-----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, Dp2VsG062NMA4+LrSIqtpaeF0WktuQf98z1axYAZnNsrweoqCu8HT+twqFEEkT72 LB/hbTLLX1bnEhFwy1GVOA== 0000950117-98-000794.txt : 19980416 0000950117-98-000794.hdr.sgml : 19980416 ACCESSION NUMBER: 0000950117-98-000794 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980415 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: EXECUTONE INFORMATION SYSTEMS INC CENTRAL INDEX KEY: 0000725282 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-TELEPHONE INTERCONNECT SYSTEMS [7385] IRS NUMBER: 860449210 STATE OF INCORPORATION: VA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-11551 FILM NUMBER: 98594087 BUSINESS ADDRESS: STREET 1: 478 WHEELERS FARMS RD CITY: MILFORD STATE: CT ZIP: 06460 BUSINESS PHONE: 2038767600 MAIL ADDRESS: STREET 1: 478 WHEELERS FARMS RD CITY: MILFORD STATE: CT ZIP: 06460-1847 FORMER COMPANY: FORMER CONFORMED NAME: VODAVI TECHNOLOGY CORP DATE OF NAME CHANGE: 19880802 10-K405 1 EXECUTONE INFORMATION SYSTEMS SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) For the fiscal year ended December 31, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) For the transition period from _______ to _______ Commission File Number: 0-11551 EXECUTONE INFORMATION SYSTEMS, INC. (Exact name of registrant as specified in its charter) Virginia 86-0449210 (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 478 Wheelers Farms Road Milford, Connecticut 06460 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (203) 876-7600 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered N/A None Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK, PAR VALUE $.01 PER SHARE 7 1/2% CONVERTIBLE SUBORDINATED DEBENTURES, DUE MARCH 15, 2011 (Title of Class) 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. [X] The aggregate market value of the common stock held by non-affiliates of the registrant (assuming for this purpose that all executive officers and directors of the registrant are affiliates) as of March 31, 1998 was $97,872,323, based on the last sale price for the common stock on that date. The number of shares outstanding of the registrant's only class of common stock, $.01 par value per share, as of March 31, 1998, was 49,721,084. DOCUMENTS INCORPORATED BY REFERENCE The following documents are incorporated by reference into the Part of this Form 10-K indicated below: Part II 1997 Annual Report to Shareholders TABLE OF CONTENTS
Item Page - ---- ---- PART I 1. Business 1 2. Properties 16 3. Legal Proceedings 16 4. Submission of Matters to a Vote of Security Holders 18 Executive Officers of the Registrant 19 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters 22 6. Selected Financial Data 22 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 22 8. Financial Statements and Supplementary Data 22 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 22 PART III 10. Directors and Executive Officers of the Registrant 23 11. Executive Compensation 24 12. Security Ownership of Certain Beneficial Owners and Management 31 13. Certain Relationships and Related Transactions 34 PART IV 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 36
PART I ITEM 1. BUSINESS General EXECUTONE Information Systems, Inc. ("Executone" or the "Company") develops, markets and supports voice and data communications systems. Products and services include telephone systems, voice mail systems, in-bound and out-bound call center systems and specialized healthcare communications systems. The Company's UniStar Entertainment indirect subsidiary ("UniStar") has the exclusive right to design, develop and manage the National Indian Lottery and US Lottery (collectively, the "Lottery") offered by the Coeur d'Alene Indian Tribe of Idaho (the "Coeur d'Alene Tribe" or the "Tribe"). Executone's products are sold under the EXECUTONE, INFOSTAR, IDS, LIFESAVER, and INFOSTAR/ILS brand names through a national network of independent distributors and direct sales and service employees. (Capitalized product names used in this report are registered or unregistered trademarks of the Company or its subsidiaries except where specifically identified with products of an unaffiliated company.) Executone's executive offices are located at 478 Wheelers Farms Road, Milford, Connecticut 06460, telephone (203) 876-7600. The common stock of EXECUTONE (the "Common Stock") is traded on the NASDAQ National Market System under the symbol "XTON", and its Convertible Subordinated Debentures due 2011 (the "Debentures") trade on the NASDAQ system under the symbol "XTONG". Recent Developments On January 8, 1998, the Company announced that Alan Kessman, Chairman, President and Chief Executive Officer of Executone, intends to retire from the management of the day to day operations of the Company. Mr. Kessman will remain as a member of the Board of Directors of Executone and will remain in his current position until his successor is selected. The search firm of Spencer Stuart is currently conducting a search for a new chief executive officer for the Company. The Company currently has three primary business units: computer telephony, healthcare communications and its subsidiary UniStar, which is engaged in the management of telephone and Internet-based national lotteries. In December 1997 the Board of Directors of the Company appointed a Special Committee consisting of Messrs. Blau, Moore and Rosenbloom to analyze the possibility of a separation of the business of UniStar from the other businesses of the Company. The Company hired Furman Selz LLC to advise the Company as to certain financing and corporate restructuring options that may be available to the Company to increase shareholder value and aid the fuller development of Executone's various business units. The Company believed that the then current market price of the Common Stock did not fairly recognize the potential of its computer telephony and healthcare communications businesses or the growth potential of UniStar. Furman Selz's engagement was to determine how these potential values may be better recognized and whether each of the Company's primary business units should remain a part of the consolidated entity, become a stand-alone company, or be sold to a third party. 1 Based upon the recommendation of the Special Committee, the Board of Directors has determined that it is in the best interests of the shareholders to separate the business of the Company's UniStar subsidiary from the operations of its computer telephony and healthcare communications businesses. The Company expects, subject to completion of further analysis and receipt of necessary approvals, that the separation would be effected through a taxable distribution to shareholders later this year. Overview of Business and Strategy The Company's revenues are derived primarily from product sales to distributors, direct sales of healthcare communications, and direct sales to national accounts and government customers. The Company also derives revenue from installations, additions, changes, upgrades or relocation of previously installed systems, maintenance contracts, and service charges to the existing base of healthcare, national account and government customers. The Company's products and services are marketed and sold through a national network of independent distributors and Company direct sales and service employees. The Company's Computer Telephony business offers value-added products and services to the small to medium-sized business customer. The Company's integrated digital telephone systems emphasize flexible software applications, such as data switching and computer telephone interface, designed to enhance the customer's ability to communicate, obtain and manage information. The Company's telephone systems provide the platform for its other voice and data software applications, such as automatic call distribution. Its sophisticated call center management products integrate a computerized digital telephone system platform with high-volume inbound, outbound and internal call processing systems, including automatic call distribution systems, predictive dialing systems, and scripting software to assist agents handling calls. The Company's Healthcare Communications business provides to its healthcare facility customers nurse and patient communication systems, the INFOSTAR/ILS infrared locator system, and integration of voice and data between such systems, telephone systems and hospital information systems, resulting in increased productivity, flexibility and efficiency in hospital operations, and improved patient care. Executone has been a recognized name in this market for many years with its LIFESAVER and CARE/COM II-E nurse call systems. The Company markets software applications specific to hospital and nursing homes to help resolve other labor intensive tasks. On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming Corp., a Delaware corporation ("Unistar Gaming"). Unistar Gaming's subsidiary, UniStar, has an exclusive five-year contract ending January 2003 to design, develop, finance, and manage the Lottery, a national lottery authorized by federal law and by a compact between the State of Idaho and the Coeur d'Alene Tribe. UniStar provides development and management of the software, network design and call center applications for the Lottery's operations. In return for providing these management services, UniStar will be paid a fee equal to 30% of the profits of the Lottery. The Lottery has commenced operations but is not yet profitable. The Internet and telephone operations of the Lottery are the subject of three pending legal proceedings. There are significant market, political and legal risks associated with the development of the Lottery. See "LEGAL PROCEEDINGS" and UNISTAR BUSINESS -- Government Regulation and Legislation." The Company believes there is a national market for the Lottery based upon research into the experience of other national lotteries and the growth of the overall lottery market. However, there is no 2 assurance that there will be acceptance of a telephone or Internet lottery. Based upon opinions from outside legal counsel, the Company also believes that favorable legal decisions rendered by the Coeur d'Alene Tribal Court and the Tribal Appellate Court will be affirmed by the Idaho federal court. The Company believes that the pending Missouri and Wisconsin cases will have similar favorable outcomes. However, there is no assurance of such legal outcomes. In the event that the Lottery does not attain the level of market acceptance anticipated by the Company or if the outcome of the pending lawsuits is adverse, the Company would have to reevaluate its investment in UniStar. 3 COMPUTER TELEPHONY BUSINESS Computer Telephony Products The Company develops and distributes a complete line of computer telephony (CT) products that the Company believes are easy to install, easy to maintain and easy to use, and that create visible value for its customers. Products include PBXs, call center management products, standards-compliant CT applications, standalone and LAN-based applications, and wireless communications. Markets for the Company's products range from small- to medium-sized businesses, to call centers and national and government organizations. The Company's telephone systems are characterized by flexible software and a hardware design that makes them readily adaptable to evolving technology and customer requirements. The Company attributes the market acceptance of its systems to standards-based, cost-effective design and the sophistication of its software options. The Company's CT products include an integrated automated attendant feature to answer and transfer calls quickly and efficiently without operator intervention. The Integrated Operator Terminal has management reports capabilities to permit the monitoring of calls and improve the efficiency of directing calls to the appropriate extensions. The systems also support sophisticated call center and healthcare applications, and the Company's Integrated Locator System. The Company's LAN Card allows users access to their organization's network, to manage the systems through their desktop PCs. The Company has introduced a portfolio of products fully compliant with the latest industry standards (TAPI, TSAPI, CSTA) and incorporating the most advanced elements of computer telephony integration. The TAPI telephones support any desktop application using the TAPI standard for computer-telephone integration. Unified Messaging and Voice Activated Speed Dial further increase productivity by speeding the calling process. The Company also offers a voice mail system that can be integrated with the IDS telephone systems and with telephone systems manufactured by others. The INFOSTAR/VX3 voice mail system receives, records, stores, distributes, transfers and replays messages from both external and internal callers and can supplement other call center systems. In 1996 the Company introduced the INFOSTAR/VXC Voice Exchange Card, a complete voice processing system built on a card that integrates directly into the IDS switch, eliminating the need for a standalone voice mail system. The Company recently introduced the Eclipse CT server platform, a centerpiece software package that enables Executone's advanced CT applications to run on all Executone configurations, from 16 to 648 stations. The Company's latest achievement in call processing, the Ultimate Operator, takes the operator's console to a new level by delivering superior call handling and reporting capabilities in a Microsoft Windows'r' environment. The Company has also recently introduced NSS, a computer telephony networking solution that connects multiple phone systems into a single, feature-rich network, improving communications across multi-location organizations. The Company's call center management products can be integrated with the Company's computer telephone systems and with each other to provide large-volume inbound, outbound and internal call management. Computer-telephone integration ("CTI") technology integrates the call processing function with information in a customer's computer database. Primarily used by large incoming call centers to automatically identify incoming callers and by outbound centers to contact and provide records of contacts, CTI limits the amount of time that an agent spends contacting or identifying the 4 caller, thereby providing better customer service, reducing the number of required agents and reducing telephone line and transmission expense. The Company recently developed a promising call center application for Internet Telephony using VocalTec's Surf&Call'tm' software in conjunction with VocalTec's Telephony Gateway'tm', which allows an Internet user, with a simple point-and-click, to actually speak to a live call center agent over the Internet, without disrupting their "surfing" session. The Company also recently introduced its Sentinel application, a server-based computer telephony software application that provides call center supervisors with the ability to manage from a single desktop. By providing data in a modern Windows'r' NT-based interface, the Sentinel product eliminates the need for multiple PCs at the supervisor workstation. The INFOSTAR/Predictive Dialer is an automated call system designed to boost productivity in outbound call centers. The system integrates telephone, data collection and transaction processing functions for those customers who require high volume contact by telephone to transact business, such as sales, credit and collections, blood banks and fund-raising. Working with the host computer and the IDS'tm' telephone system platform, the dialer automatically dials telephone numbers pulled from the host computer database and detects "live" calls. Available representatives receive these calls and, through CTI, can view screen information about the customer from the database immediately after the customer answers the phone. The system predicts the availability of agents in order to reduce abandoned calls and increase agent productivity, and reduces agent contact with busy signals, no answers, wrong numbers and answering machines. Management reports provide instant and historical feedback on call distribution, list management, data input integrity and file maintenance. Scripting software allows the call center to create a script to guide its agents through various call scenarios and prompt the input of desired information. ACD systems are designed to increase responsiveness to inbound callers and increase agent productivity. ACD systems provide the capability to distribute or route incoming calls to available agents based upon management's specifications, and allow the supervisor of the call processing group to monitor call traffic on-line via a computer terminal. The Company produces ACD software for call centers of up to 500 agents in multiple shifts (225 in any single shift), in five levels of sophistication, the highest of which is "Custom Plus ACD." Custom Plus ACD provides the capability to store and retrieve call data for a limited period, print out standard call traffic reports, customize reports to the needs of a specific application, monitor traffic with color screens and graphics, and greatly enhance the ability to store and retrieve historical call data. The Company develops its application-specific software options using high-level programming languages to facilitate further enhancements and portability. Executone's software includes remote capabilities built into certain systems that enable the Company to customize and update selected features continuously, which increases the value of such systems and lengthens their useful lives. Certain of the Company's systems are capable of having service diagnostics, updates and modifications performed on a remote basis. The ability to provide such off-site servicing increases the efficiency of customer support and service. In 1997, the Company signed an agreement to distribute Active Voice Corporation's line of voice processing and unified messaging products. Also in 1997, the Company signed an agreement with Dialogic Corporation pursuant to which the parties expect to develop the industry's first completely open business communications platform 5 with full PBX functionality. Computer Telephony Sales and Marketing The Company's computer telephony distribution network consists of (1) domestic independent distributors with approximately 186 locations operating under exclusive and nonexclusive agreements throughout the United States and Canada; (2) a National Accounts group that uses the sales, installation, service and support capabilities of direct employees and the distribution network to serve multiple offices and departments of companies; (3) a Government Systems group that uses the distribution network to serve offices of federal, state and local government agencies; and (4) 7 independent distributors operating in 6 other foreign countries. For those distributors that have exclusive distribution rights for specified computer telephony products, retention of such rights is subject to satisfaction of established criteria for sales and service to customers on an ongoing basis. The divesting of or acquisition of customer bases to or from distributors in specific geographic territories may occur in the normal course of the Company's business. The Company's National Accounts group provides uniformity in pricing, coordination, installation, billing and service for National Accounts customers such as Airborne Express, W. W. Grainger, Bridgestone/Firestone, PetsMart and Management Recruiters-Sales Consultants. The National Accounts division coordinates the sales, installation, service and support functions of independent sales offices to serve the multiple offices and departments of large multi-site companies that seek out-sourced solutions. The Company's Government Systems group addresses the special procurement and administrative requirements of federal, state and local government agencies. Sales are made through a combination of master contracts and competitively solicited proposals for large or complex telecommunications requirements. Government Systems coordinates the installation, service and support activities of independent sales offices to provide ongoing support to government agency offices nationwide. Sales to Claricom, Inc. ("Claricom"), the Company's largest distributor, decreased by $16 million in 1997 compared to 1996. The reduced level of sales to Claricom had a significant impact on the financial results for 1997. Effective April 1, 1998, Claricom became a non-exclusive distributor of the Company's products in all parts of its territory. It is the Company's intention to supplement sales in the Claricom territories with additional distribution. The Company has identified other distributors to sell the Company's products in certain parts of Claricom's territory, which over time will give the Company the ability to increase revenues by adding alternative distribution in Claricom's territories. Since Claricom accounted for more than 10% of the Company's revenues in 1997 and is expected to continue to represent a large portion of the Company's revenues, the reduction of sales to Claricom could have a material adverse effect on the Company if the Company could not supplement the shipments to the Claricom territories with other alternative distribution. The Company believes that within a reasonable period of time it can establish alternative distribution channels in Claricom's major markets to supplement the reduced volume from Claricom. However, the Company cannot state with certainty when, or the extent to which, such alternative distribution arrangements will be completed or their effect on revenues. 6 Backlog of the telephony business consists primarily of products that have been ordered and that will be shipped or installed within 30 to 60 days of the order (other than call center orders, which have a longer lead time), or systems the installation of which is not yet required by the customer. Backlog as of December 31, 1997, was $10,814,000 compared to $12,921,000 at December 31, 1996, and the Company expects virtually all of such backlog to be filled within the current fiscal year. Computer Telephony Competition The market segments in which the Company offers its products and services are highly competitive. The under 400-desktop voice communications segment in the United States, the primary market for the Company's Computer Telephony sales channels, is served by many domestic and foreign communications equipment and software manufacturers and distributors, including Lucent Technologies (the former equipment business of AT&T), Nortel (formerly named Northern Telecom), Toshiba, InterTel and Mitel, as well as numerous specialized companies. Although the Company can be competitive on price compared to several of these companies, many of Executone's competitors have substantially more capital, technology and marketing resources than the Company. The Company has not penetrated a significant portion of the call center market. Principal competitors are EIS, Davox, Mosaix and Melita. The Company competes by offering a full array of integrated telecommunication products and services to its customers. The Company also competes on the basis of the quality of its products, its customer service, nationwide distribution and installation, and price. HEALTHCARE COMMUNICATIONS BUSINESS Healthcare Communication Products The Company develops, manufactures, markets and services a line of specialized internal communications systems that are used primarily in the healthcare industry. These internal communications systems are microprocessor-based patient-to-staff and staff-to-staff communication systems, locator systems, intercoms, paging and sound equipment, and room status indicators. Patient Communication Systems The INFOSTAR/HCP Healthcare Communications Platform is a communications solution dedicated to a single platform for complete systems integration. The HCP platform is the building block allowing for shared resources resulting in cost efficiencies. It provides a single, digital communication fabric to facilitate patient-staff calls and staff-staff calls. It improves efficiency through the integration of Executone's full product line which includes LifeSaver, CareCom II-E, INFOSTAR/ILS, PRS, TeleSearch and StatLink. Nurse Call Systems. The Company's LifeSaver nurse call system is a fully software-driven, digital nurse call system. The LifeSaver system is a state-of-the-art communications network that provides routine and emergency signaling, voice communications and data transmission. The nurse console offers menu-driven functions and step-by-step user prompts. The system is highly flexible, offering many programmable features that allow customization of its operations to the hospital's needs. A single system can serve more than 300 patient beds (150 rooms) and up to eight nurse 7 control stations, and up to eight systems can be networked for centralized operation. The LifeSaver system integrates voice and data in one PC - based system. With the capability to answer calls right from the patient's bedside, this system can dramatically increase the efficiency of the nursing staff, reduce clerical activity and improve the quality of care delivered to the patient. The CARE/COM II-E nurse call system brings the benefits of a totally integrated digital communications system to the healthcare market on the Company's IDS digital platform. The CARE/COM lI-E system provides two-way patient-to-staff and staff-to-staff voice communication on an automatic three-level call priority basis. Its two-way voice and tone signal capability, emergency signaling and sophisticated features facilitate easy handling of all calls. This new system can currently support 72 patient stations per system, with the ability to integrate three systems together and support 216 patient stations. A five-line LCD display Nurse Control Station allows simple call processing and system operation. The system is highly flexible to meet the individually defined needs of today's hospitals and long-term care facilities. INFOSTAR/PRS Patient Reporting System. The Healthcare Communications group also markets the INFOSTAR /PRS patient reporting system, an automated voice storage system that allows the efficient transfer of patient information between nurses. Nurses dictate patient information into a report "patient file" using the telephone, like a voice-mail system. Nurses can listen to reports on their patients, record reports at convenient times and leave messages for other nurses, groups or staff members. Patient reports are password-protected for confidentiality and admission, and discharge and transfer information are also supported. The system uses standard telephone instruments and provides full voice messaging capability. The INFOSTAR/PRS system reduces report time, provides continuity at shift changes, and improves report quality. Wireless Telephone Systems. The Healthcare Communications group currently distributes the Monarch and the Ericsson Freeset wireless telephones. The Monarch telephones utilize PCS (personal communication systems) technology, which is an in-building wireless communications tool that provides cellular-like mobility to a facility without expensive airtime charges. The Monarch system operates on the 1.9GHz U-PCS bandwidth set aside by the Federal Communications Commission ("FCC") strictly for personal communications use which means the signal will not cause interference to or be interfered with by conventional telemetry equipment. The Monarch system is capable of supporting two base station antennas providing a coverage area of over 250,000 square feet in a typical office environment, up to 32 handsets, and up to 16 simultaneous conversations. The Ericsson Freeset system is an in-building wireless communications system which operates on the 900MHz bandwidth. Its low power output (.75mW) makes it ideal for the healthcare environment, which is very sensitive to high power devices such as cellular telephones and 2-way radios that may interfere with vital telemetry equipment. The Freeset system is extremely flexible in providing complete coverage over a large area based on its ability to add as many base stations as necessary to provide coverage. The system can grow to support up to 1,500 handsets, making it the system of choice for large installations. These wireless systems can be integrated with nurse call systems and locator systems offered by the Healthcare business. INFOSTAR/Statlink System. The INFOSTAR/StatLink product is designed to provide call management and integration of EXECUTONE nurse call systems to wireless telephones, pager devices and extension numbers. INFOSTAR/StatLink has the flexibility to modify patient call flow based on the specific requirements of the healthcare facility. Calls can be routed on a 4-level priority basis to any extension, telephone or site pager configured in the database. The system is a communications solution that can be 8 integrated with any PBX. Patient priorities and requests can be managed more efficiently and calls can be completed on a more timely basis with less strain on the staff and patients. Resource Management Systems INFOSTAR/ILS Locator Systems. The INFOSTAR/ILS locator system is an infrared based wireless locating system that allows users to find staff, patients and equipment quickly and easily via LAN-based PC's, EXECUTONE display telephones, EXECUTONE nurse communication systems, or any other touch tone telephone inside or outside the healthcare facility. The ILS is an integrated system using infrared transmitter badges to communicate location data to sensors installed throughout a facility. Each person or piece of equipment wears an individually coded badge that transmits infrared signals to sensors placed throughout the facility, which forward the location information to a central processing unit. The badges transmit regularly at user-programmed intervals and can be worn by staff personnel or attached to equipment. The location data is collected by the sensors and forwarded to a central processing unit that organizes the data so it can be accessed at one or more display stations. The display of staff and equipment location information can be in the form of a list or in the form of a map of the facility using icons. The display can be filtered to show only particular staff members, groups of personnel, particular pieces of equipment or groups of equipment. The system can be integrated with either the IDS telephone systems, allowing the activation of features and display of information on the telephone set, or the Company's nurse call systems, allowing the activation of features and display of information at the nurse control station and patient stations. The ILS system can also be integrated to other manufacturers' PBXs. The ILS system is also marketed by the Computer Telephony sales channels for office environments. INFOSTAR/EPS System. The INFOSTAR/EPS Events Processing System collects information from the ILS locator system and generates "alarms" that signal personnel that a user defined parameter has been exceeded. The system associates the data to logical, workable and productive real time data for a customer's employees and assets. Specific applications include: door monitoring, wandering patient alert, staff presence indicators, badge button press (staff assist or emergency assist), asset management and equipment tracking. The system is completely programmable, which allows customers to determine which applications will best fit their needs. INFOSTAR/VLS System. The INFOSTAR/VLS Voice Locator System integrates with the PBX telephone system and enables facilities with EXECUTONE or non-EXECUTONE PBX's or callers from outside the facility to locate people and assets, and either connect the call to the nearest phone, transfer to voice mail or obtain information about others persons presently in the location. Software Systems InfoSTAT. The INFOSTAR/InfoSTAT product is a software package intended for use in emergency departments to provide complete communication of real time events and data. Used as a daily operational tool, the InfoSTAT system provides emergency staff with priority data and conditions affecting the department. InfoSTAT means the end of the archaic "grease board". A flashing color shows which patients have been "waiting too long" or "who is next". InfoSTAT provides the speed, flexibility and efficiency that only comes with a computerized system. Staff can check at a glance the status of treatment rooms, room and bed assignments, hospital staff assignment and location, and patient status and location. InfoSTAT is customized for each hospital and integrates with a 9 facility's existing administrative software such as ADT systems. ReportStar. The ReportStar feature for Microsoft Windows 95 is a management reporting package which is designed to provide healthcare managers with information generated from data collected by the EXECUTONE HCP Healthcare Platform, LifeSaver, CARE/COM II-E and INFOSTAR/ILS locator systems. ReportStar for Windows 95 is an Oracle-based program which provides users with 6 different reports that can be viewed on screen, printed as needed or scheduled to run on any predetermined schedule. Users can select the details of the desired report from a simple screen which was designed with a graphical user interface to make it easy for staff to access. Healthcare Sales and Marketing The Company's healthcare communications distribution network consists of (1) domestic independent distributors with approximately 81 locations operating under exclusive and nonexclusive agreements throughout the United States; (2) 200 direct healthcare sales and service employees in the United States; (3) the Government Systems group, which uses the distribution network to serve healthcare customers who are federal, state and local government agencies; and (4) 16 independent distributors operating in 12 foreign countries. Distributors of the Company's healthcare communications products are required to meet established criteria for sales and service to customers on an ongoing basis. No customer of the healthcare business accounts for 10% or more of its revenue. Healthcare backlog consists primarily of products that have been ordered and that will be shipped or installed within 180 days of the order or systems the installation of which is not yet required by the customer. Healthcare order backlog as of December 31, 1997, was $14,601,000 compared to $9,583,000 at December 31, 1996, and the Company expects virtually all of such healthcare backlog to be filled within the current fiscal year. The Company's principal competitors in healthcare communications are Hill-Rom Company, DuKane and Rauland-Borg. The Company believes it has a strong competitive position in nurse call and locator products. The Company competes by offering innovative integrated healthcare communications products and services to its customers. The Company also competes on the basis of the quality of its products, its customer service, nationwide distribution and installation, and price. TELEPHONY AND HEALTHCARE OPERATIONS Product Development and Engineering As of December 31, 1997, the Company employed approximately 100 individuals engaged in computer telephony and healthcare product design and development. The Company's product development program is designed to anticipate and respond to customer needs through development of new products and enhancement of existing products. During 1997, the Company's engineering efforts focused on applications-oriented software products, including new releases of computer telephony and healthcare communications software. The Company continually strives to reduce production costs by incorporating new technology into its design and manufacturing operations. For the years ended December 31, 1997, 1996, and 1995, Company-sponsored product 10 development and engineering expenditures (including product management and testing) amounted to approximately $12.8 million, $13.8 million, and $14.7 million, respectively. Manufacturing Most of the Company's telephone products are manufactured by Wong's Electronics Company, Ltd. ("Wong's") in Malaysia, by Quality Telecommunication Products, also referred to as Compania Dominicana de Telefonos ("Codetel"), in the Dominican Republic, and by the Company directly in Poway, California. Many of the printed circuit boards for the Company's products are manufactured, and many products are assembled into systems and system components, in the United States. The Company's Manufacturing Services Agreement with Wong's currently expires in February 1999 but is automatically extended each year for an additional one-year term unless either party gives notice of termination three months prior to expiration of the current term. The contract may be terminated earlier by either party in the event of a material breach by the other party. If the agreement between Wong's and Executone should be terminated for any reason, or if Wong's is unable to ship or has to reduce shipments, or if restrictions are imposed materially limiting the importation of products produced by foreign manufacturers, the Company could be affected adversely until satisfactory alternative sources are in place. The profitability of Executone's operations could be affected to the extent it is unable to reflect the direct and indirect costs of products purchased from Wong's in its pricing policies. The prices for products purchased by Executone from its suppliers are payable in U.S. dollars. The majority of Executone's specialized healthcare and internal communication systems are produced in the United States at the Company's facility in Poway, California or at domestic subcontractors. The functions of repair, warehousing and distribution of the Company's products are performed at the Company's facilities in Poway. Product Maintenance Executone warrants parts and labor on its telephone and healthcare systems, typically for one year, and provides maintenance and service after warranty expiration either on a contract or time and materials basis. Most of the Company's products are repaired at its repair facility located in Poway, California. Trademarks, Patents and Copyrights Management believes that the continued success of Executone is dependent upon the ability to design, develop and market new products and new or enhanced applications. The patentability of such new products or applications is evaluated and patent applications are filed where necessary to protect unique developments. The Company currently holds 14 utility patents, expiring at various times between 2006 and 2017, has six U.S. patent applications pending, and six patent applications pending in several foreign countries. The Company has registered or applied to register its trademarks when it believes registration to be important to its ongoing business operations. The Company also generally claims copyright protection for software, circuit designs, schematics and technical documentation used in connection with its products, and relies upon trade secret, contract and copyright laws to protect its proprietary rights in its software, designs 11 and documentation. Certain of the telephony and healthcare products incorporate technology and software licensed from independent third parties. Generally, these licenses require payment of a royalty for each system sold that incorporates the licensed technology or require that the Company purchase the product from the licensor. Government Regulation Many of the Company's telephony and healthcare systems are designed to be connected to the public telecommunications network and as such are required to comply with certain rules of the FCC pertaining to telecommunications equipment. The Company has not experienced any material adverse effect on its business or operations as a result of such regulation and compliance. Certain uses of outbound call processing systems are regulated by federal and state law. Among other things, the FCC has adopted rules pursuant to the Federal Telephone Consumer Protection Act to protect residential telephone subscribers' privacy rights to avoid receiving telephone solicitations to which they object. Certain states have enacted similar laws limiting access to telephone subscribers who object to receiving solicitations. Although compliance with these laws may limit the potential use of the Company's predictive dialer systems in some respects, the Company's systems can be programmed to operate automatically in full compliance with these laws through the use of appropriate calling lists and calling campaign time parameters. To the extent the Company markets its telephony and healthcare products internationally, it is required to comply with applicable foreign law, including certification of its products by appropriate government regulatory organizations. Employees As of March 1, 1998, Executone employed approximately 700 persons, directly and through its subsidiaries. Less than 3% of the employees of the Company and its subsidiaries are represented by unions, all of which employees are represented by the International Brotherhood of Electrical Workers. Management believes that the Company's relations with its employees are good. UNISTAR BUSINESS UniStar History On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming. Unistar Gaming's subsidiary, UniStar, has an exclusive five-year contract ending January 2003 to design, develop, finance, and manage the Lottery, a national lottery authorized by federal law and by a compact between the State of Idaho and the Coeur d'Alene Tribe. UniStar provides development and management of the software, network design and call center applications for the Lottery's operations. In return for providing these management services, the Tribe has agreed to pay UniStar a fee equal to 30% of the profits of the Lottery. The Lottery has commenced operations but is not yet profitable. In an attempt to block the Lottery, certain states filed letters under 18 U.S.C. Section 1084 to prevent the long-distance carriers from providing toll-free telephone service to the Lottery and the States of Missouri and Wisconsin have filed suit against the Lottery. See "Legal Proceedings." 12 The Tribe's initial plan was to establish a telephone lottery that could be played by any individual of majority age, residing in one of the 36 states or the District of Columbia that currently operates a state-run lottery. It was originally contemplated that customers would call an "800" number and ticket purchases would be processed with interactive voice response equipment or live agents in a call center located on the Tribe's Reservation in Idaho. The call center would use ACD (automated call distribution) software to process nationwide lottery sales. After the Company's purchase of UniStar, the Lottery business plan evolved, in response to legal challenges, to encompass Internet-based instant lottery games, and, as of January 1998, a local, non-toll-free telephone and Internet-accessible weekly draw lottery. The Company has made a significant investment in UniStar, which initially created 8% stock dilution to the Company's shareholders, and since the purchase has invested additional cash to develop the software and hardware system, build the Lottery building, fund the legal and lobbying efforts, commence the marketing and advertising campaigns, and pay other costs related to the project. UniStar Sales and Marketing The US Lottery began test marketing its Instant ticket games on the Internet in July 1997. Through December 31, 1997, the US Lottery generated revenues of $1.5 million. On January 20, 1998 the US Lottery launched its first draw game, the "Super6". Tickets for the Super6 can be purchased either over the Internet or by telephone. As of March 31, 1998, the registered customer base of the US Lottery (including the instant and the weekly games) was approximately 21,000 established accounts with about 3,000 active players. Initially, UniStar's marketing efforts for the Lottery were confined to Internet links and advertising on gaming-related Internet sites and on general search engines. UniStar began direct mail advertising for the Tribe's instant US Lottery games in November 1997. Local print and radio advertising promoting the new weekly draw Lottery game began on a limited basis in a few small markets in January 1998. Lottery revenues were $537,000 and $1,196,000 for the quarters ending September 30, 1997 and December 31, 1997 respectively. Due to advertising, professional fees and other startup costs, the Lottery has yet to generate a profit. As a result, UniStar has not recognized any revenue as of December 31, 1997. In addition to the legal risks, there are market risks associated with the development of the Lottery. The Company believes there is a national market for the Lottery based upon research into the experience of other national lotteries and the growth of the overall lottery market. However, there is no assurance that there will be acceptance of a telephone or Internet lottery. In the event that the telephone and Internet Lottery games do not attain the level of market acceptance anticipated by the Company, the Company would have to reevaluate its investment in UniStar. UniStar Product Development During 1997, UniStar contracted with third parties for software development and system architecture for the Internet and telephone-based Lottery. The architecture of the Internet-based Lottery, particularly the business system, data base structure and the 13 banking interface, was completed in 1997 for the Tribe's Internet instant games and was a critical building block in UniStar's further development of the telephone-based Lottery that the Tribe launched in January 1998. The Lottery product portfolio consists of two product lines - instant lottery games and draw lottery games. Instant games are modeled after state lottery "scratch off" instant tickets. The instant game product line includes Lotto, Bingo and Classic "scratch off" lottery games. The Lottery currently offers four live instant games and five instant games in a "demo" mode only. The "demo" only games are scheduled to go live in the second quarter of 1998. The draw product line consists of the Super6 draw lottery where tickets are available both by telephone or over the Internet. The Super6 offers a jackpot prize of $1,000,000 which will grow as the prize pool grows. Drawings are held Tuesdays at 1:00PM Pacific Time. The Lottery expects to announce "Pick 3" and "Powerball" type games later in 1998. Patents, Trademarks, and Copyrights Management believes that the success of the Lottery, and therefore at least initially of UniStar, is dependent upon the ability to design, develop and market new products and new or enhanced applications. The patentability of such new products or applications is evaluated and patent applications are filed where necessary to protect unique developments. UniStar currently has two U.S. patent applications pending. UniStar has registered or applied to register its trademarks when it believes registration to be important to its ongoing business operations. The Company also generally claims copyright protection for its software used in connection with the Lottery and relies upon trade secret, contract and copyright laws to protect its proprietary rights in its software, designs and documentation. Certain of the Lottery products incorporate technology and software licensed by UniStar from independent third parties. Generally, these licenses have required payment of a license fee for the licensed technology. Competition UniStar has little competition in the development and management of authorized Indian gaming enterprises. The broader area of gaming entertainment is highly competitive. The market is served by the States through state-sponsored lotteries and by many domestic and foreign gaming companies, including several large land-based casino companies. All of these competitors have substantially more capital, and therefore more technology and marketing resources, than UniStar or the Company. Government Regulation and Legislation The Lottery developed and managed by UniStar for the Tribe is authorized under the federal Indian Gaming Regulatory Act of 1988 ("IGRA"). In managing the Lottery, UniStar must observe all laws and regulations applicable to the Lottery. IGRA defined three classes of Indian gaming. IGRA established the jurisdictional and regulatory control for each class and created the National Indian Gaming Commission (the "NIGC") to enforce the provisions of IGRA. Lotteries are defined as Class III gaming. Class III gaming is governed by the terms of the Tribe/State compact and the rules and regulations 14 of the NIGC. The Lottery is also governed by the rules and policies promulgated by the Coeur d'Alene Tribal Council. In 1992, the Coeur d'Alene Tribe signed a Compact with the State of Idaho (the "Compact"). The Compact specifically provides for the conduct of the Lottery games. The Compact was approved by the Secretary of the Interior on February 5, 1993 and notice thereof was published in the Federal Register. The Tribe entered into a management agreement with UniStar for the conduct of the Lottery. The Chairman of the NIGC approved the management contract and the amendments thereto as required by law. By resolution, the Tribe has authorized the Lottery to be conducted under the management agreement. The Coeur d'Alene Tribe has complied with IGRA and all other applicable rules, regulations and laws. It is the opinion of the Tribe and UniStar that state anti-gambling laws and regulations are not applicable to the Lottery because the entire subject of Indian gaming is governed by federal law and therefore state laws and regulations are preempted by IGRA. See "Legal Proceedings." The employees of the Lottery undergo extensive background checks including fingerprinting which is sent to the Federal Bureau of Investigation. The Lottery also has made and will continue to make reasonable efforts to address the issue of problem gambling and to prevent participation by minors. To attempt to address problem gamblers, the Lottery has voluntarily established a credit limit of $500 per month. The system requires each user to have a credit card. To prevent access by minors, the Lottery matches the address provided on the application to the credit card before allowing access. When verification of the account is sent to the lawful credit card holder, any unlawful access by a minor should be detected and end. The Lottery also regularly runs match tests between its database of social security numbers and other databases available to determine the age ranges of the holders by generic number sequences. The Lottery mails all correspondence to the person and address associated with the credit card so if a minor was playing, the adult would still be the person receiving the correspondence. Winnings are paid only by a check issued and mailed directly to the person and mailing address on the account. Senate Bill 474 offered by Senator Jon Kyl (the "Kyl Bill") seeks to amend 18 U.S.C. Sections 1081 and 1084, which currently prohibit the interstate transmission of bets and wagers on sporting events and contests. The Kyl Bill would remove the current limitation to sporting bets and wagers and extend Sections 1081 and 1084 to virtually all forms of bets and wagers, as well as to lotteries and other gaming, in an attempt to prohibit all gaming conducted over the telephone and the Internet. The Kyl bill was proposed in 1997 but was not voted on by the full Senate. There is a similar bill pending in the House of Representatives. There is currently no exception in any of the proposed bills for gaming conducted by an Indian tribe that is authorized by IGRA. The Company is supporting efforts to have such an exception included in the bill. The Kyl Bill and the House counterpart seek to prohibit the activities of the Lottery and the activities of UniStar in managing the Lottery, which would have a material adverse effect on UniStar's business. Employees As of March 1, 1998, UniStar employed three general and administrative management employees, not including the customer service and technical employees employed by the Lottery, none of whom are represented by unions. 15 ITEM 2. PROPERTIES Executone's principal offices are located in a leased facility in Milford, Connecticut. The Company has warehouse, manufacturing and distribution facilities in Poway, California. As of December 31, 1997, the Company leased 8 facilities in the United States with an aggregate of approximately 283,000 square feet for its ongoing operations. The current annual rent for the Company's leased facilities is approximately $3.2 million. The Company also subleases from Claricom small areas of 31 former district sales offices, aggregating approximately 24,000 square feet, for use by sales and technical employees for approximately $600,000 per year. The Company has one facility totaling approximately 14,000 square feet of space that is no longer used in ongoing operations and is subleased. The Company believes its facilities are adequate and generally suitable for its business requirements at the present time and for the immediate future. The following is a brief description of the primary facilities of the Company.
Use Location Approximate Size - --- -------- ----------------- Corporate Headquarters Milford, Connecticut 150,000 and Research, Development square feet and Engineering Facility Distribution, Production & Poway, California 112,000 Repair Center and Warehouse square feet Other, including warehouses Milford, Connecticut 45,000 and subleased office space and various locations square feet
ITEM 3. LEGAL PROCEEDINGS On October 16, 1995, the Coeur d'Alene Tribe filed an action entitled Coeur d'Alene Tribe v. AT&T Corp. in the Tribal Court, located in Plummer, Idaho (Case No. C195-097), requesting a ruling that the Tribe's Lottery to be developed and managed by the Company's UniStar subsidiary is legal under IGRA, that IGRA preempts state laws on the subject of Indian gaming, that Section 1084 is inapplicable and that therefore the states lack authority to issue Section 1084 notification letters to any carrier, and an injunction preventing AT&T from refusing to provide telephone service to the Lottery. This action was necessary because several network carriers have been sent Section 1084 letters by states opposed to the Lottery. These letters state that the Lottery is illegal under state and federal laws and prohibit the interstate carriers from carrying "800 number" network traffic for the Lottery. Although in January 1998 the Tribe began to offer a weekly draw Lottery for which tickets could be purchased over the telephone, it has done so using a local telephone number, meaning that the Lottery's customers must pay toll charges for each call. The use of an "800" number for lottery ticket sales may not begin until resolution of this proceeding and agreement of a network carrier to carry the network traffic of the Lottery. On February 28, 1996, the Tribal Court ruled (i) that all requirements of IGRA have been satisfied, (ii) that Section 1084 is inapplicable and the states lack jurisdiction to interfere with the Lottery, and (iii) that AT&T cannot refuse service to the Lottery based upon Section 1084, an allegation that the Lottery is in violation of IGRA or the federal anti-lottery statutes. This ruling and a related order dated May 1, 1996 were subsequently appealed to the Tribal Appellate Court, which on July 2, 1997 affirmed the lower Tribal Court's May 1, 1996 ruling and analysis upholding the 16 Tribe's right to conduct the telephone Lottery. On August 22, 1997, AT&T filed a complaint for declaratory judgment against the Tribe in the U.S. District Court for the District of Idaho, to obtain a federal court ruling on the validity and enforceability of the Tribal Court ruling. The Tribe has answered the complaint. In March 1998, the attorneys general of nineteen states filed a motion for permission to submit a brief as amicus curiae in the case with respect to the Tribal Court's interpretation of IGRA and in support of the position taken by AT&T. On May 28, 1997, the Attorney General of the State of Missouri brought an action in the Circuit Court of Jackson County, Missouri, against the Coeur d'Alene Tribe and UniStar seeking to enjoin the Lottery games offered by the Tribe over the Internet and managed by UniStar. The complaint also sought civil penalties, attorneys fees and court costs. The complaint alleges that the Lottery violates Missouri anti-gambling laws and that the marketing of the games violates the state's Merchandising Practices Act. UniStar and the Tribe removed the case to the U.S. District Court for the Western District of Missouri, which denied the State's subsequent motion to remand back to the state court. The court also subsequently granted a motion to dismiss the Tribe from this case based on sovereign immunity. The court denied a motion to dismiss UniStar based on sovereign immunity, although the court indicated it might reconsider that decision. UniStar filed a motion for reconsideration of its motion for dismissal. The State of Missouri has filed a notice of appeal evidencing its intent to appeal to the Eighth Circuit Court of Appeals the dismissal of the Tribe. On January 28, 1998, the State of Missouri sought to dismiss voluntarily the existing federal case against UniStar and the next day filed a new action against the Company, UniStar and two tribal officials, with essentially the same allegations, in state court. The State obtained a temporary restraining order from a state judge against the Company, UniStar, and two officials of CDA enjoining the marketing of the Internet and telephone Lottery in the State of Missouri. On February 5, 1998, the U. S. District Court for the Eastern District of Missouri ruled that this second case also should be heard in federal court, transferred the second case to the Western District of Missouri where the original case had been filed, and dissolved the state court's temporary restraining order, effective February 9, 1998. A motion to dismiss the second case based on the sovereign immunity of all the defendants and a motion to abstain in favor of the jurisdiction of the Coeur d'Alene Tribal Court are pending. The State of Missouri has filed a notice of appeal evidencing its intent to appeal the denial of its motion to remand the case to state court or, in the alternative, to grant a preliminary injunction. On September 15, 1997, the State of Wisconsin, by its Attorney General, filed an action in the Wisconsin State Circuit Court for Dane County against the Company, UniStar and the Coeur d'Alene Tribe, to permanently enjoin the US Lottery offered by the Tribe on the Internet. The complaint alleges that the offering of the US Lottery violates Wisconsin anti-gambling laws and that legality of the US Lottery has been misrepresented to Wisconsin residents in violation of state law. In addition to an injunction, the suit seeks restitution, civil penalties, attorneys' fees and court costs. The Company, UniStar and the Tribe have removed the case to the U. S. District Court in Wisconsin. On February 18, 1998, the District Court dismissed the Tribe from the case based on sovereign immunity and dismissed Executone based on the State's failure to state a claim against Executone. Motions to dismiss the case against UniStar were denied. UniStar has filed a notice of appeal evidencing its intent to appeal to the Seventh Circuit Court of Appeals the denial of its motion to dismiss. The Company has been advised by its outside counsel, Hunton & Williams, that based upon such firm's review of the applicable statutes, regulations and case law, it 17 believes that the Lottery is authorized under IGRA and that the favorable rulings issued by the Coeur d'Alene Tribal Court on February 28 and May 1, 1996 and the Tribal Appellate Court on July 2, 1997 will be affirmed by the Idaho federal court. The Company believes UniStar will also prevail in the Missouri and Wisconsin lawsuits. However, there is no assurance of such legal outcomes. UniStar and the Tribe believe that the Lottery is legal and intend to defend the right of the Tribe to offer the Lottery on the Internet and via the telephone. Based on the anticipated outcome of the pending legal actions, the Company does not believe the outcome of this litigation will have a material adverse effect on the Company's consolidated financial position, results of operations or liquidity. However, the pending litigation, as well as other litigation which could be brought by states or others opposed to the Lottery, could delay or suspend certain Lottery operations, and it is impossible at this time to predict the nature or extent of any delays or suspension of operations that might occur. The Company currently is a named defendant in a number of other lawsuits and is a party to a number of other proceedings that have arisen in the normal course of its business. Those lawsuits and proceedings relate primarily to the collection of indebtedness owed to the Company, the performance of products sold by the Company, and various contract disputes. In the opinion of the Company, these proceedings are not expected to have a material adverse effect on the consolidated financial position, results of operations or liquidity of the Company and, to the extent they are not covered by insurance, reserves adequate to satisfy such liabilities have been established. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders in the fourth quarter of the fiscal year covered by this report. 18 EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company are as follows:
Name Age Position With Company - ---- --- --------------------- Alan Kessman 51 Chairman of the Board, President and Chief Executive Officer Michael W. Yacenda 46 Executive Vice President and President, UniStar Entertainment Barbara C. Anderson 46 Vice President, General Counsel and Secretary James E. Cooke III 49 Vice President, National Accounts Anthony R. Guarascio 44 Vice President, Finance and Administration and Chief Financial Officer Israel J. Hersh 44 Vice President, Software Engineering Robert W. Hopwood 54 Vice President and Vice President-Operations, Unistar Entertainment Andrew Kontomerkos 52 Senior Vice President, Hardware Engineering and Production Vic Northrup 41 Vice President, and President, Computer Telephony Frank J. Rotatori 55 Vice President, and President, Healthcare Communications Shlomo Shur 48 Senior Vice President, Advanced Technology
Alan Kessman has served as Chairman and Chief Executive Officer of the Company since 1988. Prior to that, he had served as President and Chief Executive Officer of ISOETEC Communications, Inc., a predecessor of the Company ("ISOETEC"), since 1983. From 1978 to 1983, Mr. Kessman served as President of three operating subsidiaries of Rolm Corporation, and from 1981 to 1983, he served as a Corporate Vice President of Rolm Corporation, responsible for sales and service in the eastern United States. See "Recent Developments" above. 19 Michael W. Yacenda has served as Executive Vice President of Executone since January 1990, and as President of UniStar since 1996. Prior to that time, he was Vice President, Finance and Chief Financial Officer of the Company from July 1988 to January 1990. He served as a Vice President of ISOETEC from 1983 to 1988. From 1974 to 1983, Mr. Yacenda was employed by Arthur Andersen & Co., a public accounting firm. Mr. Yacenda is a certified public accountant. Barbara C. Anderson has been Vice President, General Counsel and Secretary since 1990. From 1985 to 1989, she was Corporate Counsel of United States Surgical Corporation, a manufacturer of medical devices. James E. Cooke III has served as Vice President, National Accounts since February 1996. Prior to that time, from 1992 until 1996, Mr. Cooke served as Division Manager of Operations for the Company, and from 1988 through 1991, Mr. Cooke was a District Manager for the Company. From 1985 until 1988, Mr. Cooke was the President of an interconnect company, and from 1981 to 1985, he was a General Manager and a Regional Manager of the Jarvis Corporation. For eight years prior to that time, he worked at Xerox Corporation in various sales and management positions. Anthony R. Guarascio has been Vice President, Finance and Chief Financial Officer since January 1994, and prior thereto was Vice President and Corporate Controller since January 1990. From 1984 until 1990, Mr. Guarascio was the Corporate Controller of the Company and ISOETEC. Israel J. Hersh has been Vice President, Software Engineering since February 1996. Mr. Hersh joined the Company as Director of Software Development in 1984, and was promoted to Senior Director of Software Engineering in January 1994. Prior to his employment with the Company, Mr. Hersh was a manager of the software development department for T-Bar, Inc. Mr. Hersh has a B.S. in Electrical Engineering from Tel Aviv University and a MS in Electrical Engineering from Bridgeport University. Robert W. Hopwood has been Vice President of the Company and Vice President-Operations of its UniStar subsidiary since May 1996, and prior thereto served as Vice President, Customer Care of the Company from January 1990. From 1983 until 1990, Mr. Hopwood was the Director of Technical Operations of the Company and ISOETEC. Andrew Kontomerkos has been Senior Vice President, Hardware Engineering and Production since January 1994, and prior thereto was Vice President, Hardware Engineering since 1988. He served as a Vice President of ISOETEC since 1983. From 1982 to 1983, he was a Vice President and founder of SAM Communications, Inc., a telecommunications research and development company which was one of the predecessors to ISOETEC; that corporation was merged into ISOETEC in 1983. From 1979 to 1982, Mr. Kontomerkos was Director of Telecommunications Systems Development of TIE/communications, Inc., a manufacturer of telecommunications systems. 20 Vic Northrup has been Vice President of the Company since February 1997, and President of the Computer Telephony business since May 1996. Prior thereto, he was Senior Director of Sales and Operations and a district general manager of the Company. Frank J. Rotatori has been Vice President, Healthcare Communications since February 1996. Prior thereto he was Vice President, European Operations since February 1994, and prior thereto was Director of Call Center Management Products during 1992 and 1993, Vice President-Direct Sales from 1990 through 1991 and Vice President-Customer Service of the Company from 1988 to 1990. Mr. Rotatori joined ISOETEC in 1986 as a regional manager. From 1982 to 1986, he served as General Manager and Eastern Regional Manager for Rolm Corporation. For 13 years prior to that time, he worked at Xerox Corporation in various manufacturing, accounting, sales and service management positions. Shlomo Shur has been Senior Vice President, Advanced Technology since January 1994, and prior thereto was Vice President, Software Engineering since 1988. He served as a Vice President of ISOETEC from 1983 to 1988. From 1982 to 1983, he was Vice President and a founder of SAM Communications, Inc., a telecommunications research and development company which was one of the predecessors to ISOETEC; that corporation was merged into ISOETEC in 1983. From 1978 to 1982, Mr. Shur was Manager, Software Development for TIE/communications, Inc., a manufacturer of telecommunications systems. 21 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Incorporated by reference to "Stock Data" in the Registrant's 1997 Annual Report to Shareholders. ITEM 6. SELECTED FINANCIAL DATA Incorporated by reference to "Selected Financial Data" in the Registrant's 1997 Annual Report to Shareholders. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Incorporated by reference to "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Registrant's 1997 Annual Report to Shareholders. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Financial Statements are incorporated by reference to the Financial Statements in the Registrant's 1997 Annual Report to Shareholders. The Schedule appears at pages S-1 through S-2 of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 22 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY The following persons are currently serving as directors of the Company. Certain information regarding each director is set forth below, including each individual's principal occupation and business experience during the last five years, directorships in other public companies, and the year in which the individual was elected a director of the Company or one of its predecessor companies.
NAME AGE PRINCIPAL OCCUPATION DIRECTOR SINCE - ---- --- -------------------- -------------- Alan Kessman 51 President, Chief Executive Officer, 1983 and Chairman of the Company since 1988; and of one of the Company's predecessor corporations since 1983. Louis K. Adler 62 Private Investor; President and Director, 1997 Bancshares, Inc., Houston, Texas, since 1973; former director of Unistar Gaming Corporation, prior to its acquisition by the Company. Mr. Adler is also a director of Hospitality Worldwide Services, Inc. Stanley M. Blau 60 President, The Blau Group Ltd., an 1983 investment firm; formerly Vice Chairman of the Company from 1988 until 1996; and Chief Executive Officer of one of the Company's predecessor corporations, from 1987 until July 1988. Thurston R. Moore 51 Partner, Hunton & Williams (Attorneys), 1990 Richmond, Virginia, since 1981. Richard S. Rosenbloom 65 David Sarnoff Professor of Business 1992 Administration, Harvard Business School, since 1980. Mr. Rosenbloom is a director of Arrow Electronics, Inc. Jerry M. Seslowe 52 Managing Director of Resource Holdings 1996 Ltd., an investment and financial consulting firm, since 1983.
EXECUTIVE OFFICERS See Part I for information concerning executive officers of the Company. 23 SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities Exchange Act of 1934 requires that the Company's directors and executive officers, and persons who own more than 10% of a registered class of the Company's equity securities, file with the Securities and Exchange Commission initial reports of ownership and reports of change in ownership of Common Stock and other equity securities of the Company. Officers, directors and greater than 10% shareholders are required by SEC regulation to furnish the Company with copies of all Section 16(a) forms that they file. To the Company's knowledge, based solely on review of the copies of such reports furnished to the Company, and written representations that no other reports were required, during the fiscal year ended December 31, 1997, all Section 16(a) filing requirements applicable to its officers, directors and greater than 10% beneficial owners were complied with. ITEM 11. EXECUTIVE COMPENSATION DIRECTOR COMPENSATION Each director who does not receive other direct compensation from the Company receives an annual retainer of $10,000, payable in equal quarterly installments, plus a fee of $1,250 for each Board meeting attended, $1,250 for each three telephone conference call meetings, and $1,250 for each Committee meeting held separately from a Board meeting. In addition, each such director is granted annually an option to purchase shares of the Company's Common Stock under the terms and conditions of the Company's 1990 Directors' Stock Option Plan (the "Plan") approved by the shareholders on June 20, 1990 and amended, with the approval of the shareholders, on July 30, 1996. As of March 31, 1998, 36,000 shares had been issued upon exercise of options granted under the original terms of the Plan, options to purchase 18,000 shares of Common Stock were outstanding under the original terms of the Plan, and options to purchase an additional 132,400 shares were outstanding under the 1996 amendment to the Plan. The number of shares for which options may be granted each year are determined by reference to the Black-Scholes option pricing model to provide an option equal in value to $10,000 based upon the market price of the Common Stock at the date of grant. An aggregate of up to 250,000 shares are issuable under the Plan. Each of Messrs. Adler, Moore, Rosenbloom and Seslowe received options to purchase 13,700 shares under this Plan in 1997. On February 1, 1996 and July 29,1997, Jerry M. Seslowe and Louis K. Adler, respectively, were each granted warrants to purchase 25,000 shares of the Company's Common Stock at $2.63 and $2.00 per share, respectively, the closing market prices on those dates. The warrants vest ratably over a three-year period and expire on February 1, 2001 and July 29, 2002, respectively. Messrs. Seslowe and Adler received these warrants upon being elected to serve on the Company's Board of Directors. The Company also reimburses directors for their travel and accommodation expenses incurred in attending Board meetings. 24 SUMMARY COMPENSATION TABLE The following table sets forth the compensation by the Company of the Chief Executive Officer and the four most highly compensated other executive officers of the Company for services in all capacities to the Company and its subsidiaries during the past three fiscal years.
LONG-TERM COMPENSATION ANNUAL COMPENSATION ---------------------- OTHER ANNUAL AWARDS OF ALL OTHER NAME AND SALARY BONUS COMPENSATION OPTIONS/ COMPENSATION PRINCIPAL POSITION YEAR ($) ($) ($) SARs(#) ($) (1) - ----------------- ----- -------- ----- ------------ --------- ------------ Alan Kessman 1997 400,000 -0- -0- -0- 9,849(2) Chairman of the Board, 1996 400,000 63,000 -0- -0- 9,536 President and Chief 1995 400,000 -0- -0- -0- 10,328 Executive Officer Michael W. Yacenda 1997 256,000 -0- -0- -0- 5,997 Executive Vice President 1996 256,000 49,900 -0- -0- 5,935 1995 256,000 -0- -0- -0- 6,353 Shlomo Shur 1997 215,700 -0- -0- -0- 5,233 Senior Vice President, 1996 215,700 12,393 -0- -0- 5,192 Advanced Technology 1995 215,700 -0- -0- -0- 5,514 Andrew Kontomerkos 1997 214,000 -0- -0- -0- 5,896 Senior Vice President, 1996 214,000 12,350 -0- -0- 5,703 Hardware Engineering 1995 214,000 -0- -0- -0- 5,535 and Production Vic Northrup 1997 162,885 31,750 -0- -0- 660 Vice President and 1996 137,837 64,375 -0- 25,000 660 President, Computer 1995 126,223 83,353 -0- -0- 660 Telephony Division
(1) This category includes for each individual a matching contribution by the Company under the Company's 401(k) plan in the amount of $660 each for each year. This column also includes premiums paid by the Company for long-term disability and life insurance for the following individuals in the following amounts in 1997: Mr. Kessman, $9,189; Mr. Yacenda, $5,337; Mr. Shur, $4,573; and Mr. Kontomerkos, $5,236; in the following amounts in 1996: Mr. Kessman, $8,876; Mr. Yacenda, $5,275; Mr. Shur, $4,532; and Mr. Kontomerkos, $5,043; and in the following amounts in 1995: Mr. Kessman, $9,668; Mr. Yacenda, $5,693; Mr. Shur, $4,854; and Mr. Kontomerkos, $4,875. (2) Does not include the payment of approximately $1,300,000 accrued under Mr. Kessman's employment continuity agreement described immediately below. EMPLOYMENT CONTINUITY AGREEMENT The Company and Mr. Kessman entered into an employment continuity agreement in January 1995 that provides certain benefits to Mr. Kessman in the event of the termination of Mr. Kessman's employment without cause or following a change in control in the Company, including a lump sum payment equal to 2.99 times his then 25 current base salary plus the average of any bonuses awarded to Mr. Kessman during the two fiscal years preceding the termination of his employment. Under the terms of the agreement, a change in control includes the acquisition of beneficial ownership of 20% of the Company's voting securities by any person or group. The agreement continues through the length of Mr. Kessman's employment with the Company. In January 1998, Mr. Kessman announced his intention to retire from the management of the day-to-day operations of the Company. Mr. Kessman is remaining in his current position until his successor is selected. In accordance with the diminishment of responsibility provisions of his employment continuity agreement, the Company will pay Mr. Kessman approximately $1.3 million, which includes severance of approximately $1.1 million and continuation of certain benefits for four years. The Company will incur this cost during the first quarter of 1998. As of March 31, 1997, Mr. Kessman had indebtedness to the Company of $2.4 million relating to the Executive Stock Incentive Plan. These obligations will remain outstanding until December 2001 notwithstanding Mr. Kessman's retirement; however, during 1998 Mr. Kessman will pledge an additional 500,000 shares of Common Stock to the Company as security for the loan and guarantee and after 1998 will pay 100% of the interest accrued on the loan as it becomes due. See "CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS." OPTION GRANTS IN LAST FISCAL YEAR There were no grants of options made to any officers during 1997. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES The following table sets forth each exercise of stock options made during the year ended December 31, 1997 by the Chief Executive Officer and the four most highly compensated other executive officers and the fiscal year-end value of unexercised options held by those individuals as of December 31, 1997. There were no exercises or holdings of stock appreciation rights by any officers during 1997, and there are no outstanding stock appreciation rights.
Number of Value of Unexercised Unexercised Options In-the Money Options at Shares at FiscalYear-End(#) Fiscal Year-End($)(1) Acquired on Value Exercisable/ Exercisable/ Name Exercise (#) Realized ($) Unexercisable Unexercisable Alan Kessman 10,000 $7,500 25,000/-0- 4,700/0 Michael W 26,000 23,556 32,000/-0- 6,016/0 Yacenda Shlomo Shur 20,000 18,120 25,000/-0- 4,700/0 Andrew 15,000 13,590 20,000/-0- 3,670/0 Kontomerkos Vic Northrup -0- -0- 34,108/28,036 -0/0-
(1) Based upon the last sale price on December 31, 1997 of $2.188 per share of Common Stock. 26 COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION It is the responsibility of the Compensation Committee of the Board of Directors to administer the Company's incentive plans, review the performance of management and approve the compensation of the Chief Executive Officer and other executive officers of the Company. The Compensation Committee believes that the Company's success depends on the coordinated efforts of individual employees working as a team toward defined common goals. The objectives of the Company's compensation program are to align executive compensation with business objectives, to reward individual and team performance furthering the business objectives, and to attract, retain and reward employees who will contribute to the long-term success of the Company with competitive salary and incentive plans. Specifically, executive compensation decisions are based on the following factors: 1. The total direct compensation package for the Company's executives is made up of three elements: base salary, a short-term incentive program in the form of a performance-based bonus, and a long-term incentive program in the form of stock options and other inducements to own the Company's stock. 2. The Committee believes that the total compensation of all executives should have a large incentive element that is dependent upon overall Company performance measured against objectives established at the beginning of the fiscal year. Bonus and stock opportunities represent a significant portion of the total compensation package, in an attempt to further the Company's goal of linking compensation more closely to the Company's performance. The percentage of direct compensation that is dependent upon the Company's attainment of its objectives also generally increases as the responsibility of the officer in question for the overall corporate performance increases. 3. Total compensation levels, i.e., base salary, bonus potential, and number of stock options, are established by individual levels of responsibility and regular reference to competitive compensation levels for executives performing similar functions and having equivalent levels of responsibility. However, whether actual bonuses are paid to each executive depends upon the achievement of Company profitability goals. In the case of certain executives who have direct responsibility for individual business units, a portion of the incentive compensation for such executives may consist of bonuses tied to the performance against predetermined targets of the individual business units for which they are responsible. 4. In 1997, the Compensation Committee reviewed executive compensation data reported in a nationally recognized independent compensation survey (the "Survey") for a group of companies in the Company's industry or similar industries and of comparable size and complexity. The Committee compared the base salary and bonus levels of the Survey group to the existing salary and bonus compensation of the Company's management. 5. The Committee views the 50th percentile of the Survey data as average compensation for comparable positions and believes it is the minimum level necessary for the Company to be competitive in attracting and retaining qualified executives in its industry and geographic locations. Therefore, since 1994 the base salaries for the Chief Executive Officer and the four other highest paid executive officers have been established at 27 approximately the 50th percentile for comparable positions in the Survey companies. In 1997, the Committee approved setting each executive's total cash compensation at approximately the median for the comparable position in the benchmark population of companies included in the Survey. As a result, the Committee approved no increase in salary for Mr. Kessman or any of the four other highest paid executive officers except one officer who was initially elected as an executive officer in 1997. 6. Merit increases in base salary for executives other than Mr. Kessman have been reviewed on an individual basis by Mr. Kessman and increases are dependent upon a favorable evaluation by Mr. Kessman of individual executive performance relative to individual goals, the functioning of the executive's team within the corporate structure, success in furthering the corporate strategy and goals, and individual management skills. Based upon his evaluation, Mr. Kessman recommends base salary increases to the Committee for its approval. 7. In addition to base salary and merit increases, the Compensation Committee considers incentive bonuses for its executive officers, including the Chief Executive Officer, both prospectively based upon the attainment of specific performance goals, and retrospectively based upon the Committee's discretionary judgment as to the performance during the year of the Company and its executive officers or other considerations deemed appropriate at the time. To establish 1997 bonus potential for executive officers, including the Chief Executive Officer, the Compensation Committee reviewed recommendations by the Chief Executive Officer based on data provided by the Survey. The Committee provided that each officer would be eligible for a bonus equal to a percentage of his or her salary consistent with the Survey data if certain pre-established 1997 pretax income targets or goals were achieved by the Company. Partial achievement of the pretax income goals (above 74% attainment) would result in partial bonus payments. The Committee also approved bonus eligibility for division presidents that would be based on division performance without regard to overall corporate performance. In 1997, the pretax income from operations for the year was below the applicable threshold. Therefore, the Committee approved no bonus payments to Mr. Kessman or any of the four other highest paid executive officers for 1997 except bonuses paid to one of the four other highest paid executive officers based on his division's performance. The Committee reserves the right to make discretionary bonus awards in appropriate circumstances where an executive might merit a bonus based on other considerations. 8. All executives, including the Chief Executive Officer, are eligible for annual stock option grants under the employee stock option plans applicable to employees generally, as approved by the Compensation Committee. The number of options granted to any individual depends on individual performance, salary level and competitive data. In addition, in determining the number of stock options granted to each senior executive, the Compensation Committee reviews the unvested options of each executive to determine the future benefits potentially available to the executive. The number of options granted will depend in part on the total number of unvested options deemed necessary to create a long-term incentive on the part of the executive to remain with the Company in order to realize future benefits. No options were granted in 1997 to Mr. Kessman or the four highest paid other executive officers. 9. In December 1997, the Board of Directors on the recommendation of the Committee approved certain modifications and waivers under the 1994 Executive Stock Incentive Plan. The Board of Directors approved the extension of the participant loans and the 28 Company's guarantee of those loans from August 1999 until December 2001, subject to the approval of the lending bank, and deferred the interest payment (15% of the bank interest accrued in 1997) that would have otherwise been due from each participant to the Company in January 1998. The Board of Directors also decided to waive restrictions in the Plan to allow participants to sell a portion or all of their Plan stock in 1998, subject to applicable legal requirements and to repayment of the loan with the proceeds of the shares sold. In conclusion, the Compensation Committee believes that the base salary, bonus and stock options of the Company's Chief Executive Officer and other executives are appropriate in light of competitive pay practices and the Company's performance against short and long-term performance goals. LOUIS K. ADLER RICHARD ROSENBLOOM JERRY SESLOWE PERFORMANCE GRAPH The graph below compares, for the last five fiscal years, the yearly percentage change in cumulative total returns (assuming reinvestment of dividends and interest) of (i) the Company's Common Stock, (ii) the Company's Debentures, (iii) the NASDAQ Stock Market and (iv) a peer group index constructed by the Company (the "Peer Group"). The Peer Group consists of the following companies: Aspect Telecommunications Corp. Inter-Tel, Inc. Boston Technology, Inc. InterVoice, Inc. Brite Voice Systems, Inc. Microlog Corporation Centigram Communications Corp. Mitel Corporation Comdial Corporation Mosaix Davox Corporation Norstan, Inc. Digital Sound Corporation Syntellect, Inc. Electronic Information Systems, Inc. Teknekron Communications Systems, Inc.(TCSI) The Peer Group includes companies who compete with the Company in the general voice communications equipment area as well as those active in several more specialized areas, such as ACD (automatic call distribution), voice mail, interactive voice response systems, and predictive dialing systems, as well as additional general voice communications companies. The Company believes that the mix of the companies in the Peer Group accurately reflects the mix of businesses in which the Company is currently engaged and will be engaged in the foreseeable future. The Peer Group is not identical to the Survey group used to evaluate compensation of executives described in the Compensation Committee Report. The Peer Group above does not provide sufficient compensation data for the Committee's purposes, and the Survey group includes non-public entities for whom stock price data for the performance graph is unavailable. 29 Although AT&T and Nortel are the Company's principal competitors in supplying voice communications equipment, software and services to the under-300-desktop market, the business in which the Company is primarily engaged, both of those companies are much larger than the Company and derive most of their revenues from other lines of business and so have not been included in the Peer Group. The returns of each Peer Group issuer have been weighted in the graph below to reflect that issuer's stock market capitalization at the beginning of each calendar year. COMPARISON OF FIVE-YEAR CUMULATIVE RETURN AMONG EXECUTONE, INCLUDING THE COMMON STOCK ("XTON") AND THE DEBENTURES ("XTONG"), THE NASDAQ (US) INDEX AND THE COMPANY'S PEER GROUP
WEIGHTED AVERAGE CUMULATIVE TOTAL RETURNS 1992 1993 1994 1995 1996 1997 XTON $100 $159 $179 $128 $131 $121 NASDAQ $100 $115 $112 $159 $195 $240 PEER GROUP $100 $190 $179 $252 $327 $306 XTONG $100 $138 $137 $160 $178 $198
[PERFORMANCE GRAPH] COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The members of the Compensation Committee are Louis K. Adler, Richard Rosenbloom and Jerry Seslowe. No member of the Committee is a former or current officer or employee of the Company or any subsidiary. No executive officer of the Company served as a director or a member of the Compensation Committee or of the equivalent body of any entity, any one of whose executive officers serve on the Compensation Committee or the Board of Directors of the Company. 30 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table lists any person (including any "group" as that term is used in Section 13(d)(3) of the Exchange Act) who, to the knowledge of the Company, was the beneficial owner as of February 28, 1998, of more than 5% of the outstanding voting shares of the Company. Unless otherwise noted, the owner has sole voting and dispositive power with respect to the securities.
Name and Address of Amount and Nature of Title of Class Beneficial Owner Beneficial Ownership Percent of Class(1) Common Stock Heartland Advisors, Inc. 9,213,455(2) 18.60% 790 North Milwaukee Street Milwaukee, WI 53202 Entities Associated with 3,245,078(3) 6.56 Edmund H., Shea, Jr. 655 Brea Canyon Road Walnut Creek, CA 91789 Series A Stock Cooper Life Sciences 78,819 31.53 160 Broadway New York, NY 10038 Watertone Holdings, L.P. 154,160 61.81 and Watertone Investments L.L.C. 730 Fifth Avenue New York, NY 10038 Series B Stock Cooper Life Sciences 31,528 31.53 160 Broadway New York, NY 10038 Watertone Holdings, L.P. 61,807 61.81 and Watertone Investments L.L.C. 730 Fifth Avenue New York, NY 10038
(1) With respect to the Common Stock, percentages shown are based upon 49,716,084 shares of Common Stock actually outstanding as of February 28, 1998. In cases where the beneficial ownership of the individual or group includes options, warrants or convertible securities, the percentage is based on 49,716,084 shares actually outstanding, plus the number of shares issuable upon exercise or conversion of any such options, warrants or convertible securities held by the individual or group. The percentage does not reflect or assume the exercise or conversion of any options, 31 warrants or convertible securities not owned by the individual or group in question. In the case of the Series A and Series B Preferred Stock, percentages shown are based on 250,000 and 100,000 shares, respectively, actually outstanding as of February 28, 1998. (2) Heartland Advisors shares power to vote 625,000 of such shares. (3) Includes 11,935 shares of Common Stock issuable upon conversion of the Company's Debentures, of which entities associated with Mr. Shea own $148,800 in principal amount, representing less than 1% of the outstanding principal amount. The Shea entities share the power to vote and dispose of all such shares. The following table sets forth as of February 28, 1998, the beneficial ownership of the Company's voting shares by all current directors and nominees of the Company, the Chief Executive Officer, and the four next most highly compensated executive officers and all directors and executive officers of the Company as a group. Unless otherwise indicated, each person listed below has sole voting and investment power over all shares beneficially owned by him or her.
Name of Amount and Nature of Title of Class Beneficial Owner Beneficial Ownership Percentage of Class (1) Common Stock Louis K. Adler 138,123(2) Stanley M. Blau 543,193 1.05 Alan Kessman 1,737,337(3) 3.35 Andrew Kontomerkos 463,284(4) * Thurston R. Moore 135,235(5) * Vic Northrup 127,537(6) * Richard S. Rosenbloom 76,900(7) * Jerry M. Seslowe 209,615(8) * Shlomo Shur 740,708(9) 1.43 Michael W. Yacenda 990,360(10) 1.91 All Directors and 6,349,422(11) 12.25 Officers as a Group (17 Persons) Series A Stock Louis K. Adler 1,436 * Stanley M. Blau -0- Alan Kessman -0- Andrew Kontomerkos -0- Thurston R. Moore -0- Vic Northrup -0- Richard S. Rosenbloom -0- Jerry M. Seslowe 4,692(12) 1.87 Shlomo Shur -0- Michael W. Yacenda -0- All Directors and 6,128 2.45 Officers as a Group (17 Persons)
32 Series B Stock Louis K. Adler 575 * Stanley M. Blau -0- ...........................Alan Kessman -0- Andrew Kontomerkos -0- Thurston R. Moore -0- Vic Northrup -0- Richard S. Rosenbloom -0- Jerry M. Seslowe 1,877(13) 1.87 Shlomo Shur -0- Michael W. Yacenda -0- All Directors and 2,452 2.45 Officers as a Group (17 Persons)
* Less than 1%. (1) With respect to the Common Stock, percentages shown are based upon 49,716,084 shares of Common Stock actually outstanding as of February 28, 1998. In cases where the beneficial ownership of the individual or group includes options, warrants or convertible securities, the percentage is based on 49,716,084 shares actually outstanding, plus the number of shares issuable upon exercise or conversion of any such options, warrants or convertible securities held by the individual or group. The percentage does not reflect or assume the exercise or conversion of any options, warrants or convertible securities not owned by the individual or group in question. In the case of the Series A and Series B Preferred Stock, percentages shown are based on 250,000 and 100,000 shares, respectively, actually outstanding as of February 28, 1998. (2) Includes 83,615 shares issuable upon exercise of options and 25,000 shares issuable upon exercise of warrants, 91,918 of which are exercisable within 60 days of June 1, 1998. Does not include 76,445 shares of Common Stock contingently issuable upon conversion of the Preferred Stock owned by Mr. Adler. (3) Includes 25,000 shares subject to options exercisable within 60 days of June 1, 1998. (4) Includes 20,000 shares subject to options exercisable within 60 days of June 1, 1998. (5) Includes 48,900 shares subject to options exercisable within 60 days of June 1, 1998. (6) Includes 56,494 shares subject to options, of which 34,108 are exercisable within 60 days of June 1, 1998. (7) Includes 48,900 shares subject to options exercisable within 60 days of June 1, 1998. (8) Includes 51,612 shares subject to options, all of which are exercisable, and 25,000 shares subject to warrants, 16,666 of which are exercisable within 60 days of June 1, 1998. Also includes 12,755 shares of Common Stock owned and 63,559 shares of Common Stock subject to exercisable options held by Resource Holdings Associates, of which Mr. Seslowe is a managing director and in which he holds a greater than 10% ownership interest. Does not include 203,756 shares of Common Stock contingently issuable upon conversion of the Preferred Stock owned by Mr. Seslowe or the 45,875 shares of Common Stock contingently issuable upon conversion of the Preferred Stock owned by Resource Holdings Associates. 33 (9) Includes 25,000 shares subject to options exercisable within 60 days of June 1, 1998. (10) Includes 32,000 shares subject to options exercisable within 60 days of June 1, 1998 and 3,576 shares issuable upon conversion of the Company's Debentures, of which Mr. Yacenda beneficially owns $38,000 in principal amount or less than 1% of the outstanding principal amount. (11) Includes 903,742 shares subject to options, and 50,000 shares subject to warrants, of which 462,327 and 16,666, respectively, are exercisable within 60 days of June 1, 1998, and 45,176 shares issuable upon conversion of the Company's Debentures. (12) Includes 862 shares held by Resource Holdings. (13) Includes 345 shares held by Resource Holdings. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In connection with the Company's acquisition of Unistar Gaming, in 1995 and 1996 the Company paid Resource Holdings Ltd, a former shareholder of Unistar Gaming, accrued investment banking fees incurred by Unistar Gaming prior to the acquisition of $105,000, and total finder's fees of $320,000 based on the value of the transaction. Mr. Seslowe was elected a director of the Company in 1996 as a nominee of the holders of the Preferred Stock.. Both Resource Holdings and Mr. Seslowe acquired Common Stock and Preferred Stock of the Company in exchange for their shares of Unistar Gaming. Mr. Seslowe is a managing director of and owns more than 10% of Resource Holdings. The Company's management believes that the transactions with Resource Holdings were on terms as favorable to the Company as could be expected from unaffiliated third parties. The 1994 Executive Stock Incentive Plan (the "Executive Plan"), approved by shareholders at the 1994 Annual Meeting, was implemented in October 1994 with 30 employees participating. Under the terms of the Executive Plan, eligible key employees were granted the right to purchase shares of the Company's Common Stock at the market price, which was $3.1875 per share at the time of purchase. Participating employees financed the purchases of these shares through loans by the Company's bank lender at the prime rate less 1/4%, payable over five years. The loans are fully-recourse to the participating employees but are guaranteed by letters of credit from the Company to the lending bank. The Company lends the employee 85% of the interest due to the bank. The Company holds the purchased Common Stock as security for its guarantees of the repayment of the loans. Sales of the shares purchased under the Plan are subject to certain restrictions. In December 1997, the Compensation Committee of the Board of Directors of the Company agreed, subject to the Company obtaining the agreement of the lending bank, that it would allow the participant loans to remain outstanding until December 2001 instead of requiring repayment in August 1999, and that it would defer collection from each participant of the 15% of the 1997 interest on the loans that would otherwise have been currently payable to the Company. The Committee also decided to waive certain restrictions in the Plan to allow participants to sell a portion or all of their Plan stock in 1998, subject to applicable legal requirements and to repayment of the loan with the proceeds of the shares sold. 34 The following table contains information about borrowings in excess of $60,000 by executive officers that were outstanding during 1997 pursuant to the Executive Plan and that are guaranteed by the Company. The amounts listed below also include the interest paid by the Company to the bank, reimbursement of which is owed by the individual to the Company. No director, nominee, or beneficial owner of more than 5% of any class of voting securities is eligible for participation in the Executive Plan.
HIGHEST AMOUNT OF UNPAID INDEBTEDNESS BETWEEN INDEBTEDNESS JANUARY 1, 1997 AND MARCH 31, 1998, AT MARCH 31, 1998 INCLUDING INCLUDING NAME ACCRUED INTEREST ACCRUED INTEREST - ---- ----------------------------------- ----------------- Alan Kessman $2,382,242 $2,353,992 Michael W. Yacenda 1,389,641 1,389,641 Shlomo Shur 694,821 694,821 Andrew Kontomerkos 694,821 694,821 Barbara C. Anderson 322,490 243,758 James E. Cooke III 397,040 397,040 Anthony R. Guarascio 555,857 555,857 Israel J. Hersh 119,112 119,112 Robert W. Hopwood 396,420 396,420 Vic Northrup 280,209 280,209 Frank J. Rotatori 238,224 238,224
35 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1), (a)(2) and (d). The financial statements required by this item and incorporated herein by reference are as follows: Report of Independent Public Accountants Consolidated Balance Sheets - December 31, 1997 and 1996 Consolidated Statements of Operations - Years ended December 31, 1997, 1996 and 1995 Consolidated Statements of Changes in Stockholders' Equity - Three years ended December 31, 1997 Consolidated Statements of Cash Flows - Years ended December 31, 1997, 1996 and 1995 Notes to Consolidated Financial Statements The schedule to consolidated financial statements required by this item and included in this report is as follows: Report of Independent Public Accountants on Schedule Schedule II - Valuation and Qualifying Accounts (a)(3) and (c). The exhibits required by this item and included in this report or incorporated herein by reference are as follows: Exhibit No. 2-1 Agreement and Plan of Merger by and among EXECUTONE Information Systems, Inc., Executone Newco, Inc., and Unistar Gaming Corp., dated as of December 19, 1995. Incorporated by reference to the Registrant's Current Report on Form 8-K dated January 3, 1996. 2-2 Asset Purchase Agreement among V Technology Acquisition Corporation, EXECUTONE Information Systems, Inc. and Vodavi, Inc. dated November 5, 1993, and Amendment dated February 18, 1994. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993. 2-3 Asset Purchase Agreement by and among Tone Holdings, Inc. and Tone Acquisition Corporation, EXECUTONE Network Services, Inc. and EXECUTONE Information Systems, Inc. dated as of April 9, 1996, and Amendment No. 1 to 36 Asset Purchase Agreement dated as of May 31, 1996, by and among Clarity Telecom Holdings, Inc. (formerly known as Tone Holdings, Inc.), Clarity Telecom, Inc. (formerly known as Tone Acquisition Corporation), EXECUTONE Network Services, Inc. and EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K/A for the year ended December 31, 1995 filed on June 4, 1996. 3-1 Articles of Incorporation, as amended through December 18, 1995. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995 filed on April 15, 1996. 3-2 Articles of Amendment dated and filed December 19, 1995, amending the Company's Articles of Incorporation. Incorporated by reference to the Registrant's Current Report on Form 8-K dated January 3, 1996. 3-3 Bylaws, as amended. Incorporated by reference to the Registrant's Registration Statement on Form S-3 (File No. 33-62257) filed August 30, 1995. 4-1 Revolving Credit Agreement dated as of October 31, 1997 between the Registrant and Bank Of America National Trust And Savings Association. Filed herewith. 4-2 Amended and Restated Loan Agreement dated as of July 22, 1996, between EXECUTONE Information Systems, Inc., certain employees thereof, and the Lenders named therein. Filed herewith. 4-10 Indenture dated March 1, 1986 with United States Trust Company of New York relating to 7 1/2% Convertible Subordinated Debentures of Vodavi Technology Corporation due March 15, 2011. Incorporated by reference to Vodavi Technology Corporation's Registration Statement on Form S-1 (as amended) (Registration No. 33-3827) filed on March 9, 1986 and amended April 1, 1986. 4-11 First Supplemental Indenture dated August 4, 1989 with United States Trust Company of New York relating to 7 1/2% Convertible Subordinated Debentures due March 15, 2011. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 4-12 Specimen Certificate representing 7 1/2% Convertible Subordinated Debentures. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 10-1 1984 Employee Stock Purchase Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 33-23294) declared effective by the Commission on August 23, 1988. 10-2 1986 Stock Option Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 33-23294) declared effective by the Commission on August 23, 1988. 10-3 1984 Stock Option Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-5 Stock Option Bonus Credit Plan of EXECUTONE Information Systems, Inc. dated 37 December 31, 1988. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 10-6 1990 Directors' Stock Option Plan as amended July 30, 1996. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, filed on March 31, 1997. 10-7 1994 Executive Stock Incentive Plan. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994. 10-16 Manufacturing Services Agreement dated as of January 10, 1995, between EXECUTONE Information Systems, Inc. and Compania Dominicana de Telefonos, C por A (Codetel). Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995 filed on April 15, 1996. 10-17 Manufacturing Services Agreement dated February 9, 1990 between Wong's Electronics Co., Ltd. and EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-19 Warrant to Purchase 25,000 Shares of Common Stock of EXECUTONE Information Systems, Inc. in favor of Louis K. Adler dated July 29, 1997. Filed herewith. 10-20 Warrant to Purchase 25,000 Shares of Common Stock of the Registrant, in favor of Jerry M. Seslowe, dated February 1, 1996. Incorporated by reference to the Registrant's Annual Report on Form 10-K/A for the year ended December 31, 1996 filed on April 30, 1997. 10-21 Management Agreement for the National Indian Lottery dated January 16, 1995. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995 filed on April 15, 1996. 10-22 Amended and Restated Distributor Agreement dated as of April 1, 1998, between EXECUTONE Information Systems, Inc. and Claricom, Inc. d/b/a/ Executone Business Solutions (formerly Clarity Telecom, Inc.). (Confidential portions have been omitted and filed separately with the Commission pursuant to a request for confidential treatment.) Filed herewith. 11 Statement regarding computation of per share earnings. Filed herewith. Please see Note E to the Consolidated Financial Statements in the Registrant's 1997 Annual Report to Shareholders. 13 1997 Annual Report to Shareholders of EXECUTONE Information Systems, Inc. Filed herewith. 21 Subsidiaries of EXECUTONE Information Systems, Inc. Filed herewith. 23.1 Consent of Arthur Andersen LLP. Filed herewith. 23.2 Consent of Hunton & Williams. Filed herewith. 27 Financial Data Schedule. Filed herewith. 38 Undertakings For the purposes of complying with the rules governing Form S-8 under the Securities Act of 1933, the undersigned registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into registrant's Registration Statements on the following Form S-8 filings: S-8 Reg. No. 2-91008 filed May 9, 1984 on 1983 Employee Stock Purchase Plan (650,000 shares) S-8 Reg. No. 33-959 filed October 17, 1985 on 1984 Stock Option Plan (390,000 shares) S-8 Reg. No. 33-6604 filed June 19, 1986 on 1983 Stock Option Plan (350,000 shares) S-8 Reg. No. 33-16585 filed August 24, 1987 on 1986 and 1983 Stock Option Plans (800,000 shares) S-8 Reg. No. 33-23294 filed August 23, 1988 on 1986 Stock Option Plan (7,000,000 shares) and Employee Stock Purchase Plan (500,000 shares) S-8 Reg. No. 33-42561 filed September 4, 1991 on 1984 Employee Stock Purchase Plan (350,000 shares) and Directors' Stock Option Plan (100,000 shares) S-8 Reg. No. 33-45015 filed January 2, 1992 on 1984 Employee Stock Purchase Plan (400,000 shares) S-8 Reg. No. 33-57519 filed January 31, 1995 on 1984 Employee Stock Purchase Plan (1,000,000 shares). Insofar as indemnification arising under the Securities Act of 1933 (the "Act") may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to the court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. Reports on Form 8-K The Registrant filed no reports on Form 8-K during the quarter ended December 31, 1997. 39 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. EXECUTONE Information Systems, Inc. By: /s/ Alan Kessman ------------------------------------ Alan Kessman, Chairman, President and Chief Executive Officer April 14, 1998 Milford, Connecticut Pursuant to the requirements of the Securities and Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. April 14, 1998 /s/ Alan Kessman ------------------------------ Alan Kessman Chairman, President and Chief Executive Officer (Principal Executive Officer) April 14, 1998 /s/ Louis K. Adler ------------------------------ Louis K. Adler, Director April 14, 1998 /s/ Stanley M. Blau ------------------------------ Stanley M. Blau, Director April 14, 1998 /s/ Anthony R. Guarascio ------------------------------- Anthony R. Guarascio Vice President, Finance and Administration, and Chief Financial Officer (Principal Financial and Accounting Officer) April 14, 1998 /s/ Thurston R. Moore ------------------------------ Thurston R. Moore, Director April 14, 1998 /s/ Richard S. Rosenbloom ------------------------------ Richard S. Rosenbloom, Director April 14, 1998 /s/ Jerry M. Seslowe ------------------------------ Jerry M. Seslowe, Director
40 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders of EXECUTONE Information Systems, Inc.: We have audited in accordance with generally accepted auditing standards, the financial statements included in EXECUTONE Information Systems, Inc. and subsidiaries' annual report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 7, 1998. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in Item 14 is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Stamford, Connecticut February 7, 1998 S-1 SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS (Amounts in Thousands)
Additions Deductions ------------------------------------- ------------------------ Charged Charged Net Balance at (Credited) (Credited) Writeoffs of Balance at Beginning to Costs and to Other Uncollectible End of Description of Period Expenses Accounts Accounts Period -------------- ------------ ------------- ---------- ------------- ---------- Year ended December 31, 1997 Deducted from asset accounts: Allowance for doubtful accounts 2,106 150 --- (442) 1,814 Allowance for uncollectible notes receivable 2,216 127 --- --- 2,343 Year ended December 31, 1996 Deducted from asset accounts: Allowance for doubtful accounts $1,715 $1,921 $ (551)* $ (979) $2,106 Allowance for uncollectible notes receivable 259 (82) 2,039* --- 2,216 Year ended December 31, 1995 Deducted from asset accounts: Allowance for doubtful accounts 1,335 1,872 --- (1,492) 1,715 Allowance for uncollectible notes receivable 691 (432) --- --- 259
* Adjustments related to sale of direct sales organization. S-2 STATEMENT OF DIFFERENCES The trademark symbol shall be expressed as..................................'tm' The registered trademark symbol shall be expressed as....................... 'r' EXECUTONE INFORMATION SYSTEMS, INC. EXHIBITS TO 1997 ANNUAL REPORT ON FORM 10-K Exhibit No. - ----------- 2-1 Agreement and Plan of Merger by and among EXECUTONE Information Systems, Inc., Executone Newco, Inc., and Unistar Gaming Corp., dated as of December 19, 1995. Incorporated by reference to the Registrant's Current Report on Form 8-K dated January 3, 1996. 2-2 Asset Purchase Agreement among V Technology Acquisition Corporation, EXECUTONE Information Systems, Inc. and Vodavi, Inc. dated November 5, 1993, and Amendment dated February 18, 1994. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993. 2-3 Asset Purchase Agreement by and among Tone Holdings, Inc. and Tone Acquisition Corporation, EXECUTONE Network Services, Inc. and EXECUTONE Information Systems, Inc. dated as of April 9, 1996, and Amendment No. 1 to Asset Purchase Agreement dated as of May 31, 1996, by and among Clarity Telecom Holdings, Inc. (formerly known as Tone Holdings, Inc.), Clarity Telecom, Inc. (formerly known as Tone Acquisition Corporation), EXECUTONE Network Services, Inc. and EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K/A for the year ended December 31, 1995 filed on June 4, 1996. 3-1 Articles of Incorporation, as amended through December 18, 1995. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995 filed on April 15, 1996. 3-2 Articles of Amendment dated and filed December 19, 1995, amending the Company's Articles of Incorporation. Incorporated by reference to the Registrant's Current Report on Form 8-K dated January 3, 1996. 3-3 Bylaws, as amended. Incorporated by reference to the Registrant's Registration Statement on Form S-3 (File No. 33-62257) filed August 30, 1995. 4-1 Revolving Credit Agreement dated as of October 31, 1997 between the Registrant and Bank Of America National Trust And Savings Association. Filed herewith. 4-2 Amended and Restated Loan Agreement dated as of July 22, 1996, between EXECUTONE Information Systems, Inc., certain employees thereof, and the Lenders named therein. Filed herewith. 4-10 Indenture dated March 1, 1986 with United States Trust Company of New York relating to 7 1/2% Convertible Subordinated Debentures of Vodavi Technology Corporation due March 15, 2011. Incorporated by reference to Vodavi Technology Corporation's Registration Statement on Form S-1 (as amended) (Registration No. 33-3827) filed on March 9, 1986 and amended April 1, 1986. 4-11 First Supplemental Indenture dated August 4, 1989 with United States Trust Company of New York relating to 7 1/2% Convertible Subordinated Debentures due March 15, 2011. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 4-12 Specimen Certificate representing 7 1/2% Convertible Subordinated Debentures. Incorporated by E-3 reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 10-1 1984 Employee Stock Purchase Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 33-23294) declared effective by the Commission on August 23, 1988. 10-2 1986 Stock Option Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Registration Statement on Form S-8 (File No. 33-23294) declared effective by the Commission on August 23, 1988. 10-3 1984 Stock Option Plan of EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-5 Stock Option Bonus Credit Plan of EXECUTONE Information Systems, Inc. dated December 31, 1988. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. 10-6 1990 Directors' Stock Option Plan as amended July 30, 1996. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1996, filed on March 31, 1997. 10-7 1994 Executive Stock Incentive Plan. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1994. 10-16 Manufacturing Services Agreement dated as of January 10, 1995, between EXECUTONE Information Systems, Inc. and Compania Dominicana de Telefonos, C por A (Codetel). Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995 filed on April 15, 1996. 10-17 Manufacturing Services Agreement dated February 9, 1990 between Wong's Electronics Co., Ltd. and EXECUTONE Information Systems, Inc. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed on August 20, 1991. 10-19 Warrant to Purchase 25,000 Shares of Common Stock of EXECUTONE Information Systems, Inc. in favor of Louis K. Adler dated July 29, 1997. Filed herewith. 10-20 Warrant to Purchase 25,000 Shares of Common Stock of the Registrant, in favor of Jerry M. Seslowe, dated February 1, 1996. Incorporated by reference to the Registrant's Annual Report on Form 10-K/A for the year ended December 31, 1996 filed on April 30, 1997. 10-21 Management Agreement for the National Indian Lottery dated January 16,1995. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1995 filed on April 15, 1996. 10-22 Amended and Restated Distributor Agreement dated as of April 1, 1998, between EXECUTONE Information Systems, Inc. and Claricom, Inc. d/b/a/ Executone Business Solutions (formerly Clarity Telecom, Inc.). (Confidential portions have been omitted and filed separately with the Commission pursuant to a request for confidential treatment.) Filed herewith. 11 Statement regarding computation of per share earnings. Filed herewith. Please see Note E to the Consolidated Financial Statements in the Registrant's 1997 Annual Report to Shareholders. E-3 13 1997 Annual Report to Shareholders of EXECUTONE Information Systems, Inc. Filed herewith. 21 Subsidiaries of EXECUTONE Information Systems, Inc. Filed herewith. 23.1 Consent of Arthur Andersen LLP. Filed herewith. 23.2 Consent of Hunton & Williams. Filed herewith. 27 Financial Data Schedule. Filed herewith. E-3 EX-4 2 EXHIBIT 4.1 EXHIBIT 4.1 REVOLVING CREDIT AGREEMENT DATED AS OF OCTOBER 31, 1997 BETWEEN EXECUTONE INFORMATION SYSTEMS, INC. AND BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION TABLE OF CONTENTS
Page ---- ARTICLE I DEFINITIONS, INTERPRETATION OF AGREEMENT AND COMPLIANCE WITH FINANCIAL RESTRICTIONS.................................... 1 1.1 Definitions..................................................... 1 "Agreement"................................................ 1 "Applicable Percentage".................................... 1 "Authorized Officer"....................................... 3 "Bank"..................................................... 3 "Banking Day".............................................. 3 "Breakage Date"............................................ 3 "Capitalized Lease"........................................ 3 "Code"..................................................... 3 "Commitment"............................................... 3 "Company".................................................. 3 "Consolidated Net Worth"................................... 3 "Credit"................................................... 4 "Disbursement Date"........................................ 4 "Dollars".................................................. 4 "EBITDA"................................................... 4 "Environmental Laws"....................................... 4 "ERISA".................................................... 4 "ERISA Affiliate".......................................... 4 "Eurocurrency Reserve Requirement"......................... 5 "Eurodollar Loan".......................................... 5 "Event of Default"......................................... 5 "Federal Funds Effective Rate"............................. 5 "Federal Reserve Board".................................... 5 "Fiscal Quarter"........................................... 5 "Fiscal Year".............................................. 6 "GAAP"..................................................... 6 "Hazard Materials"......................................... 6 "Indebtedness"............................................. 6 "Interbank Rate"........................................... 6 "Interest Period".......................................... 7 "Investment"............................................... 7 "Issuance Request"......................................... 7 "Letter of Credit"......................................... 7 "Letter of Credit Availability"............................ 7 "Letter of Credit Outstandings"............................ 8 "Liabilities".............................................. 8 "Lien"..................................................... 8 "Loan"..................................................... 8 "Occupational Safety and Health Law"....................... 8 "Note"..................................................... 8 "Payment Date"............................................. 8 "PBGC"..................................................... 9 "Person"................................................... 9 "Plan"..................................................... 9
(i)
Page ---- "Rate Hedging Obligations"................................ 9 "Reference Rate".......................................... 9 "Reference Rate Loan"..................................... 9 "Reimbursement Obligations"............................... 9 "Related Party"........................................... 9 "Reportable Event"........................................ 10 "Senior Funded Debt"...................................... 10 "Senior Funded Debt Cash Flow Ratio"...................... 10 "Stated Expiry Date"...................................... 10 "Subsidiary".............................................. 10 "Taxes"................................................... 10 "Termination Date......................................... 10 "Trade Accounts Payable".................................. 10 "Unmatured Event of Default".............................. 10 1.2 Other Definitional Provisions................... 10 1.3 Interpretation of Agreement..................... 11 1.4 Compliance with Financial Restrictions.......... 11 ARTICLE II COMMITMENT OF THE BANK; CERTAIN LOAN TERMS; LETTERS OF CREDIT................................................ 11 2.1 Loans..................................................... 11 2.2 Loan Options.............................................. 11 2.3 Borrowing Procedures...................................... 11 2.4 Continuation and/or Conversion of Loans................... 12 2.5 Note Evidencing Loans..................................... 12 2.6 Funding Losses............................................ 12 2.7 Capital Adequacy.......................................... 13 2.8 Letters of Credit......................................... 14 (a) Requests.............................................. 14 (b) Issuances............................................. 14 (c) Fees and Expenses..................................... 15 (d) Disbursements......................................... 15 (e) Reimbursement......................................... 15 (f) Deemed Disbursements.................................. 16 (g) Nature of Reimbursement Obligations................... 17 (h) Increased Costs; Indemnity............................ 17 (i) Termination Date...................................... 18 ARTICLE III INTEREST AND FEES..................................................... 18 3.1 Interest.................................................. 18 (a) Reference Rate Loans.................................. 18 (b) Eurodollar Loans...................................... 18 (c) Interest After Maturity............................... 19 3.2 Nonuse Fee................................................ 19
Page ---- 3.3 Closing Fee.................................................. 19 3.4 Method of Calculating Interest and Fees...................... 19 ARTICLE IV PAYMENTS, PREPAYMENTS, REDUCTION OR TERMINATION OF THE CREDIT.... 19 4.1 Place of Payment............................................ 19 4.2 Prepayments................................................. 20 4.3 Setoff...................................................... 20 ARTICLE V ADDITIONAL PROVISIONS RELATING TO EURODOLLAR LOANS ................................................ 21 5.1 Increased Cost ............................................. 21 5.2 Deposits Unavailable or Interest Rate Unascertainable or Inadequate; Impracticability ........................... 21 5.3 Changes in Law Rendering Eurodollar Loans Unlawful.......... 22 5.4 Funding .................................................... 23(a) (a) Discretion of the Bank as to Manner of Funding.............. 23(b) (b) Funding Through the Sale of Participations.................. 23 ARTICLE VI REPRESENTATIONS AND WARRANTIES................................... 23 6.1 Existence .................................................. 23 6.2 Authorization............................................... 23 6.3 No Conflicts................................................ 24 6.4 Validity and Binding Effect................................. 24 6.5 No Default.................................................. 24 6.6 Financial Statements........................................ 24 6.7 Litigation.................................................. 24 6.8 Liens....................................................... 25 6.9 Subsidiaries................................................ 25 6.10 Partnerships................................................ 25 6.11 Purpose..................................................... 25 6.12 Regulation U................................................ 26 6.13 Compliance.................................................. 26 6.14 Pension and Welfare Plans................................... 26 6.15 Taxes ...................................................... 26 6.16 Investment Company Act Representation....................... 26 6.17 Public Utility Holding Company Act Representation........... 26 6.18 Environmental and Safety and Health Matters................. 26 6.19 Insurance .................................................. 27 6.20 Contracts; Labor Matters.................................... 27 6.21 Accuracy of Information..................................... 28
(iii)
Page ---- 6.22 Title to Properties......................................... 28 ARTICLE VII COMPANY'S COVENANTS ............. .............................. 28 7.1 Financial Statements and Other Reports..................... 28 (a) Annual Audit Report................................... 28 (b) Quarterly Financial Statement........................ 29 (c) Officer's Certificate................................. 29 (e) Report of Change in Subsidiaries or Partnerships...... 29 (f) Requested Information................................. 30 7.2 Notices ................................................... 30 (a) Default............................................... 30 (b) Litigation............................................ 30 (c) Pension and Welfare Plans............................. 30 (d) Material Adverse Change............................... 30 (e) Other Events.......................................... 30 7.3 Existence ................................................. 30 7.4 Nature of Business......................................... 30 7.5 Books, Records and Access.................................. 30 7.6 Insurance ................................................. 31 7.7 Repair .................................................... 31 7.8 Taxes ..................................................... 31 7.9 Compliance................................................. 31 7.10 Pension Plans.............................................. 31 7.11 Merger, Purchase and Sale.................................. 31 7.12 Consolidated Net Worth..................................... 32 7.13 Capital Expenditures....................................... 32 7.14 Maintenance of Minimum Liquidity........................... 32 7.15 Senior Funded Debt Cash Flow Ratio......................... 33 7.16 Capitalized Leases......................................... 33 7.17 Liens...................................................... 33 7.18 Indebtedness............................................... 33 7.19 Other Agreements........................................... 34 7.20 Use of Proceeds............................................ 34 7.21 Transactions With Related Parties.......................... 34 7.22 Hostile Acquisitions....................................... 34 ARTICLE VIII CONDITIONS PRECEDENT TO ALL LOANS .................................... 34 8.1 Notice....................................................... 34 8.2 Default...................................................... 34 8.3 Warranties................................................... 34 8.4 Certification................................................ 35 ARTICLE IX
(iv)
Page ---- CONDITION PRECEDENT TO INITIAL LOAN................................... 35 9.1 Note ...................................................... 35 9.2 Resolutions................................................ 35 9.3 Incumbency Certificate..................................... 35 9.4 Opinion ................................................... 35 9.5 Good Standing ............................................. 35 ARTICLE X EVENTS OF DEFAULT AND REMEDIES .................................. 35 10.1 Events of Default.......................................... 35 (a) Non-Payment ........................................... 36 (b) Non-Payment of Other Indebtedness...................... 36 (c) Acceleration of Other Indebtedness..................... 36 (d) Other Obligations...................................... 36 (e) Insolvency ............................................ 36 (f) Pension Plans.......................................... 37 (g) Agreements ............................................ 37 (h) Other Agreements....................................... 37 (i) Warranty .............................................. 37 (j) Litigation ............................................ 37 10.2 Remedies................................................... 38 ARTICLE XI GENERAL......... ................................................ 38 11.1 Waiver and Amendments....................................... 38 11.2 Notices..................................................... 38 11.3 Expenses ................................................... 39 11.4 Information................................................. 39 11.5 Severability................................................ 39 11.6 Law ........................................................ 40 11.7 Successors.................................................. 40 11.8 WAIVER OF JURY TRIAL; WAIVER OF CONSEQUENTIAL DAMAGES....... 40 11.9 CONSENT TO JURISDICTION..................................... 40 11.10 COUNTERPARTS .............................................. 40
(v) EXHIBIT A -Note EXHIBIT B -Schedule of Litigation EXHIBIT C -Schedule of Liens EXHIBIT D -Schedule of Subsidiaries EXHIBIT E -Schedule of Partnerships and Joint Ventures EXHIBIT F -Opinion of Counsel (vi) REVOLVING CREDIT AGREEMENT THIS AGREEMENT, dated as of October 31, 1997, is entered into between EXECUTONE INFORMATION SYSTEMS, INC., a Virginia corporation (the "Company"), and BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION, a national banking corporation, having its principal office at 231 South LaSalle Street, Chicago, Illinois 60697 (the "Bank"). W I T N E S S E T H : WHEREAS, the Company has requested the Bank to make available to the Company a revolving line of credit for loans in an aggregate amount not to exceed $35,000,000 which extensions of credit the Company will use for its working capital needs and general business purposes; NOW, THEREFORE, in consideration of the mutual agreements herein contained, the parties hereto agree as follows: ARTICLE I DEFINITIONS, INTERPRETATION OF AGREEMENT AND COMPLIANCE WITH FINANCIAL RESTRICTIONS 1.1 Definitions. In addition to the terms defined elsewhere in this Agreement, the following terms shall have the meanings indicated for purposes of this Agreement (such meanings to be equally applicable to both the singular and plural forms of the terms defined): "Agreement" means this Revolving Credit Agreement, as it may be amended, modified or supplemented from time to time. "Applicable Percentage" means at any time of determination, with respect to Eurodollar Loans or Reference Rate Loans, the applicable percentage set forth below based on the Senior Funded Debt Cash Flow Ratio for the company at such time: -1-
- ------------------------------------------------------------------------------------------------------- Level Senior Funded Debt Cash Eurodollar Loans Reference Rate Flow Ratio Percentage Loan Percentage - ------------------------------------------------------------------------------------------------------- 1 Less than or equal to 1.00x 1.75% 0% - ------------------------------------------------------------------------------------------------------- 2 More than 1.00x but less than or equal to 2.00x 2.25% 0% - ------------------------------------------------------------------------------------------------------- 3 More than 2.00x but less than or equal to 3.00x 2.50% 0.5% - ------------------------------------------------------------------------------------------------------- 4 More than 3.00x but less than or equal to 3.50x 2.75% 0.75% - -------------------------------------------------------------------------------------------------------
For purposes of the foregoing, (a) from the closing date of this Agreement until November 20, 1997, the Applicable Percentages shall be determined in accordance with Level 2, (b) from and after such date, the Applicable Percentages shall be determined at any time by reference to the Senior Funded Debt Cash Flow Ratio in effect at the time, (c) any change in the Applicable Percentages based on a change in such Ratio shall be effective for all purposes five (5) days from delivery to the Bank of an Officer's Certificate of the Company with respect to the financial statements to be delivered pursuant to Section 7.1, (i) setting forth in reasonable detail the calculation of such Ratio for such fiscal period and (ii) stating that the signer has reviewed the terms of this Agreement and has made, or caused to be made under his or her supervision, a review in reasonable detail of the transactions and condition of the Company and its Subsidiaries during the accounting period covered by the related financial statements and that such review has not disclosed the existence during or at the end of such accounting period, and that the signer does not have knowledge of the existence as at the date of such Officer's Certificate, of any condition or event that constitutes an Unmatured Event of Default or an Event of Default and (d) notwithstanding the foregoing provisions of clauses (b) and (c), no reduction in the Applicable Percentages shall be effective if any Unmatured Event of Default or Event of Default shall have occurred and be continuing. It is understood that the foregoing Officer's Certificate shall be permitted to be delivered prior to, but in no event later than, the time of the actual delivery of the financial statements required to be delivered pursuant to Section 7.1 for the applicable fiscal period. Any change in the Applicable Percentages due to a change in the applicable Level shall be effective on the effective date of such change in the applicable Level and shall apply to all Eurodollar Rate Loans made on or after the commencement of the period (and to Reference Rate Loans that are outstanding at any time during the period) commencing on the effective date of such change in the applicable Level and ending on the date -2- immediately preceding the effective date of the next such change in applicable Level. "Authorized Officer" means any officer or employee of the Company designated by the Company from time to time in a schedule, which schedule shall become effective when received by the Bank. "Bank" -- see Preamble. "Banking Day" means any day other than a Saturday, Sunday or legal holiday on which banks are authorized or required to be closed in Chicago, Illinois and, with respect to Eurodollar Loans, a day on which dealings in Dollars may be carried on by the Bank in the interbank eurodollar market. "Breakage Date", is defined in Section 2.6. "Capital Expenditures" shall mean with respect to any Person, for any period, the aggregate of all expenditures (whether paid in cash or accrued as liabilities) during that period and including that portion of Capitalized Leases that is capitalized on the balance sheet of such Person by such Person during such period that, in conformity with GAAP, are required to be included in or reflected by the property, plant or equipment or similar fixed asset accounts reflected in the combined and consolidated balance sheet of such Person (including equipment which is purchased simultaneously with the trade-in of existing equipment owned by such Person to the extent of the gross amount of such purchase price less the book value of the equipment being traded in at such time), but excluding expenditures made in connection with the replacement or restoration of assets, to the extent reimbursed or financed from insurance proceeds paid on account of the loss of or damage to the assets being replaced or restored, or from awards of compensation arising from the taking by condemnation or eminent domain of such assets being replaced. "Capitalized Lease" means any lease which is or should be capitalized on the balance sheet of the lessee in accordance with GAAP. "Code" means the Internal Revenue Code of 1986 and any successor statute of similar import, together with the regulations thereunder, in each case as in effect from time to time. References to sections of the Code shall be construed to also refer to any successor sections. "Commitment" means $35,000,000. "Company" -- see Preamble. "Consolidated Net Worth" means, at any time, the total of shareholders, equity (including capital stock, additional paid-in -3- capital and retained earnings after deducting treasury stock) of the Company and its consolidated Subsidiaries calculated in accordance with GAAP. "Credit" means the Bank's commitment to make Loans under the terms of this Agreement. "Disbursement Date" is defined in Section 2.8(d). "Dollars" and the symbol "$" mean lawful money of the United States of America. "EBITDA" means for any period of determination, the Company's net earnings (or loss) after provision for taxes plus cash charges against income for foreign, federal and state income taxes for such period plus depreciation and amortization expenses for such period, plus the Company's aggregate interest expense for such period, plus any extraordinary losses arising outside of the ordinary course of business during such period which have been included in the calculation of net earnings, minus extraordinary gains arising outside the ordinary course of business during such period which have been included in the calculation of net earnings. "Environmental Laws" means the Resource Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation and Liability Act, any so-called "Superfund" or "Superlien" law, the Toxic Substances Control Act, the Hazardous Materials Transportation Act, the Federal Water Pollution Control Act, the Federal Insecticide, Fungicide and Rodenticide Act, and the Clean Air Act and any other federal, state or local statute, law, ordinance, code, rule, regulation, order or decree or other requirement regulating, relating to, or imposing liability or standards of conduct (including, but not limited to, permit requirements, and emission or effluent restrictions) concerning any Hazardous Materials or any hazardous, toxic or dangerous waste, substance or constituent, or any pollutant or contaminant or other substance, whether solid, liquid or gas, as now or at any time hereafter in effect. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended, and any successor statute of similar import, together with the regulations thereunder, in each case as in effect from time to time. References to sections of ERISA shall be construed to also refer to any successor sections. "ERISA Affiliate" means any corporation, trade or business that is, along with the Company, a member of a controlled group of corporations or a controlled group of trades or businesses, as described in sections 414(b) and 414(c), respectively, of the Code or Section 4001 of ERISA. -4- "Eurocurrency Reserve Requirement" means, with respect to any Eurodollar Loan for any Interest Period, a percentage equal to the daily average during such Interest Period of the percentages in effect on each day of such Interest Period, as prescribed by the Federal Reserve Board, for determining the aggregate maximum reserve requirements (including all basic, supplemental, marginal and other reserves) applicable to "Eurocurrency liabilities" pursuant to Regulation D or any other then applicable regulation of the Federal Reserve Board which prescribes reserve requirements applicable to "Eurocurrency liabilities," as presently defined in Regulation D. Without limiting the effect of the foregoing, the Eurocurrency Reserve Requirement shall reflect any other reserves required to be maintained by the Bank against (i) any category of liabilities that includes deposits by reference to which the Interbank Rate (Reserve Adjusted) is to be determined, or (ii) any category of extensions of credit or other assets that includes Eurodollar Loans. For purposes of this Agreement, any Eurodollar Loans hereunder shall be deemed to be "Eurocurrency liabilities," as defined in Regulation D, and, as such, shall be deemed to be subject to such reserve requirements without the benefit of, or credit for, proration, exceptions or offsets which may be available to the Bank from time to time under Regulation D. "Eurodollar Loan" means any Loan which bears interest at a rate determined with reference to the Interbank Rate (Reserve Adjusted). "Event of Default, means any of the events described in Section 10.1. "Federal Funds Effective Rate" means, for any day, an interest rate per annum equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers, as published for such day by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Banking Day, the average of the quotations for such day on such transactions received by the Bank from three Federal funds brokers of recognized standing selected by it. In the case of a day which is not a Banking Day, the Federal Funds Effective Rate for such day shall be the Federal Funds Effective Rate for the next preceding Banking Day. For purposes of this Agreement and the Note, each change in the Alternate Reference Rate due to a change in the Federal Funds Effective Rate shall take effect on the effective date of such change in the Federal Funds Effective Rate. "Federal Reserve Board" means the Board of Governors of the Federal Reserve System or any successor thereto. "Fiscal Quarter" means any quarter of a Fiscal Year. -5- "Fiscal Year" means any period of 12 consecutive calendar months ending on the 31st day of December. References to a Fiscal Year with a number corresponding to any calendar year (e.g. "Fiscal Year 1997") refer to the Fiscal Year ending on the 31st day of December occurring during such calendar year. "GAAP" means generally accepted accounting principles as applied in the preparation of the audited financial statement of the Company referred to in Section 6.6. "Hazardous Materials" means any pollutant, contaminant, toxic substance, hazardous substance, hazardous material, hazardous chemical or hazardous waste defined or qualifying as such in (or for the purposes of) any Environmental Law, and shall include, but not be limited to, petroleum, including crude oil or any fraction thereof which is liquid at standard conditions of temperature or pressure (60 degrees Fahrenheit and 14.7 pounds per square inch absolute), any radioactive material, including, but not limited to, any source, special nuclear or by-product material as defined at 42 U.S.C. Section 2011 et. seq., as amended or hereafter amended, polychlorinated biphenyls and asbestos in any form or condition and any chemical, material, pollutant or substance, release or discharge of which or exposure to which is prohibited, limited or regulated by any Federal, state or local governmental or regulatory authority or could pose a hazard to the health and safety of the occupants of any properties of the Company or the owners and/or occupants of property adjacent to any such property. "Indebtedness" of any Person means, without duplication, (i) any obligation of such Person for borrowed money, including, without limitation, (a) any obligation of such Person evidenced by bonds, debentures, notes or other similar debt instruments, and (b) any obligation for borrowed money which is non-recourse to the credit of such Person but which is secured by a Lien on any asset of such Person, (ii) any obligation of such Person on account of deposits or advances, (iii) any obligation of such Person for the deferred purchase price of any property or services, except Trade Accounts Payable, (iv) any obligation of such Person as lessee under a Capitalized Lease, (v) all guaranties issued by such Person and (vi) any Indebtedness of another Person secured by a Lien on any asset of such first Person, whether or not such Indebtedness is assumed by such first Person. For all purposes of this Agreement, the Indebtedness of any Person shall include the Indebtedness of any partnership or joint venture in which such Person is a general partner or a joint venturer. "Interbank Rate" means, with respect to each Interest Period for a Eurodollar Loan, the rate per annum at which Dollar deposits in immediately available funds are offered to the Bank two Banking Days prior to the beginning of such Interest Period by major banks in the interbank eurodollar market at or about 10:00 a.m., Chicago time, for delivery on the first day of such Interest Period, for -6- the number of days comprised therein and in an amount equal to the amount of the Eurodollar Loan to be outstanding during such Interest Period. "Interbank Rate (Reserve Adjusted)" means, with respect to each Interest Period for a Eurodollar Loan, a rate per annum (rounded upward, if necessary, to the nearest 1/100 of 1%) determined pursuant to the following formula: Interbank Rate Interbank Rate (Reserve Adjusted) 1-Eurocurrency Reserve Requirement "Interest Period" means (i) with respect to any Eurodollar Loan, the period commencing on the borrowing date of such Eurodollar Loan or the date a Reference Rate Loan is converted into such Eurodollar Loan or the last day of the prior Interest Period for such Eurodollar Loan, as the case may be, and ending on the numerically corresponding day one, two or three months thereafter, as selected by the Company pursuant to Section 2.3 or Section 2.4; provided, however, that: (a) any Interest Period which would otherwise end on a day which is not a Banking Day shall end on the next succeeding Banking Day unless such next succeeding Banking Day falls in another calendar month, in which case such Interest Period shall end on the next preceding Banking Day; (b) any Interest Period which begins on the last Banking Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall end on the last Banking Day of the calendar month at the end of such Interest Period; and (c) no Interest Period shall extend beyond the Termination Date. "Investment" means any investment, made in cash or by delivery of any kind of property or asset, in any Person, whether by acquisition of shares of stock or similar interest, Indebtedness or other obligation or security, or by loan, advance or capital contribution, or otherwise. "Issuance Request" is defined in Section 2.8(a). "Letter of Credit" is defined in Section 2.7. "Letter of Credit Availability" means, at any time, the difference between (i) the Commitment and (ii) the sum of (A) the aggregate outstanding principal amount of all Loans and (B) the then aggregate Letter of Credit Outstandings. -7- "Letter of Credit Outstandings" means, at any time, an amount equal to the sum of: (a) the aggregate stated amount at such time of all Letters of Credit then outstanding and undrawn (as such aggregate stated amount shall be adjusted, from time to time, as a result of drawings, the issuance of Letters of Credit, or otherwise); and (b) the then aggregate amount of all unpaid and outstanding Reimbursement Obligations. "Liabilities" means all obligations of the Company and its Subsidiaries with respect to any Indebtedness and/or any guaranty of any Indebtedness howsoever created, arising or evidenced, whether direct or indirect, absolute or contingent, now or hereafter existing, or due or to become due. "Lien" means any mortgage, pledge, hypothecation, judgment lien or similar legal process, title retention lien, or other lien or security interest, including, without limitation, the interest of a vendor under any conditional sale or other title retention agreement and the interest of a lessor under any Capitalized Lease. "Loan" means a loan by the Bank to the Company under Section 2.1, and shall be a Reference Rate Loan or a Eurodollar Loan (each of which shall be a "type" of Loan). "Occupational Safety and Health Law" means the occupational Safety and Health Act of 1970, as amended, and any other federal, state or local statute, law, ordinance, code, rule, regulation, order or decree regulating, relating to or imposing liability or standards of conduct concerning employee health and/or safety. "Note" means the Company's promissory note, substantially in the form set forth as Exhibit A with appropriate insertions, as such promissory note may be amended, supplemented or otherwise modified from time to time, and the term "Note" shall include any substitutions for, or renewals of, such promissory note. "Payment Date" means (i) with respect to any Eurodollar Loan, the last day of each Interest Period with respect thereto and, if such Interest Period is in excess of three months, the day three months after the commencement of such Interest Period and thereafter the day three months after each succeeding Payment Date; (ii) with respect to any Reference Rate Loan, the last day of each March, June, September and December, commencing on the first such date to occur after such Reference Rate Loan is made or a Eurodollar Loan is converted into such Reference Rate Loan; and (iii) as to any fees, the last day of each March, June, September and December, commencing on the first such date to occur after the date hereof. -8- "PBGC" means the Pension Benefit Guaranty Corporation and any entity succeeding to any or all of its functions under ERISA. "Person" means an individual, partnership, corporation, trust, joint venture, joint stock company, association, unincorporated organization, government or agency or political subdivision thereof, or other entity. "Plan" means a "pension plan," as such term is defined in ERISA, established or maintained by the Company or any ERISA Affiliate or as to which the Company or any ERISA Affiliate contributes or is a member or otherwise may have any liability. "Rate Hedging Obligations" of a Person means any and all obligations of such Person, whether absolute or contingent and howsoever and whensoever created, arising, evidenced or acquired (including all renewals, extensions and modifications thereof and substitutions therefor), under (a) any and all agreements, devices or arrangements designed to protect at least one of the parties thereto from the fluctuations of interest rates, exchange rates or forward rates applicable to such parties' assets, liabilities or exchange transactions, including, but not limited to, dollar-denominated or cross-currency interest rate exchange agreements, forward currency exchange agreements, interest rate cap or collar protection agreements, forward rate currency or interest rate options, puts and warrants, and (b) any and all cancellations, buybacks, reversals, terminations or assignments of any of the foregoing. "Reference Rate" means, at any time, the rate of interest then most recently announced by the Bank at Chicago, Illinois as its reference rate. For purposes of this Agreement and the Note, each change in the Reference Rate shall take effect on the effective date of the change in the Reference Rate. "Reference Rate Loan" means any Loan which bears interest at a rate determined with reference to the Reference Rate. "Reimbursement Obligations" is defined in Section 2.8(e). "Related Party" means, for purposes of Section 7.21 only, any Person (other than a Subsidiary) (i) which directly or indirectly through one or more intermediaries controls, or is controlled by, or is under common control with, the Company, (ii) which beneficially owns or holds 10% or more of the equity interest of the Company, or (iii) 10% or more of the equity interest of which is beneficially owned or held by the Company or a Subsidiary. The term "control" means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of a Person, whether through the ownership of voting securities, by contract or otherwise. -9- "Reportable Event', has the meaning given to such term in ERISA. "Senior Funded Debt" means all Loans, Letters of Credit Outstandings, Capitalized Leases and any other senior indebtedness permitted hereunder. "Senior Funded Debt Cash Flow Ratio" means the ratio, (A) for the purposes of determining the Applicable Percentage, as measured at the end of each Fiscal Quarter for the four immediately preceding Fiscal Quarters, of (i) Senior Funded Debt to (ii) EBITDA; and (B) for the purposes of Section 7.15 hereof, as measured at the end of each Fiscal Quarter for the four immediately preceding Fiscal Quarters, of (i) Senior Funded Debt to (ii) EBITDA on an annualized basis of the period of four Fiscal Quarters then ending beginning the Fiscal Quarter ending September 30, 1997. "Stated Expiry Date, is defined in Section 2.8(a). "Subsidiary" means any Person of which or in which the Company and its other Subsidiaries own directly or indirectly 50% or more of (i) the combined voting power of all classes of stock having general voting power under ordinary circumstances to elect a majority of the board of directors of such Person, if it is a corporation, (ii) the capital interest or profits interest of such Person, if it is a partnership, joint venture or similar entity, or (iii) the beneficial interest of such Person, if it is a trust, association or other unincorporated organization. "Taxes" with respect to any Person means taxes, assessments or other governmental charges or levies imposed upon such Person, its income or any of its properties, franchises or assets. "Termination Date" means January 31, 2000. "Trade Accounts Payable" of any Person means trade accounts payable of such Person with a maturity of not greater than 90 days incurred in the ordinary course of such Person's business. "Unmatured Event of Default" means any event or condition which, with the lapse of time or giving of notice to the Company or both, would constitute an Event of Default. 1.2 Other Definitional Provisions. Unless otherwise defined or the context otherwise requires, all financial and accounting terms used herein or in any certificate or other document made or delivered pursuant hereto shall be defined in accordance with GAAP. Unless otherwise defined therein, all terms defined in this Agreement shall have the defined meanings when used in the Note or in any certificate or other document made or delivered pursuant hereto. -10- 1.3 Interpretation of Agreement. A Section or an Exhibit is, unless otherwise stated, a reference to a section hereof or an exhibit hereto, as the case may be. Section captions used in this Agreement are for convenience only, and shall not affect the construction of this Agreement. The words "hereof," "herein," "hereto" and "hereunder" and words of similar purport when used in this Agreement shall refer to this Agreement as a whole and not to any particular provision of this Agreement. 1.4 Compliance With Financial Restrictions. Compliance with each of the financial ratios and restrictions contained in Article VII shall, except as otherwise provided herein, be determined in accordance with GAAP consistently followed. ARTICLE II COMMITMENT OF THE BANK; CERTAIN LOAN TERMS; LETTERS OF CREDIT 2.1 Loans. Subject to the terms and conditions of this Agreement and in reliance upon the warranties of the Company set forth herein, the Bank agrees to make Loans to the Company, which Loans the Company may prepay and reborrow during the period from the date hereof to, but not including, the Termination Date, in such amounts as the Company may from time to time request, but not exceeding the Commitment, less the then aggregate Letter of Credit Outstandings, in the aggregate at any one time outstanding. 2.2 Loan Options. Each Loan shall be a Reference Rate Loan or a Eurodollar Loan, as shall be selected by the Company, except as otherwise provided herein. Any combination of types of Loans may be outstanding at the same time, except that no more than five (5) Eurodollar Loans having different Interest Periods may be outstanding at any one time. As to any Eurodollar Loan, the Bank may, if it so elects, fulfill its commitment by causing a foreign branch or affiliate to make or continue such Loan; provided, however, that in such event such Loan shall be deemed for the purposes of this Agreement to have been made by the Bank and the obligation of the Company to repay such Loan shall nevertheless be to the Bank and shall be deemed held by the Bank, to the extent of such Loan, for the account of such branch or affiliate. 2.3 Borrowing Procedures. The Company shall give the Bank prior written or telephonic notice of each Loan, which shall be received by the Bank, in the case of a Reference Rate Loan, not later than 11:00 a.m. on the proposed borrowing date, Chicago time, with respect to such Loan, or, in the case of a Eurodollar Loan, not later than 11:00 a.m., Chicago time, two Banking Days prior to the borrowing date, with respect to such Loan. Each such notice shall specify (i) the borrowing date (which shall be a Banking Day), (ii) the amount and type of Loan, and (iii) if such Loan is -11- to be a Eurodollar Loan, the initial Interest Period for such Loan. The Company shall promptly confirm each such telephonic notice in writing (it being understood, however, that the Company's failure to confirm any telephonic notice or otherwise comply with the provisions of this Section 2.3 shall not affect the obligation of the Company to repay each Loan in accordance with the terms of this Agreement and the Note). The Bank will pay to the Company the amount of the Loan on the date designated in the notice of borrowing upon receipt of the documents required under Article VIII and IX (with respect to the initial Loan) with respect to the Loan. 2.4 Continuation and/or Conversion of Loans. The Company may elect to (i) continue any outstanding Eurodollar Loan from the current Interest Period for such Loan into a subsequent Interest Period to begin on the last day of such current Interest Period, or (ii) convert any outstanding Reference Rate Loan into a Eurodollar Loan, or (iii) convert any outstanding Eurodollar Loan into a Reference Rate Loan on the last day of the current Interest Period for such Eurodollar Loan by giving the Bank prior written or telephonic notice of such continuation or conversion, which shall be received by the Bank not later than 11:00 a.m., Chicago time, two Banking Days prior to the effective date of continuation or conversion. Each such notice shall specify (a) the effective date of continuation or conversion (which shall be a Banking Day), (b) the type of Loan the Loan is to be continued as or converted into and the amount of such Loan, and (c) the Interest Period or maturity date for such Loan, if applicable. The Company shall promptly confirm each such telephonic notice in writing. Absent timely notice of continuation or conversion, each Eurodollar Loan shall automatically convert into a Reference Rate Loan on the last day of the current Interest Period for such Loan unless paid in full on such last day. No Loan shall be converted into a Eurodollar Loan and no Eurodollar Loan shall be continued less than one month before the Termination Date or at any time that an Event of Default or an Unmatured Event of Default shall exist. 2.5 Note Evidencing Loans. The Loans shall be evidenced by the Note, which shall be dated the date of the initial Loan and shall mature on the Termination Date. All Loans made by the Bank to the Company pursuant to this Agreement and all payments of principal shall be evidenced by the Bank in its records or, at its option, on the schedule (or any continuation thereof) attached to the Note, which records or schedule shall be rebuttable presumptive evidence of the subject matter thereof. 2.6 Funding Losses. The Company will indemnify the Bank upon demand against any loss or expense which the Bank may sustain or incur (including, without limitation, any loss or expense sustained or incurred in obtaining, liquidating or employing deposits or other funds acquired to effect, fund or maintain any Loan) as a consequence of (i) any failure of the Company to make any payment when due of any amount due hereunder or under the Note, (ii) any -12- failure of the Company to borrow, continue or convert a Loan on a date specified therefor in a notice thereof, or (iii) any payment (including, without limitation, any payment pursuant to Section 5.3 or Section 10.2), prepayment or conversion of any Eurodollar Loan on a date other than the last day of the Interest Period for such Loan. In the case of a Eurodollar Loan, such loss or expense shall include an amount equal to the present value of the excess, if any, as reasonably determined by the Bank, of (a) the amount of interest that would have accrued on the principal amount so paid, prepaid or converted or not borrowed, continued or converted for the period from the date of such payment, prepayment or conversion or failure to borrow, continue or convert (such date being hereinafter referred to as the "Breakage Date") to the last day of the then current Interest Period for such Loan (or, in the case of a failure to borrow, continue or convert, the Interest Period for such Loan that would have commenced on the date of such failure) at the rate of interest applicable to such Loan under the terms of this Agreement over (b) the amount of interest that the Bank would have earned had it invested the entire amount of funds so paid, prepaid or converted or the entire amount of funds acquired to effect, fund or maintain the Loan not borrowed, continued or converted, as the case may be, in U.S. Government Treasury Securities with a maturity comparable to such period or Interest Period. The present value of such excess shall be calculated by discounting such excess to the Breakage Date at the interest rate expressly borne by such U.S. Government Treasury Securities or, if none, the effective interest rate on such Securities. Determinations by the Bank for purposes of this Section 2.6 of the amount required to indemnify the Bank against any such loss or expense shall be conclusive in the absence of manifest error. 2.7 Capital Adequacy. If the Bank shall reasonably determine that the application or adoption of any law, rule, regulation, directive, interpretation, treaty or guideline regarding capital adequacy, or any change therein or in the interpretation or administration thereof, whether or not having the force of law (including, without limitation, application of changes to Regulation H and Regulation Y of the Federal Reserve Board issued by the Federal Reserve Board on January 19, 1989 and regulations of the Comptroller of the Currency, Department of the Treasury, 12 CFR Part 3, Appendix A, issued by the Comptroller of the Currency on January 27, 1989) increases the amount of capital required or expected to be maintained by the Bank or any Person controlling the Bank, and such increase is based upon the existence of the Bank's obligations hereunder and other commitments of this type, then from time to time, within 10 days after demand from the Bank, the Company shall pay to the Bank such amount or amounts as will compensate the Bank or such controlling Person, as the case may be, for such increased capital requirement. The determination of any amount to be paid by the Company under this Section 2.7 shall take into consideration the policies of the Bank or any Person controlling the Bank with respect to capital adequacy and shall be -13- based upon any reasonable averaging, attribution and allocation methods. A certificate of the Bank setting forth the amount or amounts as shall be necessary to compensate the Bank as specified in this Section 2.7 shall be delivered to the Company and shall be conclusive in the absence of manifest error. 2.8 Letters of Credit. (a) Requests. By delivering to the Bank a request on or before 10:00 a.m., Chicago time, the Company may request, from time to time prior to the Termination Date and on not less than three nor more than ten Banking Days, notice, that the Bank issue a letter of credit in such form as approved by the Bank (each a "Letter of Credit"), and for such purposes described in the request for such Letter of Credit (an "Issuance Request"). The stated amount of any Letter of Credit requested to be issued pursuant to such Issuance Request shall be denominated in Dollars. Each Letter of Credit shall by its terms: (i) be issued in a stated amount which does not exceed (or would not exceed) the then Letter of Credit Availability; (ii) be stated to expire on a date (its "Stated Expiry Date") not later than the earlier of (a) one year from the date of issuance or (b) the Termination Date; and (iii) on or prior to its Stated Expiry Date (A) terminate immediately upon notice to the Bank from the beneficiary thereunder that all obligations covered thereby have been terminated, paid, or otherwise satisfied in full, (B) reduce in part immediately and to the extent the beneficiary thereunder has notified the Bank that the obligations covered thereby have been paid or otherwise satisfied in part, or (C) terminate thirty Banking Days after notice to the beneficiary thereunder from the Bank that an Event of Default has occurred and is continuing. (b) Issuances. Subject to the terms and conditions of this Agreement, the Bank shall issue Letters of Credit in accordance with the Issuance Requests made therefor. If the Issuance Request consists of, or is supplemented by, the Bank's standard letter of credit application form, the terms of such application shall apply with respect to such Letter of Credit, but only to the extent such terms are not inconsistent with the provisions hereof. The Bank's commitment to issue Letters of -14- Credit or extend any outstanding Letter of Credit shall terminate on the Termination Date. (c) Fees and Expenses. The Company agrees to pay to the Bank (i) in respect of each standby Letter of Credit, a fee equal to 2% per annum (calculated from and including the date of issuance (or date of renewal or extension, if any) thereof to the Stated Expiry Date thereof) on the stated amount of such Letter of Credit, payable in arrears on each Payment Date and on the Termination Date, and (ii) in respect of all other Letters of Credit, such other fees as shall be agreed to between the Bank and the Company from time to time, payable upon the issuance of each such Letter of Credit. The Company further agrees to pay to the Bank all administrative expenses of the Bank in connection with the issuance, maintenance, modification (if any), and administration of each Letter of Credit upon demand from time to time. (d) Disbursements. The Bank will notify the Company promptly of the presentment for payment of any Letter of Credit, together with notice of the date (the "Disbursement Date") such payment shall be made. Subject to the terms and provisions of such Letter of Credit, the Bank shall make such payment to the beneficiary (or its designee) of such Letter of Credit. Prior to 1:00 p.m., Chicago time, on the Disbursement Date, the Company will reimburse the Bank for all amounts which it has disbursed under such Letter of Credit. To the extent the Bank is not reimbursed in full in accordance with the third sentence of this Subsection 2.8(d), the Company's Reimbursement Obligation shall accrue interest at a fluctuating rate determined by reference to the Reference Rate, plus a margin of 2% per annum, payable on demand. In the event the Bank is not reimbursed by the Company on the Disbursement Date, or if the Bank must for any reason return or disgorge such reimbursement, the Bank shall fund the Reimbursement Obligation therefor by making Loans as provided in Section 2.3 (the Company being deemed to have given a timely request therefor for such amount); provided, however, for the purpose of determining the availability to make Loans immediately prior to giving effect to the application of the proceeds of such Loans, such Reimbursement Obligation shall be deemed not to be outstanding at such time. (e) Reimbursement. The Company's obligation (a "Reimbursement Obligation") under Subsection 2.8(d) to reimburse the Bank with respect to each disbursement under any Letter of Credit (including interest thereon) shall be absolute and unconditional under any and all circumstances and irrespective of any setoff, counterclaim, or defense to payment which the Company may have or have had against the Bank or any beneficiary of a Letter of Credit, including any defense based upon the occurrence of any Event of Default, any draft, demand, or certificate, or other document presented under a Letter of Credit proving to be forged, fraudulent, invalid, or insufficient, the failure of any disbursement under any Letter of Credit to conform to the terms of -15- the applicable Letter of Credit (if, in the Bank's good faith opinion, such disbursement is determined to be appropriate) or any non-application or misapplication by the beneficiary of the proceeds of such disbursement, or the legality, validity, form, regularity, or enforceability of such Letter of Credit; provided, however, that nothing herein shall adversely affect the right of the Company to commence or prosecute any proceeding against the Bank for any wrongful disbursement made by the Bank under a Letter of Credit as a result of acts or omissions constituting gross negligence or willful misconduct on the part of the Bank. (f) Deemed Disbursements. Upon the occurrence and during the continuation of any Event of Default, an amount equal to that portion of Letter of Credit Outstandings attributable to outstanding and undrawn Letters of Credit shall, at the option of the Bank, and without demand upon or notice to the Company, be deemed to have been paid or disbursed by the Bank under such Letters of Credit (notwithstanding that such amount may not in fact have been so paid or disbursed), and, upon notification by the Bank to the Company of its obligations under this Section, the Company shall be immediately obligated to reimburse the Bank the amount deemed to have been so paid or disbursed by the Bank. Any amounts so received by the Bank from the Company pursuant to this Section shall be held as collateral security for the repayment of the Company's obligations in connection with the Letters of Credit issued by the Bank. At any time when such Letters of Credit shall terminate and all obligations of the Company are either terminated or paid or reimbursed to the Bank in full, the obligations of the Company under this Section shall be reduced accordingly (subject, however, to reinstatement in the event any payment in respect of such Letters of Credit is recovered in any manner from the Bank), and, if no Event of Default shall be continuing, the Bank will return to the Company the excess, if any, of (i) the aggregate amount deposited by the Company with the Bank and not theretofore applied by the Bank to any Reimbursement Obligation over (ii) the aggregate amount of all Reimbursement Obligations owing to the Bank pursuant to this Section, as so adjusted. At such time when all Events of Default shall have been cured or waived, the Bank shall return to the Company all amounts then on deposit with the Bank pursuant to this Section. All amounts on deposit pursuant to this Section shall, until their application to any Reimbursement obligation or their return to the Company, as the case may be, bear interest at the daily average Interbank Rate (Reserve Adjusted), which interest shall be held by the Bank as additional collateral security for the repayment of the Company's -16- obligations in connection with the Letters of Credit issued by the Bank. (g) Nature of Reimbursement Obligations. The Company shall assume all risks of the acts, omissions, or misuse of any Letter of Credit by the beneficiary thereof. The Bank (except to the extent of its own gross negligence or willful misconduct) shall not be responsible for: (i) the form, validity, sufficiency, accuracy, genuineness, or legal effect of any Letter of Credit or any document submitted by any party in connection with the application for an issuance of a Letter of Credit, even if it should in fact prove to be in any or all respects invalid, insufficient, inaccurate, fraudulent, or forged; (ii) the form, validity, sufficiency, accuracy, genuineness, or legal effect of any instrument transferring or assigning or purporting to transfer or assign a Letter of Credit or the rights or benefits thereunder or proceeds thereof in whole or in part, which may prove to be invalid or ineffective for any reason; (iii) failure of the beneficiary to comply fully with conditions required in order to demand payment under a Letter of Credit; (iv) errors, omissions, interruptions, or delays in transmission or delivery of any messages, by mail, cable, telegraph, telex, or otherwise; or (v) any loss or delay in the transmission or otherwise of any document or draft required in order to make a disbursement under a Letter of Credit or of the proceeds thereof. None of the foregoing shall affect, impair, or prevent the vesting of any of the rights or powers granted the Bank hereunder. (h) Increased Costs; Indemnity. If by reason of (i) any change in applicable law, regulation, rule, decree or regulatory requirement, or any change in the interpretation or application by any judicial or regulatory authority of any law, regulation, rule, decree or regulatory requirement, or (ii) compliance by the Bank with any direction, request, or requirement (whether or not having the force of law) of any governmental or monetary authority including, without limitation, Regulation D) of the Federal Reserve Board: -17- (a) the Bank shall be subject to any tax (other than taxes on income and franchises), levy, charge, or withholding of any nature or to any variation thereof, or to any penalty with respect to the maintenance or fulfillment of its obligations under this Section 2.8, whether directly or by such being imposed on or suffered by the Bank; (b) any reserve, deposit, or similar requirement is or shall be applicable, imposed, or modified in respect of any Letters of Credit issued by the Bank; or (c) there shall be imposed on the Bank any other condition regarding this Section 2.8 or any Letter of Credit; and the result of the foregoing is to directly or indirectly increase the cost to the Bank of issuing, making, or maintaining any Letter of Credit or to reduce any amount receivable in respect thereof by the Bank, then, and in any such case the Bank may, at any time after the additional cost is incurred or the amount received is reduced, notify the Company thereof, and the Company shall pay on demand such amounts as the Bank may specify to be necessary to compensate the Bank for such additional cost or reduced receipt, together with interest on such amount from the date demanded until payment in full thereof at a rate equal at all times to the Reference Rate plus 2% per annum. The determination by the Bank of any amount due pursuant to this Subsection 2.8(h), as set forth in a statement setting forth the calculation thereof in reasonable detail, shall be rebuttable presumptive evidence of such amount due. (i) Termination Date. All of the Company's obligations under this Section 2.8 (including, without limitation, its Reimbursement Obligations under Subsections (d) and (e), shall continue in full force and effect after the Termination Date and/or the payment in full of all Loans. ARTICLE III INTEREST AND FEES 3.1 Interest. (a) Reference Rate Loans. The unpaid principal amount of each Reference Rate Loan shall bear interest prior to maturity at a rate per annum equal to the Reference Rate in effect from time to time plus the Applicable Percentage. Accrued interest on each Reference Rate Loan shall be payable on each Payment Date and at maturity. (b) Eurodollar Loans. The unpaid principal amount of each Eurodollar Loan shall bear interest prior to maturity at a -18- rate per annum equal to the Interbank Rate (Reserve Adjusted) in effect for each Interest Period with respect to such Eurodollar Loan plus the Applicable Percentage. Accrued interest on each Eurodollar Loan shall be payable on each Payment Date and at maturity. (c) Interest After Maturity. The Company shall pay to the Bank interest on any amount of principal of any Loan which is not paid when due, whether at stated maturity, by acceleration or otherwise, accruing from and including the date such amount shall have become due to, but not including, the date of payment thereof in full at the rate per annum which is equal to the greater of (i) 2% in excess of the rate applicable to the unpaid principal amount immediately before it became due, or (ii) 2% in excess of the applicable per annum rate of interest otherwise payable hereunder. After maturity, accrued interest shall be payable on demand. 3.2 Nonuse Fee. The Company agrees to pay to the Bank a fee equal to 0.375% per annum on the daily average amount by which the Commitment exceeds the sum of (i) the outstanding aggregate principal balance of the Loans plus (ii) the Letter of Credit Outstandings. The fee provided for in this Section 3.2 shall be payable quarterly, in arrears, on the last day of each Fiscal Quarter, and on the Termination Date for the quarter (or portion thereof) then ended. 3.3 Closing Fee. On the closing date, the Company agrees to pay to the Bank a non-refundable closing fee of $50,000. 3.4 Method of Calculating Interest and Fees. Interest on each Reference Rate Loan shall be calculated on the basis of a year consisting of 360 days and paid for actual days elapsed, calculated as to such Reference Rate Loan from and including the date such Loan is made or the date a Eurodollar Loan is converted into such Reference Rate Loan to, but not including, the date such Reference Rate Loan is paid. Interest on each Eurodollar Loan shall be calculated on the basis of a year consisting of 360 days and paid for actual days elapsed, calculated as to each Interest Period from and including the first day thereof to, but not including, the last day thereof. Any fees shall be calculated on the basis of a year consisting of 360 days and paid for actual days elapsed. ARTICLE IV PAYMENTS, PREPAYMENTS, REDUCTION OR TERMINATION OF THE CREDIT AND SETOFF 4.1 Place of Payment. All payments hereunder (including payments with respect to the Note) shall be made without setoff or counterclaim and shall be made to the Bank in immediately available funds prior to 12:30 p.m., Chicago time, on the date due at its -19- office at 231 South LaSalle Street, Chicago, Illinois 60697, or at such other place or for such other account as may be designated by the Bank to the Company in writing. Any payments received after such time shall be deemed received on the next Banking Day. Subject to the definition of the term "Interest Period," whenever any payment to be made hereunder or under the Note shall be stated to be due on a date other than a Banking Day, such payment may be made on the next succeeding Banking Day, and such extension of time shall be included in the calculation of interest or any fees. The Company hereby authorizes the Bank to debit the Company's commercial Account No. 74-75594 for payment when due of all interest, principal, fees and other amounts payable hereunder (including amounts payable under the Note). The Bank shall mail to the Company advices of debits made to such account. The preceding provision of this Section 4.1 shall not affect the Company's obligation to pay when due all amounts payable by the Company under this Agreement or the Note, whether or not there are sufficient funds therefor in such account. 4.2 Prepayments. The Company may from time to time, upon at least ten Banking Days prior written or telephonic notice received by the Bank, prepay the principal of the Loans in whole or in part, as contemplated by Section 2.1; provided, however, that any partial prepayment of principal of the Loans shall be in a minimum amount of $100,000 or an integral multiple thereof, that any prepayment of Eurodollar Loans shall only be with the consent of the Bank, and provided further that any prepayment of principal shall be subject to the indemnification provisions of Section 2.6, but shall otherwise be without any premium or penalty. Any prepayment of the principal of the Loans shall include accrued interest to the date of prepayment on the principal amount being prepaid. The Company shall promptly confirm any telephonic notice of prepayment in writing. 4.3 Setoff. In addition to and not in limitation of all other rights and remedies (including other rights of setoff) that the Bank or other holder of the Note may have, the Bank or such other holder shall, upon the occurrence of any Event of Default described in Section 10.1 or any Unmatured Event of Default described in Section 10.1(e), have the right to appropriate and apply to the payment of any and all Loans and other liabilities of the Company hereunder (whether or not then due), in such order of application as the Bank or such other holder may elect, any and all balances, credits, deposits (general or special, time or demand, provisional or final), accounts or moneys of the Company then or thereafter with the Bank or such other holder. The Bank shall promptly advise the Company of any such setoff and application but failure to do so shall not affect the validity of such setoff and application. To secure the payment of such Loans and other liabilities, the Company hereby grants the Bank and each such other holder a continuing security interest in such balances, credits, deposits, accounts or moneys. -20- ARTICLE V ADDITIONAL PROVISIONS RELATING TO EURODOLLAR LOANS 5.1 Increased Cost. If, as a result of any law, rule, regulation, treaty or directive, or any change therein or in the interpretation or administration thereof, or compliance by the Bank with any request or directive (whether or not having the force of law) from any court, central bank, governmental authority, agency or instrumentality, or comparable agency; (a) any tax, duty or other charge with respect to any Eurodollar Loan, the Note or the Bank's obligation to make Eurodollar Loans is imposed, modified or deemed applicable, or the basis of taxation of payments to the Bank of the principal of, or interest on, any Eurodollar Loan (other than taxes imposed on the overall net income of the Bank by the jurisdiction in which the Bank has its principal office) is changed; (b) any reserve, special deposit, special assessment or similar requirement against assets of, deposits with or for the account of, or credit extended by, the Bank is imposed, modified or deemed applicable; or (c) any other condition affecting this Agreement or any Eurodollar Loan is imposed on the Bank or the relevant market; and the Bank determines that, by reason thereof, the cost to the Bank of making or maintaining any Eurodollar Loan is increased, or the amount of any sum receivable by the Bank hereunder or under the Note in respect of any Eurodollar Loan is reduced; then, the Company shall pay to the Bank upon demand such additional amount or amounts as will compensate the Bank for such additional cost or reduction (provided that the Bank has not been compensated for such additional cost or reduction in the calculation of the Eurocurrency Reserve Requirement). Determinations by the Bank for purposes of this Section 5.1 of the additional amounts required to compensate the Bank in respect of the foregoing shall be conclusive in the absence of manifest error. In determining such amounts, the Bank may use any reasonable averaging, attribution and allocation methods. 5.2 Deposits Unavailable or Interest Rate Unascertainable or Inadequate; Impracticability. If the Company has any Eurodollar Loan outstanding, or has notified the Bank of its intention to borrow a Eurodollar Loan as provided herein, then in the event that, prior to any Interest Period, the Bank shall have determined (which determination shall be conclusive and binding on the parties hereto) that: -21- (a) deposits of the necessary amount for the relevant Interest Period are not available to the Bank in the relevant market or that, by reason of circumstances affecting such market, adequate and reasonable means do not exist for ascertaining the Interbank Rate for such Interest Period; or (b) the Interbank Rate (Reserve Adjusted) will not adequately and fairly reflect the cost to the Bank of making or funding the Eurodollar Loans for such Interest Period; or (c) the making or funding of Eurodollar Loans has become impracticable as a result of any event occurring after the date of this Agreement which, in the opinion of the Bank, materially and adversely affects such Loans or the Bank's obligation to make such Loans or the relevant market; the Bank shall promptly give notice of such determination to the Company, and (i) any notice of a new Eurodollar Loan previously given by the Company and not yet borrowed or converted shall be deemed to be a notice to make a Loan of another type, as selected by the Company, and (ii) the company shall be obligated to either prepay in full any outstanding Eurodollar Loans without any premium or penalty on the last day of the then current Interest Period with respect thereto or convert any such Loans to Loans of another type, as selected by the Company, on such last day. 5.3 Changes in Law Rendering Eurodollar Loans Unlawful. If at any time due to the adoption of any law, rule, regulation, treaty or directive, or any change therein or in the interpretation or administration thereof by any court, central bank, governmental authority, agency or instrumentality, or comparable agency charged with the interpretation or administration thereof, or for any other reason arising subsequent to the date hereof, it shall become unlawful or impossible for the Bank to make or fund any Eurodollar Loan which it is committed to make hereunder, the obligation of the Bank to provide such Loans shall, upon the happening of such event, forthwith be suspended for the duration of such illegality or impossibility. If any such event shall make it unlawful or impossible for the Bank to continue any Eurodollar Loans previously made by it hereunder, the Bank shall, upon the happening of such event, notify the Company thereof in writing, and the Company shall, on the earlier of (i) the last day of the then current Interest Period with respect thereto or (ii) if required by such law, rule, regulation, treaty, directive or interpretation, on such date as shall be specified in such notice, either convert each such unlawful Loan to a Loan of another type or prepay in full each such unlawful Loan, together with accrued interest thereon, without any premium or penalty (except as provided in Section 2.6). -22- 5.4 Funding. (a) Discretion of the Bank as to Manner of Funding. Notwithstanding any provision of this Agreement to the contrary, the Bank shall be entitled to fund and maintain its funding of all or any part of the Loans in any manner it sees fit; it being understood, however, that for purposes of this Agreement, all determinations hereunder shall be made as if the Bank had actually funded and maintained each Eurodollar Loan during the Interest Period for such Loan through the purchase of deposits having a term corresponding to such Interest Period and bearing an interest rate equal, in the case of a Eurodollar Loan, to the Interbank Rate for such Interest Period (whether or not the Bank shall have granted any participations in such Loan). (b) Funding Through the sale of Participations. Notwithstanding any provision of this Agreement to the contrary, the Company acknowledges that the Bank may fund all or any part of the Loans by sales of participations to various participants, and agrees that the Bank may, in invoking its rights under this Section 5 or under Section 2.6, demand and receive payment for costs and other amounts incurred by, or allocable to, any such participant, or take other action arising from circumstances applicable to any such participant, to the same extent that such participant could demand and receive payments, or take other action, under this Article V or under Section 2.6 as if such participant were the Bank under this Agreement. ARTICLE VI REPRESENTATIONS AND WARRANTIES To induce the Bank to grant the Credit and to make the Loans, the Company represents and warrants that: 6.1 Existence. The Company and all of its corporate Subsidiaries are corporations duly organized, validly existing and in good standing under the laws of the states of their respective incorporation. All of the Company's other Subsidiaries, if any, are entities duly organized, validly existing and in good standing under the laws of the jurisdictions of their respective organization. The Company and all of its Subsidiaries are in good standing and are duly qualified to do business in each state where, because of the nature of their respective activities or properties, such qualification is required. 6.2 Authorization. The Company is duly authorized to execute and deliver this Agreement and the Note and is and will continue to be duly authorized to borrow monies hereunder and to perform its obligations under this Agreement and the Note. The execution, delivery and performance by the Company of this Agreement and the -23- Note and the borrowings hereunder do not and will not require any consent or approval of any governmental agency or authority. 6.3 No Conflicts. The execution, delivery and performance by the Company of this Agreement and the Note do not and will not conflict with (i) any provision of law, (ii) the charter or by-laws of the Company, (iii) any agreement binding upon the Company, or (iv) any court or administrative order or decree applicable to the Company, and do not and will not require, or result in, the creation or imposition of any Lien on any asset of the Company or any of its Subsidiaries. 6.4 Validity and Binding Effect. This Agreement is, and the Note when duly executed and delivered will be, a legal, valid and binding obligation of the Company, enforceable against the Company in accordance with its terms, except as enforceability may be limited by bankruptcy, insolvency or other similar laws of general application affecting the enforcement of creditors' rights or by general principles of equity limiting the availability of equitable remedies. 6.5 No Default. Neither the Company nor any of its Subsidiaries is in default under any agreement or instrument to which the Company or any Subsidiary is a party or by which any of their respective properties or assets is bound or affected, which default might materially and adversely affect the financial condition or operations of the Company and its Subsidiaries taken as a whole. No Event of Default or Unmatured Event of Default has occurred and is continuing. 6.6 Financial Statements. The Company's audited consolidated and consolidating financial statement as of December 31, 1996 and the Company's unaudited consolidated and consolidating financial statement as at September 30, 1997, copies of which have been furnished to the Bank, have been prepared in conformity with generally accepted accounting principles applied on a basis consistent with that of the preceding Fiscal Year and period and present fairly the financial condition of the Company and its Subsidiaries as at such dates and the results of their operations for the periods then ended, subject (in the case of the interim financial statement) to year-end audit adjustments. Since September 30, 1997, there has been no material adverse change in the financial condition of the Company and its Subsidiaries taken as a whole. 6.7 Litigation. No claims, litigation, arbitration proceedings or governmental proceedings are pending or threatened against or are affecting the Company or any of its Subsidiaries, the results of which might materially and adversely affect the financial condition or operations of the Company and its Subsidiaries taken as a whole, except those referred to in a schedule furnished to the Bank contemporaneously herewith and -24- attached hereto as Exhibit B. Other than any liability incident to such claims, litigation or proceedings or provided for or disclosed in the financial statements referred to in Section 6.6, neither the Company nor any of its Subsidiaries has any contingent liabilities which are material to the Company and its Subsidiaries taken as a whole. 6.8 Liens. None of the property, revenues or assets of the Company or any of its subsidiaries is subject to any Lien, except: (a) Liens for current Taxes not delinquent or Taxes being contested in good faith and by appropriate proceedings and as to which such reserves or other appropriate provisions as may be required by GAAP are being maintained; (b) carriers', warehousemen's, mechanics', materialmen's and other like statutory Liens arising in the ordinary course of business securing obligations which are not overdue for a period of more than 30 days or which are being contested in good faith and by appropriate proceedings and as to which such reserves or other appropriate provisions as may be required by GAAP are being maintained; (c) pledges or deposits in connection with workers, compensation, unemployment insurance and other social security legislation; (d) deposits to secure the performance of bids, trade, contracts, leases, statutory obligations, and other obligations of a like nature incurred in the ordinary course of business; (e) Liens disclosed in the financial statements referred to in Section 6.6; (a) Liens listed on Exhibit C; and (g) other Liens approved in writing by the Bank. 6.9 Subsidiaries. The Company has no Subsidiaries except as listed on Exhibit D. The Company and its Subsidiaries own the percentage of its Subsidiaries as set forth on Exhibit D. 6.10 Partnerships. Neither the Company nor any of its Subsidiaries is a partner or joint venturer in any partnership or joint venture other than the partnerships and joint ventures listed on Exhibit E. 6.11 Purpose. The proceeds of the Loans will be used by the Company for general corporate purposes. -25- 6.12 Regulation U. The Company is not engaged in the business of purchasing or selling "margin stock," as such term is defined in Regulation U of the Federal Reserve Board, or extending credit to others for the purpose of purchasing or carrying margin stock, and no part of the proceeds of any Loan will be used to purchase or carry any margin stock or for any other purpose which would violate any of the margin regulations of the Federal Reserve Board. 6.13 Compliance. The Company and its Subsidiaries are in material compliance with ail statutes and governmental rules and regulations applicable to them. 6.14 Pension and Welfare Plans. Each Plan complies in all material respects with all applicable statutes and governmental rules and regulations, and (i) no Reportable Event has occurred and is continuing with respect to any Plan, (ii) neither the Company nor any ERISA Affiliate has withdrawn from any Plan or instituted steps to do so, and (iii) no steps have been instituted to terminate any Plan. No condition exists or event or transaction has occurred in connection with any Plan which could result in the incurrence by the Company or any ERISA Affiliate of any material liability, fine or penalty. Neither the Company nor any ERISA Affiliate is a member of, or contributes to, any multiple employer Plan as described in Section 4064 of ERISA. 6.15 Taxes. Each of the Company and its Subsidiaries has filed all tax returns which are required to have been filed and has paid, or made adequate provisions for the payment of, all of its Taxes which are due and payable, except such Taxes, if any, as are being contested in good faith and by appropriate proceedings and as to which such reserves or other appropriate provisions as may be required by GAAP have been maintained. 6.16 Investment Company Act Representation. The Company is not an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940, as amended. 6.17 Public Utility Holding Company Act Representation. The Company is not a "holding company" or a "subsidiary company" of a "holding company" or an "affiliate" of a "holding company" within the meaning of the Public Utility Holding Company Act of 1935, as amended. 6.18 Environmental and Safety and Health Matters. Except as disclosed on Schedule 6.18, the Company and each of its Subsidiaries and/or each property, operations and facility that the Company or any subsidiary may own, operate or control (i) complies in all material respects with (A) all applicable Environmental Laws and (E) all applicable occupational Safety and Health Laws; (ii) is not subject to any judicial or administrative proceeding alleging the violation of any Environmental Law or Occupational Safety and -26- Health Law; (iii) has not received any notice (A) that it may be in violation of any Environmental Law or Occupational Safety and Health Law, (B) threatening the commencement of any proceeding relating to allegedly unlawful, unsafe or unhealthy conditions or (C) alleging that it is or may be responsible for any response, cleanup, or corrective action, including but not limited to any remedial investigation/feasibility studies, under any Environmental Law or Occupational Safety and Health Law; (iv) is not the subject of federal or state investigation evaluating whether any investigation, remedial action or other response is needed to respond to (A) a spillage, disposal or release or threatened release into the environment of any Hazardous Material or other hazardous, toxic or dangerous waste, substance or constituent, or other substance or (B) any allegedly unsafe or unhealthful condition; (v) has not filed any notice under or relating to any Environmental Law or Occupational Safety and Health Law indicating or reporting (A) any past or present spillage, disposal or release into the environment of, or treatment, storage or disposal of, any Hazardous Material or other hazardous, toxic or dangerous waste, substance or constituent, or other substance or (B) any potentially unsafe or unhealthful condition, and there exists no basis for such notice irrespective of whether or not such notice was actually filed and (vi) has no material contingent liability in connection with (A) any actual or potential spillage, disposal or release into the environment of, or otherwise with respect to, any Hazardous Material or other hazardous, toxic or dangerous waste, substance or constituent, or other substance, whether on any premises owned or occupied by the company or any Subsidiary or on any other premises or (B) any unsafe or unhealthful condition. Except as disclosed on Schedule 6.18, there are no Hazardous Materials on, in or under any property or facilities owned, operated or controlled by the Company or any Subsidiary, including but not limited to such Hazardous Materials that may be contained in underground storage tanks, but excepting such Hazardous Materials used in accordance with all applicable laws and in the same manner as an ordinary consumer (e.g., gasoline in tanks of motor vehicles, small amounts of cosmetic cleaners, etc.). The materiality standard used in this Section 6.18 shall be exceeded only if the fact or facts giving rise to a breach of the representation and warranty contained herein might result in liability in excess of $100,000 in the aggregate. 6.19 Insurance. The Company and each of its Subsidiaries maintain insurance to such extent and against such hazards and liabilities as is commonly maintained by companies similarly situated. 6.20 Contracts; Labor Matters. Except as disclosed on Schedule 6.20: (a) neither the Company nor any Subsidiary is a party to any contract or agreement, or is subject to any charge, corporate restriction, judgment, decree or order, which materially and adversely affects its business, property, assets, operations or -27- condition, financial or otherwise; (b) no labor contract to which the Company or any Subsidiary is a party or is otherwise subject is scheduled to expire prior to the Termination Date; (c) neither the Company nor any Subsidiary has, within the two-year period preceding the date of this Agreement, taken any action which would have constituted or resulted in a "plant closing" or "mass layoff" within the meaning of the Federal Worker Adjustment and Retraining Notification Act of 1988 or any similar applicable federal, state or local law, and the Company has no reasonable expectation that any such action is or will be required at any time prior to the Termination Date and (d) on the date of this Agreement (i) neither the Company nor any Subsidiary is a party to any labor dispute and (ii) there are no strikes or walkouts relating to any labor contracts to which the Company or any Subsidiary is a party or is otherwise subject. 6.21 Accuracy of Information. All information supplied by the Company to the Bank in writing in connection with this Agreement and the transactions contemplated herein and therein on or before the date hereof with respect to the Company and its Subsidiaries is true, complete and accurate in all material respects; and the Company does not know of any fact which it has not disclosed in writing to the Lenders which is material to the Company or any Subsidiary or the ability of the Company or any Subsidiary to perform its obligations hereunder or under the Note. 6.22 Title to Properties. Each of the Company and Subsidiaries has good and marketable title to its properties reflected on the financial statements referred to in Section 6.2 or acquired since the date thereof except for such assets as have been disposed of since the date thereof as no longer used or useful in the conduct of its business or as have been disposed of in the ordinary course of business as presently conducted and all such properties are free and clear of Liens, except for Liens permitted under Section 7.17. ARTICLE VII COMPANY'S COVENANTS From the date of this Agreement and thereafter until the expiration or termination of the Credit and until the Note and other liabilities of the Company hereunder are paid in full, the Company agrees that, unless the Bank shall otherwise expressly consent in writing, it will: 7.1 Financial Statements and Other Reports-. Furnish to the Bank: (a) Annual Audit Report. Within 90 days after each Fiscal Year of the Company, a copy of the annual audit report -28- of the Company and its Subsidiaries prepared on a consolidating and consolidated basis and in conformity with GAAP and certified by an independent certified public accountant who shall be satisfactory to the Bank, together with a certificate from such accountant, (i) acknowledging to the Bank such accountant's understanding that the Bank is relying on such annual audit report, (ii) containing a computation of, and showing compliance with, each of the financial ratios and restrictions contained in this Article VII, and (iii) to the effect that, in making the examination necessary for the signing of such annual audit report, such accountant has not become aware of any Event of Default or Unmatured Event of Default that has occurred and is continuing, or, if such accountant has become aware of any such event, describing it and the steps, if any, being taken to cure it; (b) Quarterly Financial Statement. Within 45 days after the end of each Fiscal Quarter of the Company, a copy of the unaudited financial statement of the Company and its Subsidiaries prepared in the same manner as the audit report referred to in preceding Clause (a), signed by the Company's chief financial officer and consisting of at least a balance sheet as at the close of such Fiscal Quarter and statements of earnings and cash flows for such Fiscal Quarter and for the period from the beginning of such Fiscal Year to the end of such Fiscal Quarter; (c) Officer's Certificate. Together with the financial statements furnished by the Company under preceding Clauses (a) and (b), a certificate of the Company's chief financial officer, dated the date of such annual audit report or such quarterly or monthly financial statement, as the case may be, to the effect that no Event of Default or Unmatured Event of Default has occurred and is continuing, or, if there is any such event, describing it and the steps, if any, being taken to cure it, and containing a computation of, and showing compliance with, each of the financial ratios and restrictions contained in this Article VII; (d) SEC and Other Reports. Copies of each filing and report made by the Company or any Subsidiary with or to any securities exchange or the Securities and Exchange Commission and of each communication from the Company or any Subsidiary to shareholders generally, promptly upon the filing or making thereof; (e)Report of Change in Subsidiaries or Partnerships. Promptly from time to time, a written report of any change in the list of the Company's Subsidiaries set forth on Exhibit D or in the list of partnerships and joint ventures set forth on Exhibit E; and -29- (f) Requested Information. Promptly from time to time, such other reports or information as the Bank may reasonably request. 7.2 Notices. Notify the Bank in writing of any of the following immediately upon learning of the occurrence thereof, describing the same and, if applicable, the steps being taken by the Person(s) affected with respect thereto: (a) Default. The occurrence of an Event of Default or an Unmatured Event of Default; (b) Litigation. The institution of any litigation, arbitration proceeding or governmental proceeding which is material to the Company and its Subsidiaries taken as a whole; (c) Pension and Welfare Plans. The occurrence of a Reportable Event with respect to any Plan; the institution of any steps by the Company, any ERISA Affiliate, the PBGC or any other Person to terminate any Plan; the institution of any steps by the Company or any ERISA Affiliate to withdraw from any Plan; or the incurrence of any material increase in the contingent liability of the Company or any Subsidiary with respect to any post-retirement welfare benefits; (d) Material Adverse Change. The occurrence of a material adverse change in the business, operations or financial condition of the Company and its Subsidiaries taken as a whole; or (e) Other Events. The occurrence of such other events as the Bank may from time to time specify. 7.3 Existence. Maintain and preserve, and cause each Subsidiary to maintain and preserve, its respective existence as a corporation or other form of business organization, as the case may be, and all rights, privileges, licenses, patents, patent rights, copyrights, trademarks, trade names, franchises and other authority to the extent material and necessary for the conduct of its respective business in the ordinary course as conducted from time to time. 7.4 Nature of Business. Engage, and cause each Subsidiary to engage, in substantially the same fields of business as it is engaged in on the date hereof. 7.5 Books, Records and Access. Maintain, and cause each Subsidiary to maintain, complete and accurate books and records in which full and correct entries in conformity with GAAP shall be made of all dealings and transactions in relation to its respective business and activities; permit, and cause each Subsidiary to permit, access by the Bank to the books and records of the Company -30- and such Subsidiary during normal business hours; and permit, and cause each Subsidiary to permit, the Bank to make copies of such books and records; provided, however, the Bank shall use its best efforts to maintain the confidentiality of any information derived from such books and records. 7.6 Insurance. Maintain, and cause each Subsidiary to maintain, insurance to such extent and against such hazards and liabilities as is commonly maintained by companies similarly situated or as the Bank may reasonably request from time to time. 7.7 Repair. Maintain, preserve and keep, and cause each Subsidiary to maintain, preserve and keep, its properties in good repair, working order and condition. 7.8 Taxes. Pay, and cause each Subsidiary to pay, when due, all of its Taxes, unless and only to the extent that the Company or such Subsidiary, as the case may be, is contesting such Taxes in good faith and by appropriate proceedings and the Company or such Subsidiary has set aside on its books such reserves or other appropriate provisions therefor as may be required by GAAP. 7.9 Compliance. Comply, and cause each Subsidiary to comply, with all statutes and governmental rules and regulations applicable to it. 7.10 Pension Plans. Not permit, and not permit any Subsidiary to permit, any condition to exist in connection with any Plan (other than a "multi-employer plan", as such term is defined in ERISA) which might constitute grounds for the PBGC to institute proceedings to have such Plan terminated or a trustee appointed to administer such Plan; and not engage in, or permit to exist or occur, or permit any of its Subsidiaries to engage in, or permit to exist or occur, any other condition, event or transaction with respect to any Plan which could result in the incurrence by the Company or any of its Subsidiaries of any material liability, fine or penalty. 7.11 Merger, Purchase and Sale. Not, and not permit any Subsidiary to: (a) be a party to any merger or consolidation; (b) except in the normal course of its business, sell, transfer, convey, lease or otherwise dispose of all or any substantial part of the assets of the Company and its Subsidiaries taken as a whole; or (c) purchase or otherwise acquire the assets or capital stock of any Person without the prior written consent of the Bank except where (i) the total purchase price of such acquisition (together with all other such acquisitions made -31- during such Fiscal Year) is not greater than $10,000,000 (including the value of any stock issued, assets exchanged or transaction expenses incurred to consummate such acquisition) and (ii) there is no Event of Default or Unmatured Event of Default after giving effect to such acquisition. For purposes of this Section 7.11 only, a sale, transfer, conveyance, lease or other disposition of assets shall be deemed to be a "substantial part" of the assets of the Company and its Subsidiaries only if the value of such assets, when added to the value of all other assets sold, transferred, conveyed, leased or otherwise disposed of by the Company and its Subsidiaries (other than in the normal course of business during the same Fiscal Year, exceeds 10% of the company's consolidated total assets determined as of the end of the immediately preceding Fiscal Year. As used in the preceding sentence, the term "value" shall mean, with respect to any asset disposed of, the greater of such asset's book or fair market value as of the date of disposition, with "book value" being the value of such asset as would appear immediately prior to such disposition on a balance sheet of the owner of such asset prepared in accordance with GAAP. 7.12 Consolidated Net Worth. Not permit the Company's Consolidated Net Worth as at the last day of each Fiscal Quarter to be less than the corresponding amount set forth below opposite each such Fiscal Quarter:
Fiscal Quarter Amount --------------------------------------------------------------- For all Fiscal Quarters Ended in 1997 $79,000,000 For all Fiscal Quarters Ended in 1998 $80,000,000 For all Fiscal Quarters Ended in 1999 $81,000,000 and thereafter
7.13 Capital Expenditures. Not, and not permit any Subsidiary to make any Capital Expenditures, or commit to make any Capital Expenditures if, after giving effect to such Capital Expenditures, the aggregate amount of all Capital Expenditures made by the Company and its Subsidiaries on a consolidated basis in Fiscal Year would exceed, in the aggregate, the corresponding amount set forth below opposite such Fiscal Year:
Fiscal Year Amount ----------- ------ 1997 $4,500,000 1998 $6,500,000 1999 and thereafter $5,000,000
7.14 Maintenance of Minimum Liquidity. Not permit the ratio of total accounts receivable plus cash balances (exclusive of operating cash balances in checking accounts) to Total Senior Funded Debt, to be less than 1.20 to 1.0 at all times. -32- 7.15 Senior Funded Debt Cash Flow Ratio. Maintain the Senior Funded Debt Cash Flow Ratio of not greater than 3.5 to 1.0 at all times. 7.16 Capitalized Leases. Not, and not permit any Subsidiary to, incur or permit to exist any Indebtedness as lessee under Capitalized Leases if, after giving effect to such Capitalized Lease, the aggregate amount of all Capitalized Leases entered into by the Company and its Subsidiaries on a consolidated basis would exceed, in the aggregate, $6,500,000. 7.17 Liens. Not, and not permit any Subsidiary to, create or permit to exist any Lien with respect to any assets now owned or hereafter acquired, except: (a) Liens for current Taxes not delinquent or Taxes being contested in good faith and by appropriate proceedings and as to which such reserves or other appropriate provisions as may be required by GAAP are being maintained; (b) carriers', warehousemen's, mechanics', material-men's, repairmen's, and other like statutory Liens arising in the ordinary course of business securing obligations which are not overdue for a period of more than 30 days or which are being contested in good faith and by appropriate proceedings and as to which such reserves or other appropriate provisions as may be required by GAAP are being maintained; (c) pledges or deposits in connection with workers' compensation, unemployment insurance and other social security legislation; (d) deposits to secure the performance of bids, trade contracts, leases, statutory obligations and other obligations of a like nature incurred in the ordinary course of business; (e) Liens granted by any Subsidiary to secure such Subsidiary's Indebtedness to the Company or to any other Subsidiary; (f) Liens in favor of the Bank; and (g) other Liens approved in writing by the Bank. 7.18 Indebtedness. Not, and not permit any Subsidiary to, incur or permit to exist any Indebtedness (excluding Indebtedness as lessee under Capitalized Leases), except: (a) Indebtedness under the terms of this Agreement; (b) other Indebtedness outstanding on the date hereof and listed on Schedule 7.18; (c) Indebtedness hereafter incurred in connection with Liens permitted under Section 7.17(d) and (d) other Indebtedness approved in writing by the Bank. -33- 7.19 Other Agreements. Not, and not permit any Subsidiary to, enter into any agreement containing any provision which would be violated or breached by the Company's performance of its obligations hereunder or under any instrument or document delivered or to be delivered by the Company hereunder or in connection herewith. 7.20 Use of Proceeds. Not permit any proceeds of the Loans to be used, either directly or indirectly, for the purpose, whether immediate, incidental or ultimate, of "purchasing or carrying any margin stock" within the meaning of Regulation U of the Federal Reserve Board, as amended from time to time; and furnish to the Bank, upon its request, a statement in conformity with the requirements of Federal Reserve Form U-1 referred to in Regulation U. 7.21 Transactions With Related Parties. Not, and not permit any Subsidiary to, enter into or be a party to any transaction or arrangement, including, without limitation, the purchase, sale, lease or exchange of property or the rendering of any service, with any Related Party, except in the ordinary course of and pursuant to the reasonable requirements of the Company's or such Subsidiary's business and upon fair and reasonable terms no less favorable to the Company or such Subsidiary than would obtain in a comparable arm's-length transaction with a Person not a Related Party. 7.22 Hostile Acquisitions. Notwithstanding Section 7.11 of this Agreement, the Company will not, nor will it permit any Subsidiary to, acquire a controlling interest in any Person if the board of directors (or the functional equivalent thereof) of such Person has not recommended or approved such acquisition. ARTICLE VIII CONDITIONS PRECEDENT TO ALL LOANS The obligation of the Bank to make any Loan is subject to the satisfaction of each of the following conditions precedent; 8.1 Notice. The Bank shall have received timely notice of such Loan in accordance with Section 2.3. 8.2 Default. Before and after giving effect to such Loan, no Event of Default or Unmatured Event of Default shall have occurred and be continuing. 8.3 Warranties. Before and after giving effect to such Loan, the warranties in Article VI shall be true and correct as though made on the date of such Loan, except for such changes as are specifically permitted hereunder. -34- 8.4 Certification. The Company shall have delivered to the Bank a certificate of the Company, signed on the Company's behalf by its president or chief financial officer, as to the matters set out in Sections 8.2 and 8.3. ARTICLE IX CONDITION PRECEDENT TO INITIAL LOAN The obligation of the Bank to make the initial Loan hereunder is subject to the satisfaction of the condition precedent, in addition to the applicable conditions precedent set forth in Article VIII above, that the Company shall have delivered to the Bank all of the following, each duly executed and dated the date of the initial Loan or such earlier date as is satisfactory to the Bank and in form and substance satisfactory to the Bank: 9.1 Note. Its Note. 9.2 Resolutions. A copy, duly certified by the secretary or an assistant secretary of the Company, of (i) the resolutions of the Company's Board of Directors authorizing or ratifying the execution and delivery of this Agreement and the Note and authorizing the borrowings hereunder, (ii) all documents evidencing other necessary corporate action, and (iii) all approvals or consents, if any, with respect to this Agreement and the Note. 9.3 Incumbency Certificate. A certificate of the secretary or an assistant secretary of the Company certifying the names of the Company's officers authorized to sign this Agreement, the Note and all other documents or certificates to be delivered hereunder, together with the true signatures of such officers. 9.4 Opinion. An opinion of counsel to the Company, addressed to the Bank, in substantially the form of Exhibit F. 9.5 Good Standing. Certificates of good standing certified by the appropriate governmental officer in each of Virginia and each other state where the Company is qualified to do business or where, because of the nature of its business or properties, qualification to do business is required. ARTICLE X EVENTS OF DEFAULT AND REMEDIES 10.1 Events of Default. Each of the following shall constitute an Event of Default under this Agreement: -35- (a) Non-Payment. Default, and the continuance thereof for five days, in the payment when due of any principal of, or interest on, any Loan or any fee hereunder. (b) Non-Payment of Other Indebtedness. Default in the payment when due, whether by acceleration or otherwise subject to any applicable grace period), of any Indebtedness of, or guaranteed by, the Company or any Subsidiary (other than (i) any Indebtedness of any Subsidiary to the Company or to any other Subsidiary and (ii) the Indebtedness evidenced by the Note). (c) Acceleration of Other Indebtedness. Any event or condition shall occur which results in the acceleration of the maturity of any Indebtedness of, or guaranteed by, the Company or any Subsidiary (other than (i) any Indebtedness of any Subsidiary to the Company or to any other Subsidiary and (ii) the Indebtedness evidenced by the Note) or enables the holder or holders of such other Indebtedness or any trustee or agent for such holders (any required notice of default having been given and any applicable grace period having expired) to accelerate the maturity of such other Indebtedness. (d) Other Obligations. Default in the payment when due, whether by acceleration or otherwise, or in the performance or observance (subject to any applicable grace period) of (i) any obligation or agreement of the Company or any Subsidiary to or with the Bank (other than any obligation or agreement of the Company hereunder or under the Note), or (ii) any material obligation or agreement of the Company or any Subsidiary to or with any other Person (other than (x) any such material obligation or agreement constituting or related to Indebtedness, (y) Trade Accounts Payable, and (z) any material obligation or agreement of any Subsidiary to the Company or to any other Subsidiary), except only to the extent that the existence of any such default is being contested by the Company or such Subsidiary, as the case may be, in good faith and by appropriate proceedings and the Company or such Subsidiary shall have set aside on its books such reserves or other appropriate provisions therefor as may be required by GAAP. (e) Insolvency. The Company or any of its Subsidiaries becomes insolvent, or generally fails to pay, or admits in writing its inability to pay, its debts as they mature, or applies for, consents to, or acquiesces in, the appointment of a trustee, receiver or other custodian for the Company or such Subsidiary or for a substantial part of the property of the Company or such Subsidiary, or makes a general assignment for the benefit of creditors; or, in the absence of such application, consent or acquiescence, a trustee, receiver or other custodian is appointed for the Company or any of its -36- Subsidiaries or for a substantial part of the property of the Company or any of its Subsidiaries and is not discharged within 30 days; or any bankruptcy, reorganization, debt arrangement or other proceeding under any bankruptcy or insolvency law, or any dissolution or liquidation proceeding, is instituted by or against the Company or any of its Subsidiaries and, if instituted against the Company or any of its subsidiaries, is consented to or acquiesced in by the Company or such Subsidiary or remains for 30 days undismissed; or any warrant of attachment or similar legal process is issued against any substantial part of the property of the Company or any of its Subsidiaries which is not released within 30 days of service. (f) Pension Plans. The institution by the Company or any ERISA Affiliate of steps to terminate any Plan if, in order to effectuate such termination, (i) the Company or any ERISA Affiliate would be required to make a contribution to such Plan or would incur a liability or obligation to such Plan and (ii) immediately after giving effect to the payment or satisfaction of such contribution, liability or obligation (if made or undertaken by the Company or any Subsidiary) an Event of Default or Unmatured Event of Default would exist and be continuing; or the institution by the PBGC of steps to terminate any Plan. (g) Agreements. Default in the performance of any of the Company's agreements set forth in Sections 7.1, 7,5 and 7.11 through 7.18. (h) Other Agreements. Default in the performance of any of the Company's agreements herein set forth (and not constituting an Event of Default under any of the other subsections of this Section 10.1) and continuance of such default for 30 days after notice thereof to the Company from the Bank. (i) Warranty. Any warranty made by the Company herein is untrue or misleading in any material respect when made or deemed made; or any schedule, statement, report, notice, certificate or other writing furnished by the Company to the Bank is untrue or misleading in any material respect on the date as of which the facts set forth therein are stated or certified; or any certification made or deemed made by the Company to the Bank is untrue or misleading in any material respect on or as of the date made or deemed made. (j) Litigation. There shall be entered against the Company or any Subsidiary one or more judgments or decrees in excess of $100,000 in the aggregate at any one time outstanding for the Company and all Subsidiaries, excluding those judgments or decrees (i) that shall have been -37- outstanding less than 30 calendar days from the entry thereof, (ii) for not more than $3,000,000 during the time which a stay of enforcement of such judgment or decree is in effect by reason of a pending appeal or otherwise, or (iii) for and to the extent which the Company or any Subsidiary is insured and with respect to which the insurer has assumed responsibility in writing or for and to the extent which the Company or any Subsidiary is otherwise indemnified if the terms of such indemnification and the Person providing such indemnification are satisfactory to the Bank. 10.2 Remedies. If any Event of Default described in Section 10,1 shall have occurred and be continuing, the Bank may declare the Credit to be terminated and the Note to be due and payable, whereupon the Credit shall immediately terminate and the Note shall become immediately due and payable, all without notice of any kind (except that if an event described in Section 10.1(e) occurs, the Credit shall immediately terminate and the Note shall become immediately due and payable without declaration or notice of any kind). The Bank shall promptly advise the Company of any such declaration, but failure to do so shall not impair the effect of such declaration. ARTICLE XI GENERAL 11.1 Waiver and Amendments. No failure or delay on the part of the Bank or the holder of the Note in the exercise of any power or right, and no course of dealing between the Company and the Bank or the holder of the Note, shall operate as a waiver of such power or right, nor shall any single or partial exercise of any power or right preclude other or further exercise thereof or the exercise of any other power or right. The remedies provided for herein are cumulative and not exclusive of any remedies which may be available to the Bank at law or in equity. No notice to or demand on the Company not required hereunder or under the Note shall in any event entitle the Company to any other or further notice or demand in similar or other circumstances or constitute a waiver of the right of the Bank or the holder of the Note to any other or further action in any circumstances without notice or demand. No amendment, modification or waiver of, or consent with respect to, any provision of this Agreement or the Note shall in any event be effective unless the same shall be in writing and signed and delivered by the Bank. Any waiver of any provision of this Agreement or the Note, and any consent to any departure by the Company from the terms of any provision of this Agreement or the Note, shall be effective only in the specific instance and for the specific purpose for which given. 11.2 Notices. Except as otherwise expressly provided herein, any notice hereunder to the Company or the Bank shall be in writing -38- (including telecopy communication) and shall be given to the Company or the Bank at its address or telecopier number set forth on the signature pages hereof or at such other address or telecopier number as the Company or the Bank may, by written notice, designate as its address or telecopier number for purposes of notice hereunder. All such notices shall be deemed to be given when transmitted by telecopier, personally delivered or, in the case of a mailed notice, when sent by registered or certified mail, postage prepaid, in each case addressed as specified in this Section 11.2; provided, however, that notices to the Bank under Sections 2.3, 2.4, 4.2 and 4.3 shall not be effective until actually received by the Bank. 11.3 Expenses. The Company agrees, whether or not any Loan is made hereunder, to pay the Bank upon demand for all reasonable expenses, including reasonable fees of attorneys and paralegals for the Bank (who may be employees of the Bank) and other legal expenses and costs of collection, incurred by the Bank in connection with (i) the preparation, negotiation and execution of this Agreement, the Note and any other instrument or document provided for herein or delivered or to be delivered hereunder or in connection herewith, (ii) the preparation, negotiation and execution of any and all amendments to this Agreement, the Note or any such other instrument or document, and (iii) the enforcement of the Company's obligations hereunder or under the Note or any such other instrument or document. The Company also agrees to (a) indemnify and hold the Bank harmless from any loss or expense which may arise or be created by the acceptance of telephonic or other instructions for making Loans or disbursing the proceeds thereof, and (b) pay, and save the Bank harmless from all liability for, any stamp or other tax which may be payable with respect to the execution or delivery of this Agreement or the issuance of the Note or any other instrument or document provided for herein or delivered or to be delivered hereunder or in connection herewith. The Company's foregoing obligations shall survive any termination of this Agreement. 11.4 Information. The Bank may, upon the prior written consent of the Company, furnish any information concerning the Company in the possession of the Bank from time to time to assignees of the rights and/or obligations of the Bank hereunder and to participants in any Loan (including prospective assignees and participants) and may furnish information in response to credit inquiries consistent with general banking practice. 11.5 Severability. Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof or affecting the validity or enforceability of such provision in any other jurisdiction. -39- 11.6 Law. This Agreement and the Note shall be contracts made under and governed by the internal laws of the State of Illinois (without regard to conflict of laws provisions thereof). 11.7 Successors. This Agreement shall be binding upon the Company and the Bank and their respective successors and assigns, and shall inure to the benefit of the Company and the Bank and the successors and assigns of the Bank. The Company shall not assign its rights or duties hereunder without the consent of the Bank. 11.8 WAIVER OF JURY TRIAL; WAIVER OF CONSEQUENTIAL DAMAGES. EACH OF THE COMPANY AND THE BANK WAIVES ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING TO ENFORCE OR DEFEND ANY RIGHTS (i) UNDER THIS AGREEMENT OR UNDER ANY AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT DELIVERED OR WHICH MAY IN THE FUTURE BE DELIVERED IN CONNECTION HEREWITH OR (ii) ARISING FROM ANY BANKING RELATIONSHIP EXISTING IN CONNECTION WITH THIS AGREEMENT, AND AGREES THAT ANY SUCH ACTION OR PROCEEDING SHALL BE TRIED BEFORE A COURT AND NOT BEFORE A JURY. NEITHER THE COMPANY NOR THE BANK SHALL BE LIABLE TO THE OTHER FOR CONSEQUENTIAL DAMAGES ARISING FROM ANY BREACH OF CONTRACT, TORT OR OTHER WRONG RELATING TO THE ESTABLISHMENT, ADMINISTRATION OR COLLECTION OF THE LIABILITIES OR RELATING IN ANY WAY TO THIS AGREEMENT OR UNDER ANY AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT DELIVERED OR WHICH MAY IN THE FUTURE BE DELIVERED IN CONNECTION HEREWITH, OR THE ACTION OR INACTION OF THE COMPANY UNDER ANY ONE OR MORE HEREOF OR THEREOF. 11.9 CONSENT TO JURISDICTION. To induce the Bank to accept this Agreement, the Company irrevocably agrees that, subject to the Bank's sole and absolute election, ALL ACTIONS OR PROCEEDINGS IN ANY WAY, MANNER OR RESPECT, ARISING OUT OF OR FROM OR RELATED TO THIS AGREEMENT SHALL BE LITIGATED IN COURTS HAVING SITUS WITH THE CITY OF CHICAGO, STATE OF ILLINOIS. THE COMPANY HEREBY CONSENTS AND SUBMITS TO THE JURISDICTION OF ANY LOCAL, STATE OR FEDERAL COURT LOCATED WITHIN SAID CITY AND STATE AND WAIVES PERSONAL SERVICE OF ANY AND ALL PROCESS UPON THE COMPANY, AND AGREES THAT ALL SUCH SERVICE OF PROCESS MAY BE MADE BY REGISTERED MAIL DIRECTED TO THE COMPANY AT THE ADDRESS STATED ON THE SIGNATURE PAGE HEREOF AND SERVICE SO MADE SHALL BE DEEMED TO BE COMPLETED UPON ACTUAL RECEIPT THEREOF. 11.10 COUNTERPARTS. This Agreement may be executed in any number of counterparts and all of such counterparts taken together shall be deemed to constitute one and the same agreement. [SIGNATURE PAGE FOLLOWS] -40- IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed at Chicago, Illinois by their respective officers thereunto duly authorized as of the date first written above. EXECUTONE INFORMATION SYSTEMS, INC. By:________________________________ David Krietzberg Title: Treasurer Address: 478 Wheelers Farms Road Milford, Connecticut 06460 Attention: Barbara Anderson, Esq. Telecopier number: (203) 882-6607 BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION By:________________________________ L. Richard DiDonato Title: Vice President Address: 231 South LaSalle Street Chicago, Illinois 60697 Attention: L. Richard DiDonato Telecopier number: (312) 828-1974 -41- EXHIBIT A REVOLVING NOTE $35,000,000 Due: January 30, 2000 Chicago, Illinois: October 31,1997 FOR VALUE RECEIVED, the undersigned EXECUTONE INFORMATION SYSTEMS, INC., a Virginia corporation (the "Company"), hereby promises to pay to the order of BANK OF AMERICA NATIONAL TRUST AND SAVINGS ASSOCIATION (the "Bank") the principal sum of THIRTY FIVE MILLION DOLLARS ($35,000,000) or the amount outstanding as endorsed on the grid attached to this Note (or recorded in the Bank's books and records, if the Bank is the holder hereof). Such endorsement or recording by the Bank shall, absent manifest error, be rebuttably presumptive evidence of the principal balance due on this Note. The Company further promises to pay interest on the aggregate unpaid principal amount hereof from time to time outstanding from the date hereof until payment in full at the rates per annum which shall be determined in accordance with the provisions of the Loan Agreement hereinafter referred to. Said interest shall be payable on each date provided for in the Loan Agreement (as defined below); provided, however, that interest on any principal portion which is not paid when due shall be payable on demand. The portions of the principal sum hereof from time to time denominated as Reference Rate Loans or Eurodollar Loans and payments of principal or interest thereof shall be noted by the holder of this Note in its records, or at its option, on the grid schedule attached hereto. All payments of principal and interest under this Note shall be made in immediately available funds at the office of the Bank at 231 South LaSalle Street, Chicago, Illinois 60697, or at such other place as the Bank shall notify the Company in writing. This Note evidences indebtedness incurred by the Company under a Revolving Credit Agreement dated as of October 31, 1997 (as the same may be amended, restated, supplemented or otherwise modified and in effect from time to time, "Loan Agreement"; capitalized terms used but not otherwise defined herein shall have the meanings given to them in the Loan Agreement) between the Company and the Bank, to which Loan Agreement reference is hereby made for a statement of its terms and provisions, including those under which this Note may be paid prior to maturity. The Company expressly waives any presentment, demand, protest or notice in connection with this Note. This Note is made under and governed by the internal laws of the State of Illinois (without regard to conflict of laws provisions thereof). Address: EXECUTONE INFORMATION SYSTEMS, INC. 478 Wheelers Farms Road By:___________________________ Milford, Connecticut 06460 Title:________________________ EX-4 3 EXHIBIT 4.2 EXHIBIT 4.2 AMENDED AND RESTATED LOAN AGREEMENT THIS AMENDED AND RESTATED LOAN AGREEMENT (the"Agreement") is made as of the 22nd day of July, 1996 by and among EXECUTONE INFORMATION SYSTEMS, INC., a Virginia corporation ("Executone"), CERTAIN DESIGNATED EMPLOYEES OF EXECUTONE LISTED ON THE SIGNATURE PAGES HEREOF and Exhibit A ("Borrowers") and BANK OF AMERICA ILLINOIS, an Illinois banking corporation having its principal office at 231 South LaSalle Street, Chicago, Illinois 60697 (formerly known as Continental Bank N.A.) ("Lender"). R E C I T A L S: A. Borrowers, Executone, Bank of America Illinois, Fleet Bank N.A. and Bank of Boston were parties to a certain Loan Agreement dated as of August 30, 1994 (the "Prior Agreement"). B. Borrowers desire Lender to pay in full the portions of the loan held by Fleet Bank N.A. and Bank of Boston as Lenders under the Prior Agreement so that Bank of America Illinois will remain as the sole Lender. C. On the date hereof, the Borrowers hereto together with the balances adjacent to such Borrower's name as set forth on the respective signature page, constitute all of the obligations of such Borrower subject to this Agreement, and Executone may not designate new employee borrowers. NOW, THEREFORE, in consideration of any loan or advance or grant of credit hereafter made to Borrowers by the Lender, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties agree as follows: 1. DEFINITIONS AND OTHER TERMS. 1.1 Definitions. In addition to terms defined elsewhere in this Agreement or any Supplement, Schedule or Exhibit hereto, when used herein, the following terms shall have the following meanings (such meanings shall be equally applicable to the singular and plural forms of the terms used, as the context requires): "Agreement" is defined in the Preamble as it may be amended, restated, modified or supplemented from time to time. "Attorneys' Fees" means the reasonable value of the services (and costs, charges and expenses related thereto) of the attorneys (and all paralegals,secretaries, accountants and other staff employed by such attorneys) employed by the Lender (including but not limited to attorneys and paralegals who are employees of the Lender) from time to time (a) in the case of the Lender, (i) in connection with the negotiation, preparation, execution, delivery, administration and enforcement of this Agreement, any Related Agreement, and all other documents or instruments provided for herein or therein or delivered or to be delivered hereunder or under any thereof or in connection herewith or with any thereof, (ii) to prepare documentation related to the Loans made and other Liabilities incurred hereunder and (iii) to prepare any amendment to or waiver under this Agreement or any Related Agreement and any documents or instruments related thereto and (b) in the case of the Lender (i) to represent the Lender in any litigation, contest, dispute, suit or proceeding or to commence, defend or intervene in any litigation, contest, dispute, suit or proceeding or to file a petition, complaint, answer, motion or other pleading, or to take any other action in or with respect to, any litigation, contest, dispute, suit or proceeding (whether instituted by the Lender, Borrower or any other Person and whether in bankruptcy or otherwise) in any way or respect relating to the Collateral, this Agreement or any Related Agreement, or Borrower's affairs, (ii) to protect, collect, lease, sell, take possession of, or liquidate any of the Collateral, (iii) to attempt to enforce any security interest in any of the Collateral or to give any advice with respect to such enforcement, (iv) to prepare, negotiate and review any amendment to or any waiver under this Agreement or any Related Agreement or any documents or instruments related thereto, and (v) to enforce any right of the Lender to collect any of the Liabilities under this Agreement, any Related Agreement, and all other documents provided for herein or therein. "Banking Day" means any day other than Saturday, Sunday or legal holiday on which banks are authorized or required to be closed for the conduct of commercial banking business in Chicago, Illinois. "Borrower" has the meaning ascribed to such term in the Preamble. "Closing Date" means the date of this Agreement contained on the cover page hereof. "Demand Deposit Account" has the meaning ascribed to such term in the Executone Agreement. -2- "Executone" has the meaning ascribed to such term in the Preamble. "Executone Agreement" means the Second Amended and Restated Loan and Security Agreement between Executone and Lender dated August 30, 1994, as amended, restated, modified or supplemented from time to time. "Event of Default" has the meaning ascribed to such term in Section 7,1. "Letter of Credit Support" means the establishment and maintenance of a stand-by letter of credit on application of Executone pursuant to the Executone Agreement and Section 5.2(a) to support the Borrowers, obligations hereunder. "Liabilities" means with respect to each Borrower, all of the liabilities, obligations and indebtedness of such Borrower to the Lender of any kind or nature under or in connection with this Agreement or any Related Agreement, however created, arising or evidenced, whether direct or indirect, absolute or contingent, now or hereafter existing or due or to become due, and including but not limited to such Borrower's obligations under any Note, and tii) interest, charges, expenses, Attorneys' Fees and other sums chargeable to Borrower by the Lender under this Agreement or any Related Agreement. "Liabilities" shall also include any and all amendments, restatements, extensions, renewals, refundings or refinancings of any of the foregoing. "Loan" means any loan made pursuant to Section 2.2 of the Prior Agreement. "Maximum Eligible Amount" means, with respect to each Borrower, a maximum amount, to be determined by Executone, which was loaned to such Borrower pursuant to the Prior Agreement. "Note" means the promissory note executed by each Borrower substantially in the form attached hereto as Exhibit B evidencing any Loan to any Borrower pursuant to this Agreement or the Prior Agreement. "Person" means any individual, sole proprietorship, partnership, joint venture, trust, unincorporated organization, association, corporation, institution, entity or government (whether national, federal, state, county, city, municipal or otherwise, including, without limitation, any instrumentality, division, agency, body or department thereof). -3- "Reference Rate" means, at any time, the rate of interest then most recently announced by Lender at Chicago, Illinois as its reference rate. Each change in the interest rate on any Loan shall take effect on the effective date of the change in the Reference Rate. "Related Agreement" means any agreement, instrument or document heretofore, now, or hereafter delivered to the Lender with respect to or in connection with or pursuant to this Agreement or any of the Liabilities, and executed by or on behalf of any Borrower. "Stock Option Plan" means the Executone 1994 Executive Stock Incentive Plan established by Executone whereby certain officers of Executone who are participants under such plan may purchase shares of common stock in Executone. "Unmatured Event of Default" means any event or condition which after the giving of notice or lapse of time or both would become an Event of Default. 1.2 Interpretation of Agreement. A Section, an Exhibit, a Supplement or a Schedule is, unless otherwise stated, a reference to a section hereof, an exhibit hereto, a supplement hereto or a schedule hereto, as the case may be. Section captions used in this Agreement are for convenience only and shall not affect the construction of this Agreement. The words "hereof," "herein," "hereto" and "hereunder" and words of similar import when used in this Agreement refer to this Agreement as a whole and not to any particular provision of this Agreement. 1.3 Exercise of Discretion. Unless a different standard is specifically referred to, whenever the Lender is authorized to exercise its discretion herein or in any Related Agreement, Lender shall be entitled to take any action with respect to the matter in question that might be taken by a commercial lender acting in good faith under similar circumstances in connection with a secured financing transaction of the size and nature contemplated by this Agreement and based upon the information then available to such Person(s). 2. EXISTING LOANS. 2.1 On the date of this Agreement, Lender has made Loans to the Borrowers listed on the respective individual Borrower signature pages hereto in the amounts adjacent to such Borrower's name on such signature page (the "Loans"). It is agreed and understood that Executone may not, without further amendment, designate additional Borrowers. The Loans shall be subject to the Agreement as restated hereby and shall continue to be evidenced by the Notes. It is agreed and understood -4- that this is not a revolving facility and once repaid, no Loan may be reborrowed. 2.2 Notes. Each Loan is evidenced by a Note to Lender substantially in the form attached hereto as Exhibit B. 2.3 Principal Payments. The aggregate principal amount of the Loans made to each Borrower shall be repaid on August 30, 1999. Any Loan may be prepaid in whole or in part at any time. 3. INTEREST AND FEES. 3.1 Interest Rate. The outstanding principal balance of the Loans and other Liabilities of Borrowers hereunder shall bear interest until paid at a fluctuating rate per annum equal to the Reference Rate less one-half of one percent (0.50%), provided, however, that if any amount of any Loan to any Borrower is not paid when due, whether by acceleration or otherwise, the entire unpaid principal balance of the Loan made to such Borrower shall accrue at a rate per annum equal to the greater of (a) the rate of interest which is three percent (3%) higher than the applicable per annum rate of interest otherwise payable hereunder or (b) the rate of interest which is three percent (3t) higher than the applicable per annum rate of interest in effect at the time such amount became due. Interest on the unpaid principal amount of each Loan shall accrue from and including the date the Loan was made to, but not including, the date such Loan is paid. Interest and any fee shall be calculated an the basis of a year consisting of 360 days and paid for actual days elapsed. 3.2 Interest Payments. Interest is payable by each Borrower quarterly, in arrears, on the last Banking Day on each calendar quarter (March 31, June 30, September 30, and December 31). Executone hereby agrees that Lender may provide for the payment of such interest by charging Executone's Demand Deposit Account established with Lender pursuant to the Executone Agreement. 3.3 Fee. Executone agrees to pay Lender on each August 30 during the term hereof, an annual arrangement fee of Five Thousand Dollars ($5,000). 3.3 Attorneys' Fees. Executone agrees to pay all Attorneys' Fees. 4. CONDITIONS PRECEDENT; DELIVERY OF DOCUMENTS. 4.1 Conditions Precedent to Effectiveness of this Agreement. The effectiveness of this Agreement and the obligation of the Lender to make or continue the Loans to each -5- Borrower is subject to Section 4.2 hereof and satisfaction of the following conditions precedent: (a) Executone Agreement. The Executone Agreement shall continue to be in full force and effect as evidenced by Executone's signature to this document; (b) Fees and Expenses. All fees and expenses of the Lender that are payable by Borrowers or Executone pursuant to this Agreement shall be paid in full; (c) Secretary's Certificate. The Lender shall have received a Certificate of Executone's Secretary or Assistant Secretary, in the form of Exhibit D hereto, certifying (i) that attached thereto is a true and complete copy of the Stock Option Plan as in effect on the date thereof; (ii) that attached thereto is a true and complete copy of the resolutions of Executone's Board of Directors establishing and authorizing the Stock Option Plan and the execution and delivery of this Agreement and the provisions of the Letter of Credit Support as contemplated hereunder, (iii) attached thereto is a true and complete copy of Executone's Articles of Incorporation and Bylaws as in effect on the date thereof, and (iv) a verification of the incumbency of all officers of Executone duly authorized to execute and delivery this Agreement and any Related Agreement on behalf of Executone; (d) Opinion of Counsel. The Lenders shall have received a satisfactory opinion of counsel to Executone, substantially in form of Exhibit E hereto; (e) No Conflict. No law or regulation affecting any Lender's entering into the secured financing transaction contemplated by this Agreement shall impose upon any Lender any material obligation, fee, liability, loss, cost, expense or damage; (f) No Event of Default. There is no event of default or unmatured event of default under the Prior Agreement or under the Executone Agreement; and (g) Letter of Credit Support. The Letter of Credit substantially in the form of Exhibit C shall be in full force and effect for an amount equal to at least 102.6% of the aggregate principal amount of the Loans listed on the Borrower's signature pages hereto. 4.2 Effectiveness of Agreement with Respect to Each Borrower. The Agreement shall take effect with respect to each Borrower when Lender receives an executed signature page for each -6- Borrower and a Note executed by such Borrower. Upon receipt of the Notes, Lender will record the accurate unpaid principal amount of the Notes issued under the Prior Agreement in its records as the aggregate unpaid principal amount of the Note, mark the original Notes as replaced by the Note and, on request, return the original Notes to the Borrower. All references in the Agreement to Notes shall be deemed to refer to the Note executed in connection with this restated Agreement. The replacement of the original Notes with the Note shall not be construed to deem paid or forgiven the unpaid principal amount of, or unpaid accrued interest on, the original Notes outstanding at the time of replacement. 5. BORROWER COVENANTS. Each Borrower agrees for him or herself that until all of the Liabilities of such Borrower are paid in full, unless Lender shall otherwise consent in writing, he or she will: 5.1 Financial Reports. Within ninety (90) days after the end of each calendar year, provide the Lender, as requested, with a personal financial statement (using the financial statement format provided in connection with the Prior Agreement. 5.2 Notices. Notify the Lender in writing (or by telephone with written confirmation to follow within two -(2) Banking Days of the telephone call) immediately upon learning of the occurrence of an Event of Default. 5.3 Further Information. Promptly provide, upon the request of Lender, any further information or documents to Lender that Lender may reasonably require from time to time in relation to this Agreement or any Related Agreement. 5.4 Use of Proceeds. The proceeds of each Loan requested under Section 2.1 of the Prior Agreement have been used by Borrowers only to purchase shares of common stock in Executone pursuant to and in conformity with the Stock Option Plan. 6. DEFAULT. 6.1 Event of Default. With respect to each Borrower, each of the following shall constitute an "Event of Default" under this Agreement: (a) Non-Payment. Default in the payment, when due or declared due, of any of such Borrower's Liabilities; (b) False Information in the Designation. Any information provided by such Borrower or by Executone with respect to such Borrower herein, in any Designation or any - 7 - Borrowing Notice or otherwise in connection with this Agreement or the Related Agreements shall prove to be false or misleading in any material respect at the time made; (c) Non-Compliance with this Agreement. Default in the performance of any of Borrower's agreements set forth herein or in any Related Agreement (and not constituting an Event of Default under any of the other subsections of this Section 6.1), and the continuance of such default for more than thirty (30) days after notice thereof to Borrower from Lender; (d) Dismissal. Such Borrower's employment with Executone is terminated for any reason by either Executone or such Borrower; (e) Insolvency. Such Borrower becomes insolvent, or generally fails to pay, or admits in writing his or her inability to pay, his or her debts as they mature, or applies for, consents to, or acquiesces in the appointment of a trustee, receiver or other custodian for such Borrower or for a material part of the property of such Borrower or makes a general assignment for the benefit of creditors; or, in the absence of such application, consent or acquiescence, a trustee, receiver or other custodian is appointed for such Borrower or for a substantial part of the property of Borrower and is not discharged or dismissed within thirty (30) days; or any bankruptcy, reorganization, debt arrangement or other proceeding under any bankruptcy or insolvency law, or any dissolution or liquidation proceeding, is instituted by such Borrower; or any bankruptcy, reorganization or other proceeding under any bankruptcy or insolvency law is instituted against such Borrower and is not discharged or dismissed within 30 days; or any warrant of attachment or similar legal process is issued against any substantial part of the property of such Borrower; (f) Default under the Executone Agreement. Any "Event of Default" (as defined in the Executone Agreement) occurs under the Executone Agreement; (g) Executone's Failure to Perform. Executone fails to perform any of its obligations hereunder pursuant to this Agreement; and (h) Letter of Credit Support. The issuer of the Letter of Credit Support shall have notified the Lender that the Letter of Credit Support shall not be renewed or that it shall he terminated for any reason at any time prior to its expiration. -8- 6.2 Effect of Event of Default; Remedies; (a) In the event that one or more Events of Default described in Section 6.1(e) shall occur with respect to a Borrower, such Borrower's Note or Notes shall be immediately due and payable without demand, notice or declaration of any kind whatsoever. (b) In the event an Event of Default with respect to a Borrower other than one described in Section 6.1(e) shall occur, then Lender may declare all Liabilities of such Borrower immediately due and payable without demand or notice of any kind whatsoever. (c) The Lender may exercise any one or more or all of the following remedies, all of which are cumulative and nonexclusive; (i) Any remedy contained in this Agreement or in any of the Related Agreements; (ii) Any rights and remedies available to Lender under the Uniform Commercial Code or any other applicable law; and (iii) Draw upon the Letter of Credit Support in accordance with its terms. However, notwithstanding anything herein to the contrary, if an Event of Default described in Section 6.1(h) shall occur, then the Lender shall draw upon the Letter of Credit Support. In addition, should any Event of Default occur and be continuing with respect to any Borrower, Lender may draw upon the Letter of Credit Support, either (i) as necessary to repay any amounts then due and owing to Lender from such Borrower or (ii) as necessary to repay Lender the entire amount of the Liabilities owing to Lender from such Borrower under the terms of the applicable Note and this Agreement, whether or not such amounts are then due. 7. MISCELLANEOUS. 7.1 Covenant of Executone. Executone shall promptly notify Lender of (i) the termination of any Borrower's employment with Executone, or (ii) any alteration, amendment or termination of the Stock Option Plan. 7.2 Borrower Waiver. Except as otherwise provided for in this Agreement, each Borrower waives (i) presentment, demand and protest and notice of presentment, protest, default, non-payment, maturity, release, compromise, settlement, one or more extensions -9- or renewals of any or all Notes, contract rights, documents, and instruments, at any time held by the Lender on which any Borrower may in any way be liable and hereby ratifies and confirms whatever the Lender may do in this regard. Borrower acknowledges that it has been advised by counsel of its choice with respect to this Agreement and the transactions evidenced by this Agreement. 7.3 Lawful Interest. In no contingency or event whatsoever shall the interest rate charged pursuant to the terms of this Agreement exceed the highest rate permissible under any law which a court of competent jurisdiction shall, in a final determination, deem applicable hereto. In the event that such a court determines that any Lender has received interest hereunder or under any Note in excess of the highest lawful rate, such Lender shall promptly refund such excess interest to the applicable Borrower. 7.4 Notices. Except as otherwise expressly provided herein, any notice hereunder to any and all Borrowers or the Lender shall be in writing and shall be given to the affected Borrower, or the Lender at its address or facsimile number set forth on the signature page hereof or at such other address or facsimile number as such party may, by written notice, designate for purposes of notices hereunder. All such notices shall be deemed to be given when transmitted by facsimile and receipt thereof confirmed by telephone, delivered by courier, personally delivered or, in the case of notice by mail, three (3) Banking Days following deposit in the United States mails, properly addressed as herein provided, with proper postage prepaid. 7.5 Severability. Any provision of this Agreement which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof or affecting the validity or enforceability of such provision in any other jurisdiction. 7.6 Successors. This Agreement shall be binding upon Borrowers, Executone, and the Lender and the assigns of the Lender. None of the Borrowers or Executone shall assign their rights or duties hereunder without the consent of the Lender. 7.7 Construction and Governing Law. Each of the Borrowers and Executone acknowledge that this Agreement shall not be binding upon the Lender or become effective until and unless accepted by the Lender in writing. If so accepted by the Lender, this Agreement and the Related Agreements shall, unless otherwise expressly provided therein, be deemed to have been negotiated and entered into in, and shall be governed and controlled by the laws of, the State of Illinois as to interpretation, enforcement, validity, construction, effect, choice of -10 - law, and in all other respects, including, but not limited to the legality of the interest rate and other charges, but excluding perfection of security interests and liens which shall be governed and controlled by the laws of the relevant jurisdiction. 7.8 Consent to Jurisdiction. To induce the Lender to accept this Agreement, each of the Borrowers and Executone irrevocably agrees that, subject to the Lender's sole and absolute election, ALL ACTIONS OR PROCEEDINGS IN ANY WAY, MANNER OR RESPECT, ARISING OUT OF OR FROM OR RELATED TO THIS AGREEMENT, OR THE RELATED AGREEMENTS SHALL BE LITIGATED IN COURTS HAVING SITUS WITHIN THE CITY OF CHICAGO, STATE OF ILLINOIS. BORROWERS AND EXECUTONE HEREBY CONSENT AND SUBMIT TO THE JURISDICTION OF ANY LOCAL, STATE OR FEDERAL COURT LOCATED WITHIN SAID CITY AND STATE AND WAIVE PERSONAL SERVICE OF ANY AND ALL PROCESS, AND AGREE THAT ALL SUCH SERVICE OF PROCESS MAY BE MADE BY REGISTERED MAIL DIRECTED TO BORROWERS AND EXECUTONE AT THE ADDRESS STATED ON THE SIGNATURE PAGE HEREOF AND SERVICE SO MADE SHALL BE DEEMED TO BE COMPLETED UPON ACTUAL RECEIPT THEREOF. 7.9 Counterparts. This Agreement may be executed in any number of counterparts and by the different parties on separate counterparts, and each such counterpart shall be deemed to be an original, but all such counterparts shall together constitute but one and the same Agreement. Executone and each of the Borrowers agree that the failure of any one or more of the Borrowers to execute this Agreement does not waive or excuse the obligations and duties of Executone and any of the Borrowers who do execute this Agreement. 7.10 WAIVER OF JURY TRIAL; WAIVER OF CONSEOUENTIAL DAMAGES. EACH BORROWER, EXECUTONE, AND THE LENDER WAIVES ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING TO ENFORCE OR DEFEND ANY RIGHTS (i) UNDER THIS AGREEMENT OR ANY RELATED AGREEMENT OR UNDER ANY AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT DELIVERED OR WHICH MAY IN THE FUTURE BE DELIVERED IN CONNECTION HEREWITH OR (ii) ARISING FROM ANY BANKING RELATIONSHIP EXISTING IN CONNECTION WITH THIS AGREEMENT, AND AGREES THAT ANY SUCH ACTION OR PROCEEDING SHALL BE TRIED BEFORE A JUDGE AND NOT BEFORE A JURY. NONE OF THE BORROWERS, EXECUTONE OR THE LENDER SHALL BE LIABLE TO THE OTHER FOR CONSEQUENTIAL DAMAGES ARISING FROM ANY BREACH OF CONTRACT, TORT OR OTHER WRONG RELATING TO THE ESTABLISHMENT, ADMINISTRATION OR COLLECTION OF THE LIABILITIES OR RELATING IN ANY WAY TO THIS AGREEMENT OR ANY RELATED AGREEMENT OR UNDER ANY AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT DELIVERED OR WHICH MAY IN THE FUTURE BE DELIVERED IN CONNECTION HEREWITH, OR THE ACTION OR INACTION OF ANY BORROWER UNDER ANY ONE OR MORE HEREOF OR THEREOF. -11- 7.11 Amendment and Restatement of Prior Agreement. The Prior Agreement shall, upon execution hereof, be deemed to be amended and restated in the form hereof and Lender shall return to the Borrowers the promissory notes issued to the Lenders under the Prior Agreement, upon execution of new promissory notes payable to Lender, it being understood that Loans hereunder constitute indebtedness under the Prior Agreement, as amended and restated hereby. 12 IN WITNESS WHEREOF, the parties hereto have either executed this Agreement individually or caused this Agreement to be executed by their respective officers thereunto duly authorized as of the date first written above. EXECUTONE INFORMATION SYSTEMS, INC. By:David Krietzberg Its: Treasurer Address: 478 Wheelers Farms Road Milford, Connecticut 06460 Telephone: (203) 876-7600 Facsimile: (203) 882-0400 Attention: Barbara Anderson, Esq. BANK OF AMERICA ILLINOIS By: PF Wilcox Its Vice President Address: 231 South LaSalle Street Chicago, Illinois 60697 Telephone: (312) 828-2345 Facsimile: (312) 974-0357 Attention: Private Bank -13- EX-10 4 EXHIBIT 10.19 EXHIBIT 10-19 NEITHER THIS WARRANT NOR THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF THIS WARRANT HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (the "Act"). NEITHER THIS WARRANT NOR SUCH SHARES MAY BE SOLD, TRANSFERRED, PLEDGED OR HYPOTHECATED EXCEPT AS PROVIDED IN SECTION 4 OF THE WARRANT TO PURCHASE COMMON STOCK OF THE COMPANY EXPIRING JULY 29, 2002, A COPY OF WHICH IS ON FILE AT THE PRINCIPAL OFFICE OF THE COMPANY. Issued as of Void after July 29, 2002 July 29, 1997 WARRANT TO PURCHASE 25,000 SHARES OF COMMON STOCK OF EXECUTONE INFORMATION SYSTEMS, INC. (incorporated under the Laws of the Commonwealth of Virginia) THIS IS TO CERTIFY THAT, LOUIS K. ADLER ("Adler") or his permitted registered assigns (Adler and such assigns sometimes hereinafter being referred to as the "Holder"), is entitled, subject to the terms and conditions set forth herein, and further subject to an adjustment as hereinafter provided, to purchase from EXECUTONE INFORMATION SYSTEMS, INC., a Virginia corporation (the "Company"), an aggregate of Twenty-Five Thousand (25,000) fully paid and nonassessable shares (the "Underlying Shares") of the common stock of the Company, $0.01 par value ("Common Stock"), upon payment of the purchase price of FIFTY THOUSAND DOLLARS ($50,000.00) or TWO DOLLARS AND ZERO CENTS ($2.00) per Underlying Share (the "Purchase Price"), and also is entitled to exercise the other appurtenant rights, powers and privileges hereinafter set forth at any time from and after 9:00 a.m. (Eastern Standard Time) July 29, 1997 and on or before 5:00 p.m. (Eastern Standard Time), on July 29, 2002. This Warrant (the "Warrant") entitles the Holder hereof to purchase up to an aggregate of 25,000 shares of Common Stock, which right shall vest ratably over a period of three (3) years, one-third on July 29, 1998, one-third on July 29, 1999 and one-third on July 29, 2000; provided, however, that if Adler ceases to be a director of the Company, either voluntarily or because he has not been reelected by the Shareholders of the Company, then Adler's vesting of rights shall terminate as of the date he is no longer a director of the Company. THE EXERCISE AND TRANSFER OF THIS WARRANT ARE RESTRICTED BY THE PROVISIONS OF SECTION 4 HEREOF Exercise of Warrant. This Warrant may be exercised in whole or in part by the Holder hereof, by delivery to the Company at its principal office at 478 Wheelers Farms Road, Milford, CT 06460 of (a) a written notice to the Holder, in substantially the form of the Subscription Notice attached hereto as Exhibit "A", of such Holder's election to exercise this Warrant, which notice shall specify the number of Underlying Shares to be purchased, (b) a check payable to the Company in an amount equal to the aggregate Current Price (as defined below) of the number of shares of Common Stock being purchased and (c) this Warrant. The Company shall, as soon as reasonably practicable, execute and deliver or cause to be delivered to Holder, in accordance with such notice, one or more certificates representing the aggregate number of shares of Common Stock specified in such notice. The stock certificate(s) so delivered shall be issued in the name of the Holder or such other name as shall be designated in such notice. Such certificate(s) shall be deemed to have been issued and the Holder or any other person so designated to be named therein shall be deemed for all purposes to have become a Holder of record of such Underlying Shares as of the date such notice is received by the Company. If this Warrant shall have been exercised only in part, the Company shall, at the time of delivery of said certificate(s), deliver to the Holder a new Warrant evidencing the rights of the Holder to purchase the remaining shares of Common Stock called for by this Warrant (stated in Shares), which new Warrant shall in all other respects be identical to this Warrant, or, at the request of the Holder, appropriate notation may be made on this Warrant and the same returned to the Holder. 2. Fractional Shares. This Warrant is only exercisable with respect to whole Underlying Shares and not fractions thereof unless the Company otherwise agrees. Accordingly, the Company shall not be required to issue certificates representing fractions of Underlying Shares upon any exercise of this Warrant; provided, however, in respect of any final fraction of a share it may, at its sole option, in lieu of delivering a fractional share, make a payment in cash based upon the then fair market value of such fraction of the Underlying Shares. 3. Transfer, Division and Combination. No Warrant granted under this Agreement shall be transferable by Adler otherwise than by Will or the laws of descent and distribution and, during the lifetime of Adler, shall not be exercisable by any other person, but only by him. The Company agrees to maintain at its principal office in Milford, Connecticut, books for the registration and transfer of the Warrants and, subject to the provisions of this paragraph and Section 4 hereof, this Warrant and all rights hereunder are transferable ONLY with respect to (i) Adler's heirs and devisees, or (ii) Adler's Estate in whole or in part, on such books upon surrender of this Warrant at such office, together with a written assignment of this Warrant duly executed by the Holder hereof or his agent or attorney, and with funds sufficient to pay any stock transfer taxes payable upon the making of such transfer. Upon surrender and payment, the Company shall execute and deliver a new Warrant(s) in the name of the assignee of Holder and in the denominations specified in such instrument of assignment, and this Warrant shall be canceled promptly. If and when this Warrant is assigned in blank, the Company may, but shall not be obligated to, treat the bearer hereof as the absolute owner of this Warrant for all purposes and the Company shall not be affected by any notice to the contrary. A warrant may be exercised by a Holder for the purchase of shares of Common Stock without having a new Warrant issued. The Company shall pay all expenses, taxes (other than stock transfer taxes and any of Holder's income taxes, if any, incurred as a result of the transfer) and other charges payable in connection with the preparation, issue and delivery of Warrants hereunder. 4. Restriction on Exercise and Transfer of Warrants and Transfer of Warrants and Common Stock. Except as otherwise provided herein, this Warrant and the certificates representing the Underlying Shares shall be stamped or otherwise imprinted with a legend substantially in the following form: "Neither this Warrant nor the shares of Common Stock issuable upon exercise of this Warrant have been registered under the Securities Act of 1933, as amended (the "Act"). Neither this Warrant nor such Shares may be sold, transferred, pledged or hypothecated except as provided in Section 4 of the Warrant to purchase Common Stock of the Company expiring July 29, 2002, a copy of which is on file at the principal office of the Company." This Warrant shall be exercisable (1) only if the issue of Underlying Shares issuable upon exercise is exempt from the requirements of registration under the Securities Act of 1933, as amended (the "Act") (or any similar statute then in effect) and any applicable state securities law or (2) upon registration of such Underlying Shares in compliance therewith. This Warrant shall be transferable only (i) with the prior written consent of the Company, or (ii) by will or the laws of descent and distribution, and in either event only if the Warrant is registered or the transfer is exempt from the requirements of registration under the Act (or any similar statute then in effect) and any applicable state securities law. 5. Acknowledgment by the Holder of Restrictions. The Holder of this Warrant and certificates representing the Underlying Shares, by acceptance hereof and thereof, acknowledges and agrees that: (a) the Warrant and the Underlying Shares have not been registered under the Act in reliance upon exemptions from the registration provisions of the Act set forth therein, or in the rules and regulations promulgated thereunder (and there is no obligation on the part of the Company to register the Warrant or the Underlying Shares under the Act); and (b) the Warrant and the Underlying Shares will not be freely tradeable. The Holder represents that he fully understands the restrictions on his ability to transfer this Warrant and the Underlying Shares. Without limiting the foregoing and by way of illustration only, the Holder understands that if he presently desired to sell Underlying Shares pursuant to the exemption from the registration provisions of the Act contained in Rule 144 (the "Rule") promulgated under the Act, as presently constituted, such Underlying Shares might be sold by him pursuant to the Rule only after a minimum holding period of two (2) years (computed in accordance with the Rule) and, thereafter, only in the limited amounts, in the manner and under the limited circumstances prescribed by the Rule. 6. Change in Control. The Warrant that is outstanding on a Control Change Date, as hereinafter defined, shall be exercisable in whole or in part on that date and thereafter during the remainder of the Warrant period stated in this Warrant Agreement (the "Agreement"). A Change in Control occurs if, after the date of this Agreement, (i) any person, including a "group" as defined in Section 13(d)(3) of the Securities and Exchange Act of 1934 (the "Exchange Act"), becomes the owner or beneficial owner of Company securities having twenty percent (20%) or more of the combined voting power of the then outstanding Company securities that may be cast for the election of the Company's directors (other than as a result of an issuance of securities initiated by the Company, or open market purchases approved in advance by the board, as long as the majority at the time the purchases are made are directors who were members of the Board immediately prior to the purchases being made and approved such purchases); or (ii) as the direct or indirect result of, or in connection with, a cash tender or exchange offer, a merger or other business combination, a sale of assets, a contested election, or any combination of these transactions, the persons who were directors of the Company before such transactions cease to constitute a majority of the Company's Board, or any successor's board, within two (2) years of the last of such transactions. For purposes of this Agreement, the Control Change Date is the date on which an event described in (i) or (ii) occurs. If a Change in Control occurs on account of a series of transactions, the Control Change Date is the date of the last of such transactions. 7. Change in Management. Notwithstanding any specified vesting or applicable early exercise Warrant prices, if this Warrant is outstanding on the date Adler's directorship with the Company is terminated or constructively terminated (as described herein) as a direct or indirect result of the occurrence of one of the events specified in subsections (i) or (ii) of this paragraph, this Warrant shall be exercisable, in whole or in part, at the lowest Warrant price available during the term of the Warrant, on that date and thereafter during the remainder of the Warrant period stated herein. Such exercisability will occur if after the date of the Agreement, (i) any person, including a "group" as defined in Section 13(d)(3) of the Exchange Act, becomes the owner or beneficial owner of Company securities having twenty percent (20%) or more of the combined voting power of the then outstanding Company securities that may be cast for the election of the Company's directors (other than as a result of an issuance of securities initiated by the Company); or (ii) the Company is the subject of a successful cash tender or exchange offer, is a party to a merger or other business combination, sells a substantial portion of its assets, experiences a change in management brought about by a contested election or participates in any combination of these transactions. For purposes of this paragraph, the Transaction Date is the date on which an event described in subsections (i) or (ii) hereof occurs. The date upon which Adler is no longer a member of the Board of Directors of the Company either through resignation, a majority of the shareholders of the Company not voting for Adler as a director or voting for his earlier removal with or without cause or through his removal by a majority of the members of the Board of Directors shall constitute a constructive termination of Adler's directorship with the Company within the meaning of this paragraph. In the event Adler's service as a director of the Company terminates for any other reason or due to any other cause, including death, or a resignation or removal that is not a direct or indirect result of the events described above, then this Warrant shall be exercisable, to the same extent it was exercisable at the date of termination, for a period of seven months following the date of termination, provided that in no event shall this Warrant be exercisable after July 29, 2001. 8. Current Price: Adjustments. As used in this Warrant, "Current Price" (per share of Underlying Stock) at any date shall mean the amount equal to the quotient resulting from dividing (i) the purchase price per Share provided herein by (ii) the number of shares (including any fractional share) of Underlying Shares comprising a Share on such date. A "Share" shall consist initially of one share of Common Stock of the Company as such stock is constituted on the date of this Agreement. The Purchase Price of a Share shall be Two Dollars and Zero Cents ($2.00). In the event that the outstanding Common Stock of the Company is hereafter changed by reason of reorganization, merger, consolidation, recapitalization, reclassification, stock split-up, combination of Shares, stock dividends or the like, an appropriate adjustment shall be made by the Board of Directors in the aggregate number of Underlying Shares available under this Warrant and in the number of Underlying Shares and price per Underlying Share subject to outstanding Warrants. If the Company shall be reorganized, consolidated or merged with another corporation, or if all or substantially all of the assets of the Company shall be sold or exchanged, the Holder of the Warrant shall, at the time of issuance of the stock under such corporate event, be entitled to receive upon the exercise of the Holder's Warrant the same number and kind of shares of stock or the same amount of property, cash or securities as the Holder would have been entitled to receive upon the happening of any such corporate event as if the Holder had been, immediately prior to such event, the Holder of the number of Underlying Shares covered by the Holder's Warrant. Any adjustment in the number of Underlying Shares shall apply proportionately to only the unexercised portion of the Warrant granted hereunder. If a fraction of a share would result from any such adjustment, the adjustment shall be revised to the next lower whole number of Underlying Shares. 9. Reservation of Shares. The Company covenants and agrees that (a) so long as this Warrant is outstanding, it has or will reserve and keep available out of its authorized but unissued Common Stock, solely for the purpose of issuing Underlying Shares from time to time upon the exercise of this Warrant, an adequate number of Shares of Common Stock for delivery at the times and in the manner provided herein upon exercise of this Warrant; (b) the Underlying Shares delivered upon exercise of this Warrant shall be validly issued and outstanding and fully paid and nonassessable shares of Common Stock, free from any preemptive rights; and (c) it will pay when due any and all Federal and state original issue taxes which may be payable with respect to the issuance of the Warrant or of any Shares of Common Stock upon exercise of the Warrant. The Company shall not, however, be required (i) to pay any transfer tax which may be payable with respect to any transfer of the Warrant, the issuance of certificates of Common Stock in a name other than that of the Holder or any transfer of Underlying Shares or (ii) to pay any Federal or state income taxes of Holder which may occur as a result of the exercise of the Warrant or (iii) to issue or deliver the Warrant or any certificate for Underlying Shares until any such taxes shall have been paid by the Holder. 10. No Rights of Shareholders; Limitation of Liability. No Holder shall, based on being a holder of this Warrant, be entitled to vote or receive dividends or be deemed the holder of Common Stock or any other security of the Company which may at any time be issuable on the exercise hereof for any purpose, nor shall anything contained herein be construed to confer upon the Holder, as such, any of the rights of a shareholder of the Company or any right to vote for the election of directors or upon any matter submitted to shareholders at any meeting thereof, or to give or withhold consent to any corporate action (whether upon any recapitalization, issue of stock, reclassification of stock, change to or of par value, consolidation, merger, conveyance or otherwise) or to receive notice of meetings, or to receive dividends or subscription rights or otherwise until this Warrant shall have been exercised in accordance with Section 1 hereof. No provisions hereof, in the absence of affirmative action by the Holder hereof to purchase shares of Common Stock, and no mere enumeration herein of rights or privileges of the Holder hereof, shall give rise to any liability of such Holder for the purchase price or as a shareholder of the Company, whether such liability is asserted by the Company, creditors of the Company or others. 11. Replacement of Securities. Upon receipt of evidence reasonably satisfactory to the Company of the loss, theft, destruction or mutilation of any certificates evidencing ownership of this Warrant and in the event of any such loss, theft or destruction upon delivery of an indemnity agreement or, if the Holder so elects, a surety bond reasonably satisfactory to the Company or, in the case of any such mutilation, upon surrender and cancellation of any such certificate, the Company shall forthwith execute and deliver in lieu thereof a new Warrant of like tenor. 12. Negotiability. Every Holder of this Warrant, by accepting the same, consents and agrees with the Company that (a) this Warrant is transferable, in whole or in part, only upon compliance with the conditions set forth herein by the registered holder hereof in person or by an attorney duly authorized in writing by the Holder at the office of the Company as provided herein; (b) this Warrant may be transferred by the Holder only with respect to that portion of the Warrant to which the Holder is vested at the time of such transfer; and (c) the Company may deem and treat the person in whose name this Warrant is registered as the absolute, true and lawful owner for all purposes whatsoever, and the Company shall not be affected by any notice to the contrary. 13. Change; Waiver; Applicable Law. This Warrant and any term hereof may be changed, waived, discharged or terminated only by an instrument in writing signed by the party against whom enforcement of such change, waiver, discharge or termination is sought. This Warrant shall be construed and enforced in accordance with the laws of the Commonwealth of Virginia. 14. Notices. Any notice to be given to the Company under the terms hereof shall be addressed to the Company in care of its President at 478 Wheelers Farms Road, Milford, Connecticut 06820, and any notice to the Holder shall be addressed to his address as reflected on the records of the Company, or at such other address as the Company, the Holder and his successors or assigns may hereafter designate in writing to the other. Any such notice shall have been deemed given upon personal delivery or on the third business day after being enclosed in a properly sealed envelope or wrapper properly addressed, registered or certified and deposited (postage and registry or certification fee prepaid) in post office or branch post office regularly maintained by the United States Government. 15. Forms of Election to Exercise or Transfer Warrant. The form to be used in the event the Holder hereof desires to exercise or transfer the Warrant is attached hereto as Exhibit "A". IN WITNESS WHEREOF, the Company has caused this Warrant to be signed in its name by its President or a duly authorized Vice President. DATED this 29th day of July, 1997 COMPANY: EXECUTONE INFORMATION SYSTEMS, INC., a Virginia corporation By: Alan Kessman _____________ Alan Kessman Its: President [CORPORATE SEAL] ATTEST: Barbara C. Anderson ___________________ Barbara C. Anderson Vice President, General Counsel and Secretary HOLDER: By ______________________ Louis K. Adler EX-10 5 EXHIBIT 10.22 EXHIBIT 10-22 EXHIBIT 10-22 CONTAINS MATERIAL THAT IS THE SUBJECT OF A REQUEST FOR CONFIDENTIAL TREATMENT PURSUANT TO RULE 24B-2 UNDER THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. EXECUTONE INFORMATION SYSTEMS, INC. AMENDED AND RESTATED DISTRIBUTOR AGREEMENT AGREEMENT effective as of April 1, 1998, between EXECUTONE INFORMATION SYSTEMS, INC., a Virginia corporation ("Company") and Claricom, Inc., d/b/a/ Executone Business Solutions, a Delaware corporation ("Distributor"). WHEREAS, the parties hereto are currently party to a Distributor Agreement dated as of May 31, 1996, amended as of December 19, 1996 (as amended, the "Prior Agreement"), pursuant to which Company (as defined in Section 25 below) has appointed Distributor as an Authorized Distributor in certain territories for Authorized Products and Authorized Software; WHEREAS, the execution and delivery of the Prior Agreement was a condition to Distributor's Purchase and the Company's sale of the Company's DSO Business as defined in the Purchase Agreement pursuant to an Asset Purchase Agreement by and among the Company, EXECUTONE Network Services, Inc., Claricom Holdings, Inc. (formerly known as Tone Holdings, Inc.) and the Distributor dated April 9, 1996, as amended (the "Purchase Agreement"); WHEREAS, the parties to the Prior Agreement wish to amend and restate the Prior Agreement as provided herein; WHEREAS, Company wants to appoint Distributor as an Authorized Distributor of the products described in Exhibit B (the "Authorized Products"), including spare parts therefor, and as a licensee of any Software imbedded therein or otherwise an integral part thereof described in Exhibit B (the "Authorized Software"), within the area described in Exhibit A to this Agreement ("Distributor's Area"); and WHEREAS, Distributor wants to be appointed, to promote the sale and service of the Authorized Products, and to sublicense the use of the Authorized Software in conjunction with the sale of the Authorized Products; NOW, THEREFORE, in consideration of the mutual promises in this Agreement and other good and valuable consideration, the parties agree as follows: 1. AUTHORIZED DISTRIBUTOR. Except as provided in the Cross-Territorial Policy attached hereto as Exhibit D, which is hereby incorporated by reference in this Agreement, Distributor is granted the non-exclusive rights, as indicated in Exhibit B, and, in accordance with the terms of this Agreement Distributor agrees, to sell, service and maintain the Authorized Products and to sublicense the Authorized Software throughout Distributor's Area. Authorized Products and Authorized Software are the products and software in the Product Group described in the Exhibit B executed by the Distributor and for which a Quota has been agreed to by execution of a related Exhibit J. Distributor is not authorized hereunder to market, sell, license, sublicense or service National Accounts or Federal Accounts except as provided in Exhibit E ("National Accounts Policy" or "NAP") and Exhibit F ("Federal Accounts Policy" or "FAP"), respectively, each of which shall be effective only if separately executed by Distributor and Company. Distributor is not authorized hereunder to market, sell, license, sublicense or service the Authorized Products or Authorized Software to Call Center Customers or Health Care Accounts, except as provided in Exhibit G ("CCM Accounts Policy" or "CAP") or Exhibit H ("Health Care Accounts Policy" or "HCAP"), each of which shall be effective only if separately executed by Distributor and the Company; provided, however, that Distributor is authorized to offer, sell, install and service Authorized Telephony Products and offer, license, install and service Authorized Telephony Software to Health Care Accounts who are not Health Care National Accounts or acute care hospitals in those portions of Distributor's Area in which there is no exclusive authorized Health Care Product Group distributor. The portions of Distributor's Area in which there is an exclusive Health Care Product Group distributor are marked on Exhibit A hereto. 2. COMPANY SUPPORT OF DISTRIBUTOR NETWORK. In order to support Company's nationwide network of authorized distributors, Company shall: (a) refer to Distributor a portion of the leads for Authorized Products and Authorized Software in each county in Distributor's Area of which Company becomes aware, in the same proportion as Distributor bears to the number of all authorized distributors of Authorized Products and Authorized Software for such county in Distributor's Area; (b) make available promotional programs and materials from time to time at Company's discretion subject to Company's normal charges for such programs and materials; (c) sell, at special prices or terms, an assortment of the Authorized Products to be used by Distributor to demonstrate those products to customers and to train personnel; (d) make available courses and materials for training Distributor's personnel at Company's normal charges; (e) make available technical and service support, including installation and technical manuals, subject to Company's normal charges for such support, except that technical support shall be provided free of charge to technicians and other Distributor representatives who are employed by Distributor (while Distributor is an authorized distributor) on products or software for which the requesting Distributor representative is currently Company-certified; (f) market the Authorized Products directly to National Accounts, Cross-Territorial Accounts and Company Accounts (as defined below) in accordance with the Cross-Territorial Policy and the applicable Company Account Policy, all of which Company expressly reserves the right to amend (except as provided therein) from time to time when Company in its reasonable discretion determines such amendment to be desirable. "Company Accounts" shall mean those customer groups, i.e., National Accounts, Federal Accounts, CCM Accounts and/or Health Care Accounts, for which Distributor has executed the applicable Company Account Policy (Exhibit E, F, G and/or H, respectively); (g) act in good faith and in a fair, equitable, and ethical manner both to Distributor and end-users with respect to all matters covered by this Agreement; (h) utilize its best efforts to provide to Distributor Authorized Products that are competitive in the marketplace in function, features and price. Distributor and Company recognize that, from time to time, Company will develop and introduce new products bearing the Authorized Trademarks, and that by providing these products the Company enhances the ability of Distributor to achieve its Quotas. Company shall make such new Authorized Products available to Distributor for Distributor's Area on the same non-exclusive basis as applies to the Authorized Trademark brands hereunder and thereafter such new Authorized Products shall be Authorized Products as defined in this Agreement; (i) use its best efforts to have Distributor elected to Company's Independent Distributor Advisory Board; (j) as soon as available after the end of each fiscal year, deliver to Distributor financial statements consisting of balance sheet, income statement and, at Distributor's request, a statement of sources and uses of funds for such year prepared in accordance with generally accepted accounting principles and reviewed by a certified public accountant; and (k) not disparage the Distributor or the Distributor's employees in any sales brochures, presentations or materials produced by Company or in any advertisements approved by Company and take reasonable corrective action in the event Company determines that any employee of Company has engaged or is engaging in such disparagement. 3. TRADEMARK LICENSE AND USE. In order to promote and protect the Company's trademark rights, the parties agree that: (a) AUTHORIZED USES. Company grants to Distributor a nonexclusive, non-transferable (except as provided herein) license to use the trademarks described in Exhibit C (the "Authorized Trademarks"): (i) only in connection with the sale and service, and promotion of sale and service, of the Authorized Products and Authorized Software; (ii) only in the Distributor's Area; (iii) only during the term of this Agreement or to service products installed prior to the termination of this Agreement; (iv) only in the manner described in this Section and Exhibit C; and (v) as provided in the Purchase Agreement (excluding Sections 8.6 and 8.11(c) of the Purchase Agreement). (b) PROHIBITED USES. Distributor is not granted any license or right to use the mark or name EXECUTONE INFORMATION SYSTEMS, EISI, OR EIS, or any comparable derivative thereof. Except as expressly authorized in Exhibit C (the "Authorized Name"), Distributor shall not use the Authorized Trademarks as part of Distributor's trade or corporate name, nor shall Distributor otherwise trade under the Authorized Trademarks or any derivative thereof. (c) NONTRANSFERABILITY. Distributor shall not assign or sublicense its rights to use any of the Authorized Trademarks or Authorized Name to any other person or entity, except as otherwise permitted by this Agreement. (d) DISTRIBUTOR'S COVENANTS. Distributor hereby agrees that Distributor: (i) shall use the Authorized Trademarks only as expressly authorized and only in conjunction with the R or TM symbol as appropriate; (ii) shall not, either in or outside of Distributor's Area, use the Authorized Trademarks in any disparaging way or in any way that might confuse other products with the Authorized Products in a manner which would jeopardize the Company's interests in the Authorized Trademarks; and (iii) shall not challenge or contest in any way the validity of the Authorized Trademarks, their registration or their ownership by the Company. (e) PRODUCT ALTERATIONS. Distributor may affix to the back of any Authorized Product or packaging or documentation of a copy of Authorized Software a legend in the following form: For Sales and Service (Name of Distributor) (Address of Distributor) (Local Telephone Number of Distributor) (Installation Date) For 24-Hour Emergency Service Call: (Telephone Number) However, Distributor shall not remove, change, obscure, or add to the labels, markings, names or trademarks that Company has affixed to any Authorized Product or Authorized Software. 4. DISTRIBUTOR'S SALES RESPONSIBILITIES. In order to develop the market for the Authorized Products and Authorized Software in Distributor's Area, Distributor shall: (a) maintain accurate records with respect to sales of the Authorized Products and sublicenses of the Authorized Software (which records are acknowledged to be the proprietary business information of Distributor); (b) maintain a sufficient inventory of the Authorized Products and Authorized Software to meet the demand in Distributor's Area for accounts being installed, sold or serviced by Distributor; (c) timely install the Authorized Products and Authorized Software in a workmanlike and professional manner in accordance with instructions and specifications for accounts being installed, sold or serviced by Distributor; (d) properly train customers' personnel in the operation and use of the Authorized Products and Authorized Software, as reasonably requested by customers for accounts being installed, sold or serviced by Distributor; (e) maintain a trained sales force to sell Authorized Products and license Authorized Software within Distributor's Area; (f) not disparage the Company or the Company's employees, the Authorized Products or Authorized Software or any Other Company Products in any sales brochures, presentations or materials produced by Distributor or in any advertisements approved by Distributor and take reasonable corrective action in the event Distributor determines that any employee of Distributor has engaged or is engaging in such disparagement ; (g) except as specifically provided for in Section 4(i) and (j) herein, refrain from selling the Authorized Products or sublicensing the Authorized Software to any entity other than to end-users located in Distributor's Area; (h) refrain from selling the Authorized Products and spare parts therefor and sublicensing Authorized Software outside of Distributor's Area except as specifically authorized by the Cross-Territorial Policy, which Company expressly reserves the right to amend (except as provided therein) from time to time when Company in its reasonable discretion determines such amendment to be desirable, or as otherwise specifically authorized in writing; (i) refrain from selling the Authorized Products or Authorized Software to former authorized distributors of Authorized Products and Authorized Software and to secondary market resellers identified to Distributor by Company. The Company will provide Distributor with a list of authorized distributors upon Distributor's request. The Company will assist Distributor in the sale of Distributor's excess inventory of Authorized Product to other Authorized Distributors by coordinating an exchange program between Distributors or any other entity which Company authorizes for the purchase of Distributor's inventory of Authorized Product; (j) Company and Distributor recognize exchange between Distributors will be necessary from time to time for emergency service requirements and Company agrees that Distributor may sell Authorized Products to and purchase Authorized Products from other Authorized Distributors for this purpose. Distributor agrees that such sales and purchases of Authorized Products will be of an incidental nature for emergency purposes. Company and Distributor recognize that such incidental sales and purchases between Distributors are in the best interest of the Company and its Distributors in order to facilitate quick response to service outages; however, Distributor and Company specifically agree that it is not the intent of this Section 4(j) for Distributor to become a source of product supply to any other Distributor and/or for Distributor to purchase the Authorized Products in bulk from the Company to take advantage of Company's volume purchase discounts and resell portions of such bulk purchases to any other Authorized Distributor; and (k) obtain at Distributor's expense all state, local, and other licenses and permits necessary for operation of Distributor's business of selling, servicing and maintaining Authorized Product and Authorized Software, and furnish Company with Distributor's local sales tax license number. 5. DISTRIBUTOR'S SERVICE RESPONSIBILITIES. In order to service adequately customers being installed, sold or serviced by Distributor in Distributor's Area and to ensure consistent nationwide service of the Authorized Products and Authorized Software for such customers, Distributor shall: (a) install and service, subject to Distributor's customary charges and credit criteria, all Authorized Products and Authorized Software, being installed, sold or serviced by Distributor in Distributor's Area, subject to the Cross-Territorial Policy; provided, however, that installation and service for National Accounts and Federal Accounts shall not be provided except pursuant to the NAP, and/or the FAP, respectively, executed by Distributor, and) installation and service for CCM Accounts and Health Care Accounts shall not be provided except pursuant to the CAP and/or HCAP executed by Distributor, respectively. (b) install and service, upon the request of Company, and subject to the applicable Company Accounts Policy, Other Company Products for any group of Company Accounts for which Distributor has executed the applicable Company Account Policy (Exhibit E, F, G and/or H, respectively). "Other Company Products" are defined as any products or software marketed, sold or licensed by the Company that are not Authorized Products or Authorized Software as defined herein and are products or software approved as "Other Company Products" hereunder by the Independent Distributors' Advisory (IDA) Board. (c) except to the extent that faster response times are reasonably required by Company for Cross-Territorial Accounts or Company Accounts, respond: (i) within 4 hours to all Emergency Service Requests, defined as all requests to remedy problems that are not isolated failures of a minority of station instruments and/or a minority of trunks and/or system components not required for normal processing of voice and/or data communications; and (ii) within 48 hours to 95% of all non-Emergency Service Requests; and (iii) within ten (10) business days to 100% of customers' requests for routine adds, moves or changes of equipment, subject to availability of product from Company. It is the intent of this Section that Distributor utilize its best efforts to achieve these goals on a consistent basis. Occasional failures and/or delays will not be a Material Breach of this Agreement. (d) make available emergency service 24 hours a day, 365 days a year for all of its customers in Distributor's Area, all Cross-Territorial Accounts and all Company Accounts, as applicable, being sold, installed or serviced by Distributor, subject to the NAP, FAP, CAP and/or HCAP as agreed to in writing by the Distributor; (e) as requested by Company, make available installation and service for Authorized Products and Authorized Software to Cross-Territorial Accounts in Distributor's Area subject to the Cross-Territorial Policy and to Company Accounts, as applicable, in Distributor's Area, subject to the NAP, FAP, CAP, and/or HCAP as agreed to in writing by the Distributor, as applicable; (f) maintain trained personnel, spare parts, and equipment sufficient to service all Authorized Products and Authorized Software being sold, installed or serviced by Distributor in Distributor's Area and all Other Company Products for any group of Company Accounts for which (but only for which) Distributor has executed the applicable Company Account Policy (Exhibit E, F, G and/or H, respectively); and (g) maintain complete records of all service requests and service calls (which records are acknowledged to be the proprietary business information of Distributor), including: the name of the customer; the date(s) and time(s) of the request, response, and correction of the problem; the nature of the problem; any parts used; any charges; and whether the service was performed under warranty. 6. DISTRIBUTOR'S FINANCIAL AND REPORTING RESPONSIBILITIES. (a) FINANCIAL CONDITION. Distributor shall maintain a financial condition adequate to perform its obligations hereunder. (b) REPORTING RESPONSIBILITIES. Distributor shall submit to Company: (i) as soon as available after the end of each fiscal year, financial statements consisting of balance sheet and income statement showing Distributor's financial condition, and at Company's request, a statement of sources and uses of funds, for such year prepared in accordance with generally accepted accounting principles and reviewed by a certified public accountant; (ii) at Company's request, a list of all persons and entities having an ownership interest in Distributor, and the nature and percentage of each such ownership interest; (iii) within thirty (30) days of the end of each quarter Distributor will complete and send to Company a summary report of retail sales of Authorized Products and service activity performed by Distributor within Distributor's Area. The information required may be modified from time to time as reasonably required by changes in the market or within the industry. The information provided by Distributor will be analyzed by Company and consolidated on a national and regional basis and reported back to Distributor; (iv) upon request of the Company within 15 days after the end of each month, to the extent required by any license or VAR agreement between the Company and any third party software licensor of software contained in or sold with Authorized Products or Authorized Software, including Oracle Corporation, the names and addresses of sublicensees of such software sublicensed by Distributor within the preceding month, the date of purchase and installation, the specific Authorized Product and Authorized Software installed, including the make or model designation and the software release number of the software programs licensed, and the maximum number of users per system; provided, however, that this subparagraph shall not apply to licenses of Authorized Software licensed directly by the Company to Distributor's customers and provided further that the Distributor shall have no obligations under this paragraph unless the Company provides evidence of such third party requirement if requested by Distributor. Company agrees to provide third party software license forms when such software is ordered and/or before the software is downloaded for execution by Distributor's customers, to compile the information required to be reported, and to maintain the confidentiality of and not to use such information in any manner whatsoever, except to the extent it is required to provide such information to the third party software licensor, without the prior written consent of the Distributor; (v) [CONFIDENTIAL TREATMENT REQUESTED]; and (vi) as requested by the Company, but not more than once per quarter, a report of the size of Distributor's sales force for Authorized Products and Authorized Software by Office (for the purposes of this Agreement "Office" is defined as Distributor's main office locations, excluding any satellite locations). 7. PURCHASE, PAYMENT, SALES AND SHIPMENTS. (a) PURCHASE AND PAYMENT BY DISTRIBUTOR. (i) FORECASTS. In order to assist Company in scheduling the production and delivery of the Authorized Products, Distributor will deliver and update during the term of this Agreement a rolling six-month forecast of its purchases. Distributor's initial forecast is attached hereto as Exhibit I. On or before the first day of each calendar month, Distributor shall deliver an updated forecast in the form attached hereto as Exhibit I. Each such forecast shall cover the succeeding six calendar months. Such forecasts are nonbinding and for advisory or planning purposes only. (ii) QUOTA DETERMINATION. Quota is defined as the minimum dollar volume of Authorized Product and Authorized Software that Distributor must purchase or license from Company during each calendar year of this Agreement in order to enjoy certain benefits described in 7(b) that are contingent on Quota attainment. The Quota shall be stated in terms of actual purchases of Authorized Products and Authorized Software. Subject to Section 7 (b) (i), the Quotas as of the date of this Agreement are stated in Exhibit J hereto. Quotas for additional areas or territories, for Expansion Areas, for product groups other than the Telephony Product Group, and for New Telephony Products as defined in Exhibit B, shall be mutually agreed upon in writing by Company and Distributor with reference to (i) the actual potential new install customers within Distributor's Area, as shown by the ABI database of opportunities representing between 20 and 250 desktops, and adjusted, pursuant to formulas agreed to by the IDA Board, to take account of Distributor's existing customer base, reasonable shrinkage factor and close ratios, average system price and system life, and (ii) the estimated equipment value of MAC and service business in Distributor's Area. (iii) QUOTA MEASUREMENT. The Quota for any calendar quarter (a "Quarter") shall be one-fourth of the annual Quota for the calendar year in which the Quarter falls, unless otherwise specified herein. For any additional years of this Agreement, the Quotas shall be determined by reference to the formula set forth in subsection (ii) and as otherwise mutually agreed in writing between Company and Distributor. For purposes of Quota performance measurement, Company will calculate the Distributor's purchases based upon the aggregate actual dollar amount of Distributor's purchases of Authorized Products and Authorized Software. Provided Distributor is not on credit hold, purchases for this purpose will include orders for Authorized Product and Authorized Software that have not yet been shipped due to the Company being backordered on such Authorized Product, but purchases shall not include any orders that are delayed due to Distributor's credit hold. Following the end of each Quarter, Company will provide Distributor with a report of Distributor's Quota performance. (iv) PURCHASE ORDERS. Orders for the purchase of the Authorized Products and Authorized Software shall be made by Distributor by purchase orders, specifying the quantity and description of Authorized Products and Authorized Software desired. Any term or condition of such purchase orders that is inconsistent with any term or condition of this Agreement shall be of no force and effect whatsoever, and any additional term or condition of such purchase order shall be construed so as to be consistent with the intent of this Agreement. (v) PAYMENT. Subject to subsection 7(b), payment by Distributor to Company for each order of Authorized Products and Authorized Software shall be made in cash, or by check or wire transfer. Subject to Company's rights under Section 7(b)(ii), payment by Distributor shall be made within the longer of (i) sixty days of the invoice date or (ii) the longest payment terms provided to any of the Company's other distributors of any Authorized Products or Authorized Software that purchases an amount equal to or less than Distributor of such products for an equivalent period of time, on the same terms and conditions provided to such other authorized distributors (the "Standard Payment Period"). The Standard Payment Period shall be in effect until the earlier of May 31, 1999 and such time as 60-day payment terms are no longer required by Distributor's banks. Upon termination of the Standard Payment Period, payment by Distributor shall be made within the longer of (a) thirty days of invoice date or (b) the longest Company-approved payment terms provided to any other distributor of Authorized Product and Authorized Software whose purchases are equal to or less than Distributor's purchases in any given period for the balance of the term of this Agreement. The invoice amount shall reflect the provisions of Section 7(b)(i) and any other pricing discounts, including promotional pricing, which may be agreed to by Company and Distributor from time to time. Distributor shall pay each invoice in full subject to appropriate credits and offsets. Distributor must notify Company in writing within 30 days of the date of the invoice or the date of receipt of product ordered, whichever is later, of any disputed invoice amount along with an explanation of the reason for the dispute. (b) SALES AND SHIPMENTS BY COMPANY. (i) PRICES AND TERMS. (A) Subject to Section 7 (b) (i) (B), and Section 7 (b) (i) (C), Company will sell all Authorized Products and Authorized Software at prices and on terms determined by Company from time to time, as reflected in the Company's Authorized Product Price Book. All prices are exclusive of all taxes including federal, state, and local sales, use, value-added or similar taxes. Distributor will pay all such taxes, excluding taxes on Company's income, unless Distributor has given Company a valid exemption resale certificate prior to shipment. Subject to paragraph 7 (b) (i) (B) and 7 (b) (i) (C) hereof, Company expressly reserves the right to change prices with not less than forty-five days notice to Distributor; provided, however, that Company (a) will honor pricing for a proposal delivered prior to the price change notice for 90 days from the date of the proposal, (b) will honor pricing for any customer contract, if the contract was signed within the period following the date of proposal specified in (a) above or prior to the date of the price change notice, and if the product is shipped to Distributor within ninety (90) days from the date of the applicable contract. (B) During the calendar year 1998, the following shall apply: At all times during the period or periods in which Distributor is not in Material Breach of this Agreement, and if the dollar amount of Distributor's aggregate actual purchases of Authorized Products and Authorized Software, measured as of (and including) the last day of each Quarter, equals or exceeds, (1) with respect to the second Quarter of 1998, [CONFIDENTIAL TREATMENT REQUESTED], or (2) with respect to the second and third Quarters of 1998 together, [CONFIDENTIAL TREATMENT REQUESTED], then during the succeeding Quarter, the Company agrees to sell to Distributor at a discount of [CONFIDENTIAL TREATMENT REQUESTED] off list prices reflected in the Company's Authorized Product Price Book except for products in discount categories S, N,. P, C, D and Z, and on the most favorable terms and conditions, excluding discount levels, made available to any other authorized distributor for a territory located in the United States for the same products, excluding sales to the Federal Government, in each case on the same terms and conditions provided to such other authorized distributor applicable to such more favorable terms and conditions which terms and conditions shall be reasonably related to such other more favorable terms and conditions provided to such other distributor. If the dollar amount of Distributor's aggregate actual purchases of Authorized Products and Authorized Software, measured as of (and including) the last day in a particular Quarter, equals or exceeds, (1) with respect to the second Quarter of 1998, [CONFIDENTIAL TREATMENT REQUESTED], or (2) with respect to the second and third Quarters of 1998 together, [CONFIDENTIAL TREATMENT REQUESTED], then during the succeeding Quarter the applicable discount will be [CONFIDENTIAL TREATMENT REQUESTED] off list prices reflected in the Company's Authorized Product Price Book, except for products in discount categories S, N,. P, C, D and Z, and sales will be on the most favorable terms and conditions, excluding discount levels, made available to any other authorized distributor (for a territory located in the United States for the same products, excluding sales to the Federal Government) that purchased an amount equal to or less than Distributor during the applicable measurement period, in each case on the same terms and conditions provided to such other authorized distributor applicable to such more favorable terms and conditions which terms and conditions shall be reasonably related to such other more favorable terms and conditions. If the dollar amount of Distributor's aggregate actual purchases of Authorized Products and Authorized Software, measured as of (and including) the last day in a particular Quarter, is less than, (1) with respect to the second Quarter of 1998, [CONFIDENTIAL TREATMENT REQUESTED] or (2) with respect to the second and third Quarters of 1998 together, [CONFIDENTIAL TREATMENT REQUESTED], then during the succeeding Quarter the applicable discount will be [CONFIDENTIAL TREATMENT REQUESTED] off list prices reflected in the Company's Authorized Product Price Book, except for products in discount categories S, N,. P, C, D and Z, and sales will be on the most favorable terms and conditions, excluding discount levels, made available to any other authorized distributor (for a territory located in the United States for the same products, excluding sales to the Federal Government) that purchased an amount equal to or less than Distributor during the applicable measurement period, in each case on the same terms and conditions provided to such other authorized distributor applicable to such more favorable terms and conditions which terms and conditions shall be reasonably related to such other more favorable terms and conditions. Distributor's failure to qualify for the best or any other discount level or other more favorable terms as of the end of any Quarter shall in no way prejudice or affect the Distributor's ability to qualify for such best or any other discount level or other more favorable terms as of the end of any other Quarter. For all purposes herein, the Distributor shall be deemed pre-qualified for the [CONFIDENTIAL TREATMENT REQUESTED] discount as provided above and other more favorable terms and conditions during the second Quarter of 1998. (C) On and as of the first day of the first Quarter of 1999, the following shall apply: At all times during the period or periods in which Distributor is not in Material Breach of this Agreement, and if the dollar amount of Distributor's aggregate actual purchases of Authorized Products and Authorized Software measured as of (and including) the last day of each Quarter, equals or exceeds (1) with respect to the second, third and fourth Quarters of 1998 together, [CONFIDENTIAL TREATMENT REQUESTED], or (2) thereafter, with respect to the immediately preceding four Quarters, 100% of the Distributor's Quota for such rolling four-quarter period, then during the succeeding Quarter the Company agrees to sell to Distributor at the most favorable terms and conditions, including without limitation the greater of a [CONFIDENTIAL TREATMENT REQUESTED] discount and the most favorable prices, discount levels and promotional pricing, made available to any other authorized distributor for a territory located in the United States for the same products, excluding sales to the Federal Government, in each case on the same terms and conditions provided to such other authorized distributor applicable to such more favorable terms and conditions which terms and conditions shall be reasonably related to such other more favorable terms and conditions. If the dollar amount of Distributor's aggregate actual purchases of Authorized Products and Authorized Software, measured as of (and including) the last day of each Quarter, (1) with respect to the second, third and fourth Quarters of 1998 together, equals or exceeds [CONFIDENTIAL TREATMENT REQUESTED], or (2) thereafter, with respect to the immediately preceding four Quarters, is less than 100% of the Distributor's Quota for such rolling four-quarter period but is equal to or greater than [CONFIDENTIAL TREATMENT REQUESTED], then during the succeeding Quarter the applicable discount will be the greater of [CONFIDENTIAL TREATMENT REQUESTED] the best discount (including promotional pricing) made available to any other authorized distributor for a territory located in the United States for the same products, excluding sales to the Federal Government, in each case on the same terms and conditions provided to such other authorized distributor applicable to such more favorable terms and conditions, and sales will be on the most favorable terms and conditions, excluding discount levels, made available to any other authorized distributor (for a territory located in the United States for the same products, excluding sales to the Federal Government) that purchased an amount equal to or less than Distributor during such rolling four quarter period, in each case on the same terms and conditions provided to such other authorized distributor applicable to such more favorable terms and conditions which terms and conditions shall be reasonably related to such other more favorable terms and conditions. If the dollar amount of Distributor's aggregate actual purchases of Authorized Products and Authorized Software measured as of (and including) the last day of each Quarter, (1) with respect to the second, third and fourth Quarters of 1998 together is equal to or exceeds is less than [CONFIDENTIAL TREATMENT REQUESTED], or (2) thereafter, in a particular rolling four-quarter period, is less than [CONFIDENTIAL TREATMENT REQUESTED], then during the succeeding Quarter the applicable discount will be the greater of [CONFIDENTIAL TREATMENT REQUESTED] the best discount (including promotional pricing) made available to any other authorized distributor, for a territory located in the United States for the same products, excluding sales to the Federal Government, in each case on the same terms and conditions provided to such other authorized distributor applicable to such more favorable terms and conditions, and sales will be on the most favorable terms and conditions, excluding discount levels, made available to any other authorized distributor (for a territory located in the United States for the same products, excluding sales to the Federal Government) that purchased an amount equal to or less than Distributor during such rolling four quarter period, in each case on the same terms and conditions provided to such other authorized distributor applicable to such more favorable terms and conditions which terms and conditions shall be reasonably related to such other more favorable terms and conditions. The Distributor's failure to qualify for the best or any other discount level or other more favorable terms as of the end of any Quarter shall in no way prejudice or affect the Distributor's ability to qualify for such best or other discount level or other more favorable terms as of the end of any other Quarter. (D) In the event that Distributor's purchases during any Quarter, measured as provided in this Section 7(b)(i), do not qualify it for the best discount level, Company shall give Distributor notice within ten days of the end of the Quarter of the amount by which Distributor's purchases during the Quarter are less than the amount required to qualify Distributor for the higher discount level or levels, and Distributor shall have until 30 days following receipt of written notice from Company to order (for immediate shipment) sufficient additional Authorized Product or Authorized Software to qualify for any higher level (which additional purchases shall be applied solely to the Quarter preceding such purchases). As soon as Distributor has made such additional purchases, it shall immediately qualify for the higher discount level and if applicable to such discount level, also immediately be entitled to other more favorable terms and conditions as set forth in this Agreement, and any orders filled by Company after cure (but no orders necessary to effect the cure) shall be shipped and invoiced at the higher discount level. Notwithstanding the foregoing, in the event Company fails to provide the written notice required above, Distributor's purchases for the preceding Quarter shall be deemed to be at Quota during that Quarter. (E) Distributor acknowledges and agrees that the Company may offer special new distributor programs, terms and conditions, and incentives (collectively, the "Incentives") and that Distributor shall not be entitled to such Incentives pursuant to subsection 7(b)(i) except as otherwise provided in subsection 7(b)(i)(E)(iv) and (v) hereof; provided that (i) such Incentives are available only for a limited period of time; (ii) such Incentives are available only to new distributors or to existing distributors with respect to a new territory; (iii) such Incentives do not include pricing, discounts and promotional pricing for Authorized Product and Authorized Software; (iv) to the extent such Incentives, in the aggregate, do not exceed [CONFIDENTIAL TREATMENT REQUESTED] (the "Training Incentive Limit"); and (v) all such Incentives shall be offered to Distributor on the same terms with respect to a new territory. For the purposes of this Section 7(b)(i)(E)(iv), measurement of the Training Incentive Limit shall include the cost to Distributor should Distributor elect to purchase the same technical training directly from Company (excluding travel and lodging costs). In the event Company elects to provide technical training in excess of the applicable Training Incentive Limit to a new distributor, Distributor shall be entitled to receive technical training with a cost to Distributor equal to the difference between the cost of technical training actually provided and the applicable Training Incentive Limit, at such times and for such Offices as Distributor deems appropriate. In the event (A) [CONFIDENTIAL TREATMENT REQUESTED] or (C) commencing April 1, 1999, and measured each Quarter thereafter, Distributor has failed to purchase [CONFIDENTIAL TREATMENT REQUESTED] of Authorized Products and Authorized Software during the immediately preceding four Quarters, then Distributor shall not be entitled to any Incentives as a result of Incentives given by the Company under Sections 7(b)(i), 7(b)(i)(E)(iv), or 7(b)(i)(E)(v), in the case of (A) or (B) [CONFIDENTIAL TREATMENT REQUESTED] and in the case of (C)for all portions of Distributor's Area during the succeeding Quarter. For the purposes of this Section 7(b)(i)(E) only, territory shall not be limited to a single county in any state but shall mean the market area that includes multiple counties served by an Office. (F) Company agrees to promptly notify Distributor in writing (an "MFN Notice") if the Company has entered into an agreement with any other authorized distributor of any Authorized Products or Authorized Software that contains terms and provisions which are more favorable to such other authorized distributor than those contained herein (such notice to contain a summary of each more favorable term and condition). This Agreement shall be deemed to be automatically amended to reflect any more favorable term or provision on the same terms and conditions provided to such other authorized distributor, which terms and conditions shall be reasonably related to such other more favorable terms and conditions provided to such other authorized distributor, upon notice of acceptance by Distributor to the Company within 30 days of receipt of the MFN Notice. (G) Company and Distributor agree that notwithstanding anything to the contrary in the Purchase Agreement or the Prior Distributor Agreement, Distributor shall not be entitled to any pricing discounts, promotions or credits for any base change outs, government system sales, or particular equipment sales or software downloads except (i) the software credits provided in Section 8.22 of the Purchase Agreement, and (ii) to the extent any such discounts, promotions or credits are provided to any other authorized distributor of Authorized Products and Authorized Software in the United States, excluding sales to the Federal Government, and then only on the same terms and conditions applicable to such other authorized distributor with respect to such discounts, promotions or credits which terms and conditions shall be reasonably related to such discounts, promotions or credits. (ii) CHANGE IN CREDIT TERMS. If, in the Company's reasonable opinion, Distributor's financial condition or payment record indicates the Distributor's inability to pay amounts due or to become due hereunder,, the Company reserves the right to change credit terms at any time. If, but only so long as Distributor is materially delinquent, Distributor becomes materially delinquent in the payment of any material sum due to Company (other than amounts being disputed in good faith by Distributor), Company may suspend performance under this Agreement and may require Distributor to make payment in advance of any subsequent shipments of Authorized Products or Authorized Software. By exercising the foregoing right, Company is in no way waiving any of its other rights and remedies at law or under this Agreement. (iii) SECURITY INTEREST. Distributor hereby grants and Company reserves a purchase money security interest in each Authorized Product in respect of which the Company has not been paid pursuant to a purchase order or any lesser amount mutually agreed upon by Company and Distributor, and any proceeds thereof, for the amount of the purchase price. At Company's request, Distributor will sign any documents required to perfect such security interest. Full payment of the purchase price of the Authorized Product will release the security interest on that Product and Company will sign documents reasonably required to evidence or effect release. (iv) PRICE LISTS. Company has provided Distributor true and correct copies of the list prices, discounts and transfer pricing by part number in effect on June 1, 1996. Company agrees to provide to Distributor, within five days of Distributor's request, a report of the list prices and transfer prices by part number. (v) SHIPMENT. Except as otherwise provided herein, Company will ship to the locations designated in Distributor's purchase order in accordance with Company's published shipping schedules in effect at the time of shipment. Company will provide Authorized Products and Authorized Software to Distributor in an amount at least equal to the Distributor's forecasts provided to the Company pursuant to Section 7(a)(i). At all times during the period or periods in which Distributor is not in Material Breach as defined herein, the Company shall provide Distributor priority in shipment of each order received by Company from Distributor over all other orders received by Company after receipt of such order from Distributor, provided Distributor is willing to accept incomplete orders at Company's request and gives Company at least one day's advance notice of each $1 million of orders placed during the last month of a Quarter. Company shall not be liable for any failures to ship or delays in shipping caused by circumstances described in Section 18. Company shall use its best efforts to maintain sufficient inventory in stock to meet Distributor's purchase orders and needs. Risk of loss shall pass to Distributor F.O.B. Company dock, but Company will assist Distributor in tracking shipments and processing claims related to lost or damaged goods. Title to each shipment of Authorized Products shall pass to Distributor upon receipt by Company of payment for such shipment as provided in Section 7(a)(v) herein with the exception of Authorized Software, title to which shall remain vested in Company at all times as provided by the Software License contained in Section 14. Company may, in its sole discretion, honor Distributor's requests to drop ship to installation locations within Distributor's Area and to expedite shipments, but Company reserves the right to pass on to Distributor any additional costs incurred as a result of such requests. Company reserves the right to refuse shipment of Authorized Products or Authorized Software if Distributor has failed to make timely payment for prior shipments as required by Section 7(a)(v). In the event that Company elects to exercise its right not to ship Authorized Products or Authorized Software by reason of Distributor's failure to make timely payments for prior shipments or other breaches, or otherwise places Distributor on credit hold, it shall immediately notify Distributor as soon as such election is made. (c) EXPORTS TO AND FROM DISTRIBUTOR'S AREA. (i) If the location of Distributor's Area so requires, Company shall at its expense prepare, obtain, and transmit to the parties concerned such documents as are normally required to export the Authorized Products and Authorized Software. If such Authorized Products or Authorized Software should be subject to license or other authorization for export or reexport, Company shall at its expense apply for such export or reexport authorization with the authorities concerned. Distributor undertakes to procure the information and to supply Company with the duly signed forms required to obtain such authorization. (ii) Distributor shall not export or reexport Authorized Products or Authorized Software without such valid export or reexport authorization as may be required, or otherwise violate any export or reexport restriction imposed by authorities in the country of origin of such Authorized Products or Authorized Software or by other authorities concerned. (iii) Company shall, where applicable, issue Certificates of Origin for Authorized Products and Authorized Software shipped under this Agreement, duly verified by the authorities concerned. 8. LIMITED WARRANTY AND RESTRICTION ON ALTERATION. (a) LIMITED WARRANTY. Company warrants that all Authorized Products sold to Distributor pursuant to this Agreement will perform in accordance with Company's written specifications therefor and will be free from defects in material and workmanship for the period from the date of shipment F.O.B. Company specified in Exhibit B (the "Warranty Period"), provided that such Authorized Products are installed in compliance with Company's written installation specifications, to the extent applicable, and given normal service and maintenance by Distributor during the Warranty Period. Company warrants that all Authorized Software licensed or sublicensed by Distributor pursuant to this Agreement will be free from any defect that causes a material nonconformity between its performance as described in the Related Documentation accompanying the Authorized Software, as specified in Exhibit B, and actual performance during the Warranty Period for the Authorized Product in which the Authorized Software is imbedded or otherwise an integral part. Company's obligation under this warranty shall be limited to repair or replace, at Company's option, any part(s) of Authorized Products or Authorized Software that may prove defective under normal and proper use and service for the Warranty Period. For such repairs and replacements, Distributor shall pay the cost for shipment to Company's plant; Company shall pay the cost for shipment from Company's plant. Company agrees to use its best efforts to ship any repaired or replacement Authorized Product and Authorized Software within thirty (30) days of the date Company shall have received the defective Authorized Product or Authorized Software. This warranty shall not apply to lamps, fuses, batteries or other such items normally consumed in operation which have a normal life shorter than the Warranty Period. (b) DISCLAIMERS. THE WARRANTIES CONTAINED IN THIS SECTION AND IN SECTION 14 ARE IN LIEU OF ALL OTHER WARRANTIES, EXPRESS OR IMPLIED, INCLUDING WARRANTIES OF MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE. THESE WARRANTIES SHALL BE VOID AS TO AUTHORIZED PRODUCT OR AUTHORIZED SOFTWARE DAMAGED OR RENDERED UNSERVICEABLE OR NONFUNCTIONAL BY NEGLIGENCE OF NONCOMPANY UNAUTHORIZED PERSONNEL, MISUSE, THEFT, VANDALISM, FIRE, LIGHTNING, POWER SURGES, WATER OR OTHER PERIL, OR ACTS OF GOD, BY FAILURE OF DISTRIBUTOR TO COMPLY WITH PUBLISHED TECHNICAL REQUIREMENTS OR BY SERVICES OR PRODUCTS OF OTHER VENDORS, INCLUDING WITHOUT LIMITATION THE CENTRAL OFFICE LINES OF ANY CENTRAL EXCHANGE TELEPHONE COMPANY. REPAIR, RELOCATION OR ALTERATION OF THE PRODUCT BY PERSONS NOT AUTHORIZED BY COMPANY VOIDS THE WARRANTY. LIABILITY OF COMPANY HEREUNDER IS EXPRESSLY LIMITED TO THE REPAIR OR REPLACEMENT DESCRIBED ABOVE AND THE REMEDIES PROVIDED IN SECTION 14, AND IN NO EVENT SHALL COMPANY BE LIABLE FOR ANY INDIRECT, SPECIAL, INCIDENTAL OR CONSEQUENTIAL DAMAGES, SUCH AS LOST SALES, LOST PROFITS OR INJURY TO PROPERTY, OR ANY OTHER ECONOMIC DAMAGES RELATING TO THE PERFORMANCE OR FUNCTIONALITY OF THE AUTHORIZED PRODUCTS OR AUTHORIZED SOFTWARE, WHETHER THEY ARE ALLEGED TO ARISE IN CONTRACT OR TORT OR OTHERWISE. NO EXPRESS OR IMPLIED WARRANTY IS MADE AGAINST INTRUSIONS INTO THE AUTHORIZED PRODUCTS OR AUTHORIZED SOFTWARE BY FRAUDULENT CALLERS OR AGAINST ANY TOLL FRAUD. COMPANY MAKES NO WARRANTIES AS TO THE LAWFULNESS OF USING ANY FEATURE OF THE AUTHORIZED PRODUCTS OR AUTHORIZED SOFTWARE TO MONITOR, RECORD OR FORWARD ANY ORAL, WIRE OR ELECTRONIC COMMUNICATION. (c) RESTRICTION ON ALTERATION. Company shall not be liable for any warranty offered by Distributor that differs from the warranty quoted above. Company does not warrant any Authorized Products or Authorized Software that have been modified without Company's prior written consent, and Distributor shall not make or cause or permit to be made, any alterations or modifications of any Authorized Products or Authorized Software without the prior written consent of Company. Distributor agrees to hold harmless and indemnify Company against claims of any kind related to any unauthorized alterations or modifications of Authorized Products or Authorized Software made or authorized in writing by Distributor, or related to warranties by Distributor that differ from the warranty quoted above. (d) SURVIVAL. This Section 8 shall survive termination or expiration of this Agreement. 9. POST-WARRANTY PERIOD REPAIRS. After the Warranty Period has expired, Distributor agrees to purchase all of its required repair and replacement service for Authorized Products and Authorized Software from Company or Company's authorized subcontractors, , but only so long as the Company's prices are competitive and Company agrees to provide to Distributor all of Distributor's required repair and replacement service for Authorized Products and Authorized Software at Distributor's expense, subject to the provisions relating to shipping charges below, in accordance with the charges therefor specified in Company's Authorized Product Price Book. Company agrees that all of its charges to Distributor for repair and replacement services shall be competitive and at all times shall be no higher than the prices charged by Company to any other authorized distributor of any Authorized Products or Authorized Software in the United States. The Company's repair and replacement prices shall be deemed to be "competitive" if they are no more than 10% higher than any published or offered prices for the same repairs or replacements by another company engaged in the business of making such repairs or replacements. Distributor shall have no obligation to purchase such services from Company if it provides Company with documentary evidence that the Company's prices therefor are not "competitive". For such repairs and replacements, Distributor shall pay the cost of shipment to Company's plant; Company shall pay the cost for shipment from Company's plant. Distributor shall adhere to the return procedure described in Company's Authorized Product Price Book and shall adhere to such other return procedures as Company shall reasonably require from time to time. Distributor shall not return any defective Authorized Product or Authorized Software unless Distributor has properly completed the return forms described in Company's Authorized Product Price Book. Company agrees to use its best efforts to ship repaired or refurbished Authorized Products or Authorized Software to Distributor within thirty (30) days of the date Company shall have received the defective Authorized Products or Authorized Software at its plant. If Company has not shipped the repaired or refurbished Authorized Product or Authorized Software within forty (40) days of the date Company shall have received the defective Authorized Product or Authorized Software at its plant, the repair charge shall be reduced as specified in Company's Authorized Product Price Book. Under no circumstances shall Company be liable for any consequential or other damages resulting from failure to ship repaired or refurbished Authorized Products or Authorized Software within thirty (30) days other than any direct damages to Distributor arising from failure of Company to ship repaired or Authorized Software within sixty (60) days of receipt by Company. Notwithstanding the foregoing, if Distributor is in Material Breach of any of its payment obligations to Company, Company reserves the right to require Distributor to make payment for post-Warranty Period repairs before Company ships repaired or replacement Authorized Products or Authorized Software. By exercising the foregoing right, Company is in no way waiving any of its other rights and remedies at law or under this Agreement. 10. COMPANY'S RESERVATION OF RIGHTS. Company reserves the right at any time to: (a) discontinue, modify or upgrade existing Authorized Products and Authorized Software; provided, however, that Company shall notify Distributor ninety (90) days in advance of any product discontinuance, shall directly or indirectly provide factory repairs for such product to Distributor for a period of seven (7) years from its discontinuance, and shall directly or indirectly provide spare parts, replacement equipment, Authorized Software and Related Documentation and all other equipment, software, diagnostics and manuals required to service and maintain the Authorized Products, Authorized Software and Related Documentation for such product to Distributor for a period of five (5) years from its discontinuance; (b) nondiscriminatorily sell to Distributor any Authorized Products and Authorized Software of the Authorized Trademark brands of which Distributor is an Authorized Distributor, based upon Distributor's ability to sell, install, or service the same; and (c) make Distributor's rights under this Agreement subject to the Cross-Territorial Policy, NAP, CAP, FAP and HCAP, each of which Company reserves the right to amend as provided therein from time to time whenever Company in its reasonable discretion determines such amendment to be advisable. 11. SALES AND SERVICE OUTSIDE DISTRIBUTOR'S AREA. Distributor is an authorized distributor of Authorized Products and Authorized Software only in Distributor's Area, except as specifically provided otherwise in this Agreement. In the event that Distributor sells any Authorized Products or licenses any Authorized Software for installation outside Distributor's Area, Distributor shall comply with the Cross-Territorial Policy regarding such sale and the related installation and service requirements in effect at the time of the sale. Nothing contained herein shall limit or restrict Distributor's ability to sell other products and services outside Distributor's Area. Effective July 1, 1998 (except in relation to item c(i) hereof which is effective April 1, 1998), Company agrees that if (a) another authorized distributor ceases to have exclusive rights to sell and license the Authorized Products and Authorized Software in any area of the United States not included in Distributor's Area or has been terminated as a distributor in such area ("Expansion Area"), (b) Distributor is not in Material Breach, and (c) Distributor is either (i) entitled to the highest discount level under Section 7(b)(i) at the time of such termination, or (ii) Company offers to another authorized distributor of Authorized Products and Authorized Software who has not purchased amounts of such Authorized Products and Authorized Software equal to or exceeding its Quota for the same period during which Distributor's purchases would be measured under Section 7(b)(i), the nonexclusive rights to sell and license the Authorized Products and Authorized Software in the Expansion Area, then the Company shall offer to Distributor the right to negotiate with Company and Company shall negotiate with Distributor in good faith for a period of 30 days a Quota for the Authorized Products and Authorized Software in the Expansion Area in order that Company may expand Distributor's Area to include the Expansion Area on a non-exclusive basis and if the parties agree on a Quota, this Agreement shall be amended to include the Expansion Area. The parties acknowledge and agree that this paragraph of Section 11 shall not apply to any area listed on Exhibit M hereto if Norstan Communications is being offered or granted nonexclusive rights in such area. Company agrees that it shall not require terms and conditions, including additional Quota for the Expansion Area, less favorable to the Distributor than that offered to third party distributors in similar areas for similar products. Notwithstanding anything in this Agreement to the contrary, Distributor shall be permitted to sell, market, service, maintain and license any products, software or services, including without limitation, Competing Products (as defined in the Prior Agreement) or any other products or services of any type whatsoever in any territory whatsoever including in Distributor's Area, and to any individual or entity whatsoever. Provided Distributor has made actual aggregate purchases of Authorized Product and Authorized Software sufficient to qualify for the pricing and terms provided under the second sentence of Section 7(b)(i)(B) or the second sentence of Section 7(b)(i)(C), whichever is applicable, for the relevant period at the time of measurement, then in the event the Company determines to (i) acquire control of another of Company's authorized distributors or (ii) otherwise assume the territory of any other distributor, (any of the foregoing a "Transaction"), the Company will give written notice to the Distributor of such Transaction and afford the Distributor a thirty day period in which to negotiate a transaction with such other distributor pursuant to which Distributor would directly or indirectly assume control of or assume the territory of such other distributor before the Company gives its consent or consummates such Transaction itself. Upon the request of Distributor at any time, Company will promptly set forth in writing to Distributor the terms, if any, pursuant to which the Company will approve a potential similar Transaction by Distributor, including the additional Quota it would require the Distributor to assume in connection with such similar Transaction. 12. CONSENT OF COMPANY REQUIRED. (a) Distributor shall not, without the prior express written consent of Company, which consent shall not be unreasonably withheld: (i) assign, delegate, sell or transfer this Agreement or any rights or obligations created by it; with respect to any one or more counties in Distributor's Area, except (A) in connection with a sale or transfer of the business of selling to and servicing the customer base in such county or counties or in connection with the sale of Distributor, (B) to any lender providing financing to the Distributor as contemplated by the Purchase Agreement or any refinancing thereof, pursuant to security arrangements entered into in connection with such financings or refinancings, or (C) to any transferee of any such lender upon exercise of any of such lender's remedies pursuant to security arrangements contemplated in (B) above. (ii) appoint any subdistributor or dealer for Authorized Products or Authorized Software in any county in Distributor's Area. (b) Distributor shall not, unless Company has given its prior written consent, which may be withheld in Company's sole discretion, offer, agree to or permit any sale (including any merger or consolidation) of Distributor or of substantially all of its business or assets to Intertel Corporation or Mitel Corporation, or any of their successors or direct or indirect majority-owned subsidiaries, prior to May 31, 1999; provided, however, that the provisions of this subsection (b) shall automatically terminate upon an initial public offering of common stock of Distributor. 13. CONFIDENTIALITY. (a) NONDISCLOSURE. Without the prior express written consent of Company or Distributor, as the case may be, Distributor or Company, as the case may be, shall not disclose to any third party any confidential business information or trade secrets of the other, including but not limited to: Company product design information, product technical manuals, product technical bulletins, or Company or Distributor pricing, customer lists or other customer information, and financial information. In addition, each of the Company and Distributor, as the case may be, shall not use any confidential business information or trade secrets of the other except as expressly permitted herein. Company and Distributor recognize the necessity of disseminating selected information included in the above documents to customers or prospective customers in the sales process. Company agrees that Distributor may provide this information to customers and prospective customers in the sales process without Company's prior express written consent and Distributor and Company agree to use their best efforts to protect the confidentiality of all confidential information of the other party (including without limitation taking such actions as such party would take to protect its own confidential information). (b) NO REVERSE ENGINEERING. Distributor shall not engage in cause to be engaged in, or permit any reverse engineering of Authorized Products or Authorized Software or Other Company Products. Reverse engineering is defined as attempting through analysis of component parts and/or software to define the functionality of the components or software, and thereby gain the ability to alter or reproduce that functionality. (c) SOFTWARE. Distributor hereby acknowledges that the Authorized Software and Related Documentation listed in Exhibit B and software contained in Other Company Products are proprietary to Company and constitute trade secrets of Company. All applicable rights to patents, copyrights, trademarks, and trade secrets are and shall remain in Company. Distributor agrees to use reasonable diligence to protect the confidentiality and proprietary rights of Company in the Authorized Software and Related Documentation, and not to disclose the Authorized Software or Related Documentation to any third party. Distributor shall also promote compliance with the terms and conditions of this Agreement by employees and agrees to place the software sublicense language in Exhibit K in its sales contracts with its customers. Distributor agrees to maintain records of these software sublicense agreements and to represent Company's interest in the protection of its rights to the Authorized Software to the extent not in conflict with Distributor's rights or interests. In the event that Company has reason to believe Distributor's customer has violated the software sublicense agreement, Distributor will make available to Company these records on a customer specific basis. (d) SURVIVAL. Distributor's and Company's obligations under this confidentiality provision shall survive termination or nonrenewal of this Agreement. 14. SOFTWARE LICENSE. (a) LICENSE. The Company owns, or has licensed from the owner, the Authorized Software and any other proprietary interests in the Authorized Products and related materials and has the right to license such Authorized Software and proprietary interests to Distributor and end-users. Subject to the terms and conditions contained herein, Company grants Distributor a non-exclusive license to use, in object code form, all Authorized Software and Related Documentation as contemplated by this Agreement. This grant shall be limited to use in connection with the sale and service of the Authorized Products as contemplated by this Agreement. This license shall continue until the license is terminated in accordance with this Agreement, or for the useful life of the Authorized Product in which the Authorized Software is imbedded or of which the Authorized Software is an integral part, or for the useful life of the Authorized Software, whichever is longer. Removal of the Authorized Software from the United States by Distributor, service by any unauthorized person at the direction of Distributor, use by Distributor of the Authorized Software on any Authorized Product other than that for which it was obtained or authorized, or on any non-Authorized Product, shall constitute a breach of this Section 14 by Distributor. Except as provided in the Purchase Agreement or as provided in Sections 9 and 10, the software license will terminate on expiration or termination of this Agreement. (b) MODIFICATION AND COPIES. Distributor may not modify or copy the Authorized Software or Related Documentation without prior written consent of Company. Distributor agrees to refrain from taking any steps, including without limitation reverse engineering, reverse assembly or reverse compilation, to derive a source or object code equivalent of the Authorized Software, or for any other purpose. (c) INDEMNIFICATION. Company agrees that, if notified promptly and given sole control of the defense and all related settlement negotiations, it will indemnify and defend Distributor or its customers who have executed a software license or sublicense set forth in Exhibit K or L against any claim based on an allegation the Authorized Software infringes a valid U.S. patent, copyright or trademark. Company, expressly conditioned upon the obligations of Distributor under a software sublicense set forth in Exhibit K, will pay any resulting costs, damages and attorneys' fees awarded by a court with respect to any such claim against Distributor or its customers. Company shall have no obligations under this Section in the case of claims resulting from modifications to the Authorized Software made by Distributor, end-users, or others, or combinations with software or equipment provided by others. If any Authorized Software becomes, or in Company's opinion is likely to become, the subject of such claim of infringement, Company will, at its expense, either, at its option, procure rights for Distributor and its customers who have executed a software license or sublicense to continue using the Authorized Software, or replace or modify the Authorized Software to provide noninfringing software that performs substantially similar functions to the original Authorized Software. Upon failure of the foregoing provisions of this subsection (c), Company will refund the purchase price of the Authorized Product or license fee for the Authorized Software less a reasonable allowance for use. THIS SECTION STATES THE ENTIRE LIABILITY OF COMPANY FOR INFRINGEMENT BY ANY AUTHORIZED SOFTWARE PROVIDED HEREUNDER. (d) COMPANY LICENSING. Notwithstanding anything to the contrary in this Agreement, Company may require at any time upon reasonable notice to Distributor that any of the Authorized Software must be remotely downloaded from the Company directly to the Distributor's customer and that Distributor's customer must execute a separate software license with the Company, substantially in the form of Exhibit L hereto, directly licensing such Authorized Software and updates and revisions thereof. If the Company exercises such right, it will make timely downloads, will in no way interfere with Distributor's relationship with such customers or any sales opportunity, will not use any information regarding such customers except as expressly set forth herein, and will treat as and keep all such information confidential. (e) SURVIVAL. This section shall survive termination of this Agreement. 15. TERMINATION OF AGREEMENT. (a) This Agreement will expire on December 31, 2001, unless earlier terminated for Material Breach as defined in Section 15(b). (b) This Agreement may be terminated by either party for Material Breach no less than 90 days after mailing written notice of termination to the other party as provided in subsection (c) below. Material Breach of this Agreement shall mean: (i) failure of Distributor to make aggregate actual purchases of Authorized Products and Authorized Software [CONFIDENTIAL TREATMENT REQUESTED] in all cases on the same basis as Quota is measured (the amount, if any, by which any amount stated herein exceeds Distributor's aggregate actual purchases for the relevant period being referred to as the "Shortfall Amount"); (ii) material breach of Section 3, 4, 5, 9, 11, 12, 13, and/or 14 of this Agreement by Distributor; (iii) material breach of Section 2, 7(b), 8(a) ), 9, 11 (other than the fourth paragraph), 13(a) or 14 by the Company; (iv) dissolution, insolvency, bankruptcy of, or appointment by a court of a permanent or temporary receiver for, Distributor or Company; or a general assignment of a substantial portion of Distributor's or Company's assets for the benefit of creditors other than an assignment of assets as collateral for a loan in the normal course of business; (v) material failure to pay Distributor's accounts in accordance with the terms of sales by Company to Distributor; or (vi) failure of Company to provide Authorized Products and Authorized Software that are competitive in the marketplace in functions, features and price for a period of six consecutive months. (c) In the event that either party contends the other party is in Material Breach of any of its obligations to the other party under this Agreement, the party claiming Material Breach will provide written notice by certified mail that specifically itemizes each and every obligation of which the party contends the other party is in Material Breach. Subject to the next sentence, in the event that the nonterminating party fails to cure the breach within ninety (90) days of receipt of such notice, the termination shall become effective. In order to cure a breach described in Section 15(b)(i), Distributor must make purchases of Authorized Products and Authorized Software, within the 30 days following receipt of such notice, equal to the applicable Shortfall Amount, which purchases shall be applied only to the Quarter immediately preceding such purchases, or such termination shall become effective. 16. DISTRIBUTOR'S OBLIGATIONS UPON TERMINATION. In the event of termination of this Agreement, whether by non-renewal or for Material Breach, Distributor shall: (a) immediately pay all obligations for Authorized Product and Authorized Software delivered to Distributor prior to termination when they are due and payable to Company, subject to appropriate credits and off-sets; (b) except as provided in the Purchase Agreement, immediately insofar as reasonably possible discontinue any and all uses of the Authorized Trademarks and Authorized Name as defined in Exhibit C, if any, including: (i) cancel all governmental certificates or licenses reserving or registering Distributor's use of the Authorized Trademarks or Authorized Name, if any; (ii) remove the Authorized Trademarks or Authorized Name, if any, from its premises, vehicles, sales proposals, stationery, telephone directory listing, and other advertising and promotional material; (iii) change its corporate and trade name to delete any use of the Authorized Trademarks, Authorized Name, or any name likely to cause confusion with any Authorized Trademarks; (c) not adopt the use of any mark or name deceptively similar to any Authorized Trademarks, other than as provided in the Purchase Agreement; and (d) execute any documents or take any other reasonable steps which will help transfer to Company ownership of all goods repurchased, free and clear of any liens, encumbrances or security interests. It is understood and agreed that (i) in the event of a Material Breach of this Agreement by Distributor solely pursuant to Section 15(b)(i) or a Material Breach by Company pursuant to Section 15(b)(vi), the other party's sole remedy is to terminate this Agreement in accordance with the terms and procedures hereof and that neither party shall have any obligations under this Agreement (and neither party shall have any claims against the other) arising from such Material Breach of this Agreement pursuant to Section 15(b)(i) and Section 15(b)(vi) other than provided in this Section 16 above. 17. COMPANY'S OBLIGATIONS AND DISTRIBUTOR'S OPTIONS UPON TERMINATION. (a) In the event of termination of this Agreement whether by non-renewal or Material Breach, Company: (i) may at Company's option cancel all unfilled orders except those for such Authorized Products and Authorized Software that have been sold previously by Distributor to customers, as evidenced by signed customers' orders submitted by Distributor to Company at least twenty (20) days prior to the effective termination date; (ii) if Distributor so elects, may within thirty (30) days after written notification by Distributor of its existing inventory, purchase from Distributor at Distributor's cost less a reasonable allowance for use or damage, if any, plus freight, either for cash or by set off against debt or trade receivables owed by Distributor to Company, any or all of the Authorized Products and Authorized Software. In the event that Distributor elects to sell its inventory of Authorized Products and Authorized Software and Company elects to purchase this inventory, Distributor will allow Company to inspect this inventory; (iii) shall continue to directly or indirectly provide to Distributor factory repairs for a period not to exceed seven (7) years from the effective date at which the Authorized Products are discontinued for new system sales, or indefinitely in the case of Authorized Products not yet discontinued, so that Distributor can continue to service and maintain its end-user customers. Orders for factory repairs must be placed with Company at least 30 days in advance of the requested shipment date. The order must be paid in full prior to shipment. Prices will be at the then current Distributor Net Price for the Product Group. Company will continue to honor its warranty obligations; (iv) shall continue to directly or indirectly provide to Distributor at its request necessary spare parts, replacement parts, replacement copies of Authorized Software and Related Documentation and all other equipment, software, diagnostics and manuals required to continue to service and maintain the Authorized Products, Authorized Software and Related Documentation, for a period not to exceed five (5) years from the effective date at which the Authorized Products are discontinued for new system sales, or indefinitely in the case of Authorized Products that are not yet discontinued, so that Distributor can continue to service and maintain its end-user customers. Purchase orders for spare parts, replacement equipment and software and documentation must be placed with Company at least 30 days in advance of the requested shipment date. The order must be paid in full prior to shipment. Prices will be at a 60% discount off Company's list price for such parts; and (v) immediately pay all obligations to Distributor when they are due and payable, subject to appropriate credits and set-offs. (b) Company's obligations upon termination and Distributor's options set forth in this Section 17 are specifically conditioned upon Distributor's compliance with its obligations upon termination set forth in Section 16 above, and with Sections 3, 13, and 14, and all other provisions of this Agreement that are expressly made applicable following termination. In the event Distributor breaches any provision of Sections 3, 13, 14, or 16, or any other applicable provision of this Agreement after receipt of written notice of nonrenewal or termination from Company, and Distributor fails or refuses to cure such breach within the stated cure period (or 30 days from receipt of notice of such breach if no such cure period is stated), Company may, at its sole option, provide written notice to Distributor that any and all rights of Distributor set forth in this Section 17 are thereby forfeited, and all of Company's obligations under this Section 17 shall immediately cease as of (1) the date set forth in such notice, or (2) the date by which such breach must be cured and the same remains uncured, whichever date is later. (c) A proper termination or nonrenewal of this Agreement in accordance with the terms hereof shall not give rise to any liability for compensation, reimbursement or damages, including but not limited to claims of loss of clientele, prospective profits or anticipated sales, or for other consequential, incidental or indirect damages. If either party claims that a termination or nonrenewal of this Agreement is improper, such party shall so notify the other party in writing, setting forth the basis for the party's claim that the termination or non-renewal is improper, within thirty (30) days of receipt of the notice of termination, and in such event the other party shall have the option of rescinding the termination or nonrenewal within the fifteen (15) days following receipt of such written notification from such party without any liability to such party for an improper termination or nonrenewal. If either party fails to so notify the other party of such claim of improper termination or nonrenewal, then such party agrees that it shall have waived its rights to challenge the termination thereafter, and the other party shall have no liability to such party in respect of such termination or nonrenewal. Except as provided in this Section (c), nothing shall limit the Company's or Distributor's rights to damages or other legal or equitable remedies for any breach of this Agreement by the other. In the event of litigation or other alternative dispute resolution proceeding arising from any such claim of improper termination, Company and Distributor agree that the prevailing party shall be entitled to collect from the non-prevailing party reimbursement for all of its costs and reasonable attorneys' fees incurred in defending or bringing such litigation or proceeding. 18. FORCE MAJEURE. Either party may be excused from timely performance hereunder if and to the extent such performance is delayed or prevented by fire, flood, earthquake or other Act of God, strike, lock-out or labor dispute not involving the party, act of war, civil disturbance or any similar event or occurrence beyond the reasonable control of the party delaying or preventing its performance. Performance shall be resumed as soon as reasonably possible after the event or occurrence has been remedied. If performance is delayed or suspended for more than 90 days, and such delay or nonperformance would be a Material Breach except for the provisions of this Section, then the party entitled to the performance shall have the rights set forth in Section 15. 19. COMPLETE AGREEMENT AND NO ORAL MODIFICATION. This Agreement constitutes the complete agreement between the parties, and supersedes all previous agreements between the parties other than the Government Systems Agreement dated as of February 28, 1998, the Settlement, Release and Covenant Not to Sue Agreement dated effective March 30, 1998, and notes, credit, loan, shareholder, lease, sublease or security agreements, and guarantees. Distributor has paid no fee in connection with this Agreement. The headings of sections of this Agreement are included merely for the convenience of the parties, and shall not be construed as part of the Agreement. This Agreement and any exhibits, schedules or attachments may be modified only by a written agreement signed by both parties. 20. CHOICE OF LAW AND FORUM. This Agreement shall be governed by, and construed in accordance with, the laws of the State of New York. Except as provided in Section 26, any dispute arising under this Agreement that cannot be resolved by agreement shall, whenever diversity or subject matter jurisdiction exists, be submitted to the United States District Court in the Southern District of New York, and the parties consent and submit to the personal jurisdiction of such court. The prevailing party in any litigation, arbitration, or other proceedings arising out of this Agreement shall be reimbursed for all reasonable costs and expenses incurred in such proceedings, including reasonable attorneys' fees. 21. NO WAIVER. A waiver of any breach or default of this Agreement shall not be deemed to constitute a waiver of any subsequent breach or default. 22. SEVERABILITY. If any of the terms or provisions of this Agreement or the application thereof to any person or circumstance shall, for any reason or to any extent, be held or determined to be invalid or unenforceable, the remainder of this Agreement and the application of such provisions to other persons or circumstances shall not be affected thereby, but rather shall be enforced to the greatest extent permitted by law. 23. NOTICE. Any notice required by this Agreement shall be made in writing, signed by a duly authorized agent of the party giving the notice, and delivered by hand or deposited in the United States mail, first class, postage prepaid, unless specifically required to be by certified mail, and addressed as follows. If to Company: EXECUTONE Information Systems, Inc. 478 Wheelers Farms Road Milford, Connecticut 06460 Attention: President With a copy to: EXECUTONE Information Systems, Inc. 478 Wheelers Farms Road Milford, Connecticut 06460 Attention: General Counsel If to Distributor: Claricom, Inc. d/b/a/ EXECUTONE Business Solutions 478 Wheelers Farms Road Milford, Connecticut 06460 Attention: President With a copy to: Claricom, Inc. d/b/a/ EXECUTONE Business Solutions 478 Wheelers Farms Road Milford, Connecticut 06460 Attention: Corporate Counsel and to Ropes & Gray One International Place Boston, MA 02110 Attn: Joel Freedman and to Bain Capital, Inc. Two Copley Place Boston, MA 02116 Attention: Mr. J. Lavine and Mr. D. Poler 24. RELATIONSHIP OF PARTIES. Distributor is an independent contractor. Nothing in this Agreement shall be construed to mean that Distributor is an agent, employee, franchisee or subcontractor of Company. This Agreement shall not be construed to create any rights or obligations of any person or entity other than the parties. 25. CONSTRUCTION; DEFINITION. For purposes of this Agreement, including all exhibits hereto, the Company shall mean EXECUTONE Information Systems, Inc., a Virginia corporation, its subsidiaries and any person that directly or indirectly controls, is controlled by or is under common control thereof and any successors and assigns thereof. 26. ARBITRATION. Any controversy relating to the phrase "reasonably related to" in Section 7(b)(i) that cannot be settled by mutual agreement shall be finally settled by arbitration as follows: Any party who is aggrieved shall deliver a notice to the other party hereto setting forth the substance of the dispute. Any points remaining in dispute 10 days after the other party's receipt of such notice shall be submitted to binding arbitration in the State of Connecticut before a single arbitrator with industry experience mutually agreeable to the parties, and failing such agreement, appointed in accordance with the American Arbitration Association Arbitration Rules (the "Rules"), modified only as herein expressly provided. The arbitrator may enter a default decision against any party who fails to participate in the arbitration proceedings after having been notified of the proceedings. The arbitrator will be instructed to render a decision within ten business days. The decision of the arbitrator on the points in dispute submitted to him will be final, unappealable and binding, effective for all purposes as of the date of the controversy (as determined by such arbitrator). In any arbitration under this Section, the non-prevailing party shall pay the expenses of the arbitration, including its own and the prevailing party's fees and expenses (including reasonable attorneys' fees). 27. AUTHORIZATION AND EXECUTION. The parties and the persons signing this Agreement represent and warrant that those persons are fully authorized to enter into the terms and conditions of, and to execute, this Agreement on behalf of the respective parties. COMPANY: DISTRIBUTOR: EXECUTONE INFORMATION SYSTEMS, INC. CLARICOM, INC. By: _______________________________ By: ___________________________ _______________________________ ____________________________ Its:_______________________________ Its: _____________________________ (Corporate Seal) DESCRIPTION OF EXHIBITS EXHIBIT A Distributor's Authorized Area EXHIBIT B Distributor's Authorized Products and Authorized Software EXHIBIT C Distributor's Use of Company's Trademarks EXHIBIT D Cross Territorial Policy EXHIBIT E National Accounts Policy EXHIBIT F Federal Accounts Policy EXHIBIT G CCM Accounts Policy (Not Applicable) EXHIBIT H Health Care Accounts Policy (Not Applicable) EXHIBIT I Distributor's Forecast Form EXHIBIT J Nonexclusive Distributor's Quota EXHIBIT K Software License Form EXHIBIT I Software License Form EXHIBIT M Areas Exempt from Certain Provisions of Section 11 [EXHIBITS OMITTED] EX-11 6 EXHIBIT 11 EXHIBIT 11 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS (In Thousands, Except Per Share Amounts)
Years Ended December 31, - ------------------------------------------------------------------------------- 1997 1996 1995 ------------------------------------------------- Income (Loss) From Continuing Operations Before Extraordinary Item $ (221) $ 24,162 $(36,934) Extraordinary Item, Net of Taxes --- (355) --- ------------ ---------- ------------- Net Income (Loss) $ (221) $ 23,807 $(36,934) ========= ======== ======== Earnings (Loss) Per Share: Income (Loss) Before Extraordinary Item $ --- $ 0.47 $ (0.79) Extraordinary Item --- (0.01) --- ------------ --------- ------------ Net Income (Loss) $ --- $ 0.46 $ (0.79) =========== ========= ========= Diluted Earnings (Loss) Per Share: Income (Loss) Before Extraordinary Item $ --- $ 0.46 $ (0.79) Extraordinary Item --- (0.01) --- ------------ ---------- ------------ Net Income (Loss) $ --- $ 0.45 $ (0.79) =========== ========= ========= Average Common Shares Outstanding: Basic 49,655 51,712 46,919 ======== ======== ======== Diluted 49,655 52,251 46,919 ======== ======== ========
EX-13 7 EXHIBIT 13 EXHIBIT 13 ANNUAL REPORT TO SHAREHOLDERS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION EXECUTONE Information Systems, Inc. (the Company) develops, markets and supports voice and data communications systems. Products and services include telephone systems, voice mail systems, inbound and outbound call center systems and specialized healthcare communications systems. The Company's UniStar Entertainment indirect subsidiary has the exclusive right to design, develop and manage the National Indian Lottery (NIL). The Company's products are sold under the EXECUTONE'r', INFOSTAR'r', IDS'tm', LIFESAVER'tm' and INFOSTAR/ILS'tm' brand names through a national network of independent distributors and company direct sales and service employees. Revenues are derived from product sales to distributors, direct sales of healthcare products, and direct sales to national accounts and government customers, as well as installations, additions, changes, upgrades or relocation of previously installed systems, maintenance contracts, and service charges to the existing base of healthcare, national account and government customers. 1997 COMPARED TO 1996 Results of Operations On May 31, 1996, the Company sold substantially all of its direct sales and services organization, including its long-distance reseller business (hereinafter referred to as the "sale of the direct offices"), for consideration valued at $69.6 million to Clarity Telecom Holdings, Inc. d/b/a Executone Business Solutions (Clarity, subsequently known as Claricom). As a result of the business sales and dispositions consummated during the first half of 1996, including the sale of the direct offices, the financial results for 1997 are not comparable to 1996, other than on certain measures of overall profitability. During 1997, the Company generated approximately $0.1 million in operating income compared to an operating loss of $3.4 million in 1996. The Company had a net loss of $0.2 million, or $0.00 per share in 1997, compared to a net loss of $2.6 million, or ($0.05) per share in 1996, excluding the gain on the sale of the direct offices. The 1997 results, while improved over 1996, were not in line with the Company's expectations. Increased revenues achieved by the Healthcare Communications business in 1997 along with the non-recurring expenses incurred in the first half of 1996 relating to the sale of the direct sales offices were the primary reasons for the year over year improvement. However, these favorable variances were largely offset by the much lower than anticipated sales levels to the Company's largest distributor. Computer Telephony The mission of the Computer Telephony (CT) business is to develop and distribute telephony products that are easy to install, easy to maintain, easy to use and create value for its customers. CT offers a complete portfolio of applications built upon the IDS'tm' family of digital telephone systems. Products range from PBXs for small to medium-sized businesses to standards-compliant computer telephony applications, LAN and Internet-based applications, including voice mail, unified messaging, automatic call distribution (ACD), callback predictive dialing and wireless communications. This business targets the under-400-extension market segment. Customers range from small companies with fewer than ten employees to large national accounts and government agencies. 1 CT markets its products through independent distribution and direct sales. The direct sales effort focuses on product and service sales to National and Government Accounts. The Company utilizes its independent distribution channel to service and install direct company sales through a National Account Service Arrangement with the independent channel. CT had 1997 revenues of $117.2 million, compared to $129.4 million in 1996. The decrease in revenue is due to a $16.0 million decrease in sales to Claricom, the purchaser of the direct offices and the Company's largest distributor during 1997. For comparability, the 1996 revenue includes sales revenue to the former direct sales and service organization prior to the sale. Excluding Claricom, the remainder of the independent distribution channel increased revenue by $6.4 million, or 22%, compared to 1996. Revenues from the retail portion of CT were largely stable year over year. Repair revenue decreased approximately $2 million, primarily due to lower Claricom activity, and LCR revenues increased almost 50% to $1.8 million. The reduced level of sales to Claricom, the Company's largest distributor, had a significant impact on the financial results for 1997. Effective April 1, 1998, Claricom became a non-exclusive distributor of the Company's products in all parts of its territory. It is the Company's intention to supplement sales in the Claricom territories with additional distribution. The Company has identified other distributors to sell the Company's products in certain parts of Claricom's territory, which will give the Company the ability over time to increase revenues by adding alternative distribution in Claricom territories. Since Claricom accounted for more than 10% of the Company's revenues in 1997 and is expected to continue to represent a large portion of the Company's revenues, the reduction of sales to Claricom could have a material adverse effect on the Company if the Company could not supplement the shipments to the Claricom territories with other alternative distribution. The Company believes that within a reasonable period of time it can establish alternative distribution channels in Claricom's major markets to supplement the reduced volume from Claricom. However, the Company cannot state with certainty when, or the extent to which, such alternative distribution arrangements will be completed or their effect on revenues. Healthcare Communications The mission of the Healthcare Communications business is to provide a full array of solutions that enable healthcare facilities to realize a substantial savings in operating costs without compromising the quality of patient care. Integrated on the scaleable Healthcare Communications Platform (HCP), healthcare products are designed to improve patient care quality, prevent technological obsolescence and increase staff productivity. Products range from traditional nurse call systems, intercoms and room status indicators to more sophisticated patient reporting systems, infrared locating systems and wireless technologies. All of these products can be seamlessly integrated to enhance a facility's communications and information networking. Healthcare customers include hospitals, surgical centers, nursing homes and assisted living centers. Revenues for 1997 were $39.0 million compared to $30.2 million in 1996 due to an increase in new installations, system upgrades and expansions. Other Matters Interest expense decreased to $2.0 million in 1997 from $2.7 million in 1996 due to a decrease in the debt outstanding during 1996 after the sale of the direct offices. The proceeds of the sale in 1996 were used to repay the then entire outstanding balance on the Company's revolving credit facility. Other income, net, decreased by $0.3 million compared to 1996 primarily due to lower interest income on invested cash. The Company accounts for income taxes in accordance with FAS No. 109, "Accounting for Income Taxes". For the year ended December 31, 1997, the Company recorded a tax benefit of $0.1 million. The tax benefit for the year increased the deferred tax asset reflecting an increase in tax benefits to be utilized in the future. As of December 31, 1997, the deferred tax asset of $18.6 million represents the expected benefits to be received from the utilization of tax benefit carryforwards. The Company believes that the deferred tax asset will more likely than not be recognized in the carryforward periods. For the years ended December 31, 1997 and 1996, more than 10% of the Company's revenues were derived from a single 2 independent distributor, Claricom. Revenues, net of discounts, were $29.3 million and $31.7 million for 1997 and the seven-month period after the sale of the direct sales and service organization in 1996, respectively. Had the sale to Claricom taken place at the beginning of 1996, it is estimated that Claricom revenues for 1996 would have been $45.3 million. This includes $13.6 million in sales to the former direct sales and service organization prior to the sale to Claricom. See "Computer Telephony" above. In 1997, the Company adopted FAS No. 128, "Earnings per Share," effective for periods ending after December 15, 1997. As a result, the Company's reported earnings per share for prior years were restated. The effect of this accounting change on previously reported earnings per share data was to increase 1996 basic earnings per share by $0.01 compared to the original calculation of primary earnings per share pursuant to APB No. 15. Earnings per share did not change for 1997 or 1995. During 1996, the Company adopted FAS No. 123, "Accounting for Stock-Based Compensation". In compliance with the provisions of the new statement, the Company has elected to continue to apply APB Opinion 25 in accounting for its stock compensation plans and, accordingly, has not recognized compensation expense for its plans. If compensation cost had been determined in accordance with FAS No. 123, net income would have been reduced by $0.2 million, $0.1 million and $0.3 million for 1997, 1996 and 1995, respectively. The change in earnings per share would have been immaterial for each of the three years. The Company has conducted a review of its computer systems to identify systems that could be affected by the "Year 2000" issue. Systems that do not properly recognize such information could generate erroneous data or fail. Although the Company estimates the cost to resolve the Year 2000 issue through its current software system is less than $0.5 million, it has decided as part of its long-term information systems plan to convert to a new and more comprehensive software system which will cost approximately $2 million, including installation and data conversion costs. These costs will be capitalized and depreciated over the expected service life of the system beginning in 1999. The Company believes that the conversion to new software will resolve the Year 2000 issue. However, if the conversion is not completed timely, the Year 2000 problem may have a material impact on the operations of the Company. Unistar On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming Corporation (Unistar Gaming) for 3.7 million shares of the Company's common stock valued at $5.4 million and 350,000 shares of newly issued preferred stock valued at $7.3 million. Unistar Gaming was privately-held prior to the acquisition. Its subsidiary, UniStar Entertainment, Inc. (UniStar), has an exclusive five-year contract ending January 2003 to design, develop, finance and manage the NIL for the Coeur d'Alene Tribe of Idaho ("CDA" or "the Tribe"). See Note L of the Notes to Consolidated Financial Statements for the terms of the agreement with the Tribe. The initial goal of the investment in UniStar was to establish and manage a telephone lottery that could be played by any individual of majority age, residing in one of the 36 states or the District of Columbia that currently operates a state-run lottery. In the original telephone-based lottery, it was contemplated that calls via an 800 number would be processed with interactive voice response equipment or live agents located on the Tribe's Reservation in Idaho using ACD software to process nationwide lottery sales. The NIL business plan has evolved in response to legal challenges to encompass Internet-based instant lottery games, and as of January 1998, a local, non-toll-free telephone and Internet-accessible weekly draw lottery. The Company has made a significant investment in UniStar, which upon acquisition created 8% dilution to the Company's stockholders and, subsequent to the acquisition, has totaled an additional $11.3 million in cash. In 1997, the Company invested $6.7 million as part of the cost to develop the software systems, building and other costs related to the project, $5.9 million of which have been recorded as assets on the balance sheet. The total UniStar investment as of December 31, 1997 is $25.4 million, including $15.8 million in goodwill and $8.0 million in other assets with the remainder consisting of funded UniStar expenses. In the opinion of the Company's management, this investment is justified based upon the potential returns. In an attempt to block the NIL, certain states filed letters under 18 U.S.C. Section 1084 to prevent the long-distance carriers from providing telephone service to the NIL. In 1995, the CDA initiated legal action against AT&T Corporation (AT&T) to compel the long-distance carriers to provide telephone service to the NIL. The CDA's position is that the lottery is authorized by the Indian Gaming Regulatory Act (IGRA) passed by Congress in 1988, that IGRA preempts state law, and that 18 U.S.C. Section 1084 is inapplicable and, therefore, the states lack authority to issue the Section 3 1084 notification letters to any carrier. On February 28, 1996, the CDA Tribal Court ruled that CDA had satisfied all requirements of IGRA and the Section 1084 letters issued by certain state attorneys general in an effort to interfere with the lawful operation of the NIL are invalid. In addition, the Tribal Court ruled that the long-distance carriers cannot refuse to provide telephone service based upon 18 U.S.C. Section 1084. On July 2, 1997, the Tribal Appellate Court affirmed the lower Tribal Court's rulings and analysis, upholding the CDA's right to conduct the telephone lottery. On August 22, 1997, AT&T filed a complaint for declaratory judgment in the U.S. District Court in Idaho against the CDA, seeking a federal court ruling as to the enforceability of the Tribal Court's May 1, 1996 order affirming the CDA's right to conduct the telephone lottery. The CDA has answered that complaint. On May 28, 1997, the State of Missouri brought an action in the Missouri Circuit Court in Kansas City against UniStar and the CDA to enjoin the NIL's US Lottery Internet instant games offered by the CDA and managed by UniStar. The complaint sought civil penalties, attorneys fees and court costs. The complaint alleged that the US Lottery violates Missouri anti-gaming laws and that the marketing and promotion of the US Lottery violate the Missouri Merchandising Practices Act. The CDA and UniStar removed the case to the U.S. District Court for the Western District of Missouri, which denied the State's subsequent motion to remand the case back to the state court. The Court subsequently granted a motion to dismiss CDA from the case based on sovereign immunity. The Court denied the motion to dismiss UniStar based on sovereign immunity, although the Court indicated it might reconsider that decision. UniStar filed a motion for reconsideration of its motion for dismissal. On January 28, 1998, the State of Missouri sought to dismiss voluntarily the existing case against UniStar and filed the next day, a new action against the Company, UniStar and two tribal officials, with essentially the same allegations, in state court. The State obtained a temporary restraining order from a state judge enjoining the marketing of the Internet and telephone lottery in the State of Missouri. On February 5, 1998, the U. S. District Court for the Eastern District of Missouri ruled that this second case also should be heard in federal court, transferred the second case to the Western District of Missouri where the original case had been filed, and dissolved the state court's temporary restraining order, effective February 9, 1998. A motion to dismiss the second case based on the sovereign immunity of all the defendants and a motion to abstain in favor of the jurisdiction of the CDA Tribal Court are pending. The state has noticed its appeal of the federal district court's rulings to the Eighth Circuit Court of Appeals. On September 15, 1997, the State of Wisconsin, by its Attorney General, filed an action in the Wisconsin State Circuit Court for Dane County against the Company, UniStar and the CDA, to permanently enjoin the US Lottery offered by the Tribe on the Internet and managed by UniStar. The complaint alleges that the offering of the US Lottery violates Wisconsin anti-gambling laws and that legality of the US Lottery has been misrepresented to Wisconsin residents in violation of state law. In addition to an injunction, the suit seeks restitution, civil penalties, attorneys' fees and court costs. The Company, UniStar and the CDA have removed the case to the U.S. District Court in Wisconsin. On February 18, 1998, the District Court dismissed the Tribe from the case based on sovereign immunity and dismissed the Company based on the State's failure to state a claim against the Company. Motions to dismiss the case against UniStar were denied. UniStar has filed its notice of appeal of this decision to the Seventh Circuit Court of Appeals. The NIL conducts business under the US Lottery trade name. The US Lottery began test marketing its Instant ticket games on the Internet in July 1997. Through December 31, 1997, the US Lottery generated revenues of $1.5 million. On January 20, 1998, the US Lottery launched its first Draw game, the Super6. Tickets for the Super6 can be purchased either over the Internet or by telephone. As of March 31, 1998, the registered base of the US Lottery was approximately 21,000 people with about 3,000 active players. Due to advertising, professional fees and other startup costs, the NIL has yet to generate a profit. As a result, UniStar has not recognized any revenue as of December 31, 1997. There are market and legal risks associated with the development of the NIL. The Company believes there is a national market for the NIL based upon research into the experience of other national lotteries and the growth of the overall lottery market. However, there is no assurance that there will be acceptance of a telephone or Internet lottery. Based upon the ruling of the Tribal Appellate Court affirming the CDA's right to conduct the telephone lottery and opinions from outside legal counsel, the Company also believes that the legal decision rendered by the CDA Tribal Court and affirmed by the Tribal Appellate Court will ultimately be affirmed by the Idaho federal court. The Company believes that UniStar also will prevail in the Missouri and Wisconsin lawsuits. However, there is no assurance of such a legal outcome. In the event that the telephone and Internet lotteries do not attain the level of market acceptance anticipated by 4 the Company or if the outcome of the pending lawsuits is adverse, the Company would have to reevaluate its investment in UniStar. SUBSEQUENT EVENTS Corporate Reorganization On January 8, 1998, the Company announced the beginning of the restructuring of its businesses and the retirement of its Chief Executive Officer (CEO). These announcements have resulted in several related charges which will be reflected in the consolidated financial statements for the first quarter of 1998. Alan Kessman, Chairman and CEO of the Company announced his intention to retire from the management of the day-to-day operations of the Company. In accordance with the diminishment of responsibility section of his employment continuity agreement, Mr. Kessman will receive a severance payment of $1.3 million. The Company will establish a reserve for this cost during the first quarter of 1998. The Company has retained an executive search firm to find a successor for Mr. Kessman, who has agreed to remain in his current position until his successor is selected. The Company has incurred approximately $0.2 million in expenses to recruit a new CEO which will be expensed as part of the restructuring charge in the first quarter of 1998. In addition, the Company has restructured current operations which resulted in a workforce reduction during January and February 1998. The Company will incur approximately $0.6 million for severance, benefits and other restructuring charges in the first quarter of 1998. As previously announced, Furman Selz LLC has been hired to advise the Company as to certain financing and corporate restructuring options. Based upon advice of Furman Selz and the recommendation of a special committee of the Board of Directors, the Board has determined that it is in the best interests of the shareholders of the Company to separate the business of the Company's UniStar subsidiary from the operations of its computer telephony and healthcare communications businesses. The Company expects, subject to completion of further analysis and receipt of necessary approvals, that the separation would be effected through a taxable distribution to shareholders later this year. During the first quarter of 1998, the Company incurred approximately $0.2 million in advisory expenses related to preparation and review of corporate restructuring options. Future expenses will be dependent upon the form and nature of the corporate restructuring. The Company is also pursuing a plan to retain and motivate key employees, the details of which are expected to be concluded by the second quarter of 1998. In total, the Company expects to record a restructuring charge of approximately $2.3 million during the first quarter of 1998. Amended Distributor Agreement with Claricom On March 30, 1998, the Company entered into an Amended and Restated Distributor Agreement with Claricom (the "Amended Agreement"). The Amended Agreement, effective April 1, 1998 and continuing through December 31, 2001, provides, among other things, that Claricom will be a non-exclusive distributor of the Company's telephony products and that Claricom can market products competing with those sold by the Company. Upon execution of the Amended Agreement, Claricom released to the Company the $5 million plus interest being held in escrow to satisfy potential indemnity claims under the 1996 Asset Purchase Agreement and waived all potential contract claims under the prior distributor agreement. 1996 COMPARED TO 1995 5 Results of Operations With the sale of the direct offices and the sale of the Videoconferencing division in 1996, the year as a whole was not comparable to 1995 other than on overall measures of profitability such as operating or net income. In addition, with the timing of the sale, the first half of 1996 is not comparable to the second half of 1996 either on a financial or operational basis. For the first six months of 1996, the primary mission of the Company, and the primary focus of management resources, was to complete the sale of the direct offices while transitioning the Company, adversely affecting operating results. For the second six months of 1996, the Company operated on a post-sale standalone basis. Excluding the gain on the sale of businesses, operating income for the six-month period ended December 31, 1996 was $7.3 million compared to an operating loss of $10.7 million for the first six months of 1996. Net income for the six-month period ended December 31, 1996 was $4.4 million, or $0.09 per share, compared to a net loss of $7.0 million, or ($0.14) per share, for the first six months of 1996. The Company recorded a pretax gain of $48.9 million net of transaction, severance and other related costs of which $47.5 million was recorded during the three-month period ended June 30, 1996. An additional $1.4 million pretax gain was recorded during the three-month period ended December 31, 1996 reflecting purchase price adjustments. The proceeds were used to repay the Company's bank borrowings and the excess was invested in short-term cash investments. In June 1996, the Company sold its Videoconferencing division to BT Visual Images LLC for a $0.2 million note, royalties on videoconferencing revenue through June 1998 and contingent consideration related to the sale of inventory transferred to the buyer as part of the sale. The Company recorded a reserve for loss of $3.9 million on the transaction during the three-month period ended March 31, 1996. The Company has filed a legal action against GPT Video Systems, with whom the Company terminated its distribution agreement for failure to deliver properly functioning videoconferencing products on a timely basis, which case is in the discovery stages. In April 1996, the Company also sold its Inmate Calling business for $0.5 million in cash and notes and recorded a pretax loss of $1.0 million. CT includes independent distribution, National Accounts and Government Systems. Revenues for 1996, excluding revenues derived from the business sold, were $129.4 million, of which $76.1 million was generated during the last six months of 1996. Sales to Claricom totaled $31.7 million during the seven-month, post-sale period. Healthcare revenues for 1996 were $30.2 million, of which $17.3 million was generated during the last six months of 1996. Selling, general and administrative costs were higher than anticipated as the transition of post-sale administrative functions such as billing and inventory control was more costly than planned. LIQUIDITY AND CAPITAL RESOURCES The Company's liquidity is represented by cash, cash equivalents and cash availability under its existing credit facilities. The Company's liquidity was approximately $28 million, $50 million and $23 million as of December 31, 1997, 1996 and 1995, respectively. At December 31, 1997 and 1996, cash and cash equivalents amounted to $7.7 million and $27.7 million, respectively, or 11% and 32% of current assets, respectively. The $20.0 million decrease in cash and cash equivalents was used to repurchase $4.9 million of the Company's common stock, fund $5.8 million in operating activities, purchase $1.5 million in capital equipment and fund $5.6 million relating to the Company's investment in UniStar. Cash used by operating activities was $5.8 million compared to $11.0 million in 1996. The decrease in cash used by operating activities is primarily due to the decrease in average trade receivables due to lower revenues over the periods. Total debt at December 31, 1997 was $15.6 million, an increase of $0.9 million from $14.7 million at December 31, 1996. The increase in debt is due to $1.8 million in capital lease obligations incurred in connection with equipment acquisitions and an increase to the carrying value of the convertible subordinated debentures of $0.3 million due to accretion, offset by $1.2 million in debt repayments on other borrowings. 6 Proceeds from the sale of the direct offices included $5.0 million of cash which was held in escrow and reported on the consolidated balance sheet as of December 31, 1997 and 1996 as restricted cash. These funds were released to the Company by Claricom on March 31, 1998. The Company obtained a new revolving credit facility (the Credit Facility) in October 1997. The $35 million Credit Facility is unsecured and expires in January 2000. It consists of a revolving line of credit providing for direct borrowings and letter of credit advances, subject to availability. Direct borrowings and letter of credit advances are made available pursuant to a formula that measures total outstanding debt in relation to cash, accounts receivable and earnings before interest, taxes, depreciation and amortization. The Credit Facility agreement contains certain restrictive covenants that include, among other things, limitations on total outstanding debt, minimum levels of consolidated net worth and maximum levels of capital expenditures and capitalized leases. During 1997, the Company was in compliance with all such financial covenants. Interest rates are also subject to adjustment based upon certain financial ratios. Refer to Note C of the Notes to Consolidated Financial Statements. Required principal payments for debt in 1998 are approximately $1.0 million. The Company believes that borrowings under the Credit Facility and cash flow from operations will be sufficient to meet working capital and other requirements for 1998. 7 SELECTED FINANCIAL DATA The following is selected financial data for EXECUTONE for the five years ended December 31, 1997. (In thousands, except for per share amounts)
Years Ended December 31, --------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 --------------------------------------------------------------------------------- Revenues (1) $156,396 $212,022 $296,393 $291,969 $271,765 ======== ======== ======== ======== ======== Income (Loss) Before Income Taxes From Continuing Operations(2) $ (358) $ 39,782 $(39,221) $ 10,041 $ 7,580 ======== ======== ======== ======== ======== Income (Loss) From Continuing Operations $ (221) $ 24,162 $(36,934) $ 6,734 $ 4,903 Income From Discontinued Operations, Net of Taxes(3) --- --- --- 757 298 Extraordinary Item - Loss on Extinguishment of Debt, Net of Taxes(4) --- (355) --- --- --- -------- -------- -------- -------- ------- Net Income (Loss) $ (221) $ 23,807 $(36,934) $ 7,491 $ 5,201 ======== ======== ======== ======== ======= EARNINGS (LOSS) PER SHARE: Continuing Operations $ --- $ 0.47 $ (0.79) $ 0.15 $ 0.15 Discontinued Operations --- --- --- 0.02 0.01 Extraordinary Item --- (0.01) --- --- --- -------- -------- -------- -------- ------- Net Income (Loss) $ --- $ 0.46 $ (0.79) $ 0.17 $ 0.16 ======== ======== ======== ======== ======= DILUTED EARNINGS (LOSS) PER SHARE: Continuing Operations $ --- $ 0.46 $ (0.79) $ 0.14 $ 0.10 Discontinued Operations --- --- --- 0.02 0.01 Extraordinary Item --- (0.01) --- --- --- -------- -------- -------- -------- ------- Net Income (Loss) $ --- $ 0.45 $ (0.79) $ 0.16 $ 0.11 ======== ======== ======== ======== ======= Total Assets $138,864 $152,009 $167,844 $189,481 $175,555 ======== ======== ======== ======== ======== Long-Term Debt $ 14,643 $ 13,837 $ 29,829 $ 24,698 $ 32,279 ======== ======== ======== ======== ======== Cash Dividends Declared Per Share (5) $ --- $ --- $ --- $ --- $ --- ======== ======== ======== ======== ========
(1) The decline in revenues in 1997 and 1996 from prior years is attributable to the sale of the Company's direct sales and service organization (DSOs) in May 1996 (See Note M). (2) The 1996 financial results included a pretax gain on the sale of the Company's DSO's of $48.9 million (See Note M). The 1995 financial results included a restructuring charge of $44.0 million (See Note N). (3) Discontinued operations are presented for the Vodavi Communications Systems Division (VCS) which was sold in March 1994. (4) The 1996 extraordinary item relates to the write-off of deferred debt issue costs associated with the Company's revolving credit facility repaid in June 1996. (5) The Company has not declared or paid any cash dividends on its Common Stock. Refer to "Stock Data". 8 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except for per share amounts)
Years Ended December 31, 1997 1996 1995 ---- ---- ---- REVENUES $156,396 $212,022 $296,393 COST OF REVENUES 103,387 132,510 173,536 --------- -------- --------- Gross Profit 53,009 79,512 122,857 --------- -------- --------- OPERATING EXPENSES: Product development and engineering 12,794 13,773 14,703 Selling, general and administrative 40,125 69,180 100,520 Provision for restructuring and unusual items (Note N) --- --- 44,042 --------- -------- --------- 52,919 82,953 159,265 --------- -------- --------- OPERATING INCOME (LOSS) 90 (3,441) (36,408) INTEREST EXPENSE (1,985) (2,707) (3,920) NET GAIN ON SALE OF BUSINESSES (Note M) --- 44,060 --- OTHER INCOME, NET 1,537 1,870 2,129 ACQUISITION COSTS (Note M) --- --- (1,022) --------- -------- --------- INCOME (LOSS) BEFORE INCOME TAXES (358) 39,782 (39,221) PROVISION (BENEFIT) FOR INCOME TAXES: Cash 6 4,200 350 Noncash (Note D) (143) 11,420 (2,637) ---------- -------- --------- (137) 15,620 (2,287) ---------- -------- --------- INCOME (LOSS) BEFORE EXTRAORDINARY ITEM (221) 24,162 (36,934) Extraordinary item - loss on extinguishment of debt (net of income tax benefit of $238) --- (355) --- ---------- -------- --------- NET INCOME (LOSS) $ (221) $ 23,807 $ (36,934) ========== ======== ========= EARNINGS (LOSS) PER SHARE: INCOME (LOSS) BEFORE EXTRAORDINARY ITEM $ --- $ 0.47 $ (0.79) EXTRAORDINARY ITEM --- (0.01) --- ---------- -------- --------- NET INCOME (LOSS) $ --- $ 0.46 $ (0.79) ========== ======== ========= DILUTED EARNINGS (LOSS) PER SHARE: INCOME (LOSS) BEFORE EXTRAORDINARY ITEM $ --- $ 0.46 $ (0.79) EXTRAORDINARY ITEM --- (0.01) --- ---------- -------- --------- NET INCOME (LOSS) $ --- $ 0.45 $ (0.79) ========== ======== ========= AVERAGE COMMON SHARES OUTSTANDING: BASIC 49,655 51,712 46,919 ========== ======== ========= DILUTED 49,655 52,251 46,919 ========== ======== =========
The accompanying notes are an integral part of these consolidated statements. 9 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) Years Ended December 31, 1997 1996 1995 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Income (loss) before extraordinary item $ (221) $ 24,162 $(36,934) Adjustments to reconcile net income (loss) to net cash used by operating activities: Depreciation and amortization 2,969 4,242 6,093 Deferred income tax provision (benefit) (137) 11,420 (2,637) Net gain on sale of businesses (Note M) --- (44,060) (1,087) Provision for restructuring and unusual items (Note N) --- --- 44,042 Provision for losses on accounts receivable 277 1,921 1,440 Other, net 201 (465) (250) Changes in working capital items: Accounts receivable 5,439 (8,754) (4,205) Inventories (3,893) 1,048 (3,121) Accounts payable and accruals (8,779) (2,857) (9,402) Other working capital items, net (1,668) 2,375 2,177 --------- -------- -------- NET CASH USED BY OPERATING ACTIVITIES (5,812) (10,968) (3,884) --------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (1,469) (2,534) (3,457) Dispositions of businesses --- 56,948 125 Investment in UniStar (5,556) (4,182) --- Proceeds from sale of VCS --- --- 1,200 Other, net (1,325) 298 822 --------- -------- -------- NET CASH (USED) PROVIDED BY INVESTING ACTIVITIES (8,350) 50,530 (1,310) --------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings (repayments) under revolving credit facility --- (15,445) 4,478 Repayments of other long-term debt (1,182) (1,134) (622) Repurchase of stock (4,893) (4,554) (810) Proceeds from issuance of stock 268 819 1,641 Other borrowings --- 356 750 --------- -------- -------- NET CASH (USED) PROVIDED BY FINANCING ACTIVITIES (5,807) (19,958) 5,437 --------- -------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (19,969) 19,604 243 CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 27,696 8,092 7,849 --------- -------- -------- CASH AND CASH EQUIVALENTS - END OF YEAR $ 7,727 $ 27,696 $ 8,092 ========= ======== ========
The accompanying notes are an integral part of these consolidated statements. 10 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(In thousands, except for share amounts) December 31, December 31, 1997 1996 ------------ ----------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 7,727 $ 27,696 Restricted cash 5,084 --- Accounts receivable, net of allowance of $1,814 and $2,106 33,403 38,992 Inventories 20,436 16,814 Prepaid expenses and other current assets 4,091 3,099 -------- -------- Total Current Assets 70,741 86,601 RESTRICTED CASH --- 5,031 PROPERTY AND EQUIPMENT, net 7,767 7,578 INTANGIBLE ASSETS, net (Note L) 19,765 19,893 DEFERRED TAXES 18,577 18,434 OTHER ASSETS 22,014 14,472 -------- -------- $138,864 $152,009 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt $ 951 $ 882 Accounts payable 23,009 26,666 Accrued payroll and related costs 3,007 3,398 Accrued liabilities 13,123 17,956 Deferred revenue and customer deposits 2,541 3,164 -------- -------- Total Current Liabilities 42,631 52,066 LONG-TERM DEBT 14,643 13,837 OTHER LONG-TERM LIABILITIES 1,092 759 -------- -------- Total Liabilities 58,366 66,662 -------- -------- STOCKHOLDERS' EQUITY: Common stock: $.01 par value; 80,000,000 shares authorized; 49,660,359 and 51,173,755 issued and outstanding 497 512 Preferred stock: $.01 par value; Cumulative Convertible Preferred Stock (Series A), 250,000 shares authorized, issued and outstanding; Cumulative Contingently Convertible Preferred Stock (Series B), 100,000 shares authorized, issued and outstanding 7,300 7,300 Additional paid-in capital 71,500 76,113 Retained earnings (since July 1, 1988) 1,201 1,422 -------- -------- Total Stockholders' Equity 80,498 85,347 -------- -------- $138,864 $152,009 ======== ========
The accompanying notes are an integral part of these consolidated balance sheets. 11 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands, except for Common Stock Preferred Stock Additional Retained Total share amounts) ------------------ ------------------ Paid-In Earnings Stockholders' Shares Amount Shares Amount Capital (Deficit) Equity ------ ------ ------ ------ ------- --------- ------ Balance at December 31, 1994 45,647,894 $456 --- $ --- $72,303 $14,549 $87,308 Proceeds from issuances of stock from employee stock plans 1,934,492 19 1,613 1,632 Warrants exercised for common stock 363,549 4 (4) --- Common and preferred stock issued to acquire Unistar (Note L) 3,700,000 37 350,000 7,300 5,374 12,711 Common stock issued for investment in DCC (Note G) 353,118 4 1,100 1,104 Repurchase of stock (340,561) (3) (807) (810) Amortization of deferred compensation 89 89 Net loss (36,934) (36,934) ------------------------------------------------------------------------------------- Balance at December 31, 1995 51,658,492 $517 350,000 $7,300 $79,668 $(22,385) $65,100 Proceeds from issuances of stock from employee stock plans 810,036 8 839 847 Warrants exercised for common stock 199,431 2 7 9 Repurchase of stock (1,494,204) (15) (4,536) (4,551) Amortization of deferred compensation 135 135 Net income 23,807 23,807 ------------------------------------------------------------------------------------- Balance at December 31, 1996 51,173,755 $512 350,000 $7,300 $76,113 $1,422 $85,347 Proceeds from issuances of stock from employee stock plans 323,490 3 201 204 Warrants exercised for common stock 50,000 1 60 61 Repurchase of stock (1,886,886) (19) (4,874) (4,893) Net loss (221) (221) ------------------------------------------------------------------------------------- Balance at December 31, 1997 49,660,359 $497 350,000 $7,300 $71,500 $1,201 $80,498 =====================================================================================
The accompanying notes are an integral part of these consolidated statements. 12 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - NATURE OF THE BUSINESS AND FORMATION OF THE COMPANY EXECUTONE Information Systems, Inc. (the Company) develops, markets and supports voice and data communications systems. Products and services include telephone systems, voice mail systems, inbound and outbound call center systems and specialized healthcare communications systems. The Company's UniStar Entertainment indirect subsidiary (UniStar) has an exclusive five-year contract with the Coeur d'Alene Tribe of Idaho (CDA) to design, develop, finance and manage the National Indian Lottery (NIL). Products and services are sold under the EXECUTONE'r', INFOSTAR'r', IDS'tm', LIFESAVER'tm' and INFOSTAR/ILS'tm' brand names through a national network of independent distributors and direct sales and service employees. The Company's products are manufactured primarily in the United States, Malaysia, China and the Dominican Republic. The Company was formed in July 1988 through the merger of ISOETEC Communications, Inc. (ISOETEC) with Vodavi Technology Corporation (Vodavi). The merger of ISOETEC into Vodavi was accounted for under the purchase method of accounting and Vodavi was deemed to have undergone a quasi-reorganization for accounting purposes. As of July 1988, Vodavi's accumulated deficit of approximately $49.7 million was eliminated. Executone, Inc. was acquired in 1988 from Contel Corporation (Contel) for promissory notes and cash. NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation. The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries. In consolidating the accompanying financial statements, all significant intercompany transactions have been eliminated. Investments in affiliated companies owned more than 20%, but not in excess of 50%, are recorded under the equity method. Certain prior year amounts have been reclassified to conform to the current year's 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 reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Revenue Recognition. The Company recognizes revenue on equipment sales and software licenses to independent sales and service offices when shipped. Revenue from equipment, software and installation contracts with end-users is recognized when the contract or contract phase for major installations is substantially completed. Revenue derived from the sale of service contracts is amortized ratably over the service contract period on a straight-line basis. Earnings Per Share. Earnings per share is calculated in accordance with the provisions of FAS No. 128, "Earnings per Share", effective for periods ending after December 15, 1997. Accordingly, prior year amounts have been restated. Earnings per share is based upon the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is based upon the weighted average number of shares of common stock outstanding plus the dilutive effect of stock options and warrants outstanding during the period. Stock options and warrants, the convertible preferred stock and the convertible debentures, which are antidilutive, have been excluded from the computations. Cash Equivalents. Cash equivalents include short-term investments with original maturities of three months or less. Inventories. Inventories are stated at the lower of first-in, first-out (FIFO) cost or market and consist of the following at December 31, 1997 and 1996:
(Amounts in thousands) 1997 1996 ---------------------- ---- ---- Raw Materials $ 4,672 $ 3,493 Finished Goods 15,764 13,321 -------- -------- $20,436 $16,814 ======= =======
13 Intangible Assets. Intangible assets represent the excess of the purchase price of the predecessor companies acquired over the fair value of the net tangible assets acquired. The carrying value of intangibles is evaluated periodically in accordance with the provisions of FAS No. 121, "Accounting for the Impairment of Long-Lived Assets", by projecting the lowest level of future undiscounted net cash flows of the underlying businesses. If the sum of such cash flows is less than the book value of the long-lived assets, including intangibles, projected future cash flows are discounted and intangibles are adjusted accordingly. Amortization is provided over a 40-year period, except for the goodwill related to the UniStar acquisition which will be amortized beginning in 1998 over the five-year term of the management agreement (See Note L). Intangible assets at December 31, 1997 and 1996 are net of accumulated amortization of $1.1 million and $1.0 million, respectively. Property and Equipment. Property and equipment at December 31, 1997 and 1996 consist of the following:
(Amounts in thousands) 1997 1996 ---------------------- ---- ---- Furniture and fixtures $ 887 $ 1,992 Leasehold improvements 1,718 1,813 Machinery and equipment 16,858 20,253 --------- ---------- 19,463 24,058 Accumulated depreciation (11,696) (16,480) --------- ---------- Property and equipment, net $ 7,767 $ 7,578 ========= ==========
Depreciation is provided on a straight-line basis over the estimated economic useful lives of property and equipment which range from three to ten years for equipment. Amortization, principally of leasehold improvements, is provided over the life of the respective lease terms which range from five to ten years. Income Taxes. The Company utilizes the liability method of accounting for income taxes as set forth in FAS No. 109, "Accounting for Income Taxes". Under the liability method, deferred taxes are determined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Product Development and Engineering. Product development and engineering costs are expensed as incurred. Fair Value of Financial Instruments. The fair value of the Company's Convertible Subordinated Debentures at December 31, 1997 is approximately $14.6 million, based upon market quotes. The carrying value of all other financial instruments included in the accompanying consolidated financial statements approximate fair value as of December 31, 1997 based upon current interest rates. Noncash Investing and Financing Activities. The following noncash investing and financing activities took place during the three years ended December 31, 1997:
(Amounts in thousands) 1997 1996 1995 ---------------------- ---- ---- ---- Note Receivable and Warrants from Sale of DSOs (Note M) $ --- $ 8,100 $ --- Restricted Cash Received from Sale of DSOs (Note M) --- 5,031 --- Common and Preferred Stock issued to acquire Unistar (Note L) --- --- 12,711 Notes receivable for 1995 disposition of direct sales offices (Note M) --- --- 1,911 Equity investment in DCC (Note G) --- --- 1,505 Common shares exchanged to exercise options and warrants 507 549 1,137 Capital leases for equipment acquisitions 1,805 302 437
14 Refer to the consolidated statements of cash flows for information on cash-related operating, investing and financing activities. NOTE C - DEBT The Company's debt is summarized below at December 31, 1997 and 1996:
(Amounts in thousands) 1997 1996 - ---------------------- ---- ---- Borrowings Under Revolving Credit Facility (a) $ --- $ --- Convertible Subordinated Debentures (b) 12,569 12,317 Capital Lease Obligations (c) 2,326 1,499 Other 699 903 ------- -------- Total Debt 15,594 14,719 Less: Current Portion of Long-Term Debt 951 882 ------- -------- Total Long-Term Debt $14,643 $ 13,837 ======= ========
(a) The Company obtained a new revolving credit facility (the Credit Facility) in October 1997. The $35 million Credit Facility is unsecured and expires in January 2000. It consists of a revolving line of credit providing for direct borrowings and letter of credit advances, subject to availability. Direct borrowings and letter of credit advances are made available pursuant to a formula that measures outstanding debt in relation to cash, accounts receivable and earnings before interest, taxes, depreciation and amortization. To minimize interest expense on the revolving line of credit, the Company has the option to borrow money based upon an adjusted prime borrowing rate (8.5% at December 31, 1997) or at an adjusted eurodollar rate (8.2% at December 31, 1997). Approximately $19.8 million was available at December 31, 1997 under the revolving line of credit, after giving effect to $7.2 million that was committed to cover outstanding letters of credit. The unused portion of the line of credit has a commitment fee of 0.375%. The Company repaid all amounts outstanding under the previous revolving credit facility in June 1996. No direct borrowings against the revolving credit facility were outstanding at December 31, 1997 and 1996. The Company's average outstanding indebtedness under the revolving line of credit for the year ended December 31, 1996 was $6.5 million, and the average interest rate on such indebtedness was 7.9%. The Credit Facility agreement contains certain restrictive covenants including, among other things, limitations on total outstanding debt, minimum levels of consolidated net worth and maximum levels of capital expenditures and capitalized leases. During 1997, the Company was in compliance with all such financial covenants. Interest rates are also subject to adjustment based upon certain financial ratios. (b) The Company's Convertible Subordinated Debentures (the Debentures), issued in April 1986, are due March 15, 2011 and bear interest at 7 1/2%, payable March 15th and September 15th. The face value of the outstanding Debentures at December 31, 1997 was $16.4 million. The face value of the Debentures was adjusted to fair value in connection with the Company's 1988 quasi-reorganization. The Debentures are convertible at the option of the holder into Common Stock of the Company at any time on or before March 15, 2011, unless previously redeemed, at a conversion price of $10.625 per share, subject to adjustment in certain events. Subject to certain restrictions, the Debentures are redeemable in whole or in part, at the option of the Company, at par. The Debentures are also subject to annual sinking fund payments of $1.5 million. In January 1992, $15 million principal amount of Debentures with a book value of $10.1 million was exchanged for 674,865 shares of Convertible Preferred Stock and 2,999,400 Common Stock Purchase Warrants. Debentures reacquired by the Company in the debt-for-equity exchange and in connection with Warrant exercises were delivered in lieu of cash in satisfying sinking fund requirements. Thus, no cash sinking fund payment will be due on the Debentures until March 2008. (c) The Company has entered into capital lease arrangements for office furniture, computer and test equipment with a net book value of approximately $2.3 million and $1.5 million at December 31, 1997 and 1996, respectively. Such leases have been capitalized using implicit interest rates which range from 2% to 11%. 15 The following is a schedule of future maturities of long-term debt at December 31, 1997:
Years Ending December 31: (Amounts in thousands) ------------------------ ---------------------- 1998 $ 951 1999 551 2000 500 2001 566 2002 261 Thereafter 12,765 ------- $15,594 =======
For the years ended December 31, 1997, 1996 and 1995, the Company made cash payments of approximately $1.8 million, $2.6 million and $3.6 million, respectively, for interest expense on indebtedness. NOTE D - INCOME TAXES The components of the provision (benefit) for income taxes applicable to income (loss) from continuing operations for the three years ended December 31, 1997 are as follows:
(Amounts in thousands) 1997 1996 1995 ---------------------- ---- ---- ---- Current - Federal $ --- $ 1,100 $ 150 - State --- 3,100 200 - Foreign 6 --- --- ------ ------- ------- 6 4,200 350 ------ ------- ------- Deferred - Federal (111) 11,005 (1,922) - State (32) 415 (715) ------ ------- ------- (143) 11,420 (2,637) ------ ------- ------- $ (137) $15,620 $(2,287) ====== ======= =======
For the year ended December 31, 1996, the Company recorded a deferred income tax benefit of $238,000 related to an extraordinary loss on the extinguishment of debt. A reconciliation of the statutory federal income tax provision (benefit) to the reported income tax provision (benefit) on income (loss) from continuing operations for the three years ended December 31, 1997 is as follows:
(Amounts in thousands) 1997 1996 1995 - ---------------------- ---- ---- ---- Statutory income tax provision (benefit) $ (122) $13,924 $(13,335) State income taxes, net of federal income tax benefit (21) 2,364 (338) Impairment of intangible assets --- --- 11,392 Amortization of intangible assets 45 44 171 Research and development credit (807) (351) (148) Other 768 (361) (29) ------ ------- -------- Reported income tax provision (benefit) $ (137) $15,620 $ (2,287) ====== ======= ========
16 The components of and changes in the net deferred tax asset are as follows:
Deferred December 31, (Expense) December 31, (Amounts in thousands) 1996 Benefit 1997 - ---------------------- -------------- ----------- --------- Net operating loss and tax credit carryforwards $19,609 $ 5,552 $25,161 Inventory reserves 4,974 (2,778) 2,196 Accrued liabilities and restructuring costs 1,146 (740) 406 Debenture revaluation (1,531) 94 (1,437) Other (1,020) (1,985) (3,005) ------- -------- ------- 23,178 143 23,321 Valuation allowance (4,744) --- (4,744) ------- -------- ------- Deferred tax asset $18,434 $ 143 $18,577 ======= ======== =======
The deferred tax asset represents the benefits expected to be realized from the utilization of pre- and post-acquisition tax benefit carryforwards, which include net operating loss carryforwards (NOLs), tax credit carryforwards and the excess of tax bases over fair value of the net assets of the Company. The utilization of these tax benefits for financial reporting purposes will be reflected in the provision for income taxes each year, as applicable. In order to fully realize the remaining deferred tax asset of $18.6 million as of December 31, 1997, the Company will need to generate future taxable income of approximately $50 million prior to the expiration of the NOLs and tax credit carryforwards. Although the Company believes that it is more likely than not that the deferred tax asset will be fully realized based on current projections of future pre-tax income, a valuation allowance has been provided for a portion of the deferred tax asset. The amount of the deferred tax asset considered realizable, however, could be reduced if estimates of future taxable income during the carryforward period are reduced. As of December 31, 1997, the Company has NOLs and tax credit carryforwards (subject to review by the Internal Revenue Service) available to offset future income for tax return purposes of approximately $60.5 million and $5.0 million, respectively. A portion of the NOLs and tax credit carryforwards were generated prior to the formation of the Company and their utilization is subject to certain limitations imposed by the Internal Revenue Code. The NOLs expire as follows: $25.3 million in 2004; $9.7 million in 2005; $12.3 million in 2006; $0.8 million in 2010; $12.4 million in 2012. A reconciliation of the Company's income (loss) before taxes for financial reporting purposes to taxable income for the three years ended December 31, 1997 is as follows:
(Amounts in thousands) 1997 1996 1995 - ---------------------- ---- ---- ---- Income (loss) before taxes $ (358) $ 39,782 $(39,221) Extraordinary Item --- (592) --- --------- -------- -------- Income (loss) before taxes for financial reporting purposes (358) 39,190 (39,221) Differences between income (loss) before taxes for financial reporting purposes and taxable income: Permanent differences (28) 124 28,600 -------- -------- -------- Book taxable income (loss) (386) 39,314 (10,621) Net changes in temporary differences (12,063) (15,282) 11,433 -------- -------- -------- Taxable income (loss) $(12,449) $ 24,032 $ 812 ======== ======== ========
17 The permanent differences relate to the write-off (in 1995) and amortization of goodwill, which are not deductible, and other items which adjusted book income but are not included in determining taxable income. Changes in temporary differences principally relate to the taxable gain on the sale of businesses (in 1996), the impairment in service stock inventory (in 1995), inventory reserves and other costs accrued for book purposes, but not deducted for tax purposes until subsequently paid. For the years ended December 31, 1997, 1996 and 1995, the Company made cash payments of approximately $0.4 million, $1.5 million and $0.2 million, respectively, for income taxes. NOTE E - EARNINGS PER SHARE A reconciliation of the Company's earnings (loss) per share calculations for the three years ended December 31, 1997 is as follows:
(in thousands, except for per share amounts) Income/(Loss) Shares Per Share Amount For the year ended December 31, 1997: ------------- ------ ---------------- Basic and Diluted Loss Per Share: Net Loss $ (221) 49,655 $ --- ======= ====== ===== For the year ended December 31, 1996: Basic Earnings Per Share: Income from Continuing Operations $24,162 51,712 $0.47 ===== Stock Options and Warrants 539 ------- ------ Diluted Earnings Per Share: Income from Continuing Operations $24,162 52,251 $0.46 ======= ====== ===== For the year ended December 31, 1995: Basic and Diluted Loss Per Share: Net Loss $(36,934) 46,919 $(0.79) ======== ====== ======
The Company's Convertible Subordinated Debentures (see Note C(b)) are convertible into approximately 1.5 million shares of common stock as of December 31, 1997. The shares issuable upon conversion of the Debentures were not included in the computation of diluted earnings per share because they would be antidilutive for each of the periods presented. Due to net losses for the years ended December 31, 1997 and 1995, all stock options and warrants were antidilutive, regardless of the exercise prices. Options to purchase approximately 1.0 million shares of common stock as of December 31, 1996 were not included in the computation of diluted earnings per share because the exercise price was greater than the average market price of the shares of common stock. The convertible preferred stock issued in connection with the acquisition of UniStar (See Note L) is antidilutive and has been excluded from the above calculations. In 1997, the Company adopted FAS No. 128, "Earnings per Share," effective for periods ending after December 15, 1997. As a result, the Company's reported earnings per share for prior years were restated. The effect of this accounting change on previously reported earnings per share data was to increase 1996 basic earnings per share by $0.01 compared to the previously reported calculation of primary earnings per share. Earnings per share did not change for 1997 or 1995. 18 NOTE F - COMMITMENTS AND CONTINGENCIES Operating Leases. The Company conducts its business operations in leased premises under noncancellable operating lease agreements expiring at various dates through 2005. Rental expense under operating leases amounted to $4.2 million, $6.3 million and $9.6 million for the years ended December 31, 1997, 1996 and 1995, respectively. The following represents the future minimum rental payments due under noncancellable operating leases that have initial or remaining lease terms in excess of one year as of December 31, 1997:
Years Ending December 31, (Amounts in thousands) ------------------------ ---------------------- 1998 $ 3,219 1999 3,198 2000 3,198 2001 3,323 2002 3,586 Thereafter 7,400 ------- $23,924 =======
Litigation. The Company has various lawsuits, claims and contingent liabilities arising from the conduct of business; however, in the opinion of management, they are not expected to have a material adverse effect on the results of operations, cash flow or financial position of the Company. See Note L for discussion of legal issues related to UniStar. NOTE G - RELATED PARTY TRANSACTIONS During 1995, the Company acquired 43% of the common stock and certain other assets of Dialogic Communications Corporation (DCC), a vendor of certain telephony products, in exchange for 353,118 shares of the Company's common stock and $100,000 cash. This investment is included in Other Assets and the related equity income is included in Other Income, Net. NOTE H - STOCK OPTIONS AND WARRANTS The Company has established stock option plans under which it is authorized to grant both incentive stock options and non-qualified stock options to officers and other key employees. Options are granted at a price not less than the fair market value on the date of the grant and generally become exercisable over a four-year period and expire after five years. Shares available for granting of future options under these plans total 2.3 million as of December 31, 1997. The Company also had non-plan options outstanding at December 31, 1997, all of which were exercisable. These options expire at various dates through March 2001. Certain options include registration rights for the shares issuable thereunder. 19 A summary of the status of the Company's stock option plans, as well as non-plan options, as of December 31, 1997, 1996 and 1995 is as follows:
1997 1996 1995 ---------------------------- ----------------------------- --------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ---------------------------- ---------------------------- --------------------------- Outstanding 1/1 1,972,485 $2.54 2,858,577 $2.18 3,977,782 $1.33 Granted 251,400 $2.32 316,875 $2.65 1,027,500 $3.05 Exercised (481,786) $1.23 (761,570) $1.28 (1,970,760) $0.92 Cancelled (231,200) $2.71 (441,397) $2.46 (175,945) $2.27 ---------- ---------- ----------- Outstanding 12/31 1,510,899 $2.89 1,972,485 $2.54 2,858,577 $2.18 ========= ========== =========== Options exercisable 12/31 1,017,134 $3.04 1,335,402 $2.44 1,862,286 $1.93 ========= ========== ===========
Information relative to options outstanding at December 31, 1997 is as follows:
Options Outstanding Options Exercisable ---------------------------------------------- ------------------------- Weighted Weighted Weighted Shares Average Average Shares Average Exercises Outstanding Remaining Exercise Exercisable Exercise Prices 12/31/97 Life (yrs) Price 12/31/97 Price - ---------------- ---------------------------------------------- ------------------------- $1.75 - $ 2.00 251,300 1.2 $1.96 206,300 $1.97 $2.03 - $ 2.50 288,900 4.3 $2.35 94,077 $2.38 $2.56 - $ 3.00 330,769 3.1 $2.82 200,102 $2.89 $3.10 - $20.43 639,930 2.8 $3.55 516,655 $3.64 ---------- ---------- $1.75 - $20.43 1,510,899 2.9 $2.89 1,017,134 $3.04
The fair value of options granted during 1997, 1996 and 1995 was $1.24, $1.20 and $1.09 per share, respectively. Fair value was estimated using the Black-Scholes option-pricing model with the following assumptions: expected volatility ranging from 66% to 85%, risk-free interest rate of 6.2%, an expected option life of 5.0 years and no dividend yield. The Company applies APB Opinion 25 in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option plans. If compensation cost had been determined in accordance with FAS No. 123, "Accounting for Stock-Based Compensation," net income would have been reduced by $0.2 million, $0.1 million and $0.3 million for 1997, 1996 and 1995, respectively. The change in earnings per share would have been immaterial each year. As of December 31, 1997, the Company has warrants outstanding that permit the holders to purchase a total of 50,000 shares of Common Stock at prices ranging from $2.00 to $2.63 per share, expiring through July 2001. Warrants were exercised for 50,000, 199,431 and 488,890 shares of Common Stock for the three years ended December 31 1997, 1996 and 1995, respectively. Such exercises were at average prices of $1.21, $0.04 and $1.00 per share for the years ended December 31, 1997, 1996 and 1995, respectively. At December 31, 1997, 16,667 warrants were exercisable. 20 NOTE I - STOCK PURCHASE PLAN A total of 2,750,000 shares of Common Stock are authorized for issuance under the Company's employee stock purchase plan (the "Employee Plan"). The Employee Plan permits eligible employees to purchase up to 1,000 shares of Common Stock at the lower of 85% of the fair market value of the Common Stock at the beginning or at the end of each six-month offering period. Pursuant to the Employee Plan, 63,904, 216,504 and 229,636 shares of common stock were sold to employees during the three years ended December 31, 1997, 1996 and 1995, respectively. The weighted average fair value of these purchase rights for 1997, 1996 and 1995 was $0.67, $0.81 and $0.97 per share, respectively. Fair value was estimated using the Black-Scholes option pricing model with the following assumptions used for all three years: expected volatility ranging from 66% to 85%, risk-free interest rate of 6.0%, an expected term of six months and no dividend yield. The Company applies APB Opinion 25 in accounting for the Employee Plan and, accordingly, no compensation cost has been recognized. If compensation cost had been determined in accordance with FAS No. 123, the impact on net income and earnings per share would have been immaterial for 1997, 1996 and 1995. In 1994, the Company's shareholders adopted the 1994 Executive Stock Incentive Plan (the "Executive Plan"), which enabled officers and other key employees to purchase a total of up to 3,000,000 shares of the Company's Common Stock. During 1995 and 1994, the Participants purchased 140,000 and 2,745,000 shares of Common Stock, respectively, at fair market value, which were financed through individual bank borrowings at market interest rates by each Participant from Bank of America Illinois (the "Bank"), payable over five years. In December 1997, the Company agreed, subject to obtaining the agreement of the Bank, that it would allow the loans to remain outstanding until December 2001. The Company lends each Participant 85% of the interest due to the Bank, with $1,569,000 and $980,000 of such loans outstanding as of December 31, 1997 and 1996, respectively. In December 1997, the Company also loaned each participant the 15% of the interest that would otherwise have been currently payable. The Company guarantees the Participant borrowings under a $6.4 million letter of credit. Participant loans guaranteed by the Company with letters of credit as of December 31, 1997 and 1996 were $6.1 million and $6.5 million, respectively. Shares acquired under the Executive Plan are held by the Company as security for the guarantees under a loan and pledge agreement. Sales of such shares by Participants are subject to certain restrictions, and, generally, they may not be sold for five years. During 1996, the Company repurchased 820,000 shares of Common Stock from Participants in the Executive Plan who were no longer employees of the Company, primarily due to the sale of the direct offices (see Note M). The shares were repurchased because, as nonemployees, the Company could no longer guarantee the bank loans for these individuals or make advances of interest to the Bank on their behalf. The Company accepted the stock being held as collateral as payment in full for the purchase price plus all of the unpaid interest and satisfied the indebtedness to the Bank on behalf of these individuals. In those instances where the value of the common stock held as collateral was not sufficient to cover the purchase price plus all of the unpaid interest, the Company recorded an aggregate amount of $110,000 in compensation expense for these individuals during the year. NOTE J - SAVINGS AND POST-RETIREMENT BENEFIT PLANS The Company has a 401(k) Savings Plan under which it matches employee contributions at the discretion of the Company's Board of Directors. The Company's matching contribution, consisting of shares of its Common Stock purchased in the open market, is equal to 25% of each employee's contribution, up to a maximum of $660 per employee. The expense for the matching contribution for the years ended December 31, 1997, 1996 and 1995 was approximately $261,000, $540,000 and $687,000, respectively. The Company has an obligation remaining from the acquisition of Executone, Inc. to provide post-retirement health and life insurance benefits for a group of fewer than 75 former Executone, Inc. employees, including two current employees of the Company. The Company does not provide post-retirement health or life insurance benefits to any other employees. Effective January 1, 1993, the Company adopted FAS No. 106, "Employers' Accounting For Postretirement Benefits Other Than Pensions". This standard requires that the expected cost of these benefits must be charged to expense during the years that employees render services. The Company adopted the new standard prospectively and is amortizing the transition obligation over a 20-year period. 21 Post-retirement benefit expense for the three years ended December 31, 1997 consists of the following:
(Amounts in thousands) 1997 1996 1995 - ---------------------- ---- ---- ---- Interest on accumulated benefit obligation $220 $214 $219 Amortization of transition obligation 116 116 116 Net amortization and other 4 20 20 ---- ---- ---- $340 $350 $355 ==== ==== ====
The status of the plan at December 31, 1997 and 1996 is as follows:
(Amounts in thousands) 1997 1996 - ---------------------- ---- ---- Accumulated post-retirement benefit obligation (APBO): Retirees $2,765 $2,875 Active Employees 364 339 ------ ------ 3,129 3,214 Unamortized transition obligation (1,744) (1,861) Unrecognized net loss (312) (466) ------ ------ Accrued liability $1,073 $ 887 ====== ======
In determining the APBO as of December 31, 1997 and 1996, the weighted average discount rate used was 7%. The Company used a healthcare cost trend rate of approximately 11%, decreasing through 2007 and leveling off at 6% thereafter. A 1% increase in the healthcare trend rate would increase the APBO at December 31, 1997 by approximately 3% and increase the interest cost component of the post-retirement benefit expense for 1997 by less than $10,000. NOTE K - OTHER INCOME, NET Other Income, Net consists of the following for the three years ended December 31, 1997:
(Amounts in thousands) 1997 1996 1995 - ---------------------- ---- ---- ---- Interest income $ 741 $1,117 $ 285 Equity in earnings of DCC (Note G) 377 288 401 Gain on sale of two direct sales offices --- --- 1,213 Other, net 419 465 230 ------ ------ ------ $1,537 $1,870 $2,129 ====== ====== ======
NOTE L - UNISTAR On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming Corporation (Unistar Gaming) for 3.7 million shares of the Company's common stock valued at $5.4 million and 350,000 shares of newly issued preferred stock valued at $7.3 million. Unistar Gaming's subsidiary, UniStar Entertainment, Inc. (UniStar), has an exclusive five-year contract to design, develop, finance and manage the National Indian Lottery (NIL) for the Coeur d'Alene Tribe of Idaho (CDA). The NIL comprises a national telephone lottery authorized by federal law and a compact between the State of Idaho and CDA, as well as Internet-based lottery games. In return for providing these management services to the NIL, UniStar will be paid a fee equal to 30% of the profits of the NIL. UniStar did not have any assets or operations other than the NIL contract prior to its acquisition by the Company. The purchase price was approximately $12.7 million and was based upon the determination by an investment banking firm of the value assigned to the common and the preferred stock issued in the transaction. The common stock valuation was based upon the value of the common stock issued at the closing date, discounted for restrictions on the sale of the 22 shares, which range from six to twenty-six months. The preferred stock was valued based upon the number of shares of common stock into which it was estimated that the preferred shares may be converted at some future date. The excess of the purchase price over the value of the net liabilities assumed has been included in intangible assets and will be amortized over the five-year term of the contract commencing in the first quarter of 1998. The preferred stock consists of 250,000 shares of Cumulative Convertible Preferred Stock, Series A (Series A Preferred Stock) and 100,000 shares of Cumulative Contingently Convertible Preferred Stock, Series B (Series B Preferred Stock). The Series A Preferred Stock has voting rights equal to one share of common stock and will earn dividends equal to 18.5% of the consolidated retained earnings of UniStar as of the end of a fiscal period, less any dividends paid to the holders of the Series A Preferred Stock prior to such date. The Series B Preferred Stock has voting rights equal to one share of common stock and will earn dividends equal to 31.5% of the consolidated retained earnings of UniStar as of the end of a fiscal period, less any dividends paid to the holders of the Series B Preferred Stock prior to such date. All dividends on Preferred Stock are payable (i) when and as declared by the Board of Directors, (ii) upon conversion or redemption of the Series A and Series B Preferred Stock or (iii) upon liquidation. The Series A and Series B Preferred Stock is redeemable for a total of 13.3 million shares of common stock (Series A Preferred Stock for 4.925 million shares and Series B Preferred Stock for 8.375 million shares) at the Company's option. In the event that UniStar meets certain revenue and profit parameters, the Series A Preferred Stock is convertible for up to 4.925 million shares of common stock and the Series B Preferred Stock is convertible for up to 8.375 million shares of common stock (a total of an additional 13.3 million shares of common stock). Liquidation preferences for all shares of Series A and Series B preferred stock total $7.3 million as of December 31, 1997. Liquidation preference is based upon fair market value of the Series A and Series B preferred stock as determined by the investment banking firm engaged by the Company, plus any dividends in arrears. As of December 31, 1997, no dividends have accrued to the preferred stockholders. In an attempt to block the NIL, certain states filed letters under 18 U.S.C. Section 1084 to prevent the long-distance carriers from providing telephone service to the NIL. In 1995, the CDA initiated legal action against AT&T Corporation (AT&T) to compel the long-distance carriers to provide telephone service to the NIL. The CDA's position is that the lottery is authorized by the Indian Gaming Regulatory Act (IGRA) passed by Congress in 1988, that IGRA preempts state law, that 18 U.S.C. Section 1084 is inapplicable and, therefore, that the states lack authority to issue the Section 1084 notification letters to any carrier. On February 28, 1996, the NIL was ruled lawful by the CDA Tribal Court. The CDA Tribal Court found that all requirements of IGRA have been satisfied and the Section 1084 letters issued by certain state attorneys general in an effort to interfere with the lawful operation of the NIL are invalid. In addition, the Tribal Court found that the long-distance carriers cannot refuse to provide the service requested in the action based upon 18 U.S.C. Section 1084. This ruling and a related order dated May 1, 1996 were subsequently appealed to the Tribal Appellate Court, which on July 2, 1997 affirmed the lower Tribal Court's May 1, 1996 ruling and analysis upholding the CDA's right to conduct the telephone lottery. On August 22, 1997, AT&T filed a complaint for declaratory judgment against the CDA in the U.S. District Court for the District of Idaho. The CDA has answered that complaint. In March 1998, the attorneys general of nineteen states filed a motion for permission to submit a brief as amicus curiae in the case with respect to the Tribal Court's interpretation of IGRA and in support of the position taken by AT&T. On May 28, 1997, the State of Missouri brought an action in the Missouri Circuit Court in Kansas City against UniStar and the CDA to enjoin the NIL's US Lottery Internet instant games offered by the CDA and managed by UniStar. The complaint also seeks civil penalties, attorney's fees and court costs. The complaint alleged that the US Lottery violates Missouri anti-gaming laws and that the marketing and promotion of the US Lottery violate the Missouri Merchandising Practices Act. The CDA and UniStar removed the case to the U.S. District Court for the Western District of Missouri, which denied the State's subsequent motion to remand the case back to the state court. The Court also subsequently granted a motion to dismiss by CDA based on sovereign immunity. The Court denied the motion to dismiss UniStar based on sovereign immunity, although the Court indicated it might reconsider that decision. UniStar filed a motion for reconsideration of its motion for dismissal. The State of Missouri has filed a notice of appeal evidencing its intent to appeal to the Eighth Circuit Court of Appeals, the dismissal of the CDA. On January 28, 1998, the State of Missouri sought to dismiss voluntarily the existing case against UniStar and filed the next day, a new action against the Company, UniStar and two tribal officials, with essentially the same allegations, in a state court in a different district. The State obtained a temporary restraining order from a state judge enjoining the marketing of the Internet and telephone lottery in the State of Missouri. On February 5, 1998, the U.S. District Court for the Eastern District of Missouri ruled that this second case also should be heard in federal court, transferred the second 23 case to the Western District of Missouri, where the original case had been filed, and dissolved the state court's temporary restraining order, effective February 9, 1998. A motion to dismiss the second case based on the sovereign immunity of all the defendants and a motion to abstain in favor of the jurisdiction of the CDA Tribal Court are pending. The State of Missouri has filed a notice of appeal evidencing its intent to appeal the denial of its motion to remand the case to State Court or in the alternative to grant a preliminary injunction. On September 15, 1997, the State of Wisconsin, by its Attorney General, filed an action in the Wisconsin State Circuit Court for Dane County against the Company, UniStar and the CDA, to permanently enjoin the US Lottery offered by the Tribe on the Internet and managed by UniStar. The complaint alleges that the offering of the US Lottery violates Wisconsin anti-gambling laws and that legality of the US Lottery has been misrepresented to Wisconsin residents in violation of state law. In addition to an injunction, the suit seeks restitution, civil penalties, attorneys' fees and court costs. The Company, UniStar and the CDA have removed the case to the U.S. District Court in Wisconsin. On February 18, 1998, the District Court dismissed the Tribe from the case based on sovereign immunity and dismissed the Company based on the State's failure to state a claim against the Company. Motions to dismiss the case against UniStar were denied. UniStar has filed a notice of appeal evidencing its intent to appeal to the Seventh Circuit Court of Appeals the denial of its motion to dismiss. The Company believes, based on consultation with and opinions rendered by outside legal counsel, that the favorable rulings of the tribal courts will be affirmed by the Idaho federal court. The Company believes that UniStar also will prevail in the Missouri and Wisconsin lawsuits. However, there is no assurance of such a legal outcome. The Company accrued $1 million in 1995 to cover estimated legal costs through the possible appeal to the U.S. District Court. If the matter is appealed beyond the U.S. District Court or if additional court challenges are brought by states opposed to the NIL, the Company estimates that additional legal costs could be in the range of $1 million to $2 million. Funding for UniStar capital expenditures, including the computers and software to build the telecommunications system, will be capitalized and depreciated over the life of the management agreement. The guaranteed monthly advance of $25,000 to the CDA, which began in January 1996, will be reimbursed when the NIL is operational and making profit distributions to UniStar. In addition, the Company has capitalized other fundings, consisting primarily of direct UniStar expenses, professional fees and other expenses, which the Company believes are reimbursable in accordance with the terms of the management agreement. Cumulative funding as described above totals $8.0 million ($5.9 million for the year ended December 31, 1997) and is reflected in non-current other assets. The Company has also funded legal and other accrued liabilities assumed as part of the acquisition of UniStar totaling, on a cumulative basis, $2.4 million ($0.3 million for the year ended December 31, 1997). Such cash flows, which were previously reflected as part of the change in working capital items, are now reflected as part of the investment in UniStar in the statement of cash flows. Prior year amounts have been reclassified to conform to the current year's presentation. The investment in UniStar reflected on the statement of cash flows includes the deferred charges and assumed liabilities noted above (net of $0.6 million in capital lease obligations) for a cumulative total of $9.7 million ($5.6 million for the year ended December 31, 1997). Since inception, the Company has also funded various UniStar expenses totaling $1.6 million, which are reflected in the Company's consolidated net income. Cumulative cash expenditures on UniStar, including UniStar expenses, total $11.3 million as of December 31, 1997. Other than legal costs related to an appeal of the CDA Tribal Court ruling or other actions by the states, if any, the Company estimates that it will invest an additional $2 million to $4 million by June 1998. The costs include capital expenditures for computers and software to build the telecommunications system, funds to complete the building on the CDA reservation which will be the operations center for the lottery, and various start-up and operating expenses including personnel-related costs and advertising expenses. The Company is also required to make a guaranteed payment of $300,000 per year to the CDA, which is included in the above estimates. The Company expects it will be able to obtain additional financing for these costs, if necessary. In February 1997, the Company signed agreements with Virtual Gaming Technologies (formerly Internet Gaming Technologies (IGT)) and CasinoWorld Holdings, Ltd. (CWH). The agreements required the Company to invest $700,000 in IGT common stock in September 1996 under a previous agreement. In addition, the Company was granted a 200,000-share, five-year option set at 15% more than the price per share on the initial investment, or $3.45 per share. CWH is to provide project management services overseeing the development of the software for the NIL, with the 24 Company contracting independently for system software development. Such charges are not to exceed $2 million. The Company will acquire all hardware for the system without financial obligation by either IGT or CWH. Approximately $600,000 in hardware costs were incurred as of December 31, 1997. All of these system development costs are included in the above estimate for expenditures through June 1998. The investment in IGT is being accounted for under the cost method. All hardware costs incurred will be capitalized and depreciated over the useful life of the assets, beginning when the assets are placed in service. As of December 31, 1997, $1.5 million in progress payments have been made toward the software system. Such payments are being deferred until completion of the system and will be capitalized and depreciated over the life of the asset or term of the management agreement, whichever is shorter. There are market and legal risks associated with the development of the NIL. The Company believes there is a national market for the NIL based upon research into the experience of other national lotteries and the growth of the overall lottery market. In the event that the telephone and Internet lotteries do not attain the level of market acceptance anticipated by the Company or if the outcome of the pending lawsuits is adverse, the Company would have to reevaluate its investment in UniStar. The Company periodically evaluates the recoverability of this investment in UniStar in accordance with the provisions of FAS No. 121, "Accounting for the Impairment of Long-Lived Assets" by projecting future undiscounted net cash flows for the telephone and Internet lotteries. If the sum of such cash flows is not sufficient to recover the Company's investment in UniStar, projected cash flows would then be discounted and the Company's investment would be adjusted accordingly. NOTE M - SALE OF BUSINESSES AND OTHER ACQUISITIONS/DISPOSITIONS On May 31, 1996, the Company sold its direct sales and service organization, including its Network Services division to Clarity Telecom Holdings, Inc. d/b/a Executone Business Solutions (Clarity, subsequently renamed Claricom), a new acquisition company formed for the acquisition by Bain Capital, Inc. The Company received $61.5 million in cash, a $5.9 million junior subordinated note due July 1, 2004, with interest at 7.5% per year, and warrants to purchase 8% of the equity issued as of the closing in the new company for $1.1 million, exercisable for three years. After recording the notes and the warrants at their fair market value, the total value of the consideration received was $69.6 million. The Company and Claricom also entered into a five-year exclusive distributor agreement pursuant to which Claricom will sell and service EXECUTONE'r' and INFOSTAR'r' telephone products to business and commercial locations that require up to 400 telephones. The sale did not include the Pittsburgh direct sales and service office, which the Company sold to one of its existing independent distributors for approximately $1.3 million in cash and notes in May 1996, resulting in no gain or loss. The sale of the direct offices (including the separate sale of the Pittsburgh office) related primarily to the retail distribution channel of the Computer Telephony division and included the Network Services division. The Company recorded a pretax gain of $48.9 million on the sale to Claricom net of transaction, severance and other costs related to the sale. The proceeds were used to repay the Company's bank borrowings, and the excess was invested in short-term cash investments. The cash proceeds of $61.5 million included $5.0 million which was held in escrow and reported on the consolidated balance sheet as of December 31, 1997 and 1996 as restricted cash. These funds were released to the Company, by Claricom on March 31, 1998. For the years ended December 31, 1997 and 1996, more than 10% of the Company's revenues were derived from a single independent distributor, Claricom. Revenues, net of discounts, were $29.3 million and $31.7 for 1997 and for the seven-month post-sale period in 1996, respectively. 25 In June 1996, the Company sold its Videoconferencing division to BT Visual Images LLC for a $0.2 million note, royalties on videoconferencing revenue through June 1998 and contingent consideration related to the sale of equipment inventory. The Company recorded a loss of $3.9 million on the transaction. In April 1996, the Company also sold its Inmate Calling business for $0.5 million in cash and notes and recorded a pretax loss of $1.0 million. Neither the Pittsburgh direct sales office, the Videoconferencing division, nor the Inmate Calling business constituted a material portion of the Company's assets, revenues or net income prior to sale. During the fourth quarter of 1995, the Company sold its customer bases in Wisconsin and Iowa and the net assets of the related direct sales offices for a total of $2.1 million, consisting of $125,000 cash, a $1.8 million note, the proceeds of which were received in February 1996, and a $150,000 note due in installments by November 2001. These sales generated a gain of approximately $1.2 million, which is included in Other Income, Net for the year ended December 31, 1995. During the first quarter of 1995, the Company was involved in extensive negotiations to acquire the Dictaphone division of Pitney Bowes. In April 1995, the acquisition was awarded to another bidder. The Company incurred approximately $1 million in fees and expenses related to the attempted acquisition which were recognized during 1995. NOTE N - PROVISION FOR RESTRUCTURING In July 1995, the Company reorganized its then-existing business into five divisions: Computer Telephony, Healthcare Communications Systems, Call Center Management, Videoconferencing Products, and Network Services, and changed its business strategy in the Computer Telephony division to focus on software applications in the communications market. The business that was acquired in 1988 was a telephone equipment hardware company focused on customers with small systems, with an emphasis on selling additional hardware and service to generate add-on revenue. As a result of the change in strategy, the business acquired in 1988 was de-emphasized. The Company adopted FAS No. 121, requiring impairment to be measured by projecting the lowest level of identifiable future cash flows. The Company concluded there was an impairment. As a result, the Company recorded a $44.0 million provision for restructuring consisting of a $33.5 million goodwill impairment, an $8.8 million write-down of inventory, primarily service stock relating to the impaired assets and other non-recurring inventory adjustments, $0.9 million related to the shutdown of the Company's Scottsdale, Arizona facility and $0.8 million of other unusual items. In accordance with the provisions of FAS No. 121, the Company prepared projections of future operating cash flows relating to the telephony business acquired in 1988 based upon the Company's change in strategic direction. These projections indicated that this business would not generate sufficient operating cash flows to realize goodwill and the related service stock. The amount of impairment of the telephony goodwill was $33.5 million as of June 30, 1995. The write-off of inventory, primarily service stock, consisted of $1.3 million of raw materials inventory and $7.5 million of finished goods inventory. These amounts were determined based upon a review of specific inventory parts along with projected usage, incorporating the strategic direction of the Company. NOTE O - SUBSEQUENT EVENTS (UNAUDITED) Corporate Reorganization. On January 8, 1998, the Company announced the beginning of the restructuring of its businesses and the retirement of its Chief Executive Officer (CEO). These announcements have resulted in several related charges which will be reflected in the consolidated financial statements for the first quarter of 1998. Alan Kessman, Chairman and CEO of the Company announced his intention to retire from the management of the day-to-day operations of the Company. In accordance with the diminishment of responsibility section of his employment continuity agreement, Mr. Kessman will receive a severance payment of $1.3 million. The Company will establish a reserve for this cost during the first quarter of 1998. The Company has retained an executive search firm to find a successor for Mr. Kessman, who has agreed to remain in his current position until his successor is selected. The Company has incurred 26 approximately $0.2 million in expenses to recruit a new CEO which will be expensed as part of the restructuring charge in the first quarter of 1998. In addition, the Company has restructured current operations which resulted in a workforce reduction during January and February 1998. The Company will incur approximately $0.6 million for severance, benefits and other restructuring charges in the first quarter of 1998. As previously announced, Furman Selz LLC has been hired to advise the Company as to certain financing and corporate restructuring options. Based upon advice of Furman Selz and the recommendation of a special committee of the Board of Directors, the Board has determined that it is in the best interests of the shareholders of the Company to separate the business of the Company's UniStar subsidiary from the operations of its computer telephony and healthcare communications businesses. The Company expects, subject to completion of further analysis and receipt of necessary approvals, that the separation would be effected through a taxable distribution to shareholders later this year. During the first quarter of 1998, the Company incurred approximately $0.2 million in advisory expenses related to preparation and review of corporate restructuring options. Future expenses will be dependent upon the form and nature of the corporate restructuring. The Company is also pursuing a plan to retain and motivate key employees, the details of which are expected to be concluded by the second quarter of 1998. In total, the Company expects to record a restructuring charge of approximately $2.3 million during the first quarter of 1998. Amended Distributor Agreement with Claricom. On March 30, 1998, the Company entered into an Amended and Restated Distributor Agreement with Claricom (the "Amended Agreement"). The Amended Agreement, effective April 1, 1998 and continuing through December 31, 2001, provides, among other things, that Claricom will be a non-exclusive distributor of the Company's telephony products and that Claricom can market products competing with those sold by the Company. Upon execution of the Amended Agreement, Claricom released to the Company the $5 million plus interest being held in escrow to satisfy potential indemnity claims under the 1996 Asset Purchase Agreement and waived all potential contract claims under the prior distributor agreement. 27 NOTE P - SELECTED QUARTERLY FINANCIAL DATA The following is a summary of unaudited selected quarterly financial data for the years ended December 31, 1997 and 1996:
Three Months Ended ----------------------------------------------------------------- March 31, June 30, September 30, December 31, (In thousands, except for per share amounts) 1997 1997 1997 1997 ---------- -------- ------------- ------------ Revenues $39,019 $34,777 $42,936 $39,664 Gross Profit 14,120 9,899 14,892 14,098 Income (Loss) Before Income Taxes 854 (3,942) 1,321 1,409 Net Income (Loss) 512 (2,371) 793 845 Basic and Diluted Earnings (Loss) Per Share 0.01 (0.05) 0.02 0.02
Three Months Ended ----------------------------------------------------------------- March 31, June 30, September 30, December 31, (In thousands, except for per share amounts) 1996 1996 1996 1996 ------------ --------- ------------- ------------ Revenues $66,966 $51,982 $44,791 $48,283 Gross Profit 26,520 18,969 16,458 17,565 Income (Loss) Before Income Taxes and Extraordinary Item (8,969) 39,820 3,535 5,396 Income (Loss) Before Extraordinary Item (5,358) 23,860 2,124 3,536 Net Income (Loss) (5,358) 23,860 2,124 3,181 Earnings (Loss) Per Share: Income (Loss) Before Extraordinary Item (0.10) 0.46 0.04 0.07 Extraordinary Item --- --- --- (0.01) Diluted Earnings (Loss) Per Share: Income (Loss) Before Extraordinary Item (0.10) 0.44 0.04 0.07 Extraordinary Item --- --- --- (0.01)
The three months ended March 31, 1996 includes a loss of $4.9 million relating to the sale of the Videoconferencing and Inmate Calling businesses (see Note M). The three months ended June 30 and December 31, 1996 include a pretax gain on the sale of businesses (See Note M) of $47.5 million and $1.4 million, respectively. STOCK DATA The number of holders of record of the Company's Common Stock as of the close of business on February 28, 1998 was approximately 2,000. The Common Stock is traded on the NASDAQ National Market System under the symbol "XTON". As reported by NASDAQ on February 23, 1998, the closing sale price of the Common Stock on the NASDAQ National Market System was $2 3/8. The following table reflects in dollars the high and low closing sale prices for EXECUTONE's Common Stock as reported by the NASDAQ National Market System for the periods indicated:
Fiscal Period High Low ------------- ---- --- 1997 First Quarter $2 13/16 $2 7/16 Second Quarter 2 3/4 1 11/16 Third Quarter 2 1/8 1 11/16 Fourth Quarter 2 3/4 1 7/8
28 1996 First Quarter $3 7/16 $2 3/16 Second Quarter 3 3/4 2 5/8 Third Quarter 3 1/4 2 5/16 Fourth Quarter 3 1/16 2 3/8
It is the present policy of the Board of Directors to retain earnings for use in the business and the Company does not anticipate paying any cash dividends on the Common Stock in the foreseeable future. 29 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders of EXECUTONE Information Systems, Inc.: We have audited the accompanying consolidated balance sheets of EXECUTONE Information Systems, Inc. (a Virginia corporation) and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of EXECUTONE Information Systems, Inc. and subsidiaries as of December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Stamford, Connecticut February 7, 1998 30 STOCKHOLDER INFORMATION CORPORATE HEADQUARTERS INDEPENDENT PUBLIC ACCOUNTANTS EXECUTONE Information Systems, Inc. Arthur Andersen LLP 478 Wheelers Farms Road Champion Plaza Milford, Connecticut 06460 400 Atlantic Street (203) 876-7600 Stamford, Connecticut 06912-0021 http://www.executone.com OUTSIDE COUNSEL STOCK AND WARRANT TRANSFER AGENT Hunton & Williams American Stock Transfer and Trust Company Riverfront Plaza 40 Wall Street 951 East Byrd Street New York, New York 10005 Richmond, Virginia 23219 BOND TRANSFER AGENT ADDITIONAL INFORMATION U.S. Trust Company of New York A copy of EXECUTONE's Annual Report on Form 10-K, 114 West 47th Street which is filed with the Securities and Exchange Commission, New York, New York 10036-1532 is available without charge by writing to: DAVID KRIETZBERG Treasurer/Investor Relations Corporate Headquarters DIRECTORS AND OFFICERS BOARD OF DIRECTORS - --------------------------------------------------------------------------------------------------------------------------------- ALAN KESSMAN JERRY M. SESLOWE 2 Chairman of the Board Managing Director Resource Holdings, Ltd. STANLEY M. BLAU 1 Vice Chairman LOUIS K. ADLER 2 Private Investor THURSTON R. MOORE 1 Partner Hunton & Williams RICHARD S. ROSENBLOOM 2 David Sarnoff Professor of Business Administration Harvard Business School 1 AUDIT COMMITTEE MEMBER 2 COMPENSATION COMMITTEE MEMBER OFFICERS - --------------------------------------------------------------------------------------------------------------------------------- ALAN KESSMAN ANTHONY R. GUARASCIO VIC NORTHRUP President and Chief Executive Officer Vice President, Finance & Administration Vice President Chief Financial Officer President, Computer Telephony MICHAEL W. YACENDA Executive Vice President ISRAEL J. HERSH FRANK J. ROTATORI President, UniStar Vice President, Software Engineering Vice President President, Healthcare Communications BARBARA C. ANDERSON ROBERT W. HOPWOOD Vice President, General Counsel and Vice President SHLOMO SHUR Secretary Vice President - Operations, UniStar Senior Vice President, Advanced Technology JAMES E. COOKE III ANDREW KONTOMERKOS Vice President, National Accounts Senior Vice President, Hardware Engineering and Production
31 EX-21 8 EXHIBIT 21 EXHIBIT 21 SUBSIDIARIES OF EXECUTONE INFORMATION SYSTEMS, INC.
JURISDICTION OF % NAME INCORPORATION OWNERSHIP BUSINESS Unistar Gaming Corporation Delaware 100% Holding Company UniStar Entertainment, Inc. Idaho 100% Lottery Management
All listed subsidiaries do business only under their corporate names listed above. Certain inactive and immaterial subsidiaries, which if considered in the aggregate as a single subsidiary would not constitute a "significant subsidiary" as defined in Rule 1-02(w) of the Commission, as of December 31, 1997, are not listed. EX-23 9 EXHIBIT 23.1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our reports included or incorporated by reference in this Form 10-K into the Company's previously filed Registration Statements File Nos. 33-45015, 33-42561, 33-23294, 33-16585, 33-6604, 33-959, 2-91008, 33-40623, 33-46874, 33-46875, 33-50628, 33-57519, 33-63637, 333-7279 and 33-62257. ARTHUR ANDERSEN LLP Stamford, Connecticut April 15, 1998 EX-23 10 EXHIBIT 23.2 EXHIBIT 23.2 April 14, 1998 EXECUTONE Information Systems, Inc. 478 Wheelers Farms Road Milford, CT 06460 ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 (FILE NO. 000-11551) ------------------- Gentlemen: This firm has reviewed the information set forth in the fifth paragraph under "Overview of Business and Strategy" under Item 1., Business, and the information set forth in the fifth paragraph under Item 3, Legal Proceedings, of the Annual Report on Form 10-K for the fiscal year ended December 31, 1997 of EXECUTONE Information Systems, Inc. (the "Company"). We understand that the information set forth therein as it relates to the issue of the authorization of the National Indian Lottery under 25 U.S.C. 2701 et seg. is based upon the advice provided to the Company by this firm. We consent to the summarization of such advice and the reference to us in the Annual Report on Form 10-K. Very truly yours, HUNTON & WILLIAMS EX-27 11 EXHIBIT 27
5 This schedule contains summary financial information extracted from the consolidated balance sheet of Executone Information Systems, Inc. and subsidiaries as of December 31, 1997 and the related consolidated statement of operations for the year ended December 31, 1997 and is qualified in its entirety by reference to such financial statements. 1000 12-MOS DEC-31-1997 DEC-31-1997 7,727 0 35,217 1,814 20,436 70,741 19,463 11,696 138,864 42,631 14,643 497 0 7,300 72,701 138,864 156,396 156,396 103,387 103,387 52,919 277 1,985 (358) (137) (221) 0 0 0 (221) 0.00 0.00 -----END PRIVACY-ENHANCED MESSAGE-----