-----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, MjUO7QX6WX3hGckzD9lR6JxvxlXaR5kApsmZMnnu9jKq7xlGDvrLeOUIuuu7loKa 8OEXQFiLs/hM0u4sQDSFvA== 0000891020-98-001421.txt : 19980929 0000891020-98-001421.hdr.sgml : 19980929 ACCESSION NUMBER: 0000891020-98-001421 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980630 FILED AS OF DATE: 19980928 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERLINQ SOFTWARE CORP CENTRAL INDEX KEY: 0000802242 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-PREPACKAGED SOFTWARE [7372] IRS NUMBER: 911187540 STATE OF INCORPORATION: WA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-21402 FILM NUMBER: 98716091 BUSINESS ADDRESS: STREET 1: 11255 KIRKLAND WAY CITY: KIRKLAND STATE: WA ZIP: 98033 BUSINESS PHONE: 2068271112 MAIL ADDRESS: STREET 1: 11255 KIRKLAND WAY CITY: KIRKLAND STATE: WA ZIP: 98033 10-K 1 FORM 10-K FOR PERIOD ENDED JUNE 30, 1998 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 --------------------- FORM 10-K --------------------- (Mark One) [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended JUNE 30, 1998 OR [ ] Transition report pursuant to Section 14 or 15(d) of the Securities Exchange Act of 1934 COMMISSION FILE NUMBER 0-21402 INTERLINQ SOFTWARE CORPORATION (Exact name of registrant as specified in its charter) WASHINGTON 91-1187540 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 11255 KIRKLAND WAY KIRKLAND, WA 98033 (Address of principal executive offices) (425) 827-1112 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant, based upon the closing sale price of the Common Stock on September 22, 1998 as reported on the Nasdaq National Market, was approximately $26,569,000. As of September 22, 1998, there were 5,121,777 shares of the Registrant's Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the Company's definitive proxy statement for the annual meeting of shareholders of the Company to be held on November 10, 1998, which will be filed with the Securities and Exchange Commission within 120 days after June 30, 1998 are incorporated by reference into Part III of this report. ================================================================================ 2 PART I ITEM 1. BUSINESS OVERVIEW INTERLINQ Software Corporation ("the Company") was founded in Washington in 1982 and over the last sixteen years has developed, marketed and sold software for the mortgage lending industry. Through the 1998 fiscal year the Company concentrated on this industry as a leading business solutions provider to approximately 2,000 banks, savings institutions, mortgage banks, mortgage brokers, and credit unions. Pursuant to a purchase and sale agreement dated June 30, 1998, the Company acquired substantially all the assets and business of Logical Software Solutions Corporation ("LSS"), in a transaction accounted for using the purchase method of accounting. This acquisition included certain technology including FlowMan version 3.2 ("FlowMan"). FlowMan is an award-winning enterprise software application that integrates disparate systems and applications in order to facilitate ongoing process knowledge management by applying its business process and rules technology across an entire enterprise. In connection with this acquisition, the Company formed the Enterprise Technology Division ("ETD") and reorganized the Company's existing mortgage software business into the Mortgage Technology Division ("MTD"). The Company intends to continue to develop the FlowMan product internally and expects to release version 4.0 in the latter half of fiscal year 1999. The Company expects this version will offer significant enhancements over the current product and will be capable of integration with current MortgageWare products. MORTGAGE TECHNOLOGY DIVISION OVERVIEW Through its Mortgage Technology Division, the Company works closely with clients to provide comprehensive software applications and business solutions for the residential mortgage and construction lending industry. MTD offers a suite of products, MortgageWare Enterprise, that manages the entire life cycle of a mortgage loan. MortgageWare Enterprise is designed to provide greater operational efficiency, real-time access to data, and a cost-effective means for managing and integrating information. It is designed to allow mortgage lenders to improve business processes and practices, thereby improving profitability. MortgageWare Enterprise creates an integrated system of reliable information for business analysis; data is entered only once, managed from a central point, and accessible from every desktop licensed to utilize MortgageWare Enterprise. MortgageWare Enterprise can perform a wide variety of mission critical enterprise tasks, including matching loan programs for lenders and borrowers, originating and servicing mortgage loans and risk analysis of all loans within an organization. As of June 30, 1998, MortgageWare products had been installed and were currently supported by the Company for approximately 2,000 financial institutions. The Company's target market is the approximately 34,800 financial institutions in the United States, Puerto Rico and the Virgin Islands. According to Company estimates based on available industry data, this market is comprised of approximately 20,000 mortgage banks and brokers, 9,000 banks, 4,000 credit unions and 1,800 savings institutions. 2 3 The Company intends to generate future revenue growth within the MTD from the sale of mortgage loan servicing technology and products designed to provide customers with better information access and content. This growth is expected to complement the Company's current products, which address operational efficiency in order to decrease the cost of the mortgage loan cycle. In the near term, further penetration of the loan production market and the mortgage loan servicing market (along with additional sales of products and support services to existing customers with its current products) is expected to provide the majority of the Company's revenue. The Company has planned releases of new products and upgrades to existing products targeted for fiscal 1999. In addition, the Company plans to integrate the new FlowMan product into MortgageWare TC and MortgageWare Loan Servicing during the latter half of the 1999 fiscal year. STRATEGY The Company's strategy with respect to the MTD is to strengthen and leverage its position as a leading technology provider in the mortgage industry. This strategy includes extending the scope of the Company's easy-to-use, PC--based offerings, in order to help customers shape their business activities through the use of technology and information. The Company is supported in this strategy by a strong base of recurring revenue from long-term customer relationships and the activities of a direct sales force. Easy-to-Use Software The Company believes its customers require software solutions that are specifically designed for financial institutions and that are easy to use and support. Because the residential mortgage and construction lending processes are complex and many of these processes are performed by individuals with little computer experience. The Company's strategy is to provide software solutions that can be easily installed and used. In order to provide consistent, high-quality support and service, the Company does not create customized software; however, it does provide customized integration of MortgageWare Enterprise and has, from time to time, upgraded its products with certain customers on a "pay for priority" basis. Product upgrades, nevertheless, often include modifications and enhancements requested by customers. PC Platform The Company believes that reductions in the cost of and increases in the computing power of PCs make its systems increasingly affordable for all financial institutions. The Company's software runs on industry-standard PCs and networks, thereby providing power, flexibility, ease of use and distribution of workload at a price that the Company believes cannot be matched by minicomputer or mainframe solutions. It is the Company's belief that the underlying trend in computing price to performance will increasingly favor applications based on the Windows/Intel environment on which the Company's products run. Direct Sales Force The Company believes that industry specific expertise and knowledge are required to sell its products, and therefore, it employs a direct sales force. The Company retains sales personnel who it believes are skilled in both residential mortgage and construction lending, as well as PC-based software applications. The Company believes that maintaining its own sales force allows it to develop long-term customer relationships. 3 4 Long-term Customer Relationships The Company attempts to build long-term relationships with its customers by providing them with personal contact from management, training and implementation, and continuing services (such as consulting, toll-free telephone support and participation in user groups). The Company regularly uses an outside research firm to monitor customer satisfaction as well as industry-based survey research to stay abreast of industry needs. The Company believes that its focus on the customer and the industry strengthens its recurring revenue opportunities and decreases the possibility of customer attrition to competitive products by maintaining its responsiveness to changing customer demands. PRODUCTS AND SERVICES The Company believes the strength of its MTD lies in its ability to provide customers with an integrated approach to originating, servicing, and analyzing loans. The Company offers a variety of products for strategic and tactical business solutions in the mortgage industry, including the MortgageWare Loan Management System and MortgageWare(R)TC, MortgageWare for Brokers, MortgageWare MarketLINQ(R), MortgageWare InvestorLINQ(TM),MortgageWare Entre(TM), MortgageWare InfoLINQ(TM), MortgageWare Loan Servicing(TM), and BuilderBLOCK$(TM). Together, these technology tools make up the MortgageWare Enterprise -- designed to provide a means for greater operational efficiency enterprise-wide, faster access to information, and cost-effective management of information content. The following table briefly describes INTERLINQ's MortgageWare Enterprise products: POINT-OF-SALE AND ORIGINATION Entre Loan officers prequalify applicants in the field through the use of a Windows-based software that runs on a laptop computer Origination Loan officers enter loan applications directly into a PC, either in the office or in the field MORTGAGE LOAN MANAGEMENT SYSTEM (LMS) AND MORTGAGEWARE TC Qualifying Allows quick assessment of a potential borrower's ability to qualify for a loan Processing Handles loan application data entry, document tracking and database maintenance Closing Produces closing documents, including jurisdiction-specific promissory notes and mortgages or deeds of trust Settlement Enables a lender or settlement agent to manage checking accounts, print checks and report IRS data Tracking Produces management reports designed to meet each customer's particular needs MortgageWare Provides brokers with a scaled-down version of the for Brokers MortgageWare LMS designed to meet their specific needs for product and pricing SECONDARY MARKETING MarketLINQ Serves as a central point of data entry and maintenance for all mortgage loan programs and rates, providing automatic distribution enterprise-wide 4 5 LOAN SERVICING Loan Servicing Provides lenders with a complete and cost-effective Windows-based loan servicing solution Servicing Gateway A streamlined version of Loan Servicing designed for lenders holding loans for sale CONSTRUCTION LENDING BuilderBLOCK$ Provides ability to service and report essential components of a construction loan ANALYSIS AND COMMUNICATIONS InfoLINQ Provides mortgage lenders with a complete intranet-based environment in which to collect, extract, and distribute business analysis COMLINQ Handles inter-branch electronic communications for MortgageWare software MortgageBase Enables customers to access their MortgageWare database from FoxPro, convert files into an xbase format and print more sophisticated reports Interfaces Utilizing SmartLINQ technology, customers can interface with other products and systems. Interfaces include Fannie Mae's MortgageLINKS, Fannie Mae's Desk Top, Freddie Mac Loan Underwriter and the M&I interface MortgageWare Entre. Provides loan officers or brokers ("Originators") with tools to tailor loan programs, enabling better customer service and more expedient completion of each loan application. In order to improve communication between Originators in the field and the processing department, MortgageWare Entre is designed to increase accuracy, timeliness, and back-office tracking of each loan. The Company believes that MortgageWare Entre gives mortgage originators a competitive advantage by enabling them to quickly prequalify borrowers for purchases and refinances, show side-by-side comparisons of different loan programs, take the loan application, give the borrower conditional loan approval on the spot, and produce professional-looking open-house flyers. In addition, MortgageWare Entre provides the ability to order risk grade evaluation and mortgage insurance through Freddie Mac's Loan Prospector Second Generation, and the ability to request underwriting directly from Fannie Mae. Additionally, this Windows-based system includes a contact manager for efficient follow-up. MortgageWare TC and MortgageWare Loan Management System. MortgageWare TC and MortgageWare Loan Management System are modular systems for residential mortgage loan management that address qualifying, point-of-sale origination, processing, closing, settlement, pipeline tracking and management, and inter-branch electronic communications. MortgageWare TC, the thin-client version of the MortgageWare Loan Management System, has been designed to reduce network traffic, improve performance, simplify hardware requirements and reduce exposure to network-related problems. These systems can also receive tiered pricing from MarketLINQ, so that lenders can compare actual locked interest rates against rate sheet data. This "intelligent" system directs and streamlines the flow of work throughout a company, supporting the transition from individual workflow to an organizational workflow that boosts efficiency across the entire enterprise. MortgageWare TC utilizes a 32-bit Windows client-server architecture. 5 6 MortgageWare MarketLINQ. A Windows--based product, MortgageWare MarketLINQ serves as a central point of data entry and maintenance for all mortgage loan programs and rates including tiered pricing, which allows an administrator to electronically distribute up-to-date information enterprise-wide on demand. This program ensures that data is entered into the system only one time--whether it's being used for in-house purposes or by a loan officer working to obtain the best interest rate for a borrower. Direct links into Knight-Ridder and Dow Jones Telerate enables the pricing for loan programs to be efficiently managed and rapidly recalculated as changes in mortgage pricing occur (often multiple times daily). MortgageWare MarketLINQ utilizes a 32-bit architecture. MortgageWare Loan Servicing System. The Company believes that its MortgageWare Loan Servicing enhances a customer's profitability by offering an alternative to service bureau and mainframe-based servicing. MortgageWare Loan servicing is offered at a competitive price that provides true economic benefit to customers. In addition, it provides the benefit of having full access to the loan servicing information. This allows loan servicers to gain both a cost and an information advantage. MortgageWare Loan Servicing utilizes a 32-bit Windows client-server architecture, coupled with advanced information features that automate and manage business events for a loan servicer. Servicing Gateway. A streamlined version of Loan Servicing, Servicing Gateway is an abbreviated, low-cost product designed specifically for those lenders holding loans for sale. Using Servicing Gateway they can collect payments and account for interest paid without the cost of a full servicing operation. BuilderBLOCK$. For construction lending, BuilderBLOCK$ offers a Windows-based system that simplifies and streamlines the management of construction loans. This construction lending product offers an alternative to manual or spreadsheet calculations. The product enables users to automatically prepare Forms 1099 and 1098, enter draw requests, track inspections and print checks. Key features include the automation of IRS reporting for both suppliers and borrowers; the ability for lenders to compare the percentage of building completion against the percentage of funds disbursed to date; and the maintenance of a historical record of all transactions by supplier and contractor. The system is designed to provide quick and easy entry of inspection data; one screen captures information for all loans, and the information is then automatically transferred to each individual loan. MortgageWare InfoLINQ. MortgageWare InfoLINQ integrates all of INTERLINQ's products to create the synergy of the MortgageWare Enterprise business model. InfoLINQ provides mortgage lenders with an intranet-based environment in which to collect, extract, and distribute business information. Data for the automated creation and distribution of real-time business reports and analyses is accessible to users throughout the enterprise through easy-to-use browser-based desktops. MortgageWare InfoLINQ utilizes a 32-bit architecture. InfoLINQ allows users to access up-to-date information via a customizable "desktop" that is similar to a Web site thereby reducing the need to commit resources towards the collection and analysis of loan data. InfoLINQ automatically distributes information to each desktop based on what company information is relevant to each user's job. Information is captured and provided either on a real-time or a periodic basis, depending on the needs of the users. Users can tailor their desktops to most efficiently review the information they want to track, helping them to 6 7 quickly respond to changes in the market, optimize profitability and speed the process of researching and analyzing the entire mortgage business. Other MortgageWare Information Management Tools. The Company has developed and expects to continue to develop products that it believes speed up the cycle of mortgage loan creation. Other mortgage technology products offered by the Company include: COMLINQ. INTERLINQ's electronic communications system is designed to provide a fast, yet easy, method of transferring MortgageWare data between headquarters, branch offices and origination systems. MortgageWare MultiTrac. Multi-tasking capabilities have been added to MortgageWare Loan Management System and MortgageWare TC via MultiTrac, thereby providing users with the ability to multi-task and access numerous loan applications without interrupting in-progress activities. New Products/Modules Under Development MortgageWare InvestorLINQ. InvestorLINQ refers to managing the risk of financial loss in the origination and subsequent selling of mortgage loans. InvestorLINQ helps secondary marketing departments maximize profits from the sale of loans in the secondary market, by providing pipeline information to price loan products and hedge their position. Integration of FlowMan. During fiscal year 1999 the Company plans to integrate its newly acquired FlowMan technology into MortgageWare TC and MortgageWare Loan Servicing. This is expected to further broaden the capabilities and benefits of these packages and further strengthen the MortgageWare Enterprise. Complementary Products and Services The Company provides training, implementation services and consulting services to assist its customers in the use of its software. These services are typically performed at the customer's location and are tailored to meet the customer's needs. Customers may also attend regional training seminars or consult one of the Company's regionally based trainers for individual assistance. Electronic forms and custom electronic documents necessary in the loan production process are available to customers through a special marketing agreement with CBF Systems, Inc., VMP Mortgage Forms Division ("VMP"). Under this agreement, customers are introduced to these products by the Company's direct sales force. Responsibility for producing, maintaining compliance, and shipping documents to customers is held by VMP. The Company receives a portion of the revenue collected by VMP. The Company also sells laser fonts and font cartridges and provides laser logo services. The Company has developed interfaces to Fannie Mae's Mornet product and Freddie Mac's Midanet product, which facilitate loan delivery once a loan is closed. In addition, the Company has developed several programs to export servicing data to loan servicing systems for its customers. 7 8 Customer Service and Support INTERLINQ believes that excellent customer service is vital to its success and future growth. For many customers, the MortgageWare Enterprise products become critical to their daily operations. Accordingly, customers rely on the Company for continued support and enhancement of its products. Customers who buy licenses to use the Company's products under its purchase option also purchase an annual support contract. Regular feedback on the quality of customer service is an integral part of the Company's customer service strategy. The Company employs an independent research firm that calls each customer at least once a year to determine customer satisfaction. The reports are used by the Company to monitor its procedures to enhance customer satisfaction. In addition, the Company has advisory panels for each of its products. Advisory panels consist of customers who are chosen to be representative of the Company's diverse, mortgage lending, customer base. As a subset to the advisory panels, the Company holds annual focus group meetings to obtain information and feedback on specific cross-product issues. Currently, there are focus groups for regulatory compliance, loan processing, secondary marketing, closing/settlement, portable origination and loan servicing. The Company has a Major Account Services group to serve the needs of its largest customers. As of June 30, 1998, 48 of its customers were included in the program. The Major Account Services staff acts as liaison for each major account customer, following up on issues and setting priorities for system enhancements. With this program, the Company believes that it can better address the needs of its largest customers and improve overall service for all its customers. PRODUCT DEVELOPMENT The MortgageWare Enterprise continues to evolve, with input from many sources, including customers who submit software enhancement request forms suggesting corrections or enhancements, as well as the advisory panels for each product. The Company also maintains a database of all product support calls, which provides feedback to its Product Development Department. The Company has organized its Product Development Department into teams working on products or closely related groups of products. These teams include personnel with experience in product analysis, software engineering, research and technology, quality assurance, and product marketing. Their objective is to ensure that all products meet the Company's standards. Employees on these teams are selected for their skills in mortgage lending, software development and marketing. The Company examines new technologies and platforms on an ongoing basis to determine their potential benefits to customers. The Company currently develops products using Windows NT, Windows 95 and DOS operating systems, ODBC compliant database options (SQL Server(TM) and MS Access(TM)) Web browser-based interfaces and thin-client technology, and Visual C++, ActiveX programming tools on a PC network. Currently, MortgageWare Loan Management System runs on Windows platforms and uses licensed technology to run on the DOS operating system and on major PC networks. Other products, such as MortgageWare TC, MortgageWare Entre, MortgageWare Loan Servicing, MortgageWare MarketLINQ, Servicing Gateway and BuilderBLOCK$ all run under the Windows operating system. 8 9 During fiscal year 1999, the Company plans to integrate FlowMan into MortgageWare TC and MortgageWare Loan Servicing. This is expected to further broaden the capabilities and benefits of these packages and further strengthen the MortgageWare Enterprise. SALES AND MARKETING The Company employs a direct sales force in its MTD because it believes that considerable expertise is required to sell its mortgage technology products and that strong customer relationships are key to its success. The Company's direct sales force consists of a national sales manager and sales executives. These personnel are supported by sales administration and inside sales representatives. As of June 30, 1998, the Company employed 11 sales executives and one national sales manager located throughout the country who are each responsible for an assigned geographic territory. Certain sales representatives are exclusively devoted to sales of the Company's servicing products. Sales executives are expected by the Company to maintain relationships with existing customers and are responsible for the generation of new business and expansion of existing business. Sales administration representatives handle contracts and other administrative details, while inside sales representatives qualify sales leads, setting appointments for sales executives, and managing much of the sales follow-up. Sales leads are generated through various sources, including magazine advertising, industry databases, trade shows, purchased lists, direct mail, telemarketing, customer referral and membership in various trade organizations. The Company tracks lead sources to determine the most cost-effective use of its promotional budget. The Company offers an unconditional, 60-day, money-back guarantee on most of its mortgage-related software products. To date, it has not experienced significant returns under this guarantee. Licensing Options To attract and retain a wide diversity of customers in the residential mortgage lending industry, the Company has developed three licensing options for its products: Purchase Option. Under this option, customers may purchase a standard non-exclusive software license to use its products. The Company offers financing for the purchase option and, for an additional annual fee, provides product support services. Approximately 95% of the MTD's customers select the purchase option and the additional support services. Partnership Plan Option. Under the Partnership Plan option, customers pay an initial commitment fee, plus a monthly fee based upon the number of loan applications entered into the system. The Partnership Plan option includes the MortgageWare Loan Management System software and software support and is targeted to customers who are unwilling or unable to make the capital commitment associated with the purchase option. Rental Option. Because customers may not wish to commit to the purchase option or the Partnership Plan option, the Company created a limited-capacity version of the MortgageWare Loan Management System software for brokers that is available on a monthly rental plan. 9 10 CUSTOMERS The Company's mortgage technology customer base is geographically diverse and covers a broad range of sizes and types of financial institutions. MortgageWare products are installed and currently supported for approximately 2,000 customers in 50 states plus Puerto Rico, Guam, and the U.S. Virgin Islands. As of June 30, 1998, this customer base was comprised of approximately 750 mortgage brokers and bankers, 650 banks, 500 credit unions and 100 savings institutions. In fiscal year 1998, no single customer accounted for more than 4% of the Company's net revenues. COMPETITION The market for mortgage-related software products is highly competitive. The Company competes with software vendors offering integrated financial services packages, software consultants and value-added resellers who deliver custom or customized software products, in-house management information services and programming resources of some of the Company's larger existing and potential customers, as well as software vendors offering specialized products for the mortgage lending industry. The Company believes the main competitive factors include price, operating platform compatibility and customer support. Some competitive products cost significantly less than MortgageWare software, and price-sensitive buyers tend to choose these products. Many competitors market competing products on mainframe, mini-computer and PC platforms with a wide array of pricing and have significantly greater financial, technical, marketing and sales resources than the Company; some offer financial services products not offered by the Company. The Company believes it is the leading provider of PC-based software for residential mortgage lending solutions. In addition to the Company's current competitors, there are many companies involved in providing software and related services to segments of the financial services industry other than residential mortgage lending. Because of similarities both in the customer base and the types of products and services provided by these other companies compared to those of the Company, these companies are potential competitors of the Company. There is no assurance that the Company would be successful in competing against these potential competitors, should any of them decide to enter the Company's market. MORTGAGE LENDING REGULATIONS The residential mortgage lending industry is subject to a variety of government regulations, including the Equal Credit Opportunity Act, the Truth-in- Lending Act, the Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act, which prohibit discrimination and require the disclosure of certain basic information to borrowers concerning credit terms and settlement costs. Additionally, there are various federal, state and local laws and regulations that govern mortgage lending activities, including consumer protection and usury statutes. Entities engaged in making and selling mortgage loans are often subject to the rules and regulations of one or more of the investors, guarantors and insurers of residential mortgage loans, including the Federal Housing Authority, the Veteran's Administration, Fannie Mae, Freddie Mac and the Government National Mortgage Association. These agencies regulate the origination, processing, underwriting, selling, securitizing and servicing of mortgage loans, prohibit discrimination, establish underwriting guidelines, provide for inspections and appraisals, require credit reports on prospective borrowers and fix maximum loan amounts and interest rates. 10 11 Failure to comply with these laws and regulations could lead to a lender's loss of approved status, termination of its servicing contracts without compensation, demands for indemnification or loan repurchase, class action lawsuits and administrative enforcement actions. Should loan production processes or documentation arising from use of the Company's products result in a customer's violation of such requirements, such customer, or the government authority whose requirements were not met, might claim that the Company is responsible, which could have an adverse effect upon the Company and its reputation in the mortgage lending industry. On October 2, 1995 the Company entered into an agency and compliance delegate agreement with CBF Systems, Inc, VMP Mortgage Forms Division (VMP). Under the terms of this agreement VMP assumes compliance responsibility for all documents sold by and through the Company. ENTERPRISE TECHNOLOGY DIVISION OVERVIEW Through its Enterprise Technology Division, the Company intends to enter the Enterprise Application Integration ("EAI") market by marketing FlowMan through OEMs, system integrators and third-party application developers. FlowMan is an award-winning technology that integrates disparate systems and applications in order to facilitate ongoing process knowledge management, by applying its business process and rules technology across an entire enterprise. FlowMan is designed to coordinate the execution and timing of all tasks, events and decisions for key business processes across legacy systems, enterprise applications, client-server systems and Internet technologies. The Company expects sales of FlowMan to begin in the first half of fiscal year 1999. The Company's target markets for FlowMan include the EAI market as well as a variety of vertical markets (such as healthcare, insurance, government, transportation and utilities, etc.). EAI technologies attempt to integrate applications at the business process level rather than at the data level. The Company believes that FlowMan enables reusability of integration techniques and processes across departments and environments and allows users to implement application integration and reengineer processes without extensive user knowledge or training in the specific underlying technologies. The Company also believes that software providers in vertical markets can use FlowMan as an integration/workflow toolkit or component to enhance their products' functionality and architecture. STRATEGY The Company's strategy with respect to the ETD is to establish FlowMan as a leading technology in the EAI and workflow market contributing to overall Company growth and diversification by providing access to markets outside of the mortgage lending industry. The Company plans to establish partnerships with industry experts with the required knowledge and skills to compete both as an enterprise solutions provider within the EAI market and as a leader in certain vertical markets. Enterprise Application Integration & Workflow Market The EAI market is a new and growing marketplace, which according to some industry analysts could reach $1 billion within a few years. This large, new and growing marketplace provides the Company access to both a much larger technology market and business opportunity. In addition, the Company believes a need exists in numerous vertical markets 11 12 (such as healthcare, insurance, government, transportation and utilities, etc.) for an application integration/workflow technology that can be used to enhance existing and development stage products. The Company believes that these markets offer a significant business opportunity for the Company. Although demand for EAI software products has grown in recent years, the EAI market is still an emerging market. The Company's future financial performance will depend in large part on continued growth in the number of organizations adopting EAI computing environments and the number of applications developed for use in those environments. There can be no assurance that the market for EAI software will continue to grow. If the EAI software market fails to grow or grows more slowly than the Company currently anticipates, the Company's business, operating results and financial condition would be materially adversely affected. Indirect Sales Channel The Company believes that successful companies in the EAI market will be those that develop relationships with other experts in the field who have either specific software and hardware expertise in the EAI market and/or specialized industry knowledge in particular vertical markets. The Company plans to develop partnerships with key software and solution providers to jointly offer EAI solutions or integrated/workflow-enabled products. As such, the marketing and sales efforts primarily will be made through OEMs, system integrators and third-party application providers. There can be no assurance that the Company will be able to attract OEMs, system integrators and third-party application providers that will be able to market the Company's products effectively and will be qualified to provide timely and cost-effective customer support and service. In addition, the Company anticipates that its agreements with OEMs, system integrators and third-party application providers will not be exclusive and many of the Company's OEMs, system integrators and third-party application providers may carry competing product lines. Therefore, there can be no assurance that any OEM, system integrator or third-party application provider will be dependable in representing the Company's products, and the inability to recruit, or the loss of important OEMs, system integrators or third-party application providers could adversely affect the Company's results of operations. In addition, if it is successful in selling products through these channels, the Company expects that any material increase in the Company's indirect sales as a percentage of total revenue will adversely affect the Company's average selling prices and gross margins due to the lower unit prices that the Company receives when selling through indirect channels. PRODUCTS AND SERVICES FlowMan FlowMan is comprised of an enterprise application framework, engineering tools and a user interface. The enterprise application framework manages and controls transactions throughout the enterprise allowing collaboration between application components. The framework serves as a communication "pipeline" throughout the enterprise. The framework core elements, the business process engine, business rules engine and component interface, allow abstraction of the process model and business rules from third-party and legacy applications and technology components such as imaging, forms, DBMS and other products connected into the FlowMan framework. This tight integration results in one common enterprise-wide system, protects the 12 13 organization's technology investment and removes the need to mandate standard enterprise components in favor of a best-of-breed approach. FlowMan also provides flexibility through rapid implementation and modification of the enterprise technology framework. Applications can be added, removed, or replaced by other application components in a plug-and-play fashion. The interface layer of the FlowMan framework provides a means for the easy integration of each component into the overall enterprise framework allowing interoperability between applications and across the enterprise. FlowMan has won numerous awards over the past several years, including: - 1998 AIIM Process Innovation Award - 1998 GIGA Silver Award - 1997 GIGA Gold Award - 1996 GIGA Merit Award - 1995 and 1996 CIPA Winning Solutions Provider Complementary Products and Services Depending on the sales channel, the Company either provides training and support to the channel partner or the end user (if it is a direct sale). Additionally, the Company offers consulting services, which may include a combination of a workshop to educate the customer on the business process engine, the physical integration of FlowMan with disparate systems and applications, and training on the setup and ongoing use of the technology. Customer Service and Support For many customers, the Company expects that FlowMan will become critical to their daily operations. Accordingly, customers will rely on the Company for continued support and enhancement of its products. The Company expects that customers who buy licenses to use FlowMan products under the Company's purchase option will typically purchase an annual support contract. Depending on the sales channel and partner agreement, the support contract is made with the customer's OEM, system integrator, reseller or directly through the Company. PRODUCT DEVELOPMENT The Company is committed to enhancing the FlowMan technology to ensure that it maintains its recognition as a leading, award-winning and innovative technology. Flowman version 4.0, anticipated for commercial release during the second half of fiscal year 1999, will offer significant enhancements over version 3.2, including three-tier architecture for expanded scalability, Component Object Model (COM) technology, object-oriented methodology and ActiveX controls. FlowMan version 4.0 will be deployable across distributed network environments. The EAI software market is characterized by rapid technological change, frequent new product introductions and evolving industry standards. The introduction of products embodying new technologies and the emergence of new industry standards can render existing products obsolete and unmarketable. The Company's future success in this market will depend upon its ability to enhance its current products and to develop and introduce new products on a timely basis that keep pace with technological developments and emerging industry standards and address the increasingly sophisticated needs of its customers. There can be no assurance that 13 14 the Company will be successful in developing and marketing product enhancements or new products that respond to technological change or evolving industry standards, that the Company will not experience difficulties that could delay or prevent the successful development, introduction and marketing of these products, or that its new products and product enhancements will adequately meet the requirements of the marketplace and achieve market acceptance. If the Company is unable, for technological or other reasons, to develop and introduce new products or enhancements of existing products in a timely manner in response to changing market conditions or customer requirements, the Company's business, operating results and financial condition will be materially adversely affected. SALES AND MARKETING The Company employs an indirect sales channel with respect to its ETD because it believes that partnerships with experts and industry leaders will be necessary to create a leveraged business model. Channel development and sales leads are generated through various sources, including industry databases, trade shows, purchased lists, direct mail, telemarketing, customer referral and membership in various trade organizations. The Company tracks lead sources to determine the most cost-effective use of its promotional budget. CUSTOMERS The Company currently has 20 end-user installations of FlowMan. This customer base is industry and geographically diverse including customers in healthcare, insurance, government, education, transportation and utilities. COMPETITION The EAI software market is intensely competitive and subject to rapid change. Competitors vary in size and in the scope and breadth of the products and services offered. The majority of these companies are interested in providing specialized services or products to complement true EAI provider's products. Some suppliers are contending for position as full-fledged EAI software system providers. These include IBM and New Era of Networks among others. The Company believes the main competitive factors include price, operating platform compatibility, ease of implementation and use, and customer service. Some competitive products cost less than the Company's software, and price- sensitive buyers tend to choose those products. Increased competition is likely to result in price reductions and reduced gross margins which could materially adversely affect the Company's business, operating results and financial condition. Many of the Company's current and potential, competitors have significantly greater financial, technical, marketing and other resources than the Company; some offer complementary products not offered by the Company. As a result, they may be able to respond more quickly to new or emerging technologies and changes in customer requirements, or to devote greater 14 15 resources to the development, promotion and sale of their products than the Company can. There can be no assurance that the Company will be able to compete successfully against current and future competitors or that competitive pressures faced by the Company will not materially adversely affect its business, operating results and financial condition. GENERAL CORPORATE INFORMATION INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS The Company regards its software as proprietary and essential to its business. The Company relies primarily on a combination of copyright, trademark and trade secret laws, employee and third-party nondisclosure agreements, license agreements and other intellectual property protection methods to protect its proprietary technology. The Company received a patent covering part of the FlowMan technology in September of 1998, which will expire in April 2015. There has been frequent litigation in the computer industry regarding intellectual property rights. There can be no assurance that third-parties will not in the future claim infringement by the Company with respect to current or future products, trademarks or other proprietary rights. Any such claims could be time-consuming, result in costly litigation, cause diversion of management's attention, cause product release delays, require the Company to redesign its products or require the Company to enter into royalty or licensing agreements. These royalty or licensing agreements, if required, may not be available on terms acceptable to the Company, or at all, any of which occurrences could have a material adverse effect upon the Company's business, financial condition and results of operations. MANUFACTURING The principal materials used in the Company's products include computer diskettes and documentation. The manufacturing process includes the development and testing of software by the Company, plus the production of a master copy for duplication. The Company contracts with an outside source for all disk duplication for major product releases and updates. Accompanying documentation, which is minimal since most documentation is on-line, is created by the Company and sent to an outside source to be reproduced. The Company generally ships products within a few business days after receipt of an order. Normally the Company has little or no backlog, but has experienced occasional backlogs. At June 30, 1998, the Company's backlog was not material. CERTAIN ADDITIONAL FACTORS AFFECTING FUTURE RESULTS There is no assurance that the Company will be successful in attracting new customers in the mortgage technology market, or that its existing customers will continue to purchase its products and support services. In addition, there is no assurance that the Company's new mortgage technology products and services will be released in a timely fashion and that, if and when released, new products or services or its efforts to integrate its FlowMan product into its existing mortgage software products will be well received by its target market or that others will not successfully develop competing products and services. Each of these events could have a material adverse effect upon the Company's revenues, financial condition, and results of operations. There is no assurance that the Company will be successful in attracting new customers in the EAI market, or that its existing customers will continue to purchase its products and support services. In addition, there is no assurance that FlowMan 4.0 15 16 will be released in a timely fashion or that, if and when released, it will be well received by its target market or that others will not successfully develop competing products and services. Each of these events could have a material adverse effect upon the Company's revenues, financial condition, and results of operations. Expansion of the Company's operations in the EAI software market will require significant additional expenses and capital and could strain the Company's management, financial and operational resources. Furthermore, there can be no assurance that the Company's experience and leadership in the mortgage-related software market will benefit the Company as it enters new markets, and gross margins attributable to new business areas may be lower than those associated with the Company's existing business activities. There can be no assurance that the Company will be able to expand its operations in a cost-effective or timely manner. Furthermore, any new business launched by the Company that is not favorably received by consumers could damage the Company's reputation or the INTERLINQ brand. The lack of market acceptance of such efforts or the Company's inability to generate satisfactory revenues from such expanded services or products to offset their cost could have a material adverse effect on the Company's business, prospects, financial condition and results of operations. The Company is unable to accurately estimate unit sales of its products and the volume of annual support contracts that its customers will purchase due in general to the nature of the software markets, and specifically to the cyclical and volatile nature of the residential mortgage lending market, and the development stage of the EAI market. In early 1994, the residential mortgage lending market experienced a reduction in mortgage refinance volumes due to a rise in interest rates. The Company experienced a significant decrease in net revenues, operating income and net income during the fourth quarter of fiscal 1994 which continued through most of fiscal year 1995. During fiscal years 1998 and 1997, in part due to the increase in mortgage lending and refinance volumes, the Company has seen increases in revenues, operating income and net income. EMPLOYEES As of August 31, 1998, the Company employed 154 people, including 36 in sales and marketing, 53 in product development, 41 in customer service and 24 in operations. None of the Company's employees is represented by a labor union, and the Company believes that its relationship with its employees is good. 16 17 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company, as of September 25, 1998, are as follows:
NAME AGE POSITION ---- --- -------- Jiri M. Nechleba 40 President and Chief Executive Officer Stephen A. Yount 41 Executive Vice President - Enterprise Technology Division, Chief Financial Officer and Secretary Patricia R. Graham 45 Executive Vice President, Mortgage Technology Division
JIRI M. NECHLEBA has been President and Chief Executive Officer since September 11, 1995. From 1993 through August, 1995, he served as Senior Vice President and General Manager of SolutionWare, a subsidiary of A.C. Nielsen, a division of Dun & Bradstreet, and a provider of information systems to the consumer packaged goods industry. From 1985 to 1993, Mr. Nechleba was an independent management consultant to a variety of industries. Mr. Nechleba holds two Bachelor of Science degrees from the Massachusetts Institute of Technology. STEPHEN A. YOUNT has been Executive Vice President - Enterprise Technology Division, Chief Financial Officer and Secretary of the Company since July 1, 1998. Prior to this position he was the Vice President-Finance, Chief Financial Officer and Secretary since October 1991. Additionally, upon the resignation of the Company's President and Chief Executive Officer, Robert M. Delf in January, 1995, Mr. Yount was appointed Interim President by the Board of Directors. He continued in this capacity until the hiring of Jiri Nechleba as President and Chief Executive Officer on September 11, 1995. During 1991, Mr. Yount held a temporary position with PF Industries & Acrotech, Inc., an aerospace company, where he served as Chief Financial Officer. From 1989 to 1991, Mr. Yount was the President and Chief Financial Officer of PacSoft Incorporated, a civil engineering software firm. Mr. Yount earned a CPA certificate in 1982 and holds a BA in Business Administration from the University of Washington. PATRICIA R. GRAHAM has been Executive Vice President-Mortgage Technology Division since July 1, 1998. Prior to her promotion, Ms. Graham was Vice President -- Sales and Marketing since March 25, 1996. From 1990 to 1995, she served in various capacities with A.C. Nielsen Co., a subsidiary of Dun & Bradstreet, including executive vice president. From 1981 to 1990 she was employed by Information Resources, Inc. and departed holding the position of Senior Vice President. Ms. Graham holds a Masters degree in Political Science from Rutgers University. 17 18 ITEM 2. PROPERTIES The Company is currently subleasing and occupying approximately 46,000 square feet of office space in Kirkland, Washington. This sublease expires in November 1998 and does not contain a renewal option. The Company has entered into a seven year agreement to lease approximately 35,000 square feet of office space in Bellevue, Washington. The Company believes that its new facilities will be adequate for its needs through the end of fiscal year 1999. ITEM 3. LEGAL PROCEEDINGS The Company is not party to any litigation that would have a material adverse effect on the Company or its business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of fiscal year 1998. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock has traded on the Nasdaq National Market under the symbol INLQ since April 27, 1993. The Company had 2,312 shareholders as of September 22, 1998, based on computations including participants in security positions listings, as defined by Rule 17Ab-8 of the Exchange Act. Presented below are quarterly closing stock price ranges as reported on Nasdaq National Market for the periods indicated.
HIGH LOW ------------- ------------ Fiscal year ended June 30, 1998 Fourth quarter $7.50 $4.50 Third quarter 5.50 3.88 Second quarter 4.75 3.75 First quarter 4.63 3.50 Fiscal year ended June 30, 1997 Fourth quarter $4.13 $3.63 Third quarter 6.00 3.75 Second quarter 5.50 3.50 First quarter 4.50 3.38
The Company has never paid dividends on its Common Stock. The Company intends to retain future earnings for use in its business and therefore does not anticipate paying dividends in the foreseeable future. There is no assurance that the Company will ever pay dividends on its Common Stock. On June 30, 1998, the Company issued 233,334 shares of Common Stock in connection with the acquisition of substantially all the assets and business of LSS. No underwriters were used and the recipient of the shares of Common Stock was LSS, which subsequently distributed the shares to its shareholders. The shares were not registered under the Securities Act of 1933, as amended, pursuant to the exemption set forth in Section 4(2) thereof. All recipients of shares of the Company's Common Stock possessed a sufficient level of financial sophistication and received or had access to information about the Company. The shares issued in the transactions are subject to restrictions on transfer absent registration under the Securities Act, and no offers to sell the securities were made by any form of general solicitation or general advertisement. 18 19 ITEM 6. SELECTED FINANCIAL DATA
Years Ended June 30, 1998 1997 1996 1995 1994 -------- -------- -------- -------- -------- (In thousands except per share data) STATEMENTS OF OPERATIONS DATA: Net revenues: Software license fees $ 9,647 $ 7,055 $ 6,232 $ 4,314 $ 11,438 Software support fees 6,976 6,073 5,773 5,483 4,707 Other 1,723 1,239 1,088 1,196 2,344 -------- -------- -------- -------- -------- Total net revenues 18,346 14,367 13,093 10,993 18,489 -------- -------- -------- -------- -------- Cost of revenues: Software license fees 1,778 1,500 1,653 1,424 1,244 Software support fees 2,445 1,856 1,678 1,788 2,062 Other 859 683 589 642 1,014 -------- -------- -------- -------- -------- Total cost of revenues 5,082 4,039 3,920 3,854 4,320 -------- -------- -------- -------- -------- Gross profit 13,264 10,328 9,173 7,139 14,169 -------- -------- -------- -------- -------- Operating expenses: Product development 1,609 2,147 2,060 1,123 891 Sales and marketing 5,675 4,011 4,230 4,244 5,801 General and administrative 3,754 3,152 3,010 3,404 3,278 Purchase of in-process R&D 3,615 _____ _____ _____ _____ Other general expenses - nonrecurring _____ _____ _____ 952 _____ -------- -------- -------- -------- -------- Total operating expenses 14,653 9,310 9,300 9,723 9,970 -------- -------- -------- -------- -------- Operating income (loss) (1,389) 1,018 (127) (2,584) 4,199 Net interest and other income 745 719 811 676 322 -------- -------- -------- -------- -------- Income (loss) before income taxes and cumulative effect of change in accounting principle (644) 1,737 684 (1,908) 4,521 Income taxes 907 627 251 (780) 1,532 -------- -------- -------- -------- -------- Income (loss) before cumulative effect of change in accounting principle (1,551) 1,110 433 (1,128) 2,989 Cumulative effect of change in accounting principle _____ _____ _____ _____ (109) -------- -------- -------- -------- -------- Net income (loss) $ (1,551) $ 1,110 $ 433 $ (1,128) $ 2,880 ======== ======== ======== ======== ======== PER SHARE DATA: Net income (loss)-- basic $ (.30) $ .19 $ .07 $ (.19) $ .51 -------- -------- -------- -------- -------- Net income (loss)-- diluted $ (.30) $ .19 $ .07 $ (.19) $ .45 -------- -------- -------- -------- -------- Shares used to calculate net income (loss) -- basic 5,213 5,707 5,965 5,831 5,635 Shares used to calculate net income (loss)-- diluted 5,213 5,842 6,171 5,831 6,471 BALANCE SHEET DATA: Cash, cash equivalents and investments $ 13,908 $ 13,831 $ 14,218 $ 14,373 $ 14,585 Working capital 8,150 11,623 12,823 13,638 13,753 Total assets 24,153 21,067 22,321 21,609 23,838 Total shareholders' equity 14,599 16,050 17,771 17,338 18,703
19 20 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL MORTGAGE TECHNOLOGY Prior to the mid-1980s, mortgage loans in the United States were originated in a manual and paper-intensive process. Then, beginning in the mid-1980s and running through the mid-1990s, the mortgage lending industry implemented its first wave of automation with PC-based software solutions for mortgage originations. During this period of time, the Company experienced rapid revenue and customer growth by providing its MortgageWare(R) Loan Management System - a robust, full-featured and cost-effective PC-based software solution. This first wave of automation was accelerated and amplified from 1992 to early 1994 as mortgage interest rates reached historically low levels and mortgage refinance volumes soared. Then, in early 1994, the Federal Reserve raised interest rates, which immediately caused mortgage refinance volumes to plummet. As a result, lenders found themselves with excess labor and mortgage processing capacity. During the remainder of 1994 and for most of 1995, the Company believes that the industry was focused more on staff reduction than adding new automated loan management systems. Beginning in fiscal year 1996, and continuing into fiscal years 1997 and 1998, mortgage lending rates have reflected a lending environment that has experienced a high degree of volatility. In spite of this volatility, the overall lending conditions have been considered favorable for the borrower compared to most historical measures. With this overall favorable lending environment, mortgage lending activity has increased, driven by an increase in financing of home sales and refinancing of existing mortgages. During the last half of fiscal year 1997, the Company began to observe a shift in the mortgage origination business. There appeared to be excess production capacity coupled with a reduced profit margin. Over the 1998 fiscal year, it appears that most of this excess production capacity has been fulfilled, yet profit margins continue to be low. During the fiscal year ended June 30, 1998, the Company experienced increased license fees due to a combination of lenders once again needing additional production capacity and the immediate acceptance of MortgageWare(R)TC by existing and new customers. Looking forward, the Company believes that due to continued lower profit margins, its customers are shifting their long-term purchasing decisions to solutions that reduce unit costs and, accordingly, increase profit margins, rather than solely increasing production capacity. During fiscal years 1996 and 1997, the Company focused its product development effort to provide a more diverse and integrated "enterprise" solution for the mortgage lending industry. It is the Company's belief that this broader enterprise solution has positioned the Company well for this recent change in the mortgage lending industry and has contributed to the increases in software license revenues. This broader product offering focuses more on reducing the cost of originating, processing, and servicing a mortgage, than on solely increasing production capacity. ENTERPRISE TECHNOLOGY Pursuant to a purchase and sale agreement dated June 30, 1998, the Company acquired substantially all the assets and business of Logical Software Solutions Corporation ("LSS"), in a transaction accounted for using the purchase method of accounting. This acquisition included the LSS technology and specifically FlowMan(R) version 3.2. Since this transaction was consummated on the last day of the 1998 fiscal year and was accounted for using the purchase method of accounting, the operations of the acquired company are 20 21 included beginning on June 30, 1998. As a result of the purchase, the Company recorded a charge of $3,615,304 for the purchase of in-process research and development. This acquisition resulted in the formation of two INTERLINQ divisions - the Mortgage Technology Division ("MTD") and the Enterprise Technology Division ("ETD"). The Company has a two-prong strategy with regard to this acquisition. In the first prong, the Company intends to integrate the FlowMan product with the Company's MortgageWare(R) Enterprise product suite. This is expected to further broaden the Mortgage Technology Division's product offering and strengthen the commitment of the Company to enterprise solutions. In the second prong, the Company intends to enter the Enterprise Application Integration ("EAI") market by marketing FlowMan on a "stand alone" basis, primarily through OEMs, system integrators and third-party application developers. The Company believes that the product can be sold as an application package into other vertical markets and as a toolkit for use by other application providers. The Company believes that the EAI marketplace is in its early stages and will grow significantly over the next few years. This two-prong strategy is intended to provide growth and diversification for INTERLINQ, while allowing the Company to continue to expand and excel in its core market of mortgage technology. NET REVENUES
(In thousands) 1998 Increase 1997 Increase 1996 ------- ------- ------- ------- ------- Software license fees $ 9,647 37% $ 7,055 13% $ 6,232 Software support fees 6,976 15% 6,073 5% 5,773 Other 1,723 39% 1,239 14% 1,088 ------- ------- ------- ------- ------- Total net revenues $18,346 28% $14,367 10% $13,093 ======= ======= ======= ======= =======
Net revenues consist of software license fees, software support fees, and other revenues (which include training fees, consulting fees, custom document fees and other miscellaneous sales), net of discounts and sales returns. Software license fees increased by 37% for fiscal year 1998 compared to fiscal year 1997, and increased by 13% for fiscal year 1997 compared to fiscal year 1996. The increase in software license fees in fiscal year 1998 compared to fiscal year 1997 was primarily due to a combination of the overall favorable lending conditions discussed above as well as sales of the Company's newer products which make up the MortgageWare Enterprise. The Company continued to experience increasing sales of its flagship product MortgageWare Loan Management System, as well as the new thin client version, MortgageWare TC (released in fiscal year 1998). In addition, sales volume increased for products such as MortgageWare Loan Servicing, MortgageWare InfoLINQ(TM), and MortgageWare MarketLINQ(TM), all of which were released during fiscal year 1997. In addition, sales of MortgageWare Entre(TM) (released in fiscal year 1996) continued to increase. The increase in software license fees in fiscal year 1997 compared to fiscal year 1996 was primarily due to a combination of the overall favorable lending conditions discussed above, which increased software license fees for previously developed products, and software license fees for products released in that year. 21 22 Software support fees increased by 15% for fiscal year 1998 compared to fiscal year 1997, and by 5% for fiscal year 1997 compared to fiscal year 1996. These year-to-year increases reflected a combination of a modest number of new customer additions and an increase in the volume of software licenses sold to new and existing customers, offset slightly by a low but fairly constant attrition rate in the installed customer base. Due in part to changes, from time to time, in government regulations applicable to documentation required for residential mortgage lending, the vast majority of the Company's customers purchase annual software support agreements. However, because software support fees are recognized ratably over the term of the annual support agreement, whereas software license fees are recognized on product shipment, the percentage increase in software support fees compared to software license fees is not directly proportional. The Company believes that due to higher expected software license fees and higher support fees charged on MortgageWare TC and MortgageWare Loan Servicing, that software support fees are likely to continue to increase at a modest rate in fiscal year 1999. Other revenues increased by 39% for fiscal year 1998 compared to fiscal year 1997, and by 14% for fiscal year 1997 compared to fiscal year 1996. The increase in other revenues in fiscal year 1998 compared to fiscal year 1997 was primarily due to increases in training revenues and consulting fees. The Company sold two significant consulting engagements during the 1998 fiscal year, which accounted for the majority of the consulting revenue. The increase in other revenues in fiscal year 1997 compared to fiscal year 1996 was primarily due to an increase in on-site training fees. This increase in training fees was primarily due to an increase, beginning in the first quarter of fiscal year 1997, in the daily fee charged for on-site training. Additionally, the document fees from the marketing agreement with VMP Electronic Laser Forms increased substantially in fiscal year 1997 compared to fiscal year 1996. Because training is usually purchased with the Company's software, the Company expects training fees to increase as software license fees increase (although not proportionately). Additionally, the Company expects consulting fees to increase during fiscal year 1999 due primarily to increases in demand for MortgageWare Loan Servicing (which can require higher levels of customization and implementation services than the Company's other mortgage technology products) and the expected customization and implementation services that will be sold with FlowMan. Looking forward, the Company anticipates an increasing contribution to software license fees, and related increases to software support fees and other revenues, from its newer products, MortgageWare Loan Servicing, MortgageWare InfoLINQ, and MortgageWare MarketLINQ. The Company also anticipates a contribution to software license fees, and related increases to software support fees and other revenues, from FlowMan, acquired through the LSS acquisition as discussed above. Since the acquisition of LSS was made at the end of the fiscal year, there were no sales of this product or revenues recorded in the Company's statement of operations for fiscal year 1998. The Company believes that sales of FlowMan will begin in the first half of fiscal year 1999; however, as the Company will be spending significant resources developing an indirect sales channel for FlowMan, the majority of the sales will occur in the latter half of fiscal year 1999. As discussed above, the Company believes the overall lending environment to be favorable as of the end of fiscal year 1998. Nonetheless, there can be no assurance that mortgage lending rates will not increase or experience a high degree of volatility. Such increases or volatility could have a material adverse effect on the Company's revenues, profitability, and financial condition. Even if lending rates stabilize, if such rates are perceived as being too high, homeowners and potential homeowners may delay decisions that would otherwise result in mortgage lending transactions. Such delays may have an adverse effect upon the Company's customers, and upon the Company and its operations. The Company is just entering the EAI marketplace, which is a relatively new, constantly changing 22 23 and intensely competitive market. In addition, many of the Company's competitors in this market have longer operating histories, greater name recognition, and significantly greater financial, technical and marketing resources than the Company. There is no assurance that the Company's products will be accepted by the market or that the Company will be competitive within the market, which would have a material adverse effect on the Company's revenues, profitability and financial condition. In addition, the Company believes that while the U.S. economy has been generally strong in fiscal year 1998, changes in economic conditions could have a material adverse effect on the Company's revenues, profitability and financial condition. COST OF REVENUES
Increase (In thousands) 1998 Increase 1997 (Decrease) 1996 -------- --------- -------- ----------- -------- Software license fees $1,778 19% $1,500 (9)% $1,653 Percentage of software license fees 18% _____ 21% _____ 27% Software support fees 2,445 32% 1,856 11% 1,678 Percentage of software support fees 35% _____ 31% _____ 29% Other 859 26% 683 16% 589 Percentage of other revenues 50% _____ 55% _____ 54% Total cost of revenues $5,082 26% $4,039 3% $3,920 Percentage of total net revenues 28% _____ 28% _____ 30%
Cost of software license fees consists primarily of the amortization of capitalized software development costs and, to a lesser extent, the purchase and duplication of disks and product documentation. As a percentage of software license fees, cost of software license fees decreased to 18% for fiscal year 1998 compared to 21% for fiscal year 1997, and decreased to 21% for fiscal year 1997 compared to 27% for fiscal year 1996. The decrease for fiscal year 1998 compared to fiscal year 1997 was due primarily to revenues increasing at a rate substantially faster than cost of software license fees. The decrease for fiscal year 1997 compared to fiscal year 1996 was primarily due to a combination of software license fees increasing and the cost of software license fees decreasing. The dollar amount of the cost of software license fees increased by 19% from $1.50 million in fiscal year 1997 to $1.78 million in fiscal year 1998. This dollar increase was primarily the result of higher amortization of capitalized software development costs for MortgageWare Loan Servicing and MortgageWare Entre, offset by a decrease in amortization for MortgageWare Loan Management System. The dollar amount of cost of software license fees decreased 9% to $1.50 million for fiscal year 1997, compared to $1.65 million for fiscal year 1996. This decrease was primarily due to a decrease in amortization of capitalized software development costs associated with the MortgageWare Loan Management System, that was partially offset by the introduction of amortization of capitalized software development costs for MortgageWare Loan Servicing released during the first quarter of fiscal year 1997. Amortization of capitalized software development costs was $1,560,000, $1,290,000 and $1,430,000 for fiscal years 1998, 1997 and 1996, respectively. The Company expects the dollar amount of its amortization of capitalized software development costs to continue to increase for fiscal year 1999 compared to fiscal year 1998 primarily due to the stage of development and the timing of release of several of the Company's products. 23 24 Cost of software support fees includes salaries and other costs related to providing telephone support, and the purchase, duplication, and shipping of disks associated with software updates. As a percentage of software support fees, cost of software support fees increased to 35% for fiscal year 1998 compared to 31% for fiscal year 1997, and increased to 31% for fiscal year 1997 compared to 29% for fiscal year 1996. These year-to-year increases were primarily due to a higher salary cost and a less efficient ratio of customer support staff to customers as well as an increase in other direct cost of support expenses associated with supporting a higher software license volume. Looking forward, the Company expects the dollar cost of software support fees to increase due to the increased staffing that will be required to support a higher installed base of the Company's products and in order to support the FlowMan product. The Company also expects that these factors will lead to a modest increase in the ratio of the cost of software support fees to software support fees. Cost of other revenues includes the salaries and reimbursable expenses for the employees who provide training and consulting services, the purchase and duplication of disks associated with custom documents, and the net cost of the Company's annual MortgageWare software users' group meeting. As a percentage of other revenues, cost of other revenues decreased to 50% for fiscal year 1998 compared to 55% for fiscal year 1997, and increased slightly to 55% for fiscal year 1997 compared to 54% for fiscal year 1996. The improvement in 1998 compared to 1997 was due primarily to higher gross profit earned on training and consulting services. The slight increase in fiscal year 1997 compared to fiscal year 1996 was primarily due to a combination of a slightly higher payroll cost and increased depreciation from upgrading the trainers' equipment. Looking forward, the Company expects the cost of other revenues to increase as the revenues for customization and implementation fees increase. Additional headcount and contract labor will be required both for customization and implementation services on MTD and ETD projects. OPERATING EXPENSES
Increase Increase (In thousands) 1998 (Decrease) 1997 (Decrease) 1996 --------- ------------ ---------- ----------- -------- Product development $1,609 (25)% $2,147 4% $2,060 Percentage of net revenues 9% _____ 15% _____ 16% Sales and marketing 5,675 41% 4,011 (5)% 4,230 Percentage of net revenues 31% _____ 28% _____ 32% General and administrative 3,754 19% 3,152 5% 3,010 Percentage of net revenues 20% _____ 22% _____ 23% Purchase of in-process R&D 3,615 _____ _____ _____ _____ Percentage of net revenues 20% _____ _____ _____ _____
Product development expenses include salaries for software developers and analysts, facility costs and expenses associated with computer equipment used in software development, net of costs capitalized. As a percentage of net revenues, product development expenses decreased to 9% for fiscal year 1998 compared to 15% for fiscal year 1997, and decreased to 15% for fiscal year 1997 compared to 16% for fiscal year 1996. The decrease for 1998 consisted of a dollar decrease of $539,000, which was due primarily to an increase in the costs of software development which were capitalized, offset somewhat by increases in headcount 24 25 and the related salary expenses. The percentage decrease for fiscal year 1997 compared to fiscal year 1996 was primarily due to net revenues increasing more than product development expenses. The Company capitalized $1,846,000, $877,000 and $790,000 of product development expenditures for fiscal years 1998, 1997 and 1996, respectively. The increase in capitalized product development expenses during fiscal year 1998 compared to fiscal year 1997 was due primarily to the fact that the Company had no significant capitalized costs for MortgageWare TC, MortgageWare Entre, and MortgageWare MarketLINQ during the 1997 fiscal year, but capitalized $750,000 of costs related to these products in fiscal year 1998. These costs related to the development of significant enhancements to these products during the year. During fiscal year 1999, the Company plans additional enhancements to these products as well as significant enhancements to FlowMan associated with the planned release of FlowMan 4.0. Accordingly, the Company anticipates an increase in the dollar value of capitalized development expenditures and an increase in the dollar value of product development expenses for fiscal year 1999. Sales and marketing expenses include salaries, sales commissions, travel, and facility costs for the Company's sales and marketing personnel. Sales and marketing expenses also includes advertising, telemarketing and trade shows. As a percentage of net revenues, sales and marketing expenses increased to 31% for fiscal year 1998 compared to 28% for fiscal year 1997, and decreased to 28% for fiscal year 1997 compared to 32% for fiscal year 1996. The increase for fiscal year 1998 represented a dollar increase of $1,663,000, which was due primarily to higher salaries and related payroll taxes, recruiting costs and commissions associated with a higher performing direct sales force. These expenses increased with the increases in revenue as discussed above (although not in direct proportion). In addition, the Company incurred increases in advertising, sales promotion and public relations, as well as travel and related direct costs of sales efforts in order to promote new products and the MortgageWare Enterprise offering. The decrease in dollars and percentage for fiscal year 1997 compared to fiscal year 1996 was primarily due to revenue increasing and sales and marketing expenses decreasing. The decrease in sales and marketing expenses was primarily due to the elimination of outsourced telemarketing fees during the quarter ended March 31, 1996. The Company expects sales and marketing expenses to increase on a dollar basis but to remain relatively consistent on a percentage of revenue basis for fiscal year 1999 compared to fiscal year 1998. This will be primarily due to the completion of the ramp-up in the sales and marketing department which occurred in fiscal year 1998 and additional expenses that are expected for the launch of the Enterprise Technology Division's sales efforts. General and administrative expenses include costs associated with finance, accounting, purchasing, order fulfillment, administration and facilities. As a percentage of net revenues, general and administrative expenses decreased to 20% for fiscal year 1998 compared to 22% for fiscal year 1997, and to 22% for fiscal year 1997 compared to 23% for fiscal year 1996. The decrease for both fiscal years was primarily due to revenue increasing at a faster rate than general and administrative expenses. The Company expects general and administrative expenses on a dollar basis to increase for fiscal year 1999 compared to fiscal year 1998, but hold relatively steady as a percentage of net revenues. 25 26 Purchase of in-process R&D represents a one-time charge incurred by the Company upon acquisition of LSS (as discussed above). The Company believes that the technology obtained in this acquisition requires significant further development so that it may be successfully integrated with the existing MortgageWare products and so that it may successfully compete in the Enterprise Application Integration market, and has no future alternative uses. As such, $3,615,304 of the purchase price was recorded as in process R&D and expensed on the date of acquisition. NET INTEREST AND OTHER INCOME (EXPENSE)
(In thousands) 1998 Increase 1997 Decrease 1996 ---------- ------------- --------- ------------ --------- Net interest and other income (expense) $745 4% $719 (11)% $811 Percentage of net revenues 4% _____ 5% _____ 6%
Interest income was $766,000, $747,000 and $801,000, for the fiscal years ended June 30, 1998, 1997 and 1996, respectively. Interest income remained relatively consistent from 1997 to 1998 due primarily to stable to slightly decreasing interest rates combined with a slightly increasing average portfolio balance during the 1998 fiscal year. The decrease for fiscal year 1997 was primarily due to a combination of a slightly lower average portfolio balance and a lower average rate of return on the portfolio. As of June 30, 1998, the Company had no interest-bearing debt outstanding, and anticipates no new debt financing in the foreseeable future. Accordingly, the Company expects net interest and other income (expense) for the foreseeable future to reflect net interest income. INCOME TAXES
(In thousands) 1998 Increase 1997 Increase 1996 -------------- ------------- ------------ ------------- --------------- Income taxes $907 45% $627 151% $251 Effective income tax rate NM _____ 36% _____ 37%
The provision for income taxes includes federal and state income taxes currently payable, and deferred taxes arising from temporary differences in determining income for financial statement and tax purposes. The Company recorded income tax expense for fiscal year 1998 even though it incurred a net loss, due to the fact that the charge for purchased in-process R&D is not currently deductible for income tax purposes. This charge will be deducted over a period of 15 years in accordance with current IRS regulations. Although the non-deductibility of this charge in fiscal year 1998 resulted in a deferred tax asset, the Company has recorded a substantial valuation allowance on this asset due to the length of time over which the charge is deductible and the uncertainties inherent in the software industry. As such, the effective tax rate is not meaningful for the fiscal year ended June 30, 1998. The effective tax rate for 1997 was relatively consistent with that rate in 1996. Looking forward, the Company expects its effective tax rate to decrease slightly as the charge for in-process R&D is actually deducted for tax purposes. 26 27 LIQUIDITY AND CAPITAL RESOURCES Working capital, which consists principally of cash, cash equivalents and short-term investments, was $8,150,000 as of June 30, 1998, compared to $11,623,000 at June 30, 1997. Cash and cash equivalents decreased by $560,000 for fiscal year 1998. Cash and cash equivalents provided by operating activities was $5,092,000 in fiscal year 1998. Principal uses of cash and cash equivalents included the repurchase of $1,362,000 of Company common stock, the cash outlay of $1,267,000 for the purchase of LSS (an additional $2,600,000 was paid on July 1, 1998), the purchase of $572,000 of furniture and equipment, and $1,846,000 of capitalized software costs. The Company's capital expenditures for fiscal years 1998 and 1997 were $572,000 and $547,000, respectively. The Company expects to spend about $1,100,000 in fiscal year 1999. The Company's current facility lease expires in November of 1998 and the Company has negotiated a seven-year lease for a new facility. Net occupancy costs are not expected to change materially as a result of this move; however, the Company anticipates that approximately $300,000 of tenant improvement costs will be incurred. Long-term cash requirements, other than normal operating expenses, are anticipated for development of new software products and enhancement of existing products; financing anticipated growth; the possible acquisition of other software products, technologies and businesses; and the possible repurchase of the Company's common stock. The Company believes that its existing cash, cash equivalents, short-term investments, and cash generated by operations will be sufficient to satisfy its currently anticipated cash requirements for fiscal year 1999. YEAR 2000 The Year 2000 problem arose because many existing computer programs use only the last two digits to refer to a year. Therefore, these computer programs do not properly recognize a year that begins with "20" instead of the familiar "19." If not corrected, many computer applications could fail or create erroneous results. The Company has initiated efforts to mitigate the impact of the Year 2000 problem on three levels: (i) the products that the Company uses internally to conduct its business, (ii) the products that it sells, and (iii) the Year 2000 readiness of the Company's customers and vendors. (i) Internal Products The Company has taken an inventory of all software and hardware systems used internally to conduct its ongoing business. These systems include client/server systems, LAN systems, PC systems and related software, security systems and voice mail systems. Certain of these systems have already been made Year 2000-ready, while others are scheduled for purchase and/or update during the 1999 fiscal year. The Company has not performed significant testing to confirm Year 2000 readiness on any of these systems, but intends to do so during the 1999 fiscal year. Based on the inventory of these internal systems, the Company does not believe the cost of addressing their Year 2000 readiness will be material. The Company believes that significant record-keeping and operational deficiencies could occur should the Company's internal products not be made ready for the 27 28 Year 2000, which could have material adverse effects. The Company has no contingency plans in place should this occur. (ii) The Company's Products The products that the Company sells in the operation of its business have reached varying degrees of Year 2000 readiness. All of the products have been evaluated for the Year 2000 problem and significant strides have been made to make the products ready for the Year 2000. The following products have been made ready and have been subjected to testing for the Year 2000: MortgageWare Loan Servicing, MortgageWare Loan Management System, MortgageWare TC, MortgageWare Entre and MortgageWare MarketLINQ. In addition to internal testing, the Company has published recommendations to its customers with regards to the testing that they should be performing in house to ensure Year 2000 readiness. The following products have been made ready and are currently being tested for the Year 2000: MortgageWare InfoLINQ, MortgageWare InvestorLINQ, BuilderBlock$(TM) and FlowMan version 3.2. After subjecting these products to testing, the Company plans to publish recommendations to its customers with regards to the testing that they should be performing in house to ensure Year 2000 readiness. The following products have not been made Year 2000-ready: MortgageBase and Secondary Marketing for DOS. The Company has announced discontinuation of these products and is not currently selling them. Customers who use these products can (at their own discretion) upgrade to current products sold by the Company that are Year 2000-ready. The Company believes that all of its products will be ready for the Year 2000 by the end of the 1999 fiscal year and that no material costs will remain at that time. However, there are no assurances that there are not undetected errors in the Company's products relating to the Year 2000 that may result in material additional cost or liabilities, the magnitude of which cannot be predicted, which could have a material adverse effect on the Company. In addition, the Company believes that the purchasing patterns of customers and potential customers may be affected by Year 2000 issues in a variety of ways. Some customers may defer purchasing the Company's products because they are diverting resources to address their own Year 2000 issues. However, other customers may accelerate their decisions to purchase the Company's products to replace non-Year 2000 ready applications. The Company believes that it is not possible to predict the overall impact of these decisions. The Company has no contingency plan should the Company be unable to make all of its products ready for the Year 2000. (iii) The Company's Customers and Vendors The Company has identified third-party vendors upon which it places significant reliance and plans to ascertain their readiness for the Year 2000 during the 1999 fiscal year. The Company believes that although prudent measures are required in this area, it is unable to reasonably or accurately predict the impact to the Company if certain customers or vendors are not made ready for the Year 2000. Significant disruption in the businesses of the Company's customers and third-party vendors may have material adverse effects on the Company's business, financial condition and results of operations. 28 29 NEW ACCOUNTING STANDARDS In October 1997, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-2, Software Revenue Recognition, which supersedes SOP 91-1. This SOP provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions and is effective for transactions entered into in fiscal years beginning after December 15, 1997. The Company does not expect the impact of adoption of SOP 97-2 to be material. In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, Reporting Comprehensive Income ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and disclosure of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. SFAS No. 130, which is effective for fiscal years beginning after December 15, 1997, requires reclassification of financial statements for earlier periods to be provided for comparative purposes. The Company has not determined the manner in which it will present the information required by SFAS No. 130. In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an Enterprise and Related Information ("SFAS No. 131"). SFAS No. 131 establishes standards for the way that public business enterprises report information about operating segments. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. In the initial year of application, comparative information for earlier years must be restated. The Company has not determined the manner in which it will present the information required by SFAS No. 131. FORWARD-LOOKING STATEMENTS When used in this discussion, the words "believes," "anticipates," "expects," "intends," and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. 29 30 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page # -------------- Independent Auditors' Report 31 Balance Sheets as of June 30, 1998 and 1997 32 Statements of Operations for the years ended June 30, 1998, 1997 and 1996 33 Statements of Shareholders' Equity for the years ended June 30, 1998, 1997 and 1996 34 Statements of Cash Flows for the years ended June 30, 1998, 1997 and 1996 35 Notes to Financial Statements 36 - 45 Schedule II-- Valuation and Qualifying Accounts 47
30 31 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders INTERLINQ Software Corporation: We have audited the accompanying financial statements of INTERLINQ Software Corporation as listed in the accompanying index. In connection with our audits of these financial statements, we have also audited the financial statement schedule as listed in the accompanying index. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of INTERLINQ Software Corporation as of June 30, 1998 and 1997, and the results of its operations and its cash flows for each of the years in the three-year period ended June 30, 1998 in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, 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/ KPMG Peat Marwick LLP Seattle, Washington July 30, 1998 31 32 INTERLINQ SOFTWARE CORPORATION BALANCE SHEETS
As of June 30, 1998 1997 ----------- ----------- ASSETS Current assets: Cash and cash equivalents $ 7,233,826 $ 7,793,761 Investments available-for-sale, at fair value 3,406,389 4,024,651 Investments held-to-maturity, at amortized cost 3,267,534 2,012,894 Accounts receivable, less allowance for doubtful accounts of $255,900 in 1998 and $176,000 in 1997 3,400,194 1,602,220 Inventory 39,556 55,246 Prepaid expenses 341,717 408,909 Deferred income taxes ____ 267,660 ----------- ----------- Total current assets 17,689,216 16,165,341 ----------- ----------- Property and equipment, at cost 6,434,017 5,836,895 Less accumulated depreciation and amortization 5,434,285 4,364,628 ----------- ----------- Net property and equipment 999,732 1,472,267 ----------- ----------- Capitalized software costs, less accumulated amortization of $2,438,852 in 1998 and $1,718,683 in 1997 4,421,806 3,358,016 Goodwill 932,333 ____ Other assets 110,102 70,899 ----------- ----------- $24,153,189 $21,066,523 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 690,138 $ 235,895 Accrued compensation and benefits 1,745,908 555,402 Other accrued liabilities 695,387 498,276 Purchase consideration payable 2,600,000 ____ Customer deposits 374,151 199,636 Deferred software support fees 3,434,092 3,052,822 ----------- ----------- Total current liabilities 9,539,676 4,542,031 ----------- ----------- Noncurrent liabilities, excluding current installments: Deferred rent and other lease obligations ____ 160,443 Deferred software support fees 14,864 6,746 Deferred income taxes ____ 306,950 ----------- ----------- Total noncurrent liabilities 14,864 474,139 ----------- ----------- Shareholders' equity: Series A convertible preferred stock, $.01 par value. Authorized 5,000,000 shares; no shares issued and outstanding in 1998 and 1997 ---- ---- Common stock, $.01 par value. Authorized 30,000,000 shares; issued and outstanding 5,350,559 shares in 1998 and 5,416,512 shares in 1997 53,506 54,165 Additional paid-in capital 10,442,835 10,343,087 Retained earnings 4,102,308 5,653,101 ----------- ----------- Total shareholders' equity 14,598,649 16,050,353 Commitments ----------- ----------- $24,153,189 $21,066,523 =========== ===========
See accompanying notes to financial statements. 32 33 INTERLINQ SOFTWARE CORPORATION STATEMENTS OF OPERATIONS
Years Ended June 30, 1998 1997 1996 ------------ ------------ ------------ Net revenues: Software license fees $ 9,646,819 $ 7,055,457 $ 6,232,011 Software support fees 6,975,959 6,072,544 5,772,791 Other 1,723,615 1,239,045 1,087,613 ------------ ------------ ------------ Total net revenues 18,346,393 14,367,046 13,092,415 ------------ ------------ ------------ Cost of revenues: Software license fees 1,778,263 1,499,645 1,652,627 Software support fees 2,445,025 1,856,486 1,678,255 Other 859,269 682,666 588,987 ------------ ------------ ------------ Total cost of revenues 5,082,557 4,038,797 3,919,869 ------------ ------------ ------------ Gross profit 13,263,836 10,328,249 9,172,546 ------------ ------------ ------------ Operating expenses: Product development 1,608,840 2,147,546 2,060,427 Sales and marketing 5,674,475 4,011,440 4,229,994 General and administrative 3,754,222 3,151,761 3,010,223 Purchase of in-process research and development 3,615,304 0 0 ------------ ------------ ------------ Total operating expenses 14,652,841 9,310,747 9,300,644 ------------ ------------ ------------ Operating income (loss) (1,389,005) 1,017,502 (128,098) Net interest and other income 744,865 719,275 811,272 ------------ ------------ ------------ Income (loss) before income tax expense (644,140) 1,736,777 683,174 Income tax expense 906,653 626,900 250,398 ------------ ------------ ------------ Net income (loss) $ (1,550,793) $ 1,109,877 $ 432,776 ============ ============ ============ Net income (loss) per share -- basic and diluted $ (.30) $ .19 $ .07 Shares used to calculate net income (loss) per share - basic 5,213,217 5,707,374 5,964,877 Shares used to calculate net income (loss) per share - diluted 5,213,217 5,841,764 6,171,210
See accompanying notes to financial statements. 33 34 INTERLINQ SOFTWARE CORPORATION STATEMENTS OF SHAREHOLDERS' EQUITY
Total Common Additional Retained Shareholders' Years Ended June 30, 1998, 1997 and 1996 Stock Paid-in Capital Earnings Equity --------- --------------- ------------ -------------- Balances at June 30, 1995 $59,680 $13,167,991 $4,110,448 $17,338,119 Issuance of 170,550 shares of common stock 1,706 214,487 ____ 216,193 Tax benefit realized upon exercise of stock options ____ 96,651 ____ 96,651 Repurchase of 100,000 shares of common stock (1,000) (311,500) ____ (312,500) Net income for the year ended June 30, 1996 ____ ____ 432,776 432,776 -------- ------------ ----------- ------------- Balances at June 30, 1996 60,386 13,167,629 4,543,224 17,771,239 Issuance of 19,962 shares of common stock 199 17,321 ____ 17,520 Tax benefit realized upon exercise of stock options ____ 10,967 ____ 10,967 Repurchase of 642,000 shares of common stock (6,420) (2,852,830) ____ (2,859,250) Net income for the year ended June 30, 1997 ____ ____ 1,109,877 1,109,877 -------- ------------ ----------- ------------- Balances at June 30, 1997 54,165 10,343,087 5,653,101 16,050,353 Issuance of 251,447 shares of common stock 2,515 1,444,882 ____ 1,447,397 Tax benefit realized upon exercise of stock options ____ 13,793 ____ 13,793 Repurchase of 317,400 shares of common stock (3,174) (1,358,927) ____ (1,362,101) Net loss for the year ended June 30, 1998 ____ ____ (1,550,793) (1,550,793) -------- ------------ ----------- ------------- Balances at June 30, 1998 $53,506 $10,442,835 $4,102,308 $14,598,649 ======== ============ =========== =============
See accompanying notes to financial statements. 34 35 INTERLINQ SOFTWARE CORPORATION STATEMENTS OF CASH FLOWS
Years Ended June 30, 1998 1997 1996 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $ (1,550,793) $ 1,109,877 $ 432,776 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization of property and equipment 1,094,884 1,111,438 1,014,452 Amortization of capitalized software costs 1,559,201 1,287,881 1,430,111 Gain on disposition of equipment ____ ____ (1,473) Purchase of in-process research and development 3,615,304 ____ ____ Deferred income tax benefit (39,290) (2,217) (156,727) Tax benefit realized upon exercise of stock options 13,793 10,967 96,651 Change in certain assets and liabilities (net of acquisition): Accounts receivable (1,505,816) 369,287 (745,365) Income taxes refundable ____ ____ 987,429 Inventory and prepaid expenses 82,882 (60,485) (88,508) Other assets (39,203) (44,878) 9,613 Accounts payable 99,527 77,669 34,971 Accrued compensation and benefits, other accrued liabilities and deferred rent and other lease obligations 1,197,140 47,235 51,136 Customer deposits 174,515 (164,067) 256,613 Deferred software support fees 389,388 411,835 93,400 ------------ ------------ ------------ Net cash provided by operating activities 5,091,532 4,154,542 3,415,079 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of property and equipment (571,646) (547,059) (689,857) Capitalized software costs (1,845,881) (877,334) (789,792) Purchase of source code ____ (275,000) (2,000,000) Purchases of investments (7,402,921) (14,511,012) (18,734,310) Proceeds from sales and maturities of investments 6,766,543 16,180,313 12,498,246 Proceeds from sale of equipment ____ ____ 5,435 Cash paid for acquisition (1,266,520) ____ ____ ------------ ------------ ------------ Net cash used in investing activities (4,320,425) (30,092) (9,710,278) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 31,059 17,520 216,193 Repurchase of common stock (1,362,101) (2,859,250) (312,500) ------------ ------------ ------------ Net cash used in financing activities (1,331,042) (2,841,730) (96,307) ------------ ------------ ------------ Net increase (decrease) in cash & cash equivalents (559,935) 1,282,720 (6,391,506) ------------ ------------ ------------ Cash and cash equivalents at beginning of year 7,793,761 6,511,041 12,902,547 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 7,233,826 $ 7,793,761 $ 6,511,041 ============ ============ ============ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: $ 703,816 $ 615,891 $ (691,880) Net cash paid (received) during the year for income taxes SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Acquisition effected through issuance of common stock and purchase consideration payable $ 4,016,338 ____ ____
See accompanying notes to financial statements. 35 36 INTERLINQ SOFTWARE CORPORATION NOTES TO FINANCIAL STATEMENTS JUNE 30, 1998 AND 1997 (1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) DESCRIPTION OF BUSINESS INTERLINQ Software Corporation ("Company") provides technology that helps organizations effectively manage complex, information-intensive business transactions. The Company's mortgage technology division provides business solutions to banks, savings institutions, mortgage banks, mortgage brokers, and credit unions. This division's product line encompasses all major components of the mortgage loan production process, secondary marketing activities, mortgage loan servicing, and construction loan servicing. The Company's enterprise technology division provides application integration/workflow solutions that integrate disparate systems and applications to route information and processes seamlessly across an entire enterprise. These solutions coordinate activities across legacy systems, enterprise applications, databases and Internet technologies. The Company sells its products through a direct sales force, third-party application developers, OEMs and system integrators. (b) CASH EQUIVALENTS All highly liquid investments purchased with a maturity of three months or less are considered to be cash equivalents. (c) INVESTMENTS Investments at June 30, 1998 and 1997 consist principally of investment-grade, interest-bearing securities. The Company classifies investment securities as either available-for-sale or held-to-maturity depending upon its intentions at the time the securities are acquired. Investments available-for-sale are carried at fair value, with any unrealized holding gains and losses reported as a separate component of shareholders' equity. Investments held-to-maturity are carried at amortized cost. At June 30, 1998 and 1997, the fair value of all securities approximated amortized cost and there were no material unrealized holding gains or losses. Investments held-to-maturity have contractual maturities of less than one year. Investments available-for-sale have contractual maturities ranging from two years to thirty-two years and carry adjustable rates of interest with periodic reset dates. (d) INVENTORY Inventory is stated at the lower of cost (first-in, first-out) or replacement market. (e) PROPERTY AND EQUIPMENT Depreciation and amortization of property and equipment are provided on the straight-line method over the estimated useful lives of the assets or respective lease terms if shorter. Management periodically evaluates property and equipment for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. (f) PRODUCT DEVELOPMENT AND CAPITALIZED SOFTWARE COSTS Software development costs incurred in conjunction with product development are charged to product development expense in the period the cost is incurred until technological feasibility is established. Thereafter, all software product development costs are capitalized and 36 37 reported at the lower of unamortized cost or net realizable value. Software costs incurred in conjunction with acquisition of technologically feasible products developed externally are capitalized and reported at the lower of unamortized cost or net realizable value. Amortization of capitalized software costs begins when the related software is available for general release to customers and is provided for each software product based on the greater of (i) the ratio of current gross revenues to total current and anticipated future gross revenues for the related software or (ii) the straight-line method over two to five years, based on the remaining economic life of the software. The estimates of anticipated future gross revenues and remaining economic life of the Company's products are subject to risks inherent in the software industry, such as changes in technology and customer perceptions. Management regularly reviews these estimates and makes adjustments as appropriate. (g) GOODWILL Goodwill represents the excess of the cost of Logical Software Solutions Corporation - acquired on June 30, 1998, over the fair value of tangible and identifiable intangible assets at the date of acquisition. Goodwill will be amortized over its estimated useful life of four years. Management will evaluate goodwill for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. (h) REVENUE RECOGNITION Net revenues consist of software license fees, software support fees, and other revenues. Software license fees are earned under three different types of licensing agreements. Under the purchase option, a one-time license fee is recognized when the goods are shipped if no significant obligations remain on the part of the Company, and collection of any resulting receivables is deemed probable. Under the Partnership Plan option, revenues are recognized each month based on the monthly volume of loan transactions processed by the customer using the Company's software. Under the software rental option, revenues are recognized each month based on the monthly license fee. Software support fees relate only to licensing agreements under the purchase option and are charged separately, on an annual or quarterly basis, and are recognized over the life of the related service contracts. Deferred software support fees represent fees charged to customers but not yet recognized as revenue. Other revenues include training fees, consultation services, and custom document fees. These revenues are recognized when the related service is completed or when the goods are shipped, as applicable. (i) COST OF REVENUES Cost of software license fees includes costs related to sales of licenses such as disks and supplies, amortization of capitalized software costs and other direct costs. Cost of software support fees includes salaries and other costs related to providing telephone support and the costs of disks and supplies related to product enhancements provided under support contracts. Cost of other revenues includes direct costs related to training, consultation services, custom document fees and other revenue. (j) STOCK-BASED COMPENSATION The Company accounts for its stock option plans using the intrinsic value method. As such, compensation expense is recorded if, on the date of grant, the current market price of the underlying stock exceeded the exercise price. 37 38 (k) INCOME TAXES The Company records income taxes under the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Management evaluates the need to establish valuation allowances for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected to be recovered, and expected levels of taxable income. (l) EARNINGS PER SHARE The Company calculates earnings per share in accordance with Statement of Financial Accounting Standards ("SFAS") No. 128 Earnings Per Share. SFAS No. 128 requires the presentation of basic earnings per share, and for companies with complex financial structures, diluted earnings per share. Basic earnings per share is computed using the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Since the Company was in a net loss position for the year ended June 30, 1998, basic and diluted net loss per share are the same. The following table reconciles the shares used in calculating basic earnings per share to the shares used in calculating diluted earnings per share:
1998 1997 1996 --------- --------- --------- Shares used to calculate basic earnings per share 5,213,217 5,707,374 5,964,877 Dilutive effect of outstanding stock options ____ 134,390 206,333 --------- --------- --------- Shares used to calculate diluted earnings per share 5,213,217 5,841,764 6,171,210 ========= ========= =========
Excluded from the computation of diluted earnings per share for the year ended June 30, 1998, are options to acquire 1,031,041 shares of common stock with a weighted-average exercise price of $3.87, because their effects would be anti-dilutive. (m) 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 reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. (n) CONCENTRATION OF MARKET RISK The Company markets a substantial portion of its products to businesses involved in the residential loan production process. Changes in mortgage lending rates and other economic factors could affect the economic stability of these businesses and their ability, as a group, to purchase the Company's products. As a result, the Company's success in marketing its products may fluctuate in accordance with these economic factors. (o) RECLASSIFICATIONS Certain reclassifications have been made to the prior period financial statements to conform with the current year presentation. 38 39 (p) NEW ACCOUNTING STANDARDS In October 1997, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 97-2, Software Revenue Recognition, which supersedes SOP 91-1. This SOP provides guidance on applying generally accepted accounting principles in recognizing revenue on software transactions and is effective for transactions entered into in fiscal years beginning after December 15, 1997. The Company does not expect the impact of adoption of SOP 97-2 to be material. In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income ("SFAS No. 130"). SFAS No. 130 establishes standards for reporting and disclosure of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. SFAS No. 130, which is effective for fiscal years beginning after December 15, 1997, requires reclassification of financial statements for earlier periods to be provided for comparative purposes. The Company has not determined the manner in which it will present the information required by SFAS No. 130. In June 1997, the FASB issued SFAS No. 131, Disclosure About Segments of an Enterprise and Related Information ("SFAS No. 131"). SFAS No. 131 establishes standards for the way public business enterprises report information about operating segments. It also establishes standards for related disclosures about products and services, geographic areas and major customers. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997. In the initial year of application, comparative information for earlier years must be restated. The Company has not determined the manner in which it will present the information required by SFAS No. 131. (2) PROPERTY AND EQUIPMENT Major classes of property and equipment as of June 30 are as follows:
1998 1997 ---------- ---------- Leasehold improvements $1,502,722 $1,501,349 Furniture and fixtures 1,082,467 1,044,088 Computer equipment 3,475,017 2,919,194 Office equipment 373,811 372,264 ========== ========== $6,434,017 $5,836,895 ========== ==========
(3) ACQUISITION On June 30, 1998, the Company entered into a purchase and sale agreement to acquire Logical Software Solutions Corporation. LSS is an Enterprise Application Integration developer and service provider. The purchase price consisted of 233,334 shares of common stock valued at $1,416,338, cash of $3,600,000, and direct acquisition costs of $378,930. The 233,334 shares of common stock issued in the acquisition were placed in escrow and will vest with time over a six year period (subject to certain accelerated vesting provisions). On June 30, 1998, the Company paid $1,000,000 in cash and recorded the remaining balance of the cash purchase price as purchase consideration payable. Direct acquisition costs which were unpaid at June 30, 1998, are recorded as accounts payable. The acquisition was accounted for using the purchase method of accounting. Accordingly, the results of operations of the acquired business and the fair market values of the acquired assets and 39 40 assumed liabilities were included in the Company's financial statements as of the date of acquisition. The purchase price was allocated to the acquired assets and assumed liabilities based on fair values as follows: Accounts receivable $ 292,158 Property and equipment 50,733 Goodwill 932,333 Capitalized software 777,110 In-process research and development 3,615,304 Accounts payable and accrued liabilities (272,370) =========== $ 5,395,268 ===========
A portion of the purchase price represents purchased in-process research and development that has not yet reached technological feasibility and has no alternative future use. The value assigned to purchased in-process research and development was determined by identifying research projects in areas for which technological feasibility has not been established; estimating the costs to develop the purchased in-process research and development into commercially viable products; estimating the resulting net cash flows from such projects; and discounting the net cash flows back to the time of acquisition. The following table presents pro forma results of operations as if the acquisition had occurred at the beginning of the 1998 and 1997 fiscal year, excluding all nonrecurring acquisition-related charges. The table includes the impact of certain adjustments such as goodwill amortization and related tax effects. The pro forma information is not necessarily indicative of the combined results that would have occurred had the acquisition been in effect for the entire periods presented, nor is it necessarily indicative of results that may occur in the future.
1998 1997 ---- ---- Total net revenues $ 19,477,617 $ 16,234,949 Net income 1,398,087 1,278,783 Net income per share-- basic .26 .22 Net income per share-- diluted .25 .21
(4) COMMITMENTS (a) LEASES In March 1994, the Company moved into its current premises, which it leases under a noncancelable operating lease expiring in November 1998. In April 1998, the Company signed a noncancelable operating lease for new premises to commence in November 1998. This lease will expire in October 2005. The Company charges the total of the scheduled lease payments to rent expense using the straight-line method over the life of the lease. The Company also holds a lease for previous premises which remains in effect until October 1998. The Company negotiated a sublease to another tenant for the remaining lease term beginning in March 1994. Included in deferred rent payable and other lease obligations is $0 and $142,568, which represents the Company's remaining obligation under this lease, net of amounts to be received under the sublease at June 30, 1998 and 1997, respectively. Accrued liabilities at June 30, 1998 and 1997, include $160,443 and $223,307, respectively, representing the current portion of deferred rent payable. 40 41 Future minimum lease payments under noncancelable operating leases are as follows:
Minimum lease payments ---------------------- Year ending June 30: 1999 $ 757,377 2000 670,113 2001 691,873 2002 711,993 2003 730,473 Thereafter 1,771,153 =========== $ 5,332,982 ===========
Total rent expense amounted to $384,481, $379,994, and $381,447 for the years ended June 30, 1998, 1997, and 1996, respectively. (b) 401(K) PLAN The Company sponsors a 401(k) plan that covers substantially all employees. At its own discretion, the Company may make contributions to the plan based on a percentage of participants' contributions. The Company made contributions of $114,552 for the year ended June 30, 1998. No contributions were made for the years ended June 30, 1997 or 1996. The Company has no other postemployment or postretirement benefit plans. (5) INCOME TAXES Components of income taxes are summarized as follows:
1998 1997 1996 --------- --------- --------- Current: Federal $ 854,489 $ 580,601 $ 291,906 State 77,661 37,549 18,568 --------- --------- --------- Total current 932,150 618,150 310,474 --------- --------- --------- Deferred: Federal (33,374) (2,032) (151,137) State (5,916) (185) (5,590) --------- --------- --------- Total deferred (39,290) (2,217) (156,727) --------- --------- --------- Charge in lieu of taxes from employee stock options 13,793 10,967 96,651 --------- --------- --------- $ 906,653 $ 626,900 $ 250,398 ========= ========= =========
Income tax expense (benefit) differs from "expected" income tax expense (benefit) (computed by applying the U.S. Federal income tax rate of 34%) as follows:
1998 1997 1996 ----------- ----------- ----------- Computed "expected" tax expense (benefit) $( 219,008) $ 590,504 $ 232,279 Increase in valuation allowance on deferred tax ____ ____ assets 1,103,913 State income taxes, net of federal benefit 47,352 24,660 8,565 Other (25,604) 11,736 9,554 ----------- ----------- ----------- $ 906,653 $ 626,900 $ 250,398 =========== =========== ===========
41 42 The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are as follows:
1998 1997 ----------- ----------- Deferred tax assets: Allowance for doubtful accounts receivable $ 94,683 $ 62,112 Deferred software support fees 120,201 59,254 Deferred rent 48,894 110,646 Accrued expenses 87,272 78,775 Property and equipment 638,866 461,183 Purchased in-process R&D 1,337,662 ____ ----------- ----------- Total deferred tax assets 2,327,578 771,970 Valuation allowance on deferred tax assets (1,103,913) ____ ----------- ----------- Net deferred tax assets 1,223,665 771,970 Deferred tax liabilities - capitalized software (1,223,665) (811,260) ----------- ----------- Net deferred tax liability $ ____ $ (39,290) =========== ===========
(6) SHAREHOLDERS' EQUITY (a) PREFERRED STOCK Preferred stock authorized consists of 5,000,000 shares of Series A preferred stock. The Series A preferred stock is convertible at any time into two times the number of shares of common stock and has the same voting rights as its common stock equivalent. However, Series A preferred stock has preferential treatment with respect to any payment of dividends and any distributions of assets upon liquidation. (b) STOCK OPTION PLANS The Company has three stock option plans: the 1985 Restated Stock Option Plan ("1985 Plan"), the 1993 Stock Option Plan ("1993 Plan") and the 1993 Stock Option Plan for Nonemployee Directors ("Directors Plan"). The Company accounts for its option plans in accordance with the provisions of Accounting Principles Board Opinion No. 25 and no compensation cost has been recognized related to its stock options. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), the Company's net income (loss) would have changed to the pro forma amounts indicated below:
1998 1997 1996 ------------- ------------- ------------- Net income (loss): As reported $ (1,550,793) $ 1,109,877 $ 432,776 Pro forma (1,974,214) 821,572 265,341 Basic and Diluted per share as reported $ (.30) $ .19 $ .07 Basic and Diluted per share $ (.38) $ .14 $ .04 pro forma
Pro forma net income (loss) and net income (loss) per share reflect only options granted in the years ended June 30, 1998, 1997, and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income (loss) and net income (loss) per share amounts presented above because compensation cost is reflected over the options' vesting period and compensation cost for options granted prior to July 1, 1995, is not considered. The per share weighted-average fair value of stock options granted during the years ended June 30, 1998, 1997 and 1996 was $2.71, $3.28 and $2.05, respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted-average 42 43 assumptions: 1998 -- expected dividend yield of 0.0%, risk-free interest rate of 5.36%, expected volatility of 65%, and an expected life of 5 years; 1997 - expected dividend yield of 0.0%, risk-free interest rate of 6.02%, expected volatility of 65%, and an expected life of 5 years; 1996 - expected dividend yield of 0.0%, risk-free interest rate of 5.11%, expected volatility of 65%, and an expected life of 5 years. The 1985 and 1993 Plans provide for both incentive stock options and other stock options that may be issued to attract and retain the services of employees. The incentive stock options vest over a four-year period and may be exercised during continued employment or within one month of terminating employment for the 1985 Plan and within three months for the 1993 Plan. All options expire ten years from the date of grant. The 1985 Plan has been suspended in regard to future grants, and stock options are currently granted pursuant to the 1993 Plan. The Company has authorized 900,000 shares of common stock to be reserved for grants pursuant to the 1993 Plan. The Directors Plan provides for stock options that may be issued to attract and retain services of the members of the Board of Directors who are not otherwise employees of the Company. The stock options vest six months from the date of grant and may be exercised during the director's term or within three months of the date the option holder ceases to be a director. All options expire five years from the date of grant. The Company has authorized 215,000 shares of common stock to be reserved for grants pursuant to the Directors Plan. A summary of stock option activity under the stock option plan follows:
Outstanding options ------------------------------------------------------ Number of shares Weighted Options ---------------------------------------- average Available 1985 1993 Directors Exercise For grant Plan Plan Plan Price ------- -------- -------- -------- ----- Balances at June 30, 1995 136,039 330,268 164,961 74,000 $2.52 Increase in shares reserved under 1993 Plan 600,000 __ __ __ __ Options granted (472,275) __ 417,275 55,000 3.45 Options exercised __ (164,050) (6,500) __ 1.27 Options canceled 118,774 (3,800) (68,774) (50,000) 3.84 ------- -------- -------- -------- ----- Balances at June 30, 1996 382,538 162,418 506,962 79,000 3.17 Increase in shares reserved under Directors Plan 140,000 __ __ __ __ Options granted (228,180) __ 219,180 9,000 5.46 Options exercised __ (19,650) (312) __ .88 Options canceled 59,476 (19,150) (37,476) (22,000) 4.11 ------- -------- -------- -------- ----- Balances at June 30, 1997 353,834 123,618 688,354 66,000 3.73 Options granted (220,100) __ 197,600 22,500 4.57 Options exercised __ (13,300) (4,813) __ 1.71 Options canceled 48,118 (800) (45,118) (3,000) 5.42 ------- -------- -------- -------- ----- Balances at June 30, 1998 181,852 109,518 836,023 85,500 $3.87 ======= ======== ======== ======== =====
43 44 Additional information regarding options outstanding as of June 30, 1998 is as follows:
Options outstanding Options exercisable ---------------------------------------- ------------------- Weighted- Average Weighted- Weighted- Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise prices Outstanding Life (years) Price Exercisable Price --------------- ----------- ------------ ----- ----------- ----- $.100- .500 90,018 2.81 $ .39 90,018 $ .39 2.500-3.875 513,235 7.27 3.41 265,526 3.36 3.969-5.844 398,205 8.90 5.01 95,680 4.92 6.938-8.375 29,583 6.82 7.09 20,333 7.15 ------------- --------- ---- -------- ------- -------- $ .100-8.375 1,031,041 7.50 $ 3.87 471,557 $ 3.27 ============= ========= ==== ======== ======= ========
(7) NET INTEREST AND OTHER INCOME (EXPENSE) Net interest and other income (expense) consist of:
1998 1997 1996 --------- --------- --------- Interest income $ 765,792 $ 746,712 $ 801,434 Interest expense (21,623) (27,713) (27,579) Other, net 696 276 37,417 --------- --------- --------- $ 744,865 $ 719,275 $ 811,272 ========= ========= =========
(8) FINANCIAL INSTRUMENTS The Company's financial instruments consist primarily of investments, accounts receivable, accounts payable and accrued liabilities. The financial instruments have a short term until maturity or settlement in cash and, therefore, the carrying value approximates fair value. Credit is extended to customers based on an evaluation of their financial condition and no collateral is required. The Company performs ongoing credit evaluations of its customers and maintains allowances for possible credit losses. (9) QUARTERLY FINANCIAL DATA (UNAUDITED) The following table summarizes the unaudited statements of operations for each quarter of fiscal 1998 and 1997 (in thousands, except per share amounts):
First Second Third Fourth ------- ------- ------- ------- 1998 Net revenues $ 3,642 $ 4,369 $ 4,787 $ 5,549 Gross profit 2,459 3,158 3,455 4,192 Operating income (loss) 165 382 648 (2,584) Net income (loss) 209 357 520 (2,637) Net income (loss) per share-- basic and diluted $ .04 $ .07 $ .10 $( .52) 1997 Net revenues $ 3,579 $ 3,516 $ 3,534 $ 3,738 Gross profit 2,620 2,530 2,509 2,669 Operating income 318 246 86 368 Net income 326 271 161 352 Net income per share-- basic and diluted $ .05 $ .05 $ .03 $ .06
In the fourth quarter of 1998 the Company recorded a one-time charge of $3,615,304 related to its acquisition of LSS (in-process research and development). 44 45 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated by reference to the information under the captions "Election of Directors," "Continuing Class II Directors, Terms Expiring in 1999," "Nominees for Election as Class I Directors, Terms Expiring in 2000," "Directors' Fees," and "Filing of Forms Pursuant to Section 16 of the Securities Exchange Act of 1934" in the Company's Proxy Statement relating to its 1998 Annual Meeting of Shareholders (the "Proxy Statement"). Certain information regarding the executive officers of the Company is set forth in Part I. ITEM 11. EXECUTIVE COMPENSATION Incorporated by reference to the information under the captions "Directors Fees," "Compensation of Officers," and "Employment Contracts, Termination of Employment and Change of Control Arrangements" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference to the information under the caption "Voting Securities and Principal Holders Thereof" in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) THE FOLLOWING DOCUMENTS ARE FILED AS A PART OF THIS REPORT: 1. FINANCIAL STATEMENTS The Financial Statements, Notes thereto, and Independent Auditor's Report are included in Part II, Item 8 of this Report. 2. FINANCIAL STATEMENT SCHEDULES The following documents are filed as part of this report and should be read in conjunction with the Financial Statements of INTERLINQ Software Corporation. Schedule II - Valuation and Qualifying Accounts for the years ended June 30, 1998, 1997, and 1996 Schedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Financial Statements or Notes thereto. 45 46 3. EXHIBITS. The Exhibits listed on the accompanying Index to Exhibits immediately following the financial statement schedules are filed as part of, or incorporated by reference into, this report.
Exhibit Number Description - ------ ----------- 2.1(6) Asset Purchase Agreement, dated June 30, 1998, between INTERLINQ Software Corporation, Logical Software Solutions Corporation and Mary Collier, Michael Bennett and Keith Bluford 3.1(1) Restated Articles of Incorporation of INTERLINQ Software Corporation 3.2(1) Restated Bylaws of INTERLINQ Software Corporation 10.1(1)(2) 1985 Restated Stock Option Plan 10.2(1)(2) 1993 Stock Option Plan 10.3(1)(2) Stock Option Plan for Non-Employee Directors, as amended 10.4(1) Amended and Restated Registration Rights Agreement between INTERLINQ Software Corporation and the partners listed on Schedule A thereto dated as of March 12, 1993 10.6(1) Office Lease between Yarrow Bay Office III Limited Partnership and INTERLINQ Software Corporation dated as of July 31, 1992 10.8(1) Form of Indemnification Agreement for Directors and Officers 10.10(3) Co-Marketing Agreement between INTERLINQ Software Corporation and CMCI Corporation dated as of July 1, 1993 10.12(4) Office sublease between Halliburton Company and INTERLINQ Software Corporation dated January 21, 1994 10.15(2)(5) Letter dated August 25, 1995 regarding Jiri Nechleba Compensatory Arrangement 10.16(5) Appointment of Licensing Agent and Compliance Delegate Agreement between VMP's Electronic Laser Forms, Inc. A division of CBF Systems, Inc. And INTERLINQ Software Corporation dated October 2, 1995 10.17(5) Amendment of Co-marketing Agreement between INTERLINQ Software Corporation and CMCI Corporation dated October 1, 1995 10.18 Office Lease between Pine Forest Co. and INTERLINQ Software Corporation dated as of April 23, 1998 23.1 Consent of KPMG Peat Marwick LLP 27.1 Financial data schedule
(1) Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (Registration No. 33-59502) filed with the Securities and Exchange Commission on March 15, 1993, as same exhibit number. (2) Management contract or compensatory plan or arrangement. (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, as same exhibit number. Confidential treatment has been requested as to portions of this document. (4) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994, as same exhibit number. (5) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1996, as same exhibit number. (6) Incorporated by reference to the Company's Current Report on Form 8-K, dated June 30, 1998, as same exhibit number. (b) REPORTS ON FORM 8-K DURING THE FOURTH QUARTER ENDED JUNE 30, 1998 The Company filed a Current Report on Form 8-K, dated June 30, 1998, to report the acquisition of Logical Software Solutions Corporation ("LSS"). The Company filed a Current Report on Form 8-K/A, dated June 30, 1998, to report financial statements and pro forma financial information relating to the acquisition of LSS. 46 47 Schedule II INTERLINQ SOFTWARE CORPORATION VALUATION AND QUALIFYING ACCOUNTS Years ended June 30, 1998, 1997 and 1996
Additions ------------------------ Balance at Charged to Charged to beginning of costs and other Balance at end Description year expenses accounts Deductions of year - ----------- ---- -------- -------- ---------- ------- Allowances for doubtful accounts: Year ended June 30, 1998: Accounts receivable $ 176,000 $ 451,000 ____ $(371,100) $ 255,900 Year ended June 30, 1997: Accounts receivable 187,007 396,986 ____ (407,993) 176,000 Year ended June 30, 1996: Accounts receivable 152,287 331,224 ____ (296,504) 187,007
47 48 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 , the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Seattle, State of Washington, on the 24th day of September, 1998. INTERLINQ SOFTWARE CORPORATION By: /s/ JIRI M. NECHLEBA --------------------------------- Jiri Nechleba President and Chief Executive Officer
Signature Title --------- ----- /s/ JIRI M. NECHLEBA Chairman of the Board, President and Chief Executive Officer - ---------------------------------- (Principal Executive Officer) Jiri M. Nechleba /s/ STEPHEN A. YOUNT Executive Vice President, Chief Financial Officer and Secretary - ---------------------------------- (Principal Accounting Officer) Stephen A. Yount /s/ ROBERT W. O'REAR Director - ---------------------------------- Robert W. O'Rear /s/ THEODORE M. WIGHT Director - ---------------------------------- Theodore M. Wight /s/ ROBERT J. GALLAGHER Director - ---------------------------------- Robert J. Gallagher
48 49 INTERLINQ SOFTWARE CORPORATION INDEX TO EXHIBITS
Exhibit # Description - --------- ----------- 2.1(6) Asset Purchase Agreement, dated June 30, 1998, between INTERLINQ Software Corporation, Logical Software Solutions Corporation and Mary Collier, Michael Bennett and Keith Bluford 3.1(1) Restated Articles of Incorporation of INTERLINQ Software Corporation 3.2(1) Restated Bylaws of INTERLINQ Software Corporation 10.1(1)(2) 1985 Restated Stock Option Plan 10.2(1)(2) 1993 Stock Option Plan 10.3(1)(2) Stock Option Plan for Non-Employee Directors, as amended 10.4(1) Amended and Restated Registration Rights Agreement between INTERLINQ Software Corporation and the partners listed on Schedule A thereto dated as of March 12, 1993 10.6(1) Office Lease between Yarrow Bay Office III Limited Partnership and INTERLINQ Software Corporation dated as of July 31, 1992 10.8(1) Form of Indemnification Agreement for Directors and Officers 10.10(3) Co-Marketing Agreement between INTERLINQ Software Corporation and CMCI Corporation dated as of July 1, 1993 10.12(4) Office sublease between Halliburton Company and INTERLINQ Software Corporation dated January 21, 1994 10.15(2)(5) Letter dated August 25, 1995 regarding Jiri Nechleba Compensatory Arrangement 10.16(5) Appointment of Licensing Agent and Compliance Delegate Agreement between VMP's Electronic Laser Forms, Inc. A division of CBF Systems, Inc. And INTERLINQ Software Corporation dated October 2, 1995 10.17(5) Amendment of Co-marketing Agreement between INTERLINQ Software Corporation and CMCI Corporation dated October 1, 1995 10.18 Office Lease between Pine Forest Co. and INTERLINQ Software Corporation dated as of April 23, 1998 23.1 Consent of KPMG Peat Marwick LLP 27.1 Financial data schedule
(1) Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (Registration No. 33-59502) filed with the Securities and Exchange Commission on March 15, 1993, as same exhibit number. (2) Management contract or compensatory plan or arrangement. (3) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993, as same exhibit number. Confidential treatment has been requested as to portions of this document. (4) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1994, as same exhibit number. (5) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1996, as same exhibit number. (6) Incorporated by reference to the Company's Current Report on Form 8-K, dated June 30, 1998, as same exhibit number. 49 EX-10.18 2 OFFICE LEASE DATED APRIL 23, 1998 1 INTERLINQ OFFICE LEASE 2 TABLE OF CONTENTS Basic Lease Information 1 1. PREMISES.......................................................... 4 2. TERM AND POSSESSION............................................... 4 3. RENT.............................................................. 5 4. RESTRICTIONS ON USE............................................... 6 5. COMPLIANCE WITH LAWS.............................................. 6 6. ALTERATIONS....................................................... 9 7. REPAIRS........................................................... 10 8. LIENS............................................................. 11 9. ASSIGNMENT OR SUBLETTING.......................................... 12 10. INSURANCE AND INDEMNIFICATION.................................... 15 11. WAIVER OF SUBROGATION............................................ 18 12. SERVICES TO LANDLORD............................................. 18 13. ESTOPPEL CERTIFICATE............................................. 18 14. HOLDING OVER..................................................... 19 15. SUBORDINATION.................................................... 19 16. RULES AND REGULATIONS............................................ 20 17. RE-ENTRY BY LANDLORD............................................. 20 18. INSOLVENCY OR BANKRUPTCY......................................... 21 19. DEFAULT.......................................................... 22 20. DAMAGE BY FIRE, ETC.............................................. 25 21. EMINENT DOMAIN................................................... 26 22. SALE BY LANDLORD................................................. 28 23. RIGHT OF LANDLORD TO PERFORM..................................... 28 24. SURRENDER OF PREMISES............................................ 29 25. WAIVER........................................................... 29 26. NOTICES.......................................................... 30 27. OPERATING COSTS.................................................. 30 28. TAXES PAYABLE BY TENANT.......................................... 35 29. SUCCESSORS AND ASSIGNS........................................... 35 30. ATTORNEY'S FEES.................................................. 36 32. SIGNAGE.......................................................... 36 33. CORPORATE AUTHORITY.............................................. 37 34. LEASE EFFECTIVE DATE............................................. 37 35. BROKERAGE FEES................................................... 37 36. FORCE MAJEURE.................................................... 38 37. CHANGE IN BUILDING NAME.......................................... 38 38. CERTAIN RIGHTS RESERVED BY LANDLORD.............................. 38 39. PERSONAL LIABILITY............................................... 39 40. QUIET ENJOYMENT.................................................. 39 41. MISCELLANEOUS.................................................... 39 42. OPTION TO RENEW.................................................. 40 43. USE OF ROOF AND BUILDING STORAGE................................. 41 44. DEFINITION OF LANDLORD'S NEGLIGENCE.............................. 41
Exhibit A Legal Description Exhibit B Tenant Improvement Agreement Exhibit C Tenant Estoppel Certificate Exhibit D Rules and Regulations 3 OFFICE LEASE -- BASIC LEASE INFORMATION Lease Date: April 23, 1998 Commencement Date: The later of November 1, 1998, or the date possession of the Premises is tendered to Tenant following Substantial Completion of the Premises Landlord: Pine Forest Co. Address of Landlord: 1215 120th Ave. N.E., Suite 201 Bellevue, WA 98005-2155 Contact Person at Landlord: Scott Hall Tenant: INTERLINQ Software Corporation, a Washington corporation Contact Person at Tenant: Steve Yount Address of Tenant Prior to Commencement Date: 11255 Kirkland Way Kirkland, WA 98033 Address of the Premises: 12000 N.E. 24th Street Bellevue, WA 98005 Rentable Square Feet: Approximately 35,320 Rentable Square Feet located on two floors Base Rent: First Year: $54,451.67/month Second Year: $55,923.34/month Third Year: $57,395.00/month Fourth Year: $58,866.67/month Fifth Year: $60,338.34/month Sixth Year: $61,810.00/month Seventh Year: $63,281.67/month Estim. of Basic Operating Costs on Commencement Date: $16,188.34/month Estim. of Base Rent plus Additional Rent on Commencement: $70,640.01/month 1 4 Fiscal Year for Operating Costs: Calendar Year Tenant's Proportionate Share of Basic Operating Costs: 100% Security Deposit: $63,282 due upon execution of the Lease Term: Eighty-four (84) months, commencing approximately November 1, 1998, and ending approximately October 31, 2005, or such date which is the monthly anniversary date in the 84th month after the Commencement Date (unless sooner terminated as provided hereunder), including any extensions as provided hereunder. Options to Extend the Term: Two (2) consecutive options to extend the Term for an additional five (5) years each at 95% of the current market rates. Notice to be given no more than one (1) year or less than nine (9) months prior to the expiration of the then existing Term, which exercise is made by Tenant providing written notice to Landlord of the exercise of each option Rate for Covered Parking Stalls: Year 1: Free Year 2: $615/month ($15.00 per stall per month) Year 3: $820/month ($20.00 per stall per month) Year 4-7: $1025/month ($25.00 per stall per month) Note: All uncovered parking at the Premises is free of charge The foregoing Basic Lease Information is hereby incorporated into and made a part of this Lease. Each reference in this Lease to any of the Basic Lease Information shall mean the respective information herein above set forth and shall be construed to incorporate all of the terms provided under the particular Lease paragraph pertaining to such information. In the event of any conflict between any Basic Lease Information and the Lease, the latter shall control. 2 5 Landlord: Tenant: Pine Forest Co., INTERLINQ Software Corporation, a Washington corporation a Washington corporation By: /s/ FRED BURNSTEAD By: [SIG] -------------------------------- ----------------------------------- Fred Burnstead Its: VP Finance/CFO Its: President 3 6 LEASE AGREEMENT THIS LEASE is made as of this 23rd day of April, 1998, between Pine Forest Co., a Washington corporation (hereinafter called "Landlord") and INTERLINQ Software Corporation, a Washington corporation (hereinafter called "Tenant"). 1. PREMISES. Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the entire two story office building and all related improvements and appurtenances (including without limitation pavement, curbs and gutters, sidewalks and landscaping located on real property at 12000 N.E. 24th Street, Bellevue, Washington 98005, and legally described in Exhibit "A" attached hereto and incorporated by this reference (hereinafter collectively called "Premises"). Tenant shall use and occupy the Premises for general office purposes, with a computer server room, lunch room with food preparation for employees, athletic facilities for employees, and other uses customary for a software development company, and for no other use or purpose without the prior written consent of Landlord. 2. TERM AND POSSESSION. (a) The Term of this Lease shall be for the period specified in the Basic Lease Information, as that Term may be extended or terminated as provided herein. Landlord shall use its best reasonable efforts to deliver the Premises to Tenant on November 1, 1998. All permits required to construct the structural portions of the building shell and core have been obtained. The applications for tenant improvement permits have not yet been submitted. If Landlord cannot deliver possession by November 1, 1998, and such failure is not attributable to Landlord's gross negligence or willful misconduct, this Lease shall not be void or voidable, nor shall Landlord or its agent be liable to Tenant for any loss or damage resulting therefrom. Tenant shall not be liable for any rent until the Commencement Date (defined below) unless Tenant is responsible for a delay as provided in Exhibit B, Paragraph 14, in which case Tenant shall begin paying Rent as of the date that would have been the Commencement Date but for the Tenant Delay. If Landlord tenders possession of the Premises to Tenant prior to November 1, 1998, and the requirements for the Commencement Date have been met then the Term of this Lease and Tenant's obligations hereunder shall commence on the date that Landlord delivers such possession, if Tenant takes possession. Any failure to deliver possession by November 1, 1998 or delivery of possession prior to the Commencement Date shall not in any way affect the obligations of Tenant hereunder to lease the Premises. (b) The Commencement Date shall be the later of November 1, 1998, or the date on which one of the following sets of events has occurred: (i) the Premises have been Substantially Completed in accordance with the plans and specifications approved by Tenant and, the City of Bellevue has completed its inspection, approved the 4 7 Premises for occupancy by Tenant for its business operations as evidenced by issuance of a temporary certificate of occupancy, and the Premises have been tendered to Tenant, or (ii) the tenant takes possession of any or all of the Premises (except to the extent Tenant is entitled to early access pursuant to Paragraph 11, Exhibit B). Tenant's duty to pay Rent under this Lease shall commence on the Commencement Date. This Lease shall terminate on the day before the anniversary of the Commencement Date in the eighty-fourth (84th) month after the Commencement Date, unless sooner terminated (the "Termination Date") or extended under the terms of the Lease or by agreement of the parties. For example, if the Commencement Date were November 1, 1998, then the Termination Date would be October 31, 2005, if the Tenant does not exercise its option to extend the term. (c) Landlord agrees to complete construction of the Premises and to provide the Tenant Improvements as required in a separate Work Letter Agreement attached hereto as Exhibit "B" and made a part hereof. The term Substantial Completion as used in this Lease shall have the same meaning as that term is used in the Work Letter Agreement. (d) At either party's request both Landlord and Tenant will execute and deliver to each other a written statement specifying the Commencement Date and Termination Date. (e) If the Commencement Date has not occurred by March 1, 1999, and said delay is not caused by tenant's Delay or force majeure as described in paragraph 36 of this Lease, then tenant may terminate this Lease by written notice to Landlord; provided however that if the delay in the Commencement Date is caused by Tenant Delay or by force majeure as described in Paragraph 36 of this Lease, then Tenant's termination right in this sentence does not arise until June 1, 1999. 3. RENT. (a) Tenant shall pay Base Rent to Landlord throughout the term of this Lease as specified in the Basic Lease Information, without notice. Base Rent shall be payable in monthly installments in advance on the first day of each month during every year of the term in lawful money of the United States, without deduction or offset. It shall be paid to Landlord at the address specified in the Basic Lease Information, or to such other firm or to such other place as Landlord may from time to time designate in writing by notice to Tenant. If this Lease commences on a day other than the first day of a calendar month or ends on a day other than the last day of a calendar month, the monthly rental for the fractional month shall be appropriately prorated based on a thirty (30) day month. "Rent" means Base Rent, Tenant's Proportionate Share of Basic Operating Costs and all other amounts due pursuant to this Lease. (b) Tenant recognizes that late payment of any Rent or other sum due hereunder from Tenant to Landlord will result in administrative expense to Landlord, the extent of which additional expense is extremely difficult and economically impractical to ascertain. Tenant therefore 5 8 agrees that if Rent due hereunder from Tenant to Landlord remains unpaid ten (10) days after said amount is due, or any other payment due hereunder remains unpaid ten (10) days after written notice from Landlord, then the amount of such unpaid Rent or other payment shall be increased by a late charge to be paid to Landlord by Tenant in an amount equal to five percent (5%) of the amount of delinquent Rent or other payment. The amount of the late charge to be paid to Landlord by Tenant on any unpaid Rent or other payment shall be reassessed and added to Tenant's obligation for each successive monthly period accruing after the date on which the late charge is initially imposed. Tenant agrees that such amount is a reasonable estimate of the loss and expense to be suffered by Landlord as a result of such late payment by Tenant and may be charged by Landlord to defray such loss and expense. The provisions of this paragraph in no way relieve Tenant of the obligations to pay Rent or other payments on or before the date on which they are due, nor do the terms of this paragraph in any way affect Landlord's remedies pursuant to paragraph 19 of this Lease in the event said Rent or other payment is unpaid after the date due. 4. RESTRICTIONS ON USE. Tenant shall not use or allow the Premises to be used for any unlawful purpose. Tenant shall not cause or maintain or permit any nuisance in, on, or about the Premises. Tenant shall not commit or suffer the commission of any waste in, on or about the Premises, nor permit any use of the Premises which may be hazardous to persons or property. Tenant shall not do or permit anything to be done on or about the Premises or bring or keep anything therein which will cause an increase in the rate of any insurance of the Premises or cause a cancellation of the property and casualty insurance or any other insurance on the Premises or otherwise restrict the availability of said insurance in any manner. 5. COMPLIANCE WITH LAWS. (a) Except to the extent any non-compliance is a result of the Tenant Improvement Construction Documents (as defined in Exhibit B), Landlord warrants that upon delivery to Tenant the Premises shall be in compliance with all applicable rules, regulations and codes in effect at the time of delivery. Tenant shall not use the Premises or permit anything to be done in or about the Premises which would conflict with any law, statute, ordinance or governmental rule or regulation now in force or which may hereafter be enacted or promulgated. Tenant shall, at its sole cost and expense, promptly comply with all laws, statutes, ordinances, and governmental rules, regulations, or requirements now in force or which may hereafter be in force and with the requirements of any board of fire underwriters or other similar body now or hereafter constituted relating to its conditions, use or occupancy of the Premises, excluding structural changes and other improvements not specifically related to or affected by alterations or improvements made by or for Tenant or Tenant's acts. The judgment of any court of competent jurisdiction or the admission of Tenant in an action against Tenant, whether Landlord be a party thereto or not, that Tenant has so 6 9 violated any such law, statute, ordinance, rule, regulation, or requirement, shall be conclusive of such violation as between Landlord and Tenant. (b) "Accessibility Law" means any local, state or federal law, regulation, ordinance, order or directive relating to access, use or enjoyment of the Premises by, or employment there of disabled persons, or to the removal of any tangible or intangible barrier or impediment to access, use or enjoyment of the Premises by disabled persons, including, but not limited to, the Americans With Disabilities Act and similar state legislation. (c) Notwithstanding anything in this Lease to the contrary, Tenant shall make no Tenant alterations after the Commencement Date that violates any provision of any applicable rules, regulations and codes, including any Accessibility Laws, and all Tenant Improvements shall be in full compliance with all such rules, regulations and codes. Tenant shall not adopt or otherwise allow to exist any policy or practice related to its use or occupancy of the Premises or the conduct of its activities thereon that violates any rule, regulation or code. Tenant shall adopt any economically feasible policy or practice relating to the conduct of its business at the Premises that would cure any existing or future violation of any Accessibility Law relating to the Premises. Tenant shall bear all cost and expense of performing its duties under this paragraph. Tenant shall reimburse Landlord on demand for any cost or expense required to alter any portion of the Premises to comply with any Accessibility Law as a result of any Tenant alteration. (d) Notwithstanding any contrary provision of this Lease, Landlord shall have no obligation to approve any Tenant alterations if Landlord, in its sole discretion, determines that the Tenant alterations would obligate Landlord to make alterations of or additions to any part of the Premises in order to comply with any Accessibility Law or any other law, ordinance, code or regulation, unless Tenant agrees to make such alterations or additions at its own cost in the manner provided for other Tenant alterations, and Tenant deposits with Landlord, before undertaking the design or construction of such alternations, a sum equal to Landlord's estimate of the total cost of design and construction of such alterations. Notwithstanding the foregoing, Landlord shall have the right at any time, without the same constituting an actual or constructive eviction and without incurring any liability to Tenant therefor, to change the arrangement and/or location of entrances, passageways, doors and doorways, corridors, elevators, stairs, toilets, or other public parts of the building to the extent such change does not materially affect Tenant's business operations if said change is necessary for Landlord to bring the Premises into compliance with any rule, regulation or code, including any Accessibility Law. 7 10 (e) If any claim is asserted against one or both parties to this Lease under any Accessibility Law relating directly or indirectly to any violation by either of any of the provisions of this paragraph, such alleged violator shall defend, indemnify and hold the other party harmless from and against any claims, charges, liabilities, obligations, penalties, damages, judgments, costs and expenses (including reasonable attorneys' fees and costs) arising directly or indirectly from such violation upon determination of a court of competent jurisdiction that such a violation did occur and the extent to which the alleged violator is responsible for the violation. No approval by either party of any plans or specifications for any construction or alterations of the Premises, or failure to disapprove any such plans or specifications for construction or alterations of the Premises, shall constitute a representation or warranty by either party, whether express or implied, that such plans will comply with any Accessibility Law. (f) Landlord represents and warrants to Tenant that to the best of Landlord's knowledge there are no Hazardous Materials (as defined below) on the Premises as of the Commencement Date. Landlord agrees that Tenant is not responsible for Hazardous Materials on the Premises prior to the date Tenant commences Tenant's Work (as defined in Exhibit B) on the Premises. Tenant shall not cause or permit any Hazardous Materials to be brought upon, kept or used in or about the Premises, except in compliance with the labels on the products, and consistent with the intended use of the products for cleaning or other janitorial or maintenance purposes. If Tenant breaches its obligations in this paragraph, or if the presence of Hazardous Materials caused or permitted by Tenant results in contamination of the Premises or any part of any other property or if contamination of the Premises or other property otherwise occurs for which Tenant may be legally liable to Landlord, unless the contamination is caused solely by Landlord or its agents, employees, contractors or invitees, Tenant shall defend, indemnify and hold Landlord harmless from any and all claims, judgments, damages, penalties, fines, liabilities or losses (including, without limitation diminution in value of the Premises, damages for the loss or restriction on use of the Premises, damage arising from any adverse impact on marketing or leasing of the Premises, damages to any other property and amounts paid in settlement of claims, attorney fees and costs, consultant fees and expert fees) which arise during or within five (5) years after the end of the Term or extended Term as a result of such contamination. If Landlord breaches its warranty above, or if the presence of Hazardous Materials which is caused solely by Landlord results in contamination of the Premises or any part of any other property. Landlord shall defend, indemnify and hold Tenant harmless from any and all claims, judgments, damages, penalties, fines, liabilities or losses (including, without limitation diminution in value of the leasehold estate in the Premises, damages for the loss or restriction on use of the Premises, damages to any other property and amounts paid in settlement of claims, attorney fees and costs, consultant fees and expert fees) which arise during or within five years after the end of the Term or extended Term as a result of such 8 11 contamination. Without limiting the foregoing, the indemnification stated above includes, without limitation, reasonable costs incurred in connection with any investigation of site condition or any clean up, remedial, removal or restorative work required by any federal, state or local government agency or political subdivision because of Hazardous Materials present at the Premises due to acts of the indemnifying party. If the presence of any Hazardous Material caused or permitted by either party results in any contamination of the Premises or any other part of the property, then that party shall promptly take all actions, at its sole expense, as are necessary to return the Premises and any other property to the condition existing prior to the introduction of such Hazardous Material. Prior to commencing such action, the acting party shall obtain the other party's approval, which approval shall not be unreasonably withheld, or delayed so long as such actions would not potentially have any material adverse long- or short-term effect on the Premises or other property. As used herein, the term "Hazardous Materials" means any hazardous, dangerous, toxic or harmful substance material or waste which is or becomes regulated by any local or federal governmental authority, including the State of Washington or the United States government. 6. ALTERATIONS. (a) Tenant shall not make or suffer to be made any alterations, additions, or improvements in, on, or to the Premises or any part thereof after the Commencement Date ("Tenant Alterations") without the prior written consent of Landlord, which shall not be unreasonably withheld or delayed. All contractors, laborers, materialmen and professionals who perform work on the Premises shall agree to provide to Landlord a conditional lien release prior to release of any payment to them for work they performed as required in paragraph 8 herein. (b) At the time Tenant requests Landlord's permission to make Tenant Alterations, Tenant may request Landlord to designate in writing whether said proposed Tenant Alteration shall become part of the leasehold or whether Landlord wishes Tenant to remove said Tenant Alteration upon termination the Lease. Landlord and Tenant shall be bound by any such written agreement. If Tenant does not request Landlord to designate in writing whether said Tenant Alteration will become part of the leasehold, Landlord may make that determination when the Lease is terminated. Said determination by Landlord shall be at Landlord's sole option and shall be binding on Tenant. Notwithstanding the foregoing, Tenant's movable furniture, equipment and trade fixtures are Tenant's personal property. Upon the expiration or sooner termination of the Term, Tenant shall, at Tenant's sole cost and expense, forthwith and with all due diligence remove all Tenant's personal property and any or all Tenant Alterations which were designated by Landlord to be removed either at the time installed or, if not determined at that time as provided above, then prior to or when the Lease is terminated. Tenant shall forthwith and with all due diligence, at its sole cost and expense, repair any damage to the Premises resulting from removal of Tenant's personal property and 9 12 Tenant Alterations at the end of the Term, so as to restore the Premises to the condition that existed on the Commencement Date subject to ordinary wear and tear, damage by casualty or by the negligence or willful misconduct of Landlord or the gross negligence or willful misconduct of Landlord's agents or employees. (c) If, after the Commencement Date, Landlord makes any changes, alterations or additions to the Premises, landlord will use its best efforts to make such changes, alterations or additions without unreasonably interfering with the public access to the Premises, including Tenant's parking, and without interfering with Tenant's utility services, including without limitation all electricity, gas, water, sewer, HVAC and telecommunications services to the Premises. If such interference to utility services should occur, Landlord shall make reasonable efforts to restore such accessibility or services in coordination and cooperation with Tenant. If such interference with electricity, gas, water, sewer or telecommunication services occurs due to the acts or omissions of Landlord, its agents or employees and such interference is not cured within five (5) days of Tenant's written notice to Landlord, on the sixth day all Rent due under the lease shall abate until such interference is cured, and Tenant may engage in such measures as it sees fit to cure the interference at Tenant's sole cost so long as Tenant gives Landlord twenty four (24) hours prior actual notice of its intended actions hereunder and Landlord expresses no reasonable objection to such actions within twenty four (24) hours of receiving the notice. If the flow of electricity to the Premises is interrupted, Tenant may install a generator on the Premises at Tenant's sole expense and risk so long as such installation is in full compliance with all applicable rules, regulations and codes. Tenant hereby agrees to defend, indemnify and hold Landlord harmless from any loss, injury to persons or property, death of any person or any other damage or loss related to Tenant's installation or use of the generator and/or replacement of Tenant's uninterruptible power supply with said generator. 7. REPAIRS. (a) By taking possession of the Premises, Tenant accepts the Premises as being in the condition in which Landlord is obligated to deliver them and otherwise in good order, condition and repair. Landlord shall provide janitorial service and keep the Premises in clean condition and good repair, maintain all plumbing fixtures, HVAC systems, window and door glass, landscaping and all other systems so they remain in good condition and shall otherwise maintain the cleanliness and condition of the Premises, ordinary wear and tear, damage by Tenant's negligence or that of its agents, employees, invitees and licensees and damage from condemnation or casualty excepted. Tenant shall, at all times during the Term, reimburse the Landlord for the cost of keeping the Premises and every part thereof in good order, condition and repair, ordinary wear and tear and damage by casualty or Landlord's negligence or the gross negligence of Landlord's agents and employees excepted. Tenant shall pay said costs as part of Basic Operating Costs pursuant to paragraph 27. Tenant shall upon the expiration or sooner termination of 10 13 the Term, surrender to Landlord the Premises, neat and clean and in the same condition as when received, ordinary wear and tear and damage caused by Landlord's negligence and the gross negligence of Landlord's agents or employees, casualty or condemnation excepted. Tenant agrees that Landlord has no obligation to alter, remodel, improve, or decorate, or paint the interior of the Premises or any part thereof after the Commencement Date and that no representations respecting the condition of the Premises have been made by Landlord to Tenant, except as specifically set forth in this Lease. (b) Landlord shall at its cost without pass-through to Tenant keep the roof, gutters, power service to the Premises, exterior walls, foundations and building structure of the Premises in a good state of repair, and shall accomplish such repairs as may be needed within a reasonable time after receipt of written notice from Tenant. Except as expressly provided for herein, there shall be no abatement of Rent and no liability of Landlord by reason of any injury to or interference with Tenant's business arising from the making of any repairs, alterations or improvements in or to any portion of the Premises, building or in or to any fixtures, appurtenances and equipment therein except to the extent caused by the Landlord's negligence or the gross negligence or willful misconduct of Landlord's agents or employees. (c) If the Landlord fails to make any repairs or perform any work required herein or otherwise fails to maintain the Premises in the condition provided herein, Tenant shall so notify Landlord in writing. If after thirty (30) days prior written notice from Tenant (except in emergency or cases of urgent necessity, or for anything that cannot be done in such time period, or after such longer period as may reasonably be required to accomplish the required tasks), Landlord fails to keep and preserve the Premises as set forth in this paragraph, Tenant may, put or cause the same to be put in the appropriate condition and state of repair, at its option. Tenant must first give twenty (20) days written notice to Landlord of Tenant's intention of making the repair and the cost to be incurred. In such case, upon receipt of written statements and evidence of payment from Tenant, Landlord shall promptly reimburse the entire cost thereof to Tenant. If Landlord fails to reimburse Tenant within thirty (30) days of demand and receipt of the written statements and evidence of payment from Tenant, Tenant may offset the unreimbursed portion of the cost from the Rent, so long as Tenant is in complete compliance with this paragraph and there is no dispute as to Tenant's right to reimbursement. Notwithstanding the foregoing, if such work was required because of Tenant's negligent acts or failure to abide by this Lease, Tenant shall promptly pay Landlord for the total cost of all such work as Additional Rent. 8. LIENS. Tenant shall keep the Premises free from any liens arising out of any work performed, material furnished, or obligations incurred by Tenant subject to Tenant having the right to contest any lien in good faith and by taking the steps necessary to protect Landlord and its interest from any negative consequence of such contest. Tenant shall not permit 11 14 any person or entity to commence work on the Premises unless said person has agreed to provide Tenant and Landlord with conditional lien releases upon payment of each draw request. Tenant shall deliver to Landlord a duly executed conditional lien release in which said person or entity agrees to waive and release all his/her/its right to claim a lien on the Premises for work performed and paid for and shall deliver a final lien release at completion of the work. In the event that Tenant has not, within ten (10) days following the imposition of any lien, caused the same to be released of record by payment or posting of a proper bond or otherwise satisfying Landlord's concern, Landlord shall, in addition to all other remedies provided herein and at law, have the right, but not the obligation, to cause the same to be released by such means as it shall deem proper, including payment of the claim giving rise to such lien. All such sums paid by Landlord and all reasonable expenses incurred by it in connection therewith shall be considered Additional Rent and shall be payable to it by Tenant on demand with interest at the rate payable of twelve percent (12%) per annum or four percent (4%) above the prime rate of US Bank, whichever is greater. Landlord shall have the right at all times to post and keep posted on the Premises any notices permitted or required by law, or which Landlord shall deem proper, for the protection of Landlord, the Premises, and any other party having an interest therein, from mechanics' and materialmen's liens. Tenant shall give to Landlord at least five (5) business days prior notice of commencement of any construction on the Premises. Tenant shall not permit any lien to be placed on the Tenant's interest in the Premises by operation of law. 9. ASSIGNMENT OR SUBLETTING. Tenant shall not sell, assign, encumber or otherwise transfer by operation of law or otherwise this Lease or any interest herein, sublet the Premises or any part thereof, or suffer a person to occupy or use the Premises or any portion thereof, without the prior written consent of Landlord, which shall not be unreasonably withheld or delayed. A transfer by the present majority shareholders of ownership and control of the voting stock of a corporate tenant, or a transfer of a controlling interest in a partnership, limited liability company, or proprietorship, as applicable, shall be deemed an assignment for the purposes of this paragraph except as follows in paragraph 9a: (a) Any change in ownership of Tenant resulting from (i) a public offering of the stock of Tenant or any parent of Tenant or (ii) any transfer of stock or assets from Tenant to an affiliate or subsidiary corporation or other entity that controls or is controlled by Tenant or (iii) as a result of any merger, consolidation or other reorganization of Tenant or parent of Tenant shall not be deemed an assignment if all of the following conditions are met: Said assignee is an entity organized in the United States with its principal office in the United States and is as financially sound as Tenant. If the assignee is not organized in the United States and/or does not have its principal business office located in the United States, Tenant may assign the Lease to said entity if the assignee provides a guarantor whose assets are located in the United States that is as financially sound as the 12 15 Tenant. The assignee or guarantor shall be deemed to be as financially sound as Tenant if (i) the assignee or guarantor has unencumbered liquid assets located in the United States which are equal to or greater in value than 125 percent of the value of the unencumbered liquid assets of Tenant on the Commencement Date, and (ii) the assignee's or guarantor's net assets located in the United States as determined using Generally Accepted Accounting Principles consistently applied, are equal to or greater in value than 125 percent of the value of Tenant's net assets on the Commencement Date, and (iii) the assignee or guarantor has not been the subject of any bankruptcy proceeding or action by a prior Landlord within the seven years prior to the date of the assignment, (iv) the assignee has been in continuous operation of its business for the five years prior to the date of the assignment, and (v) no prior Landlord has commenced proceedings or refused to renew or extend a lease because of untimely payment of rent or damage to the Premises, as evidenced in writing by such prior landlord, within ten (10) years prior to the proposed assignment. In addition, the Landlord may agree with Tenant that a proposed assignee or guarantor is as financially sound as Tenant without regard to the foregoing objective standard. (b) Any other transfer, assignment or subletting shall be deemed a prohibited transfer pursuant to this paragraph and shall be subject to prior written permission of the Landlord, which shall not be unreasonably withheld or delayed. (c) Tenant shall, by written notice, advise Landlord of its desire from and after a stated date (which shall not be less than thirty (30) days or more than ninety (90) days after the date of Tenant's notice), to assign the Lease or sublet the premises or any portion thereof. Said notice by Tenant shall state the name and address of the proposed assignee or subtenant. Requests shall include audited or reviewed financial statements of assignee or sublessee and such other financial information as Landlord reasonably requests. Tenant shall include a true and complete copy of the proposed terms of the assignment or sublease. Such notice shall specify an effective date which shall be the first day of a calendar month and shall be not less than 30 days after the date of such notice. Landlord agrees to respond to Tenant's request for consent within ten (10) business days of receipt of the request and all required information. Failure to respond to Tenant within the ten-day period is deemed to be Landlord's denial of the proposal. If Landlord's consent to the transfer, sublease or assignment is required pursuant to this paragraph 9, Landlord shall have the right, by giving written notice to tenant ten (10) business days after receipt of Tenant's notice, to terminate this Lease as to the portion of the Premises described in Tenant's notice. Such notice shall, if given, terminate this Lease with respect to the portion of the premises described in Tenant's notice as of the date stated in Tenant's notice. If this Lease terminates pursuant to the foregoing with respect to less than all of the Premises, the rent shall be prorated to that date. If 13 16 Tenant proposes to sublet only a portion of the Premises, and Landlord exercises its right to recapture that portion, the effective date of recapture by Landlord shall be the effective date of the proposed subletting. On such date: (i) that portion shall not be part of the Premises; (ii) the Base Rent payable under this Lease shall be reduced by the rate per rentable square foot payable for such portion multiplied by the number of rentable square feet in such portion; the rental rate per rentable square foot is as follows: 1st year $18.50 per Rentable Square Foot 2nd year $19.00 per Rentable Square Foot 3rd year $19.50 per Rentable Square Foot 4th year $20.00 per Rentable Square Foot 5th year $20.50 per Rentable Square Foot 6th year $21.00 per Rentable Square Foot 7th year $21.50 per Rentable Square Foot The rate per rentable square foot shall be calculated according to BOMA Standards for a single tenant building as that phrase is defined in the Standard Method for Measuring Floor Area in Office Buildings (an American National Standard ANSI/BOMA 265.1 1996 (Revised and readapted June 7, 1996) published by Building Owners & Managers Association International; (iii) Tenant's share of operating costs and real estate taxes shall be reduced proportionately; and (iv) Landlord shall, at its sole cost and expense, do all that is necessary to separate the remainder of the Premises from the portion recaptured by Landlord. If Tenant requests the right to sublet a portion of the Premises and the proposed sublease is for less than the remaining Term of the Lease and if the Landlord elects to exercise its rights of recapture, as described above, then at the end of the sublessee's term, the Tenant shall take back possession of the subleased portion of the Premises for the remainder of the then current Term of this Lease, as renewed, if applicable. When Tenant regains possession of the sublessee's portion of the Premises, Tenant shall be subject to all the terms of this Lease and shall pay rent at the rate provided in this Lease, even if the rent paid by the sublessee was greater than the Rent required by this Lease. Landlord and Tenant shall execute an amendment to this Lease to revive the Lease for the sublet portion of the Premises being returned for the balance of the then current Term. The rights to renewal shall be as provided in paragraph 42. (d) As a condition to Landlord's written consent and to any subleasing, or assignment, assignees or the subtenants shall agree in writing to 14 17 comply with and be bound by all of the terms, covenants, conditions, provisions, and agreements of this Lease. Tenant shall deliver to Landlord, an executed copy of each assignment and sublease and an agreement to comply with the terms of the Lease signed by each assignee or sublessee. (e) Landlord's consent to any sale, assignment, encumbrance, subletting, occupation, lien or other transfer shall not release Tenant from any of Tenant's obligations hereunder, except as agreed in writing by Landlord, or be deemed to be a consent to any subsequent occurrence. Any sale, assignment, encumbrance, subletting, occupation, lien or other transfer of this Lease which does not substantially comply with the provision of this Paragraph shall be void. (f) The liability of the Tenant named in this Lease and any immediate or remote successor in interest of Tenant (by assignment or sublease), and the due performance of the obligations of this Lease on Tenant's part to be performed or observed, shall not in any way be discharged, released, or impaired by any (i) agreement which modifies any of the rights or obligations of the parties under the Lease, (ii) stipulation that extends the time with which an obligation under the Lease is to be performed, (iii) waiver of the performance of an obligation required under this Lease, or (iv) failure to enforce any of the obligations set forth in the Lease. Landlord shall use its best efforts to notify Tenant if any of the above enumerated actions would substantially increase Tenant's liability. (g) If Landlord elects to allow Tenant to assign or sublet all or any portion of the Premises, and the sublease rent paid by the assignee or sublessee for the Premises or the portion thereof being assigned or sublet exceeds one hundred percent (100%) of the Rent provided by this Lease, (the "Excess Subrent"), if the Landlord does not exercise his right to recapture the space as provided herein, then such Excess Subrent shall be shared equally between Tenant and Landlord. Such party's pro rata share of the Excess Subrent shall be paid to the party within fifteen (15) business days of receipt by the other party. (h) Without limiting any of the provisions of this paragraph, if Tenant has entered into any sublease of any portion of the Premises, the voluntary or other surrender of this Lease by Tenant, or a mutual cancellation by Landlord and Tenant, shall not work a merger (unless Landlord at its option by notice to the subtenant elects a merger to occur) and shall not terminate all or any subleases or subtenancies, but shall, at the option of the Landlord, operate as an assignment to Landlord of any or all such subleases or subtenancies. 10. INSURANCE AND INDEMNIFICATION. (a) Tenant shall purchase at its own expense and keep in force during the term of this Lease a policy or policies of workman's compensation and commercial general liability insurance, including personal injury and property damage, in the amount of no less than Two Million Dollars ($2,000,000) for property damage and Two Million Dollars ($2,000,000) 15 18 per claim for personal injuries or death of persons occurring in or about the Premises, or such other amount as Landlord shall reasonably deem necessary, based on periodic insurance reviews in respect to injury or damage to persons or property. Said policies shall: (i) name Landlord as an additional insured and insure Landlord's contingent liability under the Lease, (ii) be issued by an insurance company which is acceptable to Landlord and licensed to do business in the State of Washington, and, (iii) provide that such insurance shall not be canceled unless thirty (30) days prior written notice shall have been given to Landlord. Certificates of said policies shall be delivered to Landlord by Tenant on the Commencement Date and upon each renewal of said insurance. (b) If Tenant serves, distributes or sells any alcoholic beverages, the insurance carried by Tenant shall not exclude violation of any governmental statute, ordinance, regulation or rule pertaining to the sale, gift, distribution or use of any alcoholic beverages and shall extend coverage for any damages occurring at locations other than the Premises and resulting from risks insurable by Host liquor license liability insurance. (c) In addition to the insurance required above, Tenant shall, at its own cost and expenses, keep and maintain in full force and effect during the term, property insurance covering Tenant's supplies, inventory and other personal property as well as all improvements, additions and modifications to the Premises in an amount equal to one hundred percent of the replacement cost. The insurance policy shall bear an endorsement that the policy shall not be cancelled or the policy limits reduced below the coverage required by this Lease for any reason other than non-payment of premiums, except upon thirty (30) days prior written notice to Landlord. Tenant shall deliver certificates of said policies to Landlord upon the Commencement Date and upon each renewal of said insurance. (d) If Tenant fails or refuses to maintain any insurance required herein, Landlord may at its discretion, obtain and maintain insurance for such items of interest to protect Landlord in such amounts as Landlord determines to be appropriate and all premiums paid or payable by Landlord shall be deemed to be Additional Rent and payable by Tenant as provided in Paragraph 3 of this Lease for the payment of Rent. Failure to obtain and maintain insurance required by this paragraph after twenty (20) days' written notice by Landlord to Tenant of such failure shall constitute a material breach of this Lease. (e) Landlord shall not be liable to Tenant and Tenant hereby waives all claims against Landlord for any injury or damage to any person or property in or about the Premises by or from any cause whatsoever, other than Landlord's negligence or willful acts or omissions or the gross negligence or willful acts or omissions of Landlord's agents or employees. Landlord shall during the term maintain such insurance as Landlord deems necessary including replacement cost standard form property insurance and liability insurance and shall make Tenant an 16 19 additional insured under the liability insurance and provide Tenant certificates of insurance, upon request. (f) Tenant shall indemnify, defend and hold Landlord harmless from and against any and all claims and liability, including any claims brought by employees under any workman's compensation statute, for any injury or damage to any person or property whatsoever occurring in, on, or about the Premises, or any part thereof when such injury or damage is caused in part or in whole by the act, neglect, fault, or omission of Tenant or Tenant's officers, contractors, licensees, agents, servants, employees, guests, invitees, or visitors on or about the Premises. Tenant further agrees to indemnify and hold Landlord harmless against and from any and all claims by or on behalf of any person, firm or corporation arising from the conduct or management of any work or thing whatsoever done by the Tenant in or about the Premises or from the transactions of the Tenant concerning the Premises, and will further indemnify and hold Landlord harmless against and from any and all claims arising from any breach or default on the part of the Tenant in the performance of any covenant or agreement of this Lease on the part of Tenant, or any of its officers, contractors, licensees, agents, servants, employees, guests, invitees, or visitors on or about the Premises together with all costs, reasonable attorneys' fees, expenses, and liabilities incurred in connection with any such claim or action or proceeding brought thereon. If any action or proceeding is brought against Landlord by reason of any claim or liability, Tenant agrees to defend such action or proceeding at Tenant's sole expense by counsel selected by Tenant and reasonably satisfactory to Landlord. The provisions of this Paragraph shall survive the expiration or termination of the Lease with respect to any claims or liability occurring prior to such expiration or termination for a period ending five years after the Termination Date of this Lease. (g) Landlord shall indemnify, defend and hold Tenant harmless from and against any and all claims and liability for any injury or damage to any person or property whatsoever occurring in, on or about the Premises or any part thereof when such injury or damage is caused by the negligence or willful misconduct of Landlord or the gross negligence or willful misconduct of Landlord's employees or agents on or about the Premises. Landlord further agrees to indemnify and hold Tenant harmless against and from any and all claims by or on behalf of any person, firm or corporation arising solely from the conduct of any work done by the Landlord in or about the Premises, and will further indemnify and hold Tenant harmless against and from any and all claims arising from any breach or fault on the part of the Landlord in the performance of any covenant or agreement of this Lease on the part of Landlord, and all costs, reasonable attorneys' fees, expenses, and liabilities incurred in connection with any such claim or action or proceeding brought thereon. If any action or proceeding is brought against Tenant by reason of any claim or liability, Landlord agrees to defend such action or proceeding at Landlord's sole expense by counsel selected by Landlord and reasonably satisfactory to Tenant. The provisions of this paragraph shall survive the expiration or 17 20 termination of the Lease with respect to any claims or liability occurring prior to such expiration or termination for a period ending five years after the Termination Date of this Lease. 11. WAIVER OF SUBROGATION. Landlord and Tenant hereby waive any right that each may have against the other on account of any loss or damage arising in any manner which is covered by policies of insurance for fire and extended coverage, theft, public liability, workmen's compensation or other insurance now or hereafter existing during the term hereof, provided, however, the parties hereby covenant with each other that no insurer shall hold any right of subrogation against either Landlord or Tenant, as the case may be. Nothing in this paragraph shall be interpreted to have the effect of relieving or modifying any obligation of any insurance company, and shall be void to the extent it would have such effect. 12. SERVICES TO LANDLORD. Landlord shall pay as part of Basic Operating Costs, all charges for water, gas, heat, electricity, power, telephone service, sewer service and sewer rentals charged or attributable to the Premises, and all other services or utilities used in, upon or about the Premises during the Term and the cost of installing meters or check meters. Such amounts shall be billed by Landlord to Tenant at the time and in the manner Basic Operating Costs are billed and Tenant shall pay to Landlord as Additional Rent all such costs, expenses and charges so billed. Tenant shall not at any time overburden or exceed the capacity of the mains, feeders, ducts, conduits or other facilities by which utilities are supplied, distributed or serving the Premises. In no event shall Landlord be liable for an interruption or failure in the supply of any such utilities to the Premises and the same shall not constitute a termination of this Lease or eviction of Tenant except Tenant shall have the right to abatement described in paragraph 6(c) herein. 13. ESTOPPEL CERTIFICATE. (a) Within ten (10) days following any written request which Landlord may make from time to time, Tenant shall execute and deliver to Landlord a certificate substantially in the form attached hereto as Exhibit "C" and made a part hereof, indicating thereon any exceptions thereto which may exist at that time. Failure of the Tenant to execute and deliver such certificate within ten (10) days of notice that such certificate is overdue shall constitute a material default under the terms of this Lease and an acknowledgment by Tenant that the statements included in Exhibit "C" are true and correct without exception. Landlord and Tenant intend that any statement delivered pursuant to this Paragraph may be relied upon by any mortgagee, beneficiary, purchaser or prospective purchaser of the Premises or any interest therein. 18 21 (b) Within ten (10) days following any written request from Landlord, Tenant shall furnish its most recently publicly published financial statements to Landlord. 14. HOLDING OVER. (a) Any holding over after the expiration of the Term with the written consent of the Landlord of this Lease shall be a tenancy from month to month. The terms, covenants and conditions of such tenancy shall be the same as provided herein and the monthly Base Rent shall be one hundred fifty percent (150%) of the Base Rent paid monthly for the last month prior to the expiration, plus the monthly portion of Tenant's Proportionate Share of Basic Operating Costs. Acceptance by Landlord of Rent after such expiration shall not result in any other tenancy or any renewal of the Term, and the provisions of this paragraph are in addition to and do not affect Landlord's right of re-entry or other rights provided under this Lease or by applicable law. (b) If Tenant shall retain possession of the Premises or any part therefore without Landlord's consent following the expiration or sooner termination of this Lease for any reason, then Tenant shall pay to Landlord for each day of such retention as Base Rent two hundred percent (200%) of the amount of the daily Base Rent for the last month prior to the date of such expiration or termination plus a monthly portion of Tenant's Proportionate Share of Basic Operating Expenses. Tenant shall also indemnify and hold Landlord harmless from any loss or liability resulting from delay by Tenant in surrendering the Premises, including, without limitation, any claims made by any succeeding tenant founded on such delay. Acceptance of rent by Landlord following expiration or termination shall not constitute a renewal of this Lease, and nothing contained in this paragraph shall waive Landlord's right of re-entry or any other right. Tenant shall be only a Tenant at sufferance, whether or not Landlord accepts any rent from Tenant while Tenant is holding over without Landlord's written consent. 15. SUBORDINATION. Without the necessity of any additional document being executed by Tenant for the purpose of effecting a subordination, this Lease shall be subject and subordinate at all times to the lien of any mortgage or deed of trust which may now exist or hereafter be executed in any amount for which said building, land, or Landlord's interest or estate in any of said items, is specified as security; provided however that Tenant's subordination to any lien arising after the date of this Lease (except only a subsequent lien which represents the conversion of the existing construction loan secured by the Premises to a permanent financing loan of approximately the same principal amount) is subject to receipt by Tenant of an executed nondisturbance agreement (in the form attached as Exhibit C or other form acceptable to Tenant) between Tenant and the person or entity seeking subordination of Tenant's interest. Such nondisturbance agreement is not effective unless and until Tenant signs the Estoppel Certificate required under paragraph 13. Landlord will use its best efforts to obtain a nondisturbance 19 22 agreement in favor of Tenant from the holder of the permanent loan secured by the Premises. Landlord shall also have the right to subordinate or cause to be subordinated such liens to this Lease. In the event that any mortgage or deed of trust is foreclosed or a conveyance in lieu of foreclosure is made for any reason, Tenant shall, notwithstanding any subordination, attorn to and become the Tenant of the successor in interest to Landlord at the option of such successor in interest and subject to the terms of a non-disturbance agreement, and thus the successor in interest to Landlord shall respect Tenant's possession of the Premises under the Lease. Tenant covenants and agrees to execute and deliver, upon demand by Landlord and in the form reasonably requested by Landlord, any additional documents evidencing the priority or subordination of this Lease with respect to the lien of any such mortgage or deed of trust. 16. RULES AND REGULATIONS. Tenant shall faithfully observe and comply with the rules and regulations printed on or annexed to this Lease as Exhibit "D" and all reasonable modifications thereof and additions thereto from time to time put into effect by Landlord to the extent such rules and regulations are not inconsistent with the terms of this Lease or contrary to Laws, do not interfere with Tenant's operations, are not discriminatory, and do not substantially increase the costs of Tenant to comply. 17. RE-ENTRY BY LANDLORD. Landlord reserves and shall at all times have the right to re-enter the Premises to inspect the same, after reasonable prior notice to Tenant, to supply janitor service and any other service to be provided by Landlord to Tenant hereunder, to show said Premises to prospective purchasers or mortgagees or to show said Premises to prospective tenants during the last six (6) months of the term, to post notice of non-responsibility, and to alter, improve, or repair the Premises and any portion of the Premises, without abatement of Rent, (except as provided in paragraph 6(c)) and may for that purpose erect, use, and maintain scaffolding, pipes, conduit, and other necessary structures in and through the Premises where reasonably required by the character of the work to be performed, provided that entrance to the Premises shall not be blocked thereby, and further provided that the business of Tenant shall not be interfered with unreasonably or for prolonged periods of time. For each of the aforesaid purposes, Landlord shall at all times have and retain a key with which to unlock all of the doors in, upon, and about the Premises, excluding Tenant's vaults and safes, or special security areas (designated in advance by written notice to Landlord), and Landlord shall have the right to use any and all means which Landlord may deem necessary or proper to open said doors in an emergency, in order to obtain entry to any portion of the Premises. Any such emergency entry to the Premises, or portions thereof obtained by Landlord by any of said means, or otherwise, shall not under any circumstances be construed or deemed to be a forcible or unlawful entry 20 23 into, or a detainer of, the Premises, or an eviction, actual or constructive, of Tenant from the Premises or any portions thereof. 18. INSOLVENCY OR BANKRUPTCY. (a) If Tenant becomes a debtor under Chapter 7 of the Bankruptcy Code ("Code"), or if a petition for reorganization or adjustment of debts is filed concerning Tenant under Chapters 11 or 13 of the Code, or a proceeding is filed under Chapter 7 of the Code and is transferred to Chapters 11 or 13 of the Code, the Trustee or Tenant, and as debtor-in-possession, may not elect to assume this Lease unless, at the time of such assumption, the Trustee or Tenant has: (i) cured all defaults under the Lease and paid all sums due and owing under the Lease, or provided Landlord with "adequate assurance" (as defined below) that (1) within ten (10) days from the date of such assumption, the Trustee or Tenant will completely pay all sums due and owing under this Lease and compensate Landlord for any actual pecuniary loss resulting from any existing defaults or breach of this Lease, including, without limitation, Landlord's reasonable costs, expenses, accrued interest, and attorney fees and costs incurred as a result of the default or breach and/or as a result of the filing of the petition in bankruptcy; (ii) within twenty (20) days from the date of such assumption, the Trustee or Tenant will cure all non-monetary defaults and breaches under the Lease, or if the nature of such non-monetary defaults is such that more than twenty (20) days are reasonably required for such cure that the Trustee or Tenant will commence to cure such non-monetary defaults within twenty (20) days and thereafter diligently prosecute such cure to completion; and (iii) the assumption will be subject to all of the provisions of the Lease. (b) For purposes of this paragraph, Landlord and Tenant acknowledge that in the context of a bankruptcy proceeding involving Tenant, at a minimum, "adequate assurance" shall mean (i) that Trustee or Tenant has and will continue to have sufficient funds to fulfill the obligations of Tenant under this Lease; (ii) the Bankruptcy Court shall have entered an order segregating sufficient cash payable to Landlord and/or the Trustee or Tenant shall have granted a valid and perfected first lien and security interest and/or mortgage in or on the property of Trustee or Tenant acceptable as to value and kind to Landlord to secure to Landlord the obligation of the Trustee or Tenant to cure the monetary and/or non-monetary defaults and breaches under this Lease within the time period set forth above; and (iii) the Trustee or Tenant, at the very minimum, shall deposit a sum equal to two (2) months Base Rent to be held by Landlord (without any 21 24 allowance for interest thereon) to secure Tenant's future performance under the Lease. (c) If the Trustee or Tenant has assumed the Lease pursuant to the provisions of this paragraph for the purpose of assigning Tenant's interests hereunder to any other person or entity, such interest may be assigned only after the Trustee, Tenant, or the proposed assignee has complied with all the terms, covenants, and conditions of this Lease, including without limitation those with respect to additional rent. Landlord and Tenant acknowledge that such terms, covenants and conditions are commercially reasonable in the context of a bankruptcy proceeding by Tenant. Any person or entity to which the Lease is assigned pursuant to the provisions of the Code shall be deemed without further act or deed to have assumed all of the obligations arising under this Lease on and after the date of such assignment. Any such assignee shall, upon request, execute and deliver to Landlord an instrument confirming such assignment. (d) Upon the filing of a petition by or against Tenant under the Code, Tenant, as debtor and debtor-in-possession, and any Trustee who may be appointed, agree to adequately protect Landlord as follows: (i) to perform each and every obligation of Tenant under this Lease until such time as this Lease is either rejected or assumed by order of the Bankruptcy Court; (ii) to pay all monetary obligations required under this Lease, including without limitation the payment of Base Rent, Tenant's share of the increase in Operating Costs, and any other sums payable by Tenant to Landlord under this Lease which is considered reasonable compensation for the use and occupancy of the Premises; (iii) provide Landlord a minimum of thirty (30) days prior written notice, unless a shorter period is agreed to by the parties, of any proceeding relating to any assumption of the Lease or any intent to abandon the Premises, which abandonment shall be deemed a rejection of the Lease; and (iv) to perform for the benefit of the Landlord as required otherwise under the Code. Failure of Tenant to comply with the above shall result in automatic rejection of the Lease. 19. DEFAULT. A party's failure to perform or honor any covenant, condition or representation made under this Lease shall constitute a default hereunder by the party acting or failing to act upon the expiration of the applicable cure period set forth in this Paragraph following written notice of the default. If the default is failure to pay Rent, Additional Rent, or other monetary sum, then the defaulting party shall have a period of ten (10) days from the date of the notice to cure as provided by statute. Except as otherwise provided in this Lease, a party shall have a period of thirty (30) days from the date of the notice to cure any default under this Lease that is not a default in payment of Rent or Additional Rent; provided, however, that with respect to any default which cannot reasonably be cured within thirty (30) days, the party in default shall have additional time necessary to 22 25 cure the default so long as that party commences to cure within thirty (30) days from the other party's notice, and continues to prosecute diligently the curing thereof. Upon a default under this Lease by either party following failure to cure by the defaulting party within the permissible time period, the non-defaulting party, as specified below and after due process of law, shall have any or all of the following rights and remedies in addition to, or as an alternative to, at the non-defaulting party's option, any other rights or remedies available to the non-defaulting party at law or in equity. All such rights and remedies are cumulative: (a) If Tenant is the defaulting party, the unpaid balance of any amounts advanced by Landlord to Tenant for Tenant Improvements shall be immediately due and payable without notice of acceleration. Landlord may avail itself of all remedies available to collect said amounts, which are deemed to be Additional Rent, including commencing action for eviction and/or exercising any and all other remedies available under this Lease or in law and equity. (b) If the Tenant is the defaulting party, the Lease may be terminated at the option of Landlord by notice in writing to Tenant. If the Landlord gives notice of termination, the Lease will be deemed terminated as of the date specified in the notice and the Tenant shall have no further rights or obligations under the Lease except as provided in this Paragraph 19, which shall survive termination of the Lease. (c) Unless the Lease is terminated as provided in subparagraph (b), the Lease will continue in full force and effect, except Tenant's right to possession of the Premises may be terminated at any time, at the option of Landlord, by notice in writing to Tenant. If Landlord gives notice to Tenant as herein provided, Tenant's right to possession of the Premises will be deemed terminated as of the date specified in Landlord's notice, and Landlord may from time to time, but shall not be obligated to, sublet the Premises or any part thereof for such term or terms and at such rent and such other terms as is commercially reasonable, with the right to make alterations and repairs to the Premises. Upon each subletting, at the option of Landlord: (i) either Tenant shall be immediately liable to pay to Landlord, in addition to indebtedness other than rent due hereunder, the cost of such subletting and such alterations and repairs incurred by Landlord and the amount, if any, by which the rent received for the period of such subletting is less than the amount to be paid as rent for the Premises for such period, or (ii) Landlord shall apply rents received from such subletting first, to payment of any indebtedness other than rent due hereunder from Tenant to Landlord; second, to the payment of any costs of subletting and of any alterations and repairs; third, to payment of rent due and unpaid hereunder; and the residue, if any, shall be held by Landlord and applied in payment of future rent as the same becomes due hereunder. If, under option (i), the rent shall not be promptly paid to Landlord by the subtenant(s), or if, under option (ii), the rentals received from the subletting during any month are less than all amounts owed for that month by Tenant hereunder, Tenant shall pay any 23 26 such deficiency to Landlord. Such deficiency shall be calculated and paid monthly. Unless and until the Lease is terminated as provided in subparagraph (b), Tenant shall continue to be liable to Landlord for rent and all other amounts owing under the Lease when and as they become due, whether or not Tenant's possession of the Premises has been terminated, and whether or not the Premises are sublet by Landlord. No act or omission by Landlord shall be construed as an election on its part to terminate this Lease unless a written notice of such intention is given to Tenant as provided in subparagraph (b). Notwithstanding any action taken by Landlord under this subparagraph, Landlord may at any time thereafter elect to terminate this Lease for such previous uncured or continuing breach. (d) Upon termination of the Lease as provided in subparagraph (b) and/or upon termination of Tenant's right to possession of the Premises, as provided in subparagraph (c), Landlord may re-enter and take possession of the Premises, and may remove any persons or property by legal action or any other lawful means and without liability for damages. Any of Tenant's property remaining on the Premises, including, without limitation, equipment, inventory, furnishings and trade fixtures, shall be deemed to have been abandoned by Tenant, upon five (5) days written notice to Tenant, and shall be and become the property of Landlord; provided, however, that Landlord may, in its sole discretion, reject the property and elect instead to store such property in a public warehouse or elsewhere at the cost of and for the account of Tenant, and further may, but shall not be obligated to, upon five (5) days written notice to Tenant, sell such property and apply the proceeds therefrom in accordance with applicable law. (e) In the event the Lease is terminated as provided in subparagraph (b) above, Landlord shall be entitled to recover immediately, without waiting until the due date of any future Rent or until the date fixed for expiration of the Term provided in the Lease, all of the following amounts as damages: (1) All past due Rent and other amounts owing by Tenant to Landlord pursuant to the terms of this Lease as of the date of termination of the Lease; and (2) All costs associated with Tenant's default, whether or not suit was commenced, including, without limitation, costs of re-entry and re-letting, costs of clean-up, refurbishing, removal of Tenant's property and fixtures, other expenses occasioned by Tenant's failure to quit the Premises upon termination and to leave them in the required condition, any remodeling costs, reasonable attorneys fees, court costs, broker commissions, and advertising costs; and (3) The loss of the reasonable rental value of the Premises from the date of termination of the Lease until a new Tenant has been, or with the exercise of reasonable efforts, could have been secured; and 24 27 (4) Any excess of the value of the rent and all of Tenant's other obligations under this Lease, as if the Lease had not been terminated, over the reasonable expected return from the Premises for the period commencing on the earlier of the date of trial or the date of the Premises are relet and continuing through the end of the term. The present value of future amounts will be computed using a discount rate equal to the lowest prime interest rate announced by a major Washington bank on short-term commercial loans for its most credit-worthy customers, in effect on the date of trial or the date the Premises are relet. Landlord is entitled to all said amounts to the extent they are required to make Landlord whole together with double damages as provided by law. (f) Landlord may, in its sole discretion, sue periodically to recover damages during the period corresponding with the remainder of the Term, if the Lease has not been terminated. No action for damages shall bar a later action for damages subsequently accruing or, in the alternative, Landlord may elect to call the entire amount of rental for the balance of the term, or what would have been the balance of the term if the Lease had not been terminated as provided in subparagraph (b), immediately due and payable, which rent shall be paid by Tenant to Landlord as liquidated damages. (g) To the extent required by law, both Landlord and Tenant have the obligation to take reasonable steps to mitigate their damages caused by any default under this Lease. 20. DAMAGE BY FIRE, ETC. (a) If the Premises are damaged or destroyed by fire or other casualty such that the repairs can be made within one hundred fifty (150) days from the date of such damage, then Landlord shall forthwith repair the same to the condition that existed on the date of the damage, under the laws and regulations of the federal, state, and local governmental authorities having jurisdiction thereof. In such event, this Lease shall remain in full force and effect except that Tenant shall be entitled to a proportionate abatement of rent while such repairs to be made hereunder by Landlord are being made. Said proportionate abatement shall be based on the rental rates per rentable square foot in Paragraph 9(c) above, and the extent to which the making of such repairs to be made hereunder by Landlord shall interfere with the business carried on by Tenant on the Premises. If such damages or destruction resulted from the act, fault or neglect of Tenant, then rent shall abate only to the extent Landlord receives proceeds from Landlord's rental income insurance policy to compensate Landlord for the loss of such rent. Within thirty (30) days from the date of such damage, Landlord shall notify Tenant whether or not such repairs can be made within one hundred fifty (150) days from the date of such damage. If and to the extent such damage or destruction is not fully covered by Landlord's insurance policy, Landlord shall have the right to terminate this Lease upon written notice of such election to terminate within thirty (30) 25 28 days from the date of such damage or destruction. If the Landlord determines that such repairs cannot be made within one hundred fifty (150) days from the date of such damage or destruction, then Landlord shall have the option within thirty (30) days of the date of such damage or destruction either to: (a) notify Tenant of Landlord's intention to repair the damage, in which event this Lease shall continue in full force and effect and the Rent shall be reduced as provided herein; or (b) notify Tenant of Landlord's intention to terminate this Lease as of the date specified in such notice which date shall be not less than thirty (30) days nor more than sixty (60) days after such notice is given. In case of termination of the Lease by Landlord, (i) the rent shall be partially abated by a proportionate amount based upon the rental rates per rentable square foot in Paragraph 9(c) above, and the extent to which said damage interfered with the business carried on by Tenant in the Premises, and the Tenant shall pay such reduced rent up to the date of termination specified in Landlord's notice; and (ii) the unused Security Deposit and unearned rent paid by the Tenant under this Lease shall be returned to Tenant immediately upon such termination. The repairs to be made hereunder by Landlord shall not include, and Landlord shall not be required to repair, any damage by fire or other cause to Tenant's Personal Property or any repairs or replacements of any paneling, decorations, railings, floor coverings, or any alterations, additions, fixtures or improvements installed on the Premises by or at the expense of Tenant. If Landlord determines that the repairs cannot be made within one hundred fifty (150) days and elects to terminate the Lease, Tenant may request that Landlord's determination be reviewed by a Repair Architect. If the parties cannot agree on a selection of a Repair Architect within ten (10) days following Tenant's written notice to Landlord that it wishes a Repair Architect to settle the matter, both Tenant and Landlord shall appoint a Repair Architect within five (5) days who shall in turn select a third Repair Architect. The decision of the third Repair Architect shall be rendered within thirty (30) days from the date he is appointed and shall be binding upon the parties. The matter shall not be submitted to a Repair Architect if Landlord's insurance would not cover the required repairs. If the Repair Architect determines that the repairs cannot be made within one hundred fifty (150) days, then the Lease shall be terminated as of the date the decision of the Repair Architect is rendered. The parties shall share equally the cost of the Repair Architect. (b) If at the time of any such damage, less than one (1) year remains in the Term and Tenant has not exercised its option to extend the Term then either Landlord or Tenant, at either's sole option, shall have the right to terminate this Lease. 21. EMINENT DOMAIN. (a) If any part of the Premises shall be taken or appropriated under the power of eminent domain or conveyed in lieu thereof and said taking materially interferes with Tenant's business or Landlord's ability to Lease the Premises, Landlord shall have the right to terminate this 26 29 Lease. In such event, Landlord shall receive, and Tenant shall assign to Landlord upon demand from Landlord, any and all income, rent, award or any interest thereon which may be paid or owed in connection with the exercise of such power of eminent domain or conveyance in lieu thereof. Tenant shall have no claim against Landlord or against the agency exercising such power or receiving such conveyance, for any part of such sum paid by virtue of such proceedings. Notwithstanding the foregoing, Tenant may pursue its remedies against the condemning agency for the value of the unexpired Term, and for reimbursement for the value of its personal property, moving and relocation expenses and value of improvements made to the Premises at Tenant's expense after the Commencement Date so long as said action does not act to diminish Landlord's recovery of its loss. If a part of the Premises shall be so taken or appropriated or conveyed and Landlord shall elect not to terminate this Lease, Landlord shall nonetheless receive (and Tenant shall assign to Landlord upon demand from Landlord) any and all income, rent, award or any interest thereon paid or owed in connection with such taking, appropriation or conveyance. If the Premises have been damaged as a consequence of such partial taking or appropriation or conveyance, Landlord shall restore the Premises continuing under this Lease at Landlord's cost and expense provided that such restoration can be made within one hundred fifty (150) days of the time the property so taken is appropriated or conveyed. If restoration cannot be made within one hundred fifty (150) days from the time of taking, Landlord shall notify Tenant within sixty (60) days of such taking and Landlord or Tenant shall have the right to cancel this Lease by giving the other written notice of its intention to cancel within thirty (30) days of the date of Landlord's notice. If Landlord determines that the repairs cannot be made within one hundred fifty (150) days and elects to terminate the Lease, Tenant may request that Landlord's determination be reviewed by a Repair Architect. If the parties cannot agree on the selection of a Repair Architect within ten (10) days following Tenant's written notice to Landlord that it wishes a Repair Architect to settle the matter, both Tenant and Landlord shall appoint a Repair Architect within five (5) days who shall in turn select a third party Architect. The decision of the third Repair Architect shall be rendered within thirty (30) days from the date he is appointed and shall be binding upon the parties. The matter shall not be submitted to a Repair Architect if Landlord's insurance would not cover the required repairs. If the Repair Architect determines that the Lease can be terminated as decided by the Landlord, the Lease shall be terminated as of the date the decision of the Repair Architect is rendered. The parties shall share equally the cost of the Repair Architect. (b) If Landlord and/or Tenant elect not to cancel this Lease, it shall remain in full force and effect except that Tenant shall be entitled to a proportionate abatement in Rent while restoration is being made by Landlord. Such proportionate abatement shall be based upon the rental rates per rentable square foot in Paragraph 9(c) above, and the extent to which the taking, appropriation or conveyance and the restoration 27 30 being made by Landlord interferes with the business operations carried on by Tenant in the Premises. Landlord will not be required to repair or restore any injury or damage to Tenant's Personal Property or make any repairs or restoration to any alterations, additions, fixtures or improvements installed in the Premises by or at the expense of Tenant. (c) Notwithstanding anything to the contrary contained in this paragraph, if the temporary use or occupancy of any part of the Premises is taken or appropriated under power of eminent domain during the Term and such temporary use or occupancy continues for one hundred fifty (150) days or less and does not materially interfere with Tenant's ability to continue to operate its business at the Premises, this Lease shall be and remain unaffected by the taking or appropriation and Tenant shall continue to pay in full all Rent payable hereunder by Tenant during the Term. In the event of any temporary appropriation or taking, Tenant shall be entitled to receive that portion of any award which represents compensation for the use or occupancy of the Premises during the term of this Lease, and Landlord shall be entitled to receive that portion of any award which represents the cost of restoration of the Premises and the use and occupancy of the Premises after the end of the term of this Lease. 22. SALE BY LANDLORD. In the event of a sale or conveyance by Landlord of the Premises, the same shall operate to release Landlord from any future liability upon any of the covenants or conditions, express or implied, herein contained in favor of Tenant and becoming due or arising thereafter, and in such event Tenant agrees to look solely to the responsibility of the successor in interest of Landlord in and to this Lease as to any liability becoming due or arising thereafter. If Landlord transfers the Security Deposit and other deposits held to its successor, Tenant hereby releases Landlord from liability for all deposits paid by Tenant and released by Landlord to Landlord's successor. This Lease shall not be affected by any such sale, and Tenant agrees to attorn to the purchaser or assignee. As a material consideration for entering into this Lease, Landlord agrees not to sell or convey the Premises or assign Landlord's interest in this Lease before Tenant takes possession of the Premises. 23. RIGHT OF LANDLORD TO PERFORM. All covenants and agreements to be performed by Tenant under any of the terms of this Lease shall be performed by Tenant at Tenant's sole cost and expense and, without any abatement of rent, except as otherwise provided in this Lease. If Tenant shall fail to pay any sum of money, other than Rent or Additional Rent, required to be paid by it hereunder or shall fail to perform any other act on its part to be performed hereunder, and such failure shall continue after expiration of the notice period required by the Lease, if any, Landlord may, but shall not be obligated to do, and without waiving or releasing Tenant from any obligations of Tenant, to make any such payment or perform any such act on Tenant's part to be made or performed as in this Lease provided. 28 31 All sums so paid by Landlord and all necessary incidental costs (together with interest thereon at the rate of twelve percent (12%) per annum or four percent (4%) above the prime rate of US Bank per annum, whichever is more, from the date of such payment by Landlord, and shall be payable as Additional Rent to Landlord on demand, and Tenant covenants to pay any such sums. Landlord shall have, in addition to any other right or remedy of Landlord, the same rights and remedies in the event of nonpayment thereof by Tenant as in the case of default by Tenant in the payment of the Rent. 24. SURRENDER OF PREMISES. (a) At the end of the Term (as it may be extended) or other sooner termination of this Lease, or upon termination of Tenant's right to possession, Tenant will peaceably deliver up to Landlord possession of the Premises, together with all improvements or additions upon or belonging to same, by whomsoever made, in the same condition as received or first installed, ordinary wear and tear, damage by fire, earthquake, Act of God, the elements, other casualty condemnation, or the negligence or willful misconduct of Landlord, or the gross negligence or willful misconduct of Landlord's agents or employees excepted. Tenant may, prior to or upon the termination of this Lease or termination of Tenant's right to possession, remove any property or items which Tenant is entitled to remove under this Lease, at Tenant's sole cost, repairing any material damage caused by such removal. Property not so removed upon the termination of this Lease or upon termination of Tenant's right to possession shall be deemed abandoned by Tenant, and title to the same shall thereupon pass to Landlord. Upon request by Landlord, unless otherwise agreed to in writing by Landlord, Tenant shall remove, at Tenant's sole cost, any or all permanent improvements or additions to the Premises installed by or at the expense of Tenant after Tenant took possession of the Premises or which were designated by Landlord at the time of construction to be removed by Tenant upon termination and all movable furniture and equipment belonging to Tenant which are not Tenant Alterations. Tenant shall repair any material damage resulting from such removal. (b) At Landlord's option, the voluntary or other surrender of this Lease by Tenant, or mutual cancellation thereof, shall not work a merger, and shall operate as an assignment of any and all subleases or subtenancies. 25. WAIVER. If either Landlord or Tenant waives the performance of any term, covenant or condition contained in this Lease, such waiver shall not be deemed to be a waiver of any subsequent breach of the same or any other term, covenant or condition contained herein. Furthermore, the acceptance of Rent by Landlord shall not constitute a waiver of any preceding breach by Tenant of any term, covenant or condition of this Lease, regardless of Landlord's knowledge of such preceding breach at the time Landlord accepted such Rent. Failure by either party to enforce any of the terms, covenants or conditions of this Lease for any 29 32 length of time shall not be deemed to waive or to decrease the right of either party to insist thereafter upon strict performance by the other party. Waiver by either party or any term, covenant or condition contained in this Lease may only be made by a written document signed by the party waiving such term, covenant or condition. 26. NOTICES. All notices, requests and demands which may be or are required to be given by either party to the other hereunder shall be in writing. All notices and demands by Landlord to Tenant shall be sent by United States certified or registered mail, postage prepaid, or by overnight courier service, addressed to Tenant at the Premises address, or to such other place as Tenant may from time to time designate in a notice to Landlord, with a copy to Gorden Tanner, Stoel Rives LLP, 600 University Street, #3600, Seattle, WA 98101. All notices and demands by Tenant to Landlord shall be sent by United States certified or registered mail, postage prepaid, addressed to Landlord at the address specified in the Basic Lease Information, or to such other firm or to such other place as Landlord may from time to time designate in a notice to Tenant. All notices and demands shall be deemed given on the date personally delivered to the address designated above or on the date mailed as provided above. 27. OPERATING COSTS. In addition to Base Rent provided to be paid hereunder, Tenant shall pay, as Rent, Tenant's Proportionate Share of Basic Operating Costs in the manner set forth below; provided, however, that if Tenant occupies less than the entire building, then Tenant's Proportional Shares of Basic Operating Costs shall be reduced by the percentage of the space in the building occupied by other tenants calculated using BOMA Standard measurements of the other tenant's spaces divided by 35,320 square feet. (a) Definition: For purposes hereof, the terms used in this paragraph shall have the following meanings: (1) "Basic Operating Costs" shall mean, all expenses and costs of every kind and nature to the extent attributable to the Term which Landlord shall pay or become obligated to pay during the Term because of or in connection with the ownership and operation of the Premises (excluding the items in Paragraph 7(b) above) including, but not limited to, the following: (i) All wages, salaries and related expenses and benefits of all on-site and off-site employees of Landlord (excluding officers) engaged directly in the operation, management, maintenance, engineering and security of the Premises to the extent attributable to the Premises; provided, however, that Basic Operating Cost shall not include leasing commissions paid to any real estate broker, salesperson or agent. 30 33 (ii) Supplies, materials, tools and rental of equipment to the extent used in the operation, management and maintenance of the Premises. (iii) Utilities, including water and power, gas, sewer, heating, lighting, air conditioning and ventilating of the Premises. (iv) All parking lot maintenance, janitorial and service agreements for the Premises and the equipment therein, including without limitation, alarm services, garbage and waste disposal, security service, water treatment, vermin extermination, landscaping, window cleaning and elevator maintenance, subject to the obligations of Landlord under paragraph 9 of this Lease. (iv) A management fee not to exceed three and one-half percent (3 1/2%) of the Base Rent derived from the Premises. (v) Reasonable legal expenses, accounting expenses and the cost of audits by certified public accountants attributable to operation of the Premises; provided, however, that legal expenses chargeable as Basic Operating Cost shall not include the cost of negotiating leases, collecting rents or evicting other tenants nor shall it include costs incurred in legal proceedings with or against any other tenant or to enforce the provisions of any Lease. (vi) All insurance premiums and costs for insurance on the Premises obtained by Landlord, including but not limited to, the premiums and cost of fire, casualty and liability coverage, and rental abatement and earthquake insurance (if Landlord elects to provide such coverage) applicable to the Premises and Landlord's personal property used in connection therewith and any deductible payments incurred by reason of the insured loss. (vii) Repairs, replacement and general maintenance of the Premises due to ordinary wear and tear or to maintain Landlord's building standard (excluding repairs and general maintenance paid by proceeds of insurance or by Tenant or other third parties, and the alterations attributable solely to tenants of the Premises other than Tenant). (viii) All maintenance costs relating to public and service areas of the Premises, including (but without limitation) sidewalks, landscaping, service areas and mechanical rooms. (ix) All installments of taxes and assessments and governmental charges, whether federal, state, country or municipal, and whether by taxing districts or authorities presently taxing the Premises or by others, whether subsequently created or otherwise, and whether foreseen or unforeseen, and any other installments of taxes and assessments attributable to the Premises, whether or not directly paid by Landlord, including rent taxes, gross receipt taxes, business license taxes and fees for permits for the Premises, and any other tax or charge levied wholly or partly in lieu thereof, excepting only 31 34 inheritance or estate taxes and state or federal income taxes computed on the basis of the net income of the owners of the Premises; provided that all installments payable by Tenant under this paragraph shall be limited to those installments attributable to the Term. (x) Depreciation or amortization (together with reasonable financing charges) of capital improvements made to the Premises subsequent to the Commencement Date which will improve the operating efficiency of the Premises or which may be required to comply with laws, ordinances, rules or regulations promulgated, adopted or enforced after Commencement Date to the extent said capital improvements reduce the operating costs or enhance the life safety systems of the building. (xi) All reasonable costs of contesting any law applicable to the Premises or the amount of any taxes affecting the Premises. Notwithstanding anything to the contrary in this Lease, Basic Operating Costs shall not include (aa) the initial construction cost of the Premises; (bb) depreciation on the initial construction of the Premises; (cc) the cost of providing Tenant Improvements to Tenant or any other tenant; (dd) debt service or amortization (including, but without limitation, interest, principal and any impound payments) required to be made on any mortgage or deed of trust recorded with respect to the Premises; (ee) the cost of special services, goods or materials provided to any tenant; (ff) any bad debt, rent loss, or reserves for bad debt or rent loss; (gg) any expense for which Landlord is compensated through proceeds of insurance except deductible amounts paid by Landlord; (hh) any fine, interest or penalty levied against Landlord; (ii) costs of a capital nature including, without limitation, capital improvements, capital repairs, capital equipment, and capital tools, as determined under generally accepted accounting principles consistently applied; (jj) advertising or promotional expenses; (kk) expense for replacement of any items to the extent covered by a warranty; (ll) costs attributable to activities Landlord is responsible to pay for under this Lease; (mm) costs attributable to repair or replacement arising from construction or design defects, or refinancing or sale of the Premises or negligence or willful misconduct of Landlord or gross negligence or willful misconduct of Landlord's agents and invitees; (nn) costs paid to subsidiaries or affiliates of Landlord that exceed the costs of similar services from third parties; (oo) other expenses that under generally accepted accounting principles consistently applied would not be considered normal maintenance, repair, replacement due to ordinary wear and tear or to maintain Landlord's building standard, management or operating expenses. All costs and expenses shall be determined in accordance with generally accepted accounting principles which shall be consistently applied (with accruals appropriate to Landlord's business). Basic Operating Costs shall not include specific costs incurred for the account of, separately billed to and paid by specific tenants. Landlord shall not recover any item of cost more than once. Any costs that may be Basic Operating Costs shall be capitalized and allocated over their useful life in accordance with generally accepted accounting principles. 32 35 (2) "Estimated Basic Operating Costs" for any particular Fiscal Year shall mean Landlord's estimate of the Basic Operating Costs for such Fiscal Year as hereinafter provided. Landlord shall have the right from time to time to revise its Fiscal Year and interim accounting periods so long as the periods as so revised are reconciled with prior periods in accordance with generally accepted accounting principles consistently applied. (3) "Basic Operating Cost Adjustment" shall mean the difference between Basic Operating Costs and Estimated Basic Operating Costs for any Fiscal Year determined as hereinafter provided. (b) Payment of Estimated Basic Operating Costs. During the last month of each Fiscal Year during the Term, or as soon thereafter as practicable, Landlord shall give Tenant written notice of the Estimated Basic Operating Costs for such Fiscal Year. The Fiscal Year is as specified in the Basic Lease Information. The Estimated Basic Operating Costs for the Fiscal Year in which the Commencement Date falls is set forth in the Basic Lease Information sheet. Tenant shall pay in advance one twelfth (1/12th) of one hundred percent (100%) of the Estimated Basic Operating Costs with each monthly installment of Basic Rent required to be paid pursuant to paragraph 3 above for the Fiscal Year to which the estimate applies on the first day of each calendar month during such Fiscal Year. Such payment shall be construed to be Rent for all purposes hereof. If at any time during the course of a Fiscal Year, Landlord determines that Basic Operating Costs will materially vary from the then Estimated Basic Operating Costs, Landlord may, by written notice to Tenant, revise the Estimated Basic Operating Costs for the balance of such Fiscal Year and Tenant shall pay Tenant's Proportionate Share of Estimated Basic Operating Costs as so revised for the balance of the then current Fiscal Year on the first day of each calendar month thereafter. Such revised installment amounts are Rent for all purposes hereof. Failure to revise the amount paid shall not diminish Landlord's right to collect all Basic Operating Costs from Tenant as Additional Rent. (c) Computation of Basic Operating Costs Adjustment. Within ninety (90) days after the end of each Fiscal Year, or as soon after the end of the Fiscal Year as practicable, Landlord shall deliver to Tenant a statement of Basic Operating Costs for the Fiscal Year just ended, accompanied by a computation of the Basic Operating Costs Adjustment. If such statement shows that Tenant's payments of Estimated Basic Operating Costs is less than Tenant's Proportionate Share of Basic Operating Costs, then Tenant shall pay the difference within thirty (30) days after receipt of such statement, such payment to constitute Additional Rent hereunder. If such statement shows that Tenant's payments of Estimated Basic Operating Costs exceed Tenant's Proportional Share of Basic Operating Costs, then (provided that Tenant is not in default under this Lease) Landlord shall so notify Tenant and reimburse Tenant for the overpayment within thirty (30) days of notification to Tenant of the overpayment. If this Lease has been terminated or the Term hereof has expired prior to the date of such 33 36 statement, then the Basic Operating Costs Adjustment shall be paid by the appropriate party within twenty (20) days after the date of delivery of the statement. (d) Net Lease. This shall be a net Lease and Base Rent shall be paid to Landlord net of all costs and expenses of repairing, operating and maintaining the Premises. The provisions for payment of Basic Operating Costs by means of periodic payments of Tenant's Proportionate Share of Estimated Basic Operating Costs and the Basic Operating Costs Adjustment are intended to pass on to Tenant and reimburse Landlord for the costs and expenses of the nature described in Paragraph 27(a)(1) above incurred in connection with ownership and operation of the Premises now and in subsequent years as may reasonably be determined by Landlord to be necessary to the Premises. (e) Tenant Audit. Tenant shall have the right, at Tenant's expense and upon not less than seven (7) days prior written notice to Landlord, to review at reasonable times Landlord's books and records for any Fiscal Year, or portion of which that falls within the Term for the purposes of verifying Landlord's determination and calculation of Basic Operating Costs and Basic Operating Costs Adjustment. In the event that Tenant shall dispute the amount set forth in any statement provided by Landlord under paragraph 27(c) above, Tenant shall have the right, not later than sixty (60) days following the receipt of such statement to cause Landlord's books and records with respect to such Fiscal Year to be audited by certified public accountants selected by Tenant subject to Landlord's reasonable right of approval as to selection of the accountants and upon condition that Tenant shall first deposit with Landlord the full amount in dispute. The Basic Operating Costs Adjustment shall be appropriately adjusted on the basis of such audit. If such audit discloses a liability for a refund or credit by Landlord to Tenant in excess of ten percent (10%) of Tenant's Proportionate Share of Basic Operating Costs Adjustment previously reported, the cost of such audit shall be borne by Landlord. Otherwise the cost of such audit shall be paid by Tenant. If Tenant shall not request an audit in accordance with the provisions of this subparagraph 27(e) within sixty (60) days of receipt of Landlord's statement provided pursuant to paragraph 27(c), such statement shall be final and binding for all purposes hereof. Any discrepancy revealed by an audit under this subparagraph shall be promptly paid by the party owing the money based on the results. Amounts not paid upon demand shall bear interest at the rate of twelve percent (12%) per annum or four percent (4%) above the prime rate of US Bank per annum, whichever is more, from five (5) days after the date of the demand until paid in full. 34 37 28. TAXES PAYABLE BY TENANT. Landlord shall pay and Tenant shall reimburse Landlord for any and all installments of taxes levied or assessed and which become payable by Landlord (or Tenant) during the term of this Lease (excluding, however, state and federal personal or corporate income taxes measured by the income of Landlord from all sources, capital stock taxes, and estate and inheritance taxes and taxes levied on Tenant's personal property), whether or not now customary or within the contemplation of the parties hereto, which are based upon, measured by or otherwise calculated with respect to: (a) the gross or net payable under this Lease, including, without limitation, any gross receipts tax levied by any taxing authority, or any other gross income tax or excise tax levied by any taxing authority with respect to the receipt of the rental hereunder, (b) the value of Tenant's equipment, furniture, fixtures or other personal property located in the Premises; (c) the possession, lease, operation, management, maintenance, alteration, repair, use or occupancy by Tenant of the Premises or any portion thereof; (d) the value of any leasehold improvements, alterations or additions made in or to the Premises, regardless of whether title to such improvements, alterations or additions shall be in Tenant or Landlord; or (e) this transaction or any document to which Tenant is a party creating or transferring an interest or an estate in the Premises. All such taxes shall be estimated, collected and paid in the same manner as Basic Operating Costs. In the event that it shall not be lawful for Tenant to so reimburse Landlord, the Rent payable to Landlord under this Lease shall be revised to provide Landlord with the same net Rent after imposition of any such tax upon Landlord as would have been payable to Landlord prior to the imposition of any such tax. All taxes payable by Tenant under this paragraph shall be deemed to be and shall be paid as Additional Rent. Tenant shall pay directly to the taxing authority before any such taxes become delinquent all taxes levied on Tenant's income or personal property and all other taxes directly related to Tenant's assets and business operations; provided Tenant may contest any such tax in good faith without violating this provision. 29. SUCCESSORS AND ASSIGNS. Subject to the provisions of Paragraph 9 hereof, the terms, covenants and conditions contained herein shall be binding upon and inure to the benefit of the heirs, successors, executors, administrators and assigns of the parties hereto. 35 38 30. ATTORNEY'S FEES. In the event that it is necessary for either party to retain an attorney to enforce or interpret the terms of the Lease, the prevailing party shall be entitled to recover, in addition to damages proven, all reasonable attorney fees and costs incurred in enforcing this Lease, whether said fees and costs are incurred in negotiation, mediation, arbitration, litigation, appeal, bankruptcy, pre- or post-judgment collection, declaratory action, or otherwise. In the event of litigation, the prevailing party shall be determined by a court of competent jurisdiction. 31. SECURITY DEPOSIT. (a) Upon execution of this Lease, Tenant will pay Landlord a Security Deposit for the faithful performance of all terms, covenants and conditions of this Lease. The sum of said deposit is specified in the Basic Lease Information. Tenant agrees that Landlord may apply said Security Deposit to remedy any failure by Tenant to repair or maintain the Premises or to perform any other terms, covenants or conditions contained herein. If Tenant has kept and performed all terms, covenants and conditions of this Lease during the term hereof, Landlord will, on the termination hereof promptly return said sum to Tenant or the last permitted assignee of Tenant's interest hereunder at the expiration of the Lease Term or any extended Lease Term. Should Landlord use any portion of said sum to cure any default by Tenant hereunder, Tenant shall forthwith replenish said sum to such original amount. Landlord shall not be required to keep any Security Deposit separate from its general funds, and Tenant shall not be entitled to interest on any such deposit. Upon the occurrence of any events of default described in Paragraph 19 of this Lease. After the expiration of any applicable cure period without cure having been accomplished, said Security Deposit shall become the property of Landlord. Landlord may increase the amount of the deposit each time Tenant exercises its option to renew so that Landlord always has an amount equal to the last month's Base Rent as a Security Deposit. (b) Tenant hereby agrees not to look to the mortgagee, as mortgagee, mortgagee in possession, or successor in title to the property, for accountability for any Security Deposit required by the Landlord hereunder, unless said sums have actually been received by such mortgagee as security for the Tenant's performance of this Lease. 32. SIGNAGE. Subject to Landlord's prior approval, which shall not be unreasonably withheld or delayed, Tenant shall have the right to install signage on or in the Premises at its own cost. The right to install signage on or in the Premises shall be exclusive to the Tenant at all times during which Tenant leases more than ninety percent (90%) of the Premises except for identification and location signs for the other Tenants on the building directory and office doors or walls. Such signage shall be in accordance with all applicable codes, rules and regulations. 36 39 Tenant shall provide to Landlord detailed plans for the exterior signage, including colors, scale, placement, and all other elements related to the signage, prior to submitting the same to the municipality for approval. Tenant shall be responsible for acquiring and paying for all municipal approvals and permits. Tenant shall pay all costs incurred to obtain Landlord's approval including review and/or redesign by Landlord's architect or other agents. At the termination of the Lease, Tenant shall pay all costs for removing all signs and restoring the Premises to their condition at the time the sign was installed, reasonable wear and tear, damage from casualty or condemnation or Landlord's negligence or Landlord's employees and agents' gross negligence excepted. 33. CORPORATE AUTHORITY. Each of the persons executing this Lease on behalf of Landlord or Tenant does hereby covenant and warrant pertaining to the entity for whom they sign that it is a duly authorized and existing corporation, that the corporation has and is qualified to do business in Washington, that the corporation has full right and authority to enter into this Lease, and that each and all of the persons signing on behalf of the corporation are authorized to do so. Upon a party's request, the other party shall provide evidence reasonably satisfactory to the requesting party confirming the foregoing covenants and warranties. 34. LEASE EFFECTIVE DATE. Submission of this instrument for examination or signature by Tenant does not constitute a reservation of or option for Lease, and it is not effective as a Lease or otherwise until execution and delivery by both Landlord and Tenant. 35. BROKERAGE FEES. Tenant hereby represents and warrants that it has not used or dealt with any other broker, agent or other person in connection with this transaction, except Colliers MacAuley Nichols International, and that Tenant owes no brokerage fees or commission related to this Lease. Tenant agrees to defend, indemnify and hold Landlord harmless from and against any claims or liens filed by any other broker, agent, or other person claiming a commission or other form of compensation by virtue of having dealt with Tenant with regard to this leasing transaction. Landlord shall pay commissions due to Colliers MacAuley Nichols International and Leibsohn and Company for this Lease pursuant to the Listing Agreement with Leibsohn and Company. Landlord shall have no obligation to pay commissions to any agent upon Tenant's exercise of any of its options to extend the term pursuant to this Lease or if Tenant should enter into a Lease for subsequent terms. 37 40 36. FORCE MAJEURE. Whenever a period of time is herein prescribed for action to be taken by either party, the party required to act shall not be liable or responsible for, and there shall be excluded from the computation for any such period of time, any delays due to strikes, riots, Acts of God, shortages of labor or materials, war, governmental laws, regulations or restrictions or any other causes of any kind whatsoever which are beyond the reasonable control of the party required to act. The Tenant's rights of self-help in this Lease are available during periods of force majeure delay or interruption so long as required notice is given. 37. CHANGE IN BUILDING NAME. The name of the Building will be INTERLINQ PLAZA upon the execution of this Lease for as long as Tenant leases the building, subject to Paragraph 38(b)(i) below. 38. CERTAIN RIGHTS RESERVED BY LANDLORD Landlord shall have the following rights, exercisable without notice and without liability to Tenant, for damage or injury to property, persons or business and without effecting an eviction, constructive or actual, or disturbance of Tenant's use or possession or giving rise to any claim for setoff or abatement of rent if any other tenant occupies the building: (a) Landlord may, at its option, decorate and make repairs, alterations, additions, changes or improvements, whether structural or otherwise, in and about the public areas and any subleased or assigned portions of the Premises not occupied by Tenant or subject to repossession by Tenant under paragraph 9(c), ("Unoccupied Areas"), or any part thereof, and for such purposes, upon reasonable notice to Tenant, may enter upon the public areas or Unoccupied Areas of the Premises. During the continuance of any such work, Landlord may temporarily close doors or entryways in the public or unoccupied areas of the building, interrupt or temporarily suspend non-essential building services and facilities all without abatement of rent, except as otherwise provided herein, and without affecting any of Tenant's obligations hereunder, so long as the public areas of the Premises are reasonably accessible and reasonably tenantable. (b) If Tenant subleases or assigns any portion of the Premises or if another tenant enters into occupancy of the Premises, Landlord may, upon reasonable notice to Tenant, (i) change the name by which the Premises is designated if Tenant occupies less than fifty one percent (51%) of the Premises; (ii) grant to anyone the exclusive right to conduct any business or render any service in or to the Unoccupied Areas of the Premises, provided such exclusive right shall not operate to exclude Tenant from the use expressly permitted herein; (iii) have access for Landlord and other tenants of the Premises to any mail chutes located on the Premises according to the rules of the United 38 41 States Postal Service; (iv) take all such reasonable measures as Landlord may deem advisable for the security of the Project and its occupants. Said actions may be taken under such reasonable regulations as Landlord may prescribe from time to time generally applied to all Tenants. 39. PERSONAL LIABILITY. The liability of Landlord to Tenant for any default by Landlord under the terms of this Lease shall be limited to the interest of Landlord in the Premises, and Landlord shall not be personally liable for any deficiency. This clause shall not be deemed to limit or deny any remedies which Tenant may have in the event of default by Landlord hereunder which do not involve the personal liability of Landlord. No personal liability is assumed by, nor shall at any time be asserted or enforceable against Landlord or its principals on account of the Lease or on account of any covenant or agreement of Landlord contained herein. Tenant's sole and exclusive remedy shall be against Landlord's interest in the Premises and the land on which it is located. No principal of Landlord shall be served or named as a party in any suit or shall be required to answer or otherwise plead to any service of or process, and no judgment shall be entered against any principal of Landlord. Any judgment entered against any principal of Landlord may be vacated and set aside at any time nunc pro tunc. 40. QUIET ENJOYMENT. Provided Tenant observes its obligations under this Lease, Tenant shall have peaceable and quiet enjoyment of the Premises throughout the Term, and Landlord shall not act in any manner which would interfere with or disrupt Tenant's business or frustrate Tenant's business purposes at the Premises. 41. MISCELLANEOUS. (a) The paragraph headings herein are for convenience of reference and shall in no way define, increase, limit or describe the scope or intent of any provision of this Lease. The term "Landlord" in these presents shall include the Landlord, its successors, and assigns. The term "Tenant" or any pronoun used in place thereof shall indicate and include the masculine or feminine, the singular or plural number, individuals, firms or corporations, and their and each of their respective successors, executors, administrators, and permitted assigns, according to the context hereof. (b) Time is of the essence of this Lease and all its provisions. This Lease shall in all respects be governed by the laws of the State of Washington. This Lease, together with its exhibits, contains all the agreements of the parties hereto and supersedes any previous negotiations. The terms of this Lease supersede any representations made by the Landlord or understandings made between the parties other than those set forth in this Lease and its exhibits. This Lease may not be modified except by a written instrument by the parties hereto. 39 42 (c) If for any reason whatsoever any of the provisions hereof shall be unenforceable or ineffective, all of the other provisions shall be and remain in full force and effect. 42. OPTION TO RENEW. Tenant shall have two (2) consecutive options to extend the Term for an additional five (5) years each. Tenant must give Notice of its intent to exercise an option to Landlord not less than nine (9) months, nor more than one (1) year, prior to expiration of the then existing Term. The Lease shall continue in full force and effect during the Term (as so extended), except the Base Rent will be adjusted for each five year extension of the Term and Landlord may increase the amount of the Security Deposit as provided in paragraph 31 so that the Security Deposit always equals the last month's Base Rent for the Term. Commencing no later than twenty (20) days after Tenant's Notice of intent to exercise an option to extend, the parties shall attempt to agree upon the amount of the Base Rent for the Premises for the applicable extension of the Term. The Base Rent for the extension of the Term shall be equal to ninety-five percent (95%) of the current market rental rates for comparable space in comparable Class A buildings in comparable locations in Bellevue, Redmond, Kirkland and Mercer Island. If the parties cannot agree on the Base Rent for the extension of the Term within sixty (60) days of the date Landlord receives Tenant's Notice of intent to exercise the option to extend, then, at the election of either party, the Base Rent for the extension of the Term shall be established by an MAI appraiser jointly selected by the parties. The party who wishes to have the Base Rent determined for the extended term must so notify the other in writing and designate an MAI appraiser. Said designation must be received by the other party within thirty (30) days of Tenant's notice of exercise of its option to extend, or Tenant's option will automatically terminate. If the parties are unable to agree upon the selection of such an appraiser, then they shall each select an MAI appraiser and the two so designated shall select a third. The Base Rent for the extension of the Term determined by the selected MAI appraiser or any two of the three MAI appraisers so chosen shall be binding on the parties and may not be appealed. If either party fails to notify the other of its appraiser within thirty (30) days after written request to do so, the MAI appraiser selected by the other party shall make the determination of the Base Rent. Tenant's right to exercise each option to extend the Term is contingent upon Tenant's then being current in its payment of Rent and all other amounts due under this Lease, and otherwise being in compliance with all terms of the Lease (subject to any permitted cure periods), at the time Tenant gives its Notice of intent to exercise an option and on the first date of the newly extended Term. At the time that Landlord notifies Tenant of the proposed Base Rent for each extension of the Term, Landlord shall also notify Tenant of the cost of the covered parking stalls during the extension of the Term, and any dispute regarding the proposed parking fees shall be resolved in the same manner used to resolve a dispute over Base Rent for the extension 40 43 of the Term. The right to extend the Term shall not be affected by Tenant's sublease or assignment of any party of the Premises if (1) Landlord's so agreed in writing when it consented to such sublease or assignment, or (2) the assignment was permitted without Landlord's consent under Paragraph 9(a), or (3) the sublease ends and Tenant retakes the Premises prior to the end of the then current Term and Tenant is not in default at the end of the then current Term. Notwithstanding the foregoing, if Tenant has elected to extend the Term, all the terms of such extension have been agreed by Landlord and Tenant and set forth in a fully executed written extension of the Lease, then Tenant may enter a sublease under the terms of Paragraph 9 that commences prior to the end of the then current term and expires before the end of the newly extended Term without the loss of its rights to renew the Term as provided herein and in the written extension. 43. USE OF ROOF AND BUILDING STORAGE. Tenant may not use the roof and building storage areas without prior written permission of Landlord which Landlord may refuse or condition. Tenant shall be allowed to install a satellite dish on the roof. If Tenant receives permission to use the roof, roof use shall be restricted to non-commercial telecommunications and other similar uses. Landlord will not install or allow others to install commercial telecommunications equipment on the roof. Any alterations of the roof or building storage areas shall be in accordance with the provisions of this Lease and requires Landlord's prior written approval. Tenant shall not enter onto the roof unless accompanied by an employee or agent of Landlord. 44. DEFINITION OF LANDLORD'S NEGLIGENCE. "Landlord's negligence and willful misconduct" refers to the negligence of Pine Forest Co.'s officers. The other employees of Pine Forest Co. and its agents are held to the standard of gross negligence. Nothing herein shall be construed to make any individuals personally liable. //// //// //// 41 44 IN WITNESS WHEREOF, the parties hereto have executed this Lease the day and year first above written. LANDLORD: TENANT: PINE FOREST CO., a INTERLINQ SOFTWARE CORPORATION, Washington corporation a Washington corporation By: /s/ F. H. BURNSTEAD By: /s/ STEVE YOUNT ------------------------------ ------------------------------ F. H. Burnstead, President Steve Yount, Vice President, Finance Date: 4-27-98 Date: 4-23-98 ---------------------------- ---------------------------- AGENTS: We have read and acknowledge paragraph 35. TRAMMEL CROW COLLIERS McAULEY NICHOLS INTERNATIONAL By: /s/ JOSEPH A. BALDWIN By: /s/ GEOFF BOGRON ------------------------------ ------------------------------ Joseph A. Baldwin, Agent Geoff Bogron, Agent STATE OF WASHINGTON ) ) ss. COUNTY OF KING ) THIS IS TO CERTIFY that on this 27 day of April, 1998, before me, a Notary public in and for the State of Washington, duly commissioned and sworn, came Frederick H. Burnstead, personally known or having presented satisfactory evidence to be the President of Pine Forest Co., the corporation that executed the foregoing instrument, and acknowledged the said instrument to be the free and voluntary act and deed of said corporation for the uses and purposes therein mentioned, and on oath stated that he is authorized to execute the said instrument on behalf of said corporation. WITNESS MY HAND and official seal the day and year in this certificate first above written. /s/ DIANNA GOINES Print Name: Dianna Goines Notary Public in and for the [SEAL] State of Washington, residing at Redmond Expiration Date: 8-25-99 42 45 STATE OF WA ) ) ss. COUNTY OF KING ) THIS IS TO CERTIFY that on this 23rd day of April, 1998, before me, a Notary public in and for the State of Washington, duly commissioned and sworn, came Steve Yount, personally known or having presented satisfactory evidence to be the Vice President, Finance of INTERLINQ Software Corporation, the corporation that executed the foregoing instrument, and acknowledged the said instrument to be the free and voluntary act and deed of said corporation for the uses and purposes therein mentioned, and on oath stated that he is authorized to execute the said instrument on behalf of said corporation. WITNESS MY HAND and official seal the day and year in this certificate first above written. /s/ LOUIS KOVITZ, JR. Print Name: Louis Kovitz, Jr. Notary Public in and for the State of Washington, residing at Bellevue Expiration Date: 1-29-99 43 46 EXHIBIT "A" LEGAL DESCRIPTION Lot 2, Short Plat Number 81-20, as recorded under King County Recording Number 8208239014, being a correction of King County Recording Number 8109169004, being a portion of Lots 7 and 8, Block 70, Burke and Farrar's Kirkland Addition to the City of Seattle, Division No. 23, according to the plat thereof recorded in Volume 21 of Plats, page 46, in King County, Washington; EXCEPT that portion thereof condemned in King County Superior Court Cause Number 618532 for Northrup Interchange (SR 520); ALSO EXCEPT that portion conveyed to the State of Washington by Deed recorded under Recording Number 6595483. Situated in the county of King, state of Washington. 44 47 EXHIBIT "B" WORK LETTER AGREEMENT 1. TENANT IMPROVEMENTS. Landlord shall construct Tenant Improvements on the Premises pursuant to Tenant Improvements Construction Documents and in accordance with the Tenant Improvements Construction Contract. The Tenant Improvements Construction Documents shall be prepared by or at the direction of Landlord based on the Tenant Improvements Schematic Plans in a form that is mutually acceptable to Tenant and Landlord, and shall be completed and approved in writing by both Landlord and Tenant no later than May 31, 1998. The Tenant Improvements Schematic Plans shall be prepared by or at the direction of Tenant in a form that is mutually acceptable to Tenant and Landlord and shall be completed and approved in writing by both Landlord and Tenant no later than April 30, 1998. Landlord shall obtain all necessary permits for construction of the Tenant Improvements. 2. BUILDING SHELL. Landlord shall construct the Building Shell on the Premises pursuant to the Building Shell Construction Documents and in accordance with the Building Shell Construction Contract. 3. COSTS OF TENANT IMPROVEMENTS. Landlord's Maximum Contribution shall be sued only to pay Tenant Improvements Costs which include the cost of preparing the Tenant Improvement Documents and other design fees and costs, all permitting and inspection fees and costs related to the Tenant Improvements, all costs of construction, labor and materials, contractor's profit and overhead for the Tenant Improvements, taxes, bonds and all other fees and costs incurred in constructing the Tenant Improvements. 4. DETERMINATION OF THE COST OF CONSTRUCTION. Within thirty (30) days after approval of the Tenant Improvements Schematic Plans by Landlord and Tenant, Landlord shall notify Tenant of the Projected Tenant Improvements Costs pursuant to the Tenant Improvements Schematic Plans under the Tenant Improvements Construction Contract. If the Projected Tenant Improvements Costs exceed the Landlord's Maximum Contribution, of Seven Hundred Thousand Dollars ($700,000) then Tenant may (1) request changes to the Tenant Improvements Schematic Plans to bring the Projected Tenant Improvements Costs below the Landlord's Maximum Contribution, (2) tender the difference between the Projected Tenant Improvements Costs and the Landlord's Maximum Contribution to the Landlord, or (3) request that the Landlord advance up to the maximum amount of Two Hundred Thousand Dollars ($200,000) ("Landlord Advance") to Tenant to complete the Tenant Improvements, or any combination of the three, at Tenant's election. Tenant shall be responsible to pay Landlord any Excess Tenant Improvements Costs as described in Paragraph 13 below. 5. REPAYMENT OF THE LANDLORD ADVANCE. If Tenant requests a Landlord Advance to pay a portion of the Tenant Improvements Costs, then the amount advanced shall bear interest at the rate of twelve percent (12%) per annum. It shall be amortized over the Initial Term of the Lease and shall be paid as Additional Rent in monthly installments in advance, without notice, commencing with the first month Rent is due under the Lease. Landlord shall 45 48 have the same rights to enforce the payment of the Landlord Advance as it does to enforce payment of all Rent and Additional Rent due under the Lease. Tenant shall sign such Notes, Guaranties, Amendment to the Lease, and other documents Landlord deems reasonably necessary in connection with the Landlord Advance. Landlord has no obligation to commence construction of the Tenant Improvements until Landlord has received the difference between the Tenant Improvements Costs and Landlord's Maximum Contribution or Tenant has executed those documents Landlord required prior to making any Landlord Advance. 6. CONTRACTS. Landlord shall contract with the appropriate members of the Project Team (other than Tenant's Representative) for services necessary to construct the Building Shell and Tenant Improvements pursuant to the Tenant Improvement Plans. The final Tenant Improvements Construction Contract (with dollar amounts) shall be provided to Tenant and must be approved in writing by Tenant within seven (7) days of receipt by Tenant and prior to commencement of construction of the Tenant Improvements or effectiveness of such contract. Landlord shall also provide Tenant with copies of Building Shell Construction Documents with costs expunged so Tenant can review which items are allocated to Tenant Improvement Costs and which items are allocated to the Building Shell. 7. DETERMINATION OF TENANT IMPROVEMENTS SUBCONTRACTORS. Landlord and Tenant have agreed that General Contractor shall serve as contractor for the Tenant Improvements pursuant to the Tenant Improvements Construction Contract and have further agreed that the Mechanical Subcontractor and the Electrical Subcontractor shall provide those services for the Tenant Improvements. For every other subcontractor for the Tenant Improvements, General Contractor shall obtain competitive bids which bids shall be available for Tenant's review and comment if Tenant so requests. After receipt of such bids, Landlord and Tenant shall each review and consult with each other regarding the bids whereupon the subcontractors shall be selected by Landlord and General Contractor. Bids will distinguish between Building Shell and Tenant Improvement Work. Approval of Tenant's Improvement Construction Contract by Tenant shall be deemed approved of the subcontractor competitive bids used in preparing the Tenant Improvements Construction Contract. 8. RESPONSIBILITY FOR CONSTRUCTION. Landlord shall be responsible for construction of the Building Shell and Tenant Improvements and shall employ the Project Team as provided above. Landlord shall make all decisions regarding the Building Shell. Landlord shall have control over the construction of the Tenant Improvements in cooperation with the Tenant, and shall have the right to make all final decisions regarding interpretation of the Tenant Improvements Construction Documents, after making a good faith attempt to get Tenant's approval of any element regarding the Tenant Improvement Construction Documents which is subject to several interpretations, provided, if Tenant is not available or does not provide an interpretation within twenty four (24) hours, Landlord's decision is final. In the event Tenant or Landlord wishes to make a material change in the Tenant Improvement Construction Documents, the party needing or wishing to make the change shall notify the other in writing of the change in the form a written change order. The change order shall describe the change, the cost associated with making the change, and the delay associated with making the 46 49 change, if any. General Contractor, Landlord and Tenant shall sign all said change orders. Failure to sign or object in writing to a change order within two (2) business days of the date the change order is submitted for approval shall be deemed approval of the change order. If construction will be delayed until approval of the change order is received, the General Contractor, Landlord, Tenant or TI Architect may impose a shorter time limit on approval. If the cost of the change will increase the projected Tenant Improvements Costs, the Tenant shall pay the cost as a Tenant Improvement Cost pursuant to paragraph 10. Tenant's approval of the change order or failure to respond within two (2) business days shall be conclusive evidence that Tenant has approved the change and any delay or increased cost associated with the change as disclosed in the change order. If Landlord or its agents determine that changes or modifications should be made in the space plans, plans or specifications because of permitting requirements, requests of governmental authorities, design or construction efficiencies or other reasons, Landlord shall make such changes which Landlord deems necessary; provided, that if such changes would result in an increase in the Projected Tenant Improvements Costs, then Tenant or TI Architect must have approve such change before Tenant is liable to pay such increase. 9. CONSTRUCTION ADMINISTRATION. Landlord and Tenant shall each proceed with all necessary due diligence and in good faith to complete such matters as require their respective action or approval, and both parties agree to promptly and diligently respond to all questions and concerns raised by architects, engineers and other consultants. Landlord and Tenant shall each endeavor to respond to submissions from General Contractor and TI Architect promptly, on an on-going basis in order that revisions required by Landlord, Tenant or applicable governmental agencies, can be promptly completed. When Tenant approval or comment is requested, Tenant or TI Architect shall respond within two (2) business days of request unless a different response period is provided in this Agreement or unless both parties agree following a request by either. If the TI Architect believes that a response to a request of either Landlord or Tenant is required in less than two (2) business days, then the party requested shall respond within such shorter time period as prescribed by the TI Architect. During construction of the Building Shell and Tenant Improvements, Landlord, Tenant, General Contractor and TI Architect together with other applicable consultants shall meet every week (unless meeting is cancelled) in order to review status and scheduling of Tenant Improvements construction and determine possible changes required, delays anticipated, costs being incurred and all related matters. At these meetings, change orders will be presented, discussed and executed (subject to the two-day deadline). 10. TENANT IMPROVEMENT COSTS. Landlord's Maximum Contribution, together with any Landlord Advance, shall be used only to pay Tenant Improvements Costs. Landlord agrees that the Landlord's Maximum Contribution and Landlord Advance, if any, shall not be applied against, nor shall Tenant be liable for, costs associated wit the construction of the Building Shell, landscaping, public area restrooms, electrical rooms, phone closets or other public areas of the Premises except for modifications requested by Tenant such as installation of cabinets, reception desk and other fixtures located in the reception area. Tenant shall be responsible for paying any Excess Tenant Improvements Costs if applicable and shall tender said amounts to 47 50 Landlord within five (5) days of written demand as a condition to Landlord commencing or continuing with construction of the Tenant Improvements. 11. EARLY ACCESS. Tenant shall be given access to the Premises prior to installation of the ceiling grid in order to allow Tenant to install telephone and other communications and media lines and systems, computer cabling, and related similar matters. The date of Early Access to the Premises and the time by which installation of Tenant's Work must be completed will be coordinated with the General Contractor. Tenant and General Contractor shall work together to ensure that Tenant's Work is completed in an efficient and timely manner and will not unreasonably impede, interfere with or delay the progress of construction of the Tenant Improvements. Tenant shall perform such installation in accordance with all guidelines promulgated by General Contractor and shall execute and require its contractors and subcontractors to execute such releases, indemnifications and other documents that General Contractor requires of its own subcontractors. Any and all costs of installation of such items shall be at Tenant's sole cost and expense. Tenant shall also be given Early Access to the Premises for purposes of storing its furniture and personal property in portions of the Premises in which Tenant Improvements are substantially complete. General Contractor shall designate the areas in which such storage can occur to ensure that such storage will not interfere with the construction of the Tenant Improvements. Tenant hereby releases Landlord, General Contractor and all of their agents, employees, licensees, invitees and subcontractors from all liability for loss or damage to Tenant's personal property stored on the Premises prior to the Commencement Date. Tenant agrees to maintain insurance on all said property and hereby assumes full risk of loss or damage to said personal property and hereby agrees to defend, indemnify and hold Landlord, General Contractor, their agents, employees, licensees, invitees and subcontractors harmless from any claims, loss or liability related to said stored personal property. 12. INSPECTION AND PUNCHLIST. During the construction of the Building Shell and the Tenant Improvements, Tenant, Landlord and General Contractor shall meet weekly and shall inspect the Premises regularly. In the event Tenant notices any defects in construction or variations from the Building Shell Construction Documents or Tenant Improvement Construction Documents, Tenant shall bring such variations to General Contractor's and Landlord's attention, and any such discrepancies or defects shall be remedied as soon as practicable. Upon Substantial Completion of the Tenant Improvements, General Contractor and/or Landlord shall notify Tenant. Tenant shall, within forty eight (48) hours of such notification, conduct an inspection of the Premises and prepare and submit to Landlord an itemized list ("Punchlist") of all matters which must be installed, completed or corrected so as to bring the Tenant Improvements into compliance with the Tenant Improvement Construction Documents; provided, however, that no matter on the Punchlist shall exceed the scope, quality or quantity of the Tenant Improvements as set forth in the Tenant Improvement Construction Documents. Once Tenant has taken occupancy of the Premises, Tenant shall notify Landlord in writing within sixty (60) days of taking possession of the Premises of any defects in construction or variations from the Tenant 48 51 Improvement Construction Documents. Landlord shall undertake to repair said deviations within sixty (60) days of receiving written notice of the need to correct or repair said item. On the sixty first (61st) day after the Tenant has taken possession of the Premises, Tenant shall be deemed to have accepted the Premises "as is," in their then current condition subject only to corrections of items already noted in writing to Landlord and not yet corrected or items covered by warranty by third parties. 13. TENANT ADVANCES OF EXCESS TENANT IMPROVEMENTS COSTS. Landlord shall advance all Tenant Improvements Costs up to the Landlord's Maximum Contribution (and full Landlord's Advance, if applicable). Thereafter, Landlord's obligation to continue with the construction is contingent upon Tenant paying 100% of all Excess Tenant Improvements Costs upon five (5) business days of demand in advance of construction. Unless Landlord agrees otherwise in writing, Tenant shall be solely responsible for providing all Tenant's Personal Property for its business at the Premises and Tenant shall not use any amounts provided by Landlord for said property. 14. DELAYS. Landlord will use its best reasonable efforts to complete construction of the Tenant Improvements by November 1, 1998. Landlord and Tenant agree that the Commencement Date of the Lease, and the time periods for Substantial Completion may be extended in accordance with change orders as provided in paragraph 8 or by other causes not ascertainable at this time. If a delay is caused by Tenant's failure to make required payments for Change Orders, Excess Tenant Improvement Costs or failure to complete Tenant's Work on time or other reasons attributable to Tenant and such delays cause an extension of the Commencement Date beyond November 1, 1998 under this Agreement which has not been agreed to in a change order, Landlord shall give Tenant written notice of the expected delay and Commencement Date of the Lease shall be November 1, 1998. The Notice shall set forth the reasons for Landlord's conclusion that the delay is caused by Tenant. In the event Tenant believes that it is not responsible for the delay, it shall so notify Landlord of the reason for its conclusion. If Landlord and Tenant cannot agree, then the matter shall be submitted to binding arbitration. The Tenant may request arbitration only if Tenant commences tendering the Rent to Landlord on November 1, 1998 and continues to tender Rent each month until the dispute is resolved. If the arbitrator concludes that the delay was not attributable to Tenant, the Tenant shall be credited for Rent paid until the Premises are Substantially Complete. Arbitration shall be conducted by an arbitrator mutually agreeable to the parties. If the parties cannot agree upon an arbitrator, each shall submit the name of an acceptable arbitrator and those two arbitrators shall select a third arbitrator who shall conduct the arbitration. The prevailing party shall bear the cost of the arbitration. The parties must designate an arbitrator who is familiar and experienced with construction issues. The arbitration shall be conducted in accordance with the rules and procedures set forth by the American Arbitration Association for the Construction Industry and shall be non-appealable and binding on the parties. 14.1. Delays From Force Majeure. In the event Substantial Completion is delayed beyond November 1, 1998 by Force Majeure (as defined in paragraph 36 of the Lease), then the Scheduled Substantial Completion Date shall be 49 52 extended by the period of such delay, and the scheduled Commencement Date of the Lease shall be likewise extended. The inability to obtain all required permits and approvals for the construction of the Premises shall not be included in Force Majeure, except to the extent such inability is caused by Tenant Delay. Landlord nevertheless acknowledges that Substantial Completion prior to November 1, 1998, is critical to Tenant's business and that Landlord shall, upon consultation with Tenant, attempt to determine measures which could be taken to minimize any delay which may occur in the event of delay occurring due to Force Majeure; provided, however, that neither Landlord nor Tenant shall be obligated to incur additional costs other than those anticipated hereunder in the event of delay occurring due to Force Majeure. In the event of Force Majeure occurring, Landlord shall give Tenant written notice of the same, together with the estimated period of such Force Majeure. Either Tenant or Landlord may elect, by written notice to the other, to augment the construction schedule, at such party's sole cost and expense, in order to avoid the effects of any Force Majeure. Estimates of such costs of augmentation of the Construction Schedule shall be provided by General Contractor. 15. TENANT'S DEFAULT. If Tenant fails to make any payments required to be made hereunder, or otherwise fails to meet its obligations hereunder or under the Lease, Landlord may (1) discontinue construction of the Tenant Improvements, (2) terminate the Lease on ten (10) days written notice and/or (3) pursue all other remedies available in the Lease and in law and equity including recovering damages for lost profit, lost rent, attorney fees and costs incurred in enforcing the terms of this Agreement and any and all other remedies available. 16. COOPERATION. Tenant and Landlord shall cooperate in good faith with each other at all times while Landlord is obtaining the necessary approvals, permits, plans and specifications and throughout construction. Both parties shall provide prompt response to any questions or concerns that may arise relating to the Tenant Improvements and shall respond in a timely and professional manner to all questions and requests from the other. 17. INCORPORATION. This Work Letter Agreement is a part of and is incorporated into the Office Lease by and between the parties and is in addition to those provisions provided in paragraph 2 of said Office Lease relating to Tenant Improvements. LANDLORD: PINE FOREST CO., a Washington corporation By: /s/ F.H. BURNSTEAD ----------------------------- F.H. Burnstead, President 50 53 TENANT: INTERLINQ SOFTWARE CORPORATION, a Washington corporation By: /s/ STEVE YOUNT ------------------------------------ Steve Yount, Vice President, Finance Schedule A - Definitions Schedule B - Base Building Shell Description Schedule C - Tenant Improvement Specifications Outline 51 54 Schedule A to Exhibit B Work Letter Agreement DEFINITIONS As used in this Work Letter Agreement, the following capitalized terms shall have the following meanings. All other capitalized terms shall have the meanings ascribed to them in the Lease: "Building Shell" means the structure Landlord is constructing which will be completed by Landlord as set forth in the Building Shell Plans. "Building Shell Construction Contract" means that certain Construction Agreement by and between General Contractor and Landlord for actual construction of the Building Shell. "Building Shell Construction Documents" means the Building Shell Construction Contract and the Building Shell Plans. Tenant shall be given only those Building Shell Construction Documents listed on Schedule B to this Exhibit B. "Building Shell Plans" means the plans and specifications for the Building Shell which have been approved by Landlord and Tenant which are attached as Schedule B. The Building Shell Plans have been delivered to the TI Architect. "Excess Tenant Improvement Costs" means Tenant Improvements Costs in excess of Landlord's Maximum Contribution and Landlord's Advance (if Tenant elects to take the Landlord's Advance). "Final Completion" means the Building Shell and Tenant Improvements are Substantially Complete, all Punch List Items have been completed, and the Building Shell and Tenant Improvements have been approved by the City of Bellevue for occupancy, as evidenced by issuance of a final certificate of occupancy. "Landlord's Advance" means the amount of up to $200,000 to be advanced by Landlord to Tenant to pay part of the Tenant Improvements Costs to the extent requested by Tenant. Landlord Advance is to be reimbursed by Tenant. "Landlord's Maximum Contribution" means the amount of $700,000 to be paid by Landlord, without reimbursement by Tenant, as described in paragraph 2. "Project Team" means the following companies and individuals who will provide the space planning, architectural, and construction services for the Tenant Improvements; provided each is referred to individually in this Agreement by the term opposite their name: "General Contractor" RAFN Company, Bellevue, WA, subject to execution of an acceptable contract. "Representative" means the contact person at Tenant or Landlord named in the Basic Lease Information, or their successor after notice of such appointment is given to the other party. 52 55 "TI Architect" Marvin Stein and Associates "Substantial Completion" means the Tenant Improvements shall have been completed in accordance with the Tenant Improvement Construction Documents, which Substantial Completion shall be conclusively deemed to have occurred upon (i) final inspection by the City of Bellevue and preliminary approval for occupancy of the Premises as evidenced by issuance of either a temporary or final certificate of occupancy, and (ii) issuance by TI Architect of a Certificate of Substantial Completion for the Tenant Improvements, which Certificate of Substantial Completion shall be in the form of AIA Document G704. The existence of punch list Items or additional work required for issuance of a final approval for occupancy by the City of Bellevue shall not be matters which will delay Substantial Completion from having occurred; but Landlord shall correct and/or complete such Punch List Items, complete the work necessary to obtain issuance of a final approval for occupancy and obtain issuance of such final certificate of occupancy within 90 days thereafter or as soon as reasonably practical. That there are outstanding Punch List Items and/or work required for City of Bellevue issuance of a final approval of occupancy shall not delay the Commencement Date of the Lease under any circumstances provided that Substantial Completion has occurred; and the Building Shell has been completed in accordance with the Building Shell Construction Documents and approved for occupancy by the City of Bellevue as evidenced by issuance of either a temporary or a final certificate of occupancy. "Tenant Improvements" means those certain interior improvements to the Premises, to be constructed by Landlord, all of which are more specifically defined in the Tenant Improvements Schematic Plans and, ultimately, the Tenant Improvements Construction Documents. "Tenant Improvements Construction Contract" means the Construction Agreement entered into by Landlord and General Contractor for construction of the Tenant Improvements, which Construction Agreement shall be in the form of the Cost of the Work Plus a Fee with a Guaranteed Maximum Price (AIA Document A111) and shall reflect a General Contractor Fee of no more than 6% of the Cost of the Work (exclusive of applicable taxes). "Tenant Improvements Construction Documents" means detailed drawings, and final plans and specifications determined to be mutually acceptable to Landlord and Tenant providing for the construction of the Tenant Improvements which shall supersede the Tenant Improvements Schematic Plans. The Tenant Improvements Construction Documents shall detail the Tenant Improvements, shall conform to all applicable laws and building codes, and shall be complete in form and content and contain sufficient information and detail to allow for competitive bidding or negotiated pricing by contractors and subcontractors selected and engaged by Landlord or General Contractor. Landlord and Tenant shall approve the Tenant Improvement Construction Documents in writing. "Tenant Improvements Costs" means costs of construction of the Tenant Improvements which shall consist of (i) the Guaranteed Maximum Price set forth in the Tenant Improvements Construction Contract as the same may be 53 56 adjusted by changes in accordance with the terms of that Contract and this Agreement plus certain other charges not covered as a part of the Guaranteed Maximum Price, consisting of (ii) any and all applicable municipal fees and charges relating to such Tenant Improvements, including without limitation, building permit and other permit application and issuance fees and costs, all inspection fees; and (iii) all applicable taxes, including without limitation retail sales taxes and business and occupation taxes, and (iv) the cost of preparing the Tenant Improvements Construction Documents and all other design fees and costs related to the Tenant Improvements including fees and costs for bonds related to the Tenant Improvements, if any, and all other fees and costs relating to the design of and construction of the Tenant Improvements. "Tenant Improvements Schematic Plans" means the preliminary floor plans and outline specifications that have been prepared by TI Architect and approved by Landlord and Tenant, as referenced in Schedule C. "Tenant Inspection" means the inspection(s) undertaken by Tenant or its Consultant from time to time during the course of construction of the Premises, provided that inspections shall occur only following reasonable prior notice to Landlord (which notice may be delivered telephonically or otherwise without being in writing) and the inspection conducted after Substantial Completion and prior to occupancy to prepare the written punch list. Landlord and Tenant will each provide to the other in writing the name of their respective authorized Representative(s). "Tenant's Personal Property" means Tenant's office furniture, telephone lines, computer cabling and movable property place in the Premises by Tenant, including any trade fixtures and any property installed in or on the Premises by Tenant for the purposes of conducting Tenant's business, ornament, decoration or similar related use in the Premises. "Tenant's Work" means installation of telephone and other communication and media lines and systems, computer cabling and related matters for which Tenant shall be given early access under paragraph 10 of Exhibit B. 54 57 Schedule B to Exhibit B Work Letter Agreement Building Shell Plans and Base Building Shell Description 1. Base Building Shell Description. 2. Changes made to Building Shell and Core up to 4/14/98 which are not shown on the plans prepared by Lance Mueller and Associates. 3. Floor Plans and Elevations (pages A1 through A5) prepared by Lance Mueller & Associates dated 5-17-89. 55 58 BASE BUILDING SHELL DESCRIPTION 1. LANDLORD'S WORK: Landlord shall construct the building in substantial accordance with the plans of Landlord's architect and shall be completed substantial in accordance with the architect's design and all requirements necessary to obtain a temporary Certificate of Occupancy, or its equivalent, for the building shell and core. Landlord's shall, at its sole cost and expense, complete the building shell and core, including the following: a. TYPICAL OFFICE FLOOR i. Restrooms will be completed and finished by owner, shower facilities N.I.C. ii. Stairwells to be painted including walls, metal stair top and bottom where exposed, handrails, stair supports, doors and jambs, both sides. Concrete stair treads and landings to be sealed. b. TYPICAL ELEVATOR CAB AND LOBBY i. Elevator cab and lobby finishes will be completed by Landlord. c. AIR CONDITIONING AND HEATING (HVAC): i. Landlord shall install the vertical distribution of the HVAC and the horizontal distribution to and including the Variable Air Volume (VAV) control boxes to the premises including thermostats and provide for removal of the return air from the plenum. Permanent installation of thermostats will be a part of the tenant improvement construction at 5'-0" AFF, unless noted otherwise. All ductwork from VAV boxes to ceiling diffusers will be part of the tenant improvement construction phase. ii. Landlord shall provide 78.75 tons total cooling capacity from six (6) Lennox rooftop units. d. ELECTRICAL DISTRIBUTION SYSTEM: i. Landlord shall provide the house panel and main breakers for the building. There is a 1,200 amp metered service in the basement which feeds a 400 amp panel for HVAC and 400 amp panels on each floor. 59 ii. Conduits in exterior walls will be provided for Tenants access. Extending the wiring for lighting including the junction boxes and general power from the appropriate panel in the building electrical room to the point of use will be part of the tenant improvement construction phase. e. LIGHTING: i. Landlord shall provide fluorescent stairway lighting. ii. Landlord shall provide lighting at utility spaces (mechanical and electrical rooms) iii. Landlord shall provide lighting in parking garage. iv. Landlord shall provide Lobby lighting v. Landlord shall provide all deep cell parabolic 2x4 lighting fixtures stacked in the building. Any additional specialized lighting and hallway corridor lighting will be part of the tenant improvement package. f. TELEPHONE SYSTEM: i. Landlord shall provide means of access to telephone service in the building telephone room on the floor on which the premises are located. All other communications or telephone equipment or services shall be responsibility of the tenant. g. FIRE AND LIFE SAFETY i. Landlord shall install fire detection equipment in the building in accordance with the Uniform Fire Prevention Code, as well as fire prevention equipment, including sprinklers, in accordance with said fire prevention code. The building's fire and safety equipment, including the sprinkler system installed under the Landlord's Work with the sprinkler heads turned up to protect the structure, shell be consistent with that that required by code for building shell and core construction. ii. All modifications to this equipment or systems resulting from the Tenant's occupancy and space design shall be considered Tenant Improvements. The sprinkler heads are turned up to protect the structure. h. PLUMBING: i. Landlord shall furnish all plumbing and fixtures to complete the lavatory facilities on each floor. Any plumbing service for the Tenant's premises, including shower facilities, shall be considered Tenant Improvements. 60 i. FINISHES: The Landlord shall provide the following: i. Concrete floor slab which shall be flat and level within recognized industry standards and shall be left broom clean. ii. Exterior perimeter surfaces which are to receive interior finishes shall be insulated per code with drywalled screwed on. iii. Interior partitions around vertical shafts shall be covered with gypsum wall board and fire taped. iv. Doors and hardware shall be installed at all vertical shafts used as exits. v. Ceiling grid installed. vi. Ceiling tiles purchased and stacked on floor. 2. TENANT'S WORK Except as set forth above, all work, improvements, finishes and/or equipment required by Tenant and/or pursuant to the approved plans for the Premises shall be considered Tenant Improvements. All Tenant Improvements shall be completed using building standard materials and construction methods. 61 The following items will detail the changes made to the Building Shell and Core to date that are not shown on the attached plans drawn by Lance Mueller and Associates. The foregoing and the attached plans represent the approximate delivered building shell. 1. There will be only one set of entrance doors at the main entry. Located per the Tenant Improvement Space Plan drawn by Marvin Stein Associates Inc. 2. Metal framing with a Dryvit exterior finish will be used in lieu of pre-cast concrete walls. 3. Windows will be 5'6" tall rather than 5'. 4. Roofing material used will be an architectural asphalt composition rather than concrete tile. 5. Restrooms will be located per the Tenant Improvement Space Plan drawn by Marvin Stein Associates Inc. 6. Electrical and Fire Sprinkler rooms will be added in the parking garage and Storage area. Parking will not be affected. Owner reserves the right to make further modifications to the Building Shell and Core if required by any regulatory agency. 62 [MARVIN STEIN ASSOCIATES, INC. LETTERHEAD] o Schedule C to Exhibit B Work Letter Agreement. o Tenant Improvements Schematic Plans and Specifications. o The following documents prepared by Marvin Stein & Associates, Inc. are attached as Schedule C: 1. Space plan dated March 11, 1998. 2. Tenant Finish Specification for Burnstead Plaza dated revised April 22, 1998. 3. Tenant Improvement Work Letter for INTERLINQ dated revised April 22, 1998. 63 [DIAGRAM OF SECOND FLOOR PLAN] 64 [DIAGRAM OF FIRST FLOOR PLAN] 65 [DIAGRAM OF PARKING LEVEL PLAN] 66 BURNSTEAD PLAZA Prepared By: Marvin Stein & Associates Job #98010 February 6, 1998 Revised: April 22, 1998 TENANT FINISH SPECIFICATIONS TABLE OF CONTENTS This section outlines the standard Tenant Finishes selected as the Building Standard. PARTITION TYPES 2 DOORS 2 DOOR FRAMES 3 RELITE GLAZING 3 HARDWARE 3 SUSPENDED CEILING SYSTEM 4 MECHANICAL 5 LIGHTING SYSTEM 6 ELECTRICAL AND TELEPHONE OUTLETS 6 SWITCHES 7 EMERGENCY EQUIPMENT 7 FIRE EXTINGUISHER AND CABINET 7 PAINTING 7 B/S WALLCOVERING 8 FLOOR COVERING 8 WINDOW TREATMENT 9 SCHEDULE OF LIMITS - SHELL and CORE 9-10 BUILDING STANDARD DETAILS
67 PARTITION TYPES [] Partition type 1 o Partition terminates below the level of the suspended ceiling tile. o 3 1/2" or 2 1/2", 25 gauge galvanized steel studs, 24" on center up to 10'-9" high walls. Use 5 1/2" studs for plumbing walls, if required. 3 1/2" or 5 1/2", 25 gauge studs, 16" on center for 10'-9" to 12'-6" high walls. o Metal angle trim taped and finished over gypsum wallboard at ceiling. o Non combustible wood blocking under ceiling grid where runner and grid intersect. Blocking to be painted flat black. o 5/8" type "X" gypsum wallboard each side. o Tape, mud and sand. o 1/2" black reveal at top of wall. o Details #1. [] Partition type 2 o Same as Partition type 1 above. o 2 1/2" sound insulation blanket is added in ceiling plenum extending 2'0" each side of partition. o Building Standard Detail #2. [] Partial Height Partition o 3'-6" in height above finished floor. o 3 1/2" or 2 1/2", 25 gauge galvanized steel studs, 24 inches on center with steel tube bracing at 36" O.C. o Building Standard Details #10. [] Column Closures o Per Shell and Core architectural plans. [] Window Mullion and Perimeter Wall Partition Termination o Building Standard Detail #6. [] Perimeter Walls and Columns o Per Shell and Core architectural plans and specifications. o Detail #8. DOORS [] Construction o Premium grade plain sliced oak. o 5-ply construction with a "particle board" core. o All doors are pre-machined for mortise lock or passagesets plus four (4) butts each 4 1/2" x 4 1/2". 2 68 [] Size o 1-3/4" x 3'0" x 8'6" (nominal length) at all Tenant doors. o 1'-6" x 8'-6" closet doors, same construction as above, can be provided. [] Oak Door Finish Application (or pre-finished) o First coat: Benite sealer and sand. o Second coat: sanding and sealer. o Third coat: lacquer, semigloss. [] Fire Doors at One-Hour Rated Fire Separations o Fire doors may have magnetic hold-open devices or electric closures which tie into adjacent smoke detector. [] Hollow Metal or Approved Equal o Flush design doors, 1-3/4" thick, seamless hollow construction. o Single-acting swing doors, bevel both vertical edges 1/8" in 2". o Approved manufacturers. - Allied Steel Products Inc. - American Steel Products Corp. - Curries Manufacturing, Inc. - Overly Manufacturing Company - Pioneer Metals, Inc. - Precision Metals, Inc. - Security Metal Products, Inc. - Stiles - Superior Fireproof Door, Inc. DOOR FRAMES [] Wood Frames o Construction - Wood door frames - or equal. - Size of frame will receive a 1-3/4" x 3'-0" x 8'6" solid core door at all Tenant spaces. - Nominal dimension of frame per B.S. detail. - Building Standard Details #13, #14, and #15. o Application - For use on wall construction of 2-1/2" sheet metal studs with 5/8" gypsum wall board on each side. o Finished to match Building Standard sample. RELITE GLAZING [] Relite glass: Per Architectural detail 13. Relites shall be 1/4" tempered glass. HARDWARE [] Finish: Locks/Latches US32D (Satin Stainless Steel) as listed, all other hardware US26D (Dull Chrome). 3 69 [] Levers o Lockset: Sargent 8105 x LNA x 32D x Falcon cylinder C987 x 8790-2 (or equal). o Latchsets: Sargent 8115 x LNA x 32D (or equal). o Electric Locksets: Sargent 8171 x LNA x 32D x Falcon cylinder C987 x 8790-2 (or equal). [] Hinges - two pair per leaf. o Three Knuckle: McKinney TA2714 x 26D x 4-1/2 x 4-1/2 at doors with closers (or equal). T714 x 26D x 4-1/2 x 4-1/2 at all other doors (or equal). o Electric Hinges: McKinney TA714CC-4W x 26/D x 4-1/2 x 4-1/2 (or equal). [] Closers: Sargent EN350/351 or equal, arms as required. [] Wire Pulls: Closet doors. o Rockwood: 856 1/2" x 6" CTC x 26D x TB (or equal). [] Miscellaneous. All hardware to be building standard as specified or equal. o Wall Stops: H.B. Ives - 407 1/2S32D. o Floor Stops: H.B. Ives - 436B26D. o Flush Bolts: H.B. Ives - 458B26D (30" top rod, 12" bottom rod). o Dust-proof Strikes: H.B. Ives - 489 x 487B26D. o Silencers: H.B. Ives 21R wood frames, 20R HM frames. o Overhead Stops: ABH 3300 series - surface, 3000 series concealed. Type as required per condition. o Roller Latches (closed doors): BBW 1193 x 26D. SUSPENDED CEILING SYSTEM [] Suspension Grid: o Exposed double-web for heavy duty with 9/16" face and dull white finish by Donn Corporation. [] Acoustical Tile: o Building Standard for tenant areas is 24" x 48" x 5/8". - Armstrong "Cortega"; regular edge. - Alternate: Suspension grid to be USG Interiors Centricitee 9/16" grid in a white - Finish with USG Interiors Eclipse fineline bevel tile: 24" x 48" x 3/4" thick or approved equal. - Lobby is 2x2 #2195 (for 9/16" grid) MECHANICAL [] Supply Diffusers: o Titus MCD modular core diffuser, Kreger, or approved equal. [] Air Return/Exhaust Grills: o Titus 50F eggcrate grille, Krueger, or approved equal. o Installed as required by HVAC Engineer. 4 70 [] Sprinklers: The complete sprinkler system will be installed in accordance with Shell and Core specifications. All modification costs to accommodate specific Tenant layout will be a part of the Base cost for Tenant Improvements. Approximate Spacing: One head per 165 square feet of unimproved area. o In areas with suspended ceilings; quick response heads semi-recessed in ceiling with an attached cover plate flush to the ceiling. Central model GB4-FR Royal Flush concealed; Reliable Model G40R; or approved equal; cover plate shall be factory painted. [] Dishwasher: (up-grade) o High quality Kitchenaide or approved equal. o Or approved equal. [] Hot Water Heater: o Six-gallon HWT for sinks. - 2KW, 120V, single phase. o Twenty-gallon HWT for showers. - 5KW, 277V, single phase. [] Sink and Faucet: o Kitchen Sink - Elkay #PSR-2219-3, stainless steel, 22" x 19-1/2" or equal. o Provide fiberglass shower enclosures with doors at men's and women's restrooms on the first floor; float floor per Washington State Barrier Free Codes. o Faucet and Basket (Kitchen). - Delta 101 HDF - Elkay #LK-35 Basket Strainer - Or equal. [] Toilet -- flush valve: (or equal). o Kohler K-4430-ET: Wall hung, siphon-jet action, white vitreous china elongated bowl, 1-1/2" top inlet spud. o Flush valve: exposed chrome plated, diaphragm, escutcheon, integral screwdriver stop and vacuum breaker; Sloan royal 110-3 YB (or equal). o Seat: Solid white plastic, open front, without cover, Bemis 1955-Of (or equal). o Wall-mounted carrier: Surn ZR-1200 series (or equal). [] Urinal: (or equal). o Kohler K-5014-T: Wall hung, siphon jet action, white vitreous china, integral trap, 1/4" top inlet spud, concealed hanger. o Flush valve: exposed chrome plated, diaphragm type, escutcheon, integral screwdriver stop and vacuum breaker; Sloan Royal 180-1-TB. [] Lavatory: (or equal). o Kohler 2005: Countertop, 20 x 18 white vitreous china, 4" faucet centers (or equal). o Trim: Chrome plated supply fitting, water economy aerator, single-lever handle, chrome plated 17 gauge brass P-trap and arm with escutcheon; Kohler K-15199-P faucet, Jameco 629 1-1/4" chrome plated grid drain. 5 71 LIGHTING SYSTEM [] All lights will be installed during the Tenant Construction phase in accordance with the Tenant Construction Documents, and as required by the National Electrical Code and the Seattle Energy Code. [] BS/A2 Recessed parabolic fluorescent lay-in troffer nominally 24" x 48", 2 Lamp Parabolic semi-specular louver with F032T8735 Lamps, electronic ballast 277-Volt U5G-D24-23222OC-29S-(1)MOE/RS-S777-FO32/735K (or equal). [] BS-A3 Recessed compact fluorescent downlight, horizontal lamp configuration. Nominal 7" dia. clear Alzak aperture cone with color-Chek process and self flange overlap trim. Integral HPF ballast. Unit shall have a minimum efficiency of greater than 66% (or equal). o Manufacturer: Prescolite NPR-106 Series; Staff PolyQuad Series or Infinity PV600-132T-EB-MWT-BH-277. o Lamp: 3 tube o Watts: 32 [] BS/A4 Recessed compact fluorescent lensed wallwsh. Nominal 7" dia. clear Alzak aperture cone with Color-Chek process, self flange overlap trim and 55 later spread lens. Internal two part reflector system. Integral HPF ballast (or equal). o Manufacturer: Prescolite NPR-116 Series; Staff PolyQuad Series or Infinity (or equal). o Lamp: 3 tube o Watts: 32 ELECTRICAL & TELEPHONE OUTLETS [] Building Standard Wall Receptacle: o Ivory color at standard receptacle. o Gray Color at designated computer circuit. o Orange dot on ivory receptacle at dedicated, isolated ground outlet or circuit. o Red dot on ivory receptacle at dedicated outlet or circuit. o Telephone/CRT outlet consist of mud ring with pull wire and conduit in wall cavity (cabling by Tenant). [] Building Standard Floor Receptacle -- Pedestal: o Combination power and communication pedestal. o Type: Walker tap 1400 Series Poke-Thru or approved equal. [] Building Standard Timed Duplex Wall Receptacle: o Required for every coffee service. o Internatic Time clock #F14H with 14-hour timer or equal. [] Copy Machine Wall Receptacle: o 120V or 208V with junction box, dedicated circuit, and breaker. 6 72 SWITCHES Types of switches available are single-wall switches with occupancy sensors, occupancy sensors for general office areas, dimmer switches, and fan switches. Decora switches are standard. EMERGENCY EQUIPMENT [] Exit Signs: Any exit signs required beyond Shell and Core will be a part of the Tenant Improvement Allowance. o Double faced. o Type: Emergi-lite LED edgelite with clear lens and green letters. Brushed aluminum finish 277 volt (or equal). [] Emergency Speakers: All emergency speakers will be permanently installed during Tenant Improvement phase. Approximate Spacing: one per 1,200 square foot of unimproved area. Designate layout per electrical engineer's design. o Mounted flush with face of ceiling tile and painted white to match ceiling tile. o Minimum requirement: 55 decibels and 10 decibels above ambient noise levels. FIRE EXTINGUISHER & CABINET [] Cabinet: One extinguisher and cabinet is required for every 3,000 square feet of floor area to be a part of the Tenant Improvement Construction phase. o Color: white o Semi-recessed of minimum projection. Cabinets are 6 1/4" deep. o JL Industries Ambassador 1012 F10 with ADAC option, Full Glass with tempered glass (or equal). [] Fire Extinguisher: o Multi-Purpose dry chemical type. o UL rated 3A-40B:C. o JL Industries cosmic 6E. PAINTING [] Drywall o Flat latex. - First coat: Precote 95-100 primer, wet film thickness of 3.6 mils. Tint primer to approximate finish color. - Second coat: Suede Coat Interior flat latex 27-1000, wet film thickness of 3.6 mils with stipple roller finish. o Latex semi-gloss enamel. - First coat: Precote 95-100 primer, wet film thickness of 3.6 mils. Tint primer to approximate finish color. - Second coat: Stryocote Double-Hide 69-1000 latex semi-gloss enamel, wet film thickness of 3.6 mils with stipple roller finish. o Latex Enamel. - First coat: Polyvinyl acetate primer/sealer. - Second coat: Eggshell latex enamel with stipple roller finish. 7 73 [] Miscellaneous Ferrous Metal, Hollow Metal and Aluminum: - First coat: All Metal Gard Primer 28-62 MWF 1.5 mils. - Second and third coat: Velvalex Alkyd Semi-gloss Enamel 2-series MWF 3 mils. If sprayed: - Second and third coat: Luxite, Spraycraft Industrial Alkyd Enamel 43-series MWF 1.5 mils. [] Painted Woodwork and Millwork: - First coat: Alkyd Enamel Undercoat and Sealer 20-97 MWF 3 mils. - Second and third coat: 2-series MWF 3 mils or Plati-namel Dri-Fast Gloss enamel 10-series MWF 1.5 mils. [] Doors and Woodwork, Stained and Finished: (or prefinished). - First coat: Penetrating wood stain to match Architect's sample. - Second coat: Sanding and sealer. - Third coat: Lacquer, semigloss, or equal. [] Manufacturer: o Parker o Miller o Preservative o Benjamin Moore o Or approved equal B/S WALL COVERING (up grade) [] Type: Maharam, Tek-wall 1000,2000,3000,4000,5000 Class A rated wall covering. [] Or Equal FLOOR COVERING [] Carpet o All carpet to be furnished by owner, installed by contractor. All offices and open work areas otherwise specified to be 30 oz. Multi-level textured loop, Bentley "Outerbanks" series in a color to be selected, or approved equal. Carpet to be direct glue down (low VOC), application per Manufacturers suggested installation methods, or approved equal unless otherwise specified. Reference Workletter for carpet spec for base bid. [] Ceramic Tile: o Provide ceramic tile per shell and core specifications for building restrooms. [] Rubber Base o "Roppe" or approved equal, colors to follow. [] Wood Base (up-grade) o Provide 4" x 3/4" hardwood base; finish to match doors, per finish plan. 8 74 WINDOW TREATMENT [] Provide 1" slat mini-blind, standard color as approved by Developer. Manufacturer to be Levelor "Riviera Dustguard" 1" inside mounted or approved equal. SCHEDULE OF LIMITS - SHELL AND CORE This schedule of limits will detail the level of finish the Building will achieve during Shell and Core construction. This level of completion will be the basis from which all Tenant work will start. Typical Office Floor [] Restrooms: Complete and finished by owner, shower facilities N.I.C. [] Stairwells: All stairwells to be painted including walls, metal stair top and bottom where exposed, handrails, stair supports, doors and jambs, both sides. Concrete stair treads and landings to be sealed. [] Typical Elevator Lobby: o Core side lobby area GWB walls ready for finish coat and paint. o Elevator doors and jambs, satin stainless steel. o Life safety devices temporarily installed (speaker, smoke detectors). o Smoke doors at elevator lobby installed complete. [] Partitions: the partitions defining the core will be fire taped on the Tenant side ready for finish coat and paint. [] Interior Columns, Exterior Columns at Curtainwall, Sill Wall below Exterior Windows: All furred GWB will be fire taped, ready for finish coat and paint. [] Ceiling System: o Shell and Core Phase: - Suspended ceiling tiles supplied by Owner and stacked on floor. - Grid installed by Owner [] Mechanical: The Mechanical System will be installed up to and including the VAV boxes (perimeter and interior) in accordance with Shell and core Plan which will be coordinated with Tenant Space Plans. Permanent installation of thermostats will be a part of the Tenant Improvement Construction at 5'-0" AFF, unless noted otherwise. All ductwork from VAV boxes to ceiling diffusers will be a part of the Tenant Improvement Construction phase. [] Sprinklers: A complete sprinkler system will be installed. Sprinkler heads will be located in accordance with Shell and Core specifications and coordinated with Tenant Space Plans. Sprinkler additions and modifications will be a part of the Tenant Work phase. 9 75 [] Electrical: Electrical service will be available at one location on all tower floors. Power and telephone conduits have been installed through the core. All lighting, power and telephone conduit, conductors, and final trim will be installed during Tenant work phase. [] Lighting: The Shell and Core contract includes the following lighting: o Fluorescent stairway lighting. o Fluorescent lighting at utility spaces (mechanical and electrical rooms). o Fluorescent lighting in parking garage. o Tenants 2x4 fixture supplied by Owner: Stacked on floor. Tenant lighting will be installed as part of the Tenant Improvement Construction phase. [] Life Safety System: o Exit signs - exits signs are provided at each fire stairwell typical on all floors. o Emergency Speakers - emergency speakers provided at elevator lobbies, and stairwells. Additional speakers will be installed as part of Tenant Improvement Construction. o Smoke detectors - permanently installed in mechanical room, stairwell, and electrical rooms. Elevator lobby smoke detector is temporarily installed awaiting Tenant Improvement Construction. [] Fire Extinguishers: Two per floor supplied at each exit stair. [] Card Key System by Owner. 10 76 [MARVIN STEIN ASSOCIATES, INC. LETTERHEAD] March 2, 1998 Revised: March 11, 1998 Revised: March 16, 1998 Revised: April 22, 1998 TENANT IMPROVEMENT WORKLETTER FOR: INTERLINQ SOFTWARE JOB NO.: 98012 The following outline is intended to be used along with the building standard details and specifications and tenants preliminary space plan dated 3-11-98 as a guide to establishing the tenants required improvements for the Burnstead Plaza. Interlinq Software needs opportunity to review and provide input of the design and materials selection for the following base building areas. o Main Building Entry Lobby o Decorative Stair at Lobby o Elevator Lobbies and Cab o Restrooms 1. FLOOR COVERING: 1.1 Carpet o General Carpet: All areas other than those specified core areas and up-graded areas to receive the equivalent of Bently "Outbanks" series 30 oz. multi-level textured loop or equal. Follow manufacturers approved method of installation. o Or approved equal. o Inset and border carpets shall be installed in the conference center (3 rooms) and team or conference rooms indicated on plan. 1.2 Stone Flooring o Per main building entry design. 1.3 Resilient Flooring: o Provide VCT in the following areas. VCT to be Armstrong Standard Excelon, 12" x 12" x 1/8" thick; color and layouts with accent insets per final working drawings. [ ] Lunch Room Approx. 700 sf [ ] Coffee Bars Approx. 40 sf 1.4 Anti-Static Flooring [ ] Server room Approx. 150 sf 2. BASE 2.1 Wood Base: o Provide 4"H x 3/4" hardwood base in main reception area, and conference center, finish to match doors. 77 [MARVIN STEIN & ASSOCIATES, INC. LETTERHEAD] TENANT IMPROVEMENT WORKLETTER FOR: INTERLINQ SOFTWARE JOB NO: 98012 Page 2 of 5 3. WALL FINISHES: 3.1 General Paint; Building standard eggshell finish over smooth (non-textured) walls. o Provide accent colors for 20 percent of the job in colors and locations to be determined. 4. WALLS: 4.1 Building Standard per tenants space plan. o Provide building standard sound partitions at all conference rooms, lunch room, exercise room and private offices 160 sf or larger. Partition Type 2. 5. RELITES: 5.1 Provide pricing for providing relites for the project in the following schemes. o Provide 3'-0" wide by full ht. adjacent private offices 160 sf and larger. Frame finish to match door frames. Provide horizontal mini-blind as part of package price. (Base Bid) o Provide 3'-0" wide by full ht. adjacent private offices 160 sf and larger. Glass panels to be "Etchmate" by Milguard in a horizontal pattern. (Alternate Bid) o Provide 2 2'-0" x 8'x6" at Server room in hollow metal frames wire glass. (Base Bid) o Provide alternate fire lite glass at Server room. 5. OPERABLE WALLS: 6.1 Provide operable folding walls as shown on plans. Manufacturer to be Moderfold series acousti-seal model 932 series. Panel finish to be vinyl wallcovering in manufacturers standard color line. 7. CEILINGS: Building Standard o 2x4 Tegular in open office area. o 2x2 in lobby area. 8. DOORS, FRAMES AND HARDWARE: 8.1 Doors o Building standard, finish color to be reviewed and input provided by Tenant. 8.2 Frames o Building standard to match doors. 78 [MARVIN STEIN & ASSOCIATES, INC. LETTERHEAD] TENANT IMPROVEMENT WORKLETTER FOR: INTERLINQ SOFTWARE JOB NO: 98012 Page 3 of 5 8.3 Hardware o Building standard. o Landlord to provide tenant with secured entrance card key system or approved equal. o Locksets at the following rooms: [] All offices 160 sf and larger [] All storage rooms [] Server room (upstairs & downstairs) touchpad or building access system control [] Entrance door to Human Resources o Panic hardware at doors indicated on plans. Landlord to provide sample for tenants review and approval. o Provide magnetic hold open devices with automatic closers and remote release buttons on doors indicated on plans. 9. LIGHTING: 9.1 General lighting to be building standard. 9.2 Specialty Lighting o Building standard recessed incandescent light fixtures in reception area. 6 each room of conference center. o Building standard recessed incandescent wallwashers along corridor wall. Allow for 30 in corridors connecting stairs both floors. 9.3 Switching o Per code, location per final working drawings. 10. ELECTRICAL/TELEPHONE/DATA 10.1 Provide electrical outlets as required for functional use by tenant and as indicated on final working drawings. General requirements are as listed below: o Private Offices: 80 sf [] Provide two four-plex outlets on shared separate circuit for computer use. o Private Offices: 160 sf and larger [] Same as 80 sf office above, add one duplex electrical outlet. o Workstations: [] Core drill for four-plex outlet on shared separate circuit for computer use. Provide alternate price for power poles. o General: [] Provide general distribution of additional outlets as required on tenants final plans. o Special Electrical: [] Provide special electrical needs as indicated on final working drawings. Coordinate with tenants designated representative for server room, UPS requirements before final pricing. Equipment requiring special electrical needs includes but is not limited to the following: 79 [MARVIN STEIN & ASSOCIATES, INC. LETTERHEAD] TENANT IMPROVEMENT WORKLETTER FOR: INTERLINQ SOFTWARE JOB NO: 98012 Page 4 of 5 - Vending machines - Refrigerators - Microwave ovens - Range/Oven - disposal - Insta-hot - Coffee Service - Flush floor outlets in conference rooms - Power and battery back-up security and card key access systems - Intercom - AV and special training equipment needs - Server rooms (upstairs & downstairs) - Copy/printer/fax machines o Data and communications schedule [ ] Coordinate with tenants designated representative 11. MECHANICAL: 11.1 Landlord shall provide an easily accessible manually operated HVAC bypass switch for access to 24 hour air conditioning within the tenants space. Switch shall operate on 2 hour timer. 11.2 Special HVAC zones and needs -- Provide separate HVAC zones with separate exhaust fans for the following areas: - Conference center - Lunch Room - Server/computer room - Order Processing Area - Team rooms/Conference Rooms 12. EMERGENCY EQUIPMENT: 12.1 Provide all Exit signs, smoke detectors, emergency speakers, lighting and strobes as required by code. 13. PLUMBING FIXTURES: 13.1 Building Standard, locations per final working drawings. 14. APPLIANCES: 14.1 Provide high-quality Kitchenaide dishwasher in lunch room. 14.2 Provide Insta-hot at lunch room and coffee bars. 14.3 Provide high-quality oven/range in lunch room. 14.4 Provide 2 each built-in microwave ovens in lunch room. 80 [MARVIN STEIN ASSOCIATES, INC. LETTERHEAD] TENANT IMPROVEMENT WORKLETTER FOR: INTERLINQ SOFTWARE JOB NO: 98012 Page 5 of 5 15. SPECIALTY ITEMS: 15.1 Provide recessed projection screen in 1 conference room. Manufacturer to be "Da-Lite" boardroom electrol, 70"x70", #40723 or approved equal. 15.2 Provide custom casework outlined in millwork specifications. 16. WINDOW TREATMENT: 16.1 Landlord to provide 1" mini-blinds or 3 1/2" smooth PVC vertical blinds at all exterior windows. Standard color as approved by tenant. 16.2 All interior relites to receive mini-blinds. 17. MILLWORK: Provide all casework/millwork as indicated on final approved space plans. This includes but is not limited to the following: 17.1 Main reception workstation: Provide a complete built-in reception desk, lineal footage per plan. Transaction top in stone with lightstrip at reception side. Provide for 4 pedestals each with 2 box, 1 file drawer. Work area counters and pedestals to be plastic laminate faced. Reception front to be wood panels in a finish to match doors. 17.2 Mail Copy room: Provide lineal footage per plan. Provide plastic counters; 50 percent of space above to be closed cabinets with the rest to be open shelving; Provide for 150 built-in mail sots at a location to be determined above the counter. 17.3 Lunch Room: Provide for 8 lin.ft. of island counter with sink and dishwasher with closed cabinets below and transaction ledge above facing conference in a plastic laminate finish. Provide 10 lin.ft. of counter at wall with cabinets. 17.4 Order Processing: Provide +/- 100 lin.ft. of counter top at stand-up height; Provide for 3-4-7 island counters with open shelving below. Provide approximately 60 lin.ft. of 2 high adjustable shelving above counters. 17.5 Copy Area: (2 required) Provide approximately 8 lin.ft. of counter each. Closed cabinets below; 2 high open adjustable shelving above in a plastic laminate finish. 17.6 Coffee Area: (Second floor) Provide approximately 14 lin.ft. of counter with sink; Provide closed cabinets above and below in a plastic laminate finish. 18. ADA GUIDELINES: Entire layout shall conform to Washington State Barrier regulations. 19. DELIVERY STALL: Owner to provide a delivery stall at owner's cost at the northwest corner of the site plan. 81 EXHIBIT "C" FORM OF TENANT ESTOPPEL CERTIFICATE Date:________________________, 1998 To: (Lender) and To: (Landlord) Re: Property known as: Except as set forth below, respecting that certain Lease date April ______, 1998, between PINE FOREST CO., a Washington corporation, as Landlord, and INTERLINQ Software Corporation, a Washington corporation, as Tenant, Tenant hereby certifies that it has unconditionally accepted possession of the Premises described in said Lease, and that said Lease is in full force and effect and has not been modified, supplemented or amended in any way, and that the Commencement Date of the Lease is _______________________, 1998, and the final date of the Initial Term is _______________________, 2005, subject to two consecutive five year options to renew, unless sooner terminated as therein provided. Tenant further certifies that all terms and conditions to be performed by the Landlord under said Lease have been satisfied to the best of Tenant's knowledge at the date of this Certificate, and that on this date there are no existing defenses or offsets of which the Tenant is aware it may have against the full enforcement of said Lease by Landlord; and that no rent has been paid in advance (except as provided in said Lease) and that rent has continued to be paid in accordance with said Lease since the Commencement Date of the Lease. Tenant is in occupancy of the Premises; and there is ongoing full operation of Tenant's business at Premises, being conducted by named Tenant. Tenant further agrees not to look to _____________ ("Lender") as mortgagee, mortgagee in possession or successor in title to the property, for accountability for any security deposit required by Landlord under said Lease unless such sums have actually been received by ("Lender") as cash security for Tenant's performance of this Lease. Tenant understands that its Lease may be assigned as collateral security for a mortgage loan to be granted to Landlord by (Lender) under a Collateral Assignments of Lease form containing (among others) agreements by and restrictions on Landlord. Tenant further understands that, without (Lender's) prior written authorization as Assignee, Landlord will not thereafter modify, terminate, or accept surrender of the Lease and will not reduce, abate, or accept pre-payment of any Rent (except as the Lease may otherwise specify). By accepting this Estoppel Certificate, Lender agrees 57 82 that as long as Tenant is not in default under this Lease, it will not disturb Tenant's quiet enjoyment of the Premises and will respect Tenant's rights under the Lease after a foreclosure, trustee's sale or deed in lieu thereof. Tenant acknowledges its Landlord's agreements and the restrictions on Landlord's rights under said assignment and hereby agrees to be bound by said agreements and restrictions, to the extent such agreements do not reduce Tenant's rights or enlarge Tenant's obligations under the Lease or otherwise. Tenant will not assign its leasehold without (Lender's) written consent, which shall not be unreasonably withheld, conditioned or delayed. List of Exceptions: _________________________________________ (Tenant:) INTERLINQ SOFTWARE CORPORATION By: _______________________________________ 58 83 EXHIBIT "D" RULES AND REGULATIONS 1. Sidewalks, halls, passages, exits, entrances, elevators, escalators and stairways shall not be obstructed by Tenants or used by them for any purpose other than for ingress to and egress from their respective Premises. The halls, passages, exits, entrances, elevators and stairways are not for the use of the general public and Landlord and Tenant shall in all cases retain the right to control and prevent access thereto by all persons whose presence, in the judgment of Landlord or Tenant, shall be prejudicial to the safety, character, reputation and interests of the building and its Tenant, provided that nothing herein contained shall be construed to prevent such access to persons with whom any Tenant normally deals in the ordinary course of such Tenant's business unless such persons are engaged in illegal activities. 2. The bulletin board or directory of the building will be provided exclusively for the display of the name and location of Tenant and any approved subtenants or assignees only and Landlord reserves the right to exclude any other names therefrom. 3. No curtains, draperies, shades, or decorations shall be attached to, hung or placed in, or used in connection with any window or door on any Premises without the prior written consent of Landlord, which shall not unreasonably withheld or delayed. In any event with the prior written consent of Landlord, all such items shall be installed inboard of the window frame at Tenant's expense. Landlord shall provide installed Levelor mini-blinds inside the window frames of all exterior windows in the Premises at Landlord's expense as part of the Building Shell. No articles shall be placed or kept on the window sills so as to be visible from the exterior of the building. No articles shall be placed against glass partitions or doors which might appear unsightly from outside Tenant's Premises. 4. Tenant shall not employ any person or persons for the purpose of cleaning Premises unless otherwise agreed to by Landlord in writing. 5. Tenant shall see that all doors of its Building are closed and securely locked and that all areas of the Building are secure. Tenant must observe strict care and caution that all water faucets or water apparatus within Tenant's control are entirely shut off before the Tenant or its employees leave such Premises at the close of business each day, and that all utilities within Tenant's control shall likewise be carefully shut off, so as to prevent waste or damage. For any default of this rule, the Tenant shall make good all injuries sustained by other Tenants of the Building or Landlord, except to the extent such damage is covered by insurance. On multiple-tenancy floors, all Tenants shall keep the door or doors to the building corridors closed at all times except for ingress and egress. 59 84 6. As more specifically provided in the Tenant's Lease of the Premises, Tenant shall not waste electricity, water, or air-conditioning and agrees to cooperate fully with Landlord to assure the most effective operation of the building's heating and air-conditioning, and shall refrain from attempting to adjust any controls other than room thermostats installed for Tenant's use; so long as Landlord responds promptly to requests for adjustments. 7. Except for the installation of security systems within the Premises by Tenant providing cardkey access or other restricted access to the Premises, Tenant shall to alter any lock or access device or install any additional lock or access device or any bolt on any door of its Premises except secured areas agreed to by Landlord, without the prior written consent of Landlord, which shall not be unreasonably withheld or delayed. Tenant shall in each case furnish Landlord with a key or cardkey for any such lock said key to be used only in emergencies and then only upon notice promptly after its use. 8. Tenant may make or have made additional copies of any keys or access devices provided by Landlord for the use of its employees, provided that Tenant shall bear the cost of replacing any locks if such replacement is made necessary due to dissemination of keys by Tenant and misuse thereof. Tenant, upon termination of the Tenancy, shall deliver to Landlord all the keys or access devices for the building, offices, rooms, and toilet rooms which shall have been furnished the Tenant or which the Tenant shall have had made. In the event of the loss of any keys or access devices so furnished by Landlord, Tenant shall pay Landlord for the replacement therefor or for rekeying of the Premises. 9. The toilet rooms, toilets, urinal, wash bowls, and other 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. 10. Tenant shall not use or keep in its Premises or in the building any kerosene, gasoline, or inflammable or combustible fluid or material other than limited quantities necessary for the operation or maintenance of office or office equipment. 11. Tenant shall not use, keep, or permit to be used or kept in its Premises any foul or noxious gas or substance or permit or suffer such Premises to be occupied or used in a manner offensive or objectionable to Landlord or other occupants of the building by reason of noise, odors, and/or vibrations or interfere in any way with other Tenants or those having business therein. 12. No commercial cooking shall be done or permitted by any Tenant on its Premises (except that use by the Tenant of Underwriters' Laboratory approved equipment for the preparation of coffee, tea, hot chocolate, similar beverages and microwave ovens and traditional ranges and ovens for preparation and heating food for Tenants and their employees and 60 85 invitees shall be permitted, provide that such equipment and its use is in accordance with all applicable federal, state, and city laws, codes, and ordinances, rules and regulations) and Landlord has approved its installation, nor shall Premises be used for lodging. This rule does not preclude use of Tenant's lunch room facility and the hosting of receptions for or by the Tenant in the building. 13. No pets or animals of any kind are allowed on the Premises, nor in the parking lots, nor in the parking garage at any time, with the only exception being seeing-eye dogs or similar guide dogs used for the exclusive purpose of guiding individuals for whom this assistance is necessary. 14. Except with the prior written consent of Landlord, which shall not be unreasonably withheld, no Tenant shall sell, or permit the sale, at retail, of newspapers, magazines, periodicals, theater tickets or any other goods or merchandise in or on any Premises except for limited sale of girl scout cookies, tickets, etc. by employees. 15. If Tenant requires telegraphic, telephonic, burglar alarm or similar services, it shall first obtain, and comply with, Landlord's reasonable instructions in their installation. 16. Landlord, in consultation with Tenant, will direct electricians as to where and how telephone, telegraph and electrical wires are to be introduced or installed. No boring or cutting for wires will be allowed without the prior consent of Landlord, which shall not be unreasonably withheld or delayed. The location of burglar alarms, telephones, call boxes and other office equipment affixed to the Premises shall be subject to the written approval of Landlord, which shall not be unreasonably withheld or delayed. 17. Tenant shall not install any radio or television antenna, loudspeaker or any other device on the exterior walls or the roof of the building without Landlord's consent, which shall not be unreasonably withheld or delayed. Tenant shall not interfere with radio or television broadcasting or reception from or in the building or elsewhere. 18. Tenant shall not lay linoleum, tile, carpet, or any other floor covering so that the same shall be affixed to the floor of its Premises in any manner except as approved in writing by Landlord, which shall not be unreasonably withheld or delayed. The expense of repairing any damage resulting from a violation of this rule or the removal of any floor covering shall be borne by the Tenant. 19. Landlord shall have the right to prescribe the weight, size and position of all safes and other heavy equipment brought into the building. Safes or other heavy objects shall, if permitted by Landlord, stand on wood strips or other weight distribution mechanism of such thickness as determined by Landlord to be necessary to properly distribute the weight thereof. Landlord will not be responsible for loss of or damage to any such safe, equipment or property from any cause, and all damage done to the building by moving or maintaining any 61 86 such safe, equipment or other property shall be repaired at the expense of Tenant. 20. Business machines, and mechanical equipment and exercise equipment belonging to Tenant which cause noise or vibration that may be transmitted to the structure of the building or to any space therein to such a degree as to be objectionable to Landlord or to any tenants in the building shall be placed and maintained by Tenant, at Tenant's expense, on vibration eliminators or other devices sufficient to eliminate noise or vibration. The persons employed to move such equipment in or out of the building must be acceptable to Landlord. Tenant will not install or permit the use of any exercise equipment, including free weights, unless Tenant has taken appropriate steps to protect the Premises, including the floors and walls from damage. Tenant will discuss with Landlord the installation of exercise equipment and protection of the Premises to Landlord prior to installation of such equipment. At the end of the Term, Tenant shall remove all such equipment and repair all damage to the condition of the Premises prior to installation of said equipment and machines. 21. Tenant shall not place a load upon any floor of the Premises which exceeds the load per square foot which such floor was designed to carry and which is allowed by law. Tenant shall not mark, or drive nails, screw or drill into the partitions, woodwork or plaster or in any way deface such Premises or any part thereof except that Tenant shall be permitted to hang pictures, whiteboard and similar items customarily used in offices, which holes shall be ordinary wear and tear. 22. There shall not be used in any space, or in the public areas of the building, either by any Tenant or others, any hand trucks except those equipped with rubber tires and side guards or such other material-handling equipment as Landlord may approve. No other vehicles of any kind shall be brought by any Tenant or kept in or about the Premises. 23. Tenant shall store all its trash and garbage within the interior of its Premises. No material shall be placed in the trash boxes or receptacles if such material is of such nature that it may not be disposed of in the city without violation of any law or ordinance governing such disposal. All trash, garbage and refuse disposal shall be made only through the entryways and elevators provided for such purposes and at such times as Landlord shall designate. 24. Canvassing, soliciting, distribution of handbills or any other written material, and peddling in the building are prohibited and Tenant shall cooperate to prevent the same. 25. Tenant shall comply with all safety, fire protection and evacuation procedures and regulations established by the appropriate governmental agency. 62 87 26. Tenant assumes any and all responsibility for protecting its Premises from theft, robbery and pilferage, which includes keeping doors to the building locked and other means of entry to the building closed. 27. The requirements of Tenants will be attended to only upon application at the office of the building by an authorized individual. Employees of Landlord shall not perform any work or do anything outside of their regular duties unless under special instructions from Landlord, and no employees will admit any person (Tenant or otherwise) to any office without specific instructions from Landlord. 28. Tenant shall not change the designation of parking spaces reserved for the handicapped, compact cars or other such designations. 29. Tenant shall use its best efforts to see that none of Tenant's employees or guests park between designated parking lines only, and shall not occupy two parking spaces with one car. Vehicles in violation of above shall be subject to being towed away, at vehicle owner's expense. 30. Vehicles parked at Premises for more than twenty-four (24) hours without prior written consent of the Landlord shall be deemed abandoned and shall be subject to being towed away at vehicle owner's expenses at the election of Tenant or Landlord. 30. Tenant shall be responsible for the observance of all the foregoing Rules and Regulations by Tenant's employees, agents, clients, customers, invitees, and guests. 31. These Rules and Regulations shall not be construed to in any way modify, alter, or amend, in whole or in part, the terms, covenants, agreements and conditions of any lease of premises in the building. 32. Landlord may waive any one or more of these Rules and Regulations for the benefit of any particular Tenant or Tenants, but no such waiver by Landlord shall be construed as a waiver of such Rules and Regulations in favor of any other Tenant or Tenants, nor prevent Landlord from thereafter enforcing any such Rules and Regulations hereinabove stated and any additional rules and regulations which are adopted, except such rules as would modify Tenant's Lease. 33. Landlord reserves the right to make such other and reasonable rules and regulations as in its judgment and following discussion with any Tenant who occupies the entire building and consideration of said Tenant's views may from time to time be needed for safety and security, for care and cleanliness of the building and for the preservation of good order therein. Tenant agrees to abide by all such Rules and Regulations hereinabove stated and any additional rules and regulations which are adopted if they apply to all tenants after having received a copy of the same. EX-23.1 3 CONSENT OF KPMG PEAT MARWICK LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS - -------------------------------------------------------------------------------- The Board of Directors INTERLINQ Software Corporation: We consent to the incorporation by reference in the registration statements (Nos. 33-63388, 333-4558 and 333-21099) on Form S-8 of INTERLINQ Software Corporation of our report dated June 30, 1998, relating to the balance sheets of INTERLINQ Software Corporation as of June 30, 1998 and 1997, and the related statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended June 30, 1998, and the related schedule, which report appears in the June 30, 1998, annual report on Form 10-K of INTERLINQ Software Corporation. /s/ KPMG Peat Marwick LLP Seattle, Washington September 25, 1998 51 EX-27.1 4 FINANCIAL DATA SCHEDULE
5 1,000 YEAR JUN-30-1998 JUL-01-1997 JUN-30-1998 7,234 6,674 3,400 0 40 17,689 6,434 5,434 24,153 9,540 0 0 0 54 14,545 14,599 9,647 18,346 1,778 5,083 14,653 0 0 (644) 907 (1,551) 0 0 0 (1,551) (.30) (.30)
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