AeroVironment, Inc.
AeroVironment Inc (Form: 10-Q, Received: 12/09/2015 06:08:19)

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

x       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the quarterly period ended October 31, 2015

 

OR

 

o          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                 to                 

 

Commission File Number: 001-33261

 


 

AEROVIRONMENT, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

95-2705790

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

900 Innovators Way

 

 

Simi Valley, California

 

93065

(Address of principal executive offices)

 

(Zip Code)

 

(626) 357-9983

(Registrant’s telephone number, including area code)

 

N/A

(Former name, former address and former fiscal year, if changed since last report)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x   No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x   No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No x

 

As of November 27, 2015, the number of shares outstanding of the registrant’s common stock, $0.0001 par value, was 23,334,628.

 

 

 



Table of Contents

 

AeroVironment, Inc.

 

Table of Contents

 

PART I. FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements:

 

 

Consolidated Balance Sheets as of October 31, 2015 (Unaudited) and April 30, 2015

3

 

Consolidated Statements of Operations for the three and six months ended October 31, 2015 (Unaudited) and November 1, 2014 (Unaudited)

4

 

Consolidated Statements of Comprehensive Income (Loss) for the three and six months ended October 31, 2015 (Unaudited) and November 1, 2014 (Unaudited)

5

 

Consolidated Statements of Cash Flows for the six months ended October 31, 2015 (Unaudited) and November 1, 2014 (Unaudited)

6

 

Notes to Consolidated Financial Statements (Unaudited)

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

15

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

21

Item 4.

Controls and Procedures

21

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

22

Item 1A.

Risk Factors

22

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

22

Item 3.

Defaults Upon Senior Securities

22

Item 4.

Mine Safety Disclosures

22

Item 5.

Other Information

22

Item 6.

Exhibits

23

Signatures

 

23

Exhibit Index

 

 

 

2



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

AeroVironment, Inc.

Consolidated Balance Sheets

(In thousands except share and per share data)

 

 

 

October 31,
2015

 

April 30,
2015

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

128,032

 

$

143,410

 

Short-term investments

 

77,967

 

85,381

 

Accounts receivable, net of allowance for doubtful accounts of $212 at October 31, 2015 and $606 at April 30, 2015

 

42,746

 

33,607

 

Unbilled receivables and retentions

 

11,798

 

17,356

 

Inventories, net

 

48,336

 

39,414

 

Income tax receivable

 

2,836

 

 

Deferred income taxes

 

5,050

 

5,265

 

Prepaid expenses and other current assets

 

4,555

 

4,599

 

Total current assets

 

321,320

 

329,032

 

Long-term investments

 

37,715

 

46,769

 

Property and equipment, net

 

13,579

 

13,499

 

Deferred income taxes

 

6,725

 

7,426

 

Other assets

 

690

 

741

 

Total assets

 

$

380,029

 

$

397,467

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

11,590

 

$

19,243

 

Wages and related accruals

 

10,503

 

13,395

 

Income taxes payable

 

 

692

 

Customer advances

 

3,835

 

4,235

 

Other current liabilities

 

5,669

 

9,170

 

Total current liabilities

 

31,597

 

46,735

 

Deferred rent

 

1,266

 

1,381

 

Liability for uncertain tax positions

 

439

 

439

 

Commitments and contingencies

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock, $0.0001 par value:

 

 

 

 

 

Authorized shares — 10,000,000; none issued or outstanding

 

 

 

Common stock, $0.0001 par value:

 

 

 

 

 

Authorized shares — 100,000,000

 

 

 

 

 

Issued and outstanding shares — 23,318,688 at October 31, 2015 and 23,314,640 at April 30, 2015

 

2

 

2

 

Additional paid-in capital

 

151,269

 

148,293

 

Accumulated other comprehensive loss

 

(201

)

(1,358

)

Retained earnings

 

195,657

 

201,975

 

Total stockholders’ equity

 

346,727

 

348,912

 

Total liabilities and stockholders’ equity

 

$

380,029

 

$

397,467

 

 

See accompanying notes to consolidated financial statements (unaudited).

 

3



Table of Contents

 

AeroVironment, Inc.

Consolidated Statements of Operations (Unaudited)

(In thousands except share and per share data)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

October 31,

 

November 1,

 

October 31,

 

November 1,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

 

 

 

 

Product sales

 

$

49,492

 

$

42,874

 

$

76,131

 

$

85,685

 

Contract services

 

15,239

 

9,790

 

35,650

 

18,845

 

 

 

64,731

 

52,664

 

111,781

 

104,530

 

Cost of sales:

 

 

 

 

 

 

 

 

 

Product sales

 

24,802

 

27,779

 

41,567

 

58,576

 

Contract services

 

8,396

 

7,014

 

22,658

 

14,029

 

 

 

33,198

 

34,793

 

64,225

 

72,605

 

Gross margin:

 

 

 

 

 

 

 

 

 

Product sales

 

24,690

 

15,095

 

34,564

 

27,109

 

Contract services

 

6,843

 

2,776

 

12,992

 

4,816

 

 

 

31,533

 

17,871

 

47,556

 

31,925

 

Selling, general and administrative

 

14,733

 

13,470

 

29,989

 

26,873

 

Research and development

 

9,897

 

8,531

 

19,728

 

15,655

 

Income (loss) from operations

 

6,903

 

(4,130

)

(2,161

)

(10,603

)

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

268

 

193

 

492

 

405

 

Other (expense) income

 

(192

)

(583

)

(2,581

)

8

 

Income (loss) before income taxes

 

6,979

 

(4,520

)

(4,250

)

(10,190

)

Provision (benefit) for income taxes

 

2,560

 

(1,619

)

(1,688

)

(3,680

)

Net Income (loss)

 

$

4,419

 

$

(2,901

)

$

(2,562

)

$

(6,510

)

Earnings (loss) per share data:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.19

 

$

(0.13

)

$

(0.11

)

$

(0.29

)

Diluted

 

$

0.19

 

$

(0.13

)

$

(0.11

)

$

(0.29

)

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

22,985,956

 

22,878,410

 

22,966,513

 

22,840,465

 

Diluted

 

23,148,456

 

22,878,410

 

22,966,513

 

22,840,465

 

 

See accompanying notes to consolidated financial statements (unaudited).

 

4



Table of Contents

 

AeroVironment, Inc.

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

(In thousands)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

October 31,

 

November 1,

 

October 31,

 

November 1,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

4,419

 

$

(2,901

)

$

(2,562

)

$

(6,510

)

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on investments, net of tax expense of $17 and $(429) for the three months ended October 31, 2015 and November 1, 2014, respectively; and net of tax expense of $18 and $(397) for the sixth months ended October 31, 2015 and November 1, 2014, respectively

 

25

 

(644

)

27

 

(596

)

Total comprehensive income (loss)

 

$

4,444

 

$

(3,545

)

$

(2,535

)

$

(7,106

)

 

See accompanying notes to consolidated financial statements (unaudited).

 

5



Table of Contents

 

AeroVironment, Inc.

Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

 

 

 

Six Months Ended

 

 

 

October 31,
2015

 

November 1,
2014

 

Operating activities

 

 

 

 

 

Net loss

 

$

(2,562

)

$

(6,510

)

Adjustments to reconcile net loss to cash (used in) provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

2,765

 

4,303

 

Impairment of available-for-sale securities

 

2,186

 

 

Loss from equity method investments

 

122

 

98

 

Provision for doubtful accounts

 

(231

)

(105

)

Deferred income taxes

 

215

 

42

 

Loss (gain) on sale of equity securities

 

219

 

(347

)

Stock-based compensation

 

2,082

 

1,745

 

Foreign currency losses

 

63

 

281

 

Increase in fair value of conversion feature of convertible bonds

 

 

(73

)

Tax benefit from exercise of stock options

 

196

 

11

 

Excess tax benefit from stock-based compensation

 

 

(348

)

Amortization of held-to-maturity investments

 

2,146

 

2,211

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(8,908

)

748

 

Unbilled receivables and retentions

 

5,558

 

3,826

 

Inventories

 

(8,922

)

(1,105

)

Income tax receivable

 

(2,887

)

1,708

 

Other assets

 

119

 

27

 

Accounts payable

 

(7,653

)

5,082

 

Other liabilities

 

(7,417

)

764

 

Net cash (used in) provided by operating activities

 

(22,909

)

12,358

 

Investing activities

 

 

 

 

 

Acquisitions of property and equipment

 

(2,804

)

(1,070

)

Equity method investments

 

(186

)

(186

)

Purchases of held-to-maturity investments

 

(43,072

)

(68,524

)

Redemptions of held-to-maturity investments

 

55,847

 

46,727

 

Sales of available-for-sale investments

 

987

 

9,038

 

Net cash provided by (used in) investing activities

 

10,772

 

(14,015

)

Financing activities

 

 

 

 

 

Purchase and retirement of common stock

 

(3,756

)

 

Tax withholding payment related to net settlement of equity awards

 

(29

)

 

Excess tax benefit from exercise of stock options

 

 

348

 

Exercise of stock options

 

544

 

679

 

Net cash (used in) provided by financing activities

 

(3,241

)

1,027

 

Net decrease in cash and cash equivalents

 

(15,378

)

(630

)

Cash and cash equivalents at beginning of period

 

143,410

 

126,969

 

Cash and cash equivalents at end of period

 

$

128,032

 

$

126,339

 

 

 

 

 

 

 

Supplemental disclosure:

 

 

 

 

 

Unrealized change in fair value of investments recorded in other comprehensive income (loss), net of deferred taxes of $18 and $(397), respectively

 

$

27

 

$

596

 

Reclassification from share-based liability compensation to equity

 

$

228

 

 

 

See accompanying notes to consolidated financial statements (unaudited).

 

6



Table of Contents

 

AeroVironment, Inc.

Notes to Consolidated Financial Statements (Unaudited)

 

1. Organization and Significant Accounting Policies

 

Organization

 

AeroVironment, Inc., a Delaware corporation (the “Company”), is engaged in the design, development, production, support and operation of unmanned aircraft systems (“UAS”) and efficient energy systems (“EES”) for various industries and governmental agencies.

 

Basis of Presentation

 

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with the instructions of Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments necessary for a fair presentation with respect to the interim financial statements have been included. The results of operations for the three and six months ended October 31, 2015, are not necessarily indicative of the results for the full year ending April 30, 2016. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended April 30, 2015, included in the Company’s Annual Report on Form 10-K.

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions, including estimates of anticipated contract costs and revenue utilized in the revenue recognition process, that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

 

The Company’s consolidated financial statements include the assets, liabilities and operating results of wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated.

 

Reclassifications

 

Certain prior year amounts have been reclassified to conform to the current year presentation.

 

Segments

 

The Company’s products are sold and divided among two reportable segments to reflect the Company’s strategic goals. Operating segments are defined as components of an enterprise from which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker (“CODM”) in deciding how to allocate resources and in assessing performance. The Company’s CODM is the Chief Executive Officer, who reviews the revenue and gross margin results for each of these segments in order to make resource allocation decisions, including the focus of research and development (“R&D”) activities and performance assessment. The Company’s reportable segments are business units that offer different products and services and are managed separately.

 

Investments

 

The Company’s investments are accounted for as held-to-maturity and available-for-sale and reported at amortized cost and fair value, respectively.

 

Fair Values of Financial Instruments

 

Fair values of cash and cash equivalents, accounts receivable, unbilled receivables, retentions and accounts payable approximate cost due to the short period of time to maturity.

 

Government Contracts

 

Payments to the Company on government cost reimbursable contracts are based on provisional, or estimated indirect rates, which are subject to an annual audit by the Defense Contract Audit Agency (“DCAA”). The cost audits result in the negotiation and determination of the final indirect cost rates that the Company may use for the period(s) audited. The final rates, if different from the provisional billing rates, may create an additional receivable or liability for the Company.  For example, during the course of its audits, the DCAA may question the Company’s incurred project costs, and if the DCAA believes the Company has accounted for such costs in a manner inconsistent with the requirements under Federal Acquisition Regulations, the DCAA auditor may recommend to the Company’s administrative contracting officer to disallow such costs. The Company can provide no assurance that the DCAA or other government audits will not result in material disallowances for incurred costs in the future.

 

7



Table of Contents

 

AeroVironment, Inc.

Notes to Consolidated Financial Statements (Unaudited)

 

The Defense Contract Management Agency, or (“DCMA”), has disallowed a portion of the Company’s executive compensation and other costs included in the Company’s fiscal year 2006 incurred cost claim and sought interest and penalties. The Company and DCMA have resolved most of these claims. However, the Company is vigorously defending its position on the government’s remaining claims for the fiscal 2006 incurred cost claim which the Company has appealed to the Armed Services Board of Contract Appeals. Based on the Company’s current understanding of the facts and the amount in dispute, the Company believes that the outcome of these disputes will not have a material impact on the Company’s business. Claims related to other fiscal years were settled during the three and six months ended October 31, 2015, as described in Note 9. As of October 31, 2015 and April 30, 2015, the Company had reserves for incurred cost claim audits for various fiscal years.

 

Earnings (Loss) Per Share

 

Basic earnings (loss) per share is computed using the weighted-average number of common shares outstanding, excluding shares of unvested restricted stock.

 

The reconciliation of basic to diluted shares is as follows:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

October 31,
2015

 

November 1,
2014

 

October 31,
2015

 

November 1,
2014

 

Denominator for basic earnings (loss) per share:

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding, excluding unvested restricted stock

 

22,985,956

 

22,878,410

 

22,966,513

 

22,840,465

 

Dilutive effect of employee stock options and unvested restricted stock

 

162,500

 

 

 

 

Denominator for diluted earnings (loss) per share

 

23,148,456

 

22,878,410

 

22,966,513

 

22,840,465

 

 

During the three months ended October 31, 2015, approximately 21,000 shares reserved for issuance upon exercise of stock options and shares of unvested restricted stock were not included in the computation of diluted earnings per share because their inclusion would have been anti-dilutive. Due to the net loss for the three months ended November 1, 2014 and six months ended October 31, 2015 and November 1, 2014, no shares reserved for issuance upon exercise of stock options or shares of unvested restricted stock were included in the computation of diluted loss per share as their inclusion would have been anti-dilutive.

 

Recently Issued Accounting Standards

 

In July 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-17,  Income Taxes (Topic 740) - Balance Sheet Classification of Deferred Taxes.  This update simplifies the presentation of deferred income taxes, by requiring that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this update. This update is effective for financial statements issued for annual periods beginning after December 15, 2016, and interim periods within those annual periods. The Company is evaluating the potential impact of adoption on its consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) . The new standard was originally effective for reporting periods beginning after December 15, 2016 and early adoption was not permitted. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 640)-Deferral of the Effective Date. This update approved a one year delay of the effective date to reporting periods beginning after December 15, 2017, while permitting companies to voluntarily adopt the new standard as of the original effective date. The Company is currently evaluating when to adopt the new standard and the potential impact of adoption on its consolidated financial statements.

 

In July 2015, the FASB issued ASU No. 2015-11,  Inventory (Topic 330): Simplifying the Measurement of Inventory .  This ASU does not apply to inventory that is measured using last-in, first-out (LIFO) or the retail inventory method.  The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out (FIFO) or average cost.  This ASU eliminates from U.S. GAAP the requirement to measure inventory at the lower of cost or market.  Market under the previous requirement could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin.  Entities within the scope of this update will now be required to measure inventory at the lower of cost and net realizable value.  Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.  Subsequent measurement is unchanged for inventory using LIFO or the retail inventory method.  The amendments in this update are effective for fiscal years beginning after December 15, 2016, with early adoption permitted.  The Company is evaluating the potential impact of this adoption on its consolidated financial statements.

 

8



Table of Contents

 

AeroVironment, Inc.

Notes to Consolidated Financial Statements (Unaudited)

 

2. Investments

 

Investments consist of the following (in thousands):

 

 

 

October 31,
2015

 

April 30,
2015

 

Short-term investments:

 

 

 

 

 

Held-to-maturity securities:

 

 

 

 

 

Municipal securities

 

$

57,308

 

$

67,173

 

U.S. government securities

 

6,014

 

11,536

 

Corporate bonds

 

13,902

 

1,314

 

Certificates of deposit

 

743

 

3,885

 

Total held-to-maturity investments

 

77,967

 

83,908

 

Available-for-sale securities:

 

 

 

 

 

Equity securities

 

 

1,473

 

Total available-for-sale investments

 

 

1,473

 

Total short-term investments

 

$

77,967

 

$

85,381

 

Long-term investments:

 

 

 

 

 

Held-to-maturity securities:

 

 

 

 

 

Municipal securities

 

$

11,938

 

$

30,418

 

U.S. government securities

 

 

5,009

 

Corporate bonds

 

23,012

 

8,501

 

Total held-to-maturity investments

 

34,950

 

43,928

 

Available-for-sale securities:

 

 

 

 

 

Auction rate securities

 

2,765

 

2,841

 

Total available-for-sale investments

 

2,765

 

2,841

 

Total long-term investments

 

$

37,715

 

$

46,769

 

 

Held-To-Maturity Securities

 

As of October 31, 2015 and April 30, 2015, the balance of held-to-maturity securities consisted of state and local government municipal securities, U.S. treasury securities, corporate bonds and certificates of deposit. Interest earned from these investments is recorded in interest income.

 

The amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the held-to-maturity investments as of October 31, 2015, were as follows (in thousands):

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

Municipal securities

 

$

69,246

 

$

34

 

$

(3

)

$

69,277

 

U.S. government securities

 

6,014

 

5

 

 

6,019

 

Corporate bonds

 

36,914

 

5

 

(56

)

36,863

 

Certificates of deposit

 

743

 

 

 

743

 

Total held-to-maturity investments

 

$

112,917

 

$

44

 

$

(59

)

$

112,902

 

 

The amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the held-to-maturity investments as of April 30, 2015, were as follows (in thousands):

 

 

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair
Value

 

Municipal securities

 

$

97,591

 

$

8

 

$

(35

)

$

97,564

 

U.S. government securities

 

16,545

 

12

 

 

16,557

 

Corporate bonds

 

9,815

 

 

(13

)

9,802

 

Certificates of deposit

 

3,885

 

 

 

3,885

 

Total held-to-maturity investments

 

$

127,836

 

$

20

 

$

(48

)

$

127,808

 

 

9



Table of Contents

 

AeroVironment, Inc.

Notes to Consolidated Financial Statements (Unaudited)

 

The amortized cost and fair value of the held-to-maturity securities by contractual maturity at October 31, 2015, were as follows (in thousands):

 

 

 

Cost

 

Fair Value

 

 

 

 

 

 

 

Due within one year

 

$

77,967

 

$

77,976

 

Due after one year through three years

 

34,950

 

34,926

 

Total

 

$

112,917

 

$

112,902

 

 

Available-For-Sale Securities

 

Auction Rate Securities

 

As of October 31, 2015 and April 30, 2015, the entire balance of available-for-sale, auction rate securities, consisted of two investment grade auction rate municipal bonds, with maturities of approximately 4 and 19 years, respectively. These investments have characteristics similar to short-term investments, because at pre-determined intervals, generally ranging from 30 to 35 days, there is a new auction process at which the interest rates for these securities are reset to current interest rates. At the end of such period, the Company chooses to roll-over its holdings or redeem the investments for cash. A market maker facilitates the redemption of the securities and the underlying issuers are not required to redeem the investment within 365 days. Interest earned from these investments is recorded in interest income.

 

During the fourth quarter of the fiscal year ended April 30, 2008, the Company began experiencing failed auctions on some of its auction rate securities. A failed auction occurs when a buyer for the securities cannot be obtained and the market maker does not buy the security for its own account. The Company continues to earn interest on the investments that failed to settle at auction, at the maximum contractual rate until the next auction occurs. In the event the Company needs to access funds invested in these auction rate securities, the Company may not be able to liquidate these securities at the fair value recorded on October 31, 2015, until a future auction of these securities is successful or a buyer is found outside of the auction process.

 

As a result of the failed auctions, the fair values of these securities are estimated utilizing a discounted cash flow analysis as of October 31, 2015. The analysis considers, among other items, the collateralization underlying the security investments, the creditworthiness of the counterparty, the timing of expected future cash flows, and the estimated date upon which the security is expected to have a successful auction. Based on the Company’s ability to access its cash and cash equivalents, expected operating cash flows, and other sources of cash, the Company does not anticipate that the current lack of liquidity of these investments will affect its ability to operate the business in the ordinary course. The Company believes the current lack of liquidity of these investments is temporary and expects that the securities will be redeemed or refinanced at some point in the future. The Company will continue to monitor the value of its auction rate securities at each reporting period for a possible impairment if a further decline in fair value occurs. The auction rate securities have been in an unrealized loss position for more than 12 months. The Company has the ability and the intent to hold these investments until a recovery of fair value, which may be at maturity and as of October 31, 2015, the Company did not consider these investments to be other-than-temporarily impaired.

 

The amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the auction rate securities as of October 31, 2015, were as follows (in thousands):

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

Auction rate securities

 

$

3,100

 

$

 

$

(335

)

$

2,765

 

Total available-for-sale investments

 

$

3,100

 

$

 

$

(335

)

$

2,765

 

 

The amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the auction rate securities as of April 30, 2015, were as follows (in thousands):

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

Amortized

 

Unrealized

 

Unrealized

 

 

 

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

Auction rate securities

 

$

3,200

 

$

 

$

(359

)

$

2,841

 

Total available-for-sale investments

 

$

3,200

 

$

 

$

(359

)

$

2,841

 

 

10



Table of Contents

 

AeroVironment, Inc.

Notes to Consolidated Financial Statements (Unaudited)

 

The amortized cost and fair value of the auction rate securities by contractual maturity at October 31, 2015, were as follows (in thousands):

 

 

 

Cost

 

Fair Value

 

Due one through five years

 

$

1,100

 

$

1,055

 

Due after 10 years

 

2,000

 

1,710

 

Total

 

$

3,100

 

$

2,765

 

 

Equity Securities

 

At April 30, 2015, the entire balance of available-for-sale equity securities consisted of 618,042 CybAero AB (“CybAero”) common shares. The shares were classified as available-for-sale.  These shares were initially acquired on August 11, 2014, when the Company converted a convertible bond into CybAero common shares. The convertible bond was in the amount of 10 million SEK and was converted into 1,062,699 common shares of CybAero at the conversion price of 9.41 SEK per share. When the Company converted the bond on August 11, 2014, the fair value per share was 37.50 SEK which became the new cost basis going forward, with all subsequent changes in fair value being recorded to other comprehensive income.

 

At August 1, 2015, the Company reviewed these shares for impairment based on criteria that included the extent to which the investment’s carrying value exceeds its related market value, the duration of the market decline, uncertainty as to the recovery period due to sustained losses of the investee and the Company’s intent to hold its investment until recovery. In the three months ended August 1, 2015, the Company determined it was in its best interests to liquidate the remaining shares held. As a result, during the three months ended August 1, 2015, the Company recorded an other-than-temporary-impairment loss of $2,186,000 related to the Company’s investment in the CybAero shares which was recorded to Other expense in the consolidated statement of operations. As a result of recording the impairment charge, the investment’s fair value became its new cost basis. During the three months ended October 31, 2015, and the three and six months ended August 2, 2014 there was no impairment charge recorded.

 

In August 2015, the Company sold its remaining shares in CybAero in a private sale at the price of 12.00 SEK per share, resulting in proceeds of approximately $777,000.  During the three and six months ended October 31, 2015, the Company realized gains on the sale of CybAero shares of $155,000 and $207,000, respectively, based on the difference between the original conversion price of 9.41 SEK per share and the sales price at the time of sale, inclusive of the final sale of all shares.  During the three and six months ended November 1, 2014, the Company realized gains on the sale of CybAero shares of $244,000 and $4,147,000, respectively. At October 31, 2015, the Company did not hold any CybAero stock.

 

The amortized cost, gross unrealized gains, gross unrealized losses, and estimated fair value of the equity securities as of April 30, 2015, were as follows (in thousands):

 

 

 

 

 

Gross

 

Gross

 

 

 

 

 

 

 

Unrealized

 

Unrealized

 

 

 

 

 

Cost

 

Gains

 

Losses

 

Fair Value

 

Equity securities

 

$

3,357

 

$

 

$

(1,884

)

$

1,473

 

Total available-for-sale investments

 

$

3,357

 

$

 

$

(1,884

)

$

1,473

 

 

3. Fair Value Measurements

 

Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The fair value hierarchy contains three levels as follows:

 

·                 Level 1 — Inputs to the valuation based upon quoted prices (unadjusted) for identical assets or liabilities in active markets that are accessible as of the measurement date.

 

·                 Level 2 — Inputs to the valuation include quoted prices in either markets that are not active, or in active markets for similar assets or liabilities, inputs other than quoted prices that are observable, and inputs that are derived principally from or corroborated by observable market data.

 

·                 Level 3 — Inputs to the valuation that are unobservable inputs for the asset or liability.

 

11



Table of Contents

 

AeroVironment, Inc.

Notes to Consolidated Financial Statements (Unaudited)

 

The Company’s financial assets measured at fair value on a recurring basis at October 31, 2015, were as follows (in thousands):

 

 

 

Fair Value Measurement Using

 

Description

 

Quoted prices in
active markets for
identical assets
(Level 1)

 

Significant
other
observable
inputs
(Level 2)

 

Significant
unobservable
inputs
(Level 3)

 

Total

 

Auction rate securities

 

$

 

$

 

$

2,765

 

$

2,765

 

Total

 

$

 

$

 

$

2,765

 

$

2,765

 

 

The following table provides a reconciliation between the beginning and ending balances of items measured at fair value on a recurring basis in the table above that used significant unobservable inputs (Level 3) (in thousands):

 

Description

 

Fair Value
Measurements Using
Significant
Unobservable Inputs
(Level 3)

 

Balance at May 1, 2015

 

$

2,841

 

Transfers to Level 3

 

 

Total gains (realized or unrealized)

 

 

 

Included in earnings

 

 

Included in other comprehensive loss

 

24

 

Purchases, issuances and settlements, net

 

(100

)

Balance at October 31, 2015

 

$

2,765

 

The amount of total gains or (losses) for the period included in earnings (or change in net assets) attributable to the change in unrealized gains or losses relating to assets still held at October 31, 2015

 

$

 

 

The auction rate securities are valued using a discounted cash flow model.  The analysis considers, among other items, the collateralization underlying the security investments, the creditworthiness of the counterparty, the timing of expected future cash flows, and the estimated date upon which the security is expected to have a successful auction.  As of October 31, 2015, the inputs used in the Company’s discounted cash flow analysis included current coupon rates of 0.16% and 0.13%, estimated redemption periods of 4 and 19 years and discount rates of 4.30% and 14.60%. The discount rates were based on market rates for municipal bond securities, as adjusted for a risk premium to reflect the lack of liquidity of these investments.

 

4. Inventories, net

 

Inventories consist of the following (in thousands):

 

 

 

October 31,
2015

 

April 30,
2015

 

Raw materials

 

$

14,978

 

$

13,325

 

Work in process

 

8,257

 

5,140

 

Finished goods

 

28,937

 

25,537

 

Inventories, gross

 

52,172

 

44,002

 

Reserve for inventory obsolescence

 

(3,836

)

(4,588

)

Inventories, net

 

$

48,336

 

$

39,414

 

 

5. Warranty Reserves

 

The Company accrues an estimate of its exposure to warranty claims based upon both current and historical product sales data and warranty costs incurred. The warranty reserve is included in other current liabilities. The related expense is included in cost of sales.  Warranty reserve activity is summarized as follows for the three and six months ended October 31, 2015 and November 1, 2014 (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

October 31,

 

November 1,

 

October 31,

 

November 1,

 

 

 

2015

 

2014

 

2015

 

2014

 

 

 

 

 

 

 

 

 

 

 

Beginning balance

 

$

2,029

 

$

1,273

 

$

2,653

 

$

1,280

 

Warranty expense

 

1,001

 

1,027

 

1,708

 

1,409

 

Changes in estimates related to pre-existing warranties

 

 

 

(424

)

 

Warranty claims settled

 

(692

)

(341

)

(1,599

)

(730

)

Ending balance

 

$

2,338

 

$

1,959

 

$

2,338

 

$

1,959

 

 

12



Table of Contents

 

AeroVironment, Inc.

Notes to Consolidated Financial Statements (Unaudited)

 

6. Accumulated Other Comprehensive Loss and Reclassifications Adjustments

 

The components of accumulated other comprehensive loss and adjustments are as follows (in thousands):

 

 

 

Available-for-Sale
Securities

 

Accumulated Other
Comprehensive Loss

 

Balance, net of $834 of taxes, as of April 30, 2015

 

$

(1,358

)

$

(1,358

)

Reclassifications out of accumulated other comprehensive loss, net of $754 of taxes

 

1,130

 

1,130

 

Unrealized gains, net of $18 of taxes

 

27

 

27

 

Balance, net of $134 of taxes, as of October 31, 2015

 

$

(201

)

$

(201

)

 

7. Customer-Funded Research & Development

 

Customer-funded R&D costs are incurred pursuant to contracts (revenue arrangements) to perform R&D activities according to customer specifications. These costs are direct contract costs and are expensed to cost of sales when the corresponding revenue is recognized, which is generally as the R&D services are performed. Revenue from customer-funded R&D was approximately $10,234,000 and $26,761,000 for the three and six months ended October 31, 2015, respectively.  Revenue from customer-funded R&D was approximately $5,599,000 and $9,913,000 for the three and six months ended November 1, 2014, respectively.

 

8. Income Taxes

 

For the three and six months ended October 31, 2015, the Company recorded a provision (benefit) for income taxes of $2,560,000 and $(1,688,000), respectively, yielding an effective tax rate of 36.7% and 39.7%, respectively.  For the three and six months ended November 1, 2014, the Company recorded a benefit for income taxes of $1,619,000 and $3,680,000, respectively, yielding an effective tax rate of 35.8% and 36.1%, respectively.

 

9. Government Contract Reserves

 

During the three and six months ended October 31, 2015, the Company entered into settlement agreements with DCMA related to the Company’s incurred cost claims for fiscal years 2007 through 2009.  As a result of the settlement agreements, the Company paid $50,000 and reversed the remaining reserve amount of $3,499,000 related to those fiscal years as a credit to cost of sales, allocated as $3,111,000 to the UAS segment and $388,000 to the EES segment.

 

10. Share Repurchase

 

In September 2015, the Company’s Board of Directors authorized a program to repurchase up to $25,000,000 of the Company’s common stock with no specified termination date for the program. During the three and six months ended October 31, 2015, the Company repurchased and retired 183,261 shares of the Company’s common stock for a total of $3,756,000. All shares repurchased were executed in the open market and no shares were repurchased from related parties. Repurchased shares were retired and assumed the status of authorized and unissued shares.

 

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Table of Contents

 

AeroVironment, Inc.

Notes to Consolidated Financial Statements (Unaudited)

 

11. Segment Data

 

The Company’s product segments are as follows:

 

·                                           Unmanned Aircraft Systems — The UAS segment focuses primarily on the design, development, production, support and operation of innovative UAS and tactical missile systems that provide situational awareness, multi-band communications, force protection and other mission effects to increase the security and effectiveness of the operations of the Company’s customers.

 

·                                           Efficient Energy Systems — The EES segment focuses primarily on the design, development, production, marketing, support and operation of innovative efficient electric energy systems that address the growing demand for electric transportation solutions.

 

The accounting policies of the segments are the same as those described in Note 1, “Organization and Significant Accounting Policies.” The operating segments do not make sales to each other. Depreciation and amortization related to the manufacturing of goods is included in gross margin for the segments. The Company does not discretely allocate assets to its operating segments, nor does the CODM evaluate operating segments using discrete asset information. Consequently, the Company operates its financial systems as a single segment for accounting and control purposes, maintains a single indirect rate structure across all segments, has no inter-segment sales or corporate elimination transactions, and maintains limited financial statement information by segment. The segment results are as follows (in thousands):

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

October 31,

 

November 1,

 

October 31,

 

November 1,

 

 

 

2015

 

2014

 

2015

 

2014

 

Revenue:

 

 

 

 

 

 

 

 

 

UAS

 

$

56,589

 

$

43,045

 

$

96,756

 

$

84,231

 

EES

 

8,142

 

9,619

 

15,025

 

20,299

 

Total

 

64,731

 

52,664

 

111,781

 

104,530

 

Cost of sales:

 

 

 

 

 

 

 

 

 

UAS

 

28,314

 

27,575

 

54,780

 

58,590

 

EES

 

4,884

 

7,218

 

9,445

 

14,015

 

Total

 

33,198

 

34,793

 

64,225

 

72,605

 

Gross margin:

 

 

 

 

 

 

 

 

 

UAS

 

28,275

 

15,470

 

41,976

 

25,641

 

EES

 

3,258

 

2,401

 

5,580

 

6,284

 

Total

 

31,533

 

17,871

 

47,556

 

31,925

 

Selling, general and administrative

 

14,733

 

13,470

 

29,989

 

26,873

 

Research and development

 

9,897

 

8,531

 

19,728

 

15,655

 

Income (loss) from operations

 

6,903

 

(4,130

)

(2,161

)

(10,603

)

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

268

 

193

 

492

 

405

 

Other (expense) income

 

(192

)

(583

)

(2,581

)

8

 

Income (loss) before income taxes

 

$

6,979

 

$

(4,520

)

$

(4,250

)

$

(10,190

)

 

12. Subsequent Events

 

On December 4, 2015, the Compensation Committee of the Board of Directors approved entering into a Severance Protection Agreement (the “Agreement”) with each of the Company’s named executive officers which provides for the payment of certain benefits to each officer in connection with a change in control event and/or the termination of the officer’s employment in a non-change in control event. The term of each Agreement will commence on the date the Agreement is executed and continue until December 31, 2018.  If a change of control (as defined in the Agreement) occurs during the term of the Agreement, the term will be extended to the date that is 18 months after the date of the occurrence of such change in control.

 

Upon termination of the officer’s employment by the Company without cause or by the officer for good reason generally within three months before a change in control event or within 18 months afterwards, each officer will be entitled to receive a one-time cash payment as defined under each officer’s Agreement. Each officer will also be entitled to the continuation of certain employee welfare plan benefits (medical, dental and life insurance) for a period of 12 months. In addition, the vesting and exercisability of any outstanding stock options and restricted stock awards will be accelerated.

 

Upon termination by the Company for any reason other than cause in a context that does not involve a change in control, each officer will be entitled to a one-time cash payment as defined by each officer’s Agreement, and the continuation of certain employee welfare plan benefits (as described earlier) for a period of 12 months. The terms of this severance benefit are identical for each officer except the Chief Executive Officer, who is entitled to receive these benefits in the event he terminates his employment for good cause as defined in the Agreement.

 

To receive the severance benefits described above, the officer must execute a full release of any and all claims against the Company and comply with certain obligations specified in the Agreement.

 

In addition to the severance benefits for officers described above, the Compensation Committee of the Board of Directors also approved an Employee Change in Control Equity Acceleration program that would accelerate the vesting and exercisability of stock options and restricted stock awards held by any Company employee on a double trigger basis similar to the treatment of equity awards of the officers. Under the program, if an employee’s employment is terminated by the Company or a successor for a reason other than cause within 18 months after a change in control, the vesting and exercisability of all equity awards held by the employee would accelerate and the awards would become fully vested and exercisable.

On December 5, 2015, the Board of Directors approved entering into a letter agreement with each non-employee director that provides for the acceleration of vesting and exercisability of all Company stock options and restricted stock awards held by the director upon the completion of a change in control.

 

The Company determined that the actions taken by the Board of Directors and its Committee had no impact on the Company’s consolidated financial statements as of, and for the three and six months ended October 31, 2015.

 

14



Table of Contents

 

ITEM 2.                 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This section and other parts of this Quarterly Report on Form 10-Q contain forward-looking statements that involve risks and uncertainties. In some cases, forward-looking statements can be identified by words such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would” or similar expressions. Such forward-looking statements are based on current expectations, estimates and projections about our industry, our management’s beliefs and assumptions made by our management. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in Part II, Item 1A, “Risk Factors.”

 

Unless required by law, we expressly disclaim any obligation to update publicly any forward-looking statements, whether as result of new information, future events or otherwise.

 

Critical Accounting Policies and Estimates

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. When we prepare these consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Some of our accounting policies require that we make subjective judgments, including estimates that involve matters that are inherently uncertain. Our most critical estimates include those related to revenue recognition, inventories and reserves for excess and obsolescence, self-insured liabilities, accounting for stock-based awards, and income taxes. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different assumptions or conditions.

 

There have been no material changes made to the critical accounting estimates during the periods presented in the consolidated financial statements from those disclosed in the Form 10-K for the fiscal year ended April 30, 2015.

 

We review cost performance and estimates to complete at least quarterly and in many cases more frequently. Adjustments to original estimates for a contract’s revenue, estimated costs at completion and estimated profit or loss are often required as work progresses under a contract, as experience is gained and as more information is obtained, even though the scope of work required under the contract may not change, or if contract modifications occur. The impact of revisions in profit estimates for all types of contracts are recognized on a cumulative catch-up basis in the period in which the revisions are made. During the three and six months ended October 31, 2015 and November 1, 2014, changes in accounting estimates on fixed-price contracts recognized using the percentage of completion method of accounting are presented below.

 

For the three months ended October 31, 2015 and November 1, 2014, favorable and unfavorable cumulative catch-up adjustments included in cost of sales were as follows (in thousands):

 

 

 

Three Months Ended

 

 

 

October 31,

 

November 1,

 

 

 

2015

 

2014

 

 

 

 

 

 

 

Gross favorable adjustments

 

$

499

 

$

710

 

Gross unfavorable adjustments

 

(125

)

(796

)

Net favorable (unfavorable) adjustments

 

$

374

 

$

(86

)

 

For the three months ended October 31, 2015, favorable cumulative catch-up adjustments of $0.5 million were primarily due to final cost adjustments on 154 contracts, which individually were not material. For the same period, unfavorable cumulative catch-up adjustments of $0.1 million were primarily related to higher than expected costs on 96 contracts, which individually were not material.

 

For the three months ended November 1, 2014, favorable cumulative catch-up adjustments of $0.7 million were primarily due to final cost adjustments on 50 contracts, which individually were not material. For the same period, unfavorable cumulative catch-up adjustments of $0.8 million were primarily related to higher than expected costs on 164 contracts, which individually were not material.

 

15



Table of Contents

 

For the six months ended October 31, 2015 and November 1, 2014, favorable and unfavorable cumulative catch-up adjustments included in cost of sales were as follows (in thousands):

 

 

 

Six Months Ended

 

 

 

October 31,

 

November 1,

 

 

 

2015

 

2014

 

 

 

 

 

 

 

Gross favorable adjustments

 

$

437

 

$

991

 

Gross unfavorable adjustments

 

(207

)

(1,156

)

Net favorable (unfavorable) adjustments

 

$

230

 

$

(165

)

 

For the six months ended October 31, 2015, favorable cumulative catch-up adjustments of $0.4 million were primarily due to final cost adjustments on 136 contracts, which individually were not material. For the same period, unfavorable cumulative catch-up adjustments of $0.2 million were primarily related to higher than expected costs on 88 contracts, which individually were not material.

 

For the six months ended November 1, 2014, favorable cumulative catch-up adjustments of $1.0 million were primarily due to final cost adjustments on 24 contracts, which individually were not material. For the same period, unfavorable cumulative catch-up adjustments of $1.2 million were primarily related to higher than expected costs on 159 contracts, which individually were not material.

 

Fiscal Periods

 

Due to our fixed year end date of April 30, our first and fourth quarters each consist of approximately 13 weeks. The second and third quarters each consist of exactly 13 weeks. Our first three quarters end on a Saturday.  Our 2016 fiscal year ends on April 30, 2016 and our fiscal quarters end on August 1, 2015, October 31, 2015 and January 30, 2016.

 

Results of Operations

 

Our operating segments are Unmanned Aircraft Systems, or UAS, and Efficient Energy Systems, or EES. The accounting policies for each of these segments are the same. In addition, a significant portion of our research and development, or R&D, selling, general and administrative, or SG&A, and general overhead resources are shared across our segments.

 

The following table sets forth our revenue and gross margin generated by each operating segment for the periods indicated (in thousands):

 

Three Months Ended October 31, 2015 Compared to Three Months Ended November 1, 2014

 

 

 

Three Months Ended

 

 

 

October 31,

 

November 1,

 

 

 

2015

 

2014

 

Revenue:

 

 

 

 

 

UAS

 

$

56,589

 

$

43,045

 

EES

 

8,142

 

9,619

 

Total

 

64,731

 

52,664

 

Cost of sales:

 

 

 

 

 

UAS

 

28,314

 

27,575

 

EES

 

4,884

 

7,218

 

Total

 

33,198

 

34,793

 

Gross margin:

 

 

 

 

 

UAS

 

28,275

 

15,470

 

EES

 

3,258

 

2,401

 

Total

 

31,533

 

17,871

 

Selling, general and administrative

 

14,733

 

13,470

 

Research and development

 

9,897

 

8,531

 

Income (loss) from operations

 

6,903

 

(4,130

)

Other income (expense):

 

 

 

 

 

Interest income

 

268

 

193

 

Other (expense) income

 

(192

)

(583

)

Income (loss) before income taxes

 

$

6,979

 

$

(4,520

)

 

Revenue. Revenue for the three months ended October 31, 2015 was $64.7 million, as compared to $52.7 million for the three months ended November 1, 2014, representing an increase of $12.1 million, or 23%. The increase in revenue was due to an increase in product deliveries of $6.6 million and an increase in service revenue of $5.4 million. UAS revenue increased $13.5 million, or 31%, to $56.6 million for the three months ended October 31, 2015, primarily due to an increase in product deliveries of $8.0 million, an increase in service revenue of $0.9 million, and an increase in customer-funded R&D work of $4.6 million. The increase in product deliveries was primarily due to an increase in product deliveries of small UAS.  The increase in service revenue was primarily due to an increase in services for small UAS. The increase in customer-funded R&D was primarily due to an increase in development programs related to tactical missile systems and large UAS. EES revenue decreased $1.5 million, or 15%, to $8.1 million for the three months ended October 31, 2015, primarily due to a decrease in product deliveries of our industrial fast charge systems and in product deliveries of our passenger electric vehicle charging systems.

 

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Table of Contents

 

Cost of Sales. Cost of sales for the three months ended October 31, 2015 was $33.2 million, as compared to $34.8 million for the three months ended November 1, 2014, representing a decrease of $1.6 million, or 5%. Cost of sales was impacted by a government contract accounting reserve reduction of $3.5 million recorded in the quarter for the settlement of prior year incurred cost audits .  As a percentage of revenue, cost of sales decreased from 66% to 51%. The decrease in cost of sales was primarily due to a decrease in product costs of $3.0 million offset by an increase in cost of services of $1.4 million primarily due to an increase in services revenue. UAS cost of sales increased $0.7 million, or 3%, to $28.3 million for the three months ended October 31, 2015, primarily due to an increase in sales volume. As a percentage of revenue, cost of sales for UAS decreased from 64% to 50% due to favorable product mix, higher sales volume and the government contract reserve reduction.  EES cost of sales decreased $2.3 million, or 32%, to $4.9 million for the three months ended October 31, 2015. As a percentage of revenue, cost of sales for EES decreased from 75% to 60% primarily due to a favorable product mix and the government contract reserve reduction.

 

Gross Margin. Gross margin for the three months ended October 31, 2015 was $31.5 million, as compared to $17.9 million for the three months ended November 1, 2014, representing an increase of $13.7 million, or 76%. The increase in gross margin was due to an increase in product margins of $9.6 million and service revenue margins of $4.1 million, both of which were impacted by the government contract reserve reduction. As a percentage of revenue, gross margin increased from 34% to 49%. UAS gross margin increased $12.8 million, or 83%, to $28.3 million for the three months ended October 31, 2015.  The increase was primarily due to an increase in margins on product sales and service-related contracts, and the government contract reserve reduction.  As a percentage of revenue, gross margin for UAS increased from 36% to 50%. EES gross margin increased $0.9 million, or 36%, to $3.3 million for the three months ended October 31, 2015 primarily due to a favorable product mix.  As a percentage of revenue, EES gross margin increased from 25% to 40% primarily due to a favorable product mix, and the government contract reserve reduction.

 

Selling, General and Administrative .   SG&A expense for the three months ended October 31, 2015 was $14.7 million, or 23% of revenue, compared to SG&A expense of $13.5 million, or 26% of revenue, for the three months ended November 1, 2014. SG&A expense increased by $1.3 million primarily due to higher professional service costs and bid and proposal costs.

 

Research and Development. R&D expense for the three months ended October 31, 2015 was $9.9 million, or 15% of revenue, compared to R&D expense of $8.5 million, or 16% of revenue, for the three months ended November 1, 2014.  R&D expense increased by $1.4 million for the three months ended October 31, 2015, primarily due to increased development activities for certain strategic initiatives.

 

Interest Income. Interest income for the three months ended October 31, 2015 was $0.3 million compared to interest income of $0.2 million for the three months ended November 1, 2014.

 

Other Expense.  Other expense for the three months ended October 31, 2015 was $0.2 million compared to other expense of $0.6 million for the three months ended November 1, 2014. The decrease was due to the prior year change in fair value of the embedded conversion feature of our convertible bond investment, not present in the current year.

 

Income Taxes. Our effective income tax rate was 36.7% for the three months ended October 31, 2015, as compared to an effective income tax rate of 35.8% for the three months ended November 1, 2014.

 

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Table of Contents

 

Six Months Ended October 31, 2015 Compared to Six Months Ended November 1, 2014

 

 

 

Six Months Ended

 

 

 

October 31,

 

November 1,

 

 

 

2015

 

2014

 

Revenue:

 

 

 

 

 

UAS

 

$

96,756

 

$

84,231

 

EES

 

15,025

 

20,299

 

Total

 

111,781

 

104,530

 

Cost of sales:

 

 

 

 

 

UAS

 

54,780

 

58,590

 

EES

 

9,445

 

14,015

 

Total

 

64,225

 

72,605

 

Gross margin:

 

 

 

 

 

UAS

 

41,976

 

25,641

 

EES

 

5,580

 

6,284

 

Total

 

47,556

 

31,925

 

Selling, general and administrative

 

29,989

 

26,873

 

Research and development

 

19,728

 

15,655

 

Loss from operations

 

(2,161

)

(10,603

)

Other (expense) income:

 

 

 

 

 

Interest income

 

492

 

405

 

Other (expense) income

 

(2,581

)

8

 

Loss before income taxes

 

$

(4,250

)

$

(10,190

)

 

Revenue. Revenue for the six months ended October 31, 2015 was $111.8 million, as compared to $104.5 million for the six months ended November 1, 2014, representing an increase of $7.3 million, or 7%. The increase in revenue was due to an increase in service revenue of $16.8 million and a decrease in product deliveries of $9.6 million. UAS revenue increased $12.5 million, or 15%, to $96.8 million for the six months ended October 31, 2015, primarily due to an increase in customer-funded R&D work of $16.8 million, and an increase in service revenue of $0.5 million, offset by a decrease in product deliveries of $4.8 million. The increase in customer-funded R&D work was primarily due to an increase in development programs related to tactical missile systems and large UAS.  The increase in service revenue was primarily due to an increase in services for small UAS. The decrease in product deliveries was primarily due to a decrease in deliveries of our tactical missile systems. EES revenue decreased $5.3 million, or 26%, to $15.0 million for the six months ended October 31, 2015, primarily due to a decrease in product deliveries of our industrial fast charge systems and in product deliveries of our passenger electric vehicle charging systems.

 

Cost of Sales. Cost of sales for the six months ended October 31, 2015 was $64.2 million, as compared to $72.6 million for the six months ended November 1, 2014, representing a decrease of $8.4 million, or 12%. Cost of sales was impacted by a government contract accounting reserve reduction of $3.5 million recorded in the quarter for the settlement of prior year incurred cost audits .  As a percentage of revenue, cost of sales decreased from 69% to 57%. The decrease in cost of sales was primarily due to a decrease in product costs of $17.0 million due to a decrease in product deliveries offset by an increase in cost of services of $8.6 million primarily due to an increase in services revenue. UAS cost of sales decreased $3.8 million, or 7%, to $54.8 million for the six months ended October 31, 2015, primarily due to favorable product mix. As a percentage of revenue, cost of sales for UAS decreased from 70% to 57% due to favorable product mix and the government contract reserve reduction.  EES cost of sales decreased $4.6 million, or 33%, to $9.4 million for the six months ended October 31, 2015. As a percentage of revenue, cost of sales for EES decreased from 69% to 63% primarily due to a favorable product mix and the government contract reserve reduction.

 

Gross Margin. Gross margin for the six months ended October 31, 2015 was $47.6 million, as compared to $31.9 million for the six months ended November 1, 2014, representing an increase of $15.6 million, or 49%. The increase in gross margin was due to an increase in product margins of $7.5 million and service revenue margins of $8.2 million, both of which were impacted by the government contract reserve reduction. As a percentage of revenue, gross margin increased from 31% to 43%. UAS gross margin increased $16.3 million, or 64%, to $42.0 million for the six months ended October 31, 2015.  The increase was primarily due to an increase in margins on product sales and service-related contracts, and the government contract reserve reduction.  As a percentage of revenue, gross margin for UAS increased from 30% to 43%. EES gross margin decreased $0.7 million, or 11%, to $5.6 million for the six months ended October 31, 2015 primarily due to lower sales volume.  As a percentage of revenue, EES gross margin increased from 31% to 37% primarily due to a favorable product mix and the government contract reserve reduction.

 

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Table of Contents

 

Selling, General and Administrative .   SG&A expense for the six months ended October 31, 2015 was $30.0 million, or 27% of revenue, compared to SG&A expense of $26.9 million, or 26% of revenue, for the six months ended November 1, 2014. SG&A expense increased by $3.1 million primarily due to higher professional service costs and bid and proposal costs.

 

Research and Development. R&D expense for the six months ended October 31, 2015 was $19.7 million, or 18% of revenue, compared to R&D expense of $15.7 million, or 15% of revenue, for the six months ended November 1, 2014.  R&D expense increased by $4.1 million for the six months ended October 31, 2015, primarily due to increased development activities for certain strategic initiatives.

 

Interest Income. Interest income for the six months ended October 31, 2015 was $0.5 million compared to interest income of $0.4 million for the six months ended November 1, 2014.

 

Other Expense.  Other expense for the six months ended October 31, 2015 was $2.6 million compared to other income of $8,000 for the six months ended November 1, 2014. The decrease was primarily due to the recording of an other-than-temporary impairment loss of $2.2 million related to available-for-sale equity securities in the six months ended October 31, 2015. No impairment loss was recorded in the six months ended November 1, 2014.

 

Income Taxes. Our effective income tax rate was 39.7% for the six months ended October 31, 2015, as compared to an effective income tax rate of 36.1% for the six months ended November 1, 2014.

 

Backlog

 

We define funded backlog as unfilled firm orders for products and services for which funding currently is appropriated to us under the contract by the customer. As of October 31, 2015 and April 30, 2015, our funded backlog was approximately $97.2 million and $64.7 million, respectively.

 

In addition to our funded backlog, we also had unfunded backlog of $16.7 million and $19.1 million as of October 31, 2015 and April 30, 2015, respectively.  We define unfunded backlog as the total remaining potential order amounts under cost reimbursable and fixed price contracts with multiple one-year options, and indefinite delivery, indefinite quantity, or IDIQ contracts. Unfunded backlog does not obligate the U.S. government to purchase goods or services. There can be no assurance that unfunded backlog will result in any orders in any particular period, if at all. Management believes that unfunded backlog does not provide a reliable measure of future estimated revenue under our contracts. Unfunded backlog does not include the remaining potential value associated with a U.S. Army IDIQ-type contract for small UAS because the contract was awarded to five companies in 2012, including AeroVironment, and we cannot be certain that we will receive task orders issued against the contract.

 

Because of possible future changes in delivery schedules and/or cancellations of orders, backlog at any particular date is not necessarily representative of actual sales to be expected for any succeeding period, and actual sales for the year may not meet or exceed the backlog represented. Our backlog is typically subject to large variations from quarter to quarter as existing contracts expire, or are renewed, or new contracts are awarded. A majority of our contracts, specifically our IDIQ contracts, do not currently obligate the U.S. government to purchase any goods or services. Additionally, all U.S. government contracts included in backlog, whether or not they are funded, may be terminated at the convenience of the U.S. government.

 

Liquidity and Capital Resources

 

We currently have no material cash commitments, except for normal recurring trade payables, accrued expenses and ongoing R&D costs, all of which we anticipate funding through our existing working capital and funds provided by operating activities. The majority of our purchase obligations are pursuant to funded contractual arrangements with our customers. In addition, we do not currently anticipate significant investment in property, plant and equipment, and we believe that our existing cash, cash equivalents, cash provided by operating activities and other financing sources will be sufficient to meet our anticipated working capital and capital expenditure requirementsduring the next twelve months. There can be no assurance, however, that our business will continue to generate cash flow at current levels. If we are unable to generate sufficient cash flow from operations, then we may be required to sell assets, reduce capital expenditures or obtain financing. We anticipate that existing sources of liquidity and cash flows from operations will be sufficient to satisfy our cash needs for the foreseeable future.

 

Our primary liquidity needs are for financing working capital, investing in capital expenditures, supporting product development efforts, introducing new products, enhancing existing products and marketing to stimulate acceptance and adoption of our products and services. Our future capital requirements, to a certain extent, are also subject to general conditions in or affecting the defense, commercial and electric vehicle industries and are subject to general economic, political, financial, competitive, legislative and regulatory factors that are beyond our control. Moreover, to the extent that existing cash, cash equivalents, cash from operations, and cash from short-term borrowing are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financing. We may also need to seek additional equity funding or debt financing if we become a party to any agreement or letter of intent for potential investments in, or acquisitions of, businesses, services or technologies.

 

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Table of Contents

 

Our working capital requirements vary by contract type. On cost-plus-fee programs, we typically bill our incurred costs and fees monthly as work progresses, and therefore working capital investment is minimal. On fixed-price contracts, we typically are paid as we deliver products, and working capital is needed to fund labor and other expenses incurred during the lead time from contract award until contract deliveries begin.

 

Cash Flows

 

The following table provides our cash flow data for the six months ended October 31, 2015 and November 1, 2014 (in thousands):

 

 

 

Six Months Ended

 

 

 

October 31,
2015

 

November 1,
2014

 

 

 

(Unaudited)

 

Net cash (used in) provided by operating activities

 

$

(22,909

)

$

12,358

 

Net cash provided by (used in) investing activities

 

$

10,772

 

$

(14,015

)

Net cash (used in) provided by financing activities

 

$

(3,241

)

$

1,027

 

 

Cash (Used in) Provided by Operating Activities. Net cash used in operating activities for the six months ended October 31, 2015, increased by $35.3 million to $22.9 million, compared to net cash provided by operating activities of $12.4 million for the six months ended November 1, 2014. The increase in net cash used in operating activities was primarily due to an increase in working capital needs of $41.2 million and lower depreciation and amortization expense of $1.5 million, partially offset by a decreased net loss of $3.9 million and an other-than-temporary impairment loss of $2.2 million on available-for-sale equity securities.

 

Cash Provided by (Used in) Investing Activities. Net cash provided by investing activities increased by $24.8 million to $10.8 million for the six months ended October 31, 2015, compared to net cash used in investing activities of $14.0 million for the six months ended November 1, 2014. The increase in net cash provided by investing activities was primarily due to an increase in net redemptions and sales of investments of $26.5 million, partially offset by increased acquisitions of property and equipment of $1.7 million.

 

Cash (Used in) Provided by Financing Activities. Net cash used in financing activities increased by $4.3 million to $3.2 million for the six months ended October 31, 2015, compared to net cash provided by financing activities of $1.0 million for the six months ended November 1, 2014. The increase in cash used in financing activities was primarily due to the purchase and retirement of common stock of $3.8 million.

 

Off-Balance Sheet Arrangements

 

During the second quarter, there were no material changes in our off-balance sheet arrangements or contractual obligations and commercial commitments from those disclosed in the Form 10-K for the fiscal year ended April 30, 2015.

 

Inflation

 

Our operations have not been, and we do not expect them to be, materially affected by inflation. Historically, we have been successful in adjusting prices to our customers to reflect changes in our material and labor costs.

 

New Accounting Standards

 

Please refer to Note 1 “Organization and Significant Accounting Policies” to our unaudited consolidated financial statements in Part I, Item 1 of this quarterly report for a discussion of new accounting pronouncements.

 

20



Table of Contents

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

In the ordinary course of business, we are exposed to various market risk factors, including fluctuations in interest rates, changes in general economic conditions, domestic and foreign competition, and foreign currency exchange rates.

 

Interest Rate Risk

 

It is our policy not to enter into interest rate derivative financial instruments. We do not currently have any significant interest rate exposure.

 

Foreign Currency Exchange Rate Risk

 

Since a significant part of our sales and expenses are denominated in U.S. dollars, we have not experienced significant foreign exchange gains or losses to date, and do not expect to incur significant foreign exchange gains or losses in the future. We occasionally engage in forward contracts in foreign currencies to limit our exposure on non-U.S. dollar transactions.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure.

 

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

As required by Rule 13a-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures.

 

Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective and were operating at a reasonable assurance level.

 

Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting or in other factors identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during the quarter ended October 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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Table of Contents

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

We are not currently a party to any material legal proceedings. We are, however, subject to lawsuits, government investigations, audits and other legal proceedings from time to time in the ordinary course of our business. It is not possible to predict the outcome of any legal proceeding with certainty. The outcome or costs we incur in connection with a legal proceeding could adversely impact our operating results and financial position.

 

ITEM 1A. RISK FACTORS

 

There have been no material changes to the risk factors disclosed under Part I, Item 1A, “Risk Factors,” in our Annual Report on Form 10-K for the fiscal year ended April 30, 2015.  Please refer to that section for disclosures regarding the risks and uncertainties related to our business.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Issuer Purchases of Equity Securities

 

The following table provides information about repurchases by us of shares of our common stock during the quarter ended   October 31, 2015 :

 

Period

 

Total Number of
Shares

 

Average Price Paid
per Share

 

Total Number of
Shares Purchased as
Part of Share
Repurchase Program
(1)

 

Maximum Dollar
Value of Shares
Available for
Purchase Under
Share Repurchase
Program (1) (in
millions)

 

Sep. 23 – Sep. 26, 2015

 

 

$

 

 

$

25.0

 

Sep. 27 – Oct. 31, 2015

 

183,261

 

$

20.47

 

183,261

 

$

21.2

 

Total

 

183,261

 

 

 

183,261

 

$

21.2

 

 


(1)

On September 24, 2015, the Company announced that on September 23, 2015 its Board of Directors authorized a share repurchase program (the “Share Repurchase Program”), pursuant to which the Company may repurchase up to $25 million of its common stock from time to time, in amounts and at prices the Company deems appropriate, subject to market conditions and other considerations.  Share repurchases may be executed through open market transactions or negotiated purchases and may be made under a Rule 10b5-1 plan . There is no expiration date for the program. The Share Repurchase Program does not obligate the Company to acquire any particular amount of common stock and may be suspended at any time by the Company’s Board of Directors .

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

None.

 

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Table of Contents

 

ITEM 5. OTHER INFORMATION

 

Effective September 24, 2015, the Company executed a lease agreement with Monrovia Technology Campus LLC for office space located at 800 Royal Oaks Drive, Monrovia, California.  The initial term of the lease begins on January 15, 2016 and ends on June 30, 2024.  The Company will begin making monthly rental payments under the lease on July 1, 2016.  The base monthly rent during the lease term will be as follows for the periods below:

 

July 1, 2016 to June 30, 2017

 

$

83,564

 

July 1, 2017 to June 30, 2018

 

$

86,071

 

July 1, 2018 to June 30, 2019

 

$

88,653

 

July 1, 2019 to June 30, 2020

 

$

91,313

 

July 1, 2020 to June 30, 2021

 

$

94,052

 

July 1, 2021 to June 30, 2022

 

$

96,874

 

July 1, 2022 to June 30, 2023

 

$

99,780

 

July 1, 2023 to June 30, 2024

 

$

102,773

 

 

The Company has two options to renew the lease agreement for additional thirty-six month periods upon the expiration of the then current term.

 

The Company has a one-time right to cancel the lease after the fourth year of the initial term upon payment of a termination fee equal to the unamortized portion of the brokerage commissions and unamortized portion of the tenant improvement and relocation allowance under the lease.

 

The foregoing description of the lease agreement does not purport to be complete and is subject to, and qualified in its entirety by, the complete text of the lease agreement which is filed as Exhibit 10.1 to this Quarterly Report and incorporated herein by reference.

 

ITEM 6. EXHIBITS

 

Exhibit
Number

 

Description

10.1

 

Standard Multi-Tenant Office Lease — Gross, dated September 24, 2015, between AeroVironment, Inc. and Monrovia Technology Campus LLC for property at 800 Royal Oaks Dr. Monrovia, California, including addendums thereto

31.1

 

Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

31.2

 

Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

32

 

Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS

 

XBRL Instance Document.

101.SCH

 

XBRL Taxonomy Extension Schema Document.

101.CAL

 

XBRL Taxonomy Calculation Linkbase Document.

101.DEF

 

XBRL Taxonomy Extension Definition Linkbase Document.

101.LAB

 

XBRL Taxonomy Label Linkbase Document.

101.PRE

 

XBRL Taxonomy Presentation Linkbase Document.

 

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Table of Contents

 

SIGNATURES

 

Pursuant to the requirements 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.

 

Date: December 8, 2015

 

AEROVIRONMENT, INC.

 

 

 

 

By:

/s/ Timothy E. Conver

 

 

Timothy E. Conver

 

 

Chairman, Chief Executive Officer and President

 

 

(Principal Executive Officer)

 

 

 

 

 

/s/ Raymond D. Cook

 

 

Raymond D. Cook

 

 

Senior Vice President and Chief Financial Officer

 

 

(Principal Financial and Accounting Officer)

 

24


Exhibit 10.1

 

 

STANDARD MULTI-TENANT OFFICE LEASE - GROSS

AIR COMMERCIAL REAL ESTATE ASSOCIATION

 

1.              Basic Provisions (“Basic Provisions”).

 

1.1           Parties : This Lease ( Lease ) , dated for reference purposes only September 24, 2015 is made by and between MONROVIA TECHNOLOGY CAMPUS LLC (“ Lessor ”) and AEROVIRONMENT, INC. (“ Lessee ”), (collectively the “ Parties ”, or individually a “ Party ”).

 

1.2(a)      Premises : That certain portion of the Project (as defined below), known as Suite Numbers(s) 2— 2nd floor(s), consisting of approximately 35,559 rentable square feet and approximately 30,657 useable square feet (“Premises”) . The Premises are located at: 800 Royal Oaks Drive, in the City of Monrovia, County of Los Angeles, State of California, with zip code 91016. In addition to Lessee’s rights to use and occupy the Premises as hereinafter specified, Lessee shall have non-exclusive rights to the Common Areas (as defined in Paragraph 2.7 below) as hereinafter specified, but shall not have any rights to the roof, the exterior walls, the area above the dropped ceilings, or the utility raceways of the building containing the Premises (“ Building ”) or to any other buildings in the Project. The Premises, the Building, the Common Areas, the land upon which they are located, along with all other buildings and improvements thereon, are herein collectively referred to as the “ Project .” The Project consists of approximately 164,708 rentable square feet. (See also Paragraph 2) The exact rentable and usable square footage shall be measured and verified by Lessee’s space planner in accordance with the Lessor’s method of floor measurement and shall be subject to verification by Lessor, Lessee, and Lessee’s architect.

 

1.2(b)     Parking : N/A unreserved and 142 reserved vehicle parking spaces at a monthly cost of $0.00 per unreserved space and $0.00 per reserved space. (See Paragraph 2.6) See Paragraph 54.

 

1.3          Term : Eight (8) years and Five (5) months and seventeen (17) days (“ Original Term ”) commencing January 15, 2016 (“Commencement Date”) and ending June 30, 2024 (“ Expiration Date ”). (See also Paragraph 3) Subject to Lessor receiving an approved Space Plan with chosen finishes, no later than October 20, 2015, if the Premises are not available for occupancy by Lessee on that day, Lessor shall pay Lessee’s base rent and Operating Exepsnes at 1725 Peck Road, Monrovia, California until such time as Lessee is able to take full occupancy of the Premises subject to Punch List items.

 

1.4          Early Possession : If the Premises are available Lessee may have non-exclusive-possession of the Premises-commencing             (“ Early Possession Date ”). (See also Paragraphs 3.2 and 3.3)

 

1.5          Base Rent : $83,564.00 per month (“ Base Rent )”, payable on the First day of each month commencing July 1, 2016. (See also Paragraph 4)

 

x      If this box is checked, there are provisions in this Lease for the Base Rent to be adjusted. See Paragraph 50

 

1.6          Lessee’s Share of Operating Expense Increase : Twenty-One and Six Tenths percent (21.6%) (“ Lessee’s Share ”). In the event that that size of the Premises and/or the Project are modified during the term of this Lease, Lessor shall recalculate Lessee’s Share to reflect such modification. Lessee shall not be liable to pay any Operating Expenses, aside from excess electrical, until twelve (12) months have expired from Lessee’s occupancy of the Premises.

 

1.7          Base Rent and Other Monies Paid Upon Execution:

 

(a)          Base Rent : $83,564.00 for the period July 1-31, 2016

 

(b)          Security Deposit : $0.00 (“ Security Deposit ”). (See also Paragraph 5)

 

(c)           Parking : $0.00 for the period N/A .

 

(d)          Other : $0.00 for N/A.

 

(e)           Total Due Upon Execution of this Lease : $83,564.00.

 

1.8          Agreed Use : Office. (See also Paragraph 6)

 

1.9         Base Year; Insuring Party. The Base Year is 2016. Lessor is the “ Insuring Party ”. (See also Paragraphs 4.2 and 8)

 

1.10       Real Estate Brokers : (See also Paragraph 15 and 25)

 

(a)  Representation : The following real estate brokers (the “ Brokers ”) and brokerage relationships exist in this transaction (check applicable boxes):

 

x Colliers International represents Lessor exclusively (“ Lessor’s Broker ”);

x Newmark of Southern California, Inc. dba Newmark Grubb Knight Frank (“Newmark”) represents Lessee exclusively (“ Lessee’s Broker ”); or

 

o                                  represents both Lessor and Lessee (“ Dual Agency ”).

 

 

 

 

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©1999 - AIR COMMERCIAL REAL ESTATE ASSOCIATION

FORM

OFG-12-9/13E

 

 

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(b)  Payment to Brokers: Upon execution and delivery of this Lease by both Parties, Lessor shall pay to the Brokers for the brokerage services rendered by the Brokers the fee agreed to in the attach e d separate written agreement or if no such agreement is attached, the sum of or    % of the total Base Rent payable for the Original Term, the sum of      or       of the total Base Rent payable during any period of time that the Lessee occupies the Premises subsequent to the Original Term, and/or the sum of       or       % of the purchase price in the event that the Lessee or anyone affiliated with Lessee acquires from Less or any rights in the Premises .

 

1.11         Guarantor . The ob l ig a tions of the Lessee under this Lease shall be guaranteed by         (“ Guarantor ”). (See also Paragraph 37)

 

1.12                            Business Hours for the Building: 6:00 a.m. to 7:00 p.m., Mondays through Fridays (except Building Holidays) and 9:00 a.m. to 2:00 p.m. on Saturdays (except Building Holidays). “ Building Holidays shall mean the dates of observation of New Year’s Day, President’s Day, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, Christmas Day, and N/A.

 

Lessee shall have use of the Premises and its operating systems 24/7.

 

1.13                            Lessor Supplied Services. Notwithstanding the provisions of Paragraph 11.1, Lessor is NOT obligated to provide the following within the Premises:

 

o  Janitorial services

 

o  Electricity

 

o   Other (specify):

 

1.14                            Attachments. Attached hereto are the following, all of which constitute a part of this Lease:

 

x  an Addendum consisting of Paragraphs 50 through 58;

 

x   a plot plan depicting the Premises;

 

x   a current set of the Rules and Regulations;

 

x   a Work Letter;

 

x   a Janitorial schedule;

 

o   other (specify):                                                                                                                                                              .

 

2.                                           Premises.

 

2.1                                  Letting. Lessor hereby leases to Lessee, and Lessee hereby leases from Lessor, the Premises, for the term, at the rental, and upon all of the terms, covenants and conditions set forth in this Lease. While the approximate square footage of the Premises may have been used in the marketing of the Premises for purposes of comparison, the Base Rent stated herein is NOT tied to square footage and is not subject to adjustment should the actual size be determined to be different.  Note: Lessee is advised to verify the actual size prior to executing this Lease.

 

2.2                                  Condition. Lessor shall deliver the Premises to Lessee in a clean condition on the Commencement Date or the Early Possession Date, whichever first occurs (“ Start Date ”), and warrants that the existing electrical, plumbing, fire sprinkler, lighting, heating, ventilating and air conditioning systems (“ HVAC ”), and all other items which the Lessor is obligated to construct pursuant to the Work Letter attached hereto, If any, other than those constructed by Lessee, shall be in good operating condition on said date, that the structural elements of the roof, bearing walls and foundation of the Unit shall be free of material defects, and that the Premises do not contain hazardous levels of any mold or fungi defined as toxic under applicable state or federal law. Lessor also warrants, that unless otherwise specified in writing, Lessor is unaware of (i) any recorded Notices of Default affecting the Premise; (ii) any delinquent amounts due under any loan secured by the Premises; and (iii) any bankruptcy proceeding affecting the Premises.

 

2.3                                  Compliance. Lessor warrants that to the best of its knowledge the improvements on the Premises and the Common Areas comply with the building codes applicable laws, covenants or restrictions of record, regulations, and ordinances (“ Applicable Requirements ”) that were in effect at the time that each improvement, or portion thereof, was constructed. Said warranty does not apply to the use to which Lessee will put the Premises, modifications which may be required by the Americans with Disabilities Act or any similar laws as a result of Lessee’s use (see Paragraph 49), or to any Alterations or Utility Installations (as defined in Paragraph 7.3(a)) made or to be made by Lessee. NOTE: Lessee is responsible for determining whether or not the zoning and other Applicable Requirements are appropriate for Lessee’s intended use, and acknowledges that past uses of the Premises may no longer be allowed. If the Premises do not comply with said warranty, Lessor shall, except as otherwise provided, promptly after receipt of written notice from Lessee setting forth with specificity the nature and extent of such non-compliance, rectify the same. If the Applicable Requirements are hereafter changed so as to require during the term of this Lease the construction of an addition to or an alteration of the Premises, the remediation of any Hazardous Substance, or the reinforcement or other physical modification of the Premises (“ Capital Expenditure ”), Lessor and Lessee shall allocate the cost of such work as follows:

 

(a)  Subject to Paragraph 2.3(c) below, if such Capital Expenditures are required as a result of the specific and unique use of the Premises by Lessee as compared with uses by tenants in general, Lessee shall be fully responsible for the cost thereof, provided, however that if such Capital Expenditure is required during the last 2 years of this Lease and the cost thereof exceeds 6 months’ Base Rent, Lessee may instead terminate this Lease unless Lessor notifies Lessee, in writing, within 10 days after receipt of Lessee’s termination notice that Lessor has elected to pay the difference between the actual cost thereof and the amount equal to 6 months’ Base Rent. If Lessee elects termination, Lessee shall immediately cease the use of the Premises which requires such Capital Expenditure and deliver to Lessor written notice specifying a termination date at least 90 days thereafter. Such termination date shall, however, in no event be earlier than the last day that Lessee could legally utilize the Premises without commencing such Capital Expenditure.

 

                               (b)  If such Capital Expenditure is not the result of the specific and unique use of the Premises by Lessee (such as, governmentally mandated seismic modifications), then Lessor shall pay for such Capital Expenditure and Lessee shall only be obligated to pay, each month during the remainder of the term of this Lease or any extension thereof, on the date that on which the Base Rent is due, an amount equal to 1/144th of the portion of such costs reasonably attributable to the Premises. Lessee shall pay Interest on the balance but may prepay its obligation at any time. If, however, such Capital Expenditure is required during the last 2 years of this Lease or if Lessor reasonably determines that it is not economically feasible to pay its share thereof, Lessor shall have the option to terminate this Lease upon 90 days prior written notice to Lessee unless Lessee notifies Lessor, in writing, within 10 days after receipt of Lessor’s termination notice that Lessee will pay for such Capital Expenditure. If Lessor does not elect to terminate, and fails to tender its share of any such Capital Expenditure, Lessee may advance such funds and deduct same, with Interest, from Rent until Lessor’s share of such costs have been fully paid. If Lessee is unable to finance Lessor’s share, or if the balance of the Rent due and payable for the remainder of this Lease is not sufficient to fully reimburse Lessee on an offset basis, Lessee shall have the right to terminate this Lease upon 30 days written notice to Lessor.

 

(c)  Notwithstanding the above, the provisions concerning Capital Expenditures are intended to apply only to nonvoluntary, unexpected, and new Applicable Requirements. If the Capital Expenditures are instead triggered by Lessee as a result of an actual or proposed change in use, change in intensity of use, or modification to the Premises then, and in that event, Lessee shall either: (i) immediately cease such changed use or intensity of use and/or take such other steps as may be necessary to eliminate the requirement for such Capital Expenditure, or (ii) complete such Capital Expenditure at its own expense. Lessee shall not have any right to terminate this Lease.

 

2.4                              Acknowledgements. Lessee acknowledges that: (a) It has been given an opportunity to inspect and measure the Premises, (b) Lessee has been advised by Lessor and/or Brokers to satisfy itself with respect to the size and condition of the Premises (including but not limited to the electrical, HVAC and fire sprinkler systems, security, environmental aspects, and compliance with Applicable Requirements), and their suitability for Lessee’s intended use, (c) Lessee has made such investigation as it deems necessary with reference to such matters and assumes all responsibility therefor as the same relate to its occupancy of the Premises, (d) it is not relying on any representation as to the size of the Premises made by Brokers or Lessor, (e) the square footage of the Premises was not material to Lessee’s decision to lease the Premises and pay the Rent stated herein, and (f) neither Lessor, Lessor’s agents, nor Brokers have made any oral or written representations or warranties with respect to said matters other than as set forth in this Lease. In addition, Lessor acknowledges that (i) Brokers have made no representations, promises or warranties concerning Lessee’s ability to honor the Lease or suitability to occupy the Premises, and (ii) it is Lessor’s sole responsibility to investigate the financial capability and/or suitability of all proposed tenants.

 

2.5                              Lessee as Prior Owner/Occupant. The warranties made by Lessor in Paragraph 2 shall be of no force or effect if immediately prior to the Start Date, Lessee was the owner or occupant of the Premises.  In such event, Lessee shall be responsible for any necessary corrective

 

 

 

 

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work.

 

2.6                                 Vehicle Parking. So long as Lessee is not in default, and subject to the Rules and Regulations attached hereto, and as established by Lessor from time to time. Lessee shall be entitled to r e nt and use the number of parking spaces specified in Paragraph 1.2(b) at the rental rate applicable from time to time for monthly parking as set by Lessor and/or its licensee, no cost during the term of the Lease and renewal option periods. The location of Aerovirnoment’s parking spaces to be discussed and mutually agreed upon.

 

(a)   If Lessee, its employees, and/or agents commits, permits or allows any of the prohibited activities described in the Lease or the rules then in effect, then Lessor shall have the right, with out prior notice left on vehicle, in addition to such other rights and remedies that it may have, to remove or tow away the vehicle involved and charge the cost to Lessee, which cost shall be immediately payable upon demand by Lessor. Lessee, its employees, and/or agents shall be responsible for any and all expenses incurred by towing company.

 

(b)   The monthly rent per parking space specified in Paragraph 1.2(b) is subject to change upon 30 days prior written notice to Lessee. The rent for the parking is payable one month in advance prior to the first day of each calendar month.

 

2.7                                 Common Areas - Definition. The term “ Common Areas ” is defined as all areas and facilities outside the Premises and within the exterior boundary line of the Project and interior utility raceways and installations within the Premises that are provided and designated by the Lessor from time to time for the general nonexclusive use of Lessor, Lessee and other tenants of the Project and their respective employees, suppliers, shippers, customers, contractors and invitees, including, but not limited to, common entrances, lobbies, corridors, stairwells, public restrooms, elevators, parking areas, loading and unloading areas, trash areas, roadways, walkways, driveways and landscaped areas.

 

2.8                                 Common Areas - Lessee’s Rights. Lessor grants to Lessee, for the benefit of Lessee and its employees, suppliers, shippers, contractors, customers and invitees, during the term of this Lease, the nonexclusive right to use, in common with others entitled to such use, the Common Areas as they exist from time to time, subject to any rights, powers, and privileges reserved by Lessor under the terms hereof or under the terms of any rules and regulations or restrictions governing the use of the Project. Under no circumstances shall the right herein granted to use the Common Areas be deemed to include the right to store any property, temporarily or permanently, in the Common Areas. Any such storage shall be permitted only by the prior written consent of Lessor or Lessor’s designated agent, which consent may be revoked at any time. In the event that any unauthorized storage shall occur then Lessor shall have the right, without notice, in addition to such other rights and remedies that it may have, to remove the property and charge the cost to Lessee, which cost shall be immediately payable upon demand by Lessor.

 

2.9                                 Common Areas - Rules and Regulations. Lessor or such other person(s) as Lessor may appoint shall have the exclusive control and management of the Common Areas and shall have the right, from time to time, to adopt, modify, amend and enforce reasonable rules and regulations ( “Rules and Regulations” ) for the management, safety, care, and cleanliness of the grounds, the parking and unloading of vehicles and the preservation of good order, as well as for the convenience of other occupants or tenants of the Building and the Project and their invitees. The Lessee agrees to abide by and conform to all such Rules and Regulations, and shall use its best efforts to cause its employees, suppliers, shippers, customers, contractors and invitees to so abide and conform. Lessor shall not be responsible to Lessee for the noncompliance with said Rules and Regulations by other tenants of the Project

 

2.10                          Common Areas - Changes. Lessor shall have the right, in Lessor’s sole discretion, from time to time:

 

(a)                                To make changes to the Common Areas, including, without limitation, changes in the location, size, shape and number of the lobbies, windows, stairways, air shafts, elevators, escalators, restrooms, driveways, entrances, parking spaces, parking areas, loading and unloading areas, ingress, egress, direction of traffic, landscaped areas, walkways and utility raceways;

 

(b)                                To close temporarily any of the Common Areas for maintenance purposes so long as reasonable access to the Premises remains available;

 

(c)                                 To designate other land outside the boundaries of the Project to be a part of the Common Areas;

 

(d)                                To add additional buildings and improvements to the Common Areas;

 

(e)                                 To use the Common Areas while engaged in making additional improvements, repairs or alterations to the Project, or any portion thereof; and

 

(f)                                  To do and perform such other acts and make such other changes in, to or with respect to the Common Areas and Project as Lessor may, in the exercise of sound business judgment, deem to be appropriate.

 

3.                                        Term.

 

3.1                               Term. The Commencement Date, Expiration Date and Original Term of this Lease are as specified in Paragraph 1.3.

 

3.2                               Early Possession. Any provision herein granting Lessee Early Possession of the Premises Is subject to and conditioned upon the Premises being available for such possession prior to the Commencement Date. Any grant of Early Possession only conveys a non-exclusive right to occupy the Premises. If Lessee totally or partially occupies the Premises prior to the Commencement Date, the obligation to pay Base Rent shall be abated for the period of such Early Possession. All other terms of this Lease (including but not limited to the obligations to pay Lessee’s Share of the Operating Expense Increase) shall be in effect during such period. Any such Early Possession shall not affect the Expiration Date.

 

                3.3                                Delay In Possession. Lessor agrees to use its best commercially reasonable efforts to deliver possession of the Premises to Lessee by the Commencement Date. If, despite said efforts, Lessor is unable to deliver possession by such date, Lessor shall not be subject to any liability therefor, nor shall such failure affect the validity of this Lease or change the Expiration Date. Lessee shall not, however, be obligated to pay Rent or perform its other obligations until Lessor delivers possession of the Premises and any period of rent abatement that Lessee would otherwise have enjoyed shall run from the date of delivery of possession and continue for a period equal to what Lessee would otherwise have enjoyed under the terms hereof, but minus any days of delay caused by the acts or omissions of Lessee. If possession is not delivered within 60 days after the Commencement Date, as the same may be extended under the terms of any Work Letter executed by Parties, Lessee may, at its option, by notice in writing within 10 days after the end of such 60 day period, cancel this Lease, in which event the Parties shall be discharged from all obligations hereunder. If such written notice is not received by Lessor within said 10 day period, Lessee’s right to cancel shall terminate. If possession of the Premises is not delivered within 120 days after the Commencement Date, this Lease shall terminate unless other agreements are reached between Lessor and Lessee, in writing.

 

3.4                               Lessee Compliance . Lessor shall not be required to deliver possession of the Premises to Lessee until Lessee complies with its obligation to provide evidence of insurance (Paragraph 8.5). Pending delivery of such evidence, Lessee shall be required to perform all of its obligations under this Lease from and after the Start Date, including the payment of Rent, notwithstanding Lessor’s election to withhold possession pending receipt of such evidence of insurance. Further, if Lessee is required to perform any other conditions prior to or concurrent with the Start Date, the Start Date shall occur but Lessor may elect to withhold possession until such conditions are satisfied.

 

4.                                      Rent.

 

4.1.                                Rent Defined.   All monetary obligations of Lessee to Lessor under the terms of this Lease (except for the Security Deposit) are deemed to be rent (“ Rent ”).

 

4.2                              Operating Expense Increase. Lessee shall pay to Lessor during the term hereof, in addition to the Base Rent, Lessee’s Share of the amount by which all Operating Expenses for each Comparison Year exceeds the amount of all Operating Expenses for the Base Year, such excess being hereinafter referred to as the “ Operating Expense Increase ”, in accordance with the following provisions:

 

(a)                             Base Year ” is as specified in Paragraph 1.9.

 

(b)                             Comparison Year ” is defined as each calendar year during the term of this Lease subsequent to the Base Year; provided, however, Lessee shall have no obligation to pay a share of the Operating Expense Increase applicable to the first 12 months of the Lease Term (other than such as are mandated by a governmental authority, as to which government mandated expenses Lessee shall pay Lessee’s Share, notwithstanding they occur during the first twelve (12) months). Lessee’s Share of the Operating Expense Increase for the first and last Comparison Years of the Lease Term shall be prorated according to that portion of such Comparison Year as to which Lessee is responsible for a share of such increase.

 

(c)                              The following costs relating to the ownership and operation of the Project, calculated as if the Project was at least 95% occupied, are defined as “ Operating Expenses ”:

 

(i)                                     Costs relating to the operation, repair, and maintenance in neat, clean, safe, good order and condition, but not the replacement (see subparagraph (g)), of the following:

 

(aa)                            The Common Areas, including their surfaces, coverings, decorative items, carpets, drapes and window coverings, and including parking areas, loading and unloading areas, trash areas, roadways, sidewalks, walkways, stairways, parkways, driveways, landscaped areas, striping, bumpers, irrigation systems. Common Area lighting facilities, building exteriors and roofs, fences and gates;

 

(bb)                            All heating, air conditioning, plumbing, electrical systems, life safety equipment, communication

 

 

 

 

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systems and other equipment used in common by, or for the benefit of, tenants or occupants of the Project, including elevators and escalators, tenant directories, fire detection systems including sprinkler system maintenance and repair.

 

(cc)                                   All other areas and improvements that are within the exterior boundaries of the Project but outside of the Premises and/or any other space occupied by a tenant.

 

(ii)                                      The cost of trash disposal, janitorial and security services, pest control services, and the costs of any environmental Inspections;

 

(iii)                                   The cost of any other service to be provided by Lessor that is elsewhere in this Lease stated to be an “Operating Expense”;

 

(iv)                                  The cost of the premiums for the insurance policies maintained by Lessor pursuant to paragraph 8 and any deductible portion of an insured loss concerning the Building or the Common Areas;

 

(v)                                     The amount of the Real Property Taxes payable by Lessor pursuant to paragraph 10;

 

(vi)                                  The cost of water, sewer, gas, electricity, and other publicly mandated services not separately metered;

 

(vii)                               Labor, salaries, and applicable fringe benefits and costs, materials, supplies and tools, used in maintaining and/or cleaning the Project and accounting and management fees attributable to the operation of the Project;

 

(viii)                            The cost of any capital improvement to the Building or the Project not covered under the provisions of Paragraph 2.3 provided; however, that Lessor shall allocate the cost of any such capital improvement over a 12 year period and Lessee shall not be required to pay more than Lessee’s Share of 1/144th of the cost of such Capital Expenditure in any given month;

 

(ix)                                  The cost to replace equipment or improvements that have a useful life for accounting purposes of 5 years or less.

 

(x)                                     Reserves set aside for maintenance, repair and/or replacement of Common Area Improvements and equipment.

 

(d)                                    Any item of Operating Expense that is specifically attributable to the Premises, the Building or to any other building in the Project or to the operation, repair and maintenance thereof, shall be allocated entirely to such Premises, Building, or other building. However, any such item that is not specifically attributable to the Building or to any other building or to the operation, repair and maintenance thereof, shall be equitably allocated by Lessor to all buildings in the Project.

 

(e)                                     The inclusion of the improvements, facilities and services set forth in Subparagraph 4.2(c) shall not be deemed to impose an obligation upon Lessor to either have said improvements or facilities or to provide those services unless the Project already has the same. Lessor already provides the services, or Lessor has agreed elsewhere in this Lease to provide the same or some of them.

 

(f)                                      Lessee’s Share of Operating Expense Increase is payable monthly on the same day as the Base Rent is due hereunder. The amount of such payments shall be based on Lessor’s estimate of the Operating Expense Expenses. Within 60 days after written request (but not more than once each year) Lessor shall deliver to Lessee a reasonably detailed statement showing Lessee’s Share of the actual Common Area Operating Expenses for the preceding year. If Lessee’s payments during such Year exceed Lessee’s Share, Lessee shall credit the amount of such over-payment against Lessee’s future payments. If Lessee’s payments during such Year were less than Lessee’s Share, Lessee shall pay to Lessor the amount of the deficiency within 10 days after delivery by Lessor to Lessee of said statement. Lessor and Lessee shall forthwith adjust between them by cash payment any balance determined to exist with respect to that portion of the last Comparison Year for which Lessee is responsible as to Operating Expense Increases, notwithstanding that the Lease term may have terminated before the end of such Comparison Year.

 

(g)                                     Operating Expenses shall not include the costs of replacement for equipment or capital components such as the roof, foundations, exterior walls or a Common Area capital improvement, such as the parking lot paving, elevators, fences that have a useful life for accounting purposes of 5 years or more.

 

(h)                                    Operating Expenses shall not include any expenses paid by any tenant directly to third parties, or as to which Lessor is otherwise reimbursed by any third party, other tenant, or by insurance proceeds.

 

4.3                                Payment. Lessee shall cause payment of Rent to be received by Lessor in lawful money of the United States on or before the day on which it is due, without offset or deduction (except as specifically permitted in this Lease). All monetary amounts shall be rounded to the nearest whole dollar. In the event that any invoice prepared by Lessor is inaccurate such inaccuracy shall not constitute a waiver and Lessee shall be obligated to pay the amount set forth in this Lease. Rent for any period during the term hereof which is for less than one full calendar month shall be prorated based upon the actual number of days of said month. Payment of Rent shall be made to Lessor at its address stated herein or to such other persons or place as Lessor may from time to time designate in writing. Acceptance of a payment which is less than the amount then due shall not be a waiver of Lessor’s rights to the balance of such Rent, regardless of Lessor’s endorsement of any check so stating. In the event that any check, draft, or other instrument of payment given by Lessee to Lessor is dishonored for any reason, Lessee agrees to pay to Lessor the sum of $25 in addition to any Late Charge and Lessor, at its option, may require all future Rent be paid by cashier’s check. Payments will be applied first to accrued late charges and attorney’s fees, second to accrued interest, then to Base Rent and Common Area Operating Expenses, and any remaining amount to any other outstanding charges or costs.

 

5.             Security Deposit. Lessee shall deposit with Lesser upon execution hereof the Security Deposit as security for Lessee’s faithful performance of its obligations under this Lease. If Lessee fails to pay Rent, or otherwise Defaults under this Lease, Lesser may use, apply or retain all or any portion of said Security Deposit for the payment of any amount already due Lesser, for Rents which will be due in the future, and/ or to reimburse or compensate Lesser for any liability, expense, loss or damage which Lesser may suffer or incur by reason thereof. If Lesser uses or applies all or any portion of the Security Deposit, Lessee shall within 10 days after written request thereof deposit monies with Lesser sufficient to restore said Security Deposit to the full amount required by this Lease. If the Base Rent increases  during the term of this Lease. Lessee shall, upon written request from Lesser, deposit additional monies with Lesser so that the total amount of the Security Deposit shall at all times boar the same proportion to the increased Base Rent as the initial Security Deposit bore to the initial Base Rent. Should the Agreed Use be amended to accommodate a material change in the business of Lessee or to accommodate a sublessee or assignee, Lesser shall have the right to increase the Security Deposit to the extent necessary, in Lessor’s reasonable judgement, to account for any increased wear and tear that the Premises may suffer as a result thereof. If a change in control of Lessee cooers during this Lease and following such change the financial condition of Lessee is, in Lessor’s reasonable judgment, significantly reduced, Lessee shall deposit such additional monies with Lesser as shall be sufficient to cause the Security Deposit to be at a commercially reasonable level based on such change in financial condition. Lesser shall not be required to keep the Security Deposit separate from its general accounts. Within 90 days after the expiration or termination of this Lease, Lesser shall return that portion of the Security Deposit not use or applied by Lesser. No part of the Security Deposit shall be considered to be held in trust, to bear interest or to be prepayment for any monies to be paid by Lessee under this Lease.

 

6.                                       Use.

 

6.1                              Use. Lessee shall use and occupy the Premises only for the Agreed Use, or any other legal use which is reasonably comparable thereto, and for no other purpose. Lessee shall not use or permit the use of the Premises in a manner that is unlawful, creates damage, waste or a nuisance, or that disturbs occupants of or causes damage to neighboring premises or properties. Other than guide, signal and seeing eye dogs, Lessee shall not keep or allow in the Premises any pets, animals, birds, fish, or reptiles. Lessor shall not unreasonably withhold or delay its consent to any written request for a modification of the Agreed Use, so long as the same will not impair the structural integrity of the improvements of the Building, will not adversely affect the mechanical, electrical, HVAC, and other systems of the Building, and/or will not affect the exterior appearance of the Building. If Lessor elects to withhold consent, Lessor shall within 7 days after such request give written notification of same, which notice shall include an explanation of Lessor’s objections to the change in the Agreed Use.

 

6.2                               Hazardous Substances.

 

(a)  Reportable Uses Require Consent. The term  “ Hazardous Substance as used in this Lease shall mean any product, substance, or waste whose presence, use, manufacture, disposal, transportation, or release, either by itself or in combination with other materials expected to be on the Promises, is either: (i) potentially injurious to the public health, safety or welfare, the environment or the Premises, (ii) regulated or monitored by any governmental authority, or (iii) a basis for potential liability of Lessor to any governmental agency or third party under any applicable statute or common law theory. Hazardous Substances shall include, but not be limited to, hydrocarbons, petroleum, gasoline, and/or crude oil or any products, byproducts or fractions thereof. Lessee shall not engage in any activity in or on the Premises which constitutes a Reportable Use of Hazardous Substances without the express prior written consent of Lessor and timely compliance (at Lessee’s expense) with all Applicable Requirements. “ Reportable Use ” shall mean (i) the installation or use of any above or below ground storage tank, (ii) the generation, possession, storage, use, transportation, or disposal of a Hazardous Substance that requires a permit from, or with respect to which a report, notice, registration or business plan is required to be filed with, any governmental authority, and/or (iii) the presence at the Premises of a Hazardous Substance with respect to which any Applicable Requirements requires that a notice be given to persons entering or occupying the Premises or neighboring properties. Notwithstanding the foregoing, Lessee may use any ordinary and customary materials reasonably required to be used in the normal course of the Agreed Use such as ordinary office supplies (copier toner, liquid paper, glue, etc.) and common household cleaning materials, so long as such use is in compliance with all Applicable Requirements, is not a Reportable Use, and does not expose the Premises or neighboring property to any meaningful risk of contamination or damage or expose Lessor to any liability therefor. In addition, Lessor may condition its consent to any Reportable Use upon receiving such additional assurances as Lessor reasonably deems necessary to protect itself, the public, the Premises and/or the environment against

 

 

 

 

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damage, contamination, injury and/or liability, including, but not limited to, the installation (and removal on or before Lease expiration or termination) of protective modifications (such as concrete encasements) and/or increasing the Security Deposit.

 

(b)                                  Duty to Inform Lessor. If Lessee knows, or has reasonable cause to believe, that a Hazardous Substance has come to be located In, on, under or about the Premises, other than as previously consented to by Lessor, Lessee shall immediately give written notice of such fact to Lessor, and provide Lessor with a copy of any report, notice, claim or other documentation which it has concerning the presence of such Hazardous Substance.

 

(c)                                   Lessee Remediation. Lessee shall not cause or permit any Hazardous Substance to be spilled or released in, on, under, or about the Promises (including through the plumbing or sanitary sewer system) and shall promptly, at Lessee’s expense, comply with all Applicable Requirements and take all Investigatory and/or remedial action reasonably recommended, whether or not formally ordered or required, for the cleanup of any contamination of, and for the maintenance, security and/or monitoring of the Premises or neighboring properties, that was caused or materially contributed to by Lessee, or pertaining to or involving any Hazardous Substance brought onto the Premises during the term of this Lease, by or for Lessee, or any third party.

 

(d)                                  Lessee Indemnification. Lessee shall indemnify, defend and hold Lessor, its agents, employees, lenders and ground lessor. If any, harmless from and against any and all loss of rents and/or damages, liabilities, judgments, claims, expenses, penalties, and attorneys’ and consultants’ fees arising out of or involving any Hazardous Substance brought onto the Premises by or for Lessee, or any third party (provided, however, that Lessee shall have no liability under this Lease with respect to underground migration of any Hazardous Substance under the Premises from areas outside of the Project not caused or contributed to by Lessee). Lessee’s obligations shall include, but not be limited to, the effects of any contamination or injury to person, property or the environment created or suffered by Lessee, and the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease. No termination, cancellation or release agreement entered into by Lessor and Lessee shall release Lessee from its obligations under this Lease with respect to Hazardous Substances, unless specifically so agreed by Lessor in writing at the time of such agreement.

 

(e)                                   Lessor Indemnification. Except as otherwise provided in paragraph 8.7, Lessor and its successors and assigns shall indemnify, defend, reimburse and hold Lessee, its employees and lenders, harmless from and against any and all environmental damages, including the cost of remediation, which result from Hazardous Substances which existed on the Premises prior to Lessee’s occupancy or which are caused by the gross negligence or willful misconduct of Lessor, its agents or employees. Lessor’s obligations, as and when required by the Applicable Requirements, shall include, but not be limited to, the cost of investigation, removal, remediation, restoration and/or abatement, and shall survive the expiration or termination of this Lease.

 

(f)                                    Investigations and Remediations. Lessor shall retain the responsibility and pay for any investigations or remediation measures required by governmental entities having jurisdiction with respect to the existence of Hazardous Substances on the Premises prior to Lessee’s occupancy, unless such remediation measure is required as a result of Lessee’s use (Including “Alterations”, as defined in paragraph 7.3(a) below) of the Premises, in which event Lessee shall be responsible for such payment. Lessee shall cooperate fully in any such activities at the request of Lessor, including allowing Lessor and Lessor’s agents to have reasonable access to the Premises at reasonable times In order to carry out Lessor’s investigative and remedial responsibilities.

 

(g)                                   Lessor Termination Option. If a Hazardous Substance Condition (see Paragraph 9.1(e)) occurs during the term of this Lease, unless Lessee is legally responsible therefor (in which case Lessee shall make the Investigation and remediation thereof required by the Applicable Requirements and this Lease shall continue in full force and effect, but subject to Lessor’s rights under Paragraph 6.2(d) and Paragraph 13), Lessor may, at Lessor’s option, either (i) investigate and remediate such Hazardous Substance Condition, if required, as soon as reasonably possible at Lessor’s expense, in which event this Lease shall continue in full force and effect, or (ii) if the estimated cost to remediate such condition exceeds 12 times the then monthly Base Rent or $100,000, whichever is greater, give written notice to Lessee, within 30 days after receipt by Lessor of knowledge of the occurrence of such Hazardous Substance Condition, of Lessor’s desire to terminate this Lease as of the date 60 days following the date of such notice. In the event Lessor elects to give a termination notice, Lessee may, within 10 days thereafter, give written notice to Lessor of Lessee’s commitment to pay the amount by which the cost of the remediation of such Hazardous Substance Condition exceeds an amount equal to 12 times the then monthly Base Rent or $100,000, whichever is greater. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within 30 days following such commitment. In such event, this Lease shall continue in full force and effect, and Lessor shall proceed to make such remediation as soon as reasonably possible after the required funds are available. If Lessee does not give such notice and provide the required funds or assurance thereof within the time provided, this Lease shall terminate as of the date specified in Lessor’s notice of termination.

 

6.3                                Lessee’s Compliance with Applicable Requirements. Except as otherwise provided in this Lease, Lessee shall, at Lessee’s sole expense, fully, diligently and in a timely manner, materially comply with all Applicable Requirements, the requirements of any applicable fire insurance underwriter or rating bureau, and the recommendations of Lessor’s engineers and/or consultants which relate in any manner to the Premises, without regard to whether said requirements are now in effect or become effective after the Start Date. Lessee shall, within 10 days after receipt of Lessor’s written request, provide Lessor with copies of all permits and other documents, and other information evidencing Lessee’s compliance with any Applicable Requirements specified by Lessor, and shall immediately upon receipt, notify Lessor in writing (with copies of any documents involved) of any threatened or actual claim, notice, citation, warning, complaint or report pertaining to or involving the failure of Lessee or the Premises to comply with any Applicable Requirements. Likewise, Lessee shall immediately give written notice to Lessor of: (i) any water damage to the Premises and any suspected seepage, pooling, dampness or other condition conducive to the production of mold; or (ii) any mustiness or other odors that might indicate the presence of mold in the Premises.

 

6.4                                Inspection; Compliance. Lessor and Lessor’s “ Lendor ” (as defined in Paragraph 30) and consultants shall have the right to enter into Premises at any time, in the case of an emergency, and otherwise at reasonable times, after reasonable notice, for the purpose of inspecting the condition of the Premises and for verifying compliance by Lessee with this Lease. The cost of any such inspections shall be paid by Lessor, unless a violation of Applicable Requirements, or a Hazardous Substance Condition (see paragraph 9.1e) is found to exist or be imminent, or the inspection is requested or ordered by a governmental authority. In such case, Lessee shall upon request reimburse Lessor for the cost of such inspection, so long as such inspection is reasonably related to the violation or contamination. In addition, Lessee shall provide copies of all relevant material safety data sheets (MSDS) to Lessor within 10 days of the receipt of written request therefor.

 

7.                                       Maintenance; Repairs; Utility Installations; Trade Fixtures and Alterations.

 

                7.1                                Lessee’s Obligations. Notwithstanding Lessor’s obligation to keep the Premises in good condition and repair, Lessee shall be responsible for payment of the cost thereof to Lessor as additional rent for that portion of the cost of any maintenance and repair of the Premises, or any equipment (wherever located) that serves only Lessee or the Premises, to the extent such cost is attributable to abuse or misuse. In addition, Lessee rather than the Lessor shall be responsible for the cost of painting, repairing or replacing wall coverings, and to repair or replace any similar improvements within the Premises. Lessor may, at its option, upon reasonable notice, elect to have Lessee perform any particular such maintenance or repairs the cost of which is otherwise Lessee’s responsibility hereunder.”

 

7.2                                Lessor’s Obligations. Subject to the provisions of Paragraphs 2.2 (Condition), 2.3 (Compliance), 4.2 (Operating Expenses), 6 (Use), 7.1 (Lessee’s Obligations), 9 (Damage or Destruction) and 14 (Condemnation), Lessor, subject to reimbursement pursuant to Paragraph 4.2, shall keep in good order, condition and repair the foundations, exterior walls, structural condition of interior bearing walls, exterior roof, fire sprinkler system, fire alarm and/or smoke detection systems, fire hydrants, and the Common Areas. Lessee expressly waives the benefit of any statute now or hereafter in effect to the extent it is inconsistent with the terms of this Lease.

 

7.3                                Utility Installations; Trade Fixtures; Alterations.

 

(a)                                  Definitions. The term “ Utility Installations ” refers to all floor and window coverings, air lines, vacuum lines, power panels, electrical distribution, security and fire protection systems, communication cabling, lighting fixtures, HVAC equipment, and plumbing in or on the Premises. The term “ Trade Fixtures ” shall mean Lessee’s machinery and equipment that can be removed without doing material damage to the Premises. The term “ Alterations ” shall mean any modification of the improvements, other than Utility Installations or Trade Fixtures, whether by addition or deletion. “ Lessee Owned Alterations and/or Utility Installations ” are defined as Alterations and/or Utility Installations made by Lessee that are not yet owned by Lessor pursuant to Paragraph 7.4(a).

 

(b)                                  Consent. Lessee shall not make any Alterations or Utility Installations to the Premises without Lessor’s prior written consent. Lessee may, however, make non-structural Alterations or Utility Installations to the interior of the Premises (excluding the roof) without such consent but upon notice to Lessor, as long as they are not visible from the outside, do not involve puncturing, relocating or removing the roof, ceilings, floors or any existing walls, will not affect the electrical, plumbing, HVAC, and/or life safety systems, and the cumulative cost thereof during this Lease as extended does not exceed $2000. Notwithstanding the foregoing, Lessee shall not make or permit any roof penetrations and/or install anything on the roof without the prior written approval of Lessor. Lessor may, as a precondition to granting such approval, require Lessee to utilize a contractor chosen and/or approved by Lessor. Any Alterations or Utility Installations that Lessee shall desire to make and which require the consent of the Lessor shall be presented to Lessor in written form with detailed plans. Consent shall be deemed conditioned upon Lessee’s: (i) acquiring all applicable governmental permits, (ii) furnishing Lessor with copies of both the permits and the plans and specifications prior to commencement of the work, and (iii) compliance with all conditions of said permits and other Applicable Requirements in a prompt and expeditious manner. Any Alterations or Utility Installations shall be performed in a workmanlike manner with good and sufficient materials. Lessee shall promptly upon completion furnish Lessor with asbuilt plans and specifications. For work which costs an amount in excess of one month’s Base Rent, Lessor may condition its consent upon Lessee providing a lien

 

 

 

 

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and completion bond in an amount equal to 150% of the estimated cost of such Alteration or Utility Installation and/or upon Lessee’s posting an additional Security Deposit with Lessor.

 

(c)                                   Liens; Bonds. Lessee shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Lessee at or for use on the Premises, which claims are or may be secured by any mechanic’s or materialmen’s lien against the Premises or any interest therein. Lessee shall give Lessor not less than 10 days notice prior to the commencement of any work in, on or about the Premises, and Lessor shall have the right to post notices of non-responsibility. If Lessee shall contest the validity of any such lien, claim or demand, then Lessee shall, at its sole expense defend and protect itself, Lessor and the Premises against the same and shall pay and satisfy any such adverse judgment that may be rendered thereon before the enforcement thereof. If Lessor shall require, Lessee shall furnish a surety bond in an amount equal to 150% of the amount of such contested lien, claim or demand, indemnifying Lessor against liability for the same. If Lessor elects to participate in any such action, Lessee shall pay Lessor’s attorneys’ fees and costs.

 

7.4                                Ownership; Removal; Surrender; and Restoration.

 

(a)                                  Ownership. Subject to Lessor’s right to require removal or elect ownership as hereinafter provided, all Alterations and Utility Installations made by Lessee shall be the property of Lessee, but considered a part of the Premises. Lessor may, at any time, elect In writing to be the owner of all or any specified part of the Lessee Owned Alterations and Utility Installations. Unless otherwise instructed per paragraph 7.4(b) hereof, all Lessee Owned Alterations and Utility Installations shall, at the expiration or termination of this Lease, become the property of Lessor and be surrendered by Lessee with the Premises.

 

(b)                                  Removal. By delivery to Lessee of written notice from Lessor not earlier than 90 and not later than 30 days prior to the end of the term of this Lease, Lessor may require that any or all Lessee Owned Alterations or Utility Installations be removed by the expiration or termination of this Lease. Lessor may require the removal at any time of all or any part of any Lessee Owned Alterations or Utility Installations made without the required consent.

 

(c)                                   Surrender; Restoration. Lessee shall surrender the Premises by the Expiration Date or any earlier termination date, with all of the improvements, parts and surfaces thereof clean and free of debris, and in good operating order, condition and state of repair, ordinary wear and tear excepted. “Ordinary wear and tear” shall not include any damage or deterioration that would have been prevented by good maintenance practice. Notwithstanding the foregoing, if this Lease is for 12 months or less, then Lessee shall surrender the Premises in the same condition as delivered to Lessee on the Start Date with NO allowance for ordinary wear and tear. Lessee shall repair any damage occasioned by the installation, maintenance or removal of Trade Fixtures, Lessee owned Alterations and/or Utility Installations, furnishings, and equipment as well as the removal of any storage tank installed by or for Lessee. Lessee shall also completely remove from the Premises any and all Hazardous Substances brought onto the Premises by or for Lessee, or any third party (except Hazardous Substances which were deposited via underground migration from areas outside of the Premises) even if such removal would require Lessee to perform or pay for work that exceeds statutory requirements. Trade Fixtures shall remain the property of Lessee and shall be removed by Lessee. Any personal property of Lessee not removed on or before the Expiration Date or any earlier termination date shall be deemed to have been abandoned by Lessee and may be disposed of or retained by Lessor as Lessor may desire. The failure by Lessee to timely vacate the Premises pursuant to this Paragraph 7.4(c) without the express written consent of Lessor shall constitute a holdover under the provisions of Paragraph 26 below.

 

8.                                       Insurance; Indemnity.

 

8.1                                Insurance Premiums. The cost of the premiums for the insurance policies maintained by Lessor pursuant to paragraph 8 are Included as Operating Expenses (see paragraph 4.2 (c)(iv)). Said costs shall include increases in the premiums resulting from additional coverage related to requirements of the holder of a mortgage or deed of trust covering the Premises, Building and/or Project, increased valuation of the Premises, Building and/or Project, and/or a general premium rate increase. Said costs shall not, however, include any premium increases resulting from the nature of the occupancy of any other tenant of the Building. If the Project was not insured for the entirety of the Base Year, then the base premium shall be the lowest annual premium reasonably obtainable for the required insurance as of the Start Date, assuming the most nominal use possible of the Building and/or Project. In no event, however, shall Lessee be responsible for any portion of the premium cost attributable to liability Insurance coverage in excess of $2,000,000 procured under Paragraph 8.2(b).

 

8.2                                Liability Insurance.

 

(a)                                  Carried by Lessee . Lessee shall obtain and keep in force a Commercial General Liability policy of insurance protecting Lessee and Lessor as an additional insured against claims for bodily injury, personal injury and property damage based upon or arising out of the ownership, use, occupancy or maintenance of the Premises and all areas appurtenant thereto. Such insurance shall be on an occurrence basis providing single limit coverage in an amount not less than $1,000,000 per occurrence with an annual aggregate of not less than $2,000,000. Lessee shall add Lessor as an additional insured by means of an endorsement at least as broad as the Insurance Service Organization’s “Additional Insured-Managers or Lessors of Premises” Endorsement and coverage shall also be extended to include damage caused by heat, smoke or fumes from a hostile fire. The policy shall not contain any intra-insured exclusions as between insured persons or organizations, but shall include coverage for liability assumed under this Lease as an “insured contract” for the performance of Lessee’s indemnify obligations under this Lease. The limits of said insurance shall not, however, limit the liability of Lessee nor relieve Lessee of any obligation hereunder. Lessee shall provide an endorsement on its liability policy(ies) which provides that its insurance shall be primary to and not contributory with any similar insurance carried by Lessor, whose insurance shall be considered excess insurance only.

 

(b)                                  Carried by Lessor. Lessor shall maintain liability insurance as described in Paragraph 8.2(a), in addition to, and not in lieu of, the insurance required to be maintained by Lessee. Lessee shall not be named as an additional Insured therein.

 

8.3                                Property Insurance - Building, Improvements and Rental Value.

 

(a)                                  Building and Improvements. Lessor shall obtain and keep in force a policy or policies of insurance in the name of Lessor, with loss payable to Lessor, any ground-lessor, and to any Lender insuring loss or damage to the Building and/or Project. The amount of such insurance shall be equal to the full insurable replacement cost of the Building and/or Project, as the same shall exist from time to time, or the amount required by any Lender, but in no event more than the commercially reasonable and available insurable value thereof. Lessee Owned Alterations and Utility Installations, Trade Fixtures, and Lessee’s personal property shall be insured by Lessee not by Lessor. If the coverage is available and commercially appropriate, such policy or policies shall insure against all risks of direct physical loss or damage (except the perils of flood and/or earthquake unless required by a Lender), including coverage for debris removal and the enforcement of any Applicable Requirements requiring the upgrading, demolition, reconstruction or replacement of any portion of the Premises as the result of a covered loss. Said policy or policies shall also contain an agreed valuation provision In lieu of any coinsurance clause, waiver of subrogation, and inflation guard protection causing an increase in the annual property insurance coverage amount by a factor of not less than the adjusted U.S. Department of Labor Consumer Price Index for All Urban Consumers for the city nearest to where the Premises are located. If such insurance coverage has a deductible clause, the deductible amount shall not exceed $5,000 per occurrence.

 

(b)                                  Rental Value. Lessor shall also obtain and keep in force a policy or policies in the name of Lessor with loss payable to Lessor and any Lender, insuring the loss of the full Rent for one year with an extended period of indemnity for an additional 180 days (“ Rental Value Insurance ”). Said Insurance shall contain an agreed valuation provision in lieu of any coinsurance clause, and the amount of coverage shall be adjusted annually to reflect the projected Rent otherwise payable by Lessee, for the next 12 month period.

 

(c)                                   Adjacent Premises. Lessee shall pay for any increase In the premiums for the property insurance of the Building and for the Common Areas or other buildings in the Project if said increase is caused by Lessee’s acts, omissions, use or occupancy of the Premises.

 

(d)                                  Lessee’s Improvements. Since Lessor is the Insuring Party, Lessor shall not be required to insure Lessee Owned Alterations and Utility Installations unless the item in question has become the property of Lessor under the terms of this Lease.

 

8.4                                Lessee’s Property; Business Interruption Insurance; Worker’s Compensation Insurance.

 

(a)                                  Property Damage. Lessee shall obtain and maintain insurance coverage on all of Lessee’s personal property, Trade Fixtures, and Lessee Owned Alterations and Utility Installations. Such insurance shall be full replacement cost coverage with a deductible of not to exceed $1,000 per occurrence. The proceeds from any such insurance shall be used by Lessee for the replacement of personal property, Trade Fixtures and Lessee Owned Alterations and Utility Installations.

 

(b)                                  Worker’s Compensation Insurance. Lessee shall obtain and maintain Worker’s Compensation Insurance in such amount as may be required by Applicable Requirements. Such policy shall include a ‘Waiver of Subrogation’ endorsement. Lessee shall provide Lessor with a copy of such endorsement along with the certificate of insurance or copy of the policy required by paragraph 8.5.

 

(c)                                   Business Interruption. Lessee shall obtain and maintain loss of income and extra expense insurance in amounts as will reimburse Lessee for direct or indirect loss of earning attributable to all perils commonly insured against by prudent lessees in the business of Lessee or attributable to prevention of access to the Premises as a result of such perils.

 

(d)                                  No Representation of Adequate Coverage. Lessor makes no representation that the limits or forms of coverage of insurance specified herein are adequate to cover Lessee’s property, business operations or obligations under this Lease.

 

8.5                                Insurance Policies. Insurance required herein shall be by companies maintaining during the policy term a “General Policyholders Rating” of at least A-, VII, as set forth In the most current issue of “Best’s Insurance Guide”, or such other rating as may be required by a Lender. Lessee shall not do or permit to be done anything which invalidates the required insurance policies. Lessee shall, prior to the Start Date, deliver to Lessor certified copies of policies of such insurance or certificates with copies of the required endorsements evidencing the existence and amounts of

 

 

 

 

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the required insurance. No such policy shall be cancelable or subject to modification except after 10 days prior written notice to Lessor. Lessee shall, at least 30 days prior to the expiration of such policies, furnish Lessor with evidence of renewals or “insurance binders” evidencing renewal thereof, or Lessor may order such insurance and charge the cost thereof to Lessee, which amount shall be payable by Lessee to Lessor upon demand. Such policies shall be for a term of at least one year, or the length of the remaining term of this Lease, whichever is less. If either Party shall fail to procure and maintain the insurance required to be carried by it, the other Party may, but shall not be required to, procure and maintain the same.

 

8.6                                Waiver of Subrogation. Without affecting any other rights or remedies, Lessee and Lessor each hereby release and relieve the other, and waive their entire right to recover damages against the other, for loss of or damage to its property arising out of or incident to the perils required to be insured against herein. The effect of such releases and waivers is not limited by the amount of insurance carried or required, or by any deductibles applicable hereto. The Parties agree to have their respective property damage insurance carriers waive any right to subrogation that such companies may have against Lessor or Lessee, as the case may be, so long as the insurance is not invalidated thereby.

 

8.7                                Indemnity. Except for Lessor’s gross negligence or willful misconduct. Lessee shall indemnify, protect, defend and hold harmless the Premises. Lessor and its agents, Lessor’s master or ground lessor, partners and Lenders, from and against any and all claims, loss of rents and/or damages. liens, judgments, penalties, attorneys’ and consultants’ fees, expenses and/or liabilities arising out of, involving, or in connection with, the use and/or occupancy of the Premises by Lessee. If any action or proceeding is brought against Lessor by reason of any of the foregoing matters, Lessee shall upon notice defend the same at Lessee’s expense by counsel reasonably satisfactory to Lessor and Lessor shall cooperate with Lessee in such defense. Lessor need not have first paid any such claim in order to be defended or indemnified.

 

8.8                                Exemption of Lessor and Its Agents from Liability. Notwithstanding the negligence or breach of this Lease by Lessor or its agents, neither Lessor nor its agents shall be liable under any circumstances for: (i) injury or damage to the person or goods, wares, merchandise or other property of Lessee, Lessee’s employees, contractors, invitees, customers, or any other person in or about the Premises, whether such damage or injury is caused by or results from fire, steam, electricity, gas, water or rain, indoor air quality, the presence of mold or from the breakage, leakage, obstruction or other defects of pipes, are sprinklers, wires, appliances, plumbing, HVAC or lighting fixtures, or from any other cause, whether the said injury or damage results from conditions arising upon the Premises or upon other portions of the Building, or from other sources or places, (ii) any damages arising from any act or neglect of any other tenant of Lessor or from the failure of Lessor or its agents to enforce the provisions of any other lease in the Project, or (iii) injury to Lessee’s business or for any loss of income or profit therefrom. Instead, it is intended that Lessee’s sole recourse in the event of such damages or injury be to file a claim on the insurance policy(les) that Lessee is required to maintain pursuant to the provisions of paragraph 8.

 

8.9                                Failure to Provide Insurance. Lessee acknowledges that any failure on its part to obtain or maintain the insurance required herein will expose Lessor to risks and potentially cause Lessor to incur costs not contemplated by this Lease, the extent of which will be extremely difficult to ascertain. Accordingly, for any month or portion thereof that Lessee does not maintain the required insurance and/or does not provide Lessor with the required binders or certificates evidencing the existence of the required insurance, the Base Rent shall be automatically increased, without any requirement for notice to Lessee, by an amount equal to 10% of the then existing Base Rent or $100, whichever is greater. The parties agree that such increase in Base Rent represents fair and reasonable compensation for the additional risk/costs that Lessor will incur by reason of Lessee’s failure to maintain the required insurance. Such increase in Base Rent shall in no event constitute a waiver of Lessee’s Default or Breach with respect to the failure to maintain such insurance, prevent the exercise of any of the other rights and remedies granted hereunder, nor relieve Lessee of its obligation to maintain the insurance specified in this Lease.

 

9.                                       Damage or Destruction.

 

9.1                                Definitions.

 

(a)                                      Premises Partial Damage shall mean damage or destruction to the improvements on the Premises, other than Lessee Owned Alterations and Utility Installations, which can reasonably be repaired in 3 months or less from the date of the damage or destruction, and the cost thereof does not exceed a sum equal to 6 month’s Base Rent. Lessor shall notify Lessee in writing within 30 days from the date of the damage or destruction as to whether or not the damage is Partial or Total.

 

(b)                                      Premises Total Destruction shall mean damage or destruction to the improvements on the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which cannot reasonably be repaired in 3 months or less from the date of the damage or destruction and/or the cost thereof exceeds a sum equal to 6 month’s Base Rent. Lessor shall notify Lessee in writing within 30 days from the date of the damage or destruction as to whether or not the damage is Partial or Total.

 

(c)                                       Insured Loss shall mean damage or destruction to improvements on the Premises, other than Lessee Owned Alterations and Utility Installations and Trade Fixtures, which was caused by an event required to be covered by the insurance described in Paragraph 8.3(a), irrespective of any deductible amounts or coverage limits involved.

 

(d)                                      Replacement Cost shall mean the cost to repair or rebuild the improvements owned by Lessor at the time of the occurrence to their condition existing immediately prior thereto, including demolition, debris removal and upgrading required by the operation of Applicable Requirements, and without deduction for depreciation.

 

(e)                                       Hazardous Substance Condition shall mean the occurrence or discovery of a condition involving the presence of, or a contamination by, a Hazardous Substance, in, on, or under the Premises which requires restoration.

 

                9.2                                Partial Damage - Insured Loss. If a Premises Partial Damage that is an Insured Loss occurs, then Lessor shall, at Lessor’s expense, repair such damage (but not Lessee’s Trade Fixtures or Lessee Owned Alterations and Utility Installations) as soon as reasonably possible and this Lease shall continue in full force and effect; provided, however, that Lessee shall, at Lessor’s election, make the repair of any damage or destruction the total cost to repair of which is $5,000 or less, and, in such event, Lessor shall make any applicable insurance proceeds available to Lessee on a reasonable basis for that purpose. Notwithstanding the foregoing, if the required insurance was not in force or the insurance proceeds are not sufficient to effect such repair, the Insuring Party shall promptly contribute the shortage in proceeds as and when required to complete said repairs. In the event, however, such shortage was due to the fact that, by reason of the unique nature of the improvements, full replacement cost insurance coverage was not commercially reasonable and available, Lessor shall have no obligation to pay for the shortage in insurance proceeds or to fully restore the unique aspects of the Premises unless Lessee provides Lessor with the funds to cover same, or adequate assurance thereof, within 10 days following receipt of written notice of such shortage and request therefor. If Lessor receives said funds or adequate assurance thereof within said 10 day period, the party responsible for making the repairs shall complete them as soon as reasonably possible and this Lease shall remain in full force and effect. If such funds or assurance are not received, Lessor may nevertheless elect by written notice to Lessee within 10 days thereafter to: (i) make such restoration and repair as is commercially reasonable with Lessor paying any shortage in proceeds, in which case this Lease shall remain in full force and effect, or (ii) have this Lease terminate 30 days thereafter. Lessee shall not be entitled to reimbursement of any funds contributed by Lessee to repair any such damage or destruction. Premises Partial Damage due to flood or earthquake shall be subject to Paragraph 9.3, notwithstanding that there may be some insurance coverage, but the net proceeds of any such insurance shall be made available for the repairs if made by either Party.

 

9.3                                Partial Damage - Uninsured Loss. If a Premises Partial Damage that is not an Insured Loss occurs, unless caused by a negligent or willful act of Lessee (in which event Lessee shall make the repairs at Lessee’s expense), Lessor may either: (i) repair such damage as soon as reasonably possible at Lessor’s expense, in which event this Lease shall continue in full force and effect, or (ii) terminate this Lease by giving written notice to Lessee within 30 days after receipt by Lessor of knowledge of the occurrence of such damage. Such termination shall be effective 60 days following the date of such notice. In the event Lessor elects to terminate this Lease, Lessee shall have the right within 10 days after receipt of the termination notice to give written notice to Lessor of Lessee’s commitment to pay for the repair of such damage without reimbursement from Lessor. Lessee shall provide Lessor with said funds or satisfactory assurance thereof within 30 days after making such commitment. In such event this Lease shall continue in full force and effect, and Lessor shall proceed to make such repairs as soon as reasonably possible after the required funds are available. If Lessee does not make the required commitment, this Lease shall terminate as of the date specified in the termination notice.

 

9.4                                Total Destruction. Notwithstanding any other provision hereof, if a Premises Total Destruction occurs, this Lease shall terminate 60 thirty (30) days following such Destruction. If the damage or destruction was caused by the gross negligence or willful misconduct of Lessee, Lessor shall have the right to recover Lessor’s damages from Lessee, except as provided in Paragraph 8.6.

 

9.5                                Damage Near End of Term. If at any time during the last 6 months of this Lease there is damage for which the cost to repair exceeds one month’s Base Rent, whether or not an Insured Loss, Lessor may terminate this Lease effective 60 days following the date of occurrence of such damage by giving a written termination notice to Lessee within 30 days after the date of occurrence of such damage. Notwithstanding the foregoing, if Lessee at that time has an exercisable option to extend this Lease or to purchase the Premises, then Lessee may preserve this Lease by, (a) exercising such option and (b) providing Lessor with any shortage in insurance proceeds (or adequate assurance thereof) needed to make the repairs on or before the earlier of (i) the date which is 10 days after Lessee’s receipt of Lessor’s written notice purporting to terminate this Lease, or (ii) the day prior to the date upon which such option expires. If Lessee duly exercises such option during such period and provides Lessor with funds (or adequate assurance thereof) to cover any shortage in insurance proceeds, Lessor shall, at Lessor’s commercially reasonable expense, repair such damage as soon as reasonably possible and this Lease shall continue in full force and effect. If Lessee fails to exercise such option and provide such funds or assurance during such period, then this Lease shall terminate on the date specified in the termination notice and Lessee’s option shall be extinguished.

 

 

 

 

/s/ [ILLEGIBLE]

 

/s/ [ILLEGIBLE]

INITIALS

 

INITIALS

 

7



 

9.6          Abatement of Rent; Lessee’s Remedies.

 

(a)         Abatement. In the event of Premises Partial Damage or Premises Total Destruction or a Hazardous Substance Condition for which Lessee is not responsible under this Lease, the Rent payable by Lessee for the period required for the repair, remediation or restoration of such damage shall be abated in proportion to the degree to which Lessee’s use of the Premises is impaired, but not to exceed the proceeds received from the Rental Value insurance. All other obligations of Lessee hereunder shall be performed by Lessee, and Lessor shall have no liability for any such damage, destruction, remediation, repair or restoration except as provided herein.

 

(b)         Remedies.   If Lessor is obligated to repair or restore the Premises and does not commence, in a substantial and meaningful way, such repair or restoration within 90 sixty (60) days after such obligation shall accrue, Lessee may, at any time prior to the commencement of such repair or restoration, give written notice to lessor and to any Lenders of which Lessee has actual notice, of Lessee’s election to terminate this Lease on a date not less than 60 days following the giving of such notice. If Lessee gives such notice and such repair or restoration is not commenced within 30 days thereafter, this Lease shall terminate as of the date specified in said notice. If the repair or restoration is commenced within such 30 days, this Lease shall continue in full force and effect. “ Commence ” shall mean either the unconditional authorization of the preparation of the required plans, or the beginning of the actual work on the Premises, whichever first occurs.

 

9.7                                  Termination; Advance Payments.   Upon termination of this Lease pursuant to Paragraph 6.2(g) or Paragraph 9, an equitable adjustment shall be made concerning advance Base Rent and any other advance payments made by Lessee to Lessor. Lessor shall, in addition, return to Lessee so much of Lessee’s Security Deposit as has not been, or is not then required to be, used by Lessor.

 

10.                                   Real Property Taxes.

 

10.1                          Definitions. As used herein, the term “ Real Property Taxes ” shall include any form of assessment; real estate, general, special, ordinary or extraordinary, or rental levy or tax (other than inheritance, personal income or estate taxes); improvement bond; and/or license fee imposed upon or levied against any legal or equitable interest of Lessor in the Project, Lessor’s right to other Income therefrom, and/or Lessor’s business of leasing, by any authority having the direct or indirect power to tax and where the funds are generated with reference to the Project address and where the proceeds so generated are to be applied by the city, county or other local taxing authority of a jurisdiction within which the Project is located. “ Real Property Taxes ” shall also include any tax, fee, levy, assessment or charge, or any increase therein: (i) imposed by reason of events occurring during the term of this Lease, including but not limited to, a change in the ownership of the Project, (ii) a change in the improvements thereon, and/or (iii) levied or assessed on machinery or equipment provided by Lessor to Lessee pursuant to this Lease.

 

10.2                          Payment of Taxes. Except as otherwise provided in Paragraph 10.3, Lessor shall pay the Real Property Taxes applicable to the Project, and said payments shall be included in the calculation of Operating Expenses in accordance with the provisions of Paragraph 4.2.

 

10.3                          Additional Improvements. Operating Expenses shall not include Real Property Taxes specified in the tax assessor’s records and work sheets as being caused by additional improvements placed upon the Project by other lessees or by Lessor for the exclusive enjoyment of such other lessees. Notwithstanding Paragraph 10.2 hereof, Lessee shall, however, pay to Lessor at the time Operating Expenses are payable under Paragraph 4.2, the entirety of any increase in Real Property Taxes if assessed solely by reason of Alterations, Trade Fixtures or Utility Installations placed upon the Premises by Lessee or at Lessee’s request or by reason of any alterations or improvements to the Premises made by Lessor subsequent to the execution of this Lease by the Parties.

 

10.4                          Joint Assessment . If the Building is not separately assessed, Real Property Taxes allocated to the Building shall be an equitable proportion of the Real Property Taxes for all of the land and improvements included within the tax parcel assessed, such proportion to be determined by Lessor from the respective valuations assigned in the assessor’s work sheets or such other information as may be reasonably available. Lessor’s reasonable determination thereof, in good faith, shall be conclusive.

 

10.5                          Personal Property Taxes. Lessee shall pay prior to delinquency all taxes assessed against and levied upon Lessee Owned Alterations and Utility Installations, Trade Fixtures, furnishings, equipment and all personal property of Lessee contained in the Premises. When possible, Lessee shall cause its Lessee Owned Alterations and Utility Installations, Trade Fixtures, furnishings, equipment and all other personal property to be assessed and billed separately from the real property of Lessor. If any of Lessee’s said property shall be assessed with Lessor’s real property, Lessee shall pay Lessor the taxes attributable to Lessee’s property within 10 days after receipt of a written statement setting forth the taxes applicable to Lessee’s property.

 

11.                                   Utilities and Services.

 

11.1                         Services Provided by Lessor. Lessor shall provide heating, ventilation, air conditioning, reasonable amounts of electricity for normal lighting and office machines, water for reasonable and normal drinking and lavatory use in connection with an office, and replacement light bulbs and/or fluorescent tubes and ballasts for standard overhead fixtures. Lessor shall also provide janitorial services to the Premises and Common Areas 5 times per week, excludin