-----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, S4QKBWwwZDnLw7yoAkBkIgz5qyo7noMb/TjhMgXW83jKKdrKfZyM6HttPe7+QI9U sKw4E8MJAuc9DT1PFNI04w== 0000950117-99-000782.txt : 19990416 0000950117-99-000782.hdr.sgml : 19990416 ACCESSION NUMBER: 0000950117-99-000782 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990415 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: 99595048 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, INC. 10-K 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 For the fiscal year ended December 31, 1998 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 February 26, 1999 was $120,326,322, 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 February 26, 1999, was 49,425,628. DOCUMENTS INCORPORATED BY REFERENCE None TABLE OF CONTENTS
Item Page - ---- ---- PART I 1. Business 1 2. Properties 21 3. Legal Proceedings 21 4. Submission of Matters to a Vote of Security Holders 23 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters 24 6. Selected Financial Data 24 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 25 7A. Quantitative and Qualitative Disclosures About Market Risk 34 8. Financial Statements and Supplementary Data 35 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 64 PART III 10. Directors and Executive Officers of the Registrant 65 11. Executive Compensation 69 12. Security Ownership of Certain Beneficial Owners and Management 79 13. Certain Relationships and Related Transactions 82 PART IV 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 86
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 and workflow management systems. 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. The Company's eLottery, Inc. subsidiary develops, provides and maintains Internet, intranet and telephone communications, accounting, database and other applications and services for use by the domestic and international lottery market. 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 In 1998 the Board of Directors determined that it is in the best interests of the shareholders of Executone to separate the business of the Company's eLottery, Inc. subsidiary (formerly named UniStar Gaming Corp.) from the operations of its computer telephony and healthcare communications businesses. On March 29, 1999, the Board of Directors announced that it had been exploring various alternatives to the previously announced spin off of eLottery's common stock to the shareholders of Executone to accomplish the separation of eLottery Inc. from Executone's core businesses. The Company announced that it will divest its core telephony and healthcare businesses and change the name of the Company to "eLottery, Inc." At the same time, the Board of Directors announced that it had received an offer for those businesses from a group lead by Stanley J. Kabala, Chairman and Chief Executive Officer of Executone, and that it has formed a special committee of the Board, chaired by outside director Louis Adler, to accomplish the divestiture. The offer from management is in the range of $70 million and is subject to a number of conditions including negotiation of a definitive agreement, financing, the waiver or expiration of a pre-existing right of first offer, and approval of the Executone shareholders. A final decision as to the method of divesting this business has not been made by the Board of Directors. The Board of Directors stated that its analysis of the proposed sale transaction is that it creates more value for Executone's shareholders than the spin off of the eLottery common stock with its tax consequences for which the Company had previously filed a registration statement. Accordingly, the Company terminated the previously filed registration statement. The proceeds of any sale of the core businesses will remain in the Company to help it accelerate the achievement of eLottery's business plans. At the conclusion of the transaction and subject to shareholder approval, Executone Information Systems would be renamed eLottery. On April 7, 1999, the Company announced that it had received approval from 100% of its preferred shareholders to terminate the Share Exchange Agreement dated 1 August 12, 1998, as amended December 22, 1998, which was entered into to facilitate the eLottery spin off. In connection with the termination of the Share Exchange Agreement, Executone agreed to redeem its outstanding preferred stock by converting it into common stock pursuant to its original terms. The preferred stock was created when Executone purchased eLottery's predecessor company, Unistar Gaming Corp., in 1995. The redemption of the preferred stock, which will occur in the second quarter of 1999, increases the ownership percentage of the existing common stockholders compared to the previous Share Exchange Agreement. Under the terminated Share Exchange Agreement, preferred holders had the right to convert their Executone preferred stock into 15% of eLottery with the potential to reach 34% ownership upon the achievement of certain milestones. With the redemption, the preferred holders will hold 21% of Executone's common equity and will no longer be entitled to a preferred dividend of 50% of eLottery's earnings. Overview of Business and Strategy The Company's revenues are derived primarily from product sales to distributors and direct sales to healthcare, 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 and to smaller locations of large commercial and governmental organizations. The Company's integrated digital telephone systems provide the platform for other flexible voice and data software applications, including software applications offered by the Company that are designed to enhance the customer's ability to communicate, obtain and manage information. The Company's 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 develops, manufactures, sells and services nurse and patient communication systems, the INFOSTAR/ILS infrared locator system, products that integrate voice and data between such systems, telephone systems and healthcare information systems. The Company's healthcare communications products are designed to increase productivity, flexibility and efficiency in hospital operations and improve patient care. Executone has been a recognized name in the healthcare communications market segment 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 improve patient care and service and resolve labor intensive tasks. On December 19, 1995, the Company acquired 100% of the common stock of Unistar Gaming Corp., a Delaware corporation, which was renamed eLottery, Inc. in January 1999 ("eLottery"). eLottery's subsidiary, UniStar Entertainment, has an exclusive five-year contract ending January 2003 to design, develop, finance, and manage the National Indian Lottery for the Coeur d'Alene Tribe of Idaho. UniStar Entertainment provided development and management of the software, network design and call center applications for the National Indian Lottery's operations until December 17, 1998, when National Indian Lottery operations were terminated in response to an adverse legal 2 decision. See" Legal Proceedings." eLottery is pursuing opportunities to become a web-based retailer of lottery services and to license its systems and services to state and international lotteries. eLottery develops, provides and maintains Internet, Intranet, telephone, communications, accounting, banking, database and other applications and services to facilitate the electronic sale of new and existing lottery products worldwide. Using its past experience and market-tested products, eLottery is committed to leading the governmental lottery industry into the eCommerce market. The Company has positioned itself to become a leader in the area by addressing the many complex legal, political and social issues facing governmental lotteries as they react to the significant market changes signaled by the rapid growth in Internet sales. The Company has developed, installed and operated Internet, Intranet, telephone, communications, accounting, banking, database and other applications and services to facilitate the electronic sale of new and existing lottery products worldwide. eLottery has developed proprietary lottery technologies designed to take advantage of the impact that the Company believes recent advances in telecommunications and computers will have on the nature and delivery of lottery products and the support systems necessary to administer them. eLottery believes it is the first to develop and operate secure, integrated Internet, Intranet and telephone lottery gaming systems. Its Internet and Intranet systems provide for the electronic sale and support of both periodic and instant draw lottery games and instant electronic "scratch-off" games. Using eLottery's systems, lotteries will be able to electronically distribute lottery tickets for both periodic and instant draw lottery games over the Internet through its website, eLottery.com, through an Intranet, using telephony and through stand-alone custom-designed electronic lottery terminals. eLottery believes that the electronic distribution of lottery tickets through these systems will increase sales for lotteries because the systems make the purchase of tickets easier and use technology to enhance the lottery gaming experience. Subject to applicable law, the eLottery.com website can contain links to the sites of participating lotteries utilizing eLottery technologies to sell their lottery tickets over the Internet. eLottery also may sell lottery tickets as an agent for certain lottery operators. eLottery believes that its systems provide lotteries with numerous advantages relative to traditional means of distribution including player tracking ability, sale of tickets over the Internet and entertaining fast-play instant games, and that the combination of the advantages of Internet commerce and eLottery's ability to customize its systems will result in eLottery becoming an agent and leading provider of products and services for the lottery industry. 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, standalone and LAN-based computer telephony 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. 3 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 and 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 its IDS telephone systems and with telephone systems manufactured by others and a complete voice processing system built on a card that integrates directly into the IDS switch. The INFOSTAR voice mail systems receive, record, store, distribute, transfer and replay messages from both external and internal callers and can supplement other call center systems. In 1998, the Company 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 also offers 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 caller, thereby providing better customer service, reducing the number of required agents and reducing telephone line and transmission expense. The Company 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 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, 4 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 (automatic call distribution) 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 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 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. Computer Telephony Sales and Marketing The Company's computer telephony distribution network consists of (1) domestic independent distributors with approximately 188 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 independent distributors 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) five independent distributors operating in five other foreign countries. For those distributors (approximately 30 in number) 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 American Express, Future Electronics, W. W. Grainger, Bridgestone/Firestone, and PetsMart . 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 5 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. The Company's sales to the Federal Government and its agencies were approximately $16.4 million in 1998, or more than 10% of total Company revenues for 1998. Sales to Claricom, Inc. ("Claricom"), the Company's largest distributor, decreased by $13.1 or 42% in 1998 compared to 1997. The reduced level of sales to Claricom had a significant impact on the financial results for 1998. 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 plan to supplement sales in the Claricom territories with additional distribution, which over time will give the Company the ability to increase revenues by adding alternative distribution in those territories. In the thirteen months beginning February, 1998, the Company signed distributor agreements with 20 new distributors and signed additional agreements with six existing distributors covering a total of 26 territories, 18 of which were formerly exclusive Claricom territories. Revenues from the newly signed distributor agreements were not material in 1998. Since Claricom accounted for more than 10% of the Company's revenues in 1998 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. 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, 1998, was $12,885,000, compared to $10,814,000 at December 31, 1997, 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, Nortel, 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 the Company'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 6 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 and information systems that are used primarily in the acute care segment of 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 healthcare 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 and staff-staff communication throughout a facility. The HCP provides the ability to offer "seamless" communication among hospital employees, departments and facilities in "real time", thereby improving operational efficiency throughout a facility. In addition, the HCP improves efficiency through the integration of Executone's full product line, including LifeSaver, CareCom II-E, INFOSTAR/ILS, TeleSearch and INFOSTAR/StatLink. 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 signaling capability, emergency signaling and sophisticated features facilitate easy handling of all calls. 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. 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 control station 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. 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. Wireless Telephone Systems. The Healthcare Communications group currently distributes the Ericsson Freeset wireless telephones. 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. 7 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 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. 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 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, allowing customers to determine which applications will best fit their needs. NETWORK ILS. Network ILS, consisting of two software applications, Patient Suite and LightBoard, is designed to provide hospital staff with real time information on the location of groups of assets related to their area of responsibility. Patient Suite monitors the mobility and status of patients throughout a Healthcare facility. Patient Suite consists of three separate applications: Patient Track, Patient View, and Patient Report. Specifically designed for ambulatory and outpatient care facilities, Patient Suite allows the administrator to schedule, monitor, manage wait time, discharge, and create reports on each patient within the facility. The LightBoard application presents a real time display of assets located at a designated set of locations throughout a facility. Asset groups such as nurses, aides, doctors, patients, and equipment, can be observed at a glance. Detailed information is provided and reported in real-time, as these assets or people 8 move from one area to another. Three types of reports, as well as the ability to print a list of people or assets at any particular location, are also included. INFOSTAR/VLS System. The INFOSTAR/VLS Voice Locator System integrates with any PBX telephone system to enable callers from inside or outside the facility to locate people and assets. Once the person being sought has been located, callers may 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". Using color codes, the system shows which patients have been "waiting too long" or "who is next". InfoSTAT provides the speed, flexibility and efficiency that only a computerized system can provide. At a glance, staff can check the status of treatment rooms, room and bed assignments, hospital staff assignment and location, and patient status and location. InfoSTAT can be configured to meet the unique needs of each hospital and integrates with a facility's existing administrative software such as ADT systems. ReportStar. The ReportStar system is a management reporting package 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 is an Oracle(R)-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 designed with a user-friendly graphical user interface to make it easy for staff to access. Reports are useful for measuring activity, quality, efficiency and for supporting a facility's risk management efforts. Healthcare Sales and Marketing The Company's healthcare communications distribution network consists of (1) domestic independent distributors with approximately 70 locations operating under exclusive and nonexclusive agreements throughout the United States; (2) approximately 120 direct healthcare sales and service employees in the United States; (3) 22 independent distributors operating in 18 foreign countries; and (4) two National Accounts managers who work with national purchasing groups and healthcare systems to improve penetration into additional facilities. 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, 1998, was $18,526,000, compared to $14,601,000 at December 31, 1997, and the Company expects virtually all of such healthcare backlog to be filled within the current 9 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, 1998, 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 1998, 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, 1998, 1997, and 1996, Company-sponsored product development and engineering expenditures (including product management and testing) amounted to approximately $10.1 million, $12.8 million, and 13.8 million, respectively. Manufacturing Most of the Company's telephone products are manufactured by the Company directly in Poway, California , by Wong's Electronics Company, Ltd. ("Wong's") in Malaysia or China, or by Quality Telecommunication Products, also referred to as Compania Dominicana de Telefonos ("Codetel"), in the Dominican Republic. 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 2000 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. The Company believes there are reasonable alternative sources for product components necessary in its manufacturing operations. 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 facility in Poway. 10 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 19 utility patents, expiring at various times between 2007 and 2017, has six U.S. patent applications pending, and eight 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 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. Federal and state law regulates certain uses of outbound call processing systems. 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, 1999, Executone employed approximately 650 persons, directly 11 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. eLOTTERY BUSINESS eLottery History On December 19, 1995, the Company acquired 100% of the common stock of eLottery. eLottery's subsidiary, UniStar Entertainment, has an exclusive five-year contract ending January 2003 to design, develop, finance, and manage the National Indian Lottery (the "NIL") for the Coeur d'Alene Tribe of Idaho ("CDA"). Until December 1998, UniStar Entertainment provided development and management of the software, network design and call center applications for the Lottery's operations. In return for providing these management services, CDA agreed to pay UniStar Entertainment a fee equal to 30% of the profits of the NIL. The NIL was never profitable. In December 1998, the U.S. District Court for the District of Idaho ruled, in a case brought by AT&T, that the NIL was not authorized by the federal Indian Gaming Regulatory Act of 1988 ("IGRA") and was governed by state law, and the eLottery and the CDA terminated the NIL. See "Legal Proceedings." The CDA's initial plan was to establish a telephone lottery that could be played by any individual of majority age, residing in one of the 37 states or the District of Columbia that currently operates a state-run lottery. After the Company's purchase of eLottery, the NIL business plan evolved to encompass Internet-based instant lottery games, and, in January 1998, a local, non-toll-free telephone and Internet-accessible weekly draw lottery. As a result of the adverse legal decision, the Company reevaluated certain of the eLottery assets and management determined that both the intangibles and the advances to the NIL were impaired as of the date of the legal decision and these assets were written down to zero, which represented the estimated fair value of the assets as no future cash flows will be generated by the NIL. eLottery currently plans to become a web-based retailer of lottery products and to provide a wide array of products and services for the domestic and international lottery markets. eLottery develops, provides and maintains Internet, Intranet, telephone, communications, accounting, banking, database and other applications and services to facilitate the electronic sale and distribution of new and existing lottery products worldwide. eLottery has developed a new generation of proprietary lottery technologies designed to take advantage of the impact that eLottery believes recent advances in telecommunications and computers will have on the nature and delivery of lottery products and the support systems necessary to administer them. eLottery believes it is the first to develop and operate secure, integrated Internet, Intranet and telephone lottery gaming systems. Its Internet and Intranet systems provide for the electronic sale and support of both periodic and instant draw lottery games and instant electronic "scratch-off" games. Using eLottery's systems, lotteries will be able to electronically distribute lottery tickets for both periodic and instant draw lottery games over the Internet through eLottery's websites, eLottery.com or eLotteryWorld.com, through an Intranet, using telephony and through stand-alone custom-designed electronic lottery terminals located in horse racing facilities, bars and other age-regulated environments. eLottery believes that the electronic distribution of lottery tickets through these systems will increase sales for lotteries because the systems make the purchase of tickets easier and use technology to enhance the lottery gaming experience. Subject to applicable law, eLottery plans for the eLottery.com website to be a site containing links to the sites of participating lotteries 12 utilizing eLottery technologies to sell their lottery tickets over the Internet. eLottery also may sell lottery tickets as an agent for certain lottery operators. The eLottery.com website and the lotteries will have the ability to remain open 24 hours a day, seven days a week without incurring additional overhead costs, and will be able to electronically distribute lottery tickets and games and offer lottery players convenient and timely product fulfillment, including the ability to pay prize winnings or cash credits on an overnight delivery option for a fee via check or electronic funds transfer. eLottery believes that its Internet lottery distribution systems will encourage lottery patrons to play more frequently and will also attract new lottery customers. eLottery believes that its systems provide lotteries with numerous advantages relative to traditional means of distribution including player tracking ability, sale of tickets over the Internet and entertaining fast-play instant games and the combination of the advantages of Internet commerce and eLottery's ability to customize its systems will result in eLottery becoming an agent and leading provider of products and services for the lottery industry. eLottery Products eLottery develops, provides and maintains Internet, Intranet, telephone, communications, accounting, banking, database and other applications and services for use by the governmental lottery market. eLottery has developed its systems to provide secure electronic production, delivery, validation, billing and accounting for lottery games. The systems are configurable, which allows the addition, deletion and substitution of games offered. Tickets may be purchased through the lottery operations center using a personal computer connected via the Internet, via custom-designed electronic lottery terminals connected over a LAN or over the telephone. Both the Internet and Intranet systems contain significant features and procedures to prevent abusive play. eLottery believes that the Internet system contains processes and procedures to protect against play by minors and to control problem gaming and that the Intranet system as implemented will provide protections against such play at least equal to that provided by existing state-run lottery systems. The key functions and components of the Company's electronic lottery distribution system are as follows: Basic Operation. A customer registers, opens an account, and receives a user identification number and password. Registration can be through the Internet, by telephone or in person at a lottery retail store. The customer deposits funds into the account by debit card, cash or check. Once the account is funded, the customer may use the available balance to purchase tickets to play the games or other merchandise. Any prizes are credited to the account. Customer withdrawals can be requested through the Internet, by telephone or in person at a lottery retail store. Card Access. The system can also be accessed using player cards. Player cards add several dimensions to the system, particularly from a regulatory point of view. Because these cards are issued at controlled facilities, access to the system can be equally controlled, enforcing, for example, age requirements, residency requirements, use of cash and amount of play. In addition, these lottery cards can be sold through the lotteries' existing agent distribution channel. Several types of cards are available including bearer cards, bonus cards, club cards and prepaid lottery cards. A bearer card has a unique identity (consisting of an ID and Password embedded in the card) representing an account on the system. These cards contain no information other than an encrypted ID and PIN number, which are 13 associated with accounts. These cards are available throughout the hosting facility. Funds are added to the bearer cards at an "Automated Recharge Machine" ("ARM") or at a cashier's station. Cash can be added at any denomination at the cashier station, but is limited to $1, $5, $10 or $20 increments at the ARM. Once a player's card is funded (i.e., the associated account has funds deposited), it may be used in a lottery gaming station or custom-designed electronic lottery terminal to play games. A bonus card is initialized with "bonus" dollars. These are dollars that can be used to play games but cannot be cashed in. Such cards are used as promotional cards to encourage people to begin playing. They can be "recharged" with cash at any ARM or cashier's station. However, the bonus dollars are consumed prior to any cash added to the card and the bonus dollars cannot be disbursed. A club card is generally issued by an authorized lottery office or authorized agent where player information can be assured adequate protection and confidentiality. These cards are protected with personal identification numbers or "PINs". Such cards are to be used as members of the state "Lottery Club" and will entitle them to various monthly promotions and other forms of communications about the enhanced lottery games. The play activity is tracked on these club cards and enables the player to qualify for various club awards that may be established by the state lotteries. Client Server Architecture. The eLottery system is designed so that players can access the system using several different devices connected to the centralized server. For example, players can use personal computers connected over the Internet; custom-designed electronic lottery terminals connected via a LAN or over the Internet, or a voice response unit connected by telephone. Administrative terminals can be connected via the Internet, thus allowing the operation and administration of the eLottery system to be conducted from remote locations. Centralized Accounting Server. A centralized accounting server keeps track of all of the transactions on the system. This server accounts for and controls transactions with customers including registration, deposits, withdrawals, purchases of tickets or other merchandise and the awarding of prizes. The centralized accounting server produces a myriad of reports to monitor both the player's activities as well as the performance of the games according to their individual working papers. Lottery Server. The lottery server is a centralized network of computers controlling the essential operations of the games including the game play, issuance of the tickets or generation of a random event, determination of a winner and the awarding of the prize. Banking System. This system validates the credit card information received from the customer with the national Visanet network. The system is currently capable of processing 10,000 transactions per hour in about 10 seconds each and is expandable to handle a larger volume of transactions. Intranet System. The Intranet system is based on the same architecture as the Internet system using private connections instead of the Internet. 14 Lottery Stations. Lottery stations can be several different devices. The lottery games can be played using personal computers connected either via the Internet or direct dial. Games can be played using custom-designed electronic lottery terminals or the draw games can be played using a telephone. Custom-designed electronic lottery terminals are built using standard "off the shelf" hardware components consisting primarily of a touch screen monitor and a standard Pentium processor networked to the central system. Cashier Terminals. The cashier stations can accept the player deposits. The player presents the card, which is swiped reading the card ID and password into the system. Funds are received from the player and entered by the cashier. The central system then adds the deposit to the balance of the account associated with the card. To withdrawal balances from the card, the player again, presents the card to the cashier, the cashier then swipes the card and the system displays the "card" balance. The cashier disburses the requested cash to the player. Automatic Recharge Machines ("ARMs"). Funds can also be added through automated recharge machines. The player inserts the card into a reader and inserts the amount of money they wish to add into a bill collector. The system updates the balances, the ARM prints a receipt and returns the card. Agent Cards. The card reader of the ARM will also identify an authorized agent's card. This access will permit the agent to obtain information about the machine as well as perform the "empty" function. To empty a machine, the agent inserts their agent card and the appropriate PIN. The agent opens the machine and takes out the bill collection box and inserts a new bill collection box. Once this process is completed, the agent finishes the empty process and a receipt is printed that should equal the balance in the box. The receipt also identifies the ARM from which it was taken, the user ID of person emptying the machine as well as the date and time of the process. The components of the system can be used together or on a stand-alone basis depending upon the specific application. Security. eLottery believes the integrity of a lottery is essential to its successful operation. eLottery is unaware of any practical, economically feasible way to breach the security of its instant lottery tickets that could result in a material loss to any of its customers, nor is it aware of any breach thereof that has resulted in any material loss to any of its lottery customers. eLottery constantly assesses the adequacy of its security systems, incorporating various improvements, bar coding and additional layers of protection. Games. The architecture of both of eLottery's Internet and Intranet systems allow the addition, deletion and substitution of lottery games offered. The lottery games have been designed to fall within generally accepted definitions of a "lottery" game. Lottery games generally fall into two broad classifications: (i) instant games or "Scratchers" in which the outcome is predetermined and known instantly and (ii) draw games in which the outcome depends upon a random event in the future. eLottery currently has four families of games that are available on both the Internet system and Intranet system: (i) Bingo; (ii) Lotto; (iii) Classics; and (iv) Draw games. Product Development. 15 eLottery's product development efforts are devoted to continual improvement in all aspects of the systems. Software developers operating under exclusive and proprietary development contracts supplement eLottery's staff. These developers leverage eLottery's ability to produce games, create database accounting and banking systems, enhance and customize system features and provide state-of-the-art Internet design and engineering capability. eLottery believes this an efficient low cost method to gain access to the best and latest technologies in each of the respective areas. The system architecture is designed to permit several developers to work independently on various modules of the system. These games can be modified to separate key elements to run in a secure client server environment and operate efficiently on eLottery's electronic lottery distribution systems. This ability to modify the lottery games allows eLottery to work with all game publishers and modify their games to operate on the system and significantly add to the eLottery's game portfolio. eLottery is also focused on development of new products in the following areas: Browser-Based Lottery Games. These are games that would play within the players' web browser thereby facilitating the download of the software. Tournaments. eLottery is investigating the development of tournament games. Players would enter the tournament and pay a membership fee to play a lottery game of skill and win prizes according to the outcome of the tournament. Traditional Casino Games. eLottery has investigated a suite of casino games including black jack, video poker, slots, roulette and craps that can be integrated into its systems. To date, eLottery has not engaged in further development of these games because it has not had any agreements with entities legally authorized to market such games. Custom-Designed Electronic Lottery Terminals. Prototypes of custom-designed electronic lottery terminals are operational, but additional development is necessary prior to deployment of the Intranet system to customer sites. Further development of the Intranet system will involve customization to a specific customer's specifications and only will be undertaken at such time as such customer enters into a contract to purchase or license eLottery's Intranet system. eLottery believes it can complete such customization in less than six months and for less than $500,000. Although eLottery has done no formal research regarding the possible acceptance of the Intranet system, it has presented the Intranet system to several state lotteries. eLottery has spent $4.3 million on research and product development to date, primarily related to the development of its systems, and has plans to spend an additional $1.5 to $2.0 million over the next year. Sales and Marketing. eLottery is pursuing the sale of its technology and systems worldwide. eLottery is marketing (i) directly to state agencies and other licensed entities, (ii) individually through authorized lottery services companies and (iii) through strategic alliances with other providers of games and gaming technology. Such marketing includes demonstrations of its electronic lottery distribution systems and visits to eLottery's premises. The ultimate success of eLottery's lottery platform depends on its acceptance by lottery operators and lottery patrons. eLottery believes that, from the point of view of lottery operators, the attractiveness of its new electronic lottery distribution systems depends on its ability to increase lottery sales, its ease of upgrade, maintenance and 16 game change and its information management. eLottery believes that, from the lottery patron's perspective, the attractiveness of a platform is a function of entertainment value. eLottery's sales and marketing strategy is to generate product sales by highlighting the advantages presented by its electronic lottery distribution systems to lottery operators, such as the potential for increased lottery ticket sales, and by positioning itself as a partner with lottery operators. eLottery's marketing strategy also targets lottery players and will focus on developing brand recognition for the eLottery.com website, which eLottery believes can be accomplished partially through the development of proprietary lottery games that eLottery believes deliver greater entertainment value than games used in the traditional lottery industry. eLottery intends to position itself as a partner with lottery operators in establishing the next generation of lottery entertainment. eLottery is working to develop close relationships with lottery operators, utilizing its marketing representatives as consultants to lottery operators on methods to increase lottery ticket sales through the use of eLottery's products. eLottery's electronic lottery distribution systems have been designed to supplement the sales and marketing efforts of the operating lotteries enhancing their ability to attract new players and increase the revenue from their customer base. Detailed play information is accumulated in the system including lottery games played, duration of play, time of play, purchase and prize data and a host of other data elements. When matched with other demographic data, this information is valuable in designing promotional offers and advertising campaigns. Specialized e-mail features provide the capability to deliver promotional programs to specific accounts based upon the results of a contest, completion of a survey, winning a game of chance or other similar event. eLottery intends to build a sales and support organization to handle sales and after-sales service to its lottery customers, and may enter into distribution arrangements or other strategic relationships to enter additional markets. eLottery Website. The eLottery.com website includes basic information about its products and provides a mechanism to obtain customer feedback. In March 1999, eLottery expanded the website to provide a live test site to preview games and an active game environment where all of the games can be played without charge. eLottery believes this site will generate a community of players interested in electronic lotteries. This player base may be a valuable resource to provide an initial base of customers to lotteries as they go on-line for the first time as well as an ongoing source of new customers. Patents, Trademarks, and Copyrights Management believes that the success of eLotterywill be affected by its 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. eLottery currently has two U.S. patent applications pending. eLottery has registered or applied to register its trademarks when it believes registration to be important to its ongoing business operations. eLottery also generally claims copyright protection for its software used in connection with its products and relies upon trade secret, contract and copyright laws to protect its proprietary rights in its software, designs and documentation. Certain of the eLottery products incorporate technology and software licensed by eLottery from independent third parties. Generally, these licenses have required payment of a license fee for the licensed technology. 17 eLottery Competition The lottery business is highly competitive, and eLottery faces competition from a number of domestic and foreign instant ticket manufacturers, on-line lottery system providers and other competitors. In particular, there are currently three primary lottery services competitors in the United States: GTECH Corporation ("GTECH"), Automated Wagering International, Inc. ("AWI"), a subsidiary of Powerhouse Technologies, Inc. ("Powerhouse"), and Scientific Games Holdings Corp. ("Sci-Games"). eLottery believes that these companies engage in vigorous competition with respect to existing lottery technologies and services and have experienced a decline in the growth of existing lottery operations. The objective of eLottery is to provide, either alone or through partnerships with existing lottery services companies, value added lottery systems and services for the domestic and international markets. It is believed that these products, systems and services can support new methods and styles of lottery participation, providing new growth opportunities for established state lotteries and higher margin returns for the providers of related technologies and services. Internationally, there are many lottery services and product suppliers that provide competition to eLottery, in addition to the companies listed above. eLottery believes that it has the ability to provide technologies that support new methods and styles of lottery participation in foreign countries. In addition, eLottery believes that applications of its electronic lottery distribution systems, which are based on the use of standardized components that support a variety of hardware and software interfaces, can provide cost-effective solutions to improve lottery operations in remote and developing nations. eLottery anticipates that a considerable length of time will be needed to develop an independent market presence in foreign countries other than Canada and Mexico, and there will be substantially higher costs in pursuing these markets. Therefore, eLottery anticipates that the marketing of its products and services internationally will be conducted primarily through joint ventures with existing providers of lottery services. No assurance can be given that eLottery will develop such relationships to the point of having a significant impact on its financial results or operations in the near future. Both in the domestic market and internationally, factors that influence the award of lottery contracts in addition to price are believed to include, among others, the ability to optimize lottery revenues through game design and technical capability, quality of the product, dependability, production capacity, marketing experience, financial condition and reputation of the bidder, the security and integrity of the bidder's production operations, products and services and the satisfaction of various other requirements and qualifications imposed by specific jurisdictions. Management believes that it has no current competitor in the market for the specific lottery products it has developed. Competitors have typically either manufactured only instant tickets or provided only certain on-line services to support conventional sales of paper lottery tickets, including software for the management systems, marketing assistance and various other specific duties. However, certain competitors have announced plans to market Internet-based lottery systems. eLottery has two primary domestic and international competitors in this regard: Powerhouse, which changed its name from Video Lottery Technologies, Inc. in 1997, and GTECH. eLottery is a relatively recent arrival among the developers of technology and marketing concepts for lottery operators. In addition, eLottery's limited experience in the industry is expected to negatively impact eLottery's competitive position. However, in the delivery of market tested, secure, integrated telephone, Internet and Intranet technologies 18 that support new forms of lottery participation and methods of administration, eLottery believes that its experience level is superior. As the only market tested provider of products that have the unique capabilities of the electronic lottery distribution systems, eLottery believes it is the only experienced provider in its particular market niche. eLottery believes that other lottery services and product suppliers have for several years made capital investments intended to position themselves to participate in this market niche. However, none has yet demonstrated the unique focus or devoted the extensive time and resources necessary to successfully develop, customize and install an operational integrated telephone and Internet lottery system similar to that provided by and operated by eLottery for the NIL. In addition, to some extent, the technological developments inherent in eLottery's electronic lottery distribution systems have the potential to materially reduce the capital investment required to finance secure lottery operations, which could affect the perception that the experience and resources of competing companies are as valuable as they have been in the past. eLottery believes that prior lottery experience has been a factor in states' prior decisions in connection with the award of lottery contracts. Thus, eLottery believes its prior lottery experience will be a factor that limits the ability of eLottery's competitors to compete with eLottery in the development of this market niche. eLottery Government Regulation and Legislation Lotteries are not permitted in various states or jurisdictions of the United States unless expressly authorized by law. The ongoing operations of authorized lotteries in the United States typically are extensively regulated. Applicable legislation varies from jurisdiction to jurisdiction but, in addition to authorizing the lottery and creating the applicable regulatory authority, the lottery statutes generally dictate certain broad parameters of lottery operation, including the percentage of lottery revenues that must be paid out in prizes. Lottery authorities typically exercise significant control as to the selection of vendors and award of lottery contracts, ticket prices, types of games played and marketing strategy, all of which can affect eLottery's operating results. Prior to and after granting a lottery contract, governmental authorities generally conduct an investigation of the company and its employees pursuant to which such authorities may require removal of an employee deemed to be unsuitable. Certain states also require extensive personal and financial disclosure (including, among other things, submission of fingerprints, personal financial statements and federal and state income tax returns) and background checks of control persons and entities beneficially owning a specified percentage (typically 5% or more) of the company's securities. The failure of such beneficial owners to submit to such background checks and provide such disclosure could jeopardize the award of a lottery contract to eLottery or provide the basis for cancellation of any existing lottery contract. The award of lottery contracts and ongoing operations of lotteries in international jurisdictions also are extensively regulated, although this regulation usually varies from that prevailing in the United States. Restrictions are frequently imposed on foreign corporations seeking to do business in such jurisdictions. Laws and regulations applicable to lotteries in the United States and foreign jurisdictions are subject to change and the effect of such changes on eLottery's ongoing and potential operations cannot be predicted with certainty. In the last session of Congress, bills were introduced that sought to ban various forms of Internet gaming and that would have allowed state authorization of other types of Internet gaming. None of those bills were enacted into law. It is likely, however, that similar bills will be introduced into the current Congress. eLottery does not know whether such bills will be introduced, what provisions any such bills would contain, or whether 19 Congress would approve those bills. If Congress were to approve a bill similar to those pending at the end of the last session, eLottery expects to be able to conduct the type of activities contemplated under its business plan. In the event that one or more bills were enacted that did contain restrictions on the use of the Internet by state sponsored lotteries, such legislation could have a material adverse effect on eLottery. Employees eLottery operates primarily through the use of independent software development contracts to improve its access to software development talent and keep its fixed overhead to a minimum. As of March 1, 1999, eLottery employed four general and administrative management employees, none of whom are represented by unions. 20 ITEM 2. PROPERTIES Executone's principal offices are located in a leased facility in Milford, Connecticut. Executone also leases warehouse, manufacturing and distribution facilities in Poway, California. As of December 31, 1998, Executone leased 15 facilities in the United States with an aggregate of approximately 295,000 square feet for its ongoing operations. The current annual rent for the Company's leased facilities is approximately $3.4 million. The Company also subleases from Claricom small areas of 13 former district sales offices, aggregating approximately 12,500 square feet, for use by sales and technical employees for approximately $200,000 per year. 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 CDA 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 CDA's NIL, to be developed and managed by the Company's eLottery 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 were sent Section 1084 letters by states opposed to the Lottery, stating that the NIL was illegal under state and federal laws and prohibiting the interstate carriers from carrying "800 number" network traffic for the NIL. 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 NIL, and (iii) that AT&T cannot refuse service to the NIL based upon Section 1084, an allegation that the NIL is in violation of IGRA or the federal anti-lottery statutes. This ruling and a related order dated May 1, 1996 were subsequently affirmed by the Tribal Appellate Court on July 2, 1997. 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, to obtain a federal court ruling on the validity and enforceability of the Tribal Court ruling. On December 17, 1998, that Court issued an opinion and order denying the motions and counter-claims of the CDA and granting declaratory judgment in favor of AT&T upholding the position of AT&T. The 21 District Court ruled that not all of the NIL gaming activity was occurring on "Indian lands," that IGRA did not apply as a result and that IGRA did not preempt the operation of state laws with respect to the NIL. In so ruling, the District Court overruled the prior decisions of the Tribal Courts that ruled the NIL was legal under IGRA. In response to that decision, eLottery and the CDA terminated operations of the NIL and the US Lottery to every state where it had been offered. The CDA has filed a notice of appeal of the District Court decision; however, eLottery will not participate in or fund any appeal of this ruling. On September 14, 1998, the CDA, eLottery and representatives of the U.S. Department of Justice had discussions regarding a declaratory judgment to be sought jointly from the U.S. District Court for the District of Idaho as to whether the operation of the NIL is legal under 18 U.S.C. 'SS''SS' 1952 and 1955. Lottery was informed that the Department of Justice views such operation to be in violation of such statutes. The Department of Justice proposed that the parties file a joint stipulation of facts and cross-motions for summary judgment in the declaratory judgment action. In response to the adverse decision of the U.S. District Court in Idaho, eLottery and the CDA terminated operation of the NIL. In light of the ruling of the U.S. District Court of Idaho, and the termination of the NIL, eLottery has requested confirmation from the Department of Justice that no further action will be taken. 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 CDA and UniStar Entertainment seeking to enjoin the NIL games offered by the CDA over the Internet. The complaint also sought civil penalties, attorneys fees and court costs. The complaint alleged that the NIL violated Missouri anti-gambling laws and that the marketing of the games violates the state's Merchandising Practices Act. UniStar Entertainment and the CDA removed the case to the U.S. District Court for the Western District of Missouri. The court also subsequently granted a motion to dismiss the CDA from the case based on sovereign immunity. The court denied a motion to dismiss UniStar Entertainment based on sovereign immunity. The State of Missouri appealed the dismissal of the CDA to the Eighth Circuit Court of Appeals. On January 28, 1998, the State of Missouri sought to dismiss voluntarily the existing federal case against UniStar Entertainment and the next day filed a new action against Executone, UniStar Entertainment and two tribal officials, with essentially the same allegations, in state court. The State obtained a temporary restraining order from a state judge against Executone, UniStar Entertainment and two officials of CDA enjoining the marketing of the Internet and telephone NIL 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,. 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 appealed the denial of its motion to remand the case to state court or, in the alternative, to grant a preliminary injunction. On January 6, 1999, the Eighth Circuit dismissed Missouri's appeal from the Eastern District of Missouri. In the same opinion, the Eighth Circuit vacated the decisions from the Western District of Missouri as to the CDA and remanded that case to the Western District for a hearing on whether the Internet games of the NIL are gaming activities "on Indian lands." The Eighth Circuit also held valid Missouri's voluntary 22 dismissal of UniStar Entertainment from the Western District lawsuit. In light of the termination of the NIL, the Company anticipates seeking dismissal of the Missouri actions. 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 Executone, UniStar Entertainment and the CDA, to permanently enjoin the US Lottery games offered by the CDA on the Internet. The complaint alleged that the offering of the US Lottery violated Wisconsin anti-gambling laws and that legality of the US Lottery had 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. Executone, UniStar Entertainment and the CDA removed the case to the U. S. District Court in Wisconsin. On February 18, 1998, the District Court dismissed the CDA 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 Entertainment were denied. UniStar appealed the denial of its motion to dismiss to the Seventh Circuit Court of Appeals. In light of the termination of the NIL and the US Lottery, the Company anticipates seeking dismissal of this action. 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. 23 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The number of holders of record of the Company's Common Stock as of the close of business on February 28, 1999 was approximately 1,800. The Common Stock is traded on the NASDAQ National Market System under the symbol "XTON". As reported by NASDAQ on February 28, 1999, the closing sale price of the Common Stock on the NASDAQ National Market System was $2 9/16. 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 ------------- ---- --- 1998 First Quarter $2 19/32 $2 1/8 Second Quarter 2 5/8 1 23/32 Third Quarter 2 1/32 1 2/32 Fourth Quarter 2 3/32 11/16 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
It is the present policy of the Board of Directors to retain earnings for use in the business and the Company has not paid any dividends and does not anticipate paying any cash dividends on the Common Stock in the foreseeable future. ITEM 6. SELECTED FINANCIAL DATA The following is selected financial data for EXECUTONE for the five years ended December 31, 1998. (In thousands, except for per share amounts)
Years Ended December 31, ------------------------------------------------------------------- 1998 1997 1996 1995 1994 ------------------------------------------------------------------- Revenues (1) $ 133,498 $156,396 $212,022 $296,393 $291,969 ========= ======== ======== ======== ======== Income (Loss) Before Income Taxes From Continuing Operations (2) $ (41,091) $ (358) $ 39,782 $(39,221) $ 10,041 ========= ======== ======== ======== ======== Income (Loss) From Continuing Operations $ (36,859) $ (221) $ 24,162 $(36,934) $ 6,734 Income From Discontinued Operations, Net of Taxes (3) --- --- --- -- 757
24 Extraordinary Item - Loss on Extinguishment of Debt, Net of Taxes (4) --- --- (355) --- --- --------- -------- -------- -------- -------- Net Income (Loss) $ (36,859) $ (221) $ 23,807 $(36,934) $ 7,491 ========= ======== ======== ======== ======== EARNINGS (LOSS) PER SHARE: Continuing Operations $ (0.74) $ --- $ 0.47 $ (0.79) $ 0.15 Discontinued Operations --- --- --- --- 0.02 Extraordinary Item --- --- (0.01) --- --- --------- -------- -------- -------- -------- Net Income (Loss) $ (0.74) $ --- $ 0.46 $ (0.79) $ 0.17 ========= ======== ======== ======== ======== DILUTED EARNINGS (LOSS) PER SHARE: Continuing Operations $ (0.74) $ --- $ 0.46 $ (0.79) $ 0.14 Discontinued Operations --- --- --- --- 0.02 Extraordinary Item --- --- (0.01) --- --- --------- -------- -------- -------- -------- Net Income (Loss) $ (0.74) $ --- $ 0.45 $ (0.79) $ 0.16 ========= ======== ======== ======== ======== Total Assets $110,305 $138,864 $152,009 $167,844 $189,481 ========= ======== ======== ======== ======== Long-Term Debt $ 23,693 $ 14,643 $ 13,837 $ 29,829 $ 24,698 ========= ======== ======== ========= ======== Cash Dividends Declared Per Share (5) $ --- $ --- $ --- $ --- $ --- ========= ======== ======== ======== ========
(1) The decline in revenues in subsequent to 1995 is primarily attributable to the sale of the Company's direct sales and service organization (DSOs) in May 1996. (2) The 1998 financial results included an asset impairment charge of $25.5 million, special charges of $9.0 million and a non-recurring gain of $5.3 million. The 1996 financial results included a pretax gain on the sale of the Company's DSO's of $48.9 million. The 1995 financial results included a restructuring charge of $44.0 million. (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 Item 5. ITEM 7. 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 and information systems. Products and services include telephone systems, voice mail systems, inbound and outbound call center systems and specialized healthcare communications and workflow management systems. 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. The Company's eLottery subsidiary (formerly named Unistar Gaming Corp.) develops, provides and maintains Internet, intranet and telephone communications, accounting, database and other applications and services for use by the domestic and international lottery market. eLottery's UniStar Entertainment subsidiary has the exclusive right to 25 design, develop and manage the National Indian Lottery (NIL) of the Coeur d'Alene Tribe of Idaho (CDA). The NIL was operational beginning in January 1998. However, in response to an adverse legal opinion on December 17, 1998, eLottery and the CDA terminated the operations of the NIL and US Lottery telephone and Internet operations managed by eLottery (See "Asset Impairment and Other Related Charges" and "eLottery"). 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. OVERVIEW During 1998, the Company put in motion significant changes to improve its core business processes. These improvements are designed to allow the Company to operate more efficiently and profitably at its current sales level and better serve its end-user customers and distribution channel partners to support renewed revenue growth. While the Company has laid the groundwork during 1998 to return to growth and profitability, many of these actions had negative effects on the Company's results for the year. Revenues for 1998 were $133.5 million, with an operating loss of $44.3 million and a net loss of $36.9 million or ($0.74) per common share. These results include $25.5 million in asset impairment and other charges related to the eLottery business (see below), $9.0 million in special charges (see "Special Charges") and a nonrecurring gain of $5.3 million, reflecting the proceeds of a negotiated legal settlement with a former supplier of videoconferencing equipment. Revenues for 1997 were $156.4 million, with operating income of $0.1 million and a net loss of $0.2 million or $0.00 per common share. The decrease in revenues year over year was $22.9 million, or 14.6%. This was primarily attributable to lower revenues generated in the Computer Telephony group through its independent distribution channel and the Healthcare Communications group. The sales declines had a negative effect on gross profit and, ultimately, on net income. The following discussion and analysis explains trends in the Company's financial condition as of December 31, 1998 and 1997 and results of operations for each of the three years in the period ended December 31, 1998. It is intended to help shareholders and other readers understand the dynamics of the Company's business and the key factors underlying its financial results. This discussion should be read in conjunction with the consolidated financial statements and notes included elsewhere in this Form 10-K, and with the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 1998. Management believes that certain statements in this discussion and analysis constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995 in that such statements are based on current expectations, estimates and projections about the industries in which the Company operates, management's beliefs and assumptions made by management. Such forward-looking statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance or achievements of the Company, or industry results, to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. Such risks, uncertainties and assumptions include, among others, the following: general economic and business conditions; demographic changes; import protection and regulation; rapid technology development and changes; timing of product introductions; 26 the mix of products/services; industry capacity and other industry trends; and the ability of the Company to attract and retain key employees. 1998 COMPARED TO 1997 RESULTS OF OPERATIONS REVENUE Revenues were $133.5 million in 1998 compared to $156.4 million for the prior year. Revenue, by business, was distributed as follows (in millions):
Inc (Dec) --------- 1998 199 $ % ---- ---------------------------- Computer Telephony $ 98.6 $ 117.2 ($ 18.6) - 15.9% Healthcare 34.9 39.2 ( 4.3) - 11.0% ------- ------- --------------- $ 133.5 $ 156.4 ($ 22.9) - 14.6% ======= ======= ===============
Computer Telephony The mission of the Computer Telephony 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. Computer Telephony 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), 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 with fewer than 400 extensions at any individual location. These products are marketed through independent distribution and direct sales, with the direct sales effort focused on product and service sales to National and Government Accounts. Computer Telephony sales declined by $18.6 million from 1997 to 1998. The revenue decline is equivalent to about 4 months of sales through the Company's independent distribution channel. During the second half of 1998, the Company stopped offering the distributor-focused sales incentives at the end of each quarter, which in the past often resulted in inflated distributor inventories and higher than necessary receivables for the Company. Management believes the year-to-year sales decline represents inventory that is no longer in the distributors' warehouses. Order intake for our National Accounts and Government retail channels continued to grow, suggesting that the Company's product features and functionality continue to be highly competitive. This also reinforces the Company's decision to expand its independent distribution network and focus product promotion through the independent channel by helping distributors stimulate end-user demand to sell more of the Company's products. Purchases by Claricom, the Company's largest independent distributor, were approximately $13.1 million lower in 1998 than in 1997 when Claricom purchases were influenced by the old distributor contract, which required certain purchase levels to maintain exclusive distribution rights in its territories. 27 Healthcare Communications The mission of the Healthcare Communications (Healthcare) business is to provide information management and communications solutions that enable healthcare facilities to deliver high quality patient care with substantially lower operating costs. 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. Healthcare reported $4.3 million lower sales for 1998 compared to 1997 reflecting three primary factors. First, the healthcare sales process was disrupted in the second and third quarters of 1998 by competitive actions in response to the Company's efforts earlier in 1998 to offer the business for sale. Second, the Company is changing its installation process (and the related revenue recognition policy) to delay product shipments to the installation site until just before the actual installation date. Phasing delivery of the equipment in this manner makes it easier to ensure that customers receive the most up-to-date release of the Company's products and shortens the Company's cash conversion cycle. Finally, Healthcare changed its sales incentive practices with the healthcare independent distributors in a similar manner as described above for the Computer Telephony group. GROSS PROFIT Gross profit margin for 1998 was $41.7 million or 31.3 % of revenue, compared to $53.0 million or 33.9% of revenue in 1997. The decrease primarily relates to the decline in sales volume. Although pricing margins remained constant compared to the prior year, the lower volume resulted in lower fixed cost absorption and a reduction in gross profit margin percentage. OPERATING EXPENSES Excluding special charges and the eLottery asset impairment, operating expenses were $51.5 million, a decrease of $1.4 million compared to 1997. Product development expenses were the primary reason for the decrease, as the Company has redirected its efforts on more focused product development priorities. This has resulted in reduced costs and lower headcount compared to last year. Selling, general and administrative expenses for 1998 were $41.4 million, or 31.0% of revenue, compared to $40.1 million or 25.7% of revenue for 1997. During the last 6 months of 1998, the Company accelerated its investments in improved business processes with its ongoing implementation of a new enterprise software system, the purchase of a new web-based channel management system and consulting fees incurred to reengineer its business processes. The Company also incurred higher legal and employee-related benefit expenses than in 1997. This was offset by a favorable variance in selling expenses, primarily due to lower commissions on lower sales volume and reduced headcount. 28 SPECIAL CHARGES During 1998, the Company recorded $9.0 million in special charges. These charges include $5.3 million relating to changes the Company has undertaken to restructure its business, primarily involving separation costs related to changes in senior management during 1998 and a provision for losses to be incurred in subleasing a portion of the Company's leased facilities. Also included is a $3.7 million charge to settle claims made by Lucent Technologies (Lucent) which holds the patent rights to certain intellectual property allegedly used in the Company's products. Under the agreement, the Company will pay Lucent $3.7 million over the next two years to cover all past patent obligations. In addition, the parties have agreed to execute a bilateral patent cross-license agreement covering all of Lucent's and the Company's current telephony-related patents, which provides for additional royalties to be paid to Lucent. ASSET IMPAIRMENT AND OTHER RELATED CHARGES In response to the legal decision issued December 17, 1998 in AT&T vs. Coeur d'Alene Tribe, eLottery and the CDA terminated operation of the NIL and the US Lottery telephone and Internet operations managed by eLottery. As a result, the Company reevaluated certain of its assets in accordance with the provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets." Based upon this review, management determined that both the intangibles and the advances to the NIL have been impaired as of the date of this legal decision. As of December 17, 1998, net intangibles and advances to NIL of $12.9 million and $11.2 million, respectively, were written down to zero, which represented the estimated fair value of the assets, as no future cash flows will be generated by the NIL. The Company also recorded an additional charge of $1.4 million for shutdown costs and the write-off of certain deferred startup expenses related to the NIL. The total NIL-related write-off included in the 1998 statement of operations was $25.5 million. INTEREST AND OTHER EXPENSE Interest expense for 1998 was $2.4 million, an increase of $0.4 million from 1997. The increase is due to higher levels of bank borrowings in 1998. Other income, net decreased compared to the same periods in 1997 due to lower interest income on invested cash and lower royalty income. The Company also recorded a nonrecurring gain on a negotiated settlement with a former supplier of videoconferencing equipment totaling $5.3 million. The gain was recorded in the fourth quarter of 1998. INCOME TAXES The Company accounts for income taxes in accordance with FAS No. 109, "Accounting for Income Taxes". For the year ended December 31, 1998, the Company recorded a tax benefit of $4.2 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, 1998, the deferred tax asset of $22.8 million represents the expected benefits to be received from the utilization of tax benefit carryforwards. The Company did not record a tax benefit for its fourth quarter loss. Management believes that the deferred tax asset will more likely than not be recognized in the carryforward periods. SUBSEQUENT EVENT 29 On March 29, 1999, the Company announced that it planned to divest its core telephony and healthcare businesses and change the name of the Company to eLottery, Inc. At the same time, the Executone Board of Directors announced it had received an offer for those businesses from a group to be led by Stanley J. Kabala, Chairman and Chief Executive Officer of Executone, and that it has formed a special committee of the Board to accomplish that divestiture. The offer from management is in the range of $70 million and is subject to a number of conditions including negotiation of a definitive agreement, financing, the waiver or expiration of a pre-existing right of first offer, and approval of the Executone shareholders. A final decision as to the method of divesting this business has not been made by the Board. Under the management offer, the proceeds of the sale will remain in the public company, eLottery, to help it accelerate the achievement of its business plans. The Board believes this transaction creates more value for the Company's shareholders than the spin off of the eLottery common stock, which had potentially significant corporate and individual tax consequences. As a result, the Company has terminated its previously filed registration statement. On April 7, 1999, the Company announced that as part of its plan to separate its telephony and healthcare businesses from eLottery, it had received approval from 100% of its preferred shareholders to accelerate the redemption of its Series A and Series B preferred stock. The Company believes this transaction will simplify its capital structure and align the interests of the former preferred and current common shareholders. eLOTTERY On December 19, 1995, EXECUTONE Information Systems, Inc. ("Executone') acquired 100% of the common stock of Unistar Gaming Corp. for common and preferred stock with a combined value of $12.7 million. In January 1999, Unistar Gaming Corp. changed its name to eLottery, Inc. ("eLottery"). Any reference herein to eLottery shall be deemed to include business conducted under the name Unistar Gaming Corp. eLottery's wholly-owned subsidiary, UniStar Entertainment, Inc. ("UniStar Entertainment") has an exclusive five-year management agreement with the CDA, which was the primary asset acquired, to provide design, development, financial and management services to the National Indian Lottery. The NIL was operational beginning in January 1998. However, in response to an adverse legal opinion on December 17, 1998, eLottery and the CDA terminated the operations of the NIL and the US Lottery telephone and Internet operations managed by eLottery (See "Asset Impairment and Other Related Charges"). eLottery's original mission was to develop, install and manage a National Indian Lottery accessible by telephone. eLottery developed a state-of-the-art Internet and telephone-based system providing both instant and draw lottery games, full player accounting and tracking and automatic credit or debit card clearance. In early 1998, as a hedge against potential adverse legal and political decisions, eLottery began investigating alternative applications and markets for its technology. eLottery is now pursuing opportunities to become a web-based retailer of lottery services and to license its systems and services to state and international lotteries. The Company has developed and operated systems software that enables the electronic distribution of lottery tickets over the Internet, Intranet and via telephone. The Company believes that the electronic distribution of lottery tickets through these systems will increase lottery sales because they make the purchase of tickets more easily accessible and because they make use of technology to enhance and enliven the lottery gaming experience. With its unique and proven ability to offer lottery 30 operators its new Internet and Intranet-based lottery products worldwide, the Company believes it is well positioned to capitalize on the growth in non-traditional lottery sales. The Company has made a significant investment in eLottery, which upon acquisition created 8% dilution to the Company's stockholders and, subsequent to the acquisition, has required an additional $18.6 million in cash. During the year ended December 31, 1998, the Company invested $7.3 million as part of the cost to develop the software systems, building and other costs related to the project, most of which were recorded as assets on the balance sheet. The Company's cumulative investment in eLottery as of December 31, 1998 was $32.7 million, of which $24.9 million was written off during the fourth quarter of 1998. The remaining funds invested primarily relate to the computer hardware and software systems developed to run the games. With the termination of operations of the NIL, future expenditures will be directed toward generating future revenues from the sale or licensing of the technology eLottery has developed to authorized state and national lotteries. With the termination of the NIL and US Lottery, the Company continues to face certain legal and other risks. See Note L in the Notes to Consolidated Financial Statements for a discussion of the legal issues and legislative proposals, which could impact the Company and its eLottery business. YEAR 2000 Status The Company has completed a review of its computer systems to identify systems that could be affected by the "Year 2000" issue. Systems that do not properly recognize information after December 31, 1999 could generate erroneous data or fail. Although the Company estimated the cost to resolve the Year 2000 issue through its current software system would have been less than $0.5 million, it decided as part of its long-term information systems plan to convert to a new and more comprehensive software system for its information technology (IT) infrastructure. The new system will cost approximately $2.3 million, including installation and data conversion costs. The Company expects the new system to be operational by the end of the second quarter of 1999. The costs for the new system will be capitalized and depreciated over the expected service life of the system beginning in the third quarter of 1999. Implementation of the new system began during the third quarter of 1998. The Company has incurred approximately $1.1 million through December 31, 1998, primarily for the purchase of software licenses and certain system hardware, along with installation costs. The Company has completed the system blueprint, the first significant milestone in the project. Blueprinting is the evaluation and documentation of system requirements on a process by process basis and serves as the framework for the configuration of the system and the installation process. The configuration process is now underway, along with documentation of our business process procedures as they will be used in the new system. The Company has also begun data conversion processes. As of December 31, 1998, it is estimated that the installation process is approximately 40% complete. Management believes that the conversion to new software will resolve the Year 2000 issue as it relates to its IT infrastructure. There are several peripheral systems that will not be replaced by the new software. These systems are being made compliant using the Company's internal resources, which have been redeployed from other projects. The remedial effort is approximately 50% complete and is scheduled to be 100% complete by the end of the second quarter of 1999. The total remedial cost for these systems is approximately $50,000, of which approximately $25,000 has been incurred as of December 31, 1998. 31 For non-IT systems (non-information technology that typically includes imbedded technology such as micro-controllers), the Company has reviewed its production and other equipment and determined that there are no significant Year 2000 issues. The Company has also begun seeking representations and assurances from its key vendors regarding timely Year 2000 compliance. Other than such surveys of its vendors, the Company has not made an assessment as to whether any of its suppliers or service providers will be affected by the date change. Risk Assessment Although the Company believes that internal Year 2000 compliance will be achieved by December 31, 1999, there can be no assurance that the Year 2000 problem will not have a material adverse affect on the Company's business, financial condition and results of operations. The failure by the Company to correct a material Year 2000 problem could result in an interruption in, or a failure of, certain normal business activities or operations. Presently, the Company perceives that the most reasonably likely worst case scenario related to the Year 2000 issue is associated with potential concerns with the ability of third party vendors to provide products used in the manufacturing process. A significant disruption in the product manufacturing process could prevent or delay the Company from completing new installations or system upgrades and enhancements for its customers. This would adversely affect the Company's results of operations, liquidity and financial condition. The Company is not presently aware of any vendor-related Year 2000 issue that is likely to result in such a disruption. Contingency Plan The Company does not yet have a contingency plan in place to deal with unforeseen conversion failures. Such a plan is currently being developed and will include the identification of a team of employees to be on call during the millennium change to monitor key systems, providing for backup power sources, data retention and recovery procedures for critical business data and operational plans to address potential delays in product supply from vendors. The contingency plan is expected to be in place by June 1999. OTHER MATTERS For the years ended December 31, 1998 and 1997, the Company had two individual customers, each of which generated in excess of 10% of the Company's revenues. Both customers are included in the Computer Telephony segment. One customer accounted for $18.0 million and $31.1 million in sales for 1998 and 1997, respectively. The second customer accounted for $16.4 million and $14.0 million for the same periods, respectively. FAS No. 130, "Reporting Comprehensive Income," became effective for fiscal years beginning after December 15, 1997. This Statement does not apply to the Company because it had no items of other comprehensive income in any of the years presented. 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 32 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 $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 $2.9 million, or ($0.06) per share in 1996, excluding the gain on the sale of the direct offices. 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 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. 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 Computer Telephony were largely stable year over year. Repair revenue decreased approximately $2 million, primarily due to lower Claricom activity, and sales of least cost routing (LCR) products increased almost 50% to $1.8 million. Computer Telephony segment profit was approximately $3.3 million during 1997. Healthcare 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. During 1997, the Healthcare segment had a loss of $2.4 million. 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. LIQUIDITY AND CAPITAL RESOURCES On August 14, 1998, the Company entered into a new credit facility with Fleet Capital Corp. The new credit facility provides a maximum overall credit line of $30 million consisting of a revolving line of credit for direct borrowings, along with standby and trade letters of credit. Direct borrowings and letter of credit advances are made available pursuant to a formula based on the levels of eligible accounts receivable and inventories. To minimize interest on the revolving line of credit, the Company has the option to borrow based upon an adjusted prime borrowing rate or an adjusted LIBOR rate. The credit facility is secured by substantially all of the Company's assets and has a five-year term. Under the terms of the new credit facility, the Company had approximately $8.8 million in borrowings available as of December 31, 1998. The Company's liquidity is represented by cash, cash equivalents and cash availability under its existing credit facilities. The Company's liquidity was approximately $10 million, $28 million and $50 million as of December 31, 1998, 1997 and 1996, respectively. 33 At December 31, 1998 and 1997, cash and cash equivalents amounted to $1.5 million and $7.7 million, respectively, or 3% and 11% of current assets, respectively. Cash used by total operating activities was $10.6 million in 1998, $4.8 million more than in 1997. The primary reasons for the use of additional cash were disbursements of $3.4 million for special charges, and the impact on operating cash of the $9.8 million operating loss (excluding asset impairment and special charges). This was partially offset by the release of $5.1 million held in escrow since the sale of the direct offices in 1996. Cash used by investing activities totaled $3.3 million for 1998, a $5.1 million reduction compared to 1997. The reduction is due to the October 1998 receipt of $5 million in cash as part of a negotiated a settlement with a former supplier of the Company's videoconferencing equipment. The proceeds were used to reduce outstanding bank borrowings. The Company generated $7.6 million in cash from financing activities during 1998. The primary source of cash was borrowings of $8.6 million, offset by payments on capital lease obligations and other long-term debt. During 1997, the Company used $5.8 million in its financing activities, primarily to repurchase the Company's common stock for $4.9 million and to repay capital lease obligations and other long-term debt. Total debt at December 31, 1998 was $24.5 million, an increase of $8.9 million from $15.6 million at December 31, 1997. The increase is a result of $8.6 million in bank borrowings from the Company's credit facility, capital lease obligations of $1.2 million incurred in connection with the acquisition of a new computer software system and miscellaneous computer and production equipment, and an increase to the carrying value of the convertible subordinated debentures of $0.2 million due to accretion. Debt was reduced by the repayment of $1.1 million in capital lease obligations incurred in connection with equipment and software acquisitions, along with other debt repayments. On February 26, 1999, the Company received $9.3 million from Claricom as payment in full for Claricom's outstanding $5.9 million junior subordinated note plus interest, along with the redemption of the warrants issued to the Company as part of the sale of the direct offices in 1996. The Company used the proceeds to reduce outstanding bank borrowings. Required principal payments for debt in 1999 are approximately $0.9 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 1999. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information presented in the "Notes to Financial Statements" included under Item 8 is incorporated by reference. 34 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 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, 1998 and 1997, 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, 1998. 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, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP Stamford, Connecticut February 4, 1999 35 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except for per share amounts)
Years Ended December 31, 1998 1997 1996 ---- ---- ---- REVENUES $ 133,498 $ 156,396 $ 212,022 COST OF REVENUES 91,777 103,387 132,510 --------- --------- --------- Gross Profit 41,721 53,009 79,512 --------- --------- --------- OPERATING EXPENSES: Product development and engineering 10,052 12,794 13,773 Selling, general and administrative 41,435 40,125 69,180 Special charges 9,028 -- -- Asset impairment and other related charges 25,486 -- -- --------- --------- --------- 86,001 52,919 82,953 --------- --------- --------- OPERATING INCOME (LOSS) (44,280) 90 (3,441) INTEREST EXPENSE (2,393) (1,985) (2,707) NET GAIN ON SALE OF BUSINESSES 5,269 -- 44,060 OTHER INCOME, NET 313 1,537 1,870 --------- --------- --------- INCOME (LOSS) BEFORE INCOME TAXES (41,091) (358) 39,782 PROVISION (BENEFIT) FOR INCOME TAXES (4,232) (137) 15,620 INCOME (LOSS) BEFORE EXTRAORDINARY ITEM (36,859) (221) 24,162 Extraordinary item - loss on extinguishment of debt (net of income tax benefit of $238) -- -- (355) --------- --------- --------- NET INCOME (LOSS) $ (36,859) $ (221) $ 23,807 ========= ========= ========= EARNINGS (LOSS) PER SHARE: INCOME (LOSS) BEFORE EXTRAORDINARY ITEM $ (0.74) $ -- $ 0.47 EXTRAORDINARY ITEM -- -- (0.01) --------- --------- --------- NET INCOME (LOSS) $ (0.74) $ -- $ 0.46 ========= ========= ========= DILUTED EARNINGS (LOSS) PER SHARE: INCOME (LOSS) BEFORE EXTRAORDINARY ITEM $ (0.74) $ -- $ 0.46 EXTRAORDINARY ITEM -- -- (0.01) --------- --------- --------- NET INCOME (LOSS) $ (0.74) $ -- $ 0.45 ========= ========= ========= AVERAGE COMMON SHARES OUTSTANDING: BASIC 49,755 49,655 51,712 ========= ========= ========= DILUTED 49,755 49,655 52,251 ========= ========= =========
36 The accompanying notes are an integral part of these consolidated statements. 37 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands) Years Ended December 31, 1998 1997 1996 ---- ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES: Income (loss) before extraordinary item $(36,859) $ (221) $ 24,162 Adjustments to reconcile net income (loss) to net cash used by operating activities: Depreciation and amortization 3,545 2,969 4,242 Asset impairment and other related charges 25,486 -- -- Deferred income tax provision (benefit) (4,232) (137) 11,420 Net gain on sale of businesses (5,269) -- (44,060) Provision for losses on accounts receivable 1,227 277 1,921 Accrual of patent infringement settlement 3,735 -- -- Other, net (155) 201 (465) Changes in working capital items: Accounts receivable 6,862 5,439 (8,754) Inventories (4,464) (3,893) 1,048 Accounts payable and accruals (4,580) (8,779) (2,857) Other working capital items, net 4,107 (1,668) 2,375 -------- -------- -------- NET CASH USED BY OPERATING ACTIVITIES (10,597) (5,812) (10,968) -------- -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (817) (1,469) (2,534) Dispositions of businesses 5,000 -- 56,948 Investment in eLottery (7,261) (5,556) (4,182) Other, net (184) (1,325) 298 -------- -------- -------- NET CASH (USED) PROVIDED BY INVESTING ACTIVITIES (3,262) (8,350) 50,530 -------- -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Borrowings (repayments) under revolving credit facility 8,582 -- (15,445) Repayments of other long-term debt (1,092) (1,182) (1,134) Repurchase of stock (148) (4,893) (4,554) Proceeds from issuance of stock 272 268 819 Other borrowings -- -- 356 -------- -------- -------- NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES 7,614 (5,807) (19,958) -------- -------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (6,245) (19,969) 19,604 CASH AND CASH EQUIVALENTS - BEGINNING OF YEAR 7,727 27,696 8,092 -------- -------- -------- CASH AND CASH EQUIVALENTS - END OF YEAR $ 1,482 $ 7,727 $ 27,696 ======== ======== ========
The accompanying notes are an integral part of these consolidated statements. 38 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(In thousands, except for share amounts) December 31, December 31, 1998 1997 -------- ------ ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,482 $ 7,727 Restricted cash - 5,084 Accounts receivable, net of allowance of $1,720 and $1,814 25,531 33,403 Inventories 24,753 20,436 Prepaid expenses and other current assets 4,966 4,091 -------- -------- Total Current Assets 56,732 70,741 PROPERTY AND EQUIPMENT, net 10,604 7,767 INTANGIBLE ASSETS, net 3,795 19,765 DEFERRED TAXES 22,811 18,577 OTHER ASSETS 16,363 22,014 -------- -------- $110,305 $138,864 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Current portion of long-term debt $ 856 $ 951 Accounts payable 18,093 23,009 Accrued payroll and related costs 3,969 3,007 Accrued liabilities 15,046 13,123 Deferred revenue and customer deposits 2,439 2,541 -------- -------- Total Current Liabilities 40,403 42,631 LONG-TERM DEBT 23,693 14,643 OTHER LONG-TERM LIABILITIES 2,445 1,092 -------- -------- Total Liabilities 66,541 58,366 -------- -------- STOCKHOLDERS' EQUITY: Common stock: $.01 par value; 80,000,000 shares authorized; 49,834,807 and 49,660,359 issued and outstanding 498 497 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 71,624 71,500 Retained earnings (deficit) (35,658) 1,201 -------- -------- Total Stockholders' Equity 43,764 80,498 -------- --------
39 $110,305 $138,864 ======== ========
The accompanying notes are an integral part of these consolidated balance sheets. 40 EXECUTONE INFORMATION SYSTEMS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(In thousands, except for share amounts) Common Stock Preferred Stock Additional Retained Total -------------- ----------------- Paid-In Earnings Stockholders' Capital Shares Amount Shares Amount Capital (Deficit) Equity - ------- ------ ------ ------ ------ --------- --------- ----------- 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 ---------------------------------------------------------------------------------------- Proceeds from issuances of stock from employee stock plans 314,448 2 150 152 Amortization of deferred compensation 121 121 Repurchase of stock (140,000) (1) (147) (148) Net loss (36,859) (36,859) ---------------------------------------------------------------------------------------- Balance at December 31, 1998 49,834,807 $498 350,000 $7,300 $71,624 $(35,658) $43,764 ========================================================================================
The accompanying notes are an integral part of these consolidated statements. 41 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 and information systems. Products and services include telephone systems, voice mail systems, inbound and outbound call center systems and specialized healthcare communications and workflow management systems. 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's eLottery subsidiary (formerly named Unistar Gaming Corp.) develops, provides and maintains Internet, intranet and telephone communications, accounting, database and other applications and services for use by the domestic and international lottery market. eLottery's UniStar Entertainment subsidiary has the exclusive right to design, develop and manage the National Indian Lottery (NIL) of the Coeur d'Alene Tribe of Idaho (CDA). The NIL was operational beginning in January 1998. However, in response to an adverse legal opinion on December 17, 1998, eLottery and the CDA terminated the operations of the NIL and US Lottery telephone and Internet operations managed by eLottery (see Note L). 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. 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. 42 Earnings Per Share. Earnings per share is calculated in accordance with the provisions of FAS No. 128, "Earnings per Share." Basic 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, 1998 and 1997:
(Amounts in thousands) 1998 1997 ---------------------- ---- ---- Raw Materials $ 2,527 $ 4,672 Finished Goods 22,226 15,764 ------- ------- $24,753 $20,436 ======= =======
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 (see Note L). Amortization is provided over a 40-year period. Intangible assets at December 31, 1998 and 1997 are net of accumulated amortization of $1.3 million and $1.1 million, respectively. Property and Equipment. Property and equipment at December 31, 1998 and 1997 consist of the following:
(Amounts in thousands) 1998 1997 ---------------------- ---- ---- Furniture and fixtures $ 1,017 $ 887 Leasehold improvements 1,765 1,718 Machinery and equipment 20,252 16,858 -------- -------- 23,034 19,463 Accumulated depreciation (12,430) (11,696) -------- -------- Property and equipment, net $ 10,604 $ 7,767 ======== ========
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. 43 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, 1998 is approximately $11.5 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, 1998 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, 1998:
(Amounts in thousands) 1998 1997 1996 ---------------------- ---- ---- ---- Note receivable and warrants from sale of direct sales offices $ -- $ -- $8,100 Restricted cash received from sale of direct sales offices -- -- 5,031 Common shares exchanged to exercise options and warrants 230 507 549 Capital leases for equipment acquisitions 1,212 1,805 302
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, 1998 and 1997:
(Amounts in thousands) 1998 1997 - ---------------------- ---- ---- Borrowings Under Revolving Credit Facility (a) $ 8,582 $ -- Convertible Subordinated Debentures (b) 12,822 12,569 Capital Lease Obligations (c) 2,521 2,326 Other 624 699 ------- ------- Total Debt 24,549 15,594 Less: Current Portion of Long-Term Debt 856 951 ------- ------- Total Long-Term Debt $23,693 $14,643 ======= =======
(a) On August 14, 1998, the Company entered into a new revolving credit facility (the Credit Facility) with Fleet Capital Corp. expiring in 2003. The new Credit Facility 44 provides a maximum overall credit line of $30 million consisting of a revolving line of credit for direct borrowings, along with standby and trade letters of credit. Direct borrowings and letter of credit advances are made available pursuant to a formula based on the levels of eligible accounts receivable and inventories. 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 (9.0% at December 31, 1998) or at an adjusted LIBOR rate (8.6% at December 31, 1998). Approximately $8.8 million was available at December 31, 1998 under the revolving line of credit, after giving effect to $6.9 million that was committed to cover outstanding letters of credit. The unused portion of the line of credit has a commitment fee of 0.40% through December 31, 1998. Beginning in 1999, the unused commitment fee will be adjusted based upon certain financial ratios. The Company borrowed $8.6 million as of December 31, 1998. No direct borrowings against the revolving Credit Facility were outstanding at December 31, 1997. The Company's average outstanding indebtedness under the revolving line of credit for the year ended December 31, 1998 was $5.9 million, and the average interest rate on such indebtedness was 9.40%. The Credit Facility agreement contains certain restrictive covenants including, among other things, minimum levels of operating cash flows and consolidated net worth. During 1998, the Company was in compliance with all such financial covenants or was granted a waiver of the covenant by the lender. 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, 1998 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 $2.5 million and $2.3 million at December 31, 1998 and 1997, respectively. Such leases have been capitalized using implicit interest rates which range from 8% to 12%. The following is a schedule of future maturities of long-term debt at December 31, 1998: 45
Years Ending December 31: (Amounts in thousands) ------------------------- --------------------- 1999 $ 856 2000 890 2001 891 2002 293 2003 107 Thereafter 21,512 -------- $24,549 -------- --------
For the years ended December 31, 1998, 1997 and 1996, the Company made cash payments of approximately $1.7 million, $1.8 million and $2.6 million, respectively, for interest expense on indebtedness. NOTE D - INCOME TAXES The components of the provision (benefit) for income taxes applicable to income (loss) before taxes for the three years ended December 31, 1998 are as follows:
(Amounts in thousands) 1998 1997 1996 ---------------------- ---- ---- ---- Current - Federal $ -- $ -- $ 1,100 - State -- -- 3,100 - Foreign 2 6 -- ------- ------ ------- 2 6 4,200 ------- ------ ------- Deferred - Federal (3,281) (111) 11,005 - State (953) (32) 415 ------- ------ ------- (4,234) (143) 11,420 ------- ------ ------- $(4,232) $ (137) $15,620 ======= ====== =======
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) before taxes for the three years ended December 31, 1998 is as follows:
(Amounts in thousands) 1998 1997 1996 - ---------------------- ---- ---- ---- Statutory income tax provision (benefit) $(13,971) $ (122) $13,924 State income taxes, net of federal income tax benefit (629) (21) 2,364 Tax benefit not recorded 5,980 -- -- Write off and amortization of intangible assets 4,472 45 44 Research and development credit (610) (807) (351) Nondeductible employee compensation costs 444 -- --
46 Other 82 768 (361) -------- ------ ------- Reported income tax provision (benefit) $ (4,232) $ (137) $15,620 ======== ======= =======
The components of and changes in the net deferred tax asset are as follows:
Deferred December 31, (Expense) December 31, (Amounts in thousands) 1997 Benefit 1998 - ---------------------- ------------- ---------- ---------- Net operating loss and tax credit carryforwards $25,161 $ 10,520 $ 35,681 Inventory reserves 2,196 618 2,814 Accrued liabilities and restructuring costs 406 1,595 2,001 Debenture revaluation (1,437) 98 (1,339) Other (3,005) (2,304) (5,309) --------- -------- ------- 23,321 10,527 33,848 Valuation allowance (4,744) (6,293) (11,037) --------- -------- ------- Deferred tax asset $18,577 $ 4,234 $ 22,811 ========= ======== ========
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 $22.8 million as of December 31, 1998, the Company will need to generate future taxable income of approximately $62 million prior to the expiration of the NOLs and tax credit carryforwards. During the fourth quarter of 1998, the Company did not record a tax benefit on its pre-tax loss. This reflected the adoption of a more conservative accounting policy and does not change the Company's evaluation of its existing deferred tax asset. 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, 1998, 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 $67.0 million and $4.4 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: $24.6 million in 2004; $9.7 million in 2005; $12.3 million in 2006; $0.8 million in 2010; $13.4 million in 2012; $6.2 million in 2013. A reconciliation of the Company's income (loss) before taxes for financial reporting purposes to taxable income for the three years ended December 31, 1998 is as follows: 47
(Amounts in thousands) 1998 1997 1996 - ---------------------- ---- ---- ---- Income (loss) before taxes and extraordinary item $(41,091) $ (358) $ 39,782 Extraordinary Item -- -- (592) -------- -------- -------- Income (loss) before taxes for financial reporting purposes (41,091) (358) 39,190 Differences between income (loss) before taxes for financial reporting purposes and taxable income: Permanent differences 14,359 (25) 124 -------- -------- -------- Book taxable income (loss) (26,732) (383) 39,314 Net changes in temporary differences 3,525 (13,002) (15,282) -------- -------- -------- Taxable income (loss) $(23,207) $(13,385) $ 24,032 ======== ======== ========
The permanent differences relate to the write-off (in 1998) 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), inventory reserves and other costs accrued for book purposes, but not deducted for tax purposes until subsequently paid. For the years ended December 31, 1998, 1997 and 1996, the Company made cash payments of approximately $0.1 million, $0.4 million and $1.5 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, 1998 is as follows:
(in thousands, except for per share amounts) For the year ended December 31, 1998: Income/(Loss) Shares Per Share Amount - ------------------------------------- ------------- ------ ---------------- Basic and Diluted Loss Per Share: Net loss $(36,859) 49,755 $(0.74) ======== ====== ====== 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: - -------------------------------------
48 Basic Earnings Per Share: Income before extraordinary item $ 24,162 51,712 $ 0.47 Stock Options and Warrants 539 -------- ------ ------ Diluted Earnings Per Share: Income before extraordinary item $ 24,162 52,251 $ 0.46 ======== ====== =======
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, 1998. 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. Options to purchase approximately 163,000 and 139,000 shares of common stock as of December 31, 1998 and 1997, respectively, were not included in the computation of diluted earnings per share due to the net losses for those years. Options to purchase 1.8 million, 1.2 million and 1.0 million shares of common stock as of December 31, 1998, 1997 and 1996, respectively, 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 eLottery (See Note L) was antidilutive, at issuance, and has been excluded from the above calculations. Subsequent to December 31, 1998, the convertible preferred stock was redeemed (see Note Q). 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 $4.0 million, $4.2 million and $6.3 million for the years ended December 31, 1998, 1997 and 1996, 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, 1998:
Years Ending December 31, (Amounts in thousands) ------------------------- ---------------------- 1999 $ 3,313 2000 3,233 2001 3,349 2002 3,588 2003 3,595 Thereafter 4,062 --------- $21,140 =========
49 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 eLottery. NOTE G - EQUITY INVESTMENT 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 to ten years. Shares available for granting of future options under these plans total 1.4 million as of December 31, 1998. The Company also had non-plan options outstanding at December 31, 1998, all of which were exercisable. These options expire at various dates through March 2001. A summary of the status of the Company's stock option plans, as well as non-plan options, as of December 31, 1998, 1997 and 1996 is as follows:
1998 1997 1996 -------------------- ---------------------- ---------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price -------- ---------- ------- -------- ------ ----- Outstanding 1/1 1,510,899 $2.89 1,972,485 $2.54 2,858,577 $2.18 Granted 1,407,400 $1.90 251,400 $2.32 316,875 $2.65 Exercised (138,550) $2.01 (481,786) $1.23 (761,570) $1.28 Cancelled (524,550) $2.51 (231,200) $2.71 (441,397) $2.46 --------- --------- --------- Outstanding 12/31 2,255,199 $2.42 1,510,899 $2.89 1,972,485 $2.54 ========= ========= ========= Options exercisable 12/31 994,025 $3.06 1,017,134 $3.04 1,335,402 $2.44 ========= ========= =========
Information relative to options outstanding at December 31, 1998 is as follows:
Options Outstanding Options Exercisable ------------------------------------------ ------------------------- Weighted Weighted Weighted
50
Shares Average Average Shares Average Exercise Outstanding Remaining Exercise Exercisable Exercise Prices 12/31/98 Life (yrs) Price 12/31/98 Price -------- ------------------------------------------ ------------------------- $1.13 - $ 2.00 846,600 6.0 $1.58 140,650 $1.89 $2.03 - $ 2.50 577,800 3.7 $2.30 159,551 $2.37 $2.56 - $ 3.00 239,869 2.9 $2.79 155,044 $2.85 $3.10 - $20.43 590,930 1.8 $3.58 538,780 $3.62 --------- ------- $1.13 - $20.43 2,255,199 4.0 $2.42 994,025 $3.06 ========= =======
The fair value of options granted during 1998, 1997 and 1996 was $1.23, $1.24 and $1.20 per share, respectively. Fair value was estimated using the Black-Scholes option-pricing model with the following assumptions: expected volatility ranging from 66% to 108%, a risk-free interest rate ranging from 5.4% to 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 $0.4 million, $0.2 million and $0.1 million for 1998, 1997 and 1996, respectively. The change in earnings per share would have been immaterial each year. As of December 31, 1998, the Company has warrants outstanding that permit the holders to purchase a total of 75,000 shares of Common Stock at prices ranging from $1.25 to $2.63 per share, expiring through November 2003. At December 31, 1998, 25,000 of these warrants were exercisable. Warrants were exercised for 50,000 and 199,431 shares of Common Stock for the years ended December 31 1997 and 1996, respectively. Such exercises were at average prices of $1.21 and $0.04 per share for the years ended December 31, 1997 and 1996, respectively. No warrants were exercised during 1998. 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, 39,866, 63,904 and 216,504 shares of common stock were sold to employees during the three years ended December 31, 1998, 1997 and 1996, respectively. The weighted average fair value of these purchase rights for 1998, 1997 and 1996 was $0.86, $0.67 and $0.81 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 108%, 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 51 determined in accordance with FAS No. 123, the impact on net income and earnings per share would have been immaterial for 1998, 1997 and 1996. 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 $1.7 million and $1.6 million of such loans outstanding as of December 31, 1998 and 1997, respectively. Beginning 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 $5.8 million letter of credit. Participant loans guaranteed by the Company with letters of credit as of December 31, 1998, 1997 and 1996 were $5.6 million, $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. Based upon separation agreements with certain executives effective during 1998, the Company agreed to repurchase 560,000 shares of Common Stock from Participants in the Executive Plan, of which 140,000 shares were actually paid for in 1998. In 1998, the Company recorded a $1.0 million charge, representing the excess of the purchase price plus unpaid interest over the value of the stock being held as collateral (see Note O). 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. The shares were repurchased because, as non-employees, the Company could no longer guarantee the bank loans for these individuals or make advances of interest to the Bank on their behalf. In 1996, the Company recorded a charge of $110,000 related to these repurchases. 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, 1998, 1997 and 1996 was approximately $245,000, $261,000 and $540,000, 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 65 former Executone, Inc. employees, including one current employee of the Company. The Company does not provide post-retirement health or life insurance benefits to any other employees. 52 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. The change in the accumulated post-retirement benefit obligation (APBO) for 1998 and 1997, along with the funded status of the post-retirement plan as of December 31, 1998 and 1997 are as follows (amounts in thousands):
1998 1997 ---- ---- APBO beginning of year $3,129 $3,214 Interest cost 140 220 Actuarial gain (963) (150) Benefits paid (181) (155) ------ ------ APBO end of year $2,125 $3,129 Funded status $2,125 $3,129 Unamortized transition obligation (1,628) (1,744) Unrecognized net gain (loss) 707 (312) ------ ------ Accrued liability as of December 31 $1,204 $1,073 ====== ======
Post-retirement benefit expense for the three years ended December 31, 1998 consists of the following:
(Amounts in thousands) 1998 1997 1996 - ---------------------- ---- ---- ---- Interest on accumulated benefit obligation $140 $220 $214 Amortization of transition obligation 116 116 116 Net amortization and other 44 4 20 ---- ---- ---- $300 $340 $350 ==== ==== ====
In determining the APBO as of December 31, 1998 and 1997, the weighted average discount rates used were 6.75% and 7%, respectively. The Company used a healthcare cost trend rate of approximately 10%, decreasing through 2004 and leveling off at 5.5% thereafter. A 1% increase in the healthcare trend rate would increase the APBO at December 31, 1998 by approximately 4% and increase the interest cost component of the post-retirement benefit expense for 1998 by less than $10,000. NOTE K - OTHER INCOME, NET Other Income, net consists of the following for the three years ended December 31, 1998:
(Amounts in thousands) 1998 1997 1996 - ---------------------- ---- ---- ---- Interest income $ 157 $ 741 $1,117
53 Equity in earnings of DCC 258 377 288 Other, net (102) 419 465 ----- ------ ------ $ 313 $1,537 $1,870 ===== ====== ======
NOTE L - eLOTTERY Acquisition On December 19, 1995, EXECUTONE Information Systems, Inc. ("Executone') acquired 100% of the common stock of Unistar Gaming Corp. for common and preferred stock with a combined value of $12.7 million. In January 1999, Unistar Gaming Corp. changed its name to eLottery, Inc. ("eLottery"). Any reference herein to eLottery shall be deemed to include business conducted under the name Unistar Gaming Corp. eLottery's wholly-owned subsidiary, UniStar Entertainment, Inc. ("UniStar Entertainment") has an exclusive five-year management agreement with the CDA, which was the primary asset acquired, to provide design, development, financial and management services to the NIL. The NIL was operational beginning in January 1998. However, in response to an adverse legal opinion on December 17, 1998, eLottery and the CDA terminated the operations of the NIL and the US Lottery telephone and Internet operations managed by eLottery (see Impairment of Long-Lived Assets). 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, as originally issued, was to earn dividends equal to 18.5% of the consolidated retained earnings of eLottery 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, as originally issued, was to earn dividends equal to 31.5% of the consolidated retained earnings of eLottery 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 were 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. As of December 31, 1998, no dividends had accrued to the preferred stockholders. The Series A and Series B Preferred Stock were 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 eLottery met certain revenue and profit parameters, the Series A Preferred Stock was convertible for up to 4.925 million shares of common stock and the Series B Preferred Stock was convertible for up to 8.375 million shares of common stock (a total of 13.3 million shares of common stock). The Company has subsequently reached agreement with the preferred shareholders to accelerate redemption of the Series A and Series B preferred shares (see Note Q). Impairment of Long-Lived Assets 54 On December 17, 1998, the United States District Court for the District of Idaho ruled in the case of AT&T vs. Coeur d'Alene Tribe that the orders previously issued by the Tribal Court upholding the legality of the US Lottery were erroneous (see Legal and Other Risks for a description of the litigation). In response to this legal decision, eLottery and the CDA have terminated operation of the NIL and the US Lottery in every state where it had been offered. As a result, the Company has reevaluated certain of its assets in accordance with the provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets. Based upon such review, management determined that both the intangibles and the advances to the NIL have been impaired as of the date of this legal decision. As of December 17, 1998, net intangibles and Advances to NIL of $12.9 million and $11.2 million, respectively, were written down to zero, which represented the estimated fair value of the assets, as no future cash flows will be generated by the NIL. It has also been determined that a total of $0.7 million in NIL startup costs (primarily post-acquisition building costs) included in other assets were also impaired. These amounts would have been written off as of January 1, 1999 with the adoption of SOP 98-5. However, due to the termination of NIL operations, management has concluded that it should be written off during the fourth quarter of 1998. Shutdown costs and other adjustments totaled an additional $0.7 million, of which $0.6 million remains as a liability as of December 31, 1998. Legal and Other Risks On October 16, 1995, the CDA filed an action entitled Coeur d'Alene Tribe v. AT&T Corp. in the Tribal Court, located in Plummer, Idaho (Case No. C195-097): (i) requesting a ruling that the NIL is legal under the federal Indian Gaming Regulatory Act of 1988 ("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 long-distance carrier; and (ii) seeking an injunction preventing AT&T from refusing to provide telephone service to the NIL. The CDA took the position that all NIL gaming activity was occurring on "Indian lands" as required by IGRA. 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 NIL; and (iii) that AT&T cannot refuse service to the NIL. On July 2, 1997, the Tribal Appellate Court affirmed the lower Tribal Court's May 1, 1996 ruling and analysis upholding the CDA's right to conduct the NIL 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, to obtain a federal court ruling on the validity and enforceability of the Tribal Court ruling. On December 17, 1998, that Court issued an opinion and order denying the motions and counter-claims of the CDA and granting declaratory judgment in favor of AT&T upholding the position of AT&T and overruling the decisions of the Tribal Courts. In response to that decision, eLottery and the CDA terminated operations of the NIL and the US Lottery in every state where it had been offered. The CDA has filed a notice of appeal of the District Court decision; however, eLottery will not participate in or fund any appeal of this ruling. On September 14, 1998, the CDA, eLottery and representatives of the U.S. Department of Justice had discussions regarding a declaratory judgment to be sought jointly from the U.S. District Court for the District of Idaho as to whether the operation of the NIL is 55 legal under 18 U.S.C. Sections 1952 and 1955. eLottery was informed that the Department of Justice views such operation to be in violation of such statutes. The Department of Justice proposed that the parties file a joint stipulation of facts and cross-motions for summary judgment in the declaratory judgment action. On December 17, 1998, the Idaho Federal District Court issued an opinion and order granting declaratory judgment in favor of the action styled AT&T v. Coeur d' Alene Tribe. In response to that decision, eLottery and the CDA terminated operation of the NIL and the US Lottery. In light of the ruling of the U.S. District Court of Idaho and the termination of the NIL and the US Lottery, eLottery has requested confirmation from the Department of Justice that no further action will be taken. 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 CDA and UniStar Entertainment seeking to enjoin the NIL games offered by the CDA over the Internet and managed by UniStar Entertainment. The complaint also sought civil penalties, attorneys fees and court costs. The complaint alleged that the NIL violates Missouri anti-gambling laws and that the marketing of the games violates the Missouri Merchandising Practices Act. UniStar Entertainment and the CDA 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 CDA from this case based on sovereign immunity. The court preliminarily denied a motion to dismiss UniStar Entertainment based on sovereign immunity, although the court indicated it might reconsider that decision. UniStar Entertainment filed a motion for reconsideration of its motion for dismissal. The State of Missouri has appealed the dismissal of the CDA to the Eighth Circuit Court of Appeals. On January 28, 1998, the State of Missouri sought to dismiss voluntarily the existing federal case against UniStar Entertainment and the next day filed a new action against Executone, UniStar Entertainment and two tribal officials, with essentially the same allegations, in state court. The State obtained a temporary restraining order from a state judge against Executone, UniStar Entertainment and two tribal officials enjoining the marketing of the NIL Internet and telephone lotteries 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. 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 appealed to the Eighth Circuit the denial of its motion to remand the case to state court or, in the alternative, to seek a preliminary injunction. On January 6, 1999, the Eighth Circuit dismissed Missouri's appeal from the Eastern District of Missouri. In the same opinion, the Eight Circuit vacated the decisions from the Western District of Missouri as to the CDA and remanded that case to the Western District for a hearing on whether the Internet games of the NIL are gaming activities "on Indian lands." The Eighth Circuit also held valid Missouri's voluntary dismissal of UniStar Entertainment from the Western District lawsuit. In light of the termination of the NIL and the US Lottery, eLottery anticipates seeking dismissal of the Missouri actions. 56 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 Executone, UniStar Entertainment and the CDA, to permanently enjoin the NIL offered by the CDA on the Internet. The complaint alleged that the offering of the NIL violates Wisconsin anti-gambling laws and that legality of the NIL has been misrepresented to Wisconsin residents in violation of state law. In addition to an injunction, the suit sought restitution, civil penalties, attorneys' fees and court costs. Executone, UniStar Entertainment and the CDA have removed the case to the U.S. District Court in Wisconsin. On February 18, 1998, the District Court dismissed the CDA from the case based on sovereign immunity and dismissed Executone based on the State's failure to state a claim against Executone. The State of Wisconsin appealed the dismissal of the CDA to the Seventh Circuit Court of Appeals. A motion to dismiss the case against UniStar Entertainment on the basis of sovereign immunity was denied. UniStar Entertainment appealed the denial of its motion to dismiss to the Seventh Circuit Court of Appeals. In light of the termination of the NIL and the US Lottery, eLottery anticipates seeking dismissal of this action. Funding of eLottery The Company periodically evaluates the recoverability of its investment in eLottery 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 underlying businesses. If the sum of such cash flows is not sufficient to recover the Company's investment in eLottery, projected cash flows would then be discounted and the carrying value of Company's investment would be adjusted accordingly. Management determined that both the eLottery intangibles and the advance to the NIL were impaired and were written down to zero during the fourth quarter of 1998 (See Impairment of Long-Lived Assets). Funding for eLottery capital expenditures, including computer hardware and software, is being capitalized and depreciated over a five-year period. The guaranteed monthly advance of $25,000 to the CDA, which began in January 1996, was to be reimbursed when the NIL began making profit distributions to eLottery. All such amounts were written off as of December 17, 1998. In addition, the Company capitalized other fundings, consisting primarily of direct eLottery expenses, professional fees and other expenses, which the Company believed would be reimbursable in accordance with the terms of the management agreement. All such amounts were written off as of December 17, 1998. Cumulative funding as described above totals $13.4 million ($6.0 million for the year ended December 31, 1998). The Company also funded legal and other accrued liabilities assumed as part of the acquisition of eLottery totaling, on a cumulative basis, $3.1 million ($0.7 million for the year ended December 31, 1998). Such cash flows are included in the investment in eLottery in the statement of cash flows. The investment in eLottery reflected on the statement of cash flows includes the deferred charges and assumed liabilities noted above for a cumulative total of $16.5 million ($6.7 million for the year ended December 31, 1998). Since inception, the Company has also funded various eLottery expenses totaling $2.1 million ($0.5 million for the year ended December 31, 1998, excluding depreciation and amortization), which are reflected in the Company's consolidated net 57 income. Cumulative cash expenditures on eLottery, including eLottery expenses, amounts paid on capital lease obligations, and approximately $0.6 million related to the development of the enhanced lottery terminal (ELT) business, total $18.6 million as of December 31, 1998. eLottery's activities to date have been primarily related to the organization of the company, developing the necessary business and gaming systems, operating a national telephone lottery and the on-line US Lottery Internet site, and preparing a marketing plan for selling its technology to entities licensed to sell lottery tickets. With the termination of operations of the NIL, eLottery expects to derive its future revenues from acting as an Internet retailer of lottery products for legally authorized entities and the sale or licensing of the technology it has developed. eLottery has yet to record any revenue. 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 provided project management services overseeing the development of the software for the NIL, with the Company contracting independently for system software development. The Company acquired all hardware for the system without financial obligation by either IGT or CWH. Approximately $800,000 in hardware costs were incurred as of December 31, 1998. The investment in IGT is being accounted for under the cost method. All hardware costs incurred are being capitalized and depreciated over the useful life of the assets. As of December 31, 1998, approximately $3.0 million has been spent on software development. Such payments are being capitalized and depreciated over a five-year period. 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 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. 58 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. 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. On February 26, 1999, the Company received $9.3 million from Claricom as payment in full for the aforementioned $5.9 million junior subordinated note plus interest, along with the redemption of the warrants. An additional $0.3 million is being held in escrow until March 31, 2000 by the new owner of Claricom. 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 October 1998, the Company received $5 million in cash as part of a negotiated settlement with its former supplier of videoconferencing equipment, resulting in a $5.3 million gain in 1998. 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. NOTE N - SEGMENTS In 1998, the Company adopted SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information." The Company's reportable business segments provide products and services which are marketed through both retail and independent distribution channels. These businesses are managed and reported separately because they serve distinct markets. The Company has three reportable business segments: Computer Telephony, Healthcare and eLottery. Computer Telephony products range from PBX's for small to medium-sized businesses to standards-compliant computer telephony applications, LAN and 59 Internet-based applications, including voice mail, unified messaging, automatic call distribution, 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 with fewer than 400 extensions at any individual location. Healthcare products range from traditional nurse call systems, intercoms and room status indicators to more sophisticated patient reporting systems, infrared locating systems and wireless technologies. Customers include hospitals, surgical centers, nursing homes and assisted living centers. eLottery will provide a wide array of products and services to the domestic and international lottery markets. It has developed and operated systems software that enables the electronic distribution of lottery tickets over the Internet, Intranet and via telephone. The Company's accounting policies for segments are the same as those described in the summary of accounting policies. For the periods reported, management has evaluated segment performance based upon segment profit or loss. This is largely based upon direct segment costs plus the allocation of certain shared expenses. Corporate items are not assigned to a particular segment and include cash, income taxes, long-term debt and other investments. Transfers between segments are market-based. Export sales were not material. Segment information for the years ended December 31, 1998 and 1997 is shown below. Due to the magnitude and nature of the business transactions which took place during 1996 (See Note M), segment information for that year has not been presented as it would not be comparable.
1997 ------------------------------------------------------------------------------- Computer (amounts in thousands) Telephony Healthcare eLottery Corporate Totals - ----------------------------------------------------------------------------------------------------------------------- Revenue from External Customers $98,636 $34,862 $ -- $ -- $133,498 Intersegment Revenues 8,490 10,029 -- -- 18,519 Segment Loss (1,766) (5,955) (27,403) (128) (35,252) Interest Income -- -- -- 157 157 Interest Expense -- -- -- 2,393 2,393 Noncash Items: Capitalized Leases -- -- -- 1,213 1,213 Depreciation and Amortization 1,852 711 982 -- 3,545 Income from Equity Investment -- -- -- 258 258 Segment Assets 43,234 23,484 6,200 37,387 110,305 Equity Investment in DCC -- -- -- 2,298 2,298 Capital Expenditures 502 233 15 69 819
60
1997 ------------------------------------------------------------------------------- Computer (amounts in thousands) Telephony Healthcare eLottery Corporate Totals - ----------------------------------------------------------------------------------------------------------------------- Revenue from External Customers $117,240 $39,156 $ -- $ -- $156,396 Intersegment Revenues 9,303 10,053 -- -- 19,356 Segment Income (Loss) 3,272 (2,376) (806) -- 90 Interest Income -- -- -- 741 741 Interest Expense -- -- -- 1,985 1,985 Noncash Items: Capitalized Leases -- -- 611 1,805 2,416 Depreciation and Amortization 2,178 791 -- -- 2,969 Income from Equity Investment -- -- -- 377 377 Segment Assets 45,442 25,547 24,091 43,784 138,864 Equity Investment in DCC -- -- -- 2,038 2,038 Capital Expenditures 1,165 178 6 120 1,469
The following presents a reconciliation of segment information to consolidated amounts for the years ended December 31, 1998 and 1997:
(Amounts in thousands) 1998 1997 ---- ---- Revenues Total segment revenues $152,017 $175,752 Elimination of intersegment revenues (18,519) (19,356) -------- -------- $133,498 $156,396 ======== ======== Net Loss Total segment income (loss) $(35,252) $ 90 Patent litigation settlement (3,735) -- Special charges (5,293) -- Video litigation settlement 5,269 -- Interest and other unallocated expenses, net (2,080) (448) Income tax benefit 4,232 137 -------- -------- $(36,859) $ (221) ======== ========
For the years ended December 31, 1998 and 1997, the Company had two individual customers, each of which generated in excess of 10% of the Company's revenues. Both customers are included in the Computer Telephony segment. One customer accounted 61 for $18.0 million and $31.1 million in sales for 1998 and 1997, respectively. The second customer accounted for $16.4 million and $ 14.0 million for the same periods, respectively. NOTE O - SPECIAL CHARGES As a result of actions taken by the Company to improve its business processes, including significant changes in its senior management structure, along with a provision for a patent litigation settlement, the Company has recorded a total of $9.0 million in reorganization and other special charges during year ended December 31, 1998. The charges consist of $3.0 million in severance and benefit continuation costs, $1.0 million in loan forgiveness costs associated with the Executive Stock Incentive Plan, and $1.3 million to reflect a charge for idle space on leased premises and other charges. At December 31, 1998, the remaining reserve balance associated with these charges was $1.7 million. The severance charge covered the termination of 34 employees, all of who left the Company in 1998. In addition, the Company also recorded a $3.7 million charge to settle claims made by Lucent Technologies (Lucent) which holds the patent rights to certain intellectual property allegedly used in the Company's products. Under the agreement, the Company will pay Lucent $3.7 million over the next two years to cover all past patent obligations. In addition, the parties have agreed to execute a bilateral patent cross-license agreement covering all of Lucent's and the Company's current telephony-related patents, which provides for additional royalties to be paid to Lucent. NOTE P - SELECTED QUARTERLY FINANCIAL DATA The following is a summary of unaudited selected quarterly financial data for the years ended December 31, 1998 and 1997:
Three Months Ended --------------------------------- March 31, June 30, September 30, December 31, (In thousands, except for per share amounts) 1998 1998 1998 1998 ---- ---- ---- ---- Revenues $33,903 $34,707 $33,605 $31,283 Gross Profit 10,838 11,850 10,446 8,587 Loss Before Income Taxes (4,129) (2,871) (3,582) (30,509) Net Loss (2,478) (1,723) (2,149) (30,509) Basic and Diluted Loss Per Share (0.05) (0.03) (0.04) (0.61)
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
62 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
The three months ended December 31, 1998 includes the writeoff of $25.5 million in assets related to the termination of the NIL (See Note L) and a nonrecurring $5.3 million gain on a negotiated settlement with a former supplier of videoconferencing equipment. The Company also recorded nonrecurring special charges in the three-month periods ended March 31, June 30, September 30 and December 31, 1998 of $2.3 million, $2.1 million, $0.9 million and $3.7 million, respectively (see Note O). NOTE Q - SUBSEQUENT EVENTS (UNAUDITED) On March 29, 1999, the Company announced that it planned to divest its core telephone and healthcare businesses and change the name of the Company to eLottery, Inc. At the same time, the Executone Board of Directors announced it had received an offer for those businesses from a group to be led by Stanley J. Kabala, Chairman and Chief Executive Officer of Executone, and that it has formed a special committee of the Board to accomplish that divestiture. The offer from management is approximately $70 million and is subject to a number of conditions including negotiation of a definitive agreement, financing, the waiver or expiration of a pre-existing right of first offer, and approval of the Executone shareholders. A final decision as to the method of divesting this business has not been made by the Board. The Company expects to recognize a gain on the transaction, which may be deferred over some undetermined future period, dependent upon the final terms. The proceeds of any sale will remain in the Company to help it accelerate the achievement of eLottery's business plans. At the conclusion of the transaction and subject to shareholder approval, Executone would be renamed eLottery, Inc.. eLottery's activities to date have been primarily related to the organization of the company, developing the business and gaming systems necessary to operate a national telephone lottery and the USlottery.com Internet site and preparing a marketing plan for selling its technology to entities licensed to sell lottery tickets. With the termination of operations of the NIL and the divestiture of the core telephony and healthcare businesses, eLottery expects to derive its future revenues from acting as an Internet retailer of lottery products for legally authorized entities and the sale of licensing of the technology it has developed. eLottery has yet to record any revenue. For the years ended December 31, 1998, 1997 and 1996, the eLottery segment generated pretax losses of $27.4 million, $806,000 and $755,000, respectively. The 1998 loss includes $25.5 million related to the shutdown of the NIL and the resulting impairment of assets (see Note L). Net assets of eLottery at the end of each year consisted of the following:
(amounts in thousands) 1998 1997 1996 ---- ---- ---- Current assets $1,007 $ -- $ 9 Property & equipment, net 4,210 24 17
63 Intangible assets, net -- 15,841 15,841 Other assets 983 8,226 2,561 Current liabilities (2,141) (912) (1,076) Long-term debt (315) (433) -- -------- -------- ------- Net assets $3,744 $22,746 $17,352 ======== ======== =======
On April 7, 1999, the Company announced that, as part of its plan to separate its telephony and healthcare businesses from eLottery, it had received approval from 100% of its preferred shareholders to accelerate the redemption of its Series A and Series B preferred stock. With accelerated redemption, the preferred shares will be redeemable for 13.3 million shares of common stock, or approximately 21% of eLottery's common stock following the separation of the core business and will no longer be entitled to receive a total of 50% of eLottery's retained earnings as preferred dividends. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 64 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY DIRECTORS 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 - ---- --- -------------------- Stanley J. Kabala 55 Chairman of the Board, President, and Chief 1998 Executive Officer, of the Company since 1998; Prior thereto, President and Chief Executive Officer of Rogers Cantel Mobile Communications, the largest wireless telephone company in Canada, and Chief Operating Officer of its parent Rogers Communications, Inc., from 1996 to 1997. During 1995, President and Chief Executive Officer of Unitel Communications, Inc., Canada's largest alternative long distance provider. From 1968 through 1994, various positions at AT&T Corporation, most recently Vice President--Customer Service for the Business Communications Services Division and Vice President--AT&T 800 and Business Applications Services. Louis K. Adler 63 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 61 President, The Blau Group Ltd., an investment 1983 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. John P. Hectus 54 President and Chief executive Officer, AT&T 1998 Canada Enterprises, January 1999 to present; Vice President and Chief Financial Officer, AT&T - Canada Enterprises, from June 1998 to the present;
65 from 1996 through June 1998 Senior Vice President and Chief Financial Officer, AT&T Canada Long Distance Services; from 1994 through 1995, regional Vice President and Chief Financial Officer, AT&T Caribbean & Latin America; from 1990 to 1994, Executive Vice President & Chief Financial Officer, AT&T Paradyne; prior thereto, various executive positions within AT&T Corporation. Malinda Mitchell 54 Senior Vice President and Chief Operatin 1999 Officer, UCSF Stanford Health Care, Stanford Hospital and Clinics, a health care provider, since November 1997; during 1997,Interim President and Chief Executive Officer, Stanford Hospital and Clinics, and from 1898 until February 1997, Vice President, Operations and Chief Operating Officer, Stanford Hospital and Clinics; prior thereto, various nursing management positions at Stanford Hospital. Ms. Mitchell is also a director of Specialized Health Products International, Inc. Jerry M. Seslowe 53 Managing Director of Resource Holdings Ltd., an 1996 investment and financial consulting firm, since 1983.
EXECUTIVE OFFICERS EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company are as follows:
Name Age Position With Company - ---- --- ---------------------- Stanley J. Kabala 55 Chairman of the Board, President and Chief Executive Officer Edward W. Stone, Jr. 46 Senior Vice President and Chief Financial Officer Michael W. Yacenda 47 Executive Vice President and President, UniStar Entertainment Barbara C. Anderson 47 Vice President, Law and Administration and Secretary James E. Cooke III 51 Vice President, Sales and Operations Israel J. Hersh 45 Vice President, Engineering and Development
66 Robert W. Hopwood 55 Vice President and Vice President-eLottery Operations, Frank J. Rotatori 56 Vice President, Business Development, International and Strategic Alliances
67 Stanley J. Kabala was elected Chairman of the Board, President and Chief Executive Officer of Executone in June 1998. Prior to that, he was President and Chief Executive Officer of Rogers Cantel Mobile Communications, the largest wireless telephone company in Canada, and Chief Operating Officer of its parent Rogers Communications, Inc., from 1996 to 1997. During 1995, Mr. Kabala was President and Chief Executive Officer of Unitel Communications, Inc., Canada's largest alternative long distance provider. From 1968 through 1994, Mr. Kabala held various positions at AT&T Corporation, most recently Vice President--Customer Service for the Business Communications Services Division and Vice President--AT&T 800 and Business Applications Services. Edward W. (Ted) Stone, Jr. has served as Senior Vice President and Chief Financial Officer of Executone since October 1998. Prior to that time, he served as Vice President, Finance for the Thomson Corporation Publishing International group of The Thomson Corporation, a leading publisher of specialized information, from 1995 to 1998. From 1993 to 1995, Mr. Stone was Vice President and Chief Financial Officer of Krueger International, Inc., a leading manufacturer of institutional and commercial furniture. From 1988 to 1993, he was Controller and then Vice President, Finance for the Searle Pharmaceuticals subsidiary of The Monsanto Company and General Manager of Searle's Animal Health division. Earlier in his career, Mr. Stone was Chief Financial Officer for two entrepreneurial specialty chemical companies and a Division Controller for Pfizer, Inc. Mr. Stone holds an A. B. degree in Engineering Sciences from Dartmouth College and an MBA from the Amos Tuck School of Business Administration at Dartmouth. Michael W. Yacenda has served as Executive Vice President of Executone since January 1990, and as President of eLottery and UniStar Entertainment 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, Law and Administration and Secretary since October 1998. Prior to that time, she was 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, Sales and Operations, since November 1998. Prior to that time, he was Vice President, National Accounts of the Company 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. Israel J. Hersh has been Vice President, Engineering and Development, since 1999 and was Vice President, Software 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. 68 Robert W. Hopwood has been Vice President of the Company and Vice President-Operations of its lottery and Unistar Entertainment subsidiaries 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. Frank J. Rotatori has been Vice President, Business Development, since April 1999. Prior thereto, he was President of the Healthcare Communications Division 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. 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, 1998, 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 February 26, 1999, 36,000 shares had been issued upon exercise of options granted under the original terms of the Plan, no options to purchase shares of Common Stock were outstanding under the original terms of the Plan, and options to purchase an additional 96,700 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 69 of grant. An aggregate of up to 250,000 shares are issuable under the Plan. Each of Messrs. Adler, Hectus and Seslowe received options to purchase 14,700 shares under this Plan in 1998. Each director who does not receive other direct compensation from the Company also receives upon his or her initial election to the Board a warrant to purchase 25,000 shares of the Company's Common Stock at the market price at the date of grant. Each warrant vests ratably over a three-year period and has a term of five years. Under this program, the following warrants have been granted to current directors upon their initial election to the Board:
- -------------------------------------------------------------------------------- Name Date of Grant Warrant Price per Share - -------------------------------------------------------------------------------- Jerry M. Seslowe February 1, 1996 $2.63 - -------------------------------------------------------------------------------- Louis K. Adler July 29,1997 $2.00 - -------------------------------------------------------------------------------- John J. Hectus November 18, 1998 $1.25 - -------------------------------------------------------------------------------- Malinda Mitchell March 1, 1999 $3.06 - --------------------------------------------------------------------------------
The Company also reimburses directors for their travel and accommodation expenses incurred in attending Board meetings. 70 SUMMARY COMPENSATION TABLE The following table sets forth the compensation by the Company of the current Chief Executive Officer, the former Chief Executive Officer and the four most highly compensated other executive officers of the Company in 1998, for services in all capacities to the Company and its subsidiaries during the three fiscal years ended December 31,1998.
ANNUAL COMPENSATION LONG-TERM COMPENSATION OTHER ANNUAL AWARDS OF ALL OTHER NAME AND SALARY BONUS COMPENSATION OPTIONS/ COMPENSATION PRINCIPAL POSITION YEAR ($) ($)) ($) SARS (#) ($) (1) - ------------------ ---- ------ ------- ------------- ---------- ------------ Stanley J. Kabala(2) 1998 144,231 -0- 91,936 400,000 6.072 Chairman of the Board, President and Chief Executive Officer Alan Kessman 1998 1,264,210 -0- -0- -0- 10,386(3) Former Chairman of the Board, 1997 400,000 -0- -0- -0- 9,849 President and Chief 1996 400,000 63,000 -0- -0- 9,536 Executive Officer Michael W. Yacenda 1998 262,203 -0- -0- -0- 6,072 Executive Vice President 1997 256,000 -0- -0- 5,997 1996 256,000 49,900 -0- -0- 5,935 Shlomo Shur 1998 215,700 -0- -0- -0- 5,494 Senior Vice President, 1997 215,700 -0- -0- 5,233 Advanced Technology 1996 215,700 12,393 -0- -0- 5,192 Andrew Kontomerkos 1998 214,000 -0- -0- -0- 6,241 Senior Vice President, 1997 214,000 -0- -0- 5,896 Hardware Engineering 1996 214,000 12,350 -0- -0- 5,703 and Production Vic Northrup 1998 214,687 16,750 -0- -0- 660 Vice President and 1997 162,885 31,750 -0- 25,000 660 President, Computer 1996 137,837 64,375 -0- -0- 660 Telephony Division
(1) "All Other Compensation" 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 1998: Mr. Kessman, $ 9,726; Mr. Yacenda, $5,412; Mr. Shur, $4,834; and Mr. Kontomerkos, $ 5,581; in the following amounts in 1997: Mr. Kessman, $9,189; Mr. Yacenda, $5,337 Mr. Shur, $4,573; and Mr. Kontomerkos, $5,236; and in the following amounts in 1996: Mr. Kessman, $8,876; Mr. Yacenda, $5,275; Mr. Shur, $4,532;, and Mr. Kontomerkas, $5,043. (2) Mr. Kabala was elected Chairman, President and Chief Executive Officer effective June 28, 1998. See the discussion of his employment agreement below. 71 (3) Includes the 1998 payments under Mr. Kessman's employment continuity agreement described immediately below. EMPLOYMENT AGREEMENTS The Company and Alan 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, including a diminishment of his responsibilities, without cause or following a change in control in the Company, including a lump sum payment equal to 2.99 times his then current base salary plus the average of any bonuses awarded to Mr. Kessman during the two fiscal years preceding the termination of his employment. In June 1998, Mr. Kessman resigned as Chairman and President of the Company and in accordance with the diminishment of responsibility provisions of his employment continuity agreement, the Company paid Mr. Kessman approximately $1.3 million, which includes severance of approximately $1.1 million and continuation of certain benefits for four years. As of March 31, 1999, Mr. Kessman had indebtedness to the Company of $2.4 million relating to the Executive Stock Incentive Plan. These obligations may remain outstanding under the terms of Mr. Kessman's severance until December 2001; however, during 1998 Mr. Kessman pledged 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." In June 1998, the Company entered into an employment agreement with Stanley J. Kabala, its Chairman of the Board, President and Chief Executive Officer, for an initial term of one year. The employment agreement provides for a minimum base salary of $300,000 per year, eligibility for a incentive bonus of 150,000 shares of Common Stock upon achievement of objective performance goals set by the Board of Directors, a signing bonus of 200,000 restricted shares of Common Stock vesting ratably over 12 months and an initial stock option covering 200,000 shares of Common Stock vesting ratably over 12 months. The agreement further provides that in the event of the termination of Mr. Kabala's employment by the Company without cause or his voluntary termination of employment upon certain events, including diminution of his responsibilities or a change of control, the Company will pay Mr. Kabala his base salary for the remainder of the initial term, a prorated bonus and continuation of medical insurance coverage, and his restricted stock and stock options will vest immediately. 72 OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth individual grants of stock options and stock appreciation rights made during 1998 to each of the executive officers named in the Summary Compensation Table above. There were no grants of stock appreciation rights (SARs) to any officers in 1998. Option Grants in Last Fiscal Year
Potential Realizable Value At Assumed Annual Rates of Stock Price Appreciation For Option Term Individual Grants % of Number of Total Securities Options Exercise Underlying Granted to or Base Options Employees Price Expiration Name Granted (#) on Fiscal Year ($/sh) Date 5%($) 10%($) Stanley J. Kabala 200,000 14% $2.00 6/30/08 $251,906 $638,581 Alan Kessman -0- -0- -- -- -- -- Michael W. Yacenda -0- -0- -- -- -- -- Andrew Kontomerkos -0- -0- -- -- -- -- Vic Northrup -0- -0- -- -- -- -- Shlomo Shur -0- -0- -- -- -- --
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES The following table sets forth each exercise of stock options made during the year ended December 31, 1998 by the current Chief Executive Officer, the former Chief Executive Officer and the four most highly compensated other executive officers and the fiscal year-end value of unexercised options held by those individuals as of December 31, 1998. There were no exercises or holdings of stock appreciation rights by any officers during 1998, and there are no outstanding stock appreciation rights.
Number of Value of Unexercised Unexercised Options In-the Money Options at Shares at Fiscal Year-End(#) Fiscal Year-End ($)(1) Acquired on Value Exercisable/ Exercisable/ Name Exercise (#) Realized ($) Unexercisable Unexercisable Stanley J. Kabala -0- -0- 100,000/100,000 -0-/-0- Alan Kessman -0- -0- -0-/-0- -0-/0 Michael W. -0- -0- -0-/-0- -0-/0 Yacenda Shlomo Shur 25,000 11,725 -0-/-0- -0-/-0-
73 Andrew 20,000 9,380 -0-/-0- -0-/-0- Kontomerkos Vic Northrup -0- -0- 49,644/12,500 -0-/-0-
(1) Based upon the last sale price on December 31, 1998 of $1.75 per share of Common Stock. 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 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 74 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, in 1997 the base salaries for the former Chief Executive Officer and the four other highest paid executive officers were established at 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, in 1998 the Committee approved no increase in salary for Mr. Kessman or the four other highest paid executive officers except one officer who was initially elected as an executive officer in 1997 and a small percentage increase for another executive officer. 6. Merit increases in base salary for executives other than Mr. Kessman and Mr. Kabala were reviewed on an individual basis by Mr. Kessman or Mr. Kabala and increases were dependent upon a favorable evaluation by Mr. Kessman or Mr. Kabala 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 or Mr. Kabala recommended 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 1998 bonus potential for executive officers, including the Chief Executive Officer, the Compensation Committee reviewed recommendations by the former Chief Executive Officer. 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 1998 pretax income targets or goals were achieved by the Company.. The Committee also approved bonus eligibility for division presidents that would be based on division performance without regard to overall corporate performance. In 1998, 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. In June 1998, the Company entered into an employment agreement with Stanley J. Kabala, its Chairman of the Board, President and Chief Executive Officer, for an initial term of one year. The employment agreement provides for a minimum base salary of $300,000 per year, eligibility for a incentive bonus of 150,000 shares of Common Stock upon achievement of objective performance goals set by the Board of Directors, a signing bonus of 200,000 restricted shares of Common Stock vesting ratably over 12 months and an initial stock option covering 200,000 shares of Common Stock vesting ratably over 12 months. The agreement further provides that in the event of the termination of Mr. Kabala's employment by the Company without cause or his voluntary termination of 75 employment upon certain events, including diminution of his responsibilities or a change of control, the Company will pay Mr. Kabala his base salary for the remainder of the initial term, a prorated bonus and continuation of medical insurance coverage, and his restricted stock and stock options will vest immediately. 9. 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 1998 to Mr. Kessman or the four highest paid other executive officers. 10. In June 1998, the Board of Directors approved a Transition and Retention Plan (the "Transition Plan") and offered it to certain participants in the Executive Plan including certain officers. The Transition Plan provides, in exchange for a release of all prior claims by the participant, defined retention and severance payments, option grants at current market value and deferral of all loan interest to the participant. A participant in the Transition Plan will earn, through continued employment, a retention payment of up to 110% of any shortfall of the market value of the Common Stock purchased with the loan below the loan's outstanding principal and interest. The amount of this retention payment is determined, and the payment becomes payable, only if and when the participant's employment with the Company ends. A Transition Plan participant becomes vested in one-third of the retention payment by continuation of employment through March 31, 1999, and becomes vested in an additional 8.33% of the payment for each calendar quarter of continued employment thereafter. In the event the Company terminates the participant's employment without cause, or a change of control of the Company occurs, the retention payment becomes fully vested and payable immediately. The Company has the option at any time to repurchase the Purchased Shares from a Transition Plan participant at the fair market value, in which case the participant remains liable for any loan balance not repaid from the repurchase proceeds subject to the other terms of the Transition Plan. Under certain circumstances, such as termination by the Company of the participant's employment following a change of control or otherwise without cause as defined in the Transition Plan, the participant is also entitled to continuation of salary and benefits for nine months. In conclusion, the Compensation Committee believes that the base salary, bonus and stock options of the Company's former Chief Executive Officer, its new 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 JERRY M. SESLOWE PERFORMANCE GRAPH 76 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, Incorporated. 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 InterVoice, Inc. 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. Although Lucent Technologies 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 1993 1994 1995 1996 1997 1998 XTON $100 $113 $ 80 $ 83 $ 76 $ 61 NASDAQ $100 $ 98 $138 $170 $209 $293 PEER GROUP $100 $ 87 $131 $156 $148 $131
77
WEIGHTED AVERAGE CUMULATIVE TOTAL RETURNS 1993 1994 1995 1996 1997 1998 XTONG $100 $100 $116 $129 $143 $126
[PERFORMANCE GRAPH] COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The members of the Compensation Committee are Louis K. Adler 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. 78 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, 1999, 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. 9,064,855(2) 18.19% 790 North Milwaukee Street Milwaukee, WI 53202 Edmund H., Shea, Jr. 3,791,741(3) 7.61 655 Brea Canyon Road Walnut Creek, CA 91789 Lawndale Capital Management LLC 3,425,604 6.87 One Sansome Street, Suite 3900 San Francisco, CA 94104 Series A Stock Watertone Holdings, L.P.. 154,520 61.81 c/o William H. Hopson Varner, Stephens, Humphries & White Riverwood 100 Building, Suite 1700 3350 Riverwood Parkway Atlanta, GA 30339 Berkshire Bancorp Inc. 78,819 31.53 160 Broadway New York, NY 10038 Series B Stock Watertone Holdings, L. P. 61,807 61.81 c/o William H. Hopson Varner, Stephens, Humphries & White Riverwood 100 Building, Suite 1700 3350 Riverwood Parkway Atlanta, GA 30339 Berkshire Bancorp Inc. 31,528 31.53 160 Broadway New York, NY 10038
79 (1) With respect to the Common Stock, percentages shown are based upon 49,834,807 shares of Common Stock actually outstanding as of February 28, 1999. In cases where the beneficial ownership of the individual or group includes options, warrants or convertible securities, the percentage is based on 49,834,807 shares 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, 1999. (2) Heartland Advisors shares power to vote 625,000 of such shares. (3) Includes ownership by corporations and other entities controlled by Mr. Shea. 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. Mr. Shea shares the power to vote and dispose of all such shares. The following table sets forth as of February 28, 1999, the beneficial ownership of the Company's voting shares by all current directors and nominees of the Company, the Chief Executive Officer, the former Chief Executive Officer, and the four next most highly compensated executive officers in 1998, and all current 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 229,268(2) Stanley M. Blau 542,540 1.1 John P. Hectus 25,000(3) * Stanley J. Kabala 436,000(4) * Alan Kessman 1,737,337 3.4 Andrew Kontomerkos 463,284 * Malinda Mitchell 31,800(5) * Vic Northrup 127,537 * Jerry M. Seslowe 509,246(6) * Shlomo Shur 740,708 1.4 Michael W. Yacenda 857,138(7) 1.7 All Current Directors and 3,696,168(8) 7.1 Officers as a Group (14 Persons) Series A Stock Louis K. Adler 1,436 * Stanley M. Blau -0- John P. Hectus -0- Stanley J. Kabala -0- Alan Kessman -0- Andrew Kontomerkos -0-
80 Vic Northrup -0- Jerry M. Seslowe 4,692(9) 1.87 Shlomo Shur -0- Michael W. Yacenda -0- All Current Directors and 6,128 2.45 Officers as a Group (14 Persons) Series B Stock Louis K. Adler 575 * Stanley M. Blau -0- John P. Hectus -0- Stanley J. Kabala -0- Alan Kessman -0- Andrew Kontomerkos -0- Thurston R. Moore -0- Vic Northrup -0- Richard S. Rosenbloom -0- Jerry M. Seslowe 1,877(10) 1.87 Shlomo Shur -0- Michael W. Yacenda -0- All Current Directors and 2,452 2.45 Officers as a Group (14 Persons)
* Less than 1% of the class. (1) Information is provided as reported to the Company as of February 28, 1999 for all owners except Andrew Kontomerkos and Shlomo Shur, as to whom the information is provided as of May 15, 1998 when their employment by the Company terminated, Alan Kessman, as to whom the information is reported as of June 28, 1998, when his employment ended, and Vic Northrup, as to whom the information is reported as of September 11, 1998, when his employment ended. With respect to the Common Stock, percentages shown are based upon 49,834,807 shares of Common Stock actually outstanding as of February 28, 1999. In cases where the beneficial ownership of the individual or group includes options, warrants or convertible securities, the percentage is based on 49,834,807 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, 1999. On April 7, 1999, the Company announced an agreement with all the holders of the Preferred Stock to redeem their shares for Common Stock pursuant to the terms of the original issuance of the Preferred Stock. (2) Includes 98,315 shares issuable upon exercise of options, all of which are exercisable within 60 days of March 31, 1999, and 25,000 shares issuable upon exercise of warrants, 8,333 of which are exercisable within 60 days of March 31, 1999. Includes 76,445 shares of Common Stock issuable upon redemption and conversion of the Preferred Stock owned by Mr. Adler. 81 (3) Includes 25,000 shares issuable upon exercise of warrants, none of which are exerciable within 60 days of March 31, 1999. (4) Includes 200,000 shares subject to options, of which 166,666 are exercisable within 60 days of March 31, 1999. (5) Includes 6,800 shares issuable upon exercise of options and 25,000 shares issuable upon exercise of warrants, none of which are exercisable within 60 days of March 31, 1999. (6) Includes 51,612 shares subject to options, and 25,000 shares subject to warrants, all of which are exercisable within 60 days of March 31, 1999. 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. Also includes 203,756 shares of Common Stock issuable upon redemption and conversion of the Preferred Stock owned by Mr. Seslowe and the 45,875 shares of Common Stock issuable upon redemption and conversion of the Preferred Stock owned by Resource Holdings Associates. (7) Includes 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. (8) Includes 795,227 shares issuable upon exercise of options, and 75,000 shares issuable upon exercise of warrants, of which 408,143 and 50,000, respectively, are exercisable within 60 days of March 31, 1999, 45,176 shares issuable upon conversion of the Company's Debentures, and 280,201 shares issuable upon redemption and conversion of Preferred Stock. (9) Includes 862 shares held by Resource Holdings. (10) Includes 345 shares held by Resource Holdings. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 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 82 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. 83 In June 1998, the Board of Directors approved a Transition and Retention Plan (the "Transition Plan") and offered it to certain participants in the Executive Plan including certain executive officers as noted in the table below. The Transition Plan provides, in exchange for a release of all prior claims by the participant, defined retention and severance payments, option grants at current market value and deferral of all loan interest to the participant. A participant in the Transition Plan will earn, through continued employment, a retention payment of up to 110% of any shortfall of the market value of the Common Stock purchased with the loan below the loan's outstanding principal and interest. The amount of this retention payment is determined, and the payment becomes payable, only if and when the participant's employment with the Company ends. A Transition Plan participant becomes vested in one-third of the retention payment by continuation of employment through March 31, 1999, and becomes vested in an additional 8.33% of the payment for each calendar quarter of continued employment thereafter. In the event the Company terminates the participant's employment without cause, or a change of control of the Company occurs, the retention payment becomes fully vested and payable immediately. The Company has the option at any time to repurchase the Purchased Shares from a Transition Plan participant at the fair market value, in which case the participant remains liable for any loan balance not repaid from the repurchase proceeds subject the other terms of the Transition Plan. Under certain circumstances, such as termination by the Company of the participant's employment following a change of control or otherwise without cause as defined in the Transition Plan, the participant is also entitled to continuation of salary and benefits for nine months. The following table contains information about borrowings in excess of $60,000 by executive officers that were outstanding during 1998 pursuant to the Executive Plan and that were or are guaranteed by the Company. The amounts listed below also include the interest paid by the Company to the bank, reimbursement of which was or 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. In 1998 and January 1999, in connection with the termination of their employment, Messrs. Guarascio, Kontomerkos, Northrup, and Shur surrendered to the Company the shares purchased by them under the Executive Plan and the Company released them from any further obligations under their Executive Plan loans. 84
HIGHEST AMOUNT OF UNPAID INDEBTEDNESS BETWEEN INDEBTEDNESS JANUARY 1, 1998 AND AT MARCH 31, 1999, MARCH 31, 1999, INCLUDING INCLUDING NAME ACCRUED INTEREST ACCRUED INTEREST - ---- ------------------------------------------------- Barbara C. Anderson (2) 257,621 $ 257,621 James E. Cooke III (2) 421,830 421,830 Anthony R. Guarascio (2) 574,004 -0- Israel J. Hersh (2) 126,549 126,549 Robert W. Hopwood (2) 421,209 421,209 Alan Kessman (1) 2,466,380 1,940,953 Andrew Kontomerkos 728,092 -0- Vic Northrup 293,518 -0- Frank J. Rotatori (2) 253,098 253,098 Shlomo Shur 728,092 -0- Michael W. Yacenda (2) 1,476,405 1,476,405
(1) See discussion under: "Executive Compensation -- Employment Agreements" above. (2) Participant in Transition Plan. Certain software development services have been provided to eLottery by The Winston Group, one of whose principals is Robert W. Hopwood, Jr., a son of an officer of eLottery, Robert W. Hopwood, and Rosewood Computing, one of whose principals is Mark Hopwood, another son of Mr. Hopwood. During 1998, eLottery incurred $567,030 and $59,619, respectively, in fees from these firms. These contracts were entered into on terms eLottery believes are as favorable as would have been obtained through arm's-length negotiations with an independent third party. 85 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, 1998 and 1997 Consolidated Statements of Operations - Years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Changes in Stockholders' Equity - Three years ended December 31, 1998 Consolidated Statements of Cash Flows - Years ended December 31, 1998, 1997 and 1996 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
86 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 between the Registrant and Fleet. 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. Incorporated by reference to the registrant's Annual Report on Form 10-K for the year ended December 31, 1997, filed on April 15, 1998. 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.
87 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. 10-8 1998 Transition and Retention Plan. Filed herewith. 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. Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1997 filed on April 15, 1998. 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 Warrant to Purchase 25,000 Shares of Common Stock of the Registrant, in favor of John P Hectus, dated November 18, 1998. Filed herewith.. 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.) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1997 filed on April 15, 1998. 10-23 Warrant to Purchase 25,000 Shares of Common Stock of the Registrant, in favor of Malinda Mitchell, dated March 1, 1999. Filed herewith. 21 Subsidiaries of EXECUTONE Information Systems, Inc. Filed herewith. 23.1 Consent of Arthur Andersen LLP. Filed herewith. 27 Financial Data Schedule. Filed herewith.
Undertakings 88 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, 1998. 89 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/ Stanley J. Kabala ___________________________________________ Stanley J. Kabala, Chairman, President and Chief Executive Officer April 14, 1999 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, 1999 /s/ Stanley J. Kabala ________________________________________ Stanley J. Kabala Chairman, President and Chief Executive Officer (Principal Executive Officer) April 14, 1999 /s/ Louis K. Adler ________________________________________ Louis K. Adler, Director April 14, 1999 /s/ Stanley M. Blau ________________________________________ Stanley M. Blau, Director April 14, 1999 /s/ Edward W. Stone, Jr. ________________________________________ Edward W. Stone, Jr. Senior Vice President, Finance, and Chief Financial Officer (Principal Financial and Accounting Officer) April 14, 1999 /s/ ________________________________________ John P. Hectus, Director April 14, 1999 /s/ Malinda Mitchell ________________________________________ Malinda Mitchell, Director April 14, 1999 /s/ Jerry M. Seslowe ________________________________________ Jerry M. Seslowe, Director
90 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 of EXECUTONE Information Systems, Inc. and subsidiaries' included in this Form 10-K, and have issued our report thereon dated February 4, 1999. 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 4, 1999 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 Payments Period - ------------ --------- -------- -------- -------- -------- ------ Year ended December 31, 1998 Deducted from Asset Accounts Allowance for doubtful accounts $ 1,814 $ 567 -- $ (661) -0- 1,720 Allowance for uncollectible notes 2,343 218 951 -0- -0- 3,512 receivable Special Charges Reserve 9,028 (3,604) 5,424 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
* Adjustments related to sale of direct sales organization. S-2 STATEMENT OF DIFFERENCES ------------------------ The section symbol shall be expressed as................................... 'SS' The trademark symbol shall be expressed as ................................ 'TM' The registered trademark symbol shall be expressed as ..................... 'r' EX-4 2 EXHIBIT 4.1 ================================================================================ FLEET CAPITAL CORPORATION, AS ADMINISTRATIVE AND COLLATERAL AGENT AND FLEET CAPITAL CORPORATION, AS LENDER AND EXECUTONE INFORMATION SYSTEMS, INC., AS BORROWER - -------------------------------------------------------------------------------- LOAN AND SECURITY AGREEMENT Dated: As of August 14, 1998 $30,000,000 - -------------------------------------------------------------------------------- ================================================================================ TABLE OF CONTENTS SECTION 1. CREDIT FACILITY.................................................................1 1.1. REVOLVING CREDIT LOANS..................................................................1 1.1.1. Loans and Reserves..................................................................1 1.1.2. Use of Proceeds.....................................................................1 1.2. LETTERS OF CREDIT; LC GUARANTIES........................................................2 1.2.1. Request for Letter of Credit........................................................2 1.2.2. Description of Letters of Credit....................................................2 1.2.3. Indemnification.....................................................................2 1.2.4. Agent's Instructions................................................................3 1.2.5. Disbursements.......................................................................3 1.2.6. Reimbursement Obligation............................................................3 1.2.7. Lender's Reimbursement Obligations..................................................3 1.2.8. Cash Collateral.....................................................................4 1.2.9. Waiver of Liability.................................................................4 SECTION 2. INTEREST, FEES AND CHARGES.......................................................5 2.1. INTEREST................................................................................5 2.1.1. Rates of Interest...................................................................5 2.1.2. Default Rate........................................................................5 2.1.3. Maximum Interest....................................................................5 2.2. COMPUTATION OF INTEREST AND FEES........................................................6 2.3. CLOSING FEE.............................................................................6 2.4. LETTER OF CREDIT AND LC GUARANTY FEES...................................................6 2.5. UNUSED LINE FEE.........................................................................6 2.6. REIMBURSEMENT OF EXPENSES...............................................................7 2.7. BANK CHARGES............................................................................7 SECTION 3. LOAN ADMINISTRATION..............................................................7 3.1. MANNER OF BORROWING REVOLVING CREDIT LOANS..............................................8 3.1.1. Loan Requests; Payment..............................................................8 3.1.2. Disbursement.......................................................................10 3.1.3. Authorization......................................................................11 3.1.4. Eurodollar Loans and LIBOR Rate Loans..............................................11 3.1.5. Interest Periods...................................................................11 3.1.6. Conversion of Loans................................................................11 3.1.7. Continuation of Eurodollar Loans...................................................12 3.1.8. Prepayment of Eurodollar Loans.....................................................12 3.1.9. Indemnification....................................................................12 3.1.10.Inability to Make Eurodollar Loans.................................................13 3.2. PAYMENTS...............................................................................13 3.2.1. Principal..........................................................................13 3.2.2. Interest...........................................................................13 3.2.3. Costs, Fees and Charges............................................................14 3.2.4. Other Obligations..................................................................14 3.2.5. Voluntary Prepayments..............................................................14 3.3. MANDATORY PREPAYMENTS..................................................................14 3.3.1. Proceeds of Sale, Loss, Destruction or Condemnation of Collateral; Extraordinary Receipts..................................................................................14 3.4. APPLICATION OF PAYMENTS AND COLLECTIONS................................................15 3.5. ALL LOANS TO CONSTITUTE ONE OBLIGATION.................................................15 3.6. LOAN ACCOUNT...........................................................................15 3.7. STATEMENTS OF ACCOUNT..................................................................15 3.8. INCREASED COSTS........................................................................15
i 3.9. BASIS FOR DETERMINING INTEREST RATE INADEQUATE OR UNFAIR...............................16 3.10. CAPITAL ADEQUACY.....................................................................17 3.10.1.Certificate........................................................................17 SECTION 4. TERM AND TERMINATION............................................................18 4.1. TERM OF AGREEMENT......................................................................18 4.2. TERMINATION............................................................................18 4.2.1. Termination by Lenders.............................................................18 4.2.2. Termination by Borrower............................................................18 4.2.3. Termination Charges................................................................18 4.2.4. Effect of Termination..............................................................18 SECTION 5. SECURITY INTERESTS..............................................................19 5.1. SECURITY INTEREST IN COLLATERAL........................................................19 5.2. LIEN PERFECTION; FURTHER ASSURANCES....................................................19 SECTION 6. COLLATERAL ADMINISTRATION.......................................................20 6.1. GENERAL................................................................................20 6.1.1. Location of Collateral.............................................................20 6.1.2. Insurance of Collateral............................................................20 6.1.3. Protection of Collateral...........................................................20 6.2. ADMINISTRATION OF ACCOUNTS.............................................................20 6.2.1. Records, Schedules and Assignments of Accounts.....................................21 6.2.2. Discounts, Allowances, Disputes....................................................21 6.2.3. Taxes..............................................................................22 6.2.4. Account Verification...............................................................22 6.2.5. Maintenance of Dominion Account....................................................22 6.2.6. Collection of Accounts, Proceeds of Collateral.....................................22 6.3. ADMINISTRATION OF INVENTORY............................................................22 6.3.1. Records and Reports of Inventory...................................................22 6.3.2. Returns of Inventory...............................................................23 6.4. ADMINISTRATION OF EQUIPMENT............................................................23 6.4.1. Records and Schedules of Equipment.................................................23 6.4.2. Dispositions of Equipment..........................................................23 6.5. PAYMENT OF CHARGES.....................................................................23 6.6. ADDITIONAL PAYMENTS....................................................................23 SECTION 7. REPRESENTATIONS AND WARRANTIES..................................................23 7.1. GENERAL REPRESENTATIONS AND WARRANTIES.................................................23 7.1.1. Organization and Qualification.....................................................24 7.1.2. Power and Authority................................................................24 7.1.3. Legally Enforceable Agreement......................................................24 7.1.4. Capital Structure..................................................................24 7.1.5. Corporate Names....................................................................25 7.1.6. Business Locations; Agent for Process..............................................25 7.1.7. Title to Properties; Priority of Liens.............................................25 7.1.8. Accounts...........................................................................25 7.1.9. Equipment..........................................................................26 7.1.10.Financial Statements; Fiscal Year..................................................26 7.1.11.Full Disclosure....................................................................27 7.1.12.Solvent Financial Condition........................................................27 7.1.13.Surety Obligations.................................................................27 7.1.14.Taxes..............................................................................27 7.1.15.Brokers............................................................................27 7.1.16.Patents, Trademarks, Copyrights and Licenses.......................................27 7.1.17.Governmental Consents..............................................................27
ii 7.1.18.Compliance with Laws...............................................................28 7.1.19.Restrictions.......................................................................28 7.1.20.Litigation.........................................................................28 7.1.21.No Defaults........................................................................28 7.1.22.Leases.............................................................................28 7.1.23.Pension Plans......................................................................28 7.1.24.Trade Relations....................................................................29 7.1.25.Labor Relations....................................................................29 7.1.26.O.S.H.A. and Environmental Compliance..............................................29 7.2. CONTINUOUS NATURE OF REPRESENTATIONS AND WARRANTIES....................................30 7.3. SURVIVAL OF REPRESENTATIONS AND WARRANTIES.............................................30 SECTION 8. COVENANTS AND CONTINUING AGREEMENTS.............................................30 8.1. AFFIRMATIVE COVENANTS..................................................................30 8.1.1. Visits and Inspections.............................................................30 8.1.2. Notices............................................................................30 8.1.3. Financial Statements...............................................................30 8.1.4. Landlord and Storage Agreements....................................................31 8.1.5. Credit Memoranda...................................................................32 8.1.6. Projections........................................................................32 8.1.7. Environmental Matters..............................................................32 8.1.8. License Agreements.................................................................34 8.1.9. Landlord Waivers...................................................................34 8.2. NEGATIVE COVENANTS.....................................................................35 8.2.1. Mergers; Consolidations; Acquisitions..............................................35 8.2.2. Loans..............................................................................35 8.2.3. Total Indebtedness.................................................................35 8.2.4. Affiliate Transactions.............................................................36 8.2.5. Limitation on Liens................................................................36 8.2.6. Subordinated Debt..................................................................36 8.2.7. Distributions......................................................................37 8.2.8. Capital Expenditures...............................................................37 8.2.9. Disposition of Assets..............................................................37 8.2.10.Bill-and-Hold Sales, Etc...........................................................37 8.2.11.Restricted Investment..............................................................37 8.2.12.Leases.............................................................................37 8.2.13.Tax Consolidation..................................................................37 8.2.14.Stock of Subsidiaries..............................................................37 8.3. SPECIFIC FINANCIAL COVENANTS...........................................................38 8.3.1. Minimum Net Worth..................................................................38 8.3.2. Cash Flow..........................................................................38 8.3.3. Adjusted Cash Flow.................................................................38 SECTION 9. CONDITIONS PRECEDENT............................................................38 9.1. DOCUMENTATION..........................................................................39 9.2. NO DEFAULT.............................................................................39 9.3. OTHER LOAN DOCUMENTS...................................................................39 9.4. FILINGS, REGISTRATIONS AND RECORDINGS..................................................39 9.5. PROCEEDINGS OF CORPORATE PARTIES.......................................................39 9.6. INCUMBENCY CERTIFICATES OF EACH CORPORATE PARTY........................................39 9.7. CERTIFICATES...........................................................................39 9.8. GOOD STANDING CERTIFICATES.............................................................40 9.9. LEGAL OPINION..........................................................................40 9.10. NO LITIGATION........................................................................40 9.11. INFORMATION; COLLATERAL EXAMINATION..................................................40 9.12. FEES.................................................................................40
iii 9.13. INSURANCE............................................................................40 9.14. PAYMENT INSTRUCTIONS.................................................................41 9.15. NO ADVERSE MATERIAL CHANGE...........................................................41 9.16. CONTRACT REVIEW......................................................................41 9.17. ENVIRONMENTAL REPORTS................................................................41 9.18. LEASEHOLD AGREEMENTS.................................................................41 9.19. CONSENTS.............................................................................41 9.20. FINANCIAL CONDITION CERTIFICATES.....................................................41 9.21. CLOSING CERTIFICATE..................................................................42 9.22. SUBSIDIARY STOCK.....................................................................42 9.23. CORPORATE STRUCTURE..................................................................42 9.24. ERISA................................................................................42 9.25. AVAILABILITY.........................................................................42 9.26. OTHER................................................................................42 9.27. CONDITIONS TO EACH LOAN..............................................................42 SECTION 10. EVENTS OF DEFAULT; RIGHTS AND REMEDIES ON DEFAULT...............................43 10.1. EVENTS OF DEFAULT....................................................................43 10.1.1.Payment of Obligations.............................................................43 10.1.2.Misrepresentations.................................................................43 10.1.3.Breach of Specific Covenants.......................................................43 10.1.4.Breach of Other Covenants..........................................................43 10.1.5.Default Under Security Documents/Other Agreements..................................44 10.1.6.Other Defaults.....................................................................44 10.1.7.Insolvency and Related Proceedings.................................................44 10.1.8.Business Disruption; Condemnation..................................................44 10.1.9.ERISA..............................................................................44 10.1.10. Challenge to Agreement..........................................................44 10.1.11. Criminal Forfeiture.............................................................45 10.1.12. Judgments.......................................................................45 10.1.13. Repudiation of or Default Under Guaranty Agreement..............................45 10.2. ACCELERATION OF THE OBLIGATIONS......................................................45 10.3. OTHER REMEDIES.......................................................................45
iv 10.4. REMEDIES CUMULATIVE; NO WAIVER.......................................................46 SECTION 11. REGARDING AGENT.................................................................47 11.1. APPOINTMENT.........................................................................47 11.2. NATURE OF DUTIES....................................................................47 11.3. LACK OF RELIANCE ON AGENT AND RESIGNATION...........................................48 11.4. CERTAIN RIGHTS OF AGENT.............................................................48 11.5. RELIANCE............................................................................48 11.6. NOTICE OF DEFAULT...................................................................49 11.7. INDEMNIFICATION.....................................................................49 11.8. AGENT IN ITS INDIVIDUAL CAPACITY....................................................49 11.9. DELIVERY OF DOCUMENTS...............................................................49 11.10. BORROWER'S UNDERTAKING TO AGENT.....................................................50 SECTION 12. MISCELLANEOUS..................................................................50 12.1. POWER OF ATTORNEY...................................................................50 12.2. INDEMNITY...........................................................................51 12.3. MODIFICATION OF AGREEMENT...........................................................51
v 12.4. SUCCESSORS AND ASSIGNS; PARTICIPATIONS; NEW LENDERS.................................52 12.5. SEVERABILITY........................................................................54 12.6. SUCCESSORS AND ASSIGNS..............................................................54 12.7. CUMULATIVE EFFECT; CONFLICT OF TERMS................................................54 12.8. EXECUTION IN COUNTERPARTS...........................................................54 12.9. NOTICE..............................................................................54 12.10. LENDERS' CONSENT....................................................................55 12.11. CREDIT INQUIRIES....................................................................55 12.12. TIME OF ESSENCE.....................................................................55 12.13. ENTIRE AGREEMENT....................................................................55 12.14. INTERPRETATION......................................................................56 12.15. GOVERNING LAW; CONSENT TO FORUM.....................................................56 12.16. WAIVERS BY BORROWER...............................................................57
vi LIST OF EXHIBITS AND SCHEDULES Exhibit 1.1 Revolving Note Exhibit 1.3 Term Note Exhibit 6.1.1 Location of Collateral Exhibit 7.1.1 Authorization To Do Business Jurisdictions Exhibit 7.1.4 Capital Structure of Borrower Exhibit 7.1.5 Corporate Names Exhibit 7.1.6 Business Locations of Borrower and Subsidiaries Exhibit 7.1.10(b) Financial Projections Exhibit 7.1.13 Surety Obligations Exhibit 7.1.14 Tax Identification Numbers of Subsidiaries Exhibit 7.1.15 Broker Commissions and Fees Exhibit 7.1.16 Patents, Trademarks, Copyrights and Licenses Exhibit 7.1.19 Contracts Restricting Borrower's Right to Incur Debts Exhibit 7.1.20 Litigation Exhibit 7.1.22(A) Capitalized Leases Exhibit 7.1.22(B) Operating Leases Exhibit 7.1.23 Pension Plans Exhibit 7.1.25 Labor Contracts Exhibit 7.1.26 Environmental Compliance Exhibit 8.1.3 Compliance Certificate Exhibit 8.2.4 Affiliate Transactions Exhibit 8.2.5 Permitted Liens Exhibit 9.10 Litigation Exhibit 12.4 Commitment Transfer Supplement
LOAN AND SECURITY AGREEMENT THIS LOAN AND SECURITY AGREEMENT is made as of the 14th day of August, 1998, by and among the undersigned financial institutions and the various financial institutions which in accordance with the provisions of SECTION 12.4(iii) become Purchasing Lenders (collectively, "Lenders" and individually, a "Lender") and FLEET CAPITAL CORPORATION ("Fleet"), a Rhode Island corporation with an office at 200 Glastonbury Boulevard, Glastonbury, Connecticut 06033, as administrative and collateral agent for Lenders (Fleet, in such capacity, "Agent") and EXECUTONE INFORMATION SYSTEMS, INC. ("Borrower"), a Virginia corporation. Capitalized terms used in this Agreement have the meanings assigned to them in APPENDIX A, GENERAL DEFINITIONS. Accounting terms not otherwise specifically defined herein shall be construed in accordance with GAAP consistently applied. SECTION 1. CREDIT FACILITY Subject to the terms and conditions of, and in reliance upon the representations and warranties made in, this Agreement and the other Loan Documents, each Lender severally and not jointly agrees to make a Total Credit Facility in an amount equal to such Lender's Commitment Percentage of up to $30,000,000.00 available to Borrower upon request therefor, as follows: 1.1. Revolving Credit Loans. 1.1.1. Loans and Reserves. Each Lender severally and not jointly agrees, for so long as no Default or Event of Default exists, to make Revolving Credit Loans to Borrower from time to time, as requested by Borrower in the manner set forth in SUBSECTIONS 3.1.1 and 3.1.4 hereof, up to a maximum principal amount at any time outstanding equal to such Lender's Commitment Percentage of the Borrowing Base. Notwithstanding the foregoing, Agent shall have the right to establish reserves in such amounts and with respect to such matters, as Agent shall deem necessary or appropriate in the exercise of its commercially reasonable judgment, against the amount of Revolving Credit Loans which Borrower may otherwise request hereunder, including, without limitation, the Specified Reserve (any such sums, the "Reserves"). The Revolving Credit Loans shall be evidenced by and subject to the terms and conditions set forth in those certain secured promissory notes (each, a "Revolving Note" and collectively, the "Revolving Notes"), a copy of the form of which is attached hereto as EXHIBIT 1.1. 1.1.2. Use of Proceeds. The Revolving Credit Loans shall be used to provide for (a) ongoing working capital requirements of Borrower in a manner consistent with the provisions of this Agreement and all applicable laws, (b) the general corporate purposes of Borrower in a manner consistent with the provisions of this Agreement and all applicable laws, (c) the payment of transaction expenses in connection herewith and (d) the Specified Capital Contribution 1.2. Letters of Credit; LC Guaranties. Agent agrees, for so long as no Default or Event of Default exists and if requested by Borrower to (i) issue its, or cause to be issued its Affiliate's, Letters of Credit for the account of Borrower or (ii) execute LC Guaranties by which Agent or its Affiliate shall guaranty the payment or performance by Borrower of its reimbursement obligations with respect to Letters of Credit and letters of credit issued for Borrower's account by other Persons in support of Borrower's obligations (other than obligations for the repayment of Money Borrowed), provided that the Aggregate LC Amount at any time shall not exceed $10,000,000. Any amounts paid by Agent or Lenders under any LC Guaranty or in connection with any Letter of Credit shall be treated as Revolving Credit Loans, shall be secured by all of the Collateral and shall bear interest and be payable at the same rate and in the same manner as Revolving Credit Loans. 1.2.1. Request for Letter of Credit. Borrower may request Agent to issue or cause to be issued by Bank (or such other financial institution as may be acceptable to Agent) a Letter of Credit by delivering to Agent the applicable commercial letter of credit application (the "Letter of Credit Application"), completed to the reasonable satisfaction of Agent and such other certificates, documents and other papers and information as Agent may reasonably request. 1.2.2. Description of Letters of Credit. Each Letter of Credit shall, among other things, (i) provide for the payment of sight or time drafts when presented for honor thereunder in accordance with the terms thereof and when accompanied by the documents described therein and (ii) have an expiry date occurring not later than the earlier of (1) sixty days prior to the last day of the Original Term or (2)(a) for standby Letters of Credit, 12 months after such Letter of Credit's date of issuance (subject to 12 month renewal periods) and (b) for any Letter of Credit that is not a standby Letter of Credit, 180 days after such Letter of Credit's date of issuance. Each Letter of Credit Application and each Letter of Credit shall be subject to the Uniform Customs and Practice for Documentary Credits (1993 Revision), International Chamber of Commerce Publication No. 500, and any amendments or revision thereof and, to the extent not inconsistent therewith, the laws of the State of New York. 1.2.3. Indemnification. In connection with the issuance or creation of the LC Guaranties and any Letter of Credit, Borrower hereby indemnifies, saves and holds Agent and each Lender harmless from any loss, cost, expense or liability, including, without limitation, payments made by Agent and each Lender, and expenses and reasonable attorneys' fees incurred by Agent and each Lender arising out of, or in connection with the LC Guaranties and any Letter of Credit to be issued or created for Borrower except to the extent any loss, cost, expense or liability is attributable to Agent's or any Lender's or the Bank's gross negligence or willful misconduct or that of its correspondents. Borrower shall be bound by Agent's or any Lender's or any Issuing Bank's regulations and good faith interpretations of any Letter of Credit issued or created for Borrower's account, although this interpretation may be different from Borrower's own, and neither Agent, any Lender, nor the Issuing Bank, nor any of its correspondents shall be liable for any error, negligence and/or mistakes, whether of omission or commission, in following Borrower's instructions or those contained in the LC Guaranties or any Letter of Credit of any modifications, amendments or supplements thereto or in creating or paying any Letter of Credit or the LC Guaranties, except for Agent's or any Lender's gross negligence or willful misconduct or that of its correspondents. 2 1.2.4. Agent's Instructions. Borrower shall authorize and direct Bank or any other bank or financial institution which issues a Letter of Credit (an "Issuing Bank") to name Borrower as the "Account Party" therein and to deliver to Agent, with a copy to Borrower, all instruments, documents, and other writings and property received by the Issuing Bank pursuant to the Letter of Credit and to accept and rely upon Agent's instructions and agreements with respect to all matters arising in connection with the Letter of Credit, the Letter of Credit Application therefor or any acceptance thereof. 1.2.5. Disbursements. Agent will notify Borrower promptly of any demand for payment under the LC Guaranties and the presentment for payment under a Letter of Credit, following receipt by it of notification from the Issuing Bank of such presentment, together with notice of the date such payment was made. All disbursements shall be deemed irrevocably to be a request by Borrower for a Revolving Credit Loan on the date such disbursement was made. 1.2.6. Reimbursement Obligation. Borrower's obligation to reimburse Agent for disbursements described in SUBSECTION 1.2.5 shall be absolute and unconditional under any and all circumstances and irrespective of any setoff, counterclaim or defense to payment which Borrower may have against Agent, any Lender, the Issuing Bank or the beneficiary of the Letter of Credit (except in the event of such party's gross negligence or willful misconduct), including, without limitation, any defense based upon any draft, demand or certificate or other document presented under the Letter of Credit proving to be forged, fraudulent, invalid or insufficient, the failure of any disbursement or payment by the Issuing Bank under the Letter of Credit ("Bank Payment") to conform to the terms of the Letter of Credit (if, in the Issuing Bank's good faith opinion such disbursement or Bank Payment is determined to be appropriate and other than as a consequence of Agent's or the Issuing Bank's gross negligence or willful misconduct) or any non-application or misapplication by the beneficiary of the proceeds of such disbursement or Bank Payment or the legality, validity, form, regularity or enforceability of the Letter of Credit. 1.2.7. Lender's Reimbursement Obligations. Each Lender shall to the extent of the percentage amount equal to the product of such Lender's Commitment Percentage times the aggregate amount of all disbursements made with respect to the Letters of Credit and LC Guaranties be deemed to have irrevocably purchased an undivided participation in each Revolving Credit Loan made as a consequence of such disbursement. In the event that at the time a disbursement is made the unpaid balance of Revolving Credit Loans plus the Aggregate LC Amount exceeds or would exceed, with the making of such disbursement, the Maximum Revolving Amount, and the amount in excess of the Maximum Revolving Amount is not reimbursed by Borrower within two (2) Business Days, Agent shall promptly notify each Lender and upon Agent's demand each Lender shall pay to Agent such Lender's Commitment Percentage of such unreimbursed disbursement together with such Lender's Commitment Percentage of Agent's unreimbursed costs and expenses relating to such unreimbursed disbursement. Upon receipt by Agent of a repayment from Borrower of any amount disbursed by Agent for which Agent had already been reimbursed by Lenders, Agent shall deliver to each Lender that Lender's Commitment Percentage of such repayment. Each Lender's participation commitment with respect to Letters of Credit and LC Guaranties shall continue until the last to occur of the following events: (A) Agent ceases to be obligated to issue or cause the issuance of Letters of Credit and LC Guaranties; (B) no Letter of Credit or LC Guaranty issued hereunder remains outstanding and uncancelled and (C) all Persons including Agent (other 3 than Borrower) have been fully reimbursed for all payments made under or relating to Letters of Credit or LC Guaranties. 1.2.8. Cash Collateral. Upon the occurrence and during the continuation of any Event of Default, at the option of Agent, Borrower will pay to Agent, for the ratable benefit of Lenders, cash in an amount equal to the undrawn face amount of the Letters of Credit. Such cash shall be held by Agent in a cash collateral account (the "Cash Collateral Account"). The Cash Collateral Account shall be maintained at a bank designated by Agent, which shall be (i) any domestic commercial bank having capital and surplus in excess of $100,000,000 or (ii) an Affiliate of Agent, if an Affiliate of Agent then maintains a presence as a bank in the United States of America, in the name of Agent as secured party, and shall be under the sole dominion and control of Agent and subject to the terms of this SUBSECTION 1.2.8. Borrower hereby pledges, and grants to Agent a security interest in, all such cash and other amounts held in the Cash Collateral Account from time to time and all earnings thereof and proceeds thereon, as security for the payment of all Obligations. Amounts in the Cash Collateral Account shall be invested in securities of the type described in clauses (iii), (iv) and (v) of the definition of Restricted Investments, and interest and earnings on the Cash Collateral Account shall be the property of Borrower but shall be held in the Cash Collateral Account as Collateral, provided that Agent shall release from the Cash Collateral Account and return to Borrower any funds remaining in the Cash Collateral Account upon satisfaction in full of the Obligations. At such time when all Events of Default shall have been cured or waived, Agent shall return any monies then remaining in the Cash Collateral Account. If at any time, and from time to time, the aggregate amount of the Cash Collateral Account exceeds the maximum liability, fixed or contingent, of Agent with respect to the aggregate face amount of all Letters of Credit then issued and outstanding, Agent shall return any excess to Borrower. 1.2.9. Waiver of Liability. Borrower shall assume all risks of the acts, omissions or misuse of any Letter of Credit by the beneficiary thereof. None of Agent, any Lender or any Issuing Bank (except in the event of its own gross negligence or willful misconduct) shall be responsible for: (i) the form, validity, sufficiency, accuracy, genuineness or legal effect of the Letter of Credit or any document submitted by any party in connection with the application for and issuance of any 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 the 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) errors, omissions, interruptions or delays in transmission or delivery of any messages by mail, cable, telegraph, telex or otherwise; or (iv) any loss or delay in the transmission or otherwise of any document or draft required in order to make a disbursement. 4 None of the foregoing shall affect, impair or prevent the vesting of any of the rights or powers granted Agent hereunder. In furtherance, and not in limitation or derogation of any of the foregoing, any action taken or omitted to be taken by the Issuing Bank, Agent or any Lender in good faith in the absence of gross negligence or willful misconduct, shall be binding upon Borrower and shall not put the Issuing Bank, Agent or any Lender, as the case may be, under any resulting liability therefor. SECTION 2. INTEREST, FEES AND CHARGES 2.1. Interest. 2.1.1. Rates of Interest. Interest shall accrue on the principal amount of Base Rate Loans outstanding at the end of each day (computed on the actual days elapsed over a year of 360 days) at a fluctuating rate per annum equal to the Base Rate plus the Applicable Margin. After the date hereof, the foregoing rate of interest shall be increased or decreased, as the case may be, by an amount equal to any increase or decrease in the Base Rate, with such adjustments to be effective as of the opening of business on the day that any such change in the Base Rate becomes effective. The Base Rate in effect on the date hereof shall be the Base Rate effective as of the opening of business on the date hereof, but if this Agreement is executed on a day that is not a Business Day, the Base Rate in effect on the date hereof shall be the Base Rate effective as of the opening of business on the last Business Day immediately preceding the date hereof. Interest shall accrue on the principal amount of the Eurodollar Loans outstanding at the end of each day (computed on the actual days elapsed over a year of 360 days) at a fluctuating rate per annum equal to the Eurodollar Rate plus the Applicable Margin. Interest shall accrue on the principal amount of the LIBOR Rate Loans outstanding at the end of each day (computed on the actual days elapsed over a year of 360 days) at a fluctuating rate per annum equal to the LIBOR Rate plus the Applicable Margin. 2.1.2. Default Rate. Upon the occurrence of an Event of Default and during the continuation thereof, the applicable interest rate on the principal amount of all Loans and all Letter of Credit Fees shall increase by 2.0% per annum (the "Default Rate"). 2.1.3. Maximum Interest. In no event whatsoever shall the aggregate of all amounts deemed interest hereunder and charged or collected 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. If any provisions of this Agreement are in contravention of any such law, such provisions shall be deemed amended to conform thereto. 2.2. Computation of Interest and Fees. Letter of Credit and LC Guaranty fees and unused line fees and collection charges hereunder shall be calculated daily and shall be computed on the actual number of days elapsed over a year of 360 days. For the purpose of computing interest hereunder, all items of payment received by Agent shall be deemed applied by Agent on account of the Obligations (subject to final payment of such items) on the first Business Day following the Business Day Agent receives such items in Agent's account located at Fleet National Bank, Hartford, Connecticut, ABA #011900571, Account #936-933-7579, Reference: Executone. 2.3. Closing Fee. Borrower shall pay to Agent for its own account and not for the benefit of Lenders a closing fee of $150,000, which shall be fully earned and nonrefundable on the 5 Closing Date and shall be paid (a) $75,000 concurrently with the initial Loan hereunder and (b) $75,000 on the six month anniversary date of the Closing Date. 2.4. Letter of Credit and LC Guaranty Fees. (a) Borrower shall pay to Agent, for the account of Lenders, a letter of credit commission with respect to each Letter of Credit (including those for which an LC Guaranty has been issued) computed for the period from and including the date of issuance of such Letter of Credit to the date such Letter of Credit is no longer outstanding, computed at a rate per annum equal to (i) with respect to standby Letters of Credit, one and three-quarters percent (1.75%) and (ii) with respect to documentary Letters of Credit, one percent (1.0%), in each case on the average aggregate daily amount available to be drawn under such Letter of Credit for the period as to which payment of such commission is made, payable quarterly in arrears on each Letter of Credit Fee Payment Date to occur while such Letter of Credit remains outstanding and on the date such Letter of Credit expires or is cancelled. (b) In addition to the foregoing fees and commissions, Borrower shall pay to Agent all such normal and customary costs and expenses as are incurred by Agent for issuing, causing the issuance of, negotiating, effecting payment under, amending or otherwise administering any Letter of Credit or LC Guaranty. 2.5. Unused Line Fee. Borrower shall pay to Agent for the ratable benefit of Lenders a fee equal to .40% per annum of the average monthly amount by which the Maximum Revolving Amount exceeds the sum of the outstanding principal balance of the Revolving Credit Loans and the Aggregate LC Amount. The unused line fee shall be payable quarterly in arrears commencing on the first day of the first Fiscal Quarter following the Closing Date and on the first day of each Fiscal Quarter thereafter and on the last day of the Original Term or upon earlier termination of the Agreement. Commencing January 1, 1999 and as of January 1 in each Fiscal Year thereafter, the unused line fee payable under this SECTION 2.5 shall be subject to change and shall be fixed as set forth below for such Fiscal Year based upon the Fixed Charge Coverage Ratio for the immediately preceding Fiscal Year as set forth below:
Fixed Charge Coverage Unused Line Fee --------------------- --------------- Equal to or less than 1.00:1.00 .50% -------------------------------------------- ------------------------------------------ Greater than 1.00:1.00 but less than .45% 1.25:1.00 -------------------------------------------- ------------------------------------------ Greater than or equal to 1.25:1.00 but .40% less than 1.50:1.00 -------------------------------------------- ------------------------------------------ Greater than or equal to 1.50:1.00 but .35% less than 2.00:1.00 -------------------------------------------- ------------------------------------------ Greater than or equal to 2.00:1.00 but .30% less than 2.50:1.00 -------------------------------------------- ------------------------------------------ Greater than 2.50:1.00 .25% -------------------------------------------- ------------------------------------------
6 2.6. Reimbursement of Expenses. If, at any time or times regardless of whether or not an Event of Default then exists, Agent (in its capacity as Agent) incurs legal or accounting expenses or any other costs or out-of-pocket expenses in connection with (i)(a) the negotiation and preparation of this Agreement or any of the other Loan Documents, (b) any amendment of or modification of this Agreement or any of the other Loan Documents, or (c) any sale or attempted sale of any interest herein by any Lender to a Purchasing Lender; (ii) the administration of this Agreement or any of the other Loan Documents and the transactions contemplated hereby and thereby; (iii) any litigation, contest, dispute, suit, proceeding or action (whether instituted by Agent, any Lender, Borrower or any other Person) in any way relating to the Collateral, this Agreement or any of the other Loan Documents or Borrower's affairs; (iv) any attempt to enforce any rights of Agent or any Lender against Borrower or any other Person which may be obligated to Agent or any Lender by virtue of this Agreement or any of the other Loan Documents, including, without limitation, the Account Debtors; or (v) any attempt to inspect, verify, protect, preserve, restore, collect, sell, liquidate or otherwise dispose of or realize upon the Collateral; then all such legal and accounting expenses, other costs and out of pocket expenses of Agent shall be charged to Borrower. All amounts chargeable to Borrower under this SECTION 2.6 shall be Obligations secured by all of the Collateral, shall be payable on demand to Agent and shall bear interest from the date such demand is made until paid in full at the rate applicable to Base Rate Loans from time to time. Borrower shall also reimburse Agent for expenses incurred by Agent in its administration of the Collateral to the extent and in the manner provided in SECTION 6 hereof. 2.7. Bank Charges. Borrower shall pay to Agent, on demand, any and all fees, costs or expenses which Agent pays to a bank or other similar institution arising out of or in connection with (i) the forwarding to Borrower or any other Person on behalf of Borrower, by Agent, of proceeds of Loans made by Agent on behalf of Lenders to Borrower pursuant to this Agreement and (ii) the depositing for collection, by Agent, of any check or item of payment received or delivered to Agent on account of the Obligations. SECTION 3. LOAN ADMINISTRATION. 3.1. Manner of Borrowing Revolving Credit Loans. Borrowings under the credit facility established pursuant to SECTION 1 hereof shall be as follows: 3.1.1. Loan Requests; Payment. (i) A request for Revolving Credit Loans that are Base Rate Loans shall be made, or shall be deemed to be made, in the following manner: (1) Borrower may give Agent notice of its intention to borrow, in which notice Borrower shall specify to Agent, the amount of the proposed borrowing and the proposed borrowing date, no later than 11:00 A.M. New York time on the first Business Day prior to the requested borrowing date with respect to Revolving Credit Loans that are Base Rate Loans; provided, however, that no such request may be made at a time when there exists an Event of Default; and (2) the becoming due of any amount required to be paid under this Agreement, whether as interest or for any other Obligation, shall be deemed irrevocably to be a 7 request by Borrower for a Revolving Credit Loan on the due date in the amount required to pay such interest or other Obligation. Eurodollar Rate Loans and LIBOR Rate Loans shall be requested in accordance with subsection 3.1.4 hereof. As an accommodation to Borrower, Agent may permit telephonic requests for Loans and electronic transmittal of instructions, authorizations, agreements or reports to Agent by Borrower. Unless Borrower specifically directs Agent in writing not to accept or act upon telephonic or electronic communications from Borrower, Agent shall have no liability to Borrower for any loss or damage suffered by Borrower as a result of Agent's good faith honoring of any requests, execution of any instructions, authorizations or agreements or reliance on any reports communicated to it telephonically or electronically and purporting to have been sent to Agent by Borrower and Agent shall have no duty to verify the origin of any such communication or the authority of the person sending it. (ii) Each borrowing of Revolving Credit Loans shall be advanced according to the Commitment Percentages of Lenders. (iii) Each payment (including each prepayment) by Borrower on account of the principal of and interest on the Revolving Credit Loans shall be applied first, to Base Rate Loans, then to LIBOR Rate Loans pro rata according to the applicable Commitment Percentages of Lenders, and then to Eurodollar Loans pro rata according to the applicable Commitment Percentages of Lenders. (iv) Notwithstanding anything to the contrary contained in the immediately preceding CLAUSES (ii) AND (iii), commencing with the first Business Day following the Closing Date, each borrowing of Revolving Credit Loans shall be advanced by Agent and each payment by Borrower on account of Revolving Credit Loans shall be applied first to those Revolving Credit Loans made by Agent. On or before 11:00 A.M., New York time, on each Settlement Date commencing with the first Settlement Date following the Closing Date, Agent and Lenders shall make certain payments as follows: (I) if the aggregate amount of new Revolving Credit Loans made by Agent during the preceding Week exceeds the aggregate amount of repayments applied to outstanding Revolving Credit Loans during such preceding Week, then each Lender shall provide Agent with funds in an amount equal to its Commitment Percentage of the difference between (w) such Revolving Credit Loans and (x) such repayments and (II) if the aggregate amount of repayments applied to outstanding Revolving Credit Loans during such Week exceeds the aggregate amount of new Revolving Credit Loans made during such Week, then Agent shall provide each Lender with its Commitment Percentage of the difference between (y) such repayments and (z) such Revolving Credit Loans. (1) Each Lender shall be entitled to receive disbursements of interest from Agent at the applicable rates of interest set forth in SECTION 2.1. relating to outstanding Loans which it has funded. (2) Promptly following each Settlement Date, Agent shall submit to each Lender a certificate with respect to payments received and Loans made during the Week immediately preceding such Settlement Date. (v) If any Lender or Participating Lender (a "Benefited Lender") shall at any time receive any payment of all or part of its Loans, or interest thereon, or receive any Collateral in respect thereof (whether voluntarily or involuntarily or by set-off) in a greater proportion than any such 8 payment to and Collateral received by any other Lender, if any, in respect of such other Lender's Loans, or interest thereon, and such greater proportionate payment or receipt of Collateral is not expressly permitted hereunder, such Benefited Lender shall purchase for cash from the other Lenders such portion of each such other Lender's Loans, or shall provide such other Lender with the benefits of any such Collateral, or the proceeds thereof, as shall be necessary to cause such Benefited Lender to share the excess payment or benefits of such Collateral or proceeds ratably with each of the Lenders; provided, however, that if all or any portion of such excess payment or benefits is thereafter recovered from such Benefited Lender, such purchase shall be rescinded, and the purchase price and benefits returned, to the extent of such recovery, but without interest. Each Lender so purchasing a portion of another Lender's Loans may exercise all rights of payment (including, without limitation, rights of set-off) with respect to such portion as fully as if such Lender were the direct holder of such portion. (vi) Unless Agent shall have been notified by telephone, confirmed in writing, by any Lender that such Lender will not make the amount which would constitute its Commitment Percentage of the Loans available to Agent, Agent may (but shall not be obligated to) assume that such Lender shall make such amount available to Agent and, in reliance upon such assumption, make available to Borrower a corresponding amount. Agent will promptly notify Borrower of its receipt of any such notice from a Lender. If such amount is made available to Agent on a date after a Settlement Date, such Lender shall pay to Agent on demand an amount equal to the product of (i) the daily average Federal Funds Rate (computed on the basis of a year of 360 days) during such period as quoted by Agent, times (ii) such amount, times (iii) the number of days from and including such Settlement Date to the date on which such amount becomes immediately available to Agent. A certificate of Agent submitted to any Lender with respect to any amounts owing under this paragraph (vi) shall be conclusive, in the absence of manifest error. If such amount is not in fact made available to Agent by such Lender within three (3) Business Days after such Settlement Date, Agent shall be entitled to recover such an amount, with interest thereon at the rate per annum then applicable to such Revolving Credit Loans hereunder, on demand from Borrower; provided, however, that Agent's right to such recovery shall not prejudice or otherwise adversely affect Borrower's rights (if any) against such Lender. (vii) (a) Notwithstanding anything to the contrary contained herein, in the event any Lender (x) has refused (which refusal constitutes a breach by such Lender of its obligations under this Agreement) to make available its portion of any Loan or (y) notifies either Agent or Borrower that it does not intend to make available its portion of any Loan (if the actual refusal would constitute a breach by such Lender of its obligations under this Agreement) (each, a "Lender Default"), all rights and obligations hereunder of such Lender (a "Defaulting Lender") as to which a Lender Default is in effect and of the other parties hereto shall be modified to the extent of the express provisions of this SUBSECTION 3.1.1 (vii) while such Lender Default remains in effect. (b) Loans shall be incurred pro rata from Lenders (the "Non-Defaulting Lenders") which are not Defaulting Lenders based on their respective Commitment Percentages, and no Commitment Percentage of any Lender or any pro rata share of any Loans required to be advanced by any Lender shall be increased as a result of such Lender Default. Amounts received in respect of principal of any type of Loans shall be applied to reduce the applicable Loans of each Lender pro rata based on the aggregate of the outstanding Loans of that type of all Lenders at the time of such application; provided that, such amount shall not be applied to any Loans of a Defaulting 9 Lender at any time when, and to the extent that, the aggregate amount of Loans of any Non-Defaulting Lender exceeds such Non-Defaulting Lender's Commitment Percentage of all Loans then outstanding. (c) A Defaulting Lender shall not be entitled to give instructions to Agent or to approve, disapprove, consent to or vote on any matters relating to this Agreement and the Loan Documents. All amendments, waivers and other modifications of this Agreement and the Loan Documents may be made without regard to a Defaulting Lender and, solely for purposes of the definition of "Required Lenders", a Defaulting Lender shall be deemed not to be a Lender and not to have Loans outstanding. (d) Other than as expressly set forth in this SUBSECTION 3.1.1.(vii), the rights and obligations of a Defaulting Lender (including the obligation to indemnify Agent) and the other parties hereto shall remain unchanged. Nothing in this SUBSECTION 3.1.1(vii) shall be deemed to release any Defaulting Lender from its obligations under this Agreement and the Loan Documents, shall alter such obligations, shall operate as a waiver of any default by such Defaulting Lender hereunder, or shall prejudice any rights which Borrower, Agent or any other Lender may have against any Defaulting Lender as a result of any default by such Defaulting Lender hereunder. (e) In the event a Defaulting Lender retroactively cures to the satisfaction of Agent the breach which caused a Lender to become a Defaulting Lender, such Defaulting Lender shall no longer be a Defaulting Lender and shall be treated as a Lender under this Agreement. 3.1.2. Disbursement. Borrower hereby irrevocably authorizes Agent to disburse the proceeds of each Revolving Credit Loan requested, or deemed to be requested, pursuant to this SUBSECTION 3.1.2 as follows: (i) the proceeds of each Revolving Credit Loan requested under SUBSECTION 3.1.1(i)(1) and SUBSECTION 3.1.4 shall be disbursed by Agent in lawful money of the United States of America in immediately available funds, in the case of the initial borrowing, in accordance with the terms of the written disbursement letter from Borrower, and in the case of each subsequent borrowing, by wire transfer to such bank account as may be agreed upon by Borrower and Agent from time to time or elsewhere if pursuant to a written direction from Borrower and (ii) the proceeds of each Revolving Credit Loan requested under SUBSECTION 3.1.1(i)(2) shall be disbursed by Agent by way of direct payment of the relevant interest or other Obligation. 3.1.3. Authorization. Borrower hereby irrevocably authorizes Agent, in Agent's sole discretion, to advance to Borrower, and to charge to Borrower's Loan Account hereunder as a Revolving Credit Loan, a sum sufficient to pay all interest accrued on the Obligations and all principal coming due on the Obligations during the immediately preceding month and to pay all costs, fees and expenses at any time owed by Borrower to Agent and Lenders hereunder to the extent such amounts are not paid when due. 3.1.4. Eurodollar Loans and LIBOR Rate Loans. Notwithstanding the provisions of SUBSECTION 3.1.1, in the event Borrower desires to obtain a Eurodollar Loan or LIBOR Rate Loan, Borrower shall give Agent prior written irrevocable notice no later than 11:00 A.M. New York time on the 3rd Business Day prior to the requested borrowing date specifying (i) Borrower's election to obtain a Eurodollar Loan or a LIBOR Rate Loan, (ii) the date of the proposed borrowing (which 10 shall be a Business Day) and (iii) the amount to be borrowed, which amount shall be in a minimum principal amount of $500,000 and may increase in integral multiples of $100,000 and (iv) with respect to a Eurodollar Loan, the applicable Interest Period. In no event shall Borrower be permitted to have outstanding at any one time Eurodollar Loans with more than 4 different Interest Periods. 3.1.5. Interest Periods. Each interest period of a Eurodollar Loan shall commence on the date such Eurodollar Loan is made and shall end on the date which is 1 month, 2 months, 3 months or 6 months later, as may then be requested by Borrower ("Interest Period") provided that: (i) any Interest Period which would otherwise end on a day which is not a Business Day shall end on the next preceding or succeeding Business Day as is the Bank's custom in the market to which such Eurodollar Loan relates; (ii) there remains a minimum of 1 month in the Original Term; (iii) all Interest Periods of the same duration which commence on the same date shall end on the same date; and (iv) each Interest Period which commences before, and would otherwise end after the last day of the Original Term shall end on the last day of the Original Term. 3.1.6. Conversion of Loans. Provided that no Event of Default has occurred which is then continuing, Borrower may, on any Business Day, convert any: (i) Base Rate Loan into a Eurodollar Loan. If Borrower desires to convert a Base Rate Loan, Borrower shall give Agent not less than three (3) Business Days' prior written notice (prior to 11:00 A.M. New York time on such Business Day), specifying the date of such conversion and the amount to be converted. Each conversion into or conversion of a Eurodollar Loan shall be in a minimum principal amount of $500,000 and may increase in integral multiples of $100,000 in excess thereof. After giving effect to any conversion of Base Rate Loans to Eurodollar Loans, Borrower shall not be permitted to have outstanding at any one time Eurodollar Loans with more than 4 different Interest Periods; and (ii) Base Rate Loan into a LIBOR Rate Loan and LIBOR Rate Loan into a Base Rate Loan. If Borrower desires such a conversion, Borrower shall give Agent not less than three (3) Business Days prior written notice (prior to 11:00 A.M. New York time on such Business Day) specifying the date of such conversion and the amount to be converted. Each conversion into or conversion of a Eurodollar Loan shall be in a minimum principal amount of $500,000 and may increase in integral multiples of $100,000 in excess thereof. 3.1.7. Continuation of Eurodollar Loans. Borrower shall have the right on 3 Business Days' prior irrevocable written notice given to Agent, subject to the provisions of SUBSECTION 3.1.8, to continue any Eurodollar Loan into a subsequent Interest Period of the same or a different permitted duration, in each case subject to the satisfaction of the following conditions: 11 (i) in the case of a continuation of less than all Eurodollar Loans, the Eurodollar Loans continued shall each be in a minimum principal amount of $500,000 and may increase in integral multiples of $100,000; (ii) accrued interest on a Eurodollar Loan (or portion thereof) being continued shall be paid by Borrower at the time of continuation; and (iii) no Eurodollar Loan (or portion thereof) may be continued as a Eurodollar Loan if an Event of Default has occurred which is then continuing or if, after giving effect to such continuation, Borrower shall have outstanding more than 4 separate Eurodollar Loans in the aggregate. If Borrower shall fail to give timely notice of its election to continue any Eurodollar Loan or portion thereof as provided above, or if such continuation shall not be permitted, such Eurodollar Loan or portion thereof, unless such Eurodollar Loan shall be repaid, shall automatically be converted into a Base Rate Loan at the end of the Interest Period then in effect with respect to such Eurodollar Loan. 3.1.8. Prepayment of Eurodollar Loans. Subject to the provisions of SUBSECTION 3.1.9 and SECTION 4.2, Borrower may prepay any Loan in whole at any time or in part from time to time, without premium or penalty provided that a Eurodollar Loan not prepaid, continued or converted on the last Business Day of the then current Interest Period with respect thereto shall be subject to SUBSECTION 3.1.9. Borrower shall specify the date of prepayment of Loans which are Eurodollar Loans and the amount of Loans to be prepaid. In the event that any prepayment of a Eurodollar Loan is made on a date other than the last Business Day of the then current Interest Period with respect thereto, Borrower shall indemnify Agent and Lenders therefor in accordance with SUBSECTION 3.1.9 hereof. 3.1.9. Indemnification. Borrower shall indemnify Agent and Lenders and hold Agent and Lenders harmless from and against any and all losses or expenses that Agent and Lenders may sustain or incur as a consequence of any prepayment on any date other than the last Business Day of the then current Interest Period or any default by Borrower in the payment of the principal of or interest on any Eurodollar Loan or failure by Borrower to complete a borrowing of, a prepayment of or conversion of or to a Eurodollar Loan after notice thereof has been given, including (but not limited to) any interest payable by Agent or Lenders to lenders of funds obtained by it in order to make or maintain its Eurodollar Loans hereunder, and any other loss or expense incurred by Agent and Lenders by reason of the liquidation or reemployment of deposits or other funds acquired by Agent and Lenders to make, continue, convert into or maintain, a Eurodollar Loan. 3.1.10. Inability to Make Eurodollar Loans. Notwithstanding any other provision hereof, if any applicable law, treaty, regulation or directive, or any change therein or in the interpretation or application thereof, shall make it unlawful for any Lender (for purposes of this SUBSECTION 3.1.10, the term "Lender" shall include any Lender and the office or branch where any Lender or any corporation or bank controlling any Lender makes or maintains any Eurodollar Loans) to make or maintain its Eurodollar Loans, or if with respect to any Interest Period, any Lender is unable to determine the Eurodollar Rate relating thereto, or adverse or unusual conditions 12 in or changes in applicable law relating to the London interbank Eurodollar market make it, in the reasonable judgment of any Lender, impracticable to fund therein any of the Eurodollar Loans or LIBOR Rate Loans or make the projected Eurodollar Rate unreflective of the actual costs of funds therefor to any Lender, the obligation of any Lender to make Eurodollar Loans or LIBOR Rate Loans hereunder shall forthwith be suspended during the pendency of such circumstances and Borrower shall, if any affected Eurodollar Loans or LIBOR Rate Loans are then outstanding, promptly upon request from any such Lender, convert such affected Eurodollar Loans or LIBOR Rate Loans into Base Rate Loans in which case the provisions of subsection 3.1.9 shall not apply. 3.2. Payments. Except where evidenced by notes or other instruments issued or made by Borrower to Agent or any Lender specifically containing payment provisions which are in conflict with this SECTION 3.2 (in which event the conflicting provisions of said notes or other instruments shall govern and control), the Obligations shall be payable as follows: 3.2.1. Principal. Subject to the terms of SUBSECTIONS 3.2.5 AND 3.3 hereof, principal payable on account of Revolving Credit Loans shall be payable by Borrower to Agent immediately upon the earliest of (a) the occurrence of an Event of Default in consequence of which Agent elects to accelerate the maturity and payment of the Obligations, or (b) termination of this Agreement pursuant to SECTION 4 hereof; provided, however, that if an Overadvance shall exist at any time, with respect to Borrower, Borrower shall, on demand by Agent, repay the Overadvance. 3.2.2. Interest. Interest accrued on the Loans shall be due on the earliest of (i)(a) for Base Rate Loans and LIBOR Rate Loans, the first calendar day of each month (for the immediately preceding month), computed through the last calendar day of the preceding month and (b) for Eurodollar Loans, on the earlier of (x) the first day of each quarter for the immediately preceding quarter or (y) at the end of each Interest Period, (ii) the occurrence of an Event of Default in consequence of which Agent elects to accelerate the maturity and payment of the Obligations or (iii) termination of this Agreement pursuant to SECTION 4 hereof. 3.2.3. Costs, Fees and Charges. Costs, fees and charges payable pursuant to this Agreement shall be payable by Borrower as and when provided in SECTION 2 hereof, to Agent or to any other Person designated by Agent in writing. 3.2.4. Other Obligations. The balance of the Obligations requiring the payment of money, if any, shall be payable by Borrower to Agent as and when provided in this Agreement, the Other Agreements or the Security Documents, or on demand, whichever is later. 3.2.5. Voluntary Prepayments. Borrower shall have the right to prepay Loans in whole or in part, without penalty or fee except as otherwise provided in this Agreement, at any time and from time to time on the following terms and conditions: (i) Borrower shall give Agent written notice (or telephonic notice promptly confirmed in writing) (each such notice, a "Notice of Prepayment") of the intent to prepay Loans prior to 11:00 A.M. (New York time) (a) for Base Rate Loans and LIBOR Rate Loans, at least one (1) Business Day prior to the date of such prepayment and (b) for Eurodollar Loans, at least three (3) Business Days prior to the date of such prepayment, the amount of such prepayment, in the case of Eurodollar Loans, the specific borrowing(s) pursuant to which such Eurodollar Loans were made; (ii) all partial prepayments shall be in a minimum 13 principal amount of $250,000 or an integral multiple of $250,000 in excess thereof; and (iii) subject to SECTION 3.1.8, prepayment of Eurodollar Loans pursuant to this SUBSECTION 3.2.5 shall only be made the last day of the Interest Period applicable thereto. Any such prepayment shall be applied by Agent to Revolving Credit Advances and second, to the remaining Obligations in such order as Agent may determine, subject to Borrower's ability to reborrow Revolving Credit Loans in accordance with the terms hereof. Notwithstanding anything contained in this SUBSECTION 3.2.5 to the contrary, Borrower shall be permitted to prepay the Revolving Credit Loans at any time and in any amounts. 3.3. Mandatory Prepayments. 3.3.1. Proceeds of Sale, Loss, Destruction or Condemnation of Collateral; Extraordinary Receipts. Except as provided in SUBSECTION 6.4.2 hereof, when Borrower, or any of Borrower's Subsidiaries sells or otherwise disposes of any Collateral (other than Inventory in the ordinary course of business), or if any of the Collateral is lost or destroyed or taken by condemnation or if Borrower receives any Extraordinary Receipts, Borrower shall repay the Loans in an amount equal to the net proceeds of such sale or other disposition (i.e., gross proceeds less the reasonable costs of such sales or other dispositions), loss, destruction or condemnation or the amount of Extraordinary Receipts, as applicable, such repayments to be made promptly but in no event more than one (1) Business Day following receipt of such net proceeds, and until the date of payment, such proceeds shall be held in trust for Agent. The foregoing shall not be deemed to be implied consent to any such sale otherwise prohibited by the terms and conditions hereof. Any such prepayment shall be applied by Agent to the remaining Loans in such order as Agent may determine, subject to Borrower's ability to reborrow Revolving Credit Loans in accordance with the terms hereof. 3.4. Application of Payments and Collections. All items of payment received by Agent by 12:00 noon, New York City time, on any Business Day shall be deemed received on that Business Day. All items of payment received after 12:00 noon, New York City time, on any Business Day shall be deemed received on the following Business Day. Subject to the terms of SUBSECTIONS 3.2.5 AND 3.3, Borrower irrevocably waives the right to direct the application of any and all payments and collections at any time or times hereafter received by Agent from or on behalf of Borrower, and Borrower does hereby irrevocably agree that Agent shall have the continuing exclusive right to apply and reapply any and all such payments and collections received at any time or times hereafter by Agent or its agent against the Obligations, in such manner as Agent may deem advisable. 3.5. All Loans to Constitute One Obligation. The Loans shall constitute one general Obligation of Borrower, and shall be secured by Agent's Lien upon all of the Collateral. 3.6. Loan Account. Agent shall enter all Loans as debits to an account evidencing such Loans ("Loan Account") and shall also record in Borrower's Loan Account all payments made by Borrower on any Obligations and all proceeds of Collateral which are finally paid to Agent, and may record therein, in accordance with customary accounting practice, other debits and credits, including interest and all charges and expenses properly chargeable to Borrower. 14 3.7. Statements of Account. Agent will account to Borrower monthly with a statement of Loans, charges and payments made pursuant to this Agreement, and such account rendered by Agent shall be deemed final, binding and conclusive upon Borrower absent manifest error or unless Agent is notified by Borrower in writing to the contrary within 30 days of the date each accounting is mailed to Borrower. Such notice shall only be deemed an objection to those items specifically objected to therein. 3.8. Increased Costs. In the event that any change, after the date of this Agreement, in any applicable law or treaty, or in the interpretation or application thereof, or compliance by Agent or any Lender with any new request or directive (whether or not having the force of law) from any central bank or other financial, monetary or other regulatory authority (other than those in effect on the date hereof), shall: (i) (1) subject Agent or any Lender to any tax with respect to this Agreement (other than (a) any tax based on or measured by net income or otherwise in the nature of a net income tax, including, without limitation, any franchise tax or any similar tax based on capital, net worth or comparable basis for measurement and (b) any tax collected by a withholding on payments and which either is computed by reference to the net income of the payee or is in the nature of an advance collection of a tax based on or measured by the net income of the payee) or (2) change the basis of taxation of payments to Agent or any Lender of principal, fees, interest or any other amount payable hereunder or under any Loan Documents (other than in respect of (a) any tax based on or measured by net income or otherwise in the nature of a net income tax, including, without limitation, any franchise tax or any similar tax based on capital, net worth or comparable basis for measurement and (b) any tax collected by a withholding on payments and which either is computed by reference to the net income of the payee or is in the nature of an advance collection of a tax based on or measured by the net income of the payee); (i) impose, modify or hold applicable any reserve (except any reserve taken into account in the determination of the applicable Eurodollar Rate), special deposit, assessment or similar requirement against assets held by, or deposits in or for the account of, advances or loans by, or other credit extended by, any office of Agent or any Lender, including (without limitation) pursuant to Regulation D of the Board of Governors of the Federal Reserve System; or (ii) impose on Agent or any Lender or the London interbank Eurodollar market any other condition with respect to any Loan Document; and the result of any of the foregoing is to increase the cost to Agent or any Lender of making, renewing or maintaining its Loans hereunder by an amount that Agent or such Lender deems to be material or to reduce the amount of any payment (whether of principal, interest or otherwise) in respect of any of the Loans by an amount that Agent or such Lender deems to be material, then, in any such case, Borrower shall pay Agent or such Lender, upon its demand and certification not later than sixty (60) days following its receipt of notice of the imposition of such increased costs, such additional amount as will compensate Agent or such Lender for such additional cost or such reduction, as the case may be, to the extent Agent or such Lender has not otherwise been compensated, with respect to a 15 particular Loan, for such increased cost as a result of an increase in the Base Rate, Eurodollar Rate or LIBOR Rate. An officer of Agent or such Lender shall determine the amount of such additional cost or reduced amount using reasonable averaging and attribution methods and shall certify the amount of such additional cost or reduced amount to Borrower, which certification shall include a written explanation of such additional cost or reduction to Borrower. Such certification shall be conclusive absent manifest error. If Agent or any Lender claims any additional cost or reduced amount pursuant to this SECTION 3.8, then Agent or such Lender shall use reasonable efforts (consistent with legal and regulatory restrictions) to designate a different lending office or to file any certificate or document reasonably requested by Borrower if the making of such designation or filing would avoid the need for, or reduce the amount of, any such additional cost or reduced amount and would not, in the sole discretion of Agent or such Lender, be otherwise disadvantageous to Agent or such Lender. 3.9. Basis For Determining Interest Rate Inadequate or Unfair. In the event that Agent or the Required Lenders shall have determined that: (i) reasonable means do not exist for ascertaining the LIBOR Rate or the Eurodollar Rate for any Interest Period; or (ii) Dollar deposits in the relevant amount and for the relevant maturity are not available in the London interbank Eurodollar market with respect to a proposed Eurodollar Loan, or a proposed conversion of a Base Rate Loan into a Eurodollar Loan; Agent shall give Borrower prompt written, telephonic or telegraphic notice of the determination of such effect. If such notice is given, (i) any such requested Eurodollar Loan or LIBOR Rate Loan shall be made as a Base Rate Loan, unless Borrower shall notify Agent no later than 10:00 A.M. (New York City time) three (3) Business Days prior to the date of such proposed borrowing that the request for such borrowing shall be canceled or made as an unaffected type of Eurodollar Loan or LIBOR Rate Loan, and (ii) any Base Rate Loan which was to have been converted to an affected type of Eurodollar Loan or LIBOR Rate Loan shall be continued as or converted into a Base Rate Loan, or, if Borrower shall notify Agent, no later than 10:00 A.M. (New York City time) three (3) Business Days prior to the proposed conversion, shall be maintained as an unaffected type of Eurodollar Loan or LIBOR Rate Loan. 3.10. Capital Adequacy. In the event that Agent or any Lender shall have determined that any change in applicable law or guideline regarding capital adequacy, or any change in the interpretation or administration thereof by any governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by Agent or any Lender with any new request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency not in effect on the date hereof, has or would have the effect of reducing the rate of return on Agent's or any Lender's capital as a consequence of its obligations hereunder to a level below that which Agent or any Lender could have achieved but for such adoption, change or compliance (taking into consideration Agent's and each Lender's policies with respect to capital adequacy) by an amount deemed by Agent or any Lender to be material, then, from time to time, upon written demand not later than sixty (60) days following such Lender's or Agent's making such determination (which demand shall be accompanied by a certification demonstrating the calculation of such amounts in reasonable 16 detail) by Agent or such Lender, Borrower shall pay to Agent or such Lender such additional amount or amounts as will compensate Agent or such Lender for such reduction. In determining such amount or amounts, Agent or such Lender may use any reasonable averaging or attribution methods. The protection of this SECTION 3.10 shall be available to Agent or any Lender regardless of any possible contention of invalidity or inapplicability with respect to the applicable law or condition. 3.10.1. Certificate. A certificate of an officer of Agent or such Lender setting forth such amount or amounts as shall be necessary to compensate Agent or such Lender pursuant to SECTION 3.10 hereof and the reasons therefor when delivered to Borrower shall be conclusive absent manifest error. SECTION 4. TERM AND TERMINATION. 4.1. Term of Agreement. Subject to Lenders' right to cease making Loans to Borrower upon or after the occurrence of a Default or Event of Default, this Agreement shall be in effect for a period of five (5) years from the date hereof, through and including August 13, 2003 (the "Original Term") unless terminated as provided in SECTION 4.2 hereof. 4.2. Termination. 4.2.1. Termination by Lenders. Required Lenders may terminate this Agreement (without notice thereof to Borrower) upon or after the occurrence and during the continuance of an Event of Default. 4.2.2. Termination by Borrower. Upon at least ninety (90) days prior written notice to Agent, Borrower may, at its option, terminate this Agreement; provided, however, no such termination shall be effective until Borrower has paid all of the Obligations in immediately available funds and all Letters of Credit and LC Guaranties have expired or have been cash collateralized to Agent's satisfaction. Any notice of termination given by Borrower shall be irrevocable unless Required Lenders otherwise agree in writing, and Lenders shall have no obligation to make any Loans or issue or procure any Letters of Credit or LC Guaranties on or after the termination date stated in such notice. Borrower may elect to terminate this Agreement in its entirety only. No section of this Agreement or type of Loan available hereunder may be terminated singly. 4.2.3. Termination Charges. At the effective date of termination of this Agreement for any reason, Borrower shall pay to Agent for its own account (in addition to the then outstanding principal, accrued interest and other charges owing under the terms of this Agreement and any of the other Loan Documents) as liquidated damages for the loss of the bargain and not as a penalty, an amount equal to two percent (2.0%) of the average outstanding Loans and Letters of Credit during such year if termination occurs during the first Loan Year and one percent (1.0%) of the average outstanding Loans and Letters of Credit during such year if termination occurs during the second Loan Year. If Borrower shall terminate this Agreement after the second Loan Year, all charges under this Section 4.2.3 shall be waived. 17 4.2.4. Effect of Termination. All of the Obligations shall be immediately due and payable upon the termination date stated in any notice of termination of this Agreement. All undertakings, agreements, covenants, warranties and representations of Borrower contained in the Loan Documents shall survive any such termination and Agent shall retain its Liens in the Collateral and all of its rights and remedies under the Loan Documents notwithstanding such termination until Borrower has paid the Obligations to Agent, in full, in immediately available funds, together with the applicable termination charge, if any. Notwithstanding the payment in full of the Obligations, Agent shall not be required to terminate its security interests in the Collateral unless, with respect to any loss or damage Agent or Lenders may incur as a result of dishonored checks or other items of payment received by Agent or Lenders from Borrower or any Account Debtor and applied to the Obligations, Agent shall, at its option, (i) have received a written agreement, executed by Borrower and by any Person whose loans or other advances to Borrower are used in whole or in part to satisfy the Obligations, indemnifying Agent and Lenders from any such loss or damage; or (ii) have retained such monetary reserves and Liens on the Collateral for such period of time as Agent, in its reasonable discretion, may deem necessary to protect Agent and Lenders from any such loss or damage. SECTION 5. SECURITY INTERESTS 5.1. Security Interest in Collateral. To secure the prompt payment and performance to Lenders of the Obligations, Borrower hereby grants to Agent for the ratable benefit of Lenders a continuing security interest and Lien upon all of Borrower's assets, including all of the following Property and interests in Property of Borrower, whether now owned or existing or hereafter created, acquired or arising and wheresoever located: (i) Accounts; (ii) Inventory; (iii) Equipment; (iv) General Intangibles; (v) All monies and other Property of any kind now or at any time or times hereafter in the possession or under the control of Agent or any Lender or a bailee or Affiliate of Agent or any Lender; (vi) All Investment Property (as defined in the Code); (vii) All accessions to, substitutions for and all replacements, products and cash and non-cash proceeds of (i) through (vi) above, including, without limitation, proceeds of and unearned premiums with respect to insurance policies insuring any of the Collateral; and 18 (viii) All books and records (including, without limitation, customer lists, credit files, computer programs, print-outs, and other computer materials and records) of Borrower pertaining to any of (i) through (vii) above. 5.2. Lien Perfection; Further Assurances. Borrower shall execute such UCC-1 financing statements as are required by the Code and such other instruments, assignments or documents as are requested by Agent and reasonably necessary to perfect Agent's Lien upon any of the Collateral and shall take such other action as may be reasonably required to perfect or to continue the perfection of Agent's Lien upon the Collateral. Unless prohibited by applicable law, Borrower hereby authorizes Agent to execute and file any such financing statement on Borrower's behalf. The parties agree that a carbon, photographic or other reproduction of this Agreement shall be sufficient as a financing statement and may be filed in any appropriate office in lieu thereof. At Agent's request, Borrower shall also promptly execute or cause to be executed and shall deliver to Agent any and all documents, instruments and agreements deemed reasonably necessary by Agent to give effect to or carry out the terms or intent of the Loan Documents. SECTION 6. COLLATERAL ADMINISTRATION 6.1. General. 6.1.1. Location of Collateral. All Collateral, other than Inventory in transit and motor vehicles, will at all times be kept by Borrower at one or more of the business locations set forth in Exhibit 6.1.1 hereto and shall not, without the prior written approval of Agent, be moved therefrom except, prior to an Event of Default and Agent's acceleration of the maturity of the Obligations in consequence thereof, for (i) sales of Inventory in the ordinary course of business; and (ii) removals in connection with dispositions of Equipment that are authorized by SUBSECTION 6.4.2 hereof. 6.1.2. Insurance of Collateral. Borrower shall maintain and pay for insurance to the extent available at commercially reasonable rates upon all Collateral which is customarily insured wherever located and with respect to Borrower's business, covering casualty, hazard, public liability and such other customary risks in such amounts, with such insurance companies as are reasonably satisfactory to Agent. Borrower shall deliver copies of such policies to Agent with satisfactory lender's loss payable endorsements, naming Agent as loss payee, assignee or additional insured, as appropriate. Each policy of insurance or endorsement shall contain a clause requiring the insurer to give not less than 30 days prior written notice to Agent in the event of cancellation of the policy for any reason whatsoever and a clause specifying that the interest of Agent shall not be impaired or invalidated by any act or neglect of Borrower or the owner of the Property or by the occupation of the premises for purposes more hazardous than are permitted by said policy. If Borrower fails to provide and pay for such insurance, Agent may, at its option, but shall not be required to, procure the same and charge Borrower therefor. Borrower agrees to deliver to Agent, promptly as rendered, true copies of all reports made in any reporting forms to insurance companies. 6.1.3. Protection of Collateral. All expenses of protecting, storing, warehousing, insuring, handling, maintaining and shipping the Collateral, any and all excise, property, sales, and 19 use taxes imposed by any state, federal, or local authority on any of the Collateral or in respect of the sale thereof shall be borne and paid by Borrower. If Borrower fails to promptly pay any portion thereof when due, Agent may, at its option, but shall not be required to, pay the same and charge Borrower therefor. Neither Agent nor any Lender shall be liable or responsible (except for reasonable care in the custody thereof while any Collateral is in Agent's or any Lender's actual possession or under their actual control) in any way for the safekeeping of any of the Collateral or for any loss or damage thereto or for any diminution in the value thereof, or for any act or default of any warehouseman, carrier, forwarding agency, or other person whomsoever, but the same shall be at Borrower's sole risk. 6.2. Administration of Accounts. 6.2.1. Records, Schedules and Assignments of Accounts. Borrower shall keep accurate and complete records of its Accounts and all payments and collections thereon and shall submit to Agent on such periodic basis as Agent shall request a sales and collections report for the preceding period, in form satisfactory to Agent. On or before the fifteenth day of each month from and after the date hereof, Borrower shall deliver to Agent, in form acceptable to Agent, accounts payable schedules and a summary aged trial balance of all Accounts existing as of the last day of the preceding month, specifying the names of each Account Debtor obligated on an Account so listed and the aggregate outstanding balance of Accounts so listed ("Schedule of Accounts"), and, in the event Availability is less than $3,000,000 and upon Agent's request therefor, copies of proof of delivery and the original copy of all documents, including, without limitation, repayment histories and present status reports relating to the Accounts so scheduled and such other matters and information relating to the status of then existing Accounts as Agent shall reasonably request. In addition, if Accounts in an aggregate face amount in excess of $250,000 become ineligible because they fall within one of the specified categories of ineligibility set forth in the definition of Eligible Accounts or otherwise established by Agent, Borrower shall notify Agent of such occurrence on the first Business Day following such occurrence and the Borrowing base shall thereupon be adjusted to reflect such occurrence. In the event Availability is less than $3,000,000 and if requested by Agent, Borrower shall execute and deliver to Agent formal written assignments of all of its Accounts weekly or daily, which shall include all Accounts that have been created since the date of the last assignment, together with copies of invoices or invoice registers related thereto. 6.2.2. Discounts, Allowances, Disputes. If Borrower grants any discounts, allowances or credits that are not shown on the face of the invoice for the Account involved, Borrower shall report such discounts, allowances or credits, as the case may be, to Agent as part of the next required Schedule of Accounts. If any amounts due and owing in excess of $250,000 are in dispute between Borrower and any Account Debtor, Borrower shall provide Agent with written notice thereof at the time of submission of the next Schedule of Accounts, explaining in detail the reason for the dispute, all claims related thereto and the amount in controversy. Upon and after the occurrence and during the continuance of an Event of Default, Agent shall have the right to settle or adjust all disputes and claims directly with the Account Debtor and to compromise the amount or extend the time for payment of the Accounts upon such terms and conditions as Agent may deem advisable, and to charge the deficiencies, costs and expenses thereof, including attorney's fees, to Borrower. 20 6.2.3. Taxes. If an Account includes a charge for any tax payable by Borrower to any governmental taxing authority, Agent is authorized, in its sole discretion, to pay the amount thereof to the proper taxing authority for the account of the Borrower and to charge Borrower's Account therefor, unless it is (1) being contested in good faith and adequate reserves have been set aside in accordance with GAAP, and (2) none of the Collateral has become subject to forfeiture or loss as a result of such contest and (3) Agent has not advised Borrower in writing that Agent reasonably believes that non-payment is reasonably likely to have or result in a Material Adverse Effect, provided, however that Agent shall not be liable for any taxes to any governmental taxing authority that may be due by Borrower. The Agent shall promptly notify the Borrower of the payment of any such amounts. 6.2.4. Account Verification. Whether or not a Default or an Event of Default has occurred, any of Agent's officers, employees or agents shall have the right, at any time or times hereafter, in the name of Agent, any designee of Agent or Borrower, to verify the validity, amount or any other matter relating to any Accounts by mail, telephone, telegraph or otherwise. Borrower shall cooperate fully with Agent in an effort to facilitate and promptly conclude any such verification process. 6.2.5. Maintenance of Dominion Account. On or prior to November 15, 1998, Borrower shall establish and maintain a Dominion Account pursuant to a lockbox arrangement acceptable to Agent with such banks as may be selected by Borrower and be acceptable to Agent. Borrower shall issue to any such banks an irrevocable letter of instruction directing such banks to deposit all payments or other remittances received in the lockbox to the Dominion Account for application on account of the Obligations. All funds deposited in the Dominion Account shall immediately become the property of Agent and Borrower shall obtain the agreement by such banks in favor of Agent to waive any offset rights against the funds so deposited. Agent assumes no responsibility for such lockbox arrangement, including, without limitation, any claim of accord and satisfaction or release with respect to deposits accepted by any bank thereunder. 6.2.6. Collection of Accounts, Proceeds of Collateral. To expedite collection, Borrower shall endeavor in the first instance to make collection of its Accounts for Agent. All remittances received by Borrower on account of Accounts, together with the proceeds of any other Collateral, shall be held as Agent's property by Borrower as trustee of an express trust for Agent's benefit and Borrower shall immediately deposit same in kind in the Dominion Account. Agent retains the right at all times after the occurrence of a Default or an Event of Default, if continuing, to notify Account Debtors that Accounts have been assigned to Agent and to collect Accounts directly in its own name and to charge the collection costs and expenses, including attorneys' fees to Borrower. 6.3. Administration of Inventory. 6.3.1. Records and Reports of Inventory. Borrower shall keep accurate and complete records of its inventory. Borrower shall furnish to Agent Inventory reports in form and detail satisfactory to Agent at such times as Agent may request, but at least once each month, not later than the twentieth day of such month. Borrower shall conduct a physical inventory annually and shall provide to Agent a report based on each such physical inventory promptly thereafter, together with such supporting information as Agent shall request. 21 6.3.2. Returns of Inventory. If at any time or times hereafter any Account Debtor returns any Inventory to Borrower the shipment of which generated an Account on which such Account Debtor is obligated in excess of $250,000, Borrower shall immediately notify Agent of the same, specifying the reason for such return and the location, condition and intended disposition of the returned Inventory. 6.4. Administration of Equipment. 6.4.1. Records and Schedules of Equipment. Borrower shall keep accurate records itemizing and describing the kind, type, quality, quantity and value of its Equipment and all dispositions made in accordance with SUBSECTION 6.4.2 hereof, and shall furnish Agent with a current schedule containing the foregoing information on at least an annual basis and more often if requested by Agent. Immediately on request therefor by Agent, Borrower shall deliver to Agent any and all evidence of ownership, if any, of any of the Equipment. 6.4.2. Dispositions of Equipment. Borrower will not sell, lease or otherwise dispose of or transfer any of the Equipment or any part thereof without the prior written consent of Agent; provided, however, that the foregoing restriction shall not apply, for so long as no Default or Event of Default exists, to (i) dispositions of Equipment which, in the aggregate during any consecutive twelve-month period, has a fair market value or book value, whichever is less, of $250,000 or less, provided that all proceeds thereof are remitted to Agent for application to the Loans, or (ii) replacements of Equipment that is substantially worn, damaged or obsolete with Equipment of like kind, function and value, provided that the replacement Equipment shall be acquired prior to or concurrently with any disposition of the Equipment that is to be replaced, the replacement Equipment shall be subject to the Liens of Agent and shall be free and clear of all other Liens other than Permitted Liens that are not Purchase Money Liens, and Borrower shall have given Agent at least 5 days prior written notice of such disposition. 6.5. Payment of Charges. All amounts chargeable to Borrower under SECTION 6 hereof shall be Obligations secured by all of the Collateral, shall be payable on demand and shall bear interest from the date such advance was made until paid in full at the rate applicable to Base Rate Loans from time to time. 6.6. Additional Payments. Any sums expended by Agent or any Lender due to Borrower's failure to perform or comply with its obligations under this Agreement or any other Loan Document may be charged to Borrower's account as a Revolving Credit Loan and added to the Obligations. SECTION 7. REPRESENTATIONS AND WARRANTIES 7.1. General Representations and Warranties. To induce Agent and Lenders to enter into this Agreement and to make advances hereunder, Borrower warrants, represents and covenants to Agent and Lenders that: 22 7.1.1. Organization and Qualification. It is a corporation duly organized, validly existing and in good standing under the laws of the jurisdiction of its incorporation. It is duly qualified and is authorized to do business and is in good standing in all states and jurisdictions where the character of its Properties or the nature of its activities make such qualification necessary, except where the failure to be so qualified would not have a Material Adverse Effect. Exhibit 7.1.1 sets forth all states or jurisdictions where Borrower or any Subsidiary is qualified and authorized to do business as of the Closing Date. 7.1.2. Power and Authority. It is duly authorized and empowered to enter into, execute, deliver and perform this Agreement and each of the other Loan Documents to which it is a party. The execution, delivery and performance of this Agreement and each of the other Loan Documents have been duly authorized by all necessary corporate action and do not and will not (i) require any consent or approval of its shareholders; (ii) contravene its charter, articles or certificate of incorporation or by-laws; (iii) violate, or cause it to be in default under, any provision of any law, rule, regulation, order, writ, judgment, injunction, decree, determination or award in effect having applicability to it which violation or default would likely have a Material Adverse Effect; (iv) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other agreement, lease or instrument to which it is a party or by which it or its Properties may be bound or affected which violation or default would likely have a Material Adverse Effect; or (v) result in, or require, the creation or imposition of any Lien (other than Permitted Liens) upon or with respect to any of the Properties now owned or hereafter acquired by it. 7.1.3. Legally Enforceable Agreement. This Agreement is, and each of the other Loan Documents when delivered under this Agreement will be, a legal, valid and binding obligation of the Borrower enforceable against it in accordance with its respective terms; except as may be limited by applicable bankruptcy, insolvency, reorganization, moratorium or similar laws affecting creditors' rights generally and by general equitable principles (whether enforcement is sought by proceeding in equity or at law). 7.1.4. Capital Structure. Exhibit 7.1.4 hereto states (i) the correct name of Borrower and each of Borrower's Subsidiaries, its jurisdiction of incorporation and the percentage of its stock owned by each Person listed thereon, (ii) the name of the corporate or joint venture Affiliates of Borrower and of each Subsidiary of Borrower, and the nature of the affiliation, and (iii) the number, nature and holder of all outstanding stock of Borrower and of each Subsidiary of Borrower, in each case as of the Closing Date. Borrower has good title to all shares of stock it purports to own of each Subsidiary of Borrower, free and clear in each case of any Lien other than Permitted Liens. All such shares of stock have been duly issued and are fully paid and non-assessable. Except as set forth on Exhibit 7.1.4, there are (i) no outstanding options to purchase, or any rights or warrants to subscribe for, or any commitments or agreements to issue or sell, or any Securities, stock or obligations convertible into, or any powers of attorney relating to, shares of the capital stock of Borrower and (ii) no outstanding agreements or instruments binding upon any stockholders of Borrower or any Subsidiary of Borrower relating to the ownership of its shares of capital stock. 7.1.5. Corporate Names. Since 1988, neither Borrower nor any Subsidiary of Borrower has been known as or used any corporate, fictitious or trade names except those listed on Exhibit 7.1.5 hereto. Except as set forth on Exhibit 7.1.5, since 1988 Borrower has not been the 23 surviving entity of a merger or consolidation or acquired all or substantially all of the assets of any Person. 7.1.6. Business Locations; Agent for Process. The chief executive office and other places of business of Borrower and each Subsidiary of Borrower are as listed on Exhibit 7.1.6 hereto. During the preceding one-year period, neither Borrower nor any Subsidiary of Borrower has had an office, place of business or agent for service of process other than as listed on Exhibit 7.1.6. Except as shown on Exhibit 7.1.6, no Inventory is stored with a bailee, warehouseman or similar party, nor is any Inventory consigned to any Person. 7.1.7. Title to Properties; Priority of Liens. Borrower and each Subsidiary of Borrower has good, indefeasible and marketable title to and fee simple ownership of, or valid and subsisting leasehold interests in, all of its real Property, and good title to all of the Collateral and all of its other Property, in each case, free and clear of all Liens except Permitted Liens. Borrower has paid or discharged all lawful claims which, if unpaid, might become a Lien against any of its Properties that is not a Permitted Lien. The Liens granted to Agent for the ratable benefit of Lenders under SECTION 5 hereof are first priority Liens, subject only to Permitted Liens. 7.1.8. Accounts. Agent may rely, in determining which Accounts are Eligible Accounts, on all statements and representations made by Borrower with respect to any Account or Accounts. Unless otherwise indicated in writing to Agent, with respect to each Account: (i) It is genuine and in all respects what it purports to be, and it is not evidenced by a judgment; (ii) It arises out of a completed, bona fide sale and delivery of goods or rendition of services by Borrower in the ordinary course of its business and in accordance with the terms and conditions of all purchase orders, contracts or other documents relating thereto and forming a part of the contract between Borrower and the Account Debtor; (iii) It is for a liquidated amount payable on the date stated in the duplicate invoice covering such sale or rendition of services, a copy of which has been furnished or is available to Agent; (iv) Such Account, and Agent's security interest therein, is not subject to any offset, Lien, deduction, defense, dispute, counterclaim or any other adverse condition except where the amount in controversy is deemed by Agent to be immaterial, and each such Account is absolutely owing to Borrower and is not contingent in any respect or for any reason; (v) Borrower has not made any agreement with any Account Debtor thereunder for any extension, compromise, settlement or modification of any such Account or any deduction therefrom, except for discounts or allowances which are granted by Borrower in the ordinary course of its business and which are reflected in the calculation of the net amount of each respective invoice related thereto and are reflected in the Schedules of Accounts submitted to Agent pursuant to SUBSECTION 6.2.1 hereof or such other extensions, compromises, 24 settlements or modifications of any Account or any deduction therefrom disclosed in writing by Borrower to Agent and consented thereto in writing by Agent; (vi) To the best of Borrower's knowledge, the Account Debtor thereunder (1) had the capacity to contract at the time any contract or other document giving rise to the Account was executed and (2) such Account Debtor was at such time Solvent; and (vii) To the best of Borrower's knowledge at the time such Account arose, there were no proceedings or actions which are threatened or pending against any Account Debtor thereunder which might result in any material adverse change in such Account Debtor's financial condition or the collectability of such Account. 7.1.9. Equipment. Any Equipment used for the operation of the Borrower's business is in good operating condition and repair, and all necessary replacements of and repairs thereto shall be made so that the value and operating efficiency of the Equipment shall be maintained and preserved, reasonable wear and tear excepted. Borrower will not permit any of the Equipment to become affixed to any real Property leased to Borrower so that an interest arises therein under the real estate laws of the applicable jurisdiction unless the landlord of such real Property has executed a landlord waiver or consented to a leasehold mortgage in favor of and in form acceptable to Lender, and Borrower will not permit any of the Equipment to become an accession to any personal Property other than Equipment that is subject to first priority (except for Permitted Liens) Liens in favor of Agent for the benefit of Lenders. 7.1.10. Financial Statements; Fiscal Year. (a) The balance sheets of Borrower on a Consolidated Basis as of December 31, 1997 and the related statements of income, changes in stockholder's equity, and changes in financial position for the periods ended on such dates, have been prepared in accordance with GAAP, and present fairly the financial position of Borrower on a Consolidated Basis at such dates and the results of Borrower's operations for such periods, subject to normally occurring year-end audit adjustments. Since June 30, 1998, there has been no event or condition having a Material Adverse Effect and no change in the aggregate value of Equipment (except in connection with reasonable wear and tear of such Equipment) owned by Borrower. (b) Projections of Borrower on a Consolidated Basis with respect to Fiscal Years 1998 and 1999, copies of which are annexed hereto as Exhibit 7.1.10 (b), were prepared by Borrower and reviewed by its chief financial officer, treasurer or controller and, as of the Closing Date, are based on underlying assumptions which provide a reasonable basis for the Projections contained therein and reflect Borrower's judgment based on present circumstances of the most likely set of conditions and course of action for the projected period. 7.1.11. Full Disclosure. The financial statements referred to in SUBSECTION 7.1.10 hereof do not, nor does this Agreement or any other written statement delivered by Borrower to Agent or any Lender in connection herewith, contain any untrue statement of a material fact or omit a material fact necessary to make the statements contained therein or herein not materially misleading. There is no fact which Borrower has failed to disclose to Agent in writing which would likely have a Material Adverse Effect. 25 7.1.12. Solvent Financial Condition. Borrower and each Guarantor is now and, after giving effect to the Transactions, will be, Solvent. 7.1.13. Surety Obligations. Neither Borrower nor any Subsidiary of Borrower is obligated as surety or indemnitor under any surety or similar bond or other contract issued or entered into any agreement to assure payment, performance or completion of performance of any undertaking or obligation of any Person. 7.1.14. Taxes. Borrower's federal tax identification number is as set forth on Exhibit 7.1.14. The federal tax identification number of each Subsidiary of Borrower is shown on Exhibit 7.1.14 hereto. Borrower and each Subsidiary of Borrower has filed all federal, state and local tax returns and other reports it is required by law to file and has paid, or made provision for the payment of, all taxes, assessments, fees, levies and other governmental charges upon it, its income and Properties shown in such returns to be due and payable or assessed against them by any governmental authority, unless and to the extent any such amounts are being actively contested in good faith and by appropriate proceedings and Borrower and each Subsidiary of Borrower, as applicable, maintains reasonable reserves on their books therefor. The provision for taxes on the books of Borrower and each Subsidiary of Borrower are adequate for all years not closed by applicable statutes, and for its current fiscal year and, for all tax years thereafter which are not closed by applicable statutes, the provisions for taxes on the books of Borrower and each Subsidiary of Borrower will be adequate. 7.1.15. Brokers. There are no claims for brokerage commissions, finder's fees or investment banking fees in connection with the transactions contemplated by this Agreement 7.1.16. Patents, Trademarks, Copyrights and Licenses. Borrower and each Subsidiary of Borrower owns, possesses or has the right to use all the patents, trademarks, service marks, trade names, copyrights and licenses necessary for the present and planned future conduct of its business without any known conflict with the rights of others. All such patents, trademarks, service marks, tradenames, copyrights, licenses and other similar rights are listed on Exhibit 7.1.16 hereto. 7.1.17. Governmental Consents. Borrower and each Subsidiary of Borrower has, and is in good standing with respect to, all governmental consents, approvals, licenses, authorizations, permits, certificates, inspections and franchises materially necessary to continue to conduct its business as heretofore or proposed to be conducted by it and to own or lease and operate its Properties as now owned or leased by it. 7.1.18. Compliance with Laws. Borrower and each Subsidiary of Borrower has duly complied, and its Properties, business operations and leaseholds are in compliance in all material respects, with the provisions of all federal, state and local laws, rules and regulations applicable to it as applicable, its Properties or the conduct of its business and there have been no citations, notices or orders of noncompliance issued to Borrower or any Subsidiary of Borrower under any such law, rule or regulation. Borrower and each Subsidiary of Borrower has established and maintains an adequate monitoring system to insure that it remains in compliance with all federal, state and local laws, rules and regulations applicable to it. No Inventory produced by Borrower has been produced in violation of the Fair Labor Standards Act (29 U.S.C. 'SS' 201 et seq.), as amended. 26 7.1.19. Restrictions. Neither Borrower nor any Subsidiary of Borrower is a party or subject to any contract, agreement, or charter or other corporate restriction, which solely as a result of the terms thereof could reasonably be expected to have a Material Adverse Effect. Neither Borrower nor any Subsidiary of Borrower is a party or subject to any contract or agreement which restricts its right or ability to incur Indebtedness, other than as set forth on Exhibit 7.1.19 hereto, none of which prohibit the execution of or compliance with this Agreement or the other Loan Documents by Borrower or any Subsidiary of Borrower, as applicable. 7.1.20. Litigation. Except as set forth on Exhibit 7.1.20 hereto, there are no actions, suits, proceedings or investigations pending or, to the knowledge of Borrower, threatened, against or affecting Borrower or any Subsidiary of Borrower, or the business, operations, Properties, prospects, profits or condition of Borrower or any Subsidiary of Borrower, which could reasonably be expected to have a Material Adverse Effect. Neither Borrower nor any Subsidiary of Borrower is in default with respect to any order, writ, injunction, judgment, decree or rule of any court, governmental authority or arbitration board or tribunal which would likely have a Material Adverse Effect. 7.1.21. No Defaults. No event has occurred and no condition exists which would, upon or after the execution and delivery of this Agreement and the other Loan Documents or Borrower's performance hereunder or thereunder, constitute a Default or an Event of Default. Neither Borrower nor any of its Subsidiaries is in default with respect to any order, writ, injunction, judgment, decree or rule of any court, governmental authority or arbitration board or tribunal. 7.1.22. Leases. Exhibit 7.1.22(A) hereto is a complete listing of all capitalized leases of Borrower and Exhibit 7.1.22(B) hereto is a complete listing of all operating leases of Borrower. Borrower is in compliance with all of the terms of each of its respective capitalized and operating leases. 7.1.23. Pension Plans. Except as disclosed on Exhibit 7.1.23 hereto, neither Borrower nor any Subsidiary of Borrower has any Plan. Borrower and each Subsidiary of Borrower is in full compliance with the requirements of ERISA and the regulations promulgated thereunder with respect to each Plan. No fact or situation that would likely have a Material Adverse Effect exists in connection with any Plan. Neither Borrower nor any Subsidiary of Borrower has any withdrawal liability in connection with a Multiemployer Plan. 7.1.24. Trade Relations. There exists no actual or threatened termination, cancellation or limitation of, or any modification or change in, the business relationship between Borrower and any customer or any group of customers of Borrower, the absence of whose purchases individually or in the aggregate would likely have a Material Adverse Effect, or with any material supplier of Borrower, the absence of whose products or services would likely have a Material Adverse Effect. There exists no present condition or state of facts or circumstances which would have a Material Adverse Effect on Borrower or prevent Borrower from conducting its business after the consummation of the transaction contemplated by this Agreement in substantially the same manner in which it has heretofore been conducted. 27 7.1.25. Labor Relations. Except as described on Exhibit 7.1.25 hereto, neither Borrower nor any Subsidiary of Borrower is a party to any collective bargaining agreement. There are no material grievances, disputes or controversies with any union or any other organization of Borrower's or any Subsidiary of Borrower's employees or threats of strikes, work stoppages or any asserted pending demands for collective bargaining by any union or organization. 7.1.26. O.S.H.A. and Environmental Compliance. Except as set forth on Exhibit 7.1.26: (a) Borrower and each Subsidiary of Borrower has duly complied with, and its facilities, business, assets, property, leaseholds and Equipment are in compliance in all material respects with, the provisions of the Federal Occupational Safety and Health Act, the Environmental Protection Act, RCRA and all other Environmental Laws; there have been no outstanding citations, notices or orders of non-compliance issued to Borrower or any Subsidiary of Borrower or relating to its business, assets, property, leaseholds or Equipment under any such laws, rules or regulations that would have a Material Adverse Effect. (b) Borrower and each Subsidiary of Borrower has been issued all material federal, state and local licenses, certificates or permits relating to all applicable Environmental Laws. (c) (i) There are no visible signs of releases, spills, discharges, leaks or disposals (collectively referred to as "Releases") of Hazardous Substances at, upon, under or within any real Property or any premises leased by Borrower or any Subsidiary of Borrower that would have a Material Adverse Effect; (ii) to Borrower's knowledge there are no underground storage tanks or polychlorinated biphenyls on the real Property or any premises leased by Borrower or any Subsidiary of Borrower; (iii) Borrower has not used the real Property or any premises leased by Borrower or any Subsidiary of Borrower as a treatment, storage or disposal facility of Hazardous Waste; and (iv) no Hazardous Substances are used on the real Property or any premises leased by Borrower or any Subsidiary of Borrower, excepting such quantities as are handled in accordance with all applicable manufacturer's instructions and governmental regulations and in proper storage containers and as are necessary for the operation of the commercial business of Borrower or any Subsidiary of Borrower or of its tenants. 7.2. Continuous Nature of Representations and Warranties. Each representation and warranty contained in this Agreement and the other Loan Documents shall be continuous in nature and shall remain accurate, complete and not misleading at all times during the term of this Agreement, except for those representations and warranties which are expressly limited by their terms to a specific date and taking into account any amendments to the Schedules and Exhibits hereto as a result of any disclosures made by Borrower to Agent after the Closing Date. 7.3. Survival of Representations and Warranties. All representations and warranties of Borrower contained in this Agreement or any of the other Loan Documents shall survive the execution, delivery and acceptance thereof by Agent and Lenders and the parties thereto and the closing of the transactions described therein or related thereto. SECTION 8. COVENANTS AND CONTINUING AGREEMENTS 28 8.1. Affirmative Covenants. During the term of this Agreement, and thereafter for so long as there are any Obligations to Agent or Lenders, Borrower covenants that it shall: 8.1.1. Visits and Inspections. Permit representatives of Agent, from time to time, as often as may be reasonably requested, but only during normal business hours, to visit and inspect the Properties of Borrower and each of its Subsidiaries, inspect, audit and make extracts from its books and records, and discuss with its officers, its employees and its independent accountants, Borrower's and each of its Subsidiaries' business, assets, liabilities, financial condition, business prospects and results of operations. 8.1.2. Notices. Promptly notify Agent in writing of the occurrence of any event or the existence of any fact which renders any representation or warranty in this Agreement or any of the other Loan Documents inaccurate, incomplete or misleading in any material respect. 8.1.3. Financial Statements. Keep, and cause each Subsidiary to keep, adequate records and books of account with respect to its business activities in which proper entries are made in accordance with GAAP reflecting all its financial transactions; and cause to be prepared and furnished to Agent and Lenders the following (all to be prepared in accordance with GAAP applied on a consistent basis, unless Borrower's certified public accountants concur in any change therein and such change is disclosed to Agent and is consistent with GAAP): (i) not later than 90 days after the close of each Fiscal Year of Borrower, audited financial statements of Borrower on a Consolidated Basis as of the end of such Fiscal Year, reported on by a firm of independent certified public accountants of recognized standing selected by Borrower but acceptable to Agent (the "Accountants"); (ii) not later than thirty (30) days after the end of each Fiscal Month hereafter, including the last Fiscal Year of Borrower's Fiscal Year unaudited interim financial statements of Borrower as of the end of such period and of the portion of Borrower's Fiscal Year then elapsed, on a Consolidated Basis and consolidating basis, certified by the principal financial officer of Borrower as prepared in accordance with GAAP and fairly presenting the consolidating and consolidated financial position and results of operations of Borrower for such period subject only to changes from audit and year-end adjustments and except that such statements need not contain notes; (iii) promptly after the sending or filing thereof, as the case may be, copies of any proxy statements or financial statements which Borrower or any Subsidiary of Borrower has made available to its shareholders and copies of any regular, periodic and special reports or registration statements which Borrower or any Subsidiary of Borrower files with the Securities and Exchange Commission or any governmental authority which may be substituted therefor, or any national securities exchange; (iv) promptly after the filing thereof, copies of any annual report to be filed with the Pension Benefit Guaranty Corporation (the "PBGC") in connection with each Plan; and 29 (v) such other data and information (financial and otherwise) as Agent or any Lender, from time to time, may reasonably request, bearing upon or related to the Collateral or Borrower's, any Subsidiary of Borrower's or any of their respective Subsidiaries' financial condition or results of operations. Concurrently with the delivery of the financial statements described in clause (i) of this SUBSECTION 8.1.3, Borrower shall forward to Agent a copy of the accountants' letter to Borrower's management or board of directors that is prepared in connection with such financial statements and also shall cause to be prepared and shall furnish to Agent a certificate of the aforesaid certified public accountants certifying that, based upon their examination of the financial statements of Borrower and its respective Subsidiaries performed in connection with their examination of said financial statements, they are not aware of any Default or Event of Default or, if they are aware of such Default or Event of Default, specifying the nature thereof, and acknowledging, in a manner satisfactory to Agent, that they are aware that Agent and Lenders are relying on such financial statements in making their decisions with respect to the Loans. Concurrently with the delivery of the financial statements described in clauses (i) and (ii) of this SUBSECTION 8.1.3, or more frequently if requested by Agent, Borrower shall cause to be prepared and furnished to Agent a Compliance Certificate in the form of Exhibit 8.1.3 hereto executed by the chief financial officer, treasurer or controller of Borrower. 8.1.4. Landlord and Storage Agreements. Provide Agent with copies of all agreements between Borrower, each Subsidiary of Borrower or any of their respective Subsidiaries and any landlord or warehouseman which owns any premises at which any Inventory may, from time to time, be kept. 8.1.5. Credit Memoranda. Issue and process credit memoranda with respect to credits, discounts or other allowances taken by Account Debtors in the ordinary course of Borrower's business, but in no event shall such credit memoranda be issued and processed later than three (3) months after the taking of the applicable credit, discount or other allowance. 8.1.6. Projections. No later than 60 days after to the end of each fiscal year of Borrower, deliver to Agent Projections of Borrower on a Consolidated Basis for the forthcoming 3 years, year by year, and for the forthcoming fiscal year, month by month. 8.1.7. Environmental Matters. (a) Borrower shall and shall cause each Subsidiary of Borrower to ensure that the real Property remains in material compliance with all applicable Environmental Laws and they shall not place or permit to be placed any Hazardous Substances on any real Property in violation of any applicable law or governmental regulations. (b) Borrower shall and shall cause each Subsidiary of Borrower to establish and maintain a system to assure and monitor continued compliance with all applicable Environmental Laws which system shall include periodic reviews of such compliance. (c) Borrower shall and shall cause each Subsidiary of Borrower to (i) employ in connection with the use of the real Property appropriate technology necessary to maintain compliance with any applicable Environmental Laws and (ii) to the extent necessary, dispose of any and all Hazardous Waste generated at the real Property only at facilities and with carriers that maintain valid permits 30 under RCRA and any other applicable Environmental Laws. Borrower shall and shall cause each Subsidiary of Borrower to use its best efforts to obtain certificates of disposal, if required, such as hazardous waste manifest receipts, from all treatment, transport, storage or disposal facilities or operators employed by Borrower or any Subsidiary of Borrower in connection with the transport or disposal of any Hazardous Waste generated at the real Property. (d) In the event Borrower or any Subsidiary of Borrower (i) obtains, gives or receives notice of any Release or threat of Release of a reportable quantity of any Hazardous Substances at the real Property (any such event being hereinafter referred to as a "Hazardous Discharge") or (ii) receives any notice of violation, request for information or notification that it is potentially responsible for investigation or cleanup of environmental conditions at the real Property, demand letter or complaint, order, citation, or other written notice with regard to any Hazardous Discharge or violation of Environmental Laws having a Material Adverse Effect on the real Property or Borrower's or any Subsidiary of Borrower's interest therein from any state or local agency responsible in whole or in part for environmental matters in the state in which the real Property is located or the United States Environmental Protection Agency (any such person or entity hereinafter, the "Authority") (any of the foregoing is referred to herein as an "Environmental Complaint"), then Borrower shall promptly give written notice of same to Agent detailing facts and circumstances of which Borrower or any Subsidiary of Borrower is aware giving rise to the Hazardous Discharge or Environmental Complaint. Such information is to be provided to allow Agent to protect its security interest in the Collateral and is not intended to create nor shall it create any obligation upon Agent or any Lender with respect thereto. (e) Borrower shall and shall cause each Subsidiary of Borrower to promptly forward to Agent copies of any request for information, notification of potential liability, demand letter relating to potential responsibility with respect to the investigation or cleanup of Hazardous Substances at any other site owned, operated or used by Borrower or any Subsidiary of Borrower to dispose of Hazardous Substances and shall continue to forward copies of correspondence between Borrower or any Subsidiary of Borrower and the Authority regarding such claims to Agent until the claim is settled. Borrower shall and shall cause each Subsidiary of Borrower to promptly forward to Agent copies of all documents and reports concerning a Hazardous Discharge at the real Property that Borrower or any Subsidiary of Borrower is required to file under any applicable Environmental Laws. Such information is to be provided solely to allow Agent to protect Agent's security interest in the Collateral. (f) Borrower shall and shall cause each Subsidiary of Borrower to respond promptly to any Hazardous Discharge or Environmental Complaint and take all actions reasonably required by applicable Environmental Laws in order to safeguard the health of any Person and to avoid subjecting the Collateral or real Property to any Lien. If Borrower or any Subsidiary of Borrower shall fail to respond promptly to any Hazardous Discharge or Environmental Complaint or Borrower or any Subsidiary of Borrower shall fail to comply with any of the requirements of any applicable Environmental Laws, Agent on behalf of Lenders may, but without the obligation to do so, for the sole purpose of protecting Agent's interest in Collateral: (A) give such notices or (B) enter onto the real Property (or authorize third parties to enter onto the real Property) and take such actions as Agent (or such third parties as directed by Agent) deem reasonably necessary or advisable, to clean up, remove, mitigate or otherwise deal with any such Hazardous Discharge or Environmental Complaint. All reasonable costs and expenses incurred by Agent and Lenders (or such third parties) in the exercise of any such rights, including any sums paid in connection with any judicial or administrative investigation 31 or proceedings, fines and penalties, together with interest thereon from the date expended at the Default Rate for Base Rate Loans, shall be paid upon demand by Borrower, and until paid shall be added to and become a part of the Obligations secured by the Liens created by the terms of this Agreement or any other agreement between Agent, any Lender, Borrower and any Subsidiary of Borrower. (g) At any time following any Hazardous Discharge or Environmental Complaint Borrower shall and shall cause each Subsidiary of Borrower, as applicable, to provide Agent, at Borrower's expense, with any environmental site assessment or environmental audit report prepared by an environmental engineering firm acceptable in the reasonable opinion of Agent, to assess with a reasonable degree of certainty the existence of a Hazardous Discharge and if an abatement, cleanup or removal is required under applicable Environmental Laws, the potential costs in connection with abatement, cleanup and removal of any Hazardous Substances found on, under, at or within the real Property. Any report or investigation of such Hazardous Discharge proposed and acceptable to an appropriate Authority that is charged to oversee the clean-up of such Hazardous Discharge shall be acceptable to Agent. If such estimates, individually or in the aggregate, exceed $100,000, Agent shall have the right to require Borrower or any Subsidiary of Borrower, as applicable, to post a bond, letter of credit or other security reasonably satisfactory to Agent to secure payment of these costs and expenses. (h) Borrower shall and shall cause each Subsidiary of Borrower to defend and indemnify Agent and Lenders and hold Agent, Lenders and their respective employees, agents, directors and officers harmless from and against all loss, liability, damage and expense, claims, costs, fines and penalties, including reasonable attorney's fees, suffered or incurred by Agent or Lenders under or on account of any Environmental Laws, including, without limitation, the assertion of any Lien thereunder, with respect to any Hazardous Discharge, the presence of any Hazardous Substances affecting the real Property, whether or not the same originates or emerges from the real Property or any contiguous real estate, except to the extent such loss, liability, damage and expense is attributable to any Hazardous Discharge resulting from actions on the part of Agent or any Lender. Borrower's and each Subsidiary of Borrower's obligations under this Section 8.1.7 shall arise upon the discovery of the presence of any Hazardous Substances at the real Property, whether or not any federal, state, or local environmental agency has taken or threatened any action in connection with the presence of any Hazardous Substances. Borrower's and each Subsidiary of Borrower's obligation and the indemnifications hereunder shall survive the termination of this Agreement. (i) For purposes of Sections 8.1.7 and 7.1.26, all references to real Property shall be deemed to include all of Borrower's and each Subsidiary of Borrower's right, title and interest in and to its owned and leased premises. 8.1.8. License Agreements. (a) On or prior to September 15, 1998, provide Agent copies of all license agreements to which Borrower is a party and (b) use its best efforts to cause those licensors under such license agreements as Agent shall specify to deliver to Agent on or prior to thirty (30) days after Agent's request therefor (the "Specified Period") a licensor consent letter, acceptable to Agent, pursuant to which such licensor, among other things, consents to Agent's sale of Inventory with all licensed marks covered by the applicable license agreement. Borrower acknowledges that in the event Agent requests a licensor consent letter from a licensor under any of the aforementioned license agreements and Agent shall not have received such licensor consent letter executed by Borrower and such licensor on or prior to the end of the Specified Period, then until such 32 time as Agent shall have received such licensor consent letter the Inventory covered by such license agreement shall not be deemed Eligible Inventory hereunder. 8.1.9. Landlord Waivers. Use its best efforts to cause each of Borrower's landlords to deliver to Agent on or prior to November 15, 1998 a landlord waiver acceptable to Agent. Borrower acknowledges that in the event Agent shall not have received fully executed landlord waivers acceptable to Agent for all locations where Collateral is located on or prior to November 15, 1998, then Agent may establish a Reserve in an amount equal to three months rent for all such locations with respect to which Agent has not received a fully executed landlord waiver acceptable to Agent. 8.1.10. Withdrawal Liability. On or prior to November 15, 1998, deliver to Agent a statement from the applicable trustees of each of the Borrower's Multiemployer Plans specifying whether Borrower is subject to any withdrawal liability under any such Multiemployer Plan. 8.2. Negative Covenants. During the term of this Agreement, and thereafter for so long as there are any Obligations to Lenders, Borrower covenants that, it will not: 8.2.1. Mergers; Consolidations; Acquisitions. (i) Merge or consolidate, or permit any Subsidiary of Borrower to merge or consolidate, with any Person; or (ii) Acquire, or permit any of its Subsidiaries to acquire, all or substantially all of the Properties of any Person. 8.2.2. Loans. Make, or permit any Subsidiary of Borrower to make, any loans or other advances of money (other than (a) loans to employees of Borrower in connection with Borrower's 1994 Executive Stock Incentive Plan, (b) Specified Permitted Investments, (c) for salary, (d) travel advances, (e) advances against commissions and other similar advances in the ordinary course of business) to any Person. 8.2.3. Total Indebtedness. Create, incur, assume, or suffer to exist, or permit any Subsidiary of Borrower to create, incur or suffer to exist, any Indebtedness, except: (i) Obligations owing to Agent and/or Lenders; (ii) Subordinated Debt existing on the date of this Agreement; (iii) Indebtedness of Borrower to any Subsidiary of Borrower; (iv) accounts payable to trade creditors and current operating expenses (other than for Money Borrowed) which are not aged more than 90 days from billing date or more than 30 days from the due date, in each case incurred in the ordinary course of business and paid within such time period, unless the same are being actively contested in good faith and by appropriate and lawful proceedings; and Borrower or such Subsidiary shall have set aside such reserves, if 33 any, with respect thereto as are required by GAAP and deemed adequate by Borrower or such Subsidiary and its independent accountants; (v) Obligations to pay Rentals permitted by subsection 8.2.12; (vi) Purchase Money Indebtedness in an aggregate amount not to exceed $200,000 (excluding capitalized leases); (vii) contingent liabilities arising out of endorsements of checks and other negotiable instruments for deposit or collection in the ordinary course of business; and (viii) Indebtedness not included in paragraphs (i) through (vii) above which does not exceed at any time, in the aggregate, the sum of $1,000,000. 8.2.4. Affiliate Transactions. Enter into, or be a party to, or permit any Subsidiary of Borrower to enter into or be a party to, any transaction with any Affiliate of Borrower or any Subsidiary, except (a) in the ordinary course of and pursuant to the reasonable requirements of Borrower's or such Subsidiary's business and upon fair and reasonable terms which are fully disclosed to Agent and are no less favorable to Borrower or such Subsidiary than would obtain in a comparable arm's length transaction with a Person not an Affiliate or stockholder of Borrower or such Subsidiary and so long as no Default or Event of Default shall then be in existence (b) capital contributions made by Borrower to UniStar, not to exceed an aggregate amount equal to (i) $3,000,000 during the period commencing on July 1, 1998 and ending on December 31, 1998 and (ii) $6,000,000, upon consummation of the Spinoff. 8.2.5. Limitation on Liens. Create or suffer to exist, or permit any Subsidiary of Borrower or any Guarantor to create or suffer to exist, any Lien upon any of its Property (including the Subsidiary Stock and the capital stock of Borrower), income or profits, whether now owned or hereafter acquired, except: (i) Liens at any time granted in favor of Agent for the benefit of Lenders; (ii) Liens for taxes (excluding any Lien imposed pursuant to any of the provisions of ERISA) not yet due, or being contested in the manner described in SUBSECTION 7.1.14 hereto, but only if in Agent's judgment such Lien does not adversely affect Agent's rights or the priority of Agent's Lien in the Collateral; (iii) Liens arising in the ordinary course of business by operation of law or regulation, but only if payment in respect of any such Lien is not at the time required or if such payment is being contested in good faith by appropriate proceedings diligently conducted, and such Liens do not (1) have any material effect on the priority of the Liens in favor of the Agent for the benefit of Lenders or (2) in the aggregate, materially detract from the value of the Property or materially impair the use thereof in the operation of Borrower's or any Subsidiary's business; (iv) Purchase Money Liens securing Purchase Money Indebtedness permitted under SUBSECTION 8.2.3(vi) hereof; 34 (v) Liens securing Indebtedness of Borrower's or a Subsidiary of Borrower to Borrower or another such Subsidiary; and (vi) such other Liens as appear on Exhibit 8.2.5 hereto. 8.2.6. Subordinated Debt. Make, or permit any Subsidiary of Borrower to make, any payment or prepayment of any part or all of any Subordinated Debt except as permitted by the terms of the Indenture. 8.2.7. Distributions. Except in connection with rights to purchase capital stock of UniStar distributed to Borrower's shareholders in connection with the Spinoff, declare, pay or make any distribution on shares of its capital stock or apply any of its funds, property or assets to the purchase, redemption or other retirement of any shares of its capital stock, or of any options to purchase or acquire any capital stock of Borrower. 8.2.8. Capital Expenditures. Make Capital Expenditures (including, without limitation, by way of capitalized leases) which, in the aggregate, as to Borrower and its Subsidiaries, exceed (a) during the period commencing on July 1, 1998 and ending on December 31, 1998, $3,000,000 and (b) $5,000,000 during any fiscal year of Borrower thereafter. 8.2.9. Disposition of Assets. Sell, lease or otherwise dispose of any of its Properties, including any disposition of Property as part of a sale and leaseback transaction, to or in favor of any Person, except (i) sales of Inventory in the ordinary course of business, (ii) a transfer of Property to Borrower by a Subsidiary of Borrower, (iii) dispositions expressly authorized by this Agreement or (iv) so long as no Default or Event of Default shall then be in existence, Borrower shall be permitted to consummate the Spinoff. 8.2.10. Bill-and-Hold Sales, Etc. Make a sale to any customer on a bill-and-hold, guaranteed sale, sale and return, sale on approval or consignment basis, or any sale on a repurchase or return basis. 8.2.11. Restricted Investment. Make or have, or permit any Subsidiary of Borrower to make or have, any Restricted Investment. 8.2.12. Leases. Become, or permit any of its Subsidiaries to become, a lessee under any operating lease (other than a lease under which Borrower or any of its Subsidiaries is lessor) of Property if the aggregate Rentals payable during any current or future period of 12 consecutive months under the lease in question and all other leases under which Borrower or any of its Subsidiaries is then lessee would exceed $6,000,000. The term "Rentals" means, as of the date of determination, all payments which the lessee is required to make by the terms of any lease. 8.2.13. Tax Consolidation. File or consent to the filing of any Consolidated income tax return with any Person other than a Subsidiary of Borrower. 35 8.2.14. Stock of Subsidiaries. Permit any of its Subsidiaries to issue any additional shares of its capital stock except director's qualifying shares. 8.3. Specific Financial Covenants. During each period commencing on the day Availability is less than $7,500,000 and ending on the last day of the first Fiscal Quarter thereafter during which Availability has been greater than or equal to $7,500,000 during each day of such Fiscal Quarter, and for so long as there are any Obligations to Lenders, Borrower covenants that, unless otherwise consented to by Lenders in writing, it shall: 8.3.1. Minimum Net Worth. Maintain a Net Worth of Borrower on a Consolidated Basis as of the end of each Fiscal Year of not less than (i) $60,000,000 for the Fiscal Year ending December 31, 1998 (the "Base Amount") and (ii) for each Fiscal Year thereafter the sum of (a) the Base Amount and (b) 75% of the positive Adjusted Net Earnings from Operations of Borrower for each such Fiscal Year. For purposes of calculating the Base Amount under this SUBSECTION 8.3.1, upon consummation of the Spinoff, the Base Amount shall be decreased by an amount equal to the net adjustment to Borrower's equity as reflected on Borrower's Statement of Shareholders Equity for the Fiscal Year in which the Spinoff occurs. 8.3.2. Cash Flow. Maintain Cash Flow of not less than (a) negative $2,000,000 for the five months ending December 31, 1998, (b) negative $1,000,000 for the eight months ending March 31, 1999 and (c) for each fiscal quarter end, commencing with the fiscal quarter ending June 30, 1999 and each fiscal quarter end thereafter (calculated in each case on a rolling four quarter basis) the amounts indicated below.
Period Amount - ------ ------ Four quarters ending June 30, 1999 ($ 500,000) Four quarters ending September 30, 1999 $ 500,000 Four quarters ending December 31, 1999 and each four quarter period ending thereafter $1,000,000
8.3.3. Adjusted Cash Flow. Maintain for each fiscal quarter end set forth below an Adjusted Cash Flow of not less than (a) negative $2,250,000 for the five months ending December 31, 1998, (b) negative $1,250,000 for the eight months ending March 31, 1999 and (c) for each fiscal quarter end, commencing with the fiscal quarter ending June 30, 1999 and each fiscal quarter ending thereafter (calculated in each case on a rolling four quarter basis) the amounts indicated below.
Period Amount ------ ------ Four quarters ending June 30, 1999 ($750,000) Four quarters ending September 30, 1999 $250,000 Four quarters ending December 31, 1999 and each four quarter period ending thereafter $500,000
SECTION 9. CONDITIONS PRECEDENT 36 Notwithstanding any other provision of this Agreement or any of the other Loan Documents, and without affecting in any manner the rights of Agent and Lenders under the other sections of this Agreement, Lenders shall not be required to make the initial Loans under this Agreement unless and until each of the following conditions has been and continues to be satisfied or has been waived in writing by Required Lenders: 9.1. Documentation. Agent shall have received, in form and substance satisfactory to Agent and its counsel and its local counsel, a duly executed copy of this Agreement and the other Loan Documents, together with such additional documents, instruments and certificates as Lenders and their counsel shall require in connection therewith from time to time, all in form and substance satisfactory to Lenders and their counsel. 9.2. No Default. No Default or Event of Default shall exist. 9.3. Other Loan Documents. Each of the conditions precedent set forth in the other Loan Documents shall have been satisfied. 9.4. Filings, Registrations and Recordings. Each document (including, without limitation, any Uniform Commercial Code financing statement) required by this Agreement, any related agreement or under law or reasonably requested by Agent to be filed, registered or recorded in order to create, in favor of Agent, a perfected security interest in or lien upon the Collateral shall have been properly filed, registered or recorded in each jurisdiction in which the filing, registration or recordation thereof is so required or requested, and Agent shall have received an acknowledgment copy, or other evidence satisfactory to it, of each such filing, registration or recordation and satisfactory evidence of the payment of any necessary fee, tax or expense relating thereto. 9.5. Proceedings of Corporate Parties. Agent shall have received a copy of the resolutions in form and substance reasonably satisfactory to Agent, of the Board of Directors of Borrower authorizing, as applicable (i) the execution, delivery and performance of this Agreement, and any other Loan Documents (collectively the "Documents") and (ii) the granting by Borrower of the security interests in and liens upon the Collateral certified by the Secretary or an Assistant Secretary of the applicable party as of the Closing Date; and, such certificate shall state that the resolutions thereby certified have not been amended, modified, revoked or rescinded as of the date of such certificate. 9.6. Incumbency Certificates of Each Corporate Party. Agent shall have received a certificate of the Secretary or an Assistant Secretary of Borrower, dated the Closing Date, as to the incumbency and signature of the officers of Borrower executing this Agreement or any other Loan Document, any certificate or other documents to be delivered by it pursuant hereto, together with evidence of the incumbency of such Secretary or Assistant Secretary. 9.7. Certificates. Agent shall have received a copy of the Articles or Certificate of Incorporation of Borrower, and all amendments thereto, certified by the Secretary of State or other appropriate official of its jurisdiction of formation together with copies of the By-laws of Borrower and all agreements of Borrower's shareholders certified as accurate and complete by the Secretary or Assistant Secretary of Borrower and all such agreements shall be satisfactory to Agent. 37 9.8. Good Standing Certificates. Agent shall have received good standing certificates for Borrower dated not more than 30 days prior to the Closing, issued by the Secretary of State or other appropriate official of Borrower's jurisdiction of formation and each jurisdiction where the conduct of Borrower's business activities or the ownership of its properties necessitates qualification. 9.9. Legal Opinion. Agent shall have received the executed legal opinion of Hunton & Williams in form and substance satisfactory to Agent which shall cover such matters incident to the transactions contemplated by this Agreement, the Transactions and related agreements as Agent may reasonably require. 9.10. No Litigation. Except as described on Exhibit 9.10, (i) no litigation, investigation or proceeding before or by any arbitrator or governmental body shall be continuing or threatened against Borrower, any Subsidiary of Borrower or against the officers or directors of Borrower or any Subsidiary of Borrower (A) in connection with the Loan Documents or the Acquisition Agreement or any of the transactions contemplated hereby or thereby and which, in the reasonable opinion of Agent, is deemed material or (B) which if adversely determined, could, in the reasonable opinion of Agent, have a Material Adverse Effect; (ii) no injunction, writ, restraining order or other order of any nature materially adverse to Borrower or any Subsidiary of Borrower or the conduct of its business or inconsistent with the due consummation of the transactions shall have been issued by any governmental body and (iii) no material adverse change has occurred in the financial status of Borrower or its Subsidiaries from the information previously disclosed to Agent in writing prior to the Closing Date. 9.11. Information; Collateral Examination. Agent shall have received all financial, business, and other information regarding Borrower, its Subsidiaries and their respective Properties as Agent shall have reasonably requested. Agent shall have completed Collateral examinations and received appraisals, the results of which shall be satisfactory in form and substance to Lenders, of the Receivables, Inventory, General Intangibles and Equipment of Borrower and all books and records in connection therewith. 9.12. Fees. Agent shall have received payment of all fees and expenses of Agent and the Lenders on or prior to the Closing Date pursuant to this Agreement. 9.13. Insurance. Agent shall have received in form and substance satisfactory to Agent certified copies of Borrower's casualty insurance policies, together with loss payable endorsements on Agent's standard form of loss payee endorsement naming Agent as loss payee, and certified copies of Borrower's liability insurance policies, together with endorsements naming Agent as a co-insured. 9.14. Payment Instructions. Agent shall have received written instructions from Borrower directing the application of proceeds of the initial Loans made pursuant to this Agreement. 9.15. No Adverse Material Change. (i) Since June 30, 1998, there shall have occurred (x) no event or condition having a Material Adverse Effect, (y) no material damage or destruction to any of the Collateral nor any material depreciation in the value thereof and (z) no event, condition 38 or state of facts which could reasonably be expected to have a Material Adverse Effect and (ii) no representations made or information supplied to Agent shall have been proven to be inaccurate or misleading in any material respect. 9.16. Contract Review. Agent shall have reviewed all material contracts of Borrower including, without limitation, leases, union contracts, labor contracts, vendor supply contracts, license agreements and distributorship agreements and such contracts and agreements shall be reasonably satisfactory in all material respects to Agent. 9.17. Environmental Reports. Agent shall have received all environmental studies and reports prepared by independent environmental engineering firms with respect to all real Property owned or leased by Borrower and Agent shall have received evidence satisfactory to Agent (i) that the operations of Borrower and its Subsidiaries comply with applicable Environmental Laws; (ii) that such operations are not the subject of any federal, state or local investigation evaluating the need for remedial action, involving a material expenditure, to respond to a release or threatened release of any toxic or hazardous waste or substance into the environment; (iii) that neither the Borrower nor the Guarantor has or could reasonably be expected to have any contingent liability deemed material by the Lenders in connection with any release of any toxic or hazardous waste or substance into the environment. 9.18. Leasehold Agreements. Agent shall have received landlord, mortgagee or warehouseman agreements satisfactory to Agent with respect to all premises leased by Borrower at which material amounts of Inventory are located. 9.19. Consents. Agent shall have received any and all Consents necessary to permit the effectuation of the Transactions and all other transactions contemplated by this Agreement and the other Loan Documents (without the imposition of any conditions that are not acceptable to Agent or Lenders); and, Agent shall have received such Consents and waivers of such third parties as might assert claims with respect to the Collateral, as Agent and its counsel shall deem necessary. 9.20. Financial Condition Certificates. Agent shall have received executed Officer's Certificates satisfactory in form and substance to it, certifying that Borrower on a Consolidated Basis is Solvent immediately prior to and after giving effect to the Transactions and the Indebtedness contemplated hereby and as to the financial resources of Borrower on a Consolidated Basis and its ability to meet its obligations and liabilities as they become due. 9.21. Closing Certificate. Agent shall have received a closing certificate signed by an authorized officer of Borrower dated as of the date hereof, stating that (i) all representations and warranties set forth in this Agreement and the other Loan Documents are true and correct in all material respects immediately prior to and after giving effect to the making of the initial Loans hereunder, (ii) Borrower is on such date in compliance with all the terms and provisions set forth in this Agreement and the other Loan Documents and (iii) on such date no Default or Event of Default has occurred or is continuing. 39 9.22. Subsidiary Stock. Agent shall have received evidence that all issued and outstanding capital stock of each of Borrower's Subsidiaries shall be owned by Borrower or one or more of Borrower's Subsidiaries. 9.23. Corporate Structure. Agent shall be satisfied with the corporate and legal structure and capitalization of Holdings, Borrower and its Subsidiaries including, each class of capital stock of such Person and each instrument or agreement relating to such structure or capitalization. 9.24. ERISA. Agent shall be satisfied that (i) Borrower and its Subsidiaries will be able to meet their respective obligations under all employee and retiree welfare plans, (ii) the employee benefit plans of Borrower and its Subsidiaries are, in all material respects, funded in accordance with the minimum statutory requirements, (iii) no material "reportable event" (as defined in ERISA, but excluding events for which reporting has been waived) has occurred as to any such employee benefit plan and (iv) no termination of, or withdrawal from, any such employee benefit plan has occurred or is contemplated that could reasonably be expected to result in a material liability. 9.25. Availability. Agent shall have determined that after giving effect to the Transactions (including, without limitation, the initial Loans, Letters of Credit and LC Guaranties contemplated hereby), and the payment of all closing costs incurred in connection with the Transactions, Closing Availability shall not be less than $9,000,000. 9.26. Other. All corporate and other proceedings, and all documents, instruments and other legal matters in connection with the Transactions shall be satisfactory in form and substance to Agent and its counsel. 9.27. Conditions to Each Loan. The agreement of Lenders to make any Loans or cause to be opened any Letters of Credit requested to be made or opened on any date (including, without limitation, the initial Loans), is subject to the satisfaction of the following conditions precedent as of the date such Loan is made or Letter of Credit opened: (i) Representations and Warranties. Each of the representations and warranties made by Borrower in or pursuant to this Agreement and any related agreements to which it is a party, and each of the representations and warranties contained in any certificate, document or financial or other statement furnished at any time under or in connection with this Agreement or any related agreement shall be true and correct in all material respects on and as of such date as if made on and as of such date, except for those representations and warranties limited by their terms to a specified date. (ii) No Default. No Event of Default or Default shall have occurred and be continuing on such date, or would exist after giving effect to the Loans requested to be made, on such date and, in the case of the initial Loan, after giving effect to the consummation of the transaction contemplated by the Acquisition Agreement; provided, however, that Agent in its sole discretion, may continue to make Loans notwithstanding the existence of an Event of Default or Default and that any Loans so made shall not be deemed a waiver of any such Event of Default or Default; and (iii) Maximum Loans. In the case of any Loans requested to be made, after giving effect thereto, the aggregate Loans shall not exceed the maximum Loans permitted under this Agreement. 40 Each request for a Loan by Borrower hereunder shall constitute a representation and warranty by Borrower as of the date of such Loan that the conditions contained in this subsection shall have been satisfied. SECTION 10. EVENTS OF DEFAULT; RIGHTS AND REMEDIES ON DEFAULT 10.1. Events of Default. The occurrence of one or more of the following events shall constitute an "Event of Default": 10.1.1. Payment of Obligations. Borrower shall fail to pay any of the Obligations on the due date thereof (whether due at stated maturity, on demand, upon acceleration or otherwise). 10.1.2. Misrepresentations. Any representation, warranty or other statement made or furnished to Agent or any Lender by or on behalf of Borrower or any Subsidiary of Borrower in this Agreement, any of the other Loan Documents or any instrument, certificate or financial statement furnished in compliance with or in reference thereto proves to have been false or misleading in any material respect when made or furnished or when reaffirmed pursuant to SECTION 7.2 hereof. 10.1.3. Breach of Specific Covenants. Borrower shall fail or neglect to perform, keep or observe any covenant contained in SECTIONS 5.2, 6.1.1, 6.2, 6.3, 8.1.1, 8.1.3, 8.2 OR 8.3 hereof on the date that Borrower is required to perform, keep or observe such covenant. 10.1.4. Breach of Other Covenants. Borrower or any Subsidiary of Borrower shall fail or neglect to perform, keep or observe any covenant contained in this Agreement (other than a covenant which is dealt with specifically elsewhere in SECTION 10.1 hereof) and the breach of such other covenant is not cured to Agent's satisfaction within fifteen (15) days after the sooner to occur of Borrower's or Subsidiary of Borrower's receipt of notice of such breach from Agent or the date on which such failure or neglect first becomes known to any senior officer of Borrower or Subsidiary of Borrower. 10.1.5. Default Under Security Documents/Other Agreements. Any event of default shall occur under, or Borrower or any Subsidiary of Borrower shall default in the performance or observance of any term, covenant, condition or agreement contained in, any of the Security Documents or the Other Agreements and such default shall continue beyond any applicable grace period. 10.1.6. Other Defaults. There shall occur any default or event of default on the part of Borrower under any agreement, document or instrument to which Borrower is a party or by which Borrower or any of its Property is bound, creating or relating to any Indebtedness in excess of $100,000 if the payment or maturity of such Indebtedness is accelerated in consequence of such event of default or demand for payment of such Indebtedness is made. 10.1.7. Insolvency and Related Proceedings. Borrower or any Subsidiary of Borrower shall cease to be Solvent or shall suffer the appointment of a receiver, trustee, custodian 41 or similar fiduciary, or shall make an assignment for the benefit of creditors, or any petition for an order for relief shall be filed by or against Borrower or any Subsidiary of Borrower under the Bankruptcy Code (if against Borrower, the continuation of such proceeding for more than 30 days), or Borrower or any Subsidiary of Borrower shall make any offer of settlement, extension or composition to its unsecured creditors generally. 10.1.8. Business Disruption; Condemnation. There shall occur a cessation of a substantial part of the business of Borrower for a period which significantly affects Borrower's capacity to continue its business, on a profitable basis; or Borrower shall suffer the loss or revocation of any license or permit now held or hereafter acquired by Borrower which is necessary to the continued or lawful operation of Borrower's business; or Borrower shall be enjoined, restrained or in any way prevented by court, governmental or administrative order from conducting all or any material part of its business affairs; or any material lease or agreement pursuant to which Borrower leases, uses or occupies any Property shall be canceled or terminated prior to the expiration of its stated term; or any part of the Collateral shall be taken through condemnation or the value of such Property shall be impaired through condemnation. 10.1.9. ERISA. A Reportable Event shall occur which Agent, in its sole discretion, shall determine in good faith constitutes grounds for the termination by the PBGC of any Plan or for the appointment by the appropriate United States district court of a trustee for any Plan, or any Plan shall be terminated or any such trustee shall be requested or appointed, or if Borrower or any Subsidiary of Borrower is in "default" (as defined in Section 4219(c)(5) of ERISA) with respect to payments to a Multiemployer Plan resulting from Borrower's or such Subsidiary's complete or partial withdrawal from such Plan. 10.1.10. Challenge to Agreement. Borrower or any Subsidiary of Borrower, or any Affiliate of any of them, shall challenge or contest in any action, suit or proceeding the validity or enforceability of this Agreement or any of the other Loan Documents, the legality or enforceability of any of the Obligations or the perfection or priority of any Lien granted to Agent for the benefit of Lenders. 10.1.11. Criminal Forfeiture. Borrower shall be criminally indicted or convicted under any law that could lead to a forfeiture of any material Property of Borrower. 10.1.12. Judgments. Any money judgment, writ of attachment or similar process is filed against Borrower or any Subsidiary of Borrower, or any of their respective Property, if the amount thereof not covered by insurance is in excess of $250,000 and such judgment, attachment or process remains unstayed, unpaid, undischarged or unbonded (but only to the extent the issuance of such bond stays all related judgment enforcement proceedings) for 30 consecutive days. 10.1.13. Repudiation of or Default Under Guaranty Agreement. Any Guarantor shall revoke or attempt to revoke any Guaranty Agreement signed by such Guarantor, or shall repudiate such Guarantor's liability hereunder or thereunder or shall be in default under the terms thereof. 42 10.2. Acceleration of the Obligations. Without in any way limiting the right of Agent or the Lenders to demand payment of any portion of the Obligations payable on demand in accordance with SECTION 3.2 hereof, upon or at any time after the occurrence of an Event of Default, all or any portion of the Obligations shall, at the option of the Required Lenders and without presentment, demand, protest or further notice by Agent or any Lender, become at once due and payable and Borrower shall forthwith pay to Agent for the ratable benefit of Lenders, the full amount of such Obligations, provided, that upon the occurrence of an Event of Default specified in SUBSECTION 10.1.7 hereof, all of the Obligations shall become automatically due and payable without declaration, notice or demand by Agent or any Lender. 10.3. Other Remedies. Upon the occurrence of an Event of Default, Agent shall have and may exercise from time to time the following rights and remedies: 10.3.1. All of the rights and remedies of a secured party under the Code or under other applicable law, and all other legal and equitable rights to which Agent may be entitled, all of which rights and remedies shall be cumulative and shall be in addition to any other rights or remedies contained in this Agreement or any of the other Loan Documents, and none of which shall be exclusive. 10.3.2. The right to take immediate possession of the Collateral, and to (i) require Borrower to assemble the Collateral, at Borrower's expense, and make it available to Agent and Lenders at a place designated by Agent which is reasonably convenient to both parties, and (ii) enter any premises where any of the Collateral shall be located and to keep and store the Collateral on said premises until sold (and if said premises be the Property of Borrower, Borrower agrees not to charge Agent or any Lender for storage thereof). 10.3.3. The right to sell or otherwise dispose of all or any Collateral in its then condition, or after any further manufacturing or processing thereof, at public or private sale or sales, with such notice as may be required by law, in lots or in bulk, for cash or on credit, all as Agent, in its sole discretion, may deem advisable. Borrower agrees that ten (10) days written notice to Borrower of any public or private sale or other disposition of Collateral shall be reasonable notice thereof, and such sale shall be at such locations as Agent may designate in said notice. Agent shall have the right to conduct such sales on Borrower's premises, without charge therefor, and such sales may be adjourned from time to time in accordance with applicable law. Agent shall have the right to sell, lease or otherwise dispose of the Collateral, or any part thereof, in a commercially reasonable manner, for cash, credit or any combination thereof, and Agent or any Lender may purchase all or any part of the Collateral at public or, if permitted by law, private sale and, in lieu of actual payment of such purchase price, may set off the amount of such price against the Obligations. The proceeds realized from the sale of any Collateral may be applied, after allowing two (2) Business Days for collection, first to the costs, expenses and attorneys' fees incurred by Agent in collecting the Obligations, in enforcing the rights of Agents and Lenders under the Loan Documents and in collecting, retaking, completing, protecting, removing, storing, advertising for sale, selling and delivering any Collateral, second to the interest due upon any of the Obligations; and third, to the principal of the Obligations. If any deficiency shall arise, Borrower shall remain liable to Agent and Lenders therefor. 43 10.3.4. Agent is hereby granted a license or other right to use, without charge, Borrower's labels, patents, copyrights, rights of use of any name, trade secrets, tradenames, trademarks and advertising matter, or any Property of a similar nature, as it pertains to the Collateral, in advertising for sale and selling any Collateral and Borrower's rights under all licenses and all franchise agreements shall inure to Agent's benefit. 10.3.5. Agent may, at its option, require Borrower to deposit with Agent funds equal to the Aggregate LC Amount and, if Borrower fails to promptly make such deposit, Lenders may advance such amount as a Revolving Credit Loan (whether or not an Overadvance is created thereby). Any such deposit or advance shall be held by Agent as a reserve to fund future payments on outstanding LC Guaranties and future drawings against outstanding Letters of Credit. At such time as all LC Guaranties have been paid or terminated and all Letters of Credit have been drawn upon or expired, any amounts remaining in such reserve shall be applied against any outstanding Obligations, or, if all Obligations have been indefeasibly paid in full, returned to Borrower. 10.4. Remedies Cumulative; No Waiver. All covenants, conditions, provisions, warranties, guaranties, indemnities, and other undertakings of Borrower contained in this Agreement and the other Loan Documents, or in any document referred to herein or contained in any agreement supplementary hereto or in any schedule given to Agent or Lenders or contained in any other agreement between or among Agent, Lenders and Borrower, heretofore, concurrently, or hereafter entered into, shall be deemed cumulative to and not in derogation or substitution of any of the terms, covenants, conditions, or agreements of Borrower herein contained. The failure or delay of Agent or any Lender to require strict performance by Borrower of any provision of this Agreement or to exercise or enforce any rights, Liens, powers, or remedies hereunder or under any of the aforesaid agreements or other documents or security or Collateral shall not operate as a waiver of such performance by Borrower, and all such requirements, Liens, rights, powers, and remedies shall continue in full force and effect until all Loans and all other Obligations owing or to become owing from Borrower to Agent or Lenders shall have been fully satisfied. None of the undertakings, agreements, warranties, covenants and representations of Borrower contained in this Agreement or any of the other Loan Documents and no Event of Default by Borrower under this Agreement or any other Loan Documents shall be deemed to have been suspended or waived by Agent or any Lender, unless such suspension or waiver is by an instrument in writing specifying such suspension or waiver and is signed by a duly authorized representative of Agent (with the consent of Lenders or Required Lenders, as applicable, in accordance with the terms of SUBSECTION 12.3) and directed to Borrower. SECTION 11. REGARDING AGENT 11.1. Appointment. Each Lender hereby designates Fleet to act as Agent for such Lender under this Agreement and the other Loan Documents. Each Lender hereby irrevocably authorizes Agent to take such action on its behalf under the provisions of this Agreement and the other Loan Documents and to exercise such powers and to perform such duties hereunder and thereunder as are specifically delegated to or required of Agent by the terms hereof and thereof and such other powers as are reasonably incidental thereto and Agent shall hold all Collateral, payments of principal and interest, fees (except the fees set forth in SECTION 2.3), charges and collections (without giving effect 44 to any collection days) received pursuant to this Agreement, for the ratable benefit of Lenders. Agent may perform any of its duties hereunder by or through its agents or employees. As to any matters not expressly provided for by this Agreement, Agent shall not be required to exercise any discretion or take any action, but shall be required to act or to refrain from acting (and shall be fully protected in so acting or refraining from acting) upon the instructions of the Required Lenders, and such instructions shall be binding; provided, however, that Agent shall not be required to take any action which exposes Agent to liability or which is contrary to this Agreement or the other Loan Documents or applicable law unless Agent is furnished with an indemnification reasonably satisfactory to Agent with respect thereto. 11.2. Nature of Duties. Agent shall have no duties or responsibilities except those expressly set forth in this Agreement and the other Loan Documents. Neither Agent nor any of its officers, directors, employees or agents shall be (i) liable for any action taken or omitted by them as such hereunder or in connection herewith, unless caused by their gross negligence (but not mere negligence) or willful misconduct or (ii) responsible in any manner for any recitals, statements, representations or warranties made by Borrower or any officer thereof contained in this Agreement or in any other Loan Documents or in any certificate, report, statement or other document referred to or provided for in, or received by Agent under or in connection with, this Agreement or any of the other Loan Documents or for the value, validity, effectiveness, genuineness, enforceability or sufficiency of this Agreement or any of the other Loan Documents or for any failure of Borrower to perform its obligations hereunder or thereunder. Agent shall not be under any obligation to any Lender to ascertain or to inquire as to the observance or performance of any of the agreements contained in, or conditions of, this Agreement or any of the other Loan Documents, or to inspect the properties, books or records of Borrower. The duties of Agent as respects the Loans to Borrower shall be mechanical and administrative in nature; Agent shall not have by reason of this Agreement a fiduciary relationship in respect of any Lender; and nothing in this Agreement, expressed or implied, is intended to or shall be so construed as to impose upon Agent any obligations in respect of this Agreement except as expressly set forth herein. 11.3. Lack of Reliance on Agent and Resignation. Independently and without reliance upon Agent or any other Lender, each Lender has made and shall continue to make (i) its own independent investigation of the financial condition and affairs of Borrower in connection with the making and the continuance of the Loans hereunder and the taking or not taking of any action in connection herewith, and (ii) its own appraisal of the creditworthiness of Borrower. Agent shall have no duty or responsibility, either initially or on a continuing basis, to provide any Lender with any credit or other information with respect thereto, whether coming into its possession before making of the Loans or at any time or times thereafter except as shall be provided by Borrower pursuant to the terms hereof. Agent shall not be responsible to any Lender for any recitals, statements, information, representations or warranties herein or in any agreement, document, certificate or a statement delivered in connection with or for the execution, effectiveness, genuineness, validity, enforceability, collectability or sufficiency of this Agreement or any of the other Loan Documents, or of the financial condition of Borrower, or be required to make any inquiry concerning either the performance or observance of any of the terms, provisions or conditions of this Agreement or any of the other Loan Documents or the financial condition of Borrower, or the existence of any Event of Default or any Default. 45 Agent may resign on sixty (60) days' written notice to each of Lenders and Borrower. The Required Lenders will promptly designate a successor Agent which in the absence of an Event of Default shall be reasonably satisfactory to Borrower; provided that such resignation shall not be effective until a successor Agent has been designated and approved by Borrower, which such approval shall not be unreasonably withheld. Any such successor Agent shall succeed to the rights, powers and duties of Agent, and the term "Agent" shall mean such successor agent effective upon its appointment, and the former Agent's rights, powers and duties as Agent shall be terminated, without any other or further act or deed on the part of such former Agent. After any Agent's resignation as Agent, the provisions of this SECTION 11 shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Agent under this Agreement. 11.4. Certain Rights of Agent. If Agent shall request instructions from Lenders with respect to any act or action (including failure to act) in connection with this Agreement, any Other Agreement or any Security Document, Agent shall be entitled to refrain from such act or taking such action unless and until Agent shall have received instructions from the Required Lenders; and Agent shall not incur liability to any Person by reason of so refraining. Without limiting the foregoing, Lenders shall not have any right of action whatsoever against Agent as a result of its acting or refraining from acting hereunder in accordance with the instructions of the Required Lenders. 11.5. Reliance. Agent shall be entitled to rely, and shall be fully protected in relying, upon any note, writing, resolution, notice, statement, certificate, telex, teletype or telecopier message, cablegram, order or other document or telephone message believed in good faith by it to be genuine and correct and to have been signed, sent or made by the proper person or entity, and, with respect to all legal matters pertaining to this Agreement and the other Loan Documents and its duties hereunder, upon advice of counsel selected by it. Agent may employ agents and attorneys-in-fact and shall not be liable for the default or misconduct of any such agents or attorneys-in-fact selected by Agent with reasonable care. 11.6. Notice of Default. Agent shall not be deemed to have knowledge or notice of the occurrence of any Default or Event of Default hereunder or under the other Loan Documents, unless Agent has received notice from a Lender or Borrower referring to this Agreement or the other Loan Documents, describing such Default or Event of Default and stating that such notice is a "notice of default". In the event that Agent receives such a notice, Agent shall give notice thereof to Lenders. Agent shall take such action with respect to such Default or Event of Default as shall be reasonably directed by the Required Lenders; provided, that, unless and until Agent shall have received such directions, Agent may (but shall not be obligated to) take such action, or refrain from taking such action, with respect to such Default or Event of Default as it shall deem advisable in the best interests of Lenders. 11.7. Indemnification. To the extent Agent is not reimbursed and indemnified by Borrower, each Lender will reimburse and indemnify Agent in proportion to its respective portion of the Loans (or, if no Loans are outstanding, according to its Commitment Percentage), from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, 46 costs, expenses or disbursements of any kind or nature whatsoever which may be imposed on, incurred by or asserted against Agent in performing its duties hereunder, or in any way relating to or arising out of this Agreement or any other Loan Document; provided that, Lenders shall not be liable for any portion of such liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements resulting from Agent's gross negligence (but not mere negligence) or willful misconduct. 11.8. Agent in its Individual Capacity. With respect to the obligation of Agent to lend under this Agreement, the Loans made by it shall have the same rights and powers hereunder as any other Lender and as if it were not performing the duties as Agent specified herein; and the term "Lender" or any similar term shall, unless the context clearly otherwise indicates, include Agent in its individual capacity as a Lender. Agent may engage in business with Borrower ("Other Transactions") as if it were not performing the duties specified herein, and may accept fees and other consideration from Borrower for services in connection with this Agreement or otherwise without having to account for the same to Lenders; provided, however, Agent shall not exercise any rights of set-off under this Agreement with respect to Borrower's obligations to Agent arising out of any Other Transactions. 11.9. Delivery of Documents. To the extent Agent receives documents and information from Borrower pursuant to the terms of this Agreement, Agent will promptly furnish such documents and information to Lenders. 11.10. Borrower's Undertaking to Agent. Without prejudice to its obligations to the Lenders under the other provisions of this Agreement, Borrower hereby undertakes with Agent to pay to Agent from time to time on demand all amounts from time to time due and payable by it for the account of Agent or the Lenders or any of them pursuant to this Agreement to the extent not already paid. Any payment made pursuant to any such demand shall pro tanto satisfy Borrower's obligations to make payments for the account of the Lenders or the relevant one or more of them pursuant to this Agreement. SECTION 12. MISCELLANEOUS 12.1. Power of Attorney. Borrower hereby irrevocably designates, makes, constitutes and appoints Agent (and all Persons designated by Agent) as Borrower's true and lawful attorney (and agent-in-fact) and Agent, or Agent's agent, may, without notice to Borrower and in Borrower's or Agent's name, but at the cost and expense of Borrower: 12.1.1. At such time or times upon the occurrence and during the continuance of an Event of Default as Agent or said agent, in its sole discretion, may determine, endorse Borrower's name on any checks, notes, acceptances, drafts, money orders or any other evidence of payment or proceeds of the Collateral which come into the possession of Agent or any Lender or under Agent's or any Lender's control. 12.1.2. At such time or times upon the occurrence and during the continuance of an Event of Default as Agent in its sole discretion may determine: (a) demand payment of the 47 Accounts from the Account Debtors, enforce payment of the Accounts by legal proceedings or otherwise, and generally exercise all of Borrower's rights and remedies with respect to the collection of the Accounts; (b) settle, adjust, compromise, discharge or release any of the Accounts or other Collateral or any legal proceedings brought to collect any of the Accounts or other Collateral; (c) sell or assign any of the Accounts and other Collateral upon such terms, for such amounts and at such time or times as Agent deems advisable; (d) take control, in any manner, of any item of payment or proceeds relating to any Collateral; (e) prepare, file and sign Borrower's name to a proof of claim in bankruptcy or similar document against any Account Debtor or to any notice of lien, assignment or satisfaction of lien or similar document in connection with any of the Collateral; (f) receive, open and dispose of all mail addressed to Borrower and to notify postal authorities to change the address for delivery thereof to such address as Agent may designate; (g) endorse the name of Borrower upon any of the items of payment or proceeds relating to any Collateral and deposit the same to the account of Agent on account of the Obligations; (h) endorse the name of Borrower upon any chattel paper, document, instrument, invoice, freight bill, bill of lading or similar document or agreement relating to the Accounts, Inventory and any other Collateral; (i) use Borrower's stationery and sign the name of Borrower to verifications of the Accounts and notices thereof to Account Debtors; (j) use the information recorded on or contained in any data processing equipment and computer hardware and software relating to the Accounts, Inventory, Equipment and any other Collateral; (k) make and adjust claims under policies of insurance; and (l) do all other acts and things necessary, in Agent's determination, to fulfill Borrower's obligations under this Agreement. 48 12.2. Indemnity. Borrower will indemnify and hold harmless Agent, each Lender and each of their Affiliates and their officers, directors, employees, agents and advisors (each an "Indemnified Party") from and against any and all claims, damages, losses, liabilities and expenses (including, without limitation, reasonable fees and expenses of counsel) that may be incurred by or asserted or awarded against any Indemnified Party, in each case arising out of or in connection with or by reason of, or in connection with the preparation for a defense of, any investigation, litigation or proceeding arising out of, related to or in connection with (a) the Transactions and any of the other transactions contemplated by this Agreement, (b) any acquisition or proposed acquisition or similar business combination or proposed business combination by Borrower or any Subsidiary of Borrower or any of their Subsidiaries or Affiliates of all or any portion of the shares of capital stock or substantially all of the Property and assets of any other Person, (c) the Loans and any use made or proposed to be made with the proceeds thereof or (d) the actual or alleged presence of Hazardous Materials on any Property of Borrower or any Subsidiary of Borrower or any of their Subsidiaries or any environmental action or proceeding relating in any way to Borrower or any Subsidiary of Borrower or any of their Subsidiaries or any of their respective Properties, in each case, whether or not such investigation, litigation or proceeding is brought by Borrower or any Subsidiary of Borrower or any of their shareholders or creditors or an Indemnified Party, or an Indemnified Party is otherwise a party thereto and whether or not the Transactions are consummated, except to the extent such claim, damage, loss, liability or expense is found in a final, nonappealable judgment by a court of competent jurisdiction to have resulted from such Indemnified Party's gross (not mere) negligence or willful misconduct. Borrower further agrees that no Indemnified Party will have any liability (whether direct or indirect, in contract or tort or otherwise) to Borrower or any Subsidiary of Borrower or any of their respective security holders or creditors arising out of, related to or in connection with the Transactions, except for direct (as opposed to consequential) damages determined in a final nonappealable judgment by a court of competent jurisdiction to have resulted from such Indemnified Party's gross (not mere) negligence or willful misconduct. Notwithstanding any contrary provision in this Agreement, the obligation of Borrower under this SECTION 12.2 shall survive the payment in full of the Obligations and the termination of this Agreement. 12.3. Modification of Agreement. The Required Lenders and Borrower may, subject to the provisions of this SECTION 12.3, from time to time enter into written supplemental agreements to this Agreement or the other Loan Documents executed by Borrower, for the purpose of adding or deleting any provisions or otherwise changing, varying or waiving in any manner the rights of the Lenders, the Agent or Borrower thereunder or the conditions, provisions or terms thereof or waiving any Event of Default thereunder, but only to the extent specified in such written agreements; provided, however, that no such supplemental agreement shall without the consent of all the Lenders: (i) increase the Commitment Percentage of any Lender. (ii) extend the final maturity of any Note or any scheduled installment due date under SECTION 1.3 hereof, or decrease the rate of interest or reduce any fee payable by Borrower to any such Lender pursuant to this Agreement. (iii) alter the definition of the term Required Lenders or alter, amend or modify this SECTION 12.3. 49 (iv) release any Collateral during any calendar year having an aggregate value in excess of $100,000. (v) change the rights and duties of Agent. (vi) increase the Total Credit Facility. Any such supplemental agreement shall apply equally to each of the Lenders and shall be binding upon Borrower, the Lenders and the Agent and all future holders of the Obligations. In the case of any waiver, Borrower, the Agent and the Lenders shall be restored to their former positions and rights, and any Event of Default waived shall be deemed to be cured and not continuing, but no waiver of a specific Event of Default shall extend to any subsequent Event of Default (whether or not the subsequent Event of Default is the same as the Event of Default which was waived), or impair any right resulting from such subsequent Event of Default. 12.4. Successors and Assigns; Participations; New Lenders. (i) This Agreement shall be binding upon and inure to the benefit of Borrower, Agent, each Lender, all future holders of the Notes and their respective successors and assigns, except that Borrower may not assign or transfer any of its rights or obligations under this Agreement without the prior written consent of Agent and each Lender. (ii) Borrower acknowledges that in the regular course of commercial banking business one or more Lenders may at any time and from time to time sell participating interests in the Loans to other financial institutions (each such transferee or purchaser of a participating interest, a "Transferee"). Each Lender shall provide written notice to Agent and Borrower of any sales of participating interests made by each Lender. Each Transferee may exercise all rights of payment (including without limitation rights of set-off) with respect to the portion of such Loans held by it or other Obligations payable hereunder as fully as if such Transferee were the direct holder thereof provided that Borrower shall not be required to pay to any Transferee more than the amount which it would have been required to pay to Lender which granted an interest in its Loans or other Obligations payable hereunder to such Transferee had such Lender retained such interest in the Loans hereunder or other Obligations payable hereunder and in no event shall Borrower be required to pay any such amount arising from the same circumstances and with respect to the same Loans or other Obligations payable hereunder to both such Lender and such Transferee. Borrower hereby grants to any Transferee a continuing security interest in any deposits, moneys or other property actually or constructively held by such Transferee as security for the Transferee's interest in the Loans. No such participation shall create a direct contractual relationship between Borrower and such participant, and no participant shall be given (i) the right to instruct the Lender to take or to refrain from taking any action hereunder, or (ii) any voting rights hereunder (other than for reductions or postponements of any amounts payable hereunder or the release of all or substantially all of the Collateral). (iii) Any Lender may sell, assign or transfer its rights under this Agreement and the other Loan Documents to one or more additional banks or financial institutions reasonably acceptable to Agent and Borrower (such acceptance not to be unreasonably withheld or delayed) which additional 50 banks or financial institutions may commit to make Loans hereunder (each a "Purchasing Lender"), pursuant to a Commitment Transfer Supplement, executed by a Purchasing Lender, the transferor Lender, and Agent in the form annexed hereto as Exhibit 12.4 and delivered to Agent for recording provided, however, that any transfer of less than all of any Lender's rights hereunder or any transfer to a Person who is not a Lender hereunder shall be in minimum amounts of not less than $2,500,000. Upon such execution, delivery, acceptance and recording, from and after the transfer effective date determined pursuant to such Commitment Transfer Supplement, (i) Purchasing Lender thereunder shall be a party hereto and, to the extent provided in such Commitment Transfer Supplement, have the rights and obligations of a Lender thereunder with a Commitment Percentage as set forth therein, and (ii) the transferor Lender thereunder shall, to the extent provided in such Commitment Transfer Supplement, be released from its obligations under this Agreement, the Commitment Transfer Supplement creating a novation for that purpose. Such Commitment Transfer Supplement shall be deemed to amend this Agreement to the extent, and only to the extent, necessary to reflect the addition of such Purchasing Lender and the resulting adjustment of the Commitment Percentages arising from the purchase by such Purchasing Lender of all or a portion of the rights and obligations of such transferor Lender under this Agreement and the other Loan Documents. Borrower hereby consents to the addition of such Purchasing Lender and the resulting adjustment of the Commitment Percentages arising from the purchase by such Purchasing Lender in accordance with the terms of SUBSECTION 12.4(iii) of all or a portion of the rights and obligations of such transferor Lender under this Agreement and the other Loan Documents. Borrower shall execute and deliver such further documents and do such further acts and things in order to effectuate the foregoing at such transferring Lender's expense. (iv) Agent shall maintain at its address a copy of each Commitment Transfer Supplement delivered to it and a register (the "Register") for the recordation of the names and addresses of each Lender from time to time. The entries in the Register shall be conclusive, in the absence of manifest error, and Borrower, Agent and Lenders may treat each Person whose name is recorded in the Register as the owner of the Loan recorded therein for the purposes of this Agreement. The Register shall be available for inspection by Borrower or any Lender at any reasonable time and from time to time upon reasonable prior notice. Agent shall receive a fee in the amount of $3,000 payable by the applicable Purchasing Lender upon the effective date of each transfer or assignment to such Purchasing Lender. (v) Borrower authorizes each Lender to disclose to any Transferee or Purchasing Lender and any prospective Transferee or Purchasing Lender any and all financial information in such Lender's possession concerning Borrower which has been delivered to such Lender by or on behalf of Borrower pursuant to this Agreement or in connection with such Lender's credit evaluation of Borrower, subject to such prospective Transferee's agreeing to maintain the confidentiality of such information pursuant to an agreement reasonably acceptable to Borrower. (vi) Borrower agrees to take all actions that Agent may reasonably request in attempting to sell, transfer or assign any of its rights or interest under this Agreement. Such actions include, but are not limited to, (a) Borrower causing senior management and representatives of Borrower and its Subsidiaries to be available to participate in information meetings with prospective Purchasing Lenders at such times and places as Agent may reasonably request, (b) Borrower using its reasonable efforts to ensure that Agent's attempt to sell, transfer or assign any of its rights or interest under this Agreement benefit from Borrower lending relationships and (c) Borrower providing Agent with all information reasonably requested by Agent in order to accomplish such sale, transfer or assignment. 51 (vii) Notwithstanding anything to the contrary in this Section 12.4, without Agent's prior written consent, no Lender (other than Fleet) may assign or sell any of its rights or interests hereunder, provided, however, any Lender hereunder may assign all or any of its rights hereunder without the consent of Borrower or Agent to (a) the Federal Reserve Bank as collateral or (b) any Affiliate of such Lender. (viii) Upon at least 60 days prior written notice to Agent, any Lender may terminate its commitment to make Loans hereunder as of the last day of the Original Term. 12.5. Severability. Wherever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement shall be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Agreement. 12.6. Successors and Assigns. This Agreement, the Other Agreements and the Security Documents shall be binding upon and inure to the benefit of the successors and assigns of Borrower and Lenders permitted under SECTION 12.4 hereof. 12.7. Cumulative Effect; Conflict of Terms. The provisions of the Other Agreements and the Security Documents are hereby made cumulative with the provisions of this Agreement. Except as otherwise provided in SECTION 3.2 hereof and except as otherwise provided in any of the other Loan Documents by specific reference to the applicable provision of this Agreement, if any provision contained in this Agreement is in direct conflict with, or inconsistent with, any provision in any of the other Loan Documents, the provision contained in this Agreement shall govern and control. 12.8. Execution in Counterparts. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which counterparts taken together shall constitute but one and the same instrument. 12.9. Notice. Except as otherwise provided herein, all notices, requests and demands to or upon a party hereto, to be effective, shall be in writing and shall be sent by certified or registered mail, return receipt requested, by personal delivery against receipt, by overnight courier or by facsimile and, unless otherwise expressly provided herein, shall be deemed to have been validly served, given or delivered immediately when delivered against receipt, one (1) Business Day after deposit in the mail, postage prepaid, or with an overnight courier or, in the case of facsimile notice, when sent, addressed as follows: If to Agent: FLEET CAPITAL CORPORATION 200 Glastonbury Boulevard Glastonbury, Connecticut 06033 Attention: Northeast Loan Administrator Facsimile No.: (860) 657-7759 52 With a copy to: HAHN & HESSEN LLP 350 Fifth Avenue New York, New York 10118 Attention: Daniel J. Krauss, Esq. Facsimile No.: (212) 594-7167 If to Borrower: Executone Information Systems, Inc. 478 Wheelers Farm Road Milford, Connecticut Attention: Chief Financial Officer and General Counsel Facsimile No.: (203) 882-2729 or to such other address as each party may designate for itself by notice given in accordance with this SECTION 12.9; provided, however, that any notice, request or demand to or upon Agent pursuant to SUBSECTION 3.1.1 OR 4.2.2 hereof shall not be effective until received by Agent. 12.10. Lenders' Consent. Whenever Agent's, Required Lenders' or Lenders' consent is required to be obtained under this Agreement, any of the Other Agreements or any of the Security Documents as a condition to any action, inaction, condition or event, Agent, Required Lenders and Lenders, as the case may be, shall be authorized to give or withhold such consent in their sole and absolute discretion and to condition its consent upon the giving of additional collateral security for the Obligations, the payment of money or any other matter. 12.11. Credit Inquiries. Borrower and each Subsidiary of Borrower hereby authorize and permit Agent and Lenders to respond to usual and customary credit inquiries from third parties concerning Borrower or any Subsidiary of Borrower. 12.12. Time of Essence. Time is of the essence of this Agreement, the Other Agreements and the Security Documents. 12.13. Entire Agreement. This Agreement and the other Loan Documents, together with all other instruments, agreements and certificates executed by the parties in connection therewith or with reference thereto, embody the entire understanding and agreement between the parties hereto and thereto with respect to the subject matter hereof and thereof and supersede all prior agreements, understandings and inducements, whether express or implied, oral or written. 12.14. Interpretation. No provision of this Agreement or any of the other Loan Documents shall be construed against or interpreted to the disadvantage of any party hereto by any court or other governmental or judicial authority by reason of such party having or being deemed to have structured or dictated such provision. 12.15. GOVERNING LAW; CONSENT TO FORUM. THIS AGREEMENT HAS BEEN NEGOTIATED, EXECUTED AND DELIVERED AT AND SHALL BE DEEMED TO HAVE BEEN MADE IN NEW YORK, NEW YORK. THIS AGREEMENT SHALL BE 53 GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK: PROVIDED, HOWEVER, THAT IF ANY OF THE COLLATERAL SHALL BE LOCATED IN ANY JURISDICTION OTHER THAN NEW YORK, THE LAWS OF SUCH JURISDICTION SHALL GOVERN THE METHOD, MANNER AND PROCEDURE FOR FORECLOSURE OF LENDERS' LIEN UPON SUCH COLLATERAL AND THE ENFORCEMENT OF LENDERS' OTHER REMEDIES IN RESPECT OF SUCH COLLATERAL TO THE EXTENT THAT THE LAWS OF SUCH JURISDICTION ARE DIFFERENT FROM OR INCONSISTENT WITH THE LAWS OF NEW YORK. AS PART OF THE CONSIDERATION FOR NEW VALUE RECEIVED, AND REGARDLESS OF ANY PRESENT OR FUTURE DOMICILE OR PRINCIPAL PLACE OF BUSINESS OF BORROWER OR LENDERS, BORROWER HEREBY CONSENTS AND AGREES THAT ANY FEDERAL OR STATE COURT SITTING IN THE STATE OF NEW YORK SHALL HAVE EXCLUSIVE JURISDICTION TO HEAR AND DETERMINE ANY CLAIMS OR DISPUTES BETWEEN BORROWER AND LENDERS PERTAINING TO THIS AGREEMENT OR TO ANY MATTER ARISING OUT OF OR RELATED TO THIS AGREEMENT. BORROWER EXPRESSLY SUBMITS AND CONSENTS IN ADVANCE TO SUCH JURISDICTION IN ANY ACTION OR SUIT COMMENCED IN ANY SUCH COURT, AND BORROWER HEREBY WAIVES ANY OBJECTION WHICH BORROWER MAY HAVE BASED UPON LACK OF PERSONAL JURISDICTION, IMPROPER VENUE OR FORUM NON CONVENIENS AND HEREBY CONSENTS TO THE GRANTING OF SUCH LEGAL OR EQUITABLE RELIEF AS IS DEEMED APPROPRIATE BY SUCH COURT. BORROWER HEREBY WAIVES PERSONAL SERVICE OF THE SUMMONS, COMPLAINT AND OTHER PROCESS ISSUED IN ANY SUCH ACTION OR SUIT AND AGREES THAT SERVICE OF SUCH SUMMONS, COMPLAINT AND OTHER PROCESS MAY BE MADE BY REGISTERED OR CERTIFIED MAIL ADDRESSED TO BORROWER AT THE ADDRESS SET FORTH IN THIS AGREEMENT AND THAT SERVICE SO MADE SHALL BE DEEMED COMPLETED UPON THE EARLIER OF BORROWER'S ACTUAL RECEIPT THEREOF OR 3 DAYS AFTER DEPOSIT IN THE U.S. MAILS, PROPER POSTAGE PREPAID. NOTHING IN THIS AGREEMENT SHALL BE DEEMED OR OPERATE TO AFFECT THE RIGHT OF LENDER TO SERVE LEGAL PROCESS IN ANY OTHER MANNER PERMITTED BY LAW, OR TO PRECLUDE THE ENFORCEMENT BY LENDERS OF ANY JUDGMENT OR ORDER OBTAINED IN SUCH FORUM OR THE TAKING OF ANY ACTION UNDER THIS AGREEMENT TO ENFORCE SAME IN ANY OTHER APPROPRIATE FORUM OR JURISDICTION. 12.16. WAIVERS BY BORROWER. BORROWER WAIVES (i) THE RIGHT TO TRIAL BY JURY (WHICH AGENT AND LENDERS HEREBY ALSO WAIVE) IN ANY ACTION, SUIT, PROCEEDING OR COUNTERCLAIM OF ANY KIND ARISING OUT OF OR RELATED TO ANY OF THE LOAN DOCUMENTS, THE OBLIGATIONS OR THE COLLATERAL: (ii) OTHER THAN NOTICES EXPRESSLY PROVIDED TO BE GIVEN TO BORROWER HEREIN, PRESENTMENT, DEMAND AND PROTEST AND NOTICE OF PRESENTMENT, PROTEST, DEFAULT, NON PAYMENT, MATURITY, RELEASE, COMPROMISE, SETTLEMENT, EXTENSION OR RENEWAL OF ANY OR ALL COMMERCIAL PAPER, ACCOUNTS, CONTRACT RIGHTS, DOCUMENTS, INSTRUMENTS CHATTEL PAPER AND GUARANTIES AT ANY TIME HELD BY 54 LENDERS ON WHICH ANY LOAN PARTY MAY IN ANY WAY BE LIABLE AND HEREBY RATIFIES AND CONFIRMS WHATEVER LENDERS MAY DO IN THIS REGARD; (iii) NOTICE PRIOR TO TAKING POSSESSION OR CONTROL OF THE COLLATERAL OR ANY BOND OR SECURITY WHICH MIGHT BE REQUIRED BY ANY COURT PRIOR TO ALLOWING LENDERS TO EXERCISE ANY OF LENDERS' REMEDIES; (iv) THE BENEFIT OF ALL VALUATION, APPRAISEMENT AND EXEMPTION LAWS; AND (v) NOTICE OF ACCEPTANCE HEREOF. BORROWER ACKNOWLEDGES THAT THE FOREGOING WAIVERS ARE A MATERIAL INDUCEMENT TO LENDERS' ENTERING INTO THIS AGREEMENT AND THAT LENDERS ARE RELYING UPON THE FOREGOING WAIVERS IN ITS FUTURE DEALINGS WITH BORROWER. BORROWER WARRANTS AND REPRESENTS THAT IT HAS REVIEWED THE FOREGOING WAIVERS WITH ITS LEGAL COUNSEL AND HAS KNOWINGLY AND VOLUNTARILY WAIVED ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION WITH LEGAL COUNSEL. IN THE EVENT OF LITIGATION, THIS AGREEMENT MAY BE FILED AS A WRITTEN CONSENT TO A TRIAL BY THE COURT. [SIGNATURE LINES ON FOLLOWING PAGE] 55 IN WITNESS WHEREOF, this Agreement has been duly executed on the day and year specified at the beginning of this Agreement. EXECUTONE INFORMATION SYSTEMS, INC. By:________________________________ Name:______________________________ Title:_____________________________ FLEET CAPITAL CORPORATION ("Agent" and "Lender") By:________________________________ Name:______________________________ Title:_____________________________ Commitment Percentage: 100% APPENDIX A GENERAL DEFINITIONS When used in the Loan and Security Agreement dated as of August 14, 1998, by and among the financial institutions party thereto and the various financial institutions which become parties thereto ("Lenders"), Fleet Capital Corporation as administrative and collateral agent for Lenders (in such capacity, "Agent") and Execution Information Systems, Inc. ("Borrower"), the following terms shall have the following meanings (terms defined in the singular to have the same meaning when used in the plural and vice versa): Account Debtor - any Person who is or may become obligated under or on account of an Account. Accounts - all accounts, contract rights, chattel paper, instruments and documents, whether now owned or hereafter created or acquired by Borrower or in which Borrower now has or hereafter acquired any interest. Adjusted Cash Flow - for any fiscal period, means (i) Adjusted Net Earnings From Operations for such period, plus (ii) depreciation and amortization and any other non-cash expenses of Borrower (iii) plus increases and minus decreases in deferred taxes of Borrower for such period, all as determined in accordance with GAAP less (iv) non-financed Capital Expenditures, less (v) the sum of the aggregate payments of regularly scheduled principal with respect to Indebtedness for Money Borrowed (other than the Revolving Credit Loans) made during such period and less (vi) the sum of the aggregate Specified Permitted Investments made during such period. Adjusted Net Earnings From Operations - with respect to any fiscal period, means the net earnings (or loss) after provision for income taxes for such fiscal period of Borrower on a Consolidated Basis, as reflected on the Consolidated financial statement of Borrower supplied to Agent pursuant to SUBSECTION 8.1.3 of the Agreement, but excluding: (i) any gain or loss arising from the sale of capital assets; (ii) any gain arising from any write-up of assets; (iii) earnings or losses of any Subsidiary of Borrower accrued prior to the date it became a Subsidiary; (iv) earnings or losses of any corporation or Person, substantially all the assets of which have been acquired in any manner by Borrower, realized by such corporation or Person prior to the date of such acquisition; (v) net earnings of any business entity (other than a Subsidiary of Borrower) in which Borrower has an ownership interest unless such net earnings shall have actually been received by Borrower in the form of cash distributions; A-1 (vi) any portion of the net earnings of any Subsidiary of Borrower which for any reason is unavailable for payment of dividends to Borrower; (vii) the earnings or losses of any Person (other than an Affiliate of Borrower) to which any assets of Borrower shall have been sold, transferred or disposed of, or into which Borrower shall have merged, or been a party to any consolidation or other form of reorganization, prior to the date of such transaction; (viii) any gain arising from the acquisition of any Securities of Borrower; and (ix) any gain or non cash loss arising from extraordinary items. Affiliate - a 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, a Person; (ii) which beneficially owns or holds 5% or more of any class of the Voting Stock of a Person; or (iii) 5% or more of the Voting Stock (or in the case of a Person which is not a corporation, 5% or more of the equity interest) of which is beneficially owned or held by a Person or a Subsidiary of a Person. Aggregate LC Amount - at any time, without duplication, the aggregate undrawn face amount of all Letters of Credit and LC Guaranties then outstanding. Agreement - the Loan and Security Agreement referred to in the first sentence of this Appendix A, all Exhibits thereto and this Appendix A. Applicable Margin - On the Closing Date the rate per annum set forth under the relevant column heading below:
Base Rate Loans Eurodollar Loans and - --------------- LIBOR Rate Loans ---------------- 1.25% 3.00%
provided the Applicable Margin shall be subject to change as of the first day of each Fiscal Quarter based upon the Fixed Charge Coverage Ratio for the preceding four (4) Fiscal Quarters commencing with the four (4) Fiscal Quarters ended as of March 31, 1999 following the delivery of the financial statements of Borrower on a Consolidated Basis for the Fiscal Quarter then ended (so long as (i) such statements are delivered on or before the Required Delivery Date therefor and (ii) no Event of Default shall have occurred and be continuing) to the rates set forth below under the relevant column heading: A-2
EURODOLLAR LOANS AND BASE RATE LOANS LIBOR RATE LOANS Fixed Charge Ratio Less than 1.0x 3.50% 1.75% - -------------------------------------------------------------------------------- Greater than or equal to 1.0x but less than 1.25x 3.25% 1.50% - -------------------------------------------------------------------------------- Greater than or equal to 1.25x but less than 1.50x 3.00% 1.25% - -------------------------------------------------------------------------------- Greater than or equal to 1.50x but less than 2.0x 2.75% 1.00% - -------------------------------------------------------------------------------- Greater than or equal to 2.00x but less than 2.50x 2.50% .75% - -------------------------------------------------------------------------------- Greater than 2.5x 2.25% .50% - --------------------------------------------------------------------------------
Availability - the amount of money which Borrower is entitled to borrow from time to time as Revolving Credit Loans, such amount being the difference derived when the sum of the principal amount of Revolving Credit Loans then outstanding (including any amounts which Agent may have paid for the account of Borrower pursuant to any of the Loan Documents and which have not been reimbursed by Borrower) and the LC Amount is subtracted from the Borrowing Base. If the amount outstanding is equal to or greater than the Borrowing Base, Availability is 0. Bank - Fleet National Bank. Base Rate - a rate per annum equal to the higher of (i) the Federal Funds Rate in effect on such day plus 1/2 of 1% or (ii) the rate of interest announced or quoted by Bank from time to time as its prime rate for commercial loans, whether or not such rate is the lowest rate charged by Bank to its most preferred borrowers; and, if such prime rate for commercial loans is discontinued by Bank as a standard, a comparable reference rate designated by Bank as a substitute therefor shall be the Base Rate. Base Rate Loans - any Loans bearing interest computed by reference to the Base Rate. Borrower -Executone Information Systems, Inc., a Virginia corporation. Borrowing Base - as at any date of determination thereof, an amount equal to the lesser of: (i) an amount equal to: (a) the Maximum Revolving Amount; MINUS A-3 (b) the Aggregate LC Amount; MINUS (c) Reserves; or (ii) an amount equal to: (a) up to 85% ("Accounts Advance Rate") of the net amount of Eligible Accounts of Borrower; PLUS (b) the lesser of (1) $13,000,000 or (2) up to 50% ("Inventory Advance Rate") of the value of Eligible Inventory of Borrower calculated on the basis of the lower of cost or market calculated on a first-in, first-out basis; MINUS (c) Reserves. For purposes hereof, the net amount of Eligible Accounts at any time shall be the face amount of such Eligible Accounts less any and all returns, rebates, discounts (which may, at Agent's option, be calculated on shortest terms), credits, allowances or excise taxes of any nature at any time issued, owing, claimed by Account Debtors, granted, outstanding or payable in connection with such Accounts at such time. Business Day - means, with respect to Eurodollar Loans, any day on which commercial banks are open for domestic and international business including dealings in Dollar deposits in London, England and New York, New York and with respect to all other Loans, any day excluding Saturday, Sunday and any day which is a legal holiday under the laws of the State of New York or is a day on which banking institutions located in such state are closed. Capital Expenditures - expenditures made or liabilities incurred by Borrower for the acquisition of any fixed assets or improvements, replacements, substitutions or additions thereto which have a useful life of more than one year and capitalized under GAAP, including, with duplication, the total principal portion of Capitalized Lease Obligations. Capitalized Lease Obligation - any Indebtedness represented by the principal portion of obligations under a lease that is required to be capitalized for financial reporting purposes in accordance with GAAP. Cash Flow - for any fiscal period, means (i) Adjusted Net Earnings From Operations for such period, plus (ii) depreciation and amortization and any other non-cash expenses of Borrower (iii) plus increases and minus decreases in deferred taxes of Borrower for such period, all as determined in accordance with GAAP less (iv) non-financed Capital Expenditures and less (v) A-4 the sum of the aggregate payments of regularly schedule principal with respect to Indebtedness for Money Borrowed (other than the Revolving Credit Loans) made during such period. CERCLA - shall mean the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, 42 U.S.C. 'SS''SS'9601 et seq. Closing Availability - Availability minus all sums then due and owing by Borrower to trade creditors beyond normal trade terms. Closing Date - the date on which all of the conditions precedent in SECTION 9 of the Agreement are satisfied and the initial Loan is made or the initial Letter of Credit or LC Guaranty is issued under the Agreement. Code - the Uniform Commercial Code as adopted and in force in the State of New York, as from time to time in effect. Collateral - all of the Property and interests in Property described in SECTION 5 of the Agreement, and all other Property and interests in Property that now or hereafter secure the payment and performance of any of the Obligations. Commitment Percentage - of any Lender means the percentage set forth below such Lender's name on the signature page of the Agreement as same may be adjusted upon any assignment by a Lender pursuant to SECTION 12.4 thereof. Commitment Transfer Supplement - a document in the form of Exhibit 12.4 hereto, properly completed and otherwise in form and substance satisfactory to Agent by which the Purchasing Lender purchases and assumes a portion of the obligation of Lenders to make Loans under the Agreement. Consents - all material filings and all material licenses, permits, consents, approvals, authorizations, qualifications and orders of governmental authorities and other third parties, domestic or foreign, necessary to carry on Borrower's business, including, without limitation, any Consents required under all applicable federal, state or other applicable law. Consolidated Basis - the consolidation in accordance with GAAP of the accounts or other items of Borrower and its Subsidiaries. Consolidated Interest Expense - shall mean, for any period to the extent actually paid, the interest expense (net of interest income) of Borrower on a Consolidated Basis during such period determined in accordance with GAAP consistently applied, and shall in any event include, without limitation, interest on Capitalized Lease Obligations and shall exclude original issue discount amortization to the extent it is required to be included in accordance with GAAP. Current Assets - at any date means the amount at which all of the current assets of a Person would be properly classified as current assets shown on a balance sheet at such date in A-5 accordance with GAAP except that amounts due from Affiliates and investments in Affiliates shall be excluded therefrom. Default - an event or condition the occurrence of which would, with the lapse of time or the giving of notice, or both, become an Event of Default. Default Rate - as defined in SUBSECTION 2.1.2 of the Agreement. Dividend Payment - as defined in subsection 8.2.7 of the Agreement. Dollar - and the sign $ shall mean lawful money of the United States of America. Dominion Account - a special account of Agent established by Borrower pursuant to the Agreement at a bank selected by Borrower, but acceptable to Agent in its reasonable discretion, and over which Agent shall have sole and exclusive access and control for withdrawal purposes. EBITDA - with respect to any fiscal period, means the sum of Adjusted Net Earnings From Operations before interest expense, taxes, depreciation and amortization for said period as determined in accordance with GAAP of Borrower on a Consolidated Basis. Eligible Account - an Account arising in the ordinary course of Borrower's business from the sale of goods or rendition of services which Agent, in its sole credit judgment, deems to be an Eligible Account. Without limiting the generality of the foregoing, no Account shall be an Eligible Account if: (i) it arises out of a sale made by Borrower to a Subsidiary or an Affiliate of Borrower or to a Person controlled by an Affiliate of Borrower; or (ii) it is unpaid for more than (a) with respect to Accounts from Account Debtors other than the United States of America or any state or municipality thereof or Account Debtors invoiced by Borrower's healthcare division (the "Specified A Account Debtors"), 60 days after the original due date shown on the invoice and (b) with respect to Accounts from the United States of America or any state or municipality thereof or Accounts from Account Debtors invoiced by Borrower's healthcare division (the "Specified B Account Debtors"), 90 days after the original due date shown on the invoice, provided that the aggregate amount of Eligible Accounts under this clause "(b)" shall not exceed $1,500,000 at any time; or (iii) it is due or unpaid more than (a) with respect to Accounts from Specified A Account Debtors, 90 days after the original invoice date and (b) with respect to Accounts from Specified B Account Debtors, 120 days after the original invoice date, provided that the aggregate amount of Eligible Accounts under this clause "(b)" shall not exceed $1,500,000 at any time; or (iv) 50% or more of the Accounts from the Account Debtor are not deemed Eligible Accounts hereunder; or A-6 (v) (a) the total unpaid Accounts of the Account Debtor (other than Claricom, Inc.) exceed 15% of the net amount of all Eligible Accounts, to the extent of such excess or (b) the total unpaid Accounts of Claricom, Inc. exceed 25% of the amount of all Accounts, to the extent of such excess; or (vi) any covenant, representation or warranty contained in the Agreement with respect to such Account has been breached to the extent it affects the collectability of such Account ; or (vii) the Account Debtor is also Borrower's creditor or supplier, or the Account Debtor has disputed liability with respect to such Account, or the Account Debtor has made any claim with respect to any other Account due from such Account Debtor to Borrower, or the Account otherwise is or may become subject to any right of setoff by the Account Debtor to the extent such amount owed is, subject to set-off by or disputed with such Account Debtor; or (viii) the Account Debtor has commenced a voluntary case under the federal bankruptcy laws, as now constituted or hereafter amended, or made an assignment for the benefit of creditors, or a decree or order for relief has been entered by a court having jurisdiction in the premises in respect of the Account Debtor in an involuntary case under the federal bankruptcy laws, as now constituted or hereafter amended, or any other petition or other application for relief under the federal bankruptcy laws has been filed against the Account Debtor, or if the Account Debtor has failed, suspended business, ceased to be Solvent, or consented to or suffered a receiver, trustee, liquidator or custodian to be appointed for it or for all or a significant portion of its assets or affairs; or (ix) it arises from a sale to an Account Debtor outside the United States to the extent the aggregate amount of such Accounts exceeds $25,000, unless the sale is on letter of credit, guaranty or acceptance terms, in each case acceptable to Agent in its sole discretion; or (x) it arises from a sale to the Account Debtor on a bill-and-hold, guaranteed sale, sale-or-return, sale-on-approval, consignment or any other repurchase or return basis; or (xi) the Account Debtor is the United States of America or any department, agency or instrumentality thereof unless Borrower assigns its right to payment of such Account to Agent, in a manner satisfactory to Agent, so as to comply with the Assignment of Claims Act of 1940 (31 U.S.C. 'SS'.203 et seq., as amended); or (xii) the Account is subject to a Lien other than a Permitted Lien; or (xiii) the goods giving rise to such Account have not been delivered to and accepted by the Account Debtor or the services giving rise to such Account have not been performed by Borrower and accepted by the Account Debtor or the Account otherwise does not represent a final sale; or A-7 (xiv) the Account is evidenced by chattel paper or an instrument of any kind, or has been reduced to judgment; or (xv) Borrower has made any agreement with the Account Debtor for any deduction therefrom, except for discounts or allowances which are made in the ordinary course of business and which discounts or allowances are reflected in the calculation of the face value of each invoice related to such Account. Eligible Inventory - such Inventory of Borrower (other than packaging materials and supplies) which Agent, in its sole credit judgment, deems to be Eligible Inventory. Without limiting the generality of the foregoing, no Inventory shall be Eligible Inventory if: (i) it is not finished goods or raw materials; (ii) it is not in good, new and saleable condition; or (iii) it is slow-moving, obsolete or unmerchantable; or (iv) it does not meet all material standards imposed by any governmental agency or authority; or (v) it does not conform in all respects to the warranties and representations set forth in the Agreement, (vi) it is not at all times subject to Agent's duly perfected, first priority security interest and no other Lien except a Permitted Lien; or (vii) it is not situated at a location in compliance with the Agreement or is in transit. Environmental Complaint - shall have the meaning set forth in Section 8.1.7(d) hereof. Environmental Laws - shall mean all federal, state and local environmental, land use, zoning, health, chemical use, safety and sanitation laws, statutes, ordinances and codes relating to the protection of the environment and/or governing the use, storage, treatment, generation, transportation, processing, handling, production or disposal of Hazardous Substances and the rules, regulations, policies, guidelines, interpretations, decisions, orders and directives of federal, state and local governmental agencies and authorities with respect thereto. Equipment - with respect to Borrower, all machinery, apparatus, equipment, fittings, furniture, fixtures, motor vehicles and other tangible personal Property (other than Inventory) of every kind and description used in Borrower's operations or owned by Borrower, or in which Borrower has an interest, whether now owned or hereafter acquired by Borrower and wherever located, and all parts, accessories and special tools and all increases and accessions thereto and substitutions and replacements therefor. A-8 ERISA - the Employee Retirement Income Security Act of 1974, as amended, and all rules and regulations from time to time promulgated thereunder. Eurodollar Loan - any Loan bearing interest computed by reference to the Eurodollar Rate. Eurodollar Rate - for any Eurodollar Loan, for the then current Interest Period relating thereto, the rate per annum equal to the quotient of (a) LIBOR, divided by (b) a number equal to 1.00 minus the aggregate of the rates (expressed as a decimal) of reserve requirements current on the day that is two (2) Business Days prior to the beginning of the Interest Period (including without limitation basic, supplemental, marginal and emergency reserves) under any regulation promulgated by the Board of Governors of the Federal Reserve System (or any other governmental authority having jurisdiction over the Bank) as in effect from time to time, dealing with reserve requirements prescribed for Eurocurrency funding including any reserve requirements with respect to "Eurocurrency liabilities" under Regulation D of the Board of Governors of the Federal Reserve System. Event of Default - as defined in SECTION 10.1 of the Agreement. Extraordinary Receipts - means the net proceeds received by Borrower in connection with (a) the sale of the capital stock of Borrower or (b) a public offering of securities issued by Borrower. Federal Funds Rate shall mean, for any day, 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 (or if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or if such rate is not so published for any day which is a Business Day, the average of quotations for such day on such transactions received by the Bank from three Federal funds brokers of recognized standing selected by the Bank. Financial Statement - the audited financial statements of Borrower on a Consolidated Basis for each Fiscal Year. Fiscal Month - each monthly accounting period during any Fiscal Year. Fiscal Quarter - each quarterly accounting period during any Fiscal Year. Fiscal Year - the accounting period beginning on January 1 of each year and ending on December 31 of each year. Fixed Charge Coverage - means, for any period, the ratio of (i) (A) EBITDA of Borrower on a Consolidated Basis for such period minus (B) actual unfinanced Capital Expenditures of Borrower during such period minus (C) cash taxes actually paid during such period to (ii) the sum of A-9 the aggregate of payments of interest and regularly scheduled principal with respect to Indebtedness for Money Borrowed (other than the Revolving Credit Loans) made during such period. General Intangibles - with respect to Borrower all general intangibles and other personal property of Borrower (including things in action) other than goods, Accounts, chattel paper, documents, instruments and money, whether now owned or hereafter created or acquired by Borrower, including, without limitation, all choses in action, causes of action, corporate or other business records, inventions, designs, patents, patent applications, equipment formulations, manufacturing procedures, quality control procedures, trademarks, service marks, trade secrets, goodwill, copyrights, design rights, registrations, licenses, franchises, customer lists, tax refunds, tax refund claims, computer programs, all claims under guaranties, security interests or other security held by or granted to Borrower to secure payment of any of the Accounts by an Account Debtor all rights of indemnification, all deposit accounts of Borrower and all other intangible property of every kind and nature. Guarantor - means each Person that shall execute and deliver a Guaranty to Agent. Guaranty - means the guaranty of the obligations of Borrower executed by each Guarantor in favor of Agent and Lenders and each related guaranty security agreement, as applicable. Hazardous Discharge - shall have the meaning set forth in Section 4.19(d) hereof. Hazardous Substance - shall mean, without limitation, any flammable explosives, radon, radioactive materials, asbestos, urea formaldehyde foam insulation, polychlorinated biphenyls, petroleum and petroleum products, methane, hazardous materials, Hazardous Wastes, hazardous or toxic substances or related materials as defined in CERCLA, the Hazardous Materials Transportation Act, as amended (49 U.S.C. Sections 1801, et seq.), RCRA, or any other applicable Environmental Law and in the regulations adopted pursuant thereto. Hazardous Wastes - shall mean all waste materials subject to regulation under CERCLA, RCRA or applicable state law, and any other applicable Federal and state laws now in force or hereafter enacted relating to hazardous waste disposal. Indebtedness - as applied to a Person means, without duplication (i) all items which in accordance with GAAP would be included in determining total liabilities as shown on the liability side of a balance sheet of such Person as at the date as of which Indebtedness is to be determined, including, without limitation, Capitalized Lease Obligations, (ii) all obligations of other Persons which such Person has guaranteed, (iii) all reimbursement obligations in connection with letters of credit or letter of credit guaranties issued for the account of such Person, and A-10 (iv) in the case of Borrower, the Obligations. Indenture - the Indenture dated as of March 1, 1986 between Borrower (f/k/a Vodavi Technology Corporation) and United States Trust Company of New York, as Trustee, as in effect on the Closing Date. Interest Period - as defined in SUBSECTION 3.1.5. Inventory - with respect to Borrower, all of Borrower's inventory, whether now owned or hereafter acquired including, but not limited to, all goods intended for sale or lease by Borrower, or for display or demonstration; all work in process; all raw materials and other materials and supplies of every nature and description used or which might be used in connection with the manufacture, printing, packing, shipping, advertising, selling, leasing or furnishing of such goods or otherwise used or consumed in Borrower's business; and all documents evidencing and General Intangibles relating to any of the foregoing, whether now owned or hereafter acquired by Borrower. Issuing Bank - as defined in section 1.2.4. LC Guaranty - any guaranty pursuant to which Agent or any Affiliate of Agent shall guaranty the payment or performance by Borrower of its reimbursement obligation under any letter of credit. Lender and Lenders - the meaning ascribed to such terms in the Preamble to the Agreement and each person which is a transferee, successor or assign of any Lender. Letter of Credit - any letter of credit issued by Agent or any of Agent's Affiliates for the account of Borrower. Letter of Credit Fee Payment Date - the last Business Day of each March, June, September and December and on the last day of the Original Term. LIBOR - for any Eurodollar Loan for the then current Interest Period, the rate of interest equal to the average (rounded upwards, if necessary to the nearest 1/16 of 1%) of the rates per annum at which Dollar deposits in immediately available funds are offered to the Bank in the London interbank eurodollar market as at 11:00 A.M. London time two (2) Business Days prior to the beginning of such Interest Period, for delivery on the first day of such Interest Period, and in an amount approximately equal to the amount of such Eurodollar Loan for a period approximately equal to such Interest Period. LIBOR Rate - the rate per annum for the one month LIBOR rate as published in The Wall Street Journal, averaged monthly on a calendar month basis. LIBOR Rate Loan - a Revolving Credit Loan at any time that bears interest based on the LIBOR Rate. A-11 Lien - any interest in Property securing an obligation owed to, or a claim by, a Person other than the owner of the Property, whether such interest is based on common law, statute or contract. The term "Lien" shall also include reservations, exceptions, encroachments, easements, rights-of-way, covenants, conditions, restrictions, leases and other title exceptions and encumbrances affecting Property. For the purpose of the Agreement, Borrower shall be deemed to be the owner of any Property which it has acquired or holds subject to a conditional sale agreement or other arrangement pursuant to which title to the Property has been retained by or vested in some other Person for security purposes. Loan Account - the loan account established on the books of Agent pursuant to and as defined in SECTION 3.6 of the Agreement. Loan Documents - the Agreement, the Other Agreements and the Security Documents. Loan Year - the applicable year during the Term calculated initially from the Closing Date (i.e. the Closing Date through the day prior to the one year anniversary of the Closing Date, "Loan Year 1", the one year anniversary date through the day prior to the two year anniversary of the Closing Date, "Loan Year 2", etc.) Loans - all loans and advances of any kind made by Lenders pursuant to the Agreement. Material Adverse Effect - a material adverse effect on (a) the condition (financial or otherwise), operations, performance, properties, assets or business of Borrower and its Subsidiaries, taken as a whole, (b) Borrower's or any Subsidiary of Borrower's ability to pay or perform the Obligations in accordance with the terms thereof, (c) the value of the Collateral, the Liens on the Collateral or the priority of any such Lien, (d) the practical realization of the benefits of Agent's or any Lender's rights and remedies under this Agreement or the other Loan Documents or (e) any of the Transactions. Maximum Revolving Amount - $30,000,000 Money Borrowed - means (i) Indebtedness arising from the lending of money by any Person to Borrower; (ii) Indebtedness, whether or not in any such case arising from the lending by any Person of money to Borrower, (A) which is represented by notes payable or drafts accepted that evidence extensions of credit, (B) which constitutes obligations evidenced by bonds, debentures, notes or similar instruments, or (C) upon which interest charges are customarily paid (other than accounts payable) or that was issued or assumed as full or partial payment for Property; (iii) Indebtedness that constitutes a Capitalized Lease Obligation; (iv) reimbursement obligations with respect to letters of credit or guaranties of letters of credit and (v) Indebtedness of Borrower under any guaranty of obligations that would constitute Indebtedness for Money Borrowed under clauses (i) through (iii) hereof, if owed directly by Borrower. Monthly Financial Statement - the monthly consolidated financial statements of Borrower with respect to each Fiscal Month. A-12 Multiemployer Plan - has the meaning set forth in Section 4001(a)(3) of ERISA. Net Income - for any period, shall mean, the net income of Borrower on a Consolidated Basis for such period as determined in accordance with GAAP as of the Closing Date. Net Worth - at a particular date, all amounts which would be included under shareholders' equity (including preferred stock whether or not categorized as part of shareholders' equity in accordance with GAAP) on a balance sheet of Borrower on a Consolidated Basis determined in accordance with GAAP as at such date. Notes - the Revolving Notes. Obligations - all Loans and all other advances, debts, liabilities, obligations, covenants and duties, together with all interest, fees and other charges thereon, owing, arising, due or payable from Borrower to Agent or Lenders of any kind or nature, present or future, whether or not evidenced by any note, guaranty or other instrument, arising under the Agreement or any of the other Loan Documents whether direct or indirect, absolute or contingent, primary or secondary, due or to become due, now existing or hereafter arising and however created. Original Term - as defined in SECTION 4.1 of the Agreement. Other Agreements - any and all agreements, instruments and documents (other than the Agreement and the Security Documents), heretofore, now or hereafter executed by Borrower, any Subsidiary of Borrower, any Guarantor or any other third party and delivered to Agent and Lenders in respect of the Transactions. Overadvance - as to Borrower, the amount, if any, by which the outstanding principal amount of Revolving Credit Loans plus the LC Amount exceeds the Borrowing Base. Participating Lender - each Person who shall be granted the right by any Lender to participate in any of the Loans described in the Agreement and who shall have entered into a participation agreement in form and substance satisfactory to Lenders. Permitted Liens - any Lien of a kind specified in SUBSECTION 8.2.5 of the Agreement. Person - an individual, partnership, corporation, limited liability company, joint stock company, land trust, business trust, or unincorporated organization, or a government or agency or political subdivision thereof. Plan - an employee benefit plan now or hereafter maintained for employees of Borrower that is covered by Title IV of ERISA. Projections - Borrower's forecasted Consolidated and consolidating (a) balance sheets, (b) profit and loss statements, (c) cash flow statements (d) capitalization statements and (e) Accounts and Inventory valuations all prepared on a consistent basis with Borrower's historical A-13 financial statements, together with appropriate supporting details and a statement of underlying assumptions. Property - any interest in any kind of property or asset, whether real, personal or mixed, or tangible or intangible. Purchase Money Indebtedness - means and includes (i) Indebtedness (including Capitalized Lease Obligations) (other than the Obligations) for the payment of all or any part of the purchase price of any fixed assets, (ii) any Indebtedness (including Capitalized Lease Obligations) (other than the Obligations) incurred at the time of or within 10 days prior to or after the acquisition of any fixed assets for the purpose of financing all or any part of the purchase price thereof, and (iii) any renewals, extensions or refinancings thereof, but not any increases in the principal amounts thereof outstanding at the time. Purchase Money Lien - a Lien upon fixed assets which secures Purchase Money Indebtedness, but only if such Lien shall at all times be confined solely to the fixed assets the purchase price of which was financed through the incurrence of the Purchase Money Indebtedness secured by such Lien including Liens securing Capitalized Lease Obligations. Purchasing Lender - as defined in SECTION 12.4(III) of the Agreement. Quarterly Financial Statement - the quarterly consolidated financial statements of Borrower with respect to each Fiscal Quarter. RCRA - shall mean the Resource Conservation and Recovery Act, 42 U.S.C. 'SS''SS'6901 et seq., as same may be amended from time to time. Rentals - as defined in SUBSECTION 8.2.12 of the Agreement. Reportable Event - any of the events set forth in Section 4043(b) of ERISA. Required Lenders - Lenders holding at least fifty-one percent (51%) of the Loans as of the most recent Settlement Date and, if no Loans are then outstanding, Lenders holding at least fifty-one percent (51%) of the Commitment Percentages. Required Delivery Date - each date of required delivery of a Financial Statement or a Monthly Financial Statement. Reserves - as defined in SUBSECTION 1.1.1 of the Agreement. Restricted Investment - any investment made in cash or by delivery of Property to any Person, whether by acquisition of stock, Indebtedness or other obligation or Security, or by loan, advance or capital contribution, or otherwise, or in any Property except the following: (i) investments in one or more Subsidiaries of Borrower to the extent existing on the Closing Date; A-14 (ii) rights to payment arising from the sale of goods and services in the ordinary course of business of Borrower and its Subsidiaries; (iii) investments in direct obligations of the United States of America, or any agency thereof or obligations guaranteed by the United States of America, provided that such obligations mature within one year from the date of acquisition thereof; (iv) investments in certificates of deposit maturing within one year from the date of acquisition issued by a bank or trust company organized under the laws of the United States or any state thereof having capital surplus and undivided profits aggregating at least $100,000,000; (v) investments in commercial paper given the highest rating by a national credit rating agency and maturing not more than 270 days from the date of creation thereof; and (vi) Specified Permitted Investments. Revolving Credit Loan - a Loan made by any Lender as provided in SECTION 1.1 of the Agreement including, without limitation, Special Advances. Revolving Notes - shall have the meaning set forth in SUBSECTION 1.1.1. Schedule of Accounts - as defined in SUBSECTION 6.2.1 of the Agreement. Security - shall have the same meaning as in Section 2(1) of the Securities Act of 1933, as amended. Security Documents - all instruments and agreements now or at any time hereafter securing the whole or any part of the Obligations. Settlement Date - the Closing Date and thereafter on the first day of each Week unless such day is not a Business Day in which case it shall be the next succeeding Business Day; provided, however, if Agent so elects in its discretion, Settlement Date shall mean each Business Day of the Week. Solvent - as to any Person, such Person (i) owns Property whose fair saleable value is greater than the amount required to pay all of such Person's Indebtedness (including contingent debts, which will be computed at the amount which, in light of all the facts and circumstances existing at such time, represents the amount that can reasonably be expected to become an actual or matured liability), (ii) is able to pay all of its Indebtedness as such Indebtedness matures, (iii) has capital sufficient to carry on its business and transactions and all business and transactions in which it is about to engage and (iv) does not intend to, and does not believe it will, incur debts or liabilities beyond its ability to pay as such debts and liabilities mature. A-15 Specified Capital Contribution - each capital contribution made by Borrower to UniStar in accordance with the terms of SUBSECTION 8.2.4(B) hereof Specified Permitted Investments - loans made by Borrower to or investments made by Borrower in one or more entities acting as distributors of Borrower's products, not to exceed an aggregate amount outstanding at any time in excess of $6,000,000. Specified Reserve - a reserve in the amount of $6,000,000 against the amount of Revolving Credit Loans which Borrower may request under the Agreement, which such reserve shall be reduced to zero ($0) upon Borrower's making of the Specified Capital Contribution upon consummation of the Spinoff. Spinoff - the distribution of capital stock of UniStar to and/or the rights to purchase capital stock of UniStar by Borrower's shareholders. Subordinated Debt - Indebtedness of Borrower that is subordinated to the Obligations in a manner satisfactory to Lenders. Subsidiary - any corporation or limited liability company of which a Person owns, directly or indirectly through one or more intermediaries, more than 50% of the Voting Stock at the time of determination and each direct and indirect Subsidiary of such Person. Subsidiary Stock - all of the issued and outstanding shares of stock owned by Borrower or any Subsidiary of Borrower of any of its Subsidiaries. Transactions - means the transactions contemplated by the Agreement Total Credit Facility - $30,000,000. Transferee - as defined in SECTION 12.4(II) of the Agreement. UniStar - UniStar Gaming Corporation, a Delaware corporation. Voting Stock - Securities of any class or classes of a corporation or membership interests of a limited liability company, the holders of which are ordinarily, in the absence of contingencies, entitled to elect a majority of the corporate directors with respect to a corporation or entitled to elect the managers with respect to a limited liability company (or Persons performing similar functions). Week - the time period commencing with a Monday and ending on the following Monday. Other Terms. All other terms contained in the Agreement shall have, when the context so indicates, the meanings provided for by the Code to the extent the same are used or defined therein. A-16 Certain Matters of Construction. The terms "herein", "hereof" and "hereunder" and other words of similar import refer to the Agreement as a whole and not to any particular section, paragraph or subdivision. Any pronoun used shall be deemed to cover all genders. The section titles, table of contents and list of exhibits appear as a matter of convenience only and shall not affect the interpretation of the Agreement. All references to statutes and related regulations shall include any amendments of same and any successor statutes and regulations. All references to any of the Loan Documents shall include any and all modifications thereto and any and all extensions or renewals thereof. A-17 WAIVER AND AMENDMENT NO. 1 TO LOAN AND SECURITY AGREEMENT THIS WAIVER AND AMDENDMENT NO. 1 ("Amendment") is entered into as of March 29, 1999, by and between EXECUTONE INFORMATION SYSTEMS, INC., a Virginia corporation having its principal place of business at 478 Wheelers Farms Road, Milford, Connecticut ("Borrower") and FLEET CAPITAL CORPORATION, as lender ("Lender") and as administrative and collateral agent ("Agent"). BACKGROUND Borrower, Agent and Lender are parties to a Loan and Security Agreement dated as of August 14, 1998 (as amended, supplemented or otherwise modified from time to time, the "Loan Agreement") pursuant to which Lender provides Borrower certain financial accommodations. Borrower has requested that Agent and Lender waive and amend certain provisions of the Loan Agreement and Agent and Lender are willing to do so on the terms and conditions hereafter set forth. NOW, THERFORE, in consideration of any loan or advance or grant of credit heretofore or hereafter made to or for the account of Borrower by Lender, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows: 1. Definitions. All capitalized terms not otherwise defined herein shall have the meanings given to them in the Loan Agreement. 2. Amendment to Loan Agreement. Subject to satisfaction of the conditions precedent set forth in Section 4 below, the Loan Agreement is hereby amended as follows: (a) Section 8.3.2. of the Loan Agreement is amended in its entirety to provide as follows: "8.3.2. Cash Flow. Maintain Cash Flow of not less than (a) negative $2,000,000 for the five months ended December 31, 1998, (b) negative $3,500,000 for the three months ended March 31, 1999, (c) negative $5,250,000 for the six months ended June 30, 1999, (d) negative $3,000,000 for the nine months ended September 30, 1999, and (e) $750,000 for the twelve months ended December 31, 1999 and on the last day of each Fiscal Quarter thereafter calculated on a rolling four-quarter basis." (b) Section 8.3.3 of the Loan Agreement is amended in its entirety to provide as follows: 8.3.3 Adjusted Cash Flow. Maintain for each Fiscal Quarter end set forth below an Adjusted Cash Flow of not less than (a) negative $2,250,000 for the five months ended December 31, 1998, (b) negative $3,500,000 for the three months ended March 31, 1999, (c) negative $5,250,000 for the six months ended June 30, 1999, (d) negative $3,000,000 for the nine months ended September 30, 1999, and (e) $750,000 for the twelve months ended December 31, 1999 and on the last day of each Fiscal Quarter thereafter calculated on a rolling four-quarter basis. 3. Waiver. Subject to satisfaction of the conditions precedent set forth in Section 4 below, Agent and Lender hereby waive the Events of Default which have occurred solely as a result of Borrower's violations of (a) Section 8.3.2 of the Loan Agreement for the five months ended December 31, 1998 and (b) Section 8.3.3 of the Loan Agreement for the five months ended December 31, 1998. 4. Conditions of Effectiveness. This Amendment shall become effective upon satisfaction of the following conditions precedent: Agent shall have received (i) four (4) copies of this Amendment executed by Borrower, (ii) an amendment fee in an amount equal to $10,000, which fee Agent may charge to Borrower's loan account and (iii) such other certificates, instruments, documents, agreements and opinions of counsel as may be required by Agent or its counsel, each of which shall be in form and substance satisfactory to Agent and its counsel. 5. Representations and Warranties. Borrower hereby represents and warrants as follows: (a) This Amendment and the Loan Agreement, as amended hereby, constitute legal, valid and binding obligations of Borrower and are enforceable against Borrower in accordance with their respective terms. (b) Upon the effectiveness of this Amendment, Borrower hereby reaffirms all convents, representations and warranties made in the Loan Agreement to the extent the same are not amended hereby and agree that all such covenants, representations and warranties shall be deemed to have been remade as of the effective date of this Amendment. (c) No Event of Default or Default has occurred and is continuing or would exist after giving effect to this Amendment. (d) Borrower has no defense, counterclaim or offset with respect to the Loan Agreement. 6. Effect on the Loan Agreement. (a) Upon the effectiveness of Section 2 hereof, each reference in the Loan Agreement to "this Agreement," "hereunder," "hereof", "herein" or words of like import shall mean and be a reference to the Loan Agreement as amended hereby. (b) Except as specifically amended herein, the Loan Agreement, and all other documents, instruments and agreements executed and/or delivered in connection therewith, shall remain in full force and effect, and are hereby ratified and confirmed. (c) The execution, delivery and effectiveness of this Amendment shall not, except as expressly provided in Section 3 hereof, operate as a waiver of any right, power or remedy of Agent or Lender, nor constitute a waiver of any provision of the Loan Agreement, or any other documents, instruments or agreements executed and/or delivered under or in connection therewith. 7. Governing Law. This Amendment shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns and shall be governed by and construed in accordance with the laws of the State of New York. 8. Headings. Section headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this Amendment for any other purpose. 9. Counterparts. This Amendment may be executed by the parties hereto in one or more counterparts, each of which shall be deemed an original and all of which when taken together shall constitute one and the same agreement. IN WITNESS WHEREOF, this Amendment has been duly executed as of the day and year first written above. EXECUTONE INFORMAITON SYSTEMS, INC., As Borrower By: Name: Edward W. Stone Title: Sr. VP and CFO FLEET CAPITAL CORPORATION, As Agent and Lender By: Name: Howard Hanoman Title: Sr. VP EX-10 3 EXHIBIT 10.8 EXHIBIT 10-8 EXECUTONE Information Systems, Inc. Transition and Retention Plan The Board of Directors of EXECUTONE recognizes the current uncertainty associated with the succession in chief executive leadership in the Company and the board's announced consideration of a possible corporate restructuring that would be intended to (1) enhance shareholder value, (2) more efficiently allocate corporate resources and (3) channel management focus. The Board also recognizes that senior management of the Company has made a significant, debt-financed financial investment in the Company and its future through the EXECUTONE 1994 Executive Stock Incentive Plan (the "Stock Plan") and that management expects, and is committed to, playing a leadership role in implementing the Company's business plans in order to protect and enhance the value of their investment in the Company and that of all shareholders. The Board has determined, due to the substantial changes in the Company's business plan and focus since the date the Stock Plan was adopted and due to the further substantial changes currently being considered for the Company's business focus and leadership, to offer a retention and incentive program ("Transition and Retention Plan") for key employees of the Company who currently are participating in the Stock Plan, who are selected by the Board as being eligible to participate and who agree to the terms and conditions discussed below (the "Participating Employees"). 1. Employment Commitment. Each Participating Employee who enrolls in the Transition and Retention Plan and who discharges his or her employment duties diligently in support of the business plans, unity and harmony of the Company, will become entitled to the benefits described below as they vest according to the terms of this Plan. 2. Extension of Loan Maturity Date. The maturity date on each Participating Employee's Loan (as defined in the following section) will be the earlier of March 31, 2001 or the date the Participating Employee ceases to be employed by the Company. All interest due under a Loan will accrue, but will not be payable by the Participating Employee until the maturity date of the Loan. 3. Free Transferability. Shares purchased by Participating Employees under the Stock Plan ("Plan Shares") will be freely transferable, subject to applicable securities laws, Company policy and the pledge of such shares to the Company as collateral for the Company's guarantee of the employee's loan (a "Loan") from Bank of America National Trust and Savings Association (the "Bank") and the advance of interest on the Loans by the Company for the employee's benefit. (The collective amount owed to the Bank and the Company for principal and interest outstanding on a Loan at any given time is referred to hereafter as the "Loan Balance".) Any shortfall between the portion of a Loan attributable to any Plan Shares that are sold and the application of the net sales proceeds against the Loan Balance will continue to be an outstanding obligation of the Participating Employee, subject to being offset by a Retention Payment as described in paragraph 5 below. 4. Purchase Option. The Company will have the right, but not the obligation, to purchase Plan Shares from a participating Employee, at the market price therefor, at any time on or before March 31, 2001. The purchase price will be paid in each case by first offsetting any Loan Balance, with any remaining proceeds being delivered to the Participating Employee. To the extent the net proceeds from the exercise of such purchase option are not sufficient to offset fully the Loan Balance, the Participating Employee will remain liable for the Loan Balance under the Loan (which will continue to have the same maturity date and other provisions described herein), subject to the right to earn a Retention Payment and the other provisions of this plan. 5. Retention Payment. Each Participating Employee will be given the opportunity to earn a Retention Payment, as defined below. A Retention Payment will be deemed earned and vested ratably on a quarterly basis from March 31, 1999 until March 31, 2001, through continued employment of the Participating Employee as provided herein, as follows: on March 31, 1999, 33 1/3%; and 8.333% at the end of each calendar quarter thereafter until March 31, 2001. The Retention Payment earned by a Participating Employee will be paid in one installment on the maturity date (as defined in paragraph 2 above) of the Participating Employee's Loan. 6. Determination of Retention Payment Amount. The Retention Payment shall be that amount as shall be equal to 110% of the excess of the Loan Balance of the Participating Employee's Loan over (1) the purchase price paid for the Participating Employee's Plan Shares if the Company exercises its option under paragraph 4 and purchases any or all of the Participating Employee's Plan Shares, and/or (2) the closing market price of the Participating Employee's Plan Shares still owned as of the maturity date of the Participating Employee's Loan (either March 31, 2001, or as of the date of an earlier termination of employment as provided herein). The Retention Payment will be applied against a Participating Employee's Loan Balance, and any excess after the Loan Balance has been paid in full will be paid in cash, subject to any applicable withholding requirements, at the time the Retention Payment is paid. 7. Acceleration of Vesting. A Retention Payment will be deemed fully earned, vested and payable prior to March 31, 2001, if the Participating Employee has remained continuously employed by the Company since the date of this Plan and dies, becomes incapacitated, is terminated without cause, or if a "change in control" of the Company occurs. In each case, the Retention Payment will be deemed fully earned, vested and payable as of the date of the qualifying occurrence. For purposes of this Plan, a "change in control" shall be deemed to have occurred if, (i) any person, including a "group" as defined in Section 13(d)(3) of the Securities Exchange Act of 1934, becomes the owner or beneficial owner of all or substantially all of the Company's assets or of Company securities having 50% 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 by the Board, as long as the majority of the Board of Directors approving the purchases is the majority at the time the purchases are made); 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 one year of the last of such transactions. For purpose of this Plan, 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. Neither the spin-off of Unistar, nor the sale of all or a portion of the assets of the Company's Healthcare division, nor the combination of those two events, shall constitute a Change in Control for the purposes of this plan. 8. Application of Proceeds. The net proceeds from any sales of Plan Shares, whether a full or partial sale in the market or a full or partial purchase by the Company under paragraph 4, and any Retention Payment earned by a Participating Employee will in each case be applied first against any Loan Balance then due the Bank or the Company, with any excess proceeds or remaining Retention Payment being payable to the Participating Employee. Unlike under the Stock Plan, employees participating in the Transition and Retention Plan will not be required to apply 25% of any bonus earned toward repayment of the Loan Balance. 9. Examples. The following examples illustrate the application of the Retention Payment in certain cases. These examples are given for illustrative purposes only and reflect a few, but not all, potential circumstances. The actual definition of the Retention Payment set forth above, as interpreted by the Board of Directors, shall determine the computation and application of a Retention Payment in each specific case. Example (a). Assume a Participating Employee works until March 31, 2001; the Participating Employee's Loan comes due on March 31, 2001; the Participating Employee's Plan Shares are contemporaneously sold in the market for $2.50 a share with the net proceeds delivered to the Bank and the Company; the Loan Balance equals $4.90 a share on the date the Plan Shares are sold and the proceeds delivered to the Bank or the Company, as the case may be. The Retention Payment is $2.64 [1.10 x ($4.90-2.50)] a share. The Participating Employee would have discharged fully his or her liability to the Company and the Bank on the Loan and would receive $0.24 a share in cash. Example (b). A Participating Employee voluntarily quits on July 1, 1999; the Participating Employee's Loan comes due on the date employment is terminated; the Participating Employee's Plan Shares are sold in the market for $2.50 a share and the proceeds applied against the Loan Balance to the Bank and the Company; the Loan Balance equals $4.37 a share at the time of sale and delivery of proceeds. The Participating Employee is 41.67% vested in the maximum Retention Payment. The Retention Payment is $0.86 [($4.37 - $2.50) x 1.10 x .4167] a share. The Participating Employee remains liable for the remaining Loan Balance of $1.01 a share ($4.37 - $2.50 - $0.86), which is then due and payable. Example (c). The Participating Employee sells Plan Shares on August 15, 1998 for $3.00 a share and continues to be employed; the Loan Balance at the time of sale and delivery of proceeds equals $4.05 a share; the sales proceeds are applied against the Loan Balance. No Retention Payment is yet due and payable. The Retention Payment that can be earned, as determined by the difference between the Loan Balance and the net sales proceeds of the Plan Shares that were sold, is $1.16* a share [1.10 x $1.05] for each share sold. The Retention Payment is still subject to being earned and vested for the Participating Employee's account as the Participating Employee's employment continues. So, for example, the Participating Employee continues to be obligated for $1.05* a share plus interest, but that amount will be offset and reduced ratably to zero, and the Participating Employee will become entitled to receive any excess by the vesting of the Retention Payment as each quarter passes towards March 31, 2001. Example (d). A Participating Employee sells Plan Shares on June 15, 1999 for $5.00 a share and continues to be employed; the Loan Balance at the time of sale and delivery of proceeds equals $4.37 a share; the sales proceeds fully liquidates the Loan Balance to the Bank and the Company. The Participating Employee retains $0.63 a share and receives no Retention Payment under the Plan. 10. Stock Option. Each Participating Employee will be granted incentive stock options in an amount equal to one option share for each two Plan Shares originally purchased by the employee under the Stock Plan. The options will have a five year life and will vest as follows: 25% on each of March 31, 1999, March 31, 2000, March 31, 2001 and March 31, 2002. The options will be granted as of the date - -------- * These amounts will be increased by any interest that continues to accrue on the Loan Balance, or is imputed for federal income tax purposes. the Participating Employee opts into this plan. The exercise price of the options will be the fair market value of a share of Company common stock on the date of grant. 11. Separation Payment and Benefits. The Company will pay each Participating Employee, in addition to any Retention Payment, a separation payment equal to nine months of the Participating Employee's base salary as of the date of the Participating Employee's termination of employment (payable over the succeeding nine months), if the Participating Employee has remained continuously employed by the Company since the date of this Plan and the Participating Employee dies, becomes incapacitated or is terminated without cause at anytime after enrolling in the Transition and Retention Plan. For purposes of the Transition and Retention Plan, termination for cause shall include termination based on the following acts or omissions: theft, embezzlement or fraud; acts of moral turpitude or other acts which tend to disparage the reputation and good name of the Company; conviction of a felony; willful or reckless disregard of the Company's policies, practices or best interests; breach of the duties of confidentiality or loyalty; breach of a fiduciary duty to the shareholders; the deliberate or negligent failure to discharge one's duties in a zealous and good faith manner; the deliberate or negligent failure to make good faith efforts to contribute to the spirit of teamwork and internal harmony sought by EXECUTONE; and the deliberate or negligent failure to make good faith efforts to support the current CEO, or any interim or succeeding CEO, in the discharge of his or her duties. Determining whether any of the above-described causes for termination exist lies within the exclusive discretion of the Board. Before reaching a final determination regarding a termination for cause, however, the Board will allow the affected employee an opportunity to appear before designated members of the Board to discuss his or her situation. For purposes of the Transition and Retention Plan, a termination otherwise without cause which results from a change in control or a downsizing shall be considered a termination without cause. However, any Participating Employee offered comparable employment with a purchaser of all or part of the Company's business (e.g., Unistar), shall not be considered to have been terminated for purposes of this Plan. Nothing herein shall be construed as restricting the Company's right, in its sole discretion, to change or reassign the duties and responsibilities for which each Participating Employee is responsible in the future. Resignation by a Participating Employee shall not be considered a termination without cause for purposes of this Plan; however, if the base salary of a Participating Employee is reduced by greater than five percent in a single year, the Participating Employee will be allowed to resign and accept one month severance plus a Retention Payment computed at 100% of the Loan Balance deficit (rather than the 110% provided in paragraph 6 above) which will be applied against the Participating Employee's Loan Balance. The Participating Employee shall not be entitled to separation benefits if his or her salary is reduced pursuant to a salary reduction imposed upon all managers or officers of a similar classification or status. The Company will continue to provide benefits covered by COBRA in accordance therewith. The Company will also provide, for the applicable separation period, participation in the same or comparable employee benefit plans that were generally available to employees of the Company and in which the Participating Employee was participating on the date of termination, on the same basis as the employee was then participating. 12. Voluntary Participation. Participation in the Transition and Retention Plan is voluntary. Any employee who does not elect to become a Participating Employee in the Transition and Retention Plan may (1) elect to terminate his or her employment with the Company now and receive the Retention Payment (computed at 100% of the Loan Balance deficit rather than 110% provided in paragraph 6 above, and to be applied against their Loan Balance) and a one month separation payment in lieu of any and all other rights or claims, or (2) continue to hold his or her Plan Shares in accordance with the current terms, conditions, maturity date and interest payment requirements of the Stock Plan. The maturity date for Stock Plan Loans has previously been extended by the Board of Directors to December 31, 2001. The Company will continue to advance 85% of the interest payments due on a Loan for the account of employees in the Stock Plan who do not elect to become Participating Employees under the Transition and Retention Plan for the years ending December 31, 1998 and December 31, 1999 (with the employee continuing to be liable for all such interest advanced). For employees who do not elect to become Participating Employees under the Transition and Retention Plan, all other provisions of the Stock Plan, including, without limitation, the employee's obligation for all (i) accrued but unpaid interest, (ii) to fund directly 15% of interest due under a Loan with respect to 1998 and 1999 and 100% of such interest thereafter as it becomes due, and (iii) to repay the Loan and all accrued but unpaid interest upon maturity of the Loan (including early maturity as a result of termination of employment) shall remain in effect. 13. Distributions on Plan Shares. Plan Shares, as used herein, shall include any shares of Unistar or other property that may be distributed with respect to Plan Shares. Any dividends or other distributions with respect to Plan Shares will be first applied against any Loan Balance. 14. General. Any arrearages in interest payments or otherwise with respect to an employee's obligation to fund or curtail Loan interest, or any unpaid installments or required curtailments of principal, that arose prior to January 1, 1998, must be cured immediately for an employee to participate in the Transition and Retention Plan. The grant of the payment rights and options proposed by this plan will be in lieu of (a) any and all other rights or claims a Participating Employee may have prior hereto for incentive, retention, separation or similar payments or rights, whether relating to the Stock Plan, Loans, the change in leadership of the Company, any proposed restructuring of the Company, or otherwise, as well as (b) all claims arising from the employee's employment prior to the effective date of the Plan, and shall be so confirmed as the Company requires; provided, however, that this plan will not (i) affect options already granted and outstanding or written incentive plans already issued; or (ii) preclude the grant of other options or performance and incentive awards from time to time as part of any other key employee option or incentive program the Company may adopt in the future. Participating Employees shall be responsible for any and all income taxes attributable to any of the payments or benefits received or receivable by them hereunder. Participation in this program will be solely for incentive purposes and will not be deemed an entitlement to employment for a minimum term or otherwise change the at-will nature of each Participating Employee's employment. All rights and obligations hereunder, as well as those set forth in the accompanying Transition Plan Acknowledgment and Waiver, are subject to obtaining the Bank's consent to implement the plan. The Company's obligations under this plan will be unfunded and subject to being diluted by or subordinated to the general claims of creditors of the Company that exist today or that may arise in the future. The Board shall have the full discretion to interpret any and all terms and provisions of this plan and its decisions as to the meaning, intent and application of any term or provision hereof shall be final and conclusive. EXECUTONE INFORMATION SYSTEMS, INC. By: ________________________________ Alan S. Kessman Interim Chief Executive Officer I acknowledge receipt of the TRP Plan ________________________ _________________ Signature Date I choose to accept participation in the TRP ________________________ _________________ Plan Signature Date I choose not to accept participation in the TRP Plan _________________________ _________________ Signature Date As part of my choice not to participate in the TRP Plan, I have chosen the alternative described in paragraph 12 to either: (1) terminate my employment with the Company, or _________________________ _________________ Signature Date (2) continue to hold my Plan shares in accordance with the terms described _________________________ _________________ Signature Date
EX-10 4 EXHIBIT 10.21 EXHIBIT 10-21 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 NOVEMBER 18, 2003, A COPY OF WHICH IS ON FILE AT THE PRINCIPAL OFFICE OF THE COMPANY. Issued as of Void after November 18, 2003 November 18, 1998 WARRANT TO PURCHASE 25,000 SHARES OF COMMON STOCK OF EXECUTONE INFORMATION SYSTEM, INC. (incorporated under the Laws of the Commonwealth of Virginia) THIS IS TO CERTIFY THAT, JOHN P. HECTUS ("Hectus") or his permitted registered assigns (Hectus 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 THIRTY ONE THOUSAND TWO HUNDRED FIFTY DOLLARS ($31,250) or ONE and 25/100 DOLLARS ($1.25) 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) November 18, 1998 and on or before 5:00 p.m. (Eastern Standard Time), on November 18, 2003. 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 November 18, 1999, one-third on November 18, 2000 and one-third on November 18, 2001; provided, however, that if Hectus ceases to be a director of the Company, either voluntarily or because he has not been reelected by the Shareholders of the Company, then Hectus'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. 1. 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 Hectus otherwise than by Will or the laws of descent and distribution and, during the lifetime of Hectus, 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) Hectus' heirs and devisees, or (ii) Hectus' 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 not 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 November 18, 2003, 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 Hectus' 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 Hectus 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 Hectus 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 Hectus' directorship with the Company within the meaning of this paragraph. In the event Hectus' 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 November 18, 2003. 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 One and 25/100 Dollars ($1.25). 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 06460, 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______ day of ___________, 19___ COMPANY: EXECUTONE INFORMATION SYSTEMS, INC., a Virginia corporation By________________________________ Stanley Kabala Its President and Chief Executive Officer [CORPORATE SEAL] ATTEST: ____________________________________ Barbara C. Anderson Vice President, Law and Administration HOLDER: By________________________________ John P. Hectus EXHIBIT "A" SUBSCRIPTION NOTICE The undersigned, the Holder of the foregoing Warrant, hereby elects to exercise purchase rights represented by such Warrant for, and to purchase thereunder,______________________________________________(_____________________) shares of the Common Stock covered by such Warrant and herewith makes payment in full therefor in the amount of __________________________________________Dollars ($________________) in cash or check made payable to the Company, and requests that one or more certificates for such shares (and any securities or property deliverable upon such exercise) be issued in the name of and delivered to ____________________________________________________________, whose address is ____________________________________________________________. The undersigned agrees that, in the absence of an effective registration statement with respect to Common Stock issued upon this exercise, the undersigned is acquiring such Common Stock for investment and not with a view to distribution thereof and that the certificate or certificates representing such Common Stock may bear a legend substantially as follows: "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 in the absence of an effective registration statement for the shares under the Act or otherwise in compliance with the Act." The undersigned further agrees that the shares represented by this Warrant may not be transferred except as provided in Sections 3 and 4 of the Warrant to purchase Common Stock of the Company expiring November 18, 2003, a copy of which is on file at the principal office of the Company. DATED:_______________ ____________________________ John P. Hectus Address: 55 Lowther Avenue Toronto, Ontario Canada M5R 1C5 ASSIGNMENT FOR VALUE RECEIVED, the undersigned hereby sells, assigns and transfers unto ___________________________________________, the rights represented by the foregoing Warrant of EXECUTONE Information Systems, Inc. and appoints _____________________________________________, attorney to transfer said rights on the books of said corporation, with full power of substitution in the premises. DATED:____________________ ____________________________ John P. Hectus NOTICE: The signature to this assignment must correspond with the name as written upon the face of the within Warrant in every particular, without alteration or enlargement or any change whatsoever. EX-10 5 EXHIBIT 10.23 EXHIBIT 10-23 NEITHER THER WARRANT NOR THE SHARES OF COMMON STOCK ISSUABLE UPON EXERCISE OF THER WARRANT HAVE BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (the "Act"). NEITHER THER 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 MARCH 1, 2004, A COPY OF WHICH IS ON FILE AT THE PRINCIPAL OFFICE OF THE COMPANY. Issued as of Void after March 1, 2004 March 1, 1999 WARRANT TO PURCHASE 25,000 SHARES OF COMMON STOCK OF EXECUTONE INFORMATION SYSTEM, INC. (incorporated under the Laws of the Commonwealth of Virginia) THER IS TO CERTIFY THAT, MALINDA MITCHELL ("Mitchell") or her permitted registered assigns (Mitchell 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 SEVENTY SIX THOUSAND FIVE HUNDRED DOLLARS ($76,500) or THREE and 6/100 DOLLARS ($3.06) 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) March 1, 1999 and on or before 5:00 p.m. (Eastern Standard Time), on March 1, 2004. The 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 March 1, 2000, one-third on March 1, 2001 and one-third on March 1, 2002; provided, however, that if Mitchell ceases to be a director of the Company, either voluntarily or because she has not been reelected by the Shareholders of the Company, then Mitchell's vesting of rights shall terminate as of the date she is no longer a director of the Company. THE EXERCISE AND TRANSFER OF THER WARRANT ARE RESTRICTED BY THE PROVISIONS OF SECTION 4 HEREOF. 1. Exercise of Warrant. The 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 the 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) the 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 the 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 the Warrant (stated in Shares), which new Warrant shall in all other respects be identical to the Warrant, or, at the request of the Holder, appropriate notation may be made on the Warrant and the same returned to the Holder. 2. Fractional Shares. The 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 the 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 the Agreement shall be transferable by Mitchell otherwise than by Will or the laws of descent and distribution and, during the lifetime of Mitchell, shall not be exercisable by any other person, but only by her. 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 the paragraph and Section 4 hereof, the Warrant and all rights hereunder are transferable ONLY with respect to (i) Mitchell's heirs and devisees, or (ii) Mitchell's Estate in whole or in part, on such books upon surrender of the Warrant at such office, together with a written assignment of the Warrant duly executed by the Holder hereof or her 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 the Warrant shall be canceled promptly. If and when the Warrant is assigned in blank, the Company may, but shall not be obligated to, treat the bearer hereof as the absolute owner of the 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, the Warrant and the certificates representing the Underlying Shares shall be stamped or otherwise imprinted with a legend substantially in the following form: "Neither the Warrant nor the shares of Common Stock issuable upon exercise of the Warrant have been registered under the Securities Act of 1933, as amended (the "Act"). Neither the Warrant not 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 March 1, 2004, a copy of which is on file at the principal office of the Company." The 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. The 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 the 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 she fully understands the restrictions on her ability to transfer the Warrant and the Underlying Shares. Without limiting the foregoing and by way of illustration only, the Holder understands that if she 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 her 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 the Warrant Agreement (the "Agreement"). A Change in Control occurs if, after the date of the 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 the 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 the Warrant is outstanding on the date Mitchell' 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 the paragraph, the 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 the paragraph, the Transaction Date is the date on which an event described in subsections (i) or (ii) hereof occurs. The date upon which Mitchell 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 Mitchell as a director or voting for her earlier removal with or without cause or through her removal by a majority of the members of the Board of Directors shall constitute a constructive termination of Mitchell' directorship with the Company within the meaning of the paragraph. In the event Mitchell' 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 the 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 the Warrant be exercisable after March 1, 2004. 8. Current Price: Adjustments. As used in the 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 the Agreement. The Purchase Price of a Share shall be Three and 6/100 Dollars ($3.06). 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 the 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 the 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 the Warrant, an adequate number of Shares of Common Stock for delivery at the times and in the manner provided herein upon exercise of the Warrant; (b) the Underlying Shares delivered upon exercise of the 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 the 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 the 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 the 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 the Warrant, by accepting the same, consents and agrees with the Company that (a) the 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) the 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 the 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. The 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. The 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 06460, and any notice to the Holder shall be addressed to her address as reflected on the records of the Company, or at such other address as the Company, the Holder and her 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 the Warrant to be signed in its name by its President or a duly authorized Vice President. DATED the______ day of ___________, 19___ COMPANY: EXECUTONE INFORMATION SYSTEMS, INC., a Virginia corporation By________________________________ Stanley Kabala Its President and Chief Executive Officer [CORPORATE SEAL] ATTEST: ____________________________________ Barbara C. Anderson Vice President, Law and Administration HOLDER: By________________________________ Malinda Mitchell EXHIBIT "A" SUBSCRIPTION NOTICE The undersigned, the Holder of the foregoing Warrant, hereby elects to exercise purchase rights represented by such Warrant for, and to purchase thereunder,______________________________________________(_____________________) shares of the Common Stock covered by such Warrant and herewith makes payment in full therefor in the amount of __________________________________________Dollars ($________________) in cash or check made payable to the Company, and requests that one or more certificates for such shares (and any securities or property deliverable upon such exercise) be issued in the name of and delivered to ____________________________________________________________, whose address is ____________________________________________________________. The undersigned agrees that, in the absence of an effective registration statement with respect to Common Stock issued upon the exercise, the undersigned is acquiring such Common Stock for investment and not with a view to distribution thereof and that the certificate or certificates representing such Common Stock may bear a legend substantially as follows: "Neither the Warrant nor the Shares of Common Stock issuable upon exercise of the Warrant have been registered under the Securities Act of 1933, as amended (the "Act"). Neither the Warrant nor such Shares may be sold, transferred, pledged or hypothecated in the absence of an effective registration statement for the shares under the Act or otherwise in compliance with the Act." The undersigned further agrees that the shares represented by the Warrant may not be transferred except as provided in Sections 3 and 4 of the Warrant to purchase Common Stock of the Company expiring March 1, 2004, a copy of which is on file at the principal office of the Company. DATED:_______________ ____________________________ Malinda Mitchell Address: 7 Odell Place Atherton, CA 94027 ASSIGNMENT FOR VALUE RECEIVED, the undersigned hereby sells, assigns and transfers unto ___________________________________________, the rights represented by the foregoing Warrant of EXECUTONE Information Systems, Inc. and appoints _____________________________________________, attorney to transfer said rights on the books of said corporation, with full power of substitution in the premises. DATED:____________________ ____________________________ Malinda Mitchell NOTICE: The signature to the assignment must correspond with the name as written upon the face of the within Warrant in every particular, without alteration or enlargement or any change whatsoever. EX-21 6 EXHIBIT 21 Exhibit 21 SUBSIDIARIES OF EXECUTONE INFORMATION SYSTEMS, INC.
JURISDICTION OF % NAME INCORPORATION OWNERSHIP BUSINESS eLottery, Inc. Delaware 100% Lottery Services and Systems UniStar Entertainment, Inc. Idaho 100% Lottery Management Executone Systems Canada Inc. Canada 100% Marketing in Canada
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, 1998, are not listed. EX-23 7 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, 33-50628, 33-57519, 33-63637, 333-7279 and 33-62257. ARTHUR ANDERSEN LLP Stamford, Connecticut April 14, 1999 EX-27 8 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, 1998 AND THE RELATED CONSOLIDATED STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 12-MOS DEC-31-1998 DEC-31-1998 1,482 0 27,251 1,720 24,753 56,732 23,034 12,430 110,305 40,403 23,693 0 7,300 498 35,966 110,305 133,498 133,498 91,777 91,777 86,001 1,227 2,393 (41,091) (4,232) (36,859) 0 0 0 (36,859) (0.74) (0.74) -----END PRIVACY-ENHANCED MESSAGE-----