. As of June 30, 1998, approximately 73% of the Company's 233 research and development engineers had advanced degrees, including 43 with Ph.D.s. These engineers are involved in advancing the Company's core technologies, as well as applying these core technologies to the Company's product development activities in the areas of broadband communications and digital video technology for cable set-top boxes, cable modems, high-speed networking, DBS and terrestrial digital broadcast, and xDSL. The transmission solutions for each of these markets benefit from the same underlying core technologies, which enables the Company to leverage its ability to address various broadband communications markets with a relatively focused investment in research and development. The Company believes that the achievement of higher levels of integration and the introduction of new products in its target markets is essential to its growth. As a result, the Company plans to increase research and development staffing levels in 1998 and 1999. Research and development expense for 1997, 1996 and 1995 and for the six months ended June 30, 1998 was approximately $16.2 million, $5.7 million, $2.7 million and $14.6 million, respectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." MANUFACTURING Wafer Fabrication The Company's products are manufactured in standard CMOS processes, which permit the Company to engage independent silicon foundries to fabricate its ICs. By subcontracting its manufacturing requirements, the Company is able to focus its resources on design and test applications where the Company believes it has greater competitive advantages and to eliminate the high cost of owning and operating a semiconductor wafer fabrication facility. The Company's Operations and Quality Engineering Group closely manages the interface between manufacturing and design engineering. While the Company's design methodology typically creates smaller than average die for a given function, it also generates full-custom IC designs. As a result, the Company is responsible for the complete functional and parametric performance testing of its devices, including quality. The Company employs a fully staffed operations and quality organization similar to a vertically integrated semiconductor manufacturer. The Company arranges with its foundries to have online work-in-progress control, making the manufacturing subcontracting process transparent to the Company's customers. The Company's key silicon foundries are TSMC in Taiwan and Chartered in Singapore. While the Company currently uses two independent foundries, few of the Company's components are manufactured at both foundries at any given time. Any inability of one of its foundries to provide the necessary capacity or output could result in significant production delays and could have a material adverse effect on the Company's business, financial condition and results of operations. While the Company currently believes it has adequate 40 42 capacity to support its current sales levels, the Company continues to work with its existing foundries to obtain more production capacity and it intends to qualify new foundries to provide additional production capacity. There can be no assurance that adequate foundry capacity will be available on acceptable terms, if at all. In the event either foundry experiences financial difficulties (whether as a result of the Asian economic crisis or otherwise) or suffers any damage or destruction to its respective facilities, or in the event of any other disruption of foundry capacity, the Company may not be able to qualify alternative manufacturing sources for existing or new products in a timely manner. See "Risk Factors -- Dependence on Independent Foundries." The Company's devices are currently fabricated using CMOS process technology with 0.5 micron, triple layer metal and 0.35 micron, quad layer metal feature sizes. The Company continuously evaluates the benefits, on a product by product basis, of migrating to a smaller geometry process technology in order to reduce costs. The Company's experience to date with the migration of products to smaller geometry processes has been favorable, but there can be no assurance that future process migration will be achieved without difficulty. Other companies in the industry have experienced difficulty in effecting transitions to new manufacturing processes and, consequently, have suffered reduced yields or delays in product deliveries. The Company believes that the transition of its products to smaller geometries will be important for the Company to remain competitive. The Company's business, financial condition and results of operations could be materially and adversely affected if any such transition is substantially delayed or inefficiently implemented. See "Risk Factors -- Transition to Smaller Geometry Process Technologies." Assembly and Test Wafer probe testing is performed by one of the foundries or by the Company's wafer probe test subcontractors. Following completion of the wafer probe tests, the die are assembled into packages and the finished products are tested by one of the Company's two subcontractors: ASAT in Hong Kong and STATS in Singapore. While the Company has not experienced any material disruption in supply from assembly subcontractors to date, there can be no assurance that assembly problems will not occur in the future. The availability of assembly and testing services from these subcontractors could be adversely affected in the event either subcontractor experiences financial difficulties (whether as a result of the Asian economic crisis or otherwise) or suffers any damage or destruction to its respective facilities, or in the event of any other disruption of assembly and testing capacity. See "Risk Factors -- Dependence on Third-Party Subcontractors for Assembly and Test." Quality Assurance The data communications industry demands high-quality and reliability of the semiconductors incorporated into their equipment. The Company focuses on product reliability from the initial stage of the design cycle through each specific design process, including layout and production test design. In addition, the Company's designs are subjected to in-depth circuit simulation at temperature, voltage and processing extremes before being committed to silicon. The Company prequalifies each assembly and foundry subcontractor. This prequalification process consists of a series of industry standard environmental product stress tests, as well as an audit and analysis of the subcontractor's quality system and manufacturing capability. The Company also participates in quality and reliability monitoring through each stage of the production cycle by reviewing electrical and parametric data from its wafer foundry and assembly subcontractors. The Company closely monitors wafer foundry production to ensure consistent overall quality, reliability and yield levels. In cases where the Company purchases wafers on a fixed cost basis, any improvement in yields can reduce the Company's cost per IC. As part of its total quality program, the Company plans to apply for ISO 9001 certification, a comprehensive International Standards Organization specified quality system. The Company's objective is to exceed ISO 9001 requirements, especially in the areas of continuous improvements and customer satisfaction. All of the Company's principal independent foundries and package assembly facilities have achieved ISO 9000 certification. 41 43 SALES AND MARKETING The Company's sales and marketing strategy is to achieve design wins with technology leaders in each of the Company's targeted broadband communications markets by, among other things, providing superior field application and engineering support. The Company markets and sells its products in the United States through a direct sales force, which has largely been established within the last year, based out of four regional sales offices located in Irvine and San Jose, California, Atlanta, Georgia and Garwood, New Jersey. Sales managers are dedicated to principal customers to promote close cooperation and communication. The Company also provides its customers with reference platform designs, which enable its customers to achieve easier and faster transitions from the initial prototype designs through final production releases and significantly enhance the customer's confidence that the Company's products will meet their market requirements and product introduction schedules. The Company also markets and sells its products internationally through a direct sales force based out of regional sales offices located in Singapore, Taiwan, United Kingdom and the Netherlands, as well as through a network of independent distributors and representatives in France, Israel, Germany, Japan, Taiwan and Korea. The Company selects these independent entities based on their ability to provide effective field sales, marketing communications and technical support to the Company's customers. All international sales to date have been denominated in U.S. dollars. COMPETITION The broadband communications markets and semiconductor industries are intensely competitive and are characterized by rapid technological change, evolving standards, short product life cycles and price erosion. The Company believes that the principal factors of competition for silicon providers to these industries are product capabilities, level of integration, reliability, price, time-to-market, system cost, intellectual property, customer support and reputation. The Company believes it competes favorably with respect to each of these factors. The Company competes with a number of major domestic and international suppliers of equipment in the markets for cable set-top boxes, cable modems, high-speed networking, DBS and terrestrial digital broadcast, and xDSL, which competition has resulted and may continue to result in declining average selling prices for the Company's products. The Company currently competes in the cable set-top box market with Fujitsu, LSI Logic, Philips Electronics, Rockwell International and VLSI Technology for communication devices and with ATI Technologies, C-Cube, LSI Logic, Motorola and STMicroelectronics in the MPEG/graphics segment. The Company expects other major semiconductor manufacturers to enter the market as digital broadcast television and other digital cable television markets become more established. A number of companies, including Hitachi, Libit Signal Processing, LSI Logic, Rockwell International, STI and Toshiba have announced that they are developing and will introduce MCNS/DOCSIS compliant products in the future, which could result in significant competition in the cable modem market. In the high-speed networking market, the Company principally competes with established suppliers including Level One Communications, Lucent Technologies, National Semiconductor and Texas Instruments. The Company's principal competitors in the DBS/terrestrial broadcast market include LSI Logic, Lucent Technologies, Philips Electronics, Rockwell International, Sony, STMicroelectronics and VLSI Technology. The Company's principal competitors in the xDSL market include Alcatel, Analog Devices, Globespan, Motorola, Rockwell International and Texas Instruments. The Company also may face competition from suppliers of products based on new or emerging technologies. Many of the Company's competitors operate their own fabrication facilities and have longer operating histories and presence in key markets, greater name recognition, access to larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources than the Company. As a result, such competitors may be able to adapt more quickly to new or emerging technologies and changes in customer requirements or devote greater resources to the promotion and sale of their products than the Company. Current and potential competitors have established or may establish financial or strategic relationships among themselves or with existing or potential customers, resellers or other 42 44 third parties. Accordingly, it is possible that new competitors or alliances among competitors could emerge and rapidly acquire significant market share. In addition, the Company's competitors may in the future develop technologies that more effectively address the transmission of digital information through existing analog infrastructures at a lower cost. There can be no assurance that the Company will be able to compete successfully against current or potential competitors, or that competition will not have a material adverse effect on the Company's business, financial condition and results of operations. INTELLECTUAL PROPERTY The Company's success and future revenue growth will depend, in part, on its ability to protect its intellectual property. The Company relies primarily on patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other methods to protect its proprietary technologies and processes. There can be no assurance that such measures will provide meaningful protection for the Company's intellectual property. The Company has been issued three United States patents and has filed 13 United States patent applications. There can be no assurance that any patent will issue as a result of these applications or future applications or, if issued, that any claims allowed will be sufficiently broad to protect the Company's technology. In addition, there can be no assurance that any existing or future patents will not be challenged, invalidated or circumvented, or that any right granted thereunder would provide meaningful protection to the Company. The failure of any patents to provide protection to the Company's technology would make it easier for the Company's competitors to offer similar products. In connection with its participation in the development of various industry standards, the Company may be required to agree to license certain of its patents to other parties, including its competitors, that develop products based upon the adopted standards. The Company also generally enters into confidentiality agreements with its employees and strategic partners, and generally controls access to and distribution of its documentation and other proprietary information. Despite these precautions, it may be possible for a third party to copy or otherwise obtain and use the Company's products, services or technology without authorization, develop similar technology independently or design around the Company's patents. In addition, effective copyright, trademark and trade secret protection may be unavailable or limited in certain foreign countries. Certain of the Company's customers have entered into agreements with the Company pursuant to which such customers have the right to use the Company's proprietary technology in the event the Company defaults in its contractual obligations, including product supply obligations, and fails to cure the default within a specified period of time. Moreover, the Company often incorporates the intellectual property of its strategic customers into its designs, and the Company has certain obligations with respect to the non-use and non-disclosure of such intellectual property. There can be no assurance that the steps taken by the Company to prevent misappropriation or infringement of the intellectual property of the Company or its customers will be successful. Moreover, litigation may be necessary in the future to enforce the intellectual property rights of the Company or its customers, to protect the Company's trade secrets or to determine the validity and scope of proprietary rights of others, including its customers. Such litigation could result in substantial costs and diversion of the Company's resources and could have a material adverse affect on the Company's business, financial condition and results of operations. The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights. From time to time, the Company has received, and may continue to receive in the future, notices of claims of infringement, misappropriation or misuse of other parties' proprietary rights. The Company has received a letter from counsel for BroadCom, Inc. asserting rights in the "Broadcom" trademark and demanding that the Company cease and desist from any further use of the Broadcom name. The Company and Broadcom, Inc. have exchanged correspondence outlining their respective positions on the matter. In addition, the Company is currently involved in litigation with STI concerning the alleged infringement of one of STI's patents by several of the Company's modem products and with Sarnoff corporation and Sarnoff Digital Communications, Inc. concerning the alleged misappropriation and misuse of certain of their trade secrets by the Company. There can be no assurance that the Company will prevail in these actions, or that other actions alleging infringement by the Company of third-party patents, misappropriation or misuse by the Company of third-party trade secrets or invalidity of the patents held by the Company will not be asserted or prosecuted against the Company, or that any assertions of infringement, misappropriation or misuse or prosecutions seeking to establish the invalidity of Company-held patents will not materially and adversely 43 45 affect the Company's business, financial condition and results of operations. For example, in a patent or trade secret action, an injunction could be issued against the Company requiring that the Company withdraw certain products from the market or necessitating that certain products offered for sale or under development be redesigned; the Company has also entered into certain indemnification obligations in favor of its customers and strategic partners that could be triggered upon an allegation or finding of the Company's infringement misappropriation or misuse of other parties' proprietary rights. Irrespective of the validity or successful assertion of such claims, the Company would likely incur significant costs and diversion of its management and personnel resources with respect to the defense of such claims, which could also have a material adverse effect on the Company's business, financial condition and results of operations. If any claims or actions are asserted against the Company, the Company may seek to obtain a license under a third party's intellectual property rights. There can be no assurance that under such circumstances a license would be available on commercially reasonable terms, if at all. See "-- Legal Proceedings." EMPLOYEES As of June 30, 1998, the Company had 353 full-time employees and 23 contract employees, including 241 employees engaged in research and development, 45 engaged in sales and marketing, 38 engaged in manufacturing operations and 52 engaged in general administration activities. The Company's employees are not represented by any collective bargaining agreement, and the Company has never experienced a work stoppage. The Company believes its employee relations are good. PROPERTIES The Company leases three facilities in Irvine, California, which have approximately 17,000 square feet, 26,300 square feet and 31,700 square feet pursuant to three leases which expire in July 2000, December 1998 and February 1999, respectively. The Company also leases an additional 1,700 square feet in Irvine, California on a month-to-month basis. These four facilities comprise the Company's corporate headquarters and include the Company's administration, sales and marketing, and research and development departments. In addition to these facilities, the Company has leased office space, which consists of 152,350 square feet in two adjacent facilities located in Irvine, California, pursuant to a lease which expires in November 2005, and an additional 15,000 square feet in the same office complex through March 1999. The Company intends to relocate all of its Irvine employees and operations to this complex in two stages commencing in December 1998 and February 1999. The Company also leases a 16,100 square foot facility in Atlanta, Georgia, which houses the Company's Residential Broadband Business Unit. This lease terminates in May 2002. In addition, the Company leases a 11,400 square foot facility in San Jose, California, which lease expires in September 2000, for the Company's Digital Video Technology Group. The Company believes its current facilities, together with its planned expansion, will be adequate through 1999. LEGAL PROCEEDINGS In December 1996, Stanford Telecommunications, Inc. filed an action against the Company in the United States District Court for the Northern District of California. STI alleges that the Company's BCM3036, BCM3037, BCM3300, BCM93220 and BCM93220B products infringe one of STI's patents (the " '352 Patent"). STI is seeking an injunction as well as the recovery of monetary damages, including treble damages for willful infringement. The Company has filed an answer and affirmative defenses to STI's complaint, denying the allegations in STI's complaint, and has asserted a counterclaim requesting declaratory relief that the Company is not infringing the '352 Patent and that the '352 Patent is invalid and unenforceable. The Company believes that it has strong defenses to STI's claims on invalidity, noninfringement and inequitable conduct grounds. The Company and STI are currently conducting discovery in this case. On June 10, 1998 and July 21, 1998, the Court issued orders interpreting the claims of the '352 patent. The Court has scheduled trial for May 1999. Although the Company believes that it has strong defenses, a finding of infringement by the Company in this action could lead to liability for monetary damages (which could be trebled in the event that the infringement were found to have been willful), the issuance of an injunction 44 46 requiring that the Company withdraw various products from the market, substantial product redesign expenses (assuming that a non-infringing design is feasible and economic) and associated time-to-market delays, and indemnification claims by the Company's customers or strategic partners, each of which events could have a material adverse effect on the Company's business, financial condition and results of operations. In April 1997, Sarnoff Corporation and Sarnoff Digital Communications, Inc. (collectively, "Sarnoff") filed a complaint in New Jersey Superior Court against the Company and five former Sarnoff employees now employed by the Company (the "Former Employees") asserting claims against the Former Employees for breach of contract, misappropriation of trade secrets, and breach of the covenant of good faith and fair dealing, and against the Company for inducing such actions. Those claims relate to the alleged disclosure of certain technology of Sarnoff to the Company. The complaint also asserts claims against the Company and the Former Employees for unfair competition, misappropriation and misuse of trade secrets and confidential, proprietary information of Sarnoff, and tortious interference with present and prospective economic advantage, as well as a claim against the Company alleging that it "illegally pirated" Sarnoff's employees. The complaint seeks to preliminarily and permanently enjoin the Company and the Former Employees from utilizing any alleged Sarnoff trade secrets, and to restrain the Former Employees from violating their alleged statutory and contractual duties of confidentiality to Sarnoff by, for example, precluding them from working for six months in any capacity relating to certain of the Company's programs. The Company has asserted and believes that Sarnoff's claims are without merit. The Company has filed an answer and is vigorously defending itself in this action. In May 1997, the New Jersey court denied Sarnoff's request for a temporary restraining order. In June 1998, the New Jersey court denied the Company's motion for summary judgment. Sarnoff has clarified its claims to some extent by specifying in greater detail the trade secrets that it alleges the Company and the Former Employees misappropriated. The Company intends to file new motions for summary judgment based on recent admissions and other events. In August 1998, the New Jersey court set a new date, September 30, 1998, for the close of discovery in this case. Trial is scheduled for November 1998. In July 1997, the Company commenced an action against Sarnoff in the California Superior Court alleging breach of contract, fraud, misappropriation of trade secrets, false advertising, trade libel, intentional interference with prospective economic advantage and unfair competition. The claims center on Sarnoff's violation of a non-disclosure agreement entered into with the Company with respect to limited use of certain of the Company's technology and on inaccurate comparisons that the Company believes Sarnoff has made in its product advertising and in statements to potential customers and others. This action was removed to the United States District Court for the Central District of California, and was stayed pending resolution of the New Jersey action described in the preceding paragraph. Notwithstanding that the California action is currently stayed, the Company believes that it involves facts, circumstances and claims unrelated to those at issue in the New Jersey action, and the Company intends to vigorously prosecute the California action against Sarnoff. In March 1998, Scott O. Davis, the Company's former Chief Financial Officer, filed a complaint in California Superior Court against the Company and its Chief Executive Officer, Henry T. Nicholas, III, alleging claims for fraud and deceit, negligent misrepresentation, breach of contract, breach of fiduciary duty, constructive fraud, conversion, breach of the implied covenant of good faith and fair dealing, and declaratory relief. These claims relate to Mr. Davis' alleged ownership of 26,000 shares of Series D Preferred Stock originally purchased by Mr. Davis in February 1996 (which shares would have converted into 78,000 shares of Class B Common Stock upon consummation of the initial public offering). The purchase agreement between the Company and Mr. Davis contained a provision permitting the Company to repurchase all 26,000 shares of Series D Preferred Stock at the original price paid per share in the event that Mr. Davis did not continue to be employed by the Company until the later of February 22, 1998 or one year after the consummation of the Company's initial public offering. After Mr. Davis resigned from the Company in June 1997, the Company exercised its repurchase right. Mr. Davis' complaint alleges that the repurchase right should not be enforceable under several legal theories and seeks unspecified damages and declaratory relief. If Mr. Davis is successful in his claim, he may be entitled to receive the shares of Class B Common Stock described above and may be entitled to certain other rights as a holder of Series D Preferred Stock, including without limitation the right to acquire certain shares of the Company's Series E Preferred Stock (or the shares of 45 47 Class B Common Stock into which such shares of Series E Preferred Stock would have converted upon consummation of the initial public offering). This case is currently in discovery. In April 1998, the Company filed an answer and affirmative defenses to Mr. Davis' complaint, denying the allegations in Mr. Davis' complaint. The Company has also asserted counterclaims against Mr. Davis for fraud and breach of fiduciary duty and is seeking to recover compensatory and punitive damages, in addition to other relief. The Company is also involved in other non-material legal proceedings, claims and litigation arising in the ordinary course of business. The litigation involving intellectual property rights involve complex questions of fact and law and could require the expenditure of significant costs and diversion of resources to defend. Although management believes that the outcome of the Company's outstanding legal proceedings, claims and litigation will not have a material adverse effect on the Company's financial position, results of operations or liquidity, the results of litigation are inherently uncertain, and an adverse outcome in any of the Company's pending litigation is at least reasonably possible. The Company is unable to make an estimate of the range of possible loss from outstanding litigation, and no amounts have been provided for such matters in the accompanying financial statements. Any suit or proceeding involving the Company or its intellectual property could be costly, could result in a diversion of management's efforts and other Company resources, and could restrict the Company from marketing certain of its products without a license, which license may not be available on acceptable terms, if at all. Any of these factors could have a material adverse effect on the Company's business, financial condition and results of operations. See "-- Intellectual Property" and "Risk Factors -- Risks Associated with Intellectual Property Protection." 46 48 MANAGEMENT EXECUTIVE OFFICERS, KEY EMPLOYEES AND DIRECTORS The executive officers, key employees and directors of the Company, and their ages as of June 30, 1998, are as follows:
NAME AGE POSITION ---- --- -------- Henry T. Nicholas, III, Ph.D..... 38 Co-Chairman, President and Chief Executive Officer Henry Samueli, Ph.D.............. 43 Co-Chairman, Vice President of Research and Development and Chief Technical Officer William J. Ruehle................ 56 Vice President and Chief Financial Officer Timothy M. Lindenfelser.......... 38 Vice President of Marketing Martin J. Colombatto............. 39 Vice President and General Manager, Networking Business Unit Vahid Manian..................... 37 Vice President of Manufacturing Operations Aurelio E. Fernandez............. 43 Vice President of Worldwide Sales David A. Dull.................... 49 Vice President of Business Affairs, General Counsel and Secretary Nariman Yousefi.................. 36 Director of Engineering, Networking Business Unit Steve K. Tsubota................. 39 Director of Cable-TV Business Unit Charles P. Reames, Ph.D.......... 41 Director of Cable and Satellite Systems Myron S. Eichen(2)............... 69 Director Alan E. Ross(1)(2)............... 63 Director Werner F. Wolfen(1).............. 67 Director
- --------------- (1) Member of Audit Committee (2) Member of Compensation Committee Henry T. Nicholas, III co-founded the Company and has served as its President, Chief Executive Officer and Co-Chairman since the Company's inception. From 1988 through 1991, Dr. Nicholas was first a consultant and then the Director of Microelectronics for PairGain Technologies, Inc. ("PairGain"), a telecommunications equipment manufacturer, and was the founder of PairGain's microelectronics organization. Prior to joining PairGain, Dr. Nicholas held various senior management positions with the Microelectronics Center of TRW, Inc. ("TRW") between 1982 and 1989. Dr. Nicholas attended the United States Air Force Academy, and received a B.S., M.S. and Ph.D. in Electrical Engineering from the University of California, Los Angeles. Henry Samueli co-founded the Company and has served as its Co-Chairman, Vice President of Research and Development and Chief Technical Officer since the Company's inception. Since 1985, Dr. Samueli has also been a professor in the Electrical Engineering Department at the University of California, Los Angeles, where he supervises advanced research programs in broadband communications circuits and has published more than 100 papers on the subject. Dr. Samueli was the Chief Scientist and one of the founders of PairGain and he consulted for PairGain from 1988 to 1994. From 1980 until 1985, Dr. Samueli was employed in various engineering management positions in the Electronics and Technology Division of TRW. Dr. Samueli received a B.S., M.S. and Ph.D. in Electrical Engineering from the University of California, Los Angeles. William J. Ruehle has served as the Company's Vice President and Chief Financial Officer since joining the Company in June 1997. Mr. Ruehle was employed by SynOptics Communications, Inc. as Vice President and Chief Financial Officer from 1987 until the merger with Wellfleet Communications Incorporated in 1994 that created Bay Networks, Inc. ("Bay Networks"), a networking communications company. Following the merger, Mr. Ruehle was promoted to Executive Vice President and served as Chief Financial Officer of Bay Networks until January 1997. Mr. Ruehle received a B.A. in Economics from Allegheny College and an M.B.A. from Harvard Business School. 47 49 Timothy M. Lindenfelser has served as the Company's Vice President of Marketing since joining the Company in February 1994. During the past four years until December 1997, Mr. Lindenfelser also served as Vice President of Worldwide Sales. Prior to joining the Company, Mr. Lindenfelser was employed by Brooktree Corporation, a semiconductor manufacturer, from November 1988 until February 1994, where he was responsible for all marketing and new business development for the Communications Strategic Business Unit. Mr. Lindenfelser received a B.S.E.E. from the University of Minnesota and an M.B.A. from the University of San Diego. Martin J. Colombatto joined the Company in July 1996 as its Director of Marketing for Broadband Access, and became the Vice President and General Manager of the Networking Business Unit in December 1997. Prior to joining the Company, Mr. Colombatto held various sales positions with LSI Logic Corp., a semiconductor manufacturer, including Director, North American Sales Communication Segment, from August 1995 to July 1996; Director, European Sales Communication and Consumer Segment, from April 1992 to July 1995; and Regional Sales Manager from August 1987 to June 1992. Mr. Colombatto received a B.S. from the California Polytechnic University, Pomona. Vahid Manian joined the Company in January 1996 as its Director of Operations and became the Vice President of Manufacturing Operations in December 1997. Prior to joining the Company, Mr. Manian served as the Director of Operations at Silicon Systems, Inc. from November 1983 to January 1996, where he led the implementation, production ramp and qualification of advanced PRML-read channel ICs. Mr. Manian received a B.S.E.E. and an M.B.A. from the University of California, Irvine. Aurelio E. Fernandez has served as the Vice President of Worldwide Sales since joining the Company in December 1997. From November 1996 to December 1997, Mr. Fernandez served as the Senior Vice President of Sales at Exar Corporation, a semiconductor manufacturer. From November 1994 to November 1996, Mr. Fernandez served as the Senior Vice President of Sales at ICWorks, Inc., a semiconductor manufacturer. Prior to that, Mr. Fernandez served in a number of positions, most recently as Vice President of Telecom Sales, at VLSI Technology, Inc., a semiconductor manufacturer. Mr. Fernandez received a B.S.E.E. from the University of Florida and an M.B.A. from Florida Atlantic University. David A. Dull has served as the Company's Vice President of Business Affairs and General Counsel since March 1998 and was appointed Secretary in April 1998. From 1985 until 1998, Mr. Dull was a Partner in the law firm of Irell & Manella LLP ("Irell & Manella"), where as a business lawyer he represented a number of public and private companies and individuals in the entertainment and high technology industries, including the Company. Irell & Manella has represented and continues to represent the Company in various transactional and litigation matters. Mr. Dull received a B.A. and a J.D. from Yale University. Nariman Yousefi joined the Company in March 1994 as the Director of the Networking Business Unit. Prior to joining the Company, he served as an Engineering Manager at Standard Microsystems Corporation, a networking equipment manufacturer, from 1991 to 1994. From 1988 to 1991, he held various engineering positions at Western Digital Corporation, a disk drive manufacturer, and from 1984 to 1988 he led mixed-signal chip development at Silicon Systems, a semiconductor company. Mr. Yousefi received his B.S.E.E. from the University of California, Davis and an M.S.E.E. from the University of Southern California. Steve K. Tsubota joined the Company in March 1995 as its Director of the Cable-TV Business Unit. Prior to joining the Company, Mr. Tsubota served as Director of Product Marketing of Summit Design, Inc., an Electronic Design Automation ("EDA") company, from February 1994 to February 1995. From February 1991 to January 1994, he served as the Marketing Manager for the IC Group of Mentor Graphics Corporation, an EDA company, and from June 1985 to March 1990, Mr. Tsubota held various marketing, sales and engineering positions at Silicon Compiler Systems Corporation, an EDA company. Mr. Tsubota received a B.S.E.E. and M.S.E.E. from the University of California, Los Angeles. Charles P. Reames joined the Company in June 1993 as its Director of Modem Technology and most recently as the Director of Cable and Satellite Systems since October 1995. Prior to joining the Company, Dr. Reames served in various engineering positions in the Electronics and Technology Division of TRW from 48 50 June 1985 through June 1993. Dr. Reames received a B.S. in Engineering from the California Institute of Technology and an M.S. and Ph.D. in Electrical Engineering from the University of California, Los Angeles. Myron S. Eichen has served as an advisor to the Board of Directors since 1994. Mr. Eichen has served as a director of the Company since February 1998. Mr. Eichen is presently a director of Rokenbok Toy Company and has founded and served as a director for a number of companies including Brooktree Corporation (now a division of Rockwell International), a semiconductor manufacturer, and Proxima Corporation, an equipment manufacturer. Alan E. Ross has been a director of the Company since November 1995. Mr. Ross is a Board member of several companies in the semiconductor industry, including World Wide Semiconductor Manufacturing Corporation, Gambit Automated Design, Inc. (of which he is also the Chief Executive Officer), Artest Corporation, and ADC Telecommunications, Inc. In addition, Mr. Ross served as President of Rockwell Semiconductor Systems, Inc. from 1988 to 1996. Werner F. Wolfen has been a director of the Company since July 1994, when he joined the Board of Directors as the nominee of a group of investors. Mr. Wolfen is a Senior Partner of the law firm of Irell & Manella and was Co-Chairman of the firm's Executive Committee from 1982 to 1992. Irell & Manella has represented and continues to represent the Company in various transactional and litigation matters. Mr. Wolfen received a J.D. from the University of California Boalt Hall School of Law in 1953. BOARD COMMITTEES The Board of Directors has a Compensation Committee and an Audit Committee. Compensation Committee. The Compensation Committee of the Board of Directors reviews and makes recommendations to the Board regarding the Company's compensation policies and all forms of compensation to be provided to executive officers and directors of the Company, including, among other things, annual salaries and bonuses, and stock option and other incentive compensation arrangements. In addition, the Compensation Committee reviews bonus and stock compensation arrangements for all other employees of the Company. As part of the foregoing, the Compensation Committee also administers the Company's 1998 Stock Incentive Plan. The current members of the Compensation Committee are Messrs. Ross and Eichen. Audit Committee. The Audit Committee of the Board of Directors reviews and monitors the corporate financial reporting and the internal and external audits of the Company, including, among other things, the Company's internal audit and control functions, the results and scope of the annual audit and other services provided by the Company's independent auditors and the Company's compliance with legal matters that have a significant impact on the Company's financial reports. The Audit Committee also consults with the Company's management and the Company's independent auditors prior to the presentation of financial statements to shareholders and, as appropriate, initiates inquiries into aspects of the Company's financial affairs. In addition, the Audit Committee has the responsibility to consider and recommend the appointment of, and to review fee arrangements with, the Company's independent auditors. The current members of the Audit Committee are Messrs. Ross and Wolfen. DIRECTOR COMPENSATION AND OTHER ARRANGEMENTS Directors of the Company do not receive cash compensation for their service as directors. Each new nonemployee Director typically will receive an option to purchase 40,000 shares of Class A Common Stock upon joining the Board of Directors. Each incumbent director will be granted an option to purchase an additional 3,000 shares of Class A Common Stock annually. See "Management -- Employee Benefit Plans." COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee of the Board of Directors currently consists of Messrs. Ross and Eichen. No interlocking relationship exists between any member of the Company's Board of Directors or the Compensation Committee and any member of the board of directors or compensation committee of any other company, and no such interlocking relationship has existed in the past. 49 51 EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT AND CHANGE OF CONTROL ARRANGEMENTS None of the Company's executive officers have employment agreements with the Company. Accordingly, the employment of any such executive officer may be terminated at any time at the discretion of the Board of Directors. EXECUTIVE COMPENSATION The following table sets forth for the year ended December 31, 1997 all compensation received for services rendered to the Company in all capacities by the Company's Chief Executive Officer and the only other executive officer of the Company whose salary plus bonus exceeded $100,000 in 1997 (collectively, the "Named Executive Officers"). SUMMARY COMPENSATION TABLE
LONG TERM COMPENSATION ------------ AWARDS ANNUAL ------------ COMPENSATION SECURITIES ------------ UNDERLYING NAME AND PRINCIPAL POSITIONS SALARY OPTIONS ---------------------------- ------------ ------------ Henry T. Nicholas, III, Ph.D................................ $165,000(1) 375,000 Co-Chairman, President and Chief Executive Officer Henry Samueli, Ph.D......................................... 165,000(1) 375,000 Co-Chairman, Vice President of Research and Development and Chief Technical Officer
- --------------- (1) Effective January 1, 1998, the annual salary of each of Dr. Nicholas and Dr. Samueli was reduced to $110,000. OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth certain information concerning the grant of stock options to each of the Named Executive Officers during the fiscal year ended December 31, 1997.
INDIVIDUAL GRANTS POTENTIAL REALIZATION ------------------------------------------------- VALUE AT ASSUMED ANNUAL NUMBER OF % OF TOTAL RATES OF STOCK PRICE SECURITIES OPTIONS APPRECIATION FOR UNDERLYING GRANTED TO EXERCISE OPTION TERM(1) OPTIONS EMPLOYEES PRICE EXPIRATION ----------------------- NAME GRANTED IN 1997 PER SHARE DATE 5% 10% ---- ---------- ---------- --------- ---------- ---------- ---------- Henry T. Nicholas, III, Ph.D........................ 375,000(2) 7.0% $1.25(3) 06/22/07 $221,494 $630,348 Henry Samueli, Ph.D........... 375,000(2) 7.0 1.25(3) 06/22/07 221,494 630,348
- --------------- (1) The 5% and 10% assumed rates of appreciation are prescribed by the rules and regulations of the Securities and Exchange Commission (the "Commission") and do not represent the Company's estimate or projection of the future trading prices of its Common Stock. There can be no assurance that any of the values reflected in this table will be achieved. Actual gains, if any, on stock option exercises are dependent on numerous factors, including the future performance of the Company, overall conditions and the option holder's continued employment with the Company throughout the entire vesting period and option term, which factors are not reflected in this table. (2) Options were granted on June 23, 1997 under the Company's Amended and Restated 1994 Stock Option Plan and are immediately exercisable. All of the shares of Common Stock that are issuable upon exercise of unvested options are subject to repurchase by the Company. The shares underlying the options vest and the Company's repurchase right lapses in 48 equal monthly installments commencing January 1, 1998. (3) The exercise price was equal to 110% of the fair market value of the Common Stock on the date of grant, as determined by the Board of Directors. 50 52 AGGREGATED OPTIONS EXERCISED IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES The following table provides information with respect to the Named Executive Officers concerning the unexercised options held as of December 31, 1997. No options were exercised during the last fiscal year by any of the Named Executive Officers.
NUMBER OF SECURITIES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED OPTIONS AT IN-THE MONEY OPTIONS FISCAL YEAR END AT FISCAL YEAR END(1) ------------------------------ ------------------------------ NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE ---- ------------- ------------- ----------- --------------- Henry T. Nicholas, III, Ph.D.......... 375,000 -- $2,531,250 -- Henry Samueli, Ph.D................... 375,000 -- 2,531,250 --
- --------------- (1) Represents the difference between the fair market value of the shares of Common Stock underlying the options at December 31, 1997 ($8.00 per share, as determined by the Board of Directors) and the exercise price of such options ($1.25 per share) EMPLOYEE BENEFIT PLANS 1998 Stock Incentive Plan The Company's 1998 Stock Incentive Plan (the "1998 Plan"), which became effective on April 8, 1998 (the "Plan Effective Date"), is intended to serve as the successor equity incentive program to the Company's 1994 Amended and Restated Stock Option Plan (the "1994 Plan") and the Company's 1998 Special Stock Option Plan (the "Special Plan"). A total of 15,948,439 shares of Common Stock have been authorized for issuance under the 1998 Plan. Such share reserve consists of (i) the number of shares which remain available for issuance under the 1994 Plan and the Special Plan on the Plan Effective Date, including the shares subject to outstanding options, and (ii) an additional increase of 3,000,000 shares of Class A Common Stock. To the extent any unvested shares of Class B Common Stock issued under the 1994 Plan or the Special Plan are repurchased by the Company after the Plan Effective Date, at the exercise price paid per share, in connection with a shareholder's termination of service, those repurchased shares will be added to the reserve of Class A Common Stock available for issuance under the 1998 Plan. In addition, the number of shares of Class A Common Stock reserved for issuance under the 1998 Plan will automatically increase on the first trading day of each calendar year, beginning in calendar year 1999, by an amount equal to 3% percent of the total number of shares of Common Stock outstanding on the last trading day of the immediately preceding calendar year. In no event, however, may any one participant in the 1998 Plan receive option grants, separately exercisable stock appreciation rights or direct stock issuances for more than 1,500,000 shares of Class A Common Stock in the aggregate per calendar year. In April 1998, outstanding options under the 1994 Plan and the Special Plan were incorporated into the 1998 Plan, and no further option grants may be made under the 1994 Plan or the Special Plan. The incorporated options will continue to be governed by their existing terms, unless the Plan Administrator elects to extend one or more features of the 1998 Plan to those options. Except as otherwise noted below, the incorporated options have substantially the same terms as will be in effect for grants made under the Discretionary Option Grant Program of the 1998 Plan. The 1998 Plan is divided into five separate components: (i) the Discretionary Option Grant Program under which eligible individuals in the Company's employ or service (including officers, non-employee Board members and consultants) may, at the discretion of the Plan Administrator, be granted options to purchase shares of Class A Common Stock at an exercise price not less than 85% of their fair market value on the grant date, (ii) the Salary Investment Option Grant Program which may, in the Plan Administrator's sole discretion, be activated for one or more calendar years and, if so activated, will allow executive officers and other highly compensated employees the opportunity to apply a portion of their base salary to the acquisition of special below-market stock option grants, (iii) the Stock Issuance Program under which such individuals may, at the Plan Administrator's discretion, be issued shares of Class A Common Stock directly, through the 51 53 purchase of such shares at a price not less than 100% of their fair market value at the time of issuance or as a bonus tied to the performance of services, (iv) the Automatic Option Grant Program under which option grants will automatically be made at periodic intervals to eligible non-employee Board members to purchase shares of Class A Common Stock at an exercise price equal to 100% of their fair market value on the grant date and (v) the Director Fee Option Grant Program which may, in the Plan Administrator's sole discretion, be activated for one or more calendar years and, if so activated, will allow non-employee Board members the opportunity to apply a portion of the retainer fee otherwise payable to them in cash each year to the acquisition of special below-market option grants. The Discretionary Option Grant Program and the Stock Issuance Program are administered by the Option Committee except with respect to officers and directors subject to Section 16 of the Securities and Exchange Act of 1934 ("Section 16 executives"). The Option Committee as Plan Administrator has complete discretion to determine which eligible individuals are to receive option grants or stock issuances under those programs, the time or times when such option grants or stock issuances are to be made, the number of shares subject to each such grant or issuance, the status of any granted option as either an incentive stock option or a non-statutory stock option under the Federal tax laws, the vesting schedule to be in effect for the option grant or stock issuance and the maximum term for which any granted option is to remain outstanding. The Compensation Committee administers the Discretionary Option Grant and Stock Issuance Programs with respect to Section 16 executives and will also have the exclusive authority to select the executive officers and other highly compensated employees who may participate in the Salary Investment Option Grant Program in the event that program is activated for one or more calendar years, but neither the Compensation Committee nor the Option Committee nor the Board will exercise any administrative discretion with respect to the option grants made under the Salary Investment Option Grant Program or under the Automatic Option Grant and Director Fee Option Grant Programs for the non-employee Board members. All grants under those three latter programs will be made in strict compliance with the express provisions of each such program. The exercise price for the shares of Class A Common Stock subject to option grants made under the 1998 Plan may be paid in cash or in shares of Class A 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 or the purchase of their unvested shares by allowing such individuals to deliver a full-recourse promissory note in payment of the exercise price and any associated withholding taxes incurred in connection with such exercise or purchase. The Plan Administrator has the authority to effect the cancellation of outstanding options under the Discretionary Option Grant Program (including options incorporated from the 1994 Plan and the Special Plan) in return for the grant of new options for the same or different number of option shares with an exercise price per share based on the fair market value per share of Class A Common Stock on the new grant date. Stock appreciation rights are authorized for issuance under the Discretionary Option Grant Program which provide the holders with the election to surrender their outstanding options for an appreciation distribution from the Company equal to the excess of (i) the fair market value of the vested shares of Class A Common Stock subject to the surrendered option over (ii) the aggregate exercise price payable for such shares. Such appreciation distribution may be made in cash or in shares of Class A Common Stock. None of the incorporated options from the 1994 Plan or the Special Plan contain any stock appreciation rights. In the event that the Company is acquired by merger or asset sale, each outstanding option under the Discretionary Option Grant Program which is not to be assumed by the successor corporation will automatically accelerate in full, and all unvested shares under the Discretionary Option Grant and Stock Issuance Programs will immediately vest, except to the extent the Company's repurchase rights with respect to those shares are to be assigned to the successor corporation. The Plan Administrator will have complete discretion to grant one or more options under the Discretionary Option Grant Program which will become fully exercisable for all the option shares in the event those options are assumed in the acquisition and the optionee's service with the Company or the acquiring entity terminates within a designated period following such acquisition. The vesting of outstanding shares under the Stock Issuance Program may be accelerated 52 54 upon similar terms and conditions. The Plan Administrator will also have the authority to grant options which will immediately vest upon an acquisition of the Company, whether or not those options are assumed by the successor corporation. The Plan Administrator is also authorized under the Discretionary Option Grant and Stock Issuance Programs to grant options and to structure repurchase rights so that the shares subject to those options or repurchase rights will immediately vest in connection with a change in control of the Company (whether by successful tender offer for more than 50% of the outstanding voting stock or a change in the majority of the Board by reason of one or more contested elections for Board membership), with such vesting to occur either at the time of such change in control or upon the subsequent termination of the individual's service within a designated period following such change in control. The options incorporated from the 1994 Plan and the Special Plan will immediately vest in full upon an acquisition of the Company by merger or asset sale, unless those options are assumed by the successor entity. In the event the Plan Administrator elects to activate the Salary Investment Option Grant Program for one or more calendar years, each director, executive officer and other highly compensated employee of the Company selected for participation may elect, prior to the start of the calendar year, to reduce his or her base salary for that calendar year by a specified dollar amount not less than $10,000 nor more than $50,000. If such election is approved by the Plan Administrator, the individual will automatically be granted, on the first trading day in January of the calendar year for which that salary reduction is to be in effect, a non-statutory option to purchase that number of shares of Class A Common Stock determined by dividing the salary reduction amount by two-thirds of the fair market value per share of Class A Common Stock on the grant date. The option will be exercisable at a price per share equal to one-third of the fair market value of the option shares on the grant date. As a result, the total spread on the option shares at the time of grant (the fair market value of the option shares on the grant date less the aggregate exercise price payable for those shares) will be equal to the amount of salary invested in that option. The option will vest in a series of twelve successive equal monthly installments over the calendar year for which the salary reduction is to be in effect and will be subject to full and immediate vesting upon certain changes in the ownership or control of the Company. Under the Automatic Option Grant Program, each individual on the Board at the Underwriting Date or who first becomes a non-employee Board member at any time after April 18, 1998 will automatically receive an option grant for 40,000 shares of Class A Common Stock on the date such individual joins the Board, provided such individual has not been in the prior employ of the Company. In addition, on the date of each Annual Shareholders Meeting held after the Plan Effective Date, each non-employee Board member who is to continue to serve as a non-employee Board member will automatically be granted an option to purchase 3,000 shares of Class A Common Stock, provided such individual has served on the Board for at least six months. Each automatic grant for the non-employee Board members will have a term of ten years, subject to earlier termination following the optionee's cessation of Board service. Each automatic option will be immediately exercisable for all of the option shares; however, any unvested shares purchased under the option will be subject to repurchase by the Company, at the exercise price paid per share, should the optionee cease Board service prior to vesting in those shares. The shares subject to each initial 40,000 share automatic option grant will vest in a series of four successive equal annual installments upon the individual's completion of each year of Board service over the four year period measured from the option grant date. Each annual 3,000 share automatic option grant will vest upon the individual's completion of one year of Board service measured from the grant date. However, the shares subject to each automatic grant will immediately vest in full upon certain changes in control or ownership of the Company or upon the optionee's death or disability while a Board member. Should the Director Fee Option Grant Program be activated in the future, each non-employee Board member will have the opportunity to apply all or a portion of any annual retainer fee otherwise payable in cash to the acquisition of a below-market option grant. The option grant will automatically be made on the first trading day in January in the year for which the retainer fee would otherwise be payable in cash. The option will have an exercise price per share equal to one-third of the fair market value of the option shares on the grant date, and the number of shares subject to the option will be determined by dividing the amount of the 53 55 retainer fee applied to the program by two-thirds of the fair market value per share of Class A Common Stock on the grant date. As a result, the total spread on the option (the fair market value of the option shares on the grant date less the aggregate exercise price payable for those shares) will be equal to the portion of the retainer fee invested in that option. The option will become exercisable for the option shares in a series of twelve successive equal monthly installments over the calendar year for which the election is to be in effect. However, the option will become immediately exercisable for all the option shares 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. The shares subject to each option under the Salary Investment Option Grant, Automatic Option Grant and Director Fee Option Grant Programs will immediately vest upon (i) an acquisition of the Company by merger or asset sale or (ii) the successful completion of a tender offer for more than 50% of the Company's outstanding voting stock or a change in the majority of the Board effected through one or more contested elections for Board membership. Limited stock appreciation rights will automatically be included as part of each grant made under the Automatic Option Grant, Salary Investment Option Grant and Director Fee Option Grant Programs and may be granted to one or more officers of the Company as part of their option grants under the Discretionary Option Grant Program. Options with such a limited stock appreciation right may be surrendered to the Company upon the successful completion of a hostile tender offer for more than 50% of the Company's outstanding voting stock. In return for the surrendered option, the optionee will be entitled to a cash distribution from the Company in an amount per surrendered option share equal to the excess of (i) the highest price per share of Class A Common Stock paid in connection with the tender offer over (ii) the exercise price payable for such share. The Board may amend or modify the 1998 Plan at any time, subject to any required shareholder approval. The 1998 Plan will terminate on the earliest of (i) January 31, 2008, (ii) the date on which all shares available for issuance under the 1998 Plan have been issued as fully-vested shares or (iii) the termination of all outstanding options in connection with certain changes in control or ownership of the Company. As of June 30, 1998, options to purchase an aggregate of 714,550 shares of Class A Common Stock were outstanding at a weighted average exercise price per share of $32.14, and options to purchase an aggregate of 7,970,103 shares of Class B Common Stock were outstanding at a weighted average exercise price per share of $5.20. 1998 Employee Stock Purchase Plan The Company's 1998 Employee Stock Purchase Plan (the "Purchase Plan") was adopted by the Board and approved by the shareholders in February 1998 and became effective in April 1998. The Purchase Plan is designed to allow eligible employees of the Company and participating subsidiaries to purchase shares of Class A Common Stock, at semi-annual intervals, through their periodic payroll deductions under the Purchase Plan, and a reserve of 750,000 shares of Class A Common Stock has been established for this purpose. The Purchase Plan will be implemented in a series of successive offering periods, each with a maximum duration of 24 months. However, the initial offering period began in April 1998 and will end on the last business day in April 2000. The next offering period will commence on the first business day in May 2000, and subsequent offering periods will commence as designated by the Plan Administrator. Individuals who are eligible employees (scheduled to work more than 20 hours per week for more than five calendar months per year) on the start date of any offering period may enter the Purchase Plan on that start date or on any subsequent semi-annual entry date. Individuals who become eligible employees after the start date of the offering period may join the Purchase Plan on any subsequent semi-annual entry date within that offering period. Payroll deductions may not exceed 15% of total compensation, and the accumulated payroll deductions of each participant will be applied to the purchase of shares on his or her behalf on each semi-annual purchase 54 56 date (the last business day in April and October each year) at a purchase price per share equal to 85% of the lower of (i) the fair market value of the Class A Common Stock on the participant's entry date into the offering period or (ii) the fair market value on the semi-annual purchase date. In no event, however, may any one participant purchase more than 1,500 shares, nor may all participants in the aggregate purchase more than 150,000 shares on any one semi-annual purchase date. Should the fair market value per share of Class A Common Stock on any purchase date be less than the fair market value per share on the start date of the two-year offering period, then that offering period will automatically terminate, and a new two-year offering period will begin on the next business day, with all participants in the terminated offering to be automatically transferred to the new offering period. In the event the Company is acquired by merger or asset sale, all outstanding purchase rights will automatically be exercised immediately prior to the effective date of such acquisition. The purchase price will be equal to 85% of the lower of (i) the fair market value per share of Class A Common Stock on the participant's entry date into the offering period in which such acquisition occurs or (ii) the fair market value per share of Class A Common Stock immediately prior to such acquisition. The Purchase Plan will terminate on the earlier of (i) the last business day of April 2008, (ii) the date on which all shares available for issuance under the Purchase Plan shall have been sold pursuant to purchase rights exercised thereunder or (iii) the date on which all purchase rights are exercised in connection with an acquisition of the Company by merger or asset sale. The Board may at any time alter, suspend or discontinue the Purchase Plan. However, certain amendments to the Purchase Plan may require shareholder approval. 401(k) Profit Sharing Plan The Company has an employee profit sharing plan that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code (the "401(k) Plan"). The 401(k) Plan allows eligible employees to defer up to 20% of their pre-tax earnings, subject to the Internal Revenue Service annual contribution limit. At the Company's discretion, the Company may make matching contributions to the 401(k) Plan. To date, the Company has not made any matching contributions under the 401(k) Plan. LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS The Company's Articles of Incorporation limit the personal liability of its directors for monetary damages to the fullest extent permitted by the California General Corporation Law (the "California Law"). Under the California Law, a director's liability to a company or its shareholders may not be limited (i) for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (ii) for acts or omissions that a director believes to be contrary to the best interests of the Company or its shareholders or that involve the absence of good faith on the part of the director, (iii) for any transaction from which a director derived an improper personal benefit, (iv) for acts or omissions that show a reckless disregard for the director's duty to the Company or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of a serious injury to the Company or its shareholders, (v) for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Company or its shareholders, (vi) under Section 310 of the California Law concerning contacts or transactions between the Company and a director, or (vii) under Section 316 of the California Law concerning directors' liability for improper dividends, loans and guarantees. The limitation of liability does not affect the availability of injunctions and other equitable remedies available to the Company's shareholders for any violation by a director of the director's fiduciary duty to the Company or its shareholders. The Company's Articles of Incorporation also include an authorization for the Company to indemnify its "agents" (as defined in Section 317 of the California Law) through bylaw provisions, by agreement or otherwise, to the fullest extent permitted by law. Pursuant to this provision, the Company's Bylaws provide for indemnification of the Company's directors, officers and employees. In addition, the Company may, at its 55 57 discretion, provide indemnification to persons whom the Company is not obligated to indemnify. The Bylaws also allow the Company to enter into indemnity agreements with individual directors, officers, employees and other agents. These indemnity agreements have been entered into with all directors and executive officers and provide the maximum indemnification permitted by law. These agreements, together with the Company's Bylaws and Articles of Incorporation, may require the Company, among other things, to indemnify these directors or executive officers (other than for liability resulting from willful misconduct of a culpable nature), to advance expenses to them as they are incurred, provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification, and to obtain directors' and officers' insurance if available on reasonable terms. Section 317 of the California Law and the Company's Bylaws make provision for the indemnification of officers, directors and other corporate agents in terms sufficiently broad to indemnify such persons, under certain circumstances, for liabilities (including reimbursement of expense incurred) arising under the Securities Act. The Company is not aware of any pending litigation or proceeding involving any director, officer, employee or agent of the Company in which indemnification will be required or permitted. Moreover, the Company is not aware of any threatened litigation or proceeding that might result in a claim for such indemnification. The Company believes that the foregoing indemnification provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. The Company currently maintains directors' and officers' liability insurance. 56 58 CERTAIN TRANSACTIONS Since January 1, 1995, there has not been any transaction or series of similar transactions to which the Company was or is a party in which the amount involved exceeded or exceeds $60,000 and in which any director, executive officer, holder of more than 5% of any class of the Company's voting securities, or any member of the immediate family of any of the foregoing persons had or will have a direct or indirect material interest, other than the transactions described below. Series D Preferred Stock Financing. In February 1996, the Company issued and sold an aggregate of 493,839 shares of convertible Series D Preferred Stock for an aggregate purchase price of $2,963,034 or $6.00 per share. The investors in such shares included, among others, (1) Werner F. Wolfen, a director of the Company, who purchased 24,644 shares of convertible Series D Preferred Stock, (2) Alan E. Ross, a director of the Company, who purchased 5,000 shares of convertible Series D Preferred Stock, (3) Myron S. Eichen, a director of the Company, who purchased 24,644 shares of convertible Series D Preferred Stock and (4) a trust controlled by Leon M. Samueli and Barbara Jane Samueli, relatives of Henry Samueli (the Company's Co-Chairman, Vice President of Research and Development and Chief Technical Officer), which purchased 30,000 shares of convertible Series D Preferred Stock. Each share of convertible Series D Preferred Stock automatically converted into three shares of the Company's Class B Common Stock upon consummation of the Company's initial public offering. Series E Preferred Stock Financing. In September 1997, the Company issued and sold 1,500,000 shares of convertible Series E Preferred Stock to General Instrument for an aggregate purchase price of $22,725,000 or $15.15 per share (the "Series E Financing"). Each share of convertible Series E Preferred Stock automatically converted into 1.5 shares of the Company's Class B Common Stock upon consummation of the Company's initial public offering. In connection with the Series E Financing, General Instrument and the Company entered into a Development, Supply and License Agreement, pursuant to which, among other things, the Company has agreed to supply to General Instrument, and General Instrument has agreed to purchase from the Company, a specified percentage of General Instrument's silicon requirements for its digital cable set-top box subscriber products. For 1997, the Company's sales to General Instrument (and its subcontractor) were approximately $11.8 million, or 31.9% of total revenue. See "Business -- Customers and Strategic Relationships." Development Agreement with Cisco Systems. Effective September 1996, the Company entered into a development agreement with Cisco Systems, pursuant to which the Company granted to Cisco Systems an option to purchase shares of the Company's Class A Common Stock at the initial public offering price, net of underwriting discounts and commissions. Cisco Systems exercised this option and purchased 500,000 shares at a price of $22.32 per share in a non-underwritten registered offering concurrent with the closing of the Company's initial public offering. In addition, Cisco Systems has agreed that it will be subject to certain restrictions following this offering, including (1) a one-year lock-up period during which the shares purchased by Cisco Systems cannot be transferred, (2) a restriction on selling more than a certain number of shares per quarter during the first year following termination of the initial one-year lock-up period, (3) a notification obligation should Cisco Systems desire to sell more than a specified number of shares after the one-year lock-up period, (4) a three-year standstill agreement preventing Cisco Systems from acquiring more than 10% of the Company's Common Stock, and (5) a seven-year voting agreement with respect to certain matters, which agreement includes an obligation to vote its shares in favor of all directors nominated by the Board of Directors of the Company. Some of these restrictions may terminate early upon certain events, such as an acquisition of the Company. For 1997, the Company's sales to Cisco Systems were approximately $2,000,000, or 5.4% of total revenue. See "Business -- Customers and Strategic Relationships" and "Sale of Shares to Cisco Systems." Sale of Common Stock to Irell & Manella. Pursuant to an agreement dated as of October 31, 1997, the Company issued and sold 225,000 shares of Class B Common Stock to Irell & Manella for an aggregate purchase price of $1,050,000 or $4.67 per share. Werner F. Wolfen, a director of the Company, is a Senior Partner of Irell & Manella. 57 59 Engagement Agreement with Irell & Manella. Irell & Manella has represented and continues to represent the Company in various legal matters pursuant to an engagement agreement dated as of January 1, 1997, and amended as of January 1, 1998. Under the engagement agreement, the Company has agreed to pay Irell & Manella a fixed fee plus costs for the firm's legal services rendered from and after January 1, 1998 with respect to certain litigation matters. Irell & Manella has agreed to render legal services to the Company on most other matters at reduced rates from the firm's standard rates for the two-year period commencing January 1, 1998. During 1997, the Company paid approximately $1.2 million to Irell & Manella for legal services rendered by that firm. Officer Promissory Notes. Between March 1995 and December 1997, the Company entered into full-recourse promissory notes with certain of its officers and directors to finance the purchase of Class B Common Stock upon exercise of stock options. See "Management -- Executive Compensation" and "Employee Benefit Plans -- 1998 Stock Incentive Plan." All of the notes are full-recourse, secured by the shares purchased and are due and payable upon the earlier of the stated due date or thirty days (ninety days in the case of Mr. Ruehle) after the termination of such officer's employment with the Company. In July 1997, in connection with the exercise of a stock option, William J. Ruehle, the Chief Financial Officer of the Company, delivered a $467,500 full-recourse promissory note to the Company. Such note bears interest at 6.5% per annum and is due in July 2002. The Company has agreed to pay Mr. Ruehle the amount necessary to compensate him for the interest expense. In December 1997, in connection with the exercise of a stock option, Aurelio E. Fernandez, Vice President of Worldwide Sales, delivered a $1,800,000 full-recourse promissory note to the Company that is due in December 2002. Mr. Fernandez will be deemed to have paid interest with respect to such note at the applicable federal rate, 6.5% per annum at December 31, 1997. In addition, in January 1998, Mr. Fernandez delivered a $130,000 full-recourse promissory note to the Company. Such note bears interest at 6.5% per annum and is due in January 2002. This loan was made to Mr. Fernandez to allow him to pay off a similar loan from his prior employer that became due when he left that company. 58 60 PRINCIPAL AND SELLING SHAREHOLDERS The following table sets forth certain information as of June 30, 1998 regarding beneficial ownership of the Company's Common Stock, as adjusted to reflect the sale of 3,000,000 shares of Class A Common Stock offered hereby, by (i) each person (or group of affiliated persons) known by the Company to own beneficially more than 5% of the Class A Common Stock or the Class B Common Stock, (ii) each of the Company's directors and Named Executive Officers, (iii) the Company's directors and executive officers as a group and (iv) all other Selling Shareholders.
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED PRIOR TO OFFERING SHARES AFTER OFFERING -------------------------------------- OF CLASS A ------------------------------------- NUMBER OF NUMBER OF PERCENT OF COMMON NUMBER OF NUMBER OF PERCENT OF CLASS A CLASS B TOTAL VOTING STOCK CLASS A CLASS B TOTAL VOTING NAME OF BENEFICIAL OWNERS SHARES SHARES POWER(1) OFFERED(2) SHARES SHARES POWER(1) ------------------------- --------- ---------- ------------ ---------- --------- ---------- ------------ Henry T. Nicholas, III, Ph.D.(3).... -- 11,000,000(4)(5) 27.7% 450,000 -- 10,550,000 28.2% Henry Samueli, Ph.D.(3)............. -- 11,000,000(4)(6) 27.7 450,000 -- 10,550,000 28.2 General Instrument Corporation(7)... -- 2,250,000 5.7 -- -- 2,250,000 6.1 Intel Corporation................... -- 1,576,800 3.8 637,500 -- 939,300 2.5 Scientific-Atlanta, Inc............. -- 1,500,000 3.8 340,000 -- 1,160,000 3.1 Werner F. Wolfen.................... -- 590,632(8) 1.4 50,000 -- 540,632 1.5 Cisco Systems(9).................... 500,000 -- * -- 500,000 -- * Myron S. Eichen..................... -- 385,351(10) * 50,000 -- 335,351 * Zweig-DiMenna Entities(11).......... 251,200 -- * -- 251,200 -- * Alan E. Ross........................ -- 145,000(12) * 22,000 -- 123,000 * Dawson Samberg Capital Management Inc.(13) ......................... 586,000 -- * -- 586,000 -- * All executive officers and directors as a group (10 persons)(14)....... -- 24,453,373 60.5 1,230,000 -- 23,233,373 60.9 All other Selling Shareholders ( persons).......................... -- 400,000 * 400,000 -- -- --
- --------------- * Less than one percent. (1) The number of shares beneficially owned and the percentage of shares beneficially owned are based on (i) 4,839,750 shares of Class A Common Stock and 38,878,199 shares of Class B Common Stock outstanding as of June 30, 1998, and (ii) 7,839,750 shares of Class A Common Stock and 36,270,699 shares of Class B Common Stock outstanding upon consummation of this offering. Beneficial ownership is determined in accordance with the rules and regulations of the Commission. Shares of Common Stock subject to options that are currently exercisable or exercisable within 60 days of October 14, 1998 are deemed to be outstanding and beneficially owned by the person holding such options for the purpose of computing the number of shares beneficially owned and the percentage ownership of such person, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person. Except as indicated in the footnotes to this table, and subject to applicable community property laws, such persons have sole and voting investment power with respect to all shares of the Company's Common Stock shown as beneficially owned by them. (2) Assumes no exercise of the Underwriters' over-allotment option to purchase up to an aggregate of 77,500 shares of Class A Common Stock from the Company and up to an aggregate of 372,500 shares from certain of the Selling Shareholders. (3) The address for each of Dr. Nicholas and Dr. Samueli is 16251 Laguna Canyon Road, Irvine, California 92618. Dr. Nicholas and Dr. Samueli will each sell 50,000 additional shares if the Underwriters' over-allotment option is exercised in full. (4) Includes 375,000 shares of Class B Common Stock issuable pursuant to options that are currently exercisable within 60 days of October 14, 1998. (5) Includes 10,625,000 shares of Class B Common Stock held by Dr. Nicholas and his spouse, as trustees of the Nicholas Family Trust. (6) Includes (i) 900,000 shares of Class B Common Stock owned by HS Management, L.P., of which Dr. Samueli is the General Partner, (ii) 1,200,000 shares of Class B Common Stock held by Dr. Samueli, as Trustee for the Lifetime Benefit Trust for Henry Samueli, (iii) 4,025,000 shares of Class B Common Stock held by Dr. Samueli and his spouse, as Trustees of the Samueli Family 1995 Trust, and (iv) 4,500,000 shares of Class B Common Stock held by HS Portfolio L.P., of which Dr. Samueli is the General Partner. (7) The address for General Instrument Corporation is 2200 Byberry Road, Hatboro, Pennsylvania 19040. (8) Includes (i) 18,750 shares of Class B Common Stock held by Mr. Werner as trustee of the Werner F. Wolfen Annuity Trust B, of which Mr. Werner is a trustee, (ii) 18,750 shares of Class B Common Stock held by Mr. Wolfen's spouse as trustee of the Mary G. Wolfen Annuity Trust B, and (iii) 40,000 shares of Class A Common Stock issuable pursuant to options that are exercisable within 60 days of October 14, 1998. Also includes 45,000 shares of Class B Common Stock owned by the Estate of Lawrence P. Wolfen, of which Mr. Wolfen serves as executor, and 300,000 shares of Class B Common Stock held on behalf of certain current and former partners of Irell & Manella and Mr. Wolfen's two grandchildren. Mr. Wolfen disclaims beneficial ownership of all of these shares. Excludes 225,000 shares of Class B Common Stock issued and sold to Irell & Manella pursuant to an agreement dated October 31, 1997, of which Mr. Wolfen's participation in the beneficial ownership therein is less than 5% of such shares. See "Certain Transactions." (9) The address for Cisco Systems is 170 West Tasman Drive, San Jose, California. (10) Includes 345,351 shares of Class B Common Stock owned by the Eichen Family Trust, of which Mr. Eichen is a trustee. Also includes 40,000 shares of Class A Common Stock issuable pursuant to options that are exercisable within 60 days of October 14, 1998. (11) The address for the Zweig-DiMenna entities is 900 Third Avenue, New York, New York 10022. Pursuant to a Schedule 13-G filed with the Commission, includes (i) 132,800 shares of Class A Common Stock held by Zweig-DiMenna International Limited, (ii) 54,600 shares of Class A Common Stock held by Zweig-DiMenna Partners, L.P., (iii) Zweig-DiMenna International Managers, (iv) 32,500 shares of Class A Common 59 61 Stock held by Zweig-DiMenna Special Opportunities, (v) 8,200 shares of Class A Common Stock held by Gotham Advisors, Inc., on behalf of a discretionary account, and (vi) Zwieg-DiMenna Investors, L.P. (12) Includes 40,000 shares of Class B Common Stock issuable pursuant to options that are currently exercisable. (13) The address for Dawson Samberg Capital Management, Inc. is 354 Pequot Avenue, Southport, CT 06490. Ownership interest presented is based upon a Schedule 13-G filed with the Commission. (14) Includes an aggregate of 920,000 shares of Class A Common Stock and 966,875 shares of Class B Common Stock issuable pursuant to options that are exercisable within 60 days of October 14, 1998. 60 62 DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 200,000,000 shares of Class A Common Stock, 100,000,000 shares of Class B Common Stock and 10,000,000 shares of Preferred Stock. The following summary of the capital stock of the Company and certain provisions of the Company's Articles of Incorporation and Bylaws does not purport to be complete and is qualified in its entirety by the provisions of the Articles of Incorporation and Bylaws, copies of which have been filed as exhibits to the Registration Statement of which this Prospectus is a part. COMMON STOCK The Company is authorized to issue 300,000,000 shares of Common Stock, $.0001 par value, of which 200,000,000 shares have been designated as Class A Common Stock and 100,000,000 shares have been designated as Class B Common Stock. At June 30, 1998, 4,904,750 shares and 38,835,074 shares of Class A Common Stock and Class B Common Stock, respectively, were outstanding. Such shares were held of record by approximately 43 holders and 328 holders, respectively. Voting Rights. Holders of Class A Common Stock are entitled to one vote per share and holders of Class B Common Stock are entitled to ten votes per share. Holders of Common Stock will vote together as a single class on all matters submitted to a vote of shareholders, except (i) as otherwise required by law and (ii) in the case of a proposed issuance of shares of Class B Common Stock, which issuance shall require the affirmative vote of the holders of the majority of the outstanding Class B Common Stock shares voting separately as a class. Under the Company's Articles of Incorporation and Bylaws, holders of Common Stock will not have cumulative voting rights after the Company is a "listed corporation" (as defined in California Corporations Code Section 301.5) and, holders of shares representing a majority of the voting power of Common Stock can elect all of the directors. In such event, the holders of the remaining shares will not be able to elect any directors. The Company anticipates it will qualify as a listed corporation as of its first annual meeting of the shareholders following this offering, provided that the Company has at least 800 holders of its equity securities as of the record date of such meeting. Dividends. Holders of record of shares of Common Stock are entitled to receive such dividends when, if and as may be declared by the Board of Directors out of funds legally available for such purposes, subject to the rights of preferred shareholders and the terms of any existing or future agreements between the Company and its debtholders. No dividends may be declared or paid on any share of any class of Common Stock, unless such dividend, at the same rate per share, is simultaneously declared or paid on each share of the other class of Common Stock. In the case of a stock dividend or distribution, holders of Class A Common Stock are entitled to receive the same percentage dividend or distribution as holders of Class B Common Stock and vice versa, except that stock dividends and distributions shall be made in shares of Class A Common Stock to the holders of Class A Common Stock and in shares of Class B Common Stock to the holders of Class B Common Stock unless the Company's Board of Directors determines in its discretion that it is more desirable to distribute shares of Class A Common Stock with respect to Class B Common Stock. The Company presently intends to retain future earnings, if any, for use in the operation and expansion of its business and does not anticipate paying cash dividends in the foreseeable future. Convertibility. Each share of Class B Common Stock is convertible, at the option of its holder, into one fully paid and nonassessable share of Class A Common Stock at any time. The Class A Common Stock is not convertible into Class B Common Stock. Each share of Class B Common Stock shall automatically be converted into one share of Class A Common Stock in the event such share shall be transferred (including, without limitation, by way of sale, assignment, exchange, gift, bequest, appointment or otherwise) to any person or entity other than a Permitted Transferee as such term is defined in the Articles of Incorporation. A Permitted Transferee generally includes the following transferees, among others: the shareholder's spouse, the lineal descendants or spouse of such descendants, the trustee of a trust for the benefit of the holder or a charitable organization, a charitable organization, or certain corporations, partnerships or other entities owned by the holder. 60 63 Liquidation Rights. Upon liquidation, dissolution or winding-up of the Company, the holders of Class A Common Stock are entitled to share ratably with the holders of Class B Common Stock in all assets available for distributions after payment in full to creditors and holders of Preferred Stock. Other Provisions. The holders of Common Stock are not entitled to preemptive or subscription rights. In any merger, consolidation or business combination, the consideration to be received per share by holders of Class A Common Stock is identical to that to be received by holders of Class B Common Stock. No class of Common Stock may be subdivided, consolidated, reclassified or otherwise changed unless the other class of Common Stock concurrently is subdivided, consolidated, reclassified or otherwise changed in the same proportion and in the same manner. All outstanding shares are, and the shares of Class A Common Stock offered hereby will be upon issuance, validly issued, fully paid and nonassessable. PREFERRED STOCK The Company has authorized 10,000,000 shares of Preferred Stock, $.0001 par value per share, which may be issued in series from time to time with such designations, relative rights, priorities, preferences, qualifications, limitations and restrictions thereof, to the extent that such qualities are not fixed in the Company's Articles of Incorporation, as the Board of Directors determines. No shares of the Company's Preferred Stock are outstanding. The rights, preferences, limitations and restrictions of different series of Preferred Stock may differ with respect to dividend rates, amounts payable on liquidation, voting rights, conversion rights, redemption provisions, sinking fund provisions and other matters. The Board of Directors may authorize the issuance of Preferred Stock with rights senior to the Common Stock with respect to the payment of dividends and the distribution of assets on liquidation. In addition, the Board of Directors is authorized to fix the limitations and restrictions, if any, upon the payment of dividends on Common Stock to be effective while any shares of Preferred Stock are outstanding. The Board of Directors, without shareholder approval, can issue Preferred Stock with voting and conversion rights which could adversely affect the voting power of the holders of Common Stock. The Company believes that the Preferred Stock will provide the Company with increased flexibility in structuring possible future financings and acquisitions, and in meeting other corporate needs that might arise. Having such authorized shares available for issuance will allow the Company to issue shares of Preferred Stock without the expense and delay of a special shareholders' meeting. Although the Company's Board of Directors has no intention at the present time of doing so, it could issue a series of Preferred Stock, the terms of which, subject to certain limitations imposed by the securities laws, could impede the completion of a merger, tender offer or other takeover attempt. The Company's Board of Directors will make any determination to issue such shares based on its judgment as to the best interests of the Company and its shareholders at the time of issuance. The Company's Board of Directors, in so acting, could issue Preferred Stock having terms that could discourage an acquisition attempt or other transaction that some, or a majority, of the shareholders might believe to be in their best interests or in which shareholders might receive a premium for their stock over the then market price of such stock. REGISTRATION RIGHTS Upon consummation of this offering, the holders of approximately shares of Common Stock (the "Registrable Securities") will be entitled to certain rights with respect to the registration of such shares under the Securities Act. In the event that the Company proposes to register any of its securities under the Securities Act, either for its own account or the account of other securityholders, the holders of Registrable Securities are entitled to notice of such registration and are entitled to include their Registrable Securities in such registration, subject to certain marketing and other limitations. The Company is generally obligated to bear the expenses, other than underwriting discounts and sales commissions, of these registrations. The Company may in certain circumstances defer such registrations and the underwriters have the right, subject to certain limitations, to limit the number of Registrable Securities included in such registrations. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the Company's Common Stock is U.S. Stock Transfer Corporation. Its telephone number is (818) 502-1404. 61 64 SHARES ELIGIBLE FOR FUTURE SALE Sales of a substantial number of shares of Class A Common Stock in the public market following this offering could adversely affect the market price of the Company's Class A Common Stock. The number of shares of Common Stock available for sale in the public market is limited by restrictions under the Securities Act and by the following lock-up agreements: (i) in connection with the Company's initial public offering, the Company's officers, directors and certain shareholders agreed (the "IPO Lock-Up Agreements") not to sell or otherwise dispose of any of their shares for 180 days following the date of the Company's initial public offering without the prior consent of Morgan Stanley & Co. Incorporated; (ii) in connection with a partial release in August 1998 of the IPO Lock-Up Agreements of up to 850,000 shares held by certain shareholders, such shareholders agreed (the "Extended Lock-Up Agreements) to extend their respective IPO Lock-Up Agreements by an additional 30 days; and (iii) in connection with this offering, the Company's officers, directors, the Selling Shareholders [and certain other shareholders] have entered into agreements with Morgan Stanley & Co. Incorporated (the "Follow-On Lock-Up Agreement") pursuant to which such holders have agreed not to sell or otherwise dispose of any of their shares for 90 days following the date of this offering without the prior consent of Morgan Stanley & Co. Incorporated. However, Morgan Stanley & Co. Incorporated may, in its sole discretion at any time and without notice, release all or any portion of the securities subject to the lock-up agreements described above. Upon completion of this offering, the Company will have outstanding an aggregate of 44,110,449 shares of Common Stock (based upon shares outstanding at June 30, 1998), assuming no exercise of the Underwriters' over-allotment option. Of these shares, 8,260,915 shares (including the 3,000,000 shares registered in this offering, the 4,025,000 shares sold in the Company's initial public offering and 1,235,915 shares sold in connection with partial releases from the IPO Lock-Up Agreements) will be freely tradable without restriction or further registration under the Securities Act, unless such shares are purchased by "Affiliates." The remaining 35,349,504 shares of Common Stock are "restricted securities" as that term is defined in Rule 144 under the Securities Act ("Restricted Shares"). Of such shares: (i) shares will become eligible for sale on October 14, 1998 upon expiration of the IPO Lock-Up Agreements pursuant to Rule 701 or Rule 144; (ii) shares will become eligible for sale on November 14, 1996, the expiration date of the Extended Lock-Up Agreements, pursuant to Rule 701 or Rule 144; (iii) shares will become eligible for sale on the expiration date of the Follow-On Lock-Up Agreements; and (iv) the remaining shares will become eligible for sale pursuant to Rule 701 or Rule 144 on various dates after the expiration of the Follow-On Lock-Up Agreements. In addition, 500,000 shares of Common Stock sold to Cisco Systems in April 1998 will be eligible for sale upon expiration of a one-year holding period, subject to certain contractual restrictions on transfer. Furthermore, in connection with a partial release from the IPO Lock-Up Agreement by Morgan Stanley & Co. Incorporated of 600,000 shares of the Company's Class B Common Stock owned by Scientific-Atlanta commencing October 2, 1998, Scientific-Atlanta has agreed to lock-up an additional 500,000 shares until a date 180 days after the earlier of (i) the date of this offering or (ii) October 14, 1998. In general, under Rule 144 as currently in effect, a person (or persons whose shares are aggregated) who has beneficially owned Restricted Shares for at least one year (including the holding period of any prior owner except an Affiliate) would be entitled to sell within any three-month period a number of shares that does not exceed the greater of: (i) one percent of the number of shares of Class A Common Stock then outstanding (which will equal approximately 78,397 shares immediately after this offering); or (ii) the average weekly trading volume of the Class A Common Stock on the Nasdaq National Market during the four calendar weeks preceding the filing of a notice on Form 144 with respect to such sale. Sales under Rule 144 are also subject to certain manner of sale provisions and notice requirements and to the availability of current public information about the Company. Under Rule 144(k), a person who is not deemed to have been an Affiliate of the Company at any time during the 90 days preceding a sale, and who has beneficially owned the shares proposed to be sold for at least two years (including the holding period of any prior owner except an Affiliate), is entitled to sell such shares without complying with the manner of sale, public information, volume limitation or notice provisions of Rule 144; therefore, unless otherwise restricted, "144(k) shares" may therefore be sold immediately upon the completion of this offering. In general, under Rule 701 of the Securities Act as currently in effect, any employee, consultant or advisor of the Company who purchases shares from the Company pursuant to Rule 701 in connection with a compensatory stock or option plan or other written agreement is 62 65 eligible to resell, unless contractually restricted, such shares 90 days after the effective date of this offering in reliance on Rule 144, but without compliance with certain restrictions, including the holding period, contained in Rule 144. The Company is unable to estimate the number of shares that will be sold under Rule 144, as this will depend on the market price for the Common Stock of the Company, the personal circumstances of the sellers and other factors. Prior to this offering, there has been no public market for the Common Stock, and there can be no assurance that a significant public market for the Common Stock will develop or be sustained after this offering. Any future sale of substantial amounts of Common Stock in the open market may adversely affect the market price of the Common Stock offered hereby. Pursuant to a Registration Rights Agreement among the Company and certain of its shareholders, holders of shares of Common Stock will be entitled to certain piggy-back registration rights with respect to such shares. See "Description of Capital Stock -- Registration Rights." Registration of such shares under the Securities Act would result in such shares becoming freely tradable without restriction under the Securities Act (except for shares purchased by Affiliates). During the 180-day period after the date of this Prospectus, the Company has agreed not to file any registration statement with respect to the registration of any shares of Common Stock or any securities convertible into or exercisable or exchangeable into Common Stock, other than a Registration Statement on Form S-8 covering securities issuable under the 1994 Plan, the Special Plan and the 1998 Plan, without the prior written consent of Morgan Stanley & Co. Incorporated. In August 1998, the Company filed a registration statement on Form S-8 under the Securities Act covering shares of Common Stock reserved for issuance under the 1994 Plan, the Special Plan and the 1998 Plan. See "Management -- Employee Benefit Plans." Accordingly, shares registered under such registration statement are, subject to Rule 144 volume limitations applicable to affiliates of the Company, available for sale in the open market, unless such shares are subject to vesting restrictions with the Company or the lock-up agreements described above. As of June 30, 1998, options to purchase 7,970,103 shares of Class B Common Stock and 714,550 shares of Class A Common Stock were issued and outstanding. See "Management -- Executive Compensation" and "-- Employee Benefit Plans." 63 66 UNDERWRITERS Under the terms and subject to the conditions contained in an Underwriting Agreement dated the date hereof (the "Underwriting Agreement"), the Underwriters named below (the "Underwriters"), for whom Morgan Stanley & Co. Incorporated, BT Alex. Brown Incorporated, Credit Suisse First Boston Corporation, Hambrecht & Quist LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated are acting as Representatives (the "Representatives"), have severally agreed to purchase, and the Company and the Selling Shareholders have agreed to sell to them, severally, the respective number of shares of Class A Common Stock set forth opposite the names of such Underwriters below:
NUMBER NAME OF SHARES ---- --------- Morgan Stanley & Co. Incorporated........................... BT Alex. Brown Incorporated................................. Credit Suisse First Boston Corporation...................... Hambrecht & Quist LLC....................................... Merrill Lynch, Pierce, Fenner & Smith Incorporated................................... --------- Total............................................. 3,000,000 =========
The Underwriting Agreement provides that the obligations of the several Underwriters to pay for and accept delivery of the shares of Class A Common Stock offered hereby are subject to the approval of certain legal matters by their counsel and to certain other conditions. The Underwriters are obligated to take and pay for all of the shares of Class A Common Stock offered hereby (other than those covered by the Underwriters' over-allotment option described below) if any such shares are taken. The Underwriters initially propose to offer part of the shares of Class A Common Stock directly to the public at the public offering price set forth on the cover page hereof and part to certain dealers at a price that represents a concession not in excess of $ a share under the public offering price. Any Underwriter may allow, and such dealers may reallow, a concession not in excess of $ a share to other Underwriters or to certain dealers. After the initial offering of the shares of Class A Common Stock, the offering price and other selling terms may from time to time be varied by the Representatives. The Company and certain Selling Shareholders have granted to the Underwriters an option, exercisable for 30 days from the date of this Prospectus, to purchase up to an aggregate of 450,000 additional shares of Class A Common Stock at the public offering price set forth on the cover page hereof, less underwriting discounts and commissions. The Underwriters may exercise such option solely for the purpose of covering over-allotments, if any, incurred in the sale of the shares of Class A Common Stock offered hereby. To the extent such option is exercised, each Underwriter will become obligated, subject to certain conditions, to purchase approximately the same percentage of such additional shares as the number set forth next to such Underwriter's name in the preceding table bears to the total number of shares of Class A Common Stock set forth next to the names of all the Underwriters in the preceding table. The Company, the Selling Shareholders and the Underwriters have agreed to indemnify each other against certain liabilities, including liabilities under the Securities Act. Each of the Company and the directors, executive officers, Selling Shareholders and certain other shareholders of the Company has agreed that, without the prior written consent of Morgan Stanley & Co. Incorporated on behalf of the Underwriters, it will not, during the period ending 90 days after the date of this Prospectus, (i) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, lend or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock or (ii) enter into any swap or other arrangement that transfers to another, in 64 67 whole or in part, any of the economic consequences of ownership of the Common Stock, whether any such transaction described in clause (i) or (ii) above is to be settled by delivery of Common Stock or such other securities, in cash or otherwise. In order to facilitate the offering of the Class A Common Stock, the Underwriters may engage in transactions that stabilize, maintain or otherwise affect the price of the Class A Common Stock. Specifically, the Underwriters may over-allot in connection with the offering, creating a short position in the Class A Common Stock for their own account. In addition, to cover over-allotments or to stabilize the price of the Class A Common Stock, the Underwriters may bid for, and purchase, shares of Class A Common Stock in the open market. Finally, the underwriting syndicate may reclaim selling concessions allowed to an Underwriter or a dealer for distributing the Class A Common Stock in the offering, if the syndicate repurchases previously distributed Class A Common Stock in transactions to cover syndicate short positions, in stabilization transactions or otherwise. Any of these activities may stabilize or maintain the market price of the Class A Common Stock above independent market levels. The Underwriters are not required to engage in these activities, and may end any of these activities at any time. The Underwriters and dealers may engage in passive market making transactions in the Class A Common Stock in accordance with Rule 103 of Regulation M promulgated by the Commission. In general, a passive market maker may not bid for, or purchase, the Class A Common Stock at a price that exceeds the highest independent bid. In addition, the net daily purchases made by any passive market maker generally may not exceed 30% of its average daily trading volume in the Class A Common Stock during a specified two month prior period or 200 shares, whichever is greater. A passive market maker must identify passive market making bids as such on the Nasdaq electronic inter-dealer reporting system. Passive market making may stabilize or maintain the market price of the Class A Common Stock above independent market levels. Underwriters and dealers are not required to engage in passive market making and may end passive market making activities at any time. 65 68 LEGAL MATTERS The validity of the shares of Common Stock offered hereby will be passed upon for the Company and the Selling Shareholders by Brobeck, Phleger & Harrison LLP, Irvine, California. Brobeck, Phleger & Harrison LLP holds a warrant to purchase 10,000 shares of Class A Common Stock at an exercise price equal to $24.00 per share. Certain legal matters relating to this offering will be passed upon for the Underwriters by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Palo Alto, California. EXPERTS The financial statements and schedules of the Company at December 31, 1996 and 1997 and for each of the three years in the period ended December 31, 1997, appearing in this Prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their reports thereon appearing elsewhere herein, and are included in reliance upon such reports given upon the authority of such firm as experts in accounting and auditing. AVAILABLE INFORMATION The Company has filed a Registration Statement on Form S-1 under the Securities Act with respect to the Class A Common Stock offered hereby. This Prospectus, which constitutes a part of the Registration Statement, omits certain of the information contained in the Registration Statement and the exhibits and schedules thereto on file with the Commission pursuant to the Securities Act and the rules and regulations of the Commission thereunder. For further information with respect to the Company and its Common Stock, reference is made to the Registration Statement and the exhibits and schedules thereto. Statements contained in this Prospectus regarding the contents of any agreement or other document filed as an exhibit to the Registration Statement are not necessarily complete, and in each instance reference is made to the copy of such agreement filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. The Registration Statement, including the exhibits and schedules thereto, can be inspected and copied at the Commission's offices as described above. The Company is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith files annual and quarterly reports, proxy statements and other information with the Commission. Such reports, proxy statements and other information filed by the Company with the Commission pursuant to the informational requirements of the Exchange Act may be inspected and copied at the public reference facilities maintained by the Commission at 450 Fifth Street, N.W., Room 1024, Judiciary Plaza, Washington, D.C. 20549, as well as at the Commission's Regional Offices at 7 World Trade Center, Suite 1300, New York, New York 10048 and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such material may be obtained at prescribed rates from the Public Reference Room of the Commission at 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549. Information concerning the operation of the Public Reference Room may be obtained by calling the Commission at 1-800-SEC-0330. The Commission maintains an Internet site at http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants, including the Company, that file electronically with the Commission. 66 69 GLOSSARY OF TECHNICAL TERMS Adaptive Equalization......... Receiver technique for compensating for distortions in a transmission media. ADSL.......................... Asymmetric Digital Subscriber Line. Twisted-pair modem technology that achieves data rates up to 8 Mbps downstream to the subscriber and 1 Mbps upstream to the network at distances up to 18,000 feet. Bandwidth..................... A range of signal frequencies, measured in cycles per second or Hertz (Hz). Also refers to the speed at which data is transmitted, measured in bits per second (bps). Broadband Communications...... Data transmission at speeds of greater than 1.5 Mbps. CMOS.......................... Complementary Metal Oxide Semiconductor. Technology used to manufacture silicon integrated circuits. DBS........................... Digital Broadcast Satellite. A broadband communications technology that broadcasts digital television programming from satellites directly to dish antennas. DSP........................... Digital Signal Processing. Ethernet (10Base-T)........... Networking protocol widely used in LANs for connecting devices by means of copper twisted pair wiring at speeds of 10 Mbps. Fast Ethernet (100Base-T)..... An extension to the 10Base-T Ethernet network access method which operates at 100 Mbps. FEC........................... Forward Error Correction. A receiver technique for correcting errors in the received data. GHz........................... GigaHertz. One billion cycles per second. Gigabit Ethernet (1000Base-T).................. An extension to the 100Base-T Ethernet network access method which operates at 1,000 Mbps or equivalently 1 Gbps. Headend....................... The central distribution point in a cable television system. Typically serves tens to hundreds of thousands of homes. HFC........................... Hybrid Fiber Coax. Upgraded cable plant which uses a combination of fiber optic cable in the backbone and coaxial cable in the subscriber feeder plant. IC............................ Integrated Circuit. kbps.......................... Kilobits per second. LAN........................... Local Area Network. A private data communications network linking a variety of data devices such as computers and printers within an office or home environment. LMDS.......................... Local Multipoint Distribution System. A broadband wireless communications network that uses microwave frequencies around 28 GHz to transmit video and data to residences over a cellular-like network at distances under a few miles. MAC........................... Media Access Control. Protocol for controlling the upstream and downstream traffic flow in a local or wide area network. Mbps.......................... Megabits per second. Million bits per second. 67 70 MCNS/DOCSIS................... Multimedia Cable Network System/Data Over Cable Service Interface Specifications. Industry specification that defines the technical equipment for high-speed cable modem and headend equipment. MMDS.......................... Multichannel Multipoint Distribution Service. A broadband wireless communications network that uses microwave frequencies around 2.5 GHz to transmit video to residences at distances up to tens of miles. MPEG.......................... Moving Picture Experts Group. Industry standard for compressing and decompressing digital audio video signals. NIC........................... Network Interface Card. Plug-in adapter card enables a computer to connect to a LAN. QAM........................... Quadrature Amplitude Modulation. A digital modulation technique that allows very efficient transmission of data over media with limited available bandwidth. QPSK.......................... Quadrature Phase Shift Keying. A digital technique which is widely employed in direct broadcast satellite transmission systems. VDSL.......................... Very High Bit-Rate Digital Subscriber Line. Twisted pair modem technology that achieves data rates up to 52 Mbps downstream to the subscriber and 6 Mbps upstream to the network at distances up to 4,000 feet. WAN........................... Wide Area Network. A data communications network, such as the Internet, which links a variety of data devices over a large geographical distance. xDSL.......................... Generic representation of the entire family of Digital Subscriber Line technology spanning data rates from 128 kbps to 52 Mbps depending on the distance between the central office and subscriber. 68 71 BROADCOM CORPORATION INDEX TO FINANCIAL STATEMENTS
PAGE ---- Report of Independent Auditors.............................. F-2 FINANCIAL STATEMENTS Balance Sheets at December 31, 1996 and 1997 and June 30, 1998 (Unaudited).......................................... F-3 Statements of Operations for the Years Ended December 31, 1995, 1996 and 1997 and the Six Months Ended June 30, 1997 and 1998 (Unaudited)...................................... F-4 Statements of Shareholders' Equity for the Years Ended December 31, 1995, 1996 and 1997 and the Six Months Ended June 30, 1997 and 1998 (Unaudited)........................ F-5 Statements of Cash Flows for the Years Ended December 31, 1994, 1995, 1996 and 1997 and the Six Months Ended June 30, 1998 (Unaudited)...................................... F-6 Notes to Financial Statements............................... F-7
F-1 72 REPORT OF INDEPENDENT AUDITORS Board of Directors and Shareholders Broadcom Corporation We have audited the accompanying balance sheets of Broadcom Corporation as of December 31, 1996 and 1997, and the related statements of operations, shareholders' equity, and cash flows for each of the three years in the 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 financial statements referred to above present fairly, in all material respects, the financial position of Broadcom Corporation at December 31, 1996 and 1997, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Orange County, California January 16, 1998, except for Note 9, as to which the date is March 31, 1998 and Note 7, as to which the date is September 25, 1998 F-2 73 BROADCOM CORPORATION BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31, ----------------- JUNE 30, 1996 1997 1998 ------- ------- ----------- (UNAUDITED) ASSETS Current assets: Cash and cash equivalents................................. $ 4,657 $22,116 $ 64,711 Short-term investments.................................... -- -- 2,629 Accounts receivable (net of allowance for doubtful accounts and sales returns of $147, $721 and $2,892 in 1996, 1997 and 1998)................................... 3,722 9,913 24,226 Inventory................................................. 854 2,705 11,473 Deferred taxes............................................ 519 1,090 1,090 Income taxes receivable................................... -- 433 402 Prepaid expenses.......................................... 227 262 1,252 ------- ------- -------- Total current assets.............................. 9,979 36,519 105,783 Property and equipment, net................................. 4,298 8,449 16,305 Long-term investments....................................... -- -- 25,094 Other assets................................................ 90 276 919 ------- ------- -------- Total assets...................................... $14,367 $45,244 $148,101 ======= ======= ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Trade accounts payable.................................... $ 2,140 $ 7,380 $ 15,280 Wages and related benefits................................ 372 846 1,794 Income taxes payable...................................... 1,812 -- -- Accrued liabilities....................................... 57 933 2,211 Current portion of long-term debt......................... 69 1,098 89 ------- ------- -------- Total current liabilities......................... 4,450 10,257 19,374 Long-term debt, less current portion........................ 147 1,595 45 Commitments and contingencies Shareholders' equity: Convertible Preferred Stock $.0001 par value: Authorized shares -- 10,000,000 Issued and outstanding shares -- 2,093,839 in 1996, 3,567,839 in 1997 and none in 1998................... 6,084 28,617 -- Class A Common Stock, $.0001 par value: Authorized shares--200,000,000......................... Issued and outstanding shares--none in 1996, 1997 and 4,839,750 in 1998.................................... Class B Common Stock, $.0001 par value: Authorized shares--100,000,000 Issued and outstanding shares--29,403,768 in 1996, 31,501,560 in 1997 and 38,878,199 in 1998............ 3 3 4 Additional paid-in capital................................ 1,160 7,126 120,621 Notes receivable from employees........................... (748) (3,362) (3,464) Deferred compensation..................................... -- (1,090) (5,956) Retained earnings......................................... 3,271 2,098 17,477 ------- ------- -------- Total shareholders' equity........................ 9,770 33,392 128,682 ------- ------- -------- Total liabilities and shareholders' equity........ $14,367 $45,244 $148,101 ======= ======= ========
See accompanying notes. F-3 74 BROADCOM CORPORATION STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
SIX MONTHS ENDED YEARS ENDED DECEMBER 31, JUNE 30, ---------------------------- ------------------ 1995 1996 1997 1997 1998 ------ ------- ------- ------- ------- (UNAUDITED) Revenue: Product revenue......................... $4,317 $18,981 $31,668 $ 8,169 $78,493 Development revenue..................... 1,790 2,389 5,287 2,257 2,019 ------ ------- ------- ------- ------- Total revenue................... 6,107 21,370 36,955 10,426 80,512 Cost of revenue........................... 1,398 7,860 14,926 4,810 34,212 ------ ------- ------- ------- ------- Gross profit.............................. 4,709 13,510 22,029 5,616 46,300 Operating expense: Research and development................ 2,687 5,662 16,204 6,205 14,619 Selling, general and administrative..... 2,135 3,546 8,063 2,541 9,322 ------ ------- ------- ------- ------- Total operating expense......... 4,822 9,208 24,267 8,746 23,941 ------ ------- ------- ------- ------- Income (loss) from operations............. (113) 4,302 (2,238) (3,130) 22,359 Interest and other income, net............ 120 213 290 63 1,301 ------ ------- ------- ------- ------- Income (loss) before income taxes......... 7 4,515 (1,948) (3,067) 23,660 Provision (benefit) for income taxes...... 3 1,499 (775) (1,226) 8,281 ------ ------- ------- ------- ------- Net income (loss)......................... $ 4 $ 3,016 $(1,173) $(1,841) $15,379 ====== ======= ======= ======= ======= Basic earnings (loss) per share........... $ .00 $ .12 $ (.04) $ (.07) $ .45 ====== ======= ======= ======= ======= Diluted earnings (loss) per share......... $ .00 $ .09 $ (.04) $ (.07) $ .35 ====== ======= ======= ======= =======
See accompanying notes. F-4 75 BROADCOM CORPORATION STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AMOUNTS)
CONVERTIBLE NOTES PREFERRED STOCK COMMON STOCK ADDITIONAL RECEIVABLE -------------------- ------------------- PAID-IN FROM DEFERRED SHARES AMOUNT SHARES AMOUNT CAPITAL EMPLOYEES COMPENSATION ---------- ------- ---------- ------ ---------- ---------- ------------ Balance at December 31, 1994......... 1,100,000 $ 2,161 22,995,000 $2 $ 60 $ -- $ -- Issuance of Preferred Stock, net of issuance costs of $11............ 500,000 989 -- -- -- -- -- Exercise of stock options.......... -- -- 5,100,000 1 339 (332) -- Net income......................... -- -- -- -- -- -- -- ---------- ------- ---------- -- -------- ------- ------- Balance at December 31, 1995......... 1,600,000 3,150 28,095,000 3 399 (332) -- Issuance of Preferred Stock, net of issuance costs of $29............ 493,839 2,934 -- -- -- -- -- Exercise of stock options, net of repurchases...................... -- -- 1,308,768 -- 761 (416) -- Net income......................... -- -- -- -- -- -- -- ---------- ------- ---------- -- -------- ------- ------- Balance at December 31, 1996......... 2,093,839 6,084 29,403,768 3 1,160 (748) -- Issuance of Preferred Stock, net of issuance costs of $36............ 1,500,000 22,689 -- -- -- -- -- Repurchases of Preferred Stock..... (26,000) (156) -- -- -- -- -- Issuance of Class B Common Stock... -- -- 285,000 -- 1,050 -- -- Exercise of stock options, net of repurchases...................... -- -- 1,812,792 -- 3,569 (2,614) -- Tax benefit from exercise of stock options.......................... -- -- -- -- 191 -- -- Deferred compensation related to grant of stock options........... -- -- -- -- 1,156 -- (1,156) Amortization of deferred compensation..................... -- -- -- -- -- -- 66 Net loss........................... -- -- -- -- -- -- -- ---------- ------- ---------- -- -------- ------- ------- Balance at December 31, 1997......... 3,567,839 28,617 31,501,560 3 7,126 (3,362) (1,090) Conversion of Preferred Stock into Class B Common Stock (unaudited)... (3,567,839) (28,617) 8,453,517 1 28,616 -- -- Issuance of Class A Common Stock in initial public offering, net of offering costs of $1,628 (unaudited)...................... -- -- 3,620,000 -- 79,170 -- -- Exercise of stock options, net of repurchases (unaudited).......... -- -- 142,872 -- 340 (191) -- Repayment of notes receivable from employees (unaudited)............ -- -- -- -- -- 89 -- Deferred compensation related to grant of stock options (unaudited)...................... -- -- -- -- 5,369 -- (5,369) Amortization of deferred compensation (unaudited)......... -- -- -- -- -- -- 503 Net income (unaudited)............. -- -- -- -- -- -- -- ---------- ------- ---------- -- -------- ------- ------- Balance at June 30, 1998 (unaudited)........................ -- $ -- 43,717,949 $4 $120,621 $(3,464) $(5,956) ========== ======= ========== == ======== ======= ======= TOTAL RETAINED SHAREHOLDERS' EARNINGS EQUITY -------- ------------- Balance at December 31, 1994......... $ 251 $ 2,474 Issuance of Preferred Stock, net of issuance costs of $11............ -- 989 Exercise of stock options.......... -- 8 Net income......................... 4 4 ------- -------- Balance at December 31, 1995......... 255 3,475 Issuance of Preferred Stock, net of issuance costs of $29............ -- 2,934 Exercise of stock options, net of repurchases...................... -- 345 Net income......................... 3,016 3,016 ------- -------- Balance at December 31, 1996......... 3,271 9,770 Issuance of Preferred Stock, net of issuance costs of $36............ -- 22,689 Repurchases of Preferred Stock..... -- (156) Issuance of Class B Common Stock... -- 1,050 Exercise of stock options, net of repurchases...................... -- 955 Tax benefit from exercise of stock options.......................... -- 191 Deferred compensation related to grant of stock options........... -- -- Amortization of deferred compensation..................... -- 66 Net loss........................... (1,173) (1,173) ------- -------- Balance at December 31, 1997......... 2,098 33,392 Conversion of Preferred Stock into Class B Common Stock (unaudited)... -- -- Issuance of Class A Common Stock in initial public offering, net of offering costs of $1,628 (unaudited)...................... -- 79,170 Exercise of stock options, net of repurchases (unaudited).......... -- 149 Repayment of notes receivable from employees (unaudited)............ -- 89 Deferred compensation related to grant of stock options (unaudited)...................... -- -- Amortization of deferred compensation (unaudited)......... -- 503 Net income (unaudited)............. 15,379 15,379 ------- -------- Balance at June 30, 1998 (unaudited)........................ $17,477 $128,682 ======= ========
See accompanying notes. F-5 76 BROADCOM CORPORATION STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEARS ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30, ----------------------------- ------------------------- 1995 1996 1997 1997 1998 ------- ------- ------- --------- ---------- (UNAUDITED) OPERATING ACTIVITIES Net income (loss)..................... $ 4 $ 3,016 $(1,173) $(1,841) $ 15,379 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization.... 451 897 3,039 1,443 2,841 Amortization of deferred compensation................... -- -- 66 -- 503 Deferred taxes................... (48) (416) (571) -- -- Change in operating assets and liabilities: Accounts receivable............ 547 (2,982) (6,191) (874) (14,313) Inventory...................... (242) (461) (1,851) 483 (8,768) Other assets................... (32) (251) (221) (118) (1,633) Accounts payable............... 443 1,276 5,240 (704) 7,900 Income taxes payable........... (23) 1,835 (2,245) (3,076) 31 Other accrued liabilities...... (43) 285 1,350 3,118 2,226 ------- ------- ------- ------- -------- Net cash provided by (used in) operating activities................ 1,057 3,199 (2,557) (1,569) 4,166 INVESTING ACTIVITIES Purchases of property and equipment... (1,112) (3,747) (7,132) (2,985) (10,697) Proceeds from sales of investments available-for-sale.................. 996 -- -- -- (27,723) ------- ------- ------- ------- -------- Net cash used in investing activities.......................... (116) (3,747) (7,132) (2,985) (38,420) FINANCING ACTIVITIES Proceeds from bank term loan.......... -- -- 3,000 3,000 -- Payments on bank term loan............ -- -- (500) -- (2,500) Payments on capital lease obligations......................... (48) (64) (81) (36) (59) Proceeds from issuance of Preferred Stock............................... 989 2,934 22,689 -- -- Payments on repurchase of Preferred Stock............................... -- -- (156) -- -- Net proceeds from initial public offering of Class A Common Stock.... -- -- -- -- 79,170 Net proceeds from issuance (payments for repurchase) of Class B Common Stock............................... 8 345 2,196 (6) 238 ------- ------- ------- ------- -------- Net cash provided by financing activities.......................... 949 3,215 27,148 2,958 76,849 ------- ------- ------- ------- -------- Increase in cash and cash equivalents......................... 1,890 2,667 17,459 (1,596) 42,595 Cash and cash equivalents at beginning of year............................. 100 1,990 4,657 7,417 22,116 ------- ------- ------- ------- -------- Cash and cash equivalents at end of year................................ $ 1,990 $ 4,657 $22,116 $ 5,821 $ 64,711 ======= ======= ======= ======= ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Interest paid......................... $ 8 $ 26 $ 191 $ 11 $ 37 ======= ======= ======= ======= ======== Income taxes paid..................... $ 125 $ 79 $ 1,850 $ 1,500 $ 8,250 ======= ======= ======= ======= ========
See accompanying notes. F-6 77 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES THE COMPANY Broadcom is a leading developer of highly integrated silicon solutions which enable broadband digital data transmission to the home and within the business enterprise. The Company's products enable the transmission of broadband data over existing communications infrastructures, most of which were not originally intended for digital data transmission. In anticipation of an initial public offering of the Company's Class A Common Stock, in February 1998, the Board of Directors approved the amendment and restatement of the articles of incorporation to authorize 200,000,000 shares of Class A Common Stock, 100,000,000 shares of Class B Common Stock and 10,000,000 shares of Preferred Stock. Upon consummation of the initial public offering, each share of Series A, B, C and D Preferred Stock converted into three shares of Class B Common Stock, and each share of Series E Preferred Stock converted into 1.5 shares of Class B Common Stock. Effective with the amendment of the articles of incorporation, outstanding stock options at December 31, 1997 become exercisable for shares of Class B Common Stock. The shares of Class A and Class B Common Stock are substantially identical, except that holders of Class A Common Stock are entitled to one vote for each share held, and holders of Class B Common Stock are entitled to ten votes for each share held on all matters submitted to a vote of the shareholders. UNAUDITED INTERIM FINANCIAL INFORMATION The financial information at June 30, 1998 and for the six months ended June 30, 1997 and 1998 is unaudited but includes all adjustments (consisting only of normal recurring adjustments) which the Company considers necessary for a fair presentation of the financial position at such date and the operating results and cash flows for those periods. Results for the six month period ended June 30, 1998 are not necessarily indicative of results that may be expected for the year ending December 31, 1998. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Significant estimates made in preparing the financial statements include the allowance for doubtful accounts, inventory reserves and income tax valuation allowances. STATEMENT OF CASH FLOWS For purposes of the statement of cash flows, the Company considers investment securities with original maturities of three months or less to be cash equivalents. The following table sets forth certain non-cash transactions excluded from the statements of cash flows:
SIX MONTHS ENDED YEARS ENDED DECEMBER 31, JUNE 30, -------------------------- -------------------- 1995 1996 1997 1997 1998 ------ ------ -------- ---- ---- (UNAUDITED) (IN THOUSANDS) Purchase of equipment through capital leases.................................. $ 12 $231 $ 58 $ 6 $ -- Notes receivable from employees issued in connection with exercise of stock options................................. 332 416 2,614 $191 $461
F-7 78 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) REVENUE RECOGNITION Revenue from product sales is recognized at the time of shipment. Provision is made currently for estimated product returns. Development revenue is recognized when earned. INVESTMENTS The Company accounts for its investments in debt securities under Financial Accounting Standards Board (FASB) Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities. Management determines the appropriate classification of such securities at the time of purchase and reevaluates such classification as of each balance sheet date. The investments are adjusted for amortization of premiums and discounts to maturity and such amortization is included in interest income. Realized gains and losses and declines in value judged to be other than temporary are determined based on the specific identification method and are reported in the statement of operations. INVENTORY Inventory is stated at the lower of cost (first-in, first-out) or market and consists of the following:
DECEMBER 31, ----------------- JUNE 30, 1996 1997 1998 ------ ------- ----------- (UNAUDITED) (IN THOUSANDS) Work in process................................ $ 579 $ 2,315 $ 4,299 Finished goods................................. 1,024 2,076 9,875 ------ ------- ------- 1,603 4,391 14,174 Less reserve for excess and obsolete inventory.................................... (749) (1,686) (2,701) ------ ------- ------- $ 854 $ 2,705 $11,473 ====== ======= =======
PROPERTY AND EQUIPMENT Property and equipment is carried at cost. Depreciation and amortization have been provided on the straight-line method over the assets' estimated useful lives ranging from two to seven years. Property and equipment were comprised of the following:
DECEMBER 31, ------------------ JUNE 30, 1996 1997 1998 ------- ------- ----------- (UNAUDITED) (IN THOUSANDS) Office furniture.............................. $ 176 $ 273 $ 644 Computer equipment............................ 5,621 12,563 22,359 Leasehold improvements........................ 145 296 826 ------- ------- ------- 5,942 13,132 23,829 Less accumulated depreciation and amortization................................ (1,644) (4,683) (7,524) ------- ------- ------- $ 4,298 $ 8,449 $16,305 ======= ======= =======
F-8 79 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) LONG-LIVED ASSETS Effective January 1, 1996, the Company adopted FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present. Implementation of Statement No. 121 was immaterial to the financial statements of the Company. STOCK-BASED COMPENSATION The Company has elected to follow Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related Interpretations in accounting for its employee stock options because the alternative fair value accounting provided for under FASB Statement No. 123, Accounting for Stock-Based Compensation, requires use of option valuation models that were not developed for use in valuing employee stock options. EARNINGS PER SHARE In 1997, the FASB issued Statement No. 128, Earnings Per Share, which replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is similar to fully diluted earnings per share. All earnings per share amounts for all periods have been presented to conform with the Statement No. 128 requirements and the accounting rules set forth in Staff Accounting Bulletin 98 issued by the Securities and Exchange Commission on February 3, 1998. The following table sets forth the computation of earnings (loss) per share:
SIX MONTHS ENDED YEARS ENDED DECEMBER 31, JUNE 30, ----------------------------- ------------------ 1995 1996 1997 1997 1998 ------- ------- ------- ------- ------- (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE DATA) Numerator: Net income (loss)............. $ 4 $ 3,016 $(1,173) $(1,841) $15,379 ======= ======= ======= ======= ======= Denominator: Weighted-average shares outstanding.... 25,618 28,840 30,213 29,483 37,652 Less: nonvested common shares outstanding......................... (3,888) (3,901) (3,762) (3,553) (3,368) ------- ------- ------- ------- ------- Denominator for basic earnings per common share.................................. 21,730 24,939 26,451 25,930 34,284 Effect of dilutive securities: Nonvested common shares................ -- 1,851 -- -- 2,040 Stock options.......................... -- 195 -- -- 4,026 Convertible Preferred Stock............ 4,550 6,158 -- -- 4,226 ------- ------- ------- ------- ------- Denominator for diluted earnings per common share........................... 26,280 33,143 26,451 25,930 44,576 ======= ======= ======= ======= ======= Basic earnings (loss) per share........ $ .00 $ .12 $ (.04) $ (.07) $ .45 ======= ======= ======= ======= ======= Diluted earnings (loss) per share...... $ .00 $ .09 $ (.04) $ (.07) $ .35 ======= ======= ======= ======= =======
F-9 80 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) RESEARCH AND DEVELOPMENT EXPENDITURES Research and development expenditures are expensed in the period incurred. WARRANTY The Company provides a one-year warranty on all products and records a related provision for estimated warranty costs at the date of sale. The Company had no reserve for estimated warranty liability at December 31, 1995 and 1996, and had a reserve of $150,000 at December 31, 1997. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments consist principally of cash and cash equivalents, short-term and long-term investments, receivables, accounts payable, and borrowings. The Company believes all of the financial instruments' recorded values approximate current values. RECENT ACCOUNTING PRONOUNCEMENTS In June 1997, the FASB issued Statement No. 130, Reporting Comprehensive Income, which establishes standards for the reporting and display of comprehensive income and its components in financial statements. Comprehensive income generally represents all changes in shareholders' equity except those resulting from investments by distributions to shareholders. Statement No. 130 is effective for fiscal years beginning after December 15, 1997 and requires restatement of earlier periods presented. Also in June 1997, the FASB issued Statement No. 131, Disclosures about Segments of an Enterprise and Related Information, which requires publicly-held companies to report financial and descriptive information about its operating segments in financial statements issued to shareholders for interim and annual periods. The statement also requires additional disclosures with respect to products and services, geographical areas of operations, and major customers. Statement No. 131 is effective for fiscal years beginning after December 15, 1997 and requires restatement of earlier periods presented. 2. INCOME TAXES The Company utilizes the liability method of accounting for income taxes as set forth in Statement No. 109, Accounting for Income Taxes. Under the liability method, deferred taxes are determined based on the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. A reconciliation of the provision (benefit) for income taxes at the federal statutory rate compared to the Company's effective tax rate follows:
YEARS ENDED DECEMBER 31, -------------------------- 1995 1996 1997 ----- ------- ------ (IN THOUSANDS) Statutory federal provision (benefit) for income taxes...... $ 2 $1,535 $(662) Increase (decrease) in taxes resulting from: State taxes, net of federal benefit....................... 1 218 40 Benefit of research and development tax credits........... (7) (270) (229) Other..................................................... 7 16 76 --- ------ ----- Total provision (benefit) for income taxes.................. $ 3 $1,499 $(775) === ====== =====
F-10 81 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 2. INCOME TAXES (CONTINUED) The federal and state income tax provision (benefit) is summarized as follows:
YEARS ENDED DECEMBER 31, -------------------------- 1995 1996 1997 ----- ------- ------ (IN THOUSANDS) Current: Federal.................................................. $ 50 $1,578 $(205) State.................................................... 1 337 1 ---- ------ ----- 51 1,915 (204) Deferred: Federal.................................................. (48) (409) (631) State.................................................... -- (7) 60 ---- ------ ----- (48) (416) (571) ---- ------ ----- $ 3 $1,499 $(775) ==== ====== =====
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred taxes are as follows:
YEARS ENDED DECEMBER 31, -------------------------- 1995 1996 1997 ------ ----- ------- (IN THOUSANDS) Deferred tax liabilities: Tax depreciation in excess of book depreciation........... $ (33) $(54) $ -- Deferred tax assets: Book depreciation in excess of tax depreciation........... -- -- 60 Research and experimentation tax credit carryforwards..... 164 -- 141 Net operating loss carryforwards.......................... -- -- 5 Reserves and accruals not currently deductible for tax purposes............................................... 73 447 1,208 State tax, net of federal benefit......................... -- 117 -- Other..................................................... -- 9 9 Valuation allowance....................................... (101) -- (333) ----- ---- ------ Net deferred tax assets..................................... $ 103 $519 $1,090 ===== ==== ======
The reduction in the valuation allowance in 1996 was primarily due to the utilization of research and experimentation tax credit carryforwards. The increase in the valuation allowance in 1997 was entirely related to the state deferred tax assets because of the uncertainty of the effect of anticipated stock option exercises on future state taxable income. Any future benefits recognized from any reduction of the valuation allowance will result in a reduction of income tax expense. At December 31, 1997, the Company had approximately $91,000 of state net operating loss carryforwards and $141,000 of state research credit carryforwards. These state net operating loss carryforwards and research credit carryforwards will expire in 2002 and 2012, respectively. F-11 82 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 3. LONG-TERM DEBT In March 1995, the Company entered into a Loan and Security Agreement with Silicon Valley Bank (SVB) which, as amended in June 1997, provides for a $3.0 million term loan and a $3.0 million revolving credit facility. A $500,000 letter of credit facility is also provided in the agreement provided that sufficient credit is available under the other two facilities. During 1997, the full amount of the $3.0 million term loan facility was utilized at an interest rate of SVB's prime rate as announced from time to time plus .5%. At December 31, 1997, $2.5 million was outstanding under the term loan facility which matures in June 2000. The borrowing base for the revolving credit facility is equal to 80% of the Company's eligible accounts receivable from United States customers. Interest on this facility is equal to SVB's prime rate announced from time to time. At December 31, 1997, no amounts were outstanding under the revolving credit or letter of credit facilities, which expired on April 5, 1998. The Loan and Security Agreement prohibits the payment of cash dividends, limits the amount of additional indebtedness the Company may incur, and contains certain minimum net worth, profitability and various other financial ratio requirements. Substantially all of the Company's assets are collateral under the loan and security agreement. The following is a summary of the Company's long-term debt and other loans at:
DECEMBER 31, --------------- JUNE 30, 1996 1997 1998 ---- ------- ----------- (UNAUDITED) (IN THOUSANDS) Silicon Valley Bank term loan collateralized by substantially all of the Company's assets, payable in varying monthly installments at a rate of 9.3%....... $ -- $ 2,500 $ -- Capitalized lease obligations payable in varying monthly installments at rates from 10.4% to 22.3%.... 216 193 134 ---- ------- ---- 216 2,693 134 Less current portion of long-term debt................. (69) (1,098) (89) ---- ------- ---- $147 $ 1,595 $ 45 ==== ======= ====
Principal payments on long-term debt are as follows: $1,098,000 in 1998; $1,041,000 in 1999; $537,000 in 2000; $16,000 in 2001; and $1,000 in 2002. Interest expense for the years ended December 31, 1995, 1996 and 1997 was $8,000, $26,000 and $171,000, respectively. 4. COMMITMENTS The Company has entered into operating leases for its computer equipment and facilities with varying terms and escalation clauses. Future minimum payments under noncancelable operating leases with initial terms of one year or more are as follows: $656,000 in 1998; $327,000 in 1999; $244,000 in 2000; $140,000 in 2001; and $48,000 in 2002. Rent expense for the years ended December 31, 1995, 1996, and 1997 aggregated $177,000, $325,000 and $739,000, respectively. The Company had commitments totaling approximately $2.1 million as of December 31, 1997 for the purchase of test equipment. F-12 83 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 5. SHAREHOLDERS' EQUITY CONVERTIBLE PREFERRED STOCK Preferred Stock consisted of the following at December 31, 1997:
SHARES SHARES ISSUED LIQUIDATION SERIES AUTHORIZED AND OUTSTANDING PREFERENCE ------ ---------- --------------- ----------- A.............................................. 500,000 500,000 $ 1,000,000 B.............................................. 600,000 600,000 1,200,000 C.............................................. 500,000 500,000 1,000,000 D.............................................. 500,000 467,839 2,807,034 E.............................................. 1,800,000 1,500,000 22,725,000 Undesignated................................... 6,100,000 -- -- ---------- --------- ----------- 10,000,000 3,567,839 $28,732,034 ========== ========= ===========
Each share of Series A, B, C and D Preferred Stock is convertible into three shares of Class B Common Stock. Each share of Series E Preferred Stock is convertible into 1.5 shares of Class B Common Stock. Such shares may be converted at any time at the option of the holder and automatically convert into Class B Common Stock in the event of an underwritten public offering of the Company's Common Stock as long as the value of the Company for purposes of the public offering is not less than $45,000,000. Holders of the Company's Series A, B, C, D and E Preferred Stock are entitled to noncumulative annual dividends of $0.20 per share in preference to holders of Common Stock when declared by the Board of Directors. No such cash dividends have been declared since the inception of the Company. In the event of the liquidation of the Company, holders of Series A, B, C, D and E Preferred Stock are entitled to receive an amount per share equal to the original issuance price plus declared and unpaid dividends, prior and in preference to any distribution of assets to holders of Common Stock. The holders of Series A, B, C, D and E Preferred Stock have the right to purchase additional shares of stock in order to maintain their ownership percentage in the event of certain future sales of stock by the Company. Holders of Series A, B, C, D and E Preferred Stock are entitled to the same number of votes per share on any and all matters submitted to a shareholders vote as the Class B Common Stock into which the Preferred Stock is convertible. COMMON STOCK Pursuant to an agreement dated as of October 31, 1997, the Company issued and sold an aggregate of 225,000 shares of Class B Common Stock to Irell & Manella LLP for an aggregate purchase price of $1,050,000. Werner F. Wolfen, a director of the Company, is a Senior Partner of Irell & Manella. During 1997, the Company paid approximately $1.2 million to Irell & Manella for legal services rendered by that firm. Irell & Manella has represented and continues to represent the Company in various legal matters. STOCK OPTIONS Under the Company's Amended and Restated 1994 Stock Option Plan (the 1994 Plan), the Board of Directors or a Committee consisting of two or more members of its Board of Directors is authorized to grant options to purchase the Company's Class B Common Stock to its employees, members of the Board of Directors, and certain consultants. Incentive options may be granted at an exercise price equal to or greater F-13 84 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 5. SHAREHOLDERS' EQUITY (CONTINUED) than 100% of the fair market value at the date of grant, and non-qualified options may be granted at an exercise price equal to or greater than 85% of the fair market value on the date of grant. The options are exercisable immediately upon issuance and generally have a term of ten years. The Company reserves the right to purchase all unvested shares held by the participant upon the participant's termination at the original purchase price. Fully vested shares not purchased by the participant within three months after termination are cancelled and returned to the plan. The vesting schedule is determined by the Board or the Committee at the time of issuance. Stock options generally vest at the rate of 25% after one year and ratably on a monthly basis for three years thereafter. Until the Company's Common Stock is registered with the Securities and Exchange Commission, the Company has the right of first refusal to purchase any shares of Common Stock issued under the 1994 Plan. At the discretion of the Board or the Committee, the Company may make secured loans to option holders in amounts up to the exercise price of their options plus related taxes or permit the option holder to pay the exercise price in installments over a determined period. During 1995, 1996 and 1997, the Company loaned $332,000, $416,000 and $2,614,000 to employees for the exercise of options, respectively. These notes are full-recourse, are secured by the shares of stock, are interest bearing with rates ranging from 6.0% to 6.5%, are due between three and five years from the exercise date and must be repaid upon sale of the underlying shares of stock. During 1995, 1996 and 1997, the Company's Board of Directors approved an increase in the number of common shares reserved and available for issuance under the 1994 Plan by 1,650,000 shares, 4,500,000 shares and 9,600,000 shares, respectively (or from 3,750,000 shares in 1995 to 19,500,000 shares in 1997). Activity under the 1994 Plan is set forth below:
OPTIONS OUTSTANDING ---------------------------------------------- WEIGHTED- SHARES AVERAGE AVAILABLE NUMBER OF PRICE EXERCISE FOR GRANT SHARES PER SHARE PRICE ---------- ---------- -------------- -------------- Balance at December 31, 1994.......... 492,000 3,258,000 $ .07 $ .07 Additional shares reserved.......... 1,650,000 -- -- -- Options granted..................... (1,942,500) 1,942,500 .07 .07 Options canceled.................... 3,000 (3,000) .07 .07 Options exercised................... -- (5,100,000) .07 .07 ---------- ---------- -------------- ----- Balance at December 31, 1995.......... 202,500 97,500 .07 .07 Additional shares reserved.......... 4,500,000 -- -- -- Options granted..................... (3,269,250) 3,269,250 .07 - 1.13 .73 Options exercised................... -- (1,314,300) .07 - 1.13 .51 ---------- ---------- -------------- ----- Balance at December 31, 1996.......... 1,433,250 2,052,450 .07 - 1.13 .85 Additional shares reserved.......... 9,600,000 -- -- -- Options granted..................... (5,330,400) 5,330,400 1.13 - 8.00 2.52 Options canceled.................... 11,061 (11,061) .50 - 1.13 .79 Options exercised................... -- (1,970,357) .50 - 8.00 1.87 ---------- ---------- -------------- ----- Balance at December 31, 1997.......... 5,713,911 5,401,432 $ .07 - $8.00 $2.12 ========== ========== ============== =====
F-14 85 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 5. SHAREHOLDERS' EQUITY (CONTINUED) The weighted average remaining contractual life and weighted average exercise price of options outstanding and of options exercisable as of December 31, 1997 were as follows:
OUTSTANDING ------------------------------------------------- WEIGHTED AVERAGE EXERCISABLE NUMBER OF REMAINING ------------------------------ RANGE OF SHARES CONTRACTUAL LIFE WEIGHTED AVERAGE SHARES WEIGHTED AVERAGE EXERCISE PRICES OUTSTANDING (YEARS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE --------------- ----------- ---------------- ---------------- ----------- ---------------- $ .07 to $1.00....... 698,325 8.37 $ .62 698,325 $ .62 $1.13 to $1.25....... 3,089,707 9.28 $1.16 3,089,707 $1.16 $3.00 to $5.00....... 1,376,400 9.83 $4.04 1,376,400 $4.04 $8.00................ 237,000 9.99 $8.00 237,000 $8.00
Additional information relating to the 1994 Plan is as follows at December 31:
1995 1996 1997 --------- --------- ---------- Nonvested common shares subject to repurchase.... 3,888,092 3,900,590 3,572,742 Weighted average repurchase price................ $.07 $.21 $1.05 Unvested options outstanding..................... 90,000 1,997,273 5,385,588 Total reserved Class B Common Stock shares for stock option plans............................. 300,000 3,485,700 11,115,343
The Company recorded deferred compensation of $1,156,000 during the year ended December 31, 1997 for the difference between the exercise price and the deemed value of certain of the Company's stock options granted under the 1994 Plan. These amounts are being amortized by charges to operations over the vesting periods of the individual stock options, which are generally four years. In the year ended December 31, 1997, $66,000 (pre-tax) was amortized to expense. PRO FORMA DISCLOSURES OF THE EFFECT OF STOCK-BASED COMPENSATION PLANS Pro forma information regarding results of operations and net income (loss) per share is required by Statement No. 123 for stock-based awards to employees as if the Company had accounted for such awards using a valuation method permitted under Statement No. 123. Stock-based awards to employees under the Plan during the years ended December 31, 1995, 1996 and 1997 were valued using the minimum value method, assuming no expected dividends, a weighted-average expected life of 3.5 years and a weighted-average risk-free interest rate of 6.0%. Should the Company complete an initial public offering of its common stock, stock-based awards granted thereafter will be valued using the Black-Scholes option pricing model. Among other things, the Black-Scholes model considers the expected volatility of the Company's stock price, determined in accordance with Statement No. 123, in arriving at an estimated fair value. The minimum value method does not consider stock price volatility. Further, certain other assumptions necessary to apply the Black-Scholes model may differ significantly from assumptions used to calculate the value of stock-based awards under the minimum value method. F-15 86 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 5. SHAREHOLDERS' EQUITY (CONTINUED) The weighted-average minimum values of options granted to employees during 1995, 1996 and 1997 were $0.01, $0.12 and $0.75, respectively. For pro forma purposes, the estimated minimum value of the Company's stock-based awards to employees is amortized over the vesting period of the underlying instruments. The results of applying Statement No. 123 to the Company's stock-based awards to employees would approximate the following:
YEARS ENDED DECEMBER 31, ----------------------------- 1995 1996 1997 ---- ------ ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Pro forma: Net income (loss)................................... $ -- $2,947 $(1,755) Basic earnings (loss) per share..................... $.00 $ .12 $ (.07) Diluted earnings (loss) per share................... $.00 $ .08 $ (.07)
6. EMPLOYEE BENEFIT PLANS The Company sponsors a defined contribution 401(k) Savings and Investment Plan which was established in 1996, covering substantially all of the Company's employees, subject to certain eligibility requirements. At its discretion, the Company may make contributions to the plan. No contributions were made by the Company in 1996 or 1997. 7. LITIGATION In December 1996, Stanford Telecommunications, Inc. filed an action against the Company in the United States District Court for the Northern District of California. STI alleges that the Company's BCM3036, BCM3037, BCM3300, BCM93220 and BCM93220B products infringe one of STI's patents (the " '352 Patent"). STI is seeking an injunction as well as the recovery of monetary damages, including treble damages for willful infringement. The Company has filed an answer and affirmative defenses to STI's complaint, denying the allegations in STI's complaint, and has asserted a counterclaim requesting declaratory relief that the Company is not infringing the '352 Patent and that the '352 Patent is invalid and unenforceable. The Company believes that it has strong defenses to STI's claims on invalidity, noninfringement and inequitable conduct grounds. The Company and STI are currently conducting discovery in this case. On June 10, 1998 and July 21, 1998, the Court issued orders interpreting the claims of the '352 patent. The Court has scheduled trial for May 1999. Although the Company believes that it has strong defenses, a finding of infringement by the Company in this action could lead to liability for monetary damages (which could be trebled in the event that the infringement were found to have been willful), the issuance of an injunction requiring that the Company withdraw various products from the market, substantial product redesign expenses (assuming that a non-infringing design is feasible and economic) and associated time-to-market delays, and indemnification claims by the Company's customers or strategic partners, each of which events could have a material adverse effect on the Company's business, financial condition and results of operations. In April 1997, Sarnoff Corporation and Sarnoff Digital Communications, Inc. (collectively, "Sarnoff") filed a complaint in New Jersey Superior Court against the Company and five former Sarnoff employees now employed by the Company (the "Former Employees") asserting claims against the Former Employees for breach of contract, misappropriation of trade secrets, and breach of the covenant of good faith and fair dealing, and against the Company for inducing such actions. Those claims relate to the alleged disclosure of certain technology of Sarnoff to the Company. The complaint also asserts claims against the Company and the Former Employees for unfair competition, misappropriation and misuse of trade secrets and confidential, F-16 87 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 7. LITIGATION (CONTINUED) proprietary information of Sarnoff, and tortious interference with present and prospective economic advantage, as well as a claim against the Company alleging that it "illegally pirated" Sarnoff's employees. The complaint seeks to preliminarily and permanently enjoin the Company and the Former Employees from utilizing any alleged Sarnoff trade secrets, and to restrain the Former Employees from violating their alleged statutory and contractual duties of confidentiality to Sarnoff by, for example, precluding them from working for six months in any capacity relating to certain of the Company's programs. The Company has asserted and believes that Sarnoff's claims are without merit. The Company has filed an answer and is vigorously defending itself in this action. In May 1997, the New Jersey court denied Sarnoff's request for a temporary restraining order. In June 1998, the New Jersey court denied the Company's motion for summary judgment. Sarnoff has clarified its claims to some extent by specifying in greater detail the trade secrets that it alleges the Company and the Former Employees misappropriated. The Company intends to file new motions for summary judgment based on recent admissions and other events. In August 1998, the New Jersey court set a new date, September 30, 1998, for the close of discovery in this case. Trial is scheduled for November 1998. In July 1997, the Company commenced an action against Sarnoff in the California Superior Court alleging breach of contract, fraud, misappropriation of trade secrets, false advertising, trade libel, intentional interference with prospective economic advantage and unfair competition. The claims center on Sarnoff's violation of a non-disclosure agreement entered into with the Company with respect to limited use of certain of the Company's technology and on inaccurate comparisons that the Company believes Sarnoff has made in its product advertising and in statements to potential customers and others. This action was removed to the United States District Court for the Central District of California, and was stayed pending resolution of the New Jersey action described in the preceding paragraph. Notwithstanding that the California action is currently stayed, the Company believes that it involves facts, circumstances and claims unrelated to those at issue in the New Jersey action, and the Company intends to vigorously prosecute the California action against Sarnoff. In December 1997, Rockwell Semiconductor Systems, Inc. ("RSSI") filed a complaint in California Superior Court against the Company asserting misappropriation of trade secrets, breach of duty of loyalty, tortious interference with prospective business advantage, unfair business practices and unfair competition. These alleged claims related to the Company's hiring of several former employees of RSSI. The Company and RSSI have executed a settlement agreement in this action, pursuant to which the Company has agreed not to hire or extend an offer to any employees from RSSI for 30 days following the consummation of the Company's initial public offering. While the settlement agreement requires RSSI to dismiss this action without prejudice, it does not release any claims that RSSI may assert in the future regarding the actual use or misappropriation by the Company of trade secrets or other proprietary information of RSSI. In March 1998, Scott O. Davis, the Company's former Chief Financial Officer, filed a complaint in California Superior Court against the Company and its Chief Executive Officer, Henry T. Nicholas, III, alleging claims for fraud and deceit, negligent misrepresentation, breach of contract, breach of fiduciary duty, constructive fraud, conversion, breach of the implied covenant of good faith and fair dealing, and declaratory relief. These claims relate to Mr. Davis' alleged ownership of 26,000 shares of Series D Preferred Stock originally purchased by Mr. Davis in February 1996 (which shares would have converted into 78,000 shares of Class B Common Stock upon consummation of the initial public offering). The purchase agreement between the Company and Mr. Davis contained a provision permitting the Company to repurchase all 26,000 shares of Series D Preferred Stock at the original price paid per share in the event that Mr. Davis did not continue to be employed by the Company until the later of February 22, 1998 or one year after the consummation of the Company's initial public offering. After Mr. Davis resigned from the Company in June 1997, the Company F-17 88 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 7. LITIGATION (CONTINUED) exercised its repurchase right. Mr. Davis' complaint alleges that the repurchase right should not be enforceable under several legal theories and seeks unspecified damages and declaratory relief. If Mr. Davis is successful in his claim, he may be entitled to receive the shares of Class B Common Stock described above and may be entitled to certain other rights as a holder of Series D Preferred Stock, including without limitation the right to acquire certain shares of the Company's Series E Preferred Stock (or the shares of Class B Common Stock into which such shares of Series E Preferred Stock would have converted upon consummation of the initial public offering). This case is currently in discovery. In April 1998, the Company filed an answer and affirmative defenses to Mr. Davis' complaint, denying the allegations in Mr. Davis' complaint. The Company has also asserted counterclaims against Mr. Davis for fraud and breach of fiduciary duty and is seeking to recover compensatory and punitive damages, in addition to other relief. The Company is also involved in other legal proceedings, claims and litigation arising in the ordinary course of business. The cases involving intellectual property rights involve complex questions of fact and law and could require the expenditure of significant costs and diversion of resources to defend. Although management believes the outcome of the Company's outstanding legal proceedings, claims and litigation will not have a material adverse effect on the Company's financial position, results of operations or liquidity, the results of litigation are inherently uncertain, and such outcome is at least reasonably possible. The Company is unable to make an estimate of the range of possible loss from outstanding litigation, and no amounts have been provided for such matters in the accompanying financial statements. 8. SEGMENT, SIGNIFICANT CUSTOMER AND SUPPLIER INFORMATION The Company operates in one industry segment, broadband communications. During 1995, 1996 and 1997, the Company had a total of five customers whose revenue represented a significant portion of total revenue in certain or all years. Revenue from two of these customers was approximately 13.9% and 10.9% of total revenue in 1995. Revenue from another customer represented approximately 13.8% in 1995, 28.0% in 1996, and 31.9% in 1997 of total revenue for the respective year. Revenue from a fourth customer accounted for approximately 16.1% of total revenue in 1996. Revenue from a fifth customer was approximately 15.2% in 1996 and 14.6% in 1997 of total revenue for the respective year. No other customer represented more than 10% of the Company's annual revenue. The Company performs periodic credit evaluations of its customers' financial condition and generally does not require collateral. Credit losses have been within management's expectations and amounts provided for doubtful accounts. Export revenue to all foreign customers as a percent of total revenue was as follows:
YEARS ENDED DECEMBER 31, ------------------------- 1995 1996 1997 ----- ----- ----- Europe............................................... 10.5% 6.1% 5.2% Asia................................................. 10.1 2.9 6.7 Other................................................ 1.9 3.5 3.5 ---- ---- ---- 22.5% 12.5% 15.4% ==== ==== ====
The Company does not own or operate a fabrication facility, and substantially all of its semiconductor device requirements are currently supplied by two outside foundries in Asia. Any sudden demand for an F-18 89 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 8. SEGMENT, SIGNIFICANT CUSTOMER AND SUPPLIER INFORMATION (CONTINUED) increased amount of semiconductor devices or sudden reduction or elimination of any existing source or sources of semiconductor devices could result in a material delay in the shipment of the Company's products. In addition, substantially all of the Company's products are assembled and tested by one of two third-party subcontractors in Asia. The Company does not have long-term agreements with any of these suppliers. Any problems associated with the fabrication facilities, and the delivery, quality or cost of the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations. 9. SUBSEQUENT EVENTS STOCK SPLIT On February 3, 1998, the Board of Directors approved a 3-for-2 split, effective March 9, 1998, of the Company's Common Stock. All share and per share amounts in the accompanying financial statements have been retroactively restated to reflect the stock split in the Company's capital structure. SALE OF SHARES TO CISCO SYSTEMS On February 3, 1998, Cisco Systems, Inc. (Cisco) exercised its option to purchase 500,000 shares of Class A Common Stock upon consummation of the Company's initial public offering at a price per share equal to the initial public offering price, net of underwriting discounts and commissions. Such option was granted to Cisco in connection with the Development and License Agreement entered into between the Company and Cisco and effective in September 1996, as amended on February 3, 1998. STOCK OPTION PLANS The 1998 Stock Incentive Plan (the 1998 Plan) was adopted on February 3, 1998 to serve as the successor equity incentive program to the Company's 1994 Plan. A total of 15,980,563 shares of Common Stock have been authorized for issuance under the 1998 Plan. On the 1998 Plan effective date, outstanding options under the 1994 Plan and the 1998 Special Stock Option Plan (the Special Plan), a plan adopted to permit options to be granted with terms permitted by the 1998 Plan prior to the 1998 Plan becoming effective, will be incorporated into the 1998 Plan, and no further option grants will be made under the 1994 Plan or the Special Plan. During the three month period ended March 31, 1998, the Company's Board of Directors granted stock options to employees under the Company's 1994 Plan and its Special Plan on an aggregate of 3,009,675 shares of the Company's Class B Common Stock, of which options on 2,929,675 shares are exercisable at $10 per share and options on 80,000 shares are exercisable at the initial public offering price of the Company's Class A Common Stock. In the quarter ended March 31, 1998, the Company will record an additional $6.1 million of deferred compensation related to 1,518,500 options granted in late March 1998, which amount is equal to the difference between the exercise price and the deemed value of such options. This amount will be presented as a reduction of shareholders' equity and amortized ratably over the vesting period of the applicable options. As a result, the Company will amortize approximately $17,000 (pre-tax) of deferred compensation in the quarter ended March 31, 1998 and expects to amortize the remaining balance at the rate of approximately $380,000 (pre-tax) per quarter through March 31, 2002. 1998 EMPLOYEE STOCK PURCHASE PLAN The 1998 Employee Stock Purchase Plan (the Purchase Plan) was adopted on February 3, 1998, which allows employees to designate up to 15 percent of their total compensation to purchase shares of the F-19 90 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 9. SUBSEQUENT EVENTS (CONTINUED) Company's Class A Common Stock at 85% of fair market value. 750,000 shares of Class A Common Stock have been reserved for issuance under the Purchase Plan. ENGAGEMENT AGREEMENT WITH IRELL & MANELLA Irell & Manella has represented and continues to represent the Company in various legal matters pursuant to an engagement agreement dated as of January 1, 1997, and amended as of January 1, 1998. Under the engagement agreement, the Company has agreed to pay Irell & Manella a fixed fee plus costs for the firm's legal services rendered from and after January 1, 1998 with respect to certain litigation matters. Irell & Manella has agreed to render legal services to the Company on most other matters at reduced rates from the firm's standard for the two-year period commencing January 1, 1998. 10. SUPPLEMENTARY UNAUDITED INFORMATION INITIAL PUBLIC OFFERING In April 1998, the Company completed its initial public offering (the "Offering") of 4,025,000 shares of its Class A Common Stock. Of these shares, the Company sold 3,120,000 shares (including 355,000 shares issued in connection with the exercise of the underwriters' over-allotment option), and selling shareholders sold 905,000 shares (including 170,000 shares in connection with the exercise of the underwriters' over-allotment option), at a price of $24.00 per share. In addition, the Company sold 500,000 shares of Class A Common Stock to Cisco Systems, Inc. ("Cisco Systems"), in a concurrent registered offering that was not underwritten, at a price of $22.32 per share. The Company received aggregate net proceeds from the Offering and the sale of shares to Cisco Systems of approximately $79.2 million in cash (net of underwriting discounts and commissions and estimated offering costs). Upon consummation of the Offering, all outstanding shares of the Company's Convertible Preferred Stock were automatically converted into an aggregate of 8,453,517 shares of Class B Common Stock. Approximately $2.3 million of the Company's net proceeds were used to retire all outstanding indebtedness under an SVB term loan in April 1998. INVESTMENTS At June 30, 1998, all of the Company's investments were in state, municipal and county government bonds and were classified as held-to-maturity. Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity investments are stated at cost, adjusted for amortization of premiums and discounts to maturity. A summary of held-to-maturity securities by balance sheet caption at June 30, 1998, is as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- ------- (IN THOUSANDS) Cash equivalents......................... $ 8,104 $-- $ -- $ 8,104 Short-term investments................... 2,629 1 -- 2,630 Long-term investments.................... 25,094 8 (15) 25,087 ------- --- ---- ------- Securities classified as held-to-maturity....................... $35,827 $ 9 $(15) $35,821 ======= === ==== =======
F-20 91 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 10. SUPPLEMENTARY UNAUDITED INFORMATION (CONTINUED) Scheduled maturities of held-to-maturity investments at June 30, 1998 were as follows:
AMORTIZED FAIR COST VALUE --------- ------- (IN THOUSANDS) Debt securities maturing within: One year............................... $10,733 $10,734 Two years.............................. 18,326 18,320 Three years............................ 6,768 6,767 ------- ------- $35,827 $35,821 ======= =======
INCOME TAXES Income tax expense for the six month periods ended June 30, 1997 and 1998 has been provided at the estimated annualized effective tax rates based on the estimated income tax liability or asset and change in deferred taxes for the respective fiscal years. COMMITMENTS The Company had commitments totaling approximately $5.4 million as of June 30, 1998 for the purchase of workstation software and hardware. In addition, the Company has entered into additional facilities lease agreements commencing November 1998 for approximately $200,000 per month through November 2005. ISSUANCE OF STOCK OPTIONS Activity under the 1994 Plan, the Special Plan and the 1998 Plan during the six month period ended June 30, 1998 is set forth below:
OPTIONS OUTSTANDING ----------------------------------------- WEIGHTED- SHARES AVERAGE AVAILABLE NUMBER OF PRICE EXERCISE FOR GRANT SHARES PER SHARE PRICE ---------- --------- --------------- --------- Balance at December 31, 1997..... 5,713,911 5,401,432 $ .07 - $ 8.00 $ 2.12 Additional shares reserved....... 5,000,000 -- -- -- Options granted.................. (3,734,076) 3,734,076 10.00 - 69.88 14.84 Options cancelled................ 305,825 (305,825) 10.00 10.00 Options repurchased.............. 3,000 -- -- -- Options exercised................ -- (145,030) .50 - 10.00 2.56 ---------- --------- --------------- ------ Balance at June 30, 1998......... 7,288,660 8,684,653 $ .07 - $69.88 $ 7.42 ========== ========= =============== ======
Included above are stock options granted during the three month period ended June 30, 1998 to employees under the Company's Special Plan and its 1998 Plan on an aggregate of 724,401 shares of the Company's Class A & B Common Stock at an average exercise price of $33.40. F-21 92 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 10. SUPPLEMENTARY UNAUDITED INFORMATION (CONTINUED) The weighted average remaining contractual life and weighted average exercise price of all options outstanding and of all options exercisable as June 30, 1998 were as follows:
OUTSTANDING ------------------------------------------------- WEIGHTED AVERAGE EXERCISABLE NUMBER OF REMAINING ------------------------------ RANGE OF SHARES CONTRACTUAL LIFE WEIGHTED AVERAGE SHARES WEIGHTED AVERAGE EXERCISE PRICES OUTSTANDING (YEARS) EXERCISE PRICE EXERCISABLE EXERCISE PRICE --------------- ----------- ---------------- ---------------- ----------- ---------------- $ .07 - $ 1.00 687,075 7.87 $ .61 687,075 $ .61 $ 1.13 - $ 1.25 2,912,358 8.77 $ 1.16 2,912,358 $ 1.16 $ 3.00 - $ 8.00 1,533,945 9.35 $ 4.71 1,533,945 $ 4.71 $10.00 2,690,925 9.70 $10.00 2,690,925 $10.00 $24.00 - $69.88 860,350 9.82 $30.76 -- $ --
Additional information relating to the 1994 Plan, Special Plan and 1998 Plan is as follows at June 30, 1998: i) nonvested common shares subject to repurchase amount to 2,852,834 with a weighted average repurchase price of $1.23, ii) unvested options outstanding total 8,021,883 and iii) total reserved Class A and Class B Common Stock shares for stock option plans total 15,973,313. In the six months ended June 30, 1998, the Company amortized an aggregate of $503,000 of deferred compensation and eliminated approximately $705,000 in recorded deferred compensation, representing the unamortized balance of deferred compensation on stock options that were cancelled. The remaining balance of total deferred compensation will be amortized at a rate of approximately $406,000 (pre-tax) per quarter through September 2001 and approximately $338,000 (pre-tax) for the quarters ended December 2001 and March 2002. PRO FORMA DISCLOSURES OF THE EFFECT OF STOCK-BASED COMPENSATION PLANS The value of the Company's stock-based awards granted to employees prior to the initial public offering of its common stock in April 1998, was estimated using the minimum value method, which does not consider stock price volatility. Stock-based awards granted in 1998 subsequent to the initial public offering have been valued using the Black-Scholes option pricing model. Among other things, the Black-Scholes model considers the expected volatility of the Company's stock price, determined in accordance with Statement No. 123, in arriving at an option valuation. Estimates and other assumptions necessary to apply the Black-Scholes model may differ significantly from assumptions used in calculating the value of options granted prior to the initial public offering under the minimum value method. The fair value of the Company's stock-based awards to employees was estimated assuming no expected dividends, a weighted average expected life of 3.5 years, a weighted average risk-free interest rate of 6.0% and no expected volatility for options granted prior to the initial public offering and an expected volatility of 0.73 for options granted after the initial public offering. The fair value of employee stock purchase rights was estimated assuming no expected dividends, a weighted average expected life of 15 months, a weighted average risk-free interest rate of 6.0% and an expected volatility of .73. The weighted-average fair value of options granted during the six months ended June 30, 1997 and 1998 was $.34 and $5.68, respectively. The weighted-average fair value of employee stock purchase rights granted in the six months ended June 30, 1998 was $11.45. For pro forma purposes, the estimated value of the Company's stock-based awards to employees is amortized over the vesting period of the underlying instruments. The results of applying Statement No. 123 to the Company's stock-based awards to employees would approximate the following: F-22 93 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) 10. SUPPLEMENTARY UNAUDITED INFORMATION (CONTINUED)
SIX MONTHS ENDED JUNE 30, ---------------- 1997 1998 ------- ------- Pro forma: Net income (loss)...................................... $(1,935) $13,266 Basic earnings (loss) per share........................ $ (.07) $ .39 Diluted earnings (loss) per share...................... $ (.07) $ .30
ISSUANCE OF WARRANTS In April 1998, the Company issued a Class A Common Stock Purchase Warrant (the "Warrant") to Brobeck, Phleger & Harrison LLP, counsel to the Company, to purchase up to 10,000 shares of the Company's Class A Common Stock at an exercise price of $24.00 per share. The Warrant is exercisable from April 30, 1999 to April 30, 2000. The Warrant was issued in a transaction exempt from registration by virtue of Section 4(2) of the Securities Act of 1933, as amended. COMPREHENSIVE INCOME Effective January 1, 1998, the Company adopted Statement No. 130, Reporting Comprehensive Income, which establishes standards for reporting and displaying comprehensive income and its components in the financial statements. For the three months ended March 31, 1998 and 1997, the Company did not have any components of comprehensive income as defined in Statement No. 130. F-23 94 BROADCOM CORPORATION NOTES TO FINANCIAL STATEMENTS (CONTINUED) (INFORMATION AS OF JUNE 30, 1998 AND FOR THE SIX MONTHS ENDED JUNE 30, 1997 AND 1998 IS UNAUDITED) LOGO 95 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the costs and expenses, other than underwriting discounts and commissions, payable in connection with the sale and distribution of the securities being registered. All amounts are estimated except the Securities and Exchange Commission and NASD registration fees. All of the expenses below will be paid by the Company.
ITEM ---- Registration fee............................................ $ 78,367 Nasdaq listing fee.......................................... 17,500 NASD filing fee............................................. 27,065 Blue sky fees and expenses.................................. * Printing and engraving expenses............................. * Legal fees and expenses..................................... * Accounting fees and expenses................................ * Transfer Agent and Registrar fees........................... * Miscellaneous............................................... * -------- Total............................................. $500,000 ========
- --------------- * To be filed by amendment. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS The Company's Articles of Incorporation limit the personal liability of its directors for monetary damages to the fullest extent permitted by the California General Corporation Law (the "California Law"). Under the California Law, a director's liability to a company or its shareholders may not be limited (1) for acts or omissions that involve intentional misconduct or a knowing and culpable violation of law, (ii) for acts or omissions that a director believes to be contrary to the best interest of the Company or its shareholders or that involve the absence of good faith on the part of the director, (iii) for any transaction from which a director derived an improper personal benefit, (iv) for acts or omissions that show a reckless disregard for the director's duty to the Company or its shareholders in circumstances in which the director was aware, or should have been aware, in the ordinary course of performing a director's duties, of a risk of a serious injury to the Company or its shareholders, (v) for acts or omissions that constitute an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Company or its shareholders, (vi) under Section 310 of the California Law concerning contacts or transactions between the Company and a director, or (vii) under Section 316 of the California Law concerning directors' liability for improper dividends, loans and guarantees. The limitation of liability does not affect the availability of injunctions and other equitable remedies available to the Company's shareholders for any violation by a director of the director's fiduciary duty to the Company or its shareholders. The Company's Articles of Incorporation also include an authorization for the Company to indemnify its "agents" (as defined in Section 317 of the California Law), through bylaw provisions, by agreement or otherwise, to the fullest extent permitted by law. Pursuant to this provision, the Company's Bylaws provide for indemnification of the Company's directors, officers and employees. In addition, the Company, at its discretion, may provide indemnification to persons whom the Company is not obligated to indemnify. The Bylaws also allow the Company to enter into indemnity agreements with individual directors, officers, employees and other agents. These indemnity agreements have been entered into with all directors and executive officers and provide the maximum indemnification permitted by law. These agreements, together with the Company's Bylaws and Articles of Incorporation, may require the Company, among other things, to indemnify these directors or executive officers (other than for liability resulting from willful misconduct of a II-1 96 culpable nature), to advance expenses to them as they are incurred, provided that they undertake to repay the amount advanced if it is ultimately determined by a court that they are not entitled to indemnification, and to obtain directors' and officers' insurance if available on reasonable terms. Section 317 of the California Law and the Company's Bylaws make provision for the indemnification of officers, directors and other corporate agents in terms sufficiently broad to indemnify such persons, under certain circumstances, for liabilities (including reimbursement of expense incurred) arising under the Securities Act. The Company, with the approval of the Board of Directors, intends to obtain directors' and officers' liability insurance prior to the effectiveness of this offering. There is no pending litigation or proceeding involving any director, officer, employee or agent of the Company in which indemnification will be required or permitted. Moreover, the Company is not aware of any threatened litigation or proceeding that might result in a claim for such indemnification. The Company believes that the foregoing indemnification provisions and agreements are necessary to attract and retain qualified persons as directors and executive officers. The Underwriting Agreement (the form of which is filed as Exhibit 1.1 hereto) provides for indemnification by the Underwriters of the Company and its officers and directors, and by the Company of the Underwriters, for certain liabilities arising under the Securities Act or otherwise. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES Each share of Class B Common Stock is convertible into one share of Class A Common Stock at any time at the option of the holder, and will automatically convert upon transfer, except to certain Permitted Transferees as defined in the Articles of Incorporation. The following is a summary of transactions by the Registrant since January 1, 1995 involving sales of the Registrant's securities that were not registered under the Securities Act: 1. In March 1995, the Registrant issued and sold 500,000 shares of Series C Preferred Stock to Scientific-Atlanta, Inc. at a price per share of $2.00. Each share of Series C Preferred Stock will convert into three shares of Class B Common Stock upon consummation of this offering. 2. In February 1996, the Registrant issued and sold an aggregate of 493,839 shares of Series D Preferred Stock to 22 accredited individual investors and strategic partners at a price per share of $6.00, or an aggregate purchase price of $2,963,000. Each share of Series D Preferred Stock will convert into three shares of Class B Common Stock upon consummation of this offering. 3. In June 1997, the Registrant issued and sold 60,000 shares of Class B Common Stock to the Regents of the University of New Mexico ("UNM") in connection with a License Agreement between UNM and the Registrant. The shares were issued as part of the Registrant's consideration to UNM in return for a license grant and certain research and development services rendered to the Registrant. The consideration tendered to the Registrant was valued at an aggregate of $67,800 or $1.13 per share. 4. In September 1997, the Registrant issued and sold 1,500,000 shares of Series E Preferred Stock to General Instrument Corporation at a price per share of $15.15, or an aggregate purchase price of $22,750,000. This transaction was undertaken in connection with a Development, Supply and License Agreement between General Instrument and the Registrant. Each share of Series E Preferred Stock will convert into 1.5 shares of Class B Common Stock upon consummation of this offering. 5. Pursuant to an agreement dated as of October 31, 1997, the Registrant issued and sold 225,000 shares of Class B Common Stock to Irell & Manella LLP at a price per share of $4.67, or an aggregate purchase price of $1,050,000. 6. Since January 1, 1995, the Registrant has issued non-qualified stock options under its 1994 Plan and Special Plan to certain eligible officers, directors, consultants and employees to the purchase an aggregate of 13,590,325 shares of Class B Common Stock. Such optionees included consultants who rendered bonafide consulting services to the Registrant, which services included engineering support, marketing services and strategic planning and guidance. II-2 97 None of the optionees paid any cash consideration for such options. Such options did not involve a "sale" of securities; and, accordingly, registration was not required. The following table sets forth the grant date, number of options, current exercise price and class of optionees for all of such options:
NO. OF EXERCISE GRANT DATE OPTIONS PRICE CLASS OF OPTIONEES - -------------------- --------- -------- ------------------------- 03/01/95 to 01/31/96 2,212,500 $ 0.07 Employees and Consultants 03/01/96 to 07/08/96 1,507,500 $ 0.50 Employees and Consultants 07/11/96 to 07/31/96 418,500 $ 1.00 Employees and Consultants 08/06/96 to 08/29/97 3,770,250 $ 1.13 Employees and Consultants 06/23/97 750,000 $ 1.25 Two Officers 09/15/97 to 09/30/97 421,500 $ 3.00 Employees 10/09/97 to 10/31/97 514,200 $ 4.00 Employees 11/03/97 to 11/28/97 485,700 $ 5.00 Employees and a Director 12/01/97 to 12/31/97 462,000 $ 8.00 Employees 01/01/98 to 03/27/98 2,968,175 $10.00 Employees, Consultants and Officers
Between March 28, 1998 and March 31, 1998, the Company granted options to employees to purchase an aggregate of 80,000 shares of Class B Common Stock at an exercise price per share of $24.00. The sale and issuance of securities set forth above were deemed to be exempt from registration under the Securities Act by virtue of Section 4(2) thereof or Rule 701 adopted thereunder. The recipients of the securities in each of the transactions set forth in above represented their intention to acquire such securities for investment only and not with a view to or for sale in connection with any distribution thereof, and appropriate legends were affixed to the share certificates and instruments used in such transactions. All recipients received adequate information about the Registrant at the time of the acquisition of such securities or had access, through employment or other relationships with the Registrant, to such information. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES The following Exhibits are attached hereto and incorporated herein by reference.
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 1.1** Form of Underwriting Agreement. 3.1* Amended and Restated Articles of Incorporation of the Registrant. 3.2* Bylaws of the Registrant. 5.1 Opinion of Brobeck Phleger & Harrison LLP. 10.1* Form of Indemnification Agreement for the Directors of the Registrant. 10.2* Form of Indemnification Agreement for the Officers of the Registrant. 10.3* 1994 Amended and Restated Stock Option Plan, together with form of Stock Option Agreement, form of Stock Purchase Agreement, form of promissory note and form of stock pledge agreement. 10.4* 1998 Stock Incentive Plan, together with form of Stock Option Agreement and form of Stock Issuance Agreement. 10.5* 1998 Employee Stock Purchase Plan. 10.6* Loan and Security Agreement dated March 23, 1995 between the Registrant and Silicon Valley Bank, as amended. 10.7* Standard Form Office Lease dated April 30, 1995 between the Registrant and Laguna Canyon, Inc., as amended.
II-3 98
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 10.8+* Development, Supply and License Agreement dated September 29, 1997 between the Registrant and General Instrument Corporation, formerly known as NextLevel Systems, Inc. 10.9* Stock Purchase Agreement dated February 3, 1998 between the Registrant and Cisco Systems, Inc. 10.10* Registration Rights Agreement dated February 26, 1996 among the Registrant and certain of its shareholders, as amended. 10.11* Industrial Lease dated February 16, 1998 between the Registrant and Irvine Technology Partners. 10.12* 1994 Special Stock Option Plan, together with form of Stock Option Agreement and form of Stock Purchase Agreement. 10.13* Stock Purchase Agreement dated October 31, 1997 between the Registrant and Irell & Manella LLP. 10.14+* Engagement Agreement dated January 1, 1997, as amended, between the Registrant and Irell & Manella LLP. 10.15 Industrial Lease (Single Tenant; Net) dated August 7, 1998 between the Registrant and The Irvine Company. 11.1* Statement Regarding Computation of Earnings Per Share. 23.1 Consent of Independent Auditors. 23.2 Consent of Brobeck Phleger & Harrison LLP (contained in Exhibit 5.1). 24.1 Power of Attorney (contained on signature page on page II-3).
- --------------- * Incorporated by reference to the similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No. 333-45619). ** To be filed by amendment. + Confidential treatment has previously been granted by the Commission for certain portions of the referenced exhibit pursuant to Rule 406. (b)FINANCIAL STATEMENT SCHEDULES (1) Report of Independent Auditors on Financial Statement Schedule (2) Schedule II -- Valuation and Qualifying Accounts Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes thereto. II-4 99 ITEM 17. UNDERTAKINGS The Registrant hereby undertakes to provide to the Underwriters at the closing specified in the Underwriting Agreements certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit, or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus as filed as part of this Registration Statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 100 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, State of California, on the 30th day of September, 1998. BROADCOM CORPORATION By: /s/ HENRY T. NICHOLAS ------------------------------------ Henry T. Nicholas, III, Ph.D., Co-Chairman, President and Chief Executive Officer POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, the undersigned hereby constitute and appoint Henry T. Nicholas, III and William J. Ruehle, and each of them, his true and lawful attorney-in-fact and agent, each with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments (including post-effective amendments) to this Registration Statement, or any related registration statement filed pursuant to Rule 462(b) under the Securities Act of 1933, and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that each of said attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Act of 1933, this Registration Statement on Form S-1 has been signed by the following persons in the capacities and on the dates indicated:
SIGNATURE TITLE DATE --------- ----- ---- /s/ HENRY T. NICHOLAS Co-Chairman, President and September 30, 1998 - ----------------------------------------------------- Chief Executive Officer Henry T. Nicholas, III, Ph.D. (principal executive officer) /s/ HENRY SAMUELI Co-Chairman, Vice President September 30, 1998 - ----------------------------------------------------- of Research and Development Henry Samueli, Ph.D. and Chief Technical Officer /s/ WILLIAM J. RUEHLE Chief Financial Officer and September 30, 1998 - ----------------------------------------------------- Vice President, Finance William J. Ruehle (principal financial and accounting officer) /s/ MYRON S. EICHEN Director September 30, 1998 - ----------------------------------------------------- Myron S. Eichen /s/ ALAN ROSS Director September 30, 1998 - ----------------------------------------------------- Alan Ross /s/ WERNER F. WOLFEN Director September 30, 1998 - ----------------------------------------------------- Werner F. Wolfen
II-6 101 EXHIBIT INDEX
EXHIBIT SEQUENTIALLY NUMBER DESCRIPTION NUMBERED - ------- ----------- PAGE 1.1** Form of Underwriting Agreement. 3.1* Amended and Restated Articles of Incorporation of the Registrant. 3.2* Bylaws of the Registrant. 5.1 Opinion of Brobeck Phleger & Harrison LLP. 10.1* Form of Indemnification Agreement for the Directors of the Registrant. 10.2* Form of Indemnification Agreement for the Officers of the Registrant. 10.3* 1994 Amended and Restated Stock Option Plan, together with form of Stock Option Agreement, form of Stock Purchase Agreement, form of promissory note and form of stock pledge agreement. 10.4* 1998 Stock Incentive Plan, together with form of Stock Option Agreement and form of Stock Issuance Agreement. 10.5* 1998 Employee Stock Purchase Plan. 10.6* Loan and Security Agreement dated March 23, 1995 between the Registrant and Silicon Valley Bank, as amended. 10.7* Standard Form Office Lease dated April 30, 1995 between the Registrant and Laguna Canyon, Inc., as amended. 10.8+* Development, Supply and License Agreement dated September 29, 1997 between the Registrant and General Instrument Corporation, formerly known as NextLevel Systems, Inc. 10.9* Stock Purchase Agreement dated February 3, 1998 between the Registrant and Cisco Systems, Inc. 10.10* Registration Rights Agreement dated February 26, 1996 among the Registrant and certain of its shareholders, as amended. 10.11* Industrial Lease dated February 16, 1998 between the Registrant and Irvine Technology Partners. 10.12* 1994 Special Stock Option Plan, together with form of Stock Option Agreement and form of Stock Purchase Agreement. 10.13* Stock Purchase Agreement dated October 31, 1997 between the Registrant and Irell & Manella LLP. 10.14+* Engagement Agreement dated January 1, 1997, as amended, between the Registrant and Irell & Manella LLP. 10.15 Industrial Lease (Single Tenant; Net) dated August 7, 1998 between the Registrant and The Irvine Company. 11.1* Statement Regarding Computation of Earnings Per Share. 23.1 Consent of Independent Auditors. 23.2 Consent of Brobeck Phleger & Harrison LLP (contained in Exhibit 5.1). 24.1 Power of Attorney (contained on signature page on page II-3).
- --------------- * Incorporated by reference to the similarly numbered exhibit to the Registration Statement on Form S-1 filed by the Registrant (Reg. No. 333-45619). ** To be filed by amendment. + Confidential treatment has previously been granted by the Commission for certain portions of the referenced exhibit pursuant to Rule 406. II-7 102 REPORT OF INDEPENDENT AUDITORS ON FINANCIAL STATEMENT SCHEDULE Board of Directors and Shareholders Broadcom Corporation We have audited the financial statements of Broadcom Corporation as of December 31, 1996 and 1997, and for each of the three years in the period ended December 31, 1997, and have issued our report thereon dated January 16, 1998, except for Note 9, as to which the date is March 31, 1998 and Note 7, as to which the date is September 25, 1998 (included elsewhere in this Registration Statement). Our audits also included the financial statement schedule listed in Item 16(b) of this Registration Statement. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Orange County, California January 16, 1998, except for Note 9, as to which the date is March 31, 1998 and Note 7, as to which the date is September 25, 1998 S-1 103 SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS BROADCOM CORPORATION
BALANCE AT CHARGED TO CHARGED TO BALANCE AT BEGINNING OF COSTS AND OTHER END OF DESCRIPTION PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD ----------- ------------ ---------- ---------- ---------- ---------- Year ended December 31, 1995: Deducted from asset accounts: Allowance for doubtful accounts and sales returns.................... $ 50,000 $ 162,000 $ -- $ 50,000 $ 162,000 Reserve for excess and obsolete inventory........................ -- 55,000 -- -- 55,000 -------- ---------- ---- -------- ---------- Total......................... $ 50,000 $ 217,000 $ -- $ 50,000 $ 217,000 ======== ========== ==== ======== ========== Year ended December 31, 1996: Deducted from asset accounts: Allowance for doubtful accounts and sales returns.................... $162,000 $ 213,000 $ -- $228,000 $ 147,000 Reserve for excess and obsolete inventory........................ 55,000 1,055,000 -- 361,000 749,000 -------- ---------- ---- -------- ---------- Total......................... $217,000 $1,268,000 $ -- $589,000 $ 896,000 ======== ========== ==== ======== ========== Year ended December 31, 1997: Deducted from asset accounts: Allowance for doubtful accounts and sales returns.................... $147,000 $ 574,000 $ -- $ -- $ 721,000 Reserve for excess and obsolete inventory........................ 749,000 1,028,000 -- 91,000 1,686,000 -------- ---------- ---- -------- ---------- Total......................... $896,000 $1,602,000 $ -- $ 91,000 $2,407,000 ======== ========== ==== ======== ==========
S-2 EX-5.1 2 OPINION OF BROBECK PHLEGER & HARRISON LLP 1 EXHIBIT 5.1 BROBECK, PHLEGER & HARRISON LLP 38 Technology Drive Irvine, California 92618 September 30, 1998 Broadcom Corporation 16251 Laguna Canyon Road Irvine, California 92618 Re: Broadcom Corporation Registration Statement on Form S-1 for 3,450,000 Shares of Common Stock Ladies and Gentlemen: We have acted as counsel to Broadcom Corporation, a California corporation (the "Company"), in connection with the proposed issuance and sale by the Company of up to 470,000 shares of the Company's Common Stock (the "Company Shares") and the sale by certain Selling Shareholders of up to 2,980,000 shares of the Company's Common Stock (the "Selling Shareholder Shares") pursuant to the Company's Registration Statement on Form S-1 (the "Registration Statement") filed with the Securities and Exchange Commission under the Securities Act of 1933, as amended (the "Act"). This opinion is being furnished in accordance with the requirements of Item 16(a) of Form S-1 and Item 601(b)(5)(i) of Regulation S-K. We have reviewed the Company's charter documents and the corporate proceedings taken by the Company in connection with the issuance and sale of the Company Shares and the sale of the Selling Shareholder Shares. Based on such review, we are of the opinion that (i) the Company Shares and Selling Shareholder Shares have been duly authorized, and (ii) the Company Shares, if, as and when issued in accordance with the Registration Statement and the related prospectus (as amended and supplemented through the date of issuance) will be legally issued, fully paid and nonassessable. We consent to the filing of this opinion letter as Exhibit 5.1 to the Registration Statement and to the reference to this firm under the caption "Legal Matters" in the prospectus which is part of the Registration Statement. In giving this consent, we do not thereby admit that we are within the category of persons whose consent is required under Section 7 of the Act, the rules and regulations of the Securities and Exchange Commission promulgated thereunder, or Item 509 of Regulation S-K. 2 Broadcom Corporation Page 2 This opinion letter is rendered as of the date first written above and we disclaim any obligation to advise you of facts, circumstances, events or developments which hereafter may be brought to our attention and which may alter, affect or modify the opinion expressed herein. Our opinion is expressly limited to the matters set forth above and we render no opinion, whether by implication or otherwise, as to any other matters relating to the Company or the Shares. Very truly yours, BROBECK, PHLEGER & HARRISON LLP EX-10.15 3 INDUSTRIAL LEASE (SINGLE TENANT; NET) AUG 7, 1998 1 EXHIBIT 10.15 INDUSTRIAL LEASE (SINGLE TENANT; NET) BETWEEN THE IRVINE COMPANY AND BROADCOM CORPORATION 2 INDEX TO LEASE ARTICLE I. BASIC LEASE PROVISIONS ARTICLE II. PREMISES Section 2.1 Leased Premises Section 2.2 Acceptance of Premises Section 2.3 Building Name and Address Section 2.4 Landlord's Responsibilities Section 2.5 Right of First Refusal Section 2.6 Option to Expand Section 2.7 Temporary Premises Lease ARTICLE III. TERM Section 3.1 General Section 3.2 Delay in Possession Section 3.3 Right to Extend the Lease Term ARTICLE IV. RENT AND OPERATING EXPENSES Section 4.1 Basic Rent Section 4.2 Operating Expenses Section 4.3 Security Deposit Section 4.4 Special Limitation on HVAC Operating Expenses ARTICLE V. USES Section 5.1 Use Section 5.2 Signs Section 5.3 Hazardous Materials ARTICLE VI. COMMON AREAS; SERVICES Section 6.1 Utilities and Services Section 6.2 Operation and Maintenance of Common Areas Section 6.3 Use of Common Areas Section 6.4 Parking Section 6.5 Changes and Additions by Landlord Section 6.6. Outdoor Courtyard Area ARTICLE VII. MAINTAINING THE PREMISES Section 7.1 Tenant's Maintenance and Repair Section 7.2 Landlord's Maintenance and Repair Section 7.3 Alterations Section 7.4 Mechanic's Liens Section 7.5 Entry and Inspection ARTICLE VIII. TAXES AND ASSESSMENTS ON TENANT'S PROPERTY ARTICLE IX. ASSIGNMENT AND SUBLETTING Section 9.1 Rights of Parties Section 9.2 Effect of Transfer Section 9.3 Sublease Requirements Section 9.4 Certain Transfers ARTICLE X. INSURANCE AND INDEMNITY Section 10.1 Tenant's Insurance Section 10.2 Landlord's Insurance Section 10.3 Joint Indemnity Section 10.4 Landlord's Nonliability Section 10.5 Waiver of Subrogation ARTICLE XI. DAMAGE OR DESTRUCTION Section 11.1 Restoration Section 11.2 Lease Governs ARTICLE XII. EMINENT DOMAIN Section 12.1 Total or Partial Taking Section 12.2 Temporary Taking Section 12.3 Taking of Parking Area ARTICLE XIII. SUBORDINATION; ESTOPPEL CERTIFICATE; FINANCIALS Section 13.1 Subordination Section 13.2 Estoppel Certificate Section 13.3 Financials (i) 3 ARTICLE XIV. DEFAULTS AND REMEDIES Section 14.1 Tenant's Defaults Section 14.2 Landlord's Remedies Section 14.3 Late Payments Section 14.4 Right of Landlord to Perform Section 14.5 Default by Landlord Section 14.6 Expenses and Legal Fees Section 14.7 Waiver of Jury Trial Section 14.8 Satisfaction of Judgment ARTICLE XV. END OF TERM Section 15.1 Holding Over Section 15.2 Merger on Termination Section 15.3 Surrender of Premises; Removal of Property ARTICLE XVI. PAYMENTS AND NOTICES ARTICLE XVII. RULES AND REGULATIONS ARTICLE XVIII. BROKER'S COMMISSION ARTICLE XIX. TRANSFER OF LANDLORD'S INTEREST ARTICLE XX. INTERPRETATION Section 20.1 Gender and Number Section 20.2 Headings Section 20.3 Joint and Several Liability Section 20.4 Successors Section 20.5 Time of Essence Section 20.6 Controlling Law Section 20.7 Severability Section 20.8 Waiver and Cumulative Remedies Section 20.9 Inability to Perform Section 20.10 Entire Agreement Section 20.11 Quiet Enjoyment Section 20.12 Survival ARTICLE XXI. EXECUTION AND RECORDING Section 21.1 Counterparts Section 21.2 Corporate and Partnership Authority Section 21.3 Execution of Lease; No Option or Offer Section 21.4 Recording Section 21.5 Amendments Section 21.6 Executed Copy Section 21.7 Attachments ARTICLE XXII. MISCELLANEOUS Section 22.1 Nondisclosure of Lease Terms Section 22.2 Guaranty Section 22.3 Changes Requested by Lender Section 22.4 Mortgagee Protection Section 22.5 Covenants and Conditions Section 22.6 Security Measures Section 22.7 Communications/Security Equipment Section 22.8 JAMS Arbitration Exhibit A-1 Description of Premises Exhibit A-2 Temporary Premises 2nd Floor of Building C Exhibit B Environmental Questionnaire Exhibit C Landlord's Disclosures Exhibit D Insurance Requirements Exhibit E Rules and Regulations Exhibit F Form License Agreement Exhibit G Pre-Commencement Repair Schedule Exhibit H Entities Excluded from Project Signage Exhibit X Work Letter Exhibit Y Project Site Plan (ii) 4 INDUSTRIAL LEASE (SINGLE TENANT; NET) THIS LEASE is made as of the 7th day of August, 1998, (the "Effective Date") by and between THE IRVINE COMPANY, a Delaware corporation, hereafter called "Landlord" and Broadcom Corporation, a California corporation, hereinafter called "Tenant." ARTICLE I. BASIC LEASE PROVISIONS Each reference in this Lease to the "Basic Lease Provisions" shall mean and refer to the following collective terms, the application of which shall be governed by the provisions in the remaining Articles of this Lease. 1. Premises: The Premises includes all of one (1) three (3) story building known as 16215 Alton Parkway which contains approximately 88,903 rentable square feet ("Building A") and all of one (1) two (2) story building known as 16205 Alton Parkway ("Building B") which floor contains approximately 63,451 square feet. 2. Project Description: Alton Corporate Center 3. Use of Premises: General office use and any other use which does not violate applicable laws, rules and regulations or covenants, conditions and restrictions. 4. Estimated Commencement Date: The Premises shall be delivered in phases as follows: Building A: November 15, 1998 Building B: February 1, 1999 Actual Commencement Date: To be determined as provided in Section 3.1. 5. Lease Term: Eighty Four (84) months from the Building A Commencement Date, plus such additional days as may be required to cause this Lease to terminate on the final day of the calendar month. 6. Basic Rent: One Hundred Twenty Thousand Nineteen Dollars ($120,019.00) per month, based on $1.35 per rentable square foot of Building A until the Commencement Date for Building B. As of Commencement Date for Building B, the aggregate Basic Rent for the Premises shall be Two Hundred Five Thousand Six Hundred and Seventy-Eight Dollars ( $205,678.00) based on $1.35 per rentable square foot. Basic Rent is subject to adjustment as follows: Commencing on the first day of the thirteenth (13th) month of the Lease Term, the Basic Rent shall be Two Hundred Thirteen Thousand Two Hundred Ninety-Six Dollars ($213,296.00) per month, based on $1.40 per rentable square foot. Commencing on the first day of the twenty-fifth (25th) month of the Lease Term, the Basic Rent shall be Two Hundred Twenty Thousand Nine Hundred Thirteen Dollars ($220,913.00) per month, based on $1.45 per rentable square foot. Commencing on the first day of the thirty-seventh (37th) month of the Lease Term, the Basic Rent shall be Two Hundred Twenty-Eight Thousand Five Hundred Thirty-One Dollars ($228,531.00) per month, based on $1.50 per rentable square foot. Commencing on the first day of the forty-ninth (49th) month of the Lease Term, the Basic Rent shall be Two Hundred Thirty-Six Thousand One Hundred Forty-Nine Dollars ($236,149.00) per month, based on $1.55 per rentable square foot. Commencing on the first day of the sixty-first (61st) month of the Lease Term, the Basic Rent shall be Two Hundred Forty-Three Thousand Seven Hundred Sixty-Six Dollars ($243,766.00) per month, based on $1.60 per rentable square foot. Commencing on the first day of the seventy-third (73rd) month of the Lease Term, the Basic Rent shall be Two Hundred Fifty-One Thousand Three Hundred Eighty-Four Dollars ($251,384.00) per month, based on $1.65 per rentable square foot. 1 5 7. Guarantor(s): NONE 8. Floor Area of Premises: Approximately 152,354 rentable square feet based on: Building A: 88,903 Building B: 63,451 9. Security Deposit: See Section 4.3 10. Broker(s): CB Richard Ellis, Inc. 11. Additional Insureds: Insignia Commercial Group, Inc. 12. Address for Payments and Notices:
LANDLORD TENANT Insignia Commercial Group, Inc. One Technology Drive, Suite F-207 PRIOR TO COMMENCEMENT DATE: Irvine, CA 92618 Broadcom Corporation 16251 Laguna Canyon Road Irvine, CA 92618 Attention: Director of Corporate Services With an additional copy sent to the same address to the attention of Director of Corporate Services With a copy of notices to: AFTER COMMENCEMENT DATE: IRVINE INDUSTRIAL COMPANY Broadcom Corporation P.O. Box 6370 16215 Alton Parkway Newport Beach, CA 92658-6370 Irvine, CA Attn: Vice President, Industrial Attention: Director of Corporate Services Operations With an additional copy sent to the same address but to Chief Financial Officer and with a copy of notices of default only to: Brobeck, Phleger & Harrison 38 Technology Drive Irvine, CA 92618 Attention: Bruce Hallett, Esq.
13. Tenant's Liability Insurance Requirement: $ 2,000,000.00 14. Vehicle Parking Spaces: 609 spaces within the Common Area of the Project based on four (4) spaces per 1000 rentable square feet of Premises area. 15. Estimated Space Plan Approval Date: July 20, 1998. 2 6 ARTICLE II. PREMISES SECTION 2.1. LEASED PREMISES. Landlord leases to Tenant and Tenant leases from Landlord the premises shown in EXHIBIT A-1 (the "Premises"), containing approximately the floor area set forth in Item 8 of the Basic Lease Provisions and including the exterior patio area delineated on Exhibit A-1; provided, however, that any furniture or equipment placed or maintained on the exterior patio shall be subject to Landlord's prior written approval that such furniture complies with Landlord's standards for exterior furnishings. The Premises are to be located in the buildings identified in Item 1 of the Basic Lease Provisions (which together with the underlying real property, are collectively referred to as the "Building"), and is a portion of the project shown in EXHIBIT Y (the "Project"). Landlord shall have no right to relocate Tenant from the Premises at any time during the Term of this Lease or any extension. SECTION 2.2. ACCEPTANCE OF PREMISES. Tenant acknowledges that, except as expressly provided in this Lease, neither Landlord nor any representative of Landlord has made any representation or warranty with respect to the Premises or the Building or the suitability or fitness of either for any purpose, including without limitation any representations or warranties regarding zoning or other land use matters; and that neither Landlord nor any representative of Landlord has made any representations or warranties regarding (i) what other tenants or uses may be permitted or intended in the Building and the Project, or (ii) any exclusivity of use by Tenant with respect to its permitted use of the Premises as set forth in Item 3 of the Basic Lease Provisions. Tenant further acknowledges that neither Landlord nor any representative of Landlord has agreed to undertake any alterations or additions or construct any improvements to the Premises except as expressly provided in this Lease. The taking of possession or use of the Premises by Tenant for the conduct of Tenant's business therein (but not for construction or early entry for fixturization in accordance with the Work Letter) shall conclusively establish that the Premises and the Building were in satisfactory condition and in conformity with the provisions of this Lease in all respects, except for: (i) those matters which Tenant brings to Landlord's attention on a written punch list delivered to Landlord within thirty (30) days after the Term of this Lease commences with respect to such portion of the Premises as provided in Article III below, and (ii) Landlord's other obligations specifically provided in this Lease, including without limitation, the responsibilities contained in Section 2.4 hereof. Nothing contained in this Section shall affect the commencement of the Term or the obligation of Tenant to pay rent. Landlord shall diligently complete all punch list items of which it is notified as provided above. Landlord shall deliver the Premises to Tenant on the Commencement Date clean and free of debris with all items of Landlord's Work, including without limitation, the installation of the Tenant Improvements completed in accordance with the terms of EXHIBIT X. Landlord warrants to Tenant that the roof, plumbing, fire sprinkler system, lighting, heating, ventilation and air conditioning systems and electrical systems in the Premises, shall be in good operating condition on the Commencement Date. In order to cause the Building systems to be in compliance with the foregoing warranty as of the Commencement Date, Landlord shall correct the matters listed on Exhibit G (the "Pre-Commencement Repair Schedule") prior to the Commencement Date at its sole cost and expense and not as a Project Cost. If a non-compliance with such warranty exists as of the Commencement Date, Landlord shall, except as otherwise provided in this Lease, promptly after receipt of written notice from Tenant setting forth the nature and extent of such non-compliance, rectify same at Landlord's cost and expense. Tenant's acceptance of the Premises shall be subject to the foregoing and to the provisions of Section 3.2 of the Lease regarding delivery of possession and completion of Landlord's Work and all punch-list items. SECTION 2.3. BUILDING NAME AND ADDRESS. Tenant shall not utilize any name selected by Landlord from time to time for the Building and/or the Project as any part of Tenant's corporate or trade name. Landlord shall have the right to change the name, address, number or designation of the Building or Project without liability to Tenant; provided, however, if the address of the Building and/or the Project is changed by Landlord, Landlord agrees to provide Tenant with no less than sixty (60) days prior written notice and to reimburse Tenant for all expenses reasonably incurred by Tenant in conjunction with such address change (including, without limitation, the cost of changing Tenant's stationery and of notifying Tenant's clients and customers of Tenant's new address of the Building and/or the Project), not to exceed Five Thousand Dollars ($5,000.00) in the aggregate. SECTION 2.4 LANDLORD'S RESPONSIBILITIES. (a) Landlord shall correct, repair or replace, at Landlord's sole cost and expense and not as a Project Cost, any non-compliance of the Building exterior and the Common Areas with all applicable building permits and codes in effect as of the Commencement Date, including without limitation, the provisions of Title III of the Americans With Disabilities Act ("ADA") in effect as of the Commencement Date. Said costs of compliance shall be Landlord's sole cost and shall not be part of Project Costs. Landlord shall correct, repair or replace any non-compliance of the Building exterior and the Common Areas with any revisions or amendments to the ADA in effect after the Commencement Date, provided that the amortized cost of such repairs or replacements (amortized over the useful life thereof using a market cost of funds reasonably determined by Landlord) shall be included as Project Costs payable by Tenant. All other ADA compliance issues which pertain to the Premises, including without limitation, in connection with Tenant's construction of any alterations or other improvements in the Premises (and any resulting ADA compliance requirements in the Common Areas), the Tenant Improvements and the operation of Tenant's business and employment practices in the Premises, shall be the responsibility of Tenant at its sole cost and expense. Landlord shall, during the initial Lease Term, correct, repair or replace, at Landlord's sole cost and expense and not as a Project Cost, any failure of the structural components of the roof, foundations, footings and load-bearing walls of the Building. The repairs, 3 7 corrections or replacements required of Landlord or of Tenant under the foregoing provisions of this Section 2.4 shall be made promptly following notice of non-compliance from any applicable governmental agency. (b) Landlord warrants to Tenant that the Tenant Improvements to be completed pursuant to the Work Letter shall be free from defects in workmanship or materials for a period of twelve (12) months from the Commencement Date. Landlord shall promptly rectify any non-compliance at its sole cost and expense after receipt of written notice from Tenant within such time setting forth the nature and extent of any such non-compliance. (c) In connection with the completion of the Tenant Improvements pursuant to the Work Letter, Landlord shall obtain customary warranties and guaranties from the contractor(s) performing such work and/or the manufacturers of equipment installed but shall be under no obligation to incur additional expense in order to obtain or extend such warranties. If after expiration of the initial twelve (12) months of the Lease Term, Tenant is required to make repairs to any component of the Premises or any of its systems for which Landlord may have obtained a warranty, Landlord shall, upon request by Tenant, use its good faith efforts to pursue its rights under any such warranties for the benefit of Tenant. Landlord shall be under no obligation to incur any expense in connection with asserting rights under such warranties or guaranties against either the contractor or the manufacturer, but shall use reasonable good faith efforts to enforce such warranties and guaranties for Tenant's benefit. SECTION 2.5. RIGHT OF FIRST REFUSAL. Provided Tenant is not then in default of any monetary covenant of this Lease (including, without limitation, the obligation to pay Basic Rent and/or Tenant's Share of Operating Expenses), or any material non-monetary covenant, following written notice to Tenant and the expiration of the applicable cure period, Landlord hereby grants Tenant the continuing right ("First Right") to lease, during the initial Term of this Lease, any space which is available for lease in the Project ("First Right Space") in accordance with and subject to the provisions of this Section 2.5. At any time after the date of this Lease, but prior to leasing the First Right Space, or any portion thereof, to any third party, if Landlord has reached a tentative agreement (which may be a nonbinding, tentative agreement) to lease any of the First Right Space to a third party, Landlord shall give Tenant written notice describing the space (the "Designated First Right Space") and the basic economic terms including but not limited to the Basic Rent, term, operating expense base, and tenant improvement allowance (collectively, the "Economic Terms"), tentatively agreed upon for such lease, provided that the Economic Terms shall exclude brokerage commissions and other Landlord payments that do not directly inure to such third party's benefit. It is understood that should Landlord intend to lease other space in addition to the First Right Space as part of a single transaction, then Landlord's notice shall so provide and all such space shall collectively be subject to the following provisions. If the Economic Terms include a proposed lease term which is not conterminous with the Term remaining under this Lease, Tenant shall have the right to lease such space upon the terms set forth in the Designated Space Alternative (defined below) but only for the balance of the Term remaining under this Lease provided such remaining Term is not less than Thirty Six (36) months. If the Economic Terms for any Designated First Right Space would not result in a lease which is coterminous with this Lease, Landlord shall also deliver to Tenant, with such notice a proposal (the "Designated Space Alternative") which indicates the revised economic terms Landlord requires to change the term for the Designated First Right Space to be coterminous with the Term of this Lease. Within ten (10) business days after receipt of Landlord's notice, Tenant shall give Landlord written notice ("Tenant's First Right Acceptance Notice") pursuant to which Tenant shall elect to: (i) lease all, but not less than all, of the Designated First Right Space upon the Economic Terms provided, however, that if such Economic Terms would cause the commencement date for such Designated First Right Space to occur prior to the Commencement Date for Building B, Tenant may delay the commencement date for such Designated First Right Space to the earlier to occur of: (a) its occupancy of such space for any purpose other than construction or installation of furniture, fixtures or equipment; or (b) six (6) months after the date of Tenant's First Right Acceptance Notice; or (ii) lease all, but not less than all, of the Designated First Right Space upon the terms of the Designated Space Alternative commencing on a date which Tenant may designate provided such date is not more than six (6) months after the date of Landlord's notice and ending upon the expiration of the Term of this Lease; or (iii) decline to lease the Designated First Right Space, in which event Landlord may lease the Designated Space to any third party upon the Economic Terms and such other terms as it deems appropriate. In the event that Tenant fails to respond in writing to Landlord's notice within said ten (10) business day period, Tenant shall be deemed to have elected clause (iii) above. If Tenant notifies Landlord that it has elected to lease the Designated First Right Space, then Landlord shall promptly prepare and deliver to Tenant an amendment to this Lease consistent with the foregoing, and Tenant shall execute and return same to Landlord within ten (10) business days. Tenant's failure to timely return the amendment shall entitle Landlord at its option to specifically enforce Tenant's commitment to lease the Designated First Right Space, to lease such space to a third party, and/or to pursue any other available legal remedy. In the event that Landlord shall not enter into a lease for the Designated First Right Space, or a portion thereof, with a third party within one hundred eighty (180) days following Landlord's notice described above, then prior to leasing the Designated First Right Space to any third party thereafter, Landlord shall repeat the procedures set forth in this Section 2.5. In the event that Landlord leases the Designated First Right Space, or any portion thereof, to a third party in accordance with the provisions of this Section 2.5, and during the initial Term of this Lease the First Right Space, or any portion thereof, shall again become available for releasing, then prior to Landlord entering into any such new lease with a third party for the First Right Space, Landlord shall repeat the procedures specified above in this Section 2.5. Notwithstanding the foregoing, it is understood that Tenant's First Right shall be subject to any express contractual rights existing as of the Effective Date of this Lease including without limitation expansion or extension rights previously granted by Landlord to AST Research Inc. or any third party tenant now or hereafter occupying the First Right Space or any portion thereof, and in no event shall any such First Right Space be deemed available for leasing until the term of the existing lease shall have been terminated or shall have expired without such tenant's timely exercise of any preexisting contractual expansion or extension rights and the 4 8 existing tenant thereof shall have vacated the First Right Space. If any tenant occupying any portion of the First Right Space does not possess express contractual expansion or extension rights granted to such tenant prior to the applicable First Right notice to Tenant (i.e., pre-existing contractual rights), Landlord must offer such First Right Space to Tenant pursuant to this Section 2.5. Notwithstanding the foregoing, if Tenant exercises this right of first refusal or requests to lease available space in the Project (not previously offered) during the initial six (6) months of the Term (from the Commencement Date for Building A) the terms and conditions for such space shall be the same as the original Premises including without limitation the Basic and Additional Rent and the length of the Lease Term. Tenant's rights under this Section 2.5 shall belong solely to Broadcom Corporation, a California corporation, and may not be assigned or transferred except in connection with the assignment of this Lease to a "Tenant Affiliate" as hereinafter defined. Any attempted assignment or transfer of such rights except to a Tenant Affiliate shall be void and of no force or effect. SECTION 2.6. OPTION TO EXPAND INTO AST SPACE. Subject to the conditions set forth in this paragraph, Tenant shall have the right to expand the Premises under this Lease to include all but not less than all of the ground floor of 16225 Alton Parkway ("Building C"), which contains approximately 38,976 rentable square feet and is currently occupied by AST Research Inc. ("AST") together with any other space in the Project then being occupied by AST or its successors or assigns ("AST Space"). Tenant's expansion rights with respect to the AST Space may be exercised by Tenant delivering a written notice to Landlord (the "AST Space Expansion Notice") at any time during the Term of this Lease specifying the date upon which Tenant is prepared to add the AST Space to the Premises provided that such date shall not be sooner than either: (i) nine (9) months after of the date of the AST Space Expansion Notice; or (ii) prior to April 1, 2000. The commencement date for the AST Space shall be the earlier to occur of: (x) Tenant's occupancy of the AST Space for any purpose other than construction of tenant improvements or installation of furniture, fixtures and equipment; or (y) ninety (90) days after AST vacates the AST Space. Tenant may not give Landlord an AST Space Expansion Notice unless each of the following conditions is satisfied: (a) Tenant shall not be in default of any monetary covenant of this Lease (including without limitation the obligation to pay Basic Rent and/or Tenant's share of Operating Expenses) or any material non-monetary covenant following written notice to Tenant and the expiration of the applicable cure period, at the time the AST Space Expansion Notice is given; (b) There shall not be available for lease any other contiguous block of space in the Project which is greater than 20,000 square feet; and (c) There shall be a minimum of thirty six (36) months remaining in the Term of this Lease as of the date the AST Space would be incorporated into the Premises. The Basic Rent payable for the AST Space shall be at the fair market rental, including subsequent adjustments, for comparable office space being leased by Landlord in the Irvine Spectrum (the "Expansion Space Economic Terms"). In addition, Tenant shall be obligated to reimburse Landlord for fifty percent (50%) of the actual reasonable out of pocket costs incurred to relocate AST and reconnect AST's personal property as required by the terms the existing AST Lease (the pertinent provisions of which have been provided to Tenant for review) except as specifically set forth in this paragraph (the "Relocation Costs"). The AST Lease limits Landlord's obligation to fund the costs of relocating AST to a maximum of two (2) months of basic rent then payable under the AST Lease (the "Relocation Cost Cap") except that such limitation does not apply to tenant improvement expenditures related to the relocation. Landlord agrees that Relocation Costs shall be subject to the Relocation Cost Cap but the Relocation Costs shall not include the cost of tenant improvements for AST's relocation which would fall within the category of Standard Improvements as defined in the Work Letter of this Lease but Relocation Costs shall include the costs of tenant improvements which would be Non-Standard Improvements as defined in the Work Letter of this Lease including without limitation, a computer room with raised flooring, a fire suppression system, a water detection system and cabling attendant to those systems which Landlord is required to provide to AST in its new space. Tenant shall pay the Relocation Costs prior to its occupancy of the AST Space. Landlord will provide written notice to Tenant of Landlord's good faith determination of the Expansion Space Economic Terms and an estimate of the Relocation Costs not later than fifteen (15) days after the date upon which Tenant delivers an AST Expansion Space Notice to Landlord (the "Expansion Costs"). Tenant will have fifteen (15) days ("Tenant's Review Period") after receipt of Landlord's notice of the Expansion Costs within which to accept the Expansion Space Economic Terms or to reasonably object thereto in writing. In no event shall Landlord's estimate of the Relocation Costs be binding on Tenant. Tenant's failure to object to the Expansion Space Economic Terms submitted by Landlord in writing within Tenant's Review Period will conclusively be deemed Tenant's approval and acceptance thereof. If Tenant reasonably objects to the Expansion Space Economic Terms submitted by Landlord within Tenant's Review Period, Landlord and Tenant will attempt in good faith to agree upon such Expansion Space Economic Terms using their best good faith efforts. If Landlord and Tenant fail to reach agreement on such Expansion Space Economic Terms within ten (10) days following the expiration of Tenant's Review Period (the "Outside 5 9 Agreement Date"), then either party may elect, by written notice to the other party given on or before the Outside Agreement Date, cause the fair market rental, including subsequent adjustments, for the AST Space to be determined by appraisal as follows. Within ten (10) days following receipt of such appraisal election, the parties shall attempt to agree on one (1) appraiser to determine the Expansion Space Economic Terms. If the parties are unable to agree in that time, then each party shall designate an appraiser within five (5) days thereafter. Should either party fail to so designate an appraiser within that time, then the appraiser designated by the other party shall determine the fair rental value. Should each of the parties timely designate an appraiser, then the two appraisers so designated shall appoint a third appraiser who shall, acting alone, determine the Expansion Space Economic Terms. Any appraiser designated hereunder shall have an M.A.I. certification with not less than five (5) years experience in the valuation of commercial office buildings in Orange County, California. Within twenty (20) days following the selection of the appraiser, such appraiser shall determine the fair market rental value, including subsequent adjustments for the AST Space which shall become the Expansion Space Economic Terms. In determining such value, the appraiser shall first consider rental comparables for space owned by Landlord in the Irvine Spectrum area (including, without limitation, the Project), provided that if such adequate comparables do not exist, then the appraiser may consider transactions involving similarly improved space in the Irvine Spectrum area with appropriate adjustments for differences in location and quality of project. In no event shall the appraiser attribute factors for market tenant improvement allowances or brokerage commissions to reduce said fair market rental. Landlord and Tenant shall each pay for the services of their respective appraisers and shall share equally the cost of the third appraiser. Within five (5) days after the determination of the Expansion Space Economic Terms whether by agreement or by appraisal, Landlord shall prepare an amendment to this Lease reflecting Tenant's absorption of the AST Space. Tenant shall execute and return the amendment to Landlord within five (5) days after its receipt. After the Lease amendment has been fully executed and delivered, Landlord shall give notice to AST of the relocation date. If Tenant fails to execute and return the expansion amendment within said time period, Tenant's exercise of its expansion rights shall be deemed terminated and Tenant shall have no further rights to the AST Space but shall be obligated to reimburse Landlord for the reasonable costs incurred by Landlord after receipt of Tenant's AST Expansion Notice including without limitation fees and charges of space planners and the appraiser(s). In no event shall Landlord have any liability to Tenant if AST is unwilling or unable to vacate the AST Space in accordance with the terms of its lease; provided, however, that Tenant may, at its expense but with counsel reasonably acceptable to Landlord, cause legal action to be taken on Landlord's behalf and with Landlord's cooperation to enforce Landlord's relocation rights under the AST Lease. Tenant's rights under this Section 2.5 shall belong solely to Broadcom Corporation, a California corporation and may not be assigned or transferred except in connection with the assignment of this Lease to a "Tenant Affiliate" as hereinafter defined. Any attempted assignment or transfer of such rights except to a Tenant Affiliate shall be void and of no force or effect. SECTION 2.7. TEMPORARY PREMISES LEASE. Landlord leases to Tenant and Tenant leases from Landlord a portion of the premises shown on EXHIBIT A-2 located on the second floor of Building C containing not less than fifteen thousand (15,000) nor more than thirty thousand (30,000) rentable square feet to be designated by Tenant and approved by Landlord (the "Temporary Premises") . Tenant's right to occupy the Temporary Premises (the "Temporary Premises Term") shall commence on the Effective Date and shall expire not later than midnight on February 28, 1999. Tenant's use of the Temporary Premises shall be subject to all terms and conditions of this Lease except that the Basic Rent for the Temporary Premises shall be a minimum of Eleven Thousand Two Hundred Fifty Dollars ($11,250.00) based on $0.75 per rentable square foot per month but shall be determined based on the actual number of rentable square feet of Temporary Premises occupied by Tenant subject to a minimum Basic Rent on 15,000 square feet. In addition, Tenant shall pay Operating Expenses monthly with respect to the Temporary Premise pursuant to Section 4.2 hereof based upon an initial estimate of $0.27 per rentable square foot per month and a minimum of 15,000 rentable square feet subject to the adjustment for the size of the Temporary Premises; if more, than the minimum area is used by Tenant. Tenant's obligation to pay Basic and Additional Rent for the Temporary Premises shall commence on the earlier of occupancy of any portion thereof for any purpose other than construction or installation of furniture, fixtures or equipment or August 15, 1998. The Temporary Premises shall be leased to Tenant on an "AS-IS" basis. Tenant shall surrender the Temporary Premises to Landlord not later than February 28, 1999 but may do so sooner upon thirty (30) days prior written notice to Landlord and otherwise in accordance with the provisions of this Lease regarding surrender of the Premises. During the Temporary Premises Term, Tenant shall have the nonexclusive use of additional parking stalls based on four (4) stalls per one thousand (1,000) rentable square feet of Temporary Premises leased free of charge but subject to the provisions of Section 6.4 of this Lease. Provisions of this Lease referring to its "Term" or "Commencement Date" refer to the Premises unless the Temporary Premises are specifically referenced. 6 10 ARTICLE III. TERM SECTION 3.1. GENERAL. The term of this Lease (the "Term") for the Premises shall be for the period shown in Item 5 of the Basic Lease Provisions and the term of the Temporary Premises Lease shall be as set forth in Section 2.7 hereof. Subject to the provisions of Section 3.2 below, the Term with respect to each portion of the Premises (not including the Temporary Premises) shall commence ("Commencement Date") on the earlier to occur of: (i) ten (10) business days following the date that (A) Landlord notifies Tenant that Landlord has substantially completed the construction of the Tenant Improvements in accordance with the Work Letter attached as EXHIBIT X hereto, but for minor "punch list" items identified by Landlord and Tenant in a walk-through of the Premises prior to the Commencement Date, which items do not preclude or materially impair Tenant from conducting its business from the Premises, and (B) Landlord has provided Tenant with all parking required by this Lease in the Common Area of the Project, and (C) Landlord has obtained and provided Tenant with a certificate of occupancy or temporary certificate of occupancy for the Premises from the City of Irvine or (ii) the date Tenant acquires possession or commences use of such portion of the Premises (excluding the Temporary Premises) for any purpose other than construction or installation of equipment, furniture, fixtures or network and telecommunications cabling. Possession of the Premises shall be tendered to Tenant on the Commencement Date; Within ten (10) days after the Commencement Date has occurred, the parties shall memorialize on a form provided by Landlord the actual Commencement Date and the expiration date ("Expiration Date") of this Lease. Tenant's failure to execute that form shall not affect the validity of Landlord's determination of those dates. SECTION 3.2. DELAY IN POSSESSION. If Landlord, for any reason whatsoever, cannot deliver possession of the Premises to Tenant on or before the Estimated Commencement Date of either portion of the premises, of either portion of the premises this Lease shall not be void or voidable nor shall Landlord be liable to Tenant for any resulting loss or damage. However, Tenant shall not be liable for any rent and the Commencement Date shall not occur until Landlord delivers possession of the Premises and the Premises are in fact available for Tenant's occupancy with any Tenant Improvements that have been approved as per Section 3.1 above and all conditions to the Commencement Date specified in Section 3.1 above having been satisfied, except that if Landlord's failure to so deliver possession on the Estimated Commencement Date is attributable to any action or inaction by Tenant (including without limitation any Tenant Delay described in the Work Letter attached to this Lease), then the Commencement Date shall not be advanced to the date on which possession of the Premises is tendered to Tenant, and Landlord shall be entitled to full performance by Tenant (including the payment of rent) from the date Landlord would have been able to deliver the Premises to Tenant but for Tenant's Delay(s). If for reasons other than "Tenant Delays" as defined in the Work Letter attached hereto as EXHIBIT X, the Commencement Date has not occurred by the date ("Outside Date") that is one (1) year following the Estimated Commencement Date set forth in Item 4 of the Basic Lease Provisions, then Tenant shall have the right to terminate this Lease upon thirty (30) days prior written notice to Landlord delivered at any time following the Outside Date and prior to Landlord's delivery of the Premises to Tenant in the condition required under EXHIBIT X, and this Lease shall terminate thirty (30) days after such notice unless Landlord shall so deliver the Premises to Tenant within said thirty (30) days. SECTION 3.3. RIGHT TO EXTEND THE LEASE TERM. Provided that Tenant is not in default of any monetary covenant of this Lease (including, without limitation, the obligation to pay Basic Rent and/or Tenant's Share of Operating Expenses) or any material non-monetary covenant, following written notice and the expiration of the applicable cure period, either at the time of exercise of the extension right granted herein or at the time of the commencement of such extension, then Tenant may extend the Term of this Lease for up to two (2) periods of sixty (60) months each. Tenant shall exercise its right to extend the Term by and only by delivering Landlord, not less than six (6) months or more than twelve (12) months prior to the expiration date of the then current Term, Tenant's irrevocable written notice of its commitment to extend (the "Commitment Notice"). The Basic Rent payable under the Lease during any extension of the Term shall be at the fair market rental, including subsequent adjustments, for comparable office space being leased by Landlord in the Irvine Spectrum. Landlord will provide written notice to Tenant of Landlord's good faith determination of the fair market rental rate not later than thirty (30) days after the date upon which Tenant timely exercises its extension option. Tenant will have thirty (30) days ("Tenant's Review Period") after receipt of Landlord's notice of the fair market rental rate within which to accept such fair market rental rate or to reasonably object thereto in writing. Tenant's failure to object to the fair market rental rate submitted by Landlord in writing within Tenant's Review Period will conclusively be deemed Tenant's approval and acceptance thereof. If Tenant reasonably objects to the fair market rental rate submitted by Landlord within Tenant's Review Period, Landlord and Tenant will attempt in good faith to agree upon such fair market rental rate using their best good faith efforts. If Landlord and Tenant fail to reach agreement on such fair market rental rate within fifteen (15) days following the expiration of Tenant's Review Period (the "Outside Agreement Date"), then either party may elect, by written notice to the other party, to cause said rental, including subsequent adjustments, to be determined by appraisal as follows. Within ten (10) days following receipt of such appraisal election, the parties shall attempt to agree on an appraiser to determine the fair market rental. If the parties are unable to agree in that time, then each party shall designate an appraiser within ten (10) days thereafter. Should either party fail to so designate an appraiser within that time, then the appraiser designated by the other party shall determine the fair rental value. Should each of the parties timely designate an appraiser, then the two appraisers so designated shall appoint a third appraiser who shall, acting alone, determine the fair rental value of the Premises. Any appraiser designated hereunder shall have an M.A.I. certification with not less than five (5) years experience in the valuation of commercial office buildings in Orange County, California. 7 11 Within thirty (30) days following the selection of the appraiser, such appraiser shall determine the fair market rental value, including subsequent adjustments of the Premises. In determining such value, the appraiser shall consider rental comparables for space in the Irvine Spectrum (including, without limitation, the Project). In no event shall the appraiser attribute factors for market tenant improvement allowances or brokerage commissions to reduce said fair market rental. Landlord and Tenant shall each pay for the services of their respective appraisers and shall share equally the cost of the third appraiser. Within twenty (20) days after the determination of the fair market rental, Landlord shall prepare an amendment to this Lease reflecting the extended term and rental rate for the extension period, and Tenant shall execute and return same to Landlord within ten (10) days. Should the fair market rental not be established by the commencement of the extension period, then Tenant shall continue paying rent at the rate in effect during the last month of the initial Term, and a lump sum adjustment shall be made promptly upon the determination of such new rental. If Tenant fails to timely comply with any of the provisions of this Section, Tenant's right to extend the Term shall be extinguished and the Lease shall automatically terminate as of the expiration date of the Term, without any extension and without any liability to Landlord. Tenant shall have no other right to extend the Term beyond the two sixty (60) month extension created by this Section. Unless agreed to in a writing signed by Landlord and Tenant, any extension of the Term, whether created by an amendment to this Lease or by a holdover of the Premises by Tenant, or otherwise, shall be deemed a part of, and not in addition to, any duly exercised extension period permitted by this Section. ARTICLE IV. RENT AND OPERATING EXPENSES SECTION 4.1. BASIC RENT. Tenant shall pay to Landlord without deduction or offset (except as otherwise expressly provided in this Lease): (i) Basic Rent for the Temporary Premises from and after the Commencement Date, for the Temporary Premises in accordance with Section 2.7 hereof; and (ii) from and after the Commencement Date for Building A, Basic Rent for the balance of the Premises in the total amount shown (including subsequent adjustments, if any) in Item 6 of the Basic Lease Provisions. Any rental adjustment shown in Item 6 shall be deemed to occur on the specified monthly anniversary of the Commencement Date for Building A, whether or not that date occurs at the end of a calendar month. Basic Rent for the Temporary Premises and the Premises shall be due and payable in advance (as prorated for any partial month) on the first day of each successive calendar month of the Term. No demand, notice or invoice shall be required for the payment of Basic Rent. An installment of one (1) full month's Basic Rent for Building A in the amount of One Hundred Twenty Thousand Nineteen Dollars ($120,019.00) together with one (1) full month's minimum Basic and additional rent for the minimum Temporary Premises in the amount of Fifteen Thousand Three Hundred Dollars ($15,300.00) (totaling One Hundred Thirty-Five Thousand Three Hundred Nineteen Dollars ($135,319.00) shall be delivered to Landlord concurrently with Tenant's execution of this Lease and shall be applied against the first due hereunder. In addition, Tenant shall pay one (1) full month's Basic Rent for Building B in the amount of Eighty-Five Thousand Six Hundred Fifty-Nine Dollars ($85,659.00) prior to commencement of construction of Tenant Improvements for Building B which shall be applied against Basic Rent first due upon the Commencement Date for Building B. SECTION 4.2. OPERATING EXPENSES. (a) Tenant shall pay to Landlord, as additional rent, Tenant's Share of "Operating Expenses", as defined below, incurred by Landlord in the operation of any Building which includes a portion of the Premises or the Temporary Premises and the Project. The term "Tenant's Share" means that portion of an Operating Expense determined by multiplying the cost of such item by a fraction, the numerator of which is the floor area of the Premises (or the Temporary Premises as the case may be) and the denominator of which is the total square footage of the floor area within all buildings in the Project to which such Operating Expenses relate, as of the date on which the computation is made. The rentable square footage of the Project may be adjusted from time to time in the event new buildings are constructed within or incorporated within the Project. Tenant may elect to assume responsibility for the operation and maintenance of any Building comprising a portion of the Premises which is one hundred percent (100%) leased by Tenant (except that Landlord shall contract directly for and provide preventive HVAC maintenance, servicing and repair) in which event, the Operating Expenses for such Building shall be paid directly and completely by Tenant and such expenses shall not be included within Landlord's determination of Operating Expenses. (b) Commencing prior to the start of the first full "Expense Recovery Period" (as defined below) of the Lease, and prior to the start of each full or partial Expense Recovery Period thereafter, Landlord shall give Tenant a written estimate of the amount of Tenant's Share of Operating Expenses for the Expense Recovery Period. Tenant shall pay the estimated amounts to Landlord in equal monthly installments, in advance, with Basic Rent. If Landlord has not furnished its written estimate for any Expense Recovery Period by the time set forth above, Tenant shall continue to pay cost reimbursements at the rates established for the prior Expense Recovery Period, if any; provided that when the new estimate is delivered to Tenant, Tenant shall, at the next monthly payment date, pay any accrued cost reimbursements based upon the new estimate. Notwithstanding the foregoing, if Landlord is more than three (3) months late in the delivery of its written estimate for any Expense Recovery Period, Tenant shall have the right to pay any accrued cost reimbursements in equal installments over a six (6) month period rather than in one lump sum. For 8 12 purposes hereof, "Expense Recovery Period" shall mean every twelve month period during the Term (or portion thereof for the first and last lease years) commencing July 1 and ending June 30. (c) Within one hundred twenty (120) days after the end of each Expense Recovery Period, Landlord shall furnish to Tenant a statement showing in reasonable detail the actual or prorated Operating Expenses incurred by Landlord during the period, and the parties shall within thirty (30) days thereafter make any payment or allowance necessary to adjust Tenant's estimated payments, if any, to the actual Tenant's Share as shown by the annual statement. Any delay or failure by Landlord in delivering any statement hereunder shall not constitute a waiver of Landlord's right to require Tenant to pay Tenant's Share of Operating Expenses pursuant hereto. Any amount due Tenant shall be credited against installments next coming due under this Section 4.2, and any deficiency shall be paid by Tenant together with the next installment. If Tenant has not made estimated payments during the Expense Recovery Period, any amount owing by Tenant pursuant to subsection (a) above shall be paid to Landlord in accordance with Article XVI. Should Tenant fail to object in writing to Landlord's determination of actual Operating Expenses within one hundred twenty (120) days following delivery of Landlord's expense statement, Landlord's determination of actual Operating Expenses for the applicable Expense Recovery Period shall be conclusive and binding on the parties and any future claims to the contrary shall be barred except to the extent that a future audit shall determine that a particular category of expenses has been improperly included as Operating Expenses. Landlord agrees that it will maintain complete and accurate records of all costs, expenses and disbursements paid or incurred by Landlord, its employees, agents and/or contractors, with respect to the Operating Expenses in accordance with generally accepted accounting principles, consistently applied. Such records shall be kept until one (1) year after the termination of this Lease. Landlord shall provide in reasonable detail the calculation of Tenant's Share of the Operating Expenses. Provided Tenant is not then in default of any monetary covenant of this Lease (including, without limitation, the obligation to pay Basic Rent and/or Tenant's Share of Operating Expenses), or any material non-monetary covenant, following written notice and the expiration of the applicable cure period, then Tenant shall have the right to have Tenant's financial officer or a certified public accountant audit Landlord's Operating Expenses, subject to the terms and conditions hereof. In no event, however, shall such auditor be compensated by Tenant on a "contingency" basis, or on any other basis tied to the results of said audit. Tenant shall give notice to Landlord of Tenant's intent to audit within one hundred twenty (120) days following delivery of Landlord's expense statement for each of the Expense Recovery Periods. Following at least ten (10) business days notice to Landlord, such audit shall be conducted at a mutually agreeable time during normal business hours at the office of Landlord or its management agent where the records are maintained in Orange County, California. Landlord agrees to make such personnel available to Tenant as is reasonably necessary for Tenant's employees and agents, to conduct such audit. Landlord shall make such records available to Tenant's employees and agents, for inspection during normal business hours. Tenant's employees and agents shall be entitled to make photostatic copies of such records, provided Tenant bears the expense of such copying, and further provided that Tenant keeps such copies in a confidential manner and does not discuss, display or distribute such copies to any other third party. If Tenant's audit determines that actual Operating Expenses have been overstated by more than four percent (4%), then subject to Landlord's right to review and/or contest the audit results, Landlord shall reimburse Tenant for the reasonable out-of-pocket costs of such audit. Tenant's Basic Rent shall be appropriately adjusted to reflect any overstatement in Operating Expenses. In the event of a dispute between Landlord and Tenant regarding the results of such audit, such dispute shall be submitted to and resolved by JAMS as provided in Section 22.8 of this Lease. All of the information obtained by Tenant and/or its auditor in connection with such audit, as well as any compromise, settlement, or adjustment reached between Landlord and Tenant as a result thereof, shall be held in strict confidence and, except as may be required pursuant to litigation and except for inadvertent disclosures despite Tenant's reasonable efforts to keep the disclosed information confidential, shall not be disclosed to any third party, directly or indirectly, by Tenant or its auditor or any of their officers, agents or employees. Landlord may require Tenant's auditor to execute a separate confidentiality agreement affirming the foregoing as a condition precedent to any audit. (d) Even though the Lease has terminated and the Tenant has vacated the Premises, when the final determination is made of Tenant's Share of Operating Expenses for the Expense Recovery Period in which the Lease terminates, Tenant shall upon notice pay the entire increase due over the estimated expenses paid. Conversely, any overpayment made in the event expenses decrease shall be rebated promptly by Landlord to Tenant. (e) If, at any time during any Expense Recovery Period, any one or more of the Operating Expenses are increased to a rate(s) or amount(s) in excess of the rate(s) or amount(s) used in calculating the estimated expenses for the year, then the estimate of Tenant's Share of Operating Expenses shall be increased for the month in which such rate(s) or amount(s) becomes effective and for all succeeding months by an amount equal to Tenant's Share of the increase. Landlord shall give Tenant written notice of the amount or estimated amount of the increase, the month in which the increase will become effective, Tenant's Share thereof and the month for which the payments are due. Tenant shall pay the increase to Landlord as a part of Tenant's monthly payments of estimated expenses as provided in paragraph (b) above, commencing with the month in which effective. (f) The term "Operating Expenses" shall mean and include all "Project Costs" (as hereafter defined) and "Property Taxes" (as hereafter defined). 9 13 (g) The term "Project Costs" shall include all reasonable costs and expenses of operation and maintenance of the Building and the Project, together with all appurtenant Common Areas (as defined in Section 6.2), and shall include the following charges by way of illustration but not limitation: water and sewer charges; insurance premiums or reasonable premium equivalents for the reasonable cost of administering a self-insurance program should Landlord elect to self-insure any risk that Landlord is authorized to insure hereunder as provided in Section 10.2 below; license, permit, and inspection fees; heat; light; power; air conditioning; janitorial services to any interior Common Areas; supplies; materials; equipment; tools; the reasonable cost of any environmental, insurance, tax or other consultant utilized by Landlord in connection with the Premises and/or Project; establishment of reasonable reserves for replacements and/or repair of Common Area improvements, equipment and supplies; the cost of any capital investments, after application of previously established reserves for such items, to the extent of the amortized cost thereof over the useful life of such capital investment as reasonably determined by Landlord for each year of useful life during the Term; subject to the express provisions of this Lease to the contrary, costs incurred in connection with compliance of any laws or changes in laws applicable to the Premises or the Project (except for laws or changes in laws that pertain particularly to Tenant or to Tenant's particular use of the Premises and/or only to the interior of the Premises which shall be the sole responsibility of Tenant at its cost), to the extent such laws or change in laws require expenditures of a "capital" nature (as determined by generally accepted accounting principles consistently applied), then such "capital" expenditure shall be amortized (using a market cost of funds as reasonably determined by Landlord) over the useful life of such asset and only the amortized cost thereof shall be included in Project Costs during the remaining Term of the Lease; costs associated with the procurement and maintenance of an air conditioning, heating and ventilation service agreement; labor; reasonably allocated wages and salaries, fringe benefits, and payroll taxes for administrative and other personnel directly applicable to the Premises and/or Project, including both Landlord's personnel and outside personnel; any expense incurred pursuant to Sections 6.1, 6.2, 6.4, 7.2, and 10.2; and a reasonable overhead/management fee for the professional operation of the Project. Any such overhead management fee charged to Tenant shall not be in excess of those being charged for other comparable first-class office projects in the Irvine Spectrum area. It is understood that Project Costs may include competitive charges for direct services provided by any subsidiary or division of Landlord. Notwithstanding any contrary provision herein, Landlord agrees that Tenant shall have access to and use of after-hours air conditioning services to the Premises. For any Building not wholly leased to Tenant, Tenant shall pay an hourly charge based on the reasonable cost incurred by Landlord to supply such services and in any Building wholly leased to Tenant, Tenant shall pay the cost for such services directly as contemplated by Section 6.1 hereof. Notwithstanding the provisions of this Section 4.2 to the contrary, Operating Expenses shall not include any cost or expense identified as the responsibility of Landlord and not an Operating Expense or a Project Cost by the express terms of this Lease, and shall not include any of the following: (1) Leasing commissions, attorneys' fees, costs, disbursements and other expenses incurred by Landlord or its agents in connection with negotiations for leases with tenants, other occupants or prospective tenants or other occupants of the Project, and similar costs incurred in connection with disputes with and/or enforcement of any lease with tenants, other occupants, or prospective tenants or other occupants of the Project; (2) "Tenant allowances", "tenant concessions", work letter payments, and other costs or expenses (including permit, license and inspection fees) incurred in completing, fixturing, furnishing, renovating or otherwise improving, decorating or redecorating space for tenants or other occupants of the Project, or vacant, leasable space in the Project, including space planning/interior design fees for same; (3) Depreciation and other "non-cash" expense items; (4) Services, items and benefits for which Tenant or any other tenant or occupant of the Project specifically reimburses Landlord or for which Tenant or any other tenant or occupant of the Project pays third persons or services, items or benefits which are not generally made available to Tenant as an occupant of the Building or the Project; (5) Costs or expenses (including fines, penalties and legal fees) incurred due to the violation by Landlord of any terms and conditions (other than by Tenant) of this Lease or of the leases of other tenants in the Project, that would not have incurred but for such violation by Landlord; (6) Penalties for late payment of any Operating Expenses by Landlord, including, without limitation, with respect to taxes, equipment leases, etc.; (7) Payments in respect of overhead and/or profit to any subsidiary or Affiliate (hereinafter defined) of Landlord, as a result of a non-competitive selection process for services (other than the management fee) on or to the Project, or for goods, supplies or other materials, to the extent that the costs of such services, goods, supplies or materials exceed the costs that would have been paid if the services, goods, supplies or materials had been provided by parties unaffiliated with Landlord, of similar skill, competence and experience, on a competitive basis; (8) Payments of principal, finance charges or interest on debt or amortization on any deed of trust or other debt encumbering the Project, and rental payments (or increases in same) under any ground or underlying lease or leases encumbering the Project (except to the extent the same may be made to pay or reimburse, or may be measured by Property Taxes); 10 14 (9) Except for a management fee which is reasonable and commercially competitive for similar projects in the Irvine Spectrum area, costs of Landlord's general overhead and general administrative expenses (individual, partnership or corporate, as the case may be) and wages, salaries and other compensation and benefits (as well as adjustments thereto) for all employees and personnel of Landlord above the level of manager for the Project, which costs would not be chargeable to Operating Expenses in accordance with generally accepted accounting principles, consistently applied; (10) Rentals and other related expenses, if any, incurred in leasing air conditioning systems or other equipment ordinarily considered to be of a capital nature, except equipment which is used in providing janitorial services and which is not affixed to the Project and equipment which is leased on a temporary basis in emergency situations; (11) Advertising and promotional expenses; (12) Costs or expenses for the acquisition of sculpture, paintings or other works of art, but not the reasonable expenses of maintaining, repairing and insuring same; (13) Costs for which Landlord is compensated through or reimbursed by insurance; (14) Contributions to operating expense reserves (including tax reserves), except for reasonable reserves for the roof of the Building and as specifically set forth in Section 4.4 hereof; (15) Contributions to political or charitable organizations; (16) Costs incurred in removing the property of former tenants and/or other occupants of the Project; (17) The costs of any "tap fees" or one-time lump sum sewer, water or other utility connection fees for the Project; (18) Costs or fees relating to the defense of Landlord's title to or interest in the Building and/or the Project, or any part thereof; and (19) Any other expense which, under generally accepted accounting principles, consistently applied, would not be considered to be a normal maintenance or operating expense of the Building and/or the Project. As used herein, the term "Affiliate" shall mean and refer to any person or entity controlling, controlled by, or under common control with another such person or entity. "Control", as used herein, shall mean the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of such controlled person or entity; the ownership, directly or indirectly, of at least fifty-one percent (51%) of the voting securities of, or possession of the right to vote, in the ordinary direction of its affairs, at least fifty-one percent (51%) of the voting interest in, any person or entity shall be presumed to constitute such control. In the case of Landlord, the term "Affiliate" shall include any person or entity controlling or controlled by or under common control with any general partner of Landlord or any general partner of Landlord's general partner. (h) The term "Property Taxes" as used herein shall include the following: (i) all real estate taxes or personal property taxes, as such property taxes may be reassessed from time to time; and (ii) other taxes, charges and assessments which are levied with respect to this Lease or to the Building and/or the Project, and any improvements, fixtures and equipment and other property of Landlord located in the Building and/or the Project, except that general net income and franchise taxes imposed against Landlord shall be excluded; and (iii) all assessments and fees for public improvements, services, and facilities and impacts thereon, including without limitation arising out of any Community Facilities Districts, "Mello Roos" districts, similar assessment districts, and any traffic impact mitigation assessments or fees (except for assessments or fees under any Community Facilities District(s) formed after the date of this Lease); (iv) any tax, surcharge or assessment including without limitation taxes based on the receipt of rent (including gross receipts or sales taxes applicable to the receipt of rent unless such are required to be paid by Tenant) which shall be levied in addition to or in lieu of real estate or personal property taxes, other than taxes covered by Article VIII; and (v) costs and expenses incurred in contesting the amount or validity of any Property Tax by appropriate proceedings. (i) The term "Property Taxes" shall not include personal property taxes of any kind, which shall instead be governed by the provisions of Article VIII of this Lease. (j) If Tenant reasonably believes that the amount of any real property tax is improper for any reason, Tenant may notify Landlord in writing of Tenant's desire that such real property taxes be contested or challenged by Landlord with the applicable taxing authority. Tenant shall indicate the basis for Tenant's contention that such taxes are improper in Tenant's notice to Landlord. Upon receipt of any such request from Tenant, Landlord shall promptly meet with Tenant to discuss whether or not it is appropriate to initiate a challenge or contest of such taxes or to take no action with respect thereto. Landlord agrees that if Landlord is pursuing tax contests for other buildings within the Project, Landlord will also pursue such a contest for the Building if so requested by Tenant. 11 15 (k) Any assessment of real property taxes shall be deemed imposed in the maximum number of installments permitted by applicable laws, whether or not actually paid; provided, however, that if the prevailing practice in other comparable projects in the vicinity of the Project is to pay such assessments on an earlier basis, and Landlord pays the same on such basis, such assessments shall be included in real property taxes as paid by Landlord. In no event, however, shall Landlord impute any accrued interest (resulting from such installment payments of real property taxes) in its computation of real property taxes except as imposed by the taxing authority. SECTION 4.3. SECURITY DEPOSIT. (a) Prior to the execution of this Lease, Tenant has delivered to Landlord copy of its current audited financial statements and Tenant shall periodically provide copies of such Statements to Landlord pursuant to Section 13.3 of this Lease. Provided Tenant's Statements are delivered to Landlord each year during the Term and are highlighted to indicated a continuing a balance of cash and/or cash equivalents greater than Ten Million Dollars ($10,000,000.00) (the "Cash Equivalent Threshold"), Tenant shall have no obligation to deliver to Landlord a cash security deposit or prepaid rent. If any time during the Term, the cash and/or cash equivalents as shown on Tenant's then current Statements, do not exceed the Cash Equivalent Threshold amount, Tenant shall deposit with Landlord, within thirty (30) days of Landlord's written request an amount equal to One Hundred Ten percent (110%) of the sum of following: (i) the scheduled Basic Rent for the Premises for the last month of the then current term; plus (ii) one month's estimate of the Operating Expense. If at any time after delivery of funds to Landlord pursuant to this paragraph, the size of the Premises is increased, Tenant shall be required to increase the funds on deposit with Landlord in accordance with the formula outlined above. In lieu of depositing cash with Landlord, Tenant shall have the option of providing Landlord with a letter of credit which is acceptable to Landlord in form and content and is issued by a financial institution reasonably approved by Landlord which shall have one or more offices in Orange County, California which will honor a draw upon such letter of credit. (b) In the event Tenant is required to deposit with Landlord funds pursuant to subparagraph (a) of this Section, such sum shall be held by Landlord as security for the full and faithful performance of Tenant's obligations under this Lease (the "Security Deposit"). Subject to the last sentence of this Section, the Security Deposit shall be understood and agreed to be the property of Landlord upon Landlord's receipt thereof, and may be utilized by Landlord in its discretion towards the payment of all prepaid expenses by Landlord for which Tenant would be required to reimburse Landlord under this Lease, including without limitation brokerage commissions and Tenant Improvement costs. Upon any default by Tenant, including specifically Tenant's failure to pay rent or to abide by its obligations under Sections 7.1 and 15.3 below, whether or not Landlord is informed of or has knowledge of the default, the Security Deposit shall be deemed to be automatically and immediately applied, without waiver of any rights Landlord may have under this Lease or at law or in equity as a result of the default, as a setoff for full or partial compensation for that default. If any portion of the Security Deposit is applied after a default by Tenant, Tenant shall within five (5) days after written demand by Landlord deposit cash with Landlord in an amount sufficient to restore the Security Deposit to its original amount. Landlord shall not be required to keep this Security Deposit separate from its general funds, and Tenant shall not be entitled to interest on the Security Deposit. If Tenant fully performs its obligations under this Lease, the Security Deposit shall be returned to Tenant (or, at Landlord's option, to the last assignee of Tenant's interest in this Lease) after the expiration of the Term, provided that Landlord may retain the Security Deposit to the extent and until such time as all amounts due from Tenant in accordance with this Lease have been determined and paid in full. SECTION 4.4. SPECIAL LIMITATION ON HVAC OPERATING EXPENSES Notwithstanding any provision of this Lease to the contrary, Tenant's obligation to pay Operating Expenses shall be subject to the following: (a) Preventive maintenance, servicing and repair costs for heating, ventilating and air conditioning equipment ("HVAC") shall not be included within Operating Expenses payable by Tenant to the extent that such costs exceed the amount shown in the budget for the 1998-99 Expense Recovery Period plus five percent (5%) per year (on a compounded basis) throughout the initial Term of this Lease. The 1998-99 Expense Recovery Period budget for HVAC preventative maintenance costs is $.1188 per rentable square foot. (b) Tenant shall have no obligation during the initial Term of this Lease to contribute to capital reserves for replacement of rooftop HVAC package units. In the event Landlord maintains a capital reserve for its rooftop HVAC package units at the time, Operating Expenses paid by Tenant during any extension of the Term shall include a reasonable reserve for replacement of rooftop HVAC units in accordance with the provisions of Section 4.2 herein. (c) If during the initial Term of this Lease, any rooftop HVAC package units require replacement, Tenant shall have no obligation to pay any portion of such replacement cost. If in connection with any such replacement, Landlord is unable to provide Tenant with HVAC services necessary to provide to the Premises HVAC services consistent with industry standards for first class office buildings Landlord shall be obligated its sole cost and expense to obtain replacement and/or supplemental HVAC services while any such repair or replacement is underway. 12 16 ARTICLE V. USES SECTION 5.1. USE. Tenant shall use the Premises only for the purposes stated in Item 3 of the Basic Lease Provisions, all in accordance with applicable laws and restrictions and pursuant to approvals to be obtained by Tenant from all relevant and required governmental agencies and authorities. The parties agree that any contrary use shall be deemed to cause material and irreparable harm to Landlord and shall entitle Landlord to injunctive relief in addition to any other available remedy. Tenant, at its expense, shall procure, maintain and make available for Landlord's inspection throughout the Term, all governmental approvals, licenses and permits required for the proper and lawful conduct of Tenant's permitted use of the Premises. Tenant shall not do or permit anything to be done in or about the Premises which will in any way unreasonably interfere with the rights of other occupants of the Building or the Project, or use or allow the Premises to be used for any unlawful purpose, nor shall Tenant permit any nuisance or commit any waste in the Premises or the Project. Tenant shall not perform any work or conduct any business whatsoever in the Project other than inside the Premises. Tenant shall not knowingly do or permit to be done anything which will invalidate or increase the cost of any insurance policy(ies) covering the Building, the Project and/or their contents, and shall comply with all applicable and reasonable insurance underwriters rules and the requirements of the Pacific Fire Rating Bureau or any other organization performing a similar function to the extent such rules and requirements are provided to Tenant. Subject to the express provisions of this Lease to the contrary, Tenant shall comply at its expense with all present laws, ordinances, restrictions, regulations, orders, rules and requirements of all governmental authorities that pertain particularly to Tenant or its particular use of the Premises and/or pertain only to the interior of the Premises, including without limitation all federal and state occupational health and safety requirements, whether or not Tenant's compliance will necessitate expenditures or interfere with its use and enjoyment of the Premises. Tenant shall comply at its expense with all present covenants, conditions, easements or restrictions now affecting or encumbering the Building and/or Project, and any future covenants, conditions, easements or restrictions, and any amendments or modifications thereto which do not materially derogate the rights of Tenant or materially increase the obligations of Tenant hereunder, including without limitation the payment by Tenant of any periodic or special dues or assessments charged against the Premises or Tenant which may be allocated to the Premises or Tenant in accordance with the provisions thereof. Tenant shall promptly upon demand reimburse Landlord for any additional insurance premium charged by reason of Tenant's failure to comply with the provisions of this Section, and shall indemnify Landlord from any liability and/or expense resulting from Tenant's noncompliance. SECTION 5.2. SIGNS. Tenant shall have the right to install and maintain exterior signs at its sole cost ("Exterior Signage") as set forth in this Section. Tenant's rights with respect to Exterior Signage within the Project shall be as follows: (a) Tenant shall have the exclusive right to all exterior signs on any Building within the Project which it wholly leases during the Term which as of the Commencement Date, shall be Building A and Building B. If after the commencement of the Term the Premises is expanded so that Tenant solely occupies Building C, Tenant's rights shall extend to such Building as well. (b) From and after the Commencement Date for Building B and thereafter provided Tenant leases all of Buildings A and B, Tenant shall be entitled to exclusive use of the existing monument sign on Alton Parkway. (c) If at any time during the Term, or any extension thereof Tenant leases all of each of the three Buildings within the Project, Tenant shall have the exclusive right to all exterior signs within the Project. (d) In the event Tenant subleases for the remainder of the Term or assigns any portion of a Building such that Landlord has a right to recapture that space pursuant to the provisions of Article IX hereof, Tenant's exclusive right to exterior signage on such Building shall be converted as of the date of such transfer to a non-exclusive right and reduced to one exterior Building top sign which Tenant shall have the right to select provided it continues to be the Dominant Tenant in such Building. Dominant Tenant means Tenant leases in the Building in question more space than any other Tenant in such Building. (e) If after a sublease for the remainder of the Term or an assignment, Tenant leases less than the entirety of Building A and the entirety of either Buildings B or C, Tenant's right to use the existing monument sign on Alton Parkway shall be nonexclusive provided that if such monument sign is converted by Landlord to a multi-tenant identification sign, Tenant shall have the right to retain the top position on such monument sign as long as Tenant continues to be the Dominant Tenant in Building A and the Dominant Tenant in either Building B or C. (f) Provided Tenant is not then in default under this Lease, after expiration of the applicable cure period, and provided Tenant is then leasing all of Buildings A and B, Landlord shall not enter into any lease for space in the Project, or consent to any sublease or assignment, which grants to any of the companies or entities listed on Exhibit H attached hereto any right to install or maintain exterior signs in the Project. The size, design, graphics, material, style, color and other physical aspects of all exterior signs shall be subject to Landlord's written approval prior to installation (which approval shall not be unreasonably withheld), Landlord's signage program for the Project, as in effect from time to time and approved by the City of Irvine ("Signage Criteria"), and any applicable municipal or other governmental permits and approvals. Tenant acknowledges having received and reviewed a copy of the current Signage Criteria for the Project. Tenant shall be responsible for the cost of the Exterior Signage, including the fabrication, installation, insurance, maintenance and removal thereof. If Tenant fails 13 17 to maintain its Exterior Signage, or if Tenant fails to remove same upon termination of this Lease and repair any damage caused by such removal, Landlord may do so at Tenant's expense. Except for the foregoing, or as otherwise approved in writing by Landlord, in its sole discretion, Tenant shall have no right to maintain identification signs in any location in, on or about the Premises, the Building or the Project and shall not place or erect any signs, displays or other advertising materials that are visible from the exterior of the Premises. Tenant's Exterior Signage rights described in this Section 5.2 may be assigned in connection with an assignment of the Lease, but only if the name proposed for such Exterior Signage will not materially devalue the Project in Landlord's sole and absolute discretion. SECTION 5.3 HAZARDOUS MATERIALS. (a) For purposes of this Lease, the term "Hazardous Materials" includes (i) any "hazardous materials" as defined in Section 25501(n) of the California Health and Safety Code, (ii) any other substance or matter which results in liability to any person or entity from exposure to such substance or matter under any statutory or common law theory, and (iii) any substance or matter which is in excess of permitted levels set forth in any federal, California or local law or regulation pertaining to any hazardous or toxic substance, material or waste. (b) Tenant shall not cause or knowingly permit any Hazardous Materials to be brought upon, stored, used, generated, released or disposed of on, under, from or about the Premises (including without limitation the soil and groundwater thereunder) without the prior written consent of Landlord. Notwithstanding the foregoing, Tenant shall have the right, without obtaining prior written consent of Landlord, to utilize within the Premises standard office products that may contain Hazardous Materials (such as photocopy toner, "White Out", and the like), provided however, that (i) Tenant shall maintain such products in their original retail packaging, shall follow all instructions on such packaging with respect to the storage, use and disposal of such products, and shall otherwise comply with all applicable laws with respect to such products, and (ii) all of the other terms and provisions of this Section 5.3 shall apply with respect to Tenant's storage, use and disposal of all such products. Landlord may, in its sole discretion, place such conditions as Landlord deems appropriate with respect to any such Hazardous Materials, and may further require that Tenant demonstrate that any such Hazardous Materials are necessary or useful to Tenant's business and will be generated, stored, used and disposed of in a manner that complies with all applicable laws and regulations pertaining thereto and with good business practices. Tenant understands that Landlord may utilize an environmental consultant to assist in determining conditions of approval in connection with the storage, generation, release, disposal or use of Hazardous Materials by Tenant on or about the Premises, and/or to conduct periodic inspections of the storage, generation, use, release and/or disposal of such Hazardous Materials by Tenant on and from the Premises, and Tenant agrees that any costs reasonably incurred by Landlord in connection therewith shall be reimbursed by Tenant to Landlord as additional rent hereunder upon demand; however, Tenant shall have no obligation to reimburse Landlord for any costs incurred in connection with any environmental consultant retained by Landlord pursuant to this Section unless Tenant shall be in default under this Section 5.3 and such costs are covered by Tenant's indemnity contained in this Section 5.3. (c) Prior to the execution of this Lease, Tenant shall complete, execute and deliver to Landlord an Environmental Questionnaire and Disclosure Statement (the "Environmental Questionnaire") in the form of EXHIBIT B attached hereto. The completed Environmental Questionnaire shall be deemed incorporated into this Lease for all purposes, and Landlord shall be entitled to rely fully on the information contained therein. On each anniversary of the Commencement Date until the expiration or sooner termination of this Lease, Tenant shall disclose to Landlord in writing the names and amounts of all Hazardous Materials, if any, which were stored, generated, used, released and/or disposed of on, under or about the Premises for the twelve-month period prior thereto, and which Tenant desires to store, generate, use, release and/or dispose of on, under or about the Premises for the succeeding twelve-month period. In addition, to the extent Tenant is permitted to utilize Hazardous Materials upon the Premises, Tenant shall promptly provide Landlord with complete and legible copies of all the following environmental documents relating thereto: reports filed pursuant to any self-reporting requirements; permit applications, permits, monitoring reports, workplace exposure and community exposure warnings or notices and all other reports, disclosures, plans or documents (even those which may be characterized as confidential) relating to water discharges, air pollution, waste generation or disposal, and underground storage tanks for Hazardous Materials; orders, reports, notices, listings and correspondence (even those which may be considered confidential) of or concerning the release, investigation of, compliance, cleanup, remedial and corrective actions, and abatement of Hazardous Materials; and all complaints, pleadings and other legal documents filed by or against Tenant related to Tenant's use, handling, storage, release and/or disposal of Hazardous Materials. (d) Landlord and its agents shall have the right, but not the obligation, to inspect, sample and/or monitor the Premises and/or the soil or groundwater thereunder at any time to determine whether Tenant is complying with the terms of this Section 5.3, and in connection therewith Tenant shall provide Landlord with full access to all relevant facilities, records and personnel. If Tenant is not in compliance with any of the provisions of this Section 5.3, or in the event of a release of any Hazardous Material on, under or about the Premises caused or permitted by Tenant, its agents, employees, contractors, licensees or invitees, Landlord and its agents shall have the right, but not the obligation, without limitation upon any of Landlord's other rights and remedies under this Lease, to immediately enter upon the Premises without notice and to discharge Tenant's obligations under this Section 5.3 at Tenant's expense, including without limitation the taking of emergency or long-term remedial action. Landlord and its agents shall endeavor to minimize interference with Tenant's business in connection therewith, but shall not be liable for any such interference. 14 18 In addition, Landlord, at Tenant's expense, shall have the right, but not the obligation, to join and participate in any legal proceedings or actions initiated in connection with any claims arising out of the storage, generation, use, release and/or disposal by Tenant or its agents, employees, contractors, licensees or invitees of Hazardous Materials on, under, from or about the Premises. (e) If the presence of any Hazardous Materials on, under, from or about the Premises or the Project caused or permitted by Tenant or its agents, employees, contractors, licensees or invitees results in (i) injury to any person, (ii) injury to or any contamination of the Premises or the Project, or (iii) injury to or contamination of any real or personal property wherever situated, Tenant, at its expense, shall promptly take all actions necessary to return the Premises and the Project and any other affected real or personal property owned by Landlord to the condition existing prior to the introduction of such Hazardous Materials and to remedy or repair any such injury or contamination, including without limitation, any cleanup, remediation, removal, disposal, neutralization or other treatment of any such Hazardous Materials. Notwithstanding the foregoing, Tenant shall not, without Landlord's prior written consent, take any remedial action in response to the presence of any Hazardous Materials on, under or about the Premises or the Project or any other affected real or personal property owned by Landlord or enter into any similar agreement, consent, decree or other compromise with any governmental agency with respect to any Hazardous Materials claims; provided however, Landlord's prior written consent shall not be necessary in the event that the presence of Hazardous Materials on, under or about the Premises or the Project or any other affected real or personal property owned by Landlord (i) imposes an immediate threat to the health, safety or welfare of any individual or (ii) is of such a nature that an immediate remedial response is necessary and it is not possible to obtain Landlord's consent before taking such action. To the fullest extent permitted by law, Tenant shall indemnify, hold harmless, protect and defend (with attorneys acceptable to Landlord) Landlord and any successors to all or any portion of Landlord's interest in the Premises and the Project and any other real or personal property owned by Landlord from and against any and all liabilities, losses, damages, diminution in value, judgments, fines, demands, claims, recoveries, deficiencies, costs and expenses (including without limitation attorneys' fees, court costs and other professional expenses), whether foreseeable or unforeseeable, arising directly or indirectly out of the use, generation, storage, treatment, release, on- or off-site disposal or transportation of Hazardous Materials on, into, from, under or about the Premises, the Building and the Project and any other real or personal property owned by Landlord caused or permitted by Tenant, its agents, employees, contractors, licensees or invitees, specifically including without limitation the cost of any required or necessary repair, restoration, cleanup or detoxification of the Premises, the Building and the Project and any other real or personal property owned by Landlord, and the preparation of any closure or other required plans, whether or not such action is required or necessary during the Term or after the expiration of this Lease. If Landlord at any time discovers that Tenant or its agents, employees, contractors, licensees or invitees have caused or knowingly permitted the release of a Hazardous Material on, under, from or about the Premises or the Project or any other real or personal property owned by Landlord, Tenant shall, at Landlord's request, immediately prepare and submit to Landlord a comprehensive plan, subject to Landlord's reasonable approval, specifying the actions to be taken by Tenant to return the Premises or the Project or any other real or personal property owned by Landlord to the condition required under all applicable environmental laws. Upon Landlord's approval of such cleanup plan, Tenant shall, at its expense, and without limitation of any rights and remedies of Landlord under this Lease or at law or in equity, immediately implement such plan and proceed to cleanup such Hazardous Materials in accordance with all applicable laws and as required by such plan and this Lease. The provisions of this subsection (e) shall expressly survive the expiration or sooner termination of this Lease. (f) If the release of any Hazardous Materials on, under, from or about the Premises or the Project caused by Landlord, its authorized agents or employees, and not introduced by Tenant, its agents, employees, contractors, licensees, or invitees results in (i) injury to any person, or (ii) injury to or any contamination of the Premises or the Project at levels which require clean-up or remediation under applicable laws, Landlord, at its expense (which shall not be included in Operating Expenses), shall promptly take all actions necessary to return the Premises and the Project to the condition existing prior to the introduction of such Hazardous Materials, or to such condition as is satisfactory to all governmental agencies asserting jurisdiction, and to remedy or repair any such injury or contamination, including, without limitation, any clean-up, remediation, removal, disposal, neutralization or other treatment of any such Hazardous Materials. (g) If the release of Hazardous Materials caused by Landlord, its authorized agents or employees, renders the Premises untenantable in whole or in part or results in Tenant being required to vacate the Premises in whole or in part pursuant to an order or requirement of any governmental agency or authority, then the Base Rent, Real Property Taxes, insurance premiums, and other charges, if any, payable by Tenant hereunder for the period during which the Premises (or a portion thereof) remain so impaired shall be abated in proportion to the degree to which Tenant's use of the Premises is impaired and for the period of such impairment. If the period of such impairment shall exceed seven (7) months, Tenant shall have the right to terminate this Lease upon written notice to Landlord given within ten (10) days following the passage of such seven (7) month period. Tenant's termination of the Lease pursuant to this Paragraph shall be effective as of the date of such notice. (h) Landlord hereby discloses to Tenant, and Tenant hereby acknowledges, certain facts relating to Hazardous Materials at the Project known by Landlord to exist as of the date of this Lease, as more particularly described in EXHIBIT C attached hereto. Tenant shall have no liability or responsibility with respect to the Hazardous Materials facts described in EXHIBIT C, nor with respect to any Hazardous Materials which were not caused or knowingly permitted by Tenant, its agents, employees, contractors, licensees or invitees. Landlord shall take responsibility, at its sole cost and expense, for any governmentally-ordered clean-up, remediation, removal, disposal, neutralization or other treatment of Hazardous Materials conditions described in this Section 5.3(h). The foregoing 15 19 obligation on the part of Landlord shall include the reasonable costs (including, without limitation, reasonable attorney's fees) of defending Tenant (with attorneys reasonably acceptable to Tenant) from and against any legal action or proceeding instituted by any governmental agency in connection with such clean-up, remediation, removal, disposal, neutralization or other treatment of such conditions, provided that Tenant promptly tenders such defense to Landlord. Tenant agrees to notify its agents, employees, contractors, licensees, and invitees of any exposure or potential exposure to Hazardous Materials at the Premises that Landlord brings to Tenant's attention. (i) The obligations on the part of Landlord contained in Sections 5.3(f) and 5.3(h) above are personal to Landlord and shall not be binding on, nor inure against any successor in interest to Landlord as of the owner of the Premises, including without limitation, any lender acquiring the Premises by foreclosure of its mortgage or deed of trust or deed in lieu of foreclosure. (j) Except as disclosed in Section 5.3(h) above (and/or as may otherwise be disclosed to Tenant in writing), Landlord represents that, to the best of its actual knowledge without duty of inquiry or investigation whatsoever, there are no Hazardous Materials in or about the Premises which are in violation of any applicable federal, state or local law, ordinance or regulation. ARTICLE VI. COMMON AREAS; SERVICES SECTION 6.1. UTILITIES AND SERVICES. Tenant shall be responsible for and shall pay promptly, directly to the appropriate supplier, all charges for water, gas, electricity, sewer, heat, light, power, telephone, refuse pickup, janitorial service, interior landscape maintenance and all other utilities, materials and services furnished directly to Tenant or the Premises or used by Tenant in, on or about the Premises during the Term, together with any taxes thereon; provided, however, Tenant shall not be obligated to pay directly for any utilities, water, gas, electricity, sewer, heat, light, power, janitorial service, landscape maintenance, etc. to the extent such costs are billed to Tenant as Operating Expenses for the Project. Tenant, at its sole cost, may select and retain a janitorial service company to clean the Premises at such times and in a manner consistent with the operation of a first class office building. If any utilities or services are not separately metered or assessed to Tenant, Landlord shall make a reasonable determination of Tenant's proportionate share of the cost of such utilities and services and Tenant shall pay such amount to Landlord, as an item of additional rent, within ten (10) days after receipt of Landlord's statement or invoice therefor. Alternatively, Landlord may elect to include such cost in the definition of Building Costs in which event Tenant shall pay Tenant's proportionate share of such costs in the manner set forth in Section 4.2. Landlord shall not be liable for damages or otherwise for any failure or interruption of any utility or other service furnished to the Premises, and no such failure or interruption shall be deemed an eviction or entitle Tenant to terminate this Lease or withhold or abate any rent due hereunder. Landlord shall at all reasonable times have free access to all electrical and mechanical installations of Landlord. In exercising Landlord's right of free access to all mechanical and electrical installations, Landlord shall not unreasonably interfere with Tenant's use and enjoyment of the Premises. Notwithstanding the foregoing, if as a result of the actions of Landlord, its authorized agents or employees, for more than three (3) consecutive business days following written notice to Landlord there is no HVAC or electricity services to all or a portion of the Premises, or such an interruption of other essential utilities and building services, such as fire protection or water, so that all or a portion of the Premises cannot be used by Tenant, then Tenant's Basic Rent (or an equitable portion of such Basic Rent to the extent that less than all of the Premises are affected) shall thereafter be abated until the Premises are again usable by Tenant; provided, however, that if Landlord is diligently pursuing the repair of such utilities or services and Landlord provides substitute services reasonably suitable for Tenant's purposes, as for example, bringing in portable air-conditioning equipment, then there shall not be an abatement of Basic Rent. Any disputes concerning the foregoing shall be submitted to and resolved by JAMS arbitration pursuant to Section 22.8 of this Lease. The foregoing provisions shall not apply in case of damage to, or destruction of, the Premises, which shall be governed by the provisions of Article XI of the Lease. SECTION 6.2. OPERATION AND MAINTENANCE OF COMMON AREAS. During the Term, Landlord shall operate, maintain and repair all Common Areas within any Building comprising the Premises and the Project in a first-class manner comparable to other Class A office buildings in the Irvine Spectrum area and in compliance with all obligations of Landlord under this Lease. The term "Common Areas" shall mean all areas within the exterior boundaries of the Building and other buildings in the Project which are not held for exclusive use by persons entitled to occupy space, and all other appurtenant areas outside the exterior boundaries of the Building and other buildings in the Project provided by Landlord for the common use of Landlord and tenants and their respective employees and invitees, including without limitation parking areas and structures, driveways, sidewalks, landscaped and planted areas, hallways and interior stairwells not located within the premises of any tenant, common electrical rooms and roof access entries, common entrances and lobbies, elevators, and restrooms not located within any tenantable premises of the Building and/or other buildings in the Project. Building hours for any Building not wholly leased by Tenant shall be Monday through Friday 7:00 a.m. to 6:00 p.m., and Saturday 9:00 a.m. to 1:00 p.m., President's Day, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, Christmas Day, New Year's Day and Sundays excluded. Tenant shall have access to its Premises twenty-four (24) hours per day, seven (7) days per week, fifty-two (52) weeks per year including access to utilities and heating, ventilating and air conditioning services but subject to Tenant's obligation to pay the reasonable costs of any such services in any Building not wholly leased by Tenant used other than during the Building hours described above; provided that Landlord may install access control systems as it deems advisable for any Building not wholly leased by Tenant. The reasonable cost of maintaining and 16 20 repairing any such access control systems (but not the cost of installation of, or any "capital" cost of replacing, said systems) shall be included in Project Costs under Section 4.2. SECTION 6.3. USE OF COMMON AREAS. The occupancy by Tenant of the Premises shall include the use of the Common Areas in common with Landlord and with all others for whose convenience and use the Common Areas may be provided by Landlord, subject, however, to compliance with all rules and regulations as are prescribed from time to time by Landlord in a reasonable and non-discriminatory manner. Landlord shall operate and maintain the Common Areas in a first-class manner consistent with comparable Class A office buildings in the Irvine Spectrum as Landlord may determine to be appropriate. All reasonable costs incurred by Landlord for the maintenance and operation of the Common Areas shall be included in Project Costs unless excluded under Section 4.2 or unless any particular cost incurred can be charged to a specific tenant of the Project. Landlord shall at all times during the Term have exclusive control of the Common Areas, and may restrain any use or occupancy, except as authorized by Landlord's rules and regulations. Tenant shall keep the Common Areas clear of any obstruction or unauthorized use related to Tenant's operations. Nothing in this Lease shall be deemed to impose liability upon Landlord for any damage to or loss of the property of, or for any injury to, Tenant, its invitees or employees. Landlord may temporarily close any portion of the Common Areas for repairs, remodeling and/or alterations, to prevent a public dedication or the accrual of prescriptive rights, or for any other reason deemed sufficient by Landlord, without liability to Landlord. Tenant shall not be required to comply with any rules and regulations for the Project other than those attached to this Lease unless such rules and regulations are commercially reasonable and nondiscriminatory in content and application. Landlord's exclusive control, operation, maintenance and repair of the Common Area shall be subject to Tenant's parking rights contained in Section 6.4 below and to all other limitations contained in this Lease. Landlord agrees that any temporary closure of any portion of the Common Areas shall not unreasonably interfere with Tenant's intended use of the Premises, nor its reasonable access to or parking for the Premises. SECTION 6.4. PARKING. (a) Tenant shall be entitled to the number of vehicle parking spaces set forth in Item 14 of the Basic Lease Provisions, which spaces shall be located on those portions of the Common Areas designated by Landlord for parking, and said parking spaces shall be provided at no charge to Tenant during the Lease Term. Tenant shall not use more parking spaces than such number. In the event the Premises is expanded at any time during the Term, the number of spaces shall be increased by the number included in the Economic Terms for such space. Landlord shall allow Tenant to select and mark the spaces designated on Exhibit A-1 as "Visitor Only" and the additional spaces as designated on Exhibit A-1 may be marked as "Broadcom Reserved" for exclusive use by Tenant's employees and customers, provided Landlord shall have obligation to monitor the use of such stalls but such stalls shall be considered as part of the total number of stalls to which Tenant is entitled. All vehicle parking spaces shall be used only for parking by vehicles no larger than full size passenger automobiles, vans, mini-vans or pickup trucks. Tenant shall not knowingly permit or allow any vehicles that belong to or are controlled by Tenant or Tenant's employees, suppliers, shippers, customers or invitees to be loaded, unloaded, parked or stored in areas other than those designated by Landlord for shipping and receiving activities as shown on Exhibit A-1 ("Trucking Areas"). If Tenant permits or allows any of the prohibited activities described above, then Landlord shall have the right, without notice, in addition to such other rights and remedies that Landlord may have, to remove or tow away the vehicle involved and charge the costs to Tenant; provided Landlord agrees not to cause or permit the towing of any vehicle from parking within the Common Area without first attempting to contact Tenant to identify the Owner of the vehicle in question. Parking within the Common Areas shall be limited to striped parking stalls, and no parking shall be permitted in any driveways, access ways or in any area which would prohibit or impede the free flow of traffic within the Common Areas. There shall be no extended overnight parking of any vehicles of any kind unless otherwise authorized by Landlord (periodic, temporary overnight parking of employee vehicles for up to seventy-two (72) hours and vehicles used in the ordinary course of Tenant's business at the Premises shall be permitted), and vehicles which have been abandoned or parked in violation of the terms hereof may be towed away at the owner's expense. Nothing contained in this Lease shall be deemed to create liability upon Landlord for any damage to motor vehicles of visitors or employees, for any loss of property from within those motor vehicles, or for any injury to Tenant, its visitors or employees, unless ultimately determined to be caused by the sole active negligence or willful misconduct of Landlord. Landlord shall have the right to establish, and from time to time amend, and to enforce against all users all reasonable rules and regulations (including the designation of areas for employee parking) that Landlord may deem necessary and advisable for the proper and efficient operation and maintenance of parking within the Common Areas. Landlord shall have the right to construct, maintain and operate lighting facilities within the parking areas; to change the area, level, location and arrangement of the parking areas and improvements therein; to restrict parking by tenants, their officers, agents and employees to employee parking areas and to do and perform such other acts in and to the parking areas and improvements therein as, in the use of good business judgment, Landlord shall determine to be advisable. Any person using the parking area shall observe all directional signs and arrows and any posted speed limits. In no event shall Tenant interfere with the use and enjoyment of the parking area by other tenants of the Building or their employees or invitees. Parking areas shall be used only for parking passenger vehicles. Servicing of vehicles, or the parking or storage of shipping and receiving vehicles in any area other than in the Trucking Areas designated on Exhibit A-1 or in the Trucking Area for periods in excess of seventy-two hours (72), is prohibited unless otherwise authorized by Landlord. Periodic washing and detailing of automobiles shall be permitted, subject to the Landlord's reasonable conditions as to time and place and as to the operator itself, and provided further that Landlord shall have the right, from time to time, to designate an exclusive operator for such services for the Project. Tenant shall be liable for any damage to the parking areas caused by Tenant or Tenant's employees, suppliers, shippers, customers or invitees, including without limitation damage from excess oil leakage. Tenant shall have no right to install any fixtures, equipment or personal property in the parking areas. Landlord agrees to enforce all parking rights and restrictions and rules and regulations for the Project on an 17 21 equal and non-discriminatory basis. Tenant shall have no liability for non-compliance with the provisions of the Lease regarding parking other than with respect to Tenant's officers, directors and employees or persons under the control of Tenant, except for Landlord's towing rights herein provided. (b) Provided Tenant continues to be the Dominant Tenant in Building A and the Dominant Tenant in either Building B or C, Tenant shall have the right to use that portion of the parking area so designated on Exhibit A-1 for recreational purposes as a basketball court (the "Recreational Area") for the sole and exclusive use of its employees and invitees. In the event Tenant elects to use that portion of the parking area as a basketball court, those stalls shall be considered part of the total number of stalls to which Tenant is entitled. Landlord shall have no obligation to improve or maintain the Recreational Area in any manner other than as a parking facility and, notwithstanding any provision of this Lease to the contrary, Tenant shall defend, indemnify, protect, save and hold harmless Landlord, and its agents and any and all affiliates of Landlord, including without limitation any corporations or other entities controlling, controlled by, controlled under or controlled with Landlord from and against any and all claims, liabilities, costs or expenses arising from the use by any person of the Recreational Area. Any recreational equipment of any kind placed on or installed into the Recreational Area shall be considered an alteration under Section 7.3 of this Lease, must comply in all respects with all applicable laws, rules and regulations, shall be installed to Tenant's sole cost and expense and shall be removed by Tenant at its sole cost and expense at such time as Tenant and/or its subtenant ceases to be the Dominant Tenant of Building A and the Dominant Tenant of either Building B or C or upon the expiration or earlier termination of this Lease. Tenant shall repair any damage to the Common Area and the Recreational Area arising from such removal. SECTION 6.5. CHANGES AND ADDITIONS BY LANDLORD. Landlord reserves the right to make alterations or additions to the Building or the Project, or to the attendant fixtures, equipment and Common Areas. Landlord may at any time relocate or remove any of the various buildings, parking areas, and other Common Areas, and may add buildings and areas to the Project from time to time. No change shall entitle Tenant to any abatement of rent or other claim against Landlord. In no event, however, shall Landlord (i) impair visibility of Tenant's Exterior Signage; (ii) materially impair access to and from the Premises from the parking areas; (iii) reduce the number or size of Tenant's parking spaces granted under this Lease, or (iv) otherwise materially interfere with Tenant's access to and use of the Premises, the parking areas and the Common Areas adjacent to the Building in any material manner without Tenant's prior written consent, which shall not be unreasonably withheld. SECTION 6.6. OUTDOOR COURTYARD AREA. With at least five (5) days prior written notice to Landlord, Tenant shall have the right to use certain adjacent courtyard area of the Common Areas as shown on Exhibit A-1 for Tenant's social and/or business functions with no additional rent for such use payable by Tenant, on the following terms and conditions: (i) Tenant may conduct up to twelve (12) such functions within any calendar year; (ii) such functions shall be limited to a reasonable number of people consistent with applicable fire, health and safety laws; (iii) Tenant shall execute Landlord's standard form entry permit (in form reasonably acceptable to Tenant) prior to any such function, (iv) the insurance, indemnity and nonliability obligations and provisions contained in Sections 10.1, 10.3(a) and 10.4 of this Lease, respectively (including Tenant's obligations to carry liquor law liability insurance if alcoholic beverages are served or consumed during such functions), shall apply to and govern any claims, liabilities, costs or expenses arising from any such function, (v) no such proposed functions shall, in Landlord's reasonable determination, unreasonably disrupt other tenants of the Project, or the operation or maintenance of the Common Areas, and (vi) Tenant shall pay any and all Landlord's reasonable costs of preparation for, supervision of and/or clean-up in connection with, such functions. ARTICLE VII. MAINTAINING THE PREMISES SECTION 7.1. TENANT'S MAINTENANCE AND REPAIR. Tenant at its sole expense shall make all repairs necessary to keep the Premises in the condition as existed on the Commencement Date (or on any later date that the improvements may have been installed), excepting ordinary wear and tear, including without limitation all glass, the interior surfaces of all windows, all doors, door closures, hardware, fixtures, electrical, plumbing, fire extinguisher equipment and other equipment; provided, however, Tenant shall have no obligation to repair, maintain or replace the roof, foundations, footings, structural systems, exterior glass, sky lights, sky light seals, window seals and vents, electrical, plumbing, sewer and other utility lines outside the Premises, landscaping, walkways, fencing, parking areas, exterior lighting or exterior surfaces of exterior walls of the Building, and washing of exterior windows, all of which obligations shall be the sole responsibility of Landlord as provided in and subject to the terms of Section 7.2 below. Any damage or deterioration of the Premises shall not be deemed ordinary wear and tear if the same could have been prevented by good maintenance practices by Tenant. As part of its maintenance obligations hereunder, Tenant shall, at Landlord's request, provide Landlord with copies of all maintenance schedules, reports and notices prepared by, for or on behalf of Tenant. Landlord shall obtain on Tenant's behalf and as an Operating Expense but subject to the provisions of Section 4.4 hereof, a contract with a licensed contractor (the "HVAC Contractor") to provide for regular inspection, servicing, maintenance and repair of the HVAC systems servicing the Premises. Landlord shall select the HVAC Contractor with input from Tenant and if the HVAC Contractor fails to maintain the HVAC system servicing the Premises in the manner described in Section 7.2 hereof, Tenant may propose an alternate HVAC Contractor to provide such services upon expiration or sooner termination of the existing HVAC service contract. Landlord shall not be obligated to use the alternate HVAC Contractor proposed by Tenant but shall use its reasonable business judgment with Tenant's input to retain an HVAC Contractor which provides the services required consistent with the operation of a Class A building and in accordance with this Lease. All repairs shall be at least equal 18 22 in quality to the original work, shall be made only by a licensed contractor approved in writing in advance by Landlord and shall be made only at the time or times approved by Landlord. Any contractor utilized by Tenant shall be subject to Landlord's standard requirements for contractors, as modified from time to time. Landlord may impose reasonable restrictions and requirements with respect to repairs, as provided in Section 7.3, and the provisions of Section 7.4 shall apply to all repairs. If Tenant fails to properly maintain or repair any portion of the Premises as required under this Section 7.1 following written notice to Tenant and a reasonable opportunity to cure, Landlord may elect to make any such repair on behalf of Tenant and at Tenant's expense, and Tenant shall promptly reimburse Landlord for all costs incurred upon submission of an invoice. Landlord agrees not to unreasonable withhold its approval of any preventive maintenance contracts or licensed contractors selected by Tenant with respect to Tenant's maintenance and repair obligations. SECTION 7.2. LANDLORD'S MAINTENANCE AND REPAIR. Subject to Section 7.1 and Article XI, Landlord shall provide service, maintenance and repair with respect to any air conditioning, ventilating or heating equipment which serves the Premises, which shall be serviced, maintained and repaired in accordance with the manufacturer's specifications, and shall maintain in good repair in a manner consistent with the repair and maintenance of comparable Class A office buildings in the Irvine Spectrum area, the roof, foundations, and footings of the Building, the exterior surfaces of the exterior walls of the Building, all exterior glass, sky lights, sky light seals, window seals and vents of the Building, electrical, plumbing, sewer and other utility lines outside the Premises, landscaping, walkways, fencing, parking areas, exterior lighting and exterior surfaces of exterior walls of the Building, and washing of exterior windows, and the structural, electrical and mechanical systems of the Building and all Common Area improvements within the Project, except that, subject to the waiver of subrogation contained in Section 10.5 below, Tenant at its expense shall make all repairs within the Premises only which Landlord deems reasonably necessary as a result of the act or negligence of Tenant, its agents, employees, invitees, subtenants or contractors (i.e., to the extent such repairs are not or would not be covered by a standard policy of property insurance or the property insurance actually maintained by Landlord). Landlord shall have the right to employ or designate any reputable person or firm, including any employee or agent of Landlord or any of Landlord's affiliates or divisions, to perform any service, repair or maintenance function. Landlord need not make any other improvements or repairs except as specifically required under this Lease, and nothing contained in this Section shall limit Landlord's right to reimbursement from Tenant for maintenance, repair costs and replacement costs as provided elsewhere in this Lease. Tenant understands that it shall not make repairs at Landlord's expense except as specifically set forth below. Tenant further understands that Landlord shall not be required to make any repairs to the roof, foundations, footings, structural, electrical or mechanical systems unless and until Tenant has notified Landlord in writing of the need for such repair and Landlord shall have a reasonable period of time thereafter to commence and complete said repair, if warranted. Subject to the terms of Sections 2.4 and 4.2, all reasonable costs of any maintenance and repairs on the part of Landlord provided hereunder shall be considered part of Project Costs. Tenant shall have no obligation to maintain contracts for landscaping and irrigation systems or for asphalt or parking lot maintenance. Except in emergency situations, where prior notice is not reasonably possible, Landlord agrees to provide Tenant with at least twenty-four (24) hours prior notice before commencing any repairs, improvements or alterations to the Building or the Project which are reasonably likely to materially impair Tenant's use or enjoyment of the Premises, Tenant's parking areas or access to the Project or the Premises. If Landlord shall fail to perform any repair obligations required under this Lease within thirty (30) days following Tenant's written request for such repairs, or if Landlord shall fail to perform any repairs required under this Lease of an emergency condition within forty-eight (48) hours' written notice from Tenant, then Tenant may elect to make such repairs at Landlord's expense by complying with the following provisions. Before making any such repair, Tenant shall deliver to Landlord a notice for the need for such repair ("Self-Help Notice"), which notice shall specifically advise Landlord that Tenant intends to exercise its self-help right hereunder. Should Landlord fail, within ten (10) days following receipt of the Self-Help Notice (or within twenty-four (24) hours following notice in the event of necessary emergency repairs), to commence the necessary repair or to make other arrangements reasonably satisfactory to Tenant, then Tenant shall have the right to make such repair on behalf of Landlord. Landlord shall reimburse Tenant for the reasonable costs of such repairs within thirty (30) days following receipt of Tenant's invoice for such costs, provided that in no event shall Tenant have the right to offset Basic Rent or any other charges payable by Tenant hereunder against such costs. It is understood that such reimbursement obligation shall be personal to Landlord, and in no event shall any lender or other deed of trust holder succeeding to Landlord be liable for payment of any such amount. In the event that the work could affect the Building's structural, mechanical, electrical, heating, ventilating, air conditioning, life safety or plumbing components or systems, then Tenant shall use only those contractors whose names are furnished by Landlord for such work. If those contractors are unwilling or unable to perform the work, or if Landlord fails to furnish the names of its contractors to Tenant prior to the commencement of the work by Tenant, Tenant shall retain the services of qualified, reputable and licensed, bonded contractors with like experience in similar building systems. Tenant shall be responsible for obtaining any necessary governmental permits before commencing the repair work. Tenant shall be liable for any damage, loss or injury resulting from said work to the extent of Tenant's or its agent's, employee's or contractor's negligence. Any disputes regarding these self-help provisions shall be submitted to and resolved by JAMS arbitration pursuant to Section 22.8 of this Lease. SECTION 7.3. ALTERATIONS. Tenant shall make no alterations, additions or improvements to the Premises without the prior written consent of Landlord, which consent shall not be unreasonably withheld, conditioned or delayed. Notwithstanding the foregoing, but subject to the following provisions of this Section, Landlord's consent shall not be required for any alterations, additions or improvements to the Premises during the initial Term which cost less than the Alteration Cost Cap. Alteration Cost Cap means an amount equal to Seventy-Five Cents ($.75) per rentable square foot of Premises per lease year on a cumulative basis but subject to an aggregate maximum over the 19 23 initial Term of Five Dollars Twenty-Five Cents ($5.25) per rentable square foot. Any such alterations are subject to all other provisions of this Section. For example, assuming Tenant continues to occupy all of Buildings A and B but made no alterations during the first year of the Term, Tenant could make alterations without Landlord's prior written consent during the second year of the Term in an amount up to $228,531.00 (152,354 feet x .75 x 2 years). Under this example, Tenant's ability to make further alterations during the remainder of the initial Term without Landlord's consent would be subject to an annual cap of $114,265.50 and an aggregate cap of $571,327.50. Notwithstanding anything to the contrary contained in the preceding sentences of this Section, without the prior written consent of Landlord, which may be withheld in Landlord's sole and absolute discretion, in no event shall any alteration, addition or improvement: (i) affect the exterior of the Building or outside areas (or be visible from adjoining sites), or (ii) affect or penetrate any of the structural portions of the Building, including but not limited to the roof, or (iii) require any material change to the basic floor plan of the Premises, any change to any structural or mechanical systems of the Premises, or any governmental permit as a prerequisite to the construction thereof, or (iv) interfere in any manner with the proper functioning of or Landlord's access to any mechanical, electrical, plumbing or HVAC systems, facilities or equipment located in or serving the Building. Landlord may impose, as a condition to its consent, any requirements that Landlord in its discretion may deem reasonable or desirable, including but not limited to requirements as to the manner, time, and contractor mutually acceptable to Landlord and Tenant for performance of the work. Tenant shall obtain all required permits for the work and shall perform the work in compliance with all applicable laws, regulations and ordinances, all covenants, conditions and restrictions affecting the Project, and the Rules and Regulations (hereafter defined). Tenant understands and agrees that Landlord shall be entitled to a supervision fee in the amount of three percent (3%) of the cost of any work which is both in excess of the Alteration Cost Cap, and which requires a governmental permit. If any governmental entity requires, as a condition to any proposed alterations, additions or improvements to the Premises by Tenant, that improvements be made to the Common Areas, and if Landlord consents to such improvements to the Common Areas, then Tenant shall, at Tenant's sole expense, make such required improvements to the Common Areas in such manner, utilizing such materials, and with such contractors (including, if required by Landlord, Landlord's contractors) as Landlord may reasonably require. Under no circumstances shall Tenant make any improvement which incorporates any Hazardous Materials, including without limitation asbestos-containing construction materials into the Premises. Any request for Landlord's consent shall be made in writing and shall contain architectural plans describing the work in detail reasonably satisfactory to Landlord. Unless Landlord otherwise agrees in writing, all alterations, additions or improvements affixed to the Premises (excluding moveable trade fixtures and furniture) shall become the property of Landlord and shall be surrendered with the Premises at the end of the Term, except that Landlord may require Tenant to remove by the Expiration Date, or sooner termination date of this Lease, all or any alterations, decorations, fixtures, additions, improvements and the like installed either by Tenant or by Landlord at Tenant's request and to repair any damage to the Premises arising from that removal. Except as otherwise provided in this Lease or in any exhibit to this Lease, should Landlord make any alteration or improvement to the Premises for Tenant, Landlord shall be entitled to prompt reimbursement from Tenant for all costs incurred. Landlord shall have the right to require Tenant to remove (i) any of the components of the initial Tenant Improvements to the Premises but only if Landlord notifies Tenant that such removal will be required at the time of Landlord's approval of the Preliminary Plan, and (ii) any subsequent alterations, additions or improvements whether or not Landlord's consent was required unless Landlord's written consent was obtained and unless at the time of providing its consent Landlord notified Tenant in writing that Tenant would not have to remove such items upon the expiration of the Lease Term. Landlord and Tenant agree that Tenant shall have the right, upon expiration or termination of this Lease, to remove any and all phone systems, furniture, fixtures and other personal property which are not permanently affixed to the Premises or which may be removed without significant change to the Premises (including floor coverings, draperies, and/or removable shelves) that are installed in the Premises at Tenant's sole expense; provided, however, that Tenant shall, at its sole cost, repair any damage caused by such removal, reasonable wear and tear excepted. SECTION 7.4. MECHANIC'S LIENS. Tenant shall keep the Premises free from any liens arising out of any work performed, materials furnished, or obligations incurred by or for Tenant. Upon request by Landlord, Tenant shall promptly cause any such lien to be released by posting a bond in accordance with California Civil Code Section 3143 or any successor statute. In the event that Tenant shall not, within thirty (30) days following the imposition of any lien, cause the lien to be released of record by payment or posting of a proper bond, Landlord shall have, in addition to all other available remedies, the right to cause the lien to be released by any means it reasonably deems proper, including payment of or defense against the claim giving rise to the lien. All reasonable and actual expenses so incurred by Landlord, including Landlord's reasonable attorneys' fees, and any foreseeable consequential or other damages incurred by Landlord proximately caused by such lien, shall be reimbursed by Tenant promptly following Landlord's demand, together with interest from the date of payment by Landlord at the Interest Rate provided for in Section 14.3(a) below until paid. Tenant shall give Landlord no less than twenty (20) days' prior notice in writing before commencing construction of any kind on the Premises so that Landlord may post and maintain notices of nonresponsibility on the Premises. SECTION 7.5. ENTRY AND INSPECTION. Landlord shall, at all reasonable times upon at least twenty-four (24) hours advance written notice given in accordance with the provisions of Article XVI of this Lease or oral notice to Tenant's office manager or managing partner (except in emergencies, when no notice shall be required), and provided that for security and confidentiality purposes, Landlord's representatives are accompanied by a representative of Tenant at all times (except in cases of emergency), have the right to enter the Premises to inspect them, to supply services in accordance with this Lease, to protect the interests of Landlord in the Premises, and to submit the Premises to prospective or actual purchasers or encumbrance holders (or, during the last one hundred and 20 24 eighty (180) days of the Term or when a Tenant default exists [which is not cured within the expiration of the applicable cure period], to prospective tenants), all without being deemed to have caused an eviction of Tenant and without abatement of rent except as provided elsewhere in this Lease. Landlord shall have the right to use any and all reasonable means which Landlord may deem proper under the circumstances to open the doors in an emergency in order to obtain entry to the Premises, and any entry to the Premises obtained by Landlord by such means shall not under any circumstances be deemed to be a forcible or unlawful entry into, or a detainer of, the Premises, or any eviction of Tenant from the Premises. ARTICLE VIII. TAXES AND ASSESSMENTS ON TENANT'S PROPERTY Tenant shall be liable for and shall pay before delinquency, all taxes and assessments levied against all personal property of Tenant located in the Premises, and against any alterations, additions or like improvements made to the Premises by or on behalf of Tenant. When possible Tenant shall cause its personal property, Above Standard Improvements and alterations to be assessed and billed separately from the real property of which the Premises form a part. If any taxes on Tenant's personal property, and/or alterations are levied against Landlord or Landlord's property and if Landlord pays the same, or if the assessed value of Landlord's property is increased by the inclusion of a value placed upon the personal property, and/or alterations of Tenant and if Landlord pays the taxes based upon the increased assessment, Tenant shall pay to Landlord the taxes so levied against Landlord or the proportion of the taxes resulting from the increase in the assessment. ARTICLE IX. ASSIGNMENT AND SUBLETTING SECTION 9.1. RIGHTS OF PARTIES. (a) Tenant will not, either voluntarily or by operation of law, assign, sublet, encumber, or otherwise transfer all or any part of Tenant's interest in this lease, or permit the Premises to be occupied by anyone other than Tenant, without Landlord's prior written consent, which consent shall not be unreasonably withheld or conditioned in accordance with the provisions of Section 9.1(b) and shall be delivered to Tenant within fifteen (15) business days following Tenant's request. No assignment (whether voluntary, involuntary or by operation of law) and no subletting shall be valid or effective without Landlord's prior written consent and, at Landlord's election, any such assignment or subletting or attempted assignment or subletting shall constitute a material default of this Lease. Without limiting the foregoing, Landlord agrees that the use and occupancy of any portion of the Premises by any person performing office support services (such as mail room, copy center, shipping or travel services) or other services incidental to Tenant's permitted use on an outsource basis shall not constitute a sublease or other prohibited transfer of the Premises provided Tenant continues to occupy the remainder of the Premises. Landlord shall not be deemed to have given its consent to any assignment or subletting by any other course of action, including its acceptance of any name for listing in the Building directory. To the extent not prohibited by provisions of the Bankruptcy Code, 11 U.S.C. Section 101 et seq. (the "Bankruptcy Code"), including Section 365(f)(1), Tenant on behalf of itself and its creditors, administrators and assigns waives the applicability of Section 365(e) of the Bankruptcy Code unless the proposed assignee of the Trustee for the estate of the bankrupt meets Landlord's standard for consent as set forth in Section 9.1(b) of this Lease. If this Lease is assigned to any person or entity pursuant to the provisions of the Bankruptcy Code, any and all monies or other considerations to be delivered in connection with the assignment shall be delivered to Landlord, shall be and remain the exclusive property of Landlord and shall not constitute property of Tenant or of the estate of Tenant within the meaning of the Bankruptcy Code. Any person or entity to which this Lease is assigned pursuant to the provisions of the Bankruptcy Code shall be deemed to have assumed all of the obligations arising under this Lease on and after the date of the assignment, and shall upon demand execute and deliver to Landlord an instrument confirming that assumption. (b) If Tenant desires to transfer an interest in this Lease, it shall first notify Landlord of its desire and shall submit in writing to Landlord: (i) the name and address of the proposed transferee; (ii) the nature of any proposed subtenant's or assignee's business to be carried on in the Premises; (iii) the terms and provisions of any proposed sublease or assignment, including a copy of the proposed assignment or sublease form; (iv) evidence of insurance of the proposed assignee or subtenant complying with the requirements of EXHIBIT D hereto; (v) a completed Environmental Questionnaire from the proposed assignee or subtenant; and (vi) any other information reasonably requested by Landlord and reasonably related to the transfer. Except as provided in Subsection (c) of this Section, Landlord shall not unreasonably withhold its consent, provided: (1) the use of the Premises will be consistent with the provisions of this Lease and with Landlord's written contractual commitments to other tenants of the Building and Project; (2) at Landlord's election, insurance requirements relating to such transferee's occupancy shall be brought into conformity with Landlord's then current leasing practice; (3) any proposed subtenant or assignee demonstrates that it is financially responsible by submission to Landlord of all reasonable information as Landlord may request concerning the proposed subtenant or assignee, including, but not limited to, a balance sheet of the proposed subtenant or assignee as of a date within ninety (90) days of the request for Landlord's consent, statements of income or profit and loss of the proposed subtenant or assignee for the two-year period preceding the request for Landlord's consent; (4) any proposed subtenant or assignee demonstrates to Landlord's reasonable satisfaction a record of successful experience in business; (5) the proposed assignee or subtenant is not an existing tenant of the Building or Project or a prospect with whom Landlord is actively negotiating in writing to become a tenant at the Building or Project and Landlord has 21 25 available for lease within the Project space which is comparable in size to that being offered by Tenant; and (6) the proposed transfer will not impose additional burdens or adverse tax effects on Landlord. If Landlord consents to the proposed transfer, Tenant may within ninety (90) days after the date of the consent effect the transfer upon the terms described in the information furnished to Landlord; provided that any material change in the terms shall be subject to Landlord's consent as set forth in this Section. Landlord shall approve or disapprove any requested transfer within fifteen (15) business days following receipt of Tenant's written request, the information set forth above, and the fee set forth below. (c) In lieu of consenting to a proposed assignment or subletting of thirty-seven percent (37%) or more of the rentable area of the Premises in the aggregate taking into consideration prior subleases for the duration of the then remaining Term, Landlord may elect to recapture the portion of the Premises subject to the proposed subletting, and lease such recaptured Premises directly to the proposed assignee or sublessee or to any third party, as provided in this paragraph. In the event Tenant proposes to sublease any space in the Building, such space proposed for sublease must be separately leaseable and tenantable, as reasonably determined by Landlord. Tenant shall provide Landlord with notice of its proposal to sublease (which notice shall include all material terms of the proposed sublease, including rental rate, tenant improvements, base year, etc.). Landlord shall have fifteen (15) business days within which to notify Tenant of its intent to recapture the portion of the Premises designated for subletting. If Landlord declines to exercise its right to recapture, Tenant shall have one hundred eighty (180) days from the time Landlord notifies Tenant of its decision not to recapture the space, to sublease said space to any party at terms (inclusive of rental rate, tenant improvements, base year, etc.) not materially different than those proposed to Landlord and, if Tenant is unsuccessful, Tenant shall repeat the procedures set forth in this paragraph. In the event of any such recapture by Landlord, this Lease shall terminate as to the recaptured space and the rent payable under this Lease shall be proportionately reduced, and Landlord shall be responsible for any brokerage commissions and other leasing costs relating to such re-leasing of the recaptured space. (d) Tenant agrees that fifty percent (50%) of any amounts paid by an assignee or subtenant, however described, in excess of (i) the Basic Rent payable by Tenant hereunder, or in the case of a sublease of a portion of the Premises, in excess of the Basic Rent reasonably allocated to such portion, plus (ii) Tenant's direct out-of-pocket costs such as tenant improvements, moving costs or brokerage commissions which Tenant certifies to Landlord have been paid to provide occupancy related services to such assignee or subtenant of a nature commonly provided by landlords of similar space, shall be the property of Landlord and such amounts shall be payable directly to Landlord by the assignee or subtenant or, at Landlord's option, by Tenant. At Landlord's request, a written agreement shall be entered into by and among Tenant, Landlord and the proposed assignee or subtenant confirming the requirements of this subsection. (e) Tenant shall pay to Landlord a fee of Five Hundred Dollars ($500.00) if and when any transfer hereunder is requested by Tenant, except for any transfer to a "Tenant Affiliate" (as hereinafter defined). Such fee is hereby acknowledged as a reasonable amount to reimburse Landlord for all of its costs of review and evaluation of a proposed assignee/sublessee, and Landlord shall not be obligated to commence such review and evaluation unless and until such fee is paid. (f) Landlord agrees to execute and deliver to Tenant, within fifteen (15) days following Tenant's request, a consent to lien waiver, including lease estoppel language as may be requested by Tenant's lender (all in a form reasonably acceptable to Tenant's lender and Landlord). SECTION 9.2. EFFECT OF TRANSFER. No subletting or assignment, even with the consent of Landlord, shall relieve Tenant of its obligation to pay rent and to perform all its other obligations under this Lease. Moreover, Tenant shall indemnify and hold Landlord harmless, as provided in Section 10.3, for any act or omission by an assignee or subtenant. Each assignee, other than Landlord, shall be deemed to assume all obligations of Tenant under this Lease and shall be liable jointly and severally with Tenant for the payment of all rent, and for the due performance of all of Tenant's obligations, under this Lease. No transfer shall be binding on Landlord unless any document memorializing the transfer is delivered to Landlord and both the assignee/subtenant and Tenant deliver to Landlord an executed consent to transfer instrument prepared by Landlord and consistent with the requirements of this Article. The acceptance by Landlord of any payment due under this Lease from any other person shall not be deemed to be a waiver by Landlord of any provision of this Lease or to be a consent to any transfer. Consent by Landlord to one or more transfers shall not operate as a waiver or estoppel to the future enforcement by Landlord of its rights under this Lease. SECTION 9.3. SUBLEASE REQUIREMENTS. The following terms and conditions shall apply to any subletting by Tenant of all or any part of the Premises and shall be deemed included in each sublease: (a) Each and every provision contained in this Lease (other than with respect to the payment of rent hereunder) is incorporated by reference into and made a part of such sublease, with "Landlord" hereunder meaning the sublandlord therein and "Tenant" hereunder meaning the subtenant therein. (b) Tenant hereby irrevocably assigns to Landlord all of Tenant's interest in all rentals and income arising from any sublease of the Premises, and Landlord may collect such rent and income and apply same toward Tenant's obligations under this Lease; provided, however, that until a default occurs in the performance of Tenant's obligations under this Lease, Tenant shall have the right to receive and collect the sublease rentals. Landlord shall not, by reason 22 26 of this assignment or the collection of sublease rentals, be deemed liable to the subtenant for the performance of any of Tenant's obligations under the sublease. Tenant hereby irrevocably authorizes and directs any subtenant, upon receipt of a written notice from Landlord stating that an uncured default exists in the performance of Tenant's obligations under this Lease, to pay to Landlord all sums then and thereafter due under the sublease. Tenant agrees that the subtenant may rely on that notice without any duty of further inquiry and notwithstanding any notice or claim by Tenant to the contrary. Tenant shall have no right or claim against the subtenant or Landlord for any rentals so paid to Landlord. (c) Except as permitted under Section 9.4 below, in the event of the termination of this Lease, Landlord may, at its sole option, take over Tenant's entire interest in any sublease and, upon notice from Landlord, the subtenant shall attorn to Landlord. In no event, however, shall Landlord be liable for any previous act or omission by Tenant under the sublease or for the return of any advance rental payments or deposits under the sublease that have not been actually delivered to Landlord, nor shall Landlord be bound by any sublease modification executed without Landlord's consent or for any advance rental payment by the subtenant in excess of one month's rent. The general provisions of this Lease, including without limitation those pertaining to insurance and indemnification, shall be deemed incorporated by reference into the sublease despite the termination of this Lease. SECTION 9.4. CERTAIN TRANSFERS. Notwithstanding anything to the contrary contained in this Article IX, Landlord's consent shall not be required for the assignment of this Lease to any parent or wholly owned subsidiary of Tenant or as a result of a merger by Tenant with or into another entity controlling, under common control with, or controlled by Tenant, so long as (i) the net worth of the successor entity after such assignment is at least equal to the greater of the net worth of Tenant as of the execution of this Lease by Landlord or the net worth of Tenant immediately prior to the date of such assignment, evidence of which, satisfactory to Landlord, shall be presented to Landlord prior to such assignment, (ii) Tenant shall provide to Landlord, prior to such assignment or merger, written notice of such transactions and such documentation and other information as Landlord may request in connection therewith, and (iii) the terms of Section 9.2 shall be applicable to any such assignment. Each of the successor entities described in the foregoing is herein referred to as a "Tenant Affiliate". ARTICLE X. INSURANCE AND INDEMNITY SECTION 10.1. TENANT'S INSURANCE. Tenant, at its sole cost and expense, shall provide and maintain in effect the insurance described in EXHIBIT D. Evidence of that insurance must be delivered to Landlord prior to the Commencement Date. SECTION 10.2. LANDLORD'S INSURANCE. Landlord shall provide the following types of insurance, in amounts and coverages as may be determined by Landlord in its reasonable discretion provided such amounts, coverages and deductibles are reasonable and comparable to coverages maintained on comparable properties in the area: "all risk" property insurance, subject to standard exclusions covering the Building and the Project, and commercial general liability coverage. Further, Landlord may, in its sole and absolute discretion, obtain coverage for such other risks as Landlord or its mortgagees may from time to time deem appropriate, including without limitation, coverage for leasehold improvements and/or earthquake (provided, however, that the cost of earthquake insurance shall not be included as an Operating Expense unless Landlord elects or is required to carry such coverage on the entire Project). Landlord shall not be required to carry insurance of any kind on Tenant's property, including leasehold improvements, trade fixtures, furnishings, equipment, plate glass, signs and all other items of personal property, and shall not be obligated to repair or replace that property should damage occur. All proceeds of insurance maintained by Landlord upon the Building and Project shall be the property of Landlord, whether or not Landlord is obligated to or elects to make any repairs. At Landlord's option, Landlord may self-insure all or any portion of the risks for which Landlord is required or elects to provide insurance hereunder; provided, however, that in the event that Landlord transfers its fee interest in the Project including the Premises (other than to an entity affiliated with, controlled, controlling or under common control with Landlord, or in which Landlord retains an interest), such transferee shall demonstrate a financial net worth of at least Fifty Million Dollars ($50,000,000.00) or cash reserves of Ten Million Dollars ($10,000,000.00), and in the absence of such financial net worth or cash reserves, such transferee shall instead maintain insurance coverage as required by this Section 10.2 from third-party insurance carrier(s). SECTION 10.3. JOINT INDEMNITY. (a) To the fullest extent permitted by law, but subject to the express limitations on liability contained in Section 10.5 of this Lease, Tenant shall defend, indemnify, protect, save and hold harmless Landlord, its agents, and any and all affiliates of Landlord, including, without limitation, any corporations or other entities controlling, controlled by or under common control with Landlord, from and against any and all claims, liabilities, costs or expenses arising either before or after the Commencement Date from Tenant's use or occupancy of the Premises, or from the conduct of its business, or from any activity, work, or thing done, permitted or suffered by Tenant or its agents, employees, invitees or licensees in or about the Premises, or from any negligence or willful misconduct of Tenant or its agents, employees, visitors, patrons, guests, invitees or licensees. In cases of alleged negligence asserted by third parties against Landlord which arise out of, are occasioned by, or in any way attributable to Tenant's, its agents, employees, contractors, licensees or invitees use and occupancy of the Premises, or from the conduct of its business or from any activity, work or thing done, permitted or suffered by Tenant or its agents, employees, invitees 23 27 or licensees on Tenant's part to be performed under this Lease, or from any negligence or willful misconduct of Tenant, its agents, employees, licensees or invitees, Tenant shall accept any tender of defense for Landlord and shall, notwithstanding any allegation of negligence or willful misconduct on the part of the Landlord, defend Landlord and protect and hold Landlord harmless and pay all costs, expenses and attorneys' fees incurred in connection with such litigation, provided that Tenant shall not be liable for any such injury or damage, and Landlord shall reimburse Tenant for the reasonable attorney's fees and costs for the attorney representing both parties, all to the extent and in the proportion that such injury or damage is ultimately determined by a court of competent jurisdiction (or in connection with any negotiated settlement agreed to by Landlord) to be attributable to the negligence or willful misconduct of Landlord. Upon Landlord's request, Tenant shall at Tenant's sole cost and expense, retain a separate attorney reasonably selected by Landlord to represent Landlord in any such suit if Landlord reasonably determines that the representation of both Tenant and Landlord by the same attorney would cause a conflict of interest; provided, however, that to the extent and in the proportion that the injury or damage which is the subject of the suit is ultimately determined by a court of competent jurisdiction (or in connection with any negotiated settlement agreed to by Landlord) to be attributable to the negligence or willful misconduct of Landlord, Landlord shall reimburse Tenant for the reasonable legal fees and costs of the separate attorney retained by Tenant. The provisions of this Subsection 10.3(a) shall expressly survive the expiration or sooner termination of this Lease. (b) To the fullest extent permitted by law, but subject to the express limitations on liability contained in this Lease (including, without limitation, the provisions of Sections 10.4, 10.5 and 14.8 of this Lease), Landlord shall defend, indemnify, protect, save and hold harmless Tenant, its agents and any and all affiliates of Tenant, including, without limitation, any corporations, or other entities controlling, controlled by or under common control with Tenant, from and against any and all claims, liabilities, costs or expenses arising either before or after the Commencement Date from the operation, maintenance or repair of the Common Areas, the Project and/or the Building by Landlord or its employees or authorized agents. In cases of alleged negligence asserted by third parties against Tenant which arise out of, are occasioned by, or in any way attributable to the maintenance or repair of the Common Areas, the Project or the Building by Landlord or its authorized agents or employees, Landlord shall accept any tender of defense for Tenant and shall, notwithstanding any allegation of negligence or willful misconduct on the part of Tenant, defend Tenant and protect and hold Tenant harmless and pay all cost, expense and attorneys' fees incurred in connection with such litigation, provided that Landlord shall not be liable for any such injury or damage, and Tenant shall reimburse Landlord for the reasonable attorney's fees and costs for the attorney representing both parties, all to the extent and in the proportion that such injury or damage is ultimately determined by a court of competent jurisdiction (or in connection with any negotiated settlement agreed to by Tenant) to be attributable to the negligence or willful misconduct of Tenant. Upon Tenant's request, Landlord shall at Landlord's sole cost and expense, retain a separate attorney reasonably selected by Tenant to represent Tenant in any such suit if Tenant reasonably determines that the representation of both Tenant and Landlord by the same attorney would cause conflict of interest; provided, however, that to the extent and the proportion that the injury or damage which is the subject of the suit is ultimately determined by a court of competent jurisdiction (or in connection with any negotiated settlement agreed to by Tenant) to be attributable to the negligence or willful misconduct or Tenant, Tenant shall reimburse Landlord for the reasonable legal fees and costs of the separate attorney retained by Landlord. The provisions of this Subsection 10.3(b) shall expressly survive the expiration or sooner termination of this Lease. SECTION 10.4. LANDLORD'S NONLIABILITY. Subject to the express indemnity obligations contained in Section 10.3(b) of this Lease, Landlord shall not be liable to Tenant, its employees, agents and invitees, and Tenant hereby waives all claims against Landlord for loss of or damage to any property or personal injury, or any other loss, cost, damage, injury or liability whatsoever resulting from fire, explosion, falling plaster, steam, gas, electricity, water or rain which may leak or flow from or into any part of the Premises or from the breakage, leakage, obstruction or other defects of the pipes, sprinklers, wires, appliances, plumbing, air conditioning, electrical works or other fixtures in the Building, whether the damage or injury results from conditions arising in the Premises or in other portions of the Building. Notwithstanding any provision of this Lease to the contrary, including, without limitation, the provisions of Section 10.3(b) of this Lease, Landlord shall in no event be liable to Tenant, its employees, agents, and invitees, and Tenant hereby waives all claims against Landlord, for loss or interruption of Tenant's business or income (including, without limitation, any consequential damages and lost profit or opportunity costs), or any other loss, cost, damage, injury or liability resulting from, but not limited to, Acts of God (except with respect to restoration obligations pursuant to Article XI below), acts of civil disobedience or insurrection, acts or omissions (criminal or otherwise) of any third parties (other than Landlord's employees or authorized agents), including without limitation, any other tenants within the Project or their agents, employees, contractors, guests or invitees. It is understood that any such condition may require the temporary evacuation or closure of all or a portion of the Building. Except as provided in Sections 6.1, 11.1 and 12.1 below, there shall be no abatement of rent and no liability of Landlord by reason of any injury to or interference with Tenant's business (including without limitation consequential damages and lost profit or opportunity costs) arising from the making of any repairs, alterations or improvements to any portion of the Building, including repairs to the Premises, nor shall any related activity by Landlord constitute an actual or constructive eviction; provided, however, that in making repairs, alterations or improvements, Landlord shall interfere as little as reasonably practicable with the conduct of Tenant's business in the Premises. Neither Landlord nor its agents shall be liable for interference with light or other similar intangible interests. Tenant shall immediately notify Landlord in case of fire or accident in the Premises, the Building or the Project and of defects in any improvements or equipment. SECTION 10.5. WAIVER OF SUBROGATION. Landlord and Tenant each hereby waives all rights of recovery against the other and the other's agents on account of loss and damage occasioned to the property of such waiving party to the extent only that such loss or damage would be covered under any "all risk" property insurance policies required by this Article X; provided however, that (i) the foregoing waiver shall not apply to the extent of 24 28 Tenant's obligations to pay deductibles under any such policies and this Lease, and (ii) if any loss is due to the negligent act, omission or willful misconduct of Tenant or its agents, employees, contractors, guests or invitees, Tenant's liability insurance shall be primary and shall cover all losses and damages prior to any other insurance hereunder. By this waiver it is the intent of the parties that neither Landlord nor Tenant shall be liable to any insurance company (by way of subrogation or otherwise) insuring the other party for any loss or damage insured against under any "all-risk" property insurance policies required by this Article, even though such loss or damage might be occasioned by the negligence of such party, its agents, employees, contractors, guests or invitees. The provisions of this Section shall not limit the indemnification provisions elsewhere contained in this Lease. ARTICLE XI. DAMAGE OR DESTRUCTION SECTION 11.1. RESTORATION. (a) If the Building of which the Premises are a part is damaged, Landlord shall diligently repair that damage as soon as reasonably possible, at its expense, unless: (i) Landlord reasonably determines that the cost of repair is not covered by Landlord's fire and extended coverage insurance then in place (or if Landlord is self-insuring, would not be covered by a standard policy of "all risk" fire insurance), plus such additional amounts Tenant elects, at its option, to contribute, excluding however the deductible (for which Tenant shall be responsible for Tenant's Share); (ii) Landlord reasonably determines that the Premises cannot, with reasonable diligence, be fully repaired by Landlord (or cannot be safely repaired because of the presence of hazardous factors, including without limitation Hazardous Materials, earthquake faults, and other similar dangers) within two hundred seventy (270) days after the date of the damage; (iii) the damage occurs during the final twelve (12) months of the Term. Should Landlord elect not to repair the damage for one of the preceding reasons, Landlord shall so notify Tenant in writing within thirty (30) days after the damage occurs and this Lease shall terminate as of the date of that notice. (b) Unless Landlord elects to terminate this Lease in accordance with subsection (a) above, this Lease shall continue in effect for the remainder of the Term and Landlord shall promptly notify Tenant in writing of Landlord's election to restore the Premises and of the time Landlord estimates to complete such restoration; provided that so long as Tenant is not in default under this Lease following the expiration of the applicable cure period, if the damage is so extensive that Landlord reasonably determines that the Premises cannot, with reasonable diligence, be repaired by Landlord (or cannot be safely repaired because of the presence of hazardous factors, earthquake faults, and other similar dangers) so as to allow Tenant's substantial use and enjoyment of the Premises within two hundred seventy (270) days after the date of damage, then Tenant may elect to terminate this Lease by written notice to Landlord within the thirty (30) day period stated in subsection (a). (c) Commencing on the date of any damage to the Building, and ending on the sooner of the date the damage is repaired or the date this Lease is terminated, the rental to be paid under this Lease shall be abated in the same proportion that the floor area of the Premises that is rendered unusable by the damage from time to time bears to the total floor area of the Premises, and if as a result of any partial damage, Tenant reasonably determines that it cannot conduct its business in the remaining portions of the Premises, the rent for the entire Premises shall be abated. Any such abatement shall be conditioned upon Tenant's then carrying the required business interruption insurance as described in EXHIBIT D. (d) Notwithstanding the provisions of subsections (a), (b) and (c) of this Section, and subject to the provisions of Section 10.5 above, the cost of any repairs shall be borne by Tenant, and Tenant shall not be entitled to rental abatement or termination rights, if the damage is due to the fault or neglect of Tenant or its employees, subtenants, invitees or representatives, but only to the extent such damage is not covered by a standard policy of "all risk" insurance (whether or not Landlord is self-insuring). In addition, the provisions of this Section shall not be deemed to require Landlord to repair any improvements or fixtures that Tenant is obligated to repair or insure pursuant to any other provision of this Lease. (e) Tenant shall fully cooperate with Landlord in removing Tenant's personal property and any nonstructural debris from the Premises to facilitate all inspections of the Premises and the making of any repairs. Notwithstanding anything to the contrary contained in this Lease, if Landlord in good faith believes there is a risk of injury to persons or damage to property from entry into the Building or Premises following any damage or destruction thereto, Landlord may restrict entry into the Building or the Premises by Tenant, its employees, agents and contractors in a non-discriminatory manner, without being deemed to have violated Tenant's rights of quiet enjoyment to, or made an unlawful detainer of, or evicted Tenant from, the Premises. Upon request, Landlord shall consult with Tenant to determine if there are safe methods of entry into the Building or the Premises solely in order to allow Tenant to retrieve files, data in computers, and necessary inventory, subject however to all indemnities and waivers of liability from Tenant to Landlord contained in this Lease and any additional indemnities and waivers of liability which Landlord may require. If damage or destruction rendering the Premises unusable occurs during the final twelve (12) months of the Lease Term or the final twelve (12) months of any extension period which cannot be repaired within sixty (60) days following such damage or destruction, Tenant shall have the option to terminate the Lease by providing Landlord written notification of Tenant's election to terminate within thirty (30) days after the damage occurs. For all purposes of this Section 11.1, damage to Tenant's parking areas and access to the Premises shall be deemed damage to the Building. 25 29 SECTION 11.2. LEASE GOVERNS/JAMS. Tenant agrees that the provisions of this Lease, including without limitation Section 11.1, shall govern any damage or destruction and shall accordingly supersede any contrary statute or rule of law. Any disputes regarding the obligations of the parties under this Article XI shall be submitted to and resolved by JAMS arbitration pursuant to Section 22.8 of this Lease. ARTICLE XII. EMINENT DOMAIN SECTION 12.1. TOTAL OR PARTIAL TAKING. If all or a material portion of the Premises which materially impairs Tenant's ability to conduct business from the Premises is taken by any lawful authority by exercise of the right of eminent domain, or sold to prevent a taking, either Tenant or Landlord may terminate this Lease effective as of the date possession is required to be surrendered to the authority. In the event title to a portion of the Building or Project, other than the Premises, is taken or sold in lieu of taking, and if Landlord elects to restore the Building in such a way as to alter the Premises materially, either party may terminate this Lease, by written notice to the other party, effective on the date of vesting of title. In the event neither party has elected to terminate this Lease as provided above, then Landlord shall promptly, after receipt of a sufficient condemnation award, proceed to restore the Premises to substantially their condition prior to the taking, and a proportionate allowance shall be made to Tenant for the rent corresponding to the time during which, and to the part of the Premises of which, Tenant is deprived on account of the taking and restoration. In addition, Tenant's share of Operating Expenses and all other elements of this Lease which are a function of the square footage of the Premises shall be adjusted to reflect the taking. In the event of a taking, Landlord shall be entitled to the entire amount of the condemnation award without deduction for any estate or interest of Tenant; provided that nothing in this Section shall be deemed to give Landlord any interest in, or prevent Tenant from seeking any award against the taking authority for, the taking of personal property and fixtures belonging to Tenant or for relocation or business interruption expenses recoverable from the taking authority. SECTION 12.2. TEMPORARY TAKING. No temporary taking of the Premises shall terminate this Lease or give Tenant any right to abatement of rent, and any award specifically attributable to a temporary taking of the Premises shall belong entirely to Tenant. A temporary taking shall be deemed to be a taking of the use or occupancy of the Premises for a period of not to exceed ninety (90) days. SECTION 12.3. TAKING OF PARKING AREA. In the event there shall be a taking of the parking area such that Landlord can no longer provide sufficient parking to comply with this Lease, Landlord may substitute reasonably equivalent parking in a location reasonably close to the Building; provided that if Landlord fails to make that substitution within ninety (90) days following the taking and if the taking materially impairs Tenant's use and enjoyment of the Premises, Tenant may, at its option, terminate this Lease by written notice to Landlord. If this Lease is not so terminated by Tenant, there shall be no abatement of rent and this Lease shall continue in effect. Any dispute regarding the substitution of parking spaces under this Section 12.3 shall be submitted to and resolved by JAMS arbitration pursuant to Section 22.8 of this Lease. ARTICLE XIII. SUBORDINATION; ESTOPPEL CERTIFICATE; FINANCIALS SECTION 13.1. SUBORDINATION. At the option of Landlord, this Lease shall be either superior or subordinate to all ground or underlying leases, mortgages and deeds of trust, if any, which may hereafter affect the Building, and to all renewals, modifications, consolidations, replacements and extensions thereof; provided, that so long as Tenant is not in default under this Lease following the expiration of the applicable cure period, this Lease shall not be terminated or Tenant's quiet enjoyment of the Premises disturbed in the event of termination of any such ground or underlying lease, or the foreclosure of any such mortgage or deed of trust, to which Tenant has subordinated this Lease pursuant to this Section. Any such subordination instrument presented for Tenant's signature shall contain nondisturbance provisions for Tenant's benefit substantially in accordance with the provisions for Tenant's benefit set forth in this Section. In the event of a termination or foreclosure, Tenant shall become a tenant of and attorn to the successor-in-interest to Landlord upon the same terms and conditions as are contained in this Lease, and shall execute any instrument reasonably required by Landlord's successor for that purpose. Tenant shall also, upon written request of Landlord, execute and deliver all instruments as may be required from time to time to subordinate the rights of Tenant under this Lease to any ground or underlying lease or to the lien of any mortgage or deed of trust (provided that such instruments include the nondisturbance and attornment protections set forth above in form reasonably acceptable to Tenant), or, if requested by Landlord, to subordinate, in whole or in part, any ground or underlying lease or the lien of any mortgage or deed of trust to this Lease. SECTION 13.2. ESTOPPEL CERTIFICATE. (a) Tenant shall, at any time upon not less than fifteen (15) days prior written notice from Landlord, execute, acknowledge and deliver to Landlord, in any form that Landlord may reasonably require, a statement in writing (i) certifying that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of the modification and certifying that this Lease, as modified, is in full force and effect) and the dates to which the rental, additional rent and other charges have been paid in advance, if any, and (ii) acknowledging that, to Tenant's knowledge, there are no uncured defaults on the part of Landlord, or specifying each default if any are claimed, and 26 30 (iii) setting forth all further information that Landlord may reasonably require. Tenant's statement may be relied upon by any prospective purchaser or encumbrancer of all or any portion of the Building or Project. (b) Notwithstanding any other rights and remedies of Landlord, Tenant's failure to deliver any estoppel statement within fifteen (15) days following written notice therefor shall be conclusive upon Tenant that (i) this Lease is in full force and effect, without modification except as may be represented by Landlord, (ii) there are no uncured defaults in Landlord's performance, and (iii) not more than one month's rental has been paid in advance. SECTION 13.3 FINANCIALS. (a) Tenant shall deliver to Landlord, prior to the execution of this Lease and thereafter at any time within fifteen (15) days following Landlord's request but not more than once in each calendar year, Tenant's current tax returns and financial statements, certified true, accurate and complete by the chief financial officer of Tenant, including a balance sheet and profit and loss statement for the most recent prior year (collectively, the "Statements"), which Statements shall accurately and completely reflect the financial condition of Tenant. Landlord agrees that it will keep the Statements confidential, except that Landlord shall have the right to deliver the same to any proposed purchaser of the Building or Project (provided that any such purchaser shall agree to keep said Statements confidential), and to any encumbrancer of all or any portion of the Building or Project (provided that Landlord shall request that any such encumbrancer keep said Statements confidential). (b) Tenant acknowledges that Landlord is relying on the Statements in its determination to enter into this Lease, and Tenant represents to Landlord, which representation shall be deemed made on the date of this Lease and again on the Commencement Date, that no material change in the financial condition of Tenant, as reflected in the Statements, has occurred since the date Tenant delivered the Statements to Landlord. The Statements are represented and warranted by Tenant to be correct and to accurately and fully reflect Tenant's true financial condition as of the date of submission by any Statements to Landlord. ARTICLE XIV. DEFAULTS AND REMEDIES SECTION 14.1. TENANT'S DEFAULTS. In addition to any other event of default set forth in this Lease, the occurrence of any one or more of the following events shall constitute a default by Tenant: (a) The failure by Tenant to make any payment of rent or additional rent required to be made by Tenant, as and when due, where the failure continues for a period of ten (10) days after written notice from Landlord to Tenant; provided, however, that any such notice shall be in lieu of, and not in addition to, any notice required under California Code of Civil Procedure Section 1161 and 1161(a) as amended. For purposes of these default and remedies provisions, the term "additional rent" shall be deemed to include all amounts of any type whatsoever other than Basic Rent to be paid by Tenant pursuant to the terms of this Lease. (b) Assignment, sublease, encumbrance or other transfer of the Lease by Tenant, either voluntarily or by operation of law, whether by judgment, execution, transfer by intestacy or testacy, or other means, without the prior written consent of Landlord. (c) The discovery by Landlord that any financial statement provided by Tenant, or by any affiliate, successor or guarantor of Tenant, was materially false. (d) The failure of Tenant to timely and fully provide any subordination agreement, estoppel certificate or financial statements in accordance with the requirements of Article XIII. (e) The failure or inability by Tenant to observe or perform any of the express or implied covenants or provisions of this Lease to be observed or performed by Tenant, other than as specified in any other subsection of this Section, where the failure continues for a period of thirty (30) days after written notice from Landlord to Tenant or such shorter period as is specified in any other provision of this Lease; provided, however, that any such notice shall be in lieu of, and not in addition to, any notice required under California Code of Civil Procedure Section 1161 and 1161(a) as amended. However, if the nature of the failure is such that more than thirty (30) days are reasonably required for its cure, then Tenant shall not be deemed to be in default if Tenant commences the cure within thirty (30) days, and thereafter diligently pursues the cure to completion. (f) (i) The making by Tenant of any general assignment for the benefit of creditors; (ii) the filing by or against Tenant of a petition to have Tenant adjudged a Chapter 7 debtor under the Bankruptcy Code or to have debts discharged or a petition for reorganization or arrangement under any law relating to bankruptcy (unless, in the case of a petition filed against Tenant, the same is dismissed within sixty (60) days); (iii) the appointment of a trustee or receiver to take possession of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, if possession is not restored to Tenant within sixty (60) days; (iv) the attachment, execution or other judicial seizure of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease, where the seizure is not discharged within sixty (60) days; or (v) Tenant's convening of a meeting of its creditors for the purpose of effecting a moratorium upon or composition of its debts. Landlord shall not be deemed to have knowledge of any event described in this subsection unless notification in writing is received by Landlord, nor shall there be any 27 31 presumption attributable to Landlord of Tenant's insolvency. In the event that any provision of this subsection is contrary to applicable law, the provision shall be of no force or effect. SECTION 14.2. LANDLORD'S REMEDIES. (a) In the event of any default by Tenant, or in the event of the abandonment of the Premises by Tenant, then in addition to any other remedies available to Landlord, Landlord may exercise the following remedies: (i) Landlord may terminate Tenant's right to possession of the Premises by any lawful means, in which case this Lease shall terminate and Tenant shall immediately surrender possession of the Premises to Landlord. Such termination shall not affect any accrued obligations of Tenant under this Lease. Upon termination, Landlord shall have the right to reenter the Premises and remove all persons and property. Landlord shall also be entitled to recover from Tenant: (1) The worth at the time of award of the unpaid rent and additional rent which had been earned at the time of termination; (2) The worth at the time of award of the amount by which the unpaid rent and additional rent which would have been earned after termination until the time of award exceeds the amount of such loss that Tenant proves could have been reasonably avoided; (3) The worth at the time of award of the amount by which the unpaid rent and additional rent for the balance of the Term after the time of award exceeds the amount of such loss that Tenant proves could be reasonably avoided; (4) Any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result from Tenant's default, including, but not limited to, the cost of recovering possession of the Premises, refurbishment of the Premises to the condition required upon surrender under this Lease, marketing costs, commissions and other expenses of reletting, including necessary repair, the unamortized portion of any tenant improvements and brokerage commissions funded by Landlord in connection with this Lease, reasonable attorneys' fees, and any other reasonable costs (provided that the unamortized portion of any tenant improvements shall not be computed separately from the rent which includes such amounts); and (5) At Landlord's election, all other amounts in addition to or in lieu of the foregoing as may be permitted by law. The term "rent" as used in this Lease shall be deemed to mean the Basic Rent and all other sums required to be paid by Tenant to Landlord pursuant to the terms of this Lease. Any sum, other than Basic Rent, shall be computed on the basis of the average monthly amount accruing during the twenty-four (24) month period immediately prior to default, except that if it becomes necessary to compute such rental before the twenty-four (24) month period has occurred, then the computation shall be on the basis of the average monthly amount during the shorter period. As used in subparagraphs (1) and (2) above, the "worth at the time of award" shall be computed by allowing interest at the rate of ten percent (10%) per annum. As used in subparagraph (3) above, the "worth at the time of award" shall be computed by discounting the amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). (ii) Landlord may elect not to terminate Tenant's right to possession of the Premises, in which event Landlord may continue to enforce all of its rights and remedies under this Lease, including the right to collect all rent as it becomes due. Efforts by the Landlord to maintain, preserve or relet the Premises, or the appointment of a receiver to protect the Landlord's interests under this Lease, shall not constitute a termination of the Tenant's right to possession of the Premises. In the event that Landlord elects to avail itself of the remedy provided by this subsection (ii), Landlord shall not unreasonably withhold its consent to an assignment or subletting of the Premises subject to the reasonable standards for Landlord's consent as are contained in this Lease. (b) The various rights and remedies reserved to Landlord in this Lease or otherwise shall be cumulative and, except as otherwise provided by California law, Landlord may pursue any or all of its rights and remedies at the same time. (c) No delay or omission of Landlord to exercise any right or remedy shall be construed as a waiver of the right or remedy or of any default by Tenant. The acceptance by Landlord of rent shall not be a (i) waiver of any preceding breach or default by Tenant of any provision of this Lease, other than the failure of Tenant to pay the particular rent accepted, regardless of Landlord's knowledge of the preceding breach or default at the time of acceptance of rent, or (ii) a waiver of Landlord's right to exercise any remedy available to Landlord by virtue of the breach or default. The acceptance of any payment from a debtor in possession, a trustee, a receiver or any other person acting on behalf of Tenant or Tenant's estate shall not waive or cure a default under Section 14.1. No payment by Tenant or receipt by Landlord of a lesser amount than the rent required by this Lease shall be deemed to be other than a partial payment on account of the earliest due stipulated rent, nor shall any endorsement or statement on any check or letter be deemed an accord and satisfaction and Landlord shall accept the check or payment without prejudice to Landlord's right to recover the balance of the rent or pursue any other remedy available to it. No act or thing done by Landlord or Landlord's agents during the Term shall be deemed an acceptance of a surrender of the Premises, and no agreement to accept a surrender shall be valid unless in writing and signed by Landlord. No employee of Landlord 28 32 or of Landlord's agents shall have any power to accept the keys to the Premises prior to the termination of this Lease, and the delivery of the keys to any employee shall not operate as a termination of the Lease or a surrender of the Premises. SECTION 14.3. LATE PAYMENTS. Any rent due under this Lease that is not received by Landlord within ten (10) days of the date when due shall bear interest at the rate of ten percent (10%) per annum not to exceed the maximum rate permitted by law (the "Interest Rate") from the date due until fully paid. The payment of interest shall not cure any default by Tenant under this Lease. In addition, Tenant acknowledges that the late payment by Tenant to Landlord of rent will cause Landlord to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult and impracticable to ascertain. Those costs may include, but are not limited to, administrative, processing and accounting charges, and late charges which may be imposed on Landlord by the terms of any ground lease, mortgage or trust deed covering the Premises. Accordingly, if any rent due from Tenant shall not be received by Landlord or Landlord's designee within ten (10) days after the date due, then Tenant shall pay to Landlord, in addition to the interest provided above, a late charge in a sum equal to the greater of five percent (5%) of the amount overdue or Two Hundred Fifty Dollars ($250.00) for each delinquent payment; provided that such late charge shall be waived for the initial late rent payment during each calendar year during the Term and any extension. Acceptance of a late charge by Landlord shall not constitute a waiver of Tenant's default with respect to the overdue amount, nor shall it prevent Landlord from exercising any of its other rights and remedies. SECTION 14.4. RIGHT OF LANDLORD TO PERFORM. All covenants and agreements to be performed by Tenant under this Lease shall be performed at Tenant's sole cost and expense and without any abatement of rent or right of set-off. If Tenant fails to pay any sum of money, other than rent, or fails to perform any other act on its part to be performed under this Lease, and the failure continues beyond any applicable grace period set forth in Section 14.1, then in addition to any other available remedies, Landlord may, at its election make the payment or perform the other act on Tenant's part. Landlord's election to make the payment or perform the act on Tenant's part shall not give rise to any responsibility of Landlord to continue making the same or similar payments or performing the same or similar acts. Tenant shall, promptly upon demand by Landlord, reimburse Landlord for all sums paid by Landlord and all necessary incidental costs, together with interest at the maximum rate permitted by law from the date of the payment by Landlord. Landlord shall have the same rights and remedies if Tenant fails to pay those amounts as Landlord would have in the event of a default by Tenant in the payment of rent. Landlord shall provide Tenant with written notice and the appropriate cure period provided in the Lease before performing any act on behalf of Tenant and will provide Tenant with written request for any reimbursement payable under this Section 14.4. SECTION 14.5. DEFAULT BY LANDLORD. Landlord shall not be deemed to be in default in the performance of any obligation under this Lease unless and until it has failed to perform the obligation within thirty (30) days after written notice by Tenant to Landlord specifying in reasonable detail the nature and extent of the failure; provided, however, that if the nature of Landlord's obligation is such that more than thirty (30) days are required for its performance, then Landlord shall not be deemed to be in default if it commences performance within the thirty (30) day period and thereafter diligently pursues the cure to completion. If Landlord shall default in the performance of any of its obligations under the Lease (after notice and an opportunity to cure as provided herein), Tenant shall have the right to pursue any and all remedies available to it as set forth in this Lease, at law, or in equity, subject to the express limitations on liability contained in this Lease. SECTION 14.6. EXPENSES AND LEGAL FEES. All sums reasonably incurred by Landlord in connection with any event of default by Tenant under this Lease or holding over of possession by Tenant after the expiration or earlier termination of this Lease, including without limitation all costs, expenses and actual accountants, appraisers, attorneys and other professional fees, and any collection agency or other collection charges, shall be due and payable by Tenant to Landlord on demand, and shall bear interest at the rate of ten percent (10%) per annum. Should either Landlord or Tenant bring any action in connection with this Lease, the prevailing party shall be entitled to recover as a part of the action its reasonable attorneys' fees, and all other costs. The prevailing party for the purpose of this paragraph shall be determined by the trier of the facts. SECTION 14.7. WAIVER OF JURY TRIAL. LANDLORD AND TENANT EACH ACKNOWLEDGES THAT IT IS AWARE OF AND HAS HAD THE ADVICE OF COUNSEL OF ITS CHOICE WITH RESPECT TO ITS RIGHTS TO TRIAL BY JURY, AND EACH PARTY DOES HEREBY EXPRESSLY AND KNOWINGLY WAIVE AND RELEASE ALL SUCH RIGHTS TO TRIAL BY JURY IN ANY ACTION, PROCEEDING OR COUNTERCLAIM BROUGHT BY EITHER PARTY HERETO AGAINST THE OTHER (AND/OR AGAINST ITS OFFICERS, DIRECTORS, EMPLOYEES, AGENTS, OR SUBSIDIARY OR AFFILIATED ENTITIES) ON ANY MATTERS WHATSOEVER ARISING OUT OF OR IN ANY WAY CONNECTED WITH THIS LEASE, TENANT'S USE OR OCCUPANCY OF THE PREMISES, AND/OR ANY CLAIM OF INJURY OR DAMAGE. SECTION 14.8. SATISFACTION OF JUDGMENT. The obligations of Landlord do not constitute the personal obligations of the individual partners, trustees, directors, officers or shareholders of Landlord or its constituent partners. Should Tenant recover a money judgment against Landlord, such judgment shall be satisfied only out of the proceeds of sale received upon execution of such judgment and levied thereon against the right, title and interest of Landlord in the Project and out of the rent or other income from such property receivable by Landlord or out of consideration received by Landlord from the sale or other disposition of all or any part of Landlord's right, title or interest in the Project and no action for any deficiency may be sought or obtained by Tenant. 29 33 ARTICLE XV. END OF TERM SECTION 15.1. HOLDING OVER. This Lease shall terminate without further notice upon the expiration of the Term, and any holding over by Tenant after the expiration shall not constitute a renewal or extension of this Lease, or give Tenant any rights under this Lease, except when in writing signed by both parties. If Tenant holds over for any period after the expiration (or earlier termination) of the Term without the prior written consent of Landlord, such possession shall constitute a tenancy at sufferance only; such holding over with the prior written consent of Landlord shall constitute a month-to-month tenancy commencing on the first (1st) day following the termination of this Lease. In either of such events, possession shall be subject to all of the terms of this Lease, except that the monthly Basic Rent shall be one hundred twenty percent (120%) of the Basic Rent for the month immediately preceding the date of termination for the initial two (2) months of holdover by Tenant and for the third (3rd) month and each month Tenant holds over thereafter, one hundred fifty percent (150%) of the Basic Rent for the month immediately preceding the date of termination. If Tenant fails to surrender the Premises upon the expiration of this Lease despite Landlord's written demand to do so (which demand shall include notice to Tenant of a succeeding tenant and the need for Tenant's immediate surrender), then Tenant shall be liable for Landlord's foreseeable consequential and other damages (including, without limitation, reasonable attorney's fees) proximately caused by such failure to surrender. Acceptance by Landlord of rent after the termination shall not constitute a consent to a holdover or result in a renewal of this Lease. The foregoing provisions of this Section are in addition to and do not affect Landlord's right of re-entry or any other rights of Landlord under this Lease or at law. SECTION 15.2. MERGER ON TERMINATION. The voluntary or other surrender of this Lease by Tenant, or a mutual termination of this Lease, shall terminate any or all existing subleases unless Landlord, at its option, elects in writing to treat the surrender or termination as an assignment to it of any or all subleases affecting the Premises. SECTION 15.3. SURRENDER OF PREMISES; REMOVAL OF PROPERTY. Upon the Expiration Date or upon any earlier termination of this Lease, Tenant shall quit and surrender possession of the Premises to Landlord in as good order, condition and repair as when received or as hereafter may be improved by Landlord or Tenant, reasonable wear and tear and repairs which are Landlord's obligation excepted, and shall, without expense to Landlord, remove or cause to be removed from the Premises all personal property and debris, except for any items that Landlord may by written authorization allow to remain. Tenant shall repair all damage to the Premises resulting from such removal, which repair shall include the patching and filling of holes (other than holes resulting from the hanging of pictures or other items of decoration, which Tenant shall not be obligated to patch and fill) and repair of structural damage, provided that Landlord may instead elect to repair any structural damage at Tenant's expense. If Tenant shall fail to comply with the provisions of this Section following ten (10) days written notice to Tenant and failure to cure, Landlord may effect the removal and/or make any repairs, and the cost to Landlord shall be additional rent payable by Tenant upon demand. If Tenant fails to remove Tenant's personal property from the Premises upon the expiration of the Term, Landlord may remove, store, dispose of and/or retain such personal property, at Landlord's option, in accordance with then applicable laws, all at the expense of Tenant. If requested by Landlord, Tenant shall execute, acknowledge and deliver to Landlord an instrument in writing releasing and quitclaiming to Landlord all right, title and interest of Tenant in the Premises. ARTICLE XVI. PAYMENTS AND NOTICES All sums payable by Tenant to Landlord shall be paid, without deduction or offset (except as otherwise expressly provided in this Lease), in lawful money of the United States to Landlord at its address set forth in Item 12 of the Basic Lease Provisions, or at any other place as Landlord may designate in writing. Unless this Lease expressly provides otherwise, as for example in the payment of rent pursuant to Section 4.1, all payments shall be due and payable within five (5) days after demand. All payments requiring proration shall be prorated on the basis of a thirty (30) day month and a three hundred sixty (360) day year. Any notice, election, demand, consent, approval or other communication to be given or other document to be delivered by either party to the other may be delivered in person or by courier or overnight delivery service to the other party, or may be deposited in the United States mail, duly registered or certified, postage prepaid, return receipt requested, and addressed to the other party at the address set forth in Item 12 of the Basic Lease Provisions. Either party may, by written notice to the other, served in the manner provided in this Article, designate a different address. If any notice or other document is sent by mail, it shall be deemed served or delivered on the date actually received or refused as indicated on the return receipt. If more than one person or entity is named as Tenant under this Lease, service of any notice upon any one of them shall be deemed as service upon all of them. Unless the Lease expressly provides otherwise, all payments shall be due and payable within ten (10) days of demand. ARTICLE XVII. RULES AND REGULATIONS Tenant agrees to observe faithfully and comply strictly with the Rules and Regulations, attached as EXHIBIT E, and any reasonable and nondiscriminatory amendments, modifications and/or additions as may be adopted and published by written notice to tenants by Landlord for the safety, care, security, good order, or cleanliness of the 30 34 Premises, Building, Project and Common Areas. Landlord shall not be liable to Tenant for any violation of the Rules and Regulations or the breach of any covenant or condition in any lease by any other tenant or such tenant's agents, employees, contractors, guests or invitees. One or more waivers by Landlord of any breach of the Rules and Regulations by Tenant or by any other tenant(s) shall not be a waiver of any subsequent breach of that rule or any other. Tenant's failure to keep and observe the Rules and Regulations shall constitute a default under this Lease. In the case of any conflict between the Rules and Regulations and this Lease, this Lease shall be controlling. Tenant's agreement to abide by, keep and observe all reasonable rules and regulations which Landlord may make shall be limited to those rules and restrictions which are consistently applied by Landlord to all tenants of the Project in a non-discriminatory manner. ARTICLE XVIII. BROKER'S COMMISSION The parties recognize as the broker(s) who negotiated this Lease the firm(s), if any, whose name(s) is (are) stated in Item 10 of the Basic Lease Provisions, and agree that Landlord shall be responsible for the payment of brokerage commissions to those broker(s) pursuant to Landlord's separate agreement with said Broker. Tenant warrants that it has had no dealings with any other real estate broker or agent in connection with the negotiation of this Lease, and Tenant agrees to indemnify and hold Landlord harmless from any cost, expense or liability (including reasonable attorneys' fees) for any compensation, commissions or charges claimed by any other real estate broker or agent employed or claiming to represent or to have been employed by Tenant in connection with the negotiation of this Lease. The foregoing agreement shall survive the termination of this Lease. To the fullest extent permitted by law, Landlord agrees to indemnify, defend and hold harmless Tenant from and against any and all costs, expenses and liabilities for any compensation claimed by any broker, finder or agent employed or claiming to have been employed by Landlord in connection with the negotiation of this Lease. ARTICLE XIX. TRANSFER OF LANDLORD'S INTEREST In the event of any transfer of Landlord's interest in the Premises, Landlord agrees to transfer, by credit to the purchase price or otherwise, Tenant's Security Deposit to the transferee, and the transferor shall thereupon be automatically relieved of all obligations on the part of Landlord accruing under this Lease from and after the date of the transfer, provided that: (i) any other funds held by the transferor in which Tenant has an interest shall be turned over, subject to that interest, to the transferee and Tenant is notified of the transfer as required by law and (ii) any such transferee shall assume, in writing, all non-accrued obligations of Landlord under this Lease Notwithstanding the foregoing, no holder of a mortgage and/or deed of trust to which this Lease is or may be subordinate, and no landlord under a so-called sale-leaseback, shall be responsible in connection with the Security Deposit, unless the mortgagee or holder of the deed of trust or the landlord actually receives the Security Deposit. It is intended that the covenants and obligations contained in this Lease on the part of Landlord shall, subject to the foregoing, be binding on Landlord, its successors and assigns, only during and in respect to their respective successive periods of ownership. ARTICLE XX. INTERPRETATION SECTION 20.1. GENDER AND NUMBER. Whenever the context of this Lease requires, the words "Landlord" and "Tenant" shall include the plural as well as the singular, and words used in neuter, masculine or feminine genders shall include the others. SECTION 20.2. HEADINGS. The captions and headings of the articles and sections of this Lease are for convenience only, are not a part of this Lease and shall have no effect upon its construction or interpretation. SECTION 20.3. JOINT AND SEVERAL LIABILITY. If more than one person or entity is named as Tenant, the obligations imposed upon each shall be joint and several and the act of or notice from, or notice or refund to, or the signature of, any one or more of them shall be binding on all of them with respect to the tenancy of this Lease, including, but not limited to, any renewal, extension, termination or modification of this Lease. SECTION 20.4. SUCCESSORS. Subject to Articles IX and XIX, all rights and liabilities given to or imposed upon Landlord and Tenant shall extend to and bind their respective heirs, executors, administrators, successors and assigns. Nothing contained in this Section is intended, or shall be construed, to grant to any person other than Landlord and Tenant and their successors and assigns any rights or remedies under this Lease. SECTION 20.5. TIME OF ESSENCE. Time is of the essence with respect to the performance of every provision of this Lease. SECTION 20.6. CONTROLLING LAW. This Lease shall be governed by and interpreted in accordance with the laws of the State of California. 31 35 SECTION 20.7. SEVERABILITY. If any term or provision of this Lease, the deletion of which would not adversely affect the receipt of any material benefit by either party or the deletion of which is consented to by the party adversely affected, shall be held invalid or unenforceable to any extent, the remainder of this Lease shall not be affected and each term and provision of this Lease shall be valid and enforceable to the fullest extent permitted by law. SECTION 20.8. WAIVER AND CUMULATIVE REMEDIES. One or more waivers by Landlord or Tenant of any breach of any term, covenant or condition contained in this Lease shall not be a waiver of any subsequent breach of the same or any other term, covenant or condition. Consent to any act by one of the parties shall not be deemed to render unnecessary the obtaining of that party's consent to any subsequent act. No breach by Tenant of this Lease shall be deemed to have been waived by Landlord unless the waiver is in a writing signed by Landlord. The rights and remedies of Landlord under this Lease shall be cumulative and in addition to any and all other rights and remedies which Landlord may have. The failure of Tenant or Landlord to seek redress for violation of, or to insist upon the strict performance of, any term, covenant or condition of the Lease shall not be deemed a waiver of such violation or prevent a subsequent act which would have originally constituted a violation from having all the force and effect of the original violation, nor shall any custom or practice which may become established between the parties in the administration of the terms hereof be deemed a waiver of, or in any way affect, the right of a party to insist upon the performance by the other party of its obligations in strict accordance with said terms. Any payment of rents or other sums hereunder by Tenant shall not, in and of itself, be deemed a waiver of any preceding breach by Landlord of any term, covenant or condition of this Lease, regardless of Tenant's knowledge of such preceding breach at the time of payment of such rent or other sums. SECTION 20.9. INABILITY TO PERFORM. In the event that either party shall be delayed or hindered in or prevented from the performance of any work or in performing any act required under this Lease by reason of any cause beyond the reasonable control of that party, then the performance of the work or the doing of the act shall be excused for the period of the delay and the time for performance shall be extended for a period equivalent to the period of the delay. The provisions of this Section shall not operate to excuse Tenant from the prompt payment of rent or from the timely performance of any other obligation under this Lease within Tenant's reasonable control. SECTION 20.10. ENTIRE AGREEMENT. This Lease and its exhibits and other attachments cover in full each and every agreement of every kind between the parties concerning the Premises, the Building, and the Project, and all preliminary negotiations, oral agreements, understandings and/or practices, except those contained in this Lease, are superseded and of no further effect. Tenant waives its rights to rely on any representations or promises made by Landlord or others which are not contained in this Lease. No verbal agreement or implied covenant shall be held to modify the provisions of this Lease, any statute, law, or custom to the contrary notwithstanding. SECTION 20.11. QUIET ENJOYMENT. Upon the observance and performance of all the covenants, terms and conditions on Tenant's part to be observed and performed, and subject to the other provisions of this Lease, Tenant shall peaceably and quietly hold and enjoy the Premises for the Term without hindrance or interruption by Landlord or any other person claiming by or through Landlord. SECTION 20.12. SURVIVAL. All covenants of Landlord or Tenant which reasonably would be intended to survive the expiration or sooner termination of this Lease, including without limitation any warranty or indemnity hereunder, shall so survive and continue to be binding upon and inure to the benefit of the respective parties and their successors and assigns. ARTICLE XXI. EXECUTION AND RECORDING SECTION 21.1. COUNTERPARTS. This Lease may be executed in one or more counterparts, each of which shall constitute an original and all of which shall be one and the same agreement. SECTION 21.2. CORPORATE AND PARTNERSHIP AUTHORITY. Tenant and Landlord each represent and warrant that each individual executing this Lease on behalf of Tenant or Landlord, respectively, is duly authorized to execute and deliver this Lease on behalf of Tenant or Landlord, respectively, and that this Lease is binding upon Tenant or Landlord, respectively, in accordance with its terms. SECTION 21.3. EXECUTION OF LEASE; NO OPTION OR OFFER. The submission of this Lease to Tenant shall be for examination purposes only, and shall not constitute an offer to or option for Tenant to lease the Premises. Execution of this Lease by Tenant and its return to Landlord shall not be binding upon Landlord, notwithstanding any time interval, until Landlord has in fact executed and delivered this Lease to Tenant, it being intended that this Lease shall only become effective upon execution by Landlord and delivery of a fully executed counterpart to Tenant. SECTION 21.4. RECORDING. Tenant shall not record this Lease without the prior written consent of Landlord. Tenant, upon the request of Landlord, shall execute and acknowledge a "short form" memorandum of this Lease for recording purposes. SECTION 21.5. AMENDMENTS. No amendment or termination of this Lease shall be effective unless in writing signed by authorized signatories of Tenant and Landlord, or by their respective successors in interest. No 32 36 actions, policies, oral or informal arrangements, business dealings or other course of conduct by or between the parties shall be deemed to modify this Lease in any respect. SECTION 21.6. EXECUTED COPY. Any fully executed photocopy or similar reproduction of this Lease shall be deemed an original for all purposes. SECTION 21.7. ATTACHMENTS. All exhibits, amendments, riders and addenda attached to this Lease are hereby incorporated into and made a part of this Lease. ARTICLE XXII. MISCELLANEOUS SECTION 22.1. NONDISCLOSURE OF LEASE TERMS. Tenant acknowledges and agrees that the terms of this Lease are confidential and constitute proprietary information of Landlord. Disclosure of the terms could adversely affect the ability of Landlord to negotiate other leases and impair Landlord's relationship with other tenants. Accordingly, Tenant agrees that it, and its partners, officers, directors, employees and attorneys, shall not intentionally and voluntarily disclose the terms and conditions of this Lease to any other tenant or apparent prospective tenant of the Project, either directly or indirectly, without the prior written consent of Landlord, provided, however, that Tenant may disclose the terms to prospective subtenants or assignees under this Lease. The provisions of this Section are not intended to prevent Tenant from disclosing the existence or terms of this Lease as may be required of a public company in its filings with regulatory agencies. SECTION 22.2. GUARANTY. [INTENTIONALLY OMITTED] SECTION 22.3. CHANGES REQUESTED BY LENDER. If, in connection with obtaining financing for the Project, the lender shall request reasonable modifications in this Lease as a condition to the financing, Tenant will not unreasonably withhold or delay its consent, provided that the modifications do not materially increase the obligations of Tenant or materially and adversely affect the leasehold interest created by this Lease. SECTION 22.4. MORTGAGEE PROTECTION. No act or failure to act on the part of Landlord which would otherwise entitle Tenant to be relieved of its obligations hereunder or to terminate this Lease shall result in such a release or termination unless (a) Tenant has given notice by registered or certified mail to any beneficiary of a deed of trust or mortgage covering the Building whose address has been furnished to Tenant and (b) such beneficiary is afforded a reasonable opportunity to cure the default by Landlord (which in no event shall be less than sixty (60) days), including, if necessary to effect the cure, time to obtain possession of the Building by power of sale or judicial foreclosure provided that such foreclosure remedy is commenced within such sixty (60) day period and is thereafter diligently pursued. Tenant agrees that each beneficiary of a deed of trust or mortgage covering the Building is an express third party beneficiary hereof, Tenant shall have no right or claim for the collection of any deposit from such beneficiary or from any purchaser at a foreclosure sale unless such beneficiary or purchaser shall have actually received and not refunded the deposit, and Tenant shall comply with any written directions by any beneficiary to pay rent due hereunder directly to such beneficiary without determining whether an event of default exists under such beneficiary's deed of trust. SECTION 22.5. COVENANTS AND CONDITIONS. All of the provisions of this Lease shall be construed to be conditions as well as covenants as though the words specifically expressing or imparting covenants and conditions were used in each separate provision. SECTION 22.6. SECURITY MEASURES. Tenant hereby acknowledges that Landlord shall have no obligation whatsoever to provide guard service or other security measures for the benefit of the Premises or the Project. Tenant assumes all responsibility for the protection of Tenant, its agents, invitees and property from acts of third parties. Nothing herein contained shall prevent Landlord, at its sole option, from providing security protection for the Project or any part thereof, in which event the cost thereof shall be included within the definition of Project Costs. SECTION 22.7. COMMUNICATIONS/SECURITY EQUIPMENT. At any time upon the execution by Tenant of Landlord's standard License Agreement (a copy of which is attached hereto as EXHIBIT F), Tenant shall have the right at its sole cost and expense, during the Term of this Lease, to install, maintain and operate communications equipment on the roof of the Building A or in subterranean conduit between the Buildings in the area shown in the License Agreement and to install a security system on the interior and exterior of the Buildings as necessary. Such systems may include trenching and the connection of services between the Buildings. The operation and maintenance of any such equipment shall be subject to the terms of said License Agreement. Tenant shall not be obligated to pay any license fee for such equipment during the Lease Term or any extensions. SECTION 22.8. JAMS ARBITRATION. (a) All claims or disputes between Landlord and Tenant arising out of, or relating to the Lease which either party is expressly authorized by a provision hereof to submit to arbitration, shall be decided by the JAMS/ENDISPUTE, or its successor, in Orange, California ("JAMS"), unless the parties mutually agree otherwise. Within ten (10) business days following submission to JAMS, JAMS shall designate three arbitrators and each party may, within five (5) business days thereafter, veto one of the three persons so designated. If two different designated arbitrators have been vetoed, the third arbitrator shall hear and decide the matter. Any arbitration pursuant to this Section 22.8 shall be 33 37 decided within thirty (30) days of submission of JAMS. The decision of the arbitrator shall be final and binding on the parties. All costs associated with arbitration shall be awarded to the prevailing party as determined by the arbitrator. (b) Notice of the demand for arbitration by either party to the Lease shall be filed in writing with the other party to the Lease and with JAMS and shall be made within a reasonable time after the dispute has arisen. The award rendered by the arbitrators shall be final, and judgment may be entered upon it in accordance with applicable law in any court having jurisdiction thereof. Except by written consent of the person or entity sought to be joined, no arbitration arising out of or relating to the Lease shall include, by consolidation, joinder or in any other manner, any person or entity not a party to the Lease under which such arbitration is filed if (1) such person or entity is substantially involved in a common question of fact or law, (2) the presence of such person or entity is required if complete relief is to be accorded in the arbitration, or (3) the interest or responsibility of such person or entity in the matter is not insubstantial. (c) The agreement herein among the parties to the Lease and any other written agreement to arbitrate referred to herein shall be specifically enforceable under prevailing law. [seal legal approval] LANDLORD: TENANT: THE IRVINE COMPANY, BROADCOM CORPORATION A DELAWARE CORPORATION A CALIFORNIA CORPORATION By: /s/ RICHARD G. SIM By: /s/ HENRY T NICHOLAS ----------------------------------- -------------------------- Richard G. Sim Name: Henry T Nicholas -------------------------- Group President, Investment Properties Title: CEO -------------------------- By: /s/ CLARENCE W. BARKER By: /s/ DAVID DULL -------------------------------------- -------------------------- Name: David Dull Clarence W. Barker, President -------------------------- Irvine Industrial Company, Title: VP & SECRETARY a division of The Irvine Company -------------------------- 34 38 EXHIBIT A-1 DESCRIPTION OF PREMISES [drawing] Pie shaped property on corner of Laguna Canyon Road and Alton Parkway. Three buildings (A, B, C) in campus environment surrounding center courtyard area. 39 EXHIBIT A-2 TEMPORARY PREMISES - SECOND FLOOR OF BUILDING C [drawing] Second floor building C floorplan highlighting offices, common area, and steps 40 EXHIBIT B IRVINE INDUSTRIAL COMPANY HAZARDOUS MATERIALS SURVEY FORM The purpose of this form is to obtain information regarding the use of hazardous substances on Irvine Industrial Company property. Prospective tenants and contractors should answer the questions in light of their proposed operations on the premises. Existing tenants and contractors should answer the questions as they relate to ongoing operations on the premises and should update any information previously submitted. If additional space is needed to answer the questions, you may attach separate sheets of paper to this form. When completed, the form should be sent to the following address: ___________________________________ ___________________________________ ___________________________________ ___________________________________ (insert address of Property Management Company) Your cooperation in this matter is appreciated. If you have any questions, please do not hesitate to call [insert name of Property Manager] at [insert phone number] for assistance. 1. GENERAL INFORMATION Name of Responding Company: -------------------------------------------------- Check all that apply: Tenant (X) Contractor ( ) Prospective ( ) Existing ( ) Mailing Address: 16251 Laguna Canyon Road, Irvine, CA 92618 ------------------------------------------------------------- Contact Person & Title: Dick Salvi - Director Corporate Services ------------------------------------------------------ Telephone Number: ( ) - 949 - 450 - 8700 ext. 1257 ------------- ---------------------------------- Address of Leased Premises: 16251/16205 Laguna Canyon Road, Irvine, CA -------------------------------------------------- Length of Lease or Contract Term: 7 Years -------------------------------------------- Describe the proposed operations to take place on the property, including principal products manufactured or services to be conducted. Existing tenants and contractors should describe any proposed changes to ongoing operations. Research, design engineering and test of semiconductor devices -------------------------------------------------------------- -------------------------------------------------------------- 2. STORAGE OF HAZARDOUS MATERIALS 2.1 Will any hazardous materials be used or stored on-site? Wastes Yes ( ) No ( X ) Chemical Products Yes ( ) No ( X ) Biological Hazards/ Yes ( ) No ( X ) Infectious Wastes Yes ( ) No ( X ) Radioactive Materials Yes ( ) No ( X ) 2.2 List any hazardous materials to be used or stored, the quantities that will be on-site at any given time, and the location and method of storage (e.g., bottles in storage closet on the premises). Location and Method NONE 1 41 Waste/Products of Storage Quantity -------------- ------------- --------- -------------- ------------- --------- -------------- ------------- --------- -------------- ------------- --------- 2.3 Is any underground storage of hazardous substances proposed or currently conducted on the premises? Yes ( ) No (X) If yes, describe the materials to be stored, and the size and construction of the tank. Attach copies of any permits obtained for the underground storage of such substances. ------------------------ -------------------------------------------------------------------- 3. SPILLS 3.1 During the past year, have any spills occurred on the premises? Yes ( ) No (X) If so, please describe the spill and attach the results of any testing conducted to determine the extent of such spills. 3.2 Were any agencies notified in connection with such spills? Yes ( ) No (X) If so, attach copies of any spill reports or other correspondence with regulatory agencies. 3.3 Were any clean-up actions undertaken in connection with the spills? Yes ( ) No (X) If so, briefly describe the actions taken. Attach copies of any clearance letters obtained from any regulatory agencies involved and the results of any final soil or groundwater sampling done upon completion of the clean-up work. 4. WASTE MANAGEMENT 4.1 List the waste, if any, generated or to be generated at the premises, whether it is as hazardous waste, biological or radioactive hazard, its hazard class and the quantity generated on a monthly basis. Waste Hazard Class Quantity/Month None ------------- ----------------- ----------------- ------------- ----------------- ----------------- ------------- ----------------- ----------------- ------------- ----------------- ----------------- 4.2 Describe the method(s) of disposal for each waste. Indicate where and how often disposal will take place. n/a ----------------------------- -------------------------------------------------------------------- 4.3 Is any treatment or processing of hazardous, infectious or radioactive wastes currently conducted or proposed to be conducted at the premises? Yes ( ) No (X) If yes, please describe any existing or proposed treatment methods. -------------------------------------------------------------------- 4.4 Attach copies of any hazardous waste permits or licenses issued to your company with respect to its operations on the premises. 5. WASTEWATER TREATMENT/DISCHARGE 5.1 Do you discharge industrial wastewater to: storm drain? sewer? --- --- surface water? X no industrial discharge --- --- 5.2 Is your industrial wastewater treated before discharge? Yes ( ) No ( ) If yes, describe the type of treatment conducted. 5.3 Attach copies of any wastewater discharge permits issued to your company with respect to its operations on the premises. N/A 2 42 6. AIR DISCHARGES 6.1 Do you have any air filtration systems or stacks that discharge into the air? Yes ( ) No (X) 6.2 Do you operate any equipment that require air emissions permits? Yes ( ) No (X) 6.3 Attach copies of any air discharge permits pertaining to these operations. N/A 7. HAZARDOUS MATERIALS DISCLOSURES 7.1 Does your company handle an aggregate of at least 500 pounds, 55 gallons or 200 cubic feet of hazardous material at any given time? If so, state law requires that you prepare a hazardous materials management plan. Yes ( ) No (X) 7.2 Has your company prepared a hazardous materials management plan ('business plan') pursuant to state and Orange County Fire Department requirements? Yes ( ) No (X) If so, attach a copy of the business plan. 7.3 Are any of the chemicals used in your operations regulated under Proposition 65? Yes ( ) No (X) If so, describe the actions taken, or proposed actions to be taken, to comply with Proposition 65 requirements. 7.4 Is your company subject to OSHA Hazard Communication Standard Requirements? Yes ( ) No (X) If so, describe the procedures followed to comply with these requirements. 8. ENFORCEMENT ACTIONS, COMPLAINTS 8.1 Has your company ever been subject to any agency enforcement actions, administrative orders, or consent decrees? Yes ( ) No (X) If so, describe the actions and any continuing compliance obligations imposed as a result of these actions. 8.2 Has your company ever received requests for information, notice or demand letters, or any other inquiries regarding its operations? Yes ( ) No (X) 8.3 Have there ever been, or are there now pending, any lawsuits against your company regarding any environmental or health and safety concerns? Yes ( ) No (X) 8.4 Has an environmental audit ever been conducted at your company's current facility? Yes (X) No ( ) If so, discuss the results of the audit. A review of Broadcom facilities revealed no use of hazardous chemicals. 8.5 Have there been any problems or complaints from neighbors at your company's current facility? Yes (X) No ( ) ------------------------------------------- ------------------------------------------- By: /s/ HENRY T.NICHOLAS ---------------------------------------- Name: HENRY T.NICHOLAS -------------------------------------- Title: CEO ------------------------------------- Date: 8/7/98 -------------------------------------- 3 43 EXHIBIT C LANDLORD'S DISCLOSURES (SPECTRUM III) The capitalized terms used and not otherwise defined in this Exhibit shall have the same definitions as set forth in the Lease. The provisions of this Exhibit shall supersede any inconsistent or conflicting provisions of the Lease. 1. Landlord has been informed that the El Toro Marine Corps Air Station (MCAS) has been listed as a Federal Superfund site as a result of chemical releases occurring over many years of occupancy. Various chemicals including jet fuel, motor oil and solvents have been discharged in several areas throughout the MCAS site. A regional study conducted by the Orange County Water District has estimated that groundwaters beneath more than 2,900 acres have been impacted by Trichloroethlene (TCE), an industrial solvent. There is a potential that this substance may have migrated into the ground water underlying the Premises. The U.S. Environmental Protection Agency, the Santa Ana Region Quality Control Board, and the Orange County Health Care Agency are overseeing the investigation/cleanup of this contamination. To the Landlord's current actual knowledge, the ground water in this area is used for irrigation purposes only, and there is no practical impediment to the use or occupancy of the Premises due to the El Toro discharges. 2. Portions of the real property on which the Project is located or is adjacent to were used as the Orange County International Raceway from approximately the mid-1960s to the mid-1980s. During this period, oil and other substances associated with race car driving were deposited onto such real property. To the Landlord's current actual knowledge, these substances were removed, and the Landlord is currently unaware of any contamination existing upon such real property as a result of such prior use. Page 1 of 1 44 EXHIBIT D TENANT'S INSURANCE The following standards for Tenant's insurance shall be in effect at the Premises. Landlord reserves the right to adopt reasonable nondiscriminatory modifications and additions to those standards. Tenant agrees to obtain and present evidence to Landlord that it has fully complied with the insurance requirements. 1. Tenant shall, at its sole cost and expense, commencing on the date Tenant is given access to the Premises for any purpose and during the entire Term, procure, pay for and keep in full force and effect: (i) commercial general liability insurance with respect to the Premises and the operations of or on behalf of Tenant in, on or about the Premises, including but not limited to personal injury, owned and nonowned automobile, blanket contractual, independent contractors, broad form property damage (with an exception to any pollution exclusion with respect to damage arising out of heat, smoke or fumes from a hostile fire), fire and water legal liability, products liability (if a product is sold from the Premises), liquor law liability (if alcoholic beverages are sold, served or consumed within the Premises), and severability of interest, which policy(ies) shall be written on an "occurrence" basis and for not less than the amount set forth in Item 13 of the Basic Lease Provisions, with a combined single limit (with a $50,000 minimum limit on fire legal liability) per occurrence for bodily injury, death, and property damage liability, or the current limit of liability carried by Tenant, whichever is greater, and subject to such increases in amounts as Landlord may determine from time to time; (ii) workers' compensation insurance coverage as required by law, together with employers' liability insurance; (iii) with respect to improvements, alterations, and the like required or permitted to be made by Tenant under this Lease, builder's all-risk insurance, in an amount equal to the replacement cost of the work; (iv) insurance against fire, vandalism, malicious mischief and such other additional perils as may be included in a standard "all risk" form in general use in the county in which the Premises are situated, insuring Tenant's leasehold improvements, trade fixtures, furnishings, equipment and items of personal property of Tenant located in the Premises, in an amount equal to not less than ninety percent (90%) of their actual replacement cost (with replacement cost endorsement); and (v) business interruption insurance in amounts satisfactory to cover one (1) year of loss. In no event shall the limits of any policy be considered as limiting the liability of Tenant under this Lease. 2. In the event Landlord consents to Tenant's use, generation or storage of Hazardous Materials on, under or about the Premises pursuant to Section 5.3 of this Lease, Landlord shall have the continuing right to require Tenant, at Tenant's sole cost and expense (provided the same is available for purchase upon commercially reasonable terms), to purchase insurance specified and approved by Landlord, with coverage not less than Five Million Dollars ($5,000,000.00), insuring (i) any Hazardous Materials shall be removed from the Premises, (ii) the Premises shall be restored to a clean, healthy, safe and sanitary condition, and (iii) any liability of Tenant, Landlord and Landlord's officers, directors, shareholders, agents, employees and representatives, arising from such Hazardous Materials. 3. All policies of insurance required to be carried by Tenant pursuant to this Exhibit D containing a deductible exceeding Ten Thousand Dollars ($10,000.00) per occurrence must be approved in writing by Landlord prior to the issuance of such policy. Tenant shall be solely responsible for the payment of all deductibles. 4. All policies of insurance required to be carried by Tenant pursuant to this Exhibit D shall be written by responsible insurance companies authorized to do business in the State of California and with a Best's rating of not less than "A" subject to final acceptance and approval by Landlord. Any insurance required of Tenant may be furnished by Tenant under any blanket policy carried by it or under a separate policy, so long as (i) the Premises are specifically covered (by rider, endorsement or otherwise), (ii) the limits of the policy are applicable on a "per location" basis to the Premises and provide for restoration of the aggregate limits, and (iii) the policy otherwise complies with the provisions of this Exhibit D. A true and exact copy of each paid up policy evidencing the insurance (appropriately authenticated by the insurer) or a certificate of insurance, certifying that the policy has been issued, provides the coverage required by this Exhibit D and contains the required provisions, shall be delivered to Landlord prior to the date Tenant is given the right of possession of the Premises. Proper evidence of the renewal of any insurance coverage shall also be delivered to Landlord not less than thirty (30) days prior to the expiration of the coverage. Landlord may at any time, and from time to time, inspect and/or copy any and all insurance policies required by this Lease. 5. Each policy evidencing insurance required to be carried by Tenant pursuant to this Exhibit D shall contain the following provisions and/or clauses satisfactory to Landlord: (i) a provision that the policy and the coverage provided shall be primary and that any coverage carried by Landlord shall be noncontributory with respect to any policies carried by Tenant except as to workers' compensation insurance; (ii) a provision including Landlord, the Additional Insureds identified in Item 11 of the Basic Lease Provisions, and any other parties in interest designated by Landlord as an additional insured, except as to workers' compensation insurance; (iii) a waiver by the insurer of any right to subrogation against Landlord, its agents, employees, contractors and representatives which arises or might arise by reason of any payment under the policy or by reason of any act or omission of Landlord, its agents, employees, contractors or representatives; and (iv) a provision that the insurer will not cancel or change the coverage provided by the policy without first giving Landlord thirty (30) days prior written notice. 6. In the event that Tenant fails to procure, maintain and/or pay for, at the times and for the durations specified in this Exhibit D, any insurance required by this Exhibit D, or fails to carry insurance required by any governmental authority, Landlord may at its election procure that insurance and pay the premiums, in which event Tenant shall repay Landlord all sums paid by Landlord, together with interest at the maximum rate permitted by law and any related costs or expenses incurred by Landlord, within ten (10) days following Landlord's written demand to Tenant. Page 1 of 1 45 EXHIBIT E RULES AND REGULATIONS This Exhibit sets forth the rules and regulations governing Tenant's use of the Premises leased to Tenant pursuant to the terms, covenants and conditions of the Lease to which this Exhibit is attached and therein made part thereof. In the event of any conflict or inconsistency between this Exhibit and the Lease, the Lease shall control. 1. Tenant shall not place anything or allow anything to be placed near the glass of any window, door, partition or wall which may appear unsightly from outside the Premises. 2. The walls, walkways, sidewalks, entrance passages, courts and vestibules shall not be obstructed or used for any purpose other than ingress and egress of pedestrian travel to and from the Premises, and shall not be used for loitering or gathering, or to display, store or place any merchandise, equipment or devices, or for any other purpose. The walkways, entrance passageways, courts, vestibules and roof are not for the use of the general public and Landlord shall in all cases retain the right to control and prevent access thereto by all persons whose presence in the judgment of the Landlord shall be prejudicial to the safety, character, reputation and interests of the Building and its tenants, provided that nothing herein contained shall be construed to prevent such access to persons with whom Tenant normally deals in the ordinary course of Tenant's business unless such persons are engaged in illegal activities. No tenant or employee or invitee of any tenant shall be permitted upon the roof of the Building except pursuant to our executed License Agreement with Landlord. 3. No awnings or other projection shall be attached to the outside walls of the Building. No security bars or gates, curtains, blinds, shades or screens shall be attached to or hung in, or used in connection with, any window or door of the Premises without the prior written consent of Landlord. Neither the interior nor exterior of any windows shall be coated or otherwise sunscreened without the express written consent of Landlord. 4. Except for the ordinary hanging of pictures, signs, white boards or other items of decoration, Tenant shall not mark, nail, paint, drill into, or in any way deface any part of the Premises or the Building. Tenant shall not lay linoleum, tile, carpet or other similar floor covering so that the same shall be affixed to the floor of the Premises in any manner except as approved by Landlord in writing. The expense of repairing any damage resulting from a violation of this rule or removal of any floor covering shall be borne by Tenant. 5. The toilet rooms, urinals, wash bowls and other plumbing apparatus shall not be used for any purpose other than that for which they were constructed and no foreign substance of any kind whatsoever shall be thrown therein. The expense of any breakage, stoppage or damage resulting from the violation of this rule shall be borne by the tenant who, or whose employees or invitees, caused it. 6. No boring or cutting for wires will be allowed without the prior consent of Landlord 7. The Premises shall not be used for manufacturing or for the storage of merchandise except as such storage may be incidental to the permitted use of the Premises. No exterior storage shall be allowed at any time without the prior written approval of Landlord. The Premises shall not be used for cooking or washing clothes without the prior written consent of Landlord, or for lodging or sleeping or for any immoral or illegal purposes. 8. Tenant shall not make, or permit to be made, any unseemly or disturbing noises or disturb or interfere with occupants of this or neighboring buildings or premises or those having business with them, whether by the use of any musical instrument, radio, phonograph, noise, or otherwise. Tenant shall not use, keep or permit to be used, or kept, any foul or obnoxious gas or substance in the Premises or permit or suffer the Premises to be used or occupied in any manner offensive or objectionable to Landlord or other occupants of this or neighboring buildings or premises by reason of any odors, fumes or gases. 9. No animals shall be permitted at any time within the Premises. 10. Tenant shall not use the name of the Building or the Project in connection with or in promoting or advertising the business of Tenant, except as Tenant's address, without the written consent of Landlord. Landlord shall have the right to prohibit any advertising by any Tenant which, in Landlord's reasonable opinion, tends to impair the reputation of the Project or its desirability for its intended uses, and upon written notice from Landlord any Tenant shall refrain from or discontinue such advertising. 11. Canvassing, soliciting, peddling, parading, picketing, demonstrating or otherwise engaging in any conduct that unreasonably impairs the value or use of the Premises or the Project are prohibited and each Tenant shall cooperate to prevent the same. 12. No equipment of any type shall be placed on the Premises which in Landlord's opinion exceeds the load limits of the floor or otherwise threatens the soundness of the structure or improvements of the Building. 1 46 13. No air conditioning unit or other similar apparatus shall be installed or used by any Tenant without the prior written consent of Landlord. 14. No aerial antenna shall be erected on the roof or exterior walls of the Premises, or on the grounds, without in each instance, the prior written consent of Landlord as set forth in a separate License Agreement. Any aerial or antenna installed without such written consent shall be subject to removal by Landlord at any time without prior notice at the expense of the Tenant, and Tenant shall upon Landlord's demand pay a removal fee to Landlord of not less than $200.00. 15. The entire Premises, including vestibules, entrances, doors, fixtures, windows and plate glass, shall at all times be maintained in a safe, neat and clean condition by Tenant. All trash, refuse and waste materials shall be regularly removed from the Premises by Tenant and placed in the containers at the locations designated by Landlord for refuse collection. All cardboard boxes must be "broken down" prior to being placed in the trash container. All styrofoam chips must be bagged or otherwise contained prior to placement in the trash container, so as not to constitute a nuisance. Pallets may not be disposed of in the trash container or enclosures. The burning of trash, refuse or waste materials is prohibited. 16. Tenant shall use at Tenant's cost a pest extermination contractor at such intervals as may reasonably be required to maintain the Premises in first class condition. 17. All keys for the Premises shall be provided to Tenant by Landlord and Tenant shall return to Landlord any of such keys so provided upon the termination of the Lease. Tenant shall not change locks or install other locks on doors of the Premises, without the prior written consent of Landlord. In the event of loss of any keys furnished by Landlord for Tenant, Tenant shall pay to Landlord the costs thereof. 18. No person shall enter or remain within the Project while intoxicated or under the influence of liquor or drugs. Landlord shall have the right to exclude or expel from the Project any person who, in the absolute discretion of Landlord, is under the influence of liquor or drugs. Landlord reserves the right to amend or supplement the foregoing Rules and Regulations and to adopt and promulgate additional rules and regulations applicable to the Premises. Notice of such rules and regulations and amendments and supplements thereto, if any, shall be given to the Tenant. 2 47 EXHIBIT F LICENSE AGREEMENT THIS LICENSE AGREEMENT ("License") made this ____ day of ,199 , by and ______________________between __________________________________________________ ("Licensor"), and ___________________________________("Licensee"). RECITALS Licensor is the owner of certain real property, located at __________________________________, Irvine, California (the "Building"). Licensor and Licensee have entered into a lease (the "Lease") for space in the Building more particularly described as Suite__. The parties desire to provide for the use by Licensee of a portion of the roof of the Building and adjacent property as provided below. TERMS AND CONDITIONS 1. Licensed Area: For valuable consideration, receipt of which is hereby acknowledged and the covenants and conditions to be observed and performed by Licensee, Licensor hereby grants to Licensee a license and permission to enter upon the areas shown on Exhibit A of this License to: (i) install, operate and maintain one satellite dish ("Dish") on the roof of the Building in the location designated by Licensor (the "Roof License Area"); and (ii) to install, operate and maintain telecommunication transmission lines, conduits, markers and related equipment and facilities (the "Equipment") for services to its Premises (the "Equipment License Area). Licensor reserves the right upon reasonable notice to Licensee to require either (a) the relocation of all equipment installed by Licensee in the Roof License Area to another location on the roof of the Building, or (b) the removal of the Dish or related equipment or the Equipment any or all of such equipment should Licensor determine that its presence may result in damage to the Building and that Licensee has not made satisfactory arrangements to protect Licensor therefrom. 2. Term: The term of this License shall be coterminous with the Lease. 3. Use: Licensee shall use the Roof License Area for the installation and maintenance of the Dish (of which the height, appearance and installation procedures must be approved in writing by Licensor) and the necessary mechanical and electrical equipment to service said Dish and the Equipment License Area for the operation and maintenance of the Equipment. Licensee may have access to the Licensed Area during normal business hours and at other times by providing Licensor with reasonable prior notice and by reimbursing Licensor for any expenses incurred by Licensor in connection therewith. 4. Rental. Licensee shall pay no additional rent or fees for the use and occupancy of the Licensed Area. 5. Licensee's Operations: During the term of this License, the Licensed Area and all equipment placed and maintained thereon shall be used by the Licensee for the use specified and for no other use or purpose. Licensee shall not use or permit any other person to use the Licensed Area, or any part thereof, for any purposes tending to injure the reputation thereof or for any improper or offensive use or to constitute a nuisance and Licensee shall at all times conform to and cause all persons using any part of the Licensed Area to comply with all public laws, ordinances and regulations from time to time applicable thereto and to all operations thereon. Licensee shall require its employees, when using the Licensed Area, to stay within the immediate confines thereof. In addition, in the event a cable television system or other communication system is operating in the area, Licensee shall at all times during the term of the License conduct its operations so as to ensure that such systems shall not be subjected to harmful interference as a result of such operations by Licensee. Upon notification from Licensor of any such interference, Licensee agrees to immediately take the necessary steps to correct such situation, and Licensee's failure to do so shall be deemed a default under the terms of this License. During the term of this License, Licensee shall comply with any standards promulgated by applicable governmental authorities or otherwise reasonably established by Licensor regarding the generation of electromagnetic fields. Should Licensor determine in good faith at any time that the Dish or Equipment poses a health or safety hazard to occupants of the Building, Licensor may require Licensee to remove the Dish or Equipment or make other EXHIBIT F To Lease 1 48 arrangements satisfactory to Licensor. Any claim or liability resulting from the use of the Dish or Equipment shall be subject to the indemnification obligation as set forth in the Paragraph below entitled "Licensor's Nonliability." 6. Removal: Upon the expiration or earlier termination of this License, Licensee shall remove the Dish and the other Equipment installed by it and shall restore the Licensed Area to its original condition except that any conduit in the Equipment License Area shall be sealed in place. 7. Licensor's Nonliability: Licensor shall not be liable for any loss, damage or injury of any kind whatsoever to the property of Licensee or the property or person, including death, of any of Licensee's employees, agents or invitees or of any other person whomsoever caused by any use of the Licensed Area or occasioned by the failure on the part of Licensee to maintain said Licensed Area in safe condition, or by any act or omission of Licensee or of any of Licensee's employees, agents or invitees, or arising from any other cause whatsoever; and Licensee, as a material part of the consideration of this License, hereby waives on its behalf all claims and demands against Licensor for any such loss, damage or injury suffered by Licensee, and hereby agrees to indemnify, defend and save Licensor free and harmless from liability for any such loss, damage or injury of third persons, and from all costs, expenses and charges arising therefrom or in connection therewith, including reasonable attorneys' fees. In addition, Licensee agrees to reimburse Licensor for the cost of repairing any damage to the Building caused by the exercise of Licensee's rights hereunder. 8. Liens: Licensee shall not permit to be enforced against the Licensed Area any mechanics', materialmen's, contractors' or other liens arising from, or any claims for damage growing out of, any work of installation, repair or alteration as herein authorized or otherwise arising (except from the actions of Licensor) and Licensee shall pay or cause to be paid all of said liens and claims before any action is brought to enforce the same against Licensor or the Licensed Area; and Licensee agrees to indemnify and hold Licensor and the Licensed Area free and harmless from all liability for any and all such liens and claims and all costs and expenses in connection therewith. 9. Taxes: During the term of this License, Licensor shall pay all taxes attributable to the Building of which the Licensed Area is a part, and Licensee shall pay all taxes attributable to the Dish and the Equipment owned and installed by Licensee. 10. Assignment: This License shall not be assignable in whole or in part, and any attempted assignment thereof, without the consent of Licensor, shall immediately terminate this License. 11. Insurance/Indemnity: The insurance and indemnity provisions of the Lease shall govern Licensee's use of the Licensed Area. Moreover, should the exercise of Licensee's rights hereunder result in any increase in Licensor's insurance rates on the Building, Licensee shall promptly following demand reimburse Licensor for such additional expenses incurred by Licensor. 12. Remedies: Should Licensee default in the performance of or breach any covenant or condition on Licensee's part to be kept and performed under the Lease or this License, then in any such event Licensor may, at its option, without prejudice to any other right or remedy it may have, terminate this License and the Lease by giving Licensee written notice of such termination, and upon such termination all rights of Licensee shall cease and end. 13. Covenants and Conditions: This License and each and all of the covenants and conditions hereof shall inure to the benefit of and shall bind the successors in interest of Licensor and subject to the restrictions set forth in the above Paragraph entitled "Assignment," the successors and assigns of Licensee. 14. Notices: All rents, notices or other communication shall be sent by first-class mail or personally delivered to the notice address set forth under the signature blocks below, or at such other places as the parties may hereafter designate in writing. [Signatures on following page.] EXHIBIT F To Lease 2 49 The parties hereto have executed this License as of the date first above written. LICENSOR: LICENSEE: - -------------------------------- ------------------------------------ - -------------------------------- ------------------------------------ By: By: ----------------------------- --------------------------------- Name: Name: ------------------------ ---------------------------- Title: Title: ----------------------- ---------------------- By: By: ----------------------------- --------------------------------- Name: Name: ------------------------ ---------------------------- Title: Title: ----------------------- ---------------------- NOTICE ADDRESS: NOTICE ADDRESS: - -------------------------------- ---------------------------------- - -------------------------------- ---------------------------------- - -------------------------------- ---------------------------------- With a copy of notices to: The Irvine Company P.O. Box I Newport Beach, CA 92658-8904 Attn: V.P. Operations, Investment Properties Group EXHIBIT F To Lease 3 50 EXHIBIT G PRE-COMMENCEMENT REPAIR SCHEDULE SURVEY SUMMARIES =============================================================================== These findings are based upon information given to Insignia/ESG, Inc. and are a result of three diagnostic surveys conducted by; Mesa Energy Systems Inc., Ontario Refrigeration and Southland Industries. As a result the general condition of the equipment as well as a list of repairs is as follows: GENERAL INFORMATION The general appearance of the heating, ventilation and air conditioning (HVAC) units is good. In all HVAC units the P-Traps should be changed to J-Traps and the air conditioning (A/C) drain lines should be replaced with copper and properly supported. In a number of units, incompatible fuses have been installed and should be changed to the proper type. All inlet vanes and exhaust dampers need to be lubed and the linkages repaired or replaced. Some of the actuator motors need to be replaced. Also, the evaporator and condensing coils need to be cleaned but are in good condition for the age of the units. Some of the condensing coil fins are slightly deteriorating on the tope section of the coil. Existing problems with the units are space pressurization. The fan cycle controls switch must be repaired as necessary. All HVAC units require general clean up and maintenance. The refrigerant charge on each HVAC unit must be checked. All HVAC unit static controllers, fuses, conduits and linkages must be checked for proper operation and repaired or replaced as necessary. All Return Air/Outside Air Dampers and Actuators must be repaired or replaced as necessary. All Air Compressors, Circulation Pumps and Boilers require general maintenance and clean up. Each also requires chemical treatment and paint, as necessary. BUILDING NO. 1 Unit 1A 1. Condenser Fan Motor (1) - replace. 2. Inlet Guide Vane Actuator - defective linkage knuckle. 3. Fan Pressure Switch - replace. 4. Blower Motor Belts - replace. 5. Include replacement of minimum four contactors per unit. 6. Clean and coat condensate pan. =============================================================================== AST Research Engineering Survey Summary Page 1 51 SURVEY SUMMARIES (CONTINUED) =============================================================================== Unit 1B - ------- 1. Blower Motor Belts - replace. 2. Inlet Guide Vane Actuator - defective linkage knuckle; the current linkage has worn a 1/8" groove into the hollow section of the fan shaft. Replacement of fan shaft may be necessary. 3. Inlet Guide Vanes - frozen into one position due to lack of lubrication. 4. Mechanical Cooling - repair. 5. Include replacement of minimum four contactors per unit. 6. Clean and coat condensate pan. Unit 1C - ------- 1. Blower Motor Belts - replace. 2. Inlet Guide Vanes - frozen into one position due to lack of lubrication. 3. Condensate Drain - plugged with debris. 4. Include replacement of minimum four contactors per unit. 5. Clean and coat condensate pan. Unit 1D - ------- 1. Condenser Fan Motor (2) - replace. 2. Compressor (2) - possibly low on change. 3. Second Stage Compressor - replace to prevent it from failing. 4. Contactor Fuses Blower Belts - replace. 5. Include replacement of minimum four contactors per unit. 6. Clean and coat condensate pan. Unit 1F - ------- 1. Blower Motor Belts - replace. 2. Inlet Guide Vane Actuator - defective linkage knuckle. 3. Inlet Guide Vanes - frozen into one position due to lack of lubrication. 4. First Stage Compressor - circuit has a leak and is low on refrigerant; neutral wire has been removed. 5. Include replacement of minimum four contactors per unit. 6. Clean and coat condensate pan. =============================================================================== AST Research Engineering Survey Summary Page 2 52 SURVEY SUMMARIES (CONTINUED) =============================================================================== Unit 1F - ------- 1. Blower Motor Belts - replace. 2. Actuator Motor for Inlet Vane (Modutrol) - replace. 3. Inlet Guide Vane Actuator - defective linkage knuckle. 4. Inlet Guide Vanes - frozen into one position due to lack of lubrication. 5. Fan Cycle Pressure Switches (2510) and (2511) - replace. 6. Include replacement of minimum four contactors per unit. 7. Clean and coat condensate pan. Air Compressor - -------------- 1. Requires belts. 2. Requires service. Circulation Pump - ---------------- 1. Replace seal. Boiler - ------ 1. Air Vent Discharge - needs to be diverted. 2. Hoffman Air Vents (2) - recommended that the air vents located on the high points of the piping be replaced. 3. Boiler - replace metal hood. 4. Change pump seal. BUILDING NO. 2 Unit 2A - ------- 1. Linkages - connect all linkages and set for proper operation. 2. Actuator Motors - check for proper operation. 3. Include replacement of minimum four contactors per unit. 4. Clean and coat condensate pan. 5. Inlet Guide Vane Actuator - defective linkage knuckle. 6. Actuator Relief Damper Linkage - removed. 7. Clean and coat condensate pan. 8. Blower Motor Belt - replace. =============================================================================== AST Research Engineering Survey Summary Page 3 53 SURVEY SUMMARIES (CONTINUED) =============================================================================== Unit 2B - ------- 1. Compressor Contactors(2)-replace with 50 amp contactors. 2. Linkages-repair or replace. 3. Exhaust Damper Linkages and Inlet Vane-lube and adjust. 4. Condenser Fan Motor(1)-replace. 5. Inlet Guide Vane Actuator-defective linkage knuckle. 6. Relief Damper Actuator-replace. 7. Blower Motor Belt-replace. 8. Fan Cycle Switches (2510) and (2511)-replace. 9. Control Conduit-broken. 10. Actuator Relief Damper Linkage-removed. 11. Include replacement of minimum four contactors per unit. 12. Clean and coat condensate pan. Unit 2C - ------- 1. Second Stage Compressor-repair. 2. Inlet Guide Vane Actuator-defective linkage knuckle; missing crank arm. 3. Clean and coat condensate pan. 4. Dwyer Differential Pressure Transmitter-repair. 5. Fan Cycle Switch (2510)-replace. 6. Loose Control Wires-not landed. 7. Actuator Motor-check for proper operation. 8. Condenser Fan Motor(1)-replace. 9. Inlet Vanes-lube. 10. Blower Motor Belts-replace. 11. Linkage-repair or replace. 12. Evaporation Coil-check for leakage. 13. Replace contactors as necessary. Unit 2D - ------- 1. Blower Motor Belts-replace. 2. Replace contractors as necessary. 3. Clean and coat condensate pan. 4. Indoor Fan Section-large/loud vibration; replace barrings and repair. 5. Actuator Motor-check for proper operation; repair as necessary. =============================================================================== AST Research Engineering Survey Summary Page 4 54 SURVEY SUMMARIES (CONTINUED) =============================================================================== Air Compressor - -------------- 1. Belts and Pulleys - check. 2. Motor Base Plate - repair. 3. Lead-lag Setting - check. 4. Oil and Air Filters - recommend replacing. Circulation Pump - ---------------- 1. Coupler - replace. 2. Motor Shaft - realign. Boiler - ------ 1. Hot Water Pump Gasket - replace. 2. Expansion Tank HVAC Reheat System - no air gap. 3. Hot Water Pump - defective seal and relief valve (on the domestic hot water heater), which are both leaking. ================================================================================ AST Research Engineering Survey Summary Page 5 55 [INDEPENDENT ROOFING CONSULTANTS LETTERHEAD] June 12, 1998 Mr. Dick Salvi Broadcom 16251 Laguna Canyon Road Irvine, CA 92718 Reference: Site Investigation AST Buildings 1 & 3 16215 & 16205 Alton Parkway Irvine, CA IRC Project No. 12490.00 Dear Mr. Salvi: A Roof Inspection/Site Investigation was performed on the above referenced buildings on June 5, 1998. The intent of this roof inspection was to assess the existing roof conditions and note deficient conditions that could affect the performance of the roofing system. The observations made and deficient conditions noted during this inspection are documented in this report. BUILDING 1 1. The granular surfacing of the modified bitumen base flashing membrane was cracking. (Refer to Photographs #1 and #2.) The cracking was generally more severe on the South and East facing walls which are exposed to the heat of the sun for a longer period. The application of a reflective coating on the base flashing membrane could help deter or at least slow down further cracking. 2. The elastomeric sealant in the receiver lip of the surface mounted reglet along the parapet walls was cracked and had settled down allowing water to collect along the lip. (Refer to Photographs #3 & #4.) The entire length of the reglet should be resealed with new elastomeric sealant. 3. Isolated membrane blisters were noted. (Refer to Photographs #5 & #6.) A large membrane blister had formed along the edge of a drain sump. Large membrane blisters should be cut and repaired with a modified bitumen membrane. 56 AST Buildings 1 & 3 - Irvine, CA Broadcom Site Investigation - ------------------------------------------------------------------------------- 4. Dirt accumulation in the drain sumps was noted. (Refer to Photograph #7.) A general clean up should be performed on the roof. 5. The salvage edge of the modified bitumen base flashing membrane on the sides of the platform for the boiler unit was exposed as well as the nail heads. (Refer to Photograph #8.) The salvage edge should be coated with a reflective coating to prevent premature deterioration. 6. There were several tenant improvement pipe flashings that had been set and sealed with roof cement only. (Refer to Photographs #9 & #10.) An antenna stand was found screwed down through the roofing membrane and sealed with an elastomeric sealant. The pipe flashings should be stripped in with modified bitumen membrane to prevent them from being continuous maintenance items. 7. Within the equipment screen area, a puncture in the membrane that had gone through and exposed the underlying concrete deck was found beside an electrical junction box. (Refer to Photograph #11.) The puncture should be sealed with modified bitumen membrane. BUILDING 3 1. The granular surfacing of the modified bitumen base flashing membrane was cracking. (Refer to Photograph #12.) The cracking was generally more severe on the South and East facing walls and surfaces which are exposed to the heat of the sun for a longer period. The application of a reflective coating on the base flashing membrane could help deter or at least slow down further cracking. 2. The salvage edge of the modified bitumen base flashing membrane along the control joint was found exposed. (Refer to Photograph #13.) The salvage edge should be coated with a reflective coating. 3. The elastomeric sealant in the receiver lip of the surface mounted reglet along the parapet walls was cracked leaving the reglet wide open to water entry and had settled down allowing water to collect along the lip. (Refer to Photographs #14 & #15.) The entire length of the reglet should be resealed with new elastomeric sealant. 4. A tilt up wall panel joint with the concrete chipped and the sealant missing was found wide open on the East wall. (Refer to Photograph #16.) 5. A blister was noted in the base flashing membrane where the reglet was found with the sealant cracked and wide open to water entry. (Refer to Photograph #17.) The blister was probably caused by water entering through the open reglet and getting behind the base flashing membrane. Page 2 of 3 Independent Roofing Consultants (800) 666-7663 57 Broadcom AST Buildings 1 & 3 - Irvine, CA Site Investigation - -------------------------------------------------------------------------------- 6. A relief cut in the roofing membrane over a hump on the deck was not sealed and had started to open up. (Refer to Photograph #18.) The membrane cut should be sealed with a three-course application of elastomeric roof cement reinforced with fiberglass webbing and covered with an aluminum coating. 7. The top edge of a lead pipe flashing was found open to water entry with the cracking of the roof cement seal. (Refer to Photograph #19.) Several tenant improvement pipe flashings were found set in roof cement only. One such pipe flashing was found near the equipment screen door with its flange corner lifting and wide open to water entry. (Refer to Photograph #20.) 8. The platform for a compressor was blocking the water flow between the two air handling units and creating a ponding condition. (Refer to Photograph #21.) This area should be monitored closely. 9. Punctures in the roofing membrane were found along the step up transition between the roof deck and the concrete equipment pads inside the equipment screen area. (Refer to Photographs #22, #23 & #24.) The membrane punctures should be patched with a modified bitumen membrane. 10. A nail was found stepped into the roofing membrane beside the roof hatch. (Refer to Photograph #25.) 11. An open base flashing lap was observed on one side of the platform of the boiler unit. (Refer to Photograph #26.) This concludes the list of deficient conditions noted during this roof inspection. Should you have any questions concerning this report, please do not hesitate to contact me at your convenience. Sincerely, INDEPENDENT ROOFING CONSULTANTS /s/ TONY CANCIO - ----------------- Tony Cancio Consultant TC25 TC:sk Enclosures Independent Roofing Consultants Page 3 of 3 (800) 666-7663 58 EXHIBIT H ENTITIES EXCLUDED FROM PROJECT SIGNAGE Advanced Micro Devices (AMD) Alcatel C-Cube Globespan Level One LSI Logic Lucent Technologies Motorola National Semiconductor Philips Rockwell SGS Thompson Toshiba VSLI Technologies 59 EXHIBIT X INDUSTRIAL WORK LETTER DOLLAR ALLOWANCE The Tenant Improvement work (herein "Tenant Improvements") shall consist of any work, including work in place as of the date hereof, required to complete the Premises pursuant to the approved Working Drawings and Specifications (as hereinafter defined). All of the Tenant Improvement work shall be performed by a contractor mutually selected by Landlord and Tenant in accordance with the procedures and requirements set forth below. I. ARCHITECTURAL AND CONSTRUCTION PROCEDURES. A. Preliminary Plan. Tenant and Landlord have approved, or shall approve prior to the Estimated Space Plan Approval Date referenced in the Lease detailed space plan for the Premises, prepared by Beck Martin Architects who shall be engaged by Tenant ("Tenant's Architect") which includes interior partitions, ceilings, interior finishes, interior doors, suite entrance, floor coverings, window coverings, lighting, electrical and telephone outlets, plumbing connections, heavy floor loads and other special requirements ("Preliminary Plan"). B. Landlord's Review Responsibilities. Tenant agrees and understands the review of all plans pursuant to this Work Letter by Landlord is solely to protect the interest of Landlord in the Premises and Landlord shall not be the guarantor of, nor responsible for, the correctness or accuracy of any such plans or compliance of such plans with applicable laws. Tenant's administration/supervision fee described in Section II B below shall cover all of Landlord's cost incurred in approving the Preliminary Plan, Working Drawings and Specifications and Engineering Drawings. Landlord shall not receive any fee described for profit, overhead or general conditions in connection with the construction of the Tenant Improvements. C. Non-Standard Improvements. Except as specified in the Preliminary Plan or otherwise authorized by Landlord, the Tenant Improvements shall incorporate Landlord's building standard materials and specifications as shown on Schedule X-1 attached hereto ("Standards"). No deviations from the Standards shall be permitted, provided that Landlord may, in its sole and absolute discretion, authorize in writing one or more of such deviations if requested by Tenant ("Non-Standard Improvements"), in which event any excess cost of such deviations shall be part of "Tenant's Contribution" (as hereinafter defined) and Tenant shall be solely responsible for the cost of replacing same with the applicable Standard item(s) upon the expiration or termination of this Lease. Landlord shall in no event be required to approve any deviations from the Standards if Landlord determines that such improvement (i) is of a lesser quality than the corresponding Standard, (ii) fails to conform to applicable governmental requirements, (iii) requires building services beyond the level normally provided to other tenants, (iv) would delay construction of the Tenant Improvements beyond the Estimated Commencement Date and Tenant declines to accept such delay in writing as a Tenant Delay, or (v) would have an adverse aesthetic impact from the exterior of the Premises. D. Preparation And Approval of Working Drawings and Specifications. After the Preliminary Plan is finally approved by Landlord, Tenant shall submit to Landlord drawings prepared by the Tenant's Architect which shall be compatible with the design, construction and equipment of the existing building shell(s), comply with all applicable laws, be capable of logical measurement and construction, contain all such information as may be required for the construction of the Tenant Improvements and the preparation of the Engineering Drawings (as defined below), and contain all partition locations, plumbing locations, HVAC requirements and duct work, and ceiling plans. Such Working Drawings and Specifications must incorporate the Standards and approved Non-Standard Improvements. The Working Drawings and Specifications may be submitted in one or more stages and at one or more times, and the time periods for Landlord's approval shall apply with respect to each such portion submitted. Landlord shall approve the Working Drawings and Specifications, or such portion as has from time to time been submitted, within five (5) days after receipt of same or designate by notice given within such time period to Tenant the specific changes reasonably required to be made to the Working Drawings and Specifications in order to correct any design problem. Tenant's Architect shall make the changes necessary in order to correct any such design problem and shall return the Working Drawings to Landlord, which Landlord shall approve or disapprove within three (3) days after Landlord receives the revised Working Drawings and Specifications. This procedure shall be repeated until all of the Working Drawings and Specifications are finally approved by Landlord and written approval has been delivered and received by Tenant. E. Preparation and Approval of Engineering Drawings. After the Working Drawings and Specifications are finally approved by Landlord, Tenant shall submit to Landlord, for Landlord's review and approval, engineering drawings showing complete mechanical, electrical, plumbing, HVAC ("Engineering Drawings"). Engineering Drawings may be submitted in one or more stages and at one or more times, and the time periods for Landlord's approval shall apply with respect to each such portion submitted. Landlord shall approve the EXHIBIT X 1 60 Engineering Drawings, or such portion as has from time to time been submitted within five (5) days after receipt of same or designate by notice given within such time period to Tenant specific changes reasonably required to be made to the Engineering Drawings in order to correct any design problem. Tenant shall make the changes necessary in order to correct any such design problem and shall return the Engineering Drawings to Landlord, which Landlord shall approve or disapprove within three (3) days after Landlord receives revised Engineering Drawings. This procedure shall be repeated until the Engineering Drawings are finally approved by Landlord and written approval has been delivered to and received by Tenant. The Final Cost Estimate submitted by Landlord's Contractor shall reflect both the Working Drawings and Specifications and the Engineering Drawings as integrated by Tenant's Architect into the Working Drawings and Specifications. F. Selection of Landlord's Contractor. Landlord's Contractor shall be the contractor selected pursuant to a procedure whereby the Working Drawings and Specifications and a construction contract approved by Tenant are submitted to three (3) contractors, selected by Tenant from a list approved by Landlord who are requested to each submit a sealed fixed price contract bid price (on such contract form as prepared by Landlord and approved by Tenant) to construct the Tenant Improvements designated on the Working Drawings and Specifications, to Landlord and Tenant, who shall jointly open and review the bids. After adjustments for the inconsistent assumptions to reflect an "apples to apples" comparison, Landlord and Tenant shall select the qualified lowest priced bidder and such contractor with the qualified lowest priced bid ("Landlord's Contractor") shall enter into a construction contract with Landlord consistent with the terms of the bid to construct the Tenant Improvements ("Construction Contract"). The Construction Contract shall not, unless Tenant otherwise directs, require the Landlord's Contractor to post a completion bond, but shall provide a provision penalizing the Landlord's Contractor for not completing the Tenant Improvements within a specific period of time for reasons other than Tenant Delays. G. Changes. In the event that Tenant requests in writing a revision in the approved Working Drawings and Specifications ("Change"), Landlord shall advise Tenant by written change order as soon as is practical of any increase in the Completion Cost and/or any Tenant Delay such Change would cause. Tenant shall approve or disapprove such change order in writing within two (2) days following its receipt from Landlord. Tenant's approval of such Change shall be conditioned upon by Tenant's payment of any such increase in the Completion Cost. Landlord shall have the right to decline Tenant's request for a Change for any of the reasons set forth in Paragraph C above for Landlord's disapproval of a Non-Standard Improvement. It is understood that Landlord shall have no obligation to interrupt or modify the Tenant Improvement work pending Tenant's approval of a change order. H. Tenant Delays. Notwithstanding any provision in the Lease to the contrary, if Tenant fails to comply with any of the time periods specified in this Work Letter, fails otherwise to approve or reasonably disapprove any submittal within five (5) days, fails to approve in writing the Preliminary Plan for the Tenant Improvements by the Plan Approval Date, fails to provide the Working Drawings and Specifications or requests any Changes, furnishes inaccurate or erroneous specifications or other information, or otherwise delays in any manner the completion of the Tenant Improvements (including without limitation by specifying materials that are not readily available) or the issuance of an occupancy certificate (any of the foregoing being referred to in this Lease as a "Tenant Delay"), then Tenant shall bear any resulting additional construction cost or other expenses, and the Commencement Date of this Lease shall be deemed to have occurred for all purposes, including Tenant's obligation to pay rent, as of the date Landlord reasonably determines that it would have been able to deliver the Premises to Tenant but for the collective Tenant Delays. In no event, however, shall such date be earlier than the Estimated Commencement Date set forth in the Basic Lease Provisions. Should Landlord determine that the Commencement Date should be advanced in accordance with the foregoing, it shall so notify Tenant in writing. Landlord's determination shall be conclusive unless Tenant notifies Landlord in writing, within five (5) days thereafter, of Tenant's election to contest same by arbitration with JAMS Endispute in Orange County, California. Pending the outcome of such arbitration proceedings, Tenant shall make timely payment of all rent due under this Lease based upon the Commencement Date set forth in the aforesaid notice from Landlord. I. Early Entry. Landlord shall permit Tenant and its agents to enter the Premises prior to the Commencement Date of the Lease in order that Tenant may perform any work to be performed by Tenant hereunder through its own contractors, subject to Landlord's prior written approval, and in a manner and upon terms and conditions and at times satisfactory to Landlord's representative. The foregoing license to enter the Premises prior to the Commencement Date is, however, conditioned upon Tenant's contractors and their subcontractors and employees working in harmony and not interfering with the work being performed by Landlord. If at any time that entry shall cause disharmony or interfere with the work being performed by Landlord, this license may be withdrawn by Landlord upon twenty-four (24) hours written notice to Tenant. That license is further conditioned upon the compliance by Tenant's contractors with all requirements imposed by Landlord on third party contractors, including without limitation the maintenance by Tenant and its contractors and subcontractors of workers' compensation and public liability and property damage insurance in amounts and with companies and on forms satisfactory to Landlord, with certificates of such insurance being furnished to Landlord prior to proceeding with any such entry. The entry shall be deemed to be under all of the provisions of the Lease except as to the covenants to pay rent. Landlord shall not be liable in any way for any injury, loss EXHIBIT X 2 61 or damage which may occur to any such work being performed by Tenant, the same being solely at Tenant's risk. In no event shall the failure of Tenant's contractors to complete any work in the Premises extend the Commencement Date of this Lease beyond the date that Landlord has completed its Tenant Improvement work and tendered the Premises to Tenant. J. Walk-Through. After the Tenant Improvements to the Premises are substantially completed (excepting punch list items) and prior to the Commencement Date, Landlord shall cause Landlord's Contractor to inspect the Premises with the Tenant's representative and complete a punch list of unfinished or incorrect items of the Tenant Improvements. Authorized representatives for the Landlord and Tenant shall execute said punch list to indicate their approval thereof. The items listed on such punch list shall be completed by the Landlord's Contractor within thirty (30) days after the approval of such punch list or as soon thereafter as reasonable practicable. Landlord shall clean the Premises prior to the Commencement Date, including removal of all rubbish and debris. Such cleaning shall leave the Premises in a manner consistent with the commencement of business from comparable premises in the Irvine Spectrum. K. Tenant's Representative. Tenant hereby designates Richard Salvi, Telephone No. (949) 450-8700, as its representative, agent and attorney-in-fact for the purpose of receiving notices, approving submittals and issuing requests for Changes, and Landlord shall be entitled to rely upon authorizations and directives of such person(s) as if given directly by Tenant. Tenant may amend the designation of its construction representative(s) at any time upon delivery of written notice to Landlord. II. COST OF TENANT IMPROVEMENTS A. Landlord shall complete, or cause to be completed, the Tenant Improvements, at the construction cost shown in the Final Cost Estimate (subject to the provisions of this Work Letter), in accordance with final Working Drawings and Specifications approved by both Landlord and Tenant. Landlord shall pay towards the final construction costs ("Completion Cost") as incurred a maximum of Two Million Two Hundred Eighty-Three Thousand Seven Hundred Forty-Four Dollars ($2,283,744.00) ("Landlord's Contribution"), based on $16.00 per square foot of the Premises, and Tenant shall be fully responsible for the remainder ("Tenant's Contribution"). Landlord's Contribution shall only be used for construction and installation of Standards incorporated into a Preliminary Plan, except as otherwise specifically approved by Landlord and for other costs outlined below. Landlord shall pay or reimburse Tenant as part of Landlord's Contribution within fifteen (15) days after receipt of invoices from Tenant costs incurred by Tenant in connection with preparation of Tenant's preliminary space plan be up to a maximum amount of Twenty-Two Thousand Eight Hundred Fifty-Three Dollars ($22,853.00) based on Fifteen Cents (.15) per rentable square foot of the Premises. B. The Completion Cost shall include all costs of Landlord in completing the Tenant Improvements in accordance with the approved Working Drawings and Specifications, including but not limited to the following: (i) payments made to architects, engineers, contractors, subcontractors and other third party consultants in the performance of the work, (ii) salaries and fringe benefits of persons, if any, in the direct employ of Landlord performing any part of the construction work, (iii) permit fees and other sums paid to governmental agencies, and (iv) costs of all materials incorporated into the work or used in connection with the work. The Completion Cost shall also include an administrative/ supervision fee to be paid to Landlord or to Landlord's management agent in the amount of two and one-half percent (2 1/2%) of all such costs. C. Prior to start of construction of the Tenant Improvements (the "Start Date"), Tenant shall pay to Landlord forty percent (40%) of the amount of the Tenant's Contribution as set forth in the Final Cost Estimate and the balance shall be paid as follows: (i) An additional thirty percent (30%) of the Final Cost Estimate shall be paid to Landlord on or before the date which is thirty (30) days after the Start Date; (ii) An additional twenty percent (20%) of the Final Cost Estimate shall be paid to Landlord on or before the date which is sixty (60) days after the Start Date; (iii) The balance together with any increase because of modifications or extras not reflected on the approved Working Drawings and Specifications, or because of Tenant Delays, shall be due and payable upon completion of any punchlist corrective work but not later than forty-five (45) days after the Commencement Date for such Building. If Tenant defaults in the payment of any sums due under this Work Letter, Landlord shall (in addition to all other remedies) have the same rights as in the case of Tenant's failure to pay rent under the Lease. EXHIBIT X 3 62 Schedule X-1 Standards BROADCOM CORPORATION TENANT IMPROVEMENT INTERIOR CONSTRUCTION Revised 7/27/98. INTERIOR PARTITIONS: 2 1/2", 25 Ga. metal studs at 24" oc to underside of ceiling. Gyp. bd. to be 5/8" Type X both sides taped smooth and paint ready. 1-HOUR CORRIDORS: 1-hr. corridors to be gyp. bd. tunnel configuration with gyp. bd. clg. or as indicated in plans. 1 HOUR WALLS: 2 1/2", 25 Ga. metal studs at 24" oc to underside of floor or roof structure above. Gyp. bd. to be 5/8" Type X both sides with smooth finish and paint ready to 6" above ceiling. PAINT: All walls painted washable flat finish, color to be selected be Tenant. CARPET: Designweave - carpet to be selected $12.00 per yard budget. Carpet to be direct glue down Broadloom. Corridors will be different than office interiors carpet. Boardroom, Executive offices and Executive lobby to be up graded over pad. SPECIAL FLOORS: Labs, Tester and Telephone Rooms 12" x 12" Vinyl tile ESD manufactured by either: 3M 8433 Series, Marley Flexco or Forbo Colorex. VINYL COMPOSITION FLOORS: Electric rooms, lunch, copy, coffee rooms, shipping and storage rooms. Mannington Essentials 12" x 12" vinyl composition tile or Armstrong Premium Excelon 12" x 12" Color to be determined. BASE: 2 1/2" Burke or Roppe rubber base coved throughout. Color to coordinate with carpet, flooring or door trim. CEILING: Armstrong Cortega 2' x 4' with 15/16" T-bar grid (match existing to be verified). Note: Existing Ceiling and grid to be reused. Repair and or replace all damaged or stained tiles. Add compression struts if not present. "See special note for building B cafeteria ceiling. 63 -2- WINDOW COVERING: Levelor Riviera Horizontal Miniblinds. Color to match existing. Provide new blinds to match existing where walls connect to exterior window mullions. DOORS: Doors to match existing 3' x 8' x 1 3/4" solid core white ash plain sliced with Maple stain. Doors in Executive Office to match existing 3' x 8'-10". Include an allowance for cleaning and refinishing existing doors. DOOR HOLD OPEN: Provide smoke activated magnetic door hold open at corridor doors leading into rated lobbies as indicated on plan. DOOR HARDWARE: Hardware to match existing Schlage D Series Rhodes in chrome finish 625 with lock sets. Key way to match Irvine Co. standard. Existing Timely door frames to be refinished to match new. Additional Door frames to match existing Timely Steel, Prefinished black 2D Gauge. Use 4 1/2" square corner hinges chrome finish. Ratings as required. OFFICE SIDELIGHTS: Sidelights at all office doors, to be 24" w x 8'0" tall tempered glass integrated into door frame 2 1/2" AFF to bottom jamb (below jamb to receive topset base -- 2 1/2"). FIRE EXTINGUISHERS AND CABINETS: Fire Extinguisher Cabinets with extinguisher 2A-10BC min. semi-recess painted every 75' of travel. Match existing Potter Roerner. MILLWORK: Coffee and Break Area (see plan for lineal footage): Upper and lower plastic laminate cabinets with 4" polished chrome wire pulls. Stainless steel sink with disposal and insta-hot water. Provide water line to Refrigerator (by tenant) with in-line filter. Copy Areas: Upper and lower plastic laminate cabinets with 4" polished chrome wire pulls. All laminate colors to be selected by tenant and approved by landlord. ELEVATOR: Replace wall panels with new plastic laminate. Replace existing rail to 1 1/2" diameter brushed stainless steel. 64 -3- ELECTRICAL: LIGHTING: Use existing fixtures where possible: 2 x 4 w/prismatic lens. New lights to match existing as needed. 2 X 4 Fluorescent; 3 lamp energy-saving ballasts with prismatic lens as needed. Double switch per Title 24, paired in double ganged box, white plastic cover, 42" AFF to switch centerline. Relamp all lights including soffit and downlights. Clean lenses and replace any unmatched lenses with acrylic prismatic type to match existing. Install 2 lights per typical office on switch with Timeclock shut-off and override. OUTLETS: Each office will draw approximately 9 amps from anticipated equipment. Power: 15 amp 125 volt specification grade duplex receptacle mounted vertically, 18" AFF to centerline, white plastic coverplate. Telephone: Single gang box with mud ring and pull string, mounted vertically, 18" AFF to centerline, white coverplate cable by tenant. LAB ELECTRICAL REQUIREMENTS: 8' AFF 8" wide wiring cable tray, ladder type, suspended from ceiling. Provide two trays the length of the room min. with two cross connections. Provide separate circuit breaker panels per lab as required. Provide grounded bus bar along two main walls in all labs and Tester Lab. Quad outlets at 6' on center on walls and in tray rated at 80 amps 2 per circuit. No circuit sharing outside lab. Testers (6) require 480v, 60 amp connections each with dedicated panel. Provide (1) 220V AC receptacle in each lab for Test Equipment. Provide dedicated panel for each Lab. SPECIAL ITEMS, BUILDING SPECIFIC: 3 STORY, BUILDING A: Add recessed paper towel/trash receptacle in each restroom to match existing. Remove door and case opening at 2nd door leading into restrooms for HC accessibility. Remove raised floor and in-fill with compacted sand (or other) and 4" concrete slab with #3 rebar at 24" E.W. dowel into existing slab. Refinish lobby wood veneer as needed to match existing. Refinish Zolotone wall above reception. Reception Counter: Add corian counter at back to match existing. Repair/replace ceramic tile at elevator lobby. 65 -4- 2 STORY BUILDING B: Replace ceiling grid 2' x 4' and tiles in cafeteria seating area: Armstrong Fine fissured 2nd Look II angled tegular with Armstrong 15/16" T-bar to match existing. Replace with T-bar to match existing. Serving area and kitchen: Armstrong Clean room VL non-perforated 2' x 2', 2' x 4' in kitchen with new grid. Replace sheet vinyl in serving area and kitchen with similar sheet vinyl spec. Replace plastic laminate surfaces on cabinets in serving area. Fabricate and install wrought iron fencing to match adjacent building, at North East Corner between columns with exit door and electrical for point of connection for process equipment hook up. Replace lavatory counter in women's shower. Replace sheet vinyl with 12 x 12 VCT Armstrong in Men's and Women's shower. Install 9' tall x 20' long mirror on gym wall. Replace 4 Blue floor tiles in lobby with red. Add 2 shower stalls in men's locker with stalls to match existing (Handicap accessibility to be verified). 66 EXHIBIT Y [DRAWING] Pie shaped property on corner of Laguna Canyon Road and Alton Parkway. Three buildings (A, B, C) in campus environment surrounding center courtyard area. EX-23.1 4 CONSENT OF INDEPENDENT AUDITORS 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the reference to our firm under the caption "Experts" and to the use of our reports dated January 16, 1998, except for Note 9, as to which the date is March 31, 1998 and Note 7, as to which the date is September 25, 1998 in the Registration Statement (Form S-1) and related Prospectus of Broadcom Corporation to be filed on September 30, 1998. /s/ Ernst & Young LLP Orange County, California September 29, 1998 -----END PRIVACY-ENHANCED MESSAGE-----