UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington D.C. 20549
Form 10-K
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(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended December 31, 2008
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or
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For the transition period
from to .
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Commission File Number:
001-34112
Energy Recovery, Inc.
(Exact Name of Registrant as
Specified in Its Charter)
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Delaware
(State or Other Jurisdiction
of
Incorporation or Organization)
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01-0616867
(I.R.S. Employer
Identification No.)
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1908 Doolittle Drive, San Leandro, CA 94577
(Address of Principal Executive
Offices)
Registrants telephone number, including area code:
(510) 483-7370
Securities registered pursuant to Section 12(b) of the
Securities Exchange Act of 1934:
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Title of each class
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Name of exchange on which
registered
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Common stock, $0.001 par value
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The NASDAQ Stock Market LLC
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Securities registered pursuant to Section 12(g) of the
Securities Exchange Act of 1934:
None
Indicate by check mark whether the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes
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No
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Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the
Act. Yes
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No
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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
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No
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Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein and will not be contained, to the best
of registrants knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K.
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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. (Check one):
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Large accelerated filer
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Accelerated filer
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Non-accelerated filer
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(Do not check if a smaller reporting company)
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Smaller reporting company
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Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the Exchange
Act). Yes
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No
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As of June 30, 2008, the last business day of the
registrants most recently completed second quarter, there
was no established trading market for the registrants
common stock.
The number of shares of the registrants common stock
outstanding as of March 24, 2009 was 50,096,887.
DOCUMENTS
INCORPORATED BY REFERENCE
Parts of the Proxy Statement for the Registrants Annual
Meeting of Shareholders to be held in June 2009 are incorporated
by reference into Part III of this Annual Report on
Form 10-K
PART I
Overview
Energy Recovery, Inc. develops, manufactures and sells
high-efficiency energy recovery devices for use in seawater
desalination. Our products make desalination affordable by
reducing energy costs. We have one operating segment, the
manufacture and sale of high efficiency energy recovery products
and related services. Additional information on segment
reporting is contained in Note 10 of Notes to the
Consolidated Financial Statements in this
Form 10-K.
Our company was incorporated in Virginia in April 1992 and
reincorporated in Delaware in March 2001. We became a public
company in July 2008. The company has three subsidiaries:
Osmotic Power, Inc., Energy Recovery, Inc. International, and
Energy Recovery Iberia, S.L. They were incorporated in September
2005, July 2006 and September 2006, respectively.
The mailing address of our headquarters is 1908 Doolittle Drive,
San Leandro, California 94577. Our main telephone number is
(510) 483-7370.
Additional information about ERI is available on our website at
http://www.energyrecovery.com.
Information contained in the website is not part of this report.
Our Annual Report on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K
and all amendments to those reports and the Proxy Statement for
our Annual Meeting of Stockholders are made available, free of
charge, on our website,
http://www.energyrecovery.com,
as soon as reasonably practicable after the reports have been
filed with or furnished to the Securities and Exchange
Commission.
Our
Products
Energy Recovery, Inc. makes energy recovery devices for use in
the desalination industry. There are two primary methods of
producing drinking water from seawater: thermal distillation and
membrane or reverse osmosis desalination. Thermal distillation
involves heating seawater, capturing the vapor and condensing it
as potable water. Reverse osmosis desalination entails
pressurizing seawater and driving it into filtering membranes to
produce pure water and a concentrated brine, which is carried
away in a high pressure reject stream.
Our energy recovery products are used in reverse osmosis
desalination. They reduce energy costs by capturing and reusing
up to 98% of the otherwise lost pressure energy from the reject
stream, reducing the workload of the high pressure pump. Use of
our devices can reduce energy consumption by up to an estimated
60% compared to reverse osmosis plants without energy recovery.
By reducing energy costs, our devices increase the
cost-competitiveness of reverse osmosis desalination compared to
other means of fresh water production, including thermal
desalination. Our products are sold under the trademarks
ERI
®
,
PX
®
,
Pressure
Exchanger
®
and PX Pressure
Exchanger
®
.
Current Product Lines:
We develop and sell different
models and sizes of our PX Pressure Exchanger products to
address a range of process flow rates, plant designs and sizes.
Our products are designed to operate in parallel to accommodate
a range of plant sizes. Their modular design also provides
system redundancy and minimizes the need for costly plant
shut-downs. Our current offerings include:
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The 65 Series.
Our 65-Series of PX devices is designed
for reverse osmosis desalination plants capable of producing
more than 120 gallons per minute or 27 cubic meters per hour.
The PX-220, introduced in 2002, and the PX-260, introduced in
late 2007, are currently our most popular products.
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Capacity gallons per minute (cubic meters per
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Model
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hour)
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PX-260
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180 260 gpm (41 59
m
3
/hr)
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PX-220
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140 220 gpm (32 50
m
3
/hr)
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PX-180
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100 180 gpm (23 41
m
3
/hr)
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1
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The 45 Series.
The smaller 45-Series of PX devices are
adapted for plants that process between 25 to 300 gallons per
minute or 6 to 68 cubic meters per hour.
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Capacity gallons per minute (cubic meters per
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Model
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hour)
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PX-140S
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90 140 gpm (20 32
m
3
/hr)
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PX-90S
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60 90 gpm (14 20
m
3
/hr)
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PX-70S
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40 70 gpm (9 16
m
3
/hr)
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PX-45S
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30 45 gpm (7 10
m
3
/hr)
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PX-30S
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20 30 gpm (4 7
m
3
/hr)
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PX-30S.
The PX-30S is a smaller PX device designed for
pilot desalination projects. It helps municipalities qualify PX
technology for use in larger projects. The product was released
in October 2007. In addition to serving as a test unit, it
has found application in smaller marine-based or solar-powered
desalination processes.
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Brackish PX devices.
Brackish water has a lower
concentration of salt than seawater. Given its lower salt
content, brackish water typically requires less energy than
seawater to desalinate. Our line of PX devices for the
desalination of brackish water is designed to reduce energy
costs and improve energy consumption in this lower pressure
process.
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New PX devices.
We are in the process of testing two new
PX devices designed for different ends of the desalination
market.
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The Comp PX. Our new lower-priced Comp PX product is designed
for operators of small to medium-sized plants which are
sensitive to initial costs
and/or
are
located in regions where energy costs are low. We expect to
release the Comp PX device commercially in 2009.
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The Titan PX. The Titan PX product is designed to process up to
1,200 gallons per minute or 273 cubic meters per hour, more
than four times the capacity of our PX-260. Field testing began
in February 2009. We expect to evaluate the Titan PX device in a
production environment for at least two years before releasing
it for commercial use.
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Technical Support and Replacement Parts.
We provide
engineering and technical support to customers during product
installation and plant commissioning. We have dedicated
technical support personnel based in Spain, the United Arab
Emirates, China and the United States.
As our installed base of PX devices increases and ages, we
expect sales of replacement PX device parts and services to
increase. Our PX devices may also be used to retrofit or replace
older energy recovery devices in existing desalination plants.
High Pressure Circulation Pumps.
We manufacture and sell
a line of high pressure circulation pumps for use in small to
medium-sized plants. These low-powered pumps are used with our
products to move high-pressure water through our energy recovery
devices and the membranes array.
Customers
As of December 31, 2008, we had shipped approximately 5,900
PX devices to desalination plants worldwide. Our products are
used in approximately 300 plants in operation or under
construction including major plants in Australia, Spain, Africa,
South America, the Middle East, China, the Caribbean and India.
We sell directly to our customers, which include large
engineering and construction firms and original equipment
manufacturers (OEMs).
Large engineering and construction firms.
Most of our
revenue comes from sales of our products to the international
engineering and construction firms that design and build large
desalination plants or
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mega-projects.
We work with these firms to specify our products for their
plants. The time between project tender to product shipment can
range from six to 16 months. Each large mega-project
typically represents a revenue opportunity of between
$2 million to $7 million.
A limited number of these engineering and construction firms
account for a substantial portion of our net revenue. In 2008,
sales to Hyflux Ltd. and Befesa Agua, S.A. and affiliated joint
ventures accounted for approximately 16% and 11%, respectively,
of our total revenue. In 2007, sales to Acciona Agua S.A.; Geida
and its member companies; and Doosan Heavy
Industries & Construction Co., Ltd. represented
approximately 20%, 23% and 13%, respectively, of our total sales
(Geida is a consortium of Befesa Agua, a subsidiary of Abengoa
S.A; Cobra-Tedagua, a subsidiary of ACS Actividades de
Construcción y Servicios, S.A.; and Sadyt S.A., a
subsidiary of Sacyr Vallehermoso, S. A.). Sales to GE Water and
Process Technologies (formerly GE Ionics) and Geida and its
member companies represented approximately 18% and 11%
respectively of our total sales in 2006. No other customers
accounted for more than 10% of our total revenue during any of
these periods.
Original Equipment Manufacturers.
We also sell our
products and services to suppliers of pumps and other
water-related equipment for assembly and use in small to
medium-sized desalination plants for hotels, power plants,
cruise ships, farming operations, island bottlers, and small
municipalities. These original equipment manufacturers also
purchase our products for quick water or emergency
water solutions. In this market, the time from project tender to
shipment ranges from one to three months.
Competition
The market for energy recovery devices in desalination plants is
competitive. As the demand for fresh water increases and the
market expands, we expect competition to persist and intensify.
We have three main competitors: Calder AG based in Switzerland;
Fluid Equipment Development Company (FEDCO) based in Monroe,
Michigan and Pump Engineering Incorporated (PEI) based in
Monroe, Michigan. We compete with these companies on the basis
of price, technology, materials, efficiency and life cycle
maintenance costs. We believe that our products have a
competitive advantage, even though these competitors may offer
their products at prices lower than ours, because our product is
the most cost effective energy recovery device for reverse
osmosis desalination over time.
In the market for large desalination projects, our PX devices
compete primarily with Calders DWEER product. Like our
products, the DWEER uses isobaric or pressure-equalizing
technology to transfer pressure energy directly from the brine
reject stream to seawater. We believe that we have a competitive
advantage because our products are made with highly durable and
corrosion-proof ceramic parts, have a simple design with one
moving part and a small physical footprint, provide system
redundancy and scaling capability, and offer lower life cycle
maintenance costs.
In the market for small to medium-sized desalination plants, we
compete with turbine technology from Calder, FEDCO and PEI.
Unlike products that use isobaric or pressure-equalizing
technology, turbine-based energy recovery products use the
reject stream to turn a hydraulic turbine wheel that is coupled
to a high-pressure pump. These products reduce energy costs by
reducing the workload of the high pressure pump. These devices
convert pressure energy to mechanical energy and back to
pressure energy, and can recycle the pressure energy from the
reject stream with a net transfer efficiency of between 50%-79%.
We believe that our products have a competitive advantage
because they provide up to 98% energy transfer efficiency, have
lower life cycle maintenance costs, are made of highly durable
and corrosion-proof ceramic parts and feature a modular design.
Sales and
Marketing
Our sales and marketing groups work with companies that design
and build desalination plants to specify our PX technology in
their plants early in the design phase. We market and sell our
products directly to these customers through our regional sales
organization. In some countries, we also work with industry
consultants.
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Our sales organization has two groups, the Mega-Projects Group,
which is responsible for sales opportunities for desalination
projects exceeding 50,000 cubic meters per day, and our OEM
Group, which targets projects designed to produce less than
50,000 cubic meters per day.
Since many of the large engineering and construction firms that
specialize in mega-projects are located in Spain and other
European countries, we maintain a sales and technical center in
Madrid. We have an office in Dubai, United Arab Emirates to
serve the Middle East where many desalination plants and key
engineering and construction firms are located. We also have an
office in China where we have many small and medium projects and
opportunities for several large desalination projects. Our China
office is located in Shanghai. Our U.S. sales offices are
located in California and Florida.
Manufacturing
We assemble, test and package all of our finished products in
our manufacturing facility in San Leandro, California. We
purchase unfinished ceramic components for our PX products from
several suppliers. We depend on three suppliers for our vessel
housing and single suppliers for our end covers and stainless
steel castings. We perform finish machining and assembly
in-house on all ceramic components to protect the proprietary
nature of our methods of manufacturing and product designs and
to maintain our quality control standards.
For a discussion of risks attendant to our manufacturing
activities, see Risk Factors We depend on
third-party suppliers, and our revenue and gross margin could
suffer if we fail to manage supplier issues properly, in
Item 1A, which is incorporated herein by reference.
Research
and Development
Design, quality and innovation are key elements of our culture.
Our development efforts are focused on designing and testing new
PX devices adapted for different niches of the seawater reverse
osmosis desalination market and creating new applications for
our technology outside of desalination. We are also committed to
developing know-how in the material science and manufacturing of
ceramics. Research and development expense totaled
$2.4 million for 2008, $1.7 million for 2007 and
$1.3 million for 2006.
For a discussion of risks attendant to our research and
development activities, see Risk Factors The
success of our business depends in part on our ability to
develop new products and services and increase the functionality
of our current products, in Item 1A, which is
incorporated herein by reference.
Intellectual
Property
We seek patent protection for inventions and improvements that
are likely to be incorporated into our products. We rely on
trade secret law and contractual safeguards to protect the
proprietary tooling, processing techniques and other know-how
used in the production of our products.
We have five U.S. patents and eleven patents outside the U.S.
that are counterparts to one of the U.S. patents. The U.S.
patents expire between 2011 and 2025, and the corresponding
international patents expire at various dates through 2021. We
have also applied for two additional U.S. patents and seven
pending international applications corresponding to the U.S.
patents and patent applications.
We have registered the following trademarks with the United
States Patent and Trademark office: ERI,
PX, PX Pressure Exchanger,
Pressure Exchanger, the ERI logo, and Making
Desalination Affordable. We have also applied for and
received registrations in international trademark offices.
For a discussion of risks attendant to intellectual property
rights, see Risk Factors If we are unable to
protect our technology or enforce our intellectual property
rights, our competitive position could be harmed and we could be
required to incur significant expenses to enforce our
rights. in Item 1A, which is incorporated herein by
reference.
4
Employees
As of December 31, 2008, we had 89 employees: 26 in
manufacturing, 21 in sales and marketing; 34 in corporate
services and management; and eight in engineering/research and
development. Nine of these employees were located outside of the
United States. We also from time to time engage a relatively
small number of independent contractors. We have not experienced
any work stoppages. Our employees are not unionized.
We
have relied and expect to continue to rely on sales of our PX
devices for almost all of our revenue; a decline in demand for
desalination, reverse osmosis desalination or our PX devices
will reduce demand for our products and will cause our sales and
revenue to decline.
Our primary product is the PX device, and sales of our PX device
historically have accounted for approximately 95% of our
revenue. While we sell a variety of models of the PX device
depending on the design of the desalination plant and its
desired output, all of our models rely on the same basic
technology developed and refined over the past 12 years. We
expect that the revenue from our PX devices will continue to
account for most of our revenue for the foreseeable future. Any
factors adversely affecting the demand for desalination,
including changing weather patterns, increased precipitation,
new technology for producing fresh water, new energy technology
or reduced energy costs, changes in the global economy, and
political changes, would reduce the demand for PX devices and
would cause a significant decline in our revenue. For example,
desalination projects have in the past been cancelled or delayed
due to political issues, changes in precipitation and problems
with financing. Similarly, any other factors adversely affecting
the demand for our PX devices, including new methods of reverse
osmosis desalination that reduce pressure and energy
requirements, improvements in membrane technology, new energy
recovery technology, increased competition, changes in customer
spending priorities and industry regulations would also cause a
significant decline in our revenue. Some of the factors that may
affect sales of our PX device may be out of our control.
We
depend on the construction of new desalination plants for
revenue, and as a result, our operating results have
experienced, and may continue to experience, significant
variability due to volatility in capital spending, availability
of project financing, and other factors affecting the water
desalination industry.
We derive substantially all of our revenue from sales of
products and services used in desalination plants for
municipalities, hotels and resorts and agricultural operations
in dry or drought-ridden regions of the world. The demand for
our products may decrease if the construction of desalination
plants declines, especially in these regions. Other factors
could affect the number and capacity of desalination plants
built or the timing of their completion, including the current
weak global economy, the current crisis in the credit and
banking systems, changes in government priorities, changes in
governmental regulations, reduced capital spending for
desalination and lower energy costs, which could result in
cancelled orders or delays in plant construction and the
installation of our products. As a result of these factors, we
have experienced and may in the future experience significant
variability in our revenue, on both an annual and a quarterly
basis. Pronounced variability, extended delays or reductions in
spending with respect to the construction of desalination plants
could negatively impact our sales and revenue and make it
difficult for us to accurately forecast our future sales, which
could lead to increased spending by us that is not matched by
equivalent or higher revenue.
New
planned seawater reverse osmosis projects can be cancelled
and/or delayed, and cancellations and/or delays may negatively
impact our revenue.
Planned seawater reverse osmosis desalination projects can be
cancelled or delayed due to delays in, or failure to obtain,
financing or the approval of or permitting for, plant
construction because of political factors, adverse and
increasingly uncertain financing conditions or other factors,
especially in countries with political unrest. Even though we
may have a signed contract to provide a certain number of PX
devices by a certain date, if a customer requests a delay of
shipment and we delay shipment of our PX devices, our results of
operations and revenue will be negatively impacted.
5
We
rely on a limited number of engineering and construction firms
for a large portion of our revenue. If these customers delay or
cancel their commitments or do not purchase our products in
connection with future projects, our revenue could significantly
decrease, which would adversely affect our financial condition
and future growth.
A limited number of our customers can account for a substantial
portion of our net revenue. Revenue from engineering and
construction firms and other customers representing 10% or more
of total revenue varies from year to year. For the twelve months
ended December 31, 2008, sales to two customers, Hyflux Ltd
and Befesa Agua S.A. represented 27% of our net revenues. For
the twelve months ended December 31, 2007, three customers
represented approximately 56% of net revenue. No other customer
accounted for more than 10% of our net revenue during any of
these periods. We do not have long-term contracts with our
customers; instead, we sell to them on a purchase order or
project basis or under individual stand-alone contracts. Orders
may be postponed or delayed by our customers on short or no
notice. If these customers reduce their purchases, our projected
revenue may significantly decrease, which will adversely affect
our financial condition and future growth. If one of our
engineering and construction firm customers delays or cancels
one or more of its projects, or if it fails to pay amounts due
to us or delays its payments, our revenue or operating results
could be negatively affected. There are a limited number of
engineering and construction firms which are involved in the
desalination industry. Thus, if one of them decides not to
continue to use our energy recovery devices in its future
projects, we may not be able replace such a lost customer with
another such customer and our net revenue would be negatively
affected.
Our
operating results may fluctuate significantly, which makes our
future operating results difficult to predict and could cause
our operating results to fall below expectations or our
guidance.
Our operating results may fluctuate due to a variety of factors,
many of which are outside of our control. Due to the fact that a
single order for our PX devices for a particular desalination
plant may represent significant revenue, we have experienced
significant fluctuations in revenue from quarter to quarter, and
we expect such fluctuations to continue. As a result, comparing
our operating results on a period-to-period basis may not be
meaningful. You should not rely on our past results as an
indication of our future performance. If our revenue or
operating results fall below the expectations of investors or
securities analysts or below any guidance we may provide to the
market, the price of our common stock would likely decline
substantially.
In addition, factors that may affect our operating results
include, among others:
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fluctuations in demand, adoption, sales cycles and pricing
levels for our products and services;
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the cyclical nature of purchasing for seawater reverse osmosis
desalination plant construction, which typically reflects a
seasonal increase in shipments of PX devices in the fourth
quarter;
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changes in customers budgets for desalination plants and
the timing of their purchasing decisions;
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adverse changes in the local or global financing conditions
facing our customers;
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delays or postponements in the construction of desalination
plants;
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our ability to develop, introduce and ship in a timely manner
new products and product enhancements that meet customer demand,
certification requirements and technical requirements;
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the ability of our customers to obtain other key components of a
plant such as high pressure pumps or membranes;
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our ability to implement scalable internal systems for
reporting, order processing, product delivery, purchasing,
billing and general accounting, among other functions;
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unpredictability of governmental regulations and political
decision-making as to the approval or building of a desalination
plant;
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our ability to control costs, including our operating expenses;
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our ability to purchase key PX components, principally ceramics,
from third party suppliers;
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6
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our ability to compete against other companies that offer energy
recovery solutions;
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our ability to attract and retain highly skilled employees,
particularly those with relevant industry experience; and
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general economic conditions in our domestic and international
markets.
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If we
are unable to collect unbilled receivables, our operating
results will be adversely affected.
Our customer contracts generally contain holdback provisions
pursuant to which the final installments to be paid under such
sales contracts are due up to 24 months after the product
has been shipped to the customer and revenue has been
recognized. Typically, between 10 and 20%, and in some instances
up to 30% of the revenue we receive pursuant to our customer
contracts are subject to such holdback provisions and are
accounted for as unbilled receivables until we deliver invoices
for payment. As of December 31, 2008, we had approximately
$4.9 million of current unbilled receivables and
approximately $1.9 million of non-current unbilled
receivables. If we are unable to invoice and collect, or if our
customers fail to make payments due under our sales contracts,
our results of operations will be adversely affected.
If we
lose key personnel upon whom we are dependent, we may not be
able to execute our strategies. Our ability to increase our
revenue will depend on hiring highly skilled professionals with
industry-specific experience, particularly given the unique and
complex nature of our devices.
Given the specialized nature of our business, we must hire
highly skilled professionals with industry-specific experience.
Our ability to successfully grow depends on recruiting skilled
and experienced employees. We often compete with larger, better
known companies for talented employees. Also, retention of key
employees, such as our chief executive officer, who has over
30 years of experience in the water treatment industry, is
vital to the successful execution of our growth strategies. Our
failure to retain existing or attract future key personnel could
harm our business.
The
success of our business depends in part on our ability to
develop new products and services and increase the functionality
of our current products.
Since 2004, we have invested more than $5 million in
research and development costs associated with our PX products.
From time to time, our customers have expressed a need for
greater processing efficiency. In response, and as part of our
strategy to enhance our energy recovery solutions and grow our
business, we plan to continue to make substantial investments in
the research and development of new technologies. For instance,
we are in the process of developing the Titan PX as a product
for use in increasingly larger desalination plants and the Comp
PX for use in smaller desalination operations. While these
products have the potential to meet specified needs of key
markets, their pricing may not meet customer expectations and
they may not perform as well as our other PX devices. It is
possible that potential customers may not accept the new pricing
structure. It is also possible that the release of this product
may be delayed if testing reveals unexpected flaws. Our future
success will depend in part on our ability to continue to design
and manufacture new products, to enhance our existing products
and to provide new value-added services. We may experience
unforeseen problems in the performance of our existing and new
technologies or products. Furthermore, we may not achieve market
acceptance of our new products and solutions. If we are unable
to develop competitive new products, or if the market does not
accept such products, our business and results of operations
will be adversely affected.
Our
plans to manufacture a portion of our ceramic components may
prove to be more costly or less reliable than
outsourcing.
We currently outsource the production of our ceramic components
from several ceramic vendors. To diversify our supply of
ceramics and retain more control over our intellectual property,
we intend to vertically integrate by producing a portion of our
ceramic component needs in house. Recent contraction in the
ceramics manufacturing business has accelerated our schedule for
this initiative. If we are less efficient at producing our
ceramic components or are unable to achieve required yields that
are equal to or greater than the vendors to
7
which we outsource, then our cost of revenue may be adversely
affected. If we are unable to initiate the production of our
ceramics parts on schedule, unable to manufacture these parts
in-house efficiently
and/or
another of our ceramics suppliers goes out of business, we may
be exposed to increased risk of supply chain disruption and
capacity shortages.
Our
revenue and growth model depend upon the continued viability and
growth of the seawater reverse osmosis desalination industry
using current technology.
If there is a downturn in the seawater reverse osmosis
desalination industry, our sales would be directly and adversely
impacted. Changes in seawater reverse osmosis desalination
technology could also reduce the demand for our devices. For
example, a reduction in the operating pressure used in seawater
reverse osmosis desalination plants could reduce the need for
and viability of our energy recovery devices. Membrane
manufacturers are actively working on lower pressure membranes
for seawater reverse osmosis desalination that could potentially
be used on a large scale to desalinate seawater at a much lower
pressure than is currently necessary. Engineers are also
evaluating the possibility of diluting seawater prior to reverse
osmosis desalination to reduce the required membrane pressure.
Similarly, an increase in the recovery rate would reduce the
number of energy recovery devices required and would reduce the
demand for our product. A significant reduction in the cost of
power may reduce demand for our product or favor a less
expensive product from a competitor. Any of these changes would
adversely impact our revenue and growth.
The
durable nature of the PX device may reduce or delay potential
aftermarket revenue opportunities.
Our PX devices utilize ceramic components that have to date
demonstrated high durability, high corrosion resistance and long
life in seawater reverse osmosis desalination applications.
Because most of our PX devices have only been installed for
several years, it is difficult to accurately predict their
performance or endurance over a longer period of time. In the
event that our products are more durable than expected, our
opportunity for aftermarket revenue may be deferred.
Our
sales cycle can be long and unpredictable, and our sales efforts
require considerable time and expense. As a result, our sales
are difficult to predict and may vary substantially from quarter
to quarter, which may cause our operating results to
fluctuate.
Our sales efforts involve substantial education of our current
and prospective customers about the use and benefits of our PX
products. This education process can be time consuming and
typically involves a significant product evaluation process.
While the sales cycle for our OEM customers, which are involved
with smaller desalination plants, averages one to three months,
the average sales cycle for our international engineering and
construction firm customers, which are involved with larger
desalination plants, ranges from nine to 16 months and has,
in some cases, extended up to 24 months. In addition, these
customers generally must make a significant commitment of
resources to test and evaluate our technologies. As a result,
our sales process involving these customers is often subject to
delays associated with lengthy approval processes that typically
accompany the design, testing and adoption of new,
technologically complex products. This long sales cycle makes
quarter-by-quarter
revenue predictions difficult and results in our investing
significant resources well in advance of orders for our products.
Since
a significant portion of our annual sales typically occurs
during the fourth quarter, any delays could affect our fourth
quarter and annual revenue and operating results.
A significant portion of our annual sales typically occurs
during the fourth quarter, which we believe generally reflects
engineering and construction firm customer buying patterns. Any
delays or cancellation of expected sales during the fourth
quarter would reduce our quarterly and annual revenue from what
we anticipated. Such a reduction might cause our quarterly and
annual revenue or quarterly and annual operating results to fall
below the expectations of investors or securities analysts or
below any guidance we may provide to the market, causing the
price of our common stock to decline.
8
We
depend on three vendors for our supply of ceramics, which is a
key component of our products. If any of our ceramics vendors
cancels its commitments or is unable to meet our demand and/or
requirements, our business could be harmed.
We rely on a limited number of vendors to produce the ceramics
used in our products. For the year ended December 31, 2008,
three ceramics suppliers represented approximately 60% of our
purchases from all of our suppliers. For the year ended
December 31, 2007, two ceramics suppliers represented
approximately 52% of our purchases from all of our suppliers. If
any of our ceramic suppliers were to have financial
difficulties, cancel or materially change their commitments with
us or fail to meet the quality or delivery requirements needed
to satisfy customer orders for our products, we could lose
customer orders, be unable to develop or sell our products
cost-effectively or on a timely basis, if at all, and have
significantly decreased revenue, which would harm our business,
operating results and financial condition.
We
depend on single suppliers for some of our components, including
stainless steel castings. If our suppliers are not able to meet
our demand and/or requirements, our business could be
harmed.
We rely on single suppliers to produce all of our stainless
steel castings and some other components for use in our PX
products. Our reliance on single manufacturers for these parts
involves a number of significant risks, including reduced
control over delivery schedules, quality assurance,
manufacturing yields, production costs and lack of guaranteed
production capacity or product supply. We do not have a long
term supply agreement with these suppliers and instead secure
manufacturing availability on a purchase order basis. Our
suppliers have no obligation to supply products to us for any
specific period, in any specific quantity or at any specific
price, except as set forth in a particular purchase order. Our
requirements represent a small portion of the total production
capacities of these suppliers and our suppliers may reallocate
capacity to other customers, even during periods of high demand
for our products. We have in the past experienced and may in the
future experience quality control issues and delivery delays
with our suppliers due to factors such as high industry demand
or the inability of our vendors to consistently meet our quality
or delivery requirements. If our suppliers were to cancel or
materially change its commitment with us or fail to meet the
quality or delivery requirements needed to satisfy customer
orders for our products, we could lose time-sensitive customer
orders, be unable to develop or sell our products
cost-effectively or on a timely basis, if at all, and have
significantly decreased revenue, which would harm our business,
operating results and financial condition. We may qualify
additional suppliers in the future which would require time and
resources. If we do not qualify additional suppliers, we may be
exposed to increased risk of capacity shortages due to our
complete dependence on our current supplier.
We
face competition from a number of companies that offers
competing energy recovery solutions. If any of these companies
produces superior technology or offers more cost effective
products, our competitive position in the market could be harmed
and our profits may decline.
The market for energy recovery devices for desalination plants
is competitive and continually evolving. The PX device competes
with slow cycle isobaric, turbine and hydraulic energy recovery
devices. Our three primary competitors are Calder AG, Fluid
Equipment Development Company and Pump Engineering Incorporated.
Other potential competitors may enter the market. We expect
competition to persist and intensify as the desalination market
opportunity grows. Some of our current and potential competitors
may have significantly greater financial, technical, marketing
and other resources than we do and may be able to devote greater
resources to the development, promotion, sale and support of
their products. Also, our competitors may have more extensive
customer bases and broader customer relationships than we do,
including long-standing relationships or exclusive contracts
with our current or potential customers. For instance, we have
had difficulties penetrating some of the Caribbean markets
because Consolidated Water Co. Ltd., a major builder of seawater
reverse osmosis desalination plants in that area, has an
exclusive agreement with Calder AG to use Calders
technology. In addition, our competitors may have longer
operating histories and greater name recognition than we do. Our
competitors may be in a stronger position to respond quickly to
new technologies and may be able to market and sell their
products more effectively. Moreover, if one or more of our
competitors were to merge or partner with another of our
competitors or with current or potential customers,
9
the change in the competitive landscape could adversely affect
our ability to compete effectively which would affect our
business, operating results and financial condition.
We are
subject to risks related to product defects, which could lead to
warranty claims in excess of our warranty provisions or result
in a large number of warranty claims in any given
year.
We warranty our products for a period of one to two years and
provide a five year warranty for the ceramic components of our
products. We test our products in our manufacturing facilities
through a variety of means. However, there can be no assurance
that our testing will reveal latent defects in our products,
which may not become apparent until after the products have been
sold into the market. Accordingly, there is a risk that warranty
claims may be filed due to product defects. We may incur
additional operating expenses if our warranty provisions do not
reflect the actual cost of resolving issues related to defects
in our products. If these additional expenses are significant,
they could adversely affect our business, financial condition
and results of operations. While the number of warranty claims
has not been significant to date, we have offered a five year
warranty on our ceramic components for new sales agreements
executed after August 7, 2007. Accordingly, we cannot
quantify the error rate of the ceramic components of our
products with statistical accuracy and cannot assure that a
large number of warranty claims will not be filed in a given
year. As a result, our operating expenses may increase if a
large number of warranty claims are filed in any specific year,
particularly towards the end of any given warranty period.
If we
are unable to protect our technology or enforce our intellectual
property rights, our competitive position could be harmed and we
could be required to incur significant expenses to enforce our
rights.
Our competitive position depends on our ability to establish and
maintain proprietary rights in our technology and to protect our
technology from copying by others. We rely on trade secret,
patent, copyright and trademark laws and confidentiality
agreements with employees and third parties, all of which may
offer only limited protection. We hold five United States
patents and eleven patents outside the U.S. that are
counterparts to one of the U.S. patents. The expiration terms of
the U.S. patents range from 2011 to 2025, at which time we
could become more vulnerable to increased competition. In
addition, we have applied for two new United States patents and
seven pending international applications corresponding to the
U.S. patents and patent applications. We do not hold patents in
many of the countries into which we sell our PX devices,
including Saudi Arabia, Algeria and China, and accordingly, the
protection of our intellectual property in those countries may
be limited. We also do not know whether any of our pending
patent applications will result in the issuance of patents or
whether the examination process will require us to narrow our
claims, and even if patents are issued, they may be contested,
circumvented or invalidated. Moreover, while we believe our
remaining issued patents are essential to the protection of the
PX technology, the rights granted under any of our issued
patents or patents that may be issued in the future may not
provide us with proprietary protection or competitive
advantages, and, as with any technology, competitors may be able
to develop similar or superior technologies to our own now or in
the future. In addition, our granted patents may not prevent
misappropriation of our technology, particularly in foreign
countries where intellectual property laws may not protect our
proprietary rights as fully as those in the United States. This
may render our patents impaired or useless and ultimately expose
us to currently unanticipated competition. Protecting against
the unauthorized use of our products, trademarks and other
proprietary rights is expensive, difficult and, in some cases,
impossible. Litigation may be necessary in the future to enforce
or defend our intellectual property rights or to determine the
validity and scope of the proprietary rights of others. This
litigation could result in substantial costs and diversion of
management resources, either of which could harm our business.
Claims
by others that we infringe their proprietary rights could harm
our business.
Third parties could claim that our technology infringes their
proprietary rights. In addition, we may be contacted by third
parties suggesting that we obtain a license to certain of their
intellectual property rights they may believe we are infringing.
We expect that infringement claims against us may increase as
the number of products and competitors in our market increases
and overlaps occur. In addition, to the extent that we gain
greater visibility, we believe that we will face a higher risk
of being the subject of intellectual property
10
infringement claims. Any claim of infringement by a third party,
even those without merit, could cause us to incur substantial
costs defending against the claim, and could distract our
management from our business. Furthermore, a party making such a
claim, if successful, could secure a judgment that requires us
to pay substantial damages. A judgment against us could also
include an injunction or other court order that could prevent us
from offering our products. In addition, we might be required to
seek a license for the use of such intellectual property, which
may not be available on commercially reasonable terms, or at
all. Alternatively, we may be required to develop non-infringing
technology, which could require significant effort and expense
and may ultimately not be successful. Any of these events could
seriously harm our business. Third parties may also assert
infringement claims against our customers. Because we generally
indemnify our customers if our products infringe the proprietary
rights of third parties, any such claims would require us to
initiate or defend protracted and costly litigation on their
behalf, regardless of the merits of these claims. If any of
these claims succeeds, we may be forced to pay damages on behalf
of our customers.
If we
fail to expand our manufacturing facilities to meet our future
growth, our operating results could be adversely
affected.
Our existing manufacturing facilities are capable of meeting
current demand and demand for the foreseeable future. However,
the future growth of our business depends on our ability to
successfully expand our manufacturing, research and development
and technical testing facilities. Larger products currently
under development require a larger manufacturing facility with
greater capacity. We have entered into a 10 year lease for
a 124,000 square foot facility in San Leandro,
California. While this space will be available to accommodate
the consolidation of our U.S. operations and the expansion
of our manufacturing operations, the space is being built out
and will not be available until September 2009 or later. If the
build-out is delayed, our production capability could be
limited, which could adversely affect our operating results.
If we
need additional capital to fund future growth, it may not be
available on favorable terms, or at all.
We have historically relied on outside financing to fund our
operations, capital expenditures and expansion. In our initial
public offering in July 2008, we issued approximately
10,000,000 shares of common equity at $8.50 per share
before underwriting discount and issuing expenses. We may
require additional capital from equity or debt financing in the
future to fund our operations, or respond to competitive
pressures or strategic opportunities. We may not be able to
secure such additional financing on favorable terms, or at all.
The terms of additional financing may place limits on our
financial and operating flexibility. If we raise additional
funds through further issuances of equity, convertible debt
securities or other securities convertible into equity, our
existing stockholders could suffer significant dilution in their
percentage ownership of our company, and any new securities we
issue could have rights, preferences or privileges senior to
those of existing or future holders of our common stock,
including shares of common stock sold in this offering. If we
are unable to obtain necessary financing on terms satisfactory
to us, if and when we require it, our ability to grow or support
our business and to respond to business challenges could be
significantly limited.
If
foreign and local government entities no longer guarantee and
subsidize, or are willing to engage in, the construction and
maintenance of desalination plants and projects, the demand for
our products would decline and adversely affect our
business.
Our products are used in seawater reverse osmosis desalination
plants which are often times constructed and maintained through
government guarantees and subsidies. The rate of construction of
desalination plants depends on each governments
willingness and ability to allocate funds for such projects,
which may be affected by the current crisis in the financial
system and credit markets and the weak global economy. In
addition, some desalination projects in the Middle East and
North Africa have been funded by budget surpluses resulting from
once high crude oil and natural gas prices. Since prices for
crude oil and natural gas have fallen, governments in those
countries may not have budget surpluses to fund such projects
and may cancel such projects or divert funds allocated for them
to other projects. As a result, the demand for our products
could decline and negatively affect our revenue base, which
could harm the overall profitability of our business.
11
In addition, various water management agencies could alter
demand for fresh water by investing in water reuse initiatives
or limiting the use of water for certain agricultural purposes.
Certain uses of water considered to be wasteful could be
curtailed, resulting in more available water and less demand for
alternative solutions such as desalination.
Our
products are highly technical and may contain undetected flaws
or defects which could harm our business and our reputation and
adversely affect our financial condition.
The manufacture of our products is highly technical, and our
products may contain latent defects or flaws. We test our
products prior to commercial release and during such testing
have discovered and may in the future discover flaws and defects
that need to be resolved prior to release. Resolving these flaws
and defects can take a significant amount of time and prevent
our technical personnel from working on other important tasks.
In addition, our products have contained and may in the future
contain one or more flaws that were not detected prior to
commercial release to our customers. Some flaws in our products
may only be discovered after a product has been installed and
used by customers. Any flaws or defects discovered in our
products after commercial release could result in loss of
revenue or delay in revenue recognition, loss of customers and
increased service and warranty cost, any of which could
adversely affect our business, operating results and financial
condition. In addition, we could face claims for product
liability, tort or breach of warranty. Our contracts with our
customers contain provisions relating to warranty disclaimers
and liability limitations, which may not be upheld. Defending a
lawsuit, regardless of its merit, is costly and may divert
managements attention and adversely affect the
markets perception of us and our products. In addition, if
our business liability insurance coverage proves inadequate or
future coverage is unavailable on acceptable terms or at all,
our business, operating results and financial condition could be
harmed.
Our
international sales and operations subject us to additional
risks that may adversely affect our operating
results.
Historically, we have derived a significant portion of our
revenue from customers whose seawater reverse osmosis
desalination facilities utilizing the PX device are outside the
United States. Many of such customers projects are in
emerging growth countries with relatively young and unstable
market economies and volatile political environments. These
countries may also be affected significantly by the current
crisis in the global financial system and credit markets and the
weak global economy. We have sales and technical support
personnel stationed in Spain, Asia and the Middle East, among
other regions, and we expect to continue to add personnel in
other countries. As a result, any governmental changes or
reforms or disruptions in the business, regulatory or political
environments of the countries in which we operate or sell our
products could have a material adverse effect on our business,
financial condition and results of operations.
Sales of our products have to date been denominated principally
in U.S. dollars. The U.S. dollar has recently
strengthened against most other currencies, which has
effectively increased the price of our products in the currency
of the countries in which our customers are located. This may
result in our customers seeking lower-priced suppliers, which
could adversely impact our operating results. A larger portion
of our international revenue may be denominated in foreign
currencies in the future, which would subject us to increased
risks associated with fluctuations in foreign exchange rates.
Our international contracts and operations subject us to a
variety of additional risks, including:
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political and economic uncertainties, which the current global
economic crisis may exacerbate;
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reduced protection for intellectual property rights;
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trade barriers and other regulatory or contractual limitations
on our ability to sell and service our products in certain
foreign markets;
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difficulties in enforcing contracts, beginning operations as
scheduled and collecting accounts receivable, especially in
emerging markets;
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increased travel, infrastructure and legal compliance costs
associated with multiple international locations;
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competing with
non-U.S. companies
not subject to the U.S. Foreign Corrupt Practices Act;
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difficulty in attracting, hiring and retaining qualified
personnel; and
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increasing instability in the capital markets and banking
systems worldwide, especially in developing countries, that may
limit project financing availability for the construction of
desalination plants.
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As we continue to expand our business globally, our success will
depend, in large part, on our ability to anticipate and
effectively manage these and other risks associated with our
international operations. Our failure to manage any of these
risks successfully could harm our international operations and
reduce our international sales, which in turn could adversely
affect our business, operating results and financial condition.
Global
economic conditions and the current crisis in the financial
markets could have an adverse effect on our business and results
of operations.
Current economic conditions may negatively impact our business
and make forecasting future operating results more difficult and
uncertain. A weakening global economy may cause our customers to
delay or push out orders for our products or may result in the
delay, postponement or cancelling of planned or new desalination
projects or retrofits, which would reduce our revenue. Turmoil
in the financial and credit markets may also make it difficult
for our customers to obtain needed project financing, resulting
in lower sales. Negative economic conditions may also affect our
suppliers, which could impede their ability to remain in
business and supply us with parts, resulting in delays in the
availability of our products. In addition, most of our cash and
cash equivalents are currently invested in money market funds
backed by United States Treasury securities; however, given the
current weak global economy and the instability of financial
institutions, we cannot be assured that we will not experience
losses on our deposits, which would adversely affect our
financial condition. If current economic conditions persist or
worsen and negatively impact the desalination industry, our
business, financial condition or results of operations could be
materially and adversely affected.
If we
fail to manage future growth effectively, our business would be
harmed.
Future growth in our business, if it occurs, will place
significant demands on our management, infrastructure and other
resources. To manage any future growth, we will need to hire,
integrate and retain highly skilled and motivated employees. We
will also need to continue to improve our financial and
management controls, reporting and operational systems and
procedures. If we do not effectively manage our growth, our
business, operating results and financial condition would be
adversely affected.
Our
failure to achieve or maintain adequate internal control over
financial reporting in accordance with SEC rules or prevent or
detect material misstatements in our annual or interim
consolidated financial statements in the future could materially
harm our business and cause our stock price to
decline.
As a public company, SEC rules require that we maintain internal
control over financial reporting to provide reasonable assurance
regarding the reliability of financial reporting and preparation
of published financial statements in accordance with generally
accepted accounting principles. Accordingly, we will be required
to document and test our internal controls and procedures to
assess the effectiveness of our internal control over financial
reporting. In addition, our independent registered public
accounting firm will be required to report on the effectiveness
of our internal control over financial reporting. In the future,
we may identify material weaknesses and deficiencies which we
may not be able to remediate in a timely manner. Material
weaknesses may exist when we are first required to report on the
effectiveness of our internal control over financial reporting
in our Annual Report on
Form 10-K
for the year ending December 31, 2009. If there are
material weaknesses or deficiencies in our internal control, we
will not be able to conclude that we have maintained effective
internal control over financial reporting or our independent
registered public accounting firm may not be able to issue an
unqualified report on the effectiveness of our internal control
over financial reporting. As a result, our ability to report our
financial results on a timely and accurate basis may be
13
adversely affected and investors may lose confidence in our
financial information, which in turn could cause the market
price of our common stock to decrease. We may also be required
to restate our financial statements from prior periods. In
addition, testing and maintaining internal control will require
increased management time and resources. Any failure to maintain
effective internal control over financial reporting could impair
the success of our business and harm our financial results and
you could lose all or a significant portion of your investment.
If we have material weaknesses in our internal control over
financial reporting, the accuracy and timing of our financial
reporting may be adversely affected.
Changes
to financial accounting standards may affect our results of
operations and cause us to change our business
practices.
We prepare our financial statements to conform to generally
accepted accounting principles, or GAAP, in the United States.
These accounting principles are subject to interpretation by the
SEC and various other bodies. A change in those policies can
have a significant effect on our reported results and may affect
our reporting of transactions completed before a change is
announced. Changes to those rules or the interpretation of our
current practices may adversely affect our reported financial
results or the way we conduct our business.
We may
engage in future acquisitions that could disrupt our business,
cause dilution to our stockholders and harm our financial
condition and operating results.
In the future, we may acquire companies or assets that we
believe may enhance our market position. We may not be able to
find suitable acquisition candidates and we may not be able to
complete acquisitions on favorable terms, if at all. If we do
complete acquisitions, we cannot assure you that they will
ultimately strengthen our competitive position or that they will
not be viewed negatively by customers, financial markets or
investors. In addition, any acquisitions that we make could lead
to difficulties in integrating personnel and operations from the
acquired businesses and in retaining and motivating key
personnel from these businesses. Acquisitions may disrupt our
ongoing operations, divert management from day-to-day
responsibilities, increase our expenses and harm our operating
results or financial condition. Future acquisitions may reduce
our cash available for operations and other uses and could
result in an increase in amortization expense related to
identifiable assets acquired, potentially dilutive issuances of
equity securities or the incurrence of debt, any of which could
harm our business, operating results and financial condition.
Insiders
will continue to have substantial control over us after this
offering and will be able to influence corporate
matters.
Our directors and executive officers and their affiliates
beneficially own, in the aggregate, approximately 14% of our
outstanding common stock as of March 19, 2009. As a result,
these stockholders will be able to exercise significant
influence over all matters requiring stockholder approval,
including the election of directors and approval of significant
corporate transactions, such as a merger or other sale of our
company or its assets.
Anti-takeover
provisions in our charter documents and under Delaware law could
discourage, delay or prevent a change in control of our company
and may affect the trading price of our common
stock.
Provisions in our amended and restated certificate of
incorporation and bylaws may have the effect of delaying or
preventing a change of control or changes in our management. Our
amended and restated certificate of incorporation and amended
and restated bylaws include provisions that:
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authorize our board of directors to issue, without further
action by the stockholders, up to 10,000,000 shares of
undesignated preferred stock;
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require that any action to be taken by our stockholders be
effected at a duly called annual or special meeting and not by
written consent;
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specify that special meetings of our stockholders can be called
only by our board of directors, the chairman of the board, the
chief executive officer or the president;
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establish an advance notice procedure for stockholder approvals
to be brought before an annual meeting of our stockholders,
including proposed nominations of persons for election to our
board of directors;
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establish that our board of directors is divided into three
classes, Class I, Class II and Class III, with
each class serving staggered terms;
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provide that our directors may be removed only for cause;
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provide that vacancies on our board of directors may be filled
only by a majority vote of directors then in office, even though
less than a quorum;
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specify that no stockholder is permitted to cumulate votes at
any election of directors; and
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require a super-majority of votes to amend certain of the
above-mentioned provisions.
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In addition, we are subject to the provisions of
Section 203 of the Delaware General Corporation Law
regulating corporate takeovers. Section 203 generally
prohibits us from engaging in a business combination with an
interested stockholder subject certain exceptions.
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Item 1B.
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Unresolved
Staff Comments
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None.
We lease approximately 29,000 square feet of space in
San Leandro, California, under a lease that expires in June
2010, for product manufacturing, research and development and
executive headquarters. We also lease approximately
9,000 square feet for corporate office space in a building
located approximately two miles away from our headquarters under
a lease that expires in March 2010. In November 2008, we entered
into a 10 year lease for approximately 124,000 square
feet of space in a building located near our current
headquarters and scheduled for occupancy in late 2009. This new
building will house all of our manufacturing, research and
development and executive staff and allow for the expansion of
our manufacturing operations. We also lease sales offices in
Spain, the United Arab Emirates, China and Florida. We believe
these facilities will be adequate for our purposes for the
foreseeable future.
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Item 3.
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Legal
Proceedings
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We are not party to any material litigation, and we are not
aware of any pending or threatened litigation against us that we
believe would adversely affect our business, operating results,
financial condition or cash flows. In the future, we may be
subject to legal proceedings in the ordinary course of our
business.
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Item 4.
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Submission
of Matters to a Vote of Security Holders
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There were no submissions of matters to a vote of security
holders in the quarter ended December 31, 2008.
15
PART II
Item 5.
Market
for the Registrants Common Stock Equity, Related
Stockholder Matters and Issuer Purchases of Equity
Securities
Market
Information
Since July 2, 2008, our common stock has been quoted on the
Nasdaq Global Market under the symbol ERII.
The following table sets forth the high and low sales prices of
our common stock for the periods indicated.
|
|
|
|
|
|
|
|
|
|
|
High
|
|
|
Low
|
|
|
2008
|
|
|
|
|
|
|
|
|
Third Quarter (from July 2, 2008)
|
|
$
|
13.25
|
|
|
$
|
6.89
|
|
Fourth Quarter
|
|
$
|
10.12
|
|
|
$
|
4.57
|
|
Stockholders
As of March 24, 2009, there were approximately 75
stockholders of record of our common stock.
Use of
Proceeds
On July 1, 2008, our registration statement
(No. 333-150007)
on
Form S-1
was declared effective for our initial public offering, pursuant
to which we registered the offering and sale of an aggregate
16,100,000 shares of common stock, including the
underwriters over-allotment option, at a public offering
price of $8.50 per share, or aggregate offering price of
$136.9 million, of which $86.5 million related to
10,178,566 shares sold by us and $50.4 million related
to 5,921,434 shares sold by selling stockholders. The
offering closed on July 8, 2008 with respect to the primary
shares and on July 11, 2008 with respect to the
over-allotment shares. The managing underwriters were Citigroup
Global Markets Inc. and Credit Suisse Securities (USA) LLC.
As a result of the offering, we received net proceeds of
approximately $76.7 million, after deducting underwriting
discounts and commissions of $6.1 million and additional
offering-related expenses of approximately $3.7 million. No
payments for such expenses were made directly or indirectly to
(i) any of our officers or directors or their associates,
(ii) any persons owning 10% or more of any class of our
equity securities, or (iii) any of our affiliates. We
anticipate that we will use the remaining net proceeds from our
IPO for working capital and other general corporate purposes,
including to finance our growth, develop new products, fund
capital expenditures, or to expand our existing business through
acquisitions of other businesses, products or technologies.
However, we do not have agreements or commitments for
acquisitions at this time. Pending such uses, we have deposited
a substantial amount of the net proceeds in a U.S. Treasury
based money market fund as of December 31, 2008. There has
been no material change in the planned use of proceeds from our
IPO from that described in the final prospectus filed with the
SEC pursuant to Rule 424(b).
Dividend
Policy
We have never declared or paid any cash dividends on our capital
stock and we do not currently intend to pay any cash dividends
on our capital stock for the foreseeable future. We expect to
retain future earnings, if any, to fund the development and
growth of our business. Any future determination to pay
dividends on our capital stock will be, subject to applicable
law, at the discretion of our board of directors and will depend
upon, among other factors, our results of operations, financial
condition, capital requirements and contractual restrictions in
loan agreements or other agreements.
Stock
Performance Graph
The following graph shows the cumulative total shareholder
return of an investment of $100 on July 2, 2008 in
(i) our common stock and (ii) a selected group of peer
issuers (Peer Group) and (iii) on
June 30, 2008
16
in the Nasdaq Composite Index. The total return for our stock
and each index and peer group assumes the reinvestment of
dividends, although dividends have never been declared on our
stock, and is based on the returns of the component companies
weighted according to their capitalizations as of the end of
each quarterly period. The Nasdaq Composite Index tracks the
aggregate price performance of equity securities traded on the
Nasdaq. The Peer Group tracks the weighted average price
performance of equity securities of seven companies in our
industry, including Consolidated Water Company Limited,
Flowserve Corporation, Hyflux Ltd, Kurita Water Industries
Limited, Pentair Inc., Tetra Tech, Inc. and The Gorman-Rupp
Company. The returns of each component issuer of the Peer Group
is weighted according to the respective issuers stock
market capitalization at the beginning of each period for which
a return is indicated. Our stock price performance shown in the
graph below is not indicative of future stock price performance.
The following graph and its related information is not
soliciting material, is not deemed filed
with the SEC, and is not to be incorporated by reference into
any filing of the Company under the 1933 Act or
1934 Act, whether made before or after the date hereof and
irrespective of any general incorporation language contained in
such filing.
COMPARISON
OF 6 MONTH CUMULATIVE TOTAL RETURN*
Among
Energy Recovery Inc., The NASDAQ Composite Index
And A Peer Group
* $100 invested on 7/2/08 in
Energy Recovery, Inc. or peer group stock or on 6/30/08 in
index, including reinvestment of dividends. Fiscal year ending
December 31.
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|
|
|
|
|
|
|
|
|
6/30/08 or
|
|
|
|
|
|
|
7/2/08(1)
|
|
|
12/31/08
|
|
|
Energy Recovery, Inc.
|
|
|
100.00
|
|
|
|
77.11
|
|
NASDAQ Composite
|
|
|
100.00
|
|
|
|
67.14
|
|
Peer Group
|
|
|
100.00
|
|
|
|
62.14
|
|
|
|
|
(1)
|
|
The index measurement date is 6/30/08; stock measurement dates
are 7/2/08
|
Recent
Sales of Unregistered Securities
None.
17
Purchases
of Equity Securities by the Issuer and Affiliated
Purchasers
Stock repurchase activity during the three months ended
December 31, 2008 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Number of
|
|
|
Maximum Dollar
|
|
|
|
Total Number of
|
|
|
Average
|
|
|
Shares Purchased as
|
|
|
Value that May Yet
|
|
|
|
Shares
|
|
|
Price Paid
|
|
|
Part of Publicly
|
|
|
be Purchased Under
|
|
Period
|
|
Purchased(1)
|
|
|
per Share
|
|
|
Announced Programs
|
|
|
the Programs
|
|
|
October 1, 2008- October 31, 2008
|
|
|
1,667
|
|
|
$
|
0.25
|
|
|
|
|
|
|
$
|
|
|
November 1, 2008- November 30, 2008
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
$
|
|
|
December 1, 2008- December 31, 2008
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
1,667
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
The company exercised its rights to repurchase 1,667 unvested
shares related to the early exercise of stock options. The
unvested shares were repurchased from a shareholder in exchange
for cash and were cancelled upon completion of the repurchase.
|
|
|
Item 6.
|
Selected
Financial Data
|
The following selected financial data should be read in
conjunction with the Managements Discussion and
Analysis of Financial Condition and Results of Operations
and the financial statements and notes thereto included in this
Report on
Form 10-K.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008(1)
|
|
|
2007(1)
|
|
|
2006(1)
|
|
|
2005
|
|
|
2004
|
|
|
Consolidated Statement of Income Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
52,119
|
|
|
$
|
35,414
|
|
|
$
|
20,058
|
|
|
$
|
10,689
|
|
|
$
|
4,047
|
|
Cost of revenue(2)
|
|
|
18,933
|
|
|
|
14,852
|
|
|
|
8,131
|
|
|
|
4,685
|
|
|
|
2,015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
33,186
|
|
|
|
20,562
|
|
|
|
11,927
|
|
|
|
6,004
|
|
|
|
2,032
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative(2)
|
|
|
11,321
|
|
|
|
4,299
|
|
|
|
3,372
|
|
|
|
2,458
|
|
|
|
1,055
|
|
Sales and marketing(2)
|
|
|
6,549
|
|
|
|
5,230
|
|
|
|
3,648
|
|
|
|
1,779
|
|
|
|
1,037
|
|
Research and development(2)
|
|
|
2,415
|
|
|
|
1,705
|
|
|
|
1,267
|
|
|
|
630
|
|
|
|
340
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
20,285
|
|
|
|
11,234
|
|
|
|
8,287
|
|
|
|
4,867
|
|
|
|
2,432
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
12,901
|
|
|
|
9,328
|
|
|
|
3,640
|
|
|
|
1,137
|
|
|
|
(400
|
)
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(79
|
)
|
|
|
(105
|
)
|
|
|
(77
|
)
|
|
|
(216
|
)
|
|
|
(54
|
)
|
Interest and other income
|
|
|
873
|
|
|
|
517
|
|
|
|
58
|
|
|
|
35
|
|
|
|
1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before provision for income taxes
|
|
|
13,695
|
|
|
|
9,740
|
|
|
|
3,621
|
|
|
|
956
|
|
|
|
(453
|
)
|
Provision for income taxes
|
|
|
5,032
|
|
|
|
3,947
|
|
|
|
1,239
|
|
|
|
62
|
|
|
|
53
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
8,663
|
|
|
$
|
5,793
|
|
|
$
|
2,382
|
|
|
$
|
894
|
|
|
$
|
(506
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share-basic
|
|
$
|
0.19
|
|
|
$
|
0.15
|
|
|
$
|
0.06
|
|
|
$
|
0.02
|
|
|
$
|
(0.02
|
)
|
Earnings per share-diluted
|
|
$
|
0.18
|
|
|
$
|
0.14
|
|
|
$
|
0.06
|
|
|
$
|
0.02
|
|
|
$
|
(0.02
|
)
|
Number of shares used in per share calculations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
44,848
|
|
|
|
39,060
|
|
|
|
38,018
|
|
|
|
36,790
|
|
|
|
32,161
|
|
Diluted
|
|
|
47,392
|
|
|
|
41,433
|
|
|
|
40,244
|
|
|
|
38,454
|
|
|
|
32,161
|
|
18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31,
|
|
|
|
2008
|
|
|
2007(4)
|
|
|
2006(4)
|
|
|
2005
|
|
|
2004
|
|
|
Consolidated Balance Sheet Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash, cash equivalents and short-term investments
|
|
$
|
79,287
|
|
|
$
|
240
|
|
|
$
|
42
|
|
|
$
|
261
|
|
|
$
|
140
|
|
Total assets
|
|
|
120,612
|
|
|
|
28,227
|
|
|
|
17,937
|
|
|
|
8,496
|
|
|
|
3,054
|
|
Long-term liabilities
|
|
|
420
|
|
|
|
620
|
|
|
|
234
|
|
|
|
306
|
|
|
|
11
|
|
Total liabilities
|
|
|
13,613
|
|
|
|
8,166
|
|
|
|
9,810
|
|
|
|
3,794
|
|
|
|
2,061
|
|
Total stockholders equity
|
|
|
106,999
|
|
|
|
20,061
|
|
|
|
8,127
|
|
|
|
4,702
|
|
|
|
993
|
|
|
|
|
(1)
|
|
Effective January 1, 2006, we adopted the fair value
recognition provisions of Statement of Financial Accounting
Standards No. 123 (revised 2004),
Share-Based
Payment
, or SFAS 123(R), using the prospective
transition method, which requires the application of the
provisions of SFAS 123(R) only to share-based payment
awards granted, modified, repurchased or cancelled on or after
the modification date. Under this method, we recognize
stock-based compensation expense for all share-based payment
awards granted after December 31, 2005 in accordance with
SFAS 123(R).
|
|
(2)
|
|
Includes employee and non-employee stock-based compensation as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2004(3)
|
|
|
Cost of revenue
|
|
$
|
103
|
|
|
$
|
117
|
|
|
$
|
143
|
|
|
$
|
88
|
|
|
|
|
|
General and administrative
|
|
|
512
|
|
|
|
388
|
|
|
|
428
|
|
|
|
731
|
|
|
|
|
|
Sales and marketing
|
|
|
279
|
|
|
|
372
|
|
|
|
310
|
|
|
|
86
|
|
|
|
|
|
Research and development
|
|
|
140
|
|
|
|
159
|
|
|
|
183
|
|
|
|
98
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total stock-based compensation
|
|
$
|
1,034
|
|
|
$
|
1,036
|
|
|
$
|
1,064
|
|
|
$
|
1,003
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(3)
|
|
No stock-based compensation expense was recognized as we used
the intrinsic method of accounting and the options were granted
with an exercise price equal to the fair market value.
|
|
(4)
|
|
Certain prior period balances have been reclassified to conform
to the current period presentation.
|
|
|
Item 7.
|
Managements
Discussion and Analysis of Financial Condition and Results of
Operations
|
This Annual Report on
Form 10-K
and certain information incorporated by reference contain
forward-looking statements within the safe harbor
provisions of the Private Securities Litigation Reform Act of
1995. Forward-looking statements in this report include, but are
not limited to, statements about our expectations, objectives,
anticipations, plans, hopes, beliefs, intentions or strategies
regarding the future.
Forward-looking statements represent our current expectations
about future events and are based on assumptions and involve
risks and uncertainties. If the risks or uncertainties occur or
the assumptions prove incorrect, then our results may differ
materially from those set forth or implied by the
forward-looking statements. Our forward-looking statements are
not guarantees of future performance or events.
Forward-looking statements in this report include, without
limitation, statements about the following:
|
|
|
|
|
our belief that our PX devices make seawater reverse osmosis
a more affordable means of fresh water production;
|
|
|
our plan to enhance our existing PX devices and to develop
and manufacture new PX devices;
|
|
|
our plans to release the Titan and Comp PX devices in the
future;
|
|
|
our belief that our ceramics components are highly durable
and corrosion-proof;
|
|
|
our objective of finding new applications for our technology
outside of desalination and expanding and diversifying our
product offerings;
|
|
|
our plan to integrate vertically and manufacture a portion of
our ceramics components internally;
|
19
|
|
|
|
|
our expectation that our expenditures for research and
development will increase;
|
|
|
our expectation that we will continue to rely on sales of our
PX devices for a substantial portion of our revenue;
|
|
|
our expectation that a significant portion of our annual
sales will continue to occur during the fourth quarter;
|
|
|
our belief that our current facilities will be adequate
through 2009;
|
|
|
our expectation that sales outside of the United States will
remain a significant portion of our revenue;
|
|
|
our expectation that future sales and marketing expense will
increase;
|
|
|
our belief that our existing cash balances and cash generated
from our operations will be sufficient to meet our anticipated
capital requirements for at least the next 12 months;
and
|
|
|
our expectation that, as we expand our international sales, a
portion of our revenue could continue to be denominated in
foreign currencies.
|
All forward-looking statements included in this document are
subject to additional risks and uncertainties further discussed
under Item 1A: Risk Factors and are based on
information available to us as of March 26, 2009. We assume
no obligation to update any such forward-looking statements. It
is important to note that our actual results could differ
materially from the results set forth or implied by our
forward-looking statements. The factors that could cause our
actual results to differ from those included in such
forward-looking statements are set forth under the heading
Item 1A: Risk Factors, and our results
disclosed from time to time in our reports on
Forms 10-Q
and
8-K
and
our Annual Reports to Stockholders.
The following discussion should be read in conjunction with
our Consolidated Financial Statements and related notes included
elsewhere in this report.
Overview
We are in the business of designing, developing and
manufacturing energy recovery devices for sea water reverse
osmosis desalination. Our company was founded in 1992 and we
introduced the initial version of our energy recovery device,
the
PX
®
,
in early 1997. As of December 31, 2008, we had shipped
approximately 5,900 PX devices to desalination plants worldwide.
A majority of our net revenue has been generated by sales to
large engineering and construction firms, which are involved
with the design and construction of larger desalination plants.
Sales to these firms often involve a long sales cycle, which can
range from six to 16 months. A single large desalination
project can generate an order for numerous PX devices and
generally represents an opportunity for significant revenue. We
also sell PX devices to original equipment manufacturers, or
OEMs, which commission smaller desalination plants, order fewer
PX devices per plant and have shorter sales cycles.
Due to the fact that a single order for PX devices by a large
engineering and construction firm for a particular plant may
represent significant revenue, we often experience significant
fluctuations in net revenue from quarter to quarter. In
addition, our engineering and construction firm customers tend
to order a significant amount of equipment for delivery in the
fourth quarter and, as a consequence, a significant portion of
our annual sales typically occurs during that quarter.
A limited number of our customers accounts for a substantial
portion of our net revenue. Five customers accounted for
approximately 82% of our accounts receivable at December 31,
2008. As of December 31, 2007, three customers accounted
for approximately 74% of accounts receivable.
Revenue from customers representing 10% or more of total revenue
varies from year to year. For the year ended December 31,
2008, two customers, Hyflux Ltd. and Befesa Agua, S.A. and
affiliated joint ventures accounted for approximately 16% and
11% of our net revenue, respectively. For the year ended
December 31, 2007, three customers represented
approximately 20%, 23% and 13% of our net revenue
specifically Acciona Agua, Geida and its member companies, and
Doosan Heavy Industries, respectively. In 2006, two customers,
GE Water and Process Technologies (formerly GE Ionics) and
Geida, including its member companies, accounted for
approximately 18% and 11% of our net revenue, respectively. No
other customer
20
accounted for more than 10% of net revenue during any of these
periods. Geida is a consortium of Befesa Agua S.A., a subsidiary
of Abengoa S.A; Cobra-Tedagua, a subsidiary of ACS Actividades
de Construcción y Servicios, S.A.; and Sadyt S.A., a
subsidiary of Sacyr Vallehermoso, S. A.
During the years ended December 31, 2008, 2007 and 2006
most of our revenue was attributable to sales outside of the
United States. We expect sales outside of the United States to
remain a significant portion of our revenue for the foreseeable
future.
Our revenue is principally derived from the sales of our PX
devices. We receive a small amount of revenue from the sale of
high pressure circulation pumps, which we manufacture and sell
in connection with PX devices to smaller desalination plants. We
also receive incidental revenue from services, such as product
support, that we provide to our PX customers.
21
Critical
Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance
with generally accepted accounting principles in the United
States, or GAAP. These accounting principles require us to make
estimates and judgments that can affect the reported amounts of
assets and liabilities as of the date of the consolidated
financial statements as well as the reported amounts of revenue
and expense during the periods presented. We believe that the
estimates and judgments upon which we rely are reasonable based
upon information available to us at the time that we make these
estimates and judgments. To the extent there are material
differences between these estimates and actual results, our
consolidated financial results will be affected. The accounting
policies that reflect our more significant estimates and
judgments and which we believe are the most critical to aid in
fully understanding and evaluating our reported financial
results are revenue recognition, warranty costs, stock-based
compensation, inventory valuation, allowances for doubtful
accounts and income taxes.
Revenue
Recognition
We recognize revenue in accordance with SEC Staff Accounting
Bulletin No. 104,
Revenue Recognition
. Revenue
is recognized when the earnings process is complete, as
evidenced by an agreement with the customer, transfer of title
occurs, fixed pricing is determinable and collection is
reasonably assured. Transfer of title typically occurs upon
shipment of the equipment pursuant to a written purchase order
or contract. Emerging Issues Task Force
No. 00-21,
Revenue Arrangements with Multiple Deliverables
requires
us to allocate the purchase price between the device and the
value of the undelivered services by applying the residual value
method. Under this method, revenue allocated to undelivered
elements is based on vendor objective evidence of fair value of
such undelivered elements, and the residual revenue is allocated
to the delivered elements, assuming that the delivered elements
have stand-alone value. Vendor objective evidence of fair value
for such undelivered elements is based upon the price we charge
for such product or service when it is sold separately. We may
modify our pricing practices in the future, which could result
in changes to our vendor objective evidence of fair value for
such undelivered elements. Our purchase agreements typically
provide for the provision by us of field services and training
for commissioning of a desalination plant. Recognition of the
revenue in respect of those services is deferred until provision
of those services is complete. The services element of our
contracts represent an incidental portion of the total contract
price.
Under our revenue recognition policy, evidence of an arrangement
has been met when we have an executed purchase order or a
stand-alone contract. Typically, our smaller projects utilize
purchase orders that conform to our standard terms and
conditions that require the customer to remit payment generally
within 30 to 90 days from product delivery. In some cases,
if credit worthiness cannot be determined, prepayment is
required from the smaller customers.
For our large projects, stand-alone contracts are utilized. For
these contracts, consistent with industry practice, the
customers typically require their suppliers, including our
company, to accept contractual holdback provisions whereby the
final amounts due under the sales contract are remitted over
extended periods of time. These retention payments typically
range between 10% and 20%, and in some instances up to 30%, of
the total contract amount and are due and payable when the
customer is satisfied that certain specified product performance
criteria have been met upon commissioning of the desalination
plant, which in the case of our PX device may be 12 months
to 24 months from the date of product delivery as described
further below.
The specified product performance criteria for our PX device
generally pertains to the ability of our products to meet our
published performance specifications and warranty provisions,
which our products have demonstrated on a consistent basis. This
factor, combined with our historical performance metrics
measured over the past 10 years, provides us with a
reasonable basis to conclude that the PX device will perform
satisfactorily upon commissioning of the plant. To help ensure
this successful product performance, we provide service,
consisting principally of advisory, consulting and training
services to the customers during the commissioning of the plant.
The installation of the PX device is relatively simple, requires
no customization and is performed by the customer with the
consultation of our personnel. We defer the value of the service
and training component of the contract and recognize such
revenue as services are rendered. Based on these
22
factors, we have concluded that delivery and performance have
been completed when the product has been delivered (title
transfers) to the customer.
We perform an evaluation of credit worthiness on an individual
contract basis to assess whether collectability is reasonably
assured. As part of this evaluation, we consider many factors
about the individual customer, including the underlying
financial strength of the customer
and/or
partnership consortium and our prior history or industry
specific knowledge about the customer and its supplier
relationships. To date, we have been able to conclude that
collectability was reasonably assured on our sales contracts at
the time the product was delivered and title has transferred;
however, to the extent that we conclude that we are unable to
determine that collectability is reasonably assured at the time
of product delivery, we will defer all or a portion of the
contract amount based on the specific facts and circumstances of
the contract and the customer.
Under the stand-alone contracts, the usual payment arrangements
are summarized as follows:
|
|
|
|
|
An advance payment, typically 10% to 20% of the total contract
amount, is due upon execution of the contract;
|
|
|
|
A payment upon delivery of the product, typically in the range
of 50% to 70% of the total contract amount, is due on average
between 90 and 150 days from product delivery, and in some
cases up to 180 days;
|
|
|
|
A retention payment, typically in the range of 10% to 20%, and
in some cases up to 30%, of the total contract amount is due
subsequent to product delivery as described further below.
|
Under the terms of the retention payment component, we are
generally required to issue to the customer a product
performance guarantee in the form of an irrevocable standby
letter of credit, which is issued to the customer approximately
12 to 24 months after the product delivery date. The letter
of credit is either collateralized by restricted cash on deposit
with our financial institution (see Restricted Cash under
Summary of Significant Accounting Policies) or funds
available through a credit facility. The letter of credit
remains in place for the performance period as specified in the
contract, which is generally 12 to 36 months and, in some
cases, up to 65 months from issuance. The performance
period generally runs concurrent with our standard product
warranty period. Once the letter of credit has been put in
place, we invoice the customer for this final retention payment
under the sales contract. During the time between the product
delivery and the issuance of the letter of credit, the amount of
the final retention is classified on the balance sheet as
unbilled receivable, of which a portion may be classified as
long term to the extent that the billable period extends beyond
one year. Once the letter of credit is issued, we invoice the
customer and reclassify the retention amount from unbilled
receivable to accounts receivable where it remains until
payment, typically 90 to 150 days after invoicing, and in
some cases up to 180 days (see Note 3
Balance Sheet Information: Unbilled Receivables).
Shipping and handling charges billed to customers are included
in sales. The cost of shipping to customers is included in cost
of revenue.
We do not provide our customers with a right to return our
products. However, we accept returns of products that are deemed
to be damaged or defective when delivered, subject to the
provisions of the product warranty. Historically, product
returns have not been significant.
We sell our products to large engineering and construction firms
that are not subject to sales tax. Accordingly, the adoption of
EITF Issue
No. 06-3,
How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income
Statement (That is, Gross versus Net Presentation)
, does not
have an impact on our consolidated financial statements.
Warranty
Costs
We sell products with a limited warranty generally for a period
of one to two years. In August 2007, we modified the warranty to
offer a five-year term on the ceramic components for new sales
agreements executed after August 7, 2007. We accrue for
warranty costs based on estimated product failure rates,
historical activity and expectations of future costs. We
periodically evaluate and adjust the warranty costs to the
extent actual warranty costs vary from the original estimates.
23
We may offer extended warranties on an exception basis and these
are accounted for in accordance with Financial Accounting
Standards Board Technical
Bulletin 90-1,
Accounting for Separately Priced Extended Warranty and
Product Maintenance Contracts for Sales of Extended
Warranties
.
Stock-Based
Compensation
Prior to January 1, 2006, we accounted for stock-based
employee compensation arrangements in accordance with the
provisions of Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees
, or APB 25, and
FASB Interpretation No. 44,
Accounting for Certain
Transactions Involving Stock Compensation
, an Interpretation
of APB Opinion No. 25, or FIN 44, and had adopted the
disclosure provisions of Statement of Financial Accounting
Standards No. 123,
Accounting for Stock-Based
Compensation
, or SFAS 123, and SFAS No. 148,
Accounting for Share-Based Compensation
Transition and Disclosure
, or SFAS 148.
In February 2005, we offered to each of our employees the option
to borrow from us an amount equal to the aggregate exercise
price for all of their outstanding options pursuant to full
recourse promissory notes at 3.76% interest, which are due in
February 2010. The interest rate on the notes was deemed to be
below market rate, resulting in a change in the deemed exercise
price for the options. As a result, we are accounting for these
options as variable option awards. For 2008, 2007 and 2006, we
recorded $155,000, $783,000, and $1.1 million,
respectively, of stock-based compensation related to the options
exercised with promissory notes. All of our executive officers
and directors have subsequently repaid their notes.
Effective January 1, 2006, we adopted the fair value
recognition provisions of SFAS No. 123(R),
Share-Based Payment
, using the prospective transition
method, which requires us to apply the provisions of
SFAS 123(R) only to awards granted, modified, repurchased
or cancelled after the adoption date. Upon adoption of
SFAS 123(R), we selected the Black-Scholes option pricing
model as the most appropriate method for determining the
estimated fair value for stock-based awards. The Black-Scholes
model requires the use of highly subjective and complex
assumptions to determine the fair value of stock-based awards,
including the options expected term and the price
volatility of the underlying stock. The value of the portion of
the award that is ultimately expected to vest is recognized as
expense over the requisite vesting period on a straight-line
basis in our consolidated statements of income. SFAS 123(R)
requires forfeitures to be estimated at the time of grant and
revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. For the years ended
December 31, 2008, 2007 and 2006 we recognized stock-based
compensation under SFAS 123(R) and
EITF 96-18
related to employees and consultants of $879,000, $253,000 and
$13,000, respectively.
We use the Black-Scholes options pricing model to determine the
fair value of stock options. The determination of the fair value
of stock-based payment awards on the date of grant is affected
by stock price as well as assumptions regarding a number of
complex and subjective variables. These variables include
expected stock price volatility over the term of the awards,
actual and projected employee stock option exercise behaviors,
risk-free interest rates and expected dividends. The estimated
grant date fair values of the employee stock options were
calculated using the Black-Scholes options pricing model, based
on the following assumptions:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Expected term
|
|
|
5 years
|
|
|
|
5 years
|
|
|
|
5 years
|
|
Expected volatility
|
|
|
48%
|
|
|
|
50%
|
|
|
|
50%
|
|
Risk-free interest rate
|
|
|
1.55-3.41%
|
|
|
|
3.41-4.92%
|
|
|
|
4.45-5.10%
|
|
Dividend yield
|
|
|
0%
|
|
|
|
0%
|
|
|
|
0%
|
|
Expected Term.
Under our option plans, the expected term
of options granted is determined using the weighted average
period during which the stock options are expected to remain
outstanding and is based on the options vesting term,
contractual terms and disclosure information from similar
publicly traded companies
24
to develop reasonable expectations about future exercise
patterns and post-vesting employment termination behavior.
Expected Volatility.
Since we are a newly public entity
with limited historical data regarding the volatility of our
common stock price, the expected volatility used is based on
volatility of a representative industry peer group. In
evaluating similarity, we considered factors such as industry,
stage of life cycle and size.
Risk-Free Interest Rate.
The risk-free rate is based on
U.S. Treasury issues with remaining terms similar to the
expected term on the options.
Dividend Yield.
We have never declared or paid any cash
dividends and do not plan to pay cash dividends in the
foreseeable future, and, therefore, used an expected dividend
yield of zero in the valuation model.
Forfeitures.
SFAS No. 123R also requires us to
estimate forfeitures at the time of grant, and revise those
estimates in subsequent periods if actual forfeitures differ
from those estimates. We use historical data to estimate
pre-vesting option forfeitures and record stock-based
compensation expense only for those awards that are expected to
vest. All stock-based payment awards are amortized on a
straight-line basis over the requisite service periods of the
awards, which are generally the vesting periods. If our actual
forfeiture rate is materially different from our estimate, the
stock-based compensation expense could be significantly
different from what we have recorded in the current period.
The absence of an active market for our common stock prior to
July 2008 required management and the board of directors to
estimate the fair value of its common stock for purposes of
granting options and for determining stock-based compensation
expense for options granted prior to July 2008. In response to
these requirements, management and the board of directors
estimated the fair market value of common stock based on factors
such as the price of the most recent common stock sales to
investors, the valuations of comparable companies, the status of
development and sales efforts, our cash and working capital
amounts, revenue growth, and additional objective and subjective
factors relating to our business on an annual basis.
Stock-based compensation expense related to awards granted and
or modified to employees was allocated as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Cost of revenue
|
|
$
|
103
|
|
|
$
|
117
|
|
|
$
|
143
|
|
General and administrative
|
|
|
419
|
|
|
|
383
|
|
|
|
425
|
|
Sales and marketing
|
|
|
274
|
|
|
|
349
|
|
|
|
310
|
|
Research and development
|
|
|
140
|
|
|
|
159
|
|
|
|
183
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
936
|
|
|
$
|
1,008
|
|
|
$
|
1,061
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
To calculate the excess tax benefits available as of the date of
adoption for use in offsetting future tax shortfalls, we elected
the short-form method in accordance with FASB Staff
Position
FAS No. 123R-3,
Transition Election Related to Accounting for the Tax Effects
of Share-Based Payment Awards
.
Stock-Based
Compensation Non-Employees
We account for awards granted to non-employees other than
members of our board of directors in accordance with
SFAS 123 and the EITF Abstract
No. 96-18,
Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling
Goods or Services,
which require such awards to be recorded
at their fair value on the measurement date. The measurement of
stock-based compensation is subject to periodic adjustment as
the underlying awards vest. We amortize compensation expense
related to non-employee awards in accordance with FASB
Interpretation No. 28,
Accounting for Stock Appreciation
Rights and Other Variable Stock Option or Award Plans.
25
The fair value of stock options issued to consultants was
calculated using the Black-Scholes options pricing model, based
on the following assumptions:
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
2008
|
|
2007
|
|
2006
|
|
Expected term
|
|
1-10 years
|
|
1-10 years
|
|
10 years
|
Expected volatility
|
|
48%
|
|
50%
|
|
50%
|
Risk-free interest rate
|
|
1.55% 2.46%
|
|
3.45%-4.92%
|
|
4.70%
|
Dividend yield
|
|
0%
|
|
0%
|
|
0%
|
Stock-based compensation expense related to awards granted
and/or
modified to non-employees was allocated as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
General and administrative
|
|
$
|
93
|
|
|
$
|
23
|
|
|
$
|
|
|
Sales and marketing
|
|
|
5
|
|
|
|
5
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
98
|
|
|
$
|
28
|
|
|
$
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventories
Inventories are stated at the lower of cost (using the weighted
average cost method) or market. We calculate inventory reserves
for excess and obsolete inventories based on estimated future
demand of the products and spare parts. Cost of inventory is
determined in accordance with Statement of Financial Accounting
Standards No. 151,
Inventory Costs
, an amendment of
ARB No. 43, Chapter 4, or SFAS 151.
Allowances
for Doubtful Accounts
We record a provision for doubtful accounts based on our
historical experience and a detailed assessment of the
collectability of our accounts receivable. In estimating the
allowance for doubtful accounts, our management considers, among
other factors, (1) the aging of the accounts receivable,
(2) our historical
write-offs,
(3) the credit worthiness of each customer and
(4) general economic conditions. Our allowance for doubtful
accounts was $59,000, $121,000 and $230,000 as of
December 31, 2008, 2007 and 2006, respectively. If we were
to experience unanticipated collections issues, it could have an
adverse affect on our operating results in future periods.
Income
Taxes
We account for income taxes in accordance with
SFAS No. 109,
Accounting for Income Taxes
, or
SFAS 109, issued by the Financial Accounting Standards
Board, or FASB. SFAS 109 requires an entity to recognize
deferred tax liabilities and assets. Deferred tax assets and
liabilities are recognized for the future tax consequence
attributable to the difference between the tax bases of assets
and liabilities and their reported amounts in the financial
statements. Deferred tax assets and liabilities are measured
using the enacted tax rate expected to apply to taxable income
in the years in which those temporary differences are expected
to be recovered or settled. The effect on deferred tax assets
and liabilities of a change in tax rates is recognized in income
in the period that included the enactment date. Valuation
allowances are provided if, based upon the available evidence,
management believes it is more likely than not that some or all
of the deferred assets will not be realized or the use of prior
years net operating losses may be limited.
On July 13, 2006, the FASB issued Interpretation
No. 48,
Accounting for Uncertainty in Income
Taxes An Interpretation of FASB Statement
No. 109
, or FIN 48. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in any
entitys financial statements in accordance with
SFAS 109 and prescribes a recognition threshold and
measurement attributes for financial statement disclosure of tax
positions taken or expected to be taken on a tax return. Under
FIN 48, the impact of an uncertain income tax position on
the
26
income tax return must be recognized at the largest amount that
is more likely than not to be sustained upon audit by the
relevant taxing authority. An uncertain income tax position will
not be recognized if it has less than a 50% likelihood of being
sustained. Additionally, FIN 48 provides guidance on
de-recognition, classification, interest and penalties,
accounting in interim periods, disclosure and transition. We
adopted the provisions of FIN 48 on January 1, 2007.
Measurement under FIN 48 is based on judgment regarding the
largest amount that is greater than 50% likely of being realized
upon ultimate settlement with a taxing authority. The total
amount of unrecognized tax benefits as of the date of adoption
was immaterial. As a result of the implementation of
FIN 48, there was no change to our tax liability.
We adopted the accounting policy that interest recognized in
accordance with Paragraph 15 of FIN 48 and penalty
recognized in accordance with Paragraph 16 of FIN 48
are classified as part of income taxes. The amounts of interest
and penalty recognized in the statement of income and statement
of financial position for 2008 and 2007 were insignificant.
Our operations are subject to income and transaction taxes in
the United States and in foreign jurisdictions. Significant
estimates and judgments are required in determining our
worldwide provision for income taxes. Some of these estimates
are based on interpretations of existing tax laws or
regulations. The ultimate amount of tax liability may be
uncertain as a result.
We are subject to taxation in the U.S. and various states
and foreign jurisdictions. There are no ongoing examinations by
taxing authorities at this time. Our various tax years from 1995
through 2008 remain open in various taxing jurisdictions.
Results
of Operations
2008
Compared to 2007
The following table sets forth certain data from our historical
operating results as a percentage of revenue for the years
indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For The Year Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Increase (Decrease)
|
|
|
Results of Operations:*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
52,119
|
|
|
|
100.0%
|
|
|
$
|
35,414
|
|
|
|
100.0%
|
|
|
$
|
16,705
|
|
|
|
47.2%
|
|
Cost of revenue
|
|
|
18,933
|
|
|
|
36.3%
|
|
|
|
14,852
|
|
|
|
41.9%
|
|
|
|
4,081
|
|
|
|
27.5%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
33,186
|
|
|
|
63.7%
|
|
|
|
20,562
|
|
|
|
58.1%
|
|
|
|
12,624
|
|
|
|
61.4%
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
11,321
|
|
|
|
21.7%
|
|
|
|
4,299
|
|
|
|
12.1%
|
|
|
|
7,022
|
|
|
|
163.3%
|
|
Sales and marketing
|
|
|
6,549
|
|
|
|
12.6%
|
|
|
|
5,230
|
|
|
|
14.8%
|
|
|
|
1,319
|
|
|
|
25.2%
|
|
Research and development
|
|
|
2,415
|
|
|
|
4.6%
|
|
|
|
1,705
|
|
|
|
4.8%
|
|
|
|
710
|
|
|
|
41.6%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Operating Expenses
|
|
|
20,285
|
|
|
|
38.9%
|
|
|
|
11,234
|
|
|
|
31.7%
|
|
|
|
9,051
|
|
|
|
80.6%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
12,901
|
|
|
|
24.8%
|
|
|
|
9,328
|
|
|
|
26.3%
|
|
|
|
3,573
|
|
|
|
38.3%
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense & finance charges
|
|
|
(79
|
)
|
|
|
(0.2)%
|
|
|
|
(105
|
)
|
|
|
(0.3)%
|
|
|
|
(26
|
)
|
|
|
(24.8)%
|
|
Interest and other income
|
|
|
873
|
|
|
|
1.7%
|
|
|
|
517
|
|
|
|
1.5%
|
|
|
|
356
|
|
|
|
68.9%
|
|
Provision for income tax expense
|
|
|
5,032
|
|
|
|
9.7%
|
|
|
|
3,947
|
|
|
|
11.1%
|
|
|
|
1,085
|
|
|
|
27.5%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Income
|
|
$
|
8,663
|
|
|
|
16.6%
|
|
|
$
|
5,793
|
|
|
|
16.4%
|
|
|
$
|
2,870
|
|
|
|
49.5%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
*
|
|
Percentages may not add up to 100% due to rounding.
|
27
Net
Revenue
Our net revenue increased by $16.7 million, or 47%, to
$52.1 million for the year ended December 31, 2008
from $35.4 million for the year ended December 31,
2007. This increase was primarily due to higher sales of our
PX-220 device and the newly introduced PX-260 device. Greater
market acceptance of the PX devices and the overall growth of
the desalination market drove the increased demand for the
products. The net revenue increase from the higher sales volume
was offset in part by a decrease in our average unit selling
price of approximately 6%. For the year ended December 31,
2008, the sales of PX devices accounted for approximately 95% of
our revenue, pump sales accounted for approximately 3% and spare
parts and service accounted for 2%. For the year ended
December 31, 2007, the sales of PX devices accounted for
approximately 94% of revenue, pump sales accounted for
approximately 4%, and spare parts and service accounted for the
remainder.
The following geographic information includes net revenue to our
domestic and international customers based on the
customers requested delivery locations, except for certain
cases in which the customer directed us to deliver our products
to a location that differs from the known ultimate location of
use. In such cases, the ultimate location of use is reflected in
the table below instead of the delivery location. The amounts
below are in thousands, except percentage data.
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Domestic net revenue
|
|
$
|
3,517
|
|
|
$
|
2,125
|
|
International net revenue
|
|
|
48,602
|
|
|
|
33,289
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$
|
52,119
|
|
|
$
|
35,414
|
|
|
|
|
|
|
|
|
|
|
Revenue by country:
|
|
|
|
|
|
|
|
|
Algeria
|
|
|
24%
|
|
|
|
12%
|
|
Spain
|
|
|
16
|
|
|
|
35
|
|
China
|
|
|
11
|
|
|
|
8
|
|
United Arab Emirates
|
|
|
7
|
|
|
|
2
|
|
Saudi Arabia
|
|
|
*
|
|
|
|
13
|
|
Others
|
|
|
42
|
|
|
|
30
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100%
|
|
|
|
100%
|
|
|
|
|
|
|
|
|
|
|
* Less than 1%
The impact of the current global economic climate on future
demand for our products is uncertain. The weakening global
economy may cause our customers to delay or cancel plans for
future orders of our products.
Gross
Profit
Gross profit represents our net revenue less our cost of
revenue. Our cost of revenue consists primarily of raw
materials, personnel costs (including stock-based compensation),
manufacturing overhead, warranty costs, capital costs, excess
and obsolete inventory expense, and manufactured components. The
largest component of our cost of revenue is raw materials,
primarily ceramic materials, which we obtain from several
suppliers. For the year ended December 31, 2008, gross
profit as a percentage of net revenue was 63.7%, as compared to
58.1% for the year ended December 31, 2007. The increase in
gross margin as a percentage of revenue of 5.6% was comprised of
the following: (1) the reversal of a warranty provision in
the amount of $688,000, or 1.3% of revenue, related to the
cancellation of an extended product warranty contract and
(2) an increase in
28
PX-260 and PX-220 devices, which have higher margins than our
other product offerings, as a component of our sales mix in 2008
versus 2007.
Stock-based compensation expense included in the cost of revenue
was $103,000 for the year ended December 31, 2008 and
$117,000 for the year ended December 31, 2007.
Future gross profit is highly dependent on the product and
customer mix of our net revenues. Accordingly, we are not able
to predict our future gross profit levels with certainty.
General
and Administrative Expense
General and administrative expense increased by
$7.0 million, or 163%, to $11.3 million for the year
ended December 31, 2008 from $4.3 million for the year
ended December 31, 2007. As a percentage of net revenue,
general and administrative expense was 22% for the year ended
December 31, 2008 and 12% for the year ended
December 31, 2007. The increase of general and
administrative expense was attributable primarily to the
increase in general and administrative headcount and
professional services to support our growth in operations and to
support the requirements for operating as a public company. This
increase reflected in part the increase in general and
administrative employees to 34 at December 31, 2008 from 13
at December 31, 2007.
Of the $7.0 million increase in general and administrative
expense, $2.8 million was related to professional services,
$2.6 million was related to compensation and
employee-related benefits, $0.4 million was related to
Value Added Taxes (VAT), $0.6 million was related to
occupancy costs, $0.1 million related to export credit
insurance, $0.1 million related to bad debt expense and
$0.4 million related to other administrative costs.
Stock-based compensation expense included in general and
administrative expense was $512,000 for the year ended
December 31, 2008 and $388,000 for the year ended
December 31, 2007.
Sales and
Marketing Expense
Sales and marketing expense increased by $1.3 million, or
25%, to $6.5 million for the year ended December 31,
2008 from $5.2 million for the year ended December 31,
2007. This increase was primarily related to growth in our sales
that resulted in higher headcount with sales and marketing
employees increasing to 21 at December 31, 2008 from 17 at
December 31, 2007. In addition, our sales team is
compensated in part by commissions, resulting in increased sales
expense as our sales levels increase.
As a percentage of our net revenue, sales and marketing expense
decreased to 13% for the year ended December 31, 2008 from
15% for the year ended December 31, 2007. The decrease in
2008 was attributable primarily to the significant increase in
our net revenue that period, which grew at a greater rate than
our sales and marketing expense.
Of the $1.3 million net increase in sales and marketing
expense for the year ended December 31, 2008,
$1.1 million related to compensation, employee-related
benefits and commissions to outside sales representatives,
$0.2 million related to sales and marketing efforts.
Stock-based compensation expense included in sales and marketing
expense was $279,000 for the year ended December 31, 2008
and $372,000 for the year ended December 31, 2007.
We expect that our future sales and marketing expense will
increase in absolute dollars as our revenue increases.
Research
and Development Expense
Research and development expense increased by $710,000, or 42%,
to $2.4 million for the year ended December 31, 2008
from $1.7 million for the year ended December 31,
2007. Of the $710,000 increase, compensation and
employee-related benefits accounted for $340,000, consulting and
professional service fees accounted for $160,000, research and
development direct project costs accounted for $190,000, and
occupancy and other miscellaneous costs accounted for $20,000.
29
Headcount in our research and development department increased
to eight at December 31, 2008 from six at December 31,
2007. Stock-based compensation expense included in research and
development expense was $140,000 for year ended
December 31, 2008 and $159,000 for the year ended
December 31, 2007.
We anticipate that our research and development expenditures
will increase in the future as we expand and diversify our
product offerings.
Other
Income (Expense), Net
Other net income (expense) increased by $382,000 to $794,000 for
the year ended December 31, 2008 from $412,000 for the year
ended December 31, 2007. The increase from 2007 to 2008 was
primarily due to higher interest earnings of $486,000 resulting
from IPO net proceeds of $76.7 million received in July 2008 and
by a decrease in net interest expense of $27,000 resulting from
the reduction of equipment loans outstanding. The increase was
in part offset by a reduction in foreign currency transaction
gains in the amount of $131,000 related to accounts receivable
denominated in foreign currencies.
2007
Compared to 2006
The following table sets forth certain data from our historical
operating results as a percentage of revenue for the years
indicated:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Year Ended December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
Increase(decrease)
|
|
|
Results of Operations:*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
35,414
|
|
|
|
100.0%
|
|
|
$
|
20,058
|
|
|
|
100.0%
|
|
|
$
|
15,356
|
|
|
|
76.6%
|
|
Cost of revenue
|
|
|
14,852
|
|
|
|
41.9%
|
|
|
|
8,131
|
|
|
|
40.5%
|
|
|
|
6,721
|
|
|
|
82.7%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
20,562
|
|
|
|
58.1%
|
|
|
|
11,927
|
|
|
|
59.5%
|
|
|
|
8,635
|
|
|
|
72.4%
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
4,299
|
|
|
|
12.1%
|
|
|
|
3,372
|
|
|
|
16.8%
|
|
|
|
927
|
|
|
|
27.5%
|
|
Sales and marketing
|
|
|
5,230
|
|
|
|
14.8%
|
|
|
|
3,648
|
|
|
|
18.2%
|
|
|
|
1,582
|
|
|
|
43.4%
|
|
Research and development
|
|
|
1,705
|
|
|
|
4.8%
|
|
|
|
1,267
|
|
|
|
6.3%
|
|
|
|
438
|
|
|
|
34.6%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Operating Expenses
|
|
|
11,234
|
|
|
|
31.7%
|
|
|
|
8,287
|
|
|
|
41.3%
|
|
|
|
2,947
|
|
|
|
35.6%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
9,328
|
|
|
|
26.3%
|
|
|
|
3,640
|
|
|
|
18.1%
|
|
|
|
5,688
|
|
|
|
156.3%
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense & finance charges
|
|
|
(105
|
)
|
|
|
(0.3)%
|
|
|
|
(77
|
)
|
|
|
(0.4)%
|
|
|
|
28
|
|
|
|
36.4%
|
|
Interest and other income
|
|
|
517
|
|
|
|
1.5%
|
|
|
|
58
|
|
|
|
0.3%
|
|
|
|
459
|
|
|
|
791.4%
|
|
Provision for income tax expense
|
|
|
3,947
|
|
|
|
11.1%
|
|
|
|
1,239
|
|
|
|
6.2%
|
|
|
|
2,708
|
|
|
|
218.6%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Income
|
|
$
|
5,793
|
|
|
|
16.4%
|
|
|
$
|
2,382
|
|
|
|
11.9%
|
|
|
$
|
3,411
|
|
|
|
143.2%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* Percentages may not add up to 100% due to rounding.
Net
Revenue
Our net revenue increased by $15.4 million, or 77%, to
$35.4 million in 2007 from $20.1 million in 2006.
These increases were principally due to higher sales of our
PX-220 device, which resulted primarily from increased market
acceptance of the device and the overall growth of the
desalination market. Prices were relatively constant for our PX
devices in 2007 and 2006. For the year ended December 31,
2007, the sales of PX devices accounted for approximately 94% of
revenue, pump sales accounted for approximately 4%, and spare
parts and service accounted for the remainder. For the year
ended December 31, 2006, the sales of PX devices accounted
for approximately 92% of revenue, pump sales accounted for
approximately 4%, and spare parts and service accounted for the
remainder.
30
The following geographic information includes net revenue to our
domestic and international customers based on the
customers requested delivery locations, except for certain
cases in which the customer directed us to deliver our products
to a location that differs from the known ultimate location of
use. In such cases, the ultimate location of use is reflected in
the table below instead of the delivery location. The amounts
below are in thousands, except percentage data.
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
|
2007
|
|
|
2006
|
|
|
Domestic net revenue
|
|
$
|
2,125
|
|
|
$
|
1,003
|
|
International net revenue
|
|
|
33,289
|
|
|
|
19,055
|
|
|
|
|
|
|
|
|
|
|
Total net revenue
|
|
$
|
35,414
|
|
|
$
|
20,058
|
|
|
|
|
|
|
|
|
|
|
Revenue by country:
|
|
|
|
|
|
|
|
|
Algeria
|
|
|
12%
|
|
|
|
30%
|
|
Spain
|
|
|
35
|
|
|
|
9
|
|
China
|
|
|
8
|
|
|
|
5
|
|
United Arab Emirates
|
|
|
2
|
|
|
|
10
|
|
Saudi Arabia
|
|
|
13
|
|
|
|
*
|
|
Others
|
|
|
30
|
|
|
|
46
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100%
|
|
|
|
100%
|
|
|
|
|
|
|
|
|
|
|
* Less than 1%.
Gross
Profit
Gross profit represents our net revenue less our cost of
revenue. Our cost of revenue consists primarily of raw
materials, personnel costs (including stock-based compensation),
manufacturing overhead, warranty costs, capital costs, excess
and obsolete inventory expense, and manufactured components. The
largest component of our cost of revenue is raw materials,
principally ceramic materials, which we obtain from several
suppliers. Gross profit, as a percentage of net revenue,
remained relatively constant at 58.1% in 2007 as compared to
59.5% in 2006. Stock compensation expense included in cost of
revenue was $117,000 in 2007 and $143,000 in 2006.
General
and Administrative Expense
General and administrative expense increased by $927,000, or
28%, to $4.3 million in 2007 from $3.4 million in
2006. These increases reflected in part the increase in general
and administrative employees to 13 at December 31, 2007
from eight at December 31, 2006.
As a percentage of our net revenue, general and administrative
expense was 12% in 2007 and 17% in 2006. The decrease of general
and administrative expense as a percentage of net revenue was
attributable principally to the significant increases in our net
revenue.
The primary reason for the increase in general and
administrative expense was the growth in our operations that
resulted in higher headcount including the recruitment of an
officer, renting of additional facility space, increased travel
and increased bank fees. With respect to the $927,000 increase
in such expense in 2007, $513,000 related to compensation,
employee-related benefits and professional services fees,
$139,000 related to bank charges, $46,000 related to office
supplies and equipment, $89,000 related to occupancy costs, and
$324,000 related to other expense (general recruiting, patent
amortization and travel), offset by $184,000 related to bad
debt. Stock-based compensation expense included in general and
administrative expense was $388,000 in 2007 and $428,000 in 2006.
31
Sales and
Marketing Expense
Sales and marketing expense increased by $1.6 million, or
43%, to $5.2 million in 2007 from $3.6 million in
2006. These increases were primarily related to growth in our
sales that resulted in higher headcount with sales and marketing
employees increasing to 17 at December 31, 2007 from six at
December 31, 2006. In addition, our sales team is
compensated in part by commissions, resulting in increased sales
expense as our sales levels increase.
As a percentage of our net revenue, sales and marketing expense
decreased to 15% in 2007 from 18% in 2006. The decrease in 2007
was attributable principally to the significant increase in our
net revenue that year, which grew at a greater rate than our
sales and marketing expense.
With respect to the $1.6 million increase in sales and
marketing expense in 2007, $0.7 million of such increase
related to compensation and employee related benefits,
$0.3 million related to consultant fees, $0.2 million
related to travel and related expense, $0.2 million related
to increased occupancy costs and $0.2 million related to
sales and marketing efforts. Stock-based compensation expense
included in sales and marketing expense was $372,000 in 2007 and
$310,000 in 2006.
Research
and Development Expense
Research and development expense increased by $438,000, or 35%,
to $1.7 million in 2007 from $1.3 million in 2006. As
a percentage of our net revenue, research and development
expense decreased to 5% in 2007 from 6% in 2006.
Compensation, employee-related benefits, consulting services and
depreciation of development equipment accounted for $151,000 of
the $438,000 increase from 2006 to 2007. The remainder of the
increase in 2007 was attributable to $173,000 in product
development costs and $114,000 in travel and other expense.
Stock-based compensation expense included in research and
development expense was $159,000 in 2007 and $183,000 in 2006.
Other
Income (Expense), Net
Other income (expense), net increased by $431,000 to $412,000 in
2007 from $(19,000) in 2006. The increase in net interest and
other income from 2006 to 2007 was primarily attributable to
gains on foreign currency transactions of $355,000 in 2007 and
higher average cash balances, which resulted in higher interest
income in 2007.
Liquidity
and Capital Resources
Our primary source of cash historically has been proceeds from
the issuance of common stock, customer payments for our products
and services, and borrowings under our credit facility. From
January 1, 2005 through December 31, 2008, we issued
common stock for aggregate net proceeds of $83.3 million,
excluding common stock issued in exchange for promissory notes.
The proceeds from the sales of common stock have been used to
fund our operations and capital expenditures.
As of December 31, 2008, our principal sources of liquidity
consisted of cash and cash equivalents of $79.3 million,
which are invested primarily in money market funds, and accounts
receivable of $20.6 million. In July 2008, we received
approximately $76.7 million of net proceeds from the IPO.
On March 27, 2008 we entered into a new credit agreement
(credit agreement) with our existing financial
institution that replaced a $2.0 million credit facility
and $3.5 million revolving note. In September 2008 and
December 2008, we modified the credit agreement to increase
the allowable borrowings on the credit facility and to extend
the credit facility term. The modified credit agreement allows
borrowings of up to $12.0 million on a revolving basis at
LIBOR plus 2.75%, expires on March 31, 2009 and is secured
by our accounts receivable, inventories, property, equipment and
other intangibles except intellectual property. We are subject
to certain financial and administrative covenants under the new
credit agreement. As of December 31, 2008, we were
non-compliant with one financial covenant related to financial
reporting. In January 2009, the
32
lender granted a waiver for this non-compliance. There were no
outstanding borrowings under the credit agreement as of
December 31, 2008.
During the years ended December 31, 2008 and 2007, we
provided certain customers with irrevocable standby letters of
credit to secure our obligations for the delivery and
performance of products in accordance with sales arrangements.
These letters of credit were issued largely under our revolving
note credit facility in 2007 and our credit agreement in 2008.
The letters of credit generally terminate within 12 to
36 months, and in some cases up to 65 months from
issuance. At December 31, 2008, the amounts outstanding on
the letters of credit totaled approximately $8.7 million of
which $8.4 million were issued under our credit agreement.
In February 2009, the Company terminated the March 2008 credit
agreement. As a result, the Company transferred
$9.1 million in cash to a restricted cash account as
collateral for outstanding irrevocable standby letters of credit
that were collateralized by the credit agreement as of the date
of termination.
In January 2009, the Company entered into a new loan and
security agreement with another financial institution which
became effective in February 2009 and provides a total available
credit line of $15.0 million. Under this new agreement, the
Company is allowed to draw advances up to $10.0 million on
a revolving line of credit or utilize up to $14.8 million
as collateral for irrevocable standby letters of credit,
provided that the aggregate of the advances and the collateral
do not exceed $15.0 million. Advances under the revolving
line of credit incur interest based on either a prime rate index
or LIBOR plus 1.375%. The new loan and security agreement
expires on December 31, 2009 and is collateralized by
substantially all of the Companys assets. The Company is
subject to certain financial and administrative covenants under
this new agreement.
We have unbilled receivables pertaining to customer contractual
holdback provisions, whereby we invoice the final installment
due under a sales contract 12 to 24 months after the
product has been shipped to the customer and revenue has been
recognized. Long-term unbilled receivables as of
December 31, 2008 consisted of unbilled receivables from
customers due more than one year subsequent to period end. The
customer holdbacks represent amounts intended to provide a form
of security for the customer rather than a form of long-term
financing; accordingly, these receivables have not been
discounted to present value. At December 31, 2008, we had
$4.9 million of current unbilled receivables and
$1.9 million of non-current unbilled receivables. At
December 31, 2007, we had $1.7 million of current
unbilled receivables and $2.5 million of non-current
unbilled receivables.
On March 28, 2007, we entered into a $1.0 million
equipment promissory note. The equipment promissory note bears
an interest rate of cost of funds plus 2.75% and matures in
September 2012. The amounts outstanding on the equipment
promissory note as of December 31, 2008 and 2007 was
$468,000 and $596,000, respectively. The interest rate for the
equipment promissory note at December 31, 2008 and 2007 was
7.81%.
On December 1, 2005, we entered into a $222,000 fixed
rate-installment note, or fixed note, with maturity date of
December 15, 2010. The fixed note bears an annual interest
rate of 10%. These notes are secured by our accounts receivable,
inventories, property, equipment and other general intangibles
except for intellectual property. The amounts outstanding on the
fixed note as of December 31, 2008 and 2007 was $89,000 and
$133,000, respectively. In February 2009, the Company paid the
remaining balance of the fixed promissory note for a total of
$83,000, including accrued interest.
Cash
Flows from Operating Activities
Net cash provided by (used in) operating activities was
$1.4 million and $(2.8) million for the years ended
December 31, 2008 and 2007, respectively. For the years
ended December 31, 2008 and 2007, cash provided by net
income of $8.7 million and $5.8 million, respectively,
was adjusted to $10.1 million and $7.6 million,
respectively, by non-cash items (depreciation, amortization,
unrealized gains and losses on foreign exchange, stock-based
compensation, provisions for doubtful accounts, warranty
reserves and excess and obsolete inventory) totaling
$1.4 million and $1.8 million, respectively. The net
cash outflow effect from changes in assets and liabilities was
$(8.7) million and $(10.4) million for the year ended
December 31, 2008 and 2007, respectively. Net changes in
assets and liabilities are primarily attributable to increases
in inventory
33
as a result of the growth of our business, changes in accounts
receivable, unbilled receivables as a result of timing of
invoices and collections for large projects, and changes in
prepaid expenses and accrued liabilities as a result of the
timing of payments to employees, vendors and other third parties.
Net cash provided by (used in) operating activities was
$(2.8) million and $822,000 for 2007 and 2006,
respectively. The $3.7 million increase in net cash used in
operating activities from 2006 to 2007 was primarily
attributable to increases in receivables and inventory and
decreases in deferred revenue billings.
Within changes in assets and liabilities, changes in accounts
and unbilled receivables used $(5.7) million in cash in
2007 compared to $(7.6) million used in 2006 due to the
timing of invoices for large projects at the end of 2007, along
with a 77%, or $15.4 million, increase in net sales for the
year. Changes in inventory used $(2.0) million in cash in
2007 compared to $(960,000) in 2006 primarily as a result of the
growth of our business. Changes in accounts payable provided
$583,000 in 2007 compared to $270,000 in 2006 due to the timing
of payments. Changes in accrued liabilities (including income
taxes) used $(29,000) in cash in 2007 compared to provided
$2.3 million in 2006, primarily due to timing of payments.
Lastly, decreases in deferred revenue used ($2.9) million
in cash in 2007 compared to provided $4.0 million in 2006,
primarily due to an increase in revenue recognized on product
deliveries previously billed in advance.
Cash
Flows from Investing Activities
Cash flows used in investing activities primarily relate to
capital expenditures to support our growth, as well as increases
in our restricted cash used to collateralize our letters of
credit.
Net cash provided by (used in) investing activities was $650,000
and $(2.0) million for the years ended December 31,
2008, and 2007, respectively. The increase in net cash provided
by investing activities was primarily attributable to the
release of restricted cash of $1.3 million in 2008 compared
to an increase in restricted cash of $1.0 million in 2007.
The remaining portion of the increase resulted from a reduction
in property and equipment purchases of $251,000.
Net cash (used in) investing activities was $(2.0) million
in 2007 and $(511,000) in 2006. $1.0 million of the
increase in net cash used in investing activities from 2006 to
2007 was attributable to the increase in restricted cash
balances and the balance of the increase was due largely to an
increase in purchases of property and equipment in 2007 compared
to 2006.
Cash
Flows from Financing Activities
Net cash provided by financing activities increased
$72.0 million to $77.1 million for the year ended
December 31, 2008 from $5.1 million for the year ended
December 31, 2007. The $72.0 million increase in cash
flows from financing activities is primarily attributable to the
receipt of net proceeds of $76.7 million from the sale of common
stock in our IPO during the year ended December 31, 2008
versus the receipt of net proceeds of $5.0 million from a
private placement of common stock and $143,000 from the exercise
of warrants during the year ended December 31, 2007.
Additionally, repayments of promissory notes by stockholders
increased $551,000 for the year ended December 31, 2008
over 2007.
Net cash provided by financing activities was $5.1 million
in 2007 and net cash used was $(530,000) in 2006. The increase
in net cash provided by financing activities in 2007 from 2006
was primarily attributable to our issuance of common stock in a
private placement.
We believe that our existing cash balances and cash generated
from our operations will be sufficient to meet our anticipated
capital requirements for at least the next 12 months.
However, we may need to raise additional capital or incur
additional indebtedness to continue to fund our operations in
the future. Our future capital requirements will depend on many
factors, including our rate of revenue growth, if any, the
expansion of our sales and marketing and research and
development activities, the timing and extent of our expansion
into new geographic territories, the timing of introductions of
new products and the continuing market acceptance of our
products. Although we currently are not a party to any agreement
or letter of intent with respect to potential material
investments in, or acquisitions of, complementary businesses,
services or
34
technologies, we may enter into these types of arrangements in
the future, which could also require us to seek additional
equity or debt financing. Additional funds may not be available
on terms favorable to us or at all.
Contractual
Obligations
We lease facilities under fixed non-cancelable operating leases
that expire on various dates through 2019. In the course of our
normal operations, we also entered into purchase commitments
with our suppliers for various key raw materials and component
parts. The purchase commitments covered by these arrangements
are subject to change based on our sales forecasts for future
deliveries.
The following is a summary of our contractual obligations as of
December 31, 2008 (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period
|
|
|
|
|
|
|
|
|
|
Less than
|
|
|
|
|
|
|
|
|
More than
|
|
|
|
|
|
|
Total
|
|
|
1 Year
|
|
|
1-3 Years
|
|
|
3-5 Years
|
|
|
5 Years
|
|
|
|
|
|
Notes payable
|
|
$
|
557
|
|
|
$
|
172
|
|
|
$
|
300
|
|
|
$
|
85
|
|
|
$
|
|
|
|
|
|
|
Operating lease obligations (1)
|
|
|
15,828
|
|
|
|
4,050
|
|
|
|
2,501
|
|
|
|
2,282
|
|
|
|
6,995
|
|
|
|
|
|
Capital lease obligations (including interest) (2)
|
|
|
72
|
|
|
|
43
|
|
|
|
29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contractual purchase obligations
|
|
|
250
|
|
|
|
|
|
|
|
250
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
16,707
|
|
|
$
|
4,265
|
|
|
$
|
3,080
|
|
|
$
|
2,367
|
|
|
$
|
6,995
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Includes $3 million for obligations related to tenant
improvement costs. Estimates for such costs range from $2
million to $3 million and are expected to be realized in
less than one year.
|
(2) Present value of net minimum capital lease payments is
$64, as reflected on the balance sheet.
This table excludes agreements with guarantees or indemnity
provisions that we have entered into with customers and others
in the ordinary course of business. Based on our historical
experience and information known to us as of December 31,
2008, we believe that our exposure related to these guarantees
and indemnities as of December 31, 2008 was not material.
Supplier
Concentration
Certain of the raw materials and components that we use in the
manufacturing of our products are available from a limited
number of suppliers. We do not enter into long-term supply
contracts with these suppliers. For instance, we purchase the
ceramic components for the PX device pursuant to standard
purchase orders that specify the quantity and price of various
component parts to be delivered over a three-month period. We
then update the pricing and quantity of our purchase orders
based upon our most current forecast on a quarterly basis.
Shortages could occur in these essential materials and
components due to an interruption of supply or increased demand
in the industry. If we are unable to procure certain of such
materials or components, we would be required to reduce our
manufacturing operations, which could have a material adverse
effect on our results of operations.
For the year ended December 31, 2008, four suppliers (of
which three were ceramics suppliers) represented approximately
72% of our total purchases. For the years ended 2007 and 2006,
three suppliers (of which two were ceramics suppliers)
represented approximately 66% and 71%, respectively, of our
total purchases. As of December 31, 2008 and 2007,
approximately 68% and 60%, respectively, of our accounts payable
were due to these suppliers.
Off-Balance
Sheet Arrangements
During the periods presented, we did not have any relationships
with unconsolidated entities or financial partnerships, such as
entities often referred to as structured finance or special
purpose entities, which would have been established for the
purpose of facilitating off-balance sheet arrangements or other
contractually narrow or limited purpose.
35
Recent
Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements
, or SFAS 157. SFAS 157
defines fair value, establishes a framework for measuring fair
value, and enhances fair value measurement disclosure. In
February 2008, the FASB issued FASB Staff Position
157-1,
Application of FASB Statement No. 157 to FASB Statement
No. 13 and Other Accounting Pronouncements That Address
Fair Value Measurements for Purposes of Lease Classification or
Measurement under Statement 13, or
FSP 157-1,
and
FSP 157-2,
Effective Date of FASB Statement No. 157, or
FSP 157-2.
FSP 157-1
amends SFAS 157 to remove certain leasing transactions from
its scope.
FSP 157-2
delays the effective date of SFAS 157 for all non-financial
assets and non-financial liabilities, except for items that are
recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually), until the
beginning of the first quarter of 2009. The measurement and
disclosure requirements related to financial assets and
financial liabilities are effective for us beginning in the
first quarter of 2008. The adoption of SFAS 157 for
financial assets and financial liabilities in the three months
ended March 31, 2008 did not have a significant impact on
our consolidated financial statements. We are currently
evaluating the impact that SFAS 157 will have on our
consolidated financial statements when it is applied to
non-financial assets and non-financial liabilities beginning in
the first quarter of 2009.
In February 2007, the FASB issued SFAS No. 159,
The
Fair Value Option for Financial Assets and Financial
Liabilities
, or SFAS 159. SFAS 159 permits
companies to choose to measure certain financial instruments and
other items at fair value. The standard requires that unrealized
gains and losses are reported in earnings for items measured
using the fair value option. SFAS 159 is effective for us
beginning in the first quarter of 2008. The adoption of
SFAS 159 did not have an impact on our consolidated
financial statements.
In December 2007, the SEC issued SAB 110 to amend the
SECs views discussed in SAB 107 regarding the use of
the simplified method in developing an estimate of expected life
of share options in accordance with SFAS 123R. SAB 110
is effective for us beginning in the first quarter of 2008. As
of December 31, 2007, we did not use the simplified method
and the adoption of SAB 107, as amended by SAB 110,
did not have an impact on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141
(revised 2007),
Business Combinations
, or
FAS 141(R). FAS 141(R) will change how business
acquisitions are accounted for. FAS 141(R) is effective for
fiscal years beginning on or after December 15, 2008. The
adoption of FAS 141(R) is not expected to have a material
impact on our consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements an amendment of Accounting Research
Bulletin No. 51
. SFAS No. 160
establishes accounting and reporting standards for ownership
interests in subsidiaries held by parties other than the parent,
the amount of consolidated net income attributable to the parent
and to the noncontrolling interest, changes in a parents
ownership interest, and the valuation of retained noncontrolling
equity investments when a subsidiary is deconsolidated.
SFAS No. 160 also establishes disclosure requirements
that clearly identify and distinguish between the interests of
the parent and the interests of the noncontrolling owners.
SFAS No. 160 is effective for fiscal years beginning
after December 15, 2008. The adoption of
SFAS No. 160 is not expected to have a material impact
on our consolidated financial statements.
In March 2008, the FASB issued FAS No. 161,
Disclosures about Derivative Instruments and Hedging
Activities, an amendment of FASB Statement
No. 133
(FAS 161). FAS 161 requires us
to provide greater transparency about how and why we use
derivative instruments, how the instruments and related hedged
items are accounted for under FAS No. 133,
Accounting for Derivative Instruments and Hedging
Activities
(FAS 133), and how the instruments and
related hedged items affect our financial position, results of
operations, and cash flows. FAS 161 became effective for us
on January 1, 2009. We do not expect the adoption of
FAS 161 to have an effect on our consolidated financial
statements.
In April 2008, the FASB has issued FASB Staff Position
142-3
(FSP 142-3),
Determination of the Useful Life of Intangible Assets.
FSP 142-3
amends the factors that should be considered in developing
renewal or extension assumptions used to determine the useful
life of a recognized intangible asset under
36
FASB Statement No. 142,
Goodwill and Other Intangible
Asset.
The intent of
FSP 142-3
is to improve the consistency between the useful life of a
recognized intangible asset under FASB Statement No. 142
and the period of expected cash flows used to measure the fair
value of the asset under FAS 141(R), and other
U.S. generally accepted accounting principles.
FSP 142-3
is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods
within those fiscal years. We do not expect the adoption of
FSP 142-3
to have an effect on our consolidated financial statements.
|
|
Item 7A.
|
Quantitative
and Qualitative Disclosure About Market Risk
|
Foreign
Currency Risk
Currently, the majority of our revenue contracts have been
denominated in United States dollars. In some circumstances, we
have priced certain international sales in Euros and to a much
lesser degree in Maltese Liras. The amount of revenue
transactions denominated in Euros amounted to approximately
$7.1 million, $10.0 million and zero in 2008, 2007 and
2006, respectively. In 2006, $1.0 million of our revenue
was denominated in Maltese Liras. There were no revenue
contracts denominated in Maltese Liras in either 2008 or 2007.
We experienced a net foreign currency gain (loss) of
approximately a $220,000, $351,000 and $(4,000) related to our
revenue contracts for the years ended December 31, 2008,
2007 and 2006, respectively.
As we expand our international sales, we expect that a portion
of our revenue could continue to be denominated in foreign
currencies. As a result, our cash and cash equivalents and
operating results could be increasingly affected by changes in
exchange rates. Our international sales and marketing operations
incur expense that is denominated in foreign currencies. This
expense could be materially affected by currency fluctuations.
Our exposures are to fluctuations in exchange rates for the
United States dollar versus the Euro. Changes in currency
exchange rates could adversely affect our consolidated operating
results or financial position. Additionally, our international
sales and marketing operations maintain cash balances
denominated in foreign currencies. In order to decrease the
inherent risk associated with translation of foreign cash
balances into our reporting currency, we have not maintained
excess cash balances in foreign currencies. We have not hedged
our exposure to changes in foreign currency exchange rates
because expenses in foreign currencies have been insignificant
to date, and exchange rate fluctuations have had little impact
on our operating results and cash flows.
Interest
Rate Risk
We had cash and cash equivalents totaling $79.3 million,
$240,000 and $42,000 at December 31, 2008, 2007 and 2006,
respectively. These amounts were invested primarily in money
market funds. The unrestricted cash and cash equivalents are
held for working capital purposes. We do not enter into
investments for trading or speculative purposes. We believe that
we do not have any material exposure to changes in the fair
value as a result of changes in interest rates due to the short
term nature of our cash equivalents and short-term investments.
Declines in interest rates, however, would reduce future
investment income.
Concentration
of Credit Rate Risk
The market risk inherent in our financial instruments and in our
financial position represents the potential loss arising from
disruptions caused by recent financial market conditions.
Currently, our cash and cash equivalents are primarily deposited
in a money market fund backed by U.S. Treasury securities;
however, substantially all of our cash and cash equivalents are
in excess of federally insured limits at a very limited number
of financial institutions. This represents a high concentration
of credit risk.
37
|
|
Item 8.
|
Financial
Statements and Supplementary Data
|
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders of
Energy Recovery, Inc.
We have audited the accompanying consolidated balance sheets of
Energy Recovery, Inc. as of December 31, 2008 and 2007 and
the related consolidated statements of income,
stockholders equity and comprehensive income, and cash
flows for each of the three years in the period ended
December 31, 2008. In connection with our audits of the
financial statements, we have also audited the financial
statement schedule (schedule) listed in
Item 15(a)(2). These financial statements and schedule are
the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are
free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included
consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion
on the effectiveness of the Companys internal control over
financial reporting. Accordingly, we express no such opinion. An
audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial
statements and schedule, assessing the accounting principles
used and significant estimates made by management, as well as
evaluating the overall presentation of the financial statements
and schedule. We believe that our audits provide a reasonable
basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of Energy Recovery, Inc. at December 31, 2008 and
2007, and the results of its operations and its cash flows for
each of the three years in the period ended December 31,
2008, in conformity with accounting principles generally
accepted in the United States of America.
Also, in our opinion, the financial statement schedule, when
considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
/s/ BDO Seidman, LLP
San Jose, California
March 26, 2009
38
ENERGY
RECOVERY, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
79,287
|
|
|
$
|
240
|
|
Restricted cash
|
|
|
246
|
|
|
|
366
|
|
Accounts receivable, net of allowance for doubtful accounts of
$59 and $121 at December 31, 2008 and 2007, respectively
|
|
|
20,615
|
|
|
|
13,772
|
|
Unbilled receivables, current
|
|
|
4,948
|
|
|
|
1,733
|
|
Notes receivable from stockholders
|
|
|
|
|
|
|
20
|
|
Inventories
|
|
|
8,493
|
|
|
|
4,791
|
|
Deferred tax assets, net
|
|
|
1,755
|
|
|
|
1,052
|
|
Prepaid expenses and other current assets
|
|
|
984
|
|
|
|
369
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
116,328
|
|
|
|
22,343
|
|
Unbilled receivables, non-current
|
|
|
1,929
|
|
|
|
2,457
|
|
Restricted cash, non-current
|
|
|
19
|
|
|
|
1,221
|
|
Property and equipment, net
|
|
|
1,845
|
|
|
|
1,671
|
|
Intangible assets, net
|
|
|
321
|
|
|
|
345
|
|
Deferred tax assets, non-current, net
|
|
|
119
|
|
|
|
148
|
|
Other assets, non-current
|
|
|
51
|
|
|
|
42
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
120,612
|
|
|
$
|
28,227
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
2,270
|
|
|
$
|
1,697
|
|
Accrued expenses and other current liabilities
|
|
|
4,787
|
|
|
|
1,868
|
|
Liability for early exercise of stock options
|
|
|
|
|
|
|
20
|
|
Income taxes payable
|
|
|
1,657
|
|
|
|
1,154
|
|
Accrued warranty reserve
|
|
|
270
|
|
|
|
868
|
|
Deferred revenue
|
|
|
4,000
|
|
|
|
1,729
|
|
Current portion of long-term debt
|
|
|
172
|
|
|
|
172
|
|
Current portion of capital lease obligations
|
|
|
37
|
|
|
|
38
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
13,193
|
|
|
|
7,546
|
|
Long-term debt
|
|
|
385
|
|
|
|
557
|
|
Capital lease obligations, non-current
|
|
|
27
|
|
|
|
63
|
|
Other non-current liabilities
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
13,613
|
|
|
|
8,166
|
|
|
|
|
|
|
|
|
|
|
Commitments and Contingencies (Note 7)
|
|
|
|
|
|
|
|
|
Stockholders equity:
|
|
|
|
|
|
|
|
|
Preferred stock, $0.001 par value; 10,000,000 shares
authorized; no shares issued or outstanding
|
|
|
|
|
|
|
|
|
Common stock, $0.001 par value; 200,000,000 shares
authorized; 50,015,718 and 39,777,446 shares issued and
outstanding at December 31, 2008 and 2007, respectively
|
|
|
50
|
|
|
|
40
|
|
Additional paid-in capital
|
|
|
98,527
|
|
|
|
20,762
|
|
Notes receivable from stockholders
|
|
|
(296
|
)
|
|
|
(835
|
)
|
Accumulated other comprehensive loss
|
|
|
(44
|
)
|
|
|
(5
|
)
|
Retained earnings
|
|
|
8,762
|
|
|
|
99
|
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
106,999
|
|
|
|
20,061
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$
|
120,612
|
|
|
$
|
28,227
|
|
|
|
|
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements
39
ENERGY
RECOVERY, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Net revenue
|
|
$
|
52,119
|
|
|
$
|
35,414
|
|
|
$
|
20,058
|
|
Cost of revenue
|
|
|
18,933
|
|
|
|
14,852
|
|
|
|
8,131
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
33,186
|
|
|
|
20,562
|
|
|
|
11,927
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
General and administrative
|
|
|
11,321
|
|
|
|
4,299
|
|
|
|
3,372
|
|
Sales and marketing
|
|
|
6,549
|
|
|
|
5,230
|
|
|
|
3,648
|
|
Research and development
|
|
|
2,415
|
|
|
|
1,705
|
|
|
|
1,267
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
20,285
|
|
|
|
11,234
|
|
|
|
8,287
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
12,901
|
|
|
|
9,328
|
|
|
|
3,640
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense
|
|
|
(79
|
)
|
|
|
(105
|
)
|
|
|
(77
|
)
|
Interest and other income
|
|
|
873
|
|
|
|
517
|
|
|
|
58
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before provision for income taxes
|
|
|
13,695
|
|
|
|
9,740
|
|
|
|
3,621
|
|
Provision for income taxes
|
|
|
5,032
|
|
|
|
3,947
|
|
|
|
1,239
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Income
|
|
$
|
8,663
|
|
|
$
|
5,793
|
|
|
$
|
2,382
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.19
|
|
|
$
|
0.15
|
|
|
$
|
0.06
|
|
Diluted
|
|
$
|
0.18
|
|
|
$
|
0.14
|
|
|
$
|
0.06
|
|
Number of shares used in per share calculations:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
44,848
|
|
|
|
39,060
|
|
|
|
38,018
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
|
47,392
|
|
|
|
41,433
|
|
|
|
40,244
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements
40
ENERGY
RECOVERY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY AND
COMPREHENSIVE INCOME
Years Ended December 31, 2008, 2007 and 2006
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Notes
|
|
|
Accumulated
|
|
|
Retained
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
Receivable
|
|
|
Other
|
|
|
Earnings
|
|
|
Total
|
|
|
|
|
|
|
Common Stock
|
|
|
Paid-in
|
|
|
from
|
|
|
Comprehensive
|
|
|
(Accumulated
|
|
|
Stockholders
|
|
|
|
|
|
|
Shares
|
|
|
Amount
|
|
|
Capital
|
|
|
Stockholders
|
|
|
Income
|
|
|
Deficit)
|
|
|
Equity
|
|
|
|
|
|
Balance at December 31, 2005
|
|
|
37,769
|
|
|
$
|
38
|
|
|
$
|
13,313
|
|
|
$
|
(573
|
)
|
|
$
|
|
|
|
$
|
(8,076
|
)
|
|
$
|
4,702
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,382
|
|
|
|
2,382
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,382
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock
|
|
|
453
|
|
|
|
|
|
|
|
142
|
|
|
|
(137
|
)
|
|
|
|
|
|
|
|
|
|
|
5
|
|
|
|
|
|
Interest on notes receivable from stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(31
|
)
|
|
|
|
|
|
|
|
|
|
|
(31
|
)
|
|
|
|
|
Repayment of notes receivable from stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
5
|
|
|
|
|
|
Employee stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
1,061
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,061
|
|
|
|
|
|
Non-employee stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2006
|
|
|
38,222
|
|
|
|
38
|
|
|
|
14,519
|
|
|
|
(736
|
)
|
|
|
|
|
|
|
(5,694
|
)
|
|
|
8,127
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,793
|
|
|
|
5,793
|
|
|
|
|
|
Foreign currency translation adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(5
|
)
|
|
|
|
|
|
|
(5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5,788
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock
|
|
|
1,555
|
|
|
|
2
|
|
|
|
5,207
|
|
|
|
(91
|
)
|
|
|
|
|
|
|
|
|
|
|
5,118
|
|
|
|
|
|
Interest on notes receivable from stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(31
|
)
|
|
|
|
|
|
|
|
|
|
|
(31
|
)
|
|
|
|
|
Repayment of notes receivable from stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
23
|
|
|
|
|
|
|
|
|
|
|
|
23
|
|
|
|
|
|
Employee stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
1,008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,008
|
|
|
|
|
|
Non-employee stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2007
|
|
|
39,777
|
|
|
|
40
|
|
|
|
20,762
|
|
|
|
(835
|
)
|
|
|
(5
|
)
|
|
|
99
|
|
|
|
20,061
|
|
|
|
|
|
Net income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,663
|
|
|
|
8,663
|
|
|
|
|
|
Foreign currency translation adjustments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(39
|
)
|
|
|
|
|
|
|
(39
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8,624
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock
|
|
|
10,238
|
|
|
|
10
|
|
|
|
76,717
|
|
|
|
(20
|
)
|
|
|
|
|
|
|
|
|
|
|
76,707
|
|
|
|
|
|
Interest on notes receivable from stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(15
|
)
|
|
|
|
|
|
|
|
|
|
|
(15
|
)
|
|
|
|
|
Repayment of notes receivable from stockholders
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
574
|
|
|
|
|
|
|
|
|
|
|
|
574
|
|
|
|
|
|
Stock option income tax benefit
|
|
|
|
|
|
|
|
|
|
|
14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14
|
|
|
|
|
|
Employee stock-based compensation
|
|
|
1
|
|
|
|
|
|
|
|
936
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
936
|
|
|
|
|
|
Non-employee stock-based compensation
|
|
|
|
|
|
|
|
|
|
|
98
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
98
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at December 31, 2008
|
|
|
50,016
|
|
|
$
|
50
|
|
|
$
|
98,527
|
|
|
$
|
(296
|
)
|
|
$
|
(44
|
)
|
|
$
|
8,762
|
|
|
$
|
106,999
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements
41
ENERGY
RECOVERY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Cash Flows From Operating Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
8,663
|
|
|
$
|
5,793
|
|
|
$
|
2,382
|
|
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization
|
|
|
522
|
|
|
|
323
|
|
|
|
231
|
|
Impairment of intangible assets
|
|
|
|
|
|
|
31
|
|
|
|
|
|
Interest accrued on notes receivables from stockholders
|
|
|
(15
|
)
|
|
|
(31
|
)
|
|
|
(31
|
)
|
Stock-based compensation
|
|
|
1,034
|
|
|
|
1, 036
|
|
|
|
1,064
|
|
Loss (gain) on foreign currency transactions
|
|
|
373
|
|
|
|
(351
|
)
|
|
|
4
|
|
Provision for doubtful accounts
|
|
|
7
|
|
|
|
(105
|
)
|
|
|
80
|
|
Provision for warranty claims
|
|
|
(495
|
)
|
|
|
850
|
|
|
|
61
|
|
Provision for excess or obsolete inventory
|
|
|
26
|
|
|
|
47
|
|
|
|
30
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(7,622
|
)
|
|
|
(3,554
|
)
|
|
|
(5,911
|
)
|
Unbilled receivables
|
|
|
(2,687
|
)
|
|
|
(2,189
|
)
|
|
|
(1,719
|
)
|
Inventories
|
|
|
(3,728
|
)
|
|
|
(1,950
|
)
|
|
|
(960
|
)
|
Deferred tax assets, net
|
|
|
(674
|
)
|
|
|
(341
|
)
|
|
|
(859
|
)
|
Prepaid and other assets
|
|
|
(624
|
)
|
|
|
(49
|
)
|
|
|
(135
|
)
|
Accounts payable
|
|
|
573
|
|
|
|
583
|
|
|
|
270
|
|
Accrued expenses and other liabilities
|
|
|
3,223
|
|
|
|
214
|
|
|
|
1,002
|
|
Income taxes payable
|
|
|
517
|
|
|
|
(243
|
)
|
|
|
1,334
|
|
Deferred revenue
|
|
|
2,271
|
|
|
|
(2,893
|
)
|
|
|
3,979
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities
|
|
|
1,364
|
|
|
|
(2,829
|
)
|
|
|
822
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows From Investing Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital expenditures
|
|
|
(667
|
)
|
|
|
(918
|
)
|
|
|
(328
|
)
|
Restricted cash
|
|
|
1,322
|
|
|
|
(1,043
|
)
|
|
|
(109
|
)
|
Other
|
|
|
(5
|
)
|
|
|
(84
|
)
|
|
|
(74
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities
|
|
|
650
|
|
|
|
(2,045
|
)
|
|
|
(511
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash Flows From Financing Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Proceeds from long-term debt
|
|
|
|
|
|
|
639
|
|
|
|
118
|
|
Repayment of long-term debt
|
|
|
(172
|
)
|
|
|
(98
|
)
|
|
|
(164
|
)
|
Repayment of revolving note, net
|
|
|
|
|
|
|
(438
|
)
|
|
|
(563
|
)
|
Repayment of capital lease obligation
|
|
|
(37
|
)
|
|
|
(38
|
)
|
|
|
(60
|
)
|
Net proceeds from issuance of common stock (see Note 9)
|
|
|
76,707
|
|
|
|
5,118
|
|
|
|
5
|
|
Repayment of notes receivable from stockholders
|
|
|
574
|
|
|
|
23
|
|
|
|
5
|
|
Other short term financing activities
|
|
|
|
|
|
|
(129
|
)
|
|
|
129
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities
|
|
|
77,072
|
|
|
|
5,077
|
|
|
|
(530
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect of exchange rate differences on cash and cash
equivalents
|
|
|
(39
|
)
|
|
|
(5
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net change in cash and cash equivalents
|
|
|
79,047
|
|
|
|
198
|
|
|
|
(219
|
)
|
Cash and cash equivalents, beginning of period
|
|
|
240
|
|
|
|
42
|
|
|
|
261
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period
|
|
$
|
79,287
|
|
|
$
|
240
|
|
|
$
|
42
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
75
|
|
|
$
|
97
|
|
|
$
|
78
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash paid for income taxes
|
|
$
|
5,144
|
|
|
$
|
4,555
|
|
|
$
|
764
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental disclosure of non-cash transactions
|
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common stock in exchange for notes receivable from
stockholders
|
|
$
|
20
|
|
|
$
|
91
|
|
|
$
|
137
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equipment purchased under capital leases
|
|
$
|
|
|
|
$
|
|
|
|
$
|
42
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See accompanying Notes to Consolidated Financial Statements
42
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Description
of Business
Energy Recovery, Inc. (the Company or
ERI) was established in 1992, and is a leading
global developer and manufacturer of highly efficient energy
recovery devices utilized in the water desalination industry.
The Company operates primarily in the sea water reverse osmosis
(SWRO) segment of the industry, which uses pressure
to drive sea water through filtering membranes to produce fresh
water. The Companys primary energy recovery device is the
PX Pressure
Exchanger
®
(PX device), which helps optimize the energy
intensive SWRO process by reducing energy consumption. Products
are manufactured in the United States of America
(U.S.) at ERIs headquarters located in
San Leandro, California, and shipped from this location to
specified customer locations worldwide. The Company has direct
sales offices and technical support centers in Madrid, Dubai,
Shanghai and Fort Lauderdale and the research and
development center is located in San Leandro, California.
The Company was incorporated in Virginia in April 1992 and
reincorporated in Delaware in March 2001. The Company
incorporated its wholly owned subsidiaries, Osmotic Power, Inc.,
Energy Recovery, Inc. International and Energy Recovery Iberia,
S.L., in September 2005, July 2006 and September 2006,
respectively.
|
|
Note 2.
|
Summary
of Significant Accounting Policies
|
Basis
of Presentation
The consolidated financial statements include the accounts of
the Company and its foreign wholly owned subsidiaries. All
significant intercompany accounts and transactions have been
eliminated in consolidation.
Certain prior period balances have been reclassified to conform
to the current period presentation. Specifically, we
reclassified $923,000 of contra accounts receivable and $318,000
of customer deposits to deferred revenue as of December 31,
2007, related to advance payments. The Company believes that
reclassifying these amounts presents a more useful
representation of accounts receivable, unearned revenue and
deferred liabilities.
Use of
Estimates
The preparation of consolidated financial statements in
conformity with U.S. generally accepted accounting
principles (U.S. GAAP) requires management to
make judgments, estimates and assumptions that affect the
amounts reported in the consolidated financial statements and
accompanying notes. The Companys most significant
estimates and judgments involve the determination of revenue
recognition, allowance for doubtful accounts, allowance for
product warranty, valuation of the Companys stock and
stock-based compensation, reserve for excess and obsolete
inventory, deferred taxes and valuation allowances on deferred
tax assets. Actual results could materially differ from those
estimates.
Cash
and Cash Equivalents
The Company considers all highly liquid investments with an
original or remaining maturity of three months or less at the
time of purchase to be cash equivalents. Cash equivalents are
stated at cost, which approximates fair value. Our cash and cash
equivalents are maintained in demand deposit accounts with large
financial institutions and invested in institutional money
market funds. The Company frequently monitors the
creditworthiness of the financial institutions and institutional
money market funds in which it invests its surplus funds. The
Company has not experienced any credit losses from its cash
investments.
Restricted
Cash
The Company has irrevocable standby letters of credit with two
financial institutions securing performance and warranty
commitments under contracts with customers and lessors. These
standby letters of credit
43
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
are collateralized by either a line of credit (see
Note 4) or restricted cash. At December 31, 2008
and 2007, the amount of irrevocable standby letters of credit
collateralized by restricted cash was $265,000 and $1,587,000,
respectively. The company has deposited a corresponding amount
into money market accounts and certificates of deposit.
Allowances
of Doubtful Accounts
The Company records a provision for doubtful accounts based on
its historical experience and a detailed assessment of the
collectability of its accounts receivable. In estimating the
allowance for doubtful accounts, the Companys management
considers, among other factors, (1) the aging of the
accounts receivable, (2) the Companys historical
write-offs, (3) the credit worthiness of each customer and
(4) general economic conditions.
Inventories
Inventories are stated at the lower of cost (using the weighted
average cost method) or market. The Company calculates inventory
reserves for excess and obsolete inventories based on current
inventory levels, expected useful life and estimated future
demand of the products and spare parts. Cost of inventory is
determined in accordance with Statement of Financial Accounting
Standards (SFAS) No. 151,
Inventory
Costs
, an amendment of ARB No. 43, Chapter 4.
Property
and Equipment
Property and equipment are stated at cost and depreciated over
the estimated useful lives of the assets (generally three to
seven years) using the straight-line method. A portion of
equipment for the Companys manufacturing facility is
acquired under capital lease obligations. These assets are
amortized over periods consistent with depreciation of owned
assets of similar types, generally five years. Lease
improvements represent the remodeling expenses for the leased
office space and are depreciated over the shorter of either the
estimated useful lives or the term of the lease using the
straight-line method. Software purchased for internal use
consists primarily of amounts paid for perpetual licenses to
third party software providers and are depreciated over the
estimated useful lives, generally three to five years.
SFAS No. 143,
Accounting for Asset Retirement
Obligations
and Interpretation No. 47,
Accounting
for Conditional Asset Retirement Obligations
, an
interpretation of SFAS 143, requires the recognition of a
liability for the fair value of a legally required conditional
asset retirement obligation when incurred, if the
liabilitys fair value can be reasonably estimated.
Management reviewed the Companys facility lease and
concluded that the cost, if any of potential physical
reinstatement obligations is not reasonably determinable, and as
such, no asset retirement obligation was recorded in the
financial statements for the years presented.
Maintenance and repairs are charged directly to expense as
incurred, whereas improvements and renewals are generally
capitalized in their respective property accounts. When an item
is retired or otherwise disposed of, the cost and applicable
accumulated depreciation are removed and the resulting gain or
loss is recognized in the results of operations.
Intangible
Assets
Intangible assets represent patents owned by the Company and are
recorded at cost (i.e., the cost of obtaining the patent) and
are amortized on a straight-line basis over their expected
useful life of 16 to 20 years.
44
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
Impairment
of Long-Lived Assets
The Company accounts for its long-lived assets, including
property and equipment and intangibles, in accordance with
SFAS No. 144,
Accounting for the Impairment or
Disposal of Long-Lived Assets
. The Company evaluates its
long-lived assets for indicators of possible impairment whenever
events or changes in business circumstances indicate that the
carrying amount of the assets may not be fully recoverable. An
impairment loss would be recognized when estimated undiscounted
future cash flows expected to result from the use of an asset
and its eventual disposition are less than its carrying amount.
During 2007, the Company determined that a patent was impaired
as a result of the development of a new patent which effectively
superseded and replaced an existing patent; accordingly, the
Company recorded an impairment reserve of $31,000 for the year
ended December 31, 2007, and this amount was included in
research and development expense in the consolidated statement
of income. No impairment expense was recorded for the years
ended December 31, 2008 and 2006.
Revenue
Recognition
The Company recognizes revenue in accordance with
U.S. Securities and Exchange Commission (SEC)
Staff Accounting Bulletin (SAB) No. 104,
Revenue Recognition
(SAB 104). The
Company recognizes revenue when the earnings process is
complete, as evidenced by an agreement with the customer,
transfer of title occurs, fixed pricing is determinable and
collection is reasonably assured. Transfer of title typically
occurs upon shipment of the equipment pursuant to a written
purchase order or contract. The portion of the sales agreement
related to the field services and training for commissioning of
a desalination plant is deferred per guidance of Emerging Issues
Task Force (EITF)
No. 00-21,
Revenue Arrangements with Multiple Deliverables
, by
applying the residual value method. Under this method, revenue
allocated to undelivered elements is based on vendor objective
evidence of fair value of such undelivered elements, and the
residual revenue is allocated to the delivered elements,
assuming that the delivered elements have stand-alone value.
Vendor objective evidence of fair value for such undelivered
elements is based upon the price the Company charges for such
product or service when it is sold separately. The Company may
modify its pricing in the future, which could result in changes
to our vendor objective evidence of fair value for such
undelivered elements. The services element of the Companys
contracts represents an incidental portion of the total contract
price.
Under the Companys revenue recognition policy, evidence of
an arrangement has been met when it has an executed purchase
order or a stand-alone contract. Typically, smaller projects
utilize purchase orders that conform to standard terms and
conditions that require the customer to remit payment generally
within 30 to 90 days from product delivery. In some cases,
if credit worthiness cannot be determined, prepayment is
required from the smaller customers.
For large projects, stand-alone contracts are utilized. For
these contracts, consistent with industry practice, the
customers typically require their suppliers, including the
Company, to accept contractual holdback provisions whereby the
final amounts due under the sales contract are remitted over
extended periods of time. These retention payments typically
range between 10% and 20%, and in some instances up to 30%, of
the total contract amount and are due and payable when the
customer is satisfied that certain specified product performance
criteria have been met upon commissioning of the desalinization
plant, which in the case of the Companys PX device may be
12 months to 24 months from the date of product
delivery as described further below.
The specified product performance criteria for the
Companys PX device generally pertains to the ability of
the Companys product to meet its published performance
specifications and warranty provisions, which the Companys
products have demonstrated on a consistent basis. This factor,
combined with the Companys historical performance metrics
measured over the past 10 years, provides management with a
reasonable basis to conclude that its PX device will perform
satisfactorily upon commissioning of the plant. To ensure this
45
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
successful product performance, the Company provides service,
consisting principally of supervision of customer personnel, and
training to the customers during the commissioning of the plant.
The installation of the PX device is relatively simple, requires
no customization and is performed by the customer under the
supervision of Company personnel. The Company defers the value
of the service and training component of the contract and
recognizes such revenue as services are rendered. Based on these
factors, management has concluded that delivery and performance
have been completed when the product has been delivered (title
transfers) to the customer.
The Company performs an evaluation of credit worthiness on an
individual contract basis, to assess whether collectability is
reasonably assured. As part of this evaluation, management
considers many factors about the individual customer, including
the underlying financial strength of the customer
and/or
partnership consortium and managements prior history or
industry specific knowledge about the customer and its supplier
relationships. To date, the Company has been able to conclude
that collectability was reasonably assured on its sales
contracts at the time the product was delivered and title has
transferred; however, to the extent that management concludes
that it is unable to determine that collectability is reasonably
assured at the time of product delivery, the Company will defer
all or a portion of the contract amount based on the specific
facts and circumstances of the contract and the customer.
Under the stand-alone contracts, the usual payment arrangements
are summarized as follows:
|
|
|
|
|
an advance payment, typically 10% to 20% of the total contract
amount, is due upon execution of the contract;
|
|
|
|
a payment upon delivery of the product, typically in the range
of 50% to 70% of the total contract amount, is due on average
between 90 and 150 days from product delivery, and in some
cases up to 180 days; and
|
|
|
|
a retention payment, typically in the range of 10% to 20%, and
in some cases up to 30%, of the total contract amount is due
subsequent to product delivery as described further below.
|
Under the terms of the retention payment component, the Company
is generally required to issue to the customer a product
performance guarantee that takes the form of an irrevocable
standby letter of credit, which is issued to the customer
approximately 12 to 24 months after the product delivery
date. The letter of credit is either collateralized by
restricted cash on deposit with the Companys financial
institution (see Restricted Cash under Summary of Significant
Accounting Policies) or funds available through a credit
facility (see Note 4). The letter of credit remains in
place for the performance period as specified in the contract,
which is generally 12 to 36 months and, in some cases, up
to 65 months from issuance. The performance period
generally runs concurrent with the Companys standard
product warranty period. Once the letter of credit has been put
in place, the Company invoices the customer for this final
retention payment under the sales contract. During the time
between the product delivery and the issuance of the letter of
credit, the amount of the final retention payment is classified
on the balance sheet as an unbilled receivable, of which a
portion may be classified as long term to the extent that the
billable period extends beyond one year. Once the letter of
credit is issued, the Company invoices the customer and
reclassifies the retention amount from unbilled receivable to
accounts receivable where it remains until payment, typically 90
to 150 days after invoicing, and in some cases up to
180 days. (See Note 3 Balance Sheet
Information: Unbilled Receivables).
The Company does not provide its customers with a right of
product return. However, the Company will accept returns of
products that are deemed to be damaged or defective when
delivered that are covered by the terms and conditions of the
product warranty. Product returns have not been significant.
Reserves are established for possible product returns related to
the advance replacement of products pending the determination of
a warranty claim.
Shipping and handling charges billed to customers are included
in sales. The cost of shipping to customers is included in cost
of revenue.
46
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
The Company sells its product to resellers and engineering and
construction firms which are not subject to sales tax.
Accordingly, the adoption of EITF Issue
No. 06-3,
How Taxes Collected from Customers and Remitted to
Governmental Authorities Should Be Presented in the Income
Statement (That is, Gross versus Net Presentation)
, does not
have an impact on the Companys consolidated financial
statements.
Warranty
Costs
The Company sells products with a limited warranty for a period
ranging from one to five years. The Company accrues for warranty
costs based on estimated product failure rates, historical
activity and expectations of future costs. The Company
periodically evaluates and adjusts the warranty costs to the
extent actual warranty costs vary from the original estimates.
The Company may offer extended warranties on an exception basis
and these are accounted for in accordance with Financial
Accounting Standards Board (FASB) Technical
Bulletin 90-1,
Accounting for Separately Priced Extended Warranty and
Product Maintenance Contracts for Sales of Extended
Warranties
.
Income
Taxes
The Company accounts for income taxes in accordance with
SFAS No. 109,
Accounting for Income
Taxes
(SFAS 109), issued by FASB.
SFAS 109 requires an entity to recognize deferred tax
assets and liabilities. Deferred tax assets and liabilities are
recognized for the future tax consequence attributable to the
difference between the tax bases of assets and liabilities and
their reported amounts in the financial statements. Deferred tax
assets and liabilities are measured using the enacted tax rate
expected to apply to taxable income in the years in which those
temporary differences are expected to be recovered or settled.
The effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that included
the enactment date. Valuation allowances are provided if, based
upon the available evidence, management believes it is more
likely than not that some or all of the deferred assets will not
be realized or the use of prior years net operating losses
may be limited.
On July 13, 2006, the FASB issued Interpretation
No. 48, Accounting for Uncertainty in Income
Taxes An Interpretation of FASB Statement
No. 109 (FIN 48). FIN 48
clarifies the accounting for uncertainty in income taxes
recognized in any entitys financial statements in
accordance with SFAS 109 and prescribes a recognition
threshold and measurement attributes for financial statement
disclosure of tax positions taken or expected to be taken on a
tax return. Under FIN 48, the impact of an uncertain income
tax position on the income tax return must be recognized at the
largest amount that is more likely than not to be sustained upon
audit by the relevant taxing authority. An uncertain income tax
position will not be recognized if it has less than a 50%
likelihood of being sustained. Additionally, FIN 48
provides guidance on
de-recognition,
classification, interest and penalties, accounting in interim
periods, disclosure and transition. The Company adopted the
provisions of FIN 48 on January 1, 2007. Measurement
under FIN 48 is based on judgment regarding the largest
amount that is greater than 50% likely of being realized upon
ultimate settlement with a taxing authority. The total amount of
unrecognized tax benefits as of the date of adoption was
immaterial. As a result of the implementation of FIN 48,
the Company recognized no increase in the liability for
unrecognized tax benefits.
The Company adopted the accounting policy that interest
recognized in accordance with Paragraph 15 of FIN 48
and penalty recognized in accordance with Paragraph 16 of
FIN 48 are classified as part of its income taxes. The
amounts of interest and penalty recognized in the statement of
income and statement of financial position for the years ended
December 31, 2008 and 2007 were insignificant.
The Companys operations are subject to income and
transaction taxes in the U.S. and in foreign jurisdictions.
Significant estimates and judgments are required in determining
the Companys worldwide provision for income taxes. Some of
these estimates are based on interpretations of existing tax
laws or regulations. The ultimate amount of tax liability may be
uncertain as a result.
47
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
Stock-Based
Compensation Employees
Prior to January 1, 2006, the Company accounted for
stock-based compensation to employees and members of the
Companys board of directors under the recognition and
measurement principles of Accounting Principles Board Opinion
No. 25,
Accounting for Stock Issued to Employees
(APB 25), and related interpretations. Under APB
25, compensation expense for stock-based payment awards is based
on the difference, if any, on the date of the grant, between the
value of the Companys stock and the exercise price and is
recognized over the vesting period of the awards. Accordingly,
prior to January 1, 2006, no stock-based compensation
expense was recognized in the Companys statements of
income for stock options granted to employees and directors that
had an exercise price equal to the value of the Companys
stock on the date of grant. The Company also followed the
disclosure requirements of SFAS No. 123,
Accounting
for Stock-Based Compensation
, amended by
SFAS No. 148,
Accounting for Stock-Based
Compensation-Transition and Disclosure
and used the minimum
value method for pro-forma disclosures based on the disclosure
provisions that was available for non public
companies.
On January 1, 2006, the Company adopted
SFAS No. 123 (revised 2004),
Share-Based Payment
(SFAS 123R), which requires the measurement
and recognition of compensation expense in the statement of
income for all awards made to employees and members of the
Companys board of directors using estimated fair values.
Under the provisions of SFAS 123R, share-based compensation
expense is measured at the grant date, based on the fair value
of the award, and is recognized as an expense over the
employees requisite service period, generally the vesting
period of the awards. Under SFAS 123R, non-public companies
that used the minimum value method under disclosure provisions
of SFAS 148 shall apply the provisions of SFAS 123R
prospectively to new
and/or
modified awards at the adoption date, and shall continue to
account for any portion of awards outstanding at the adoption
date, using the accounting principles originally applied to
those awards. Accordingly, for awards granted prior to
January 1, 2006 for which the requisite service period had
not been performed as of December 31, 2005, the Company
continued to recognize compensation expense on the remaining
unvested awards under the intrinsic-value method of APB 25. In
accordance with the requirements of SFAS 123R for
non-public companies, the Company has not provided pro-forma
disclosures for the year ended December 31, 2005 since the
Company used the minimum value method for pro-forma disclosures
for awards granted prior to January 1, 2006. For all awards
granted or modified after December 31, 2005, the Company
began recognizing compensation expense of the fair value, less
expected forfeitures, on a straight-line basis over the vesting
period.
To determine the inputs for the Black-Scholes options pricing
model, the Company is required to develop several assumptions,
which are highly subjective. These assumptions include:
|
|
|
|
|
the length of its options lives, which is based on
anticipated future exercises;
|
|
|
|
its common stocks volatility;
|
|
|
|
the number of shares of common stock pursuant to which options
which will ultimately be forfeited;
|
|
|
|
the risk-free rate of return; and
|
|
|
|
future dividends.
|
48
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
The estimated grant date fair values of the employee stock
options were calculated using the Black-Scholes options pricing
model, based on the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Expected term
|
|
|
5 years
|
|
|
|
5 years
|
|
|
|
5 years
|
|
Expected volatility
|
|
|
48%
|
|
|
|
50%
|
|
|
|
50%
|
|
Risk-free interest rate
|
|
|
1.55 - 3.41%
|
|
|
|
3.41 - 4.92%
|
|
|
|
4.45 - 5.10%
|
|
Dividend yield
|
|
|
0%
|
|
|
|
0%
|
|
|
|
0%
|
|
Expected Term.
Under the Companys option plans, the
expected term of options granted is determined using the
weighted average period during which the stock options are
expected to remain outstanding and is based on the options
vesting term, contractual terms and disclosure information from
similar publicly traded companies to develop reasonable
expectations about future exercise patterns and post-vesting
employment termination behavior.
Expected Volatility.
Since the Company is a newly public
entity with limited historical data regarding the volatility of
its common stock price, the expected volatility used is based on
volatility of a representative industry peer group. In
evaluating similarity, the Company considered factors such as
industry, stage of life cycle and size.
Risk-Free Interest Rate.
The risk-free rate is based on
U.S. Treasury issues with remaining terms similar to the
expected term on the options.
Dividend Yield.
The Company has never declared or paid
any cash dividends and does not plan to pay cash dividends in
the foreseeable future, and, therefore, used an expected
dividend yield of zero in the valuation model.
Forfeitures.
SFAS No. 123R also requires the
Company to estimate forfeitures at the time of grant, and revise
those estimates in subsequent periods if actual forfeitures
differ from those estimates. The Company uses historical data to
estimate pre-vesting option forfeitures and records stock-based
compensation expense only for those awards that are expected to
vest. All stock-based payment awards are amortized on a
straight-line basis over the requisite service periods of the
awards, which are generally the vesting periods. If the
Companys actual forfeiture rate is materially different
from its estimate, the stock-based compensation expense could be
significantly different from what the Company has recorded in
the current period.
The absence of an active market for its common stock prior to
July 2008 required management and the board of directors to
estimate the fair value of its common stock for purposes of
granting options and for determining stock-based compensation
expense for options granted prior to July 2008. In response to
these requirements, management and the board of directors
estimated the fair market value common stock based on factors
such as the price of the most recent common stock sales to
investors, the valuations of comparable companies, the status of
the Companys development and sales efforts, its cash and
working capital amounts, revenue growth, and additional
objective and subjective factors relating to its business on an
annual basis.
49
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
Stock-based compensation expense related to awards granted and
or modified to employees was allocated as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Cost of revenue
|
|
$
|
103
|
|
|
$
|
117
|
|
|
$
|
143
|
|
General and administrative
|
|
|
419
|
|
|
|
383
|
|
|
|
425
|
|
Sales and marketing
|
|
|
274
|
|
|
|
349
|
|
|
|
310
|
|
Research and development
|
|
|
140
|
|
|
|
159
|
|
|
|
183
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
936
|
|
|
$
|
1,008
|
|
|
$
|
1,061
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
To calculate the excess tax benefits available as of the date of
adoption for use in offsetting future tax shortfalls, the
Company elected the short-form method in accordance
with FASB Staff Position
FAS No. 123R-3,
Transition Election Related to Accounting for the Tax Effects
of Share-Based Payment Awards
.
Stock-Based
Compensation Non-Employees
The Company accounts for awards granted to non-employees other
than members of the Companys board of directors in
accordance with SFAS 123 and the EITF Abstract
No. 96-18,
Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling
Goods or Services
(EITF 96-18)
,
which require such awards to be recorded at their fair value
on the measurement date. The measurement of stock-based
compensation is subject to periodic adjustment as the underlying
awards vest. The Company amortizes compensation expense related
to non-employee awards in accordance with FASB Interpretation
No. 28,
Accounting for Stock Appreciation Rights and
Other Variable Stock Option or Award Plans.
The fair value of stock options issued to consultants was
calculated using the Black-Scholes options pricing model, based
on the following assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Expected term
|
|
|
1-10 years
|
|
|
|
1-10 years
|
|
|
|
10 years
|
|
Expected volatility
|
|
|
48%
|
|
|
|
50%
|
|
|
|
50
|
%
|
Risk-free interest rate
|
|
|
1.55% - 2.46%
|
|
|
|
3.45% - 4.92%
|
|
|
|
4.70
|
%
|
Dividend yield
|
|
|
0%
|
|
|
|
0%
|
|
|
|
0
|
%
|
Stock-based compensation expense related to awards granted
and/or
modified to non-employees was allocated as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
General and administrative
|
|
$
|
93
|
|
|
$
|
5
|
|
|
$
|
3
|
|
Sales and marketing
|
|
|
5
|
|
|
|
23
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
98
|
|
|
$
|
28
|
|
|
$
|
3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
Currency
The Companys reporting currency is the U.S. dollar,
while the functional currencies of the Companys foreign
subsidiaries are their respective local currencies. The asset
and liability accounts of the Companys foreign
50
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
subsidiaries are translated from their local currencies at the
rates in effect at the balance sheet date. Revenue and expenses
are translated at average rates of exchange prevailing during
the period. Translation adjustments are accumulated and reported
as a component of stockholders equity. Foreign currency
transaction gains and losses which result from transactions with
customers that are denominated in a currency other than the
entitys functional currency are recorded in other income
and expense in the consolidated statements of income.
Advertising
Expense
Advertising expense is charged to operations in the year in
which it is incurred. Total advertising expense amounted to
$103,000, $118,000, and $68,000 for the years ended
December 31, 2008, 2007, and 2006, respectively.
Comprehensive
Income
In accordance with SFAS No. 130,
Reporting
Comprehensive Income
, the Company is required to display
comprehensive income and its components as part of the
Companys full set of consolidated financial statements.
Comprehensive income is composed of net income and other
comprehensive income, including foreign currency translation
adjustments.
Fair
Value of Financial Instruments
The carrying amount of cash, cash equivalents and restricted
cash are reasonable estimates of their fair value because of the
short maturity of these items.
The carrying amount of long-term debt reasonably approximates
its fair value as the majority of the borrowings are at interest
rates that fluctuate with current market conditions.
The Company has determined that it is not practicable to
estimate the fair value of its non-current unbilled receivables
as there is no ready market for such instruments. See
Note 3 Balance Sheet Information: Unbilled
Receivables for additional information.
Earnings
Per Share
In accordance with SFAS No. 128, Earnings per Share,
the following table sets forth the computation of basic and
diluted earnings per share (in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Numerator:
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
8,663
|
|
|
$
|
5,793
|
|
|
$
|
2,382
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
|
44,848
|
|
|
|
39,060
|
|
|
|
38,018
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonvested shares
|
|
|
5
|
|
|
|
4
|
|
|
|
|
|
Stock options
|
|
|
635
|
|
|
|
438
|
|
|
|
318
|
|
Warrants
|
|
|
1,904
|
|
|
|
1,931
|
|
|
|
1,908
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total shares for purpose of calculating diluted net income per
share
|
|
|
47,392
|
|
|
|
41,433
|
|
|
|
40,244
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.19
|
|
|
$
|
0.15
|
|
|
$
|
0.06
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted
|
|
$
|
0.18
|
|
|
$
|
0.14
|
|
|
$
|
0.06
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
51
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
The following potential common shares were excluded from the
computation of diluted net income per share because their effect
would have been anti-dilutive (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
December 31,
|
|
|
2008
|
|
2007
|
|
2006
|
|
Nonvested shares
|
|
|
|
|
|
|
78
|
|
|
|
481
|
|
Stock options
|
|
|
669
|
|
|
|
283
|
|
|
|
38
|
|
Recent
Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157,
Fair Value Measurements
(SFAS 157).
SFAS 157 defines fair value, establishes a framework for
measuring fair value, and enhances fair value measurement
disclosure. In February 2008, the FASB issued FASB Staff
Position
157-1,
Application of FASB Statement No. 157 to FASB Statement
No. 13 and Other Accounting Pronouncements That Address
Fair Value Measurements for Purposes of Lease Classification or
Measurement under Statement 13
(FSP 157-1)
and
FSP 157-2,
Effective Date of FASB Statement No. 157.
FSP 157-1
amends SFAS 157 to remove certain leasing transactions from
its scope.
FSP 157-2
delays the effective date of SFAS 157 for all non-financial
assets and non-financial liabilities, except for items that are
recognized or disclosed at fair value in the financial
statements on a recurring basis (at least annually), until the
beginning of the first quarter of 2009. The measurement and
disclosure requirements related to financial assets and
financial liabilities are effective for the Company beginning in
the first quarter of 2008. The adoption of SFAS 157 for
financial assets and financial liabilities in the first quarter
of 2008 did not have a significant impact on the Companys
consolidated financial statements. The Company is currently
evaluating the impact that SFAS 157 will have on its
consolidated financial statements when it is applied to
non-financial assets and non-financial liabilities beginning in
the first quarter of 2009.
In February 2007, the FASB issued SFAS No. 159,
The
Fair Value Option for Financial Assets and Financial Liabilities
(SFAS 159). SFAS 159 permits companies
to choose to measure certain financial instruments and other
items at fair value. The standard requires that unrealized gains
and losses are reported in earnings for items measured using the
fair value option. SFAS 159 is effective for the Company
beginning in the first quarter of 2008. The adoption of
SFAS 159 did not have an impact on the Companys
consolidated financial statements.
In December 2007, the SEC issued SAB 110 to amend the
SECs views discussed in SAB 107 regarding the use of
the simplified method in developing an estimate of expected life
of share options in accordance with SFAS 123R. SAB 110
is effective for the Company beginning in the first quarter of
2008. As of December 31, 2007, the Company did not use the
simplified method and the adoption of SAB 107, as amended
by SAB 110, did not have an impact on the Companys
consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141
(revised 2007),
Business Combinations
(SFAS 141(R)). SFAS 141(R) will change
how business acquisitions are accounted for. SFAS 141(R) is
effective for fiscal years beginning on or after
December 15, 2008. The adoption of SFAS 141(R) is not
expected to have a material impact on the Companys
consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160,
Noncontrolling Interests in Consolidated Financial
Statements an amendment of Accounting Research
Bulletin No. 51
. SFAS No. 160
establishes accounting and reporting standards for ownership
interests in subsidiaries held by parties other than the parent,
the amount of consolidated net income attributable to the parent
and to the noncontrolling interest, changes in a parents
ownership interest, and the valuation of retained noncontrolling
equity investments when a subsidiary is deconsolidated.
SFAS No. 160 also establishes disclosure requirements
that clearly identify and distinguish between the interests of
the parent and the interests of the noncontrolling owners.
SFAS No. 160 is effective
52
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
for fiscal years beginning after December 15, 2008. The
adoption of SFAS No. 160 is not expected to have a
material impact on the Companys consolidated financial
statements.
In March 2008, the FASB issued SFAS No. 161,
Disclosures about Derivative Instruments and Hedging
Activities, an amendment of FASB Statement No. 133
(SFAS 161). SFAS 161 requires the Company to
provide greater transparency about how and why it uses
derivative instruments, how the instruments and related hedged
items are accounted for under SFAS No. 133,
Accounting for Derivative Instruments and Hedging
Activities
(SFAS 133), and how the instruments
and related hedged items affect the Companys financial
position, results of operations, and cash flows. SFAS 161
became effective on January 1, 2009. The adoption of
SFAS 161 is not expected to have a material impact on the
Companys consolidated financial statements.
In April 2008, the FASB has issued FASB Staff Position
142-3
(FSP 142-3),
Determination of the Useful Life of Intangible Assets.
FSP 142-3
amends the factors that should be considered in developing
renewal or extension assumptions used to determine the useful
life of a recognized intangible asset under FASB Statement
No. 142,
Goodwill and Other Intangible Asset.
The
intent of
FSP 142-3
is to improve the consistency between the useful life of a
recognized intangible asset under FASB Statement No. 142
and the period of expected cash flows used to measure the fair
value of the asset under SFAS 141(R), and other
U.S. generally accepted accounting principles.
FSP 142-3
is effective for financial statements issued for fiscal years
beginning after December 15, 2008, and interim periods
within those fiscal years. The adoption of
FSP 142-3
is not expected to have a material impact on the Companys
consolidated financial statements.
|
|
Note 3.
|
Balance
Sheet Information
|
Accounts
Receivable:
Accounts receivable consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Accounts receivable
|
|
$
|
20,674
|
|
|
$
|
13,893
|
|
Less: allowance for doubtful accounts
|
|
|
(59
|
)
|
|
|
(121
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
20,615
|
|
|
$
|
13,772
|
|
|
|
|
|
|
|
|
|
|
Unbilled
Receivables
The Company has unbilled receivables pertaining to customer
contractual holdback provisions, whereby the Company invoices
the final retention payment(s) due under its sales contracts in
periods generally ranging from 12 to 24 months after the
product has been shipped to the customer and revenue has been
recognized.
Long-term unbilled receivables as of December 31, 2008 and
2007 consisted of unbilled receivables from customers due more
than one year subsequent to period end. The customer holdbacks
represent amounts intended to provide a form of security for the
customer rather than a form of long-term financing; accordingly,
these receivables have not been discounted to present value. At
December 31, 2008, the expected payment schedule for these
accounts was as follows (in thousands):
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2009
|
|
$
|
|
|
2010
|
|
|
1,929
|
|
|
|
|
|
|
|
|
$
|
1,929
|
|
|
|
|
|
|
53
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
Inventories
Inventories consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Raw materials
|
|
$
|
2,894
|
|
|
$
|
3,450
|
|
Work in process
|
|
|
139
|
|
|
|
102
|
|
Finished goods
|
|
|
5,460
|
|
|
|
1,239
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
8,493
|
|
|
$
|
4,791
|
|
|
|
|
|
|
|
|
|
|
Excess and obsolete reserves included in inventory at
December 31, 2008 and 2007 were $128,000 and $102,000,
respectively.
Property
and Equipment
Property and equipment consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Machinery and equipment
|
|
$
|
2,434
|
|
|
$
|
2,209
|
|
Office equipment, furniture, and fixtures
|
|
|
772
|
|
|
|
368
|
|
Automobiles
|
|
|
22
|
|
|
|
22
|
|
Software
|
|
|
208
|
|
|
|
166
|
|
Leasehold improvements
|
|
|
466
|
|
|
|
301
|
|
Construction in progress
|
|
|
|
|
|
|
169
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,902
|
|
|
|
3,235
|
|
Less: accumulated depreciation and amortization
|
|
|
(2,057
|
)
|
|
|
(1,564
|
)
|
|
|
|
|
|
|
|
|
|
|
|
$
|
1,845
|
|
|
$
|
1,671
|
|
|
|
|
|
|
|
|
|
|
Depreciation and amortization expense was approximately
$493,000, $304,000, and $212,000 for the years ended
December 31, 2008, 2007, and 2006, respectively. Included
in these amounts was depreciation expense related to equipment
under capital leases of approximately $35,000, $37,000, and
$39,000 for the years ended December 31, 2008, 2007, and
2006, respectively.
Intangible
Assets
Intangible assets consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Patents at cost
|
|
$
|
578
|
|
|
$
|
573
|
|
Less: accumulated amortization
|
|
|
(226
|
)
|
|
|
(197
|
)
|
Less: impairment reserve
|
|
|
(31
|
)
|
|
|
(31
|
)
|
|
|
|
|
|
|
|
|
|
Net carrying amount
|
|
$
|
321
|
|
|
$
|
345
|
|
|
|
|
|
|
|
|
|
|
Amortization of intangibles was approximately $29,000, $19,000
and $19,000 for the years ended December 31, 2008, 2007 and
2006, respectively.
54
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
Future estimated amortization expense on intangible assets is as
follows (in thousands):
|
|
|
|
|
|
|
December 31, 2008
|
|
|
2009
|
|
$
|
25
|
|
2010
|
|
|
25
|
|
2011
|
|
|
25
|
|
2012
|
|
|
25
|
|
2013
|
|
|
25
|
|
Thereafter
|
|
|
196
|
|
|
|
|
|
|
|
|
$
|
321
|
|
|
|
|
|
|
The weighted average remaining life at December 31, 2008
and December 31, 2007 was 13.6 and 14.6 years,
respectively.
Accrued
Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consisted of the
following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Accrued payroll and commission expenses
|
|
$
|
2,929
|
|
|
$
|
1,014
|
|
Accrued collaboration fees
|
|
|
916
|
|
|
|
|
|
Inventory in transit
|
|
|
251
|
|
|
|
393
|
|
Professional fees
|
|
|
193
|
|
|
|
180
|
|
Other accrued expenses and current liabilities
|
|
|
498
|
|
|
|
281
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
4,787
|
|
|
$
|
1,868
|
|
|
|
|
|
|
|
|
|
|
Long-term debt consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Promissory notes payable
|
|
$
|
557
|
|
|
$
|
729
|
|
Less: current portion
|
|
|
(172
|
)
|
|
|
(172
|
)
|
|
|
|
|
|
|
|
|
|
Long-term debt
|
|
$
|
385
|
|
|
$
|
557
|
|
|
|
|
|
|
|
|
|
|
Future minimum principal payments due under long-term debt
arrangements consist of the following (in thousands):
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2009
|
|
$
|
172
|
|
2010
|
|
|
172
|
|
2011
|
|
|
128
|
|
2012
|
|
|
85
|
|
|
|
|
|
|
|
|
$
|
557
|
|
|
|
|
|
|
55
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
Revolving
Notes Payable and Promissory Note Payable
On December 1, 2005, the Company entered into an agreement
with a financial institution for a $2.0 million revolving
note (revolving note) and a $222,000 fixed
rate-installment note (fixed promissory note) with
maturity dates of December 1, 2006, subsequently extended
to March 1, 2007 and December 15, 2010, respectively.
The revolving note bears interest at a base rate or LIBOR-based
rate as elected by the Company. The interest rate was amended on
April 26, 2006 to modify the definition of base rate and
increase the rate to base rate plus 1% or LIBOR plus 2.5%. The
fixed promissory note bears an annual interest rate of 10%.
These notes are secured by the Companys accounts
receivable, inventories, property, equipment and other general
intangibles except for intellectual property.
On April 26, 2006, the Company entered into a loan and
security agreement (loan and security agreement)
with the financial institution for an additional
$2.0 million credit facility (credit facility)
with a maturity date of December 1, 2006, subsequently
extended to March 1, 2007. The credit facility advances
bear interest rates of base rate plus 1% or LIBOR plus 2.5%. The
credit facility is secured by the Companys cash and cash
equivalents, accounts receivable, inventory, property and other
general intangibles except for intellectual property.
On December 7, 2006, the revolving note was amended to
increase the face amount of the note to $3.5 million.
On March 1, 2007, the Company renewed the revolving note
and the loan and security agreement (the first
modification) to a maturity date of March 31, 2008.
Additional amended terms under the first modification were an
interest rate change to base rate or LIBOR plus 2.5%, limitation
of advances to a borrowing base, and various reporting
requirements and satisfaction of certain financial ratios and
covenants by the Company.
On March 28, 2007, the Company modified the loan and
security agreement (the second modification) to add
a $1.0 million equipment promissory note (equipment
promissory note). The equipment promissory note bears an
interest rate of cost of funds plus 2.75% and matures
September 30, 2012. Additional amended terms under the
second modification were changes to the financial ratios and
covenants that were to be maintained by the Company.
As of December 31, 2008 and 2007 there were no borrowings
under the revolving note and the credit facility. The amounts
outstanding on the fixed promissory note and the equipment
promissory note were $89,000 and $468,000, respectively, at
December 31, 2008 and $133,000 and $596,000, respectively,
at December 31, 2007. The interest rate for the equipment
promissory note at December 31, 2008 and 2007 was 7.81%.
The Company was in compliance with all covenants under the loan
and security agreement. In February 2009, the Company paid the
remaining balance of the fixed promissory note for a total of
$83,000, including accrued interest.
On March 27, 2008 the Company entered into a new credit
agreement (credit agreement) with its existing
financial institution that replaces the $2.0 million credit
facility and the $3.5 million revolving note. The new
credit agreement, as amended in September 2008 and December
2008, allows borrowings of up to $12.0 million on a
revolving basis at LIBOR plus 2.75% and expires on
March 31, 2009. The credit agreement is secured by the
Companys accounts receivable, inventories, property,
equipment and other intangibles except intellectual property.
The Company is subject to certain financial and administrative
covenants under the new credit agreement. As of
December 31, 2008, the Company was non-compliant with
certain financial reporting covenants under this credit
agreement. Subsequent to December 31, 2008, the lender
granted a waiver for this non-compliance.
During the periods presented, the Company provided certain
customers with irrevocable standby letters of credit to secure
its obligations for the delivery of products, performance
guarantees and warranty commitments in accordance with sales
arrangements. These letters of credit were issued under the
Companys revolving note
56
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
credit facility up to March 2008 and under the Companys
credit agreement beginning in March 2008. The letters of credit
generally terminate within 12 to 36 months but, in some
instances, up to 65 months from issuance. At
December 31, 2008 and December 31, 2007, the amounts
outstanding on these letters of credit totaled approximately
$8.4 million and $2.2 million, respectively.
In February 2009, the Company terminated the March 2008 credit
agreement. As a result, the Company transferred
$9.1 million in cash to a restricted cash account as
collateral for outstanding irrevocable standby letters of credit
that were collateralized by the credit agreement as of the date
of termination.
In January 2009, the Company entered into a new loan and
security agreement with another financial institution which
became effective in February 2009 and provides a total available
credit line of $15.0 million. Under this new agreement, the
Company is allowed to draw advances up to $10.0 million on
a revolving line of credit or utilize up to $14.8 million
as collateral for irrevocable standby letters of credit,
provided that the aggregate of the advances and the collateral
do not exceed $15.0 million. Advances under the revolving
line of credit incur interest based on either a prime rate index
or LIBOR plus 1.375%. The new loan and security agreement
expires on December 31, 2009 and is collateralized by
substantially all of the Companys assets. The Company is
subject to certain financial and administrative covenants under
this new agreement.
The Company leases certain equipment under agreements classified
as capital leases. The terms of the lease agreements generally
range up to five years. Costs and accumulated depreciation of
equipment under capital leases were $175,000 and $115,000 as of
December 31, 2008, respectively. As of December 31,
2007, costs and accumulated depreciation of equipment under
capital leases were $175,000 and $80,000, respectively.
Future minimum payments under capital leases consist of the
following (in thousands):
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2009
|
|
$
|
43
|
|
2010
|
|
|
29
|
|
|
|
|
|
|
Total future minimum lease payments
|
|
|
72
|
|
Less: amount representing interest
|
|
|
(8
|
)
|
|
|
|
|
|
Present value of net minimum capital lease payments
|
|
|
64
|
|
Less: current portion
|
|
|
(37
|
)
|
|
|
|
|
|
Long-term portion
|
|
$
|
27
|
|
|
|
|
|
|
57
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
The components of the provision for income taxes consist of the
following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Current tax expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
$
|
4,817
|
|
|
$
|
3,466
|
|
|
$
|
1,654
|
|
State
|
|
|
803
|
|
|
|
806
|
|
|
|
442
|
|
Foreign
|
|
|
86
|
|
|
|
16
|
|
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
5,706
|
|
|
$
|
4,288
|
|
|
$
|
2,098
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred tax benefit:
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
(612
|
)
|
|
|
(327
|
)
|
|
|
(775
|
)
|
State
|
|
|
(62
|
)
|
|
|
(14
|
)
|
|
|
(84
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(674
|
)
|
|
$
|
(341
|
)
|
|
$
|
(859
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total provision for income taxes
|
|
$
|
5,032
|
|
|
$
|
3,947
|
|
|
$
|
1,239
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
A reconciliation of income taxes computed at the statutory
federal income tax rate to the provision for income taxes
included in the accompanying statements of income is as follows
(in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
U.S. federal taxes at statutory rate
|
|
|
35
|
%
|
|
|
35
|
%
|
|
|
34
|
%
|
State income taxes, net of federal benefit
|
|
|
3
|
|
|
|
5
|
|
|
|
5
|
|
Stock-based compensation
|
|
|
2
|
|
|
|
3
|
|
|
|
11
|
|
Valuation allowance
|
|
|
|
|
|
|
|
|
|
|
(13
|
)
|
Extraterritorial income exclusion
|
|
|
|
|
|
|
|
|
|
|
(3
|
)
|
Other
|
|
|
(3
|
)
|
|
|
(1
|
)
|
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effective tax rate
|
|
|
37
|
%
|
|
|
42
|
%
|
|
|
33
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
58
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
Total deferred tax assets and liabilities consist of the
following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Deferred tax assets:
|
|
|
|
|
|
|
|
|
Net operating loss carry forwards
|
|
$
|
206
|
|
|
$
|
220
|
|
Accruals and reserves
|
|
|
1,941
|
|
|
|
1,210
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
2,147
|
|
|
$
|
1,430
|
|
|
|
|
|
|
|
|
|
|
Deferred tax liabilities:
|
|
|
|
|
|
|
|
|
Depreciation on property and equipment
|
|
$
|
(207
|
)
|
|
$
|
(90
|
)
|
Unrecognized gain on translation of foreign currency receivables
|
|
|
(7
|
)
|
|
|
(140
|
)
|
§481(a) Adjustment - Unicap
|
|
|
(59
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
$
|
(273
|
)
|
|
$
|
(230
|
)
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
1,874
|
|
|
$
|
1,200
|
|
|
|
|
|
|
|
|
|
|
As reported on the balance sheet:
|
|
|
|
|
|
|
|
|
Current assets, net
|
|
$
|
1,755
|
|
|
$
|
1,052
|
|
Non-current assets, net
|
|
|
119
|
|
|
|
148
|
|
|
|
|
|
|
|
|
|
|
Net deferred tax assets
|
|
$
|
1,874
|
|
|
$
|
1,200
|
|
|
|
|
|
|
|
|
|
|
In assessing the recoverability of deferred tax assets,
management considers whether it is more likely than not that the
assets will be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences
become deductible.
Management considers, among other things, projected future
taxable income in making this assessment. Based upon the
projections for future taxable income over the periods in which
the deferred tax items are recognizable for tax reporting
purposes, management has determined it is more likely than not
that the Company will realize the benefits of these differences
at December 31, 2008 and 2007.
At December 31, 2008 and 2007, the Company had net
operating loss carry-forwards of approximately $546,000 and
$588,000, respectively, for federal and $252,000 for California.
The net operating loss carry-forwards, if not utilized, will
expire in 2021 for federal and 2015 for California purposes.
Utilization of the net operating loss carry-forwards is subject
to a substantial annual limitation due to the ownership change
limitations provided by the Internal Revenue Code and similar
state provisions. The annual limitation will result in the
expiration of the net operating loss carry-forwards before
utilization. Management has estimated the amount which may
ultimately be realized and recorded deferred tax assets
accordingly.
The Company adopted the provisions of FIN 48 on
January 1, 2007. Measurement under FIN 48 is based on
judgment regarding the largest amount that is greater than 50%
likely of being realized upon ultimate settlement with a taxing
authority. The total amount of unrecognized tax benefits as of
the date of adoption was immaterial. As a result of the
implementation of FIN 48, the Company recognized no
increase in the liability for unrecognized tax benefits, and
there were no unrecognized income tax benefits during the tax
year ended December 31, 2008.
The Company adopted the accounting policy that interest
recognized in accordance with Paragraph 15 of FIN 48
and penalty recognized in accordance with Paragraph 16 of
FIN 48 are classified as part of its income taxes. The
amounts of interest and penalty recognized in the statements of
income and statements of financial position for the years ended
December 31, 2008 and 2007 were insignificant.
The Company is subject to taxation in the U.S. and various
states and foreign jurisdictions. There are no ongoing
examinations by taxing authorities at this time. The
Companys various tax years from 1995 to 2008 remain open
in various taxing jurisdictions.
59
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
|
|
Note 7.
|
Commitments
and Contingencies
|
Lease
Obligations
The Company leases facilities under fixed non-cancelable
operating leases that expire on various dates through July 2019.
Future minimum lease payments consist of the following (in
thousands):
|
|
|
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2009
|
|
$
|
1,050
|
|
2010
|
|
|
1,342
|
|
2011
|
|
|
1,159
|
|
2012
|
|
|
1,127
|
|
2013
|
|
|
1,155
|
|
Thereafter
|
|
|
6,995
|
|
|
|
|
|
|
|
|
$
|
12,828
|
|
|
|
|
|
|
Total rent and lease expense $651,000, $462,000, and $287,000
for the years ended December 31, 2008, 2007, and 2006,
respectively.
The Company is obligated under an operating lease to pay for
certain tenant improvement costs in excess of a construction
allowance. The Company believes that a reasonable estimate of
its obligation under this agreement ranges from $2 million
to $3 million and expects to incur the costs in 2009.
Warranty
Changes in the Companys accrued warranty reserve and the
expenses incurred under its warranties were as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Balance, beginning of period
|
|
$
|
868
|
|
|
$
|
85
|
|
Warranty costs charged to cost of revenue, including extended
warranty costs
|
|
|
193
|
|
|
|
850
|
|
Utilization of warranty
|
|
|
(103
|
)
|
|
|
(67
|
)
|
Reduction of extended warranty reserve
|
|
|
(688
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance, end of period
|
|
$
|
270
|
|
|
$
|
868
|
|
|
|
|
|
|
|
|
|
|
Warranty costs during 2007 included costs attributable to
estimated service costs under extended service contracts. During
2008, the Company reduced the accrued warranty reserve by
$688,000 to reflect the cancellation of an extended product
warranty contract and the related elimination of the estimated
warranty liability.
Purchase
Obligations
In 2008, the Company entered into a supply agreement with a
vendor. Under this agreement, the Company is obligated to pay a
fee of up to $250,000 if the Company does not meet minimum
purchase requirements by 2012. The Company did not have any
other non-cancelable contractual purchase obligations with its
vendors at December 31, 2008 or December 31, 2007.
The Company had purchase order arrangements with its vendors for
which it had not received the related goods or services at
December 31, 2008 and at December 31, 2007. These
arrangements are subject to change
60
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
based on the Companys sales demand forecasts and the
Company has the right to cancel the arrangements prior to the
date of delivery. The majority of these purchase order
arrangements were related to various key raw materials and
components parts. As of December 31, 2008 and
December 31, 2007, the Company had approximately
$7.1 million and $8.1 million, respectively, of open
cancelable purchase order arrangements.
Guarantees
The Company enters into indemnification provisions under its
agreements with other companies in the ordinary course of
business, typically with customers. Under these provisions, the
Company generally indemnifies and holds harmless the indemnified
party for losses suffered or incurred by the indemnified party
as a result of the Companys activities, generally limited
to personal injury and property damage caused by the
Companys employees at a customers desalination plant
in proportion to the employees percentage of fault for the
accident. Damages incurred for these indemnifications would be
covered by the Companys general liability insurance to the
extent provided by the policy limitations. The Company has not
incurred material costs to defend lawsuits or settle claims
related to these indemnification agreements. As a result, the
estimated fair value of these agreements is not material.
Accordingly, the Company has no liabilities recorded for these
agreements as of December 31, 2008 and December 31,
2007.
In certain cases, the Company issues warranty and product
performance guarantees to its customers for amounts ranging from
10% to 30% of the total sales agreement to endorse the execution
of product delivery and the warranty of design work, fabrication
and operating performance of the PX device. These guarantees are
issued under the Companys credit facility (see
Note 4) or collateralized by restricted cash (see
Note 2). These guarantees typically remain in place for
periods ranging from 24 to 36 months and, in some cases, up
to 65 months, which relate to the underlying product
warranty period.
Employee
Agreements
The Company had agreements with certain executives governing the
terms of their employment for certain periods. All but one of
these agreements expired on December 31, 2008. The
remaining agreement with the Companys chief executive
officer will expire in December 2009.
Litigation
The Company is not party to any material litigation, and the
Company is not aware of any pending or threatened litigation
against it that the Company believes would adversely affect its
business, operating results, financial condition or cash flows.
However, in the future, the Company may be subject to legal
proceedings in the ordinary course of business.
|
|
Note 8.
|
Defined
Contribution Plan
|
The Company has a 401(k) defined contribution plan for all
employees over age 18. Generally, employees can defer up to
20% of their compensation through payroll withholdings into the
plan. The Company can make discretionary matching contributions.
The Company made contributions $105,000, $100,000, and $68,000
during the years ended December 31, 2008, 2007 and 2006,
respectively.
|
|
Note 9.
|
Stockholders
Equity
|
Preferred
Stock
The Company has the authority to issue 10,000,000 shares of
$0.001 par value preferred stock. The Companys board
of directors has the authority, without action by the
Companys stockholders, to designate and issue shares of
preferred stock in one or more series. The board of directors is
also authorized to designate the rights, preferences, and voting
powers of each series of preferred stock, any or all of which
may be greater
61
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
than the rights of the common stock including restrictions of
dividends on the common stock, dilution of the voting power of
the common stock, reduction of the liquidation rights of the
common stock, and delaying or preventing a change in control of
the Company without further action by the stockholders. To date,
the board of directors has not designated any rights, preference
or powers of any preferred stock and as of December 31,
2008 and 2007, none was issued or outstanding.
Common
Stock
The Company has the authority to issue 200,000,000 shares
of $0.001 par value common stock. Subject to the preferred
rights of the holders of shares of any class or series of
preferred stock as provided by the board of directors with
respect to any such class or series of preferred stock, the
holders of the common stock shall be entitled to receive
dividends, as and when declared by the board of directors. In
the event of any liquidation, dissolution or winding up of the
Company, whether voluntary or involuntary, after the
distribution or payment to the holders of shares of any class or
series of preferred stock as provided by the board of directors
with respect to any such class or series of preferred stock, the
remaining assets of the Company available for distribution to
stockholders shall be distributed among and paid to the holders
of common stock ratably in proportion to the number of shares of
common stock held by them respectively. As of December 31,
2008 and 2007, 50,015,718 and 39,777,446 shares were issued
and outstanding, respectively.
On July 2, 2008, the Company sold 14,000,000 shares of
its common stock in its initial public offering
(IPO) at $8.50 per share, before underwriting
discounts and commissions. Of the 14,000,000 shares sold in
the offering, 8,078,566 shares were sold by the Company and
5,921,434 shares were sold by stockholders at an offering
price of $8.50 per share. On July 9, 2008, the underwriters
exercised their option to purchase an additional
2,100,000 shares from the Company at the IPO price to cover
overallotments. The Company received net proceeds of
approximately $76.7 million from these transactions, after
deducting underwriting discounts and commissions of
$6.1 million and additional offering-related expenses of
approximately $3.7 million.
Private
Placement
In June 2007, the Company issued 1,000,000 shares of common
stock with an issuance price of $5.00 per share. Net proceeds
from the issuance were $5.0 million, less $41,000 in fees.
Stock
Option Plans
In April 2001, the Company adopted the 2001 Stock Option Plan
under which 2,500,000 shares of the Companys common
stock were reserved for issuance to employees, directors and
consultants. In April 2002, the Company adopted the 2002 Stock
Option/Stock Issuance Plan under which 1,509,375 shares of
the Companys common stock were reserved for issuance to
employees, directors and consultants. In January 2004, the
Company adopted the 2004 Stock Option/Stock Issuance Plan under
which 850,000 shares of the Companys common stock
were reserved for issuance to employees, directors and
consultants. In May 2006, the Company adopted the 2006 Stock
Option/Stock Issuance Plan under which 800,000 shares of
the Companys common stock were reserved for issuance to
employees, directors and consultants. During the first quarter
of 2008, an additional 60,000 shares of common stock were
reserved for issuance under the 2006 plan, resulting in a total
of 860,000 shares reserved for issuance under this plan. In
2008, the Companys board of directors passed a resolution
that, upon the effectiveness of the IPO in July 2008, no further
options would be issued under the 2001 Stock Option Plan and the
2002, 2004, and 2006 Stock Option/Stock Issuance Plans.
In connection with the IPO in July 2008, the Companys
board of directors adopted the 2008 Equity Incentive Plan
(2008 Plan) which became effective immediately
preceding the effectiveness of the IPO. The 2008 Plan permits
the grant of stock options, stock appreciation rights,
restricted stock, restricted stock units, performance units,
performance shares and other stock-based awards. Under this
plan, 1,400,000 shares of
62
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
common stock were reserved for issuance in 2008, of which
146,449 shares remain available for issuance as of December
31, 2008. In February 2009, the Companys board of
directors approved an additional 2,500,000 shares to
reserve for issuance under this plan, as provided for in the
plan agreement.
The option plans provide for the issuance of common stock and
the granting of incentive stock options and other share-based
awards to employees, officers and directors and the granting of
non-statutory stock options and other share-based awards to
employees, officers and directors or consultants of the Company.
The Company has granted stock options under these plans. The
Company grants incentive stock options with exercise prices of
not less than the estimated fair value of the stock on the date
of grant (85% of the estimated fair value for non-statutory
stock options). If, at the time the Company grants an option,
the optionee directly owns stock possessing more than 10% of the
total combined voting power of all classes of stock of the
Company, the option price must be at least 110% of the estimated
fair value and are not exercisable for more than five years
after the date of grant. Options granted under the plans vest
generally over four years and generally expire no more than ten
years after the date of grant or earlier if employment is
terminated.
Early
Exercise of Employee Options
Options issued under the 2001 Stock Option Plan and the 2002,
2004, and 2006 Stock Option/Stock Issuance Plans may be
exercised prior to vesting, with the underlying shares subject
to the Companys right of repurchase, which lapses over the
vesting term. The 2008 Plan does not allow options to be
exercised prior to vesting. In accordance with EITF Issue
No. 23, Issues Related to the Accounting for Stock
Compensation under APB 25 and FIN 44, shares purchased by
employees pursuant to the early exercise of stock options are
not deemed to be issued until all restrictions on such shares
lapse (i.e., the employee is vested in the award). Therefore,
consideration received in exchange for exercised and restricted
shares related to the early exercise of stock options is
recorded as a liability for early exercise of stock options in
the accompanying consolidated balance sheets and will be
transferred into common stock and additional paid-in capital as
the restrictions on such shares lapse.
In February 2005, both vested and unvested options to purchase
4,293,958 shares of common stock were exercised by the
signing of full recourse promissory notes totaling $948,000. The
notes bear interest at 3.76% and are due in February 2010. The
interest rate on the notes was deemed to be a below market rate
of interest resulting in a deemed modification in exercise price
of the options. As a result, the Company accounted for these
options as variable option awards until the employees were
vested in the award. For the years ended December 31, 2008,
2007 and 2006, the Company recorded $155,000, $783,000, and
$1.1 million, respectively, of stock-based compensation
related to the options exercised with promissory notes.
As of December 31, 2008, there were no shares outstanding
subject to the Companys right of repurchase as a result of
the early exercise of options. As of December 31, 2007,
56,879 shares of common stock were outstanding subject to
the Companys right of repurchase at prices ranging from
$0.20 to $1.00, totaling $20,000 and classified in current
liabilities.
The promissory notes related to the exercise of the unvested
shares and the corresponding aggregate exercise price for these
shares were recorded as notes receivable from stockholders. Of
the $948,000 of promissory notes, notes in an aggregate amount
of $552,000 were issued by executive officers and directors. As
of December 31, 2008, all notes issued by executive
officers and directors were paid in full. The remaining
outstanding balances of the full recourse promissory notes at
December 31, 2008 were $296,000 and were related entirely
to vested shares. There were no outstanding balances related to
unvested shares at December 31, 2008. The outstanding
balances of the full recourse promissory notes at
December 31, 2007 were $855,000, of which $835,000 related
to vested shares and $20,000 related to unvested shares.
For the years ended December 31, 2008, 2007 and 2006, the
Company adopted SFAS 123R and recognized stock-based
compensation under SFAS 123R and
EITF 96-18
related to employees and consultants of $879,000, $253,000 and
$13,000, respectively. See Note 2 Summary of
Significant Accounting Policies.
63
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
The following table summarizes the stock option activity under
the Companys stock option plans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
Average
|
|
|
Aggregate
|
|
|
|
|
|
|
Average
|
|
|
Remaining
|
|
|
Intrinsic
|
|
|
|
|
|
|
Exercise
|
|
|
Contractual
|
|
|
Value (in
|
|
|
|
Shares
|
|
|
Price
|
|
|
Life (in years)
|
|
|
thousands)(2)
|
|
|
Balance 12/31/05
|
|
|
556,042
|
|
|
$
|
1.00
|
|
|
|
9.8
|
|
|
|
|
|
Granted
|
|
|
642,000
|
|
|
$
|
2.65
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(5,000
|
)
|
|
$
|
1.00
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(25,730
|
)
|
|
$
|
1.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance 12/31/06
|
|
|
1,167,312
|
|
|
$
|
1.91
|
|
|
|
9.4
|
|
|
|
|
|
Granted
|
|
|
181,900
|
|
|
$
|
5.00
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(17,083
|
)
|
|
$
|
1.00
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(51,521
|
)
|
|
$
|
1.32
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance 12/31/07
|
|
|
1,280,608
|
|
|
$
|
2.38
|
|
|
|
8.6
|
|
|
$
|
3,355
|
|
Granted
|
|
|
1,367,078
|
|
|
$
|
8.27
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(26,511
|
)
|
|
$
|
1.96
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(89,189
|
)
|
|
$
|
4.78
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance 12/31/08
|
|
|
2,531,986
|
|
|
$
|
5.48
|
|
|
|
8.6
|
|
|
$
|
6,593
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and exercisable as of December 31, 2008
|
|
|
693,964
|
|
|
$
|
1.99
|
|
|
|
7.4
|
|
|
$
|
3,879
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Vested and exercisable as of December 31, 2008
and expected to vest thereafter(1)
|
|
|
1,896,470
|
|
|
$
|
5.20
|
|
|
|
8.5
|
|
|
$
|
5,409
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
|
Options that are expected to vest are net of estimated future
option forfeitures in accordance with the provisions of
SFAS 123R.
|
|
(2)
|
|
The aggregate intrinsic value is calculated as the difference
between the exercise price of the underlying options and the
fair value of the Companys stock as of December 31,
2008 of $7.58 per share.
|
Shares available for grant under the option plans at
December 31, 2008 and 2007 were 146,449 and 53,351,
respectively.
The weighted average per share fair value of options granted to
employees for the years ended December 31, 2008, 2007 and
2006 was $3.87, $2.41 and $1.30, respectively. The aggregate
intrinsic value of options exercised for the years ended
December 31, 2008, 2007, and 2006 was $108,000, $62,000,
and $8,000, respectively. As of December 31, 2008, total
unrecognized compensation cost, net of forfeitures, related to
non-vested options was $3.3 million, which is expected to
be recognized as expense over a weighted-average period of
approximately 3.4 years.
64
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
The following table summarizes options outstanding after
exercises and cancellations as of December 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
|
|
|
Weighted
|
|
|
|
|
|
Weighted
|
|
|
|
Outstanding
|
|
|
Remaining
|
|
|
Average
|
|
|
|
|
|
Average
|
|
|
|
and
|
|
|
Contractual
|
|
|
Exercise
|
|
|
Vested and
|
|
|
Exercise
|
|
Range of Exercise
Prices
|
|
Exercisable
|
|
|
Life
|
|
|
Price
|
|
|
Exercisable
|
|
|
Price
|
|
|
$1.00 $2.65
|
|
|
1,039,281
|
|
|
|
7.4
|
|
|
$
|
1.95
|
|
|
|
643,472
|
|
|
$
|
1.75
|
|
$5.00 $7.94
|
|
|
334,854
|
|
|
|
9.1
|
|
|
$
|
5.39
|
|
|
|
50,492
|
|
|
$
|
5.00
|
|
$8.50 $11.05
|
|
|
1,157,851
|
|
|
|
9.5
|
|
|
$
|
8.68
|
|
|
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,531,986
|
|
|
|
|
|
|
|
|
|
|
|
693,964
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Warrants
As of December 31, 2008, the Company had outstanding
warrants to purchase an aggregate of 2,074,122 shares of
the Companys common stock at prices ranging from $0.20 to
$1.00 per share. The warrants, issued in 2002 through 2005, are
fully exercisable over a 10 year term, expiring in 2012
through 2015. The outstanding warrants include a warrant issued
in November 2005 to an executive officer of the Company to
purchase 150,000 shares of common stock at $1.00 per share.
During the year ended December 31, 2008, no warrants were
exercised.
During the year ended December 31, 2007, warrants to
purchase 314,950 shares of common stock were exercised for
cash and the proceeds received by the Company from these
exercises were $143,000.
During the year ended December 31, 2006, no warrants were
exercised.
In February 2005, warrants to purchase 315,974 shares of
common stock were exercised by the signing of full recourse
promissory notes totaling $63,000. The notes bear interest at
3.76% and are due February 2010. As of December 31, 2008,
all of the notes have been repaid and, as of December 31,
2007, $43,000 of the notes had been repaid.
A summary of the Companys warrant activity for the years
ended (in thousands, except exercise prices and contractual life
data):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Outstanding, beginning of period
|
|
|
2,074
|
|
|
|
2,389
|
|
|
|
2,589
|
|
Exercised during the period
|
|
|
|
|
|
|
(315
|
)
|
|
|
|
|
Cancelled during the period
|
|
|
|
|
|
|
|
|
|
|
(200
|
)
|
Issued during the period
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, end of period
|
|
|
2,074
|
|
|
|
2,074
|
|
|
|
2,389
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted average exercise price of warrants outstanding at end
of period
|
|
$
|
0.52
|
|
|
$
|
0.52
|
|
|
$
|
0.52
|
|
Weighted average remaining contractual life, in years, of
warrants outstanding at end of period
|
|
|
4.7
|
|
|
|
5.7
|
|
|
|
6.7
|
|
65
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
|
|
Note 10.
|
Business
Segment and Geographic Information
|
The Company manufactures and sells high efficiency energy
recovery products and related services and operates under one
segment. The Companys chief operating decision maker is
the chief executive officer (CEO). The CEO reviews
financial information presented on a consolidated basis,
accompanied by disaggregated information about revenue by
geographic region for purposes of making operating decisions and
assessing financial performance. Accordingly, the Company has
concluded that it has one reportable segment.
The following geographic information includes net revenue to the
Companys domestic and international customers based on the
customers requested delivery locations, except for certain
cases in which the customer directed the Company to deliver its
products to a location that differs from the known ultimate
location of use. In such cases, the ultimate location of use,
rather than the delivery location, is reflected in the table
below (in thousands, except percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended
|
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
Domestic revenue
|
|
$
|
3,517
|
|
|
$
|
2,125
|
|
|
$
|
1,003
|
|
International revenue
|
|
|
48,602
|
|
|
|
33,289
|
|
|
|
19,055
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
$
|
52,119
|
|
|
$
|
35,414
|
|
|
$
|
20,058
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue by country:
|
|
|
|
|
|
|
|
|
|
|
|
|
Algeria
|
|
|
24
|
%
|
|
|
12
|
%
|
|
|
30
|
%
|
Spain
|
|
|
16
|
|
|
|
35
|
|
|
|
9
|
|
China
|
|
|
11
|
|
|
|
8
|
|
|
|
5
|
|
United Arab Emirates
|
|
|
7
|
|
|
|
2
|
|
|
|
10
|
|
Saudi Arabia
|
|
|
*
|
|
|
|
13
|
|
|
|
*
|
|
Others
|
|
|
42
|
|
|
|
30
|
|
|
|
46
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
100
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
* Less than 1%.
Approximately 100% of the Companys long-lived assets were
located in the United States at December 31, 2008 and 2007.
Concentration
of Credit Risk
Substantially all of the Companys cash and cash
equivalents are placed on deposit and in money market funds at
two major financial institutions in the U.S. Amounts
located in the U.S. are insured by the Federal Deposit
Insurance Corporation, or FDIC, generally up to $250,000. The
Companys deposits may be in excess of FDIC insured limits.
To date, the Company has not experienced any losses in such
accounts.
The Companys accounts receivable are derived from sales to
customers in the water desalination industry located around the
world. The Company generally does not require collateral to
support customer receivables, but frequently requires letters of
credit securing payment. The Company performs ongoing
evaluations of its customers financial condition and
periodically reviews credit risk associated with receivables.
For sales with customers outside the U.S. (see
Note 10 Business Segment and Geographic
Information), the Company may also obtain credit risk insurance
to minimize credit risk exposure. As of December 31, 2008,
approximately 50% of the Companys accounts receivable were
insured against credit risk. An allowance for doubtful accounts
is determined with respect to receivable amounts that the
Company has determined to be doubtful of
66
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
collection using specific identification of doubtful accounts
and an aging of receivables analysis based on invoice due dates.
Actual collection losses may differ from managements
estimates, and such differences could be material to the
financial position, results of operations and cash flows.
Uncollectible receivables are written off against the allowance
for doubtful accounts when all efforts to collect them have been
exhausted while recoveries are recognized when they are received.
Five customers accounted for approximately 81% of the
Companys accounts receivable at December 31, 2008. As
of December 31, 2007, three customers accounted for
approximately 74% of accounts receivable.
Revenue from customers representing 10% or more of total revenue
varies from year to year. For the year ended December 31,
2008, two customers, Hyflux Limited and Befesa Agua S.A. and
affiliated joint ventures, accounted for approximately 16% and
11% of the Companys net revenue, respectively. For the
year ended December 31, 2007, three customers represented
approximately 20%, 23% and 13% of the Companys net
revenue specifically Acciona Agua, Geida and its
member companies, and Doosan Heavy Industries, respectively. In
2006, two customers, GE Water and Process Technologies (formerly
GE Ionics) and Geida, including its member companies, accounted
for approximately 18% and 11% of the Companys net revenue,
respectively. No other customer accounted for more than 10% of
the Companys net revenue during any of these periods.
Geida is a consortium of Befesa Agua, a subsidiary of Abengoa
S.A; Cobra-Tedagua, a subsidiary of ACS Actividades de
Construcción y Servicios, S.A.; and Sadyt S.A., a
subsidiary of Sacyr Vallehermoso, S. A.
Supplier
Concentration
Certain of the raw materials and components used by the Company
in the manufacture of its products are available from a limited
number of suppliers. Shortages could occur in these essential
materials and components due to an interruption of supply or
increased demand in the industry. If the Company were unable to
procure certain of such materials or components, it would be
required to reduce its manufacturing operations, which could
have a material adverse effect on its results of operations.
For year ended December 31, 2008, four suppliers (of which
three were ceramics suppliers) represented approximately 72% of
the total purchases of the Company. For the years ended 2007 and
2006, three suppliers (of which two were ceramics suppliers)
represented approximately 66% and 71%, respectively, of the
total purchases of the Company. As of December 31, 2008 and
2007, approximately 68% and 60%, respectively, of the
Companys accounts payable were due to these suppliers.
|
|
Note 12.
|
Related
Party Transactions
|
The Company entered into a supply agreement with Piedmont
Pacific Corporation, a company owned by James Medanich, a former
director of the Company. Expenses incurred under this supply
agreement amounted to $14,000, $18,000 and $4,000 for the years
ending December 31, 2008, 2007 and 2006, respectively.
There were no payments outstanding to this vendor as of
December 31, 2008 and $1,000 was outstanding as of
December 31, 2007. The Company believes that the
transactions under the supply agreement were conducted as if
consummated on an arms-length basis between two
independent parties.
The Company entered into a consulting agreement with Darby
Engineering, LLC (invoiced as Think Mechanical, LLC), a firm
owned by Peter Darby, a former director of the Company. Expenses
incurred under this consulting agreement amounted to $119,000
for the year ended December 31, 2008; $27,000 in payments
remained outstanding related to the agreement as of
December 31, 2008. There were no expenses or payments
related to the consulting agreement during the years ended
December 31, 2007 or 2006. The Company believes that the
transactions under the consulting agreement were conducted as if
consummated on an arms-length basis between two
independent parties.
67
ENERGY
RECOVERY, INC.
NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS(Continued)
|
|
Note 13.
|
Supplementary
Data Quarterly Financial Data (unaudited)
|
The following table presents certain unaudited consolidated
quarterly financial information for each of the eight fiscal
quarters in the period ended December 31, 2008. This
quarterly information has been prepared on the same basis as the
audited Consolidated Financial Statements and includes all
adjustments, consisting only of normal recurring adjustments,
necessary for a fair presentation of the information for the
periods presented. The results for these quarterly periods are
not necessarily indicative of the operating results for a full
year or any future period.
QUARTERLY
FINANCIAL DATA (unaudited)
(in thousands, except per share amounts)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended,
|
|
|
|
Dec. 31,
|
|
|
Sept. 30,
|
|
|
June 30,
|
|
|
March 31,
|
|
|
Dec. 31,
|
|
|
Sept. 30,
|
|
|
June 30,
|
|
|
March 31,
|
|
|
|
2008
|
|
|
2008
|
|
|
2008
|
|
|
2008
|
|
|
2007
|
|
|
2007
|
|
|
2007
|
|
|
2007
|
|
|
Quarterly Results of Operations*
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net revenue
|
|
$
|
21,994
|
|
|
$
|
9,044
|
|
|
$
|
11,961
|
|
|
$
|
9,120
|
|
|
$
|
13,845
|
|
|
$
|
10,978
|
|
|
$
|
3,452
|
|
|
$
|
7,139
|
|
Gross profit
|
|
|
14,183
|
|
|
|
5,547
|
|
|
|
8,010
|
|
|
|
5,446
|
|
|
|
7,517
|
|
|
|
6,882
|
|
|
|
1,878
|
|
|
|
4,285
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General administrative
|
|
|
3,110
|
|
|
|
2,696
|
|
|
|
2,854
|
|
|
|
2,661
|
|
|
|
1,513
|
|
|
|
1,053
|
|
|
|
960
|
|
|
|
773
|
|
Sales and marketing
|
|
|
2,286
|
|
|
|
1,467
|
|
|
|
1,453
|
|
|
|
1,343
|
|
|
|
1,443
|
|
|
|
1,372
|
|
|
|
1,224
|
|
|
|
1,191
|
|
Research and development
|
|
|
692
|
|
|
|
678
|
|
|
|
536
|
|
|
|
509
|
|
|
|
484
|
|
|
|
392
|
|
|
|
440
|
|
|
|
389
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
$
|
8,095
|
|
|
$
|
706
|
|
|
$
|
3,167
|
|
|
$
|
933
|
|
|
$
|
4,077
|
|
|
$
|
4,065
|
|
|
$
|
(746
|
)
|
|
$
|
1,932
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income (loss)
|
|
$
|
5,264
|
|
|
$
|
623
|
|
|
$
|
1,829
|
|
|
$
|
947
|
|
|
$
|
2,701
|
|
|
$
|
2,397
|
|
|
$
|
(424
|
)
|
|
$
|
1,119
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.11
|
|
|
$
|
0.01
|
|
|
$
|
0.05
|
|
|
$
|
0.02
|
|
|
$
|
0.07
|
|
|
$
|
0.06
|
|
|
$
|
(0.01
|
)
|
|
$
|
0.03
|
|
Diluted
|
|
$
|
0.10
|
|
|
$
|
0.01
|
|
|
$
|
0.04
|
|
|
$
|
0.02
|
|
|
$
|
0.06
|
|
|
$
|
0.06
|
|
|
$
|
(0.01
|
)
|
|
$
|
0.03
|
|
* Quarterly results may not add up to annual results due to
rounding.
68
|
|
Item 9.
|
Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure
|
None.
|
|
Item 9A(T).
|
Controls
and Procedures
|
Evaluation
of Disclosure Controls and Procedures
Our management, with the participation of our chief executive
officer and chief financial officer, has evaluated the
effectiveness of our disclosure controls and procedures (as
defined in
Rules 13a-15(e)
and
15d-15(e)
under the Securities Exchange Act of 1934, or Exchange
Act) pursuant to
Rules 13a-15(e)
and
15d-15(e)
under the Exchange Act as of the end of the period covered by
this Annual Report on
Form 10-K.
Based on this evaluation, our chief executive officer and chief
financial officer have concluded that, as of such date, our
disclosure controls and procedures were effective to ensure that
information we are required to disclose in reports that we file
or submit under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms, and that
such information is accumulated and communicated to management
as appropriate to allow for timely decisions regarding required
disclosure.
Our disclosure controls and procedures are designed to provide
reasonable assurance of achieving their objectives and our chief
executive officer and chief financial officer have concluded
that these controls and procedures are effective at the
reasonable assurance level. Our management,
including the chief executive officer and chief financial
officer, believes that a control system, no matter how well
designed and operated, cannot provide absolute assurance that
the objectives of the control system are met, and that no
evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within a company
have been detected.
Managements
Annual Report on Internal Control Over Financial Reporting and
Attestation Report of the Registered Accounting Firm
This annual report does not include a report of
managements assessment regarding internal control over
financial reporting or an attestation report of the
companys registered public accounting firm due to a
transition period established by rules of the Securities and
Exchange Commission for newly public companies. We are required
to comply with the internal control reporting requirements of
Section 404 of the Sarbanes-Oxley Act of 2002 for our
fiscal year ending December 31, 2009. The management report and
auditor attestation on the effectiveness of the Companys
internal control over financial reporting must be included in
our annual report for the fiscal year ending December 31,
2009.
Changes
in Internal Control Over Financial Reporting
There were no changes in our internal control over financial
reporting that occurred during our most recent fiscal quarter
that have materially affected, or are reasonably likely to
materially affect, our internal control over financial reporting.
|
|
Item 9B.
|
Other
Information
|
None.
69
PART III
|
|
Item 10.
|
Directors,
Executive Officers and Corporate Governance
|
The information required by this Item is incorporated by
reference from the Companys Definitive Proxy Statement
related to the Annual Meeting of Shareholders to be held
June 12, 2009, to be filed by the Company with the SEC (the
Proxy Statement).
|
|
Item 11.
|
Executive
Compensation
|
The information required by this Item is incorporated by
reference from the Proxy Statement.
|
|
Item 12.
|
Security
Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
|
The information required by this Item is incorporated by
reference from the Proxy Statement.
|
|
Item 13.
|
Certain
Relationships and Related Transactions and Director
Independence
|
The information required by this Item is incorporated by
reference from the Proxy Statement.
|
|
Item 14.
|
Principal
Accountant Fees and Services
|
The information required by this item is incorporated by
reference from the Proxy Statement.
PART IV
|
|
Item 15.
|
Exhibits
and Financial Statement Schedules
|
(a) The following documents are included as part of this
Annual Report on
Form 10-K.
(1)
Financial Statements.
|
|
|
|
|
|
|
Page in
|
|
|
Form 10-K
|
|
|
|
|
38
|
|
|
|
|
39
|
|
|
|
|
40
|
|
|
|
|
41
|
|
|
|
|
42
|
|
|
|
|
43
|
|
(2)
Financial Statement Schedules.
70
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additions
|
|
|
|
|
|
|
|
|
|
Balance at
|
|
|
to Charged
|
|
|
|
|
|
|
|
|
|
Beginning of
|
|
|
Costs and
|
|
|
|
|
|
Balance at
|
|
Description
|
|
Period
|
|
|
Expenses
|
|
|
Deductions
|
|
|
End of Period
|
|
|
Year Ended December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts
|
|
|
150
|
|
|
|
80
|
|
|
|
|
|
|
|
230
|
|
Reserve for obsolete inventory
|
|
|
97
|
|
|
|
30
|
|
|
|
(72
|
)
|
|
|
55
|
|
Warranty reserve
|
|
|
110
|
|
|
|
61
|
|
|
|
(86
|
)
|
|
|
85
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts
|
|
|
230
|
|
|
|
(105
|
)
|
|
|
(4
|
)
|
|
|
121
|
|
Reserve for obsolete inventory
|
|
|
55
|
|
|
|
47
|
|
|
|
|
|
|
|
102
|
|
Warranty reserve
|
|
|
85
|
|
|
|
850
|
|
|
|
(67
|
)
|
|
|
868
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year Ended December 31, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for doubtful accounts
|
|
|
121
|
|
|
|
75
|
|
|
|
(137
|
)
|
|
|
59
|
|
Reserve for obsolete inventory
|
|
|
102
|
|
|
|
26
|
|
|
|
|
|
|
|
128
|
|
Warranty reserve
|
|
|
868
|
|
|
|
193
|
|
|
|
(791
|
)
|
|
|
270
|
|
All other schedules have been omitted because the information
required to be presented in them is not applicable or is shown
in the consolidated financial statements or related notes.
(3)
Exhibits:
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
|
Description
|
3.1
|
|
|
*
|
|
|
Amended and Restated Certificate of Incorporation, as filed with
the Delaware Secretary of State on July 7, 2008.
|
|
3.2
|
|
|
*
|
|
|
Amended and Restated Bylaws, effective as of July 8, 2008.
|
|
10.1
|
|
|
(2)
u
|
|
|
Form of Indemnification Agreement between the Company and its
directors and officers.
|
|
10.2
|
|
|
(1)
u
|
|
|
2001 Stock Option Plan of the Company and form of Stock Option
Agreement thereunder.
|
|
10.3
|
|
|
(1)
u
|
|
|
2002 Stock Option/Stock Issuance Plan of the Company and forms
of Stock Option and Stock Purchase Agreements thereunder.
|
|
10.4
|
|
|
(1)
u
|
|
|
2004 Stock Option/Stock Issuance Plan of the Company and forms
of Stock Option and Stock Purchase Agreements thereunder.
|
|
10.5
|
|
|
(1)
u
|
|
|
2006 Stock Option/Stock Issuance Plan of the Company and forms
of Stock Option and Stock Purchase Agreements thereunder.
|
|
10.5.1
|
|
|
(1)
u
|
|
|
Amendment to 2006 Stock Option/Stock Issuance Plan of the
Company.
|
|
10.5.2
|
|
|
(1)
u
|
|
|
Second Amendment to 2006 Stock Option/Stock Issuance Plan of the
Company.
|
|
10.6
|
|
|
(2)
u
|
|
|
2008 Equity Incentive Plan of the Company and form of Stock
Option Agreement thereunder.
|
|
10.6.1
|
|
|
(4)
u
|
|
|
Amendment to 2008 Equity Incentive Plan of the Company.
|
|
10.7
|
|
|
(1)
u
|
|
|
Employment Agreement dated March 1, 2006, between the Company
and G.G. Pique.
|
|
10.7.1
|
|
|
(1)
u
|
|
|
Amendment to Employment Agreement dated January 1, 2008, between
the Company and G.G. Pique.
|
|
71
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
|
Description
|
10.7.2
|
|
|
(3)
u
|
|
|
Amendment to Employment Agreement dated May 28, 2008, between
the Company and G.G. Pique.
|
|
10.7.3
|
|
|
*
u
|
|
|
Amendment to Employment Agreement dated December 31, 2008,
between the Company and G.G. Pique.
|
|
10.8
|
|
|
(1)
u
|
|
|
Employment Agreement dated November 1, 2007, between the Company
and Tom Willardson.
|
|
10.8.1
|
|
|
(1)
u
|
|
|
Amendment to Employment Agreement dated February 25, 2008,
between the Company and Tom Willardson.
|
|
10.9
|
|
|
(1)
u
|
|
|
Employment Agreement dated July 1, 2006, between the Company and
Richard Stover.
|
|
10.9.1
|
|
|
(1)
u
|
|
|
Amendment to Employment Agreement dated February 25, 2008,
between the Company and Richard Stover.
|
|
10.10
|
|
|
(1)
u
|
|
|
Employment Agreement dated July 1, 2006, between the Company and
Terrill Sandlin.
|
|
10.10.1
|
|
|
(1)
u
|
|
|
Amendment to Employment Agreement dated February 25, 2008,
between the Company and Terrill Sandlin.
|
|
10.11
|
|
|
(1)
u
|
|
|
Employment Agreement dated July 1, 2006, between the Company and
MariaElena Ross.
|
|
10.11.1
|
|
|
(1)
u
|
|
|
Amendment to Employment Agreement dated February 25, 2008,
between the Company and MariaElena Ross.
|
|
10.12
|
|
|
(1)
|
|
|
Independent Contractor Agreement dated January 23, 2008, between
the Company and Darby Engineering LLC.
|
|
10.13
|
|
|
(1)
|
|
|
Lease Agreement dated February 28, 2005, between the Company and
2101 Williams Associates, LLC.
|
|
10.13.1
|
|
|
(1)
|
|
|
Amendment to Lease Agreement dated October 3, 2005, between the
Company and 2101 Williams Associates, LLC.
|
|
10.13.2
|
|
|
(1)
|
|
|
Second Amendment to Lease Agreement dated January 4, 2006,
between the Company and 2101 Williams Associates, LLC.
|
|
10.13.3
|
|
|
(1)
|
|
|
Third Amendment to Lease Agreement dated September 26, 2006,
between the Company and 2101 Williams Associates, LLC.
|
|
10.14
|
|
|
(1)
|
|
|
Lease Agreement dated February 15, 2008, between the Company and
Beretta Investment Group.
|
|
10.15
|
|
|
(1)
|
|
|
Lease Agreement dated August 7, 2006, between Energy Recovery
Iberia, S.L. and REGUS Business Centre.
|
|
10.16
|
|
|
(2)
|
|
|
Loan and Security Agreement dated March 27, 2008, between the
Company and Comerica Bank.
|
|
10.16.1
|
|
|
(2)
|
|
|
First Modification to Loan and Security Agreement dated March
27, 2008, between the Company and Comerica Bank.
|
|
10.16.2
|
|
|
(3)
|
|
|
Second Modification to Loan and Security Agreement dated May 29,
2008, between the Company and Comerica Bank.
|
|
10.16.3
|
|
|
|
|
|
Third Modification to Loan and Security Agreement dated
September 18, 2008, between the Company and Comerica Bank,
incorporated by reference herein to Exhibit 10.16.3 previously
filed with the Companys Quarterly Report on Form 10-Q for
the quarter ended September 30, 2008.
|
|
10.16.4
|
|
|
*
|
|
|
Fourth Modification to Loan and Security Agreement dated
December 23, 2008, between the Company and Comerica Bank.
|
|
72
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
|
Description
|
10.17
|
|
|
*
|
|
|
Lease Agreement dated November 25, 2008, between the Company and
Doolittle Williams, LLC.
|
|
10.18
|
|
|
*
|
|
|
Lease Agreement dated September 1, 2008, between Energy Recovery
Iberia, S.L. and Lambaesis, S.L.
|
|
14.1
|
|
|
*
|
|
|
Code of Ethics.
|
|
21.1
|
|
|
*
|
|
|
List of subsidiaries of the Company.
|
|
23.1
|
|
|
*
|
|
|
Consent of BDO Seidman, LLP, Independent Registered Public
Accounting Firm.
|
|
31.1
|
|
|
*
|
|
|
Certification of Principal Executive Officer pursuant to
Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
31.2
|
|
|
*
|
|
|
Certification of Principal Financial Officer pursuant to
Exchange Act Rule 13a-14(a) or 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
32.1
|
|
|
*
|
|
|
Certification of Principal Executive Officer and Principal
Financial Officer, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
(1)
|
|
|
|
|
|
Incorporated by reference herein to the same numbered exhibit
previously filed with the Companys Registration Statement
on Form S-1, as amended (Registration No. 333-150007), filed
April 1, 2008.
|
|
(2)
|
|
|
|
|
|
Incorporated by reference herein to the same numbered exhibit
previously filed with the Companys Registration Statement
on Form S-1, as amended (Registration No. 333-150007), filed May
12, 2008.
|
|
(3)
|
|
|
|
|
|
Incorporated by reference herein to the same numbered exhibit
previously filed with the Companys Registration Statement
on Form S-1, as amended (Registration No. 333-150007), filed
June 9, 2008.
|
|
(4)
|
|
|
|
|
|
Incorporated by reference herein to the same numbered exhibit
previously filed with the Companys Registration Statement
on Form S-1, as amended (Registration No. 333-150007), filed
June 27, 2008.
|
|
|
|
|
u
|
|
Indicates management compensatory plan, contract or arrangement.
|
|
*
|
|
Filed or furnished herewith, as applicable.
|
(b)
Index to Exhibits.
See Exhibits listed under Item 15(a) (3).
(c)
Financial Statement Schedules.
All financial statement schedules are omitted because they are
not applicable or not required or because the required
information is included in the financial statements, or notes
there to, or in the Exhibits listed under Item 15(a)(2).
73
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused
this Report to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of San Leandro,
State of California, on the 26th day of March 2009.
ENERGY RECOVERY, INC.
G.G. Pique
President and Chief Executive Officer
Pursuant to the requirements of the Securities and Exchange Act
of 1934, this Report has been signed below by the following
persons on behalf of the Registrant and in the capacities and on
the dates indicated.
|
|
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
|
/s/
G.G.
PIQUE
G.G.
Pique
|
|
President and Chief Executive Officer
(Principal Executive Officer) and Director
|
|
March 26, 2009
|
|
|
|
|
|
/s/
THOMAS
D. WILLARDSON
Thomas
D. Willardson
|
|
Chief Financial Officer (Principal
Financial Officer)
|
|
March 26, 2009
|
|
|
|
|
|
/s/
DENO
G. BOKAS
Deno
G. Bokas
|
|
Vice President Finance and Chief
Accounting Officer (Principal Accounting
Officer)
|
|
March 26, 2009
|
|
|
|
|
|
/s/
HANS
PETER MICHELET
Hans
Peter Michelet
|
|
Executive Chairman
|
|
March 26, 2009
|
|
|
|
|
|
/s/
ARVE
HANSTVEIT
Arve
Hanstveit
|
|
Director
|
|
March 26, 2009
|
|
|
|
|
|
/s/
FRED
OLAV JOHANNESSEN
Fred
Olav Johannessen
|
|
Director
|
|
March 26, 2009
|
|
|
|
|
|
/s/
DOMINIQUE
TREMPONT
Dominique
Trempont
|
|
Director
|
|
March 26, 2009
|
|
|
|
|
|
/s/
PAUL
M. COOK
Paul
M. Cook
|
|
Director
|
|
March 26, 2009
|
|
|
|
|
|
/s/
JACKALYNE
PFANNESTIEL
Jackalyne
Pfannestiel
|
|
Director
|
|
March 26, 2009
|
|
|
|
|
|
Marie-Elisabeth
Paté-Cornell
|
|
Director
|
|
|
74
EXHIBIT INDEX
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
|
Description
|
3.1
|
|
|
*
|
|
|
Amended and Restated Certificate of Incorporation, as filed with
the Delaware Secretary of State on July 7, 2008.
|
|
3.2
|
|
|
*
|
|
|
Amended and Restated Bylaws, effective as of July 8, 2008.
|
|
10.1
|
|
|
(2)
u
|
|
|
Form of Indemnification Agreement between the Company and its
directors and officers.
|
|
10.2
|
|
|
(1)
u
|
|
|
2001 Stock Option Plan of the Company and form of Stock Option
Agreement thereunder.
|
|
10.3
|
|
|
(1)
u
|
|
|
2002 Stock Option/Stock Issuance Plan of the Company and forms
of Stock Option and Stock Purchase Agreements thereunder.
|
|
10.4
|
|
|
(1)
u
|
|
|
2004 Stock Option/Stock Issuance Plan of the Company and forms
of Stock Option and Stock Purchase Agreements thereunder.
|
|
10.5
|
|
|
(1)
u
|
|
|
2006 Stock Option/Stock Issuance Plan of the Company and forms
of Stock Option and Stock Purchase Agreements thereunder.
|
|
10.5.1
|
|
|
(1)
u
|
|
|
Amendment to 2006 Stock Option/Stock Issuance Plan of the
Company.
|
|
10.5.2
|
|
|
(1)
u
|
|
|
Second Amendment to 2006 Stock Option/Stock Issuance Plan of the
Company.
|
|
10.6
|
|
|
(2)
u
|
|
|
2008 Equity Incentive Plan of the Company and form of Stock
Option Agreement thereunder.
|
|
10.6.1
|
|
|
(4)
u
|
|
|
Amendment to 2008 Equity Incentive Plan of the Company.
|
|
10.7
|
|
|
(1)
u
|
|
|
Employment Agreement dated March 1, 2006, between the
Company and G.G. Pique.
|
|
10.7.1
|
|
|
(1)
u
|
|
|
Amendment to Employment Agreement dated January 1, 2008,
between the Company and G.G. Pique.
|
|
10.7.2
|
|
|
(3)
u
|
|
|
Amendment to Employment Agreement dated May 28, 2008,
between the Company and G.G. Pique.
|
|
10.7.3
|
|
|
*
u
|
|
|
Amendment to Employment Agreement dated December 31, 2008,
between the Company and G.G. Pique.
|
|
10.8
|
|
|
(1)
u
|
|
|
Employment Agreement dated November 1, 2007, between the
Company and Tom Willardson.
|
|
10.8.1
|
|
|
(1)
u
|
|
|
Amendment to Employment Agreement dated February 25, 2008,
between the Company and Tom Willardson.
|
|
10.9
|
|
|
(1)
u
|
|
|
Employment Agreement dated July 1, 2006, between the
Company and Richard Stover.
|
|
10.9.1
|
|
|
(1)
u
|
|
|
Amendment to Employment Agreement dated February 25, 2008,
between the Company and Richard Stover.
|
|
10.10
|
|
|
(1)
u
|
|
|
Employment Agreement dated July 1, 2006, between the
Company and Terrill Sandlin.
|
|
10.10.1
|
|
|
(1)
u
|
|
|
Amendment to Employment Agreement dated February 25, 2008,
between the Company and Terrill Sandlin.
|
|
10.11
|
|
|
(1)
u
|
|
|
Employment Agreement dated July 1, 2006, between the
Company and MariaElena Ross.
|
|
10.11.1
|
|
|
(1)
u
|
|
|
Amendment to Employment Agreement dated February 25, 2008,
between the Company and MariaElena Ross.
|
|
10.12
|
|
|
(1)
|
|
|
Independent Contractor Agreement dated January 23, 2008,
between the Company and Darby Engineering LLC.
|
|
10.13
|
|
|
(1)
|
|
|
Lease Agreement dated February 28, 2005, between the
Company and 2101 Williams Associates, LLC.
|
|
75
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
|
Description
|
10.13.1
|
|
|
(1)
|
|
|
Amendment to Lease Agreement dated October 3, 2005, between
the Company and 2101 Williams Associates, LLC.
|
|
10.13.2
|
|
|
(1)
|
|
|
Second Amendment to Lease Agreement dated January 4, 2006,
between the Company and 2101 Williams Associates, LLC.
|
|
10.13.3
|
|
|
(1)
|
|
|
Third Amendment to Lease Agreement dated September 26,
2006, between the Company and 2101 Williams Associates, LLC.
|
|
10.14
|
|
|
(1)
|
|
|
Lease Agreement dated February 15, 2008, between the
Company and Beretta Investment Group.
|
|
10.15
|
|
|
(1)
|
|
|
Lease Agreement dated August 7, 2006, between Energy
Recovery Iberia, S.L. and REGUS Business Centre.
|
|
10.16
|
|
|
(2)
|
|
|
Loan and Security Agreement dated March 27, 2008, between
the Company and Comerical Bank.
|
|
10.16.1
|
|
|
(2)
|
|
|
First Modification to Loan and Security Agreement dated
March 27, 2008, between the Company and Comerica Bank.
|
|
10.16.2
|
|
|
(3)
|
|
|
Second Modification to Loan and Security Agreement dated
May 29, 2008, between the Company and Comerica Bank.
|
|
10.16.3
|
|
|
|
|
|
Third Modification to Loan and Security Agreement dated
September 18, 2008, between the Company and Comerica Bank,
incorporated by reference herein to Exhibit 10.16.3
previously filed with the Companys Quarterly Report on
Form 10-Q
for the quarter ended September 30, 2008.
|
|
10.16.4
|
|
|
*
|
|
|
Fourth Modification to Loan and Security Agreement dated
December 23, 2008, between the Company and Comerica Bank.
|
|
10.17
|
|
|
*
|
|
|
Lease Agreement dated November 25, 2008, between the
Company and Doolittle Williams, LLC.
|
|
10.18
|
|
|
*
|
|
|
Lease Agreement dated September 1, 2008, between Energy
Recovery Iberia, S.L. and Lambaesis, S.L.
|
|
14.1
|
|
|
*
|
|
|
Code of Ethics.
|
|
21.1
|
|
|
*
|
|
|
List of subsidiaries of the Company.
|
|
23.1
|
|
|
*
|
|
|
Consent of BDO Seidman, LLP, Independent Registered Public
Accounting Firm.
|
|
31.1
|
|
|
*
|
|
|
Certification of Principal Executive Officer pursuant to
Exchange Act
Rule 13a-14(a)
or 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
31.2
|
|
|
*
|
|
|
Certification of Principal Financial Officer pursuant to
Exchange Act
Rule 13a-14(a)
or 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
32.1
|
|
|
*
|
|
|
Certification of Principal Executive Officer and Principal
Financial Officer, pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
|
|
(1)
|
|
|
|
|
|
Incorporated by reference herein to the same numbered exhibit
previously filed with the Companys Registration Statement
on
Form S-1,
as amended (Registration
No. 333-150007),
filed April 1, 2008.
|
|
(2)
|
|
|
|
|
|
Incorporated by reference herein to the same numbered exhibit
previously filed with the Companys Registration Statement
on
Form S-1,
as amended (Registration
No. 333-150007),
filed May 12, 2008.
|
|
76
|
|
|
|
|
|
|
Exhibit
|
|
|
|
|
|
Description
|
(3)
|
|
|
|
|
|
Incorporated by reference herein to the same numbered exhibit
previously filed with the Companys Registration Statement
on
Form S-1,
as amended (Registration
No. 333-150007),
filed June 9, 2008.
|
|
(4)
|
|
|
|
|
|
Incorporated by reference herein to the same numbered exhibit
previously filed with the Companys Registration Statement
on
Form S-1,
as amended (Registration
No. 333-150007),
filed June 27, 2008.
|
|
|
|
|
u
|
|
Indicates management compensatory plan, contract or arrangement.
|
|
*
|
|
Filed or furnished herewith, as applicable.
|
77
Exhibit 3.2
AMENDED AND RESTATED BYLAWS
OF
ENERGY RECOVERY, INC.
(Amended and Restated effective as of July 8, 2008)
ARTICLE I CORPORATE OFFICES
1.1 REGISTERED OFFICE.
The registered office of Energy Recovery, Inc. shall be fixed in the corporations certificate
of incorporation, as the same may be amended and/or restated from time to time (as so amended
and/or restated, the
Certificate
).
1.2 OTHER OFFICES.
The corporations Board of Directors (the
Board
) may at any time establish other
offices at any place or places where the corporation is qualified to do business.
ARTICLE II MEETINGS OF STOCKHOLDERS
2.1 PLACE OF MEETINGS.
Meetings of stockholders shall be held at any place within or outside the State of Delaware as
designated by the Board. The Board may, in its sole discretion, determine that a meeting of
stockholders shall not be held at any place, but may instead be held solely by means of remote
communication as authorized by Section 211(a)(2) of the Delaware General Corporation Law (the
DGCL
). In the absence of any such designation or determination, stockholders meetings
shall be held at the corporations principal executive office.
2.2 ANNUAL MEETING.
The annual meeting of stockholders shall be held each year on a date and at a time designated
by the Board. At the annual meeting, directors shall be elected and any other proper business may
be transacted.
2.3 SPECIAL MEETING.
Unless otherwise required by law or the Certificate, special meetings of the stockholders may
be called at any time, for any purpose or purposes, only by (a) the Board, (b) the Chairperson of
the Board, (c) the chief executive officer or (d) the president of the corporation.
No business may be transacted at such special meeting other than the business specified in the
notice to stockholders of such meeting.
2.4 NOTICE OF STOCKHOLDERS MEETINGS.
All notices of meetings of stockholders shall be sent or otherwise given in accordance with
either Section 2.5 or Section 8.1 of these bylaws not less than ten (10) nor more than 60 days
before the date of the meeting to each stockholder entitled to vote at such meeting, except as
otherwise required by applicable law. The notice shall specify the place, if any, date and hour of
the meeting, the means of remote communication, if any, by which stockholders and proxy holders may
be deemed to be present in person and vote at such meeting, and, in the case of a special meeting,
the purpose or purposes for which the meeting is called. Any previously scheduled meeting of
stockholders may be postponed, and, unless the Certificate provides otherwise, any special meeting
of the stockholders may be cancelled by resolution
duly adopted by a majority of the Board members then in office upon public notice given prior
to the date previously scheduled for such meeting of stockholders.
Whenever notice is required to be given, under the DGCL, the Certificate or these bylaws, to
any person with whom communication is unlawful, the giving of such notice to such person shall not
be required and there shall be no duty to apply to any governmental authority or agency for a
license or permit to give such notice to such person. Any action or meeting which shall be taken
or held without notice to any such person with whom communication is unlawful shall have the same
force and effect as if such notice had been duly given. In the event that the action taken by the
corporation is such as to require the filing of a certificate with the Secretary of State of
Delaware, the certificate shall state, if such is the fact and if notice is required, that notice
was given to all persons entitled to receive notice except such persons with whom communication is
unlawful.
Whenever notice is required to be given, under any provision of the DGCL, the Certificate or
these bylaws, to any stockholder to whom (A) notice of two (2) consecutive annual meetings, or
(B) all, and at least two (2), payments (if sent by first-class mail) of dividends or interest on
securities during a 12 month period, have been mailed addressed to such person at such persons
address as shown on the records of the corporation and have been returned undeliverable, the giving
of such notice to such person shall not be required. Any action or meeting which shall be taken or
held without notice to such person shall have the same force and effect as if such notice had been
duly given. If any such person shall deliver to the corporation a written notice setting forth
such persons then current address, the requirement that notice be given to such person shall be
reinstated. In the event that the action taken by the corporation is such as to require the filing
of a certificate with the Secretary of State of Delaware, the certificate need not state that
notice was not given to persons to whom notice was not required to be given pursuant to
Section 230(b) of the DGCL.
The exception in subsection (A) of the above paragraph to the requirement that notice be given
shall not be applicable to any notice returned as undeliverable if the notice was given by
electronic transmission.
2.5 MANNER OF GIVING NOTICE; AFFIDAVIT OF NOTICE.
Notice of any meeting of stockholders shall be given:
(a) if mailed, when deposited in the United States mail, postage prepaid, directed to the
stockholder at his or her address as it appears on the corporations records;
(b) if electronically transmitted, as provided in Section 8.1 of these bylaws; or
(c) otherwise, when delivered.
An affidavit of the secretary or an assistant secretary of the corporation or of the transfer
agent or any other agent of the corporation that the notice has been given shall, in the absence of
fraud, be
prima facie
evidence of the facts stated therein.
Notice may be waived in accordance with Section 7.12 of these bylaws.
2.6 QUORUM.
Unless otherwise provided in the Certificate or required by law, stockholders representing a
majority of the voting power of the issued and outstanding capital stock of the corporation,
present in person or represented by proxy, shall constitute a quorum for the transaction of
business at all meetings of the stockholders. If such quorum is not present or represented at any
meeting of the stockholders, then the chairperson of the meeting, or the stockholders representing
a majority of the voting power of the capital
- 2 -
stock at the meeting, present in person or represented by proxy, shall have power to adjourn
the meeting from time to time until a quorum is present or represented. At such adjourned meeting
at which a quorum is present or represented, any business may be transacted that might have been
transacted at the meeting as originally noticed. The stockholders present at a duly called meeting
at which a quorum is present may continue to transact business until adjournment, notwithstanding
the withdrawal of enough stockholders to leave less than a quorum unless the number of stockholders
who withdrew does not permit action to be taken by the stockholders in accordance with the DGCL.
2.7 ADJOURNED MEETING; NOTICE.
When a meeting is adjourned to another time or place, unless these bylaws otherwise require,
notice need not be given of the adjourned meeting if the time, place if any thereof, and the means
of remote communications if any by which stockholders and proxy holders may be deemed to be present
in person and vote at such adjourned meeting are announced at the meeting at which the adjournment
is taken. At the continuation of the adjourned meeting, the corporation may transact any business
that might have been transacted at the original meeting. If the adjournment is for more than 30
days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of
the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting
in accordance with the provisions of Section 2.4 and Section 2.5 of these bylaws.
2.8 ADMINISTRATION OF THE MEETING.
Meetings of stockholders shall be presided over by the Chairperson of the Board and the chief
executive officer of the corporation. If both the Chairperson of the Board and the chief executive
officer will not be present at a meeting of stockholders, such meeting shall be presided over by
such chairperson as the Board shall appoint, or, in the event that the Board shall fail to make
such appointment, any officer of the corporation elected by the Board. The secretary of the meeting
shall be the secretary of the corporation, or, in the absence of the secretary of the corporation,
such person as the chairperson of the meeting appoints.
The Board shall, in advance of any meeting of stockholders, appoint one (1) or more
inspector(s), who may include individual(s) who serve the corporation in other capacities,
including without limitation as officers, employees or agents, to act at the meeting of
stockholders and make a written report thereof. The Board may designate one (1) or more persons as
alternate inspector(s) to replace any inspector, who fails to act. If no inspector or alternate has
been appointed or is able to act at a meeting of stockholders, the chairperson of the meeting shall
appoint one (1) or more inspector(s) to act at the meeting. Each inspector, before discharging his
or her duties, shall take and sign an oath to faithfully execute the duties of inspector with
strict impartiality and according to the best of his or her ability. The inspector(s) or
alternate(s) shall have the duties prescribed pursuant to Section 231 of the DGCL or other
applicable law.
The Board shall be entitled to make such rules or regulations for the conduct of meetings of
stockholders as it shall deem necessary, appropriate or convenient. Subject to such rules and
regulations, if any, the chairperson of the meeting shall have the right and authority to prescribe
such rules, regulations and procedures and to do all acts as, in the judgment of such chairperson,
are necessary, appropriate or convenient for the proper conduct of the meeting, including without
limitation establishing an agenda of business of the meeting, rules or regulations to maintain
order, restrictions on entry to the meeting after the time fixed for commencement thereof and the
fixing of the date and time of the opening and closing of the polls for each matter upon which the
stockholders will vote at a meeting (and shall announce such at the meeting).
- 3 -
2.9 VOTING.
The stockholders entitled to vote at any meeting of stockholders shall be determined in
accordance with the provisions of Section 2.11 of these bylaws, subject to Section 217 (relating to
voting rights of fiduciaries, pledgors and joint owners of stock) and Section 218 (relating to
voting trusts and other voting agreements) of the DGCL.
Except as otherwise provided in the provisions of Section 213 of the DGCL (relating to the
fixing of a date for determination of stockholders of record), each stockholder shall be entitled
to that number of votes for each share of capital stock held by such stockholder as set forth in
the Certificate.
In all matters, other than the election of directors and except as otherwise required by law,
the Certificate or these bylaws, the affirmative vote of a majority of the voting power of the
shares present or represented by proxy at the meeting and entitled to vote on the subject matter
shall be the act of the stockholders. Directors shall be elected by a plurality of the voting power
of the shares present in person or represented by proxy at the meeting and entitled to vote on the
election of directors.
The stockholders of the corporation shall not have the right to cumulate their votes for the
election of directors of the corporation.
2.10 NO STOCKHOLDER ACTION BY WRITTEN CONSENT WITHOUT A MEETING.
Any action required or permitted to be taken by the stockholders of the corporation (if the
corporation has more than one stockholder at such time) must be effected at a duly called annual or
special meeting of stockholders of the corporation and may not be effected by any consent in
writing by such stockholders.
2.11 RECORD DATE FOR STOCKHOLDER NOTICE; VOTING; GIVING CONSENTS.
In order that the corporation may determine the stockholders entitled to notice of or to vote
at any meeting of stockholders or any adjournment thereof, or entitled to receive payment of any
dividend or other distribution or allotment of any rights, or entitled to exercise any rights in
respect of any change, conversion or exchange of stock or for the purpose of any other lawful
action, the Board may fix, in advance, a record date, which record date shall not precede the date
on which the resolution fixing the record date is adopted and which shall not be more than 60 nor
less than ten (10) days before the date of such meeting, nor more than 60 days prior to any other
such action.
If the Board does not fix a record date in accordance with these bylaws and applicable law:
(a) The record date for determining stockholders entitled to notice of or to vote at a meeting
of stockholders shall be at the close of business on the day next preceding the day on which notice
is given, or, if notice is waived, at the close of business on the day next preceding the day on
which the meeting is held.
(b) The record date for determining stockholders entitled to consent to corporate action in
writing without a meeting, when no prior action by the Board is necessary, shall be the first day
on which a signed written consent setting forth the action taken or proposed to be taken is
delivered to the corporation.
(c) The record date for determining stockholders for any other purpose shall be at the close
of business on the day on which the Board adopts the resolution relating thereto.
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A determination of stockholders of record entitled to notice of or to vote at a meeting of
stockholders shall apply to any adjournment of the meeting; provided, however, that the Board may
fix a new record date for the adjourned meeting.
2.12 PROXIES.
Each stockholder entitled to vote at a meeting of stockholders may authorize another person or
persons to act for such stockholder by proxy authorized by an instrument in writing or by a
transmission permitted by law and filed with the secretary of the corporation, but no such proxy
shall be voted or acted upon after three (3) years from its date, unless the proxy provides for a
longer period. A stockholder may also authorize another person or persons to act for him, her or it
as proxy in the manner(s) provided under Section 212(c) of the DGCL or as otherwise provided under
Delaware law. The revocability of a proxy that states on its face that it is irrevocable shall be
governed by the provisions of Section 212 of the DGCL.
2.13 LIST OF STOCKHOLDERS ENTITLED TO VOTE.
The officer who has charge of the stock ledger of the corporation shall prepare and make, at
least ten (10) days before every meeting of stockholders, a complete list of the stockholders
entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each
stockholder and the number of shares registered in the name of each stockholder. The corporation
shall not be required to include electronic mail addresses or other electronic contact information
on such list. Such list shall be open to the examination of any stockholder, for any purpose
germane to the meeting for a period of at least ten (10) days prior to the meeting: (a) on a
reasonably accessible electronic network, provided that the information required to gain access to
such list is provided with the notice of the meeting, or (b) during ordinary business hours, at the
corporations principal place of business.
In the event that the corporation determines to make the list available on an electronic
network, the corporation may take reasonable steps to ensure that such information is available
only to stockholders of the corporation. If the meeting is to be held at a place, then the list
shall be produced and kept at the time and place of the meeting during the whole time thereof, and
may be inspected by any stockholder who is present. If the meeting is to be held solely by means
of remote communication, then the list shall also be open to the examination of any stockholder
during the whole time of the meeting on a reasonably accessible electronic network, and the
information required to access such list shall be provided with the notice of the meeting. Such
list shall presumptively determine the identity of the stockholders entitled to vote at the meeting
and the number of shares held by each of them.
2.14 ADVANCE NOTICE OF STOCKHOLDER BUSINESS.
Only such business shall be conducted as shall have been properly brought before a meeting of
the stockholders of the corporation. To be properly brought before an annual meeting, and except
as otherwise provided in Section 2.15 which governs director nominations, business must be
(a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of
the Board, (b) otherwise properly brought before the meeting by or at the direction of the Board,
or (c) a proper matter for stockholder action under the DGCL that has been properly brought before
the meeting by a stockholder (i) who is a stockholder of record on the date of the giving of the
notice provided for in this Section 2.14 and on the record date for the determination of
stockholders entitled to vote at such annual meeting and (ii) who complies with the notice
procedures set forth in this Section 2.14. For such business to be considered properly brought
before the meeting by a stockholder such stockholder must, in addition to any other applicable
requirements, have given timely notice in proper form of such stockholders intent to bring such
business before such meeting. To be timely, such stockholders notice must be delivered to or
mailed and received by the secretary of the corporation at the principal executive offices of the
corporation not later than the close of business on the ninetieth (90
th
) day, nor
earlier than the close of
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business on the one hundred twentieth (120
th
) day, prior to the anniversary date on
which the corporation first mailed its proxy statement to stockholders in connection with the
immediately preceding annual meeting; provided, however, that in the event that no annual meeting
was held in the previous year or the annual meeting is called for a date that is not within thirty
(30) days before or after such anniversary date, notice by the stockholder to be timely must be so
received not later than the close of business the tenth (10
th
) day following the day on
which such notice of the date of the meeting was mailed or public disclosure of the date of the
meeting was made, whichever occurs first. For purposes of this Section 2.14 and Section 2.15,
public disclosure means disclosure in a press release reported by a national news service or in a
document filed by the corporation with the Securities and Exchange Commission pursuant to Section
13, 14 or 15(d) of the Securities Exchange Act of 1934 (the Exchange Act) and the rules and
regulations promulgated thereunder.
To be in proper form, a stockholders notice to the secretary shall be in writing and shall
set forth:
(a) the name and record address of the stockholder who intends to propose the business and the
class or series and number of shares of capital stock of the corporation which are owned
beneficially or of record by such stockholder;
(b) a representation that the stockholder is a holder of record of stock of the corporation
entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to
introduce the business specified in the notice;
(c) a brief description of the business desired to be brought before the annual meeting and
the reasons for conducting such business at the annual meeting;
(d) any material interest of the stockholder in such business; and
(e) any other information that is required to be provided by the stockholder pursuant to
Regulation 14A under the Securities Exchange Act of 1934, as amended (the
Exchange Act
).
Notwithstanding the foregoing, in order to include information with respect to a stockholder
proposal in the corporations proxy statement and form of proxy for a stockholders meeting,
stockholders must provide notice (earlier than the deadline stated above) as required by, and
otherwise comply with the requirements of, the Exchange Act and the regulations promulgated
thereunder, and the proposal must be eligible for such inclusion within the meaning of the Exchange
Act and those regulations. Without limiting the generality of the foregoing, nothing in this
Section 2.14, Section 2.15 or any other provisions of these bylaws shall obligate the corporation
to include in the corporations proxy statement and form of proxy nominations for directors made by
stockholders (unless, and except to the extent that, future laws or regulations would obligate the
corporation to do so).
No business shall be conducted at the annual meeting of stockholders except business brought
before the annual meeting in accordance with the procedures set forth in this Section 2.14 and
Section 2.15, as applicable. The chairperson of the meeting may refuse to acknowledge the proposal
of any business not made in compliance with the foregoing procedure. The term business shall
include any nomination of directors and any other proposal by a shareholder or shareholders outside
or different from the specific nominations or proposals recommended by the corporations directors
in the corporations annual meeting proxy statement. Sections 2.14 and Section 2.15 shall apply
according to their respective terms whether a shareholder seeks to include a proposal in the
corporations proxy statement or form of proxy, files a separate proxy solicitation in contest with
the corporations proxy statement, or in any other manner attempts to bring business before the
annual meeting.
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2.15 ADVANCE NOTICE OF DIRECTOR NOMINATIONS.
Only persons who are nominated in accordance with the following procedures shall be eligible
for election as directors of the corporation, except as may be otherwise provided in the
Certificate with respect to the right of holders of Preferred Stock of the corporation to nominate
and elect a specified number of directors, if any. To be properly brought before an annual meeting
of stockholders, or any special meeting of stockholders called for the purpose of electing
directors, nominations for the election of director must be (a) specified in the notice of meeting
(or any supplement thereto), (b) made by or at the direction of the Board (or any duly authorized
committee thereof) or (c) made by any stockholder of the corporation (i) who is a stockholder of
record on the date of the giving of the notice provided for in this Section 2.15 and on the record
date for the determination of stockholders entitled to vote at such meeting and (ii) who complies
with the notice procedures set forth in this Section 2.15.
In addition to any other applicable requirements, for a nomination to be made by a
stockholder, such stockholder must have given timely notice thereof in proper written form to the
secretary of the corporation. To be timely, a stockholders notice to the secretary must be
delivered to or mailed and
received at the principal executive offices of the corporation, in the case of an annual
meeting, in accordance with the provisions set forth in Section 2.14 of these bylaws, and, in the
case of a special meeting of stockholders called for the purpose of electing directors, not later
than the close of business on the tenth (10th) day following the day on which notice of the date of
the special meeting was mailed or public disclosure of the date of the special meeting was made,
whichever first occurs.
To be in proper written form, a stockholders notice to the secretary must set forth:
(a) as to each person whom the stockholder proposes to nominate for election as a director
(i) the name, age, business address and residence address of the person, (ii) the principal
occupation or employment of the person, (iii) the class or series and number of shares of capital
stock of the corporation which are owned beneficially or of record by the person, (iv) a
description of all arrangements or understandings between the stockholder and each nominee and any
other person or persons (naming such person or persons) pursuant to which the nominations are to be
made by the stockholder, and (v) any other information relating to such person that is required to
be disclosed in solicitations of proxies for elections of directors, or is otherwise required, in
each case pursuant to Regulation 14A under the Exchange Act (including without limitation such
persons written consent to being named in the proxy statement, if any, as a nominee and to serving
as a director if elected); and
(b) as to such stockholder giving notice, the information required to be provided pursuant to
Section 2.14 of these bylaws.
Subject to the rights of any holders of Preferred Stock of the corporation, if any, no person
shall be eligible for election as a director of the corporation unless nominated in accordance with
the procedures set forth in this Section 2.15. If the chairperson of the meeting properly
determines that a nomination was not made in accordance with the foregoing procedures, the
chairperson shall declare to the meeting that the nomination was defective and such defective
nomination shall be disregarded.
ARTICLE III DIRECTORS
3.1 POWERS.
Subject to the provisions of the DGCL and any limitations in the Certificate, the business and
affairs of the corporation shall be managed and all corporate powers shall be exercised by or under
the direction of the Board.
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3.2 NUMBER OF DIRECTORS; CHAIRPERSON OR CHAIRMAN.
The authorized number of directors shall be determined from time to time by resolution of the
Board, provided the Board shall consist of at least one member. No reduction of the authorized
number of directors shall have the effect of removing any director before that directors term of
office expires. The Board may, in its discretion, designate one of the directors to serve in the
capacity of Chairperson with duties and responsibilities as the Board may from time to time assign
to such person. The Board, and the Corporations documents and public filings, may refer to the
Chairperson as the Chairman.
3.3 ELECTION, QUALIFICATION AND TERM OF OFFICE OF DIRECTORS.
Except as provided in Section 3.4 and Section 3.14 of these bylaws, directors shall be elected
at each annual meeting of stockholders to hold office until the next annual meeting. Directors need
not be stockholders unless so required by the Certificate or these bylaws. The Certificate or these
bylaws may prescribe other qualifications for directors. Each director, including a director
elected to fill a vacancy, shall hold office until such directors successor is elected and
qualified or until such directors earlier death, resignation or removal.
Except as provided in the Certificate or Section 3.4 of these bylaws, directors shall be
classified, with respect to the time for which they severally hold office, into three (3) classes,
as nearly equal in number as possible, one (1) class to be originally elected for a term expiring
at the annual meeting of stockholders to be held in 2009, another class to be originally elected
for a term expiring at the annual meeting of stockholders to be held in 2010, and another class to
be originally elected for a term expiring at the annual meeting of stockholders to be held in 2011,
with each class to hold office until its successor is duly elected and qualified. At each
succeeding annual meeting of stockholders, commencing with the first annual meeting (a) directors
elected to succeed those directors whose terms then expire shall be elected for a term of office to
expire at the third succeeding annual meeting of stockholders after their election, with each
director to hold office until his or her successor shall have been duly elected and qualified, and
(b) if authorized by a resolution of the Board, directors may be elected to fill any vacancy on the
Board, regardless of how such vacancy shall have been created (as set forth in Section 3.4 below).
3.4 RESIGNATION AND VACANCIES.
Any director may resign at any time upon written notice or by electronic transmission to the
corporation.
Subject to the rights of the holders of any series of Preferred Stock of the corporation then
outstanding, if any, and unless the Board otherwise determines, newly created directorships
resulting from any increase in the authorized number of directors, or any vacancies on the Board
resulting from the death, resignation, retirement, disqualification, removal from office or other
cause shall, unless otherwise required by law, be filled by the affirmative vote of a majority of
the remaining directors then in office, even though less than a quorum of the Board, or by a sole
remaining director. A person so elected by the directors then in office to fill a vacancy or newly
created directorship shall hold office until the next election of the class for which such director
shall have been chosen and until his or her successor shall have been duly elected and qualified.
When one or more directors resigns and the resignation is effective at a future date, a majority of
the directors then in office, including those who have so resigned, shall have power to fill such
vacancy or vacancies, the vote thereon to take effect when such resignation or resignations shall
become effective, and each director so chosen shall hold office as provided in this Section 3.4 in
the filling of other vacancies.
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3.5 PLACE OF MEETINGS; MEETINGS BY TELEPHONE.
The Board may hold meetings, both regular and special, either within or outside the State of
Delaware.
Unless otherwise restricted by the Certificate or these bylaws, members of the Board, or any
committee designated by the Board, may participate in a meeting of the Board, or any committee, by
means of conference telephone or other communications equipment by means of which all persons
participating in the meeting can hear each other, and such participation in a meeting shall
constitute presence in person at the meeting.
3.6 CONDUCT OF BUSINESS.
Meetings of the Board shall be presided over by the Chairperson of the Board, if any, or in
his or her absence by a chairperson designated by the Board, or in the absence of such designation
by a chairperson chosen at the meeting. The secretary shall act as secretary of the meeting, but in
his or her absence the chairperson of the meeting may appoint any person to act as secretary of the
meeting.
3.7 REGULAR MEETINGS.
Regular meetings of the Board may be held without notice at such time and at such place as
shall from time to time be determined by the Board.
3.8 SPECIAL MEETINGS; NOTICE.
Special meetings of the Board for any purpose or purposes may be called at any time by the
Chairperson of the Board, the chief executive officer, the president, the secretary or a majority
of the authorized number of directors. The person(s) authorized to call special meetings of the
Board may fix the place and time of the meeting.
Notice of the time and place of special meetings shall be:
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(a)
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delivered personally by hand, by courier or by telephone;
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(b)
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sent by United States first-class mail, postage prepaid;
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(c)
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sent by facsimile; or
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(d)
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sent by electronic mail,
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directed to each director at that directors address, telephone number, facsimile number or
electronic mail address, as the case may be, as shown on the corporations records.
If the notice is (i) delivered personally by hand, by courier or by telephone, (ii) sent by
facsimile or (iii) sent by electronic mail, it shall be delivered or sent at least 24 hours before
the time of the holding of the meeting. If the notice is sent by United States mail, it shall be
deposited in the United States mail at least four days before the time of the holding of the
meeting. Any oral notice may be communicated either to the director or to a person at the office of
the director who the person giving notice has reason to believe will promptly communicate such
notice to the director. The notice need not specify the place of the meeting if the meeting is to
be held at the corporations principal executive office nor the purpose of the meeting.
3.9 QUORUM.
Except as otherwise required by law or the Certificate, at all meetings of the Board, a
majority of the authorized number of directors (as determined pursuant to Section 3.2 of these
bylaws) shall constitute a
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quorum for the transaction of business, except to adjourn as provided in Section 3.12 of these
bylaws. The vote of a majority of the directors present at any meeting at which a quorum is present
shall be the act of the Board, except as may be otherwise specifically provided by statute, the
Certificate or these bylaws.
A meeting at which a quorum is initially present may continue to transact business
notwithstanding the withdrawal of directors, if any action taken is approved by at least a majority
of the directors present at that meeting.
3.10 WAIVER OF NOTICE.
Whenever notice is required to be given under any provisions of the DGCL, the Certificate or
these bylaws, a written waiver thereof, signed by the person entitled to notice, or a waiver by
electronic transmission by the person entitled to notice, whether before or after the time stated
therein, shall be deemed equivalent to notice. Attendance of a person at a meeting shall constitute
a waiver of notice of such meeting, except when the person attends a meeting solely for the express
purpose of objecting, at the beginning of the meeting, to the transaction of any business because
the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the
purpose of, any regular or special meeting of the directors, or members of a committee of
directors, need be specified in any written waiver of notice or any waiver by electronic
transmission unless so required by the Certificate or these bylaws.
3.11 BOARD ACTION BY WRITTEN CONSENT WITHOUT A MEETING.
Unless otherwise restricted by the Certificate or these bylaws, any action required or
permitted to be taken at any meeting of the Board, or of any committee thereof, may be taken
without a meeting if all members of the Board or committee, as the case may be, consent thereto in
writing or by electronic transmission and the writing or writings or electronic transmission or
transmissions are filed with the minutes of proceedings of the Board or committee. Such filing
shall be in paper form if the minutes are maintained in paper form and shall be in electronic form
if the minutes are maintained in electronic form.
3.12 ADJOURNED MEETING; NOTICE.
If a quorum is not present at any meeting of the Board, then a majority of the directors
present thereat may adjourn the meeting from time to time, without notice other than announcement
at the meeting, until a quorum is present.
3.13 FEES AND COMPENSATION OF DIRECTORS.
Unless otherwise restricted by the Certificate or these bylaws, the Board shall have the
authority to fix the compensation of directors.
3.14 REMOVAL OF DIRECTORS.
Unless otherwise restricted by statute, the Certificate or these bylaws, any director, or all
of the directors, may be removed from the Board, but only for cause, and only by the affirmative
vote of the holders of at least a majority of the voting power of all the then outstanding shares
of capital stock of the corporation then entitled to vote at the election of directors, voting
together as a single class.
ARTICLE IV COMMITTEES
4.1 COMMITTEES OF DIRECTORS.
The Board may designate one or more committees, each committee to consist of one or more of
the directors of the corporation. The Board may designate one or more directors as alternate
members of any committee, who may replace any absent or disqualified member at any meeting of the
committee. In the absence or disqualification of a member of a committee, the member or members
thereof present at any
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meeting and not disqualified from voting, whether or not such member or members constitute a
quorum, may unanimously appoint another member of the Board to act at the meeting in the place of
any such absent or disqualified member. Any such committee, to the extent provided in the
resolution of the Board or in these bylaws, shall have and may exercise such lawfully delegable
powers and duties as the Board may confer.
4.2 COMMITTEE MINUTES.
Each committee shall keep regular minutes of its meetings and report to the Board when
required.
4.3 MEETINGS AND ACTION OF COMMITTEES.
Meetings and actions of committees shall be governed by, and held and taken in accordance
with, the provisions of:
(a) Section 3.5 (relating to place of meetings and meetings by telephone);
(b) Section 3.7 (relating to regular meetings);
(c) Section 3.8 (relating to special meetings and notice);
(d) Section 3.9 (relating to quorum);
(e) Section 3.10 (relating to waiver of notice);
(f) Section 3.11 (relating to action without a meeting); and
(g) Section 3.12 (relating to adjournment and notice of adjournment) of these bylaws, with
such changes in the context of those bylaws as are necessary to substitute the committee and its
members for the Board and its members.
Notwithstanding the foregoing:
(i) the time of regular meetings of committees may be determined either by resolution of the
Board or by resolution of the committee;
(ii) special meetings of committees may also be called by resolution of the Board; and
(iii) notice of special meetings of committees shall also be given to all alternate members,
who shall have the right to attend all meetings of the committee. The Board may adopt rules for the
government of any committee not inconsistent with the provisions of these bylaws.
ARTICLE V OFFICERS
5.1 OFFICERS.
The officers of the corporation shall be a president and a secretary. The corporation may also
have, at the discretion of the Board, a chief executive officer, a chief financial officer or
treasurer, one or more vice presidents, one or more assistant vice presidents, one or more
assistant treasurers, one or more assistant secretaries, and any such other officers as may be
appointed in accordance with the provisions of these bylaws.
Any number of offices may be held by the same person.
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5.2 APPOINTMENT OF OFFICERS.
The Board shall appoint the officers of the corporation, except such officers as may be
appointed in accordance with the provisions of Section 5.3 of these bylaws, subject to the rights,
if any, of an officer under any contract of employment. Each officer shall hold office until his or
her successor is elected and qualified or until his or her earlier resignation or removal. A
failure to elect officers shall not dissolve or otherwise affect the corporation.
5.3 SUBORDINATE OFFICERS.
The Board may appoint, or empower the chief executive officer or, in the absence of a chief
executive officer, the president of the corporation to appoint, such other officers and agents as
the business of the corporation may require. Each of such officers and agents shall hold office for
such period, have such authority, and perform such duties as are provided in these bylaws or as the
Board may from time to time determine.
5.4 REMOVAL AND RESIGNATION OF OFFICERS.
Any officer may be removed, either with or without cause, by an affirmative vote of the
majority of the Board at any regular or special meeting of the Board or, except in the case of an
officer appointed by the Board, by any officer upon whom such power of removal may be conferred by
the Board.
Any officer may resign at any time by giving written notice to the corporation. Any
resignation shall take effect at the date of the receipt of that notice or at any later time
specified in that notice. Unless otherwise specified in the notice of resignation, the acceptance
of the resignation shall not be necessary to make it effective. Any resignation is without
prejudice to the rights, if any, of the corporation under any contract to which the officer is a
party.
5.5 VACANCIES IN OFFICES.
Any vacancy occurring in any office of the corporation may only be filled by the Board or as
provided in Section 5.3 of these bylaws.
5.6 REPRESENTATION OF SHARES OF OTHER CORPORATIONS.
The chairperson of the Board, the chief executive officer, the president, any vice president,
the treasurer, the secretary or assistant secretary of this corporation, or any other person
authorized by the Board, the chief executive officer, the president or a vice president, is
authorized to vote, represent, and exercise on behalf of this corporation all rights incident to
any and all shares or other equity interests of any other corporation or entity standing in the
name of this corporation. The authority granted herein may be exercised either by such person
directly or by any other person authorized to do so by proxy or power of attorney duly executed by
such person having the authority.
5.7 AUTHORITY AND DUTIES OF OFFICERS.
In addition to the foregoing authority and duties, all officers of the corporation shall
respectively have such authority and perform such duties in the management of the business of the
corporation as may be designated from time to time by the Board.
ARTICLE VI RECORDS AND REPORTS
6.1 MAINTENANCE AND INSPECTION OF RECORDS.
The corporation shall, either at its principal executive office or at such place or places as
designated by the Board, keep a record of its stockholders listing their names and addresses and
the number and class
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of shares held by each stockholder, a copy of these bylaws, as may be amended to date, minute
books, accounting books and other records.
Any such records maintained by the corporation may be kept on, or by means of, or be in the
form of, any information storage device or method, provided that the records so kept can be
converted into clearly legible paper form within a reasonable time. The corporation shall so
convert any records so kept upon the request of any person entitled to inspect such records
pursuant to the provisions of the DGCL. When records are kept in such manner, a clearly legible
paper form produced from or by means of the information storage device or method shall be
admissible in evidence, and accepted for all other purposes, to the same extent as an original
paper form accurately portrays the record.
Any stockholder of record, in person or by attorney or other agent, shall, upon written demand
under oath stating the purpose thereof, have the right during the usual hours for business to
inspect for any proper purpose the corporations stock ledger, a list of its stockholders, and its
other books and records and to make copies or extracts therefrom. A proper purpose shall mean a
purpose reasonably related to such persons interest as a stockholder. In every instance where an
attorney or other agent is the person who seeks the right to inspection, the demand under oath
shall be accompanied by a power of attorney or such other writing that authorizes the attorney or
other agent to so act on behalf of the stockholder. The demand under oath shall be directed to the
corporation at its registered office in Delaware or at its principal executive office.
6.2 INSPECTION BY DIRECTORS.
Any director shall have the right to examine the corporations stock ledger, a list of its
stockholders, and its other books and records for a purpose reasonably related to his or her
position as a director.
ARTICLE VII GENERAL MATTERS
7.1 CHECKS; DRAFTS; EVIDENCES OF INDEBTEDNESS.
From time to time, the Board shall determine by resolution which person or persons may sign or
endorse all checks, drafts, other orders for payment of money, notes or other evidences of
indebtedness that are issued in the name of or payable to the corporation, and only the persons so
authorized shall sign or endorse those instruments.
7.2 EXECUTION OF CORPORATE CONTRACTS AND INSTRUMENTS.
Except as otherwise provided in these bylaws, the Board, or any officers of the corporation
authorized thereby, may authorize any officer or officers, or agent or agents, to enter into any
contract or execute any instrument in the name of and on behalf of the corporation; such authority
may be general or confined to specific instances.
7.3 STOCK CERTIFICATES; PARTLY PAID SHARES.
The shares of the corporation shall be represented by certificates, provided that the Board
may provide by resolution or resolutions that some or all of any or all classes or series of its
stock shall be uncertificated shares. Any such resolution shall not apply to shares represented by
a certificate until such certificate is surrendered to the corporation. Every holder of stock
represented by certificates shall be entitled to have a certificate signed by, or in the name of
the corporation by the chairperson or vice-chairperson of the Board, or the president or
vice-president, and by the treasurer or an assistant treasurer, or the secretary or an assistant
secretary of the corporation representing the number of shares registered in certificate form. Any
or all of the signatures on the certificate may be a facsimile. In case any officer, transfer agent
or registrar who has signed or whose facsimile signature has been placed upon a certificate has
ceased to be such officer, transfer agent or registrar before such certificate is issued, it may be
issued
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by the corporation with the same effect as if he or she were such officer, transfer agent or
registrar at the date of issue.
The corporation may issue the whole or any part of its shares as partly paid and subject to
call for the remainder of the consideration to be paid therefor. Upon the face or back of each
stock certificate issued to represent any such partly paid shares, and upon the books and records
of the corporation in the case of uncertificated partly paid shares, the total amount of the
consideration to be paid therefor and the amount paid thereon shall be stated. Upon the declaration
of any dividend on fully paid shares, the corporation shall declare a dividend upon partly paid
shares of the same class, but only upon the basis of the percentage of the consideration actually
paid thereon.
7.4 SPECIAL DESIGNATION ON CERTIFICATES.
If the corporation is authorized to issue more than one class of stock or more than one series
of any class, then the powers, designations, preferences, and relative, participating, optional or
other special rights of each class of stock or series thereof and the qualifications, limitations
or restrictions of such preferences and/or rights shall be set forth in full or summarized on the
face or back of the certificate that the corporation shall issue to represent such class or series
of stock;
provided
,
however
, that, except as otherwise provided in Section 202 of
the DGCL, in lieu of the foregoing requirements there may be set forth on the face or back of the
certificate that the corporation shall issue to represent such class or series of stock a statement
that the corporation will furnish without charge to each stockholder who so requests the powers,
designations, preferences, and relative, participating, optional or other special rights of each
class of stock or series thereof and the qualifications, limitations or restrictions of such
preferences and/or rights.
Within a reasonable time after the issuance or transfer of uncertificated stock, the
corporation shall send to the registered owner thereof a written notice containing the information
required to be set forth or stated on certificates pursuant to Sections 151, 156, 202(a) or 218(a)
of the General Corporation Law of the State of Delaware or, with respect to Section 151 of General
Corporation Law of the State of Delaware, a statement that the corporation will furnish without
charge to each stockholder who so requests the powers, designations, preferences and relative
participating, optional or other special rights of each class of stock or series thereof and the
qualifications, limitations or restrictions of such preferences and/or rights. Except as otherwise
expressly provided by law, the rights and obligations of the holders of uncertificated stock and
the rights and obligations of the holders of certificates representing stock of the same class and
series shall be identical.
7.5 LOST CERTIFICATES.
Except as provided in this Section 7.5, no new certificates for shares shall be issued to
replace a previously issued certificate unless the latter is surrendered to the corporation and
cancelled at the same time. The corporation may issue a new certificate of stock or uncertificated
shares in the place of any certificate theretofore issued by it, alleged to have been lost, stolen
or destroyed, and the corporation may require the owner of the lost, stolen or destroyed
certificate, or such owners legal representative, to give the corporation a bond sufficient to
indemnify it against any claim that may be made against it on account of the alleged loss, theft or
destruction of any such certificate or the issuance of such new certificate or uncertificated
shares.
7.6 DIVIDENDS.
The Board, subject to any restrictions contained in either (a) the DGCL or (b) the
Certificate, may declare and pay dividends upon the shares of its capital stock. Dividends may be
paid in cash, in property, or in shares of the corporations capital stock.
- 14 -
The Board may set apart out of any of the funds of the corporation available for dividends a
reserve or reserves for any proper purpose and may abolish any such reserve.
7.7 FISCAL YEAR.
The fiscal year of the corporation shall be fixed by resolution of the Board and may be
changed by the Board.
7.8 SEAL.
The corporation may adopt a corporate seal, which shall be adopted and which may be altered by
the Board. The corporation may use the corporate seal by causing it or a facsimile thereof to be
impressed or affixed or in any other manner reproduced.
7.9 TRANSFER OF STOCK.
Shares of stock of the corporation shall be transferable in the manner prescribed by law and
in these Bylaws. Transfers of shares of stock of the corporation shall be made only on the books
of the corporation or by transfer agents designated to transfer shares of stock of the corporation.
Subject to applicable law, shares of stock represented by certificates shall be transferred only
on the books of the corporation by the surrender to the corporation or its transfer agent of the
certificate representing such shares properly endorsed or accompanied by a written assignment or
power of attorney properly executed, and with such proof of authority or the authenticity of
signature as the corporation or its transfer agent may reasonably require.
7.10 STOCK TRANSFER AGREEMENTS.
The corporation shall have power to enter into and perform any agreement with any number of
stockholders of any one or more classes or series of stock of the corporation to restrict the
transfer of shares of stock of the corporation of any one or more classes or series owned by such
stockholders in any manner not prohibited by the DGCL.
7.11 REGISTERED STOCKHOLDERS.
The corporation:
(a) shall be entitled to recognize the exclusive right of a person registered on its books as
the owner of shares to receive dividends and to vote as such owner;
(b) shall be entitled to hold liable for calls and assessments on partly paid shares the
person registered on its books as the owner of shares; and
(c) shall not be bound to recognize any equitable or other claim to or interest in such share
or shares on the part of another person, whether or not it shall have express or other notice
thereof, except as otherwise provided by the laws of Delaware.
7.12 WAIVER OF NOTICE.
Whenever notice is required to be given under any provision of the DGCL, the Certificate or
these bylaws, a written waiver, signed by the person entitled to notice, or a waiver by electronic
transmission by the person entitled to notice, whether before or after the time of the event for
which notice is to be given, shall be deemed equivalent to notice. Attendance of a person at a
meeting shall constitute a waiver of notice of such meeting, except when the person attends a
meeting solely for the express purpose of objecting at the beginning of the meeting, to the
transaction of any business because the meeting is not lawfully called or convened. Neither the
business to be transacted at, nor the purpose of, any regular or
- 15 -
special meeting of the directors, members of a committee of the directors or the stockholders
need be specified in any written waiver of notice or any waiver by electronic transmission unless
so required by the Certificate or these bylaws.
ARTICLE VIII NOTICE BY ELECTRONIC TRANSMISSION
8.1 NOTICE BY ELECTRONIC TRANSMISSION.
Without limiting the manner by which notice otherwise may be given effectively to stockholders
pursuant to the DGCL, the Certificate or these bylaws, any notice to stockholders given by the
corporation under any provision of the DGCL, the Certificate or these bylaws shall be effective if
given by a form of electronic transmission consented to by the stockholder to whom the notice is
given. Any such consent shall be revocable by the stockholder by written notice to the corporation.
Any such consent shall be deemed revoked if:
(a) the corporation is unable to deliver by electronic transmission two consecutive notices
given by the corporation in accordance with such consent; and
(b) such inability becomes known to the secretary or an assistant secretary of the corporation
or to the transfer agent, or other person responsible for the giving of notice.
However, the inadvertent failure to treat such inability as a revocation shall not invalidate any
meeting or other action.
Any notice given pursuant to the preceding paragraph shall be deemed given:
(i) if by facsimile telecommunication, when directed to a number at which the stockholder has
consented to receive notice;
(ii) if by electronic mail, when directed to an electronic mail address at which the
stockholder has consented to receive notice;
(iii) if by a posting on an electronic network together with separate notice to the
stockholder of such specific posting, upon the later of (A) such posting and (B) the giving of such
separate notice; and
(iv) if by any other form of electronic transmission, when directed to the stockholder.
An affidavit of the secretary or an assistant secretary or of the transfer agent or other
agent of the corporation that the notice has been given by a form of electronic transmission shall,
in the absence of fraud, be prima facie evidence of the facts stated therein.
8.2 DEFINITION OF ELECTRONIC TRANSMISSION.
An electronic transmission means any form of communication, not directly involving the
physical transmission of paper, that creates a record that may be retained, retrieved, and reviewed
by a recipient thereof, and that may be directly reproduced in paper form by such a recipient
through an automated process.
8.3 INAPPLICABILITY.
Notice by a form of electronic transmission shall not apply to Section 164 (relating to
failure to pay for stock; remedies), Section 296 (relating to adjudication of claims; appeal),
Section 311 (relating to revocation of voluntary dissolution), Section 312 (relating to renewal,
revival, extension and restoration of certificate of incorporation) or Section 324 (relating to
attachment of shares of stock or any option, right or interest therein) of the DGCL.
- 16 -
ARTICLE IX INDEMNIFICATION OF DIRECTORS AND OFFICERS
9.1 POWER TO INDEMNIFY IN ACTIONS, SUITS OR PROCEEDINGS OTHER THAN THOSE BY OR IN THE RIGHT OF
THE CORPORATION.
Subject to Section 9.3 of these bylaws, the corporation shall indemnify, to the fullest extent
permitted by the DGCL, as now or hereafter in effect, any person who was or is a party or is
threatened to be made a party to any threatened, pending or completed action, suit or proceeding,
whether civil, criminal, administrative or investigative (other than an action by or in the right
of the corporation) by reason of the fact that such person (or the legal representative of such
person) is or was a director or officer of the corporation or any predecessor of the corporation,
or is or was a director or officer of the corporation serving at the request of the corporation as
a director or officer, employee or agent of another corporation, partnership, joint venture, trust,
employee benefit plan or other enterprise, against expenses (including attorneys fees), judgments,
fines and amounts paid in settlement actually and reasonably incurred by such person in connection
with such action, suit or proceeding if such person acted in good faith and in a manner such person
reasonably believed to be in or not opposed to the best interests of the corporation, and, with
respect to any criminal action or proceeding, had no reasonable cause to believe such persons
conduct was unlawful. The termination of any action, suit or proceeding by judgment, order,
settlement, conviction, or upon a plea of
nolo contendere
or its equivalent, shall not, of itself,
create a presumption that the person did not act in good faith and in a manner which such person
reasonably believed to be in or not opposed to the best interests of the corporation, and, with
respect to any criminal action or proceeding, had reasonable cause to believe that such persons
conduct was unlawful.
9.2 POWER TO INDEMNIFY IN ACTIONS, SUITS OR PROCEEDINGS BY OR IN THE RIGHT OF THE CORPORATION.
Subject to Section 9.3 of these bylaws, the corporation shall indemnify, to the fullest extent
permitted by the DGCL, as now or hereafter in effect, any person who was or is a party or is
threatened to be made a party to any threatened, pending or completed action or suit by or in the
right of the corporation to procure a judgment in its favor by reason of the fact that such person
(or the legal representative of such person) is or was a director or officer of the corporation or
any predecessor of the corporation, or is or was a director or officer of the corporation serving
at the request of the corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust, employee benefit plan or other enterprise against expenses
(including attorneys fees) actually and reasonably incurred by such person in connection with the
defense or settlement of such action or suit if such person acted in good faith and in a manner
such person reasonably believed to be in or not opposed to the best interests of the corporation;
except that no indemnification shall be made in respect of any claim, issue or matter as to which
such person shall have been adjudged to be liable to the corporation unless and only to the extent
that the Court of Chancery or the court in which such action or suit was brought shall determine
upon application that, despite the adjudication of liability but in view of all the circumstances
of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the
Court of Chancery or such other court shall deem proper.
9.3 AUTHORIZATION OF INDEMNIFICATION.
Any indemnification under this Article IX (unless ordered by a court) shall be made by the
corporation only as authorized in the specific case upon a determination that indemnification of
the director or officer is proper in the circumstances because such person has met the applicable
standard of conduct set forth in Section 9.1 or Section 9.2 of these bylaws, as the case may be.
Such determination shall be made, with respect to a person who is either a director or officer at
the time of such determination or a former director or officer, (i) by a majority vote of the
directors who are not parties to such action, suit or proceeding, even though less than a quorum,
or (ii) by a committee of such directors designated by
- 17 -
a majority vote of such directors, even though less than a quorum, or (iii) if there are no
such directors, or if such directors so direct, by independent legal counsel in a written opinion
or (iv) by the stockholders (but only if a majority of the directors who are not parties to such
action, suit or proceeding, if they constitute a quorum of the board of directors, presents the
issue of entitlement to indemnification to the stockholders for their determination). To the
extent, however, that a present or former director or officer of the corporation has been
successful on the merits or otherwise in defense of any action, suit or proceeding described above,
or in defense of any claim, issue or matter therein, such person shall be indemnified against
expenses (including attorneys fees) actually and reasonably incurred by such person in connection
therewith, without the necessity of authorization in the specific case.
9.4 GOOD FAITH DEFINED.
For purposes of any determination under Section 9.3 of these bylaws, to the fullest extent
permitted by applicable law, a person shall be deemed to have acted in good faith and in a manner
such person reasonably believed to be in or not opposed to the best interests of the corporation,
or, with respect to any criminal action or proceeding, to have had no reasonable cause to believe
such persons conduct was unlawful, if such persons action is based on the records or books of
account of the corporation or another enterprise, or on information supplied to such person by the
officers of the corporation or another enterprise in the course of their duties, or on the advice
of legal counsel for the corporation or another enterprise or on information or records given or
reports made to the corporation or another enterprise by an independent certified public accountant
or by an appraiser or other expert selected with reasonable care by the corporation or another
enterprise. The term another enterprise as used in this Section 9.4 shall mean any other
corporation or any partnership, joint venture, trust, employee benefit plan or other enterprise of
which such person is or was serving at the request of the corporation as a director, officer,
employee or agent. The provisions of this Section 9.4 shall not be deemed to be exclusive or to
limit in any way the circumstances in which a person may be deemed to have met the applicable
standard of conduct set forth in Section 9.1 or 9.2 of these bylaws, as the case may be.
9.5 INDEMNIFICATION BY A COURT.
Notwithstanding any contrary determination in the specific case under Section 9.3 of this
Article IX, and notwithstanding the absence of any determination thereunder, any director or
officer may apply to the Court of Chancery in the State of Delaware for indemnification to the
extent otherwise permissible under Section 9.1 and Section 9.2 of these bylaws. The basis of such
indemnification by a court shall be a determination by such court that indemnification of the
director or officer is proper in the circumstances because such person has met the applicable
standards of conduct set forth in Section 9.1 or Section 9.2 of these bylaws, as the case may be.
Neither a contrary determination in the specific case under Section 9.3 of these bylaws nor the
absence of any determination thereunder shall be a defense to such application or create a
presumption that the director or officer seeking indemnification has not met any applicable
standard of conduct. Notice of any application for indemnification pursuant to this Section 9.5
shall be given to the corporation promptly upon the filing of such application. If successful, in
whole or in part, the director or officer seeking indemnification shall also be entitled to be paid
the expense of prosecuting such application.
9.6 EXPENSES PAYABLE IN ADVANCE.
To the fullest extent not prohibited by the DGCL, or by any other applicable law, expenses
incurred by a person who is or was a director or officer in defending any civil, criminal,
administrative or investigative action, suit or proceeding shall be paid by the corporation in
advance of the final disposition of such action, suit or proceeding; provided, however, that if the
DGCL requires, an advance of expenses incurred by any person in his or her capacity as a director
or officer (and not in any other capacity) shall be made only upon receipt of an undertaking by or
on behalf of such person to repay such amount if it
- 18 -
shall ultimately be determined that such person is not entitled to be indemnified by the
corporation as authorized in this Article IX.
9.7 NONEXCLUSIVITY OF INDEMNIFICATION AND ADVANCEMENT OF EXPENSES.
The indemnification and advancement of expenses provided by or granted pursuant to this
Article IX shall not be deemed exclusive of any other rights to which those seeking indemnification
or advancement of expenses may be entitled under the Certificate, any bylaw, agreement, vote of
stockholders or disinterested directors or otherwise, both as to action in such persons
official capacity and as to action in another capacity while holding such office, it being the
policy of the corporation that indemnification of the persons specified in Section 9.1 and
Section 9.2 of these bylaws shall be made to the fullest extent permitted by law. The provisions of
this Article IX shall not be deemed to preclude the indemnification of any person who is not
specified in Section 9.1 or Section 9.2 of these bylaws but whom the corporation has the power or
obligation to indemnify under the provisions of the DGCL, or otherwise. The corporation is
specifically authorized to enter into individual contracts with any or all of its directors,
officers, employees or agents respecting indemnification and advances, to the fullest extent not
prohibited by the DGCL, or by any other applicable law.
9.8 INSURANCE.
To the fullest extent permitted by the DGCL or any other applicable law, the corporation may
purchase and maintain insurance on behalf of any person who is or was a director, officer, employee
or agent of the corporation, or is or was a director, officer, employee or agent of the corporation
serving at the request of the corporation as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust, employee benefit plan or other enterprise against
any liability asserted against such person and incurred by such person in any such capacity, or
arising out of such persons status as such, whether or not the corporation would have the power or
the obligation to indemnify such person against such liability under the provisions of this
Article IX.
9.9 CERTAIN DEFINITIONS.
For purposes of this Article IX, references to the corporation shall include, in addition to
the resulting corporation, any constituent corporation (including any constituent of a constituent)
absorbed in a consolidation or merger which, if its separate existence had continued, would have
had power and authority to indemnify its directors or officers, so that any person who is or was a
director or officer of such constituent corporation, or is or was a director or officer of such
constituent corporation serving at the request of such constituent corporation as a director,
officer, employee or agent of another corporation, partnership, joint venture, trust, employee
benefit plan or other enterprise, shall stand in the same position under the provisions of this
Article IX with respect to the resulting or surviving corporation as such person would have with
respect to such constituent corporation if its separate existence had continued. For purposes of
this Article IX, references to fines shall include any excise taxes assessed on a person with
respect to an employee benefit plan; and references to serving at the request of the corporation
shall include any service as a director, officer, employee or agent of the corporation which
imposes duties on, or involves services by, such director or officer with respect to an employee
benefit plan, its participants or beneficiaries; and a person who acted in good faith and in a
manner such person reasonably believed to be in the interest of the participants and beneficiaries
of an employee benefit plan shall be deemed to have acted in a manner not opposed to the best
interests of the corporation as referred to in this Article IX.
- 19 -
9.10 SURVIVAL OF INDEMNIFICATION AND ADVANCEMENT OF EXPENSES.
The rights to indemnification and advancement of expenses conferred by this Article IX shall
continue as to a person who has ceased to be a director or officer and shall inure to the benefit
of the heirs, executors, administrators and other personal and legal representatives of such a
person.
9.11 LIMITATION ON INDEMNIFICATION.
Notwithstanding anything contained in this Article IX to the contrary, except for proceedings
to enforce rights to indemnification (which shall be governed by Section 9.5 of these bylaws), the
corporation shall not be obligated to indemnify any director or officer in connection with a
proceeding (or part thereof) initiated by such person unless such proceeding (or part thereof) was
authorized or consented to by the board of directors of the corporation.
9.12 INDEMNIFICATION OF EMPLOYEES AND AGENTS.
The corporation may, to the extent authorized from time to time by the board of directors,
provide rights to indemnification and to the advancement of expenses to employees and agents of the
corporation similar to those conferred in this Article IX to directors and officers of the
corporation.
9.13 EFFECT OF AMENDMENT OR REPEAL.
Neither any amendment or repeal of any Section of this Article IX, nor the adoption of any
provision of the Certificate or the bylaws inconsistent with this Article IX, shall adversely
affect any right or protection of any director, officer, employee or other agent established
pursuant to this Article IX existing at the time of such amendment, repeal or adoption of an
inconsistent provision, including without limitation by eliminating or reducing the effect of this
Article IX, for or in respect of any act, omission or other matter occurring, or any action or
proceeding accruing or arising (or that, but for this Article IX, would accrue or arise), prior to
such amendment, repeal or adoption of an inconsistent provision.
ARTICLE X MISCELLANEOUS
10.1 PROVISIONS OF CERTIFICATE GOVERN.
In the event of any inconsistency between the terms of these bylaws and the Certificate, the
terms of the Certificate will govern.
10.2 CONSTRUCTION; DEFINITIONS.
Unless the context requires otherwise, the general provisions, rules of construction, and
definitions in the DGCL shall govern the construction of these bylaws. Without limiting the
generality of this provision, the singular number includes the plural, the plural number includes
the singular, and the term person includes both a corporation and a natural person.
10.3 SEVERABILITY.
In the event that any bylaw or the application thereof becomes or is declared by a court of
competent jurisdiction to be illegal, void or unenforceable, the remaining bylaws will continue in
full force and effect.
10.4 AMENDMENT.
The bylaws of the corporation may be adopted, amended or repealed by a majority of the voting
power of the stockholders entitled to vote; provided, however, that the corporation may, in its
Certificate, also confer the power to adopt, amend or repeal bylaws upon the Board. As set forth in
the Certificate, the affirmative vote of at least a majority of the Board of Directors then in
office shall be required in order for
- 20 -
the Board of Directors to adopt, amend, alter or repeal the Corporations Bylaws. The fact
that such power has been so conferred upon the Board shall not divest the stockholders of the
power, nor limit their power to adopt, amend or repeal bylaws. In the case of amendments by
stockholders, notwithstanding the foregoing and any provision of law that might otherwise permit a
lesser vote or no vote, the affirmative vote of the holders at least sixty-six and two-thirds
percent (66
2
/3%) of the voting power of the issued and outstanding shares of capital
stock of the corporation then entitled to vote shall be required to amend or repeal Section 2.3,
the last paragraph of Section 2.9 (relating to no cumulative voting), Section 2.10, Section 2.14,
Section 2.15, Section 3.2, Section 3.3, Section 3.4, Section 3.14 and Section 9.13 of these bylaws,
or this sentence of this Section 10.4.
- 21 -
ENERGY RECOVERY, INC.
CERTIFICATE OF AMENDMENT OF BYLAWS
The undersigned hereby certifies that he or she is the duly elected, qualified, and acting
Secretary or Assistant Secretary of Energy Recovery, Inc., a Delaware corporation (the
Company
),
and that the foregoing bylaws, comprising twenty (21) pages, were amended and restated effective as
of July 8, 2008 by the Companys board of directors.
The undersigned has executed this certificate as of July 8, 2008.
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/s/ MariaElena Ross
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(
signature
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MariaElena Ross
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print name
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Secretary
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- 22 -
Exhibit 10.17
1717 DOOLITTLE DRIVE
2250 WILLIAMS STREET
MODIFIED INDUSTRIAL GROSS LEASE
1717 DOOLITTLE DRIVE
2250 WILLIAMS STREET
MODIFIED INDUSTRIAL GROSS LEASE
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Page
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1. DEFINED TERMS, EXHIBITS, PREMISES AND LANDLORDS RESERVED RIGHTS
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1
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1.01.
Defined Terms
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1
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1.02.
Exhibits
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2
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1.03.
Premises
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2
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1.04.
Common Area
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2
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1.05.
Landlords Reserved Rights
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2
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2. TENANTS ACCEPTANCE OF PREMISES
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2
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3. TERM
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2
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3.01.
Commencement Date
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2
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3.02.
Term
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2
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3.03.
Delay in Possession
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3
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3.04.
Renewal Options
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3
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4. RENT
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4
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4.01.
Base Rent
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4
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4.02.
Escalation
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4
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4.03.
Additional Rent and Estimated Payments
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4
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4.04.
Rent Defined
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4
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4.05.
Interest and Late Charge
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4
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4.06.
Letter of Credit
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4
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5. REAL PROPERTY TAXES
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5
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5.01.
Tenants Obligations
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5
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5.02.
Limitation
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6
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5.03.
Personal Property Taxes
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6
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5.04.
Proposition 13
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6
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6. INSURANCE
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6
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6.01.
Tenants Obligations
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6
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6.02.
Landlords Property
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6
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6.03.
Landlords Liability Insurance
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7
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6.04.
Tenants Liability
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7
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6.05.
Fire and All Risk Coverage Insurance
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7
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6.06.
Rental Abatement Insurance
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7
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6.07.
Insurance Certificates; Other Requirements
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7
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6.08.
Tenants Failure
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7
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6.09.
Waiver of Subrogation
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7
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6.10.
Indemnification of Landlord
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7
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6.11.
Intentionally Deleted
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7
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6.12.
Workers Compensation Insurance
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7
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6.13.
Business Interruption Insurance
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7
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6.14.
Comprehensive Automobile Liability Insurance
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7
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6.15.
Landlords Disclaimer
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8
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7. OPERATING EXPENSES, REPAIRS AND MAINTENANCE
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8
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7.01.
Operating Expenses
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8
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7.02.
Tenant Repairs and Maintenance
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8
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7.03.
Landlord Repairs and Maintenance
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8
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7.04.
Inspection of Premises
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8
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7.05.
Liens
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9
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7.06.
Audit Rights
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9
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8. ALTERATIONS
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9
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8.01.
Fixtures and Personal Property
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9
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8.02.
Alterations
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9
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9. UTILITIES AND EASEMENTS
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9
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9.01.
Utilities
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9
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10. USE OF PREMISES
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9
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10.01.
General
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9
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10.02.
Hazardous Materials
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10
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10.03.
Environmental Disclosure
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10
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10.04.
Reclaimed Water
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10
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10.05.
Signs
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10
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10.06.
Parking
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10
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11. DAMAGE AND DESTRUCTION
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11
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11.01.
Reconstruction
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11
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11.02.
Rent Abatement
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11
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11.03.
Option to Terminate
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11
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11.04.
Uninsured Casualty
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11
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11.05.
Waiver
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11
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12. EMINENT DOMAIN
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11
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12.01.
Total Condemnation
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11
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12.02.
Partial Condemnation
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11
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12.03.
Landlords Award
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12
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12.04
. Tenants Award
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12
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12.05.
Temporary Condemnation
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12
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12.06
. Delivery of Documents
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12
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13. DEFAULT
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12
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13.01.
Events of Default
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12
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13.02.
Landlords Remedies
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12
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13.03.
Landlords Remedies Cumulative
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13
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14. ASSIGNMENT AND SUBLETTING
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13
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i
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Page
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14.01.
Approval
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13
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14.02.
Landlord Option
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14
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14.03.
Bonus Rental
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14
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14.04.
Scope
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14
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14.05.
Release
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14
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14.06.
Holding Over
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14
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14.07.
Waiver
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14
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14.08.
Permitted Transfers
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14
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15. ESTOPPEL CERTIFICATE, ATTORNMENT AND SUBORDINATION
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15
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15.01.
Estoppel Certificate
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15
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15.02.
Attornment
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15
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15.03.
Subordination
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15
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16. MISCELLANEOUS
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15
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16.01.
Waiver
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15
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16.02.
Financial Statements
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15
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16.03.
Accord and Satisfaction
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15
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16.04.
Limitation of Landlords Liability
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15
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16.05.
Entire Agreement
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15
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16.06.
Time
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15
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16.07.
Attorneys Fees
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15
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16.08.
Captions and Article Letters
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15
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16.09.
Severability
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15
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16.10.
Applicable Regulations
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15
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16.11.
Examination of Lease
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15
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16.12.
Surrender
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15
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16.13.
Authority
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16
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16.14.
Broker
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16
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16.15.
Landlords Right to Perform
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16
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16.16.
Modification for Lender
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16
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16.17.
Landlords Lien
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16
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16.18.
Notices
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16
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16.19.
Hazardous Materials Notification
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16
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16.20.
Force Majeure
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16
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16.21.
USA Patriot Act and Anti-Terrorism Laws
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16
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16.22.
Right of First Negotiation
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17
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ii
1717 DOOLITTLE DRIVE
2250 WILLIAMS STREET
MODIFIED INDUSTRIAL GROSS LEASE
THIS LEASE (Lease), dated as of November 25, 2008 (the
Effective Date), is made by and between
DOOLITTLE WILLIAMS, LLC, a California limited liability company (Landlord), and ENERGY RECOVERY,
INC., a Delaware corporation (Tenant).
1. DEFINED TERMS, EXHIBITS, PREMISES AND LANDLORDS RESERVED RIGHTS
1.01 Defined Terms.
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1. Landlord:
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Doolittle Williams, LLC, a California limited liability company
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2. Landlords Address:
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c/o McGrath Properties
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130 Webster Street, Suite 200
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Oakland, CA 94607
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3. Tenant:
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Energy Recovery, Inc., a Delaware corporation
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4. Tenants Address prior to the Commencement
Date:
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1908 Doolittle Drive
San Leandro, CA 94577
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4.a. Tenants Address as of the Commencement
Date:
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1717 Doolittle Drive
San Leandro, CA 94577
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5. Property:
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All of the real property and improvements identified in
Exhibit A
attached hereto.
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6. Building:
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The building located upon the Property and commonly known as
1717 Doolittle
Drive, San Leandro, CA, containing approximately 106,250
rentable square feet.
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7. Warehouse:
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The warehouse building located upon the Property and commonly
known as 2250 Williams street, san Leandro, CA, containing
approximately 223,125 rentable square feet.
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8. Warehouse Premises:
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The portion of the Warehouse identified in
Exhibit B
attached
hereto containing approximately 17,500 rentable square feet.
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9. Premises:
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The Building (in its entirety) and the Warehouse Premises.
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10. Term:
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10 years
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11. Scheduled Commencement Date:
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August 1, 2009
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12. Base Rent:
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$0.75 per rentable square foot of the Building per month
and
$0.50 per rentable square foot of the Warehouse Premises per
month.
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13. Prepaid Rent:
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$88,437.50
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14. Rent Escalations:
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The Base Rent shall increase by 2.5% upon each anniversary of
the Commencement Date (as hereinafter defined).
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15. Base Year:
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Calendar year 2009
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16. Intentionally Deleted:
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17. Tenants Share of Building Tax Expenses:
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100%
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17.a. Tenants Share of Warehouse Tax Expenses:
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7.84%
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18. Intentionally Deleted:
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19. Tenants Share of Building Insurance Expenses:
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100%
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19.a. Tenants Share of Warehouse Insurance
Expenses:
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7.84%
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20. Commercial General Liability Policy Limit:
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Five Million Dollars ($5,000,000)
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21. Tenants Share of Building Operating Expenses:
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100%
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22. Tenants Share of Warehouse Operating
Expenses:
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7.84%
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23. Letter of Credit:
|
|
See Section 4.06
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24. Permitted Uses:
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Design, manufacturing, assembly, research and development,
testing associated with Tenants business, and administrative
and office use associated with Tenants business.
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25. Landlords Broker:
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CBRE (Michael Barry and Mark Kol)
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26. Tenants Broker:
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Jones Development Companies (Don Jones)
|
The foregoing provisions constitute the defined terms (Defined Terms). Each reference in this
Lease to Section 1.01 or the Defined Terms shall be construed to incorporate the applicable Defined
Terms in this Section 1.01.
1
1.02. Exhibits. The following Exhibits are attached to this Lease and incorporated herein by
reference thereto.
Exhibit A
Legal Description of the Property
Exhibit B
First Floor of the Building and the Warehouse Premises
Exhibit B
1 Second Floor of the Building
Exhibit C
Form of commencement Date Memorandum
Exhibit D
Work Letter
Exhibit E
Environmental Disclosure Statement
Exhibit F
Hazardous Materials Notification
1.03. Premises. Landlord hereby leases to Tenant, and Tenant hereby leases from Landlord, the
Premises, subject to the provisions of this Lease, With respect to the portion of the premises
located in the Warehouse, the Premises shall extend from the top surface of the subfloor to the
bottom surface of the roof deck, but exclude the portion of the Common Area (as hereinafter
defined) located within due warehouse.
1.04. Common Area. Tenant may, as appurtenant to the Premises and subject to the rules made by
Landlord of which Tenant is given notice, use the following areas (collectively Common Area) in
common with other tenants or occupants of the Property:
a. Floor Common Area. With respect to the Warehouse, the lobbies, hallways, toilets, refuse
facilities, interior utility raceways, and other common facilities located therein, if any;
and
b. Lot common Area. The parking area, together with adjoining landscaping, walkways,
sidewalks, driveways, and other surfaced areas, fences, drainage and utility lines, exterior
lighting and project signage, if any, serving the Premises (the Lot).
Under no circumstances shall the right herein granted to use the Common Area be deemed to include
the right to store any property, temporarily or permanently, in the Common Area. Any such storage
shall be permitted only by the prior written consent of Landlord, which consent may be revoked at
any time. In the event that any unauthorized storage shall occur then Landlord 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 Tenant, which cost shall be immediately payable upon demand by
Landlord.
1.05. Landlords Reserved Rights .Provided Landlord does not unreasonably interface with Tenants
use of the Premises and given Tenant prior notice thereof if the applicable change will affect
Tenants use of or require access to the premises, Landlord reserves the right to make the
following changes:
a. Building / Warehouse Charges. To install, use, maintain, repair, relocate and replace pipes,
ducts, conduits, wires and appurtenant meters and equipment included in the Premises or outside the
Premises: and to make any alterations to the Premises that, in Landlords reasonable judgment, are
required or authorized by any existing or future governmental codes;
b. Boundary Charges. To change the boundary lines of the Lot or the Property;
c. Common Area Changes. To install, use, maintain, repair, alter or relocate and replace any
Common Area; provided, however, that substitutions, if any, shall be equivalent or better in quality; and
d. Closure. To close temporarily any of the common Area for maintenance purposes so long as
reasonable access to the Premises remains available.
2.
TENANTS ACCEPTANCE OF PREMISES.
Except as set forth in
Exhibit D
, Tenant shall accept the
Premises as is on the Commencement Date (as hereinafter defined). By taking possession or using
the Premises, Tenant shall be deemed to accept the same in their condition existing as of the date
of such possession or use and subject to all applicable municipal, county, state and federal
statutes, laws, ordinances, including zoning ordinances, and regulations governing and relating to
the use, occupancy or possession of the Premises (collectively Regulations). Tenant shall, at
Tenants sole cost and expense, comply with all Regulations now in force or which may hereafter be
in force relating to the Premises and the use of the Premise. Except for any punchlist items
identified pursuant to
Exhibit D
, the taking of possession or use of the Premises by Tenant shall
conclusively establish that the Landlords Work (as defined in
Exhibit D
) has been constructed in
accordance with
Exhibit D
and that the Tenant Improvements (as defined in
Exhibit D
) have been
constructed in accordance with the Working Drawings (as defined in
Exhibit D
). Nothing in this
Section shall limit or expand Landlords maintenance and repair obligations set forth in Section
7.03. Tenant acknowledges that the only warranties and representations Landlord has made in
connection with the physical condition of the Premises or Tenants use of the same upon which it
has relied directly or indirectly are those expressly provided in this Lease, Notwithstanding
anything in this Section 2 to the contrary, Landlord warrants for thirty (30) days following the
Commencement Date that the mechanical and plumbing systems serving the Premises are in good
working order. Landlord shall repair any defective or malfunctioning component of such systems of
which Landlord has received written notice from Tenant describing the failure or malfunction;
provided such written notice is given within
thirty (30) days of the Commencement Date. In addition, and notwithstanding anything in this Section
2 to the contrary, Landlord warrants that to its actual knowledge the buildings constituting the
premises comply with applicable Regulations that were in effect at the time that each building, or
portion thereof, was constructed. Such warranty does not apply to (i) modifications which may be
required as a result of Tenants use of the Premises or (ii) Tenants alterations, additions, or
improvements to the premises. If the premises do not comply with such warranty, Landlord shall
rectify the same at Landlords expense. Tenant shall make a claim under such warranty (if at all )
within thirty (30) days of the Commencement Date and Tenants failure to deliver a written claim
within such time period shall be deemed a waiver of its rights under such warranty.
3.
TERM
3.01 Commencement Date, The Term shall commence on the later to occur of the following dates (the
Commencement Date): (a) the earlier to occur of the following dates: (i) the date of Substantial
Completion (as defined in
Exhibit D
) or (ii) the date on which the Landlords Work and the Tenant
Improvements would have been Substantially Completed but for the occurrence of any Tenant Delay
Days ( as defined in
Exhibit D
) and (b) the Scheduled Commencement Date.
3.02. Term. The Term of this Lease shall be for the period as stated in Section 1.01, commencing on
the Commencement Date of the Term as provided in Section 3.01. If the last day of the Term falls on
a date other than the last day of the month, then the term shall be
2
extended so that the last day of the Term shall be the last calendar day of the calendar month in
which the Term would otherwise end. Upon Landlords request,
Tenant shall execute a memorandum
confirming the Term in the form attached hereto as
Exhibit C
(the Commencement Date
Memorandum) which Commencement Date Memorandum shall thereupon be deemed a part of this Lease;
provided, however, the execution of such Commencement Date Memorandum shall not be a condition
precedent to the parties obligation hereunder.
3.03.
Delay in Possession.
If for any reason the Commencement Date does not occur on or
before the Scheduled Commencement Date, Landlord shall not be subject to any liability therefor,
and such failure shall not affect the validity of this Lease or the obligations of Tenant
hereunder, but in such case, Tenant shall not be obligated to pay Base Rent or Additional Rent (as
hereinafter defined) until the Commencement Date has occurred.
3.04.
Renewal Options.
a. If Tenant has not committed an Event of Default (as hereinafter defined) at any time during the
Term, and Energy Recovery, Inc. (or a Permitted Transferee (as hereinafter defined) of Energy
Recovery, Inc.) is occupying the entire Premises at the time of such election, Tenant may renew
this Lease for two (2) additional periods of five (5) years each (each a Renewal Term), by
delivering written notice of the exercise thereof to Landlord not later than twelve (12) months
before the expiration of the initial Term or the first Renewal Term (as applicable). The Base Rent
payable for each month during a Renewal Term shall be ninety-five percent (95%) of the Fair Market
Rent (as hereinafter defined); provided, that the Base Rent payable in any Renewal Term shall in no
event be lower than the Base Rent payable during the month immediately preceding the commencement
of the first Renewal Term. On or before that date which is six (6) months before the expiration of
the initial Term or the first Renewal Term (as applicable), Landlord shall deliver to Tenant
written notice of Landlords Fair Market Rent proposal for the Renewal Term (Landlords Fair Market Rent Proposal) and shall advise Tenant of the required
adjustment to Base Rent, if any. Within fifteen (15) days after receipt of Landlords Fair Market
Rent Proposal, Tenant shall notify Landlord in writing whether Tenant accepts or rejects Landlords
Fair Market Rent Proposal. If Tenant rejects Landlords Fair Market Rent Proposal, then Tenants
written notice shall include Tenants determination of the Fair Market Rent. If Tenant does not
deliver Tenants written determination of Fair Market Rent to Landlord within fifteen (15) days
after receipt of Landlords Fair Market Rent Proposal, Tenant will be deemed to have accepted
Landlords Fair Market Rent Proposal. If Tenant and Landlord disagree on the Fair Market Rent, then
Landlord and Tenant shall attempt in good faith to agree upon the Fair Market Rent. If by that date
which is one hundred and twenty-five (125) days prior to the commencement of the Renewal Term (the
Trigger Date), Landlord and Tenant have not agreed in
writing as to the Fair Market Rent, the parties shall
determine the Fair Market Rent for such Renewal Term in accordance with the procedure set forth in
Section 3.04.c below.
b.
For purposes of this Section 3.04, the term Fair Market
Rent shall mean the rental rate for
comparable space to be used for the Permitted Uses under primary lease (and not sublease) to new
tenants, taking into consideration such amenities as existing improvements (but specifically
excluding any Tenant Improvements that are not paid from the Construction Allowance (as defined in
Exhibit D
)), and parking rights, situated in the city of San Leandro, in comparable
physical and economic condition, taking into consideration the then-prevailing ordinary rental
market practices with respect to tenant concessions. Fair Market Rent shall include the periodic
rental increases, if any, that would be included for space leased for the period the space will be
covered by the Lease. As used herein, then-prevailing shall mean the time period which is five
(5) months prior to the commencement of the Renewal Term and not the commencement date of the
Renewal Term.
c. If Landlord and Tenant are unable to reach agreement on the Fair Market Rent by the Trigger
Date, then within seven (7) days of the Trigger Date, Landlord and Tenant shall each simultaneously
submit to the other in a sealed envelope its good faith estimate of the Fair Market Rent for the
Renewal Term. If either Landlord or Tenant fails to propose a Fair Market Rent, then the Fair
Market Rent for the Renewal Term proposed by the other party shall prevail. If the higher of such
estimates is not more than one hundred five percent (105%) of the lower, then the Fair Market Rent
shall be the average of the two. Otherwise, the dispute shall be resolved by arbitration in
accordance with the remainder of this Section 3.04.c. Within
seven (7) days after the exchange of
estimates, the parties shall select as an arbitrator either (i) a licensed real estate broker with
at least ten (10) years of experience leasing premises in industrial buildings in the San Leandro
area or (ii) an independent MAI appraiser with at least five (5) years of experience in appraising
industrial buildings in the San Leandro area (a Qualified Arbitrator). If the parties cannot
agree on a Qualified Arbitrator, then within a second period of seven (7) days, each shall select a
Qualified Arbitrator and within ten (10) days thereafter the two appointed Qualified Arbitrators
shall select a third Qualified Arbitrator and the third Qualified Arbitrator shall be the sole
arbitrator. If one party shall fail to select a Qualified Arbitrator
within the second seven (7)-day period, then the Qualified Arbitrator chosen by the other party shall be the sole arbitrator.
Within thirty (30) days after submission of the matter to the sole arbitrator, the sole arbitrator
shall determine the Fair Market Rent by choosing whichever of the estimates submitted by Landlord
and Tenant the arbitrator judges to be more accurate. The sole arbitrator shall notify Landlord and
Tenant of his or her decision, which shall be final and binding. If the arbitrator believes that
expert advice would materially assist him or her, the arbitrator may retain one or more qualified
persons to provide expert advice. The fees of the sole arbitrator and the expenses of the
arbitration proceeding, including the fees of any expert witnesses retained by the arbitrator,
shall be shared equally by Landlord and Tenant. Each party shall pay the fees of its respective counsel and the fees of any witness called
by that party.
d. On or before the commencement date of the applicable Renewal Term, Landlord and Tenant shall
execute an
amendment to this Lease prepared by Landlord extending the Term on the same terms provided in this
Lease, except as follows:
(i) Base Rent shall be adjusted to ninety-five percent (95%) of the Fair Market Rent (which shall
be the rental rate set forth in Landlords Fair Market Rent Proposal or the Fair Market Rent
determined by mutual agreement or arbitration, as the case may be); provided, that the Base Rent
payable in any Renewal Term shall in no event be lower than the Base Rent payable during the month
immediately preceding the commencement of the first Renewal Term; and
(ii)
Landlord shall lease to Tenant the Premises in their then-current condition, and Landlord
shall not provide to Tenant any allowances (e.g., moving allowance, construction allowance, and the
like) or other tenant inducements.
e. In the event that Fair Market Rent is not established prior to the commencement of a Renewal
Term, then Tenant shall
continue to pay the Base Rent at the rate in effect immediately prior to the expiration of the
initial Term or the First Renewal Term
(as applicable) and within thirty (30) days of the determination of Fair Market Rent, reimburse
Landlord for any difference.
f. Tenants rights under this Section 3.04 shall terminate if: (i) Tenant assigns any of its
interest in this Lease or sublets
any portion of the Premises to any entity other than a Permitted Transferee; (ii) Tenant fails to
timely exercise either of its options
under this Section 3.04, time being of the essence with respect to Tenants exercise thereof; or
(iii) Tenant commits an Event of
Default under the Lease. Further if Tenant fails to exercise the option for the first Renewal Term,
then the option for the second
Renewal Term shall automatically be null and void.
3
4. RENT
4.01.
Base Rent.
The Base Rent shall be the Base Rent set forth in Section 1.01, payable in
equal monthly installments as set forth in Section 1.01 and as confirmed in the Commencement Date
Memorandum. Tenant shall pay the monthly Base Rent to Landlord in advance upon the first day of
each calendar month of the Term, at Landlords address or at such other place designated by
Landlord in a notice to Tenant, without any prior demand therefor. If the Term shall commence or
end on a day other than the first day of a calendar month, then Tenant shall pay, upon the
Commencement Date, a pro rata portion of the monthly Base Rent, prorated on a per diem basis, with
respect to the portions of the fractional calendar month included in the Term. Upon executing this
Lease, Tenant shall pay the Prepaid Rent as set forth in Section 1.01. Base Rent shall be
calculated based on the rentable square footage of the Premises set forth in Section 1.01. Landlord
and Tenant stipulate that the square footage of the Building and the Warehouse Premises set forth
in Section 1.01 shall be conclusive as to the square footage of the Building and the Warehouse
Premises for purposes of determining Base Rent and shall be binding upon them.
4.02.
Escalation.
The Base Rent shall be adjusted during the Term as provided in Section 1.01.
4.03.
Additional Rent and Estimated Payments.
Additional Rent shall include all monies,
except for Base Rent, required to be paid by Tenant to Landlord under the Lease, including without
limitation, any late payments, interest, and payments required to be made by Tenant to Landlord on
account of costs incurred by Landlord for Building Tax Expenses (as defined in Section 5.01 below),
Warehouse Tax Expenses (as defined in Section 5.01 below), Building Insurance Expenses (as defined
in Section 6.01 below), Warehouse Insurance Expenses (as defined in Section 6.01 below), Building
Operating Expenses and/or Warehouse Operating Expenses. Additional Rent shall be payable by Tenant
within thirty (30) days after a reasonably detailed statement of actual expenses is presented to
Tenant by Landlord. At Landlords option, however, an amount may be estimated by Landlord from
time to time of Building Tax Expenses, Warehouse Tax Expenses, Building Insurance Expenses,
Warehouse Insurance Expenses, Building Operating Expenses and/or Warehouse Operating Expenses
payable by Tenant and the same shall be payable monthly during each accounting year of the Term, on
the same day as Base Rent is due hereunder. By May 1 of each calendar year, or as soon thereafter
as practicable, Landlord shall furnish to Tenant a statement of Building Tax Expenses, Warehouse
Tax Expenses, Building Insurance Expenses, Warehouse Insurance Expenses, Building Operating
Expenses, and Warehouse Operating Expenses for the previous year (the Statement). If Tenants
estimated payments of Building Tax Expenses, Warehouse Tax Expenses, Building Insurance Expenses,
Warehouse Insurance Expenses, Building Operating Expenses, and Warehouse Operating Expenses exceed
Tenants shares of such items as indicated in the Statement, then Landlord shall promptly credit or
reimburse Tenant for such excess; likewise, if Tenants estimated payments of Building Tax Expenses,
Warehouse Tax Expenses, Building Insurance Expenses, Warehouse Insurance Expenses, Building
Operating Expenses, and Warehouse Operating Expenses for such
year are less than Tenants shares of such items as indicated in the Statement, then Tenant shall
pay Landlord such deficiency within ten (10) days of demand therefor, notwithstanding that the Term
has expired and Tenant has vacated the Premises. Except as set forth to the contrary in this
Section 4.03, Tenants Shares of, respectively, Building Tax Expenses, Warehouse Tax Expenses,
Building Insurance Expenses, Warehouse Insurance Expenses, Building Operating Expenses, and
Warehouse Operating Expenses, shall be as set forth in
Section 1.01. Notwithstanding the foregoing,
(a) to the extent Warehouse Operating Expenses vary, as reasonably determined by Landlord,
according to the level of occupancy of the Warehouse or the Property, as applicable, Landlord may
compute and charge Tenant for such variable expenses an amount greater than Tenants Share of
Warehouse Operating Expenses equal to Landlords reasonable estimate of the extent to which such
variable Warehouse Operating Expenses are attributable to Tenants occupancy and (b) if the
Warehouse is not at least ninety-five percent (95%) occupied on average during any year of the
Term, Warehouse Operating Expenses for such year shall be computed as though the Warehouse had been
ninety-five percent (95%) occupied on average during such year. In the event that Tenant or any other tenant
of the Property has a use, performs acts (including, without limitation, construction at the
Property), or whose presence or occupancy results, in Landlords good faith determination, in an
inequitable allocation of Warehouse Operating Expenses, Warehouse Tax
Expenses, or Warehouse
Insurance Expenses among the tenants of the Property, then Landlord may, without any obligation to
do so and notwithstanding any provision to the contrary in this Lease, reallocate one or more of
Tenants Share of, respectively, Warehouse Operating Expenses, Warehouse Tax Expenses, and/or
Warehouse Insurance Expenses in such a manner so as to achieve an allocation of such expenses which
Landlord determines to be equitable in Landlords good faith determination.
4.04.
Rent Defined
. Base Rent and Additional Rent shall be deemed to constitute Rent. Rent shall
be paid in lawful money of the United States without any abatement, set off or deduction
whatsoever.
4.05.
Interest and Late Charge.
If any installment of Rent is not paid when due, such amount shall
bear interest at the rate of ten percent (10%) per annum (the Default Rate) from the date on which
said payment shall be due until the date on which Landlord shall receive said payment regardless of
whether or not a notice of default or notice of termination has been given by Landlord. In
addition, Tenant shall pay Landlord a late charge of ten percent (10%) of the amount delinquent.
Landlord and Tenant recognize that the damage which Landlord shall suffer as a result of Tenants
failure to pay Rent is difficult to ascertain, said late charge being the best estimate of the
damage which Landlord shall suffer in the event of Tenants late payment. This provision shall not
relieve Tenant of Tenants obligation to pay Rent at the time and in the manner herein specified.
4.06.
Letter of Credit
.
(a) Tenant acknowledges that Landlord is unwilling to execute this Lease unless Tenant provides
Landlord with additional security for Tenants obligations under the Lease.
Therefore, Tenant shall deliver to Landlord, within five
(5) business days of the Commencement Date,
an Irrevocable Standby Letter of Credit (Letter of Credit) which shall (1) be in a form
reasonably acceptable to Landlord and based on a draft issued by Tenants bank prior to issuance
thereof and approved by Landlord in its sole discretion, (2) be issued by a bank reasonably
acceptable to Landlord with minimum assets of $10,000,000,000, upon which presentment may be made
in San Francisco or Oakland, California, (3) be in an amount equal to $1,500,000, (4) allow for
partial and multiple draws thereunder, and (5) have an expiration date not earlier than thirty (30)
days after the third anniversary of the Commencement Date or in the alternative, have a term of not less
than one (1) year and be automatically renewable for an additional one (1) year period unless, on or
before the date thirty (30) days prior to the expiration of the term of such Letter of Credit, the
issuer of such Letter of Credit gives notice to Landlord of its election not to renew such Letter
of Credit for any additional period pursuant thereto. In addition , the Letter of Credit shall
provide that, in the event of Landlords assignment of its interest in this Lease, the Letter of
Credit shall be freely transferable by Landlord to the assignee without charge to Landlord. The
Letter of Credit shall provide for same day payment to Landlord upon the issuers receipt of a
sight draft from Landlord together with Landlords certificate (signed by its manager or an
officer) certifying that the requested sum is due and payable from Tenant and Tenant has failed to
pay, and with no other conditions. Tenant agrees that it shall form time to time, as necessary,
whether as a result of a draw on the Letter of Credit by Landlord pursuant to the terms hereof or
as a result of the expiration of the Letter of Credit then in effect, renew or replace the original
and any subsequent Letter of Credit so that a Letter of Credit, in the amount required hereunder,
and satisfying all the conditions thereof, is in effect until a date
which is at least thirty (30)
days after the third anniversary of the Commencement Date. If Tenant fails to furnish such renewal
or replacement at least thirty (30) days prior to the stated expiration date of the Letter of
Credit then held by Landlord, Landlord may draw upon such Letter of Credit (and/or Additional
Letter(s) of Credit (as hereinafter defined)) and hold the proceeds thereof without payment of
interest (and such proceeds need not be segregated) (Security
Proceeds).
4
(b) If there is an Event of Default under this Lease, then Landlord shall have the
right, at any time after the occurrence of such Event of Default, without giving any
further notice to Tenant, to draw upon said Letter of Credit (or Additional Letter of
Credit, as defined below, as the case may be) (i) the amount necessary to cure such default
or (b) if such default cannot reasonably be cured by the expenditure of money, and Landlord
exercises any rights and remedies Landlord may have on account of such default, the amount
which, in Landlords opinion, is necessary to satisfy Tenants liability on account
thereof. In the event of any such draw by Landlord, Tenant shall, within fifteen (15)
business days of written demand therefor, deliver to Landlord an additional Letter of
Credit satisfying the foregoing conditions (Additional Letter of Credit), except that the
amount of such Additional Letter of Credit shall be the amount of such draw. In addition,
in the event of a termination based upon the default of Tenant under this Lease, or a
rejection of this Lease pursuant to the provisions of the Federal Bankruptcy Code, Landlord
shall have the right to draw upon the Letter of Credit (from time to time, if necessary) to
cover the full amount of damages and other amounts due from Tenant to Landlord under this
Lease. Any amounts so drawn shall, at Landlords election, be applied first to any unpaid
rent and other charges which were due prior to the filing of the petition for protection
under the Federal Bankruptcy Code. Any such draw on the Letter of Credit shall not
constitute a waiver of any other rights of Landlord with respect to Tenants default under
this Lease. Tenant hereby covenants and agrees not to oppose, contest or otherwise
interfere with any attempt by Landlord to draw upon said Letter of
Credit including, without limitation, by commencing an action seeking
to enjoin or restrain Landlord from drawing upon said Letter of Credit. Tenant also
hereby expressly waives any right or claim it may have to seek such equitable relief. In
addition to whatever other rights and remedies it may have against Tenant if Tenant
breaches its obligations under this paragraph, Tenant hereby acknowledges that it shall be
liable for any and all damages which Landlord may suffer as a result of any such breach.
(c) Upon request of Landlord or any (prospective) purchaser or mortgagee of the
Property, Tenant shall, at its expense, cooperate with Landlord in obtaining an amendment
to or replacement of any Letter of Credit which Landlord is then holding so that the
amended or new Letter of Credit reflects the name of the new owner and/or mortgagee of the
Property.
(d) To the extent that Landlord has not previously drawn upon any Letter of Credit,
Additional Letter of Credit, or Security Proceeds (collectively, Collateral) held by
Landlord, and to the extent that Tenant is not otherwise in default of its obligations
under this Lease, Landlord shall return such Collateral to Tenant within ninety (90) days
of the third anniversary of the Commencement Date.
(e) In no event shall the proceeds of any Letter of Credit be deemed to be a
prepayment of rent nor shall it be considered as a measure of liquidated damages.
(f) Landlord and Tenant (i) agree that the Letter of Credit shall in no event be
deemed or treated as a security deposit under any law applicable to security deposits in
the commercial context, (ii) further acknowledge and agree that the Letter of Credit is not
intended to serve as a security deposit and the laws applicable to security deposits shall
have no applicability or relevancy thereto, and (iii) waive any and all rights, duties and
obligations either party may now have or, in the future, will have relating to or arising
from the laws applicable to security deposits.
(g) Provided that there has not been an Event of Default by Tenant under this Lease
during the immediately preceding twelve (12)-month period and that no Event of Default by
Tenant under this Lease has occurred and is still continuing as of the effective date of
reduction, then Tenant shall be permitted to decrease the Letter of Credit as follows: (i) as of
the first anniversary of the Commencement Date, the amount of the
Letter of Credit may be
reduced to $1,000,000 and (ii) as of the second anniversary of the Commencement Date, the
amount of the Letter of Credit may be reduced to $500,000. Upon Landlords receipt of any
replacement letter of credit which is in the amount of the remaining balance set forth
above, and which in all other respects is in conformance with the Letter of Credit
requirements described in this Section 4.06, Landlord shall promptly return to Tenant the
Letter of Credit being replaced. Notwithstanding the foregoing, in no event shall any such
reduction be construed as an admission by Landlord that Tenant has performed all of its
covenants and obligations hereunder. Moreover, if an Event of Default occurs then Tenant
shall be required to restore the Letter of Credit to the originally required amount of
$1,500,000.
(h) In consideration of Tenants provision of the Letter of Credit, Landlord, upon
receipt of appropriate invoices or bills and such other documents and information as
Landlord may reasonably request, agrees to reimburse Tenant for Tenants actual cost to
provide the Letter of Credit pursuant to this Section 4.06 (the LC Reimbursement),
provided, however, that (i) the LC Reimbursement shall not exceed Fifteen Thousand Dollars
($15,000) with respect to the Letter of Credit provided during the
first twelve (12) months
of the Term, (ii) the LC Reimbursement shall not exceed Ten Thousand Dollars ($10,000) with
respect to the Letter of Credit provided during the second twelve (12) months of the Term,
and (iii) the LC Reimbursement shall not exceed Five Thousand Dollars ($5,000) during the
third twelve (12) months of the Term. Landlord shall have no obligation to reimburse Tenant
for any costs incurred by Tenant in connection with any letters of credit following the
expiration of the third year of the Term.
(i) Rather than deliver a new letter of credit to satisfy Tenants initial obligation
to deliver the Letter of Credit, Tenant may instead, within five
(5) business days of the
Commencement Date, amend the TI Letter of Credit (as defined in
Exhibit D
) so that
it satisfies the requirements of the Letter of Credit (as set forth in this Section 4.06)
and continues to satisfy the requirements of the
TI Letter of Credit. Tenants delivery of such amended TI Letter of Credit shall
satisfy Tenants initial obligation to deliver the Letter of Credit.
5. REAL PROPERTY TAXES
5.01.
Tenants Obligations
. Tenant shall pay to Landlord, pursuant to the terms of Section
4.03, (a) Tenants Share of Building Tax Expenses multiplied by the amount, if any, by which
Building Tax Expenses exceed the Building Tax Expenses allocated to the Base Year and (b) Tenants
Share of Warehouse Tax Expenses multiplied by the amount, if any, by which Warehouse Tax Expenses
exceed the Warehouse Tax Expenses allocated to the Base Year. Tax Expenses shall mean and include
the sum of the following: all real estate taxes and other taxes relating to the Property,
governmental and quasi-governmental assessments and charges, commercial rental taxes, fees and
levies, general and special, ordinary and extraordinary, unforeseen as well as foreseen, of any
kind and nature for public improvements, services, benefits, or otherwise, and all other fees or
taxes which may be levied which: (i) are assessed, levied, conformed, imposed or become a lien upon
the Property; (ii) are imposed in lien of any of the above and become payable by Landlord during
the Term, or (iii) may be assessed after the expiration of the Term for a period during the Term;
provided, however, that:
a. The amount owed by Tenant for Tax Expenses, as set forth in this Section 5.01,
shall be prorated between Landlord and Tenant so that Tenant shall pay for amounts
applicable to the period of time occurring prior to the expiration of the Term; and
b. Any sum payable by Tenant, which would not otherwise be due until after the date of
the termination of this Lease, shall be paid by Tenant to Landlord
upon such termination.
5
Building Tax Expenses shall mean the portion of Tax Expenses that Landlord equitably allocates to
the Building (which allocation shall be consistent with Landlords allocation as of the Effective
Date). Warehouse Tax Expenses shall mean the portion of Tax Expenses that Landlord equitably
allocates to the Warehouse (which allocation shall be consistent with Landlords allocation as of
the Effective Date).
Notwithstanding anything to the contrary herein, the Building Tax Expenses and Warehouse Tax
Expenses allocated to the Base Year shall be established by reference to the Building and the
Warehouse, respectively, prior to the installation of the Tenant Improvements. Accordingly, if
Building Tax Expenses or Warehouse Tax Expenses increase due to the construction of the Tenant
Improvements, Tenant shall reimburse Landlord for all taxes and assessments levied upon the
Property due to the construction of the Tenant Improvements and the Building Tax Expenses and the
Warehouse Tax Expenses allocated to the Base Year shall not include taxes and assessments levied
upon the Property due to the construction of the Tenant Improvements. If any or all of the Tax
Expenses hereunder are permitted by applicable Regulations to be paid in installments,
notwithstanding how Landlord pays the same, then, for purposes of calculating Tax Expenses, such
Tax Expenses shall be deemed to have been divided and paid in the maximum number of installments
permitted by applicable Regulations, and there shall be included in Tax Expenses for each year only
such installments as are required by applicable Regulations to be paid within such year, together
with interest thereon and on future such installments at a commercially reasonable rate. In the
event that Warehouse Tax Expenses attributable to particular portions of the Warehouse that are
leased (or available for lease) by tenants are materially greater than Warehouse Tax Expenses
attributable to other portions of the Warehouse that are leased (or available for lease) by
tenants, such that payment of Warehouse Tax Expenses in accordance herewith would result in an
inequitable allocation of Warehouse Tax Expenses among the tenants of the Warehouse, then Landlord
shall reallocate Tenants Share of Warehouse Tax Expenses applicable to the Warehouse Premises in
such a manner so as to achieve an allocation of such Warehouse Tax Expenses which is equitable in
Landlords good faith determination.
The parties acknowledge that the Building and the Warehouse are part of a multi-tenant,
multi-building project and the some Tax Expenses incurred in connection with the Property and not
attributable solely to any particular building should be shared among the tenants of the Property.
Accordingly, certain Tax Expenses (e.g. certain costs attributable to the Common Areas) are
determined annually for the Property as a whole, and a portion of such Tax Expenses, which portion
shall be determined by Landlord on an equitable basis, shall be allocated (i) to the Building (as
opposed to the other buildings) and such portion shall be included in Building Tax Expenses and
(ii) to the Warehouse (as opposed to the other buildings) and such portion shall be included in
Warehouse Tax Expenses. Landlord shall have the right, from time to time, to equitably allocate
some or all Tax Expenses for the Property among different portions or occupants of the Property, in
Landlords reasonable discretion. Notwithstanding anything in the contrary herein, Tax Expenses
shall not include any taxes assessed with respect to improvements made to the Property after the
Commencement Date which do not benefit the Premises and/or the Common Areas.
5.02.
Limitation.
Nothing contained in this Lease shall require Tenant to pay any franchise,
corporate, estate, inheritance, succession or documentary transfer tax or Landlord, or any income,
profits or revenue tax or charge, upon the net income of Landlord; provided, however, that if under
the laws of the United States Government or the state, city or county in which the Property is
located, or any political subdivision thereof or any improvement district therein, a tax or excise
on rent, or any other tax however described, is levied or assessed by any such body against
Landlord on account of rentals payable to Landlord from the Property, Tenant shall pay Tenants
Share of such tax or excise on rent as Tenants Share of Building Tax Expenses or Tenants Share of
Warehouse Tax Expenses (as applicable) as set forth in Section 1.01.
5.03.
Personal Property Taxes.
Prior to delinquency, Tenant shall pay all taxes and
assessments levied upon Tenants trade fixtures, inventories and other personal property located on
or about the Premises.
5.04.
Proposition 13.
Notwithstanding any other provision of this Lease to the contrary, if
during the initial Term there is a change of ownership (as defined in Cal. Rev. and Taxation Code
sections 60-62 or any amendments or successors to those sections) of all or any portion of the
Property (a Disposition) and, as a result, any or all of the Property is reassessed (a
Reassessment) for real estate tax purposes by the appropriate government authority, the terms of
this Section 5.04 shall apply. For the purposes of this Section 5.04, the term Tax Increase shall
mean that portion of Tax Expenses allocable to the Property that are attributable solely to a
Reassessment. Accordingly, a Tax Increase shall not include any portion of Tax Expenses that are or
would be (a) attributable to the initial assessment of the value of the Property or any portion
thereof, (b) attributable to assessments pending immediately
before a Reassessment that were conducted during, and included in, such Reassessment or that
were rendered unnecessary following such Reassessment, or (c) attributable to the annual
inflationary increase in real estate taxes actually permitted under Proposition 13 (as adopted by
the voters of the State of California in the June 1978 election). Tax Expenses attributable to a
Tax Increase shall be capped such that the increase in Tax Expenses attributable to a Tax Increase
shall not cause the total amount of Tax Expenses payable by Tenant under Section 5.01 to increase
by more than $0.02 per rentable square foot of the Premises. The benefit to Tenant of the
protections provided under this Section 5.04 shall not apply during any extension of the Term
beyond the initial Term.
6. INSURANCE
6.01.
Tenants Obligations.
Tenant shall pay to Landlord, pursuant to the terms of Section
4.03, (a) Tenants Share of Building Insurance Expenses multiplied by the amount, if any, by which
the Building Insurance Expenses in each of Landlords accounting years of the Term exceed the
Building Insurance Expenses allocated to the Base Year and (b) Tenants Share of Warehouse
Insurance Expenses multiplied by the amount, if any, by which the Warehouse Insurance Expenses in
each of Landlords accounting years of the Term exceed Warehouse Insurance Expenses allocated to
the Base Year. Insurance Expenses shall include the cost of premiums for insurance maintained
under this Section 6 and any deductible portion of any insured loss concerning the Building, the
Warehouse, or the Common Area; provided, however that Insurance Expenses shall not include the cost
of premiums for earthquake or flood insurance. The amount owed by Tenant for Insurance Expenses, as
set forth in this Section 6.01, shall be prorated between Landlord and Tenant so that Tenant shall
pay that portion attributable to the Term. Notwithstanding anything to the contrary herein, if
Insurance Expenses increase due to the construction or existence of the Tenant Improvements, Tenant
shall, upon receipt of appropriate premium invoices, reimburse Landlord for such increased amount
and the Building Insurance Expenses and Warehouse Insurance Expenses allocated to the Base Year
shall not include insurance expenses attributable to the construction or existence of the Tenant
Improvements. Building Insurance Expenses shall mean the portion of Insurance Expenses that
Landlord equitably allocates to the Building (which allocation shall be consistent with Landlords
allocation as of the Effective Date). Warehouse Insurance Expenses shall mean the portion of
Insurance Expenses that Landlord equitably allocates to the Warehouse (which allocation shall be
consistent with Landlords as allocation of the Effective Date). The parties acknowledge that the
Building and the Warehouse are part of a multi-tenant, multi-building project and that some
Insurance Expenses incurred in connection with the Property and not attributable solely to any
particular building should be shared among the tenants of the Property. Accordingly, certain
Insurance Expenses (e.g. certain costs attributable to the Common Areas) are determined annually
for the Property as a whole, and a portion of such Insurance Expenses, which portion shall be
determined by Landlord on an equitable basis, shall be allocated (i) to the Building (as opposed to
the other buildings) and such portion shall be included in Building Insurance Expenses and (ii) to
the Warehouse (as opposed to the other buildings) and such portion shall be included in Warehouse
Insurance Expenses. Landlord shall have the right, from time to time, to equitably allocate some or
all Insurance Expenses for the Property among different portions or occupants of the Property, in
Landlords reasonable discretion.
6.02.
Landlords Property.
During the Term, Landlord shall procure and maintain in full force
and effect with respect to the Property, a policy or policies of all risk insurance (including
sprinkler leakage coverage and any other endorsements or types of coverage required by the holder
of any fee or leasehold mortgage) in an amount equal to the full insurance replacement value
(replacement cost new, including debris removal, and demolition) thereof. If the annual premiums
charged Landlord for such casualty insurance exceed the standard
6
premium rates because the nature of Tenants operations results in increased exposure, then Tenant
shall, upon receipt of appropriate premium invoices, reimburse Landlord for such increased amount.
6.03.
Landlords Liability Insurance
. During the Term of this Lease, Landlord shall procure
and maintain in force a commercial general liability insurance covering the Property in
commercially reasonable amounts as determined by Landlord, from time to time in Landlords
reasonable discretion.
6.04.
Tenants Liability
. Tenant shall, at Tenants sole cost and expense, procure and
maintain in full force throughout the Term a policy or policies of commercial general liability
insurance, written by an insurance company approved by Landlord meeting the requirements set forth
in Section 6.07 below and in the form customary to the locality in which the Property is located,
insuring Tenants activities and those of Tenants employees, agents, licensees and invitees with
respect to the Property against loss, damage or liability for personal injury or death of any
person or loss or damage to property occurring on the Property or as a result of occupancy of the
Property in an aggregate amount not less than the Commercial General Liability Policy Limit set
forth in Section 1.01, with a combined single occurrence limit for personal injury and property
damage of Two Million Dollars ($2,000,000). If Tenant has in full force and effect a blanket policy
of liability insurance with the same coverage for the Property as described above, as well as
coverage of other premises and properties of Tenant, or in which Tenant has some interest, such
blanket insurance shall satisfy the requirement hereof. Such insurance shall include coverage for
liability assumed under this Lease as an insured contract for the performance of Tenants
indemnity obligations under this Lease. All such policies shall provide that such coverage shall be
primary and that any insurance maintained by Landlord shall be excess insurance only. Such coverage
shall also contain the following endorsements: (i) deleting any employee exclusion of personal
injury coverage; (ii) deleting any liquor liability exclusion, (iii) an Additional
Insured-Managers or Lessors of Premises Endorsement, and (iv) the Amendment of the Pollution
Exclusion Endorsement for damage caused by heat, smoke or fumes from a hostile fire. All such
insurance shall provide for severability of interests; shall provide that an act or omission of one
of the named insureds shall not reduce or avoid coverage to the other named insureds; and shall
afford coverage for all claims based on acts, omissions, injury and damage, which claims occurred
or arose (or the onset of which occurred or arose) in whole or in part during the policy period.
6.05.
Fire and All Risk Coverage Insurance
. Tenant, at Tenants expense, shall provide and
keep in force during the Term of this Lease a policy or polices of broad form or special form
property insurance, including sprinkler leakage if the Premises is equipped with an automatic
sprinkler system, in an amount not less than one hundred percent (100%) replacement value covering
Tenants merchandise, furniture, equipment, fixtures, and Tenants improvements that Tenant owns or
has installed at Tenants sole cost and expense to the Premises. Landlord and Tenant agree that
proceeds from such insurance policy or policies shall be used for the repair or replacement of
Tenants improvements and Property.
6.06.
Rental Abatement Insurance
. Landlord shall maintain in full force and effect rental
abatement insurance against abatement or loss of Rent with respect to the Property in case of fire
or other casualty, in an amount and with coverage periods as reasonably determined by Landlord.
6.07.
Insurance Certificates; Other Requirements
. Tenant shall furnish to Landlord on the
Commencement Date, and thereafter within thirty (30) days prior to the expiration of each such
policy, certificates of insurance issued by the insurance carrier of each policy of insurance
required to be carried by Tenant pursuant hereto. Each certificate shall expressly provide that
such policies shall not be cancellable or subject to reduction of coverage or otherwise be subject
to modification except after thirty (30) days prior written notice to the parties named as insureds
in this Section 6.07. Landlord, McGrath Properties, Inc., Landlords successors and assigns, and
any nominee of Landlord holding any interest in the Premises, including, without limitation any
ground lessor and holder of any fee or leasehold mortgage, shall be named as additional insureds
under each policy of insurance maintained by Tenant. All insurance policies required to be carried
by Tenant under this Lease shall: (i) be written by companies rated A-VI or better in Bests
Insurance Guide and authorized to do business in California; and (ii) name any parties designated
by Landlord as additional insureds. Any deductible amounts under any insurance policies required to
be carried by Tenant hereunder shall be subject to Landlords prior written approval. If at any
time during the Term the amount or coverage of any insurance which Tenant is required to carry
under this Lease is, in Landlords good faith judgment, materially less than the amount or type of
insurance coverage typically carried by owners or lessees or properties located in the same general
market area as the Property, Landlord shall have the right to require Tenant to increase the amount
or change the types of insurance coverage required under this Section.
6.08.
Tenants Failure
. If Tenant fails to maintain any insurance required in this Lease,
Tenant shall be liable for all losses and costs resulting from said failure. Tenant shall also be
responsible for reimbursing Landlord for any costs incurred by Landlord pursuant to Section 16.15.
Nothing herein shall be a waiver of any of Landlords rights and remedies under any other article
of this Lease or at law or equity.
6.09.
Waiver of Subrogation
. All policies of property and liability coverage insurance which
Tenant obtains in connection with the Property shall include a clause or endorsement denying the
insurer any rights of subrogation against Landlord. Tenant waives any rights of recovery against
Landlord for injury or loss due to hazards covered by insurance to the extent of the proceeds
recovered therefrom.
6.10.
Indemnification of Landlord
. Tenant shall indemnify, defend (by counsel reasonably
acceptable to Landlord), protect, and hold Landlord, Landlords partners, members, managers,
employees, authorized agents and contractors (collectively, Landlords Authorized
Representatives), and the Property harmless from and against all claims, liabilities, penalties,
losses, damages, costs and expenses, claims or judgments (including, without limitation, attorneys
fees) which may be imposed upon Landlord or any Landlords Authorized Representatives by any third
party in connection with or arising out of any injury to persons or damage to property occurring
in, on or about the Premises, or any accident or other occurrence on or about the Property
occasioned by any act or omission of Tenant, Tenants officers, managers, employees, agents,
sub-tenants, contractors, visitors, or invitees, or arising from Tenants use, maintenance,
occupation or operation of the Premises, the Building, the Warehouse, the Common Area or the Lot or
arising as a result of an Event of Default by Tenant under this Lease; provided, however that
Tenant shall not be obligated to indemnify Landlord for any injury or damage to the extent arising
as the result of the gross negligence or willful misconduct of Landlord or Landlords Authorized
Representatives. Landlord need not have first paid any such claim in order to be defended or
indemnified.
6.11.
Intentionally Deleted
.
6.12.
Workers Compensation Insurance
. Both parties shall procure and maintain throughout the
Term at their sole cost and expense Workers Compensation Insurance in compliance with California
law.
6.13.
Business Interruption Insurance
. Tenant shall procure and maintain throughout the Term
at Tenants sole cost and expense a policy of Business Interruption Insurance adequate to insure
over a one (1) year period of time.
6.14.
Comprehensive Automobile Liability Insurance
. If Tenant operates owned, hired or
nonowned vehicles on the Property then Tenant shall procure and maintain throughout the Term a
Comprehensive Automobile Liability Insurance policy, at a limit of liability of not less than One
Million Dollars ($1,000,000) combined bodily injury and property damage.
7
6.15.
Landlords Disclaimer
. Neither Landlord nor Landlords Authorized Representatives shall
be responsible or liable at any time for damage to Tenants equipment, fixtures or other personal
property or to Tenants business, and neither Landlord nor Landlords Authorized Representatives
shall be responsible or liable to Tenant or to those claiming by, through or under Tenant for any
damage to person or property that may be occasioned by the acts or omissions of third parties and
neither Landlord nor Landlords Authorized Representatives shall be responsible or liable for any
defect in any building or Common Area on the Property or any of the equipment, machinery,
utilities, appliances or apparatus therein, nor shall they be responsible or liable for any damage
to any person or to any property of Tenant or other person caused by bursting, breakage or leakage,
steam or the running, seepage or overflow of water or sewage in any part of the Premises or by the
use of reclaimed water or for any damage caused by or resulting from acts of God or the elements or
for any damage caused by or resulting from any defect or negligence in the occupancy, construction,
operation or use of any of the Property, machinery, apparatus or equipment by any other person or
by or from the acts or negligence of any occupant of the Property, except to the extent such
defect, damage or loss is caused by the gross negligence or willful misconduct of Landlord or
Landlords Authorized Representatives. Notwithstanding Landlords or Landlords Authorized
Representatives negligence or breach of this Lease, neither Landlord nor its Authorized
Representatives shall be liable for injury to Tenants business or for any loss of income or profit
therefrom.
7. OPERATING EXPENSES, REPAIRS AND MAINTENANCE
7.01.
Operating Expenses
. Tenant shall pay to Landlord, pursuant to the terms of Section 4.03,
Tenants Share of Building Operating Expenses and Tenants Share of Warehouse Operating Expenses
incurred by Landlord (including, without limitation, all expenses incurred by Landlord pursuant to
Section 7.03). Building Operating Expenses shall include all reasonable and necessary expenses
incurred by Landlord for the administration, management, cleaning, maintenance and repair of the
Building. Warehouse Operating Expenses shall include all reasonable and necessary expenses
incurred by Landlord for the administration, management, cleaning, maintenance and repair of the
Warehouse. Expenses constituting Building Operating Expenses and Warehouse Operating Expenses shall
include, without limitation: the cost of utilities relating to the Property that are not separately
metered to the Premises; costs for the maintenance and repair of the Common Areas of the Property
including, without limitation, parking areas, landscaping, sprinkler systems, walkways, and fire
alarm systems; costs for maintenance and repair of the heating, ventilation and air conditioning
equipment and systems serving the Building and the elevators located in the Building; reserves set
aside for maintenance and repair of the Common Area; and costs for capital improvements and repairs
made to the Building, the Warehouse, the Common Areas and/or the Property, during Tenants tenancy
in the Premises, amortized using a commercially reasonable interest rate over the time period
reasonably estimated by Landlord to recover the costs thereof, as determined by Landlord using its
good faith, commercially reasonable judgment. Building Operating Expenses and Warehouse Operating
Expenses shall not include (a) the costs for capital improvements and repairs made to the Building
or the Warehouse which are triggered by the specific and unique use of the Premises by Tenant,
which shall be paid in full by Tenant at the time incurred, (b) Insurance Expenses, (c) Tax
Expenses, (d) the costs to maintain and repair the foundations, exterior walls, structural
condition of interior load-bearing walls, and the exterior roof structure (but excluding the roof
membrane), (e) the costs to maintain and repair any utility systems or heating, ventilation and air
conditioning equipment and systems that exclusively serve the premises of any tenant other than
Tenant, and (f) costs for capital improvements other than as set forth in the preceding sentence.
The parties acknowledge that the Building and Warehouse are part of a multi-tenant, multi-building
project and that some costs and expenses incurred in connection with the Property and not
attributable solely to any particular building should be shared among the tenants of the Property.
Accordingly, certain costs and expenses (e.g. certain costs attributable to the Common Areas) are
determined annually for the Property as a whole, and a portion of such costs and expenses, which
portion shall be determined by Landlord on an equitable basis, shall be allocated (i) to the
Building (as opposed to the other buildings) and such portion shall be included in Building
Operating Expenses and (ii) to the Warehouse (as opposed to the other buildings) and such portion
shall be included in Warehouse Operating Expenses. Landlord shall have the right, from time to
time, to equitably allocate some or all operating expenses for the Property among different
portions or occupants of the Property, in Landlords reasonable discretion. In addition to Tenants
Share of Building Operating Expenses and Tenants Share of Warehouse Operating Expenses, in
consideration of Landlords administration of the Premises and the Property, Tenant shall pay to
Landlord as Additional Rent a monthly administrative charge equal to three percent (3%) of the Base
Rent.
7.02.
Tenant Repairs and Maintenance
. Subject to the casualty and condemnation provisions of
Sections 11 and 12 except for any repair and maintenance obligations of Landlord which are
specifically described in Section
7.03, Tenant, at Tenants sole cost and expense, shall maintain the Premises and every part
thereof in good order and in a clean and safe condition, and shall repair and replace (whether or
not such portion of the Premises requiring repair, or the means of repairing the same, are
reasonably or readily accessible to Tenant, and whether or not the need for such repairs occurs as
a result of Tenants use, any prior use, the elements or the age of such portion of the Premises),
without limitation, the following: interior surfaces of walls and ceilings; floors; wall and floor
coverings; interior and exterior windows and plate glass; skylights (if any); window coverings;
doors, roll up doors, locks on closing devices; window casements and frames; storefronts; signs;
awnings (if any); canopies and display windows; plumbing; electrical wiring and systems within the
Premises (including replacement of light bulbs, tubes and ballasts); exterior entrances; staircases
and elevators; warehouse dock doors; and all switches, fixtures and equipment in the Premises.
Tenant shall, at Tenants sole cost and expenses, immediately replace all broken or damaged glass,
in the Premises with glass equal to the specification and quality of the original glass. Upon
receipt of reasonable notice from Tenant, Landlord shall perform, at the expense of Tenant, all
repairs and maintenance to plumbing, pipes and electrical wiring located within walls, above
ceiling surfaces and below floor surfaces resulting from the use of the Warehouse by Tenant.
Landlord shall be responsible for any plumbing, pipes, electrical wiring, switches, fixtures or
equipment located in the Warehouse but serving another tenant (subject to reimbursement pursuant to
Section 7.01). Notwithstanding anything to the contrary herein, Tenant shall at Tenants sole cost
and expense, repair any area, in the Premises or the Common Area, damaged by Tenant, Tenants
agents, employees, contractors, or visitors, provided that Tenant obtains Landlords prior approval
with respect to the method and quality of such repair. Any repair or replacement required of Tenant
shall be made with equipment and/or materials at least equal to the specification and quality of
the original and shall be made by contractors approved by Landlord. Tenant shall install rug
protectors in all carpeted areas in which desk chairs are located. Tenant shall keep all areas
immediately adjoining the Premises free from trash, litter and obstructions resulting from Tenants
business at the Premises. Tenant recognizes the use of some chemicals and/or maintenance techniques
are potentially harmful to the Premises or the Property, and consequently, Tenants use of such
chemicals and or maintenance techniques shall be subject to Landlords prior written approval.
Tenant hereby waives the provisions of California Civil Code Sections 1941 and 1942 and any similar
or successor laws, to the extent applicable, regarding Tenants right to terminate this lease or
make repairs and deduct the cost thereof from Rent.
7.03.
Landlord Repairs and Maintenance
. Landlord shall, subject to the casualty and
condemnation provisions of Sections 11 and 12 and Tenants obligations under Sections 4.03 and
7.02, maintain in good order, condition, and repair the foundations, exterior walls, structural
condition of interior load-bearing walls, exterior roof, fire sprinkler system, Common Area fire
alarm and/or smoke detection systems, fire hydrants, parking lots, walkways, parkways, driveways,
landscaping, fences, signs; utility systems serving the Common Areas and all parts thereof; the
heating, ventilation and air conditioning equipment and systems serving the Building; and the
elevators located in the Building. Landlord shall not be obligated to paint the exterior or
interior surfaces of exterior walls nor shall Landlord be obligated to maintain, repair or replace
windows, doors or plate glass of the Premises. There shall be no abatement of Rent during the
performance of any work described in this Section 7.03. Landlord shall not be liable to Tenant for
injury or damage that may result from any defect in the construction or condition of the Premises,
nor for any damage that may result from interruption of Tenants use of the Premises during any
repairs by Landlord.
7.04.
Inspection of Premises
. Landlord may enter the Premises at reasonable times upon advance
written or telephonic notice to Tenant in order to inspect the same, to inspect the performance by
Tenant of the terms and conditions hereof, to affix reasonable signs and
8
displays and to show the Premises to prospective purchasers, tenants and leaders. There shall be no
abatement of Rent for any such entry of the Premises.
7.05.
Liens.
Tenant shall promptly pay and discharge all claims for labor performed, supplies
furnished and services rendered at the request of Tenant and shall keep the Property free of all
mechanics and materialmens liens in connection therewith. Tenant shall give Landlord not less
than ten (10) days notice prior to the commencement of any work, in on or about the Premises.
Landlord shall have the right to post in or on the Premises, or in the immediate vicinity thereof,
notices of non-responsibility as provided by law. If Tenant shall, in good faith, contest the
validity of any such lien, claim or demand, then Tenant shall, as its sole cost and expense, defend
and protect itself, Landlord and the Premises against the same and shall pay and satisfy any such
adverse judgment that may be rendered thereon before the enforcement thereof against Landlord or
the Premises. If Landlord shall require, Tenant shall furnish to Landlord a surety bond
satisfactory to Landlord in an amount equal to one and one-half times the amount of such contested
lien claim or demand, indemnifying Landlord against liability for the same, as required by law for
the holding of the Premises free from the effect of such lien or claim. In addition, Landlord may
require Tenant to pay Landlords attorneys fees and costs in participating in such action if
Landlord shall decide it is in its best interests to do so.
7.06.
Audit Rights
. Tenant may audit Landlords Building Operating Expenses, Warehouse
Operating Expenses, Building Insurance Expenses, Warehouse Insurance Expenses, Building Tax
Expenses, and Warehouse Tax Expenses for the immediately preceding accounting year in order to
verify the accuracy thereof provided that: (i) Tenant specifically notifies Landlord that it
intends to conduct such audit within ninety (90) days after the receipt of the Statement for such
year; and (ii) such audit will be conducted only during regular business hours at the office where
Landlord maintains such expenses records and only after Tenant gives Landlord fourteen (14) days
prior written notice. Any such audit must be completed by Tenant within ninety (90) days after
notice of its intent to audit. Tenant shall deliver to Landlord a copy of the results of such audit
within fifteen (15) days of its receipt by Tenant. No such audit shall be conducted if any other
tenant has conducted an audit for the time period Tenant intends to audit and Landlord furnishes to
Tenant a copy of the result of such audit. No audit shall be conducted at any time there is an
Event of Default under the terms of this Lease. No subtenant shall have any right to conduct an
audit and no assignee shall conduct an audit for any period during which such assignee is not in
possession of the Premises. Notwithstanding the preceding, a subtenant that is subleasing all of
the Premises may exercise Tenants right to conduct an audit under this Section 7.06, provided,
however, that such subtenant shall be deemed Tenants agent for such purpose and Tenant shall be
liable for subtenants acts or omissions relating to such audit. In the event that Tenant elects to
audit in accordance with this Section, such audit must be conducted by an independent nationally
recognized accounting firm that is not being compensated by Tenant on a contingency fee basis. Each
Statement shall be final and binding upon Tenant unless Tenant, within ninety (90) days after the
receipt of such Statement, shall contest any item therein by giving written notice to Landlord,
specifying each item contested and the reason thereof, or notify Landlord of its intention to
conduct an audit of such Statement in accordance with this Section 7.06.
8. ALTERATIONS
8.01.
Fixtures and Personal Property
. Tenant, at Tenants sole cost and expense, may install
necessary trade fixtures, equipment and furniture in the Premises, provided that such items are
installed and removable without structural damage to the Building or the Warehouse (as applicable).
Said trade fixtures, equipment and furniture shall remain Tenants property and shall be removed by
Tenant prior to expiration of the Term or earlier termination of this Lease. Tenant shall assume
the risk of damage to any of Tenants trade fixtures, equipment and furniture. Tenant shall repair,
at Tenants sole cost and expense, all damage caused by the installation or removal of trade
fixtures, equipment and furniture. If Tenant fails to remove the foregoing items on termination of
this Lease, Landlord may keep and use them or remove any of them and cause them to be stored or
sold in accordance with applicable law, at Tenants sole cost and expense.
8.02.
Alterations.
Tenant shall not make or allow to be made any alterations, additions, or
improvements to the Premises, either at the inception of this Lease or subsequently during the
Term, without obtaining the prior written consent of Landlord. With respect to any alterations,
additions, or improvements approved by Landlord, Tenant shall, at Landlords election, remove such
alterations, additions or improvement at Tenants expense prior to expiration of the Term or
earlier termination of this Lease and repair any damage caused by said removal. All alterations,
additions and improvements shall remain the property of Tenant until termination of this Lease, at
which
time they shall be and become the property of Landlord if Landlord so elects; provided,
however, that Landlord may, at Landlords option, upon written notice to Tenant on or before thirty
(30) days prior to termination of this Lease, require that Tenant, at Tenants expense, immediately
remove any or all alterations, additions, and improvements made by Tenant and restore the Premises
to their condition existing prior to the construction of any such alterations, additions or
improvements, If Tenant fails to timely remove such alterations, additions or improvements or
Tenants trade fixtures, equipment or furniture, Landlord may keep and use them or remove any of
them and, in the case of trade fixtures, equipment or furniture, cause them to be stored or sold in
accordance with applicable law, all at Tenants sole cost and expense. The terms of the preceding
two sentences shall survive the termination of this Lease. Tenant shall deliver to Landlord full
and complete plans and specifications of all such alterations, additions or improvements, and no
such work shall be commenced by Tenant until Landlord has given its written approval thereof and
Tenant has acquired all applicable permits therefor required by governmental authorities. Landlord
does not expressly or implicitly covenant or warrant that any plans or specifications submitted by
Tenant and reviewed or approved by Landlord are safe or that the same comply with any Regulations.
Further, Tenant shall indemnify, defend (by counsel reasonably acceptable to Landlord) and hold
Landlord harmless from any loss, cost or expense, including attorneys fees and costs, incurred by
Landlord as a result of any defects in design, materials or workmanship resulting from Tenants
alterations, additions or improvements to the Premises. All repairs, alterations, additions, and
restoration by Tenant hereinafter required or permitted shall be done in a good and workmanlike
manner and in compliance with all Regulations and requirements of the insurers of the Property.
Tenant shall reimburse Landlord for Landlords reasonable charges and expenses for reviewing and
approving or disapproving plans and specifications and any other documents for any alterations
proposed by Tenant. Tenant shall require that any contractors used by Tenant be licensed and carry
a commercial general liability insurance policy in such amounts as Landlord may reasonably require.
Landlord may require proof of such insurance prior to commencement of any work on the Premises.
9. UTILITIES
9.01.
Utilities.
Tenant shall promptly pay for all utilities and services supplied to the
Premises, including, but not limited to, heat, water, reclaimed water, gas, electricity, telephone,
internet, communication facilities, sewage, air conditioning, ventilating, refuse removal, cleaning
of the Premises, together with any taxes thereon. Landlord shall not be liable to Tenant for
interruption in or curtailment of any utility service, nor shall any such interruption or
curtailment constitute constructive eviction or grounds for rental abatement. If any such utilities
are not separately metered, Tenant shall pay a pro rata share, based on use, as reasonably
determined by Landlord; such expenses shall be an element of Building Operating Expenses and/or
Warehouse Operating Expenses pursuant to the terms of Section 7.01.
10. USE OF PREMISES
10.01.
General.
Tenant shall use and occupy the Premises only for the Permitted Uses and for
no other purpose. Tenant 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 owners and/or occupants of, or
causes damage to, neighboring properties. Tenant agrees, by Tenants entry, that Tenant has
conducted an investigation of the Premises and the acceptability of the Premises for Tenants use,
to the extent that such investigation might affect or influence Tenants execution of this Lease.
Tenant acknowledges that Landlord has made no representations or warranties in connection with the
physical
9
condition of the Premises, Tenants use of the same, or any other matter upon which Tenant has
relied directly or indirectly for any purpose. Landlord, at its sole cost and expense, shall obtain
all governmental permits necessary to permit Tenant to use and occupy the Premises for the
Permitted Uses as of the Commencement Date in accordance with applicable Requirements. Tenant
agrees to reasonably cooperate with Landlord in connection with Landlords procurement of any such
permits.
10.02.
Hazardous Materials
. Tenant shall strictly comply with all Regulations now or
hereinafter mandated or advised by any federal state, local or other governmental agency with
respect to the use, generation, storage, or disposal of hazardous, toxic, or radioactive materials
(collectively,
Hazardous Materials
). As herein used, Hazardous Materials shall include, but not
be limited to, those materials identified in Sections 66680 through 66685 of Title 22 of the
California Administrative Code, Division 4, Chapter 30, as amended from time to time, and those
substances defined as hazardous substances, hazardous materials, hazardous wastes, toxic
substances, or other similar designations in the Comprehensive Environmental Response,
Compensation and Liability Act of 1980, as amended, 42 U.S.C. Section 9601, et seq., the Resource
Conservation and Recovery Act, 42 U.S.C. Section 6901, et seq., the Hazardous Materials
Transportation Act, 49 U.S.C. Section 1801, et seq., and California Health and Public Safety Code
Section 25117. Tenant shall not cause, or allow anyone else to cause, any Hazardous Materials to be
used, generated, stored, released or disposed of in, on or about the Property without the prior
written consent of Landlord, which consent may be withheld in the sole discretion of Landlord, and
which consent may be revoked at any time. Tenants indemnification of Landlord pursuant to Section
6.10, above, shall extend to all liability, including all foreseeable and unforeseeable
consequential damages, directly arising out of the use, generation, storage, release or disposal of
Hazardous Materials by Tenant or any person on the Premises during the Term, including, without
limitation, the cost of any required or necessary repair, cleanup, or detoxification and the
preparation of any closure or other required plans, whether such action is required or necessary
prior to or following the termination of this Lease. Neither the written consent by Landlord to the
use, generation, storage, or disposal of Hazardous Materials nor the strict compliance by Tenant
with all Regulations pertaining to Hazardous Materials shall excuse Tenant from Tenants
indemnification obligation pursuant to this Section, which obligation shall survive the termination
of this Lease. Landlord, its lenders and its consultants shall have the right to enter into the
Premises at any time, in the case of an emergency, and otherwise at reasonable times, for the
purpose of inspecting the condition of the Premises and for verifying compliance by Tenant with
this Lease. The cost of any such inspections shall be paid by Landlord, unless a violation of any
Regulation, or a contamination is found to exist or be imminent, or the inspection is requested or
ordered by a governmental authority. In such case, Tenant shall upon request reimburse Landlord for
the cost of such inspections, so long as such inspection is reasonably related to the violation or
contamination. Notwithstanding anything to the contrary herein, Tenants obligations under this
Section 10.02 shall not apply to (i) any Hazardous Materials that were located at the Property on
the Commencement Date, any Hazardous Materials placed on the Property by Landlord, its employees,
agents, or contractors, (except to the extent the release thereof or liability therefor is due to
the acts of Tenant or its employees, agents, or contractors), (ii) any Hazardous Materials that
migrate onto or under the Property from adjacent properties (except to the extent the release
thereof or liability therefor is due to the acts of Tenant or its employees, agents, or
contractors), or (iii) any Hazardous Materials placed on the Property by any other tenant of the
Property (except to the extent the release thereof or liability therefor is due to the acts of
Tenant or its employees, agents, or contractors).
10.03.
Environmental Disclosure
. Should Tenant wish to use, generate or store Hazardous
Materials on or about the Property, Tenant shall complete, execute and deliver to Landlord an
Environmental Disclosure Statement (the Environmental Disclosure) in the form of
Exhibit
E
attached hereto, and Tenant shall certify to Landlord all information contained in the
Environmental Disclosure as true and correct to the best of Tenants knowledge and belief. The
completed Environmental Disclosure shall be deemed incorporated into this Lease for all purposes,
and Landlord shall be entitled to rely fully on the information contained therein. In the event
Tenant provides an Environmental Disclosure, on each anniversary of the Commencement Date (each
such date is hereinafter referred to as a Disclosure Date), until and including the first
Disclosure Date occurring after the expiration or sooner termination of this Lease, Tenant shall
disclose to Landlord, in writing, the names and amounts of all Hazardous Materials, or any
combination thereof, which were stored, generated, used or disposed of on, under or about the
Premises for the twelve-month period prior to and after each Disclosure Date, or which Tenant
intends to store, generate, or use on, under or about the Premises. At Landlords option, Tenant
shall execute and deliver to Landlord an Environmental Disclosure as the same may be modified by
Landlord from time to time whether or not Tenant wishes to use, generate or store Hazardous
Materials on or about the Property.
10.04.
Reclaimed Water
. In the event the Property uses reclaimed water, Tenant acknowledges
that Tenant shall comply with all Regulations governing the use thereof. Landlord may periodically
conduct such tests as may be reasonably necessary for the use of reclaimed water, including a dual
shut down test to establish that there exists no cross over in water systems, and the reasonable
costs thereof shall be an operating expense.
10.05.
Signs
. Tenant shall have the exclusive right to signage on the façade of the Building.
Any sign placed by Tenant on any portion of the Premises shall contain only Tenants name and no
advertising material, and shall otherwise comply with Landlords sign criteria (if any). No sign
(including, but not limited to, signs advertising an assignment or subletting) shall be placed on
the exterior of the Premises without Landlords written approval of the location, material, size,
design and content thereof nor without Tenants obtaining any necessary permit therefor. If
Landlord installs a sign for Tenant, Tenant shall reimburse Landlord for any costs incurred by
Landlord within five (5) days of demand by Landlord. Tenant shall remove any sign upon termination
of this Lease, using a contractor reasonably acceptable to Landlord, and shall return the Premises
to their condition prior to the placement of said sign (including completing all necessary
repainting and patching).
10.06.
Parking
. Any monetary obligations imposed relative to parking rights with respect to
the Premises shall be considered as Tax Expenses and shall be paid by Tenant under Section 5.
Landlord grants Tenant the right to use all of the parking spaces located in the parking area
adjacent to the Building (approximately one hundred and ten (110) parking spaces), with the rules
regulating the use thereof to be established, from time to time, by Landlord. Tenant shall control
Tenants employees, agents, customers, visitors, invitees, licensees, contractors, assignees and
subtenants (Tenants Parties) to ensure compliance with such rules. Landlord may take such
actions or incur such cost which it deems reasonably necessary to enforce the proper parking on the
Property, including the reasonable allocation to Tenant of all costs and expenses to do so. Tenant
shall not use the areas outside of the Premises for the placement of dumpsters, refuse collection,
outdoor storage or parking of cars and/or pickup trucks which are not in working order. Tenant
shall have the right to request that Landlord provide Tenant with the right to use an additional
forty (40) parking spaces (the Additional Parking Spaces). The Additional Parking Spaces will be
located at the property commonly known as 1750 Doolittle Drive, San Leandro, CA, and/or the 3.75
acre parcel located across the street from the Property and directly north of 1750 Doolittle Drive,
San Leandro, CA (as determined by Landlord in its sole discretion). If Tenant requests the
Additional Parking Spaces, Landlord shall use commercially reasonable efforts to obtain all
permits, licenses, and other authorizations necessary to permit Landlord to lease or license the
Additional Parking Spaces to Tenant (the Additional Parking Permits) and if Landlord is able to
obtain the Additional Parking Permits, Landlord shall lease or license the Additional Parking
Spaces to Tenant pursuant to the terms of this Lease. Further, if the City of San Leandro should
determine that Tenants use of the Premises requires the availability of the Additional Parking
Spaces, Landlord shall use commercially reasonable efforts to obtain the Additional Parking Permits
and if Landlord is able to obtain the Additional Parking Permits, Landlord shall lease or license
the Additional Parking Spaces to Tenant pursuant to the terms of this Lease. Notwithstanding
anything to the contrary herein, Landlords failure to lease or license the Additional Parking
Spaces to Tenant due to Landlords failure to obtain the Additional Parking Permits shall not
constitute a default by Landlord under this Lease. In all events, Landlord shall have one hundred
eighty (180) days after its receipt of Tenants request for the Additional Parking Spaces or the
City of San Leandros determination, as applicable, to obtain the Additional Parking Permits and
deliver the Additional Parking Spaces to Tenant. Landlord shall pay for its costs incurred with
respect to the procurement of the Additional Parking Permits. Landlord and Tenant acknowledge that
Landlord has an option to purchase (the Option) the 3.75 acre parcel located across the
10
street from the Property and directly north of 1750 Doolittle Drive, San Leandro, CA (the Option
Property). As of the Effective Date, the Option will expire on November 15, 2010. If Tenant
desires to acquire the Option Property for the purpose of obtaining additional parking spaces, it
can notify Landlord in writing of the same. If Landlord does not intend to exercise the Option,
Landlord shall notify Tenant thereof (which notice Landlord shall provide within thirty (30) days
of its receipt of Tenants notice) and, for a period of ninety (90) days, shall reasonably
cooperate at no cost to Landlord with Tenant in connection with Tenants negotiation of a contract
to acquire the Option Property. It shall not be a default by Landlord under this Lease if Tenant is
unable to acquire the Option Property. If Landlord intends to exercise the Option, Landlord shall
have no obligation to assist Tenant in connection with its acquisition of the Option Property. If
the City of San Leandro should determine that Tenants use of the Premises requires the
availability of more than one hundred fifty (150) parking spaces (or if the Additional Parking
Spaces are not being leased or licensed to Tenant, one hundred ten (110) parking spaces), and
provided that there are parking spaces at the Property that are not then subject to lease or
license, Landlord shall grant Tenant the right to use up to fifty (50) additional parking spaces
(or if the Additional Parking Spaces are not being leased or licensed to Tenant, up to ninety (90)
additional parking spaces) at the Property (in locations to be reasonably agreed upon by Landlord
and Tenant). Further, if Tenant should reasonably determine that Tenants use of the Premises
requires the availability of more than one hundred fifty (150) parking spaces (or if the Additional
Parking Spaces are not being leased or licensed to Tenant, one hundred ten (110) parking spaces),
and provided that there are parking spaces at the Property that are not then subject to lease or
license, Landlord shall grant Tenant the right to use up to fifty (50) additional parking spaces
(or if the Additional Parking Spaces are not being leased or licensed to Tenant, up to ninety (90)
additional parking spaces) at the Property (in locations to be reasonably agreed upon by Landlord
and Tenant).
11. DAMAGE AND DESTRUCTION
11.01.
Reconstruction
. If the Building or the Warehouse is damaged or destroyed, Landlord
shall, except as hereinafter provided, diligently repair or rebuild the Building or the Warehouse
(as applicable) to substantially the condition in which the Building or the Warehouse (as
applicable) existed immediately prior to such damage or destruction, provided that insurance is
available to pay one hundred percent (100%) or more of the cost of such restoration, excluding the
deductible amount. Landlord shall not be obligated to repair any improvements made or paid for by
Tenant.
11.02.
Rent Abatement
. Base Rent shall be abated proportionately, but only to the extent of
any proceeds received by Landlord from rental abatement insurance described in Section 6.06, during
any period when, by reason of such damage or destruction, Landlord reasonably determines that there
is substantial interference with Tenants use of the Premises, having regard to the extent to which
Tenant may be required to discontinue Tenants use of the Premises. Such abatement shall commence
upon the date of such damage or destruction and end upon substantial completion by Landlord of the
repair or reconstruction which Landlord is obligated or undertakes to do. If Landlord reasonably
determines that continuation of business is not practical pending reconstruction, Base Rent shall
abate to the extent of proceeds from rental abatement insurance until reconstruction is
substantially completed or until business is totally or partially resumed, whichever occurs
earlier.
11.03.
Option to Terminate.
(i) If the Building is damaged or destroyed to the extent that
Landlord determines in good faith that the Building cannot, with reasonable diligence, be fully
repaired or restored by Landlord within two hundred seventy (270) days after the date of the damage
or destruction, notwithstanding the fact that the Premises have not been totally damaged or
destroyed, the sole right of both Landlord and Tenant shall be the option to terminate this Lease.
(ii) If the Warehouse is damaged or destroyed to the extent that Landlord determines in good faith
that the Warehouse cannot, with reasonable diligence, be fully repaired or restored by Landlord
within two hundred seventy (270) days after the date of the damage or destruction, notwithstanding
the fact that the Premises have not been totally damaged or destroyed, the sole right of Landlord
shall be the option to terminate this Lease with respect to the Warehouse only. (iii) If the
Warehouse is damaged or destroyed to the extent that Landlord determines in good faith that the
Warehouse cannot, with reasonable diligence, be fully repaired or restored by Landlord within two
hundred seventy (270) days after the date of the damage or destruction, notwithstanding the fact
that the Premises have not been totally damaged or destroyed, the sole right of Tenant shall be the
option to terminate this Lease. Landlords determination with respect to the extent of damage or
destruction shall be conclusive on Tenant. Landlord shall notify Tenant of Landlords
determination, in writing, within sixty (60) days after the date of the damage or destruction. If
Landlord determines that under clause (i) above the Building can be fully repaired or restored
within the two hundred seventy (270)-day period, or if Landlord determines that such
repair or restoration cannot be made within said period but neither party elects to terminate
within thirty (30) days from the date of said determination, this Lease shall remain in full force
and effect and Landlord shall diligently repair and restore the damage as soon as reasonably
possible. If Landlord determines that under clause (ii) above the Warehouse can be fully repaired
or restored within the two hundred seventy (270)-day period, or if Landlord determines that such
repair or restoration cannot be made within said period but neither party elects to terminate
within thirty (30) days from the date of said determination, this Lease shall remain in full force
and effect and Landlord shall diligently repair and restore the damage as soon as reasonably
possible. If this Lease is terminated pursuant to this Section 11.03 with respect to the Warehouse
only, (a) after the date of such termination the Base Rent, Tenants Share of Warehouse Tax
Expenses, and Tenants Share of Warehouse Insurance Expenses shall be adjusted as reasonably
determined by Landlord and (b) upon Tenants written request and provided alternative warehouse
space at the Property is then vacant and available for lease, Landlord agrees to negotiate in good
faith with Tenant with respect to the lease of alternative warehouse space at the Property, either
on a temporary basis (pending restoration of the Warehouse Premises) or on a long-term basis, as
the parties shall mutually agree.
11.04.
Uninsured Casualty.
In the event the Building is damaged or destroyed and is not fully
covered by the insurance proceeds received by Landlord under the insurance policies required under
Section 6.02, Landlord may terminate this Lease by written notice to Tenant given within thirty
(30) days after the date of Landlords receipt of written notice from Landlords insurance company
that said damage or destruction is not
so covered. In the event the Warehouse is damaged
or destroyed and is not fully covered by the insurance proceeds received by Landlord under the
insurance policies required under Section 6.02, Landlord may terminate this Lease with respect to
the Warehouse only by written notice to Tenant given within thirty (30) days after the date of
Landlords receipt of written notice from Landlords insurance company that said damage or
destruction is not so covered. If Landlord does not elect to terminate this Lease, this Lease shall
remain in full force and effect, and the Building or Warehouse (as applicable) shall be repaired
and rebuilt in accordance with the provisions for repair set forth in Section 11.01. If this Lease
is terminated pursuant to this Section 11.04 with respect to the Warehouse only, after the date of
such termination the Base Rent shall be adjusted as reasonably determined by Landlord.
11.05.
Waiver.
With respect to any damage or destruction which Landlord is obligated to repair
or may elect to repair under the terms of this Section 11, Tenant waives all rights to terminate
this Lease pursuant to rights otherwise presently or hereafter accorded by law to tenants,
including, without limitation, any rights arising pursuant to California Civil Code Sections 1932
and 1933.
12. EMINENT DOMAIN
12.01.
Total Condemnation.
If all of the Premises is taken under the power of eminent domain
or sold in lieu of condemnation, for any public or quasi-public use or purpose (Condemned), this
Lease shall terminate as of the date of title vesting in such proceeding, and Rent shall be
adjusted to the date of termination.
12.02.
Partial Condemnation.
If any portion of the Premises is Condemned, and such partial
condemnation renders the Premises unusable for Tenants business, or if a substantial portion of
the Building is Condemned, as reasonably determined by Landlord, this Lease shall terminate as of
the date of title vesting in such proceeding and rent shall be adjusted to the date of termination.
If such partial
11
condemnation does not render the Premises unusable for the business of Tenant or less than a
substantial portion of the Building is Condemned, Landlord shall promptly restore the Premises to
the extent of any condemnation proceeds recovered by Landlord, less the portion thereof lost in
such condemnation, and this Lease shall continue in full force and effect except that after the
date of such title vesting the Base Rent, Tenants Share of Warehouse Tax Expenses, Tenants Share
of Warehouse Insurance Expenses, and Tenants Share of Warehouse Operating Expenses shall be
adjusted as reasonably determined by Landlord. Tenant hereby waives the provisions of California
Code of Civil Procedure Section 1265.130 permitting a court of law to terminate this Lease.
12.03.
Landlords Award.
If the Premises are wholly or partially Condemned, Landlord shall be
entitled to the entire award paid for such condemnation, subject to the provisions of Section
12.04, and Tenant waives any claim to any part of the award from Landlord or the condemning
authority.
12.04.
Tenants Award.
Tenant shall have the right to recover from the condemning authority,
but not from Landlord, such compensation as may be separately awarded to Tenant in connection with
loss of good will and costs in removing Tenants merchandise, furniture, fixtures, leasehold
improvements and equipment to a new location, so long as such award does not diminish the award
granted to Landlord.
12.05.
Temporary Condemnation.
In the event the Premises is temporarily Condemned, as
reasonably determined by Landlord, this Lease shall remain in effect and Tenant shall receive any
award made for such condemnation. If a temporary condemnation remains in effect at the expiration
or earlier termination of this Lease, Tenant shall pay Landlord the reasonable cost of performing
any obligations required of Tenant by this Lease with respect to the surrender of the Premises, and
upon such payment Tenant shall be excused from such obligations. If a temporary condemnation is for
a period which extends beyond the Term, this Lease shall terminate as of the date of occupancy by
the condemning authority, the award shall be distributed as provided in Sections 12.03 and 12.04
above, and Rent shall be adjusted to the date of such occupancy.
12.06.
Delivery of Documents.
Tenant shall immediately execute and deliver to Landlord all
instruments required to effectuate the provisions of this Section 12.
13. DEFAULT
13.01.
Events of Default.
The occurrence of any of the following events shall constitute an
Event of Default by Tenant with or without notice from Landlord:
a. Vacating or Abandoning. Vacating or abandoning the Premises;
b. Payment. Failure to pay Rent within seven (7) days of Tenants receipt of Landlords
written notice that the same is due; provided, however, Landlord shall not be obligated to
provide written notice of monetary default more than two (2) times in any calendar year, and
each subsequent monetary default shall be an Event of Default if not received when the same is
due; provided further, such notice shall be in lieu of, and not in addition to, any notice
required under Section 1161 et seq. of the California Code of Civil Procedure;
c. Performance. Default in the performance of Tenants covenants, agreements and
obligations hereunder, except default in the payment of Rent, the default continuing for
thirty (30) days after notice thereof from Landlord; provided, however, if such default is of
the type which cannot reasonably be cured within thirty (30) days, then Tenant shall have such
longer time as is reasonably necessary provided Tenant commences to cure within ten (10) days
after receipt of written notice from Landlord and diligently prosecutes such cure to
completion within sixty (60) days of such notice;
d. Assignment. A general assignment by Tenant for the benefit of creditors;
e. Bankruptcy. The filing of a voluntary petition by Tenant or the filing of an
involuntary petition by any of Tenants creditors seeking the rehabilitation, liquidation or
reorganization of Tenant under any law relating to bankruptcy;
f. Receivership. The appointment of a receiver or other custodian to take possession of
substantially all of Tenants assets or this leasehold;
g. Insolvency, Dissolution, Etc. Tenants insolvency or inability to pay Tenants debts,
or failure generally to pay Tenants debts when due; or any court entering a decree or order
directing the winding up or
liquidation of Tenant or of substantially all of Tenants assets; or Tenant taking any
action toward the dissolution or winding up of Tenants affairs or the cessation or suspension
of Tenants use of the Premises;
h. Attachment. Attachment, execution or other judicial seizure of substantially all of
Tenants assets or this leasehold;
i. Estoppel/Financial Statements. Tenants failure to deliver to Landlord an Estoppel
Certificate mandated by Section 15.01 or a Financial Statement mandated by Section 16.02
within thirty (30) days after Landlords written request; or
j. False Financial Statements. The discovery that any Financial Statement of Tenant given
to Landlord was materially false.
Tenant hereby waives the redemption provisions of California Code of Civil Procedure Sections 1174
and 1179.
13.02.
Landlords Remedies.
Upon any Event of Default, Landlord may, in addition to all other
rights and remedies afforded Landlord hereunder or by law or equity, take any one or more of the
following actions:
a. Termination of Lease. Terminate this Lease by giving Tenant written notice thereof, in
which event Tenant shall immediately surrender the Premises to Landlord. In the event that
Landlord shall elect to so terminate this Lease, then Landlord may recover from Tenant:
(i) The worth at the time of award of any unpaid Rent which had been earned at the
time of such termination; plus
(ii) The worth at the time of award of the amount by which the unpaid Rent which
would have been earned after termination until the time of award exceeds the amount of
such Rent loss Tenant proves reasonably could have been avoided; plus
(iii) The worth at the time of award of the amount by which the unpaid Rent for the
balance of the Term after the time of award exceeds the amount of such Rent loss that
Tenant proves reasonably could be avoided; plus
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(iv) Any other amount necessary to compensate Landlord for all detriment
proximately caused by Tenants failure to perform its obligations under this Lease or
which in the ordinary course would be likely to result therefrom; plus
(v) At Landlords election, such other amounts in addition to or in lieu of the
foregoing as may be permitted from time to time by applicable California law.
As used in subparagraphs (i) and (ii) above, the worth at the time of award is computed by
allowing interest at the Default Rate. As used in subparagraph (iii) above, the worth at the
time of award is computed by discounting such amount at the discount rate of the Federal
Reserve Bank of San Francisco at the time of award plus one percent (1%). Forbearance by
Landlord to enforce one or more of the remedies herein provided upon an Event of Default shall
not be deemed or construed to constitute a waiver of such default. Tenant hereby waives for
Tenant and for all those claiming under Tenant all rights now or hereafter existing to redeem
by order or judgment of any court or by any legal process or writ, Tenants right of occupancy
of the Premises after any termination of this Lease.
b. Termination of Possession. Terminate Tenants right to possess the Premises without
terminating this Lease by giving written notice thereof to Tenant, in which event Tenant shall
pay to Landlord: (1) all Rent and other amounts accrued hereunder to the date of termination
of possession and (2) all Rent and other net sums required hereunder to be paid by Tenant
during the remainder of the Term, diminished by any net sums thereafter received by Landlord
through reletting the Premises during such period, after deducting all costs incurred by
Landlord in relating the Premises. Any sums due under the foregoing Section 13.02(b)(2) shall
be calculated and due monthly. If Landlord elects to proceed under this Section 13.02(b),
Landlord may remove all of Tenants property from the Premises and store the same in a public
warehouse or elsewhere at the cost of, and for the account of, Tenant, without becoming liable
for any loss or damage which may be occasioned thereby. If and to the extent required by
applicable Regulations, Landlord shall use commercially reasonable efforts to relet the
Premises on such terms as Landlord in its sole discretion may determine (including a term
different from the Term, rental concessions, and alterations to, and improvement of, the
Premises); however, Landlord shall not be obligated to expend funds in connection with
reletting the Premises, nor to relet the Premises before leasing other portions of the
Property, and Landlord shall not be obligated to accept any prospective tenant proposed by
Tenant unless such proposed tenant meets all of Landlords leasing criteria then in effect.
Landlord shall not be liable for, nor shall Tenants obligations hereunder be diminished
because of, Landlords failure to relet the Premises or to collect rent due for such
reletting. Tenant shall not be entitled to the excess of any consideration obtained by
reletting over the Rent due hereunder. Reentry by Landlord in the Premises shall not affect
Tenants obligations hereunder for the unexpired Term; rather, Landlord may, from time to
time, bring an action against Tenant to collect amounts due by Tenant, without the necessity
of Landlords waiting until the expiration of the Term. Unless Landlord delivers written
notice to Tenant expressly stating that it has elected to terminate this Lease, all actions
taken by Landlord to dispossess or exclude Tenant from the Premises shall be deemed to be
taken under this Section 13.02(b). If landlord elects to proceed under this Section 13.02(b),
it may at any time elect to terminate this Lease under Section 13.02(a).
c. Continue Lease in Effect. In addition to all other rights and remedies provided
Landlord in this Lease and by Regulations, Landlord shall have the remedy described in
California Civil Code Section 1951.4 (Landlord may continue the Lease in effect after Tenants
breach and abandonment and recover Rent as it becomes due if Tenant has the right to sublet or
assign the Lease, subject to reasonable limitations).
d. Additional Remedies. In addition to the foregoing remedies and so long as this Lease
is not terminated, Landlord shall have the right to remedy any default of Tenant, to maintain
or improve the Premises without terminating this Lease, to incur expenses on behalf of Tenant
in seeking a new subtenant, to cause a receiver to be appointed to administer the Premises and
new or existing subleases and to add to the Rent payable hereunder all of Landlords
reasonable costs in so doing, with interest at the Default Rate from the date of such
expenditure until the same is repaid.
e. Alteration of Locks. Additionally, with or without notice, and to the extent permitted
by applicable Regulations, Landlord may alter locks or other access control devices at the
Premises to deprive Tenant of access thereto, and Landlord shall not be required to provide a
new key or right of access to Tenant.
f. Other. If Tenant causes or threatens to cause a breach of any of the covenants, terms
or conditions contained in this Lease, Landlord shall be entitled to obtain all sums held by
Tenant, by any trustee or in any account provided for herein, to enjoin such breach or
threatened breach, and to invoke any remedy allowed at law, in equity, by statute or otherwise
as though re-entry, summary proceedings and other remedies were not provided for in this
Lease. If a notice and grace period required under Section 13.01 was not previously given, a
notice to pay rent or quit, or to perform or quit given to Tenant under the unlawful detainer
statute (California Code of Civil Procedure Sections 1161 et seq.) shall also constitute the
notice required by Section 13.01. In such case, the applicable grace period required by
Section 13.01 and the unlawful detainer statute shall run concurrently, and the failure of
Tenant to cure the Event of Default within the greater of the two such grace periods shall
constitute both an unlawful detainer and a breach of this Lease entitling Landlord to the
remedies provided for in this Lease and/or by said statute.
13.03.
Landlords Remedies Cumulative
. Each right and remedy of Landlord provided for in this
Lease or now or hereafter existing at law, in equity, by statute or otherwise, shall be cumulative
and shall not preclude Landlord from exercising any other rights or remedies provided for in this
Lease or now or hereafter existing at law or equity, by statute or otherwise. Nothing in this
Section 13 shall affect the right of Landlord to indemnification by Tenant in accordance with
Section 6.10 for liability arising from personal injuries or property damage prior to the
termination of this Lease.
14. ASSIGNMENT AND SUBLETTING
14.01.
Approval
. Tenant shall not assign, sublease, mortgage, pledge or otherwise transfer
this Lease, in whole or in part, nor sublet or permit occupancy by any party other than Tenant of
all or any part of the Premises without Landlords prior written consent which shall not be
unreasonably withheld, conditioned or delayed. If Tenant is a corporation, limited liability
company or a partnership, other than a corporation whose stock is publicly traded, the transfer of
fifty percent (50%) or more of the beneficial ownership interest of the corporate stock, membership
interests or partnership interests of Tenant, as the case may be, shall constitute an assignment
hereunder for which such consent is required. This Lease may not be assigned by operation of law.
Any purported assignment or subletting contrary to the provisions hereof shall be void.
Notwithstanding that Landlord shall have no legal obligation to do so, if Landlord should decide in
the future to permit an assignment or subletting, such consent by Landlord to any assignment or
subletting shall not constitute a consent to any subsequent assignment or subletting. Under no
circumstances shall this Lease be assigned, sublet, or assumed, in whole or in part, unless
Landlord receives adequate assurance of future performance of all the terms and conditions of this
Lease. Such adequate assurance shall include adequate assurance: (a) of the source of Rent due
under this Lease; (b) that the assignment, subletting, or assumption of this Lease shall not cause
any breach in any respect of any provision in any other lease, financing agreement, or master
agreement relating to the Building, the Warehouse, or Property; and (c) that the assignment,
subletting, or assumption shall not disrupt in any respect any tenant mix or balance in
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the Building, the Warehouse, or on the Premises. Tenant shall pay promptly upon billing any and all
attorneys fees and other costs reasonably incurred by Landlord for the review or preparation of
any documents in connection with a proposed assignment or sublease.
14.02.
Landlord Option
.
a. Right to Cancel. In connection with any proposed assignment or sublease, Landlord
shall have the option to cancel and terminate this Lease if the request is to assign this
Lease or to sublet all of the Premises; or, if the request is to sublet a portion of the
Premises only, to cancel and terminate this Lease with respect to such portion. Landlord may
exercise said option by notifying Tenant in writing within thirty (30) days after Landlords
receipt from Tenant of such request, and in each case such cancellation or termination shall
occur as of the date set forth in Landlords notice of exercise of such option, which shall
not be less than sixty (60) days nor more than one hundred twenty (120) days following the
giving of such notice.
b. Cancellation. If Landlord exercises Landlords option to cancel this Lease or any
portion thereof, Tenant shall surrender possession of the Premises, or the portion thereof
which is the subject of the option, as the case may be, on the date set forth in such notice
in accordance with the provisions of this Lease relating to surrender of the Premises at the
expiration of the Term. If this Lease is canceled as to a portion of the Premises only, Rent
after the date of cancellation shall be abated on a pro rata basis, as determined by Landlord.
After any such cancellation, Landlord may directly lease the Premises to any party, including,
without limitation, any party with whom Tenant previously discussed an assignment or
subletting.
c. Noncancellation. If Landlord does not exercise Landlords option to cancel this Lease
pursuant to the foregoing provisions, Landlord may withhold Landlords consent to such
proposed assignment or subletting, provided such consent is not unreasonably withheld.
14.03.
Bonus Rental
. If Tenant receives rent or other consideration for any assignment or
sublease in excess of the Rent or, in case of the sublease of a portion of the Premises, in excess
of such Rent that is fairly allocable to such portion, as determined by Landlord, after appropriate
adjustments to assure that all other payments required hereunder are appropriately taken into
account, Tenant shall pay Landlord fifty percent (50%) of the difference between each such payment
of rent or other consideration and the Rent required hereunder. Tenant may deduct from the excess,
on a straight-line basis, all reasonable and customary expenses directly incurred by Tenant
attributable to the assignment or sublease, including brokerage fees, legal fees, and construction
costs.
14.04.
Scope.
If (a) this Lease is assigned, (b) the underlying beneficial interest of Tenant
is transferred or (c) the Premises or any part thereof is sublet or occupied by anyone other than
Tenant, Landlord may collect rent from the assignee, subtenant or occupant and apply the net amount
collected to the Rent herein reserved and apportion any excess rent so collected in accordance with
the terms of Section 14.03; provided that no such assignment, subletting, occupancy or collection
shall be deemed a waiver of this covenant, or the acceptance of the assignee, subtenant or occupant
as tenant, or a release of Tenant from the further performance by Tenant or covenants on the part
of Tenant herein contained. No assignment or subletting shall affect the continuing liability of
Tenant (which, following assignment, shall be joint and several with the assignee), and Tenant
shall not be released from performing any of the terms, covenants and conditions of this Lease.
14.05.
Release.
The term Landlord as used herein shall mean the owner or owners at the time
in question of the fee title to the Premises, or, if this is a sublease, of the Tenants interest
in the master lease. The obligations and/or covenants in this Lease to be performed by the Landlord
shall be binding only upon the Landlord as hereinabove defined.
14.06.
Holding Over.
If Tenant fails to vacate the Premises at the end of the Term, then
Tenant shall be a tenant at sufferance and, in addition to all other damages and remedies to which
Landlord may be entitled for such holding over: (a) Tenant shall pay, in addition to the other
Rent, Base Rent equal to two hundred percent (200%) of the Base Rent payable during the last month
of the Term; and (b) Tenant shall otherwise continue to be subject to all of Tenants obligations
under this Lease. The provisions of this Section 14.06 shall not be deemed to limit or constitute a
waiver of any other rights or remedies of Landlord provided herein or pursuant to applicable
Regulations. If Tenant fails to surrender the Premises upon the termination or expiration of this
Lease, in addition to any other liabilities to Landlord accruing therefrom, Tenant shall protect,
defend, indemnify and hold Landlord harmless from all loss, costs (including reasonable attorneys
fees) and liability resulting from such failure,
including any claims made by any succeeding tenant founded upon such failure to surrender, and
any lost profits to Landlord resulting therefrom. Notwithstanding the foregoing, if Tenant holds
over with Landlords express written consent, then Tenant shall be a month-to-month tenant and
Tenant shall pay, in addition to the other Rent, Base Rent equal to one hundred twenty-five percent
(125%) of the Base Rent payable during the last month of the Term.
14.07.
Waiver.
Tenant waives notice of any default of any assignee or sublessee and agrees
that Landlord may, at Landlords option, proceed against Tenant without having taken action against
or joined such assignee or sublessee, except that Tenant shall have the benefit of any indulgences,
waivers and extensions of time granted to any such assignee or sublessee.
14.08.
Permitted Transfers.
Notwithstanding Section 14.01, Tenant may transfer its interest in
this Lease or all or part of the Premises (a Permitted Transfer) to the following types of
entities (a Permitted Transferee) without the written consent of Landlord:
(1) any person or entity which, directly or indirectly, through one or more
intermediaries, controls, is controlled by, or is under common control with Tenant;
(2) any corporation, limited partnership, limited liability partnership, limited
liability company or other business entity in which or with which Tenant, or its corporate
successors or assigns, is merged or consolidated, in accordance with applicable statutory
provisions governing merger and consolidation of business entities, so long as (A) Tenants
obligations hereunder are assumed by the entity surviving such merger or created by such
consolidation; and (B) the Tangible Net Worth of the surviving or created entity is not less
than the Tangible Net Worth of Tenant as of the date of execution of this Lease; or
(3) any corporation, limited partnership, limited liability partnership, limited
liability company or other business entity acquiring all or substantially all of Tenants
assets if such entitys Tangible Net Worth after such acquisition is not less than the
Tangible Net Worth of Tenant as of the date of execution of this Lease.
Tenant shall promptly notify Landlord of any such Permitted Transfer. Tenant shall remain
liable for the performance of all of the obligations of Tenant hereunder, or if Tenant no longer
exists because of a merger, consolidation, or acquisition, the surviving or acquiring entity shall
expressly assume in writing the obligations of Tenant hereunder. Additionally, the Permitted
Transferee shall comply with all of the terms and conditions of this Lease, including the Permitted
Uses, and the use of the Premises by the Permitted Transferee may not violate any other agreements
affecting the Premises, the Building, the Warehouse, or the Property. No later than five (5)
business days after the effective date of any Permitted Transfer, Tenant agrees to furnish Landlord
with (A) copies of the instrument effecting any of the foregoing transfers, (B) documentation
establishing Tenants satisfaction of the requirements set forth above applicable to any such
transfer, and (C) evidence of insurance as required under this Lease with respect to the Permitted
Transferee. The occurrence of a Permitted Transfer shall not waive Landlords rights as to any
subsequent transfers. Tangible Net Worth means the excess of total assets over total liabilities,
in
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each case as determined in accordance with generally accepted accounting principles consistently
applied (GAAP), excluding, however, from the determination of total assets all assets which would
be classified as intangible assets under GAAP including goodwill, licenses, patents, trademarks,
trade names, copyrights and franchises. Any subsequent transfer by a Permitted Transferee shall be
subject to the terms of this Section 14. Landlords right to cancel under Section 14.02 shall not
apply with respect to a Permitted Transfer.
15. ESTOPPEL CERTIFICATE, ATTORNMENT AND SUBORDINATION
15.01.
Estoppel Certificate.
Within ten (10) days after request by Landlord, Tenant shall
deliver, in recordable form, an estoppel certificate in the form determined by Landlord or
Landlords mortgagee or purchaser, to any proposed mortgagee, purchaser or Landlord. Tenants
failure to deliver said statement in such time period shall be conclusive upon Tenant that (a) this
Lease is in full force and effect, without modification except as may be represented by Landlord;
(b) there are no uncured defaults in Landlords performance and Tenant has no right of offset,
counterclaim or deduction against Rent hereunder; and (c) no more than one months Rent has been
paid in advance.
15.02.
Attornment
. Tenant shall, if requested, attorn to the purchaser upon a foreclosure,
sale or a grant of a deed in lieu of foreclosure of the Property, and recognize such purchaser as
Landlord under this Lease in the event of (a) a foreclosure proceeding (b) the exercise of the
power of sale under any mortgage or deed of trust made by Landlord, Landlords successors or
assigns which encumbers the Premises, any part thereof; or (c) the termination of a ground lease;
or (d) a sale of the Property.
15.03.
Subordination.
The rights of Tenant hereunder are subject and subordinate to the lien
of any mortgage or lien resulting from any other method of financing or refinancing, now or
hereafter in force against the Premises, and to all advances made upon the security thereof;
provided, however, that notwithstanding such subordination, so long as Tenant is not in default
under this Lease, this Lease shall not be terminated or subject to termination by any trustees
sale, action to enforce the security or proceeding or action in foreclosure. If requested, Tenant
shall execute whatever documentation may be required to further effect the provisions of this
Section 15.03.
16. MISCELLANEOUS
16.01.
Waiver.
No waiver by Landlord of any default or breach of any covenant by Tenant
hereunder shall be implied from any omission by Landlord to take action on account of such default
if such default persists or is repeated, and no express waiver shall affect any default other than
the default specified in the waiver and then said waiver shall be operative only for the time and
to the extent therein stated. Waivers of any covenant, term or condition contained herein by
Landlord shall not be construed as a waiver of any subsequent breach of the same covenant, term or
condition. The consent or. approval by Landlord to any act of Tenant requiring further consent or
approval by Landlord shall not be deemed to waive or render unnecessary landlords consent or
approval to any subsequent similar acts. No waiver by Landlord of any provision under this Lease
shall be effective unless in writing and signed by Landlord. Landlords acceptance of full or
partial payment of Rent during the continuance of any breach of this Lease shall not constitute a
waiver of any such breach of this Lease. Efforts by Landlord to mitigate the damages caused by
Tenants breach of this Lease shall not be construed as a waiver of Landlords right to recover
damages under Section 13.
16.02.
Financial Statements.
Within ten (10) days after Landlords written request from time
to time during the Term, Tenant shall deliver to Landlord current audited financial statements of
Tenant. Tenant represents and warrants that all financial statements delivered to Landlord shall be
true and complete in all material respects.
16.03.
Accord and Satisfaction.
No payment by Tenant of a lesser amount than the Rent nor any
endorsement on any check or letter accompanying any check or payment as Rent shall be deemed an
accord and satisfaction of full payment of Rent, and Landlord may accept such payment without
prejudice to Landlords right to recover the balance of such Rent or to pursue other remedies.
16.04.
Limitation of Landlords Liability.
The obligations of Landlord under this Lease are
not personal obligations of the individual partners, directors, members, managers, officers and
shareholders of Landlord, and Tenant shall look solely to the Property for satisfaction of any
liability and shall not look to other assets of Landlord nor seek recourse against the assets of
the individual partners, directors, members, managers, officers and shareholders of Landlord.
16.05.
Entire Agreement.
This Lease sets forth all the covenants, agreements, conditions and
understandings between Landlord and Tenant concerning the Property, and there are no covenants,
agreements, conditions or understandings, either oral or written, between Landlord and Tenant other
than as set forth herein. No alteration, amendment, change or addition to this Lease shall be
binding upon Landlord and Tenant unless in writing and signed by both Landlord and Tenant.
16.06.
Time.
Time is of the essence of this Lease.
16.07.
Attorneys Fees.
In any action which Landlord or Tenant brings to enforce its
respective rights hereunder, the unsuccessful party shall pay all costs incurred by the prevailing
party including reasonable attorneys fees, to be fixed by the court, and said costs and attorneys
fees shall be a part of the judgment in said action.
16.08.
Captions and Article Letters.
The captions, article letters and table of contents
appearing in this Lease are inserted as a matter of convenience and in no way define or limit the
provisions of this Lease.
16.09.
Severability.
If any provision of this Lease or the application of any such provision
shall be held by a court of competent jurisdiction to be invalid, void or unenforceable to any
extent, the remaining provisions of this Lease and the application thereof shall remain in full
force and effect and shall not be affected, impaired or invalidated.
16.10.
Applicable Regulations.
This Lease, and the rights and obligations of the parties
hereto, shall be construed and enforced in accordance with the laws of the State of California.
16.11.
Examination of Lease.
Submission of this Lease to Tenant does not constitute an option
to Lease, and this Lease is not effective until execution and delivery by both Landlord and Tenant.
16.12.
Surrender.
Upon the expiration or earlier termination of this Lease, Tenant shall
surrender the Premises to Landlord in the same condition as existed on the date Tenant originally
took possession thereof, reasonable wear and tear excepted, including, but not limited to, all
interior walls cleaned, all interior painted surfaces repainted in the original color, all holes in
walls repaired, all carpets shampooed and cleaned, and all floors cleaned, waxed, and free of any
Tenant-introduced marking or painting, all to the reasonable satisfaction of Landlord. Tenant shall
not commit or allow any waste or damage to be committed on any portion of the Premises or the
Property. All property that Tenant is required to surrender shall become Landlords property upon
the termination of this Lease. If Tenant fails to timely remove its personal property from the
Premises, Landlord may keep and use them or remove any of them and cause them to be stored or sold
in accordance with applicable law, all at Tenants sole cost and expense. All keys to the Premises
or any part thereof shall be surrendered to Landlord upon expiration or sooner termination of the
Term. Tenant shall give written notice to Landlord at least thirty (30) days prior to vacating the
Premises and shall meet with Landlord for a joint inspection of the Premises at the time of
vacating, but nothing contained
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herein shall be construed as an extension of the Term or as a consent by Landlord to any holding
over by Tenant. In the event of Tenants failure to give such notice or participate in such joint
inspection, Landlords inspection at or after Tenants vacating the Premises shall conclusively be
deemed correct for purposes of determining Tenants responsibility for repairs and restoration.
Notwithstanding anything to the contrary herein, as part of Tenants surrender obligations Tenant
shall return the service corridor in the same condition as existed on the date hereof. Such
obligation shall include, if applicable, restoration of the wall separating the Building from the
Warehouse and installation of a carbon dioxide ventilation system equivalent to the one located in
the Building as of the date hereof.
16.13
Authority.
If Tenant is a corporation, trust, limited liability company, partnership, or
similar entity, each individual executing this Lease on behalf of such entity represents and
warrants that he or she is duly authorized to execute and deliver this Lease on its behalf. Tenant
shall, within thirty (30) days after request, deliver to Landlord satisfactory evidence of such
authority.
16.14
. Broker.
Tenant warrants that it has had no dealings with any real estate broker or
agent other than Landlords Broker and Tenants Broker set forth in Section 1.01 in connection with
the negotiation of this Lease, and that it knows of no other real estate broker or agent who is
entitled to any commission or finders fee in connection with this Lease. Tenant agrees to
indemnify Landlord and hold Landlord harmless from and against any and all claims, demands, losses,
liabilities lawsuits, judgments, costs and expenses (including without limitation, attorneys fees
and costs) with respect to any leasing commission or equivalent compensation alleged to be owing on
account of Tenants dealings with any real estate broker or agent other than Landlords Broker and
Tenants Broker. Landlord agrees to indemnify Tenant and hold Tenant harmless from and against any
and all claims, demands, losses, liabilities, lawsuits, judgments, costs and expenses (including
without limitation, attorneys fees and costs) with respect to any leasing commission or equivalent
compensation alleged to be owing on account of Landlords dealings with any real estate broker or
agent other than Landlords Broker and Tenants Broker. Landlord shall pay a commission to
Landlords Broker (to be shared with Tenants Broker) pursuant to a separate agreement.
16.15.
Landlords Right to Perform.
Upon Tenants failure to perform any obligation of Tenant
hereunder, including without limitation, payment of Tenants insurance premiums, charges of
contractors who have supplied materials or labor to the Premises, etc., Landlord shall have the
right to perform such obligations of Tenant on behalf of Tenant and/or to make payment on behalf of
Tenant to such parties. Tenant shall reimburse Landlord the reasonable cost of Landlords
performing such obligations on Tenants behalf, including reimbursement of any amounts that may be
expended by Landlord, plus interest at the Default Rate as Additional Rent.
16.16.
Modification for Lender.
If, in connection with obtaining construction, interim or
permanent financing for the Building, the Warehouse, or the Property, Landlords lender shall
request reasonable modifications in this Lease as a condition to such financing. Tenant shall not
unreasonably withhold, delay or defer its consent thereto, provided that such modifications do not
materially increase the obligations of Tenant hereunder or materially adversely affect the
leasehold interest hereby created or Tenants rights hereunder.
16.17.
Landlords Lien.
In addition to any statutory lien for Rent in Landlords favor,
Landlord shall have and Tenant hereby grants to Landlord a continuing security interest for all
Rent becoming due hereunder from Tenant, upon all goods, wares, equipment, fixtures, furniture,
inventory, accounts, contract rights, chattel paper and other personal property of Tenant situated
on the Premises, and such property shall not be removed therefrom without the consent of Landlord
until all arrearages in Rent shall first have been paid and discharged. In the event of a default
under this Lease, Landlord shall have, in addition to any other remedies provided herein or by law,
all rights and remedies under the Uniform Commercial Code, including without limitation the right
to sell the property described in this Section 16.17 at public or private sale upon ten (10) days
notice to Tenant. Tenant hereby agrees to execute a California Form UCC-1 and such other
instruments necessary or desirable in Landlords discretion, from time to time, to perfect the
security interest hereby created. Any statutory lien for rent is not hereby waived, the express
contractual lien herein granted being in addition and supplementary thereto.
16.18.
Notices.
All notices to be given hereunder shall be in writing and mailed postage
prepaid by certified or registered mail, return receipt requested, or delivered by personal
delivery (including via a nationally recognized overnight courier service), to Landlords Address
and Tenants Address, or to such other
place as Landlord or Tenant may designate in a written notice given to the other party.
Notices shall be deemed served three (3) days after the date of mailing or upon personal delivery,
as the case may be.
16.19.
Hazardous Materials Notification
Tenant acknowledges that Tenant has received the
notification letter attached to this Lease as
Exhibit F
hereto.
16.20.
Force Majeure.
Other than Tenants obligations under this Lease that can be performed
by the payment of money (e.g., payment of Rent and maintenance of insurance) and Tenants
obligations pursuant to
Exhibit D
hereto, whenever a period of time is herein prescribed
for action to be taken by either party hereto, such party shall not be liable or responsible for,
and there shall be excluded from the computation of any such period of time, any delays due to
strikes, riots, acts of God, shortages of labor or materials, war, acts of terrorism, governmental
laws, regulations, or restrictions, or any other causes of any kind whatsoever which are beyond the
control of such party.
16.21.
USA Patriot Act and Anti-Terrorism Laws
.
(a) Tenant represents and warrants to, and covenants with, Landlord that neither Tenant
nor any of its respective constituent owners or affiliates currently are, or shall be at any
time during the Term hereof, in violation of any laws relating to terrorism or money
laundering (collectively, the Anti-Terrorism Laws), including without limitation Executive
Order No. 13224 on Terrorist Financing, effective September 24, 2001 and relating to Blocking
Property and Prohibiting Transactions With Persons Who Commit, Threaten to Commit, or Support
Terrorism (the Executive Order) and/or the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (Public Law 107-56)
(the USA Patriot Act).
(b) Tenant covenants with Landlord that neither Tenant nor any of its respective
constituent owners or affiliates is or shall be during the Term hereof a Prohibited Person,
which is defined as follows: (i) a person or entity that is listed in the Annex to
,
or is otherwise subject to, the provisions of the Executive Order; (ii) a person or
entity owned or controlled by, or acting for or on behalf of, any person or entity that is
listed in the Annex to, or is otherwise subject to the provisions of, the Executive Order;
(iii) a person or entity with whom Landlord is prohibited from dealing with or otherwise
engaging in any transaction by any Anti-Terrorism Law, including without limitation the
Executive Order and the USA Patriot Act; (iv) a person or entity who commits, threatens or
conspires to commit or support terrorism as defined in Section 3(d) of the Executive Order;
(v) a person or entity that is named as a specially designated national and blocked person
on the then-most current list published by the U.S. Treasury Department Office of Foreign
Assets Control at its official website,
http://www.treas.gov/offices/eotffc/ofac/sdn/tllsdn.pdf, or at any replacement website or
other replacement official publication of such list; and (vi) a person or entity who is
affiliated with a person or entity listed in items (i) through (v) above.
(c) At any time and from time to time during the Term, Tenant shall deliver to Landlord,
within ten (10) days after receipt of a written request therefor, a written certification or
such other evidence reasonably acceptable to Landlord evidencing and confirming Tenants
compliance with this
Section 16.21
.
16
16.22.
Right of First Negotiation
. Landlord grants to Tenant a right of first negotiation to
lease additional space in the Warehouse that becomes available upon the vacation thereof by the
then-current tenant. As such space becomes available to lease, Landlord shall notify Tenant thereof
and offer such space to Tenant for lease. Tenant shall have ten (10) days in which to notify
Landlord in writing of its desire to lease the offered space. Landlord and Tenant shall be free to
agree on the terms of the lease of the offered space and shall not be bound by the terms of this
Lease. If Tenant does not notify Landlord of its intention to lease the offered space within the
applicable ten (10) day period, or if Landlord and Tenant cannot agree in writing on the terms for
such a lease within ten (10) days of Tenants notice of its desire to lease the offered space, time
being of the essence with respect to each ten (10) day period, Landlord shall be free to lease such
space to another party on such terms as Landlord shall determine in its sole discretion and Tenant
shall have no further rights with respect to such space.
IN WITNESS WHEREOF, the parties have executed this Lease as of the date and year first above
written.
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LANDLORD:
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DOOLITTLE WILLIAMS, LLC.,
A California limited liability company
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By:
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/s/ TERRENCE McGRATH
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Name:
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Terrence M. McGrath
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Title:
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Managing Member
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Date: November 26, 2008
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TENANT:
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ENERGY RECOVERY, INC.,
A Delaware corporation
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By:
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/s/ CAROLYN F. BOSTICK
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Name:
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Carolyn F. Bostick
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Title:
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General Counsel
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Date: November 26, 2008
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By:
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/s/ TOM WILLARDSON
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Name:
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Thomas Willardson
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Title:
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Chief Financial Officer
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Date: November 26, 2008
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17
EXHIBIT A
(Legal Description)
[to be attached]
Exhibit A
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Order Number: NCS-260884-CC
Page Number: 7
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LEGAL DESCRIPTION
Real property in the City of San Leandro, County of Alameda, State of California, described as
follows:
PARCEL 1:
BEGINNING AT THE INTERSECTION OF THE NORTHWESTERN LINE OF WEST AVENUE 129, ALSO KNOWN AS WILLIAMS
STREET, SAID NORTHWESTERN LINE BEING THE SOUTHEASTERN LINE OF THAT CERTAIN 129.20 ACRE TRACT OF
LAND DESCRIBED IN THE DEED FROM RENE DE TOCQUEVILLE AND HENRIETTA LEROY DE TOCQJEVILLE TO JOSE
BERNARDO MENDONCA, DATED NOVEMBER 01, 1901 AND RECORDED NOVEMBER 01, 1901 IN BOOK 799 OF DEEDS,
PAGE 273, ALAMEDA COUNTY RECORDS, WITH THE SOUTHWESTERN LINE OF DOOLITTLE DRIVE, ALSO KNOWN AS
COUNTY ROAD NO. 7960 (80.00 FEET WIDE) AS DESCRIBED IN GRANT OF RIGHT OF WAY FROM MARY C. SKILLEN
TO THE COUNTY OF ALAMEDA, DATED JANUARY 21, 1947 AND RECORDED FEBRUARY 28, 1947 IN BOOK 5091, PAGE
335, SERIES NO. AB/17434, ALAMEDA COUNTY RECORDS, RUNNING THE THENCE ALONG THE SAID LINE OF
DOOLITTLE DRIVE, NORTH 26° 31 WEST 50.00 FEET; THENCE SOUTH 63° 29 WEST 1200.00 FEET, THENCE
SOUTHWESTERLY AND WESTERLY, ALONG THE ARC OF A CURVE TO THE RIGHT WITH A RADIUS OF 372.204 FEET,
TANGENT TO THE SAID LAST MENTIONED COURSE, A DISTANCE OF 327.90 FEET; THENCE NORTH 66° 02 43
WEST, TANGENT TO THE SAID LAST MENTIONED ARC, 8.64 FEET; THENCE NORTH 26° 31 WEST 800.00 FEET FROM
THE INTERSECTION THEREOF WITH THE SAID NORTHWESTERN LINE OF WILLIAMS STREET; THENCE ALONG THE
DIRECT PRODUCTION OF THE LINE SO DRAWN SOUTH 63° 29 WEST 122.66 FEET UNTIL INTERSECTED BY A LINE
DRAWN NORTH 26° 31 WEST FROM A POINT ON THE SAID SOUTHEASTERN LINE OF THE 129.20 ACRE TRACT OF
LAND, DISTANT THEREON SOUTH 62° 30 WEST 1615.51 FEET FROM THE POINT OF INTERSECTION THEREOF WITH
THE SAID SOUTHWESTERN LINE OF DOOLITTLE DRIVE; THENCE ALONG THE LINE SO DRAWN SOUTH 26° 31 EAST
827.72 FEET TO A POINT ON THE SAID SOUTHEASTERN LINE OF THE 129.20 ACRE TRACT OF LAND; THENCE ALONG
THE SAID LAST MENTIONED LINE NORTH 62° 30 EAST 1615.51 FEET TO THE POINT OF BEGINNING.
EXCEPTING THEREFROM THAT PORTION DESCRIBED IN THE DEED TO THE PACIFIC TELEPHONE AND TELEGRAPH
COMPANY RECORDED APRIL 01, 1958, BOOK 8634, PAGE 315, SERIES NO. AP-32149, ALAMEDA COUNTY RECORDS.
ALSO EXCEPTING THEREFROM THE INTEREST CONVEYED TO THE CITY OF SAN LEANDRO IN AND TO THAT PORTION
LYING WITHIN AURORA DRIVE AS DESCRIBED IN THE STREET DEDICATION RECORDED JUNE 24, 1954, BOOK 7353,
PAGE 471, SERIES NO. AJ-53172, ALAMEDA COUNTY RECORDS.
PARCEL 2:
A NON-EXCLUSIVE PERPETUAL EASEMENT AND RIGHT OF WAY, AS GRANTED TO WESTERN ELECTRIC COMPANY,
INCORPORATED IN THE DEED RECORDED DECEMBER 31, 1952, BOOK 6912, PAGE 376, SERIES NO. AG-108216,
ALAMEDA COUNTRY RECORDS, APPURTENANT TO AND FOR THE USE OF THE OWNER OR OWNERS OF PARCEL 1 HEREIN
DESCRIBED, AND ANY SUBSEQUENT SUBDIVISION OR SUBDIVISIONS THEREOF, FOR RAILROAD PURPOSES OVER THE
First American Title Insurance Company
Exhibit A
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Order Number: NCS-260884-CC
Page Number: 8
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FOLLOWING DESCRIBED PARCEL OF LAND:
BEGINNING AT THE INTERSECTION OF THE NORTHWESTERN LINE OF WEST AVENUE 129, ALSO KNOWN AS WILLIAMS
STREET, SAID NORTHWESTERN LINE BEING THE SOUTHEASTERN LINE OF THAT CERTAIN 129.20 ACRE TRACT OF
LAND DESCRIBED IN THE DEED) FROM RENE DE TOCQUEVILLE AND HENRIETTA LEROY DE TOCQUEVILLE TO JOSE
BERNARDO MENDONCA, DATED NOVEMBER 01,1901 AND RECORDED NOVEMBER 01,1901 IN BOOK 799 OF DEEDS, PAGE
273, ALAMEDA COUNTY RECORDS, WITH THE SOUTHWESTERN LINE OF DOOLITTLE DRIVE, ALSO KNOWN AS COUNTY
ROAD NO. 7960 (80.00) FEET WIDE) AS DESCRIBED IN GRANT OF RIGHT OF WAY FROM MARY C SKILLEN TO THE
COUNTY OF ALAMEDA, DATED JANUARY 21, 1947 AND RECORDED FEBRUARY 28, 1947 IN BOOK 5091, PAGE 335,
SERIES NO. AB/17434, ALAMEDA COUNTY RECORDS; RUNNING THENCE ALONG THE SOUTHEASTERN LINE OF THE SAID
129.20 ACRE TRACT OF LAND SOUTH 62° 30 WEST 1615.51 FEET, THENCE NORTH 26° 31 WEST 827.72 FEET
TO THE ACTUAL POINT OF BEGINNING; THENCE SOUTH 63° 29 WEST 245.95 FEET; THENCE NORTH 67° 35 16
EAST 81.24 FEET; THENCE NORTHEASTERLY AND EASTERLY ALONG THE ARC OF A CURVE TO THE RIGHT WITH A
RADIUS OF 372.24 FEET, FROM A TANGENT WHICH BEARS NORTH 69° 51 EAST A DISTANCE OF 177.17 FEET
UNTIL INTERSECTED BY A LINE DRAWN SOUTH 26° 31 EAST FROM THE ACTUAL POINT OF BEGINNING; THENCE
ALONG THE LINE SO DRAWN NORTH 26° 31 WEST 65.84 FEET TO THE ACTUAL POINT OF BEGINNING.
PARCEL 3:
A NON-EXCLUSIVE PERPETUAL EASEMENT AND RIGHT OF WAY, AS GRANTED TO WESTERN ELECTRIC COMPANY,
INCORPORATED IN THE DEED RECORDED DECEMBER 31,1952, BOOK 6912, PAGE 376, SERIES NO. AG-108216,
ALAMEDA COUNTY RECORDS, APPURTENANT TO AND FOR THE USE OF THE OWNER OR OWNERS OF PARCEL 1 HEREIN
DESCRIBED, AND ANY SUBSEQUENT SUBDIVISION OR SUBDIVISIONS THEREOF, FOR DRAINAGE PURPOSES, WITH THE
RIGHT AND PRIVILEGE TO CONSTRUCT, REPAIR, REPLACE, MAINTAIN AND USE A SEWER AND A DRAINAGE DITCH,
EACH OF SUCH SEE, TYPE AND CHARACTER AS GRANTEE FROM TIME TO TIME DEEMS NECESSARY, OVER, ACROSS AND
UNDER THE FOLLOWING DESCRIBED PARCEL OF LAND:
BEGINNING AT THE INTERSECTION OF THE NORTHWESTERN LINE OF WEST AVENUE 129, ALSO KNOWN AS WILLIAMS
STREET, SAID NORTHWESTERN LINE BEING THE SOUTHEASTERN LINE OF THAT CERTAIN 129.20 ACRE TRACT OF
LAND DESCRIBED IN THE DEED FROM RENE DE TOCQUEVILLE AND HENRIETT ALEROY DE TOCQUEVILLE TO JOSE
BERNARDO MENDONCA, DATED NOVEMBER 01,1901 AND RECORDED NOVEMBER 01,1901 IN BOOK 799 OF DEEDS, PAGE
273, ALAMEDA COUNTY RECORDS, WITH THE SOUTHWESTERN LINE OF DOOLITTLE DRIVE, ALSO KNOWN AS COUNTY
ROAD NO. 7960 (80.00 FEET WIDE) AS DESCRIBED IN GRANT OF RIGHT OF WAY FROM MARY C. SKILLEN TO THE
COUNTY OF ALAMEDA, DATED JANUARY 21,1947 AND RECORDED FEBRUARY 28,19-17 IN BOOK 5091, PAGE 335,
SERIES NO. AB/17434, ALAMEDA COUNTY RECORDS; RUNNING THENCE ALONG THE SOUTHEASTERN LINE OF THE SAID
129.20 ACRE TRACT OF LAND SOUTH 62° 30 WEST 1615.51 FEET; THENCE NORTH 26° 31 WEST 735.08 FEET TO
THE ACTUAL POINT OF BEGINNING; THENCE CONTINUING NORTH 26° 31 WEST 26.80 FEET TO THE SOUTHEASTERN
CORNER OF PARCEL 2 AS DESCRIBED IN THE DEED TO ALAMEDA COUNTY EAST BAY TITLE INSURANCE COMPANY
RECORDED DECEMBER 31,1952, BOOK 6912, PAGE 369, ALAMEDA COUNTY RECORDS; THENCE ALONG THE SOUTHERN
BOUNDARY LINE OF SAID PARCEL 2, WESTERLY ALONG THE ARC OF A CURVE TO THE LEFT WITH A RADIUS OF
372.24 FEET, FROM A TANGENT WHICH BEARS NORTH 82° 52 48 WEST, A DISTANCE OF 125,91 FEET TO A
POINT ON A LINE DRAWN PARALLEL WITH THE NORTHWESTERN BOUNDARY LINE OF SAID PARCEL 2 AND DISTANT
First American Title Insurance Company
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Order Number: NCS-260884-CC
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Page Number: 9
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15.00 FEET SOUTHEASTERLY THEREFROM, MEASURED AT RIGHT ANGLES THERETO; THENCE ALONG THE PARALLEL
LINE SO DRAWN AND ITS DIRECT PRODUCTION SOUTH 63° 29 WEST 725.58 FEET; THENCE SOUTH 26° 31 EAST
22.00 FEET; THENCE NORTH 63° 29 EAST 722.76 FEET; THENCE EASTERLY ALONG THE ARC OF A CURVE TO THE
RIGHT WITH A RADIUS OF 350.24 FEET, FROM A TANGENT WHICH BEARS NORTH
77° 44 22 EAST, A DISTANCE
OF 130.53 FEET TO THE ACTUAL POINT OF BEGINNING.
APN: 079A-0541-010
First American Title Insurance Company
EXHIBIT B
(First Floor of the Building and the Warehouse Premises)
[to be attached]
Exhibit B
EXHIBIT B-1
(Second Floor of the Building)
[to be attached]
Exhibit B-1
EXHIBIT C
COMMENCEMENT DATE MEMORANDUM
, 200_
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Re:
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1717 Doolittle Drive / 2250 Williams Street Modified Industrial Gross Lease
(the Lease) dated as of November 21, 2008, between DOOLITTLE WILLIAMS, LLC, a
California limited liability company (Landlord), and
ENERGY RECOVERY, INC., a Delware corporation (Tenant). Capitalized terms used herein but
not defined shall be given the meanings assigned to them in the Lease.
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Ladies and Gentlemen:
1.
Condition of Premises
. Tenant has accepted possession of the Premises pursuant to the
Lease. Any improvements required by the terms of the Lease to be made by Landlord have been
completed to the full and complete satisfaction of Tenant in all respects except for the punchlist
items (if any) described on
Schedule 1
hereto (the Punchlist Items), and except for such
Punchlist Items (if any), Landlord has fulfilled all of its duties under the Lease with respect to
such initial improvements. Furthermore, Tenant acknowledges that the Premises are suitable for the
Permitted Uses.
2.
Commencement Date
. The Commencement Date of the Lease is _________, 200__.
3.
Expiration Date.
The Term is scheduled to expire on _________, 20__.
4.
Premises.
The Building contains 106,250 rentable square feet and the Warehouse
Premises contain 17,500 rentable square feet. Landlord and Tenant stipulate that the
square footage measurements set forth in the preceding sentence are conclusive as to
the square footage of the Building and the Warehouse Premises for purpose of
determining Base Rent and shall be binding upon them.
5.
Base Rent.
Base Rent shall be the following amounts for the following
periods of time:
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Lease Year
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Monthly Base Rent
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1
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$
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88,437.50
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2
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$
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90,648.44
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3
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$
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92,914.65
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4
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$
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95,237.51
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5
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$
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97,618.45
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6
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$
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100,058.91
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7
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$
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102,560.39
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8
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$
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105,124.40
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9
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$
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107,752.51
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10
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$
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110,446.32
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6.
Contact
Person
. Tenants contact person in the Premises is:
Attention:
Telephone:
Facsimile:
7.
Ratification.
Tenant hereby ratifies and confirms its obligations under the Lease, and
represents and warrants to Landlord that it has no defenses thereto. Additionally, Tenant further
confirms and ratifies that, as of the date hereof, (a) the Lease is and remains in good standing
and in full force and effect, and (b) Tenant has no claims, counterclaims, set-offs or defenses
against Landlord arising out of the Lease or in any way relating thereto or arising out of any
other transaction between Landlord and Tenant.
8.
Binding Effect; Governing Law.
Except as modified hereby, the Lease shall remain in full
effect and this Commencement Date Memorandum shall be binding upon Landlord and Tenant and their
respective successors and assigns. If any inconsistency exists or arises between the terms of this
Commencement Date Memorandum and the terms of the Lease, the terms of this Commencement Date
Memorandum shall prevail. This Commencement Date Memorandum shall be governed by the laws of the
State of California.
Exhibit C
Please indicate your agreement to the above matters by signing this letter in the space indicated
below and returning an executed original to us.
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Sincerely,
DOOLITTLE WILLIAMS, LLC,
a California limited liability company,
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By:
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Name:
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Title:
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Agreed and accepted:
ENERGY RECOVERY, INC.,
a Delaware corporation
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By:
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Name:
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Title:
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Exhibit C
SCHEDULE 1
(Punchlist Items)
Exhibit C
EXHIBIT D
WORK LETTER
1.
Acceptance of Premises.
Except as set forth in this
Exhibit D
,
Tenant accepts the
Premises in their AS-IS condition on the date that this Lease is entered into.
2.
Landlords Work.
Landlord at its expense shall perform the following work in the Premises
(the Landlords Work): (a) removal of any tiles in the Buildings stairwell that contain
asbestos and that are identified by Tenant prior to the Commencement Date and (b) leveling of
the floor slabs in the area identified on
Schedule 1
attached hereto between column
lines N2-N5 and P2-P5.
3.
Space Plans.
Landlord and Tenant hereby approve of the space plans prepared by Anthony
Tobacco and Associates (the Architect) depicting tenant improvements to be installed in the
Premises and attached hereto as
Schedule 2
(the Space Plans).
4.
Working Drawings.
(a) Preparation and Delivery. On or before January 15, 2009, (the Working Drawings Delivery
Deadline), Tenant shall provide to Landlord for its approval (in its sole and absolute discretion)
final working drawings, prepared by the Architect, of all tenant improvements that Tenant proposes
to have installed in the Premises; such working drawings shall include the partition layout,
ceiling plan, electrical outlets and switches, telephone outlets, drawings for any modifications to
the mechanical and plumbing systems of the Building and/or the Warehouse, and detailed plans and
specifications for the construction of the tenant improvements called for under this Exhibit in
accordance with all applicable Regulations. If Tenant fails to timely deliver such drawings, then
each day after the Working Drawings Delivery Deadline that such drawings are not delivered to
Landlord shall be a Tenant Delay Day.
(b) Approval Process. Landlord shall notify Tenant whether it approves of the submitted
working drawings (in its sole and absolute discretion) within ten (10) business days after Tenants
submission thereof. If Landlord disapproves of such working drawings, then Landlord shall notify
Tenant thereof specifying in reasonable detail the reasons for such disapproval, in which case
Tenant shall, within five (5) business days after such notice, revise such working drawings in
accordance with Landlords objections and submit the revised working drawings to Landlord for its
review and approval. Landlord shall notify Tenant in writing whether it approves of the resubmitted
working drawings (in its sole and absolute discretion) within five (5) business days after its receipt thereof. This process
shall be repeated until the working drawings have been finally approved by Landlord (in its sole
and absolute discretion) and Tenant. If the working drawings are not fully approved by both
Landlord and Tenant by the twentieth (20th) business day after the delivery of the initial draft
thereof to Landlord, then each day after such time period that such working drawings are not fully
approved by both Landlord and Tenant shall constitute a Tenant Delay Day. Further, if the Working
Drawings and any related materials are not submitted by the Architect to the City of San Leandro
(with a copy to Landlord) by January 15, 2009, then each day thereafter until the occurrence of
such submittal shall constitute a Tenant Delay Day.
(c) Landlords Approval; Performance of the Tenant Improvements. If any of Tenants proposed
construction work will affect the Buildings or Warehouses structure or any of the Buildings or
Warehouses systems, then the working drawings pertaining thereto must be approved by Landlords
engineer. As used herein, Working Drawings shall mean the final working drawings approved by
Landlord, as amended from time to time by any approved changes thereto, and the Tenant
Improvements shall mean all tenant improvements to be constructed in accordance with and as
indicated on the Working Drawings, together with any work required by governmental authorities to
be made to other areas of the Property as a result of the improvements indicated by the Working
Drawings. Landlords approval of the Working Drawings shall not be a representation or warranty of
Landlord that such drawings are adequate for any use or comply with any applicable Requirements,
but shall merely be the consent of Landlord thereto. Tenant shall, at Landlords request, sign the
Working Drawings to evidence its review and approval thereof. After the Working Drawings have been
approved, Landlord shall cause the Tenant Improvements to be performed in substantial accordance
with the Working Drawings.
5.
Construction Manager.
Landlord and Tenant hereby agree that Landlord shall engage Engineered
Construction Services Corporation, or such other construction manager as may be designated by
Landlord and Tenant (the Construction Manager), to (a) obtain all applicable building permits for
construction of the Tenant Improvements and (b) manage the performance of the Tenant Improvements
in compliance with such building permits and all applicable Regulations. If Landlord and Tenant
elect to designate a construction manager other than Engineered Construction Services Corporation,
neither Landlord nor Tenant shall unreasonably withhold their approval of such new construction
manager.
6.
Bidding of the Tenant Improvements.
Prior to commencement of the Tenant Improvements, Landlord
shall cause the Construction Manager to competitively bid the Tenant Improvements to at least three
(3) subcontractors for each of the major trades necessary to perform the Tenant Improvements.
Promptly after receipt of the bids for each major trade so bid, Landlord will cause Construction
Manager to deliver to Tenant a comparative summary of the bids. Upon request by Tenant, Landlord
shall also cause Construction Manager to deliver to Tenant copies of or make available for Tenants
review the bids. If requested by Tenant within three (3) business days after delivery of the
comparative summary of the bids to Tenant, Landlord shall inform Tenant of the bids Landlord
intends to accept, entertain Tenants questions, comments and suggestions concerning selection of
the successful bidder for each of the major trades, and take Tenants reasonable comments and
suggestions into account in determining which bids to accept.
7.
Change Orders.
Tenant may initiate changes in the Tenant Improvements. Each such change must
receive the prior written approval of Landlord, such approval to be granted or withheld in its sole
and absolute discretion. Upon completion of the Tenant Improvements, Tenant shall cause the
Architect to furnish Landlord with an accurate architectural as-built plan of the Tenant
Improvements as constructed, which plan shall be incorporated into this
Exhibit D
by this
reference for all purposes. If Tenant requests any changes to the Tenant
Improvements described in the Space Plans or the Working Drawings, then such increased costs and
any additional design costs incurred in connection therewith as the result of any such change shall
be added to the Total Construction Costs.
8.
Definitions.
As used herein, a Tenant Delay Day shall mean each day of delay in the
performance of the Landlords Work and/or the Tenant Improvements that occurs (a) because of
Tenants failure to timely deliver or approve any required documentation such as the Working
Drawings, (b) because Tenant fails to timely furnish any information required for preparation or
completion of documents such as the Working Drawings (whether preliminary, interim revisions or
final), pricing estimates, construction bids, and the like, (c) because of any change by Tenant to
the Space Plans or Working Drawings, (d) because Tenant fails to attend any meeting with Landlord,
the Architect, any other design professional, the Construction Manager, or any contractor, or their
respective employees or representatives, as may be required or scheduled hereunder or otherwise
necessary in connection with the preparation or completion of any construction documents, such as
the Working Drawings, or in connection with the performance of the Landlords Work and/or the
Tenant Improvements,
Exhibit D
(e) because of any specification by Tenant of materials or installations requiring unusually long
lead times, or (f) because Tenant or its agents, employees, contractors, or visitors otherwise
delays completion of the Landlords Work and/or the Tenant Improvements. As used herein
Substantial Completion, Substantially Completed, and any derivations thereof mean (i) the
Landlords Work in the Premises has been substantially completed (other than any details of
construction, mechanical adjustment or other similar matter, the noncompletion of which does not
materially interfere with Tenants use or occupancy of the Premises) and (ii) the Tenant
Improvements have been performed in substantial accordance with the Working Drawings, as reasonably
determined by the Construction Manager and the Architect (other than any details of construction,
mechanical adjustment or other similar matters, the noncompletion of which do not materially
interfere with Tenants use or occupancy of the Premises).
9.
Walk-Through; Punchlist
. When Landlord considers the Tenant Improvements and the Landlords Work
to be Substantially Completed, Landlord will notify Tenant and within three (3) business days
thereafter, Landlords representative and Tenants representative shall conduct a walk-through of
the Premises and identify any necessary touch-up work, repairs and minor completion items that are
necessary for final completion of the Tenant Improvements and the Landlords Work. Neither
Landlords representative nor Tenants representative shall unreasonably withhold his or her
agreement on punchlist items. Landlord shall use reasonable efforts to cause the Construction
Manager to complete all punchlist items within thirty (30) days after agreement thereon; however,
Landlord shall not be obligated to engage overtime labor in order to complete such items.
10.
Excess Costs
. The entire cost of performing the Tenant Improvements (including costs of
construction labor and materials, electrical usage during construction, additional janitorial
services, general tenant signage, related taxes and insurance costs, and the Construction Managers
fees and charges are herein collectively called the Total Construction Costs) in excess of the
Construction Allowance (hereinafter defined) shall be paid by Tenant. Notwithstanding the preceding
to the contrary, Total Construction Costs shall not include the following costs which costs shall
be paid solely by Tenant: preparation of the Space Plans and the Working Drawings, the Architects
fees and charges, and any and all costs related to any Tenant Improvements that are not considered
capital improvements (as determined in accordance with GAAP) (collectively, Tenants Construction
Costs). Upon approval of the Working Drawings and selection of the subcontractors for each of the
major trades necessary to perform the Tenant Improvements, Tenant shall promptly execute a work
order agreement prepared by Landlord which identifies such drawings and itemizes the Total
Construction Costs and sets forth the Construction Allowance. Once the Construction Allowance has
been exhausted, as and when Landlord incurs additional Total Construction Costs Tenant shall pay to
Landlord within three (3) days of demand therefor, an amount equal to the Total Construction Costs,
less (a) the amounts already paid by Tenant to Landlord on account of the Total Construction Costs,
and (b) the amount of the Construction Allowance. In the event of default of payment of such excess
costs, Landlord (in addition to all other remedies) shall have the same rights as for an Event of
Default under the Lease. Tenant shall pay to Landlord within three (3) days of demand therefor any
Tenants Construction Costs paid by Landlord.
In the event of default of payment of Tenants Construction Costs, Landlord (in addition to all
other remedies) shall have the same rights as for an Event of Default under the Lease.
11.
Construction Allowance
. Landlord shall provide to Tenant a construction allowance not to exceed
$1,000,000.00 (the Construction Allowance) to be applied toward the Total Construction Costs. The
Construction Allowance shall not be disbursed to Tenant in cash, but shall be applied by Landlord
to the payment of the Total Construction Costs, if, as, and when such costs are actually incurred
and paid by Landlord.
12.
Construction Representatives
. Landlords and Tenants representatives for coordination of
construction and approval of change orders will be as follows, provided that either party may
change its representative upon written notice to the other:
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Landlords Representative:
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Terry McGrath
McGrath Properties
130 Webster Street, Suite 200
Oakland, CA 94607
Telephone: (510) 273-2001
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Tenants Representative:
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Terry Sandlin
Energy Recovery, Inc.
1908 Doolittle Drive
San Leandro, CA 94577
Telephone:
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13.
Miscellaneous
. To the extent not inconsistent with this Exhibit, Sections 8 and 16.12 of the
Lease shall govern the performance of the Tenant Improvements and Landlords and Tenants
respective rights and obligations regarding the improvements installed pursuant thereto.
14.
Security
.
(a) Tenant acknowledges that Landlord in unwilling to execute the Lease unless Tenant
provides Landlord with additional security for Tenants obligations under the Lease.
Therefore, Tenant shall either (i) deliver to Landlord, within five (5) business days of
the Effective Date, an Irrevocable Standby Letter of Credit (the TI Letter of Credit)
which shall (1) be in a form reasonably acceptable to Landlord and based on a draft issued
by Tenants bank prior to Lease execution and approved by Landlord in its sole discretion,
(2) be issued by a bank reasonably acceptable to Landlord with minimum assets of
$10,000,000,000, upon which presentment may be made in San Francisco or Oakland,
California, (3) be in an amount equal to $1,000,000, (4) allow for partial and multiple
draws thereunder, and (5) have an expiration date not earlier than thirty (30) days after
the later of (x) the Commencement Date and (y) Tenants commencement of payment of Base
Rent pursuant to Section 4.01 of the Lease or in the alternative, have a term of not less
than one (1) year and be automatically renewable for an additional one (1) year period
unless, on or before the date thirty
(30) days prior to the expiration of the term of such TI Letter of Credit, the issuer of
such TI Letter of Credit gives notice to Landlord of its election not to renew such TI
Letter of Credit for any additional period pursuant thereto or (ii) deposit $1,000,000 into
an escrow account (the Escrow Account) within five (5) business days of the Effective
Date, which escrow account shall (1) be pursuant to an escrow agreement reasonably
acceptable to Landlord, (2) be with an escrow agent reasonably acceptable to Landlord, (3)
allow for partial and multiple disbursements to Landlord, and (4) have a termination date
not earlier than thirty (30) days after the later of (x) the Commencement Date and (y)
Tenants commencement of payment of Base Rent pursuant to Section 4.01 of the Lease.
(b) The TI Letter of Credit shall provide that, in the event of Landlords assignment of
its interest in this Lease, the TI Letter of Credit shall be freely transferable by
Landlord to the assignee, without charge to Landlord. The TI Letter of Credit shall
provide for same day payment to Landlord upon the issuers receipt of a sight draft from
Landlord together with Landlords certificate (signed by its manager or an officer)
certifying that the requested sum is due and payable from Tenant and Tenant has failed to
pay, and with no other conditions. Tenant agrees that it shall from time to time, as
necessary, whether as a result of the expiration of the TI Letter of Credit then in effect
or otherwise, renew or replace the original and any subsequent TI Letter of Credit
Exhibit D
so that a TI Letter of Credit, in the amount required hereunder, and satisfying all the conditions
hereof, is in effect until the later of thirty (30) days after the later of (x) the Commencement
Date and (y) Tenants commencement of payment of Base Rent pursuant to Section 4.01 of the Lease.
If Tenant fails to furnish such renewal or replacement at least thirty (30) days prior to the
stated expiration date of the TI Letter of Credit then held by Landlord, Landlord may draw upon
such TI Letter of Credit and hold the proceeds thereof without payment of interest (and such
proceeds need not be segregated) (TI Security Proceeds).
(c) In the event that Tenant is in default of its obligations under the Lease, then Landlord shall
have the right, at any time after such event, without giving any further notice to Tenant, to draw
upon said TI Letter of Credit or obtain a disbursement from the Escrow Account up to (i) the amount
necessary to cure such default (or if such default cannot reasonably be cured by the expenditure of
money, and Landlord exercises any rights and remedies Landlord may have on account of such default,
the amount which, in Landlords opinion, is necessary to satisfy Tenants liability on account
thereof)
plus
(ii) the Total Construction Costs. In addition, in the event of a termination based
upon the default of Tenant under the Lease, or a rejection of the Lease pursuant to the provisions
of the Federal Bankruptcy Code, Landlord shall have the right to draw upon the TI Letter of Credit
(from time to time, if necessary) or receive disbursements from the Escrow Account to cover the
full amount of damages and other amounts due from Tenant to Landlord under the Lease and the full
amount of the Total Construction Costs. Any such draw on the TI Letter of Credit or disbursement
from the Escrow Account shall not constitute a waiver of any other rights of Landlord with respect
to Tenants default under the Lease. Tenant hereby covenants and agrees not to oppose, contest or
otherwise interfere with any attempt by Landlord to draw upon the TI Letter of Credit or receive a
disbursement from the Escrow Account. Including without limitation, by commencing an action seeking
to enjoin or restrain Landlord from drawing upon said TI Letter of Credit or receiving a
disbursement from the Escrow Account. Tenant also hereby expressly waives any right or claim it may
have to seek such equitable relief. In addition to whatever other rights and remedies it may have
against Tenant if Tenant breaches its obligations under this paragraph, Tenant hereby acknowledges
that it shall be liable for any and all damages which Landlord may suffer as a result of any such
breach.
(d) Upon request of Landlord or any (prospective) purchaser or mortgagee of the Property, Tenant
shall, at its expense, cooperate with Landlord in obtaining an amendment to or replacement of any
TI Letter of Credit which Landlord is then holding so that the amended or new TI Letter of Credit
reflects the name of the new owner and/or mortgagee of the Property.
(e) To the extent that (i) Landlord has not previously drawn upon, as applicable, (x) the TI Letter
of Credit or (y) the TI Security Proceeds held by Landlord or (ii) Landlord has not sought
disbursement of funds from the Escrow Account (as applicable, Collateral), and provided that
Tenant is not otherwise in default of its obligations under the Lease as of the later of the
Commencement Date and Tenants commencement of payment of Base Rent pursuant to Section 4.01 of the
Lease, Landlord shall return such Collateral to Tenant.
(f) In no event shall the proceeds of any TI Letter of Credit or any disbursement from the Escrow
Account be deemed to be a prepayment of rent nor shall it be considered as a measure of liquidated
damages.
(g) Landlord and Tenant (i) agree that neither the TI Letter of Credit nor the Escrow Account shall
be deemed or treated as a security deposit under any law applicable to security deposits in the
commercial context, (ii) further acknowledge and agree that neither the TI Letter of Credit nor the
Escrow Account is intended to serve as a security deposit and the laws applicable to security
deposits shall have no applicability or relevancy thereto, and (iii) waive any and all rights,
duties and obligations either party may now have or, in the future, will have relating to or
arising from the laws applicable to security deposits.
15.
Tenant Access.
(a) Landlord hereby agrees to permit Tenant access, at Tenants sole risk and expense, to the
Premises 15 days prior to the Commencement Date (as reasonably estimated by Landlord) to commence
installation of Tenants furniture, fixtures, and equipment, provided that such access will not
hinder or delay completion of the Landlords Work or the Tenant Improvements. Notwithstanding the
foregoing, Tenant shall have no right to enter onto the Premises or the Property unless and until
Tenant shall deliver to Landlord evidence reasonably satisfactory to Landlord demonstrating that
any insurance reasonably required by Landlord in connection with such pre-commencement access
(including, but not limited to, any insurance that Landlord may require pursuant to the Lease) is
in full force and effect. Any entry by Tenant shall comply with all established safety practices of
the Construction Manager and Landlord. Upon such entry, all terms and conditions of the Lease shall
apply in full except with respect to payment of rent, which obligation shall commence on the
Commencement Date.
(b) Tenant shall not interfere with the performance of Landlords Work or the Tenant Improvements,
or with any inspections or issuance of final approvals by applicable governmental authorities, and
upon any such interference, Landlord shall have the right to exclude Tenant from the Premises and
the Property until Substantial Completion of the Landlords Work and the Tenant Improvements.
Exhibit D
SCHEDULE
1
[to be attached]
Exhibit D
SCHEDULE
2
[to be attached]
Exhibit D
EXHIBIT
E
ENVIRONMENTAL DISCLOSURE STATEMENT
This Environmental Disclosure Statement is designed to solicit information concerning your proposed
use of Hazardous Materials (as defined in Section 10.02 of the Lease) on property (the Premises)
owned by DOOLITTLE WILLIAMS, LLC, a California limited liability company (the Landlord). Please
complete the questionnaire and return it to Landlord or its designee for evaluation. If additional
space is necessary, please continue your answer on separate paper. In the event your proposed use,
generation or storage of Hazardous Materials is considered to be significant, we may require
further information. Thank you for your cooperation with this matter.
I.
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BACKGROUND INFORMATION
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Name (Corporation, Partnership, Public Agency or individual)
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Contact
Person and Title:
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Telephone
Number:
(
)
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Address of the Premises (property to be leased)
Street Address, City, State, Zip Code
IF NOT
APPLICABLE TO YOUR BUSINESS INITIAL HERE
II.
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DESCRIPTION OF PROPOSED FACILITY
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A.
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Describe in detail your proposed facility and the type of operations to be conducted on the
Premises including principal products to be produced and/or services to be performed:
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B.
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What environmental laws (e.g. Resource Conservation and Recovery Act; Clean Air Act;
California Occupational Safety and Health Act; California Hazardous Waste Control Law; The
Porter-Cologne Water Quality Control Act; The Safe Drinking and Toxic Enforcement Act of 1986)
must be complied with in connection with your proposed facility and operations? Identify the governmental
agencies responsible
for monitoring and evaluating the compliance of the proposed facility with any
environmental law:
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III.
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STORAGE OF HAZARDOUS MATERIALS
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A.
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Do you intend to store any Hazardous Materials on the Premises?
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If yes, describe (i) the Hazardous Materials to be stored, (ii) the estimated quantity (on
an annual basis) of Hazardous Materials to be stored, and (iii) the proposed method of
storage (e.g. above-ground storage tanks, underground storage tanks, drums, pipelines):
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Hazardous Material
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Method of Storage
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Quantity
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(Describe capacity and composition of container)
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(On an annual basis)
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B.
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Identify any permits and/or licenses which must be obtained in connection with the
storage of any Hazardous Materials:
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IV.
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HAZARDOUS WASTE MANAGEMENT
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Identify any Hazardous Materials (other than air emissions and wastewater described in V
and VI) which will be generated by the facility, the hazard class, and the quantity of
generation on a monthly basis:
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Hazardous Material
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Hazard Class
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Quantity
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(On an monthly basis)
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Describe the method(s) of disposal for each Hazardous Material:
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Exhibit E
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Do you intend to treat or process any Hazardous Materials on the Premises? If yes, describe
the proposed method(s) of treatment and/or processing:
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Identify any permits and/or licenses which must be obtained in connection with (i) the
disposal of each Hazardous Material and (ii) any treatment or processing of Hazardous
Materials:
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V.
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AIR EMISSIONS
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A.
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Describe air emissions from each source of anticipated air pollutants including fuel burning
equipment (described type of fuel burned) on the Premises:
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B.
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Describe the air pollution control equipment to be used to reduce emissions from each source
of air emissions:
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C.
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Describe the method(s) to be used to monitor any air emissions:
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D.
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Identify any permits and/or licenses which must be obtained in connection with any air
emissions:
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VI.
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WATER DISCHARGES
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A.
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List all sources of wastewater discharges to surface waters, septic systems or holding ponds:
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B.
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List all sources of wastewater discharges to public sewer systems:
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C.
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List the average daily flow for each discharge:
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D.
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Identify any permits and/or licenses which must be obtained in connection with any wastewater
discharge:
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VII.
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PAST AND PRESENT OPERATIONS
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A.
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Are there any governmental agency enforcement actions, past, pending or, to the best of your
knowledge, threatened administrative or court orders or actions or consent decrees concerning
compliance by your company with environmental laws in connection with facilities similar to
the proposed facility? If yes, are there any continuing compliance obligations as a result of
such orders or decrees?
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B.
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Has your company received requests for information from governmental agencies responsible for
regulating compliance with environmental laws? If yes, please explain the basis of such
request(s):
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C.
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Has your company been the subject of any administrative inquiries in connection with
Hazardous Materials? If yes, please explain the basis of such inquiry:
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D.
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Are there any past, pending or, to the best of your knowledge, threatened private actions
against your company concerning compliance with environmental laws? If yes, what is the status
and/or result of each action:
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As an officer, a general partner or a duly authorized representative of the company, I am
familiar with all operations of the company and the operations to be conducted on the Premises. I
have made due inquiry in answering the foregoing questions and hereby certify to Landlord that to the
best of my knowledge, information and belief the information disclosed above is true and correct
and complete.
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(Signature)
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(Title)
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(Date)
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Exhibit E
EXHIBIT F
HAZARDOUS
MATERIALS NOTIFICATION
1.
Nestle Plume
. Tenant acknowledges that Landlord has disclosed the following and
Tenant agrees to accept the Premises and Property with knowledge of the disclosed
conditions:
The Property is down gradient of the Nestle Plume which is subject to a 2000 Regional Water Quality
Control Board (RWQCB) cleanup order to remediate groundwater VOC contamination. Landlords
understanding is that the responsible parties for the Nestle Plume have been complying with the RWQCB
Order and the remediation is actively proceeding on properties east
of the Property with positive
results. According to the RWQCB order, the RWQCB expects the remediation to be complete within three to
four years of the initiation of remedial efforts.
Landlord engaged Schutze & Associates (Schutze) to perform a survey of soil vapor, soil and
groundwater as well as indoor air sampling to determine the nature and extent of the impact of the
Nestle Plume on the Property and to identify any other issues of concern.
Although no soil contamination was identified in the study, Schutze concluded that there is some
impact in groundwater from the Nestle Plume on the Property. Schutze concluded that the
contamination does not present a health risk and should not impact commercial use of the Premises
or the Property. Moreover, the Nestle Plume is being remediated by responsible parties and
contamination levels are expected to decrease as that remediation continues.
Schutze also isolated some limited onsite sources of contamination (including PCE, VC and DCE) that
will require limited cleanup and monitoring but concluded that this contamination does not present
a human health risk.
2.
Proposition 65 Notice
.
WARNING: The Property contains chemicals known to the State of California to cause cancer,
birth defects or other reproductive harm.
The following chemicals known to cause cancer and birth defects or other reproductive harm are
often found in and around structures and related areas:
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Tobacco products and tobacco smoke;
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Furnishings and buildings materials may contain many chemicals, including
formaldehyde and lead;
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Construction and maintenance materials, such as roofing materials, may contain
vinyl chloride monomer, benzene and ceramic fibers;
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Construction materials used in walls, floors and outside cladding may contain
chemicals such as formaldehyde resin, asbestos, arsenic, cadmium and creosote;
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Cleaning materials may contains chlorinated solvents;
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Certain paints and painted surfaces may contain chemicals such as lead and
crystalline silica;
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The operation and maintenance of vehicles and engines involve the use and
exhaust of various chemicals, including benzene and carbon monoxide; and
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Pest control and landscaping products used to control insects and weeds may
contain resmethrin, mycobutonil, triforine and arsenic trioxide.
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It is possible that some or all of the chemicals listed above and additional chemicals
may be present in or around the Property. In addition, other tenants of the Property
may also use chemicals that are known to the State of California to cause cancer or
reproductive harm. This list is not intended to be exhaustive but to alert Tenant
generally to the types of chemicals that Landlord understands may be present in
structures and related areas. This public disclosure notice is made pursuant to the
requirement of Section 25249.6 of the Safe Drinking Water and Toxic Enforcement Act of
1986 (Proposition 65). For a complete list of the chemicals required to be disclosed
under Proposition 65, contact the California Office of Environmental Health Hazard
Assessment, 1001 I Street, Sacramento, California 95814. For further information call
(916)324 7572 or visit their website at www.oehha.ca.gov/pubic_info.html.
Exhibit F