-----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, Ji3XVboFnDM5wLuWjEIx9583WOQ70wjKIJG09gk++cxvmgg031K2uqBMX2sc0jnU 8RovqO4+7yVw4/ewKg2uIA== 0000950153-99-001564.txt : 19991230 0000950153-99-001564.hdr.sgml : 19991230 ACCESSION NUMBER: 0000950153-99-001564 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991229 FILER: COMPANY DATA: COMPANY CONFORMED NAME: KUSHNER LOCKE CO CENTRAL INDEX KEY: 0000842009 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MOTION PICTURE & VIDEO TAPE PRODUCTION [7812] IRS NUMBER: 954079057 STATE OF INCORPORATION: CA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10661 FILM NUMBER: 99782010 BUSINESS ADDRESS: STREET 1: 11601 WILSHIRE BLVD 21ST FLR CITY: LOS ANGELES STATE: CA ZIP: 95202 BUSINESS PHONE: 3104812000 MAIL ADDRESS: STREET 1: 11601 WILSHIRE BLVD STREET 2: 21ST FLOOR CITY: LOS ANGELES STATE: CA ZIP: 90025 10-K 1 FORM 10-K 1 - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1999 COMMISSION FILE NO. 0-17295 THE KUSHNER-LOCKE COMPANY (Exact name of registrant as specified in its charter) CALIFORNIA 95-4079057 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 11601 Wilshire Blvd., 21st Floor, Los Angeles, California 90025 (Address of principal executive offices) (Zip Code) (310) 481-2000 Registrant's telephone number, including area code Securities registered pursuant to Section 12(b) of the Act: Not Applicable Securities registered pursuant to Section 12(g) of the Act: Common Stock, without par value 13 3/4% Convertible Subordinated Debentures, Series B due 2000 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. [ ] The aggregate market value based on the closing price of the Registrant's Common Stock held by nonaffiliates of the Registrant was approximately $48,550,000 as of December 16, 1999. There were 13,818,767 shares of outstanding Common Stock of the Registrant as of December 16, 1999. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive Proxy Statement for its 2000 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A not later than 120 days after the end of the Registrant's fiscal year (September 30, 1999) are incorporated by reference in Part III Items 10, 11, 12 and 13 of this Form 10-K. Total number of pages 144. Exhibit Index begins on page 72. - -------------------------------------------------------------------------------- 2 PART I 1. BUSINESS GENERAL The Kushner-Locke Company (the "Company") is a leading independent entertainment company which principally develops, produces, and distributes original feature films and television programming. The Company's feature films are developed and produced for the theatrical, made-for-video and pay cable motion picture markets. The Company's television programming has included television series, mini-series, movies-for-television, animation, reality and game show programming for the major networks, cable television, first-run syndication and international markets. The Company established its feature film production operations in 1993. In 1994, the Company established an international theatrical film subsidiary to expand into foreign theatrical distribution. In 1995, in response to the increased demand for product by the pay-per-view, telephone delivery, pay cable and basic cable services, the Company formed an entity called KLC/New City Tele-Ventures to acquire product from third parties for distribution in the cable, pay service and satellite markets, as well as other emerging markets. The joint venture has acquired over 100 films for this purpose. The Company owns 82.5% of this entity. In late 1997, the Company acquired an 80% interest in US SEARCH.com, a leading provider of fee-based people search and other customized individual reference services. In June 1999 US SEARCH.com completed an initial pubic offering in which the Company sold a portion of its shareholdings. Currently, the Company owns 55.2% of US SEARCH.com. In February 1998 the Company established KL/Phoenix, an 80% owned venture, which distributes film and television product in Latin America. In November 1998, the Company launched Gran Canal Latino ("GCL"), a satellite channel through a newly-formed 80%-owned subsidiary. GCL broadcasts 24 hours a day, with a selection of Spanish language films mostly from Spain. GCL's satellite transmission reaches the United States and all of Latin America including Mexico. Under a distribution arrangement with Enrique Cerezo, the Company is broadcasting selections from 1,500 Spanish language movie titles. In June 1999 the Company obtained a 20% ownership interest in Digital Renaissance, a German digital special effects facility. In April 1999 the Company obtained warrants and a minority ownership interest in The Harvey Entertainment Company in exchange for 468,886 shares of common stock of the Company. The Company's feature films for fiscal 1999 generated $14,081,000 of revenues. One Man's Hero starring Tom Berenger and distributed domestically by MGM, Ringmaster starring Jerry Springer, which Artisan Entertainment released domestically in November 1998, and But I'm A Cheerleader, which is to be released theatrically by New Line Cinema, were delivered by the Company in fiscal 1999. In addition, the Company has recently completed principal photography on Picking Up The Pieces starring Woody Allen, Sharon Stone and David Schwimmer, The St. Francisville Experiment and They Nest, starring Dean Stockwell, John Savage and Thomas Calabro, and is preparing for principal photography on Vlad the Impaler. Since its inception in 1983, the Company has produced or distributed over 1,000 hours of original television programming, including various television series, movies-for-television and mini-series. For fiscal 1999, the Company's television slate generated $6,878,000 of revenue, principally from network and international licensing of three feature length television movies, The Last Producer directed by Burt Reynolds and starring Burt Reynolds, Lauren Holly and Benjamin Bratt, Mambo Cafe starring Thalia and Danny Aiello, Freeway II: Confessions of a Trick Baby starring Natasha Leone, Vincent Gallo, a pilot for a television series and a co-produced 13-episode series, Would You Believe It for the Discovery Channel. TV First, a partnership 50% owned by the Company, purchases media time for Christian music infomercials and commenced retail marketing of compact discs and audio and video cassettes in fiscal 1999. Fiscal 1999 sales by the joint venture exceeded $1,300,000. In October 1999 the Company sold its partnership interest to its partner. The Company's operating revenues were $49,890,000 for the fiscal year ended September 30, 1999, a decrease of 34% from the $76,130,000 recognized for the fiscal year ended September 30, 1998. This decrease reflects reduced television series production, partially offset by increased revenues from US SEARCH.com and increased availabilities of feature 2 3 films. FORWARD LOOKING STATEMENTS Except for the historical information contained herein, certain of the matters discussed in this annual report are "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995 which involve certain risks and uncertainties which could cause actual results to differ materially from those discussed herein. Such risks and uncertainties include, but are not limited to, liquidity and financing requirements, variability of quarterly results and prior losses, increased interest expense, dependence on a limited number of projects, certain accounting policies including amortization of film costs, dependence on key personnel, production deficits, the risk involved in the Internet, television and theatrical film industries, competition, government regulation, labor relations, limited operating history and continued operating losses of US SEARCH.com, reliance of US SEARCH.com on strategic relationships in Internet market, uncertain acceptance and maintenance of the 1-800-US SEARCH brand, risks associated with offering new services, risks associated with growth and expansion, liability for online content, rapidly changing technology, standards and consumer demands, online commerce security risks, including credit card fraud, system disruptions and capacity constraints for US SEARCH.com, risks associated with domain names, year 2000 compliance, shares available for future sale, and the volatility of public markets. See the relevant discussions elsewhere herein, and in the Company's registration statement on Form S-3 (Registration No. 333-80521), as filed on June 11, 1999 and the Company's periodic reports and other documents filed with the Securities and Exchange Commission for further discussions of these and other risks and uncertainties pertaining to the Company and its business. U.S. SEARCH.COM, INC. GENERAL. US SEARCH.com, Inc. ("US SEARCH.com"), a 55.2% owned subsidiary of the Company as of September 30, 1999, is a leading provider of fee-based people search and other customized individual reference services. US SEARCH.com uses a wide variety of public records and other publicly available information on individuals. In June 1999 US SEARCH.com completed an initial pubic offering in which the Company sold a portion of its shareholdings as well. US SEARCH.com's services are marketed through its US SEARCH.COM and 1800USSEARCH.COM Internet world wide web ("Web") sites and through its direct response 1-800USSEARCH telephone number. US SEARCH.com operates a 24 hour, seven days a week sales and service center, where its employees research, aggregate and cross-check data from a wide variety of sources. Research results are placed in a pre-formatted template and then delivered to US SEARCH.com's customers via e-mail, fax or U.S. mail. US SEARCH.com's quarterly revenues have grown from $1,804,000 in the quarter ended March 31, 1998 to $6,163,000 in the quarter ended September 30, 1999. Unique visitors to the websites have increased from 4,600,000 in the quarter ended March 31, 1999 to 11,200,000 in the quarter ended September 30, 1999. US SEARCH Services US SEARCH.com provides individual, corporate and professional clients with quick, easy and inexpensive access to a broad range of public record information about individuals. A client can request a search from anywhere, at any time through US SEARCH.com's Web site, 1800USSEARCH.com, or by calling its toll free telephone number, 1-800 U.S. SEARCH. The search is performed quickly by electronically accessing multiple, geographically-dispersed public record databases, aggregating the requested information, and then delivering the search results in a user-friendly format, often within seconds or minutes. US SEARCH.com is often able to fulfill a client's search requests based on minimal client input information, such as a first and last name or a date of birth. US SEARCH.com provides clients with a single, comprehensive access point to a broad range of public record information about individuals. The fees for US SEARCH.com's services range from $10.00 to $500.00 per transaction based on the nature and amount of information gathered and whether or not the search is assisted by a search specialist. In November 1999 US SEARCH.com expanded its service offerings to include pre-employment background screening and other services 3 4 for corporate and professional clients and government agencies. Instant Searches. US SEARCH.com offers Internet-based "Instant Searches," which include general individual locator, first name only, national death records, real estate records, civil court records, civil judgments and bankruptcy searches. Instant Searches are performed automatically and results are delivered via the Web site, often in a matter of seconds or minutes. US SEARCH.com applies up to a portion of the cost of the individual locator "Instant Searches" purchased online by the client towards the cost of the more comprehensive search. Individual Locator. This service is targeted at individual, corporate and professional clients interested in locating missing individuals such as long-lost friends, family, former employees, or business contacts. Corporate and professional organizations may also wish to locate a large number of members in connection with class reunions, corporate gatherings or fundraising efforts. Individual Public Record Reports. Individual or corporate clients can order a public record search to verify information about a person and determine whether there is any material information about a person's history that has not been disclosed. Using this service, a client will receive information about a person's previous addresses, lawsuits, judgments, UCC filings, property ownership and corporate affiliations. Anti-Fraud Identification Verification. This service allows clients to search for evidence of anyone using their social security number or assuming their identity for fraudulent purposes. One of the major causes of credit card fraud is the unlawful use of a person's social security number to gain credit. US SEARCH.com's service allows for early detection of this activity, avoiding time consuming and costly resolution. Nationwide Court Records Search. This service allows clients to search court records across all 50 states to determine if an individual has filed any lawsuits, had lawsuits filed against them, obtained a civil judgment, had a civil judgment filed against them, had property or tax liens against them, had any foreclosures, or had any unlawful detainers filed against them. US SEARCH.com also recently introduced Criminal Records Searches on a county-by county basis in all 50 states. For the nine months ended September 30, 1999, US SEARCH.com's individual locator and "Instant Searches" services accounted for over 85% of its revenues. Services Under Development During Fiscal 1999 Additional "Instant Searches." US SEARCH.com intends to begin offering several additional Internet-based "Instant Searches" on its Web site. For example, US SEARCH.com recently began offering "Instant" lawsuit searches, legal judgment searches, real property searches, and intends to introduce instant UCC filings searches and unclaimed property searches. As with its current "Instant Searches," clients would be able to directly access these services online and receive results in a completely automated fashion via its Web site, often in as little as seconds or minutes. Pre-Employment Background Screening. In November 1999, US SEARCH.com began offering pre-employment background screening services to corporate and professional clients. This service allows corporate and professional clients to conduct automated public record information searches in connection with hiring and other employment decisions. US SEARCH.com expects to design customized templates with appropriate fields on separate Web pages with secure access for its corporate and professional clients. Using US SEARCH Services Using US SEARCH.com's services is quick, easy and inexpensive. Clients can access US SEARCH.com's services through its user-friendly Web site, 1800USSEARCH.com, as well as its toll free telephone number, 1-800 U.S. SEARCH. Services are available 24 hours a day, seven days a week. 1800USSEARCH.Com Web Site. Clients can access US SEARCH.com's Web site directly or can click through via its advertising on the people search services of one of the following Internet search engines and popular Web sites: AOL.com, 4 5 msn.com, Excite.com, InfoSpace.com, Lycos.com, Snap.com, Infoseek.com, WhoWhere.com, Tripod.com and Angelfire.com. From US SEARCH.com's Web site, a client can choose from one of its completely automated "Instant Searches" or from several different types of assisted searches. Once a search is selected, a client will be prompted to fill in specific information, such as the full name, birth date, social security number or last known address of the individual about whom the information is requested. In the case of Internet-based "Instant Searches," the search request is processed online, and the results are delivered in often as little as a few seconds or minutes. In the case of partially-automated searches, the request is forwarded to one of US SEARCH.com's search specialists for fulfillment. US SEARCH.com's computer system then assembles the results into a pre-formatted template. After review, the completed report is delivered to the client by email, facsimile or mail. US SEARCH Telephone Services. Through its toll free telephone number, 1-800 U.S. SEARCH, US SEARCH.com provides additional search services for more complex and in- depth search requests. US SEARCH.com's operations and support center has trained search specialists and customer service agents available 24 hours a day, seven days a week. If a client's online search via US SEARCH.com's Web site is unsuccessful or he desires additional information, the client can then call in to request additional, more comprehensive search services which may include using a search specialist to assist in completing the search request. Public Record Information Database Sources. US SEARCH.com has direct and indirect electronic access to a broad range of public record databases and other information sources such as CSRA/Ameridex, Metromail and DBT Online. US SEARCH.com maintains open accounts with its data providers and pays fixed fees per inquiry. US SEARCH.com continually evaluates its information database sources both to ensure that it has access to the most timely, cost-effective, accurate and comprehensive data, and to expand the number of automated searches offered to its clients. If US SEARCH.com determines that a particular information database source is inadequate or it otherwise becomes unavailable, US SEARCH.com believes it can switch to an alternative data source with some increase in cost and without significant delay. From time to time US SEARCH.com expects to evaluate potential acquisitions or investments in in-house proprietary information databases to complement its access to third party data providers. Marketing and Brand Awareness US SEARCH.com markets its services through a combination of Internet and television advertising featuring its US SEARCH brand. US SEARCH.com intends to strengthen its US SEARCH brand through extensive advertising, emphasis on its 1800USSEARCH.com Web site and promotion of additional public record information and search services under the US SEARCH brand. US SEARCH.com also intends to combine an increasing level of key Internet advertising with strategically placed television advertising to attract a great number of users to its Web site. Internet Advertising. US SEARCH.com believes that marketing agreements with Internet search engines and popular Web sites have increased its brand recognition and attracted clients. US SEARCH.com generates visitors to its Web site from its various forms of Internet advertising, such as banners, buttons, text links and key words within search engines, and online white pages. US SEARCH.com maintains marketing agreements with leading Internet search engines and popular Web sites, including InfoSpace.com, The Lycos Network, Go Network/Infoseek, Snap.com and Yahoo!. These marketing agreements have placed its advertising on major Web sites such as InfoSpace.com, AOL.com, msn.com, Lycos.com, Snap.com, WhoWhere.com, Tripod.com, Angelfire.com, Go Network/Infoseek.com, Excite.com and Yahoo.com. US SEARCH.com intends to develop relationships with other companies, based on traffic patterns, customer profiles, and related services in order to increase its advertising presence on the Internet. Television Advertising. US SEARCH.com uses television advertising to promote its services. The principal form of television advertising used includes 10-second promotional fee spots on national television programs that prominently feature its toll free telephone number, 1-800 U.S. SEARCH, and Web site address, 1800USSEARCH.com. US SEARCH.com believes that its television advertising has enabled it to increase the reach of its US SEARCH brand and services. 5 6 US SEARCH.com is currently the network closed captioning sponsor for CNBC and regularly appears on other cable networks including MSNBC, CNN, CNN Headline News and Fox News. US SEARCH.com is also a fee spot sponsor of the two highest rated syndicated television programs, Jeopardy and Wheel of Fortune. US SEARCH.com advertises weekly on Leeza, The Ricki Lake Show, Hollywood Squares, Judge Judy, The Dating Game, Newlywed Game and Judge Joe Brown. US SEARCH.com intends to expand its fee spot advertising as opportunities arise. US SEARCH.com intends to reach a wider audience and to attract more clients through the use of longer length commercials (15, 30 and 60 seconds) and longer format commercials which provide marketing flexibility not available with the 10-second fee spots. Marketing to Corporate and Professional Clients. US SEARCH.com is establishing a corporate sales force and a team of research specialists to promote and increase the marketing of its services to prospective professional and corporate clients and to address the specific needs of each corporate and professional client. US SEARCH.com also has begun to offer corporate accounts with volume discounts to promote and market its services. For example, beginning in November 1999, US SEARCH.com began offering pre-employment background screening services to corporate and professional clients, allowing these clients to conduct automated public record information searches in connection with hiring and other employment decisions. In addition, US SEARCH.com expects to design customized Web pages with specific search criteria tailored to the needs of each corporate and professional client. US SEARCH.com's executive offices are currently located at 9107 Wilshire Blvd., Suite 700, Beverly Hills, California 90210, and its telephone number is (310) 553-7000. US SEARCH.com had 198 full time employees and 45 part time employees as of December 10, 1999. MOTION PICTURE INDUSTRY OVERVIEW The business of the motion picture industry may be broadly divided into two major segments: production, involving the development, financing and making of motion pictures; and distribution, involving the promotion and exploitation of completed motion pictures in a variety of media. Historically, the largest companies, the so-called "Majors" and "mini-Majors," have dominated the motion picture industry by both producing and distributing a majority of the motion pictures which generate significant theatrical box office receipts. Over the past 15 years, however, "Independents" or smaller film production and distribution companies, such as the Company, have played an increasing role in the production and distribution of motion pictures to fill the increasing worldwide demand for filmed entertainment product. The Majors (and mini-Majors) include Universal Pictures (a division of Seagram), Warner Bros. Pictures (a division of Time Warner), Metro-Goldwyn-Mayer Inc., Twentieth Century Fox Film Corporation (a division of News Corporation), Paramount Pictures Corporation (a division of Viacom) , Sony Pictures Entertainment (including Columbia Pictures, TriStar Pictures and Triumph Releasing; altogether divisions of Sony) and The Walt Disney Company (Buena Vista Pictures, Touchstone Pictures and Hollywood Pictures). Generally, the Majors own their own production studios (including lots, sound stages and post-production facilities), have nationwide or worldwide distribution organizations, release pictures with direct production costs generally ranging from $25,000,000 to $75,000,000, and provide a continual source of pictures to film exhibitors. In addition, some of the Majors have divisions which are promoted as "independent" distributors of motion pictures. These "independent" divisions of Majors include Miramax Films (a division of The Walt Disney Company), Sony Classics (a division of Sony Pictures), Fox Searchlight (a division of News Corporation), and New Line (a division of Time Warner) and its Fine Line distribution label. Most of these divisions were formerly Independents. In addition to the Majors, the Independents engaged primarily in the distribution of motion pictures produced by companies other than the Majors include, among others, Trimark Holdings and Artisan Entertainment. The Independents typically do not own production studios or employ as large a development or production staff as the Majors. MOTION PICTURE PRODUCTION AND FINANCING 6 7 The production of a motion picture requires the financing of the direct costs and indirect overhead costs of production. Direct production costs include film studio rental, cinematography, post-production costs and the compensation of creative and other production personnel. Distribution costs (including costs of advertising and release prints) are not included in direct production costs. Majors generally have sufficient cash flow from their motion picture and related activities, or in some cases, from unrelated businesses (e.g., theme parks, publishing, electronics, and merchandising) to pay or otherwise provide for their production costs. Overhead costs are, in substantial part, the salaries and related costs of the production staff and physical facilities which Majors maintain on a full-time basis. Majors often enter into contracts with writers, producers and other creative personnel for multiple projects or for fixed periods of time. Independents generally avoid incurring substantial overhead costs by hiring creative and other production personnel, but retaining the other elements required for pre-production, principal photography and post-production activities only on a project-by-project basis. Independents also typically finance their production activities from various sources, including bank loans, "pre-sales," equity offerings and joint ventures. Independents generally attempt to complete their financing of a motion picture production prior to commencement of principal photography, at which point substantial production costs begin to be incurred and require payment. "Pre-sales" are often used by Independents to finance all or a portion of the direct production costs of a motion picture. Pre-sales consist of fees or advances paid or guaranteed to the producer by third parties in return for the right to exhibit the completed motion picture in theaters or to distribute it in home video, television, international or other ancillary markets. Payment commitments in a pre-sale are typically subject to delivery and to the approval of a number of prenegotiated factors, including script, production budget, cast and director. Both Majors and Independents often acquire motion pictures for distribution through an arrangement known as a "negative pickup" under which the Major or Independent agrees to acquire from another production company some or all rights to a film upon its completion. The Independent often finances production of the motion picture pursuant to financing arrangements with banks or other lenders wherein the lender obtains a security interest in the film and in the Independent's rights under its distribution arrangement. When the Major or Independent "picks up" the completed motion picture, it may assume some or all of the production financing indebtedness incurred by the production company in connection with the film. In addition, the production company is often paid a production fee and is granted a participation in the profits from distribution of the motion picture. Both Majors and Independents often grant third-party participations in connection with the distribution and production of a motion picture. Participations are contractual rights of actors, directors, screenwriters, producers, owners of rights and other creative and financial contributors entitling them to share in revenues or profits (as defined in the respective agreements) from a particular motion picture. Except for the most sought-after talent, participations are generally payable only after all distribution and marketing fees and costs, direct production costs (including overhead) and financing costs are recouped by the producer in full. MOTION PICTURE DISTRIBUTION Distribution of a motion picture involves the domestic and international licensing of the picture for (i) theatrical exhibition, (ii) home video, (iii) presentation on television, including pay-per-view, video-on-demand, satellites, pay cable, network, basic cable and syndication, (iv) non-theatrical exhibition, which includes airlines, hotels, armed forces facilities and schools and (v) marketing of the other rights in the picture, which may include books, CD-ROMs, merchandising and soundtrack recordings. Theatrical Distribution and Exhibition. Motion pictures are often exhibited first in theaters open to the public where an admission fee is charged. Theatrical distribution involves the manufacture of release prints, licensing of motion pictures to theatrical exhibitors, and promotion of the motion picture through advertising and promotional campaigns. The size and 7 8 success of the promotional and advertising campaign may materially affect the revenues realized from its theatrical release, generally referred to as "box office gross." Box office gross represents the total amounts paid by patrons at motion picture theaters for a particular film, as determined from reports furnished by exhibitors. The ability to exhibit films during summer and holiday periods, which are generally considered peak exhibition seasons, may affect the theatrical success of a film. Competition among distributors to obtain exhibition dates in theaters during these seasons is significant. In addition, the costs incurred in connection with the distribution of a motion picture can vary significantly depending on the number of screens on which the motion picture is to be exhibited and the ability to exhibit motion pictures during peak exhibition seasons. Similarly, the ability to exhibit motion pictures in the most popular theaters in each area can affect theatrical revenues. Exhibition arrangements with theater operators for the first run of a film generally provide for the exhibitor to pay the greater of 90% of ticket sales in excess of fixed amounts relating to the theater's costs of operation and overhead, or a minimum percentage of ticket sales which varies from 40% to 70% for the first week of an engagement at a particular theater, decreasing each subsequent week to 25% to 30% for the final weeks of the engagement. The length of an engagement depends principally on the audience response to the film. Films with theatrical releases (which generally may continue for several months domestically) typically are made available for release in other media as follows:
Market Months After Theatrical Release Approximate Release Period --------------------------------------------------------------------------------------------------------------------------------- Domestic home video........................................... 4 - 6 months 6 months Domestic pay-per-view......................................... 6 - 9 months 3 months Domestic pay cable............................................ 10 - 18 months 12 - 21 months Domestic network or basic cable............................... 30 - 36 months 18 - 36 months Domestic syndication.......................................... 30 - 36 months 3 - 15 years International theatrical...................................... --- 4 - 6 months International home video...................................... 6 - 12 months 6 months International television...................................... 18 - 24 months 18 months - 10 years
Home Video. The home video distribution business involves the promotion and sale of videocassettes, DVDs and videodiscs to video retailers (including video specialty stores, convenience stores, record stores and other outlets), which then rent or sell the videocassettes and videodiscs to consumers for private viewing. The home video marketplace now generates total revenues greater than the domestic theatrical exhibition market. Videocassettes of feature films are generally sold to domestic wholesalers on a unit basis. Unit-based sales typically involve the sales of individual videocassettes to wholesalers or distributors at $20.00 to $50.00 per unit and generally are rented by consumers for fees ranging from $1.00 to $5.00 per day (with all rental fees retained by the retailer). Wholesalers who meet certain sales and performance objectives may earn rebates, return credits and cooperative advertising allowances. Selected titles including certain made-for-video programs, are priced significantly lower to encourage direct purchase by consumers. The market for direct sale to consumers is referred to as the "priced-for-sale" or "sell-through" market. Technological developments, including videoserver and compression technologies which regional telephone companies and others are developing, and expanding markets for DVD and laser discs, could make competing delivery systems economically viable and could significantly impact the home video market generally and, as a consequence, the Company's home video revenues. Pay-Per-View. Pay-per-view television allows cable and satellite television subscribers to purchase individual programs, primarily recently released theatrical motion pictures, sporting events and music concerts, on a "per use" basis. The fee a subscriber is charged is typically split among the program distributor, the pay- per-view operator and the cable operator. Pay Cable. The domestic pay cable industry (as it pertains to motion pictures) currently consists primarily of HBO/Cinemax, Showtime/The Movie Channel, Encore/Starz and a number of regional pay services. Pay cable services are sold to cable system operators for a monthly license fee based on the number of subscribers receiving the service. These pay programming services are in turn offered by cable system operators to subscribers for a monthly subscription 8 9 fee. The pay television networks generally acquire their film programming by purchasing the distribution rights from motion picture distributors. Non-Theatrical Markets. In addition to the distribution media described above, a number of sources of revenue exist for motion picture distribution through the exploitation of other rights, including the right to distribute films to airlines, schools, libraries, hotels, armed forces facilities and hospitals. International Markets. The worldwide demand for motion pictures has expanded significantly as evidenced by the development of new international markets and media. This growth is primarily driven by the overseas privatization of television stations, introduction of direct broadcast satellite services, growth of home video and increased cable penetration. . COMPANY MOTION PICTURE ACQUISITIONS In addition to its own production activities, the Company continually seeks to acquire rights to films and other programming from Independent film producers, distribution companies and others in order to increase the number of films it can distribute in the emerging new delivery systems. To be successful, the Company must locate and track the development and production of numerous independent feature films. Types of Motion Pictures Acquired. The Company generally seeks to produce or acquire motion pictures across a broad range of genres, including drama, thriller, comedy, science fiction, family, action and fantasy/adventure, which will individually appeal to a targeted audience. The Company has been very selective in acquiring higher budget (over $10,000,000) films because of the interest that the Majors have shown in acquiring such films, and the associated competition and higher production advances, minimum guarantees and other costs. The Company acquires projects when it believes it can limit its financial risk on such projects through, for example, significant presales, and when it believes that a project has significant marketability. In most cases, the Company attempts to acquire rights to motion pictures with a recognizable marquis "name" personality with public recognition, thereby enhancing promotion of the motion pictures in the home video or international markets. The Company believes that this approach increases the likelihood of producing a product capable of generating positive cash flow, ancillary rights income and the possibility of a theatrical release. Methods of Acquisition. The Company typically acquires films on either a "pick-up" basis or a "pre-buy" basis. The "pick-up" basis refers to those films in which the Company acquires distribution rights following completion of most or all of the production and post-production process. These films are generally acquired after management of the Company has viewed the film to evaluate its commercial viability. The "pre-buy" basis refers to films in which the Company acquires distribution rights prior to completion of a substantial portion of production and post-production. Management's willingness to acquire films on a pre-buy basis is based upon factors generally including the track record and reputation of the picture's producer, the quality and commercial value of the screenplay, the "package" elements of the picture, including the director and principal cast members, the budget of the picture and the genre of the picture. Before making an offer to acquire rights in a film on a pre-buy basis, the Company may work with the producer to modify certain of these elements. Once the modifications are considered acceptable, the Company's obligation to accept delivery and make payment is conditioned upon receipt of a finished film conforming to the script reviewed by the Company and other specifications considered important by the Company. Acquisition Process. If the Company locates a motion picture project which it believes satisfies its criteria, the Company may pay an advance or a guaranteed minimum payment conditioned upon delivery of a completed film ("minimum guarantee") against a share or participation in the revenue actually received by the Company from the exploitation of a film in each licensed media. The minimum guarantee is generally paid prior to the film's release. Typically, the Company will have the right to recoup the minimum guarantee and certain other amounts from the distribution revenues realized by the Company prior to paying any additional revenue participation to the production company. Film Library. The Company's distribution rights for acquired films and television programs, which may include worldwide, foreign, or domestic rights, generally range from an initial licensing cycle of seven to 21 years to perpetuity. 9 10 COMPANY FEATURE FILM PRODUCTION The Company's feature film division was established in 1993 to develop and produce low and medium budget films. The Company's low to medium budget films to date have had production budgets ranging from less than $1 million to $10 million, although the Company from time to time may release films having higher budgets. The Company's low-budget films are primarily targeted for direct distribution to the television market and its medium-budget films may be targeted for theatrical release. The Company generally retains distribution rights for licensing to third parties internationally. The Company's films generally are distributed by third parties domestically or are limited to international distribution. In unique circumstances, the Company undertakes limited domestic distribution or co-distribution activities. The Company's feature film strategy generally is to develop and produce feature films when the production budgets for the films are expected to be substantially covered through a combination of pre-sales, output arrangements, equity arrangements and production loans with "gap" financing. To further limit the Company's financing risk or to obtain production loans, the Company often purchases completion bonds to guarantee the completion of production. The following films were released or delivered by the Company or its joint ventures in fiscal 1999:
Picture Initial Media Delivery/Release Date Principal Talent - --------------------------------------------------------------------------------------------------------------------------- Ringmaster Theatrical November 1998 Jerry Springer One Man's Hero Theatrical June 1999 Tom Berenger But I'm A Cheerleader Theatrical June 1999 Natasha Lyonne, Clea DuVall
The following films are currently scheduled for release or delivery by the Company in fiscal 2000: Expected Picture Initial Media - -------------------------------------------------------------------------- Picking Up The Pieces Theatrical The St. Francisville Experiment Theatrical There is no assurance that any motion picture which has not yet been released will be released, that a change in the scheduled release dates of any such films will not occur or, if such motion picture is released, it will be successful. The Company has various additional potential feature films under development. There is no assurance that any project under development will be produced. International Distribution In September 1994 the Company established foreign distribution operations for its own and third party product. The Company recently hired Rob Aft to handle the Company's international distribution activities as President of International Distribution. Arturo Feliu handles Latin American distribution activities as President of KL/Phoenix. See Note 10 of Notes to Consolidated Financial Statements for information on international revenues. 10 11 TELEVISION INDUSTRY OVERVIEW The United States television market remains the largest in the world, consisting of the principal broadcast networks and their affiliates, independent television stations and cable television networks. Expanding international television broadcast, cable and satellite delivery systems offer further opportunities for the exploitation of television programming. Domestic Market. The domestic market for television programming primarily is composed of four submarkets: the broadcast television networks (ABC, CBS, NBC and Fox and emerging networks UPN and WBN), pay cable services (such as HBO/Cinemax, Encore/Starz and Showtime/The Movie Channel), basic cable services (such as USA Network, the Arts & Entertainment Network, Lifetime, The Family Channel, The Disney Channel, and Turner Broadcasting Network) and syndicators of first-run programming (such as Universal, King World Productions and Multimedia, Inc.). The domestic broadcast television market currently is dominated by the four major networks, each of which has approximately 200 affiliated stations. Two of the four major networks are owned by major motion picture companies. The affiliates broadcast network-supplied programming and national commercials in return for payments by the major networks. This relationship results in the networks being able to reach virtually all of the significant domestic television markets. There are also a significant number of independent commercial television stations in the United States. These stations offer an alternative to network distribution through syndication. The network schedule provides affiliates with only a portion of their daily program schedule, and the balance of the time is filled with programs acquired through television syndication companies or produced locally by the station. Cable services generally are classified as being in one of four categories: telephone delivery, superstations, pay cable services (e.g., HBO/Cinemax) and basic cable networks (advertiser-supported, e.g., The Family Channel). The most successful cable networks reach more than 60% of the U.S. television households. Recently developed digital compression technology combined with fiber optics or small-sized satellite dishes may permit cable companies, telephone companies or direct broadcast satellite systems to expand the domestic television market up to 500 or more channels. Television Programming. Each of the four major television networks currently broadcasts approximately 22 hours of prime-time programming and approximately 30 hours of daytime programming each week. The increased channel capacity and large base of cable subscribers that have developed during the 1980s and 1990s have made possible the development of a number of pay cable and basic cable networks which have become important purchasers of both original and rerun television programming, including movies-for-television, mini-series and series. Suppliers of television programming include the production division or affiliated companies of the major networks, major film studios (Majors), station owners and independent producers (Independents) such as the Company. International Markets. The number of international outlets for television programming has been increasing with the worldwide proliferation of broadcast, cable and satellite delivery systems. Over the last ten years, European governments have privatized television systems in several countries, including Germany, Italy, France and Spain. The Company believes privatized systems are more likely to broadcast American programming than government-owned networks. In addition, both the number of pay and satellite television systems in Europe and the number of subscribers to these systems have increased. Pay television and satellite distribution systems also are developing in other geographic areas, including many Asian countries. In international markets, suppliers of programming may be subject to local content and quota requirements which prohibit or limit the amount of American programming in particular markets. See "Business-Government Regulations." COMPANY TELEVISION STRATEGY The Company was founded in 1983 to develop and produce, on a cost-effective basis, quality television programming with broad appeal. The Company's television business has evolved from the production of programs owned by third parties and typically airing on local television stations in the first-run syndication market, such as the long-running daytime series Divorce Court, to the development, production and ownership of series, movies-for-television and mini-series for major domestic and international television networks and the expanding pay and basic cable markets. In 1991, the Company 11 12 established an international distribution licensing operation for its own and acquired television programming. The Company believes that through the control of the distribution of its own programming this operation has increased the Company's ability to recover the cost of new programs and to retain the fees and profit potential previously realized by third parties. Due to the major networks' ability to produce programming as well as distribute it, the Company has decreased the amount of programming it provides to the major U.S. networks. To position itself for the perceived growth in the overall television market, the Company is actively acquiring various forms of domestic cable, video-on-demand and satellite rights from third party producers for license periods ranging from fifteen years to perpetuity through its KLC/New City joint venture. The customary release cycle includes a period of approximately six months of pay-per-view followed by 18 to 24 months of pay cable (HBO, Showtime or USA Network, for example), followed by 24 to 48 months of basic cable (Romance Channel, Discovery Channel or A&E, for example), and free television thereafter. The Company utilizes licensing and co-production arrangements to fund the costs of production, and generally retains additional licensing rights including, in the case of series, rerun syndication rights which offer future upside profit potential. The Company generally does not commence principal photography of its television programming without first obtaining license or other revenue commitments or production financing which equal all or a substantial portion of the budgeted production costs. By obtaining license fees and other pre-committed revenues through the efforts of its international television distribution division to cover a substantial portion or all of its budgeted production costs, the Company believes that it reduces many of the financial risks associated with an individual production. TELEVISION PROGRAM FINANCING Development Costs. The Company generally finances project development costs without third-party involvement until the script commitment stage. Because of the likelihood that the significant costs in producing scripts and pilots will not be recovered, the Company attempts to limit its financial investment by obtaining financial commitments from networks or other third parties to cover all or a substantial portion of these costs. See "Business-Television Projects in Development." Program Licensing. Generally, the Company licenses to United States media the right to broadcast a program for a period ending the earlier of the second broadcast of the program or four years from delivery in exchange for a license fee which represents a portion of the program's budgeted production cost. A production order sets forth the principal terms for a license of the Company's product to a network and specifies the license fee to be paid and the conditions to be met for payment. Production orders typically are contingent on the producer's obtaining certain approvals from the network, including the script, principal cast and director, prior to commencement of principal photography. The Company generally retains all other rights to the program and will usually license certain rights to international broadcasters, enabling the Company to recoup all, or a portion, of the production costs. In addition, the Company will typically license additional domestic releases in other media to cover the remainder, if any, of the production costs. The Company usually receives its license fee in installments, with one-third due on or prior to commencement of principal photography, one-third due upon completion of principal photography and one-third due upon delivery of the completed program. International distribution typically involves licensing the rights to exhibit programming in international territories to broadcasters within those territories for a fixed license fee usually payable after the program has been completed. Due to timing differences between the Company's receipt of license fees and its payment of production costs, the Company generally is required to fund at least a portion of its production costs from working capital or secured borrowings, even if the original license fees equal or exceed budgeted production costs. For first-run syndication programs, license agreements with the first-run syndicator generally provide the Company a fixed license fee and a percentage of revenues from distribution after the syndicator recoups the fixed license fee and its distribution fees and costs. An alternate first-run syndication revenue source is called "barter" sales. A television station, in lieu of or in combination with paying licensing fees, may grant to the Company's distributor the right to sell advertising spots during the exhibition of the Company's television program. For a program to be barterable, exhibition of the program on stations reaching at least 70% of the U.S. television households and in most of the top ten major metropolitan areas typically is required. The 12 13 amount of the fee paid by the advertiser is conditioned upon the program achieving certain agreed upon ratings. If the specified rating is not achieved, the distributor is required to "make good" by giving the advertiser additional advertising time or cash payment, and the Company's share of barter revenues decreases. The Company has licensed its television series Hammer and Could It Be a Miracle on this basis. The Company seeks to cover all of its production costs with license fees and other pre-committed revenues, however it may finance some of the production costs on its own and may rely on subsequent licensing in international or other ancillary markets to recoup the remaining production costs. Additional profits from a television program initially shown on a network or cable service are realized from subsequent reruns of the program on local television stations, international delivery systems and cable services after exhibition on a major network or cable service. In any event, any production is subject to the risk of cost overruns, and there is no assurance that the Company will be able to recover any investment it undertakes in a deficit-financed project. International Co-Productions. The Company has entered into international co-production arrangements in the past. An international co-production is a joint venture or partnership between entities in two or more countries which in certain cases take advantage of alternative sources of financing for its productions, to utilize international tax benefits, to pass foreign quota restrictions and to benefit from lower pre-production costs in certain foreign countries. In a typical co-production arrangement, the Company transfers all or part of its copyright ownership in the project to third parties (the co-production entities), which generally provide a portion of the production financing and other services. Typically, the co-production partners grant distribution rights to the Company. Receipts from its distribution of the project recoup production funding, production fees, talent participations, distribution fees and expenses. Excess receipts, if any, are distributed to the various parties in accordance with their agreed-upon profit participation. The Adventures of Pinocchio is an example of a co-production with German, French and English participation, and Swing was a co-production with English participation. Producer-for-Hire. In addition to developing and producing its own programs, the Company on occasion is engaged as a producer-for-hire for a creative concept or literary property owned by another person. During the late 1980s, as a producer for hire, the Company produced 860 episodes of Divorce Court, 65 episodes of the Night Games game show, the animated feature film Pound Puppies: The Legend of Big Paw and the Family Dog episode of Steven Spielberg's Amazing Stories. This programming is not included in the Company's library. There are at least two types of producer-for-hire arrangements. Under the first type, the Company receives a set fee and agrees to deliver the completed program for that fee. The Company's profit is the excess of its fee over its production costs. If production costs exceed the package fee, the Company bears the deficit. Under the second type, the Company furnishes personnel as a producer, receives a fixed fee per episode and the production costs of the program are reimbursed directly by the distributor. Rerun Syndication. Domestic rerun syndication typically involves the exhibition of programming on local television stations and cable services after exhibition on a major network. Since production costs for network series may exceed network license fees and other pre-committed revenues, some television production companies depend on successful syndication of their programming for profitable operations. Generally, to be successful in rerun syndication, a television series must have at least 66 episodes (the equivalent of three full television seasons). TELEVISION PRODUCTION ACTIVITIES As a producer, the Company first develops literary properties internally or acquires them from third parties. The Company may refine the concept of an acquired property. It then attempts to interest one of the networks or another buyer in the project. If the buyer is interested in a concept presented to it, the buyer will usually order a script from the Company. Once the script is delivered, the buyer may order production of a single pilot episode or a limited number of episodes in the case of a series, or the entire production in the case of a movie-for-television or mini-series. Once production is ordered, the Company and the buyer negotiate a financing arrangement. The Company then undertakes pre-production activities in which a budget is prepared, the screenplay is polished or rewritten, director, actors, a line producer and technical personnel are engaged, filming is scheduled, locations are arranged and other steps are taken to prepare the project for principal photography. By this point, the Company generally has negotiated license fees and obtained other commitments to cover a substantial portion of the budgeted production costs. Principal photography is then 13 14 undertaken, followed by post-production, in which the film is edited, synchronized with music and dialogue and, in certain cases, special effects are added. In the case of a series, if episodes are ordered and the ratings are sufficiently strong, additional episodes may be ordered for the entire season and then for additional seasons. The Company hires writers, directors, cast and crew members on a project-by-project basis. The terms of employment and compensation are negotiated in light of an individual's previous experience, the prevailing market conditions and, where applicable, collective bargaining agreements. The Company also obtains locations, sets and post-production personnel and facilities on an as-needed basis. The Company believes that production and post-production personnel and facilities are in ample supply at competitive rates. The production of animated programming is a labor-intensive process that commences with artistic sketches of the various characters and the story line. Storyboards, models, songs and voice elements are then sent to various production companies, typically in Asia, where drawings of the animation frames are prepared. The frames are painted and then subsequently photographed to create film. The film is then usually sent back to the United States, where final editing of footage and mixing of sound effects, dialogue and music is completed, although on occasion final editing and mixing may be completed in Asia. The following table summarizes the Company's television programming for fiscal 1999, the type of program and the network or other medium where such programming initially exhibited or will exhibit:
Title Type of program First Exhibition - -------------------------------------------------------------------------------------- Killer App Pilot of a one hour Series Fox Criminal Minds Pilot of a one hour Series CBS Mambo Cafe Television movie Cable Freeway II: Confessions of a Trickbaby Television movie Cable The Last Producer Television movie Cable
There is no assurance that any television program which has not yet aired will be aired, that a change in the scheduled airing date of such programming will not occur or, if such television program is aired, that it will be successful. TELEVISION PROJECTS IN DEVELOPMENT To develop successful television projects, the Company requires adequate access to program concepts, ideas and scripts. Such access is dependent upon numerous factors, including the reputation and credibility of the Company in the creative community, the relationships the Company has in the entertainment industry and the Company's financial and other resources. The Company occasionally enters into agreements with producers and writers to develop or acquire new programming. While the Company may finance the early development of such projects, the Company typically does not proceed with the preparation of a script or the production of a pilot, which involves a more significant financial commitment, unless a network or other buyer has agreed to fund all or a substantial portion of the costs associated therewith. The following table sets forth potential television programming in various stages of development and the potential network or other medium to which each may be delivered, if known: Working Title Type of Program - ------------------------------------------------------------------------ They Nest Cable Premiere Vlad the Impaler Cable Premiere Aliens Ate My Homework Movie-of-the-week (Showtime) The Life She Left Behind Movie-of-the-week (CBS) Coast Guard One Hour Drama (ABC) Murder of Tut Movie-of-the-Week (Fox) Death Cloud Movie-of-the-week (TBS) While the Company has many projects in development, as is typical in the industry, only a relatively small number of such projects are ultimately produced (with the likelihood of production being more remote in the case of television series). It is rare for any projects in development to have production commitments until late in the development process. There is no 14 15 assurance that the Company's efforts in developing or acquiring potential new programs, including any of the projects described above, will lead to production commitments or that any programs that are ultimately produced will be successful. TELEVISION DISTRIBUTION ACTIVITIES United States Distribution. The Company's original and acquired programming generally is initially licensed to a network or cable broadcaster for a period expiring on the earlier of two broadcasts or a period of up to four years from delivery. Following the expiration of the license, the rights typically revert to the Company's library and become available for additional licensing. Further revenues are generally obtained from subsequent licensing in the domestic market in other media, including syndication, cable and home video. International Distribution. In 1991, the Company commenced the distribution of its own television programming and, to a lesser extent, acquired television programs for distribution in international markets. Programming is distributed primarily to local international broadcasters and, where available, the home video market, pay television and cable services. In December 1994, the Company expanded its activities in international distribution by establishing an international distribution subsidiary. The Company's combined film and television distribution division gives the Company increased control over the marketing of its product line, greater bargaining strength, and improved cost efficiencies. The Company's strategy has been to reduce its business risks in international markets by securing business relationships with strong local distributors and broadcasters. The Company has entered into output arrangements in certain foreign territories with broadcasters and distributors who have agreed to license distribution rights in such markets for all of the Company's product produced during the specified term of the agreement (generally between three and five years) at designated prices for various types of film or television product. LIBRARY Since its inception in 1983, the Company has produced or acquired more than 1,000 hours of television programming. The Company's current library includes a variety of feature films, movies-for-television, television series, game shows and talk shows produced or acquired by the Company since its inception. The following table sets forth, as of December 15, 1999, certain completed feature films and television programming in which the Company has ownership rights, distribution rights or the right to share in future profit participation:
Title First Exhibition - --------------------------------------------------------------------------------------------------------- ABOUT SARAH TELEVISION ADVENTURE EXPRESS HOME VIDEO ALIEN ABDUCTION: INTIMATE SECRETS HOME VIDEO ALIEN ARSENAL HOME VIDEO ALIENS IN THE WILD WILD WEST HOME VIDEO ANDRE THEATRICAL ANDROMINA: THE FANTASY PLANET HOME VIDEO ANGEL EYES HOME VIDEO ANGEL IN TRAINING HOME VIDEO ANGEL OF PASSION HOME VIDEO ANGRY DOGS TELEVISION ANIMALYMPICS THEATRICAL BABYSITTERS HOME VIDEO BACKLASH: OBLIVION 2 HOME VIDEO BARE EXPOSURE HOME VIDEO BASIL THEATRICAL
15 16 BEACH BABES FROM BEYOND HOME VIDEO BEOWULF THEATRICAL BIKINI DRIVE-IN HOME VIDEO BIKINI HOE DOWN HOME VIDEO BIKINI SUMMER 3: SOUTH BEACH HEAT HOME VIDEO BIKINI TRAFFIC SCHOOL HOME VIDEO BILLY LONE BEAR TELEVISION BIMBO MOVIE BASH HOME VIDEO BLACK AND WHITE PAY CABLE BLONDE HEAVEN HOME VIDEO BLOOD DOLLS HOME VIDEO BLUE ICE PAY CABLE BODY STROKES HOME VIDEO BONE DADDY PAY CABLE BRAVE LITTLE TOASTER HOME VIDEO BRAVE LITTLE TOASTER GOES TO MARS HOME VIDEO BRAVE LITTLE TOASTER TO THE RESCUE HOME VIDEO BUT I'M A CHEERLEADER THEATRICAL CAB TO CANADA TELEVISION CAFE SOCIETY PAY CABLE CAGED HEARTS HOME VIDEO CALL GIRL HOME VIDEO CARNAL FATE HOME VIDEO CAVE GIRL ISLAND HOME VIDEO CELL BLOCK SISTERS HOME VIDEO CENTERFOLD HOME VIDEO CHRISTMAS WISH TELEVISION CLOCKMAKER, THE HOME VIDEO CLOSER, THE THEATRICAL COMING UNGLUED TELEVISION CONFESSIONS OF A LAPDANCER HOME VIDEO CREEPS, THE HOME VIDEO CRISS CROSS HOME VIDEO CURSE OF THE PUPPETMASTER HOME VIDEO DEAD HATE THE LIVING HOME VIDEO DENIAL PAY CABLE DESIRES OF INNOCENCE HOME VIDEO DIARY OF LUST HOME VIDEO DIFFERENT STROKES HOME VIDEO DISH DOGS TELEVISION DONOR, THE HOME VIDEO DOUBLE EXPOSURE HOME VIDEO DOUBLE TAP PAY CABLE DRAGONBALL Z THEATRICAL DRAGON WORLD: THE LEGEND CONTINUES HOME VIDEO DREAM MASTER: THE EROTIC INVADER HOME VIDEO DREAM WITH THE FISHES THEATRICAL DUNGEON OF DESIRE HOME VIDEO EGGS FROM 70 MILLION BC HOME VIDEO ELECTRA HOME VIDEO
16 17 ELKE'S EROTIC NIGHTS HOME VIDEO EROTIC BOUNDARIES HOME VIDEO EROTIC HOUSE OF WAX HOME VIDEO ESCORT, THE HOME VIDEO ESCORT 2, THE HOME VIDEO ESCORT 3, THE HOME VIDEO EXCALIBUR KID, THE HOME VIDEO EXOTIC TIME MACHINE HOME VIDEO FATAL COMBAT HOME VIDEO FEMALIEN HOME VIDEO FEMALIEN 2 HOME VIDEO FLESH SUITCASE PAY CABLE FORBIDDEN GAMES HOME VIDEO FORBIDDEN GAMES II HOME VIDEO FORBIDDEN PASSIONS HOME VIDEO FOREVER LOVE TELEVISION FREEWAY PAY CABLE FREEWAY II: CONFESSIONS OF A TRICKBABY HOME VIDEO FUGITIVE RAGE HOME VIDEO GALAXY GIRLS HOME VIDEO GIRL PAY CABLE GIRLS OF SURRENDER CINEMA HOME VIDEO GRAVE, THE PAY CABLE HARBINGER TELEVISION HARD BOUNTY HOME VIDEO HEAD OF THE FAMILY HOME VIDEO HEATWAVE HOME VIDEO HIDDEN BEAUTIES HOME VIDEO HIDEOUS HOME VIDEO HOLLYWOOD MADAM (aka LADY IN WAITING) PAY CABLE HOTEL EXOTICA HOME VIDEO HOTTEST BID, THE HOME VIDEO HUMAN PETS HOME VIDEO HUSBAND, WIFE, AND LOVER PAY CABLE IF I DIE BEFORE I WAKE PAY CABLE ILLICIT DREAMS HOME VIDEO ILLICIT DREAMS II HOME VIDEO ILLUSIONS OF SIN HOME VIDEO IMPROPER CONDUCT HOME VIDEO INCREDIBLE GENIE, THE HOME VIDEO INDECENT BEHAVIOR 3 HOME VIDEO INDECENT BEHAVIOR 4 HOME VIDEO INNER ACTION HOME VIDEO INNOCENCE BETRAYED HOME VIDEO INSATIABLE WIVES HOME VIDEO INVISIBLE HOME VIDEO IRRESISTIBLE IMPULSE HOME VIDEO JACK-O HOME VIDEO JOHNNY MYSTO: BOY WIZARD HOME VIDEO JOURNEY TO THE MAGIC CAVERN HOME VIDEO
17 18 JUNGLE BOOK, THE: SEARCH FOR THE LOST TREASURE HOME VIDEO KILLER EYE, THE HOME VIDEO KISS AND TELL TELEVISION KISSING A DREAM HOME VIDEO KRAA! THE SEA MONSTER HOME VIDEO LA CUCARACHA TELEVISION LADY IN BLUE HOME VIDEO LAP DANCER HOME VIDEO LAST BATTLE FOR THE UNIVERSE HOME VIDEO LAST PRODUCER, THE CABLE LAST TIME I COMMITTED SUICIDE, THE THEATRICAL L.I.P. SERVICE HOME VIDEO LITTLE GHOST HOME VIDEO LITTLE MISS MAGIC HOME VIDEO LONG WEEKEND TELEVISION LOVE ME TWICE HOME VIDEO LOVE ME TWICE 2 HOME VIDEO LOVER'S LEAP HOME VIDEO LURED INNOCENCE TELEVISION LURID TALES OF THE CASTLE QUEEN HOME VIDEO LURKING FEAR HOME VIDEO MAMBO CAFE THEATRICAL MANDROID HOME VIDEO MASSEUSE HOME VIDEO MASSEUSE 3 HOME VIDEO MAXIMUM REVENGE HOME VIDEO MIAMI MODELS HOME VIDEO MICROSCOPIC BOY, THE HOME VIDEO MIDAS TOUCH, THE HOME VIDEO MIDNIGHT CONFESSIONS HOME VIDEO MIDNIGHT TEASE II HOME VIDEO MIDNIGHT TEMPTATIONS HOME VIDEO MIDNIGHT TEMPTATIONS II HOME VIDEO MILO TELEVISION MINDRIPPER, THE PAY CABLE MISTRESS CLUB HOME VIDEO MISTRESS OF SEDUCTION HOME VIDEO MURDERCYCLE HOME VIDEO MY SANTA, MY DAD HOME VIDEO MYSTERIOUS MUSEUM HOME VIDEO MYSTERY MONSTERS HOME VIDEO NAKED SOULS HOME VIDEO NEMESIS-CRY OF ANGELS HOME VIDEO NIGHTMARE STREET TELEVISION NOOSE THEATRICAL O LITA 2000 HOME VIDEO OBLIVION HOME VIDEO ONE HELL OF A GUY TELEVISION ONE MAN'S HERO THEATRICAL PASSION'S DESIRE HOME VIDEO
18 19 PASSION OBSESSION HOME VIDEO PERFECT GETAWAY TELEVISION PETTICOAT PLANET HOME VIDEO PHANTOM LOVE HOME VIDEO PHANTOM TOWN HOME VIDEO PHOENIX THEATRICAL PICKING UP THE PIECES THEATRICAL PINOCCHIO, THE ADVENTURES OF THEATRICAL PLANET OF THE DINO-KNIGHTS HOME VIDEO PLANET PATROL HOME VIDEO PLEASURE IN PARADISE HOME VIDEO PLEASURECRAFT HOME VIDEO POSSUMS HOME VIDEO POWDER BURN HOME VIDEO PRELUDE TO LOVE HOME VIDEO PRIVATE LESSONS II HOME VIDEO PRIVATE OBSESSION HOME VIDEO PROFESSIONAL AFFAIR HOME VIDEO RAPID ASSAULT HOME VIDEO REBECCA'S SECRET HOME VIDEO RED RIBBON BLUES PAY CABLE RETRO-PUPPETMASTER HOME VIDEO RINGMASTER THEATRICAL SAVIOR THEATRICAL SCORING HOME VIDEO SECRET KINGDOM, THE HOME VIDEO SEDUCTION OF INNOCENCE HOME VIDEO SENSATIONS HOME VIDEO SENSUOUS SUMMER, A HOME VIDEO SERPENT'S LAIR PAY CABLE SEXUAL IMPULSE HOME VIDEO SEXUAL ROULETTE HOME VIDEO SHADOWDANCER HOME VIDEO SHANDRA: THE JUNGLE GIRL HOME VIDEO SHAPESHIFTER HOME VIDEO SHOOTER, THE PAY CABLE SHRIEK HOME VIDEO SHRUNKEN CITY, THE HOME VIDEO SHRUNKEN HEADS HOME VIDEO SINFUL INTRIGUE HOME VIDEO SKYJACKED TELEVISION SMOOTH TALKER TELEVISION SPIRIT OF THE NIGHT HOME VIDEO ST. FRANCISVILLE EXPERIMENT, THE THEATRICAL STOLEN HEARTS HOME VIDEO STORM SWEPT HOME VIDEO STORMY NIGHTS HOME VIDEO STREET LAW HOME VIDEO STRIPSHOW HOME VIDEO SUBSPECIES: THE AWAKENING HOME VIDEO
19 20 SUSAN'S PLAN PAY CABLE SWING THEATRICAL TALISMAN HOME VIDEO TARGET OF SEDUCTION HOME VIDEO TAXMAN THEATRICAL TEEN KNIGHT HOME VIDEO TEEN SORCERY HOME VIDEO TEEN TASK FORCE HOME VIDEO TEENAGE SPACE VAMPIRES HOME VIDEO TEST TUBE TEENS FROM THE YEAR 2000 HOME VIDEO THE BRAVE TELEVISION THE KIDNAPPING TELEVISION THE LAST LIE TELEVISION THE POET TELEVISION THE STAIRCASE TELEVISION TIMEGATE: TALES OF THE SADDLE TRAMPS HOME VIDEO TOTALLY EXPOSED HOME VIDEO TRAINSPOTTING THEATRICAL TRAPPED ON TOY WORLD HOME VIDEO TROPICAL TEASE HOME VIDEO ULTIMATE TABOO HOME VIDEO UNDER LOCK AND KEY HOME VIDEO UNDER THE GUN HOME VIDEO UNINHIBITED HOME VIDEO UNWED FATHER TELEVISION VAMPIRE JOURNALS HOME VIDEO VERONICA 2030 HOME VIDEO VERY BAD THINGS THEATRICAL VICE GIRLS HOME VIDEO VIRGINS OF SHERWOOD FOREST HOME VIDEO VIRTUAL DESIRE HOME VIDEO VIRTUAL ENCOUNTERS HOME VIDEO VIRTUAL ENCOUNTERS II HOME VIDEO VOYEUR, THE HOME VIDEO WAGER OF LOVE HOME VIDEO WAITING FOR SUNSET PAY CABLE WAITING FOR THE MAN PAY CABLE WHOLE WIDE WORLD THEATRICAL WITCHOUSE HOME VIDEO X-RAY KID, THE HOME VIDEO YOUNGER & YOUNGER THEATRICAL ZARKORR! THE INVADER HOME VIDEO ZORRITA: PASSION'S AVENGER HOME VIDEO
Television Movies and Mini-Series Title First Exhibition - -------------------------------------------------------------------------------- A Husband, A Wife and A Lover CBS Aladdin International Candles in the Dark Family Channel Carolina Skeletons NBC Child in the Night CBS City Boy CBS 20 21 Confessions: Two Faces of Evil NBC Dangerous Intentions CBS Echo ABC Every Woman's Dream CBS Family Pictures (4 hours) ABC Father and Son: Dangerous Relations NBC Fire in the Dark CBS Getting Gotti: The Diane Giacalone Story CBS Glory Years (6 hours) HBO Good Cops, Bad Cops NBC Innocent Victims (4 hours) NBC Jack Reed: A Search For Justice NBC Jack Reed: A Killer Amongst Us NBC Jack Reed: Death and Vengeance NBC JFK: Reckless Youth (4 hours) ABC Kiss Shot CBS Lady Killer CBS Liberace: Behind the Music CBS Murder C.O.D NBC Overruled NBC Princess in Love CBS Sins of the Mother CBS Sweet Bird of Youth NBC Then There Were Giants (4 hours) NBC To Save the Children CBS Unlikely Angel CBS Your Mother Wears Combat Boots NBC Television Series/Game Shows
Episodes Title Produced First Exhibition - ----------------------------------------------------------------------------------------------------- 1st and Ten 80 HBO Could It Be a Miracle 24 Syndication Cracker 16 ABC Erotic Confessions 39 HBO Gun 6 ABC Harts of the West 15 CBS Heroes: Made in the USA 38 Syndication Mapletown 39 Syndication Mike Hammer 26 Syndication Mowgli: The New Adventures of The Jungle Book 26 Fox Kids Worldwide Pigasso's Place 13 Syndication Profiles-Unauthorized Biographies 4 A&E Relatively Speaking 90 Syndication Sweating Bullets 66 CBS Teen Wolf 21 CBS The Barbara De Angelis Show 70 CBS Trial Watch 118 NBC Would You Believe It? 13 Discovery Channel
A significant portion of the Company's library is under license in many of the major domestic and international markets. Following the expiration of the licenses, rights generally revert to the Company for relicensing. JOINT VENTURES AND ANCILLARY ACTIVITIES The Company has expanded into areas which exploit the characters and story ideas in its feature films and television programs through joint ventures and partnerships. The Company markets the music used in its productions through an arrangement with Cherry Lane Music, Inc., a music publisher. Using its expertise as a television producer, the Company produced two infomercials for its 50% owned partnership TVFirst. TVFirst markets recorded Christian music sung by contemporary Christian artists. From October 1995 through September 1999 music revenues have exceeded $12,900,000. 21 22 The Company sold its interest in TVFirst in October 1999. The Company currently holds 50% ownership interests in BLT Ventures, which produced the two sequels to the animated feature Brave Little Toaster, Cracker Company LLC, which produced the network television series Cracker, Swing Ventures, which produced the feature Swing, Trick Productions which produced the feature Freeway II: Confessions of A Trickbaby, and a 25% interest in Grendel Productions LLC, which produced the feature Beowulf. The Company currently holds a 55.2% ownership interest in US SEARCH.com, an 82.5% ownership interest in KLC/New City, and an 80% ownership interest in Gran Canal Latino, each as previously described. COMPETITION In the film and television program business, the Company competes against many vertically integrated production and distribution businesses that have substantially greater resources than the Company, and smaller independent companies of a similar size to the Company. See "Motion Picture Industry Overview" above and "Government Regulations" below. Due to the artistic quality of the product produced, consumer acceptance of individual productions rather than distributor brand name tend to generate revenues. The individual reference service industry is highly competitive and highly fragmented. Currently, US SEARCH.com's primary competitors in the area of individual locator searches include major telephone companies and other third parties who publish free printed or electronic directories, private investigation firms and a variety of other companies. Their primary competitors for individual profile report search services include these companies, as well as LEXIS-NEXIS, a division of Reed Elsevier Inc., The Dun & Bradstreet Corporation, Reuters Limited, Avert, Inc., Choice Point, KnowX.com, a division of DBT Online, inc., the primary data supplier to US SEARCH.com, The Kroll-O'Gara Company, Pinkerton and the Proudfoot Reports Division of ASI Solutions, Inc. Many of these companies have greater financial and marketing resources than US SEARCH.com does and may have significant competitive advantages through other lines of business and existing business relationships. US SEARCH.com also competes with online services and other Web site operators, as well as traditional media such as television, radio and print for a share of advertisers' total advertising space or programs. US SEARCH.com does not presently consider major Internet search directories or Web sites as competitors. In fact, US SEARCH.com views them as lead generators through their search directories and other services, and presently benefits from strategic advertising arrangements with several of the major Internet portals and Web sites. However, there is no guarantee that these Web sites, many of which have financial and other resources greater than those of US SEARCH.com will not acquire businesses that compete with or introduce new products and services in direct competition with US SEARCH.com. More generally, competitors or potential competitors of US SEARCH.com may develop services that are superior, are less expensive or achieve greater market acceptance. BUSINESS CONCENTRATION AND DEPENDENCE The Company conducts its film and television business world-wide, with no concentrations in one or a few geographic areas, or to one or a few individual customers the loss of whom would materially adversely affect Company results. GOVERNMENT REGULATIONS The United States Federal Communications Commission ("FCC") repealed its financial interest and syndication rules in September 1995. Those FCC rules, which had been adopted in 1970 to limit television network control over television programming and thereby foster the development of diverse programming sources, restricted the ability of U.S. television networks ABC, CBS and NBC to own and syndicate television programming. As a result of the repeal of the FCC's financial interest and syndication rules, there has been an increase in internal television network production of programming for their own use. This has placed additional competitive pressures on program suppliers, such as the Company. 22 23 Under the Telecommunications Act of 1996 (the "1996 Act"), manufacturers of television set equipment are required to equip all new television receivers with a so-called "V-Chip" which allows for parental blocking of violent, sexually-explicit or indecent programming based on a rating for any given program that is broadcast along with the program. The FCC was directed by the 1996 Act to develop a ratings system based upon the recommendations of an advisory committee selected by the FCC unless the television industry established its own voluntary ratings system by February 1997. The majority of the television networks did establish and have implemented such a system. Other provisions of the 1996 Act revise the broadcast multiple ownership rules, allow local exchange telephone companies to offer multichannel video programming service, subject to certain regulatory requirements, and allow for cable companies to offer local exchange telephone service, subject to certain regulatory requirements. The full impact on the Company of the changes brought about by the 1996 Act, including the new content ratings guidelines and accompanying changes in FCC rules cannot be predicted at the present time. However, it is possible that recent alliances of certain program producers and television station group owners may place additional competitive pressures on program suppliers, such as the Company, to the extent they are unaligned with the major networks or any television station group owners. These alliances have been further encouraged by recent FCC rule revisions which permit greater consolidation of ownership of television stations on the national level by allowing a single television station licensee to own television stations reaching up to 35% of the nation's television households and which permit a single owner to own two television stations in a single market. The FCC has also adopted rules that require certain programs to be broadcast with closed captioning for the hearing impaired and the Company may have to make additional closed-captioning expenditures to ensure the value of its library for television licensing. Further, the FCC is considering a proposal to require that programs be accompanied by a video description of settings and actions not otherwise in the dialogue for the visually impaired which may result in the Company being required to further enhance its library for future television licensing. Recently enacted legislation requires direct broadcast satellite operators to carry certain local broadcast channels. Such legislation may limit the number of pay-per-view and other niche channels available for the Company's programming. The FCC is considering whether to compel cable systems to carry all the digital signals that a local station broadcasts. Since local stations will be able to broadcast multiple signals, this may result in decreased availability of open cable channels for pay-per-view and other niche channels. If this occurs, the Company may face increased competition for a limited supply of pay-per-view and other niche channels for distribution. In international markets, the Company's programming is occasionally subject to domestic content and quota requirements, and/or other limitations, which prohibit or limit the amount of programming produced outside of the local market. Although the Company believes these requirements have not affected the Company's licensing of its programs in international markets to date, such restrictions, or new or different restrictions, could have an adverse impact on the Company's operations. In connection with certain services provided or intended to be provided by US SEARCH.com, particularly individual background checks used for certain purposes, US SEARCH.com may be considered a "consumer reporting agency" as such term is used in the Fair Credit Reporting Act, as amended ("FCRA"), and, therefore, may be required to comply with the various consumer credit disclosure requirements of the FCRA. While US SEARCH.com intends to comply with the FCRA as a "consumer reporting agency" in connection with providing individual background checks for employment purposes, the procedures which are implemented by the Company may be deemed to be insufficient. In addition, US SEARCH.com's limited procedures to date to avoid being regulated as a consumer reporting agency by attempting to restrict its individual background check service to permissible purposes (which do not permit use for employment purposes), may not be sufficient. Willful or negligent noncompliance with the FCRA, including with respect to US SEARCH.com's prior operations, could result in civil liability to the subjects of reports. Also, the Americans with Disabilities Act of 1990 ("ADA") contains pre-employment inquiry and confidentiality restrictions designed to prevent discrimination against individuals with disabilities in the hiring process. The use by US SEARCH.com's customers of certain information sold to them is also regulated, both in respect to the type of information and the timing of its use by the ADA. Similarly, there are a number of states which have laws similar to the FCRA, and some states which have laws 23 24 more restrictive than the ADA. Further, many state laws limit the type of information which can be made available to the public. In addition, certain state laws may require US SEARCH.com to be licensed in order to conduct its background check business within those states. Customers in such states can access US SEARCH.com's Web site, which may subject US SEARCH.com to the laws of such states. There is no assurance that US SEARCH.com will not be subject to the laws of states in which US SEARCH.com has no contacts other than through residents of such state ordering services through US SEARCH.com's Web site and US SEARCH.com mailing, faxing or e-mailing reports to the resident within such state. In the event US SEARCH.com is determined to have violated any of the federal or state laws referred to herein, US SEARCH.com could be subject to substantial civil and/or criminal liability which could have a material adverse effect on the Company's business, financial condition, results of operations and prospects. EMPLOYEES The Company and its subsidiaries had approximately 265 full-time and 45 part-time employees as of December 10, 1999. The Company's executive offices are located at 11601 Wilshire Boulevard, Suite 2100, Los Angeles, California 90025, and its telephone number is (310) 481-2000. The Company has employment contracts with certain key executives due to its reliance upon them for critical functions. The Company relies upon the personal contacts of its senior officers which have been generated through their prior business and personal dealings with Majors, other Independents, legal and accounting firms, business management firms, talent agencies, production lenders and personal managers who are actively involved in the production community. No employees of the Company are represented by unions, although staff temporarily employed for specific film and television program productions are often so represented. Management believes that employee relations are wholly satisfactory. 24 25 2. PROPERTIES The Company leases approximately 23,000 square feet of office space on the 20th and 21st floors at 11601 Wilshire Boulevard, Los Angeles, California under a lease agreement recently extended through June 2005. The minimum annual rent under the lease currently is $528,000 but will increase in fiscal 2000 and beyond. The Company's subsidiary, US SEARCH.com, leases approximately 8,000 square feet of office space in Beverly Hills, California under a lease agreement through February 2001. The minimum annual rent under the lease is $188,000. US SEARCH.com recently entered into a five year lease for approximately 52,500 square feet of office space in Marina Del Rey, California commencing in December 1999. The minimum annual rent under that lease will be $1,006,000. The Company rents studio facilities as needed for production, except that certain post-production off-line editing is performed at the Company's executive offices. 3. LEGAL PROCEEDINGS The Company is party to certain legal proceedings and claims arising out of the normal course of business. The Company believes that the ultimate resolution of all of these matters will not have a material adverse effect upon the Company's financial position, results of operations or liquidity. 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. PART II 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is quoted on the NASDAQ National Market ("NNM") under the symbol "KLOC." Additionally, the stock is listed on the Pacific Stock Exchange under the symbol "KLO." The following table sets forth the range of high and low sale prices for the Common Stock, as reported on the NNM, for the periods indicated:
COMMON STOCK HIGH LOW ------------ ---------------------- FISCAL 1998 First Quarter (ended December 31, 1997).................................................. $5.25 $2.44 Second Quarter (ended March 31, 1998).................................................... $3.19 $1.75 Third Quarter (ended June 30, 1998)...................................................... $3.78 $1.75 Fourth Quarter (ended September 30, 1998)................................................ $5.13 $2.44 FISCAL 1999 First Quarter (ended December 31, 1998) $8.38 $1.63 Second Quarter (ended March 31, 1999) $16.00 $7.00 Third Quarter (ended June 30, 1999) $21.63 $4.88 Fourth Quarter (ended September 30, 1999) $8.75 $3.03 FISCAL 2000 First Quarter (through December 14, 1999)................................................ $5.63 $3.56
On December 14, 1999, the last sale price for the Common Stock as reported on the NNM was $3.97. On November 30, 25 26 1999, there were approximately 596 record holders RECENT SALES OF UNREGISTERED SECURITIES; USES OF PROCEEDS None. DIVIDENDS The Company has never paid any cash dividends and has no present intention to declare or to pay cash dividends. The payment of dividends also is restricted by covenants in the Company's credit agreement and the indentures and fiscal agency agreements under which the Company's Convertible Subordinated Debentures were issued. It is the present policy of the Company to retain any earnings to finance the growth and development of the Company's business. 6. SELECTED FINANCIAL DATA The following table summarizes selected consolidated financial data for the Company and should be read in conjunction with the detailed consolidated financial statements included elsewhere in this Annual Report. The selected consolidated financial data for the fiscal years are derived from the consolidated financial statements audited by PricewaterhouseCoopers LLP, independent public accountants, whose report with respect to the consolidated balance sheets of the Company as of September 30, 1999 and 1998, and the related consolidated statements of operations, cash flows and stockholders' equity for the years ended September 30, 1999 and 1998, and by KPMG LLP, independent public accountants, whose report with respect to the consolidated statements of operations, cash flows and stockholders' equity of the Company for the year ended September 30, 1997 each appears elsewhere in this Annual Report. On October 20, 1998, the Company changed its independent public accountants. 26 27 CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Year Ended September 30, ------------------------------------------------------------------------- (in thousands, except per share data) 1999 (1) 1998 (1) 1997 1996 1995 -------- -------- -------- -------- -------- Operating revenues ..................................... $ 49,890 $ 76,130 $ 54,746 $ 80,157 $ 20,407 Costs relating to operating revenues ................... (39,666) (61,627) (52,084) (70,648) (17,404) Selling, general and administrative expenses ........... (31,186) (12,028) (4,023) (3,096) (3,388) Provision for doubtful accounts ........................ (2,959) (2,118) (1,310) (499) (450) -------- -------- -------- -------- -------- Earnings (loss) from operations ........................ (23,921) 357 (2,671) 5,914 (835) Equity in earnings (losses) of unconsolidated entities (520) (330) 2,189 -- -- Gain on sale of interest in subsidiary ................. 13,148 -- -- -- -- Gain on issuance of stock by subsidiary ................ 21,018 -- -- -- -- Interest and dividend income ........................... 687 79 163 198 300 Interest expense ....................................... (7,782) (6,261) (4,027) (4,027) (3,409) Interest expense related to bridge note financing ...... -- -- -- (943) -- -------- -------- -------- -------- -------- Earnings (loss) before minority interest, income taxes and extraordinary item ......................... 2,630 (6,155) (4,346) 1,142 (3,944) Minority interest in subsidiary net losses ............. 2,567 -- -- -- -- -------- -------- -------- -------- -------- Earnings (loss) before income taxes and extraordinary item ................................................. 5,197 (6,155) (4,346) 1,142 (3,944) Income taxes ........................................... (726) (181) (23) (47) (31) -------- -------- -------- -------- -------- Earnings (loss) before extraordinary item .............. 4,471 (6,336) (4,369) 1,095 (3,975) Extraordinary item: costs associated with repayment of credit facility ................................... -- -- -- (365) -- -------- -------- -------- -------- -------- Net earnings (loss) .................................... $ 4,471 ($ 6,336) $ (4,369) $ 730 $ (3,975) ======== ======== ======== ======== ======== Basic earnings (loss) per share (2): Before extraordinary item ........................ $ .38 $ (.69) $ (.49) $ .16 $ (.75) Extraordinary item .............................. -- -- -- (.05) -- -------- -------- -------- -------- Net earnings (loss) ............................. $ .38 $ (.69) $ (.49) $ .11 $ (.75) ======== ======== ======== ======== ======== Diluted earnings (loss) per share (2): Before extraordinary item ........................ $ .36 $ (.69) $ (.49) $ .16 $ (.75) Extraordinary item Net -- -- -- (.05) -- -------- -------- -------- -------- -------- $ .36 $ (.69) $ (.49) $ .11 $ (.75) ======== ======== ======== ======== ======== Weighted average common shares outstanding (2) 11,755 9,181 8,959 6,668 5,286 ======== ======== ======== ======== ========
CONDENSED CONSOLIDATED BALANCE SHEET DATA:
September 30, ---------------------------------------------------------------- (In thousands) 1999 (1) 1998 (1) 1997 1996 1995 -------- -------- -------- -------- -------- Cash and cash equivalents (3) ........... $ 36,434 $ 3,309 $ 16,791 $ 11,636 $ 4,301 Accounts receivable, net ................. 30,030 40,418 27,696 22,885 7,864 Film and television program costs, net ... 91,499 73,773 68,507 58,463 73,716 Investments in unconsolidated subsidiaries 12,045 10,798 5,326 1,495 -- Total assets ............................. 185,115 137,105 124,368 100,152 88,952 Notes payable and other indebtedness ..... 85,194 84,677 74,278 53,520 46,143 Total liabilities ........................ 112,790 111,639 93,232 65,902 69,745 Stockholders' equity ..................... 60,745 25,466 31,136 34,250 19,207 ======== ======== ======== ======== ========
27 28 - ----------- (1) In November 1997 the Company acquired a controlling interest in US SEARCH.com. In June 1999 US SEARCH.com completed an initial public offering in which the Company sold a portion of its shareholdings as well. Because US SEARCH.com has incurred net losses since acquisition and the Company funded 100% of such losses through its initial public offering, the Company recognized 100% of those incurred net losses in its consolidated financial statements through June 1999. Subsequent to the public offering, the Company has recognized in its consolidated balance sheet a minority interest in the net equity of US SEARCH.com, and has recognized in its consolidated statements of operations a minority interest in the net losses of US SEARCH.com proportionate to the minority ownership. In April 1999 the Company acquired a minority interest in The Harvey Entertainment Company. (2) In September 1997 the Company effected a 1-for-6 reverse stock split. Amounts for all periods presented herein give retroactive effect to the reverse split. (3) $2,088 of cash and cash equivalents are restricted deposits that are collateral for a sale/leaseback transaction and for certain production loans for 1999 ($1,988 for 1998, $1,609 for 1997, $419 for 1996 and $1,162 for 1995), $2,000 of cash and cash equivalents for 1999 are restricted deposits of subsidiary US SEARCH.com, and $734 is cash collected by the Company and reserved for use by Chase Manhattan Bank to pay down outstanding borrowings under the Company's credit facility ($66 for 1998, $105 for 1997, $4,126 for 1996 and none for 1995). 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company's revenues are derived primarily from the production or the acquisition of distribution rights in films licensed for release domestically; from the production and distribution of television programming for the major domestic television networks, basic and pay cable television and first-run syndicators; and from the licensing of rights to films and television programs in international markets. Major domestic television networks are reducing the volume of independently produced television programming. The Company generally finances all or a substantial portion of the budgeted production costs of films and television programming it produces through advances obtained from distributors and borrowings secured by domestic and international licenses. The Company typically retains rights to be exploited in future periods or in additional markets or media. The Company produces a limited number of higher-budget theatrical films to the extent the Company is able to obtain an acceptable domestic studio to release the film theatrically in the U.S. In November 1997, the Company acquired control of US SEARCH.com, Inc., a leading provider of fee-based people search and other customized individual reference services. In February 1998 the Company established KL/Phoenix, an 80% owned venture, which distributes film and television product in Latin America. In November 1998 the Company established Gran Canal Latino, an 80% owned venture which broadcasts Spanish and Portuguese language programming in the Americas. The Company's revenues and results of operations are significantly affected by accounting policies required for the industries in which it operates (see Note 1 of Notes to Consolidated Financial Statements). Among the more significant policies are the following: Film and Television Programs. The Company generally capitalizes the costs it has incurred to produce a film or television program. These costs include direct production expenditures, certain exploitation costs, production overhead, and interest relating to financing the project. Capitalized exploitation or distribution costs include those costs that clearly benefit future periods such as film prints and prerelease and early release advertising that is expected to benefit the film or program in future markets. These costs, as well as third party participations and talent residuals, are amortized each period on an individual film or television program basis in the ratio that the current period's gross revenues for the program bear to management's estimate of anticipated total remaining gross revenues for such film or program from all sources. When management reduces its estimates of the future gross revenues for a particular product, a significant write-down and a corresponding decrease in the Company's earnings could result. See "Results of Operations" Below. Film and television program costs, net of accumulated amortization, increased to $91,499,000 at September 30, 1999 from $73,773,000 at September 30, 1998. Film and television program costs in process or development at September 30, 1999 increased to $20,472,000 from $10,570,000 at September 30, 1998. See "Results of Operations - Comparison of Fiscal Years Ended 28 29 September 30, 1999 and 1998" below. Gross profits for any period are a function, in part, of the number of programs delivered in that period and the recognition of costs in that period. Because initial licensing revenues and related costs generally are recognized either when the program has been delivered or is available for delivery, significant fluctuations in revenues and net earnings may occur from period to period. Thus, a change in the amount of entertainment product available for delivery from period to period may materially affect a given period's revenues and results of operations and year-to-year results may not be comparable. The continuing shift of the Company's film and television program mix during a fiscal year may further affect the Company's quarter-to-quarter or year-to-year results of operations as new products may be amortized differently as determined by length of product life cycle and the number of related revenue sources. Distributor production advances or license fees received prior to delivery or completion of a program are deferred. License fees are generally recognized as revenue on the date the film or program is delivered or available for delivery. Activities conducted through joint ventures, wherein the Company reports its equity in earnings (losses) as revenues, can significantly affect comparability of net earnings. See "Results of Operations" below. US Search.com. In November 1997, the Company acquired an 80% interest of US SEARCH.com, a leading provider of fee-based people search and other customized individual reference services. In June 1999 the Company sold shares of US SEARCH.com and US SEARCH.com completed an initial public offering which resulted in the Company's ownership position declining to 55.2%. Since its acquisition, US SEARCH.com's financial position and results of operations have been consolidated in the Company's financial statements. The consolidation of Search has resulted in a substantial change in the presentation of the Company's results of operations due to the inclusion of this new business segment. Since such acquisition, the Company has consolidated $23,616,000 of revenues and $15,291,000 of net losses attributable to US SEARCH.com. US SEARCH.com has significantly higher gross profit margins than the film and television program segment. Management's strategy is to enhance US SEARCH.com's brand awareness and market position through increased advertising and distribution and marketing alliances. As an expected result of increases in revenues trailing such increases in expenditures, the Company believes that US SEARCH.com will continue to adversely affect the Company's consolidated results of operations for the foreseeable future. See Note 10 of Notes to Consolidated Financial Statements. Gran Canal Latino. In November 1998, the Company launched Gran Canal Latino ("GCL"), its first satellite channel. GCL broadcasts 24 hours a day, with a selection of films mostly from Spain. GCL's satellite transmission reaches the United States and all of Latin America including Mexico. Through November 30, 1999, GCL's cable distributors had a base of 1,300,000 subscribers including its multiple system operators. Under a distribution agreement with Enrique Cerezo, the Company is broadcasting selections from approximately 1,500 Spanish language movie titles. RESULTS OF OPERATIONS COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1999 AND 1998 The following tables provide the dollar and percentage changes in operating results by segment and in total for fiscal 1999 versus fiscal 1998:
$000 % ---------------------------------------------- ------------------------------------- Film Film and TV Search Consol. and TV Search Consol. ------------- ------------ ------------- ----------- ---------- -------- Operating revenues $(34,118) $7,878 $(26,240) (50)% 100% (34)% Costs relating to operating revenues $(24,812) $2,851 $(21,961) (43)% 79% (36)% Gross profit $(9,306) $5,027 $(4,279) (91)% 118% (30)%
29 30 Selling, general and administrative expenses $4,168 $14,990 $19,158 91% 202% 159% Provision for doubtful accounts $390 $451 $841 28% 61% 40% Earnings (loss) from operations $(13,864) $(10,414) $(24,278) NM 268% NM
- ----------------------- NM - not meaningful The Company's operating revenues for fiscal 1999 decreased ($26,240,000) (34%) from fiscal 1998. The decrease resulted from a $(34,118,000) or (50%) decline in film and television licensing revenues due primarily to a decline in the delivery and/or availability of films and television programs. Television program revenues declined $18,000,000 as episodic deliveries to networks concluded in fiscal 1998. Also seven larger feature films were delivered during fiscal 1999 in comparison to 25 moderate-sized feature films delivered or available in fiscal 1998. Partially offsetting this decrease was a $7,878,000 or 100% increase in revenues from US SEARCH.com versus 1998. This increase was attributable to increased marketing and advertising expenditures. See Note 10 to the consolidated financial statements for revenue information by territory and for significant customers. The Company recognized $15,747,000 (32%) of revenues during the fiscal 1999 from US SEARCH.com. The Company recognized $14,081,000 (28%) of revenues during the fiscal 1999 from the delivery and/or availability of seven feature films, including Ringmaster, starring Jerry Springer which was released in the United States by Artisan Entertainment, and One Man's Hero starring Tom Berenger, which was released in the United States by MGM. The Company recognized $11,548,000 (23%) of revenues in fiscal 1999 from continuing licenses of product from the Company's library to domestic cable channel operators through its majority-owned subsidiary KLC/New City, and through international sub-distributors including KL/Phoenix. Revenues of $6,878,000 (14%) came from television feature or pilot productions. Revenues of $1,135,000 (2%) came from producer fees on third party productions. Revenues of $1,306,000 (3%) came from deliveries in the Company's family division of direct-to-video product. In various stages of production for the Company's fiscal 2000 distribution slate are Picking Up The Pieces starring Woody Allen, The St. Francisville Experiment, They Nest starring Dean Stockwell, John Savage and Thomas Collabro, and Vlad the Impaler. Costs relating to operating revenues during fiscal 1999 decreased $21,961,000 (36%) as compared to fiscal 1998. As a percentage of operating revenues, costs relating to operating revenues were 80% for fiscal 1999 in comparison to the 81% rate for fiscal 1998. Film and television costs declined 43%, which was less than the revenue decline principally because management reduced its estimates of likely future revenues on several released titles in fiscal 1999. US SEARCH.com costs increased 79%, which was less than the revenue increase as Internet-sourced revenues were less costly to provide to consumers. Gross profit during fiscal 1999 decreased ($4,279,000) (30%) from fiscal 1998. As a percentage of operating revenues, gross profit was 20% for fiscal 1999, slightly more than the 19% rate for fiscal 1998. Film and television gross profit amounts declined 91%, principally due to reduced operating revenues and management reducing its estimates of likely future revenues on several released titles in fiscal 1999. US SEARCH.com gross profit amounts increased 118%, as Internet-sourced revenues were less costly to provide to consumers. Selling, general and administrative expenses increased $19,158,000 or 159% for fiscal 1999 from fiscal 1998. The increase in such expenses is principally due to a $10,392,000 (200%) increase in US SEARCH.com advertising expenses and a $3,392,000 (122%) increase in US SEARCH.com administrative expenses. As a percentage of US SEARCH.com's net revenues, advertising and marketing expenses increased to approximately 99% for fiscal 1999, from approximately 67% for fiscal 1998. This increase is primarily attributable to an increase in the level of Internet-based advertising. As a percentage of net revenues, general and administrative expenses increased to approximately 64% for fiscal 1999, from approximately 16% for fiscal 1998. This increase in general and administrative expenses in absolute dollars is primarily attributable to the cost associated with the hiring of additional management and administrative personnel in 1999. Also included in US SEARCH.com's 1999 selling, general and administrative expenses is $1,834,000 of US SEARCH.com 30 31 non-cash director and officer stock option costs in connection with options granted in fiscal 1999. No options were granted in fiscal 1998. Also included in fiscal 1999 expenses are $1,511,000 of bonuses to the Co-Chairmen and Co-Chief Executive Officers, the President and Chief Operating Officer, and the Chief Financial Officer. No such bonuses were included in fiscal 1998 expenses. 31 32 The provisions for doubtful accounts increased $841,000 or 40% during fiscal 1999 principally due to a $390,000 increase in such provisions for film and television license receivables based upon estimated collections, and a $451,000 increase in such provisions for US SEARCH.com. The US SEARCH.com increase is primarily due to increases in the accruals for potential chargebacks regarding uncollectible consumer checks, credit card charges and 900 number telephone sales. During fiscal 1999 the Company recognized a $21,018,000 pre-tax gain on the issuance of stock by its subsidiary, US SEARCH.com. This resulted from the subsidiary's initial public offering on June 25, 1999, in which new shareholders invested an amount per share substantially in excess of the Company's per-share investment in the subsidiary, resulting in a substantial increase in the subsidiary's net worth. The gain represents the increase in the Company's revised proportionate share of the subsidiary's net equity. No comparable transaction occurred in fiscal 1998. During fiscal 1999 the Company recognized a $13,148,000 pre-tax gain on sale to the public of 1,500,000 shares of its holdings in its subsidiary US SEARCH.com in conjunction with the initial public offering by the subsidiary. No comparable transaction occurred in fiscal 1998. Interest and dividend income increased $608,000 (770%) during fiscal 1999 due to earnings on invested proceeds from the US SEARCH.com initial public offering and dividends received from the investment in The Harvey Entertainment Company during fiscal 1999. Interest expense during fiscal 1999 increased $1,521,000. The 24% increase was principally attributable to the increased average levels of borrowing in fiscal 1999 and an increase in the average interest rate. Total indebtedness for borrowed money increased 1% to $85,194,000 at September 30, 1999 from $84,677,000 at September 30, 1998. Earnings before income taxes of $5,197,000 were reported for fiscal 1999, versus a loss before income taxes of ($6,155,000) for fiscal 1998. The Company's effective income tax rate was 13% for fiscal 1999 compared to an effective income tax rate of 3% for fiscal 1998. Income tax expense for fiscal 1999 consisted of alternative minimum taxes and state income taxes. Through September 30, 1999 the Company and US SEARCH.com had combined estimated Federal and state net operating loss carryforwards totaling $35,368,000 and $9,198,000, respectively. The Federal net operating loss carryforwards begin to expire in fiscal 2008. The state net operating loss carryforwards begin to expire in fiscal 2004. Due to the sale of US SEARCH.com common stock in connection with the subsidiary's initial public offering in June 1999, effective July 1999 US SEARCH.com taxable income or loss will not be consolidated in the Company's income tax returns. As a result, in future periods taxable income or loss could vary significantly from financial statement earnings or losses before income taxes. The Company reported net earnings of $4,471,000, or $0.38 per basic share and $0.36 per diluted share, for fiscal 1999 as compared to a net loss of ($6,336,000), or losses of ($0.69) per basic and diluted share, for fiscal 1998. Weighted number of common shares for the compared year were 11,755,000 (basic) and 12,696,000 (diluted) in fiscal 1999 and 9,181,000 (basic and diluted) in fiscal 1998. COMPARISON OF FISCAL YEARS ENDED SEPTEMBER 30, 1998 AND 1997 The following tables provide the dollar and percentage changes in operating results by segment and in total for fiscal 1998 versus fiscal 1997: 32 33
$000 % ------------------------------------------ -------------------------------------- Film Film and TV Search Consol. and TV Search Consol. ----------- ----------- ------------ ----------- ---------- --------- Operating revenues $13,515 $7,869 $21,384 25% NM 39% Costs relating to operating revenues $5,954 $3,589 $9,543 11% NM 18% Gross profit $7,561 $4,280 $11,841 284% NM 445% Selling, general and administrative expenses $574 $7,431 $8,005 14% NM 199% Provision for doubtful accounts $73 $735 $808 6% NM 62% Earnings (loss) from operations $6,914 $(3,886) $3,028 259% NM 113%
- ----------------------- NM - not meaningful The Company's operating revenues for fiscal 1998 increased $21,384,000 (39%). This increase was due primarily to the timing of delivery and/or availability of films and television programs, to the increase during fiscal 1998 in revenues related to certain films previously marketed by Conquistador and to the inclusion in fiscal 1998 of the revenues of newly acquired US SEARCH.com. The Company recognized $26,200,000 (34%) of revenues during the fiscal year ended September 30, 1998 from the delivery and/or availability of 25 feature films, including Susan's Plan written and directed by John Landis and starring Natassja Kinski, Billy Zane, Michael Biehn, Rob Schneider, Lara Flynn Boyle and Dan Aykroyd, Black and White starring Gina Gershon, Girl starring Dominique Swain, Taxman starring Joe Pantoliano, Minion starring Dolph Lundgren, Noose directed by Ted Demme, and Legion starring Parker Stevenson. Also included were the Company's equity in net earnings of joint ventures which delivered Beowulf starring Christopher Lambert, Swing starring Lisa Stansfield and Hugo Speer, and Denial starring Jason Alexander and directed by Adam Rifkin. In addition, the Company recognized $18,500,000 (24%) of revenues from its television slate during fiscal 1998, including revenues from the delivery and/or availability of the remaining episodes of the first-run syndication series Hammer and Mowgli: The New Adventures of The Jungle Boy, and the net earnings from the delivery by a joint venture of the remaining episodes of the ABC network series Cracker. Revenues of $4,300,000 (6%) came from deliveries of nine films in the Company's family division of direct-to-video product. In addition, the Company recognized $12,900,000 (17%) of revenues from continuing licenses of product from the Company's library to domestic cable channel operators through its majority-owned subsidiary KLC/New City, and through international sub-distributors. Revenues of $7,869,000 (10%) were recognized from delivery of people search services by the recently acquired US SEARCH.com business. Remaining revenues of approximately $6,000,000 (8%) came from the sales of contemporary Christian music on behalf of a joint venture and from other sources. Costs relating to operating revenues for fiscal 1998 increased $9,543,000 (18%). As a percentage of operating revenues, costs relating to operating revenues were 81% for fiscal 1998 compared to 95% for fiscal 1997. The decreased percentage in fiscal 1998 principally reflects a change in the product mix. This principally includes the effects in fiscal 1998 of consolidating $3,589,000 of Search costs which were substantially less than the related consolidation of $7,869,000 of Search revenues. The increase in gross profit margins was partially offset by the inclusion in fiscal 1998 of $15,265,000 of amortization expense pertaining to film titles produced by others which were previously marketed by Conquistador Entertainment that are expected to be less profitable than Company titles included in fiscal 1997 costs where the Company assumed greater risks. Selling, general and administrative expenses for fiscal 1998 increased $8,005,000 (199%). The increase in such expenses is due to inclusion of $7,431,000 of advertising and administrative expenses of US SEARCH.com (primarily $4,747,000 of advertising expenses), which was acquired in fiscal 1998. In addition, the Company's new Latin American operations, which commenced operations in the fiscal 1998 second quarter, incurred $962,000 of administrative expenses during fiscal 33 34 1998 and none in fiscal 1997. A $808,000 (62%) increase in the provision for doubtful accounts in fiscal 1998 resulted principally from a deterioration in net expected international collections. Interest expense for fiscal 1998 increased $2,234,000 (55%). The increase was principally attributable to the increased average levels of borrowing in fiscal 1998, which was not offset by increased production-related interest capitalized. Total indebtedness for borrowed money increased 13% to $84,296,000 at September 30, 1998 from $74,278,000 at September 30, 1997. The Company's effective income tax rate was 3% for fiscal year 1998 compared to an effective income tax rate of 1% for fiscal 1997. Income tax expense for fiscal 1998 consisted of minimum state income and federal alternative minimum taxes. The Company reported a net loss of ($6,336,000) ($0.69 per basic and diluted share) for fiscal 1998 as compared to a net loss of ($4,369,000) ($0.49 per basic and diluted share) for the fiscal year ended September 30, 1997. Weighted number of common shares for the compared fiscal years were 9,181,000 in 1998 and 8,959,000 in 1997. The fiscal 1998 net loss resulted primarily from consolidating US SEARCH.com operations into the Company's financial statements resulting in a net loss of ($3,284,000). In addition, the Company's film and television business experienced a change in product mix in fiscal 1998, including the release of low profit margin titles formerly distributed by Conquistador which generated $15,689,000 of revenues but only $424,000 of gross profit. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents increased 1001% to $36,434,000 (including $2,088,000 of restricted cash being used as collateral for film sale/leaseback transactions, and $2,000,000 of restricted deposits of subsidiary US SEARCH.com, and $734,000 of reserved cash to be applied against the Company's outstanding borrowings under its credit facility) at September 30, 1999 from $3,309,000 (including $1,988,000 of restricted cash and $66,000 of reserved cash) at September 30, 1998 primarily resulting from proceeds obtained from the initial public offering of US SEARCH.com. The Company's film and television program operations, and operations of US SEARCH.com are capital intensive. The June 1999 initial public offering of US SEARCH.com financed that subsidiary's capital needs. While the Company is not contractually obligated to finance US SEARCH.com, from time to time the Company may consider doing so out of its capital resources. The Company has funded its working capital requirements through receipt of third party domestic and international licensing payments as well as other operating revenues, and proceeds from debt and equity financings, and has relied upon its line of credit and transactional production loans to provide bridge production financing prior to receipt of license fees. The Company funds production and acquisition costs out of its working capital, including the line of credit, and through certain pre-sale of rights in international markets. In addition, the expansion of the Company's international distribution business, the establishment of its feature film division and its Internet and direct marketing subsidiary US SEARCH.com have significantly increased the Company's working capital requirements and use of related production loans. The amount available under the credit facility as of December 17, 1999 was $3,906,000. The Company experienced net negative cash flows of ($38,145,000) from operating activities primarily resulting from the Company's operating expenditures exceeding operating receipts at the Company and its subsidiary US SEARCH.com. This was offset by net cash of $58,324,000 provided by financing activities from production loans, greater usage of the Company's revolving line of credit, and receipt of proceeds from the US SEARCH.com initial public offering. Net unrestricted cash increased by $30,357,000 to $31,612,000 on September 30, 1999. On December 16, 1999 the Company and its subsidiaries held more than $25,000,000 in net unrestricted cash. As the Company expands production and distribution activities and increases its debt service burdens, it will continue to experience net negative cash flows from operating activities, pending receipt of licensing revenues, other revenues and sales from its library. 34 35 CREDIT FACILITY In June 1996, the Company obtained a $40,000,000 syndicated revolving credit facility with a group of banks led by The Chase Manhattan Bank N.A. ("Chase"). A September 1997 amendment increased the maximum amount of revolving credit to $60,000,000, and a December 1998 amendment increased the maximum amount of revolving credit to $75,000,000, as discussed more fully below. The agreement provides for borrowing by the Company on specified percentages of receivables and a specified amount of the Company's appraised library value for unsold or unlicensed rights. In addition, the Company may from time to time allocate a production tranche in its line of credit for the Company's productions. Such tranche will allow the Company to borrow production funding after a required Company equity participation. Loans made pursuant to such agreement are secured by substantially all of the Company's otherwise unencumbered assets and bear interest, at the Company's option, either (i) at LIBOR (6.46% as of December 17,1999) plus 3% or (ii) at the Alternate Base Rate (which is the greater of (a) Chase's Prime Rate (8.5% as of December 17, 1999), (b) Chase's Base CD Rate (6.44% as of December 17, 1999) plus 1% or (c) the Federal Funds Effective Rate (5.54% as of December 17, 1999) plus 1/2%) plus 2%. The Company pays an annual commitment fee of .5% of the unused portion of the credit line. As of December 16, 1999, the Company had drawn down $64,094,000 under the credit facility out of a total net borrowing base availability of $68,000,000. Also on that date, the Company held over $25,000,000 of unrestricted cash and over $4,000,000 of restricted cash. The credit agreement contains restrictive covenants to which the Company must adhere. These covenants include limitations on additional indebtedness, liens, investments, disposition of assets, guarantees, deficit financing, capital expenditures, affiliate transactions, the use of proceeds, and prohibit payment of cash dividends and prepayment of subordinated debt. In addition, the credit agreement requires the Company to maintain a minimum liquidity level, limits overhead expense and requires the Company to meet certain ratios. The credit agreement also contains a provision permitting the bank to declare an event of default if either of Messrs. Locke or Kushner fails to be the Chief Executive Officer of the Company or if any person or group acquires ownership or control of capital stock of the Company having voting power greater than the voting power at the time controlled by Messrs. Kushner and Locke combined (other than any institutional investor able to report its holdings on Schedule 13G which holds no more than 15% of such voting power. For fiscal 1999 the group has waived the Company's noncompliance with the annual overhead covenant. In December 1998 the banks increased the maximum amount of the Company's collateralized line of credit from $60,000,000 to $75,000,000. Existing participants in the syndicate approved the increase and are committed to lend up to $68,000,000. Additional availability is subject to adding new banks to the syndicate. As of December 16, 1999, the principal amount outstanding under this credit line was $64,094,000 and $3,906,000 remained available for borrowing. The credit facility expires in June 2000. The Company is currently in discussions with Chase regarding extending the secured revolving facility beyond its current maturity date. While the discussions are presently in an early stage and no agreement has been reached, Chase has expressed a willingness to extend the maturity date beyond fiscal 2000. See Summary below. PROCEEDS FROM SECURITIES OFFERINGS In September 1994, the Company filed a registration statement for 21,388,064 shares of common stock (now 3,564,678 shares giving effect to the fiscal 1997 1-for-6 reverse stock split) comprising the shares of common stock issuable upon conversion of the 8% Convertible Subordinated Debentures and the 9% Convertible Subordinated Debentures and certain warrants issued to underwriters. In July 1996, the Company closed a secondary public offering of an aggregate of 4,750,000 units (a "Unit"), each Unit consisting of two shares of Common Stock (now equivalent to 1,583,334 shares in the aggregate giving effect to the 1-for-6 reverse stock split) and one five year Class C Redeemable Common Stock Purchase Warrant to purchase Common Stock at an adjusted exercise price of $6.8625 per share. The Company received net proceeds in the amount of $9,203,000. In connection with such offering, the Company issued warrants to purchase up to an aggregate of 475,000 Units (prior to the reverse split) at an adjusted rate of $18.00 per Unit to the underwriter thereof and a consultant. 35 36 In December 1998 the Company obtained net proceeds of $5,673,000 ($6,000,000 of gross proceeds) through a private placement of 1,200,000 newly-issued shares of common stock. In February 1999 the Company filed a registration statement for such shares. On April 26, 1999 the Company issued 468,883 shares of restricted common stock to The Harvey Entertainment Company ("Harvey") in exchange for 55,000 shares of Series A Preferred Stock of Harvey and 388,215 warrants exerciseable into common stock of Harvey, all pursuant to a stock purchase agreement involving a new Harvey investor group which includes the Company. The Harvey Series A Preferred Stock are convertible into 814,814 shares of Harvey common stock commencing October 26, 1999 and require payment of quarterly dividends in cash or in additional shares of Harvey Series A Preferred Stock at a 7% annual rate. The Company holds certain demand and piggyback registration rights relating to its Harvey securities. On a fully-diluted basis, assuming all securities exerciseable or convertible into Harvey common stock are so exercised or converted, the Company would own 12% of the voting shares of Harvey. In June 1999 the Company filed a registration statement for the shares of its restricted common stock issued to Harvey. Effective May 14, 1999 the Company called for redemption of all of its Class C Redeemable Common Stock Purchase Warrants (the "Class C Warrants") and its outstanding 10% Convertible Subordinated Debentures, Series A due 2000. In advance of the redemption, a total of 794,215 Class C Warrants were exercised for 794,215 shares of Common Stock and the Company received proceeds of $5,419,000. In advance of the redemption, the Company issued 6,435 new shares of common stock for the conversion of $49,000 aggregate principal amount of the Series A Debentures. The Company redeemed $28,000 aggregate principal amount of the Series A Debentures. On June 25, 1999, the Company's subsidiary US SEARCH.com consummated an initial public offering of newly-issued common stock. The subsidiary sold 4,500,000 newly-issued shares and obtained $36,263,000 of net proceeds. Also on June 25, 1999 the Company sold 1,500,000 shares out of its holdings of US SEARCH.com common stock and obtained $12,555,000 of net proceeds. The Company retains a 55.2% interest in the subsidiary and continues to consolidate the subsidiary in the accompanying financial statements. The Company recognized a $13,148,000 pre-tax gain on the sale of the 1,500,000 shares and a $21,018152,000 gain on the increased value of its proportion of the net equity of the subsidiary. PRODUCTION LOANS The Company's production loans, totaling $16,272,000 as of September 30, 1999, consisted of production loans by Comerica Bank - California ("Comerica") and Far East National Bank ("Far East") to consolidated production entities, and loans to the Company's 55.2%-owned subsidiary, US SEARCH.com. The Company provided limited corporate guarantees for portions of the production loans which are callable in the event that the respective borrower does not repay the loans by the respective maturity date. In general these loans are non-recourse to the Company except to the extent of the guaranties. However, the Company occasionally advances funds to the lenders in advance of receipts from customers. Deposits paid by the distributing licensees prior to the delivery of the financed pictures are held as restricted cash collateral by the Lenders The table below shows production loans as of September 30, 1999: 36 37
KUSHNER- LOCKE ORIGINAL AMOUNT WEIGHTED CORPORATE PRESENT FILM OR COMPANY LENDER LOAN AMOUNT OUTSTANDING INTEREST GUARANTY MATURITY - ----------------------------------------------------------------------------------------------------------------------------------- Susan's Plan Comerica $ 4,625,000 $ 2,529,000 Prime + 1% $ 600,000 6/30/2000 Ringmaster Comerica 4,200,000 1,099,000 Prime + 1% 800,000 12/31/1999 Mambo Cafe Far East 1,400,000 743,000 Prime + 1.5% -- 4/30/2000 Picking Up The Comerica 12,000,000 10,544,000 Prime + 1% 700,000 3/31/2000 Pieces The Last Producer Far East 1,626,000 1,285,000 Prime + 1% 6/30/2000 Conquistador Comerica (1) 72,000 -- ------------------- ---------------- ----------------- $23,851,000 $16,272,000 $2,100,000 =================== ================ =================
- ------------- (1) assumed from former employee. In February 1997, a $6,300,000 production loan was obtained by a consolidated subsidiary from Banque Paribas (Los Angeles Agency) to cover a portion of the production budget of Basil. In June 1999 the $229,000 remaining balance of the loan was repaid. In November 1997, an $8,200,000 production loan was obtained from Comerica by an unconsolidated company 25%-owned by the Company to cover a portion of the production budget of Beowulf. The loan bears interest at Prime (8.5 % as of December 17, 1999) plus 1% or at LIBOR (6.46% as of December 17, 1999) plus 2%. The Company has provided a corporate guaranty in the reduced amount of $500,000 in connection with this loan. The loan is collateralized by the rights, title and assets related to the film. As extended, the loan matures on December 31, 1999. In April 1998, a $4,625,000 production loan was obtained by a consolidated subsidiary from Comerica to cover the production budget of Susan's Plan. The loan bears interest at Prime (8.5 % as of December 17, 1999) plus 1% or at LIBOR (6.46% as of December 17, 1999) plus 2%. The loan is collateralized by the rights, title and assets related to the film. The Company provided a corporate guaranty in the amount of $600,000 in connection with this loan. As extended, the loan matures on June 30, 2000. In April 1998, a $1,850,000 production loan was obtained by a consolidated subsidiary from Comerica to cover the production budget of Black and White. In July 1999 the $379,000 remaining balance of the loan was repaid. In August 1998, a $2,900,000 production loan was obtained by a consolidated subsidiary from Comerica to cover the production budget of Ringmaster. In November 1998, the loan amount was increased to $4,200,000. The loan bears interest at Prime (8.5 % as of December 17, 1999) plus 1% or at LIBOR (6.46% as of December 17 , 1999) plus 2%. The loan is collateralized by the rights, title and assets related to the film. The Company provided a corporate guaranty in the amount of $800,000 in connection with this loan. As extended, the loan matures on December 31, 1999. In October 1998, a $1,400,000 production loan was obtained by a consolidated subsidiary from Far East to cover the production budget of Mambo Cafe. The loan bears interest at Prime (8.5 % as of December 17, 1999) plus 1.5%. The loan is collateralized by the rights, title and assets related to the film. As extended, the loan matures on April 30, 2000. In October 1998, a $2,500,000 production loan was obtained by an unconsolidated company from Far East to cover the production budget of Freeway II: Confessions of a Trickbaby. The loan bears interest at Prime (8.5 % as of December 17, 1999) plus 1.5%. The loan is collateralized by the rights, title and assets related to the film. The Company provided a corporate guaranty in the amount of $400,000 in connection with this loan. As extended, the loan matures on April 30, 2000. In April 1999 a $12,000,000 loan was obtained by a consolidated subsidiary from Comerica to cover the production budget of Picking Up The Pieces. The loan bears interest at Prime (8.5 % at December 17, 1999) plus 1% or at LIBOR (6.46% at December 17, 1999) plus 2%. The loan is collateralized by the rights, title and assets related to the film. The Company provided a corporate guaranty in the amount of $700,000 in connection with this loan. The loan matures on March 31, 2000. 37 38 \ In June 1999, a $1,626,000 production loan was obtained by a consolidated subsidiary from Far East to cover a portion of the production budget of The Last Producer. The loan bears interest at Prime (8.5 % as of December 17, 1999) plus 1%. The loan is collateralized by the rights, title and assets related to the film. The loan matures on June 30, 2000. In February 1998, US SEARCH.com obtained a collateralized line of credit from Comerica. Advances under the line bore interest at Prime plus 2.50% payable monthly. In August 1998 the bank and the Company agreed that the loan would be capped at the $345,000 amount outstanding as of that date. In December 1998 Comerica extended the loan's maturity date from November 1998 to March 1999. In March 1999, US SEARCH.com repaid the loan. In May 1998, a Canadian dollar 5,100,000 production loan was obtained from a Canadian financial institution, by a formerly consolidated subsidiary to cover a portion of the production budgets of six direct-to-video feature films. The loan bears interest at the Canadian Prime Rate plus 2%. The loan is collateralized by the rights, title and assets related to the films. The Company agreed to pay $550,000 to the former subsidiary borrower upon delivery of each of the films for the acquisition of distribution rights. The Company deconsolidated the subsidiary in March 1999. The Company made all $550,000 payments to the former subsidiary borrower. CAPITAL EXPENDITURE COMMITMENTS Management expects to finance future production, broadcast and distribution arrangements through a combination of production loans and credit facility borrowings. No assurance can be given that such financing will be available when and if needed. Management believes the Company will comply with the restrictive covenants of the Chase agreement and accordingly the credit facility will be available through June 2000, the current maturity date. The Company is currently in negotiations to extend the secured revolving facility beyond June 2000. Chase has expressed a willingness to extend the facility, however no agreement has been executed. US SEARCH.com has several cancelable and noncancelable agreements with various Internet companies. At September 30, 1999, the minimum noncancelable payments required under these agreements are approximately $2,555,000, $3,300,000, $4,200,000 and $4,200,000 for 2000, 2001, 2002 and 2003, respectively. The Company expects US SEARCH.com to increase its Internet and television advertising of US SEARCH.com's services. As a result, US SEARCH.com's net losses may continue to increase. Such losses would adversely impact the Company's consolidated results of operations, however the Company is not obligated to fund any US SEARCH.com operating cash flow deficiencies. SUMMARY The Company from time to time evaluates strategic alternatives for enhancing liquidity in its core and non-core businesses. To pursue strategic alternatives, the Company has engaged Prudential Securities. In addition the Company will continue its advisory agreement with Allen & Company Incorporated. Strategic alternatives include but are not limited to, the pursuit of opportunities to enhance the exploitation of the Company's library properties, its distribution system, and its satellite channel. This approach may include consolidations with, acquisition of or strategic partnering with companies in our core businesses or in businesses complementary to our core businesses. In addition to expanding production and its distribution business, whether internally or by acquisition, the Company also considers acquisition possibilities from time to time, including film libraries and companies which may or may not be ancillary to the Company's existing business, subject to the availability of financing as necessary. There can be no assurances that any of these transactions will occur. Many of these 38 39 alternatives might require a change in the capital structure or equity or debt financing. There is no assurance that financing sources will be available or, if available, will be available on commercially acceptable terms. Management believes that existing resources and cash generated from operating activities, together with amounts anticipated to be available under the syndicated revolving credit agreement with Chase will be sufficient to meet the Company's working capital requirements for at least the next twelve months The Company is currently in negotiations to extend the secured revolving facility beyond its current maturity date, however no agreement has been executed. Chase has expressed a willingness to extend the facility, however there can be no assurance that an extension of the maturity date will be obtained or, if obtained, will continue the credit facility on its present terms. If not extended, all amounts outstanding under the credit facility at June 30, 2000 will become due and payable on that date. The Company would then be required to obtain additional capital from other sources to satisfy such obligations. The inability to obtain such resources on commercially acceptable terms would have a material adverse effect on the Company's cash flow, the scope of strategic alternatives available to the Company and its operations. The Company may seek other sources of financing to meet its working capital requirements, including a separate equity financing for US SEARCH.com or other possible sources of financing. The Company from time to time seeks additional financing through the issuance of new debt or equity securities, additional bank financings, or other means available to the Company to increase its working capital. The Company may not obtain additional financing on terms satisfactory to the Company or at all. International operations are a significant portion of total operations. Therefore the Company is exposed to risks of currency translation losses, cash collection and repatriation risks and risks of adverse political, regulatory and economic changes. The Company's business and operations have not been materially affected by inflation. Management believes that the Company's film and television sales volumes are not subject to significant fluctuations based upon seasonality, however search services have generally declined during holiday periods. YEAR 2000 ("Y2K") ISSUES The "Year 2000 Issue" is typically the result of certain firmware limitations and of limitations of certain software written using two digits rather than four to define the applicable year. If software and firmware with date-sensitive functions are not Year 2000 compliant, they may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, interruptions in customer service operations, a temporary inability to process transactions, conduct searches, or engage in similar normal business activities. Corporate operations and film and television segment. The Company has upgraded or replaced virtually all firmware in part to mitigate Year 2000 exposure. The Company utilizes off-the-shelf and custom software developed internally and by third parties. The Company believes that its off-the-shelf software is Year 2000 compliant. However, there is no assurance that the Company will not be required to modify or replace significant portions of its software so that its systems will function properly with respect to dates in the year 2000 and thereafter. The Company has completed a Year 2000 evaluation including Information Technology ("IT") systems, non-IT systems, and critical third-party entities with which the Company transacts business. If required modifications to existing software and firmware or conversions to new software or firmware are not made, or are not completed timely, or if there is a malfunction in software or firmware used on computer systems utilized by those upon whom the Company depends for provision of its services, there is no assurance that potential systems interruptions or the cost necessary to update such software or firmware or any outages or delays in services will not have a material adverse effect on the Company's business, financial condition, results of operations and prospects. Further, the failure of the Company to successfully resolve such issues could result in a shut-down of some or a substantial portion of the corporate or film and television operations, which could have a material adverse effect on the business, financial condition, results of operations and prospects of the Company. 39 40 US SEARCH.com. The Year 2000 Issue could result in a system failure or miscalculations causing significant disruption of operations, including, among other things, interruptions in Internet traffic, accessibility of the Web site, delivery of service, transaction processing or searching and other features of US SEARCH.com services. It is possible that this disruption will continue for an extended period of time. US SEARCH.com depends on information contained primarily in electronic format in databases and computer systems maintained by third parties, including governmental agencies. The disruption of third-party systems or its systems interacting with these third-party systems could prevent US SEARCH.com from receiving orders or delivering search results in a timely manner. In addition, US SEARCH.com relies on the integration of many systems in aggregating search data from multiple sources. The failure of any of those systems as a result of Year 2000 compliance issues could prevent it from delivering products and services. Failure of its systems or third-party systems providing information used in our services could materially adversely affect US SEARCH.com's business and results of operations. Management has received information confirming the Year 2000 compliance from present data suppliers. Management has also confirmed Year 2000 compliance with key third party vendors. US SEARCH.com has conducted an evaluation of internal systems. The objective was to ensure uninterrupted transition into the Year 2000. The scope of the Year 2000 objective included: (1) information technology ("IT") such as software and hardware, (2) non-IT systems such as components contained in various safety systems, facilities and utilities, and (3) readiness of key third parties, including suppliers and customers. US SEARCH.com has obtained written confirmation of the Year 2000 status of its third party software. US SEARCH.com has utilized internal resources to test internally developed software for Year 2000 compliance. USEARCH.com has modified or replaced certain portions of its software so that its systems will function properly with respect to dates in the year 2000 and thereafter. If there is a malfunction in its systems, potential systems interruptions or delays in services may have a material adverse effect on US SEARCH.com's business, financial condition and results of operations. Further, if management fails to successfully resolve these issues, some or all of US SEARCH.com's operations may shut-down, which would have a material adverse effect on its business, financial condition and results of operations. US SEARCH.com has a process in place to assess the Year 2000 readiness of its business critical vendors and customers, and has worked with these vendors and customers on Year 2000 compliance issues. Disruptions with respect to computer systems of vendors or customers, whose systems are outside US SEARCH.com's control, could impair its ability to provide support to customers, and could have a material adverse effect on its financial condition and results of operations. Overall. Management has developed contingency plans to be implemented as part of its efforts to identify and correct Year 2000 problems with internal and Web-based systems. Within the plans, management addresses various problems, including disruptions to Web-servers, significant interruption of data flow between the Company and third party data providers, and failures associated with internal systems. The contingency plans emphasize the identification and accessibility of additional data sources for US SEARCH.com services. There is no assurance that the contingency plans will adequately address all Year 2000 issues. US SEARCH.com has incorporated the utilization of (1) additional data sources, (2) manual procedures for order processing and delivery of search results (3) standby equipment and accelerated availability of replacement parts, and (4) increased staffing levels for resolution of information technology issues and to manually process orders. Failure to implement any of these plans, if and when necessary, may have a material adverse effect on US SEARCH.com's business and results of operations. Finally, the Company is also vulnerable to external forces that might generally affect industry and commerce, such as utility or transportation company or Internet Year 2000 compliance failures and related service interruptions. Any significant interruption of general access to the Internet, or the customary function and operations of, the Internet could have a material adverse effect on the Company's business, financial condition, results of operations and prospects. Some commentators have predicted significant litigation regarding Year 2000 compliance issues. Because of the unprecedented nature of such litigation, it is uncertain whether or to what extent the Company may be affected by it. The Company currently believes that this issue will not pose significant operational problems for its corporate or film and television operations, however delays in the modification or conversion of its or US SEARCH.com's systems, or those of vendors and suppliers of services to the Company and US SEARCH.com, or the failure to fully identify all Year 2000 40 41 dependencies in the systems could have a material adverse effect on the Company's business, financial condition, results of operations and prospects. The Company cannot quantify the impact of the Year 2000 Issue; however, failure of critical internal IT systems, non-IT systems, third-party vendors and financial institutions may limit or prevent the Company from performing services for its customers, and could have a material adverse effect on the Company's business, financial condition, results of operations and prospects. We estimate that the total cost of implementing and maintaining our Year 2000 compliance program will not exceed $200,000 and most of these costs have been incurred to date. This estimate includes implementation of redundant hardware, software and communications systems. 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data required by Item 8 are set forth in the pages indicated in Item 14. 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On October 20, 1998, the Company changed its independent public accountants. This change (and the response of the Company's former independent public accountants) is described in the Company's Current Report on Form 8-K filed on October 27, 1998, which is incorporated by reference herein. This Annual Report contains an independent auditor's report issued by the Company's former independent public accountants. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT The information called for in Item 10 of Part III shall be filed not later than 120 days after the Company's fiscal year end (September 30, 1999) in the Company's definitive Proxy Statement in connection with its 1999 Annual Meeting of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or in an amendment to this Annual Report of Form 10-K. ITEM 11. EXECUTIVE COMPENSATION The information called for in Item 11 of Part III shall be filed not later than 120 days after the Company's fiscal year end (September 30, 1999) in the Company's definitive Proxy Statement in connection with its 1999 Annual Meeting of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or in an amendment to this Annual Report of Form 10-K. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information called for in Item 12 of Part III shall be filed not later than 120 days after the Company's fiscal year end (September 30, 1999) in the Company's definitive Proxy Statement in connection with its 1999 Annual Meeting of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or in an amendment to this Annual Report of Form 10-K. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information called for in Item 13 of Part III shall be filed not later than 120 days after the Company's fiscal year end (September 30, 1999) in the Company's definitive Proxy Statement in connection with its 1999 Annual Meeting of Stockholders pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, or in an amendment to this Annual Report of Form 10-K. 41 42 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
PAGE (a) Financial Statements: (1) Report of Independent Accountants....................................................................... 43 Independent Auditors' Report............................................................................ 44 Consolidated Balance Sheets at September 30, 1999 and 1998.............................................. 45 Consolidated Statements of Operations for the years ended September 30, 1999, 1998 and 1997............. 46 Consolidated Statements of Stockholders' Equity for the years ended September 30, 1999, 1998, and 1997.. 47 Consolidated Statements of Cash Flows for the years ended September 30, 1999, 1998, and 1997............ 48 Notes to Consolidated Financial Statements.............................................................. 49 (2) Financial Statement Schedule Schedule II for the years ended September 30, 1999, 1998, and 1997...................................... 69 All other schedules are inapplicable and, therefore, have been omitted. (3) Exhibits Exhibits filed as part of this report are listed in the Exhibit Index, which follows the Signatures..... 72 (b) Report on Form 8-K: None
42 43 REPORT OF INDEPENDENT ACCOUNTANTS The Board of Directors and Stockholders of The Kushner-Locke Company: In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of cash flows and of stockholders' equity present fairly, in all material respects, the financial position of The Kushner-Locke Company (the "Company") and its subsidiaries at September 30, 1999 and 1998, and the results of their operations and their cash flows for each of the two years in the period ended September 30, 1999, in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein for the years ended September 30, 1999 and 1998 when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audits 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, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Century City, California December 21, 1999 43 44 INDEPENDENT AUDITORS' REPORT The Board of Directors The Kushner-Locke Company: We have audited the accompanying consolidated statements of operations, cash flows and stockholders' equity of The Kushner-Locke Company and subsidiaries for the year ended September 30, 1997. In connection with our audit of the consolidated financial statements, we have also audited the accompanying financial statement schedule for the year ended September 30, 1997. These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits. We conducted our audit 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 audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of The Kushner-Locke Company and subsidiaries for the year ended September 30, 1997, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule for the year ended September 30, 1997, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG LLP Los Angeles, California December 26, 1997 44 45 THE KUSHNER-LOCKE COMPANY CONSOLIDATED BALANCE SHEETS
September 30, -------------------------------- 1999 1998 ------------ ------------ ASSETS Assets: Cash and cash equivalents............................................................... $ 31,612,000 $ 1,255,000 Reserved cash........................................................................... 734,000 66,000 Restricted cash......................................................................... 4,088,000 1,988,000 Accounts receivable, net of allowance for doubtful accounts of $3,248,000 in 1999 and $2,509,000 in 1998.............................................................. 30,030,000 40,418,000 Due from related party.................................................................. 2,611,000 2,719,000 Film and television program costs, net of accumulated amortization...................... 91,499,000 73,773,000 Investments in unconsolidated entities, at equity....................................... 12,045,000 10,798,000 Other assets............................................................................ 12,496,000 6,088,000 ------------ ------------ Total assets......................................................................... $185,115,000 $137,105,000 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Accounts payable and accrued liabilities................................................ $ 11,104,000 $ 6,031,000 Due to related party.................................................................... 233,000 -- Notes payable........................................................................... 82,925,000 73,151,000 Deferred revenue........................................................................ 3,628,000 4,111,000 Contractual obligations................................................................. 11,039,000 13,851,000 Production advances..................................................................... 1,592,000 2,969,000 Convertible subordinated debentures, net of deferred issuance costs..................... 2,269,000 11,526,000 ------------ ------------ Total liabilities.................................................................... 112,790,000 111,639,000 Minority interest 11,580,000 -- Commitments and contingencies (Note 8) Stockholders' equity: Common stock, no par value. Authorized 50,000,000 shares: issued and outstanding 13,810,767 shares at September 30, 1999 and 9,217,029 shares at September 30, 1998................................................................... 70,379,000 39,571,000 Accumulated deficit.................................................................... (9,634,000) (14,105,000) ------------ ------------ Net stockholders' equity.......................................................... 60,745,000 25,466,000 ------------ ------------ Total liabilities and stockholders' equity....................................... $185,115,000 $137,105,000 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 45 46 THE KUSHNER-LOCKE COMPANY CONSOLIDATED STATEMENTS OF OPERATIONS
Year Ended September 30, --------------------------------------------------------- 1999 1998 1997 ------------------ ----------------- ----------------- Operating revenues: Film and television program licensing.......................... $34,143,000 $68,261,000 $54,746,000 Search and individual reference services....................... 15,747,000 7,869,000 -- ----------- ----------- ----------- Total operating revenues................................... 49,890,000 76,130,000 54,746,000 ----------- ----------- ----------- Costs related to operating revenues: Film and television program licensing.......................... (33,226,000) (58,038,000) (52,084,000) Search and individual reference services....................... (6,440,000) (3,589,000) -- ----------- ----------- ----------- Total costs related to operating revenues................. (39,666,000) (61,627,000) (52,084,000) ----------- ----------- ----------- Gross profit............................................... 10,224,000 14,503,000 2,662,000 Selling, general and administrative expenses........................ (31,186,000) (12,028,000) (4,023,000) Provision for doubtful accounts..................................... (2,959,000) (2,118,000) (1,310,000) ----------- ----------- ----------- (Losses) earnings from operations.......................... (23,921,000) 357,000 (2,671,000) Equity in net (losses) earnings of unconsolidated entities......... (520,000) (330,000) 2,189,000 Dividend income................................................. 167,000 -- -- Interest income..................................................... 520,000 79,000 163,000 Interest expense.................................................... (7,782,000) (6,261,000) (4,027,000) Gain on sale of interest in subsidiary.............................. 13,148,000 -- -- Gain on issuance of stock by subsidiary............................. 21,018,000 -- -- ----------- ----------- ----------- Earnings (loss) before minority interest and income taxes.. 2,630,000 (6,155,000) (4,346,000) Minority interest in subsidiary net losses.......................... 2,567,000 -- -- ----------- ----------- ----------- Earnings (loss) before income taxes........................ 5,197,000 (6,155,000) (4,346,000) Income tax expense.................................................. (726,000) (181,000) (23,000) ----------- ----------- ----------- Net earnings (loss)....................................... $ 4,471,000 $(6,336,000) $(4,369,000) =========== =========== =========== Basic earnings (loss) per share................................. $.38 $(.69) $(.49) =========== =========== =========== Diluted earnings (loss) per share............................... $.36 $(.69) $(.49) =========== =========== =========== Weighted average common shares outstanding.......................... 11,755,000 9,181,000 8,959,000 =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 46 47 THE KUSHNER-LOCKE COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Net ------------------------------- Accumulated Stockholders' Shares Amount Deficit Equity ---------- ----------- ----------- ----------- Balance at September 30, 1996......... 8,777,541 $37,650,000 $(3,400,000) $34,250,000 Issuance of common stock.................... 227,500 598,000 -- 598,000 Conversion of subordinated debentures....... 84,562 613,000 -- 613,000 Other 477 44,000 -- 44,000 Net loss.................................... -- -- (4,369,000) (4,369,000) ---------- ----------- ----------- ----------- Balance at September 30, 1997......... 9,090,080 38,905,000 (7,769,000) 31,136,000 Stock options exercised..................... 9,000 34,000 -- 34,000 Conversion of subordinated debentures....... 51,282 284,000 -- 284,000 Issuance of stock grants.................... 66,667 16,000 -- 16,000 Compensatory warrant grants................. -- 332,000 -- 332,000 Net loss.................................... -- -- (6,336,000) (6,336,000) ---------- ----------- ----------- ----------- Balance at September 30, 1998......... 9,217,029 39,571,000 (14,105,000) 25,466,000 Private placement........................... 1,200,000 5,456,000 -- 5,456,000 Investment in The Harvey Entertainment Company.............................. 468,883 5,820,000 -- 5,820,000 Exercises of warrants....................... 1,219,361 8,122,000 -- 8,122,000 Stock options exercised..................... 317,309 857,000 -- 857,000 Issuance of stock grants.................... 100,000 488,000 -- 488,000 Conversion of subordinated debentures....... 1,288,185 9,336,000 -- 9,336,000 Compensatory option and warrant grants...... -- 729,000 -- 729,000 Net earnings................................ -- -- 4,471,000 4,471,000 ---------- ----------- ----------- ----------- Balance at September 30, 1999......... 13,810,767 $70,379,000 $(9,634,000) $60,745,000 ========== =========== =========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 47 48 THE KUSHNER-LOCKE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended September 30, -------------------------------------------------------- 1999 1998 1997 ------------------ ----------------- ---------------- Cash flows from operating activities: Net earnings (loss).................................................. $ 4,471,000 $(6,336,000) $(4,369,000) Adjustments to reconcile net earnings (loss) to net cash Used by operating activities: Minority interest................................................ (2,567,000) -- -- Gain on issuance of stock by subsidiary.......................... (21,018,000) -- -- Gain on sale of interest in subsidiary........................... (13,148,000) -- -- Dividend income.................................................. (167,000) -- -- Equity in net losses (earnings) of unconsolidated entities....... 520,000 330,000 (2,189,000) Depreciation and amortization.................................... 435,000 530,000 192,000 Provisions and allowances........................................ 2,959,000 2,118,000 1,310,000 Amortization of capitalized issuance costs....................... 123,000 213,000 969,000 Issuance of stock grants......................................... 488,000 16,000 -- Compensatory options and warrants................................ 729,000 332,000 -- Amortization of film costs....................................... 32,354,000 53,916,000 50,835,000 Changes in assets and liabilities: Reserved cash.................................................... (668,000) (379,000) (1,190,000) Restricted cash.................................................. (2,100,000) 39,000 4,021,000 Accounts receivable.............................................. 7,413,000 (14,755,000) (6,121,000) Due from related party........................................... 84,000 (1,708,000) 767,000 Film and television program costs................................ (51,890,000) (59,182,000) (60,879,000) Other assets..................................................... 2,704,000 (130,000) -- Accounts payable and accrued liabilities......................... 5,303,000 1,608,000 (342,000) Due to related party............................................. 502,000 -- -- Deferred revenue (483,000) 749,000 (98,000) Contractual obligations.......................................... (2,812,000) 6,901,000 2,643,000 Production advances.............................................. (1,377,000) (3,533,000) 4,369,000 ------------------ ----------------- ---------------- Net cash used by operating activities (38,145,000) (19,271,000) (10,082,000) ------------------ ----------------- ---------------- Cash flows from investing activities: Proceeds from sale of interest in subsidiary, net................ 12,555,000 -- -- Investments in unconsolidated entities............................ (1,767,000) (3,993,000) (3,432,000) Purchases of property, plant and equipment........................ (610,000) (786,000) (157,000) ------------------ ----------------- ---------------- Net cash provided (used) by investing activities 10,178,000 (4,779,000) (3,589,000) ------------------ ----------------- ---------------- Cash flows from financing activities: Borrowings under notes payable.................................... 43,626,000 42,094,000 54,716,000 Repayment of notes payable........................................ (35,802,000) (31,864,000) (33,550,000) Proceeds from subsidiary's issuance of common stock............... 36,109,000 -- -- Proceeds from issuance of common stock............................ 5,456,000 -- -- Proceeds from exercise of warrants and stock options.............. 8,979,000 34,000 -- Repayment of debentures........................................... (44,000) (36,000) -- Other............................................................. -- -- 491,000 ------------------ ----------------- ---------------- Net cash provided by financing activities 58,324,000 10,228,000 21,657,000 ------------------ ----------------- ---------------- Net increase (decrease) in cash and cash equivalents................. 30,357,000 (13,822,000) 7,986,000 Cash and cash equivalents at beginning of year....................... 1,255,000 15,077,000 7,091,000 ------------------ ----------------- ---------------- Cash and cash equivalents at end of year............................. $31,612,000 $ 1,255,000 $15,077,000 ================== ================= ================
The accompanying notes are an integral part of these consolidated financial statements. 48 49 THE KUSHNER-LOCKE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) Summary of Significant Accounting Policies The Company The Kushner-Locke Company (the "Company") is a leading independent entertainment company which principally develops, produces, and distributes original feature films and television programming. Feature films are developed and produced principally for the theatrical, video and pay cable motion picture markets. Television programming includes television series, mini-series, movies for television, animation, reality and game show programming. The Company established feature film production operations in 1993. In 1994, an international theatrical film subsidiary was established to expand into foreign theatrical distribution. In 1995, the Company formed KLC/New City Tele-Ventures ("KLC/New City") to acquire films for distribution through other delivery systems, including pay cable, pay-per-view, basic cable, video-on-demand and satellite systems. In 1997, the Company acquired control of US SEARCH.com Inc. ("US SEARCH.com"), a leading provider of fee-based public record search and other customized individual reference services. In November 1998 the Company launched a 24 hour Spanish language movie channel called Gran Canal Latino. Fiscal Year The Company's fiscal year ends on September 30. US SEARCH.com has a December 31 fiscal year end, however its financial position and results are consolidated herein from October 1 through September 30 of each year. All references to years herein refer to the Company's fiscal year end. Basis of Presentation The accompanying consolidated financial statements include the accounts of the Company and all majority-owned subsidiaries. Entities in which the Company holds a 20% to 50% interest are not consolidated, but are accounted for under the equity method. Entities in which the Company holds less than a 20% interest are accounted for under the cost method and included in other assets. All significant intercompany balances and transactions have been eliminated. In 1995, the Company formed the 82.5%-owned subsidiary KLC/New City. Since establishment, the Company has consolidated 100% of the net losses of that subsidiary. In November 1997, the Company acquired 80% of US SEARCH.com and commenced consolidation of its accounts. US SEARCH.com has incurred net losses since acquisition and the Company funded 100% of such losses through its initial public offering (Note 2). The Company recognized 100% of the net losses through June 30, 1999. Subsequent to the public offering, the Company has recognized a minority interest in the net losses and equity of US SEARCH.com proportionate to the 44.8% minority ownership percentage. In November 1997, the Company established KL/Phoenix, an 80%-owned joint venture for Latin American distribution of film and television programs. In November 1998, the Company established Gran Canal Latino, an 80%-owned joint venture for satellite broadcasting of Spanish and Portuguese language film and television programs. Since establishment, the Company has consolidated 100% of these ventures' net losses. Reclassifications Certain reclassifications have been made to conform prior year balances with the current presentation. 49 50 Revenue Recognition Revenues from feature film and television program distribution licensing agreements are recognized on the date the completed film or program is delivered or becomes available for delivery, is available for exploitation in the relevant media window purchased by that customer or licensee and certain other conditions of sale have been met pursuant to criteria specified by SFAS No. 53, Financial Reporting By Producers and Distributors of Motion Picture Films. Revenues from barter transactions, whereby the program is exchanged for television advertising time which is sold to product sponsors, are recognized when the television program has aired and all conditions precedent have been satisfied. The revenue cycle generally extends 7 to 10 years on film and television products. Producer fees received from production of films and television programs for outside parties where the Company has no continuing ownership interest in the project are recognized on a percentage-of-completion basis as determined by applying the cost-to-cost method. The cost of such films and television series is expensed as incurred. US SEARCH.com generates revenues by performing various information search services for customers. Revenue is recognized when the results of the search services are delivered to clients. The terms of each sale do not provide for client refunds after search services have been delivered, however, in certain instances, where the clients indicate that the initial search is unsuccessful, US SEARCH.com may perform, at no charge to the client, up to three identical searches during the one year period following their first search. The costs related to such additional searches are recorded in the period of the initial sale and are based upon the estimated number of additional searches. In addition, where clients request to broaden the scope of their fully automated searches, US SEARCH.com may apply up to a portion of the cost of the client's fully automated searches towards the cost of the broader and more extensive searches. The estimated credits are recorded in the period of the initial sale and are based upon the amount estimated to be redeemed by clients. To date, the costs of additional searches and estimated credits to be provided in future periods have not been material. Advertising Costs US SEARCH.com's advertising production costs are expensed the first time the advertisement is run. Media costs are expensed in the month the advertising appears. Advertising expense related to US SEARCH.com for fiscal 1999 and 1998 was $15,592,000 and $5,200,000, respectively. Concentration of Risk Financial instruments which subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and trade accounts receivable. Cash and cash equivalents are deposited throughout the world with high credit quality financial institutions. The Company's customers are located throughout the world. For certain revenue streams, the Company does not require guarantee of payment and establishes an allowance for doubtful accounts based upon historical trends and other information. To date, such losses have been within management's expectations. Cash and Cash Equivalents The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Restricted and Reserved Cash At September 30, 1999 and 1998, the Company had $ 2,088,000 and $1,988,000, respectively, in restricted cash related to deposits held at a British bank pursuant to film sale/leaseback transactions, and $2,000,000 which are restricted deposits of US SEARCH.com pledged as collateral on an outstanding letter of credit related to a recent lease of a facility. In addition, the Company has $734,000 in cash collected and reserved for use by Chase Manhattan Bank to be applied against the Company's outstanding borrowings under the terms of the Company's credit facility ($66,000 at September 30, 1998). 50 51 Allowances for Doubtful Accounts The Company provides for doubtful accounts based on historical collection experience and periodically adjusts the allowance based on the aging of accounts receivable and other conditions. Receivables are written off against the allowance in the period they are deemed uncollectible. Accounting for Film and Television Program Costs The Company capitalizes direct costs incurred to produce a film or television project. The costs include interest expense funded under production loans, certain exploitation costs and production overhead. Capitalized exploitation or distribution costs include prints and advertising that is expected to benefit the film in future markets. These costs, including management's estimates of anticipated total costs, are amortized each period on an individual film or television program basis in the ratio that the current period's gross revenues from all sources for the program bear to management's estimate of anticipated total gross revenues for such film or program from all sources. Revenue estimates are reviewed quarterly and adjusted where appropriate. Film and television program costs are stated at the lower of unamortized cost or estimated net realizable value. Losses are charged to operations through additional amortization. Investments in Equity Securities - Cost Method In April 1999, the Company issued 468,883 shares of common stock with a value of $5,820,000 to The Harvey Entertainment Company ("Harvey") in exchange for convertible preferred stock and detachable warrants. The investment is not subject to Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities," as the Harvey preferred stock is not publicly traded. The preferred stock is convertible into publicly traded common shares of Harvey and earns mandatory dividends payable in cash or additional shares of Harvey preferred stock. As of September 30, 1999 the Company earned approximately $167,000 of dividends in the form of additional Harvey preferred shares. The detachable warrants are convertible into Harvey common stock and were fully exercisable at issuance. At September 30, 1999, the Company has warrants exercisable into 388,235 shares of Harvey common stock. The warrants begin to expire in 2005. Property and Equipment Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method based upon the estimated useful lives of the assets. Leasehold improvements and equipment under capital leases are amortized over the shorter of the estimated useful life or the life of the lease. Depreciation and amortization periods by asset category are as follows: Equipment................................3 - 10 years Furniture and fixtures...................5 - 7 years Leasehold improvements...................Shorter of useful life or lease term Equipment under capital lease............Shorter of useful life or lease term Maintenance and repairs are charged to expense as incurred while renewals and improvements are capitalized. Upon the sale or retirement of property and equipment, the accounts are relieved of the cost and the related accumulated depreciation, with any resulting gain or loss included in the Statement of Operations. 51 52 Long-Lived Assets The carrying value of long-lived assets, consisting primarily of investments and property and equipment, is periodically reviewed by management. The Company records impairment losses on long-lived assets when events or circumstances indicate that such assets might be impaired. Measurement of any impairment would include a comparison of estimated future cash flows anticipated to be generated during the remaining life of the long-lived asset to the net carrying value of the long-lived asset. Participants' Share Payable and Talent Residuals The Company charges profit participation and talent residual costs to expense in the same manner as amortization of film and television program costs. Payments for profit participations are made in accordance with the participants' contractual agreements. Payments for talent residuals are remitted to the respective guilds in accordance with the provisions of their union agreements. Production Advances The Company receives license fees for projects in the production phase. Production advances are generally nonrefundable and are recognized as earned revenue when the film or television program is available for delivery. International Currency Transactions The majority of the Company's foreign sales transactions are payable in U.S. dollars. Accordingly, international currency transaction gains and losses included in the consolidated statements of operations for the three years ended September 30, 1999 were not significant. Income Taxes The Company utilizes the liability method of accounting for income taxes. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and the tax bases of assets and liabilities using enacted tax rates in effect for the period in which the differences are expected to reverse. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from estimated amounts. Stock-Based Compensation The Company accounts for stock-based employee compensation arrangements in accordance with Accounting Principles Board ("APB") No. 25, "Accounting for Stock Issued to Employees," and complies with the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation." Under APB No. 25, compensation cost, if any, is recognized over the respective vesting period based upon the difference on the grant date between the fair value of the Company's common stock and the grant price. Pro forma disclosures reflect stock option grants subsequent to fiscal 1996. 52 53 Fair Value of Financial Instruments The recorded value of the Company's cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, contractual obligations and participants' share payable for talent residuals approximate their fair value due to the relatively short maturities of these instruments. The fair value of notes payable and convertible subordinated debentures approximates the recorded value due to the stated interest rate on such instruments and the indeterminate nature of the value of the convertibility feature of such debt instruments. Reverse Stock Split In September 1997 the Company effected a 1-for-6 reverse split of the issued and outstanding shares of common stock. All references to shares outstanding give effect to this reverse stock split as if it had occurred at the beginning of the earliest period presented. Net Earnings (Loss) Per Share Basic net earnings (loss) per share is computed using the weighted average number of common shares outstanding during the period. Diluted net earnings (loss) per share is computed using the weighted average number of common shares and common equivalent shares outstanding during the period. Common equivalent shares related to options and warrants are excluded from the computation when their effect is antidilutive. Comprehensive Income In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS No. 130, "Reporting Comprehensive Income." This statement established standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income generally represents all changes in shareholders' equity during the period except those resulting from investments by, or distributions to, shareholders. SFAS No. 130 is effective for fiscal years beginning after December 15, 1997, and requires restatement of earlier periods presented. SFAS No. 130 defines comprehensive income as net income plus all other changes in equity from nonowner sources. The Company had no other comprehensive income items and accordingly net income equals comprehensive income. Segment Reporting The company adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" for the year ended September 30, 1999. Comparative fiscal 1998 and 1997 disclosures have been included. SFAS No. 131 supersedes SFAS No. 14, "Financial Reporting for Segments of a Business Enterprise," replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS No. 131 also requires disclosures about products or services, geographic areas, and major customers. The Company's management reporting structure provides for two reportable segments. (2) Subsidiary Public Offering On June 25, 1999 US SEARCH.com consummated its initial public offering ("offering") and issued 4,500,000 new shares of its common stock to the public. US SEARCH.com obtained $36,109,000 in net proceeds related to the offering. US SEARCH.com is traded on the NASDAQ National Market under the symbol "SRCH." 53 54 Concurrent with the offering, the Company exercised warrants to purchase 1,360,173 additional shares of US SEARCH.com common stock for $2,752,000. The Company has no remaining warrants to purchase additional common stock of US SEARCH.com. In conjunction with the offering, the Company sold 1,500,000 of its shares in US SEARCH.com to the public in exchange for net proceeds of $12,555,000. The Company recognized a $13,148,000 pre-tax gain on the sale of the 1,500,000 shares. Subsequent to the offering, the Company retains a 55.2% interest in the subsidiary. The Company recognized a $21,018,000 pre-tax gain based on its revised proportionate share in the subsidiary's increased net equity. (3) Film and Television Program Costs Film and television program costs consist of the following:
September 30, September 30, 1999 1998 ------------------ ------------------ In process or development......................................... $20,472,000 $10,570,000 Released, net of accumulated amortization......................... 71,027,000 63,203,000 ------------------ ------------------ Total............................................................. $91,499,000 $73,773,000 ================== ==================
Based upon present estimates of anticipated future revenues at September 30, 1999, approximately 70% of the costs related to released films and television programs will be amortized during the three-year period ending September 30, 2002. The Company capitalized interest of $372,000, $982,000 and $1,429,000 to film and television program costs for the years ended September 30, 1999, 1998, and 1997, respectively. During the same respective periods, $8,154,000, $7,243,000 and $5,456,000 of total interest costs were incurred. (4) Investments in Unconsolidated Entities, at Equity Significant investments in unconsolidated entities are accounted for under the equity method ("equity affiliates"). These entities are principally engaged in the production and distribution of films and television programs. The Company's share of earnings of these equity affiliates is included in income as earned. Investments in equity affiliates at September 30 consist of the following:
Ownership Percentage 1999 1998 -------------------------------------- ----------------- BLT Ventures..................................... 50% $ 808,000 $ 827,000 Cracker Company LLC.............................. 50% 5,829,000 5,648,000 TV First......................................... 50% 357,000 520,000 Grendel Productions LLC.......................... 25% 2,161,000 2,093,000 Swing Ventures................................... 50% 1,188,000 1,230,000 Trick Productions................................ 50% 1,047,000 -- Others........................................... 20%-50% 655,000 480,000 ================= ================= $12,045,000 $10,798,000 ================= =================
54 55 The summarized unaudited information below at September 30 represents an aggregation of the Company's equity affiliates: Financial Information (unaudited)
Balance Sheet Data 1999 1998 ------------------ ------------------- Assets.......................................................... $22,710,000 $30,375,000 Liabilities..................................................... 4,133,000 9,238,000 Net assets...................................................... 18,577,000 21,137,000 Company's equity in net assets................................. $12,045,000 $10,798,000
Earnings Data 1999 1998 1997 ----------------- ------------------- ----------------- Operating revenues.............................................. $4,229,000 $31,871,000 $24,681,000 Gross profit.................................................... (293,000) 963,000 4,403,000 Net (losses) earnings........................................... $(1,168,000) $972,000 $4,378,000 Company's equity in net (losses) earnings....................... $(520,000) $(330,000) $2,189,000
No dividends were received from equity affiliates for the years ended September 30, 1999, 1998, or 1997. 55 56 (5) Credit Agreement and Financing Arrangements Credit arrangements and borrowings consist of the following:
September 30, September 30, 1999 1998 ------------------ ----------------- Note payable to bank, under a revolving credit facility collateralized by substantially all Company assets, interest at Libor (5.38% at September 30, 1999) plus 3%, outstanding principal balance due June 2000............................ $66,455,000 $58,980,000 Notes payable to banks and/or financial institutions consisting of production loans principally collateralized by film rights, interest at rates from Libor (5.38% at September 30, 1999) plus 2% to Prime (8.25% at September 30, 1999) plus 2.5%, and maturities at varying dates through June 2000.......................... 16,272,000 13,432,000 Series A Convertible Subordinated Debentures due December 2000, bearing interest at 10% per annum payable June 15 and December 15, net........... -- 73,000 Series B Convertible Subordinated Debentures due December 2000, bearing interest at 13-3/4% per annum payable monthly, net....................... 1,535,000 3,061,000 8% Convertible Subordinated Debentures due December 2000, interest payable February 1 and August 1, net.................................... 734,000 4,513,000 9% Convertible Subordinated Debentures due July 2002, interest payable January 1 and July 1, net................................................ -- 3,879,000 Trade notes payable and debt of US SEARCH.com 198,000 739,000 =================== ================ Total credit agreements and financing arrangements $85,194,000 $84,677,000 =================== ================ Total notes payable......................................................... $82,925,000 $73,151,000 =================== ================ Total convertible subordinated debentures, net of deferred issuance costs... $2,269,000 $11,526,000 =================== ================
At September 30, 1999 the Company had a $75,000,000 revolving credit facility with a syndicated group of banks. Chase Manhattan Bank is the agent bank. Unused borrowings on this facility were $1,148,000 at September 30, 1999. The credit facility expires in June 2000. The Company is currently in negotiations to extend the revolving facility beyond its current maturity date, however no agreement has been executed. The credit agreement contains restrictive covenants which include, but are not limited to, limitations on additional indebtedness, liens, investments, disposition of assets, guarantees, deficit financing, capital expenditures, affiliate transactions and the use of proceeds, and prohibit the payment of cash dividends and prepayment of most subordinated debt. In addition, the Company must maintain a minimum liquidity level, limit overhead expense and to meet certain financial ratios. The bank could declare an event of default if either of Messrs. Locke or Kushner failed to be the Chief Executive Officer of the Company or if any person or group acquired ownership or control of capital stock of the Company having voting power greater than the voting power at the time controlled by Messrs. Kushner and Locke combined (other than any institutional investor able to report its holdings on Schedule 13G which holds no more than 15% of such voting power). The Company received a waiver of default due to non-compliance with an overhead covenant for fiscal 1999. At September 30, 1999, the Company had outstanding $16,272,000 of production loans to consolidated entities from Comerica Bank - California ("Comerica") and Far East National Bank. The unused portion of credit available under these production loans at September 30, 1999 was $671,000. The Company provided $2,100,000 in corporate guarantees for loans to consolidated entities and $400,000 for one loan to an equity affiliate. The guarantees are callable in the event the respective borrower does not repay the loan made by the respective maturity date. Deposits paid by distributing licensees prior to the delivery of the financed pictures are held as restricted cash collateral by the lenders. 56 57 In April 1999 the Company called the Series A Debentures for redemption. In May 1999, $49,000 of principal was converted into 6,435 newly-issued shares of common stock at a rate of $7.61 per share, and the remaining $28,000 was redeemed. Approximately $2,000 of capitalized issuance costs were amortized under the straight-line method as interest expense during each of the years ended September 30, 1999 and 1998. During the year ended September 30, 1999, $1,616,000 of the Series B Debentures principal were converted into 174,382 newly-issued shares of common stock of the Company at a rate of $9.2664 per share. Unamortized discounts were $38,000 at September 30, 1999. Approximately $49,000 and $68,000 of these costs were amortized under the straight-line method as interest expense for the years ended September 30, 1999 and 1998, respectively. During the year ended September 30, 1999, $3,948,000 of the 8% Debentures principal were converted into 674,873 new-issued shares of common stock at a rate of $5.85 per share. Unamortized discounts were $18,000 at September 30, 1999. Approximately $43,000 and $86,000 of these costs were amortized under the straight-line method as interest expense for the years ended September 30, 1999 and 1998, respectively. The Company has the right to redeem the debentures at a redemption price of 100% of par commencing in February 2000. During the year ended September 30, 1999, all of the 9% Debentures were converted into 432,495 newly-issued shares of common stock at a rate of $9.48 per share. Approximately $29,000 and $59,000 of capitalized issuance costs were amortized under the straight-line method as interest expense for the years ended September 30, 1999 and 1998, respectively. The debentures are subordinated to all existing and future senior indebtedness. The term senior indebtedness includes principal and interest on all indebtedness of the Company to banks, insurance companies and similar institutional lenders, and to the public for securities registered under the Securities Act of 1933. Senior indebtedness does not include other debentures, indebtedness to affiliates and indebtedness expressly subordinated to or on parity with the debentures. Credit arrangements and borrowings are due as follows:
Fiscal Year Ending September 30, Amount - ----------------------------------------------------------------------------------------------------------------------------------- 2000 $82,875,000 2001 2,319,000 ---------------- Total $85,194,000 ================
(6) Income Taxes Income tax expense (benefit) consisted of the following:
Year Ended September 30, ----------------------------------------------------- 1999 1998 1997 ----------------- --------------- -------------- Current: Federal................................................................... $186,000 $154,000 $ -- State..................................................................... 540,000 27,000 23,000 ----------------- --------------- -------------- 726,000 181,000 23,000 Deferred: Federal................................................................... -- -- -- State..................................................................... -- -- -- ----------------- --------------- -------------- Total income tax expense .............................................. $726,000 $181,000 $23,000 ================= =============== ==============
57 58 A reconciliation of the statutory Federal income tax rate to the effective rate is presented below:
Year Ended September 30, -------------------------------------------------- 1999 1998 1997 ---------------- -------------- --------------- Statutory Federal income tax rate......................................... 34% (34)% (34)% Alternative minimum taxes and permanent differences....................... 3 2 -- Change in valuation allowance............................................. (30) 34 34 State income taxes, net of Federal tax benefit............................ 6 1 1 ---------------- --------------- -------------- 13% 3 % 1 % ================= ============== ==============
Significant components of deferred tax assets and liabilities, using enacted tax rates, are as follows:
At September 30, ---------------------------------------- 1999 1998 --------------------- ----------------- Deferred tax assets: Net operating loss carryforwards and credits............................... $13,589,000 $13,299,000 Allowance for doubtful accounts and other reserves......................... 1,169,000 695,000 Deferred film license fees................................................. 1,306,000 1,571,000 Other temporary differences ............................................... 1,953,000 265,000 Depreciation............................................................... 85,000 53,000 State taxes................................................................ 212,000 -- --------------------- ----------------- Total gross deferred assets............................................. 18,314,000 15,883,000 Valuation allowance..................................................... (5,432,000) (7,694,000) --------------------- ----------------- Net deferred tax assets................................................. $12,882,000 $ 8,189,000 ===================== ================= Deferred tax liabilities: Film amortization.......................................................... $ 5,150,000 $ 7,239,000 Partnerships............................................................... 94,000 721,000 Deferred gain on sale of subsidiary stock.................................. 7,638,000 -- State taxes................................................................ -- 229,000 --------------------- ----------------- Total deferred tax liabilities.......................................... $12,882,000 $ 8,189,000 ===================== =================
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. Due to the uncertainty surrounding the realizability of the net deferred tax assets, a full valuation allowance has been established as management believes that it is more likely than not, based upon available evidence, that the deferred tax assets will not be realized. Due to the sale of US SEARCH.com common stock in connection with the subsidiary's initial public offering in June 1999, effective July, 1999, US SEARCH.com will no longer join the Company in the filing of a consolidated income tax return. Accordingly, as of September 30, 1999, the Company and US SEARCH.com had net operating loss and tax credit carryforwards as follows:
Amount -------------------------------------------- Expiration Date Kushner-Locke US SEARCH.com Beginning -------------------- ------------------- --------------------- NOLs for Federal tax purposes $20,580,000 $14,788,000 Fiscal 2008 NOLs for state tax purposes -- 9,198,000 Fiscal 2004 International tax credits 122,000 -- Fiscal 2000 General business credits 197,000 -- Fiscal 2003 Alternative minimum tax credits 437,000 -- N/A
58 59 (7) Warrants and Stock Options Warrants A summary of exercisable warrants at September 30, 1999 is as follows:
Warrant Holder Amount Exercise Price Expiration Date - --------------------------------------------------------------------- ---------------- ------------------ ------------------ Allen &Company warrants 500,000 $2.0625 September 2004 Friedman warrants 50,000 $2.0625 September 2004 Friedman consulting warrants 35,000 $1.6875 June 2002 ================ 585,000 ================
In 1994, in connection with the 8% Convertible Subordinated Debentures offering, the Company issued warrants to the underwriter to purchase up to $1,643,700 of the aggregate principal amount of the debentures at an exercise price equal to 120% of the principal amount of the debentures, subject to adjustment in certain circumstances. The warrants were fully exercised in fiscal 1999 for $1,775,000 and the Company issued new shares of common stock. In 1994, in connection with the 9% Convertible Subordinated Debenture offering, the Company issued warrants to the underwriters to purchase up to $505,000 of the aggregate principal amount of the debentures sold at an exercise price equal to 120% of the principal amount of the debentures, subject to adjustments in certain circumstances. The warrants were exercisable through July 1999, when they expired unexercised. In 1996 the Company had a public offering of 4,750,000 units (the "unit offering"). Each unit consisted of two pre-reverse split shares of common stock and one Class C Redeemable Common Stock Purchase Warrant to purchase one share of common stock, at an exercise price of $6.8625 per share, as adjusted. In connection with the unit offering, the Company issued warrants to the underwriter to purchase 71,167 units at an adjusted exercise price of $19.1825 each (the "Underwriter Warrants"). In addition, the Company issued warrants to a consultant to purchase 47,500 units at the same exercise price (the "Consultant Warrants"). In April 1999, the Company called all Class C Warrants for redemption in May 1999. Included in the redemption were the Class C Warrants issued as a part of the Underwriter Warrants and Consultant Warrants. The Company issued 794,215 shares of common stock and received proceeds of $5,419,000 from the exercise of the Class C Warrants. A total of 14,410 warrants were redeemed at a total cost of $1,441. In June 1997 the Company issued warrants to I. Friedman Equities, Inc. (the "Friedman consulting warrants") to purchase up to 50,000 shares of common stock. In September 1997, the Company issued additional warrants to I. Friedman Equities, Inc. of 50,000 (the "Friedman warrants"). In August 1999, 15,000 Friedman consulting warrants were exercised. In September 1997, in connection with a consulting agreement, the Company issued warrants to Allen & Company, Incorporated (the "Allen & Company Warrants") to purchase 500,000 share of common stock. The value assigned to the warrants of $1,339,000 is recorded as consulting expense over the term of the agreement with a portion allocated to the private placement financing consummated in fiscal 1999. For the years ended September 30, 1999 and 1998, the Company recognized consulting expense of $579,000 and $332,000, respectively. The Company will recognize the remaining $230,000 of consulting expense during the year ended September 30, 2000. At September 30,1999, the warrants were fully vested. Options In 1989, the Board of Directors approved a stock incentive plan (the "Plan") that covers directors, third party consultants and advisors, independent contractors, officers and other employees of the Company. In April 1999 the stockholders approved an increase in the number of shares of Common Stock reserved for issuance from 1,250,000 shares to 1,820,000 59 60 shares. The Plan allows for the issuance of options to purchase shares of the Company's common stock at an exercise price at least equal to the fair value of the stock on the date of grant. Options generally vest over a three year term subject to continued employment or the completion of services rendered, and have a maximum term of ten years. The Company granted options during the year ended September 30, 1999 which resulted in compensation of $150,000. There were no option grants which resulted in compensation expense for the years ended September 30, 1998 or 1997. At September 30, 1999, 1,509 shares remained available for future grant. The following table summarizes stock option activity for the period from September 30, 1996 to September 30, 1999:
Weighted Price per Average Shares Share Exercise Prices --------------------------------------------------------- Balance at September 30, 1996...................................... 699,519 $1.50 - $11.64 $5.95 Granted Fiscal 1997................................................ 466,673 $1.88 - $ 2.81 $1.97 Options Expired/Canceled........................................... (70,833) $4.50 - $15.18 $7.84 -------------------- Balance at September 30, 1997...................................... 1,095,359 $1.50 - $11.64 $4.65 Granted Fiscal 1998................................................ 121,668 $1.50 - $4.00 $2.65 Options Expired/Canceled........................................... (112,501) $2.63 - $6.36 $3.98 Options Exercised.................................................. (9,000) $3.75 $3.75 -------------------- Balance at September 30, 1998...................................... 1,095,526 $1.50 - $11.64 $2.93 Granted Fiscal 1999................................................ 502,243 $2.97 - $10.25 $4.63 Options Exercised.................................................. (317,309) $1.50 - $6.36 $2.74 ==================== Balance at September 30, 1999...................................... 1,280,460 $1.50 - $11.64 $4.42 ====================
Additional information with respect to the outstanding options as of September 30, 1999 is as follows:
Options Outstanding Options Exercisable --------------------------------------------------------------- ------------------------------- Weighted Average Average Average Range of Number of Remaining Exercise Number of Exercise Exercise Prices: Shares Contractual Life Price Shares Price - ---------------------------- ------------------ ----------------------- -------------- ---------------- ----------- $1.50- $3.00 465,110 7.55 years $1.95 277,335 $1.94 $3.01 - $6.00 613,332 6.86 years $4.84 610,832 $4.84 $6.01 - $11.64 202,018 4.71 years $8.88 172,018 $9.17 ================== ================ 1,280,460 1,060,185 ================== ================
Options exercisable at September 30, 1998 and 1997 were 671,087 and 528,141, respectively. The weighted average exercise price of these exercisable options at September 30, 1998 and 1997 were $4.79 and $6.16, respectively. 60 61 The pro forma effects of applying SFAS No. 123 are as follows:
Year Ended September 30, ----------------------------------------------------- 1999 1998 1997 ----------------- ---------------- -------------- Net earnings (loss) As reported $ 4,471,000 $ (6,336,000) $ (4,369,000) ============= ============= ============= Pro forma $ 3,689,000 $ (6,662,000) $ (4,577,000) ============= ============= ============= Earnings (loss) per share As reported $ .38 $ (.69) $ (.49) ============= ============= ============= Pro forma $ .31 $ (.73) $ (.51) ============= ============= =============
The pro forma disclosure of applying SFAS No. 123 is estimated on the option's date of grant using assumptions of the expected term to exercise, volatility, risk-free rate, and the expected dividend yield. A summary of these assumptions is as follows:
Dividend Expected Term Volatility Risk-free Rate Yield ------------------- ------------------ ---------------------- ----------- Fiscal 1999 10 years 71.6%-76.2% 5.11%-7.09% 0% Fiscal 1998 10 years 71.6% 5.67%-5.89% 0% Fiscal 1997 10 years 71.6% 6.22%-6.99% 0%
US SEARCH.com Stock Incentive Plan US SEARCH.com has a stock incentive plan administered by the US SEARCH.com Compensation Committee. US SEARCH.com has authorized for issuance 2,600,650 options under this plan. At September 30, 1999, 189,820 options issued under this plan are potentially dilutive to the Company's current ownership percentage of 55.2%. (8) Commitments and Contingencies Compensation Messrs. Kushner and Locke entered into employment agreements which expire in March 2004. Those agreements provide for base compensation to each individual of $475,000, $500,000, $525,000, $550,000 and $575,000 in the fiscal years ended September 30, 2000, 2001, 2002, 2003 and 2004, respectively. The Company also provides Messrs. Kushner and Locke with certain fringe benefits, including $3,500,000 of term life insurance with a split dollar ownership structure and disability insurance for each person The Company has agreements with twelve other employees and officers of the Company, including consolidated subsidiaries, which provide for annual base salaries each ranging from $150,000 to $400,000, eligibility for options, performance bonuses, and severance payments. Employee Benefit Plans The Company participates in various multiemployer defined benefit and defined contribution pension plans under union and industry agreements. These plans include substantially all temporary film production employees covered under various collective bargaining agreements. The Company incurred $425,000, $345,000, and $378,000 of multiemployer plan costs in fiscal 1999, 1998, and 1997, respectively. Such costs are capitalized as a component of film and television programming costs. The Company funds the costs of such plans as incurred. 61 62 Leases The Company and its subsidiaries lease certain facilities and equipment. The leases generally provide for the lessee to pay taxes, maintenance, insurance and certain other operating costs of the leased property. At September 30, 1999, the future minimum payments under leases that have initial or remaining noncancelable lease terms in excess of one year are as follows:
Capital Operating Year Ending September 30, Leases Leases - ------------------------------------------------------------------------------------------------------------------------------------ 2000................................................................................ $228,000 $1,615,000 2001................................................................................ 193,000 1,884,000 2002................................................................................ 35,000 1,770,000 2003................................................................................ 9,000 1,804,000 2004................................................................................ -- 1,848,000 Thereafter........................................................................... -- 729,000 ----------- -------------- Total minimum future lease rental payments 465,000 $9,650,000 ============== Less: amounts representing interest (22,000) ----------- Capitalized lease obligations, included within Contractual obligations in the consolidated balance sheet at September 30, 1999..................................... $443,000 ==========
Rental expense for all operating leases for the years ended September 30, 1999, 1998 and 1997 was approximately $678,000, $657,000 and $541,000, respectively. Commitments of US Search.com US SEARCH.com has several cancelable and noncancelable agreements with data suppliers and various Internet companies. The Company also has cancelable and noncancelable broadcast and cable advertising commitments. At September 30, 1999, the minimum noncancelable payments required under these agreements are approximately :
Year ending September 30, Amount ------------------------- ----------- 2000.......................................... $15,940,000 2001.......................................... $ 8,600,000 2002.......................................... $ 5,950,000 2003.......................................... $ 4,200,000 2004.......................................... $ 4,200,000 Thereafter.................................... $ 1,050,000
Film and Television Program Production The Company has certain films and television projects in development (Note 3). The Company routinely makes contractual down payments to acquire film distribution rights. This initial advance for rights ranges from 10% to 30% of the total purchase price. The balance of the payment is generally due upon the complete delivery by third party producers of acceptable film and video materials and other proof of rights held and insurance policies that may be required for the Company to begin exploitation of the product. 62 63 Litigation The Company is involved in certain legal proceedings and claims arising out of the normal course of business. Management believes the resolution of these matters will not have a material adverse effect upon the Company's results of operations, financial position or cash flows. (9) Related Party Transactions In fiscal 1997 and 1998 Messrs. Kushner and Locke each earned annual base compensation of $425,000. In fiscal 1999 Messrs. Kushner and Locke each earned base compensation at an annual rate of $450,000 through March 1999 and $475,000 thereafter. In August 1997, the Company granted to each of Messrs. Kushner and Locke options to purchase 166,666 shares of common stock. In March 1999, the Company granted to each of Messrs. Kushner and Locke 50,000 shares of restricted common stock and accelerated the vesting of 33,333 then unvested stock options. In September 1999, the Company granted to each of Messrs. Kushner and Locke bonuses of $500,000 and options to purchase 100,000 shares of common stock. The following is a summary of stock and option compensation to each of Messrs. Kushner and Locke for the three year period ended September 30, 1999:
Options/Shares Vested, net of exercise Grant Date Issued Exercise Price at September 30, 1999 Vesting Required - ------------------------ --------------- ------------------- ----------------------- ---------------- August 1997 83,333 $1.875 50,000 (1) August 1997 83,333 $1.875 83,333 (2) February 1999 50,000 N/A N/A (3) September 1999 100,000 $4.6875 100,000 (4)
- ------------------ (1) Originally vested over five years commencing each anniversary of the grant date. Vesting of options for 33,333 shares was accelerated in March 1999. The difference in intrinsic value of these options between the grant date and the date of accelerated vesting is $277,000. (2) Achievement of profit targets set by the Board of Directors or the price of the Company's common stock reaching trading prices between $3.00 and $6.00 per share; portions accelerated in March 1999. (3) Restrictions removed in June 1999. (4) Immediately vested upon grant. Outside directors each receive annual compensation between $15,000 and $25,000 in cash. The following is a summary of option compensation to outside directors for the three year period ended September 30, 1999
Vested, net of Options Exercise exercises, at Vesting Holder Grant Date Issued Price September 30, 1999 Required - ----------------------- ------------------ ------------- ------------ ------------------- ---------- Irwin Friedman June 1998 16,667 $2.8438 5,556 (1) Irwin Friedman February 1999 13,333 $7.19 13,333 (2) Irwin Friedman September 1999 13,333 $4.8125 13,333 (2) Stuart Hersch August 1997 16,667 $1.875 16,667 (1) Stuart Hersch February 1999 13,333 $7.19 13,333 (2) Stuart Hersch September 1999 13,333 $4.8125 13,333 (2) Stuart Hersch September 1999 40,000 $4.8125 40,000 (2) John Lannan June 1998 16,667 $2.8438 11,111 (1) John Lannan February 1999 13,333 $7.19 13,333 (2) John Lannan September 1999 13,333 $4.8125 13,333 (2)
- ------------------ (1) Vests one-third at grant date and one-third over next two anniversaries of the grant date. (2) Immediately vested upon grant. 63 64 The Company loaned the President and Chief Operating Officer a total of $300,000 in September and October 1996. The loan bears interest at 8% per year and is due through October 2001. Pursuant to his employment contract, during fiscal 1998 and fiscal 1999 $50,000 and $100,000 principal amounts of the loan, respectively, plus interest on such amounts, were forgiven and recorded as additional compensation expense. The unpaid principal balance at September 30, 1999 was $150,000. During 1989, the Company entered into a consulting agreement with Stuart Hersch, a director of the Company. The agreement is on a month-to-month basis. For the years ended September 30, 1997, 1998 and 1999 the Company recognized $90,000, $90,000 and $71,000 respectively, in consulting expense under this agreement. Mr. Hersch sold 8,333 shares of the Company's common stock in December 1997 at $3.625 per share. Since 1991 Irwin Friedman, a director of the Company, has rendered financial consulting services to the Company through the firm I. Friedman Equities, Inc. During 1997 in connection with rendering certain services, that firm was granted warrants exercisable for 100,000 shares of common stock (Note 7). For the years ended September 30, 1997, 1998 and 1999 the Company recognized $72,000, $24,000 and $48,000, respectively, in consulting expense under various agreements with that firm. During the year ended September 30, 1999, I. Friedman Equities, Inc. was also paid $62,000 pursuant to a 1996 agreement in connection with the redemption of Class C Common Stock Warrants, and that amount was charged to stockholders' equity. In December 1994, the Company loaned August Entertainment, Inc. ("August") $650,000 against distribution rights to third party product. August is majority owned by Gregory Cascante, former President of the Company's international film distribution division. The loan bore interest at the lesser of (a) Prime plus 2% or (b) 10%. In January 1999 the loan was assigned to a subsidiary, and was used to reduce pre-existing obligations to August. From May 1997 to October 1997, Peter Locke (co-chairman of US SEARCH.com and the Company) personally loaned to US SEARCH.com amounts aggregating approximately $397,000 (gross of any repayments which occurred during such period). The loans with interest at 10% per annum were repaid in full. In addition, US SEARCH.com paid approximately $40,000 in consulting fees and interest to Mr. Locke for services rendered through December 31, 1997. US SEARCH.com loaned approximately $41,000 in 1995, $176,000 in 1996 and $32,000 in 1997, to an existing stockholder and co-founder of US SEARCH.com (the "Stockholder"). US SEARCH.com received repayments of approximately $5,000 in 1995 and $3,000 in 1996 from Stockholder. In June 1997, the Stockholder personally assumed US SEARCH.com's obligations under a $296,000 promissory note payable to a former stockholder of US SEARCH.com (the "Related Loan"). In consideration of the Stockholder's assumption of US SEARCH.com's obligations under the Stockholder Loan, the prior outstanding amounts loaned to this Stockholder were repaid in full and an amount payable to Stockholder was established to the extent the assumption of the Related Loan exceeded loans made to the Stockholder. In September 1998, in connection with US SEARCH.com's amended and restated employment agreement with the Stockholder, US SEARCH.com agreed to assume the Stockholder's obligations on the Related Loan. The assumption resulted in a $296,000 compensation charge recorded in general and administrative expenses in the year ended September 30, 1999. An affiliate of a former stockholder/executive officer of US SEARCH.com lent this subsidiary $50,000 in December 1996 and $50,000 in May 1997, bearing interest at 20% per annum and payable in six monthly installments of $10,000 each (including interest). US SEARCH.com subsequently defaulted in its obligations under these notes. In January 1998, the notes were restructured providing for the payment of $120,000, including all past and future interest, in 36 equal monthly installments of approximately $3,333 each, beginning in January 1998, and guaranteed by the Company. As of September 30, 1999, US SEARCH.com owed $70,000 under this note. 64 65 (10) Segment Information Prior to fiscal 1998, the Company operated in one business segment, film and television programs. Early in fiscal 1998 the Company obtained controlling interest in US SEARCH.com. The Company subsequently operated in two segments: film and television program production and distribution, and search services related to US SEARCH.com. Each segment is a strategic business unit that offers different products and services. They are managed separately because each requires different investment, technology and marketing strategies. Management evaluates business segment performance based on operating revenues, operating earnings and asset growth. The film and television program business segment exploits distribution rights in its film and television program libraries, films and television programs produced by the Company or co-produced with equity affiliates, and film and television programs produced by third parties. Products are licensed in both the United States and virtually all international markets. The search services business segment consists solely of the Company's interest in US SEARCH.com., which provides people search and customized individual reference services. Services are provided almost exclusively to United States customers. Summarized financial information regarding the Company's business segments is shown in the table below.
Film and television Search services Consolidated ------------ --------------- ------------ Fiscal 1999: Operating revenues $ 34,143,000 $ 15,747,000 $ 49,890,000 Gross profit 917,000 9,307,000 9,704,000 Earnings (loss) before income taxes 16,539,000 (11,342,000) 5,197,000 Total assets 154,627,000 30,488,000 185,115,000 Fiscal 1998: Operating revenues 68,261,000 7,869,000 76,130,000 Gross profit 10,223,000 4,280,000 14,503,000 (Loss) before income taxes (1,419,000) (4,736,000) (6,155,000) Total assets 134,319,000 2,786,000 137,105,000 Fiscal 1997: Operating revenues 54,746,000 -- 54,746,000 Gross profit 2,662,000 -- 2,662,000 (Loss) before income taxes (4,346,000) -- (4,346,000) Total assets 124,368,000 -- 124,368,000
65 66 Geographic Data The revenues of equity affiliates are generated worldwide and their operations are principally located in the United States. The table below presents sources of operating revenue by country or territory for the Company and consolidated subsidiaries. Equity affiliates are not included.
Year ended September 30. ----------------------------------------------------- 1999 1998 1997 ----------- ----------- ----------- United States $33,862,000 $40,251,000 $24,489,000 Germany 4,420,000 12,954,000 5,873,000 France 281,000 2,302,000 1,036,000 Great Britain 1,712,000 1,596,000 1,310,000 Latin America 5,625,000 3,574,000 766,000 Australia 719,000 2,181,000 2,985,000 Japan 637,000 3,077,000 1,985,000 Spain -- 3,289,000 6,347,000 Italy 383,000 3,463,000 1,545,000 Other foreign countries or territories 2,251,000 3,443,000 8,410,000 ----------- ----------- ----------- Total revenues $49,890,000 $76,130,000 $54,746,000 =========== =========== ===========
The following table presents film and television program costs and total assets based upon their geographic location:
- ------------------------------------------------------------------------------------------------------------------------ United Latin Great States America Britain Total ------------ ----------- ----------- ------------ September 30, 1999: Film and television program costs $89,163,000 $2,508,000 $ -- $ 91,499,000 Total assets 179,864,000 3,163,000 2,088,000 185,115,000 September 30, 1998: Film and television program costs 73,773,000 -- -- 73,773,000 Total assets 132,756,000 2,361,000 1,988,000 137,105,000 September 30, 1997: Film and television program costs 68,507,000 -- -- 68,507,000 Total assets 122,759,000 -- 1,609,000 124,368,000
Customer Concentration For the year ended September 30, 1999, sales to one United States film and television program customer represented 18% of the Company's consolidated operating revenues. At September 30, 1999, accounts receivable from two customers represented 31% of the Company's consolidated accounts receivable. For the year ended September 30, 1998, sales to two international film and television program customers represented 26% of the Company's consolidated operating revenues. At September 30, 1998, accounts receivable from two customers represented 41% of the Company's consolidated accounts receivable. There were no customer concentrations for the year ended September 30, 1997. 66 67 (11) Earnings (Loss) Per Share The table below reconciles net earnings (loss) and average shares of common stock outstanding to those amounts used to calculate basic and diluted earnings (loss) per share.
Year Ended September 30, ---------------------------------------------- 1999 1998 1997 ----------- ----------- ----------- Numerator: Numerator for basic earnings per share - earnings (loss) available to common stockholders $ 4,471,000 $(6,336,000) $(4,369,000) Effect of dilutive securities: interest on convertible debt 60,000 -- -- ----------- ----------- ----------- Numerator for diluted earnings per share - earnings (loss) available to common stockholders after assumed conversions $4,531,,000 $(6,336,000) $(4,369,000) =========== =========== =========== Denominator: Denominator for basic earnings per share - weighted average shares 11,755,000 9,181,000 8,959,000 ----------- ----------- ----------- Effect of dilutive securities: Employee stock options 378,000 -- -- Warrants 434,000 -- -- Convertible debentures 129,000 -- -- ----------- ----------- ----------- Dilutive potential common shares 941,000 -- -- =========== =========== =========== Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions 12,696,000 9,181,000 8,959,000 =========== =========== =========== Basic earnings (loss) per share $ .38 $ (.69) $ (49) =========== =========== =========== Diluted earnings (loss) per share $ .36 $ (.69) $ (.49) =========== =========== ===========
A total of 367,000 shares of common stock representing the potential exercise of options, warrants and the potential conversion of debentures were not included in the calculation of diluted earnings per share for fiscal 1999, as the impact of including such securities would be antidilutive. All options, warrants, and convertible debentures were antidilutive for the years ended September 30, 1998 and 1997. (12) Fourth Quarter Adjustments During the fourth quarter of 1997, the Company revised its estimates of future revenues for certain product no longer being produced by the Company. In addition during the fourth quarter of 1997, the Company increased its provision for bad debts. The adjustments to revise estimates of future revenues and increase the allowance for doubtful accounts recorded in the fourth quarter of 1997 amounted to approximately $2,600,000. (13) Supplemental Cash Flow Information
Year ended September 30, ---------------------------------------------------------------- Cash paid for: 1999 1998 1997 --------------- ------------- ------------- Interest $7,436,000 $6,427,000 $4,487,000 Taxes $30,000 $40,000 $23,000
Fiscal 1997: o $667,000 of convertible subordinated debentures were converted into 84,562 adjusted shares of common stock. 67 68 Fiscal 1998: o The Company acquired an 80% interest in 800-US Search in exchange for certain guaranties of indebtedness. In conjunction with the acquisition, liabilities assumed were: Fair value of assets acquired $461,000 Cash paid for the capital stock -- Liabilities assumed $2,557,000 o $300,000 of convertible subordinated debentures were converted into 51,282 adjusted shares of common. Fiscal 1999: o The Company assigned a note receivable from August of $192,000 to a subsidiary to reduce pre-existing subsidiary obligations to August (Note 9) o $100,000 of a note receivable from an officer of the Company was forgiven (Note 9). o $296,000 in related party notes of US Search.com were forgiven (Note 9). o The Company issued common stock with a value of $5,820,000 in exchange for convertible preferred stock and detachable warrants in Harvey (Note 1). o $9,713,000 of convertible subordinated debentures were converted into 1,288,185 adjusted shares of common stock. o A formerly-consolidated film production subsidiary was deconsolidated as the Company no longer exercised control. The non-cash reduction in assets and liabilities were: Accounts receivable $ 16,000 Film and television program costs $ 1,810,000 Other assets $ 40,000 Accounts payable and accrueds $ 38,000 Notes payable $ 1,950,000 68 69 THE KUSHNER-LOCKE COMPANY VALUATION AND QUALIFYING ACCOUNTS SCHEDULE II
Balance at Additions Charged Beginning of to Costs and Deductions Due Balance at End Period Expenses to Write-offs of Period ----------------------------------------------------------------- Allowances for Doubtful Accounts: Year Ended 9/30/99 $2,509,000 2,959,000 (2,220,000) $3,248,000 ============================================================== Year Ended 9/30/98 $ 925,000 2,118,000 (534,000) $2,509,000 ============================================================== Year Ended 9/30/97 $ 693,000 1,310,000 (1,078,000) $ 925,000 ==============================================================
69 70 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. THE KUSHNER-LOCKE COMPANY (Registrant) Dated: December 27, 1999 /s/ DONALD KUSHNER ---------------------------------- Donald Kushner Co-Chairman of the Board, Co-Chief Executive Officer and Secretary Dated: December 27, 1999 /s/ ROBERT SWAN ---------------------------------- Robert Swan Senior Vice President and Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and the capacities and on the dated indicated. THE KUSHNER-LOCKE COMPANY (Registrant) Dated: December 27, 1999 /s/ PETER LOCKE ---------------------------------- Peter Locke Co-Chairman of the Board and Co-Chief Executive Officer Dated: December 27, 1999 /s/ DONALD KUSHNER ---------------------------------- Donald Kushner Co-Chairman of the Board, Co-Chief Executive Officer and Secretary Dated: December 27, 1999 /s/ ROBERT SWAN ---------------------------------- Robert Swan Senior Vice President and Chief Financial Officer Dated: December 27, 1999 /s/ ADELINA VILLAFLOR ---------------------------------- Adelina Villaflor Controller (Chief Accounting Officer) Dated: December 27, 1999 /s/ IRWIN FRIEDMAN ---------------------------------- Irwin Friedman Director 70 71 Dated: December , 1999 ---------------------------------- Stuart Hersch Director Dated: December 27, 1999 /s/ JOHN LANNAN ---------------------------------- John Lannan Director 71 72 INDEX TO EXHIBITS 3 Articles of Incorporation (A) 4.1 Indenture between the Company and National City Bank of Minneapolis, as Trustee, dated as of December 1, 1990 pertaining to 10% Convertible Subordinated Debentures Due 2000, Series A (E) 4.2 First Supplemental Indenture between the Company and National City Bank of Minneapolis, as Trustee, dated as of March 15, 1991 pertaining to 10% Convertible Subordinated Debentures Due 2000, Series A (F) 4.3 Indenture between the Company and National City Bank of Minneapolis, as Trustee, dated as of December 1, 1990 pertaining to 133*4% Convertible Subordinated Debentures Due 2000, Series B (E) 4.4 Warrant agreement between the Company and City National Bank, as Warrant Agent, dated as of March 19, 1991 pertaining to Common Stock Purchase Warrants (F) 4.5 Warrant agreement dated September 5, 1997 between the Company and Allen & Company Incorporated.(U) 4.6 Warrant agreement dated September 5, 1997 between the Company and I. Friedman Equities, Inc. (U) 4.7 Warrant Agreement dated June 27, 1997 between the Company and I. Friedman Equities, Inc.(U) 10.1 Amended and Restated Employment Agreement dated October 1, 1997 between the Company and Donald Kushner. (W) 10.1.1 First Amendment to Amended and Restated Employment Agreement dated March 2, 1999 between the Company and Donald Kushner. 10.2 Amended and Restated Employment Agreement dated October 1, 1997 between the Company and Peter Locke. (W) 10.2.1 First Amendment to Amended and Restated Employment Agreement dated March 2, 1999 between the Company and Peter Locke. 10.3 1988 Stock Incentive Plan of the Company (A) 10.4 Form of Indemnification Agreement (A) 10.5 Kushner-Locke Shareholders' Cross-Purchase Agreement dated as of October 1, 1988 between and among Donald Kushner, Rebecca Hight, Peter Locke, Karen Locke, Peter Locke Productions, Inc. and Twelfth Street Limited (A) 10.5.1 Amendment dated as of May 14, 1992 to the Kushner-Locke Shareholders' Cross-Purchase Agreement dated as of October 1, 1988 between and among Donald Kushner, Rebecca Hight, Peter Locke, Karen Locke, Peter Locke Productions, Inc. and Twelfth Street Limited (I) 10.6 Kushner-Locke Trust Agreement dated as of October 1, 1988 between and among Donald Kushner, Rebecca Hight, Peter Locke, Karen Locke, Peter Locke Productions, Inc. and Twelfth Street Limited (A) 10.6.1 Amendment dated May 14, 1992 to the Kushner-Locke Trust Agreement dated as of October 1, 1988 between and among Donald Kushner, Rebecca Hight, Peter Locke, Karen Locke, Peter Locke Productions, Inc. and Twelfth Street Limited (I) 10.12 Lease Agreement, dated as of November 1989, between the Company and 11601 Wilshire Associates (G) 10.12.1 Amended Lease Agreement (G) 10.12.2 Lease Agreement by and between Arden Realty Limited Partnership and the Kushner-Locke Company as of August 13, 1999 10.16 Warrant Agreement between the Company and Chatfield Dean & Co., Inc. dated as of November 13, 1992 (J) 10.19 Fiscal Agency Agreement dated March 10, 1994 between and among the Company, Bank America National Trust Company and Bank of America National Trust and Savings Association (K) 10.19.1 Side letter between the Company and BankAmerica Trust Company to the Fiscal Agency Agreement dated March 10, 1994 between and among the Company, BankAmerica Trust Company and Bank of America National Trust and Savings Association (K) 10.20 Warrant Agreement dated March 10, 1994 between the Company and RAS Securities Corp. (K) 10.21 Warrant Agreement dated March 10, 1994 between the Company and I. Friedman Equities, Inc. (K) 10.22 Fiscal Agency Agreement dated July 25, 1994 between and among the Company, Bank America National Trust Company and Bank of America National Trust and Savings Association (L) 72 73 10.27 Loan and Security Agreement dated December 1, 1994 between the Company and August Entertainment, Inc., and Guarantees between the Company, August Entertainment, Inc. and the Allied Entertainments Group PLC and certain of its subsidiaries (M) 10.44 Amendment to the 1988 Stock Incentive Plan dated May 17, 1994 (Q) 10.56 Letter Agreement, dated as of April 12, 1996, by and among The Kushner-Locke Company, Chemical Bank and Chase Securities Inc. (T) 10.57 Credit, Security, Guaranty and Pledge Agreement, dated as of June 19, 1996, among The Kushner-Locke Company, the Guarantors named therein, the lenders named therein and The Chase Manhattan Bank, N.A., (formerly Chemical Bank) as Agent, and as Fronting Bank for the lenders (the "Credit Agreement") (T) 10.58 Employment Agreement dated September 14, 1996 between The Kushner-Locke Company and Bruce St. J Lilliston (V) 10.59 Loan and Security Agreement dated March 1, 1996 between The Kushner-Locke Company and its subsidiaries and Banque Paribas, Los Angeles Agency (V) 10.61 Waiver of Section 6.17 Overhead Expenses of the Credit Agreement, dated as of . (V) 10.62 Amendment No. 5 dated as of December 22, 1997 to the Credit Agreement. (W) 10.63 Amendment No. 6 dated as of May 13, 1998 to the Credit Agreement. (X) 10.64 Amendment No. 7 dated as of December , 1998 to the Credit Agreement. (Y) 10.65 Waiver of Section 6.17 Overhead Expenses of the Credit Agreement, dated as of December 9, 1999. 23.1 Consent of PricewaterhouseCoopers LLP 23.2 Consent of KPMG LLP 27. Financial Data Schedule - ----------- (A) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-18, as amended, effective December 5, 1988 (Commission File No. 33-25101-LA). (B) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1989. (C) Incorporated by reference from the Exhibit to the Company's Report on Form 10-Q for the fiscal quarter ended March 31, 1990. (D) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-1 (File No. 33-37192), as initially filed on October 5, 1990 or as amended on November 30, 1990. (E) Incorporated by reference from the Exhibits to the Company's Registration Statements on Form S-1, as amended, effective November 30, 1990 (File No. 33-37192), and effective December 20, 1990 (File No. 33-37193). (F) Incorporated by reference to the Company's Registration Statement on Form S-1, as amended, effective March 20, 1991. (G) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended March 31, 1991. (H) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1991. (I) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended June 30, 1992. (J) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-2, as amended, effective November 12, 1992 (Commission File No. 33-51544). 73 74 (K) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal quarter ended March 31, 1994. (L) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended June 30, 1994. (M) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1994. (N) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended March 31, 1995. (O) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended June 30, 1995. (P) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1995. (Q) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended December 31, 1995. (R) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended March 31, 1996. (S) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended June 30, 1996. (T) Incorporated by reference from the Exhibits to the Company's Registration Statement on Form S-2, as amended, effective August 15, 1996 (Commission File No. 333-05089). (U) Incorporated by reference from the Exhibits to the Company's Registration Statement on form S-3 as filed November 17, 1997 (Commission File No. 333-40391). (V) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1996. (W) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1997. (X) Incorporated by reference from the Exhibits to the Company's Report on Form 10-Q for the fiscal quarter ended June 30, 1998. (Y) Incorporated by reference from the Exhibits to the Company's Report on Form 10-K for the fiscal year ended September 30, 1999. 74 EX-10.1.1 2 EXHIBIT 10.1.1 1 EXHIBIT 10.1.1 FIRST AMENDMENT TO AMENDED AND RESTATED EMPLOYMENT AGREEMENT This First Amendment to Amended and Restated Employment Agreement (the "First Amendment") is entered into by and between Donald Kushner, as "Employee," and The Kushner-Locke Company, a California corporation, as "Employer" or "Company," as of March 2, 1999, based upon the following facts: RECITALS A. Employee and Company executed an Amended and Restated Employment Agreement as of October 1, 1997, setting forth the terms and conditions of Employee's employment by Company. B. On March 2, 1999, a special meeting of the Board of Directors of Company was held at which the Board of Directors took the following action: (1) granted to Employee 50,000 shares of restricted common stock of The Kushner-Locke Company with the terms and conditions of such restrictions to be determined by the Board at a later date; (2) accelerated the vesting of one-half of all previously issued but currently unvested stock options granted to Employee; (3) amended the Amended and Restated Employment Agreement of Employee dated October 1, 1997 to immediately increase Employee's Salary by $25,000 on an annual basis, effective as of March 2, 1999; (4) extended the term of Employee's Amended and Restated Employment Agreement to expire on March 2, 2004; (5) established Employee's annualized Base Salary for the employment year ending September 30, 2003 at $550,000 and established the annualized Base Salary for the partial employment year ending March 2, 2004 at $575,000; and (6) ratified and confirmed the Amended and Restated Employment Agreement except as so amended. A true and correct copy of the Minutes of Directors' Meeting of The Kushner-Locke Company of March 2, 1999 is attached as Exhibit A to this First Amendment to Amended and Restated Employment Agreement. C. Company and Employee now wish to amend Employee's Amended and Restated Employment Agreement to reflect the action taken by Company's Board of Directors on March 2, 1999. NOW, THEREFORE, in consideration of the parties' mutual promises contained herein and in the Amended and Restated Employment Agreement, which consideration is acknowledged to be adequate and sufficient, the parties hereto hereby agree as follows: AGREEMENT 1. The above Recitals are hereby incorporated in this First Amendment by reference. 2. Employee's Amended and Restated Employment Agreement is hereby amended in conformance with the March 2, 1999 Minutes of Directors' Meeting of The Kushner-Locke Company, and as stated in Recital B above. 2 IN WITNESS WHEREOF, the parties hereto have executed this First Amendment as of March 2, 1999. "Employer": THE KUSHNER-LOCKE COMPANY, a California corporation By: /s/ BRUCE ST.J LILLISTON ----------------------------------- Title: Chief Operating Officer and President "Employee": /s/ DONALD KUSHNER ----------------------------------- EX-10.2.1 3 EXHIBIT 10.2.1 1 EXHIBIT 10.2.1 FIRST AMENDMENT TO AMENDED AND RESTATED EMPLOYMENT AGREEMENT This First Amendment to Amended and Restated Employment Agreement (the "First Amendment") is entered into by and between Peter Locke, as "Employee," and The Kushner-Locke Company, a California corporation, as "Employer" or "Company," as of March 2, 1999, based upon the following facts: RECITALS A. Employee and Company executed an Amended and Restated Employment Agreement as of October 1, 1997, setting forth the terms and conditions of Employee's employment by Company. B. On March 2, 1999, a special meeting of the Board of Directors of Company was held at which the Board of Directors took the following action: (1) granted to Employee 50,000 shares of restricted common stock of The Kushner-Locke Company with the terms and conditions of such restrictions to be determined by the Board at a later date; (2) accelerated the vesting of one-half of all previously issued but currently unvested stock options granted to Employee; (3) amended the Amended and Restated Employment Agreement of Employee dated October 1, 1997 to immediately increase Employee's Salary by $25,000 on an annual basis, effective as of March 2, 1999; (4) extended the term of Employee's Amended and Restated Employment Agreement to expire on March 2, 2004; (5) established Employee's annualized Base Salary for the employment year ending September 30, 2003 at $550,000 and established the annualized Base Salary for the partial employment year ending March 2, 2004 at $575,000; and (6) ratified and confirmed the Amended and Restated Employment Agreement except as so amended. A true and correct copy of the Minutes of Directors' Meeting of The Kushner-Locke Company of March 2, 1999 is attached as Exhibit A to this First Amendment to Amended and Restated Employment Agreement. C. Company and Employee now wish to amend Employee's Amended and Restated Employment Agreement to reflect the action taken by Company's Board of Directors on March 2, 1999. NOW, THEREFORE, in consideration of the parties' mutual promises contained herein and in the Amended and Restated Employment Agreement, which consideration is acknowledged to be adequate and sufficient, the parties hereto hereby agree as follows: AGREEMENT 1. The above Recitals are hereby incorporated in this First Amendment by reference. 2. Employee's Amended and Restated Employment Agreement is hereby amended in conformance with the March 2, 1999 Minutes of Directors' Meeting of The Kushner-Locke Company, and as stated in Recital B above. 2 IN WITNESS WHEREOF, the parties hereto have executed this First Amendment as of March 2, 1999. "Employer": THE KUSHNER-LOCKE COMPANY, a California corporation By: /s/ BRUCE ST.J LILLISTON ------------------------------------ Title: Chief Operating Officer and President /s/ PETER LOCKE "Employee": ------------------------------------ EX-10.65 4 EXHIBIT 10.65 1 EXHIBIT 10.65 As of December 9, 1999 The Kushner-Locke Company 11601 Wilshire Boulevard, 21st floor Los Angeles, California 90025 Dear Sirs: Reference is hereby made to that certain Credit, Security, Guaranty and Pledge Agreement, dated as of June 19, 1996 (as the same has been, and may be, amended, supplemented or otherwise modified, renewed or replaced from time to time, the "Credit Agreement"), among The Kushner-Locke Company (the "Borrower"), the Guarantors referred to therein, the Lenders referred to therein, and The Chase Manhattan Bank (formerly known as Chemical Bank), as Agent. Capitalized terms used herein and not otherwise defined are used herein as defined in the Credit Agreement. You have requested that the Required Lenders waive compliance with Section 6.17 (Overhead Expenses) of the Credit Agreement solely with respect to the requirement for fiscal year 1999. Each of the undersigned hereby waives the Credit Parties' non-compliance with Section 6.17 of the Credit Agreement solely with respect to the requirement for fiscal year 1999. By its execution hereof, the Credit Parties hereby represents and warrants that as of the date hereof, there exists no Default or Event of Default. This waiver may be executed in counterparts, each of which shall constitute an original, but all of which when taken together, shall constitute one and the same instrument. This waiver shall become effective when the Agent shall have received executed counterparts of this waiver which, when taken together, bear the signatures of the Required Lenders and all the Credit Parties. This waiver shall not be construed as extending to any other matter, similar or dissimilar, or entitling the Credit Parties to any future waivers regarding similar matters or otherwise. Except to the extent expressly set forth above, this letter does not constitute a waiver or modification of any provision of the Credit Agreement or a waiver of any Default or Event of Default, whether or not known to the Agent or the Lenders. Except as expressly modified herein, all terms of the Credit Agreement remain in full force and effect. THIS WAIVER SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK. Very truly yours, THE CHASE MANHATTAN BANK, individually and as Agent 2 By: /s/ CONSTANCE M. COLEMAN -------------------------------------- Name: Constance M. Coleman Title: Vice President DE NATIONALE INVESTERINGSBANK N.V. By: /s/ ERIC SNATERSE -------------------------------------- Name: Eric Snaterse Title: Senior Vice President By: /s/ H. Rynberg -------------------------------------- Name: H. Rynberg Title: Vice President COMERICA BANK -- CALIFORNIA By: /s/ D. JEFFREY ANDRICK ------------------------------------- Name: D. Jeffrey Andrick Title: First Vice President FAR EAST NATIONAL BANK By: /s/ CHARLES H. AVIS ------------------------------------ Name: Charles H. Avis Title: Regional Vice President AGREED TO BY: THE KUSHNER-LOCKE COMPANY KL PRODUCTIONS, INC. KL INTERNATIONAL, INC. ACME PRODUCTIONS, INC. KUSHNER-LOCKE PRODUCTIONS, INC. THE RELATIVES COMPANY POST AND PRODUCTION SERVICES, INC. L-K ENTERTAINMENT, INC. INTERNATIONAL COURTROOM NEWS SERVICE FAMILY PICTURES, INC. TROPICAL HEAT, INC. KL SYNDICATION, INC. ANDRE PRODUCTIONS, INC. TKLC NO. 2, INC. TWILIGHT ENTERTAINMENT, INC. KLC FILMS, INC. KL FEATURES, INC. 3 KLF GUILD CO. KLF DEVELOPMENT CO. KLTV GUILD CO. KLTV DEVELOPMENT CO. KUSHNER-LOCKE INTERNATIONAL, INC. KL INTERACTIVE MEDIA, INC. DAYTON WAY PICTURES, INC. DAYTON WAY PICTURES II, INC. DAYTON WAY PICTURES III, INC. DAYTON WAY PICTURES IV, INC. FW COLD CO., INC. By /s/ BRUCE LILLISTON ------------------------------------ Name: Bruce Lilliston Title: President and Chief Operating Officer KLC/NEW CITY By its General Partner THE KUSHNER-LOCKE COMPANY By /s/ BRUCE LILLISTON ------------------------------------ Name: Bruce Lilliston Title: President and Chief Operating Officer 4 Exhibit 10.12.2 STANDARD OFFICE LEASE BY AND BETWEEN ARDEN REALTY LIMITED PARTNERSHIP, Maryland limited partnership AS LANDLORD, AND THE KUSHNER-LOCKE COMPANY, a California corporation, AS TENANT SUITES 2030 and 2100 WORLD SAVINGS CENTER TABLE OF CONTENTS PAGES ARTICLE 1 BASIC LEASE PROVISIONS 1 ARTICLE 2 TERM/PREMISES 2 ARTICLE 3 RENTAL 2 (a) Basic Rental 2 (b) Increase in Direct Costs 2 (c) Definitions 2 d) Determination of Payment 5 ARTICLE 4 SECURITY DEPOSIT 7 ARTICLE 5 HOLDING OVER 7 ARTICLE 6 PERSONAL PROPERTY TAXES 7 ARTICLE 7 USE 8 ARTICLE 8 CONDITION OF PREMISES 8 ARTICLE 9 REPAIRS AND ALTERATIONS 9 ARTICLE 10 LIENS 10 ARTICLE 11 PROJECT SERVICES 10 ARTICLE 12 RIGHTS OF LANDLORD 12 ARTICLE 13 INDEMNITY; EXEMPTION OF LANDLORD FROM LIABILITY 12 (a) Indemnity 12 (b) Exemption of Landlord from Liability 13 ARTICLE 14 INSURANCE 13 (a) Tenant's Insurance 13 (b) Form of Policies 13 5 (c) Landlord's Insurance 14 (d) Waiver of Subrogation 14 (e) Compliance with Law 14 ARTICLE 15 ASSIGNMENT AND SUBLETTING 15 ARTICLE 16 DAMAGE OR DESTRUCTION 17 ARTICLE 17 SUBORDINATION 19 ARTICLE 18 EMINENT DOMAIN 19 ARTICLE 19 DEFAULT 20 (a) Tenant's Default 20 (b) Landlord's Default 20 ARTICLE 20 REMEDIES 20 ARTICLE 21 TRANSFER OF LANDLORD'S INTEREST 21 ARTICLE 22 BROKER 22 ARTICLE 23 PARKING 22 ARTICLE 24 WAIVER 23 ARTICLE 25 ESTOPPEL CERTIFICATE 23 ARTICLE 26 LIABILITY OF LANDLORD 23 ARTICLE 27 INABILITY TO PERFORM 24 ARTICLE 28 HAZARDOUS WASTE 24 ARTICLE 29 SURRENDER OF PREMISES; REMOVAL OF PROPERTY 25 ARTICLE 30 MISCELLANEOUS 25 (a) Severability; Entire Agreement 25 (b) Attorneys' Fees; Waiver of Jury Trial 26 (c) Time of Essence 26 (d) Headings; Joint and Several 26 (e) Reserved Area 26 (f) No Option 26 (g) Use of Project Name; Improvements 26 (h) Rules and Regulations 26 (i) Quiet Possession 27 (j) Rent 27 (k) Successors and Assigns 27 (l) Notices 27 (m) Intentionally Omitted 27 (n) Right of Landlord to Perform 27 (o) Access, Changes in Project, Facilities, Name 27 (p) Signing Authority 28 (q) Intentionally Omitted 28 (r) Substitute Premises 28 (s) Survival of Obligations 28 (t) Reasonable Consent 28 (u) Governing Law 28 (v) Exhibits and Addendum 29 ARTICLE 31 OPTION TO EXTEND 29 (a) Option Right 29 (b) Option Rent 29 (c) Exercise of Option 29 (d) Determination of Market Rent 30 ARTICLE 32 RIGHT OF FIRST OFFER 31 ARTICLE 33 SIGNAGE 32 ARTICLE 34 STORAGE SPACE 32 (a) Monthly Storage Rent. 33 (b) Indemnification. 33 (c) Use of Storage Space 33 (d) Incorporation of Lease Provisions. 33 Exhibit "A" Premises Exhibit "B" Rules and Regulations 6 Exhibit "C" Notice of Lease Term Dates and Tenant's Proportionate Share Exhibit "D" Tenant Work Letter INDEX OF DEFINED TERMS DEFINED TERMS PAGE Abatement Event 11 Abatement Notice 11 ADA 4 Additional Rent 2 Affiliate 16 Affiliated Assignee 16 Alterations 9 Annual Storage Rent 33 Approved Working Drawings Exhibit D Architect Exhibit D Base Year 1 Base, Shell and Core Exhibit D Basic Rental 1 Brokers 1 Claims 12 Code Exhibit D Commencement Date 1 Construction Drawings Exhibit D Contemplated Effective Date 17 Contemplated Term 17 Contemplated Transfer Space 17 Contractor Exhibit D Control 16 Co-Producers 17 Cosmetic Alterations 9 Damage Repair Estimate 17 Direct Costs 2 Economic Terms 31 Eligibility Period 12 Engineers Exhibit D Estimate 5 Estimate Statement 5 Estimated Excess 6 Event of Default 20 Excess 5 Exercise Notice 29 Expiration Date 1 Final Retention Exhibit D Final Space Plan Exhibit D Final Working Drawings Exhibit D First Offer Notice 31 First Offer Space 31 Force Majeure 24 Hazardous Material 24 Improvement Allowance Exhibit D Improvement Allowance Items Exhibit D Intention to Transfer Notice 17 Interest Notice 30 Landlord 1 Landlord Coordination Fee Exhibit D 7 Laws 25 Lease 1 Lease Year 2 Market Rent 29 Miscellaneous Items Exhibit D Objectionable Name 32 Operating Costs 3 Option 29 Option Rent 29 Option Rent Notice 30 Option Term 29 Original Tenant 29 Outside Agreement Date 30 Parking Passes 2 Permits Exhibit D Permitted Use 1 Premises 1 Project 1 Real Property 3 Reassessment 3 Representative 23 Review Period 6 RSF 32 Second Chance Notice 31 Security Deposit 1 Six Month Period 17 Specifications Exhibit D Square Footage 1 Standard Improvement Package Exhibit D Statement 6 Storage Space 32 Superior Leases 31 Superior Rights 31 Tax Costs 3 Tax Increase 3 Tenant 1 Tenant's Acceptance 30 Tenant Improvements 8 Tenant's Agents Exhibit D Tenant's Proportionate Share 1 Tenant's Signage 32 Term 1 Transfer 15 Transfer Premium 16 Transferee 16 STANDARD OFFICE LEASE This Standard Office Lease ("Lease") is made and entered into as of the 13th day of August, 1999, by and between ARDEN REALTY LIMITED PARTNERSHIP, a Maryland limited partnership ("Landlord"), and THE KUSHNER-LOCKE COMPANY, a California corporation ("Tenant"). Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the premises described as Suites 2030 and 2100, as designated on the plans attached hereto and incorporated herein as Exhibit "A" 8 ("Premises"), of the project ("Project" ") now known as World Savings Center whose address is 11601 Wilshire Boulevard, Los Angeles, California 90025 for the Term and upon the terms and conditions hereinafter set forth, and Landlord and Tenant hereby agree as follows: ARTICLE 1 BASIC LEASE PROVISIONS A. Term: Suite 2100: Five (5) years and three (3) months. Suite 2030: Twenty-one (21) months, subject to extension pursuant to Article 31 below. Commencement Date: April 1, 2000. Expiration Date: Suite 2100: June 30, 2005. Suite 2030: December 31, 2001. B. Square Footage: 23,132 rentable (21,695 usable) square feet, of which 3,774 rentable (3,306 usable) square feet comprise Suite 2030 and the remainder of which comprises Suite 2100. C. Basic Rental: Annual Monthly Monthly Basic Rental Lease Month Basic Rental Basic Rental Per Rentable Square Foot 1-3 $527,409.60 $43,950.80 $1.90 4-33 $804,993.60* $67,082.80* $2.90 34-63 $860,510.40* $71,709.20* $3.10 Subject to decrease in the event Tenant elects not to exercise its option(s) to extend the Term as to Suite 2030. D. Base Year: 2000 E. Tenant's Proportionate: 4.93%, based on a total Project rentable square footage of 469,115. F. Security Deposit: $43,950.80 in accordance with Article 4 of the Lease. G. Permitted: General office use H. Brokers: Travers Realty. I. Parking Passes: Tenant shall have the use of fifty-six (56) unreserved parking passes and fourteen (14) reserved parking passes 9 for use in the Project's parking facility, at the rate provided in Article 23 hereof (which shall be decreased on a pro rata basis in the event Tenant does not exercise its Suite 2030 Option(s) pursuant to Article 31 below). ARTICLE 2 TERM/PREMISES The Term of this Lease shall commence on the Commencement Date as set forth in Article 1.A. of the Basic Lease Provisions and shall end on the Expiration Date set forth in Article 1.A. of the Basic Lease Provisions. For purposes of this Lease, the term "Lease Year" shall mean each consecutive twelve (12) month period during the Lease Term, with the first Lease Year commencing on the Commencement Date. Landlord and Tenant hereby stipulate that the Premises contains the number of square feet specified in Article 1.B. of the Basic Lease Provisions. Landlord may deliver to Tenant a Commencement Letter in a form substantially similar to that attached hereto as Exhibit "C", which Tenant shall execute and return to Landlord within five (5) days of receipt thereof. Failure of Tenant to timely execute and deliver the Commencement Letter shall constitute acknowledgment by Tenant that the statements included in such notice in good faith are true and correct, without exception. ARTICLE 3 RENTAL (a) Basic Rental. Tenant agrees to pay to Landlord during the Term hereof, at Landlord's office or to such other person or at such other place as directed from time to time by written notice to Tenant from Landlord, the initial monthly and annual sums as set forth in Article 1.C of the Basic Lease Provisions, payable in advance on the first day of each calendar month, without demand, setoff or deduction, except as expressly provided in this Lease. (b) Increase in Direct Costs" Increase in Direct Costs. The term "Base Year" means the calendar year set forth in Article 1.D. of the Basic Lease Provisions. If, in any calendar year during the Term of this Lease, the "Direct Costs" (as hereinafter defined) paid or incurred by Landlord shall be higher than the Direct Costs for the Base Year, Tenant shall pay an additional sum for such and each subsequent calendar year equal to the product of the amount set forth in Article 1.E. of the Basic Lease Provisions multiplied by such increased amount of "Direct Costs." In the event either the Premises and/or the Project is expanded, then Tenant's Proportionate Share shall be appropriately adjusted, and as to the calendar year in which such change occurs, Tenant's Proportionate Share for such year shall be determined on the basis of the number of days during that particular calendar year that such Tenant's Proportionate Share was in effect. In the event this Lease shall terminate on any date other than the last day of a calendar year, the additional sum payable hereunder by Tenant during the calendar year in which this Lease terminates shall be prorated on the basis of the relationship which the number of days which have elapsed 10 from the commencement of said calendar year to and including said date on which this Lease terminates bears to three hundred sixty-five (365). Any and all amounts due and payable by Tenant pursuant to Article 3(b),(c) and (d) hereof shall be deemed "Additional Rent" and Landlord shall be entitled to exercise the same rights and remedies upon default in these payments as Landlord is entitled to exercise with respect to defaults in monthly Basic Rental payments. (c) Definitions" As used herein the term "Direct Costs" shall mean the sum of the following: (i) "Tax Costs", which shall mean any and all real estate taxes and other similar charges on real property or improvements, assessments, water and sewer charges, and all other charges assessed, reassessed or levied upon the Project and appurtenances thereto and the parking or other facilities thereof, or the real property thereunder (collectively the "Real Property") or attributable thereto or on the rents, issues, profits or income received or derived therefrom which are assessed, reassessed or levied by the United States, the State of California or any local government authority or agency or any political subdivision thereof, and shall include Landlord's reasonable legal fees, costs and disbursements incurred in connection with proceedings for reduction of Tax Costs or any part thereof; provided, however, if at any time after the date of this Lease the methods of taxation now prevailing shall be altered so that in lieu of or as a supplement to or a substitute for the whole or any part of any Tax Costs, there shall be assessed, reassessed or levied (a) a tax, assessment, reassessment, levy, imposition or charge wholly or partially on the rents, or (b) a tax, assessment, reassessment, levy (including but not limited to any municipal, state or federal levy), imposition or charge measured by or based in whole or in part upon the Real Property and imposed upon Landlord, or (c) a license fee measured by the rent payable under this Lease, then all such taxes, assessments, reassessments or levies or the part thereof so measured or based, shall be deemed to be included in the term "Direct Costs." In no event shall Tax Costs included in Direct Costs for any year subsequent to the Base Year be less than the amount of Tax Costs included in Direct Costs for the Base Year. In addition, when calculating Tax Costs for the Base Year, special assessments shall only be deemed included in Tax Costs for the Base Year to the extent that such special assessments are included in Tax Costs for the applicable subsequent calendar year during the Term. Notwithstanding anything to the contrary contained in this Section 3(c)(i), there shall be excluded from Tax Costs (i) all excess profits taxes, franchise taxes, gift taxes, capital stock taxes, inheritance and succession taxes, estate taxes, federal and state income taxes, and other taxes to the extent applicable to Landlord's general or net income (as opposed to rents or receipts attributable to operations at the Project), (ii) any items included as Operating Costs, (iii) any items paid by Tenant under Article 6 of this Lease, and (iv) any assessments on other leasehold improvements in the Project to the extent such assessment is attributable to a level of improvement for which Tenant would be directly responsible pursuant to Article 6 of this Lease. Notwithstanding anything to the contrary contained in this Lease, in the event that, at any time during the first two (2) Lease Years, any sale, refinancing, or change in ownership of the Real Property is consummated, and as a result thereof, and to the extent that in connection therewith, the Real Property is reassessed (the 11 "Reassessment") for real estate tax purposes by the appropriate governmental authority pursuant to the terms of Proposition 13, then the following provisions shall apply to such Reassessment of the Real Property. For purposes of this Section 3(c)(i), the term "Tax Increase " shall mean that portion of the Tax Costs, as calculated immediately following the Reassessment, which is attributable solely to the Reassessment. Accordingly, the term Tax Increase shall not include any portion of the Tax Costs, as calculated immediately following the Reassessment, which (1) is attributable to the initial assessment of the value of the Real Property, the Base, Shell and Core of the Project or the tenant improvements located in the Project, (2) is attributable to assessments which were pending immediately prior to the Reassessment which assessments were conducted during, and included in, such Reassessment, or which assessments were otherwise rendered unnecessary following the Reassessment, or (3) is attributable to the annual inflationary increase of real estate taxes permitted to be assessed annually under Proposition 13. During the first two (2) years of the initial Lease Term, any Tax Increase shall be excluded from Tax Costs. After the first two (2) years of the initial Lease Term, any Tax Increase shall be included in Tax Costs. (ii) "Operating Costs ", which shall mean all costs and expenses incurred by Landlord in connection with the maintenance, operation, ownership and repair of the Project, the equipment, the intrabuilding network cable, adjacent walks, malls and landscaped and common areas and the parking structure, areas and facilities of the Project, including, but not limited to, salaries, wages, medical, surgical and general welfare benefits and pension payments, payroll taxes, fringe benefits, employment taxes, workers' compensation, uniforms and dry cleaning thereof for all persons who perform duties connected with the operation, maintenance and repair of the Project, its equipment, the intrabuilding network cable and the adjacent walks and landscaped areas, including janitorial, gardening, security, parking, operating engineer, elevator, painting, plumbing, electrical, carpentry, heating, ventilation, air conditioning, window washing, hired services, a reasonable allowance for depreciation of the cost of acquiring or the rental expense of personal property used in the maintenance, operation and repair of the Project, accountant's fees incurred in the preparation of rent adjustment statements, legal fees, real estate tax consulting fees, personal property taxes on property used in the maintenance and operation of the Project, fees, costs, expenses or dues payable pursuant to the terms of any covenants, conditions or restrictions or owners' association pertaining to the Project, capital expenditures incurred which are reasonably anticipated to effect economies of operation of the Project in an amount in excess of the expenditure and capital expenditures required by government regulations, laws, or ordinances not in effect as of the Commencement Date; the cost of all charges for electricity, gas, water and other utilities furnished to the Project, including any taxes thereon; the cost of all charges for fire and extended coverage, liability and all other insurance for the Project carried by Landlord; the cost of all building and cleaning supplies and materials; the cost of all charges for cleaning, maintenance and service contracts and other services with independent contractors and administration fees; a commercially reasonable property management fee (which fee may be imputed if 12 Landlord has internalized management or otherwise acts as its own property manager) and license, permit and inspection fees relating to the Project. In the event, during any calendar year, the Project is less than ninety-five percent (95%) occupied at all times, Operating Costs shall be adjusted to reflect the Operating Costs of the Project as though ninety-five percent (95%) were occupied at all times, and the increase or decrease in the sums owed hereunder shall be based upon such Operating Costs as so adjusted. Notwithstanding anything to the contrary set forth in this Article 3, when calculating Operating Costs for the Base Year, Operating Costs shall exclude (a) market-wide labor-rate increases due to extraordinary circumstances including, but not limited to, boycotts and strikes, (b) utility rate increases due to extraordinary circumstances including, but not limited to, conservation surcharges, boycotts, embargoes or other shortages, and (c) amortization of any capital items including, but not limited to, capital improvements, capital repairs and capital replacements (including such amortized costs where the actual improvement, repair or replacement was made in prior years). Notwithstanding anything above to the contrary, Operating Costs shall not include (1) the cost of providing any service directly to and paid directly by any tenant (outside of such tenant's Direct Cost payments); (2) the cost of any items for which Landlord is reimbursed by insurance proceeds, condemnation awards, a tenant of the Project, or otherwise to the extent so reimbursed; (3) any real estate brokerage commissions or other costs incurred in procuring tenants, or any fee in lieu of commission; (4) depreciation, amortization of principal and interest on mortgages or ground lease payments (if any); (5) costs of items considered capital repairs, replacements, improvements and equipment under generally accepted accounting principles consistently applied except as expressly included in Operating Costs pursuant to the definition above; (6) costs incurred by Landlord due to the violation by Landlord or any tenant of the terms and conditions of any lease of space in the Project or any law, code, regulation, ordinance or the like; (7) Landlord's general corporate overhead and general and administrative expenses; (8) any compensation paid to clerks, attendants or other persons in commercial concessions operated by Landlord (other than in the parking facility for the Project); (9) costs incurred in connection with upgrading the Project to comply with disability, life, seismic, fire and safety codes, ordinances, statutes, or other laws in effect prior to the Commencement Date, including, without limitation, the Americans with Disabilities Act ("ADA"), including penalties or damages incurred due to such non-compliance; (10) bad debt expenses and interest, principal, points and fees on debts (except in connection with the financing of items which may be included in Operating Costs) or amortization on any ground lease, mortgage or mortgages or any other debt instrument encumbering the Project (including the land on which the Project is situated); (11) marketing costs, including leasing commissions, attorneys' fees in connection with the negotiation and preparation of letters, deal memos, letters of intent, leases, subleases and/or assignments, space planning costs, and other costs and expenses incurred in connection with lease, sublease and/or assignment negotiations and transactions with present or prospective tenants or other occupants of the Project, including attorneys' fees and other costs and expenditures incurred in connection with disputes with present or prospective tenants or other occupants of the Project; (12) real estate brokers' leasing commissions; (13) costs, 13 including permit, license and inspection costs, incurred with respect to the installation of other tenants' or occupants' improvements made for tenants or other occupants in the Project or incurred in renovating or otherwise improving, decorating, painting or redecorating vacant space for tenants or other occupants in the Project; (14) any costs expressly excluded from Operating Costs elsewhere in this Lease; (15) costs of any items (including, but not limited to, costs incurred by Landlord for the repair of damage to the Project) to the extent Landlord receives reimbursement from insurance proceeds or from a third party (except that any deductible amount under any insurance policy shall be included within Operating Costs); (16) rentals and other related expenses for leasing an HVAC system, elevators, or other items (except when needed in connection with normal repairs and maintenance of the Project) which if purchased, rather than rented, would constitute a capital improvement not included in Operating Costs pursuant to this Lease; (17) depreciation, amortization and interest payments, except as specifically included in Operating Costs pursuant to the terms of this Lease and except on materials, tools, supplies and vendor-type equipment purchased by Landlord to enable Landlord to supply services Landlord might otherwise contract for with a third party, where such depreciation, amortization and interest payments would otherwise have been included in the charge for such third party's services, all as determined in accordance with generally accepted accounting principles, consistently applied, and when depreciation or amortization is permitted or required, the item shall be amortized over its reasonably anticipated useful life; (18) costs incurred by Landlord for alterations (including structural additions), repairs, equipment and tools which are of a capital nature and/or which are considered capital improvements or replacements under generally accepted accounting principles, consistently applied, except as specifically included in Operating Costs pursuant to the terms of this Lease; (19) expenses in connection with services or other benefits which are not offered to Tenant or for which Tenant is charged for directly but which are provided to another tenant or occupant of the Project, without charge; (20) electric power costs or other utility costs for which any tenant directly contracts with the local public service company (but Landlord shall have the right to "gross up" as if such space was vacant); (21) costs incurred in connection with the operation of retail stores selling merchandise and restaurants in the Project to the extent such costs are in excess of the costs Landlord reasonably estimates would have been incurred had such space been used for general office use; (22) costs (including in connection therewith all attorneys' fees and costs of settlement, judgments and/or payments in lieu thereof) arising from claims, disputes or potential disputes in connection with potential or actual claims litigation or arbitrations pertaining to Landlord and/or the Project, other than such claims or disputes respecting any services or equipment used in the operation of the Building by Landlord; (23) costs associated with the operation of the business of the partnership which constitutes Landlord as the same are distinguished from the costs of operation of the Project; (24) costs incurred in connection with the original construction of the Project; (25) costs of correcting defects in or inadequacy of the initial design or construction of the Project; (26) costs incurred to (i) comply with laws relating to the removal of any "Hazardous Material," as that term is defined in Article 28 of this Lease, and (ii) remove, remedy, contain, or treat any Hazardous Material; and (27) any cost incurred in order to correct problems in the Project resulting from the so called 14 "year 2000" computer issue. If Landlord does not carry earthquake insurance for the Project during any part of the Base Year but subsequently obtains earthquake insurance for the Project during the Lease Term, then from and after the date upon which Landlord obtains such earthquake insurance and continuing throughout the period during which Landlord maintains such insurance, Operating Costs for the Base Year shall be deemed to be increased by the amount of the premium Landlord reasonably estimates it would have incurred had Landlord maintained such insurance for the same period of time during the Base Year as such insurance was maintained by Landlord during such subsequent calendar year. (d) Determination of Payment (i) If for any calendar year ending or commencing within the Term, Tenant's Proportionate Share of Direct Costs for such calendar year exceeds Tenant's Proportionate Share of Direct Costs for the Base Year, then Tenant shall pay to Landlord, in the manner set forth in Sections 3(d)(ii) and (iii), below, and as additional rent, an amount equal to the excess (the "Excess"). (ii) Landlord shall give Tenant a yearly expense estimate statement (the "Estimate Statement") which shall set forth Landlord's reasonable estimate (the "Estimate") of what the total amount of Direct Costs for the then-current calendar year shall be and the estimated Excess (the "Estimated Excess ") as calculated by comparing Tenant's Proportionate Share of Direct Costs for such calendar year, which shall be based upon the Estimate, to Tenant's Proportionate Share of Direct Costs for the Base Year. The failure of Landlord to timely furnish the Estimate Statement for any calendar year shall not preclude Landlord from enforcing its rights to collect any Estimated Excess under this Article 3. If pursuant to the Estimate Statement an Estimated Excess is calculated for the then-current calendar year, Tenant shall pay, with its next installment of Monthly Basic Rental due, a fraction of the Estimated Excess for the then-current calendar year (reduced by any amounts paid pursuant to the last sentence of this Section 3(d)(ii)). Such fraction shall have as its numerator the number of months which have elapsed in such current calendar year to the month of such payment, both months inclusive, and shall have twelve (12) as its denominator. Until a new Estimate Statement is furnished, Tenant shall pay monthly, with the Monthly Basic Rental installments, an amount equal to one-twelfth (1/12) of the total Estimated Excess set forth in the previous Estimate Statement delivered by Landlord to Tenant. (iii) In addition, Landlord shall endeavor to give to Tenant on or before the first day of April following the end of each calendar year, a statement (the "Statement") which shall state the Direct Costs incurred or accrued for such preceding calendar year, and which shall indicate the amount, if any, of the Excess. Upon receipt of the Statement for each calendar year during the Term, if amounts paid by Tenant as Estimated Excess are less than the actual Excess as specified on the Statement, Tenant shall pay, with its next installment of Monthly Basic Rental due, the full amount of the Excess for such calendar year, less the amounts, if any, paid during such calendar year as Estimated Excess. If, however, the Statement indicates that amounts paid by Tenant as Estimated Excess are greater than the actual Excess as specified on the Statement, such overpayment shall be credited 15 against Tenant's next installments of Estimated Excess. The failure of Landlord to timely furnish the Statement for any calendar year shall not prejudice Landlord from enforcing its rights under this Article 3. Even though the Term has expired and Tenant has vacated the Premises, when the final determination is made of Tenant's Proportionate Share of the Direct Costs for the calendar year in which this Lease terminates, if an Excess is present, Tenant shall promptly pay to Landlord an amount as calculated pursuant to the provisions of this Article 3(d). The provisions of this Section 3(d)(iii) shall survive the expiration or earlier termination of the Term. (iv) Within one hundred eighty (180) days after receipt of a Statement by Tenant ("Review Period"), if Tenant disputes the amount set forth in the Statement, Tenant's employees or an independent certified public accountant designated by Tenant, may, after reasonable notice to Landlord and at reasonable times, inspect Landlord's records at Landlord's offices, provided that Tenant is not then in default after expiration of all applicable cure periods and provided further that Tenant and such accountant or representative shall, and each of them shall use their commercially reasonable efforts to cause their respective agents and employees to, maintain all information contained in Landlord's records in strict confidence. Notwithstanding the foregoing, Tenant shall only have the right to review Landlord's records one (1) time during any twelve (12) month period. Tenant's failure to dispute the amounts set forth in any Statement within the Review Period shall be deemed to be Tenant's approval of such Statement and Tenant, thereafter, waives the right or ability to dispute the amounts set forth in such Statement. If after such inspection, but within thirty (30) days after the Review Period, Tenant notifies Landlord in writing that Tenant still disputes such amounts, a certification as to the proper amount shall be made in accordance with Landlord's standard accounting practices, at Tenant's expense, by an independent certified public accountant selected by Landlord and who is a member of a nationally or regionally recognized accounting firm. Landlord shall cooperate in good faith with Tenant and the accountant to show Tenant and the accountant the information upon which the certification is to be based. However, if such certification by the accountant proves that the Direct Costs set forth in the Statement were overstated by more than five percent (5%), then the cost of the accountant and the cost of such certification shall be paid for by Landlord. Promptly following the parties receipt of such certification, the parties shall make such appropriate payments or reimbursements, as the case may be, to each other, as are determined to be owing pursuant to such certification. ARTICLE 4 SECURITY DEPOSIT Tenant has previously deposited with Landlord the sum set forth in Article 1.F. of the Basic Lease Provisions in connection with its previous lease of the Premises. Landlord shall continue to hold said Security Deposit in accordance with the terms of this Article 4 and as security for the full and faithful performance of every provision of this Lease to be performed by Tenant. If Tenant breaches any provision of this Lease, including but not limited to the payment of rent, Landlord may use such part of this security deposit required for the payment of any rent or any other sums in default, or to compensate 16 Landlord for any other loss or damage which Landlord may suffer by reason of Tenant's default. If any portion of said deposit is so used or applied, Tenant shall, within fifteen (15) days after written demand therefor, deposit cash with Landlord in an amount sufficient to restore the security deposit to its original amount. Tenant agrees that Landlord shall not be required to keep the security deposit in trust, segregate it or keep it separate from Landlord's general funds but Landlord may commingle the security deposit with its general funds and Tenant shall not be entitled to interest on such deposit. At the expiration of the Lease Term, and provided there exists no default by Tenant hereunder, the security deposit or any balance thereof shall be returned to Tenant (or, at Landlord's option, to Tenant's assignee), provided that subsequent to the expiration of this Lease, Landlord may retain from said security deposit any and all amounts permitted by law or this Article 4. Tenant hereby waives the provisions of Section 1950.7 of the California Civil Code and all other provisions of law, now or hereafter in effect, to the extent the same are inconsistent with Landlord's right to claim those sums specified in this Article 4 above and/or those sums reasonably necessary to compensate Landlord for any other loss or damage, foreseeable or unforeseeable, caused by the acts or omissions of Tenant or any officer, employee, agent, contractor or invitee of Tenant. ARTICLE 5 HOLDING OVER Should Tenant, without Landlord's written consent, hold over after termination of this Lease, Tenant shall become a tenant from month to month, only upon each and all of the terms herein provided as may be applicable to a month to month tenancy and any such holding over shall not constitute an extension of this Lease. During such holding over, Tenant shall pay in advance, monthly, rent at one hundred fifty percent (150%) of the rate in effect for the last month of the Term of this Lease, in addition to, and not in lieu of, all other payments required to be made by Tenant hereunder including but not limited to Tenant's Proportionate Share of any increase in Direct Costs. Nothing contained in this Article 5 shall be construed as consent by Landlord to any holding over of the Premises by Tenant, and Landlord expressly reserves the right to require Tenant to surrender possession of the Premises to Landlord as provided in this Lease upon the expiration or earlier termination of the Term. If Landlord notifies Tenant in writing at least thirty (30) days prior to the Lease Expiration Date that Landlord has signed proposal from a succeeding tenant to lease the Premises, and if Tenant fails to surrender the Premises upon the expiration or termination of this Lease, Tenant agrees to indemnify, defend and hold Landlord harmless from all costs, loss, expense or liability, including without limitation, claims made by any succeeding tenant and real estate brokers claims and attorney's fees. ARTICLE 6 PERSONAL PROPERTY TAXES Tenant shall pay, prior to delinquency, all taxes assessed against or levied upon trade fixtures, furnishings, equipment and all other personal property of Tenant located in the Premises. In the event any or all of Tenant's trade fixtures, furnishings, equipment and other personal property shall be assessed and taxed with property of 17 Landlord, or if the cost or value of any leasehold improvements in the Premises exceeds the cost or value of a Project-standard buildout as determined by Landlord and, as a result, real property taxes for the Project are increased, Tenant shall pay to Landlord its share of such taxes within thirty (30) days after delivery to Tenant by Landlord of a statement in writing setting forth the amount of such taxes applicable to Tenant's property or above-standard improvements and Tenant's receipt of substantiating documentation. Tenant shall assume and pay to Landlord at the time of paying Basic Rental any excise, sales, use, rent, occupancy, garage, parking, gross receipts or other taxes (other than net income taxes) which may be imposed on or on account of letting of the Premises or the payment of Basic Rental or any other sums due or payable hereunder, and which Landlord may be required to pay or collect under any law now in effect or hereafter enacted. Tenant shall pay directly to the party or entity entitled thereto all business license fees, gross receipts taxes and similar taxes and impositions which may from time to time be assessed against or levied upon Tenant, as and when the same become due and before delinquency. Notwithstanding anything to the contrary contained herein, any sums payable by Tenant under this Article 6 shall not be included in the computation of "Tax Costs." ARTICLE 7 USE Tenant shall use and occupy the Premises only for the use set forth in Article 1.G. of the Basic Lease Provisions and shall not use or occupy the Premises or permit the same to be used or occupied for any other purpose without the prior written consent of Landlord, which consent may be given or withheld in Landlord's sole and absolute discretion, and Tenant agrees that it will use the Premises in such a manner so as not to unreasonably interfere with or infringe the rights of other tenants in the Project. Tenant shall, at its sole cost and expense, promptly comply with all laws, statutes, ordinances and governmental regulations or requirements now in force or which may hereafter be in force relating to or affecting (i) the condition, use or occupancy of the Premises or the Project excluding structural changes to the Project not related to Tenant's particular use of the Premises, and (ii) improvements installed or constructed in the Premises by or for the benefit of Tenant. Tenant shall not do or permit to be done anything which would invalidate or increase the cost of any fire and extended coverage insurance policy covering the Project and/or the property located therein and Tenant shall comply with all rules, orders, regulations and requirements of any organization which sets out standards, requirements or recommendations commonly referred to by major fire insurance underwriters. Tenant shall within thirty (30) days after demand reimburse Landlord for any additional premium charges for any such insurance policy assessed or increased, to the extent such assessment or increase is attributable to Tenant's failure to comply with the provisions of this Article after Tenant's receipt of substantiating documentation. Landlord represents that Landlord has taken or shall take the necessary steps to comply with what Landlord reasonably believes are the requirements of ADA in effect as of the date of this Lease as it pertains to the common areas within the Project. Operating Costs shall not include any cost incurred by Landlord in connection with upgrading the Project to comply with the requirements of the ADA that are in effect as of the date of this 18 Lease, including penalties or damages incurred due to such noncompliance. ARTICLE 8 CONDITION OF PREMISES The Premises shall be renovated as provided in, and subject to, the Tenant Work Letter attached hereto as Exhibit "D" and made a part hereof. The existing leasehold improvements in the Premises as of the date of this Lease, together with the Improvements (as defined in the Tenant Work Letter) may be collectively referred to herein as the "Tenant Improvements" The taking of possession of the Premises by Tenant shall conclusively establish that the Premises and the Project were at such time in satisfactory condition, subject to latent defects. Tenant hereby waives Sections 1941 and 1942 of the Civil Code of California or any successor provision of law. So long as none of the following increases Tenant's obligations or decreases Tenant's rights hereunder (unless the action is required by law), Landlord reserves the right from time to time, but subject to payment by and/or reimbursement from Tenant as otherwise provided herein: (i) to install, use, maintain, repair, replace and relocate for service to the Premises and/or other parts of the Project pipes, ducts, conduits, wires, appurtenant fixtures, and mechanical systems, wherever located in the Premises or the Project, (ii) to alter, close or relocate any facility in the Premises or the Common Areas or otherwise conduct any of the above activities for the purpose of complying with a general plan for fire/life safety for the Project or otherwise and (iii) to comply with any federal, state or local law, rule or order with respect thereto or the regulation thereof not currently in effect. Landlord shall attempt to perform any such work with the least inconvenience to Tenant as possible, and provided Landlord uses commercially reasonable efforts to do so, in no event shall Tenant be permitted to withhold or reduce Basic Rental or other charges due hereunder as a result of same or otherwise make claim against Landlord for interruption or interference with Tenant's business and/or operations except as provided in Section 11(g) below. ARTICLE 9 REPAIRS AND ALTERATIONS Landlord shall maintain the structural portions of the Project including the foundation, floor/ceiling slabs, roof, curtain wall, exterior glass, columns, beams, shafts, stairs, stairwells, elevator cabs and common areas and shall also maintain and repair the basic mechanical, electrical, lifesafety, plumbing, sprinkler systems and heating, ventilating and air-conditioning systems. Except as expressly provided as Landlord's obligation in this Article 9, Tenant shall keep the Premises in good condition and repair. All damage or injury to the Premises or the Project resulting from the act or negligence of Tenant, its employees, agents or visitors, guests, invitees or licensees or by the use of the Premises shall be promptly repaired by Tenant, at its sole cost and expense (to the extent not covered by Landlord's insurance), to the satisfaction of Landlord; provided, however, that for damage to the Project as a result of casualty or for any repairs that may impact the mechanical, electrical, plumbing, heating, ventilation or air-conditioning systems of the Project, Landlord shall have the right (but not the obligation) to select the contractor and 19 oversee all such repairs. Landlord may make any repairs which are not promptly made by Tenant after Tenant's receipt of written notice and the reasonable opportunity of Tenant to make said repair within fifteen (15) business days from receipt of said written notice, and charge Tenant for the cost thereof, which cost shall be paid by Tenant within five (5) days from invoice from Landlord. Tenant shall be responsible for the design and function of all non-standard improvements of the Premises, whether or not installed by Landlord at Tenant's request. Tenant waives all rights to make repairs at the expense of Landlord, or to deduct the cost thereof from the rent. Tenant shall make no alterations, changes or additions in or to the Premises (collectively, "Alterations ") without Landlord's prior written consent, and then only by contractors or mechanics approved by Landlord in writing and upon the approval by Landlord in writing of fully detailed and dimensioned plans and specifications pertaining to the Alterations in question, to be prepared and submitted by Tenant at its sole cost and expense. Tenant shall at its sole cost and expense obtain all necessary approvals and permits pertaining to any Alterations. If Landlord, in approving any Alterations, specifies a commencement date therefor, Tenant shall not commence any work with respect to such Alterations prior to such date. Notwithstanding anything to the contrary contained herein, Tenant may make strictly cosmetic changes to the finish work in the Premises (the "Cosmetic Alterations") without Landlord's consent, provided that such alterations do not (i) require any structural or other substantial modifications to the Premises, (ii) require any changes to, nor adversely affect, the systems and equipment of the Project, and (iii) affect the exterior appearance of the Project. Tenant shall give Landlord at least fifteen (15) days prior notice of such Cosmetic Alterations, which notice shall be accompanied by reasonably adequate evidence that such changes meet the criteria contained in this Article 9. Tenant hereby indemnifies, defends and agrees to hold Landlord free and harmless from all liens and claims of lien, and all other liability, claims and demands arising out of any work done or material supplied to the Premises by or at the request of Tenant in connection with any Alterations. If permitted Alterations are made, they shall be made at Tenant's sole cost and expense and shall be and become the property of Landlord, except that Landlord may, by written notice to Tenant given at the time of Landlord's consent thereto (or if no consent is required, then within fifteen (15) days after written request by Tenant for such determination by Landlord), require Tenant at Tenant's expense to remove all partitions, counters, railings and other Alterations installed by Tenant, and to repair any damages to the Premises caused by such removal. Any and all costs attributable to or related to the applicable building codes of the city in which the Project is located (or any other authority having jurisdiction over the Project) arising from Tenants plans, specifications, improvements, alterations or otherwise shall be paid by Tenant at its sole cost and expense. With regard to repairs, Alterations or any other work arising from or related to this Article 9 other than Cosmetic Alterations, Landlord shall be entitled to receive an administrative/supervision fee (which fee shall vary depending upon whether or not Tenant orders the work directly from Landlord but shall not exceed five percent (5%)) sufficient to compensate Landlord for all overhead, general conditions, fees and other costs and expenses arising from Landlord's involvement with such work. The construction of initial improvements to the Premises shall be governed by the terms of the Tenant Work Letter and not the terms of this Article 9. 20 ARTICLE 10 LIENS Tenant shall keep the Premises and the Project free from any mechanics' liens, vendors liens or any other liens arising out of any work performed, materials furnished or obligations incurred by Tenant, and agrees to defend, indemnify and hold harmless Landlord from and against any such lien or claim or action thereon, together with costs of suit and reasonable attorneys' fees incurred by Landlord in connection with any such claim or action. Before commencing any work of alteration, addition or improvement to the Premises, Tenant shall give Landlord at least ten (10) business days' written notice of the proposed commencement of such work (to afford Landlord an opportunity to post appropriate notices of non-responsibility). In the event that there shall be recorded against the Premises or the Project or the property of which the Premises is a part any claim or lien arising out of any such work performed, materials furnished or obligations incurred by Tenant and such claim or lien shall not be removed or discharged within ten (10) days of filing, Landlord shall have the right but not the obligation to pay and discharge said lien without regard to whether such lien shall be lawful or correct or to require that Tenant deposit with Landlord in cash, lawful money of the United States, one hundred fifty percent (150%) of the amount of such claim, which sum may be retained by Landlord until such claim shall have been removed of record or until judgment shall have been rendered on such claim and such judgment shall have become final, at which time Landlord shall have the right to apply such deposit in discharge of the judgment on said claim and any costs, including attorneys' fees incurred by Landlord, and shall remit the balance thereof to Tenant. ARTICLE 11 PROJECT SERVICES (a) Landlord agrees to maintain, operate and repair the Building in a first-class manner. Landlord agrees to furnish to the Premises, at a cost to be included in Operating Costs, from 8:00 a.m. to 6:00 p.m. Mondays through Fridays and 9:00 a.m. to 2:00 p.m. on Saturdays, excepting local and national holidays, air conditioning and heat all in such reasonable quantities as in the judgment of Landlord is reasonably necessary for the comfortable occupancy of the Premises. In addition, Landlord shall provide electric current for normal lighting and normal office machines, elevator service and water on the same floor as the Premises for lavatory and drinking purposes in such reasonable quantities as in the judgment of Landlord is reasonably necessary for general office use. Janitorial and maintenance services shall be furnished five (5) days per week, excepting local and national holidays. Tenant shall comply with all rules and regulations which Landlord may reasonably establish for the proper functioning and protection of the common area air conditioning, heating, elevator, electrical intrabuilding network cable and plumbing systems. Except as provided in Section 11(g) below, Landlord shall not be liable for, and there shall be no rent abatement as a result of, any stoppage, reduction or interruption of any such services caused by governmental rules, regulations or ordinances, riot, strike, labor disputes, breakdowns, accidents, necessary repairs or other cause. Except as specifically provided in this Article 11, Tenant agrees to pay for all 21 utilities and other services utilized by Tenant and additional building services furnished to Tenant not uniformly furnished to all tenants of the Project at the rate generally charged by Landlord to tenants of the Project. (b) Tenant will not, without the prior written consent of Landlord, use any apparatus or device in the Premises which will in any way increase the amount of electricity or water usually furnished or supplied for use of the Premises as general office space; nor connect any apparatus, machine or device with water pipes or electric current (except through existing electrical outlets in the Premises), for the purpose of using electric current or water. (c) If Tenant shall require electric current in excess of that which Landlord is obligated to furnish under Article 11(a) above, Tenant shall first obtain the written consent of Landlord, which Landlord may refuse in its sole and absolute discretion, to the use thereof and Landlord may cause an electric current meter or submeter to be installed in the Premises to measure the amount of such excess electric current consumed by Tenant in the Premises. The cost of any such meter and of installation, maintenance and repair thereof shall be paid for by Tenant and Tenant agrees to pay to Landlord, promptly upon demand therefor by Landlord, for all such excess electric current consumed by any such use as shown by said meter at the rates charged for such service by the city in which the Project is located or the local public utility, as the case may be, furnishing the same, plus any additional expense incurred by Landlord in keeping account of the electric current so consumed. (d) If any lights, machines or equipment (including but not limited to computers) are used by Tenant in the Premises which materially affect the temperature otherwise maintained by the air conditioning system, or generate substantially more heat in the Premises than would be generated by the building standard lights and usual office equipment, Landlord shall have the right to install any machinery and equipment which Landlord reasonably deems necessary to restore temperature balance, including but not limited to modifications to the standard air conditioning equipment, and the cost thereof, including the cost of installation and any additional cost of operation and maintenance occasioned thereby, shall be paid by Tenant to Landlord upon demand by Landlord. Landlord shall not be liable under any circumstances for loss of or injury to property, however occurring, through or in connection with or incidental to failure to furnish any of the foregoing. (e) If Tenant requires heating, ventilation and/or air conditioning during times other than the times provided in Article 11(a) above, Tenant shall give Landlord such advance notice as Landlord shall reasonably require and shall pay Landlord's standard charge for such after-hours use, which standard charge as of the date of this Lease is $3.29 per hour per sector (with approximately twenty-five (25) sectors per floor in the Project), provided that any increase in the charge per hour per sector shall be based upon Landlord's reasonable estimate of increases in its actual cost of providing such service. (f) Landlord may impose a reasonable charge for any utilities or services (other than electric current and heating, ventilation and/or 22 air conditioning which shall be governed by Articles 11(c) and (e) above) utilized by Tenant in excess of the amount or type that Landlord reasonably determines is typical for general office use. (g) An "Abatement Event" shall be defined as an event that prevents Tenant from using the Premises or any portion thereof, as a result of any failure to provide services or access to the Premises, where (i) Tenant does not actually use the Premises or such portion thereof, and (ii) such event is not caused by the negligence or willful misconduct of Tenant, its agents, employees or contractors. Tenant shall give Landlord notice ("Abatement Notice") of any such Abatement Event, and if such Abatement Event continues beyond the "Eligibility Period" (as that term is defined below), then the Basic Rental and Tenant's Proportionate Share of Direct Costs and Tenant's obligation to pay for parking shall be abated entirely or reduced, as the case may be, after expiration of the Eligibility Period for such time that Tenant continues to be so prevented from using, and does not use, the Premises or a portion thereof, in the proportion that the rentable area of the portion of the Premises that Tenant is prevented from using, and does not use, bears to the total rentable area of the Premises; provided, however, in the event that Tenant is prevented from using, and does not use, a portion of the Premises for a period of time in excess of the Eligibility Period and the remaining portion of the Premises is not sufficient to allow Tenant to effectively conduct its business therein, and if Tenant does not conduct its business from such remaining portion, then for such time after expiration of the Eligibility Period during which Tenant is so prevented from effectively conducting its business therein, the Basic Rental and Tenant's Proportionate Share of Direct Costs and Tenant's obligation to pay for parking for the entire Premises shall be abated entirely for such time as Tenant continues to be so prevented from using, and does not use, the Premises. If, however, Tenant reoccupies any portion of the Premises during such period, the Basic Rental and Tenant's Proportionate Share of Direct Costs allocable to such reoccupied portion, based on the proportion that the rentable area of such reoccupied portion of the Premises bears to the total rentable area of the Premises, shall be payable by Tenant from the date Tenant reoccupies such portion of the Premises. The term "Eligibility Period" shall mean a period of five (5) consecutive business days after Landlord's receipt of any Abatement Notice(s). Such right to abate Basic Rental and Tenant's Proportionate Share of Direct Costs shall be Tenant's sole and exclusive remedy at law or in equity for an Abatement Event. ARTICLE 12 RIGHTS OF LANDLORD Landlord and its agents shall have the right to enter the Premises at all reasonable times (upon reasonable prior notice to Tenant except in the case of emergency or regularly scheduled service (e.g., janitorial service)) for the purpose of cleaning the Premises, examining or inspecting the same, serving or posting and keeping posted thereon notices as provided by law, or which Landlord deems necessary for the protection of Landlord or the Property, showing the same to prospective tenants (but as to prospective tenants only during the last nine (9) months of the Term or Option Term, as applicable), lenders or purchasers of the Project, in the case of an emergency, and for making 23 such alterations, repairs, improvements or additions to the Premises or to the Project as Landlord may deem necessary or desirable. Landlord shall provide Tenant with an opportunity to have a representative of Tenant accompany Landlord in connection with any such entry (except in the case of an emergency). If Tenant shall not be personally present to open and permit an entry into the Premises at any time when such an entry by Landlord is necessary or permitted hereunder, Landlord may enter by means of a master key or may enter forcibly, only in the case of an emergency, without liability to Tenant and without affecting this Lease. ARTICLE 13 INDEMNITY; EXEMPTION OF LANDLORD FROM LIABILITY (a) Indemnity. Tenant shall indemnify, defend and hold Landlord harmless from any and all claims arising from Tenant's use of the Premises or the Project including Tenant's Signage rights set forth in Article 33 or from the conduct of its business or from any activity, work or thing which may be permitted or suffered by Tenant in or about the Premises or the Project and shall further indemnify, defend and hold Landlord harmless from and against any and all claims arising from any negligence of Tenant or any of its agents, contractors, employees or invitees, patrons, customers or members in or about the Project and from any and all costs, attorneys' fees, expenses and liabilities incurred in the defense of any claim or any action or proceeding brought thereon, including negotiations in connection therewith. However, notwithstanding the foregoing, Tenant shall not be required to indemnify and/or hold Landlord harmless from any loss, cost, liability, damage or expense, including, but not limited to, penalties, fines, attorneys' fees or costs (collectively, "Claims"), to any person, property or entity to the extent resulting from the negligence or willful misconduct of Landlord or its agents, contractors, or employees (except for damage to the Improvements and Tenant's personal property, fixtures, furniture and equipment in the Premises in which case Tenant shall be responsible to the extent Tenant is required to obtain the requisite insurance coverage pursuant to this Lease). Landlord hereby indemnifies Tenant and holds Tenant harmless from any Claims to the extent resulting from the negligence or willful misconduct of Landlord or its agents, contractors or employees; provided, however, that because Landlord maintains insurance on the Project and Tenant compensates Landlord for such insurance as part of Tenant's Proportionate Share of Direct Costs and because of the existence of waivers of subrogation set forth in Article 14 of this Lease, Landlord hereby indemnifies and holds Tenant harmless from any Claims to any property outside of the Premises to the extent such Claim is covered by such insurance, even if resulting from the negligence or willful misconduct of Tenant or those of its agents, contractors, or employees. Similarly, since Tenant must carry insurance pursuant to Article 14 to cover its personal property within the Premises and the Improvements, Tenant hereby indemnifies and holds Landlord harmless from any Claim to any property within the Premises, to the extent such Claim is covered by such insurance, even if resulting from the negligence or willful misconduct of Landlord or those of its agents, contractors, or employees. Tenant hereby assumes all risk of damage to property or injury to persons in or about the Premises from any cause, and Tenant hereby waives all claims in respect thereof against Landlord, excepting and to the extent the damage is caused by the negligence or willful 24 misconduct of Landlord, its agents, employees or contractors (in which case Landlord shall be responsible for such damage to the extent not covered by insurance required to be carried by Tenant under this Lease or actually carried by Tenant). (b) Exemption of Landlord from Liability. Landlord shall not be liable for injury to Tenant's business, or loss of income therefrom, or, except in connection with damage or injury resulting from the negligence or willful misconduct of Landlord, or its authorized agents, employees or contractors (in which case Landlord shall be responsible for such damage to the extent not covered by insurance required to be carried by Tenant under this Lease or actually carried by Tenant) for damage that may be sustained by the person, goods, wares, merchandise or property of Tenant, its employees, invitees, customers, agents, or contractors, or any other person in, on or about the Premises directly or indirectly caused by or resulting from fire, steam, electricity, gas, water, or rain which may leak or flow from or into any part of the Premises, or from the breakage, leakage, obstruction or other defects of the pipes, sprinklers, wires, appliances, plumbing, air conditioning, light fixtures, or mechanical or electrical systems or from intrabuilding network cable, whether such damage or injury results from conditions arising upon the Premises or upon other portions of the Project or from other sources or places and regardless of whether the cause of such damage or injury or the means of repairing the same is inaccessible to Tenant. Landlord shall not be liable to Tenant for any damages arising from any act or neglect of any other tenant of the building. Landlord shall not be liable for losses due to theft, vandalism, or like causes. ARTICLE 14 INSURANCE (a) Tenant's Insurance. Tenant, shall at all times during the Term of this Lease, and at its own cost and expense, procure and continue in force the following insurance coverage: (i) Commercial General Liability Insurance with a combined single limit for bodily injury and property damages of not less than One Million Dollars ($1,000,000) per occurrence and Three Million Dollars ($3,000,000) in the annual aggregate, including products liability coverage if applicable, covering the insuring provisions of this Lease and the performance of Tenant of the indemnity and exemption of Landlord from liability agreements set forth in Article 13 hereof; (ii) a policy of standard fire, extended coverage and special extended coverage insurance (all risks), including a vandalism and malicious mischief endorsement, sprinkler leakage coverage and earthquake sprinkler leakage where sprinklers are provided in an amount equal to the full replacement value new without deduction for depreciation of all (A) Tenant Improvements, Alterations, fixtures and other improvements in the Premises and (B) trade fixtures, furniture, equipment and other personal property installed by or at the expense of Tenant; (iii) Worker's Compensation coverage as required by law; and (iv) business interruption, loss of income and extra expense insurance. Tenant shall carry and maintain during the entire Lease Term (including any option periods, if applicable), at Tenant's sole cost and expense, increased amounts of the insurance required to be carried by Tenant pursuant to 25 this Article 14 and such other reasonable types of insurance coverage and in such reasonable amounts covering the Premises and Tenant's operations therein, as may be reasonably required by Landlord, so long as such increased amounts and/or other types of insurance coverage are then generally required by comparable landlords of comparable first-class, institutional quality office buildings in the vicinity of the Project. (b) Form of Policies. The aforementioned minimum limits of policies and Tenant's procurement and maintenance thereof shall in no event limit the liability of Tenant hereunder. The Commercial General Liability Insurance policy shall name Landlord, Landlord's property manager, Landlord's lender(s) and such other persons or firms as Landlord specifies from time to time, as additional insureds with an appropriate endorsement to the policy(s). All such insurance policies carried by Tenant shall be with companies having a rating of not less than A-VIII in Best's Insurance Guide. Tenant shall furnish to Landlord, from the insurance companies, or cause the insurance companies to furnish, certificates of coverage. No such policy shall be cancelable or subject to reduction of coverage or cancellation except after thirty (30) days prior written notice to Landlord by the insurer. All such policies shall be endorsed to agree that Tenant's policy is primary as to Claims arising within the Premises and that any insurance carried by Landlord is excess and not contributing with any Tenant insurance requirement hereunder. Tenant shall, at least twenty (20) days prior to the expiration of such policies, furnish Landlord with renewals or binders. Tenant agrees that if Tenant does not take out and maintain such insurance or furnish Landlord with renewals or binders, Landlord may (but shall not be required to), upon prior notice to Tenant and the expiration of a five (5) day cure period, procure said insurance on Tenant's behalf and charge Tenant the cost thereof, which amount shall be payable by Tenant upon demand with interest (at the rate set forth in Section 20(e) below) from the date such sums are extended. Tenant shall have the right to provide such insurance coverage pursuant to blanket policies obtained by Tenant, provided such blanket policies expressly afford coverage to the Premises and to Tenant as required by this Lease. (c) Landlord's Insurance. Landlord shall, as a cost to be included in Operating Costs, procure and maintain at all times during the Term of this Lease, a policy or policies of insurance covering loss or damage to the Project in the amount of the full replacement costs without deduction for depreciation thereof (exclusive of Tenant's trade fixtures, inventory, personal property and equipment), providing protection against all perils included within the classification of fire and extended coverage, vandalism coverage and malicious mischief, sprinkler leakage, water damage, and special extended coverage on building. Additionally, Landlord may (but shall not be required to) carry: (i) Bodily Injury and Property Damage Liability Insurance and/or Excess Liability Coverage Insurance; and (ii) Earthquake and/or Flood Damage Insurance; and (iii) Rental Income Insurance at its election or if required by its lender from time to time during the Term hereof, in such amounts and with such limits as Landlord or its lender may deem appropriate. The costs of such insurance shall be included in Operating Costs. However, notwithstanding the foregoing, Landlord shall either carry, or shall be deemed to have elected to self-insure, the Bodily Injury and Property Damage Liability Insurance coverage 26 described in subsection (i) of the immediately preceding sentence, and if Landlord elects to self-insure any or all of such coverage, Tenant shall be deemed to be in the same position it would have been in had Landlord actually purchased such insurance from a third party carrier. (d) Waiver of Subrogation. Landlord and Tenant each agree to have their respective insurers issuing the insurance described in Sections 14(a)(ii), 14(a)(iv) and the first sentence of Section 14(c) waive any rights of subrogation that such companies may have against the other party. Tenant hereby waives any right that Tenant may have against Landlord and Landlord hereby waives any right that Landlord may have against Tenant as a result of any loss or damage to the extent such loss or damage is insurable under such policies. (e) Compliance with Law. Tenant agrees that it will not, at any time, during the Term of this Lease, carry any stock of goods or do anything in or about the Premises that will in any way tend to increase the insurance rates upon the Project. Tenant agrees to pay Landlord within thirty (30) days after demand the amount of any increase in premiums for insurance against loss by fire that may be charged during the Term of this Lease on the amount of insurance to be carried by Landlord on the Project resulting from the foregoing, or from Tenant doing any act in or about said Premises that does so increase the insurance rates, whether or not Landlord shall have consented to such act on the part of Tenant, so long as Tenant receives substantiating documentation. If Tenant installs upon the Premises any electrical equipment which constitutes an overload of electrical lines of the Premises, Tenant shall at its own cost and expense in accordance with all other Lease provisions, and subject to the provisions of Article 9, 10 and 11, hereof, make whatever changes are necessary to comply with requirements of the insurance underwriters and any governmental authority having jurisdiction thereover, but nothing herein contained shall be deemed to constitute Landlord's consent to such overloading. Tenant shall, at its own expense, comply with all requirements of the insurance authority having jurisdiction over the Project necessary for the maintenance of reasonable fire and extended coverage insurance for the Premises, including without limitation thereto, the installation of fire extinguishers or an automatic dry chemical extinguishing system. ARTICLE 15 ASSIGNMENT AND SUBLETTING Tenant shall have no power to, either voluntarily, involuntarily, by operation of law or otherwise, sell, assign, transfer or hypothecate this Lease, or sublet the Premises or any part thereof, or permit the Premises or any part thereof to be used or occupied by anyone other than Tenant or Tenant's employees without the prior written consent of Landlord which shall not be unreasonably withheld. Landlord shall grant or deny consent to a proposed Transfer by written notice to Tenant within ten (10) business days after Landlord's receipt of an executed duplicate original of the Transfer document together with a completed lease application by the Transferee and financial information reasonably requested by Landlord. Landlord's failure to withhold its consent by written notice to Tenant within said ten (10) business day period shall be deemed to constitute Landlord's consent to such Transfer. Tenant may transfer its interest pursuant to this Lease only upon the following express conditions, which conditions are agreed by 27 Landlord and Tenant to be reasonable: (a) That the proposed transferee shall be subject to the prior written consent of Landlord, which consent will not be unreasonably withheld but, without limiting the generality of the foregoing, it shall be reasonable for Landlord to deny such consent if: (i) The use to be made of the Premises by the proposed transferee is (a) not generally consistent with the character and nature of all other tenancies in the Project, or (b) a use which conflicts with any so-called "exclusive" then in favor of, or for any use which is the same as that stated in any percentage rent lease to, another tenant of the Project or any other buildings which are in the same complex as the Project, or (c) a use which would be prohibited by any other portion of this Lease (including but not limited to any Rules and Regulations then in effect); (ii) The financial responsibility of the proposed transferee is not reasonably satisfactory to Landlord; (iii) The proposed transferee is either a governmental agency or instrumentality thereof; or (iv) Either the proposed transferee or any person or entity which directly or indirectly controls, is controlled by or is under common control with the proposed transferee is negotiating with Landlord to lease space in the Project. (b) Whether or not Landlord consents to any such transfer, Tenant shall pay to Landlord Landlord's then standard processing fee and reasonable attorneys' fees incurred in connection with the proposed transfer up to the aggregate sum of $1,000.00; (c) That the proposed transferee shall execute an agreement pursuant to which it shall agree to perform faithfully and be bound by all of the terms, covenants, conditions, provisions and agreements of this Lease applicable to that portion of the Premises so transferred; and (d) That an executed duplicate original of said assignment and assumption agreement or other transfer on a form reasonably approved by Landlord, shall be delivered to Landlord within five (5) days after the execution thereof, and that such transfer shall not be binding upon Landlord until the delivery thereof to Landlord and the execution and delivery of Landlord's consent thereto. It shall be a condition to Landlord's consent to any subleasing, assignment or other transfer of part or all of Tenant's interest in the Premises (hereinafter referred to as a "Transfer") that (i) upon Landlord's consent to any Transfer, Tenant shall pay and continue to pay fifty percent (50%) of any "Transfer Premium" (defined below), received by Tenant from the transferee; (ii) any sublessee of part or all of Tenant's interest in the Premises shall agree that in the event Landlord gives such sublessee notice that Tenant is in default under this Lease, such sublessee shall thereafter make all sublease or other payments directly to Landlord, which will be received by Landlord without any liability whether to honor the sublease or otherwise (except to credit such payments against sums due under this Lease), and any sublessee shall 28 agree to attorn to Landlord or its successors and assigns at their request should this Lease be terminated for any reason, except that in no event shall Landlord or its successors or assigns be obligated to accept such attornment; (iii) any such Transfer and consent shall be effected on forms supplied by Landlord and/or its legal counsel; (iv) Landlord may require that Tenant not then be in default hereunder in any respect; and (v) Tenant or the proposed subtenant or assignee (collectively, "Transferee") shall agree to pay Landlord, upon demand, as additional rent, a sum equal to the additional costs, if any, incurred by Landlord for maintenance and repair as a result of any change in the nature of occupancy caused by such subletting or assignment. "Transfer Premium" shall mean all rent, additional rent or other consideration payable by a Transferee in connection with a Transfer in excess of the rent and Additional Rent payable by Tenant under this Lease during the term of the Transfer and if such Transfer is less than all of the Premises, the Transfer Premium shall be calculated on a rentable square foot basis. In any event, the Transfer Premium shall be calculated after deducting the reasonable expenses incurred by Tenant for (1) any changes, alterations and improvements to the Premises paid for by Tenant in connection with the Transfer, (2) any other out-off-pocket monetary concessionsprovided by Tenant to the Transferee, (3) any brokerage commissions paid for by Tenant in connection with the Transfer, (4) advertising costs incurred in connection with the Transfer, (5) attorneys' fees incurred in connection with the Transfer, (6) lease takeover costs incurred in connection with the Transfer, and (7) the unamortized cost of alterations and improvements made or paid for by Tenant and applicable to the space which is the subject of the Transfer (amortized on a straight-line basis from date of installation until the Expiration Date). "Transfer Premium" shall also include, but not be limited to, key money, bonus money or other cash consideration paid by a transferee to Tenant in connection with such Transfer, and any payment in excess of fair market value for services rendered by Tenant to the Transferee and any payment in excess of fair market value for assets, fixtures, inventory, equipment, or furniture transferred by Tenant to the Transferee in connection with such Transfer. Any sale, assignment, hypothecation, transfer or subletting of this Lease which is not in compliance with the provisions of this Article 15 shall be voidable at the option of Landlord. In no event shall the consent by Landlord to an assignment or subletting be construed as relieving Tenant, any assignee, or sublessee from obtaining the express written consent of Landlord to any further assignment or subletting, or as releasing Tenant from any liability or obligation hereunder whether or not then accrued and Tenant shall continue to be fully liable therefor. No collection or acceptance of rent by Landlord from any person other than Tenant shall be deemed a waiver of any provision of this Article 15 or the acceptance of any assignee or subtenant hereunder, or a release of Tenant (or of any successor of Tenant or any subtenant). Notwithstanding anything to the contrary in this Lease, if Tenant or any proposed Transferee claims that Landlord has unreasonably withheld or delayed its consent under this Article 15 or otherwise has breached or acted unreasonably under this Article 15, their sole remedies shall be a declaratory judgment, an injunction for the relief sought and/or monetary damages, and Tenant hereby waives any right at law or equity to terminate this Lease. The term "Affiliate" shall mean (i) any entity that is controlled 29 by, controls or is under common control with, Tenant or (ii) any entity that merges with, is acquired by, or acquires Tenant through the purchase of stock or assets and where the net worth of the surviving entity as of the date such transaction is completed is not less than the net worth of Tenant as of the date of this Lease, calculated under generally accepted accounting principles. Notwithstanding anything to the contrary contained in this Article 15, an assignment or subletting of all or a portion of the Premises to an Affiliate, shall not be deemed a Transfer under this Article 15, provided that Tenant notifies Landlord of any such assignment or sublease and promptly supplies Landlord with any documents or information requested by Landlord regarding such assignment or sublease or such affiliate, and further provided that such assignment or sublease is not a subterfuge by Tenant to avoid its obligations under this Lease. An assignee of Tenant's entire interest in this Lease pursuant to the immediately preceding sentence may be referred to herein as an "Affiliated Assignee" "Control" ," as used in this Article 15, shall mean the ownership, directly or indirectly, of greater than fifty percent (50%) of the voting securities of, or possession of the right to vote, in the ordinary direction of its affairs, of greater than fifty percent (50%) of the voting interest in, an entity. In addition, notwithstanding anything to the contrary contained in this Article 15, Landlord and Tenant acknowledge that, from time to time, without the Premises being separately demised, certain offices within the Premises may be utilized on a temporary basis by entities or persons ("Co-Producers") with whom Tenant is then working on entertainment-related projects in the ordinary course of its business as an entertainment production company. Upon written request of Landlord, Tenant shall from time to time identify to Landlord in writing the Co-Producers so utilizing the Premises. Such occupancy by the Co-Producers shall not be deemed an assignment or subletting, and shall not require Tenant's compliance with the provisions of this Article 15, so long as Tenant is not being compensated for use of such space beyond reimbursement of Tenant's costs of such space. The amount of all space occupied at any one time by Co-Producers shall not exceed in the aggregate 8,000 usable square feet. Co-Producers shall not have any of the rights of Tenant under this Lease and Landlord shall not be obligated to deal directly with any such Co-Producer. No signage shall be posted outside the Premises or elsewhere in the Project naming any of such Co-Producers as occupants of the Premises or the Project, except as permitted in accordance with Article 33 below. The provisions of this paragraph shall be solely for the benefit of The Kushner-Locke Company and shall not apply to its assignees or subtenants, if any. Notwithstanding anything to the contrary contained in this Article 15, if Tenant contemplates a Transfer to other than an Affiliate or Co- Producer, then Tenant shall give Landlord notice (the "Intention to Transfer Notice") of such contemplated Transfer (whether or not the contemplated Transferee or the terms of such contemplated Transfer have been determined). The Intention to Transfer Notice shall specify the portion of and number of rentable square feet of the Premises which Tenant intends to Transfer (the "Contemplated Transfer Space"), the contemplated date of commencement of the contemplated Transfer (the "Contemplated Effective Date") and the contemplated length of the term of such contemplated Transfer ("Contemplated Term"). Thereafter, Landlord shall have the option, by giving written notice to Tenant within ten (10) business days after Landlord's receipt of the Intention 30 to Transfer Notice, to recapture the Contemplated Transfer Space effective as of the Contemplated Effective Date for the Contemplated Term. In the event that such option is exercised by Landlord, this Lease shall be terminated (or where appropriate, suspended if the last day of the Contemplated Term is not the last day of the Term, and at the end of such suspension period the Premises or the applicable portion thereof, shall be returned to Tenant in the same condition as when received, reasonable wear and tear excepted) with respect to the Contemplated Transfer Space effective as of the Contemplated Effective Date until the last day of the Contemplated Term. In the event of a recapture by Landlord with respect to less than the entire Premises, the Monthly Basic Rental reserved herein shall be prorated on the basis of the number of rentable square feet retained by Tenant in proportion to the number of rentable square feet contained in the entire Premises, and this Lease as so amended shall continue thereafter in full force and effect, and upon request of either party, the parties shall execute written confirmation of the same. If Landlord declines, or fails to elect in a timely manner to recapture as to the Contemplated Transfer Space under this Article 15 within such ten (10) business day period, then, provided Landlord has consented to the proposed Transfer, Tenant shall be entitled to proceed to transfer the Contemplated Transfer Space to a proposed Transferee and Landlord shall not have any right to recapture such Contemplated Transfer Space with respect to any Transfer thereof consummated within a period of six (6) months (the "Six Month Period") commencing on the expiration of such ten (10) business day period; provided, however, that any such Transfer shall be subject to other terms of this Article 15. If such a Transfer is not so consummated within the Six Month Period (or if a Transfer is so consummated, then upon the expiration of the term of any Transfer of such Contemplated Transfer Space consummated within such Six Month Period), Tenant shall again be required to submit a new Intention to Transfer Notice to Landlord with respect to any contemplated Transfer, as provided above in this Article 15. ARTICLE 16 DAMAGE OR DESTRUCTION Within sixty (60) days after the date Landlord learns of the necessity for repairs as a result of damage, Landlord shall notify Tenant ("Damage Repair Estimate") of Landlord's estimated assessment of the period of time in which the repairs will be completed. If the Project is damaged by fire or other insured casualty and the insurance proceeds have been made available therefor by the holder or holders of any mortgages or deeds of trust covering the Premises or the Project, the damage shall be repaired by Landlord to the extent such insurance proceeds are available therefor and provided the Damage Repair Estimate indicates that repairs can be completed within one hundred eighty (180) days after the necessity for repairs as a result of such damage becomes known to Landlord without the payment of overtime or other premiums, and until such repairs are completed rent shall be abated in proportion to the part of the Premises which is unusable by Tenant in the conduct of its business (but there shall be no abatement of rent by reason of any portion of the Premises being unusable for a period equal to one (1) day or less). However, if the damage is due to the fault or neglect of Tenant, its employees, agents, contractors, guests, invitees and the like, there shall be no abatement of rent, unless and to the extent Landlord receives rental income insurance proceeds or would have 31 received such insurance had Landlord carried standard rental income insurance. Upon the occurrence of any damage to the Premises, Tenant shall assign to Landlord (or to any party designated by Landlord) all insurance proceeds payable to Tenant under Section 14(a)(ii)(A) above; provided, however, that if the cost of repair of improvements within the Premises by Landlord exceeds the amount of insurance proceeds received by Landlord from Tenant's insurance carrier, as so assigned by Tenant, plus proceeds received from Landlord's insurance carrier allocable to such leasehold improvements, such excess costs shall be paid by Tenant to Landlord prior to Landlord's repair of such damage. If, however, the Damage Repair Estimate indicates that repairs cannot be completed within one hundred eighty (180) days after the necessity for repairs as a result of such damage becomes known to Landlord without the payment of overtime or other premiums, Landlord may, at its option, either (i) make them in a reasonable time and in such event this Lease shall continue in effect and the rent shall be abated, if at all, in the manner provided in this Article 16, or (ii) elect not to effect such repairs and instead terminate this Lease, by notifying Tenant in writing of such termination within sixty (60) days after Landlord learns of the necessity for repairs as a result of damage, such notice to include a termination date giving Tenant sixty (60) days to vacate the Premises. In addition, Landlord may elect to terminate this Lease if the Project shall be materially damaged by fire or other casualty or cause, whether or not the Premises are affected, and the damage is not fully covered, except for deductible amounts, by Landlord's insurance policies. However, if Landlord does not elect to terminate this Lease pursuant to Landlord's termination right as provided above, and the Damage Repair Estimate indicates that repairs cannot be completed within one hundred eighty (180) days after being commenced, Tenant may elect, not later than thirty (30) days after Tenant's receipt of the Damage Repair Estimate, to terminate this Lease by written notice to Landlord effective as of the date specified in Tenant's notice. Finally, if the Premises or the Project is damaged to any substantial extent during the last twelve (12) months of the Term, then notwithstanding anything contained in this Article 16 to the contrary, Landlord shall have the option to terminate this Lease by giving written notice to Tenant of the exercise of such option within sixty (60) days after Landlord learns of the necessity for repairs as the result of such damage. In the event that the Premises or the Project is destroyed or damaged to any substantial extent during the last twelve (12) months of the Lease Term and if such damage shall take longer than sixty (60) days to repair and if such damage is not the result of the negligence or willful misconduct of Tenant or Tenant's employees, licensees, invitees or agents, then notwithstanding anything in this Article 16 to the contrary, Tenant shall have the option to terminate this Lease by written notice to Landlord of the exercise of such option within sixty (60) days after Tenant learns of the necessity for repairs as the result of such damage. A total destruction of the Project shall automatically terminate this Lease. Except as provided in this Article 16, there shall be no abatement of rent and no liability of Landlord by reason of any injury to or interference with Tenant's business or property arising from such damage or destruction or the making of any repairs, alterations or improvements in or to any portion of the Project or the Premises or in or to fixtures, appurtenances and equipment therein. Tenant understands that Landlord will not carry insurance of any kind on Tenant's furniture, furnishings, trade fixtures or equipment, and that Landlord shall not 32 be obligated to repair any damage thereto or replace the same. Except for proceeds relating to Tenant's furniture, furnishings, trade fixtures and equipment, Tenant acknowledges that Tenant shall have no right to any proceeds of insurance relating to property damage. With respect to any damage which Landlord is obligated to repair or elects to repair, Tenant, as a material inducement to Landlord entering into this Lease, irrevocably waives and releases its rights under the provisions of Sections 1932 and 1933 of the California Civil Code. ARTICLE 17 SUBORDINATION This Lease is subject and subordinate to all ground or underlying leases, mortgages and deeds of trust which affect the property or the Project, including all renewals, modifications, consolidations, replacements and extensions thereof; provided, however, if the lessor under any such lease or the holder or holders of any such mortgage or deed of trust shall advise Landlord that they desire or require this Lease to be prior and superior thereto, upon written request of Landlord to Tenant, Tenant agrees to promptly execute, acknowledge and deliver any and all documents or instruments which Landlord or such lessor, holder or holders deem necessary or desirable for purposes thereof. Landlord shall have the right to cause this Lease to be and become and remain subject and subordinate to any and all ground or underlying leases, mortgages or deeds of trust which may hereafter be executed covering the Premises, the Project or the property or any renewals, modifications, consolidations, replacements or extensions thereof, for the full amount of all advances made or to be made thereunder and without regard to the time or character of such advances, together with interest thereon and subject to all the terms and provisions thereof; provided, however, that a condition precedent to such subordination shall be that Landlord obtains from the lender or other party in question a commercially reasonable non-disturbance agreement in favor of Tenant. Tenant agrees, within twenty (20) days after Landlord's written request therefor, to execute, acknowledge and deliver upon request any and all documents or instruments requested by Landlord or necessary or proper to assure the subordination of this Lease to any such mortgages, deed of trust, or leasehold estates. Tenant agrees that in the event any proceedings are brought for the foreclosure of any mortgage or deed of trust or any deed in lieu thereof, to attorn to the purchaser or any successors thereto upon any such foreclosure sale or deed in lieu thereof as so requested to do so by such purchaser and to recognize such purchaser as the lessor under this Lease; Tenant shall, within fifteen (15) days after request execute such further instruments or assurances as such purchaser may reasonably deem necessary to evidence or confirm such attornment. Tenant agrees to provide copies of any notices of Landlord's default under this Lease to any mortgagee or deed of trust beneficiary whose address has been provided to Tenant and Tenant shall provide such mortgagee or deed of trust beneficiary a commercially reasonable time after receipt of such notice within which to cure any such default. Tenant waives the provisions of any current or future statute, rule or law which may give or purport to give Tenant any right or election to terminate or otherwise adversely affect this Lease and the obligations of the Tenant hereunder in the event of any foreclosure proceeding or sale. 33 ARTICLE 18 EMINENT DOMAIN If the whole of the Premises or the Project or so much thereof as to render the balance unusable by Tenant shall be taken under power of eminent domain, or is sold, transferred or conveyed in lieu thereof, this Lease shall automatically terminate as of the date of such condemnation, or as of the date possession is taken by the condemning authority, at Landlord's option. No award for any partial or entire taking shall be apportioned, and Tenant hereby assigns to Landlord any award which may be made in such taking or condemnation, together with any and all rights of Tenant now or hereafter arising in or to the same or any part thereof; provided, however, that nothing contained herein shall be deemed to give Landlord any interest in or to require Tenant to assign to Landlord any award made to Tenant for the taking of personal property and trade fixtures belonging to Tenant and removable by Tenant at the expiration of the Term hereof as provided hereunder or for the interruption of, or damage to, Tenant's business. In the event of a partial taking described in this Article 18, or a sale, transfer or conveyance in lieu thereof, which does not result in a termination of this Lease, the rent shall be apportioned according to the ratio that the part of the Premises remaining useable by Tenant bears to the total area of the Premises. Tenant hereby waives any and all rights it might otherwise have pursuant to Section 1265.130 of the California Code of Civil Procedure. ARTICLE 19 DEFAULT (a) Tenant's Default. Each of the following acts or omissions of Tenant or of any guarantor of Tenant's performance hereunder, or occurrences, shall constitute an "Event of Default": (i) Failure or refusal to pay Basic Rental, Additional Rent or any other amount to be paid by Tenant to Landlord hereunder within five (5) business days after notice that the same is due or payable hereunder; said five (5) day period shall be in addition to, and not in lieu of, the notice requirements of Section 1161 of the California Code of Civil Procedure or any similar or successor law; (ii) Except as set forth in items (i) above and (iii) below, failure to perform or observe any other covenant or condition of this Lease to be performed or observed within thirty (30) days following written notice to Tenant of such failure; however, if the nature of such default is such that the same cannot be reasonably cured within a thirty (30) day period, Tenant shall not be deemed to be in default if Tenant diligently commences such cure within such period and thereafter diligently proceeds to rectify and cure said default. Such thirty (30) day notice shall be in addition to, and not in lieu of, any required under Section 1161 of the California Code of Civil Procedure or any similar or successor law; or (iii) Tenant's failure to observe or perform according to the provisions of Articles 17 or 25 within five (5) business days after notice from Landlord. (b) Landlord's Default. Notwithstanding anything to the contrary 34 set forth in this Lease, Landlord shall be in default in the performance of any obligation required to be performed by Landlord pursuant to this Lease if Landlord fails to perform such obligation within thirty (30) days after the receipt of notice from Tenant specifying in detail Landlord's failure to perform; provided, however, if the nature of Landlord's obligation is such that more than thirty (30) days are required for its performance, then Landlord shall not be in default under this Lease if it shall commence such performance within such thirty (30) day period and thereafter diligently pursue the same to completion. Upon any such default by Landlord under this Lease, Tenant may, except as otherwise specifically provided in this Lease to the contrary, exercise any of its rights provided at law or in equity. ARTICLE 20 REMEDIES (a) Upon the occurrence of an Event of Default under this Lease as provided in Article 19 hereof, Landlord may exercise all of its remedies as may be permitted by law, including but not limited to the remedy provided by Section 1951.4 of the California Civil Code, and including without limitation, terminating this Lease, reentering the Premises and removing all persons and property therefrom, which property may be stored by Landlord at a warehouse or elsewhere at the risk, expense and for the account of Tenant. If Landlord elects to terminate this Lease, Landlord shall be entitled to recover from Tenant the aggregate of all amounts permitted by law, including but not limited to (i) the worth at the time of award of the amount of any unpaid rent which had been earned at the time of such termination; plus (ii) the worth at the time of award of the amount by which the unpaid rent which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; plus (iii) the worth at the time of award of the amount by which the unpaid rent for the balance of the Lease Term after the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; plus (iv) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom; and (v) at Landlord's election, such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time by applicable law. The term "rent" as used in this Article 20(a) shall be deemed to be and to mean all sums of every nature required to be paid by Tenant pursuant to the terms of this Lease, whether to Landlord or to others. As used in items (i) and (ii), above, the "worth at the time of award" shall be computed by allowing interest at the rate set forth in item (e), below, but in no case greater than the maxximum amount of such interestpermitted by law. As used in item (iii), above, the "worth at the time of award" shall be computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). (b) Nothing in this Article 20 shall be deemed to affect Landlord's right to indemnification for liability or liabilities arising prior to the termination of this Lease for personal injuries or property damage under the indemnification clause or clauses contained 35 in this Lease. (c) Notwithstanding anything to the contrary set forth herein, Landlord's re-entry to perform acts of maintenance or preservation of or in connection with efforts to relet the Premises or any portion thereof, or the appointment of a receiver upon Landlord's initiative to protect Landlord's interest under this Lease shall not terminate Tenant's right to possession of the Premises or any portion thereof and, until Landlord does elect to terminate this Lease, this Lease shall continue in full force and effect and Landlord may enforce all of Landlord's rights and remedies hereunder including, without limitation, the remedy described in California Civil Code Section 1951.4 (lessor may continue lease in effect after lessee's breach and abandonment and recover rent as it becomes due, if lessee has the right to sublet or assign, subject only to reasonable limitations). Accordingly, if Landlord does not elect to terminate this Lease on account of any default by Tenant, Landlord may, from time to time, without terminating this Lease, enforce all of its rights and remedies under this Lease, including the right to recover all rent as it becomes due. (d) All rights, powers and remedies of Landlord hereunder and under any other agreement now or hereafter in force between Landlord and Tenant shall be cumulative and not alternative and shall be in addition to all rights, powers and remedies given to Landlord by law, and the exercise of one or more rights or remedies shall not impair Landlord's right to exercise any other right or remedy. (e) Any amount due from Tenant to Landlord hereunder which is not paid within five (5) days after notice to Tenant the same is due shall bear interest at the lower of twelve percent (12%) per annum or the maximum lawful rate of interest from the due date until paid, unless otherwise specifically provided herein, but the payment of such interest shall not excuse or cure any default by Tenant under this Lease. In addition to such interest: (i) if Basic Rental is not paid within ten (10) days after notice to Tenant the same is due, a late charge equal to five percent (5%) of the amount overdue shall be assessed and shall accrue for each calendar month or part thereof until such rental, including the late charge, is paid in full, which late charge Tenant hereby agrees is a reasonable estimate of the damages Landlord shall suffer as a result of Tenant's late payment and (ii) an additional charge of $25 shall be assessed for any check given to Landlord by or on behalf of Tenant which is not honored by the drawee thereof; which damages include Landlord's additional administrative and other costs associated with such late payment and unsatisfied checks and the parties agree that it would be impracticable or extremely difficult to fix Landlord's actual damage in such event. Such charges for interest and late payments and unsatisfied checks are separate and cumulative and are in addition to and shall not diminish or represent a substitute for any or all of Landlord's rights or remedies under any other provision of this Lease. ARTICLE 21 TRANSFER OF LANDLORD'S INTEREST In the event of any transfer or termination of Landlord's interest in the Premises or the Project by sale, assignment, transfer, foreclosure, deed-in-lieu of foreclosure or otherwise whether voluntary 36 or involuntary (and the assumption in writing by the transferee of all of Landlord's obligations hereunder), Landlord shall be automatically relieved of any and all obligations and liabilities on the part of Landlord from and after the date of such transfer or termination, including furthermore without limitation, the obligation of Landlord under Article 4 and California Civil Code 1950.7 above to return the security deposit, provided said security deposit is transferred to said transferee. Tenant agrees to attorn to the transferee upon any such transfer and to recognize such transferee as the lessor under this Lease and Tenant shall, within five (5) days after request, execute such further instruments or assurances as such transferee may reasonably deem necessary to evidence or confirm such attornment. ARTICLE 22 BROKER In connection with this Lease, Landlord and Tenant warrant and represents that they have had dealings only with firm(s) set forth in Article 1.H. of the Basic Lease Provisions and that they know of no other person or entity who is or might be entitled to a commission, finder's fee or other like payment in connection herewith and do hereby indemnify and agree to hold the other, their agents, members, partners, representatives, officers, affiliates, shareholders, employees, successors and assigns harmless from and against any and all loss, liability and expenses that the other party may incur should such warranty and representation prove incorrect, inaccurate or false. ARTICLE 23 PARKING Tenant shall have the right, but not the obligation, to rent from Landlord, commencing on the Commencement Date, the number of parking passes set forth in Section 1(I) of the Basic Lease Provisions, which parking passes shall pertain to the Project parking facility. Tenant's reserved parking shall be at locations within such structure currently utilized by Tenant's under Tenant's existing lease at the Project, and any additional reserved parking shall be at locations reasonably designated by Landlord. Tenant shall have the right to vary the number of parking passes rented by Tenant (up to the maximum set forth in Section 1(I) of the Basic Lease Provisions); provided, however, if at any time Tenant elects to rent less than all of the parking passes to which Tenant is entitled, Tenant shall only have the right to subsequently rent such parking passes if, at the time Tenant desires to rent such passes, Landlord reasonably determines that such additional parking passes are available in the Project. Tenant shall pay to Landlord for automobile parking passes the prevailing rate charged from time to time at the location of such parking passes, which rates are currently, as of the date of this Lease, One Hundred Four and 50/100 Dollars ($104.50) per month per unreserved parking pass and One Hundred Sixty-Five Dollars ($165.00) per month per reserved parking pass and which rates shall remain in effect throughout calendar year 1999. For each calendar year thereafter, the maximum parking rates shall be one hundred five percent (105%) of the maximum rate in effect as of the immediately preceding calendar year (whether or not such maximum rate is actually charged). In addition to the rates described above, Tenant shall be responsible for the full amount of any taxes imposed by any governmental authority in connection with the renting of such parking 37 passes by Tenant or the use of the parking facility by Tenant. Tenant's continued right to use the parking passes is conditioned upon Tenant abiding by all rules and regulations which are prescribed from time to time for the orderly operation and use of the parking facility where the parking passes are located, including any sticker or other identification system established by Landlord, Tenant's cooperation in seeing that Tenant's employees and visitors also comply with such rules and regulations, and Tenant not being in default under this Lease beyond any applicable cure period. Landlord specifically reserves the right to change the size, configuration, design, layout and all other aspects of the Project parking facility at any time and Tenant acknowledges and agrees that Landlord may, without incurring any liability to Tenant and without any abatement of rent under this Lease, from time to time, to temporarily close-off or restrict access to the Project parking facility for purposes of permitting or facilitating any such construction, alteration or improvements. Landlord may delegate its responsibilities hereunder to a parking operator or a lessee of the parking facility in which case such parking operator or lessee shall have all the rights of control attributed hereby to the Landlord. The parking passes rented by Tenant pursuant to this Article 23 are provided to Tenant solely for use by Tenant's own personnel and such passes may not be transferred, assigned, subleased or otherwise alienated by Tenant without Landlord's prior approval. Tenant may validate visitor parking by such method or methods as the Landlord may establish, at the validation rate from time to time generally applicable to visitor parking. ARTICLE 24 WAIVER No waiver by Landlord or Tenant of any provision of this Lease shall be deemed to be a waiver of any other provision hereof or of any subsequent breach of the same or any other provision. No provision of this Lease may be waived by Landlord or Tenant, except by an instrument in writing executed by Landlord and Tenant. Landlord's consent to or approval of any act by Tenant requiring Landlord's consent or approval shall not be deemed to render unnecessary the obtaining of Landlord's consent to or approval of any subsequent act of Tenant, whether or not similar to the act so consented to or approved. No act or thing done by Landlord or Landlord's agents during the Term of this Lease shall be deemed an acceptance of a surrender of the Premises, and no agreement to accept such surrender shall be valid unless in writing and signed by Landlord. Any payment by Tenant or receipt by Landlord of an amount less than the total amount then due hereunder shall be deemed to be in partial payment only thereof and not a waiver of the balance due or an accord and satisfaction, notwithstanding any statement or endorsement to the contrary on any check or any other instrument delivered concurrently therewith or in reference thereto. Accordingly, Landlord may accept any such amount and negotiate any such check without prejudice to Landlord's right to recover all balances due and owing and to pursue its other rights against Tenant under this Lease, regardless of whether Landlord makes any notation on such instrument of payment or otherwise notifies Tenant that such acceptance or negotiation is without prejudice to Landlord's rights. ARTICLE 25 ESTOPPEL CERTIFICATE 38 Tenant shall, at any time and from time to time, upon not less than twenty (20) days' prior written notice from Landlord, execute, acknowledge and deliver to Landlord a statement in writing certifying the following information, (but not limited to the following information in the event further information is requested by Landlord): (i) that this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification and certifying that this Lease, as modified, is in full force and effect); (ii) the dates to which the rental and other charges are paid in advance, if any; (iii) the amount of Tenant's security deposit, if any; and (iv) acknowledging that there are not, to Tenant's knowledge, any uncured defaults on the part of Landlord hereunder, and no events or conditions then in existence which, with the passage of time or notice or both, would constitute a default on the part of Landlord hereunder, or specifying such defaults, events or conditions, if any are claimed. It is expressly understood and agreed that any such statement may be relied upon by any prospective purchaser or encumbrancer of all or any portion of the Real Property. Tenant's failure to deliver such statement within such time shall constitute an admission by Tenant that all statements contained therein are true and correct. ARTICLE 26 LIABILITY OF LANDLORD Notwithstanding anything in this Lease to the contrary, any remedy of Tenant for the collection of a judgment (or other judicial process) requiring the payment of money by Landlord in the event of any default by Landlord hereunder or any claim, cause of action or obligation, contractual, statutory or otherwise by Tenant against Landlord concerning, arising out of or relating to any matter relating to this Lease and all of the covenants and conditions or any obligations, contractual, statutory, or otherwise set forth herein, shall be limited solely and exclusively to an amount which is equal to the lesser of (i) the interest of Landlord in and to the Project, and (ii) the interest Landlord would have in the Project if the Project were encumbered by third party debt in an amount equal to eighty percent (80%) of the then current value of the Project. No other property or assets of Landlord, or any member, officer, director, shareholder, partner, trustee, agent, servant or employee of Landlord (the "Representative") shall be subject to levy, execution or other enforcement procedure for the satisfaction of Tenant's remedies under or with respect to this Lease, Landlord's obligations to Tenant, whether contractual, statutory or otherwise, the relationship of Landlord and Tenant hereunder, or Tenant's use or occupancy of the Premises. Tenant further understands that any liability, duty or obligation of Landlord to Tenant, shall automatically cease and terminate as of the date that Landlord or any of Landlord's Representatives no longer have any right, title or interest in or to the Project. ARTICLE 27 INABILITY TO PERFORM This Lease and the obligations of both parties hereunder shall not be affected or impaired because such party is unable to fulfill any of its obligations hereunder or is delayed in doing so, if such inability 39 or delay is caused by reason of any prevention, delay, stoppage due to strikes, lockouts, acts of God, or any other cause previously, or at such time, beyond the reasonable control or anticipation of such party (collectively, a "Force Majeure") and both parties' obligations under this Lease shall be forgiven and suspended by any such Force Majeure; provided, however, that this Article 27 is not intended to, and shall not, extend the time period for the payment of any monetary amounts due (including, without limitation, rent payments from Tenant) from either party to the other under this Lease nor relieve either party from their monetary obligations to the other under this Lease. ARTICLE 28 HAZARDOUS WASTE (a) Tenant shall not cause or permit any Hazardous Material (as defined in Article 28(c) below) to be brought, kept or used in or about the Project by Tenant, its agents, employees, contractors, or invitees. (b) It shall not be unreasonable for Landlord to withhold its consent to any proposed Transfer if (i) the proposed transferee's anticipated use of the Premises involves the generation, storage, use, treatment, or disposal of Hazardous Material; (ii) the proposed Transferee has been required by any prior landlord, lender, or governmental authority to take remedial action in connection with Hazardous Material contaminating a property if the contamination resulted from such Transferee's actions or use of the property in question; or (iii) the proposed Transferee is subject to an enforcement order issued by any governmental authority in connection with the use, disposal, or storage of a Hazardous Material. (c) As used herein, the term "Hazardous Material" means any hazardous or toxic substance, material, or waste which is or becomes regulated by any local governmental authority, the State of California or the United States Government. The term "Hazardous Material" includes, without limitation, any material or substance which is (i) defined as "Hazardous Waste," "Extremely Hazardous Waste," or "Restricted Hazardous Waste" under Sections 25115, 25117 or 25122.7, or listed pursuant to Section 25140, of the California Health and Safety Code, Division 20, Chapter 6.5 (Hazardous Waste Control Law), (ii) defined as a "Hazardous Substance" under Section 25316 of the California Health and Safety Code, Division 20, Chapter 6.8 (Carpenter- Presley-Tanner Hazardous Substance Account Act), (iii) defined as a "Hazardous Material," "Hazardous Substance," or "Hazardous Waste" under Section 25501 of the California Health and Safety Code, Division 20, Chapter 6.95 (Hazardous Materials Release Response Plans and Inventory), (iv) defined as a "Hazardous Substance" under Section 25281 of the California Health and Safety Code, Division 20, Chapter 6.7 (Underground Storage of Hazardous Substances), (v) petroleum, (vi) asbestos, (vii) listed under Article 9 or defined as Hazardous or extremely hazardous pursuant to Article 11 of Title 22 of the California Administrative Code, Division 4, Chapter 20, (viii) designated as a "Hazardous Substance" pursuant to Section 311 of the Federal Water Pollution Control Act (33 U.S.C. ss. 1317), (ix) defined as a "Hazardous Waste" pursuant to Section 1004 of the Federal Resource Conservation and Recovery Act, 42 U.S.C. ss. 6901 et seq. (42 U.S.C. ss. 6903), or (x) defined as a "Hazardous Substance" pursuant to Section 101 of the Comprehensive Environmental Response, Compensation and 40 Liability Act, 42 U.S.C. ss. 9601 et seq. (42 U.S.C. ss. 9601). (d) As used herein, the term "Laws" mean any applicable federal, state or local laws, ordinances, or regulations relating to any Hazardous Material affecting the Project, including, without limitation, the laws, ordinances, and regulations referred to in Article 28(c) above. ARTICLE 29 SURRENDER OF PREMISES; REMOVAL OF PROPERTY (a) The voluntary or other surrender of this Lease by Tenant to Landlord, or a mutual termination hereof, shall not work a merger, and shall at the option of Landlord, operate as an assignment to it of any or all subleases or subtenancies affecting the Premises. (b) Upon the expiration of the Term of this Lease, or upon any earlier termination of this Lease, Tenant shall quit and surrender possession of the Premises to Landlord in as good order and condition as the same are now and hereafter may be improved by Landlord or Tenant, reasonable wear and tear, damage by casualty resulting in termination of this Lease and repairs which are Landlord's obligation excepted, and shall, without expense to Landlord, remove or cause to be removed from the Premises all debris and rubbish, all furniture, equipment, business and trade fixtures, free-standing cabinet work, moveable partitioning, telephone and data cabling and other articles of personal property owned by Tenant or installed or placed by Tenant at its own expense in the Premises, and all similar articles of any other persons claiming under Tenant unless Landlord exercises its option to have any subleases or subtenancies assigned to it, and Tenant shall repair all damage to the Premises resulting from the installation and removal of such items to be removed. (c) Whenever Landlord shall reenter the Premises as provided in Article 12 hereof, or as otherwise provided in this Lease, any property of Tenant not removed by Tenant upon the expiration of the Term of this Lease (or within two (2) business days after a termination by reason of Tenant's default), as provided in this Lease, shall be considered abandoned and Landlord may remove any or all of such items and dispose of the same in accordance with applicable law or store the same in a public warehouse or elsewhere for the account and at the expense and risk of Tenant, and if Tenant shall fail to pay the cost of storing any such property after it has been stored for a period of ninety (90) days or more, Landlord may sell any or all of such property at public or private sale, in such manner and at such times and places as Landlord, in its sole discretion, may deem proper, without notice or to demand upon Tenant, for the payment of all or any part of such charges or the removal of any such property, and shall apply the proceeds of such sale as follows: first, to the cost and expense of such sale, including reasonable attorneys' fees for services rendered; second, to the payment of the cost of or charges for storing any such property; third, to the payment of any other sums of money which may then or thereafter be due to Landlord from Tenant under any of the terms hereof; and fourth, the balance, if any, to Tenant. (d) All fixtures, equipment, leasehold improvements, Alterations and/or appurtenances attached to or built into the Premises prior to or 41 during the Term, whether by Landlord or Tenant and whether at the expense of Landlord or Tenant, or of both, shall be and remain part of the Premises and shall not be removed by Tenant at the end of the Term unless otherwise expressly provided for in this Lease or unless such removal is required by Landlord. Such fixtures, equipment, leasehold improvements, Alterations, additions, improvements and/or appurtenances shall include but not be limited to: all floor coverings, drapes, paneling, built-in cabinetry, molding, doors, vaults (including vault doors), plumbing systems, security systems, electrical systems, lighting systems, silencing equipment, communication systems, all fixtures and outlets for the systems mentioned above and for all telephone, radio, telegraph and television purposes, and any special flooring or ceiling installations. ARTICLE 30 MISCELLANEOUS (a) Severability; Entire Agreement. Any provision of this Lease which shall prove to be invalid, void, or illegal shall in no way affect, impair or invalidate any other provision hereof and such other provisions shall remain in full force and effect. This Lease and the Exhibits and any Addendum attached hereto constitute the entire agreement between the parties hereto with respect to the subject matter hereof, and no prior agreement or understanding pertaining to any such matter shall be effective for any purpose. No provision of this Lease may be amended or supplemented except by an agreement in writing signed by the parties hereto or their successor in interest. (b) Attorneys' Fees; Waiver of Jury Trial. (i) In any action to enforce the terms of this Lease, including any suit by Landlord for the recovery of rent or possession of the Premises, the losing party shall pay the successful party a reasonable sum for attorneys' fees in such suit and such attorneys' fees shall be deemed to have accrued prior to the commencement of such action and shall be paid whether or not such action is prosecuted to judgment. (ii) EACH PARTY HEREBY WAIVES ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION SEEKING SPECIFIC PERFORMANCE OF ANY PROVISION OF THIS LEASE, FOR DAMAGES FOR ANY BREACH UNDER THIS LEASE, OR OTHERWISE FOR ENFORCEMENT OF ANY RIGHT OR REMEDY HEREUNDER. (c) Time of Essence. Time is of the essence with respect to the performance of every provision of this Lease. (d) Headings; Joint and Several. The article headings contained in this Lease are for convenience only and do not in any way limit or amplify any term or provision hereof. The terms "Landlord" and "Tenant" as used herein shall include the plural as well as the singular, the neuter shall include the masculine and feminine genders and the obligations herein imposed upon Tenant shall be joint and several as to each of the persons, firms or corporations of which Tenant may be composed. (e) Reserved Area. Tenant hereby acknowledges and agrees that the exterior walls of the Premises and the area between the finished ceiling of the Premises and the slab of the floor of the project 42 thereabove have not been demised hereby and the use thereof together with the right to install, maintain, use, repair and replace pipes, ducts, conduits and wires leading through, under or above the Premises in locations which will not materially interfere with Tenant's use of the Premises and serving other parts of the Project are hereby excepted and reserved unto Landlord. (f) NO OPTION. THE SUBMISSION OF THIS LEASE BY LANDLORD, ITS AGENT OR REPRESENTATIVE FOR EXAMINATION OR EXECUTION BY TENANT DOES NOT CONSTITUTE AN OPTION OR OFFER TO LEASE THE PREMISES UPON THE TERMS AND CONDITIONS CONTAINED HEREIN OR A RESERVATION OF THE PREMISES IN FAVOR OF TENANT, IT BEING INTENDED HEREBY THAT THIS LEASE SHALL ONLY BECOME EFFECTIVE UPON THE EXECUTION HEREOF BY LANDLORD AND DELIVERY OF A FULLY EXECUTED LEASE TO TENANT. (g) Use of Project Name; Improvements. Tenant shall not be allowed to use the name, picture or representation of the Project, or words to that effect, in connection with any business carried on in the Premises or otherwise (except as Tenant's address) without the prior written consent of Landlord. In the event that Landlord undertakes any additional improvements on the Real Property including but not limited to new construction or renovation or additions to the existing improvements, provided that Landlord uses commercially reasonable efforts not to interfere with Tenant's business operations or access to the Premises, Landlord shall not be liable to Tenant for any noise, dust, vibration or interference with access to the Premises or disruption in Tenant's business caused thereby, except as provided in Section 11(g) above. (h) Rules and Regulations. Tenant shall observe faithfully and comply strictly with the Rules and Regulations attached to this Lease as Exhibit "B" and made a part hereof, and such other Rules and Regulations as Landlord may from time to time reasonably adopt for the safety, care and cleanliness of the Project, the facilities thereof, or the preservation of good order therein. Landlord shall not be liable to Tenant for violation of any such Rules and Regulations, or for the breach of any covenant or condition in any lease by any other tenant in the Project. A waiver by Landlord of any Rule or Regulation for any other tenant shall not constitute nor be deemed a waiver of the Rule or Regulation for this Tenant. Landlord agrees not to discriminate among tenants of the Project in its enforcement of the Rules and Regulations and not to apply such Rules and Regulations in an unreasonable manner. (i) Quiet Possession. Upon Tenant's paying the Basic Rent, Additional Rent and other sums provided hereunder and observing and performing all of the covenants, conditions and provisions on Tenant's part to be observed and performed hereunder, Tenant shall have quiet possession of the Premises for the entire Term hereof, subject to all of the provisions of this Lease. (j) Rent. All payments required to be made hereunder to Landlord shall be deemed to be rent, whether or not described as such. (k) Successors and Assigns. Subject to the provisions of Article 15 hereof, all of the covenants, conditions and provisions of this Lease shall be binding upon and shall inure to the benefit of the parties hereto and their respective heirs, personal representatives, 43 successors and assigns. (l) Notices. Any notice required or permitted to be given hereunder shall be in writing and may be given by personal service evidenced by a signed receipt or sent by registered or certified mail, return receipt requested, or via overnight courier, and shall be effective upon proof of delivery, addressed to Tenant at the Premises or to Landlord at the management office for the Project, with a copy to Landlord, c/o Arden Realty, Inc., 11601 Wilshire Boulevard, Fourth Floor, Los Angeles, California 90025, Attn: Legal Department. Either party may by notice to the other specify a different address for notice purposes except that, upon Tenant's taking possession of the Premises, the Premises shall constitute Tenant's address for notice purposes. A copy of all notices to be given to Landlord hereunder shall be concurrently transmitted by Tenant to such party hereafter designated by notice from Landlord to Tenant. Any notices sent by Landlord regarding or relating to eviction procedures, including without limitation three day notices, may be sent by regular mail. (m) Intentionally Omitted. (n) Right of Landlord to Perform. All covenants and agreements to be performed by Tenant under any of the terms of this Lease shall be performed by Tenant at Tenant's sole cost and expense and without any abatement of rent. If Tenant shall fail to pay any sum of money, other than rent, required to be paid by it hereunder or shall fail to perform any other act on its part to be performed hereunder, and such failure shall continue beyond any applicable cure period set forth in this Lease, Landlord may, but shall not be obligated to, after reasonable notice to Tenant, without waiving or releasing Tenant from any obligations of Tenant, make any such payment or perform any such other act on Tenant's part to be made or performed as is in this Lease provided. All sums so paid by Landlord and all reasonable incidental costs, together with interest thereon at the rate of ten percent (10%) per annum from the date of such payment by Landlord, shall be payable to Landlord within thirty (30) days after demand and Tenant covenants to pay any such sums, and Landlord shall have (in addition to any other right or remedy of Landlord) the same rights and remedies in the event of the nonpayment thereof by Tenant as in the case of default by Tenant in the payment of the rent. (o) Access, Changes in Project, Facilities, Name. (i) Every part of the Project except the inside surfaces of all walls, windows and doors bounding the Premises (including exterior building walls, core corridor walls and doors and any core corridor entrance), and any space in or adjacent to the Premises used for shafts, stacks, pipes, conduits, fan rooms, ducts, electric or other utilities, sinks or other building facilities, and the use thereof, as well as access thereto through the Premises for the purposes of operation, maintenance, decoration and repair, are reserved to Landlord. (ii) Tenant shall permit Landlord to install, use and maintain pipes, ducts and conduits within the walls, columns and ceilings of the Premises. 44 (iii) Landlord reserves the right, without incurring any liability to Tenant therefor, to make such changes in or to the Project and the fixtures and equipment thereof, as well as in or to the street entrances, halls, passages, elevators, stairways and other improvements thereof, as it may deem necessary or desirable. (iv) Landlord may adopt any name for the Project and Landlord reserves the right to change the name or address of the Project at any time, so long as Landlord pays for Tenant's reprinting costs for announcements, stationery and business cards where the new name or address is initiated by Landlord and is not imposed involuntarily upon Landlord by any governmental agency or other third party. Landlord agrees that, except where required by law, Landlord's exercise of its rights under this Section 30(o) shall be conditioned upon Landlord not unreasonably interfering with Tenant's access to or use of the Premises and the parking facilities of the Project. (p) Signing Authority. Concurrently with Tenant's execution of this Lease, Tenant shall provide to Landlord reasonably satisfactory evidence that the individuals executing this Lease on behalf of Tenant are authorized to bind Tenant and to enter into this Lease. (q) Intentionally Omitted. (r) Substitute Premises. Landlord shall have the right at any time during the Term hereof, upon giving Tenant not less than sixty (60) days prior notice, to provide and furnish Tenant with comparable space elsewhere in the Project of approximately the same size as Suite 2030 and remove and place Tenant in such space, with Landlord to pay all verified and previously approved costs and expenses incurred as a result of such movement to such new space. Such new space shall have comparable identity with similar views to that of Suite 2030, shall be located on the twentieth (20th) floor of the Project or higher, shall be of at least substantially the same size as Suite 2030 and shall have a perimeter configuration substantially usable for the purposes for which Suite 2030 was then being used by Tenant. If Landlord moves Suite 2030 to such new space, this Lease and each and all of its terms, covenants and conditions shall remain in full force and effect and shall be deemed applicable to such new space and such new space shall thereafter be deemed to be a portion of the "Premises" as though Landlord and Tenant had entered into an express written amendment of this Lease with respect thereto. (s) Survival of Obligations. Any obligations of Tenant occurring prior to the expiration or earlier termination of this Lease shall survive such expiration or earlier termination. (t) Reasonable Consent. Except for matters for which there is a standard of consent or approval specifically set forth in this Lease (other than a reasonableness standard), and except for matters which could affect (i) the systems and equipment of the Project; (ii) structural aspects of the Project or (iii) the exterior appearance of the Project, in which case Landlord shall have the right to act in its sole and absolute discretion (but at all times in good faith), any time the consent or approval of Landlord or Tenant is required under this Lease, such consent or approval shall not be unreasonably withheld, 45 conditioned or delayed. (u) Governing Law. This Lease shall be governed by and construed in accordance with the laws of the State of California. No conflicts of law rules of any state or country (including, without limitation, California conflicts of law rules) shall be applied to result in the application of any substantive or procedural laws of any state or country other than California. All controversies, claims, actions or causes of action arising between the parties hereto and/or their respective successors and assigns, shall be brought, heard and adjudicated by the courts of the State of California, with venue in the County of Los Angeles. Each of the parties hereto hereby consents to personal jurisdiction by the courts of the State of California in connection with any such controversy, claim, action or cause of action, and each of the parties hereto consents to service of process by any means authorized by California law and consent to the enforcement of any judgment so obtained in the courts of the State of California on the same terms and conditions as if such controversy, claim, action or cause of action had been originally heard and adjudicated to a final judgment in such courts. Each of the parties hereto further acknowledges that the laws and courts of California were freely and voluntarily chosen to govern this Lease and to adjudicate any claims or disputes hereunder. (v) Exhibits and Addendum. The Exhibits and Addendum, if applicable, attached hereto are incorporated herein by this reference as if fully set forth herein. ARTICLE 31 OPTIONS TO EXTEND (a) Option Right. Landlord hereby grants Tenant the following options: (i) two (2) consecutive options to extend Tenant's lease of Suite 2030 for a period of twenty-one (21) months each ("Suite 2030 Option"); provided that the second Suite 2030 Option shall be exercisable only in the event Tenant has exercised the first Suite 2030 Option, and (ii) one (1) option ("Option") to extend the Lease Term for the entire Premises for a period of five (5) years ("Option Term"), both of which options shall be exercisable only by written notice delivered by Tenant to Landlord set forth below. The rights contained in this Article 31 shall be personal to the Tenant named in this Lease (the "Original Tenant") and any Affiliated Assignee. (b) Option Rent. (i) In the event Tenant exercises its Suite 2030 Options, the Term of Tenant's lease of Suite 2030 shall be extended on all the same terms and conditions set forth in this Lease and the rent payable during the two (2) Suite 2030 Options shall be the same rate per rentable square foot as Tenant is paying for Suite 2100. In no event shall Tenant be entitled to exercise the second (2nd) Suite 2030 Option unless Tenant has exercised the first Suite 2030 Option. Tenant shall not be entitled to any additional Tenant Improvement Allowance during the Suite 2030 Option periods. (ii) In the event Tenant exercises the Option as to the entire Premises, the rent payable by Tenant during the Option Term ("Option 46 Rent") shall be equal to the "Market Rent" (defined below). "Market Rent" shall mean the applicable Monthly Basic Rental, including all escalations, Direct Costs, additional rent and other charges at which tenants, as of the time of Landlord's "Option Rent Notice" (as defined below), are entering into leases for non-sublease, non-encumbered, space comparable in size, location and quality to the Premises in renewal transactions for a term comparable to the Option Term which comparable space is located in office buildings comparable to the Project on Wilshire Boulevard in the Brentwood area of Los Angeles, California, taking into consideration the value of the existing improvements in the Premises to Tenant, as compared to the value of the existing improvements in such comparable space, with such value to be based upon the age, quality and layout of the improvements and the extent to which the same could be utilized by Tenant with consideration given to the fact that the improvements existing in the Premises are specifically suitable to Tenant. (c) Exercise of Options. (i) The Suite 2030 Options shall be exercised by Tenant only in the following manner: (i) Tenant shall not be in default beyond any applicable cure periods on the delivery date of the Exercise Notice; and (ii) Tenant shall deliver written notice ("Exercise Notice") to Landlord not less than six (6) months prior to the expiration of the then current Lease Term as to Suite 2030, stating that Tenant is exercising the Option. Tenant's failure to deliver the Exercise Notice on or before the date specified above shall be deemed to constitute Tenant's election not to exercise the Suite 2030 Option. If Tenant timely and properly exercises its Suite 2030 Option(s), the Lease Term shall be extended as to Suite 2030 for an additional twenty-one (21) months upon all of the terms and conditions set forth in this Lease. (ii) The Option shall be exercised by Tenant only in the following manner: (A) Tenant shall not be in default beyond any applicable cure periods on the delivery date of the Interest Notice and Tenant's Acceptance; (B) Tenant shall deliver written notice ("Interest Notice") to Landlord not more than twelve (12) months nor less than nine (9) months prior to the expiration of the Lease Term, stating that Tenant is interested in exercising the Option, (C) within fifteen (15) business days of Landlord's receipt of Tenant's written notice, Landlord shall deliver notice ("Option Rent Notice") to Tenant setting forth the Option Rent; and (D) if Tenant desires to exercise such Option, Tenant shall provide Landlord written notice within fifteen (15) business days after receipt of the Option Rent Notice ("Tenant's Acceptance") and upon, and concurrent with such exercise, Tenant may, at its option, object to the Option Rent contained in the Option Rent Notice. Tenant's failure to deliver the Interest Notice or Tenant's Acceptance on or before the dates specified above shall be deemed to constitute Tenant's election not to exercise the Option. If Tenant timely and properly exercises its Option, the Lease Term shall be extended for the Option Term upon all of the terms and conditions set forth in this Lease, except that the rent for the Option Term shall be as indicated in the Option Rent Notice unless Tenant, concurrently with Tenant's Acceptance, objects to the Option Rent contained in the Option Rent Notice, in which case the parties shall follow the procedure and the Option Rent shall be determined, as set forth in Section 31(d) below. 47 (d) Determination of Market Rent. If Tenant timely and appropriately objects to the Market Rent in Tenant's Acceptance, Landlord and Tenant shall attempt to agree upon the Market Rent using their best good-faith efforts. If Landlord and Tenant fail to reach agreement within twenty-one (21) days following Tenant's Acceptance ("Outside Agreement Date"), then each party shall make a separate determination of the Market Rent which shall be submitted to each other and to arbitration in accordance with the following items (i) through (vii): (i) Landlord and Tenant shall each appoint, within ten (10) days of the Outside Agreement Date, one arbitrator who shall by profession be a current real estate broker or appraiser of commercial high-rise properties in the immediate vicinity of the Project, and who has been active in such field over the last five (5) years. The determination of the arbitrators shall be limited solely to the issue of whether Landlord's or Tenant's submitted Market Rent is the closest to the actual Market Rent as determined by the arbitrators, taking into account the requirements of item (b), above. (ii) The two arbitrators so appointed shall within five (5) business days of the date of the appointment of the last appointed arbitrator agree upon and appoint a third arbitrator who shall be qualified under the same criteria set forth hereinabove for qualification of the initial two arbitrators. (iii) The three arbitrators shall within fifteen (15) days of the appointment of the third arbitrator reach a decision as to whether the parties shall use Landlord's or Tenant's submitted Market Rent, and shall notify Landlord and Tenant thereof. (iv) The decision of the majority of the three arbitrators shall be binding upon Landlord and Tenant. (v) If either Landlord or Tenant fails to appoint an arbitrator within ten (10) days after the applicable Outside Agreement Date, the arbitrator appointed by one of them shall reach a decision, notify Landlord and Tenant thereof, and such arbitrator's decision shall be binding upon Landlord and Tenant. (vi) If the two arbitrators fail to agree upon and appoint a third arbitrator, or both parties fail to appoint an arbitrator, then the appointment of the third arbitrator or any arbitrator shall be dismissed and the matter to be decided shall be forthwith submitted to arbitration under the provisions of the American Arbitration Association, but subject to the instruction set forth in this item (d). (vii) The cost of arbitration shall be paid by Landlord and Tenant equally. ARTICLE 32 RIGHT OF FIRST OFFER Landlord hereby grants to Tenant a right of first offer with respect to all space on the twentieth (20th) floor of the Building other than the Premises ("First Offer Space"). Notwithstanding the 48 foregoing, such first offer right of Tenant shall commence only following the expiration or earlier termination of (A) any existing lease pertaining to the First Offer Space, and (B) as to any First Offer Space which is vacant as of the date of this Lease, the first lease pertaining to any portion of such First Offer Space entered into by Landlord after the date of this Lease (collectively, the "Superior Leases"), including any renewal or extension of such existing or future lease, whether or not such renewal or extension is pursuant to an express written provision in such lease, and regardless of whether any such renewal or extension is consummated pursuant to a lease amendment or a new lease (the rights described above to be known collectively as "Superior Rights"). Tenant's right of first offer shall be on the terms and conditions set forth in this Section 32. (a) Procedure for Offer. Landlord shall notify Tenant (the "First Offer Notice") from time to time when Landlord determines that Landlord shall commence the marketing of any First Offer Space because such space shall become available for lease to third parties, where no holder of a Superior Right desires to lease such space. The First Offer Notice shall describe the space so offered to Tenant and shall set forth Landlord's proposed economic terms and conditions applicable to Tenant's lease of such space (collectively, the "Economic Terms"). Notwithstanding the foregoing, Landlord's obligation to deliver the First Offer Notice shall not apply during the last nine (9) months of the initial Lease Term unless Tenant has delivered an Interest Notice to Landlord pursuant to Section 31(c) above nor shall Landlord be obligated to deliver the First Offer Notice during the last eight (8) months of the initial Lease Term unless Tenant has timely delivered Tenant's Acceptance to Landlord pursuant to Section 31(c) above. (b) Procedure for Acceptance. If Tenant wishes to exercise Tenant's right of first offer with respect to the space described in the First Offer Notice, then within five (5) business days after delivery of the First Offer Notice to Tenant, Tenant shall deliver notice to Landlord of Tenant's intention to exercise its right of first offer with respect to the entire space described in the First Offer Notice. If concurrently with Tenant's exercise of the first offer right, Tenant notifies Landlord that it does not accept the Economic Terms set forth in the First Offer Notice, Landlord and Tenant shall, for a period of fifteen (15) days after Tenant's exercise, negotiate in good faith to reach agreement as to such Economic Terms. If Tenant does not so notify Landlord that it does not accept the Economic Terms set forth in the First Offer Notice concurrently with Tenant's exercise of the first offer right, the Economic Terms shall be as set forth in the First Offer Notice. In addition, if Tenant does not exercise its right of first offer within the five (5) business day period, or, if Tenant exercises its first offer right but timely objects to Landlord's determination of the Economic Terms and if Landlord and Tenant are unable to reach agreement on such Economic Terms within said fifteen (15) day period, then Landlord shall be free to lease the space described in the First Offer Notice to anyone to whom Landlord desires on any terms Landlord desires ; provided, however, that if Landlord intends to enter into a lease upon Economic Terms which are more favorable to a third (3rd) party tenant than those Economic Terms proposed by Landlord in the First Offer Notice, Landlord shall first deliver written notice to Tenant ("Second Chance Notice") providing Tenant with the opportunity to lease the First Offer Space on such more 49 favorable Economic Terms. Tenant's failure to elect to lease the First Offer Space upon such more favorable Economic Terms by written notice to Landlord within three (3) business days after Tenant's receipt of such Second Chance Notice from Landlord shall be deemed to constitute Tenant's election not to lease such space upon such more favorable Economic Terms, in which case Landlord shall be entitled to lease such space to any third (3rd) party on terms no more favorable to the third (3rd) party than those set forth in the Second Chance Notice. If Landlord does lease such First Offer Space to a third (3rd) party tenant pursuant to the terms and conditions of this Section 32(b) above, Tenant shall have no further right to lease such First Offer Space and Tenant's right of first offer shall terminate as to the First Offer Space described in the First Offer Notice. Notwithstanding anything to the contrary contained herein, Tenant must elect to exercise its right of first offer, if at all, with respect to all of the space offered by Landlord to Tenant at any particular time, and Tenant may not elect to lease only a portion thereof. (c) Lease of First Offer Space. If Tenant timely exercises Tenant's right to lease the First Offer Space as set forth herein, Landlord and Tenant shall execute an amendment adding such First Offer Space to this Lease upon the same non-economic terms and conditions as applicable to the initial Premises, and the economic terms and conditions as provided in this Article 32. Tenant shall commence payment of rent for the First Offer Space and the Lease Term of the First Offer Space shall commence upon the date of delivery of such space to Tenant. The Lease Term for the First Offer Space shall expire co-terminously with Tenant's lease of the initial Premises. (d) No Defaults. The rights contained in this Article 32 shall be personal to the Original Tenant and any Affiliated Assignee and may only be exercised by the Original Tenant or an Affiliated Assignee (and not any other assignee, sublessee or other transferee) if the Original Tenant or such Affiliated Assignee occupies the entire Premises as of the date of the First Offer Notice. Tenant shall not have the right to lease First Offer Space as provided in this Article 32 if, as of the date of the First Offer Notice, or, at Landlord's option, as of the scheduled date of delivery of such First Offer Space to Tenant, Tenant is in default under this Lease after expiration of applicable cure periods. ARTICLE 33 SIGNAGE Tenant shall be entitled to retain the number of directory listings utilized by Tenant as of the date of this Lease under its existing lease at the Project. Further, Tenant shall have the right to maintain up to five (5) lines in the lobby directory on the Twentieth (20th) floor of the Project, which directory may list up to four (4) Co-Producers, subject to Landlord's approval as indicated below and provided that the Co-Producers do not have an Objectionable Name, as defined below. In addition, Tenant shall have the right to maintain signage identifying Tenant in the lobby of the Project (in its current location utilized pursuant to Tenant's existing lease in the Project) ("Tenant's Signage"), which signage (including size, design, materials and content) shall conform to the signage specifications of the Project. In connection with any assignment of Tenant's interest under 50 this Lease, which assignment is permitted by Landlord pursuant to the provisions of Article 15 hereof (including without limitation any Affiliated Assignee), Tenant's Signage may be assigned to the assignee with Landlord's prior consent, which consent shall not be unreasonably withheld by Landlord so long as the name of the assignee is not an "Objectionable Name," as that term is defined below. Should the name of the Original Tenant change, Tenant shall be entitled to modify, at Tenant's sole cost and expense, Tenant's Signage to reflect Tenant's new name, but only if Tenant's new name is not an "Objectionable Name." The term "Objectionable Name" shall mean any name that relates (i) to an entity that is of a character or reputation, or is associated with a political orientation or faction that is materially inconsistent with the quality of the Project, or which would otherwise reasonably offend a landlord of a building comparable to the Project, taking into consideration the level and visibility of Tenant's Signage, or (ii) conflicts with any covenants in other leases of space in the Project. ARTICLE 34 STORAGE SPACE Commencing as of the Commencement Date, and continuing on a month-to-month basis terminable by either party upon at least thirty (30) days prior written notice to the other, Tenant shall lease from Landlord and Landlord shall lease to Tenant certain storage area located on the P-1 floor of the Project("Storage Space") which Storage Space consists of approximately 362 rentable square feet ("RSF"), at the location currently leased by Tenant pursuant to its existing lease at the Project. Tenant hereby agrees to accept the Storage Space in its "as-is" condition and Tenant hereby acknowledges that Landlord shall not be obligated to provide or pay for any improvement work or services related to the improvement of the Storage Space. Tenant also acknowledges that Landlord has made no representation or warranty regarding the condition of the Storage Space. (a) Monthly Storage Rent. The monthly rental rate for the Storage Space ("Monthly Storage Rent") shall be One and 50/100 Dollar ($1.50) per RSF per month of the Storage Space per month ($543.00 per month) throughout the term of Tenant's lease of the Storage Space. Such Monthly Storage Rent shall be payable on the first day of each month in advance during the Lease Term at the same time and in the same manner as monthly Basic Rental for the Premises. In the event the Monthly Storage Rent is not paid when due, Landlord shall have the same rights as provided in Article 20 of this Lease for unpaid rent. Tenant's Proportionate Share shall not be increased as a result of Tenant's leasing the Storage Space. (b) Indemnification. Except to the extent any loss, costs, damage, expense or liability exceeds the coverage of the liability insurance and property insurance coverage required hereunder to be carried by Tenant and is caused by (i) any default by Landlord in the observance or performance of any of the terms, covenants or conditions to be observed or performed by Landlord under this Lease, or (ii) the negligence or willful misconduct of Landlord or any of its agents, employees, contractors, or licensees, Tenant hereby absolves Landlord from any and all loss, cost, damage, expense and liability, whether foreseeable or not, from any cause whatsoever, that Tenant may suffer to its personal property located anywhere in the Storage Space or that 51 it or its agents, employees, principals, invitees, or licensees may suffer as a direct or indirect consequence of Tenant's lease of or use of the Storage Space or access areas to the Storage Space. In addition, Tenant hereby agrees to indemnify, defend, protect and hold Landlord harmless from and against any loss, cost, damage, liability, expense, claim, action or cause of action of any third party, whether foreseeable or not, resulting as a direct or indirect consequence of Tenant's lease or use of the Storage Space or access areas to the Storage Space. (c) Use of Storage Space. Tenant agrees not to store any flammable or highly combustible materials in the Storage Space. Tenant also agrees not to store excess or highly concentrated waste in the Storage Space; it shall be Tenant's responsibility to obtain from Landlord the tolerable limits thereof. Tenant agrees to use the Storage Space solely for storage purposes and not as office space. Tenant agrees that Landlord and its agents may enter and inspect the Storage Space and any goods stored therein at any time during regular business hours upon giving twenty-four (24) hours prior notice to Tenant. Tenant shall, at its sole cost and expense, deliver to Landlord a key for any locks installed by Tenant for Landlord's emergency entrance purposes. (d) Incorporation of Lease Provisions. The provisions of this Lease with regard to the Premises, to the extent applicable and not inconsistent with the provisions of this Article 34, shall be deemed to apply to the Storage Space as though the Storage Space is part of the Premises, and as though the Monthly Storage Rent is part of the monthly Basic Rental. IN WITNESS WHEREOF, the parties have executed this Lease, consisting of the foregoing provisions and Articles, including all exhibits and other attachments referenced therein, as of the date first above written. "LANDLORD" ARDEN REALTY LIMITED PARTNERSHIP, a Maryland limited partnership By: ARDEN REALTY, INC., ---------------------------- a Maryland corporation Its: Sole General Partner By: /s/ VICTOR J. COLEMAN ---------------------------- VICTOR J. COLEMAN Its: President and COO By: /s/ ANDREW J. SOBEL ---------------------------- ANDREW J. SOBEL Its: Exec. V.P. and Assistant Secretary "TENANT" THE KUSHNER-LOCKE COMPANY, a California corporation 52 By: /s/ DONALD KUSHNER ---------------------------- Print Name: Title: By: /s/ ROBERT SWAN ---------------------------- Print Name: ROBERT SWAN Title: SR. V.P. & CFO EXHIBIT "A" PREMISES [ Floor plans: omitted.] EXHIBIT "B" RULES AND REGULATIONS 1. No sign, advertisement or notice shall be displayed, printed or affixed on or to the Premises or to the outside or inside of the Project or so as to be visible from outside the Premises or Project without Landlord's prior written consent. Landlord shall have the right to remove any non-approved sign, advertisement or notice, without notice to and at the expense of Tenant, and Landlord shall not be liable in damages for such removal. All approved signs or lettering on doors and walls shall be printed, painted, affixed or inscribed at the expense of Tenant by Landlord or by a person selected by Landlord and in a manner and style acceptable to Landlord. 2. Tenant shall not obtain for use on the Premises ice, waxing, cleaning, interior glass polishing, rubbish removal, towel or other similar services, or accept barbering or bootblackening, or coffee cart services, milk, soft drinks or other like services on the Premises, except from persons reasonably authorized by Landlord and at the hours and under regulations reasonably fixed by Landlord. Except for a reasonable number of soft drink and snack vending machines for use by Tenant's employees, no vending machines or machines of any description shall be installed, maintained or operated upon the Premises without Landlord's prior written consent. 3. The sidewalks, halls, passages, exits, entrances, elevators and stairways shall not be obstructed by Tenant or used for any purpose other than for ingress and egress from Tenant's Premises. Under no circumstances is trash to be stored in the corridors. Notice must be given to Landlord for any large deliveries. Furniture, freight and other large or heavy articles, and all other deliveries may be brought into the Project only at times and in the manner designated by Landlord, and always at Tenant's sole responsibility and risk. Landlord may impose reasonable charges for use of freight elevators after or before normal business hours. All damage done to the Project by moving or maintaining such furniture, freight or articles shall be repaired by Landlord at Tenant's expense. Tenant shall not take or permit to be taken in or out of entrances or passenger elevators of the Project, any item normally taken, or which Landlord otherwise reasonably requires to be taken, in or out through service doors or on freight elevators. Tenant shall move all supplies, furniture and equipment as soon as received directly to the Premises, and shall move 53 all waste that is at any time being taken from the Premises directly to the areas designated for disposal. 4. Toilet rooms, toilets, urinals, wash bowls and other apparatus shall not be used for any purpose other than for which they were constructed and no foreign substance of any kind whatsoever shall be thrown therein. 5. Tenant shall not overload the floor of the Premises or , except for customary wall-hangings, mark, drive nails, screw or drill into the partitions, ceilings or floor or in any way deface the Premises. Tenant shall not place typed, handwritten or computer generated signs in the corridors or any other common areas. Should there be a need for signage additional to the Project standard tenant placard, a written request shall be made to Landlord to obtain approval prior to any installation. All costs for said signage shall be Tenant's responsibility. 6. In no event shall Tenant place a load upon any floor of the Premises or portion of any such flooring exceeding the floor load per square foot of area for which such floor is designed to carry and which is allowed by law, or any machinery or equipment which shall cause excessive vibration to the Premises or noticeable vibration to any other part of the Project. Prior to bringing any heavy safes, vaults, large computers or similarly heavy equipment into the Project, Tenant shall inform Landlord in writing of the dimensions and weights thereof and shall obtain Landlord's consent thereto. Such consent shall not constitute a representation or warranty by Landlord that the safe, vault or other equipment complies, with regard to distribution of weight and/or vibration, with the provisions of this Rule 6 nor relieve Tenant from responsibility for the consequences of such noncompliance, and any such safe, vault or other equipment which Landlord determines to constitute a danger of damage to the Project or a nuisance to other tenants, either alone or in combination with other heavy and/or vibrating objects and equipment, shall be promptly removed by Tenant, at Tenant's cost, upon Landlord's written notice of such determination and demand for removal thereof. 7. Except for normal office supplies used in accordance with Law and in commercially reasonable amounts, Tenant shall not use or keep in the Premises or Project any kerosene, gasoline or inflammable, explosive or combustible fluid or material, or use any method of heating or air-conditioning other than that supplied by Landlord. 8. Tenant shall not lay linoleum, tile, carpet or other similar floor covering so that the same shall be affixed to the floor of the Premises in any manner except as approved by Landlord. 9. Tenant shall not install or use any blinds, shades, awnings or screens in connection with any window or door of the Premises and shall not use any drape or window covering facing any exterior glass surface other than the standard drapes, blinds or other window covering established by Landlord. 10. Tenant shall cooperate with Landlord in obtaining maximum effectiveness of the cooling system by closing window coverings when the sun's rays fall directly on windows of the Premises. Tenant shall 54 not obstruct, alter, or in any way impair the efficient operation of Landlord's heating, ventilating and air-conditioning system. Tenant shall not tamper with or change the setting of any thermostats or control valves. 11. The Premises shall not be used for manufacturing or for the storage of merchandise except as such storage may be incidental to the permitted use of the Premises. Tenant shall not, without Landlord's prior written consent, occupy or permit any portion of the Premises to be occupied or used for the manufacture or sale of liquor or tobacco in any form, or a barber or manicure shop, or as an employment bureau. The Premises hall not be used for lodging or sleeping or for any improper, objectionable or immoral purpose. No auction shall be conducted on the Premises. 12. Tenant shall not make, or permit to be made, any unseemly or disturbing noises, or disturb or unreasonably interfere with occupants of Project or neighboring buildings or premises or those having business with it by the use of any musical instrument, radio, phonographs or unusual noise, or in any other way. 13. No bicycles, vehicles or animals of any kind shall be brought into or kept in or about the Premises, and no cooking shall be done or permitted by any tenant in the Premises, except that the preparation of coffee, tea, hot chocolate and similar items for tenants, their employees and visitors shall be permitted. No tenant shall cause or permit any unusual or objectionable odors to be produced in or permeate from or throughout the Premises. The foregoing notwithstanding, Tenant shall have the right to use a microwave and to heat microwavable items typically heated in an office. No hot plates or similar open element cooking apparatus shall be permitted in the Premises. 14. The sashes, sash doors, skylights, windows and doors that reflect or admit light and air into the halls, passageways or other public places in the Project shall not be covered or obstructed by any tenant, nor shall any bottles, parcels or other articles be placed on the window sills. 15. No additional locks or bolts of any kind shall be placed upon any of the doors or windows by any tenant, nor shall any changes be made in existing locks or the mechanisms thereof unless Landlord is first notified thereof, gives written approval, and is furnished a key therefor. Each tenant must, upon the termination of his tenancy, give to Landlord all keys and key cards of stores, offices, or toilets or toilet rooms, either furnished to, or otherwise procured by, such tenant, and in the event of the loss of any keys so furnished, such tenant shall pay Landlord the cost of replacing the same or of changing the lock or locks opened by such lost key if Landlord shall deem it necessary to make such change. If more than two keys for one lock are desired, Landlord will provide them upon payment therefor by Tenant. Tenant shall not key or re-key any locks. All locks shall be keyed by Landlord's locksmith only. 16. Landlord shall have the right to prohibit any advertising by any tenant which, in Landlord's opinion, tends to impair the reputation of the Project or its desirability as an office building and upon written notice from Landlord any tenant shall refrain from and 55 discontinue such advertising. 17. Landlord reserves the right to control access to the Project by all persons after reasonable hours of generally recognized business days and at all hours on Sundays and legal holidays. Each tenant shall be responsible for all persons for whom it requests after hours access and shall be liable to Landlord for all acts of such persons. Landlord shall have the right from time to time to establish reasonable rules pertaining to freight elevator usage, including the allocation and reservation of such usage for tenants' initial move-in to their premises, and final departure therefrom. 18. Any person employed by any tenant to do janitorial work shall, while in the Project and outside of the Premises, be subject to and under the control and direction of the Office of the Project or its designated representative such as security personnel (but not as an agent or servant of Landlord, and the Tenant shall be responsible for all acts of such persons). 19. All doors opening on to public corridors shall be kept closed, except when being used for ingress and egress. Tenant shall cooperate and comply with any reasonable safety or security programs, including fire drills and air raid drills, and the appointment of "fire wardens" developed by Landlord for the Project, or required by law. Before leaving the Premises unattended, Tenant shall close and securely lock all doors or other means of entry to the Premises and shut off all lights and water faucets in the Premises. 20. The requirements of tenants will be attended to only upon application to the Office of the Project. 21. Canvassing, soliciting and peddling in the Project are prohibited and each tenant shall cooperate to prevent the same. 22. All office equipment of any electrical or mechanical nature shall be placed by tenants in the Premises in settings approved by Landlord, to absorb or prevent any vibration, noise or annoyance. 23. No air-conditioning unit or other similar apparatus shall be installed or used by any tenant without the prior written consent of Landlord. Tenant shall pay the cost of all electricity used for air-conditioning in the Premises if such electrical consumption exceeds normal office requirements, regardless of whether additional apparatus is installed pursuant to the preceding sentence. 24. There shall not be used in any space, or in the public halls of the Project, either by any tenant or others, any hand trucks except those equippedwith rubber tires and side guards. 25. All electrical ceiling fixtures hung in offices or spaces along the perimeter of the Project must be fluorescent and/or of a quality, type, design and bulb color approved by Landlord. Tenant shall not permit the consumption in the Premises of more than 3 watts per net usable square foot in the Premises in reespect of office lighting norshall Tenant permit the consumption in the Premises of more than 2 watts per net usable square foot of space in the Premises in respect of the power outlets therein, at any one time. In the event 56 that such limits are exceeded, Landlord shall have the right to require Tenant to remove lighting fixtures and equipment and/or to charge Tenant for the cost of the additional electricity consumed. 26. Parking. (a) Garage hours shall be 7:00 a.m. to 7:00 p.m., Monday through Friday, and closed on weekends, state and federal holidays excepted, as such hours may be revised from time to time by Landlord. (b) Automobiles must be parked entirely within the stall lines on the floor. (c) All directional signs and arrows must be observed. (d) The speed limit shall be 5 miles per hour. (e) Parking is prohibited in areas not striped for parking. (f) Parking cards or any other device or form of identification supplied by Landlord (or its operator) shall remain the property of Landlord (or its operator). Such parking identification device must be displayed as requested and may not be mutilated in any manner. The serial number of the parking identification device may not be obliterated. Devices are not transferable or assignable and any device in the possession of an unauthorized holder will be void. There will be a replacement charge to the Tenant or person designated by Tenant of $25.00 for loss of any parking card. There shall be a security deposit of $25.00 due at issuance for each card key issued to Tenant. (g) The monthly rate for parking is payable in advance and must be paid by the third business day of each month. Failure to do so will automatically cancel parking privileges and a charge at the prevailing daily rate will be due. No deductions or allowances from the monthly rate will be made for days parker does not use the parking facilities. (h) Tenant may validate visitor parking by such method or methods as the Landlord may approve, at the validation rate from time to time generally applicable to visitor parking. (i) Landlord (and its operator) may refuse to permit any person who violates the within rules to park in the garage, and any violation of the rules shall subject the automobile to removal from the garage at the parker's expense. In either of said events, Landlord (or its operator) shall refund a prorata portion of the current monthly parking rate and the sticker or any other form of identification supplied by Landlord (or its operator) will be returned to Landlord (or its operator). (j) Garage managers or attendants are not authorized to make or allow any exceptions to these Rules and Regulations. (k) All responsibility for any loss or damage to automobiles or any personal property therein is assumed by the parker. (l) Loss or theft of parking identification devices from automobiles must be reported to the garage manager immediately, and a lost or stolen report must be filed by the parker at that time. (m) The Parking facilities are for the sole purpose of parking one automobile per space. Washing, waxing, cleaning or servicing of any vehicles by the parker or his agents is prohibited. (n) Landlord (and its operator) reserves the right to refuse the issuance of monthly stickers or other parking identification devices to any Tenant and/or its employees who refuse to comply with the above Rules and Regulations and all City, State or Federal ordinances, laws or agreements. 57 (o) Tenant agrees to acquaint all employees with these Rules and Regulations. (p) No vehicle shall be stored in the garage for a period of more than one (1) week. 27. The Project is a non-smoking Project. Smoking or carrying lighted cigars or cigarettes in the Premises or the Project, including the elevators in the Project, is prohibited. EXHIBIT "C" NOTICE OF LEASE TERM DATES AND TENANT'S PROPORTIONATE SHARE TO: DATE: RE: Lease dated ________________, 1999, between ("Landlord"), and ("Tenant"), concerning Suite ________, located at __________________________________________. Ladies and Gentlemen: In accordance with the Lease, Landlord wishes to advise and/or confirm the following: 1. That the Premises have been accepted herewith by the Tenant as being substantially complete in accordance with the Lease and that there is no deficiency in construction. 2. That the Tenant has taken possession of the Premises and acknowledges that under the provisions of the Lease the Term of said Lease shall commence as of ____________ for a term of ________________________ ending on ________________________. 3. That in accordance with the Lease, Basic Rental commenced to accrue on ________________________. 4. If the Commencement Date of the Lease is other than the first day of the month, the first billing will contain a prorata adjustment. Each billing thereafter shall be for the full amount of the monthly installment as provided for in said Lease. 5. Rent is due and payable in advance on the first day of each and every month during the Term of said Lease. Your rent checks should be made payable to ________________________ at ________________________________. 6. The exact number of rentable square feet within the Premises is __________ square feet. 7. Tenant's Proportionate Share, as adjusted based upon the exact number of rentable square feet within the Premises is _______%. AGREED AND ACCEPTED: 58 TENANT: , a By: Its: EXHIBIT "D" TENANT WORK LETTER This Tenant Work Letter shall set forth the terms and conditions relating to the renovation of the tenant improvements in the Premises. This Tenant Work Letter is essentially organized chronologically and addresses the issues of the construction of the Premises, in sequence, as such issues will arise. SECTION 1 LANDLORD'S INITIAL CONSTRUCTION IN THE PREMISES Landlord has constructed, at its sole cost and expense, the base, shell and core (i) of the Premises, and (ii) of the floor of the Building on which the Premises is located (collectively, the "Base, Shell and Core"). Tenant has inspected and hereby approves the condition of the Premises and the Base, Shell and Core, and agrees that the Premises and the Base, Shell and Core shall be delivered to Tenant in their current "as-is" condition. The renovation to the improvements in the Premises shall be designed and constructed pursuant to this Tenant Work Letter. SECTION 2 IMPROVEMENTS 2.1 Improvement Allowance. Tenant shall be entitled to a one-time improvement allowance (the "Improvement Allowance") in the amount of $295,671.00 (based on $15.00 per usable square foot of Suite 2100 and $6.00 per usable square foot of Suite 2030) for the costs relating to the initial design and construction of Tenant's improvements which are permanently affixed to the Premises (the "Improvements"). In no event shall Landlord be obligated to make disbursements pursuant to this Tenant Work Letter in a total amount which exceeds the Improvement Allowance. Tenant may elect, by written notice to Landlord, to receive up to $6.00 per usable square foot (i.e., $130,170.00) of the Premises of the Improvement Allowance as a cash payment from Landlord, which shall be due and payable within thirty (30) days after the date of Tenant's execution and delivery of this Lease. In no event shall Tenant be entitled to any credit to the extent any portion of the Improvement Allowance is not used by Tenant for such cash payment or otherwise on or before June 30, 2001. 2.2 Disbursement of the Improvement Allowance. Except as otherwise set forth in this Tenant Work Letter, the Improvement Allowance shall be disbursed by Landlord (each of which disbursements shall be made pursuant to Landlord's disbursement process provided below) for costs related to the construction of the Improvements and for the following items and costs (collectively, the "Improvement Allowance Items"): (i) payment of the fees of the "Architect" and the 59 "Engineers," as those terms are defined in Section 3.1 of this Tenant Work Letter, and payment of the fees incurred by, and the cost of documents and materials supplied by, Landlord and Landlord's consultants in connection with the preparation and review of the "Construction Drawings," as that term is defined in Section 3.1 of this Tenant Work Letter, and designer/consultant fees; (ii) the cost of permits and construction supervision fees; (iii) the cost of any changes in the Base, Shell and Core required by the Construction Drawings; (iv) the cost of any changes to the Construction Drawings or Improvements required by applicable building codes (the "Code"); (v) the "Landlord Coordination Fee," as that term is defined in Section 4.3 of this Tenant Work Letter; and (vi) installation of telecommunications equipment, wiring and cabling and furniture, fixtures and equipment (collectively, "Miscellaneous Items"). However, in no event shall more than $2.00 per usable square foot of the Improvement Allowance be used for the items described in (i) and (ii) above nor shall more than $3.00 per usable square foot of the Improvement Allowance be used for the Miscellaneous Items; any additional amount incurred shall be deemed to constitute an Over-Allowance Amount. During the construction of the Improvements, Landlord shall make monthly disbursements of the Improvement Allowance for Improvement Allowance Items for the benefit of Tenant and shall authorize the release of monies for the benefit of Tenant as follows. 2.2.1 Monthly Disbursements. On or before the first day of each calendar month, during the construction of the Improvements Tenant shall deliver to Landlord: (i) a request for payment of the "Contractor," as that term is defined in Section 4.1 of this Tenant Work Letter, approved by Tenant, in a form to be provided by Landlord, showing the schedule, by trade, of percentage of completion of the Improvements in the Premises, detailing the portion of the work completed and the portion not completed; (ii) invoices from all of "Tenant's Agents," as that term is defined in Section 4.2 of this Tenant Work Letter, for labor rendered and materials delivered to the Premises; (iii) executed mechanic's lien releases from all of Tenant's Agents which shall comply with the appropriate provisions, as reasonably determined by Landlord, of California Civil Code Section 3262(d); and (iv) all other information reasonably requested by Landlord. Tenant's request for payment shall be deemed Tenant's acceptance and approval of the work furnished and/or the materials supplied as set forth in Tenant's payment request. Thereafter, Landlord shall deliver a check to Tenant in payment of the lesser of: (A) the amounts so requested by Tenant, as set forth in this Section 2.2.1, above, less a ten percent (10%) retention (the aggregate amount of such retentions to be known as the "Final Retention"), and (B) the balance of any remaining available portion of the Improvement Allowance (not including the Final Retention), provided that Landlord does not dispute any request for payment based on non-compliance of any work with the "Approved Working Drawings," as that term is defined in Section 3.4 below, or due to any substandard work, or for any other reason. Landlord's payment of such amounts shall not be deemed Landlord's approval or acceptance of the work furnished or materials supplied as set forth in Tenant's payment request. 2.2.2. Final Retention. Subject to the provisions of this Tenant Work Letter, a check for the Final Retention payable to Tenant shall be delivered by Landlord to Tenant following the completion of 60 construction of the Premises, provided that (i) Tenant delivers to Landlord properly executed mechanics lien releases in compliance with both California Civil Code Section 3262(d)(2) and either Section 3262(d)(3) or Section 3262(d)(4), (ii) Landlord has determined that no substandard work exists which adversely affects the mechanical, electrical, plumbing, heating, ventilating and air conditioning, life- safety or other systems of the Building, the curtain wall of the Building, the structure or exterior appearance of the Building, or any other tenant's use of such other tenant's leased premises in the Building and (iii) Architectdelivers to Landlord a certificate, in a form reasonably acceptable to Landlord, certifying that the construction of the Improvements in the Premises has been substantially completed. 2.2.3 Other Terms. Landlord shall only be obligated to make disbursements from the Improvement Allowance to the extent costs are incurred by Tenant for Improvement Allowance Items. All Improvement Allowance Items for which the Improvement Allowance has been made available shall be deemed Landlord's property. 2.3 Standard Tenant Improvement Package. Landlord has established specifications (the "Specifications") for the Building- standard components to be used in the construction of the Improvements in the Premises (collectively, the "Standard Improvement Package"), which Specifications are available upon request. The quality of Improvements shall be equal to or of greater quality than the quality of the Specifications, provided that Landlord may, at Landlord's option, require the Improvements to comply with certain Specifications. SECTION 3 CONSTRUCTION DRAWINGS 3.1 Selection of Architect/Construction Drawings. If based upon the scope of the Improvements, Landlord reasonably determines that plans and specifications are necessary, Tenant shall retain an architect/space planner reasonably approved by Landlord (the "Architect") to prepare the "Construction Drawings," as that term is defined in this Section 3.1. If necessary, Tenant shall also retain the engineering consultants designated by Landlord (the "Engineers") to prepare all plans and engineering working drawings relating to the structural, mechanical, electrical, plumbing, HVAC and lifesafety work of the Improvements; provided, however, that Landlord shall ensure that the charges of such engineering consultants designated by Landlord are commercially competitive. The plans and drawings to be prepared by Architect and the Engineers hereunder shall be known collectively as the "Construction Drawings" All Construction Drawings shall comply with the drawing format and specifications as reasonably determined by Landlord, and shall be subject to Landlord's reasonable approval. Tenant and Architect shall verify, in the field, the dimensions and conditions as shown on the relevant portions of the base building plans, and Tenant and Architect shall be solely responsible for the same, and Landlord shall have no responsibility in connection therewith. Landlord's review of the Construction Drawings as set forth in this Section 3, shall be for its sole purpose and shall not imply Landlord's review of the same, or obligate Landlord to review the same, for quality, design, Code compliance or other like matters. 61 Accordingly, notwithstanding that any Construction Drawings are reviewed by Landlord or its space planner, architect, engineers and consultants, and notwithstanding any advice or assistance which may be rendered to Tenant by Landlord or Landlord's space planner, architect, engineers, and consultants, Landlord shall have no liability whatsoever in connection therewith and shall not be responsible for any omissions or errors contained in the Construction Drawings. 3.2 Final Space Plan. Tenant and the Architect shall prepare the final space plan for Improvements in the Premises (collectively, the "Final Space Plan "), which Final Space Plan shall include a layout and designation of all offices, rooms and other partitioning, their intended use, and equipment to be contained therein, and shall deliver the Final Space Plan to Landlord for Landlord's approval. 3.3 Final Working Drawings. Architect and the Engineers shall complete the architectural and engineering drawings for the Premises, and the final architectural working drawings in a form which is complete to allow subcontractors to bid on the work and to obtain all applicable permits (collectively, the "Final Working Drawings") and shall submit the same to Landlord for Landlord's approval. 3.4 Permits. The Final Working Drawings shall be approved by Landlord (the "Approved Working Drawings") prior to the commencement of the construction of the Improvements. Tenant shall cause the Architect to immediately submit the Approved Working Drawings to the appropriate municipal authorities for all applicable building permits necessary to allow "Contractor," as that term is defined in Section 4.1, below, to commence and fully complete the construction of the Improvements (the "Permits"). No changes, modifications or alterations in the Approved Working Drawings may be made without the prior written consent of Landlord, which consent shall not be unreasonably withheld. SECTION 4 CONSTRUCTION OF THE IMPROVEMENTS 4.1 Contractor. A general contractor shall be retained by the Tenant to construct the Improvements. Such general contractor ("Contractor") shall be selected by the Tenant and approved by Landlord. 4.2 Tenant's Agents. All subcontractors, laborers, materialmen, and suppliers used by the Tenant (such subcontractors, laborers, materialmen, and suppliers, and the Contractor to be known collectively as "Tenant's Agents") must be approved in writing by Landlord, which approval shall not be unreasonably withheld or delayed. If Landlord does not approve any of the Tenant's proposed subcontractors, laborers, materialmen or suppliers, the Tenant shall submit other proposed subcontractors, laborers, materialmen or suppliers for Landlord's written approval. Notwithstanding the foregoing, the Tenant shall be required to utilize subcontractors designated by Landlord for any mechanical, electrical, plumbing, life-safety, sprinkler, structural and air-balancing work; provided, however, that Landlord shall ensure that the rates charged by such designated subcontractors are commercially competitive. 62 4.3 Construction of Improvements by Contractor. The Tenant shall independently retain, in accordance with Section 4.1 above, Contractor to construct the Improvements in accordance with the Approved Working Drawings. The Tenant shall pay a logistical coordination fee (the "Landlord Coordination Fee") to Landlord in an amount equal to five percent (5%) of the total amount of the construction contract and general conditions between the Tenant and the Contractor, excluding any flooring, painting and wallcovering. 4.4 Indemnification & Insurance. 4.4.1 Indemnity. Tenant's indemnity of Landlord as set forth in Article 13 of the Lease shall also apply with respect to any and all costs, losses, damages, injuries and liabilities related in any way to any act or omission of Tenant or Tenant's Agents. 4.4.2 Requirements of Tenant's Agents. Each of Tenant's Agents shall guarantee to Tenant and for the benefit of Landlord that the portion of the Improvements for which it is responsible shall be free from any defects in workmanship and materials for a period of not less than one (1) year from the date of completion thereof. All such warranties or guarantees as to materials or workmanship of or with respect to the Improvements shall be contained in the contract or subcontract and shall be written such that such guarantees or warranties shall inure to the benefit of both Landlord and Tenant, as their respective interests may appear, and can be directly enforced by either. Tenant covenants to give to Landlord any assignment or other assurances which may be necessary to effect such right of direct enforcement. 4.4.3 Insurance Requirements. 4.4.3.1 General Coverages. All of Tenant's Agents shall carry worker's compensation insurance covering all of their respective employees, and shall also carry public liability insurance, including property damage, all with limits, in form and with companies as are required to be carried by Tenant as set forth in Article 14 of the Lease. 4.4.3.2 Special Coverages. Tenant shall carry "Builder's All Risk" insurance in an amount approved by Landlord covering the construction of the Improvements, and such other insurance as Landlord may require. Such insurance shall be in amounts and shall include such extended coverage endorsements as may be reasonably required by Landlord. 4.4.3.3 General Terms. Certificates for all insurance carried pursuant to this Section 4.4.3.3 shall be delivered to Landlord before the commencement of construction of the Improvements and before the Contractor's equipment is moved onto the site. In the event that the Improvements are damaged by any cause during the course of the construction thereof, Tenant shall immediately repair the same at Tenant's sole cost and expense. SECTION 5 MISCELLANEOUS 63 5.1 Tenant's Representative. The Tenant has designated Richard Marks as its sole representative with respect to the matters set forth in this Tenant Work Letter, who, until further notice to Landlord, shall have full authority and responsibility to act on behalf of the Tenant as required in this Tenant Work Letter. 5.2 Landlord's Representative. Prior to commencement of construction of Improvements, Landlord shall designate a representative with respect to the matters set forth in this Tenant Work Letter, who, until further notice to the Tenant, shall have full authority and responsibility to act on behalf of the Landlord as required in this Tenant Work Letter. 5.3 Time of the Essence in This Tenant Work Letter. Unless otherwise indicated, all references herein to a "number of days" shall mean and refer to calendar days. Tenant acknowledges that the work to be performed by Tenant pursuant to this Tenant Work Letter may be performed during the Lease Term, that Tenant shall be entitled to (but shall not be obligated to) conduct business throughout the course of such renovations and that Tenant shall not be entitled to any abatement of rent, nor shall Tenant be deemed to be constructively evicted from the Premises, as a result of the construction of such renovations. 5.4 Miscellaneous Charges. Landlord agrees that the Contractor shall not be charged for utilities, freight elevator usage during normal business hours, or parking during the construction of these renovations. EX-23.1 5 EXHIBIT 23.1 1 Exhibit 23.1 The Board of Directors The Kushner-Locke Company: We consent to incorporation by reference in the registration statements (Nos. 333-72785, 333-80521, 333-40391, 333-10239 and 33-82942) on Form S-3 and (Nos. 333-79729, 333-63297, 33-45248 and 33-86768) on Form S-8 of our report dated December 21, 1999, on our audits of the consolidated financial statements and financial statement schedule of The Kushner-Locke Company as of and for each of the years in the two-year period ended September 30, 1999, which report is included in the Annual Report on Form 10-K. PriceWaterhouseCoopers LLP Century City, California December 28, 1999 84 EX-23.2 6 EXHIBIT 23.2 1 Exhibit 23.2 The Board of Directors The Kushner-Locke Company: We consent to incorporation by reference in the registration statements (Nos. 333-72785, 333-80521, 333-40391, 333-10239 and 33-82942) on Form S-3 and (Nos. 333-79729, 333-63297, 33-45248 and 33-86768) on Form S-8 of The Kushner-Locke Company of our report dated December 26, 1997, relating to the consolidated statements of operations, stockholders' equity and cash flows of The Kushner-Locke Company for the year ended September 30, 1997, and the related schedule for the year ended September 30,1997, which report appears in the September 30, 1999 annual report on Form 10-K of The Kushner-Locke Company. KPMG LLP Los Angeles, California December 21, 1999 EX-27 7 FINANCIAL DATA SCHEDULE
5 1000 YEAR SEP-30-1999 OCT-01-1998 SEP-30-1999 36,434 0 35,889 3,248 0 0 2,490 1,281 185,115 0 0 0 0 70,379 (9,634) 185,115 711 49,890 723 39,666 31,186 2,959 7,782 5,197 726 4,471 0 0 0 4,471 .38 .36 Included in total assets is $91,499 representing net film and television program assets. The Company presents its financial position in an unclassified consolidated balance sheet.
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