-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DsmUimRmSY/dL0SaYD0vpqhlo0CTMG90bF2VACgdY7ap2W9rF4k6JPZjUNR7kI3Y ajOpsjIcS0x6GgDZPzz6xA== 0000892569-96-002553.txt : 19961206 0000892569-96-002553.hdr.sgml : 19961206 ACCESSION NUMBER: 0000892569-96-002553 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 19961205 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROCOM TECHNOLOGY INC CENTRAL INDEX KEY: 0001025711 STANDARD INDUSTRIAL CLASSIFICATION: COMPUTER PERIPHERAL EQUIPMENT, NEC [3577] IRS NUMBER: 330268063 STATE OF INCORPORATION: CA FISCAL YEAR END: 0731 FILING VALUES: FORM TYPE: S-1/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-15109 FILM NUMBER: 96676005 BUSINESS ADDRESS: STREET 1: 2181 DUPONT DRIVE CITY: IRVINE STATE: CA ZIP: 92715 BUSINESS PHONE: 7148521000 MAIL ADDRESS: STREET 1: 2181 DUPONT DRIVE CITY: IRVINE STATE: CA ZIP: 92715 S-1/A 1 AMENDMENT #2 TO THE FORM S-1 DATED DEC. 5, 1996 1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 5, 1996 REGISTRATION NO. 333-15109 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ AMENDMENT NO. 2 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 ------------------------ PROCOM TECHNOLOGY, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 3577 33-0268063 (STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
2181 DUPONT DRIVE, IRVINE, CALIFORNIA 92715 (714) 852-1000 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICE) ------------------------ FREDERICK JUDD VICE PRESIDENT, FINANCE AND GENERAL COUNSEL PROCOM TECHNOLOGY, INC. 2181 DUPONT DRIVE, IRVINE, CALIFORNIA 92715 (714) 852-1000 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) ------------------------ COPIES TO: J. JAY HERRON, ESQ. LAIRD H. SIMONS III, ESQ. KEVIN BAKER, ESQ. EILEEN DUFFY ROBINETT, ESQ. CHRISTOPHER R. DI MAURO, ESQ. MELISSA H. SAYER, ESQ. O'MELVENY & MYERS LLP FENWICK & WEST LLP 610 NEWPORT CENTER DRIVE, SUITE 1700 TWO PALO ALTO SQUARE NEWPORT BEACH, CALIFORNIA 92660 PALO ALTO, CALIFORNIA 94306 (714) 760-9600 (415) 494-0600
------------------------ APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this Registration Statement becomes effective. ------------------------ If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [ ] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ]________________ If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [ ]________________ If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box. [ ] ------------------------ THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 Information contained herein is subject to completion or amendment. A registration statement relating to these securities has been filed with the Securities and Exchange Commission. These securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This prospectus shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of these securities in any State in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such State. SUBJECT TO COMPLETION, DATED DECEMBER 5, 1996 3,025,000 SHARES LOGO COMMON STOCK Of the 3,025,000 shares of Common Stock offered hereby, 2,000,000 shares are being sold by Procom Technology, Inc. (the "Company") and 1,025,000 shares are being sold by the Selling Shareholders. The Company will not receive any proceeds from the sale of the shares by the Selling Shareholders. See "Principal and Selling Shareholders." Prior to this offering, there has been no public market for the Common Stock of the Company. It is currently estimated that the initial public offering price will be between $9.00 and $11.00 per share. See "Underwriting" for a discussion of factors considered in determining the initial public offering price. The Company's Common Stock has been approved for quotation on the Nasdaq National Market, subject to notice of issuance, under the symbol "PRCM." THIS OFFERING INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS" COMMENCING ON PAGE 5 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY. ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Proceeds to Price to Underwriting Proceeds to Selling Public Discount(1) Company(2) Shareholders - -------------------------------------------------------------------------------------------------- Per Share......................... $ $ $ $ Total(3).......................... $ $ $ $
- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- (1) See "Underwriting" for information concerning indemnification of the Underwriters and other matters. (2) Before deducting expenses payable by the Company, estimated at $780,000. (3) Certain Selling Shareholders have granted to the Underwriters a 30-day option to purchase up to 453,750 additional shares of Common Stock solely to cover over-allotments, if any. If the Underwriters exercise this option in full, the Price to Public will total $ , the Underwriting Discount will total $ and the Proceeds to Selling Shareholders will total $ . See "Underwriting." The shares of Common Stock are offered by the several Underwriters named herein, subject to receipt and acceptance by them and to their right to reject any order in whole or in part. It is expected that delivery of the certificates representing such shares will be made against payment therefor at the office of Montgomery Securities on or about , 1996. ------------------------ MONTGOMERY SECURITIESDDAIN BOSWORTH INCORPORATED , 1996 3 PROCOM TECHNOLOGY INTELLIGENT STORAGE FOR THE ENTERPRISE(TM) [Photographs of various CD-ROM and computer storage peripherals, some of which are displayed indicating connectivity to networks and access through the Internet. The photographs bear the following captions: "Procom Technology's family of file server disk drive upgrade solutions," "Procom Technology's family of CD networking systems providing multi-protocol, mixed topology and 30x performance," "Procom Technology's family of notebook disk drive upgrade solutions," "Procom Technology's family of high capacity digital linear tape backup devices" and "Procom Technology's family of LANForce Systems providing high performance, fault tolerant data storage and retrieval solutions." Background text reads as follows: "CD-ROM Servers - CD-ROM Arrays - CD Force Servers - Hyper CD-30x Servers - LAN Force R2000 RAID RAX - Hardware Based Disk Arrays - LDLT Tape Library - PCDR CD Recorders."] IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. 2 4 PROSPECTUS SUMMARY The following summary information is qualified in its entirety by the more detailed information, including "Risk Factors" and Consolidated Financial Statements and notes thereto, appearing elsewhere in this Prospectus. THE COMPANY Procom Technology, Inc. ("Procom" or the "Company") designs, manufactures and markets enterprise-wide data storage and information access solutions that are compatible with all major hardware platforms, operating systems and network protocols. The Company has become a leading provider of CD-ROM servers and arrays as a result of its extensive distribution channels as well as the scalability, performance, ease of use and multi-protocol support of its products. The Company provides end users with disk drive upgrades for servers, desktop and notebook computers and also provides high performance, fault tolerant RAID solutions (Redundant Array of Independent Disks) and tape backup subsystems. The Company utilizes computer resellers, value-added resellers ("VARs") and distributors to sell its products to a wide variety of end users, including Fortune 500 corporations, governmental agencies and financial and educational institutions. Recognizing the growing demand for fast and reliable access to large volumes of information increasingly stored on CD-ROM media across enterprise-wide networks, the Company introduced the first of its CD server and array products in early 1994. These products enable a large number of network users to simultaneously access computer data stored on multiple CD-ROMs. The Company has recently introduced its CD FORCE server, which provides plug and play compatibility with most popular operating systems and network topologies and improves functionality by relieving the network operating system from the burden of managing requests for access to information stored on CD-ROMs. The CD FORCE server incorporates Procom's CD FORCE software, which manages network connectivity and access to information contained on CD-ROMs. The Company has continued to improve the capacity and performance of its product offerings, which include the Company's recently introduced Hyper CD-30x server, which is capable of providing access to up to 40 gigabytes of information (63 CDs) with 30x data transfer rates. The Company has experienced rapid growth in sales of its CD servers and arrays to end users such as law and accounting firms, educational and governmental entities and other companies and organizations that require frequent access to large amounts of information stored on CD-ROMs. The Company first developed its expertise in computer data storage products by providing upgrade storage solutions for desktop computers. Since that time, the Company has expanded its product offerings to provide upgrade and replacement disk drive products for notebook computers and servers, which have become more popular in recent years as client/server computing has proliferated. The Company's disk drive upgrades allow users to utilize their existing hardware for longer periods of time, thereby extending the life of their initial investment. The Company's RAID products provide high performance, fault tolerant storage of over one terabyte of data for large network information databases. The key elements of the Company's strategy include the following: (i) developing additional network storage products incorporating the Company's proprietary storage management software; (ii) accessing end users in key vertical markets by leveraging relationships with computer resellers, VARs and distributors; (iii) expanding relationships with key component suppliers in order to enable the Company to anticipate and respond to technological developments; and (iv) delivering timely storage solutions compatible with all major operating systems and network topologies. The Company's CD servers and arrays can be configured for Unix, Novell NetWare, IBM OS/2 Warp, Windows NT, Windows 95, Windows 3.1 and Macintosh OS, while supporting different topologies such as Ethernet, FDDI, Fast Ethernet and Token Ring. The Company's high-capacity storage subsystems will support varying RAID levels to meet virtually any network or operating system storage requirements. The Company's major customers include Vanstar Corporation, Entex Information Services Inc., Inacom and Intelligent Electronics, and end users include Microsoft, Ernst & Young, Federal Express, Prudential Insurance and Bank One. 3 5 THE OFFERING Common Stock offered by the Company............. 2,000,000 shares Common Stock offered by the Selling Shareholders.................................. 1,025,000 shares Common Stock to be outstanding after the offering...................................... 11,000,000 shares(1) Use of proceeds................................. Repayment of outstanding debt (approximately $3.7 million at October 25, 1996), approximately $300,000 to acquire capital equipment to increase production capacity and the remainder for general corporate purposes, including working capital. Proposed Nasdaq National Market symbol.......... PRCM
SUMMARY CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED QUARTERS ENDED ---------------------------------------------------- ------------------------- JULY 31, JULY 30, JULY 29, JULY 28, JULY 26, OCTOBER 27, OCTOBER 25, 1992 1993 1994 1995 1996 1995 1996 -------- -------- -------- -------- -------- ----------- ----------- CONSOLIDATED STATEMENT OF OPERATIONS DATA: Net sales.................................... $42,898 $41,726 $34,502 $44,660 $73,456 $15,275 $24,915 Gross profit................................. 8,869 9,453 7,315 11,802 21,967 4,142 8,425 Income (loss) before income taxes............ 861 906 (1,130) 1,137 4,649 915 3,310 Net income (loss)............................ 576 609 (773) 723 2,849 559 2,015 Net income (loss) per share(2)............... $ 0.06 $ 0.07 $ (0.08) $ 0.08 $ 0.31 $ 0.06 $ 0.22 Weighted average number of shares(2)......... 9,172 9,172 9,172 9,172 9,172 9,172 9,172
OCTOBER 25, 1996 -------------------------- ACTUAL AS ADJUSTED(3) ------- -------------- CONSOLIDATED BALANCE SHEET DATA: Cash....................................................................... $ 58 $ 13,918 Working capital............................................................ 6,569 24,089 Total assets............................................................... 25,325 39,485 Line of credit............................................................. 3,660 -- Long-term obligations...................................................... -- -- Total shareholders' equity................................................. 7,151 24,971
- --------------- (1) Based on shares outstanding as of October 25, 1996. Excludes an aggregate of 271,800 shares of Common Stock issuable upon the exercise of stock options outstanding as of October 25, 1996 at a weighted average exercise price of $3.67 per share and an aggregate of 268,200 additional shares of Common Stock reserved for future issuance under the Company's 1995 Stock Option Plan. (2) See Note 1 of Notes to Consolidated Financial Statements for a description of the computation of net income (loss) per share. (3) Adjusted to give effect to the sale of shares offered by the Company hereby at an assumed initial public offering price of $10.00 per share, after deducting the estimated underwriting discount and offering expenses, and the application of the net proceeds therefrom. See "Use of Proceeds" and "Underwriting." ------------------------ The Company was organized as a California corporation in 1987. The Company's executive offices are located at 2181 Dupont Drive, Irvine, California 92715, and its telephone number is (714) 852-1000. ------------------------ Unless otherwise indicated, the information in this Prospectus (i) assumes an initial public offering price of $10.00 per share of Common Stock, (ii) assumes no exercise of the Underwriters' over-allotment option, (iii) reflects the effect of a 10,000-for-1 stock split, which occurred on September 15, 1995, and a 3-for-1 stock split which occurred on November 13, 1996 and (iv) assumes no retroactive change in the par value of the Common Stock. This Prospectus contains forward-looking statements that involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in "Risk Factors." 4 6 RISK FACTORS In addition to the other information in this Prospectus, the following factors should be considered carefully in evaluating the Company and its business before purchasing the shares of Common Stock offered hereby. POTENTIAL FLUCTUATIONS IN FUTURE RESULTS OF OPERATIONS The Company's results of operations have in the past varied significantly and are likely in the future to vary significantly as a result of a number of factors, including the mix of products sold, the volume and timing of orders received during the period, the timing of new product introductions by the Company and its competitors, product line maturation, the impact of price competition on the Company's average selling prices, the availability and pricing of components for the Company's products, changes in distribution channel mix and product returns or price protection charges from customers. Many of these factors are beyond the Company's control. Although the Company has experienced growth in sales in recent periods, there can be no assurance that the Company will experience growth in the future or be profitable on an operating basis in any future period. In addition, due to the short product life cycles that characterize the Company's markets, a significant percentage of the Company's sales each quarter may result from new products or product enhancements introduced in that quarter. Since the Company relies on new products and product enhancements for a significant percentage of sales, failure to continue to develop and introduce new products and product enhancements or failure of these products or product enhancements to achieve market acceptance could have a material adverse effect on the Company's business, financial condition and results of operations. The Company also has historically capitalized on short-term market opportunities for volume purchases of certain components at favorable prices. For example, in the quarter ended July 26, 1996, the Company capitalized on a one-time opportunity to sell a significant volume of high capacity disk drive upgrade products purchased at below market prices in the prior quarter, which resulted in a price advantage to the Company that enhanced the Company's sales and results of operations for that quarter. There can be no assurance that the Company will be able to capitalize on such opportunities in the future. In addition, the Company's fiscal second quarter sales have historically remained relatively flat due primarily to heavy reseller participation in trade shows that detract from reseller selling efforts, end user budget constraints that restrict end user purchases, and a higher than average number of holidays during that quarter. The volume and timing of orders received during a quarter are difficult to forecast. Customers generally order on an as-needed basis and, accordingly, the Company historically has operated with a relatively small backlog. Notwithstanding the difficulty in forecasting future sales and the relatively small level of backlog at any given time, the Company generally must plan production, order components and undertake its development, sales and marketing activities and other commitments months in advance. Accordingly, any shortfall in sales in a given quarter may disproportionately affect the Company's results of operations due to relatively fixed short-term expenses. Due to the foregoing factors, the Company believes that period-to-period comparisons of its results are not necessarily meaningful and should not be relied upon as indicators of future performance. Further, it is likely that in some future quarter or quarters the Company's net sales or results of operations will be below the expectations of public market analysts and investors. In such event, the price of the Common Stock could be materially adversely affected. Historically, the Company's gross margins have experienced significant volatility. The Company's gross margins vary significantly by product line, and, therefore, the Company's overall gross margin varies with the mix of products sold by the Company. The Company's markets are also characterized by intense competition and declining average unit selling prices over the course of the relatively short life cycles of individual products, which have often ranged from six to twelve months. In addition, the Company's gross margins may be adversely affected by availability and price increases associated with key products and components from the Company's suppliers, some of which have been in short supply, and inventory obsolescence resulting from older generation products or the unexpected discontinuance of third party components. Finally, the Company's gross margins may vary with the mix of its distribution channels and general economic conditions. Accordingly, the Company's margins may decline in the future from the levels experienced in recent quarters. 5 7 See "Risk Factors -- Component Shortages; Reliance on Sole or Limited Source Suppliers" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." SUBSTANTIAL COMPETITION The markets for the Company's products are intensely competitive. In each of its primary product lines, the Company competes with a large number of disk drive manufacturers, computer resellers, VARs and distributors. Some of the Company's vendors also sell competing products to distributors, which then sell these products to the Company's customers. Many of the Company's current and potential competitors have significantly greater market presence, name recognition and financial and technical resources than the Company, and many have longstanding positions and established brand names in their respective markets. In addition, certain of the Company's current and potential competitors possess competitive cost advantages due to a number of factors, including lower taxes and substantially lower costs of labor associated with international operations. Finally, manufacturers of disk drives such as Seagate Technology, Inc., IBM, Quantum Corporation and Western Digital Corporation, and manufacturers of CD-ROM drives, such as Toshiba America Information Systems, Inc. ("Toshiba"), NEC Corporation and Plextor Corporation, may in the future become more direct competitors of the Company to the extent that such manufacturers elect to expand into the disk drive upgrade market or the CD server and array market. The Company's primary competitors in the CD server and array market consist of (i) CD array manufacturers such as Microtest Inc., Meridian Data, Inc. and Micro Design, Inc., which also furnish CD-ROM management software with their CD array products, (ii) a number of hardware aggregators, computer resellers and VARs that sell CD server products directly to end users and (iii) various CD server and array manufacturers. The Company's primary competitors in the disk drive upgrade market are (i) computer manufacturers that also market and sell storage upgrades, such as IBM, Compaq Computer Corporation, ("Compaq") and Hewlett-Packard Company ("Hewlett-Packard"), (ii) companies that specialize in reselling replacement or increased capacity storage disk drives, such as Storage Dimensions Inc. or Ameriquest Technologies Inc. and (iii) various national distributors of third party upgrade drives such as Ingram Micro Inc., Merisel Inc. and Tech Data Corporation. The Company's primary competitors in the RAID product market are (i) computer manufacturers, such as IBM, Compaq and Hewlett-Packard, which generally focus on providing storage upgrades for their products and (ii) companies that sell storage solutions directly to end users, such as EMC Corporation and Storage Technology Corporation. These direct sales competitors historically have focused their efforts on sales of high capacity storage products in the mainframe and minicomputer environments. In addition, the Company competes with many smaller enterprises that provide and sell unique solutions to various computer users. The Company's success depends to a great extent on its ability to continue to develop products that incorporate new and rapidly evolving technologies to provide network users cost-effective data storage and information access solutions. However, to the extent that disk drive storage or information access products become more of a commodity, price competition among both computer manufacturers and suppliers of disk drives and CD-ROM drives may result in the availability of such storage and access at a low cost. These factors could create increased competition for the Company's products, which could cause the Company to experience reduced gross profit margins on its products and could have a material adverse effect on the Company's business, financial condition and results of operations. The Company believes that the principal competitive factors in the Company's markets are product reliability, price/value relationship, product features and performance, brand name recognition, trade periodical reviews, time to market with new features and products, industry relationships, ease of installation and use, the quality of distribution channels, product quality, technical support and customer service. See "Business -- Competition." 6 8 RAPID TECHNOLOGICAL CHANGE; SHORT PRODUCT LIFE CYCLES The market for the Company's products is characterized by frequent new product introductions and rapid product obsolescence. These factors typically result in short product life cycles, which have often ranged from six to twelve months. For example, the data transfer rate of CD-ROM products has increased rapidly, resulting in the introduction of four, eight, ten and twelve speed CD-ROMs. Similar technological advances have been made with regard to disk drive storage capabilities and other performance standards. Each new product cycle presents new opportunities for current or prospective competitors of the Company to gain market share. The Company must continually monitor industry trends in selecting new technologies and features to incorporate into its products. If the Company is unable to introduce new products successfully on a timely basis, the Company's sales could be adversely affected. Any such failure also could impair the Company's brand name and the Company's ability to command the attention and loyalty of computer resellers, VARs and distributors in future periods. Moreover, because short product life cycles are accompanied by long lead times for many components of the Company's products, the Company may be unable to reduce or increase production in response to unexpected demand. The Company's ability to introduce new products in a timely manner is heavily dependent on its ability to develop or purchase firmware and software drivers for its CD-ROM and disk drive products. While the Company endeavors to work with its component suppliers to plan for the timing of introduction of new components and to develop the associated firmware and software, unforeseen design issues or other factors that delay introduction of these products could adversely affect the Company's ability to ship new products. In addition, third party suppliers may not employ adequate testing and quality assurance procedures, resulting in the receipt by the Company of defective components. This could require the Company to find replacement components or wait for the resolution of the problem, either of which could delay the Company's ability to bring products to market and have a material adverse effect on the Company's business, financial condition and results of operations. The Company's business also will be adversely affected if new disk drives, CD-ROM drives or other components that it selects from among those offered by its various vendors do not perform favorably on a cost or performance basis compared to competing products. In addition, products and technologies developed by competitors may render the Company's products and technologies noncompetitive or obsolete. Finally, advances in network and on-line technology and development of new, higher-capacity storage media such as Digital Video Disc ("DVD") may result in a reduction or replacement of CD-ROM as a data storage and information access medium. If the Company is unable to adapt to these and other technological advances by developing new products, the Company's financial performance would be materially adversely affected. See "Business -- Research and Development." The Company has historically experienced steep declines in sales, prices and gross profit toward the end of the life cycles of most of its products, the precise timing of which is difficult to predict. Historically, as the Company has planned and implemented new products, it has experienced unexpected reductions in sales and gross profit of older generation products as customers have anticipated new products. These reductions have in the past given and could continue to give rise to charges for obsolete or excess inventory, returns of older generation products by computer resellers, VARs and distributors or substantial price protection charges. See "-- Customer Concentration; Distribution Strategy Risks; Inventory Protection." For example, in fiscal 1994, the Company incurred losses when it discontinued sales of CD-ROM multimedia kits to mass merchants and distributors. From time to time, the Company has experienced and may in the future experience inventory obsolescence resulting from the unexpected discontinuance of third party components, such as disk drives, included in the Company's products. To the extent the Company is unsuccessful in managing product transitions, it may have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON CD SERVERS AND ARRAYS Sales of CD servers and arrays, including individual CD-ROM drives, recordable CD-ROMs, modules and other related components ("CD servers and arrays"), accounted for approximately 32%, 49% and 45% of the Company's net sales for fiscal 1995, fiscal 1996 and the first quarter of fiscal 1997, respectively. The widespread use of CD-ROM as a data storage and information access medium is relatively recent, and there can be no assurance that another technology will not replace CD-ROM as a widely accepted data storage and 7 9 information access medium, or that there will be widespread acceptance or continuing growth of CD servers and arrays in general, or of the Company's CD servers and arrays in particular. In addition, if on-line services (such as Westlaw and Lexis/Nexis) become more cost-effective and develop user friendly methods of accessing information, they may have an adverse impact on the use of CD-ROM as an information storage medium. Furthermore, the successful development and marketing of DVD would enable end users to store significantly more data than currently stored on a CD used with the Company's products. Accordingly, even if the Company were able to adapt its products to incorporate DVD technology, the number of servers and arrays required by end users may decline compared to current levels. Finally, even if the CD server and array market continues to grow, there can be no assurance that the Company will be able to maintain its market share or its gross margins in that market. The Company currently incorporates software with many of its CD servers and arrays, which allows a network to manage effectively direct access to information contained on CD-ROMs by network users. The Company ships CD servers and arrays both with CD-ROM network data access management software from third party vendors and with recently introduced, internally developed CD-ROM network data access management software. The Company's internally developed software is not presently available on all major hardware platforms, and of the Company's CD servers and arrays shipped to date that contain CD-ROM network data access management software, substantially all included third party software. In addition, the Company historically has focused its efforts on hardware development and does not have substantial experience in the development, testing and marketing of CD-ROM network data access management software. Given the high percentage of the Company's sales that are derived from CD servers and arrays, the failure to secure from a third party effective CD-ROM network data access management software, or the failure of the Company to continue the development and marketing of its internally developed software, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Products and Technology." COMPONENT SHORTAGES; RELIANCE ON SOLE OR LIMITED SOURCE SUPPLIERS The Company depends on sole or limited source suppliers for certain key components used in its products, particularly disk and CD-ROM drives. In recent years, these components have been in short supply and frequently on allocation by manufacturers, and the Company's size may place it at a competitive disadvantage during such periods relative to larger competitors. Although the Company maintains ongoing efforts to obtain adequate supplies of components, there can be no assurances that the Company will obtain adequate supplies or obtain such supplies at cost levels that would not adversely affect the Company's gross margins. The Company has no guaranteed supply arrangements with any of its sole or limited source suppliers and customarily purchases sole or limited source components pursuant to purchase orders placed from time to time in the ordinary course of business. Moreover, the Company's suppliers may, from time to time, experience production shortfalls or interruptions that impair the supply of components to the Company. Component shortages are likely to continue, and there can be no assurance that such shortages will not adversely affect the Company's business, financial condition and results of operations. Conversely, in its attempt to counter actual or perceived component shortages, the Company may overpurchase certain components, resulting in excess inventory and reducing the Company's liquidity or, in the event of inventory obsolescence or a decline in the market value of such inventory, causing inventory write-offs that could materially adversely affect the Company's business, financial condition and results of operations. See "-- Rapid Technological Change; Short Product Life Cycles." The Company relies on a small number of suppliers to continue to develop, introduce and manufacture disk drives, CD-ROM drives and other components that incorporate new technologies and features that compete favorably in functionality and price with the offerings of other disk drive and CD-ROM manufacturers, including competitors of the Company. The Company's dependence on these sole or limited source suppliers, and the risks associated with any delay or shortfall in supply, are exacerbated by the short life cycles that characterize the Company's products. Any delay in the introduction by or availability of disk drives or CD-ROM drives from the Company's suppliers or the failure of such suppliers to provide functionality and performance on a cost effective basis could have a material adverse effect on the Company's business, financial condition and results of operations. Furthermore, it is possible that the technology of the components the 8 10 Company uses in manufacturing its products will be rendered undesirable or obsolete by the components of other suppliers. The Company would then be forced to establish relationships with new suppliers, which could delay or preclude the Company from bringing competitive products to market and have a material adverse effect on the Company's business, financial condition and results of operations. The Company also relies on a network of independent subcontractors to supply certain custom components manufactured to the Company's specifications. This network consists of a number of small firms with limited financial resources. While the Company utilizes several firms to mitigate the risk of business interruption, it is possible that several vendors could simultaneously experience problems with production or financial stability, which could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Manufacturing." CUSTOMER CONCENTRATION; DISTRIBUTION STRATEGY RISKS; INVENTORY PROTECTION The Company sells its products primarily to a domestic and international network of computer resellers, VARs and distributors, and the Company's success depends on the continued viability and financial stability of its customer base. During the last two fiscal years, the Company has increased its reliance on sales to large hardware aggregators, computer resellers and VARs (including large corporate consultants) while reducing its use of mass merchants. During fiscal 1996 and the first quarter of fiscal 1997, combined net sales to Vanstar Corporation, Intelligent Electronics, Inc. and Entex Information Services, Inc. totalled approximately 23.3% and 25.4%, respectively, of net sales. In addition, as of October 25, 1996, the Company held accounts receivable from Intelligent Electronics, Vanstar and Entex totalling approximately $4.0 million. If the Company were to experience difficulty in collecting these accounts receivable, due to the failure of any of these customers or otherwise, it could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, a loss of either or both of these customers could materially and adversely affect the Company's net sales. The Company must continually develop and maintain relationships with its key computer resellers, VARs and distributors. Due to the rapid changes in the computer industry and the methods by which end users purchase computer products, there can be no assurance that the Company will be successful in developing and maintaining an effective distribution system. The computer distribution and computer retail industries historically have been characterized by rapid change, including periods of widespread financial difficulties and consolidation and the emergence of alternative distribution channels. The loss of, or reduction in sales to, the Company's key customers could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's computer resellers, VARs and distributors generally offer products of several different companies, including products competitive with the Company's products. Accordingly, there is a risk that these computer resellers, VARs and distributors may give higher priority to products of other suppliers and may reduce their efforts to sell the Company's products. Although since fiscal 1994 the Company has relied on computer resellers and VARs as its primary domestic sales channels, the Company recently entered into an agreement with Tech Data Corporation, a computer products distributor, to sell the Company's products nationally. An increased use of distributors to sell the Company's products, whether domestically or through increased international sales (which are generally made through distributors), could adversely affect the Company's gross margins as sales to distributors are typically made at slightly lower average prices than sales to computer resellers and VARs. The Company frequently grants limited rights to customers to return products purchased from the Company, in some cases in exchange for new purchases, and also provides price protection to its customers. The short product life cycles of the Company's products and the difficulty in predicting future sales increase the risk that new product introductions, price reductions by the Company or its competitors or other factors affecting the markets for the Company's products could result in significant product returns. In addition, new product introductions by the Company's suppliers or its competitors, or other market factors, may require the Company to reduce prices in a manner or at a time that gives rise to significant price protection charges. The Company estimates product returns and potential price protection charges based on historical experience and accrues reserves therefor. However, these accruals may prove to be insufficient, and unanticipated future returns and price protection charges could have a material adverse effect on the Company's business, financial condition and results of operations, particularly in light of the rapid product obsolescence that often occurs 9 11 during product transitions. See "-- Rapid Technological Change; Short Product Life Cycles," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Sales and Marketing." INTELLECTUAL PROPERTY RIGHTS The Company relies primarily on a combination of copyright and trade secret protections and confidentiality agreements to establish and protect its intellectual property rights. The Company has no patent protection for its current product lines. There can be no assurance that the Company's measures to protect its intellectual property rights will deter or prevent unauthorized use of the Company's technology. In addition, the laws of certain foreign countries may not protect the Company's intellectual property rights to the same extent as the laws of the United States. The Company's inability to protect its proprietary rights in the United States or internationally may have a material adverse effect on the Company's business, financial condition and results of operations. Claims by third parties that the Company's current or future products, procedures or processes infringe upon their intellectual property rights may have a material adverse effect on the Company. The Company does not normally perform any formal surveys or studies relating to whether its products or processes infringe upon the intellectual property rights of others, and it would be difficult to establish whether a given product or process infringes upon the intellectual property rights of others. Intellectual property litigation is complex and expensive, and the outcome of such litigation is difficult to predict. Any future litigation, regardless of outcome, may result in substantial expense to the Company and significant diversion of the efforts of the Company's management and technical personnel. An adverse determination in any such litigation may subject the Company to significant liabilities to third parties, require disputed rights to be licensed from such parties, if licenses to such rights could be obtained, or require the Company to cease using such technology. There can be no assurance that if such licenses were obtainable, they would be obtainable at costs reasonable to the Company. If forced to cease using such technology, there can be no assurance that the Company would be able to develop or obtain alternate technology. Accordingly, an adverse determination in a judicial or administrative proceeding, changes in patent or copyright laws or failure of the Company to obtain necessary licenses may prevent the Company from manufacturing, using or selling certain of its products or processes, which may have a material adverse effect on the Company's financial condition and results of operations. In May 1995, Compaq made certain infringement and other claims against the Company and obtained an injunction prohibiting the Company's use of a small string of software code contained in certain of the Company's disk drive products. Although the Company has rewritten the infringing code and settled the lawsuit, the lawsuit required substantial management time, significant expenditures for legal fees and costs and a one-time settlement payment and ongoing royalty payments to Compaq for these products. See "Business -- Intellectual Property." MANAGEMENT OF CHANGE In recent years, the Company has expanded the overall size of its business and scope of its operations, including research and development, marketing, technical support and sales and distribution. The Company increased its number of employees from 126 at the beginning of fiscal 1996 to 186 at the end of the first quarter of fiscal 1997, and has also recently increased the breadth of its CD server and array product line, enlarged the scope of its international operations and increased its marketing and product development expenditures. The expansion of the Company's business and product lines has required significant investments in infrastructure and systems. Managing this change has presented numerous challenges, including hiring and retaining key employees, integrating or changing management information systems and coordinating suppliers. The Company's future success will depend in large measure on its ability to implement sufficient operating, manufacturing and financial procedures and controls successfully, to improve coordination among different operating functions, to strengthen management information and telecommunications systems and to continue to hire qualified personnel in all areas. There can be no assurance that the Company will manage these activities and implement these additional systems and controls successfully, and any failure to do so could 10 12 have a material adverse effect upon the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." RISKS OF INTERNATIONAL SALES AND OPERATIONS The Company's international sales accounted for approximately 14%, 11% and 8% of the Company's net sales for fiscal 1995, fiscal 1996 and the first quarter of fiscal 1997, respectively. During fiscal 1996, the Company added independent sales representatives in Canada, France and Germany, and it plans to add additional foreign sales representatives in the future. The Company's international sales and operations are subject to a number of risks generally associated with international operations, including export regulations, government imposed restrictions on the purchase of technological equipment, import and export duties and restrictions, the logistical difficulties of managing multinational operations, potentially adverse tax consequences and lower gross margins associated with the increased proportion of international sales made to distributors. While all of the Company's sales are denominated in U.S. dollars, fluctuations in currency exchange rates could cause the Company's products to become relatively more expensive to end users in a particular country, leading to a reduction of sales in that country. The Company may also experience competition specific to a given local market. In addition, the Company's business may be adversely affected by seasonal sales declines in Europe, which typically occur during the summer months. Because the Company has operations in different countries, the Company's management must address the difficulty of merging geographically disparate operations as well as differences in regulatory environments, cultures and time zones. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business -- Sales and Marketing." WARRANTY EXPOSURE The Company's primary warranty efforts consist of accepting defective products from customers and either repairing them or returning the defective component to the original manufacturer for repair or replacement during the applicable warranty period. The Company generally protects itself by extending to its customers a warranty that corresponds to the warranty provided to the Company by its suppliers. However, if a supplier were to fail to meet its warranty obligations, the Company would be forced to assume responsibility for warranties on all components manufactured by that supplier. Such an event could have a material adverse effect on the Company's business, financial condition and results of operations. See "Business -- Sales and Marketing." DEPENDENCE ON KEY PERSONNEL The Company's success depends to a significant extent upon the continued service of its executive officers and other key management and technical personnel. In particular, the Company relies on the services of its four founders, Messrs. Razmjoo, Alaghband, Aydin and Shahrestany (the "Founders"). The loss of any of these individuals or other management or technical personnel may have a material adverse effect on the Company's operations, including the ability to establish and strengthen strategic relationships, its ability to open new offices successfully, its ability to adapt its products to changes in technology and its ability to attract and retain technical personnel and other employees, the competition for which is intense. The Company maintains employment agreements with each of the Founders, but does not maintain key-person life insurance policies on the lives of these individuals. See "Business -- Employees" and "Management." FUTURE CAPITAL REQUIREMENTS The Company's business plan will require significant amounts of working capital. While the Company has funded its growth historically through working capital loans and internally generated funds, there can be no assurance that the proceeds of this offering, together with available cash, bank lines of credit and cash from operations, will be sufficient to satisfy the Company's anticipated cash requirements. If additional funds are required, the Company's operations may need to be significantly curtailed or the Company could be forced to obtain financing on terms that cause the Company's business, financial condition and results of operations to be adversely affected. 11 13 The Company may expand its product lines through the acquisition of complementary businesses, products and technologies. However, the Company has no present plans, agreements or commitments to make any such acquisitions. Acquisitions involve numerous risks, including difficulties in the assimilation of operations and products, the ability to manage geographically remote units, the diversion of management's attention from other business concerns, the risks of entering markets in which the Company has little or no experience or expertise and the potential loss of key employees of any acquired companies. In addition, acquisitions may involve the expenditure of significant funds. The Company's management has no prior experience in managing acquisitions. There can be no assurance that any acquisition would result in long-term benefits to the Company or that management would be able to manage effectively the acquired business. See "Use of Proceeds," "Capitalization" and "Management's Discussion and Analysis of Financial Condition and Results of Operations." CONCENTRATION OF SHARE OWNERSHIP AND CONTROL OF COMPANY Upon completion of this offering, the Founders of the Company will beneficially own approximately 66.1% of the Company's outstanding Common Stock (62.0% if the Underwriters' over-allotment option is exercised in full). Accordingly, the Founders will, acting together, have sufficient voting power to control the outcome of all corporate matters submitted to the vote of shareholders, including election of most or all directors, proxy contests, mergers, tender offers, open-market purchase programs and other purchases of the Company's Common Stock that could give shareholders of the Company the opportunity to realize a premium over the then prevailing market price for their shares of Common Stock. See "Principal and Selling Shareholders." BROAD MANAGEMENT DISCRETION IN ALLOCATION OF PROCEEDS The net proceeds to the Company from the sale of the shares of Common Stock offered by the Company hereby at an assumed initial public offering price of $10.00 per share, after deducting the estimated underwriting discount and offering expenses, are estimated to be approximately $17,820,000. The Company has not designated a specific use for a significant portion of such net proceeds. The Company intends to use a portion of the net proceeds from this Offering to repay all outstanding short-term debt under its line of credit (approximately $3.7 million at October 25, 1996), approximately $300,000 to acquire capital equipment to increase production capacity and the remainder for general corporate purposes, including working capital. A portion of the net proceeds also may be used for the acquisition of businesses, products and technologies that are complementary to those of the Company. Accordingly, the Company's management will retain broad discretion as to the allocation of the proceeds of this Offering. The failure of management to apply such funds effectively could have a material adverse effect on the Company's business, financial condition and results of operations. See "Use of Proceeds." The Offering is being made at this time in order to create a public market for the Company's Common Stock, to provide liquidity to the Company's existing stockholders, to provide increased visibility and credibility for the Company in a marketplace where many of the Company's competitors are publicly held and to fund increased working capital requirements created by the Company's growth over the last three fiscal years. ANTI-TAKEOVER PROTECTIONS The Company's Articles of Incorporation provide for authorized but unissued Preferred Stock, the terms of which may be fixed by the Board of Directors, and eliminate cumulative voting and provide for a classified 12 14 Board of Directors once the Company is listed on the Nasdaq National Market and has 800 shareholders of record on the record date for an annual meeting of shareholders. The Company's Bylaws establish advance notice requirements for shareholder proposals and director nominations, subject to certain exceptions. These provisions could have the effect of delaying, deterring or preventing a change in control of the Company. See "Description of Capital Stock -- Certain Anti-Takeover Effects." NO PRIOR MARKET; VOLATILITY OF STOCK PRICE The initial public offering price will be determined by negotiations among the Company, the Selling Shareholders and the Representatives of the Underwriters. Prior to this Offering, there has been no public market for the Common Stock, and, although the Company has applied for listing of the Common Stock on the Nasdaq National Market, there can be no assurance that an active public market for the Common Stock will develop or be sustained after this Offering. The Company believes that factors such as announcements of developments related to the Company's business, fluctuations in the Company's operating results, general conditions in the data storage and information access markets served by the Company or in the worldwide economy, an outbreak of hostilities, a shortfall in sales or net income compared to securities analysts' expectations, announcements of technological innovations or new data storage and information access products or enhancements by the Company or its competitors, developments in patents or other intellectual property rights and developments in the Company's relationships with its customers, suppliers, computer resellers, VARs and distributors could cause the price of the Company's Common Stock to fluctuate, perhaps substantially. In addition, in recent years the stock market in general, and the market for shares of technology companies and of small capitalization companies in particular, have experienced extreme price fluctuations, which have often been unrelated or disproportionate to the operating performance of the affected companies. There can be no assurance that the market price of the Company's Common Stock will not experience such fluctuations. See "Underwriting." SHARES ELIGIBLE FOR FUTURE SALE Sales of Common Stock in the public market after this Offering could adversely affect the market price of the Common Stock. Unless purchased by an affiliate of the Company, the 3,025,000 shares of Common Stock to be sold in this Offering will be freely transferable without restriction. All of the Company's existing shareholders, who will hold 7,975,000 shares of Common Stock after this Offering, have agreed that they will not, without the consent of Montgomery Securities, sell or otherwise dispose of any equity securities of the Company for a period of 180 days following the effective date of this Offering. Upon expiration of the lock-up agreements with Montgomery Securities, substantially all of such shares will be eligible for resale subject to the limitations of Rule 144 promulgated under the Securities Act of 1933, as amended (the "Securities Act"). In general, under Rule 144 as currently in effect, a person who has beneficially owned shares for at least two years is entitled to sell in "broker's transactions" or to market makers, within any three-month period commencing 90 days after the date of this Prospectus, a number of shares that does not exceed 1% of the number of shares of Common Stock then outstanding (approximately 110,000 shares immediately after this Offering) or, if greater, a number based on average weekly trading volume of the Common Stock. Such sales are also subject to certain notice requirements and to the availability of current public information about the Company. The Securities and Exchange Commission has proposed to reduce each of these Rule 144 holding periods by one year. The Founders, who will hold 7,273,000 shares of Common Stock (6,819,250 shares if the Underwriters' over-allotment option is exercised in full) after this Offering, are entitled to certain demand and "piggy back" registration rights with respect to the registration of such shares for offer or sale to the public. In addition, the Company intends to register with the Securities and Exchange Commission a total of 540,000 shares of Common Stock reserved for issuance under the 1995 Stock Option Plan as soon as practicable following the date of this Prospectus, of which approximately 55,000 shares of Common Stock subject to vested options will be eligible for resale upon the expiration of lock-up agreements 180 days following the effective date of this Offering, unless earlier released for resale by the Company. The Underwriting Agreement prohibits the Company from releasing such shares for resale until 90 days following the effective date of the Registration Statement of which this Prospectus is a part (the "Effective Date"). Any 13 15 shares subject to lock-up agreements may be released at any time without notice by Montgomery Securities. Sales of substantial amounts of shares in the public market may adversely affect the market price of the Company's Common Stock. See "Shares Eligible For Future Sale." ABSENCE OF DIVIDENDS The Company has never declared or paid dividends on its Common Stock and does not anticipate declaring or paying any cash dividends in the foreseeable future. See "Dividend Policy." IMMEDIATE AND SUBSTANTIAL DILUTION Purchasers of the Common Stock offered hereby will incur immediate and substantial dilution of $7.73 in the net tangible book value per share of Common Stock. Additional dilution will occur when existing optionholders exercise their options. See "Dilution." BENEFITS OF OFFERING TO FOUNDERS The existing shareholders of the Company will receive certain benefits from the sale of the Common Stock offered hereby. The Offering will establish a public market for the Common Stock and provide increased liquidity to the existing shareholders for the shares of Common Stock they will own after the Offering, subject to certain limitations. See "Shares Eligible For Future Sale." The Founders will sell 1,000,000 shares of Common Stock in the Offering and will receive approximately $9.3 million in net proceeds, based upon an initial public offering price of $10.00 per share and after deducting the estimated underwriting discount, reflecting a net gain of $9.30 per share over the original cost of the shares and an aggregate net gain of approximately $9.30 million. Mr. Judd will sell 25,000 shares of Common Stock in the Offering and will receive approximately $232,500 in net proceeds and have a net gain of approximately $223,750 based upon the assumed initial public offering price and after deducting the estimated underwriting discount. If the Underwriters' over-allotment option is exercised in full, the Founders will sell, in the aggregate, 1,453,750 shares of Common Stock and will receive approximately $13.5 million in net proceeds based upon the assumed initial public offering price and after deducting the estimated underwriting discount. See "Principal and Selling Shareholders." The Company intends to use a portion of the net proceeds of the Offering to repay short-term debt under the Company's line of credit (approximately $3.7 million at October 25, 1996), which is guaranteed by the Founders. See "Use of Proceeds." Additionally, immediately following the Offering, the Founders will have an average unrealized gain over the original cost of the shares that will continue to be held by them of $9.91 per share, based upon the assumed initial public offering price, or an aggregate unrealized gain of approximately $72.1 million (approximately $67.5 million if the Underwriters' over-allotment option is exercised in full). See "Dilution" and "Principal and Selling Shareholders." 14 16 CAPITALIZATION The following table sets forth the capitalization of the Company as of October 25, 1996 and as adjusted for the sale of the shares of Common Stock offered by the Company hereby at an assumed initial public offering price of $10.00 per share and the application by the Company of the estimated net proceeds therefrom (after deducting the estimated underwriting discount and offering expenses).
OCTOBER 25, 1996 ---------------------- ACTUAL AS ADJUSTED ------ ----------- (IN THOUSANDS) Line of credit......................................................... $3,660 $ -- ====== ======= Shareholders' equity: Preferred stock, no par value; 10,000,000 shares authorized; none issued and outstanding, actual and as adjusted............... -- -- Common stock, no par value; 65,000,000 shares authorized, 9,000,000 shares issued and outstanding actual; 11,000,000 shares issued and outstanding, as adjusted(1)....................................... 3 17,823 Retained earnings.................................................... 7,148 7,148 ------ ------- Total shareholders' equity........................................ 7,151 24,971 ------ ------- Total capitalization......................................... $7,151 $24,971 ====== =======
- --------------- (1) Excludes 271,800 shares of Common Stock issuable upon exercise of options outstanding as of October 25, 1996 at a weighted average exercise price of $3.67 and an aggregate of 268,200 additional shares reserved for future issuance as of such date under the Company's 1995 Stock Option Plan. See "Management -- Employee Benefit Plans." 15 17 DILUTION As of October 25, 1996, the Company had a net tangible book value of $7,151,000, or $0.79 per share of Common Stock. Net tangible book value per share is determined by dividing the net tangible book value of the Company (total tangible assets less total liabilities) by the number of shares of Common Stock outstanding as of October 25, 1996. After giving effect to the sale by the Company of the shares of Common Stock offered by the Company hereby at an assumed initial public offering price per share of $10.00 and (after deducting the estimated underwriting discount and offering expenses), the Company's net tangible book value as of October 25, 1996 would have been $24,971,000 or $2.27 per share of Common Stock. This represents an immediate increase in net tangible book value of $1.48 per share to existing shareholders and an immediate dilution of $7.73 per share to new investors purchasing shares in the Offering. The following table illustrates this per share dilution: Assumed initial public offering price per share..................... $10.00 Net tangible book value per share before the Offering............. $0.79 Increase per share attributable to new investors.................. 1.48 ----- Pro forma net tangible book value per share after the Offering...... 2.27 ------ Dilution per share to new investors............................... $ 7.73 ======
The following table sets forth on a pro forma basis, as of October 25, 1996, the relative investments of all existing shareholders and new investors purchasing shares of Common Stock from the Company in the Offering. The calculations are based on an assumed initial public offering price of $10.00 per share.
SHARES PURCHASED TOTAL CONSIDERATION --------------------- ---------------------- AVERAGE PRICE NUMBER PERCENT AMOUNT PERCENT PER SHARE ---------- ------- ----------- ------- ------------- Existing shareholders(1)....... 9,000,000 81.8% $ 3,000 --% $ -- New investors.................. 2,000,000 18.2 20,000,000 100.0 10.00 ---------- ----- ----------- ----- Total........................ 11,000,000 100.0% $20,003,000 100.0% ========== ===== =========== =====
- --------------- (1) Sales by the Selling Shareholders in the Offering will reduce the number of shares held by existing shareholders to 7,975,000 shares, or 72.5% of the total shares of Common Stock outstanding (7,521,250 shares, or 68.4% of the total shares of Common Stock if the Underwriters' over-allotment option is exercised in full), and will increase the number of shares held by new investors to 3,025,000 shares, or 27.5% of the total shares of Common Stock outstanding (3,478,750 shares, or 31.6% of the total shares of Common Stock if the Underwriters' over-allotment option is exercised in full) after the Offering. The foregoing table excludes an aggregate of 271,800 shares of Common Stock issuable upon the exercise of stock options outstanding as of October 25, 1996 at a weighted average exercise price of $3.67 per share and an aggregate of 268,200 additional shares of Common Stock reserved for future issuance as of such date under the Company's 1995 Stock Option Plan. To the extent that any options of the Company are exercised, there will be further dilution to new investors. See "Management -- Employee Benefit Plans" and "Principal and Selling Shareholders." 16 18 SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data of the Company set forth below should be read in conjunction with the Consolidated Financial Statements of the Company, including the notes thereto, and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein. The Company utilizes a fiscal year ending on the Friday nearest July 31. The selected consolidated financial data as of July 28, 1995 and July 26, 1996 and for the three years in the period ended July 26, 1996 are derived from the consolidated financial statements of the Company audited by Arthur Andersen LLP, independent public accountants, whose report appears elsewhere in the Prospectus. The selected consolidated financial data as of July 31, 1992, July 30, 1993 and July 29, 1994 and for the two years ended July 30, 1993 are derived from the audited consolidated financial statements of the Company not included herein. The selected consolidated financial data presented below as of October 25, 1996 and for the quarters ended October 27, 1995 and October 25, 1996 are unaudited but have been prepared on the same basis as the audited financial statements and, in the opinion of management, contain all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results of operations for such periods. Historical results are not necessarily indicative of results to be expected in the future.
YEARS ENDED QUARTERS ENDED ---------------------------------------------------- ------------------------- JULY 31, JULY 30, JULY 29, JULY 28, JULY 26, OCTOBER 27, OCTOBER 25, 1992 1993 1994 1995 1996 1995 1996 -------- -------- -------- -------- -------- ----------- ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Net sales.............................. $ 42,898 $ 41,726 $ 34,502 $ 44,660 $ 73,456 $15,275 $24,915 Cost of sales.......................... 34,029 32,273 27,187 32,858 51,489 11,133 16,490 ------- ------- ------- ------- ------- ------- ------- Gross profit......................... 8,869 9,453 7,315 11,802 21,967 4,142 8,425 Selling, general and administrative expenses............................. 7,045 7,293 6,902 9,362 15,401 2,875 4,367 Research and development expenses...... 886 1,014 983 1,108 1,635 292 688 Loss on closure of German subsidiary... -- -- 409 -- -- -- -- ------- ------- ------- ------- ------- ------- ------- Operating income (loss).............. 938 1,145 (979) 1,332 4,931 975 3,370 Interest expense....................... (91) (195) (151) (195) (282) (60) (60) Other income (expense), net............ 13 (44) -- -- -- -- -- ------- ------- ------- ------- ------- ------- ------- Income (loss) before income taxes.... 861 906 (1,130) 1,137 4,649 915 3,310 Provision (benefit) for income taxes... 285 297 (357) 414 1,800 356 1,295 ------- ------- ------- ------- ------- ------- ------- Net income (loss).................... $ 576 $ 609 $ (773) $ 723 $ 2,849 559 2,015 ======= ======= ======= ======= ======= ======= ======= Net income (loss) per share(1)......... $ 0.06 $ 0.07 $ (0.08) $ 0.08 $ 0.31 $ 0.06 $ 0.22 ======= ======= ======= ======= ======= ======= ======= Weighted average number of shares(1)... 9,172 9,172 9,172 9,172 9,172 9,172 9,172 ======= ======= ======= ======= ======= ======= =======
JULY 31, JULY 30, JULY 29, JULY 28, JULY 26, OCTOBER 25, 1992 1993 1994 1995 1996 1996 -------- -------- -------- -------- -------- ----------- (IN THOUSANDS) CONSOLIDATED BALANCE SHEET DATA: Cash......................................... $ 24 $ 57 $ 211 $ 212 $ 793 $ 58 Working capital.............................. 1,285 1,911 1,275 1,868 4,632 6,569 Total assets................................. 8,230 9,072 7,638 11,011 21,112 25,325 Line of credit............................... 1,909 2,868 1,679 1,484 4,185 3,660 Long-term obligations........................ 87 58 39 34 -- -- Total shareholders' equity................... 1,729 2,338 1,564 2,287 5,136 7,151
- ------------------ (1) See Note 1 of Notes to Consolidated Financial Statements for a description of the computation of net income (loss) per share. 17 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This Prospectus contains forward-looking statements that involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in "Risk Factors." OVERVIEW The Company was formed in 1987. Its first product was a 5 1/4 inch floppy disk drive for the IBM PS/2 personal computer. At the time, IBM was shipping the PS/2 with only a 3 1/2 inch floppy disk drive, although the software and data of most computer users were still stored on 5 1/4 inch formats. The Company subsequently began producing aftermarket disk drive upgrade products for computer products sold by other manufacturers, and such upgrade products continue to be an important area of focus of the Company's business. In 1991, the Company developed and began selling CD-ROM multimedia kits, consisting of a CD-ROM drive, a sound card, software drivers and various CD-ROM software titles. The Company initially achieved rapid growth in the sales of multimedia kits to mass merchants and national distributors. However, in fiscal 1994, the Company began to experience significant losses on sales of its multimedia kits due to high return rates, high product support costs and rapid price erosion that resulted both in decreased margins on initial sales and in losses on unsold inventory and returned products. Accordingly, in early fiscal 1994, the Company began to phase out sales of multimedia kits, and in fiscal 1995 it discontinued sales of these kits. Sales of multimedia kits declined from 31% of net sales in fiscal 1994 to 5% of net sales in fiscal 1995. Additionally, the Company incurred a one-time charge to operations of $409,000 in fiscal 1994 related to the closure of its German sales office. These factors contributed to the Company's net loss for fiscal 1994. In fiscal 1994, the Company introduced its CD server and array product line while continuing to provide a broad line of disk drive upgrade products. In addition, during fiscal 1994, the Company began utilizing computer resellers and VARs as its primary sales channel instead of mass merchants and national distributors and commenced shipment of its first RAID arrays and fault tolerant, high performance storage servers. During fiscal 1995, the Company experienced rapid growth in sales of its CD servers and arrays. Sales of hard disk drive upgrade products, CD servers and arrays, and RAID and tape backup subsystem products represented 63%, 4% and 2% of net sales in fiscal 1994, and 59%, 32% and 5% of net sales in fiscal 1995, respectively. During fiscal 1996, sales of CD servers and arrays increased more rapidly than sales of the Company's other product lines. As a result, in fiscal 1996, sales of CD servers and arrays represented 49% of net sales, while sales of hard disk drive upgrade products and RAID and tape backup subsystem products represented 47% and 4% of net sales, respectively. See "Business -- Products and Technology." The Company generally records sales upon product shipment. The Company presently maintains agreements with many of its computer resellers, VARs and distributors that allow limited returns (including stock balancing) and price protection privileges. The Company has in the past experienced high return rates. During fiscal 1996, customer returns and price protection charges represented approximately 12% of gross sales. The Company maintains reserves for anticipated returns (including stock balancing) and price protection privileges. These reserves are adjusted at each financial reporting date to state fairly the anticipated returns (including stock balancing) and price protection claims relating to each reporting period. Generally, the reserves will increase as sales and corresponding returns increase. In addition, under a product evaluation program established by the Company, computer resellers, VARs, distributors and end users generally are able to purchase products on a trial basis and return the products within a specified period if they are not satisfied. Evaluation units are not recorded as sales until the customer has paid for such units. All of the Company's sales are denominated in U.S. dollars, and accordingly, the Company does not believe that fluctuations in foreign exchange rates have had or will have a material adverse effect on the Company's results of operations or financial condition, except to the extent that such fluctuations could cause the Company's products to become relatively more expensive to end users in a particular country, leading to a reduction of sales in that country. 18 20 Historically, the Company's gross margins have experienced significant volatility. The Company's gross margins vary significantly by product line, and, therefore, the Company's overall gross margin varies with the mix of products sold by the Company. For example, low capacity disk drive subsystems generally result in lower gross margins than CD servers and arrays. As sales of CD servers and arrays have become a larger percentage of the Company's total sales, the Company has experienced a corresponding increase in its overall gross margins. From fiscal 1994 to fiscal 1996, sales of CD servers and arrays grew from approximately 4% to 49% of net sales, contributing to an improvement in the Company's gross margin from approximately 21.2% to 29.9%. The Company's markets are also characterized by intense competition and declining average unit selling prices as products mature over the course of the relatively short life cycle of individual products, which have often ranged from six to twelve months. In addition, the Company's gross margins may be adversely affected by availability and price increases associated with key products and components from the Company's suppliers, some of which have been in short supply, and inventory obsolescence resulting from older generation products or the unexpected discontinuance of third party components. Finally, the Company's margins vary with the mix of its distribution channels and with general economic conditions. For any of the foregoing reasons, the Company's overall margin could decline in the future from the levels experienced in recent quarters. See "Risk Factors -- Potential Fluctuations in Future Results of Operations," "-- Component Shortages; Reliance on Sole or Limited Source Suppliers" and "-- Rapid Technological Change; Short Product Life Cycles." RESULTS OF OPERATIONS The following table sets forth the Company's statement of operations data as a percentage of net sales for the periods indicated.
YEARS ENDED QUARTERS ENDED -------------------------------- -------------------------- JULY 29, JULY 28, JULY 26, OCTOBER 27, OCTOBER 25, 1994 1995 1996 1995 1996 -------- -------- -------- ----------- ----------- Net sales..................................... 100.0% 100.0% 100.0% 100.0% 100.0% Cost of sales................................. 78.8 73.6 70.1 72.9 66.2 ----- ----- ----- ----- ----- Gross profit................................ 21.2 26.4 29.9 27.1 33.8 Selling, general and administrative expenses.................................... 20.0 20.9 21.0 18.8 17.5 Research and development expenses............. 2.8 2.5 2.2 1.9 2.8 Loss on closure of German subsidiary.......... 1.2 -- -- -- -- ----- ----- ----- ----- ----- Operating income (loss)..................... (2.8) 3.0 6.7 6.4 13.5 Interest expense.............................. 0.4 0.4 0.4 0.4 0.2 ----- ----- ----- ----- ----- Income (loss) before income taxes........... (3.2) 2.6 6.3 6.0 13.3 Provision (benefit) for income taxes.......... (1.0) 1.0 2.4 2.3 5.2 ----- ----- ----- ----- ----- Net income (loss)........................... (2.2)% 1.6% 3.9% 3.7% 8.1% ===== ===== ===== ===== =====
QUARTER ENDED OCTOBER 25, 1996 COMPARED TO QUARTER ENDED OCTOBER 27, 1995 Net Sales Net sales increased 63.1% from $15,275,000 for the quarter ended October 27, 1995 to $24,915,000 for the quarter ended October 25, 1996. This increase was primarily due to increases in sales of CD servers and arrays and sales of disk drive upgrade subsystems for desktop and notebook computers and, to a lesser extent, increases in net sales of RAID high capacity storage devices. For the quarter ended October 25, 1996, sales of CD servers and arrays, disk drive upgrade products and RAID storage systems comprised approximately 45%, 48% and 7% of net sales, respectively. International sales increased approximately 23.4% from $1.7 million, or approximately 11% of net sales, in the quarter ended October 27, 1995 to $2.0 million, or approximately 8% of net sales, in the quarter ended October 25, 1996. Sales were affected by an increase in the allowance for sales returns during the first quarter of each of fiscal 1997 and 1996 of approximately $92,000 and $72,000, respectively, due primarily to increasing sales volumes and slightly higher overall return rates. For the quarter 19 21 ending January 24, 1997, the Company does not anticipate significant growth in net sales, if any, over the quarter ended October 25, 1996. The Company's fiscal second quarter sales have historically remained relatively flat due primarily to heavy reseller participation in trade shows that detract from reseller selling efforts, end user budget constraints that restrict end user purchases and a higher than average number of holidays during the fiscal second quarter. Gross Profit The Company's gross profit increased from 27.1% of net sales, or $4,142,000, for the quarter ended October 27, 1995 to 33.8% of net sales, or $8,425,000, for the quarter ended October 25, 1996. These increases were primarily the result of higher margins on sales of recently introduced CD servers and arrays and, to a lesser extent, higher margins on sales of disk drive upgrade products for notebook computers and RAID storage products. Selling, General and Administrative Expenses Selling, general and administrative expenses increased 52.0% from $2,875,000 for the quarter ended October 27, 1995 to $4,367,000 for the quarter ended October 25, 1996. These expenses represented 18.8% and 17.5% of net sales in the quarters ended October 27, 1995 and October 25, 1996, respectively. The dollar increase in selling, general and administrative expenses for the first quarter of fiscal 1997 was primarily a result of increased marketing and promotional costs and increased personnel and related costs necessary to support the Company's growth in net sales. The decrease in selling, general and administrative expenses as a percentage of net sales for the first quarter of fiscal 1997 was due primarily to a decrease in management bonuses from $571,000 for the first quarter of fiscal 1996 to $125,000 for the first quarter of fiscal 1997. Bad debt expense for the first quarter of fiscal 1997 was approximately $124,000, or .50% of net sales, compared to approximately $67,000, or .44% of net sales, for the first quarter of fiscal 1996. The Company anticipates that the dollar amount of its selling, general and administrative expenses will increase as the Company continues to expand its efforts to penetrate certain sales channels and regions and continues to strengthen management information and telecommunications systems. Research and Development Research and development expenses increased 135.6% from $292,000 for the quarter ended October 27, 1995 to $688,000 for the quarter ended October 25, 1996. These expenses represented 1.9% and 2.8% of net sales for the quarters ended October 25, 1995 and October 27, 1996, respectively. These increases were primarily due to continued increases in additional hardware developers and software programmers and increased related support costs to develop additional products and enhance existing product features. The Company anticipates that the dollar amount of its research and development expenses will increase, and also may increase as a percentage of net sales, with the addition of dedicated engineering resources to develop new product categories, to ensure that the Company's products are compatible with a wide range of hardware platforms and network topologies and to further develop MESA, the Company's proprietary client/server management storage architecture. In addition, the Company intends to continue to update software drivers to ensure that the Company's CD servers and arrays function with a variety of hardware platforms and network operating systems. To date, all of the Company's software development costs have been expensed as incurred, as the impact of capitalizing software costs under Financial Accounting Standard No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed" would have been immaterial to the Company's financial statements. Income Taxes The Company's effective tax rates for the quarters ended October 27, 1995 and October 25, 1996 were 38.9% and 39.1% of net income, respectively, which approximate the federal and state statutory rates with modest reductions for benefits resulting from the Company's use of its foreign sales corporation ("FSC") and a research and development credit. 20 22 COMPARISON OF YEARS ENDED JULY 29, 1994, JULY 28, 1995 AND JULY 26, 1996 Net Sales The following table sets forth the net sales and percentages of net sales represented by each of the Company's product lines.
YEARS ENDED ------------------------------- JULY JULY JULY 29, 28, 26, 1994 1995 1996 ------- ------- ------- (DOLLARS IN THOUSANDS) NET SALES DATA: CD servers and arrays......................................... $ 1,568 $14,426 $36,079 Disk drive upgrade products................................... 21,726 26,000 34,789 RAID and tape backup subsystem products....................... 686 2,421 2,588 Multimedia kits............................................... 10,522 1,813 -- ------ ------ ------ Total............................................... $34,502 $44,660 $73,456 ====== ====== ======
YEARS ENDED ------------------------------- JULY JULY JULY 29, 28, 26, 1994 1995 1996 ------- ------- ------- PERCENTAGE OF NET SALES DATA: CD servers and arrays......................................... 4% 32% 49% Disk drive upgrade products................................... 63 59 47 RAID and tape backup system products.......................... 2 4 4 Multimedia kits............................................... 31 5 -- ------ ------ ------ Total............................................... 100% 100% 100% ====== ====== ======
Net sales increased 29.4% from $34.5 million in fiscal 1994 to $44.7 million in fiscal 1995 and increased an additional 64.5% to $73.5 million in fiscal 1996. Net sales increased from fiscal 1994 to fiscal 1995 primarily as a result of increased sales of the Company's CD servers and arrays and, to a lesser extent, increased sales of its disk drive upgrade products and RAID products, which were partially offset by decreased sales of its CD-ROM multimedia kits that were discontinued in fiscal 1995. Net sales increased from fiscal 1995 to fiscal 1996 primarily as a result of increased sales of CD servers and arrays (including sales of higher performance CD servers) and, to a lesser extent, increased sales of hard disk drive upgrade products. For fiscal 1996, sales were reduced by approximately $130,000 as the Company increased its allowance for anticipated sales returns. For fiscal 1995 and 1994, the allowances for anticipated sales returns were reduced by $52,000 and $50,000, respectively, as the Company phased out sales of its multimedia kits which had high return rates. International sales, primarily to European customers and secondarily to Middle Eastern, Latin American and Pacific Rim customers, were $6.5 million, $6.2 million and $8.4 million, and accounted for approximately 19%, 14% and 11% of net sales for fiscal 1994, 1995 and 1996, respectively. International sales remained essentially constant for fiscal 1995 compared to fiscal 1994 as increased sales of hard disk drive upgrade products were offset by decreased sales of CD-ROM multimedia kits. International sales increased by 35.6% from fiscal 1995 to fiscal 1996 primarily as a result of increased sales of CD-ROM servers and arrays. See "Risk Factors -- Risks of International Sales and Operations." Gross Profit The Company's gross profit totalled $7.3 million, $11.8 million and $22.0 million during fiscal 1994, 1995 and 1996, respectively. The Company's gross margin increased from 21.2% in fiscal 1994 to 26.4% in fiscal 1995, due primarily to a shift in product mix toward higher margin CD servers and arrays and a decrease in the losses associated with the discontinuance of sales of the Company's CD-ROM multi-media kits. During fiscal 1996, gross margin further increased to approximately 29.9% due primarily to a continuing shift in product mix toward higher margin CD servers and arrays as well as an increase in gross margins for the Company's 21 23 CD servers and arrays, and to a lesser extent from an increase in gross margins on the Company's hard disk drive upgrade and RAID products. Selling, General and Administrative Expenses Selling, general and administrative expenses increased 35.6% from $6.9 million in fiscal 1994 to $9.4 million in fiscal 1995 and further increased 64.5% to $15.4 million in fiscal 1996. These expenses represented 20.0%, 20.9% and 21.0% of net sales in fiscal 1994, 1995 and 1996, respectively. The increase from fiscal 1994 to fiscal 1995 was due primarily to an increase in various marketing and advertising programs to promote sales of the Company's CD servers and arrays and RAID subsystems in vertical niche markets, as well as increases in staffing to support the Company's growth. The increase from fiscal 1995 to fiscal 1996 was due primarily to increased marketing expenses associated with advertising, direct mail and channel telemarketing, as well as increases in sales commissions and general and administrative staffing necessary to support the Company's growth. For fiscal 1994 and 1995, bad debt expense was $241,000 and $322,000, or approximately .69% and .72% of net sales, respectively, compared to $473,000, or approximately .64% of net sales, for fiscal 1996. Selling, general and administrative expenses for fiscal 1995 and 1996 included $0.9 million and $2.9 million, respectively, for bonuses for executive officers. Research and Development Expenses Research and development expenses, consisting primarily of personnel expenses, increased 12.7% from $1.0 million in fiscal 1994 to $1.1 million in fiscal 1995 and further increased 47.6% to $1.6 million in fiscal 1996. These expenses represented 2.8%, 2.5% and 2.2% of net sales in fiscal 1994, 1995 and 1996, respectively. The slight dollar increase from fiscal 1994 to fiscal 1995 resulted primarily from the Company's enhanced efforts to develop its CD server and array product lines and RAID subsystems. This increase was largely offset by the Company's discontinuation of its development efforts for its CD-ROM multimedia kit business. The dollar increase from fiscal 1995 to fiscal 1996 was due primarily to the Company's expanded efforts to develop new CD servers and RAID products and to develop CD FORCE, a CD-ROM network server incorporating Procom's proprietary software data access management system. Loss on Closure of German Subsidiary The Company incurred a one-time charge to operations of $409,000 related to the closure of its German sales office during fiscal 1994. The Company formed its German subsidiary in fiscal 1993 to support its increasing European sales and marketing efforts primarily related to sales of CD-ROM multimedia kits. However, the Company closed its German office in April 1994 due to the subsidiary's lack of profitability resulting from higher average general and administrative costs, slower realization of sales than anticipated and a lower gross margin product mix. During fiscal 1995, the Company completed the liquidation of the subsidiary's assets. Interest Expense The Company maintains a working capital line of credit to support its accounts receivable and inventory levels. Interest expense increased from $151,000 in fiscal 1994 to $195,000 in fiscal 1995 as the Company's sales, and resulting accounts receivable and inventory levels, increased. Interest expense further increased to $282,000 for fiscal 1996 as the Company utilized its available credit lines to support further increases in accounts receivables and inventory levels. Income Taxes The Company's effective tax rates were (31.6)%, 36.4% and 38.7% for fiscal 1994, 1995 and 1996, respectively. In fiscal 1994, the Company utilized net operating losses to reduce its state income tax rate below the statutory level. For fiscal 1995 and 1996, the Company's effective tax rate approximated federal and state statutory rates, with moderate reductions due to the Company's use of its FSC. For fiscal 1994 and 1995, the Company received benefits from a research and development credit, while the fiscal 1996 benefit was 22 24 significantly reduced due to legislation which temporarily denied the credit. See Note 4 of Notes to Consolidated Financial Statements. The Company adopted Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes," on July 28, 1994. The cumulative effect of the adoption as of July 28, 1994 was immaterial and, as a result, the Company did not restate any prior financial statements. QUARTERLY INFORMATION The following tables set forth certain unaudited financial information in dollars and as a percentage of net sales for the eight quarters of fiscal 1995 and 1996 and the first quarter of fiscal 1997. The Company believes that all necessary adjustments, consisting only of normal recurring accruals, have been included in the amounts stated below to present fairly the selected quarterly information when read in conjunction with the Consolidated Financial Statements and the notes thereto included elsewhere herein. The operating results for any quarter are not necessarily indicative of results for any subsequent period or for the entire fiscal year. The Company operates under thirteen week quarters that end on the Friday closest to the calendar quarter end. As a result, a fiscal quarter may not end on the same day as the calendar quarter end.
QUARTERS ENDED ----------------------------------------------------------------------------------------------------------------- OCTOBER 28, JANUARY 27, APRIL 28, JULY 28, OCTOBER 27, JANUARY 26, APRIL 26, JULY 26, OCTOBER 25, 1994 1995 1995 1995 1995 1996 1996 1996 1996 ----------- ----------- --------- -------- ----------- ----------- --------- -------- ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net sales..... $9,048 $10,040 $12,121 $13,451 $15,275 $15,801 $17,775 $24,605 $24,915 Cost of sales....... 6,701 7,213 9,100 9,844 11,133 10,948 12,263 17,145 16,490 ------ ------- ------- ------- ------- ------- ------- ------- ------- Gross profit.... 2,347 2,827 3,021 3,607 4,142 4,853 5,512 7,460 8,425 ------ ------- ------- ------- ------- ------- ------- ------- ------- Selling, general and adminis- trative... 1,851 2,255 2,350 2,906 2,875 3,333 3,829 5,364 4,367 Research and development... 210 226 325 347 292 386 459 498 688 ------ ------- ------- ------- ------- ------- ------- ------- ------- Operating income.... 286 346 346 354 975 1,134 1,224 1,598 3,370 Interest expense..... 40 58 56 41 60 61 51 110 60 ------ ------- ------- ------- ------- ------- ------- ------- ------- Income before income taxes..... 246 288 290 313 915 1,073 1,173 1,488 3,310 Provision for income taxes....... 91 105 104 114 356 418 457 569 1,295 ------ ------- ------- ------- ------- ------- ------- ------- ------- Net income.... $ 155 $ 183 $ 186 $ 199 $ 559 $ 655 $ 716 $ 919 $ 2,015 ====== ======= ======= ======= ======= ======= ======= ======= ======= Net income per share....... $ 0.02 $ 0.02 $ 0.02 $ 0.02 $ 0.06 $ 0.07 $ 0.08 $ 0.10 $ 0.22 ====== ======= ======= ======= ======= ======= ======= ======= ======= Weighted average number of shares(1)... 9,172 9,172 9,172 9,172 9,172 9,172 9,172 9,172 9,172 ====== ======= ======= ======= ======= ======= ======= ======= =======
- ------------------ (1) See Note 1 of Notes to Consolidated Financial Statements for a description of the computation of net income (loss) per share. 23 25 The following table sets forth certain unaudited quarterly financial information of the Company for the eight quarters of fiscal 1995 and 1996 and the first quarter of fiscal 1997 expressed as a percentage of net sales.
QUARTERS ENDED ----------------------------------------------------------------------------------------------------------------- OCTOBER 28, JANUARY 27, APRIL 28, JULY 28, OCTOBER 27, JANUARY 26, APRIL 26, JULY 26, OCTOBER 25, 1994 1995 1995 1995 1995 1996 1996 1996 1996 ----------- ----------- --------- -------- ----------- ----------- --------- -------- ----------- Net sales..... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% Cost of sales....... 74.1 71.8 75.1 73.2 72.9 69.3 69.0 69.7 66.2 ----- ----- ----- ----- ----- ----- ----- ----- ----- Gross profit.... 25.9 28.2 24.9 26.8 27.1 30.7 31.0 30.3 33.8 ----- ----- ----- ----- ----- ----- ----- ----- ----- Selling, general and administrative... 20.4 22.5 19.4 21.6 18.8 21.1 21.5 21.8 17.5 Research and development... 2.3 2.3 2.7 2.6 1.9 2.4 2.6 2.0 2.8 ----- ----- ----- ----- ----- ----- ----- ----- ----- Operating income.... 3.2 3.4 2.8 2.6 6.4 7.2 6.9 6.5 13.5 Interest expense..... 0.5 0.6 0.4 0.3 0.4 0.4 0.3 0.5 0.2 ----- ----- ----- ----- ----- ----- ----- ----- ----- Income before income taxes..... 2.7 2.8 2.4 2.3 6.0 6.8 6.6 6.0 13.3 Provision for income taxes....... 1.0 1.0 0.9 0.8 2.3 2.6 2.6 2.3 5.2 ----- ----- ----- ----- ----- ----- ----- ----- ----- Net income.... 1.7% 1.8% 1.5% 1.5% 3.7% 4.2% 4.0% 3.7% 8.1% ===== ===== ===== ===== ===== ===== ===== ===== =====
The Company's net sales have increased every quarter for the eight quarters of fiscal 1995 and 1996 and the first quarter of fiscal 1997. The increased sales have resulted primarily from increased shipments of CD servers and arrays and higher capacity disk drive upgrade products. In addition to seasonal factors that generally contribute to a relatively flat second fiscal quarter, the Company believes that its net sales for the second quarter of fiscal 1996 were adversely impacted by inclement weather and the federal government shutdown, which restricted federal purchasing due to budgetary uncertainty and the absence of federal purchasing decision-makers. The 38.4% increase in net sales for the fourth quarter of fiscal 1996 over the third quarter of fiscal 1996 was due primarily to a significant increase in sales of high capacity storage upgrade products as the Company capitalized on unique market opportunities and, to a lesser extent, increased sales of CD servers and arrays. Gross margin ranged from 24.9% for the third quarter of fiscal 1995 to 33.8% for the first quarter of fiscal 1997. Fluctuations in gross margin resulted from variations in revenue mix from sales of higher margin CD servers and arrays and RAID products, and sales of lower margin medium capacity disk drive storage products. Certain other factors which contribute to decreases in the Company's gross margins include the lower margins generated by sales of products near the end of their life cycles and increased international sales, which generally involve slightly lower average unit sales prices as a result of the increased use of distributors rather than computer resellers or VARs. Selling, general and administrative expenses ranged from 17.5% of net sales in the first quarter of fiscal 1997 to 22.5% of net sales in the second quarter of fiscal 1995. While selling, general and administrative expenses have generally increased, fluctuations in these expenses as a percentage of net sales have resulted primarily from varying levels of net sales, management bonuses and seasonal variations in marketing, advertising and trade show expenditures. Research and development expenses ranged from 1.9% of net sales in the first quarter of fiscal 1996 to 2.8% of net sales in the first quarter of fiscal 1997. Research and development expense levels fluctuated quarterly depending primarily on the size of the Company's engineering staff, as well as the number and nature of projects under development during any given quarter. The Company's results of operations have in the past varied significantly and are likely in the future to vary significantly as a result of a number of factors, including the mix of products sold, the volume and timing of orders received during the period, the timing of new product introductions by the Company and its competitors, product line maturation, the impact of price competition on the Company's average selling prices, the availability and pricing of components for the Company's products, changes in distribution channel mix and product returns or price protection charges from customers. Many of these factors are beyond the Company's control. Although the Company has experienced growth in sales in recent periods, there can be no assurance that the Company will experience growth in the future or be profitable on an operating basis in any future period. In addition, due to the short product life cycles that characterize the Company's markets, a 24 26 significant percentage of the Company's sales each quarter may result from new products or product enhancements introduced in that quarter. Since the Company relies on new products and product enhancements for a significant percentage of sales, failure to continue to develop and introduce new products and product enhancements or failure of these products or product enhancements to achieve market acceptance could have a material adverse effect on the Company's business, financial condition and results of operations. Historically, as the Company has planned and implemented new products, it has experienced unexpected reductions in sales and gross profit of older generation products as customers have anticipated new products. These reductions have in the past given and could continue to give rise to charges for obsolete or excess inventory, returns of older generation products by computer resellers, VARs and distributors or substantial price protection charges. See "Risk Factors -- Rapid Technological Change; Short Product Life Cycles" and "-- Customer Concentration; Distribution Strategy Risks; Inventory Protection." For example, in fiscal 1994, the Company incurred losses when it discontinued sales of CD-ROM multimedia kits to mass merchants and distributors. From time to time, the Company has experienced and may in the future experience inventory obsolescence resulting from the unexpected discontinuance of third party components, such as disk drives, included in the Company's products. To the extent the Company is unsuccessful in managing product transitions, it may have a material adverse effect on the Company's business, financial condition and results of operations. The Company also has historically capitalized on short-term market opportunities for volume purchases of certain components at favorable prices. For example, in the quarter ended July 26, 1996, the Company capitalized on a one-time opportunity to sell a significant volume of high capacity disk drive upgrade products purchased at below market prices in the prior quarter, which resulted in a price advantage to the Company that enhanced the Company's sales and results of operations for that quarter. There can be no assurance that the Company will be able to capitalize on such opportunities in the future. In addition, the Company's fiscal second quarter sales have historically remained relatively flat due primarily to heavy reseller participation in trade shows that detract from reseller selling efforts, end user budget constraints that restrict end user purchases, and a higher than average number of holidays during that quarter. LIQUIDITY AND CAPITAL RESOURCES The Company was founded with minimal capital and has never raised additional equity funds. For the past three fiscal years, the Company has satisfied its operating cash requirements principally through net income, supplemented by periodic borrowings of funds under its working capital line of credit and increases in accounts payable and accrued expenses. Net cash provided by operating activities was $1.4 million and $0.4 million in fiscal 1994 and fiscal 1995, respectively, and net cash used in operating activities was $1.7 million, $1.1 million and $0.1 million in fiscal 1996 and the first quarter of each of fiscal 1996 and 1997, respectively. In fiscal 1994, net cash provided by operating activities was provided primarily by a decrease in accounts receivable and an increase in accounts payable, partially offset by the Company's net loss for the year. In fiscal 1995, net cash provided by operating activities resulted primarily from an increase in accounts payable and accrued expenses, together with the Company's net income, offset in large part by increases in inventories and accounts receivable. In fiscal 1996 and the first quarter of each of fiscal 1996 and 1997, net cash used in operating activities resulted primarily from increases in accounts receivable due to increased sales during each of the periods and increases in inventories due to both increased sales and the higher value added components of the Company's products. These increased uses of capital were offset in part by the Company's net income and increases in accounts payable and accrued expenses. In fiscal 1994, 1995 and 1996, and in the first quarter of each of fiscal 1996 and 1997, the Company's investing activities consisted primarily of purchases of property and equipment. Property and equipment expenditures totaled $71,000, $179,000, $431,000, $124,000 and $141,000 for such periods, respectively. During fiscal 1994 and 1995, the Company used $1.2 million and $0.2 million, respectively, to repay net borrowings under its line of credit, and, during fiscal 1996, the Company borrowed $2.7 million, net of repayments, to finance operations and purchase $431,000 of property and equipment. In the first quarter of fiscal 1996, the Company borrowed $1.0 million net of repayments to finance operations, and in the first quarter of fiscal 1997, the Company used $0.5 million to repay net borrowings under its line of credit. As the Company's net sales have increased, the Company's working capital requirements also have increased, and consequently, the Company has experienced a trend of increasing borrowings under and payments on its line 25 27 of credit. In fiscal 1994, 1995 and 1996, and in the first quarter of each of fiscal 1996 and 1997, the Company's borrowings under its line of credit were $34.9 million, $43.8 million, $64.8 million, $14.5 million and $22.6 million, respectively, and its payments on its line of credit were $36.1 million, $44.0 million, $62.1 million, $13.5 million and $23.1 million, respectively. In November 1994, the Company instituted a revolving line of credit with Finova Capital ("Finova"). The facility was amended in November 1995 to provide the Company with up to $6.0 million in working capital loans, based upon the Company's accounts receivable and inventory levels. The line of credit accrues certain commitment fees, unused facility fees and interest on outstanding amounts at the lender's prime rate (8.25% at October 25, 1996) plus 1.5%. Finova also makes available to the Company various flooring commitments pursuant to which the Company may finance the purchase of up to $13.0 million in inventory (less any amounts outstanding in working capital loans) from certain of the Company's vendors who have credit arrangements with Finova. As of October 25, 1996, there was approximately $3.7 million outstanding under the credit facility, and $7.5 million outstanding under the flooring arrangements. The agreement governing the credit facility requires the Company to maintain certain financial covenants (including the maintenance of working capital of at least $500,000), minimum levels of tangible net worth and minimum levels of liquidity. As of October 25, 1996, the Company was in material compliance with the covenants of the Finova line of credit. The line is secured by substantially all of the assets of the Company and is guaranteed by the Founders. The initial term of the line of credit expires on November 29, 1996, but automatically renews for successive one year periods unless terminated by either party within a specified period in advance of the automatic renewal date. See Note 5 of Notes to Consolidated Financial Statements. As of October 25, 1996, the Company had cash balances of $0.1 million and $2.3 million of availability under its line of credit. The Company believes that the cash proceeds from this offering, together with existing cash balances and available credit under its existing line of credit, will be sufficient to meet anticipated cash requirements for at least the next twelve months. As of October 25, 1996, the Company had no material commitments for capital expenditures. However, the Company intends to spend approximately $300,000 to acquire capital equipment to increase production capacity, to build out new production space and to retain consultants to evaluate and make recommendations regarding the efficiency of the Company's manufacturing operations. While the Company has no present plans, agreements or commitments to make any acquisitions, the Company may acquire businesses, products and technologies that are complementary to those of the Company. In the event the Company's plans require more capital than is presently anticipated, the Company's remaining cash balances may be consumed and additional sources of liquidity such as debt or equity financings may be required to meet working capital needs. There can be no assurance that additional capital beyond the amounts currently forecasted by the Company will not be required nor that any such required additional capital will be available on reasonable terms, if at all, at such time or times as required by the Company. RECENT ACCOUNTING PRONOUNCEMENTS During March 1995, the Financial Accounting Standards Board issued Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which requires the Company to review for impairment of long-lived assets, certain identifiable intangibles and goodwill related to those assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In certain situations, an impairment loss should be recognized under the statement. The Company's adoption of the statement will be effective for fiscal 1997. The Company has studied the implications of the statement, and based on its initial evaluation, does not expect it to have a material impact on the Company's financial condition and results of operations. During October 1995, the Financial Accounting Standards Board issued Statement No. 123 ("SFAS No. 123"), "Accounting for Stock-Based Compensation," which establishes a fair value based method of accounting for stock-based compensation plans under the statement. The Company is currently following the requirements of APB Opinion No. 25, "Accounting for Stock Issued to Employees." The Company plans to adopt SFAS No. 123 during fiscal 1997 utilizing the disclosure alternative under the statement. 26 28 BUSINESS This Prospectus contains forward-looking statements which involve risks and uncertainties. The Company's actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in "Risk Factors." Procom designs, manufactures and markets enterprise-wide data storage and information access solutions that are compatible with all major hardware platforms, network protocols and operating systems. The Company believes it is currently a leader in the market for CD-ROM servers and arrays due to its extensive distribution channels as well as the scalability, performance, ease of use and multi-protocol support of its products. The Company provides end users with disk drive upgrades for servers, desktop and notebook computers and also provides high performance, fault tolerant RAID solutions and tape backup subsystems. The Company utilizes computer resellers, VARs and distributors to sell its products to a wide variety of end users, including Fortune 500 corporations, governmental agencies and financial and educational institutions. BACKGROUND In recent years, there has been a significant migration to client/server and network computing. Today's networks are much larger and more complex than early networks, often consisting of multiple servers (application servers, file servers, database servers and communications servers) and hundreds or even thousands of desktop clients manufactured by a number of different vendors. These servers and clients may utilize a number of different operating systems, including Unix, Novell NetWare, IBM OS/2 Warp, Windows NT, Windows 95, Windows 3.1 and Macintosh OS. The distributed nature of these networks, together with the increased use of computers throughout organizations to create and store files, has resulted in an increase in the amount and dispersion of critical data across the clients and servers on these networks. As the size of networks and the amount of information used and stored on those networks have increased, access to such data has become increasingly important to end users. Users increasingly rely on the information resident on networks and PCs, such as customer databases, inventory records, sales tracking reports and research reference materials, for the effective accomplishment of daily business activities. As a result, end users must have real-time access to secure and reliable network data, regardless of the location of such data, and the supporting operating system. These factors have made it complicated to access information stored on networks. The increase in the size of networks has been accompanied by concurrent increases in the size and complexity of computer data and files. Application software developers continue to introduce software packages that increasingly incorporate features which require large amounts of storage, such as graphics, video and sound. For example, a minute of uncompressed full motion video and sound could require approximately 1,100 megabytes of storage. Similarly, the size and complexity of images stored and manipulated using document imaging systems have intensified network storage requirements. Further, the increasing popularity of the Internet as a means of communication and a medium by which to access and distribute information has contributed to the demand for increased storage, as users download a wide variety of complex data from the Internet. Organizations evaluating alternatives for additional storage capacity must consider a number of factors, including total cost of ownership, capacity, access time, security, reliability and the ability to integrate such additional storage into an existing network. The cost of ownership includes not only the initial cost of a storage system but also the expenses associated with the ongoing administration of the network. Administrative costs associated with network data storage have increased as networks have grown more complex and systems administrators have been required to monitor storage systems that support multiple operating systems and multiple applications across numerous clients. In response to increased demand for cost-effective storage of different types of information, a variety of storage media have been developed, including hard disk, magnetic tape and CD-ROM. Hard disk storage is a popular means of storing and accessing large amounts of information that is continually changing. Hard disk storage provides rapid access time but is a relatively expensive storage medium and is easily erased. Magnetic 27 29 tape is the least expensive storage medium, but has the slowest access times. Magnetic tape is therefore ideal for backing up large amounts of information that is only expected to be accessed infrequently. CD-ROM technology emerged in the early 1980s as a cost-effective method by which to store and distribute large amounts of information. A single CD can store approximately 650 megabytes of information, the same amount which could be contained on over 100,000 pages of paper. In addition, CD-ROMs offer data reliability and security, as they cannot be altered or erased, are not susceptible to data loss when computer systems fail and have a life expectancy of 50 to 100 years. Since CD-ROMs cannot be erased or written over, however, they are not suitable for storage situations in which information must be continually updated and altered. However, for organizations that require periodic distribution of written material, such as law reference books, parts lists, catalogues or manuals, CD-ROMs are much more cost-effective and practical than paper-based documents. The proliferation of network computing and the rapid increase in CD-ROMs as a means of information distribution and storage have fueled demand for CD-ROM systems that provide network wide access. RAID storage systems have developed in response to demand for increased data storage, performance, security, reliability, fault tolerance and availability, as well as for constant access. RAID is a method for allocating data across several hard disk drives and allowing a server microprocessor to access those drives simultaneously, thus increasing system storage and input/output performance. In addition, lost data on any drive can be recreated using special RAID algorithms, thus ensuring the immediate availability of RAID protected data even in the event of a disk drive failure. The increase in the importance and volume of stored, complex data has increased demand for secure and reliable methods of storage that allow for efficient and cost-effective protection and management of such data. These factors have also increased demand for total storage solutions that can quickly and efficiently provide access to large volumes of data resident on a variety of clients and servers running different operating environments, as well as data generated by a wide range of applications. In addition, users are increasingly demanding solutions comprised of not only hardware for cost-effective storage of and access to large amounts of secure and reliable information, but also software that manages information flow and reduces the high costs of network storage administration. PROCOM SOLUTION The Company provides a wide range of products designed to address the data storage and information access requirements of client/server computing environments. The Company's CD servers and arrays, disk drive upgrades and RAID and tape backup subsystems are easy to install and use and have a relatively low overall cost of ownership. Procom's CD servers and arrays address the expanding use of CD-ROM as a distribution medium by providing clients with simultaneous access to up to 63 CD-ROMs at 30x speed. The Company's disk drive upgrades allow users to utilize their existing hardware for longer periods of time, thereby extending the life of their initial investment. The Company's RAID and tape backup subsystems provide high performance, fault tolerant storage of over a terabyte of data for large network information databases. The Company's recently introduced CD FORCE CD-ROM network server incorporates an embedded operating system that centralizes data access management services, thereby reducing administrative costs. This embedded operating system is based on the Company's managed enterprise storage architecture ("MESA"). MESA's operating system software is designed to provide non-intrusive plug and play compatibility with most popular network operating systems, allowing products incorporating the MESA architecture to be installed by simply connecting one cable to the network. The central processing unit contained in each MESA-equipped server is designed to allow the server to manage and process data without burdening the network server. See "-- Products and Technology -- Products Under Development." The core elements of the Company's solution include: Broad Product Line. The Company supplies a wide range of products with a variety of prices, storage capacities, access times, storage media, hardware/software combinations and levels of redundancy. The Company's products are designed to meet a broad spectrum of end user data storage and information access 28 30 needs and range from disk drive storage upgrade products to the Company's recently introduced Hyper CD-30x module, a CD-ROM and hard disk combination, which the Company believes has the fastest CD-ROM access time and data transfer rates available. The Company's broad range of products allows its computer reseller and VAR customers to utilize Procom as a single source to satisfy the storage requirements of a wide range of end users, thereby reducing the need for multiple vendors. Modular and Scalable Design. The Company's products are designed to address the evolving data storage and information access requirements of enterprise-wide computing environments. Procom's products are modular and can be linked together to accommodate a customer's expanding data storage and information access requirements. Ease of Installation and Use. The Company's data storage and information access solutions have been designed for ease of installation, configuration and use in a variety of client/server networks. Many of the Company's CD servers and arrays can be added to computer networks by simply attaching them as nodes to existing network cabling. The Company's recently introduced CD FORCE server contains a graphical user interface that facilitates end user access to information contained on CD-ROMs. Reduced Cost of Ownership. Procom incorporates a number of features into its products that reduce the costs associated with both the installation of its products and the down-time of networks and storage systems. The Company's products include numerous fault tolerant features, such as redundant and hot-swappable power supplies and fans and hot-swappable disk and CD-ROM drives that allow users to repair a damaged drive without interrupting the operation of the network. The Company's CD-ROM and RAID products include features that reduce administrative costs for network administrators by providing remote management and notification of actual or potential system or component failures, and its RAID products also provide automatic reconstruction of data and easy adjustment of RAID levels. In addition, the operating system software incorporated into the Company's MESA architecture is designed to further reduce administrative costs by centralizing network data storage management. Multi-platform, Multi-protocol Support. Procom's products are compatible with a wide range of client networks and operating systems, including Unix, Novell NetWare, IBM OS/2 Warp, Windows NT, Windows 95, Windows 3.1 and Macintosh OS. In addition, the Company's products support multiple network topologies such as Ethernet, FDDI, Fast Ethernet and Token Ring. This compatibility allows customers to implement the Company's storage solutions in a broad range of enterprise-wide computing environments. BUSINESS STRATEGY The Company's objective is to provide products that fulfill customers' evolving needs for data storage and information access products across all major computers and operating systems. The key elements of the Company's strategy to achieve this objective are as follows: Develop Additional Network Storage Products. The Company is focused on developing server products that will enable networks to provide and manage additional storage capacity more efficiently. These products will share many of the design characteristics of the Company's current CD FORCE network server, integrating a high performance central processing unit, network interface card and Procom's proprietary embedded operating system software, and will be designed to allow users on the network to store and access information more quickly. The Company plans to develop additional storage management software and to introduce additional servers that will utilize a variety of storage media, including hard disks (with RAID functionality) and magnetic tape, which can be attached directly to and will be compatible with a wide variety of network environments. Enhance Reseller Relationships. The Company focuses its marketing efforts on developing an awareness of the Company's data storage and information access solutions with various computer resellers, VARs and distributors of its products. These relationships provide the Company with indirect access to and improved visibility among large corporations and other institutional end users. The computer resellers, VARs and distributors also function as a sales force for the Company, allowing the Company to reach a large number of end users without incurring the significant expenditures associated with a direct sales force, and provide 29 31 ongoing service for the Company's storage systems. The Company intends to sell a broader range of its products and services to these existing customers. Target Vertical Markets. The Company promotes higher levels of sales of its CD servers and arrays through its channel partners by targeting a portion of its marketing efforts to specific end users that require enterprise-wide access to information published on CD-ROM, such as law and accounting firms, educational organizations, medical service providers and governmental agencies. The Company employs a similar strategy with regard to the sale of its high capacity RAID solutions by targeting its marketing efforts to end users with large information storage and access requirements, such as companies that have recently migrated from mainframe computer systems to personal computer networks, video-on-demand providers and companies developing electronic imaging applications. The Company intends to continue to target these vertical markets in the future. Expand Strategic Relationships. The Company seeks to expand its relationships with the primary suppliers of components of its products, including drive manufacturers such as Seagate Technology, Inc. and Toshiba and network software operating system developers such as Novell, Inc. and Microsoft Corporation. These relationships provide the Company with early access to information regarding future product releases and technological developments that allow the Company to anticipate and respond to market opportunities. The Company also collaborates with manufacturers regarding the design of many components that the Company ultimately incorporates into its data storage and information access products. In addition, the Company maintains relationships with content providers, such as legal publishers and video suppliers. These relationships provide the Company with opportunities to receive free publicity and promotion within niche end user markets when content providers utilize Procom data storage and information access systems in conjunction with the display of their own products at trade shows and other marketing events. Finally, the Company also maintains informal relationships with certain end users of its products that enable the Company to learn of and respond to changing end user needs. The Company intends to expand its relationships with suppliers and manufacturers, content providers and end users in the future. Deliver Timely Solutions. The Company believes that its focus on cost-effective data storage and information access allows it to remain a technology leader. The Company has focused on responding quickly to and capitalizing on demands for specialized data storage and information access products. The Company anticipates that additional market opportunities will arise as demand for data storage and information access products continues to increase, and the Company intends to maintain an organizational structure that will allow it to quickly respond to these opportunities if they develop. PRODUCTS AND TECHNOLOGY The Company's principal product lines are CD servers and arrays, disk drive upgrade products and RAID and tape backup subsystems. These product lines accounted for approximately 32%, 59% and 5%, respectively, of the Company's net sales in fiscal 1995, approximately 49%, 47% and 4%, respectively, of the Company's net sales in fiscal 1996, and approximately 45%, 48% and 7%, respectively, of the Company's net sales in the first quarter of fiscal 1997. Many of the Company's products are offered in a variety of storage capacities and performance levels and, as a result, are sold at varying prices. See "Risk Factors -- Dependence on CD Servers and Arrays." CD Servers and Arrays The Company's CD servers and arrays provide an efficient method by which to store and share large amounts of information across a network. The Company's CD servers and arrays are available in a variety of plug and play configurations, from four to 63 CD drives, and can be configured with either 4x or 8x CD-ROM drives. In addition, the Company has recently introduced its Hyper CD-30x module, a CD-ROM and hard disk combination, which allows 30x data transfer speeds and is based on proprietary technology obtained by the Company pursuant to a marketing and integration arrangement with a third party. Several CD arrays also are available as servers, configured at the Company's factory with specified hardware and software. The Company provides each CD server and array with optional software drivers for Unix, Novell NetWare, 30 32 IBM OS/2 Warp, Windows NT, Windows 95, Windows 3.1, and Macintosh OS. Many of the Company's CD servers and arrays contain the Company's built-in "Smart SCSI CD" board, which maps up to seven CD drives to a single SCSI ID, thereby allowing additional CD servers and arrays to be added to a network. The Company's recently released CD FORCE Server incorporates the Company's MESA architecture and is designed to (i) provide plug and play compatibility with most popular network operating systems, (ii) function without burdening the network server and (iii) provide cross/multi-platform compatibility. The Company's internally developed CD-ROM network data access management software is not presently available on all major hardware platforms, and of the Company's CD servers and arrays shipped to date that contain network data management software, substantially all included third-party software. See "Risk Factors -- Dependence on CD Servers and Arrays." In addition, by working with CD manufacturers and component suppliers, the Company has developed special enclosures to provide security for the CDs and prevent their loss, theft or damage. Certain information with respect to the Company's primary CD servers and arrays is set forth below:
- --------------------------------------------------------------------------------------------- APPROXIMATE PRODUCT LINE KEY FEATURES RETAIL PRICE - --------------------------------------------------------------------------------------------- CDT Array - Allows up to 13GB of information to be distributed $2,100-$13,600 over a network via 7, 14 or 21 CD-ROMs. - Requires no hardware installation. - Ethernet or Token Ring network connectivity. - --------------------------------------------------------------------------------------------- CDT Server - Allows up to 13GB of information to be distributed $8,300-$26,500 over a network via 14 or 21 CD-ROMs. - Requires no hardware installation. - In addition to Ethernet and Token Ring connectivity, CDT Servers support most popular network connectivity. - Includes CD-ROM management software for most popular network platforms. - Includes embedded Pentium-based server to improve overall performance. - --------------------------------------------------------------------------------------------- CDRAX - Allows up to 40GB of information on CD-ROM to be up to $76,400 distributed over a network. - Provides simultaneous access to up to 63 CD-ROMs. - Requires no hardware installation. - In addition to Ethernet and Token Ring connectivity, CDRAX supports other popular network connectivity. - Contains hot swappable CD-ROM drives and redundant power supplies and fans. - Includes CD-ROM management software for most popular network platforms. - Includes embedded Pentium-based server to improve overall performance. - ---------------------------------------------------------------------------------------------
31 33 The Company has recently introduced the following products:
- --------------------------------------------------------------------------------------------- APPROXIMATE RETAIL PRODUCT LINE KEY FEATURES PRICE - --------------------------------------------------------------------------------------------- Hyper CD-30x Module - Provides access time as low as 10.5 ms and $5,300-$86,500 data transfer rate of 4,500KB/sec. - Includes intelligent SCSI adapter designed to migrate CD-ROM images onto the embedded FAST-SCSI hard drive, providing 30x performance. - Supports most operating systems. - Allows up to 41GB of information to be distributed over a network via 12, 18 and 63 CD-ROMs. - --------------------------------------------------------------------------------------------- CD FORCE 14, 21 and 63 - Enables cross-platform CD-ROM access by $10,300-$83,300 embedding Procom's proprietary storage management software within its CD Servers. - Provides direct connect features to heterogeneous networking environments. - Operates independently of the network operating system. - Includes scalable architecture and multi-protocol access. - Allows up to 41GB of information to be distributed over a network via 12, 18 and 63 CD-ROMs. - Provides advanced security and metering options. - Includes embedded Pentium-based server to improve overall performance. - Supports Ethernet, Fast Ethernet, FDDI and Token Ring connectivity. - Available in 4x, 8x and 30x configurations. - ---------------------------------------------------------------------------------------------
The Company also produces CD-ROM publishing and recording packages as part of its strategy to capitalize on the use of CD-ROM as a popular information storage medium for a number of industries. Procom's internal and external CD-Recorders are designed to meet the archiving needs of desktop computer users. Disk Drive Upgrades The Company remains committed to supplying products that enhance the performance and capacity of notebook and desktop computers, as well as network servers. The addition of a single high-capacity hard disk drive subsystem to a network server adds several gigabytes of storage capacity and improves overall speed and performance. A complete installation kit is included with each hard disk drive for easy integration. Several hard disk drives can be combined to enable data to be spanned, striped or mirrored in a variety of configurations. Due to the increase in the popularity of notebook computers, sales of the Company's ATOM notebook upgrade drive kits constituted 14% of net sales in fiscal 1996 and 19% of net sales in the first quarter of fiscal 1997. 32 34 Certain information with respect to the Company's hard disk drive storage upgrade products is set forth below:
- ----------------------------------------------------------------------------------------------- APPROXIMATE PRODUCT LINE KEY FEATURES RETAIL PRICE - ----------------------------------------------------------------------------------------------- ATOM - Includes internal 2.5 inch IDE hard drives. $350-$1,100 - Ranges in capacity from 500MB to 2.1GB. - Equipped with all necessary components required for installation. - Compatible with most popular notebook computers. - ----------------------------------------------------------------------------------------------- SI - High-performance internal FAST SCSI hard drives. $250-$3,650 - Ranges in capacity from 540MB to 9GB. - Equipped with all necessary components required for installation. - Compatible with most popular desktop computers, workstations and servers. - ----------------------------------------------------------------------------------------------- MD - High-performance external FAST SCSI hard drives. $400-$5,900 - Ranges in capacity from 540MB to 18GB. - Equipped with all necessary components required for installation. - Compatible with most popular workstations and servers. - ----------------------------------------------------------------------------------------------- PR-IDE - Includes Internal 3.5 inch IDE hard drives with software. $250-$550 - Ranges in capacity from 500MB to 2.5GB. - Equipped with all necessary components required for installation. - Compatible with most popular desktop computers and workstations. - -----------------------------------------------------------------------------------------------
The Company also offers CD-ROM drives for stand-alone desktop applications and a variety of other storage peripheral products. RAID and Tape Backup Subsystems The Company's RAID products present a solution to the storage and input/output ("I/O") speed, capacity and reliability challenges presented by network computing. RAID is a method of distributing data in stripes across several hard disk drives, allowing the microprocessor to access those drives simultaneously, thus increasing storage system I/O performance. RAID solutions generally reduce bottlenecks that occur in non-RAID environments when multiple users access data simultaneously. In addition, RAID configurations can provide a high degree of fault tolerance because they continuously calculate and store a unique parity, using logic to accompany each data stripe. If any drive fails, the remaining drives in the system may use the parity value to reconstruct the data on the failed drive, thus ensuring the immediate availability of RAID protected data even in the event of a disk drive failure. RAID is available in several levels that differ in the ways they allocate data for storage and achieve fault tolerance. End users of RAID products select the appropriate RAID level depending on overall cost and performance for their particular requirements. Often, the user's actual application will dictate the appropriate level of data access, fault tolerance and redundancy desired. For example, applications such as on-line processing of financial transactions require instantaneous access to multiple disks, while multimedia or video- on-demand applications generally require single-user access, but at a significantly higher data transfer rate. The Company offers RAID products for all commonly used RAID levels for most hardware platforms and network environments. In addition, the Company also designs and sells tape backup storage solutions for a variety of computing environments to provide an additional level of protection for mission-critical data. 33 35 Certain information with respect to the Company's high capacity fault tolerant RAID and tape storage systems is set forth below:
- ---------------------------------------------------------------------------------------------- APPROXIMATE PRODUCT KEY FEATURES RETAIL PRICE - ---------------------------------------------------------------------------------------------- LANForce - Provides storage capacities up to 56GB. $8,900-$33,800 - Includes redundant components to reduce system failures. - Operating system independent. - Hardware-based RAID solution frees host computer from RAID management tasks. - Supports varying levels of RAID. - Offers optional cache memory to increase I/O performance. - ---------------------------------------------------------------------------------------------- RAID RAX - Provides all LANForce features. $34,400-$144,200 - Provides storage capacity from 50GB to over 1 terabyte. - Available in rack-mounted configuration that allows flexibility for expansion as storage needs increase. - Accommodates both 3.5 inch and 5.25 inch drive shuttles concurrently. - Accepts multiple host inputs. - ---------------------------------------------------------------------------------------------- DLT Tape Drive - Digital linear tape backup up to 280GB. $4,000-$13,500 - Provides cost-effective method of unattended backup. - Compatible with most major backup software. - ----------------------------------------------------------------------------------------------
Products Under Development The Company's product development priorities are aimed at meeting the growing market demand for complete storage solutions that are capable of addressing the evolving needs and challenges associated with distributed network computing. Current product development efforts focus on developing and integrating the Company's own proprietary software as a value-added component of the Company's complete storage solutions. The Company is continuing to enhance MESA, to address the growing complexity of network data storage management that has resulted from increases in heterogeneous network computing environments and the amount and complexity of data. The MESA client/server storage management architecture incorporates an embedded operating system designed to centralize data storage management services, and thereby reduce administrative costs associated with data storage management. MESA's operating system software furnishes it with non-intrusive plug and play compatibility with most popular network operating systems, allowing products incorporating the MESA architecture to be installed by simply connecting one cable to the network. The multi-platform support provided by MESA will enable client workstations to use their own operating systems and still benefit from the functionality of MESA without any additional software. The central processing unit contained in each MESA-equipped server is designed to allow the server to manage and process data without burdening the network server. MESA is being designed to provide a cost-effective storage management solution that supports heterogenous client/server computing environments, is scalable to support networks and allows clients using multiple operating systems to access simultaneously a single storage system. MESA-equipped products enable systems administrators to manage CD-ROM storage systems and are being designed to manage other storage systems either locally or remotely and provide administrators with the ability to monitor and restrict access by end users within the network. The Company's recently released CD FORCE server incorporates the Company's MESA architecture and is designed to centralize data management storage services for information contained on CD-ROM. See "-- CD Servers and Arrays." No assurances can be given, however, that the Company will be successful in any of its product development efforts or that, even if 34 36 successfully developed, the Company's products will achieve timely market acceptance. See "Risk Factors -- Rapid Technological Change; Short Product Life Cycles" and "-- Research and Development." CUSTOMERS AND APPLICATIONS The Company sells its products principally to computer resellers, VARs and distributors, which in turn sell to end users of the Company's products. During fiscal 1996 and the first quarter of fiscal 1997, combined sales to Vanstar Corporation, Intelligent Electronics Inc. and Entex Information Services Inc. totalled approximately 23.3% and 25.4%, respectively, of net sales. The loss of any of these customers could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Customer Concentration; Distribution Strategy Risks; Inventory Protection." End users of the Company's products include Fortune 500 corporations, government agencies and financial and educational institutions. The following table lists certain end users of the Company's products. INDUSTRIAL GOVERNMENT LEGAL AND ACCOUNTING - ---------- ---------- -------------------- United Airlines Executive Office of the President Cravath Swaine & Moore Exxon US Navy Weil Gotshal & Manges Mitsubishi Los Angeles City Attorney Ernst & Young LLP Lockheed Los Angeles County Recorder Price Waterhouse LLP Gilette U.S. Public Defender Clark Hill PLC Hoechst Celanese Veterans Administration EDUCATION TELECOMMUNICATIONS TECHNOLOGY - --------- ------------------ ---------- George Washington University AT&T EDS Boston University MCI IBM UCLA Pacific Bell Microsoft UC Davis Law School US West Wang Southwestern Bell Sybase ENTERTAINMENT - ------------- 20th Century Fox FINANCIAL SERVICES Buena Vista Home Video ------------------ California State Lottery Bank One McGraw Hill Prudential Walt Disney American Express
35 37 SALES AND MARKETING The Company's strategy is to deploy a comprehensive sales, marketing and support infrastructure to meet the data storage and information access requirements of users of complex client/server networks, both in the U.S. and internationally. The Company uses multiple distribution channels to reach end user customers. In the United States, the Company has agreements with and sells its products through domestic computer aggregators such as Intelligent Electronics Inc. and Inacom Corporation, as well as smaller independent VARs and computer resellers. The Company also sells its products to computer resellers that function as corporate computer consultants to large corporations, educational institutions and governmental agencies, and maintains sales agreements with many of these consultants. These corporate computer consultants include AmeriData, Inc., Electronic Data Systems Corporation, Entex Information Services, Vanstar Corporation and others. Often these entities, and many of the Company's other customers, consult with end users of the Company's products in business and government, and then incorporate the Company's products into larger overall enterprise solutions. The Company recently reached an agreement with Tech Data Corporation, a computer products distributor, to sell the Company's products nationally. Outside the United States, the Company's products are sold through approximately 40 major distributors in a number of countries throughout the world. See "Risk Factors -- Customer Concentration; Distribution Strategy Risks; Inventory Protection." The Company has agreements with many of its computer resellers, VARs and distributors relating to purchases of the Company's products. These agreements do not provide the Company with any guaranteed levels of purchases. The Company frequently grants limited rights to customers to return products purchased from the Company, in some cases in exchange for new purchases, and also provides price protection to its customers. The short product life cycles of the Company's products and the difficulty in predicting future sales increase the risk that new product introductions, price reductions by the Company or its competitors or other factors affecting the personal computer and upgrade storage industries could result in significant product returns. In addition, new product introductions by the Company's suppliers or its competitors or other market factors may require the Company to reduce prices in a manner or at a time that gives rise to significant price protection charges. The Company estimates returns and potential price protection charges based on historical experience and accrues reserves therefor. However, these accruals may prove insufficient, and future returns and price protection charges may have a material adverse effect on the Company's business, financial condition and results of operations, particularly in light of the rapid product obsolescence that often occurs during product transitions. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Historically, the Company enjoyed a relatively short sales cycle due to the low cost of its disk drive upgrade products. The typical sales cycle, from the time an end user contacted a reseller to the shipment by the Company of the desired product, often took less than one week. However, as the Company's product mix has shifted to increasingly complex and higher priced data storage and information access solutions, the Company's sales cycle has lengthened significantly. Because Procom's CD servers and arrays and RAID storage and access systems often represent a significant expenditure for end users, these users frequently require the approval of several individuals within their organization before placing purchase orders. In addition, the complexity of the Company's storage and RAID storage access solutions often require the Company to demonstrate its products for end users, further lengthening the sales cycle. In response to increasing demand from end users, the Company has instituted an evaluation program that provides for a specified period in which end users may install and evaluate the Company's products. Evaluation units are not booked as revenue until the Company has received payment for such units. During fiscal 1996, approximately half of all evaluation units were purchased at the end of their trial period. The Company maintains a sales and sales support staff that at October 25, 1996 consisted of 48 people, substantially all of whom were located at the Company's principal offices in Irvine, California. The Company's sales are made to computer resellers, VARs and distributors through telemarketing efforts by sales representatives. The Company has recently hired its first U.S. field sales representative and is considering the implementation of a field sales force in various cities throughout the U.S. In addition, the Company has recently added independent sales representatives in Canada, France and Germany. The field sales representatives provide, among other things, regional technical support for customers, perform product demonstrations and, where desirable, accompany computer resellers and VARs on sales calls with end users. The Company 36 38 intends to expand the number of its international sales representatives. The Company also intends to add additional international distributors in targeted countries and is developing joint marketing relationships with certain distributors. For fiscal 1995, 1996 and the first quarter of fiscal 1997, international sales represented approximately 14%, 11% and 8%, respectively, of the Company's net sales. See "Risk Factors -- Risks of International Sales and Operations." The Company's marketing group, as of October 25, 1996, consisted of 12 persons engaged in a number of activities designed to help the Company achieve better market recognition and ultimately increased sales. This group's responsibilities include (i) advertising in magazines targeted to specific markets, (ii) conducting various promotional programs with the Company's computer resellers, VARs and distributors, including cooperative advertising arrangements and special programs where employees of the Company's computer resellers, VARs and distributors can earn cash awards for their efforts in recommending or selling the Company's products to end users, (iii) coordinating the Company's participation in various trade shows, including COMDEX and specific vertical applications shows such as LegalTech and (iv) cooperating with publishers and authors of industry magazines in the testing and review of the Company's products since market acceptance of each new generation of products is influenced significantly by reviews in leading computer industry magazines and related awards. CUSTOMER SERVICE AND SUPPORT The Company employs engineers and technicians who work closely with the Company's sales personnel to assist computer resellers, VARs and distributors and end users with pre- and post-sales support matters, as well as to provide customers with technical support, education, training and consulting services. The Company's customer service and technical support staff at October 25, 1996 consisted of approximately 12 people located in Irvine, California. Customer service personnel provide customer service through software driver updates, upgrade programs and warranty service. Technical support personnel assist end users and distributors by telephone, facsimile and on-line services, including 24-hour bulletin board services and World Wide Web sites, in the installation, configuration and use of the Company's products. The Company also relies on its computer resellers, VARs and distributors to provide technical support and service. In November 1995, the Company signed an agreement with Siemens Nixdorf Information Systems, a national provider of computer technical services ("Siemens"), to provide on-site installation and service to end users of its high capacity CD servers and arrays. By contracting with Siemens, which has many offices located throughout the U.S., the Company believes it should be able to offer a rapid response to end user technical problems throughout the country. The Company expects that its return rates resulting from technical problems will decrease as Siemens field representatives demonstrate effective installation and service methods at customer sites. The Company offers warranties on its products ranging from one to five years. The Company's primary warranty efforts consist of accepting defective products from customers and either repairing them or returning the defective component to the original manufacturer for repair or replacement during the applicable warranty period. The Company generally protects itself by extending to its customers a warranty that corresponds to the warranty provided to the Company by its suppliers. However, if a supplier were to fail to meet its warranty obligations, the Company would be forced to assume responsibility for warranties on all components manufactured by that supplier. Such an event could have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Warranty Exposure." RESEARCH AND DEVELOPMENT The Company believes that continued investment in research and development is critical to the Company's ability to continue to introduce, on a timely basis and at competitive prices, new and enhanced products incorporating the latest technology and addressing emerging market needs. The Company's research and development staff consisted of 34 employees as of October 25, 1996, which includes software and hardware engineers and software quality assurance technicians. Research and development expenses, primarily consisting of personnel expenses, were $1.0 million, $1.1 million and $1.6 million in fiscal 1994, 1995 and 1996, respectively, constituting 2.8%, 2.5% and 2.2% of net sales, respectively and were $0.3 million and $0.7 million in the first quarter of each of fiscal 1996 and 1997, respectively, constituting 1.9% and 2.8% of net 37 39 sales for these periods, respectively. The Company anticipates that the dollar amount of its research and development expenses will increase and that such expenses also may increase as a percentage of net sales with the addition of dedicated engineering resources to develop new product categories, to ensure that the Company's products are compatible with a wide range of hardware platforms and network topologies, and to develop additional software associated with the Company's MESA architecture, allowing the Company to develop servers that support not only CD-ROM, but also hard disk drive and magnetic tape storage media. The Company's hardware and software engineers are engaged in ongoing development of new storage subsystems that offer increasing storage capacity and compatibility with an expanding base of computer networks and operating systems. See "-- Products and Technology -- Products Under Development." There can be no assurance that the Company's development efforts will be successful, or that the Company will be able to introduce competitive new products in a timely manner. The market for the Company's products is characterized by frequent new product introductions and rapid product obsolescence. These factors typically result in short product life cycles, historically ranging from six to twelve months. For example, the data transfer rate of CD-ROM products has increased rapidly, resulting in the introduction of four, eight, ten and twelve speed CD-ROMs. Similar technological advances have been made with regard to disk drive storage capabilities and other performance standards. Each new product cycle presents new opportunities for current or prospective competitors of the Company to gain market share. The Company must continually monitor industry trends in selecting new technologies and features to incorporate into its products. If the Company is unable to successfully introduce new products on a timely basis, the Company's sales could be adversely affected. Any such failure also could impair the Company's brand name and the Company's ability to command the attention and loyalty of computer resellers, VARs and distributors in future periods. Moreover, because short product life cycles are accompanied by long lead times for many components of the Company's products, the Company may be unable to reduce or increase production in response to unexpected demand. The Company's ability to introduce new products in a timely manner is heavily dependent on its ability to develop or purchase firmware and software drivers for its CD-ROM and disk drive products. While the Company endeavors to work with its component suppliers to plan for the timing of introduction of new components and to develop the associated firmware and software, unforeseen design issues or other factors that delay introduction of these products could adversely affect the Company's ability to ship new products. In addition, third party suppliers may not employ adequate testing and quality assurance procedures, resulting in the receipt by the Company of defective components. This could require the Company to find replacement components or wait for the resolution of the problem, either of which could delay the Company's ability to bring products to market and have a material adverse effect on the Company's business, financial condition and results of operations. The Company's business also will be adversely affected if new disk drives, CD-ROM drives or other components that it selects from among those offered by its various vendors do not perform favorably on a cost or performance basis compared to competing products. In addition, products and technologies developed by competitors may render the Company's products and technologies noncompetitive or obsolete. Finally, advances in network and on-line technology and development of new, higher-capacity storage media such as DVD may result in a reduction or replacement of CD-ROM as a data storage and information access medium. If the Company is unable to adapt to these and other technological advances by developing new products, the Company's financial performance would be materially adversely affected. See "Risk Factors -- Substantial Competition" and "-- Rapid Technological Change; Short Product Life Cycles." MANUFACTURING The Company's primary manufacturing activities, located at the Company's headquarters in Irvine, California, consist of testing, assembling and integrating components to form data storage and information access subsystems. The Company has historically operated without a material backlog. The Company generally purchases the major components of such subsystems (hard disk drives, CD-ROM drives or tape drives) based on historical requirements and forecasted needs to provide it with two to three weeks of inventory. Some of the Company's products require printed circuit boards, the assembly of which the 38 40 Company often subcontracts to third party vendors. The Company's CD servers and arrays generally require a special housing of either metal or plastic, and the Company contracts with third party vendors for the manufacture of those housing units. The Company performs quality assurance testing on most of its products and subjects third-party supplied components to testing and evaluation before including such components in the Company's product offerings. The Company packages the assembled hard disk drives, CD-ROM drives and tape backup drives with software, manuals and additional hardware components, which it generally purchases from third party suppliers. The Company relies on a network of independent subcontractors to supply certain custom components manufactured to the Company's specifications. This network consists of a number of small firms with limited financial resources. While the Company utilizes several firms to mitigate the risk of business interruption, it is possible that several vendors could simultaneously experience problems with production or financial stability, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company depends on sole or limited source suppliers for certain key components used in its products, particularly disk and CD-ROM drives. In recent years, these components have been in short supply and frequently on allocation by manufacturers, and the Company's size may place it at a competitive disadvantage during such periods relative to larger competitors. Although the Company maintains ongoing efforts to obtain adequate supplies of components, there can be no assurances that the Company will obtain adequate supplies or obtain such supplies at cost levels that would not adversely affect the Company's gross margins. The Company has no guaranteed supply arrangements with any of its sole or limited source suppliers and customarily purchases sole or limited source components pursuant to purchase orders placed from time to time in the ordinary course of business. Moreover, the Company's suppliers may, from time to time, experience production shortfalls or interruptions that impair the supply of components to the Company. Component shortages are likely to continue, and there can be no assurance that such shortages will not adversely affect the Company's business, financial condition and results of operations. Conversely, in its attempt to counter actual or perceived component shortages, the Company may overpurchase certain components, resulting in excess inventory and reducing the Company's liquidity or, in the event of inventory obsolescence or a decline in the market value of such inventory, causing inventory write-offs that could materially adversely affect the Company's business, financial condition and results of operations. The Company relies on a small number of suppliers to continue to develop, introduce and manufacture disk drives, CD-ROM drives and other components that incorporate new technologies and features that compete favorably in functionality and price with the offerings of other disk drive and CD-ROM manufacturers, including competitors of the Company. The Company's dependence on these sole or limited source suppliers, and the risks associated with any delay or shortfall in supply, are exacerbated by the short life cycles that characterize the Company's products. Any delay in the introduction by or availability of disk drives or CD-ROM drives from the Company's suppliers or the failure of such suppliers to provide functionality and performance on a cost effective basis could have a material adverse effect on the Company's business, financial condition and results of operations. Furthermore, it is possible that the technology of the components the Company uses in manufacturing its products will be rendered undesirable or obsolete by the components of other suppliers. The Company would then be forced to establish relationships with new suppliers, which could delay or preclude the Company from bringing competitive products to market and have a material adverse effect on the Company's business, financial condition and results of operations. See "Risk Factors -- Rapid Technological Change; Short Product Life Cycles" and "-- Component Shortages; Reliance on Sole or Limited Source Suppliers." COMPETITION The markets for the Company's products are intensely competitive. In each of its primary product lines, the Company competes with a large number of disk drive manufacturers, computer resellers, VARs and distributors. Some of the Company's vendors also sell competing products to distributors, which then sell these products to the Company's customers. Many of the Company's current and potential competitors have significantly greater market presence, name recognition and financial and technical resources than the Company, and many have longstanding positions and established brand names in their respective markets. In addition, certain of the Company's current and potential competitors possess competitive cost advantages due 39 41 to a number of factors, including lower taxes and substantially lower costs of labor associated with international operations. Finally, manufacturers of disk drives such as Seagate Technology Inc., IBM, Quantum Corporation and Western Digital Corporation, and manufacturers of CD-ROM drives, such as Toshiba, NEC Corporation and Plextor Corporation, may in the future become more direct competitors of the Company to the extent that such manufacturers elect to expand into the disk drive upgrade market or the CD server and array market. The Company's primary competitors in the CD server and array market consist of (i) CD array manufacturers such as Microtest, Inc., Meridian Data, Inc. and Micro Design, Inc., which also furnish CD-ROM management software with their CD array products, (ii) a number of hardware aggregators, computer resellers and VARs that sell CD server products directly to end users, and (iii) various CD server and array manufacturers. The Company believes that it competes effectively in the CD server and array market by maintaining relationships with computer resellers and VARs that possess key relationships with decision makers at end users, while at the same time developing brand name identity through end user marketing and advertisements. The Company's primary competitors in the disk drive upgrade market are (i) computer manufacturers that also market and sell storage upgrades, such as IBM, Compaq and Hewlett-Packard, (ii) companies that specialize in reselling replacement or increased capacity storage disk drives, such as Storage Dimensions Inc. or Ameriquest Technologies, Inc., and (iii) various national distributors of third party upgrade drives such as Ingram Micro Inc., Merisel Inc. and Tech Data Corporation. The Company believes it competes effectively against each of these three classes of competitors in the disk drive upgrade market by offering a broad range of reasonably priced storage upgrade products to its computer resellers, VARs and distributors throughout the U.S. and worldwide. The Company's primary competitors in the RAID product market are (i) computer manufacturers, such as IBM, Compaq and Hewlett-Packard, which generally focus on providing storage upgrades for their products and (iii) companies that sell storage solutions directly to end users, such as EMC Corporation and Storage Technology Corporation. These direct sales competitors historically have focused their efforts on sales of high capacity storage products in the mainframe and minicomputer environments. In addition, the Company competes with many smaller enterprises that provide and sell unique solutions to various computer users. The Company believes that its relationships with computer resellers, VARs and distributors provide it with a competitive advantage over those manufacturers that have in the past sold high capacity storage systems directly to end users. The Company's success depends to a great extent on its ability to continue to develop products that incorporate new and rapidly evolving technologies to provide network users cost-effective data storage and information access solutions. However, to the extent that disk drive storage or information access products become more of a commodity, price competition among both computer manufacturers and suppliers of disk drives and CD-ROM drives may result in the availability of such storage and access at a low cost. These factors could create increased competition for the Company's products which could cause the Company to experience reduced gross profit margins on its products and could have a material adverse effect on the Company's business, financial condition and result of operations. The Company believes that the principal competitive factors in the Company's markets are product reliability, price/value relationship, product features and performance, brand name recognition, trade periodical reviews, time to market with new features and products, industry relationships, ease of installation and use, the quality of distribution channels, product quality, technical support and customer service. The Company believes that its brand name recognition allows the Company to remain competitive in the network storage solutions aftermarket and the CD server and array markets, and that the Company generally competes effectively with respect to the other competitive factors enumerated above. See "Risk Factors -- Substantial Competition" and "-- Rapid Technological Change; Short Product Life Cycles." 40 42 INTELLECTUAL PROPERTY The Company relies primarily on a combination of copyright and trade secret protections and confidentiality agreements to establish and protect its intellectual property rights. The Company has no patent protection for its current product line. There can be no assurance that the Company's measures to protect its intellectual property rights will deter or prevent unauthorized use of the Company's technology. In addition, the laws of certain foreign countries may not protect the Company's intellectual property rights to the same extent as the laws of the United States. The Company's inability to protect its proprietary rights in the United States or internationally may have a material adverse effect on the Company's business, financial condition and results of operations. Claims by third parties that the Company's current or future products, procedures or processes infringe upon their intellectual property rights may have a material adverse effect on the Company. The Company does not normally perform any formal surveys or studies relating to whether its products or processes infringe upon the intellectual property rights of others, and it would be difficult to establish whether a given product or process infringes upon the intellectual property rights of others. Intellectual property litigation is complex and expensive, and the outcome of such litigation is difficult to predict. Any future litigation, regardless of outcome, may result in substantial expense to the Company and significant diversion of the efforts of the Company's management and technical personnel. An adverse determination in any such litigation may subject the Company to significant liabilities to third parties, require disputed rights to be licensed from such parties, if licenses to such rights could be obtained, or require the Company to cease using such technology. There can be no assurance that if such licenses were obtainable, they would be obtainable at costs reasonable to the Company. If forced to cease using such technology, there can be no assurance that the Company would be able to develop or obtain alternate technology. Accordingly, an adverse determination in a judicial or administrative proceeding, changes in patent or copyright laws or failure of the Company to obtain necessary licenses may prevent the Company from manufacturing, using or selling certain of its products or processes, which may have a material adverse effect on the Company's financial condition and results of operations. In May 1995, Compaq made certain infringement and other claims against the Company and obtained an injunction prohibiting the Company's use of a small string of software code contained in certain of the Company's disk drive products. Although the Company has rewritten the infringing code and settled the lawsuit, the lawsuit required substantial management time, significant expenditures for legal fees and costs and a one-time settlement payment and ongoing royalty payments to Compaq for these products. See "Risk Factors -- Intellectual Property Rights." EMPLOYEES As of October 25, 1996, the Company had 186 full-time employees, 55 of whom were engaged in manufacturing (including testing, quality assurance and materials functions), 34 in engineering and product development, 60 in sales and marketing, 12 in customer service and technical support, and 25 in finance and administration. The Company's employees are not represented by any collective bargaining agreements, and the Company has never experienced a work stoppage. The Company believes that its employee relations are good. The Company's success depends to a significant extent upon the continued service of its executive officers and other key management and technical personnel. See "Risk Factors -- Dependence on Key Personnel." FACILITIES The Company leases approximately 81,000 square feet of space in Irvine, California for its corporate offices and operations. The property is leased by the Company under a lease expiring in July 1998. The Company has an option to extend the lease for an additional four months. The Company believes that its existing facilities will be adequate to meet its facilities requirements through July 1998. 41 43 MANAGEMENT EXECUTIVE OFFICERS AND DIRECTORS The executive officers and directors of the Company as of October 25, 1996 were as follows:
NAME AGE POSITION - ------------------ --- ---------------------------------------------------------------- Alex Razmjoo 34 Chairman of the Board, President and Chief Executive Officer Frank Alaghband 33 Executive Vice President, Operations, and Director Alex Aydin 34 Executive Vice President, Finance and Administration, and Director Nick Shahrestany 33 Executive Vice President, Marketing and Information Technology, and Director Frederick Judd 38 Vice President, Finance and General Counsel Richard W. Ormond 44 Vice President, Marketing and Corporate Relations Sam Inman(1)(2) 45 Director Sam Yau(1)(2) 47 Director
- --------------- (1) Member of the Audit Committee. (2) Member of the Compensation Committee. All directors hold office until the next annual meeting of shareholders or until their successors have been elected and qualified. Officers serve at the discretion of the Board of Directors (the "Board") and are appointed annually, subject to the terms of their employment agreements. There are no family relationships between the executive officers or directors of the Company. Mr. Razmjoo is one of the Company founders and has served as its Chairman of the Board, President and Chief Executive Officer since 1987. From 1984 to 1987, Mr. Razmjoo served as Director of Engineering of CMS Enhancements, Inc. He received a B.S. degree in Electrical Engineering in 1985 from the University of California, Irvine. Mr. Alaghband is one of the Company founders and has served as its Executive Vice President, Operations and as a director since 1987. From 1984 to 1987, Mr. Alaghband served as a Systems Engineer in the Computer Systems Division of McDonnell Douglas. He received a B.S. degree in Electrical Engineering in 1985 from the University of California, Irvine. Mr. Aydin is one of the Company founders and has served as the Company's Executive Vice President, Finance and Administration and as a director since 1987. From December 1984 to August 1987, Mr. Aydin served as a Product Development Engineer for Toshiba America, Inc. He received dual B.S. degrees in Electrical Engineering and Biological Sciences in 1984 from the University of California, Irvine and a M.S. degree in Biomedical Engineering in 1985 from California State University, Long Beach. Mr. Shahrestany is one of the Company founders and has served as its Executive Vice President, Marketing and Information Technology and as a director since 1987. From 1985 to 1987, Mr. Shahrestany served as Regional Sales Manager of CMS Enhancements, Inc. He received a B.S. degree in Biological Sciences with a minor in Electrical Engineering in 1984 from the University of California, Irvine. Mr. Judd has served as the Company's Vice President, Finance and General Counsel since joining the Company in November 1993. Mr. Judd was General Counsel for CMS Enhancements, Inc. from February 1992 to November 1993. From April 1987 to February 1992, Mr. Judd served as the Chief Financial Officer and Treasurer of CMS Enhancements, Inc. Mr. Judd received a B.S. degree in Accounting in 1980 from Arizona State University and a J.D. degree in April 1985 from Brigham Young University. Mr. Judd is a certified public accountant and is licensed to practice law in California and Arizona. Mr. Ormond has served as the Company's Vice President, Sales and Marketing since October 1996. Mr. Ormond was a principal of Regis McKenna, Incorporated, a management consulting company, from October 1990 to October 1996. Prior to April 1990, Mr. Ormond held various executive positions with 42 44 MiniScribe Corporation, a computer manufacturer that filed a petition under the federal bankruptcy laws in January 1990. He received a B.A. in 1974 from the University of Notre Dame, and an M.B.A. in 1977 from the University of Southern California. Mr. Inman has served as a director since October 1996. Mr. Inman has been the Chief Executive Officer of Centura Software Corp. since January 1996. Mr. Inman served as President and Chief Operating Officer of Centura Software Corp. from April 1995 until January 1996. Immediately prior to joining Centura Software Corp., Mr. Inman served as an independent consultant to a number of high technology companies from 1994 until April 1995. Mr. Inman served as President and Chief Operating Officer of Ingram Micro Inc., a worldwide distributor of microcomputer products, from 1993 to 1994. Prior to assuming this position, Mr. Inman served as President of IBM's Personal Computer Company for the Americas from July 1992 to September 1993, President of IBM's National Distribution Division from March 1991 to July 1992, Director for IBM's Enterprise Systems Marketing Division from November 1988 to March 1991, and prior to this he served in various other positions within IBM. Mr. Inman received a B.S. degree in Mathematics from Purdue University. Mr. Yau has served as a director since October 1996. Mr. Yau has been a director and the President and Chief Executive Officer of National Education Corporation, a provider of proprietary educational programs, since May 1995. From May 1993 to November 1994, Mr. Yau was the Chief Operating Officer of Advacare, Inc., a medical management company. From May 1987 to May 1993, Mr. Yau was the Senior Vice President of Finance and Administration of Archive Corporation, now part of Seagate Technologies Inc., a computer storage company. He is a director of Steck Vaughn Publishing Corporation and Milcom International Inc. Mr. Yau received a B.S. degree in Economics from the University of Hong Kong and an M.B.A. from the University of Chicago. BOARD COMMITTEES The Board formed a Compensation Committee and an Audit Committee in October 1996. Each committee is comprised of Messrs. Yau and Inman, the outside directors of the Company. Prior to such date, there were no committees of the Board. The Compensation Committee makes recommendations to the Board concerning salaries and incentive compensation for the Company's officers and employees and administers the Company's 1995 Stock Option Plan. The Audit Committee reviews the results and scope of the audit and other accounting-related services and evaluates the Company's internal audit and control functions. DIRECTOR COMPENSATION Directors who are not compensated as employees of or consultants to the Company receive a $6,000 annual retainer fee, a fee of $2,000 per board meeting, a fee of $500 for service on any committee and reimbursement of expenses incurred in attending Board meetings. In October 1996, Messrs. Yau and Inman were each granted stock options under the 1995 Stock Option Plan to purchase 9,000 shares of the Company's Common Stock with an exercise price equal to $8.33 per share. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The Compensation Committee of the Board consists of Messrs. Yau and Inman. No member of the Compensation Committee or executive officer of the Company has a relationship that constitutes an interlocking relationship with executive officers or directors of another entity. LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS The Company has adopted provisions in its Articles of Incorporation that limit the liability of its directors for monetary damages arising from a breach of their fiduciary duties as directors to the fullest extent permitted by the California Corporations Code. The Company's Bylaws provide that the Company must indemnify its directors and officers to the fullest extent permitted by the California Corporations Code. The Company also has entered into indemnification agreements with its executive officers and directors and expects to obtain officer and director liability insurance with respect to certain liabilities. See "Description of Capital Stock -- Limitation of Liability of Directors and Indemnification of Directors and Officers." 43 45 EXECUTIVE COMPENSATION The following table shows the compensation earned in fiscal 1996 by each of the Company's executive officers at the end of fiscal 1996 (collectively, the "Named Executive Officers"). SUMMARY COMPENSATION TABLE
LONG-TERM COMPENSATION ANNUAL COMPENSATION ------------ --------------------------------------- SECURITIES OTHER ANNUAL UNDERLYING ALL OTHER NAME AND PRINCIPAL POSITION SALARY($) BONUS($) COMPENSATION($)(1) OPTIONS(#) COMPENSATION($)(2) - ------------------------------- -------- -------- ------------------ ------------ ------------------ Alex Razmjoo................... $193,608 $737,500 $5,101 -- $7,470 Chairman, President and CEO Frank Alaghband................ 193,608 737,500 9,959 -- 7,470 EVP-Operations Alex Aydin..................... 193,608 702,500 4,217 -- 7,470 EVP-Finance & Admin. Nick Shahrestany............... 193,608 712,500 6,580 -- 8,160 EVP-Marketing & Info. Tech. Frederick Judd................. 84,000 43,371 -- 9,600 -- VP-Finance & General Counsel
- --------------- (1) Reimbursement of various personal expenses included in the executive officer's taxable income and, in the case of Mr. Alaghband, the portion of certain car lease payments considered as personal. (2) Represents life insurance premiums paid by the Company. The Company granted no stock options and no stock options were exercised through the end of fiscal 1995. The following table summarizes option grants during fiscal 1996 to each of the Named Executive Officers: OPTION GRANTS IN FISCAL 1996
POTENTIAL REALIZABLE VALUE AT INDIVIDUAL GRANTS ASSUMED ANNUAL ------------------------------------------------------------------- RATES OF STOCK NUMBER OF PERCENT OF TOTAL PRICE APPRECIATION SECURITIES OPTIONS GRANTED TO FOR OPTION TERM(2) UNDERLYING OPTIONS EMPLOYEES IN EXERCISE EXPIRATION ------------------- NAME GRANTED(#) FISCAL 1996(%) PRICE ($/SH) DATE 5% 10% - --------------------- ------------------ ------------------ ------------ ---------- -------- -------- Alex Razmjoo......... -- -- -- -- -- -- Frank Alaghband...... -- -- -- -- -- -- Alex Aydin........... -- -- -- -- -- -- Nick Shahrestany..... -- -- -- -- -- -- Frederick Judd....... 9,600(1) 4.1% $ 2.50 9/15/05 $132,384 $225,024
- --------------- (1) The option vests in 25% installments on each anniversary of the date of grant. In November 1993, Mr. Judd was also granted an option by Mr. Aydin to purchase 90,000 shares of the Company's Common Stock owned by Mr. Aydin. The exercise price of the option is $0.35 per share, which was the estimated fair market value of the Company's Common Stock on the date of grant. (2) This column shows the hypothetical gains or "option spreads" of the options granted based on both the fair market value of the Common Stock for financial reporting purposes and assumed annual compound stock appreciation rates of 5% and 10% over the full 10-year term of the options. The 5% and 10% assumed rates of appreciation are mandated by the rules of the Securities and Exchange Commission and do not represent the Company's estimate or projection of future Common Stock prices. The gains shown are net of the option exercise price, but do not include deductions for taxes or other expenses associated with the exercise of the option or the sale of the underlying shares. The actual gains, if any, on the exercises of stock options will depend on the future performance of the Common Stock, the option holder's continued employment through the option period, and the date on which the options are exercised. 44 46 The following table summarizes the value of options held at July 26, 1996 by the Named Executive Officers. There were no options exercised by the Named Executive Officers during the fiscal year ended July 26, 1996. FISCAL YEAR-END OPTION VALUES
NUMBER OF SECURITIES VALUE OF UNEXERCISED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT OPTIONS AT JULY 26, 1996 (#) JULY 26, 1996 ($)(1) --------------------------- --------------------------- NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - ------------------------------------------------- ----------- ------------- ----------- ------------- Alex Razmjoo..................................... -- -- -- -- Frank Alaghband.................................. -- -- -- -- Alex Aydin....................................... -- -- -- -- Nick Shahrestany................................. -- -- -- -- Frederick Judd................................... -- 9,600 -- $25,632
- --------------- (1) The amounts set forth represent the difference between the estimated fair market value of $5.17 per share as of July 26, 1996 and the exercise price of the options, multiplied by the applicable number of shares underlying the options. EMPLOYEE BENEFIT PLANS 1995 Stock Option Plan In September 1995, the Board adopted and the Company's shareholders approved the 1995 Stock Option Plan, as amended (the "1995 Plan"), and reserved 540,000 shares of Common Stock for issuance thereunder. The 1995 Plan provides for the grant to employees of the Company of incentive stock options within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), and for the grant to employees, directors, and consultants of the Company of nonstatutory stock options. As of October 25, 1996, options to purchase an aggregate of 271,800 shares were outstanding under the 1995 Plan (47,888 of which were vested), and an aggregate of 268,200 additional shares remained available for additional grants. The 1995 Plan may be administered by the Board or a committee approved by the Board. Currently, the 1995 Plan is administered by the Compensation Committee of the Board, which determines the terms of options granted thereunder, including the exercise price, number of shares subject to the option and vesting schedule. Options granted under the 1995 Plan are not transferable other than by will or the laws of descent or distribution, and each option is exercisable during the lifetime of the recipient only by such person. Options that are outstanding under the 1995 Plan will remain outstanding until they are exercised or they expire in accordance with these terms. The exercise price of all incentive stock options granted under the 1995 Plan must be at least equal to the fair market value of a share of Common Stock on the date of grant. With respect to any participant who owns stock possessing more than 10% of the voting power of all classes of stock of the Company, the exercise price of any incentive stock option granted must equal at least 110% of the fair market value on the grant date and the maximum term of the option must not exceed five years. The term of all other options granted under the 1995 Plan may not exceed ten years. In the event the shareholders of the Company approve certain mergers or consolidations, or the sale of substantially all of the business assets of the Company or certain persons other than beneficial owners of greater than 5% of the then outstanding voting power become the beneficial owner of more than 50% of the voting power of the Company, unless prior to such event the Board determines that there shall be either no acceleration or limited acceleration of awards, each option outstanding under the 1995 Plan will become immediately exercisable. 401(k) Plan Effective August 1992, the Company adopted a tax deferred savings plan (the "401(k) Plan") that covers all full-time employees over the age of 21 with more than one year of service. An employee may 45 47 contribute to the 401(k) Plan from 1% to 15% of his or her pretax compensation not to exceed in any given year the maximum amount allowable under Internal Revenue Service regulations. At the discretion of the Board, the Company may elect to match up to 100% of an employee's contributions to the 401(k) Plan. The Company is not obligated to make matching contributions, but has done so in the past on a discretionary basis. The rates of pre-tax contributions may be reduced with respect to highly compensated employees, as defined in the Code, so that the 401(k) Plan will comply with Section 401(k) of the Code. Pre-tax contributions are allocated to each employee's individual account, which is invested in selected investment alternatives according to the direction of the employee. An employee's pre-tax contributions are fully vested and nonforfeitable at all times, while employer contributions to an employee's account vest over a five-year period. An employee may also borrow from his or her account. All vested benefits are generally distributed to employees upon termination of employment. See Note 8 of Notes to Consolidated Financial Statements. EMPLOYMENT AGREEMENTS The Company has employment agreements with Messrs. Razmjoo, Alaghband, Aydin and Shahrestany. Each employment agreement has a three-year term with an automatic renewal provision which provides that the agreement will perpetually maintain a three-year term unless terminated. Pursuant to the agreements, each officer receives an annual salary of not less than $225,000, which may at the discretion of the Board be increased in light of performance, inflation or other factors. Each officer is also entitled to receive an annual bonus based on the Company's performance, awarded at the discretion of the Board based upon the attainment of mutually agreed upon performance goals. Performance goals of the Company for purposes of calculating bonus payments are not specified in the employment agreements but rather are determined on a yearly basis by mutual agreement between the Board and the officer. The bonuses received by Messrs. Razmjoo, Alaghband, Aydin and Shahrestany in fiscal 1996 were based upon a formula contained in each of their original employment agreements which provided for a bonus equal to a specified percentage of the Company's earnings before taxes, not to exceed $750,000. This provision governing the calculation of bonuses was subsequently amended to provide for bonuses based upon the attainment of mutually agreed upon performance goals as described above. For purposes of calculating the bonuses of Messrs. Razmjoo, Alaghband, Aydin and Shahrestany for fiscal 1997, the Board has not yet established performance goals for the Company but expects to do so in consultation with the Compensation Committee after the closing of the Offering. Each officer is entitled to receive a monthly automobile allowance of $750 and reimbursement of business expenses. The Company is required to maintain a life insurance policy of $1 million for the benefit of each officer, and each officer is entitled to participate in the other benefit programs of the Company available to its executive officers. Each officer is entitled to an annual tax preparation allowance of $1,000. If the Company terminates an officer's employment without Cause (as defined in the employment agreement) or the officer terminates his employment for Good Reason (as defined in the employment agreement), the Company is obligated to provide certain benefits to the terminated officer, including paying the officer 35 months base salary, subject to Internal Revenue Code restrictions, a pro rata bonus for the year of termination and the continuation for up to two years of all life insurance and medical benefits. On November 15, 1993, Mr. Judd joined the Company as Vice President, Finance and General Counsel. Pursuant to the Company's employment agreement with Mr. Judd, Mr. Judd's base salary is $84,000, and Mr. Judd can qualify for performance-based bonuses of up to $32,000 per year which may be adjusted in the future. 46 48 CERTAIN TRANSACTIONS The Company made product sales totaling $411,000 and $398,000 to an entity owned by a relative of Mr. Razmjoo during fiscal 1994 and 1995, respectively. At July 29, 1994, the Company had accounts receivable from this related party of $323,000. As a result of an Executive Order issued in May 1995 related to transactions with Iranian companies, the Company determined that amounts owed by this entity might not be collectible in the near future and, accordingly, during fiscal 1995, wrote off the outstanding balances owed to the Company by this entity of approximately $251,000. As a result, at July 28, 1995, the Company had no account receivable from this entity. In fiscal 1995, the Company purchased $38,000 of CD-ROM software products and $128,000 of software programming services from, and made cash advances totalling $159,000 to, Softbit, Inc., an entity that is 90 percent owned by the Founders and of which each of the Founders is a director and officer. At July 28, 1994 and July 28, 1995, the Company had a net receivable of $80,000 and $181,000, respectively, from this entity. During fiscal 1996, the Company made cash advances of approximately $93,000 to the entity, sold products valued at approximately $2,000 to the entity and incurred expenses of approximately $25,000 on behalf of the entity. At July 26, 1996, the Company had a net receivable of $301,000 from the entity, and due to the financial position of the entity, the Company determined that the receivable was uncollectible and wrote off the entire amount. The Company has entered into indemnification agreements with each of its directors and executive officers. These agreements require the Company to indemnify such individuals for certain liabilities to which they may be subject as a result of their affiliation with the Company, to the fullest extent allowed by law. The Company has adopted a policy that transactions, other than compensation matters, between the Company and its executive officers, directors and affiliates, will be submitted to the Company's non-employee directors for approval. 47 49 PRINCIPAL AND SELLING SHAREHOLDERS The following table sets forth certain information regarding beneficial ownership of the Company's Common Stock as of October 25, 1996, and as adjusted to give effect to the sale of shares offered hereby, (i) by each person who is known by the Company to own beneficially 5% or more of the outstanding shares of Common Stock, (ii) each of the Company's directors, (iii) each of the Named Executive Officers, (iv) all directors and executive officers as a group and (v) each Selling Shareholder. Except as indicated in the footnotes to the table, the persons named in the table have sole voting and investment power with respect to all shares of Common Stock shown as beneficially owned by them, subject to community property laws where applicable.
SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED PRIOR TO OWNED AFTER OFFERING NUMBER OF OFFERING(1) ----------------------- SHARES ----------------------- BENEFICIAL OWNER NUMBER PERCENT(2) BEING OFFERED(1) NUMBER PERCENT(2) - ----------------------------------- --------- ---------- ---------------- --------- ---------- Alex Razmjoo(3)(4)................. 2,250,000 25.0% 250,000 2,000,000 18.2% 2181 Dupont Irvine, California 92715 Frank Alaghband(3)(4).............. 2,127,000 23.6% 250,000 1,877,000 17.1% 2181 Dupont Irvine, California 92715 Alex Aydin(3)(4)(5)................ 1,872,000 20.8% 250,000 1,597,000(5) 14.5% 2181 Dupont Irvine, California 92715 Nick Shahrestany(3)(4)............. 2,049,000 22.8% 250,000 1,799,000 16.4% 2181 Dupont Irvine, California 92715 Frederick Judd(4)(6)(7)............ 92,400 1.0% 25,000 67,400 * Samuel Inman(3).................... -- -- -- -- -- Samuel Yau(3)...................... -- -- -- -- -- All directors and executive 8,300,400 92.2% 1,025,000 7,275,400 66.1% officers as a group (8 persons)(7)......................
- --------------- * Less than one percent. (1) Assumes no exercise of the Underwriters' over-allotment option. If the Underwriters' over-allotment option is exercised in full, Mr. Aydin will sell an additional 113,430 shares of Common Stock and each of Messrs. Razmjoo, Alaghband and Shahrestany will sell an additional 113,440 shares of Common Stock. (2) Percentage calculation is based upon 9,000,000 shares outstanding as of October 25, 1996 (or 11,000,000 shares following the Offering, based on the proposed issuance of 2,000,000 shares by the Company in the Offering). (3) A director of the Company. (4) An officer of the Company. (5) Includes the number of shares being sold by Mr. Aydin in the Offering and the sale of 25,000 shares by Mr. Judd in the Offering, which shares Mr. Judd will acquire upon partial exercise of the option described in footnote (6) below. In addition, the number of shares owned after the Offering reflects 65,000 shares of Common Stock owned by Mr. Aydin that remain subject to the option. (6) Includes shares subject to an option granted to Mr. Judd by Mr. Aydin to acquire 90,000 shares of Common Stock owned by Mr. Aydin, which option is presently exercisable in full, and of which 25,000 shares will be exercised and sold in the Offering. (7) Includes 2,400 shares of Common Stock subject to vested options. 48 50 DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 65,000,000 shares of Common Stock, $.01 par value, and 10,000,000 shares of Preferred Stock, $.01 par value. COMMON STOCK Holders of Common Stock are entitled to receive such dividends as may from time to time be declared by the Board out of funds legally available therefor. Holders of Common Stock are entitled to one vote per share on all matters on which they are entitled to vote other than the election of directors, in which event, until the Company becomes a listed corporation as defined below, any holder may demand cumulative voting. See "-- Certain Anti-Takeover Effects -- Classified Board of Directors" and "-- No Cumulative Voting." Holders of Common Stock have no preemptive, conversion, redemption or sinking funds rights. In the event of a liquidation, dissolution or winding-up of the Company, holders of Common Stock are entitled to share equally and ratably in the assets of the Company, if any, remaining after the payment of all debts and liabilities of the Company and the liquidation preference of any outstanding Preferred Stock. The outstanding shares of Common Stock are, and the shares of Common Stock offered by the Company hereby when issued will be, fully paid and nonassessable. The rights, preferences and privileges of holders of Common Stock are subject to any series of Preferred Stock that the Company may issue in the future. PREFERRED STOCK The Board is authorized to provide for the issuance of Preferred Stock in one or more series and to fix the designations, preferences, powers and relative, participating, optional and other rights, qualifications, limitations and restrictions thereof, including the dividend rate, conversion rights, voting rights, redemption price and liquidation preference, and to fix the number of shares to be included in any such series. Any Preferred Stock so issued may rank senior to the Common Stock with respect to the payment of dividends or amounts upon liquidation, dissolution or winding-up, or both. In addition, any such shares of Preferred Stock may have class or series voting rights. Issuances of Preferred Stock, while providing the Company with flexibility in connection with general corporate purposes, may, among other things, have an adverse effect on the rights of holders of Common Stock, may have the effect of delaying, deterring or preventing a change in control of the Company without further action by the shareholders, may discourage bids for the Company's Common Stock at a premium over the market price of the Common Stock, and may adversely affect the market price and the voting and other rights of the holders of Common Stock. At present, the Company has no plans to issue any shares of Preferred Stock. REGISTRATION RIGHTS After this Offering, the Founders will be entitled, upon expiration of the lock-up agreements with the Underwriters, to certain rights with respect to the registration of their shares under the Securities Act. Under the terms of the Registration Rights Agreement to which each Founder is a party, if the Company proposes to register any of its securities under the Securities Act, either for its own account or for the account of others, the Founders, as the holders of 7,273,000 (assuming the consummation of this Offering and no exercise of the Underwriters' over-allotment option) shares of Common Stock, are entitled, subject to certain limitations and exceptions, to notice of such registration and are entitled to include shares of their Common Stock therein. In addition, at any time after the first anniversary of the Company's initial public offering and the Company becomes eligible to file registration statements on Form S-3 under the Securities Act, each Founder may, no more often than once during any 12-month period, request that the Company file a registration statement on Form S-3 with respect to shares of his Common Stock, and the Company is required to use its best efforts to effect such registration, subject to certain conditions and limitations. In general, all fees, costs and expenses of such registration will be borne by the Founders. 49 51 LIMITATION OF LIABILITY OF DIRECTORS AND INDEMNIFICATION OF DIRECTORS AND OFFICERS The California General Corporation Law (the "Law") provides that California corporations may include provisions in their articles of incorporation relieving directors of monetary liability for breach of their fiduciary duties as directors, except for the liability of a director resulting from (i) any transaction from which the director derives an improper personal benefit, (ii) acts or omissions involving intentional misconduct or a knowing and culpable violation of law, (iii) acts or omissions that a director believes to be contrary to the best interests of the Company or its shareholders or that involve the absence of good faith on the part of the director, (iv) acts or omissions constituting an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Company or its shareholders, (v) acts or omissions showing a reckless disregard for the director's duty to the Company or its shareholders in circumstances in which the director was aware or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to the Company or its shareholders, (vi) any improper transaction between a director and the Company in which the director has a material financial interest or (vii) the making of an illegal distribution to shareholders or an illegal loan or guaranty. In addition, the Company may not indemnify directors and officers in circumstances in which indemnification is expressly prohibited by Section 317 of the Law. The Company's Articles of Incorporation provide that the Company's directors are not liable to the Company or its shareholders for monetary damages for breach of their fiduciary duties to the fullest extent permitted by California law. Such limitation of liability does not affect the availability of equitable remedies such as injunctive relief or rescission. The Bylaws of the Company (the "Bylaws") provide that the Company will indemnify its directors and officers to the fullest extent permitted by California law, including circumstances in which indemnification is otherwise discretionary under California law, subject to certain limitations for actions initiated by the director or officer, settlements not approved by the Company, losses covered by the directors' and officers' liability insurance policy maintained by the Company and judgments for an accounting of profits pursuant to Section 16(b) of the Securities Exchange Act of 1934 and similar laws. The inclusion of the above provisions in the Company's Articles of Incorporation and Bylaws may have the effect of reducing the likelihood of derivative litigation against directors and may discourage or deter shareholders or management from bringing a lawsuit against directors for breach of their duty of care, even though such an action, if successful, might otherwise have benefitted the Company and its shareholders. This provision does not affect a director's responsibilities under certain other laws such as the federal securities laws or state or federal environmental laws. At present, there is no litigation or proceeding pending involving a director of the Company pursuant to which indemnification is being sought, nor is the Company aware of any threatened litigation that might result in claims for indemnification by any director. The Company has entered into indemnification agreements with its directors and executive officers that require the Company to indemnify such directors and officers to the fullest extent permitted by applicable provisions of law provided that any settlement of a third party action against a director or officer is approved by the Company, and subject to limitations for actions initiated by the director or officer, penalties paid by insurance and violations of Section 16(b) of the Securities Exchange Act of 1934, as amended, and similar laws. The agreements contain provisions that are broader in some respects than the specific indemnification provisions contained in the California Corporations Code. The indemnification agreements may require the Company, among other things, to indemnify its officers and directors against certain liabilities that may arise by reason of their status or service as directors or executive officers (other than liabilities arising from willful misconduct of a culpable nature), to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified and to obtain directors' and officers' insurance, if available on reasonable terms. The Company expects to obtain directors' and officers' liability insurance with respect to liabilities arising out of certain matters, including matters arising under the Securities Act. The Company believes the foregoing provisions are necessary to attract and retain qualified persons as directors and executive officers. 50 52 CERTAIN ANTI-TAKEOVER EFFECTS The provisions of the Articles of Incorporation and the Company's Bylaws summarized in the succeeding paragraphs may be deemed to have anti-takeover effects and may delay, deter or prevent a tender offer or takeover attempt that a shareholder might consider to be in such shareholder's best interest, including those attempts that might result in a premium over the market price for the shares held by shareholders. Classified Board of Directors. The Articles of Incorporation and Bylaws provide that when the Company becomes a "listed corporation" as defined below, as long as the size of the Board is at least six but less than nine directors, the Board will be divided into two classes of directors with each class serving staggered two-year terms and, if the number of directors is increased to nine or more, the Board will be divided into three classes serving staggered three-year terms. The Company will be deemed a "listed corporation" when it has been listed on the Nasdaq National Market and has at least 800 shareholders on the record date of an annual meeting of shareholders, as calculated in accordance with the California Corporations Code. The classification of the Board may discourage a third party from making a tender offer or otherwise attempting to obtain control of the Company and may maintain the incumbency of the directors, as a classified Board generally makes it more difficult for shareholders to replace a majority of the directors. No Cumulative Voting. The Articles of Incorporation and Bylaws provide that, when the Company becomes a "listed corporation," cumulative voting will be eliminated. Without cumulative voting, which entitles a holder of Common Stock to cast a number of votes for each share held by such holder equal to the number of directors to be elected, the holders of a majority of the shares present or represented at an annual meeting of shareholders will be able to elect all of the directors to be elected at that meeting. Consequently, the elimination of cumulative voting may make a change in control of the Company more difficult by denying minority shareholders representation on the Board. Advance Notice Requirements for Shareholder Proposals and Director Nominations. The Bylaws establish advance notice procedures with regard to shareholder proposals and the nomination, other than by or at the direction of the Board or a committee thereof, of candidates for election as directors. The Company may, subject to compliance with Securities and Exchange Commission rules and regulations regarding proxy solicitation, reject a shareholder proposal or nomination that is not made in accordance with such procedures. TRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for the Common Stock is U.S. Stock Transfer Corporation. LISTING The Company's Common Stock has been approved for quotation on the Nasdaq National Market, subject to notice of issuance, under the trading symbol "PRCM." 51 53 SHARES ELIGIBLE FOR FUTURE SALE Sales of substantial amounts of Common Stock in the public market could adversely affect the market price of the Common Stock and could impair the Company's future ability to raise capital through the sale of its equity securities. Upon the closing of this Offering, the Company will have outstanding 11,000,000 shares of Common Stock. Of these shares, the 3,025,000 shares sold in this Offering will be freely tradeable without restriction under the Securities Act, unless purchased by "affiliates" of the Company. The remaining 7,975,000 shares of Common Stock held by existing shareholders will be "restricted" shares under the Securities Act (the "Restricted Shares"). Upon the expiration of lock-up agreements between each shareholder and the Underwriters, which will occur 180 days after the Effective Date, all 7,975,000 Restricted Shares will become eligible for sale, subject to the volume limitations described below. At October 25, 1996, an aggregate of 271,800 shares of Common Stock are subject to outstanding options. A total of 47,888 shares subject to options are vested as of the date of this Prospectus and an aggregate of 268,200 additional shares are reserved for future issuance pursuant to the Company's 1995 Stock Option Plan. The Company plans to file a Registration Statement on Form S-8 to register the shares of Common Stock issuable pursuant to the 1995 Stock Option Plan. Approximately 55,000 shares of Common Stock subject to vested options will be eligible for resale upon the expiration of lock-up agreements 180 days following the Effective Date, unless earlier released for resale by the Company. The Underwriting Agreement prohibits the Company from releasing such shares for resale until 90 days following the Effective Date. Accordingly, shares of Common Stock issued under the 1995 Stock Option Plan will be available for sale in the public market upon vesting of such shares, subject to certain volume limitations under Rule 144 with respect to affiliates. In general, under Rule 144 as currently in effect, a person (or persons whose shares are aggregated) who has beneficially owned Restricted Shares for at least two years, will be entitled to sell in any three-month period a number of shares that does not exceed the greater of: (i) 1% of the number of shares of Common Stock then outstanding (approximately 110,000 shares immediately after this Offering) or (ii) the average weekly trading volume of the Company's Common Stock in the Nasdaq National Market during the four calendar weeks immediately preceding the date on which notice of the sale is filed with the Securities and Exchange Commission. Sales pursuant to Rule 144 are subject to certain requirements relating to manner of sale, notice and availability of current public information about the Company. A person (or persons whose shares are aggregated) who is not deemed to have been an affiliate of the Company at any time during the 90 days immediately preceding the sale and who has beneficially owned Restricted Shares for at least three years is entitled to sell such shares pursuant to Rule 144(k) without regard to the limitations and requirements described above. The Securities and Exchange Commission has recently proposed to reduce the Rule 144 holding periods. If enacted, such modification could have an impact on the timing of when shares of Common Stock become eligible for resale. All of the Company's shareholders have agreed with Montgomery Securities that until 180 days after the Effective Date they will not sell, offer to sell, contract to sell, transfer the economic risk of ownership in, make any short sale, pledge or otherwise dispose of, any shares of Common Stock, or any securities exercisable or exchangeable for or any other rights to purchase or acquire shares of Common Stock owned directly by such holders or with respect to which they have power of disposition. The Company has also agreed not to issue, sell, offer to sell, grant any option to purchase or otherwise dispose of any equity securities or any securities convertible into, exercisable or exchangeable for Common Stock or other equity security for a period of 180 days after the Effective Date without the prior written consent of Montgomery Securities, subject to certain limited exceptions including grants of options and sales of shares under the 1995 Plan. The lock-up agreements with Montgomery Securities may be released at any time as to all or any portion of the shares subject to such agreements at the sole discretion of Montgomery Securities. 52 54 UNDERWRITING The underwriters named below (the "Underwriters"), represented by Montgomery Securities and Dain Bosworth Incorporated (the "Representatives"), have severally agreed, subject to the terms and conditions set forth in the Underwriting Agreement, to purchase from the Company and the Selling Shareholders the number of shares of Common Stock indicated below opposite their respective names at the initial public offering price less the underwriting discount set forth on the cover page of this Prospectus. The Underwriting Agreement provides that the obligations of the Underwriters are subject to certain conditions precedent and that the Underwriters are committed to purchase all of such shares, if any are purchased.
NUMBER OF UNDERWRITER SHARES -------------------------------------------------------------------------- --------- Montgomery Securities..................................................... Dain Bosworth Incorporated................................................ --------- Total........................................................... 3,025,000 ========
The Representatives have advised the Company that the Underwriters initially propose to offer the Common Stock to the public on the terms set forth on the cover page of this Prospectus. The Underwriters may allow to selected dealers a concession of not more than $ per share, and the Underwriters may allow, and such dealers may reallow, a concession of not more than $ per share to certain other dealers. After the initial public offering, the offering price and other selling terms may be changed by the Representatives. The Common Stock is offered subject to receipt and acceptance by the Underwriters and to certain other conditions, including the right to reject orders in whole or in part. The Selling Shareholders have granted an option to the Underwriters, exercisable during the 30-day period after the date of this Prospectus, to purchase up to a maximum of 453,750 additional shares of Common Stock to cover over-allotments, if any, at the same price per share as the initial shares to be purchased by the Underwriters. To the extent the Underwriters exercise this option, each of the Underwriters will be committed, subject to certain conditions, to purchase such additional shares in approximately the same proportion as set forth in the above table. The Underwriters may purchase such shares only to cover over-allotments made in connection with this Offering. All holders of Common Stock prior to this Offering have agreed, subject to certain limited exceptions, not to sell or offer to sell, contract to sell, transfer the economic risk of ownership in, make any short sale, pledge or otherwise dispose of the shares of Common Stock currently held by them, or any securities exercisable or exchangeable for or any other rights to purchase or acquire any shares of Common Stock for a period of 180 days after the Effective Date without the prior written consent of Montgomery Securities. Montgomery Securities may, in its sole discretion and at any time without notice, release all or any portion of the securities subject to these lock-up agreements. In addition, the Company has agreed that for a period of 180 days after the Effective Date it will not, without the prior written consent of Montgomery Securities, issue, offer, sell, grant options to purchase or otherwise dispose of any equity securities or securities convertible into, exercisable or exchangeable for Common Stock or other equity securities, subject to certain limited exceptions including grants of options and sales of shares under the 1995 Plan. The Underwriting Agreement provides that the Company and the Selling Shareholders will indemnify the Underwriters and their controlling persons against certain liabilities, including civil liabilities under the Securities Act, or will contribute to payments the Underwriters may be required to make in respect thereof. The Representatives have advised the Company that the Underwriters will not confirm sales to any accounts over which they exercise discretionary authority in excess of 5% of the number of shares of Common Stock offered hereby. Prior to this Offering, there has been no public market for the Common Stock. Consequently, the initial public offering price has been determined through negotiations among the Company, the Selling Shareholders and the Representatives. Among the factors considered in such negotiations were the history of, and prospects for, the Company and the industry in which it competes, an assessment of the Company management, its past 53 55 and present operations and financial performance, the prospects for future earnings of the Company, the present state of the Company's development, the general condition of the securities markets at the time of the Offering, the market prices of and demand for publicly traded common stocks of comparable companies in recent periods and other factors deemed relevant. LEGAL MATTERS The validity of the shares of Common Stock offered hereby will be passed upon for the Company and any Selling Shareholders by O'Melveny & Myers LLP, Newport Beach, California. Certain legal matters will be passed upon for the Underwriters by Fenwick & West LLP, Palo Alto, California. EXPERTS The consolidated balance sheets as of July 28, 1995 and July 26, 1996 and the consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended July 26, 1996 included in this Prospectus and the related financial statement schedule included elsewhere in the Registration Statement have been included herein in reliance on the report of Arthur Andersen LLP ("Arthur Andersen"), independent accountants, given on the authority of that firm as experts in accounting and auditing. CHANGE IN ACCOUNTANTS Effective July 24, 1995, Arthur Andersen was engaged as the principal independent accountants for the Company to replace the Company's prior accounting firm, which was dismissed effective the same date. The decision to change independent accountants was approved by the Board. In connection with the audit of fiscal 1994, there were no disagreements with the prior accounting firm on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements if not resolved to the satisfaction of the firm would have caused the firm to make reference to the matter in its report. The audit report of the prior accounting firm on the consolidated financial statements of the Company as of and for the year ended July 29, 1994 did not contain any adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principles. During fiscal 1994 and through July 24, 1995, there were no reportable events. During the two fiscal years and the subsequent interim period preceding the engagement of Arthur Andersen, the Company had not consulted with Arthur Andersen on items that were or should have been subject to SAS 50 or concerned the subject matter of a disagreement or reportable event with the prior accounting firm. ADDITIONAL INFORMATION The Company has filed with the Securities and Exchange Commission (the "Commission") a Registration Statement on Form S-1 (together with all amendments, exhibits and schedule thereto, "Registration Statement"), of which this Prospectus forms a part, covering the Common Stock to be sold pursuant to the Offering. As permitted by the rules and regulations of the Commission, this Prospectus omits certain information, exhibits and undertakings and the schedule contained in the Registration Statement. Such additional information, exhibits, undertakings and schedule can be inspected at and obtained from the Commission at the public reference facilities maintained by the Commission at Room 1024, 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549 and at certain regional offices of the Commission located at Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661 and 13th Floor, 7 World Trade Center, New York, New York, 10048. Copies of such material can be obtained from the Public Reference Section of the Commission, 450 Fifth Street, N.W., Judiciary Plaza, Washington, D.C. 20549 at prescribed rates. For additional information with respect to the Company, the Common Stock and related matters and documents, reference is made to the Registration Statement and the exhibits thereto. Statements contained herein concerning any such document are not necessarily complete and, in each instance, reference is made to the copy of such document filed as an exhibit to the Registration Statement. Each such statement is qualified in its entirety by such reference. The Commission maintains a Web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission at http://www.sec.gov. 54 56 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Public Accountants.............................................. F-2 Consolidated Financial Statements: Consolidated Balance Sheets........................................................... F-3 Consolidated Statements of Operations................................................. F-4 Consolidated Statements of Shareholders' Equity....................................... F-5 Consolidated Statements of Cash Flows................................................. F-6 Notes to Consolidated Financial Statements............................................ F-7
F-1 57 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS The Board of Directors Procom Technology, Inc.: We have audited the accompanying consolidated balance sheets of Procom Technology, Inc. (a California corporation) and subsidiary (the "Company") as of July 28, 1995 and July 26, 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended July 26, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Procom Technology, Inc. and subsidiary as of July 28, 1995 and July 26, 1996, and the results of their operations and their cash flows for each of the three years in the period ended July 26, 1996 in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Orange County, California December 4, 1996 F-2 58 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS ASSETS
JULY 28, JULY 26, OCTOBER 25, 1995 1996 1996 ----------- ----------- ----------- (UNAUDITED) Current assets: Cash................................................ $ 212,000 $ 793,000 $ 58,000 Accounts receivable, less allowance for doubtful accounts and sales returns of $179,000, $373,000 and $575,000, respectively........................... 5,507,000 9,234,000 11,083,000 Inventories, net.................................... 4,296,000 9,760,000 12,559,000 Deferred income taxes............................... 359,000 605,000 790,000 Prepaid expenses.................................... 166,000 204,000 249,000 Other current assets................................ 18,000 12,000 4,000 ----------- ----------- ----------- Total current assets........................ 10,558,000 20,608,000 24,743,000 Property and equipment, net........................... 239,000 476,000 553,000 Other assets.......................................... 214,000 28,000 29,000 ----------- ----------- ----------- Total assets................................ $11,011,000 $21,112,000 $25,325,000 =========== =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Line of credit...................................... $ 1,484,000 $ 4,185,000 $ 3,660,000 Accounts payable.................................... 5,530,000 8,254,000 11,583,000 Accrued expenses and other current liabilities...... 368,000 471,000 592,000 Accrued compensation................................ 1,230,000 2,596,000 958,000 Capital lease obligations........................... 8,000 34,000 32,000 Income taxes payable................................ 70,000 436,000 1,349,000 ----------- ----------- ----------- Total current liabilities................... 8,690,000 15,976,000 18,174,000 Capital lease obligations, less current portion....... 34,000 -- -- ----------- ----------- ----------- Total liabilities........................... 8,724,000 15,976,000 18,174,000 ----------- ----------- ----------- Commitments and contingencies Shareholders' equity: Preferred stock, no par value; 10,000,000 shares authorized, no shares issued and outstanding..... -- -- -- Common stock, no par value; 65,000,000 shares authorized, 9,000,000 shares issued and outstanding...................................... 3,000 3,000 3,000 Retained earnings................................... 2,284,000 5,133,000 7,148,000 ----------- ----------- ----------- Total shareholders' equity.................. 2,287,000 5,136,000 7,151,000 ----------- ----------- ----------- Total liabilities and shareholders' equity............ $11,011,000 $21,112,000 $25,325,000 =========== =========== ===========
The accompanying notes are an integral part of these consolidated balance sheets. F-3 59 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED QUARTERS ENDED --------------------------------------- ------------------------- JULY 29, JULY 28, JULY 26, OCTOBER 27, OCTOBER 25, 1994 1995 1996 1995 1996 ----------- ----------- ----------- ----------- ----------- (UNAUDITED) (UNAUDITED) Net sales....................... $34,502,000 $44,660,000 $73,456,000 $15,275,000 $24,915,000 Cost of sales................... 27,187,000 32,858,000 51,489,000 11,133,000 16,490,000 ----------- ----------- ----------- ----------- ----------- Gross profit............... 7,315,000 11,802,000 21,967,000 4,142,000 8,425,000 Selling, general and administrative expenses....... 6,902,000 9,362,000 15,401,000 2,875,000 4,367,000 Research and development expenses...................... 983,000 1,108,000 1,635,000 292,000 688,000 Loss on closure of German subsidiary.................... 409,000 -- -- -- -- ----------- ----------- ----------- ----------- ----------- Operating income (loss).... (979,000) 1,332,000 4,931,000 975,000 3,370,000 Interest expense................ 151,000 195,000 282,000 60,000 60,000 ----------- ----------- ----------- ----------- ----------- Income (loss) before income taxes...................... (1,130,000) 1,137,000 4,649,000 915,000 3,310,000 Provision (benefit) for income taxes......................... (357,000) 414,000 1,800,000 356,000 1,295,000 ----------- ----------- ----------- ----------- ----------- Net income (loss).......... $ (773,000) $ 723,000 $ 2,849,000 $ 559,000 $ 2,015,000 =========== =========== =========== =========== =========== Net income (loss) per share..... $ (0.08) $ 0.08 $ 0.31 $ 0.06 $ 0.22 =========== =========== =========== =========== =========== Weighted average number of shares........................ 9,171,950 9,171,950 9,171,950 9,171,950 9,171,950 =========== =========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. F-4 60 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
COMMON STOCK -------------------- RETAINED SHARES AMOUNT EARNINGS TOTAL --------- ------ ---------- ---------- Balance at July 30, 1993...................... 9,000,000 $3,000 $2,334,000 $2,337,000 Net income.................................. -- -- (773,000) (773,000) --------- ------ ---------- ---------- Balance at July 29, 1994...................... 9,000,000 3,000 1,561,000 1,564,000 Net income.................................. -- -- 723,000 723,000 --------- ------ ---------- ---------- Balance at July 28, 1995...................... 9,000,000 3,000 2,284,000 2,287,000 Net income.................................. -- -- 2,849,000 2,849,000 --------- ------ ---------- ---------- Balance at July 26, 1996...................... 9,000,000 3,000 5,133,000 5,136,000 Net income (unaudited)...................... -- -- 2,015,000 2,015,000 --------- ------ ---------- ---------- Balance at October 25, 1996 (unaudited)....... 9,000,000 $3,000 $7,148,000 $7,151,000 ========= ====== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. F-5 61 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED QUARTERS ENDED ------------------------------------------ --------------------------- JULY 29, JULY 28, JULY 26, OCTOBER 27, OCTOBER 25, 1994 1995 1996 1995 1996 ------------ ------------ ------------ ------------ ------------ (UNAUDITED) (UNAUDITED) Cash flows from operating activities: Net income (loss).................. $ (773,000) $ 723,000 $ 2,849,000 $ 559,000 $ 2,015,000 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization................ 220,000 235,000 194,000 49,000 64,000 Changes in assets and liabilities: Accounts receivable......... 1,535,000 (1,457,000) (3,727,000) (1,243,000) (1,849,000) Inventories................. 334,000 (2,048,000) (5,464,000) (1,027,000) (2,799,000) Deferred income taxes....... (67,000) (18,000) (246,000) (78,000) (185,000) Prepaid expenses............ (2,000) (128,000) (38,000) (26,000) (35,000) Income tax refund receivable................ (274,000) 274,000 -- -- -- Other current assets........ (93,000) 129,000 6,000 7,000 (2,000) Other assets................ 7,000 (180,000) 186,000 (27,000) (1,000) Accounts payable............ 596,000 1,616,000 2,724,000 697,000 3,329,000 Accrued expenses............ (15,000) 1,175,000 1,469,000 (309,000) (1,517,000) Income taxes payable........ (24,000) 70,000 366,000 314,000 913,000 ----------- ----------- ----------- ------------ ----------- Net cash provided by (used in) operating activities............ 1,444,000 391,000 (1,681,000) (1,084,000) (67,000) ----------- ----------- ----------- ------------ ----------- Cash flows from investing activities: Purchase of property and equipment........................ (71,000) (179,000) (431,000) (124,000) (141,000) ----------- ----------- ----------- ------------ ----------- Cash flows from financing activities: Principal payments for capital lease obligations................ (29,000) (16,000) (8,000) (2,000) (2,000) Borrowings on line of credit....... 34,919,000 43,771,000 64,825,000 14,527,000 22,575,000 Payments made on line of credit.... (36,108,000) (43,966,000) (62,124,000) (13,529,000) (23,100,000) ----------- ----------- ----------- ------------ ----------- Net cash provided by (used in) financing activities............ (1,218,000) (211,000) 2,693,000 996,000 (527,000) ----------- ----------- ----------- ------------ ----------- Increase (decrease) in cash...... 155,000 1,000 581,000 (212,000) (735,000) Cash at beginning of period.......... 56,000 211,000 212,000 212,000 793,000 ----------- ----------- ----------- ------------ ----------- Cash at end of period................ $ 211,000 $ 212,000 $ 793,000 $ 0 $ 58,000 =========== =========== =========== ============ =========== Supplemental disclosures of cash flow information: Cash paid during the year for: Interest......................... $ 161,000 $ 170,000 $ 248,000 42,000 106,000 Income taxes..................... 3,000 360,000 1,472,000 73,000 500,000
The accompanying notes are an integral part of these consolidated financial statements. F-6 62 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization Procom Technology, Inc. (the "Company") was incorporated in California in 1987. The Company designs, manufactures and markets enterprise-wide data storage and information access solutions that are compatible with all major hardware platforms, network protocols and operating systems. Principles of Consolidation The consolidated financial statements include the accounts of Procom Technology, Inc. and its wholly-owned subsidiary, Procom Technology FSC, a foreign sales corporation. All significant intercompany transactions have been eliminated in consolidation. Fiscal Year The Company's fiscal year ends on the Friday of, or nearest to, July 31. Fiscal 1994, 1995 and 1996 each had 52 weeks. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Accounts Receivable The allowance for doubtful accounts includes management's estimate of the amount expected to be lost on specific accounts and for losses on other as yet unidentified accounts included in accounts receivable. In estimating the potential losses on specific accounts, management relies on in-house prepared analyses and review of other available information. The allowance for sales returns includes management's estimates of the anticipated sales returns relating to each reporting period. In estimating the allowance for sales returns, management relies on historical experience. The amounts the Company will ultimately realize could differ materially in the near term from the amounts assumed in arriving at the allowance for doubtful accounts and sales returns in the accompanying financial statements. Inventories Inventories are valued at the lower of cost (on a first-in, first-out (FIFO) basis) or market. Allowances for obsolete inventory are based on management's estimate of the amount considered obsolete based on specific reviews of inventory items. In estimating the allowance, management relies on its knowledge of the industry (including technological and design changes) as well as its current inventory levels. The amounts the Company will ultimately realize could differ materially in the near term from amounts estimated by management. Property and Equipment Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the respective estimated useful lives of the assets, which range from three to seven years. Leasehold improvements and assets under capital leases are amortized using the straight-line method over the lesser of the lease term or the estimated useful life of the assets. Expenditures for major renewals and betterments are capitalized, while minor replacements, maintenance and repairs that do not extend the assets' lives are charged to operations as incurred. Upon sale or disposition, F-7 63 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS) the cost and related accumulated depreciation are removed from the Company's accounts and any gain or loss is included in the statement of operations. Income Taxes The Company reports certain expenses differently for financial and tax reporting purposes and, accordingly, provides for the related deferred income taxes. Income taxes are accounted for under the liability method in accordance with Statement of Financial Accounting Standards No. 109. Revenue Recognition The Company recognizes revenue from product sales upon shipment. All sales are denominated in U.S. dollars. The Company has established a program that, under specified conditions, enables distributors and resellers to return products to the Company for credit against additional purchases or, in the event the Company reduces its selling prices, to receive credits for the reduction in selling price. The amount of potential product returns, including returns under the Company's warranty program, and credits for selling price reductions are estimated and provided for in the period of the sale. Under an evaluation program, products may be shipped to customers on a trial basis and returned within a specified period if the customers are not satisfied. Evaluation units shipped are not recorded as sales until the customer has paid for such units. Research and Development Costs Costs and expenses that can be clearly identified as research and development, including software development costs, are charged to research and development expenses as incurred. Concentration of Credit Risk Three customers accounted for approximately 30% and 36% of the Company's total accounts receivable on July 28, 1995 and July 26, 1996, respectively, and one customer accounted for approximately 14% and 9% of the Company's net sales for fiscal 1995 and 1996, respectively. The loss of any one of the Company's significant customers could have an adverse effect on the Company's business. Impact of Recent Accounting Pronouncements Effective in fiscal 1997, the Company will be required to adopt Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-lived Assets and Long-lived Assets to be Disposed of" and SFAS No. 123, "Accounting for Stock Based Compensation." The Company plans to adopt SFAS No. 123 utilizing the disclosure alternative under the Statement. The impact of the adoption of these pronouncements is not expected to be material to the Company's financial position or results of operations. Net income (loss) per share Net income (loss) per share has been computed using the weighted average number of shares of common stock outstanding during the periods. Pursuant to the requirements of the Securities and Exchange Commission, options granted under the Company's stock option plan (see Note 10) at prices below the expected initial public offering price have been included in the Company's net income (loss) per share calculation as if they had been outstanding for all periods presented (using the treasury stock method and utilizing an initial public offering price of $10 per share). F-8 64 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS) Unaudited Information The accompanying financial data as of October 25, 1996 and for the three month periods ended October 27, 1995 and October 25, 1996 is unaudited and has been prepared on substantially the same basis as the annual financial statements. In the opinion of management, the unaudited information contains all adjustments (consisting only of normal recurring accruals) necessary to present fairly the financial position and results of operations as of such date and for such periods. 2. INVENTORIES A summary of inventories is as follows:
JULY 28, JULY 26, OCTOBER 25, 1995 1996 1996 ---------- ---------- ----------- (UNAUDITED) Raw materials................................. $2,988,000 $6,960,000 $ 9,057,000 Work-in-process............................... 383,000 496,000 1,277,000 Finished goods................................ 925,000 2,304,000 2,225,000 ---------- ---------- ----------- $4,296,000 $9,760,000 $12,559,000 ========== ========== ===========
3. PROPERTY AND EQUIPMENT A summary of property and equipment is as follows:
JULY 28, JULY 26, OCTOBER 25, 1995 1996 1996 ---------- ----------- ---------- (UNAUDITED) Computer equipment.............................. $ 381,000 $ 552,000 $ 609,000 Furniture and fixtures.......................... 401,000 466,000 502,000 Office equipment................................ 302,000 490,000 536,000 Vehicles........................................ 82,000 82,000 82,000 Leasehold improvements.......................... 71,000 77,000 77,000 ---------- ----------- ---------- 1,237,000 1,667,000 1,808,000 Less accumulated depreciation................... (998,000) (1,191,000) (1,255,000) ---------- ----------- ---------- Total................................. $ 239,000 $ 476,000 $ 553,000 ========== =========== ==========
Depreciation and amortization expense for fiscal 1994, 1995 and 1996 totaled $220,000, $235,000 and $194,000, respectively. F-9 65 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS) 4. INCOME TAXES The components of the provision (benefit) for income taxes for fiscal 1994, 1995 and 1996 are summarized as follows:
FISCAL YEAR ------------------------------------- 1994 1995 1996 --------- -------- ---------- Current: Federal........................................ $(308,000) $379,000 $1,612,000 State.......................................... 18,000 53,000 434,000 --------- -------- ---------- (290,000) 432,000 2,046,000 --------- -------- ---------- Deferred: Federal........................................ (46,000) (15,000) (223,000) State.......................................... (21,000) (3,000) (23,000) --------- -------- ---------- (67,000) (18,000) (246,000) --------- -------- ---------- Provision (benefit) for income taxes............. $(357,000) $414,000 $1,800,000 ========= ======== ==========
Components of the Company's deferred income tax provision are presented below:
FISCAL YEAR ---------------------------------- 1994 1995 1996 -------- -------- -------- State tax payments......................... $(16,000) $ (7,000) $137,000 Depreciation............................... 21,000 35,000 (3,000) Inventory reserves......................... (5,000) 18,000 36,000 Reserves for bad debts and returns......... 31,000 (41,000) 102,000 Other...................................... 36,000 13,000 (26,000) -------- -------- -------- Deferred income tax provision.............. $ 67,000 $ 18,000 $246,000 ======== ======== ========
The following table reconciles the federal statutory income tax rate to the effective tax rate of the provision (benefit) for income taxes.
FISCAL YEAR ------------------------- 1994 1995 1996 ----- ---- ----- Federal statutory income tax rate................... (34.0)% 34.0% 34.0% State income taxes, net of federal benefit.......... (6.3) 6.3 6.1 Foreign sales benefit............................... -- (3.4) (1.1) Research and development tax credit................. (0.5) (2.0) (0.6) Unused prior year loss carryforwards and assessments....................................... 7.8 -- -- Other............................................... 1.4 1.5 0.3 ----- ---- ---- Effective tax rate................................ (31.6)% 36.4% 38.7% ===== ==== ====
F-10 66 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS) Deferred tax assets are summarized below:
JULY 28, JULY 26, 1995 1996 -------- -------- Deferred tax assets: State tax payments................................... $ 34,000 $171,000 Depreciation......................................... 71,000 68,000 Inventory reserves................................... 85,000 121,000 Reserves for bad debts and returns................... 99,000 201,000 Other................................................ 70,000 44,000 -------- -------- Deferred income taxes............................. $359,000 $605,000 ======== ========
5. LINE OF CREDIT The Company has established a revolving line of credit with an institutional lender. The line is based on a percentage of the Company's eligible accounts receivable and inventory, up to a maximum of $6,000,000 in working capital loans. The line of credit accrues certain commitment fees, unused facility fees, and interest on outstanding amounts at the lender's prime rate (8.25% at July 26, 1996) plus 1.5%. The initial term of the line of credit expires on November 29, 1996, but automatically renews for successive one year periods unless terminated by either party within a specified period in advance of the automatic renewal date. The institutional lender also makes available to the Company various flooring commitments pursuant to which the Company may finance the purchase of up to $13.0 million in inventory (less any amounts outstanding in working capital loans) from certain of the Company's vendors who have credit arrangements with the institutional lender. The combined line of credit contains restrictive covenants that, among other provisions, require compliance with certain financial covenants, including the maintenance of working capital of at least $500,000. The combined line of credit is collateralized by all the assets of the Company and is guaranteed by the shareholders of the Company. At July 28, 1995 and July 26, 1996, the Company owed $1,484,000 and $4,185,000 under the line of credit and $2,875,000 and $4,464,000, which is included in accounts payable, under the flooring agreements, respectively (see Note 6). 6. COMMITMENTS AND CONTINGENCIES Lease Commitments The Company leases a facility under a noncancellable operating lease that expires in fiscal 1998. The facility lease contains an option to extend the lease under the same terms for four months. Future minimum lease payments at July 26, 1996, under these leases were as follows:
CAPITAL OPERATING LEASE LEASE ------- -------- Fiscal year ending: 1997............................................ $35,000 $450,000 1998............................................ -- 412,500 ------- -------- Total minimum lease payments.................... 35,000 $862,500 ======== Less, amounts representing interest............. 1,000 ------- Present value of future minimum capital lease obligations................................... $34,000 =======
Rent expense was $395,000, $425,000 and $398,000 for fiscal 1994, 1995 and 1996, respectively. F-11 67 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS) Flooring Agreements As is customary in the computer reseller industry, the Company is contingently liable at July 26, 1996 under the terms of repurchase agreements with several financial institutions providing inventory financing for dealers of the Company's products. The contingent liability under these agreements approximates the amount financed, reduced by the resale value of any products that may be repurchased, and the risk of loss is spread over several dealers and financial institutions. Losses under these agreements have been immaterial in the past. Litigation The Company is involved solely in routine litigation arising in the ordinary course of its business. While the outcome of litigation cannot be predicted with certainty, the Company believes that none of the pending litigation will have a material adverse effect on the Company's financial position or results of operations. Employment Agreements The Company has employment agreements with the Company's President and three Executive Vice Presidents. Each agreement is for a three year term with an automatic renewal provision which provides that the agreement will perpetually maintain a three-year term unless terminated. Each agreement contains severance provisions that require the payment of 35 months of base salary in the event of the termination of the covered executives. Should all four executives be terminated, the aggregate commitment arising under the severance provisions would be approximately $2.6 million and, in addition, the Company would be obligated to pay a pro rata bonus for the year of termination and the continuation for up to two years of all life insurance and medical benefits. 7. RELATED PARTY TRANSACTIONS The Company made product sales totaling $411,000 and $398,000 to an entity owned by a relative of one of the Company's stockholders during fiscal 1994 and 1995, respectively. At July 29, 1994, the Company had accounts receivable from this related party of $323,000. As a result of an Executive Order issued by the President of the United States in May 1995 related to transactions with Iranian companies, the Company determined that amounts owed by this entity might not be collectible in the near future and, accordingly, during fiscal 1995, wrote off the outstanding balances owed the Company by this entity of approximately $251,000. There were no transactions with this entity in fiscal 1996. At July 28, 1995, the Company had a net receivable of $181,000, from an entity 90 percent of which is owned by the Company's four shareholders. During fiscal 1996, the Company made cash advances of approximately $93,000 to the entity. In addition, during fiscal 1996, the Company sold products valued at approximately $2,000 to the entity, and incurred other expenses of approximately $25,000 on behalf of the entity. At July 26, 1996, the Company had a net receivable of $301,000 from the entity, and due to the financial position of the entity, the Company determined that the receivable was uncollectible and wrote off the entire amount. 8. RETIREMENT PLAN The Company has a defined contribution plan covering substantially all full-time employees with more than one year of service. Each participant can elect to contribute up to 15% of his or her annual compensation. While employer contributions to the plan are discretionary, during fiscal 1994, 1995 and 1996, the Company elected to make matching contributions equivalent to between 38% and 50% of the first 4% of the employee's contribution. Total expense for fiscal 1994, 1995 and 1996 was $16,000, $21,000 and $47,000, respectively. F-12 68 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS) 9. LOSS ON CLOSURE OF GERMAN SUBSIDIARY During fiscal 1993, the Company formed a subsidiary in West Germany. During fiscal 1994, the Company made cash advances, and shipped products, to the German subsidiary totaling $550,000. Due to a lack of profitability, management decided to terminate this operation in April 1994. The Company has recorded the loss on closure of this subsidiary in its consolidated financial statements at July 29, 1994. During fiscal 1995, the Company completed the liquidation of the German subsidiary's assets. 10. STOCK SPLIT AND STOCK OPTION PLAN In September 1995, the shareholders of the Company approved a stock split, whereby each shareholder was issued 10,000 shares of common stock for each share held. During November 1993, options to purchase 90,000 shares of common stock at the estimated fair market value on the date of grant were granted by a principal shareholder to an officer of the Company in connection with the officer's employment. In addition, during fiscal 1996, the Company instituted the 1995 Stock Option Plan (the "1995 Plan") for its key employees and reserved 540,000 shares for grant under the 1995 Plan. Pursuant to the terms of the 1995 Plan, options to purchase the Company's common stock may be granted with exercise prices equal to the fair market value of the stock on the date of grant. Options granted vest over a period of four years. The following table sets forth options authorized, granted and outstanding under the 1995 Plan:
AUTHORIZED OUTSTANDING AVERAGE FOR GRANT OPTIONS PRICE ---------- ----------- ----------- Balances, July 28, 1995................ -- -- -- Institution of the 1995 Plan......... 540,000 -- -- Options granted...................... (235,050) 235,050 $2.50-$4.50 Options cancelled.................... 7,350 (7,350) $2.50 ------- ------- Balances, July 26, 1996................ 312,300 227,700 $2.50-$4.50 Activity in Quarter Ended October 25, 1996 (unaudited) Options granted...................... (51,000) 51,000 $5.16-$8.33 Options cancelled.................... 6,900 (6,900) $2.50 ------- ------- Balances, October 25, 1996 (unaudited).......................... 268,200 271,800 $2.50-$8.33 ======= =======
In addition to the September 1995 stock split discussed above, the Company filed amended and restated articles of incorporation on November 13, 1996, which, among other things, effected a stock split pursuant to which each shareholder was issued three shares of common stock for each common share held. All share and per share amounts have been restated to give retroactive effect to this stock split as well as the September 1995 stock split. F-13 69 PROCOM TECHNOLOGY, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (INCLUDING DATA APPLICABLE TO UNAUDITED PERIODS) 11. GEOGRAPHIC Export sales as a percentage of net sales amounted to 19%, 14% and 11% for fiscal years 1994, 1995 and 1996, respectively. A summary of the Company's net sales and gross profit by geographic area is as follows (in thousands):
YEAR ENDED QUARTER ENDED -------------------------------- ------------------------- JULY 29, JULY 28, JULY 26, OCTOBER 28, OCTOBER 26, 1994 1995 1996 1995 1996 -------- -------- -------- ----------- ----------- (UNAUDITED) Net sales United States.................. $ 27,953 $ 38,478 $ 65,072 $13,586 $22,761 Foreign........................ 6,549 6,182 8,384 1,689 2,154 -------- -------- -------- ----------- ----------- Total..................... $ 34,502 $ 44,660 $ 73,456 $15,275 $24,915 ======= ======= ======= ======== ======== Gross profit United States.................. $ 6,365 $ 10,812 $ 20,004 $ 3,799 $ 7,802 Foreign........................ 950 990 1,963 343 623 -------- -------- -------- ----------- ----------- Total..................... $ 7,315 $ 11,802 $ 21,967 $ 4,142 $ 8,425 ======= ======= ======= ======== ========
The Company has no material identifiable assets used in connection with the Company's foreign operations. 12. SUBSEQUENT EVENT The Company's amended and restated articles of incorporation, which were filed on November 13, 1996, as discussed above in Note 10, also effected a change in common stock from no par value to par value of $.01 per share. In the quarter ending January 24, 1997, $89,700 will be transferred from retained earnings to common stock to reflect the change in par value. F-14 70 [PHOTOGRAPHS OF A CD-ROM AND A CD FORCE SERVER AND GRAPHICS DISPLAYING NETWORK CONNECTIVITY, GRAPHICAL USER INTERFACES, ACCESS THROUGH THE INTERNET AND MESA ARCHITECTURE BEARING THE FOLLOWING CAPTIONS: "CD FORCE - THE POWER TO SEAMLESSLY NETWORK CDS(TM)," "CD -- FORCE SERVERS PROVIDE CROSS-PLATFORM ACCESS TO CD-ROMS," "ENTERPRISE WIDE CD-ROM NETWORKING SOFTWARE," "WINDOWS -- MACINTOSH O/S -- IBM OS/2 WARP -- UNIX," "CENTRALIZED AND REMOTE ADMINISTRATOR ACCESS AND GRAPHICAL USER INTERFACE ("GUI")," "EASY USER ACCESS TO CDS FROM NETWORKS OR WITH SIMILAR GUIS THROUGH THE INTERNET," "MESA(TM) -- MANAGED ENTERPRISE STORAGE ARCHITECTURE" AND "PROCOM TECHNOLOGY -- INTELLIGENT STORAGE FOR THE ENTERPRISE(TM)."] 71 - ------------------------------------------------------------ - ------------------------------------------------------------ No dealer, salesperson or other person has been authorized to give any information or to make any representation not contained in this Prospectus in connection with the offer made in this Prospectus and, if given or made, such information or representation must not be relied upon as having been authorized by the Company, the Underwriters or the Selling Shareholders. This Prospectus does not constitute an offer to sell or solicitation of an offer to buy any of the securities offered hereby by anyone in any jurisdiction in which the person making such offer or solicitation is not qualified to do so or to anyone to whom it is unlawful to make such offer or solicitation. Neither the delivery of this Prospectus nor any sale made hereunder shall under any circumstances create any implication that the affairs of the Company since the date hereof or the information herein is correct as of any time subsequent to the date of this Prospectus. --------------------------------- TABLE OF CONTENTS ---------------------------------
PAGE ----- Prospectus Summary........................ 3 Risk Factors.............................. 5 Capitalization............................ 15 Dilution.................................. 16 Selected Consolidated Financial Data...... 17 Management's Discussion and Analysis of Financial Condition and Results of Operations.............................. 18 Business.................................. 27 Management................................ 42 Certain Transactions...................... 47 Principal and Selling Shareholders........ 48 Description of Capital Stock.............. 49 Shares Eligible for Future Sale........... 52 Underwriting.............................. 53 Legal Matters............................. 54 Experts................................... 54 Change in Accountants..................... 54 Additional Information.................... 54 Index to Consolidated Financial Statements.............................. F-1
------------------------ Until , 1997 (25 days after the date of this Prospectus), all dealers effecting transactions in the registered securities, whether or not participating in this distribution, may be required to deliver a Prospectus. This delivery requirement is in addition to the obligation of dealers to deliver a Prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions. - ------------------------------------------------------------ - ------------------------------------------------------------ - ------------------------------------------------------------ - ------------------------------------------------------------ 3,025,000 SHARES [PROCOM LOGO] COMMON STOCK ------------------------ PROSPECTUS ------------------------ MONTGOMERY SECURITIES DAIN BOSWORTH INCORPORATED , 1996 - ------------------------------------------------------------ - ------------------------------------------------------------ 72 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION The following table sets forth the expenses, other than underwriting discounts and commissions, payable in connection with the issuance and distribution of the Common Stock being registered, all of which will be paid by the Company. All amounts are estimates except the Securities and Exchange Commission registration fee, the NASD filing fee and the Nasdaq National Market listing fee. Securities and Exchange Commission registration fee.............. $ 11,596 NASD filing fee.................................................. 4,327 Nasdaq National Market listing fee............................... 45,000 Accounting fees and expenses..................................... 120,000 Legal fees and expenses.......................................... 250,000 Blue Sky qualification fees and expenses......................... 7,000 Printing and engraving expenses.................................. 100,000 Transfer agent and registrar fees................................ 3,000 D&O Insurance.................................................... 200,000 Road Show expenses............................................... 30,000 Miscellaneous.................................................... 9,077 -------- Total.................................................. $780,000 ========
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS The California General Corporation Law provides that California corporations may include provisions in their articles of incorporation relieving directors of monetary liability for breach of their fiduciary duties as directors, except for the liability of a director resulting from (i) any transaction from which the director derives an improper personal benefit, (ii) acts or omissions involving intentional misconduct or a knowing and culpable violation of law, (iii) acts or omissions that a director believes to be contrary to the best interests of the Company or its shareholders or that involve the absence of good faith on the part of the director, (iv) acts or omissions constituting an unexcused pattern of inattention that amounts to an abdication of the director's duty to the Company or its shareholders, (v) acts or omissions showing a reckless disregard for the director's duty to the Company or its shareholders in circumstances in which the director was aware or should have been aware, in the ordinary course of performing a director's duties, of a risk of serious injury to the Company or its shareholders, (vi) any improper transaction between a director and the Company in which the director has a material financial interest (Section 310) or (vii) the making of an illegal distribution to shareholders or an illegal loan or guaranty (Section 316). The Company's Articles of Incorporation provide that the Company's directors are not liable to the Company or its shareholders for monetary damages for breach of their fiduciary duties to the fullest extent permitted by California law. Such limitation of liability does not affect the availability of equitable remedies such as injunctive relief or rescission. The Bylaws of the Company (the "Bylaws") provide that the Company will indemnify its directors and officers to the fullest extent permitted by California law, including circumstances in which indemnification is otherwise discretionary under California law, subject to certain limitations for actions initiated by the director or officer, settlements not approved by the Company, losses covered by the directors' and officers' liability insurance policy maintained by the Company and judgments for an accounting of profits pursuant to Section 16(b) of the Securities Exchange Act of 1934 and similar laws. In addition, the Company may not indemnify directors and officers in circumstances in which indemnification is expressly prohibited by Section 317 of the Law. The Company has entered into indemnification agreements with certain of its directors and officers that require the Company to indemnify such directors and officers to the fullest extent permitted by applicable provisions of law, provided that any settlement of a third party action against a director or officer is approved II-1 73 by the Company, and subject to limitations for actions initiated by the director or officer, penalties paid by insurance and violations of Section 16(b) of the Securities Exchange Act of 1934, as amended, and similar laws. The agreements contain provisions that are broader in some respects than the specific indemnification provisions contained in the California Corporations Code. The indemnification agreements may require the Company, among other things, to indemnify its officers and directors against certain liabilities that may arise by reason of their status or service as directors or executive officers (other than liabilities arising from willful misconduct of a culpable nature), to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified and to obtain directors' and officers' insurance, if available on reasonable terms. The Company expects to obtain directors' and officers' liability insurance with respect to liabilities arising out of certain matters, including matters arising under the Securities Act. The inclusion of the above provisions in the Company's Articles of Incorporation and Bylaws may have the effect of reducing the likelihood of derivative litigation against directors and may discourage or deter shareholders or management from bringing a lawsuit against directors for breach of their duty of care, even though such an action, if successful, might otherwise have benefitted the Company and its shareholders. This provision does not affect a director's responsibilities under certain other laws such as the federal securities laws or state or federal environmental laws. At present, there is no litigation or proceeding pending involving a director of the Company pursuant to which indemnification is being sought, nor is the Company aware of any threatened litigation that might result in claims for indemnification by any director. The Form of Underwriting Agreement filed as Exhibit 1.1 to this Registration Statement provides for indemnification by the Underwriters of the Company and its directors and officers for certain liabilities arising under the Securities Act or otherwise. ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES The following is a summary of transactions by the Company during the last three years preceding the date hereof involving sales of the Company's securities that were not registered under the Act: From time to time during the three years preceding the date hereof, the Registrant issued stock options to purchase 286,050 shares of Common Stock pursuant to the Registrant's 1995 Stock Option Plan (the "1995 Plan") to officers, directors and employees of the Registrant, of which 18,750 shares have been cancelled and made available for future grant. During the period referred to above, no options granted pursuant to 1995 Plan were exercised. Exemption from the registration provisions of the Act is claimed with respect to the grant of options referred to above in reliance on Section 2(3) of the Act as transactions by an issuer not involving the sale of a security and in reliance on the exemption provided for offers of securities contained in Rule 701 promulgated under the Act. II-2 74 ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES (A) EXHIBITS.
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT - ------- ------------------------------------------------------------------------------------- 1.1 Form of Underwriting Agreement 3.1+ Amended and Restated Articles of Incorporation of the Company 3.2+ Amended and Restated Bylaws of the Company 5.1+ Opinion of O'Melveny & Myers 10.1+ Form of Indemnity Agreement between the Company and each of its executive officers and directors 10.2+ Procom Technology, Inc. 1995 Stock Option Plan 10.3+ Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Alex Razmjoo 10.4+ Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Frank Alaghband 10.5+ Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Alex Aydin 10.6+ Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Nick Shahrestany 10.7+ Form of Registration Rights Agreement 10.8+ Lease, dated February 10, 1992, between 2181 Dupont Associates and the Company, as amended 10.9 Loan and Security Agreement, dated November 18, 1994, by and between the Company and FINOVA Capital Corporation, as amended 11.1+ Statement re: Computation of Earnings Per Share 16.1+ Letter re Change in Certifying Accountant 21.1+ List of Subsidiaries 23.1 Consent of Arthur Andersen LLP 23.3+ Consent of O'Melveny & Myers (included in Exhibit 5.1) 27.1+ Financial Data Schedule
- --------------- + Previously filed (b) FINANCIAL STATEMENT SCHEDULE AND REPORT OF INDEPENDENT AUDITOR. Report of Arthur Andersen LLP Set forth below is the financial statement schedule included as part of the Registration Statement: Schedule II All other schedules are omitted because they are not required, are not applicable, or the information is included in the Consolidated Financial Statements or notes thereto. II-3 75 ITEM 17. UNDERTAKINGS (a) The undersigned Registrant hereby undertakes to provide to the Underwriters at the closing specified in the Underwriting Agreement certificates in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. (b) Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered hereunder, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue. (c) The undersigned Registrant hereby undertakes that: (1) For purposes of determining any liability under the Securities Act, the information omitted from the form of prospectus filed as part of a registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of the registration statement as of the time it was declared effective. (2) For purposes of determining any liability under the Securities Act, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-4 76 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, as amended, the Registrant has duly caused this Amendment No. 2 to Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, County of Orange, State of California, on the 4th day of December, 1996. PROCOM TECHNOLOGY, INC. By: /s/ Alex Razmjoo -------------------------------------- Alex Razmjoo Chairman, President and Chief Executive Officer Pursuant to the requirements of the Securities Act of 1933, as amended, this Amendment No. 2 to Registration Statement has been signed below by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE - --------------------------------- ----------------------------------------- ----------------- /s/ Alex Razmjoo Chairman of the Board, President and December 4, 1996 - --------------------------------- Chief Executive Officer (Principal Alex Razmjoo Executive Officer) /s/ Alex Aydin Executive Vice President, Finance and December 4, 1996 - --------------------------------- Administration (Principal Financial Alex Aydin Officer) /s/ Frederick Judd Vice President, Finance and General December 4, 1996 - --------------------------------- Counsel (Principal Accounting Officer) Frederick Judd /s/ Frank Alaghband Director December 4, 1996 - --------------------------------- Frank Alaghband /s/ Nick Shahrestany Director December 4, 1996 - --------------------------------- Nick Shahrestany Director December , 1996 - --------------------------------- Samuel Inman Director December , 1996 - --------------------------------- Samuel Yau
II-5 77 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS The Board of Directors Procom Technology, Inc.: We have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Procom Technology, Inc. and subsidiary as of July 28, 1995 and July 26, 1996 and for each of the three years in the period ended July 26, 1996, which financial statements are included in this registration statement, and have issued our report thereon dated November 13, 1996. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in Item 16(b) herein is presented for purposes of complying with the Securities and Exchange Commissions rules and is not part of the basic financial statements. The information in the schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Orange County, California November 13, 1996 II-6 78 SCHEDULE II PROCOM TECHNOLOGY, INC. AND SUBSIDIARIES
COL. C ------------------------ COL. B ADDITIONS COL. E ------------ ------------------------ --------- COL. A BALANCE AT CHARGED TO CHARGED TO COL. D BALANCE - --------------------------------------------- BEGINNING OF COSTS AND OTHER ---------- AT END DESCRIPTION PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD - --------------------------------------------- ------------ ---------- ---------- ---------- --------- Year ended July 29, 1994: Allowance for sales returns................ $175,000 $ -- -- $ (50,000) $ 125,000 Allowance for doubtful accounts............ 171,000 241,000 -- (277,000) 135,000 Allowance for excess and obsolete inventory................................ 110,000 88,000 -- (118,000) 80,000 Year ended July 28, 1995: Allowance for sales returns................ $125,000 $ -- -- $ (52,000) $ 73,000 Allowance for doubtful accounts............ 135,000 322,000 -- (351,000) 106,000 Allowance for excess and obsolete inventory................................ 80,000 467,000 -- (477,000) 70,000 Year ended July 26, 1996: Allowance for sales returns................ $ 73,000 $130,000 -- $ -- $ 203,000 Allowance for doubtful accounts............ 106,000 473,000 -- (409,000) 170,000 Allowance for excess and obsolete inventory................................ 70,000 284,000 -- (199,000) 155,000
II-7 79 INDEX TO EXHIBITS
SEQUENTIALLY EXHIBIT NUMBER NUMBER DESCRIPTION PAGE - ------- -------------------------------------------------------------------------- ------------ 1.1 Form of Underwriting Agreement............................................ 3.1+ Amended and Restated Articles of Incorporation of the Company............. 3.2+ Amended and Restated Bylaws of the Company................................ 5.1+ Opinion of O'Melveny & Myers.............................................. 10.1+ Form of Indemnity Agreement between the Company and each of its executive officers and directors.................................................... 10.2+ Procom Technology, Inc. 1995 Stock Option Plan............................ 10.3+ Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Alex Razmjoo............................ 10.4+ Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Frank Alaghband......................... 10.5+ Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Alex Aydin.............................. 10.6+ Amended and Restated Executive Employment Agreement, dated as of October 28, 1996, between the Company and Nick Shahrestany........................ 10.7+ Form of Registration Rights Agreement..................................... 10.8+ Lease, dated February 10, 1992, between 2181 Dupont Associates and the Company, as amended....................................................... 10.9 Loan and Security Agreement, dated November 18, 1994, by and between the Company and FINOVA Capital Corporation, as amended........................ 11.1+ Statement re: Computation of Earnings Per Share........................... 16.1+ Letter re Change in Certifying Accountant................................. 21.1+ List of Subsidiaries...................................................... 23.1 Consent of Arthur Andersen LLP............................................ 23.3+ Consent of O'Melveny & Myers (included in Exhibit 5.1).................... 27.1+ Financial Data Schedule...................................................
- --------------- + Previously filed
EX-1.1 2 UNDERWRITING AGREEMENT 1 Exhibit 1.1 3,025,000 Shares* PROCOM TECHNOLOGY, INC. Common Stock UNDERWRITING AGREEMENT December __, 1996 MONTGOMERY SECURITIES DAIN BOSWORTH INC. As Representatives of the several Underwriters c/o MONTGOMERY SECURITIES 600 Montgomery Street San Francisco, California 94111 Dear Sirs: SECTION 1 INTRODUCTORY Procom Technology, Inc., a California corporation (the "Company"), proposes to issue and sell 2,000,000 shares of its authorized but unissued Common Stock, having a par value of $.01 per share (the "Common Stock"), and certain shareholders of the Company named in Schedule B annexed hereto (the "Selling Shareholders") propose to sell an aggregate of 1,025,000 shares of the Company's issued and outstanding Common Stock to the several underwriters named in Schedule A annexed hereto (the "Underwriters"), for whom you are acting as Representatives. Said aggregate of 3,025,000 shares are herein called the "Firm Common Shares." In addition, certain of the Selling Shareholders listed under "Optional Common Shares" in Schedule B annexed hereto propose to grant to the Underwriters an option to purchase up to 453,750 additional shares of Common Stock (the "Optional Common Shares"), as provided in Section 5 hereof. The Firm Common Shares and, to the extent such option is exercised, the Optional Common Shares are hereinafter collectively referred to as the "Common Shares." You have advised the Company and the Selling Shareholders that the Underwriters propose to make a public offering of their respective portions of the Common Shares on the effective date of the registration statement hereinafter referred to or as soon thereafter as in your judgment is advisable. The Company and each of the Selling Shareholders hereby confirm their respective agreements with respect to the purchase of the Common Shares by the Underwriters as follows: - -------- * Plus an option to purchase from certain of the Selling Shareholders, in the aggregate, up to 453,750 additional shares to cover over-allotments. 2 SECTION 2 REPRESENTATIONS AND WARRANTIES OF THE COMPANY AND THE SELLING SHAREHOLDERS. Each of the Selling Shareholders (other than Frederick Judd) and the Company, severally and not jointly, represent and warrant to the several Underwriters that: (a) A registration statement on Form S-1 (File No. 333-15109) with respect to the Common Shares has been prepared by the Company in conformity with the requirements of the Securities Act of 1933, as amended (the "Act"), and the rules and regulations (the "Rules and Regulations") of the Securities and Exchange Commission (the "Commission") thereunder, and has been filed with the Commission. The Company has prepared and has filed or proposes to file prior to the effective date of such registration statement an amendment or amendments to such registration statement, which amendment or amendments have been or will be similarly prepared. There have been delivered to you three signed copies of such registration statement and amendments, together with three copies of each exhibit filed therewith. Conformed copies of such registration statement and amendments (but without exhibits) and of the related preliminary prospectus have been delivered to you in such reasonable quantities as you have requested for each of the Underwriters. The Company will next file with the Commission one of the following: (i) prior to effectiveness of such registration statement, a further amendment thereto, including the form of final prospectus, (ii) a final prospectus in accordance with Rules 430A and 424(b) of the Rules and Regulations or (iii) a term sheet (the "Term Sheet") as described in and in accordance with Rules 434 and 424(b) of the Rules and Regulations. As filed, the final prospectus, if one is used, or the Term Sheet and Preliminary Prospectus, if a final prospectus is not used, shall include all Rule 430A Information (as hereinafter defined) and, except to the extent that you shall agree in writing to a modification, shall be in all substantive respects in the form furnished to you prior to the date and time that this Agreement was executed and delivered by the parties hereto or, to the extent not completed at such date and time, shall contain only such specific additional information and other changes (beyond those contained in the latest Preliminary Prospectus) as the Company shall have previously advised you in writing would be included or made therein. The term "Registration Statement" as used in this Agreement shall mean such registration statement at the time such registration statement becomes effective and, in the event any post-effective amendment thereto becomes effective prior to the First Closing Date (as hereinafter defined), shall also mean such registration statement as so amended; provided, however, that such term shall also include (i) all Rule 430A Information deemed to be included in such registration statement at the time such registration statement becomes effective as provided by Rule 430A of the Rules and Regulations and (ii) any registration statement filed pursuant to 462(b) of the Rules and Regulations relating to the Common Stock. The term "Preliminary Prospectus" shall mean any preliminary prospectus referred to in the preceding paragraph and any preliminary prospectus included in the Registration Statement at the time it becomes effective that omits Rule 430A Information. The term "Prospectus" as used in this Agreement shall mean either (i) the prospectus relating to the Common Shares in the form in which it is first filed with the Commission pursuant to Rule 424(b) of the Rules and Regulations, (ii) if a Term Sheet is not used and no filing pursuant to Rule 424(b) of the Rules and Regulations is required, shall mean the form of final prospectus included in the Registration Statement at the time such registration statement becomes effective or (iii) if a Term Sheet is used, the Term Sheet in the form in which it is first filed with the Commission pursuant to Rule 424(b) of the Rules and Regulations, together with the Preliminary Prospectus included in the Registration Statement at the time it becomes effective. The term "Rule -2- 3 430A Information" means information with respect to the Common Shares and the offering thereof permitted to be omitted from the Registration Statement when it becomes effective pursuant to Rule 430A of the Rules and Regulations. (b) The Commission has not issued any order preventing or suspending the use of any Preliminary Prospectus, and each Preliminary Prospectus has conformed in all material respects to the requirements of the Act and the Rules and Regulations and, as of its date, has not included any untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading; and at the time the Registration Statement becomes effective, and at all times subsequent thereto up to and including each Closing Date hereinafter mentioned, the Registration Statement and the Prospectus, and any amendments or supplements thereto, will contain all material statements and information required to be included therein by the Act and the Rules and Regulations and will in all material respects conform to the requirements of the Act and the Rules and Regulations, and neither the Registration Statement nor the Prospectus, nor any amendment or supplement thereto, will include any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading; provided, however, no representation or warranty contained in this subsection 2(b) shall be applicable to information contained in or omitted from any Preliminary Prospectus, the Registration Statement, the Prospectus or any such amendment or supplement in reliance upon and in conformity with written information furnished to the Company by or on behalf of any Underwriter, directly or through the Representatives, specifically for use in the preparation thereof. (c) The Company does not own or control, directly or indirectly, any corporation, association, joint venture or other entity other than the subsidiaries listed in Exhibit 21.1 to the Registration Statement. The Company and each of its subsidiaries have been duly incorporated and are validly existing as corporations in good standing under the laws of their respective jurisdictions of incorporation, with full power and authority (corporate and other) to own and lease their properties and conduct their respective businesses as described in the Prospectus; the Company owns all of the outstanding capital stock of its subsidiaries free and clear of all claims, liens, charges and encumbrances; the Company and each of its subsidiaries are in possession of and operating in compliance with all authorizations, licenses, permits, consents, certificates and orders material to the conduct of their respective businesses, all of which are valid and in full force and effect; the Company and each of its subsidiaries are duly qualified to do business and in good standing as foreign corporations in each jurisdiction in which the ownership or leasing of properties or the conduct of their respective businesses requires such qualification, except for jurisdictions in which the failure to so qualify would not have a material adverse effect upon the Company and its subsidiaries taken as a whole; and no proceeding has been instituted in any such jurisdiction, revoking, limiting or curtailing, or seeking to revoke, limit or curtail, such power and authority or qualification. (d) The Company, subject to the assumptions set forth in the Prospectus, has an authorized and outstanding Common Stock as set forth under the heading "Capitalization" in the Prospectus; the issued and outstanding shares of capital stock have been duly authorized and validly issued, are fully paid and nonassessable, have been issued in compliance with all federal and state securities laws, were not issued in violation of, or subject to, any preemptive rights or other rights to subscribe for or purchase securities, conform in all material respects to the description thereof contained in the Prospectus and, as of the First Closing Date (defined in Section 5(b) below), such Common Stock (including, without limitation, the Common Shares) will be duly listed or -3- 4 designated on the National Association of Securities Dealers Automated Quotation ("Nasdaq") National Market, subject to notice of issuance. All issued and outstanding shares of capital stock of each subsidiary of the Company have been duly authorized and validly issued and are fully paid and nonassessable. Except as disclosed in or contemplated by the Prospectus and the financial statements of the Company, and the related notes thereto, included in the Prospectus, neither the Company nor any subsidiary has outstanding any options to purchase, or any preemptive rights or other rights to subscribe for or to purchase, any securities or obligations convertible into, or any contracts or commitments to issue or sell, shares of its capital stock or any such options, rights, convertible securities or obligations. The description of the Company's stock option, stock bonus and other stock plans or arrangements, and the options or other rights granted and exercised thereunder, set forth in the Prospectus accurately and fairly presents the information required to be shown with respect to such plans, arrangements, options and rights. (e) The Common Shares to be sold by the Company have been duly authorized and, when issued, delivered and paid for in the manner set forth in this Agreement, will be duly authorized, validly issued, fully paid and nonassessable, and will conform in all material respects to the description thereof contained in the Prospectus. No preemptive rights or other rights to subscribe for or purchase exist with respect to the issuance and sale of the Common Shares by the Company pursuant to this Agreement. No shareholder of the Company has any right that has not been waived to require the Company to register the sale of any shares owned by such shareholder under the Act in the public offering contemplated by this Agreement. No further approval or authority of the shareholders or the Board of Directors of the Company will be required for the transfer and sale of the Common Shares to be sold by the Selling Shareholders or the issuance and sale of the Common Shares to be sold by the Company as contemplated herein. (f) The Company has full legal right, power and authority to enter into this Agreement and perform the transactions contemplated hereby. This Agreement has been duly authorized, executed and delivered by the Company and constitutes a valid and binding obligation of the Company enforceable in accordance with its terms. The making and performance of this Agreement by the Company and the consummation of the transactions herein contemplated will not violate any provisions of the articles of incorporation or bylaws, or other organizational documents, of the Company or any of its subsidiaries, and will not conflict with, result in the breach or violation of, or constitute, either by itself or upon notice or the passage of time or both, a default under any agreement, mortgage, deed of trust, lease, franchise, license, indenture, permit or other instrument to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries or any of their respective properties may be bound or affected, any statute or any authorization, judgment, decree, order, rule or regulation of any court or any regulatory body, administrative agency or other governmental body applicable to the Company or any of its subsidiaries or any of their respective properties. No consent, approval, authorization or other order of any court, regulatory body, administrative agency or other governmental body is required for the execution and delivery of this Agreement or the consummation of the transactions contemplated by this Agreement, except for compliance with the Act, the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Blue Sky laws applicable to the public offering of the Common Shares by the several Underwriters and the clearance of such offering with the National Association of Securities Dealers, Inc. (the "NASD"). (g) Arthur Andersen LLP has expressed its opinion with respect to the financial statements and schedule filed with the Commission as a part of the Registration Statement and -4- 5 included in the Prospectus and in the Registration Statement and are independent accountants as required by the Act and the Rules and Regulations. (h) The financial statements and schedule of the Company, and the related notes thereto, included in the Registration Statement and the Prospectus present fairly, in all material respects, the financial position of the Company as of the respective dates of such financial statements and schedule, and the results of operations and changes in financial position of the Company for the respective periods covered thereby. Such statements, schedule and related notes have been prepared in accordance with generally accepted accounting principles applied on a consistent basis as certified by the independent accountants named in subsection 2(g). No other financial statements or schedules are required to be included in the Registration Statement. The selected financial and statistical data set forth in the Prospectus under the captions "Prospectus Summary," "Capitalization," "Dilution," "Selected Consolidated Financial Data," "Management's Discussion and Analysis of Financial Condition and Results of Operations," "Management," "Certain Transactions," "Principal and Selling Shareholders" and "Shares Eligible for Future Sale" fairly present, in all material respects, the information set forth therein on the basis stated in the Registration Statement. (i) Neither the Company nor any of its subsidiaries is in violation or default of any provision of its certificate of incorporation or bylaws, or other organizational documents. Except as disclosed in the Prospectus, and except as to defaults which individually or in the aggregate would not be material to the Company and its subsidiaries taken as a whole, neither the Company nor any of its subsidiaries is in breach of or default with respect to any provision of any agreement, judgment, decree, order, mortgage, deed of trust, lease, franchise, license, indenture, permit or other instrument to which it is a party or by which it or any of its properties are bound. The Company is not aware of any state of facts which constitutes an event of default on the part of the Company or any such subsidiary as defined in such documents or which, with notice or lapse of time or both, would constitute such an event of default. (j) There is no statute, contract or other document required to be described in the Registration Statement or contract or other document required to be filed as an exhibit to the Registration Statement by the Act or by the Rules and Regulations which has not been described or filed as required. The statutes, contracts or other documents described in the Registration Statement and the Prospectus fairly present, in all material respects, the information required to be provided by the Act and the Rules and Regulations. The contracts so described in the Prospectus or filed as exhibits to the Registration Statement are in full force and effect on the date hereof. Except as to breaches or defaults which in any single case or in the aggregate would not have a material adverse effect on the Company and its subsidiaries taken as a whole, neither the Company nor any of its subsidiaries, nor to the best of the Company's knowledge, any other party is in breach of or default under any of such contracts. Complete and fully executed copies of such contracts were made available to counsel for the Underwriters and there exist no agreements or other documents which modify, change or amend such contracts. (k) There is no legal or governmental action, suit or proceeding pending or, to the best of the Company's knowledge, threatened to which the Company or any of its subsidiaries is or may be a party or of which property owned or leased by the Company or any of its subsidiaries is or may be the subject, or related to environmental or discrimination matters, which action, suit or proceeding might, individually or in the aggregate with all such actions, suits or proceedings, prevent or adversely affect the transactions contemplated by this Agreement or result in a material adverse change in the condition (financial or otherwise), properties, business, results of operations or -5- 6 prospects of the Company and its subsidiaries taken as a whole; and no labor disturbance by the employees of the Company or any of its subsidiaries exists or is imminent which might be expected to materially adversely affect such condition, properties, business, results of operations or prospects. Neither the Company nor any of its subsidiaries is a party or subject to the provisions of any material injunction, judgment, decree or order of any court, regulatory body, administrative agency or other governmental body. (l) The Company or the applicable subsidiary has good and marketable title to all the properties and assets reflected as owned in the financial statements described above (or elsewhere in the Prospectus), subject to no lien, mortgage, pledge, charge or encumbrance of any kind except (i) those, if any, reflected in such financial statements (or elsewhere in the Prospectus) or (ii) those which are not material in amount and do not materially adversely affect the use made and proposed to be made of such property by the Company and its subsidiaries. The Company or the applicable subsidiary holds its leased properties under valid and binding leases, with such exceptions as are not materially significant in relation to the business of the Company and its subsidiaries taken as a whole. Except as disclosed in the Prospectus, the Company owns or leases all such properties as are necessary to its operations as now conducted or as proposed to be conducted. (m) Since the respective dates as of which information is given in the Registration Statement and Prospectus, and except as described in or specifically contemplated by the Prospectus: (i) the Company and its subsidiaries have not incurred any material liabilities or obligations, indirect, direct or contingent, or entered into any material verbal or written agreement or other transaction which is not in the ordinary course of business or which could result in a material reduction in the future net income of the Company and its subsidiaries taken as a whole; (ii) the Company and its subsidiaries have not sustained any material loss or interference with their respective businesses or properties from fire, flood, windstorm, earthquake, accident or other calamity, whether or not covered by insurance; (iii) the Company has not paid or declared any dividends or other distributions with respect to its capital stock and the Company and its subsidiaries are not in default in the payment of principal or interest on any outstanding material debt obligations; (iv) there has not been any change in the capital stock (other than upon the sale of the Common Shares hereunder) or indebtedness material to the Company and its subsidiaries taken as a whole (other than in the ordinary course of business); and (v) there has not been any material adverse change in the condition (financial or otherwise), business, properties, results of operations or prospects of the Company and its subsidiaries taken as a whole. (n) Except as disclosed in or specifically contemplated by the Prospectus, the Company and its subsidiaries have sufficient trademarks, trade names, patent rights, mask works, copyrights, moral rights, licenses, approvals and governmental authorizations to conduct their businesses as now conducted; the expiration of any trademarks, trade names, patent rights, mask works, moral rights, copyrights, licenses, approvals or governmental authorizations would not have a material adverse effect on the condition (financial or otherwise), business, results of operations or prospects of the Company or its subsidiaries taken as a whole; and the Company has no knowledge of any infringement by it or its subsidiaries of trademark, trade name rights, patent rights, mask works, copyrights, moral rights, licenses, trade secret or other similar rights of others, and there is no claim being made against the Company or its subsidiaries regarding trademark, trade name, patent, mask work, copyright, moral right, license, trade secret or other infringement which could have a material adverse effect on the condition (financial or otherwise), business, results of operations or prospects of the Company and its subsidiaries taken as a whole. -6- 7 (o) The Company has not been advised, and has no reason to believe, that either it or any of its subsidiaries is not conducting business in compliance with all applicable laws, rules and regulations of the jurisdictions in which it is conducting business, including, without limitation, all applicable local, state and federal environmental laws and regulations, except where failure to be so in compliance would not materially adversely affect the condition (financial or otherwise), business, results of operations or prospects of the Company and its subsidiaries taken as a whole. (p) The Company and its subsidiaries have filed all necessary federal, state and foreign income and franchise tax returns and have paid all taxes shown as due thereon; and the Company has no knowledge of any tax deficiency which has been or might be asserted or threatened against the Company or its subsidiaries which could materially and adversely affect the business, operations or properties of the Company and its subsidiaries taken as a whole. (q) Neither the Company nor any of its subsidiaries is or, after application of the net proceeds of this offering as described under the caption "Use of Proceeds" in the Prospectus, will become an "investment company" or an entity "controlled" by an "investment company" as such terms are defined in the Investment Company Act of 1940, as amended (the "Investment Company Act"), and the rules and regulations of the Commission thereunder. The Company intends to conduct its business in a manner such that it will not become an "investment company" subject to regulation under the Investment Company Act. (r) The Company has not distributed nor caused to be distributed, and will not distribute nor cause to be distributed prior to the First Closing Date, any offering material in connection with the offering and sale of the Common Shares other than the Prospectus, the Registration Statement and the other materials permitted by the Act. (s) Each of the Company and its subsidiaries maintains insurance of such types and in such amounts as are customary for its business, including, but not limited to, insurance covering real and personal property owned or leased by the Company and its subsidiaries against theft, damage, destruction, acts of vandalism and all other risks customarily insured against, all of which insurance is in full force and effect. (t) Neither the Company nor any of its subsidiaries has at any time during the last five years (i) made any unlawful contribution to any candidate for foreign office or failed to disclose fully any contribution in violation of law or (ii) made any payment to any federal or state governmental officer or official, or other person charged with similar public or quasi-public duties, other than payments required or permitted by the laws of the United States or any jurisdiction thereof. (u) The Company maintains a system of internal accounting controls that it believes is sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorization, (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets, (iii) access to assets is permitted only in accordance with management's general or specific authorization and (iv) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (v) The Company has not taken and will not take, directly or indirectly, any action designed to or that might be reasonably expected to cause or result in stabilization or manipulation of the price of the Common Stock to facilitate the sale or resale of the Common Shares. -7- 8 (w) All material transactions that are required to be disclosed in the Prospectus under applicable Rules and Regulations between the Company and/or any of its subsidiaries, on the one hand, and any of their officers, directors and shareholders holding 5% or more of the Company's capital stock, on the other hand, have been accurately disclosed in all material respects in the Prospectus. (x) The Company has obtained agreements from each of its directors, officers and shareholders holding more than 6,000 shares providing that such person will not, for a period of 180 days directly or indirectly, sell, transfer the economic risk of ownership in, make any short sale, pledge, offer to sell, contract to sell or otherwise dispose of any shares of Common Stock or any securities exercisable for or exchangeable with or any other rights to purchase or acquire any shares of Common Stock, other than (i) as a bona fide gift or gifts where prior notice is provided to you and the donee or donees agree to be bound to the agreement or (ii) with the prior written consent of Montgomery Securities, which consent may be withheld at the sole discretion of Montgomery Securities. Each such person has also agreed and consented to the entry of stop transfer instructions with the Company's transfer agent and registrar against the transfer of shares of Common Stock held by such persons or entity, unless in compliance with the foregoing restrictions. (y) The Company is not aware that (A) any executive, key employee or significant group of employees of the Company or any subsidiary plans to terminate employment with the Company or any such subsidiary or (B) any such executive or key employee is subject to any noncompete, nondisclosure, confidentiality, employment, consulting or similar agreement that would be violated by the present or proposed business activities of the Company and its subsidiaries. Neither the Company nor any subsidiary has or expects to have any liability for any prohibited transaction or funding deficiency or any complete or partial withdrawal liability with respect to any pension, profit sharing or other plan which is subject to the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), or any other retirement, pension, profit sharing plan or other plan, to which the Company or any subsidiary makes or ever has made a contribution and in which any employee of the Company or any subsidiary is or has ever been a participant. With respect to such plans, the Company and each subsidiary are in compliance in all material respects with all applicable provisions of ERISA. (z) Other than as contemplated by this Agreement, there is no broker, finder or other party that is entitled to receive from the Company any brokerage or finder's fee or other fee or commission as a result of any of the transactions contemplated by this Agreement. SECTION 3 REPRESENTATIONS. WARRANTIES AND COVENANTS OF THE SELLING SHAREHOLDERS (a) Each of the Selling Shareholders, severally and not jointly, represents and warrants to, and agrees with, the several Underwriters that: (i) Such Selling Shareholder has, and on the First Closing Date and the Second Closing Date hereinafter mentioned will have, good and marketable title to the Common Shares proposed to be sold by such Selling Shareholder hereunder on such Closing Date and full right, power and authority to enter into this Agreement and to sell, assign, transfer and deliver such Common Shares hereunder, free and clear of all voting trust arrangements, liens, encumbrances, equities, security interests, restrictions and claims whatsoever; and upon delivery of and payment for such Common Shares hereunder, the Underwriters will acquire good and marketable title thereto, -8- 9 free and clear of all liens, encumbrances, equities, claims, restrictions, security interests, voting trusts or other defects of title whatsoever. (ii) Such Selling Shareholder has executed and delivered a Custody Agreement (hereinafter referred to as the "Custody Agreement") and in connection herewith such Selling Shareholder further represents, warrants and agrees that such Selling Shareholder has deposited in custody, under the Custody Agreement, with the agent named therein (the "Agent") as custodian, certificates in negotiable form for the Common Shares to be sold hereunder by such Selling Shareholder, for the purpose of further delivery pursuant to this Agreement. Such Selling Shareholder agrees that the Common Shares to be sold by such Selling Shareholder on deposit with the Agent are subject to the interests of the Company and the Underwriters, that the arrangements made for such custody are to that extent irrevocable, and that the obligations of such Selling Shareholder hereunder shall not be terminated, except as provided in this Agreement or in the Custody Agreement, by any act of such Selling Shareholder, by operation of law, by the death or incapacity of such Selling Shareholder or by the occurrence of any other event. If the Selling Shareholder should die or become incapacitated, or if any other event should occur, before the delivery of the Common Shares hereunder, the documents evidencing Common Shares then on deposit with the Agent shall be delivered by the Agent in accordance with the terms and conditions of this Agreement as if such death, incapacity or other event had not occurred, regardless of whether or not the Agent shall have received notice thereof. This Agreement and the Custody Agreement have been duly executed and delivered by or on behalf of such Selling Shareholder and the form of such Custody Agreement has been delivered to you. (iii) The performance of this Agreement and the Custody Agreement and the consummation of the transactions contemplated hereby and by the Custody Agreement will not result in a breach or violation by such Selling Shareholder of any of the terms or provisions of, or constitute a default by such Selling Shareholder under, any material indenture, mortgage, deed of trust, trust (constructive or other), loan agreement, lease, franchise, license or other agreement or instrument to which such Selling Shareholder is a party or by which such Selling Shareholder or any of its properties is bound, any statute, or any judgment, decree, order, rule or regulation of any court or governmental agency or body applicable to such Selling Shareholder or any of its properties. (iv) Such Selling Shareholder has not taken and will not take, directly or indirectly, any action designed to or which has constituted or which might reasonably be expected to cause or result in stabilization or manipulation of the price of any security of the Company to facilitate the sale or resale of the Common Shares. (b) Frederick Judd represents and warrants that, after due inquiry and investigation, he is not aware that any of the representations and warranties of the Company and the other Selling Stockholders set forth in Section 2 above is untrue, inaccurate or incomplete in any material respect. SECTION 4 REPRESENTATIONS AND WARRANTIES OF THE UNDERWRITERS The Representatives, on behalf of the several Underwriters, represent and warrant to the Company and to the Selling Shareholders that the information set forth (i) on the cover page of the Prospectus with respect to price, underwriting discounts and commissions and terms of offering and (ii) under "Underwriting" in the Prospectus was furnished to the Company by and on behalf of the Underwriters for use in connection with the preparation of the Registration Statement and the Prospectus and is correct in all material respects. Each Representative represents and warrants that -9- 10 it has been authorized by each of the other Underwriters as such Underwriter's Representative to enter into this Agreement on its behalf and to act for it in the manner herein provided. SECTION 5 PURCHASE. SALE AND DELIVERY OF COMMON SHARES On the basis of the representations, warranties and agreements herein contained, but subject to the terms and conditions herein set forth, (i) the Company agrees to issue and sell to the Underwriters 2,000,000 of the Firm Common Shares, and (ii) the Selling Shareholders agree, severally and not jointly, to sell to the Underwriters in the respective amounts set forth in Schedule B hereto, an aggregate of 1,025,000 of the Firm Common Shares. The Underwriters agree, severally and not jointly, to purchase from the Company and the Selling Shareholders, respectively, the number of Firm Common Shares described below. (a) The purchase price per share to be paid by the several Underwriters to the Company and to the Selling Shareholders, respectively, shall be $ _____ per share. The obligation of each Underwriter to the Company shall be to purchase from the Company that number of full shares which (as nearly as practicable, as determined by you) bears to 2,000,000 the same proportion as the number of shares set forth opposite the name of such Underwriter in Schedule A hereto bears to the total number of Firm Common Shares. The obligation of each Underwriter to the Selling Shareholders shall be to purchase from the Selling Shareholders that number of full shares which (as nearly as practicable, as determined by you) bears to 1,025,000 the same proportion as the number of shares set forth opposite the name of such Underwriter in Schedule A hereto bears to the total number of Firm Common Shares. (b) Delivery of certificates for the Firm Common Shares to be purchased by the Underwriters and payment therefor shall be made at the offices of O'Melveny & Myers, 610 Newport Centre Drive, Suite 1700, Newport Beach, California (or such other place as may be agreed upon by the Company and the Representatives) at such time and date, not later than the third (or, if the Firm Common Shares are priced as contemplated by Rule 15c6-1(c) under the Exchange Act, after 4:30 P.M. Washington DC time, the fourth) full business day following the first date that any of the Common Shares are released by you for sale to the public, as you shall designate by at least 48 hours prior notice to the Company (or at such other time and date, not later than one week after such third full business day as may be agreed upon by the Company and the Representatives) (the "First Closing Date"); provided, however, that if the Prospectus is at any time prior to the First Closing Date recirculated to the public, the First Closing Date shall occur upon the later of the third or fourth, as the case may be, full business day following the first date that any of the Common Shares are released by you for sale to the public or the date that is 48 hours after the date that the Prospectus has been so recirculated. (c) Delivery of certificates for the Firm Common Shares shall be made by or on behalf of the Company and the Selling Shareholders to you, for the respective accounts of the Underwriters with respect to the Firm Common Shares to be sold by the Company and by the Selling Shareholders against payment by you, for the accounts of the several Underwriters, of the purchase price therefor by a wire transfer of immediately available funds to an account designated by the Company and of the Agent in proportion to the number of Firm Common Shares to be sold by the Company and the Selling Shareholders, respectively. The certificates for the Firm Common Shares shall be registered in such names and denominations as you shall have requested at least two full business days prior to the First Closing Date, and shall be made available for checking and packaging on the business day preceding the First Closing Date at a location in New York, New -10- 11 York, as may be designated by you. Time shall be of the essence, and delivery at the time and place specified in this Agreement is a further condition to the obligations of the Underwriters. (d) In addition to the Firm Common Shares and on the basis of the representations, warranties and agreements herein contained, but subject to the terms and conditions herein set forth, certain of the Selling Shareholders as indicated in Schedule B annexed hereto, severally and not jointly, hereby grant an option to the several Underwriters to purchase, severally and not jointly, up to an aggregate of 453,750 Optional Common Shares at the purchase price per share to be paid for the Firm Common Shares, for use solely in covering any over-allotments made by you for the account of the Underwriters in the sale and distribution of the Firm Common Shares. The option granted hereunder may be exercised at any time (but not more than once) within 30 days after the first date that any of the Common Shares are released by you for sale to the public, upon notice by you to the Selling Shareholders setting forth the aggregate number of Optional Common Shares as to which the Underwriters are exercising the option, the names and denominations in which the certificates for such shares are to be registered and the time and place at which such certificates will be delivered. Such time of delivery (which may not be earlier than the First Closing Date), being herein referred to as the "Second Closing Date," shall be determined by you, but if at any time other than the First Closing Date shall not be earlier than three nor later than five full business days after delivery of such notice of exercise. The number of Optional Common Shares to be purchased by each Underwriter shall be determined by multiplying the number of Optional Common Shares to be sold by such Selling Shareholders pursuant to such notice of exercise by a fraction, the numerator of which is the number of Firm Common Shares to be purchased by such Underwriter as set forth opposite its name in Schedule A and the denominator of which is 3,025,000 (subject to such adjustments to eliminate any fractional share purchases as you in your discretion may make). Certificates for the Optional Common Shares will be made available for checking and packaging on the business day preceding the Second Closing Date at a location in New York, New York, as may be designated by you. The manner of payment for and delivery of the Optional Common Shares shall be the same as for the Firm Common Shares purchased from such Selling Shareholders as specified in the two preceding paragraphs. At any time before lapse of the option, you may cancel such option by giving written notice of such cancellation to such Selling Shareholders. If the option is canceled or expires unexercised in whole or in part, the Company will deregister under the Act the number of Optional Common Shares as to which the option has not been exercised. (e) You have advised the Company and the Selling Shareholders that each Underwriter has authorized you to accept delivery of its Common Shares, to make payment and to deliver a receipt therefor. You, individually and not as the Representatives of the Underwriters, may (but shall not be obligated to) make payment for any Common Shares to be purchased by any Underwriter whose funds shall not have been received by you by the First Closing Date or the Second Closing Date, as the case may be, for the account of such Underwriter, but any such payment shall not relieve such Underwriter from any of its obligations under this Agreement. (f) Subject to the terms and conditions hereof, the Underwriters propose to make a public offering of their respective portions of the Common Shares as soon after the effective date of the Registration Statement as in the judgment of the Representatives is advisable and at the public offering price set forth on the cover page of, and on the terms set forth in, the final prospectus, if one is used, or on the first page of the Term Sheet, if one is used. -11- 12 SECTION 6 COVENANTS OF THE COMPANY The Company covenants and agrees that: (a) The Company will use its best efforts to cause the Registration Statement and any amendment thereof, if not effective at the time and date that this Agreement is executed and delivered by the parties hereto, to become effective. If the Registration Statement has become or becomes effective pursuant to Rule 430A of the Rules and Regulations, or the filing of the Prospectus is otherwise required under Rule 424(b) of the Rules and Regulations, the Company will file the Prospectus, properly completed, pursuant to the applicable paragraph of Rule 424(b) of the Rules and Regulations within the time period prescribed and will provide evidence satisfactory to you of such timely filing. The Company will promptly advise you in writing (i) of the receipt of any comments of the Commission, (ii) of any request of the Commission for amendment of or supplement to the Registration Statement (either before or after it becomes effective), any Preliminary Prospectus or the Prospectus or for additional information, (iii) when the Registration Statement shall have become effective and (iv) of the issuance by the Commission of any stop order suspending the effectiveness of the Registration Statement or of the institution of any proceedings for that purpose. If the Commission shall enter any such stop order at any time, the Company will use its best efforts to obtain the lifting of such order at the earliest possible moment. The Company will not file any amendment or supplement to the Registration Statement (either before or after it becomes effective), any Preliminary Prospectus or the Prospectus unless a copy of the same has been furnished to you a reasonable time prior to such filing and will not file any such document to which you reasonably object or which is not in compliance with the Act and the Rules and Regulations. (b) The Company will prepare and file with the Commission, promptly upon your request, any amendments or supplements to the Registration Statement or the Prospectus which in your judgment may be necessary or advisable to enable the several Underwriters to continue the distribution of the Common Shares and will use its best efforts to cause the same to become effective as promptly as possible. The Company will fully and completely comply with the provisions of Rule 430A of the Rules and Regulations with respect to information omitted from the Registration Statement in reliance upon such Rule. (c) If at any time within the nine-month period referred to in Section 10(a)(3) of the Act during which a prospectus relating to the Common Shares is required to be delivered under the Act any event occurs, as a result of which the Prospectus, including any amendments or supplements, would include an untrue statement of a material fact, or omit to state any material fact required to be stated therein or necessary to make the statements therein not misleading, or if it is necessary at any time to amend the Prospectus, including any amendments or supplements, to comply with the Act or the Rules and Regulations, the Company will promptly advise you thereof and will promptly prepare and file with the Commission, at its own expense, an amendment or supplement which will correct such statement or omission or an amendment or supplement which will effect such compliance and will use its best efforts to cause the same to become effective as soon as possible; and, in case any Underwriter is required to deliver a prospectus after such nine-month period, the Company upon request, but at the expense of such Underwriter, will promptly prepare such amendment or amendments to the Registration Statement and such Prospectus or Prospectuses as may be necessary to permit compliance with the requirements of Section 10(a)(3) of the Act. -12- 13 (d) As soon as practicable, but not later than 45 days after the end of the first quarter ending after one year following the "effective date of the Registration Statement" (as defined in Rule 158(c) of the Rules and Regulations), the Company will make generally available to its security holders an earnings statement (which need not be audited) covering a period of 12 consecutive months beginning after the effective date of the Registration Statement which will satisfy the provisions of the last paragraph of Section 11(a) of the Act. (e) During such period as a prospectus is required by law to be delivered in connection with sales by an Underwriter or dealer, the Company, at its expense, but only for the nine-month period referred to in Section 10(a)(3) of the Act, will furnish to you and the Selling Shareholders or mail to your order copies of the Registration Statement, the Prospectus, the Preliminary Prospectus and all amendments and supplements to any such documents in each case as soon as available and in such quantities as you and the Selling Shareholders may reasonably request, for the purposes contemplated by the Act. (f) The Company shall cooperate with you and your counsel in order to qualify or register the Common Shares for sale under (or obtain exemptions from the application of) the Blue Sky laws of such jurisdictions as you designate, will comply with such laws and will continue such qualifications, registrations and exemptions in effect so long as reasonably required for the distribution of the Common Shares. The Company shall not be required to qualify as a foreign corporation or to file a general consent to service of process in any such jurisdiction where it is not presently qualified or where it would be subject to taxation as a foreign corporation. The Company will advise you promptly of the suspension of the qualification or registration of (or any such exemption relating to) the Common Shares for offering, sale or trading in any jurisdiction or any initiation or threat of any proceeding for any such purpose, and in the event of the issuance of any order suspending such qualification, registration or exemption, the Company, with your cooperation, will use its best efforts to obtain the withdrawal thereof. (g) During the period of five years hereafter, the Company will furnish to the Representatives and, upon request of the Representatives, to each of the other Underwriters: (i) as soon as practicable after the end of each fiscal year, copies of the Annual Report of the Company containing the balance sheet of the Company as of the close of such fiscal year and statements of income, shareholders' equity and cash flows for the year then ended and the opinion thereon of the Company's independent public accountants; (ii) as soon as practicable after the filing thereof, copies of each proxy statement, Annual Report on Form 10-K, Quarterly Report on Form 10-Q, Report on Form 8-K or other report filed by the Company with the Commission, the NASD or any securities exchange; and (iii) as soon as available, copies of any report or communication of the Company mailed generally to holders of its Common Stock. (h) During the period of 180 days after the effective date of the Registration Statement, without the prior written consent of either Montgomery Securities or each of the Representatives (which consent may be withheld at the sole discretion of Montgomery Securities or the Representatives, as the case may be), the Company will not (other than the grant of additional options, the issuance of other securities under the Company's 1995 Stock Option Plan or pursuant to outstanding stock options disclosed in the Prospectus) issue, offer, sell, grant options to purchase or otherwise dispose of any of the Company's equity securities or any other securities convertible into, exercisable for or exchangeable with its Common Stock or other equity security. -13- 14 (i) The Company will apply the net proceeds of the sale of the Common Shares sold by it substantially in accordance with its statements under the caption "Use of Proceeds" in the Prospectus. (j) The Company will use its best efforts to qualify or register its Common Stock for sale in non-issuer transactions under (or obtain exemptions from the application of) the Blue Sky laws of the State of California (and thereby permit market making transactions and secondary trading in the Company's Common Stock in California), will comply with such Blue Sky laws and will continue such qualifications, registrations and exemptions in effect for a period of the shorter of (i) five years after the date hereof and (ii) such date as the Common Stock is no longer registered under the Exchange Act. (k) The Company will use its best efforts to designate its Common Stock, including the Common Shares to be issued and sold by the Company and the Selling Shareholders, for quotation on the Nasdaq National Market. (l) The Company will take the steps, if any, necessary to create and enforce lock-up agreements with each option holder of the Company for a period of 90 days after the effective date of the Registration Statement and will not waive any such lock-up agreements during such 90-day period without the prior written consent of Montgomery Securities. You, on behalf of the Underwriters, may, in your sole discretion, waive in writing the performance by the Company of any one or more of the foregoing covenants or extend the time for their performance. SECTION 7 PAYMENT OF EXPENSES Whether or not the transactions contemplated hereunder are consummated or this Agreement becomes effective or is terminated, the Company and, unless otherwise paid by the Company, the Selling Shareholders agree to pay all costs, fees and expenses incurred in connection with the performance of their obligations hereunder and in connection with the transactions contemplated hereby, including without limiting the generality of the foregoing, (i) all expenses incident to the issuance and delivery of the Common Shares (including all printing and engraving costs), (ii) all fees and expenses of the registrar and transfer agent of the Common Stock, (iii) all necessary issue, transfer and other stamp taxes in connection with the issuance and sale of the Common Shares to the Underwriters, (iv) all fees and expenses of the Company's and the Selling Shareholder's counsel and the Company's independent accountants, (v) all costs and expenses incurred in connection with the preparation, printing, filing, shipping and distribution of the Registration Statement, each Preliminary Prospectus and the Prospectus (including all exhibits and financial statements) and all amendments and supplements provided for herein, this Agreement, the Agreement Among Underwriters, the Selected Dealers Agreement, the Underwriters' Questionnaire, the Underwriters' Power of Attorney and the Blue Sky memorandum, (vi) all filing fees, reasonable attorneys' fees and expenses incurred by the Company or the Underwriters in connection with qualifying or registering (or obtaining exemptions from the qualification or registration of) all or any part of the Common Shares for offer and sale under the Blue Sky laws or with obtaining clearance from the NASD and (vii) all other fees, costs and expenses referred to in Item 13 of the Registration Statement. The Underwriters may deem the Company to be the primary obligor with respect to all costs, fees and expenses to be paid by the Company and by the Selling Shareholders. Except as provided in this Section 7, Section 9 and Section 11 hereof, the Underwriters shall pay all of their own expenses, -14- 15 including the fees and disbursements of their counsel (excluding those relating to qualification, registration or exemption under the Blue Sky laws, the obtaining of clearance from the NASD and the Blue Sky memorandum referred to above, which will be paid by the Company). This Section 7 shall not affect any agreements relating to the payment of expenses between the Company and the Selling Shareholders. The Selling Shareholders will pay (directly or by reimbursement) all fees and expenses incident to the performance of their obligations under this Agreement which are not otherwise specifically provided for herein, including but not limited to (i) any fees and expenses of counsel for such Selling Shareholders, (ii) any fees and expenses of the Agent and (iii) all expenses and taxes incident to the sale and delivery of the Common Shares to be sold by such Selling Shareholders to the Underwriters hereunder. SECTION 8 CONDITIONS OF THE OBLIGATIONS OF THE UNDERWRITERS The obligations of the several Underwriters to purchase and pay for the Firm Common Shares on the First Closing Date and the Optional Common Shares on the Second Closing Date shall be subject to the accuracy of the representations and warranties on the part of the Company and the Selling Shareholders herein set forth as of the date hereof and as of the First Closing Date or the Second Closing Date, as the case may be, to the accuracy of the statements of Company officers and the Selling Shareholders made pursuant to the provisions hereof, to the performance by the Company and the Selling Shareholders of their respective obligations hereunder, and to the following additional conditions: (a) The Registration Statement shall have become effective not later than 5:00 P.M. (or in the case of a registration statement filed pursuant to Rule 462(b) of the Rules and Regulations relating to the Common Shares, not later than 10 P.M.), Washington, D.C. Time, on the date of this Agreement, or at such later time as shall have been consented to by you; if the filing of the Prospectus, or any supplement thereto, is required pursuant to Rule 424(b) of the Rules and Regulations, the Prospectus shall have been filed in the manner and within the time period required by Rule 424(b) of the Rules and Regulations; and prior to such Closing Date, no stop order suspending the effectiveness of the Registration Statement shall have been issued and no proceedings for that purpose shall have been instituted or shall be pending or, to the knowledge of the Company, the Selling Shareholders or you, shall be contemplated by the Commission; and any request of the Commission for inclusion of additional information in the Registration Statement, or otherwise, shall have been complied with to your reasonable satisfaction. (b) You shall be reasonably satisfied that since the respective dates as of which information is given in the Registration Statement and Prospectus, (i) except as set forth in or contemplated by the Registration Statement or the Prospectus, there shall not have been any change in the capital stock (other than pursuant to the exercise of outstanding options disclosed in the Prospectus) of the Company or any of its subsidiaries or any material change in the indebtedness (other than in the ordinary course of business) of the Company or any of its subsidiaries, (ii) except as set forth in or contemplated by the Registration Statement or the Prospectus, no material verbal or written agreement or other transaction shall have been entered into by the Company or any of its subsidiaries, which is not in the ordinary course of business or which could result in a material reduction in the future net income of the Company and its subsidiaries taken as a whole, (iii) no loss or damage (whether or not insured) to the property of the Company or any of its subsidiaries shall have been sustained which materially and adversely affects the condition (financial or otherwise), -15- 16 business, results of operations or prospects of the Company and its subsidiaries taken as a whole, (iv) no legal or governmental action, suit or proceeding affecting the Company or any of its subsidiaries which is material to the Company and its subsidiaries taken as a whole or which affects or may affect the transactions contemplated by this Agreement shall have been instituted or threatened and (v) there shall not have been any material change in the condition (financial or otherwise), business, management, results of operations or prospects of the Company and its subsidiaries taken as a whole which makes it impractical or inadvisable in the judgment of the Representatives to proceed with the public offering or purchase the Common Shares as contemplated hereby. (c) There shall have been furnished to you, as Representatives of the Underwriters, on each Closing Date, in form and substance reasonably satisfactory to you, except as otherwise expressly provided below: (i) An opinion of O'Melveny & Myers, counsel for the Company and the Selling Shareholders, addressed to the Underwriters and dated the First Closing Date, or the Second Closing Date, as the case may be, to the following effect. (1) Each of the Company and its subsidiaries has been duly incorporated and is validly existing as a corporation in good standing under the laws of its jurisdiction of incorporation, is duly qualified to do business as a foreign corporation and is in good standing in all other jurisdictions where the ownership or leasing of properties or the conduct of its business requires such qualification, except for jurisdictions in which the failure to so qualify would not have a material adverse effect on the Company and its subsidiaries, and has full corporate power and authority to own its properties and conduct its business as described in the Registration Statement. (2) The authorized, issued and outstanding capital stock of the Company is as set forth under the caption "Capitalization" in the Prospectus; all necessary and proper corporate proceedings have been taken in order to authorize validly such authorized capital stock; all outstanding shares of such capital stock (including the Firm Common Shares and any Optional Common Shares) have been duly and validly issued, are fully paid and nonassessable, have been issued in compliance with federal and state securities laws, were not issued in violation of or subject to any preemptive rights or other rights to subscribe for or purchase any securities and conform to the description thereof contained in the Prospectus; without limiting the foregoing, there are no preemptive or other rights to subscribe for or purchase any of the Common Shares to be sold by the Company hereunder. (3) All of the issued and outstanding shares of the capital stock of the Company's subsidiaries have been duly and validly authorized and issued, are fully paid and nonassessable and are owned beneficially by the Company free and clear of all liens, encumbrances, equities, claims, security interests, voting trusts or other defects of title whatsoever. (4) The certificates evidencing the Common Shares to be delivered hereunder are in due and proper form under California law, and when duly countersigned by the Company's transfer agent and registrar, and delivered to you or upon your order against payment of the agreed consideration therefor in accordance with the provisions of this Agreement, the Common Shares represented thereby will -16- 17 be duly authorized and validly issued, fully paid and nonassessable, will not have been issued in violation of or subject to any preemptive rights or other rights to subscribe for or purchase securities and will conform in all respects to the description thereof contained in the Prospectus. (5) Except as disclosed in the Prospectus, to the best of such counsel's knowledge, there are no outstanding options, warrants or other rights calling for the issuance of, and no commitments, plans or arrangements to issue, any shares of capital stock of the Company or any security convertible into or exchangeable for capital stock of the Company. (6) The Company's Common Stock (including the Common Shares) has been duly approved for listing and quotation on the Nasdaq National Market. (7) (A) The Registration Statement has become effective under the Act, and, to the best of such counsel's knowledge, no stop order suspending the effectiveness of the Registration Statement or preventing the use of the Prospectus has been issued and no proceedings for that purpose have been instituted or are pending or contemplated by the Commission; any required filing of the Prospectus and any supplement thereto pursuant to Rule 424(b) of the Rules and Regulations has been made in the manner and within the time period required by such Rule 424(b); (B) The Registration Statement, the Prospectus and each amendment or supplement thereto (except for the financial statements and schedule included therein as to which such counsel need express no opinion) comply as to form in all material respects with the requirements of the Act and the Rules and Regulations; (C) To the best of such counsel's knowledge, there are no franchises, leases, contracts, agreements or documents of a character required to be disclosed in the Registration Statement or Prospectus or to be filed as exhibits to the Registration Statement which are not disclosed or filed, as required by the Act and the Rules and Regulations; (D) The description in the Registration Statement and Prospectus of the charter and by-laws of the Company is accurate in all material respects and such descriptions fairly present the information required to be shown by the Act or the Rules and Regulations; the statements set forth in the Prospectus under the captions "Management," "Certain Transactions," "Description of Capital Stock" and "Shares Eligible for Future Sale," insofar as they represent summaries of document, contracts, statutes, rules and regulations, are complete, accurate and fairly present the information required to be disclosed; and (E) To the best of such counsel's knowledge, there are no legal or governmental actions, suits or proceedings pending or threatened against the Company that are required under the Act and the Rules and Regulations to be described in the Prospectus and that are not described as required. (8) The Company has full right, power and authority to enter into this Agreement and to sell and deliver the Common Shares to be sold by it to the several Underwriters; this Agreement has been duly and validly authorized by all necessary -17- 18 corporate action by the Company, has been duly and validly executed and delivered by and on behalf of the Company, and is a valid and binding agreement of the Company in accordance with its terms, except as enforceability may be limited by general equitable principles, bankruptcy, insolvency, reorganization, moratorium or other laws affecting creditors' rights generally and except as to those provisions relating to indemnity or contribution for liabilities arising under the Act as to which no opinion need be expressed; and no approval, authorization, order, consent, registration, filing, qualification, license or permit of or with any court, regulatory, administrative or other governmental body is required for the execution and delivery of this Agreement by the Company or the consummation of the transactions contemplated by this Agreement, except such as have been obtained and are in full force and effect under the Act and such as may be required under applicable Blue Sky laws in connection with the purchase and distribution of the Common Shares by the Underwriters and the clearance of such offering with the NASD. (9) The execution and performance of this Agreement and the consummation of the transactions herein contemplated will not conflict with, result in the breach of, or constitute, either by itself or upon notice or the passage of time or both, a default under, any agreement, mortgage, deed of trust, lease, franchise, license, indenture, permit or other instrument known to such counsel to which the Company or any of its subsidiaries is a party or by which the Company or any of its subsidiaries or any of its or their property may be bound or affected that is material to the Company and its subsidiaries, or violate any of the provisions of the charter or bylaws, or other organizational documents, of the Company or any of its subsidiaries or, so far as is known to such counsel, violate any statute, judgment, decree, order, rule or regulation of any court or governmental body having jurisdiction over the Company or any of its subsidiaries or any of its or their property. (10) Neither the Company nor any subsidiary is in violation of its charter or bylaws, or other organizational documents, or to the best of such counsel's knowledge, in breach of, or in default with respect to, any provision of any agreement, mortgage, deed of trust, lease, franchise, license, indenture, permit or other instrument known to such counsel to which the Company or any such subsidiary is a party or by which it or any of its properties may be bound or affected, except where such default would not materially adversely affect the Company and its subsidiaries; and, to the best of such counsel's knowledge, the Company and its subsidiaries are in compliance with all laws, rules, regulations, judgments, decrees, orders and statutes of any court or jurisdiction to which they are subject, except where noncompliance would not materially adversely affect the Company and its subsidiaries. (11) To the best of such counsel's knowledge, the Company and each of its subsidiaries own or possess all patents, trademarks, trademark registrations, service marks, service mark registrations, trade names, copyrights, licenses, inventions, trade secrets and rights described in the Prospectus as being owned by them or any of them or necessary for the conduct of their respective businesses, and the Company is not aware of any claim to the contrary or any challenge by any other person to the rights of the Company or any of its subsidiaries with respect to the foregoing. The Company's business as now conducted and as proposed to be conducted does not and will not infringe or conflict with any patents, trademarks, service marks, trade names, -18- 19 copyrights, trade secrets, licenses or other intellectual property or franchise right of any person; (12) To the best of such counsel's knowledge, the Company and each of its subsidiaries have, and the Company and each of its subsidiaries as of the Closing Dates will have, good and marketable title in fee simple to all real property and good and marketable title to all personal property owned or proposed to be owned by them which is material to the business of the Company or any of its subsidiaries, in each case free and clear of all liens, encumbrances and defects; and any real property and buildings held under lease by the Company and its subsidiaries or proposed to be held after giving effect to the transactions described in the Prospectus are, or will be as of the Closing Dates, held by them under valid, subsisting and enforceable leases with such exceptions as would not have a material adverse effect on the Company and its subsidiaries considered as a whole; (13) The Company and each of its subsidiaries are not, nor will they be immediately after receiving the proceeds from the sale of the Shares, an "investment company" or an entity "controlled" by an "investment company" as such terms are defined in the Investment Company Act of 1940, as amended. (14) To the best of such counsel's knowledge, no holders of securities of the Company have rights that have not been waived to the registration of shares of Common Stock or other securities, because of the filing of the Registration Statement by the Company or the offering contemplated hereby. (15) To the best of such counsel's knowledge, this Agreement and the Custody Agreement have been duly authorized, executed and delivered by or on behalf of each of the Selling Shareholders; the Agent has been duly and validly authorized to act as the custodian of the Common Shares to be sold by each such Selling Shareholder; and the performance of this Agreement and the Shareholders Agreement and the consummation of the transactions contemplated herein or in the Custody Agreement by the Selling Shareholders will not result in a breach of, or constitute a default under, any indenture, mortgage, deed of trust, trust (constructive or other), loan agreement, lease, franchise, license or other agreement or instrument to which any of the Selling Shareholders is a party or by which any of the Selling Shareholders or any of their properties may be bound, or violate any statute, judgment, decree, order, rule or regulation known to such counsel of any court or governmental body having jurisdiction over any of the Selling Shareholders or any of their properties; and to the best of such counsel's knowledge, no approval, authorization, order or consent of any court, regulatory body, administrative agency or other governmental body is required for the execution and delivery of this Agreement or the Custody Agreement or the consummation by the Selling Shareholders of the transactions contemplated by this Agreement, except such as have been obtained and are in full force and effect under the Act and such as may be required under the rules of the NASD and applicable Blue Sky laws. (16) To the best of such counsel's knowledge, the Selling Shareholders have full right, power and authority to enter into this Agreement and the Custody Agreement and to sell, transfer and deliver the Common Shares to be sold on such Closing Date by such Selling Shareholders hereunder and good and marketable title -19- 20 to such Common Shares so sold, free and clear of all liens, encumbrances, equities, claims, restrictions, security interests, voting trusts, or other defects of title whatsoever, has been transferred to the Underwriters (whom counsel may assume to be bona fide purchasers) who have purchased such Common Shares hereunder. (17) To the best of such counsel's knowledge, this Agreement and the Custody Agreement are valid and binding agreements of each of the Selling Shareholders enforceable in accordance with their terms except as enforceability may be limited by general equitable principles, bankruptcy, insolvency, reorganization, moratorium or other laws affecting creditors' rights generally and except with respect to those provisions relating to indemnities or contributions for liabilities under the Act, as to which no opinion need be expressed. (18) No transfer taxes are required to be paid in connection with the sale and delivery of the Common Shares to the Underwriters hereunder. In rendering such opinion, such counsel may rely as to the matters set forth in paragraphs (15), (16), (17) and (18), on opinions of other counsel retained by the Selling Shareholders, as to matters of governed by the laws of states or jurisdictions other than California or federal laws, on opinions of local counsel, and as to matters of fact, on certificates of the Selling Shareholders and of officers of the Company and of governmental officials, in which case their opinion is to state that they are so doing and that the Underwriters are justified in relying on such opinions or certificates and copies of said opinions or certificates are to be attached to the opinion. In addition to the matters set forth above, counsel rendering the foregoing opinion shall also include a statement to the effect that, based upon their participation in the preparation of the Registration Statement and Prospectus and their review and discussion of the contents thereof, nothing has come to such counsel's attention during the course of their representation that would lead such counsel to believe (i) that (except for the financial statement and schedule as to which such counsel need not express any statement) the Registration Statement or Prospectus included therein, at the time the Registration Statement became effective, did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading and (ii) that (except for the financial statements and schedule as to which such counsel need not express any statement) the Registration Statement or Prospectus and any amendment or supplement thereto effected on or before the First Closing Date or the Second Closing Date, as the case may be, does not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading. (ii) Such opinion or opinions of Fenwick & West LLP, counsel for the Underwriters, dated the First Closing Date or the Second Closing Date, as the case may be, with respect to the incorporation of the Company, the sufficiency of all corporate proceedings and other legal matters relating to this Agreement, the validity of the Common Shares, the Registration Statement and the Prospectus and other related matters as you may reasonably require, and the Company and the Selling Shareholders shall have furnished to such counsel such documents and shall have exhibited to them such papers and records as they may reasonably request for the purpose of enabling them to pass upon such matters. In connection with such opinions, such counsel may rely on representations or certificates of officers of the Company and governmental officials. -20- 21 (iii) A certificate of the Company executed by the Chairman of the Board or President and the chief financial or accounting officer of the Company, dated the First Closing Date or the Second Closing Date, as the case may be, to the following effect. (1) The representations and warranties of the Company set forth in Section 2 of this Agreement are true, complete and correct as of the date of this Agreement and as of the First Closing Date or the Second Closing Date, as the case may be, and the Company has complied with all the agreements and satisfied all the conditions on its part to be performed or satisfied on or prior to such Closing Date. (2) The Commission has not issued any order preventing or suspending the use of the Prospectus or any Preliminary Prospectus filed as a part of the Registration Statement or any amendment thereto; no stop order suspending the effectiveness of the Registration Statement has been issued; and to the best of the knowledge of the respective signers, no proceedings for that purpose have been instituted or are pending or contemplated under the Act. (3) Each of the respective signers of the certificate has carefully examined the Registration Statement and the Prospectus; in his opinion and to the best of his knowledge, the Registration Statement and the Prospectus and any amendments or supplements thereto contain all statements required to be stated therein regarding the Company and its subsidiaries; and to the best of his knowledge neither the Registration Statement nor the Prospectus nor any amendment or supplement thereto includes any untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein not misleading. (4) Since the initial date on which the Registration Statement was filed, no agreement, written or oral, transaction or event has occurred which should have been set forth in an amendment to the Registration Statement or in a supplement to or amendment of any prospectus which has not been disclosed in such a supplement or amendment. (5) Since the respective dates as of which information is given in the Registration Statement and the Prospectus, and except as disclosed in or contemplated by the Prospectus, there has not been any material adverse change or a development involving a material adverse change in the condition (financial or otherwise), business, properties, results of operations, management or prospects of the Company and its subsidiaries taken as a whole; and no legal or governmental action, suit or proceeding is pending or threatened against the Company or any of its subsidiaries which is material to the Company and its subsidiaries taken as a whole, whether or not arising from transactions in the ordinary course of business, or which may adversely affect the transactions contemplated by this Agreement; since such dates and except as so disclosed, neither the Company nor any of its subsidiaries has entered into any verbal or written agreement or other transaction which is not in the ordinary course of business or which could result in a material reduction in the future net income of the Company and its subsidiaries taken as a whole or incurred any material liability or obligation, direct, contingent or indirect, made any material change in its capital stock, made any material change in its short-term debt or funded debt or repurchased or otherwise acquired any of the Company's capital stock; and -21- 22 the Company has not declared or paid any dividend, or made any other distribution, upon its outstanding capital stock payable to shareholders of record on a date prior to the First Closing Date or Second Closing Date. (6) Since the respective dates as of which information is given in the Registration Statement and the Prospectus and except as disclosed in or contemplated by the Prospectus, the Company and its subsidiaries have not sustained a material loss or damage by strike, fire, flood, earthquake, windstorm, accident or other calamity (whether or not insured). (iv) On the First Closing Date or the Second Closing Date, as the case may be, a certificate, dated such Closing Date and addressed to you, signed by or on behalf of each of the Selling Shareholders to the effect that the representations and warranties of such Selling Shareholder in Sections 2 (with respect to each Selling Shareholder except Frederick Judd) and 3 of this Agreement are true, complete and correct, as if made at and as of the First Closing Date or the Second Closing Date, as the case may be, and such Selling Shareholder has complied with all the agreements and satisfied all the conditions on his part to be performed or satisfied prior to the First Closing Date or the Second Closing Date, as the case may be. (v) On the date before this Agreement is executed and also on the First Closing Date and the Second Closing Date a letter addressed to you, as Representatives of the Underwriters, from each of Arthur Andersen LLP and Coopers & Lybrand L.L.P., independent accountants, the first one to be dated the day before the date of this Agreement, the second one to be dated the First Closing Date and the third one (in the event of a Second Closing) to be dated the Second Closing Date, in form and substance reasonably satisfactory to you. All such opinions, certificates, letters and documents shall be in compliance with the provisions hereof only if they are reasonably satisfactory to you and to Fenwick & West LLP, counsel for the Underwriters. The Company shall furnish you with such manually signed or conformed copies of such opinions, certificates, letters and documents as you reasonably request. Any certificate signed by any officer of the Company and delivered to the Representatives or to counsel for the Underwriters shall be deemed to be a representation and warranty by the Company to the Underwriters as to the statements made therein. If any condition to the Underwriters' obligations hereunder to be satisfied prior to or at the First Closing Date is not so satisfied, this Agreement at your election will terminate upon notification by you as Representatives to the Company and the Selling Shareholders without liability on the part of any Underwriter, the Company or the Selling Shareholders except for the expenses to be paid or reimbursed by the Company and by the Selling Shareholders pursuant to Sections 7 and 9 hereof and except to the extent provided in Section 11 hereof. SECTION 9 REIMBURSEMENT OF UNDERWRITERS' EXPENSES Notwithstanding any other provisions hereof, if this Agreement shall be terminated by you pursuant to Section 8, or if the sale to the Underwriters of the Common Shares at the First Closing is not consummated because of any refusal, inability or failure on the part of the Company or the Selling Shareholders to perform any agreement herein or to comply with any provision hereof, the -22- 23 Company agrees to reimburse you and the other Underwriters upon demand for all out-of-pocket expenses that shall have been reasonably incurred by you and them in connection with the proposed purchase and the sale of the Common Shares, including, but not limited to, reasonable fees and disbursements of counsel, printing expenses, travel expenses, postage, telegraph charges and telephone charges relating directly to the offering contemplated by the Prospectus. Any such termination shall be without liability of any party to any other party except that the provisions of this Section, Section 7 and Section 11 shall at all times be effective and shall apply. SECTION 10 EFFECTIVENESS OF REGISTRATION STATEMENT You, the Company and the Selling Shareholders will use their best efforts to cause the Registration Statement to become effective, to prevent the issuance of any stop order suspending the effectiveness of the Registration Statement and, if such stop order be issued, to obtain as soon as possible the lifting thereof. SECTION 11 INDEMNIFICATION (a) The Company and each of the Selling Shareholders, severally and not jointly, agree to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of the Act against any losses, claims, damages, liabilities or expenses, joint or several, to which such Underwriter or such controlling person may become subject, under the Act, the Exchange Act, or other federal or state statutory law or regulation, or at common law or otherwise (including in settlement of any litigation, if such settlement is effected with the written consent of the Company and such Selling Shareholder), insofar as such losses, claims, damages, liabilities or expenses (or actions in respect thereof as contemplated below) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in the Registration Statement, any Preliminary Prospectus, the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state in any of them a material fact required to be stated therein or necessary to make the statements in any of them not misleading, or arise out of or are based in whole or in part on any inaccuracy in the representations and warranties of the Company or such Selling Shareholder, respectively, contained herein or any failure of the Company or such Selling Shareholder to perform their respective obligations hereunder or under law; and will reimburse each Underwriter and each such controlling person for any legal and other expenses as such expenses are reasonably incurred by such Underwriter or such controlling person in connection with investigating, defending, settling, compromising or paying any such loss, claim, damage, liability, expense or action; provided, however, that neither the Company nor the Selling Shareholders will be liable in any such case to the extent that any such loss, claim, damage, liability or expense arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in the Registration Statement, any Preliminary Prospectus, the Prospectus or any amendment or supplement thereto in reliance upon and in conformity with the information furnished to the Company pursuant to Section 4 hereof; provided further, however, that the indemnification obligations contained in this Section 11 shall not apply to any losses, claims, damages, liabilities or expenses with respect to any Preliminary Prospectus and shall not inure to the benefit of any Underwriter from whom the person asserting any such losses, claims, damages, liabilities or expenses purchased the Common Shares which are the subject thereof (or to the benefit of any person controlling such Underwriter) if at or prior to the written confirmation of the sale of such -23- 24 Common Shares, a copy of the Prospectus (or the Prospectus as amended or supplemented) was not sent or delivered to such person and the untrue statement or omission of a material fact contained in such Preliminary Prospectus was corrected in the Prospectus (or in the Prospectus as amended or supplemented). In addition to its other obligations under this Section 11(a), the Company and the Selling Shareholders agree that, as an interim measure during the pendency of any claim, action, investigation, inquiry or other proceeding arising out of or based upon any statement or omission, or any alleged statement or omission, or any inaccuracy in the representations and warranties of the Company or such Selling Shareholder, respectively, herein or failure to perform their respective obligations hereunder, all as described in this Section 11(a), it will reimburse each Underwriter on a quarterly basis for all reasonable legal or other expenses incurred in connection with investigating or defending any such claim, action, investigation, inquiry or other proceeding, notwithstanding the absence of a judicial determination as to the propriety and enforceability of the Company's or such Selling Shareholder;s obligation to reimburse each Underwriter for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim reimbursement payment is so held to have been improper, each Underwriter shall promptly return it to the Company together with interest, compounded daily, determined on the basis of the prime rate (or other commercial lending rate for borrowers of the highest credit standing) announced from time to time by Bank of America NT&SA, San Francisco, California (the "Prime Rate"). Any such interim reimbursement payments which are not made to an Underwriter within 30 days of a request for reimbursement, shall bear interest at the Prime Rate from the date of such request. This indemnity agreement will be in addition to any liability which the Company or the Selling Shareholders may otherwise have. (b) Each Underwriter will severally indemnify and hold harmless the Company, each of its directors, each of its officers who signed the Registration Statement, the Selling Shareholders and each person, if any, who controls the Company within the meaning of the Act, against any losses, claims, damages, liabilities or expenses to which the Company, or any such director, officer, Selling Shareholder or controlling person may become subject, under the Act, the Exchange Act, or other federal or state statutory law or regulation, or at common law or otherwise (including in settlement of any litigation, if such settlement is effected with the written consent of such Underwriter), insofar as such losses, claims, damages, liabilities or expenses (or actions in respect thereof as contemplated below) arise out of or are based upon any untrue or alleged untrue statement of any material fact contained in the Registration Statement, any Preliminary Prospectus, the Prospectus, or any amendment or supplement thereto, or arise out of or are based upon the omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, in each case to the extent, but only to the extent, that such untrue statement or alleged untrue statement or omission or alleged omission was made in the Registration Statement, any Preliminary Prospectus, the Prospectus, or any amendment or supplement thereto, in reliance upon and in conformity with the information furnished to the Company pursuant to Section 4 hereof; and will reimburse the Company, or any such director, officer, Selling Shareholder or controlling person for any legal and other expense reasonably incurred by the Company, or any such director, officer, Selling Shareholder or controlling person in connection with investigating, defending, settling, compromising or paying any such loss, claim, damage, liability, expense or action. In addition to its other obligations under this Section 11(b), each Underwriter severally agrees that, as an interim measure during the pendency of any claim, action, investigation, inquiry or other proceeding arising out of or based upon any statement or omission, or any alleged statement or omission, described in this Section 11(b) which relates to information furnished to the Company pursuant to Section 4 hereof, it will reimburse the Company (and, to the extent applicable, each officer, director, controlling person or Selling Shareholder) on a quarterly basis for all reasonable -24- 25 legal or other expenses incurred in connection with investigating or defending any such claim, action, investigation, inquiry or other proceeding, not withstanding the absence of a judicial determination as to the propriety and enforceability of the Underwriters' obligation to reimburse the Company (and, to the extent applicable, each officer, director, controlling person or Selling Shareholder) for such expenses and the possibility that such payments might later be held to have been improper by a court of competent jurisdiction. To the extent that any such interim reimbursement payment is so held to have been improper, the Company (and, to the extent applicable, each officer, director, controlling person or Selling Shareholder) shall promptly return it to the Underwriters together with interest, compounded daily, determined on the basis of the Prime Rate. Any such interim reimbursement payments which are not made to the Company (and, to the extent applicable, each officer, director, controlling person or Selling Shareholder) within 30 days of a request for reimbursement, shall bear interest at the Prime Rate from the date of such request. This indemnity agreement will be in addition to any liability which such Underwriter may otherwise have. (c) Promptly after receipt by an indemnified party under this Section of notice of the commencement of any action, such indemnified party will, if a claim in respect thereof is to be made against an indemnifying party under this Section , notify the indemnifying party in writing of the commencement thereof; but the omission so to notify the indemnifying party will not relieve the indemnifying party from any liability which it may have to any indemnified party to the extent it is not prejudiced as a proximate result of such failure nor will it relieve any indemnifying party from its contribution obligations or from any obligations arising otherwise than under the indemnity agreement contained in this Section. In case any such action is brought against any indemnified party and such indemnified party seeks or intends to seek indemnity from an indemnifying party, the indemnifying party will be entitled to participate in, and, to the extent that it may wish, jointly with all other indemnifying parties similarly notified, to assume the defense thereof with counsel reasonably satisfactory to such indemnified party; provided, however, if the defendants in any such action include both the indemnified party and the indemnifying party and the indemnified party shall have reasonably concluded that there may be a conflict between the positions of the indemnifying party and the indemnified party in conducting the defense of any such action or that there may be legal defenses available to it and/or other indemnified parties which are different from or additional to those available to the indemnifying party, the indemnified party or parties shall have the right to select separate counsel to assume such legal defenses and to otherwise participate in the defense of such action on behalf of such indemnified party or parties. Upon receipt of notice from the indemnifying party to such indemnified party of its election so to assume the defense of such action and approval by the indemnified party of counsel, the indemnifying party will not be liable to such indemnified party under this Section for any legal or other expenses subsequently incurred by such indemnified party in connection with the defense thereof unless (i) the indemnified party shall have employed such counsel in connection with the assumption of legal defenses in accordance with the proviso to the next preceding sentence or (ii) the indemnifying party shall not have employed counsel reasonably satisfactory to the indemnified party to represent the indemnified party within a reasonable time after notice of commencement of the action, in each of which cases the reasonable fees and expenses of counsel shall be at the expense of the indemnifying party. (d) If the indemnification provided for in this Section 11 is required by its terms but is for any reason held to be unavailable to or otherwise insufficient to hold harmless an indemnified party under paragraphs (a), (b) or (c) in respect of any losses, claims, damages, liabilities or expenses referred to herein, then each applicable indemnifying party shall contribute to the amount paid or payable by such indemnified party as a result of any losses, claims, damages, liabilities or -25- 26 expenses referred to herein (i) in such proportion as is appropriate to reflect the relative benefits received by the Company, the Selling Shareholders and the Underwriters from the offering of the Common Shares or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the Company, the Selling Shareholders and the Underwriters in connection with the statements or omissions or inaccuracies in the representations and warranties herein which resulted in such losses, claims, damages, liabilities or expenses, as well as any other relevant equitable considerations. The respective relative benefits received by the Company, the Selling Shareholders and the Underwriters shall be deemed to be in the same proportion, in the case of the Company and the Selling Shareholders as the total price paid to the Company and to the Selling Shareholders, respectively, for the Common Shares sold by them to the Underwriters (net of underwriting commissions but before deducting expenses), and in the case of the Underwriters as the underwriting commissions received by them bears to the total of such amounts paid to the Company and to the Selling Shareholders and received by the Underwriters as underwriting commissions. The relative fault of the Company, the Selling Shareholders and the Underwriters shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact or the inaccurate or the alleged inaccurate representation and/or warranty relates to information supplied by the Company, the Selling Shareholders or the Underwriters and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The amount paid or payable by a party as a result of the losses, claims, damages, liabilities and expenses referred to above shall be deemed to include, subject to the limitations set forth in subparagraph (c) of this Section 11, any legal or other fees or expenses reasonably incurred by such party in connection with investigating or defending any action or claim. The provisions set forth in subparagraph (c) of this Section 11 with respect to notice of commencement of any action shall apply if a claim for contribution is to be made under this subparagraph (d); provided, however, that no additional notice shall be required with respect to any action for which notice has been given under subparagraph (c) for purposes of indemnification. The Company, the Selling Shareholders and the Underwriters agree that it would not be just and equitable if contribution pursuant to this Section 11 were determined solely by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation which does not take account of the equitable considerations referred to in the immediately preceding paragraph. Notwithstanding the provisions of this Section 11, no Underwriter shall be required to contribute any amount in excess of the amount of the total underwriting commissions received by such Underwriter in connection with the Common Shares underwritten by it and distributed to the public. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The Underwriters' obligations to contribute pursuant to this Section 11 are several in proportion to their respective underwriting commitments and not joint. (e) It is agreed that any controversy arising out of the operation of the interim reimbursement arrangements set forth in Sections 11(a) and 11(b) hereof, including the amounts of any requested reimbursement payments and the method of determining such amounts, shall be settled by arbitration conducted under the provisions of the Constitution and Rules of the Board of Governors of the New York Stock Exchange, Inc. or pursuant to the Code of Arbitration Procedure of the NASD. Any such arbitration must be commenced by service of a written demand for arbitration or written notice of intention to arbitrate, therein electing the arbitration tribunal. In the event the party demanding arbitration does not make such designation of an arbitration tribunal in such demand or notice, then the party responding to said demand or notice is authorized to do so. Such an -26- 27 arbitration would be conducted in Orange County, California and would be limited to the operation of the interim reimbursement provisions contained in Sections 11(a) and 11(b) hereof and would not resolve the ultimate propriety or enforceability of the obligation to reimburse expenses which is created by the provisions of such Sections 11(a) and 11(b) hereof. (f) Notwithstanding any other term or provision of this Agreement, the liability of any Selling Shareholder for indemnification or other claim under this Agreement shall not exceed the proceeds received by such Selling Shareholder from the Underwriters. SECTION 12 DEFAULT OF UNDERWRITERS It shall be a condition to this Agreement and the obligation of the Company and the Selling Shareholders to sell and deliver the Common Shares hereunder, and of each Underwriter to purchase the Common Shares in the manner as described herein, that, except as hereinafter in this paragraph provided, each of the Underwriters shall purchase and pay for all the Common Shares agreed to be purchased by such Underwriter hereunder upon tender to the Representatives of all such shares in accordance with the terms hereof. If any Underwriter or Underwriters default in their obligations to purchase Common Shares hereunder on either the First or Second Closing Date and the aggregate number of Common Shares which such defaulting Underwriter or Underwriters agreed but failed to purchase on such Closing Date does not exceed 10% of the total number of Common Shares which the Underwriters are obligated to purchase on such Closing Date, the non-defaulting Underwriters shall be obligated severally, in proportion to their respective commitments hereunder, to purchase the Common Shares which such defaulting Underwriters agreed but failed to purchase on such Closing Date. If any Underwriter or Underwriters so default and the aggregate number of Common Shares with respect to which such default occurs is more than the above percentage and arrangements satisfactory to the Representatives and the Company for the purchase of such Common Shares by other persons are not made within 48 hours after such default, this Agreement will terminate without liability on the part of any non-defaulting Underwriter or the Company or the Selling Shareholders except for the expenses to be paid by the Company and the Selling Shareholders pursuant to Section 7 hereof and except to the extent provided in Section 11 hereof. In the event that Common Shares to which a default relates are to be purchased by the non-defaulting Underwriters or by another party or parties, the Representatives or the Company shall have the right to postpone the First or Second Closing Date, as the case may be, for not more than five business days in order that the necessary changes in the Registration Statement, Prospectus and any other documents, as well as any other arrangements, may be effected. As used in this Agreement, the term "Underwriter" includes any person substituted for an Underwriter under this Section . Nothing herein will relieve a defaulting Underwriter from liability for its default. SECTION 13 EFFECTIVE DATE This Agreement shall become effective immediately as to Sections 7, 9, 11, 13, 14 and 16 and, as to all other provisions, (i) if at the time of execution of this Agreement the Registration Statement has not become effective, at 2:00 P.M., California time, on the first full business day following the effectiveness of the Registration Statement, or (ii) if at the time of execution of this Agreement the Registration Statement has been declared effective, at 2:00 P.M., California time, on -27- 28 the first full business day following the date of execution of this Agreement; but this Agreement shall nevertheless become effective at such earlier time after the Registration Statement becomes effective as you may determine on and by notice to the Company or by release of any of the Common Shares for sale to the public. For the purposes of this Section 13, the Common Shares shall be deemed to have been so released upon the release for publication of any newspaper advertisement relating to the Common Shares or upon the release by you of telegrams (i) advising Underwriters that the Common Shares are released for public offering, or (ii) offering the Common Shares for sale to securities dealers, whichever may occur first. SECTION 14 TERMINATION Without limiting the right to terminate this Agreement pursuant to any other provision hereof: (a) This Agreement may be terminated by the Company by notice to you and the Selling Shareholders or by you by notice to the Company and the Selling Shareholders at any time prior to the time this Agreement shall become effective as to all its provisions, and any such termination shall be without liability on the part of the Company or the Selling Shareholders to any Underwriter (except for the expenses to be paid or reimbursed by the Company and the Selling Shareholders pursuant to Sections 7 and 9 hereof and except to the extent provided in Section 11 hereof) or of any Underwriter to the Company or the Selling Shareholders (except to the extent provided in Section 11 hereof). (b) This Agreement may also be terminated by you prior to the First Closing Date by notice to the Company (i) if additional material governmental restrictions, not in force and effect on the date hereof, shall have been imposed upon trading in securities generally or minimum or maximum prices shall have been generally established on the New York Stock Exchange or on the American Stock Exchange or in the Nasdaq National Market, or trading in securities generally shall have been suspended on either such exchange or the Nasdaq National Market, or a general banking moratorium shall have been established by federal, New York or California authorities, (ii) if an outbreak of major hostilities or other national or international calamity or any substantial change in political, financial or economic conditions shall have occurred or shall have accelerated or escalated to such an extent, as, in the judgment of the Representatives, to affect adversely the marketability of the Common Shares, (iii) if any adverse event shall have occurred or shall exist which makes untrue, incomplete or incorrect in any material respect any statement or information contained in the Registration Statement or Prospectus or which is not reflected in the Registration Statement or Prospectus but should be reflected therein in order to make the statements or information contained therein not misleading in any material respect, or (iv) if there shall be any action, suit or proceeding pending or threatened, or there shall have been any development or prospective development involving particularly the business or properties or securities of the Company or any of its subsidiaries or the transactions contemplated by this Agreement, which, in the reasonable judgment of the Representatives, may materially and adversely affect the Company's and its subsidiaries' business or net income taken as a whole and makes it impracticable or inadvisable to offer or sell the Common Shares. Any termination pursuant to this subsection (b) shall without liability on the part of any Underwriter to the Company or the Selling Shareholders or on the part of the Company or the Selling Shareholders to any Underwriter (except for expenses to be paid or reimbursed by the Company and the Selling Shareholders pursuant to Sections 7 and 9 hereof and except to the extent provided in Section 11 hereof. -28- 29 SECTION 15 FAILURE OF THE SELLING SHAREHOLDERS TO SELL AND DELIVER If one or more of the Selling Shareholders shall fail to sell and deliver to the Underwriters the Common Shares to be sold and delivered by such Selling Shareholders at the First Closing Date under the terms of this Agreement, then the Underwriters may at their option, by written notice from you to the Company and the Selling Shareholders, either (i) terminate this Agreement without any liability on the part of any Underwriter or, except as provided in Sections 7, 9 and 11 hereof, the Company or the Selling Shareholders, or (ii) purchase the shares which the Company and other Selling Shareholders have agreed to sell and deliver in accordance with the terms hereof. In the event of a failure by one or more of the Selling Shareholders to sell and deliver as referred to in this Section , either you or the Company shall have the right to postpone the Closing Date for a period not exceeding seven business days in order that the necessary changes in the Registration Statement, Prospectus and any other documents, as well as any other arrangements, may be effected. SECTION 16 REPRESENTATIONS AND INDEMNITIES TO SURVIVE DELIVERY The respective indemnities, agreements, representations, warranties and other statements of the Company, of its officers, of the Selling Shareholders and of the several Underwriters set forth in or made pursuant to this Agreement will remain in full force and effect, regardless of any investigation made by or on behalf of any Underwriter or the Company or any of its or their partners, officers or directors or any controlling person, or the Selling Shareholders, as the case may be, and will survive delivery of and payment for the Common Shares sold hereunder and any termination of this Agreement. SECTION 17 NOTICES All communications hereunder shall be in writing and, if sent to the Representatives, shall be mailed, delivered or telegraphed and confirmed to you at 600 Montgomery Street, San Francisco, California 94111, Attention: David DeRuff, with a copy to Laird H. Simons III, Esq., Fenwick & West LLP, Two Palo Alto Square, Palo Alto, California 94306; and if sent to the Company or the Selling Shareholders shall be mailed, delivered or telegraphed and confirmed to the Company at 2181 Dupont Drive, Irvine, California 92715, Attention: Frederick Judd, with a copy to Jay Herron, Esq., O'Melveny & Myers, 610 Newport Centre Drive, Suite 1700, Newport Beach, California 92660. The Company, the Selling Shareholders or you may change the address for receipt of communications hereunder by giving notice to the others. SECTION 18 SUCCESSORS This Agreement will inure to the benefit of and be binding upon the parties hereto, including any substitute Underwriters pursuant to Section 12 hereof, and to the benefit of the officers and directors and controlling persons referred to in Section 11, and in each case their respective successors, personal representatives and assigns, and no other person will have any right or obligation hereunder. No such assignment shall relieve any party of its obligations hereunder. The term "successors" shall not include any purchaser of the Common Shares as such from any of the Underwriters merely by reason of such purchase. -29- 30 SECTION 19 REPRESENTATION OF UNDERWRITERS You will act as Representatives for the several Underwriters in connection with all dealings hereunder, and any action under or in respect of this Agreement taken by you jointly or by Montgomery Securities, as Representatives, will be binding upon all the Underwriters. SECTION 20 PARTIAL UNENFORCEABILITY The invalidity or unenforceability of any Section , subsection, paragraph or provision of this Agreement shall not affect the validity or enforceability of any other Section , subsection, paragraph or provision hereof. If any Section , subsection, paragraph or provision of this Agreement is for any reason determined to be invalid or unenforceable, there shall be deemed to be made such minor changes (and only such minor changes) as are necessary to make it valid and enforceable. SECTION 21 APPLICABLE LAW This Agreement shale be governed by and construed in accordance with the internal laws (and not the laws pertaining to conflicts of laws) of the State of California. SECTION 22 GENERAL This Agreement constitutes the entire agreement of the parties to this Agreement and supersedes all prior written or oral and all contemporaneous oral agreements, understandings and negotiations with respect to the subject matter hereof. This Agreement may be executed in several counterparts, each one of which shall be an original, and all of which shall constitute one and the same document. In this Agreement, the masculine, feminine and neuter genders and the singular and the plural include one another. The section headings in this Agreement are for the convenience of the parties only and will not affect the construction or interpretation of this Agreement. This Agreement may be amended or modified, and the observance of any term of this Agreement may be waived, only by a writing signed by the Company, the Selling Shareholders and you. Any person executing and delivering this Agreement as Attorney-in-fact for the Selling Shareholders represents by so doing that he has been duly appointed as Attorney-in-fact by such Selling Shareholder pursuant to a validly existing and binding Power of Attorney which authorizes such Attorney-in-fact to take such action. Any action taken under this Agreement by any of the Attorneys-in-fact will be binding on all the Selling Shareholders. -30- 31 If the foregoing is in accordance with your understanding of our agreement, kindly sign and return to us the enclosed copies hereof, whereupon it will become a binding agreement among the Company, the Selling Shareholders and the several Underwriters including you, all in accordance with its terms. Very truly yours, PROCOM TECHNOLOGY, INC. By:____________________________ Name:__________________________ Title:_________________________ SELLING SHAREHOLDERS _______________________________ Alex Razmjoo _______________________________ Frank Alaghband _______________________________ Alex Aydin _______________________________ Nick Shahrestany _______________________________ Frederick Judd The foregoing Underwriting Agreement is hereby confirmed and accepted by us in San Francisco, California as of the date first above written. MONTGOMERY SECURITIES DAIN BOSWORTH INC. Acting as Representatives of the several Underwriters named in the attached Schedule A. By: Montgomery Securities By:__________________________________ -31- 32 SCHEDULE A
NUMBER OF FIRM COMMON SHARES NAME OF UNDERWRITER TO BE PURCHASED ------------------- --------------- Montgomery Securities.......................... Dain Bosworth Inc.............................. --------- TOTAL..................................... 3,025,000 =========
33 SCHEDULE B FIRM COMMON SHARES
NUMBER OF FIRM COMMON SHARES TO BE SOLD BY SELLING NAME OF SELLING SHAREHOLDER SHAREHOLDERS - --------------------------- ------------------ Alex Razmjoo......................................................................... 250,000 Frank Alaghband...................................................................... 250,000 Alex Aydin........................................................................... 250,000 Nick Shahrestany..................................................................... 250,000 Frederick Judd....................................................................... 25,000 --------- TOTAL....................................................................... 1,025,000 =========
OPTIONAL COMMON SHARES
MAXIMUM NUMBER OF OPTIONAL COMMON SHARES TO BE SOLD BY SELLING NAME OF SELLING SHAREHOLDER SHAREHOLDERS - --------------------------- ------------------ Alex Razmjoo........................................................................ 113,440 Frank Alaghband..................................................................... 113,440 Alex Aydin.......................................................................... 113,430 Nick Shahrestany.................................................................... 113,440 ------- Frederick Judd...................................................................... -- TOTAL...................................................................... 453,750 =======
EX-10.9 3 LOAN AND SECURITY AGREEMENT 1 EXHIBIT 10.9 GFC LOAN AND SECURITY AGREEMENT BORROWER: PROCOM TECHNOLOGY, INC. ADDRESS: 2181 DUPONT DRIVE IRVINE, CALIFORNIA 92715 DATE: NOVEMBER 18, 1994 THIS LOAN AND SECURITY AGREEMENT ("Agreement") dated the date set forth above, is entered into by and between the borrower named above (jointly and severally, the "Borrower"), whose address is set forth above and Greyhound Financial Corporation ("GFC"), whose address is 201 North Figueroa Street, Suite 900, Los Angeles, California 90012. 1. LOANS 1.1 Total Facility. Upon the terms and conditions set forth herein and provided that no Event of Default or event which, with the giving of notice or the passage of time, or both, would constitute an Event of Default, shall have occurred and be continuing, GFC may, upon Borrower's request, make advances to Borrower from time to time in an aggregate outstanding principal amount not to exceed the Total Facility amount (the "Total Facility") set forth on the schedule hereto (the "Schedule"), subject to deduction of reserves for accrued interest and such other reserves as GFC reasonably deems proper from time to time, and less amounts GFC may be obligated to pay in the future on behalf of Borrower. GFC shall notify Borrower with reasonable promptness of the establishment any of such reserves. The Schedule is an integral part of this Agreement and all references to "herein", "herewith" and words of similar import shall for all purposes be deemed to include the Schedule. 1.2 Loans. Advances under the Total Facility ("Loans") shall be comprised of the amounts shown on the Schedule. 1.3 Overlines. If at any time or for any reason (i) the outstanding amount of advances made pursuant hereto exceeds any of the dollar or percentage limitations contained in the Schedule or (ii) the outstanding amount of advances under the Floorplan Credit Line exceeds the amount of Floorplanned Inventory plus the unused amount of the Revolving Credit Line referred to in the Schedule (any such excess, an "Overline"), then Borrower shall, upon GFC's demand, immediately pay to GFC, in cash, the full amount of such Overline. Without limiting Borrower's obligation to repay to GFC on demand the amount of any Overline, Borrower agrees to pay GFC interest on the outstanding principal amount of any Overline, on demand, at the rate set forth on the Schedule. 1.4. Floorplan Credit Line. At the request of Borrower and as part of the Total Facility, GFC may, in its sole discretion, make Floorplan Loans to or for the account of Borrower for the purpose of financing Qualified Inventory proposed by Borrower to be financed pursuant to this Section 1.4 (the "Floorplan Credit Line"). At no time shall the sum of Borrower's Obligations to GFC in respect of the Floorplan Credit Line exceed the amount specified in the Schedule. Upon receipt by GFC of an invoice for Floorplanned Inventory from Borrower or the manufacturer of such Floorplanned Inventory, which invoice is acceptable to GFC in its discretion reasonably exercised, GFC shall, if it elects to finance such Floorplanned Inventory, make a Floorplan Loan to Borrower in an amount not to exceed (subject to the other limitations set forth in this Agreement) the cost of such Floorplanned Inventory, including freight. GFC may, in its discretion reasonably exercised, refuse to make a Floorplan Loan 2 against any invoice. If GFC elects to make a Floorplan Loan, GFC may disburse the proceeds of such Floorplan Loan, less the amount of any discount agreed to between GFC and the manufacturer of the Floorplanned Inventory, directly to such manufacturer on Borrower's behalf in accordance with the payment arrangement then in effect between GFC and such manufacturer. GFC will charge Borrower's loan account for the full amount of the Floorplan Loan without regard to any discount that GFC may be entitled to receive pursuant to any payment arrangement referred to in the immediately preceding sentence. The Floorplan Credit Line is an uncommitted line of credit, may be terminated in whole or in part by GFC, in its discretion reasonably exercised, at any time and, upon such termination, no further Floorplan Loans shall be available from GFC. 1.5 Loan Account. All advances made hereunder shall be added to and deemed part of the Obligations when made. GFC may from time to time charge all Obligations of Borrower to Borrower's loan account with GFC. 2. CONDITIONS PRECEDENT. 2.1 Initial Advance. The obligation of GFC to make the initial advance hereunder is subject to the fulfillment, to the satisfaction of GFC and its counsel, of each of the following conditions and any additional conditions specified in the Schedule on or prior to the date set forth on the Schedule (the date of fulfillment of all such conditions, the "Closing Date"): (a) Loan Documents. GFC shall have received each of the following Loan Documents: (i) Guaranties executed by each of the Guarantors; (ii) such security agreements, intellectual property assignments and deeds of trust as GFC may require with respect to this Agreement and any Guaranties, executed by each of the parties thereto and, if applicable, duly acknowledged for recording or filing in the appropriate governmental offices; (iii) such Blocked Account or Dominion Account agreements as it shall determine; and (iv) such other documents, instruments and agreements in connection herewith as GFC shall require, executed, certified and/or acknowledged by such parties as GFC shall designate; (b) Terminations by Existing Lender. Borrower's existing lender(s) shall have executed and delivered UCC termination statements and other documentation evidencing the termination of its liens and security interests in the assets of Borrower or a subordination agreement in form and substance satisfactory to GFC in its sole discretion; (c) Charter Documents. GFC shall have received copies of Borrower's By-laws and Articles or Certificate of Incorporation, as amended, modified, or supplemented to the Closing Date, certified by the Secretary of Borrower; (d) Good Standing. GFC shall have received a certificate of corporate status with respect to Borrower, dated within ten (10) days of the Closing Date, by the Secretary of State of the state of incorporation of Borrower; which certificate shall indicate that Borrower is in good standing in such state; (e) Foreign Qualification. GFC shall have received certificates of corporate status with respect to Borrower and each other Loan Party, each dated within ten (10) days of the Closing Date, issued by the Secretary of State of each state in which such party's failure to be duly qualified or licensed would have a material adverse effect on its financial condition or assets, indicating that such party is in good standing; (f) Authorizing Resolutions and Incumbency. GFC shall have received a certificate from the Secretary of Borrower attesting to (i) the adoption of resolutions of Borrower's Board of Directors authorizing the execution and delivery of this Agreement and the other Loan Documents to which Borrower is a party, and authorizing specific officers of Borrower to execute same, and (ii) the authenticity of original specimen signatures of such officers; (g) Property Insurance. GFC shall have received the insurance certificates and certified copies of policies required by Section 4.4 hereof, along with a BFU438 Lender's Loss Payable Endorsement naming GFC as sole loss payee, all in form and substance satisfactory to GFC and its counsel; (h) Title Insurance. GFC shall have received binding commitments to issue such title insurance with respect to Collateral or security for Guaranties which is comprised of real property as it shall determine; (i) Searches; Certificates of Title. GFC shall have received searches reflecting the filing of its financing statements and fixture filings in such jurisdictions as it shall determine, and shall have received certificates of title with respect to the Collateral which shall have been 2 3 duly executed in a manner sufficient to perfect all of the security interests granted to GFC; (j) Intentionally Deleted. (k) Fees. Borrower shall have paid all fees payable by it on the closing date pursuant to this agreement; (l) Opinion of Counsel. GFC shall have received an opinion of Borrower's counsel covering such matters as GFC shall determine in its sole discretion; (m) Officer Certificate. GFC shall have received a certificate of the President and the Chief Financial Officer or similar official of Borrower, attesting to the accuracy of each of the representations and warranties of Borrower set forth in this Agreement and the fulfillment of all conditions precedent to the initial advance hereunder; (n) Solvency Certificate. If requested by GFC, a signed certificate of the Borrower's duly elected Chief Financial Officer concerning the solvency and financial condition of Borrower, on GFC's standard form; (o) Blocked Account. The Blocked Account referred to in Section 7.3 hereof shall have been established to the satisfaction of GFC in its sole discretion; (p) Intentionally Omitted. (q) Environmental Certificate. GFC shall have received an Environmental Certificate from Borrower, in form and substance satisfactory to GFC in its discretion, with respect to all locations of Collateral; and (r) Other Matters. All other documents and legal matters in connection with the transactions contemplated by this Agreement shall have been delivered, executed or recorded and shall be in form and substance satisfactory to GFC and its counsel. 2.2 Subsequent Advances. The obligation of GFC to make any advance hereunder (including the initial advance) shall be subject to the further conditions precedent that, on and as of the date of such advance: (a) the representations and warranties of Borrower set forth in this Agreement shall be accurate, before and after giving effect to such advance and to the application of any proceeds thereof; (b) no Event of Default and no event which, with notice or passage of time or both, would constitute an Event of Default has occurred and is continuing, or would result from such advance or from the application of any proceeds thereof; (c) no material adverse change has occurred in the Borrower's business, operations, financial condition, or assets or in the prospect of repayment of the Obligations; and (d) GFC shall have received such other approvals, opinions or documents as GFC shall reasonably request. 3. INTEREST RATE AND OTHER CHARGES. 3.1 Interest; Fees. Borrower shall pay GFC interest on the daily outstanding balance of Borrower's loan account at the per annum rate set forth on the Schedule. Borrower shall also pay GFC the fees set forth on the Schedule. 3.2 Default Interest Rate. Upon the occurrence and during the continuation of an Event of Default, Borrower shall pay GFC interest on the daily outstanding balance of Borrower's loan account at a rate per annum which is two percent (2%) in excess of the rate which would otherwise be applicable thereto pursuant to the Schedule. In addition, in the event that Borrower fails to make any payment to GFC when due with respect to the Floorplan Credit Line, Borrower shall pay GFC interest on the daily amount past due at a rate per annum which is six percent (6%) in excess of the Base Rate referred to in the Schedule. All such default interest shall be payable upon demand of GFC. 3.3 Examination Fees. Borrower agrees to pay to GFC an examination fee in the amount set forth on the Schedule in connection with each audit or examination of Borrower performed by GFC prior to or after the date hereof. Without limiting the generality of the foregoing, Borrower shall pay to GFC an initial examination fee in an amount equal to the amount set forth on the Schedule. Such initial examination fee shall be deemed fully earned at the time of payment and due and payable upon the closing of this transaction, and shall be deducted from any good faith deposit paid by Borrower to GFC prior to the date of this Agreement. 3.4 Excess Interest. The contracted for rate of interest of the loan contemplated hereby, without limitation, shall consist of the following: (i) the interest rate set 3 4 forth on the Schedule, calculated and applied to the principal balance of the Obligations in accordance with the provisions of this Agreement; (ii) interest after an Event of Default, calculated and applied to the amount of the Obligations in accordance with the provisions hereof; and (iii) all Additional Sums (as herein defined), if any. Borrower agrees to pay an effective contracted for rate of interest which is the sum of the above-referenced elements. The examination fees, attorneys fees, expert witness fees, letter of credit fees, collateral monitoring fees, closing fees, facility fees, Termination Fees, Minimum Interest Charges, other charges, goods, things in action or any other sums or things of value paid or payable by Borrower (collectively, the "Additional Sums"), whether pursuant to this Agreement or any other documents or instruments in any way pertaining to this lending transaction, or otherwise with respect to this lending transaction, that under any applicable law may be deemed to be interest with respect to this lending transaction, for the purpose of any applicable law that may limit the maximum amount of interest to be charged with respect to this lending transaction, shall be payable by Borrower as, and shall be deemed to be, additional interest and for such purposes only, the agreed upon and "contracted for rate of interest" of this lending transaction shall be deemed to be increased by the rate of interest resulting from the inclusion of the Additional Sums. It is the intent of the parties to comply with the usury laws of the State of Arizona (the "Applicable Usury Law"). Accordingly, it is agreed that notwithstanding any provisions to the contrary in this Agreement, or in any of the documents securing payment hereof or otherwise relating hereto, in no event shall this Agreement or such documents require the payment or permit the collection of interest in excess of the maximum contract rate permitted by the Applicable Usury Law (the "Maximum Interest Rate"). In the event (a) any such excess of interest otherwise would be contracted for, charged or received from Borrower or otherwise in connection with the loan evidenced hereby, (b) the maturity of the Obligations is accelerated in whole or in part, or (c) all or part of the Obligations shall be prepaid, so that under any of such circumstances the amount of interest contracted for, shared or received in connection with the loan evidenced hereby, would exceed the Maximum Interest Rate, then in any such event (1) the provisions of this paragraph shall govern and control, (2) neither Borrower nor any other person or entity now or hereafter liable for the payment of the Obligations shall be obligated to pay the amount of such interest to the extent that it is in excess of the Maximum Interest Rate, (3) any such excess which may have been collected shall be either applied as a credit against the then unpaid principal amount of the Obligations or refunded to Borrower, at GFC's option, and (4) the effective rate of interest shall be automatically reduced to the Maximum Interest Rate. It is further agreed, without limiting the generality of the foregoing, that to the extent permitted by the Applicable Usury Law; (x) all calculations of interest which are made for the purpose of determining whether such rate would exceed the Maximum Interest Rate shall be made by amortizing, prorating, allocating and spreading during the period of the full stated term of the loan evidenced hereby, all interest at any time contracted for, charged or received from Borrower or otherwise in connection with such loan; and (y) in the event that the effective rate of interest on the loan should at any time exceed the Maximum Interest Rate, such excess interest that would otherwise have been collected had there been no ceiling imposed by the Applicable Usury Law shall be paid to GFC from time to time, if and when the effective interest rate on the loan otherwise falls below the Maximum Interest Rate, to the extent that interest paid to the date of calculation does not exceed the Maximum Interest Rate, until the entire amount of interest which would otherwise have been collected had there been no ceiling imposed by the Applicable Usury Law has been paid in full. Borrower further agrees that should the Maximum Interest Rate be increased at any time hereafter because of a change in the Applicable Usury Law, then to the extent not prohibited by the Applicable Usury Law, such increases shall apply to all indebtedness evidenced hereby regardless of when incurred; but, again to the extent not prohibited by the Applicable Usury Law, should the Maximum Interest Rate be decreased because of a change in the Applicable Usury Law, such decreases shall not apply to the indebtedness evidenced hereby regardless of when incurred. 4. COLLATERAL. 4.1 Security Interest in the Collateral. To secure the payment and performance of the Obligations when due, Borrower hereby grants to GFC a security interest in all of Borrower's now owned or hereafter acquired or arising Inventory, Equipment, Receivables, and General Intangibles, including, without limitation, all of Borrower's Deposit Accounts, money, any and all property now or at any time hereafter in GFC's possession (including claims and credit balances), and 4 5 all proceeds (including proceeds of any insurance policies, proceeds of proceeds and claims against third parties), all products and all books and records related to any of the foregoing (all of the foregoing, together with all other property in which GFC may be granted a lien or security interest, is referred to herein, collectively, as the "Collateral"). 4.2 Perfection and Protection of Security Interest. Borrower shall, at its expense, take all actions requested by GFC at any time to perfect, maintain, protect and enforce GFC's security interest and other rights in the Collateral and the priority thereof from time to time, including, without limitation, (i) executing and filing financing or continuation statements and amendments thereof and executing and delivering such documents and titles in connection with motor vehicles as GFC shall require, all in form and substance satisfactory to GFC, (ii) maintaining a perpetual inventory and complete and accurate stock records, (iii) delivering to GFC warehouse receipts covering any portion of the Collateral located in warehouses and for which warehouse receipts are issued, and when requested transferring Inventory to warehouses designated by GFC, (iv) placing notations on Borrower's books of account to disclose GFC's security interest therein, and (v) when requested, delivering to GFC all letters of credit on which Borrower is named beneficiary. GFC may file, without Borrower's signature, one or more financing statements disclosing GFC's security interest under this Agreement. Borrower agrees that a carbon, photographic, photostatic or other reproduction of this Agreement or of a financing statement is sufficient as a financing statement. If any Collateral is at any time in the possession or control of any warehouseman, bailee or any of Borrower's agents or processors, Borrower shall notify such Person of GFC's security interest in such Collateral and, upon GFC's request, instruct them to hold all such Collateral for GFC's account subject to GFC's instructions. From time to time, Borrower shall, upon GFC's request, execute and deliver confirmatory written instruments pledging the Collateral to GFC, but Borrower's failure to do so shall not affect or limit GFC's security interest or other rights in and to the Collateral. Until the Obligations have been fully satisfied and GFC's obligation to make further advances hereunder has terminated, GFC's security interest in the Collateral shall continue in full force and effect. 4.3 Preservation of Collateral. GFC may, in its sole discretion, at any time discharge any lien or encumbrance on the Collateral or bond the same, pay any insurance, maintain guards, pay any service bureau, obtain any record or take any other action to preserve the Collateral and charge the cost thereof to Borrower's loan account as an Obligation. 4.4 Insurance. Borrower shall insure the Collateral against loss or damage by fire, theft, burglary, pilferage, loss in transit and such other hazards as GFC shall specify, in amounts, form, under policies and by insurers acceptable to GFC, with a rating by A.M. Best Company, Inc., of at least AA. Each policy shall include a provision requiring thirty (30) days' prior written notice to GFC of any cancellation or substantial modification and shall contain a lender's loss payable indorsement in favor of GFC in form acceptable to GFC. All premiums shall be paid by Borrower as and when due and accurate and complete copies of the policies shall be delivered by Borrower to GFC. If Borrower fails to do so, GFC may (but shall not be required to) procure such insurance at Borrower's expense. 5. EXAMINATION OF RECORDS; FINANCIAL REPORTING. 5.1 Examinations. GFC shall at all reasonable times have full access to and the right to examine, audit, make abstracts and copies from and inspect Borrower's records, files, books of account and all other documents, instruments and agreements relating to the Collateral and the right to check, test and appraise the Collateral. Borrower shall deliver to GFC any instrument necessary for GFC to obtain records from any service bureau maintaining records for Borrower. All instruments and certificates prepared by Borrower showing the value of any of the Collateral shall be accompanied, upon GFC's request, by copies of related purchase orders and invoices. GFC may, at any time after the occurrence of an Event of Default, remove from Borrower's premises Borrower's books and records (or copies thereof) or require Borrower to deliver such books and records or copies to GFC. GFC may, without expense to GFC, use such of Borrower's personnel, supplies and premises as may be reasonably necessary for maintaining or enforcing GFC's security interest. 5.2 Reporting Requirements. Borrower shall furnish GFC, upon request, such information and statements as GFC shall request from time to time regarding Borrower's business affairs, financial condition and the results of its operations. Without limiting the generality of the foregoing, Borrower shall provide GFC with (i) copies of sales invoices, customer statements and credit 5 6 memoranda issued, remittance advices and reports and copies of deposit slips, daily; (ii) copies of shipping and delivery documents, upon request; (iii) on or prior to the date set forth on the Schedule, monthly agings and reconciliations of Receivables, payables reports, inventory reports and unaudited financial statements (certified by an officer of Borrower acceptable to GFC) with respect to the prior month prepared on a basis consistent with such statements prepared in prior months and otherwise in accordance with generally accepted accounting principles, consistently applied; (iv) audited annual consolidated and consolidating financial statements, prepared in accordance with generally accepted accounting principles applied on a basis consistent with the most recent Prepared Financials provided to GFC by Borrower, including balance sheets, income and cash flow statements, accompanied by the unqualified report thereon of independent certified public accountants acceptable to GFC, as soon as available, and in any event, within ninety (90) days after the end of each of Borrower's fiscal years; and (v) such certificates relating to the foregoing as GFC may request, including, without limitation, a monthly certificate from the president and the chief financial officer of Borrower showing Borrower's compliance with each of the financial covenants set forth in this Agreement, and stating whether any Event of Default has occurred or event which, with giving of notice or the passage of time, or both, would constitute an Event of Default, and if so, the steps being taken to prevent or cure such Event of Default. 5.3 Guarantor's Financial Statements and Tax Returns. Borrower shall cause each of the Guarantors to deliver to GFC such Guarantor's annual financial statement (in form acceptable to GFC) and a copy of such Guarantor's federal income tax return with respect to the corresponding year, in each case on the date when such tax return is due or, if earlier, on the date when available. 6. COLLATERAL REPORTING; INVENTORY 6.1 Invoices. Borrower shall not re-date any invoice or sale from the original date thereof or make sales on extended terms beyond those customary in Borrower's industry, or otherwise extend or modify the term of any Receivable. If Borrower becomes aware of any matter affecting any Receivable, including information affecting the credit of the account debtor thereon, Borrower shall promptly notify GFC in writing. 6.2 Instruments. In the event any Receivable is or becomes evidenced by a promissory note, trade acceptance or any other instrument for the payment of money, Borrower shall immediately deliver such instrument to GFC appropriately endorsed to GFC and, regardless of the form of any presentment, demand, notice of dishonor, protest or notice of protest with respect thereto, Borrower shall, to the extent of any Obligations then existing, remain liable thereon until such instrument is paid in full. 6.3 Physical Inventory. Borrower shall conduct a physical count of the Inventory at such intervals as GFC requests and promptly supply GFC with a copy of such accounts accompanied by a report of the value (calculated at the lower of cost or market value on a first in, first out basis) of the Inventory and such additional information with respect to the Inventory as GFC may request from time to time. 6.4 Returns. For so long as no Event of Default has occurred and is continuing and subject to the provisions of Section 9.2, if any account debtor returns any Inventory to Borrower in the ordinary course of its business, Borrower shall promptly determine the reason for such return and promptly issue a credit memorandum to the account debtor (sending a listing thereof to GFC and, in the case of credit memorandum in excess of $5,000, copies of such credit memorandum) in the appropriate amount. In the event any attempted return for credit occurs after the occurrence of any Event of Default, Borrower shall (i) hold such returned Inventory in trust for GFC, (ii) segregate all such returned Inventory from all of Borrower's other property, (iii) conspicuously label such returned Inventory as GFC's property, and (iv) immediately notify GFC of the return for credit of any Inventory, specifying the reason for such return, the location and condition of such returned Inventory, and on GFC's request deliver such returned Inventory to GFC. Borrower shall not consign any Inventory without the prior written consent of GFC. 7. PRINCIPAL PAYMENTS; PROCEEDS OF COLLATERAL. 7.1 Principal Payments. Except where evidenced by notes or other instruments issued or made by Borrower to GFC specifically containing payment provisions which are in conflict with this Section 7.1 (in which event the conflicting provisions of said notes or other instruments shall govern and control), that portion of the Obligations consisting of principal payable on account of Receivable Loans, Inventory Loans and Floorplan Loans 6 7 shall be payable by Borrower to GFC immediately upon the earliest of (i) the receipt by GFC or Borrower of any proceeds of any of the Collateral, to the extent of said proceeds, (ii) the occurrence of an Event of Default in consequence of which GFC elects to accelerate the maturity and payment of such loans, (iii) any termination of this Agreement pursuant to Section 16 hereof and (iv) in the case of any Floorplan Loan, the date that is the number of days set forth in Exhibit A to this Agreement after the invoice date for the Floorplanned Inventory purchased with the proceeds of such Floorplan Loan, which number of days are specified opposite the name of the manufacturer of such Floorplanned Inventory in such Exhibit A (and GFC shall have the right, in its sole discretion, to amend or supplement such Exhibit A in whole or in part by delivery from time to time of a new such Exhibit A to Borrower); provided, however, that any Overline shall be payable on demand pursuant to the provisions of Section 1.3 hereof. 7.2 Collections. To the extent Borrower receives any collections of Receivables, it shall receive all payments as trustee of GFC and immediately deliver all payments to GFC in their original form as set forth below, duly endorsed in blank. GFC or its designee may, at any time in its reasonable discretion and upon the occurrence of an Event of Default, notify account debtors that the Receivables have been assigned to GFC and of GFC's security interest therein, and may collect the Receivables directly and charge the collection costs and expenses to Borrower's loan account. Borrower agrees that, in computing the charges under this Agreement, all items of payment shall be deemed applied by GFC on account of the Obligations upon receipt of GFC of good funds which have been finally credited to GFC's account, whether such funds are received directly from Borrower or from the Blocked Account bank or the Dominion Account bank, pursuant to Section 7.3 hereof. GFC is not, however, required to credit Borrower's account for the amount of any item of payment which is unsatisfactory to GFC in its discretion reasonably exercised and GFC may charge Borrower's loan account for the amount of any item of payment which is returned to GFC unpaid. 7.3 Establishment of a Lockbox Account or Dominion Account. All proceeds of Collateral shall, at the direction of GFC, be deposited by Borrower into a lockbox account, or such other "blocked account" as GFC may require (each, a "Blocked Account") pursuant to an arrangement with such bank as may be selected by Borrower and be acceptable to GFC. Borrower shall issue to any such bank an irrevocable letter of instruction directing said bank to transfer such funds so deposited to GFC, either to any account maintained by GFC at said bank or by wire transfer to appropriate account(s) of GFC. All funds deposited in a Blocked Account shall immediately become the sole property of GFC and Borrower shall obtain the agreement by such bank to waive any offset rights against the funds so deposited. GFC assumes no responsibility for any Blocked Account arrangement, including without limitation, any claim of accord and satisfaction or release with respect to deposits accepted by any bank thereunder. Alternatively, GFC may establish depository accounts in the name of GFC at a bank or banks for the deposit of such funds (each, a "Dominion Account") and Borrower shall deposit all proceeds of Receivables and all cash proceeds of any sale of Inventory or, to the extent permitted herein, Equipment or cause same to be deposited, in kind, in such Dominion Accounts of GFC in lieu of depositing same to Blocked Accounts. 7.4 Payments Without Deductions. Borrower shall pay principal, interest, and all other amounts payable hereunder, or under any related agreement, without any deduction whatsoever, including, but not limited to, any deduction for any setoff or counterclaim. 7.5 Collection Days Upon Repayment. In the event Borrower repays the Obligations in full at any time hereafter, such payment in full shall be credited (conditioned upon final collection) to Borrower's loan upon GFC's receipt thereof. 7.6 Monthly Accounting. GFC shall provide Borrower monthly with an account of advances, charges, expenses and payments made pursuant to this Agreement. Such account shall be deemed correct, accurate and binding on Borrower and an account stated (except for reverses and reapplications of payments made and corrections of errors discovered by GFC), unless Borrower notifies GFC in writing to the contrary within ninety (90) days after each account is rendered, describing the nature of any alleged errors or admissions; and notwithstanding such 90-day period, in the event GFC at any time determines that it has mistakenly charged Borrower's account for an amount due to GFC from a third party, or has mistakenly transferred any of Borrower's property to a third party, then GFC shall make a commercially reasonable attempt to recover such amounts or property, as applicable from such third party, and shall credit Borrower's 7 8 account or return such property, as applicable, to the extent any recovery is realized. 8. POWER OF ATTORNEY. Borrower appoints GFC and its designees as Borrower's attorney, with the power to endorse Borrower's name on any checks, notes, acceptances, money orders or other forms of payment or security that come into GFC's possession; to sign Borrower's name on any invoice or bill of lading relating to any Receivable, on drafts against customers, on assignments of Receivables, on notices of assignment, financing statements and other public records, on verifications of accounts and on notices to customers or account debtors; to send requests for verification of Receivables to customers or account debtors. After the occurrence of any Event of Default GFC shall have the following additional powers of attorney: to notify the post office authorities to change the address for delivery of Borrower's mail to an address designated by GFC; to open and dispose of all mail addressed to Borrower; and to do all other things GFC deems reasonably necessary or desirable to carry out the terms of this Agreement. Borrower hereby ratifies and approves all acts of such attorney. Neither GFC nor any of its designees shall be liable for any acts or omissions nor for any error of judgment or mistake of fact or law while acting as Borrower's attorney, except for GFC's gross negligence or willful misconduct. This power, being coupled with an interest, is irrevocable until the Obligations have been fully satisfied and GFC's obligation to provide loans hereunder shall have terminated. 9. RECEIVABLES. 9.1 Eligibility. Borrower represents and warrants that each Receivable covers and shall cover a bona fide sale or lease and delivery by it of goods or the rendition by it of services in the ordinary course of its business, and shall be for a liquidated amount and GFC's security interest shall not be subject to any offset, deduction, counterclaim, rights of return or cancellation, lien or other condition. If any representation or warranty herein is breached as to any Receivable or any Receivable ceases to be an Eligible Receivable for any reason other than payment thereof, then GFC may, in addition to its other rights hereunder, designated any and all Receivables owing by that account debtor as not Eligible Receivables; provided, that GFC shall in any such event retain its security interest in all Receivables, whether or not Eligible Receivables, until the Obligations have been fully satisfied and GFC's obligation to provide loans hereunder has terminated. 9.2 Disputes. Borrower shall notify GFC promptly of all disputes or claims and settle or adjust such disputes or claims at no expense to GFC, but no discount, credit or allowance shall be granted to any account debtor and no returns of merchandise shall be accepted by Borrower without GFC's consent, except for discounts, credits and allowances made or given in the ordinary course of Borrower's business, provided if no Event of Default has occurred and is continuing, Borrower may grant adjustments to the ineligible Receivables. GFC may, at any time after the occurrence of an Event of Default, settle or adjust disputes or claims directly with account debtors for amounts and upon terms which GFC considers advisable in its reasonable credit judgment and, in all cases, GFC shall credit Borrower's loan account with only the net amounts received by GFC in payment of any Receivables. 10. EQUIPMENT. Borrower shall keep and maintain the Equipment in good operating condition and repair and make all necessary replacements thereto to maintain and preserve the value and operating efficiency thereof at all times consistent with Borrower's past practice, ordinary wear and tear excepted. Borrower shall not permit any item of Equipment to become a fixture (other than a trade fixture) to real estate or an accession to other property. 11. OTHER LIENS; NO DISPOSITION OF COLLATERAL. Borrower represents, warrants and covenants that (a) all Collateral is and shall continue to be owned by it free and clear of all liens, claims and encumbrances whatsoever (except for GFC's security interest, Permitted Encumbrances, and such other liens, claims and encumbrances as may be permitted by GFC in its sole discretion from time to time in writing), and (b) Borrower shall not, without GFC's prior written approval, sell, encumber or dispose of or permit the sale, encumbrance or disposal of any Collateral or any interest of Borrower therein, except for the sale of Inventory in the ordinary course of Borrower's business. The proceeds of any such sales shall be remitted to GFC pursuant to this Agreement for application to the Obligations. 8 9 12. GENERAL REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants that: 12.1 Due Organization. It is a corporation duly organized, validly existing and in good standing under the laws of the State set forth on the Schedule, is qualified and authorized to do business and is in good standing in all states in which such qualification and good standing are necessary in order for it to conduct its business and own its property, and has all requisite power and authority to conduct its business as presently conducted, to own its property and to execute and deliver each of the Loan Documents to which it is a party and perform all of its Obligations thereunder; 12.2 Other Names. Borrower has not, during the preceding five (5) years, been known by or used any other corporate or fictitious name except as set forth on the Schedule, nor has Borrower been the surviving corporation of a merger or consolidation or acquired all or substantially all of the assets of any person during such time; 12.3 Due Authorization. The execution, delivery and performance by Borrower of the Loan Documents to which it is a party have been authorized by all necessary corporate action and do not and shall not constitute a violation of any applicable law or of Borrower's Articles or Certificate of Incorporation or By-Laws or any other document, agreement or instrument to which Borrower is a party or by which Borrower or its assets are bound; 12.4 Binding Obligation. Each of the Loan Documents to which Borrower is a party is the legal, valid and binding obligation of Borrower enforceable against Borrower in accordance with its terms; 12.5 Intangible Property. Borrower possesses adequate assets, licenses, patents, patent applications, copyrights, trademarks, trademark applications and trade names for the present and planned future conduct of its business without any known conflict with the rights of others, and each is valid and has been duly registered or filed with the appropriate governmental authorities; 12.6 Capital. Borrower has capital sufficient to conduct its business, is able to pay its debts as they mature and owns property having a fair salable value greater than the amount required to pay all of its debts (including contingent debts); 12.7 Material Litigation. Borrower has no pending or overtly threatened litigation, actions or proceedings which would materially and adversely affect its business, assets, operations, prospects or condition, financial or otherwise, or the Collateral or any of GFC's interests therein; 12.8 Title: Security Interests of GFC. Borrower has good, indefeasible and merchantable title to the Collateral and, upon the filing of UCC-1 Financing Statements and the recording of any mortgages or deeds of trust with respect to real property, in each case in the appropriate offices, this Agreement and such documents shall create valid and perfected first priority liens in the Collateral, subject only to Permitted Encumbrances; 12.9 Restrictive Agreement: Labor Contracts. Borrower is not a party or subject to any contract or subject to any charge, corporate restriction, judgment, decree or order materially and adversely affecting its business, assets, operations, prospects or condition, financial or otherwise, or which restricts its right or ability to incur Indebtedness, and it is not party to any labor dispute. In addition, no labor contract is scheduled to expire during the Initial Term of this Agreement, except as disclosed to GFC in writing prior to the date hereof; 12.10 Laws. Borrower is not in violation of any applicable statute, regulation, ordinance or any order of any court, tribunal or governmental agency, in any respect materially and adversely affecting the Collateral or its business, assets, operations, prospects or condition, financial or otherwise; 12.11 Consents. Borrower has obtained or caused to be obtained or issued any required consent of a governmental agency or other Person in connection with the financing contemplated hereby; 12.12 Defaults. Borrower is not in default with respect to any note, indenture, loan agreement, mortgage, lease, deed or other agreement to which it is a party or by which it or its assets are bound, nor has any event occurred which, with the giving of notice or the lapse of time, or both, would cause such a default; 12.13 Financial Condition. The Prepared Financials fairly present Borrower's financial condition and results of operations and those of such other Persons described therein as of the date thereof; there are no material 9 10 omissions from the Prepared Financials or other facts or circumstances not reflected in the Prepared Financials; and there has been no material and adverse change in such financial condition or operations since the date of the initial Prepared Financials delivered to GFC hereunder; 12.14 ERISA. None of Borrower, any ERISA Affiliate, or any Plan is or has been in violation of any of the provisions of ERISA, any of the qualification requirements of IRC Section 401(a) or any of the published interpretations thereunder, nor has Borrower or any ERISA Affiliate received any notice to such effect. No notice of intent to terminate a Plan has been filed under Section 4041 of ERISA, nor has any Plan been terminated under ERISA. The PBGC has not instituted proceedings to terminate, or appointed a trustee to administer, a Plan. No lien upon the assets of Borrower has arisen with respect to a Plan. No prohibited transaction or Reportable Event has occurred with respect to a Plan. Neither Borrower nor any ERISA Affiliate has incurred any withdrawal liability with respect to any Multiemployer Plan. Borrower and each ERISA Affiliate have made all contributions required to be made by them to any Plan or Multiemployer Plan when due. There is no accumulated funding deficiency in any Plan, whether or not waived; 12.15 Taxes. Borrower has filed all tax returns and such other reports as it is required by law to file and has paid or made adequate provision for the payment on or prior to the date when due of all taxes, assessments and similar charges that are due and payable; 12.16 Locations. Borrower's chief executive office and the offices and locations where it keeps the Collateral (except for Inventory in transit) are at the locations set forth on the Schedule, except to the extent that such locations may have been changed after notice to GFC in accordance with Section 13.5 below; 12.17 Business Relationships. There exists no actual or threatened termination, cancellation or limitation of, or any modification or change in, the business relationship between Borrower and any customer or any group of customers whose purchases individually or in the aggregate are material to the business of Borrower, or with any material supplier, and there exists no present condition or state of facts or circumstances which would materially and adversely affect Borrower or prevent Borrower from conducting such business after the consummation of the transactions contemplated by this Agreement in substantially the same manner in which it has heretofore been conducted; and 12.18 Reaffirmations. Each request for a loan made by Borrower pursuant to this Agreement shall constitute (i) an automatic representation and warranty by Borrower to GFC that there does not then exist any Event of Default and (ii) a reaffirmation as of the date of said request of all of the representations and warranties of Borrower contained in this Agreement and the other Loan Documents. 13. AFFIRMATIVE COVENANTS. Borrower covenants that, so long as any Obligation remains outstanding and this Agreement is in effect, it shall: 13.1 Expenses. Promptly reimburse GFC for all reasonable costs, fees and expenses incurred by GFC in connection with the negotiation, preparation, execution, delivery, administration and enforcement of each of the Loan Documents, including, but not limited to, the attorneys' and paralegals' fees of in-house and outside counsel, expert witness fees, lien, title search and insurance fees, appraisal fees, all charges and expenses incurred in connection with any and all environmental reports and environmental remediation activities, and all other costs, expenses, taxes and filing or recording fees payable in connection with the transactions contemplated by this Agreement, including without limitation all such costs, fees and expenses as GFC shall incur or for which GFC shall become obligated in connection with (i) any inspection or verification of the Collateral, (ii) any proceeding relating to the Loan Documents or the Collateral, (iii) actions taken with respect to the Collateral and GFC's security interest therein, including, without limitation, the defense or prosecution of any action involving GFC and Borrower or any third party, (iv) enforcement of any of GFC's rights and remedies with respect to the Obligations or Collateral, and (v) consultation with GFC's attorneys and participation in any workout, bankruptcy or other insolvency or other proceeding involving any Loan Party or any Affiliate, whether or not suit is filed. Borrower shall also pay all GFC's out-of-pocket charges in connection with bank wire transfers, forwarding of loan proceeds, deposits of checks and other items of payment, returned checks, establishment and maintenance of lockboxes and other Blocked Accounts, and all other bank and administrative matters, in accordance with GFC's schedule of bank and 10 11 administrative fees and charges in effect from time to time; 13.2 Taxes. File all tax returns and pay or make adequate provision for the payment of all taxes, assessments and other charges on or prior to the date when due; 13.3 Notice of Litigation. Promptly notify GFC in writing of any litigation, suit or administrative proceeding which may materially and adversely affect the Collateral or Borrower's business, assets, operations, prospects or condition, financial or otherwise, whether or not the claim is covered by insurance; 13.4 ERISA. Notify GFC in writing (i) promptly upon the occurrence of any event described in Paragraph 4043 of ERISA, other than a termination, partial termination or merger of a Plan or a transfer of a Plan's assets and (ii) prior to any termination, partial termination or merger of a Plan or a transfer of a Plan's assets; 13.5 Change in Location. Notify GFC in writing forty-five (45) days prior to any change in the location of Borrower's chief executive office or the location of any Collateral, or Borrower's opening or closing of any other place of business; 13.6 Corporate Existence. Maintain its corporate existence and its qualification to do business and good standing in all states necessary for the conduct of its business and the ownership of its property and maintain adequate assets, licenses, patents, copyrights, trademarks and trade names for the conduct of its business; 13.7 Labor Disputes. Promptly notify GFC in writing of any labor dispute to which Borrower is or may become subject and the expiration of any labor contract to which Borrower is a party or bound; 13.8 Violations of Law. Promptly notify GFC in writing of any violation of any law, statute, regulation or ordinance of any governmental entity, or of any agency thereof, applicable to Borrower which may materially and adversely affect the Collateral or Borrower's business, assets, prospects, operations or condition, financial or otherwise; 13.9 Defaults. Notify GFC in writing within five (5) business days of Borrower's default under any note, indenture, loan agreement, mortgage, lease or other agreement to which Borrower is a party or by which Borrower is bound, or of any other default under any Indebtedness of Borrower; 13.10 Capital Expenditures. Promptly notify GFC in writing of the making of any Capital Expenditure materially affecting Borrower's business, assets, prospects, operations or condition, financial or otherwise; 13.11 Books and Records. Keep adequate records and books of account with respect to its business activities in which proper entries are made in accordance with generally accepted accounting principles consistently applied, reflecting all of its financial transactions; 13.12 Leases; Warehouse Agreements. Provide GFC with (i) copies of all agreements between Borrower and any landlord or warehouseman which owns any premises at which any Collateral may, from time to time, be located, and (ii) without limiting the landlord and mortgage waivers to be provided pursuant to Section 2.1(j) above, landlord and mortgage waivers in form acceptable to GFC with respect to all locations where any Collateral is hereafter located; 13.13 Additional Documents. At GFC's request, promptly execute or cause to be executed and delivered to GFC any and all documents, instruments or agreements deemed necessary by GFC to facilitate the collection of the Obligations or the Collateral or otherwise to give effect to or carry out the terms or intent of this Agreement or any of the other Loan Documents. Without limiting the generality of the foregoing, if any of the Receivables with a face value in excess of $10,000.00 arises out of a contract with the United States of America or any department, agency, subdivision or instrumentality thereof, Borrower shall promptly notify GFC of such fact in writing and shall execute any instruments and take any other action required or requested by GFC to comply with the provisions of the Federal Assignment of Claims Act; and 13.14 Financial Covenants. Comply with the financial covenants set forth on the Schedule. 13.15 Landlord Waiver. Within ninety days of the date hereof obtain a landlord waiver from the lessor of the Irvine, California location, in form and substance acceptable to GFC. 11 12 14. NEGATIVE COVENANTS. Without GFC's prior written consent, which consent GFC may withhold in its sole discretion (provided that as to Sections 14.2 and 14.12, GFC may withhold its consent in its discretion, reasonably exercised), so long as any Obligation remains outstanding and this Agreement is in effect, Borrower shall not: 14.1 Mergers. Merge or consolidate with or acquire any other Person, or make any other material change in its capital structure or in its business or operations which might adversely affect the repayment of the Obligations: 14.2 Loans. Make advances, loans or extensions of credit to, or invest in, any Person exceeding $250,000 in the aggregate for all Persons; 14.3 Dividends. Declare or pay cash dividends upon any of its stock or distribute any of its property or redeem, retire, purchase or acquire directly or indirectly any of its stock; 14.4 Adverse Transactions. Enter into any transaction which materially and adversely affects the Collateral or its ability to repay the Obligations in full as and when due; 14.5 Indebtedness of Others. Become directly or contingently liable for the Indebtedness of any Person, except by endorsement of instruments for deposit; 14.6 Repurchase. Make a sale to any customer on a bill-and-hold, guaranteed sale, sale and return, sale on approval, consignment, or any other repurchase or return basis; 14.7 Name. Use any corporate or fictitious name other than its corporate name as set forth in its Articles or Certificate of Incorporation on the date hereof or as set forth on the Schedule; 14.8 Prepayment. Prepay any Indebtedness other than trade payables and other than the Obligations; 14.9 Intentionally Omitted. 14.10 Compensation. Pay total compensation, including salaries, withdrawals, fees, bonuses, commissions, drawing accounts and other payments, whether directly or indirectly, in money or otherwise, during any fiscal year to all of Borrower's executives, officers and directors (or any relative thereof) in an amount in excess of the amount set forth on the Schedule; 14.11 Intentionally Omitted. 14.12 Affiliate Transactions. Except as set forth below or in Section 14.2 above, sell, transfer, distribute or pay any money or property to any Affiliate, or invest in (by capital contribution or otherwise) or purchase or repurchase any stock or Indebtedness, or any property, of any Affiliate, or become liable on any guaranty of the indebtedness, dividends or other obligations of any Affiliate. Notwithstanding the foregoing, Borrower may pay compensation permitted by Section 14.10 to employees who are Affiliates and, if no Event of Default has occurred, Borrower may engage in transactions with Affiliates in the normal course of business, in amounts and upon terms which are fully disclosed to GFC and which are not less favorable to Borrower than would be obtainable in a comparable arm's length transaction with a Person who is not an Affiliate; 14.13 Nature of Business. Enter into any new business or make any material change in any of Borrower's business objectives, purposes or operations; 14.14 GFC's Name. Use the name of GFC in connection with any of Borrower's business or activities, except in connection with internal business matters or as required in dealings with governmental agencies and financial institutions or with trade creditors of Borrower, solely for credit reference purposes; or 14.15 Margin Security. Own, purchase or acquire (or enter into any contract to purchase or acquire) any "margin security" as defined by any requlation of the Federal Reserve Board as now in effect or as the same may herafter be in effect. 15. ENVIRONMENTAL MATTERS. 15.1 Definitions. The following definitions apply to the provisions of this Section 15: (1) the term "Applicable Law" shall include, but shall not be limited to, each statute named or referred to in this Section 15.1 and all rules and regulations thereunder, and any other local, state and/or federal laws, rules, regulations or ordinances, whether currently in existence or hereafter enacted, which govern, to the extent applicable to the Property or to Borrower, (i) the 12 13 existence, cleanup and/or remedy of contamination on real property; (ii) the protection of the environment from soil, air or water pollution, or from spilled, deposited or otherwise emplaced contamination; (iii) the emission or discharge of hazardous substances into the environment; (iv) the control of hazardous wastes; or (v) the use, generation, transport, treatment, removal or recovery of Hazardous Substances; (b) The term "Hazardous Substance" shall mean (i) any oil, flammable substance, explosives, radioactive materials, hazardous wastes or substances, toxic wastes or substances or any other wastes, materials or pollutants which either pose a hazard to the Property or to persons on or about the Property or cause the Property to be in violation of any Applicable Law; (ii) asbestos in any form which is or could become friable, urea formaldehyde foam insulation, transformers or other equipment which contain dielectric fluid containing levels of polychlorinated biphenyls, or radon gas; (iii) any chemical, material or substance defined as or included in the definition of "hazardous substances," "waste," "hazardous wastes," "hazardous materials," "extremely hazardous waste," "restricted hazardous waste," or "toxic substances" or words of similar import under any Applicable Law, including, but not limited to, the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), 42 USC Sections 9601 et seq.; the Resource Conservation and Recovery Act ("RCRA"), 42 USC Sections 6901 et seq.; the Hazardous Materials Transportation Act, 49 USC Sections 1801 et seq.; the Federal Water Pollution Control Act, 33 USC Sections 1251 et seq.; the California Hazardous Waste Common Law ("HWCL"), Cal. Health & Safety Sections 25100 et seq.; the Underground Storage of Hazardous Substances Act (Cal. Health & Safety Sections 25280 et seq.; Hazardous Substance Account Act ("HSAA"), Cal. Health & Safety Code Sections 25300 et seq.; the Porter-Cologne Water Quality Control Act (the "Porter-Cologne Act"), Cal. Water Code Sections 13000 et seq.; the Safe Drinking Water and Toxic Enforcement Act of 1986 (Proposition 65); Title 22 of the California Code of Regulations, Division 4, Chapter 30; (iv) any other chemical, material or substance, exposure to which is prohibited, limited or regulated by any governmental authority which may or could pose a hazard to the health or safety of the occupants of the Property or the owners and/or occupants of property adjacent to or surrounding the Property, or any other person coming upon the Property or adjacent property; and (v) any other chemical, materials or substance which may or could pose a hazard to the environment; and (c) the term "Property" shall mean all real property, wherever located, in which Borrower or any Affiliate of Borrower has any right, title or interest, whether now existing or hereafter arising, and including, without limitation, as owner, lessor or lessee. 15.2 Covenants and Representations. (a) Borrower represents and warrants that, (x) to the best of its knowledge, at no time have there been, and (y) during the period of Borrower's possession of any interest in the Property, Borrower has not been involved in, any activities on the Property involving, directly or indirectly, the use, generation, treatment, storage or disposal of any Hazardous Substances except in compliance with Applicable Law (i) under, on or in the land included in the Property, whether contained in soil, tanks, sumps, ponds, lagoons, barrels, cans or other containments, structures or equipment, (ii) incorporated in the buildings, structures or improvements included in the Property, including any building material containing asbestos, or (iii) used in connection with any operations on or in the Property. (b) Without limiting the generality of the foregoing and to the extent not included within the scope of this Section 15.2, Borrower represents and warrants that it is in full compliance with Applicable Law and has received no notice from any person or any governmental agency or other entity of any violation by Borrower or its Affiliates of any Applicable Law. (c) Borrower shall be solely responsible for and agrees to indemnify GFC, protect and defend GFC with counsel reasonably acceptable to GFC, and hold GFC harmless from and against any claims, actions, administrative proceedings, judgments, damages, punitive damages, penalties, fines, costs, liabilities (including sums paid in settlements of claims), interest or losses, attorneys' fees (including any fees and expenses incurred in enforcing this indemnity), consultant fees, expert fees, and other out-of-pocket costs or expenses actually incurred by GFC (collectively, the "Environmental Costs"), that may, at any time or from time to time, arise directly or indirectly from or in connection with any of the following for which Borrower or any of its Affiliates is responsible or is currently aware of or with reasonable diligence should be aware of; (i) the presence, suspected presence, release or suspected release of any Hazardous Substance whether into the air, soil, surface 13 14 water or groundwater of or at the Property, or any other violation of Applicable Law, or (ii) any breach of the foregoing representations and covenants; except to the extent any of the foregoing result from the actions of GFC, its employees, agents and representatives. All reasonable Environmental Costs incurred or advanced by GFC shall be deemed to be made by GFC in good faith and shall constitute Obligations hereunder. 16. TERM; TERMINATION. 16.1 Term. The initial term of this Agreement shall be as set forth on the Schedule (the "Initial Term") and shall be automatically renewed for successive periods of one (1) year (each, a "Renewal Term"), unless earlier terminated as provided herein. 16.2 Prior Notice. Each party shall have the right to terminate this Agreement at the end of the Initial Term or at the end of any Renewal Term by giving the other party written notice not less than sixty (60) days prior to the effective date of such termination, by registered or certified mail. 16.3 Payment in Full. Upon the effective date of termination, the Obligations shall become immediately due and payable in full in cash. 16.4 Early Termination; Termination Fee. In addition to the procedure set forth in Section 16.2, Borrower may terminate this Agreement at any time but only upon sixty (60) days' prior written notice and prepayment of the Obligations. Upon any such early termination by Borrower or any termination of this Agreement by GFC upon the occurrence of an Event of Default, the, and in any such event, Borrower shall pay to GFC upon the effective date of such termination a fee (the "Termination Fee") in an amount equal to the amount shown on the Schedule. 17. DEFAULT. 17.1 Events of Default. Anyone or more of the following events shall constitute an Event of Default under this Agreement: (a) Borrower fails to pay when due and payable any portion of the Obligations at stated maturity, upon acceleration or otherwise; (b) Borrower or any other Loan Party fails or neglects to perform, keep, or observe any term, provision, condition, covenant or agreement contained in any Loan Document to which Borrower or such other Loan Party is a party; (c) Any material adverse change occurs in Borrower's business, assets, operations, prospects or condition, financial or otherwise; (d) The prospect of repayment of any portion of the Obligations or the value or priority of GFC's security interest in the Collateral is materially impaired; (e) Any material portion of Borrower's assets is seized, attached, subjected to a writ or distress warrant, is levied upon or comes into the possession of any judicial officer and not released within 5 days thereafter; (f) Borrower shall generally not pay its debts as they become due or shall enter into any agreement (whether written or oral), or offer to enter into any agreement, with all or a significant number of its creditors regarding any moratorium or other indulgence with respect to its debts or the participation of such creditors or their representatives in the supervision, management or control of the business of Borrower; (g) Any bankruptcy or other insolvency proceeding is commenced by Borrower, or any such proceeding is commenced against Borrower and remains undischarged or unstayed for forty-five (45) days; (h) Any notice of lien, levy or assessment in excess of $25,000 is filed of record with respect to any of Borrower's assets (subject to GFC's right to create reserves for amount below the foregoing); (i) Any judgments are entered against Borrower in an aggregate amount exceeding $50,000 (subject to GFC's right to create reserves for amounts below the foregoing); (j) Any default shall occur under any material agreement between Borrower and any third party including, without limitation, any default which would result in a right by such third party to accelerate the maturity of any material Indebtedness of Borrower to such third party; (k) Any representation or warranty made or deemed to be made by Borrower, any Affiliate or any other Loan Party in any Loan Document or any other statement, document or report made or delivered to GFC in connection therewith shall prove to have been misleading in any material respect; 14 15 (1) If more than one Guarantor dies, or if any Guarantor terminates or attempts to terminate its Guaranty or any security therefor or becomes subject to any bankruptcy or other insolvency proceeding; (m) Any Prohibited Transaction or Reportable Event shall occur with respect to a Plan which could have a material adverse effect on the financial condition of Borrower; any lien upon the assets of Borrower in connection with any Plan shall arise; Borrower or any of its ERISA Affiliates shall fail to make full payment when due of all amounts which Borrower or any of its ERISA Affiliates may be required to pay to any Plan or any Multiemployer Plan as one or more contributions thereto; Borrower or any of its ERISA Affiliates creates or permits the creation of any accumulated funding deficiency, whether or not waived; or (n) Any transfer of more than ten percent (10%) of the issued and outstanding shares of common stock or other evidence of ownership of Borrower. 17.2 Remedies. Upon the occurrence of an Event of Default, GFC may, at its option and in its sole discretion and in addition to all of its other rights under the Loan Documents, terminate this Agreement and declare all of the Obligations to be immediately payable in full. GFC shall also have all of its rights and remedies under applicable law, including, without limitation, the default rights and remedies of a secured party under the Code. Further, GFC may, at any time, take possession of the Collateral and keep it on Borrower's premises, at no cost to GFC, or remove any part of it to such other place(s) as GFC may desire, or Borrower shall, upon GFC's demand, at Borrower's sole cost, assemble the Collateral and make it available to GFC at a place reasonably convenient to GFC. GFC may sell and deliver any Collateral at public or private sales, for cash, upon credit or otherwise, at such prices and upon such terms as GFC deems advisable, at GFC's discretion, and may, if GFC deems it reasonable, postpone or adjourn any sale of the Collateral by an announcement at the time and place of sale or of such postponed or adjourned sale without giving a new notice of sale. Borrower agrees that GFC has no obligation to preserve rights to the Collateral or marshall any Collateral for the benefit of any Person. GFC is hereby granted a license or other right to use, without charge, Borrower's labels, patents, copyrights, name, trade secrets, trade names, trademarks and advertising matter, or any similar property, in completing production, advertising or selling any Collateral and Borrower's rights under all licenses and all franchise agreements shall inure to GFC's benefit. Any requirement of reasonable notice shall be met if such notice is mailed postage prepaid to Borrower at its address set forth in the heading to this Agreement at least five (5) days before sale or other disposition. The proceeds of sale shall be applied, first, to all attorneys fees and other expenses of sale, and second, to the Obligations in such order as GFC shall elect, in its sole discretion. GFC shall promptly return any excess to Borrower and Borrower shall remain liable for any deficiency to the fullest extent permitted by law. 17.3 Standards for Determining Commercial Reasonableness. Borrower and GFC agree that the following conduct by GFC with respect to any disposition of Collateral shall conclusively be deemed commercially reasonable (but other conduct by GFC, including, but not limited to, GFC's use in its sole discretion of other or different times, places and manners of noticing and conducting any disposition of Collateral shall not be deemed unreasonable): Any public or private disposition; (i) as to which on no later than the fifth calendar day prior thereto written notice thereof is mailed or personally delivered to Borrower and, with respect to any public disposition, no later than the fifth calendar day prior thereto notice thereof describing in general non-specific terms, the Collateral to be disposed of is published once in a newspaper of general circulation in the county where the sale is to be conducted (provided that no notice of any public or private disposition need be given to the Borrower or published if the Collateral is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market); (ii) which is conducted at any place designated by GFC, with or without the Collateral being present; and (iii) which commences at any time between 8:00 a.m. and 5:00 p.m. Without limiting the generality of the foregoing, Borrower expressly agrees that, with respect to any disposition of accounts, instruments and general intangibles, it shall be commercially reasonable for GFC to direct any perspective purchaser thereof to ascertain directly from Borrower any and all information concerning the same, including, but not limited to, the terms of payment, aging and delinquency, if any, the financial condition of any obligor or account debtor thereon or guarantor thereof, and any collateral therefor. 18. DEFINITIONS. 18.1 Defined Terms. As used in this Agreement, the following terms have the definitions set forth below: 15 16 "Affiliate" means any Person controlling, controlled by or under common control with Borrower. For purposes of this definition, "control" means the possession, directly or indirectly, of the power to direct or cause direction of the management and policies of any Person, whether through ownership of common or preferred stock or other equity interests, by contract or otherwise. Without limiting the generality of the foregoing, each of the following shall be an Affiliate: any officer, director, employee or other agent of Borrower, any shareholder or subsidiary of Borrower, and any other Person with whom or which Borrower has common shareholders, officers or directors. "Business Day" means any day on which commercial banks in both Los Angeles, California and Phoenix, Arizona are open for business. "Capital Expenditures" means all expenditures made and liabilities incurred for the acquisition of any fixed asset or improvement, replacement, substitution or addition thereto which has a useful life of more than one year and including, without limitation, those arising in connection with Capital Leases. "Capital Lease" means any lease of property by Borrower that, in accordance with generally accepted accounting principles, should be capitalized for financial reporting purposes and reflected as a liability on the balance sheet of Borrower. "Code" means the Uniform Commercial Code as adopted and in effect in the State of Arizona from time to time. "Collateral" has the meaning set forth in Section 4.1 above. "Current Liabilities" at any date means the amount at which the current liabilities of Borrower would be shown on a balance sheet of Borrower as at such date, prepared in accordance with generally accepted accounting principles. "Deposit Accounts" has the meaning set forth in Section 9105 of the California Commercial Code. "Eligible Inventory" means Inventory which GFC, in its sole judgment, deems Eligible Inventory, based on such considerations as GFC may from time to time deem appropriate. Without limiting the generality of the foregoing, no Inventory shall be Eligible Inventory unless, in GFC's sole judgment, such Inventory (i) consists of raw materials or finished goods, in good, new and salable condition which are not obsolete or unmerchantable, and are not comprised of packaging, materials or supplies; (iii) meets all standards imposed by any governmental agency or authority; (iv) conforms in all respects to the warranties and representations set forth herein; (v) is at all times subject to GFC's duly perfected, first priority security interest; and (vi) is situated at a location in compliance with Section 12.16 hereof. "Eligible Receivables" means Receivables arising in the ordinary course of Borrower's business from the sale of goods or rendition of services which GFC, in its sole judgment, shall deem eligible based on such considerations as GFC may from time to time deem appropriate. Without limiting the foregoing, a Receivable shall not be deemed to be an Eligible Receivable if (i) the account debtor has failed to pay the Receivable within a period of ninety (90) days after invoice date or, if the goods relating thereto are sold on a C.O.D. basis, thirty (30) days after invoice date, in each case to the extent of any amount remaining unpaid after such period; (ii) the account debtor has failed to pay more than twenty-five percent (25%) of all outstanding Receivables owed by it to Borrower within ninety (90) days after invoice date; (iii) the account debtor is an Affiliate of Borrower; (iv) the goods relating thereto are placed on consignment, guaranteed sale, evaluation or other terms pursuant to which payment by the account debtor may be conditional; (v) the account debtor is not located in the United States or Canada, unless the Receivable is supported by a letter of credit or other form of guaranty or security, in each case in form and substance satisfactory to GFC or insured by FCIA insurance, in form and substance satisfactory to GFC; (vi) the account debtor is the United States or any department, agency or instrumentality thereof or, any State, city or municipality of the United States unless, as to any State, city or municipality, the sale is evidenced by a purchase order and not a contract; (vii) Borrower becomes liable to the account debtor for goods sold or services rendered by the account debtor to Borrower if the liability is in excess of 15% of the outstanding Receivables of the account debtor in question; (viii) the account debtor's total obligations to Borrower exceed twenty percent (20%) of all Eligible Receivables, to the extent of such excess; (ix) the account debtor disputes liability or makes any claim with respect thereto (up to the amount of such liability or claim), or is subject to any insolvency or bankruptcy proceeding, or becomes insolvent, fails or goes out of a material portion of its 16 17 business; (x) the amount thereof consists of late charges or finance charges; (xi) the amount thereof consists of a credit balance more than ninety (90) days past due; or (xii) the face amount of any single invoice thereof exceeds $20,000.00, unless accompanied by evidence of shipment of the goods relating thereto satisfactory to GFC in its sole discretion. "Equipment" means all of Borrower's present and hereafter acquired machinery, molds, machine tools, motors, furniture, equipment, furnishings, fixtures, trade fixtures, motor vehicles, tools, parts, dyes, jigs, goods and other tangible personal property (other than Inventory) of every kind and description used in Borrower's operations or owned by Borrower and any interest in any of the foregoing, and all attachments, accessories, accessions, replacements, substitutions, additions or improvements to any of the foregoing, wherever located. "ERISA" means the Employment Retirement Income Security Act of 1974, as amended, and the regulations thereunder. "ERISA Affiliate" means each trade or business (whether or not incorporated and whether or not foreign) which is or may hereafter become a member of a group of which Borrower is a member and which is treated as a single employer under ERISA Section 4001(b)(1), or IRC Section 414. "Event of Default" means any of the events set forth in Section 17.1 of this Agreement. "Floorplan Loans" has the meaning set forth on the Schedule. "Floorplanned Inventory" means all Qualified Inventory financed by GFC pursuant to Section 1.4 of this Agreement. "General Intangibles" means all general intangibles of Borrower, whether now owned or hereafter created or acquired by Borrower, including, without limitation, all chosen in action, causes of action, corporate or other business records, Deposit Accounts, inventions, designs, drawings, blueprints, patents, patent applications, trademarks and the goodwill of the business symbolized thereby, names, trade names, trade secrets, goodwill, copyrights, registrations, licenses, franchises, customer lists, security and other deposits, rights in all litigation presently or hereafter pending for any cause or claim (whether in contract, tort or otherwise), and all judgments now or hereafter arising therefrom, all claims of Borrower against GFC, rights to purchase or sell real or personal property, rights as a licensor or licensee of any kind, royalties, telephone numbers, proprietary information, purchase orders, and all insurance policies and claims (including without limitation credit, liability, property and other insurance) tax refunds and claims, computer programs, discs, tapes and tape files, claims under guaranties, security interests or other security held by or granted to Borrower to secure payment of any of the Receivables by an account debtor, all rights to indemnification and all other intangible property of every kind and nature (other than Receivables). "Guarantors" means the persons set forth on the Schedule. "Indebtedness" means all of Borrower's present and future obligations, liabilities, debts, claims and indebtedness, contingent, fixed or otherwise, however evidenced, created, incurred, acquired, owing or arising, whether under written or oral agreement, operation of law or otherwise, and includes, without limiting the foregoing (i) the Obligations, (ii) obligations and liabilities of any Person secured by a lien, claim, encumbrance or security interest upon property owned by Borrower, even though Borrower has not assumed or become liable therefor, (iii) obligations and liabilities created or arising under any lease (including Capital Leases) or conditional sales contract or other title retention agreement with respect to property used or acquired by Borrower, even though the rights and remedies of the lessor, seller or lender are limited to repossession, (iv) all unfunded pension fund obligations and liabilities and (v) deferred taxes. "Initial Term" has the meaning set forth on the Schedule. "Inventory" means all of Borrower's now owned and hereafter acquired goods, merchandise or other personal property, wherever located, to be furnished under any contract of service or held for sale or lease, all raw materials, work in process, finished goods and materials and supplies of any kind, nature or description which are or might be used or consumed in Borrower's business or used in connection with the manufacture, packing, shipping, advertising, selling or finishing of such goods, merchandise or other personal property, and all documents of title or other documents representing them. 17 18 "Inventory Loans" has the meaning set forth on the Schedule. "IRC" means the Internal Revenue Code of 1986, as amended, and the regulations thereunder. "Loan Documents" means, collectively, this Agreement, any note or notes executed by Borrower and payable to GFC, and any other agreement entered into in connection with this Agreement, together with all alterations, amendments, changes, extensions, modifications, refinancings, refundings, renewals, replacements, restatements, or supplements, of or to any of the foregoing. "Loan Party" means Borrower, each Guarantor and each other party (other than GFC) to any Loan Document. "Minimum Working Capital" at any date means an amount equal to (i) the sum of the amounts at which Borrower's cash, Receivables, Inventory (calculated at the lower of cost or market and determined on a first-in, first-out basis) and the current portion of deferred tax assets would be shown on a balance sheet of Borrower at such date prepared in accordance with generally accepted accounting principles, provided that amounts due from Affiliates shall be excluded therefrom, minus (ii) current liabilities of Borrower at such date. "Multiemployer Plan" means a "multiemployer plan" as defined in ERISA Sections 3(37) or 4001(a)(3) or IRC Section 414(f) which covers employees of Borrower or any ERISA Affiliate. "Obligations" means all present and future loans, advances, debts, liabilities, obligations, covenants, duties and indebtedness at any time owing by Borrower to GFC, whether evidenced by this Agreement, any note or other instrument or document, whether arising from an extension of credit, opening of a letter of credit, banker's acceptance, loan, guaranty, indemnification or otherwise, whether direct or indirect (including, without limitation, those acquired by assignment and any participation by GFC in Borrower's debts owing to others), absolute or contingent, due or to become due, including, without limitation, all interest, charges, expenses, fees, attorney's fees, expert witness fees, examination fees, letter of credit fees, collateral monitoring fees, closing fees, facility fees, Termination Fees, Minimum Interest Charges and any other sums chargeable to Borrower hereunder or under any other agreement with GFC. "Overlines" has the meaning set forth in Section 1.3 hereof. "PBGC" means the Pension Benefit Guarantee Corporation. "Permitted Encumbrances" means each of the liens, mortgages and other security interests set forth on the Schedule and incorporated herein by this reference. "Person" means any individual, sole proprietorship, partnership, joint venture, trust, unincorporated organization, association, corporation, government, or any agency or political division thereof, or any other entity. "Plan" means any plan described in ERISA Section 3(2) maintained for employees of Borrower or any ERISA Affiliate, other than a Multiemployer Plan. "Prepared Financials" means the balance sheets of Borrower as of the date set forth in the Schedule, and as of each subsequent date on which audited balance sheets are delivered to GFC from time to time hereunder, and the related statements of operations, changes in stockholder's equity and changes in cash flow for the periods ended on such dates. "Prohibited Transaction" means any transaction described in Section 406 of ERISA which is not exempt by reason of Section 408 of ERISA, and any transaction described in Section 4975(c) of the IRC which is not exempt by reason of Section 4975(c)(2) of the IRC. "Qualified Inventory" means Eligible Inventory (calculated at the lower cost or market value, taking into account any manufacturer's notice to Borrower of price reductions, and determined on a first-in, first-out basis) that (i) has been purchased from manufacturers approved by GFC in its sole discretion, (ii) has been in Borrower's possession for not more than ninety (90) days; (iii) is not pending return subject to an issued return merchandise authorization; and (iv) meets such other specifications and requirements (including manufacturer concentration limits) that may from time to time be established by GFC. "Receivable Loans" has the meaning set forth on the Schedule. 18 19 "Receivables" means all of Borrower's now owned and hereafter acquired accounts (whether or not earned by performance), proceeds of any letters of credit naming Borrower as beneficiary, contract rights, chattel paper, instruments, documents and all other forms of obligations at any time owing to Borrower, all guaranties and other security therefor, whether secured or unsecured, all merchandise returned to or repossessed by Borrower, and all rights of stoppage in transit and all other rights or remedies of an unpaid vendor, lienor or secured party. "Renewal Term" has the meaning set forth on the Schedule. "Reportable Event" means a reportable event described in Section 4043 of ERISA or the regulations thereunder, a withdrawal from a Plan described in Section 4063 of ERISA, or a cessation of operations described in Section 4068(f) of ERISA. "Subordinated Debt" means liabilities of Borrower the repayment of which is subordinated to the payment and performance of the Obligations. "Tangible Capital Funds" at any date means an amount equal to (i) the sum of the amounts at which Borrower's cash, Receivables, Inventory (calculated at the lower of cost or market and determined on a first-in, first-out basis), net fixed assets and the current portion of deferred tax assets would be shown on a balance sheet of Borrower at such date prepared in accordance with generally accepted accounting principles, provided that amounts due from Affiliates shall be excluded therefrom, minus (ii) Current Liabilities of Borrower at such date (excluding Subordinated Debt of Borrower). "Total Facility" has the meaning set forth on the Schedule. 18.2 Other Terms. All accounting terms used in this Agreement, unless otherwise indicated, shall have the meanings given to such terms in accordance with generally accepted accounting principles, consistently applied. All other terms contained in this Agreement, unless otherwise indicated, shall have the meanings provided by the Code, to the extent such terms are defined therein. 19. MISCELLANEOUS. 19.1 Recourse to Security; Certain Waivers. All Obligations shall be payable by Borrower as provided for herein and, in full, at the termination of this Agreement; recourse to security shall not be required at any time. Borrower waives presentment and protest of any instrument and notice thereof. 19.2 No Waiver by GFC. Neither GFC's failure to exercise any right, remedy or option under this Agreement, any supplement, the Loan Documents or other agreement between GFC and Borrower nor any delay by GFC in exercising the same shall operate as a waiver. No waiver by GFC shall be effective unless in writing and then only to the extent stated. No waiver by GFC shall affect its right to require strict performance of this Agreement. GFC's rights and remedies shall be cumulative and not exclusive. 19.3 Binding on Successor and Assigns. All terms, conditions, promises, covenants, provisions and warranties shall inure to the benefit of and bind GFC's and Borrower's respective representatives, successors and assigns. 19.4 Severability. If any provision of this Agreement shall be prohibited or invalid under applicable law, it shall be ineffective only to such extent, without invalidating the remainder of this Agreement. 19.5 Amendments; Assignments. This Agreement may not be modified, altered or amended, except by an agreement in writing signed by Borrower and GFC; provided that Exhibit A to this Agreement may be amended in whole or in part by GFC in its sole discretion as provided in Section 7.1 of this Agreement. Borrower may not sell, assign or transfer any interest in this Agreement or any other Loan Document, or any portion thereof, including, without limitation, any of Borrower's rights, title, interests, remedies, powers and duties hereunder or thereunder. Borrower hereby consents to GFC's participation, sale, assignment, transfer or other disposition, at any time or times hereafter, of this Agreement and any of the other Loan Documents, or of any portion hereof or thereof, including, without limitation, GFC's rights, title, interests, remedies, powers and duties hereunder or thereunder. In connection therewith, GFC may disclose all documents and information which GFC now or hereafter may have relating to Borrower or Borrower's business, provided that each such participant receiving such information shall agree to maintain the confidentiality thereof pursuant to a confidentiality 19 20 agreement reasonably acceptable to Borrower and GFC. To the extent that GFC assigns its rights and obligations hereunder to a third party, GFC shall thereafter be released from such assigned obligations to Borrower and such assignment shall effect a novation between Borrower and such third party. 19.6 Integration. This Agreement, together with the Schedule (which is a part hereof) and the other Loan Documents, reflect the entire understanding of the parties with respect to the transactions contemplated hereby. 19.7 Governing Law; Waivers. THIS AGREEMENT SHALL BE INTERPRETED IN ACCORDANCE WITH THE INTERNAL LAWS (AND NOT THE CONFLICT OF LAWS RULES) OF THE STATE OF ARIZONA GOVERNING CONTRACTS TO BE PERFORMED ENTIRELY WITHIN SUCH STATE. BORROWER HEREBY CONSENTS TO THE EXCLUSIVE JURISDICTION OF ANY STATE OR FEDERAL COURT LOCATED WITHIN THE COUNTY OF MARICOPA, THE STATE OF ARIZONA OR, AT THE SOLE OPTION OF GFC, IN ANY OTHER COURT IN WHICH GFC SHALL INITIATE LEGAL OR EQUITABLE PROCEEDINGS AND WHICH HAS SUBJECT MATTER JURISDICTION OVER THE MATTER IN CONTROVERSY. BORROWER WAIVES ANY OBJECTION OF FORUM NON CONVENIENS AND VENUE. BORROWER WAIVES PERSONAL SERVICE OF ANY AND ALL PROCESS UPON IT, AND CONSENTS THAT ALL SUCH SERVICE OF PROCESS BE MADE IN THE MANNER SET FORTH IN SECTION 19.13 HEREOF FOR THE GIVING OF NOTICE. BORROWER FURTHER WAIVES ANY RIGHT IT MAY OTHERWISE HAVE TO COLLATERALLY ATTACK ANY JUDGMENT ENTERED AGAINST IT. 19.8 Survival. All of the representations and warranties of Borrower contained in this Agreement shall survive the execution, delivery and acceptance of this Agreement by the parties. No termination of this Agreement or of any guaranty of the Obligations shall affect or impair the powers, obligations, duties, rights, representations, warranties or liabilities of the parties hereto and all shall survive any such termination. 19.9 Evidence of Obligations. Each Obligation may, in GFC's discretion, be evidenced by notes or other instruments issued or made by Borrower to GFC. If not so evidenced, such Obligation shall be evidenced solely by entries upon GFC's books and records. 19.10 Collateral Security. The Obligations shall constitute one loan secured by the Collateral. GFC may, in its sole discretion, (i) exchange, enforce, waive or release any of the Collateral, (ii) apply Collateral and direct the order or manner of sale thereof as it may determine, and (iii) settle, compromise, collect or otherwise liquidate any Collateral in any manner without affecting its right to take any other action with respect to any other Collateral. 19.11 Application of Collateral. GFC shall have the continuing and exclusive right to apply or reverse and re-apply any and all payments to any portion of the Obligations. To the extent that Borrower makes a payment or GFC receives any payment or proceeds of the Collateral for Borrower's benefit which is subsequently invalidated, declared to be fraudulent or preferential, set aside or required to be repaid to a trustee, debtor in possession, receiver or any other party under any bankruptcy law, common law or equitable cause, then, to such extent, the Obligations or part thereof intended to be satisfied shall be revived and continue as if such payment or proceeds had not been received by GFC. 19.12 Loan Requests. Each oral or written request for a loan by any Person who purports to be any employee, officer or authorized agent of Borrower shall be made to GFC on or prior to 5:00 p.m., Pennsylvania time, on the Business Day immediately preceding the Business Day on which the proceeds thereof are requested to be paid to Borrower and shall be conclusively presumed to be made by a Person authorized by Borrower to do so and the crediting of a loan to Borrower's operating account shall conclusively establish Borrower's obligation to repay such loan. Unless and until Borrower otherwise directs GFC in writing or unless otherwise provided in this Agreement, all loans shall be wired to Borrower's operating account set forth on the Schedule. 19.13 Notices. Any notice required hereunder shall be in writing and addressed to the Borrower and GFC at their addresses set forth at the beginning of this Agreement. Notices hereunder shall be deemed received on the earlier of receipt, whether by mail, personal delivery, facsimile, or otherwise, or upon deposit in the United States mail, postage prepaid. 19.14 Brokerage Fees. Borrower represents and warrants to GFC that, with respect to the financing transaction herein contemplated, no Person is entitled to 20 21 any brokerage fee or other commission and Borrower agrees to indemnify and hold GFC harmless against any and all such claims. 19.15 Disclosure. No representation or warranty made by Borrower in this Agreement, or in any financial statement, report, certificate or any other document furnished in connection herewith contains any untrue statement of a material fact or omits to state any material fact necessary to make the statements herein or therein not misleading. There is no fact known to Borrower or which reasonably should be known to Borrower which Borrower has not disclosed to GFC in writing with respect to the transactions contemplated by this Agreement which materially and adversely affects the business, assets, operations, prospects or condition (financial or otherwise), of Borrower. 19.16 Publicity. GFC is hereby authorized to issue appropriate press releases and to cause a tombstone to be published announcing the consummation of this transaction and the aggregate amount thereof. 19.17 Captions. The Section titles contained in this Agreement are without substantive meaning and are not part of this Agreement. 19.18 Injunctive Relief. Borrower recognizes that, in the event Borrower fails to perform, observe or discharge any of its Obligations under this Agreement, any remedy at law may prove to be inadequate relief to GFC. Therefore, GFC, if it so requests, shall be entitled to temporary and permanent injunctive relief in any such case without the necessity of proving actual damages. 19.19 Counterparts. This Agreement may be executed in one or more counterparts, each of which taken together shall constitute one and the same instrument. 19.20 Construction. The parties acknowledge that each party and its counsel have reviewed this Agreement and that the normal rule of construction to the effect that any ambiguities are to be resolved against the drafting party shall not be employed in the interpretation of this Agreement or any amendments or exhibits hereto. 19.21 Time of Essence. Time is of the essence for the performance by Borrower of the Obligations set forth in this Agreement. 19.22 Limitation of Actions. Borrower agrees that any claim or cause of action by Borrower against GFC, or any of GFC's directors, officers, employees, agents, accountants or attorneys, based upon, arising from, or relating to this Agreement, or any other present or future agreement, or any other transaction contemplated hereby or thereby or relating hereto or thereto, or any other matter, cause or thing whatsoever, whether or not relating hereto or thereto, occurred, done, omitted or suffered to be done by GFC, or by GFC's directors, officers, employees, agents, accountants or attorneys, whether sounding in contract or in tort or otherwise, shall be barred unless asserted by Borrower by the commencement of an action or proceeding in a court of competent jurisdiction by the filing of a complaint within one year after the first act, occurrence or omission upon which such claim or cause of action, or any part thereof, is based and service of a summons and complaint on an officer of GFC or any other person authorized to accept service of process on behalf of GFC, within 30 days thereafter. Borrower agrees that such one-year period of time is a reasonable and sufficient time for Borrower to investigate and act upon any such claim or cause of action. The one-year period provided herein shall not be waived, tolled, or extended except by a specific written agreement of GFC. This provision shall survive any termination of this Loan Agreement or any other agreement. 19.23 Liability. Neither GFC nor any GFC Affiliate shall be liable for any indirect, special, incidental or consequential damages in connection with any breach of contract, tort or other wrong relating to this Agreement or the Obligations or the establishment, administration or collection thereof (including without limitation damages for loss of profits, business interruption, or the like), whether such damages are foreseeable or unforeseeable, even if GFC has been advised of the possibility of such damages. Neither GFC, nor any GFC Affiliate shall be liable for any claims, demands, losses or damages, of any kind whatsoever, made, claimed, incurred or suffered by the Borrower through the ordinary negligence of GFC, or any GFC Affiliate. "GFC Affiliate" shall mean GFC's directors, officers, employees, agents, attorneys or other person or entity affiliated with or representing GFC. 19.24 Notice of Breach by GFC. Borrower agrees to give GFC written notice of (i) any action or inaction by GFC or any attorney of GFC in connection with any Loan Documents that may be actionable against GFC or any attorney of GFC or (ii) any defense to the payment of the Obligations for any reason, including, but not limited to, commission of a tort or violation of any 21 22 contractual duty or duty implied by law. Borrower agrees that unless such notice is fully given as promptly as possible (and in any event within thirty (30) days) after Borrower has knowledge, or with the exercise of reasonable diligence should have had knowledge, of any such action, inaction or defense. Borrower shall not assert, and Borrower shall be deemed to have waived, any claim or defense arising therefrom. 19.25 MUTUAL WAIVER OR RIGHT TO JURY TRIAL. GFC AND BORROWER EACH HEREBY WAIVES THE RIGHT TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING BASED UPON, ARISING OUT OF, OR IN ANY WAY RELATING TO: (i) THIS AGREEMENT; (ii) ANY OTHER PRESENT OR FUTURE INSTRUMENT OR AGREEMENT BETWEEN GFC AND BORROWER; OR (iii) ANY CONDUCT, ACTS OR OMISSIONS OF GFC OR BORROWER OR ANY OR THEIR DIRECTORS, OFFICERS, EMPLOYEES, AGENTS, ATTORNEYS OR ANY OTHER PERSONS AFFILIATED WITH GFC OR BORROWER; IN EACH OF THE FOREGOING CASES, WHETHER SOUNDING IN CONTRACT OR TORT OR OTHERWISE. Borrower: PROCOM TECHNOLOGY, INC. By___________________________________ Title________________________________ By___________________________________ Secretary or Ass't Secretary GFC: GREYHOUND FINANCIAL CORPORATION By___________________________________ Title________________________________ 22 23 GFC SCHEDULE TO LOAN AND SECURITY AGREEMENT BORROWER: PROCOM TECHNOLOGY, INC. ADDRESS: 2181 DUPONT DRIVE IRVINE, CALIFORNIA 92715 DATE: NOVEMBER 18, 1994 This Schedule forms an integral part of the Loan and Security Agreement between the above Borrower and Greyhound Financial Corporation dated the above date, and all references herein and therein to "this Agreement" shall be deemed to refer to said Agreement and to this Schedule. TOTAL FACILITY (SECTION 1.1): $9,000,000.00 (the "Total Facility") LOANS (SECTION 1.2): A. REVOLVING LOANS: a revolving line of credit ("Revolving Credit Line") consisting of loans against Borrower's Eligible Receivables ("Receivable Loans") and against Borrower's Eligible Inventory other than Floorplanned Inventory ("Inventory Loans") in an aggregate outstanding principal amount not to exceed at any time the lesser of: (a) Four Million Dollars ($4,000,000.00) (the "Maximum Revolving Facility Amount"), or S-1 24 (b) the sum of (i) an amount equal to seventy-five percent (75%) of the net amount of Eligible Receivables; plus (ii) an amount equal to the sum of: (A) fifty percent (50%) of the value of Borrower's Eligible Inventory, minus (B) the value of Borrower's Floorplanned Inventory, in each case calculated at the lower of cost or market value and determined on a first-in, first-out basis. B. FLOORPLAN LOANS: a floorplan line of credit consisting of loans against Borrower's Floorplanned Inventory ("Floorplan Loans") in an aggregate outstanding principal amount not to exceed at any time the lesser of: (a) Five Million Dollars ($5,000,000.00), or (b) the sum of the amount of (i) Borrower's Qualified Inventory and (ii) all original credit memoranda held by GFC and received from manufacturers of Qualified Inventory. CONDITIONS PRECEDENT (SECTION 2.1): The obligation of GFC to make the initial advance hereunder is subject to the fulfillment, to the satisfaction of GFC and its counsel, of the condition, in addition to the conditions set forth in Sections 2.1 and 2.2 above, that there shall have been no material adverse change in the business, operations, profits or prospects of Borrower, or in the condition of the assets of Borrower, between August 31, 1994 and the date hereof. Borrower shall cause the conditions precedent set forth in Section 2.1 of this Agreement and set forth above in this Schedule to be satisfied on or before November 18, 1994. INTERESTS AND FEES (SECTION 3.1): Interest. Borrower shall pay GFC interest on the daily outstanding balance of Borrower's loan account at a per annum rate of one and one-half percent (1.50%) in excess of the highest rate of interest published from time to time in the "Money Rates" section of The Wall Street Journal under "Prime Rate" or, if such rate is not so published from time to time, the rate of interest announced publicly by Citibank, N.A., from time to time as its "base rate" (or any successor thereto), which, in either case, may not be such institution's or GFC's lowest rate (the "Base Rate"); provided, however, that (i) if, during any full calendar quarter during the term of this Agreement (or other period specified below), volume under the Floorplan Credit Line (as measured by the total of the face amounts of invoices funded by GFC under the Floorplan Credit Line during such period) is less than Four Million Dollars ($4,000,000.00) (such amount S-2 25 to be prorated for the initial and final calendar quarters of the term, as applicable) and provided that the failure to meet the minimum of $4,000,000 was not due to a termination of the Floorplan Credit Line by GFC or GFC's refusal to make Floorplan Loans (unless due to an Event of Default), the interest rate applicable to Borrower's loan account for such quarter (or such other period specified above) shall be retroactively increased to a per annum rate equal to three and three quarters percent (3.75%) in excess of the Base Rate (with any adjustment amount to be immediately due upon demand by GFC and (ii) interest shall not be payable by Borrower with respect to Floorplan Loans reflected in Borrower's loan account except as provided in Section 3.2 of this Agreement. The interest rate chargeable hereunder shall be increased or decreased, as the case may be, without notice of demand of any kind, upon the publishing or announcement, as the case may be, of any change in the Base Rate. Each change in the Base Rate shall be effective hereunder on the first day following the publishing or announcement, as the case may be, of such change, provided, that a cumulative change of less than one-quarter of one percent (0.25%) shall not be considered. Interest charges and all other fees and charges herein shall be computed on the basis of a year of 360 days and actual days elapsed and shall be payable to GFC in arrears on the first day of each month. Closing Fee. At the closing of this transaction, Borrower shall pay to GFC a closing fee in an amount equal to Forty Thousand Dollars ($40,000.00), which shall be deemed fully earned at the time of payment. Facility Fee. Borrower shall pay to GFC a facility fee equal to one-half of one percent (0.50%) per annum on the daily average unused amount of the Maximum Revolving Facility Amount. The facility fee shall be deemed fully earned at the time when due and is otherwise due and payable in arrears on the first day of each month, commencing on the first such day after the date of this Agreement, on the first day of each subsequent month thereafter and on the date on which this Agreement is terminated. Examination Fees. Borrower agrees to pay to GFC an examination fee in the amount of Four Hundred Dollars ($400.00) per person per day in connection with each audit or examination of Borrower performed by GFC prior to or after the date hereof. The initial examination fee payable under this Agreement shall be deemed fully earned at the time of payment and due and payable upon the closing of this transaction, and shall be deducted from any good faith deposit paid by Borrower to GFC prior to the date of this Agreement. REPORTING REQUIREMENTS (SECTION 5.2): 1. Borrower shall provide GFC with monthly agings aged by invoice date and reconciliations of Receivables within ten (10) days after the end of each month. 2. Borrower shall provide GFC with monthly accounts payable agings aged by invoice date, outstanding or held check registers and inventory certificates within ten (10) days after the end of each month. S-3 26 3. Borrower shall provide GFC with weekly perpetual inventory reports for the Inventory (as well as separate inventory reports as to Floorplanned Inventory) valued on a first-in, first-out basis at the lower of cost or market (in accordance with generally accepted accounting principles) or such other inventory reports as are reasonably requested by GFC, all by Wednesday of each week with respect to reports for the immediately preceding week. 4. Borrower shall provide GFC with monthly unaudited financial statements within thirty (30) days after the end of each month. 5. Borrower shall provide GFC with annual operating budgets (including income statements, balance sheets and cash flow statements, by month) for the upcoming fiscal year of Borrower by the end of each fiscal year of Borrower. BORROWER INFORMATION: Borrower's State of Incorporation (Section 12.1): California Fictitious Names/Prior Corporate Names (Section 12.2): None Borrower Locations (Section 12.16): 2181 Dupont Drive Irvine, California 92715 Permitted Encumbrances (Section 18.1): None FINANCIAL COVENANTS (SECTION 13.14): Borrower shall comply with all of the following covenants. Compliance shall be determined as of the end of each fiscal quarter of Borrower, except as otherwise specifically provided below: Working Capital. Borrower shall maintain Minimum Working Capital of not less than Five Hundred Thousand Dollars ($500,000.00); Tangible Capital Funds. Borrower shall maintain Tangible Capital Funds of not less than One Million Dollars ($1,000,000.00); and Debt to Tangible Borrower shall maintain a ratio of Indebtedness Capital Funds. (excluding Subordinated Debt) to Tangible Capital Funds of not greater than 5.0 to 1.0. S-4 27 NEGATIVE COVENANTS (SECTION 14): Compensation: Borrower may pay salaries during any fiscal year to all of Borrower's executives, officers and directors (or any relative thereof) in an amount not to exceed 110% of the amount paid to all such Persons during the immediately preceding fiscal year of Borrower; and Borrower may pay additional compensation ("Compensation") including, without limitation, withdrawals, fees, bonuses, commissions, drawing accounts and other payments, whether directly or indirectly, in money or otherwise during any fiscal year to all of Borrower's executives, officers and directors (or any relative thereof), provided no Event of Default has occurred, and only to the extent that the total fiscal year-to-date Compensation to such Persons will not exceed 50% of Borrower's year-to-date net profits as determined by generally accepted accounting principals. Said additional Compensation may be paid semiannually, but only after Borrower has issued its unaudited financials for the first six months of the fiscal year or its year end financials, as applicable. TERM (SECTION 16.1): The initial term of this Agreement shall be two (2) years from the date hereof (the "Initial Term") and shall be automatically renewed for successive periods of one (1) year each (each, a "Renewal Term"), unless earlier terminated as provided in Section 16 or 17 above or elsewhere in this Agreement. TERMINATION FEE (SECTION 16.4): The Termination Fee provided in Section 16.4 shall be an amount equal to the following percentage of (a) the Total Facility, if both the Revolving Credit Line and the Floorplan Credit Line are terminated, or (b) the Maximum Revolving Facility Amount, if (with GFC's consent) the Revolving Credit Line is terminated singly and the Floorplan Credit Line remains in effect: (i) seven-tenths of one percent (0.7%), if such early termination occurs on or prior to the first anniversary of this Agreement; (ii) four-tenths of one percent (0.4%), if such early termination occurs after the first anniversary of this Agreement. S-5 28 ADDITIONAL DEFINITIONS (Section 18.1): "Prepared Financials" means the balance sheets of Borrower as of August 31, 1994, and as of each subsequent date on which audited balance sheets are delivered to GFC from time to time hereunder, and the related statements of operations, changes in stockholder's equity and changes in cash flow for the periods ended on such dates. "Guarantors" means each of Alex Razm'joo, Alex Aydim, Frank Alaghband, Nick Shahrestang and each such Person's respective spouse. DISBURSEMENT (Section 19.12): Unless and until Borrower otherwise directs GFC in writing, all loans (other than Floorplan Loans disbursed directly to manufacturers of Floorplanned Inventory as contemplated in Section 1.4 of this Agreement) shall be wired to Borrower's following operating account: SANWA BANK ACCOUNT NO. 0896-23013. Borrower: GFC: PROCOM TECHNOLOGY, INC. GREYHOUND FINANCIAL CORPORATION By [SIG] By [SIG] -------------------------------- -------------------------------- Title EVP Title VP ----------------------------- ----------------------------- By [SIG] -------------------------------- Secretary or Ass't Secretary S-6 29 EXHIBIT A TO LOAN AND SECURITY AGREEMENT BORROWER: PROCOM TECHNOLOGY, INC. ADDRESS: 2181 DUPONT DRIVE IRVINE, CALIFORNIA 92715 DATE: NOVEMBER 18, 1994 This Schedule forms an integral part of the Loan and Security Agreement between the above Borrower and Greyhound Financial Corporation dated the above date. FLOORPLAN LOAN PRINCIPAL PAYMENT DATES: (SECTION 7.1): Number of Days After Invoice Date that Principal is Manufacturer Repayable by Borrower ------------ --------------------- NEC 45 Toshiba 45 Conner Peripherals 45 CPC 45 Seagate 45 Sony 60 Fujitsu 60 30 ADDENDUM This Addendum references and amends that certain Loan and Security Agreement dated as of November 18, 1994 (the "Agreement") by and between Greyhound Financial Corporation ("GFC") and Procom Technology, Inc. ("Borrower"). 1. Overlines. Section 1.3 of the Agreement is hereby deleted and the following is substituted therefor: 1.3 Overlines. If at any time or for any reason (i) the outstanding amount of advances made pursuant hereto exceeds any of the dollar or percentage limitations contained in the Schedule or (ii) the outstanding amount of advances under the Floorplan Credit Line exceeds the amount available under the "Inventory True-up Schedule" (any such excess, an "Overline"), then Borrower shall, upon GFC's demand, immediately pay to GFC, in cash, the full amount of such Overline. The Inventory True-up Schedule shall be substantially in the form attached hereto as Exhibit A, containing such information as GFC deems necessary or appropriate, and shall be delivered weekly by Borrower to Lender. Without limiting Borrower's obligation to repay to GFC on demand the amount of any Overline, Borrower agrees to pay GFC interest on the outstanding principal amount of any Overline, on demand, at the rate set forth on the Schedule. Exhibit A to this Addendum is hereby incorporated as Exhibit A to the Agreement. In all other respects, Section 1.3 remains in full force and effect. Notwithstanding the foregoing, if by December 28, 1994, Elham Razmjoo delivers her guaranty in the form executed by the other guarantors, the Adjustment on Exhibit A hereto will be changed from $250,000 to $500,000 as of the date of GFC's receipt of such guaranty. 31 2. Definition of Inventory Loans. Subparagraph (b)(ii) of the Revolving Loans calculation set forth in the Schedule to the Agreement is hereby deleted and the following is substituted therefor: (ii) an amount equal to 50% of the sum of (A) the value of Borrower's Eligible Inventory, calculated at the lower of cost or market value and determined on a first-in, first-out basis, minus (B) the aggregate outstanding balance of Floorplan Loans. 3. 60-Day Flooring Invoice Option. GFC and Borrower agree that Borrower may pay Floor Plan Loans for Seagate purchases floor planned by GFC ("Seagate/GFC Invoices") at any time prior to 50 days after the date of invoice without an interest charge. Borrower may pay Seagate/GFC Invoices after 50 days, but before 60 days, after the date of invoice with an interest charge of .34% of the amount of the unpaid Seagate/GFC Invoice. This rate will be charged as it accrues. The .34% rate shall be increased or decreased by .1% for every .25% increase or decrease in the Base Rate from the current rate of 8.5%. On or after 60 days, the unpaid Seagate/GFC Invoices will be subject to the interest rate set forth in Section 3.2 of the Agreement (6% in excess of the Base Rate). 4. Closing Fee. The Closing Fee of $40,000 as set forth in the Schedule to the Agreement is hereby changed to $50,000. Notwithstanding the foregoing, if both Elham Razmjoo and Stephannie Alaghband deliver either their guaranty or Spousal Waiver in forms presented previously by GFC, and 2 32 such documents are received by December 28, 1994, the Closing Fee will be reduced to $40,000 and the $10,000 difference will be returned to Borrower. 5. Current Seagate Account Payable. Borrower agrees to pay its indebtedness to Seagate and cause Seagate to terminate its security interest in Borrower's assets within 60 days from the date hereof. 6. Incorporation. The terms and covenants herein are hereby incorporated in the Agreement. This Addendum has been executed by the parties hereto as of November 18, 1994. GREYHOUND FINANCIAL CORPORATION By ___________________________________ Its __________________________________ PROCOM TECHNOLOGY, INC. By /s/ [ILLEGIBLE] ------------------------------------ Its Senior Vice President ----------------------------------- 3 33 EXHIBIT A Floorplan Inventory True-up Schedule to Loan and Security Agreement between Greyhound Financial Corporation and Procom Technology, Inc. dated as of November 18, 1994 (the "Agreement") All capitalized terms used in this Exhibit A and not otherwise defined herein shall have the meanings given them in the Agreement. AMOUNT ------ I. Value of Eligible Inventory $_________ plus II. Adjustment $25,000.00 minus III. Inventory Loan availability under Revolving Loans $_________ IV. TOTAL AMOUNT OF "TRUE-UP INVENTORY" (I plus II minus III) $_________ V. AGGREGATE OUTSTANDING BALANCE OF FLOORPLAN LOANS UNDER AGREEMENT $_________ If the amount set forth in Item V exceeds the amount set forth in Item IV, Borrower shall pay the difference to Lender in accordance with the terms of Section 1.3 of the Agreement. Date:________________________ PROCOM TECHNOLOGY, INC. By:__________________________ Its:_________________________ 4 34 TRANSACTION REPORT AND LOAN REQUEST Certificate TO: GREYHOUND FINANCIAL CORPORATION No. 107 1060 First Avenue ------------ King of Prussia, PA 19406 Date: 11/28/94 ------------ The Undersigned hereby certifies the following:
- ------------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------- COMPUTATION OF ACCOUNTS RECEIVABLE A B COLLATERAL ACCTS RECEIVABLE (INVENTORY) COMBINED ----------------------------------------------------------------------------------------------------------------------- 1. Collateral Balance per Previous Report $5,715,161.15 $3,316,046.09 $9,031,207.24 ----------------------------------------------------------------------------------------------------------------------- 2. Add: New A/R Assigned Sales Orders / (Purchases) $154,504.53 $41,037.40 $195,541.93 ----------------------------------------------------------------------------------------------------------------------- 3. Less: Credit Memos / (Other Inv. Issues) ($28,128.00) ($2,417.47) ($30,545.47) ----------------------------------------------------------------------------------------------------------------------- 4. Less: A/R Collections / (Shipments) ($283,760.17) ($78,582.18) ($362,342.35) ----------------------------------------------------------------------------------------------------------------------- 5. Adjustments - Increase or (Decrease) $0.00 ----------------------------------------------------------------------------------------------------------------------- 6. New Balance: A/R / (Inventory) $5,557,777.51 $3,276,083.84 $8,833,861.35 ----------------------------------------------------------------------------------------------------------------------- 7. Less: Ineligible: A/R / (Inventory (WHS 3-999)) 148140 ($1,821,119.00) ($898,054.85) ($2,719,173.85) ----------------------------------------------------------------------------------------------------------------------- 8. Less: Floor Plan Liability ($1,250,000.00) ($1,250,000.00) ----------------------------------------------------------------------------------------------------------------------- 9. Total Eligible: Receivables / (Inventory) $3,736,658.51 $1,128,028.99 $4,864,687.50 ----------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------- 10. Accounts Receivable: Total Eligible Receivables from Line A9 above @ 75% $2,802,493.88 $2,802,493.88 ----------------------------------------------------------------------------------------------------------------------- 11. Accounts Receivable: Total Eligible Inventory from Line B9 above @ 50% $564,014.50 $564,014.50 ----------------------------------------------------------------------------------------------------------------------- 12. Less L.C. Balance $0.00 $0.00 -------------------------------------------------------------------------------- ------------------- 13. Net Availability (Line 9 plus Line 10 less Line 11) not to exceed $4,000,000.00 $3,366,508.38 ----------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------- COMPUTATION OF LOAN ----------------------------------------------------------------------------------------------------------------------- 14. Loan Balance per pervious report $1,690.041.81 ------------------------------------------------------------ ------------------- 15. PAYDOWN (Sanwa wire to GFC) ($732,643.80) ------------------------------------------------------------ ------------------- 16. Adjustments - Increase or (Decrease) ------------------------------------------------------------ ------------------- 17. Adjusted Loan Balance (Line 14 plus/(less) Line 16) $957,398.01 ------------------------------------------------------------ ------------------- 18. Availability Before Loan Request (Line 13 less Line 17) $2,409,110.37 ------------------------------------------------------------ ------------------- 19. The undersigned requests a loan in the amount of ------------------------------------------------------------ ------------------- 20. New Loan Balance (Line 17 plus Line 19) $957,398.01 ----------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------
The above collateral is subject to a security interest in favor of GREYHOUND FINANCIAL CORP. pursuant to the Accounts Receivable Credit Agreement (the "Agreement") executed between the Financer and the undersigned. $_____________________________ has been deposited to your account pursuant to the request set forth above.
- ------------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------- GREYHOUND FINANCIAL CORP. BORROWER ----------------------------------------------------------------------------------------------------------------------- Office KING OF PRUSSIA Date PROCOM TECHNOLOGY, INC. ----------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------
35 CONTINUING PERSONAL GUARANTY FOR VALUE RECEIVED, and in consideration of any loan or other financial accommodation heretofore or hereafter at any time made or granted to PROCOM TECHNOLOGY, INC., a California corporation ("Borrower") by GREYHOUND FINANCIAL CORPORATION ("Lender"), the undersigned, Farrokh Alaghband ("Guarantor"), hereby agrees as follows: 1. Guaranty of Obligations. Guarantor unconditionally, absolutely and irrevocably guarantees the full and prompt payment and performance when due, whether by acceleration or otherwise, and at all times thereafter, of all obligations of Borrower to Lender, howsoever created, arising or evidenced, whether direct or indirect, absolute or contingent, or now or hereafter existing or due or to become due, including, without limitation, under or in connection with that certain Loan and Security Agreement of even date, between Borrower and Lender (the "Loan Agreement") and each of the documents, instruments and agreements executed and delivered in connection therewith, as each may be modified, amended, supplemented or replaced from time to time (all such obligations are herein referred to collectively as the "Liabilities", and all documents evidencing or securing any of the Liabilities are herein referred to, collectively, as the "Loan Documents"). This Continuing Personal Guaranty (this "Continuing Guaranty") is a guaranty of payment and performance when due and not of collection. In the event of any default by Borrower in making payment of, or default by Borrower in performance of, any of the Liabilities, Guarantor agrees on demand by Lender to pay and perform all of the Liabilities as are then or thereafter become due and owing or are to be performed under the terms of the Loan Documents. Guarantor further agrees to pay all expenses (including reasonable attorneys' fees and expenses) paid or incurred by Lender in endeavoring to collect the Liabilities, or any part thereof, and in enforcing this Continuing Guaranty. 2. Continuing Nature of Guaranty and Liabilities. This Continuing Guaranty shall be continuing and shall not be discharged, impaired or affected by: a. the insolvency of Guarantor or the payment in full of all of the Liabilities at any time or from time to time; b. the power or authority or lack thereof of Borrower to incur the Liabilities; c. the validity or invalidity of any of the Loan Documents or the documents securing the same; d. the existence or non-existence of Borrower as a legal entity; 36 e. any transfer by Borrower of all or any part of any collateral in which Lender has been granted a lien or security interest pursuant to the Loan Documents; f. any statute of limitations affecting the liability of Guarantor under this Continuing Guaranty or the Loan Documents or the ability of Lender to enforce this Continuing Guaranty or any provision of the Loan Documents or the Security Documents; or g. any right of offset, counterclaim or defense of Guarantor, including, without limitation, those which have been waived by Guarantor pursuant to Paragraph 6 hereof. 3. Insolvency of Borrower or Guarantor. Without limiting the generality of any other provision hereof, Guarantor agrees that, in the event of the dissolution or insolvency of Borrower or Guarantor or the inability of Borrower or Guarantor to pay their respective debts as they mature, or an assignment by Borrower or Guarantor for the benefit of creditors, or the institution of any proceeding by or against Borrower or Guarantor alleging that Borrower or Guarantor is insolvent or unable to pay their respective debts as they mature, Guarantor will pay to Lender forthwith the full amount which would be payable hereunder by Guarantor if all of the Liabilities were then due and payable, whether or not such event occurs at a time when any of the Liabilities are otherwise due and payable. 4. Payment of the Liabilities. Any amounts received by Lender from whatever source on account of the Liabilities may be applied by Lender toward the payment of such of the Liabilities, and in such order of application, as Lender may from time to time elect, and notwithstanding any payments made by or for the account of Guarantor pursuant to this Continuing Guaranty. Guarantor agrees that, if at any time all or any part of any payment theretofore applied by Lender to any of the Liabilities is or must be rescinded or returned by Lender for any reason whatsoever (including, without limitation, the insolvency, bankruptcy or reorganization of Borrower), such Liabilities shall, for the purposes of this continuing Guaranty and to the extent that such payment is or must be rescinded or returned, be deemed to have continued in existence notwithstanding such application by Lender, and this Continuing Guaranty shall continue to be effective or be reinstated, as the case may be, as to such Liabilities, all as though such application by Lender had not been made. 5. Permitted Actions of Lender. Lender may from time to time, in its sole discretion and without notice to Guarantor, take any or all of the following actions: a. retain or obtain a security interest in any assets of Borrower or any third party to secure any of the Liabilities or any obligations of Guarantor hereunder; 2 37 b. retain or obtain the primary or secondary obligation of any obligor or obligors, in addition to Guarantor, with respect to any of the Liabilities; c. extend or renew for one or more periods (whether or not longer than the original period), alter or exchange any of the Liabilities; d. waive, ignore or forbear from taking action or otherwise exercising any of its default rights or remedies with respect to any default by Borrower under the Loan Documents; e. release, waive or compromise any obligation of Guarantor hereunder or any obligation of any nature of any other obligor primarily or secondarily obligated with respect to any of the Liabilities; f. release its security interest in, or surrender, release or permit any substitution or exchange for, all or any part of any collateral now or hereafter securing any of the Liabilities or any obligation hereunder, or extend or renew for one or more periods (whether or not longer than the original period) or release, waive, compromise, alter or exchange any obligations of any nature of any obligor with respect to any such property; and g. demand payment or performance of any of the Liabilities from Guarantor at any time or from time to time, whether or not Lender shall have exercised any of its rights or remedies with respect to any property securing any of the Liabilities or any obligation hereunder or proceeded against any other obligor primarily or secondarily liable for payment or performance of any of the Liabilities. 6. Specific Waivers. Without limiting the generality of any other provision of this Continuing Guaranty, Guarantor hereby expressly waives: a. notice of the acceptance by Lender of this Continuing Guaranty; b. notice of the existence, creation, payment, nonpayment, performance or nonperformance of all or any of the Liabilities; c. presentment, demand, notice of dishonor, protest, notice of protest and all other notices whatsoever with respect to the payment or performance of the Liabilities or the amount thereof or any payment or performance by Guarantor hereunder; d. all diligence in collection or protection of or realization upon the Liabilities or any thereof, any obligation hereunder or any security for or guaranty of any of the foregoing; e. any right to direct or affect the manner or timing of Lender's enforcement of its rights or remedies; 3 38 f. all rights and benefits under Section 2809 of the California Civil Code purporting to reduce Guarantor's obligation in proportion to the principal obligation hereby guaranteed, and any defense based on or arising out of any defense the person or entity primarily liable may have to payment or to performance of any covenants or obligations; g. all rights and benefits under Section 2845 of the California Civil Code which, among other things, permits a guarantor or surety to require any creditor to pursue its debtor, any security which said creditor may hold, or any other remedy before proceeding against Guarantor; h. any defense, right of set-off or other claim whatsoever (other than payment in full and performance in full of all of the Liabilities after any termination of the Loan Agreement in accordance with the terms of the Loan Documents) that Borrower or any third party may or might have to the payment or performance of the Liabilities; i. any and all defenses which would otherwise arise upon the occurrence of any event or contingency described in Paragraph 1 hereof or upon the taking of any action by Lender permitted hereunder; j. any defense, right of set-off, claim or counterclaim whatsoever (other than payment and performance in full of all of the Liabilities after any termination of the Loan Agreement in accordance with the terms of the Loan Documents), and any and all other rights, benefits, protections and other defenses which Guarantor may have, now or at any time hereafter, to full payment or performance of the Liabilities pursuant to the terms of this Continuing Guaranty, including, without limitation, under California Civil Code Sections 2809, 2810, 2819, 2820, 2821, 2839, 2845, 2847, 2848, 2849, 2850 and 2855, and California Code of Civil Procedure Sections 580a, 580b, and 580d, and all successor sections; and k. all other principles or provisions of law, if any, that conflict with the terms of this Continuing Guaranty, including, without limitation, the effect of any circumstances that may or might constitute a legal or equitable discharge of a guarantor or surety. 7. Irrevocability. Guarantor hereby further waives all rights to revoke this Continuing Guaranty at any time, and all rights to revoke any agreement executed by Guarantor at any time to secure the payment and performance of Guarantor's obligations under this Continuing Guaranty. Without limiting the generality of this paragraph, Guarantor hereby specifically waives the provisions of California Civil Code Section 2815, and any successor section, with respect to this Continuing Guaranty and all security for the obligations of Guarantor hereunder. 8. Waiver of Subrogation and Certain Other Rights. Guarantor hereby waives and shall have no right of subrogation, reimbursement, exoneration, contribution or 4 39 indemnity against Borrower or any other guarantor for any reason, including but not limited to, by reason of any payments made or acts performed by Guarantor in compliance with the obligations of Guarantor hereunder or any actions taken by Lender pursuant to this Continuing Guaranty or pursuant to the Loan Documents. Without limiting the generality of the foregoing, Guarantor hereby waives all rights and benefits under Section 580d of the California Code of Civil Procedure stating that no deficiency may be recovered on an obligation secured by a deed of trust on real property if the real property, or any part thereof, subject to any deed of trust given by Borrower to secure all or any part of the Liabilities is sold under a power of sale contained therein, and all defenses based on any loss as a result of any such private sale of Guarantor's right to recover any such amount from the person or entity primarily liable, whether by right of subrogation or otherwise. GUARANTOR HEREBY ACKNOWLEDGES THAT BUT FOR THE FOREGOING WAIVER AND OTHER WAIVERS CONTAINED HEREIN, THE LOSS OF DEFICIENCY RIGHTS AGAINST BORROWER RESULTING FROM A PRIVATE SALE OF ANY REAL PROPERTY UNDER SUCH A DEED OF TRUST COULD CREATE A DEFENSE TO PAYMENT BY GUARANTOR HEREUNDER. Guarantor agrees that nothing contained in this Continuing Guaranty shall prevent Lender from suing to collect on the Liabilities or from exercising concurrently or successively any rights available to it at law and/or in equity or under any of the Loan Documents, and that the exercise of any of the aforesaid rights shall not constitute a legal or equitable discharge of Guarantor. Guarantor hereby authorizes and empowers Lender to exercise, in its sole discretion, any rights and remedies, or any combination thereof, which may then be available, since it is the intent and purpose of Guarantor that the obligations hereunder shall be absolute, independent and unconditional under any and all circumstances. Notwithstanding any foreclosure of the lien of any deed of trust or security agreement with respect to any or all of any real or personal property secured thereby, whether by the exercise of the power of sale contained therein, by an action for judicial foreclosure, or by the acceptance of a deed or possession of any other collateral in lieu of foreclosure, Guarantor shall remain bound under this Continuing Guaranty. Without limiting the generality of the foregoing, Guarantor specifically agrees that upon an Event of Default under and as defined in the Loan Agreement, Lender may elect to nonjudicially or judicially foreclose against any real or personal property, or any part thereof, subject to any deed of trust given by Borrower to secure all or any part of the Liabilities, or exercise any other remedy against Borrower, any security for the Liabilities or any other guarantor, even if the effect of that action is to deprive Guarantor of the right to collect reimbursement from the applicable third party for any sums paid to Lender hereunder. 9. Subordination. Guarantor hereby subordinates any and all indebtedness of Borrower to Guarantor to the full and prompt payment and performance of all of the Liabilities. Guarantor agrees that Lender shall be entitled to receive payment of all Liabilities prior to Guarantor's receipt of payment of any amount of any indebtedness of Borrower to Guarantor. Any payments on such indebtedness to Guarantor, if Lender so requests, shall be collected, enforced and received by Guarantor, in trust, as trustee for 5 40 Lender and shall be paid over to Lender on account of the Liabilities, but without reducing or affecting in any manner the liability of Guarantor under the other provisions of this Guaranty. Lender is authorized and empowered, but not obligated, in its discretion, (a) in the name of Guarantor, to collect and enforce, and to submit claims in respect of, any indebtedness of Borrower to Guarantor and to apply any amounts received thereon to the Liabilities, and (b) to require Guarantor (i) to collect and enforce, and to submit claims in respect of, any indebtedness of Borrower to Guarantor, and (ii) to pay any amounts received on such indebtedness to Lender for application to the Liabilities. 10. Assignment of Lender's Rights. Lender may, from time to time, without notice to Guarantor, assign or transfer any or all of the Liabilities or any interest therein and, notwithstanding any such assignment or transfer of the Liabilities or any subsequent assignment or transfer thereof, the Liabilities shall be and remain the Liabilities for the purpose of this Continuing Guaranty. Each and every immediate and successive assignee or transferee of any of the Liabilities or of any interest therein shall, to the extent of such party's interest in the Liabilities, be entitled to the benefits of this Continuing Guaranty to the same extent as if such assignee or transferee were Lender; provided, however, that unless Lender shall otherwise consent in writing, Lender shall have an unimpaired right, prior and superior to that of any such assignee or transferee, to enforce this Continuing Guaranty for its own benefit as to those of the Liabilities which Lender has not assigned or transferred. 11. Indulgences Not Waivers. No delay in the exercise of any right or remedy shall operate as a waiver thereof, and no single or partial exercise by Lender of any right or remedy shall preclude other or further exercise thereof or the exercise of any other right or remedy; nor shall any modification or waiver of any of the provisions of this Continuing Guaranty be binding upon Lender, except as expressly set forth in a writing duly signed and delivered by Lender. No action of Lender permitted hereunder shall in any way affect or impair the rights of Lender or the obligations of Guarantor under this Continuing Guaranty. 12. Financial Condition of Borrower. Guarantor represents and warrants that it is fully aware of the financial condition of Borrower, and Guarantor delivers this Continuing Guaranty based solely upon its own independent investigation of Borrower's financial condition and in no part upon any representation or statement of Lender with respect thereto. Guarantor further represents and warrants that it is in a position to and hereby does assume full responsibility for obtaining such additional information concerning Borrower's financial condition as Guarantor may deem material to its obligations hereunder, and Guarantor is not relying upon, nor expecting Lender to furnish it any information in Lender's possession concerning Borrower's financial condition or concerning any circumstances bearing on the existence or creation, or the risk of nonpayment or nonperformance of the Liabilities. Guarantor hereby waives any duty on the part of Lender to disclose to Guarantor any facts it may now or hereafter know about Borrower, regardless of whether Lender has reason to believe that any such facts materially increase the risk beyond that 6 41 which Guarantor intends to assume or has reason to believe that such facts are unknown to Guarantor. Guarantor hereby knowingly accepts the full range of risk encompassed within a contract of "Continuing Guaranty" which includes, without limitation, the possibility that Borrower will contract for additional indebtedness for which Guarantor may be liable hereunder after Borrower's financial condition or ability to pay its lawful debts when they fall due has deteriorated. 13. Representations and Warranties. Guarantor represents and warrants to Lender that each of the following statements is accurate and complete as of the date of this Continuing Guaranty: a. this Continuing Guaranty has been duly executed and delivered by Guarantor and constitutes a legal, valid and binding obligation of Guarantor, enforceable against Guarantor in accordance with its terms, except as limited by bankruptcy, insolvency or other laws of general application relating to or affecting the enforcement of creditors' rights generally; b. the execution, delivery and performance of this Continuing Guaranty do not (i) violate any provisions of law or any order of any court or other agency of government (each, a "Requirement of Law"), (ii) contravene any provision of any material contract or agreement to which Guarantor is a party or by which Guarantor or Guarantor's assets are bound (each, a "Contractual Obligation"), or (iii) result in the creation or imposition of any lien, charge or encumbrance of any nature upon any property, asset or revenue of Guarantor except pursuant to or as set forth in the Security Documents; c. all consents, approvals, orders and authorizations of, and registrations, declarations and filings with, any governmental agency or authority or other person or entity (including, without limitation, the shareholders or partners of any entity), if any, which are required to be obtained in connection with the execution and delivery of this continuing Guaranty or the performance of Guarantor's obligations hereunder have been obtained, and each is in full force and effect; d. Guarantor has paid all taxes and other charges imposed by any governmental agency or authority due and payable by Guarantor other than those which are being challenged in good faith by appropriate proceedings except pursuant to or as set forth in the Security Documents; e. Guarantor is not in violation of any Requirement of Law or Contractual Obligation other than any violation the consequences of which could not have a material averse effect on Guarantor's ability to perform its obligations hereunder (a "Material Adverse Effect"); and 7 42 f. no action, proceeding, investigation or litigation is pending or overtly threatened against Guarantor by any person or entity which, if adversely determined, could have a Material Adverse Effect. 14. Guarantor Financial Information. Guarantor will provide Lender in writing such financial and other information with respect to his assets and liabilities as Lender shall reasonably request from time to time, in form satisfactory to Lender. 15. Binding Upon Successors; Death of Guarantor. This Continuing Guaranty shall be binding upon Guarantor and Guarantor's successors and assigns and shall inure to the benefit of Lender and its successors and assigns. This Continuing Guaranty shall not terminate or be revoked upon the death of Guarantor, notwithstanding any knowledge by Lender of Guarantor's death. All references herein to Borrower shall be deemed to include its successors and assigns, and all references herein to Guarantor shall be deemed to include Guarantor and Guarantor's successors and assigns or, upon the death of Guarantor, the duly appointed representative, executor or administrator of Guarantor's estate. In addition and notwithstanding anything to the contrary contained in this Continuing Guaranty or in any other document, instrument or agreement between or among any of Lender, Borrower, Guarantor or any third party, the obligations of Guarantor with respect to the Liabilities shall be joint and several with any other person or entity that now or hereafter executes a guaranty of any of the Liabilities separate from this Continuing Guaranty. 16. Notices. All notices required or permitted to be given hereunder shall be in writing and shall be either personally delivered, faxed to the fax numbers provided herein or sent by United States certified or registered mail, return receipt requested, addressed to Guarantor or Lender at their respective addresses stated below or at such other address as either party hereafter notifies the other party as herein provided. Notices shall be deemed received on the earlier of (i) the date noted on the return receipt as delivered if mail delivery of the notice is successful or the date inscribed on a confirmation of successful transmission, if sent by facsimile; (ii) the last date of attempted delivery, as noted by the United States Postal Service on the envelope containing the notice, if mail delivery is unsuccessful; or (iii) the date of the actual delivery if personally delivered. 17. Governing Law; Additional Waivers. This Continuing Guaranty has been delivered and shall be governed by and construed in accordance with the internal laws (as opposed to the conflicts of law provisions) of the State of Arizona, provided that Guarantor agrees that each of the waivers and agreements of Guarantor herein which refer to provisions of the California Civil Code and the California Code of Civil Procedure shall be effective and enforceable to the extent permitted under applicable law, and to the extent that any court of competent jurisdiction shall apply the laws of the State of California to determine the relative rights or remedies of Lender and Guarantor hereunder, such waivers and agreements by Guarantor shall be governed by the laws of the State of California. 8 43 GUARANTOR HEREBY (i) WAIVES ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION TO ENFORCE OR DEFEND ANY MATTER ARISING FROM OR RELATED TO THIS CONTINUING GUARANTY, AND ACKNOWLEDGES THAT LENDER ALSO WAIVES SUCH RIGHT; (ii) IRREVOCABLY SUBMITS TO THE JURISDICTION OF ANY STATE OR FEDERAL COURT LOCATED IN MARICOPA COUNTY, ARIZONA, OVER ANY ACTION OR PROCEEDING TO ENFORCE OR DEFEND ANY MATTER ARISING FROM OR RELATED TO THIS CONTINUING GUARANTY; (iii) IRREVOCABLY WAIVES, TO THE FULLEST EXTENT GUARANTOR MAY EFFECTIVELY DO SO, THE DEFENSE OF AN INCONVENIENT FORUM TO THE MAINTENANCE OF ANY SUCH ACTION OR PROCEEDING; (iv) agrees that a final judgment in any such action or proceeding shall be conclusive and may be enforced in any other jurisdictions by suit on the judgment or in any other manner provided by law; and (v) agrees not to institute any legal action or proceeding against Lender or any of Lender's directors, officers, employees, agents or property concerning any matter arising out of or relating to this Continuing Guaranty in any court other than one located in Maricopa County, Arizona. Nothing herein shall affect or impair Lender's right to serve legal process in any manner permitted by law or Lender's right to bring any action or proceeding against Guarantor or its property in the courts of any other jurisdiction. Wherever possible each provision of this Continuing Guaranty shall be interpreted as to be effective and valid under applicable law, but if any provision of this Continuing Guaranty shall be prohibited by or invalid under such law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Continuing Guaranty. 18. KNOWING AND EXPLICIT WAIVERS. GUARANTOR REPRESENTS AND WARRANTS THAT GUARANTOR IS FULLY AWARE OF THE SPECIFIC PROVISIONS OF DIVISION THREE, PART 4, TITLE 13 OF THE CALIFORNIA CIVIL CODE, INCLUDING SECTIONS 2787 THROUGH 2855, AND OF SECTIONS 580A, 580B AND 580D OF THE CALIFORNIA CODE OF CIVIL PROCEDURE, AND THAT GUARANTOR'S WAIVERS HEREIN OF ALL RIGHTS, BENEFITS, PROTECTIONS AND DEFENSES THAT MAY BE AVAILABLE THEREUNDER AND ALL OTHER WAIVERS HEREIN ARE EXPLICIT, KNOWING WAIVERS. 9 44 GUARANTOR ACKNOWLEDGES THAT GUARANTOR HAS EITHER OBTAINED THE ADVICE OF COUNSEL OR HAS HAD THE OPPORTUNITY TO OBTAIN SUCH ADVICE IN CONNECTION WITH THE TERMS AND PROVISIONS OF THIS CONTINUING GUARANTY. GUARANTOR FURTHER ACKNOWLEDGES THAT BY EXECUTING THIS CONTINUING GUARANTY, GUARANTOR IS WAIVING CERTAIN RIGHTS AS OTHERWISE SET FORTH HEREIN TO WHICH GUARANTOR MAY OTHERWISE BE ENTITLED BY LAW. THIS CONTINUING GUARANTY CONTAINS THE COMPLETE UNDERSTANDING OF THE PARTIES HERETO WITH RESPECT TO THE SUBJECT MATTER HEREIN. GUARANTOR ACKNOWLEDGES THAT GUARANTOR IS NOT RELYING UPON ANY STATEMENTS OR REPRESENTATIONS OF LENDER NOT CONTAINED IN THIS CONTINUING GUARANTY AND THAT SUCH STATEMENTS OR REPRESENTATIONS, IF ANY, ARE OF NO FORCE OR EFFECT AND ARE FULLY SUPERSEDED BY THIS CONTINUING GUARANTY. This Continuing Guaranty may only be modified by a writing executed by Guarantor and Lender. IN WITNESS WHEREOF, Guarantor has executed this Continuing Guaranty this 18th day of November, 1994. "Guarantor" /s/ FARROKH ALAGHBAND ------------------------------- Farrokh Alaghband Guarantor's address for notices: 2807 Harborview Dr. -------------------------------- Corona Del Mar, CA 92625 -------------------------------- Lender's address for notices: Greyhound Financial Corporation 201 N. Figueroa St., Ste. 900 Los Angeles, CA 90012 Facsimile: (213) 580-5678 10 45 AMENDMENT TO LOAN AND SECURITY AGREEMENT This Amendment to Loan and Security Agreement is made as of this 8th day of November 1995 between FINOVA Capital Corporation, successor in interest to Greyhound Financial Corporation ("FINOVA") and Procom Technology, Inc. ("Procom") in reference to the following stipulated facts: A. FINOVA and Procom have previously entered into the certain Loan and Security Agreement dated November 18, 1994 ("Loan Agreement"), regarding FINOVA's financial accomodations to Procom. B. Procom has requested certain modifications to the Loan Agreement. FINOVA is willing to make certain modifications but only on the terms and conditions set forth below. Now therefore, the parties agree as follow: 1. Capitalized terms herein, unless otherwise defined herein, shall have the meaning set forth in the Loan Agreement. 2. The Total Facility, as set forth on page S-1 of the Loan Agreement, is hereby changed from $9,000,000 to $13,000,000. 3. Paragraph A.(a) on page S-1 on the Loan Agreement is hereby modified by replacing "Four Million Dollars ($4,000,000)" with "Six Million Dollars ($6,000,000)." 4. Paragraph B.(a) on page S-2 of the Loan Agreement is hereby modified by replacing "Five Million Dollars ($5,000,000)" with "Seven Million Dollars ($7,000,000)." 5. The paragraph titled "Interest" on page S-2 is hereby modified by deleting the reference therein to "Four Million Dollars ($4,000,000)" in the two places set forth in that paragraph and replacing it with "Six Million Dollars ($6,000,000)." The paragraph is further modified by adding the following: "If, during any full calendar quarter during the term of this Agreement, volume under the Floorplan Credit Line (as measured by the total of the face amounts of invoices funded by FINOVA under the Floorplan Credit Line during such period) is equal to or greater than the amount set forth below, the interest rate of 1.5% in excess of the Base Rate shall be retroactively reduced to a per annum rate (over a 360 day year) to the corresponding rate set forth below.
QUARTERLY FLOORPLAN VOLUME RATE OVER BASE RATE - ---------------- ------------------- $7,000,000 1.0% $8,500,000 0.5% $10,500,000 0.0% (Interest charged at Prime)
46 6. In addition to all other fees and expenses, Borrower agrees to pay on the date hereof an amendment fee of $20,000 plus all of FINOVA's out-of-pocket legal expenses and costs not to exceed $1,000 incurred in connection with the negotiation, documentation and closing of this Amendment. The $20,000 Amendment fee shall be paid as follows: $10,000 shall be charged to borrower's Revolving Credit Line on the date hereof. The remaining $10,000 will be charged on May 1, 1996. 7. Except as otherwise provided by the terms of this Amendment, the Loan Agreement remains in full force and effect. 8. This Amendment may be executed in counterparts, each of which when taken together shall be one and the same document. 9. This Amendment shall be governed by the laws of the State of Arizona. PROCOM TECHNOLOGY, INC. By [SIG] ----------------------------- Its [SIG] ---------------------------- FINOVA Capital Corporation By ----------------------------- Its ---------------------------- The undersigned guarantors hereby consent and agree to the foregoing and confirm and acknowledge that their respective Guaranties remain in full force and effect in accordance with their terms. /s/ ALEX AYDIN - ------------------------------------------- Alex Aydin /s/ ALIREZA RAZMJOO - ------------------------------------------- Alireza Razmjoo /s/ NEWSHA SHAHRESTANY - ------------------------------------------- Newsha Shahrestany /s/ FARROKH ALAGHBAND - ------------------------------------------- Farrokh Alaghband 47 [PROCOM TECHNOLOGY LETTERHEAD] September 18, 1996 Mr. Murray August FINOVA Capital 1060 First Ave. Ste. 100 King of Prussia, PA 19406 RE: Notification of Officer Compensation, Year Ended July 26, 1996 Dear Murray: Pursuant to your recent request, I provide for your review a report of the amounts paid to the four executive officers of the Company for bonuses for the year ended July 26, 1996. Our Loan Agreement allows for the payment of bonuses of up to 50% of the Company's pretax income, twice a year, after the issuance of financial statements. I have enclosed for your review copies of the financial statements for the year ended July 26, 1996. These financials reflect pretax income of $5.056 million, but included are actual or accrued bonus payments of $2.890 million, for adjusted prebonus income of $7.946 million. One half that amount would be $3.973 million, and the bonuses of $2.850 would be in compliance with our agreement. The accrued bonuses will be paid within the next month or so. I have also attached for your review a computation showing our compliance with the various financial covenants at July 26, 1996. Our auditors have asked me to have you confirm receipt of our August 11, 1996 letter asking for your understanding of the previous compensation arrangements. Please acknowledge receipt by initialling below, and faxing a copy to me at (714) 261-5481, and to Brenda at Arthur Andersen at (714) 757-3163. Thank you, and fee free to call me with any questions. Sincerely, /s/ FRED JUDD Frederick Judd Vice President Finance Fred- Finova has received and acknowledges this letter and the August 11, 1996 letter re: compensation. Any technical violations are waived by Finova (without waiving the right of Finova to declare any similar or other violation a default of the Loan Agreement). FINOVA By /s/ MURRAY D. AUGUST Title ACCOUNT EXECUTIVE --------------------------- ------------------------- Date 9/20/96 ------------------------- 48 [FINOVA LETTERHEAD] October 29, 1996 Procom Technology, Inc. Mr. Fred Judd Vice President, Director of Finance 2181 Dupont Drive Irvine, CA 92715 Dear Fred: Please accept this letter as FINOVA's consent to allow Procom Technology Inc. ("Procom") to alter its capital structure as prevented in the Negative Covenant 14.1 Mergers (page 12) of The Loan & Security Agreement. We understand this change to include a 3:1 stock split and subsequent sale of 3 million shares of stock in the $9-to-$11 per share range. Everyone at FINOVA is proud of Procom's accomplishments and success. We view this momentous event as a significant milestone for Procom and look forward to sharing with you more such events. We wish you continued success. Sincerely, FINOVA Capital Corporation /s/ MURRAY D. AUGUST Murray D. August Account Executive 49 [FINOVA LETTERHEAD] November 14, 1996 Procom Technology, Inc. Mr. Fred Judd Vice President 2181 Dupont Drive Irvine, CA 92715 Dear Fred: This letter confirms that Procom Technology, Inc. ("Procom") may purchase up to $13 million, reduced by any amount outstanding under the Revolving Line of Credit, in inventory from FINOVA approved vendors. FINOVA has reviewed the Certain Transactions and to the extent necessary waives any violation that any transaction listed may have caused in the Loan & Security agreement between Procom and FINOVA. FINOVA acknowledges the officer bonuses of $2.89 million were earned by the officers for the year ended 7/26/96 and that the amount and payment of these bonuses is not a violation of any term of the loan agreement. Thank you very much for giving FINOVA the opportunity to handle your account. Sincerely, FINOVA Capital Corporation /s/ MURRAY D. AUGUST Murray D. August Account Executive
EX-23.1 4 CONSENT OF ARTHUR ANDERSEN LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the use of our reports (and all references to our Firm) included in or made part of this registration statement. ARTHUR ANDERSEN LLP Orange County, California December 4, 1996
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