<PAGE>
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ________________ TO ________________
COMMISSION FILE NUMBER 0-21399
--------------------------
PEERLESS GROUP, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 75-2275966
(State of (IRS Employer Identification No.)
incorporation)
</TABLE>
1212 EAST ARAPAHO ROAD
RICHARDSON, TEXAS 75081
(972) 497-5500
(Address, including zip code, and telephone number, including
area code, of registrant's principal executive offices)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock ($.01 par value)
(Title of Class)
--------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. /X/
On February 28, 1998, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $14,909,899 (based on the average of the
reported high and low sales prices on such date as reported by NASDAQ). For
purposes of determination of the above stated amount, only directors, executive
officers and 10% or greater stockholders have been deemed affiliates.
As of February 28, 1998, there were 4,880,126 outstanding shares of Common
Stock, $0.01 par value per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the Annual Meeting of
Stockholders of Peerless Group, Inc. to be held during 1998 are incorporated by
reference into Part III of this Form 10-K.
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PART I
ITEM 1. BUSINESS
GENERAL
Peerless Group, Inc. (the "Company") designs, develops, installs and
supports integrated information systems, including proprietary computer software
and third-party software and hardware, for community banks and credit unions
located in the United States and Canada. The Company was incorporated in 1989
when a group of management executives from Electronic Data Systems Corporation
("EDS") purchased EDS's turnkey community bank data processing systems division,
which EDS had acquired in 1980. In 1992, the Company acquired and began offering
a credit union information software system. In 1994, the Company began marketing
a check and statement imaging system that is fully integrated with
Peerless21-Registered Trademark-, the Company's flagship banking product. In
September 1996, the Company began an outsourcing service bureau. On October 3,
1996, the Company completed an initial public offering of its Common Stock,
resulting in the issuance of 2,440,000 shares and net proceeds to the Company of
approximately $10.1 million.
The Company was incorporated under the laws of the State of Texas in 1989
and was reincorporated under the laws of the State of Delaware in 1996.
MARKET
According to industry sources, total spending on technology by U.S. banks
was approximately $16 billion in 1994 and spending is projected to increase to
over $21 billion in 1998. This growth is driven by banks investing in technology
to improve their efficiency and competitiveness in an environment where
competition is generally increasing among banks and between banks and non-bank
financial service companies. While the costs of acquiring and maintaining
in-house computer systems have historically been prohibitively high for many
community banks and credit unions, in recent years such costs have declined to
an affordable level which allows these financial institutions to purchase
integrated software/hardware solutions from third party vendors such as the
Company.
The Company's target bank market is comprised of community banks with assets
ranging from $50 million to $1 billion. However, most of the Company's community
bank customers have total assets ranging from $100 million to $500 million, and
the number of community banks in this size range increased slightly between 1995
and 1996 to approximately 2,580 banks. Most of the Company's credit union
customers have total assets ranging from $5 million to $200 million. As of
December 31, 1997, the Company had more than 350 bank and credit union customers
in 38 U.S. states and in Canada. In 1997, approximately 91% of the Company's
total revenue was from community bank customers, and no customer accounted for
10% or more of the Company's total revenue.
Because the Company's existing customer base is a significant source of
recurring revenues for the Company, an increase in the level of bank merger and
acquisition activity may cause the Company to lose customers or the number of
potential customers in the Company's target market to decline.
STRATEGY
The Company's objective is to continue to be a leading provider of
information systems for community banks and credit unions and to expand its
offerings into other complementary products and services. In addition to
leveraging its existing customer base, the Company's strategy to achieve this
objective involves continuing to enhance its Peerless21 and
PeerlessCU-Registered Trademark- software systems; continuing to expand sales of
check and statement imaging systems; continuing to develop and offer new
technology, products and services; differentiating itself from competitors
through outstanding customer service and support; and continuing to pursue
delivery of its products through the Company's outsourcing service bureau
operations.
2
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PRODUCTS AND SERVICES
The Company's revenues are derived primarily from software license and
installation, hardware and equipment sales, and maintenance and services.
Software license and installation revenues include fees from the sale of the
Company's own software products and the sale of third-party software products,
and the installation of such software products. Hardware and equipment sales
relate to the hardware and equipment on which the Company's, as well as other
vendors', software products operate. Maintenance and service revenues relate
primarily to the processing fees of the outsourcing service bureau operations
and revenues derived from maintenance contracts with its customers, under which
the Company provides customers with telephone support 24 hours a day, 7 days a
week, and modifications and enhancements to its software products. The following
table presents the revenue composition of the Company for the three years ending
December 31, 1997:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Software license and installation....................................... 34.3% 37.7% 36.5%
Hardware and equipment.................................................. 37.1 38.8 34.2
Maintenance and services................................................ 28.6 23.5 29.3
----- ----- -----
Total revenues........................................................ 100.0% 100.0% 100.0%
</TABLE>
The Company's two core software products are Peerless21, its proprietary
information system for community banks, and PeerlessCU, its proprietary
information system for credit unions. Peerless21 and PeerlessCU provide software
solutions for substantially all areas of financial institution data processing,
customer relationship management, management decision making and product
creation and sales. The Company also offers its customers an automated teller
machine transaction processing system and telephone banking using an interactive
voice response system that are fully integrated with Peerless21 and PeerlessCU.
As a part of its service offerings, the Company provides its customers with
comprehensive training and education programs for its systems and continuing
customer maintenance and support as well as business recovery services.
The Company's software products run on International Business Machines
("IBM") computing platforms, which are the leading hardware platforms in the
Company's target market. According to industry sources, approximately 44% of
community banks with in-house information systems utilized IBM computing
platforms in 1996. The Company is an authorized IBM reseller.
Company customers that purchase Peerless21 or PeerlessCU information systems
typically enter into three to five-year maintenance and service agreements with
the Company at the time of installation. As part of the maintenance and service
agreements, customers automatically receive two to three product updates each
year.
The Company markets a check and statement imaging system that is fully
integrated with Peerless21. According to industry sources, bank spending for
imaging technology is projected to increase from $260 million in 1995 to $425
million in 1998. The Company's check and statement imaging system enables banks
to reduce costs by scanning digital images of checks into a bank's computer
system, which can then be printed on checking account statements, thereby
eliminating the need to return checks to customers and improving check
processing speeds. During 1997, revenues from the shipment and installation of
check and statement imaging systems accounted for approximately 25% of the
Company's total revenues, compared to 22% in 1996. Currently, approximately 15%
of the Company's existing bank customers have check and statement imaging
systems, and the Company believes it has a significant opportunity to leverage
its installed base of bank customers by continuing to sell imaging systems to
existing and new customers.
In addition, the Company believes that it can further leverage its installed
customer base by providing additional products, services and upgrades to these
customers, including product offerings in electronic
3
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banking. The Company believes its success at leveraging its customer base is
reflected in a compounded annual growth in total revenues of 20% between 1991
and 1997.
According to industry sources, approximately 36% of community banks with
assets of under $500 million and approximately 26% of credit unions outsourced
their information systems requirements in 1996. In 1996 the Company established
an outsourcing service bureau to serve those community banks and credit unions
that choose to use a service bureau for their information processing and check
and statement imaging requirements, a market previously not served by the
Company. During 1997, revenues from outsourcing operations accounted for
approximately 4% of the Company's total revenues, compared to less than 1% in
1996. The Company currently has sixteen outsourcing customer contracts, eight of
which are both check and statement imaging and data processing, two of which are
data processing only and six of which are check imaging or item processing only.
Currently, all data processing services are performed at the Company's facility
in Richardson, Texas, and at the Company's processing center in Port Arthur,
Texas, and no additional data processing centers are currently expected to be
established. Due to the nature of item processing services, the Company has
established four item capture centers in close proximity to the customers
serviced and expects to open additional item processing centers as contracts
necessary to support such centers are executed. The Company's outsourcing
business is still in the early stages of growth and investment. While management
believes this business will reach profitability in 1998, there can be no
assurance that the Company will be successful in this business.
The Company offers business recovery services. These services are intended
to allow its customers to be back online after a disaster in as little as 24
hours and to satisfy U.S. financial institution regulatory obligations to
maintain and annually test a business recovery plan.
The market for the Company's products is characterized by technological
advances, evolving industry standards, changes in end-user requirements and
frequent new product introductions and enhancements. As a developer of computer
software, the Company will be required to modify its software products so that
the software will function properly in the year 2000. The Company has developed
a Year 2000 compliance plan which was certified by the Information Technology
Association of America in December 1997. This external certification is part of
the Federal Financial Institutions Examination Council Safety and Soundness
approval process. The Company's future success will depend upon its ability to
enhance its current products and to develop and introduce new products that keep
pace with technological developments and emerging industry standards and address
the increasingly sophisticated needs of its customers. See "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Outlook-- Year 2000."
This item should be read in conjunction with "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations--Outlook."
SEASONALITY AND CYCLICALITY
The Company recognizes a significant portion of its revenues upon the
installation of its software. Since its customers generally do not want to have
systems installed at or near the end of the calendar year, revenues have
generally been lower during the months of December and January than in the
remainder of the year. An economic downturn in the Company's target market could
have a materially adverse effect on the Company's operating results.
PRINCIPAL SUPPLIERS
Since 1989, the Company has been a value-added remarketer of IBM products
pursuant to standard IBM remarketer agreements. These products include non-IBM
software that IBM authorizes the Company to sell. The Company does not maintain
an inventory of IBM products but purchases such products only upon receipt of a
customer order. IBM has sole discretion with respect to pricing the products
offered by the Company pursuant to this agreement.
4
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The Company's current remarketing agreement with IBM expires February 28,
1999. Both IBM and the Company may terminate the agreement, with or without
cause, upon three months written notice. The Company has no indication that IBM
will discontinue these remarketing arrangements.
Since 1993, the Company has been a value-added remarketer of NCR products
pursuant to an NCR value-added remarketer agreement. These products include the
hardware on which the Company's check and statement imaging and processing
systems operate. Under its agreement with NCR, the Company markets and resells
or licenses such NCR products, which it purchases from NCR at a volume-based
discount. The Company may from time to time purchase NCR products in advance of
an order, based on forecasted demand. NCR may add new products or discontinue or
change the design of any products subject to the agreement at any time. The
agreement has no term, but either party may terminate it upon 90 days' written
notice.
The Company licenses software for its check and statement imaging and
processing systems from Document Solutions, Inc. ("DSI") pursuant to a system
integrator agreement. The Company provides all normal customer support for the
Company's customers, and DSI provides software releases as necessary. The
Company does not maintain a significant inventory of DSI products, but generally
purchases such products upon receipt of a customer order.
The Company's agreement with DSI automatically renews for one year each
January 1, unless terminated upon written notice 120 days prior to the
expiration of the then-current year. During the term of the agreement and for
two years following its termination, the Company may not develop, sell or
otherwise distribute products competitive with those of DSI, so long as DSI's
products offer competitive features and are competitively priced. If competitive
products have additional features or are priced lower than DSI's, the Company
may advise DSI in writing and allow DSI 180 days to enhance the features or
reduce the price of DSI's products. If DSI cannot suitably enhance its products
or reduce its prices within 180 days, the Company may then purchase the
competing products.
The Company has in the past experienced delays in the delivery of hardware
products that are in high demand. The Company believes a prolonged interruption
or delay in the supply of computer hardware or the Company's inability to
purchase hardware at competitive prices could have a materially adverse effect
on the Company's results of operations. In addition, the Company's results of
operations could be materially and adversely affected if a principal supplier
decided to terminate its agreement to supply products to the Company or if such
a supplier decided to develop or acquire a product that would compete with the
Company's financial institution software applications products.
INTELLECTUAL PROPERTY
The Company relies primarily on a combination of copyright and trademark
laws, trade secrets, confidentiality procedures and contractual provisions to
protect its proprietary rights. The Company seeks to protect its software,
documentation and other written materials under trade secret and copyright laws.
The Company presently has no patents or patent applications pending. There can
be no assurance that the mechanisms used by the Company to protect its software
will be adequate or that the Company's competitors will not independently
develop software products that are substantially equivalent or superior to the
Company's software products. Although the Company does not believe that its
intellectual property rights infringe on the existing rights of third parties,
there can be no assurance that third parties will not assert infringement claims
against the Company.
BACKLOG
The Company's backlog of license and installation fees and hardware and
equipment sales was approximately $4.5 million at December 31, 1997, compared to
approximately $4.7 million at December 31, 1996. This backlog amount excludes
revenues to be derived from long-term customer contracts for maintenance and
outsourcing activities, which are typically three to five-year contract
commitments. The
5
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Company's backlog can fluctuate significantly due to many reasons, including,
but not limited to, the sales cycle length of varying products, product
availability, the duration of the installation period, and customer requested
installation date.
COMPETITION
The financial institution management information systems market is intensely
competitive and subject to rapid change. Competitors vary in size and in the
scope and breadth of the products and services offered. The Company believes
that the primary competitive factors in system selection are features and
functions, flexibility and ease of use, software enhancements and maintenance,
technological advantages and customer support and training. The price of the
software and related services is also a significant competitive factor which may
be determinative, particularly for smaller institutions. The Company competes
with several firms that offer software products that compete with the Company's
products, as well as competing with firms that provide data processing services
to financial institutions that desire to outsource that function. These
competitors vary in size from large to small and in geographical coverage from
national to regional and local operations.
There are a number of larger companies, including major computer hardware
manufacturers, computer software companies and outsourcing services, that have
substantially greater financial and management resources than the Company and
the technological ability to develop products similar to those offered by the
Company. As a result, they may be able to respond more quickly to new or
emerging technologies and changes in customer requirements or to devote greater
resources to the development, promotion and sale of their products than the
Company.
The Company's principal competitors in its target market for community
banking information management systems are Jack Henry & Associates and Fiserv,
Inc. The Company also competes in this market against EDS, ALLTEL Information
Systems, Inc. and others.
The credit union market is highly fragmented, and no one firm has a dominant
market share. The Company's competitors in its target market for credit union
information management systems are EDS, Fiserv, Inc., ULTRADATA Corporation and
others.
Additionally, the Company believes that no one firm may be considered
dominant in providing outsourcing data processing service to customers in the
Company's marketplace. The Company believes that EDS, Fiserv, Inc. and The BISYS
Group, Inc. are its main outsourcing services competitors.
The Company's principal competitors in the check-imaging industry are
BancTec Financial Systems, Advanced Financial Solutions, Inc., and Greenway
Corporation.
SALES AND MARKETING
The Company markets its products and services throughout the United States
through a direct sales force. The Company maintains separate sales forces for
its community bank, credit union, and outsourcing products and services, which
allows the Company's sales representatives to concentrate on each separate
customer market.
The Company markets its products and services through specific product
advertising in trade journals directed at community banks and credit unions, its
Internet home page and sales support literature. The Company also relies on
customer referrals, networking, direct mail, trade shows and contacts with
independent consultants. The sales cycle associated with the purchase of the
Company's products is typically lengthy and subject to a number of significant
risks, including customers' budgetary constraints and internal acceptance
reviews.
6
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EMPLOYEES
As of December 31, 1997, the Company had a total of 184 employees, compared
to 157 at December 31, 1996. The increase in the number of employees was due
primarily to hiring additional service bureau personnel during the year. None of
the Company's employees are represented by a labor union. The Company has not
experienced any work stoppages and considers its relations with its employees to
be satisfactory. The Company's success depends on the performance of its
executive officers and other key personnel, as well as its ability to attract
and retain such personnel. Competition in the recruiting and retention of highly
qualified technical and other personnel in the information systems industry is
intense, especially in the regions in which the Company operates, and the
Company anticipates that it may become more difficult to attract, assimilate and
retain qualified personnel in the future.
EXECUTIVE OFFICERS
Set forth below is the name, age, position, term of office and a brief
account of the business experience of each person who is an executive officer of
the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------- --- ------------------------------------------------------------
<S> <C> <C>
Rodney L. Armstrong, Jr.............. 53 Chairman of the Board and Chief Executive Officer
Steven W. Tomson..................... 35 President
Kevin W. Marsh....................... 45 Executive Vice President--Sales
Ann L. Puddister..................... 37 Director of Administration and Corporate Secretary
Douglas K. Hansen.................... 30 Treasurer and Controller
</TABLE>
RODNEY L. ARMSTRONG, JR. is one of the Company's founders and has been
Chairman of the Board and Chief Executive Officer since 1989. Mr. Armstrong was
the Company's President from 1994 to June 1996. Mr. Armstrong has 24 years of
experience in the information technology and financial institution marketplace.
In 1974, he joined United Virginia Bankshares (now known as Crestar Corporation)
as Corporate Planning Officer responsible for the bank holding company's
long-range strategic planning. Between 1977 and 1989, Mr. Armstrong held various
management positions with EDS, where he started and managed its electronic ATM
and point of sale networking division and was responsible for corporate
development for its Financial and Insurance Group, before initiating the buyout
of EDS' turnkey community bank data processing systems division by the Company
in 1989.
STEVEN W. TOMSON joined the Company in 1991 as Regional Marketing Manager,
Banking. In June 1994, Mr. Tomson left the Company to work for Bermac
Communications, Inc., a software development company, as an Account Manager. Mr.
Tomson returned to the Company in February 1995 and has served as President of
the Company's credit union systems subsidiary and as Executive Vice President
and Chief Operating Officer of the Company. Mr. Tomson has served as President
of the Company since April 1997. Prior to joining the Company, Mr. Tomson was
employed as an Account Sales Representative by IBM.
KEVIN W. MARSH joined the Company in 1989 and has served in various
capacities since that time, including Vice President of Sales of the Company's
banking systems subsidiary and Vice President of sales of the Company's
outsourcing subsidiary. Mr. Marsh has served as Executive Vice President-Sales
of the Company since July 1997.
ANN L. PUDDISTER joined the Company in 1989. Ms. Puddister has served as
Director of Administration since 1992 and Corporate Secretary since 1994. Prior
to joining the Company, Ms. Puddister worked at EDS for 10 years.
7
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DOUGLAS K. HANSEN joined the Company in 1994 as Controller and has served as
Treasurer of the Company since May 1996. From 1989 to 1994, Mr. Hansen was
employed by Ernst & Young LLP, most recently as an Audit Manager. Mr. Hansen is
a certified public accountant.
GOVERNMENT REGULATION
As a provider of in-house software application systems and hardware, the
Company is not directly subject to Federal or state regulations specifically
applicable to financial institutions. As a provider of products to these
entities, however, the Company must take into account such regulations in order
to provide products that help its customers comply with such regulations. The
implementation of the Company's products by its customers is reviewed from time
to time by government regulators in connection with compliance audits of the
customers' operations. The Company must continually update its products to
reflect changes in applicable regulations or the adoption of new regulations.
Any such changes or new regulations could have a materially adverse effect on
the Company's business, financial condition and results of operations. To the
extent the Company provides information services to financial institutions that
desire to outsource that function, the Company is subject to examinations by
various Federal and state regulatory agencies.
ITEM 2. PROPERTIES
The Company's community banking, credit union and outsourcing subsidiaries
are located in three facilities in Richardson, Texas with a total of
approximately 31,000 square feet. These facilities are leased pursuant to
agreements which expire beginning November 30, 1998 through June 30, 2001 and
provide for monthly rental payments of approximately $22,000. The Company's
check and statement imaging and business recovery operations are located in a
facility of 5,525 square feet in Plano, Texas. This facility is leased pursuant
to an agreement that expires on January 31, 1999 and provides for a monthly
rental payment of approximately $3,160. The Company leases three additional
facilities totaling 8,719 square feet which serve as item processing centers and
require total monthly rental payments of $8,337. In May 1997 the Company entered
into an agreement to lease a 82,600 square foot building and certain real
property in Allen, Texas. The lease is expected to commence in the third quarter
of 1998. The Company intends to sublease certain of its existing facilities upon
moving to the Allen location.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company has been involved in litigation relating to
claims arising out of its operations in the normal course of business. As of the
date of this Form 10-K, the Company is not a party to any legal proceeding, the
adverse outcome of which would, in management's opinion, have a materially
adverse effect on the Company's results of operations or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock, $.01 par value, is traded on the Nasdaq National
Market under the symbol "PLSS." Prior to the Company's initial public offering
of its Common Stock on October 3, 1996, there was no market for its Common
Stock. The following were the reported high and low sales prices for the
Company's common stock for the period October 3, 1996, through December 31,
1997:
<TABLE>
<CAPTION>
HIGH LOW
----- ---
<S> <C> <C>
1996:
Fourth Quarter................................................................. 8 1/2 5 7/8
1997:
First Quarter.................................................................. 7 1/8 5
Second Quarter................................................................. 7 1/2 5 1/8
Third Quarter.................................................................. 7 3/8 4 3/8
Fourth Quarter................................................................. 5 1/4 4 1/4
</TABLE>
As of February 28, 1998, there were 267 holders of record, although the
Company believes that the number of beneficial owners is significantly greater
than that number because a large number of shares are held of record by
brokerage firms on behalf of their customers.
The Company has not since its inception paid cash dividends on its Common
Stock and intends to retain all earnings, if any, for use in the Company's
business and does not anticipate paying cash dividends in the foreseeable
future. Further, certain covenants in the Company's credit agreement prohibit
the payment of cash dividends by the Company.
9
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Revenues:
Software license and installation............... $ 4,789 $ 4,558 $ 7,181 $ 9,987 $10,339
Hardware and equipment.......................... 7,118 5,019 6,727 10,303 11,171
Maintenance and services........................ 4,382 5,165 5,782 6,235 8,621
------- ------- ------- ------- -------
Total revenues................................ 16,289 14,742 19,690 26,525 30,131
Cost of revenues:
Hardware and equipment.......................... 5,380 3,892 5,258 7,754 8,528
Software license and installation, maintenance
and services.................................. 6,306 5,855 6,872 8,882 11,794
------- ------- ------- ------- -------
Total cost of revenues........................ 11,686 9,747 12,130 16,636 20,322
------- ------- ------- ------- -------
Gross margin...................................... 4,603 4,995 7,560 9,889 9,809
Operating costs and expenses:
Research and development........................ 1,404 1,365 1,398 1,696 2,004
Selling and marketing........................... 2,610 2,301 2,502 3,477 3,412
General and administrative...................... 853 1,181 1,222 1,512 2,216
Severance charge(1)............................. -- -- -- 341 --
------- ------- ------- ------- -------
Total operating costs and expenses............ 4,867 4,847 5,122 7,026 7,632
------- ------- ------- ------- -------
Income (loss) from operations..................... (264) 148 2,438 2,863 2,177
Other income (expense):
Interest expense................................ (494) (776) (612) (548) (20)
Interest income................................. 15 63 68 133 280
------- ------- ------- ------- -------
Total other income (expense).................. (479) (713) (544) (415) 260
------- ------- ------- ------- -------
Income (loss) before income taxes................. (743) (565) 1,894 2,448 2,437
Provision for income taxes........................ -- -- 64(2) 155(2) 534(3)
------- ------- ------- ------- -------
Net income (loss)................................. $ (743) $ (565) $ 1,830 $ 2,293 $ 1,903
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Basic earnings (loss) per share(4)................ $ (0.36) $ (0.29) $ 0.90 $ 0.82 $ 0.40
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Diluted earnings (loss) per share(4).............. $ (0.36) $ (0.32) $ 0.49 $ 0.55 $ 0.37
------- ------- ------- ------- -------
------- ------- ------- ------- -------
Shares used in computing basic earnings (loss) per
share........................................... 2,054 1,949 1,976 2,745 4,712(6)
Shares used in computing diluted earnings (loss)
per share....................................... 2,054(5) 1,949(5) 3,648 4,055 5,130(6)
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------------------------------------
1993 1994 1995 1996 1997
------- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents......................... $ 1,554 $ 1,081 $ 1,394 $ 8,378 $ 2,845
Total assets...................................... 6,555 6,346 7,130 17,359 19,942
Unearned revenues................................. 5,046 8,231 8,144 7,573 7,121
Current and long-term debt due to related
parties......................................... 7,479 5,469 3,627 -- --
Stockholders' equity (deficit).................... (7,807) (9,586) (7,729) 6,312 8,159
</TABLE>
- ------------------------------
(1) During the year ended December 31, 1996, the Company incurred a severance
charge related to the resignation of a former officer.
(2) The Company's effective income tax rate was positively impacted by the
utilization of previously unbenefitted net operating loss carryforwards.
(3) The Company's effective income tax rate was positively impacted by the
utilization of research and development tax credits.
(4) For a description of the calculation of basic and diluted earnings (loss)
per share, see Note 12 of Notes to Consolidated Financial Statements. All
earnings (loss) per share amounts have been presented, and where
appropriate, restated to conform to the requirements of Financial Accounting
Standards Board Statement No. 128, EARNINGS PER SHARE.
(5) The exercise of options and warrants is not assumed in the calculation of
diluted loss per share as the result would be antidilutive.
(6) The increase in share basis in 1997 as compared to 1996 is due primarily to
the additional shares issued in the Company's October 3, 1996 initial public
offering.
10
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
The Company was formed in 1989 when a group of management executives from
EDS purchased EDS' turnkey bank data processing systems division, which EDS had
acquired in 1980. In 1992, the Company acquired and began offering a credit
union information software system. In 1994, the Company began marketing a check
and statement imaging system that is fully integrated with Peerless21, the
Company's flagship banking product. In September 1996, the Company began an
outsourcing service bureau. On October 3, 1996, the Company commenced an initial
public offering of its Common Stock (the "Offering"), resulting in the issuance
of 2,440,000 shares and net proceeds of approximately $10.1 million.
The Company's total revenues are derived primarily from software license and
installation, hardware and equipment and maintenance and services. Approximately
91% of the Company's total revenues for 1997 are from its banking customers and,
historically, a large part of the Company's total revenues and growth have been
derived from its installed customer base. See "Outlook--Revenues" below.
Software license and installation consists of revenue recorded by the
Company on the installation of its software products, which in the case of most
of the Company's contracts, involves the use of the percentage-of-completion
method of accounting for revenues, as installation services are performed over
several months. Revenues from sales of software licenses not involving
installation are recognized upon delivery of the software to the customer.
Revenues from hardware and equipment sales are recognized upon shipment by the
manufacturer to the customer. Revenues from maintenance contracts are recognized
ratably over the periods of the respective contracts, which typically have terms
of three to five years. Revenues from services, including processing fees, are
recognized in the period in which the services are performed.
In the case of revenues from software license and installation and hardware
and equipment, the Company generally requires significant deposits and
prepayments. Maintenance and service agreements are administered on a calendar
year basis with fees generally received in December or January. Deposits
received and amounts billed for software licenses, installation and hardware in
advance of installation or delivery, and for annual software maintenance prior
to performance of related services, are reflected as unearned until such amounts
are recognized in accordance with the Company's revenue recognition policy. See
Note 2 of Notes to Consolidated Financial Statements.
The Company expenses all software development costs as incurred until
technological feasibility has been established for the product, at which time
the costs are capitalized until the product is available for general release to
customers. The Company has expensed substantially all software development costs
since 1994, as primarily all software development efforts have been related to
enhancing the Company's existing products.
YEARS ENDED DECEMBER 31, 1997 AND 1996
REVENUES. Revenues for the year ended December 31, 1997 increased $3.6
million, or 13.6%, over the prior year. Revenues from software license and
installation increased $0.4 million, or 3.5%, over the prior year, and revenues
from hardware and equipment increased $0.9 million, or 8.4%, over the prior
year. Increases in revenues from installations of check and statement imaging
systems as well as additional software license and hardware revenues associated
with the sales of ancillary products were offset by decreases in revenues from
implementations of Peerless21. Shipments and installations of check and
statement imaging systems contributed $7.6 million in software license and
installation and in hardware and equipment revenues, as compared to $5.9 million
in 1996. Revenues from installations of Peerless21 decreased $0.7 million, or
14.5%, from the prior year. This decrease occurred primarily because the Company
made a greater number of Peerless21 installations in 1997 to smaller financial
institutions than in 1996. The Company typically recognizes lower revenues from
a Peerless21 implementation for a smaller
11
<PAGE>
financial institution than for a larger financial institution. In response to
the decrease in Peerless21 revenues, the Company made certain management changes
to better focus its Peerless21 sales strategy. Revenues from maintenance and
services increased $2.4 million, or 38.3% over the prior year, due primarily to
data and item processing fees earned during 1997, which was the first full year
of operations for the Company's outsourcing service bureau. Data and item
processing revenues from the Company's outsourcing service bureau were $1.1
million in 1997, compared to $0.1 million in 1996.
GROSS MARGIN. Gross margin for the year ended December 31, 1997 declined to
32.6% of total revenues from 37.3% for the prior year. Increased shipments of
check and statement imaging systems and continuing investment in the Company's
service bureau contributed to the lower margins for the year. Check and
statement imaging systems generally have lower margins than other software and
hardware products, and investments in service bureau operations may continue to
contribute to lower margins in the future (See "Outlook--Outsourcing Service
Bureau"). Excluding the service bureau component, gross margin for the year
ended December 31, 1997 was 35.3% of total revenues.
Shifts in the mix of the sources of the Company's revenues, including
revenues from software license and installation fees, check and statement
imaging systems and processing fees, may cause significant fluctuations in total
revenue and gross margin. In addition, the Company manages its expenses based on
anticipated revenue levels, and a high percentage of these expenses are
relatively fixed. Therefore, variations in the amount and timing of revenue may
cause significant variations in operating results from period to period.
Further, in response to a changing competitive environment, the Company may
elect to make certain pricing, product or marketing decisions that could have a
material adverse effect on the Company's results of operations.
RESEARCH AND DEVELOPMENT. Research and development expenses for the year
ended December 31, 1997 increased $308,000, or 18.2%, from the prior year. This
increase primarily resulted from the Company's focus on product upgrades that
will complete the Year 2000 solution and provide its customers with the most
current technology. As a percentage of total revenues, research and development
expenses increased slightly to 6.7% for the year from 6.4% for the prior year.
See "Outlook--Year 2000" below.
SELLING AND MARKETING. Selling and marketing expenses for the year ended
December 31, 1997 decreased $65,000, or 1.9%, from the prior year. As a
percentage of total revenues, selling and marketing expenses decreased to 11.3%
for the year from 13.1% for the prior year. This decrease was due to cost
control initiatives undertaken by management during the year.
GENERAL AND ADMINISTRATIVE. General and administrative expenses for the
year ended December 31, 1997 increased $704,000, or 46.6%, from the prior year.
This increase primarily resulted from additional insurance, professional fees
and administrative costs associated with being a public company. As a percentage
of total revenues, general and administrative expenses increased to 7.4% for the
year from 5.7% for the prior year.
INTEREST EXPENSE. Interest expense for the year ended December 31, 1997
decreased $528,000, or 96.4% from the prior year. This decrease primarily
resulted from the repayment of all outstanding debt subsequent to the Offering.
INTEREST INCOME. Interest income for the year ended December 31, 1997
increased $147,000 from the prior year. This increase was a result of the
investment of cash obtained from the Offering.
BASIC AND DILUTED EARNINGS PER SHARE. Basic and diluted earnings per share
for the year ended December 31, 1997, were negatively impacted by an increase in
the Company's tax rate and an increase in the shares used in computing earnings
per share, which resulted from the additional shares issued in the Offering and
the exercise of outstanding warrants to purchase the Company's common stock.
12
<PAGE>
YEARS ENDED DECEMBER 31, 1996 AND 1995
REVENUES. Revenues for the year ended December 31, 1996 increased $6.8
million, or 34.7%, over the prior year. Revenues from software license and
installation fees increased $2.8 million, or 39.1%, over the prior year, and
revenues from hardware and equipment sales increased $3.6 million, or 53.2%,
over the prior year. These increases were due primarily to increases in revenue
from installations of Peerless21 and shipments and installations of check and
statement imaging systems. Installations of Peerless21 contributed $4.7 million
in software license and installation fees, as well as additional software
license fees and hardware revenues associated with the sales of ancillary
products, representing an increase of $1.6 million, or 52.2%, over the prior
year. Shipments and installations of check and statement imaging systems
contributed $5.9 million in revenues, representing an increase of $2.5 million,
or 74.5%, over the prior year.
GROSS MARGIN. Gross margin for the year ended December 31, 1996 declined
slightly to 37.3% of total revenues from 38.4% for the prior year. This decrease
was attributable primarily to the Company hiring and training additional
employees to support revenue growth. These margin declines were partially offset
by an improvement in the gross margin percentage from hardware and equipment
sales, which increased to 24.7% for the year from 21.8% for the prior year,
which is primarily attributable to an increase in the margins on check and
statement imaging hardware.
RESEARCH AND DEVELOPMENT. Research and development expenses for the year
ended December 31, 1996 increased $298,000, or 21.3%, from the prior year. This
increase primarily resulted from hiring additional research and development
employees to modify and enhance existing products. As a percentage of total
revenues, research and development expenses decreased slightly to 6.4% for the
year from 7.1% for the prior year.
SELLING AND MARKETING. Selling and marketing expenses for the year ended
December 31, 1996 increased by $975,000, or 39.0%, from the prior year. This
increase primarily resulted from an increase in the number of employees in sales
and marketing to support increased revenues and increased compensation levels
for existing employees due to increased production. As a percentage of total
revenues, selling and marketing expenses increased slightly to 13.1% for the
year from 12.7% for the prior year.
GENERAL AND ADMINISTRATIVE. General and administrative expenses for the
year ended December 31, 1996 increased $290,000, or 23.7%, from the prior year.
This increase primarily resulted from placement agency fees and other costs
associated with the hiring of additional employees, as well as additional
insurance and legal costs associated with being a public company. As a
percentage of total revenues, general and administrative expenses decreased
slightly to 5.7% for the year from 6.2% for the prior year.
SEVERANCE CHARGE. During 1996 the Company incurred a severance charge of
$341,000 related to the resignation of a former officer ($289,000 of which were
non-cash compensation charges related to the extension of the exercise period of
certain stock options and the acceleration of vesting of restricted stock
awards).
INTEREST EXPENSE. Interest expense for the year ended December 31, 1996
decreased $64,000, or 10.5%, from the prior year. This decrease primarily
resulted from the repayment of all outstanding debt subsequent to the Offering,
and was slightly offset by amortization of deferred debt costs associated with
the Company's line of credit, which the Company obtained in October 1995.
BASIC AND DILUTED EARNINGS PER SHARE. Basic and diluted earnings per share
for the year ended December 31, 1996, were negatively impacted by an increase in
the shares used in computing earnings per share, resulting from the additional
shares issued in the Offering.
13
<PAGE>
PROVISION FOR INCOME TAXES
The Company's provision for income taxes for the year ended December 31,
1996 included the Alternative Minimum Tax under the Internal Revenue Code of
1986, as amended, and state income taxes. In the fourth quarter of 1996, the
Company eliminated the valuation allowance against its deferred tax assets,
resulting in the recording of a federal deferred tax benefit of approximately
$250,000. The majority of the Company's net operating loss carryforwards for
Federal income tax purposes were utilized in late 1996. The Company's 1997
effective tax rate was favorably impacted by the utilization of research and
development tax credits totaling $459,000. The effective tax rate for the year
ended December 31, 1997 was 21.9%, up from 6.3% in the prior year.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash and cash equivalents at December 31, 1997 decreased to
$2.8 million from $8.4 million at December 31, 1996. During 1997, the Company
invested $2.2 million in capital expenditures, compared to $1.4 million in 1996
and $381,000 in 1995. Approximately $1.6 million of the 1997 capital
expenditures were for investments made in the Company's service bureau
operations, including the addition of a processing center in Southeast Texas.
Additionally, the Company invested $2.5 million in the preferred stock of Online
Resources & Communications Corporation ("Online"), a private electronic
financial services company. See "Outlook--Investment in Online" below. Cash used
in operating activities was $520,000 in 1997, primarily due to a significant
increase in trade accounts receivable. The increase in trade accounts receivable
was primarily due to an increase in the volume of billings in December as a
result of the timing of imaging system shipments as well as a lower amount of
collections on annual maintenance contracts in December as compared to December
of the prior year.
The Company generally requires its customers to make significant deposits
and prepayments on contracts to purchase software and hardware, and the
Company's maintenance and service agreements are administered on a calendar year
basis with fees generally received in December and January. The amounts that are
received in advance of performing the related services and in advance of
hardware shipment are reflected as unearned revenues until such amounts are
recognized in accordance with the Company's revenue recognition policy. See Note
2 of Notes to Consolidated Financial Statements.
The Company expects to relocate its headquarters in the third quarter of
1998. The capital expenditures associated with this relocation, including those
for computer equipment, furniture and fixtures and other related costs, are
expected to approximate $1.5 million. See Note 6 of Notes to Consolidated
Financial Statements for a schedule of the future lease payments associated with
the new facility. Initially, the additional monthly cash outlays for rent on the
new facility will increase the amount currently paid by approximately $84,000.
The lease provides for escalating base rental payments after every five years of
the lease term. In accordance with generally accepted accounting principles,
rental expense will be recognized in the financial statements on a straight-line
basis over the term of the lease. The Company intends to sublease certain of its
existing leased facilities upon relocating to the new facility.
The Company expects that capital expenditures associated with service bureau
operations in 1998 could reach $1.5 million, depending upon the growth of this
business. The Company anticipates that new item processing centers will only be
opened as contracts necessary to support such centers are executed.
The Company has a $2.5 million line of credit (the "Credit Agreement") with
State Street Bank and Trust ("State Street") that expires on February 1, 1999.
Borrowings under the Credit Agreement bear interest at State Street's prime rate
(8.5% at December 31, 1997) plus 1/2% and are secured by the assets and stock of
the Company's wholly owned subsidiaries. Amounts available under the Credit
Agreement are reduced by the value of outstanding letters of credit issued by
State Street on behalf of the Company. As of December 31, 1997, no amounts were
outstanding under the Credit Agreement, and State Street had issued a letter of
credit with a value of $600,000 on behalf of the Company. The Credit Agreement
imposes certain requirements on the Company, including minimum annual net
income, and quarterly cash flow and
14
<PAGE>
liquidity levels. The Credit Agreement prohibits the Company from incurring or
otherwise becoming liable for any indebtedness for liens on any property owned
by the Company, except for certain trade and other indebtedness. The Credit
Agreement also contains other restrictive covenants, including limitations on
dispositions of material amounts of assets, capital expenditures, mergers,
consolidations, related party transactions, alterations in the nature of the
Company's business, employee compensation, the making of any loans, investments
in other entities, entering into any guarantees and the payment of cash
dividends. At September 30, 1997, the Company was not in compliance with certain
covenants in the Credit Agreement regarding limitations on capital spending and
maintenance by the Company of minimum quarterly cash flow levels. State Street
waived non-compliance with those covenants for certain periods in 1997. These
covenants are measured on a quarterly and annual basis, and the Company has now
returned to compliance with all covenants in the Credit Agreement. There can be
no assurance that the Company will not require additional waivers in the future
or, if required, that State Street will grant them. See Note 4 of Notes to
Consolidated Financial Statements.
The Company believes that its cash and cash equivalents at December 31,
1997, amounts available under the Credit Agreement and operating cash flows will
be sufficient to meet its anticipated capital expenditure requirements at least
through the next twelve months.
RECENTLY ISSUED ACCOUNTING STANDARDS
STATEMENT OF POSITION 97-2. In October 1997, the Accounting Standards
Executive Committee of the American Institute of Public Accountants issued
Statement of Position (SOP) 97-2, SOFTWARE REVENUE RECOGNITION, which supersedes
SOP 91-1. The Company will be required to adopt SOP 97-2 for software
transactions entered into beginning January 1, 1998, and retroactive application
to years prior to adoption is prohibited. SOP 97-2 generally requires revenue
earned on software arrangements involving multiple elements (i.e., software
products, upgrades/enhancements, postcontract customer support, installation,
training, etc.) to be allocated to each element based on the relative fair
values of the elements. The fair value of an element must be based on evidence
which is specific to the vendor. The revenue allocated to software products
(including specified upgrades/enhancements) generally is recognized upon
delivery of the products. The revenue allocated to postcontract customer support
generally is recognized ratably over the term of the support and revenue
allocated to service elements (such as training and installation) generally is
recognized as the services are performed. If a vendor does not have evidence of
the fair value for all elements in a multiple-element arrangement, all revenue
from the arrangement is deferred until such evidence exists or until all
elements are delivered. The Company's management anticipates that the adoption
of SOP 97-2 will not have a material impact on the Company's results of
operations.
STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 131. In June 1997, the
Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION, which is effective for years beginning after December 15, 1997.
Statement 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports. It also establishes standards for related
disclosures about products and services, geographic areas, and major customers.
The Company will adopt the new requirements retroactively in 1998. Management
has not completed its review of Statement 131, but does not anticipate that the
adoption of this statement will affect results of operations or financial
position, but will affect the disclosure of segment information.
OUTLOOK
FORWARD-LOOKING STATEMENTS. This Annual Report on Form 10-K contains
forward-looking statements relating to such matters as anticipated financial
performance and business prospects. When used in this Annual Report, the words
"anticipate," "estimate," "expect," "may," "project," "believes," and "will" and
similar expressions are intended to be among the statements that identify
forward-looking statements.
15
<PAGE>
From time to time, the Company may also publish forward-looking statements. The
Private Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In order to comply with the terms of the safe
harbor, the Company notes that a variety of factors, including those discussed
in this Form 10-K, could cause the Company's actual results and experience to
differ materially from the anticipated results or other expectations expressed
in the Company's forward-looking statements.
REVENUES. The Company has historically grown its revenues primarily from
its existing customers. For example, revenue per bank customer has increased
from approximately $40,000 in 1991 to approximately $117,000 in 1997. The
Company believes the growth from its existing customer base is attributable to
the quality and growth of its customers and the importance its customers place
on technology. The Company anticipates that substantially all of its current
banking customers will be utilizing the Peerless21 information processing system
by the end of 1998; therefore, the Company will increasingly have to sell its
products and services to new customers as well as continue to sell ancillary
products, including check and statement imaging systems, to its existing
customers in order to maintain historical growth rates. Due to the intense
competition in the industry and the relative size of the Company to its
competitors, there can be no assurance that the Company will be successful in
obtaining a sufficient amount of new customers to maintain historical growth
rates. The Company has initiated several measures to focus on new customer
opportunities, including changes in key sales personnel, sales territories,
compensation strategies, and the hiring of additional sales resources.
CHECK AND STATEMENT IMAGING. The Company installed its first check and
statement imaging system in the fourth quarter of 1994. Revenues from the
shipment and installation of check and statement imaging systems increased to
$7.6 million in 1997, representing a 26.7% growth rate over the 1996 level. As
of December 31, 1997, approximately 15% of the Company's bank customers utilized
a check and statement imaging system. The Company expects many of its customers
will implement check and statement imaging services, whether in a turnkey or
outsourcing solution, in the future. However, given the significant expenditure
associated with check and statement imaging solutions, the Company is unable to
determine how many and when its customers may purchase such a system. Therefore,
any revenue growth from these systems may be at a rate less than those
historically experienced. In order to address the issue of the significant costs
of check and statement imaging solutions to customers, the Company has
substantially broadened its check and statement imaging solutions by adding
entry and mid-level products to complement the high-end products it offers.
OUTSOURCING SERVICE BUREAU. According to industry sources, approximately
36% of community banks with assets of less than $500 million and 26% of credit
unions outsourced their information systems requirements in 1996. As a result,
in September 1996 when the Company began offering an outsourcing service bureau
alternative to its customers and new customers, the Company's target market
increased. As of February 27, 1998, the Company had entered into sixteen
outsourcing contracts: eight of which are both check and statement imaging and
data processing, two of which are data processing only and six of which are
check imaging or item processing only. The Company expects to continue to
leverage its experience in both the banking and credit union processing
industry, as well as its Peerless21 and PeerlessCU products, in order to
continue to grow the outsourcing operations. Any future expansion of these
operations will depend to a significant extent on any capital and other
expenditures the Company is able to make to expand this aspect of its business.
The future profitability of these operations is primarily dependent on obtaining
additional customers and processing volumes to cover operating expenses, which
are primarily fixed in nature.
INVESTMENT IN ONLINE. In May 1997, the Company purchased 25,000 shares of
the preferred stock of Online for $2.5 million. This preferred stock is
convertible into approximately 833,000 shares of Online's common stock. The
Company also received warrants to purchase approximately 333,000 shares of
Online's common stock at $3.00 per share. The Company understands that Online is
seeking additional financing. If
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<PAGE>
Online is not able to obtain additional financing, the Company may be required
to write off some or all of this investment.
YEAR 2000. The Company has adopted a plan to modify its software products
to make them Year 2000 compliant. This plan has been certified by the
Information Technology Association of America. Management believes that
principally all of the software modifications necessary to make its products
Year 2000 compliant will be substantially completed by December 31, 1998. Based
on currently available information, management estimates that the total costs to
implement the plan will range from $1.0 to $2.0 million. The Company could
experience delays in the modification of its software or cost overruns as a
result of various factors, including but not limited to, difficulties in hiring
and retaining appropriate personnel.
The Company also purchases software and hardware from certain vendors, which
the Company resells to its customers. See "Item 1. Business--Principal
Suppliers". The Company is currently evaluating the hardware and software
provided by its vendors to identify any systems that need to be made Year 2000
compliant. The Company's primary vendors have assured the Company that the
systems they provide will be made Year 2000 compliant in a timely fashion,
although there can be no assurances made as to these representations. The
failure of the Company's vendors to make their systems Year 2000 compliant could
pose a material financial risk to the Company.
The Company believes that the Year 2000 issue may create additional
opportunities in both its turnkey and outsourcing markets. Many financial
institutions have been notified by their software or service vendors that their
systems will not be made Year 2000 compliant. Therefore, the Company believes
that these institutions will need to change their systems, creating additional
potential customers for the Company's software and services.
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<PAGE>
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors.......................................................... 19
Consolidated Balance Sheets as of December 31, 1997 and 1996............................................... 20
Consolidated Statements of Income for the years ended December 31, 1997, 1996 and 1995..................... 21
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1997, 1996, and
1995..................................................................................................... 22
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996, and 1995................ 23
Notes to Consolidated Financial Statements................................................................. 24
</TABLE>
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<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors
Peerless Group, Inc.
We have audited the accompanying consolidated balance sheets of Peerless
Group, Inc. (the Company), as of December 31, 1997 and 1996, and the related
consolidated statements of income, cash flows, and stockholders' equity
(deficit) for each of the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Peerless
Group, Inc., at December 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Dallas, Texas
January 20, 1998
19
<PAGE>
PEERLESS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
ASSETS (NOTE 4)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................................................. $ 2,845 $ 8,378
Trade accounts receivable................................................................. 9,346 5,712
Prepaid expenses and other current assets................................................. 1,152 541
--------- ---------
Total current assets.................................................................... 13,343 14,631
Computer and other equipment, at cost....................................................... 4,337 2,335
Less accumulated depreciation............................................................... 1,135 589
--------- ---------
3,202 1,746
Computer software, maintenance contracts, and other assets, net of accumulated amortization
of $396 and $1,482 at December 31, 1997 and 1996, respectively............................ 897 982
Investment in preferred stock, at cost...................................................... 2,500 --
--------- ---------
Total assets............................................................................ $ 19,942 $ 17,359
--------- ---------
--------- ---------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................................................... $ 3,014 $ 1,865
Accrued liabilities....................................................................... 1,002 1,041
Sales tax payable......................................................................... 646 568
Unearned revenues......................................................................... 7,121 7,573
--------- ---------
Total current liabilities............................................................... 11,783 11,047
Commitments (NOTE 6)
Stockholders' equity (NOTES 4 AND 8):
Preferred stock, $.01 par value:
Authorized shares--5,000
Issued shares--none
Common stock, $.01 par value:
Authorized shares--10,000
Issued shares--4,948 and 4,598 at December 31, 1997 and 1996, respectively.............. 49 46
Additional paid-in capital................................................................ 7,958 7,720
Retained earnings (deficit)............................................................... 649 (1,254)
Treasury stock, at cost (73 and 1 at December 31, 1997 and 1996, respectively)............ (379) (1)
Unearned compensation..................................................................... (118) (199)
--------- ---------
Total stockholders' equity.............................................................. 8,159 6,312
--------- ---------
Total liabilities and stockholders' equity.............................................. $ 19,942 $ 17,359
--------- ---------
--------- ---------
</TABLE>
SEE ACCOMPANYING NOTES
20
<PAGE>
PEERLESS GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Revenues:
Software license and installation.............................................. $ 10,339 $ 9,987 $ 7,181
Hardware and equipment......................................................... 11,171 10,303 6,727
Maintenance and services....................................................... 8,621 6,235 5,782
--------- --------- ---------
Total revenues............................................................... 30,131 26,525 19,690
Cost of revenues:
Hardware and equipment......................................................... 8,528 7,754 5,258
Software license and installation, maintenance and services.................... 11,794 8,882 6,872
--------- --------- ---------
Total cost of revenues....................................................... 20,322 16,636 12,130
--------- --------- ---------
Gross margin..................................................................... 9,809 9,889 7,560
Operating costs and expenses:
Research and development....................................................... 2,004 1,696 1,398
Selling and marketing.......................................................... 3,412 3,477 2,502
General and administrative..................................................... 2,216 1,512 1,222
Severance charge (NOTE 11)..................................................... -- 341 --
--------- --------- ---------
Total operating costs and expenses........................................... 7,632 7,026 5,122
--------- --------- ---------
Income from operations........................................................... 2,177 2,863 2,438
Other income (expense):
Interest expense............................................................... (20) (548) (612)
Interest income................................................................ 280 133 68
--------- --------- ---------
Total other income (expense)................................................. 260 (415) (544)
--------- --------- ---------
Income before income taxes....................................................... 2,437 2,448 1,894
Provision for income taxes....................................................... 534 155 64
--------- --------- ---------
Net income....................................................................... $ 1,903 $ 2,293 $ 1,830
--------- --------- ---------
--------- --------- ---------
Basic earnings per share......................................................... $ 0.40 $ 0.82 $ 0.90
--------- --------- ---------
--------- --------- ---------
Diluted earnings per share....................................................... $ 0.37 $ 0.55 $ 0.49
--------- --------- ---------
--------- --------- ---------
Shares used in computing basic earnings per share................................ 4,712 2,745 1,976
Shares used in computing diluted earnings per share.............................. 5,130 4,055 3,648
</TABLE>
SEE ACCOMPANYING NOTES.
21
<PAGE>
PEERLESS GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK TREASURY STOCK
------------------ ADDITIONAL RETAINED ------------------
NUMBER OF PAID-IN EARNINGS NUMBER OF UNEARNED
SHARES AMOUNT CAPITAL (DEFICIT) SHARES AMOUNT COMPENSATION
--------- ------ ---------- -------- --------- ------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994...................... 2,080 $20 $(3,948) $(5,377) 237 $(281) $ --
Net income...................................... -- -- -- 1,830 -- -- --
Common stock issued, net of unearned
compensation.................................. 162 2 291 -- -- -- (195)
Common stock repurchased........................ -- -- 141 -- 67 (154) --
Accretion of redeemable common stock............ -- -- (58) -- -- -- --
--------- ------ ---------- -------- --- ------ -----
Balance at December 31, 1995...................... 2,242 22 (3,574) (3,547) 304 (435) (195)
Net income...................................... -- -- -- 2,293 -- -- --
Common stock issued upon exercise of warrants... 506 5 8 -- -- -- --
Common stock issued upon exercise of options.... 79 1 79 -- -- -- --
Common stock issued, net of unearned
compensation.................................. 45 1 295 -- -- -- (4)
Common stock repurchased........................ -- -- -- -- 8 (9) --
Cancellation of treasury stock upon change-of-
domicile merger............................... (311) (3) (440) -- (311) 443 --
Common stock issued upon initial public
offering...................................... 2,037 20 10,117 -- -- -- --
Accretion of redeemable common stock............ -- -- (44) -- -- -- --
Compensation expense on options................. -- -- 268 -- -- -- --
Reclassification of redeemable common stock upon
exercise of underlying options................ -- -- 1,011 -- -- -- --
--------- ------ ---------- -------- --- ------ -----
Balance at December 31, 1996...................... 4,598 46 7,720 (1,254) 1 (1) (199)
Net income...................................... -- -- -- 1,903 -- -- --
Common stock issued upon exercise of warrants... 182 2 3 -- -- -- --
Common stock issued upon exercise of options.... 168 1 247 -- -- -- --
Common stock issued, net of unearned
compensation.................................. -- -- 1 -- (2) 10 72
Common stock issued, employee stock purchase
plan.......................................... -- -- (13) -- (30) 202 --
Common stock repurchased........................ -- -- -- -- 104 (590) 9
--------- ------ ---------- -------- --- ------ -----
Balance at December 31, 1997...................... 4,948 $49 $ 7,958 $ 649 73 $(379) $(118)
--------- ------ ---------- -------- --- ------ -----
--------- ------ ---------- -------- --- ------ -----
</TABLE>
SEE ACCOMPANYING NOTES.
22
<PAGE>
PEERLESS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income........................................................................ $ 1,903 $ 2,293 $ 1,830
Adjustments to reconcile net income to net cash provided by (used in) operating
activities:
Depreciation and amortization................................................... 1,052 757 523
Compensation expense............................................................ 83 366 54
Changes in operating assets and liabilities:
Trade accounts receivable..................................................... (3,634) (1,506) (584)
Prepaid expenses and other current assets..................................... (660) (451) 34
Accounts payable and accrued liabilities...................................... 1,188 812 939
Unearned revenues............................................................. (452) (594) (87)
--------- --------- ---------
Net cash provided by (used in) operating activities............................... (520) 1,677 2,709
INVESTING ACTIVITIES
Additions to computer and other equipment......................................... (2,246) (1,419) (381)
Investment in preferred stock..................................................... (2,500) -- --
Other............................................................................. (120) (160) --
--------- --------- ---------
Net cash used in investing activities............................................. (4,866) (1,579) (381)
FINANCING ACTIVITIES
Note receivable from officer...................................................... -- 271 --
Proceeds from borrowings.......................................................... -- -- 4,111
Payments on borrowings............................................................ -- (3,627) (5,953)
Issuance of common stock.......................................................... 297 94 30
Purchase of treasury stock........................................................ (436) (9) (140)
Net proceeds from initial public offering......................................... -- 10,137 --
Other............................................................................. (8) 20 (63)
--------- --------- ---------
Net cash provided by (used in) financing activities............................... (147) 6,886 (2,015)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents.............................. (5,533) 6,984 313
Cash and cash equivalents at beginning of period.................................. 8,378 1,394 1,081
--------- --------- ---------
Cash and cash equivalents at end of period........................................ $ 2,845 $ 8,378 $ 1,394
--------- --------- ---------
--------- --------- ---------
SUPPLEMENTAL CASH FLOWS INFORMATION
Cash paid for interest............................................................ $ 19 $ 542 $ 737
--------- --------- ---------
--------- --------- ---------
Cash paid for income taxes........................................................ $ 545 $ 265 $ 38
--------- --------- ---------
--------- --------- ---------
</TABLE>
SEE ACCOMPANYING NOTES.
23
<PAGE>
PEERLESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
DESCRIPTION OF THE COMPANY
Peerless Group, Inc., formerly known as TPG Holdings, Inc. (the "Company"),
is a computer software company which develops and provides banking and credit
union software systems and services. The Company markets these systems along
with the computer equipment (hardware) to financial institutions primarily
located in the United States and Canada and provides conversion, support, and
maintenance and outsourcing services to customers using the systems. In
conjunction with the initial public offering of its common stock on October 3,
1996 (the "Offering"), TPG Holdings, Inc. formed a new wholly-owned Delaware
subsidiary, Peerless Group, Inc., and TPG Holdings, Inc., was merged into this
new corporation. The financial statements included herein reflect the merger and
resulting change in capitalization as all share and per share amounts have been
retroactively restated to reflect the merger. In conjunction with this change in
capitalization, all treasury shares outstanding were cancelled.
The consolidated financial statements of the Company include the accounts of
the Company and all its subsidiaries. All significant intercompany transactions
and balances are eliminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of money market funds, certificates of
deposit and Treasury Bills with original purchased maturities of three months or
less.
DEPRECIATION
Depreciation is provided on computer and other equipment using the
straight-line method over a five-to ten-year estimated useful life.
COMPUTER SOFTWARE AND MAINTENANCE CONTRACTS
Computer software and maintenance contracts consist of fair values assigned
to acquired software and maintenance contracts. The amounts are being amortized
on a straight-line basis over the estimated economic benefit period of five
years. The amounts amortized and charged to cost of sales were approximately
$358,000, $403,000, and $308,000 in 1997, 1996 and 1995, respectively.
CAPITALIZED SOFTWARE
The Company expenses all software development costs as incurred until
technological feasibility has been established for the product, at which time
the costs are capitalized until the product is available for general release to
customers.
REVENUE RECOGNITION
The Company's sources of revenue and the methods of revenue recognition are
as follows:
Software license and installation--Revenues from software contracts
involving installation are recognized when the installation is performed
according to contractual terms, which, in the case of long-term contracts,
involves the use of the percentage-of-completion method of accounting.
Progress towards completion is measured based upon the percentage
relationship that costs incurred to date
24
<PAGE>
PEERLESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
bear to total estimated costs to complete the installation. Revenues from
license fees not involving installation are recognized upon delivery of the
software to the customer when no significant vendor obligations remain.
Hardware and equipment--Commissions and revenues from hardware and equipment
sales are recognized upon shipment by the manufacturer.
Maintenance and services--Revenues from maintenance and service contracts
are recognized ratably over the periods of the respective contracts.
Revenues from data and check and statement imaging processing services are
recognized in the period in which the services are performed.
UNEARNED REVENUES
Deposits received and amounts billed for software licenses, installation and
hardware in advance of installation or delivery, and for annual software
maintenance prior to performance of related services, are reflected as unearned
until such amounts are recognized in accordance with the Company's revenue
recognition policy.
FINANCIAL INSTRUMENTS AND RISK CONCENTRATION
Cash and cash equivalents, accounts receivable, accounts payable, accrued
liabilities and unearned revenues are stated at expected settlement values which
approximate fair value.
Accounts receivable potentially subject the Company to concentrations of
credit risk as the Company markets its products and services primarily to
financial institutions throughout the United States and Canada. The Company
performs periodic credit evaluations of its customers' financial condition and
generally does not require collateral; however, deposits for future services or
products are frequently required.
STOCK OPTIONS
The Company has elected to follow Accounting Principles Board Opinion No.
25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES (APB 25) and related
Interpretations in accounting for its employee stock options because, as
discussed in Note 9, the alternative fair value accounting provided for under
Financial Accounting Standards Board Statement No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION (Statement 123), requires use of option valuation
models that were not developed for use in valuing employee stock options.
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, the
disclosure of contingent assets and liabilities at the date of the financial
statement, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
25
<PAGE>
PEERLESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, EARNINGS PER SHARE (Statement 128).
Statement 128 replaced the calculation of primary and fully diluted earnings per
share with basic and diluted earnings per share. Unlike primary earnings per
share, basic earnings per share excludes any dilutive effects of options,
warrants and convertible securities. Diluted earnings per share is very similar
to the previously reported fully diluted earnings per share. All earnings per
share amounts for all periods have been presented, and where appropriate,
restated to conform to the Statement 128 requirements.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION (Statement 131), which is effective for years
beginning after December 15, 1997. Statement 131 establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that those enterprises report
selected information about operating segments in interim financial reports. It
also establishes standards for related disclosures about products and services,
geographic areas, and major customers. The Company will adopt the new
requirements retroactively in 1998. Management has not completed its review of
Statement 131, but does not anticipate that the adoption of this statement will
affect results of operations or financial position, but will affect the
disclosure of segment information.
In October 1997, the Accounting Standards Executive Committee of the
American Institute of Public Accountants issued Statement of Position (SOP)
97-2, SOFTWARE REVENUE RECOGNITION, which supersedes SOP 91-1. The Company will
be required to adopt SOP 97-2 for software transactions entered into beginning
January 1, 1998. SOP 97-2 generally requires revenue earned on software
arrangements involving multiple elements (i.e., software products,
upgrades/enhancements, postcontract customer support, installation, training,
etc.) to be allocated to each element based on the relative fair values of the
elements. The fair value of an element must be based on evidence which is
specific to the vendor. The revenue allocated to software products (including
specified upgrades/enhancements) generally is recognized upon delivery of the
products. The revenue allocated to postcontract customer support generally is
recognized ratably over the term of the support and revenue allocated to service
elements (such as training and installation) generally is recognized as the
services are performed. If a vendor does not have evidence of the fair value for
all elements in a multiple-element arrangement, all revenue from the arrangement
is deferred until such evidence exists or until all elements are delivered. The
Company's management anticipates that the adoption of SOP 97-2 will not have a
material impact on the Company's results of
operations.
CHANGES IN PRESENTATION
Certain prior year amounts have been reclassified to conform to current year
presentation.
3. INVESTMENT IN PREFERRED STOCK
In May 1997, the Company purchased 25,000 shares of the preferred stock of
Online Resources & Communications Corporation ("Online"), a private electronic
financial services company, for $2.5 million.
26
<PAGE>
PEERLESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENT IN PREFERRED STOCK (CONTINUED)
This preferred stock is convertible into approximately 833,000 shares of
Online's common stock. The Company also received warrants to purchase
approximately 333,000 shares of Online's common stock at $3.00 per share. The
Company understands that Online is seeking additional financing. If Online is
not able to obtain additional financing, the Company may be required to write
off some or all of this investment.
4. DEBT AND CREDIT AGREEMENTS
LINE OF CREDIT
In January 1997, the Company amended its line of credit agreement with a
bank that provides for borrowings up to $2,500,000, reduced by the value of
outstanding letters of credit issued by the bank on behalf of the Company.
Borrowings using this line of credit bear interest at the bank's prime rate
(8.50% at December 31, 1997) plus 1/2% and are collateralized by the assets of
the Company's wholly owned subsidiaries. The facility will expire on February 1,
1999. No amounts were outstanding on the line of credit at December 31, 1997,
and a letter of credit in the amount of $600,000 was issued by the bank on
behalf of the Company at that date.
The line of credit agreement contains restrictive covenants, the most
significant of which relate to minimum defined annual net income, quarterly cash
flow and the restriction on the payment of cash dividends. At December 31, 1997,
the Company was in compliance with such covenants.
Under the terms of the line of credit agreement, the bank was issued a
warrant to purchase at any time on or before October 1, 2002, 115,680 shares of
the Company's common stock at a purchase price of $5.42 per share. Included in
the warrant agreement was a provision allowing the bank to put the warrant back
to the Company at any time after October 1, 1999, at a price equal to the
then-current market price of the Company's common stock. No value was assigned
to the warrant at the date of issuance and no accretion was recorded, as the
Company determined that there was no significant value separately assignable to
the warrant and put option. In June 1996, the line of credit agreement was
amended such that the provision allowing the bank to put the warrant back to the
Company was terminated.
LONG-TERM DEBT DUE TO RELATED PARTIES
The Company repaid all of its debt upon completion of the Offering. In prior
years, the terms of certain Subordinated Debentures and Acquisition notes
included warrants to purchase up to 65% of the Company's common stock by the
holders of the Subordinated Debentures (the "Holders"). After giving effect to
several transactions, including the repurchase of warrants for $3,776,000 in
cash and notes, which were recorded as reductions to additional paid-in-capital,
the Holders had warrants to purchase 37.5% of the outstanding common stock of
the Company at December 31, 1995. In June 1996, the Holders exercised warrants
to purchase 505,710 shares of the Company's common stock, and in October 1996,
in conjunction with the Offering, they sold warrants to the underwriters to
purchase 597,360 shares of the Company's common stock. In December 1997, the
Holders exercised warrants to purchase an additional 181,654 shares of the
Company's common stock. Therefore, at December 31, 1997, the Holders own
warrants to purchase 181,654 shares of the Company's common stock. The warrants
are exercisable at a price of $0.025 per share and expire in October, 2000.
27
<PAGE>
PEERLESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INCOME TAXES
The Company uses the liability method in accounting for income taxes as
required by Statement of Financial Accounting Standards No. 109 ACCOUNTING FOR
INCOME TAXES. The components of the provision for income taxes are as follows
(in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Current:
Federal....................................................................... $ 312 $ 51 $ 38
State......................................................................... 124 362 26
--------- --------- ---------
Total current................................................................... 436 413 64
Deferred:
Federal....................................................................... 70 (245) --
State......................................................................... 28 (13) --
--------- --------- ---------
Total deferred.................................................................. 98 (258) --
--------- --------- ---------
Total provision for income taxes................................................ $ 534 $ 155 $ 64
--------- --------- ---------
--------- --------- ---------
</TABLE>
The effective income tax rate on income before income taxes differed from
the Federal income tax statutory rate for the following reasons (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Income tax charge:
At Federal statutory rate.................................................... $ 824 $ 832 $ 644
Unbenefitted (utilized) net operating losses................................. -- (832) (644)
Benefit of research and development tax credits.............................. (459) -- --
Federal alternative minimum tax.............................................. -- 48 38
Deferred federal benefit relating to the elimination of the valuation
allowance.................................................................. -- (245) --
State income tax............................................................. 96 271 26
Other........................................................................ 73 81 --
--------- --------- ---------
$ 534 $ 155 $ 64
--------- --------- ---------
--------- --------- ---------
</TABLE>
Given the historical trends in generating taxable income and the expected
future earnings, in the fourth quarter of 1996 the Company determined that it
was more likely than not that its net deferred tax assets would be realized. As
a result of the Company's judgement, the valuation allowance was eliminated and
a deferred tax benefit of approximately $250,000 was recorded.
During the three months ended September 30, 1997, the Company identified
research and development tax credits totaling $459,000. As a result, the
estimated effective tax rate for the fiscal year was lowered to 21.9%. As of
December 31, 1997, the Company had $302,000 of research and development tax
credits available for carryforward to future periods. These credits begin to
expire in 2008.
28
<PAGE>
PEERLESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INCOME TAXES (CONTINUED)
The significant components of the Company's deferred tax assets and
liabilities consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
--------- ---------
<S> <C> <C>
Deferred tax assets:
Alternative minimum tax credit carryforward........................................... $ -- $ 85
Net operating loss carryforwards...................................................... -- 65
Compensation expense on options....................................................... -- 103
Research and development tax credits.................................................. 302 --
Allowance for bad debts............................................................... 52 --
Other................................................................................. 43 24
--------- ---------
Total deferred tax assets............................................................... 397 277
Deferred tax liabilities:
Prepaid expenses...................................................................... 185 --
Amortization.......................................................................... 51 19
--------- ---------
Total deferred tax liabilities.......................................................... 236 19
--------- ---------
Deferred income tax assets, net of deferred income tax liabilities...................... $ 161 $ 258
--------- ---------
--------- ---------
</TABLE>
6. LEASE COMMITMENTS
In May 1997, the Company entered into an agreement to lease a building and
certain real property for fifteen years. This operating lease requires monthly
base rent payments of approximately $84,000 plus operating expenses and taxes,
with the monthly base rent amount escalating every five years during the lease
term. The lease is expected to commence in the third quarter of 1998. The
Company intends to sublease certain of its existing facilities upon moving to
the new facility.
Minimum noncancelable lease payments required under operating leases for the
years subsequent to December 31, 1997, are as follows (in thousands):
<TABLE>
<CAPTION>
EXISTING
YEAR NEW LEASE LEASES TOTAL
- -------------------------------------------------------------- --------- ----------- ---------
<S> <C> <C> <C>
1998.......................................................... $ 505 $ 396 $ 901
1999.......................................................... 1,009 356 1,365
2000.......................................................... 1,009 320 1,329
2001.......................................................... 1,009 160 1,169
2002.......................................................... 1,009 65 1,074
Thereafter.................................................... 12,994 6 13,000
</TABLE>
Rental expense totaled approximately $323,000, $269,000, and $247,000 for
the years ended December 31, 1997, 1996 and 1995, respectively.
29
<PAGE>
PEERLESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. EMPLOYEE 401(k) PLAN
The Company has a plan which provides retirement benefits under the
provisions of Section 401(k) of the Internal Revenue Code (the "Plan") for
substantially all employees who have completed a specified term of service. The
Company's contributions equal 50% of employee contributions, up to a maximum of
6% of eligible employee compensation, as defined. Benefits under the Plan are
limited to the assets of the Plan. Contributions by the Company charged to
expense during the years ended December 31, 1997, 1996 and 1995, were
approximately $128,000, $122,000, and $90,000, respectively.
8. COMMON STOCK
In July 1996, the Company adopted an employee stock purchase plan under
Section 423 of the Internal Revenue Code of 1986, as amended. Under the employee
stock purchase plan, employees may make annual purchases of the Company's common
stock at a price equal to 85% of the market value of the common stock on certain
specified dates. The Company has reserved 250,000 shares of its common stock for
issuance under the employee stock purchase plan.
During 1997 and 1996, the Company issued 1,675 and 19,620 shares,
respectively, of restricted stock to employees at weighted-average fair values
of $6.38 and $5.38 per share, respectively. The Company recorded approximately
$10,000 and $102,000, respectively, of unearned compensation for the excess of
the deemed value for accounting purposes of the common stock issued over the
proceeds received upon issuance. The unearned compensation is charged to expense
ratably over the vesting period of the common stock. During 1997 and 1996,
approximately $83,000 and $98,000 was charged to operations.
9. STOCK OPTIONS
The Board of Directors and the stockholders of the Company approved the
Peerless Group, Inc. 1997 Stock Option Plan (the "Plan") effective as of April
22, 1997. The Plan reserves 450,000 shares of the Company's common stock for
future issuance. Each option to be granted under the Plan will be exercisable as
provided by the terms of each option, but in no case longer than ten years from
the date of the option's grant. Historically, the Company's options have
generally vested 20% on the date of grant and 20% each year for the following
four years, with an exercise period of five years from the date of grant.
30
<PAGE>
PEERLESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS (CONTINUED)
A summary of the Company's stock option activity and related information for
the years ended December 31 follows (in thousands except for per share data):
<TABLE>
<CAPTION>
1997 1996 1995
---------------------------- ---------------------------- ----------------------------
WEIGHTED WEIGHTED WEIGHTED
NUMBER OF AVERAGE NUMBER OF AVERAGE NUMBER OF AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
----------- --------------- ----------- --------------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year...... 433 $ 4.14 348 $ 1.76 299 $ 1.09
Granted-Exercise price exceeds market
price on date of grant.............. 170 8.05 10 8.80 24 2.87
Granted-Exercise price equals market
price on date of grant.............. 10 4.50 154 7.60 95 2.74
Exercised............................. (168) 1.48 (79) 1.01 (60) 0.44
Forfeited............................. (39) 8.00 -- -- (10) 1.93
----------- ----------- -----------
Outstanding at end of year............ 406 6.51 433 4.14 348 1.76
----------- ----------- -----------
----------- ----------- -----------
Exercisable at end of year............ 148 $ 5.67 241 $ 2.53 148 $ 1.48
Weighted average fair value of options
granted-Exercise price exceeds
market price on date of grant....... $ 1.83 $ 1.98 $ 0.86
Weighted average fair value of options
granted-Exercise price equals market
price on date of grant.............. $ 1.97 $ 2.22 $ 0.99
</TABLE>
The total options outstanding at December 31, 1997, included 96,000 options
with exercise prices ranging from $2.60 to $2.87 and a weighted-average
remaining contractual life of 2.0 years; and 310,000 options with exercise
prices ranging from $4.50 to $8.80 and a weighted-average remaining contractual
life of 4.2 years. Exercisable options at December 31, 1997, included 58,800
options with exercise prices ranging from $2.60 to $2.87 and a weighted-average
exercise price of $2.67; and 89,540 options with exercise prices ranging from
$4.50 to $8.80 and a weighted-average exercise price of $7.64. Under APB 25,
because the exercise price of the Company's employee stock options equals or
exceeds the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 1997, 1996 and 1995 respectively: risk-free interest rates of
5.82%, 5.79% and 7.37%; volatility factors of the expected market price of the
Company's common stock of .502, .347 and .447; and no dividend yields. In
addition, the fair value of these options was estimated based on an expected
life of one year from the vesting date using the multiple option method.
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly subjective assumptions including the expected stock price volatility.
Because the
31
<PAGE>
PEERLESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. STOCK OPTIONS (CONTINUED)
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows (in thousands, except for earnings per share
information):
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Pro forma net income............................................. $ 1,698 $ 2,170 $ 1,789
Pro forma basic earnings per share............................... $ 0.36 $ 0.77 $ 0.88
Pro forma diluted earnings per share............................. $ 0.34 $ 0.53 $ 0.48
</TABLE>
The pro forma disclosures only include the effect of options granted
subsequent to December 31, 1994. Accordingly, the pro forma information does not
reflect the pro forma effect of all previous stock option grants of the Company,
and thus is not indicative of future amounts until Statement No. 123 is applied
to all outstanding stock options.
10. OPERATIONS
The Company is dependent upon International Business Machines Corporation
(IBM) as its principal computer hardware vendor for its financial institution
applications systems. Additionally, operating systems on which the Company's
products function have been developed by IBM. Since its inception in 1989, the
Company has been a value-added remarketer of IBM products pursuant to standard
IBM Remarketer Agreements. The Company's current remarketing agreement with IBM
expires on February 28, 1999. Both IBM and the Company may, with or without
cause, upon three months written notice, terminate the agreement. The Company
has no indication that IBM will discontinue the remarketing agreement. The
Company believes that its relationships with IBM are good.
11. SEVERANCE CHARGE
During the year ended December 31, 1996, the Company incurred a severance
charge of $341,000 related to the resignation of a former officer ($289,000 of
which were non-cash compensation charges related to the extension of the
exercise period of certain stock options and the acceleration of vesting of
restricted stock awards).
32
<PAGE>
PEERLESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings
per share (amounts in thousands except for earnings per share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Numerator:
Net income......................................................................... $ 1,903 $ 2,293 $ 1,830
Accretion on redeemable common stock............................................... -- (44) (58)
--------- --------- ---------
Numerator for basic and diluted earnings per share................................... $ 1,903 $ 2,249 $ 1,772
--------- --------- ---------
--------- --------- ---------
Denominator:
Denominator for basic earnings per share-weighted average shares................... 4,712 2,745 1,976
Effect of dilutive securities:
Stock options...................................................................... 76 266 169
Warrants........................................................................... 365 1,072 1,503
Employee stock purchase plan....................................................... 4 -- --
Non-vested stock................................................................... (27) (28) --
--------- --------- ---------
Dilutive potential common shares..................................................... 418 1,310 1,672
Denominator for diluted earnings per share-adjusted weighted average shares and
assumed conversions................................................................ 5,130 4,055 3,648
--------- --------- ---------
--------- --------- ---------
Basic earnings per share............................................................. $ 0.40 $ 0.82 $ 0.90
Diluted earnings per share........................................................... $ 0.37 $ 0.55 $ 0.49
</TABLE>
Options to purchase 251,200 shares of common stock at $8.00 per share and
20,000 shares of common stock at $8.80 per share were outstanding during 1997
but were not included in the computation of diluted earnings per share because
the options' exercise prices were greater than the average market price of the
common shares and, therefore, the effect would be antidilutive.
33
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item regarding Directors of the Company is
set forth in the Proxy Statement (the "Proxy Statement") to be delivered to the
Company's stockholders in connection with the Company's 1998 Annual Meeting of
Stockholders under the heading "Election of Directors," which information is
incorporated herein by reference. The name, age and position of each executive
officer of the Company is set forth under the heading "Executive Officers" in
Part I of this Form10-K, which information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information under the caption "Executive Compensation" in the Proxy
Statement is incorporated herein by reference. Information contained in the
Proxy Statement under the captions "Report on Executive Compensation" and "Stock
Performance Graph" is not incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption "Security Ownership of Certain Beneficial
Owners and Management" in the Company's Proxy Statement is incorporated herein
by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption "Certain Transactions" in the Proxy
Statement is incorporated herein by reference.
34
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Report:
1. FINANCIAL STATEMENTS:
The following Consolidated Financial Statements of the Company and its
subsidiaries and the Reports of Independent Auditors thereon appear under Item 8
of this Report:
<TABLE>
<C> <S>
-- Report of Ernst & Young LLP, Independent Auditors.
-- Consolidated Balance Sheets as of December 31, 1997 and 1996.
-- Consolidated Statements of Income for the years ended December 31, 1997, 1996, and
1995.
-- Consolidated Statements of Stockholders' Equity (Deficit) for the years ended
December 31, 1997, 1996, and 1995.
-- Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996,
and 1995.
-- Notes to Consolidated Financial Statements.
</TABLE>
2. FINANCIAL STATEMENT SCHEDULES:
All schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
3. LIST OF EXHIBITS:
Except as otherwise specifically noted, the following documents are
incorporated by reference as exhibits hereto pursuant to Rule 12b-32:
<TABLE>
<C> <S>
(2.2) Plan of Merger dated as of June 17, 1996 by and between Peerless Group, Inc.
(the "Company") and TPG Holdings, Inc. filed as Exhibit 2.2 to the Company's
Registration Statement on Form SB-2, filed October 3, 1996 (the "Registration
Statement").
(3.1) Certificate of Incorporation of the Company filed as Exhibit 3.1 to the
Registration Statement.
(3.2) Bylaws of the Company filed as Exhibit 3.2 to the Registration Statement.
(10.1) Investment Agreement ("Investment Agreement") dated November 27, 1989 by and
among the Company, Rodney L. Armstrong, Jr., Harrell J. Stringer, Kevin W.
Marsh, Allied Investment Corporation, Allied Venture Partnership and Allied
Investment Corporation II filed as Exhibit 10.1 to the Registration Statement.
(10.2) Amendment to Investment Agreement dated April 26, 1991 by and among the Company,
Rodney L. Armstrong, Jr., Harrell J. Stringer, Allied Investment Corporation,
Allied Venture Partnership and Allied Investment Corporation II filed as Exhibit
10.2 to the Registration Statement.
(10.3) Second Amendment to Investment Agreement dated March 6, 1992 by and among the
Company, Allied Investment Corporation, Allied Venture Partnership and Allied
Investment Corporation II filed as Exhibit 10.3 to the Registration Statement.
</TABLE>
35
<PAGE>
<TABLE>
<C> <S>
(10.4) Third Amendment to Investment Agreement dated September 30, 1992 by and among
the Company, Rodney L. Armstrong, Jr., Harrell J. Stringer, Allied Investment
Corporation and Allied Investment Corporation II filed as Exhibit 10.4 to the
Registration Statement.
(10.5) Fourth Amendment to Investment Agreement dated March 3, 1993 by and among the
Company, Rodney L. Armstrong, Jr., Harrell J. Stringer, Allied Investment
Corporation and Allied Capital Corporation II filed as Exhibit 10.5 to the
Registration Statement.
(10.6) Fifth Amendment to Investment Agreement dated September 9, 1993 by and among the
Company, Rodney L. Armstrong, Jr., Harrell J. Stringer, Allied Investment
Corporation, Allied Investment Corporation II and Allied Venture Partnership
filed as Exhibit 10.6 to the Registration Statement.
(10.7) Warrant Sale Agreement and Sixth Amendment to Investment Agreement dated
November 3, 1993 by and among the Company, Rodney L. Armstrong, Jr., Harrell J.
Stringer, Allied Investment Corporation, Allied Capital Corporation II and
Allied Venture Partnership filed as Exhibit 10.7 to the Registration Statement.
(10.8) Seventh Amendment to Investment Agreement dated September 26, 1994 by and among
the Company, Rodney L. Armstrong, Jr., Allied Investment Corporation and Allied
Capital Corporation II filed as Exhibit 10.8 to the Registration Statement.
(10.9) Eighth Amendment to Investment Agreement dated December 20, 1994 by and among
the Company, Rodney L. Armstrong, Jr., Allied Investment Corporation, Allied
Capital Corporation II and Allied Venture Partnership filed as Exhibit 10.9 to
the Registration Statement.
(10.10) Ninth Amendment to Investment Agreement dated on or about May 15, 1995 by and
among the Company, Rodney L. Armstrong, Jr., Allied Investment Corporation,
Allied Capital Corporation and Allied Capital Corporation II filed as Exhibit
10.10 to the Registration Statement.
(10.11) Tenth Amendment to Investment Agreement dated October 12, 1995 by an among the
Company, Rodney L. Armstrong, Jr., Allied Investment Corporation, Allied Capital
Corporation and Allied Capital Corporation II filed as Exhibit 10.11 to the
Registration Statement.
(10.12) Eleventh Amendment to Investment Agreement dated October 13, 1995 by and among
the Company, Allied Investment Corporation, Allied Capital Corporation and
Allied Capital Corporation II filed as Exhibit 10.12 to the Registration
Statement.
(10.13) Amended and Restated Consent and Agreement dated July 12, 1996 by and among the
Company, Rodney L. Armstrong, Jr., Allied Investment Corporation, Allied Capital
Corporation, Allied Capital Corporation II and Allied Venture Partnership filed
as Exhibit 10.13 to the Registration Statement.
(10.14) Credit Agreement dated as of October 12, 1995 by and among the Company, Peerless
Systems, Inc., Peerless Systems CU Services, Inc., Peerless Recovery Services,
Inc. and State Street Bank and Trust Company filed as Exhibit 10.14 to the
Registration Statement.
(10.15) Consent and Agreement dated as of June 17, 1996 by and among the Company,
Peerless Systems, Inc., Peerless Systems CU Services, Inc., Peerless Recovery
Services, Inc., Peerless Data Services, Inc., Rodney L. Armstrong, Jr., Kathleen
M. Armstrong and State Street Bank and Trust Company filed as Exhibit 10.15 to
the Registration Statement.
(10.16) Warrant Agreement dated October 12, 1995 by and between the Company and State
Street Bank and Trust Company filed as Exhibit 10.16 to the Registration
Statement.
(10.17) Common Stock Purchase Warrant, dated October 12, 1995 executed by the Company in
favor of State Street Bank and Trust Company filed as Exhibit 10.17 to the
Registration Statement.
</TABLE>
36
<PAGE>
<TABLE>
<C> <S>
(10.18) Form of Associate Agreement of the Company filed as Exhibit 10.21 to the
Registration Statement.
(10.19) Office Lease Agreement (the "1212 Arapaho Lease") dated September 21, 1992 by
and between the Company and Aetna Life Insurance Company filed as Exhibit 10.24
to the Registration Statement.
(10.20) First Amendment to the 1212 Arapaho Lease dated March 5, 1995 by and between
Peerless Systems, Inc. and Aetna Life Insurance Company filed as Exhibit 10.25
to the Registration Statement.
(10.21) Second Amendment to the 1212 Arapaho Lease dated April 5, 1996 by and between
Peerless Systems, Inc. and Aetna Life Insurance Company filed as Exhibit 10.26
to the Registration Statement.
(10.22) Office/Showroom/Warehouse Lease Agreement dated April 5, 1996 by and between
Peerless Systems, Inc. and Aetna Life Insurance Company filed as Exhibit 10.27
to the Registration Statement.
(10.23) Lease Agreement (the "Plano Lease") dated August 17, 1994 by and between
Peerless Systems, Inc. and Collin Creek Business Center Associates, Ltd. filed
as Exhibit 10.28 to the Registration Statement.
(10.24) First Amendment to the Plano Lease dated November 27, 1995 by and between
Peerless Systems, Inc. and Collin Creek One Joint Venture filed as Exhibit 10.29
to the Registration Statement.
(10.25) Value Added Reseller Agreement (the "VAR Agreement") dated March 29, 1993 by and
between the Company and NCR Corporation filed as Exhibit 10.30 to the
Registration Statement.
(10.26) CMD Addendum to VAR Agreement dated March 23, 1993 by and between the Company
and NCR Corporation filed as Exhibit 10.31 to the Registration Statement.
(10.27) Marketing & Sales Assistance Agreement dated November 2, 1995 by and between
International Business Machines Corporation and Peerless Systems, Inc. filed as
Exhibit 10.32 to the Registration Statement.
(10.28) Business Partner Agreement dated February 15, 1995 by and between Peerless
Systems, Inc. and International Business Machines Corporation filed as Exhibit
10.33 to the Registration Statement.
(10.29) System Integrator Agreement effective January 1, 1994 by and between Peerless
Systems, Inc. and Document Solutions Inc. filed as Exhibit 10.34 to the
Registration Statement.
(10.30) Resignation Agreement dated May 14, 1996 by and among the Company, Peerless
Systems, Inc. and Michael S. Jones filed as Exhibit 10.37 to the Registration
Statement.
(10.31) Employee Stock Purchase Plan filed as Exhibit 10.40 to the Registration
Statement.
(10.32) First Amendment to Credit Agreement dated as of August 20, 1996 by and among the
Company, Peerless Data Services, Inc., Peerless Systems, Inc., Peerless Systems
CU Services, Inc., Peerless Recovery Services, Inc. and State Street Bank and
Trust Company filed as Exhibit 10.42 to the Registration Statement.
(10.33) Second Amendment to Credit Agreement dated as of January 15, 1997 by and among
the Company, Peerless Data Services, Inc., Peerless Systems, Inc., Peerless
Systems CU Services, Inc., Peerless Recovery Services, Inc. and State Street
Bank and Trust Company filed as Exhibit 10.45 to the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 1996 (the "1996 Form 10-K").
</TABLE>
37
<PAGE>
<TABLE>
<C> <S>
(10.34) First Amendment to Lease Agreement dated as of September 3, 1996 by and between
Aetna Life Insurance Company and Peerless Systems, Inc. filed as Exhibit 10.46
to the 1996 Form 10-K.
(10.35) Peerless Group, Inc. 1997 Stock Option Plan filed as Exhibit 10.47 to the 1996
Form 10-K.
(10.36) Business Partner Agreement dated February 21, 1997 by and between Peerless
Systems, Inc. and International Business Machines Corporation filed as Exhibit
10.48 to the 1996 Form 10-K.
(10.37) Commercial Lease Agreement (the "Allen Lease") dated May 23, 1997 by and between
Dallas/Fort Worth Real Estate Investments #1 Limited Partnership and Peerless
Group, Inc. (filed herewith).
(10.38) Amendment to the Allen Lease dated December 11, 1997 (filed herewith).
(10.39) Amendment to the Peerless Group, Inc. Employee Stock Purchase Plan dated
December 17, 1997 (filed herewith).
(23.1) Consent of Independent Auditors (filed herewith).
(21.1) Subsidiaries of the Company filed as Exhibit 21.1 to the Registration Statement.
(27.1) Financial Data Schedule (filed herewith).
</TABLE>
(b) Reports on Form 8-K:
None.
38
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
PEERLESS GROUP, INC.
By: /s/ RODNEY L. ARMSTRONG, JR.
-----------------------------------------
Rodney L. Armstrong, Jr.
CHAIRMAN OF THE BOARD, CHIEF EXECUTIVE
OFFICER
AND PRINCIPAL FINANCIAL OFFICER
</TABLE>
Date: March 30, 1998
--------------------------------------
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 in the capacities and on the dates indicated.
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ RODNEY L. ARMSTRONG, JR.
- ------------------------------ Chairman of the Board and March 30, 1998
Rodney L. Armstrong, Jr. Chief Executive Officer
/s/ ALLEN D. FLEENER
- ------------------------------ Director March 30, 1998
Allen D. Fleener
/s/ WILLIAM F. DUNBAR
- ------------------------------ Director March 30, 1998
William F. Dunbar
/s/ DAVID A. O'CONNOR
- ------------------------------ Director March 30, 1998
David A. O'Connor
/s/ JANE C. WALSH
- ------------------------------ Director March 30, 1998
Jane C. Walsh
/s/ DOUGLAS K. HANSEN Treasurer and Controller
- ------------------------------ (Principal Accounting March 30, 1998
Douglas K. Hansen Officer)
39
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT
- ----------- ---------------------------------------------------------------------------------------------------
<C> <S>
(2.2) Plan of Merger dated as of June 17, 1996 by and between Peerless Group, Inc. (the "Company") and
TPG Holdings, Inc. filed as Exhibit 2.2 to the Company's Registration Statement on Form SB-2, filed
October 3, 1996 (the "Registration Statement").
(3.1) Certificate of Incorporation of the Company filed as Exhibit 3.1 to the Registration Statement.
(3.2) Bylaws of the Company filed as Exhibit 3.2 to the Registration Statement.
(10.1) Investment Agreement ("Investment Agreement") dated November 27, 1989 by and among the Company,
Rodney L. Armstrong, Jr., Harrell J. Stringer, Kevin W. Marsh, Allied Investment Corporation,
Allied Venture Partnership and Allied Investment Corporation II filed as Exhibit 10.1 to the
Registration Statement.
(10.2) Amendment to Investment Agreement dated April 26, 1991 by and among the Company, Rodney L.
Armstrong, Jr., Harrell J. Stringer, Allied Investment Corporation, Allied Venture Partnership and
Allied Investment Corporation II filed as Exhibit 10.2 to the Registration Statement.
(10.3) Second Amendment to Investment Agreement dated March 6, 1992 by and among the Company, Allied
Investment Corporation, Allied Venture Partnership and Allied Investment Corporation II filed as
Exhibit 10.3 to the Registration Statement.
(10.4) Third Amendment to Investment Agreement dated September 30, 1992 by and among the Company, Rodney
L. Armstrong, Jr., Harrell J. Stringer, Allied Investment Corporation and Allied Investment
Corporation II filed as Exhibit 10.4 to the Registration Statement.
(10.5) Fourth Amendment to Investment Agreement dated March 3, 1993 by and among the Company, Rodney L.
Armstrong, Jr., Harrell J. Stringer, Allied Investment Corporation and Allied Capital Corporation
II filed as Exhibit 10.5 to the Registration Statement.
(10.6) Fifth Amendment to Investment Agreement dated September 9, 1993 by and among the Company, Rodney L.
Armstrong, Jr., Harrell J. Stringer, Allied Investment Corporation, Allied Investment Corporation
II and Allied Venture Partnership filed as Exhibit 10.6 to the Registration Statement.
(10.7) Warrant Sale Agreement and Sixth Amendment to Investment Agreement dated November 3, 1993 by and
among the Company, Rodney L. Armstrong, Jr., Harrell J. Stringer, Allied Investment Corporation,
Allied Capital Corporation II and Allied Venture Partnership filed as Exhibit 10.7 to the
Registration Statement.
(10.8) Seventh Amendment to Investment Agreement dated September 26, 1994 by and among the Company, Rodney
L. Armstrong, Jr., Allied Investment Corporation and Allied Capital Corporation II filed as Exhibit
10.8 to the Registration Statement.
(10.9) Eighth Amendment to Investment Agreement dated December 20, 1994 by and among the Company, Rodney
L. Armstrong, Jr., Allied Investment Corporation, Allied Capital Corporation II and Allied Venture
Partnership filed as Exhibit 10.9 to the Registration Statement.
(10.10) Ninth Amendment to Investment Agreement dated on or about May 15, 1995 by and among the Company,
Rodney L. Armstrong, Jr., Allied Investment Corporation, Allied Capital Corporation and Allied
Capital Corporation II filed as Exhibit 10.10 to the Registration Statement.
(10.11) Tenth Amendment to Investment Agreement dated October 12, 1995 by an among the Company, Rodney L.
Armstrong, Jr., Allied Investment Corporation, Allied Capital Corporation and Allied Capital
Corporation II filed as Exhibit 10.11 to the Registration Statement.
</TABLE>
<PAGE>
<TABLE>
<C> <S>
(10.12) Eleventh Amendment to Investment Agreement dated October 13, 1995 by and among the Company, Allied
Investment Corporation, Allied Capital Corporation and Allied Capital Corporation II filed as
Exhibit 10.12 to the Registration Statement.
(10.13) Amended and Restated Consent and Agreement dated July 12, 1996 by and among the Company, Rodney L.
Armstrong, Jr., Allied Investment Corporation, Allied Capital Corporation, Allied Capital
Corporation II and Allied Venture Partnership filed as Exhibit 10.13 to the Registration Statement.
(10.14) Credit Agreement dated as of October 12, 1995 by and among the Company, Peerless Systems, Inc.,
Peerless Systems CU Services, Inc., Peerless Recovery Services, Inc. and State Street Bank and
Trust Company filed as Exhibit 10.14 to the Registration Statement.
(10.15) Consent and Agreement dated as of June 17, 1996 by and among the Company, Peerless Systems, Inc.,
Peerless Systems CU Services, Inc., Peerless Recovery Services, Inc., Peerless Data Services, Inc.,
Rodney L. Armstrong, Jr., Kathleen M. Armstrong and State Street Bank and Trust Company filed as
Exhibit 10.15 to the Registration Statement.
(10.16) Warrant Agreement dated October 12, 1995 by and between the Company and State Street Bank and Trust
Company filed as Exhibit 10.16 to the Registration Statement.
(10.17) Common Stock Purchase Warrant, dated October 12, 1995 executed by the Company in favor of State
Street Bank and Trust Company filed as Exhibit 10.17 to the Registration Statement.
(10.18) Form of Associate Agreement of the Company filed as Exhibit 10.21 to the Registration Statement.
(10.19) Office Lease Agreement (the "1212 Arapaho Lease") dated September 21, 1992 by and between the
Company and Aetna Life Insurance Company filed as Exhibit 10.24 to the Registration Statement.
(10.20) First Amendment to the 1212 Arapaho Lease dated March 5, 1995 by and between Peerless Systems, Inc.
and Aetna Life Insurance Company filed as Exhibit 10.25 to the Registration Statement.
(10.21) Second Amendment to the 1212 Arapaho Lease dated April 5, 1996 by and between Peerless Systems,
Inc. and Aetna Life Insurance Company filed as Exhibit 10.26 to the Registration Statement.
(10.22) Office/Showroom/Warehouse Lease Agreement dated April 5, 1996 by and between Peerless Systems, Inc.
and Aetna Life Insurance Company filed as Exhibit 10.27 to the Registration Statement.
(10.23) Lease Agreement (the "Plano Lease") dated August 17, 1994 by and between Peerless Systems, Inc. and
Collin Creek Business Center Associates, Ltd. filed as Exhibit 10.28 to the Registration Statement.
(10.24) First Amendment to the Plano Lease dated November 27, 1995 by and between Peerless Systems, Inc.
and Collin Creek One Joint Venture filed as Exhibit 10.29 to the Registration Statement.
(10.25) Value Added Reseller Agreement (the "VAR Agreement") dated March 29, 1993 by and between the
Company and NCR Corporation filed as Exhibit 10.30 to the Registration Statement.
(10.26) CMD Addendum to VAR Agreement dated March 23, 1993 by and between the Company and NCR Corporation
filed as Exhibit 10.31 to the Registration Statement.
(10.27) Marketing & Sales Assistance Agreement dated November 2, 1995 by and between International Business
Machines Corporation and Peerless Systems, Inc. filed as Exhibit 10.32 to the Registration
Statement.
</TABLE>
<PAGE>
<TABLE>
<C> <S>
(10.28) Business Partner Agreement dated February 15, 1995 by and between Peerless Systems, Inc. and
International Business Machines Corporation filed as Exhibit 10.33 to the Registration Statement.
(10.29) System Integrator Agreement effective January 1, 1994 by and between Peerless Systems, Inc. and
Document Solutions Inc. filed as Exhibit 10.34 to the Registration Statement.
(10.30) Resignation Agreement dated May 14, 1996 by and among the Company, Peerless Systems, Inc. and
Michael S. Jones filed as Exhibit 10.37 to the Registration Statement.
(10.31) Employee Stock Purchase Plan filed as Exhibit 10.40 to the Registration Statement.
(10.32) First Amendment to Credit Agreement dated as of August 20, 1996 by and among the Company, Peerless
Data Services, Inc., Peerless Systems, Inc., Peerless Systems CU Services, Inc., Peerless Recovery
Services, Inc. and State Street Bank and Trust Company filed as Exhibit 10.42 to the Registration
Statement.
(10.33) Second Amendment to Credit Agreement dated as of January 15, 1997 by and among the Company,
Peerless Data Services, Inc., Peerless Systems, Inc., Peerless Systems CU Services, Inc., Peerless
Recovery Services, Inc. and State Street Bank and Trust Company filed as Exhibit 10.45 to the
Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996 (the "1996 Form
10-K").
(10.34) First Amendment to Lease Agreement dated as of September 3, 1996 by and between Aetna Life
Insurance Company and Peerless Systems, Inc. filed as Exhibit 10.46 to the 1996 Form 10-K.
(10.35) Peerless Group, Inc. 1997 Stock Option Plan filed as Exhibit 10.46 to the 1996 Form 10-K.
(10.36) Business Partner Agreement dated February 21, 1997 by and between Peerless Systems, Inc. and
International Business Machines Corporation filed as Exhibit 10.48 to the 1996 Form 10-K.
(10.37) Commercial Lease Agreement (the "Allen Lease") dated May 23, 1997 by and between Dallas/Fort Worth
Real Estate Investments #1 Limited Partnership and Peerless Group, Inc. (filed herewith).
(10.38) Amendment to the Allen Lease dated December 11, 1997 (filed herewith).
(10.39) Amendment to the Peerless Group, Inc. Employee Stock Purchase Plan dated December 17, 1997 (filed
herewith).
(23.1) Consent of Independent Auditors (filed herewith).
(21.1) Subsidiaries of the Company filed as Exhibit 21.1 to the Registration Statement.
(27.1) Financial Data Schedule (filed herewith).
</TABLE>
<PAGE>
EXHIBIT 10.37
COMMERCIAL LEASE AGREEMENT
DALLAS/FORT WORTH REAL ESTATE
INVESTMENTS #1 LIMITED PARTNERSHIP
(LANDLORD)
AND
PEERLESS GROUP, INC.
(TENANT)
PROJECT: ENTERPRISE
BUSINESS CENTER
LOCATION: ALLEN, TEXAS
<PAGE>
TABLE OF CONTENTS
-----------------
Page No.
--------
1. PREMISES, TERM, AND INITIAL IMPROVEMENTS........................ 1
2. BASE RENT, SECURITY DEPOSIT AND ADDITIONAL RENT................. 1
3. TAXES........................................................... 2
4. LANDLORD'S MAINTENANCE.......................................... 3
5. TENANT'S MAINTENANCE AND REPAIR OBLIGATIONS..................... 3
7. SIGNS........................................................... 4
8. UTILITIES....................................................... 4
9. INSURANCE....................................................... 4
10. CASUALTY DAMAGE................................................. 5
11. LIABILITY, INDEMNIFICATION...................................... 5
12. USE............................................................. 6
13. INSPECTION...................................................... 6
14. ASSIGNMENT AND SUBLETTING....................................... 6
15. CONDEMNATION.................................................... 7
16. SURRENDER OF PREMISES; HOLDING OVER............................. 7
17. QUIET ENJOYMENT................................................. 8
18. EVENTS OF DEFAULT............................................... 8
19. REMEDIES........................................................ 8
20. LANDLORD'S DEFAULT.............................................. 9
21. MORTGAGES....................................................... 9
22. ENCUMBRANCES.................................................... 10
23. MISCELLANEOUS................................................... 10
24. NOTICES......................................................... 11
25. HAZARDOUS WASTE................................................. 11
26. CONDITIONS TO LANDLORD'S OBLIGATIONS............................ 12
27. LANDLORD'S LIEN................................................. 12
28. ROOFTOP EQUIPMENT............................................... 12
29. EXHIBITS........................................................ 12
i
<PAGE>
LIST OF DEFINED TERMS
---------------------
Page No.
--------
Additional Work....................................................... B-2
Affiliate............................................................. 10
Base Rent............................................................. 1
Building.............................................................. 1
Building's Structure.................................................. 3
Claimant.............................................................. 9
Commencement Date..................................................... 1
Election Notice....................................................... C-1
Environmental Law..................................................... 11
Event of Default...................................................... 8
Fair Market Rental Rate............................................... C-1
Financial Conditions.................................................. 1
Force Majeure Delay Days.............................................. B-1
Force Majeure Event................................................... 10
GAAP.................................................................. 1
Hazardous Substances.................................................. 11
HVAC System........................................................... 3
Improvements.......................................................... B-1
including............................................................. 10
Interior Drawings..................................................... B-1
Interior Improvements................................................. B-1
Land.................................................................. 1
Landlord.............................................................. 1
Landlord's Assessment................................................. C-1
Landlord's Mortgagee.................................................. 9
Law................................................................... 10
Laws.................................................................. 10
Lease................................................................. 1
Lease Year............................................................ B-3
Legal Requirements.................................................... 4
Loss.................................................................. 5
Mortgage.............................................................. 9
MSDS.................................................................. 11
Objection Notice...................................................... C-1
Operating Expenses.................................................... 2
Outline Specifications................................................ B-1
Permitted Activities.................................................. 11
Permitted Materials................................................... 11
Permitted Transferee.................................................. 6
Premises.............................................................. 1
Primary Lease......................................................... 9
Removable Item........................................................ 4
rent.................................................................. 2
Repair Period......................................................... 5
Rooftop Equipment..................................................... 12
Security Deposit...................................................... 1
Shell Building........................................................ B-1
Shell Building and the Interior Improvements.......................... B-1
Shell Plans........................................................... B-1
Substantial Completion................................................ B-1
Taking................................................................ 7
Tangible Net Worth.................................................... 1
Tenant................................................................ 1
Tenant Delay Days..................................................... B-1
Tenant Party.......................................................... 10
Tenant's Financial Statements......................................... 1
Term.................................................................. 1
Termination Date...................................................... B-1
Transfer.............................................................. 6
Twelve-Year Mortgage Money Rate....................................... B-2
Vacation Date......................................................... 6
ii
<PAGE>
LEASE AGREEMENT
---------------
This Lease Agreement (this "LEASE") is entered into by DALLAS/FORT WORTH
- ----- REAL ESTATE INVESTMENTS #1 LIMITED PARTNERSHIP, a Texas limited
partnership ("LANDLORD"), and PEERLESS GROUP, INC., a Delaware corporation
("TENANT"). -------- ------
1. PREMISES, TERM, AND INITIAL IMPROVEMENTS.
----------------------------------------
(a) Landlord leases to Tenant, and Tenant leases from Landlord,
the real property described on Exhibit A (the "PREMISES"), which includes the
- --------- -------- approximately 82,600 square foot building (the "BUILDING")
to be constructed on -------- the real property described on Exhibit A (the
"LAND"), subject to the terms and --------- ---- conditions in this Lease.
(b) The Lease term shall be 180 months, beginning on the
Commencement Date (defined below) (the "TERM", which defined term shall
include all ---- renewals and extensions of the Term); however, if the
Commencement Date is not the first day of a calendar month, then the Term
shall end on the last day of the 180-month period that begins with the first
day of the first full calendar month of the Term. The "COMMENCEMENT DATE"
shall be the date on which ----------------- Substantial Completion occurs,
except as provided in the last sentence of Section 1.(d) of Exhibit B and the
penultimate sentence of Section 3 of Exhibit --------- ------- B. Following
the Commencement Date, Landlord and Tenant shall execute an - instrument
specifying the Commencement Date and the expiration date of the Term.
(c) Landlord shall construct the Building in substantial
accordance with the plans and specifications referenced on Exhibit B. Upon
Substantial --------- Completion, Tenant shall move into and occupy the
Premises. By occupying the Premises, Tenant shall have accepted the Premises
in their condition, subject to completion of any punch-list items relating to
the Interior Improvements and Additional Work (defined in Exhibit B), and
subject to Landlord's maintenance --------- and repair obligations as
specifically set forth herein.
2. BASE RENT, SECURITY DEPOSIT AND ADDITIONAL RENT.
-----------------------------------------------
(a) Tenant shall pay to Landlord "BASE RENT", in advance, without
- --------- demand, deduction or set off, except as otherwise specifically
provided herein, equal to the following amounts for the following intervals:
<TABLE>
<CAPTION>
TIME PERIOD ANNUAL BASE RENT RATE MONTHLY BASE RENT
PER RENTABLE SQUARE FOOT
<S> <C> <C>
Months 1 through 60 $12.22 $ 84,114.33
Months 61 through 120 $14.06 $ 96,779.67
Months 121 through the $16.18 $111,372.33 expiration date
</TABLE>
<PAGE>
The first monthly installment of Base Rent shall be due on the date hereof;
thereafter, monthly installments of Base Rent shall be due on the first day
of each calendar month following the Commencement Date. If the Term begins
on a day other than the first day of a month or ends on a day other than the
last day of a month, the Base Rent and additional rent under Section 2.(c),
for such partial month shall be prorated.
(b) Tenant shall deposit with Landlord on the date hereof
$98,982.33 (the "SECURITY DEPOSIT"), which shall be held by Landlord to
secure Tenant's ---------------- obligations under this Lease; however, the
Security Deposit is not an advance rental deposit or a measure of Landlord's
damages for an Event of Default (defined below). Landlord may use any
portion of the Security Deposit to satisfy Tenant's unperformed obligations
hereunder, without prejudice to any of Landlord's other remedies. If so
used, Tenant shall pay Landlord an amount that will restore the Security
Deposit to its original amount upon request. In connection with any waiver
of a Tenant default or modification of this Lease, Landlord may require that
Tenant provide Landlord with an additional amount to be held as part of the
Security Deposit. The Security Deposit shall be Landlord's property. The
unused portion of the Security Deposit will be returned to Tenant within a
reasonable time after the end of the Term, provided that Tenant has fully and
timely performed its obligations hereunder throughout the Term.
Notwithstanding the foregoing, if no Event of Default has occurred, then
after the commencement of the sixth year of the Term, Landlord shall return
the Security Deposit to Tenant within 30 days after Landlord's receipt of
Tenant's audited financial statements (such audited financial statements are
herein called "TENANT'S FINANCIAL STATEMENTS") for the immediately preceding
- ----------------------------- fiscal year prepared in accordance with
generally accepted accounting principles ("GAAP") verifying the following
financial conditions are satisfied (the ---- "FINANCIAL CONDITIONS"): (1)
Tenant's then-current Tangible Net Worth -------------------- (hereinafter
defined) exceeds $10,000,000 and (2) the ratio of Tenant's current assets
minus inventory to current liabilities (contingent or otherwise) is not
greater than 1.4 to 1. As used herein, "TANGIBLE NET WORTH" shall mean the
- ------------------ excess of total assets over total liabilities (in each
case, determined in accordance with GAAP) excluding from the determination of
total assets all assets which would be classified as intangible assets under
GAAP, including, without limitation, goodwill, licenses, patents, trademarks,
trade names, copyrights, and franchises. If the initial Security Deposit has
been returned as provided above, Tenant shall deposit $98,982.33 with
Landlord as a Security Deposit on the earlier to occur of the following (A)
the occurrence of an Event of Default, (B) the Financial Conditions for any
subsequent year during the Term are not met, or (C) at least eight months
before the expiration of the Term, which shall be held and applied by
Landlord as provided in this Section 2.(b). After
1
<PAGE>
the fifth year of the Term, within 90 days after the end of each year during
the Term Tenant shall deliver to Landlord Tenant's Financial Statements.
(c) Tenant shall pay, as additional rent, all costs incurred in
owning, managing, operating and maintaining the Premises and the facilities
and services provided for the use of Tenant (collectively, "OPERATING
EXPENSES"), ------------------ including the following items: (1) Taxes
(defined below) and the reasonable cost of any tax consultant employed to
assist Landlord in determining the fair tax valuation of the Premises; (2)
the cost of insurance maintained by Landlord with respect to the Premises and
its ownership thereof (including commercial liability insurance premiums, all
risk or fire extended coverage premiums and amounts not covered by insurance
because the amount of the loss falls within the deductible amounts under such
insurance policies); and (3) the cost of repairs, replacement, management
fees (not to exceed 2.7% of annual gross rent) and expenses, landscape
maintenance and replacement, security service (if requested by Tenant and
provided), sewer service (if provided), and trash service (if provided); (4)
maintenance of the Building's fire sprinkler system; (5) alterations,
additions, and improvements made by Landlord to comply with Law (defined
below) promulgated after the date hereof; and (6) cost of termite control. No
management, administrative or similar expenses or fees, other than those set
forth in clause (3) above, shall be included as Operating Expenses.
Additional rent under this Section 2.(c) shall be payable by Tenant to
Landlord in monthly installments equal to 1/12 of Landlord's estimate of the
annual Operating Expenses. The initial monthly payments are based upon
Landlord's estimate of the Operating Expenses for the year in question, and
shall be increased or decreased annually to reflect the projected actual
Operating Expenses for that year. Within 90 days after each calendar year or
as soon thereafter as is reasonably practicable, Landlord shall deliver to
Tenant a statement setting forth the actual Operating Expenses for such year.
If Tenant's total payments in respect of Operating Expenses for any year are
less than the Operating Expenses for that year, Tenant shall pay the
difference to Landlord within 30 days after Landlord's written request
therefor; if such payments are more than such Operating Expenses, Landlord
shall retain such excess and credit it against Tenant's next accruing
installments of Base Rent, or if the Term has expired or will expire before
the credit is given, then Landlord shall pay such amount to Tenant within 30
days after the amount has been determined. Operating Expenses shall not
include the following: (A) any costs for interest, amortization, or other
payments on loans to Landlord; (B) federal income taxes imposed on or
measured by the income of Landlord from the operation of the Building; (C)
rents under ground leases; (D) costs incurred in selling, syndicating,
financing, mortgaging, or hypothecating any of Landlord's interests in the
Premises; and (E) any costs or expenses incurred by Landlord in fulfilling
its maintenance and repair obligations with respect to the Building's
Structure as provided in Section 4.(a). There shall be no duplication of
costs for reimbursements in calculating Operating Expenses. The amounts of
the initial monthly installments of Base Rent and Operating Expenses (and the
portion thereof attributable to Taxes) are as follows:
<TABLE>
<S> <C>
Base Rent (Section 2.(a))............................ $84,114.33
Operating Expenses, excluding Taxes (Section 2.(c)).. $ 6,263.83
Taxes (Sections 2.(c) and 3.(a))..................... $ 8,604.17
----------
Total initial monthly payment...................... $98,982.33
==========
</TABLE>
The first monthly installments of additional rent under Section 2.(c)
shall be due on the date hereof; thereafter, monthly installments of such
additional rent shall be due on the first day of each calendar month
following the Commencement Date.
(d) If any payment required of Tenant under this Lease is not paid
when due, Landlord may charge Tenant a fee equal to 5% of any delinquent
payment that is not paid to Landlord within five days after Landlord has
delivered to Tenant written notice of such delinquency; however, if Landlord
has notified Tenant of a delinquency twice during the 12-month period before
the delinquent payment in question, Landlord may charge Tenant such 5% fee
immediately without delivering to Tenant notice that it failed to make such
payment when due.
(e) All payments and reimbursements required to be made by Tenant
under this Lease shall constitute "RENT" (herein so called) and shall be ----
payable without demand, deduction or set off, except as otherwise
specifically provided herein.
(f) Tenant may, after giving Landlord 30-days' prior written
notice thereof, inspect or audit Landlord's records relating to Operating
Expenses for any year during the Term; however, if Tenant fails to deliver
such notice within two months after Landlord has delivered to Tenant a
statement setting forth the Operating Expenses for the year in question, then
Tenant's right to inspect and audit Operating Expenses for that year shall
expire, and the calculation of that year's Operating Expenses on such
statement shall be binding on Tenant. Tenant's audit or inspection shall be
conducted only during business hours reasonably designated by Landlord and in
a manner so as not to unreasonably interfere with Landlord's business
operations. Tenant shall deliver a copy of such audit or inspection to
Landlord promptly after it is completed. If it is determined that an error
was made in the calculation of Operating Expenses charged to Tenant, Landlord
shall refund to Tenant any overpayment of any such costs, or Tenant shall pay
to Landlord any underpayment of any such costs, as the case may be, within 30
days after notification thereof.
(g) Landlord shall pay to Tenant interest on the Security Deposit
from the date it is received by Landlord through the day before it is
returned to Tenant, if at all, pursuant to Section 2.(b), at a rate of 6% per
annum.
2
<PAGE>
3. TAXES.
-----
(a) Landlord shall pay all taxes, assessments and governmental
charges whether federal, state, county, or municipal and whether they are
imposed by taxing or management districts or authorities presently existing
or hereafter created (collectively, "TAXES") that accrue against the
Premises; -----provided, however, that in no event shall Tenant be obligated
to make payment or reimbursement for income taxes imposed on or measured by
the income of Landlord from the operation of the Building (except as provided
in the next sentence) or for penalties and interest resulting from Landlord's
late payment of Taxes if Tenant has promptly paid to Landlord the amount of
such Taxes as provided herein. If, during the Term, there is levied, assessed
or imposed on Landlord a capital levy or other tax directly on the rent or a
franchise tax, assessment, levy or charge measured by or based, in whole or
in part, upon rent, then all such taxes, assessments, levies or charges, or
the part thereof so measured or based, shall be included within the term
"Taxes." If Landlord has not engaged a tax consultant to contest Taxes for a
calendar year, then Tenant may hire a tax consultant, at its expense, to
contest Taxes for that year, provided that such contest is coordinated with
Landlord and is conducted in a manner that would not pose a threat of loss or
seizure of the Premises or Landlord's interest therein. Landlord shall
deliver to Tenant copies of all tax statements that it receives promptly
after its receipt thereof and, in any event, at least 30 days before the
deadline for filing a petition to contest the Taxes specified thereon if
Landlord has received such statement by such date.
(b) Tenant shall (1) before delinquency pay all taxes levied or
assessed against any personal property, fixtures or alterations placed in the
Premises and (2) upon the request of Landlord, deliver to Landlord receipts
from the applicable taxing authority or other evidence acceptable to Landlord
to verify that such taxes have been paid. If any such taxes are levied or
assessed against Landlord or Landlord's property and (A) Landlord pays them
or (B) the assessed value of Landlord's property is increased thereby and
Landlord pays the increased taxes, then Tenant shall pay to Landlord such
taxes within ten days after Landlord's request therefor.
4. LANDLORD'S MAINTENANCE.
----------------------
(a) This Lease is intended to be a net lease; accordingly,
Landlord's maintenance obligations are limited to the repair and replacement
of the Building's roof and maintenance of the foundation, foundation piers
and structural members of the exterior walls (collectively, the "BUILDING'S
- ----------STRUCTURE"); however, Landlord shall not be responsible (1) for any
such work --------- until Tenant delivers to Landlord written notice of the
need therefor or (2) for alterations to the Building's Structure required by
Law because of Tenant's specific use of the Premises (which alterations shall
be performed by Tenant). The Building's Structure does not include windows or
components thereof (including caulking, flashing, etc.), glass or plate
glass, doors, special store fronts or office entries, all of which shall be
maintained by Tenant. Landlord's liability for any defects, repairs,
replacement or maintenance for which Landlord is responsible hereunder shall
be limited to the cost of performing such work.
(b) Additionally, Landlord shall, at Tenant's expense, maintain
the parking areas, driveways, alleys and grounds surrounding the Premises in
a clean and sanitary condition, consistent with the operation of a
first-class office/warehouse building, including prompt maintenance, repairs
and replacements of (1) any drill or spur track servicing the Premises, (2)
the exterior of the Building (including painting), (3) sprinkler systems and
sewage lines, (4) skylights, and (5) any other items normally associated with
the foregoing. Tenant shall promptly notify Landlord of any work required to
be performed under this Section 4.(b), and Landlord shall not be responsible
for performing such work until Tenant delivers to Landlord such notice. All
costs in performing the work described in this Section 4.(b) shall be
included in Operating Expenses (unless the amount thereof was included in
Landlord's estimate of Operating Expenses for the year in which they were
incurred).
(c) If Tenant has delivered written notice to Landlord that it is
not satisfied with Landlord's work under Section 4.(b) (which notice must
specify in detail the reasons for such dissatisfaction) and Landlord fails to
correct the deficiencies in its performance to Tenant's satisfaction within
60 days after the delivery of such notice, or if such correction cannot
reasonably be completed within such 60-day period, Landlord commences such
correction within such 60-day period and thereafter diligently pursues the
completion thereof, then Tenant may elect to perform such work or hire a
contractor reasonably acceptable to Landlord to perform such work, in which
case Tenant shall deliver written notice thereof to Landlord in writing.
Unless Tenant agrees otherwise, Landlord shall solicit and obtain bids for
all work required to be performed by Landlord under Section 4.(b) from at
least three contractors and shall accept the lowest, qualified bid for the
work in question. If any emergency repairs are required to prevent imminent
loss of property or physical injury to any individual, then Tenant shall
promptly notify Landlord thereof (which notice may be given orally) and may
take such steps as may be necessary to protect the endangered property or to
prevent such physical injury; however, Tenant shall take no action which
would impair Landlord's right to receive insurance proceeds in respect of the
event giving rise to such peril.
5. TENANT'S MAINTENANCE AND REPAIR OBLIGATIONS.
-------------------------------------------
(a) Subject to Sections 10 and 15, Tenant shall maintain all parts
of the Premises (except for maintenance work which Landlord is expressly
responsible for under Section 4) in good condition and promptly make all
necessary repairs and replacements to the Premises. Tenant shall repair and
pay for any damage caused by a Tenant Party (defined below) or caused by
Tenant's default hereunder.
(b) Tenant shall maintain the hot water equipment and the heating,
air conditioning, and ventilation equipment and system (the "HVAC SYSTEM") in
- ----------- good repair and condition and in accordance with Law and with
such equipment manufacturers' suggested operation/maintenance service
program; such obligation shall include replacement of all equipment necessary
to maintain such equipment and system in good working order. Within ten days
after the Commencement Date, Tenant shall enter into regularly scheduled
preventive maintenance/service contracts for
3
<PAGE>
such equipment, each in compliance with Landlord's specifications (provided
such specifications have been furnished to Tenant) and otherwise in form and
substance and with a contractor reasonably acceptable to Landlord, and
deliver copies thereof to Landlord. At least 14 days before the end of the
Term, Tenant shall deliver to Landlord a certificate from an engineer
reasonably acceptable to Landlord certifying that the hot water equipment and
the HVAC System are then in good repair and working order.
(c) Except for termite control, Tenant shall be responsible for
all pest control in the Premises. If requested by Landlord, Tenant shall
enter into a regularly scheduled preventive pest control contract with a
contractor reasonably acceptable to Landlord. At Landlord's election,
Landlord may perform the work required under this Section 5.(c), at Tenant's
expense.
(d) To the extent they may be assigned, Landlord shall assign to
Tenant during the Term any guaranties and warranties related to the Building,
including, but not limited to, those guaranties and warranties for the HVAC
System, interior finishes, and mechanical, electrical, and plumbing systems
(but excluding the Building's Structure and those relating to the matters
described in Section 4.(b)). Such assignment shall be limited to enforcement
of such guaranties and warranties and Tenant shall have no right to amend
such guaranties or warranties. Landlord will provide Tenant copies of all
documents relating to such guaranties or warranties. Throughout the Term,
Landlord shall, at Tenant's expense, provide reasonable assistance to Tenant
in obtaining the benefits of such guaranties and warranties, to the extent
Landlord may do so. Landlord may rescind this assignment while an Event of
Default exists by delivering to Tenant written notice thereof. This
assignment shall expire and be of no further effect upon the expiration of
the Term.
6. ALTERATIONS. Tenant shall not make any alterations, additions or
- ----------- improvements to the Premises without the prior written consent of
Landlord, which shall not be unreasonably withheld; however, Landlord may
withhold its consent in its sole and absolute discretion to any alteration or
addition that would affect the Building's Structure, or the Building's HVAC
System, plumbing, electrical, or mechanical systems. Landlord shall not be
required to notify Tenant of whether it consents to any alteration, addition
or improvements until it (a) has received plans and specifications therefor
which are sufficiently detailed to allow construction of the work depicted
thereon to be performed in a good and workmanlike manner, and (b) has had a
reasonable opportunity to review them. If the alteration, addition or
improvement will affect the Building's Structure, HVAC System, or mechanical,
electrical, or plumbing systems, then the plans and specifications therefor
must be prepared by a licensed engineer reasonably acceptable to Landlord.
Landlord's approval of any plans and specifications shall not be a
representation that the plans or the work depicted thereon will comply with
Law or be adequate for any purpose, but shall merely be Landlord's consent to
performance of the work. Upon completion of any alteration, addition, or
improvement, Tenant shall deliver to Landlord accurate, reproducible as-built
plans therefor. Tenant may erect shelves, bins, machinery and trade fixtures
provided that such items (1) do not alter the basic character of the
Premises; (2) do not overload or damage the Premises; and (3) may be removed
without damage to the Premises. All alterations, additions, and improvements
shall be Landlord's property when installed in the Premises, unless Landlord
specifies in writing that Tenant may remove the item in question (a
"REMOVABLE ITEM"). All work performed by a Tenant Party in the Premises
- -------------- (including that relating to the installations, repair,
replacement, or removal of any item) shall be performed in accordance with
Law and with Landlord's specifications and requirements, in a good and
workmanlike manner, and so as not to damage or alter the Building's Structure
or the Premises. In connection with any such alteration, addition, or
improvement, Tenant shall pay to Landlord an administration fee of 5% of all
costs incurred for such work up to a maximum of $3,000 for each single
requested alteration, addition or improvement; provided, however, that if the
total cost of such alteration, addition or improvement exceeds $200,000, then
such cap shall not apply and Tenant shall pay to Landlord an administrative
fee of 3% of all costs incurred for such work. For example, if such total
costs were $75,000, the administrative fee would equal $3,000, and if such
total costs were $300,000, the administrative fee would equal $9,000.
7. SIGNS. Tenant shall not place, install or attach any signage,
- ----- decorations, advertising media, blinds, draperies, window treatments,
bars, or security installations to the Premises or the Building which can be
viewed from the exterior of the Building without Landlord's prior written
approval. Tenant shall repair, paint, and/or replace any portion of the
Premises or the Building damaged or altered as a result of its signage when
it is removed (including, without limitation, any discoloration of the
Building). Tenant shall not (a) make any changes to the exterior of the
Premises or the Building, (b) install any exterior lights, decorations,
balloons, flags, pennants, banners or paintings, or (c) erect or install any
signs, windows or door lettering, decals, window or storefront stickers,
placards, decorations or advertising media of any type that is visible from
the exterior of the Premises without Landlord's prior written consent.
Landlord shall not be required to notify Tenant of whether it consents to any
sign until it (1) has received detailed, to-scale drawings thereof specifying
design, material composition, color scheme, and method of installation, and
(2) has had a reasonable opportunity to review them. If any sign will be
attached to the Building or will involve the construction of a monument sign,
Tenant shall deliver to Landlord plans and specifications specifying the
method of attaching or installing such sign for Landlord's approval, which
approval shall not be unreasonably withheld. After the installation of any
sign, Tenant shall maintain such sign in a good, clean, and safe condition in
accordance with all Laws and architectural guidelines in effect for the area
where the Premises is located, as the same may be amended from time to time
(the "LEGAL REQUIREMENTS"). Tenant shall repair all damage
- ------------------ caused by the installation, use, maintenance, and removal
of any sign and, upon its removal, restore the Premises to its condition
immediately before the installation thereof (ordinary wear and tear excepted,
other than any discoloration caused thereby which shall be corrected).
Within ten days after the earlier of (a) the termination of this Lease, (b)
termination of Tenant's right to possess the Premises, or (c) expiration of
the Term, Tenant shall remove the signs and perform all restoration work as
provided above. If Tenant fails to do so within such ten-day period,
Landlord may perform such work and dispose of the signs in any manner it
deems appropriate without any compensation to Tenant; Tenant shall pay to
Landlord all reasonable costs incurred in connection therewith within 30 days
after Landlord's request therefor.
8. UTILITIES. Tenant shall obtain and pay for all water, gas,
- --------- electricity, heat, telephone, sewer, sprinkler charges and other
utilities and services used at the Premises, together with any taxes,
penalties, surcharges,
4
<PAGE>
maintenance charges, and the like pertaining to the Tenant's use of the
Premises. Landlord shall not be liable for any interruption or failure of
utility service to the Premises. If Tenant fails to pay any such amounts
when due, Landlord may do so, in which case, Tenant shall reimburse Landlord
for all amounts paid by Landlord within 30 days after Landlord's request
therefor.
9. INSURANCE. Tenant shall maintain (a) workers' compensation
insurance --------- (with a waiver of subrogation endorsement reasonably
acceptable to Landlord) and commercial general liability insurance (with
contractual liability endorsement), including personal injury and property
damage in the amount of $1,000,000 per occurrence combined single limit for
personal injuries and death of persons and property damage occurring in or
about the Premises, plus umbrella coverage of at least $2,000,000 per
occurrence, (b) fire and extended coverage insurance covering (1) the
replacement cost of all alterations, additions, partitions and improvements
installed in the Premises, (2) the replacement cost of all of Tenant's
personal property in the Premises, and (3) loss of profits in the event of an
insured peril damaging the Premises, and (c) such other insurance as Landlord
may reasonably require based on industry standards for landlords leasing
space to entities engaging in business operations similar to those conducted
by Tenant in the Premises. Such policies shall (A) name Landlord, Landlord's
agents, and their respective Affiliates (defined below), as additional
insureds (and as loss payees on the fire and extended coverage insurance),
(B) be issued by an insurance company acceptable to Landlord, (C) provide
that such insurance may not be cancelled unless 30-days' prior written notice
is first given to Landlord, (D) be delivered to Landlord by Tenant before the
Commencement Date and at least 15 days before each renewal thereof, and (E)
provide primary coverage to Landlord when any policy issued to Landlord is
similar or duplicate in coverage, in which case Landlord's policy shall be
excess over Tenant's policies. Landlord shall maintain all risk property
insurance covering the full replacement cost of the Shell Building, with
deductibles in such amounts as Landlord may determine are commercially
reasonable.
10. CASUALTY DAMAGE.
---------------
(a) Tenant immediately shall give written notice to Landlord of
any damage to the Premises. If the Premises are totally destroyed by an
insured peril, or so damaged by an insured peril that, in Landlord's
estimation, rebuilding or repairs cannot be substantially completed within
180 days after the date of Landlord's actual knowledge of such damage, then
Landlord or (if a Tenant Party did not cause such damage) Tenant may
terminate this Lease by delivering to the other written notice thereof within
30 days after such damage, in which case, the rent shall be abated during the
unexpired portion of this Lease, effective upon the date such damage
occurred. Time is of the essence with respect to the delivery of such
notices.
(b) Subject to Section 10.(c), if this Lease is not terminated
under Section 10.(a), then Landlord shall restore the Premises to
substantially its previous condition, except that Landlord shall not be
required to rebuild, repair or replace any part of the partitions, fixtures,
additions and other improvements or personal property required to be covered
by Tenant's insurance under Section 9. If the Premises are untenantable, in
whole or in part, during the period beginning on the date such damage
occurred and ending on the date of substantial completion of Landlord's
repair or restoration work (the "REPAIR ------ PERIOD"), then the rent for
such period shall be reduced to such extent as may ------ be fair and
reasonable under the circumstances and the Term shall be extended by the
number of days in the Repair Period.
(c) If the Premises are destroyed or substantially damaged by any
peril not covered by the insurance maintained by Landlord or any Landlord's
Mortgagee (defined below) requires that insurance proceeds be applied to the
indebtedness secured by its Mortgage (defined below) or to the Primary Lease
(defined below) obligations, Landlord may elect to restore the Premises
pursuant to Section 10.(b) or to terminate this Lease by delivering written
notice of termination to Tenant within 30 days after such destruction or
damage or such requirement is made known by any such Landlord's Mortgagee, as
applicable. If Landlord does not deliver to Tenant written notice electing
to restore within such 30-day period, then Landlord shall have elected to
terminate this Lease under this Section 10.(c), whereupon all rights and
obligations hereunder shall cease and terminate, except for any liabilities
of Tenant which accrued before this Lease is terminated.
<PAGE>
11. LIABILITY, INDEMNIFICATION, WAIVER OF SUBROGATION AND NEGLIGENCE
- ---------------------------------------------------------------- CLAIMS.
- ------
(a) Subject to Section 11.(b), Tenant shall indemnify, defend, and
hold harmless Landlord, its successors, assigns, agents, employees,
contractors, partners, directors, officers and affiliates (collectively, the
"INDEMNIFIED ----------- PARTIES") from and against all fines, suits, losses,
costs, liabilities, claims, ------- demands, actions and judgments of every
kind or character (1) arising from Tenant's failure to perform its covenants
hereunder, (2) recovered from or asserted against any of the Indemnified
Parties on account of any Loss (defined below) to the extent that any such
Loss may be incident to, arise out of, or be caused, either proximately or
remotely, wholly or in part, by a Tenant Party or any other person entering
upon the Premises under or with a Tenant Party's express or implied
invitation or permission, (3) arising from or out of the occupancy or use by
a Tenant Party or arising from or out of any occurrence in the Premises,
howsoever caused, or (4) suffered by, recovered from or asserted against any
of the Indemnified Parties by a Tenant Party, REGARDLESS OF WHETHER
LANDLORD'S JOINT, CONCURRENT OR COMPARATIVE NEGLIGENCE CAUSED SUCH LOSS OR
DAMAGE. HOWEVER, SUCH INDEMNIFICATION OF THE INDEMNIFIED PARTIES BY TENANT
SHALL NOT BE APPLICABLE IF SUCH LOSS, DAMAGE, OR INJURY IS CAUSED BY THE SOLE
OR GROSS NEGLIGENCE OR WILLFUL MISCONDUCT OF LANDLORD OR ANY OF ITS AGENTS,
CONTRACTORS, OR EMPLOYEES. Subject to Section 11.(b), Landlord shall
indemnify, defend, and hold harmless Tenant, its successors, assigns, agents,
employees, contractors, partners, directors, officers, and affiliates from
and against all fines, suits, losses, costs, liabilities, claims, demands,
actions and judgments of every kind and character arising out of the sole or
gross negligence or willful misconduct of Landlord or any of its duly
authorized agents or employees.
(b) Landlord shall not be liable to Tenant or those claiming by,
through, or under Tenant for any injury to or death of any person or persons
or the damage to or theft, destruction, loss, or loss of use of any property
or
5
<PAGE>
inconvenience (a "LOSS") caused by casualty, theft, fire, third parties, or
- ---- any other matter (including Losses arising through repair or alteration
of any part of the Building, or failure to make repairs, or from any other
cause), EVEN IF SUCH LOSS IS CAUSED BY THE JOINT, CONCURRENT, OR COMPARATIVE
NEGLIGENCE (BUT NOT THE SOLE OR GROSS NEGLIGENCE) OF LANDLORD. Landlord and
Tenant each waives any claim it might have against the other for any damage
to or theft, destruction, loss, or loss of use of any property, to the extent
the same is insured against under any insurance policy maintained by it that
covers the Premises, Landlord's or Tenant's fixtures, personal property,
leasehold improvements, or business, or is required to be insured against by
the waiving party under the terms hereof, REGARDLESS OF WHETHER THE
NEGLIGENCE OR FAULT OF THE OTHER PARTY CAUSED SUCH LOSS; HOWEVER, LANDLORD'S
WAIVER SHALL NOT APPLY TO ANY DEDUCTIBLE AMOUNTS MAINTAINED BY LANDLORD UNDER
ITS INSURANCE. Each party shall cause its insurance carrier to endorse all
applicable policies waiving the carrier's rights of recovery under
subrogation or otherwise against the other party.
12. USE.
---
(a) The Premises shall be used only for receiving, storing,
shipping and selling products, materials and merchandise made or distributed
by Tenant and for such other lawful purposes as may be incidental thereto
(the PERMITTED USE"); however, no retail sales may be made from the Premises.
Tenant ------------- shall not use the Premises to receive, store or handle
any product, material or merchandise that is explosive or highly inflammable
or hazardous. Outside storage is prohibited. Tenant shall be solely
responsible for complying with all Laws applicable to its specific use,
occupancy, and condition of the Premises. Tenant shall not permit any
objectionable or unpleasant odors, smoke, dust, gas, light, noise or
vibrations to emanate from the Premises; nor take any other action that would
constitute a nuisance or would disturb, unreasonably interfere with, or
endanger Landlord or any other person; nor permit the Premises to be used for
any purpose or in any manner that would (1) void the insurance thereon, (2)
increase the insurance risk, or (3) cause the disallowance of any sprinkler
credits. Tenant shall pay to Landlord on demand any increase in the cost of
any insurance on the Premises incurred by Landlord, which is caused by
Tenant's use of the Premises or because Tenant vacates the Premises.
(b) Tenant and its employees and invitees may use any parking
areas associated with the Premises. Landlord shall not be responsible for
enforcing Tenant's parking rights against third parties.
13. INSPECTION. Upon not less than 24 hours advance notice (which may
be ---------- oral), except in case of emergency in which case such notice is
not required, Landlord and Landlord's agents and representatives may enter
the Premises during business hours to inspect the Premises; to make such
repairs as may be required or permitted under this Lease; to perform any
unperformed obligations of Tenant hereunder; and to show the Premises to
prospective purchasers, mortgagees, ground lessors, and (during the last 12
months of the Term) tenants. During the last 12 months of the Term, Landlord
may erect a sign on the Premises indicating that the Premises are available.
Tenant shall notify Landlord in writing of its intention to vacate the
Premises at least 60 days before Tenant will vacate the Premises; such notice
shall specify the date on which Tenant intends to vacate the Premises (the
"VACATION DATE"). At least 30 days before the Vacation ------------- Date,
Tenant shall arrange to meet with Landlord for a joint inspection of the
Premises. After such inspection, Landlord shall prepare a list of items that
Tenant must perform before the Vacation Date. If Tenant fails to arrange for
such inspection, then Landlord may conduct such inspection and Landlord's
determination of the work Tenant is required to perform before the Vacation
Date shall be conclusive. If Tenant fails to perform such work before the
Vacation Date, then Landlord may perform such work at Tenant's cost. Tenant
shall pay all costs incurred by Landlord in performing such work within ten
days after Landlord's request therefor.
14. ASSIGNMENT AND SUBLETTING.
-------------------------
(a) Tenant shall not, without the prior written consent of
Landlord, (1) assign, transfer, or encumber this Lease or any estate or
interest herein, whether directly or by operation of law, (2) permit any
other entity to become Tenant hereunder by merger, consolidation, or other
reorganization, (3) if Tenant is an entity other than a corporation whose
stock is publicly traded, permit the transfer of an ownership interest in
Tenant so as to result in a change in the current control of Tenant, (4)
sublet any portion of the Premises, (5) grant any license, concession, or
other right of occupancy of any portion of the Premises, or (6) permit the
use of the Premises by any parties other than Tenant (any of the events
listed in Sections 14.(a)(1) through 14.(a)(6) being a "TRANSFER"). Landlord
shall not unreasonably withhold or delay its consent to -------- any Transfer
to a party which (A) is, in the reasonable judgment of Landlord, of a
character or reputation or is engaged in a business which would not be
harmful to the image and reputation of Enterprise Business Center and can
reasonably be expected to perform the obligations of "Tenant" hereunder, (B)
will not use the Premises in a manner that would conflict with any exclusive
use agreement or other similar agreement entered into by Landlord with any
other tenant of Enterprise Business Center, and (C) will not compete with the
business of any other tenant of Enterprise Business Center. Without limiting
the foregoing, Landlord may withhold its consent to any such assignment or
subletting of the Premises to any party (i) which is a governmental entity
(or subdivision or agency thereof), (ii) would use the Premises, in whole or
in part, for other than the Permitted Use, (iii) which is a prospective
tenant that has delivered to, or received from, Landlord a written proposal
to lease space in Enterprise Business Center before Tenant or its agent
contacts such party, (iv) which is a tenant of Enterprise Business Center, or
(v) which intends to use, store, or generate any Hazardous Materials in, on
or about the Premises. If Tenant requests Landlord's consent to a Transfer,
then Tenant shall provide Landlord with a written description of all terms
and conditions of the proposed Transfer, copies of the proposed
documentation, and the following information about the proposed transferee:
name and address; reasonably satisfactory information about its business and
business history; its proposed use of the Premises; banking, financial, and
other credit information; and general references sufficient to enable
Landlord to determine the proposed transferee's creditworthiness and
character. Tenant shall reimburse Landlord for its reasonable attorneys' fees
and other expenses incurred in connection with considering any request for
its consent to a Transfer. If Landlord consents to a proposed Transfer, then
the proposed transferee shall deliver to Landlord a written agreement whereby
it expressly assumes the Tenant's obligations hereunder (however, any
transferee of less than all of the space in the
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<PAGE>
Premises shall be liable only for obligations under this Lease that are
properly allocable to the space subject to the Transfer, and only to the
extent of the rent it has agreed to pay Tenant therefor). Landlord's consent
to a Transfer shall not release Tenant from performing its obligations under
this Lease, but rather Tenant and its transferee shall be jointly and
severally liable therefor. Landlord's consent to any Transfer shall not waive
Landlord's rights as to any subsequent Transfers. If an Event of Default
occurs while the Premises or any part thereof are subject to a Transfer, then
Landlord, in addition to its other remedies, may collect directly from such
transferee all rents becoming due to Tenant and apply such rents against
Tenant's rent obligations. Tenant authorizes its transferees to make payments
of rent directly to Landlord upon receipt of notice from Landlord to do so.
Notwithstanding the foregoing, Tenant may transfer or assign all or any
portion of Tenant's interest hereunder to an affiliate (a "PERMITTED
TRANSFEREE") and such transfer or assignment shall not --------------------be
deemed a Transfer, provided that (D) Landlord is notified of such transfer
within 15 days after such occurrence, (E) Tenant shall remain fully liable
hereunder, and (F) the affiliate shall assume Tenant's obligations hereunder.
(b) If after giving effect to a proposed sublease or assignment
more than 50% of the Premises would be subject to a Transfer, then Landlord
may, within 30 days after submission of Tenant's written request for
Landlord's consent to a Transfer, cancel this Lease as to all space then
subject to a Transfer (or, as to a subletting or assignment, cancel as to the
portion of the Premises proposed to be sublet or assigned) as of the date the
proposed Transfer was to be effective. If Landlord cancels this Lease as to
any portion of the Premises, then this Lease shall cease for such portion of
the Premises and Tenant shall pay to Landlord all rent accrued through the
cancellation date relating to the portion of the Premises covered by the
proposed Transfer. Thereafter, Landlord may lease such portion of the
Premises to the prospective transferee (or to any other person) without
liability to Tenant.
(c) If no Event of Default exists, all compensation received by
Tenant for a Transfer in respect of the interval in question that exceeds the
Base Rent and the Operating Expenses allocable to the portion of the Premises
covered thereby for the same interval shall be payable as follows:
(1) first, to Tenant until Tenant has received an amount
equal to all actual, third-party, out-of-pocket costs incurred by Tenant in
connection with such Transfer (including, without limitation, brokerage
commissions, attorneys' fees and expenses, tenant-finish-work, and other
tenant inducements); and
(2) thereafter, 50% to Landlord and 50% to Tenant. If an
Event of Default exists, all such excess compensation shall be payable to
Landlord. Tenant shall hold all amounts it receives which are payable to
Landlord in trust and shall deliver all such amounts to Landlord within ten
days after Tenant's receipt thereof.
15. CONDEMNATION. If more than 30% of the Premises is taken for any
- ------------ public or quasi-public use by right of eminent domain or private
purchase in lieu thereof (a "TAKING"), and the Taking prevents or materially
interferes ------ with the use of the remainder of the Premises for the
purpose for which they were leased to Tenant, either party may terminate this
Lease by delivering to the other written notice thereof within 30 days after
the Taking, in which case rent shall be abated during the unexpired portion
of the Term, effective on the date of such Taking. If (a) less than 30% of
the Premises are subject to a Taking or (b) more than 30% of the Premises are
subject to a Taking, but the Taking does not prevent or materially interfere
with the use of the remainder of the Premises for the purpose for which they
were leased to Tenant, then neither party may terminate this Lease, but the
rent payable during the unexpired portion of the Term shall be reduced to
such extent as may be fair and reasonable under the circumstances. All
compensation awarded for any Taking shall be the property of Landlord and
Tenant assigns any interest it may have in any such award to Landlord;
however, Landlord shall have no interest in any award made to Tenant for loss
of business or goodwill or for the taking of Tenant's trade fixtures or for
Tenant's moving expenses, if a separate award for such items is made to
Tenant. Tenant shall be entitled to pursue recovery of all amounts to which
it is entitled relating to any of its personal property or improvements to
the Premises which Tenant is permitted to remove hereunder, if any, from the
entity conducting such Taking.
16. SURRENDER OF PREMISES; HOLDING OVER.
-----------------------------------
(a) No act by Landlord shall be an acceptance of a surrender of
the Premises, and no agreement to accept a surrender of the Premises shall be
valid unless it is in writing and signed by Landlord. At the end of the Term
or the termination of Tenant's right to possess the Premises, Tenant shall
(1) deliver to Landlord the Premises with all improvements located thereon in
good repair and condition, reasonable wear and tear (subject however to
Tenant's maintenance obligations) excepted, and with the HVAC System and hot
water equipment, light and light fixtures (including ballasts), and overhead
doors and related equipment in good working order, (2) deliver to Landlord
all keys to the Premises, and (3) remove all signage placed on the Premises,
by or at Tenant's request. All fixtures, alterations, additions, and
improvements (whether temporary or permanent) shall be Landlord's property
and shall remain on the Premises except as provided in the next two
sentences. Provided that Tenant has performed all of its obligations
hereunder, Tenant may remove all Removable Items, unattached trade fixtures,
furniture, and personal property placed in the Premises by Tenant (but Tenant
shall not remove any such item which was paid for, in whole or in part, by
Landlord). Additionally, Tenant shall remove such alterations, additions,
improvements, fixtures, equipment, wiring, furniture, and other property as
Landlord may request except for items that Landlord has specifically agreed
in writing need not be removed by Tenant at the end of the Term, provided
such request is made within six months after the end of the Term. All items
not so removed shall, at the option of Landlord, be deemed abandoned by
Tenant and may be appropriated, sold, stored, destroyed, or otherwise
disposed of by Landlord without notice to Tenant and without any obligation
to account for such items and Tenant shall pay for the costs incurred by
Landlord in connection therewith. Any such disposition shall not be
considered a strict foreclosure or other exercise of Landlord's rights in
respect of the security interest granted under Section 27. All work required
of Tenant under this Section 16.(a) shall be coordinated with Landlord and be
done in a good and workmanlike manner, in accordance with all Laws, and so as
not to damage the Building. Tenant shall, at its expense, repair all damage
caused by any work performed by Tenant under this Section 16.(a).
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(b) If Tenant fails to vacate the Premises at the end of the Term,
then Tenant shall be a Tenant at will and Tenant shall pay, in addition to
the other rent due hereunder, a daily base rental equal to 150% of the daily
Base Rent payable during the last month of the Term, even if Landlord
consents to such holdover, unless Landlord agrees otherwise in writing.
Additionally, Tenant shall defend, indemnify, and hold harmless Landlord from
any damage, liability and expense (including reasonable attorneys' fees and
expenses) incurred because of such holding over. No payments of money by
Tenant to Landlord after the Term shall reinstate, continue or extend the
Term, and no extension of the Term shall be valid unless it is in writing and
signed by Landlord and Tenant.
17. QUIET ENJOYMENT. Provided Tenant has fully performed its
obligations --------------- under this Lease, Tenant shall peaceably and
quietly hold and enjoy the Premises for the Term, without hindrance from
Landlord or any party claiming by, through, or under Landlord, but not
otherwise.
18. EVENTS OF DEFAULT. Each of the following events shall constitute
an ----------------- "EVENT OF DEFAULT" under this Lease: ----------------
(a) Tenant fails to pay any rent when due or any payment or
reimbursement required under any other lease with Landlord when due, and in
either case such failure continues for a period of five days after Landlord
delivers to Tenant written notice thereof.
(b) The filing of a petition by or against Tenant or any guarantor
of Tenant's obligations hereunder (1) in any bankruptcy or other insolvency
proceeding; (2) seeking in any relief under any debtor relief Law; (3) for
the appointment of a liquidator, receiver, trustee, custodian, or similar
official for all or substantially all of Tenant's property or for Tenant's
interest in this Lease; or (4) for reorganization or modification of Tenant's
capital structure (however, if any such petition is filed against Tenant,
then the filing of such petition shall not constitute an Event of Default,
unless it is not dismissed within 45 days after the filing thereof).
(c) For a period of more than 12 months, Tenant (1) vacates more
than 50% of the Premises or (2) fails to continuously operate its business at
the Premises for the permitted use set forth herein and Landlord delivers to
Tenant written notice declaring such event as an Event of Default.
(d) Tenant fails to discharge or bond around (in an amount
satisfactory to Landlord) any lien placed upon the Premises in violation of
Section 22 within 15 days after any such lien or encumbrance is filed against
the Premises.
(e) Tenant fails to comply with any term, provision or covenant of
this Lease (other than those listed in this Section 18), and such failure
continues for 20 days after written notice thereof to Tenant (except that if
compliance cannot reasonably be achieved within the 20-day period, there
shall be no Event of Default so long as Tenant promptly attempts and
diligently and continuously pursues actions intended to bring about
compliance and brings about such compliance within 60 days after the
expiration of the initial 20-day period).
19. REMEDIES.
--------
(a) Upon any Event of Default, Landlord may, in addition to all
other rights and remedies afforded Landlord hereunder or by Law, take any of
the following actions:
(1) Terminate this Lease by giving Tenant written notice
thereof, in which event, Tenant shall pay to Landlord the sum of (A) all rent
accrued hereunder through the date of termination, (B) all amounts due under
Section 19.(b), and (C) an amount equal to (i) the total rent that Tenant
would have been required to pay for the remainder of the Term discounted to
present value at a per annum rate equal to the rate of interest set forth for
26-week U.S. governmental bills sold at a discount from face value in units
of $10,000 to $1,000,000 as published on the date this Lease is terminated by
The Wall Street Journal, Southwest Edition, in its listing of "Money Rates"
under the heading "Treasury Bills" (or, if no such rate is published, the
"Discount Rate" as published on such date under the "Money Rate" listing),
minus (ii the then present fair rental value of the Premises for such period,
similarly discounted; or
(2) Terminate Tenant's right to possess the Premises without
terminating this Lease by giving written notice thereof to Tenant, in which
event Tenant shall pay to Landlord (A) all rent and other amounts accrued
hereunder to the date of termination of possession, (B) all amounts due from
time to time under Section 19.(b), and (C) all rent and other sums required
hereunder to be paid by Tenant during the remainder of the Term, diminished
by any net sums thereafter received by Landlord through reletting the
Premises during such period. Landlord shall use reasonable efforts to relet
the Premises on such terms and conditions as Landlord, in its sole
discretion, may determine (including a term different than the Term, rental
concessions, alterations to, and improvement of, the Premises); however,
Landlord shall not be obligated to relet the Premises before leasing other
portions of the business park of which the Building is a part. Landlord shall
not be liable for, nor shall Tenant's obligations hereunder be diminished
because of, Landlord's failure to relet the Premises or to collect rent due
for a reletting. Tenant shall not be entitled to the excess of any
consideration obtained by reletting over the rent due hereunder. Reentry by
Landlord in the Premises shall not affect Tenant's obligations hereunder for
the unexpired Term; rather, Landlord may, from time to time, bring action
against Tenant to collect amounts due by Tenant, without the necessity of
Landlord's waiting until the expiration of the Term. Unless Landlord delivers
written notice to Tenant expressly stating that it has elected to terminate
this
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Lease, all actions taken by Landlord to exclude or dispossess Tenant of
the Premises shall be deemed to be taken under this Section 19.(a)(2). If
Landlord elects to proceed under this Section 19.(a)(2), it may at any time
elect to terminate this Lease under Section 19.(a)(1). Additionally, without
notice, Landlord may alter locks or other security devices at the Premises to
deprive Tenant of access thereto, and Landlord shall not be required to
provide a new key or right of access to Tenant.
(b) Tenant shall pay to Landlord all costs incurred by Landlord
(including court costs and reasonable attorneys' fees and expenses) in (1)
obtaining possession of the Premises, (2) removing and storing Tenant's or
any other occupant's property, (3) repairing, restoring, altering,
remodeling, or otherwise putting the Premises into condition acceptable to a
new tenant, (4) if Tenant is dispossessed of the Premises and this Lease is
not terminated, reletting all or any part of the Premises (including
brokerage commissions, cost of tenant finish work, and other costs incidental
to such reletting), (5) performing Tenant's obligations which Tenant failed
to perform, and (6) enforcing, or advising Landlord of, its rights, remedies,
and recourses. Landlord's acceptance of rent following an Event of Default
shall not waive Landlord's rights regarding such Event of Default.
Landlord's receipt of rent with knowledge of any default by Tenant hereunder
shall not be a waiver of such default, and no waiver by Landlord of any
provision of this Lease shall be deemed to have been made unless set forth in
writing and signed by Landlord. No waiver by Landlord of any violation or
breach of any of the terms contained herein shall waive Landlord's rights
regarding any future violation of such term or violation of any other term.
If Landlord repossesses the Premises pursuant to the authority herein
granted, then Landlord shall have the right to (A) keep in place and use or
(B) remove and store, at Tenant's expense. Subject to Section 27, all of the
furniture, fixtures, equipment and other property in the Premises, including
that which is owned by or leased to Tenant at all times before any
foreclosure thereon by Landlord or repossession thereof by any lessor thereof
or third party having a lien thereon. Landlord may relinquish possession of
all or any portion of such furniture, fixtures, equipment and other property
to any person (a "CLAIMANT") who presents to Landlord a copy of -------- any
instrument represented by Claimant to have been executed by Tenant (or any
predecessor of Tenant) granting Claimant the right under various
circumstances to take possession of such furniture, fixtures, equipment or
other property, without the necessity on the part of Landlord to inquire into
the authenticity or legality of the instrument. Landlord may, at its option
and without prejudice to or waiver of any rights it may have, (i) escort
Tenant to the Premises to retrieve any personal belongings of Tenant and/or
its employees not covered by the Landlord's statutory lien or the security
interest described in Section 27 or (ii) obtain a list from Tenant of the
personal property of Tenant and/or its employees that is not covered by the
Landlord's statutory lien or the security interest described in Section 27,
and make such property available to Tenant and/or Tenant's employees;
however, Tenant first shall pay in cash all costs and estimated expenses to
be incurred in connection with the removal of such property and making it
available. The rights of Landlord herein stated are in addition to any and
all other rights that Landlord has or may hereafter have at law or in equity,
and Tenant agrees that the rights herein granted Landlord are commercially
reasonable.
20. LANDLORD'S DEFAULT. If Landlord fails to perform any of its
- ------------------ obligations hereunder within 30 days after written notice
from Tenant specifying such failure, Tenant's exclusive remedy shall be an
action for damages (except as provided below). If, however, such failure
cannot reasonably be cured within such 30-day period, but Landlord commences
to cure such failure within such 30-day period and thereafter diligently
pursues the curing thereof to completion, then Landlord shall not be in
default hereunder or liable for damages therefor. Unless Landlord fails to so
cure such default after such notice, Tenant shall not have any remedy or
cause of action by reason thereof. If Landlord fails to perform its
obligations within the time period specified in this Section 20, and such
failure materially and adversely affects Tenant's use of the Premises such
that Tenant is unable to make reasonable use of the Premises for their
intended purposes, then Tenant may perform such obligations and Landlord
shall reimburse Tenant all actual third-party, out-of-pocket costs incurred
by Tenant in connection with performing such obligations within 30 days after
Tenant delivers to Landlord written demand therefor, accompanied by invoices
substantiating Tenant's claim. Tenant's right to perform the work under this
Section 20 is subject to the following conditions: (a) all such work shall
be performed in a good and workmanlike manner, in accordance with Law, and in
a manner so as not to affect any existing warranties with respect to the
Building's roof or the Building's Structure; (b) all such work shall be
performed in accordance with plans and specifications approved by Landlord,
whose approval shall be deemed given if Landlord fails to disapprove any
submitted plans and specifications within three business days after their
submission to Landlord; (c) all such work shall be performed by contractors
reasonably acceptable to Landlord which maintain commercial liability
insurance in an amount not less than $1,000,000 per occurrence naming
Landlord as an additional insured (Landlord's approval shall be deemed given
if Landlord fails to disapprove any contractor within three business days
after Tenant delivers to Landlord a written request for its consent thereto);
(d) Tenant delivers to Landlord "as-built" plans of the work performed by
Tenant; and (e) Tenant shall defend, indemnify, and hold harmless Landlord
from and against any claims, liabilities, damages, and expenses (including,
without limitation, reasonable attorneys' fees and expenses) arising from
Tenant's performance of such work. Tenant may not offset against its
obligation to pay rent any amount unless Tenant obtains a final,
non-appealable judgment that such amount is payable to Tenant by Landlord
under this Lease. Liability of Landlord to Tenant for any default by
Landlord, shall be limited to actual, direct, but not consequential, damages
therefor and shall be recoverable only from the interest of Landlord in the
Building, and the Land, and neither Landlord nor Landlord's owners shall have
any personal liability therefor.
21. MORTGAGES.
---------
(a) This Lease shall be subordinate to any deed of trust, mortgage
or other security instrument (a "MORTGAGE"), and any ground lease, master
lease, -------- or primary lease (a "PRIMARY LEASE") that now or hereafter
covers any portion ------------- of the Premises (the mortgagee under any
Mortgage or the lessor under any Primary Lease is referred to herein as
"LANDLORD'S MORTGAGEE"), and to -------------------- increases, renewals,
modifications, consolidations, replacements, and extensions thereof; provided
that the subordination of this Lease to any Mortgage or Primary Lease is
conditioned upon Landlord's Mortgagee's execution and delivery of a
subordination, non-disturbance and attornment agreement substantially in the
form of Exhibit D or, at Landlord's election, another form which is ---------
reasonably acceptable to Tenant
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<PAGE>
(the "SNDA"). However, any Landlord's Mortgagee may elect to subordinate its
- ---- Mortgage or Primary Lease (as the case may be) to this Lease by
delivering written notice thereof to Tenant. Tenant shall from time to time
within ten days after request therefor, execute any instruments that may be
required by any Landlord's Mortgagee to further evidence the subordination of
this Lease to any such Mortgage or Primary Lease, including without
limitation the SNDA. If Tenant fails to execute the same within such ten-day
period, Landlord may execute the same as attorney-in-fact for Tenant.
(b) Tenant shall attorn to any party succeeding to Landlord's
interest in the Premises, whether by purchase, foreclosure, deed in lieu of
foreclosure, power of sale, termination of lease, or otherwise, upon such
party's request, and shall execute such agreements confirming such attornment
as such party may reasonably request. Tenant shall not seek to enforce any
remedy it may have for any default on the part of Landlord without first
giving written notice by certified mail, return receipt requested, specifying
the default in reasonable detail to any Landlord's Mortgagee whose address
has been given to Tenant, and affording such Landlord's Mortgagee a
reasonable opportunity to perform Landlord's obligations hereunder.
(c) Notwithstanding any such attornment or subordination of a
Mortgage or Primary Lease to this Lease, the Landlord's Mortgagee shall not
be liable for any acts of any previous landlord, shall not be obligated to
install the Interior Improvements, and shall not be bound by any amendment to
which it did not consent in writing nor any payment of rent made more than
one month in advance.
22. ENCUMBRANCES. Tenant has no authority, express or implied, to
create ------------ or place any lien or encumbrance of any kind or nature
whatsoever upon, or in any manner to bind Landlord's property or the interest
of Landlord or Tenant in the Premises or to charge the rent for any claim in
favor of any person dealing with Tenant, including those who may furnish
materials or perform labor for any construction or repairs. Tenant shall pay
or cause to be paid all sums due for any labor performed or materials
furnished in connection with any work performed on the Premises by or at the
request of Tenant. Tenant shall give Landlord immediate written notice of
the placing of any lien or encumbrance against the Premises.
23. MISCELLANEOUS.
-------------
(a) Words of any gender used in this Lease shall include any other
gender, and words in the singular shall include the plural, unless the
context otherwise requires. The captions inserted in this Lease are for
convenience only and in no way affect the interpretation of this Lease. The
following terms shall have the following meanings: "LAWS" means all federal,
state, and local ---- laws, rules, and regulations; all court orders,
governmental directives, and governmental orders; and all restrictive
covenants affecting the Property, "LAW" means any of the foregoing;
"AFFILIATE" means any person or entity which, --- --------- directly or
indirectly, controls, is controlled by, or is under common control with the
party in question; "TENANT PARTY" shall include Tenant, any assignees
- ------------ claiming by, through, or under Tenant, any subtenants claiming
by, through, or under Tenant, and any of their respective agents,
contractors, employees, and invitees; and "INCLUDING" means "including,
without limitation." The normal --------- rule of construction that any
ambiguities be resolved against the drafting party shall not apply to the
interpretation of this Lease or any exhibits or amendments hereto.
(b) At any time after Substantial Completion, Landlord may
transfer and assign, in whole or in part, its rights and obligations in the
Premises, and upon the express written assumption by the assignee of all of
Landlord's liabilities and obligations hereunder, Landlord shall have no
further liability hereunder. Notwithstanding the foregoing, Landlord may
transfer and assign, in whole or in part, its rights and obligations in the
Premises at any time to an Affiliate, in which case and upon the express
written assumption by the assignee of all of Landlord's liabilities and
<PAGE>
obligations hereunder, Landlord shall have no further liability hereunder.
Each party shall furnish to the other, promptly upon demand, a corporate
resolution, proof of due authorization by partners, or other appropriate
documentation evidencing the due authorization of such party to enter into
this Lease.
(c) Except for obligations regarding the payment of money and the
maintenance of insurance, whenever a period of time is herein prescribed for
action to be taken by Landlord or Tenant, neither party shall be liable or
responsible for, and there shall be excluded from the computation for any
such period of time, any delays due to strikes, riots, acts of God, shortages
of labor or materials, war, governmental laws, regulations, or restrictions,
or any other causes of any kind whatsoever which are beyond the control of
such party (a "FORCE MAJEURE EVENT"). -------------------
(d) Tenant shall, from time to time, within ten days after request
of Landlord, deliver to Landlord, or Landlord's designee, a certificate of
occupancy for the Premises, financial statements for itself and any guarantor
of its obligations hereunder, evidence reasonably satisfactory to Landlord
that Tenant has performed its obligations under this Lease (including
evidence of the payment of the Security Deposit), and an estoppel certificate
stating that this Lease is in full effect, the date to which rent has been
paid, the unexpired Term and such other factual matters pertaining to this
Lease as may be requested by Landlord. Tenant's obligation to furnish the
above-described items in a timely fashion is a material inducement for
Landlord's execution of this Lease. If Tenant fails to execute any such
estoppel certificate within such ten-day period, Landlord may do so as
attorney-in-fact for Tenant.
(e) This Lease constitutes the entire agreement of the Landlord
and Tenant with respect to the subject matter of this Lease, and contains all
of the covenants and agreements of Landlord and Tenant with respect thereto.
Landlord and Tenant each acknowledge that no representations, inducements,
promises or agreements, oral or written, have been made by Landlord or
Tenant, or anyone acting on behalf of Landlord or Tenant, which are not
contained herein, and any prior agreements, promises, negotiations, or
representations not expressly set forth in this Lease are of no effect. This
Lease may not be altered, changed or amended except by an instrument in
writing signed by both parties hereto.
10
<PAGE>
(f) All obligations of Landlord or Tenant hereunder not fully
performed by the end of the Term shall survive, including, without
limitation, all payment obligations with respect to Taxes and insurance and
all obligations concerning the condition and repair of the Premises. Upon
the end of the Term and before Tenant vacates the Premises, Tenant shall pay
to Landlord any amount reasonably estimated by Landlord as necessary to put
the Premises in good condition and repair, reasonable wear and tear excluded.
Tenant shall also, prior to vacating the Premises, pay to Landlord the
amount, as estimated by Landlord, of Tenant's obligation hereunder for
Operating Expenses for the year in which the Term ends. All such amounts
shall be used and held by Landlord for payment of such obligations of Tenant
hereunder, with Tenant being liable for any additional costs therefor upon
demand by Landlord or with any excess to be returned to Tenant after all such
obligations have been determined and satisfied as the case may be. Any
Security Deposit held by Landlord may be credited against the amount due by
Tenant under this Section 23.(f).
(g) If any provision of this Lease is illegal, invalid or
unenforceable, then the remainder of this Lease shall not be affected
thereby, and in lieu of each such provision, there shall be added, as a part
of this Lease, a provision as similar in terms to such illegal, invalid or
unenforceable clause or provision as may be possible and be legal, valid and
enforceable.
(h) All references in this Lease to "the date hereof" or similar
references shall be deemed to refer to the last date, in point of time, on
which all parties hereto have executed this Lease.
(i) Landlord and Tenant each warrant to the other that it has not
dealt with any broker or agent in connection with this Lease, other than
Trammell Crow Dallas Industrial, Ltd. and Cushman and Wakefield of Texas,
Inc., whose commissions shall be paid by Landlord. Tenant and Landlord shall
each indemnify the other against all costs, attorneys' fees, and other
liabilities for commissions or other compensation claimed by any broker or
agent claiming the same by, through, or under the indemnifying party.
(j) If and when included within the term "Tenant," as used in this
instrument, there is more than one person, firm or corporation, all shall
jointly arrange among themselves for their joint execution of a notice
specifying an individual at a specific address within the continental United
States for the receipt of notices and payments to Tenant. All parties
included within the terms "Landlord" and "Tenant," respectively, shall be
bound by notices given in accordance with the provisions of Section 24 to the
same effect as if each had received such notice.
(k) The terms and conditions of this Lease are confidential and
Tenant shall not disclose the terms of this Lease to any third party (other
than its officers, directors, shareholders, employees, legal counsel,
accountants, insurer, agents or representatives) except as may be required by
law, including rules of the Securities and Exchange Commission, or to enforce
its rights hereunder.
(l) Tenant shall pay interest on all past-due rent from the date
due until paid at the maximum lawful rate. In no event, however, shall the
charges permitted under this Section 23.(l) or elsewhere in this Lease, to
the extent they are considered to be interest under applicable Law, exceed
the maximum lawful rate of interest.
24. NOTICES. Each provision of this instrument or of any applicable
Laws ------- and other requirements with reference to the sending, mailing or
delivering of notice or the making of any payment hereunder shall be deemed
to be complied with when and if the following steps are taken:
(a) All rent shall be payable to Landlord at the address for
Landlord set forth below or at such other address as Landlord may specify
from time to time by written notice delivered in accordance herewith.
Tenant's obligation to pay rent shall not be deemed satisfied until such rent
has been actually received by Landlord.
(b) All payments required to be made by Landlord to Tenant
hereunder shall be payable to Tenant at the address set forth below, or at
such other address within the continental United States as Tenant may specify
from time to time by written notice delivered in accordance herewith.
(c) Any written notice or document required or permitted to be
delivered hereunder shall be deemed to be delivered upon the earlier to occur
of (1) tender of delivery (in the case of a hand-delivered notice), (2)
deposit in the United States Mail, postage prepaid, Certified Mail, or (3)
receipt by facsimile transmission, in each case, addressed to the parties
hereto at the respective addresses set out below, or at such other address as
they have theretofore specified by written notice delivered in accordance
herewith. If Landlord has attempted to deliver notice to Tenant at Tenant's
address reflected on Landlord's books but such notice was returned or
acceptance thereof was refused, then Landlord may post such notice in or on
the Premises, which notice shall be deemed delivered to Tenant upon the
posting thereof.
25. HAZARDOUS WASTE. The term "HAZARDOUS SUBSTANCES," as used in this
- --------------- -------------------- Lease shall mean pollutants,
contaminants, toxic or hazardous wastes, or any other substances, the removal
of which is required or the use of which is restricted, prohibited or
penalized by any "ENVIRONMENTAL LAW," which term ----------------- shall mean
any Law relating to health, pollution or protection of the environment.
Tenant hereby agrees that (a) no activity will be conducted on the Premises
that will produce any Hazardous Substances, except for such activities that
are part of the ordinary course of Tenant's business activities (the
"PERMITTED ACTIVITIES") provided such Permitted Activities are conducted in
- -------------------- accordance with all Environmental Laws and have been
approved in advance in writing by Landlord; (b) the Premises will not be used
in any manner for the storage of any Hazardous Substances except for any
temporary storage of such materials that are used in the ordinary course of
Tenant's business (the "PERMITTED MATERIALS") provided such Permitted
Materials are properly stored in ------------------- a manner and location
satisfying all Environmental Laws and approved in advance in writing by
Landlord; (c) no portion of the Premises will be used as a landfill or a
dump; (d) Tenant will not install any underground tanks of any type; (e)
Tenant will not allow any surface or subsurface conditions to exist or come
into existence that
11
<PAGE>
constitute, or with the passage of time may constitute a public or private
nuisance; and (f) Tenant will not permit any Hazardous Substances to be
brought onto the Premises, except for the Permitted Materials, and if so
brought or found located thereon, the same shall be immediately removed by
Tenant, with proper disposal, and all required cleanup procedures shall be
diligently undertaken pursuant to all Environmental Laws. If at any time
during or after the Term, the Premises are found to be so contaminated or
subject to such conditions, Tenant shall defend, indemnify and hold Landlord
harmless from all claims, demands, actions, liabilities, costs, expenses,
damages and obligations of any nature arising from or as a result of the use
of the Premises by Tenant. Tenant will maintain on the Premises a list of all
materials stored at the Premises for which a material safety data sheet (an
"MSDS") was issued by the ---- producers or manufacturers thereof, together
with copies of the MSDS's for such materials and shall deliver such lists and
MSDS copies to Landlord upon Landlord's request therefor. Tenant shall remove
all Permitted Materials from the Premises in a manner acceptable to Landlord
before Tenant's right to possess the Premises ends. Unless expressly
identified on an addendum to this Lease, as of the date hereof there are no
"Permitted Activities" or "Permitted Materials" for purposes of the foregoing
provision and none shall exist unless and until approved in writing by the
Landlord. Landlord may enter the Premises and conduct environmental
inspections and tests therein as it may require from time to time, provided
that Landlord shall use reasonable efforts to minimize the interference with
Tenant's business. Such inspections and tests shall be conducted at
Landlord's expense, unless they reveal the presence of Hazardous Substances
(other than Permitted Materials) or that Tenant has not complied with the
requirements set forth in this Section 25, in which case Tenant shall
reimburse Landlord for the cost thereof within ten days after Landlord's
request therefor. Landlord shall be responsible for any violation of
Environmental Laws on the Premises which are solely caused by Landlord, its
agents, or employees.
26. CONDITIONS TO LANDLORD'S OBLIGATIONS. Notwithstanding anything in
- ------------------------------------ this Lease to the contrary, Landlord's
obligations hereunder are conditioned upon its acquiring the Land on
satisfactory terms and conditions, including without limitation obtaining
financing acceptable to Landlord in its sole discretion in all respects for
the acquisition of the Land and the construction of the Building.
27. LANDLORD'S LIEN. In addition to the statutory landlord's lien,
Tenant --------------- grants to Landlord, to secure performance of Tenant's
obligations hereunder, a security interest in all goods, inventory,
equipment, fixtures, furniture, improvements, chattel paper, accounts, and
general intangibles, and other personal property of Tenant now or hereafter
situated on or relating to Tenant's use of the Premises (but excluding all
computer hardware and software and any patents, copyrights, trade secrets,
and other intellectual property rights of Tenant), and all proceeds therefrom
(the "COLLATERAL"), and the Collateral shall ---------- not be removed from
the Premises without the consent of Landlord until all obligations of Tenant
have been fully performed. Upon the occurrence of an Event of Default,
Landlord may, in addition to all other remedies, without notice or demand
except as provided below, exercise the rights afforded a secured party under
the Uniform Commercial Code of the State in which the Building is located
(the "UCC"). In connection with any public or private sale --- under the
UCC, Landlord shall give Tenant five-days' prior written notice of the time
and place of any public sale of the Collateral or of the time after which any
private sale or other intended disposition thereof is to be made, which is
agreed to be a reasonable notice of such sale or other disposition. All
proceeds of any such sale may be applied first to the payment of expenses
incurred by Landlord in enforcing the security interests herein granted
(including reasonable attorneys' fees and expenses). Tenant grants to
Landlord a power of attorney to execute and file any financing statement or
other instrument necessary to perfect Landlord's security interest under this
Section 27, which power is coupled with an interest and is irrevocable during
the Term. Landlord may also file a copy of this Lease or this provision as a
financing statement to perfect its security interest in the Collateral. Upon
written request from Tenant, Landlord shall review and, if applicable,
approve (which approval shall not be unreasonably withheld), documentation
subordinating Landlord's contractual lien set forth in this Section 27 to
specific credit facilities for the benefit of Tenant. When delivering such
request, Tenant shall provide Landlord all information reasonably necessary
for Landlord's review including, but not limited to, (a) the name of Tenant's
lender, (b) the amount of Tenant's facility, and (c) the purpose of the
credit facility. Additionally, Tenant shall pay all of Landlord's reasonable
expenses incurred in connection with such request, including reasonable
attorneys' fees and expenses.
28. ROOFTOP EQUIPMENT. Provided that Tenant complies with the terms of
- ----------------- this Section, Tenant may, at its risk and expense, install
a satellite dish and related communications equipment and wiring
(collectively, the "ROOFTOP ------- EQUIPMENT") on the roof of the Building
at a location approved by Landlord, --------- which equipment may be used
solely by Tenant. Before installing the Rooftop Equipment, Tenant shall
submit to Landlord for its approval (which approval shall be in Landlord's
sole discretion) plans and specifications which (a) specify in detail the
design, location, size, and, in the case of a satellite dish, frequency of
the Rooftop Equipment and (b) are sufficiently detailed to allow for the
installation of the Rooftop Equipment in a good and workmanlike manner and in
accordance with all Legal Requirements. If Landlord approves of such plans,
Tenant shall install (in a good and workmanlike manner), maintain and use the
Rooftop Equipment in accordance with all Legal Requirements and shall obtain
all consents and permits required for the installation and operation thereof;
copies of all such permits and evidence of such consents must be submitted to
Landlord before Tenant begins to install the Rooftop Equipment. Tenant shall
thereafter maintain all permits necessary for the maintenance and operation
of the Rooftop Equipment while it is on the Building and operate and maintain
the Rooftop Equipment in such a manner so as not to unreasonably interfere
with any other satellite, antennae, or other transmission facility on the
Building's roof or in the Building. Landlord may require that Tenant screen
the Rooftop Equipment with a parapet or other screening device acceptable to
Landlord. Tenant shall maintain the Rooftop Equipment and screening device
in good repair and condition. Tenant shall, at its risk and expense, remove
the Rooftop Equipment (including all wiring related thereto), within five
days after the occurrence of any of the following events: (1) the termination
of Tenant's right to possess the Premises; (2) the termination of the Lease;
(3) the expiration of the Term; or (4) Tenant's vacating the Premises. If
Tenant fails to do so, Landlord may remove the Rooftop Equipment and store or
dispose of it in any manner Landlord deems appropriate without liability to
Tenant; Tenant shall reimburse Landlord for all costs incurred by Landlord in
connection therewith within ten days after Landlord's request therefor.
Tenant shall repair any damage to the Building caused by or relating to the
Rooftop Equipment, including that which is caused by its installation,
maintenance, use, or removal and shall indemnify Landlord against all Losses
arising from the installation, maintenance, use, or removal of the Rooftop
Equipment, INCLUDING --------- THAT CAUSED BY LANDLORD'S
- -------------------------
12
<PAGE>
NEGLIGENCE. All work relating to the Rooftop Equipment shall, at Tenant's
- ---------- expense, be coordinated with Landlord's roofing contractor so as
not to affect any warranty for the Building's roof.
29. EXHIBITS. The exhibits attached hereto are incorporated herein by
- -------- reference with the same effect as if fully set forth herein.
Executed by Tenant on __________, 1997.
TENANT:
PEERLESS GROUP, INC.
By:
-----------------------------------------------
Steve Tomson, President
Address:
--------------------------------
--------------------------------
--------------------------------
Telephone:
--------------------------------
Fax:
--------------------------------
Executed by Landlord on __________, 1997.
LANDLORD:
DALLAS/FORT WORTH REAL ESTATE INVESTMENTS #1
LIMITED PARTNERSHIP, a Texas limited partnership
By: Dallas/Fort Worth Real Estate
Investments, Inc., a Delaware
corporation
By:
-------------------------------------
Thomas A. Leiser, Executive Vice
President
Address: 2200 Ross Avenue, Suite 3700
Dallas, Texas 75201
Telephone: (214) 979-6300
Fax: (214) 979-6355
13
<PAGE>
EXHIBIT A
[Description of Premises and Land]
A-1
<PAGE>
EXHIBIT B
1. PLANS.
-----
(a) OUTLINE SPECIFICATIONS. Attached as Exhibit B-1 are the
- ---------------------- ----------- preliminary site plans and outline
specifications and elevations for the construction of the shell of the
Building (the "SHELL BUILDING") which are -------------- hereby approved by
Landlord and Tenant (the "OUTLINE SPECIFICATIONS"). ----------------------
(b) SHELL PLANS. Landlord shall cause to be prepared all plans and
- ----------- specifications for the improvements depicted on the Outline
Specifications, including, without limitation, working drawings, construction
drawings, electrical, plumbing and mechanical drawings necessary to construct
the Shell Building ("SHELL PLANS"). The Shell Plans shall be prepared in
accordance ----------- with the Outline Specifications.
(c) INTERIOR DRAWINGS. Landlord shall cause to be prepared (at
- ----------------- Tenant's cost as provided below) the "INTERIOR DRAWINGS" for
the interior ----------------- improvements (the "INTERIOR IMPROVEMENTS")
depicted on the Outline --------------------- Specifications to be constructed
in the Shell Building, which shall include all construction drawings, plans,
documents and mechanical, electrical, and plumbing drawings necessary to
construct the Interior Improvements and shall be accompanied by an estimate of
the cost of constructing the Interior Improvements. The Interior Drawings
shall provide for Interior Improvements to be constructed in accordance with
Landlord's standard finish specifications. The initial Interior Drawings shall
be delivered to Tenant as soon as reasonably practicable after preparation of
the Shell Plans. Tenant shall notify Landlord whether it approves of the
submitted Interior Drawings within ten days after Landlord's submission
thereof. If Tenant disapproves of such Interior Drawings, then Tenant shall
notify Landlord thereof specifying in detail the reasons for such disapproval,
in which case, Landlord shall correct the submitted Interior Drawings and
deliver them to Tenant for its approval within ten days after Landlord
receives Tenant's notice disapproving the submitted drawings. Tenant shall
have five days to approve or disapprove any resubmitted Interior Drawings
(provided that Tenant may not disapprove of any resubmitted Interior Drawings
for any reason other than based on objections made to the Interior Drawings
which were initially submitted to Tenant), and Landlord shall have five days
to correct any such resubmitted Interior Drawings disapproved by Tenant. This
process shall be repeated until the Interior Drawings have been finally
approved. If Tenant fails to notify Landlord that it disapproves of the
initial Interior Drawings within ten days or any resubmitted Interior Drawings
within five days after the submission thereof, then Tenant shall be deemed to
have approved the Interior Drawings.
(d) CHANGES. After approval of the Interior Drawings, Landlord and
- ------- Tenant shall initial the plans in question. Tenant may from time to
time make changes to the Shell Plans and the Interior Drawings by delivering
written notice to Landlord, specifying in detail the requested change. If
Tenant requests any changes to any submitted Shell Plans or submitted Interior
Drawings that relate to matters other than changes necessary to conform such
drawings to the Outline Specifications or requests any changes to the Shell
Plans or approved Interior Drawings, then (1) such change shall require
Landlord's approval, (2)Tenant shall pay all additional costs in designing and
constructing the Improvements (defined below) as a result of any such changes
before any such change will be made, and (3) all delays in designing and
constructing the Improvements caused by such changes shall not delay the
Commencement Date.
2. CONSTRUCTION OF IMPROVEMENTS. Landlord shall diligently construct
the ---------------------------- Shell Building and the Interior Improvements
in accordance with the Shell Plans and the Interior Drawings in a good and
workmanlike manner using materials specified in the Shell Plans and Interior
Drawings and in compliance with Law. The Shell Building and Interior
Improvements are collectively referred to as the "IMPROVEMENTS". Landlord
assumes no liability for special, consequential, or ------------ incidental
damages of any kind whatsoever in connection with the design or construction
of the Improvements, AND MAKES NO REPRESENTATIONS, WARRANTIES, OR GUARANTIES
REGARDING THE SAME, EXPRESSED OR IMPLIED, INCLUDING, WITHOUT LIMITATION,
WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, OR OF
HABITABILITY, EXCEPT AS EXPRESSLY SET FORTH HEREIN. Landlord shall
competitively bid the work for all Interior Improvements to at least three
qualified contractors and shall let the contract to the contractor submitting
the lowest qualified bid, unless otherwise approved by Tenant.
3. SUBSTANTIAL COMPLETION. "SUBSTANTIAL COMPLETION" shall occur when
- ---------------------- ---------------------- the Improvements are
substantially completed as certified by the architect preparing the Shell
Plans utilizing AIA document G704, Certificate of Substantial Completion, and
Landlord has obtained all requisite governmental approvals relating to
substantial completion such that Tenant may lawfully occupy the Building.
Substantial Completion shall have occurred even though minor details of
construction, decoration, landscaping, and mechanical adjustments remain to be
completed by Landlord. When the Certificate of Substantial Completion is
issued, Landlord and the architect shall prepare a punch list of incomplete,
minor, detail items and Landlord shall use all reasonable efforts to complete
such items within 30 days after the Certificate of Substantial Completion is
issued, except as to such items that, by their nature, will take a longer
period to complete as set forth in the punch list. If Substantial Completion
has not occurred within 12 months after the Interior Drawings have been
approved by Landlord and Tenant, plus the sum of the number of Force Majeure
Delay Days (defined below) and the number of Tenant Delay Days (defined below)
(the "TERMINATION DATE"), then Tenant may terminate this Lease
- ---------------- by delivering written notice thereof to Landlord (a
"TERMINATION NOTICE") before ------------------ the earlier of (a) ten days
after the Termination Date or (b) the date of Substantial Completion. "FORCE
MAJEURE DELAY DAYS" means the number of days ------------------------ of delay
for Substantial Completion caused by Force Majeure Events. "TENANT ------
DELAY DAYS" means the number of days of delay for Substantial Completion
caused ---------- by (1) any acts of a Tenant Party, (2) changes requested by
Tenant in the approved Shell Plans or approved Interior Drawings, or (3) any
specifications by Tenant of materials or installations which are not readily
available. If Substantial Completion is delayed because of Tenant Delay Days,
then the Commencement Date shall not be extended, but rather shall start on
the date on which Substantial Completion would have occurred but for such
delay days. The termination right herein provided shall be Tenant's sole
remedy for Landlord's failure to cause Substantial Completion to occur by the
Termination Date.
B-1
<PAGE>
4. ALLOCATION OF CONSTRUCTION COSTS.
--------------------------------
(a) Landlord shall design and construct the Shell Building; all
costs incurred in connection therewith shall be at Landlord's expense, other
than costs relating to the Interior Drawings. The costs relating to the
Interior Drawings, and, except as provided in the preceding sentence, all
other work required to design and construct the Improvements, including the
costs of Tenant's signs (the "ADDITIONAL WORK") shall be performed at Tenant's
expense. --------------- Tenant shall pay to Landlord an administration fee of
3% of the cost of the Additional Work. Landlord shall provide to Tenant an
allowance (the "ALLOWANCE") of $21 per rentable square foot in the initial
Premises. The --------- Allowance may be applied toward the following expenses
(collectively, the "PERMITTED EXPENSES"), without duplication of costs:
expenses for the Additional ------------------- Work and Moving Costs.
However, a minimum of $19.50 per rentable square foot must be applied towards
improvements to the Premises. Upon approval of the Interior Drawings and
selection of the contractor, Tenant shall pay to Landlord 100% of the amount
by which the estimated cost of designing and constructing the Additional Work
exceeds the Allowance. "MOVING COSTS" shall equal the actual, ------------
out-of-pocket costs incurred by Tenant in connection with moving to the
Premises including, without limitation, new stationery and business cards and
installation of furniture, fixtures and equipment. Any portion of the
Allowance relating to Moving Costs shall be paid by Landlord as costs are
incurred by Tenant upon submission of payment requests from Tenant and receipt
by Landlord of satisfactory evidence of such costs, but in no event before the
Commencement Date, Tenant's occupancy of the Premises, and Tenant's delivery
to Landlord of any estoppel certificate requested by Landlord relating to the
commencement of the Lease.
(b) Tenant may at its option elect to increase the amount of the
Allowance by up to $3.00 per rentable square foot in the initial Premises for
Interior Improvements by delivering written notice thereof to Landlord before
Substantial Completion; however, Tenant may not elect to increase the amount of
the Allowance in excess of the Permitted Expenses minus the Moving Costs. If
Tenant exercises such option, the parties shall execute an amendment to this
Lease increasing the monthly Base Rent by the amount of each monthly payment
that would be due on a hypothetical loan whose interest rate is 11% per annum,
whose principal balance equals the amount of the increase in the Allowance,
which is payable in 179 equal monthly installments of principal and interest.
(c) If the entire Allowance exceeds the Permitted Expenses, such
excess (the "EXCESS ALLOWANCE") may be applied by Tenant to offset its
- ---------------- obligation to pay Base Rent as follows: the Excess Allowance
shall be divided by the remaining months in the initial Term, and Base Rent
for each such remaining month during the initial Term shall be reduced by such
amount so long as no Event of Default has occurred. If at any time an Event
of Default occurs, Tenant's right to such offset shall terminate and Base Rent
shall be due and payable as originally provided without respect to such offset.
5. EARLY ENTRY BY TENANT. Tenant may enter the Shell Building before
the --------------------- Commencement Date with Landlord's prior consent
(which shall not be unreasonably withheld) to perform work therein, provided
that (a) Landlord is given prior written notice of any such entry, (b) such
entry shall be coordinated with Landlord and shall not interfere with
Landlord's work, (c) Tenant shall deliver to Landlord evidence that the
insurance required under Section 9 of this Lease has been obtained, and (d)
Tenant shall pay all utility charges reasonably allocable to Tenant by
Landlord in connection with such early entry. Any such entry shall be on the
terms of this Lease, but no rent shall accrue in respect of Base Rent or
Operating Expenses during the period that Tenant so enters the Premises.
Tenant shall conduct its activities therein so as not to interfere with
Landlord's construction activities, and shall do so at its risk and expense.
If, in Landlord's judgment, Tenant's activities therein interfere with
Landlord's construction activities, Landlord may terminate Tenant's right to
enter the Premises before the Commencement Date.
6. EXPANSION.
---------
(a) EXERCISE OF OPTION. Provided that (1) no Event of Default then
- ------------------ exists, (2) there has been no material adverse change in
Tenant's financial condition, comparing the time the Lease is executed and the
time that Tenant exercises the expansion option, (3) Tenant is not in default
(beyond any applicable cure or grace periods) under its covenants with its
then current lenders, if any (which defaults have not been waived in writing
by such lenders), Tenant may elect to expand the Premises by approximately
47,200 square feet (with approximately 15,200 square feet on the second floor)
(the "EXPANSION --------- SPACE") by delivering to Landlord written notice
thereof (the "EXPANSION -------------- NOTICE") and (4) the Expansion Space
can be constructed in accordance with Law. ------ This expansion right must be
exercised by Tenant by delivering to Landlord an Expansion Notice after six
months after Substantial Completion but before the fourth anniversary date of
Substantial Completion. Tenant's rights hereunder shall terminate if Tenant
fails to timely deliver such notice.
(b) EXPANSION SPACE LEASE. After Tenant has delivered the
Expansion --------------------- Notice as provided above, Tenant and Landlord
shall execute a new lease for the Expansion Space in question (an "EXPANSION
SPACE LEASE") on substantially the --------------------- same terms and
conditions as this Lease, but with a term coterminous with the Term, including
any extensions thereof (beginning on substantial completion of the Expansion
Space as provided in Section 6(d)) and an annual base rent rate equal to (1)
in the case of the first year of Expansion Space Lease term, an amount equal
to (A) the Total Expansion Costs (defined below), times (B) the sum of (i) a
mortgage constant rate equal to the Twelve-Year Mortgage Money Rate (defined
below) at the time in question, and (ii) 250 basis points, plus (C) $0.10 per
rentable square foot in the Expansion Space (for a structural reserve); and
(2) in the case of each of the remaining years of the Expansion Space Lease
term, 103% of the annual base rent rate for the preceding Lease Year. For
example, if the Twelve-Year Mortgage Money Rate is 7.5% and the Total
Expansion Costs for the Expansion Space are $4,389,000, then the annual base
rent for such Expansion Space during the first year of the Expansion Space
Lease term for such Expansion Space would be $443,620 (calculated as follows:
[$4,389,000 x .10 = $438,900] + [$0.10 x 47,200=$4,720], and $456,928.60 for
the second year of the Expansion Space Lease term, increasing by 3% each year
thereafter. The term "TWELVE-YEAR MORTGAGE MONEY RATE" shall mean the
- ------------------------------- mortgage constant (i.e., the amount of
B-2
<PAGE>
annual debt service, expressed as a percentage of the loan amount, that is
necessary to pay interest and the entire principal over the amortization
period) at the time such determination is being made associated with mortgage
loans made available by the following institutional lenders for permanent
loans for properties similar to the Premises, with an amortization schedule of
25 years and a maturity date of no less than twelve years: Metropolitan Life
Insurance Company; Prudential Life Insurance Company; and The Principal
Financial Group. If, however, any of such institutional lenders are not
providing permanent financing for properties similar to the Premises, then
Landlord may substitute another institutional lender therefor. Tenant may
select the day on which the mortgage constant shall be determined within 30
days after Landlord notifies Tenant that the selection should be made (the
"SELECTION PERIOD"). Within five ---------------- days after the end of the
Selection Period, Tenant shall notify Landlord of Tenant's selected day. If
Tenant does not notify Landlord as provided in the preceding sentence, then
the mortgage constant shall be determined as of the day on which Landlord
receives the Expansion Notice. "LEASE YEAR" means the 12-month ----------
period commencing on the commencement date of the Expansion Space Lease and
each 12-month period thereafter during the term of the Expansion Space Lease.
(c) EXPANSION SPACE IMPROVEMENTS. Within 30 days after the
Expansion ---------------------------- Space Lease is executed, Landlord will
prepare and submit to Tenant for its review preliminary plans and outline
specifications (the "EXPANSION OUTLINE ----------------- SPECIFICATIONS") for
the construction of the shell of the Expansion Space (the --------------
"EXPANSION SHELL") and the interior improvements of the Expansion Space (the
- ---------------- "EXPANSION INTERIOR") (which must be acceptable to Landlord
and Tenant and ------------------- provide for improvements that can be
constructed for a Total Expansion Cost of not more than $100 per square foot,
unless Tenant agrees in writing to pay the total Expansion Cost in excess of
such amount). Tenant shall notify Landlord whether it approves of the
submitted Expansion Outline Specifications within 14 days after Landlord's
submission thereof. If Tenant disapproves of such Expansion Outline
Specifications, then Tenant shall notify Landlord thereof specifying in detail
the reasons for such disapproval, in which case Landlord shall amend the
submitted Expansion Outline Specifications and deliver them to Tenant for its
approval within ten days after receiving Tenant's notice disapproving the
submitted Expansion Outline Specifications. This process shall be repeated
until the Expansion Outline Specifications have been finally approved. Within
15 days after Landlord and Tenant have approved the Expansion Outline
Specifications, Landlord shall submit to Tenant a written preliminary estimate
of the Total Expansion Costs (which shall be based in part upon the lowest
qualified estimates of at least four contractors' written preliminary
estimates of the cost of constructing the Expansion Space in accordance with
the Expansion Outline Specifications solicited by Landlord). Tenant shall
either approve or disapprove of such preliminary estimate within ten days
after Tenant's receipt thereof. If Tenant disapproves the estimate, then
Tenant shall notify Landlord of the reasons for such disapproval, in which
case Landlord shall attempt to address Tenant's reasons for disapproval and
resubmit the preliminary estimate to Tenant within ten days after Landlord's
receipt of Tenant's disapproval. This process shall be repeated until Tenant
has approved the preliminary estimate. Upon receipt of Tenant's approval of
the preliminary estimate, Landlord shall proceed to prepare detailed plans and
specifications for the Expansion Space (the "EXPANSION PLANS AND
SPECIFICATIONS"), including, ---------------------------------- without
limitation, working drawings, construction drawings, electrical, plumbing and
mechanical drawings necessary to construct the Expansion Shell and the
Expansion Interior. After Landlord and Tenant have approved the Expansion
Plans and Specifications, if Landlord believes that the actual cost to
complete the Expansion Space exceeds the preliminary estimates by more than
10%, Landlord shall submit to Tenant Landlord's written estimate of the cost
of constructing such improvements in accordance with the completed Expansion
Plans and Specifications. Upon receipt of Tenant's approval of any such
revised estimate, Landlord shall construct the improvements depicted thereon
in the same manner as provided in this Exhibit. "TOTAL EXPANSION COSTS" shall
mean all soft and hard --------------------- costs incurred in connection with
the design and construction of the improvements for the Expansion Space in
question, including, without limitation, all architecture, engineering,
contractors, market leasing (not to exceed 6.75% of the anticipated base rent
due for the Expansion Space for the full term of the lease thereof),
development fees (not to exceed 3% of total construction costs), brokerage and
legal fees and expenses (however, Total Expansion Costs shall not include any
brokerage commissions other than the market leasing fee described above), any
interest expense, tax and insurance payments incurred during such construction
process, and any loan or mortgage fees, and any other costs, fees or expenses
incurred with the construction of the Expansion Space.
(d) EXPANSION SPACE TARGET DATE. The "EXPANSION SPACE TARGET DATE"
- --------------------------- --------------------------- for substantial
completion of the Expansion Space and commencement of the Expansion Space
Lease is 8 months after the Expansion Plans and Specifications have been
approved by Landlord and Tenant. If the actual date of substantial completion
of the Expansion Space is delayed beyond the Expansion Space Target Date
because of events beyond Landlord's reasonable control, including weather
conditions more extreme than those normally encountered in the area and Force
Majeure Events, then Landlord shall have no liability therefor and the date
for substantial completion of the Expansion Space shall be extended by the
period of any such delay. If substantial completion of the Expansion Space is
delayed because of (1) any acts of a Tenant Party, or (2) changes in the
approved Expansion Outline or Specifications or Expansion Plans and
Specifications, then the commencement date for the Expansion Space shall not
be extended, but rather shall start on the date on which it would have
occurred but for such event. The Expansion Space Lease shall remain in full
effect notwithstanding any such delay in substantial completion.
(e) COMMISSIONS. Upon consummation of the Expansion Space Lease,
- ------------ Landlord shall pay a commission of 2.25% of the total annual base
rent thereunder to Trammell Crow Dallas Industrial, Ltd. and a commission of
4.5% of the total annual base rent thereunder to Cushman and Wakefield of
Texas, Inc. (unless Tenant designates another broker in writing in the
Expansion Notice). In addition, in consideration of the performance of certain
services relating to the development of the Building and the Expansion Space
and the negotiation and execution of this Lease, Landlord hereby appoints
Trammell Crow Dallas Industrial, Ltd. as its exclusive developer for the
Expansion Space and agrees to pay to Trammell Crow Dallas Industrial, Ltd. 3%
of the total construction costs for the Expansion Space as a development fee
upon substantial completion of the Expansion Space. The obligations of the
Landlord hereunder shall run with the Land and be binding upon any future
owners of the Land or the Building.
B-3
<PAGE>
EXHIBIT C
---------
EXTENSION OPTIONS
1. OPTION. Provided no Event of Default exists and Tenant or its
- ------ Permitted Transferees are occupying the entire Premises when Tenant
delivers such notice, Tenant may renew this Lease as to all of the then-leased
Premises for two additional period of five years each on the same terms
provided in this Lease (except as set forth below). On or before the
commencement date of the extended Term in question, Landlord and Tenant shall
execute an amendment to this Lease extending the Term on the same terms
provided in this Lease, except as follows:
(a) The Base Rent payable for each month during the extended Term in
question shall be the Fair Market Rental Rate determined in accordance with
paragraph 2 below;
(b) Tenant shall have no further renewal options unless expressly
granted by Landlord in writing (other than those that have not been exercised
hereunder); and
(c) Landlord shall lease to Tenant the Premises in their
then-current condition, and Landlord shall not provide to Tenant any
allowances (e.g., moving allowance, construction allowance, and the like) or
other tenant inducements. Tenant's rights under this Exhibit shall terminate
if (1) this Lease expires or is cancelled or, because of an Event of Default,
this Lease or Tenant's right to possession of the Premises is terminated, or
(2) Tenant fails timely to exercise its option under this Exhibit, time being
of the essence with respect to Tenant's exercise thereof. Tenant's rights
under this Exhibit are personal to Tenant and may only be exercised by Tenant
or a Permitted Transferee which is occupying the entire Premises at the time
the option provided herein is exercised.
2. EXERCISE OF OPTION. Tenant shall elect whether to extend the Term
by ------------------ delivering to Landlord written notice thereof (the
"ELECTION NOTICE") not --------------- sooner than 12 nor later than 10 months
before the expiration of the Term. If Tenant fails to deliver the Election
Notice at least 10 months before the end of the Term, Tenant's rights under
this Exhibit shall terminate; time being of the essence with respect to such
delivery. Within 30 days after Landlord receives the Election Notice,
Landlord shall deliver to Tenant its assessment of the Fair Market Rental Rate
("LANDLORD'S ASSESSMENT"). If Tenant disagrees with ---------------------
Landlord's Assessment, it shall deliver to Landlord written notice thereof (an
"OBJECTION NOTICE") within 15 days after Landlord delivers to Tenant
Landlord's ---------------- Assessment; otherwise, Landlord's Assessment shall
be the Base Rent for the extended Term. If Tenant timely delivers an Objection
Notice, Landlord and Tenant shall meet to attempt to determine the prevailing
rental rate for the extended Term. If Tenant and Landlord are unable to agree
on such prevailing rental rate within 15 days after Tenant delivers to
Landlord the Objection Notice, Landlord and Tenant shall jointly appoint an
independent real estate appraiser with at least five-years' commercial real
estate experience in the vicinity of the Premises and submit to the appraiser
its assessment of the prevailing rental rate for the extended Term, together
with the data used to support such assessment. Within 20 days after its
selection, the appraiser shall select the assessment closest to his
determination of the Fair Market Rental Rate for the extended Term, which
assessment shall be the Base Rent for the extended Term. Landlord and Tenant
shall share equally the cost of the appraiser. Tenant shall have the right to
rescind its election to extend the Term by delivering written notice to
Landlord within 10 days after the Fair Market Rental Rate has been
established, in which case Tenant shall pay the cost of the appraiser and
reimburse Landlord for all reasonable costs incurred by Landlord prior to the
date Tenant delivers such rescission notice in connection with the exercise of
such option. Such reimbursement shall be due within 30 days after Landlord
delivers to Tenant an invoice therefor. The term "FAIR MARKET -----------
RENTAL RATE" shall mean the market rental rate for the time period such
- ----------- determination is being made for office space in comparable office
buildings in the vicinity of the Building of comparable condition for space of
equivalent quality, size, utility, and location. Such determination shall
take into account all relevant factors, including, without limitation, length
of term, credit standing of Tenant, market concessions and other factors.
<PAGE>
AMENDMENT NO. 1
This Amendment No. 1 (this "AMENDMENT") is entered into as of December
11, 1997, between 1021 CENTRAL EXPRESSWAY SOUTH, LTD., a Texas limited
partnership and successor in interest to Dallas/Fort Worth Real Estate
Investments #1, Limited Partnership ("LANDLORD"), and PEERLESS GROUP, INC.
("TENANT"), for the purpose of amending the Commercial Lease Agreement
between Landlord and Tenant dated May 27, 1997 (the "LEASE").
AGREEMENTS
For valuable consideration, whose receipt and sufficiency are
acknowledged, Landlord and Tenant agree as follows:
1. DEFINITIONS. Unless specified otherwise, all capitalized terms used
herein shall have the meanings assigned to them in the Lease.
2. LETTER OF CREDIT. Within five business days after the date hereof,
Tenant shall deposit with Landlord the Letter of Credit (defined below),
which shall be held by Landlord in addition to the Security Deposit to secure
Tenant's obligations under the Lease. If an Event of Default occurs,
Landlord may, in addition and without prejudice to all other rights and
remedies, draw on the Letter of Credit from time to time, up to the amount
necessary to pay to Landlord Rent under the Lease (including, without
limitation, Base Rent, Operating Expenses, and all amounts payable by Tenant
under Sections 8,11 and 19 of the Lease). The receipt by Landlord of proceeds
of the Letter of Credit shall not be deemed to cure or satisfy any Event of
Default, and Landlord may still exercise any and all remedies available under
the Lease or Law with the same effect as if such proceeds had not been
received; however, in any action brought by Landlord to obtain a monetary
judgment against Tenant, credit shall be given for all proceeds received by
Landlord. As used herein, "LETTER OF CREDIT" shall mean a standby,
unconditional, irrevocable, assignable, sight-draft letter of credit in the
initial face amount of $600,000, (a) naming Landlord as beneficiary issued by
a bank or financial institution that has a Standard & Poor's Corporation
unsecured senior debt rating of "A" or better or an equivalent rating from
another nationally-recognized rating agency (in either case, without regard
to credit enhancements), that is otherwise acceptable to Landlord and that
has banking offices in Dallas, Texas (or that has a confirming bank on which
draws may be presented with a banking office in Dallas, Texas), (b)
permitting partial draws thereon, (c) having an initial expiration date of no
less than one year after the date hereof, (d) expressly stating that it is
assignable, and (e) otherwise being in form acceptable to Landlord (the
term "Letter of Credit" shall include all renewals, reissuances, replacements
and substitutions for the initial Letter of Credit). Upon any transfer of the
Premises by Landlord, Tenant shall within ten days after Landlord's request
cause the Letter of Credit to be reissued, naming the transferee of the
Premises as the beneficiary. Tenant shall from time to time cause the Letter
of Credit to be renewed no later than 30 days prior to any expiration date
thereof; if Tenant fails timely to renew the Letter of Credit or fails to
deliver a substitute Letter of Credit to a transferee of Landlord as provided
above, then Landlord may draw thereon for the entire balance, and retain the
amounts so drawn as additional security for the performance of Tenant's
obligations under the Lease. Each substitute, reissued, renewal, and
1
<PAGE>
replacement Letter of Credit must satisfy the conditions for the initial
Letter of Credit, except to the extent the amount thereof may be reduced as
provided in Section 3. If (1) Tenant fails to timely renew the Letter of
Credit or fails to deliver a substitute Letter of Credit to a transferee of
Landlord as provided above and (2) Landlord elects to draw on the entire
Letter of Credit and hold any unapplied proceeds thereof, then Tenant may
deliver to Landlord a substitute Letter of Credit in the amount of the
remaining unapplied amount held by Landlord, in which case, Landlord shall
deliver to Tenant the remaining unapplied proceeds held by Landlord.
3. REDUCTION OF THE LETTER OF CREDIT. If (a) no monetary default and
no Event of Default exists on the Reduction Date (defined below) in
question, (b) Landlord has not elected to terminate Tenant's right to possess
the Premises or this Lease because of an Event of Default, and (c) each of
the Financial Conditions (defined below) is satisfied on the Reduction Date
in question, then the Letter of Credit shall be reduced as follows:
(1) first Reduction Date: the Letter of Credit shall be
reduced to $400,000;
(2) second Reduction Date: the Letter of Credit shall be
reduced to $200,000; and
(3) third Reduction Date: the Letter of Credit shall be
returned to Tenant.
Each of the following shall be a "REDUCTION DATE": (A) the first Reduction Date
shall be the later of the second anniversary of the Commencement Date or, if
the conditions described in clauses (a) through (c) of this Section (the
"REDUCTION CONDITIONS") are not satisfied on such anniversary date, the date
on which the Reductions Conditions are thereafter satisfied; (B) the second
Reduction Date shall be the later of the first anniversary of the first
Reduction Date or, if the Reduction Conditions are not satisfied on such
anniversary date, the date on which the Reduction Conditions are thereafter
satisfied; and (C) the third Reduction Date shall be the later of the first
anniversary of the second Reduction Date or, if the Reduction Conditions are
not satisfied on such anniversary date, the date on which the Reduction
Conditions are thereafter satisfied. The determination of whether the
Reduction Conditions are satisfied shall be based on the financial statements
as of the most recently ended fiscal quarter of Tenant.
Notwithstanding the foregoing, if Standard & Poor's Corporation assigns
to Tenant an unsecured senior debt rating of "B" or higher or an equivalent
rating is assigned to Tenant by another nationally-recognized rating agency
(in either case, without regard to credit enhancements), then the Letter of
Credit shall be returned to Tenant, provided that no monetary and no Event of
Default then exists and Landlord has not elected to terminate Tenant's right
to possess the Premises or this Lease because of an Event of Default.
The following are the "FINANCIAL CONDITIONS":
(i) Tenant's Current Ratio shall be equal to or greater than 1.0
to 1.0. The term "CURRENT RATIO" means the ratio of current
assets to current liabilities.
2
<PAGE>
(ii) Tenant's Leverage Ratio shall not be greater than 1.0 to 2.0.
The term "LEVERAGE RATIO" means the ratio of the total
liabilities of Tenant (contingent or otherwise, but excluding
current liabilities) to Tangible Net Worth.
(iii) Tenant shall have retained earnings of not less than a
negative $215,000.
(iv) The ratio of Tenant's EBITDA plus rent expense during such
period to the sum of Tenant's interest expense, rent expense,
and preferred dividends payable by Tenant during the same
period shall be equal to or greater than 2.5 to 1.0. "EBITDA"
means the income of Tenant plus interest expense, federal income
taxes, depreciation, and amortization.
Each of the Financial Conditions and the related calculations shall be
determined and calculated in accordance with GAAP and shall be based on the
financial statements for the four most recently ended fiscal quarters of
Tenant in the case of the Financial Conditions specified in clauses (iii) and
(iv) and on the most recent fiscal quarter's financial statements in the case
of the Financial Conditions in clauses (i) and (ii).
4. RATIFICATION. Tenant hereby ratifies and confirms its obligations
under the Lease, and represents and warrants to Landlord that it has no
defenses thereto.
5. BINDING EFFECT; GOVERNING LAW. Except as modified hereby, the Lease
shall remain in full effect and this Amendment shall be binding upon Landlord
and Tenant and their respective successors and assigns. This Amendment shall
be governed by Texas law.
Executed as set forth above.
LANDLORD: 1021 CENTRAL EXPRESSWAY SOUTH, LTD.,
a Texas limited partnership
By: Dallas/Fort Worth Real Estate Investments,
Inc., a Delaware corporation
By: /s/ Thomas A. Leiser
------------------------------------------
Thomas A. Leiser, Executive Vice President
TENANT: PEERLESS GROUP, INC.
By: /s/ Rodney L. Armstrong, Jr.
------------------------------------------
Rodney L. Armstrong, Jr., Chairman & CEO
3
<PAGE>
AMENDMENT TO PEERLESS GROUP, INC.
EMPLOYEE STOCK PURCHASE PLAN
WHEREAS, Peerless Group, Inc. (the "Company") previously established the
Peerless Group, Inc. Employee Stock Purchase Plan (the "Plan"); and
WHEREAS, all capitalized terms used but not defined herein shall have
the respective meanings assigned to them in the Plan;
WHEREAS, Section 20 of the Plan authorizes the Company's Board of
Directors to make certain amendments to the Plan; and
WHEREAS, the Board of Directors has approved an amendment to the Plan to
(i) reduce the length of each Offering Period from one year to six months and
(ii) to change the dates with respect to which the Initial Offering Price and
Alternate Offering Price are determined; and
NOW, THEREFORE, effective December 17, 1997, the Plan is hereby amended
as follows:
I.
Section 3 of the Plan is amended to read in its entirety as follows:
"3. OFFERINGS. The Company may make periodic offerings to eligible
employees to purchase Common Stock under the Plan, which offerings shall
not be made more often than twice every calendar year ("Offerings").
The initial Offering will run from a period beginning on the date of the
Company's initial public offering of stock ("IPO") and ending on June 30,
1997, and future Offerings will run from each July 1 to December 31 and
January 1 to June 30 (an "Offering Period"). With respect to each
Offering, the Committee, at its discretion, shall specify the maximum
number of shares of Common Stock that may be purchased under the
Offering. Unless otherwise specified by the Committee, the number of
shares of Common Stock that may be purchased under each successive
Offering shall be the balance of the 250,000 shares authorized but not
purchased under the terms of this Plan."
II.
Section 11(a) of the Plan is amended to read in its entirety as follows:
"(a) 85% of the average of the daily prices per share of the
Common Stock during the ten (10) day trading period ending on the
Offering Date for such Offering determined as set forth below in
this paragraph (a) (the "Initial Offering Price"). If closing sale
prices are reported, the daily prices used shall be the average
closing sale prices per share on any stock exchange or inter-dealer
quotation system on which the Common Stock is listed or traded. If
closing sale prices are not reported, the daily prices used shall
be the mean between the closing or average (as the case may be) bid
and asked
<PAGE>
prices per share of Common Stock on the over-the-counter market; or"
III.
Section 11(b) of the Plan is amended to read in its entirety as follows:
"(b) 85% of the average of the daily prices per share of the
Common Stock during the ten (10) day trading period ending on the
last day of the Offering Period for such Offering determined as set
forth below in this paragraph (b) (the "Alternate Offering Price").
If closing sale prices are reported, the daily prices used shall be
the average closing sale prices per share on any stock exchange or
inter-dealer quotation system on which the Common Stock is listed
or traded. If closing sale prices are not reported, the daily
prices used shall be the mean between the closing or average (as
the case may be) bid and asked prices per share of Common Stock on
the over-the-counter market."
* * * * *
<PAGE>
IN WITNESS WHEREOF, the Company has executed this Amendment this 17th
day of December, 1997.
PEERLESS GROUP, INC.
By:
Name:
Title:
Attest:
Ann L. Puddister, Secretary
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-24819) pertaining to the Peerless Group, Inc. 1997 Stock
Option Plan, Peerless Group, Inc. Amended and Restated Stock Option Plan,
Peerless Group, Inc. Employee Stock Purchase Plan, and Stock Option
Agreements with certain directors and advisors and to the incorporation by
reference therein of our report dated January 20, 1998, with respect to the
consolidated financial statements of Peerless Group, Inc. included in its
Annual Report on Form 10-K for the year ended December 31, 1997, filed with
the Securities and Exchange Commission.
Ernst & Young, LLP
Dallas, Texas
March 25, 1998
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 2,845
<SECURITIES> 0
<RECEIVABLES> 9,346
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 13,343
<PP&E> 4,337
<DEPRECIATION> 1,135
<TOTAL-ASSETS> 19,942
<CURRENT-LIABILITIES> 11,783
<BONDS> 0
0
0
<COMMON> 49
<OTHER-SE> 8,110
<TOTAL-LIABILITY-AND-EQUITY> 19,942
<SALES> 21,510
<TOTAL-REVENUES> 30,131
<CGS> 20,322
<TOTAL-COSTS> 20,322
<OTHER-EXPENSES> 7,632
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 20
<INCOME-PRETAX> 2,437
<INCOME-TAX> 534
<INCOME-CONTINUING> 1,903
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,903
<EPS-PRIMARY> 0.40
<EPS-DILUTED> 0.37
</TABLE>
