-----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, HVWpJKLTDJSf7ikuc0+MsT5w8UNunp3spgNHE/prCsFlGc2Ah92Wrsij0wr/Xw62 3c1ek7dN9BcXSkJtvt8yZg== 0000912057-97-013117.txt : 19970416 0000912057-97-013117.hdr.sgml : 19970416 ACCESSION NUMBER: 0000912057-97-013117 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970415 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: INCOMNET INC CENTRAL INDEX KEY: 0000353356 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 952871296 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-12386 FILM NUMBER: 97581297 BUSINESS ADDRESS: STREET 1: 21031 VENTURA BLVD STREET 2: STE 1100 CITY: WOODLAND HILLS STATE: CA ZIP: 91364 BUSINESS PHONE: 8188873400 MAIL ADDRESS: STREET 1: 21031 VENTURA BLVD STREET 2: SUITE 1100 CITY: WOODLAND HILLS STATE: CA ZIP: 91364 FORMER COMPANY: FORMER CONFORMED NAME: INTELLIGENT COMMUNICATIONS NETWORKS INC DATE OF NAME CHANGE: 19860805 10-K 1 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996 COMMISSION FILE NO. 0-12386 INCOMNET, INC. A California IRS Employer No. Corporation 95-2871296 21031 Ventura Blvd., Suite 1100 Woodland Hills, California 91364 Telephone no. (818) 887-3400 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:................................................................None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:..........................................Common Stock, No Par Value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO__ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Aggregate market value of voting common stock held by non-affiliates of the registrant (based upon the average of the closing bid and ask prices of $2 13/16 and $2 15/16 respectively, as reported by the NASDAQ System on March 21, 1997) $30,958,080 Number of shares of registrant's common stock outstanding as of March 21, 1997.................................................13,520,669 DOCUMENTS INCORPORATED BY REFERENCE: Portions of registrant's proxy statements relating to registrant's 1997 annual meeting of shareholders have been incorporated by reference into Part III hereof. 1 TABLE OF CONTENTS PAGE ---- INTRODUCTORY NOTE 7 PART I ITEM 1 - BUSINESS General 7 Telephone Services 7 Optical Systems 7 Network Products and Services 8 National Telephone & Communications, Inc. (NTC) 8 Products 8 Network Marketing Program 8 Disclosure of Independent Representative Organizations Related to NTC Executives 9 Wiltel Contract 9 Management Incentive Agreement 9 Reincorporation of NTC in Delaware 11 Rapid Cast, Inc. (RCI) 11 General 11 The Optical Marketplace 11 The Production and Dispensing of Prescription Eyeglass Lenses 12 The Fast Cast LenSystem 13 Technical Overview of the Rapid Cast LenSystem 13 Marketing and Pricing Strategy 14 Manufacturing Strategy 14 Research and Development Strategy 14 Maintenance, Warranty and Insurance 14 Competition 15 Patents and Proprietary Rights 15 Governmental Regulation 16 Recent Capitalization of Rapid Cast, Inc. (RCI) 16 Issuance of Convertible Preferred Stock 20 Agreement with Price International, Inc. 22 Network Services 22 Employees, Officers and Directors 22 Employees 22 Directors and Officers 23 Appointment of New Director by the Company 24 Appointment of Committee Members 24 2 TABLE OF CONTENTS (CONT'D) PAGE ---- ITEM 2 - PROPERTIES 24 ITEM 3 - LEGAL PROCEEDINGS 25 Class Action and Related Lawsuits 25 Settlement with RCI Parties 26 Settlement of Stevens Lawsuit 26 Settlement of the Atlanta Lawsuits 26 Section 16 (b) Lawsuit 26 Settlement of Patent Infringement Lawsuit 27 Legal Action Against Prior Representatives 27 Settlement With Prior Noteholders 27 Settlement with Price International 28 Potential Lawsuits 28 ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 29 PART II ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS 29 Market Information 29 Dividends 29 ITEM 6 - SELECTED FINANCIAL DATA 29 ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 30 Liquidity and Capital Resources 30 Results of Operations 31 ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 33 ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 33 PART III ITEM 10 - DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT 33 ITEM 11 - EXECUTIVE COMPENSATION 33 ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 34 ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 34 PART IV ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 10-K 34 Index to Financial Statements 34 Index to Exhibits 34 Signatures 37 Report of Independent Auditors 38 Consolidated Balance Sheet 39 Consolidated Statement of Operations 40 3 TABLE OF CONTENTS (CONT'D) PAGE ---- Consolidated Statement of Cash Flows 41 Consolidated Statement of Shareholders' Equity 42 Notes to Consolidated Financial Statements 43 Note 1 - Summary of Significant Accounting Policies 43 Note 2 - Funding of Marketing Commissions and Deferred Income 45 Note 3 - Related Party Transactions 45 Note 4 - Acquisition of Rapid Cast, Inc. 45 Note 5 - Property, Plant and Equipment 46 Note 6 - Patent Rights from Acquisition of RCI 46 Note 7 - Investments, Notes Receivable and Other Assets 46 Note 8 - Notes Payable 46 Note 9 - Income Taxes 47 Note 10 - Shareholders' Equity 48 Note 11 - Commitments, Contingencies and Other 51 Note 12 - Network Marketing Costs 53 Note 13 - Compensation of Independent Sales Representatives 53 Note 14 - Segment Information 53 Note 15 - Fourth Quarter Adjustments 55 Note 16 - Changes in Accounting 55 Note 17 - Subsequent Events 55 Schedule II - Valuation and Qualifying Accounts 56 Exhibit 3.1 - Certificate of Determination for Series A 2% Convertible Preferred Stock. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on November 22, 1996.) Exhibit 4.1 - Form of Warrant to Purchase 75,000 Shares of Incomnet, Inc. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) Exhibit 4.2 - Form of Warrant to Purchase 510,000 Shares of RCI Common Stock with Registration Rights Agreement, dated April 19, 1996. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) Exhibit 4.3 - Form of Warrant to Purchase RCI Common Stock, dated February 8, 1995. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) Exhibit 4.4 - Form of Warrant to Purchase 360,000 Shares of Incomnet, Inc. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) Exhibit 4.5 - Form of Warrant to Purchase 12,500 Shares of Incomnet, Inc. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) Exhibit 10.1 - Employment Agreement with James Quandt, dated January 6, 4 1997. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) Exhibit 10.2 - Amended and Restated Management Incentive Agreement Between NTC and Incomnet, Inc., dated January 28, 1997. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) Exhibit 10.3 - Settlement Agreements With Prior Noteholders. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) Exhibit 10.4 - Form of 8% Convertible Note Issued by RCI in January 1996. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) Exhibit 10.5 - Form of Short-Term 10% Note Issued by RCI in April 1996. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996.) Exhibit 10.6 - Amended Carrier Switched Services Agreement with Wiltel, Inc. dated June 17, 1996. (Incorporated by reference from Incomnet's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996 and declared effective on October 31, 1996, or incorporated by reference from the Company's filings with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Certain information has been deleted from this agreement pursuant to a request for confidential treatment pursuant to Rule 406.) Exhibit 10.7 - Settlement Agreement Between Joel W. Greenberg and Incomnet, Inc. (Incorporated by reference from the Company's Report on Form 8-K, dated June 7, 1996, relating to the settlement agreement with Joel W. Greenberg and his resignation as a director of the Company.) Exhibit 10.8 - Form of Registration Rights Agreement Between Incomnet, Inc. and Purchasers of Series A Convertible Preferred Stock. (Incorporated by reference from Incomnet's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996 and declared effective on October 31, 1996, or incorporated by reference from the Company's filings with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended.) Exhibit 10.9 - Form of Purchase Agreement for the Series A 2% Convertible Preferred Stock. (Incorporated by reference from Incomnet's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996 and declared effective on October 31, 1996, or incorporated by reference from the Company's filings with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended.) Exhibit 10.10 -Management Incentive Agreement with NTC, dated October 14, 1996. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on November 22, 1996.) Exhibit 10.11 -Settlement Agreements With Edward Jacobs and Jerry Ballah, dated November 14, 1996. (Incorporated by reference from 5 Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on November 22, 1996.) Exhibit 10.12 - Shareholders Agreement for Rapid Cast, Inc., dated January 16, 1997. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) Exhibit 10.13 - Registration Rights Agreement for Rapid Cast, Inc., dated January 16, 1997. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) Exhibit 10.14 - Settlement Agreement and Mutual Release Between Incomnet, Inc. and the RCI Parties, dated January 9, 1996. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997.) Exhibit 10.15 - Lease Agreement By NTC for space in Honolulu, Hawaii. Exhibit 10.16 - Credit Agreement dated March 27, 1997 between National Telephone & Communication, Inc. and First Bank & Trust, Irvine Regional office. Exhibit 21 - Subsidiaries of the Registrant Exhibit 27 - Financial Data Schedule 6 INTRODUCTORY NOTE This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Company intends that such forward-looking statements be subject to the safe harbors created by such statutes. The forward-looking statements included herein are based on current expectations that involve a number of risks and uncertainties. Accordingly, to the extent that this Annual Report contains forward-looking statements regarding the financial condition, operating results, business prospects or any other aspect of the Company and its subsidiaries, please be advised that the Company and its subsidiaries' actual financial condition, operating results and business performance may differ materially from that projected or estimated by the Company in forward-looking statements. The differences may be caused by a variety of factors, including but not limited to adverse economic conditions, intense competition, including intensification of price competition and entry of new competitors and products, adverse federal, state and local government regulation, inadequate capital, unexpected costs and operating deficits, increases in general and administrative costs, lower sales and revenues than forecast, loss of customers, customer returns of products sold to them by the Company or its subsidiaries, disadvantageous currency exchange rates, termination of contracts, loss of supplies, technological obsolescence of the Company's products, technical problems with the Company's products, price increases for supplies and components, inability to raise prices, failure to obtain new customers, litigation and administrative proceedings involving the Company, including the pending class action and related lawsuits and SEC investigation, the possible acquisition of new businesses that result in operating losses or that do not perform as anticipated, resulting in unanticipated losses, the possible fluctuation and volatility of the Company's operating results, financial condition and stock price, losses incurred in litigating and settling cases, dilution in the Company's ownership of its subsidiaries and businesses, adverse publicity and news coverage, inability to carry out marketing and sales plans, challenges to the Company's patents, loss or retirement of key executives, changes in interest rates, inflationary factors, and other specific risks that may be alluded to in this Annual Report or in other reports issued by the Company. In addition, the business and operations of the Company are subject to substantial risks which increase the uncertainty inherent in the forward-looking statements. In light of the significant uncertainties inherent in the forward-looking information included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives or plans of the Company will be achieved. PART I ITEM 1. BUSINESS GENERAL: Incomnet, Inc. (the "Company") was incorporated under the laws of the State of California on January 31, 1974. The Company is engaged in the following businesses: TELEPHONE SERVICES- The Company, through its wholly-owned subsidiary, National Telephone & Communications,-Registered Trademark- Inc. (NTC), markets long distance telecommunications services to commercial and residential customers in the United States. Service is provided by procuring long distance telecommunications transmission services from long distance communication carriers at high volume wholesale rates and reselling those services at retail rates. NTC uses a network marketing program of independent representatives to sell its telecommunications-related services to retail customers. The growth in NTC's telecommunications-related revenues is directly tied to its network marketing program. NTC's independent representatives typically pay an annual fee for certain materials, training and services from NTC which are used by the independent representatives to sell new retail customers and enroll other representatives in the NTC program. NTC pays the independent representatives a residual monthly commission on the telecommunications revenue. In addition, the network marketing program pays various bonuses and overrides when and if representatives obtain a minimum number of new telephone customers within a specific 30 to 60 day period. This program has been designed to bring NTC new retail telephone customers even if little or no growth occurs in the marketing program revenues. The new telecommunications revenues generally lag the new marketing program revenues by one to three months. Sales from this segment accounted for 94.2% of the Company's total 1996 sales. 7 OPTICAL SYSTEMS- The Company, through its 35%-owned subsidiary Rapid Cast, Inc. (RCI), acquired in February 1995, manufactures and markets the FastCast-TM- LenSystem that allows retail optical stores and wholesale optical lens manufacturing laboratories to produce single vision, flat-top bifocal and progressive bifocal lenses on demand, in approximately 30 minutes. The FastCast-TM- LenSystem uses a series of high-accuracy prescription glass molds that are filled with a proprietary liquid monomer (plastic). When exposed to ultraviolet light within the system's curing chamber, the monomer undergoes a chemical reaction that rapidly "cures" or hardens the lens. Sales from this segment accounted for 4.4% of the Company's total 1996 sales. Rapid Cast's operating results are included in the accompanying financial statements. NETWORK PRODUCTS AND SERVICES- The Company acquires and/or develops hardware and software, primarily for interactive data communications networks. In this regard, the Company operates a communications network known under the tradename "AutoNETWORK" that services the automotive dismantling industry in California, Nevada, Arizona, Oregon and Washington. Sales from this segment accounted for 1.4% of the Company's total 1996 sales. NATIONAL TELEPHONE & COMMUNICATIONS, INC. (NTC): PRODUCTS - NTC is an inter-exchange carrier and reseller of long distance telephone services to residential and small business customers throughout the United States. NTC's primary product is its Dial-1 Telephone Service. Its other long distance telephone products are 800-Number Services and Calling Card Services, which include the Flag Card, Sure$aver Card, Sure$aver Gold Card, Global$aver Card, and Call$aver Card. In order to provide these products, NTC generally contracts to purchase long distance telephone time from national carriers at wholesale rates based upon high volume usage. NTC then resells this time to its customers at its own discounted retail rates which are generally 10% to 30% or more below AT&T's published, tariffed MTS rates. NTC's Dial-1 Service is transparent to its customers once a customer's long distance service has been converted to NTC. NTC's calling card products operate similarly to the calling card products offered by the major carriers. NTC's customers pay for their long distance calling usage either through direct billing from NTC , through billing from the customer's local exchange carrier ("LEC"), through direct billing by NTC of the customer's major credit card, or by prepaying for long distance time in the case of certain NTC calling card products. In certain states, NTC has an agency agreement with an unaffiliated company which bills customers' local intrastate calls through the local telephone company. Commencing in the second quarter of 1996, NTC increased its use of LECs to bill and collect telephone service accounts receivable. The increase in the use of LECs has increased the amount of time that it takes for NTC to receive payment on its accounts receivable. NETWORK MARKETING PROGRAM - NTC markets its products on a nationwide basis through a multi-level, network marketing program of independent sales representatives. NTC authorizes and trains the independent representatives to resell its services to residential and small business customers, and allows the individual representatives to build up their own "downline" sales force of other independent representatives. NTC currently has in excess of 40,000 independent representatives in its network marketing program. Once an independent representative has signed up a long distance telephone customer on one or more of NTC's services/products, the customer becomes an NTC customer. NTC takes over the servicing and billing of the customers as well as the collection of monies owed by the customers for their use of the NTC telephone services/products. NTC pays each independent representative a commission on the telephone usage monies billed to those retail telephone customers who are directly sourced by that representative. NTC also pays override commissions to each independent representative on the monies billed to those telephone customers sourced by the representative's downline as well as a bonus percentage of all telephone monies billed by NTC from the retail telephone customers collectively sourced by all independent representatives, if certain minimums of retail telephone business are personally achieved by the representative. In addition, NTC pays sales quota bonuses to independent representatives for assisting other representatives to obtain certain minimum quotas of new retail long distance telephone business. NTC does not pay any monies to independent representatives simply for recruiting other representatives into NTC's network marketing program. NTC generally maintains communications with its independent representatives through (1) NTC's proprietary communications systems, (2) NTC's internal personnel dedicated to the support of the independent representatives, (3) various NTC manuals, newsletters and other publications that are periodically and continually sent to the independent representatives, (4) NTC's network 8 of senior independent representatives, and (5) various training programs offered by NTC and its senior independent representatives throughout the United States. NTC believes it is in compliance with all State and Federal regulations governing multi-level marketing companies. However, to ensure the Company has objective and knowledgeable outside legal opinion in this area, NTC has formed a Regulatory Compliance Committee consisting of four former States Attorney General that periodically reviews NTC's marketing programs for such compliance. DISCLOSURE OF INDEPENDENT REPRESENTATIVE ORGANIZATIONS RELATED TO NTC EXECUTIVES - - In order to eliminate potential conflicts of interest, at the end of 1992, NTC implemented its current policy that no senior, decision-making NTC executive or officer may have a downline organization of independent representatives involved with the selling of NTC's long distance telephone services and/or marketing programs ("Executive Downlines"). Violation of this policy subjects such an NTC officer/executive to immediate termination and forfeiture of all past and future commissions from such disallowed Executive Downlines. To the best of the Company's knowledge, none of NTC's senior officers/executives have an Executive Downline, including Ed Jacobs (Chairman of the Board), James R. Quandt (President), Victor C. Streufert (Vice President of Finance and Administration and Chief Financial Officer), Debra Chuckas (Vice President-Marketing Support), Louis W. Cheng (Vice President-Information Services), and Michael A. Keebaugh (Vice President of Operations). In addition, NTC's current policy requires full disclosure by all senior NTC officers and executives of any NTC downline organizations headed by an immediate family member of such senior officer or executive as well as disclosure of the personal involvement of an immediate family member in the sale of NTC's long distance telephone services to retail customers ("Immediate Family Customers/Downlines"). To the best of the Company's knowledge, none of NTC's senior officers or executives have Immediate Family Customers/Downlines. WILTEL CONTRACT - In September 1995, NTC entered into a new carrier contract with Wiltel, Inc. of Tulsa, Oklahoma, a subsidiary of WorldCom, Inc., covering a potential volume purchase of $600 million of long distance telephone time over a five year period commencing in November 1995. Effective February 1996, NTC entered into a revised multiple-year $1.0 billion contract with Wiltel, Inc., which has a fixed term expiring January 2002. As in the prior carrier contract with Wiltel, Inc., NTC has committed to purchase the designated volume of telephone time in accordance with a schedule over the term of the contract. NTC currently relies in part on the purchases of another unaffiliated long distance telephone service provider to meet its volume purchase requirements under the new contract. MANAGEMENT INCENTIVE AGREEMENT - On January 28, 1997 the Company entered into an amended and restated management incentive agreement with NTC pursuant to which the Company agreed to spin-off 10% of the shares it owns in NTC, to establish stock option programs for the senior executives, employees and key independent sales representatives of NTC, and to vote its shares for NTC management's slate of director nominees. The new management incentive agreement entirely supersedes the incentive agreements entered into by the Company with NTC in February and November 1996. See "Item 5. Other Information - Agreement with NTC Management" in the Company's Form 10-Q for the quarter ended September 30, 1996. In November 1996 the Company also entered into settlement agreements with Edward Jacobs and Jerry Ballah (the former Executive Vice President and director of NTC, who is now the Executive Director, Global Marketing of NTC's network marketing program as a consultant to NTC), pursuant to which mutual general releases were given. The Company agreed to assume certain debt obligations of Mr. Jacobs and Mr. Ballah to NTC, as well as to make a cash payment to them to cover their tax liabilities from the debt forgiveness. See "Item 5. Other Information - Settlement Agreement with NTC Directors" in the Company's Form 10-Q for the quarter ended September 30, 1996. With respect to a potential spin-off of NTC shares by the Company, there is no assurance as to if or when a spin-off will occur, or whether or not NTC will make a public offering of its stock. 9 The amended and restated management incentive agreement essentially contains the same terms and conditions as the agreement entered into in November 1996, except as follows: The Company and NTC agree that the Company, as the owner of 100% of the total issued and outstanding stock of NTC, owns ten million shares of NTC. The three NTC stock option plans previously agreed to have been revised. The Company and NTC have now agreed that there will be three stock option plans and one convertible debt plan. The exercise price of all stock options issued under the option plans will not be less than the fair market value of NTC common stock on the date of the grant, and the conversion price of the convertible debt issued under the convertible debt plan will not be less than the fair market value of NTC common stock on the date of the issuance of the convertible debenture. Shares issuable pursuant to the plans are expected to be registered with the Securities and Exchange Commission no later than at the time of NTC's planned public offering. Upon the creation of the plans and first grant of options and convertible debt units pursuant to the plans, Edward Jacobs will waive his rights to all remaining outstanding unexercised warrants and options issued to him by the Company pursuant to his employment agreement, dated December 28, 1994. The first stock option plan is the one for key independent sales representatives. A total of 2,884,615 shares are reserved for issuance under this plan. Options to purchase 961,538 shares of NTC common stock have been granted to key independent sales representatives who are Corporate Team members, 480,769 of which will vest on June 30, 1998, subject to acceleration if NTC's public offering occurs prior to January 1, 1998. Options to purchase the other 480,769 shares will vest on June 30, 1999. The remaining 1,923,077 shares reserved for issuance pursuant to stock options granted under this plan may be granted to key independent sales representatives after each of June 30, 1997, December 31, 1997, June 30, 1998 and December 31, 1998 if NTC's gross revenues for the three month periods ending on each of such dates exceed NTC's gross revenues for the corresponding three month periods ending December 31, 1996, June 30, 1997, December 31, 1997 and June 30, 1998, by the percentage amounts indicated on the following table:
Percentage Increase in NTC Gross Revenues In Number of Options Available For Grant At End Comparative Three Month Period of Each Period(1) ------------------------------ ----------------- 30% 125,000 40% 250,000 50% 500,000(1)
- -------------------- (1) Stock options in the amount indicated may be granted at the end of each of the four comparative three month periods. If the percentage increase for all four of the comparative periods is 50% or more, then the total stock options available for grant in the fourth period would be 423,077 instead of 500,000 because there are 1,923,077 (not 2,000,000) options available for grant under this portion of the key independent sales representatives' stock option plan. These stock options, once granted, will vest in four equal annual installments on each anniversary date after the stock option grant date. The NTC Board of Directors will determine when and to whom these stock options will be granted. The second stock option plan is the one for NTC executives, employees and key consultants. A total of 3,705,001 shares are reserved for issuance under this plan. Options representing 1,446,076 of these reserved shares will be subject only to a time-in-service vesting requirement, but in no event will such options vest prior to January 1, 1998. Options representing 1,682,051 of the reserved shares will vest in four equal annual installments on each anniversary date of the option grant date, subject to the acceleration of vesting in the event that NTC achieves certain income targets in 1997, to be determined by the NTC Board of Directors. No more than 480,770 shares issuable pursuant to options granted under this plan may be issued to persons eligible to receive convertible debt units under the Senior Executive and Consultant Convertible Debt Plan described below in this section. The NTC Board of Directors will determine when and to whom these stock options will be granted. Options representing 576,924 shares will be reserved under this plan for issuance to persons eligible to receive convertible debt units under the Senior Executive and Consultant Convertible Debt Plan described below in this section in equal amounts. These options will be granted upon the creation of the plan but will not vest until January 31, 2002, except that the vesting of these options will accelerate in the following amounts if NTC achieves revenues which exceed the following amounts for any calendar quarter ending prior to January 1, 2000. QUARTERLY REVENUES NUMBER OF SHARES VESTING ------------------ ------------------------ $100 million 192,308 $125 million 192,308 $180 million 192,308 The third stock option plan is the one for members of NTC's Board of Directors. A total of 300,000 shares are reserved for issuance under this plan. Each director of NTC will receive an option to purchase 25,000 shares of NTC common stock which will vest in four equal annual installments on each anniversary date of the option grant date. 10 The fourth option plan is the Senior Executive and Consultant Convertible Debt Plan for Edward Jacobs and Jerry Ballah. A total of 2,664,231 shares are reserved for issuance under this plan to be allocated between Mr. Jacobs and Mr. Ballah as determined by the NTC Board of Directors. These units will vest upon grant. A portion of the convertible debt units granted under this plan may be assignable. The amended and restated NTC management incentive agreement provides that, until four additional independent directors are appointed to the NTC Board of Directors, if a vacancy is created on the NTC Board of Directors by reason of the death, resignation or removal, with or without cause, of Mr. Jacobs or Mr. Ballah, then the Company has agreed to vote its shares for the individual nominated by the remaining NTC management director. In addition to the regular members of the NTC Board of Directors, a key independent sales representative may be nominated and elected to the NTC Board of Directors on a rotating basis, such that the same sales representative cannot serve consecutive terms. NTC has agreed to make total cash payments to the Company on or before December 31, 1997 equal to $2,200,000, of which $1,200,000 of payments have already been made as of March 17, 1997. The cash payments of up to $2,200,000 by NTC to Incomnet, Inc. will be treated as a return of capital to the Company. NTC may make advances to Incomnet, Inc. in excess of its cash payment obligation of $2,200,000, subject to the limitations of its credit agreement, which Incomnet, Inc. will be obligated to repay with interest upon demand. Any charge to earnings or taxable income associated with advances made by NTC to Incomnet, Inc. or costs incurred in the spin-off of NTC shares will be incurred by Incomnet, Inc. for financial reporting purposes rather than by NTC. REINCORPORATION OF NTC IN DELAWARE Effective March 21, 1997, NTC, previously a Nevada corporation, reincorporated under the laws of the State of Delaware. Pursuant to its new Articles of Incorporation, NTC has authorized 100 million shares of common stock, par value $.01 per share, of which 10 million shares are issued and outstanding, all of which are held by Incomnet Inc., and 1.5 million shares of preferred stock, none of which are issued or outstanding. RAPID CAST, INC. (RCI): GENERAL - RCI is a Delaware corporation formed in February 1994 which acquired 100% of the outstanding capital stock of Q2100, Inc. ("Q2100") from Pearle, Inc., an unaffiliated subsidiary of Grand Metropolitan, Ltd., a United Kingdom conglomerate. Q2100 owns certain domestic and foreign patents and patent applications relating to a new technology, commonly known as Thick Film Radiation Cured Polymer Technology (the "Technology"), which enables retail optical stores and wholesale optical lens manufacturing laboratories to produce many prescription ophthalmic lenses on site at a cost generally lower than if they were purchased from third party manufacturers or distributors. RCI is marketing the Technology under the name Fast Cast-TM- LenSystem. THE OPTICAL MARKETPLACE - Nearly 60% of the United States population (approximately 151 million people) required some form of vision correction in 1992, according to CENSUS INTERNATIONAL '93: THE OPTICAL INDUSTRY FACT BOOK ("Census93"). It is estimated that, by the year 2000, the United States prescription eyewear population will rise to approximately 164 million people and that, in the following decade, over 180 million people will use prescription eyewear products. Census93 reports that, in the approximately $11.9 billion United States retail optical market in 1992, the average optical retailer's breakdown of dollar revenue by product category was: (a) approximately 47% (or nearly $5.6 billion) from the sale of eyeglass lenses and lens treatments (e.g., the application of scratch-resistant and ultraviolet 11 coatings), (b) approximately 38% from the sale of eyeglass frames and sunglasses, and (c) approximately 15% from the sale of contact lenses. Census93 reports that, out of the approximately 80 million pairs of prescription eyeglass lenses sold in the United States in 1992, an estimated 55% to 60% were single vision lenses, while an estimated 40% to 45% were multifocal lenses (i.e., bifocal, trifocal and cataract lenses). According to Census93, bifocal lenses currently constitute the substantial majority of consumer purchases of multifocal lenses, representing an estimated average of approximately 84% of all multifocal lenses purchased in the years 1987, 1989 and 1991. Multifocal lenses are produced as either "flat-top" or "progressive" lenses. Progressive lenses are distinguished from flat-top lens by the absence of visible horizontal lines separating the different corrective prescription areas. Census93 reports that, by the end of 1992, flat-top bifocal and trifocal lenses held approximately 79% of the multifocal market, while approximately 21% of this market consisted of progressive lenses. The LenSystem is capable of producing single vision, flat-top bifocal and progressive bifocal lenses. Although no assurance can be given in this regard, RCI believes that the market for progressive bifocal lenses offers particularly great opportunities, both because of the potential to convert persons currently wearing flat-top bifocals to the "no-line" option offered by progressive lenses, and because the bulk of the baby boomer generation (ages 30 to 49 in 1994) has not yet reached their early 40s, when people typically first experience the presbyopia that requires correction by bifocals. Single vision and multifocal prescription eyeglass lenses are currently manufactured using one of three basic types of materials. According to Census93, the two conventional materials, glass and hard-resin plastic, accounted respectively for approximately 13% and 64% of 1993 United States prescription lens sales, while the newer premium materials such as polycarbonates, high index plastic and high index glass, accounted for approximately 23% of such sales. Within the categories of single vision and multifocal lenses, there are many types of premium lenses (generally designed to be especially thin, strong, and light) that the LenSystem currently cannot manufacture: (a) high index plastic and high index glass lenses, which generally are very thin, lightweight lenses used to reduce the thickness of very high strength prescription lenses; (b) polycarbonate lenses, which are made from a material with superior impact resistance and are typically used for sports and other eye-safety purposes; and (c) aspheric lenses, which are made to have flatter curves than conventional spherical lenses, thereby improving visual acuity and the appearance of the eyes through the lenses. Census93 estimates that aspheric lenses represented about 1% of 1992 United States sales of prescription lenses. RCI anticipates that sales of high index lenses will continue to grow steadily over the next several years. During the years 1990 through 1992, the United States market of contact lens wearers remained basically flat, according to Census93, at approximately 25 million users. There can be no assurance, however, that technological developments, medical advances, changes in consumer tastes or other factors will not cause the use of contact lenses to grow significantly in the future at the expense of prescription eyeglass lenses. Census93 reports that, despite the recent flat rate of overall contact lens use, a Bausch & Lomb study has found that first-time usage of disposable contact lenses grew at a compounded annual growth rate of 47% from 1989 through 1992. THE PRODUCTION AND DISPENSING OF PRESCRIPTION EYEGLASS LENSES - As previously noted, approximately 77% of all conventional single vision and multifocal prescription eyeglass lenses are currently manufactured from glass or hard-resin plastic. According to Census93, during the years 1991 through 1993 hard-resin plastic was used in the manufacturing of approximately 82% of all prescription lenses made from conventional materials. Although there can be no assurance in this regard, RCI anticipates that the use of glass in manufacturing conventional lenses will decrease over time due to a variety of factors, including its relatively greater weight and inferior impact resistance. After being prescribed for an individual by his or her medical doctor (ophthalmologist) or optometrist, prescription eyeglass lenses reach the consumer through three traditional channels: independent dispensers (consisting of thousands of private sector optometrists, opticians and ophthalmologists), retail optical chain stores (i.e., retailers having at least four stores, including so-called "superoptical" stores or "superstores", mass merchandisers and warehouse membership clubs), and miscellaneous third party and other dispensers. Census93 estimates that independent dispensers accounted for approximately 62% of 1992 United States optical sales, retail optical chain stores accounted for approximately 33% of such sales, and third party and other dispensers accounted for approximately 5% of such sales. 12 The substantial majority of glass and hard-resin plastic prescription lenses purchased in the United States are currently obtained from lens dispensers (such as independent optometrists, opticians, ophthalmologists and retail chain stores) who do not manufacture the lenses on-site. They instead obtain lenses from third party manufacturers and distributors, including hundreds of large factories and large, mid-sized and small wholesale manufacturing laboratories. These manufacturers and distributors have invested in the space and equipment required to grind glass or plastic lenses into a specific prescription and then to finish (i.e., polish) the lenses in order to provide clarity. In the case of plastic lenses, these manufacturers additionally possess the molds and other machinery required in order to form and then "cure" (i.e., harden) such lenses. Conventional curing processes utilize heat-driven reactions to harden the plastic. Heat-curing processes are relatively time-consuming, generally requiring between approximately six and 16 hours, depending upon the specific type of plastic involved. In most cases, a retail lens dispenser who obtains finished lenses from third party manufacturers and distributors cannot offer consumers "same day" service unless that retailer maintains a relatively large, mostly idle and generally expensive inventory of lens blanks. This inventory generally has consisted principally of single vision and flat-top bifocal lenses, due to the historically greater demand for such lenses. Even a retailer who maintains a very extensive inventory of lens blanks typically must place special orders for the majority of lenses required to fill more complex prescriptions and for most premium lenses. Filling any such order generally takes one or more days. Largely as a result of these limitations in the ability of retail lens dispensers to provide consumers with same day service for certain lenses, full service eyeglass lens manufacturing began to move into retail optical outlets in the form of the so-called "superoptical store". Many of these superstores are operated by the large retail optical chain stores, such as LensCrafters, Opti-World and Pearle Express. A "superoptical store" is generally understood in the United States optical industry to be a retail store with the on-site equipment necessary to produce the great majority of finished prescription lenses in about one hour. The required equipment generally consists of a surfacing (or grinding) laboratory and a finishing machine. According to Census93, superoptical stores rarely fall below 1,900 square feet in total area. In addition to an investment in equipment and space, a superoptical store typically requires the maintenance of a largely idle inventory of semi-finished lens blanks. THE FAST CAST LENSYSTEM - The LenSystem incorporates a new technology called Thick Film Radiation Cured Polymer Technology, which uses ultraviolet light instead of heat to initiate the chemical reaction that hardens the Fast Cast Liquid Monomer into a plastic lens. The Technology resulted from a research program that was initially begun in 1985 by the University of Louisville. In 1988, Dr. Larry Joel, one of the RCI founding shareholders, and others formed ORGIC, which contracted with the University of Kentucky to sponsor and continue that research program in return for the ownership of all resulting patents and discoveries. By 1990, ORGIC (then majority-owned by Dr. Joel and the predecessor of Q2100) had developed and tested a new liquid monomer, an ultraviolet curing unit and a lens casting machine. ORGIC believed that equipment utilizing the Technology could permit on-site production of prescription eyeglass lenses at a low cost and in a very short amount of time. ORGIC also believed that, in order to commercialize the use of such equipment and effectively bring it to the marketplace, financial and other resources would be required that ORGIC did not possess. In 1991, ORGIC, with the Technology (together with all related issued patents and patent applications), was sold to Pearle and subsequently renamed Q2100, Inc. On February 8, 1995, RCI purchased 100% of Q2100 from Pearle, and the Company purchased 51% of RCI. See "Item 1. Business - Acquisition of Rapid Cast, Inc." in the Company's Form 10-K for the fiscal year ending December 31, 1995. TECHNICAL OVERVIEW OF THE FAST CAST LENSYSTEM - The Rapid Cast LenSystem consists of three primary components: The Fast Cast Mold and Gasket Library, the Fast Cast Liquid Monomer (the "Monomer"), and the Fast Cast Ultraviolet Curing Unit (the "Curing Unit"). The Fast Cast Mold and Gasket Library is used to create the actual mold assembly from which a lens will be made. Once the type of lens (i.e., single vision, flat-top bifocal or progressive bifocal) and prescription to be produced are known, a front mold and a back mold are selected from an easy to read wall chart. A gasket is used to hold the front and back molds in place, creating a mold assembly consisting of a hollow cavity. This cavity is then filled with the Fast Cast Liquid Monomer. The Fast Cast Liquid Monomer is a proprietary monomer that is injected in liquid form into the mold assembly using a standard squeeze bottle. This Monomer is a "thick film" monomer, meaning that its thickness is best measured in parts of centimeters (as opposed to thin film monomers, which are measured in parts of millimeters). The Fast Cast Liquid Monomer is chemically inert and, because it is cured by ultraviolet light, does not require the addition of a separate 13 chemical initiator for the hardening process. As a result of its chemical stability, the Fast Cast Liquid Monomer has a shelf-life of many years and does not require special shipping and storage precautions. These advantages are not generally realized by conventional lens manufacturing processes which use hard-resin monomers to produce plastic lenses. These conventional monomers (such as the CR-39 Monomer, which has long been the substance most commonly used in manufacturing plastic lenses) require the addition of chemical initiators prior to being cured, and those initiators are in some cases flammable or explosive prior to being mixed with the monomer. Temperature-controlled shipping and storage arrangements must accordingly be made, and cold storage facilities must be utilized even after the monomer and initiator are mixed, since the resulting substance hardens and becomes useless when exposed for an extended period to temperatures above approximately 25 degrees fahrenheit. The Curing Unit controls the chemical reaction that occurs when the Fast Cast Liquid Monomer is exposed to ultraviolet light. It monitors the exact temperature of the lens during this reaction, utilizing multiple cold air jets to control the temperature of each sector of a lens. The Curing Unit also continuously monitors the energy output of the ultraviolet light in order to maintain a constant output, even with fluctuations in electrical current. RCI currently intends to utilize two versions of the Curing Unit, which differ only in the quantity of the lenses that can be produced at one time. The Premier Curing Unit will cure two pairs of lenses within approximately 30 minutes. The smaller Deluxe Curing Unit will cure one pair of lenses in the same amount of time. In addition, the front mold assembly may be coated with a scratch resistant coating and then cured with high intensity UV light onto the mold surface. This coating then adheres to the lens during the curing process. A lens produced by the LenSystem can be subjected to the application of various additional treatments (such as scratch resistant, anti-reflective and ultraviolet coatings) using the same materials and process now employed to apply such coatings to conventional plastic lenses. Scratch resistant and ultraviolet coatings can generally be applied on site in under ten minutes, whereas the application of an anti-reflective coating requires that the lens be sent out to a third party service company. If inadequacies appear in the LenSystem during day to day operation, there is no assurance that any such inadequacies can be corrected at commercially acceptable cost, or at all. Certain RCI customers have experienced technical problems with the LenSystem, including the calibration of the molds, the generation of heat by the Curing Unit, and related problems. As a result, machine orders have declined significantly while RCI works on corrective measures. While RCI management believes that the design and functional problems can be corrected, there is no assurance that these problems will be resolved or that new problems will not arise. There is no assurance that the rate of machine orders received by RCI will stabilize or increase in the future. MARKETING AND PRICING STRATEGY - RCI expects that initially the bulk of RCI's revenues will be derived from sales of equipment and that as the installed base of equipment stabilizes, an increasing share of revenues will be derived from Monomer sales. RCI is initially seeking to market the LenSystem principally to operators of retail optical stores and small to mid-sized wholesale lens manufacturing laboratories, both inside and outside the United States. Currently the sale price for a single LenSystem with one set of molds is approximately $37,000 for a smaller unit and $43,000 for a larger unit. Operators may be able to lease RCI equipment from third party lessors for approximately $750 to $950 per month at current interest rates over a 60 month period. RCI expects that each purchaser or lessee of a LenSystem will at least initially use RCI's Fast Cast Liquid Monomer. RCI does not believe that, in the short term, marketing of the LenSystem will require the purchase of significant print, television, radio or other advertising. RCI instead anticipates that the LenSystem will receive a large amount of nonpaid publicity within trade magazines that regularly report on technological changes in the optical industry. RCI may nonetheless utilize limited print advertising in optical industry trade magazines for the purpose of highlighting the LenSystem's perceived advantages. RCI currently intends to focus its marketing resources in the short term on the introduction and demonstration of the LenSystem at one or more optical industry conventions and trade shows. RCI believes that such conventions will provide an attractive forum for exhibiting the LenSystem's limited space requirements, ease of use and high quality output. MANUFACTURING STRATEGY - RCI currently does not have the facilities or the experience to manufacture the components of the LenSystem and has no plans to develop its own manufacturing capabilities. RCI currently has such components manufactured through subcontractors. RESEARCH AND DEVELOPMENT STRATEGY - RCI anticipates that its research and development efforts will emphasize the further development and enhancement of the Technology and the LenSystem, generally in response to potential future changes in technologies, customer preferences and optical industry standards. Should RCI be unable to anticipate these changes (whether because of a lack of adequate research and development funding or otherwise) or fail to improve the LenSystem or develop new technologies in response to these changes, RCI's ability to grow and become profitable could be materially adversely affected. RCI has experienced several customer requests for service and replacement 14 parts due to problems with the design and functioning of certain aspects of the Fast Cast LenSystem. As a result, RCI is making design modifications and servicing these customers, which have resulted in increased costs and slower sales than anticipated. RCI believes that it will be able to satisfy these customers and make the necessary design modifications to solve the problems. There is no assurance, however, that RCI's design modifications will solve the current problems with the Fast Cast LenSystem or that future design and operating problems may not occur. More specifically, RCI believes that, in addition to single vision, flat-top bifocal and progressive bifocal lenses, the Technology could be enhanced to enable it to produce other existing types of prescription lenses as well as new lens designs that may be developed in the future. If and to the extent funds become available, RCI accordingly expects that it might seek to improve the LenSystem so as to broaden the range of low cost, high quality lenses it can produce. There can be no assurance, however, that RCI will in fact ever undertake to develop any such improvements or that any effort to do so would be successful or commercially viable. RCI does not currently anticipate that it will conduct future research and development relating to technologies or products that are not related to the on-site production of prescription eyeglass lenses. There can be no assurance that, if conducted in the future, any of RCI's research and development efforts will be successful, be completed in a timely manner, improve RCI's profitability, or enable it to respond effectively to technological or medical advances or new product developments by competitors. MAINTENANCE, WARRANTY AND INSURANCE - Initial sales of LenSystems are supported by sales and technical representatives who provide installation and training services. RCI provides its customers with a complete operations manual and training videos. RCI currently offers the LenSystem with a one year warranty for parts and labor. RCI currently maintains product liability insurance which provides coverage of $6,000,000 per occurrence and $7,000,000 in the aggregate. There can be no assurance that the coverage provided by those policies is sufficient to protect RCI against liability. RCI's inability or failure to protect itself adequately against such liabilities could have a material adverse effect upon its prospects, financial condition and results of operations. COMPETITION - The prescription ophthalmic lens industry is intensely competitive. Numerous manufacturers and distributors currently supply United States lens dispensers, including such dispensers as retail optical stores and small to mid-sized wholesale optical lens manufacturing laboratories. These are the customers to whom RCI initially intends to market the LenSystem. Many of these manufacturers and distributors are currently capable of supplying lenses to a lens dispenser within 24 hours after receipt of the dispenser's order, and, in many cases they can do so at prices competitive with the cost of producing such lenses utilizing the LenSystem. Innotech Corporation is one competitor of RCI which uses plastic to produce lenses. RCI believes that the LenSystem has superior quality (i.e. better durability) and equivalent pricing to other manufacturers of single vision lenses, and both superior quality and lower pricing with respect to flat-top bifocal and progressive bifocal lenses. If RCI is successful in marketing the LenSystem, it anticipates that other companies or entities will attempt to develop competitive lens casting systems capable of being placed in retail optical store locations. Potential competitors may include companies that own large optical lens manufacturing factories, owners of chains of retail optical stores, large wholesale optical lens manufacturing laboratories, mass merchandisers and warehouse membership clubs that have entered or may enter the retail optical industry, companies in the optical instrument business, companies in the contact lens industry, pharmaceutical and chemical companies that have entered or may enter the retail optical industry or the optical lens manufacturing industry, and universities and public research organizations. Many of these competitors have substantially greater financial, technological, research, product development, manufacturing, sales, marketing and human resources than RCI. There can be no assurance that one or more of these competitors will not develop a system for on-site production of prescription ophthalmic lenses which is competitive with or superior to the LenSystem, or that RCI will have the technological, marketing or financial resources or flexibility to respond to any such development. The development of such a system would, in all likelihood, exert adverse price pressures on the LenSystem and could render it obsolete and unmarketable. PATENTS AND PROPRIETARY RIGHTS - In February 1995 RCI acquired all of the capital stock of Q2100 and thus all of Q2100's issued patents and patent applications that relate to the Technology. RCI is not aware that any party, in the United States or elsewhere, has challenged the validity or enforceability of the issued patents relating to the 15 Technology, other than the patent dispute with Ronald D. Blum O.D., which was settled in January 1997. See "Item 3. Legal Proceedings - Settlement of Patent Infringement Lawsuit." The status of pending patent applications involves complex legal and factual questions, and the scope and breadth of claims to be allowed is uncertain. Accordingly, there can be no assurance that pending patent applications, or patent applications that may be filed by RCI in the future, will result in patents being issued, or that any patents that may be issued in the future will afford protection against competitors with similar technology. Patent applications in the United States are maintained in secrecy until patents are issued and, since publication of discoveries in the scientific or patent literature tends to lag behind actual discoveries by several months or even years, there can be no assurance with respect to pending patent applications that the covered inventions were not first created by other parties, or that such applications were the first to be filed on such inventions. In addition, patents relating to the Technology that have been or may be issued in some foreign countries may not afford the same protection to RCI as is provided under the patent laws of the United States. No assurance can be given that the issued patents relating to the Technology will afford protection against competitors with similar technology, or that any fo such patents will not be infringed, designed around by others or invalidated. Applications of the Technology (or future technologies RCI may develop) may infringe patents or proprietary rights of others. If any licenses are found to be required in order for RCI to use the Technology or other processes or products, such licenses may not be available on acceptable terms, if at all. Furthermore, there can be no assurance that challenges will not be instituted against the validity or enforceability of any patent owned by RCI or, if instituted, that such challenges will not be successful. The cost of litigation to uphold the validity and prevent infringement of a patent can be substantial and could have a material adverse effect upon RCI's financial condition and results of operations. In addition to potential patent protection, RCI will rely upon the laws of unfair competition and trade secrets to protect its proprietary rights. RCI currently intends to seek to protect its trade secrets and other proprietary information in part by entering into appropriate confidentiality and nondisclosure agreements with its future employees, consultants, suppliers, joint venturers, subcontractors, licensees, scientific collaborators, sponsored researchers and others. These agreements will generally provide that all confidential information developed by or made known to the other party during the course of the relationship with RCI is to be kept confidential and not disclosed to third parties, except in certain circumstances. In the case of employees, consultants, scientific collaborators and sponsored researchers, the agreements will generally provide that all inventions conceived by them relating to the business of RCI will be the exclusive property of RCI. There can be no assurance, however, that any such agreements will provide meaningful protection for RCI's trade secrets in the event of unauthorized use or disclosure of such information. Although RCI intends to protect its rights vigorously, there can be no assurance that trade secrets will be established or maintained, that secrecy, confidentiality or nondisclosure agreements will be honored, or that others will not independently develop similar or superior technologies. To the extent that employees, consultants or other third parties (such as prospective joint venturers or subcontractors) apply technological information to RCI's projects which has been independently developed by them or others, disputes may arise as to the proprietary rights to such information, which disputes may not be resolved in favor of RCI. RCI currently utilizes the tradenames and marks "Fast Cast," "Rapidcast," and "LenSystem." None of these marks have been federally registered. GOVERNMENTAL REGULATION - The lens produced by the LenSystem may be medical "devices" within the meaning of the Federal Food, Drug and Cosmetic Act (the "Food and Drug Act"), but management believes that the lenses may be marketed without pre-market notification, review, approval or clearance by the Federal Food and Drug Administration ("FDA"). Other requirements, principally those concerning impact resistance, good manufacturing practices, labeling and reporting of certain alleged adverse effects, apply to RCI's business. Although the FDA may disagree, RCI also believes that the LenSystem is itself not a "medical device" under the Food and Drug Act. Certain state and local governmental authorities (such as the State of California) also regulate medical device manufacturers. Depending upon where LenSystem equipment is manufactured, RCI may be subject to such additional regulations. Although there can be no assurance in this regard, RCI does not anticipate that compliance with such governmental regulation will have an adverse effect upon its business. 16 RECENT CAPITALIZATION OF RCI: On January 16, 1997, Rapid Cast, Inc., a minority owned subsidiary of the Company, issued 8,000,000 shares of Series A and Series B 7% Convertible Preferred Stock to institutional investors in a private placement pursuant to Regulation D of the Securities Act of 1933, as amended. The investors contributed $12,000,000 in capital in consideration for the issuance of 7,275,000 shares of voting Series A 7% Convertible Preferred Stock and 725,000 shares of nonvoting Series B 7% Convertible Preferred Stock. The investors also have the option to purchase up to an additional 6,666,666 shares of voting or nonvoting 7% Convertible Preferred Stock from RCI for a purchase price $1.50 per share, exercisable with respect to 3,333,333 of the shares upon the sooner to occur of (i) the appointment of a permanent Chief Executive Officer of RCI, or (ii) July 15, 1997, or the option relating to those shares will expire unexercised. The option with respect to the remaining 3,333,333 shares must be exercised on or before July 16, 1998, or the option with respect to those shares will expire unexercised. Frank Pipp, the new Chairman of the Board of Directors of RCI, also has an option to purchase up to 1,333,333 shares of Series A 7% Preferred Stock at any time until July 15, 1998 for a price of $1.50 per share. The Company's ownership of RCI will be diluted to the extent that those investors or Mr. Pipp exercise their options to purchase additional shares of Series A 7% Preferred Stock. The proceeds of the issuance of the Series A and Series B 7% Convertible Preferred Stock were utilized by RCI (i) to repay short-term bridge loans made to RCI by its shareholders, including Incomnet, Inc., in the approximate total amount of $3,705,430; (ii) to repurchase 1,200,000 shares of RCI common stock from Dr. Larry Joel for a redemption price of $1.28 per share; (iii) to make the final settlement payment and license new technology for $325,000 on the patent infringement lawsuit known as RONALD BLUM, O.D. VS. RAPID CAST, INC., ET AL., which has been dismissed; (iv) to repay the bank line of credit with Bank Leumi in the approximate outstanding amount of $500,000 plus interest; (v) to pay placement costs of approximately $700,000; (vi) to pay all overdue trade payables in the approximate outstanding amount of $1,700,000, and (vii) the balance for working capital. The outstanding RCI founder loans in the approximate outstanding principal balance of $1,205,000 on the date of the closing, the other RCI shareholder bridge loans which were not repaid from the proceeds of the private placement of the Series A and Series B 7% Convertible Preferred Stock, and the outstanding 8% convertible notes in the approximate outstanding balance of $648,000 (which were convertible into RCI common stock at a price of $.80 per share), were all converted into newly issued RCI common stock and Series C 7% Convertible Preferred Stock as follows:
No. of Shares of Series C No. of Shares Name of RCI Shareholder Preferred Stock(1) of Common Stock (2) - ----------------------- ------------------ ------------------- Robert Cohen 121,543 260,708(3) Alan Cohen 120,194 260,708(5) Jeff Rubin 122,260 45,752 Dr. Shawn Zimberg 111,781 135,252 Dr. Larry Joel(6) 0 255,099 Huberfeld Bodner Partnership 0 543,390 Martin Price 27,485 52,628 Incomnet, Inc. 0 428,570
- -------------------- (1) Issued at a price of $1.50 per share. (2) Issued at a price of $.80 per share with respect to the conversion of the outstanding principal balance of the 8% convertible promissory notes, and $1.28 with respect to the conversion of the RCI founder loans, the accrued but unpaid interest on the 8% convertible promissory notes, the unpaid bridge notes and accrued interest. (3) Includes 36,603 shares issued in the name of Robert Cohen's children. (4) Includes 120,194 shares issued in the name of Alan Cohen's children. (5) Includes 36,602 shares issued in the name of Alan Cohen's children. 17 (6) In September 1996 Dr. Joel surrendered 142,222 shares of RCI common stock to RCI as the settlement payment for $448,000 of liabilities owed by Dr. Joel to RCI. From the proceeds of the capitalization of RCI on January 15, 1997, Incomnet, Inc. was repaid $2,647,348 of principal and accrued interest on its short term bridge loans which it made to RCI during the period from April 1996 through January 1997. RCI also issued 428,570 shares of its common stock to Incomnet, Inc. in exchange for the conversion by Incomnet, Inc. of $326,400 of 8% convertible promissory notes purchased by it from RCI in January 1996. Incomnet, Inc. now owns 10,628,570 shares of RCI common stock. Melvyn Reznick was repaid $80,000 plus interest at the rate of 10% per annum for the loan he made to RCI in late December 1996, and Stephen Caswell was repaid $12,500 plus interest at the rate of 10% per annum for the loan he made to RCI in early January 1997. Pursuant to its Amended and Restated Certificate of Incorporation filed on January 15, 1997, RCI is authorized to issue a total of 60,000,000 shares of common stock, 22,000,000 shares of which are nonvoting common stock, and 42,500,000 shares of preferred stock, all having a par value of $.001 per share. As of March 17, 1997, RCI has a total of 22,233,335 shares of common stock issued and 20,891,113 outstanding, 10,628,570 of which are owned by Incomnet, Inc., 7,275,000 shares of voting Series A 7% Convertible Preferred Stock, 725,000 shares of nonvoting Series B 7% Convertible Preferred Stock, and 503,264 voting Series C 7% Convertible Preferred Stock. Incomnet, Inc. does not own any outstanding RCI preferred stock. Each share of issued and outstanding Series A, Series B and Series C Preferred Stock is convertible into one share of RCI common stock (subject to adjustment) at any time at the option of the preferred shareholder, and automatically upon the occurrence of a "qualified public offering" by RCI, as that term is defined in the Certificate of Determination of Rights, References and Privileges for all outstanding series of RCI preferred stock. The terms of conversion and other rights of the outstanding RCI preferred stock are all subject to customary adjustments and antidilution provisions in the event of stock splits, certain stock dividends, stock combinations, reorganizations, recapitalizations and similar events. A "qualified public offering" by RCI occurs when RCI makes a public offering of its securities having gross proceeds of at least $20,000,000 and an offering price of at least $1.90 per share if it occurs on or prior to December 31, 1997, $2.14 per share if it occurs on or prior to June 30, 1998, $2.40 per share if it occurs on or prior to December 31, 1998, $2.69 per share if it occurs on or prior to June 30, 1999, $3.02 per share if it occurs on or prior to December 31, 1999, $3.40 per share it occurs on or prior to June 30, 2000, $3.81 per share if it occurs on or prior to December 31, 2000, $4.29 per share if it occurs on or prior to June 30, 2001, $4.82 per share if it occurs on or prior to December 31, 2001, $5.41 per share it if occurs on or prior to June 30, 2002, and $6.08 per share if it occurs after June 30, 2002, in each case as adjusted for stock splits, certain stock dividends, stock combinations and similar events. The Series A, Series B and Series C 7% Convertible Preferred Stock have a liquidation preference of $1.50 per share. All outstanding RCI preferred stock have a cumulative noncompounded dividend of 7% per annum which must be declared and paid in full before any dividends may be declared or paid on the RCI common stock. All dividends on outstanding RCI preferred stock, regardless of whether Series A, Series B or Series C, must be declared and paid ratably on all such outstanding preferred stock. Each holder of outstanding RCI preferred stock has the right to be paid the 7% dividend, when declared, either in cash, in shares of Series A, Series B or Series C Preferred Stock (at a price of $1.50 per preferred share, subject to adjustment), or in a combination of cash and preferred stock. The cumulative unpaid dividend on the outstanding RCI preferred stock must be paid in full in shares of RCI common stock (at a price of $1.50 per common share, subject to adjustment) or in cash, at the option of the preferred shareholder, upon the conversion of the preferred stock into common stock. The preferred shareholder may require RCI to redeem the outstanding preferred stock beginning after January 1, 2003 if the preferred stock has not otherwise been converted. The redemption price would equal the original issue price plus cumulative unpaid dividends. The Certificate of Determination for the outstanding RCI preferred stock contains numerous restrictive covenants applicable to RCI with respect to the incurrence of debt, sale of assets, issuance of shares, mergers, reorganizations, recapitalizations, affiliate transactions, and similar transactions by RCI. In connection with the issuance of the preferred stock by RCI, RCI and its shareholders entered into a Registration Rights Agreement, a Shareholders Agreement and related agreements governing the outstanding RCI shares and the management of RCI. 18 Pursuant to the Registration Rights Agreements, the Series A and Series B Preferred Shareholders have priority demand and piggyback registration rights with respect to the shares of RCI common stock issuable upon the conversion of the preferred stock, and issuable upon the exercise of warrants held by them. The Series A and Series B Preferred Shareholders are the only RCI shareholders with demand registration rights, of which they have three for less than $5,000,000 of proposed sales and an unlimited number of proposed sales in excess of $5,000,000. With respect to piggyback registration rights, the holders of Series A and Series B Preferred Stock are entitled to 80% of the available registration of shares for selling security holders on a pro rata basis, and the other existing RCI shareholders are entitled to 20% of the available share registration for selling security holders on a pro rata basis, subject to other conditions and limitations. Pursuant to the RCI Shareholders Agreement, the RCI shareholders and RCI are granted certain first rights of refusal to purchase RCI stock proposed for sale by other RCI shareholders. The RCI Shareholders Agreement imposes certain other restrictions on the transferability of RCI shares, except for Rule 144 sales, a sale of shares in a public offering pursuant to the Registration Rights Agreement, and a transfer to RCI. The RCI shareholders also agree to vote their shares so that (i) the RCI Board of Directors will consist of nine members, (ii) subject to certain conditions, the RCI Board of Directors will consist of two members designated by J.P.Morgan Investment Corporation and its related investors, two members designated by Clipper Capital Associates, L.P. and its related investors, one member designated by Incomnet, Inc., provided, that if Incomnet, Inc. undergoes a "change of control" (defined as the cessation of Melvyn Reznick's service on the RCI Board of Directors for any reason or certain other changes in the Incomnet, Inc. Board of Directors or the stock ownership of Incomnet, Inc.), then the Incomnet designee must be approved by a majority of the other members of the RCI Board of Directors, one member designated by Jeff Rubin, one member designated by Robert Cohen, one member (initially Frank Pipp) designated by a majority of the RCI Board of Directors who qualify as outside directors and approved by a majority of the RCI shareholders, and one member who is the interim or permanent Chief Executive Officer of RCI. RCI has established Executive, Audit and Compensation Committees. The following persons are the current members of the RCI Board of Directors and its Committees: I. BOARD OF DIRECTORS(1) Molly F., Ashby (J.P. Morgan Designee) Robert Cohen Patrick H. Garrett (J.P. Morgan Designee) Kevin A. Macdonald (Clipper Designee) Frank Pipp (Chairman and Interim Chief Executive Officer)(2) Melvyn Reznick (Incomnet Designee) Jeff Rubin II. EXECUTIVE COMMITTEE Molly F., Ashby (Chairman) Kevin A. Macdonald Frank Pipp III. COMPENSATION COMMITTEE Patrick H. Garrett (Chairman) Kevin A. Macdonald Frank Pipp Melvyn Reznick IV. AUDIT COMMITTEE Melvyn Reznick (Chairman) Patrick H. Garrett 19 Kevin A. Macdonald - -------------------- (1) The Board of Directors currently has one vacancy which is reserved for the permanent Chief Executive Officer when he is hired. (2) John L. Vidovich is currently a consultant and acting co-Chief Executive Officer of RCI with Frank Pipp. Mr. Vidovich may become the permanent Chief Executive Officer of RCI. The permanent Chief Executive Officer of RCI is expected to join the RCI Board of Directors and may join one or more of its Committees. Upon the completion of a "qualified public offering" by RCI, as that term is defined in the Certificate of Determination for the outstanding RCI preferred stock and as described above, the voting and transferability restrictions in the RCI Shareholders Agreement generally terminate, except that the RCI shareholders agree to vote for one director designee each for J.P. Morgan and Clipper after the "qualified public offering" as long as their investors hold a specified minimum number of shares of RCI. The RCI Shareholders Agreement grants the RCI shareholders pro rata preemptive rights to purchase new securities proposed to be issued by RCI, except in circumstances such as when RCI makes a public offering, issues stock to acquire another company in a purchase, merger or other reorganization, issues stock pursuant to outstanding conversion rights, options or warrants, issues up to 120,000 shares to John L. Vidovich or 450,000 shares to Frank Pipp, implements a stock split or stock dividend, or issues stock after a "qualified public offering" by RCI. In connection with the short term bridge loans made to RCI from April 1996 to January 1997 and the issuance of the preferred stock by RCI on January 16, 1997, RCI issued options and warrants to purchase its common stock, and amended and restated its 1994 Stock Option Plan. The RCI 1994 Stock Option Plan was amended to authorize and reserve up to 4,514,732 shares of its common stock for issuance upon the exercise of stock options granted and which may be granted by the RCI Board of Directors in the future. Under the RCI 1994 Stock Option Plan, a total of 3,260,000 stock options have been granted to various officers, directors, employees and key consultants of RCI. The exercise price of 1,408,000 of the stock options is $2.25 per share and the exercise price of 1,342,000 of the stock options is $2.00 per share. These stock options have vested (subject to continued employment) and are exercisable at any time from the date of grant until dates ranging from November 1, 2005 until July 31, 2006. Melvyn Reznick was granted 100,000 of these options by RCI, having an exercise price of $2.25 per share and exercisable at any time until July 31, 2006. Frank Pipp was granted 450,000 of these stock options to purchase a total of 450,000 shares of RCI common stock at any time until January 20, 2007, 225,000 to which may be purchased at an exercise price of $1.28 per share and 225,000 of which may be purchased at an exercise price of $4.00 per share. RCI also granted to John L. Vidovich 60,000 of these stock options to purchase 60,000 common stock at any time until January 20, 2007 at an exercise price of $1.28 per share. RCI issued to the purchasers of the Series A and Series B Preferred Stock warrants to purchase 1,400,000 shares of RCI common stock at an exercise price of $1.74 per share, exercisable at any time until January 16, 2004. The holders of these warrants have certain registration rights under the Registration Rights Agreement described above, and customary adjustment and antidilution protection. In connection with short term bridge loans made to RCI by its shareholders and others during the period from April 1996 until early January 1997, RCI issued a total of 4,441,933 warrants to purchase 4,441,933 shares of RCI common stock at any time until dates ranging from September 30, 2003 to December 31, 2003. The exercise price of 1,853,683 of the warrants is $2.25 per share, the exercise price of 302,500 of the warrants is $1.28 per share, and the exercise price of 2,285,750 of the warrants is $.75 per share. Incomnet, Inc. holds 841,416 of these warrants to purchase 841,416 shares of RCI common stock at an exercise price of $2.25 per share at any time until September 30, 2003, 480,000 of these warrants to purchase 480,000 shares of RCI common stock at an exercise price of $.75 per share at any time until December 30, 2003, 150,000 of these warrants to purchase 150,000 shares of RCI common stock at an exercise price of $1.28 per share at any time until December 31, 2003, and 1,090,000 of these warrants to purchase 1,090,000 shares of RCI common stock at an exercise price of $.75 per share at any time until November 30, 2003. In consideration for personal loans and loan guarantees, Melvyn Reznick holds 175,000 of these warrants to purchase 175,000 shares of RCI common stock at an exercise price of $2.25 per share at any time 20 until September 30, 2003, and 160,000 of these warrants to purchase 160,000 shares of RCI common stock at an exercise price of $.75 per share at any time until December 31, 2003. In consideration for personal loans to RCI, Albert Milstein was issued 25,000 warrants to purchase 25,000 shares of RCI common stock at an exercise price of $1.28 per share at any time until December 31, 2003. In consideration for personal loans to RCI, Steve Caswell was issued 12,500 of these warrants to purchase 12,500 shares of RCI common stock at an exercise price of $1.28 per share at any time until December 31, 2003. RCI also has a total of 1,000,000 additional warrants outstanding which entitle their holders to purchase a total of 1,000,000 shares of RCI common stock at an exercise price equal to 50% of the average of the last reported sales price of RCI shares during the first 30 business days after the shares of RCI first become publicly traded, provided that they become publicly traded on or before December 31, 1998. If RCI becomes publicly traded on or before December 31, 1998, these warrants are then exercisable for a period of 180 days after the public trading commencement date. These 1,000,000 RCI warrants were issued on February 8, 1995 in connection with the issuance of 8% convertible promissory notes by Incomnet, Inc. on that date to finance its acquisition of a controlling interest in RCI. See "Item 1. Business - Acquisition of Rapid Cast, Inc." in the Company's Form 10-K for the fiscal year ending December 31, 1995. ISSUANCE OF CONVERTIBLE PREFERRED STOCK: From September 20, 1996 to October 25, 1996, the Company issued 2,440 shares of Series A 2% Convertible Preferred Stock to 12 accredited investors in a private placement pursuant to Regulation D of the Securities Act of 1933, as amended. The shares of Series A 2% Convertible Preferred Stock were purchased by four affiliated individuals and eight unaffiliated investors. The Company raised $2,440,000 in capital from the issuance of the Preferred Stock, a portion of which it utilized to repay advances made to it by Melvyn Reznick, the Company's Chairman and Chief Executive Officer, who in turn owed approximately $723,000 to a bank on a loan with a maturity date of September 16, 1996. Mr. Reznick had borrowed these funds from the bank in order to make a substantial portion of his loan to the Company, which enabled the Company to make its pro rata share of loans to RCI. See "Item 5. Other Information - Loan to Company By Melvyn Reznick" in the Company's Form 10-Q for the fiscal quarter ending September 30, 1996. The balance of the proceeds is being utilized and is expected to be utilized for general working capital and to pay the costs of settling pending litigation. The Company paid a referral fee to Newport Capital Partners, an unaffiliated financial consultant, equal to 5% of the capital raised through its referrals, which was $1,700,000. The Company has therefore paid $85,000 of referral fees to Newport Capital Partners. The basic terms and conditions of the Series A 2% Convertible Preferred Stock are described in the following paragraphs: VOTING - The Series A 2% Convertible Preferred Stock does not have voting rights. DIVIDEND - The Series A 2% Convertible Preferred Stock has a cumulative noncompounded annual dividend of 2% payable in cash or stock at the Company's option upon conversion of the Preferred Stock into Common Stock, and prior to the payment of any dividends on the Common Stock. LIQUIDATION PREFERENCE - The Series A 2% Convertible Preferred Stock has a liquidation preference of $1,000 per share plus all cumulative unpaid dividends, whether or not declared by the Company's Board of Directors. Upon any liquidation or change of control of the Company (i.e. transfer of more than 50% of its voting stock), the Preferred Shareholders are entitled to the first priority in payment from the Company's assets, before any payments are made on the Company's Common Stock, until the liquidation preference is paid in full. CONVERSION - The Preferred Shareholders may convert each share of Series A 2% Convertible Preferred Stock into the number of shares of the Company's Common Stock calculated as follows, at any time upon the earlier of (i) 90 days after the issuance of the Preferred Stock, or (ii) 60 days after the shares of Common Stock underlying the Preferred Stock are registered with the Securities and Exchange Commission: The conversion price (the "Conversion Price") for each share of Series A 2% Convertible Preferred Stock is equal to the LESSER of (a) 80% of the average bid price for the Company's Common Stock on the public trading market for the five trading days immediately preceding the conversion date, as specified by the Preferred Shareholder, or (b) the bid price of the Company's Common Stock on the funding date (i.e. the issuance date of the Preferred Stock). To calculate the number of shares of Common Stock issuable upon the conversion of the Preferred Stock, the Conversion Price is multiplied by a ratio, the numerator of which is the sum of 1,000 and the accrued but unpaid dividends, and the denominator of which is the Conversion Price. If for any reason a registration statement covering the shares of Common Stock issuable upon the conversion of the Preferred Stock is not in effect with the Securities and Exchange Commission at the time of a valid conversion by a Preferred Shareholder, 21 then the Conversion Price is reduced by 3% per month for each of the first three months that the effectiveness of the registration is late. The Company has the right to cause a conversion of the Preferred Stock into Common Stock on the same terms at any time after one year after the Preferred Stock is issued. REDEMPTION - The Company has the right to redeem the Preferred Stock for its issuance price plus cumulative unpaid dividends if the Company's stock trades at a price which averages $2.00 per share or less for any period of five consecutive trading days after the Preferred Stock is issued. REGISTRATION RIGHTS - Pursuant to a Registration Rights Agreement entered into by the Company with each purchaser of the Series A 2% Convertible Preferred Stock, the Company is obligated to file a registration statement with the Securities and Exchange Commission covering the shares of Common Stock underlying the Preferred Stock within 30 days after the Preferred Stock is issued, and to have the registration statement declared effective within 75 days after it is filed. The Underlying Shares issuable upon the conversion of the first 365 shares of Series A 2% Convertible Preferred Stock were covered by a prior registration statement declared effective by the Securities and Exchange Commission on October 31, 1996. The balance of the shares of Common Stock issuable upon the conversion of outstanding Series A 2% Convertible Preferred Stock are covered by this Prospectus. ANTIDILUTION PROVISION - The Certificate of Determination for the Series A 2% Convertible Preferred Stock contains comprehensive provisions for adjustments to the Conversion Price and the conversion ratio of the Preferred Stock in the event of stock dividends, asset distributions, reorganizations, recapitalizations, mergers, stock splits or similar transactions by the Company, in order to protect the Preferred Stock from dilution as a result of such transactions. RESTRICTIVE COVENANTS - During the first 90 days after the Series A 2% Convertible Preferred Stock is issued, the Company is not permitted to issue any other securities, except in limited circumstances, including pursuant to the exercise of outstanding options or warrants or pursuant to existing settlement agreements, without first notifying the Preferred Shareholders and giving them a right of first refusal to purchase the securities themselves. While the Series A 2% Convertible Preferred Stock is outstanding or until it is converted into Common Stock, the Company is not permitted to engage in certain transactions, such as the redemption or purchase of its own Common Stock (except in connection with the collection of Section 16(b) short-swing profits), without the prior consent of the Preferred Shareholders. Furthermore, the Company is not permitted to pay cash dividends on its Common Stock unless all cumulative unpaid dividends on the Series A 2% Convertible Preferred Stock is paid. The Company cannot take any action which would modify the rights of the Preferred Shareholders under the Certificate of Determination without the prior consent of the Preferred Shareholder being affected by the modification. AGREEMENT WITH PRICE INTERNATIONAL, INC.: On October 27, 1994, the Company entered into an exclusive agreement with Price International, Inc. ("PRI") of Boca Raton, FL, to provide production, management and marketing services for sports-oriented private label and collectible telephone calling cards. In June 1996, the license with the NHLPA expired and was not renewed. PRI and Incomnet also agreed to end their relationship in providing telephone calling cards. Incomnet has also decided, at this point in time, not to issue additional cards to the ones issued under the agreement. In August 1996, the Company entered into a settlement agreement with PRI pursuant to which the Company agreed to lower the exercise price of PRI's 75,000 warrants from $11.25 to $4.50 per share, and to extend the expiration date of the warrants from November 15, 1997 until December 31, 1998. The Company also registered the 75,000 shares issuable upon the exercise of the warrants in a registration statement with the Securities & Exchange Commission declared effective on October 31, 1996 (see Item 3. Legal Proceedings - "Settlement With Price International, Inc."). NETWORK SERVICES: The Company's major network service is the Auto Dismantler Network (known under the tradename "AutoNETWORK") that currently links several hundred licensed automobile dismantlers in California, Nevada, Arizona, Utah, Oregon and Washington. AutoNETWORK is a monthly subscription service that auto dismantlers utilize to buy, sell and trade used parts that have been salvaged from automobiles damaged in traffic collisions. The Company evaluates on a continual basis other applications that could use the Company's broadcast and point-to-point business communications technologies. 22 AutoNETWORK allows automobile dismantlers to buy, sell and trade used automobile parts. By entering a parts request into a personal computer, the request is transmitted to the communications message switching system, which in turn broadcasts the request within seconds to every dismantler on the network or to a selected local or regional subgroup of dismantlers. Those dismantlers who have the requested part in stock and wish to sell it then transmit private messages and enter into private negotiations to sell the part. Generally, a dismantler using AutoNETWORK can locate a part, if available, within minutes of entering his request. The majority of dismantlers on the network generate substantially increased parts sales per month using the network. During September 1989, the Company agreed to a joint venture with Dismantlers Exchange, a privately-owned, Fairfield, California-based operator of voice telephone hotlines used by more than 200 auto dismantlers to locate auto parts throughout Central and Northern California, Oregon and Washington. Under the joint venture agreement, Dismantlers Exchange markets its own version of the Company's computerized parts locator network in its marketing area under the tradename "DX PC Network". Although both companies operate their networks separately, customers of each network are able to receive appropriate parts requests and send private messages to each other. Dismantlers Exchange also operates a central clearinghouse so that customers of either network can search for parts on each network as required. In February 1997, the Company agreed with Dismantlers Exchange to end the joint venture. Incomnet has taken over the customer base serviced by Dismantler's Exchange. In 1997, the Company intends to invest approximately $5,000 into the AutoNETWORK business to enhance the services provided to the automobile dismantlers in the network. EMPLOYEES, OFFICERS AND DIRECTORS: EMPLOYEES - As of December 31, 1996, the Company, including its subsidiaries, NTC and RCI, employed 288 full-time people, consisting of 73 general and administrative, 46 marketing and sales, and 169 operations and customer service personnel. None of the Company's employees are subject to a collective bargaining agreement, and the Company has not experienced any slow-downs, strikes or work stoppages due to labor difficulties. The Company considers its employee relations to be satisfactory. DIRECTORS AND OFFICERS - The success of the Company is heavily dependent on the Company's President and Chief Executive Officer, Melvyn Reznick, and the Chief Executive Officer and President of the Company's NTC subsidiary, Edward R. Jacobs and James R. Quandt, respectively. The Company has a three-year employment contract with Mr. Jacobs that expires on July 25, 1997. Should Mr. Jacobs become unavailable or incapable of performing his duties and functions, the Company could suffer material adverse consequences. There can be no assurance that the Company would be able to attract a competent replacement on a timely basis should the Company find it necessary to replace Mr. Jacobs. On January 6, 1997, NTC entered into an employment agreement with James R. Quandt pursuant to which Mr. Quandt is serving as NTC's President and is a member of NTC's Board of Directors. The employment agreement contemplates that Mr. Quandt will eventually become the Chief Executive Officer of NTC upon the retirement of Edward Jacobs, the current Chief Executive Officer, which is presently scheduled for January 1, 1999. Mr. Quandt's employment agreement commenced on January 6, 1997 and has a term of three years. The employment agreement recites that Mr. Jacobs also contemplates retiring as the Chairman of the Board of Directors of NTC on July 25, 1999, although such retirement is not contractually mandated. The employment agreement contemplates that Mr. Quandt may be nominated to become the Chairman of the Board of Directors of NTC upon Mr. Jacobs' retirement from that position. 23 Pursuant to the employment agreement, Mr. Quandt is entitled to the following compensation: (1) A base salary of $40,000 per month, (2) an incentive bonus equal to one and one-half (1.5%) of the quarterly net profit earned by NTC, provided that the quarterly net profit is at least $1,250,000, and the payment of the bonus does not cause the quarterly net profit of NTC to be less than $1,250,000, and NTC's pretax profit for the succeeding calendar quarter is reasonably expected to exceed the minimum quarterly net profit of $1,250,000, and (3) nonqualified stock options to purchase 600,000 shares of the common stock of NTC. The stock options will have an exercise price determined by the Board of Directors of NTC in accordance with the NTC Stock Options Plan, but in no event greater than the higher of $5.00 per share or the fair market value of NTC's stock at the time of the grant. See "THE COMPANY - Amendment to NTC management Incentive Agreement." The stock options will have an exercise period of five years from the date of grant. The stock options will vest as follows: (1) 300,000 stock options will vest upon Mr. Quandt completing 15 months of employment for NTC under the employment agreement, and (2) 350,000 stock options will vest only in the event NTC achieves certain pretax profits goals prior to January 1, 1998 or prior to January 1, 1999 whichever first occurs. In addition to the base salary, regular bonus and stock options, Mr. Quandt will earn a hiring bonus equal to $225,000, payable if NTC's quarterly net profits exceed $1,250,000, but in any event no later than December 31, 1997 with respect to $150,000 of the guaranteed hiring bonus, and the balance by no later than June 30, 1998. The hiring bonus will be paid at the rate of 1.5% of quarterly pre-tax profits of NTC in excess of $1,250,000, and if not earned in that manner, will be paid in full in two installments as follows: $150,000 by December 31, 1997 and the balance by June 30, 1998. To the extent that the regular bonus and guaranteed hiring bonuses are paid to Mr. Quandt pursuant to his employment agreement, Mr. Jacobs has agreed to waive any remaining portion of the quarterly incentive bonus payable by NTC to Mr. Jacobs (i.e. 1.5% of the pre-tax net profits in excess of $1,250,000 of net profits of NTC per calendar quarter) pursuant to Mr. Jacobs' current employment agreement with NTC. Under the employment agreement, Mr. Quandt is entitled to a significant severance payment if his employment terminates prior to the agreement's termination date because of his death, disability, or for a reason other than cause, or because of a voluntary resignation by Mr. Quandt for "good cause", as defined in the employment agreement. Mr. Quandt has agreed not to compete with NTC during the term of his employment agreement and for a period of one year after the agreement terminates for any reason. Prior to assuming his executive position with NTC, Mr. Quandt was the Chairman of the Board of Directors of Global Financial Information Corporation, a privately held group of companies in the financial information and technology industry. Global Financial Information corporation operates from a base of 27 offices internationally, with a staff of approximately 840 professionals. From 1991 to 1995, Mr. Quandt was the President and Chief Executive Officer of Standard & Poors Financial Information Services, a subsidiary of McGraw Hill Corporation in New York, New York. At Standard & Poors, Mr. Quandt was responsible for all executive, administrative and operational functions of nine domestic and international companies that comprised the Standard & Poors Group. From 1980 to 1991, Mr. Quandt was an executive officer in various capacities with Security Pacific Bank in Los Angeles, California. Mr. Quandt was the Senior Vice President and Group Division Head of Security Pacific Bank's Financial Management & Trust Services Group from 1988 to 1991. From 1983 to 1990, Mr. Quandt was the President and Chief Executive Officer of Security Pacific Brokerage, Inc., a subsidiary of Security Pacific Bank. Effective April 8, 1997, James R. Quandt was elected to be a member of the Board of Directors of NTC to replace Jerry Ballah, who resigned as a director and as an officer of NTC. Mr. Ballah is now a marketing consultant to NTC. Effective January 17, 1997, the Company entered into an Amendment to the Employment Agreement with Melvyn Reznick pursuant to which the term of Mr. Reznick's Employment Agreement has been extended for two additional years, until November 30, 1999. Mr. Reznick is also a director and a member of several committees of the Board of Directors of RCI, as well as being a director of NTC. APPOINTMENT OF NEW DIRECTOR BY THE COMPANY - On January 20, 1997, the Company's Board of Directors appointed Dr. Howard Silverman to fill a vacancy and become a member of the Board of Directors. Since March 1996, Dr. Silverman has been consulting for various companies in the optical and financial areas, including Andrew, Alexander, Wise & Company in New York, and Rapid Cast, Inc. From August 1995 to March 1996, Dr. Silverman served as a Vice President of Corporate Finance for Rickel & Associates, an investment banking firm. From 1991 until he joined Rickel & Associates in 1995, Dr. Silverman was an independent business consultant specializing in early stage and mid-size operating companies. From 1985 to 1991, Dr. Silverman was the founder and Chairman of the Board of Directors of Vision Sciences, Inc., a company that developed, manufactured and sold in-office lens casting systems, which enabled the optical retailer to cast his own finished plastic optical lenses. Dr. Silverman was a member of the Board of Directors and the director of business development for Staar Surgical Co., Inc., a publicly owned company, from 1984 to 1990. He was the co-founder and Chief Operating Officer of Hydro-Optics, Inc., a manufacturer of hydrophilic contact lens, from 1974 until 1984. Dr. Silverman has also been the Vice President and Chief Operating Officer of Diversified Health Industries, Inc. and the President and Chief Executive Officer of Precision Contact Lens, Inc. Dr. Silverman had a private optometric practice in New York City from 1968 to 1972, specializing in contact lenses. Dr. Silverman earned a Bachelor of Science in Chemical Engineering from the College of the City of New York in 1965 and a Doctor of Optometry form Illinois College of Optometry in 1968. See the Company's Report on Form 8-K, dated January 20, 1997. 24 APPOINTMENT OF COMMITTEE MEMBERS - The current members of the Audit Committee of the Company's Board of Directors are Albert Milstein, Nancy Zivitz and Dr. Howard Silverman. The current members of the Compliance Committee of the Company's Board of Directors are Melvyn Reznick, Mark Richardson, Albert Milstein and Nancy Zivitz. The current members of the Compensation Committee of the Company's Board of Directors are Albert Milstein, Nancy Zivitz, Stephen Caswell and Dr. Howard Silverman. ITEM 2. PROPERTIES The Company does not own any real estate. The Company leases approximately 6,224 square feet of office facilities at 21031 Ventura Boulevard, Suite 1100, Woodland Hills, California 91364. The Company has been obligated to make lease payments at the rate of $8,713 per month from May 1995 through July 1998. The Company's subsidiary, NTC, currently leases approximately 64,000 square feet of office space in Irvine, California at a rate of approximately $52,000 per month. NTC has entered into an agreement to extend the lease on its headquarters building at 2801 Main Street, Irvine, California. According to the terms of this agreement, NTC would be obligated to pay formula based monthly lease payments estimated to be approximately $57,000 per month during 1997 and increasing to approximately $72,000 per month for the remainder of the initial five year lease term. In addition, in February 1997, NTC entered into a ten year lease for office space in Honolulu, Hawaii, with the lease expiring in 2007. The monthly payments on the lease in Honolulu, Hawaii commence at $36,698 per month in 1997 and 1998, and increase on a bi-annual basis through the term of the lease to $43,536 per month in 2006 and 2007. The Company's other subsidiary, Rapid Cast, Inc., has entered into a lease on approximately 12,250 square feet of office, research and development space for its facilities in Louisville, Kentucky, expiring on May 30, 2000. RCI is obligated to make lease payments at the rate of $8,167 per month through December 31, 1997, $8,322 per month in 1998, and $8,433 per month from January 1999 through May 2000. RCI also leases approximately 2,850 square feet of office space in East Meadow, New York, for $2,417 per month with annual escalations. ITEM 3. LEGAL PROCEEDINGS SECURITIES AND EXCHANGE COMMISSION INVESTIGATION: In August 1994, the Company was notified by the Pacific Regional Office of the Securities and Exchange Commission that the Commission had initiated an informal inquiry of the Company. In September 1994 the Commission issued a formal order of private investigation. The Commission stated in its correspondence to the Company that the investigation "should not be construed as an adverse reflection on any person, entity or security, or as an indication by the Commission or its staff that any violation of law has occurred." In August and September 1994, the Company supplied copies of its books and records to the Commission, and the Company's present and prior independent certified public accounting firms submitted their working papers pursuant to the Commission's subpoena. In February 1995, the Company provided to the Commission pursuant to its subpoena additional documents associated with NTC's regulatory authorizations and with the Company's recent acquisition of a controlling interest in RCI. The Company continues to fully cooperate with the Commission. While the Company believes that the outcome of the fact finding investigation will not have a material adverse effect on the financial condition or operating results of the Company, no assurance can be given on this matter until the investigation is concluded. See "Item 3. Legal Proceedings - Securities and Exchange Commission Investigation" in the Company's 1995 Form 10-K, as updated in the Company's Form 10-Q for the quarter ended September 30, 1996 under "Item 1. Legal Proceedings - Securities and Exchange Commission Investigation." CLASS ACTION AND RELATED LAWSUITS: On October 17, 1995, the Company was served with an amended complaint in the class action lawsuit entitled SANDRA GAYLES; THOMAS COMISKEY, AS TRUSTEE FBO THOMAS COMISKEY, IRA; CHARLES KOWAL; ARTHUR KALTER; MATTHEW G. HYDE; ARTHUR WIRTH; AND ISABEL SPERBER, VS. SAM D. SCHWARTZ AND INCOMNET, INC., Case No. CV95-0399 AWT (BQRx), filed in the United States District Court for the Central District of California, Western Division, which was originally filed in January 1995. The amended complaint retains the claim alleging that the Company violated Sections (10)b and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated under Section 10(b) of the Exchange Act, because it did not disclose and falsely denied the existence of the non-public investigation of the Company commenced by the Securities and Exchange Commission in August 1994. The complaint adds claims that the Company and its former Chairman, Sam D. Schwartz, violated Sections 10, 16(a), 25 20(a) and 23(a) of the Exchange Act, and Section 25400 of the California Corporations Code, because they did not disclose until August 1995 purchases and sales of the Company's stock made in the open market by an affiliate of Mr. Schwartz between September 1994 and August 1995. The amended complaint seeks (i) certification of the class, (ii) compensatory damages, (iii) damages pursuant to Section 25500 of the California Corporations Code, (iv) interest and attorneys' fees and costs, and (v) other extraordinary, equitable and injunctive relief as may be appropriate. On January 11, 1996, the case was certified as a class action pursuant to the parties' stipulation. The Company has answered the complaint and the lawsuit is currently in the discovery phase. The plaintiffs in the class action lawsuit SAUNDRA GAYLES VS. INCOMNET, INC. AND SAM D. SCHWARTZ have conducted written discovery and taken the deposition of the Company's custodian of records. The discovery phase of the case is currently scheduled to close on May 31, 1997. A hearing is expected to be held on May 5, 1997 to determine whether a specific group of investors who filed a motion to elect not to be part of the class will be entitled to opt-out of the class action lawsuit and commence their own lawsuit. The plaintiffs and the Company have filed motions opposing the request for opt-out status by those investors, who filed their election forms after the deadline established for such elections. Several other parties have timely filed elections to be separate from the class, but none have filed separate lawsuits to date. The Company is not certain whether any of those potential plaintiffs will file separate lawsuits against the Company or any of the other defendants. The Company and the class plaintiffs have and continue to engage in settlement discussions. No assurance can be given that a settlement will be reached, or the terms of such settlement, if any. The Company has been served with a complaint in the lawsuit entitled SILVA RUN WORLDWIDE LIMITED VS. INCOMNET, INC., SAM D. SCHWARTZ, BEAR STEARNS & CO., INC., LESLIE SOLMONSON, RONALD F. SEALE, MARINER RESERVE FUND, COMPANIA DI INVESTIMENTO ANTILLIANO, COUTTS & CO. AG, SALVATORE M. FRANZELLA, PETER G. EMBIRICOS, AND JOS SCHUETZ, filed in the United States District Court for the Southern District of New York. The complaint states that the plaintiff was a purchaser of the Company's stock in July 1995. The complaint alleges that the Company and it's former Chairman, Sam D. Schwartz, violated Sections 10(b) and 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934, as amended, and committed common law fraud, as a result of false and misleading statements made by the defendants and undisclosed trading in the Company's stock engaged in by Mr. Schwartz and his affiliate. The plaintiff also alleges that Mr. Schwartz and his affiliate owed a fiduciary duty to the plaintiff that was breached by their conduct. The complaint also alleges other causes of action against other unrelated defendants. The Company answered the complaint in November 1996 and moved to have it transferred to California. In March 1997, the claims relating to the Company and Sam Schwartz was ordered severed and transferred from the court in New York to the same court in California which is hearing the pending class action lawsuit. See "Part II, Item 1. Legal Proceedings - Class Action and Related Lawsuits" in the company's Form 10-Q for the fiscal quarter ending September 30, 1996. SETTLEMENT WITH RCI PARTIES As of December 9, 1996, the Company entered into a Settlement and Mutual Release Agreement with Robert Cohen, Alan Cohen, Jeff Rubin, Jeff Cohen, Broadway Partners, a partnership comprised of the children of Alan and Robert Cohen, and Lenore Katz (the "RCI Parties"). Robert Cohen is a director and shareholder of Rapid Cast, Inc. and Jeff Rubin is a director, shareholder and executive officer of Rapid Cast, Inc. Jeff Cohen is the son-in-law of Robert Cohen. Pursuant to the settlement agreement, the RCI Parties purchased 360,000 Warrants entitling them to purchase 360,000 shares of the Common Stock of the Company for an exercise price of $3.75 per share at any time until December 9, 1999. The RCI Parties paid a total of $36,000 in cash to the Company for the warrants. Certain of the RCI Parties also purchased a total of 33,000 shares of the Common Stock of the Company for an aggregate purchase price of $100,000. The Company is registering those shares and the shares issuable upon the exercise of the warrants pursuant to a registration statement pending with the Securities and Exchange Commission in accordance with its agreement to do so in the Settlement and Mutual Release Agreement. The Company and the RCI Parties also mutually released each other from all claims, if any, which they may have had against each other, and the RCI Parties assigned all of the claims which they may have against Sam and Rita Schwartz, prior directors of the Company, to the Company. SETTLEMENT OF THE STEVENS LAWSUIT In January 1997, the Company entered into a Settlement Agreement and Mutual Release of all claims in the pending lawsuit entitled CHARLES STEVENS VS. SAM D. SCHWARTZ AND INCOMNET, INC. Pursuant to the settlement, the Company paid $7,500 in cash to the plaintiff and issued 12,500 warrants to purchase 12,500 shares of the Company's Common Stock at an exercise price of $2.94 per share, exercisable at any time until December 16, 2001. The Company agreed to register the shares underlying the 12,500 warrants issued to Mr. Stevens and his legal counsel. In consideration for the 26 issuance of warrants and payment of cash, the plaintiff released the Company from all claims and dismissed the lawsuit against the Company with prejudice. The settlement did not include Sam D. Schwartz. SETTLEMENT OF THE ATLANTA LAWSUITS In February 1997, the Company entered into a settlement and release agreement with the plaintiffs in the lawsuits entitled HERBERT M. SCHWARTZ ET AL. VS. INCOMNET, INC., SAM D. SCHWARTZ AND KALIBER MANAGEMENT CORP. and BRENT ABRAHM ET AL. VS. INCOMNET, INC., SAM D. SCHWARTZ AND KALIBER MANAGEMENT CORP. pursuant to which the lawsuit against the Company were dismissed and an order was entered barring indemnification or contribution between the Company and Sam D. Schwartz. In consideration for the payment of $400,000 in cash and the issuance of a note in the principal amount of $400,000 to the plaintiffs, the plaintiffs released the Company from all claims and dismissed their lawsuits against the Company with prejudice. The $400,000 note was issued as of January 1, 1997 and bears interest at the rate of 12% per annum from January 1, 1997 to January 22, 1997, and 8% per annum thereafter until December 31, 1997, when the note is due and payable in full. The note is secured by a certificate of deposit in the amount of $415,000 purchased by the Company, which the Company has the right to replace with a number of registered shares of its Common Stock equivalent in value to the certificate of deposit as collateral for the note. SECTION 16(b) LAWSUIT: In January 1996, the Company was served with a derivative shareholders lawsuit entitled RICHARD MORALES VS. INCOMNET, INC. AND SAM D. SCHWARTZ, 96 Civil 0225 in the United States District Court for the Southern District of New York, alleging violations of Section 16(b) of the Securities Exchange Act of 1934, as amended, and demanding that the Company assert claims against Mr. Schwartz for the payment of short-swing profits plus interest. Mr. Schwartz has retained separate counsel for this action. In early July 1996, Mr. Schwartz deposited 800,000 shares of his Incomnet, Inc. Common Stock into a court-approved escrow account with the Company's New York counsel as security for his obligation to pay short swing profits. In early February 1997, plaintiff's counsel prepared a motion for summary judgment in the case seeking $5,050,000 in short swing profits from Mr. Schwartz plus pre-judgment interest. On February 21, 1997, the plaintiffs and Sam Schwartz entered into a stipulated settlement pursuant to which Mr. Schwartz agreed to pay $4,250,000 to the Company as full payment of his short swing profit obligation to the Company. The plaintiff's lawyer indicated that he would request a fee of $850,000 plus reimbursement of $65,000 of expenses, to be paid by the Company from the proceeds of the recovery. Under the stipulated settlement, the disgorgement of short-swing profits would be payable $600,000 in cash and the balance by tender to the Company of shares of the Company's Common Stock owned by Mr. Schwartz, based on 90% of the average between the bid and the asked price of the Company's Common Stock on the NASDAQ market during the 30 calendar days immediately preceding the date that the court enters an order approving the settlement. Pursuant to the agreement, Mr. Schwartz has deposited $600,000 in cash and has agreed to deposit additional shares of the Company's common stock into a separate escrow account from the one which already contains 800,000 shares of the Company's stock owned by him or his affiliates. The Company intends to oppose the amount of plaintiff's attorney's fees sought. The Company does not otherwise intend to oppose the proposed settlement. On April 11, 1997, a revised stipulation was filed containing the same economic terms. Notice of the settlement is to be given to the shareholders by April 21, 1997. Any opposition to the settlement is due by May 16, 1997, and a hearing to approve the settlement is to be held on May 30, 1997. There is no assurance that the Company will recover the short-swing profits from Mr. Schwartz. SETTLEMENT OF PATENT INFRINGEMENT LAWSUIT: In July 1995 Rapid Cast, Inc. was served with a lawsuit entitled RONALD D. BLUM, O.D. VS. RAPID CAST, INC., Case No. 95-CV5113, filed in the United States District Court in the Southern District of New York. The complaint alleges that Rapid Cast, Inc. has infringed on the plaintiff's patent for curing plastic lenses by virtue of employing its technology in the FastCastTM LenSystem. On January 16, 1997, RCI settled the lawsuit and the lawsuit has been dismissed. In consideration for a total cash payment of $525,000 in cash to Dr. Blum and the release by RCI of all claims which it may have had against Dr. Blum, RCI received a release of all claims by Dr. Blum. See "Item 1. Legal Proceedings - Patent Infringement Lawsuit" in the Company's Form 10-Q for the fiscal quarter ending September 30, 1996. LEGAL ACTION AGAINST PRIOR REPRESENTATIVES: 27 On July 28, 1994, NTC filed a lawsuit against six prior independent marketing representatives who terminated their relationship with NTC on March 31, 1994. The lawsuit alleges that the defendants breached their agreements with NTC after terminating their representative status by (i) soliciting NTC's customers to leave NTC and sign up with a competitor, (ii) soliciting NTC's other independent marketing representatives to leave NTC and work for a competitor, (iii) misappropriating and failing to return the NTC customer and independent sales representative lists, (iv) disclosing NTC's customers, representatives and other trade secrets to a competitor and (v) willfully and maliciously conspiring to injure NTC's business in order to improve their own business. The causes of action against the defendants are breach of contract, misappropriation of trade secrets and intentional interference with NTC's economic relationships. NTC sought injunctive relief and is seeking monetary damages of at least $500,000, as well as punitive damages in an unspecified amount. On August 31, 1994, the court awarded NTC a temporary injunction against the defendants, enjoining them from disclosing or utilizing any of NTC's trade secrets, including its list of customers and independent sales representatives. A permanent injunction was subsequently denied by the court on the basis that NTC had failed to demonstrate irreparable harm. All of the defendants were located in Northern California. The Company believes that as a result of the defendants' wrongful actions, NTC lost independent marketing representatives in Northern California and retail customers. While these actions slowed the growth rate of NTC's customers and marketing representatives in the spring of 1994, growth is continuing. The rate at which NTC is signing new representatives, especially from other parts of the United States, is also increasing, which may result in an increased rate of growth in the customer base in the future. On August 30, 1994, the defendants filed a cross-complaint against NTC and the Company, claiming that NTC failed to meet its contractual obligations to the defendants and that actions taken by the defendants as a result were proper and legal. The cross complainants are seeking compensatory and special damages, along with general and punitive damages. Management cannot predict the ultimate resolution of the lawsuit or its impact on the Company at this time. SETTLEMENT WITH PRIOR NOTEHOLDERS: In January 1996 a civil action was filed against the Company and Sam D. Schwartz in the United States District Court for the Eastern District of New York, entitled JULES NORDLICHT VS. INCOMNET, INC. AND SAM D. SCHWARTZ, Case No. CV 95-5134, alleging breach of contract and material misrepresentations and nondisclosures in connection with the issuance and conversion of promissory notes by the Company in a private placement. The complaint sought damages of $750,000. In early February 1996 the Company entered into a settlement agreement with Mr. Nordlicht pursuant to which the Company agreed to issue to Mr. Nordlicht and register 31,000 shares of the Company's common stock, repay the outstanding balance of his note (i.e. $500,000 plus interest), and issue him 5,000 additional warrants to purchase shares of Rapid Cast, Inc. (if and when it goes public) which the Company had received pursuant to the redemption of another convertible promissory note previously issued by the Company. The settlement agreement has been filed with the court and the case has been dismissed with prejudice. Commencing in March 1996 the Company entered into a series of settlement agreements with six other prior holders of a total of $325,000 in principal amount of 8% convertible promissory notes issued by the Company on February 8, 1995 to finance the acquisition of 51% of RCI. See "Item 1. Business - Acquisition of RCI" in the Company's 1995 Form 10-K. Pursuant to the settlement agreements with Mr. Nordlicht and the six other noteholders, the Company issued a total of 74,917 new shares and registered a total of 138,417 outstanding and newly issued shares, including the 74,917 newly issued settlement shares. The registration statement covering the prior noteholders' outstanding shares and newly issued settlement shares issued pursuant to the settlement agreements was declared effective by the Securities and Exchange Commission on October 31, 1996. See also "Item 3. Legal Proceedings - Claims by Prior Noteholders" in the Company's 1995 Form 10-K and "Part II, Item 1. Legal Proceedings - Claims By Prior Noteholders" in the Company's Form 10-Q for the fiscal quarter ended September 30, 1996. SETTLEMENT WITH PRICE INTERNATIONAL: Price International, Inc. (PRI) asserted a claim for breach of contract and federal securities laws violations in connection with the exercise of 25,000 warrants at $11.25 per share by it allegedly based on statements made to it by the Company (See Agreement with Price International, Inc.). PRI asserted this claim in a letter written to the Company by its counsel in October 1995. In August 1996, the Company entered into a settlement agreement with Price International pursuant to which the Company agreed to lower the exercise price of Price International's 75,000 warrants from $11.25 per share to $4.50 per share, and to extend the expiration date of the warrants from November 15, 1997 until December 31, 1998. The Company also agreed to register the 75,000 shares issuable upon the exercise of the warrants. Those shares were registered by the Company in the registration statement which was declared effective by the Securities and Exchange Commission on October 31, 1996. In consideration for the modification to the terms and conditions of the warrants, Price International agreed that (a) it would be required to exercise at least 25,000 of the warrants once the trading price 28 of the Company's stock averages $5.30 per share during any 30 day period, and (b) it releases and forever discharges the Company from all claims it may have had against the Company for events occurring prior to the date of the settlement agreement. Price International has not yet exercised any of the warrants issued to it in its settlement agreement with the Company. POTENTIAL LAWSUITS: There is no assurance that claims similar to those asserted in the pending class action and related lawsuits, or other claims, will not be asserted against the Company by new parties in the future. In this regard, potential plaintiffs have from time to time orally asserted claims against the Company and its prior directors. Several members of the class in the pending class action lawsuit against the Company have opted out, and certain other class members are attempting to opt out even though they did not file their elections in a timely manner. See "Legal Proceedings - Class Action and Related Lawsuits." Sam Schwartz may file claims against the Company for indemnification and payments under his Severance Agreement with the Company. See "Item 1. Business - Employees, Officers and Directors - Officers" in the Company's 1995 Form 10-K. If such claims are filed as legal complaints, the Company will seek to have them consolidated with other pending lawsuits, if appropriate, or will defend them separately. From time to time, the Company is also involved in litigation arising from the ordinary course of business, the ultimate resolution of which management believes will not have a material adverse effect on the financial condition or results of operations of the Company. See "Part II, Item 1. Legal Proceedings - Potential Lawsuits" in the Company's Form 10-Q for the fiscal quarter ended September 30, 1996. From time to time, the Company is involved in litigation arising from the ordinary course of business, the ultimate resolution of which management believes will not have a material adverse effect on the financial condition or results of operations of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of the year ended December 31, 1996. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS MARKET INFORMATION: The Company's common stock trades on the NASDAQ Small-Cap Market under the symbol "ICNT". The following table sets forth the range of bid prices for the common stock during the periods indicated. Prices represent the actual high and low sale prices of the Company's stock as provided by NASDAQ real-time pricing information. YEAR ENDED DECEMBER 31, 1996: Quarter High Low Last Sale ------- ---- --- --------- 4 5 2 7/8 2 31/32 3 5 5/16 4 3/16 4 5/16 2 6 1/4 4 3/8 4 3/4 1 6 3/16 4 3/8 5 3/8 YEAR ENDED DECEMBER 31, 1995: Quarter High Low Last Sale ------- ---- --- --------- 4 11 1/4 2 1/2 4 9/16 29 3 24 1/2 9 11 2 16 3/8 10 7/8 15 1 14 5/8 8 1/4 14 3/8 On March 21, 1997, the last sales price per share of the Company's common stock, as reported by the NASDAQ Stock Market, was $2 15/16. On March 21, 1997, the Company's 13,520,669 shares of common stock outstanding were held by approximately 797 shareholders of record. DIVIDENDS: The Company has not paid cash dividends on its common stock since inception. Payment of dividends is within the discretion of the Company's Board of Directors and will depend, among other factors, on earnings, capital requirements and the operating and financial condition of the Company. Furthermore, the payment of dividends on the Company's common stock is subject to the payment in full of all accrued but unpaid dividends on its outstanding Series A 2% Convertible Preferred Stock. See "Item 1. Business - Issuance of Convertible Preferred Stock." At the present time, the Company's anticipated working capital requirements are such that it intends to follow a policy of retaining earnings in order to finance the development of its business. (See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.") ITEM 6. SELECTED FINANCIAL DATA A summary of selected financial data for the five years ended December 31, 1996, 1995, 1994, 1993, and 1992, is presented below, and should be read in conjunction with the audited consolidated financial statements for the years ended December 31, 1996, 1995 and 1994 at "Item 8. Financial Statements and Supplementary Data." Segment information is presented at "Item 1. Business segment information" (In thousands, except per share amounts).
FOR THE YEAR: 1996(2) 1995(2) 1994(2) 1993(1,2) 1992(2) ------ ------ ------ -------- ------- Sales $106,905 $86,565 $46,815 $11,299 $5,535 Income (loss) before income taxes, minority interest and extraordinary items (51,517) 957 4,000 (1,607) (2,265) Income (loss) before minority interest and extraordinary items (43,705) 857 3,999 (1,607) (2,462) Net Income (37,676) 1,366 4,071 (949) (2,021) PER SHARE: Net income (loss) before extraordinary items (2.75) 0.11 0.42 (0.20) (0.34) Net income (loss) (2.82) 0.11 0.42 (0.12) (0.28) AT YEAR END: Total assets $40,587 $74,106 $26,158 $8,666 $6,745 Long-term obligations 1,040 8,460 1 20 176
- ------------------------- (1) In 1992, the Company acquired a controlling interest in National Telephone & Communications, Inc. This information is described in "Item 1. Business - Acquisition of National Telephone & Communications, Inc. (NTC)" in the Company's 1995 Form 10-K. (2) The Company is engaged in legal proceedings where the ultimate outcome cannot presently be determined. This information is described at "Item 3. Legal Proceedings." ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW: 30 The following is management's discussion and analysis of certain significant factors which have affected the results of operations and financial condition of the Company during the period included in the accompanying financial statements. This discussion should be read in conjunction with the financial statements and associated notes. The discussion herein is qualified by reference to the Introductory Note. LIQUIDITY AND CAPITAL RESOURCES: GENERAL - Overall, the Company achieved slightly positive cash flows of $0.6 million during 1996 resulting from positive cash flows from operating activities ($3.0 million) and from financing activities ($5.2 million), which were almost entirely offset by negative cash flows from investing activities ($7.6 million). The Company may need to raise additional capital in 1997 to fund settlement costs relating to pending litigation or to make a business acquisition, although specific needs have not yet been identified. Pursuant to its management incentive agreement with NTC, the Company receives cash distributions from NTC on a periodic basis, which are scheduled to be made until December 31, 1997. See "Item 1. Business - National Telephone & Communications, Inc. - Management Incentive Agreement." The Company does not expect to have to make loans to RCI in 1997, and RCI's capital needs in the short-term have been met through its private placement of preferred stock and warrants in January 1997. See "Item 1. Business - The Recent Capitalization of RCI." NTC is expected to have sufficient capital and financing to fund its requirements in 1997, including funds required for the establishment of its branch marketing offices, one of which is currently being built on leased premises in Honolulu, Hawaii. There is no assurance that the cash distributions by NTC to the Company or the cash flow from AutoNETWORK will be sufficient to meet the Company's future funding requirements, or that RCI or NTC will have sufficient capital or financing to meet their needs. CASH FLOW FROM OPERATIONS - Net cash provided by operating activities of $3.0 million in 1996 was primarily attributable to the operating loss for 1996 ($37.7 million) and non-cash items principally from a devaluation of the Company's investment in RCI ($39.1 million), depreciation and amortization ($4.3 million), and changes in operating assets and liabilities ($11.7 million). With regard to the collection of accounts receivable, the Company increased its allowance for doubtful accounts to 13.2% of gross receivables as of December 31, 1996 compared to 8.0% of gross receivables as of December 31, 1995. This increased provisioning reflects NTC's reserves for all direct-billed Dial-one receivables which have been submitted to collection agencies for collection and a modest improvement in collection rates for LEC-billed and calling card products. CASH FLOW FROM INVESTING - Net cash used in investing activities of $7.6 million in 1996 was attributable principally to the Company's additions to property, plant and equipment ($7.2 million) and additions to patents ($0.7 million). CASH FLOW FROM FINANCING - Net cash provided by financing activities of $5.2 million in 1996 was attributable principally to changes in short-term debt ($2.9 million), proceeds from the issuance of preferred stock ($2.3 million) and additions to long-term debt ($1.3 million), partially offset by reduction of long-term debt ($1.8 million). In addition, positive cash flow resulted primarily from RCI entering into various loan agreements to finance the building of infrastructure to support its anticipated future sales growth. In September 1996, the Company also raised $0.4 million from the sale of 365 shares of Series A 2% Convertible Preferred Stock, and raised an additional $2.1 million in October 1996 through the placement of additional shares of Series A 2% Convertible Preferred Stock. The Company paid aggregate referral fees equal to approximately 5% of the capital raised from the placement of the Series A 2% Convertible Preferred Stock. Cash paid to reduce debt totaled $1.2 million, $0.0 million and $0.3 million during 1996, 1995 and 1994, respectively. The Company had material commitments for capital expenditures of $1.5 million in tenant improvements for its Honolulu, Hawaii office space at December 31, 1996, and expects to continue making improvements to the NTC headquarters building and purchasing additional equipment commensurate with the expansion of its business. During 1996, the Company had capital expenditures of $7.2 million for plant and equipment. 31 At December 31, 1996, the Company had net operating loss carryforwards for federal income tax purposes of approximately $22.6 million, which are expected to be available to offset taxable income for the next several years. LITIGATION - The Company is subject to pending litigation and an investigation by the Securities and Exchange Commission. Management is not yet able to predict the impact of the pending litigation on its financial condition and results of operations. Management does not believe that the investigation by the Securities and Exchange Commission will result in a material impact on the Company's financial condition or results of operations. See "Item 3. Legal Proceedings." RESULTS OF OPERATIONS: FINANCIAL ANALYSIS- SALES - For 1996, 1995 and 1994, the Company's net sales totaled approximately $106.9 million, $86.6 million and $46.8 million, respectively. The increases in sales in 1996 compared with 1995 and 1995 compared with 1994, were attributable principally to increases sales at NTC. The following table summarizes the Company's year-to-year sales performance by subsidiary and segment:
$ in millions ----------------------------------- Subsidiary Segment 1996 1995 1994 - ---------- ------- ----------------------------------- NTC Telephone (telecommunications services) $83.7 $ 70.0 $ 34.2 NTC Telephone (marketing programs) 17.1 13.1 11.4 RCI Optical 4.7 2.0 -- AutoNETWORK Network 1.4 1.5 1.2 ----------------------------------- Total Company Net Sales $106.9 $ 86.6 $ 46.8 ----------------------------------- -----------------------------------
NTC's net sales increase was driven largely by continued expansion of the customer base for its telecommunication services. As a result of this continuing expansion, NTC's telecommunication service revenues represented 83.0%, 84.2% and 75.0% of NTC's total revenues for 1996, 1995 and 1994, respectively, with the remaining 17.0%, 15.8% and 25.0% generated by sales of NTC's marketing programs for 1996, 1995 and 1994, respectively. Revenues from the optical segment may decline in 1997 because the Company's percentage ownership in RCI is lower than in 1995 and 1996, and machine orders at RCI have declined while RCI implements design modifications and improvements. See "Item 1. Business--Rapid Cast, Inc.--Technical Overview of the Rapid Cast LenSystem." COST OF SALES - Total Company cost of sales for 1996, 1995 and 1994, were approximately $68.6 million, $57.9 million and $31.2 million, respectively. The increases in cost of sales were attributed principally to the increase in carrier costs associated with increased telephone service sales by NTC and a volume related rise in RCI cost of sales. Gross margin when stated as a percentage of net sales was 35.9%, 33.1% and 33.3% for 1996, 1995 and 1994, respectively. The increase in gross margin in 1996 was attributable principally to reductions in NTC's telecommunication service cost of sales resulting from: 1) lower long-distance transport costs from NTC's carriers and, 2) continuing improvements in the mix of sales in the higher profit product lines. The following table summarizes the Company's year-to-year changes in three major cost components:
$ in millions ----------------------------------- 1996 1995 1994 ----------------------------------- Carrier costs for NTC's long distance telephone service $44.7 $ 40.4 $ 21.3 Commissions paid to NTC independent sales reps 18.0 14.2 7.7 All other costs of sales 5.9 3.3 2.2 ----------------------------------- Total Company Cost of Sales $68.6 $ 57.9 $ 31.2 ----------------------------------- -----------------------------------
32 NTC's total commission expenses for 1996, 1995 and 1994, were $18.0 million, $14.2 million and $7.7 million, respectively. The increases were attributed principally to the residual monthly sales commissions and various bonuses and overrides paid to sales representatives on increased marketing and telephone service revenues. The third cost component shown in the table above is "all other costs of sales" which represents: (1) NTC's costs of producing sales materials for its independent sales representatives, (2) RCI's costs of producing optical systems and ancillary goods, and (3) AutoNETWORK costs of providing communications network products and services. GENERAL AND ADMINISTRATIVE - Total general and administrative costs for 1996, 1995 and 1994, were approximately $36.9 million, $19.8 million and $9.4 million, respectively. General and administrative expenses represented 34.57%, 22.9% and 20.2% of net sales in 1996, 1995 and 1994, respectively. General and administrative costs generally include the costs of employee salaries, fringe benefits, supplies, and related support costs which are required in order to provide such operating functions as customer service, billing, marketing, product development, information systems, collections of accounts receivable, and accounting. NTC's general and administrative costs increased to 24.5% of sales in 1996 from 20.3% of sales in 1995. This increase was due principally to: (1) increases in fees paid to local exchange carriers (LEC's) to process NTC's billing and collection of its LEC-billed long distance telephone service, and (2) increases in compensation and fringe benefits expended as NTC continues to build infrastructure to support anticipated future sales growth. RCI's general and administrative costs continue to reflect the startup nature of its operations. DEPRECIATION AND AMORTIZATION - The Company's depreciation and amortization expense totaled $2.0 million, $1.0 million and $0.4 million for 1996, 1995 and 1994, respectively. These increases were caused by the continuing investment by NTC in computer hardware and software, furniture and equipment, and leasehold improvements required to support its rapid expansion in sales. BAD DEBT EXPENSE - The Company's bad debt expense totaled $6.1 million, $4.1 million and $1.8 million for 1996, 1995 and 1994, respectively. Bad debt expense represented 5.7%, 4.8% and 3.8% of net sales in 1996, 1995 and 1994, respectively. The increase in bad debt was caused primarily by increased provisioning of NTC's LEC billed receivables which currently carry a higher than estimated bad debt provision and direct billed collection agency write-offs. OTHER (INCOME) AND EXPENSE - The Company's other (income) and expense totaled $3.4 million, $1.0 million and $(0.3) million for 1996, 1995 and 1994, respectively. The increase in 1996 was attributable in large part to settlement costs of $2.0 million associated with claims by officers against the Company. The increase in 1995 was attributed principally to: (1) a $0.4 million settlement with convertible noteholders relating to the acquisition of RCI, (2) a $0.2 million settlement with a former Company officer, and (3) a $0.3 million write-off of marketable securities by NTC. CHARGE FOR ASSET IMPAIRMENT - The charge for asset impairment totaled $39.1 million for 1996 for the devaluation of the Company's investment in RCI. There was no impairment in 1995 and 1994. MINORITY INTEREST - Beginning on July 1, 1995, the Company converted from the equity method to the consolidated method of accounting for its 51% ownership in RCI. As a result, 49% of RCI's losses from July 1 through December 31, 1995 (the "minority interest") were eliminated from the Company's "Consolidated Statements of Operations" for 1995. NET INCOME (LOSS) - The Company's net income (loss) totaled $(37.7) million, $1.4 million and $4.1 million for 1996, 1995 and 1994, respectively. Net income (loss) represented (35.2)%, 1.6% and 8.7% of net sales for 1996, 1995 and 1994, respectively. The decreases were attributed principally to: (1) higher losses at RCI in 1996 due to the devaluation of patent rights and significantly increased operating costs incurred to build infrastructure for future potential sales growth, and (2) higher losses at the Company's headquarters which were caused by the establishment of reserves for devaluation of the Company's investment in RCI and for settlement costs. EMPLOYMENT - Employment of the Company totaled 288 at December 31, 1996, not including independent sales representatives, who are classified as independent sales representatives and not employees of the Company. 33 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The consolidated financial statements and supplementary financial information which are required to be filed under this item are presented under "Item 14. Exhibits, Financial Statement Schedules and Reports on Form 10-K" in this document, and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT The information required under this Item is contained in the definitive Proxy Statement for the Company's 1997 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A by May 31, 1997, and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required under this Item is contained in the definitive Proxy Statement for the Company's 1997 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A by May 31, 1997, and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required under this Item is contained in the definitive Proxy Statement for the Company's 1997 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A by May 31, 1997, and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required under this Item is contained in the definitive Proxy Statement for the Company's 1997 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission pursuant to Regulation 14A by May 31, 1997, and is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 10-K INDEX TO FINANCIAL STATEMENTS: Page ---- Report of Independent Auditors..............................................37 Consolidated balance sheet at December 31, 1996 and 1995....................38 Consolidated statement of operations for the years ended December 31, 1996, 1995 and 1994.........................................................39 Consolidated statement of cash flows for the years ended December 31, 1996, 1995 and 1994.........................................................40 Consolidated statement of shareholders' equity for the years ended December 31, 1996, 1995 and 1994............................................41 34 Notes to consolidated financial statements..................................42 Schedule II - Valuation and qualifying accounts at December 31, 1996 and 1995....................................................................55 All other schedules are omitted as the required information is not present or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or notes thereto. INDEX TO EXHIBITS: Exhibits designated by the symbol ** are management contracts or compensatory plans or arrangements that are required to be filed with this report pursuant to this Item 14. The Company undertakes to furnish to any shareholder so requesting a copy of any of the following exhibits upon payment to the Company of the reasonable costs incurred by the Company in furnishing any such exhibit. EXHIBIT NO. DESCRIPTION - ----------- ----------- 3.1 Certificate of Determination for Series A 2% Convertible Preferred Stock. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on November 22, 1996). 4.1 Form of Warrant to Purchase 75,000 Shares of Incomnet, Inc. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996). 4.2 Form of Warrant to Purchase 510,000 Shares of RCI Common Stock with Registration Rights Agreement, dated April 19, 1996. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996). 4.3 Form of Warrant to Purchase RCI Common Stock, dated February 8, 1995. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996). 4.4 Form of Warrant to Purchase 360,000 Shares of Incomnet, Inc. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997). 4.5 Form of Warrant to Purchase 12,500 Shares of Incomnet, Inc. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997). 10.1 Employment Agreement with James Quandt, dated January 6, 1997. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997). 10.2 Amended and Restated Management Incentive Agreement Between NTC and Incomnet, Inc., dated January 28, 1997. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997). 10.3 Settlement Agreements With Prior Noteholders. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996). 35 10.4 Form of 8% Convertible Note Issued by RCI in January 1996. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996). 10.5 Form of Short-Term 10% Note Issued by RCI in April 1996. (Incorporated by reference from the Company's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996). 10.6 Amended Carrier Switched Services Agreement with Wiltel, Inc. dated June 17, 1996. (Incorporated by reference from Incomnet's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996 and declared effective on October 31, 1996, or incorporated by reference from the Company's filings with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended. Certain information has been deleted from this agreement pursuant to a request for confidential treatment pursuant to Rule 406). 10.7 Settlement Agreement Between Joel W. Greenberg and Incomnet, Inc. (Incorporated by reference from the Company's Report on Form 8-K, dated June 7, 1996, relating to the settlement agreement with Joel W. Greenberg and his resignation as a director of the Company). 10.8 Form of Registration Rights Agreement Between Incomnet, Inc. and Purchasers of Series A Convertible Preferred Stock. (Incorporated by reference from Incomnet's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996 and declared effective on October 31, 1996, or incorporated by reference from the Company's filings with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended). 10.9 Form of Purchase Agreement for the Series A 2% Convertible Preferred Stock. (Incorporated by reference from Incomnet's Registration Statement on Form S-3 filed with the Securities and Exchange Commission on May 10, 1996 and declared effective on October 31, 1996, or incorporated by reference from the Company's filings with the Securities and Exchange Commission pursuant to the Securities Exchange Act of 1934, as amended). 10.10 Management Incentive Agreement with NTC, dated October 14, 1996. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on November 22, 1996). 10.11 Settlement Agreements With Edward Jacobs and Jerry Ballah, dated November 14, 1996. (Incorporated by reference from Incomnet, Inc.'s Registration Statement on Form S-3 filed with the Securities and Exchange Commission on November 22, 1996). 10.12 Shareholders Agreement for Rapid Cast, Inc., dated January 16, 1997. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997). 10.13 Registration Rights Agreement for Rapid Cast, Inc., dated January 16, 1997. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997). 10.14 Settlement Agreement and Mutual Release Between Incomnet, Inc. and the RCI Parties, dated January 9, 1996. (Incorporated by reference from Incomnet, Inc.'s Pre-Effective Amendment Number One to the Registration Statement on Form S-3 filed with the Securities and Exchange Commission on March 24, 1997). 10.15 Lease Agreement By NTC for space in Honolulu, Hawaii. 10.16 Credit Agreement dated March 27, 1997 between National Telephone & Communication, Inc. and First Bank & Trust, Irvine Regional office. 21 Subsidiaries of the Registrant 36 23 Consent of independent auditors 27 Financial data schedule (Article 5 of regulations S-X) REPORTS ON FORM 8-K, FILED IN 1996 20.1 Report on Form 8-K - Agreement with National Telephone & Communications, Inc. (NTC) for incentive stock option program and for a public offering of NTC's stock dated February 6, 1996 and filed on February 9, 1996. 20.2 Report on Form 8-K - Settlement Agreement with Joel W. Greenberg. 20.3 Report on Form 8-K - Gerald Katell's Resignation from the Board of Directors dated August 8, 1996 and filed on August 15, 1996. 20.4 Report on Form 8-K - Appointment of Dr. Howard Silverman as director dated January 20, 1997 and filed on January 28, 1997. 37 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: April 11, 1997 INCOMNET, INC. (Registrant) By: /s/ MELVYN REZNICK ------------------ MELVYN REZNICK President and Chief Executive Officer Pursuant to requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
Signature Capacity Date --------- -------- ---- /s/ MELVYN REZNICK President, Chief Executive Officer, - ------------------ and Chairman of the Board of Directors April 11, 1997 MELVYN REZNICK /s/ ALBERT MILSTEIN Director April 11, 1997 - ------------------- ALBERT MILSTEIN /s/ Dr. HOWARD SILVERMAN Director April 11, 1997 - ------------------------ Dr. HOWARD SILVERMAN /s/ NANCY ZIVITZ Director April 11, 1997 - ---------------- NANCY ZIVITZ
38 REPORT OF INDEPENDENT AUDITORS Board of Directors and Shareholders Incomnet, Inc. We have audited the consolidated balance sheet of Incomnet, Inc. and subsidiaries as of December 31, 1996 and 1995 and the related consolidated statements of operations, shareholders' equity and cash flow for each of the three years in the period ended December 31, 1996, and the schedule listed in Item 14. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and schedule are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements and schedule. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Incomnet, Inc. at December 31, 1996 and 1995 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. As discussed in Note 11 to the financial statements, the Company is a party to a class action matter, claiming losses arising from alleged securities violations based upon the denial and non-disclosure of a pending investigation by the Securities and Exchange Commission and on alleged undisclosed securities transactions by its former President. Legal counsel to the Company has advised that the ultimate outcome of this matter and a range of potential loss cannot presently be determined. Accordingly, no provision for any liability that may result upon adjudication has been made in the accompanying financial statements. /s/ Stonefield Josephson ACCOUNTANCY CORPORATION Santa Monica, California March 27, 1997 39 INCOMNET, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS)
December 31, ------------ ASSETS 1996 1995 ---- ---- Current assets: Cash & cash equivalents $ 2,214 $ 1,645 Accounts receivable, including $267 and $542 due from related party at December 31, 1996 and 1995 and less allowance for doubtful accounts of $1,993 at December 31, 1996 and $1,063 at December 31, 1995 13,137 12,177 Notes receivable - current portion 323 103 Notes receivable from officers & shareholders, net of reserves of $209 438 863 Inventories 2,760 1,647 Other current assets 1,332 1,197 ---------- ---------- Total current assets 20,204 17,632 Property, plant and equipment, at cost, net 14,357 9,146 Patent rights, net 1,241 41,689 Goodwill, net 4,542 4,839 Investments, notes receivable and other assets 243 800 ---------- ---------- Total assets $40,587 $74,106 ---------- ---------- ---------- ---------- LIABILITIES, MINORITY INTEREST AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 14,746 $ 8,784 Accrued expenses 8,217 3,687 Current portion of notes payable 3,918 2,531 Deferred income 4,040 1,190 ---------- ---------- Total current liabilities 30,921 16,192 Deferred tax liability, net -- 8,449 Other long-term liabilities 1,040 11 Commitments (Note 12) -- -- Minority Interest -- 6,906 Shareholders' equity: Common stock, no par value; 20,000,000 shares authorized; 13,369,681 shares issued and outstanding at December 31, 1996 and 13,262,648 shares at December 31, 1995 61,320 60,884 Preferred stock, no par value; 100,000 shares authorized; 2,440 shares issued and outstanding at December 31, 1996 2,355 -- Treasury stock (5,492) (5,492) Accumulated deficit (49,557) (12,844) ---------- ---------- Total shareholders' equity 8,626 42,548 ---------- ---------- Total liabilities, minority interest & shareholders' equity $ 40,587 $ 74,106 40 ---------- ---------- ---------- ----------
See accompanying "Notes to Consolidated Financial Statements." 41 INCOMNET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS
Years Ended December 31, ------------------------ (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1996 1995 1994 ---- ---- ---- NET SALES $106,905 $86,565 $46,815 ---------- ---------- ---------- OPERATING COSTS & EXPENSES: Cost of sales 68,562 57,948 31,221 General & administrative 36,886 19,793 9,438 Depreciation & amortization 2,013 1,007 444 Bad debt expense 6,051 4,125 1,789 Total acquisition costs & expenses 2,334 1,625 265 Charge for asset impairment 39,147 -- -- Other (income) expense 3,429 1,002 (342) ---------- ---------- ---------- Total operating costs and expenses 158,422 85,500 42,815 ---------- ---------- ---------- Operating income (loss) (51,517) 1,065 4,000 INCOME TAXES (BENEFIT) (7,812) 111 1 ---------- ---------- ---------- Income (loss) before minority interest and extraordinary items (43,705) 954 3,999 RCI acquisition - equity in profit (loss) of unconsolidated subsidiary, net of tax -- (97) -- MINORITY INTEREST 6,906 509 -- EXTRAORDINARY ITEMS: Cumulative effect of accounting change on years prior to 1996, net of tax of $10 (Note 16) (877) -- -- Gain (loss) on settlement with creditors -- -- 72 ---------- ---------- ---------- Net income (loss) $ (37,676) $ 1,366 $ 4,071 ---------- ---------- ---------- ---------- ---------- ---------- INCOME (LOSS) PER COMMON SHARE AND COMMON SHARE EQUIVALENTS: Net income (loss) before extraordinary items $ (2.75) $ 0.11 $ 0.42 Cumulative effect of accounting change (0.07) -- -- ---------- ---------- ---------- Net income (loss) per share $ (2.82) $ 0.11 $ 0.42 ---------- ---------- ---------- ---------- ---------- ---------- WEIGHTED AVERAGE NUMBER OF COMMON SHARES FOR 1996 AND COMMON SHARE AND COMMON SHARE EQUIVALENTS OUTSTANDING FOR 1995 13,370 12,706 9,593 ---------- ---------- ---------- ---------- ---------- ----------
See accompanying "Notes to Consolidated Financial Statements." 42 INCOMNET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)
Years Ended December 31, ------------------------ 1996 1995 1994 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: After tax profit (loss) $(37,676) $ 1,366 $ 4,071 Depreciation & amortization - operations 2,013 1,413 444 Depreciation & amortization - acquisitions 2,334 651 121 Write-off of patent rights 39,147 -- -- Deferred income taxes (8,449) -- -- Minority interest (6,906) (8,227) -- Other non-cash (income) loss 877 358 (54) Changes in operating assets and liabilities: Accounts receivable (960) (2,784) (6,718) Notes receivable - current portion (220) (103) -- Notes receivable - due from officers and shareholders 425 (863) -- Inventories (1,113) (401) 42 Other current assets 171 (1,000) (82) Accounts payable 5,962 2,571 3,316 Accrued expenses 4,540 1,834 150 Deferred income 2,848 (896) 1,649 ---------- ---------- ---------- Net cash provided (used) by operating activities 2,993 (6,081) 2,939 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property, plant and equipment (7,224) (7,389) (1,694) Additions to patents (717) (21,002) -- (Increase) decrease in investments 281 16 (263) ---------- ---------- ---------- Net cash used in investing activities (7,660) (28,375) (1,957) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase (decrease) in short-term debt 2,904 1,306 (265) Additions to long-term debt 1,274 -- -- Reduction of long-term debt (1,763) -- -- Sale of preferred stock, net 2,355 -- -- Issuance of common stock, net 436 29,508 8,069 Treasury stock -- (4,827) 465 Other, net 30 419 39 ---------- ---------- ---------- Net cash provided by financing activities 5,236 26,406 8,308 ---------- ---------- ---------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 569 (8,050) 9,290 Cash and cash equivalents at beginning of year 1,645 9,695 405 ---------- ---------- ---------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,214 $ 1,645 $ 9,695 ---------- ---------- ---------- ---------- ---------- ---------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 181 $ 153 $ 1 Income taxes 635 574 1
See accompanying "Notes to Consolidated Financial Statements." 43 INCOMNET, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (AMOUNTS IN THOUSANDS, EXCEPT SHARES DATA)
Common Stock Common Stock Preferred Treasury Accumulated Shares Amount Stock Stock Deficit Total - ------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1993 9,061,382 $22,176 -- -- $(18,247) $3,929 Common stock issued upon exercise of warrants 1,308,833 8,545 -- -- -- 8,545 Common stock issued under private placement 100,000 500 -- -- -- 500 Common stock issued in exchange for NTC shares 82,639 155 -- -- -- 155 Repurchase of treasury shares (70,000) -- -- (665) -- (665) Net income -- -- -- -- 4,071 4,071 - ------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1994 10,482,854 $31,376 -- $ (665) $(14,176) $16,535 Common stock issued upon exercise of warrants 489,582 4,343 -- -- -- 4,343 Common stock issued under private placement 157,500 1,890 -- -- -- 1,890 Common stock issued upon conversion of note 2,300,000 22,664 -- -- -- 22,664 Common stock issued in exchange for NTC shares 253,712 507 -- -- -- 507 Repurchase of treasury shares (451,000) -- (5,085) -- (5,085) Treasury shares sold 30,000 -- 362 -- 362 Change in valuation of marketable securities -- -- -- -- (34) (34) Other -- 104 -- (104) -- -- Net income -- -- -- -- 1,366 1,366 - ------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1995 13,262,648 $60,884 -- $(5,492) $(12,844) $42,548 Common stock issued upon settlement of litigation 107,033 436 -- -- -- 436 Issuance of preferred stock, net (2,440 shares issued) -- -- 2,355 -- -- 2,355 Cumulative effect -- -- -- -- 877 877 Change in valuation of marketable securities 86 86 Net loss -- -- -- -- (37,676) (37,676) - ------------------------------------------------------------------------------------------------------------------------ BALANCE AT DECEMBER 31, 1996 13,369,681 $61,320 $2,355 $(5,492) $(49,557) $8,626
See accompanying "Notes to Consolidated Financial Statements." 44 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: PRINCIPLES OF CONSOLIDATION - The consolidated financial statements include the accounts of the Company, its wholly-owned subsidiary National Telephone & Communications-Registered Trademark-, Inc. (NTC), and its 51%-owned subsidiary Rapid Cast, Inc. (RCI). As a company with a controlling interest in RCI, the Company is accounting for RCI using the consolidation method of accounting. The Company shifted from the equity method of accounting for RCI under FASB Statement No. 94 in the first and second quarters of 1995 to the consolidation method when control became other than temporary. In the first quarter of 1997, outside equity investments in RCI (see Note 17) reduced Incomnet's ownership interest to less than 50%, thereby requiring the equity method of accounting for RCI in 1997. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior year amounts to conform to current year presentation. USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Significant estimates made in preparing the consolidated financial statements include the allowance for doubtful accounts, deferred marketing reserve, income tax valuation allowance, investment reserves, litigation settlement costs and future undiscounted cash flows used in the analysis of the impairment of long-lived assets. REVENUE RECOGNITION - The Company recognizes revenue during the month in which services or products are delivered, as follows: (1) NTC's long distance telecommunications service revenues are generated when customers make long distance telephone calls from their business or residential telephones or by using any of NTC's telephone calling cards. Proceeds from prepaid telephone calling cards are recorded as deferred income when the cash is received, and recognized as income as the telephone service is utilized. Deferred income is carried on the balance sheet as an accrued liability. Total 1996 long distance telephone service sales totaled $83.7 million. (2) NTC's marketing-related revenues are derived from programs and material sold to the Company's base of independent sales representatives, including forms and supplies, fees for representative and certified trainer renewals, and the Company's Certified Trainer, Independent Representative and Long Distance University programs. The Company requires that all such services and materials be paid at the time of purchase. Revenues from marketing-related materials, net of amounts deferred for future services to be provided to the representatives, are booked as cash sales when the revenues are received. A portion of the revenues from marketing-related programs and materials are deferred and recognized over a twelve month period, to accrue its obligation to provide customer support to its independent sales representatives. For the fiscal year ended December 31, 1996, marketing sales totaled $17.1 million. (3) RCI's optical-related revenues are derived from the sale of the Company's optical lens manufacturing system and related supplies. Revenues from optical-related systems and supplies are recognized as sales at the time the products are shipped to the customer. Based on historical experience of immaterial returns, RCI does not establish a reserve for returns at the time of sale. All items returned to RCI are placed back into inventory at the lower of cost or fair market value. For the fiscal year ended December 31, 1996, optical product sales totaled $4.7 million. (4) The Company's network service revenues are recognized as sales as the service is delivered. Total 1996 network service sales totaled $1.4 million. CONCENTRATION OF CREDIT RISK - The Company sells its telephone and network services to individuals and small businesses throughout the United States and does not require collateral. It sells its optical products both domestically and internationally. Reserves for uncollectible amounts are provided, which management believes are sufficient. INCOME TAXES - The Company recognizes the amount of current and deferred taxes payable or refundable at the date of the financial statements as a result of all events that have been recognized in the financial statements and as measured by the provisions of enacted laws. Deferred income taxes result from temporary differences in the basis of assets and liabilities reported for financial statement and income tax purposes. 45 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 COMPUTER HARDWARE, FURNITURE AND OFFICE EQUIPMENT - Computer hardware, furniture and office equipment are stated at cost. Depreciation is provided by the straight-line method over estimated useful lives ranging from five to ten years. COMPUTER SOFTWARE - The Company capitalizes the costs associated with purchasing, developing and enhancing its computer software. All software costs are amortized using the straight-line method over estimated useful lives ranging from three to ten years. LEASEHOLD IMPROVEMENTS - All leasehold improvements are stated at cost and are amortized using the straight-line method over the expected lease term. NET INCOME (LOSS) PER SHARE - Net income (loss) per common share is based on the weighted average number of common shares for 1996 and common shares and common share equivalents for 1995. Common share equivalents have been excluded in 1994 because their effect was immaterial. The Financial Accounting Standards Board has issued a new statement recently which requires companies to report "basic" earnings per share, which will exclude options, warrants and other convertible securities. The accounting and disclosure requirements of this statement are effective for financial statements for fiscal years beginning after December 15, 1997, with earlier adoption encouraged. Management does not believe that the adoption of this pronouncement will have a material impact on the financial statements. CASH AND CASH EQUIVALENTS - Cash and cash equivalents consist of cash-on-hand and short-term certificates of deposit. FAIR VALUES OF FINANCIAL INSTRUMENTS - Unless otherwise indicated, the fair values of all reported assets and liabilities which represent financial instruments (none of which are held for trading purposes) approximate the carrying values of such amounts. INVENTORIES - Inventory primarily consists of completed optical machines at the RCI subsidiary and is valued at the lower of cost (weighted average method) or market. INVESTMENTS - Marketable securities are considered available-for-sale and are stated at fair market value. The excess of fair market value over cost would be included as a separate component of Shareholders' Equity. During the fourth quarter of 1996, the Company deemed these investments permanently impaired and recorded a loss of $0.3 million to their estimated realizable value. INTANGIBLE ASSETS - Goodwill, representing the excess of purchase price over the fair value of the net assets of NTC, is amortized on a straight-line method basis over its estimated useful life of twenty years. Accumulated amortization at December 31, 1996 and 1995 was $1.2 million and $0.9 million, respectively. Patent rights are stated at cost since the date of acquisition of RCI, and are amortized on a straight-line basis over seventeen years (see below). Accumulated amortization at December 31, 1996 and 1995 was $9.9 million and $0.04 million, respectively. LONG-LIVED ASSETS - The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" (SFAS No. 121), in March 1995. In accordance with SFAS No. 121, the Company reviewed its long-lived assets and certain identifiable intangibles for impairment. Patent rights obtained in the February 1995 acquisition of a controlling interest in RCI were evaluated by management and deemed to have been impaired. There was a significant decrease in market value of RCI as evidenced by an outside equity investment in January of 1997, the change in the market acceptance of products which were based on those patent rights, and actual and forecasted operating losses and cash flow losses which were significantly greater than originally anticipated. Accordingly, management estimated the fair value of the patent rights acquired in the RCI acquisition, based upon, among other valuation techniques, the present value of estimated expected cash flows. The carrying value of the patent rights exceeded management's estimates of the discounted present value of net cash flows to be derived therefrom, and a writedown of approximately $39.1 million and elimination of a related deferred tax liability of $8.5 million. 46 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 STOCK OPTION PLANS - The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), and related Interpretations in accounting for the employee stock options, rather than adopt the alternative fair value accounting provided under The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation." 2. FUNDING OF MARKETING COMMISSIONS AND DEFERRED INCOME: The Company's subsidiary, NTC, maintains a separate bank account for the payment of marketing commissions. Funding of this account is adjusted regularly to provide for management's estimates of required reserve balances. NTC estimates the total commissions owed to active independent representatives ("IR Earned Compensation") each week for all monies collected that week due to the efforts of those active independent representatives. All IR Earned Compensation is then paid to the independent representatives, when due, directly out of the separate bank account. 3. RELATED PARTY TRANSACTIONS: Notes receivable from officers and shareholders arise from aggregate loans of $0.6 million made to three individuals in connection with the exercise of their options to purchase the Company's common stock. The notes are non-interest bearing and due on demand, and are partially secured by the stock acquired upon the exercise of the options. For one of the officer loans, the Company agreed to look only to the shares held by the officer as a source of loan repayment. Accordingly, a reserve of $208,800 was provided in the fourth quarter of 1995, representing the difference between the market value of the shares held by the officer and the amount of the loan. Included in accounts receivable is approximately $0.3 million and $0.5 million at December 31, 1996 and 1995, respectively, due from companies controlled by an individual who is an Incomnet shareholder and a founding shareholder of RCI. On August 15, 1996, RCI and one of its shareholders/officers entered into an agreement whereby (1) certain contributed property received from the shareholder/officer valued at $250,000 reduced the amount of indebtedness to RCI relating to the purchase of equipment and supplies by the shareholder/officer and certain other entities controlled by the shareholder/officer from RCI approximating $445,000, with a remaining balance due RCI of approximately $195,000, (2) the remaining balance due to RCI described in (1) will be used to reduce the amount of indebtedness to the shareholder/officer by the Company of approximately $513,000 (including accrued interest through the date of the agreement), with a remaining balance due to the shareholder/officer of approximately $318,000 as of the date of the agreement, and (3) in connection with RCI terminating a "Purchase Commitment Agreement" with the shareholder/officer and certain other entities controlled by the shareholder/officer, the shareholder/officer surrendered 142,222 shares of common stock (representing approximately 4% of the shareholder/officer's holdings in RCI) with an estimated fair value of $448,000. 4. ACQUISITION OF RAPID CAST, INC.: On February 8, 1995, the Company acquired a 51% ownership in Rapid Cast, Inc. for $28,164,000 in a transaction accounted for using the purchase method of accounting. The acquisition resulted in the recognition of intangible patent assets of approximately $42.0 million, $8.0 million of which was written off in the third quarter ending September 30, 1996, and the remaining balance of $31.1 million of which was written off in the fourth quarter ending December 31, 1996. The remaining balance is being amortized over 17 years. The following summary, prepared on a pro forma basis, combines the consolidated results of operations as if RCI had been acquired as of the beginning of the periods presented, after including the impact of certain adjustments, such as minority interest, equity in loss of unconsolidated subsidiary and patent amortization. (Dollars in thousands, except per share amounts). 1995 1994 ---- ---- Sales $87,860 $46,815 47 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 Net income $ 1,080 $ 4,071 Net income per share $ .08 $ 0.42 The pro forma results are not necessarily indicative of what would have occurred if the acquisition had been in effect for the entire periods presented. In addition, they are not intended to be a projection of future results and do not reflect any synergy that might be achieved from combined operations. 5. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment, at cost, including capitalized lease assets, consist of the following: (IN THOUSANDS) December 31, ------------------------ 1996 1995 ---- ---- Computer hardware and software $ 7,100 $ 5,113 Furniture and office equipment 3,456 1,878 Leasehold improvements 7,595 4,134 ------ ----- 18,151 11,125 Less accumulated depreciation 3,794 1,979 ------ ----- $14,357 $9,146 ------ ----- ------ ----- 6. PATENT RIGHTS FROM ACQUISITION OF RCI During the third and fourth quarters of 1996, the Company evaluated the carrying value of its patent rights in comparison with management's estimates of discounted net present values of cash flows from those patents, and provided impairment losses of approximately $8.0 million and $31.1 million, respectively. 7. INVESTMENTS, NOTES RECEIVABLE AND OTHER ASSETS Investments, notes receivable and other assets consist of the following: (IN THOUSANDS) December 31, ------------------------- 1996 1995 ---- ---- Marketable securities available-for-sale $ 35 $321 Notes receivable -- 155 Other assets 208 324 --- --- $243 $800 --- --- --- --- Marketable securities available-for-sale consist of shares of common stocks of publicly traded companies. During the fourth quarter of 1996, the Company deemed these investments permanently impaired and recorded a loss of $0.3 million to their estimated realizable value. Notes receivable are carried at lower of amortized cost or net realizable value. Other assets consist primarily of deposits. 8. NOTES PAYABLE: Notes payable consists of the following:
(IN THOUSANDS) December 31, -------------- 1996 1995 ---- ---- Current Portion of Notes Payable: Notes payable to founding shareholders of RCI, interest at 7%, due in July 1996, $1,091 of which was exchanged for RCI shares in January 1997, balance repaid $1,205 $1,518 Notes payable to certain shareholders, officers and director
48 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 of RCI, interest at 10%, $543 repaid in January 1997 from the proceeds of private placement (see Note 17) balances exchanged for equity shares of RCI 1,587 -- Revolving line of credit of RCI, interest at bank reference rate (approximately 10% at December 31, 1996 and 1995) repaid in January 1997 from the proceeds of private placement 500 490 Convertible notes payable to certain shareholders and officers of RCI, interest at 8%, exchanged for equity shares of RCI in January of 1997 322 -- Capitalized lease obligations, payable in varying installments to 2000 288 -- Note payable in connection with financing of RCI acquisition, interest at 8%, repaid in January 1996 -- 500 Miscellaneous 16 23 -------- ------- Total current portion of notes payable $3,918 $2,531 -------- ------- Long Term Portion of Notes Payable: Capitalized lease obligations, payable in varying installments to 2000 $1,002 $ -- Miscellaneous 38 11 -------- ------- Total long term portion of notes payable $1,040 $ 11 -------- ------- Total notes payable $4,958 $2,542 -------- ------- -------- -------
Interest paid for 1996 and 1995 was approximately $0.2 million in each year and none in 1994. Interest resulted primarily from interest paid on Notes used to acquire RCI and from interest paid by RCI on its bank revolving line of credit. 9. INCOME TAXES: On February 15, 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 109 "Accounting for Income Taxes". Effective January 1, 1993, the Company adopted SFAS No, 109, the effect of which was immaterial to the Company's financial statements in 1994 and resulted in a deferred tax liability in 1995. Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to significant portions of the deferred income tax assets and liabilities are as follows: (IN THOUSANDS) December 31, ------------------------ 1996 1995 -------- --------- Deferred tax assets Allowance for doubtful accounts $ 3,205 $ 1,360 Nondeductible reserves 67 -- Net operating loss carryforwards 11,526 7,503 Other -- 113 49 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 -------- -------- Subtotal 14,798 8,976 -------- -------- Deferred tax liabilities Property and equipment, principally due to differences in depreciation 1,847 676 Patent rights -- 8,449 -------- -------- Subtotal 1,847 9,125 -------- -------- Total 12,951 (149) Less valuation allowance (12,951) (8,300) -------- -------- Net deferred tax liability $ -- $ 8,449 -------- -------- -------- -------- The deferred taxes at December 31, 1995 are presented in the accompanying balance sheet as deferred tax assets-current (included in prepaid expenses and other) of $0.4 million and deferred tax liability-noncurrent of $8.4 million. The following is a reconciliation of the federal statutory tax rate and the effective tax rate: 1996 1995 ---- ---- Federal statutory tax rate (34.0)% 34.0% Goodwill 0.6 9.9 Loss producing no current tax benefit 17.0 -- State taxes, net of federal benefits -- 38.2 Benefit from net operating loss carryforward -- (71.5) Other, net 1.2 -- -------- -------- Effective tax rate (15.2)% 10.6% -------- -------- -------- -------- Income tax benefits are recognized only when their realization is assured. Accordingly, potential future income tax benefits resulting from net operating losses incurred to date are not reflected in the consolidated financial statements. At December 31, 1996, Incomnet had available net operating loss carryforwards for federal income tax purposes of approximately $22,600,000, expiring in various years between 2000 and 2011, and Rapid Cast had a carryforward of approximately $6,028,000 expiring through 2012. The company files combined income tax returns for Incomnet and NTC and separate returns for RCI. Accordingly, the respective federal net operating loss carryforwards of each corporation are available to offset taxable income only of each separate corporation. 10. SHAREHOLDERS' EQUITY: STOCK OPTIONS - In July 1996, the Company's shareholders adopted a stock option plan that replaced a previous plan adopted by shareholders in 1994. The plan is for executives at the Company's parent company level. The plan allows for the issuance of up to 1,500,000 shares at an exercise price equal to the price of the last sale of the Company's common stock on the date of issuance. The Company's subsidiaries have adopted their own separate stock option plans to be implemented when those companies become publicly traded. To date, the Company has issued 685,000 stock options that are now vested and can be exercised at prices from $4.25 to $4.87 up to May 31, 2002. The Company has also issued 300,000 stock options at prices from $4.37 to $4.85 that will vest when the Company's RCI subsidiary reaches certain financial goals. These options have not yet vested. In November 1994, the Company approved the 1994 Plan for directors, employees, and key outside consultants of the Company that provided for the issuance of up to 1,500,000 shares of common stock. The plan requires that the option price must be at least 100% of the fair market value of the shares on the date the option is granted. In November 1994, options to purchase 1,200,000 shares of the Company's common stock were granted at exercise 50 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 prices of $10 per share. These options will be vested based upon a performance requirement in which National Telephone & Communications, Inc. must earn at least $15.0 million in pre-tax profits during any continuous four audited quarterly periods until December 31, 1997. The Company applies Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its plans. Accordingly, no compensation expense has been recognized for its stock-based compensation plans. Had compensation cost for the Company's stock option plans been determined based upon the fair value at the grant date for awards under these plans consistent with the methodology prescribed under SFAS 123, the Company's net loss and loss per share would have been increased to the pro forma amounts indicated below: (IN THOUSANDS) 1996 ---- Net loss - reported $(37,676) ------ Net loss - pro forma $(37,940) ------ Loss per share - reported $ (2.82) ---- Loss per share - pro forma $ (2.83) ---- The fair value of each option grant in 1996 and 1995 was estimated on the date of the grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: divided yield of 0.0%; expected annual volatility of 66.1%; risk-free interest rate of 6.0% and expected lives of 3 years for options. The weighted average per share fair value of options granted in 1996 was approximately $2.50. The pro forma amounts shown for the impact of SFAS 123 are not necessarily indicative of future results because of the phase in rules and differences in number of grants, stock price and assumptions for future years. WARRANTS - Since 1994, the Company has issued warrants to purchase the Company's common stock to key employees, directors or other individuals or organizations as follows: 51 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996
Dollar Canceled or Issued Number Price Exercised Amount Expired Expiration ------ ------ ----- --------- ------ ----------- ---------- 1-17-94 500,000 $ 7.00 500,000 $3,500,000 5/27/94 500,000 10.00 500,000 5,000,000 5/27/94 100,000 8.50 100,000 850,000 5/27/94 100,000 8.50 100,000 850,000 5/27/94 50,000 8.50 5/27/97 5/27/94 50,000 8.50 5/27/97 8/14/94 10,000 8.50 10,000 85,000 11/15/94 100,000 11.25 25,000 281,250 11/15/94 10,000 11.25 10,000 112,500 1/10/95 500,000 10.25 500,000 1/10/95 500,000 11.25 500,000 6/30/95 900,000 14.00 900,000 8/29/95 250,000 11.00 250,000 8/29/95 35,000 4.875 (1) 8/29/97 8/29/95 35,000 4.875 (1) 8/29/97 8/29/95 25,000 4.875 (1) 25,000 12/20/95 2,000 5.125 (1) 2,000 12/20/95 3,000 5.125 (1) 3,000 12/20/95 1,000 5.125 (1) 1,000 12/20/95 1,000 5.125 (1) 1,000 5/9/96 100,000 6.00 (2) 5/9/01 5/9/96 50,000 7.00 (2) 5/9/01 5/9/96 75,000 5.37 (2) 12/31/98 12/9/96 360,000 3.75 (2) 12/9/99 12/17/96 12,500 2.94 (2) 12/17/01 --------- --------- ----------- --------- 4,269,500 1,245,000 $10,678,750 2,182,000
(1) The exercise price on these warrants was adjusted pursuant to a redemption of old stock options and a reissuance of an equivalent number of new stock options with the same expiration date. (2) These warrants were issued pursuant to legal settlements in 1996. Since 1994, the Company has issued warrants to purchase a total of 4,269,500 shares of the Company's common stock. At March 21, 1997, warrants to purchase 1,245,000 of those shares have been exercised bringing the Company $10,678,750; warrants to purchase 2,182,000 shares have been canceled or have expired; and warrants remain outstanding to purchase 767,500 shares of the Company's common stock at prices ranging from $2.94 to $8.50. COMMON STOCK - On August 5, 1994, the Company announced that its Board of Directors authorized the repurchase of up to 1,000,000 shares of its common stock from time to time on the open market or in private transactions. The Company's Chief Executive Officer was given the discretion to decide when and if the Company would repurchase shares and to effect such transactions. As of March 27, 1997, the Company has repurchased a net of 486,000 shares of common stock with a value of $5,491,845 under the terms of the repurchase authorization as follows: Years ended Shares December 31, Repurchased Cost (IN THOUSANDS) -------------- --------------- --------------------- 1994 70,000 $ 665 1995 416,000 4,827 --------------- --------------------- 486,000 $5,492 --------------- --------------------- --------------- --------------------- PRIVATE PLACEMENT - On June 30, 1995, the Company initiated a private placement of 900,000 shares of the Company's restricted common stock at $12 per share for a total of $10,800,000 and warrants to purchase 900,000 additional shares of the Company's common stock at $14 per share. The warrants were exercisable for a period of 52 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 six months until December 31, 1995. The Company received $1,890,000 in cash from subscribers to the private placement, which was the effective purchase of 157,500 shares and warrants to purchase an additional 157,500 shares for $14 per share. The Company also received subscription notes for $8,910,000 payable upon the registration of the shares and shares underlying the warrants with the Securities and Exchange Commission. These notes were for the purchase of 742,500 shares of the Company's common stock and warrants to purchase an additional 742,500 shares for a purchase price of $14 per share. As the Company did not register the shares, the notes for $8,910,000 were canceled on December 31, 1995 by mutual consent with the investors. As a result, the investors were no longer obligated to pay the notes to the Company and the Company was no longer obligated to issue additional shares or warrants to the investors. Since the warrants to purchase 157,500 additional shares were not exercised, these warrants expired on December 31, 1995. As a result, the Company issued a total of 157,500 shares in consideration for the $1,890,000 in cash paid by the investors. The Company's balance sheet reflects the issuance of 157,500 shares of the Company's common stock in exchange for $1,890,000 in capital. SHORT SWING PROFITS - In January 1996, the Company was served with a derivative shareholders lawsuit entitled RICHARD MORALES VS. INCOMNET, INC. AND SAM D. SCHWARTZ, 96 Civil 0225 in the United States District Court for the Southern District of New York, alleging violations of Section 16(b) of the Securities Exchange Act of 1934, as amended, and demanding that the Company assert claims against Mr. Schwartz for the payment of short-swing profits plus interest. Mr. Schwartz has retained separate counsel for this action. In early July 1996, Mr. Schwartz deposited 800,000 shares of his Incomnet, Inc. Common Stock into a court-approved escrow account with the Company's New York counsel as security for his obligation to pay short swing profits. In early February 1997, plaintiff's counsel prepared a motion for summary judgment in the case seeking $5,050,000 in short swing profits from Mr. Schwartz plus pre-judgment interest. On February 21, 1997, the plaintiffs and Sam Schwartz, entered into a stipulated settlement pursuant to which Mr. Schwartz agreed to pay $4,250,000 to the Company as full payment of his short swing profit obligation to the Company. The plaintiff's lawyer indicated that he would request a fee of $850,000 plus reimbursement of $65,000 of expenses, to be paid by the Company from the proceeds of the recovery. Under the stipulated settlement, the disgorgement of short-swing profits would be payable $600,000 in cash and the balance by tender to the Company of shares of the Company's Common Stock owned by Mr. Schwartz, based on 90% of the average between the bid and the asked price of the Company's Common Stock on the NASDAQ market during the 30 calendar days immediately preceding the date that the court enters an order approving the settlement. Pursuant to the agreement, Mr. Schwartz has deposited $600,000 in cash and has agreed to deposit additional shares of the Company's common stock into a separate escrow account from the one which already contains 800,000 shares of the Company's stock owned by him or his affiliates. The Company intends to oppose the amount of plaintiff's attorney's fees sought. The Company does not otherwise intend to oppose the proposed settlement. On April 11, 1997, a revised stipulation was filed containing the same economic terms. Notice of the settlement is to be given to the shareholders by April 21, 1997. Any opposition to the settlement is due by May 16, 1997, and a hearing to approve the settlement is to be held on May 30, 1997. There is no assurance that the Company will recover the short-swing profits from Mr. Schwartz. 11. COMMITMENTS, CONTINGENCIES AND OTHER: LITIGATION - The Company is a defendant in a class action matter alleging securities violation with respect to alleged false denial and non-disclosure of a Securities and Exchange Commission investigation and alleged non-disclosure of purchases and sales of the Company's stock by an affiliate of the former Chairman of the Board. Counsel for the company is unable to estimate the ultimate outcome of this matter and is unable to predict a range of potential loss. Accordingly, no amounts have been provided for the class action lawsuit in the accompanying financial statements. The Company is under investigation by the Securities and Exchange Commission under a non-public "formal order of private investigation." Management has furnished all information requested by the Commission and does not believe that the matter will have a material adverse impact on its financial position or results of operations. ALLOWANCE FOR DOUBTFUL ACCOUNTS - The total Company allowance for doubtful accounts totaled $2.0 million or 13.2% of gross accounts receivable at December 31, 1996 and $1.1 million or 8.0% of gross accounts receivable at December 31, 1995. The following table summarizes the Company's year-to-year reserve balances by subsidiary and segment: $ IN THOUSANDS December 31, --------------------- Subsidiary Segment 1996 1995 - ------------ ---------- --------------------- 53 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 NTC Telephone $1,908 $1,063 RCI Optical 85 -- AutoNETWORK Network -- -- --------------------- Total Company $1,993 $1,063 --------------------- --------------------- % of Gross Accounts Receivables 13.2% 8.0% --------------------- --------------------- Reserves for NTC's telecommunications service accounts receivable relate primarily to its direct billed and LEC billed long distance telephone services. Delinquent direct billed receivables are collected by a combination of NTC's internal collection department and by external collection agencies. Delinquent LEC billed receivables are collected by the LEC's. The estimated percentage of accounts which will become uncollectible is reviewed periodically by management and is adjusted in accordance with historical experience. Reserves for NTC's marketing program accounts receivable are provided at 100% of the expected bad debt. These receivables result from payments for marketing programs which have been denied due to returned checks and rejected credit card payments. BUILDING LEASES - Rent expense for the years ended December 31, 1996, 1995 and 1994 was $0.8 million, $0.8 million, and $0.3 million, respectively. The Company leases its office and operating facilities, equipment and automobiles under noncancellable operating leases. The aggregate future minimum annual rental payments required under these leases are as follows (IN THOUSANDS): For years ending December 31, ------------- 1997 $2,146 1998 2,176 1999 1,643 2000 1,455 2001 1,361 Thereafter 2,602 In addition, effective February 1996, NTC entered into a revised multiple-year $1.0 billion contract with Wiltel, Inc., which has a fixed term expiring January 2002. As in the prior carrier contract with Wiltel, Inc., NTC commits to purchase the designated volume of telephone time in accordance with a schedule over the term of the contract. NTC currently relies in part, on the purchases of another unaffiliated long distance telephone service provider to meet its volume purchase requirements under the new contract. 12. NETWORK MARKETING COSTS: NTC's net cost to operate its network marketing program consist of the following: (IN $ MILLIONS) 1996 1995 -------------------- Sales $17.4 $13.1 Cost of sales 13.7 11.2 Operating expenses for support services 4.3 3.8 -------------------- Total marketing-related costs 18.0 15.0 -------------------- Net marketing cost $ 0.6 $ 1.9 -------------------- -------------------- 54 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 % of total NTC (long distance & marketing) sales 0.6% 2.3% Marketing sales are generated by the sale of materials, training and support services to assist NTC independent sales representatives in selling new retail customers and enrolling other representatives in the NTC program. Beginning in January 1996, NTC began to accrue its obligation to provide customer support to its representatives (see Note 16). These reserved marketing revenues are reflected as deferred income on the Company's balance sheet and are amortized over the succeeding twelve months. The marketing-related costs include commissions paid to independent sales representatives for acquiring new retail telephone customers, as well as the cost of sales materials, salaries and wages of marketing department personnel, services required to support the independent sales representatives, and other directly identifiable support costs, but do not include residual commissions paid on continuing long distance telephone usage or the typical indirect cost allocations, such as floor-space and supporting departments. Marketing-related costs for 1996 and 1995, of $18.0 million and $15.0 million, respectively, are compared against marketing-related revenues for 1996 and 1995 of $17.4 million and $13.1 million, respectively. The results are a net loss in marketing-related activities for 1996 and 1995 of $0.6 million and $1.9 million, or 0.6% and 2.3%, respectively, of total NTC sales. 13. COMPENSATION OF INDEPENDENT SALES REPRESENTATIVES: The Company's subsidiary, NTC, compensates its independent sales representatives by an earned commission structure based upon signing up new telephone customers and based upon the telephone usage generated by those customers. Expenses associated with commissions, bonuses and overrides paid out to NTC's independent sales representatives for 1996 and 1995 were $18.0 million and $14.2 million, respectively. 14. SEGMENT INFORMATION: In 1994, the Company conducted its business operations in two industry segments, including Network Services and Telephone Services. In 1995 and 1996, because of the acquisition of RCI, the Company conducted business in three segments, including Network Services, Telephone Services and Optical Systems. No one customer accounted for as much as 10% of the revenues of any segment in 1996, 1995 or 1994. 55 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996
(IN THOUSANDS) Telephone Optical Network General YEAR ENDED DECEMBER 31, 1996 Services Systems Services Corporate Consolidated - ---------------------------- --------- -------- -------- --------- ------------ Sales $100,811 $ 4,660 $1,426 $ 8 $106,905 -------- -------- ------ -------- -------- Operating income (loss) 3,735 (26,495) 475 (29,232) (51,517) Income taxes 374 (8,449) 263 -- (7,812) -------- -------- ------ -------- -------- Income (loss) before minority interest and extraordinary items $ 3,361 $(18,046) $ 212 $(29,232) $(43,705) -------- -------- ------ -------- -------- -------- -------- ------ -------- -------- Identifiable assets $ 32,987 $ 5,951 $1,562 $ 87 $ 40,587 Depreciation and amortization 1,630 118 265 $ 2,334 4,347 Capital expenditures 6,412 669 143 -- 7,224 Telephone Optical Network General YEAR ENDED DECEMBER 31, 1995 Services Systems Services Corporate Consolidated - ---------------------------- --------- -------- -------- --------- ------------ Sales $ 83,127 $ 1,993 $1,370 $ 75 $ 86,565 -------- -------- ------ -------- -------- Operating income (loss) 5,060 (1,040) 369 (3,324) 1.065 Income taxes 365 -- (102) $ (152) 111 -------- -------- ------ -------- -------- Income (loss) before minority interest and extraordinary items $ 4,695 $ (1,040) $ 471 $ (3,172) $ 954 -------- -------- ------ -------- -------- -------- -------- ------ -------- -------- Identifiable assets $ 21,758 $ 25,345 $1,569 $ 25,434 $ 74,106 Depreciation and amortization 705 429 279 $ 1,100 2,513 Capital expenditures 6,681 199 509 -- 7,389 Telephone Optical Network General YEAR ENDED DECEMBER 31, 1994 Services Systems Services Corporate Consolidated - ---------------------------- --------- -------- -------- --------- ------------ Sales $ 45,609 $ -- $1,206 $ -- $ 46,815 -------- -------- ------ -------- -------- Operating income (loss) 3,742 -- 154 104 4,000 Income taxes -- -- 1 -- 1 -------- -------- ------ -------- -------- Income (loss) before extraordinary items $ 3,742 $ -- $ 153 $ 104 $ 3,999 -------- -------- ------ -------- -------- -------- -------- ------ -------- -------- Identifiable assets $ 12,830 $ -- $4,271 $ 9,057 $ 26,158 Depreciation and amortization 221 -- 489 -- 710 Capital expenditures 1,547 -- 147 -- 1,694
56 INCOMNET, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 15. FOURTH QUARTER ADJUSTMENTS: During the fourth quarter of 1995, the Company recorded adjustments having the effect of reducing net income by approximately $3.1 million or $ 0.24 per share. These adjustments resulted primarily from reserve provisioning related to settlements with shareholders and with the Company's former Chairman, revisions of management's estimates regarding the collectibility of accounts receivable, write-off of marketable securities and inventory, and reserve provisioning for estimated legal fees. 16. CHANGE IN ACCOUNTING: Effective January 1, 1996, the Company changed its accounting procedures to defer a portion of marketing revenues, which had previously been recognized upon receipt. The Company believes that the change is preferable because it provides a better matching of revenues with services provided to the marketing representatives. The cumulative effect of this change and certain other changes for the periods prior to January 1, 1996 of approximately $0.9 million is shown as a cumulative effect adjustment. The effect of the changes on 1996 is to increase income before cumulative effect adjustment by $0.03 per share. 17. SUBSEQUENT EVENTS: On January 15, 1997, RCI completed a Convertible Preferred Stock and Warrants Purchase Agreement with two institutional investors whereby they issued (i) 7,275,000 shares of newly created Series A Convertible Preferred Stock, par value $.001 per share, (ii) 725,000 shares of newly created Series B Non-Voting Convertible Preferred Stock, par value $.001 per share, and (iii) 1,400,000 warrants (expiring five years from the date of issuance) with each warrant entitling the holder thereof to purchase one share of common stock at an exercise price of $1.74 per share, for aggregate gross proceeds of $12,000,000. The proceeds were used to (i) repay $500,000 of principal, plus accrued and unpaid interest, under RCI's existing note payable to bank, (ii) repay $2,765,339 of existing bridge financing owing to Incomnet, including accrued and unpaid interest thereon, (iii) repay $940,091 of additional existing bridge financing owing to certain shareholders including accrued and unpaid interest thereon, (iv) to repurchase 1,200,000 shares of common stock from one of RCI's shareholders/officers for a purchase price of $1,536,000, (v) to make a $325,000 partial settlement payment to complete the settlement of the RCI patent infringement case, which has been dismissed, (vi) to pay fees and expenses incurred by the institutional investors estimated to be approximately $500,000, and (vii) the balance is for general working capital purposes including the immediate repayment of overdue accounts payable of approximately $1,800,000. The two institutional investors retain an option to invest an additional $5,000,000 by July 15, 1997 and an additional $5,000,000 by July 15, 1998 with substantially the same terms as previously described. This transaction reduced the Company's outstanding interest to less than 50% of the voting control of RCI. Accordingly, commencing in the first quarter of 1997, RCI will be accounted for using the equity method of accounting. In addition, on March 26, 1997, NTC entered into a credit agreement with a bank for a $5.0 million accounts receivable line of credit to support NTC's operations and establishment of additional branch marketing offices. This new agreement provides for interest at prime plus 1.0% and is secured generally by NTC's accounts receivable. As of March 31, 1997, there are no borrowings against this line of credit. Under the terms of the agreement, NTC is required to comply with various covenants, including covenants requiring NTC to maintain specified ratios and levels of tangible net worth and net income, and limiting the ability of NTC to pledge assets or incur liens on assets. 57 Schedule II INCOMNET, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS DECEMBER 31, 1996 AND 1995
(IN THOUSANDS) Balance at Amounts Balance beginning charged to costs at end Classification of period and expenses Write-offs (1) of period - -------------------- ---------- ---------------- -------------- --------- Year ended December 31, 1996 Deducted from asset accounts: Accounts receivable reserve $1,063 $9,517 $ (8,587) $1,993 Patent reserves 2,019 7,916 (9,891) 44 Goodwill reserves 942 296 -- 1,238 Notes receivable reserve 209 1,472 (1,472) 209 Inventory reserves 100 70 170 Reserve for marketable securities 34 225 (34) 225 ------ ------- -------- ------ Total $4,367 $19,496 $(19,984) $3,879 ------ ------- -------- ------ ------ ------- -------- ------ Year ended December 31, 1995 Deducted from asset accounts: Accounts receivable reserve $ 991 $ 7,590 $ (7,518) $1,063 Patent reserves 0 2,019 -- 2,019 Goodwill reserves 664 278 -- 942 Notes receivable reserve 0 209 -- 209 Inventory reserves 0 100 -- 100 Reserve for marketable securities 2,000 -- (1,966) 34 ------ ------- -------- ------ Total $3,655 $10,196 $ (9,484) $4,367 ------ ------- -------- ------ ------ ------- -------- ------ Year ended December 31, 1994 Deducted from asset accounts: Accounts receivable reserve $ 356 $ 4,576 $ (3,941) $ 991 Goodwill reserves 0 664 -- 664 Reserve for marketable securities 2,845 -- (845) 2,000 ------ ------- -------- ------ Total $3,201 $ 5,240 $ (4,786) $3,655 ------ ------- -------- ------ ------ ------- -------- ------
(1) Amounts are net of recoveries. 58 EX-10.15 2 EXHIBIT 10.15 AIRPORT TRADE CENTER 550 PAIEA STREET, HONOLULU, HAWAII 96819 ------------------------------- REVISED STANDARD LEASE ------------------------------- TENANT: NATIONAL TELEPHONE & COMMUNICATIONS, INC. PREMISES: L-1 AND L-2 PREMISES TYPE: FIRST FLOOR RETAIL DATE: NOVEMBER 20, 1996 AIRPORT TRADE CENTER TABLE OF CONTENTS ARTICLE 1 - SPECIAL PROVISIONS AND EXHIBITS . . . . . . . . . . . . . . . . . 1 1.01 SPECIFIC PROVISIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.02 EXHIBITS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.03 [INTENTIONALLY OMITTED]. . . . . . . . . . . . . . . . . . . . . . . . . 2 ARTICLE 2 - DEFINITIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2.01 BUILDING . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2.02 BUILDING AREAS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2.03 COMMON AREAS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2.04 IMPROVEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2.05 LAND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2.06 LEASE MONTH. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 2.07 NET RENTABLE AREA. . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.08 NET USABLE AREA. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 2.09 OPERATING EXPENSES . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.10 OPERATING EXPENSE PAYMENT. . . . . . . . . . . . . . . . . . . . . . . . 4 2.11 PROJECT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.12 PREMISES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.13 PREMISES TYPE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.14 RULES AND REGULATIONS. . . . . . . . . . . . . . . . . . . . . . . . . . 4 2.15 TENANT'S EMPLOYEES AND LANDLORD'S EMPLOYEES. . . . . . . . . . . . . . . 4 2.16 TENANT'S PROPORTIONATE SHARE . . . . . . . . . . . . . . . . . . . . . . 4 2.17 TERM . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 ARTICLE 3 - RENT, SECURITY DEPOSIT AND OTHER TENANT CHARGES . . . . . . . . . 4 3.01 BASE RENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 3.02 OPERATING EXPENSE PAYMENT. . . . . . . . . . . . . . . . . . . . . . . . 4 3.03 REIMBURSEMENT FOR REPAIRS. . . . . . . . . . . . . . . . . . . . . . . . 5 3.04 LATE PAYMENT CHARGES . . . . . . . . . . . . . . . . . . . . . . . . . . 5 3.05 TAX ON RENT AND OTHER PAYMENTS . . . . . . . . . . . . . . . . . . . . . 5 3.06 CONVEYANCE TAX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 3.07 TAXES ON TENANT'S BUSINESS AND PERSONAL PROPERTY . . . . . . . . . . . . 6 3.08 SECURITY DEPOSIT . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 3.09 CHARGE FOR PROVIDING ELECTRICAL POWER AND EXTRAORDINARY PROPERTY AND SERVICES. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 3.10 APPARATUS REQUIRING EXCESSIVE UTILITIES USAGE. . . . . . . . . . . . . . 7 3.11 LANDLORD'S RIGHT TO MAKE TENANT'S REPAIRS. . . . . . . . . . . . . . . . 6 3.12 OPTION TO PERFORM LEASE COVENANTS. . . . . . . . . . . . . . . . . . . . 7 3.13 INTEREST . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 3.14 TENANT'S COST. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 3.15 CASHIER'S OR CERTIFIED CHECKS. . . . . . . . . . . . . . . . . . . . . . 7 3.16 ADDITIONAL RENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 ARTICLE 4 - CONDITION, USE AND OCCUPANCY OF PREMISES. . . . . . . . . . . . . 7 4.01 TENANT'S INSPECTION AND ACCEPTANCE OF THE PREMISES . . . . . . . . . . . 7 4.02 PERMITTED USE OF PREMISES. . . . . . . . . . . . . . . . . . . . . . . . 8 4.03 LEGAL COMPLIANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 4.04 PROHIBITED USE OF PREMISES . . . . . . . . . . . . . . . . . . . . . . . 8 4.05 RULES AND REGULATIONS. . . . . . . . . . . . . . . . . . . . . . . . . . 8 4.06 PARKING AND AUTOMOBILES. . . . . . . . . . . . . . . . . . . . . . . . . 9 4.07 COMMON AREAS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 4.08 ADVERTISING. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 4.09 CARE OF PREMISES . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 4.10 SECURITY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 4.11 [INTENTIONALLY OMITTED]. . . . . . . . . . . . . . . . . . . . . . . . . 10 4.12 QUIET ENJOYMENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 4.13 INSPECTION OF PREMISES . . . . . . . . . . . . . . . . . . . . . . . . . 10 4.14 [INTENTIONALLY OMITTED]. . . . . . . . . . . . . . . . . . . . . . . . . 10 4.15 CHANGE OF BUILDING NAME. . . . . . . . . . . . . . . . . . . . . . . . . 10 4.16 [INTENTIONALLY OMMITED]. . . . . . . . . . . . . . . . . . . . . . . . . 10 4.17 [INTENTIONALLY OMITTED]. . . . . . . . . . . . . . . . . . . . . . . . . 10 4.18 OTHER TENANTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 4.19 NO SIGNS ON STATE PROPERTY . . . . . . . . . . . . . . . . . . . . . . . 10 4.20 CONDUCT OF TENANT'S EMPLOYEES. . . . . . . . . . . . . . . . . . . . . . 10 4.21 CONSUMPTION OF ALCOHOLIC BEVERAGES . . . . . . . . . . . . . . . . . . . 10 4.22 SMOKING AND EATING IN COMMON AREAS . . . . . . . . . . . . . . . . . . . 10 ARTICLE 5 - SERVICES PROVIDED BY LANDLORD . . . . . . . . . . . . . . . . . . 11 5.01 STANDARD SERVICES. . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 5.02 LIMITATION ON LIABILITY. . . . . . . . . . . . . . . . . . . . . . . . . 11 5.03 SERVICE CONTRACTS. . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 -i- ARTICLE 6 - TENANT IMPROVEMENTS, ALTERATIONS, REPAIRS AND RENOVATIONS . . . . 11 6.01 CONSENT REQUIRED . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 6.02 LIEN PROTECTION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 6.03 OWNERSHIP. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 6.04 LEGALLY REQUIRED . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 6.05 REPAIRS BY TENANT. . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 6.06 IMPROVEMENT OF THE PREMISES. . . . . . . . . . . . . . . . . . . . . . . 12 ARTICLE 7 - IMPROVEMENTS AND REPAIRS BY LANDLORD. . . . . . . . . . . . . . . 12 7.01 ALTERATIONS, ADDITIONS OR CAPITAL IMPROVEMENTS BY LANDLORD . . . . . . . 12 7.02 REPAIR OF STRUCTURAL ELEMENTS. . . . . . . . . . . . . . . . . . . . . . 12 7.03 REPLACEMENT OF CEILING, ETC. . . . . . . . . . . . . . . . . . . . . . . 13 7.04 IMPROVEMENTS TO THE PREMISES . . . . . . . . . . . . . . . . . . . . . . 13 ARTICLE 8 - TENANT ASSIGNMENT, SUBLETTING AND MORTGAGING. . . . . . . . . . . 13 8.01 CONSENT REQUIRED . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 8.02 ADDITIONAL CONDITIONS TO ASSIGNMENT OR SUBLEASE. . . . . . . . . . . . . 13 8.03 MORTGAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 8.04 CHANGE OF CONTROL. . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 ARTICLE 9 - SUBORDINATION, ATTORNMENT AND MORTGAGE REQUIREMENTS . . . . . . . 14 9.01 SUBORDINATION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 9.02 REQUIREMENTS OF LANDLORD'S MORTGAGEE AND GROUND LESSOR . . . . . . . . . 14 9.03 ESTOPPEL CERTIFICATES. . . . . . . . . . . . . . . . . . . . . . . . . . 15 9.04 LEASE AMENDMENT, FINANCIAL INFORMATION . . . . . . . . . . . . . . . . . 15 ARTICLE 10 - SALE OF LANDLORD'S INTEREST. . . . . . . . . . . . . . . . . . . 15 10.01 SALE OF LANDLORD'S INTEREST . . . . . . . . . . . . . . . . . . . . . . 15 10.02 TENANT ATTORNMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 10.03 SALE OR ASSIGNMENT BY LANDLORD. . . . . . . . . . . . . . . . . . . . . 15 ARTICLE 11 - INDEMNITY AND RISK OF INJURY, LOSS AND DAMAGE. . . . . . . . . . 15 11.01 INDEMNITY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 11.02 NON-LIABILITY OF LANDLORD . . . . . . . . . . . . . . . . . . . . . . . 16 ARTICLE 12 - INSURANCE. . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 12.01 PUBLIC LIABILITY AND PROPERTY DAMAGE. . . . . . . . . . . . . . . . . . 16 12.02 INSURANCE ON PERSONAL PROPERTY, IMPROVEMENTS AND BUSINESS INTERRUPTION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 12.03 NOTICE TO LANDLORD. . . . . . . . . . . . . . . . . . . . . . . . . . . 17 12.04 RECIPROCAL WAIVERS OF SUBROGATION . . . . . . . . . . . . . . . . . . . 17 12.05 OTHER PROVISIONS. . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 12.06 BLANKET INSURANCE . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 ARTICLE 13 - DAMAGE AND RESTORATION . . . . . . . . . . . . . . . . . . . . . 17 13.01 REPAIRS BY LANDLORD . . . . . . . . . . . . . . . . . . . . . . . . . . 17 13.02 CONTINUATION OF BUSINESS. . . . . . . . . . . . . . . . . . . . . . . . 18 13.03 REPAIRS BY TENANT . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 13.04 ABATEMENT OF RENT . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 ARTICLE 14 - CONDEMNATION . . . . . . . . . . . . . . . . . . . . . . . . . . 18 14.01 TERMINATION OF LEASE AS TO PORTION TAKEN. . . . . . . . . . . . . . . . 18 14.02 LANDLORD'S OPTION TO TERMINATE. . . . . . . . . . . . . . . . . . . . . 18 14.03 TENANT'S OPINION TO TERMINATE . . . . . . . . . . . . . . . . . . . . . 18 14.04 REDUCTION OF RENT . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 14.05 RIGHT TO COMPENSATION . . . . . . . . . . . . . . . . . . . . . . . . . 18 14.06 TAKING FOR A LIMITED PERIOD . . . . . . . . . . . . . . . . . . . . . . 19 ARTICLE 15 - DEFAULT BY TENANT. . . . . . . . . . . . . . . . . . . . . . . . 19 15.01 DEFINITION OF DEFAULT . . . . . . . . . . . . . . . . . . . . . . . . . 19 15.02 LANDLORD'S REMEDIES . . . . . . . . . . . . . . . . . . . . . . . . . . 20 15.03 REMEDIES ARE CUMULATIVE . . . . . . . . . . . . . . . . . . . . . . . . 21 ARTICLE 16 - TERMINATION. . . . . . . . . . . . . . . . . . . . . . . . . . . 21 16.01 SURRENDER OF THE PREMISES . . . . . . . . . . . . . . . . . . . . . . . 21 16.02 HOLDING OVER. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 ARTICLE 17 - GROUND LEASE . . . . . . . . . . . . . . . . . . . . . . . . . . 21 17.01 GROUND LEASE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 ARTICLE 18 - LANDLORD'S LIABILITY . . . . . . . . . . . . . . . . . . . . . . 22 18.01 LANDLORD'S FAILURE TO PERFORM . . . . . . . . . . . . . . . . . . . . . 22 18.02 NOTICE TO LANDLORD'S MORTGAGEES . . . . . . . . . . . . . . . . . . . . 22 18.03 LIMITATION ON LIABILITY OF LANDLORD AND MORTGAGEE . . . . . . . . . . . 22 ARTICLE 19 - MISCELLANEOUS. . . . . . . . . . . . . . . . . . . . . . . . . . 22 19.01 NO LIGHT, VIEW OR AIR EASEMENT. . . . . . . . . . . . . . . . . . . . . 22 -ii- 19.02 TIME OF ESSENCE . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 19.03 BROKERAGE COMMISSIONS . . . . . . . . . . . . . . . . . . . . . . . . . 22 19.04 EXECUTION BY LANDLORD . . . . . . . . . . . . . . . . . . . . . . . . . 22 19.05 RENEWAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 19.06 COST AND ATTORNEY'S FEES. . . . . . . . . . . . . . . . . . . . . . . . 23 19.07 LANDLORD'S CONSENT. . . . . . . . . . . . . . . . . . . . . . . . . . . 23 19.08 NOTICE. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 19.09 SEVERABILITY. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 19.10 WAIVER. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 19.11 SUCCESSORS. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 19.12 JOINT AND SEVERAL OBLIGATIONS . . . . . . . . . . . . . . . . . . . . . 24 19.13 CHOICE OF LAW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 19.14 ARTICLE AND SECTION HEADINGS. . . . . . . . . . . . . . . . . . . . . . 24 19.15 SHORT-FORM LEASE. . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 19.16 FORCE MAJEURE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 19.17 HAZARDOUS MATERIALS . . . . . . . . . . . . . . . . . . . . . . . . . . 24 19.18 PERIODIC FINANCIAL STATEMENTS TO LANDLORD . . . . . . . . . . . . . . . 27 19.19 ACKNOWLEDGMENT OF WAVIER OF JURY TRIAL. . . . . . . . . . . . . . . . . 27 19.20 ENTIRE AGREEMENT. . . . . . . . . . . . . . . . . . . . . . . . . . . . 27 -iii- AIRPORT TRADE CENTER 550 PAIEA STREET, HONOLULU, HAWAII REVISED STANDARD LEASE THIS LEASE is made as of November 20, 1996, by and between PAIEA PROPERTIES, a Hawaii limited partnership ("Landlord"), whose principal place of business and post office address is 550 Paiea Street, Suite 102, Honolulu, Hawaii 96819 and NATIONAL TELEPHONE & COMMUNICATIONS, INC., a Nevada corporation ("Tenant"), whose principal place of business is 2801 Main Street, Irvine, California 92714. WITNESSETH: Landlord leases to Tenant, and Tenant leases from Landlord, the Premises described below, located in the Project now known as "Airport Trade Center", for the Term and subject to and upon consideration of the terms, duties, obligations, covenants, conditions, rules and regulations, and special conditions set forth in this Lease. ARTICLE 1 SPECIAL PROVISIONS AND EXHIBITS 1.01 SPECIFIC PROVISIONS. The following constitute specific provisions of this Lease: (a) Premises: AIRPORT TRADE CENTER as shown on Exhibit A attached, to include area "L-1 and L-2", the exact size of which shall be measured by Landlord's architect in accordance with BOMA standards following construction of all demising walls. Net Usable Area [approximate]: Retail - L-1.................... 7,912 Sq.Ft. Retail - L-2.................... 695 Sq.Ft. Total...................... 8,607 Sq.Ft. Premises Type:.................. FIRST FLOOR RETAIL (b) Net Rentable Area [approximate]: Retail - L-1.................... 9,110 Sq.Ft. Retail - L-2.................... 800 Sq.Ft. Total...................... 9,910 Sq.Ft. (c) Term:........................... 120 Lease Months. Commencement Date:.............. The earlier to occur of (i) February 1, 1997, or (ii) the date upon which Tenant substantially completes its improvements and takes occupancy of the Premises. Termination Date:............... 120 Lease Months following the Commencement Date. (d) Initial Monthly Operating Expense Payment Estimate:....... $3,765.80 (e) Security Deposit:............... $36,697.68 (f) Use:............................ General offices, meeting facilities, retail sales of support collateral materials exclusive to Tenant's business operations and other lawful uses pertaining to Tenant's business subject to the prior written approval of Landlord. Maximum Occupancy:.............. As determined by the City and County of Honolulu fire and building codes. (g) Number of unassigned parking spaces:. 50; see Exhibit E for additional parking requirements of Tenant for restricted time period use. Initial monthly fee per space subject to adjustment per Exhibit C (Rules and Regulations): Unassigned $60.00 Tandem $90.00 Reserved $85.00 -1- (h) [Intentionally Omitted] 1.02 EXHIBITS. The following are attached as Exhibits and by this reference incorporated in the Lease: Exhibit A: Location of Premises and Floor Plan Exhibit B: Land Description Exhibit C: Rules and Regulations Exhibit D: Base Rent and Summary of First Payment Exhibit E: Special Conditions Exhibit F: Improvement Specifications and Construction Plans- By Tenant By Landlord Exhibit G: Allocations of Operating Expenses and Tenant's Proportionate Share Exhibit H: Location of Parking Area 1.03 [Intentionally Omitted] ARTICLE 2 DEFINITIONS Unless the context otherwise specifies or requires, the following terms shall have the meanings hereinafter specified: 2.01 "BUILDING" shall mean the present building located upon the Land. 2.02 "BUILDING AREAS" shall mean the areas identified on Exhibit A as Building Area 1, Building Area 2, Roof Top Area and Open Area, and shall at all times include that Area of the Building which contains the Premises. 2.03 "COMMON AREAS" shall mean those portions of and facilities in the Building and the Project designated by Landlord for the nonexclusive use of Tenant in common with other authorized users, subject to the Rules and Regulations Landlord shall promulgate. 2.04 "IMPROVEMENTS" shall include all improvements existing at the commencement of the Term or at any time thereafter built, installed or finished by anyone in the Premises, including, without limitation, all walls and partitions which are not load-bearing; the interior decorated or finished surfaces of all perimeter and load-bearing walls and floors; all ceilings and ceiling light fixtures (including those furnished by Landlord); all interior windows, entrance doors, mechanical and electrical conduits, wiring fixtures and equipment; all floor tile, carpeting and wall coverings; all ceiling sprinkler systems, air-conditioning equipment, other fixtures of all kinds; and water, electric, telephone and other utility lines, ducts, conduits and facilities serving other portions of the Building which may pass through the Premises. 2.05 "LAND" shall mean the real property described in Exhibit B, subject to reduction in area as provided in Section 7.01. 2.06 "LEASE MONTH" shall mean a full calendar month. The number of Lease Months comprising the term is specified in Section 1.01 (c). The first Lease Month shall begin on the Commencement Date set forth in Section 1.01 (c) if such date is the first day of the calendar month. If such Commencement Date shall not fall on the first day of a calendar month, the first Lease Month shall begin on the first day of the calendar month immediately following the month in which commencement occurs. In any event, Tenant shall be liable for Base Rent, any other payments required and performance of all other obligations of Tenant under this Lease from the Commencement Date. "Lease Year" shall mean twelve (12) full Lease Months, beginning the first Lease Month under this Lease. 2.07 "NET RENTABLE AREA" shall mean the Net Usable Area of the Premises plus Tenant's pro rata share of the Building and Project common areas calculated in accordance with Exhibit G. 2.08 "NET USABLE AREA"" shall mean: (a) For Building Area 1: (i) In the case of a Tenant leasing a full floor, the area measured from the finished inside surface of the outer Building wall, or from the inside surface of the Building glass line if more than fifty percent (50%) of the Building wall is glass, to the inside surface of the opposite Building wall, or glass line, specifically including the area of the restrooms, and electrical, mechanical and -2- janitorial rooms but less the area (measured from the midpoint of the enclosing walls) of all elevator shafts and stairs located on such floor. No deductions shall be made for columns and projections necessary to the Building. (ii) In the case of a Tenant leasing less than a full floor, the area measured from the finished inside surface of the outer Building wall, or from the inside surface of the Building glass line if more than fifty percent (50%) of the Building wall is glass, to the mid-point of partitions that separate the Premises from adjoining premises not leased by Tenant and to the finished inside surface of partitions that separate the Premises from the corridors, and to the inside finished surface of other permanent walls. All measurements to the inside of corridor walls shall be to the general line of the corridor wall, as shown on Exhibit A, without reduction for recessed Tenant entry areas. No deductions shall be made for columns and projections necessary to the Building. (b) For Building Area 2: [Intentionally Omitted] (c) For Roof Top and Open Area Premises: [Intentionally Omitted] 2.09 "OPERATING EXPENSES" shall mean all expenses which shall be incurred, accrued or paid due to the ownership, operation, maintenance or repair of the Project including the Common Areas. Without in any way limiting the generality of the foregoing, such expenses shall include the wages, salaries and payroll burden of employees; Project administration costs and property management fees; janitorial, maintenance, guard and other services; electricity, water, waste disposal and other utilities for the Project, including the Common Areas; materials and supplies (including janitorial); maintenance and repairs to all equipment and all interior and exterior (including roofing and structural members) areas of the Project; cleaning and replacement of all carpets and other floor coverings; pest control costs; all interior and exterior painting; replacement of light bulbs and fluorescent tubes, and lighting fixtures; all interior and exterior window cleaning; all costs of utilities, labor, material and supplies for the operation, repair, maintenance, renovation and replacement of the air conditioning equipment and system, which may include costs otherwise considered as capital costs or capital improvements; paving, sealing and stripping the parking and driveway areas; all insurance, including liability, worker's compensation, Temporary Disability, fire and casualty, and business (rental) interruption; any additions to or modifications of the Building or Project required by governmental authority or Landlord's insurance carrier; the cost of guest parking spaces at the rate Landlord is charging tenants for comparable parking spaces; all costs of exterior lighting; cost, deprecation or rental of tools and equipment; accounting, legal and other professional fees and costs; costs of landscaping the Project and maintenance thereof; the fair rental value of areas used in the operation, management, leasing and maintenance of the Project; all taxes, assessments and other charges by governmental authorities, present or future, excluding income taxes and any taxes already recovered under other provisions of this Lease but specifically including real property taxes and any substitute charges; depreciation or amortization (with interest) on capital improvements made to reduce operating or energy expenses or required by present or future governmental regulation, over the shorter of their useful life or the remaining useful life of the Project and at the interest rate provided in Section 3.13; and the amount of any increase in the lease rent and other charges payable under the Ground Lease described in Article 17 after March 15, 1994. The Operating Expenses shall not include capital expenditures (except the costs of capital improvements mentioned above), depreciation of improvements in the Project, interest on any indebtedness related to the Project or any expenses specifically charged to particular tenants or reimbursed by insurance. Notwithstanding the foregoing to the contrary, Operating Expenses shall specifically excluded the following: a. The cost (inclusive of legal and other professional fees) of negotiating leases, collecting rents, evicting tenants or costs incurred to enforce the provisions of any lease; b. Repairs, general maintenance, legal fees or professional fees paid by proceeds from any tenant or subject to reimbursement by other third parties; c. Inheritance or estate taxes imposed upon or assessed against the interest of any person in the Building or any part thereof or interest therein and taxes computed upon the basis of the net income of the owners of the Building or any part thereof or interest therein; d. The cost of providing tenant improvements to any tenant of the Building or Project; e. Franchise or transfer taxes imposed upon or assessed against the Building or Project for a change of ownership of any interest therein (except the conveyance of the leasehold interest under the Lease to Tenant); and f. Any compensation or expense whatsoever paid to any real estate broker, salesperson or agent in connection with the leasing or sale of the Building or Project. 2.10 "OPERATING EXPENSE PAYMENT" shall mean the portion of the Operating Expenses which is payable by Tenant as provided in Article 3 hereinbelow. -3- 2.11 "PROJECT" shall mean the Land and all Improvements located thereon, including without limitation, the Building, parking facilities and Common Areas commonly referred to as 550 Paiea Street. 2.12 "PREMISES" shall mean the space leased hereunder and all Improvements therein. The space leased shall consist of the area highlighted or otherwise marked on Exhibit A. 2.13 "PREMISES TYPE" shall mean the type of use for which the Premises are maintained and leased to Tenant as indicated in Section 1.01 (a). The Project has six (6) different Premises Types: Retail, Office, Lower Floor Flex, Highcube Warehouse, Roof Top and Open Area. The use to be made of the Premises by Tenant is restricted by Section 1.01 (f). The Retail, Office and Lower Floor Flex premises are located in Building Area 1, the Highcube Warehouse premises are located in Building Area 2, the Roof Top is located on the top of the Building, and the Open Area premises includes any portion of the unbuilt ground surface area outside the Building leased to a tenant. 2.14 "RULES AND REGULATIONS" shall be those established by Landlord from time-to-time as provided in this Lease. The initial Rules and Regulations are attached as Exhibit C. 2.15 "TENANT'S EMPLOYEES" shall mean, collectively, Tenant's directors, officers, partners, trustees, employees, agents, licensees, contractors and invitees. "LANDLORD'S EMPLOYEES" shall mean, collectively, Landlord's directors, officers, partners, trustees, employees, agents, licensees, contractors and invitees. 2.16 "TENANT'S PROPORTIONATE SHARE" shall mean Tenant's share of Operating Expenses which benefit the Premises, calculated in accordance with Exhibit G. If for any reason Tenant's Net Rentable Area or the Net Rentable Area of the Project shall change or be corrected, both as reasonably determined by Landlord, Tenant's Proportionate Share shall be adjusted accordingly. Tenant agrees that all allocations to tenants by Landlord of Operating Expenses based on the same general concepts as were used in Exhibit G shall be final and not subject to dispute by Tenant. The initial allocation of Operating Expenses to the various portions of the Project is set forth in Exhibit G. 2.17 "TERM" shall mean the period set forth in Section 1.01 (c), beginning on the Commencement Date and ending upon the expiration of the last Lease Month, unless sooner terminated as provided in this Lease. ARTICLE 3 RENT, SECURITY DEPOSIT AND OTHER TENANT CHARGES 3.01 BASE RENT. Tenant shall pay to Landlord on the first day of each month, in advance and without the necessity of notice to Tenant by Landlord, throughout the Term, the amount specified in Exhibit D as "Base Rent" for the Premises, in United States currency, over and above all other charges herein described and without any set-off or counterclaim. Base Rent payable for any period less than a full calendar month shall be a pro rata share of that payable for the full calendar month as reasonably calculated by Landlord. 3.02 OPERATING EXPENSE PAYMENT. (a) OPERATING EXPENSE PAYMENT. In addition to Base Rent, Tenant shall pay, as additional rent, a share of Operating Expenses on the first day of each month, in advance and without the necessity of notice to Tenant by Landlord, throughout the Term. The estimated initial monthly Operating Expense Payment is specified in Section 1.01 (d). The intent of such Operating Expense Payment is to create a true net lease whereby tenants are responsible for the payment of all Operating Expenses according to their proportionate share, so that the amount retained by Landlord from total receipts, after payment of all expenses of the Project, is the total of all tenant base rents. (b) BASIS FOR DETERMINING OPERATING EXPENSE PAYMENT. The Operating Expense Payment shall be the dollar amount obtained by (i) multiplying Tenant's Proportionate Share by (ii) Landlord's estimate of Operating Expenses for each period January I to December 31, and (iii) dividing the resulting product by 12. Landlord shall provide Tenant notice of Tenant's Operating Expense Payment for each such period by the preceding December 15. (c) ANNUAL ADJUSTMENT FOR ACTUAL OPERATING EXPENSES. After each December 31 during the Term, Landlord shall compute Tenant's Proportionate Share of the actual Operating Expenses for the preceding twelve (12) calendar months and notify Tenant of any correction from Tenant's Operating Expense Payments for such period. Within thirty (30) days after the giving of notice that Tenant's Proportionate Share of actual Operating Expenses was greater than Tenant's Operating Expense Payments, Tenant shall pay to Landlord an amount equal to the excess of Tenant's Proportionate Share of -4- actual Operating Expenses over Tenant's Operating Expense Payments for such period. Should it be determined that Tenant's Proportionate Share of actual Operating Expenses was less than Tenant's Operating Expense Payments for such period, Tenant shall be entitled to a credit against future Operating Expense Payments in an amount equal to the difference between Tenant's Proportionate Share of actual Operating Expenses and Tenant's Operating Expense Payments for such period. (If this Lease terminates during such a period, Tenant shall pay or be refunded any deficiency or excess, respectively, between estimated and actual Operating Expenses on a pro rata basis as if Operating Expenses accrued uniformly during the period.) (d) NORMALIZATION. If any part of the Project is not fully occupied and used during any twelve (12) month period preceding a December 31, the calculations of Operating Expenses, both estimated and actual, shall be adjusted by adding amounts and items of Operating Expenses which would normally have been incurred if the Project had been fully occupied and used during such period, and by deducting any abnormal start-up or other costs incurred, all as estimated by Landlord; PROVIDED, HOWEVER, for this Section 3.02 (d), ground rent increases, insurance and real property taxes shall be excluded in the calculation of Operating Expenses for normalization. (e) STATEMENT OF OPERATING EXPENSES. Landlord shall have available for inspection by Tenant during normal business hours a written statement showing in reasonable detail Landlord's actual Operating Expenses for the previous twelve (12) month period which shall be retained for a period of twenty-four (24) months after the calendar year in question pursuant to which the notice referred to in Section 3.02 (c) has been given. Landlord agrees that Tenant, its accountants and authorized representatives at Tenant's expense shall have the right within two (2) years after the close of each calendar year to audit all of the books and records of Landlord relating to Operating Expenses for the calendar year in question. Any such audit shall be performed in Landlord's office during Landlord's normal business hours. If such audit shows that Operating Expenses attributable to Tenant for the calendar year were overstated by more than five percent (5%), then Landlord shall reimburse Tenant for its Proportionate Share of such overstated amount and the reasonable costs of the audit. If the overstatement is five percent (5%) or less, Landlord shall reimburse Tenant for its Proportionate Share of such overstated amount. 3.03 REIMBURSEMENT FOR REPAIRS. Unless the same is promptly repaired by Tenant if such damage is of an emergency or safety related nature or unless the repair is promptly commenced by Tenant and the same is diligently pursued to completion in accordance with Landlord's written requirements, Tenant shall reimburse Landlord for all expenses incurred by Landlord in repairing damage to the Project, including damage to structural elements, which is attributable to the conduct of Tenant or Tenant's Employees. Upon demand Tenant shall reimburse Landlord therefor, together with a surcharge of twenty percent (20%) of such expenses. 3.04 LATE PAYMENT CHARGES. It is agreed that since collection of any amount past due imposes an administrative cost on Landlord, in addition to any fees of collection agents or attorneys or other out-of-pocket costs, Tenant will pay to Landlord a sum equal to five cents ($.05) for every dollar not paid within five (5) days of when due. 3.05 TAX ON RENT AND OTHER PAYMENTS. In addition to Base Rent, the Operating Expense Payment and any other payment to Landlord provided in this Lease, Tenant shall also pay to Landlord with each payment, an amount equal to the State of Hawaii general excise or gross income tax assessed against Landlord and attributable to the total payment, including the amount paid by Tenant to Landlord under this Section. For example, the amount of such tax is presently four percent (4%), resulting in a figure of 1.04167 to be multiplied by said Base Rent, Operating Expense Payment or other payment in order to calculate the total payment due from Tenant. Tenant shall pay any and all increases in said taxes made from time-to-time and any and all other taxes or duties levied or assessed by the federal government, State of Hawaii, the City and County of Honolulu, or any other political subdivision of the State of Hawaii now or hereafter having power to levy taxes or duties which are attributable to any payments made by Tenant under the terms of the Lease. It is the intent of this Section and of the other provisions of this Lease to insure that the rent and other sums to be paid to Landlord by Tenant will be received by Landlord without diminution by any tax, assessment, charge or levy of any nature whatever, except United States and State of Hawaii net income taxes, and the terms and conditions of this Lease shall be liberally construed to effect such purpose. 3.06 CONVEYANCE TAX. Any conveyance tax imposed by law due to this Lease shall be paid by Tenant. Landlord shall inform Tenant of the amount of such tax, if any, and it shall be thereupon due and payable by Tenant. At the request of Landlord, Tenant shall promptly execute such documents as may be necessary in connection with such tax. 3.07 TAXES ON TENANT'S BUSINESS AND PERSONAL PROPERTY. Tenant shall be responsible for and shall pay before delinquency all City and County of Honolulu and State of Hawaii taxes assessed during the Term against Tenant by reason of the conduct of its business in the Premises, Improvements to the Premises and with respect to personal property of any kind owned by or placed in, upon or about the Premises by or at the expense of Tenant. -5- 3.08 SECURITY DEPOSIT. (a) DEPOSIT. Upon execution of this Lease, Tenant shall deposit the sum specified in Section 1.01(e) (the "Security Deposit") as security for Tenant's performance under this Lease. The Security Deposit may be commingled by Landlord with other funds of Landlord, and Tenant shall not be entitled to interest on the Security Deposit. (b) INCREASE. The Security Deposit shall be increased from time-to-time, as necessary so that the amount thereof is always equal to the Base Rent plus estimated Operating Expense Payments. Upon written notice of such increase from Landlord, Tenant shall deposit with Landlord the increased amount within thirty (30) days of such notice. (c) USE. If Tenant shall be in default under this Lease, Landlord may apply the whole or any part of the Security Deposit to the payment of any sum in default or any other sum which Landlord may be required to spend by reason of Tenant's default. In the event Landlord should so apply all or any part of the Security Deposit Tenant shall pay to Landlord, within fifteen (15) days after receipt of notice from Landlord, an amount equal to the sum so expended in order to replenish the Security Deposit. Failure to do so shall be a default under this Lease. (d) REFUND. If Tenant complies with all of the terms and conditions of this Lease, the Security Deposit or any balance thereof shall be returned to Tenant within thirty (30) business days of the expiration of the Term. (e) ASSIGNMENT. Landlord may assign and deliver the Security Deposit to any purchaser of Landlord's interest in this Lease or the Premises or the Project without Tenant's approval, and Landlord shall thereupon be released and discharged from any and all obligations and liabilities related to the Security Deposit. After such transfer, Tenant shall look only to such purchaser for any recovery of the Security Deposit to which Tenant is entitled. In the event of any valid assignment of this Lease by Tenant, Landlord shall not be required to return the Security Deposit to Tenant, but only to Tenant's valid assignee. 3.09 CHARGE FOR PROVIDING UTILITY AND EXTRAORDINARY PROPERTY AND SERVICES. (a) SEPARATELY SUBMETERED UTILITY SERVICE. Unless otherwise set forth herein, all premises in the Project are separately submetered by Landlord to measure the consumption of electrical power, natural gas and domestic water usage therein. Tenant shall pay for such utility charges directly to Landlord (or to the utility company if so directed by Landlord), within ten (10) days of receipt by Tenant at the Premises of the bill for same. Tenant's failure to so pay shall be a default under this Lease. Tenant shall have the right, at any time that the local utility will allow, to have a separate meter installed to directly measure Tenant's usage and to directly bill Tenant. All costs associated with installing such separate meter shall be borne by Tenant. (b) EXTRAORDINARY SERVICE. Any property or services, other than those Landlord has agreed to provide Tenant under this Lease, provided by Landlord to or for the benefit of Tenant shall be at Tenant's expense, including a surcharge of five percent (5%) to cover Landlord's administrative costs. Landlord shall advise Tenant in writing of the estimated cost to furnish such property or service. If the same is approved in writing by Tenant, Landlord shall furnish such property or service and thereafter notify Tenant of the amount due and Tenant shall make such payment on or before ten (10) days following the date such notice is given. Such extraordinary property and services shall include, without limitation, providing extraordinary janitorial services (those not normally provided for Office and Retail tenants as reasonably determined by Landlord). 3.10 APPARATUS REQUIRING EXCESSIVE UTILITIES USAGE. Tenant shall not, without the prior written consent of Landlord, connect to any utility service, including, but not limited to, electrical, water, sewer or natural gas, requiring amounts of such utility service in excess of that required for the equipment listed in Tenant's Construction Plans as set forth on Exhibit F as approved in writing by Landlord. If Tenant shall install in the Premises any equipment requiring utilities in excess of the approved equipment list in Tenant's Construction Plans, Tenant shall pay for such excessive utilities usage. Tenant agrees to pay Landlord promptly upon demand (but not more frequently than monthly), for all excess utilities consumed, at the rates charged for such utilities by the public utility or governmental or quasi-governmental department furnishing the same, plus any additional expense incurred by Landlord in keeping accounts of the utilities consumed. 3.11 LANDLORD'S RIGHT TO MAKE TENANT'S REPAIRS. If Tenant does not make, within thirty (30) days after written notice from Landlord, proper repairs or alterations in accordance with Section 6.04 and 6.05 or, if the nature of the repair or alternation is such that more than thirty (30) days are required for its performance and Tenant does not diligently continue the cure to completion, Landlord may make such repairs or alterations without liability to Tenant for any loss or damage which may accrue to Tenant's property, Improvements or business by reason thereof. Upon completion of such repairs or -6- alterations, Landlord shall notify Tenant of the cost of any such repair or alteration expenses, and Tenant shall reimburse Landlord therefore pursuant to and in accordance with the provisions of Section 3.02. 3.12 OPTION TO PERFORM LEASE COVENANTS. If Tenant shall fail to pay any sum of money, other than monies required to be paid to Landlord hereunder, or shall fail to perform any other act on its part to be performed hereunder, Landlord may, without waiving or releasing Tenant from any obligations of Tenant and upon prior written notice to Tenant, make any such payment and perform any other such act. All sums so paid by Landlord and all costs incurred in performing such acts (including reasonable attorney's fees), together with interest thereon at the rate provided in Section 3.13, shall be payable by Tenant upon demand, and Tenant hereby covenants to pay any and all such sums. 3.13 INTEREST. Interest shall be charged to Tenant on late payments of Base Rent, Operating Expense Payment and other sums due under this Lease from the date such payment is due until received by Landlord, at the greater of (a) one and one-half percent (1 1/2%) per month or (b) at a floating rate equal to five (5) percentage points over the base rate then being charged by Bank of Hawaii, but not to exceed the maximum rate of interest allowed by law. 3.14 TENANT'S COST. All covenants and agreements to be performed by Tenant under any of the terms of this Lease shall be performed by Tenant at Tenant's sole cost and expense. 3.15 CASHIER'S OR CERTIFIED CHECKS. If for any reason Tenant's check for Base Rent and/or Operating Expense Payment is returned unpaid by Tenant's bank to Landlord more than one (1) time in any twelve (12) month period, then, for the remainder of the Term, Landlord, in its sole discretion, may require Tenant to pay Base Rent and Operating Expense Payment by cashier's or certified check. 3.16 ADDITIONAL RENT. All amounts required to be paid by Tenant to Landlord hereunder, exclusive of Base Rent, but specifically including Operating Expense Payments, shall be deemed to be additional rent. ARTICLE 4 CONDITION, USE AND OCCUPANCY OF PREMISES 4.01 TENANT'S INSPECTION AND ACCEPTANCE OF THE PREMISES. Notwithstanding anything contained herein to the contrary, Tenant understands and agrees that the Premises, Building and Project are "AS IS, WHERE IS AND WITH ALL FAULTS", and Landlord has not made and does not make any warranties or representations of any kind, expressed or implied, as to the condition, zoning, merchantability or state of repair or fitness of the Premises, Building or the Project for any particular purpose, the availability of utilities to the Premises, Building or Project, the likelihood of appreciation in value of the Premises, Building or Project, the existence of violations of building setbacks or building restrictions, or as to the compliance of the Premises, Building or Project with any applicable county, state or federal statute, ordinance, rule or regulation or as to any other matter whatsoever pertaining to the Premises, Building or Project. Tenant accepts all risks of any defects or deficiencies in the Premises, Building or Project, whether known or unknown, and Tenant acknowledges that Landlord makes no expressed warranties of any kind except as specifically set forth in this Section 4.01(c) below, and hereby disclaims all implied warranties of any nature whatsoever pertaining to the Premises, Building or Project. (a) [Intentionally Omitted] (b) EXISTING PREMISES. As to all other Premises, Tenant, by Tenant's execution of this Lease, represents and agrees that Tenant has inspected the Premises, or has been provided an opportunity to inspect the Premises which Tenant has declined, and, excluding any Improvements yet to be completed by Landlord as specified in Exhibit F, if any, Tenant accepts the Premises in its current condition or has provided Landlord with a written statement listing all damage and defects. Tenant agrees the Term of this Lease shall commence even if there are defects or damage to the Premises, if the Premises are occupiable as reasonably determined by Landlord. (c) REPRESENTATIONS OF LANDLORD AS OF THE COMMENCEMENT DATE: Notwithstanding this Section 4.01 to the contrary, Landlord represents and warrants that as of the execution date of this Lease: (i) all Improvements installed by Landlord as specified in Exhibit F are and/or will be of new and good quality and free from defects and in full compliance with all relevant regulatory requirements; (ii) to the best of Landlord's knowledge the Building, of which the Premises is a part, is structurally sound and the roof of over the Premises is free of leaks; and (iii) to the best of Landlord's knowledge no Hazardous Material in violation of applicable laws are located on the Premises. -7- 4.02 PERMITTED USE OF PREMISES. The Premises may be used only for the purpose set forth in Section 1.01 (f) and for no other purposes, and may be occupied by no more than the number of persons set forth in Section 1.01 (f), except as consented to in writing by Landlord. Notwithstanding the foregoing to the contrary, Landlord acknowledges that from time to time Tenant will have meetings, sessions or conferences in the Premises and Tenant represents and warrants to Landlord that any such meetings, sessions or conferences (i) will be held in accordance with the terms of this Lease and all applicable local laws, ordinances and codes, and (ii) will not interfere with the rights and quiet enjoyment of any other tenant in the Project. Tenant acknowledges that neither Landlord nor any agent or employee of Landlord has made any representation or warranty with respect to the Premises or Project or with respect to the suitability of the Premises or Project for Tenant's intended use, except as may be expressly set forth in this Lease. 4.03 LEGAL COMPLIANCE. Tenant will comply, at its own expense, with all laws and ordinances and governmental rules and regulations applicable to the Premises and Landlord will comply at its own expense, with all laws and ordinances and governmental rules and regulations applicable to the portions of the Project other than tenant premises. Landlord agrees to cooperate with and assist Tenant in obtaining, processing or receiving any and all permits necessary to install Tenant's Improvements previously approved by Landlord. Such cooperation and assistance shall not involve any cost to Landlord. 4.04 PROHIBITED USE OF PREMISES. No use shall be made of the Premises, nor act done in or about the Premises, which will increase the existing rate of any insurance upon the Building or Project, nor shall any use be made of the Premises which would cause Landlord to be in default under the Ground Lease, mortgage or other lien on Landlord's estate. Any deficiencies found in a fire inspection by any governmental authority or Landlord's insurance carrier shall be immediately corrected by Tenant, at Tenant's sole cost and expense. Tenant shall not commit or allow to be committed any waste upon the Premises, or any public or private nuisance or other act or thing which disturbs the quiet enjoyment of any other tenant in the Project, nor shall Tenant use any apparatus, machinery or device in or about the Premises which shall cause any substantial noise or vibration, or which shall overload the floor of the Premises. If any of Tenant's machines or equipment should disturb the quiet enjoyment of any other tenant in the Project, then Tenant shall provide adequate insulation, or take such other action as may be necessary or required by Landlord to eliminate such disturbance. 4.05 RULES AND REGULATIONS. Landlord, for the proper maintenance, safety, order, cleanliness and efficient operation of the Building and the Project, may from time-to-time make, amend and enforce rules and regulations applicable to tenants of the Building or Project (the "Rules and Regulations"). Such Rules and Regulations may be applicable to all tenants of the Project or, because of the differing uses of the Project, may be only applicable to tenants of a certain Premises Type. The Rules and Regulations in force at the date hereof are those set forth in Exhibit C. Tenant shall observe and comply with all Rules and Regulations of which Tenant receives written notice. Any failure to so observe and comply shall constitute a default under this Lease. Landlord shall not be liable or responsible to Tenant for the violation of any Rules or Regulations by any other tenant or occupant of the Building or Project. 4.06 PARKING AND AUTOMOBILES. (a) NON-PREMISES PARKING FACILITIES. Tenant shall have use of the number of parking spaces in the Project parking facilities outside the area of the Premises, on an unassigned, tandem or reserved basis, as shown in Section 1.01 (g), if any. The fee charged for Tenant's use of such non-Premises parking spaces shall be established by Landlord from time-to-time in accordance with the prevailing market rate; however, in no event shall the amount charged for said spaces be less than the initial monthly fee shown in Section 1.01 (g). Tenant shall not sublease or otherwise rent to others any of Tenant's parking spaces in the Project. The location of the non-Premises parking spaces shall be determined by Landlord and may from time to time be relocated within the Project parking facilities, all in the sole discretion of Landlord. Tenant and Tenant's Employees shall enter into such parking agreements (herein called "Parking Agreements") that Landlord or any operator of the Project parking facilities may request from time-to-time. Failure by Tenant or Tenant's Employees to execute, or to perform or comply with any provision of, the Parking Agreement shall constitute an event of default under this Lease. In the event Landlord becomes unable to provide the number of parking spaces agreed upon above by reason of government regulation, condemnation or damage, then such inability shall not constitute a breach of this Lease on the part of Landlord. (b) VALIDATED PARKING. If Landlord at any time concludes, in its sole judgment, that validated parking for the Project would be advisable, Landlord shall have the right to enforce validated parking in the parking facilities of the Project by controlled entrances or otherwise and upon such terms and conditions as Landlord shall, at its sole discretion, stipulate from time-to-time. In such event, the revenues derived from such validated parking program shall belong to Landlord; PROVIDED, HOWEVER, all Tenant parking referred to in Section 1.01(g) and Exhibit E shall be at no additional cost to Tenant under any such validated parking program. -8- (c) MISCELLANEOUS. Tenant and Tenant's Employees shall not store vehicles in parking spaces or otherwise within the Project, bring upon the Project any junk vehicles, make repairs to any vehicles while within the Project, drive or park any vehicle on landscaped areas or on sidewalks, exceed the speed limits posted upon the Project, allow any vehicle with an oil or anti- freeze leak to remain on the Project, or post, place or otherwise display any sign, picture, placard, poster or sandwich board in, on or attached to any vehicle parked in or upon the Project. Tenant and Tenant's Employees shall observe all rules for guest parking established by Landlord. Landlord shall not be responsible for any loss of or damage to any vehicle while upon the Project. (d) VALET PARKING BY TENANT. Subject to the same being provided in accordance with the provisions of this Lease and the Rules and Regulations, Tenant from time to time may provide valet parking services for Tenant's clients, agents and invitees. Tenant shall enter into a written agreement with such valet parking service provider, the terms of which shall be subject to the prior written approval of Landlord. 4.07 COMMON AREAS. in addition to the Premises, Tenant shall, as an appurtenance thereto, have full right of access to the Premises over and across the Common Areas and the non-exclusive right to use the Common Areas in connection with Tenant's use of the Premises; subject, however, to the rights of other tenants and to the Rules and Regulations. 4.08 ADVERTISING. (a) SIGNS. Tenant shall not inscribe any inscription or post, place or in any manner display any sign, notice, picture, placard or poster, or any advertising matter whatsoever, anywhere in or about the Premises, at places visible (either directly or indirectly as an outline or shadow on a glass pane) from anywhere outside the Premises, or in or about the Building or the Project except as permitted under the Rules and Regulations. (b) LIMITATION ON DISTRIBUTION OF ADVERTISING. Tenant shall not distribute to any of the other tenants in the Project or to their employees, customers, clients or invitees, affix to vehicles parked in the parking area of the Project, or place or cause to be placed in any of the suites of the Building or any other area of the Project, any notices, advertisements or written solicitations, or solicit or originate, or attempt to originate, any business whatsoever by distributing handbills or literature from any part of the Project, except within the Premises. 4.09 CARE OF PREMISES. Tenant shall keep and maintain the Premises, including all Improvements, clean and in good condition and repair. All furniture, fixtures and equipment installed or placed in the Premises shall be of first class quality. 4.10 SECURITY. Tenant shall be solely responsible for providing security for the Premises and Landlord shall have no responsibility therefor. 4.11 [Intentionally Omitted] 4.12 QUIET ENJOYMENT. Upon Tenant's payment of the Base Rent and additional rent herein provided and Tenant's observance and performance of the covenants herein contained on the part of Tenant to be observed and performed, Tenant shall peaceably hold and enjoy the Premises without disturbance from Landlord and Landlord's Employees for the Term; subject, however, to the terms and provisions of the Lease, the Ground Lease described in Article 17 (as presently existing or as amended in the future), or any mortgage of Landlord's estate or interest in the Lease, Premises, Building, or Project. 4.13 INSPECTION OF PREMISES. Landlord and Landlord's Employees shall have a passkey to the Premises. Tenant will permit Landlord, and Landlord's agents, at all reasonable times during the Term of this Lease (upon not less than twenty-four (24) hours notice), and during any emergency, to enter the Premises to examine the state of repair and condition of the Premises, to make repairs or Improvements and for the purpose of exhibiting the Premises to potential mortgagees, purchasers of the Project and tenants. Landlord also reserves the right to enter the Premises after the Commencement Date to complete Landlord's construction obligation under Exhibit F. 4.14 [Intentionally Omitted] 4.15 CHANGE OF BUILDING NAME. Landlord may, in its sole judgment, change the name of the Building or the Project at any time and in any manner. 4.16 [Intentionally Omitted] 4.17 [Intentionally Omitted] 4.18 OTHER TENANTS. Landlord reserves the right to enter into other leases in the Project, in Landlord's sole discretion, without restriction as to the tenants thereunder; and Tenant acknowledges that -9- no representations have been made by Landlord, or Landlord's agents or employees, regarding Landlord's intent or ability to lease or not lease to any specific tenant or class of tenant and that Tenant is not relying, in entering into the Lease, on any specific tenant, class of tenant or number of tenants leasing or not leasing a portion of the Project during the Term of this Lease. 4.19 NO SIGNS ON STATE PROPERTY. On the Paiea Street side of the Project, between the curb of the street and the beginning of the Land, there is a strip of land owned by the State of Hawaii ("State land"). Tenant shall not place or post any sign, notice, picture, placard or poster upon or within the boundaries of the State Land. Any such item placed upon or therein may be removed and destroyed or otherwise disposed of by Landlord without notice at the sole cost and expense of Tenant. 4.20 CONDUCT OF TENANT'S EMPLOYEES. Tenant shall be responsible for the conduct of Tenant's Employees when upon or within the Project. If any of Tenant's Employees shall fail to observe the Rules and Regulations, or otherwise shall fail to conduct themselves in a responsible manner, Tenant shall promptly, but in not event later than fourteen (14) days following written notice from Landlord, remove and bar such Tenant Employee from the Premises and Project. Landlord's written notice shall provide reasonable detail as to the infraction. Failure of Tenant to comply with this Section shall be a default under the Lease. Notwithstanding anything contained in this Section 4.20 to the contrary, Tenant shall be required to comply with this provision to the extent such is not in violation of a union agreement or applicable federal, state or local law. 4.21 CONSUMPTION OF ALCOHOLIC BEVERAGES. Consumption of alcoholic beverages shall be allowed only within the Premises. It shall be within the sole discretion of Tenant whether to allow such consumption. In no circumstances shall Tenant or Tenant's Employees consume, or carry open containers of, alcoholic beverages outside of the Premises. 4.22 SMOKING AND EATING IN COMMON AREAS. Smoking, and consumption of beverages and food is not allowed in the interior Common Areas of the Building. ARTICLE 5 SERVICES PROVIDED BY LANDLORD 5.01 STANDARD SERVICES. (a) UTILITIES AND JANITORIAL SERVICE. Provided that Tenant shall not be in monetary default hereunder, the following services shall be provided by Landlord in Common Areas of the Project and, if applicable, portions of the Premises within the Building: Landlord agrees to furnish Tenant with unheated water to public restrooms, electricity for lighting and other normal use (but in no event more than the Premises' pro rata share of electricity available for the Project) and restroom facilities and supplies. Landlord shall also furnish customary janitorial and cleaning services to the Office premises, as reasonably determined by Landlord, within the Premises on the basis of five (5) days per week, at reasonable intervals shall wash both sides of the exterior windows of the Building. Within the Premises, Building standard light bulbs shall be replaced by Landlord's maintenance staff at Tenant's expense. Tenant shall be responsible for all janitorial and cleaning not provided by Landlord. All such services will be rendered in accordance with the Rules and Regulations. (b) AIR CONDITIONING. For Office type premises, provided Tenant shall not be in monetary default hereunder, Landlord shall provide as part of such Premises, routine air conditioning system maintenance which system shall be separately submetered for electrical consumption and charges pursuant to the provisions of Section 3.09 (a) hereof. Landlord may install an air conditioning system timing or other energy saving device in the Premises which Tenant agrees to operate in accordance with instructions received from Landlord. Landlord will be responsible for the routine maintenance of the air conditioning system within the Premises, the cost of which will be included in Operating Expenses. (c) COMMON AREA MAINTENANCE. Except as otherwise herein provided, Landlord will use best efforts to maintain the public and Common Areas of the Project, such as stairs, lobbies, corridors and restrooms, in good order, condition and repair. (d) KEYS. Landlord shall provide to Tenant up to four (4) outside door keys or cards for access to the Building. Tenant shall be responsible for the cost of additional keys or cards. Landlord may at any time change the lock or reprogram card access in Landlord's sole discretion and shall immediately thereafter provide Tenant with four (4) new outside door keys or cards. Tenant shall collect keys and cards from any of Tenant's Employees who terminate employment with Tenant. 5.02 LIMITATION ON LIABILITY. Unless caused by Landlord's failure to make payment for such utilities or services after receipt by Landlord of Tenant's payment for its full share of same or except to the extent that gross negligence of Landlord or Landlord's Employees is the proximate cause of such damage, Landlord shall not be liable for any damages caused by the utilities and services described under Section 5.01, or for the interruption, malfunction or curtailment of any of said utilities and services -10- caused by maintenance, labor disturbances or labor disputes (whether caused by Landlord or otherwise), accidents, repairs, wars, riots, termination of electrical power by Landlord pursuant to Section 3.09 (a) or other causes, nor shall Landlord be liable, except as provided in Section 11.01 hereinbelow, for loss of or injury to persons or property, however occurring, through or in connection with or incidental to the furnishing of any of the foregoing. No such interruption, malfunction, termination or curtailment shall relieve Tenant from any of its obligations under this Lease or constitute or be construed as a constructive or other eviction of Tenant or disturbance of Tenant's use and possession of the Premises or breach by Landlord of any of its obligations hereunder. 5.03 SERVICE CONTRACTS. Any service which Landlord may or is required to furnish pursuant to the provisions of this Lease may, at Landlord's option, be furnished from time-to-time in whole or in part by employees of Landlord or by the managing agent of the Project or by one or more third persons. ARTICLE 6 TENANT IMPROVEMENTS, ALTERATIONS, REPAIRS AND RENOVATIONS 6.01 CONSENT REQUIRED. Tenant shall make no alterations, additions or improvements in or to the Premises without Landlord's prior written consent which shall not be unreasonably withheld or delayed, and then only upon such conditions as Landlord may reasonably impose. All such work shall be done at such times and in such manner as Landlord designates and in full compliance with all requirements of governmental authorities having jurisdiction, including obtaining a valid building permit prior to commencement of work. Tenant shall reimburse Landlord for all reasonable costs and expenses incurred by Landlord in connection with Tenant's work including, but not limited to, the review of all Construction Plans, any future plans and construction observation by Landlord's representatives. Landlord shall provide a written estimate of such expenses upon Tenant's request. 6.02 LIEN PROTECTION. Before commencing any work, Tenant shall reasonably satisfy Landlord that Tenant has sufficient resources to pay for such work or if requested by the Ground Lessor or any mortgagee of Landlord shall secure, at Tenant's sole cost and expense, a completion and lien indemnity bond, satisfactory to Ground Lessor or any mortgagee of Landlord, for said work. Any mechanic's lien application filed against the Premises, Building or Project for work claimed to have been done for, or materials claimed to have been furnished to Tenant, shall be discharged by Tenant, by bond or otherwise, within ten (10) days after the filing thereof. 6.03 OWNERSHIP. All alterations, additions, or improvements to the Premises, whether temporary or permanent, made either by Landlord or Tenant, shall be for the benefit of and owned by Landlord, shall not be removed unless otherwise provided for in this Lease or consented to in writing by Landlord, and shall be an integral part of the Premises. Notwithstanding anything contained in this Section 6.03 to the contrary and Tenant not being in default of this Lease, this provision shall not apply to the trade fixtures, machinery and movable equipment of Tenant, and the same may be removed from the Premises by Tenant at any time without Landlord's consent provided that Tenant shall repair all damage to the Premises and any remaining Improvements caused by or resulting from such removal and shall leave the Premises in a clean and orderly condition. 6.04 LEGALLY REQUIRED. Except as may be otherwise provided in Section 4.01 of this Lease, if, during the Term, any change, alteration, addition or correction shall be required by any governmental authority to be made in or to the Premises or any portion thereof, Landlord shall first give its written consent thereto and such change, alteration, addition or correction shall then be made by, and at the sole expense of, Tenant. 6.05 REPAIRS BY TENANT. Tenant will promptly make all repairs to the Premises necessary to meet Tenant's obligation under Section 4.09. Within thirty (30) days after written notice from Landlord to do so, Tenant shall repair and make good all defects which this Lease requires. Tenant hereby waives any right to make repairs at Landlord's expense or to deduct the cost thereof from the Base Rent or any other sums to be paid hereunder by Tenant. Tenant shall not make changes to locks on doors or add, disturb or in any way change any plumbing, electrical, mechanical or air-conditioning system without first obtaining the written consent of Landlord which shall not be unreasonably withheld or delayed unless such changes affect the capacity of the electrical, plumbing or mechanical systems of the Project in which event the consent of Landlord shall be at its absolute discretion. Tenant shall give Landlord prompt written notice of any damage to, or defect in, any water or other pipes or plumbing, electric light or other fixtures, equipment or appurtenances of the Premises. All damage or injury done to the Premises by Tenant or by any persons who may be in or upon the Premises shall be promptly repaired by Tenant, in quality and style not less than as originally installed by Landlord or Tenant, to the reasonable satisfaction of Landlord. All repairs to the structure of the Buildings shall be done by or under the direction of Landlord as provided in Section 7.02 hereinbelow. Except as otherwise provided in this Lease, Landlord shall have no obligation to repair the interior of the Premises or any improvements therein; PROVIDED, HOWEVER, Landlord may, at its option, cure Tenant's default under this Section as provided in Section 3.11. -11- 6.06 IMPROVEMENT OF THE PREMISES. Tenant, at Tenant's sole cost and subject to the requirements of this Article and Exhibit F, shall make all improvements to the Premises necessary for Tenant's occupancy and use thereof. ARTICLE 7 IMPROVEMENTS AND REPAIRS BY LANDLORD 7.01 ALTERATIONS, ADDITIONS OR CAPITAL IMPROVEMENTS BY LANDLORD. Landlord may make any alterations, additions or improvements which Landlord may deem necessary or desirable for the preservation, safety, improvement, or efficient operation of the Premises, or Project, or to comply with any laws, codes, regulations or ordinances now or hereafter in effect, or for the purpose of reducing operating expenses or energy requirements of the Building or Project, provided that Landlord shall not materially interfere with Tenant's use of the Premises (including Tenant's parking stalls) except in an emergency. Landlord reserves the right to make further improvements, alterations, additions or renovations to the Premises, Buildings and Project in Landlord's sole discretion. Landlord also reserves the right to reduce the area of the Land upon which the Building and Project are located, and to use the portion of the Land removed from the Project for any purpose whatsoever; PROVIDED, HOWEVER, any such reduction of the area of the Land shall not reduce Landlord's ability to provide Tenant with such parking as set forth herein. 7.02 REPAIR OF STRUCTURAL ELEMENTS. Landlord shall repair the structural elements of the Building, including, without limitation, those within the Premises, and restore the same to the condition existing immediately prior to such damage, provided that Landlord shall not materially interfere with Tenant's use of the Premises except in an emergency. Landlord shall commence to make repairs under this Section within thirty (30) days following receipt of a written notice from Tenant of the need for such repairs. In no event shall rent be abated nor shall Landlord have any liability for the interruption of or interference with Tenant's business, due to Landlord's making, or failure to make, repairs pursuant to this Section. The obligation of Landlord to repair hereunder shall be subject to the operation of Article 13 of this Lease. Except as otherwise set forth in this Lease to the contrary, Tenant shall have no obligation to repair any structural element of the Building unless such repair is occasioned by Tenant's negligence or willful misconduct. 7.03 REPLACEMENT OF CEILING, ETC.. Landlord reserves and shall have the right to install, repair, replace, maintain and remove, at its sole discretion, any ceiling, ceiling light fixtures or ceiling sprinkler system; air-conditioning equipment; water, electric, telephone and other utility lines; and all types of ducts, conduits and other facilities serving other portions of the Building, or other buildings, which may pass through the Premises, provided that Landlord shall not materially interfere with Tenant's use of the Premises except in an emergency. 7.04 IMPROVEMENTS TO THE PREMISES. Except as set forth in Exhibit F, Landlord shall not be obligated to make any improvements to the Premises prior to the Commencement Date hereof. ARTICLE 8 TENANT ASSIGNMENT, SUBLETTING AND MORTGAGING 8.01 CONSENT REQUIRED. Tenant shall not, without the prior written consent of Landlord which shall not be unreasonably withheld or delayed, assign, mortgage, pledge, encumber or otherwise transfer this Lease or any interest herein, or sublet or abandon the Premises, or any part thereof, or any parking space or other area used by Tenant within the Project. The term "sublet" shall include, without limitation, any permitted use of the Premises by any party other than Tenant, but shall exclude the permitted use of the Premises by "independent representatives" as that term is used as of the date hereof by Tenant in it business operations. Any of the foregoing acts, without such consent shall be void and constitute a default under this Lease. Notwithstanding the above and Tenant not otherwise being in default of this Lease, Landlord's approval shall not be required for an assignment or sublease of the Premises to a person or entity controlling, controlled by or under common control with Tenant, or into or with which Tenant merges, or to which Tenant sells substantially all of its assets provided that in all cases such person or entity has financial net worth equal to or greater than Ten Million Dollars ($10,000,000). Any such consent by Landlord shall not release Tenant from any of Tenant's obligations hereunder, or be deemed to be a consent to any subsequent assignment, mortgage, pledge, encumbrance, transfer or subletting. No assignment, subletting, mortgaging, pledge, encumbrance or transfer may be made by Tenant if there is any default by Tenant under the terms of this Lease. 8.02 ADDITIONAL CONDITIONS TO ASSIGNMENT OR SUBLEASE. (a) Tenant shall give Landlord at least sixty (60) days written notice of Tenant's desire to assign or sublease, accompanied by a description of the terms thereof, an identification of the proposed assignee or sublessee and proof of their financial responsibility. -12- (b) Tenant shall pay Landlord all costs and expenses incurred by Landlord in connection with any assignment or sublease, including, but not limited to preparation of the consent document, review by and consultation with Landlord's legal counsel, securing credit reports, administrative overhead and the like. (c) The proposed assignee or sublessee shall execute an agreement pursuant to which it shall agree to perform and be bound by all of the terms, covenants, conditions, provisions and agreements of this Lease. (d) An executed copy of the assignment or sublease and the agreement described in Section 8.02 (c), shall be delivered to Landlord prior to the assignee or sublessee taking possession of the Premises. (e) Seventy-five percent (75%) of any monies or the value of other economic consideration received by Tenant from such assignment or subletting (except that attributable to the amortization over the Lease Term of Improvements made to sublet a portion of the Premises and that attributable to the amounts payable by Tenant as to the sublet portion of the Premises, which costs shall be subject to audit by Landlord) shall be payable to Landlord without reducing any other Tenant obligation under this Lease. (f) If Tenant provides Landlord such notice pursuant to Section 8.02(a), Landlord may by thirty (30) days written notice to Tenant elect to terminate the Lease. Such termination shall not be effective before the date of the proposed assignment or sublease as specified by Tenant's notice under Section 8.02 (a). 8.03 MORTGAGE. Tenant shall not have the right to mortgage or otherwise encumber its leasehold interest in the Premises, but may only encumber its interest in fixtures, equipment, installations and Improvements that are not attached to, built into or considered part of the Premises. 8.04 CHANGE OF CONTROL. If at any time during the Term, the ownership of Tenant shall be changed as a result of sale of assets, transfer of stock, transfer of partnership interest, merger, consolidation or otherwise so as to result in a change of the controlling interest in Tenant, Tenant shall give immediate notice thereof to Landlord. Unless Tenant shall furnish reasonable adequate assurance that there has been no reduction in the financial responsibility of Tenant as a result of any such change, Landlord may terminate this Lease at any time after receipt of such notice, or if such notice shall not be given, after discovery by Landlord of such change of controlling interest by giving Tenant sixty (60) days written notice of such termination. A "reduction in the financial responsibility of Tenant" shall occur if (a) there is a material diminution in the tangible net worth of Tenant, or (b) the debt equity ratio of Tenant is materially increased from that in effect as at the Commencement Date. For the purposes of this Section 8.04, "controlling interest" shall mean such person or entity with more than 66 2/3% of the beneficial interest in Tenant. A transfer of stock or a partnership interest in Tenant shall not be deemed to effect a change of control if the transferor controls, is controlled by or is under common control with Tenant. ARTICLE 9 SUBORDINATION, ATTORNMENT AND MORTGAGE REQUIREMENTS 9.01 SUBORDINATION. This Lease shall be subject to and subordinate at all times to the Ground Lease, and to such mortgages, liens and encumbrances as are now on or as Landlord may hereafter impose on the Project, Building or Premises, and on Landlord's interest or estate herein without the necessity of any further instrument or act on the part of Tenant to effectuate such subordination. Said liens shall include, without limitation, the lien of a mortgage executed in part to secure a loan to pay for the construction of Improvements upon the Land or in the Project. In confirmation of such subordination, Tenant agrees to promptly execute and deliver any instrument that the Ground Lessor or lien holder may require to evidence such subordination, and Tenant hereby irrevocably appoints Landlord its attorney-in-fact to execute and deliver such instruments on behalf of Tenant should Tenant refuse or fail to do so within ten (10) days after a request is made therefor. Said appointment of Landlord as Tenant's attorney-in-fact is coupled with an interest and irrevocable. Tenant shall not be required to effectuate such subordination to any mortgage, nor shall Landlord be authorized to effect such subordination on behalf of Tenant, unless the mortgagee named in such mortgage shall first agree in writing for the benefit of Tenant, that so long as Tenant is not in default under any of the provisions, covenants or conditions of this Lease, that neither this Lease nor the rights of Tenant hereunder shall be terminated or modified or be subject to termination or modification, nor shall Tenant's possession of the Premises be disturbed or interfered with, by any action or proceeding to foreclose said mortgage. 9.02 REQUIREMENTS OF LANDLORD'S MORTGAGEE AND GROUND LESSOR. In the event any mortgagee of Landlord shall elect to have this Lease, in whole or in part, as a lien prior to its mortgage, then, upon such mortgagee notifying Tenant in writing to that effect, this Lease shall have priority over the lien of such mortgage to the same extent as if the same had been placed on record prior to such mortgage. In the event any proceedings are brought for the foreclosure of, or in the event of the exercise -13- of the power of sale under, any mortgage, whether or not this Lease is terminated by such foreclosure or sale, Tenant agrees that it will, upon request by the purchaser, attorn to the purchaser upon any foreclosure or sale and recognize such purchaser as Landlord under this Lease, and agrees to execute on request a non-disturbance and attornment agreement with any such purchaser, it being the intent hereof that if this Lease should be terminated by such foreclosure or sale, it shall, upon request by such purchaser, be reinstated as a lease between such purchaser and Tenant. In the event that any mortgagee of Landlord's interest hereunder shall take possession of the Premises prior to or pending foreclosure pursuant to the terms of such mortgage, Tenant agrees upon request of such mortgagee to attorn to such mortgagee as provided in the immediately preceding sentence. If the Ground Lessor shall require, Tenant shall attorn to it and this Lease shall then continue in effect in the event of termination of the Ground Lease. Tenant, upon request of any party in interest, shall execute upon presentation such instrument or instruments as shall be requested to carry out the requirements of this Section. 9.03 ESTOPPEL CERTIFICATES. Tenant shall, at any time and from time-to-time, upon not more than ten (10) days following receipt of written notice from Landlord, execute, acknowledge and deliver to Landlord a statement in writing certifying that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease, as so modified, is in full force and effect), the dates to which the rental and other charges, if any, have been paid in advance and the amount of Tenant's Security Deposit, if any, and acknowledging that there are not, to Tenant's knowledge, any uncured defaults on the part of Landlord hereunder, and that there are no events or conditions, then in existence which, with the passage of time or notice or both, would constitute a default on the part of Landlord hereunder, or specifying such defaults, events or conditions, if any are claimed, and addressing other items required by Landlord. It is expressly understood and agreed that any such statement may be relied upon by any prospective purchaser or encumbrancer of all or any portion of the Premises, Building or Project. Tenant's failure to deliver such statement within such time shall, at the option of Landlord, constitute a default under this Lease and, in any event, shall be conclusive evidence that this Lease is in full force and effect without modification except as may be represented by Landlord in any such certificate prepared by Landlord and delivered to Tenant for execution. 9.04 LEASE AMENDMENT, FINANCIAL INFORMATION. Should a prospective mortgagee or purchaser of the Project require financial statements relating to Tenant, Tenant shall provide the requested balance sheets and income statements upon the understanding that such information shall be kept confidential. ARTICLE 10 SALE OF LANDLORD'S INTEREST 10.01 SALE OF LANDLORD'S INTEREST. Landlord shall have the right to sell, convey, transfer or assign all or any part of its interest in the Premises, Building or Project, or all or any of its rights and obligations under this Lease, without prior notice to or the consent of Tenant. 10.02 TENANT ATTORNMENT. Tenant shall attorn to any purchaser or assignee under Section 10.01. 10.03 SALE OR ASSIGNMENT BY LANDLORD. Landlord shall be automatically freed and relieved from all liability respecting the performance of any covenants or obligations on the part of Landlord contained in this Lease upon a sale, conveyance or assignment of its interest in the Premises, Building or Protect except as to the obligations already accrued. Upon any such sale, conveyance or assignment, the buyer, grantee or assignee shall become responsible for all of the covenants and conditions herein contained and on the part of Landlord to be observed or performed after the time of such sale or conveyance. ARTICLE 11 INDEMNITY AND RISK OF INJURY, LOSS AND DAMAGE 11.01 INDEMNITY. Tenant, as a material part of the consideration to Landlord for this Lease, will and does hereby assume all risk of bodily injury, wrongful death and/or property damage occasioned by any accident or nuisance made or suffered in the Premises, except where such injury, death or damage is caused by the gross negligence or willful misconduct of Landlord or Landlord's Employees, or resulting from any failure on the part of Tenant to maintain the Premises in a safe condition. Tenant hereby waives all claims in respect thereof against Landlord and Landlord's Employees, and acknowledges that this assumption of risk by Tenant has been bargained for in determining rent and other obligations of Tenant under this Lease. Tenant hereby agrees to indemnify and save harmless Landlord and Landlord's Employees from and against any and all claims, loss, cost and liability for bodily injury, wrongful death and/or property damage by any persons (including, without limitation, Tenant's Employees and Landlord's Employees) arising out of, caused or occasioned by, or resulting from any accident, fire or nuisance in the Premises, or failure to maintain the Premises, except where such injury, death or damage is caused by the gross negligence or willful misconduct of Landlord or Landlord's -14- Employees or the failure of Landlord, after reasonable written notice, to repair any structural defect, in which cases Landlord hereby agrees to indemnify and defend Tenant from and against any and all such claims, loss, cost and liability. Without limitation, Tenant will indemnify and save harmless Landlord and Landlord's Employees against and from any and all claims by or on behalf of any person or persons, firm or firms, corporation or corporations, arising from the conduct or management of any work or thing whatsoever done by Tenant or Tenant's Employees in or about the Project, or from transactions of Tenant concerning the Premises, and will further indemnify and save Landlord and Landlord's Employees harmless against and from any and all claims arising from any breach or default on the part of Tenant in the performance of any covenant or agreement on the part of Tenant to be performed pursuant to the terms of this Lease, or arising from any act or negligence of Tenant or Tenant's Employees, and shall reimburse Landlord the costs, attorneys' fees, expenses and liabilities incurred in connection with any such claim or any action or proceeding brought thereon. Tenant and Landlord further agrees that in case of any claim, demand, proceeding, action or cause of action, threatened or actual, against Landlord relating to a matter which Landlord shall be entitled to indemnification hereunder, upon Landlord's written request, Tenant shall defend Landlord at Tenant's expense by counsel mutually satisfactory to Landlord, Tenant and their respective insurance carriers. If Landlord does not request such defense or Tenant does not provide such defense, then Tenant will reimburse Landlord as aforesaid, and agrees to cooperate with Landlord in such defense, including, but not limited to, the providing of affidavits and testimony upon request of Landlord. 11.02 NON-LIABILITY OF LANDLORD. Tenant, as a material part of the consideration to Landlord for this Lease, will and hereby does assume all risk of loss or damage to furniture, fixtures, supplies, merchandise, and other property, by whomsoever owned, stored or placed in, upon or about the Premises, and does hereby agree that Landlord will not be responsible for loss or damage to any such property, unless caused by the gross negligence or willful misconduct of Landlord or Landlord's Employees, and waives all claims in respect thereof against Landlord and Landlord's Employees and acknowledges that this assumption of risk by Tenant has been bargained for in determining rent and other obligations of Tenant under this Lease. Tenant hereby agrees to indemnify and save harmless Landlord from and against any and all claims for such loss or damage, other than damage caused by the gross negligence or willful misconduct of Landlord or arising out of a defect which Landlord is required hereunder to repair and has failed to remedy within a reasonable time after having been given written notice. Without prejudice to the generality of the foregoing, Landlord shall not be liable for any damage to any property entrusted Landlord or Landlord's Employees, nor for damage to any property at any time stored or kept in the Premises or any other part of the Building or Project, arising from rain or from any other water which may leak, issue or flow from any part of the Project, or from the pipes or plumbing from the same or any other place or quarter, nor for any damage to property in the Project caused by theft or accident involving elevators, or for damage of any character arising out of defects of construction of the Project, the Premises or any machinery, equipment, electrical wiring or facility therein or failure or breakdown thereof, or from lack of repair or proper operation of the same, or from any other cause unless the cause be a defect which Landlord is required hereunder to repair and Landlord shall have failed to remedy such defect within a reasonable time after written notice. ARTICLE 12 INSURANCE 12.01 PUBLIC LIABILITY AND PROPERTY DAMAGE. Tenant shall procure at Tenant's expense and keep in force during the Term and any extension thereof, commercial general liability insurance insuring Landlord, Tenant, any mortgagee of Landlord's and/or Tenant's interest in this Lease, and such other parties as Landlord may specify, against any liability arising out of the use, occupancy or maintenance of the Premises and all areas appurtenant thereto by Tenant and Tenant's Employees. Such insurance shall be written by a company reasonably acceptable to Landlord and have reasonable minimum limits set by Landlord from time-to-time, but not less frequently than every three (3) years during the Term, based on acceptable minimum limits used for similar properties at the time of such setting. Initially, such limits shall not be less than Five Hundred Thousand Dollars ($500,000.00) for property damage against claims for property damage per single occurrence with an aggregate of One Million Dollars ($1,000,000), and One Million Dollars ($1,000,000.00) for bodily injuries including death of persons per single occurrence with an aggregate of Three Million Dollars ($3,000,000). Such insurance shall be primary and shall insure performance by Tenant of the provisions of Section 11.01; PROVIDED, HOWEVER, that the limits of such insurance shall not limit the liability of Tenant under Section 11.01. 12.02 INSURANCE ON PERSONAL PROPERTY, IMPROVEMENTS AND BUSINESS INTERRUPTION. Tenant shall procure at its own expense and will keep in force during the Term and any extension thereof, insurance on all Improvements and Tenant's trade fixtures, merchandise and personal property in the Premises, with fire, extended coverage, vandalism, malicious mischief and ceiling sprinkler leakage protection, with a responsible insurance company authorized to do business in the State of Hawaii and otherwise reasonably acceptable to Landlord, in an amount as near as practicable to the full replacement cost of such Improvements, trade fixtures, merchandise and personal property, in the joint names of Landlord, Tenant, any mortgagee of Landlord's and/or Tenant's interest in this Lease, and such other parties as Landlord may specify, as their interests may appear. All proceeds shall be payable in case of -15- loss to Tenant, and Tenant will pay all premiums on such insurance when due. Notwithstanding anything in Section 13.01 hereinbelow to the contrary, in every case of loss or damage to such Improvements, trade fixtures, merchandise and personal property, Tenant, with all reasonable speed, will use all proceeds of such insurance for rebuilding, repairing or otherwise reinstating the Improvements, trade fixtures, merchandise and personal property, in a good and substantial manner and Tenant will make up from its own funds any deficiency in such insurance proceeds. Landlord may elect to maintain such insurance, which would insure against loss of the Improvements, and in such event, upon written notice to Tenant from Landlord, Tenant will be relieved of the requirement of this Section of the Lease but only as to Improvements. The cost of any such insurance shall be an Operating Expenses as provided in Section 2.09. The foregoing provisions shall not affect the requirement of business interruption insurance which Tenant must carry and Tenant may keep the proceeds thereof for its own account. The amount of business interruption insurance shall be sufficient for Tenant to make all payments required under this Lease as well as all other continuing obligations of Tenant respecting its operations in the Premises for a period of twelve (12) months. 12.03 NOTICE TO LANDLORD. Each insurance policy required under the provisions of this Article 12 shall provide that it cannot be canceled without not less than thirty (30) days prior written notice to Landlord and any such mortgagees and, if obtainable, shall provide for notice to Landlord and any such mortgagees if not renewed at the expiration thereof. A current certificate that each such policy is in effect and, if required by Landlord, a true copy of each such policy shall be deposited with Landlord and any such mortgagees by Tenant at the commencement of the Term and renewed thereafter so as to be kept current at all times. 12.04 RECIPROCAL WAIVERS OF SUBROGATION. Landlord hereby waives on behalf of itself and on behalf of its insurance carrier, if any, any claim which Landlord might otherwise have against Tenant or Tenant's Employees arising out of any loss or damage, including consequential loss or damage, to any property of Landlord within the Premises, Building or Project from any risk required to be insured against by Landlord. Tenant hereby waives, on its behalf and on behalf of its insurance carrier, if any, any claim which Tenant might otherwise have against Landlord or Landlord's Employees arising out of loss or damage, including consequential loss or damage, to any property of Tenant within the Premises, Building or Project from any risk required to be insured against by Tenant. 12.05 OTHER PROVISIONS. Each policy of insurance required to be maintained by Tenant hereunder shall contain such further provisions and be with such insurance carriers as the Ground Lessor and any mortgagee holding an interest in the Premises, Building or Project may require. 12.06 BLANKET INSURANCE. Tenant may fulfill its obligations under this Article by maintaining a "blanket" policy or policies of insurance covering other properties besides the Premises; provided that by specific endorsement thereto coverage of the Premises is maintained at or above the level required hereunder. ARTICLE 13 DAMAGE AND RESTORATION 13.01 REPAIRS BY LANDLORD. (a) If the Premises, not including Improvements, or any portion of the Building shall be damaged or destroyed during the Term by any casualty insurable under standard fire and extended coverage policies, or if the Building shall be damaged by any other type of casualty to an extent which is less than twenty-five percent (25%) of what had been the assessed value of the Building for real property tax purposes immediately prior to such other type of casualty, Landlord shall, except as otherwise provided in this Lease and subject to any delay or inability from causes beyond its control, repair and rebuild the same substantially to its condition immediately prior to such damage or destruction. If Landlord elects under Section 12.02 to insure Improvements to the Premises, Landlord shall also repair and rebuild the Improvements hereunder. (b) If the Building shall be totally destroyed or damaged to the extent of twenty-five percent (25%) or more of what had been its assessed value for real property tax purposes immediately prior to the casualty and such casualty shall not have been insurable under standard fire and extended coverage policies, then Landlord may, at its option, either terminate this Lease or elect to repair such damage or rebuild the Building. If Landlord elects to repair or rebuild the Building, it shall perform such repair or rebuilding as provided in Section 13.01 (a), and rent shall be abated proportionately as provided in Section 13.04. Within thirty (30) days after any such casualty Landlord shall notify Tenant whether Landlord intends to repair or rebuild the Building. If Landlord elects not to repair or rebuild, this Lease shall terminate without further notice, Tenant shall immediately vacate the Premises and all further obligations of both parties hereunder shall cease (other than those which shall theretofore have accrued), effective as of the date on which Tenant vacate or ceases doing business in the Premises. If such damage or destruction occurs and the Lease is not terminated by Landlord, this Lease shall remain in full force and effect, and Landlord and Tenant waive the provisions of any law to the contrary. -16- (c) Landlord's obligation under this Section shall in no event exceed the scope of the work done by Landlord in the original construction of the Building and Premises, nor the scope of the work done in the construction of the Improvements (if Landlord shall be obligated to repair or rebuild the Improvements hereunder). 13.02 CONTINUATION OF BUSINESS. During any period of reconstruction or repair of the Premises and/or the Building, Tenant shall continue the operation of Tenant's business in the Premises to the extent reasonably practicable from the standpoint of good business practice. 13.03 REPAIRS BY TENANT. Notwithstanding anything contained in Section 13.01 to the contrary (except any obligation of Landlord to repair or rebuild the Improvements), in the event of any damage or destruction affecting the Premises, Tenant shall, unless this Lease is terminated pursuant to Section 13.01 (b), forthwith replace or fully repair all Improvements, exterior signs, trade fixtures, equipment, display cases and other property originally installed by Tenant in the Premises. 13.04 ABATEMENT OF RENT. During any period in which, by reason of any damage or destruction to the Premises and/or Building, there is substantial interference with the operation of Tenant's business in the Premises, Base Rent shall be abated proportionately according to the extent to which Tenant may be required to discontinue Tenant's business in the Premises. Such abatement shall continue for the period commencing with such destruction or damage and ending with the completion by Landlord of such repair or rebuilding work as Landlord is obligated to perform pursuant to this Lease. ARTICLE 14 CONDEMNATION 14.01 TERMINATION OF LEASE AS TO PORTION TAKEN. If the Premises or any part thereof or interest therein (including Landlord's ability to provide Tenant with parking as set forth herein) is taken by condemnation (other than a temporary taking, which is provided for in Section 14.06), this Lease shall terminate as to the part so taken upon the earlier of the time possession or title thereof vests in the condemnor. 14.02 LANDLORD'S OPTION TO TERMINATE. If (a) any part of or interest in the Premises is taken by condemnation or (b) a substantial portion of the Building or Project is taken by condemnation and Landlord shall decide to discontinue the use or operation of the Building or to demolish, alter or rebuild the same as a result of such taking, then Landlord shall have the right to terminate this Lease by giving Tenant written notice of termination within sixty (60) days after such taking. Any such termination shall be effective as of the last day of the calendar month next following the month in which such notice is given. 14.03 TENANT'S OPTION TO TERMINATE. If more than twenty-five percent (25%) of the Premises is taken by condemnation and the remaining part is thereby rendered reasonably unfit for Tenant's use, Tenant may terminate this Lease by giving Landlord written notice of termination within fifteen (15) days after possession is lost or title passes, whichever shall first occur unless Landlord is able to relocate Tenant as provided in Section 4.14 or is able to replace the portion of the Premises so taken within thirty (30) days of the effective date of the termination of the Lease. Any such termination shall be effective as of the last day of the calendar month next following the month in which such notice is given. 14.04 REDUCTION OF RENT. If part of the Premises is taken by condemnation (other than a temporary taking which is provided for in Section 14.06 hereinbelow) and neither Landlord nor Tenant shall terminate this Lease as provided herein, then this Lease shall continue as to the part of the Premises not taken and the Base Rent shall be reduced in the same proportion as the Net Rentable Area of the Premises shall have been reduced as a result of such taking, and Tenant's Proportionate Share shall be recalculated. 14.05 RIGHT TO COMPENSATION. In the event of any taking described in Sections 14.01, 14.02 or 14.03, all compensation and damages payable or to be paid for or by reason of such taking shall be payable to and be the sole property of Landlord without any apportionment to Tenant, and Tenant hereby assigns to Landlord any right to compensation or damages for its leasehold interest in the Premises condemned; PROVIDED, HOWEVER, that Tenant shall not be prevented hereby from filing any claim against the condemning authority for the taking of any Improvements, equipment or fixtures owned by Tenant and for moving expenses. Termination of this Lease by Landlord pursuant to Section 14.02 or by Tenant pursuant to Section 14.03 shall not affect the respective rights of Landlord and Tenant to compensation and damages. 14.06 TAKING FOR A LIMITED PERIOD. If the Premises or any part thereof shall be temporarily taken by condemnation for a limited period, this Lease shall not terminate. Tenant shall continue to pay in full all amounts provided for herein, in the manner and at the times herein specified, and, except only to the extent that Tenant is prevented from so doing by reason of any order of the condemning authority, -17- Tenant shall continue to perform and observe all of the other covenants, agreements, terms and provisions of this Lease as though such taking had not occurred. In the event of any such taking, Tenant shall be entitled to the entire amount paid by governmental authority with respect to governmental occupancy of the Premises during the Term (whether paid by the authority as damages, rent or otherwise), and in the event any such governmental occupancy extends beyond the date of termination of this Lease, all such amounts paid by governmental authority shall be prorated as of the date of termination of this Lease. Landlord shall have a lien on all amounts payable to Tenant and may require Tenant to assign the same to Landlord to be held without interest as security for the payment of rent and other sums that shall be payable by Tenant during such period. Tenant covenants that at the termination of any such limited taking prior to the expiration or earlier termination of this Lease, Tenant will restore the Premises and Improvements therein as near as reasonably possible to the condition that the same were in prior to such taking. ARTICLE 15 DEFAULT BY TENANT 15.01 DEFINITION OF DEFAULT. Tenant will be in default under this Lease if any of the following events occur: (a) Tenant shall fail to pay Base Rent, Operating Expense Payment or any other amount on the date the same becomes due and such failure continues for five (5) days following Tenant's receipt of Landlord's written notice thereof. (b) Tenant shall fail to increase the Security Deposit as provided in Section 3.08(b) or to replenish the Security Deposit as provided in Section 3.08(c). (c) Tenant shall fail to make repairs as provided in Section 6.05. (d) Tenant shall fail to observe and comply with the Rules and Regulations. (e) Tenant or Tenant's Employees shall fail to perform or comply with any provision of the Parking Agreements to which they are a party. (f) Tenant shall fail to remove and bar a Tenant Employee as provided in Section 4.20. (g) Tenant shall fail to pay when due any billing for utility consumption under Section 3.09(a) and such failure continues for five (5) days following Tenant's receipt of Landlord's written notice thereof. (h) Tenant shall, or shall attempt to, assign, mortgage, pledge, encumber, transfer or sublet the Premises without Landlord's required consent. (i) Tenant shall fail to timely deliver an Estoppel Certificate as required by Section 9.03. (j) Tenant shall fail to observe or perform any of the other covenants in the Lease which are Tenant's responsibility, and such default shall continue for ten (10) days after written notice thereof is given to Tenant, or, if such default cannot reasonably be cured within said 10-day period, such longer time as may be required, provided that Tenant shall within said period commence such cure and then continue it to completion. (k) Tenant shall become bankrupt, or file any debtor proceedings, or any case or proceeding, voluntary or involuntary, shall be filed by or against Tenant as debtor under any provision of the Federal Bankruptcy code or any State statute governing any debtor-creditor rights, which seeks to have an order or decree rendered against Tenant directing any readjustment, arrangement, composition or reduction of Tenant's debts, liabilities or obligations, or making any assignment for the benefit of creditors and such proceedings are not dismissed within ninety (90) days. (l) Tenant shall vacate or abandon the Premises, or shall fail to take occupancy of the Premise on the Commencement Date. (m) Tenant shall fail to procure insurance and keep such insurance in force as provided in Section 12.01. (n) This Lease or any interest of Tenant hereunder shall become subject to any attachment or judgment, or to any lien, charge or encumbrance not consented to by Landlord pursuant to the provisions of this Lease. -18- (o) Any guarantor of this Lease shall default under any guaranty of this Lease, or shall repudiate or revoke such guaranty or any obligation under such guaranty. 15.02 LANDLORD'S REMEDIES. In the event of any default described in Section 15.01 or if otherwise provided in this Lease, the following shall be Landlord's remedies: (a) RIGHT OF RE-ENTRY. Landlord may at once re-enter and take possession of the Premises without notice and without being deemed guilty of any trespass or becoming liable for any loss or damage occasioned thereby. (b) SUMMARY POSSESSION. Landlord may bring an action for summary possession and, in any such action, service of prior notice of default and intent to terminate the Lease or demand for payment are hereby expressly waived. (c) REMOVAL OF PERSONS AND PROPERTY. In the event of Landlord's resumption of possession whether by summary proceedings or by any other means, Landlord, or any receiver appointed by a court having jurisdiction, may dispossess and remove all persons and property from the Premises, and any property so removed may be stored in any public warehouse or elsewhere at the cost of and for the account of Tenant, and Landlord shall not be responsible for the care of safekeeping thereof, and Tenant hereby waives any and all claims for loss, destruction, damages or injury which may be occasioned thereby. All property removed from the Premises and not claimed, including payment of all charges incurred by Landlord in the removal and storage of such property, within forty-five (45) days of removal shall be considered abandoned. All abandoned property may be destroyed or disposed of by Landlord in any manner in its sole discretion, including by public or private sale. All proceeds from such sale shall be applied, in order, to expenses of sale, to cost of removal and storage, to all amounts owed by Tenant to Landlord and, lastly, any balance shall be paid over to Tenant. (d) DAMAGES, ATTORNEYS' FEES AND COSTS. Landlord may recover from Tenant all damages, attorneys' fees and costs which may be incurred by Landlord as a result of any default of Tenant hereunder, including the expense of recovering possession. (e) ELECTION TO TERMINATE LEASE. Landlord may terminate the Lease. No re-entry or taking of possession of the Premises by Landlord shall be construed as an election on Landlord's part to terminate this Lease, unless a written notice that this Lease is terminated is given by Landlord to Tenant, or a judicial order is secured stating that this Lease is terminated. The effective date of a termination of this Lease shall be as of the date set forth or provided in the notice or order. (f) RELETTING OF PREMISES. Landlord may, without terminating this Lease, relet for the account of Tenant the Premises or any part thereof, for all or any portion of the remainder of the Term, to a tenant or tenants satisfactory to Landlord, and at such rental or rentals as may, in the exercise of reasonable effort, be obtained, with the right to Landlord to put the Premises in good order and condition and to make reasonable alterations and repairs to facilitate such reletting at Tenant's expense, and Landlord shall receive such rentals and apply them, first to the payment of the expense of recovering possession of the Premises and the re-renting thereof, including without limitation, all attorneys' fees and brokers' commissions, together with such expenses as Landlord may have incurred in putting the Premises in good order and condition or in making such alterations and repairs, and then to the payment of rent and to the fulfillment of the covenants of Tenant, the balance, if any, to be paid over to Tenant; PROVIDED, HOWEVER, that Tenant shall remain liable for any deficiency, which deficiency Tenant agrees to pay monthly as the same may accrue. Notwithstanding any such reletting without termination, Landlord may at any time thereafter elect to terminate this Lease for such previous breach. (g) LIQUIDATED DAMAGES. If the Lease is terminated by Landlord by reason of Tenant's default, Landlord shall be entitled to recover from Tenant liquidated damages in an amount equal to the excess, if any, of the then cash value of rent payable by Tenant for the balance of the Term, over the reasonable rental value of the Premises at the time of such termination, for the same period and on the same terms, except as to rent. The cause of action for such damage shall accrue upon such termination. (h) USE OF SECURITY DEPOSIT. Landlord may apply the Security Deposit to the cure of Tenant's default as provided in Section 3.08(c). (i) RIGHT TO CURE. Landlord may, at Tenant's cost and expense, cure a default of Tenant as provided in Section 3.12. (j) RIGHT TO MAKE REPAIRS. Landlord may, at Tenant's cost and expense, pursuant to Section 3.11, make repairs Tenant has failed to make. (k) TERMINATION OF ELECTRICAL POWER. Upon a failure to pay for electrical power under Section 3.09(a), Landlord may cease providing electrical service to the Premises without further notice. -19- (l) SEPARATE SUITS. Landlord shall have the right to divide its causes of action hereunder so as to permit separate suits for summary possession of the Premises, and for Base Rent and additional rent under the Lease, and no institution of a suit or entry of judgment thereunder shall bar Landlord from a subsequent suit or be deemed an election of remedies by Landlord. 15.03 REMEDIES ARE CUMULATIVE. Each and all of the remedies given to Landlord hereunder are cumulative and the exercise of one remedy by Landlord shall not impair Landlord's right to any other remedy. ARTICLE 16 TERMINATION 16.01 SURRENDER OF THE PREMISES. At the expiration or sooner termination of this Lease, Tenant will surrender and deliver to Landlord possession of the Premises, including all Improvements, in good condition and repair, ordinary use and wear excepted. If there shall be no default on the part of Tenant at the expiration or termination of this Lease, Tenant may, or if Landlord shall so require will, remove all signs and trade fixtures (including all audio/visual equipment) erected or placed upon the Premises and, on Landlord's requirement only, shall also remove any Improvements made or placed in the Premises by Tenant to the extent specified in Section 6.03 and otherwise specified by Landlord on the Construction Plans set forth on Exhibit F contemporaneously with Landlord's approval of same. Tenant shall repair all damage to the Premises and remaining Improvements caused by or resulting from such removal and leave the Premises in a clean and orderly condition, ordinary wear and tear excepted. In the event Tenant shall fail to perform such removal and restoration, Landlord may do so and Tenant, upon demand, will pay to Landlord the cost thereof, plus interest as provided in Section 3.13. This obligation shall survive the expiration or termination of this Lease. Any property left upon the Premises by Tenant at the expiration or earlier termination of this Lease may, at the option of Landlord, be (a) removed and stored by Landlord, at Tenant's cost, or (b) be deemed by Landlord to have been abandoned by Tenant, in which case Landlord may appropriate, destroy or dispose of the same without liability or accountability to Tenant. 16.02 HOLDING OVER. If Tenant shall remain in possession after the expiration or sooner termination of this Lease, all the terms, covenants and agreements hereof shall continue to apply and bind Tenant so long as Tenant shall remain in possession, insofar as the same are applicable; except, that, if Tenant remains in possession without Landlord's written consent, the Base Rent shall be two (2) times the Base Rent for the last Lease Month of the Term, prorated on a daily basis for each day that Tenant remains in possession, and Tenant shall also be liable to Landlord for any damages resulting from failure to surrender possession. If Tenant remains in possession with Landlord's written consent, such tenancy shall be month-to-month, terminable by either party by not less than twenty-five (25) days written notice prior to the end of a Lease Month. ARTICLE 17 GROUND LEASE 17.01 GROUND LEASE. The Land described in Exhibit B is owned in fee by Loyalty Development Company, Ltd., a Hawaii corporation. The Land is leased to Landlord under ground lease dated April 14, 1981, filed with the Office of the Assistant Registrar of the Land Court of the State of Hawaii as Document No. 1063148, as amended and restated by instrument dated November 22,1985, filed as aforesaid as Document No. 1344011 and as may be further amended from time to time (the "Ground Lease"). ARTICLE 18 LANDLORD'S LIABILITY 18.01 LANDLORD'S FAILURE TO PERFORM. Landlord shall not be deemed to be in default in the performance of any obligation required by this Lease unless Landlord has failed to perform such obligation within thirty (30) days after written notice by Tenant to Landlord. The notice shall specify what obligation Landlord has failed to perform. If the nature of Landlord's obligation is such that more than thirty (30) days are required for its performance, Landlord shall not be in default if Landlord within thirty (30) day period commences to cure the default and then continues the cure to completion. No such default by Landlord shall constitute grounds for canceling this Lease. If Landlord does not perform any such obligations within said thirty (30) day period or, if the nature of the obligation is such that more than thirty (30) days are required for its performance and Landlord does not reasonably continue the cure to completion, Tenant may, after a ten (10) day written notice of its intent to cure such default and failure of Landlord to cure or commence such cure within such ten (10) day period, perform such obligation and bill Landlord for the reasonable cost of same. Landlord shall promptly pay Tenant for all such reasonable costs incurred and upon Landlord's failure to reimburse Tenant within sixty (60) days following -20- Landlord's receipt of Tenant's bill, Tenant shall have the right to offset such amount against Base Rent notwithstanding any other provision of this Lease to the contrary. 18.02 NOTICE TO LANDLORD'S MORTGAGEES. Tenant agrees to give all mortgagees, under mortgages of any interest of Landlord in the Premises, Building or Project, by registered mail, a copy of any notice of failure to perform served upon Landlord; provided that prior to such notice Tenant has been notified, in writing, of the address of any such mortgagee. Tenant further agrees that, if Landlord shall fail to cure such failure to perform within the time provided for in this Lease, before Tenant pursues its other remedies any such mortgagee shall have an additional sixty (60) days within which to cure the default, or if such default cannot be cured within that time, then such additional time as may be necessary, provided that such mortgagee has commenced and is diligently pursuing the remedies necessary to cure such default within such sixty (60) days. 18.03 LIMITATION ON LIABILITY OF LANDLORD AND MORTGAGEE. In the event Landlord is a trust or partnership, if Landlord fails to perform any covenant or obligation on the part of Landlord contained in this Lease, Tenant may proceed only against the trust or partnership and may recover only from the assets of the trust or partnership. Tenant shall have no right to proceed against or recover from any trustee or partner of Landlord, individually or collectively, or Landlord's Employees, except to the extent provided in the preceding sentence. The liability of any mortgagee who succeeds to the interest of Landlord under this Lease by foreclosure, deed in lieu of foreclosure or otherwise shall be limited to such mortgagee's interest in the Project. ARTICLE 19 MISCELLANEOUS 19.01 NO LIGHT, VIEW OR AIR EASEMENT. Any diminution or shutting off of light, view or air by any structure which may be erected on the Land or on land adjacent to or in the vicinity of the Premises (including any structure erected on any portion of the Land removed from the Project) shall in no way affect this Lease, abate rent or otherwise impose any liability on Landlord. 19.02 TIME OF ESSENCE. Time is of the essence of this Lease. 19.03 BROKERAGE COMMISSIONS. Unless stated otherwise in Exhibit E - Special Conditions, Landlord and Tenant represents that they have dealt directly with each other in connection with this Lease and that no brokers negotiated, or are entitled to any commission in connection with, this Lease. Landlord and Tenant agree to indemnify each other against, and hold each other harmless from, all liabilities and costs (including, without limitation, attorneys' fees incurred by Landlord) arising from the claims of any broker based upon acts of the indemnifying party. 19.04 EXECUTION BY LANDLORD. The submission of this Lease for examination does not constitute a reservation of or option to lease the Premises, and this Lease shall become effective as a lease only upon execution and delivery by both Tenant and Landlord. 19.05 RENEWAL. Unless otherwise stated in Exhibit E - Special Conditions, Landlord shall have no obligation to extend or renew this Lease, or to enter into another lease of the Premises with Tenant upon expiration of this Lease. Upon expiration of this Lease, Landlord may lease the Premises to whomever it chooses for the operation therein of a business that is the same as or different from that operated by Tenant in the Premises. 19.06 COST AND ATTORNEY'S FEES. In the event of any action or proceeding brought by either party against the other based upon or arising out of any breach of the terms and conditions hereof, the prevailing party shall be entitled to recover all reasonable costs, including reasonable attorneys' fees, from the other. Tenant also agrees to pay all cost and reasonable attorneys' fees which may be incurred or paid by Landlord in enforcing without litigation any of the covenants, conditions or agreements contained in this Lease, and all such amounts shall be deemed payable upon demand. If Landlord becomes involved in any action, threatened or actual, by or against anyone not a party to this Lease, but arising by reason of or related to any act or omission of Tenant or Tenant's Employees, Tenant agrees to pay Landlord's reasonable attorneys' fees and other reasonable costs incurred in connection with such action. 19.07 LANDLORD'S CONSENT. If Landlord's approval or consent is required in this Lease, unless otherwise specifically provided to the contrary, such approval or consent may be granted or denied by Landlord at its sole discretion and Landlord shall not be required to provide Tenant with an explanation for the denial of any approval or consent. 19.08 NOTICE. All notices required or permitted hereunder shall be in writing and may be delivered for all purposes by being (a) sent as registered or certified mail, postage prepaid, return receipt requested, nationally recognized overnight express service or by telecopy addressed to Tenant at its post office address hereinbelow set forth, or to Landlord at its post office address hereinbelow set forth or at such other post office address as Landlord may from time-to-time designate in writing by notice to -21- Tenant, or (b) delivered personally to Tenant (if Tenant is an individual), to a general partner of Tenant (if Tenant is a partnership), or to an officer or director of Tenant (if Tenant is a corporation). Any such notice shall be conclusively deemed to have been delivered upon the earlier of (a) actual receipt of mail or telecopy, or (b) two (2) days after the date of such mailing. If there is more than one Tenant, delivery of notice to any one thereof shall be construed as notice to all Tenants. All notices shall be made to: IF TO TENANT: Ed Jacobs, President National Telephone & Communications, Inc. 2801 Main Street Irvine, California 92614 Fax: 714-251-8085 With copy to: National Telephone & Communications, Inc. Legal & Regulatory Department Attn: Dale R. DeForge 2801 Main Street Irvine, California 92614 Fax: 714-224-7751 IF TO LANDLORD: Paiea Properties 550 Paiea Street, Suite 102 Honolulu, Hawaii 96819 Attn: Property Management Fax: 808-833-3046 19.09 SEVERABILITY. If for any reason any of the provisions of this Lease shall be unenforceable or ineffective, all of the other provisions shall remain in full force and effect. 19.10 WAIVER. Landlord's failure to take advantage of any default or breach of covenant on the part of Tenant shall not be construed as a waiver thereof, nor shall any custom or practice which may grow up between Landlord and Tenant in the course of administering this Lease be construed to waive or to lessen the right of Landlord to insist upon the performance by Tenant of any term, covenant or condition hereof, or to waive or lessen the right of Landlord to exercise any remedies given Landlord due to any default by Tenant. A waiver by Landlord of a particular breach or default shall not be deemed to be a waiver of the same or any other subsequent breach or default. The acceptance of Base Rent or any other sum due hereunder shall not be, or be construed to be, a waiver of any breach of any term, covenant or condition of this Lease, whether or not Landlord has knowledge of such breach at the time of such acceptance. 19.11 SUCCESSORS. Except as otherwise provided, all of the covenants, agreements, terms and conditions contained in this Lease shall be for the benefit of and binding upon Landlord and Tenant and their respective heirs, personal representatives, successors and permitted assigns. 19.12 JOINT AND SEVERAL OBLIGATIONS. In any case where this Lease is signed by more than one Tenant, the obligations hereunder shall be joint and several. 19.13 CHOICE OF LAW. This Lease shall be governed by and construed in accordance with the laws of the State of Hawaii. 19.14 ARTICLE AND SECTION HEADINGS. The article and section headings herein are for convenience of reference, and shall in no way define, limit or describe the scope or intent of any provisions of this Lease. 19.15 SHORT-FORM LEASE. This Lease shall not be recorded by either Landlord or Tenant; PROVIDED, HOWEVER, that upon request by Landlord, Tenant will execute and deliver a recordable short-form of this Lease, stating the names of the parties, the Term, the description of the Premises, and the nature of any options for renewal. Landlord will supply the short-form Lease and Tenant will pay to Landlord a reasonable fee for the preparation and recordation of such short-form Lease including, without limitation, reasonable attorneys' fees. Tenant shall pay the amount of the State of Hawaii conveyance tax as a result of this Lease, if any. 19.16 FORCE MAJEURE. Unless otherwise specifically provided herein, if either Landlord or Tenant shall be delayed or hindered in or prevented from the performance of any act required hereunder by reason of strikes, lockouts, labor disputes or disturbances, inability to produce materials, failure of power, restrictive governmental laws or regulations, riots, insurrection, war or any other reason of a like nature not the fault of the party delayed in performing work or doing acts required by this Lease, then performance of such act shall be excused for the period of the delay, and the period for the performance of such act shall be extended for a period equivalent to the period of such delay; PROVIDED, -22- HOWEVER, that this Section shall not operate to excuse Tenant from the prompt payment of Base Rent, Operating Expense Payment or other sums required by this Lease to be paid by Tenant. 19.17 HAZARDOUS MATERIALS. (a) DEFINITIONS. (i) As used in this Lease, the term "Hazardous Materials Laws" means and includes all federal, state or local laws, ordinances or regulations, now or hereafter in effect, relating to environmental conditions, industrial hygiene or Hazardous Materials on, within, under or about the Project. (ii) As used in this Lease, the term "Hazardous Materials" means and includes all radioactive materials, asbestos, organic compounds known as polychlorinated biphenyls, chemicals known to cause cancer or reproductive toxicity, pollutants, contaminants, hazardous wastes, toxic substances, and any and all other substances or materials defined as or included in the definition of "hazardous substances," "hazardous wastes," "hazardous materials," or "toxic substances" under, or for the purposes of, the Hazardous Materials Laws. (iii) As used in this Lease, the term "Hazardous Discharge'' means any event involving the use, deposit, disposal, spill, release or discharge of any Hazardous Material on, within or under the Project. (iv) As used in this Lease, the term "Hazardous Materials Claims" means and includes (1) any and all enforcement, clean-up, removal, mitigation or other governmental or regulatory actions instituted, or to the best of Tenant's knowledge contemplated or threatened, in respect of the Project pursuant to any Hazardous Materials Laws, and (2) any and all claims made or to the best of Tenant's knowledge contemplated or threatened, by any third party against Tenant or any other person or entity seeking damages, contribution, cost recovery, compensation, injunctive relief or similar relief resulting from any Hazardous Discharge or from the existence of any Hazardous Material on, within or under the Project. (v) As used in this Lease, the term "Hazardous Material Contamination" means the contamination (whether presently existing or hereafter occurring) of the Improvements, facilities, soil, groundwater, air or other elements on or of the Premises by Hazardous Material, or the contamination of the buildings, facilities, soil, groundwater, air or other elements on or of any other property as a result of Hazardous Material at any time emanating from the Premises. (vi) As used in this Lease, the term "Release" means any spilling, leaking, pumping, pouring, emitting, emptying, discharging, injecting, escaping, leaching, dumping or disposing into the environment (including, but not limited to the abandonment or discarding of barrels, containers, and other receptacles containing any Hazardous Material). (vii) As used in this Lease, the term "Reportable Quantity" means that quantity of a material as set forth in 40 C.F.R. Part 302. (viii) As used in this Lease, the term "Adverse Environmental Impact" means (i) Release of a Hazardous Material in a Reportable Quantity or (ii) any material adverse impact on human health or the quality of any property. (b) REPRESENTATIONS OF LANDLORD REGARDING PREMISES. (i) Notwithstanding any other provision in this Lease to the contrary, Landlord hereby warrants, covenants and represents to Tenant that, with respect to the Premises, except as disclosed in the Environmental Assessment Dated May 16, 1994 performed by RERC Environmental, Inc. (the "Phase I Report"): (1) to Landlord's best knowledge and belief, it is in material compliance, without exception, with Hazardous Materials Laws; (2) Landlord has no present knowledge, directly or indirectly, of the issuance or threat of issuance by a Governmental Agency of any notice or violation of the Hazardous Materials Laws by the Landlord or a co- tenant; (3) to Landlord's best knowledge and belief, no Hazardous Material in violation of applicable laws are located on the Premises in such a manner or condition that results or could reasonably be expected to result in any Adverse Environmental Impact; (4) to Landlord's best knowledge and belief, no part of the Premises has ever been used for the disposal, storage, treatment, processing, manufacturing or other handling of Hazardous Material in such a manner as to result in any Adverse Environmental Impact, nor has any part of the Premises been affected by any Hazardous Materials contamination; (5) Landlord has not obtained and is not required to obtain any licenses, permits or authorizations pursuant to any Hazardous Materials Laws in order to construct, occupy, -23- operate or use any building, improvements, fixture or equipment constituting any part of the Premises; and (6) no investigation, administrative order, consent order and agreement, litigation or settlement with respect to Hazardous Material or Hazardous Material Contamination is proposed, threatened, anticipated or in existence. (c) REPRESENTATIONS OF TENANT REGARDING PREMISES. (i) For the purpose of inducing Landlord to lease to Tenant the Premises, Tenant does hereby represent to and agree with Landlord as follows: (1) Tenant covenants to Landlord that Tenant and Tenant's Employees on, within, under or about the Project will not use, generate, manufacture, treat, handle, refine, produce, process, store, discharge, release, dispose of or allow to exist on, within, under or about the Project, any Hazardous Material, except in full compliance with all applicable Hazardous Materials Laws. (2) If Tenant at any time becomes aware of any Hazardous Discharge, of any Hazardous Materials Claim or any inquiry, test or investigation with respect to the Premises, Tenant will immediately advise Landlord thereof, in writing, and provide to Landlord such detailed reports thereof as may be in Tenant's possession. Landlord shall have the right to join and participate in, as a party if it so elects, any settlements, remedial actions, legal proceedings or actions initiated in respect of any Hazardous Materials Claims. (3) In the event any investigation or monitoring of site conditions or any clean-up, containment, restoration, removal or other remedial work (collectively, the "Remedial Work") is required under any applicable federal, state or local law, by any judicial order, or by any governmental entity as the result of operations or activities upon, or any use or occupancy of any portion of the Premises by Tenant, Tenant shall perform or cause to be performed the Remedial Work in compliance with such law or order. All Remedial Work shall be performed by one or more contractors, selected by Tenant and approved in advance in writing by Landlord, and under the supervision of a consulting engineer, selected by Tenant and approved in advance in writing by Landlord. All costs and expenses of such Remedial Work shall be paid by Tenant, including, without limitation, the charges of such contractor(s), the consulting engineer and Landlord's reasonable attorneys' fees and costs incurred in connection with monitoring or review of such Remedial Work. Notwithstanding such payment by Tenant, Tenant shall be entitled to file a claim for reimbursement under any state or local trust or clean-up fund provided by state or any local governmental entity. (d) INDEMNIFICATION. Each party will indemnify such other party against and hold harmless from all reasonable expenses (including reasonable fees of legal counsel), losses, damages (including foreseeable or unforeseeable consequential damages) and liabilities incurred by such other party which may arise out of or may be directly or indirectly attributable to (i) the use, generation, manufacture, treatment, handling, refining, production, processing, storage, Release, discharge, disposal or presence in violation of Hazardous Materials Laws of any Hazardous Materials on, within, under or about the Premises, caused by such party or such party's employees, (ii) such other party's investigation and handling (including the defense) of any Hazardous Materials Claims, whether or not any lawsuit or other formal legal proceeding shall have been commenced in respect thereof, and (iii) such other party's enforcement of this Lease, whether or not suit is brought therefor. The provisions of this paragraph shall survive the expiration, termination, assignment or cancellation of this Lease. Landlord will also indemnify and hold harmless Tenant from all reasonable expenses (including reasonable fees of legal counsel), losses, damages (including foreseeable or unforeseeable consequential damages) and liability incurred by Tenant which may arise out of or may be directly or indirectly attributable to the use, generation, manufacture, treatment, handling, refining, production, processing, storage, Release, discharge, disposal or presence of any Hazardous Materials in violation of Hazardous Materials Laws prior to Tenant's lease period. (e) SURVIVAL. Each of the covenants, agreements and indemnities of Tenant set forth in this Section shall survive the expiration or earlier termination of this Lease. (f) TRANSFER. It shall not be unreasonable for Landlord to withhold its consent to any proposed transfer, assignment or subletting of the Premises if (i) the proposed transferee's anticipated use of the Premises involves the use, handling, storage, generation, treatment or disposal of Hazardous Materials; (ii) the proposed transferee has been required by any prior landlord, lender or governmental authority to take any remedial action in connection with Hazardous Materials contaminating a property if the contamination resulted from such transferee's actions or use of the property in question and transferee has failed to timely comply, or (iii) the proposed transferee is subject to and has failed to comply with an enforcement order issued by any governmental authority in connection with the use, handling, storage, generation, treatment or disposal of Hazardous Materials. (g) LANDLORD INSPECTIONS AND TESTS. Landlord and its employees, representatives and agents shall have access to the Premises and the Land during reasonable hours and upon reasonable notice to Tenant in order to conduct environmental inspections and tests of Hazardous Materials -24- contamination of the Premises and Land or for such other reasons as Landlord deems necessary. Such testing shall be at Tenant's expense if Landlord has a reasonable belief that such contamination exists. (h) ENVIRONMENTAL CLAIMS. Notwithstanding anything to the contrary hereinabove provided in this Section 19.17, the following shall apply: (i) Whenever Landlord learns of a claim (including but not limited to a governmental notice of violation of any Hazardous Materials Laws) which, if allowed, would or might give rise to a right of indemnification from Tenant (the "Claim"), then before paying the same or making any commitment to pay the same, and within ten (10) days of learning of such claim, Landlord shall give Tenant written notice of the Claim. Tenant shall notify Landlord in writing within (10) days of the giving of notice of the Claim whether Tenant agrees to the merits of the Claim or disputes the same. Failure by Tenant to give notice of dispute shall be deemed an agreement to the merits of the Claim. Any Claim as to which timely notice of dispute is given is referred to hereinafter as a "Disputed Claim". (ii) If Tenant disputes a Claim, Tenant at its sole cost and expense, shall promptly take all steps necessary to defend Landlord against the Claim, and Tenant shall pay any final judgment, award or fine that is entered in connection with the Claim. Landlord shall have the right to participate in any proceedings in connection with the Claim, but so long as Tenant is diligently defending against the Claim, such participation by Landlord shall be solely at its own cost and expense. If Tenant fails to diligently defend against the Claim at its sole cost, Landlord may defend against the Claim as it shall see fit, and Tenant shall be liable to Landlord pursuant to its indemnity obligations as provided above in this Section 19.17. (iii) In the event of any Claim to which Tenant's indemnification obligations apply, Landlord will provide Tenant with reasonable access to such of Landlord's records and such of Landlord's Employees and agents as may be reasonably necessary to enable Tenant to evaluate the Claim, to effectively defend against the Claim, and to otherwise effectively perform its indemnification obligations. In addition, Landlord will use its best efforts to cause such employees and agents to cooperate with Tenant in connection with its investigation and/or defense of the Claim. (iv) If (i) notice of the Claim shall not be given to Tenant or (ii) a Disputed Claim is paid or settled without the consent of Tenant, then no liability shall be imposed on Tenant with regard to that Claim. (v) Nothing in this Section 19.17 shall be construed to make Tenant liable hereunder for any Hazardous Discharge or the presence of any Hazardous Materials affecting the Property except to the extent such Hazardous Discharge or presence was a result of Tenant's own actions or the action of Tenant's Employees, agents, contractors, licensees or invitees. 19.18 PERIODIC FINANCIAL STATEMENTS TO LANDLORD. As a material inducement to Landlord to execute this Lease, Tenant at all times represents that all financial data and other information provided to Landlord is accurate and discloses fully the financial condition of Tenant in accordance with generally accepted accounting principles. Tenant agrees to provide its annual financial statements to Landlord (i) within ninety (90) days of Tenant's year- end, and (ii) within thirty (30) days following Landlord's written request for same at any time during the Term of this Lease. If Tenant's annual financial statements are not audited and certified as to accuracy by a Certified Public Accountant, then Tenant, in addition to providing the annual financial statements, agrees to provide Landlord with its federal income tax returns for each year contemporaneously with the filing of same. 19.19 ACKNOWLEDGMENT OF WAVIER OF JURY TRIAL. Landlord and Tenant agree that to the extent permitted by law, each shall and does waive trial by jury in any action, proceeding or counterclaim brought by either against the other on any matter whatsoever arising out of or in any way connected with this Lease, the relationship of Landlord and Tenant, Tenant's use or occupancy of the Premises or any emergency or statutory remedy. Tenant's initials EJ ----------- 19.20 ENTIRE AGREEMENT. The provisions of this Lease constitute, and are intended to constitute, the entire agreement of Landlord and Tenant regarding the Lease. No terms, conditions, warranties, promises or undertakings of any nature whatever, express or implied, exist between Landlord and Tenant except as expressly set forth in this Lease. Any amendment or modification of this Lease must be in writing and signed by both Landlord and tenant. -25- IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease as of the day and year first above written. LANDLORD: PAIEA PROPERTIES, a Hawaii limited partnership By: NIMITZ-PAIEA, INC., its general partner By: /s/ T. Gregory Kemp ------------------------------------------- T. Gregory Kemp Its Vice President TENANT: NATIONAL TELEPHONE & COMMUNICATIONS, INC., a Nevada corporation By: /s/ Ed Jacobs ------------------------------------------- Its President ---------------------------------------- By: ------------------------------------------- Its ---------------------------------------- -26- STATE OF HAWAII ) ) SS. COUNTY OF HONOLULU ) On this 22nd day of November, 1996, before me, Sheila A. Tomei, Notary Public, State of Hawaii, duly licensed and sworn, personally appeared T. Gregory Kemp, proved to me on the basis of satisfactory evidence to be the person who executed the within instrument as Vice President of NIMITZ-PAIEA, INC., a Hawaii corporation, which corporation is the sole general partner of PAIEA PROPERTIES, a Hawaii registered limited partnership, and acknowledged that said instrument was signed in behalf of said corporation by authority of its Board of Directors, and the said officer acknowledged said instrument to be the free act and deed of the corporation and the partnership. WITNESS my hand and official seal. /s/ Sheila A. Tomei ----------------------------------------- Notary Public, in and for said State and County My Commission Expires: 8-4-98 ------------------- -27- STATE OF California ) ) SS. COUNTY OF Orange ) On this 20 day of November, 1996, before me, Debra A. Checka, Notary Public, State of California, duly licensed and sworn, personally appeared E.R. Jacobs and _____________________________, proved to me on the basis of satisfactory evidence to be the persons who executed the within instrument as President and Chief Executive Officer of NATIONAL TELEPHONE & COMMUNICATIONS, INC., a Nevada corporation, and acknowledged that said instrument was signed in behalf of said corporation by authority of its Board of Directors, and the said officers acknowledged said instrument to be the free act and deed of the corporation. WITNESS my hand and official seal. /s/ Debra A. Chuckas ----------------------------------- Notary Public, in and for said State and County My Commission Expires: July 3, 1998 --------------- -28- EXHIBIT A LOCATION OF PREMISES AND FLOOR PLAN EXHIBIT A - Page 1 EXHIBIT B LAND DESCRIPTION FOR AIRPORT TRADE CENTER [550 PAIEA STREET, HONOLULU] All of that certain parcel of land situate at Moanalua, Honolulu, City and County of Honolulu, State of Hawaii, described as follows: LOT 3836, area 298,147.0 square feet, more or less, as shown on Map 652, filed in the Office of the Assistant Registrar of the Land Court of the State of Hawaii with Land Court Application No. 1074 of the Trustees under the Will and of the Estate of Samuel M. Damon, Deceased; Being a portion of the premise described in Transfer Certificate of Title No. 406,734 issued to Loyalty Development Company, Ltd., a Hawaii corporation (the "Ground Lessor") and Assignment of Lease issued to Paiea Properties in Land Court Document No. 1791977 and SUBJECT also to all encumbrances noted on said Transfer Certificate. EXCEPTING AND RESERVING THEREFROM all such rights and easements as Landlord and Ground Lessor in their several and sole discretion may from time to time require for overhead wire lines and poles or underground lines, pipes and appurtenances thereto for drains, sewers, water, utilities and any other purposes, services, substances whatsoever over, across and under any portion of said Premises lying between a street boundary thereof and any setback line along such boundary as shown on said Map 652 (herein called the 'service area') or any easement shown on said Map, said reserved right to be exercised in such manner as to cause the least practicable interference with the use and occupancy of such Premises. EXHIBIT B - Page 1 EXHIBIT C STANDARD RULES AND REGULATIONS Except as may be otherwise specifically set forth in any provision of the Lease, the following Rules and Regulations shall apply in accordance with Section 4.05 of the Lease: 1. CONTROL OF COMMON AREA. The sidewalks, entrances, passages, vestibules, stairways, corridors or halls shall not be obstructed or used for any purpose other than ingress or egress. The halls, passages, entrances, stairways, balconies are not for the use of the general public and Landlord shall in all cases retain the right to control or prevent access thereto by all persons whose presence in the reasonable judgment of Landlord shall be prejudicial to the safety, character, reputation or interest of the Building(s) and its tenants, provided that nothing herein contained shall be construed to prevent such access by persons with whom Tenant normally deals in the ordinary course of its business unless such persons are engaged in illegal activities or are violating terms of the Lease or these Rules and Regulations. Tenant shall not enter the mechanical rooms, air handler area, electrical closets or janitorial closets. All parking ramps and area, pedestrian walkways, and other public areas forming a part of the Building, if any, shall be under the sole and absolute control of Landlord, who shall have the exclusive right to regulate and control these areas. 2. ACCESS. On all days between the hours of 11:00 p.m. to 6:00 a.m. the following day, access to the Building or to the Premises may be refused unless the person seeking access is known to a tenant and has a key or is otherwise properly identified. Each Tenant shall be responsible for all persons for whom he permits entry to the Building and shall be liable to Landlord for all acts of such persons. Landlord shall in no case be liable for damages for any error with regard to the admission to or exclusion from the Building of any person. In case of invasion, mob, riot, public excitement, or other commotion, Landlord reserves the right to prevent access to the Building(s) during the continuance of the same by closing the door or otherwise, for the safety of the tenants and protection of property. Landlord reserves the right to exclude or expel from the Building(s) any person who, in the judgment of Landlord is intoxicated or under the influence of liquor or drugs, or who shall in any manner do any act in violation of the Lease or these Rules and Regulations. 3. AIR CONDITIONING. For Office, Retail and Lower Floor Flex space, Tenant shall have an individual air conditioning system which shall be under the control of Tenant as to the temperature setting and hours of its usage; PROVIDED, HOWEVER, Landlord may install a timing or energy saving device on the air conditioning system and Tenant will operate same in accordance with instructions received from Landlord. Tenant shall be solely responsible for the utilities charged for the use of its system. Landlord shall provide routine maintenance of the system as an operating expense in accordance with Tenant's Lease. 4. EXTERIOR APPEARANCE. Other than as provided in the Construction Plans described on Exhibit F approved by Landlord, no awning or other projections shall be attached to the outside walls of the Building(s) and no window shades, blinds, drapes or other window coverings shall be hung in the Premises without the prior written consent of Landlord. Except as otherwise specifically approved by Landlord, all electrical ceiling fixtures hung in the Premises must be fluorescent, of a quality, type, number, design and bulb color approved by Landlord. No radio or television antenna, loudspeakers, flood lights, flag poles or any other devices shall be installed or attached to the roof or the exterior walls of the Building(s), without the prior written consent of Landlord. 5. SIGNAGE. These criteria have been established for the purpose of ensuring an outstanding office/retail complex, and for the mutual benefit of all tenants. Conformity will be strictly enforced; any non-conforming or unapproved signs by Tenant must be brought into conformity at the expense of Tenant, or promptly removed without liability. Landlord shall administer and interpret the criteria, and Landlord may, in Landlord's sole discretion, grant or withhold consent to any deviation therefrom. Landlord makes no representation or warranty that any signage it has approved will meet the approval of appropriate governmental entities. Tenant is advised that the cumulative effect of signage within the Project may prevent equal signage allotment or treatment among the tenants. A. GENERAL REQUIREMENTS (1) No sign shall be installed on the exterior of the Building(s) in which Tenant's demised Premises is located except such sign as shall first have been approved by Landlord, as to color, size, location and design. EXHIBIT C - Page 1 (2) No sign, picture, advertisement or notice shall be inscribed, exhibited, painted or affixed by any tenant on any part of Premises so as to be seen from the outside of, the Premises or the Building without the prior written consent of Landlord. (3) No obstructions or advertising devices of any kind whatsoever shall be placed in front of or in passageways, hallways, lobbies or corridors of the Building(s) by Tenant. (4) Interior signs on doors within the Building(s) and directory tablets shall be inscribed, painted or affixed for each tenant by Landlord at the expense of such Tenant, and shall be of a size, color and style acceptable to Landlord. (5) Each Tenant shall submit, or cause to be submitted, to Landlord for written approval before fabrication, at least two copies of detailed drawings covering the location, size, layout, design and color of the proposed sign, including all lettering and/or graphics. (6) All permits for signs and their installation shall be obtained by Tenant or his representative, at Tenant's expense, prior to installation. (7) Tenant shall be responsible for the fulfillment of all requirements and specifications. (8) It is Tenant's responsibility to maintain all signs erected. If any sign is not maintained after written notice by Landlord, the sign may be removed by Landlord at Tenant's cost. (9) Upon termination of Lease, for any reason, any signs erected by Tenant shall be immediately removed and the Building(s) repaired at Tenant's cost. B. GENERAL SPECIFICATIONS (1) Painted lettering will not be permitted, except as specified under Section E (2) of these Rules and Regulations. (2) Flashing, moving or audible signs will not be permitted. (3) Pylon or pole signs will not be permitted. (4) All electrical signs shall bear the UL label; and their installation must comply with all local building and electrical codes. (5) No exposed conduit, tubing or raceways will be permitted. (6) All cabinets, conductors, transformers and other equipment shall be concealed. (7) Electrical service to all signs shall be on Tenant's meter(s). C. CONSTRUCTION REQUIREMENTS (1) All exterior signs, bolts, fastenings and clips shall be of hot dipped galvanized iron, stainless steel, aluminum, brass or bronze, and no black iron materials of any type will be permitted. (2) All exterior letters or signs exposed to the weather shall be mounted at least 3/4" from the Building wall to permit proper dirt and water drainage. (3) Location of all openings for conduit and sleeves in Building walls shall be indicated by the sign contractor on drawings submitted to Landlord. Sign contractors shall install the same in accordance with the approved drawings. (4) No labels will be permitted on the exposed surface of signs, except those required by local ordinance which shall be applied in an inconspicuous location. (5) All penetrations of the Building structure required for sign installation shall be neatly sealed in a watertight condition. (6) Sign contractor shall repair any damage to any work caused by his work. EXHIBIT C - Page 2 (7) Tenant shall be fully responsible for the operations of Tenant's sign contractors. (8) Signs which lack a professional appearance in design and manufacture shall not be allowed. D. DESIGN REQUIREMENTS (1) All Tenant storefront entrance/store identification designs shall be subject to the approval of Landlord and shall be in conformance with the City and County of Honolulu Sign Ordinance(s) as applicable. (2) Tenant's identification signs shall be designed as an integral part of the storefront in a manner compatible with and complimentary to adjacent and facing storefronts and the overall design concept of the Building(s). Letter size and location shall be approximately scaled and proportioned to the overall storefront design. Maximum letter size shall not exceed 12" for lower case letters and 14" for capital letters. If two lines of copy are required, the total height of the two lines shall not exceed 14". (3) Signs perpendicular to the face of the Building(s) or storefront will not be permitted. (4) No signs of any sort shall be permitted on canopy, soffits or Building roofs. (5) Wording of signs shall not include the product sold, except as part of Tenant trade name or insignia. (6) No sign, or any portion thereof, may project above the parapet or top of wall upon which it is mounted. E. MISCELLANEOUS REQUIREMENTS (1) Each Tenant will be permitted to place upon each entrance to its Premises an information sign of not more than 144 square inches, indicating hours of business, emergency telephone number, etc., as approved by Landlord in writing prior to installation. (2) Each Tenant who has a non-customer door for receiving merchandise may have uniformly applied on said door, in a location as directed by Landlord, Tenant's name and address. Where more than one Tenant uses the same door, each name and address shall be applied. The color and size of letters must receive Landlord's prior written approval. (3) Tenant may install on the mall front, if required by the U.S. Post Office, the numbers only for the street address in exact location determined by Landlord. Size, type, and color of numbers shall be as determined by Landlord. (4) Floor signs shall be permitted within Tenant's lease line in their store fronts, if approved by Landlord. (5) Tenants with two or more entrances in one front may install an additional sign if the entries are recessed a minimum of three feet back of the lease line. The additional sign is to be installed in the recess area, and is limited to the store name only, and the letters shall not exceed 6". All other criteria contained in this sign regulation shall apply and govern such signs also. (6) Credit card signs or other decals of any type are not to be affixed to windows or doors. Such signs are to be mounted on their individual stands or pedestals and set back a minimum of 12 inches from the glass line unless otherwise approved by Landlord. F. DIRECTORIES. The directories of the Building(s) will be provided exclusively for the display of the name and location of Tenant only and Landlord reserves the right to exclude any other names therefrom. Landlord may reasonably limit the amount of space utilized by any one tenant at Landlord's discretion. Landlord may charge for initial listings and any subsequent changes or additional listings which shall be the sole judgment of Landlord. A building standard sign will be installed by Landlord on or adjacent to Tenant's office entrance door at Tenant's expense. No other signs shall be permitted. EXHIBIT C - Page 3 6. CONTROL OF NAME. Without the written consent of Landlord, Tenant shall not use the name of the Project in connection with or in promoting or advertising the business of Tenant, except in connection with providing the business address at which Tenant's business may be found. No Tenant shall engage in advertising which in Landlord's opinion, tends to impair the reputation of the Project or its desirability as an of office-commercial complex. 7. SOLICITORS. Landlord reserves the right to eject from the Project, any solicitors, canvassers or peddlers and any other class of persons who, in the judgment of Landlord, are annoying or interfering with any of Tenant's or Landlord's operations or who are otherwise undesirable. Canvassing, peddling, soliciting and distribution of any written materials on the Project are prohibited and each Tenant shall cooperate to prevent the same. 8. USE RESTRICTION. The Premises shall be used only for the purpose described in Section 1.01(f) of the Lease. Except as may be specifically permitted in a tenant's Lease, no tenant shall occupy or permit any portion of Premises to be occupied as an office for a public stenographer or typist, or for the manufacture of direct sale of liquor, narcotics, or tobacco in any form or as a medical office, or as a barber shop, hair salon, manicure shop or employment agency. No tenant shall engage or pay any employees on the Premises except those actually working for such tenant on the Premises, excluding only "independent representatives" as that term is used as of this date in Tenant's business operations, nor advertise for laborers giving an address at the Premises. The Premises shall not be used for lodging or sleeping or for any immoral or illegal purposes. 9. RESTRICTED ACTIVITIES. Other than as provided in the Construction Plans described on Exhibit F approved by Landlord, the following activities are restricted without the prior written consent of Landlord and then only as Landlord may direct. Tenant and its agents, employees or visitors shall not: a. Mark, paint, drill into or in any way deface any part of the Premises or the Building(s). b. Bore, string or cut wires. c. Bring animals, bicycles or vehicles into the Building(s). d. Prepare or cook any food on the Premises, except coffee, tea, hot chocolate and similar items for Tenant and its employees and business visitors. This restriction shall not apply to Retail tenants, such as restaurants or convenience shops, where the use clause of their lease permits food cooking or preparation. e. Install air-conditioning unit, engine, boiler, machinery or similar apparatus. f. Operate any hand truck in spaces other than the Premises or in the public corridors of the Building(s) except those equipped with rubber tires and side guards. g. Bring firearms or explosives onto the Premises. h. Install, maintain or operate vending machines of any description on the Premises, except for the exclusive use of Tenant and Tenant's Employees. i. Use of the water supplied by Landlord not separately metered for other than drinking and toilet purposes. j. No windows, glass doors or any other light sources that reflect into the lobbies or other places of the Project shall be obstructed or covered except in a manner approved in writing by Landlord. k. No water cooled condenser or other water cooled apparatus shall be used by Tenant, except upon such conditions as are established by, and with the written consent of, Landlord. 10. PROHIBITED ACTIVITIES. The following activities are strictly prohibited and shall not be conducted by Tenant and its agents, employees or visitors: a. Make or permit to be made any unseemly or disturbing noises, sounds or vibrations, or otherwise disturb or interfere with occupants of this nor neighboring buildings or premises or those having business with them by the use of any musical instrument, radio, phonograph, unusual noise, or in any other way. b. Use toilet, wash basins and other plumbing fixtures for any purpose other than those for which they were constructed, and no sweeping, rubbish rags or other substances shall be thrown therein. All damage resulting from any misuse of such fixtures shall be borne by Tenant or Tenant's Employees. EXHIBIT C - Page 4 c. Throw anything out of doors, windows, or down the public corridors, stairwells or other areas of the Building(s) nor shall Tenant place or allow to be placed any object on ledges or lanais of the Building(s). d. Smoke, drink or eat in elevators, vestibules, entrances, passages, stairways, corridors, hallways or restrooms. Open food or beverages shall not be allowed in these areas. e. Bring or keep in the Premises any inflammable, combustible or explosive fluid, chemical, or substance nor do or permit anything to be done in the Premises, or bring or keep anything therein which shall in any way increase the rate of fire insurance on the Building(s) or on the property kept therein, or obstruct or interfere with the rights of other tenants or in any way injure or annoy them, or conflict with the regulations of the Fire Department or the fire laws, or with any insurance policy upon the Building or any part thereof, or with any rules and ordinances established by the Board of Health or other governmental authority. f. No Tenant shall cause or permit any unusual or objectionable odors to be produced upon or permeate from the Premises. g. All windows are to be kept closed during periods when the Building(s) is being air-conditioned. h. Overload the floors or the elevators or in anyway violate the structural integrity of the Building(s). 11. CLOSING PRECAUTIONS. Each Tenant shall, before leaving the Building close and securely lock all windows and doors of the Premises, turn off all water faucets or water apparatus, and turn off all electrical equipment (including air conditioning system but excluding any required night lighting) within the Premises. Tenant will be responsible for all injuries sustained by Landlord's other tenants or occupants of the Building(s) due to Tenant's default or carelessness. 12. KEYS AND LOCKS. No locks or bolts other than those provided by Landlord shall be placed on any doors without the written consent of Landlord. A total of four keys per lock will be furnished to Tenant by Landlord. Additional keys will be provided by Landlord upon Tenant's request at Tenant's cost. Lock cylinders and keys shall be changed by Landlord at Tenant's expense upon receipt of written request from Tenant. All keys will be surrendered upon termination of Lease. Janitor and contract cleaners will be provided with a passkey to Tenant's Premises unless Tenant declines in writing and thereby understands that Landlord will not be responsible for providing janitorial services and emergency access to the Premises. 13. DOORS. All doors opening onto public corridors shall be kept closed during business hours, and, during non business hours, locked, except when in use for ingress or egress. 14. TENANT EQUIPMENT. All equipment and any other devise of any electrical or mechanical nature shall be placed by Tenant in the Premises so as to absorb or prevent any vibration, noise or annoyance to other tenants of the Project. Landlord will direct electricians as to where and how telephone and telegraph wires are to be introduced. No boring or cutting for wires or stringing of wires will be allowed without the prior written consent of Landlord, and then only as Landlord may direct. The location of telephones, call boxes and other office equipment affixed to the Premises shall be subject to the reasonable approval of Landlord. 15. CONTROL OF CONTRACTORS. Any work to be done in order to repair the Premises, or to alter, improve or add to Tenant's space shall be done by contractors reasonably approved by Landlord. No person or contractor not approved by Landlord shall be used to repair, alter, improve or add to the Premises without the prior written consent of Landlord. Tenant shall not permit any contractor or other person making any alterations, additions or installations within the Premises, to use any Common Area as storage or work areas, without the prior written consent of Landlord and Tenant shall be liable for and pay the expense of any additional cleaning cost resulting from the transportation or storage of materials and/or work performed within the Building(s). 16. DRAPERIES. Draperies and wall coverings must be treated with fire retardant and may be installed by Tenant only with the prior written consent of Landlord. Cleaning of all draperies shall be the responsibility of Tenant and shall be done as reasonably required. 17. JANITORIAL SERVICE. No one other than those reasonably approved in writing by Landlord shall be permitted to perform any janitorial service on the Property. Janitorial service, if supplied by Landlord, shall not include shampooing or spot-cleaning of carpet nor dry cleaning of draperies. Landlord shall not be responsible for any loss of or damage to any Tenant's property by the janitor, its employees or any other person performing janitorial services. EXHIBIT C - Page 5 18. MAINTENANCE REQUESTS. All request for services by Tenant shall be made to Landlord's Property Manager only. No employee of Landlord shall perform any work or service for any Tenant or admit any person into any locked portion of the Building(s) except under the specific instructions of Landlord's Property Manager. 19. DELIVERIES AND SERVICE AREA. Except for warehouse operations, only hand trucks equipped with rubber tires and side guards will be permitted on the Project. All deliveries shall only be brought through a service entrance of the Project designated by the Property Manager. All deliveries requiring exclusive use of an elevator shall be scheduled through the Property Manager and in any event such use will not be permitted without the use of elevator protective padding and such use will not be permitted between the hours of 6:00 - - 9:00 a.m., 11:30 a.m. -1:30 p.m. and 3:30-5:00 p.m. Any damage to the Building (s) caused by any such Tenant or its delivery service will be immediately reported to Landlord's Property Manager and the repair will be made at Tenant's expense. 20. MOVING OF HEAVY OBJECTS. Except for warehouse operations, all removal, or the carrying in or out of any safes, freight, furniture, or bulky matter of any description must take place at the time and in the manner which Landlord may determine from time-to-time. The moving of safes or other fixtures or bulky matter of any kind must be made upon previous notice to the Property Manager of the Building and under his supervision, and the persons employed by a Tenant for such work must be acceptable to Landlord. Landlord reserves the right to inspect all safes, freight or other bulky articles to be brought into the Building and to exclude from the Building all safes, freight or other bulky articles which violate any of these Rules and Regulations or the Lease of which these Rules and Regulations are a part. Landlord shall have the right to prescribe the location of heavy objects and if considered necessary, the means as to distribute the weight thereof (no more than 50 pounds per square foot shall be allowed unless written approval is granted by Landlord). All cost incurred will be charged to Tenant. Any damage to the Project caused by any such Tenant or its contractor, delivery or moving service, will be repaired at such Tenant's expense. 21. MOVING IN/OUT. All moving of furniture, fixtures and other personal property in and out of the Building(s) must be done through the loading area designed by the Property Manager and only via the designated elevator. Tenant and its moving company should investigate loading area conditions prior to the scheduled move. The freight elevator must be reserved at lease 24 hours prior to the contemplated move date. Reservations must be made with the Property Manager. 22. REMOVAL OF PROPERTY. Unless otherwise provided in the Lease to the contrary, Tenant shall deliver a list of any fixtures or Improvements in the Premises which Tenant desires to remove from the Building, and the list must be approved by Landlord in writing before any such fixture of improvement is removed. No fixtures permanently attached shall be removed. 23. CHANGE OF NAME AND ADDRESS. Landlord shall have the right, exercisable without liability to Tenant, to change the name and the street address of the Building(s) and Project. Landlord shall reimburse Tenant for its reasonable costs necessitated by Landlord's name and address change. 24. TRASH REMOVAL. Each Tenant shall store all its trash within the Premises in a location reasonably approved by Landlord until removal of the same. No material shall be placed in trash boxes or receptacles if such material is of such nature that it may not be disposed of in the ordinary and customary manner of removing and disposing of trash and garbage in the City and County of Honolulu without being in violation of any law, ordinance, or regulation governing such disposal. The Premises shall at all times be kept in a clean and sanitary condition. No open containers of food or liquid shall be placed in waste baskets due to the possibility of carpet damage during their removal by janitorial personnel. All Tenant construction debris shall be removed from the Premises by Tenant, its contractor or its employees. Food or similar type of waste product shall be sufficiently wrapped to prevent odors and/or other residue from escaping through the container in or on Common Areas or in the trash receptacles. Landlord reserves the right throughout the term of any lease to cause any tenant whose waste consists of food or similar type of product to independently arrange for the daily removal of such waste from the Project at the tenant's sole cost. Further, all tenants will comply with any applicable governmental regulation concerning recycling of waste. 25. COMPLIANCE WITH PROFESSIONAL STANDARDS. Any Tenant who shall be engaged in any trade, occupation or profession which is regulated by the City and County, State or Federal government or which is self policing, shall at all times during the term of its Lease or any extension thereof, be and remain in good standing with such regulatory or self policing body, and in the event such Tenant shall be disciplined pursuant to final disciplinary action from which there is no further appeal, at Landlord's sole discretion, Landlord may terminate such Tenant's Lease forthwith excepted where such final disciplinary action was as a direct result of the actions of an "independent representative" as that term is used as of the date hereof in Tenant's business operations. 26. AUTHORIZED VENDORS. No Tenant shall purchase or otherwise obtain for use in the Premises water, ice, towel, vending machine, barbering, bootblacking, or other like service, or purchase EXHIBIT C - Page 6 or otherwise obtain janitorial, maintenance or other like services, except from persons authorized by Landlord, and at hours and under regulations fixed by Landlord. 27. COMMON ROOMS/AREA. Rooms used in common by Tenant shall be subject to regulations adopted by Landlord, including the parking areas and the rates applicable thereto. 28. SHOWING PREMISES. Landlord may show the Premises to any prospective tenants within twelve (12) months prior to the expiration of the Lease; PROVIDED, HOWEVER, that during the term of normal occupancy and Tenant not being in default, Landlord shall have access to the Premises during Tenant's regular business hours or as otherwise provided elsewhere in the Lease. 29. PREVENTION OF DEDICATION. Landlord reserves the right to close off any and all of the streets, promenades and sidewalks of the Project for twenty-four hours once every five years or as may be necessary to prevent dedication. 30. RULES AND REGULATIONS. Pursuant to Section 4.05 of the Lease, Landlord has the right to modify, supplement or rescind any of these Rules and Regulations. Tenant shall be liable for injury or damage caused by the infraction of any of these Rules and Regulations. Landlord will repair such damage and shall charge the resulting costs to Tenant. Such costs shall be payable within five (5) days following Tenant's receipt of Landlord's billing and, if unpaid, shall constitute sums due under Section 3.03 of the Lease. Landlord shall not be responsible to any Tenant for the non-observance or violation of any Rules and Regulations by any other tenant or other person. Tenant acknowledges it has read these Rules and Regulations and agrees to abide by them as a condition to its occupancy. Landlord will appreciate any suggestions for the betterment of service in the Building(s) and Project. Please address all communications to: PAIEA PROPERTIES 550 Paiea Street Suite 102 Honolulu, HI 96819 Attn: Property Manager REVIEWED AND ACCEPTED BY TENANT this 20th day of November, 1996. NATIONAL TELEPHONE & COMMUNICATIONS, INC., a Nevada corporation By: /s/ Ed Jacobs ------------------------------------- Its ---------------------------------- By: ------------------------------------- Its ---------------------------------- EXHIBIT C - Page 7 EXHIBIT D BASE RENT THE FOLLOWING IS A SCHEDULE OF THE BASE RENT for the Term of the Lease dated November 20, 1996, by and between PAIEA PROPERTIES, a Hawaii limited partnership ("Landlord"), and NATIONAL TELEPHONE & COMMUNICATIONS, INC., a Nevada corporation ("Tenant"), leasing a portion of Airport Trade Center: Lease Month Base Rent per ----------- ----------------------------- SF of Net Rentable Area Lease Month ------------- ----------- 1-24 $2.62 $25,964.20 25-48 $2.78 $27,549.80 49-72 $2.94 $29,135.40 73-96 $3.12 $30,919.20 97-120 $3.31 $32,802.10 The initial monthly payment due under this Lease shall be the sum of: Base Rent $25,964.20 Initial Operating Expense Payment @ $0.38 3,765.80 Parking Monthly Fee [50 x $60] 3,000.00 Evening/Weekend Parking Monthly Minimum 2,500.00 ---------- Sub Total 35,230.00 Hawaii State General Excise Tax 1,467.68 ---------- Total Initial Monthly Payment 36,697.68 Security Deposit 36,697.68 ---------- Total Due on execution of Lease $73,395.36 ---------- ---------- LANDLORD: PAIEA PROPERTIES, a Hawaii limited partnership By: NIMITZ-PAIEA, INC., its general partner By: /s/ T. Gregory Kemp ---------------------------------------- T. Gregory Kemp Its Vice President TENANT: NATIONAL TELEPHONE & COMMUNICATIONS, INC., a Nevada corporation By: /s/ Ed Jacobs ---------------------------------------- Its President ----------------------------------- By: ---------------------------------------- Its ----------------------------------- EXHIBIT D - Page 1 EXHIBIT E SPECIAL CONDITIONS THE FOLLOWING CONSTITUTES THE SPECIAL CONDITIONS of the Lease dated November 20, 1996, by and between PAIEA PROPERTIES, a Hawaii limited partnership ("Landlord"), and NATIONAL TELEPHONE & COMMUNICATIONS, INC., a Nevada corporation ("Tenant"), leasing a portion of Airport Trade Center: 1. OPTION TO TERMINATE LEASE. Landlord and Tenant understand and agree that Tenant shall use its best efforts, diligently and consistently applied, to complete the Construction Plans for the Premises and submit application for a building permit. Notwithstanding anything contained in this Lease to the contrary, Tenant shall have a one (1) time option to terminate this Lease on or before January 15, 1997 if the building permit is not issued to Tenant by giving written notice thereof to Landlord; PROVIDED, HOWEVER, if such written notice is not received by Landlord on or before the aforementioned date, or Landlord, at its sole discretion does not agree in writing to extend said date, then Tenant's option to terminate this Lease pursuant to this provision shall expire. If Tenant shall exercise the option to terminate this Lease in a timely manner, as consideration for such option, Landlord shall deduct from the Security Deposit the amount of $307.00 per day for each day after November 10, 1996 that Tenant's written notice of termination is received by Landlord and the balance of the Security Deposit shall immediately be return to Tenant. No deduction shall be made from the Security Deposit in consideration of the option if Tenant does not exercise such option. 2. SIGNAGE. Landlord will reasonably approve Tenant's signage plan on the exterior of its Premises consistent with the Project signage standards and which meets all City and County of Honolulu signage codes. Landlord will consider additional Tenant signage in other areas of the Project, including the facade of the roof mechanical area, subject to the same meeting all code requirements and not being in conflict with any other tenant or tenant premises in the Project. It is understood that the area surrounding the roof mechanical area is under a long term lease with Budget Rent a Car and that Tenant signage in this area of the building must be disclosed and agreed to by Budget Rent a Car. 3. RESTRICTED ADDITIONAL PARKING. In addition to the parking stalls allocated to Tenant pursuant to Section 1.01(g) of the Lease, Landlord agrees to provide Tenant with up to a maximum of 100 unreserved parking stalls for Tenant's customers for weekday evening use (only between the hours of 6:00 PM and 11:00 PM) and for weekend use (Saturday and Sunday between the hours of 8:00 AM and 11:00 PM) only ("Restricted Parking"). Tenant shall advise Landlord in writing as to the number and time requirement for such Restricted Parking stalls on a business day prior to such use; the initial parking charge for the period six (6) months from the date hereof shall be $2,500.00 per month to be charged to Tenant as additional rent and billed to Tenant monthly. Prior to the expiration of the initial 6-month period, Tenant and Landlord shall enter into good faith negotiations to reach mutually agreeable terms and conditions for such Restricted Parking; it being understood that should no agreement be reached between Tenant and Landlord within thirty (30) days following the expiration of the initial 6-month period, Landlord shall not be required to provide any Restricted Parking thereafter during the Term of the Lease. Landlord shall advise Tenant of the location(s) to be used on the Project, the Koapaka Street lots and/or on the privately owned portion of Koapaka Street for such additional parking (being the area graphically described on Exhibit H - Location of Parking Area - attached hereto) and Tenant shall be responsible to cone off such area (or otherwise identify the specified area as reasonably directed by Landlord) and to monitor that its customers use such specified location. Any additional parking needs of Tenant shall be provided by Landlord subject to availability as determined by Landlord in compliance with other leases in the Project and all code requirements of the City and County of Honolulu. 4. TENANT'S OPTION FOR EARLY TERMINATION. Provided Tenant is not then in default under the Lease, Tenant shall have the irrevocable option to terminate this Lease effective the last day of the sixtieth (60th) Lease Month; PROVIDED, HOWEVER, in order for such early termination to be effective, Tenant shall (i) notify Landlord in writing as to Tenant irrevocably exercising such termination option on or before the last day of the fiftieth (50th) Lease Month, and (ii) pay to Landlord within ten (10) day following receipt of Landlord's billing all reasonable costs of Landlord including, but not limited to, the unamortized portion of real estate brokerage commissions. Tenant's written notice for early termination shall be irrevocable and may not be withdrawn by Tenant without the written approval of Landlord in its absolute and sole discretion. 5. FIRST RIGHT TO LEASE ADDITIONAL SPACE. Subject to the rights of any other tenant in the Project and provided Tenant is not then in default and has not been in material default under the Lease, Tenant shall have the first right to lease any first floor Retail space fronting Paiea Street as the same may become available during the Term of the Lease. Landlord shall provide Tenant with a written notice that such Retail space is available for lease and shall provide a listing of the terms and Prevailing Rate thereof EXHIBIT E - Page 1 in accordance with the method set forth in Section 1(e) of this Exhibit E. Within ten (10) days following the date of Tenant's receipt thereof, Tenant shall advise Landlord in writing as to its acceptance of the terms of Landlord's notice. If Tenant rejects the terms of Landlord's notice or fails to provide Landlord with its response within the 10-day period, Tenant's first right to lease shall be void and Landlord shall be free to enter into any agreement to lease such space with any party upon any terms (whether similar or otherwise as those contained in Landlord's notice to Tenant) as Landlord may choose in its sole discretion. 6. OTHER TENANT USES. During the Term of the Lease, Landlord shall not lease space in the mauka portion of the first floor Retail space fronting Paiea Street (the area of which is marked on Exhibit A as "Exhibit E-Section 6 Space") to any tenant whose use of such space would be materially detrimental to Tenant's business operations in the Premises specifically including the sale of sexually explicit adult materials or services. 7. ADA COMPLIANCE. Upon completion of Landlord's current renovation program, the Project (excluding any premises for which the tenant shall be responsible) shall be fully in compliance with The Americans with Disabilities Act. 8. PREMISES ACCESS. Notwithstanding contained in the Lease to the contrary and Tenant not being in default hereunder, Tenant shall be entitled to have access to the Premises and parking area(s) (as such parking area is designated from time to time by Landlord) 24-hours per day, 365-days per year except in the case of an emergency. 9. RENEWAL. a) If Tenant is not then in default and has not been in material default hereunder and has not assigned this Lease or subleased all or any portion of the Premises other than as may be permitted in Section 8.01 of the Lease, then Tenant shall have the option to extend the Term for one (1) additional five (5) year period commencing on the day next following the Termination Date ("Extended Term") by giving written notice of said extension to Landlord not later than nine (9) months prior to the Termination Date, time being of the essence. b) The Extended Term shall be for the period of Lease Months 121 to 180. c) If Tenant exercises its option to extend the Term for an Extended Term, then, not later than fifteen (15) days thereafter (or, if later, not later than seventy-five (75) days prior to the expiration of the Term), Landlord shall notify Tenant in writing ("Landlord's Rental Notice") of its determination of the Prevailing Rental (as defined herein) for the Premises for the Extended Term. Tenant shall notify Landlord not later than fifteen (15) days after receipt of Landlord's Rental Notice that it elects either (i) to accept Landlord's determination of the Prevailing Rental, (ii) to rescind the exercise of its option to extend or (iii) to elect to have the Prevailing Rental determined by appraisal in accordance with subparagraph (f) below. If Tenant fails to so elect, it shall be deemed to have rescinded the exercise of its option to extend. If the Term is extended it shall be so extended on the same terms and conditions then set forth in this Lease except that (v) the Annual Base Rent during the Extended Term shall be equal to the Prevailing Base Rental Rate (as defined herein) set forth in Landlord's Rental Notice or by the number of rentable square feet in the Premises, (x) Tenant shall receive the benefit of the Prevailing Rental Concessions (as defined herein), if any, set forth in Landlord's Rental Notice, (y) Tenant shall pay Additional Rent in the manner set forth in this Lease, and (z) this Lease shall be modified to incorporate any Other Prevailing Rental Terms (as defined herein) set forth in Landlord's Rental Notice; PROVIDED, HOWEVER in no event shall the Annual Base Rent after adjustment for Prevailing Rental Concessions during the Extended Term be LESS than the Base Rent per square foot of Net Rentable Area on the Termination Date. d) Landlord and Tenant shall enter into a written supplement to this Lease confirming the terms, conditions and provisions applicable during the Extended Term as determined in accordance with the provisions of this Section. If Tenant fails to timely exercise its option to extend the Term for the Extended Term, then this Lease shall expire by its terms on the expiration of the Term. e) For purposes of this Lease, the "Prevailing Rental" shall be the rental for comparable space located near the Honolulu airport, determined by Landlord, taking into consideration the class of building, size, location, zoning and degree of improvements included in the space in question and for the length of term comparable to the term of the lease in question. The Prevailing Rental shall consist of an annual base rental rate per rentable square foot ("Prevailing Base Rental Rate") and shall include or take into account the following rental related terms: (i) rent concessions such as rental abatements, construction allowances and other concessions ("Prevailing Rental Concessions"), (ii) periodic adjustments or additions to a fixed annual rent based on a share of taxes and Operating Expenses and (iii) periodic increases in rent and other then prevailing rental related terms, conditions and components of rent ("Other Prevailing Rental Terms"). f) If Landlord or Tenant desires to invoke the appraisal procedure set forth in this Section, the party invoking the appraisal procedure shall give a notice ("Appraisal Notice") to the other party, stating that the party sending the Appraisal Notice desires to meet within fourteen (14) days to attempt to agree on a single appraiser to determine the Base Market Rent. The appraiser (i) shall be MAI EXHIBIT E - Page 2 certified, (ii) shall have a minimum of five (5) years experience in the City of Honolulu in real estate leasing or appraisal of leases in office and warehouse buildings in Honolulu, and (iii) shall not have conducted within the previous three years and shall not be presently conducting a material amount of business with either Landlord or Tenant or their affiliates or otherwise have a financial interest in or with either Landlord or Tenant or their affiliates and shall be otherwise independent ("Appraiser Qualifications"). If Tenant and Landlord are unable to agree upon a single appraiser within fifteen(15) days of the giving of the Appraisal Notice, then Landlord and Tenant shall draw by lot to determine which of them ("First Party") shall within the following seven (7) days provide the other ("Second Party") with the names and qualifications of five appraisers who are acceptable to the First Party and who meet the Appraiser Qualifications. Such list shall be accompanied by a statement of all business conducted by each such proposed appraiser with the First Party within the previous three years. The Second Party within seven (7) days thereafter shall select one of the five appraisers and shall notify the First Party in writing of its selection. The appraiser so selected shall be the appraiser hereunder. The parties shall share equally the cost of the appraiser. Within ten (10) days following the selection of the appraiser, Landlord and Tenant shall each notify the other (but not the appraiser) of their determination of the Prevailing Rental for the applicable Extended Term. During the next seven (7) days following said 10-day period, both Landlord and Tenant shall prepare a written critique of the other's determination and on the seventh day, Landlord's and Tenant's determinations (as originally submitted to the other party, with any modification or additions whatsoever permitted) and Landlord's and Tenant's critique shall be submitted to the appraiser. Within fifteen (15) days thereafter, the appraiser shall decide in writing whether Landlord's or Tenant's determination of the Prevailing Rental is more correct and shall state in detail the reasons therefor. The appraiser shall be empowered to choose only the Landlord's or the Tenant's determinations, and shall reach no other or compromise decision. The appraiser's decision shall be final, conclusive and binding on Landlord and Tenant. g) Except as set forth in this Section, Landlord shall have no obligation to extend or renew this Lease, or to enter into another lease of the Premises with Tenant upon expiration of this Lease. Upon expiration of this Lease, or if this Lease is extended, the Extended Term, Landlord may lease the Premises to whomever it chooses for the operation therein of a business that is the same as or different from that operated by Tenant in the Premises. 10. BROKERAGE COMMISSIONS. Landlord entered into an exclusive listing agreement for the Project with CB Commercial Real Estate of Hawaii, Inc. and will pay all commission to CB Commercial in accordance with the terms thereof resulting from this Lease. LANDLORD: PAIEA PROPERTIES, a Hawaii limited partnership By: NIMITZ-PAIEA, INC., its general partner By: /s/ T. Gregory Kemp ----------------------------------------------- T. Gregory Kemp Its Vice President TENANT: NATIONAL TELEPHONE & COMMUNICATIONS, INC., a Nevada corporation By: /s/ Ed Jacobs ----------------------------------------------- Its President ------------------------------------------ By: ----------------------------------------------- Its ------------------------------------------ EXHIBIT E - Page 3 EXHIBIT F IMPROVEMENT SPECIFICATIONS All Improvements shall be installed in the Premises by Tenant at the expense of Tenant. All construction drawings detailing the improvements to be install in the Premises by Tenant shall be approved by Landlord in writing and the final construction draws thereof shall be attached to this Exhibit F and by this reference incorporated herein ("Construction Plans"). Tenant may wish to install a satellite communications dish on a portion of the Building or Project that is outside of the area of Tenant's Premises. Tenant shall provide full plans relating to such equipment and the preferred location for the installation of same and such other detail as may be requested by Landlord. Landlord shall provide its reasonable approval of such satellite communications dish specifically subject to the requirements of any building codes, the rights of all other tenants in the Project and the favorable appearance and/or screening of same. EXHIBIT F - Page 1 EXHIBIT G ALLOCATIONS OF OPERATING EXPENSES AND TENANT'S PROPORTIONATE SHARE The schedules attached hereto set forth the Net Usable Area as defined in Section 2.08, the Net Rentable Area, the current year Operating Expense budget in accordance with Section 2.09 and Tenant's Proportionate Share as defined in Section 2.16. EXHIBIT G - Page 1 EXHIBIT H LOCATION OF PARKING AREA EXHIBIT H - Page 1 EX-10.16 3 EXHIBIT 10.16 PROMISSORY NOTE
- ----------------------------------------------------------------------------------------------------------------------- PRINCIPAL LOAN DATE MATURITY LOAN NO CALL COLLATERAL ACCOUNT OFFICER INITIALS $5,000,000.00 03-27-1997 04-30-1998 9730000139 110 - ----------------------------------------------------------------------------------------------------------------------- References in the shaded area are for Lender's use only and do not limit the applicability of this document to any Particular loan or item. - -----------------------------------------------------------------------------------------------------------------------
BORROWER: NATIONAL TELEPHONE & LENDER: FIRST BANK & TRUST COMMUNICATIONS, INC. IRVINE REGIONAL OFFICE - 400 2801 MAIN STREET 2400 MICHELSON DRIVE IRVINE, CA 92614 IRVINE, CA 92612 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Principal Amount: Initial Rate: Date of Note: $5,000,000.00 9.500% March 27, 1997 PROMISE TO PAY, NATIONAL TELEPHONE & COMMUNICATIONS, INC. ("Borrower") promises to pay to FIRST BANK & TRUST ("Lender"), or order, in lawful money of the United States of America, the principal amount of Five Million & 00/100 Dollars ($5,000,000.00) or so much as may be outstanding, together with interest on the unpaid outstanding principal balance of each advance. Interest shall be calculated from the date of each advance until repayment of each advance. PAYMENT. Borrower will pay this loan on demand, or if no demand is made, in one payment of all outstanding principal plus all accrued unpaid interest on April 30, 1998. In addition, Borrower will pay regular monthly payments of accrued unpaid interest beginning April 27, 1997, and all subsequent interest payments are due on the same day of each month after that. Interest on this Note is computed on a 365/360 simple interest basis; that is, by applying the ratio of the annual interest rate over a year of 360 days, multiplied by the outstanding principal balance, multiplied by the actual number of days the principal balance is outstanding. Borrower will pay Lender at Lender's address shown above or at such other place as Lender may designate in writing. Unless otherwise agreed or required by applicable law, payments will be applied first to accrued unpaid interest, then to principal, and any remaining amount to any unpaid collection costs and late charges. VARIABLE INTEREST RATE. The interest rate on this Note is subject to change from time to time based on changes in an independent index which is the Prime rate as published in the Wall Street Journal. When a range of rates has been published, the higher of the rates will be used (the "Index"). The Index is not necessarily the lowest rate charged by Lender on its loans. If the Index becomes unavailable during the term of this loan, Lender may designate a substitute index after notice to Borrower. Lender will tell Borrower the current Index rate upon Borrower's request. Borrower understands that Lender may make loans based on other rates as well. The interest rate change will not occur more often than each day. The Index currently is 8.500% per annum. The interest rate to be applied to the unpaid principal balance of this Note will be at a rate of 1.000 percentage point over the Index, resulting in an initial rate of 9.500% per annum. NOTICE: Under no circumstances will the interest rate on this Note be more than the maximum rate allowed by applicable law. PREPAYMENT. Borrower agrees that all loan fees and other prepaid finance charges are earned fully as of the date of the loan and will not be subject to refund upon early payment (whether voluntary or as a result of default), except as otherwise required by law. Except for the foregoing, Borrower may pay without penalty all or a portion of the amount owed earlier than it is due. Early payments will not, unless agreed to by Lender in writing, relieve Borrower of Borrower's obligation to continue to make payments of accrued unpaid interest. Rather, they will reduce the principal balance due. LATE CHARGE. If a payment is 10 days or more late, Borrower will be charged 5.000% of the unpaid portion of the regularly scheduled payment or $1.00, whichever is greater. DEFAULT. Borrower will be in default if any of the following happens: (a) Borrower fails to make any payment when due. (b) Borrower breaks any promise Borrower has made to Lender, or Borrower fails to comply with or to perform when due any other term, obligation, covenant, or condition contained in this Note or any agreement related to this Note, or in any other agreement or loan Borrower has with Lender. (c) Borrower defaults under any loan, extension of credit, security agreement, purchase or sales agreement, or any other agreement, in favor of any other creditor or person that may materially affect any of Borrower's property or Borrower's ability to repay this Note or perform Borrower's obligations under this Note or any of the Related Documents. (d) Any representation or statement made or furnished to Lender by Borrower or on Borrower's behalf is false or misleading in any material respect either now or at the time made or furnished. (e) Borrower becomes insolvent, a receiver is appointed for any part of Borrower's property, Borrower makes an assignment for the benefit of creditors, or any proceeding is commenced either by Borrower or against Borrower under any bankruptcy or insolvency laws. (f) Any creditor tries to take any of Borrower's property on or in which Lender has a lien or security interest. This includes a garnishment of any of Borrower's accounts with Lender. (g) Any guarantor dies or any of the other events described in this default section occurs with respect to any guarantor of this Note. (h) A material adverse change occurs in Borrower's financial condition, or Lender believes the prospect of payment or performance of the indebtedness is impaired. If any default, other than a default in payment, is curable and if Borrower has not been given a notice of a breach of the same provision of this Note within the preceding twelve (12) months, it may be cured (and no event of default will have occurred) if Borrower, after receiving written notice from Lender demanding cure of such default: (a) cures the default within fifteen (15) days; or (b) if the cure requires more than fifteen (15) days, immediately initiates steps which Lender deems in Lender's sole discretion to be sufficient to cure the default and thereafter continues and completes all reasonable and necessary steps sufficient to produce compliance as soon as reasonably practical. LENDER'S RIGHTS. Upon default, Lender may declare the entire unpaid principal balance on this Note and all accrued unpaid interest immediately due, without notice, and then Borrower will pay that amount. Upon Borrower's failure to pay all amounts declared due pursuant to this section, including failure to pay upon final maturity, Lender, at its option, may also, if permitted under applicable law, increase the variable interest rate on this Note to 6.000 percentage points over the Index. Lender may hire or pay someone else to help collect this Note if Borrower does not pay. Borrower also will pay Lender that amount. This includes, subject to any limits under applicable law, Lender's attorney's fees and Lender's legal expenses whether or not there is a lawsuit, including attorney's fees and legal expenses for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Borrower also will pay any court costs, in addition to all other sums provided by law. This Note has been delivered to Lender and accepted by Lender in the State of California. If there is a lawsuit, Borrower agrees upon Lender's request to submit to the jurisdiction of the courts of Orange County, the State of California. Lender and Borrower hereby waive the right to any jury trial in any action, proceeding, or counterclaim brought by either Lender or Borrower against the other. (Initial Here /s/ VCS) This Note shall be governed by and construed in accordance with the laws of the State of California. DISHONORED ITEM FEE. Borrower will pay a fee to Lender of $15.00 if Borrower makes a payment on Borrower's loan and the check or preauthorized charge with which borrower pays is later dishonored. LINE OF CREDIT. This Note evidences a revolving line of credit. Advances under this Note may be requested orally by Borrower or by an authorized person. All oral requests shall be confirmed in writing on the day of the request. All communications, instructions, or directions by telephone or otherwise to Lender are to be directed to Lender's office shown above. The following party or parties are authorized to request advances under the line of credit until Lender receives from Borrower at Lender's address shown above written notice of revocation of their authority: JAMES R. QUANDT, PRESIDENT; VICTOR C. STREUFERT, CHIEF FINANCIAL OFFICER; and JERRY DECICCIO, CONTROLLER. Borrower agrees to be liable for all sums either: (a) advanced in accordance with the instructions of an authorized person or (b) credited to any of Borrower's accounts with Lender. The unpaid principal balance owing on this Note at any time may be evidenced by endorsements on this Note or by Lender's internal records, including daily computer print-outs. Lender will have no obligation to advance funds under this Note if: (a) Borrower or any guarantor is in default under the terms of this Note or any agreement that Borrower or any guarantor has with Lender, including any agreement made in connection with the signing of this Note; (b) Borrower or any guarantor ceases doing business or is insolvent; (c) any guarantor seeks, claims or otherwise attempts to limit, modify or revoke such guarantor's guarantee of this Note or any other loan with Lender; or (d) Borrower has applied funds provided pursuant to this Note for purposes other than those authorized by Lender. GENERAL PROVISIONS. This Note is payable on demand. The inclusion of specific default provisions or rights of Lender shall not preclude Lender's right to declare payment of this Note on its demand. Lender may delay or forgo enforcing any of its rights or remedies under this Note without losing them. Borrower and any other person who signs, guarantees or endorses this Note, to the extent allowed by law, waive any applicable statute of limitations, presentment, demand for payment, protest and notice of dishonor. Upon any change in the terms of this Note, and unless otherwise expressly stated in writing, no party who signs this Note, whether as maker, guarantor, accommodation maker or endorser, shall be released from liability. All such parties agree that Lender may renew or extend (repeatedly and for any length of time) this loan, or release any party or guarantor or collateral; or impair, fail to realize upon or perfect Lender's security interest in the collateral; and take any other action deemed necessary by Lender without the consent of or notice to anyone. All such parties also agree that Lender may modify this loan without the consent of or notice to anyone other than the party with whom the modification is made. 2 Loan No 9730000139 (Continued) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- PRIOR TO SIGNING THIS NOTE, BORROWER READ AND UNDERSTOOD ALL THE PROVISIONS OF THIS NOTE, INCLUDING THE VARIABLE INTEREST RATE PROVISIONS. BORROWER AGREES TO THE TERMS OF THE NOTE AND ACKNOWLEDGES RECEIPT OF A COMPLETED COPY OF THE NOTE. BORROWER: NATIONAL TELEPHONE & COMMUNICATIONS, INC. By: /s/ Victor C. Streufert ---------------------------------------------- VICTOR C. STREUFERT, CHIEF FINANCIAL OFFICER - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 3 BUSINESS LOAN AGREEMENT
- ----------------------------------------------------------------------------------------------------------------------- PRINCIPAL LOAN DATE MATURITY LOAN NO CALL COLLATERAL ACCOUNT OFFICER INITIALS $5,000,000.00 03-27-1997 04-30-1998 9730000139 110 - ----------------------------------------------------------------------------------------------------------------------- References in the shaded area are for Lender's use only and do not limit the applicability of this document to any particular loan or item. - -----------------------------------------------------------------------------------------------------------------------
BORROWER: NATIONAL TELEPHONE & LENDER: FIRST BANK & TRUST COMMUNICATIONS, INC. IRVINE REGIONAL OFFICE - 400 2801 MAIN STREET 2400 MICHELSON DRIVE IRVINE, CA 92614 IRVINE, CA 92612 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- THIS BUSINESS LOAN AGREEMENT between NATIONAL TELEPHONE & COMMUNICATIONS, INC. ("Borrower") and FIRST BANK & TRUST ("Lender") is made and executed on the following terms and conditions. Borrower has received prior commercial loans from Lender or has applied to Lender for a commercial loan or loans and other financial accommodations, including those which may be described on any exhibit or schedule attached to this Agreement. All such loans and financial accommodations, together with all future loans and financial accommodations from Lender to Borrower, are referred to in this Agreement individually as the "Loan" and collectively as the "Loans." Borrower understands and agrees that: (a) in granting, renewing, or extending any Loan, Lender is relying upon Borrower's representations, warranties, and agreements, as set forth in this Agreement; (b) the granting, renewing, or extending of any Loan by Lender at all times shall be subject to Lender's sole judgment and discretion; and (c) all such Loans shall be and shall remain subject to the following terms and conditions of this Agreement. TERM. This Agreement shall be effective as of March 27, 1997, and shall continue thereafter until all indebtedness of Borrower to Lender has been performed in full and the parties terminate this Agreement in writing. DEFINITIONS. The following words shall have the following meanings when used in this Agreement. Terms not otherwise defined in this Agreement shall have the meanings attributed to such terms in the Uniform Commercial Code. All references to dollar amounts shall mean amounts in lawful money of the United States of America. AGREEMENT. The word "Agreement" means this Business Loan Agreement, as this Business Loan Agreement may be amended or modified from time to time, together with all exhibits and schedules attached to this Business Loan Agreement from time to time. BORROWER. The word "Borrower" means NATIONAL TELEPHONE & COMMUNICATIONS, INC. The word "Borrower" also includes, as applicable, all subsidiaries and affiliates of Borrower as provided below in the paragraph titled "Subsidiaries and Affiliates." CERCLA. The word "CERCLA" means the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended. CASH FLOW. The words "Cash Flow" mean net income after taxes, and exclusive of extraordinary gains and income, plus depreciation and amortization. COLLATERAL. The word "Collateral" means and includes without limitation all property and assets granted as collateral security for a Loan, whether real or personal property, whether granted directly or indirectly, whether granted now or in the future, and whether granted in the form of a security interest, mortgage, deed of trust, assignment, pledge, chattel mortgage, chattel trust, factor's lien, equipment trust, conditional sale, trust receipt, lien, charge, lien or title retention contract, lease or consignment intended as a security device, or any other security or lien interest whatsoever, whether created by law, contract, or otherwise. DEBT. The word "Debt" means all of Borrower's liabilities excluding Subordinated Debt. ERISA. The word "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. EVENT OF DEFAULT. The words "Event of Default" mean and include without limitation any of the Events of Default set forth below in the section titled "EVENTS OF DEFAULT." GRANTOR. The word "Grantor" means and includes without limitation each and all of the persons or entities granting a Security Interest in any Collateral for the indebtedness, including without limitation all Borrowers granting such a Security Interest. GUARANTOR. The word "Guarantor" means and includes without limitation each and all of the guarantors, sureties, and accommodation parties in connection with any indebtedness. INDEBTEDNESS. The word "Indebtedness" means and includes without limitation all Loans, together with all other obligations, debts and liabilities of Borrower to Lender, or any one or more of them, as well as all claims by Lender against Borrower, or any one or more of them; whether now or hereafter existing, voluntary or involuntary, due or not due, absolute or contingent, liquidated or unliquidated; whether Borrower may be liable individually or jointly with others; whether Borrower may be obligated as a guarantor, surety, or otherwise; whether recovery upon such indebtedness may be or hereafter may become barred by any statute of limitations; and whether such indebtedness may be or hereafter may become otherwise unenforceable. LENDER. The word "Lender" means FIRST BANK & TRUST, its successors and assigns. LIQUID ASSETS. The words "Liquid Assets" mean Borrower's cash on hand plus Borrower's readily marketable securities. LOAN. The word "Loan" or "Loans" means and includes without limitation any and all commercial loans and financial accommodations from Lender to Borrower, whether now or hereafter existing, and however evidenced, including without limitation those loans and financial accommodations described herein or described on any exhibit or schedule attached to this Agreement from time to time. NOTE. The word "Note" means and includes without limitation Borrower's promissory note or notes, if any, evidencing Borrower's Loan obligations in favor of Lender, as well as any substitute, replacement or refinancing note or notes therefor. PERMITTED LIENS. The words "Permitted Liens" mean: (a) liens and security interests securing indebtedness owed by Borrower to Lender; (b) liens for taxes, assessments, or similar charges either not yet due or being contested in good faith; (c) liens of materialmen, mechanics, warehousemen, or carriers, or other like liens arising in the ordinary course of business and securing obligations which are not yet delinquent; (d) purchase money liens or purchase money security interests upon or in any property acquired or held by Borrower in the ordinary course of business to secure indebtedness outstanding on the date of this Agreement or permitted to be incurred under the paragraph of this Agreement titled "Indebtedness and Liens"; (e) liens and security interests which, as of the date of this Agreement, have been disclosed to and approved by the Lender in writing; and (f) those liens and security interests which in the aggregate constitute an immaterial and insignificant monetary amount with respect to the net value of Borrower's assets. RELATED DOCUMENTS. The words "Related Documents" mean and include without limitation all promissory notes, credit agreements, loan agreements, environmental agreements, guarantees, security agreements, mortgages, deeds of trust, and all other instruments, agreements and documents, whether now or hereafter existing, executed in connection with the indebtedness. SECURITY AGREEMENT. The words "Security Agreement" mean and include without limitation any agreements, promises, covenants, arrangements, understandings or other agreements, whether created by law, contract, or otherwise, evidencing, governing, representing, or creating a Security Interest. SECURITY INTEREST. The words "Security Interest" mean and include without limitation any type of collateral security, whether in the form of a lien, charge, mortgage, deed of trust, assignment, pledge, chattel mortgage, chattel trust, factor's lien, equipment trust, conditional sale, trust receipt, lien or title retention contract, lease or consignment intended as a security device, or any other security or lien interest whatsoever, whether created by law, contract, or otherwise. SARA. The word "SARA" means the Superfund Amendments and Reauthorization Act of 1986 as now or hereafter amended. SUBORDINATED DEBT. The words "Subordinated Debt" mean indebtedness and liabilities of Borrower which have been subordinated by written agreement to indebtedness owed by Borrower to Lender in form and substance acceptable to Lender. TANGIBLE NET WORTH. The words "Tangible Net Worth" mean Borrower's total assets excluding all intangible assets (i.e., goodwill, trademarks, patents, copyrights, organizational expenses, and similar intangible items, but including leaseholds and leasehold improvements) less total Debt. WORKING CAPITAL. The words "Working Capital" mean Borrower's current assets, excluding prepaid expenses, less Borrower's current liabilities. CONDITIONS PRECEDENT TO EACH ADVANCE. Lender's obligation to make the initial Loan Advance and each subsequent Loan Advance under this Agreement shall be subject to the fulfillment to Lender's satisfaction of all of the conditions set forth in this Agreement and in the Related Documents. 4 03-27-1997 BUSINESS LOAN AGREEMENT Page 2 Loan No. 9730000139 (Continued) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- LOAN DOCUMENTS. Borrower shall provide to Lender in form satisfactory to Lender the following documents for the Loan: (a) the Note, (b) Security Agreements granting to Lender security interests in the Collateral, (c) Financing Statements perfecting Lender's Security Interests; (d) evidence of Insurance as required below; and (e) any other documents required under this Agreement or by Lender or its counsel. BORROWER'S AUTHORIZATION. Borrower shall have provided in form and substance satisfactory to Lender properly certified resolutions, duly authorizing the execution and delivery of this Agreement, the Note and the Related Documents, and such other authorizations and other documents and instruments as Lender or its counsel, in their sole discretion, may require. PAYMENT OF FEES AND EXPENSES. Borrower shall have paid to Lender all fees, charges, and other expenses which are then due and payable as specified in this Agreement or any Related Document. REPRESENTATIONS AND WARRANTIES. The representations and warranties set forth in this Agreement, in the Related Documents, and in any document or certificate delivered to Lender under this Agreement are true and correct. NO EVENT OF DEFAULT. There shall not exist at the time of any advance a condition which would constitute an Event of Default under this Agreement. REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants to Lender, as of the date of this Agreement, as of the date of each disbursement of Loan proceeds, as of the date of any renewal, extension or modification of any Loan, and at all times any indebtedness exists: ORGANIZATION. Borrower is a corporation which is duly organized, validly existing, and in good standing under the laws of the Sate of Delaware and is validly existing and in good standing in all states in which Borrower is doing business. Borrower has the full power and authority to own its properties and to transact the businesses in which it is presently engaged or presently proposed to engage. Borrower also is duly qualified as a foreign corporation and is in good standing in all states in which the failure to so qualify would have a material adverse effect on its businesses or financial condition. AUTHORIZATION. The execution, delivery, and performance of this Agreement and all Related Documents by Borrower, to the extent to be executed, delivered or performed by Borrower, have been duly authorized by all necessary action by Borrower; do not require the consent or approval of any other person, regulatory authority or governmental body; and do not conflict with, result in a violation of, or constitute a default under (a) any provision of its articles of incorporation or organization, or bylaws, or any agreement or other instrument binding upon Borrower or (b) any law, governmental regulation, court decree, or order applicable to Borrower. FINANCIAL INFORMATION. Each financial statement of Borrower supplied to Lender truly and completely disclosed Borrower's financial condition as of the date of the statement, and there has been no material adverse change in Borrower's financial condition subsequent to the date of the most recent financial statement supplied to Lender. Borrower has no material contingent obligations except as disclosed in such financial statements. LEGAL EFFECT. This Agreement constitutes, and any instrument or agreement required hereunder to be given by Borrower when delivered will constitute, legal, valid and binding obligations of Borrower enforceable against Borrower in accordance with their respective terms. PROPERTIES. Except as contemplated by this Agreement or as previously disclosed in Borrower's financial statements or in writing to Lender and as accepted by Lender, and except for property tax liens for taxes not presently due and payable, Borrower owns and has good title to all of Borrower's properties free and clear of all Security Interests, and has not executed any security documents or financing statements relating to such properties. All of Borrower's properties are titled in Borrower's legal name, and Borrower has not used, or filed a financing statement under, any other name for at least the last five (5) years. HAZARDOUS SUBSTANCES. The terms "hazardous waste," "hazardous substance," "disposal," "release," and "threatened release," as used in this Agreement, shall have the same meanings as set forth in the "CERCLA," "SARA," the Hazardous Materials Transportation Act, 49 U.S.C. Section 1801, et seq., the Resource Conservation and Recovery Act, 42 U.S.C. Section 6901, et seq., Chapters 6.5 through 7.7 of Division 20 of the California Health and Safety Code, Section 25100, et seq., or other applicable state or Federal laws, rules, or regulations adopted pursuant to any of the foregoing. Except as disclosed to and acknowledged by Lender in writing, Borrower represents and warrants that: (a) During the period of Borrower's ownership of the properties, there has been no use, generation, manufacture, storage, treatment, disposal, release or threatened release of any hazardous waste or substance by any person on, under, about or from any of the properties. (b) Borrower has no knowledge of, or reason to believe that there has been (i) any use, generation, manufacture, storage, treatment, disposal, release, or threatened release of any hazardous waste or substance on, under, about or from the properties by any prior owners or occupants of any of the properties, or (ii) any actual or threatened litigation or claims of any kind by any person relating to such matters. (c) Neither Borrower nor any tenant, contractor, agent or other authorized user of any of the properties shall use, generate, manufacture, store, treat, dispose of, or release any hazardous waste or substance on, under, about or from any other properties; and any such activity shall be conducted in compliance with all applicable federal, state and local laws, regulations, and ordinances, including without limitation those laws, regulations and ordinances described above. Borrower authorizes Lender and its agents to enter upon the properties to make such inspections and tests as Lender may deem appropriate to determine compliance of the properties with this section of the Agreement. Any inspections or tests made by Lender shall be at Borrower's expense and for Lender's purposes only and shall not be construed to create any responsibility or liability on the part of Lender to Borrower or to any other person. The representations and warranties contained herein are based on Borrower's due diligence in investigating the properties for hazardous waste and hazardous substances. Borrower hereby (a) releases and waives any future claims against Lender for indemnity or contribution in the event Borrower becomes liable for cleanup or other costs under any such laws, and (b) agrees to indemnify and hold harmless Lender against any and all claims, losses, liabilities, damages, penalties, and expenses which Lender may directly or indirectly sustain or suffer resulting from a breach of this section of the Agreement or as a consequence of any use, generation, manufacture, storage, disposal, release or threatened release occurring prior to Borrower's ownership or interest in the properties, whether or not the same was or should have been known to Borrower. The provisions of this section of the Agreement, including the obligation to indemnify, shall survive the payment of the indebtedness and the termination or expiration of this Agreement and shall not be affected by Lender's acquisition of any interest in any of the properties, whether by foreclosure or otherwise. LITIGATION AND CLAIMS. No litigation, claim, investigation, administrative proceeding or similar action (including those for unpaid taxes) against Borrower is pending or threatened, and no other event has occurred which may materially adversely affect Borrower's financial condition or properties, other than litigation, claims, or other events, if any, that have been disclosed to and acknowledged by Lender in writing. TAXES. To the best of Borrower's knowledge, all tax returns and reports of Borrower that are or were required to be filed, have been filed, and all taxes, assessments and other governmental charges have been paid in full, except those presently being or to be contested by Borrower in good faith in the ordinary course of business and for which adequate reserves have been provided. LIEN PRIORITY. Unless otherwise previously disclosed to Lender in writing, Borrower has not entered into or granted any Security Agreements, or permitted the filing or attachment of any Security Interests on or affecting any of the Collateral directly or indirectly securing repayment of Borrower's Loan and Note, that would be prior or that may in any way be superior to Lender's Security Interests and rights in and to such Collateral. BINDING EFFECT. This Agreement, the Note, all Security Agreements directly or indirectly securing repayment of Borrower's Loan and Note and all of the Related Documents are binding upon Borrower as well as upon Borrower's successors, representatives and assigns, and are legally enforceable in accordance with their respective terms. COMMERCIAL PURPOSES. Borrower intends to use the Loan proceeds solely for business or commercial related purposes. EMPLOYEE BENEFIT PLANS. Each employee benefit plan as to which Borrower may have any liability complies in all material respects with all applicable requirements of law and regulations, and (i) no Reportable Event nor Prohibited Transaction (as defined in ERISA) has occurred with respect to any such plan, (ii) Borrower has not withdrawn from any such plan or initiated steps to do so, (iii) no steps have been taken to terminate any such plan, and (iv) there are no unfunded liabilities other than those previously disclosed to Lender in writing. LOCATION OF BORROWER'S OFFICES AND RECORDS. Borrower's place of business, or Borrower's Chief executive office, if Borrower has more than one place of business, is located at 2801 MAIN STREET, IRVINE, CA 92614. Unless Borrower has designated otherwise in writing this location is also the office or offices where Borrower keeps its records concerning the Collateral. INFORMATION. All information heretofore or contemporaneously herewith furnished by Borrower to Lender for the purposes of or in connection with this Agreement or any transaction contemplated hereby is, and all information hereafter furnished by or on behalf of Borrower to Lender will be, true and accurate in every material respect on the date as of which such information is dated or certified; and none of such information is or will be incomplete by omitting to state any material fact necessary to make such information not misleading. SURVIVAL OF REPRESENTATIONS AND WARRANTIES. Borrower understands and agrees that Lender, without independent investigation, is relying upon the above representations and warranties in extending Loan Advances to Borrower. Borrower further agrees that the foregoing representations and warranties shall be continuing in nature and shall remain in full force and effect until such time as Borrower's indebtedness shall be paid in full, or until this Agreement shall be terminated in the manner provided above, whichever is the last to occur. 5 03-27-1997 BUSINESS LOAN AGREEMENT Page 3 Loan No. 9730000139 (Continued) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- AFFIRMATIVE COVENANTS. Borrower covenants and agrees with Lender that, while this Agreement is in effect, Borrower will: LITIGATION. Promptly inform Lender in writing of (a) all material adverse changes in Borrower's financial condition, and (b) all existing and all threatened litigation, claims, investigations, administrative proceedings or similar actions affecting Borrower or any Guarantor which could materially affect the financial condition of Borrower or the financial condition of any Guarantor. FINANCIAL RECORDS. Maintain its books and records in accordance with generally accepted accounting principles, applied on a consistent basis, and permit Lender to examine and audit Borrower's books and records at all reasonable times. ADDITIONAL INFORMATION. Furnish such additional information and statements, lists of assets and liabilities, agings of receivables and payables, inventory schedules, budgets, forecasts, tax returns, and other reports with respect to Borrower's financial condition and business operations as Lender may request from time to time. FINANCIAL COVENANTS AND RATIOS. Comply with the following covenants and ratios: NET WORTH RATIO. Maintain a ratio of Total Liabilities to Tangible Net Worth of less than 3.00 to 1.00. Except as provided above, all computations made to determine compliance with the requirements contained in this paragraph shall be made in accordance with generally accepted accounting principles, applied on a consistent basis, and certified by Borrower as being true and correct. INSURANCE. Maintain fire and other risk insurance, public liability insurance, and such other insurance as Lender may require with respect to Borrower's properties and operations, in form, amounts, coverages and with insurance companies reasonably acceptable to Lender. Borrower, upon request of Lender, will deliver to Lender from time to time the policies or certificates of insurance in form satisfactory to Lender, including stipulations that coverages will not be cancelled or diminished without at least ten (10) days' prior written notice to Lender. Each insurance policy also shall include an endorsement providing that coverage in favor of Lender will not be impaired in any way by any act, omission or default of Borrower or any other person. In connection with all policies covering assets in which Lender holds or is offered a security interest for the Loans, Borrower will provide Lender with such loss payable or other endorsements as Lender may require. INSURANCE REPORTS. Furnish to Lender, upon request of Lender, reports on each existing insurance policy showing such information as Lender may reasonably request, including without limitation the following: (a) the name of the insurer; (b) the risks insured; (c) the amount of the policy; (d) the properties insured; (e) the then current property values on the basis of which insurance has been obtained, and the manner of determining those values; and (f) the expiration date of the policy. In addition, upon request of Lender (however not more often than annually), Borrower will have an independent appraiser satisfactory to Lender determine, as applicable, the actual cash value or replacement cost of any Collateral. The cost of such appraisal shall be paid by Borrower. OTHER AGREEMENTS. Comply with all terms and conditions of all other agreements, whether now or hereafter existing, between Borrower and any other party and notify Lender immediately in writing of any default in connection with any other such agreements. LOAN PROCEEDS. Use all Loan proceeds solely for Borrower's business operations, unless specifically consented to the contrary by Lender in writing. TAXES, CHARGES AND LIENS. Pay and discharge when due all of its indebtedness and obligations, including without limitation all assessments, taxes, governmental charges, levies and liens, of every kind and nature, imposed upon Borrower or its properties, income, or profits, prior to the date on which penalties would attach, and all lawful claims that, if unpaid, might become a lien or charge upon any of Borrower's properties, income, or profits. Provided however, Borrower will not be required to pay and discharge any such assessment, tax, charge, levy, lien or claim so long as (a) the legality of the same shall be contested in good faith by appropriate proceedings, and (b) Borrower shall have established on its books adequate reserves with respect to such contested assessment, tax, charge, levy, lien, or claim in accordance with generally accepted accounting practices. Borrower, upon demand of Lender, will furnish to Lender evidence of payment of the assessments, taxes, charges, levies, liens and claims and will authorize the appropriate governmental official to deliver to Lender at any time a written statement of any assessments, taxes, charges, levies, liens and claims against Borrower's properties, income, or profits. PERFORMANCE. Perform and comply with all terms, conditions, and provisions set forth in this Agreement and in the Related Documents in a timely manner, and promptly notify Lender if Borrower learns of the occurrence of any event which constitutes an Event of Default under this Agreement or under any of the Related Documents. OPERATIONS. Maintain executive and management personnel with substantially the same qualifications and experience as the present executive and management personnel; provide written notice to Lender of any change in executive and management personnel; conduct its business affairs in a reasonable and prudent manner and in compliance with all applicable federal, state and municipal laws, ordinances, rules and regulations respecting its properties, charters, businesses and operations, including without limitation, compliance with the Americans With Disabilities Act and with all minimum funding standards and other requirements of ERISA and other laws applicable to Borrower's employee benefit plans. INSPECTION. Permit employees or agents of Lender at any reasonable time to inspect any and all Collateral for the Loan or Loans and Borrower's other properties and to examine or audit Borrower's books, accounts, and records and to make copies and memoranda of Borrower's books, accounts, and records. If Borrower now or at any time hereafter maintains any records (including without limitation computer generated records and computer software programs for the generation of such records) in the possession of a third party, Borrower, upon request of Lender, shall notify such party to permit Lender free access to such records at all reasonable times and to provide Lender with copies of any records it may request, all at Borrower's expense. COMPLIANCE CERTIFICATE. Unless waived in writing by Lender, provide Lender at least annually and at the time of each disbursement of Loan proceeds with a certificate executed by Borrower's chief financial officer, or other officer or person acceptable to Lender, certifying that the representations and warranties set forth in this Agreement are true and correct as of the date of the certificate and further certifying that, as of the date of the certificate, no Event of Default exists under this Agreement. ENVIRONMENTAL COMPLIANCE AND REPORTS. Borrower shall comply in all respects with all environmental protection federal, state and local laws, statutes, regulations and ordinances; not cause or permit to exist, as a result of an intentional or unintentional action or omission on its part or on the part of any third party, on property owned and/or occupied by Borrower, any environmental activity where damage may result to the environment, unless such environmental activity is pursuant to and in compliance with the conditions of a permit issued by the appropriate federal, state or local governmental authorities; shall furnish to Lender promptly and in any event within thirty (30) days after receipt thereof a copy of any notice, summons, lien, citation, directive, letter or other communication from any governmental agency or instrumentality concerning any intentional or unintentional action or omission on Borrower's part in connection with any environmental activity whether or not there is damage to the environment and/or other natural resources. ADDITIONAL ASSURANCES. Make, execute and deliver to Lender such promissory notes, mortgages, deeds of trust, security agreements, financing statements, instruments, documents and other agreements as Lender or its attorneys may reasonably request to evidence and secure the Loans and to perfect all Security Interests. NEGATIVE COVENANTS. Borrower covenants and agrees with Lender that while this Agreement is in effect, Borrower shall not, without the prior written consent of Lender: INDEBTEDNESS AND LIENS. (a) Except for trade debt incurred in the normal course of business and indebtedness to Lender contemplated by this Agreement, create, incur or assume indebtedness for borrowed money, including capital leases, (b) except as allowed as a Permitted Lien, sell, transfer, mortgage, assign, pledge, lease, grant a security interest in, or encumber any of Borrower's assets, or (c) sell with recourse any of the Borrower's accounts, except to Lender. CONTINUITY OF OPERATIONS. (a) Engage in any business activities substantially different than those in which Borrower is presently engaged, (b) cease operations, liquidate, merge, transfer, acquire or consolidate with any other entity, change ownership, change its name, dissolve or transfer or sell Collateral out of the ordinary course of business, (c) pay any dividends on Borrower's stock (other than dividends payable in its stock), provided, however that notwithstanding the foregoing, but only so long as no Event of Default has occurred and is continuing or would result from the payment of dividends, if Borrower is a "Subchapter S Corporation" (as defined in the Internal Revenue Code of 1986, as amended), Borrower may pay cash dividends on its stock to its shareholders from time to time in amounts necessary to enable the shareholders to pay income taxes and make estimated income tax payments to satisfy their liabilities under federal and state law which arise solely from their status as Shareholders of a Subchapter S Corporation because of their ownership of shares of stock of Borrower, or (d) purchase or retire any of Borrower's outstanding shares or alter or amend Borrower's capital structure. LOANS, ACQUISITIONS AND GUARANTIES. (a) Loan, invest in or advance money or assets, (b) purchase, create or acquire any interest in any other enterprise or entity, or (c) incur any obligation as surety or guarantor other than in the ordinary course of business. CESSATION OF ADVANCES. If Lender has made any commitment to make any Loan to Borrower, whether under this Agreement or under any other agreement, Lender shall have no obligation to make Loan Advances or to disburse Loan proceeds if: (a) Borrower or any Guarantor is in default under the terms of this Agreement or any of the Related Documents or any other agreement that Borrower or any Guarantor has with Lender, (b) Borrower becomes insolvent, files a petition in bankruptcy or similar proceedings, or is adjudged a bankrupt; (c) there occurs a material adverse change in Borrower's financial condition, in the financial condition of any Guarantor, or in the value of any Collateral securing any Loan; or (d) a Guarantor seeks, claims or otherwise attempts to limit, modify or revoke such Guarantor's guaranty of the Loan or any other loan with Lender. 6 03-27-1997 BUSINESS LOAN AGREEMENT Page 4 Loan No. 9730000139 (Continued) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ADDITIONAL PROVISIONS. 1. BORROWERS TANGIBLE NET WORTH AT SEPTEMBER 30, 1997 WILL BE $10,000,000.00 AND AT DECEMBER 31, 1997 WILL BE $11,000,000.00. 2. NET INCOME AFTER TAX AT DECEMBER 31, 1997 WILL BE AT LEAST $2,000,000.00. 3. BORROWER WILL NOT UPSTREAM CASH TO ITS PARENT OR OTHER AFFILIATED COMPANIES IN EXCESS OF $100,000.00 PER MONTH OR $1,200,000.00 ANNUALLY, WITHOUT THE PRIOR WRITTEN CONSENT OF FIRST BANK & TRUST. BORROWER CAN ONLY UPSTREAM CASH UPON MEETING ALL OF ITS FINANCIAL OBLIGATIONS/COMMITMENTS WITH FIRST BANK & TRUST AND ALL OTHERS. A CONDITION OF DEFAULT UNDER ANY NOTE OR CONTRACTUAL AGREEMENT MAY NOT EXIST AT THE TIME OF UPSTREAMING CASH. 4. A DEFAULT UNDER ANY AND ALL CONTRACTUAL AGREEMENTS ENTERED INTO BY AND BETWEEN NATIONAL TELEPHONE & COMMUNICATIONS, INC. AND WILTEL, INC., A DELAWARE CORPORATION, OR WORLDCOM NETWORK SERVICES, INC., WILL BE AN AUTOMATIC DEFAULT UNDER THE SUBJECT LOAN DOCUMENTS AND ANY FUTURE MODIFICATIONS TO THE SUBJECT LOAN DOCUMENTS. 5. BORROWER IS REQUIRED TO NOTIFY FIRST BANK & TRUST OF ALL LEGAL SETTLEMENTS OF $100,000.00 OR MORE AND OPEN LAW SUITS PENDING IN WRITING AS SOON AS ITS MANAGEMENT IS AWARE OF IT. 6. BORROWER AGREES NOT TO GUARANTEE THE OBLIGATIONS OR DEBT OF ANOTHER ENTITY WITHOUT THE PRIOR WRITTEN CONSENT OF FIRST BANK & TRUST. 7. BORROWER AGREES TO AT LEAST ONE ACCOUNTS RECEIVABLE AUDIT ANNUALLY, TO BE PERFORMED AT BORROWER'S EXPENSE. (____/s/____INITIAL HERE). EVENTS OF DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: DEFAULT ON INDEBTEDNESS. Failure of Borrower to make any payment when due on the Loans. OTHER DEFAULTS. Failure of Borrower or any Grantor to comply with or to perform when due any other term, obligation, covenant or condition contained in this Agreement or in any of the Related Documents, or failure of Borrower to comply with or to perform any other term, obligation, covenant or condition contained in any other agreement between Lender and Borrower. DEFAULT IN FAVOR OF THIRD PARTIES. Should Borrower or any Grantor default under any loan, extension of credit, security agreement, purchase or sales agreement, or any other agreement, in favor of any other creditor or person that may materially affect any of Borrower's property or Borrower's or any Grantor's ability to repay the Loans or perform their respective obligations under this Agreement or any of the Related Documents. FALSE STATEMENTS. Any warranty, representation or statement made or furnished to Lender by or on behalf of Borrower or any Grantor under this Agreement or the Related Documents is false or misleading in any material respect at the time made or furnished, or becomes false or misleading at any time thereafter. DEFECTIVE COLLATERALIZATION. This Agreement or any of the Related Documents ceases to be in full force and effect (including failure of any Security Agreement to create a valid and perfected Security Interest) at any time and for any reason. INSOLVENCY. The dissolution or termination of Borrower's existence as a going business, the insolvency of Borrower, the appointment of a receiver for any part of Borrower's property, any assignment for the benefit of creditors, any type of creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against Borrower. CREDITOR OR FORFEITURE PROCEEDINGS. Commencement of foreclosure or forfeiture proceedings, whether by judicial proceeding, self-help, repossession or any other method, by any creditor of Borrower, any creditor of any Grantor against any collateral securing the Indebtedness, or by any governmental agency. This includes a garnishment, attachment, or levy on or of any of Borrower's deposit accounts with Lender. However, this Event of Default shall not apply if there is a good faith dispute by Borrower or Grantor, as the case may be, as to the validity or reasonableness of the claim which is the basis of the creditor or forfeiture proceeding, and if Borrower or Grantor gives Lender written notice of the creditor or forfeiture proceeding and furnishes reserves or a surety bond for the creditor or forfeiture proceeding satisfactory to Lender. EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with respect to any Guarantor of any of the Indebtedness or any Guarantor dies or becomes incompetent, or revokes or disputes the validity of, or liability under, any Guaranty of the Indebtedness. Lender, at its option, may, but shall not be required to, permit the Guarantor's estate to assume unconditionally the obligations arising under the guaranty in a manner satisfactory to Lender, and, in doing so, cure the Event of Default. CHANGE IN OWNERSHIP. Any change in ownership of twenty-five percent (25%) or more of the common stock of Borrower. ADVERSE CHANGE. A material adverse change occurs in Borrower's financial condition, or Lender believes the prospect of payment or performance of the Indebtedness is impaired. RIGHT TO CURE. If any default, other than a Default on Indebtedness, is curable and if Borrower or Grantor, as the case may be, has not been given a notice of a similar default within the preceding twelve (12) months, it may be cured (and no Event of Default will have occurred) if Borrower or Grantor, as the case may be, after receiving written notice from Lender demanding cure of such default: (a) cures the default within fifteen (15) days; or (b) if the cure requires more than fifteen (15) days, immediately initiates steps which Lender deems in Lender's sole discretion to be sufficient to cure the default and thereafter continues and completes all reasonable and necessary steps sufficient to produce compliance as soon as reasonably practical. EFFECT OF AN EVENT OF DEFAULT. If any Event of Default shall occur, except where otherwise provided in this Agreement or the Related Documents, all commitments and obligations of Lender under this Agreement or the Related Documents or any other agreement immediately will terminate (including any obligation to make Loan Advances or disbursements), and, at Lender's option, all indebtedness immediately will become due and payable, all without notice of any kind to Borrower, except that in the case of an Event of Default of the type described in the "Insolvency" subsection above, such acceleration shall be automatic and not optional. In addition, Lender shall have all the rights and remedies provided in the Related Documents or available at law, in equity, or otherwise. Except as may be prohibited by applicable law, all of Lender's rights and remedies shall be cumulative and may be exercised singularly or concurrently. Election by Lender to pursue any remedy shall not exclude pursuit of any other remedy, and an election to make expenditures or to take action to perform an obligation of Borrower or of any Grantor shall not affect Lender's right to declare a default and to exercise its rights and remedies. MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of this Agreement: AMENDMENTS. This Agreement, together with any Related Documents, constitutes the entire understanding and agreement of the parties as to the matters set forth in this Agreement. No alteration of or amendment to this Agreement shall be effective unless given in writing and signed by the party or parties sought to be charged or bound by the alteration or amendment. APPLICABLE LAW. This Agreement has been delivered to Lender and accepted by Lender in the State of California. If there is a lawsuit, Borrower agrees upon Lender's request to submit to the jurisdiction of the court of Orange County, the State of California. Lender and Borrower hereby waive the right to any jury trial in any action, proceeding, or counterclaim brought by either Lender or Borrower against the other. (Initial Here__/s/__) This Agreement shall be governed by and construed in accordance with the laws of the State of California. CAPTION HEADINGS. Caption headings in this Agreement are for convenience purposes only and are not to be used to interpret or define the provisions of this Agreement. MULTIPLE PARTIES; CORPORATE AUTHORITY. All obligations of Borrower under this Agreement shall be joint and several, and all references to Borrower shall mean each and every Borrower. This means that each of the persons signing below is responsible for all obligations in this Agreement. CONSENT TO LOAN PARTICIPATION. Borrower agrees and consents to Lender's sale or transfer, whether now or later, of one or more participation interests in the Loans to one or more purchasers, whether related or unrelated to Lender. Lender may provide, without any limitation whatsoever, to any one or more purchasers, or potential purchasers, any information or knowledge Lender may have about Borrower or about any other matter relating to the Loan, and Borrower hereby waives any rights to privacy it may have with respect to such matters. Borrower additionally waives any and all notices of sale of participation interests, as well as all notices of any repurchase of such participation interests. Borrower also agrees that the purchasers of any such participation interests will be considered as the absolute owners of such interests in the Loans and will have all the rights granted under the participation agreement or agreements governing the sale of such participation interests. Borrower further waives all rights of offset or counterclaim that it may have now or later against Lender or against any purchaser of such a participation interest and unconditionally agrees that either Lender or such purchaser may enforce Borrower's obligation under the Loans irrespective of the failure or insolvency of any holder of any interest in the Loans. Borrower further agrees that the purchaser of any such participation interests may enforce its interests irrespective of any personal claims or defenses that Borrower may have against Lender. COSTS AND EXPENSES. Borrower agrees to pay upon demand all of Lender's expenses, including without limitation attorneys' fees, incurred in connection with the preparation, execution, enforcement, modification and collection of this Agreement or in connection with the Loans made pursuant to this Agreement. Lender may pay someone else to help collect the Loans and to enforce this Agreement, and Borrower will pay that amount. This includes, subject to any limits under applicable law, Lender's attorneys' fees and Lender's legal expenses, whether or not there is a lawsuit, including attorneys' fees for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Borrower also will pay any court costs, in addition to all other sums provided by law. NOTICES. All notices required to be given under this Agreement shall be given in writing, may be sent by telefacsimile, and shall be effective when 7 03-27-1997 BUSINESS LOAN AGREEMENT Page 5 Loan No. 9730000139 (Continued) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- actually delivered or when deposited with a nationally recognized overnight courier or deposited in the United States mail, first class, postage prepaid, addressed to the party to whom the notice is to be given at the address shown above. Any party may change its address for notices under this Agreement by giving formal written notice to the other parties, specifying that the purpose of the notice is to change the party's address. To the extent permitted by applicable law, if there is more than one Borrower, notice to any Borrower will constitute notice to all Borrowers. For notice purposes, Borrower will keep Lender informed at all times of Borrower's current address(es). SEVERABILITY. If a court of competent jurisdiction finds any provision of this Agreement to be invalid or unenforceable as to any person or circumstance, such finding shall not render that provision invalid or unenforceable as to any other persons or circumstances. If feasible, any such offending provision shall be deemed to be modified to be within the limits of enforceability or validity; however, if the offending provision cannot be so modified, it shall be stricken and all other provisions of this Agreement in all other respects shall remain valid and enforceable. SUBSIDIARIES AND AFFILIATES OF BORROWER. To the extent the context of any provisions of this Agreement makes it appropriate, including without limitation any representation, warranty or covenant, the word "Borrower" as used herein shall include all subsidiaries and affiliates of Borrower. Notwithstanding the foregoing however, under no circumstances shall this Agreement be construed to require Lender to make any Loan or other financial accommodation to any subsidiary or affiliate of Borrower. SUCCESSORS AND ASSIGNS. All covenants and agreements contained by or on behalf of Borrower shall bind its successors and assigns and shall inure to the benefit of Lender, its successors and assigns. Borrower shall not, however, have the right to assign its rights under this Agreement or any interest therein, without the prior written consent of Lender. SURVIVAL. All warranties, representations, and covenants made by Borrower in this Agreement or in any certificate or other instrument delivered by Borrower to Lender under this Agreement shall be considered to have been relied upon by Lender and will survive the making of the Loan and delivery to Lender of the Related Documents, regardless of any investigation made by Lender or on Lender's behalf. TIME IS OF THE ESSENCE. Time is of the essence in the performance of this Agreement. WAIVER. Lender shall not be deemed to have waived any rights under this Agreement unless such waiver is given in writing and signed by Lender. No delay or omission on the part of Lender in exercising any right shall operate as a waiver of such right of any other right. A waiver by Lender of a provision of this Agreement shall not prejudice or constitute a waiver of Lender's right otherwise to demand strict compliance with that provision or any other provision of this Agreement. No prior waiver by Lender, nor any course of dealing between Lender and Borrower, or between Lender and any Grantor, shall constitute a waiver of any of Lender's rights or of any obligations of Borrower or of any Grantor as to any future transactions. Whenever the consent of Lender is required under this Agreement, the granting of such consent by Lender in any instance shall not constitute continuing consent in subsequent instances where such consent is required, and in all cases such consent may be granted or withheld in the sole discretion of Lender. BORROWER ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS BUSINESS LOAN AGREEMENT, AND BORROWER AGREES TO ITS TERMS. THIS AGREEMENT IS DATED AS OF MARCH 27, 1997. BORROWER: NATIONAL TELEPHONE & COMMUNICATIONS, INC. By: /s/ Victor C. Streufert ---------------------------------------------- VICTOR C. STREUFERT, CHIEF FINANCIAL OFFICER LENDER: FIRST BANK & TRUST By: /s/ K.P. Balkrishna ---------------------------------------------- Authorized Officer - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 8 [LETTERHEAD] COMMERCIAL SECURITY AGREEMENT
- ----------------------------------------------------------------------------------------------------------------------- PRINCIPAL LOAN DATE MATURITY LOAN NO CALL COLLATERAL ACCOUNT OFFICER INITIALS $5,000,000.00 03-27-1997 04-30-1998 9730000139 110 - ----------------------------------------------------------------------------------------------------------------------- References in the shaded area are for Lender's use only and do not limit the applicability of this document to any Particular loan or item. - -----------------------------------------------------------------------------------------------------------------------
BORROWER: NATIONAL TELEPHONE & LENDER: FIRST BANK & TRUST COMMUNICATIONS, INC. IRVINE REGIONAL OFFICE - 400 2801 MAIN STREET 2400 MICHELSON DRIVE IRVINE, CA 92614 IRVINE, CA 92612 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- THIS COMMERCIAL SECURITY AGREEMENT is entered into between NATIONAL TELEPHONE & COMMUNICATIONS, INC. (referred to below as "Grantor"); and FIRST BANK & TRUST (referred to below as "Lender"). For valuable consideration, Grantor grants to Lender a security interest in the Collateral to secure the Indebtedness and agrees that Lender shall have the rights stated in this Agreement with respect to the Collateral, in addition to all other rights which Lender may have by law. DEFINITIONS. The following words shall have the following meanings when used in this Agreement. Terms not otherwise defined in this Agreement shall have the meanings attributed to such terms in the Uniform Commercial Code. All references to dollar amounts shall mean amounts in lawful money of the United States of America. AGREEMENT. The word "Agreement" means this Commercial Security Agreement, as this Commercial Security Agreement may be amended or modified from time to time, together with all exhibits and schedules attached to this Commercial Security Agreement from time to time. COLLATERAL. The word "Collateral" means the following described property of Grantor, whether now owned or hereafter acquired, whether now existing or hereafter arising, and wherever located: All inventory, chattel paper, accounts, equipment and general intangibles, together with the following specifically described property: EXCLUDING AND EXCEPTING LEASEHOLD IMPROVEMENTS AND CUSTOMER LISTS. In addition, the word "Collateral" includes all the following, whether now owned or hereafter acquired, whether now existing or hereafter arising, and wherever located: (a) All attachments, accessions, accessories, tools, parts, supplies, increases, and additions to and all replacements of and substitutions for any property described above. (b) All products and produce of any of the property described in this Collateral section. (c) All accounts, general intangibles, instruments, rents, monies, payments, and all other rights, arising out of a sale, lease, or other disposition of any of the property described in this Collateral section. (d) All proceeds (including insurance proceeds) from the sale, destruction, loss, or other disposition of any of the property described in this Collateral section. (e) All records and data relating to any of the property described in this Collateral section, whether in the form of a writing, photograph, microfilm, microfiche, or electronic media, together with all of Grantor's right, title, and interest in and to all computer software required to utilize, create, maintain, and process any such records or data on electronic media. EVENT OF DEFAULT. The words "Event of Default" mean and include without limitation any of the Events of Default set forth below in the section titled "Events of Default." GRANTOR. The word "Grantor" means NATIONAL TELEPHONE & COMMUNICATIONS, INC., its successors and assigns. GUARANTOR. The word "Guarantor" means and includes without limitation each and all of the guarantors, sureties, and accommodation parties in connection with the indebtedness. INDEBTEDNESS. The word "Indebtedness" means the indebtedness evidenced by the Note, including all principal and interest, together with all other indebtedness and costs and expenses for which Grantor is responsible under this Agreement or under any of the Related Documents. In addition, the word "Indebtedness" includes all other obligations, debts and liabilities, plus interest thereon, of Grantor, or any one or more of them, to Lender, as well as all claims by Lender against Grantor, or any one or more of them, whether existing now or later; whether they are voluntary or involuntary, due or not due, direct or indirect, absolute or contingent, liquidated or unliquidated; whether Grantor may be liable individually or jointly with others; whether Grantor may be obligated as guarantor, surety, accommodation party or otherwise; whether recovery upon such indebtedness may be or hereafter may become barred by any statute of limitations; and whether such indebtedness may be or hereafter may become otherwise unenforceable. (Initial Here /s/ VCS) LENDER. The word "Lender" means FIRST BANK & TRUST, its successor and assigns. NOTE. The word "Note" means the note or credit agreement dated March 27, 1997, in the principal amount of $5,000,000.00 from NATIONAL TELEPHONE & COMMUNICATIONS, INC. to Lender, together with all renewals of, extensions of, modifications of, refinancings of, consolidations of and substitutions for the note or credit agreement. RELATED DOCUMENTS. The words "Related Documents" mean and include without limitation all promissory notes, credit agreements, loan agreements, environmental agreements, guaranties, security agreements, mortgages, deeds of trust, and all other instruments, agreements and documents, whether now or hereafter existing, executed in connection with the indebtedness. OBLIGATIONS OF GRANTOR. Grantor warrants and covenants to Lender as follows: PERFECTION OF SECURITY INTEREST. Grantor agrees to execute such financing statements and to take whatever other actions are requested by Lender to perfect and continue Lender's security interest in the Collateral. Upon request of Lender, Grantor will deliver to Lender any and all of the documents evidencing or constituting the Collateral, and Grantor will note Lender's Interest upon any and all chattel paper if not delivered to Lender for possession by Lender. Grantor hereby appoints Lender as its irrevocable attorney-in-fact for the purpose of executing any documents necessary to perfect or to continue the security interest granted in this Agreement. Lender may at any time, and without further authorization from Grantor, file a carbon, photographic or other reproduction of any financing statement or of this Agreement for use as a financing statement. Grantor will reimburse Lender for all expenses for the perfection and the continuation of the perfection of Lender's security interest in the Collateral. Grantor promptly will notify Lender before any change in Grantor's name including any change to the assumed business names of Grantor. This is a continuing Security Agreement and will continue in effect even though all or any part of the Indebtedness is paid in full and even though for a period of time Grantor may not be indebted to Lender. NO VIOLATION. The execution and delivery of this Agreement will not violate any law or agreement governing Grantor or to which Grantor is a party, and its certificate or articles of incorporation and bylaws do not prohibit any term or condition of this Agreement. ENFORCEABILITY OF COLLATERAL. To the extent the Collateral consists of accounts, chattel paper, or general intangibles, the Collateral is enforceable in accordance with its terms, is genuine, and complies with applicable laws concerning form, content and manner of preparation and execution, and all persons appearing to be obligated on the Collateral have authority and capacity to contract and are in fact obligated as they appear to be on the Collateral. At the time any account becomes subject to a security interest in favor of Lender, the account shall be a good and valid account representing an undisputed, bona fide indebtedness incurred by the account debtor, for merchandise held subject to delivery instructions or theretofore shipped or delivered pursuant to a contract of sale, or for services theretofore performed by Grantor with or for the account debtor; there shall be no setoffs or counterclaims against any such account; and no agreement under which any deductions or discounts may be claimed shall have been made with the account debtor except those disclosed to Lender in writing. LOCATION OF THE COLLATERAL. Grantor, upon request of Lender, will deliver to Lender in form satisfactory to Lender a schedule of real properties and Collateral locations relating to Grantor's operations, including without limitation the following: (a) all real property owned or being purchased by Grantor; (b) all real property being rented or leased by Grantor; (c) all storage facilities owned, rented, leased, or being used by Grantor; and (d) all other properties where Collateral is or may be located. Except in the ordinary course of its business, Grantor shall not remove the Collateral from its existing locations without the prior written consent of Lender. REMOVAL OF COLLATERAL. Grantor shall keep the Collateral (or to the extent the Collateral consists of Intangible property such as accounts, the records concerning the Collateral) at Grantor's address shown above, or at such other locations as are acceptable to Lender. Except in the 9 Loan No. 9730000139 (Continued) - -------------------------------------------------------------------------------- ordinary course of its business, including the sales of inventory, Grantor shall not remove the Collateral from its existing locations without the prior written consent of Lender. To the extent that the Collateral consists of vehicles, or other titled property, Grantor shall not take or permit any action which would require application for certificates of title for the vehicles outside the State of California, without the prior written consent of Lender. TRANSACTIONS INVOLVING COLLATERAL. Except for inventory sold or accounts collected in the ordinary course of Grantor's business, Grantor shall not sell, offer to sell, or otherwise transfer or dispose of the Collateral. While Grantor is not in default under this Agreement, Grantor may sell inventory, but only in the ordinary course of its business and only to buyers who qualify as a buyer in the ordinary course of business. A sale in the ordinary course of Grantor's business does not include a transfer in partial or total satisfaction of a debt or any bulk sale. Grantor shall not pledge, mortgage, encumber or otherwise permit the Collateral to be subject to any lien, security interest, encumbrance, or charge, other than the security interest provided for in this Agreement, without the prior written consent of Lender. This includes security interests even if junior in right to the security interests granted under this Agreement. Unless waived by Lender, all proceeds from any disposition of the Collateral (for whatever reason) shall be held in trust for Lender and shall not be commingled with any other funds; provided however, this requirement shall not constitute consent by Lender to any sale or other disposition. Upon receipt, Grantor shall immediately deliver any such proceeds to Lender. TITLE. Grantor represents and warrants to Lender that it holds good and marketable title to the Collateral, free and clear of all liens and encumbrances except for the lien of this Agreement. No financing statement covering any of the Collateral is on file in any public office other than those which reflect the security interest created by this Agreement or to which Lender has specifically consented. Grantor shall defend Lender's rights in the Collateral against the claims and demands of all other persons. COLLATERAL SCHEDULES AND LOCATIONS. As often as Lender shall require, and insofar as the Collateral consists of accounts and general intangibles, Grantor shall deliver to Lender schedules of such Collateral, including such information as Lender may require, including without limitation names and addresses of account debtors and agings of accounts and general intangibles. Insofar as the Collateral consists of inventory and equipment, Grantor shall deliver to Lender, as often as Lender shall require, such lists, descriptions, and designations of such Collateral as Lender may require to identify the nature, extent, and location of such Collateral. Such information shall be submitted for Grantor and each of its subsidiaries or related companies. MAINTENANCE AND INSPECTION OF COLLATERAL. Grantor shall maintain all tangible Collateral in good condition and repair. Grantor will not commit or permit damage to or destruction of the Collateral or any part of the Collateral. Lender and its designated representatives and agents shall have the right at all reasonable times to examine, inspect, and audit the Collateral wherever located. Grantor shall immediately notify Lender of all cases involving the return, rejection, repossession, loss or damage of or to any Collateral; of any request for credit or adjustment or of any other dispute arising with respect to the Collateral; and generally of all happenings and events affecting the Collateral or the value or the amount of the Collateral. TAXES, ASSESSMENTS AND LIENS. Grantor will pay when due all taxes, assessments and liens upon the Collateral, its use or operation, upon this Agreement, upon any promissory note or notes evidencing the Indebtedness, or upon any of the other Related Documents. Grantor may withhold any such payment or may elect to contest any lien if Grantor is in good faith conducting an appropriate proceeding to contest the obligation to pay and so long as Lender's interest in the Collateral is not jeopardized in Lender's sole opinion. If the Collateral is subjected to a lien which is not discharged within fifteen (15) days, Grantor shall deposit with Lender cash, a sufficient corporate surety bond or other security satisfactory to Lender in an amount adequate to provide for the discharge of the lien plus any interest, costs, attorneys' fees or other charges that could accrue as a result of foreclosure or sale of the Collateral. In any contest Grantor shall defend itself and Lender and shall satisfy any final adverse judgment before enforcement against the Collateral. Grantor shall name Lender as an additional obligee under any surety bond furnished in the contest proceedings. COMPLIANCE WITH GOVERNMENTAL REQUIREMENTS. Grantor shall comply promptly with all laws, ordinances, rules and regulations of all governmental authorities, now or hereafter in effect, applicable to the ownership, production, disposition, or use of the Collateral. Grantor may contest in good faith any such law, ordinance or regulation and withhold compliance during any proceeding, including appropriate appeals, so long as Lender's interest in the Collateral, in Lender's opinion, is not jeopardized. HAZARDOUS SUBSTANCES. Grantor represents and warrants that the Collateral never has been, and never will be so long as this Agreement remains a lien on the Collateral, used for the generation, manufacture, storage, transportation, treatment, disposal, release or threatened release of any hazardous waste or substance, as those terms are defined in the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended, 42 U.S.C. Section 9601, et seq. ("CERCLA"), the Superfund Amendments and Reauthorization Act of 1986, Pub. L. No. 99-499 ("SARA"), the Hazardous Materials Transportation Act, 49 U.S.C. Section 1801, et seq., the Resource Conservation and Recovery Act, 42 U.S.C. Section 6901, et seq., Chapters 6.5 through 7.7 of Division 20 of the California Health and Safety Code, Section 25100, et seq., or other applicable state or Federal laws, rules, or regulations adopted pursuant to any of the foregoing. The terms "hazardous waste" and "hazardous substance" shall also include, without limitation, petroleum and petroleum by-products or any fraction thereof and asbestos. The representations and warranties contained herein are based on Grantor's due diligence in investigating the Collateral for hazardous wastes and substances. Grantor hereby (a) releases and waives any future claims against Lender for indemnity or contribution in the event Grantor becomes liable for cleanup or other costs under any such laws, and (b) agrees to indemnify and hold harmless Lender against any and all claims and losses resulting from a breach of this provision of this Agreement. This obligation to indemnify shall survive the payment of the indebtedness and the satisfaction of this Agreement. MAINTENANCE OF CASUALTY INSURANCE. Grantor shall procure and maintain all risks insurance, including without limitation fire, theft and liability coverage together with such other insurance as Lender may require with respect to the Collateral, in form, amounts, coverages and basis reasonably acceptable to Lender and issued by a company or companies reasonably acceptable to Lender. Grantor, upon request of Lender, will deliver to Lender from time to time the policies or certificates of insurance in form satisfactory to Lender, including stipulations that coverages will not be cancelled or diminished without at lease ten (10) days' prior written notice to Lender and not including any disclaimer of the insurer's liability for failure to give such a notice. Each insurance policy also shall include an endorsement providing that coverage in favor of Lender will not be impaired in any way by any act, omission or default of Grantor or any other person. In connection with all policies covering assets in which Lender holds or is offered a security interest, Grantor will provide Lender with such loss payable or other endorsements as Lender may require. If Grantor at any time fails to obtain or maintain any insurance as required under this Agreement, Lender may (but shall not be obligated to) obtain such insurance as Lender deems appropriate, including if it so chooses "single interest insurance," which will cover only Lender's interest in the Collateral. APPLICATION OF INSURANCE PROCEEDS. Grantor shall promptly notify Lender of any loss or damage to the Collateral. Lender may make proof of loss if Grantor fails to do so within fifteen (15) days of the casualty. All proceeds of any insurance on the Collateral, including accrued proceeds thereon, shall be held by Lender as part of the Collateral. If Lender consents to repair or replacement of the damaged or destroyed Collateral, Lender shall, upon satisfactory proof of expenditure, pay or reimburse Grantor from the proceeds for the reasonable cost of repair or restoration. If Lender does not consent to repair or replacement of the Collateral, Lender shall retain a sufficient amount of the proceeds to pay all of the indebtedness, and shall pay the balance to Grantor. Any proceeds which have not been disbursed with six (6) months after their receipt and which Grantor has not committed to the repair or restoration of the Collateral shall be used to prepay the Indebtedness. INSURANCE RESERVES. Lender may require Grantor to maintain with Lender reserves for payment of insurance premiums, which reserves shall be created by monthly payments from Grantor of a sum estimated by Lender to be sufficient to produce, at lease fifteen (15) days before the premium due date, amounts at least equal to the insurance premiums to be paid. If fifteen (15) days before payment is due, the reserve funds are insufficient, Grantor shall upon demand pay any deficiency to Lender. The reserve funds shall be held by Lender as a general deposit and shall constitute a non-interest-bearing account which Lender may satisfy by payment of the insurance premiums required to be paid by Grantor as they become due. Lender does not hold the reserve funds in trust for Grantor, and Lender is not the agent of Grantor for payment of the insurance premiums required to be paid by Grantor. The responsibility for the payment of premiums shall remain Grantor's sole responsibility. INSURANCE REPORTS. Grantor, upon request of Lender, shall furnish to Lender reports on each existing policy of insurance showing such information as Lender may reasonably request including the following: (a) the name of the insurer; (b) the risks insured; (c) the amount of the policy; (d) the property insured; (e) the then current value on the basis of which insurance has been obtained and the manner of determining that value; and (f) the expiration date of the policy. In addition, Grantor shall upon request by Lender (however not more often than annually) have an independent appraiser satisfactory to Lender determine, as applicable, the cash value or replacement cost of the Collateral. GRANTOR'S RIGHT TO POSSESSION AND TO COLLECT ACCOUNTS. Until default and except as otherwise provided below with respect to accounts, Grantor may have possession of the tangible personal property and beneficial use of all the Collateral and may use it in any lawful manner not inconsistent with this Agreement or the Related Documents, provided that Grantor's right to possession and beneficial use shall not apply to any Collateral where possession of the Collateral by Lender is required by law to perfect Lender's security interest in such Collateral. Until otherwise notified by Lender, Grantor may collect any of the Collateral consisting of accounts. At any time and even though no Event of Default exists, Lender may exercise its rights to collect the accounts and to notify account debtors to make payments directly to Lender for application to the indebtedness. If Lender at any time has possession of any Collateral, whether before or after an Event of Default, Lender shall be deemed to have exercised reasonable care in the custody and preservation of the Collateral if Lender takes such action for that purpose as Grantor shall request or as Lender, in Lender's sole discretion, shall deem appropriate under the circumstances, but failure to honor any request by Grantor shall not of itself be deemed to be a failure to exercise reasonable care. Lender shall not be required to take any steps necessary to preserve any rights in the Collateral against prior parties, nor to protect, preserve or maintain any security interest given to secure the indebtedness. 10 03-27-1997 COMMERCIAL SECURITY AGREEMENT Page 3 Loan No 9730000139 (Continued) - -------------------------------------------------------------------------------- EXPENDITURES BY LENDER. If not discharged or paid when due, Lender may (but shall not be obligated to) discharge or pay any amounts required to be discharged or paid by Grantor under this Agreement, including without limitation all taxes, liens, security interests, encumbrances, and other claims, at any time levied or placed on the Collateral. Lender also may (but shall not be obligated to) pay all costs for insuring, maintaining and preserving the Collateral. All such expenditures incurred or paid by Lender for such purposes will then bear interest at the rate charged under the Note from the date incurred or paid by Lender to the date of repayment by Grantor. All such expenses shall become a part of the Indebtedness and, at Lender's option, will (a) be payable on demand, (b) be added to the balance of the Note and be apportioned among and be payable with any installment payments to become due during either (i) the term of any applicable insurance policy or (ii) the remaining term of the Note, or (c) be treated as a balloon payment which will be due and payable at the Note's maturity. This Agreement also will secure payment of these amounts. Such right shall be in addition to all other rights and remedies to which Lender may be entitled upon the occurrence of an Event of Default. EVENTS OF DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: DEFAULT ON INDEBTEDNESS. Failure of Grantor to make any payment when due on the Indebtedness. OTHER DEFAULTS. Failure of Grantor to comply with or to perform any other term, obligation, covenant or condition contained in this Agreement or in any of the Related Documents or in any other agreement between Lender and Grantor. DEFAULT IN FAVOR OF THIRD PARTIES. Should Borrower or any Grantor default under any loan, extension of credit, security agreement, purchase or sales agreement, or any other agreement, in favor of any other creditor or person that may materially affect any of Borrower's property or Borrower's or any Grantor's ability to repay the Loans or perform their respective obligations under this Agreement or any of the Related Documents. FALSE STATEMENTS. Any warranty, representation or statement made or furnished to Lender by or on behalf of Grantor under this Agreement, the Note or the Related Documents is false or misleading in any material respect, either now or at the time made or furnished. DEFECTIVE COLLATERALIZATION. This Agreement or any of the Related Documents ceases to be in full force and effect (including failure of any collateral documents to create a valid and perfected security interest or lien) at any time and for any reason. INSOLVENCY. The dissolution or termination of Grantor's existence as a going business, the insolvency of Grantor, the appointment of a receiver for any part of Grantor's property, any assignment for the benefit of creditors, any type of creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against Grantor. CREDITOR OR FORFEITURE PROCEEDINGS. Commencement of foreclosure or forfeiture proceedings, whether by judicial proceeding, self-help, repossession or any other method, by any creditor of Grantor or by any governmental agency against the Collateral or any other collateral securing the Indebtedness. This includes a garnishment of any of Grantor's deposit accounts with Lender. However, this Event of Default shall not apply if there is a good faith dispute by Grantor as to the validity or reasonableness of the claim which is the basis of the creditor or forfeiture proceeding and if Grantor gives Lender written notice of the creditor or forfeiture proceeding and deposits with Lender monies or a surety bond for the creditor or forfeiture proceeding, in an amount determined by Lender, in its sole discretion, as being an adequate reserve or bond for the dispute. EVENTS AFFECTING GUARANTOR. Any of the preceding events occurs with respect to any Guarantor of any of the Indebtedness or such Guarantor dies or becomes incompetent. Lender, at its option, may, but shall not be required to, permit the Guarantor's estate to assume unconditionally the obligations arising under the guaranty in a manner satisfactory to Lender, and, in doing so, cure the Event of Default. ADVERSE CHANGE. A material adverse change occurs in Grantor's financial condition, or Lender believes the prospect of payment or performance of the indebtedness is impaired. RIGHT TO CURE. If any default, other than a Default on Indebtedness, is curable and if Grantor has not been given a prior notice of a breach of the same provision of this Agreement, it may be cured (and no Event of Default will have occurred) if Grantor, after Lender sends written notice demanding cure of such default, (a) cures the default within fifteen (15) days; or (b) if the cure requires more than fifteen (15) days, immediately initiates steps which Lender deems in Lender's sole discretion to be sufficient to cure the default and thereafter continues and completes all reasonable and necessary steps sufficient to produce compliance as soon as reasonably practical. RIGHTS AND REMEDIES ON DEFAULT. If an Event of Default occurs under this Agreement, at any time thereafter, Lender shall have all the rights of a secured party under the California Uniform Commercial Code. In addition and without limitation, Lender may exercise any one or more of the following rights and remedies: ACCELERATE INDEBTEDNESS. Lender may declare the entire indebtedness, including any prepayment penalty which Grantor would be required to pay, immediately due and payable, without notice. ASSEMBLE COLLATERAL. Lender may require Grantor to deliver to Lender all or any portion of the Collateral and any and all certificates of title and other documents relating to the Collateral. Lender may require Grantor to assemble the Collateral and make it available to Lender at a place to be designated by Lender. Lender also shall have full power to enter upon the property of Grantor to take possession of and remove the Collateral. If the Collateral contains other goods not covered by this Agreement at the time of repossession, Grantor agrees Lender may take such other goods, provided that Lender makes reasonable efforts to return them to Grantor after repossession. SELL THE COLLATERAL. Lender shall have full power to sell, lease, transfer, or otherwise deal with the Collateral or proceeds thereof in its own name or that of Grantor. Lender may sell the Collateral at public auction or private sale. Unless the Collateral threatens to decline speedily in value or is of a type customarily sold on a recognized market, Lender will give Grantor reasonable notice of the time after which any private sale or any other intended disposition of the Collateral is to be made. The requirements of reasonable notice shall be met if such notice is given at lease ten (10) days, or such lesser time as required by state law, before the time of the sale or disposition. All expenses relating to the disposition of the Collateral, including without limitation the expenses of retaking, holding, insuring, preparing for sale and selling the Collateral, shall become a part of the indebtedness secured by this Agreement and shall be payable on demand, with interest at the Note rate from date of expenditure until repaid. APPOINT RECEIVER. To the extent permitted by applicable law, Lender shall have the following rights and remedies regarding the appointment of a receiver: (a) Lender may have a receiver appointed as a matter of right, (b) the receiver may be an employee of Lender and may serve without bond, and (c) all fees of the receiver and his or her attorney shall become part of the Indebtedness secured by this Agreement and shall be payable on demand, with interest at the Note rate from date of expenditure until repaid. COLLECT REVENUES, APPLY ACCOUNTS. Lender, either itself or through a receiver, may collect the payments, rents, income, and revenues from the Collateral. Lender may at any time in its discretion transfer any Collateral into its own name or that of its nominee and receive the payments, rents, income, and revenues therefrom and hold the same as security for the Indebtedness or apply it to payment of the Indebtedness in such order of preference as Lender may determine. Insofar as the Collateral consists of accounts, general intangibles, insurance policies, instruments, chattel paper, choses in action, or similar property, Lender may demand, collect, receipt for, settle, compromise, adjust, sue for, foreclose, or realize on the Collateral as Lender may determine, whether or not Indebtedness or Collateral is then due. For these purposes, Lender may, on behalf of and in the name of Grantor, receive, open and dispose of mail addressed to Grantor; change any address to which mail and payments are to be sent; and endorse notes, checks, drafts, money orders, documents of title, instruments and items pertaining to payment, shipment, or storage of any Collateral. To facilitate collection, Lender may notify account debtors and obligors on any Collateral to make payments directly to Lender. OBTAIN DEFICIENCY. If Lender chooses to sell any or all of the Collateral, Lender may obtain a judgment against Grantor for any deficiency remaining on the Indebtedness due to Lender after application of all amounts received from the exercise of the rights provided in this Agreement. Grantor shall be liable for a deficiency even if the transaction described in this subsection is a sale of accounts or chattel paper. OTHER RIGHTS AND REMEDIES. Lender shall have all the rights and remedies of a secured creditor under the provisions of the Uniform Commercial Code, as may be amended from time to time. In addition, Lender shall have and may exercise any or all other rights and remedies it may have available at law, in equity, or otherwise. CUMULATIVE REMEDIES. All of Lender's rights and remedies, whether evidenced by this Agreement or the Related Documents or by any other writing, shall be cumulative and may be exercised singularly or concurrently. Election by Lender to pursue any remedy shall not exclude pursuit of any other remedy, and an election to make expenditures or to take action to perform an obligation of Grantor under this Agreement, after Grantor's failure to perform, shall not affect Lender's right to declare a default and to exercise its remedies. MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of this Agreement: AMENDMENTS. This Agreement, together with any Related Documents, constitutes the entire understanding and agreement of the parties as to the matters set forth in this Agreement. No alteration of or amendment to this Agreement shall be effective unless given in writing and signed by the party or parties sought to be charged or bound by the alteration or amendment. APPLICABLE LAW. This Agreement has been delivered to Lender and accepted by Lender in the State of California. If there is a lawsuit, Grantor agrees upon Lender's request to submit to the jurisdiction of the courts of Orange County, the State of California. Lender and Grantor hereby waive the rights to any jury trial in any action, proceeding, or counterclaim brought by either Lender or Grantor against the other. (Initial Here VCS) This Agreement shall be governed by and construed in accordance with the laws of the State of California. 11 Loan No. 9730000139 (Continued) - -------------------------------------------------------------------------------- ATTORNEYS' FEES; EXPENSES. Grantor agrees to pay upon demand all of Lender's costs and expenses, including attorneys' fees and Lender's legal expenses, incurred in connection with the enforcement of this Agreement. Lender may pay someone else to help enforce this Agreement, and Grantor shall pay the costs and expenses of such enforcement. Costs and expenses include Lender's attorneys' fees and legal expenses whether or not there is a lawsuit, including attorneys' fees and legal expenses for bankruptcy proceedings (and including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Grantor also shall pay all court costs and such additional fees as may be directed by the court. CAPTION HEADINGS. Caption headings in this Agreement are for convenience purposes only and are not to be used to interpret or define the provisions of this Agreement. MULTIPLE PARTIES; CORPORATE AUTHORITY. All obligations of Grantor under this Agreement shall be joint and several, and all references to Grantor shall mean each and every Grantor. This means that each of the persons signing below is responsible for all obligations in this Agreement. NOTICES. All notices required to be given under this Agreement shall be given in writing, may be sent by telefacsimile, and shall be effective when actually delivered or when deposited with a nationally recognized overnight courier or deposited in the United States mail, first class, postage prepaid, addressed to the party to whom the notice is to be given at the address shown above. Any party may change its address for notices under this Agreement by giving formal written notice to the other parties, specifying that the purpose of the notice is to change the party's address. To the extent permitted by applicable law, if there is more than one Grantor, notice to any Grantor will constitute notice to all Grantors. For notice purposes, Grantor will keep Lender informed at all times of Grantor's current address(es). POWER OF ATTORNEY. Grantor hereby appoints Lender as its true and lawful attorney-in-fact, irrevocably, with full power of substitution to do the following: (a) to demand, collect, receive, receipt for, sue and recover all sums of money or other property which may now or hereafter become due, owing or payable from the Collateral; (b) to execute, sign and endorse any and all claims, instruments, receipts, checks, drafts or warrants issued in payment for the Collateral; (c) to settle or compromise any and all claims arising under the Collateral, and, in the place and stead of Grantor, to execute and deliver its release and settlement for the claim; and (d) to file any claim or claims or to take any action or institute or take part in any proceedings, either in its own name or in the name of Grantor, or otherwise, which in the discretion of Lender may seem to be necessary or advisable. This power is given as security for the Indebtedness, and the authority hereby conferred is and shall be irrevocable and shall remain in full force and effect until renounced by Lender. PREFERENCE PAYMENTS. Any monies Lender pays because of an asserted preference claim in Borrower's bankruptcy will become a part of the Indebtedness and, at Lender's option, shall be payable by Borrower as provided above in the "EXPENDITURES BY LENDER" paragraph. SEVERABILITY. If a court of competent jurisdiction finds any provision of this Agreement to be invalid or unenforceable as to any person or circumstance, such finding shall not render that provision invalid or unenforceable as to any other persons or circumstances. If feasible, any such offending provision shall be deemed to be modified to be within the limits of enforceability or validity; however, if the offending provision cannot be so modified, it shall be stricken and all other provisions of this Agreement in all other respects shall remain valid and enforceable. SUCCESSOR INTERESTS. Subject to the limitations set forth above on transfer of the Collateral, this Agreement shall be binding upon and inure to the benefit of the parties, their successors and assigns. WAIVER. Lender shall not be deemed to have waived any rights under this Agreement unless such waiver is given in writing and signed by Lender. No delay or omission on the part of Lender in exercising any right shall operate as a waiver of such right or any other right. A waiver by Lender of a provision of this Agreement shall not prejudice or constitute a waiver of Lender's right otherwise to demand strict compliance with that provision or any other provision of this Agreement. No prior waiver by Lender, nor any course of dealing between Lender and Grantor, shall constitute a waiver of any of Lender's rights or of any of Grantor's obligations as to any future transactions. Whenever the consent of Lender is required under this Agreement, the granting of such consent by Lender in any instance shall not constitute continuing consent to subsequent instances where such consent is required and in all cases such consent may be granted or withheld in the sole discretion of Lender. WAIVER OF CO-OBLIGOR'S RIGHTS. If more than one person is obligated for the Indebtedness, Borrower irrevocably waives, disclaims and relinquishes all claims against such other person which Borrower has or would otherwise have by virtue of payment of the Indebtedness or any part thereof, specifically including but not limited to all rights of indemnity, contribution or exoneration. GRANTOR ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS COMMERCIAL SECURITY AGREEMENT, AND GRANTOR AGREES TO ITS TERMS. THIS AGREEMENT IS DATED MARCH 27, 1997. GRANTOR: NATIONAL TELEPHONE & COMMUNICATIONS, INC. By: /s/ Victor C. Streufert ---------------------------------------------- VICTOR C. STREUFERT, CHIEF FINANCIAL OFFICER - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 12 MASTER ADDENDUM TO LOAN DOCUMENTS This MASTER ADDENDUM TO LOAN DOCUMENTS (this "ADDENDUM") dated as of March 27, 1997, is made between National Telephone & Communications, Inc. (the "BORROWER") and First Bank & Trust (the "LENDER"). RECITALS WHEREAS, the Borrower and the Lender are parties to the Business Loan Agreement, dated as of March 27, 1997 (the "CREDIT AGREEMENT"), pursuant to which the Lender shall extend credit to the Borrower in an aggregate principal amount not exceeding $5,000,000 to finance the purchase of the Borrower's headquarters and for other commercial purposes; WHEREAS, the Borrower shall, contemporaneously with the execution of this Agreement, execute a Promissory Note, dated as of March 27, 1997 (the "NOTE") in favor of the Lender in an aggregate principal amount of $5,000,000 and enter into Commercial Security Agreement, dated as of March 27, 1997 (the "SECURITY AGREEMENT"), pursuant to which the Borrower shall grant to the Lender a security interest in certain property of the Borrower as security for the Borrower's obligations under the Credit Agreement and the Note; and WHEREAS, the Borrower and the Lender have agreed that the Credit Agreement, the Note, the Security Agreement and all Related Documents (as defined below) shall be modified and amended in the respects set forth below. NOW, THEREFORE, in consideration of the foregoing, the mutual covenants and agreements set forth below and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: Section 1. DEFINITIONS. Capitalized terms used but not defined in this Addendum shall have the meanings assigned to such terms in the Credit Agreement. Section 2. AMENDMENTS TO THE CREDIT AGREEMENT. 2.01 AMENDMENTS TO "DEFINITIONS". (a) The "Definitions" section of the Credit Agreement is amended by adding the following new definitions in the correct alphabetical order: "INITIAL PUBLIC OFFERING. The words "Initial Public Offering" mean, the initial public offering by Incomnet, Inc. of certain of Borrower's equity as previously disclosed to Lender by Borrower and pursuant to that certain letter agreement dated January 28, 1997 between Borrower and Incomnet, Inc. 13 "TOTAL LIABILITIES. The words "Total Liabilities" mean, as at any date, all liabilities of Borrower as reflected on the Borrower's balance sheet for such date, excluding any and all deferred income and minority interests of Borrower. (b) The "Definitions" section of the Credit Agreement is amended by replacing subsection (e) of the definition of "Permitted Liens" with the following new subsection (e): "(e) liens and security interests of Borrower which are in existence as of the date of this Agreement;" 2.02 AMENDMENTS TO "REPRESENTATIONS AND WARRANTIES". The "Representations and Warranties" section of the Credit Agreement is amended as follows: (a) The "Properties" representation is amended by adding the words "Permitted Liens or" after the words "except for" contained in the second line of such representation. (b) The "Hazardous Substances" representation is amended by deleting the third and fourth sentences in their entirety. (c) The "Taxes" representation is replaced with the following new representation: "TAXES. To the best of Borrower's knowledge, all tax returns and reports of Borrower that are or were required to be filed, have been filed, and all taxes, assessments and other governmental charges have been paid in full, except (a) those that Borrower believes in good faith are not yet due and payable or those presently being or to be contested by Borrower in good faith in the ordinary course of business and (b) for which adequate reserves have been provided." (d) The "Lien Priority" representation is amended by adding the words ", other than Permitted Liens" after the words "Security Interests" in the second line of such representation. (e) The "Commercial Purposes" representation is replaced with the following new representation: "COMMERCIAL PURPOSES. Borrower intends to use the Loan proceeds solely for the acquisition of certain real property and other business or commercial related purposes." 2.03 WAIVER OF "CONDITION PRECEDENT TO EACH ADVANCE". Lender hereby agrees that the provision of evidence of insurance as required by subsection (c) of this section may be provided within thirty days subsequent to the date of this Addendum. 2.04 AMENDMENTS TO "AFFIRMATIVE COVENANTS". The "Affirmative Covenants" section of the Credit Agreement is amended as follows: 14 (a) The "Taxes, Charges and Liens" covenant is amended by adding the following words at the beginning of subclause (a) "Borrower believes in good faith such amount is not yet due and payable or; (b) The "Compliance Certificate" covenant is replaced with the following new covenant: "COMPLIANCE CERTIFICATE. Unless waived in writing by Lender, provide Lender (a) within 45 days of the last day of each of the first three fiscal quarters of Borrower and (b) within 90 days of the last day of the fourth fiscal quarter of Borrower, with a certificate executed by Borrower's chief financial officer, or other officer or person acceptable to Lender, certifying that the representations and warranties set forth in this Agreement are true and correct as of the date of the certificate (or, if stated to be made solely as of an earlier date, were true and correct as of such date) and further certifying that, as of the date of the certificate, no Event of Default exists under this Agreement." 2.05 AMENDMENT TO "NEGATIVE COVENANTS". The "Negative Covenants" section of the Credit Agreement is amended as follows: (a) The "Indebtedness and Liens" section is amended by (i) adding the words "indebtedness that is in existence as of the date of this Agreement and" after the word "Except" in subsection (a) of such section, (ii) adding the words "and indebtedness which would be secured by a Permitted Lien," after the words "this Agreement" in the second line of subsection (a) of such section and (iii) replacing the word "including" with the word "other" in the second line of subsection (a) of such section; (b) The "Continuity of Operations" section is amended as follows: (i) by deleting the words "change ownership" in subsection (b) of such section, (ii) by adding the words "after the occurrence of an Event of Default," before the words "pay any dividends" in subsection (c) of such section and (iii) by adding at the end of such section the words "other than in connection with the Initial Public Offering"; and (c) The "Loans, Acquisitions and Guaranties" section is amended by adding the words "Except as provided in the "Additional Provisions" section below," at the beginning of subsection (a) of such section. 2.06 AMENDMENT TO "EVENTS OF DEFAULT". The "Events of Default" section of the Credit Agreement is amended by deleting the "Change in Ownership" default. 2.07 AMENDMENT TO "MISCELLANEOUS". The "Miscellaneous" section of the Credit Agreement is amended by adding the following new sentence to the end of the "Consent of Loan Participation Section": "Notwithstanding anything to the contrary contained in the foregoing or in this Agreement, Lender agrees to hold at least $5,000,000 of the Loans and remain the "lead bank" or "agent" with respect to the administration of the Loans and the Collateral." 15 Section 3. AMENDMENTS TO THE NOTE. 3.01 AMENDMENT TO "PAYMENT". The first sentence of the "Payment" section of the Note is amended to read as follows: "Borrower will pay this loan in one payment of all outstanding principal (plus all accrued interest not paid pursuant to the following sentence) on April 30, 1998." 3.02 AMENDMENT TO "GENERAL PROVISIONS". The "General Provisions" section of the Note is amended by deleting the first two sentences of such section. Section 4. AMENDMENTS TO THE SECURITY AGREEMENT. 4.01 AMENDMENT TO "DEFINITIONS". The "Definitions" section of the Security Agreement is amended by adding the following to the list of excluded property of Borrower. ", ANY ARCHITECTURAL DESIGN AND DEVELOPMENT COSTS AND ANY PRE-PAID COSTS REFLECTED AS AN ASSET ON THE FINANCIAL STATEMENTS OF BORROWER AND RELATED TO THE LEASEHOLD IMPROVEMENTS OR REAL PROPERTY TO BE PURCHASED BY BORROWER, ANY CUSTOMER LISTS AND ALL NOTES RECEIVABLE OF A CERTAIN JIM CARTER TO BORROWER. 4.02 AMENDMENT TO "TITLE". The "Title" section of the Security Agreement is amended (i) by adding the words "and except for Permitted Liens" at the end of the first sentence of such section and (ii) by adding the words "and other than those relating to Permitted Liens" at the end of the second sentence to such section. 4.03 AMENDMENT TO "TAXES, ASSESSMENTS AND LIENS". The "Taxes, Assessments and Liens" section of the Security Agreement is amended by replacing the second sentence of such section with the following: "Grantor may withhold any such payment or may elect to contest any lien if Grantor in good faith believes that such amount is not yet due and payable or Grantor is in good faith conducting an appropriate proceeding to contest the obligation to pay and so long as Lender's interest in the Collateral is not jeopardized in Lender's sole opinion." Section 5. REPRESENTATIONS AND WARRANTIES. Each party represents and warrants as follows: (a) this Addendum constitutes the legal, valid and binding obligation of such party enforceable against such party in accordance with its terms, except as may be limited by bankruptcy, insolvency, reorganization, moratorium or other similar laws relating to or limiting creditors' rights generally or by equitable principles relating to enforceability; and (b) none of the execution and delivery by such party of this Addendum, the consummation of the transactions contemplated by this Addendum 16 does or will conflict with, violate any provision of, or require any consent under, the charter or by-laws of such party. Section 6. CONDITIONS TO EFFECTIVENESS. This Addendum shall be and become effective upon the execution and delivery by the parties of this Addendum, the Credit Agreement, the Note, the Security Agreement and each Related Document. Section 7. REFERENCE TO AND EFFECT ON THE AFFECTED DOCUMENTS. This Addendum shall be construed as one with the Credit Agreement, the Note, the Security Agreement and the Related Documents, and each such document shall, where the context requires, be read and construed throughout so as to incorporate this Addendum. Section 8. ENTIRE AGREEMENT. This Addendum, together with the Credit Agreement, the Note, the Security Agreement and each Related Document supersede all prior agreements and understandings, written or oral, among the parties with respect to the subject matter of this Addendum. No party shall have any duties or responsibilities except those expressly set forth in the Credit Agreement, the Note, the Security Agreement and each Related Document (as from time to time amended, including by this Addendum). Section 9. SUCCESSORS AND ASSIGNS. This Addendum shall be binding upon and inure to the benefit of its parties and their respective successors and permitted assigns. Section 10. COUNTERPARTS. This Addendum may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument and any of the parties to this Addendum may execute this Addendum by signing any such counterpart. Section 11. GOVERNING LAW. THIS ADDENDUM HAS BEEN DELIVERED TO BY EACH PARTY HERETO AND ACCEPTED BY SUCH PARTY IN THE STATE OF CALIFORNIA. IF THERE IS A LAWSUIT, EACH PARTY AGREES TO SUBMIT TO THE JURISDICTION OF THE COURTS OF ORANGE COUNTY, THE STATE OF CALIFORNIA. LENDER AND BORROWER HEREBY WAIVE THE RIGHT TO ANY JURY TRIAL IN ANY ACTION, PROCEEDING OR COUNTERCLAIM BROUGHT BY EITHER LENDER OR BORROWER AGAINST THE OTHER. THIS ADDENDUM SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF CALIFORNIA. 17 IN WITNESS WHEREOF, the parties have caused this Addendum to be duly executed and delivered as of the day and year first above written. NATIONAL TELEPHONE & COMMUNICATIONS, INC. By: /s/ Victor C. Streufert ---------------------------------------- Name: Victor C. Streufert Title: VP, CFO FIRST BANK & TRUST By: /s/ K.P. Balkrishna ---------------------------------------- Name: Title: Sr. V.P. 18 National Telephone & Communications, Inc. March 26, 1997 Page five ACCEPTANCE: This proposal to extend credit shall expire, unless accepted in writing, on or before 5:00 p.m., March 26, 1997. Please indicate your acceptance of the foregoing agreement on or before such date by signing as indicated below. We appreciate the opportunity to make this proposal to you and we hope that it lays the foundation for a long and mutually beneficial relationship. Sincerely, /s/ K.P. Balkrishna - -------------------------------- K.P. Balkrishna Senior Vice President Regional Manager The undersigned hereby accepts the foregoing Agreement on the terms and conditions set forth therein. /s/ Victor C. Streufert - -------------------------------- (Name) VP, CFO - -------------------------------- (Title) 19 EX-21 4 EXHIBIT 21 EXHIBIT 21 INCOMNET, INC. SUBSIDIARIES OF THE REGISTRANT
Percentage of voting State or other jurisdiction of securities Name incorporation or organization owned - ------- ------------------------------ ---------- Incomnet India Limited India 32% Rapid Cast, Inc. New Jersey 35% National Telephone & Nevada 100% Communications, Inc.
59 EX-27 5 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMPANY'S CONSOLIDATED STATEMENTS OF OPERATIONS, BALANCE SHEETS AND STATEMENTS OF CASH FLOWS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH CONSOLIDATED FINANCIAL STATEMENTS CONTAINED WITHIN THE COMPANY'S FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1996. 1,000 YEAR DEC-31-1996 DEC-31-1996 2,214 0 15,130 1,993 2,760 20,204 18,151 3,794 40,587 30,922 1,040 0 2,355 61,320 (55,049) 20,204 106,905 106,905 68,562 68,562 89,860 10,989 0 (51,517) (7,812) (43,705) 0 0 (877) (37,676) (2.82) (2.82)
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