-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BgTDu/iTvhKukK2e70wVBnvoc6pgeEflb++s+UeuPkGR6N+tu4EHazhbrt/C0fXk 9kfDsPSuIQRr+fp2Q9T98w== 0000939802-98-000020.txt : 19980415 0000939802-98-000020.hdr.sgml : 19980415 ACCESSION NUMBER: 0000939802-98-000020 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 8 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980414 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: AVTEL COMMUNICATIONS INC/UT CENTRAL INDEX KEY: 0001005974 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-TELEPHONE INTERCONNECT SYSTEMS [7385] IRS NUMBER: 870378021 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-27580 FILM NUMBER: 98592900 BUSINESS ADDRESS: STREET 1: 505 BATH STREET CITY: SANTA BARBARA STATE: CA ZIP: 93101 BUSINESS PHONE: (805) 685-0355 MAIL ADDRESS: STREET 1: 130 CREMONA DRIVE STE C CITY: SANTA BARBARA STATE: CA ZIP: 93117 FORMER COMPANY: FORMER CONFORMED NAME: HI TIGER INTERNATIONAL INC DATE OF NAME CHANGE: 19960119 10-K 1 FORM 10-K U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For Fiscal Year Ended: December 31, 1997 OR [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from ____________ to ___________. Commission file number 0-27580 AvTel Communications, Inc. -------------------------- (Name of Registrant in Its Charter) Delaware 87-0378021 -------- ---------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 501 Bath Street, Santa Barbara, CA 93101 - ----------------------------------- ----- (Address of Principal Executive Offices) (Zip Code) (805) 685-0355 -------------- (Issuer's Telephone Number, Including Area Code) Securities registered under Section 12(b) of the Act: None. Securities registered under Section 12(g) of the Act: Common Stock Par Value $0.01 - ----------------------------- (Title of class) Indicated by check mark whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 in this form herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the Registrant's Common Stock held by non-affiliates of the Registrant was approximately $29,173,500, computed at the average bid and asked price of such Common Stock as of March 13, 1998. APPLICABLE ONLY TO CORPORATE REGISTRANTS As of March 15, 1998, there were 9,522,247 shares of the Registrant's Common Stock, par value $0.01, issued and outstanding, excluding treasury stock. DOCUMENTS INCORPORATED BY REFERENCE The information required by Part III (Items 10, 11, 12 and 13) of Form 10-K is incorporated by reference to the Registrant's definitive Proxy Statement relating to its annual meeting of stockholders to be held on or about May 28, 1998, which will be filed with the Commission within 120 days after the end of the Registrant's fiscal year. 1 TABLE OF CONTENTS Item Number Page Number PART I 1. Business 3 2. Properties 12 3. Legal Proceedings 12 4. Submission of Matters to a Vote of Security Holders 12 PART II 5. Market for Common Equity and Related Stockholder Matters 13 6. Selected Financial Data 14 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16 7A. Quantitative and Qualitative Disclosures about Market Risk 22 8. Financial Statements and Supplementary Data 22 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 22 PART III 10. Directors and Executive Officers of the Registrant 22 11. Executive Compensation 22 12. Security Ownership of Certain Beneficial Owners and Management 23 13. Certain Relationships and Related Transactions 23 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K 23 2 PART I ITEM 1. BUSINESS INTRODUCTORY STATEMENT - ---------------------- THIS ANNUAL REPORT ON FORM 10-K CONTAINS "FORWARD-LOOKING STATEMENTS" WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT") AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). FORWARD-LOOKING STATEMENTS ARE STATEMENTS OTHER THAN HISTORICAL INFORMATION OR STATEMENTS OF CURRENT CONDITION AND RELATE TO FUTURE EVENTS OR THE FUTURE FINANCIAL PERFORMANCE OF THE COMPANY. FORWARD-LOOKING STATEMENTS INVOLVE RISKS AND UNCERTAINTIES, SUCH AS STATEMENTS OF THE COMPANY'S STRATEGIES, PLANS, OBJECTIVES, EXPECTATIONS, ESTIMATES AND INTENTIONS. SOME FORWARD-LOOKING STATEMENTS MAY BE IDENTIFIED BY USE OF SUCH TERMS AS "BELIEVES," "ANTICIPATES," "INTENDS" OR "EXPECTS." THE COMPANY'S ACTUAL RESULTS MAY DIFFER SIGNIFICANTLY FROM THE RESULTS DISCUSSED IN THE FORWARD-LOOKING STATEMENTS. THE COMPANY UNDERTAKES NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY FORWARD-LOOKING STATEMENTS, WHETHER AS A RESULT OF NEW INFORMATION, FUTURE EVENTS OR OTHERWISE. THE CAUTIONARY STATEMENTS MADE IN THIS ANNUAL REPORT SHOULD BE READ AS BEING APPLICABLE TO ALL RELATED FORWARD-LOOKING STATEMENTS WHEREVER THEY APPEAR IN THIS ANNUAL REPORT. BACKGROUND - ---------- General AvTel Communications, Inc. (the "Company" or "AvTel") is a provider of broadband network services integrating voice, data and video solutions for individuals and corporate customers. The Company sells and markets a broad range of telecommunications and advanced network services through independent value added resellers and internal direct sales professionals. The Company targets mid-size corporations, small-office home-office professionals and select residential market segments. The Company was formerly a Utah corporation. On December 1, 1997, the Company merged with and into its wholly-owned Delaware subsidiary, thus effecting the Company's reincorporation in Delaware (the "Reincorporation Merger"). The conversion of the Company's stock in the Reincorporation Merger resulted in an effective one-for-four reverse stock split, which was effective on December 1, 1997 (the "Reverse Stock Split"). All share and option numbers and prices set forth herein have been adjusted to reflect the Reverse Stock Split. History The Company was incorporated on October 31, 1981, but did not commence its current business until February, 1995 when it acquired, through a subsidiary, an 80% interest in The Friendly Net, LLC ("TFN") a Utah limited liability company. TFN is a Utah-based Internet Service Provider ("ISP"). The remaining 20% interest in TFN was acquired by the Company in March 1997. Prior to October 23, 1996, the Company conducted operations under the name "Hi, Tiger International, Inc.". The name change was effected in connection with the Company's acquisition of AvTel Holdings, Inc., a California corporation ("AHI") on that date. As a result of the acquisition of AHI, the Company implemented a complete change in its Board of Directors and executive management, began to pursue several acquisitions and strategic alliances and started development of a sales and operational strategy to position the Company as a telecommunications carrier providing a comprehensive array of broadband voice and data network services. The acquisition of AHI was effected pursuant to the merger of a wholly-owned subsidiary of the Company with and into AHI (the "AHI Merger") as a result of which the Company acquired 100% of the issued and outstanding capital stock of AHI in exchange for 1,063,127 shares of the Company Common Stock, representing approximately 61% of the issued and outstanding Company Common Stock after giving effect to the AHI Merger, and 250,000 shares of newly authorized shares of the Company's Series A Convertible Preferred Stock. For accounting purposes, the acquisition was treated as a reverse acquisition with AHI as the acquirer. 3 In November, 1996, the Company acquired Silicon Beach Communications, Inc. ("SBC"), a privately held California corporation that serves as an ISP and provides software development services. In February, 1997, the Company acquired all the issued and outstanding capital stock of WestNet Communications, Inc. ("WNI"), a Ventura, California ISP. Following completion of this acquisition, the Company began to integrate the customer bases, network facilities and other operations of SBC and WNI in order to achieve desired efficiencies and economies of scale. On December 1, 1997, the Company acquired Matrix Telecom, Inc., a privately-held Texas corporation ("Matrix") by means of a share for share exchange (the "Share Exchange"). Matrix is a provider of long distance telephone services. See "Background - Acquisition of Matrix" below. The Reincorporation Merger and the Reverse Stock Split were conditions to the closing of the Share Exchange. Acquisition of Matrix. AvTel and Matrix entered into a Stock Exchange Agreement dated April 29, 1997, and subsequently amended (the "Exchange Agreement"), pursuant to which the persons or entities who owned the issued and outstanding common stock of Matrix ("Matrix Stockholders") would transfer to AvTel all of their Matrix stock and, in exchange, AvTel would issue to the Matrix Stockholders shares of the AvTel's Common Stock (the "Share Exchange"). The Share Exchange was completed pursuant to the terms of the Exchange Agreement on December 1, 1997. Following the Share Exchange, the former Matrix Stockholders now own approximately 81% of the issued and outstanding Common Stock of the Company. For accounting purposes, the acquisition was treated as a reverse acquisition with Matrix as the acquirer. In connection with the completion of the Share Exchange, the Matrix Stock Holders and the Company entered into a Registration Rights and Lockup Agreement dated December 1, 1997 (the "Registration Rights and Lockup Agreement"). Pursuant to the Registration Rights and Lockup Agreement, certain persons and entities who hold an aggregate of 67.4% of the outstanding Matrix Common Stock (85.2% of the outstanding Matrix Common Stock, excluding the shares held by New Best Connections Inc., a wholly-owned subsidiary of Matrix; "Best") agreed, for a two-year period commencing on the closing of the Share Exchange, not to offer, pledge, sell, or otherwise dispose of any shares of the Company issued to them pursuant to the terms of the Exchange Agreement. The Matrix Stockholders who have agreed to this two-year lockup period are Ronald L. Jensen, his adult children (James J. Jensen, Jami J. Jensen, Janet Jensen Krieger, Jeffrey J. Jensen, and Julie J. Jensen), and United Group Association, Inc. and UA Plus, Inc. (which are controlled by Mr. Jensen and his adult children). The Registration Rights and Lockup Agreement requires that the Company use its best efforts to become listed on the NASDAQ SmallCap Market or the NASDAQ National Market and to file a shelf registration statement providing for the sale by the Matrix Stockholders of all securities issued to them in connection with the Exchange Agreement, subject to the two-year holding restriction imposed on certain of the Matrix Stockholders described above. Under the Registration Rights and Lockup Agreement, the Company is obliged to use its reasonable efforts to keep the shelf registration statement effective on a continuous basis for a period described in the Registration Rights and Lockup Agreement. If the Company's securities are not listed on the NASDAQ SmallCap Market or the NASDAQ National Market within six months following the Closing or if the Company is unable to qualify for use of a shelf registration statement within such period, the Matrix Stockholders (other than those subject to the two-year restriction) are entitled to demand that the Company register the AvTel Common Stock received by them in connection with the Share Exchange on any registration statement then available to the Company. The Matrix Stockholders may also require the Company to undertake up to two additional demand registrations of their securities. All costs and expenses of both shelf and demand registrations (excluding any underwriting discounts and fees of counsel to the Matrix Stockholders) will be borne by the Company. Pursuant to the terms of the Exchange Agreement, Barry A. Peters and Frank Dziuba resigned as directors of the Company immediately prior to the completion of the Share Exchange. Also pursuant to the terms of the Exchange Agreement, on December 1, 1997, John E. Allen, Ronald W. Howard and Gregory T. Mutz were appointed to fill vacancies on the Company's Board of Directors. 4 BUSINESS OF THE COMPANY - ------------------------ As noted above, the Company is a provider of broadband network services integrating voice, data and video solutions for individuals and corporate customers. The Company sells and markets a broad range of telecommunications and advanced network services through independent value added resellers and internal direct sales professionals. The Company targets mid-size corporations, small-office home-office professionals and select residential market segments through two primary business units; Business Network Services ("BNS") and Consumer Markets. Business Network Services BNS targets mid-size corporate customers for their broadband data and voice network needs. Leading this sales strategy, the Company's objective is to become the underlying telecommunications carrier for the transport of data, voice and video traffic over various wide area network configurations and protocol. Through a value-added sales process, BNS designs, provisions and manages its customers' networks. BNS will provide a host of additional value added services assisting its customers create enhanced intranet and extranet applications. The Company believes its strategy to focus on the corporate customer for wide-area network ("WAN") and global-area network ("GAN") needs offers significant opportunity. BNS cross-markets to its customer base a variety of traditional telecommunications products and services such as long distance telephone service, executive calling cards and wireless paging. Industry. Information technology is fast becoming the driving force in telecommunications. The Company's BNS strategy is driven by corporate end users' needs for network connectivity as a result of new software applications and technology advancements developed in the information technology arena. This is becoming a critical element in the ability of businesses, professional and other organizations to improve productivity and lower costs. This can be accomplished through the use of a variety of telecommunications services, including branch office, remote office and telecommuter networking ("intranets") as well as providing network access to customers, vendors, financial institutions ("extranets") and the Internet. While management expects that these factors will result in an increased market demand for these services, there are no assurances regarding the size of such demand or that the Company will be selected to provide its services in response to such demand. Strategy. The implementation of this strategy involves the creation and marketing of products and services designed for business applications under BNS. BNS is developing and implementing sales and marketing strategies which result in monthly, recurring revenues from networking customers under multi-year term agreements. The group's primary sales channel is an agent program through which BNS distributes its services through value added resellers ("VARs") of information technology products. BNS leverages the existing customer relationships of these channel partners gaining more immediate access to a wider group of prospective customers and greater credibility in the sales process. Additionally, this VAR channel becomes the service organization for BNS customers requiring on-site repair and maintenance visits. BNS also deploys a direct sales force, targeting specific niche industries. However, this strategy is in its formative stages and the Company is recruiting, hiring, training and developing the personnel resources necessary to manage and staff the sales and marketing efforts. Delays or other difficulties in these recruitment and other activities could adversely affect the Company's ability to timely and effectively implement these revenue-generating objectives. Internetworking. At an increasing rate, business, professional and other organizations are seeking to inter-network their local area networks ("LANs") and WANs to share information and computing resources for applications such as e-mail, transaction processing, the sharing of databases, multi-site engineering and product development and electronic image transfer. The communications traffic of many organizations has grown steadily during the past two decades leading to enterprise-wide networks facilitating rapid and efficient data communications between work groups, departments and branch locations. Additionally, a shift to enterprise-wide remote access has occurred due to increased business mobility, increased telecommuting, reduced cost of WAN services and widespread adoption of remote access standards. Internet and remote access devices extend the organization network beyond the branch office, bringing remote users closer to the enterprise and permitting connection to the corporate LAN so users can work anywhere, any time. Users can access e-mail, databases and servers as if they were in the corporate office. 5 The Company believes that, as a result of these shifts, internetworking, the method used for interconnecting networks, has been undergoing rapid growth over the past ten years. This is reflected in the significant growth in sales and distribution of routers, remote access servers, intranet software and other various components that enable internetworking. As the computing paradigm migrates to client-server architectures, enterprise-wide networks allow those technologies to be implemented. The Company's strategy recognizes the opportunity to bridge the gap between telecom and computer providers and simplify networking complexities by becoming a single point of contact. Connectivity and Bandwidth. The Company believes that communications requirements such as bandwidth availability and network design are replacing computer requirements such as processor speed, memory or operating systems as the delimiting factors for business applications. Video conferencing, remote patient diagnostics with medical imaging and telecommuting are all business applications in which the success of the deployment is defined by the available bandwidth. The ultimate realization of this trend is the World-Wide Web ("WWW") and applications developed with Internet-specific tools such as SUN Microsystems' Java. These Web applications are computer platform and operating system independent but depend entirely upon connectivity and bandwidth for successful deployment and execution. As a result, connectivity is becoming one of the most important factors in enhancing business productivity and customer service. Large corporations have historically created private wide area networks through leased dedicated data lines. However, dedicated point-to-point facilities have several deficiencies: leased lines are very expensive; remote offices and telecommuters are omitted; and leased lines are not suited for unscheduled and asynchronous communications. Accordingly, small and medium size companies that have sought the benefits of internetworking have been required to use modems and dial-up telephone lines which are generally too slow to handle today's applications. Growing demands for high speed capabilities have given way to the emergence of new carrier-based data communication services to overcome the deficiencies of both dedicated leased and dial-up lines. WAN solutions vary substantially depending on an organization's size and communications needs. Traditionally, wideband digital transmission circuits (such as T1 and DS-1) were leased from public carriers to provide voice, fax and data communications links between larger offices and low speed leased lines (such as DS-O) for branch office connectivity. For some applications, however, this has proven expensive and inefficient because the entire bandwidth capacity is dedicated 24 hours per day, whether or not it is used. The birth of "packet" based services such as X.25 were developed to address the issue of allocation and utilization. Today, "fast packet" networking technologies such as Frame Relay and Asynchronous Transfer Mode ("ATM") have emerged as an integrated, cost-effective, flexible WAN solution. These networks allow for "bandwidth on demand" between any two endpoints on a WAN. Consumer Markets The Company's Consumer Markets group targets home-based office professionals and select residential customers primarily for domestic and international long distance telephone services, wireless paging, 800 numbers and calling cards. This group sells its portfolio of services through third party distributors such as agent organizations and affiliate groups. These products and services are marketed under the MatrixTM brand name and provided through the Company's wholly owned subsidiary, Matrix. Additionally, the Consumer Markets group sells and markets Internet services to business and residential customers in select geographic locations. Through the Company's Internet service subsidiaries, the Company services the areas of San Luis Obispo, Santa Barbara and Ventura counties in California and Salt Lake City, Utah. The Company's Internet service subsidiaries cross-market a variety of products and services including WAN connectivity, software, Web development and long distance telephone service. The Consumer Markets group provides long distance telephone and other services to customers in 49 states. The Company is fully certified or registered in all states where required and operates under Section 214 authority from Federal Communications Commission ("FCC"). The Company, through a wholly owned subsidiary has a national-deployed Carrier Identification Code ("CIC"). The CIC permits the Company to market to subscribers of other carriers by having the customer dial the CIC directly, a process, which is known in the industry as "casual calling." 6 MatrixTM services are primarily marketed through direct mail, outbound telemarketing and a network of over 6,000 independent agents. Sales consist of both long distance telephone service, for which the customer must select Matrix as its long distance carrier, and casual calling. Products consist of services which have fixed charges for either "peak" and "off peak" periods, or a "flat rate" which is the same 24 hours a day, 7 days a week. Products which follow the "peak-off peak" structure generally have slightly higher charges during the day, and lower charges during the nights and weekends, than "flat rate" products, and are often more attractive to residential subscribers who place the majority of their long distance calls during "off peak" periods. The Consumer Markets group sells through agent distributors with a niche orientation such as ethnic focus and home based professionals. These independent agent groups are provided with a variety of value-added support services which include: in-house multi-lingual Customer Service department open 24 hours a day, 7 days a week; direct electronic provisioning to local exchange carriers ("LECs"); and custom billing and management reports. Operations and Support Customer Service Center. The Company's inbound customer service center is designed to provide the Company's customer base with a high-level of service and support. Customer Service Representatives ("CSRs") are available 24 hours a day, 7 days a week in order to answer inquiries generated by the Company's marketing campaigns, as well as to support existing customers. CSRs are trained to answer a broad range of inquiries from prospective customers relating to service, pricing, and optional features. In addition to competitive rates and a wide variety of products, the Company is able to offer business customers a highly specialized direct bill summary package that includes call summaries by account code, department, employee, project, client, area code, country code, and time-of-day. Customer call management reports are available in a variety of media formats. The Company's call centers are equipped with state-of-the-art computer and telecommunications technology. Incoming calls are managed with the help of an automatic call distributor and an automated attendant. Such a system allows for management of call queue time, the formation of distinct work groups for different projects, and on-line monitoring of customer service calls for quality assurance purposes. Bilingual CSRs are available during day and evening shifts. Billing and Information Systems. The Company has dedicated substantial resources to its management information systems. The Company's information systems enable the Company to (i) monitor and respond to the evolving needs of its customers by developing new and customized services; (ii) provide sophisticated billing information that can be tailored to meet the requirements of its customer base;(iii) provide high quality customer service; (iv) detect and minimize fraud; (v) verify payables to suppliers; and (vi) integrate additions to its customer base. In addition, the Company has complete facilities for rating, formatting and distributing direct bills to its larger commercial subscribers. Small business customers may receive either a direct or a LEC bill, depending upon the services provided to the customer. Through its wholly-owned Matrix subsidiary, the Company has invested in call rating, billing, and customer service infrastructure. In addition, the Company holds billing and collection agreements with LECs, including all of the Regional Bell Operating Companies ("RBOCs"), and Independent Local Exchange Companies ("ILECs"). These billing agreements permit the Company to include its billing on the customer's local telephone bill. The Company's billing information systems and services also allows it to provide direct bills to customers. Strategic Alliances and Carrier Agreements. The Company has executed strategic alliances with Sprint for its underlying voice carrier services, LCI International for data carrier services and GST for Internet backbone services. As noted above, the Company holds billing and collection agreements with all of the RBOCs and ILEC's. The Company has also executed a development agreement with Prosoft I-Net Solutions to develop a specialized training agreement designed to educate value-added resellers of the Company's services on the integration of data, voice and video products. 7 ACE Certified Engineer Training Program. On March 16, 1998 the Company announced the availability of its ACE Certified Engineering training program. The ACE program has been designed specifically for value added resellers in the telecommunications industry. The ACE program provides a complete curriculum over a broad range of courses. The program includes four tracks: 1) a general overview of the telecommunications industry and technologies; 2) voice equipment and network design; 3) data communications and network design; and 4) the integration of voice, video and data, traffic design and network engineering. Each track is a technical course focusing on how to use, engineer and integrate proven and leading-edge voice, video and data networking technologies. The complete program requires 128 hours of in-depth course work and labs. Regulation The services which the Company provides, either directly or through its subsidiaries, are subject to varying degrees of federal, state and local regulation. The FCC exercises jurisdiction over all facilities of, and services offered by, telecommunications common carriers to the extent that they involve the provision, origination or termination of jurisdictionally interstate or international communications. The state public service commissions ("PSCs") retain jurisdiction over jurisdictionally intrastate communications. The FCC and relevant PSCs have the authority to regulate interstate and intrastate rates, respectively, ownership of transmission facilities and the terms and conditions under which Matrix's services are provided. In general, neither the FCC nor the relevant state PSCs exercise direct oversight over cost justification for the Company's services or the Company's profit levels, but either or both may do so in the future. However, the Company is required by federal and state law and regulations to file tariffs listing the rates, terms and conditions of services provided. The Company generally is also required to obtain certification from the relevant state PSC prior to the initiation of certain intrastate service, and is required to maintain a certificate issued by the FCC in connection with the provision of certain international services. Any failure to maintain proper federal and state tariffs or certification or any difficulties or delays in obtaining required authorization could have a material adverse effect on the Company. Competition The telecommunications industry is highly competitive and affected by rapid regulatory and technological change. The Company believes that the principal competitive factors in its business include pricing, customer service, network quality, service offerings and the flexibility to adapt to changing market conditions. The Company's future success will depend in part upon its ability to compete with AT&T, MCI, Sprint and other carriers (including the RBOCs when approved to enter the long distance market) and other long distance providers, and America On-Line and other national and local ISPs, many of which have considerably greater financial and other resources than the Company. Intellectual Property The Company uses several unregistered trademarks as part of its networking business, including PointStreamTM and FrameLinkTM, which it may seek to register. Matrix has registered several trademarks for use in its marketing materials. The logo used by Matrix to market its long distance service is a registered trademark of Matrix. While the Company believes its trademarks are important to its business, the Company does not believe that failure to register its trademarks poses any material risk of infringement on its rights to use such trademarks. Employees As of March 15, 1998, the Company, including its subsidiaries, had approximately 140 full-time employees. Approximately 76% of these employees were leased from United Group Service Center, an entity affiliated with certain of the Company's principal stockholders. (See Note 6 of the Notes to Consolidated Financial Statements). None of the employees of the Company are represented by a union. The Company supplements its work force from time to time with contractors, administrative personnel through employment agencies, and part time employees. The Company believes that it has good relations with its employees. 8 RECENT DEVELOPMENTS - ------------------- Board of Directors On January 5, 1998, Ronald W. Howard tendered his resignation from the Company's Board of Directors. On January 9, 1998, the Board accepted Mr. Howard's resignation and elected Jeffrey J. Jensen to fill the vacancy created by Mr. Howard's resignation. Application for Listing on Nasdaq SmallCap Market On March 2, 1998, the Company filed an application to have its Common Stock listed on the Nasdaq SmallCap Market. The Company is currently pursuing its application and believes that it will be successful in such listing. However, there can be no assurance that Nasdaq will accept the Common Stock for listing. RISK FACTORS - ------------ IN EVALUATING THE COMPANY, ITS BUSINESS, OPERATIONS AND FINANCIAL POSITION, THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY, IN ADDITION TO THE OTHER INFORMATION CONTAINED IN THIS FORM 10-K. THE FOLLOWING FACTORS, AMONG OTHERS, COULD AFFECT THE COMPANY'S ACTUAL FUTURE OPERATING RESULTS AND COULD CAUSE SUCH RESULTS TO DIFFER FROM THE RESULTS DISCUSSED IN ANY FORWARD-LOOKING STATEMENTS MADE BY OR ON BEHALF OF THE COMPANY. Operating Results Subject to Significant Fluctuations The Company's quarterly operating results are difficult to forecast with any degree of accuracy because a number of factors subject these results to significant fluctuations. As a result, the Company believes that period-to-period comparisons of its operating results are not necessarily meaningful and should not be relied upon as indications of future performance. Factors Influencing Operating Results, Including Revenues, Costs and Margins. The Company's revenues, costs and expenses have fluctuated significantly in the past and are likely to continue to fluctuate significantly in the future as a result of numerous factors. The Company's revenues in any given period can vary due to factors such as call volume fluctuations; the addition or loss of major customers, whether through competition, merger, consolidation or otherwise; the loss of economically beneficial routing options for the termination of the Company's traffic; pricing pressure resulting from increased competition; and technical difficulties with or failures of portions of the network used by the Company that impact the Company's ability to provide service to or bill its customers. The Company's cost of services and operating expenses in any given period can vary due to factors such as fluctuations in rates charged by carriers to terminate the Company's traffic; increases in bad debt expense and reserves; compensation expense resulting from stock options granted by the Company; changes in the Company's sales incentive plans; and costs associated with changes in staffing levels of sales, marketing, technical support and administrative personnel. In addition, the Company's operating results can vary due to factors such as loss of favorable routing options; actions by regulatory entities; and general economic and political conditions. Risks Inherent in Acquisition Strategy An important component of the Company's past growth has been to develop its business through acquisitions. This growth strategy is dependent on the continued availability of suitable acquisition candidates and subjects the Company to a number of risks. Acquisitions may place significant demands on the Company's financial and management resources, as the process for integrating acquired operations presents a significant challenge to the Company's management and may lead to unanticipated costs or a diversion of management's attention from day-to-day operations. There can be no assurance that the 9 Company will be able to successfully integrate any acquisitions made by the Company in the future into Company operations. Additionally, the Company may incur unknown liabilities despite management's efforts to investigate the operations of the acquired business. Potential Adverse Effects of Government Regulation The Company's business is subject to various federal and state laws, regulations, agency actions and court decisions. These laws, regulations, actions and decisions may impose prior certification, notification, registration and/or tariff requirements. Certificates of authority can generally be conditioned, modified or revoked by state regulatory authorities for failure to comply with state laws and regulations. Fines and other penalties, including revocation of a certificate of authority, may be imposed. In addition, future changes in any of these sources of regulation could have a material adverse effect on the Company's business, operating results and financial condition. Dependence on Key Personnel The Company's success depends to a significant degree upon the efforts of senior management personnel, in particular, Anthony E. Papa, the Company's Chairman and Chief Executive Officer, and James P. Pisani, the Company's President and Chief Operating Officer. The Company believes that its future success will depend in large part upon its continuing ability to attract and retain highly skilled personnel. Competition for qualified, high-level telecommunications personnel is intense and there can be no assurance that the Company will be successful in attracting and retaining such personnel. The loss of the services of one or more of the Company's key individuals, or the failure to attract and retain other key personnel, could materially adversely affect the Company's business, operating results and financial condition. Significant Competition The telecommunications industry is intensely competitive and subject to rapid change. The Company's competitors include facilities-based and non-facilities-based providers, many of which have substantially more resources than the Company. Providers compete on the basis of price, customer service, transmission quality, breadth of service offerings and value-added services. Additionally, the telecommunications industry is in a period of rapid technological evolution, marked by the introduction of competitive product and service offerings, such as the utilization of the Internet for international voice and data communications. The Company is unable to predict which technological development will challenge its competitive position or the amount of expenditures will be required to respond to a rapidly changing technological environment. The Company believes that competition will continue to increase, placing downward pressure on prices. Such pressure could adversely affect the Company's gross margins if the Company is not able to reduce its costs commensurate with such price reductions. Need for Additional Capital to Finance Growth and Capital Requirements In the past, the Company's cash flow from operations has been sufficient to meet its working capital and capital expenditure requirements. However, there can be no assurance that such cash from operation will continue to meet the Company's requirements, particularly if the Company obtains one or more attractive opportunities to purchase the business or assets of another company. In such event, the Company will need to raise additional capital from equity or debt sources. There can be no assurance that the Company will be able to raise such capital on favorable terms or at all. Volatility of Stock Price To date the Common Stock has been traded on Nasdaq's Electronic Bulletin Board; its trading volume has been variable, but generally low. As a result, relatively small trades may significantly affect the market price of the Common Stock. The market price of the shares of Common Stock has been highly volatile since the public announcement of the Share Exchange, and may be significantly affected by factors such as actual or anticipated fluctuations in the Company's operating results, the announcement of potential acquisitions by the Company, changes in regulations, activities of the largest domestic 10 providers, industry consolidation and mergers, conditions and trends in the telecommunications market, adoption of new accounting standards affecting the telecommunications industry, changes in recommendations and estimates by securities analysts, general market conditions and other factors. In addition, the stock market has from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for the shares of emerging growth companies like the Company. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. Year 2000 Computer Program Failure A significant percentage of the software that runs most of the computers in the United States relies on two-digit date codes to perform computations and decision-making functions. Commencing on January 1, 2000, these computer programs may fail from an inability to interpret date codes properly, misinterpreting "00" as the year 1900 rather than 2000. The Company is in the process of confirming its belief that the Company's billing, credit and call tracking systems are Year 2000 compliant and do not use programs with the two-digit date code flaw. At the same time, a number of the computers of the Company's vendors that interface with the Company's systems may run on programs that have Year 2000 problems and may disrupt the Company's billing, credit and tracking systems. Failure of any of the computer programs integral to the Company's vendors could adversely affect the Company's business, operating results and financial condition. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Forward-looking Statements Certain statements contained in this Form 10-K, including without limitation, statements containing the words "believes," "anticipates," "intends," "expects" and words of similar import, constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, among others, those set forth above. GIVEN THESE UNCERTAINTIES, THE STOCKHOLDERS OF THE COMPANY ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON SUCH FORWARD-LOOKING STATEMENTS. 11 ITEM 2. PROPERTIES The Company does not own any real property. The Company's new corporate headquarters location is approximately 7,000 square feet and is located at 501 Bath Street Santa Barbara, CA 93101. The Company leases these facilities under a five-year lease expiring in March 2003 (subject to certain renewal options held by the Company). The current monthly rent under the lease is approximately $12,000, on a "triple-net" basis. Matrix currently leases approximately 24,050 square feet of space for its offices at 8721 Airport Freeway in Fort Worth, Texas, pursuant to a lease agreement expiring on June 30, 2000. The monthly rent (not including electricity) is currently approximately $19,888. TFN's office location is approximately 1,100 square feet and is located at 350 West Broadway, Suite 111, Salt Lake City, UT 84101. TFN's office lease is rented on a month-to-month basis at a monthly rate of $1,400. SBC's office location is approximately 3,441 square feet and is located at 104 West Anapamu, Suite C, Santa Barbara 93101. SBC leases this space under a five-year lease, expiring in September 2001, at a monthly rate of $4,645. The Company currently plans to relocate SBC's operations and consolidate them in the Company's new corporate headquarters location in May 1998. The Company believes that it will be able to terminate its obligations with respect to SBC's current space without the payment of additional consideration. The Company and its subsidiaries also operate points-of-presence for the purpose of creating local access points to its network backbone. ITEM 3. LEGAL PROCEEDINGS The Company is not currently a party to any material legal proceedings. The Company is not aware of proceeding against the Company contemplated by any governmental authority. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held a special meeting of its stockholders on November 20, 1997, for the purposes of approving (i) the Exchange Agreement and the acquisition of Matrix by means of the Share Exchange, and (ii) the Agreement and Plan of Merger that effectuated the Reincorporation Merger and the Reverse Stock Split (including approval of the Company's Delaware Certificate of Incorporation and Bylaws). Present at the meeting were approximately 81.2% of the shares of the Company's Common Stock and 100% of the shares of the Company's Series A Preferred Stock outstanding as of the record date for the meeting. Both measures were approved with 1,449,656 shares of the Common Stock (representing 81.2% of the Common Stock then outstanding) and all shares of the Series A Preferred Stock voting for, no shares of the Common Stock voting against, and 375 shares of the Common Stock abstaining. (The numbers of shares of Common Stock in such tally have been adjusted to reflect the Reverse Stock Split). There were no broker non-votes. 12 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock is traded over-the-counter on the NASD's Electronic Bulletin Board (the "Bulletin Board") under the trading symbol "AVCO". There is no established public trading market for the Company's Preferred Stock. The following high and low bid information for the Company's Common Stock was provided by various market makers and on-line quote reporting services. The quotations provided reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions. All prices have been adjusted to reflect the Reverse Stock Split. Year ending December 31, 1996 High Bid Low Bid - ------------------------------- -------- ------- First Quarter $ 3.50 $ 2.00 Second Quarter $ 5.75 $ 3.00 Third Quarter $ 4.00 $ 4.00 Fourth Quarter $ 5.50 $ 2.00 Year ending December 31, 1997 High Bid Low Bid - ------------------------------- -------- ------- First Quarter $ 3.50 $ 2.00 Second Quarter $18.00 $ 3.13 Third Quarter $19.00 $ 9.75 Fourth Quarter $19.00 $ 7.00 The number of shareholders of record of the Company Common Stock as of February 28, 1998, was 190. At that date there were two record holders of the Company's Preferred Stock. The Company has applied to The Nasdaq Stock Market for inclusion of the Common Stock on The Nasdaq SmallCap Market. While management believes that the Company size, shareholder base and other factors will enable it to be included on The Nasdaq SmallCap Market, there are no assurances that this will occur, in which event the trading in the Company's Common Stock will continue to be reported on the Bulletin Board. The Company has not paid any cash dividends to date and does not anticipate paying dividends in the foreseeable future. It is the present intention of management to utilize all available funds for the development of the Company's business. The terms of the Company's Series A Convertible Preferred Stock prevent the payment of any dividend on the Company's Common Stock unless (i) all cumulative dividends on the Series A Convertible Preferred Stock have been fully paid, and (ii) the holders of at least 50% of the outstanding shares of the Series A Convertible Preferred Stock have approved such dividend. On December 1, 1997, the Company issued 9,582,493 shares of its Common Stock, which were not registered under the Securities Act, in connection with the Share Exchange; 1,999,997 of such shares are currently held by a subsidiary of the Company as treasury stock. No underwriters were used in this transaction and none of such shares were issued publicly. The Company relied on the exemptions from registration provided by Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder. The person receiving shares were the 23 former Matrix shareholders. The Company also issued options for 22,338 shares of Common Stock to three former Matrix optionholders with an exercise price of $2.24 per share. These persons were and are believed by the Company to possess the requisite level of financial sophistication and experience in order to qualify for such exemptions. The Company made available to the recipients of such Common Stock all material information with respect to the Company and the Share Exchange. Each such person 13 signed an Exchange Statement containing appropriate investment representations and covenants. The specific details of the issuances were disclosed in the Company's definitive Proxy Statement dated October 31, 1997, and as part of relevant Form 8-K and Form 10-KSB filings. In July 1997, New Best Connections, Inc. ("Best"), a subsidiary of Matrix, issued options to purchase Matrix Common Stock to __ individuals in recognition of their past services to Best, Matrix and related companies (and in satisfaction of certain obligations of Best to shareholders of Matrix who had contributed shares of Matrix stock to Best). As a result of the Share Exchange, the shares of Matrix Common Stock subject to such options have been converted into 247,500 shares of the Company's Common Stock. The exercise price for such options is $1.50 per share. These options have fully vested in the respective optionees; however, upon exercise the shares will be subject to certain significant restrictions on transfer. None of such options has been exercised as of March 31, 1998. No underwriters were or will be used in this connection with these options and none of the shares issuable upon exercise will be issued publicly. The Company has relied and will rely on the exemptions from registration provided by Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder. The options are believed by the Company to possess the requisite level of financial sophistication and experience in order to qualify for such exemptions. The Company made available, and will make available, to the recipients of such Common Stock all material information with respect to the Company. In June 1997, Best awarded options to purchase shares of Matrix Common Stock to members of its outside sales force in recognition of their past services to Best, Matrix and related companies (and in satisfaction of certain obligations of Best to shareholders of Matrix who had contributed shares of Matrix stock to Best). As a result of the Share Exchange, the shares of Matrix Common Stock subject to such options have been converted into 1,292,000 shares of the Company's Common Stock. The exercise price for such options will be $1.50 per share. The Company will be required to register such shares of its Common Stock before such options can become exercisable. ITEM 6. SELECTED FINANCIAL DATA For accounting purposes, the Share Exchange is treated as a reverse acquisition of AvTel by Matrix. Accordingly, the Company's results of operations reflect the operations of Matrix prior to December 1, 1997 and reflect the combined operations of AvTel and Matrix subsequent to December 1, 1997. The following selected operations data of the Company for the years ended December 31, 1997, 1996, 1995 and 1994 and balance sheet data as of December 31, 1997, 1996, 1995 and 1994 have been derived from the Company's (or Matrix's) audited financial statements. The selected operations data of the Company for the year ended December 31, 1993, and balance sheet data as of December 31, 1993, have been derived from unaudited financial statements of Matrix. These selected financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the financial statements and notes thereto included elsewhere herein. 14 Statement of Operations Data:
Years ended December 31, 1997 1996 1995 1994 1993 ------------ ---------- ----------- ---------- ----------- Revenues $ 51,389,080 71,558,295 64,289,718 59,551,307 40,568,307 Operating income (loss) (10,757,960) 4,091,034 2,422,393 604,109 (397,804) Net income (loss) (10,191,720) 2,566,734 (2,440,493) 643,200 (474,797) Proforma net loss per common share-basic and diluted (1.23) N/A N/A N/A N/A Cash dividends per common share -- -- -- -- N/A
Balance Sheet Data:
As of December 31, 1997 1996 1995 1994 1993 ------------ ---------- ----------- ---------- ----------- Working capital (deficit) $ 5,570,657 6,066,620 206,071 (140,741) (326,746) Total assets 18,724,850 20,338,404 17,580,694 14,957,279 11,167,630 Long term debt -- -- -- -- -- Stockholders' equity 7,809,048 7,861,883 3,539,522 2,372,333 1,729,133
N/A - not applicable Notes to Selected Financial Data of Matrix (1) Matrix was originally formed May 29, 1990 as a Texas general partnership. The partners consisted of Matrix Communications, Limited ("MCL") a Texas limited liability partnership and Onward and Upward, Inc. ("OUI"). Effective January 1, 1994, the partnership was dissolved. Prior to the dissolution, cash distributions were made to OUI in satisfaction of its partnership interest. Concurrent with the dissolution, all remaining tangible and intangible assets and liabilities of Matrix then owned by MCL were transferred to Matrix Telecom, Inc., a Texas corporation. Effective June 30, 1995, MCL was liquidated and its sole asset (Matrix capital stock) was distributed to MCL's partners in proportion to their ownership interests. (2) Matrix original stock issuance consisted of 100 common shares. Effective December 31, 1994, a 10 for 1 stock split was declared. Concurrent with the dissolution of MCL on June 30, 1995, Matrix's then outstanding 1,000 shares of common stock were canceled and 100,000 shares were distributed to the prior MCL partners in proportion to the ownership 15 interest in MCL. Effective March 10, 1997, a 18 for 1 stock split was declared resulting in 3,484,260 shares being then outstanding. On December 1, 1997, the Company effected the Reverse Stock Split as part of the Reincorporation Merger, and then acquired Matrix through the issuance of 9,582,493 shares of Common Stock (including 1,999,997 shares now held as treasury stock). All share amounts have been restated to reflect the stock splits and share exchanges. (3) In October 1995, Matrix issued 2,405,499 shares of its common stock valued at $3,607,682 in exchange for all of the outstanding common stock of DNS Communications, Inc., a Houston based long distance reseller. Subsequent to the acquisition, the operations of DNS generated substantial losses. DNS's customer churn rate and bad debts as well as projected cash flows were evaluated and as of December 31, 1995 it was determined that the remaining investment in the DNS acquired customer base totaling approximately $4,462,000 should be written off. See note 2 to the Company's financial statements included elsewhere herein. (4) Per share amounts are not reflected for 1996, 1995 and 1994 due to the recapitalization of the Company as a result of the reverse acquisition in 1997. During 1993 the Company operated as a partnership. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS BACKGROUND - ---------- The following information should be read in connection with the consolidated financial statements of the Company and related notes included elsewhere in this report. Share Exchange As described above under "Business -- Background -- Acquisition of Matrix," on December 1, 1997, AvTel and Matrix completed the Share Exchange. For accounting purposes, the Share Exchange was treated as a reverse acquisition of AvTel by Matrix. AvTel was the legal acquirer and accordingly, the Share Exchange was effected by the issuance of AvTel Common Stock in exchange for all of the common stock then outstanding of Matrix. In addition, holders of Matrix outstanding stock options received non-qualified stock options of AvTel. The following discussion of results of operations reflects the operations of Matrix prior to December 1, 1997 and reflects the combined operations of AvTel and Matrix subsequent to December 1, 1997. Accordingly, references to the Company refer to operations of Matrix prior to the Share Exchange and the combined operations of Matrix and AvTel subsequent to the Share Exchange. The reverse acquisition of AvTel by Matrix was accounted for using the purchase method of accounting. In order to value the consideration given in the Share Exchange, the market price of AvTel's common stock for a period immediately preceding the announcement of the Share Exchange was used. As of the date of acquisition, the Company determined the fair value of the net tangible and intangible assets and liabilities acquired. The underlying fair value of AvTel's net assets was substantially less than the indicated market value of AvTel's common and preferred stock. Accordingly, the Company recorded a charge to income of $9.1 million immediately subsequent to the reverse acquisition. Acquisition of New Best Connections, Inc. Effective July 1, 1997, Matrix acquired New Best Connections, Inc., a Texas corporation ("Best"), an affiliate of Matrix through substantially similar common ownership, by means of a share-for-share exchange. Best's primary assets were cash of $211,000, ownership of shares of Matrix common stock (subsequently exchanged for 1,999,997 16 shares of AvTel Common Stock in the Share Exchange), and Best's relationships with the field force of sales agents. The assets and liabilities of Best were recorded at their historical cost, which approximated the fair value of such assets as of July 1, 1997. Acquisition and Disposition of DNS Communications, Inc. In October 1995, Matrix issued shares of its common stock valued at $3.6 million in exchange for all of the outstanding common stock of DNS Communications, Inc. ("DNS"), a Houston-based long distance reseller. The transaction was accounted for under the purchase method. The purchase price in excess of the book value of DNS net assets was pushed down to DNS and was allocated based upon the estimated fair value of the assets and liabilities acquired at the date of acquisition. Subsequent to the acquisition, the operations of DNS generated substantial losses. DNS's customer churn rate and bad debts as well as projected cash flows were evaluated and as of December 31, 1995 it was determined that the remaining investment in the DNS acquired customer base totaling approximately $4.4 million should be written off. In June 1996, Matrix sold the customer base acquired in the DNS acquisition in addition to certain blocks of customers acquired during 1995 and 1996 together with related assets to a former officer of Matrix and a former shareholder of DNS for approximately $5.2 million. Matrix recorded a gain on this sale of approximately $3.2 million. Due to the timing of the acquisition and subsequent decision to sell the operations of DNS, Matrix has recorded its interest in DNS operations using the equity method of accounting. RESULTS OF OPERATIONS - --------------------- Year Ended December 31, 1997 compared with Year Ended December 31, 1996 Revenue Revenue for the year ended December 31, 1997, decreased 28.1 % or $20.1 million to $51.4 million from $71.5 million for the year ended December 31, 1996. The decrease in revenue resulted primarily from decreases in sales from three significant sales channels, all of which were affiliated with the Company through substantially common ownership. These sales channels were a distributor selling via telemarketing, a distributor focusing on the casual or dial-around customer, and a DNS distributor of long distance services. The relationship with the DNS distributor was terminated resulting from the sale of the DNS customer bases in June of 1996. The Company in 1997 chose to reduce its focus on the promotion of the casual or dial-around customer due to the significant costs of direct mailing and bad debt associated with this product. Reduced sales from the telemarketing distributor resulted from the erosion of the retail pricing in the market for the residential consumer. Pricing continued to decline during 1997, and attrition from a maturing customer base resulted in losing customers on higher gross margin products. Attrition rates associated with long distance products are a normal industry occurrence; however, methods of calculation differ within the industry. The Company has sought to reduce its risk from reliance on a small group of distributors, and has refocused to obtain multiple revenue sources external to the Company. New distributors have significantly contributed to the mix in 1997. 1997 sales from sources other than the Company's primary 1996 distributors have increased more than 20%. 17 Additionally, the combination of AvTel and Matrix has added significant growth opportunities for the Company in 1998. AvTel sells and markets a broad range of telecommunications and advanced network services through independent value added resellers and internal direct sales professionals. AvTel capabilities include the provisioning of broadband network services integrating voice, data and video solutions. The Company has positioned itself to be a fully integrated telecom provider focusing on the mid-size corporations in addition to continuing to provide value added services to small business owners and residential consumers in niche marketing areas. Revenue from prior AvTel operations has been included in the Company's financial results only since December 1, 1998. AvTel revenues for the eleven months ended November 30, 1997 were approximately $2.6 million. Gross margin Gross margin decreased $8.7 million in 1997, to $15.1 million for the year ended December 31, 1997 from $23.8 million for the year ended December 31, 1996. As a percentage of net sales gross margin decreased 3.9% to 29.5% for the year ended December 31, 1997 from 33.4% for the year ended December 31, 1996. Two primary factors contributed to the decrease in gross margin in 1997. First, due to increasing competitive market demands, the Company was forced to continue decreasing its retail rates in 1997 to meet the competitive rate reductions; however, the underlying carrier costs to the Company did not change due to contractual commitments. Accordingly, cost of network as a percentage of revenue increased reflecting a lower gross margin in 1997 over 1996. The Company believes that its network costs will decrease in 1998 due to new carrier contracts negotiated since the end of 1997. Second, bad debt as a percentage of revenue increased approximately 2% in 1997, primarily resulting from increased bad debt associated with the casual or dial-around product. The majority of the Company's revenues are billed and collected from the Local Exchange Carriers ("LECs"), with which the Company has agreements. Collection policies and aggressiveness in collection procedures differ among the LECs. The Company experienced significant sales growth in a geographical location in which the LECs' bad debt percentages were significantly higher than other LECs. The LECs bad debt percentages are typically higher than those experienced by the Company's internal collectors for those customers being direct billed. The Company anticipates its percentage of customers billed on a direct basis to increase in 1998, as the Company attempts to decrease its costs related to bad debts. Selling, general, and administrative costs The Company's selling, general, and administrative costs decreased $2.6 million in 1997 from 1996. As a percentage of revenue, such costs increased 5.1% to 31.4% for the year ended December 31, 1997 compared to 26.3% for the year ended December 31, 1996. This increase resulted primarily from the decrease in revenues causing the expense as a percentage of revenue to increase. Certain changes are more fully described below. Certain selling, general, and administrative costs related to the addition of AvTel operations to Matrix subsequent to the effective date of the Share Exchange, December 1, 1997, amounted to approximately $286,000, accounting for.56% of the increase as a percentage of revenues in 1997 over 1996. Selling costs related to direct mailing to the casual or dial-around customer (which were absorbed by the sales distributor in 1996) were approximately $605,000 in 1997, accounting for 1.18% of the increase as a percentage of revenues in 1997 over 1996. Salary expenses increased approximately $651,000 between the years, or 3.76% as a percentage of revenues in 1997 over 1996, resulting primarily from integration of AvTel employees subsequent to the Share Exchange and certain sales and marketing personnel in 1997. Billing and collection fees and distributor commissions decreased approximately $3.9 million, or 1.82% as a percentage of revenues. Most of the new products sold in 1997 were direct billed. As the percentage of direct billed customers increase, billing and collection fees have decreased. Similarly, as sales of certain products having a higher commission structure have declined, commission expense has also declined. 18 Certain regulatory and professional services increased approximately $266,000, or 1.22% as a percentage of revenues in 1997 over 1996. Carrier fees specific to telecommunication providers upon reaching certain thresholds of customers were met in the last half of the year in 1996; therefore, increased fees in 1997 resulted from being charged the fees for a full year. Professional fees increased in 1997 over 1996 for two primary reasons. First, due to increased market demands for information systems programmers, the Company was forced to secure external contractors. Second, certain telemarketing and verification costs associated with the sales process increased in 1997 primarily resulting from the sales distributor absorbing these costs in 1996. Other selling, general and administrative costs decreased approximately $213,000 in 1997. As a percentage of revenue, these costs increased .81% in 1997 over 1996 due to decreasing revenues. Acquisition-related writeoff The $9.1 million write off relates to the Share Exchange and is discussed under "Background" above. Depreciation and Amortization Depreciation and amortization expense decreased approximately $314,000 for the year ended December 31, 1997, compared to the year ended December 31, 1996, resulting primarily from older assets becoming fully depreciated. Interest expense and other income, net Interest expense decreased $219,000 to $12,000 for the year ended December 31, 1997 from $231,000 for the year ended December 31, 1996. The decrease resulted from reduced borrowings in 1997 compared to 1996. The Company had sufficient cash from operations to meet operating expenses and capital expenditures. Other income net of other expenses increased more than 11% for 1997 over 1996 primarily resulting from increases in interest earned from cash investments. Income taxes The Company recognized a tax benefit of $276,000 for the year ended December 31, 1997 compared to a tax expense of $1.7 million for the year ended December 31, 1996. The tax benefit in 1997 resulted from the loss from operations for the year 1997. Year Ended December 31, 1996 compared with Year Ended December 31, 1995 Revenues Revenues for the year ended December 31, 1996 increased 11.3% or $7.3 million to $71.6 million from $64.3 million for the year ended December 31, 1995. The increase was due in part to increases in revenues from a significant affiliated distributor of the casual or dial around product. Prior to 1996, marketing for the casual or dial around product was limited to the state of California; however, in 1996 direct mailing of this service was expanded to eleven additional states increasing total revenues in 1996 over 1995 by more than $2.8 million. Additional revenues were also driven from the resale of certain long distance products. This sales program was implemented at the end of 1995 and increased total sales over 1995 by approximately $3 million. Finally, new distributors not actively selling products in 1995 increased revenues in 1996 by approximately $1.5 million. Gross margin Gross margin increased $2.5 million to $23.8 million for the year ended December 31, 1996 from $21.3 million for the year ended December 31, 1995. As a percentage of net revenues, gross margin increased to 33.4% for the year ended December 31, 1996 from 33.2% for the year ended December 31, 1995. The slight change in gross margin resulted from a percentage increase in the cost of network accounting which was more than offset by a percentage decrease in bad debt expense. 19 Network cost for the year ended December 31, 1996 increased $5.5 million to $46.1 million for the year ended December 31, 1996 from $40.6 million for the year ended December 31, 1995. Primarily, the increase resulted from the increase in revenues. As a percentage of revenue, network cost increased 1.3% in 1996 over 1995. The primary reason for the increase was increased revenues from distributors whose products are being sold at lower retail rates than in the prior year in response to the competitive demand of the industry; thus, decreasing the Company's product margins. Bad debt as a percentage of revenue decreased 1.5% for the year 1996 over 1995. The majority of the Company's revenues are billed and collected from the LECs, with which the Company has agreements. The Company records bad debt as a percentage of revenue based on the percentage being reserved by the LEC plus or minus any true ups to actual amounts by the LEC. Collection policies and aggressiveness in collection procedures differ among the LECs. Collection percentages for the LECs were significantly higher in 1996 over 1995. Additionally, travel card fraud was significantly less in 1996 compared to 1995 resulting primarily from changing its travel card vendor to one providing real time fraud monitoring. Selling, general and administrative expenses Selling, general and administrative expenses increased 5.1% or $910,000 to $18.8 million for the year ended December 31, 1996 from $17.9 million for the year ending December 31, 1995. As a percentage of revenue, selling general and administrative expenses decreased 1.5% to 26.3% for the year ended December 31, 1996 from 27.8% for the year ended December 1995. The decrease resulted primarily from the rise in revenues causing the expense as a percentage of revenue to decrease. As a percentage of revenue, commission expense decreased approximately 1.7% in 1996 over 1995. The change was due to the growth of an internal revenue base in 1996 for which commissions are not paid; therefore, commission as a percentage of revenues declined as this particular revenue continued to grow. Professional and legal expense as a percentage of revenues decreased approximately .5% in 1996 over 1995 primarily from 1995 accruals for contingent liabilities. Salary expense as a percentage of revenues increased in 1996 over 1995 approximately .4% resulting primarily from the addition of key employee positions and certain other positions among operational groups to provide carrier services to other companies. Depreciation and Amortization Depreciation and amortization expense for 1996 decreased by an immaterial amount from that for 1995. Interest expense and other income, net Interest expense increased to approximately $231,000 for the year ended December 31, 1996 from $6,000 for the year ended December 31, 1995. The Company increased its borrowing for use in operations in 1996; however this borrowing was extinguished by the end of the second quarter in 1996. Other income increased to approximately $271,000 for the year ended December 31, 1996 from $166,000 for the year ended December 1995. The increase resulted primarily from income from cash investments and income from contract services provided to other companies. Income taxes Income taxes increased approximately $605,000 to $1.7 million for the year ended December 31, 1996 from $1.1 million for the year ended December 31, 1995 due to increased operating income. The effective tax rate was 40.8% and 41.8% for the years ended December 31, 1996 and 1995, respectively. 20 Equity in net income (loss) of DNS Equity in DNS increased approximately $4.1 million for the year ended December 31, 1996 from a loss of $3.9 million for the year ended December 31, 1995. In June 1996, the Company sold the customer base acquired in the DNS acquisition in addition to certain blocks of customers acquired during 1995 and 1996 together with related assets for approximately $5.2 million. The Company recorded a gain on this sale of approximately $3.2 million. This gain offset the loss from operations of DNS prior to its sale of $3.1 million. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- The primary sources of operating cash flow for the Company are revenues derived from the resale of domestic and international long distance services to the public. Minor sources of revenues are received for the provision of back office support to affiliated and non-affiliated companies and for earnings from investment income. The primary uses of cash are payments to underlying network vendors for provisioning long distance facilities, to sales distributors for soliciting long distance sales, and to the major LECs for billing and collecting directly from the long distance end user. To date, the Company has financed its growth, including its capital expenditures, primarily through funds provided by operations. Net cash provided from operations totaled $1.7 million for the year ended December 31, 1997, $1.0 million for the year ended December 31, 1996, and $5.1 million for the year ended December 31, 1995. The Company's accounts receivable decreased to $6.9 million at December 31, 1997 from $10.5 million at December 31, 1996. The decrease was primarily due to a corresponding decrease in sales described elsewhere in this discussion. Current liabilities decreased to $9.7 million as of December 31, 1997 from $11.5 million as of December 31, 1996. The decrease in current liabilities is due to a corresponding decrease in sales. Sales and excise taxes included in current liabilities decreased to $736,000 for the year ended December 31, 1997, from $1.7 million for the year ended December 31, 1996, largely as a result of the decrease in sales and an adjustment for prior overaccruals. Prior to the Share Exchange, the Company loaned $2.0 million to an affiliated company, Core Marketing, LLC, during 1997, of which $201,111 was repaid prior to December 31, 1997. The remainder of the loan is due on or before September 1, 1998. Additionally, the Company had loans outstanding from DNS for $1.6 million at December 31, 1995; all of which were paid in 1996. AvTel's operations for the twelve months ended September 30, 1997 (its last full fiscal year prior to the completion of the Share Exchange) resulted in revenues of approximately $2.3 million and a net loss of approximately $2.4 million. These losses primarily resulted from costs associated with the commencement of AvTel's operations and an impairment loss of approximately $1.4 million recorded in connection with the AHI Merger. There is no assurance that these operations will produce operating income in 1998. The Company has been able to finance its capital expenditures, which have consisted primarily of property and equipment, from funds generated from operations. Cash received in acquisitions totaled $478,643 during 1997. An important component of the Company's past growth has been to develop its business through acquisitions, including the Share Exchange. The Company intends to continue this strategy, and has retained Van Kasper & Company to advise it in connection with this strategy. Although cash provided by operations has provided sufficient cash to fund its growth to date, the Company anticipates that future growth strategies in 1998 (including possible acquisitions) will require funding from other sources. The Company is evaluating its financing alternatives. In addition to debt financing, the Company may utilize its capital stock for acquisitions under appropriate circumstances. 21 INFLATION - --------- The Company does not believe that the relatively moderate rates of inflation over the past three years have had a significant effect on its net sales or its profitability. YEAR 2000 COMPLIANCE - -------------------- The Company has made an effort to insure that the software components of its information and billing systems are Year 2000 compliant. Management is in the process of confirming that all of such systems are Year 2000 compliant. Upon such confirmation, management believes that, after January 1, 2000, the Company will be able to continue to accurately track and bill calls. At the same time, it is likely that the operations of a number of the Company's vendors rely on software that is not Year 2000 compliant. ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements of the Company and supplementary data are included beginning immediately following the signature page to this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On December 1, 1997, the Company engaged KPMG Peat Marwick LLP to audit its financial statements for fiscal 1997. This and certain other changes in the Company's accountants were previously reported in Forms 8-K filed on November 7, 1997, and December 9, 1997. There are no, and have not been, any disagreements between the Company and its accountants on any matter of accounting principles, practices or financial statements disclosure. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders under the captions "Election of Directors" and "Compliance with Section 16(a) of the Securities Exchange Act of 1934." ITEM 11. EXECUTIVE COMPENSATION The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders under the caption "Executive Compensation." 22 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders under the captions "Stock Ownership" and "Principal Shareholders." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item will be contained in the Company's definitive Proxy Statement for its 1998 Annual Meeting of Stockholders under the captions "Certain Relationships and Transactions." ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) The index to the financial statements and financial statement schedules filed as part of this report is set forth immediately following the signature page. (b) The index to the exhibits filed as part of this report is set forth immediately following the financial statements. (c) During the quarter ended December 31, 1997, the Company filed the following Current Reports on Form 8-K: (i) Amendment to Current Report on Form 8-K/A filed on October 20, 1997, amending a Current Report on Form 8-K filed by Hi, Tiger International, Inc. (a predecessor corporation) on November 7, 1996. Amending Item 7 to file financial statements and pro forma financial information with respect to the acquisition of AvTel Holdings, Inc. (ii) Amendment to Current Report on Form 8-K/A filed on October 23, 1997, amending a Current Report on Form 8-K filed on March 6, 1997. Amending Item 7 to file financial statements and pro forma financial information with respect to the acquisition of WestNet Communications, Inc. (iii) Current Report filed on November 7, 1997. Item 4 - regarding dismissal of AvTel's prior independent auditor. (iv) Current Report filed on December 9, 1997 (subsequently amended by Amendment to Current Report on Form 8-K/A filed on February 9, 1998.) Items 1, 2, 4 and 7. Completion of the Reincorporation Merger and the Share Exchange, engagement of KPMG Peat Marwick LLP as independent auditors and change in fiscal year. 23 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant has caused this report to be signed on it behalf by the undersigned, thereunto duly authorized. AVTEL COMMUNICATIONS, INC. Dated: April 10, 1998 By /S/ ANTHONY E. PAPA ------------------------ Anthony E. Papa, Chairman of the Board and Chief Executive Officer (Principal Executive Officer) Dated: April 10, 1998 By /S/ JAMES P. PISANI ------------------------ James P. Pisani, President, Chief Operating Officer and Chief Financial Officer (Principal Financial Officer) Dated: April 10, 1998 By /S/ VIRGINIA A. BAKER ------------------------ Virginia A. Baker Controller and Chief Accounting Officer (Principal Accounting Officer) 24 In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on this 10th day of April, 1998. AVTEL COMMUNICATIONS, INC. By /S/ ANTHONY E. PAPA ------------------------ Anthony E. Papa, Chairman of the Board and Chief Executive Officer By /S/ JAMES P. PISANI ------------------------ James P. Pisani, President, Chief Operating Officer and Chief Financial Officer, Director By /S/ VIRGINIA A. BAKER ------------------------- Virginia A. Baker Controller and Chief Accounting Officer By /S/ JOHN E. ALLEN ------------------------- John E. Allen Director By /S/ JEFFREY J. JENSEN -------------------------- Jeffrey J. Jensen Director By /S/ GREGORY T. MUTZ -------------------------- Gregory T. Mutz Director 25 INDEPENDENT AUDITORS' REPORT The Board of Directors AvTel Communications, Inc.: We have audited the accompanying consolidated balance sheets of AvTel Communications, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997. In connection with our audits of the consolidated financial statements, we also have audited the accompanying financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements 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 AvTel Communications, Inc. and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KPMG Peat Marwick LLP. Dallas, Texas March 24, 1998 F-1 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1997 and 1996
Assets 1997 1996 ------ ------------ ----------- Current assets: Cash and cash equivalents ......................................... $ 4,807,441 4,622,395 Accounts receivable, net .......................................... 6,961,953 10,507,580 Due from affiliates ............................................... 2,127,771 1,212,414 Federal and state income tax receivable ........................... 598,970 -- Other current assets .............................................. 861,950 2,200,751 ------------ ----------- Total current assets ................................ 15,358,085 18,543,140 Property and equipment, net .......................................... 1,791,682 1,621,355 Other assets, net .................................................... 1,575,083 173,909 ------------ ----------- Total assets ........................................ $ 18,724,850 20,338,404 ============ =========== Liabilities and Stockholders' Equity ------------------------------------ Current liabilities: Accounts payable and other accrued expenses ....................... $ 1,546,762 1,888,026 Accrued network service costs ..................................... 4,319,198 4,863,663 Sales and excise taxes payable .................................... 736,012 1,676,677 Due to affiliates ................................................. 2,719,417 2,597,559 Other current liabilities ......................................... 466,039 554,596 ------------ ----------- Total current liabilities ........................... 9,787,428 11,580,521 Deferred income taxes ................................................ 498,712 -- Other liabilities .................................................... 50,782 -- Common stock subject to put option (note 4) .......................... 578,880 896,000 ------------ ----------- Total liabilities ................................... 10,915,802 12,476,521 ------------ ----------- Stockholders' equity: Series A convertible preferred stock, cumulative as to 8% dividends. Authorized 1,000,000 shares, $0.01 par value, 207,700 shares issued and outstanding. (Liquidation preference of $919,000 including dividends in arrears.) ......... 2,077 -- Common stock, Authorized 20,000,000 shares. At December 31, 1997, $0.01 par value; 11,437,056 shares issued, including 385,920 shares subject to put options .. At December 31, 1996, no par value; 8,819,054 shares issued, including 482,400 shares subject to put options ......... 110,511 7,532,026 Additional paid in capital ........................................ 17,138,739 -- Retained earnings (accumulated deficit) ........................... (9,422,729) 769,441 Treasury stock, 1,999,997 shares in 1997 and 171,548 shares in 1996 (20,000) (439,584) ------------ ----------- Total stockholders' equity .......................... 7,809,048 7,861,883 Commitments and contingencies Total liabilities and stockholders' equity .......... $ 18,724,850 20,338,404 ============ =========== See accompanying notes to consolidated financial statements.
F-2 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ------------ ----------- ----------- Revenues (note 6) .......................................... $ 51,389,080 71,558,295 64,289,718 Cost of revenues (note 6) .................................. 36,227,507 47,674,396 42,980,127 ------------ ----------- ----------- Gross margin ................................ 15,161,573 23,883,899 21,309,591 ------------ ----------- ----------- Operating expenses: Selling, general and administrative (note 6) ...... 16,141,132 18,798,925 17,888,856 Acquisition related write off ..................... 9,098,545 -- -- Depreciation and amortization ..................... 679,856 993,940 998,342 ------------ ----------- ----------- 25,919,533 19,792,865 18,887,198 ------------ ----------- ----------- Operating income (loss) .................... (10,757,960) 4,091,034 2,422,393 Interest expense (note 6) .................................. (11,692) (230,922) (6,299) Other income, net .......................................... 301,580 271,171 165,616 ------------ ----------- ----------- Income (loss) before income tax expense and equity in net income (loss) of DNS .................. (10,468,072) 4,131,283 2,581,710 Income tax expense (benefit) ............................... (276,352) 1,686,876 1,081,726 ------------ ----------- ----------- (10,191,720) 2,444,407 1,499,984 Equity in net income (loss) of DNS ......................... -- 122,327 (3,940,477) ------------ ----------- ----------- Net income (loss) ........................ $(10,191,720) 2,566,734 (2,440,493) ============ =========== =========== Proforma net loss per common share - basic and diluted ............................................. $ (1.23) ============
See accompanying notes to consolidated financial statements F-3 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity Years ended December 31, 1997, 1996 and 1995
Retained Preferred Stock Common Stock Additional earnings Treasury Stock --------------- ------------ paid in (accumulated -------------- Shares Amount Shares Amount capital deficit) Shares Amount Total ------- ------ ----------- ------------ ---------- ----------- ---------- ----------- ----------- Balances at December 31, 1994 . -- $ -- 4,467,384 $ 1,729,133 -- 643,200 -- $ -- 2,372,333 Acquisition of DNS Communications, Inc. -- -- 2,405,499 3,607,682 -- -- -- -- 3,607,682 Net loss ......... -- -- -- -- -- (2,440,493) -- -- (2,440,493) ------- ------ ----------- ------------ ---------- ----------- ---------- ----------- ----------- Balances at December 31, 1995 . -- -- 6,872,883 5,336,815 -- (1,797,293) -- -- 3,539,522 Purchase of common stock .... -- -- -- -- -- -- (171,548) (439,584) (439,584) Issuance of common stock .... -- -- 1,463,771 2,195,211 -- -- -- -- 2,195,211 Net income ....... -- -- -- -- -- 2,566,734 -- -- 2,566,734 ------- ------ ----------- ------------ ---------- ----------- ---------- ----------- ----------- Balances at December 31, 1996 -- -- 8,336,654 7,532,026 -- 769,441 (171,548) (439,584) 7,861,883 Acquisition of Best (note 2) ........ -- -- 934,987 3,361,208 -- -- (1,999,997) (3,317,940) 43,268 Share for share exchange between AvTel and Matrix (note 2): Reverse acquisition of AvTel ........... 207,700 2,077 1,839,563 18,396 9,129,040 -- -- -- 9,149,513 Reflect new capitalization of Company ..... -- -- (171,548) (10,802,234) 7,064,710 -- 171,548 3,737,524 -- Issuance of common stock for exercise of options ...... -- -- 15,000 150 52,350 -- -- -- 52,500 Expired put options (note 4) -- -- 96,480 965 143,755 -- -- -- 144,720 Stock compensation earned (note 7) . -- -- -- -- 748,884 -- -- -- 748,884 Net loss ......... -- -- -- -- -- (10,191,720) -- -- (10,191,720) ------- ------ ----------- ------------ ---------- ----------- ---------- ----------- ----------- Balances at December 31, 1997 . 207,700 $2,077 11,051,136 $ 110,511 17,138,739 (9,422,729) (1,999,997) $ (20,000) 7,809,048 ======= ====== =========== ============ ========== =========== ========== =========== ===========
See accompanying notes to consolidated financial statements. F-4 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 1997, 1996 and 1995
1997 1996 1995 ------------ ---------- ---------- Cash flows from operating activities: Net income (loss) ..................................... $(10,191,720) 2,566,734 (2,440,493) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization ...................... 679,856 993,940 998,342 Amortization of advanced commissions ............... 1,355,492 618,791 -- Acquisition related write off ...................... 9,098,545 -- -- Provision for bad debts ............................ 1,829,770 1,461,471 1,955,842 Deferred income taxes .............................. (80,377) (321,678) 530,885 Stock compensation earned .......................... 748,884 -- -- Equity in (income) loss of DNS ..................... -- (122,327) 3,940,477 Changes in certain operating assets and liabilities: Accounts receivable .............................. 1,969,332 (1,971,970) (2,170,807) Due from affiliates .............................. (915,357) 345,336 630,395 Federal and state income tax receivable .......... (598,970) -- 631,183 Other current assets ............................. 1,787,672 (393,781) (96,791) Accounts payable and accrued liabilities ......... (2,877,789) (1,397,160) 526,850 Due to affiliates ................................ (1,138,568) (742,663) 591,889 ------------ ---------- ---------- Net cash provided by operating activities .. 1,667,770 1,036,693 5,097,772 ------------ ---------- ---------- Cash flows from investing activities: Cash received in acquisitions ......................... 477,643 -- -- Loans to affiliate .................................... (2,000,000) -- -- Payments received on loans to affiliates .............. 201,111 -- -- Purchase of property and equipment .................... (212,421) (701,718) (529,805) Purchase of customer base ............................. -- -- (103,970) Repayments from (to) DNS, net ......................... -- 1,577,432 (1,577,432) Other ................................................. 2,749 (14,482) 52,173 ------------ ---------- ---------- Net cash provided by (used in) investing activities ..................... (1,530,918) 861,232 (2,159,034) ------------ ---------- ---------- Cash flows from financing activities: Principal payments on capital leases .................. (4,306) -- -- Cash received for exercise of options ................. 52,500 -- -- Purchase of common stock for treasury ................. -- (439,583) -- ------------ ---------- ---------- Net cash provided by (used in) ............ 48,194 (439,583) -- ------------ ---------- ---------- financing activities Net increase in cash and cash equivalents ................ 185,046 1,458,342 2,938,738 Cash and cash equivalents at beginning of year ........... 4,622,395 3,164,053 225,315 ------------ ---------- ---------- Cash and cash equivalents at end of year ................. $ 4,807,441 4,622,395 3,164,053 ============ ========== ========== (Continued)
F-5 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued
1997 1996 1995 ------------ ---------- ---------- Cash paid (received) during the year for: Interest .............................................. $ 11,594 212,404 6,300 ============ ========== ========== Income taxes, net of refunds .......................... $ 925,161 1,482,103 (475,177) ============ ========== ========== Noncash financing activities: Common stock issued for DNS acquisition ............... $ -- -- 3,607,682 ============ ========== ========== Common stock issued for advanced commissions .......... $ -- 2,195,211 ============ ========== Common stock issued for receivable from major shareholder ................................... $ -- 723,600 -- ============ ========== ========== Common stock issued for Best acquisition .............. $ 3,361,208 -- ============ ========== Treasury stock acquired with Best acquisition ......... $ (3,317,940) -- ============ ========== Common and preferred stock issued in AvTel reverse acquisition ......................................... $ 9,149,513 -- -- ============ ========== ==========
See accompanying notes to consolidated financial statements. F-6 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 (1) Summary of Significant Accounting Policies (a) Business and Background On December 1, 1997, AvTel Communications, Inc. ("AvTel") and Matrix Telecom, Inc. ("Matrix") completed a share for share exchange pursuant to a stock exchange agreement dated April 29, 1997 as subsequently amended ("Share Exchange"). For accounting purposes, the Share Exchange was treated as a reverse acquisition of AvTel by Matrix. AvTel was the legal acquiror and accordingly, the Share Exchange was effected by the issuance by AvTel of 9,582,493 shares of common stock in exchange for all of the common stock then outstanding of Matrix. In addition, holders of outstanding Matrix stock options received 22,338 non-qualified stock options of AvTel. The purchase method of accounting was used, with Matrix being treated as the acquiror for accounting purposes. The results of operations reported in these consolidated financial statements reflect the operations of Matrix prior to December 1, 1997 and reflect the combined operations of AvTel and Matrix subsequent to December 1, 1997. References to the "Company" refer to operations of Matrix prior to the Share Exchange and the combined operations of Matrix and AvTel subsequent to the Share Exchange. As a result of the Share Exchange, Matrix became a wholly owned subsidiary of AvTel. (See note 2). The Share Exchange provided that each Matrix shareholder would receive 2.4819 AvTel common shares for each common share of Matrix then issued including treasury shares held by Matrix. For periods prior to the December 1, 1997 Share Exchange, all share amounts have been restated to reflect the Share Exchange as a 2.4819 for one stock split. In addition, on March 10, 1997 Matrix declared an 18 for one stock split. All share amounts have been restated to also reflect this stock split. AvTel was formed to be a provider of broadband network services integrating voice, data and video solutions for individuals and corporate customers. The Company sells and markets a broad range of telecommunications and advanced network services through independent value added resellers and internal direct sales professionals. The Company targets mid-size corporations, small-office home-office professionals and select residential market segments. To date AvTel has generated revenues primarily through the provisioning of data networking and internet service. F-7 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Matrix provides long distance telephone service in forty-nine states over intercity facilities provided by fully certified dominant domestic and international carriers. Matrix resells to both residential and commercial customers; however, the primary focus is to the small business owner and select residential customers. Matrix is fully certified by the Federal Communications Commission and certified to operate in all states requiring such certification. Matrix holds billing and collection agreements with all regional bell operating companies, GTE, and other independent telephone companies. (b) Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. (c) Cash and Cash Equivalents For purposes of the statement of cash flows, the Company considers all demand deposits, time deposits, and other highly liquid investments with a remaining maturity at date of purchase of less than ninety days to be cash equivalents. (d) Commissions Commissions to sales agents are paid and expensed based on a percentage of billings as incurred. Commissions paid in advance of $221,000 and $1,576,000 as of December 31, 1997 and 1996, respectively, included in other current assets, are being expensed over a period of eighteen months based on estimated billings of the customers for which the commissions were paid. (e) Revenue Recognition Long distance, frame relay and internet service revenues are recognized as service is provided. Amounts paid in advance are recorded as deferred revenue. (f) Property and Equipment Property and equipment are recorded at cost. Maintenance and repairs are charged against income as incurred, while renewals and major replacements are capitalized. The cost and related accumulated depreciation of assets sold or retired are removed from the accounts, and any resulting gain or loss is reflected in operations. The Company provides depreciation on fixed assets using the straight-line method over the estimated useful lives of the respective assets. F-8 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (g) Income Taxes The Company utilizes the asset and liability method for accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. (h) Use of Estimates Management of the Company has made a number of estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period to prepare these consolidated financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. (i) Concentrations of Credit Risk The Company's subscribers are primarily small business owners and residential subscribers and are not concentrated in any specific geographic region of the United States. The Company has agreements with Local Exchange Companies, which provide billing and collection services to the majority of the Company's subscribers. A significant portion of the Company's accounts receivable is due from these Companies. (j) Accounts Receivable Accounts receivable are net of allowances for doubtful accounts and other provisions of $982,000 and $627,000 as of December 31, 1997 and 1996, respectively. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of subscribers, historical trends and other information. (k) Financial Instruments The Company's financial instruments include cash, receivables, payables and accrued expenses. The carrying amount of such financial instruments approximates fair value because of the short maturity of these instruments. F-9 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (l) Acquired Customer Base Acquired customer base of $1,575,083, which is net of accumulated amortization of $8,000, at December 31, 1997, included in other assets, is being amortized on a straight-line basis over five years. The Company assesses the recoverability of this intangible asset by determining whether the acquired customer base balance can be recovered through undiscounted future operating cash flows of the acquired operations. The amount of impairment, if any, is measured based on projected discounted cash flows. The assessment of the recoverability of the acquired customer base will be impacted if estimated future operating cash flows are not achieved. (2) Acquisitions Matrix Telecom, Inc. -- On December 1, 1997, AvTel and Matrix completed the Share Exchange. For accounting purposes the Share Exchange was treated as a reverse acquisition of AvTel by Matrix. AvTel was the legal acquiror and, accordingly, the Share Exchange was effected by the issuance of AvTel common stock in exchange for all of the common stock then outstanding of Matrix. In addition, holders of outstanding Matrix stock options received non-qualified stock options of the Company. After the Share Exchange the former shareholders of Matrix held approximately 84% of the then outstanding common stock of the Company. The consummation of the Share Exchange was subject to the satisfaction of several conditions by AvTel. These included the reincorporation of AvTel (then a Utah corporation; "AvTel Utah") in Delaware by way of a merger (the "Reincorporation Merger") with and into AvTel Communications, Inc., a Delaware corporation, a wholly-owned subsidiary formed for the sole purpose of this merger. As part of the merger, AvTel (the surviving Delaware corporation) issued to its stockholders one share of new Delaware Common Stock for each four shares of AvTel-Utah's Common Stock outstanding immediately prior to the Reincorporation Merger. AvTel's Series A Convertible Preferred Stock and its outstanding options were similarly adjusted. Accordingly, the Reincorporation Merger essentially effected a one for four reverse stock split of AvTel's shares. In connection with the reverse acquisition of AvTel by Matrix, the following assets were acquired, liabilities assumed, and common and preferred stock issued. Current assets other than cash $ 258,041 Fixed assets 577,836 Customer base 1,583,000 Goodwill 9,098,545 Current liabilities (1,945,526) Long-term liabilities (688,854) Common and preferred stock issued (9,149,513) ----------- Cash acquired $ 266,471 =========== F-10 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The reverse acquisition of AvTel by Matrix was accounted for using the purchase method of accounting. In order to value the consideration given in the Share Exchange the market price of AvTel's common stock for a period immediately preceding the announcement of the Share Exchange was used. As of the date of acquisition, the Company determined the fair value of the net tangible and intangible assets acquired and liabilities assumed. Concurrently, the Company determined that the carrying amount of recorded goodwill was not recoverable. Accordingly, the Company recorded a charge to income of $9,098,545 immediately subsequent to the reverse acquisition. Proforma results of operations of the Company as if the Share Exchange had occurred as of the beginning of the periods presented is as follows except that the acquisition related loss is reflected as of January 1, 1997, for comparative purposes: Year ended December 31, ------------ 1997 1996 -------------- ---------- Revenue $ 54,094,095 73,512,954 Net income (loss) (12,634,346) 2,289,495 Proforma net loss per share $ (1.11) -- Best Connections, Inc. ("Best") -- Effective July 1, 1997, shareholders of Best, an affiliate of Matrix through substantially common ownership, contributed their ownership of Best to Matrix in exchange for 934,987 shares of Matrix common stock. Best's primary assets were 1,999,997 shares of Matrix common stock and cash of $211,000. The assets and liabilities of Best were recorded at their historical cost which approximated the fair value of such assets as of July 1, 1997. As a result of the combination, Matrix assumed the obligation to grant up to 1,999,997 stock options to agents of Best, certain employees of affiliated companies and potentially others. Such option grants relate to services, including sales promotion activities, to be performed by the recipients on behalf of the Company. Accordingly, the fair value of such options will be charged to expense by the Company as the related services are provided. In connection with the Matrix and Best combination, the following assets were acquired, liabilities assumed and common stock issued: Fixed assets $ 15,137 Current liabilities (183,014) Common stock issued 3,361,208 Treasury stock acquired (3,317,940) ----------- Cash acquired $ 211,172 =========== F-11 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Results of operations for 1997 and 1996 would not have been significantly different had the Best and Matrix combination occurred as of the beginning of the respective years. DNS Communications, Inc. ("DNS") -- In October 1995, Matrix issued 2,405,499 shares of its common stock valued at $3,607,682 in exchange for all of the outstanding common stock of DNS, a Houston based long distance reseller. The transaction was accounted for under the purchase method. The purchase price in excess of the book value of DNS net assets was allocated based upon the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition and included the following: Current assets $ 1,978,262 Acquired customer base 6,351,131 Other noncurrent assets 114,384 Accounts payable and accrued expenses (2,346,102) Deferred tax liability (2,489,993) ----------- Value assigned to common stock issued $ 3,607,682 =========== Summarized results of operations of DNS is as follows: Period from Year Ended October 1, 1995 to December 31, 1996 December 31, 1995 ----------------- ----------------- Revenue $ 11,027,000 $ 4,277,000 Net income (loss) 122,000 (3,940,000) Subsequent to the acquisition, the operations of DNS generated substantial losses. DNS's customer churn rate and bad debts as well as projected cash flows were evaluated and as of December 31, 1995 it was determined that the remaining investment in the DNS acquired customer base totaling approximately $4,462,000 should be written off. Such amount net of related deferred taxes is included in the loss of DNS reflected above for 1995. In June 1996, Matrix sold the customer base acquired in the DNS acquisition in addition to certain blocks of customers acquired during 1995 and 1996 together with related assets to a former officer of Matrix and a former shareholder of DNS for approximately $5,270,000. Matrix recorded a gain on this sale of approximately $3,221,000. This gain is included in equity in net income (loss) of DNS in the 1996 statement of operations. F-12 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Due to the timing of the acquisition and subsequent decision to sell the operations of DNS, Matrix has recorded its interest in DNS operations using the equity method of accounting. (3) Property and Equipment Property and equipment consisted of the following: Estimated December 31 ----------- useful life 1997 1996 ----------- ---------- --------- Communications system 2-5 years $1,318,326 1,328,679 Office furniture and equipment 1-7 years 2,945,795 2,815,451 Leasehold improvements lease term 416,220 416,220 ---------- ---------- 4,680,341 4,560,350 (2,888,659)(2,938,995) ---------- --------- $1,791,682 1,621,355 ========== ========= Depreciation expense was $632,000, $877,000 and $882,000 for 1997, 1996 and 1995, respectively. (4) Stockholders' Equity The preferred shareholders are entitled to receive cumulative annual dividends at a rate of 8% and are entitled to a preference in liquidation in the amount of $4 per share plus unpaid dividends. There were $88,000 cumulative preferred stock dividends in arrears at December 31, 1997. The preferred stock is convertible, on a one-for-one basis, into shares of Company common stock. The Company has 1,000,000 preferred shares authorized. In October 1995, the Company issued 2,405,499 shares of its no par value common stock valued at $3,607,682 for 100% of the outstanding shares of DNS Communications, Inc. ("DNS"), a Houston based long distance reseller. In December 1996, the Company issued 1,463,771 shares of its no par value common stock for future commissions due to affiliates as of October 31, 1996. A value of $1.50 per share was used in determining the number of shares to issue in settlement of the $2,195,211 obligation. Of this amount, $1,355,000 and $619,000 was expensed as commission expense in 1997 and 1996, respectively. During 1996, the Company sold to certain employees 482,400 shares of common stock at $1.50 per share. As of December 31, 1996, the Company had recorded a $723,600 receivable for such shares, which was subsequently collected. Proceeds used to repay the $723,600 receivable were loaned to F-13 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements the employees by a major shareholder of the Company. As of December 31, 1997 and 1996, the shares subject to this agreement could be put to the Company at the option of the employee at approximately $1.50 and $1.86 per share ($578,880 and $896,000), respectively. Such amounts have been included in other liabilities. Activity in common stock outstanding related to shares subject to put follows: Shares Amount -------- --------- Sale of common shares subject to put 482,400 $ 723,600 Increase in share value subject to put charged to expense -- 172,400 -------- -------- Balance, December 31, 1996 482,400 896,000 Decrease in share value subject to put recorded as a reduction to expense -- (172,400) Vested shares no longer subject to put (96,480) (144,720) Balance, December 31, 1997 385,920 $ 578,880 ======== ======== Under certain circumstances (e.g., employee termination) the Company has a call at amounts discussed above. During May 1996, the Company purchased 171,548 shares of its no par common stock as treasury stock for $439,584. As further discussed in note 8 in connection with the Best and Matrix combination effective July 1, 1997, Matrix acquired an additional 1,999,997 shares of its common stock as treasury stock. As a part of the recapitalization done in connection with the AvTel reverse acquisition, Matrix retired the 171,548 shares of its common stock discussed above and the Company recorded the remaining treasury stock at par value. (5) Federal and State Income Taxes The provision for income taxes consisted of the following: 1997 1996 1995 ---- ---- ---- Current tax expense (benefit): Federal $ (234,899) 1,751,047 480,736 State and local (41,453) 257,507 70,105 -------- --------- ------- (276,352) 2,008,554 550,841 -------- --------- ------- F-14 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Deferred tax expense (benefit): Federal -- (254,350) 424,708 State and local -- (67,328) 106,177 -------- ---------- --------- -- (321,678) 530,885 -------- ---------- --------- $ (276,352) 1,686,876 1,081,726 ======== ========== ========= Income tax expense differs from the amounts computed by applying the U.S. federal income tax rate of 34 percent to pretax income as a result of the following: 1997 1996 1995 ----------- --------- --------- Computed "expected" tax expense (benefit) $(3,559,144) 1,404,637 870,502 State and local taxes, net of federal income tax effect (27,359) 125,518 116,346 Nondeductible acquisition related write off 3,093,522 -- -- Losses not providing tax benefit 330,190 -- -- Other (113,561) 156,721 94,878 ----------- --------- --------- $ (276,352) 1,686,876 1,081,726 =========== ========= ========= Deferred income taxes as of December 31, 1997 and 1996 reflect the impact of temporary differences between financial statement carrying amounts and tax bases of assets and liabilities. The tax effects of temporary differences that give rise to significant portions of the net deferred tax assets at December 31, 1997 and 1996 are presented below: December 31 1997 1996 ----------- ------- Deferred tax assets: Net operating loss carryover $ 814,425 -- Compensation related items 299,554 -- Contingent liabilities and other items 204,978 134,288 ----------- ------- Gross deferred tax asset 1,318,957 134,288 Less valuation allowance (1,184,669) -- ----------- ------- Net deferred tax asset 134,288 134,288 Deferred tax liabilities: Customer base intangible (633,000) -- ----------- ------- Net deferred tax asset (liability) $ (498,712) 134,288 =========== ======= F-15 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The valuation allowance for deferred tax assets increased $1,184,669 during 1997, $854,479 of which relates to temporary differences of AvTel as the date of the acquisition. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and prior taxes paid in making this assessment. Based upon its evaluation of these factors, management believes that it is more likely than not that the Company will realize the benefits of these deductible differences, net of the valuation allowance, at December 31, 1997. At December 31, 1997, the Company has net operating loss carryforwards for federal tax purposes of approximately $2,400,000 which had been generated by AvTel prior to the reverse acquisition which are available on a limited basis to offset future federal taxable income, if any, through 2012. When realized such benefit will first be utilized to reduce long term intangible assets recorded in the reverse acquisition of AvTel by Matrix. (6) Related Party Transactions The Company has had transactions in the normal course of business with various companies which are affiliated with shareholders of the Company. Pacific Gateway Exchange, Inc. ("PGE"), an affiliated company, provides the Company with significant domestic and international transmission services. Common shareholders hold an interest in both PGE and the Company. Affiliates of the Company also act as agents for the Company in the solicitation of new customers. A significant number of the Company's employees are leased from United Group Service Center, an affiliate, who provides such services to a number of affiliated companies. The Company provides long distance service to a number of affiliated companies. Balances with affiliates related to operating activities are settled monthly. In addition, the Company has made both interest bearing and noninterest bearing advances to affiliated companies. F-16 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Due from affiliates consists of the following: December 31 1997 1996 ---------- --------- Core Marketing - note receivable due September 1, 1998 $1,798,889 -- United Membership Marketing Group (long distance services) 44,888 -- Specialized Card Services (long distance services) 20,564 -- UICI Administrators (long distance services) 28,965 -- Excell Agent Services (long distance services) -- 193,285 Interactive Media Works (IMW) (long distance services) 25,263 525 Core Marketing (long distance services) 111,280 134,652 Other receivables from various affiliates 97,922 160,352 Receivable from major shareholder for stock issued -- 723,600 ---------- --------- $2,127,771 1,212,414 ========== ========= Due to affiliates consists of the following: 1997 1996 ---------- --------- PGE (network transmission services) $2,335,787 2,244,411 Group Association (UGA) and Core Marketing (commissions) 134,618 144,612 Other payables to various affiliates 249,012 208,536 ---------- --------- $2,719,417 2,597,559 ========== ========= Significant services and transactions incurred in the normal course of operations with affiliated companies are summarized as follows: 1997 1996 1995 ---------- --------- --------- Revenues include the following: U.S. Teleco-billing and collection services, customer service and accounting services $ 200,370 -- -- Long distance revenues from affiliates: UGA, UICI, IMW, and Core Marketing 3,351,375 5,445,903 3,180,302 ---------- --------- --------- $3,551,745 5,445,903 3,180,302 ========== ========= ========= F-17 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
Cost of revenues includes the following: Network transmission services - PGE $15,917,688 20,527,236 17,195,182 =========== ========== ========== Selling, general and administrative includes the following: Expenses paid on behalf of PGE for access services, for which the Company was reimbursed $ 3,534,154 5,040,051 3,142,222 Expenses incurred for leasing employees from United Group Service Center 4,395,820 4,542,007 3,655,712 Sales commissions to affiliates: TravelCom 800, Core Marketing, UICI, UGA and Best Connections 990,533 5,335,233 6,314,878 Overhead expenses reimbursed to/from UGA Divisions 110,761 77,231 105,007 Core Marketing - casual mailings 603,742 -- -- ----------- ---------- ---------- $ 9,635,010 14,994,522 13,217,819 =========== ========== ========== Interest expense includes the following: Interest paid to shareholder $ -- 173,380 6,299 =========== ========== ==========
During 1996, the Company obtained loans of $4,900,000 from a significant shareholder for working capital and other purposes. Such amount was repaid during 1996. (7) Stock Compensation AvTel options -- Prior to the Share Exchange AvTel adopted a 1997 Incentive Stock Option Plan (the "AvTel 1997 Plan") for option grants to officers and key employees. The AvTel 1997 Plan authorizes grants of options to purchase up to 250,000 shares of authorized but unissued common stock and 125,000 shares of restricted common stock. Stock options are to be granted with an exercise price greater than or equal to the stock's fair market value at the date of grant. Options generally vest 25% after one year and 25% each year thereafter until fully vested. Such options typically expire after ten years. In addition, AvTel had other options which had been granted prior to the adoption of the AvTel 1997 Plan. After the Share Exchange all outstanding options became obligations of the Company. Matrix options -- Periodically, the Board of Matrix approved stock options for certain officers and employees. Stock option transactions of Matrix prior to the Share Exchange are reflected in the table below. At the time of the Share Exchange, Matrix had 22,338 options outstanding to purchase its common stock. In connection with the Share Exchange, the Company reissued these stock options and they vested immediately. These reissued options expire in December 2002. F-18 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements The per share weighted average fair value of stock options granted during 1995 was $1.67 on the date of the grant using the Black Scholes option - pricing model with the following weighted-average assumptions: risk-free interest rate of 7.0%, and an expected life of 20 years. The Company applies APB Opinion No. 25 in accounting for the AvTel 1997 Plan and the Matrix options discussed above; and, accordingly, no compensation cost has been recognized for its stock options issued to employees in the financial statements. For stock options granted to nonemployees, the Company accounts for such options in accordance with the requirements of SFAS No. 123. Had the Company determined compensation cost based on the fair value at the grant date for stock options issued to employees under SFAS No. 123, the Company's net loss in 1997 and 1995 would have been increased by approximately $5,000 and net income in 1996 would have been decreased by approximately $5,000. Best Connections, Inc. options -- As discussed in note 2 as a result of the Matrix combination with Best, Matrix assumed the obligation to issue stock options to Best's agents under Best's 1997 Option Plan. Effective as of the date of combination, July 1, 1997, 1,292,000 options to purchase Matrix common shares were granted to Best agents at $1.50 per share which will result in aggregate commission expense of approximately $764,000 over the vesting period. The option price per share was $1.50. The agents' options become exercisable no later than December 31, 1999 and may be exercised earlier based on qualified billings of long distance customers generated by the agents during six month measurement periods. After the Share Exchange such options became obligations of the Company. As of December 31, 1997, 421,343 options have been earned under the Plan and the Company recorded expense totaling approximately $249,000 related to such options based on qualified billings for 1997. In January 1998, 311,985 of such options became exercisable. Options generally expire two years from the date they become exercisable or sixty days subsequent to termination of employment. The per share weighted average fair value of stock options granted on July 1, 1997 was $.59 on the date of the grant using the Black Scholes option - pricing model with the following weighted-average assumptions: expected volatility of 30%, risk-free interest rate of 6.0%, and an expected life of 3.5 years. Best Connections, Inc. options and restricted stock agreements -- As discussed in note 2 as a result of the Matrix combination with Best, Matrix assumed the obligation to issue stock options, consisting of Matrix common shares owned by Best, to employees of affiliated companies. Effective July 15, 1997, the Company issued 247,500 options to purchase an equal number of shares of its common stock, at $1.50 per share subject to the provisions of a Restricted Stock Agreement. The stock options expire if unexercised after December 15, 2002. The Restricted Stock Agreement includes a call provision by the Company that lapses ten percent each six months beginning December 15, 1997 through June 15, 2002 F-19 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements or fully lapses in the event of death or permanent disability of the option holder. The call price is equal to the initial purchase price of $1.50 plus the aggregate amount of net income or loss per share for each fiscal quarter beginning after December 15, 1997. In no event will the call price be less than the initial purchase price. The Company is recognizing expense over the life of the options in accordance with the provisions of SFAS No. 123 and, during 1997, the Company recorded expense of $499,000. At December 31, 1997, no options had been exercised and therefore no shares were subject to the terms of the Restricted Stock Agreement. The per share weighted average fair value of stock options granted on December 15, 1997 was $6.88 on the date of the grant using the Black Scholes option - pricing model with the following weighted-average assumptions: expected volatility of 30%, risk-free interest rate of 6.0%, and an expected life of five years. Stock option activity is as follows: Weighted average Exercise Options Price ---------- --------- Outstanding at December 31, 1994 -- $ -- Granted 53,607 2.24 --------- Outstanding at December 31, 1995 53,607 2.24 Canceled (31,269) 2.24 --------- Outstanding at December 31, 1996 22,338 2.24 AvTel options outstanding at time of Share Exchange 255,109 4.52 Granted 1,539,500 1.50 Exercised (15,000) 3.50 --------- Outstanding at December 31, 1997 1,801,947 1.78 ========== ========= Exercisable at December 31, 1995 -- $ -- Exercisable at December 31, 1996 3,574 2.24 Exercisable at December 31, 1997 349,972 2.21 Total expense recorded for stock based awards during 1997 was $748,884. The following table summarizes certain information about the Company's stock options at December 31, 1997. F-20 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements
Options Outstanding Options Exercisable ------------------- ------------------- Weighted average Weighted Range of Number of remaining average Number of Weighted average exercise prices options contractual life exercise price options exercisable exercise price --------------- --------- ---------------- -------------- ------------------- -------------- $ 1.00 - 3.00 1,756,674 3.8 years $ 1.64 310,949 $ 1.56 4.00 - 6.00 28,097 6.4 4.89 21,847 4.86 8.00 5,429 9.1 8.00 5,429 8.00 12.00 11,747 8.8 12.00 11,747 12.00
(8) Proforma Net Loss per Common Share In February 1997, the Financial Accounting Standards Board issued SFAS 128, Earnings per Share. SFAS 128 supersedes the earnings per share calculation methods of APB 15, effective for annual and interim periods ending after December 15, 1997. In accordance with this standard, the net loss per share amount presented on the Company's Consolidated Statement of Operations for 1997 have been calculated using the measurement provisions of SFAS 128. The following data show amounts used in computing net loss per share under the provisions of SFAS 128. 1997 ------------ Net loss $(10,191,720) Less preferred dividends 5,540 ------------ Loss applicable to common shareholders $(10,197,260) ============ Proforma weighted average number of common shares used in basic and diluted net loss per common share 8,267,296 Net loss per common share - Basic and diluted $ (1.23) ============ Per share amounts are not reflected for 1996 and 1995 due to the recapitalization of the Company as a result of the reverse acquisition in 1997. F-21 (Continued) AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements For the period prior to the reverse acquisition, the number of shares outstanding of Matrix multiplied by the exchange ratio was used to calculate the weighted average number of shares outstanding for pro forma purposes. Basic and diluted proforma net loss per common share are equal as assuming conversion of potentially dilutive securities would be antidilutive. At December 31, 1997, the Company has 509,947 outstanding options at a weighted-average exercise price per share of $2.49 (note 7) and 207,700 shares of preferred stock which are convertible into an equal number of shares of common stock (note 4). The potentially dilutive effect of these securities has not been considered in the computation of diluted net loss per common share since their effect would be antidilutive. (9) Leasing Activities and Other Commitments The Company leases office space and various equipment under operating leases expiring in various years through 2001. In the normal course of business, operating leases are generally renewed or replaced by other leases. Total rental expenses were $245,000 in 1997, $325,000 in 1996 and $239,000 in 1995. Future minimum lease payments under noncancelable operating leases (with initial or remaining lease terms in excess of one year) and future minimum capital lease payments as of December 31, 1997 are: 1998 - $353,000; 1999 - $353,000; 2000 - $329,000 and 2001 - 68,000. Substantially all of the Company's switching and transmission facilities have been provided by two suppliers under negotiated contractual agreements. The Company purchases long distance services at certain per-minute rates, which vary depending on the time and type of call. At December 31, 1997, there are outstanding contractual agreements committing the Company to $6,773,000 minimum usage for 1998. (10) Contingencies The Company presently has contingent liabilities relating to various lawsuits and other matters related to the conduct of its business. On the basis of information furnished by counsel and others, management believes these contingencies upon resolution will not materially affect the financial condition or results of operations of the Company. F-22 AVTEL COMMUNICATIONS, INC. AND SUBSIDIARIES Schedule II - Valuation and Qualifying Accounts Years ended December 31, 1997, 1996, and 1995 Balance at Balance at beginning end of Description of period Additions (a) Deductions (b) period Allowance for doubtful accounts - year ended December 31, 1997 $ 627,000 1,829,770 1,474,770 982,000 ========== ========= ========= ======= Allowance for doubtful accounts - year ended December 31, 1996 $ 730,000 1,461,471 1,564,471 627,000 ========== ========= ========= ======= Allowance for doubtful accounts - year ended December 31, 1995 $ 789,000 1,955,842 2,014,842 730,000 ========== ========= ========= ======= (a) Charged to costs and expense (b) Accounts written off F-23 EXHIBIT INDEX Exhibit Number Title of Document Page Number - ---- --------------------------------------------------- ----------- 2.1 Acquisition Agreement, dated as of August 30, 1996, by and among Hi-Tiger International, Inc., a Utah corporation, AvTel Communications, Inc., a Utah corporation, and AvTel Holdings, Inc., a California corporation. (Incorporated by reference to Exhibit A to Registrant's Information Statement on Schedule 14C dated October 2, 1996). 2.2 Amendment No.1 to Acquisition Agreement, dated October 22, 1996, among Hi-Tiger International, Inc., AvTel Communications, Inc. and AvTel Holdings, Inc. (Incorporated by reference to Exhibit 2.2 to Registrant's Current Report on Form 8-K dated October 23, 1996). 2.3 Agreement and Plan of Reorganization, dated November 20, 1996 between the Registrant and Silicon Beach Communications, Inc. (Incorporated by reference to Exhibit 10.04 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1996). 2.4 Stock Purchase Agreement, dated as of February 1, 1997, by and among the Registrant, Hi, Tiger, Inc., WestNet Communications, Inc., Theodore E. Padova, Howard M. Tamaroff and Christiana G. Bryson, Hallas Color Photo Lab, Inc., dba Image Source, Inc., Joseph P. and Lisa Gerardin, James D. Hennigan, Kathleen Sweeney Jonsson and Alan J. Noelle. (Incorporated by reference to Exhibit 2.1 to Registrant's Current Report on Form 8-K dated February 21, 1997). 2.5 Stock Exchange Agreement, dated as of April 29, 1997, by and between the Registrant and Matrix Telecom, Inc. (Incorporated by reference to Exhibit 2 to Registrant's Current Report on Form 8-K dated April 30, 1997). 2.6 Amendment to Stock Exchange Agreement, dated as of August 25, 1997, by and between AvTel Communications, Inc. and Matrix Telecom, Inc. (Incorporated by reference to Exhibit 2 to Registrant's Current Report on Form 8-K dated August 25, 1997). 2.7 Agreement and Plan of Merger, dated as of October 3, 1997, between AvTel Communications, Inc., a Delaware corporation and AvTel Communications, Inc., a Utah corporation. (Incorporated by reference to Exhibit 2.7 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1997). 3.1 Certificate of Incorporation of the Registrant. (Incorporated by reference to Exhibit 3.1 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1997). 3.2 Bylaws of the Registrant. (Incorporated by reference to Exhibit 3.2 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1997). 10.1 Rights Agreements dated October 23, 1996, between the Registrant and holders of the Registrant's Series A Convertible Preferred Stock. (Incorporated by reference to Exhibit 4.2 to Registrant's Current Report on Form 8-K dated October 23, 1996). 10.2 Employment Agreement, dated as of August 1, 1996, between the Registrant and Anthony E. Papa. (Incorporated by reference to Exhibit 10.01 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1996). 10.3 Employment Agreement, dated as of August 1, 1996, between the Registrant and James P. Pisani. (Incorporated by reference to Exhibit 10.01 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1996). 10.4 Employment Agreement, dated as of November 20, 1996, between the Registrant and Frank Dziuba. (Incorporated by reference to Exhibit 10.4 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1997). 10.5 Employment Agreement, dated as of January 27, 1997, between the Registrant and D. Stephen DeWindt, as amended. (Incorporated by reference to Exhibit 10.5 to Registrant's Annual Report on Form 10-KSB for the year ended September 30, 1997). 10.6 1997 Stock Incentive Plan. (Incorporated by reference to Exhibit A to the Registrant's definitive Proxy Statement on Schedule 14A dated January 8, 1997.) 10.7 Registration Rights and Lockup Agreement dated December 1, 1997, between the Registrant and Matrix Telecom, Inc., on behalf of the stockholders of Matrix, (Incorporated by reference to Exhibit 4 to Registrant's Current Report on Form 8-K dated December 1, 1997). 10.8 Triple Net Real Property Lease (Multi-Tenant Building) dated as of February 16, 1998, by and between Bath Street Partners, a California limited partnership and the Company. 10.9 Commercial Lease Agreement dated February 28, 1995, Matrix Telecom, Inc. and Ameritas Life Insurance Corp., as amended by Lease Modification Agreement dated March 2, 1995. 10.10 Resale Solutions Switched Services Agreement dated March 12, 1998, between Matrix Telecom, Inc. and Sprint Communications Company L.P. 10.11 IXplus License Agreement dated as of April 23, 1991, between Matrix Telecom and Electronic Data Systems Corporation, as amended by Amendment Number One dated as of October 1, 1992. 21 List of Subsidiaries. 23 Consent of KPMG Peat Marwick LLP. 27 Financial Data Schedule. EX-10 2 TRIPLE NET REAL PROPERTY LEASE EXHIBIT 10.8 TRIPLE NET REAL PROPERTY LEASE (Multi-Tenant Building) THIS TRIPLE NET REAL PROPERTY LEASE (this "Lease"), dated for reference purposes only as of February 16, 1998, is made and entered into by and between BATH STREET PARTNERS, a California limited partnership (the "Landlord"), and AVTEL COMMUNICATIONS, INC., a Delaware corporation (the "Tenant"), who, intending to be legally bound, agree as follows: 1. LEASED PREMISES Landlord leases to Tenant, and Tenant leases from Landlord, those certain premises identified as the entire first floor of the building located at 505 Bath Street, Santa Barbara, California (the "Building"), as depicted on the Plot Plan attached as Exhibit A (the "Premises"), together with all fixtures presently located in the Premises, upon the terms and conditions set forth below. Landlord and Tenant acknowledge and agree that the Premises consist of 6,978 square feet. The Premises do not include approximately 1,317 square feet on the first floor of the Building comprised of the stair and elevator wells, pump rooms, back reception area, the electric room, and the mail room. 1.1 Acceptance of Condition. Landlord shall remove all of the prior tenant's furnishings prior to the Commencement Date. The Premises are accepted "AS IS" by Tenant, after Tenant's inspection, in the condition in which they exist as of the execution of this Lease. Tenant acknowledges that there are no warranties, express or implied, made by Landlord with regard to the Premises. 1.2 Parking. Tenant shall have the nonexclusive right, in common with the other tenants of the Building, to use parking spaces used by all tenants of the Building. Prior to the Commencement Date, Landlord shall cause all existing reserved spaces for the Building to be relocated or eliminated. 1.3 Phone Room. Landlord shall have reasonable access to the main phone room in the Premises with 24 hours' prior notice except in the event of an emergency. Tenant may relocate the other tenant's phone and computer equipment from this room at Tenant's expense and with Landlord's prior approval of the relocation site. 1.4 New Address. Tenant shall, within ninety (90) days from the Commencement Date, take such actions as may be necessary to obtain a separate street address for the Premises. From and after the date that a separate street address is obtained for the Premises, the Premises shall be deemed to refer to such new street address. 2. TERM 2.1 Initial Term. The term of this Lease (the "Term") shall commence thirty (30) days from the execution of this Lease by Landlord and Tenant (the "Commencement Date"). The Term shall expire upon the passage of five (5) years from that date, unless sooner terminated as provided in this Lease. 2.2 Options to Extend. Landlord hereby grants to Tenant, on the terms and conditions set forth below, one (1) conditional option (the "Option") to extend the term of this Lease for an additional period of five (5) years (the "Renewal Term"). The Renewal Term shall be subject to all of the provisions of this Lease. Landlord has no duty whatsoever to advise or remind Tenant of its rights hereunder. The right of Tenant to exercise the Renewal Term to extend the term of the Lease is subject to the satisfaction of the following conditions precedent: 2.2.1 The Lease shall be in effect at the time notice of exercise is given and on the last day of the expiring term of the Lease; 2.2.2 Landlord shall not, in good faith, have at any time served Tenant with a three-day notice to pay rent or quit under California Code of Civil Procedure Section 1161 during the preceding term of the Lease; 2.2.3 Tenant shall not be in default at the time notice of exercise is given or on the last day of the then-expiring term of the Lease; and 2.2.4 Tenant shall have given notice of exercise of its Option pursuant to this Section 2.2 not less than one hundred eighty days, nor more than two hundred ten days, prior to the expiration of the then-expiring term of this Lease. 3. RENT Commencing thirty days from the Commencement Date (the "Rent Commencement Date"), Tenant shall pay to Landlord the minimum monthly rent provided in Section 3.1, all Operating Costs provided in Section 3.2, and any other payments required under the terms of this Lease, without set-off or reduction. All such sums owing under this Lease shall be considered additional rent ("Rent") and shall be payable at Landlord's office identified on the signature page of this Lease. Minimum monthly rent and all additional Rent shall be payable in advance, commencing on the Rent Commencement Date, and continuing on the first day of each month thereafter during the term of this Lease, without reduction or set-off (except as otherwise expressly provided in Section 3.5). Upon execution of this Lease, Tenant shall prepay the first month's minimum monthly rent that would otherwise be due on the Rent Commencement Date. Should the Rent Commencement Date be a date other than the first day of a month, then the rent due on the Rent Commencement Date shall be prorated, on the basis of a thirty-day month, for the number of days between the Rent Commencement Date (including the Commencement Date) and the end of the month in which the Rent Commencement Date occurs. 3.1 Minimum Monthly Rent. 3.1.1 The minimum monthly rent payable from the Rent Commencement Date through the expiration of the first twelve (12) months of the Term shall be One Dollar and Seventy Cents ($1.70) per square foot, or Eleven Thousand Eight Hundred Sixty-Two Dollars and Sixty Cents ($11,862.60). 3.1.2 The minimum monthly rent shall be adjusted upon the expiration of the first year of the Term and each year thereafter. Commencing on the first day of the thirteenth month of the Term (the "Adjustment Date"), the parties shall ascertain from the official Consumer's Price Index for Urban Wage Earners and Clerical Workers, All Items, for the Los Angeles, Anaheim-Riverside area, 1982-1984=100 Base, as published by the United States Department of Labor, Bureau of Labor Statistics (the "Index") the Index figure for the month four months preceding the Commencement Date (the "Base Index"), and for the corresponding month prior to the Adjustment Date (the "Adjustment Index"). The minimum monthly rent payable from each Adjustment Date until the next date upon which minimum monthly rent is adjusted as provided in this Lease shall be determined by multiplying the minimum monthly rent payable at the Rent Commencement Date by a fraction, the numerator of which shall be the Adjustment Index, and the denominator of which shall be the Base Index. Notwithstanding the preceding, in no event will the adjusted minimum monthly rent be less than two percent (2%) more than the minimum monthly rent in effect prior to the Adjustment Date, nor more than five percent (5%) more than the minimum monthly rent in effect prior to the Adjustment Date. A. If the Index is no longer published on the Adjustment Date, then appropriate reference figures for the Base Index and the Adjustment Index shall be derived from any successor or comparable index mutually agreed by the parties to be authoritative. If the parties are unable to agree, then the substituted index shall be selected by the then-presiding judge of the Santa Barbara County, California Superior Court upon the application of either party. B. The parties acknowledge that the Adjustment Index may not be available on the Adjustment Date. In such event, the minimum monthly rent in effect immediately prior to the Adjustment Date shall continue in effect until the appropriate Index figure is available. At that time, an appropriate adjustment shall be made (retroactive to the Adjustment Date) between Landlord and Tenant with respect to the minimum monthly rent payable by Tenant. Any amounts then determined to be owing by Tenant to Landlord shall be paid by Tenant within ten (10) days following Landlord's delivery to Tenant of written notice of the appropriate adjustment. No delay by Landlord in the delivery of any such notice shall constitute a waiver by Landlord of the right to receive any rent owing. 3.1.3 The minimum monthly rent payable during the first year of the Renewal Term shall be the greater of (a) the Fair Market Rental of the Premises upon the commencement of any such Renewal Term, or (b) the minimum monthly rent in effect immediately prior to the expiration of the immediately preceding Initial Term. Such Fair Market Rental shall be determined in accordance with the provisions of this Section 3.1.3. A. The following definitions shall apply for the purposes of this Section 3.1.3: (1) "Fair Market Rental" means the price at which a willing landlord and a willing tenant would rent the Premises, or similar first class premises having comparable visibility, parking, access and location that the Premises have, neither being under abnormal pressure to rent. For the purposes of determining such Fair Market Rental, it shall be assumed that the Tenant will not require that any tenant improvements be made to the Premises in connection with its occupancy. The Fair Market Rental shall be determined by giving appropriate consideration to rental rates per rentable square foot, the type of escalation clauses contained in leases for comparable premises, the length of the Renewal Term, the fact that this Lease is a Triple Net Lease, the location of the Premises being leased and other generally applicable terms and conditions of leases for comparable premises. (2) "Qualified Appraiser" shall mean a State certified general real estate appraiser qualified for commercial lease rental appraisals of the type of property and the improvements then comprising the Premises with at least five years' full-time commercial appraisal experience in Santa Barbara County. B. Commencing six months prior to the expiration of the Initial Term, if Tenant has properly exercised its Option for the Renewal Term, Landlord and Tenant shall attempt to agree upon the Fair Market Rental for the Premises within fifteen days. If Landlord and Tenant are able to agree on such Fair Market Rental, the amount so agreed upon shall become the Fair Market Rental upon the commencement of the Renewal Term. C. If Landlord and Tenant fail to agree upon the Fair Market Rental within the fifteen-day period set forth in Subsection B, above, then within ten days following the expiration of such fifteen-day period Landlord shall appoint a Qualified Appraiser, at its sole cost and expense, to appraise the Fair Market Rental of the Premises within thirty days following the appointment of the appraiser. Following such determination, Landlord shall give notice to Tenant of the appraised Fair Market Rental of the Premises. If Tenant does not dispute such appraised Fair Market Rental, it shall be the Fair Market Rental upon the commencement of the Renewal Term. If Tenant disputes such appraised Fair Market Rental, then within ten days after the delivery of notice of such Fair Market Rental delivered by Landlord, Tenant shall appoint a Qualified Appraiser, at its sole cost and expense, to appraise the Fair Market Rental of the Premises within thirty days following the appointment of the second appraiser. Within ten days following the completion of the second appraisal, the two appraisers so appointed shall endeavor to agree upon a Fair Market Rental for the Premises. D. If such two appraisers are able to agree as to the Fair Market Rental of the Premises within ten days after the second appraisal has been completed, then the appraisers shall so inform Landlord and Tenant of their decision, and such agreed upon Fair Market Rental shall become the Fair Market Rental upon the commencement of the Renewal Term. If such appraisers are unable to agree on the Fair Market Rental for the Premises within such ten-day period, then the appraisers shall, within five days of the expiration of such ten-day period, designate a third Qualified Appraiser and give written notice to Landlord and Tenant of their inability to agree and the Fair Market Rental proposed by each appraiser. Such notice shall also specify the third Qualified Appraiser designated by such two appraisers. Either Landlord or Tenant may appoint such designated third Qualified Appraiser to assist in the determination of Fair Market Rental by delivering written notice of such election to the other within five days of the expiration of such ten-day period without an agreement as to the Fair Market Rental by the two Qualified Appraisers. If a third Qualified Appraiser is appointed, then the fees and costs of the third appraiser shall be borne equally by Landlord and Tenant. E. Upon appointment of the third Qualified Appraiser, the three appraisers shall meet and attempt to reach agreement upon the Fair Market Rental for the Premises for the Renewal Term within the ten-day period following the appointment of the third Qualified Appraiser. If the three Qualified Appraisers are able to reach unanimous agreement regarding the Fair Market Rental, the agreed upon Fair Market Rental shall become the Fair Market Rental upon the commencement of the Renewal Term. If the three Qualified Appraisers are unable to agree upon the Fair Market Rental, then the Third Qualified Appraiser shall appraise the Fair Market Rental of the Premises within thirty days following the expiration of such ten-day period. On or prior to the expiration of such thirty-day period, the three Qualified Appraisers shall give Landlord and Tenant written notice of their inability to agree and the Fair Market Rentals proposed by each appraiser. If the highest appraised Fair Market Rental is more than one hundred five percent (105%) of the middle appraised Fair Market Rental, then the highest appraised Fair Market Rental shall be disregarded. If the lowest appraised Fair Market Rental is less than ninety-five percent (95%) of the middle appraised Fair Market Rental, then the lowest appraised Fair Market Rental shall be disregarded. If there is then only one remaining appraised Fair Market Rental, it shall be the Fair Market Rental upon the commencement of the Renewal Term. If there is then more than one remaining appraised Fair Market Rental, the remaining appraised Fair Market Rentals shall be averaged and the average of such appraised Fair Market Rentals shall be the Fair Market Rental upon the commencement of the Renewal Term. F. If the appraisal proceedings provided for in this Section are not complete prior to the commencement of the Renewal Term, then Tenant shall pay the minimum monthly rent in effect immediately prior to such Renewal Term until the appraisal proceedings have been completed and a new minimum monthly rent is determined. Once the new minimum monthly rent has been determined, a retroactive adjustment to such rent shall be made, effective as of the commencement date of the Renewal Term. Within ten days after the date on which the new minimum monthly rent has been determined, (1) Tenant shall pay any deficiency owing to Landlord, and (2) Landlord and Tenant shall enter into a written agreement setting forth the minimum monthly rent upon the commencement of the Renewal Term. G. Following the establishment of the minimum monthly rent upon the commencement of the Renewal Term, such minimum monthly rent shall be adjusted as provided herein. The adjustment shall be made in accordance with the provisions of Section 3.1.2, with the following modifications: (1) all references to the "Initial Term" shall be deemed to refer to the Renewal Term; (2) the term "Commencement Date" shall refer to the first day of the Renewal Term; and (3) the term "Rent Commencement Date" shall be deemed to refer to the first day of such Renewal Term. 3.2 Common Area Expenses; Operating Costs. 3.2.1 In addition to any other payments due under this Lease, Tenant shall pay to Landlord, as additional rent, Tenant's monthly proportionate share of Landlord's estimated total Operating Costs. Such payments shall commence on the Rent Commencement Date and continue thereafter through the end of the Term. For the purposes of this Lease, the term "Operating Costs" shall mean all costs and expenses whatsoever incurred or accrued by Landlord in connection with the ownership, operation, maintenance, repair and improvement of the Premises, the common areas, the Building and the land upon which the Building is situated (collectively, the "Property"), except as otherwise specifically provided in this Lease. Tenant's proportionate share of the total Operating Costs (the "Tenant's Proportionate Share") shall be forty-three percent (43%). Landlord estimates that Tenant's Proportionate Share of the Operating Costs will be $0.50 per square foot per month. In no event shall Tenant's Proportionate Share of the Operating Costs for the calendar year 1998 exceed $0.60 per square foot per month. After the calendar year 1998, the foregoing limitation of Tenant's Proportionate Share of the Operating Costs shall not apply. A. Operating Costs for any portion of Landlord's accounting period not included within the Term, or occurring prior to the Rent Commencement Date, shall be prorated on the basis of a 360-day year. B. The accounting period for determining Landlord's total Operating Costs shall be the calendar year, except that the first accounting period shall commence on the Rent Commencement Date and the last accounting period shall end on the date the Term expires or Lease otherwise terminates. 3.2.2 Tenant shall pay Tenant's Proportionate Share of Operating Costs as additional rent owing in the manner provided in this Section 3.2.2. A. Landlord may furnish to Tenant, on the Rent Commencement Date and at the commencement of each accounting period, an estimate of the Operating Costs reasonably anticipated by Landlord for the ensuing accounting period or the remainder of such accounting period, and Tenant's Proportionate Share thereof, calculated on a monthly basis. If Tenant's Proportionate Share of the actual Operating Costs for the preceding accounting period exceeds the estimated payments made by Tenant, then Tenant shall pay any deficiency to Landlord within ten (10) days after Tenant's receipt of Landlord's statement. Should the estimated payments made by Tenant during the preceding accounting period exceed Tenant's Proportionate Share of the Operating Costs, Landlord shall credit Tenant the excess through reductions to the subsequent accounting period's payments of Tenant's Proportionate Share of Operating Costs due from Tenant. B. Alternatively, Landlord may bill Tenant for Tenant's Proportionate Share of the actual Operating Costs incurred by Landlord. Any such bill shall be made in arrears for Operating Costs incurred during the preceding month, and shall be due and payable within ten (10) days following delivery of such bill. The expiration of the Term shall not affect Tenant's obligation to pay its Proportionate Share of Operating Costs accrued during the last month of the Term. 3.2.3 As used herein, the term "Operating Costs" shall include, without limitation, all amounts paid or incurred by Landlord for: real property taxes and assessments, as provided in Section 4, and other taxes and assessments of any nature levied and assessed against Landlord on account of, and/or against the, Property; repair, remodeling, renovation, replacement, improvement and operation of the Property, including, without limitation, wiring, machinery and equipment, plumbing, sewers, the roof, load bearing exterior walls, joists, supports, subflooring, gutters, downspouts, heating, ventilating and air-conditioning, glass and doors, and reasonable reserves pertaining thereto; Landlord's reasonable costs of supervision and administration, including the costs of any property manager engaged by Landlord; attorneys' fees and costs not relating to a particular tenant or lease; maintenance of the Property, including, without limitation, costs of resurfacing and repainting, costs of security, cleaning, sweeping, and other services, supplies, policing, purchase, construction, location, and maintenance of refuse receptacles, maintaining and operating the heating, ventilating, and air-conditioning equipment and related distribution facilities and controls providing climatic control of the common areas, the Building and the Premises, planting and relandscaping, maintaining directional signs and other markers and lighting; premiums and deductible amounts payable on insurance purchased by Landlord as provided herein; and all costs of utilities used in connection with the maintenance, operation and management of the Property that are not separately metered and billed to particular tenants. 3.2.4 Landlord shall keep at its principal place of business, full, accurate and separate books of account showing Landlord's Operating Costs. The statements of Landlord to Tenant shall accurately reflect the total Operating Costs shown on such books of account. These books of account shall be retained by Landlord for at least six (6) months after the close of each accounting period. Tenant shall have the right at reasonable times during the Term to inspect these books of account. 3.2.5 Notwithstanding the foregoing, Landlord reserves the right to bill Tenant promptly for any surcharge or penalty incurred by Landlord as a result of utilities in the Premises or the Building in which the Premises are located. If such surcharge or penalty pertains to the Premises, Tenant shall pay all of such penalty or surcharge. If such surcharge or penalty relates to the Building or common area, Tenant shall pay its pro rata portion. Such payment shall be payable in full prior to the expiration of thirty (30) days from the date Landlord delivers such a statement of the amount of the surcharge to Tenant. 3.3 Late Payment Charges. If Tenant fails to make any payment of rent within five (5) days of the date when such payment first becomes due, or if any check tendered to Landlord by Tenant is returned to Landlord by Tenant's bank for insufficient funds, then Tenant shall pay to Landlord, in addition to such payment, a late charge in the amount of five percent (5%) of the rent or other payment due. The parties agree this late payment charge is a reasonable estimate of the amount necessary to reimburse damages and additional costs not contemplated by this Lease that Landlord will incur as a result of the delinquent payment or returned check, including processing and accounting charges and late charges that may be imposed on Landlord by its lender. Upon notice of nonpayment given by Landlord to Tenant, the entire amount then due, including such late charge, shall thereafter bear interest at the highest rate permitted by law on the due date for such payment, until paid in full. Landlord's acceptance of any payment shall not constitute waiver of any late charges or interest which may be due. 3.4 Security Deposit. On execution of this Lease, Tenant shall deposit with Landlord Eleven Thousand Eight Hundred Sixty-Two Dollars and Sixty Cents ($11,862.60), as a security deposit (the "Security Deposit") for the performance by Tenant of the provisions of this Lease. If Tenant is in default, Landlord may use the Security Deposit, or any portion of it, to cure the default or to compensate Landlord for all damage sustained by Landlord resulting from Tenant's default. Tenant shall immediately on demand pay to Landlord any amounts required to maintain the Security Deposit in the amount required to be deposited with Landlord. Upon the adjustment of any minimum monthly rent owing, Tenant shall deposit with Landlord such sum as necessary to maintain the Security Deposit in the same proportion to the minimum monthly rent then owing as the original Security Deposit bore to the initial minimum monthly rent. Landlord's obligations with respect to the Security Deposit are those of a debtor and not a trustee. Landlord may maintain the Security Deposit separate and apart from Landlord's general funds or may commingle the Security Deposit with Landlord's general and other funds. Landlord shall not be required to pay Tenant interest on the Security Deposit. In the event of bankruptcy or other debtor-creditor proceedings against Tenant, the Security Deposit shall be offset against any unpaid rent. If Tenant is not in default at the termination of this Lease, and after Tenant has vacated the Premises, then Landlord shall return the Security Deposit, less any damages, to Tenant (or at Landlord's option, to the last assignee, if any, of Tenant's interest). 3.5 Temporary Rent Abatement. Provided that Tenant is not in default of its obligations under this Lease, minimum monthly rent shall abate for the first six (6) months for which rent is payable in the amount of Four Thousand Six Hundred Fifty-Two Dollars ($4,652) per month, for total rent abatement of Twenty-Seven Thousand Nine Hundred Twelve Dollars ($27,912) (i.e., 6,978 square feet x $4.00 per square foot). 4. PROPERTY TAXES AND ASSESSMENTS 4.1 Personal Property Taxes. Tenant shall pay before delinquency all taxes assessed against any personal property of Tenant installed or located in or upon the Premises and that are attributable to any period included within the Term, whether or not such taxes are actually payable during the Term. 4.2 Real Property Taxes. In addition to all other rent payable by Tenant, Tenant agrees to pay as additional rent Tenant's Proportionate Share of real property taxes levied and assessed against the Property. Such payments shall be made as a part of Tenant's payments of Tenant's Proportionate Share of Operating Costs, as provided above. Real property taxes for any fractional portion of a fiscal year included in the Term shall be prorated on the basis of a 360-day year. 4.3 Taxes Defined; Special Assessments. The term "real property taxes"as used in this Section shall include, without limitation, all taxes, assessments, improvement bonds, levies and other governmental charges, general and special, ordinary and extraordinary, of any kind and nature whatsoever, levied or assessed against the Property, or against Landlord as a result of its ownership thereof, including but not limited to, assessments for public improvements or benefits that are levied or assessed against the Property, and any changes in taxes resulting from a change in ownership or other reassessment, but excluding franchise, estate, inheritance, succession, capital levy, transfer, income or excess profits tax imposed upon Landlord. If at any time during the Term, under the laws of California, or any political subdivision thereof in which the Premises are situated, a tax or excise on rents or other tax, however described, is levied or assessed against Landlord on account of the rent expressly reserved hereunder, in addition to or as a substitute in whole or in part for taxes assessed or imposed by California or such political subdivision on land and/or buildings, such tax or excise shall be included within the definition of "real property taxes", but only to the extent of the amount thereof which is lawfully assessed or imposed as a direct result of Landlord's ownership of leases related to the Property, or of the rental accruing under such leases. With respect to any assessment which may be levied against or upon the Property, and which, under the laws then in force, may be evidenced by improvement or other bonds, or may be paid in installments, Tenant shall be required to pay each year only the amount of such installments as Landlord is required to pay during such year (with appropriate proration for any partial year) and shall have no obligation to continue such payments after the expiration of the Term. 5. UTILITIES Tenant shall pay when due all utility charges when separately billed to Tenant because of separate installation or connection of service by Tenant. Any utility, including, without limitation, refuse disposal, for which no separate installation or connection can be made for Tenant, shall be paid as prorated in Landlord's discretion among Tenants of the Building based on either percentage of leased space or estimated usage, as reasonably determined by Landlord. Tenant shall comply with all applicable laws and regulations and rules regarding utilities. The suspension or interruption in utility services to the Property for reasons beyond Landlord's ability to control shall not constitute a default by Landlord or entitle Tenant to any reduction or abatement of rent. 6. LANDLORD'S MANAGEMENT OF THE BUILDING 6.1 Management of the Building. Landlord shall have the right, at its sole cost and expense, which will be reimbursed by Tenant as an Operating Cost: 6.1.1 To close the common areas when and to the extent necessary for maintenance or renovation purposes or to prevent a dedication of any part thereof or the accrual of any rights therein in favor of the public or any third person; 6.1.2 To make changes to the common areas, including, without limitation, changes in the location or nature of entrances and exits; 6.1.3 To remodel or renovate the Property and, in connection therewith, to install pipes, supports, utilities, conduits, ducts and similar fixtures beneath or through the Premises, provided that such remodeling or renovation does not substantially change the size, dimension, configuration or nature of the Premises or unreasonably interfere with Tenant's use thereof; and 6.1.4 To change the plan of the Building to the extent necessary for its expansion, or the remodeling or renovation thereof, so long as the changes do not substantially interfere with ingress to and egress from the Premises. 6.2 Other Tenants. Landlord reserves the right to effect such other tenancies in the Building as Landlord, in the exercise of its sole business judgment, determines will best promote Landlord's interests. Tenant acknowledges that Tenant does not rely on the fact, and Landlord does not represent, that any specific tenant, or number or type of tenants, shall occupy any space in the Building. 6.3 Rules and Regulations. Landlord shall have the right, from time to time, to promulgate, amend and enforce against all occupants of the Building, reasonable rules and regulations for the safety, care and cleanliness of the Building, or for the preservation of good order. All such rules and regulations shall apply without discrimination to all occupants and tenants in the Building. Tenant agrees to conform to and abide by such rules and regulations. A violation of any of them shall constitute a default by Tenant under this Lease. 6.4 Tenant's Use of Premises. Tenant agrees that the Premises shall be used and occupied only for general office use, and for no other purpose whatsoever without Landlord's prior written consent. No exclusive rights regarding use are granted. Tenant shall neither engage in nor permit others to engage in any activity or conduct that will cause the cancellation of or an increase in the premium for any fire or other insurance maintained by Landlord. 6.5 Compliance with Law. Tenant shall, at Tenant's sole cost and expense, comply promptly and at all times with all laws, requirements, ordinances, statutes, and regulations of all municipal, state or federal authorities, or any board of fire insurance underwriters, or other similar bodies, now in force, or which may hereafter be in force, pertaining to the Building and the Premises and the occupancy thereof, including, without limitation, any law that requires alteration, maintenance or improvement of the Premises as the result of Tenant's use. 6.6 Waste, Nuisance. Tenant shall not commit, or suffer to be committed, any waste of the Premises, or any nuisance, annoyance or other unreasonable annoyance which may disturb the quiet enjoyment of other portions of the Building or the common areas by the owners or occupants. 7. CARE AND MAINTENANCE 7.1 Landlord's Maintenance. Except as otherwise provided in this Lease, Landlord agrees to maintain in good condition and repair (1) the structural components of the Building, which structural components are limited to the foundation and the exterior walls; (2) the common areas and the exterior of the Building; and (3) any heating, ventilating and air conditioning systems furnished by Landlord to the common areas or to the Building. All such costs, whether related to repairs, replacements or improvements, shall be Operating Costs. 7.2 Tenant's Maintenance. Except as otherwise provided in this Lease, Tenant, at its own cost and expense, agrees: 7.2.1 To maintain throughout the Term in good and sanitary order, condition and repair, all portions of the Premises, including, without limitation, (1) the interior of the Premises, including flooring, exposed plumbing and wiring, paint and finish; (2) any windows, lights or skylights; (3) any storefront or portion of the Premises fronting on any common area or the exterior of the Building; (4) any heating, ventilating and air conditioning which serves only the Premises; and (5) any personal property of Tenant situated in or upon the Premises; 7.2.2 To notify Landlord promptly of any damage to the Premises resulting from or attributable to the acts or omissions of Tenant, its invitees or its authorized representatives, or any other party and thereafter to promptly repair all such damage; and 7.2.3 To keep the front of the Premises adjacent to any property line or common area, any area adjacent thereto, and the refuse area used by Tenant clean and neat at all times, and to remove immediately therefrom any litter, debris or other unsightly or offensive matter placed or deposited thereon by Tenant's agents or customers. 8. IMPROVEMENT TO LEASED PREMISES Any improvements to the Premises shall be constructed by Tenant, or its designated agent, at Tenant's sole cost and expense. Tenant shall pay, prior to delinquency, absolutely all costs for such improvements. 8.1 Conditions to Commencement of Construction. Before construction of the improvements is commenced on the Premises, and before any building materials have been delivered thereto by or pursuant to the authority or request of Tenant, Tenant shall comply with the following conditions, or obtain Landlord's prior written waiver thereof: 8.1.1 Tenant shall prepare and deliver to Landlord for approval a complete set of all preliminary and final plans and specifications to be utilized by Tenant for the purpose of constructing the new improvements. Tenant must obtain the written approval of Landlord to the final plans and specifications prior to the commencement of any construction work. Tenant will reimburse Landlord for Landlord's architect's or contractor's charges to review these plans. Landlord shall not unreasonably withhold approval of the plans and specifications. No review, inspection or approval by Landlord, or its architect, shall relieve Tenant of any liability or create any obligation or responsibility for Landlord. 8.1.2 Tenant shall give Landlord at least fifteen (15) days' written notice prior to (a) the commencement of construction of any tenant improvements, or (b) the delivery of any building materials to the site. Landlord, or, upon request, Tenant, as the agent of Landlord, shall post on and affix to the Premises a "Notice of Non-Responsibility" in the name and on behalf of Landlord, as provided in Sections 3094 and 3129 of the California Civil Code, and shall cause such Notice to be recorded promptly following posting in the Santa Barbara County Recorder's Office. 8.1.3 Tenant shall purchase and maintain in effect, until a Notice of Completion is filed and recorded, insurance coverage for all-risk "Builders' Risk" or "Course of Construction" insurance and "Worker's Compensation" insurance covering all persons employed in connection with the construction of the improvements and with respect to whom claims could be asserted against Landlord, the Building or the Premises. Tenant shall furnish to Landlord certificates of such insurance, and evidence of the payment of premiums therefor, and for any other insurance required by the provisions of this Lease to be furnished by Tenant. 8.1.4 Tenant shall pay, when due, all claims for labor or materials furnished or alleged to have been furnished to or for Tenant. Landlord reserves the right to require Tenant to deliver to Landlord payment and performance bonds in an amount equal to one hundred fifty percent (150%) of the estimated cost of the work undertaken by Tenant pursuant hereto. Tenant promptly shall cause the elimination and removal of any mechanic's, materialmen's or other liens arising out of any improvements performed, materials furnished or obliga- tions incurred by or on behalf of Tenant in connection with any tenant improvements in accordance with Section 9.2. 8.2 Construction of Improvements. Tenant warrants and covenants to Landlord that: 8.2.1 The improvements shall be of good quality and the development and construction work shall be performed in a good and workmanlike manner, consistent with and comparable to standards of practice in the area in which the Building is located for similar space of first-class construction; 8.2.2 Tenant shall secure or cause to be secured all permits and licenses necessary for the proper construction and completion of the improvements, and shall assume full responsibility for the compliance of Tenant and the improvements with all governmental laws, codes, ordinances, regulations and standards applicable thereto; and 8.2.3 The improvements shall be constructed in accordance with the plans and specifications. All such improvements shall be completed by Tenant and a certificate of occupancy for the Premises shall be obtained by Tenant on or before the Commencement Date. Tenant shall give notice to Landlord of the imminent completion of the improvements not less than ten (10) days prior to their expected completion. Promptly upon completion of the improvements, Tenant shall cause a "Notice of Completion" as described in Section 3093 of the California Civil Code, to be filed and recorded in the manner provided by such Section. 8.3 Cooperation by Landlord. Landlord agrees, upon the request of Tenant, to join with Tenant to execute and deliver such documents and instruments as may be necessary or proper for applying for or obtaining any permits, licenses, approvals or records as may be necessary or appropriate to the construction of the improvements and operation of the Premises. Landlord shall incur no expense and no liability as a result of such cooperation. Landlord shall have the right to approve any conditions imposed by any governmental agency in connection with obtaining any such permits, or other documents or approvals, which may impact the Premises separate and apart from Tenant's occupancy thereof, which approval shall not be withheld unreasonably. 8.4 Ownership of Improvements. All of Tenant's improvements constructed hereunder, and all subsequent additions and alterations thereto and replacements thereof, shall be deemed affixed to, become and remain a part of the Premises and shall not be removed, encumbered, transferred or materially altered except as provided by this Lease. Upon the expiration of the Term, or upon the sooner termination of this Lease, all of the improvements other than Tenant's personal property, removable trade fixtures and equipment, shall become the property of Landlord without further obligation to Tenant. 9. ALTERATIONS; LIENS 9.1 Changes by Tenant. Following the completion of the improvements contemplated by Section 8, if any, any alterations, additions, improvements or changes, including any remodeling or redecorating, that Tenant may desire to make in, to or upon the Premises, shall be made at Tenant's sole cost and expense. Prior to undertaking any such alterations, Tenant shall first submit the plans and specifications therefor to Landlord and obtain the consent of Landlord thereto in writing. The parties' rights and obligations with respect to such alterations, additions, improvements or changes shall be identical to those rights and remedies concerning Tenant's construction of improvements, as set forth in Section 8. Should Landlord so elect, any such alterations, additions, improvements or changes shall become a part of the Premises at the expiration or sooner termination of the Lease, and shall be surrendered to Landlord upon the expiration of the Term or the sooner termination of this Lease. Alternatively, at any time prior to the ten (10) days following the expiration or sooner termination of this Lease, Landlord may elect to have Tenant remove any such alterations, additions or improvements. In such case, Tenant shall so remove such items within ten (10) days following Tenant's receipt of Landlord's notice of election, and shall restore the Premises to the condition in which they existed prior to the completion of the work that Landlord specifies should be removed. 9.2 Mechanic's Liens. Tenant agrees to keep the Premises, and any improvements thereon, at all times free of mechanic's liens and other liens for labor, services, supplies, equipment or material purchased by or directly or indirectly furnished to Tenant. Tenant, however, shall have the right to contest the validity or amount of any such lien as filed upon posting a bond in an amount equal to one hundred fifty percent (150%) of the dollar amount sufficient to discharge the lien. Upon the final determination of any such contest, Tenant shall immediately pay and discharge any judgment rendered, together with all costs and charges incidental thereto, and shall cause the lien thereof to be released from the Premises. If Tenant fails, within thirty (30) days after notice of the filing of any such lien, to discharge or cause the release of such liens or charges or to contest the same and post bond as above provided for, then Landlord, at Landlord's option, may satisfy such liens by payment. In such event, the amount of such payment, together with interest thereon at the maximum rate permitted by law, from the time the payment is so made until repayment the- reof, shall be payable by Tenant at the time installment of rent shall be due and payable. Tenant shall reimburse Landlord, within ten days following written demand, for all costs and expenses, including, without limitation, attorneys' fees, incurred by Landlord in connection with addressing any mechanic's liens or similar claims related to Tenant's occupancy of the Premises. 10. TENANT'S PERSONAL PROPERTY 10.1 Installation of Property. Landlord shall have no interest in any removable equipment, furniture or trade fixtures owned by Tenant or installed in or upon the Premises solely at the cost and expense of Tenant. Prior to creating or permitting the creation of any lien or security or reversionary interest in any removable personal property to be placed in or upon the Premises, Tenant shall obtain the written agreement of the party holding such lien or interest to make such repairs required by the removal of such property as may be necessary to restore the Premises to good condition and repair, excepting only reasonable wear and tear, in the event such property is thereafter removed from the Premises by such party, or by any agent or representative thereof or purchaser therefrom, without any cost or expense to Landlord. 10.2 Removal of Personal Property. Tenant shall have the right to remove at its own cost and expense upon the expiration of this Lease all removable equipment, furniture or trade fixtures owned by or installed at the expense of Tenant on the Premises during the Term. All such personal property shall be removed prior to the close of business on the last day of the Term. Tenant shall make such repairs required by the removal of such property and any damage resulting therefrom as may be necessary to restore the Premises to good condition and repair, excepting only reasonable wear and tear. Any such property not so removed shall be deemed to have been abandoned or, at the option of Landlord, shall be removed and placed in storage for the account and at the cost and expense of Tenant. 11. WAIVER AND INDEMNITY This Lease is made upon the express condition that Landlord is to be free from all liability and claims for damages by reason of any injury to any person and damage to any property (including Tenant's), resulting from any cause whatsoever while in, upon, about, or in any way connected with the Premises or the Building in which the Premises is located, during the Term. In no event shall Landlord be liable for events that occur in the common areas, or for damage or injury caused by fire, utility outage or interruption, pipe or sprinkler leakage, or similar causes. Tenant waives all claims against Landlord for, and agrees to defend with counsel acceptable to Landlord, and to indemnify and hold Landlord harmless from, any loss or liability, and all costs or expenses, including attorneys' fees and costs of defense, arising from or attributable to any such injury or damage from any cause at any time related in any way to the Premises during the term hereof, other than those caused by the gross negligence or willful misconduct of Landlord, to the extent of such gross negligence or willful misconduct. This Section 11 shall survive the termination of the Lease. 12. INSURANCE, PUBLIC LIABILITY AND PROPERTY DAMAGE 12.1 Insurance Coverage. Tenant agrees to maintain in force throughout the Term, at Tenant's sole cost and expense, comprehensive general liability insurance with a broad form general liability endorsement insuring against any liability to the public for any claim for damages due to death, bodily injury or property damage related to the use of or resulting from any accident occurring in or about the Premises, with single limit coverage of not less than $1,000,000 for any loss and $3,000,000 for any policy period. 12.1.1 Such policy shall insure the contingent liability of Landlord and the performance by Tenant of its indemnity obligations under this Lease. Landlord shall be named as an additional insured in such policy, and such policy shall contain a cross-liability endorsement. 12.1.2 Tenant further agrees that the amount of the insurance coverage shall be reviewed every three (3) years, at least sixty (60) days before the expiration of a three-year period. If the parties are unable to agree upon the amount of such coverage, Tenant shall be required to maintain for the next three-year period (or prior to the expiration of the Term, whichever is less) the amount of coverage recommended in writing by an insurer selected by Landlord. 12.2 Tenant's Property Insurance. Tenant, at its own cost, shall maintain on all of its personal property and removable fixtures and equipment situated in, on or about the Premises, a policy of standard fire and extended coverage insurance, with vandalism and malicious mischief endorsements (and sprinkler leakage and earthquake sprinkler leakage endorsements, if the Building has sprinklers), to the extent of at least one hundred percent (100%) of their actual replacement cost. The proceeds of any such policy that become payable due to damage, loss or destruction of such property shall be used by Tenant for the repair or replacement of such property. 12.3 Miscellaneous Insurance Provisions. 12.3.1 Each policy of insurance required of Tenant by this Lease shall be a primary policy, issued by an insurance company reasonably satisfactory to Landlord, and shall contain an endorsement requiring thirty (30) days' written notice from the insurer to Landlord before cancellation or change in the nature, scope or amount of coverage. Each policy of insurance maintained by Tenant shall be primary and noncontributing with any policy maintained by Landlord. Each policy, or a certificate of the policy, together with evidence of the payment of premiums, shall be deposited with Landlord at the commencement of the Term of this Lease and prior to any expiration of any such policy. 12.3.2 Landlord and Tenant each release the other, and their respective agents and representatives, from any claims for damage to any person or to the Premises and to the fixtures and personal property situated therein, resulting from or attributable to any risk insured under any insurance policies carried by the parties and in force at the time of the damage. Each party shall cause any insurer providing insurance to it pursuant to this Lease to waive all rights or recovery by way of subrogation against either party by virtue of the payment of any loss under such insurance. Such waiver shall be effective as long as such insurance is required under the provisions of this Lease. 12.4 Casualty Insurance; Damage or Destruction. Landlord shall, at all times during the Term, keep the Building and improvements in which the Premises are situated insured against loss or damage by fire and the perils covered by a combined single limit bodily injury and broad form property damage insurance policy, extended coverage, or an "all risk" insurance, with inflation guard, vandalism and malicious mischief endorsements, zoning ordinance coverage, and any other endorsements selected by Landlord. Landlord, at its discretion, may purchase (a) an earthquake policy of insurance and zoning ordinance coverage, in any amount sufficient to prevent either Landlord or Tenant from becoming a co-insured under the provisions of the policies, (b) a policy of rental value or rent continuation insurance for a period of one year, and (c) any other insurance that may be required from time to time by Landlord's lender. In addition, Landlord may purchase any other insurance which it, in its sole discretion, deems necessary or desirable. All such insurance shall be payable to Landlord and the holder of any encumbrances on the Property as their interests may appear. All of the costs and expenses and deductible amounts of such insurance shall be an Operating Cost. 12.5 Insurable Casualty Loss. 12.5.1 Except as provided in Section 12.5.2, in the event the Premises, or the Building in which the Premises are situated, is damaged or destroyed as the result of any risk required to be insured against by this Section 12, then Landlord shall forthwith restore the Premises or the Building to substantially the same condition as existed immediately prior to such damage or destruction. Any insurance proceeds remaining after the completion of such work shall belong to Landlord. Except as otherwise provided in Section 12.5.2, below, any amount by which the cost of such repair and the deductible amount required by such insurance policies exceeds the amount of such insurance proceeds shall be deemed an Operating Cost pursuant to Section 3.2. 12.5.2 If at any time during the Term, the Premises are totally destroyed, or are sufficiently damaged to render them unusable without substantial repair or reconstruction, due to a casualty required to be insured against as provided herein, or should then applicable laws or zoning ordinances preclude the restoration or repair of the Premises, or should the costs of restoration exceed five percent (5%) of the amount of the insurance proceeds, then Landlord shall have the option, exercisable by giving at least ten (10) days' prior written notice to Tenant within one hundred twenty (120) days after the occurrence of any such casualty, to terminate this Lease. 12.6 Uninsured Casualty Loss. 12.6.1 If, during the Term, the Premises or the Building are damaged or partially destroyed from a risk not required to be insured against by this Section 12, Landlord shall restore the Premises to substantially the same condition as existed immediately prior to such damage or destruction. 12.6.2 If the costs of repair or restoration necessitated by an uninsured casualty loss exceed five percent (5%) of the then replacement value of the Premises, then Landlord shall have the option, exercisable by giving at least ten (10) days' prior written notice to Tenant within one hundred twenty (120) days after the occurrence of any such casualty, to terminate this Lease. 12.7 Termination; Abatement of Rent. This Lease shall not be terminated by any damage to or destruction of the Premises or other improvements of which the Premises are a part, unless notice of termination is given by Landlord to Tenant as provided by this Section 12. Tenant waives the provisions of Section 1932(2) and 1933(4) of the California Civil Code with respect to any such damage or destruction. 12.7.1 Should the Premises be damaged or destroyed at any time during the Term, there shall be an abatement or reduction of the minimum monthly rent, between the date of destruction and the date of completion of restoration, based on the extent to which the destruction interferes with Tenant's use of the Premises. 12.7.2 Should it be determined by Landlord that then-applicable laws or zoning ordinances would preclude the restoration or replacement of the Premises in a manner that will result in the approximate functional equivalent of the Premises, then Landlord shall have the right to terminate this Lease within ninety (90) days of such determination by giving written notice of termination to Tenant. 12.8 Notice; Tenant's Right to Terminate. Notwithstanding any provision of this Lease to the contrary, if Landlord determines in good faith that the repair and restoration of the Premises to be made by Landlord pursuant to this Section 12 reasonably cannot be made within eighteen (18) months following the occurrence of any casualty, Landlord shall give written notice of such determination to Tenant within ninety (90) days following the occurrence of the casualty. Tenant may terminate this Lease only by written notice given to Landlord within thirty (30) days after receipt by Tenant of Landlord's notice of such determination. 13. CONDEMNATION 13.1 Entire Premises. Should title or possession of the whole of the Premises or the Building be taken by duly constituted authority in condemnation proceedings under the exercise of the right of eminent domain, or should a partial taking render the remaining portion of the Premises wholly unacceptable for occupation, then this Lease shall terminate upon the vesting of title or taking of possession. 13.2 Partial Taking. 13.2.1 Landlord shall have the right to terminate this Lease upon such thirty (30) days' notice if title to a portion of the Premises is taken in connection with, or by deed in lieu of, any condemnation proceedings under the exercise of the right of eminent domain, and is such as to prevent Tenant from using the Premises, or the remaining portion, in substantially the same manner as they were used prior to such taking. If Landlord does not terminate this Lease as provided herein, then this Lease shall remain in full force and effect. In such event, Landlord shall promptly make any necessary repairs or restoration at the cost and expense of Landlord. The minimum monthly rent from and after the date of the taking shall be reduced in the proportion that the value of the area of the portion of the Premises taken bears to the total value of the Premises immediately prior to the date of such taking or conveyance. 13.2.2 Each party waives the provisions of Code of Civil Procedure Section 1265.130 allowing either party to petition the Superior Court to terminate this Lease in the event of a partial taking of the Premises. Any dispute between the parties concerning the extent to which a partial taking by eminent domain interferes with the use and occupancy of the Premises by Tenant shall be settled by arbitration in the city in which the Premises are located, in accordance with the rules of the American Arbitration Association then in effect. 13.3 Conveyance Under Threat of Condemnation. Any sale or conveyance by Landlord to any person or entity having the power of eminent domain, either under threat of condemnation or while condemnation proceedings are pending, shall be deemed to be a taking by eminent domain under this Section 13. 13.4 Awards and Damages. All payments made on account of any taking by eminent domain shall be made to Landlord, except that Tenant shall be entitled to any payment or award made for or attributable to the reasonable removal and relocation costs of any removable property that Tenant has the right to remove, or for loss and damage to any such property that Tenant elects or is not required to remove. 14. ASSIGNING, MORTGAGING, SUBLETTING OR CHANGE IN OWNERSHIP 14.1 Limitation. Tenant shall not transfer, assign, sublet, mortgage, hypothecate, share rights in this Lease or Tenant's interest in the Premises, or permit any other person or entity to use the Premises (collectively, a "Transfer"), without first procuring the written consent of Landlord, which consent shall not be unreasonably withheld. Any attempted Transfer without Landlord's written consent shall be void and shall constitute a material default under this Lease. Tenant agrees to reimburse Landlord for Landlord's attorneys' fees (if any) incurred in connection with any requested Transfer by Tenant of Tenant's rights hereunder. 14.2 Deemed Transfer. If Tenant is a nonpublicly traded corporation, or an unincorporated association or partnership, any direct or indirect cumulative transfer, assignment or hypothecation of any stock or interest in such corporation, association or partnership in the aggregate in excess of thirty percent (30%) of the beneficial ownership thereof (or, in the case of a partnership, of the beneficial ownership thereof or of the general partner interest thereof) shall be deemed a Transfer within the meaning and provisions of this Section 14 and subject to its provisions. 14.3 Standard for Consent. If Tenant desires at any time to assign this Lease or to sublease the Premises, or any portion thereof, it shall first notify Landlord of its desire to do so and shall submit in writing to Landlord: (a) the name of the proposed subtenant or assignee and the proposed guarantors of such subtenant's or assignee's obligations; (b) the nature of the proposed subtenant's or assignee's business to be carried on in the Premises; (c) the terms and provisions of the proposed sale, transfer or sublease of Tenant's business and leasehold interest, including the price, rent and terms of payment; and (d) any other information required by Landlord. Landlord shall not unreasonably withhold its consent provided: (i) the use of the Premises remains the same as provided in this Lease (unless Landlord, for reasonable cause, decides that the use and/or the location of the use is incompatible with Landlord's present or future plans for operation of the Property); (ii) the proposed subtenant or assignee and their respective guarantors demonstrate that it is financially responsible by submission to Landlord of such reasonable information as Landlord may request concerning the proposed subtenant or assignee, including, but not limited to, a balance sheet of the proposed subtenant or assignee as of a date within ninety (90) days of the request for Landlord's consent, and statements of income or profit and loss of the proposed subtenant or assignee and guarantor for the two-year period preceding the request for Landlord's consent; (iii) the proposed subtenant or assignee demonstrates a record of successful experience in operating the same type of business by submission to Landlord of such reasonable information as Landlord may request concerning the proposed subtenant or assignee, including, but not limited to, a written statement in reasonable detail as to the business experience of the proposed subtenant or assignee during the five (5) years preceding the request for Landlord's consent; and (iv) the proposed subtenant or assignee has a reputation for honesty and is of good moral character. No subletting or assignment, even with the consent of Landlord, shall relieve Tenant of its obligation to pay the rent and to perform all of the other obligations to be performed by Tenant hereunder. 14.4 Conditions. Each Transfer to which there has been consent shall be by an instrument in writing, in a form satisfactory to Landlord. Such instrument shall be executed by the transferor, assignor, sublessor, hypothecator or mortgagor and the transferee, assignee, sublessee, mortgagee or other person or entity, as the case may be. Each transferee, assignee, sublessee, mortgagee or other person or entity shall agree in writing for the benefit of Landlord to assume, to be bound by, and to perform the terms, covenants and conditions of this Lease to be performed by Tenant, including the payment of all amounts due, or to become due, under this Lease. In addition, as conditions precedent to Landlord's consent to any Transfer of this Lease, Landlord may require any or all of the following: 14.4.1 Tenant shall provide Landlord with evidence reasonably satisfactory to Landlord that the value of Landlord's interest under this Lease will not thereby be diminished or reduced, which evidence shall include, but not need be limited to, evidence respecting the relevant business experience and financial responsibility and status of the third party concerned; 14.4.2 If the Transfer provides for the receipt by, on behalf of, or on account of Tenant of any consideration or any kind whatsoever (including, but not by way of limitation, a premium rental for the sublease or lump sum payment for an assignment) in excess of the rent due Landlord under this Lease, Tenant shall pay seventy-five percent (75%) of such excess, less Tenant's reasonable costs (not to exceed twenty five percent (25%) of such excess) to Landlord, which payment(s) to Landlord shall be made upon receipt of any such payment(s) by Tenant; 14.4.3 Tenant shall not be then in default hereunder in any respect; 14.4.4 Tenant shall deliver to Landlord one executed copy of all written instruments evidencing or relating to Tenant's assignment, transfer or sharing of the Premises; and 14.4.5 Tenant shall provide a written agreement from any third party concerned that, in the event Landlord gives such third party notice that Tenant is in default under this Lease, such third party shall thereinafter make all payments otherwise due Tenant directly to Landlord. Any such payments will be received by Landlord without the imposition of any liability on Landlord, except to credit such payments against those due under the Lease. Any such third party shall agree to attorn to Landlord, or its successors and assigns, should this Lease be terminated for any reason; provided, however, that in no event shall Landlord, or its successors or assigns, be obligated to accept such attorn- ment. 14.5 Limitation on Consent. 14.5.1 Tenant agrees and acknowledges that the conditions permitted to be imposed upon Landlord's grant of its consent hereunder are reasonable. Landlord's imposition of such conditions shall under no circumstances impair or limit Landlord's rights and remedies under California Civil Code Section 1951.4 or any successor statute. 14.5.2 Landlord's consent to Tenant's Transfer on any one occasion shall apply only to the specific transaction thereby authorized. Such consent shall not be construed as a waiver of the duty of Tenant, or any transferee, to obtain Landlord's consent to any other or subsequent Transfer, or as modifying or limiting Landlord's rights hereunder in any way. Landlord's acceptance of rent, or any other payment directly from any third party, shall not be construed as a waiver of any of Landlord's rights or as Landlord's agreement to accept the attornment of any third party, in the event of a termination of this Lease. In no event shall Landlord's enforcement of any provision of this Lease against any third party be deemed a waiver of Landlord's right to enforce any provision of this Lease against Tenant or any other person. 14.6 Applicability to Successors. If Landlord gives consent to a Transfer, such third party in respect of which such consent was given may in turn apply to Landlord for its consent to subsequent Transfers. In such case, the provisions of this Section 14 shall apply as fully as possible to such third party (including this Section 14.5 in the case of more remote transfers). Any such transfer shall be subject to all the terms and conditions of this Lease, and each such successive transfer shall be made only upon like conditions. Tenant, and each successor to Tenant's interest in the Premises, shall agree to remain fully responsible to Landlord for the performance of all of Tenant's obligations under this Lease. 15. DEFAULT BY TENANT; LANDLORD'S REMEDIES 15.1 Events of Default. Each of the following shall constitute a material default and breach by Tenant under this Lease: 15.1.1 If Tenant is at any time in default of its obligations to pay any rent or other charges, and such default continues for more than five (5) days after the date upon which the obligation to pay is due; 15.1.2 If Tenant is in default in the prompt and full performance of any other of its obligations under this Lease and such default continues more than thirty (30) days after Landlord's delivery of written notice specifying the particulars of such default, unless such default cannot be cured within thirty (30) days, in which case Tenant shall be in default if Tenant (a) does not commence the cure of such default within such thirty-day period, and (b) actually cures such default within sixty (60) days of Landlord's delivery of written notice of such default; 15.1.3 If Tenant vacates or abandons the Premises or otherwise fails to occupy and operate the Premises in accordance with the terms of this Lease; 15.1.4 If Tenant or any guarantor of this Lease makes a general assignment or general arrangement for the benefit of creditors; or if a petition for adjudication of bankruptcy or for reorganization or rearrangement is filed by or against Tenant or any guarantor and is not dismissed within thirty (30) days; or if a trustee or receiver is appointed to take possession of substantially all of Tenant's assets located at the Premises or of Tenant's interest in this Lease and possession is not restored to Tenant within sixty (60) days; or if substantially all of Tenant's assets located at the Premises or Tenant's interest in this Lease is subjected to attachment, execution or other judicial seizure which is not discharged within sixty (60) days. If a court of competent jurisdiction determines that any of the acts described in this Section 15.1.4 is not a default under this Lease and a trustee is appointed to take possession of Tenant's assets or if Tenant remains a debtor in possession and such trustee or Tenant transfers Tenant's interest in this Lease, then Landlord shall receive, as additional rent, the excess, if any, of the rent (or any other consideration) paid in connection with such assignment or sublease over the rent payable by Tenant hereunder; or 15.1.5 If any guarantor of the Lease revokes or otherwise terminates, or purports to revoke or otherwise terminate, any guaranty of all or any portion of Tenant's obligations under the Lease. 15.2 Remedies Upon Breach of Lease. On the occurrence of any breach of this Lease by Tenant, Landlord may, at any time thereafter, with or without notice or demand and without limiting Landlord in the exercise of any right or remedy which Landlord may have: 15.2.1 Terminate Tenant's right to possession of the Premises and re-enter the Premises by any lawful means. In such case, Tenant shall immediately surrender possession of the Premises to Landlord. If Landlord reenters the Premises under the provisions of this Section, Landlord shall not be deemed to have terminated this Lease, or the liability of Tenant to pay any rent or other charges that are due or thereafter accruing, or Tenant's liability for damages under any of the provisions of this Lease. In the event of any such entry or taking possession of the Premises, Landlord shall have the right, but not the obligation, to remove from the Premises any personal property located therein and to place it in storage at a public warehouse at Tenant's expense and risk; 15.2.2 Maintain Tenant's right to possession of the Premises, in which case this Lease shall continue in effect whether or not Tenant has abandoned the Premises. In such event, Landlord shall be entitled to enforce all of Landlord's rights and remedies under this Lease, including the right to recover the rent as it becomes due, and Landlord shall have the right to occupy or relet the whole or any part of the Premises for the account of Tenant; or 15.2.3 Pursue any other remedy now or hereafter available to Landlord under the laws or judicial decisions of the State of California. 15.3 Termination. Notwithstanding any other term or provision hereof to the contrary, this Lease shall terminate on the occurrence of any act which affirms Landlord's intention to terminate this Lease as provided in this Section 15.3, including the filing of an unlawful detainer action against Tenant. Acts of maintenance or preservation, efforts to relet the Premises, or the appointment of a receiver at the initiative of Landlord shall not constitute a termination of Tenant's right to possession unless written notice of termination is given. On any such termination, Landlord's damages for default shall include all costs and fees, including reasonable attorneys' fees, incurred by Landlord in connection with filing, commencing, pursuing or defending any action in any bankruptcy court or other court with respect to the Lease, obtaining relief from any stay in bankruptcy restraining any action to evict Tenant or pursuing any action with respect to Landlord's right to possession of the Premises. All such damages suffered (apart from minimum monthly rent and other rent payable hereunder) shall constitute pecuniary damages which must be reimbursed to Landlord prior to assumption of the Lease by Tenant or any successor to Tenant in any bankruptcy or other proceeding. 15.4 Cumulative Rights. The rights and remedies given to Landlord in this Section shall be in addition and supplemental to all other rights or remedies which Landlord may have under the laws in force when the default occurs. Landlord's exercise of any right or remedy shall not prevent it from exercising any other right or remedy. 15.5 Landlord's Damages. 15.5.1 If Landlord elects to terminate this Lease and Tenant's rights to possession of the Premises in accordance with the provisions of this Lease, Landlord may recover from Tenant as damages all of the following: A. The worth at the time of award of any unpaid rent and other charges which has been earned at the time of such termination; plus B. The worth at the time of award of the amount by which the unpaid rent and other charges which would have been earned after termination until the time of award exceeds the amount of such rental loss Tenant proves Landlord could have reasonably avoided; plus C. The worth at the time of award of the amount by which the unpaid rent and all other charges which Tenant would have paid for the balance of the term of the Lease after the time of award exceeds the amount of such rental loss that Tenant proves Landlord could have reasonably avoided; plus D. Any other amount necessary to compensate Landlord for all of the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or which in the ordinary course of things would be likely to result therefrom, including, without limitation, any costs or expenses incurred by Landlord in (a) maintaining or preserving the Premises after such default, (b) recovering possession of the Premises, including reasonable attorneys' fees therefor; (c) expenses of reletting the Premises to a new tenant, including necessary renovations or alterations of the Premises, reasonable attorneys' fees incurred, and leasing commission incurred; plus E. Such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time by the laws of the State of California. 15.5.2 As used in Subsections A and B, above, the "worth at the time of award" is computed by allowing interest on unpaid amounts at the rate of ten percent (10%) per annum. As used in Subsection C, above, the "worth at the time of award" is computed by discounting such amount at the discount rate of the Federal Reserve Bank located nearest to the Building in effect at the time of award, plus one percent (1%). 15.5.3 For purposes of this Section 15, all rent other than minimum monthly rent shall, for purposes of calculating any amount due under the provisions of Subsection C, above, be computed on the basis of the average monthly amount of rent, other than minimum monthly rent, payable by Tenant during the immediately preceding thirty-six-month period, except that if it becomes necessary to compute such rental before such thirty-six-month period has expired, then such rent shall be computed on the basis of the average monthly amount of rent payable during such shorter period. 15.6 No Waiver. The waiver by Landlord of any breach by Tenant of any provision, covenant or condition contained in this Lease shall not be deemed to be a waiver of such provision, covenant or condition, of any subsequent breach thereof, or of any other provision, covenant or condition of this Lease. 15.6.1 The subsequent acceptance of rent hereunder by Landlord shall not be deemed to be a waiver of any preceding breach by Tenant of any provision, covenant or condition of this Lease or of any right of Landlord to a forfeiture of the Lease by reason of such breach, regardless of Landlord's knowledge of such preceding breach at the time of acceptance of such rent. No provision, covenant or condition of this Lease shall be deemed to have been waived by Landlord unless such waiver is in writing and signed by Landlord. 15.6.2 Landlord is entitled to accept, receive and cash or deposit any payment made by Tenant for any reason or purpose or in any amount whatsoever, and apply the same at Landlord's option to any obligation of Tenant and the same shall not constitute payment of any amount owed, except that to which Landlord has applied the same. No endorsement or statement on any check or letter of Tenant shall be deemed an accord and satisfaction or otherwise recognized for any purpose whatsoever. The acceptance of any such check or payment shall be without prejudice to Landlord's right to recover any and all amounts owed by Tenant hereunder and Landlord's right to pursue any other available remedy. 15.7 Power of Receiver. Upon a default by Tenant, Landlord shall have the right to obtain the appointment of a receiver to take possession of the Premises and/or to collect the rents or profits. Tenant irrevocably agrees that any such receiver may, if necessary or convenient in order to collect such rents and profits, conduct the business then being carried on by Tenant on the Premises and that the receiver may take possession of any personal property belonging to Tenant and used in the conduct of such business, and may use the same in conducting such business on the Premises without compensation to Tenant for such use. Neither the application for nor the appointment of such a receiver shall be construed as an election on Landlord's part to terminate this Lease unless a written notice of such intention is given by Landlord. 15.8 Landlord's Right to Cure Defaults. Landlord, at any time after Tenant commits a default in the performance of any of Tenant's obligations under this Lease, shall be entitled (but is not obligated) to cure such default, or to cause such default to be cured, at the sole cost and expense of Tenant. If, by reason of any default by Tenant, Landlord incurs any expense or pays any sum, or performs any act requiring Landlord to incur any expense or to pay any sum, including reasonable fees and expenses paid or incurred by Landlord in order to prepare and post or deliver any notice permitted or required by the provisions of this Lease, or otherwise permitted or contemplated by law, then the amount so paid or incurred by Landlord shall be immediately due and payable to Landlord by Tenant as additional Rent. Tenant hereby authorizes Landlord to deduct such sums from any Security Deposit held by Landlord. If there is no Security Deposit, such sums shall be paid by Tenant immediately upon demand by Landlord, and shall bear interest at the rate of ten percent (10%) per annum, or such greater sum as may be permitted by law from the date of such demand until paid in full. 15.9 Assumption of Lease. If Tenant becomes a Debtor under Chapter 7 of the Bankruptcy Code ("Code"), or a petition for reorganization or adjustment of debts is filed concerning Tenant under Chapters 11 or 13 of the Code, or a proceeding is filed under Chapter 7 and is transferred to Chapters 11 or 13 of the Code, the Trustee or Tenant, as Debtor and as Debtor-In-Possession, may not elect to assume this Lease unless, at the time of such assumption, the Trustee or Tenant has: 15.9.1 Cured or provided Landlord "Adequate Assurance" (as defined below) that: (a) within ten days from the date of such assumption the Trustee or Tenant will cure all monetary defaults under this Lease and compensate Landlord for any actual pecuniary loss resulting from any existing default, including, without limitation, Landlord's reasonable costs, expenses, late charges and accrued interest as set forth in this Lease, and attorneys' fees incurred as a result of the default; (b) within thirty (30) days from the date of such assumption, the Trustee or Tenant will cure all nonmonetary defaults under this Lease; and (c) the assumption will be subject to all of the provisions of this Lease. 15.9.2 For purposes of Sections 15.9 and 15.10, Landlord and Tenant acknowledge that, in the context of a bankruptcy proceeding of Tenant, at a minimum, "Adequate Assurance" shall mean: (a) the Trustee or Tenant has and will continue to have sufficient unencumbered assets after the payment of all secured obligations and administrative expenses to assure Landlord that the Trustee or Tenant will have sufficient funds to fulfill the obligations of Tenant under this Lease, and to keep the Premises properly staffed with sufficient employees to conduct a fully-operational, actively promoted business in the Premises; (b) the Bankruptcy Court shall have entered an order segregating sufficient cash payable to Landlord and/or the Trustee, or Tenant shall have granted a valid and perfected first lien and security interest and/or mortgage in property of Trustee or Tenant acceptable as to value and kind to Landlord, to secure to Landlord the obligation of the Trustee or Tenant to cure the monetary and/or nonmonetary defaults under this Lease within the time periods set forth above; and (c) the Trustee or Tenant at the very least shall deposit a sum equal to one month's minimum monthly rent to be held by Landlord (without any allowance for interest thereon) to secure Tenant's future performance under the Lease. 15.10 Assignment of Lease. If the Trustee or Tenant has assumed the Lease pursuant to the provisions of Sections 15.9 and 15.10, for the purpose of assigning Tenant's interest hereunder to any other person or entity, such interest may be assigned only after the Trustee, Tenant or the proposed assignee has complied with all of the provisions, covenants and conditions of Section 14. Landlord and Tenant acknowledge that such provisions, covenants and conditions are commercially reasonable in the context of a bankruptcy proceeding of Tenant. Any person or entity to which this Lease is assigned pursuant to the provisions of the Code shall be deemed without further act or deed to have assumed all of the obligations arising under this Lease on and after the date of such assignment. Any such assignee shall upon request execute and deliver to Landlord an instrument confirming such assignment. 15.11 Adequate Protection. Upon the filing of a petition by or against Tenant under the Code, Tenant, as Debtor and as Debtor-in-Possession, and any Trustee who may be appointed agree to adequately protect Landlord as follows: 15.11.1 To perform each and every obligation of Tenant under this Lease until such time as this Lease is either rejected or assumed by order of the Bankruptcy Court; 15.11.2 To pay all monetary obligations required under this Lease, including, without limitation, the payment of minimum monthly rent, and such other additional rent charges payable hereunder which are considered reasonable compensation for the use and occupancy of the Premises; 15.11.3 To provide Landlord a minimum thirty days' written notice, unless a shorter period is agreed to in writing by the parties, of any proceeding relating to any assumption of this Lease or any intent to abandon the Premises, which abandonment shall be deemed a rejection of this Lease; and 15.11.4 To perform to the benefit of Landlord otherwise required under the Code. The failure of Tenant to comply with the above shall result in an automatic rejection of this Lease. 15.12 Cumulative Rights. The rights, remedies and liabilities of Landlord and Tenant set forth in Sections 15.9, 15.10 and 15.11 shall be in addition to those which may now or hereafter be accorded, or imposed upon, Landlord and Tenant by the Code. 16. DEFAULTS BY LANDLORD If Landlord fails to perform any covenant, condition or agreement contained in this Lease within thirty (30) days after receipt of written notice from Tenant specifying such failure (or if such failure cannot reasonably be cured within thirty (30) days, if Landlord does not commence to cure the failure within that thirty-day period), then such failure shall constitute a default by Landlord. In such case, Landlord shall be liable to Tenant for any damages sustained by Tenant as a result of Landlord's default. 16.1 Liability Limitation. Tenant and Landlord expressly agree that if Tenant obtains a money judgment against Landlord resulting from any default or other claim arising under this Lease, that judgment shall be satisfied only out of the rents, issues, profits, and other income, including insurance proceeds, if any, actually received on account of Landlord's right, title and interest in the Property. No other real, personal or mixed property of Landlord (or of any of the partners which comprise Landlord, or of partners or principals of such partners comprising Landlord, if any, or of the officers, shareholders or directors, if any, of any such entity) wherever situated, shall be subject to levy, attachment or execution, or otherwise used to satisfy any such judgment. Tenant hereby waives any right to satisfy a judgment against Landlord except from the rents, issues, profits and other income, including insurance proceeds, if any, actually received on account of Landlord's right, title and interest in the Property. 16.2 Cure. If, after notice to Landlord of default, Landlord fails to cure the default as provided below, then subject to the provisions of this Lease, Tenant shall have the right to cure that default at Landlord's expense. In such case, Landlord shall pay the reasonable cost of such cure promptly following receipt of a bill from Tenant itemizing the cost of such cure. Tenant shall not have the right to terminate this Lease or to withhold, reduce or offset any cost of such cure against any payments of rent or other charges due and payable to Landlord under this Lease, except as otherwise specifically provided in this Lease. 16.3 Waiver of Code Provisions. Tenant hereby agrees that Civil Code Sections 1932(2), 1933(4), 1941 and 1942 shall not be applicable to this Lease and Tenant hereby waives any right it may have under any of such Civil Code Sections. 17. ENVIRONMENTAL MATTERS Landlord does not have actual knowledge of the presence of any Hazardous Substances, as defined below, on the Property not in conformance with applicable law. Tenant has had sufficient opportunity to satisfy itself of the condition of the Premises prior to the execution hereof. 17.1 Compliance. Tenant shall at all times and in all respects comply with all federal, state and local laws, ordinances and regulations (collectively, "Hazardous Substances Laws") relating to industrial hygiene, environmental protection or the use, analysis, generation, manufacture, storage, disposal or transportation of any oil, hydrocarbons, flammables, explosives, asbestos, radioactive materials or wastes or other hazardous, toxic, contaminating or polluting materials, substances or wastes, including, without limitation, any hazardous substances which are the subject of any laws, ordinances or regulations intend to protect the environment or health, safety and welfare (collectively, the "Hazardous Substances"). 17.2 Licenses and Permits. Tenant shall, at its own expense, procure, maintain in effect, and comply with all conditions of any and all permits, licenses and other governmental and regulatory approval required for Tenant's use of the Premises, including, without limitation, discharge of appropriately treated materials or wastes which may be discharged into or through any sanitary sewer serving the Premises. Tenant shall, in all respects, deal with the Hazardous Substances in conformity with the Hazardous Substances Laws. 17.3 Indemnification. Tenant shall indemnify, defend, by counsel reasonably acceptable to Landlord, protect, and hold Landlord and each of Landlord's partners, employees, agents, attorneys, successors and assigns, free and harmless from and against any and all claims, liabilities, penalties, forfeitures, losses or expenses (including attorneys' fees), damages or death of or injury to any person or damage to any property whatsoever, arising from or caused in whole or in part, directly or indirectly, by Tenant's failure to comply with any Hazardous Substances Law, or other environmental, health or safety law, regulation or ordinance. Tenant's obligations hereunder shall include, without limitation, and whether foreseeable or unforeseeable, all costs of any kind whatsoever related in any way to the repair, clean-up or remediation of the Premises, and the preparation and implementation of any closure, remedial action or other required plans. Tenant's obligations hereunder shall survive the expiration or earlier termination of the Term. For purposes of this indemnity provision, any acts or omission of Tenant, or by employees, agents, assignees, contractors or subcontractors of Tenant, or others acting for or on behalf of Tenant (whether or not they are negligent, intentional, willful or unlawful) shall be strictly attributable to Tenant. 18. SUBORDINATION OF LEASE 18.1 Subordination Agreement. Tenant agrees to execute, acknowledge and deliver to Landlord within ten days following Landlord's written request, such documents and instruments that may be necessary to subordinate this Lease to (a) any mortgages or trust deeds that now exist or may hereafter be placed upon the Premises by Landlord, (b) to any and all advances made or to be made thereunder, (c) to the interest on all obligations secured thereby, (d) to all renewals, modifications, consolidations, replacements and extensions thereof, and (e) any easements, covenants, conditions or restrictions executed by Landlord provided that they do not materially interfere with Tenant's use, enjoyment and occupancy of the Premises. In each case the mortgagee or beneficiary named in any such mortgage or trust deed shall agree in writing that, as long as Tenant performs its obligations under this Lease, no foreclosure or deed in lieu of foreclosure, or sale under the encumbrance or other procedures to enforce the rights incident thereto, shall affect Tenant's rights under this Lease. 18.2 Attornment. Tenant shall attorn to any purchaser at any foreclosure sale or to any grantee or transferee designated in any deed given in lieu of foreclosure. 18.3 Estoppel Certificate. Within ten (10) days after receipt of a written request therefor, Tenant shall deliver in recordable form a written statement certifying (if such is the case) that this Lease is in full force and effect and that there are no defenses or offsets thereto, or stating those claimed to exist and such other information as Landlord may reasonably request be included in such statement. The failure of Tenant to deliver such certificate within such time period shall constitute conclusive affirmation by Tenant for the benefit of Landlord, its lender, mortgagee or assignee, and their respective successors in interest, that this Lease is in full force and effect and has not been modified except as may be represented by Landlord in its written request for such statement. 19. LANDLORD'S ENTRY ON PREMISES 19.1 Right of Entry. Landlord and its authorized representatives shall have the right without liability and without abatement of rent to enter the Premises at all reasonable times for, without limitation, any of the following purposes: 19.1.1 To determine whether the Premises and/or the Building are in good condition, and whether Tenant is complying with its obligations under this Lease; 19.1.2 To do any necessary maintenance, repairs, restoration or remodeling to the Premises and/or the Building that Landlord has the right or obligation to perform; 19.1.3 To serve, post, or keep posted any notices required or allowed under the provisions of this Lease, including "for rent" or "for lease" notices during the last six months of this Lease, or during any period while Tenant is in default, and any notices provided by law for the protection of Landlord's interest in the Premises; 19.1.4 To shore the foundations, footings and walls of the Building, and to erect scaffolding and protective barricades around and about the Building, but not so as to prevent entry to the Premises, and to do any other act or thing necessary for the safety or preservation of the Premises or the Building; and 19.1.5 To show the Premises and/or the Building to prospective purchasers, lenders, tenants, brokers and others for business purposes, and for such other purposes as Landlord may deem appropriate. 19.2 Exercise of Right. Landlord shall exercise its rights of entry in a manner that will not interfere unreasonably with Tenant's use and occupancy of the Premises; provided that Landlord's entry and activities do not result from Tenant's default. Landlord shall not be liable in any other manner for any inconvenience, disturbance, loss of business, nuisance, or other damage arising out of Landlord's entry on the Premises as provided herein, except damage resulting from the acts or omissions of Landlord or its authorized represent- atives. 20. SALE OR TRANSFER OF PREMISES If Landlord sells or transfers all or any portion of the Premises, the Building, or the improvements and land of which the Premises and the Building are a part, then Landlord shall be released from any liability thereafter accruing under this Lease upon (a) the consummation of such sale or transfer, and (b) Landlord accounting to any such transferee for any Security Deposit and prepaid rent of Tenant. 21. SURRENDER ON TERMINATION; HOLDING OVER 21.1 Surrender. On the last day of the Term, or upon sooner termination of this Lease, Tenant shall surrender to Landlord the Premises and all Tenant's improvements and alterations (except for improvements and alterations that Tenant has the right or is obligated to remove under the provisions of this Lease), broom clean, maintained and repaired in accordance with the terms hereof, and otherwise in the same condition as when received, except for reasonable wear and tear. Any damage to or deterioration of the Premises will not be deemed reasonable wear and tear if the same could have been prevented by good maintenance practices of Tenant. Tenant shall also remove all of its personal property on or prior to such last day. Tenant shall promptly repair any physical damage to the Premises arising as a result of Tenant's vacation of the Premises. Landlord may elect to retain or dispose of in any manner any improvements or alterations or Tenant's personal property that Tenant does not remove from the Premises on expiration or termination of the Term as allowed or required by this Lease by giving at least ten days' written notice to Tenant. Title to any such improvements or alterations or Tenant's personal property that Landlord elects to retain or dispose of on expiration of the ten-day period shall vest in Landlord. Tenant waives all claims against Landlord for any damage to Tenant resulting from Landlord's retention or disposition of any such alterations or Tenant's personal property. 21.2 Holding Over. If Tenant, with Landlord's consent, remains in possession of the Premises after expiration or termination of the Term, or after the date in any notice given by Landlord to Tenant terminating this Lease, such possession by Tenant shall be deemed to be a month-to-month tenancy terminable on thirty (30) days' notice given at any time by either party. The minimum monthly rent for any such tenancy shall be equal to double the aggregate of the monthly minimum rent in effect on the date of such expiration. Such minimum rent shall be subject to adjustment as provided in this Lease. Such tenancy shall otherwise be subject to all of the terms and conditions of this Lease, except those pertaining to Term and Option(s) to extend, if any. Any holding over without Landlord's consent shall not give Tenant tenure. 22. GENERAL PROVISIONS 22.1 Notices. Any and all notices by Landlord to Tenant, or by Tenant to Landlord, shall be in writing and delivered personally or by U.S. certified mail, return receipt requested, addressed to the parties at the addresses specified on the signature page of this Lease. Either party may, at any time, change the address by written notice to the other party in accordance with this Section. If notice is mailed, it shall be deemed received on the third business day following the date on which it is mailed. 22.2 Binding Effect; Complete Agreement. Landlord and Tenant agree that each of the provisions, conditions and obligations of this Lease shall extend to and bind, or inure to the benefit of (as the case may require), the respective parties hereto, and each and every one of their respective heirs, executors, administrators, representatives, successors and assigns. This Lease, and the exhibits hereto, constitute the entire agreement between the parties and may not be altered, amended, modified or extended, except by an instrument in writing signed by all parties. The parties respectively acknowledge and agree that neither has made any representations or warranties to the other not expressly set forth in this Lease. This Lease supersedes any proposals regarding the leasing of the Premises, whether written or oral. Any such proposals will be terminated, and of no force or effect, effective upon the execution of this Lease. 22.3 Attorneys' Fees. If any legal action is instituted by either of the parties hereto to enforce or construe any of the provisions, conditions or covenants of this Lease, or the validity thereof, the party prevailing in any such action shall be entitled to recover from the other party all court costs and reasonable attorneys' fees to be set by the court, and the costs and fees incurred in enforcing any judgment entered. Attorneys' fees and costs, whenever mentioned in this Lease, shall include those incurred with respect to arbitration proceedings, if any. 22.4 Partial Invalidity. If any term or provision, in whole or in part, of this Lease or the application thereof to any person or circumstance shall, to any extent, be invalid, unenforceable, or inapplicable in the stated circumstances or for stated purposes, in any jurisdiction, then the remainder of this Lease, or the application of such term or provision to persons or circumstances other than those to which it is held invalid, unenforceable or inapplicable, shall not be affected. Each term and provision of this Lease shall be valid and be enforceable to the fullest extent permitted by law. 22.5 Recordation; Quitclaim. Neither party shall record this Lease. Upon the request of Landlord, in Landlord's sole discretion, Tenant shall execute and acknowledge in recordable form a Memorandum of Lease in content agreeable to Landlord. The reasonable costs and expenses, including attorneys' fees, incurred by Landlord in preparing, filing and recording the Memorandum of Lease shall be borne by Landlord. Concurrently with the execution of any Memorandum of Lease, Tenant shall execute and deliver to Landlord for filing and recording, upon the expiration or termination of this Lease, a quitclaim deed designating Landlord, its successors and assigns, as the transferee of the Premises. 22.6 Broker. Landlord shall pay a leasing commission to Leider Commercial Real Estate and Blair Hayes Commercial Real Estate in accordance with the terms of a separate listing agreement between Landlord and Leider Commercial Real Estate. Tenant represents and warrants to Landlord that Tenant has not engaged any broker or finder other than Blair Hayes Commercial Real Estate and shall indemnify, defend, and hold Landlord free and harmless from any and all claims arising from this transaction brought by any other finder or broker. 22.7 Consent of Party. If this Lease requires the consent of a party hereto, such consent shall not be unreasonably withheld or delayed. 22.8 Corporate Authority. If Tenant is a corporation, each individual executing this Lease on behalf of such corporation represents and warrants that he or she is duly authorized to execute and deliver this Lease on behalf of such corporation, in accordance with a duly adopted resolution of the Board of Directors, or in accordance with the Bylaws of such corporation; that this Lease is binding upon such corporation in accordance with its terms; that Tenant is a duly qualified corporation and all steps have been taken prior to the date hereof to qualify Tenant to do business in the State in which the Premises are situated, if Tenant is a foreign corporation; that all franchise and corporate taxes have been paid to date; and that all future forms, reports, fees and other documents necessary to comply with applicable laws will be filed when due. 22.9 Time. Time is of the essence of this Lease and each and every term, covenant and condition. 22.10 Signs. Tenant shall install signs, at Tenant's sole expense, on the Premises in accordance with the City of Santa Barbara sign ordinance and with Landlord's prior approval. Tenant shall have the exclusive right to signage to the main entrance to the Building, with the exception of the existing wall-mounted tenant directory sign. The monument sign will be converted back to building identification signage. 22.11 Financial Statements. Tenant shall deliver to Landlord copies of such financial statements as are submitted to the Securities and Exchange Commission with Tenant's Form 10-Q and 10-K within ten (10) business days of the filing thereof. 22.12 Confidentiality of Lease. Tenant acknowledges and agrees that the terms of this Lease are confidential and constitute proprietary information of Landlord. Disclosure of the terms hereof could adversely affect the ability of Landlord to negotiate other leases with respect to the Building and impair Landlord's relationship with other tenants of the Building. Tenant agrees that it, its partners, officers, directors, employees and attorneys, shall not disclose the terms and conditions of this Lease to any other person without the prior written consent of Landlord. A breach of this covenant by Tenant shall constitute a material default under this Lease that, by its nature, is not susceptible to cure by Tenant. It is understood and agreed that damages, alone, would be an inadequate remedy for the breach of this provision by Tenant. Landlord therefore shall have the right to specific performance of this provision and to injunctive relief to prevent its breach or continued breach, as well as all other remedies available at law or in equity. 22.13 Security Measures. Tenant hereby acknowledges that Landlord shall have no obligation whatsoever to provide guard service or other security measures for the benefit of the Premises or the Building. Tenant assumes all responsibility for the protection of Tenant and its agents, employees and invitees, and the property of Tenant, and its agents, employees and invitees, from acts of third parties. Nothing herein contained shall prevent Landlord, at Landlord's sole option, from providing security protection for the Building or any part thereof, in which event the cost thereof shall be included as an Operating Cost. 22.14 Construction of Lease. The language in all parts of this Lease shall in all cases be construed as a whole according to its fair meaning and not strictly for nor against Landlord or Tenant. 22.15 Negation of Joint Venture. Nothing in this Lease shall cause Landlord in any way to be construed as an employer, employee, fiduciary, a partner, a joint venturer, or otherwise associated in any way with Tenant in the operation of the Premises. Nothing contained herein shall subject Landlord to any obligation, loss, charge or expense connected with or arising from Tenant's operation in or use of the Premises. 22.16 Triple Net Lease. The parties agree that the general intent and purpose of this Lease is that this Lease shall be an absolute triple net lease with respect to Landlord. Tenant shall pay its pro rata share of all Operating Costs for the Premises, the common areas of the Building, the Building and the land on which it is situated. Landlord and Tenant intend that the rental return to Landlord shall not be reduced, offset or diminished directly or indirectly by any cost, charge or expense due from Tenant and others in connection with the Premises, Building or land upon which the Building is situated, nor subject to suspension or termination for any reason. Landlord and Tenant agree that all provisions of this Lease shall be interpreted in a manner consistent with and subordinate to such general intent and purpose. Tenant further acknowledges that all tenants of the Building may not be subject to triple net leases. 22.17 Liquidated Damages. BY INITIALING IN THE SPACES PROVIDED BELOW, THE PARTIES AGREE THAT A LATE OPENING OF THE PREMISES, LATE OR INSUFFICIENT PAYMENT OF RENT OR OTHER CHARGES PAYABLE HEREUNDER, OR TENANT'S HOLDING OVER, WILL CAUSE LANDLORD TO INCUR COSTS NOT CONTEMPLATED BY THIS LEASE, THE EXACT AMOUNT OF SUCH COSTS BEING EXTREMELY DIFFICULT AND IMPRACTICABLE TO ASCERTAIN. SUCH COSTS INCLUDE ADMINISTRATIVE EXPENSES AND LOST GOOD WILL TO THE BUILDING. THEREFORE, THIS LEASE PROVIDES FOR CERTAIN LATE CHARGES AND OTHER LIQUIDATED DAMAGES. SUCH LATE CHARGES AND DAMAGES REPRESENT FAIR AND REASONABLE ESTIMATES OF THE COSTS AND/OR DAMAGES THAT LANDLORD WILL INCUR UNDER THE CIRCUMSTANCES. ACCEPTANCE OF ANY SUCH LATE CHARGE OR DAMAGES SHALL CONSTITUTE NEITHER A WAIVER OF TENANT'S DEFAULT NOR AN ELECTION OF REMEDY. LANDLORD TENANT (Signatures appear on the following page.) IN WITNESS WHEREOF, the parties have executed this Lease on this 16 day of February, 1998, at the location of the Premises. "LANDLORD": BATH STREET PARTNERS, a California limited partnership By /s/ ALEX N. PANANIDES --------------------- Alex N. Pananides, General Partner Address: 3740 State Street Santa Barbara, California 93105 "TENANT": AVTEL COMMUNICATIONS, INC., a Delaware corporation By /s/ ANTHONY E. PAPA ------------------- Anthony E. Papa, Chief Executive Officer By /s/ JAMES P. PISANI ------------------- James P. Pisani, Chief Operating Officer Address: Prior to the Commencement Date: AvTel Communications, Inc. 130 Cremona Drive, Suite C Santa Barbara, California 93117 After the Commencement Date: AvTel Communications, Inc. 505 Bath Street* Santa Barbara, California 93101 *subject to the provisions of Section 1.4 EX-10 3 COMMERCIAL LEASE AGREEMENT EXHIBIT 10.9 COMMERCIAL LEASE AGREEMENT This Lease Agreement is made and entered into this 28th day of February, 1995, by and between Ameritas Life Insurance Corp. corporation (hereinafter called "Lessor"), and Matrix Telecom, Inc., a Texas Corporation (hereinafter called "Lessee"). WITNESSETH: Lessor. In consideration of the rent to be paid and the covenants and agreements to be performed by Lessee, as hereinafter set forth, does hereby lease, demise, and let unto Lessee and Lessee accepts that certain office space containing approximately 24,050 rentable square feet on the First & Second floor in the building known as Northstar Plaza I (hereinafter called the "Building"), located on that certain tract of land situated in the City of Fort Worth, County of Tarrant, State of Texas, more particularly described in Exhibit "A" attached hereto and made a part hereof (hereinafter called the "Land"). The area hereby leased (hereinafter called "Leased Premises") in the Building is shown and designated on the Floor Plan(s) attached hereto and made a part hereof as Exhibit "B". The Leased Premises are leased by Lessor to Lessee, are accepted, and are to be used and possessed by Lessee upon and subject to the following terms, provisions, covenants, agreements, and conditions: 1. TERM: Subject to and upon the conditions set forth below, including without limitation subparagraph 34(d), the term of this Lease shall commence on July 1, 1995 (the "Commencement Date") or, if such date is different from the Commencement Date, the Completion Date as defined in subparagraph 34(d), which Lessor shall use its best efforts to establish by the Commencement Date, and shall terminate June 30, 2000 (60) months thereafter (plus the partial month in which the Commencement Date or Completion Date occurs, if applicable). If lessee takes possession of the Leased Premises before July 1, 1995 the monthly rental for the first month shall be prorated based on Year 1 rent. 2. RENT: (a) Lessee agrees to pay monthly as base rental during the term of this Lease the sum of ($ ), which amount shall be payable to Lessor at the address shown below on the first day of the month. One monthly installment of rent shall be due and payable on the date of execution of this Lease by Lessee for the first month's rent and a like monthly installment shall be due and payable on or before the first day of each calendar month succeeding the Commencement Date or Completion Date during the demised term; provided, that if the Commencement Date or the Completion date should be a date other than the first day of a calendar month, the monthly rental set forth above shall be prorated to the end of that calendar month, and all succeeding installments of rent shall be payable on or before the first day of each succeeding calendar month during the demised term. (b) On the date of execution of this Lease by Lessee, there shall be due and payable by Lessee a security deposit in an amount equal to one monthly rental installment to be held for the performance by Lessee of Lessee's covenants and obligations under this Lease, it being expressly understood that the deposit shall not be considered an advance payment of rental or a measure of Lessor's damage in case of default by Lessee. Upon the occurrence of any event of default by Lessee or breach by Lessee of Lessee's covenants under this Lease, Lessor may, from time to time, without prejudice to any other remedy, use the security deposit to the extent necessary to make good any arrears of rent and/or any damage, injury, expense or liability caused to Lessor by the event of default or breach of covenant, any remaining balance of the security deposit to be returned by Lessor to Lessee upon termination of this Lease. Said security deposit shall be placed in an interest bearing account and the interest shall be credited to Lessee provided Lessee is not in default of an (c) If any increase in the fire and extended coverage insurance premiums paid by Lessor for the Building in which Lessor occupies space is caused by Lessee's use and occupancy of the Leased Premises, or if Lessee vacates the Leased Premises and causes an increase in such premiums, then Lessee shall pay as additional rental the amount of such increase to Lessor. (d) Other remedies for non-payment of rent notwithstanding, if the monthly rental payment is not received by Lessor on or before the fifth day of the month for which rent is due, or if any other payment due Lessor by Lessee is not received by Lessor on or before the tenth day after an invoice or other demand therefor has been sent to Lessee, a service charge of five percent (5%) of such past due amount shall become due and payable in addition to such amounts owed under this Lease. (e) In the event the operating expenses as defined below (hereafter "Operating Expenses") of Lessor relating to the Building, the Land and other improvements on the Land shall, in any calendar year during the term of this Lease, exceed the sum of $3.70 per rentable square foot, with the total rentable square footage of the Building being 24,050 for the purpose of this calculation, Lessee agrees to pay as additional rental Lessee's pro rata share (100%) of the excess Operating Expenses. The increase in operating expenses will be limited to a 5% increase above $3.70 per rentable square foot for the first year and a 5% increase over the prior year operating expenses thereafter for the purpose of calculating the Lessee's pro rata share. In the case of the calendar year during which the Commencement Date or Completion Date occurs, the foregoing calculation shall be made based upon a pro rata share (as the balance of the year after the Commencement Date or Completion Dates bears to the entire year) of the Operating Expenses for that calendar year for which additional rental is due under this paragraph, invoice Lessee for the excess Operating Expenses. The invoice shall include in reasonable detail all computations of the additional rental, and Lessee agrees to make payment of the additional rental to Lessor within ten days following receipt of the invoice. In the year in which this Lease terminates, Lessor, in lieu of waiting until the close of the calendar year in order to determine any excess Operating Expenses, has the option to invoice Lessee for Lessee's pro rata share of the Operating Expenses based upon the previous year's excess Operating Expenses; Lessor shall invoice Lessee under this option within thirty days prior to the termination of this Lease increase the monthly rental to an amount which reflects the Lessee's pro rata share of the Operating Expenses based upon the previous year's excess Operating Expenses after giving Lessee thirty days notice. Lessor shall provide Lessee thirty days notice. (f) Operating Expenses include all expenses incurred with respect to the maintenance and operation of the Building, the Land and other improvements on the Land, including, but not limited to, maintenance and repair costs, fuel, water, sewer, gas and other utility charges, security, window washing, janitorial services, trash removal, landscaping, pest control, Lessor's managing agent whose duties are connected with the operation and maintenance of the Building or other expenses on the Land, amounts paid to management firm to supervise operation of the Building, amounts paid to contractors or subcontractors for work or services performed in connection with the operation of the Building or other expenses on the Land, and all services, supplies, repairs, replacements or other expenses for maintaining and operating the Building and other expenses on the land, including common areas and parking area. Operating Expenses also include all real property taxes and all insurance premiums which lessor is required to pay or deems advisable to pay, including public liability insurance, with respect to the Building, the Land and other improvements on the Land. Operating Expenses do not include any capital improvement to the Building, nor shall it include repairs, restoration or other work occasioned by fire, windstorm or other casualty, income and franchise taxes of Lessor, expenses incurred in leasing to or procuring of tenants, leasing commissions, advertising expenses, expenses for the renovating of space for new tenants, interest or principal payments on any mortgage or other indebtedness of Lessor or depreciation allowance or expense. (g) Lessee will pay the electric bill for the entire property as received from the utility company each month during the primary term and any renewal or extension period. 3. SIGNS: (a) Lessor will furnish and install a suitable building directory and establish suite numbers to facilitate locating and identifying Lessee's premises. In order to effect uniformity, to control the graphics, and to maintain dignified aesthetics, Lessor will also furnish and install at the entrance door to Lessee's premises a uniform suite number plate and a name plate. Signs, name plates or graphics which are wholly within the Leased Premises and not visible from the exterior of the Building or from public spaces within the Building will be permitted. 4. USAGE AND INSURANCE: Lessee represents to and agrees with Lessor that the Leased Premises shall be used and occupied only for the purpose of general office use. Lessee shall occupy the Leased Premises, conduct its business and control its agents, employees, contractors, customers and invitees in such a manner as is lawful, acceptable and will not create any nuisance or otherwise interfere with, annoy or disturb any other tenant in its normal business operations or Lessor in its management of the Building. Lessee shall not commit, or suffer to be committed, any waste on the Leased Premises, nor shall Lessee permit the Leased Premises to be used in any way which would, in the opinion of Lessor, be extra hazardous on account of fire or otherwise which would in any way increase or render void the fire insurance on the Leased Premises or contents in the Building. 5. BUILDING SERVICES: Lessor shall furnish janitorial services five times per week during the term of this Lease. Lessee shall pay for the cost of cleaning services required by non-standard improvements or special operations. Lessor shall furnish water for Lessee during the term of this lease. Lessee shall pay all telephone charges. Lessor shall furnish Lessee hot and cold water at those points of supply provided for general use of other tenants in the Building, central heating and air conditioning (at times Lessor normally furnishes these services to other tenants in the Building, and at temperatures and in amounts as are considered by Lessor to be standard, routine maintenance, painting and electric lighting service for all common areas of the Building in the manner and to the extent deemed by Lessor to be standard. Failure by Lessor to any extent to furnish these defined services, or any cessation thereof, resulting from causes beyond the control of Lessor shall neither render Lessor liable in any respect for damages to either person or property, be construed as an eviction of Lessee, work an abatement of rent nor relieve Lessee from fulfillment of any covenant in this Lease. Should any of the equipment or machinery break down, or for any cause cease to function properly, Lessor shall use reasonable diligence to repair the same promptly, but Lessee shall have no claim for rebate on account of any interruption in service occasioned by the repairs, nor shall the same be construed as an eviction of Lessee, nor relieve Lessee from fulfillment of any covenant in this Lease. Under no circumstances will Lessor be liable for any indirect or consequential damages caused by any interruption of building services. 6. REPAIR AND MAINTENANCE: Lessor will, at its own cost and expense, except as may be provided elsewhere herein, make necessary repairs to the Building corridors, lobby, and other common areas of the Building and other improvements on the Land and to the structural parts of the Building and other improvements on the Land, and to the lines and equipment used to provide the services referred to herein up to the point of entry into the Leased Premises, unless any such damage is caused by the negligent acts or omissions of Lessee, its agents, employees, contractors, customers or invitees, in which event Lessee, its agents, employees, contractors, customers or invitees, in which event Lessee will bear the cost of such repair. Lessee will promptly give Lessor written notice of repair required to be done by Lessor, as aforesaid, of which Lessee may become aware. Lessor shall not be liable to Lessee, except as expressly provided in this Lease, for any damage or inconvenience, and Lessee shall not be entitled to any abatement or reduction of rent, by reason of any repairs, alterations or additions made by Lessor under this Lease. All requests for repairs or maintenance that are the responsibility of Lessor pursuant to any provision of this Lease must be made in writing to Lessor at the address set forth below and Lessor shall not be deemed in breach of its obligations unless it fails to commence such repairs within ten (10) days after receipt thereof. 7. LESSEE'S REPAIRS AND ALTERATIONS: Lessee will not, in any manner, deface, injure or damage the Leased Premises, the Building, or any improvements on the Land, and will pay the cost of repairing any damage or injury done to the Leased Premises, the Building or such other improvements by Lessee or Lessee's agents, employees, contractors, customers or invitees. Lessee shall throughout the term of this Lease take good care of the leased Premises and keep them free from waste and nuisance of any kind. Lessee further agrees to keep the Leased Premises, including all fixtures installed by lessee, any plate glass and any mechanical lines and equipment within the Leased Premises, in good condition and make all necessary repairs thereto except for those caused by fire, casualty, or acts of God covered by Landlord's fire insurance policy covering the Building and except for repairs to structural parts of the Building which are required to be done by the Lessor. If Lessee fails to make such repairs within fifteen (15) days after the occurrence of the damage or injury, Lessor may, at its option, make such repair and Lessee shall, upon demand therefor, pay Lessor for the cost thereof, plus a charge in the amount of 15% of the cost thereof to cover the overhead and administrative expenses of Lessor. Lessee will not make or allow to be made any alterations or physical additions in or to the Leased Premises without the prior written consent of Lessor. All maintenance, repairs, alterations, additions, or improvements shall be conducted only by contractors and subcontractors approved in writing by Lessor, it being understood that Lessee shall procure and maintain, and shall cause such contractors and subcontractors engaged by or on behalf of Lessee, to procure and maintain, insurance coverage against such risks, in such amounts and with such companies as Lessor may require in connection with any such maintenance, repair, alteration, addition, or improvement. Upon termination of this Lease, Lessee will surrender and deliver up the Leased Premises in the same condition, order and repair as existed at the Commencement Date or Completion Date, excepting ordinary wear and tear. 8. COMPLIANCE WITH LAWS, RULES AND REGULATIONS: Lessee shall comply with all laws, ordinances, orders, rules and regulations of state, federal, municipal or other agencies or bodies having jurisdiction relating to the use, condition and occupancy of the Leased Premises. Lessee will comply with the rules of the Building adopted by Lessor which are set forth on EXHIBIT C attached to this Lease. Lessor shall have the right at all times to change the rules and regulations of the Building or to amend them in any reasonable manner as may be deemed advisable for the safety, care and cleanliness, and for the preservation of good order, of the Leased Premises. All changes and amendments in the rules and regulations of the Building will be sent by Lessor to Lessee in writing and shall thereafter be carried out and observed by Lessee. 9. LESSOR IMPROVEMENTS: If construction is to be done by Lessor to the Leased Premises prior to Lessee's occupancy, Lessor will, at its expense, *commence and/or complete the construction of the improvements constituting the Leased Premises, including partitions, in accordance with the floor plan set forth on Exhibit B and the specifications agreed to by the parties and made a part of this Lease by reference. Upon completion of the Building and other improvements in accordance with the plans and specifications, Lessee agrees to accept delivery of the Leased Premises and to execute and deliver to Lessor a letter accepting delivery of the Leased Premises. 10. ALTERATIONS AND IMPROVEMENTS: Lessee shall not make or allow to be made any alterations or physical additions in or to the Leased Premises without first obtaining the written consent of Lessor. Any alterations, physical additions or improvements to the Leased Premises made by Lessee shall at once become the property of Lessor and shall be surrendered to Lessor upon the termination of this Lease. Lessor, at its option, may require Lessee to remove any physical additions and/or repair any alterations in order to restore the premises to the condition existing prior to the time Lessee took possession, all costs of removal and/or alterations to be borne by Lessee. This clause shall not apply to moveable equipment or furniture owned by Lessee which may be removed by Lessee at the end of the term of this Lease if Lessee is not then in default and if such equipment and furniture is not then subject to any other rights, liens and interests of Lessor, provided that Lessee repairs any damage caused by the installation or removal thereof. 11. CONDEMNATION: (a) If, during the term (or any extension or renewal) of this Lease, all or a substantial part of the Leased Premises are taken for any public or quasi-public use under any governmental law, ordinance or regulation, or by right of eminent domain or by private purchase in lieu thereof, and the taking would prevent or materially interfere with the use of the Leased Premises for the purpose for which they are then being used, this Lease shall terminate and the rent shall be abated during the unexpired portion of this Lease effective on the date physical possession is taken by the condemning authority. Lessee shall have no claim to the condemnation award. (b) In the event a portion of the Leased Premises shall be taken for any public or quasi-public use under any governmental law, ordinance or regulation, or by right of eminent domain or by private sale in lieu thereof, and this Lease is not terminated as provided in the subparagraph above, Lessor may, at Lessor's sole risk and expense, restore and reconstruct the Building and other improvements on the Leased Premises to the extent necessary to make it reasonably tenantable. The rent payable under this Lease during the unexpired portion of the term shall be adjusted to such an extent as may be fair and reasonable under the circumstances. Lessee shall have no claim to the condemnation award. 12. FIRE AND CASUALTY: (a) If the Leased Premises should be totally destroyed by fire, tornado or other casualty, or if the Leased Premises should be so damaged so that rebuilding cannot reasonably be completed within one hundred and eighty (180) working days after the date of written notification by Lessee to Lessor of the destruction, this Lease shall terminate and the rent shall be abated for the unexpired portion of the Lease, effective as of the date of the written notification. In no event shall rent be paid by Lessee when the building is not in an acceptable condition as it relates to the casualties described in this paragraph. (b) If the Leased Premises should be partially damaged by fire, tornado or other casualty, and rebuilding or repairs can reasonably be completed within one hundred and eighty (180) working days from the date of written notification by Lessee to Lessor of the destruction, this Lease shall not terminate, but Lessor may at its sole risk and expense proceed with reasonable diligence to rebuild or repair the Building to substantially the condition in which they existed prior to the damage. If the Leased Premises are to be rebuilt or repaired and are untenantable in whole or in part following the damage, and the damage or destruction was not caused or contributed to by act or negligence of Lessee, its agents, employees, contractors, customers, invitees or others for whom Lessee is responsible, the rent payable under this Lease during the period for which the Leased Premises are untenantable shall be adjusted to such an extent as may be fair and reasonable under the circumstances. In the event that Lessor fails to complete the necessary repairs or rebuilding within one hundred and eighty (180) working days from the date of written terminate this Lease by delivering written notice of termination to Lessor, whereupon all rights and obligations under the Lease shall cease to exist. 13. CASUALTY INSURANCE: Lessor shall at all times during the term of this Lease maintain a policy or policies of insurance with the premiums paid in advance, issued by and binding upon some solvent insurance company, insuring the Building against loss or damage by fire, explosion or other hazards and contingencies for the full insurable value; provided, that Lessor shall not be obligated in any way or manner to insure any personal property (including, but not limited to, any furniture, machinery, goods or supplies) of Lessee or which Lessee may have upon or within the Leased Premises or any fixtures installed by or paid for by Lessee upon or within the Leased Premises or any additional improvements which Lessee may construct on the Leased Premises. Lessee shall at all times during the term of this Lease maintain a policy or policies of insurance with the premiums paid in advance, issued by and binding upon some solvent insurance company, insuring all of Lessee's property at the Leased Premises against loss or damage by fire, explosion or other hazards and contingencies for the full insurable value thereof and shall provide to Lessor at all such times a certificate of such insurance. 14. WAIVER OF SUBROGATION: Anything in this Lease to the contrary notwithstanding, Lessor and Lessee hereby waive and release each other of and from any and all rights of recovery, claim, action or cause of action, against each other, their agents, officers and employees, for any loss or damage that may occur to the Leased Premises, and any additional improvements thereto, the Building or other improvements on the Land, or personal property (including contents) within the Building, by reason of fire or other causes which are covered by standard extended coverage hazard insurance regardless of cause or origin, including negligence of Lessor or Lessee and their agents, officers and employees. Because this paragraph will preclude the assignment of any claim mentioned in it by way as subrogation (or otherwise) to an insurance company (or any other person), each party to this Lease agrees immediately to give to each insurance company which has issued to it policies of fire and extended coverage insurance, written notice of the terms of the mutual waivers contained in this paragraph, and to have the insurance policies properly endorsed, if necessary, to prevent the invalidation of the insurance coverage by reason of the mutual waivers contained in this paragraph. 15. HOLD HARMLESS: Lessor shall not be liable to Lessee, or to Lessee's agents, employees, contractors, customers or invitees for any damage to person or property caused by any act, omission or neglect of Lessee, its agents, employees, contractors, customers or invitees, and Lessee agrees to indemnify and hold Lessor harmless from all liability and claims for any such damage. Lessee shall not be liable to Lessor, or to Lessor's agents, employees, contractors, customers or invitees for any damage to person or property caused by any act, omission or neglect of Lessor, its agents, employees, contractors, customers or invitees and Lessor agrees to indemnify and hold Lessee harmless from all claims for such damage. The provisions of this paragraph shall be subject to the provisions of paragraph 14. 16. LIABILITY INSURANCE, INDEMNITY AND EXCULPATION: (a) Lessee must procure and maintain throughout the term of this Lease and any extensions or renewals of such term general commercial liability insurance (including blanket contractual liability coverage), which shall cover any claims for bodily injury, death and/or property damage occurring in or resulting from any occurrence in or about the Leased Premises, including injury, death and/or damage caused by the condition of or any defect in the Leased Premises. The policies evidencing such insurance must be in broad form satisfactory to Lessor, must name Lessor as an additional insured, must be issued by insurance companies acceptable to Lessor, and must afford immediate protection to the limit of not less than $1,000,000 per accident. With respect to each policy evidencing such liability insurance, Lessee shall obtain any available endorsements required by Lessor. Lessee shall also deliver the policy or a certificate evidencing the same to Lessor prior to occupying the Leased Premises or commencing the construction of any improvements therein, and Lessee shall deliver a certificate of renewal from the applicable insurer at least ten days prior to the expiration of the policy. In addition, Lessee shall obtain and deliver to Lessor a written obligation on the part of each of its insurance companies to notify Lessor at least 10 days prior to any cancellation of or material change to such insurance. (b) Lessee shall indemnify and hold Lessor harmless from all fines, suits, costs and liability of every kind, including without limitation, attorney fees and costs in defense of any claim relating thereto, arising because of: (i) any violation or nonperformance by Lessee of representation or covenant contained in this Lease: (ii) any bodily injury, death and/or damage to property occurring in or resulting from any occurrence in the Leased Premises during the term of this Lease; and (iii) any bodily injury, death and/or property damage that is incident to, arises out of, or is in any way caused by the acts or negligent omissions of Lessee or any of its agents, employees, contractors, customers or invitees. The indemnity set out in the preceding sentence will not be impaired or affected by negligence on the part of Lessor or anyone acting for Lessor and is not limited in any way to the amount of insurance required by the preceding subparagraph (a). (c) Lessee accepts responsibility for keeping all personal property and equipment in the Leased Premises adequately insured and for maintaining adequate business interruption insurance. Lessor will not be liable to Lessee, its employees, agents, licensees, invitees or insurers for bodily injury, death or property damage occasioned by the acts or omissions of any other tenant of the Building or of other tenants, agents, employees, licensees, or invitees within the Building. Further, Lessor will not be liable to Lessee for any property damage, bodily injury or inconvenience caused by the condition, maintenance, repair or alteration of the Building, or the failure to provide maintenance or repairs, except to the extent caused by Lessor's gross negligence or willful misconduct. 17. PEACEFUL ENJOYMENT: Lessor warrants that it has full right to execute and to perform this Lease and to grant the estate demised and that Lessee, upon payment of the required rents and performing the terms, conditions, covenants and agreements contained in this Lease, shall peaceably and quietly have, hold and enjoy the Leased Premises during the full term of this Lease as well as any extension or renewal thereof. 18. LESSOR'S RIGHT OF ENTRY: Lessor shall have the right, at all reasonable hours, to enter the Leased Premises for the following reasons: inspection; cleaning or making repairs, or alterations or additions as Lessor may deem necessary or desirable, whether to the Leased premises or to other portions of the Building; determining Lessee's use of the Leased Premises or determining if an act of default under this Lease has occurred; or showing the Leased Premises to any existing or prospective mortgagee or purchaser of the Building. 19. ASSIGNMENT OR SUBLEASE: Lessor shall have the right to transfer and assign, in whole or in part, its rights and obligations in the Building and property that are the subject of this Lease. Lessee shall not assign this lease or sublet all or any part of the Leased Premises without the prior written consent of Lessor.* Lessor shall have the option, upon receipt from Lessee of written request for Lessor's consent to subletting or assignment, to cancel this Lease as of the date the requested subletting or assignment is to be effective. The option shall be exercised, if at all, within fifteen (15) days following Lessor's receipt of written notice by delivery to Lessee of written notice of Lessor's intention to exercise the option. In the event of any assignment or subletting, Lessee shall nevertheless at all times remain fully responsible and liable for the payment of the rent and for compliance with all of its other obligations under the terms, provisions and covenants of this Lease. Upon the occurrence of an "event of default" as defined below, if all or any part of the Leased Premises are then assigned or sublet, Lessor, in addition to any other remedies provided by this Lease or provided by law, may, at its option, collect directly from the assignee or subtenant all rents becoming due to Lessee by reason of the assignment or sublease, and Lessor shall have a security interest in all properties on the Leased Premises to secure payment of such sums. Any collection directly by lessor from the assignee or subtenant shall not be construed to constitute a novation or a release of Lessee from the further performance of its obligations under this Lease.* Such consent shall not be unreasonably withheld. 20. LANDLORD'S LIEN: In addition to and cumulative of any statutory landlord's lien provided by law, as security for Lessee's payment of rent, damages and all other payments required to be made by this Lease, Lessee hereby grants to Lessor a lien upon all property of Lessee now or subsequently located upon the Leased Premises. If Lessee abandons or vacates any substantial portion of the Leased premises or is in default in the payment of any rentals, damages or other payments required to be made by this Lease or is in default of any other provision of this Lease, Lessor may enter upon the Leased Premises, by changing locks if necessary, and take possession of all or any part of the personal property, and may sell all or any part of the personal property at a public or private sale, in one or successive sales, with or without notice, to the highest bidder for cash, and, on behalf of Lessee, sell and convey all or part of the personal property to the highest bidder, delivering to the highest bidder all of Lessee's title and interest in the personal property sold to him. The proceeds of the sale of the personal property shall be applied by Lessor toward the reasonable costs and expenses of the sale, including attorney's fees, and then toward the payment of all sums then due by Lessee to Lessor under the terms of this Lease; any excess remaining shall be paid to Lessee or any other person entitled thereto by law. 21. UNIFORM COMMERCIAL CODE: To the extent, if any, this Lease grants Lessor any lien or lien rights greater than provided by the laws of Texas pertaining to "Landlord's Liens", this Lease is intended as and constitutes a security agreement within the meaning of the Uniform Commercial Code of Texas and, Lessor, in addition to the rights prescribed in this Lease, shall have all of the rights, titles, liens and interests in and to Lessee's property now or hereafter located upon the Leased Premises which are granted a secured party, as that term is defined, under the Uniform Commercial Code in Texas to secure the payment to lessor of the various amounts provided in this Lease. Lessee will on request execute and deliver to lessor a financing statement for the purpose of perfecting Lessor's security interest under this Lease or Lessor may file this Lease or a copy thereof as a financing statement. 22. MECHANIC'S LIENS: Lessee shall not permit the placing of any mechanic's liens against the Building, the Land or other improvements on the Land caused by or resulting from any work performed, materials furnished or obligation incurred by or at the request of (or at the request of) Tenant. Nothing in this Lease or in any other agreement between lessor and Lessee constitutes the consent or request of Lessor, express or implied, to any contractor, subcontractors, laborer or materialman for the performance of any labor or the furnishing of any materials for any specific improvement alteration or repair to the Building, the Land or other improvements on the Land. Nor does anything contained herein or in any other agreement made by Lessor and Lessee concerning the Leased Premises give Lessee any right, power or authority to contract for or permit the rendering of any services or the furnishing of any materials that would give rise to the filing of any mechanic's or other liens against the interest of Lessor in the Building, the Land or other improvements on the Land. If any lien is filed against the interest of Lessor in the Building or against the interest of Lessor in the Leased Premises because of work performed, materials supplied or an obligation incurred by or at the request of (or alleged request of) Lessee, then Lessee shall cause the same to be discharged of record within 20 days after filing. If Lessee fails to discharge the lien within such period, then, in addition to any other right or remedy of Lessor, Lessor may, but will not be obligated to, discharge the same either by paying the amount claimed to be due or by procuring the discharge by deposit in court or bonding. Any amount paid by Lessor to discharge the lien, and all reasonable legal and other expenses of Lessor, including reasonable attorneys' fees, in defending any such action or in procuring the discharge of the lien shall be repaid by Lessee on demand. 23. DEFAULT BY LESSEE: The following shall be deemed to be events of default by Lessee under this Lease: (a) Lessee shall fail to pay when due any installment of rent or any other payment required pursuant to this Lease. Lessee shall have ten (10) days to cure this default after receiving written notice of non-payment from Lessor; (b) Lessee shall abandon any substantial portion of the Leased Premises; (c) Lessee shall fail to comply with any term, provision or covenant of this Lease, other than the payment of rent, and the failure is not cured within thirty (30) days after written notice to Lessee; (d) Lessee shall file a petition or be adjudged bankrupt or insolvent under the Federal Bankruptcy Act, as amended, or any similar law or statute of the United States or any state; or a receiver or trustee shall be appointed for all or substantially all of the assets of Lessee; or Lessee shall make a transfer in fraud of creditors or shall make an assignment for the benefit of creditors; (e) Lessee shall do or permit to be done any act which results in a lien being filed against the Leased Premises. 24. REMEDIES FOR LESSEE'S DEFAULT: Upon the occurrence of any event of default set forth in this Lease Agreement, Lessor shall have the option to pursue any one or more of the following remedies without any notice or demand: (a) Terminate this Lease, in which event Lessee shall immediately surrender the Leased Premises to Lessor, and, if Lessee fails to surrender the Leased Premises, Lessor may, without prejudice to any other remedy which it may have for possession or arrearages in rent, enter upon and take possession of the Leased Premises, by changing locks if necessary, and lock out, expel or remove Lessee and any other person who may be occupying all or any part of the Leased Premises without being liable for prosecution of any claim for damages. Upon the termination of this Lease, in addition to all unpaid rentals and other monetary obligations of Lessee to Lessor, Lessor will be entitled to recover, not as rent or a penalty but as compensation for Lessor's loss of the benefit of its bargain with Lessee, the difference between (i) an amount equal to the present value of the rental and other sums that this Lease provides Lessee will pay for the remainder of the term hereof and for the balance of any then effective extension of the term hereof, and (ii) the present value of the net future rentals for such period that will be or with reasonable efforts could be collected by Lessor by reletting the Leased Premises. The foregoing present values will be calculated by discounting at the rate of 8 percent per annum. For purposes of determining what could be collected by Lessor by reletting under the preceding sentence, it will be assumed that Lessor is not required to relet when other comparable space in the Building is available for lease and that Lessor will not be required to incur any cost to relet, other than customary leasing commissions. (b) Enter upon and take possession of the Leased Premises, by changing locks if necessary, and lock out, expel or remove Lessee and any other person who may be occupying all of any part of the Leased Premises without being deemed guilty of trespass, without being liable for any claim for damages, and without causing a termination of or forfeiture of this Lease or of Lessee's obligation to pay rent and other charges, and may relet the Leased Premises on behalf of Lessee and receive directly the rent by reason of the reletting, but the failure to so relet shall not reduce Lessee's liability for rents and other charges or for damages. Lessee agrees to pay Lessor on demand any deficiency that may arise by reason of any reletting of the Leased Premises; further, Lessee agrees to reimburse Lessor for any expenditures made by it for remodeling or repairing in order to relet the Leased Premises. In connection with any such reletting, Lessor will not be obligated to incur any cost to relet, other than customary leasing commissions, will not be obligated to relet for less than the then market value of the leased Premises or to relet the leased Premises when other comparable rental space in the Building is available for lease, and may relet the Leased Premises for a term to expire at the same time as, earlier than, or subsequent to, the expiration of the term hereof and/or relet all or any portion of the Leased Premises as a part of a larger area. Lessee may retain the excess, if any, of the rent earned from reletting the Leased Premises over the rentals specified in this Lease. (c) Enter upon the Leased Premises, by changing locks if necessary, without being liable for prosecution of any claim for damages, and do whatever Lessee is obligated to do under the terms of this Lease. Lessee agrees to reimburse Lessor on demand for any expenses which Lessor may incur in effecting compliance with Lessee's obligations under this Lease; further, Lessee agrees that Lessor shall not be liable for any damages resulting to Lessee from effecting compliance with Lessee's obligations under this subparagraph caused by the negligence of Lessor or otherwise. (d) After an event of default by Lessee, Lessor may recover from Lessee from time to time and Lessee shall pay to Lessor upon demand, whether or not Lessor has relet the Leased Premises or terminated this Lease, (i) such expenses as Lessor may incur in recovering possession of the Leased Premises, terminating this Lease, placing the Leased Premises in good order and condition and altering or repairing the same for reletting; (ii) all other costs and expenses (including brokerage commissions and legal fees) paid or incurred by Lessor in exercising any remedy or as a result of the event of default by Lessee; and (iii) any other amount necessary to compensate Lessor for all the detriment proximately caused by Lessee's failure to perform Lessee's obligations under this Lease or which in the ordinary course of things would be likely to result from such failure. (e) To the extent permitted by law, Lessee and Lessor agree that paragraphs (a), (b), (c), (e) and (g) of Section 93.002 of the Texas Property Code shall not apply to this Lease. However, as provided in Section 93.002(d) of the Texas Property Code, Lessee will be presumed to have abandoned the Leased Premises if goods, equipment, or other property, in an amount substantial enough to indicate a probable intent to abandon the Leased Premises, is being or has been removed from the Leased Premises and the removal is not within the normal course of Lessee's business. 25. WAIVER OF DEFAULT OR REMEDY: Failure of Lessor to declare an event of default immediately upon its occurrence or delay in taking any action in connection with an event of default shall not constitute a waiver of the default, but Lessor shall have the right to declare the default at any time and take such action as is lawful or authorized under this Lease. Pursuit of any one or more of the remedies set forth in the above paragraph shall not preclude pursuit of any other of the remedies set forth in the above paragraph and/or any one or more of the other remedies provided elsewhere in this Lease or provided by law, nor shall pursuit of any remedy provided constitute a forfeiture or waiver of any rent or damages accruing to Lessor by reason of the violation of any of the terms, provisions or covenants of this Lease. Failure by Lessor to enforce one or more of the remedies provided upon an event of default shall not be deemed or construed to constitute a waiver of the default or of any other violation or breach of any of the terms, provisions and covenants contained in this Lease. 26. ACTS OF GOD: Lessor shall not be required to perform any covenant or obligation in this Lease, or be liable in damages to Lessee, so long as the performance or non-performance of the covenant or obligation is delayed, caused by or prevented by an act of God or force majeure. 27. ATTORNEYS' FEES: In the event Lessee defaults in the performance of any of the terms, covenants, agreements or conditions contained in this Lease and Lessor places in the hands of an attorney the enforcement of all or any part of this Lease, the collection of any rent or other sums due or to become due or recovery of the possession of the Leased Premises, Lessee agrees to pay Lessor reasonable attorneys' fees for the services of the attorney, whether suit is actually filed or not. In no event shall the attorneys' fees be less than fifteen percent of the outstanding balance owed by Lessee to Lessor. 28. HOLDING OVER: In the event of holding over by Lessee after the expiration or termination of this Lease or any extension thereof, the holdover shall be as a tenant at will and all of the terms and provisions of this Lease shall be applicable during that period, except that Lessee shall pay Lessor as rental for the period of such holdover an amount equal to one and A Quarter the rent which would have been payable by Lessee had the holdover period been a part of the original or extended term of this Lease. Additionally, Lessee shall be liable to Lessor for any damages caused to Lessor by such holdover. Lessee agrees to vacate and deliver the Leased Premises to Lessor upon Lessee's receipt of notice from Lessor on demand. No holding over by Lessee, whether with or without consent of Lessor, shall operate to extend this Lease except as otherwise expressly provided. 29. RIGHTS OF MORTGAGEE: Lessee accepts this Lease subject and subordinate to any recorded mortgage, deed of trust or other lien presently existing upon the Leased Premises. Lessee further agrees that this Lease is subject and subordinate to any mortgage, deed of trust or other lien hereafter placed on the Leased Premises, and, although this provision is self-operative, Lessee agrees upon demand to execute additional instruments subordinating this Lease as Lessor may require. If the interests of Lessor under this Lease shall be transferred by reason of foreclosure or other proceedings for enforcement of any mortgage, deed of trust or other lien on the Leased Premises, Lessee shall be bound to the transferee (sometimes called the "Purchaser") under the terms, covenants and conditions of this Lease for the balance of the term remaining, and any extensions or renewals, with the same force and effect as if the Purchaser were Lessor under this Lease, and Lessee agrees to attorn to and upon the request of the Purchaser including the mortgagee or beneficiary under any such mortgage or deed of trust if it be the Purchaser, as its lessor, the attornment to be effective and self-operative without the execution of any further instruments upon the Purchaser succeeding to the interest of Lessor under this Lease and requiring such attornment. The respective rights and obligations of Lessee and the Purchaser upon the attornment, to the extent of the then remaining balance of the term of this Lease, and any extensions and renewals, shall be and are the same as those set forth in this Lease. Notwithstanding that such attornment is self-operative, Lessee agrees to execute such further agreements in confirmation thereof as shall be reasonably requested by Lessor or such mortgagee or beneficiary, and Lessee further agrees to include in such agreements such other provisions as may be reasonably requested by Lessor or such mortgagee or beneficiary, including without limitation provisions for notice of default and opportunity to cure to such mortgagee or beneficiary and the non-liability of such mortgagee or beneficiary for claims against the Lessor. 30. ESTOPPEL CERTIFICATES: Lessee agrees to furnish promptly, from time to time, upon request of Lessor or Lessor's mortgagee or beneficiary or prospective mortgagee or beneficiary or prospective purchaser, a statement certifying that: Lessee is in possession of the Leased Premises: the Leased Premises are acceptable; the Lease is in full force and effect, the Lease is unmodified; Lessee claims no present charge, lien, or claim of offset against rent; the rent is paid for the current month, but is not paid and will not be paid for more than one month in advance; there is no existing default by reason of some act or omission by Lessor; and such other matters as may be reasonably required by Lessor or Lessor's mortgagee or beneficiary. 31. SUCCESSORS: This Lease shall be binding upon and inure to the benefit of Lessor and Lessee and their respective heirs, personal representatives, successors and assigns, and references herein to "Lessor" or "Lessee" shall include all of such heirs, personal representatives, successors and assigns, but the foregoing does not detract in any way from the provisions of Paragraph 19 hereof. It is hereby covenanted and agreed that should Lessor's interest in the Leased Premises cease to exist for any reason during the term of the Lease, then notwithstanding the happening of such event this Lease nevertheless shall remain unimpaired and in full force and effect and Lessee hereunder agrees to attorn to the then owner of the Leased Premises. 32. RENT TAX: If applicable in the jurisdiction where the Leased Premises are situated, Lessee shall pay and be liable for all rental, sales and use taxes or other similar taxes, if any, levied or imposed by any city, state, county or other governmental body having authority, such payments to be in addition to all other payments required to be paid to Lessor by Lessee under the terms of this Lease. Any such payment shall be paid concurrently with the payment of the rent upon which the tax is based as set forth above. 33. NOTICE: (a) all rent and other payments required to be made by Lessee shall be payable to Lessor at the address set forth below, or any other address Lessor may specify from time to time by written notice delivered to Lessee. (b) All payments required to be made by Lessor to Lessee shall be payable to Lessee at the address set forth below, or at any other address within the United States as Lessee may specify from time to time by written notice. (c) Any notice or document required or permitted to be delivered by this Lease shall be deemed to be delivered (whether or not actually required) when deposited in the United States Mail, postage prepaid, certified mail, return receipt requested, addressed to the parties at the respective addresses set out below: LESSOR: LESSEE: Ameritas Life Insurance Corp. Matrix Telecom, Inc. c/o The Centra Group, L.L.C. 8721 Airport Freeway 1901 Central Drive, Suite 212 North Richland Hills, TX 76180 Bedford, TX 76021 34. DEFINITIONS: These definitions apply to the terms defined as those terms are used throughout this Lease. (a) "Abandon" means the vacating of all or a substantial portion of the Leased Premises by Lessee, whether or not Lessee is in default of the rental payments due under this Lease. (b) An "act of God" or "force majeure" is defined for the purpose of this Lease as strikes, lockouts, sit-downs, material or labor restrictions by any governmental authority, riots, floods, washouts, explosions, earthquakes, fire, storms, acts of the public enemy, wars, insurrections and any other cause not reasonably within the control of Lessor and which by the exercise of due diligence Lessor is unable, wholly or in part, to prevent or overcome. (c) The Commencement Date shall be the date set forth in paragraph 2. The Commencement Date shall constitute the commencement of this Lease Agreement for all purposes, whether or not Lessee has actually taken possession. (d) The Completion Date shall be the date on which the improvements erected and to be erected upon the Leased Premises shall have been completed in accordance with the plans and specifications described in paragraph 9. Lessor shall use its best efforts to establish the Completion Date as the date set forth in paragraph 2. In the event that the improvements have not in fact been completed as of that date, Lessee shall notify Lessor in writing of its objections. Lessor shall have a reasonable time after delivery of the notice in which to take such corrective action as may be necessary, and shall notify Lessee in writing as soon as it deems such corrective action has been completed so that the improvements are completed and ready for occupancy. Taking of possession by Lessee shall be conclusively deemed to establish that the improvements have been completed and that the Leased Premises are in good and satisfactory condition, as of the date possession was so taken by Lessee, except for latent defects, if any. (e) "Real property tax" means all city, state and county taxes and assessments including special district taxes or assessments. (f) The captions appearing in this Lease are inserted only as a matter of convenience and in no way define, limit, construe or describe the scope or intent of such paragraph. 35. LIMITED LIABILITY OF LESSOR: All liability of Lessor for damages for breach of any covenant, duty or obligation of Lessor hereunder may be satisfied only out of the interest of Lessor in the Building existing at the time any such liability if adjudicated in a proceeding as to which judgment adjudicating such liability is non-appealable and not subject to further review. In no event will Lessee be entitled to execution under any judgment against any assets of the Lessor, or any partners, shareholders, policyholders, or other persons or entities having an interest in the Lessor, except as to their interest in the Building as set forth above, and no deficiency judgment or money judgment of any kind shall be sought or entered against Lessor, Lessee agreeing that Lessor shall have no personal liability hereunder. All obligations of Lessor hereunder will be construed as covenants, not conditions. 36. SEVERABILITY: A determination that any term or provision of this Lease, or the application thereof to any person or circumstance, is invalid or unenforceable, shall not affect the remainder of this Lease or the application of such term or provision to persons or circumstances other than those as to which it is invalid or unenforceable. 37. BROKERAGE FEES INCURRED BY LESSEE: Lessee represents and agrees that Lessor will not be responsible for and Lessee shall indemnify, defend and hold Lessor harmless against, any brokerage or leasing commission or finder's fee claimed by any party in connection with this Lease, except any such claim made pursuant to a separate written agreement executed by Lessor and the party making such claim. 38. JOINT AND SEVERAL LIABILITY: If Lessee consists of more than one person or entity at any time, all such persons or entities are jointly and severally liable hereunder for the obligations of Lessee. 39. TIME IS OF THE ESSENCE: Time is of the essence with respect to the performance by Lessee of all of its obligations under this Lease. 40. RECORDATION: Lessee agrees not to record this Lease or any memorandum of this Lease without Lessor's consent. 41. ENTIRE AGREEMENT AND LIMITATION OF WARRANTIES: It is expressly agreed by Lessee, as a material consideration for the execution of this Lease, that this Lease, with the specific reference to written extrinsic documents, is the entire agreement of the parties and that there are, and were, no verbal representations, warranties, understandings, stipulations, agreements or promises pertaining to this Lease or the expressly mentioned written extrinsic documents not incorporated in writing in this Lease. Any representation of Lessor's agents which is not incorporated in this Lease shall not be binding upon Lessor and should be considered as unauthorized. Lessor and Lessee expressly agree that there are and shall be no implied warranties of merchantability, fitness or of any other kind arising out of this Lease. It is likewise agreed that this Lease may not be altered, waived, amended or extended except by an instrument in writing signed by both Lessor and Lessee. 42. OTHER PROVISIONS: 1) Exhibits A, B and C are attached hereto and made a part hereof. 2) This Lease Agreement is subject to Lessor's approval and will be a valid Lease Agreement only when signed by the Lessor. 3) Lessor will enter into a license agreement with Lessee for additional parking not to exceed fifty (50) spaces at 8713 Airport Freeway Property (Northstar II). Lessee agrees to utilize the additional parking only on an "as needed" basis. The license agreement will be subject to cancellation with forty-five (45) days written notice from Lessor to Lessee if Owner of Northstar II (8713 Airport Freeway) sells or otherwise transfers the property at 8713 Airport Freeway to another owner. This license agreement will also be subject to cancellation with forty-five (45) days written notice from Lessor to Lessee if Owner of 8713 Airport Freeway Property decides in its sole discretion that the above-mentioned fifty (50) spaces are needed for any existing or future Tenant of the 8713 Airport Freeway Property. 4) Lessor agrees to give Lessee one (1) five year option to renew this Lease Agreement at the then existing market rate. This renewal will be negotiated one hundred eighty (180) days prior to the expiration of the primary term. 5) Lessor will use its best efforts to make Lessee aware of any space in excess of 5,000 rentable square feet which comes available at the 8713 Airport Freeway Property as long as Lessor retains an ownership position at 8713 Airport Freeway Property during the term of this Lease Agreement. LESSOR: LESSEE: AMERITAS LIFE INSURANCE CORP. MATRIX TELECOM, INC. By /s/ JOHN B. WEISBERG By /s/ CHARLES G. TAYLOR, JR. LEASE MODIFICATION AGREEMENT THIS LEASE MODIFICATION is made this 2nd day of March 1995, by and between American Life Insurance Corp. herein called "Lessor" and Matrix Telecom, Inc. herein called "Lessee". RECITALS WHEREAS, by a lease dated February 28, 1995 Ameritas Life Insurance Corp. did lease to Lessee 24,050 rentable square feet on the First and Second floor(s) in that certain office building known as Northstar Plaza I, located at 8721 Airport Freeway, Fort Worth, Texas. Said space consists of approximately 24,050 rentable square feet, is shown in Exhibit "A" attached to said lease, and is herein called the "premises". WHEREAS, the term of such lease is scheduled to expire on June 20, 2000 and WHEREAS, the parties desire to make certain changes to said lease. AGREEMENT NOW, THEREFORE, in consideration of mutual covenants contained herein and in said lease, the parties hereto agree as follows: 1. Exhibit B. The last paragraph of Exhibit "B" which reads "Lessee will have the right to cancel this Lease Agreement if the City of North Richland Hills requires a fire sprinkler system to be installed in the building during their plan review and prior to their issuance of a building permit. This right to cancel will not be available to Lessee once a building permit is issued and a contract for construction is signed.", is hereby deleted in its entirety. If Lessee is a division or subsidiary of a corporation, each individual executing this Agreement on behalf of the division or subsidiary represents and warrants that he or she is duly authorized to execute and deliver this Agreement on behalf of the division or subsidiary, in accordance with a duly adopted resolution of the Board of Directors or the parent corporation, that this Agreement is binding upon the parent corporation (as well as the division or subsidiary) in accordance with its terms, and that said division or subsidiary shall, within thirty (30) days after request by Lessor, deliver to Lessor a certified copy of a resolution of the Board of Directors of the parent corporation authorizing or ratifying the execution of this Agreement. If Lessee is a partnership, each individual executing this Agreement on behalf of said partnership represents and warrants that he or she is duly authorized to sign and deliver this Agreement on behalf of said partnership and that this Agreement is binding upon said partnership in accordance with its terms. 2. Miscellaneous: a. The provisions of this Lease Modification Agreement shall remain in full force and effect for the duration of the said lease. b. Except as otherwise set forth herein, all of the terms and conditions of said lease shall remain in full force and effect, and shall remain fully applicable to the premises, throughout the duration of said lease. Said lease, as amended herein, constitutes the entire agreement between the parties hereto, and no further modification of said lease shall be binding unless evidenced by an agreement in writing signed by Lessor and Lessee. c. The captions and paragraph numbers appearing in this Agreement are inserted only as a matter of convenience and in no way define, limit, construe, affect or describe the scope or intent of the provisions in this Agreement. IN WITNESS WHEREOF, Lessor and Lessee have executed this Lease Modification Agreement as of the day first above written. Ameritas Life Insurance Corp. LESSOR By: /s/ JOHN B. WEISBERG Matrix Telecom, Inc. LESSEE By: /s/ CHARLES G. TAYLOR, JR. DATE: 3/3/95 EX-10 4 RESALE SOLUTIONS SWITCHED SERVICES AGREEMENT EXHIBIT 10.10 RESALE SOLUTIONS SWITCHED SERVICES AGREEMENT THIS AGREEMENT (the "Agreement") is entered into by and between SPRINT COMMUNICATIONS COMPANY L.P. ("Sprint"), and MATRIX TELECOM, INC. ("Customer"). Sprint and Customer are "Parties" hereto. In consideration of the mutual promises contained herein, the Parties agree as follows: 1. DEFINITIONS. Capitalized terms appearing in bold print are defined in Exhibit 1. 2. CONFIDENTIALITY. During the Term and thereafter, neither Party shall disclose any terms of this Agreement, including pricing, or Proprietary Information of the other Party. Proprietary Information shall remain the property of the disclosing Party. A Party receiving Proprietary Information shall: (i) use or reproduce such information only when necessary to perform this Agreement; (ii) provide at least the same care to avoid disclosure or unauthorized use of such information as it provides to protect its own Proprietary Information; (iii) limit access to such information to its employees or agents who need such information to perform this Agreement; and (iv) return or destroy all such information, including copies, after the need for it has expired, upon request of the disclosing Party, or upon termination of this Agreement. The foregoing notwithstanding, Sprint agrees to allow AvTel Communications, Inc., the corporate parent of Matrix ("AvTel") to disclose to the Securities and Exchange Commission ("SEC") the minimum amount of information necessary to insure AvTel's compliance with applicable filing requirements under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. In no event will any rates, charges, pricing, or other information in any Attachment to the Agreement be disclosed to the SEC without the express written consent of Sprint, which shall not be unreasonably withheld. Because of the unique nature of Proprietary Information, a breach of this paragraph may cause irreparable harm for which monetary damages may be inadequate compensation. Accordingly, in addition to other remedies, a Party may seek injunctive relief to enforce this paragraph. 3. TERM. Provided Customer executes this Agreement by March 13, 1998, the Term will commence on February 14, 1998. The Term will continue after commencement for the period specified in Attachment A. 4. TERMINATION FOR CAUSE. 4.1 A Party may terminate this Agreement upon the other Party's failure to cure any of the following within 30 days following written notice thereof: (a) the (i) insolvency, corporate reorganization, arrangement with creditors, receivership or dissolution of the other Party; or (ii) institution of bankruptcy proceedings by or against the other Party; (b) assignment or attempted assignment of the Agreement or any interest therein, except as permitted by Paragraph 24 hereof; (c) change in control of the defaulting Party without the other Party's prior written consent, which consent shall not be unreasonably withheld; (d) a final order by a government entity with appropriate jurisdiction that a Service or the relationship hereunder is contrary to law or regulation; or (e) breach of any material provision herein not otherwise referred to in Paragraph 4. 4.2 Sprint may terminate this Agreement immediately and without notice if Customer fails to cure a breach as provided in Paragraph 8 or breaches a provision of Paragraph 17 or 18. 4.3 Customer may terminate the Agreement upon 30 days written notice if special rate adjustments exceed the maximum provided in Paragraph 16. 4.4 Upon termination of this Agreement a Party may recover from the other all sums it is owed at the time of termination. 5. TERMINATION WITHOUT CAUSE: EARLY TERMINATION CHARGE. 5.1 Customer may terminate this Agreement at any time without cause upon 90 days prior written notice to Sprint and payment to Sprint of the Early Termination Charge in Subparagraph 5.2. Service will be discontinued the first business day of the fourth month after such notice of termination. 5.2 Carrier Transport Base Rates and Promotional Discounts are based on Customer's agreement to purchase Service for the entire Term. It is difficult if not impossible to calculate Sprint's loss if Customer terminates the Agreement pursuant to Subparagraph 5.1 prior to the end of the Term. Therefore, to Compensate Sprint for such loss, and not as a penalty, Customer shall pay Sprint an Early Termination Charge in the event of such termination. The Early Termination Charge shall equal 50% of the sum of the Minimum Commitment for each month remaining in the Term when Service is discontinued pursuant to Subparagraph 5.1. The Early Termination Charge shall be paid within 30 days after the notice provided pursuant to Subparagraph 5.1. 6. APPLICATION OF TARIFFS: INTERSTATE ADJUSTMENT 6.1 Interstate and international Service shall be provided pursuant to Tariff as supplemented by this Agreement. In the event of a conflict between this Agreement and any Tariff, the Tariff shall control. 6.2 Intrastate Service is provided pursuant to Tariff in every respect. Promotional Discounts will not apply to intrastate Service. An Interstate Adjustment may be applied based on intrastate usage as provided in Attachment D. The Interstate Adjustment shall be based on intrastate usage at the Product Hierarchy Level and will equal the difference between (a) such usage priced at Tariff less Tariff discounts and (b) such usage priced at the Interstate Adjustment Rate in Attachment D less Discount One discounts. The Interstate Adjustment for a given month shall not exceed interstate billing for such month. 6.3 Customer shall pay all Tariff charges including, without limitation, fixed charges, feature charges, enhanced 800 charges, access facility charges, installation and other non-recurring charges except as noted in the Attachments to this Agreement. 6.4 Sprint may modify or withdraw Tariffs from time to time, which may include discontinuation of any Service without Sprint's liability. 7. RELATIONSHIP OF PARTIES. Neither this Agreement nor the provision of Service creates a joint venture, partnership or agency between Sprint and Customer. Customer is the service provider with respect to End Users. Sprint is merely a supplier to Customer with no relationship to End Users. 8. USE OF NAME AND MARKS. This Agreement confers no right to use the name, service marks, trademarks, copyrights, patents or CIC of either Party except as expressly provided herein. Neither Party shall take any action which would compromise the registered copyrights or service marks of the other. Sprint's name is proprietary and nothing herein constitutes a general license authorizing its use. Customer may not: (a) promote or advertise Sprint's name or capabilities to End Users or prospective End Users; (b) attempt to sell its service using Sprint's name; or (c) represent to End Users or prospective End Users that they would be Sprint customers or that they may obtain Sprint service from Customer. Sprint shall provide Customer written notice of a breach of this paragraph. Customer shall use its best efforts to immediately cure such breach, advising Sprint of its actions. If, in Sprint's notice, then Sprint may, at its option, terminate the Agreement pursuant to Subparagraph 4.2. Sprint's provision of Network Extension Service may result in End Users being notified by their LEC that Sprint is their designated PIC. Therefore, to avoid confusion and potential "slamming" complaints, Sprint hereby authorizes Customer to use Sprint's name under the following conditions to provide End Users from whom Customer has obtained a PIC Authorization with a fulfillment piece containing the following Notice (the "Notice"): We want to affirm how ____ will provide your long distance service. Although ____ will provide your invoice and customer service, we use major national carriers to actually carry your long distance calls. After subscribing to our service, you may receive a notice from your local phone company which says that your long distance "Carrier of Choice" is Sprint. ______ has selected Sprint as the long distance network provider it will use to handle your calls. That selection was based on your quality and price requirements. If you have any questions about your order, please call our toll free customer service number, 1-800-____-_________. If Customer subscribes to Sprint Express, calls placed by End Users to the Sprint ITFS number will be answered "Sprint operator." This may cause confusion if the End User does not know its calls are being carried on the Sprint network. Therefore, to avoid such confusion, Sprint hereby authorizes Customer to provide End Users who use Sprint Express with a fulfillment piece containing the following notice (the "Sprint Express Notice"): "International call origination may be provided by a Sprint operator." Sprint may withdraw consent to use the Sprint Express Notice upon 10 days written notice. Customer shall obtain Sprint's prior written approval of any fulfillment piece in which the Notice or the Sprint Express Notice will appear. 9. SERVICE. Services provided hereunder are described in Exhibit 2. 10. LEGAL COMPLIANCE: REMEDIES FOR NON-COMPLIANCE. 10.1 Customer represents and warrants that (a) it has obtained all licenses and regulatory authority necessary to operate as contemplated herein and (b) it will not submit an End User ANI for activation without obtaining and maintaining a proper PIC Authorization. 10.2 If, in Sprint's opinion, Customer breaches this paragraph, Sprint may (a) terminate this Agreement pursuant to Subparagraph 4.1(e), (b) reject End User ANIs submitted by Customer for placement under its account, and/or (c) discontinue Promotional Discounts. If Sprint elects option (b) or (c), it will resume accepting ANIs and/or reinstate Promotional Discounts only after Customer produces evidence satisfactory to Sprint that it has cured its breach. 11. CUSTOMER RESPONSIBILITIES. 11.1 Customer shall not be relieved of any obligation hereunder by virtue of the fact that Service is ultimately used by End Users. 11.2 Customer shall produce for Sprint's inspection, at Customer's expense, any PIC Authorization within 48 hours after Sprint's oral or written request, or within any shorter period required by a LEC or regulatory agency. If Customer fails to comply with this subparagraph, then Sprint may (a) discontinue Promotional Discounts and/or (b) refuse to activate additional ANIs under Customer's account. 11.3 Customer shall reimburse Sprint for any charge assessed by a LEC for processing a PIC request initiated by Customer and pay Sprint a PIC Assessment Fee equal to 25% of such charge. 11.4 Customer shall be solely responsible for End User solicitation, service requests, creditworthiness, customer service, billing and collection. 11.5 Customer shall be financially liable for usage generated by each End User ANI activated by Sprint until such ANI is presubscribed to another IXC. Customer may request Sprint to block Network Extension Service to an ANI upon the End User's failure to pay Customer, subject to Customer's prior certification to Sprint that it has given the End User any notice required by law. Customer shall reimburse Sprint for expenses incurred to block an ANI. 11.6 Customer shall be solely liable for amounts it cannot collect from End Users, and billing adjustments it grants End Users, including adjustments for fraudulent charges, directory assistance or any other form of credit. 11.7 Customer shall comply with Sprint's network interface procedures when it orders its own access facilities. 12. SERVICE ACTIVATION. Sprint will use reasonable efforts to provide switched Service within 15 days, and dedicated Service within 30 days, following Customer's order, or the requested delivery date, whichever is later. These deadlines will be extended by the time it takes to address activation errors or obtain from Customer a complete and accurate order or PIC Authorization. Customer shall reimburse Sprint for LEC imposed fees resulting from a request to expedite Service. 13. PRICING; FORWARD PRICING; GENERAL CONDITIONS. 13.1 Pricing. Resale Solutions Base Rates and Promotional Discounts are contained in the Attachments hereto. 13.2 Prices in Lieu of Other Discounts. Resale Solutions Base Rates and Promotional Discounts are extended in lieu of any other Tariff or contractual discount, special pricing, or discount term plan. Discounts upon discounts are only permitted if expressly provided for herein. 13.3 Prices Contingent on Performance. Resale Solutions Base Rates and Promotional Discounts are contingent on Customer's full performance of all terms of the Agreement. If Customer fails to pay the undisputed portion of an invoice pursuant to Paragraph 17, all Service for which payment is past due may, at Sprint's option, be priced at Resale Solutions Base Rates. 13.4 Per Minute Charges. Resale Solutions Base Rates are invoiced based on Per Minute Charges utilizing the Rate Periods and Billing Increments in Attachment B. 13.5 Non-Bell Switched Origination, Termination and 800 Origination Charges. Customer shall pay the charges specified in Attachment B for each originating minute and each terminating minute of an interstate call that originates and/or terminates in a Non-Bell Service Area. 13.6 Switched Origination, and Termination Charges. Customer shall pay the charges specified in Attachment B for each originating minute and each terminating minute of an interstate call. 13.7 Promotional Pricing Levels. Customer will receive Discount One and Discount Two discounts applied only to Rate Elements as provided in Attachments C and D. 13.8 Forward Pricing. As a transition to the pricing hereunder, Discount Two discounts may be based for a period of time on the grater of Customer's actual Discount Two Monthly Volume of Service or a specified Forward Pricing Volume of Service. The Forward Pricing Volume of Service and the period during which it may be applied are specified in Attachment A. 13.9 Pricing Contingent on Primary Carrier Status. Pricing hereunder is contingent on Customer utilizing Sprint as its Primary Carrier for the Primary Carrier Services listed in Attachment A. If 800 Service is a Primary Carrier Service then Customer shall (a) designate Sprint as its Primary Carrier in the 800 Service Management System database for all interstate 800 traffic that is not originated directly by Customer and (b) maintain access facilities sufficient to send at least 80% of its traffic to Sprint with no more than 2% blockage during the peak busy hour of Customer's average business day. If Resale Connect One Plus is a Primary Carrier Service then 80% of all End User ANIs under Customer's control shall be PICed to Sprint during the Term. If Resale Direct Extension is a Primary Carrier Service then 80% of all Dedicated Access End Users under Customer's control shall be placed on the Sprint network during the Term. If Resale Direct is a Primary Carrier Service then Customer shall maintain access facilities sufficient to send to Sprint at least 99% of the traffic Customer does not terminate itself. Customer shall produce, within 30 days following Sprint's request, evidence acceptable to Sprint that it is in compliance with this subparagraph. Failure to maintain Sprint as Primary Carrier on any Primary Carrier Service will result in Service being provided hereunder at Carrier Transport Base Rates for the remainder of the Term. Customer may select a temporary back-up carrier for any period during which it is affected by a Sprint network outage. 14. SURCHARGES. 14.1 Minimum Commitment Surcharge. Any month Customer fails to meet the Minimum Commitment stated on Attachment A, Customer shall pay a surcharge for Service provided during such month equal to 25% of the difference between the Minimum Commitment and Customer's Net Usage. The Minimum Commitment shall not relieve Customer of any credit or security obligation hereunder. 14.2 LEC Cap Surcharge. Any month Customer exceeds the Maximum Non-Bell Traffic Percentage specified in Attachment B for any Service type, Customer shall pay Sprint the per minute surcharge for such Service specified in Attachment B for each minute above the Maximum Non-Bell Traffic Percentage that originates from or terminates to a Non-Bell Service Area. Maximum Non-Bell Traffic Percentages will be calculated independently for originating and terminating minutes at each Product Hierarchy Level. 14.3 Minimum Average Time Requirement Surcharge. Any month Customer fails to equal or exceed the Minimum Average Time Requirement specified in Attachment B for Services specified in Attachment B, then Customer shall pay Sprint a per minute surcharge on such usage equal to (a) the per minute surcharge specified in Attachment B multiplied by (b) the difference between (i) the number of minutes the Service was used and (ii) the number of calls using the Service multiplied by the Minimum Average Time Requirement. This surcharge shall be calculated at each Product Hierarchy Level. 14.4 Noncomplete Call Surcharge. Any month Customer exceeds the Maximum Noncomplete 800 Call percentage for interstate Resale Direct Toll Free, Resale Direct Toll Free Extension, and/or interstate Resale Connect Toll Free traffic as stated on Attachment B, Customer shall pay Sprint a surcharge equal to the amount stated in Attachment B for each Noncomplete 800 Call in excess of the Maximum Noncomplete 800 Call Percentage. This surcharge shall be calculated at each Product Hierarchy Level. 14.5 Minimum Port Usage Surcharge. Any month Customer fails to equal or exceed the Minimum Port Usage per Active Resale Direct Port as stated on Attachment A, Customer shall pay Sprint a surcharge on its Direct usage equal to the difference between (a) Customer's actual Net Usage for Resale Direct Service and (b) the Minimum Port Usage multiplied by the total number of Active Resale Direct Ports. This surcharge shall be calculated at each Product Hierarchy Level. 15. SERVICE CHARGES. Customer shall pay Sprint a $25 service charge for each End User ANI or 800 number Customer submits for activation (a) that sprint determines lacks a proper PIC Authorization or (b) that requires Sprint to disconnect or transfer such ANI or 800 number from Sprint's data base before placing it within Customer's CTIS hierarchy. However, the service charge provided for in 15(b) will be waived if such End User ANIs, or 800 numbers, do not exceed 15% of the total ANIs, or 800 numbers, submitted by Customer during the previous 90 days. 16. SPECIAL RATE ADJUSTMENTS. 16.1 Sprint may, after 15 days notice to Customer, adjust the price of Service provided hereunder to reflect changes in international cost of service or currency exchange rates. 16.2 Sprint will amend Attachment B switched origination and switched termination access charges effective on the first day of January and July. The adjustment will reflect increases and/or decreases in statewide average per-minute originating and terminating interstate LEC access charges imposed on Sprint. Customer will pay amended Attachment B charges beginning on the effective date of the amendment until the effective date of the succeeding amendment. Attachment B charges apply only to those Services identified in Attachment B, paragraph B.13.6. 17. PAYMENT FOR SERVICE. 17.1 Payment Obligation. Customer shall pay Sprint for Service pursuant to the terms of this Agreement and applicable Tariffs. 17.2 Call Detail. Sprint will provide Customer with a call detail media containing Customer's Service usage. Sprint may, at it's option, and without liability to Customer, modify the format of the call detail media following 30 days written notice to Customer. 17.3 Payment Procedure. Sprint will invoice Customer monthly for service provided hereunder. Invoices shall be due and payable upon receipt. Undisputed charges for Service that are not paid within 30 days after Customer's receipt of the invoice shall be past due. Interest will be charged on past due amounts beginning the 31st day following Customer's receipt of the invoice at a rate equal to the lesser of 18% per annum or the maximum rate allowed by law. The price of Service is exclusive of applicable taxes. Resale Solutions Base Rates and Promotional Discounts are contingent on Customer providing Sprint with certificates from appropriate taxing authorities exempting Customer from taxes that would otherwise be invoiced hereunder. 17.4 BILLING DISPUTES. If Customer in good faith disputes any invoiced amount, it shall submit to Sprint, within 60 days following receipt of the invoice, full payment of the undisputed portion of the invoice and written documentation identifying and substantiating the disputed amount. If the Parties, in good faith, cannot resolve the dispute within a reasonable period of time, then the dispute shall be settled by arbitration pursuant to Paragraph 22. 18. PAYMENT SECURITY. Provision of Service is contingent on credit approval by Sprint. Upon request by Sprint, Customer shall provide Sprint with financial statements, or other indications of Customer's Financial circumstances. If Customer's financial circumstances or payment history is or becomes unacceptable to Sprint, then Sprint may require a deposit, irrevocable letter of credit or other form of security acceptable to Sprint. Customer's failure to provide such security within 10 days following Sprint's request shall constitute a default under Subparagraph 4.2. 19. INDEMNIFICATION. Each Party (as "Indemnitor") shall indemnify, defend and hold harmless the other party (as "Indemnitee") from and against any and all liabilities, costs, damages, fines, assessments, penalties and expenses (including reasonable attorneys' fees) resulting from (a) breach of any provision in this Agreement by Indemnitor, its employees or agents, or (b) any misrepresentation or illegal act of Indemnitor, its employees or agents, arising out of the Indemnitor's performance hereunder. Customer shall indemnify, defend and hold Sprint harmless from and against any and all liabilities, costs and damages (including reasonable attorneys' fees) resulting from any claim arising out of: (i) use of Service by Customer to extend its service to End Users; (ii) use of Service by Customer or End Users; (iii) libel, slander, or patent or trademark infringement arising from the combination or use of Service with Customer provided service or facilities; or (iv) Customer's marketing, advertising, sales or promotional activities. 20. LIMITATION OF LIABILITY. IN NO EVENT SHALL EITHER PARTY BE LIABLE FOR SPECIAL, INDIRECT, INCIDENTAL, CONSEQUENTIAL OR EXEMPLARY DAMAGES, INCLUDING LOSS OF PROFITS, LOSS OF CUSTOMERS OR GOODWILL ARISING FROM THE RELATIONSHIP OR CONDUCT OF BUSINESS HEREUNDER. 21. WARRANTIES. WARRANTIES AND REMEDIES SET FORTH IN THE AGREEMENT AND SPRINTS TARIFFS ARE THE ONLY WARRANTIES AND REMEDIES WITH RESPECT TO THE SERVICE, AND ARE IN LIEU OF ANY OTHER WARRANTY, WRITTEN OR ORAL, STATUTORY, EXPRESS OR IMPLIED, INCLUDING WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. 22. ARBITRATION. Any dispute arising out of or relating to the Agreement will be finally settled by arbitration in accordance with the rules of the American Arbitration Association. The arbitration will be governed by the United States Arbitration Act, 9 U.S.C. Sec. 1, et. seq., and judgment upon the award rendered by the arbitrator(s) may be entered by any court with jurisdiction. The arbitration will be held in the Kansas City, MO metropolitan area. 23. NOTICES. Notices, requests or other communications (excluding invoices) hereunder shall be in writing and sent by certified mail addressed as follows: If to Sprint: Sprint Communications Company 5420 LBJ Freeway, Suite 1700 Dallas, TX 75240 Attention: Vice President-Wholesale Services With copy to: Sprint Communications Company 8140 Ward Parkway Kansas City, MO 64114 Attention: Vice President Law- Marketing/Sales If to Customer:______________________________ ============================== Attention:____________________ 24. ASSIGNMENT. Neither this Agreement nor any right or obligation hereunder may be assigned or delegated to any other entity without the prior written consent of the other Party, which consent shall not be unreasonably withheld. 25. EXCUSABLE DELAY. In the event of an Excusable Delay the performance obligations of the Parties hereunder shall be suspended and the Term shall be extended for a period of time equal to the length of such delay; provided, however, the affected Party shall promptly notify the other Party of the nature of the delay and the estimated time that it will continue. If an Excusable Delay continues for more than 90 days and has a material adverse impact on the other Party, such other Party may, at its option and upon written notice to the other Party, terminate this Agreement without liability other than payment for Service provided prior to termination. Notwithstanding the foregoing, neither party may invoke this paragraph with regard to any event listed in Paragraph 4 or to delay performance of Paragraphs 17 or 18. 26. CAPTIONS. Captions of the paragraphs and subparagraphs herein are for convenience only, are not part of the Agreement and shall not define or limit any of the Agreement's terms. 27. CHOICE OF LAW. This Agreement shall be construed in accordance with, and governed by, the laws of the State of Kansas. 28. RULES OF CONSTRUCTION. No rule of construction requiring interpretation against the draftsman shall apply in the interpretation of this Agreement. 29. ENTIRE AGREEMENT. This Agreement, together with the attached Exhibits and Attachments, represents the entire agreement of the Parties with respect to the subject matter hereof and supersedes all other agreements between the Parties relating to the Service. 30. MODIFICATION OF AGREEMENT. This Agreement, including its Exhibits and Attachments, may be amended, modified or supplemented only by a separate written document executed by both Parties with the formality of this Agreement. 31. WAIVER OF TERMS. No term or provision herein shall be waived, and no breach or default excused, unless such waiver or consent is in writing and signed by the Party to which it is attributed. No consent by a Party to, or waiver of, a breach or default by the other, whether express or implied, shall constitute a consent to, or waiver of, any subsequent breach or default. 32. PARTIAL INVALIDITY. If any provision of this Agreement shall be invalid or unenforceable, such invalidity or unenforceability shall not invalidate or render the Agreement unenforceable, but rather the Agreement shall be construed as if not containing the invalid or unenforceable provision. However, if such provision is an essential element of this Agreement, the Parties shall promptly attempt to negotiate a substitute therefor. 33. CUMULATIVE REMEDIES. Except as otherwise provided herein, the remedies provided for in this Agreement are in addition to any other remedies available at law or in equity. 34. EXPIRATION OF OFFER. Sprint's offer to enter into this Agreement shall be withdrawn if the Agreement is not executed by both Parties within 45 days after the Proposal Date stated on Attachment A. EXECUTED and made effective as provided herein. MATRIX TELECOM, INC. SPRINT COMMUNICATIONS COMPANY L.P. By /s/ JAMES P. PISANI By /s/ PAGET ALVES - ---------------------- ---------------------------------- President President, Wholesale Services Group Date: March 12, 1998 EX-10 5 IXPLUS LICENSE AGREEMENT AND AMENDED ONE EXHIBIT 10.11 IXplus LICENSE AGREEMENT THIS LICENSE AGREEMENT ("Agreement"), dated as of April 23, 1991, (the "Effective Date"), is by and between ELECTRONIC DATA SYSTEMS CORPORATION, a Texas corporation ("EDS") and MATRIX Telecom, a Texas general partnership ("Licensee"). WHEREAS, Licensee desires to use certain software proprietary to EDS; and WHEREAS, EDS is willing to license such software to Licensee upon the terms and conditions set forth herein. NOW, THEREFORE, EDS and Licensee hereby agree as follows: ARTICLE I - GRANT 1.1 Grant of License to the Licensed Program. Subject to the terms and conditions set forth in this Agreement, EDS grants to Licensee, a non-exclusive, non-transferable license: (a) to use (as provided in this Article I) on the equipment designated by type, model and serial number on Schedule 1.1 hereto (the "Designated Equipment") and at the location designated on Schedule 1.1 hereto (the "Designated Location") one copy, in object code form, of EDS' proprietary computer software program known as the IXplus software, which software program is more specifically described on Schedule 1.1 (such program, including all new releases and modifications made thereto which are provided to Licensee pursuant to this Agreement, is referred to herein as the "Licensed Program"); and (b) to use (as provided in this Article I) one copy of the documentation relating to the Licensed Program, including a user's guide and examples of menu screens and reports, setting forth specifications for the Licensed Program provided to Licensee by EDS (the "Documentation"). 1.2 Delivery. EDS shall deliver to Licensee the Licensed Program [as modified pursuant to Section 3.1(a)] and the Documentation at the Designated Location on or before the Delivery Date. For the purposes of this Agreement, the Delivery Date shall be the fifth working day after the date on which the later of the following occurs: (a) the testing of the modifications to the Licensed Program made pursuant to Section 3.1(a) is completed, or (b) the improvements to the Designated Location required in order to adequately accommodate the Designated Equipment are completed. 1.3 Ownership. For purposes of Section 117 of the Copyright Act of 1976, as amended, and for all other purposes, EDS shall be considered the owner of the Licensed Program and Documentation and all modifications made thereto, any copies thereof, and of all copyright, trade secret, patent and other intellectual or industrial property rights contained or evidenced therein. Physical copies of the Licensed Program (in diskette, tape or other form provided by EDS) and Documentation shall remain the property of EDS and such copies shall be deemed to be on loan to Licensee during the License Term (defined in Section 2.1 below). 1.4 Restrictions on Use. (a) Data. The Licensed Program and Documentation shall be utilized only to process Licensee's data and shall be operated only by Licensee's employees. (b) Designated Equipment and Location. Further, the Licensed Program shall be operated only on the Designated Equipment and at the Designated Location, unless Licensee obtains EDS' prior written approval of a change in the Designated Equipment (including a change in any one or more of the following: the manufacturer, description, model number or serial number of the Designated Equipment) or the Designated Location, which approval shall not be unreasonably withheld. EDS' approval regarding a change in the Designated Equipment which increases the processing capacity of the Designated Equipment or which involves the replacement of the Designated Equipment with different equipment which has greater processing capacity than the Designated Equipment shall be subject to payment by Licensee of the fees described in Section 5.3. Any EDS-approved change in the Designated Equipment or the Designated Location shall be documented by amending Schedule 1.1 to reflect such change. (c) Temporary Backup. Licensee shall have the limited right without obtaining EDS' prior written approval, in the event that the Designated Equipment is inoperative due to (i) malfunction or (ii) engineering changes or similar occurrences, to temporarily use the Licensed Program on backup equipment until the Designated Equipment is restored to operative status. In such case, the backup equipment shall, for all purposes hereunder, be deemed to be the Designated Equipment. In no event shall Licensee's right to temporarily use the Licensed Program on backup equipment continue for a period exceeding thirty (30) days, unless Licensee obtains EDS' prior written approval, which approval shall not be unreasonably withheld. 1.5 Confidentiality. (a) Non-disclosure. The Licensed Program and Documentation will be disclosed by EDS to Licensee in confidence, and Licensee shall not cause or permit disclosure, display, loan, publication, transfer of possession (whether by sale, exchange, gift, operation of law or otherwise), sublicensing or other dissemination of the Licensed Program or Documentation, in whole or in part, to any third party without the prior written consent of EDS. Licensee shall limit use of and access to the Licensed Program to such of Licensee's employees as are directly involved in the utilization of the Licensed Program and who are bound to comply, with the confidentiality obligations set forth in this Agreement. (b) Copying or Modifying. Licensee shall not reverse assemble, reverse compile or otherwise copy, reproduce, recreate or modify the Licensed Program. Licensee may make one copy of the Licensed Program to be used as a backup which will be placed in archival storage. Licensee shall not copy or reproduce the Licensed Program or Documentation except as expressly provided for in this Agreement. Licensee may copy or reproduce the Documentation for distribution only to those employees of Licensee who are directly involved in the use of the Licensed Program and who are bound to comply with the confidentiality obligations set forth in this Agreement. (c) Safeguards. Licensee shall exercise reasonable precautions, no less vigorous than those Licensee uses to protect its own confidential information, to safeguard the Licensed Program and Documentation and to ensure that no unauthorized persons have access to the Licensed Program and Documentation, and to ensure that no persons authorized to have such access shall take any action which would be in violation of Sections 1.4 or 1.5 of this Agreement if taken by Licensee. Licensee shall promptly report to EDS any actual or suspected violation of Sections 1.4 or 1.5 and Licensee shall, at its expense, take such further steps as may reasonably be requested by EDS to prevent or remedy any such violation and shall reimburse EDS for all reasonable expenses EDS incurs related to the remedy of such violation. 1.6 Licensee's Responsibilities. Licensee accepts responsibility, financial and otherwise, for (i) the selection of the Licensed Program to achieve the desired result, (ii) the acquisition of a license from CCMI/McGraw Hill for the Q-TEL 9000 software and installation of such software prior to the Delivery Date and, thereafter, for maintaining the license for such software during the License Term (as defined in Section 2.1), (iii) the installation of the Licensed Program [with assistance from EDS as provided pursuant to Section 3.1(b)], (iv) the use of the Licensed Program, and (v) the results obtained from the Licensed Program. 1.7 Copyright. Licensee shall not alter or remove any copyright, trade secret, patent, proprietary and/or other legal notices contained on or in copies of the Licensed Program and Documentation. Licensee shall include on all copies of the Licensed Program or the Documentation which it may have in its possession, or create, whatever type of designation EDS may reasonably require to indicate that such material is the proprietary property of EDS or another party. 1.8 Verification. At least twice each year during the License Term (as defined in Section 2.1), Licensee shall permit EDS access to Licensee's premises, computer systems and records related to this Agreement and the use of the Licensed Program and Documentation so that EDS may conduct, at EDS' expense, an investigation to determine Licensee's compliance with the terms of this Agreement. EDS shall notify Licensee at least 10 days prior to the date EDS desires such access, and Licensee shall provide such access during Licensee's normal business hours on the date indicated in the notice. 1.9 Injunctive Relief. Licensee acknowledges and agrees that the Licensed Program and the Documentation are the valuable property and trade secrets of EDS or other parties, that any violation by Licensee of the provisions of Article I would cause EDS or such other parties irreparable injury for which they would have no adequate remedy at law, and that, in addition to any other remedies which EDS may have, it shall be entitled to preliminary and other injunctive relief against any such violation. 1.10 Survival. Notwithstanding anything to the contrary herein, the restrictions set forth in this Article I shall survive any termination of the License Term, the Maintenance Service Term (as defined in Section 2.2) and any Extension Period (as defined in Section 2.2) until the provisions of Section 7.4 of this Agreement have been fully complied with or have been waived in writing by EDS. ARTICLE II - TERM 2.1 Term of License. The term of the license granted under this Agreement pursuant to Section 1.1 shall commence on the Delivery Date and shall continue in perpetuity, unless terminated pursuant to Article VII of this Agreement (the "License Term"). 2.2 Term of Maintenance Service. The term during which the maintenance services described at Section 3.3 of this Agreement shall be provided shall consist of two phases: the Free Maintenance Service Period and the Maintenance Service Term, unless earlier terminated pursuant to Article VII of this Agreement. The Free Maintenance Service Period shall commence on the Installation Date [as defined in Section 3.1(b)] and shall continue for six months after the Installation Date. The Maintenance Service Term shall commence on the first day of the seventh month after the Installation Date (the first "Maintenance Service Fee Date") and shall end on the fifth anniversary of the Maintenance Service Fee Date; provided, however, the Maintenance Service Term shall be automatically extended for additional one year periods (each such one-year period is referred to herein as an "Extension Period") unless either EDS or Licensee shall have given written notice of its desire to not extend the Maintenance Service Term at least thirty (30) days prior to the end of the Maintenance Service Term or prior to the end of any Extension Period. ARTICLE III - CUSTOMIZATION, INSTALLATION, TRAINING AND MAINTENANCE 3.1 Customization and Installation Assistance. (a) Customization. EDS and Licensee shall jointly develop and implement a plan ("Customization Plan") to modify the Licensed Program in accordance with those requirements of Licensee which are agreed upon by EDS. The Customization Plan shall identify the tasks required to be performed by each party in connection with the definition and analysis of Licensee's requirements and the design, construction and testing of the modifications to the Licensed Program. To perform those tasks anticipated to be assigned to EDS in the Customization Plan, the parties estimate that the effort required will be 6 Person-Months (as defined in Section 5.4); notwithstanding the foregoing, the parties acknowledge and agree that such estimate was determined for planning purposes only and shall not be binding on either party. (b) Installation. Commencing on the Delivery Date and continuing until the Installation Date (as defined herein) , EDS shall provide to Licensee up to the number of hours of installation assistance set forth on Schedule 3. 1; provided, however, EDS shall be relieved of its obligation to provide installation assistance until and unless Licensee has fulfilled its obligation to acquire and install the Q-TEL 9000 software pursuant to Section 1.6(ii). For the purposes of this Agreement, the "Installation Date" shall be the earlier of (i) the date on which the first bills of Licensee are produced for delivery or mailing using the Licensed Program (bills produced for testing purposes only would not be considered to be produced for delivery or mailing), or (ii) the date on which the last hour of the amount of installation assistance set forth on Schedule 3.1 is expended. If Licensee requests that EDS provide installation assistance in addition to the amount of installation assistance set forth on Schedule 3.1, such assistance would be provided as an Additional Service pursuant to Section 3.4. 3.2 Training. EDS shall provide to Licensee up to the number of hours of training set forth on Schedule 3.1 regarding the use and operation of the Licensed Program. If Licensee requests that EDS provide additional training, such training would be provided as an Additional Service pursuant to Section 3.4. 3.3 Maintenance. (a) Maintenance Service. (i) During the Maintenance Service Term and any Extension Period, EDS will use all reasonable efforts to repair or replace the then current release of the Licensed Program if it is not performing substantially in accordance with the Documentation, upon receiving written notice of the nonperformance from Licensee in accordance with Section 3.3(b). The methods and techniques for resolving nonperformance will be at the sole discretion of EDS. If the Designated Equipment can be accessed remotely through dial-up capability or otherwise, Licensee shall make such remote access capability available to EDS for use in performing maintenance services. (ii) If after reasonable efforts to repair or replace the Licensed Program which is not performing substantially in accordance with the Documentation, EDS is unable to make such repairs or replacement, Licensee's sole remedy shall be the refund of an amount not to exceed the actual payments received by EDS from Licensee pursuant to this Agreement. (iii) EDS shall have no obligation to repair or replace the Licensed Program if the nonperformance is found by EDS to have been caused or contributed to by computer equipment malfunction, Licensee's negligence or fault, Licensee's failure to follow instructions as set forth in the Documentation, improper or unauthorized use of the Licensed Program, unauthorized hardware changes, changes in any software not provided by EDS, modifications made by or on behalf of Licensee, or any other cause beyond the control of EDS. However, if requested by Licensee, EDS will provide Licensee with assistance in resolving any nonperformance resulting from such causes as an Additional Service pursuant to Section 3.4. (b) Notice. To obtain the maintenance services described in Section 3.3(a), Licensee must provide EDS with the following during the Maintenance Service Term and any Extension Period: (i) written notice to the maintenance service address set forth on Schedule 9.3 of the operating problem which includes the information described in this Section 3.3(b) or notice by telephone to the maintenance service telephone number set forth on Schedule 9.3 of the information described in this Section 3.3(b) which information is documented in a written notice delivered to the maintenance service address by facsimile transmission or overnight mail within 24 hours after the telephone notice was given, (ii) a detailed description of the failure to perform substantially in accordance with the Documentation, (iii) a detailed description of the operating conditions, including the specific hardware/software configuration, under which such failure to perform occurred, and (iv) a representative sample of inputs and outputs for replicating and analyzing such failure to perform. (c) New Releases. From time to time, EDS may make updates, improvements or changes to the Licensed Program in separate releases to the Licensed Program which are designed to enhance operating performance without changing the basic functions of the Licensed Program. During the Maintenance Service Term and any Extension Period and in consideration of the Maintenance Service Fee, EDS will make all new releases available to Licensee which are generally made available to EDS 1, other licensees of the Licensed Program and will provide revisions to the Documentation necessary to reflect the updates, improvements or changes included in such new releases. EDS may discontinue maintenance services as described in Section 3.3(a) for a prior release of the Licensed Program replaced by a new release one hundred eighty (180) days after the date such new release is first made available. EDS will provide to Licensee maintenance services as described in Section 3.3(a) for prior releases of the Licensed Program which Licensee elects to continue to use as an Additional Service pursuant to Section 3.4, so long as Licensee continues to pay for and receive maintenance services for the most current release of the Licensed Program in anticipation of eventually using the most current release. (d) Requested Changes. Any changes to the Licensed Program or Documentation requested by Licensee which EDS, in its sole discretion, has not or does not intend to make part of a new release would be provided as an Additional Service pursuant to Section 3.4.-3.4 Additional Services. Licensee may from time to time request that EDS provide support or services which are beyond the scope or amount of the support or services provided pursuant to this Agreement ("Additional Services"). Any requested Additional Services will be provided by EDS to Licensee on such terms as are mutually agreed upon by Licensee and EDS and documented in writing, including without limitation the description of the Additional Services to be provided, the price to be paid, and any other appropriate terms and conditions. ARTICLE IV - WARRANTY 4.1 Rights in Licensed Program. EDS hereby represents and warrants that from the Effective Date until the expiration of the License Term it has all rights, title, ownership interest and/or marketing rights necessary to grant the rights and license to Licensee set forth herein. 4.2 Nonperformance of Licensed Program. EDS further warrants that on the Delivery Date the Licensed Program shall be capable of performing substantially in accordance with the Documentation. EDS shall resolve any failure of the Licensed Program to perform substantially in accordance with the Documentation pursuant to the terms and conditions of Section 3.3. 4.3 Limitation on warranty. EDS does not warrant that the functions contained in the Licensed Program will meet Licensee's requirements or that the operation of the Licensed Program will be uninterrupted or error free. Further, EDS shall have no responsibility with respect to Licensee's data files. The remedies of Licensee set forth in Sections 3.3(a) and in Section 8.1 shall be exclusive and EDS' liability for all matters relating to the warranties set forth in this Article IV shall be limited as provided in Sections 3.3(a), 8.1 and 8.2. 4.4 No Other Warranties. THE WARRANTIES CONTAINED IN THIS ARTICLE IV ARE LIMITED WARRANTIES AND ARE THE ONLY WARRANTIES MADE BY EDS. EDS MAKES AND LICENSEE RECEIVES NO OTHER WARRANTY EXPRESS OR IMPLIED, INCLUDING WITHOUT LIMITATION, WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE. THE STATED EXPRESS WARRANTIES ARE IN LIEU OF ALL LIABILITIES OR OBLIGATIONS OF EDS FOR DAMAGES ARISING OUT OF OR IN CONNECTION WITH THE DELIVERY, USE OR PERFORMANCE OF THE LICENSED PROGRAM. ARTICLE V - PAYMENTS TO EDS 5.1 License Fee. Licensee shall pay to EDS for the grant of the license pursuant to Section 1.1 hereunder a license fee in the amount indicated on Schedule 5.1 ("License Feel') payable as follows: (a) Licensee shall pay to EDS one-half of the License Fee on the Delivery Date, and (b) Licensee shall pay to EDS one-half of the License Fee on the Installation Date. 5.2 Maintenance Service Fee. (a) Amount of Fee. For each year during the Maintenance Service Term and any Extension Period, Licensee shall pay to EDS for the maintenance services provided pursuant to Section 3.3 the applicable annual maintenance service fee ("Maintenance Service Fee") at the time for payment indicated in Section 5.2(b). The applicable Maintenance Service Fee shall be determined in accordance with the following procedures: (i) Fee for First Year. Subject to Section 5.3(b) the Maintenance Service Fee applicable for the first year of the Maintenance Service Term is indicated on Schedule 5.1. (ii) Fee for Subsequent Years. Subject to Section 5.3(b), the Maintenance Service Fee applicable for the remaining years of the Maintenance Service Term and any Extension Periods shall be the lesser of: (x) the amount of the Maintenance Service Fee indicated on EDS' License and Maintenance Service Fee Schedule in effect on the Maintenance Service Fee Date for the then current year for the Designated Equipment in use on such date, or (y) the sum of the amount of the Maintenance Service Fee indicated on EDS License and Maintenance Service Fee Schedule in effect on the Maintenance Service Fee Date for the prior year for the Designated Equipment in use on the Maintenance Service Fee Date for the then current year, plus 10% of such amount. The License and Maintenance Service Fee Schedule in effect on the Effective Date is attached to this Agreement as Schedule 5.2. The License and Maintenance Service Fee Schedule may be amended or replaced by a new schedule from time to time by EDS in its sole discretion, which new schedule shall be deemed to amend and replace the License and Maintenance Service Fee Schedule attached as Schedule 5.2. The new schedule shall be provided to Licensee at least 45 days before the day the new rates are effective. (b) Payment of Fee. Licensee shall pay the first annual Maintenance Service Fee on the first Maintenance Service Fee Date, and subsequent annual Maintenance Service Fees shall be paid each year on the anniversary of the first Maintenance Service Fee Date (each such anniversary is also referred to herein as a "Maintenance Service Fee Date"). 5.3 Upgrade in Designated Equipment. (a) Upgrade Fee. If during the License Term Licensee upgrades the Designated Equipment to increase its processing capacity or replaces the Designated Equipment with different equipment which has greater processing capacity than the Designated Equipment, Licensee shall pay to EDS on or before the upgrade or replacement of the Designated Equipment occurs an upgrade fee ("Upgrade Fee") in an amount equal to the difference resulting when the amount of the License Fee paid by Licensee is subtracted from the amount of the then current licensee fee applicable to the upgraded or replaced Designated Equipment as indicated on EDS' License and Maintenance Service Fee Schedule then in effect. The following illustrates the calculation of the Upgrade Fee: Then Current License Fee Applicable to Upgraded or Replaced - Amount of = Upgrade Designated Equipment License Fee Fee Per Schedule 5.2 Paid As provided in Section 5.2, the License and Maintenance Service Fee Schedule in effect on the Effective Date is attached to this Agreement as Schedule 5.2, and may be amended from time to time by EDS in its sole discretion. (b) Change in Maintenance Service Fee. If the upgrade or replacement of the Designated Equipment occurs on or before the first Maintenance Service Fee Date, Licensee shall pay on such date the Maintenance Service Fee applicable for the upgraded or replaced Designated Equipment as indicated on EDS' License and Maintenance Service Fee Schedule in effect on the first Maintenance Service Fee Date. If the upgrade or replacement of the Designated Equipment occurs at any time after the first Maintenance Service Fee Date, Licensee shall pay on the next Maintenance Service Fee Date occurring on or after the upgrade or replacement of the Designated Equipment, the sum of (i) an amount equal to: the difference between the amount of the Maintenance Service Fee paid on the immediately previous maintenance Service Fee Date and the Maintenance Service Fee applicable for the upgraded or replaced Designated Equipment as indicated on EDS' License and Maintenance Service Fee Schedule in effect at the time the upgrade or replacement of the Designated Equipment occurs, multiplied by the number of months which would occur from the time the upgrade or replacement until the next Maintenance Service Fee Date, and divided by 12, as illustrated in the following formula: Months from Then Current Maintenance upgrade to Service Fee Applicable Maintenance Service Maintenance to Upgraded/Replaced - Fee Paid X Service Fee Designated Equipment Previously Date Per Schedule 5.2 12 = Change Amount plus (ii) the Maintenance Service Fee applicable for the upgraded or replaced Designated Equipment as determined in accordance with Sections 5.2(a)(i) and (ii). Subsequent Maintenance Service Fees shall be determined in accordance with Section 5.2(a)(ii). 5.4 Customization Charge. In addition to the other fees described in Article 5, Licensee shall pay to EDS a monthly charge ("Customization Charge") of $12,000 per Person-Month (as defined herein) for the services performed by EDS pursuant to Section 3.1(a). For the purposes of this Section 5.4, the term "Person-Month" shall mean one person provided for that number of working days which occur during the applicable month. The Customization Charge for any partial month shall be prorated on a per them basis. 5.5 Out-of-Pocket Expenses. In addition to the other fees described in Article 5, Licensee shall pay, or reimburse EDS for, the reasonable out-of-pocket expenses incurred by EDS with the approval of Licensee, including but not limited to, the travel, meals and lodging expenses incurred by EDS personnel performing the installation assistance, training, maintenance service and any Additional Services described in this Agreement. 5.6 Time for Payment. Except as otherwise provided herein, any sum due EDS hereunder shall be due and payable within thirty days after receipt by Licensee of an invoice from EDS. Any sum due EDS hereunder that is not paid to EDS within thirty calendar days after its due date shall thereafter bear interest until paid at the lesser of (i) two percent per annum more than the prime rate established from time to time by Citibank N.A., New York, or (ii) the maximum rate of interest allowed by applicable law. 5.7 Taxes. There will be added to any charges hereunder, and Licensee shall pay to EDS, all taxes, assessments, duties, permits and fees, however designated or levied, which are based upon any charges under this Agreement, or upon this Agreement or the Licensed Program, services or materials provided hereunder, or their use, including without limitation state and local privilege or excise taxes based on gross revenue, sales and use taxes, and any taxes or amounts in lieu thereof paid or payable by EDS in respect of the foregoing, but excluding franchise taxes and taxes based on the net income of EDS. ARTICLE VI - ARBITRATION 6.1 Arbitration. In the event that the parties are not able to resolve any dispute or controversy through informal discussions, the parties agree as follows: (a) Procedures. All disputes and controversies between the parties of every kind and nature, including but not limited to, those arising under or in connection with this Agreement, including the creation, validity interpretation, breach or termination of the License Term, Maintenance Service Term or any Extension Period, shall be submitted to arbitration using the following procedure: (i) Either party may demand arbitration in writing, stating the nature of the controversy and naming the arbitrator selected by it. (ii) Within thirty days after such demand, the other party shall name its arbitrator, and the two named arbitrators shall, within sixty days thereafter, select the third arbitrator to serve on the arbitration panel. The two arbitrators named by the parties may have prior relationships with the naming party, which in a judicial setting would be considered a conflict of interest. The third arbitrator, selected by the first two, should be a neutral participant, with no prior working relationship with either party. (iii) The arbitration shall be governed by the Commercial Arbitration Rules of the American Arbitration Association. (iv) The arbitration shall be conducted in Dallas, Texas. (v) Each party shall bear its own arbitration costs and expenses; provided, however, the arbitrators may modify the allocation of fees, costs and expenses in the award in those cases where fairness dictates other than an equal allocation between the parties. (vi) The arbitrators shall allow such discovery as is appropriate to the purposes of arbitration in accomplishing fair, speedy and cost effective resolution of disputes. The arbitrators shall reference the rules of evidence of the Federal Rules of Civil Procedure then in effect insetting the direction of such discovery. (vii) The award shall be final and binding on the parties, and judgment on the award may be entered in and enforced by any court of competent jurisdiction. (b) Exclusive Remedy. Other than those matters involving injunctive relief as a remedy, or any action necessary to enforce the award of the arbitrators, the parties agree that the provisions of this Section 6.1 are a complete defense to any suit, action or other proceeding instituted in any court or before any administrative tribunal with respect to any dispute or controversy arising out of or in connection with this Agreement. The provisions of this Section 6.1 will survive termination of the License Term, the Maintenance Service Term and any Extension Period. Nothing in this Section prevents the parties from exercising their rights to terminate the License Term, the Maintenance Service Term or any Extension Period as specified in this Agreement. (c) Continued Performance. Unless EDS is bringing an action under this Section for nonpayment by Licensee, EDS shall continue to provide services, if applicable, under this Agreement during the arbitration proceedings and Licensee shall continue to make payments to EDS in accordance with this Agreement. Any disputed payments shall be paid into an interest-bearing escrow account, structured by agreement of the parties, or as ordered by the arbitrators if agreement can not be reached, for distribution in accordance with the arbitrators' award. If a disputed payment is paid into an escrow account on or before its due date, the interest accruing on the escrow account shall be paid to the party to whom the arbitrators award the disputed amount. ARTICLE VII - TERMINATION 7.1 Termination for Cause. If either party hereto materially defaults in the performance of any of its obligations hereunder (other than a payment obligation) and if such default continues for more than thirty (30) days after written notice specifying the default is given to the defaulting party, then the other party may, by giving the defaulting party written notice thereof, terminate the License Term and/or the Maintenance Service Term or any Extension Period as of a date specified in such notice of termination. 7.2 Termination for Adverse Change in Business. If (i) Licensee ceases to carry on its business, (ii) a receiver or similar officer is appointed for Licensee, (iii) Licensee makes an assignment for the benefit of, or a composition with, its creditors, or another arrangement of similar import, or (iv) if proceedings under any bankruptcy or insolvency law are commenced by or against Licensee, then in such event EDS may, by giving Licensee written notice thereof, terminate the License Term and/or the Maintenance Service Term or any Extension Period as of a date specified in such notice of termination. 7.3 Termination for Nonpayment. (a) License Fees. In the event Licensee defaults in the payment when due of the License Fee or the Upgrade Fee due to EDS hereunder and does not cure such default within fifteen (15) days after being given written notice of such default, then EDS may, by giving written notice thereof to Licensee, terminate the License Term as of a date specified in such notice of termination. (b) Maintenance Service and Other Fees. In the event Licensee defaults in the payment when due of any Maintenance Service Fee or any other amount due to EDS hereunder and does not cure such default within fifteen (15) days after being given written notice of such default, then EDS may, by giving written notice thereof to Licensee, terminate the Maintenance Service Term or any Extension Period as of a date specified in such notice of termination. 7.4 Rights Upon Termination. Upon termination of the License Term for any reason, then, in addition to any other rights which either party may have, Licensee shall promptly return to EDS all copies of the Licensed Program and the Documentation in Licensee's possession and completely erase the Licensed Program and all elements thereof from the Designated Equipment and any other computer system of Licensee and upon EDS' request, shall execute and deliver to EDS a written certification that Licensee has complied with the provisions of this Section and no longer retains any material relating to the Licensed Program or the Documentation. ARTICLE VIII - INDEMNIFICATION, REMEDIES AND LIABILITY 8.1 Infringement Indemnity. (a) Defense of Claim. EDS will defend any action brought against Licensee to the extent that such action is based on a claim that the Licensed Program or Documentation used within the scope of the license granted herein, in whole or in part infringes (i) a copyright perfected under United States statute, (ii) a patent granted under United States law, or (iii) constitutes an unlawful disclosure, use or misappropriation of another party's trade secret. EDS will bear the expense of such defense and pay any costs and damages which are finally awarded as a result of such claim, provided that Licensee notifies EDS promptly in writing of the claim and that Licensee allows EDS to fully direct the defense or settlement of such claim. EDS shall not be responsible for any settlement or compromise made without its consent. (b) Continued Right to Use. Should the Licensed Program or the Documentation become, or in EDS' opinion be likely to become, the subject of a claim of infringement of a copyright or patent, EDS will attempt to procure for Licensee the right to continue using the Licensed Program or Documentation, or replace or modify the Licensed Program or Documentation to make its use hereunder non-infringing. If with respect to the Licensed Program neither option is reasonably available in EDS' judgment, (i) Licensee shall return the Licensed Program and the Documentation to EDS, and (ii) the License Term, the Maintenance Service Term and any Extension Period and all of the rights granted hereunder shall terminate. (c) Infringement Caused by Licensee. EDS shall have no liability to Licensee under this Section 8.1 or under any other provision of this Agreement, if any claim of infringement is based upon the use of the Licensed Program or Documentation delivered hereunder in combination with equipment, devices or software not supplied by EDS, the use of the Licensed Program in an application or environment for which it was not designed or was not contemplated under this Agreement, or the modification of the Licensed Program by anyone other than EDS or its employees or agents. Further, Licensee shall indemnify and hold EDS harmless from any liability, loss, claim or damage to persons or property arising out of Licensee's possession, operation, use or modification of the Licensed Program or arising out of the fault or negligence of Licensee, its employees or agents, and shall indemnify EDS from any expense or cost incurred if any such claims are made. (d) Entire Obligation. This Section 8.1 states EDS' entire obligation to Licensee regarding infringement. 8.2 Remedies and Limit of Liability. For all claims relating to this Agreement, whether in contract or in tort, Licensee's exclusive remedy shall be (i) for a breach of any warranty, the correction of such breach at no charge to Licensee as described in Section 4.3, and (ii) for any other claim, including a claim of a failure to correct a breach of warranty, the recovery of Licensee's actual, direct damages up to, in the aggregate, an amount equal to the total amount of all fees paid to EDS by Licensee under this Agreement. This limitation will apply regardless of the form of action, whether in contract or in tort, including negligence. EDS shall have no liability for any punitive, indirect or consequential damages, including lost profits, lost income or lost savings, or for any claim against Licensee by any other party [except as provided in Section 8.1(a)]. Further, neither party may assert any cause of action against the other party which accrued more than two (2) years prior to the filing of a suit alleging such cause of action. The limitations described in this Section 8.2 will not apply to the payment of costs and damages referred to in Section 8.1(a). 8.3 Acknowledgement. The parties acknowledge that each of the provisions of this Agreement including the fees for the license and services were based in part on the limitations contained in Section 8.2 and that each party fully understands and accepts the obligations and limitations described in this Agreement. The parties further acknowledge and agree that the obligations and limitations described in Section 8.2 shall survive the termination of the License Term, the Maintenance Service Term and any Extension Period. ARTICLE IX - MISCELLANEOUS 9.1 Other Confidential Information. In addition to the provisions of Section 1.5, each party shall use the same means as it uses to protect its own confidential information, but in any event not less than reasonable means, to prevent the disclosure and to protect the confidentiality of both (i) written information received from the other party which is marked or identified as confidential; and (ii) oral or visual information identified as confidential at the time of disclosure. The information described in the preceding sentence at (i) and (ii) shall be referred to in this Agreement as "Confidential Information". Each party shall use Confidential Information received from the other party only in connection with the purposes of this Agreement. The foregoing shall not prevent either party from disclosing Confidential Information which belongs to such party or is (i) already known by the recipient party without an obligation of confidentiality; (ii) publicly known or becomes publicly known through no unauthorized act of the recipient party; (iii) rightfully received from a third party; (iv) independently developed by the recipient party without use of the other party's Confidential Information; (v) disclosed without similar restrictions to a third party by the party owning the Confidential Information; (vi) approved by the other party for disclosure; or (vii) required to be disclosed pursuant to a requirement of a governmental agency or law so long as the disclosing party provides the other party with notice of such requirement prior to any such disclosure. The provisions of this Section 9.1 will survive the expiration or termination of the Maintenance Service Term, or if extended, the last Extension Period, for a period of three years. 9.2 Assignment. This Agreement shall be binding on the parties hereto and their successors and assigns, but Licensee may not assign this Agreement or the license granted pursuant to this Agreement without the prior written consent of EDS, which consent shall not be unreasonably withheld. The parties acknowledge and agree that the following includes, without limitation, circumstances in which it shall be reasonable for EDS to withhold its consent to the proposed assignment of this Agreement: the proposed assignment to a competitor of EDS or to an entity which is a higher credit risk than Licensee. Notwithstanding the foregoing, EDS will have the right to subcontract portions of the services to be performed by it pursuant hereto; provided, however, no such subcontract will relieve EDS of any of its obligations hereunder. 9.3 Notice. Wherever under this Agreement one party is required to give notice to the other, such notice shall be deemed given if actually delivered or on the third day after mailing, if mailed by United States mail, first-class, postage prepaid, and addressed as provided on Schedule 9.3. Either party may at any time change its address for notification purposes by mailing a notice stating the change and setting forth the new address. 9.4 Headings. The article and section headings and the table of contents used herein are for reference and convenience only and shall not enter into the interpretation hereof. 9.5 Relationship of Parties. EDS, in furnishing services to Licensee, is providing services only as an independent contractor. EDS does not undertake by this Agreement or otherwise to perform any obligation of Licensee, whether regulatory or contractual. 9.6 Force Majeure. Each party hereto shall be excused from performance hereunder (other than the performance of payment obligations) for any period and to the extent that it is prevented from performing pursuant hereto, in whole or in part, as a result of delays caused by the other party or an act of God, war, civil disturbance, court order, labor dispute, third party nonperformance, or other cause beyond its reasonable control, including failures, fluctuations or non-availability of electrical power, heat, light, air conditioning or telecommunications equipment, and such nonperformance shall not be a default hereunder nor a ground for termination of the License Term, Maintenance Service Term or any Extension Period. 9.7 Severability. If any provision of this Agreement is declared or found to be illegal, unenforceable or void (other than a provision relating to a payment obligation) then both parties shall be relieved of all obligations arising under such provision, but if the remainder of this Agreement shall not be affected by such declaration or finding, then each provision not so affected shall be enforced to the extent permitted by law. 9.8 Attorneys' Fee. If any legal action or other proceeding is brought for the enforcement of this Agreement, or because of an alleged dispute, breach, default or misrepresentation in connection with any of the provisions of this Agreement, the prevailing party shall be entitled to recover reasonable attorneys' fees and other costs incurred in that action or proceeding, in addition to any other relief to which it may be entitled. 9.9 Media Releases. All media releases, public announcements and public disclosures by Licensee or its employees or agents relating to this Agreement or its subject matter, including without limitation promotional or marketing material, but not including any announcement intended solely for internal distribution at Licensee or any disclosure required by legal, accounting or regulatory requirements beyond the reasonable control of Licensee, shall be coordinated with and approved by EDS in writing prior to the release thereof, which approval shall not be unreasonably withheld. 9.10 No Third Party Beneficiary. Nothing in this Agreement may be relied upon or shall benefit any party other than the parties hereto. 9.11 Waiver. No delay or omission by either party hereto to exercise any right or power accruing upon any noncompliance or default by the other party with respect to any of the terms of this Agreement shall impair any such right or power or be construed to be a waiver thereof. A waiver by either of the parties hereto of any of the covenants, conditions, or agreements to be performed by the other shall not be construed to be a waiver of any succeeding breach thereof or of any other covenant, condition or agreement herein contained. 9.12 Entire Agreement. This Agreement constitutes the entire agreement between the parties with respect to the subject matter hereof. There are no understandings or agreements relative hereto which are not fully expressed herein and, except as provided herein, no change, waiver or discharge hereof shall be valid unless in writing and executed by the party against whom such change, waiver or discharge is sought to be enforced. 9.13 Governing Law. THIS AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS, OTHER THAN CHOICE OF LAW RULES, OF THE STATE OF TEXAS. IN WITNESS WHEREOF, EDS and Licensee have caused this Agreement to be signed by their duly authorized representatives as of the Effective Date. ELECTRONIC DATA SYSTEMS MATRIX TELECOM CORPORATION By: /s/ BOB A. MCCLESKEY By: /s/ DENNIS L. MIGA - -------------------------- ------------------------------- Bob A. McCleskey Dennis L. Miga Regional Vice President Managing Partner AMENDMENT NUMBER ONE TO IXplus LICENSE AGREEMENT BETWEEN ELECTRONIC DATA SYSTEMS CORPORATION AND MATRIX TELECOM THIS AMENDMENT NUMBER ONE, dated as of the 1st day of October, 1992, is between Electronic Data Systems Corporation ("EDS") and MATRIX Telecom ("Licensee"), and is an amendment of that certain IXplus License Agreement between EDS and Licensee dated as of April 23, 1991 (the "Agreement"). For and in consideration of the mutual agreements of the parties herein contained and other good and sufficient consideration the receipt of which is hereby acknowledged, EDS and Licensee agree as follows: 1. Effective as of the date of the Agreement and at no additional cost to Licensee, Section 1.1(a) of the Agreement is amended to read in its entirety as follows: "to use (as provided in this Article I) on the equipment designated by type and model on Schedule 1.1 hereto (the "Designated Equipment") and at the location designated on Schedule 1.1 hereto (the "Designated Location") multiple copies, in object and source code form, of EDS' proprietary computer software program known as the IXplus software, which software program is more specifically described on Schedule 1.1 (such program, including all new releases and modification made thereto which are provided to Licensee pursuant to this Agreement is referred to herein as the "Licensed Program"); and" 2. Effective as of the date of this Amendment, Section 5.2 of the Agreement is amended to read in its entirety as follows: "Maintenance Service Fee. For each year during the Maintenance Service Term and any Extension Period, Licensee shall pay to EDS for the right to receive new releases to the Licensed Program pursuant to Section 3.3, a maintenance service fee ("Maintenance Service Fee") equal to the total aggregate number of billable messages processed by Licensee each month, multiplied by $.00075 per Billable Message. A "Billable Message" shall mean any group of data which represents the statistical nature of a single long distance telephone call for the purpose of billing and/or reporting such telephone calls on behalf of the company providing such long distance telephone service to its customers, and can be identified with a valid customer account, rated, taxed and presented to a customer for payment. The monthly Maintenance Service Fee to be paid by Licensee shall be adjusted bi-annually based on Licensee's highest Billable Message volume for any one month during the prior six-month period, multiplied by $.00075 per Billable Message. At the end of each six month period, Licensee shall provide EDS with the actual number of Billable Messages processed by Licensee during such period. Any overpayment or underpayment of the actual Maintenance Service Fee during any such six-month period will be reflected as an adjustment on the next monthly invoice payable by Licensee to EDS. During the Maintenance Service Term, Licensee shall provide EDS with such reports and information as EDS reasonably requests for the purpose of verifying the number of Billable Messages processed by Licensee, including but not limited to, a monthly rating summary report of all Billable Messages rated through Licensee's system." 3. Effective as of the date of the Agreement, Section 5.3 of the Agreement shall be deleted in its entirety. Furthermore, the parties acknowledge and agree that the waiver of the Upgrade Fee shall apply to Licensee's current use of the AS/400 equipment, Models E10, D35 and E50. 4. Effective as of the date of this Amendment, a new Section 1.11 is added to the Agreement as follows: "Licensee's Purchase Obligations. Licensee shall purchase its requirements for any upgrades, replacements and/or additional IBM AS/400 equipment through EDS. Upon notification from Licensee of its IBM equipment needs, EDS will use commercially reasonable efforts to cause IBM to provide such equipment to EDS on behalf of Licensee. Any IBM equipment purchased by EDS on behalf of Licensee will be offered to Licensee at a price equal to EDS' then current cost for such equipment, plus 10%." 5. Pursuant to Section 1.4(a), EDS and Licensee hereby acknowledge and agree that, in addition to operation by Licensee's employees, the Licensed Program shall be operated by EDS acting on behalf of Licensee. 6. The Agreement is hereby amended by deleting the Designated Equipment and Designated Location Sections of Schedule 1.1 and substituting therefor the Designated Equipment and Designated Located Sections set forth on Exhibit A attached to this Amendment. Except as expressly provided by this Amendment, the Agreement remains in full force and effect and except as expressly amended by this Agreement the Agreement remains unchanged. IN WITNESS WHEREOF, EDS and Licensee have executed and delivered this Amendment to be effective as of the date set forth above. ELECTRONIC DATA SYSTEMS CORPORATION By: /s/ ROY A. FREDERICKSON - --------------------------- Regional Vice President MATRIX TELECOM By: /s/ CHARLES G. TAYLOR, JR. - ------------------------------ General Partner EX-21 6 LIST OF SUBSIDIARIES EXHIBIT 21 LIST OF SUBSIDIARIES Name Jurisdiction of Incorporation ------------------------ ----------------------------- Matrix Telecom, Inc. Texas Hi, Tiger, Inc. Utah Silicon Beach Communications, Inc. California Westnet Communications, Inc. California The Friendly Net, LLC Utah New Best Connections, Inc. Texas AvTel Holdings, Inc. California EX-23 7 CONSENT OF KPMH PEAT MARWICK LLP EXHIBIT 23 Independent Auditors' Consent The Board of Directors AvTel Communications, Inc. We consent to incorporation by reference in the Registration Statement (No. 333-30725) on Form S-8 of AvTel Communications, Inc. of our report dated March 24, 1998, relating to the consolidated balance sheets of AvTel Communications, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity, and cash flows and related schedule, for each of the years in the three-year period ended December 31, 1997, which report appears in the annual report on Form 10-K of AvTel Communications, Inc. for the fiscal year ended December 31, 1997. /s/ KPMG PEAT MARWICK LLP KPMG PEAT MARWICK LLP Dallas, Texas April 10, 1998 EX-27 8 FDS 12/31/97
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE OF AVTEL COMMUNICATIONS, INC. AS OF DECEMBER 31, 1997 AND THE RELATED STATEMENTS OF OPERATIONS AND CASH FLOWS FOR THE YEAR THEN ENDED AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 YEAR DEC-31-1997 DEC-31-1997 4807 0 7944 982 0 15358 4681 2889 18725 9787 0 2 0 111 7696 18725 51389 51389 36228 36228 25920 0 12 (10468) (276) 0 0 0 0 (10191) (1.23) 0
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