-----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, MGblP2ssVXzb/xPeyPkk8jdu5CAs9rDvnQNXBnWPwy/cdh5ECqON+JwgXPUC9iKw EUdUbmsFvJP097yGpUyvQQ== 0000950168-97-000438.txt : 19970227 0000950168-97-000438.hdr.sgml : 19970227 ACCESSION NUMBER: 0000950168-97-000438 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 16 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970226 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FLAGSTAR COMPANIES INC CENTRAL INDEX KEY: 0000852772 STANDARD INDUSTRIAL CLASSIFICATION: RETAIL-EATING PLACES [5812] IRS NUMBER: 133487402 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-18051 FILM NUMBER: 97544369 BUSINESS ADDRESS: STREET 1: 203 E MAIN ST CITY: SPARTANBURG STATE: SC ZIP: 29319 BUSINESS PHONE: 8035978700 MAIL ADDRESS: STREET 1: 203 EAST MAINE STREET CITY: SPARTANBURG STATE: SC ZIP: 29319 FORMER COMPANY: FORMER CONFORMED NAME: TW HOLDINGS INC DATE OF NAME CHANGE: 19920703 10-K 1 FLAGSTAR COMPANIES, INC. 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number 0-18051 FLAGSTAR COMPANIES, INC. (Exact name of registrant as specified in its charter) DELAWARE 13-3487402 (State or other jurisdiction (I.R.S. employer of incorporation or identification no.) organization) 203 EAST MAIN STREET 29319-9966 SPARTANBURG, SOUTH CAROLINA (Zip code) (Address of principal executive offices)
Registrant's telephone number, including area code: (864) 597-8000. Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED None None
Securities registered pursuant to Section 12(g) of the Act: $.50 Par Value, Common Stock TITLE OF CLASS $.10 Par Value, $2.25 Series A Cumulative Convertible Exchangeable Preferred Stock TITLE OF CLASS Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to Rule 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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 voting stock held by non-affiliates of the registrant was approximately $19,893,592 based upon the closing sales price of registrant's Common Stock on February 19, 1997 of $1.03 per share. As of February 19, 1997, 42,434,669 shares of registrant's Common Stock, $.50 par value per share, were outstanding. DOCUMENTS INCORPORATED BY REFERENCE. Information required by Part III of this Form 10-K shall be incorporated by reference to the registrant's Proxy Statement for the 1997 Annual Meeting of Stockholders or shall be included as an amendment to this Form 10-K to be filed no later than April 30, 1997. TABLE OF CONTENTS
PAGE PART I Item 1. Business................................................................................................... 1 Item 2. Properties................................................................................................. 10 Item 3. Legal Proceedings.......................................................................................... 11 Item 4. Submission of Matters to a Vote of Security Holders........................................................ 12 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...................................... 13 Item 6. Selected Financial Data.................................................................................... 13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...................... 14 Item 8. Financial Statements and Supplementary Data................................................................ 27 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....................... 27 PART III Item 10. Directors and Executive Officers of the Registrant......................................................... 27 Item 11. Executive Compensation..................................................................................... 27 Item 12. Security Ownership of Certain Beneficial Owners and Management............................................. 27 Item 13. Certain Relationships and Related Transactions............................................................. 27 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................................... 33 INDEX TO FINANCIAL STATEMENTS.......................................................................................... F-1 SIGNATURES.............................................................................................................
FORWARD-LOOKING STATEMENTS The forward-looking statements included in the "Business", "Legal Proceedings" and "Management's Discussion and Analysis of Financial Condition and Results of Operations" sections, which reflect management's best judgment based on factors currently known, involve risks and uncertainties. Words such as "expects", "anticipates", "believes", "intends", and "hopes", variations of such words and similar expressions are intended to identify such forward-looking statements. Actual results could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including but not limited to, the factors discussed in such sections and those set forth in the cautionary statements contained in Exhibit 99 to this Form 10-K. (See Exhibit 99 -- Safe Harbor Under the Private Securities Litigation Reform Act of 1995.) Forward-looking information provided by the Company in such sections pursuant to the safe harbor established under the Private Securities Litigation Reform Act of 1995 should be evaluated in the context of these factors. PART I ITEM 1. BUSINESS INTRODUCTION Flagstar Companies, Inc. ("FCI" or, together with its subsidiaries, the "Company"), through its wholly-owned subsidiary Flagstar Corporation ("Flagstar"), is one of the largest restaurant companies in the United States, operating (directly and through franchisees) more than 3,200 moderately priced restaurants. FCI is a holding company that was organized in Delaware in 1988 in order to effect the leveraged buyout of Flagstar in 1989. On November 16, 1992, FCI and Flagstar consummated the principal elements of a recapitalization (the "Recapitalization"), which included, among other things, an equity investment by TW Associates, L.P. ("TW Associates") and KKR Partners II, L.P. ("KKR Partners II") (collectively, "Associates"), partnerships affiliated with Kohlberg Kravis Roberts & Co. ("KKR"). As a result of such transactions, Associates acquired control of FCI and Flagstar. Prior to June 16, 1993, FCI and Flagstar had been known, respectively, as TW Holdings, Inc. and TW Services, Inc. As a result of the 1989 leveraged buyout of Flagstar, the Company became and remains very highly leveraged. While the Company's cash flows have been sufficient to cover interest costs, operating results since the buyout in 1989 have fallen short of expectations. Such shortfalls have resulted from negative operating trends due to increased competition, intensive pressure on pricing due to discounting, declining customer traffic, adverse economic conditions, and relatively limited capital resources to respond to these changes. These operating trends have generally continued through 1996. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" for additional information. On May 23, 1996, the Company, through FRD Acquisition Co. ("FRD"), a newly formed subsidiary, consummated the acquisition of the Coco's and Carrows restaurant chains consisting of 347 Company-owned units within the mid-scale family-style dining category in order to capitalize on the Company's experience in the restaurant industry and the California market and to maximize the synergies among the Company's restaurant chains, including increased purchasing power. The ultimate acquisition price of $313.4 million was paid in consideration for all of the outstanding stock of FRI-M Corporation ("FRI-M"), the subsidiary of Family Restaurants, Inc. ("FRI") which owns the Coco's and Carrows chains. The acquisition was accounted for using the purchase method of accounting and is reflected in the Company's Consolidated Financial Statements and Notes thereto included herein as of the acquisition date. During the third quarter of 1996, the Company sold its two food processing operations, Portion-Trol Foods, Inc. and the Mother Butler Pies division of Denny's, Inc., a subsidiary of Flagstar (Portion-Trol Foods, Inc. and the Mother Butler Pies division are hereinafter referred to collectively as "PTF"). These transactions mark the last in a series of non-restaurant divestitures which began with the sale of Canteen Corporation, the Company's food and vending business, in 1994 and also included the 1995 sales of TW Recreational Services, Inc., a concession and recreation services subsidiary; Volume Services, Inc., a stadium concession services subsidiary; and Proficient Food Company ("PFC"), the Company's food distribution subsidiary. On January 21, 1997, the Company hired Donaldson, Lufkin & Jenrette Securities Corporation as a financial advisor to assist in exploring alternatives to improve the Company's capital structure. The Company intends to explore all alternatives to reduce its debt service requirements, which may include a negotiated restructuring or other exchange transaction. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" for additional information. RESTAURANTS Flagstar's operations are conducted through six restaurant chains or concepts, four chains in the full-service mid-scale dining segment and two in the quick-service segment. Denny's, Flagstar's largest concept, is the nation's largest chain of family-style full-service restaurants, with almost 1,600 units in 49 states, two U.S. territories, and six foreign countries. Denny's largest concentration domestically is in California and Florida with 531 units in these two states. According to an independent survey conducted in 1996, Denny's has the leading share of the national market in the family-style category. Quincy's, with 199 locations, is one of the largest chains of family-steak restaurants in the southeastern United States, offering steak, chicken and seafood entrees as well as a buffet bar, called "America's Home Plate." A weekend breakfast buffet is also available at most Quincy's locations. Flagstar also operates El Pollo Loco, a chain of 241 quick-service restaurants featuring flame-broiled chicken and steak products and related Mexican food items, with a strong regional presence in California. As indicated above, Flagstar acquired the Coco's and Carrows chains in 1996. Coco's is a regional 1 bakery restaurant chain operating 466 units in seven western states and two foreign countries. Coco's offers a wide variety of fresh-baked goods and value priced meals that capitalize on emerging food trends in the western United States. The Carrows chain, consisting of 160 units in seven western states, specializes in traditional American food, with an emphasis on quality, homestyle fare at an excellent value. Hardee's is a chain of quick-service restaurants of which Flagstar, with 580 units located primarily in the Southeast, is the largest franchisee. Although specializing in sandwiches, Flagstar's Hardee's restaurants serve fried chicken and offer a breakfast menu that accounts for approximately 44% of total sales and features the chain's famous "made-from-scratch" biscuits. For a breakdown of the total revenues contributed by each referenced concept for the last three years, see the corresponding section of "Management's Discussion and Analysis of Financial Condition and Results of Operations". Although operating in two distinct segments of the restaurant industry -- full-service and quick-service -- the Company's restaurants benefit from a single management strategy that emphasizes superior value and quality, friendly and attentive service and appealing facilities. During 1996, the Company continued its strategy of growth through franchising, adding a net 66 total units to the system (excluding the impact of the additional 610 units acquired through the Coco's and Carrows acquisition), representing an increase of 133 franchise units, offset by a decline of 67 Company-operated units. The increase in franchise units and the decrease in Company-operated units includes 27 units which were sold to franchisees (turnkeyed). The Company intends to continue focusing on growth in the franchise arena in 1997. The Company believes its restaurant operations benefit from the diversity of the restaurant concepts represented by its six chains, the generally strong market positions and consumer recognition enjoyed by these chains, the benefits of a centralized support system for purchasing, menu development, human resources, management information systems, site selection, restaurant design and construction, and an aggressive new management team. Denny's, Quincy's, Coco's and Carrows may benefit from the demographic trend of aging baby boomers and the growing population of elderly persons. The largest percentage of "mid-scale" customers comes from the 35 and up age group. In the quick-service segment, the Company is making efforts to recapture Hardee's restaurants' traditionally strong market position in the Southeast, and expects El Pollo Loco to increase its strong position in the Southwest. During the fourth quarter of 1993, the Company approved a restructuring plan for its restaurant concepts which included, among other things, the identification of units for sale, closure or conversion to another concept. At December 31, 1996 four units remain relative to the 1993 restructuring plan, of which two are scheduled for disposal in 1997. Management has decided to continue to operate the remaining two units. During 1995, the Company identified 36 additional underperforming units for sale or closure of which 29 units were disposed of through 1996 and two are scheduled for disposal in 1997. Management has decided to continue to operate the remaining five units. See Note 3 to the Consolidated Financial Statements for additional information concerning these identified units. DENNY'S Denny's is the largest full-service family-style restaurant chain in the mid-scale segment in the United States in terms of both number of units and total revenues. Denny's restaurants currently operate in 49 states, two U.S. territories, and six foreign countries, with principal concentrations in California, Florida, Texas, Arizona, Washington, Illinois, Ohio, and Pennsylvania. Denny's restaurants are designed to provide a casual dining atmosphere with moderately priced food and quick, efficient service to a broad spectrum of customers. The restaurants generally are open 24 hours a day, seven days a week. All Denny's restaurants have uniform menus (with some regional and seasonal variations) offering traditional family fare (including breakfast items, steaks, seafood, hamburgers, chicken and sandwiches) and provide both counter and table service. In 1996, Denny's sales were evenly distributed across each of its dayparts, with breakfast and lunch representing approximately 60% of total traffic. Denny's restaurants had a 1996 average guest check of $5.03 and average annual unit sales of $1.3 million. Denny's currently employs approximately 41,000 people. In 1994, the Company began a "reimaging" strategy designed to enhance the competitive positioning of Denny's. This reimaging strategy involved all restaurants within a market area and included an updated exterior, new signage, an improved interior layout with more comfortable seating and enhanced lighting. The Company completed the reimaging of 306 restaurants through 1995. During 1995, management curtailed this reimaging program in order to focus its attention and resources on programs specifically designed to enhance the customer's experience at Denny's by improving service and value positioning. In 1996, the Company started limited exterior refurbishments on 588 units primarily focusing on exterior improvements, such as landscaping, exterior lighting, sign replacement and parking lot repairs to enhance the 2 curb appeal of the restaurants. At December 31, 1996 approximately three-quarters of the 588 units scheduled to receive this limited refurbishment have been completed. Historically, Denny's has had the lowest average guest check within the family-style category. In January 1996, Denny's rolled out a value menu that featured value priced items for breakfast, lunch and dinner with tiered pricing starting at $1.99, $2.99 and $3.99, respectively. At the same time, the Company launched several initiatives (including a more operationally focused organizational structure, modern information systems and reengineered restaurant processes) designed to deliver better service and more consistent product quality. The Company expects to refine and accelerate these efforts in 1997. During 1997, the Company intends to continue its focus on opening new franchise units, and to capitalize on its status as a leading franchisor (according to a 1996 Arthur Andersen study published in Success Magazine). For the last three years, Denny's has opened more new units than any competitor in the mid-scale segment. Furthermore, Denny's has supplemented its franchise development efforts by selectively selling Company-owned units to franchisees. During 1996, the Company added a net 82 new Denny's franchise units, including the sale of 19 Company-owned units to franchisees, bringing the total franchised units to 702, or 44% of all Denny's restaurants. The initial fee for a single Denny's franchise is $35,000, and the current royalty payment is approximately 4% of gross sales. HARDEE'S The Company's Hardee's restaurants are operated under licenses from Hardee's Food Systems, Inc. ("HFS"). The Company is HFS' largest franchisee, operating 16% of Hardee's restaurants nationwide. HFS is the seventh largest chain in the United States based on national systemwide sales. Of the 580 Hardee's restaurants operated by the Company at December 31, 1996, 557 were located in nine southeastern states. Flagstar's Hardee's currently employ approximately 22,000 people. The Company's Hardee's restaurants provide uniform menus in a quick-service format targeted to a broad spectrum of customers. The restaurants offer hamburgers, chicken, roast beef and fish sandwiches, hot dogs and low-fat yogurt, as well as a breakfast menu featuring Hardee's popular "made-from-scratch" biscuits. To add variety to its menu, further differentiate its restaurants from those of its major competitors and increase customer traffic during the traditionally slower late afternoon and evening periods, HFS completed the rollout of fresh fried chicken as a menu item in 1993. Substantially all of the Company's Hardee's restaurants have drive-thru facilities, which provided 51% of the chain's revenues in 1996. Most of the restaurants are open 16-17 hours a day, seven days a week. Operating hours of selected units have been extended to 24 hours a day, primarily on weekends. Hardee's breakfast menu, featuring the chain's signature "made-from-scratch" biscuits, accounts for approximately 44% of total sales at the Company's Hardee's restaurants. The average guest check at the Company's Hardee's was $3.17 in 1996, and average annual unit sales for the Company's Hardee's restaurants was $1.0 million. Management implemented several action plans in the second half of 1996 to focus on customer satisfaction. These initiatives included new menu boards in all 580 units and a "touch-up" project in 276 units. The "touch-up" project included new roofs, paint, trim and wallpaper as well as minor landscaping and parking lot repairs and is substantially complete. Hardee's has also installed new microwaves in all units and implemented procedures to provide customers with a hot product. Additionally, management costs have been reduced by the elimination of two layers of management and the streamlining of management reporting relationships. During 1996, the Company closed 14 under-performing Hardee's units. Management continues to review under-performing units and may in the future decide to close additional units. Each Hardee's restaurant is operated under a separate license from HFS. Each license grants the exclusive right, in exchange for a franchise fee, royalty payments and certain covenants, to operate a Hardee's restaurant in a described territory, generally a town or an area measured by a radius from the restaurant site. Each license has a term of 20 years from the date the restaurant is first opened for business and is non-cancellable by HFS, except for the Company's failure to abide by its covenants. Earlier issued license agreements are renewable under HFS' renewal policy; more recent license agreements provide for successive five-year renewals upon expiration, generally at rates then in effect for new licenses. Each year, a number of the Company's licenses are scheduled for renewal. The Company has historically experienced no difficulty in obtaining such renewals and does not anticipate any problems in the future. The Company's territorial development agreement with HFS which called for the Company to open a specified number of Hardee's restaurants in a development territory in the Southeast (and certain adjacent areas) by the end of 3 1996 was terminated during the fourth quarter of 1995. Termination of such agreement makes the Company's development rights non-exclusive in the development territory. As a result, HFS and other Hardee's franchisees along with the Company are permitted to open Hardee's restaurants in such territory. In 1997, the focus of the Company will be to better position its Hardee's restaurants in the marketplace through a variety of means, including dual branding, refurbishment, and in appropriate circumstances, subject to legal obligations and restrictions, conversion to another concept. QUINCY'S Ranked by 1996 sales, Quincy's is the sixth largest family-steak (grill buffet) chain in the country and is one of the largest such chains in the southeastern United States. The Quincy's chain, employing approximately 11,000 people, currently consists of 199 Company-operated limited service restaurants, which are designed to provide value conscious customers with a varied menu, abundant portions and great steaks at moderate prices. The average guest check at Quincy's in 1996 was $6.06. All Quincy's are open seven days a week for lunch and dinner. The dinner daypart is Quincy's strongest, representing 63% of total sales in 1996. The average annual unit sales for a Quincy's restaurant was approximately $1.3 million in 1996. The restaurants serve steak, chicken and seafood entrees along with a buffet-style food bar, called "America's Home Plate," offering hot foods, soups, salads and desserts. In addition, weekend breakfast service, which is available at most locations, allows Quincy's to utilize its base assets more efficiently. After experimenting with a number of formats at Quincy's from 1993 through 1995, including enhancements to the scatter bar buffet and a few buffet only restaurants, management has determined that a repositioning of Quincy's with better quality food and the "No Mistake Steak" would provide a more effective marketing strategy. In that regard, Quincy's initiated a "Relaunch" program in October 1996 designed to improve service basics, food quality and the marketing effectiveness of Quincy's, and to differentiate Quincy's from other family-steak restaurants. While the initial results have been positive, the program is still in its early stages and additional time will be required to measure its full impact on results. EL POLLO LOCO El Pollo Loco is the leading chain specializing in flame-broiled chicken in the quick-service segment of the restaurant industry. Of the total 241 El Pollo Loco restaurants, which are located in five southwestern states and two foreign countries, 86% are located in Southern California. El Pollo Loco currently employs approximately 2,500 people. El Pollo Loco restaurants are generally open 12 hours a day, seven days a week for lunch and dinner. A majority of the Company's El Pollo Loco restaurants have drive-thru facilities, which provided 33% of the chain's revenues in 1996. The dinner daypart for El Pollo Loco is the strongest, representing 54% of total sales. El Pollo Loco directs its marketing at customers desiring an alternative to traditional fast food products, offering unique tasting and high quality products which help position the brand as high quality fast food at a competitive price. The restaurants are designed to facilitate customer viewing of the preparation of the flame-broiled chicken, and the food is served quickly, but prepared slowly, using fresh ingredients. Much of the brand's recent growth can be attributed to successful menu positioning, new product offerings, dual branding with the complementary Fosters Freeze dessert line, which commenced in late 1995, and restaurant remodeling. The average guest check at El Pollo Loco in 1996 was $6.63 and average annual Company-owned restaurant sales reached record levels of approximately $1.2 million in 1996. Based on El Pollo Loco's recent success, the Company is optimistic about future expansion of the El Pollo Loco concept, principally through franchising in Texas and in other California markets. By the year 2000, the Company hopes to add as many as 250 additional El Pollo Loco restaurant units. In 1997, the Company intends to open relatively few Company-owned El Pollo Loco restaurants and focus instead on its franchising efforts. To accelerate the franchise expansion, in 1996 the Company sold eight units to franchisees which were not part of the growth strategy for Company-owned El Pollo Loco units. In the first quarter of 1996, the Company secured the international rights to the El Pollo Loco brand to facilitate expansion opportunities in Mexico and other countries. In 1996 the chain had a net increase of 24 units, representing a net 31 franchise unit increase, offset by a Company-operated decrease of seven units. The initial fee for a single El Pollo Loco franchise is $35,000 and the current royalty payment rate is 4% of gross sales. El Pollo Loco recently launched a co-branding effort with Flagstar's Hardee's restaurants in South Carolina. This partnership, which is intended to take advantage of Hardee's exceptional breakfast business and El Pollo Loco's strong 4 lunch and dinner dayparts, will serve as an initial test of the appeal of El Pollo Loco to consumers in the eastern United States. COCO'S Coco's is a regional bakery restaurant chain operating primarily in California, Arizona, and Texas, as well as Japan and Korea. Coco's currently consists of 183 Company-operated, five domestic franchised and 278 international licensed restaurants, and employs approximately 9,000 people. Coco's offers a variety of fresh-baked goods such as pies, muffins and cookies and value-priced, innovative menu items that capitalize on emerging food trends in the western United States. The chain has positioned itself at the upper end of the mid-scale family-style category, offering a variety of great food, great service, and a pleasant atmosphere at fair prices, to answer the needs of quality conscious family diners. The restaurants are generally open 18 hours a day, with several units opened 24 hours a day on weekends. Coco's restaurants have uniform menus and serve breakfast, lunch and dinner, as well as a "late night" menu in those restaurants open around the clock. Lunch and dinner dayparts are Coco's strongest, comprising 37% and 39% of 1996 sales, respectively. In 1996, the average guest check was $6.79, with average annual unit sales of approximately $1.5 million. With a foreign presence that is among the largest of any U.S. based, non-fast food restaurant chain, Coco's has laid the foundation to aggressively expand its international operations. Internationally, 21 units have been added to the system since the Company acquired the chain in May 1996. Additionally, Coco's is placing new emphasis on domestic franchising as an opportunity to achieve further growth of the brand. The initial fee for a single Coco's franchise is $35,000 and the current royalty payment rate is 4% of net sales. CARROWS Carrows is a regional mid-scale family-style restaurant chain operating primarily in seven western states. Carrows currently consists of 160 Company-operated units and employs approximately 7,000 people. Carrows specializes in traditional American food, with an emphasis on quality, homestyle fare at an excellent value. The concept appeals strongly to families with children as well as to mature adults -- two groups expected to grow rapidly into the next century. The menu is always current, but not trendy, and is revised regularly to reflect the most appealing foods that guests demand. The restaurants are generally open 18 hours a day, with 25% open 24 hours a day. Carrows restaurants have uniform menus and serve breakfast, lunch and dinner, as well as a "late night" menu in those restaurants open 24 hours a day. Lunch and dinner dayparts are Carrows' strongest, comprising 30% and 44% of 1996 sales, respectively. In 1996, the average guest check was $6.26, with average annual unit sales of approximately $1.3 million. OPERATIONS The Company believes that successful execution of basic restaurant operations in each of its restaurant chains is critical to its success. Accordingly, significant effort is devoted to ensuring that all restaurants offer quality food and service. Through a network of division, region, district and restaurant level managers or leaders, the Company standardizes specifications for the preparation and efficient service of quality food, the maintenance and repair of its premises and the appearance and conduct of its employees. Major emphasis is placed on the proper preparation and delivery of the product to the consumer and on the cost-effective procurement and distribution of quality products. A principal feature of the Company's restaurant operations is the constant focus on improving operations at the unit level. Unit managers are especially hands-on and versatile in their supervisory activities. Region and district leaders have no offices and spend substantially all of their time in the restaurants. A significant majority of restaurant management personnel began as hourly employees in the restaurants and therefore perform restaurant functions and train by example. The Company benefits from an experienced management team. Each of the Company's restaurant chains maintains training programs for employees and restaurant managers. Restaurant managers and assistant managers receive training at specially designated training units. Areas of training for managers include customer interaction, kitchen management and food preparation, data processing and cost control techniques, equipment and building maintenance and leadership skills. Video training tapes demonstrating various restaurant job functions are located at each restaurant location and are viewed by employees prior to a change in job function or using new equipment or procedures. 5 Each of the Company's restaurant chains continuously evaluates its menu. New products are developed in Company test kitchens and then introduced in selected restaurants to determine customer response and to ensure that consistency, quality standards and profitability are maintained. If a new item proves successful at the research and development level, it is usually tested in selected markets, both with and without market support. A successful menu item is then incorporated into the restaurant system. In the case of the Hardee's restaurants, menu development is coordinated with HFS. Financial and management control is facilitated by the use of point-of-sale ("POS") systems in all of the Company's restaurants which transmit detailed sales reports, payroll data and periodic inventory information for management review. During the fourth quarter of 1996, the Company began rolling out new POS systems in its Company-owned Denny's restaurants. These systems are expected to help the restaurants improve customer service by providing more accurate and faster turnaround of customer orders and better inventory control. In addition, the new POS systems will aid in decision-making by providing sales information on a more timely basis, with a higher level of detail for better data analysis. Over the next two years, management intends to install new POS systems in all of Flagstar's Company-owned restaurants pursuant to its information services agreement with Integrated Systems Solution Corporation ("ISSC") as more fully discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." ADVERTISING The Company uses an integrated process to promote its concepts, including media, menu strategy, interior/exterior building design, style of service and specialized promotions to help differentiate itself in the marketplace. Media advertising is primarily product oriented, generally featuring high margin, special entrees or meal combinations presented and priced to convey high value. Such advertising is conducted through national, regional and local television advertising as well as radio, outdoor and print advertising depending on the target market. Sophisticated consumer marketing research techniques are utilized to measure customer satisfaction and customers' evolving expectations. During 1996, the Company spent from 3% to 7% of its concepts' gross sales on advertising. In accordance with the HFS licensing agreements, the Company spent approximately 7.1% of its Hardee's units' total gross sales on marketing and advertising during 1996. Of this amount, approximately 3.0% of total gross sales is contributed to media cooperatives and HFS' national advertising fund. The balance was directed by the Company at local levels. SITE SELECTION The success of any restaurant is influenced significantly by its location. The site selection process for Company-owned restaurants consists of three main phases: strategic planning, site identification and detailed site review. The planning phase ensures that restaurants are located in strategic markets. In the site identification phase, the major trade areas within a market area are analyzed and a potential site identified. The final and most time consuming phase is the detailed site review. In this phase, the site's demographics, traffic and pedestrian counts, visibility, building constraints and competition are studied in detail. A detailed budget and return on investment analysis are also completed. The Company considers its site selection standards and procedures to be rigorous and will not compromise those standards or procedures in order to achieve accelerated growth. RAW MATERIALS SOURCES AND AVAILABILITY The Company has a centralized purchasing program which is designed to ensure uniform product quality as well as reduced food, beverage and supply costs. The Company's size provides it with significant purchasing power which often enables it to obtain products at more favorable prices from several nationally recognized manufacturers. Food and packaging products for the Company's Hardee's restaurants are purchased from HFS and independent suppliers approved by HFS. A substantial portion of the products for the Company's Hardee's and Quincy's restaurants is obtained from MBM Corporation ("MBM"), an independent supplier/distributor. In connection with the 1995 sale of its distribution subsidiary, PFC, to MBM, the Company entered into an eight year distribution agreement, subsequently extended to ten years, with MBM under which PFC/MBM will continue to distribute and supply certain products and supplies to the Company's Denny's, Hardee's, Quincy's and El Pollo Loco restaurants. Beginning in November 1997, Coco's and Carrows will become subject to similar agreements. There are no volume requirements relative to these agreements; however, the products named therein must be purchased through PFC/MBM unless they are unable to make delivery within a reasonable period. During the third quarter of 1996, the Company sold Portion-Trol Foods, Inc. and the Mother Butler Pies division of Denny's, its two food processing operations. In conjunction with each of these sales, the Company entered into a five year purchasing agreement with the acquirer under which the Company is required to 6 purchase certain minimum annual volumes. If such volumes are not purchased, the agreements provide for the payment of penalties. The Company believes that satisfactory sources of supply are generally available for all the items regularly used by its restaurants and has not experienced any material shortages of food, equipment, or other products which are necessary to its restaurant operations. SEASONALITY The Company's business is moderately seasonal. Restaurant sales are generally greater in the second and third calendar quarters (April through September) than in the first and fourth calendar quarters (October through March). Occupancy and other operating costs, which remain relatively constant, have a disproportionately negative effect on operating results during quarters with lower restaurant sales. The Company's working capital requirements also fluctuate seasonally, with its greatest needs occurring during its first and fourth quarters. TRADEMARKS AND SERVICE MARKS The Company, either directly or through wholly-owned subsidiaries, has registered certain trademarks and service marks with the United States Patent and Trademark office and in international jurisdictions, some of which include Denny's(Register mark), El Pollo Loco(Register mark), Quincy's(Register mark), Coco's(Register mark), Carrows(Register mark), and Grand Slam Breakfast(Register mark). The Company regards its trademarks and service marks as important to the identification of its restaurants and believes they are of material importance to the conduct of its business. Domestic trademark and service mark registrations are renewable at various intervals from 10 to 20 years, while international trademark and service mark registrations have various durations from five to 20 years. The Company generally intends to renew trademarks and service marks which come up for renewal. The Company owns or has rights to all trademarks it believes are material to its restaurant operations. RESEARCH AND DEVELOPMENT The Company engages in research and development on an ongoing basis, testing new products and procedures for possible introduction into the Company's systems. The Company has also frequently helped HFS develop and test-market new products. While research and development activities are important to the Company's business, amounts expended for these activities are not material. COMPETITION The restaurant industry can be divided into three main segments: full-service restaurants, quick-service restaurants, and other miscellaneous establishments. Since the early 1970s, growth in eating places has been driven primarily by quick-service restaurants. On a segment-wide basis, the full-service and quick-service restaurants currently have approximately the same revenues and an equal share of the market. Full-service restaurants include the mid-scale (family-style and family-steak), casual dining and upscale (fine dining) segments. The mid-scale segment, which includes Coco's, Carrows, Denny's and Quincy's, is characterized by complete meals, menu variety and moderate prices ($5-$7 average check), and includes a small number of national chains, many local and regional chains, and thousands of independent operators. The casual dining segment, which typically has higher menu prices ($8-$16 average check) and availability of alcoholic beverages, primarily consists of regional chains and small independents. The quick-service segment, which includes Hardee's and El Pollo Loco, is characterized by low prices (generally, $3-$5 average check), finger foods, fast service, and convenience. A small number of large sandwich, pizza, and chicken chains overwhelmingly dominate the quick-service segment. The restaurant industry is highly competitive and affected by many factors, including changes in economic conditions affecting consumer spending, changes in socio-demographic characteristics of areas in which restaurants are located, changes in customer tastes and preferences and increases in the number of restaurants generally and in particular areas. Competition among a few major companies that own or operate quick-service restaurant chains is especially intense. Restaurants, particularly those in the quick-service segment, compete on the basis of name recognition and advertising, the quality and perceived value of their food offerings, the quality and speed of their service, the attractiveness of their facilities and, to a large degree in a recessionary environment, price and perceived value. Management believes the Company's principal competitive strengths include its restaurants' brand name recognition; the value, variety and quality of food products served; the quality and training of its employees; and the Company's market penetration, which has resulted in economies of scale in a variety of areas, including advertising, distribution and field supervision. 7 GOVERNMENT REGULATIONS The Company and its franchisees are subject to various local, state and Federal laws and regulations governing various aspects of the restaurant business, including, but not limited to, health, sanitation, environmental matters, safety, disabled persons' access to its restaurant facilities, the sale of alcoholic beverages and regulations regarding hiring and employment practices. The operation of the Company's franchise system is also subject to regulations enacted by a number of states and rules promulgated by the Federal Trade Commission. The Company believes that it is in material compliance with applicable laws and regulations, but it cannot predict the effect on operations of the enactment of additional requirements in the future. The Company is subject to Federal and state laws governing matters such as minimum wage, overtime and other working conditions. At December 31, 1996, a substantial number of the Company's employees were paid the minimum wage. Accordingly, increases in the minimum wage or decreases in the allowable tip credit (which reduces the minimum wage that must be paid to tipped employees in certain states) increase the Company's labor costs. This is especially the case in California, where there is no tip credit. In November, 1996, an initiative in California was passed raising the minimum wage in California from $4.25 to $5.00 per hour, effective March 1, 1997, and to $5.75 per hour effective March 1, 1998. Also the Federal minimum wage increased from $4.25 per hour to $4.75 per hour on October 1, 1996 and will increase again to $5.15 per hour on September 1, 1997. Employers must pay the higher of the Federal or state minimum wage. The Company will attempt to offset increases in the minimum wage through pricing and other cost control efforts; however, there can be no assurance that the Company or its franchisees will be able to pass such additional costs on to its customers. ENVIRONMENTAL MATTERS Federal, state and local environmental laws and regulations have not historically had a material impact on the operations of the Company; however, the Company cannot predict the effect on its operations of possible future environmental legislation or regulations. 8 EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth information with respect to each executive officer of FCI, along with senior level executive officers of Flagstar.
CURRENT PRINCIPAL OCCUPATION OR NAME AGE EMPLOYMENT AND FIVE-YEAR EMPLOYMENT HISTORY James B. Adamson 49 Chairman, President and Chief Executive Officer of FCI and Flagstar (1995-present); Chief Executive Officer of Burger King Corporation (1993-1995); Chief Operating Officer of Burger King Corporation (1991-1993); President of Burger King U.S.A. Retail Division (1991); Executive Vice President, Marketing of Revco, Inc. (1988-1991). Craig S. Bushey 41 Senior Vice President of Flagstar and President of Hardee's Division (May 1996-present); Managing Director, Vice President (Western Europe) of Burger King (1995-May 1996); Region Vice President (Central Region) of Burger King (1994-1995); Burger King Reengineering Team (1993-1994); Region Vice President (Midwest Retail) of Burger King (1992-1993); Region Vice President (Atlanta Retail) of Burger King (1990-1992). C. Robert Campbell 52 Vice President and Chief Financial Officer of FCI and Executive Vice President and Chief Financial Officer of Flagstar (1995-present); Executive Vice President of Human Resources and Administration for Ryder System, Inc. (1991-1995); Executive Vice President -- Finance of Vehicle Leasing and Services Division of Ryder System, Inc. (1981-1991). Ronald B. Hutchison 47 Vice President and Treasurer of Flagstar (1995 to present); Vice President and Treasurer of Leaseway Transportation Corp. (1988-1995). Donna M. Mascolo 42 Vice President and Corporate Controller of Flagstar (February 1996-present); Vice President and Broker Associate, Transworld Business Brokers, Inc., (1995-present); President, DonMar Global Business Services (1995-present); Regional Vice President and Chief Financial Officer, Kentucky Fried Chicken International Latin American/Carribbean Region (1990-1994). Edna K. Morris 45 Executive Vice President of Flagstar and President of Quincy's Division (April 1996-present); Executive Vice President, Human Resources and Corporate Affairs of Flagstar (1995-April 1996); Senior Vice President, Human Resources of Flagstar (1993-1995); Vice President, Education and Development of Flagstar (1992-1993); Senior Vice President/Human Resources of HFS (1987-1992). Rhonda J. Parish 40 Vice President and General Counsel of FCI and Senior Vice President and General Counsel of Flagstar (1995-present); Secretary of FCI and Flagstar (1995-present); Assistant General Counsel of Wal-Mart Stores, Inc. (1990-1994); Corporate Counsel of Wal-Mart Stores, Inc. (1983-1990). John A. Romandetti 46 Senior Vice President of Flagstar and President, Denny's Division (January 1997-present); Senior Vice President of Flagstar and President of El Pollo Loco (1995-present); Vice President of Operations for Burger King Corporation (1989-1995). Mark L. Shipman 47 Senior Vice President of Flagstar and President of Coco's/Carrows Division (May 1996-present); Vice President of Acquisitions and Development of Flagstar (1995-May 1996); Vice President of Administration of Denny's Division (1993-1995); Vice President of Operations (West) of Denny's Division (1991-1993). Paul R. Wexler 53 Senior Vice President, Procurement and Distribution of Flagstar (1995-present); Vice President, Procurement and Quality Assurance -- Marriott International (1991-1995). Stephen W. Wood 38 Senior Vice President, Human Resources and Corporate Affairs of Flagstar (April 1996-present); Vice President, Compensation, Benefits, and Employee Information Systems and Corporate Office Human Resources of Flagstar (1993-April 1996); Senior Director, Compensation, Benefits and Employee Information Systems of Flagstar (1993); Director, Benefits and Executive Compensation of Hardee's Food System (1991-1993).
EMPLOYEES At December 31, 1996, the Company had approximately 93,000 employees. Many of the Company's restaurant employees work part-time, and many are paid at or slightly above minimum wage levels. The Company has experienced no significant work stoppages and considers its relations with its employees to be satisfactory. 9 ITEM 2. PROPERTIES Most of the Company's restaurants are free-standing facilities. Presented below is a schedule of the average property and building square footage, as well as average seating capacity for each of the Company's concepts:
AVERAGE AVERAGE AVERAGE PROPERTY BUILDING SEATING CONCEPT SIZE IN SQ. FT. SIZE IN SQ. FT. CAPACITY Carrows.................................................... 35,000 5,400 160 Coco's..................................................... 35,000 5,000 160 Denny's.................................................... 42,000 4,750 150 El Pollo Loco.............................................. 20,000 2,100 60 Hardee's................................................... 52,000 3,400 95 Quincy's................................................... 64,000 7,100 250
The following table sets forth certain additional information regarding the Company's restaurant properties as of December 31, 1996:
LAND LEASED LAND AND AND LAND AND BUILDING BUILDING BUILDING CONCEPT OWNED OWNED LEASED TOTAL Carrows................................................ 3 10 147 160 Coco's................................................. 2 39 142 183 Denny's................................................ 254 36 604 894 El Pollo Loco.......................................... 9 33 54 96 Hardee's............................................... 288 100 192 580 Quincy's............................................... 152 41 6 199 Total................................................ 708 259 1,145 2,112
10 The number and location of the Company's restaurants in each chain as of December 31, 1996 are presented below:
DENNY'S EL POLLO LOCO COCO'S FRANCHISED FRANCHISED FRANCHISED STATE OWNED LICENSED HARDEE'S QUINCY'S OWNED LICENSED OWNED LICENSED CARROWS Alabama.................. 1 8 156 45 -- -- -- -- -- Alaska................... -- 8 -- -- -- -- -- -- -- Arizona.................. 27 47 -- -- 1 1 17 1 9 Arkansas................. 1 5 3 -- -- -- -- -- -- California............... 223 129 -- -- 95 123 135 4 120 Colorado................. 25 13 -- -- -- -- 6 -- -- Connecticut.............. 5 3 -- -- -- -- -- -- -- Delaware................. 3 -- -- -- -- -- -- -- -- District of Columbia..... -- -- -- -- -- -- -- -- -- Florida.................. 102 77 56 41 -- -- -- -- -- Georgia.................. -- 24 10 11 -- -- -- -- -- Hawaii................... 4 2 -- -- -- -- -- -- -- Idaho.................... -- 7 -- -- -- -- -- -- -- Illinois................. 47 10 -- -- -- -- -- -- -- Indiana.................. 14 9 -- -- -- -- 3 -- -- Iowa..................... -- 5 -- -- -- -- -- -- -- Kansas................... 9 4 -- -- -- -- -- -- -- Kentucky................. -- 20 -- -- -- -- -- -- -- Louisiana................ 7 2 1 -- -- -- -- -- -- Maine.................... -- 4 -- -- -- -- -- -- -- Maryland................. 14 16 -- -- -- -- -- -- -- Massachusetts............ 9 -- -- -- -- -- -- -- -- Michigan................. 38 2 -- -- -- -- -- -- -- Minnesota................ 13 4 -- -- -- -- -- -- -- Mississippi.............. 2 2 40 8 -- -- -- -- -- Missouri................. 29 6 -- -- -- -- 2 -- -- Montana.................. -- 5 -- -- -- -- -- -- -- Nebraska................. -- 4 -- -- -- -- -- -- -- Nevada................... 12 6 -- -- -- 6 -- -- 7 New Hampshire............ 2 1 -- -- -- -- -- -- -- New Jersey............... 11 2 -- -- -- -- -- -- -- New Mexico............... 2 12 -- -- -- -- -- -- 4 New York................. 17 18 -- -- -- -- -- -- -- North Carolina........... 7 12 58 39 -- -- -- -- -- North Dakota............. -- 3 -- -- -- -- -- -- -- Ohio..................... 33 22 18 1 -- -- -- -- -- Oklahoma................. 9 13 -- -- -- -- -- -- -- Oregon................... 5 18 -- -- -- -- -- -- 9 Pennsylvania............. 51 3 2 -- -- -- -- -- -- Rhode Island............. -- -- -- -- -- -- -- -- -- South Carolina........... 9 5 123 42 -- 1 -- -- -- South Dakota............. -- 1 -- -- -- -- -- -- -- Tennessee................ 3 11 110 9 -- -- -- -- -- Texas.................... 62 57 -- -- -- 4 14 -- 10 Utah..................... 7 12 -- -- -- -- -- -- -- Vermont.................. -- 2 -- -- -- -- -- -- -- Virginia................. 19 8 3 3 -- -- -- -- -- Washington............... 50 19 -- -- -- -- 6 -- 1 West Virginia............ -- 3 -- -- -- -- -- -- -- Wisconsin................ 12 7 -- -- -- -- -- -- -- Wyoming.................. -- 6 -- -- -- -- -- -- -- Canada................... 10 20 -- -- -- -- -- -- -- International............ -- 25 -- -- -- 10 -- 278 -- Total.................. 894 702 580 199 96 145 183 283 160
In addition to the restaurant locations set forth above, the Company also owns a nineteen story, 187,000 square foot office tower, which serves as its corporate headquarters, located in Spartanburg, South Carolina. The Company's corporate offices currently occupy approximately sixteen floors of the tower, with the balance leased to others. The Company also owns a 107,000 square foot building located in Irvine, California. The Irvine facility, which was acquired in 1996 in the Coco's and Carrows acquisition, is used as a commissary, which manufactures soups, salad dressings and sauces for Coco's and Carrows, and as warehouse and office space (currently leased to FRI). This facility is currently in the process of being sold. The completion of such sale is expected in the first quarter of 1997. See "Certain Relationships and Related Transactions -- Description of Indebtedness" and Note 4 to the accompanying Consolidated Financial Statements for information concerning encumbrances on certain properties of the Company. ITEM 3. LEGAL PROCEEDINGS FCI, Flagstar, El Pollo Loco and Denny's, along with several former officers and directors of those companies, are named as defendants in an action filed on August 28, 1991 in the Superior Court of Orange County, California. The 11 remaining plaintiffs, who are former El Pollo Loco franchisees, allege that the defendants, among other things, failed or caused a failure to promote, develop and expand the El Pollo Loco franchise system in breach of contractual obligations to the plaintiff franchisees and made certain misrepresentations to the plaintiffs concerning the El Pollo Loco system. Asserting various legal theories, the plaintiffs seek actual and punitive damages in excess of $90 million, together with declaratory and certain other equitable relief. The defendants have denied all material allegations, and certain defendants have filed cross-complaints against various plaintiffs in the action for breach of contract and other claims. Since the filing of the action the defendants have entered into settlements with six of the plaintiffs leaving two plaintiff franchisees remaining in the lawsuit. With respect to the remaining plaintiffs, discovery has been completed, and a trial date to hear the outstanding issues in the case is anticipated sometime during 1997. In 1994, Flagstar was advised of proposed deficiencies from the Internal Revenue Service for Federal income taxes totaling approximately $12.7 million. The proposed deficiencies relate to examinations of certain income tax returns filed by the Company for the seven taxable periods ended December 31, 1992. In the third quarter of 1996 this proposed deficiency was reduced by approximately $7.0 million as a direct result of the passage of the Small Business Jobs Protection Act ("the Act") in August 1996. This Act includes a provision that clarified Internal Revenue Code Section 162(k) to allow for amortization of borrowing costs incurred by a corporation in connection with a redemption of its stock. The Company believes the remaining proposed deficiencies relating to the proposed disallowance of certain costs incurred in connection with the 1989 leveraged buyout of Flagstar are substantially incorrect, and it intends to continue to contest such proposed deficiencies. On June 15, 1994, a derivative action was filed in the Alameda County Superior Court for the State of California by Mr. Adam Lazar, purporting to act on behalf of the Company, against the Company's directors and certain of its current and former officers alleging breach of fiduciary duty and waste of corporate assets by the defendants relating to alleged acts of mismanagement or the alleged failure to act with due care, resulting in policies and practices at Denny's that allegedly gave rise to certain public accommodations class action lawsuits against the Company that were settled in 1994. The action seeks unspecified damages against the defendants on behalf of the Company and its stockholders, including punitive damages, and injunctive relief. The defendants deny any wrongdoing. There has been limited discovery in this action to date with the parties having reached an agreement in principle as to a settlement of the action. Such settlement is contingent upon the approval of the special litigation committee of the Company's Board and the approval of the Court. Other proceedings are pending against the Company, in many cases involving ordinary and routine claims incidental to the business of the Company, and in others presenting allegations that are nonroutine and include compensatory or punitive damage claims. The ultimate legal and financial liability of the Company with respect to the matters mentioned above and these other proceedings cannot be estimated with certainty. However, the Company believes, based on its examination of these matters and its experience to date, that the ultimate disposition of these matters will not materially affect the financial position or results of operations of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The common stock of FCI, $.50 par value per share (the "Common Stock"), is currently traded on the NASDAQ National Market tier of the NASDAQ Stock Market under the symbol "FLST." As of February 19, 1997, 42,434,669 shares of Common Stock were outstanding, and there were approximately 12,000 record and beneficial stockholders. FCI has not paid and does not expect to pay dividends on its outstanding Common Stock. Restrictions contained in the instruments governing the outstanding indebtedness of Flagstar restrict its ability to provide funds that might otherwise be used by FCI for the payment of dividends on its Common Stock. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources" and Note 4 to the accompanying Consolidated Financial Statements of the Company. The following table lists the high and low closing sales prices for the Common Stock for each quarter in the last two fiscal years. The sales prices were obtained from the National Association of Securities Dealers, Inc.
HIGH LOW 1995 First quarter...................................................................... 7 7/8 5 1/2 Second quarter..................................................................... 6 1/2 4 1/4 Third quarter...................................................................... 6 1/8 4 5/8 Fourth quarter..................................................................... 5 1/2 2 7/8 1996 First quarter...................................................................... 5 2 7/8 Second quarter..................................................................... 4 1/4 2 7/8 Third quarter...................................................................... 3 5/16 1 15/16 Fourth quarter..................................................................... 2 1/8 29/32
ITEM 6. SELECTED FINANCIAL DATA Set forth below are certain selected financial data concerning the Company for each of the five years ended December 31, 1996. Such data generally have been derived from the Consolidated Financial Statements of the Company for such periods which have been audited. The following information should be read in conjunction with the Consolidated Financial Statements of the Company and Notes thereto presented elsewhere herein and "Management's Discussion and Analysis of Financial Condition and Results of Operations".
YEAR ENDED DECEMBER 31, 1992 1993 1994 1995 1996 (IN MILLIONS, EXCEPT RATIOS) (A) (A) (A) (A) (K) Income Statement data: Operating revenue.................................. $2,443.0 $2,615.2 $2,666.0 $2,571.5 $2,542.3 Operating income (loss)............................ 196.7 (1,102.4)(b) 211.5(c) 98.2(d) 156.4 Loss from continuing operations (e)................ (39.2) (1,238.6) (16.8) (132.9) (85.5) Primary earnings (loss) per share applicable to common shareholders: Continuing operations............................ (1.82) (29.56) (0.14) (3.47) (2.35) Discontinued operations (e)...................... (0.50) (9.67) 7.52 1.82 -- Net income (loss)(f)............................. (9.29) (40.14) 7.16 (1.64) (2.35) Fully diluted earnings (loss) per share applicable to common shareholders: Continuing operations............................ (1.82) (29.56) 0.26 (3.47) (2.35) Discontinued operations (e)...................... (0.50) (9.67) 6.05 1.82 -- Net income (loss) (f)............................ (9.29) (40.14) 6.13 (1.64) (2.35) Cash dividends per common share (g)................ -- -- -- -- -- Ratio of earnings to fixed charges (h)............. -- -- -- -- -- Deficiency in the coverage of fixed charges to earnings before fixed charges (h)................ 45.8 1,318.2 19.3 133.0 101.9 Balance Sheet data (at end of period): Current assets (i)................................. 98.4 122.2 186.1 285.3 185.5 Working capital (deficiency) (i)(j)................ (256.3) (273.0) (205.6) (122.2) (297.7) Net property and equipment......................... 1,269.9 1,167.2 1,196.4 1,104.4 1,168.6 Total assets....................................... 3,170.9 1,538.9 1,587.5 1,507.8 1,687.4 Long-term debt..................................... 2,171.3 2,341.2 2,067.6 1,996.1 2,179.4
(a) Certain amounts for the four years ended December 31, 1995 have been reclassified to conform to the 1996 presentation. (b) Operating loss for the year ended December 31, 1993 reflects charges for the write-off of goodwill and certain other intangible assets of $1,104.6 million and the provision for restructuring charges of $158.6 million. 13 (c) Operating income for the year ended December 31, 1994 reflects a recovery of restructuring charges of $7.2 million. (d) Operating income for the year ended December 31, 1995 reflects a provision for restructuring charges of $15.9 million and a charge for impaired assets of $51.4 million. (e) The Company has classified as discontinued operations, Canteen Corporation, a food and vending subsidiary, sold in 1994, TW Recreational Services, Inc. ("TWRS"), a recreation services subsidiary, and Volume Services, Inc. ("VS"), a stadium concessions subsidiary. TWRS and VS were sold during 1995. (f) For the year ended December 31, 1992, net loss includes extraordinary losses of $6.25 per share related to premiums paid to retire certain indebtedness and to charge-off the related unamortized deferred financing costs and losses of $0.72 per share for the cumulative effect of a change in accounting principle related to implementation of Statement of Financial Accounting Standards No. 106. For the year ended December 31, 1993, net loss includes extraordinary losses of $0.62 per share related to the repurchase of Flagstar's 10% Convertible Junior Subordinated Debentures Due 2014 (the "10% Debentures") and to the charge off of unamortized deferred financing costs related to a prepayment of Flagstar's senior term loan; net loss for 1993 also includes a charge of $0.29 per share due to a change of accounting method relating to the discount rate applied to the Company's liability for self insurance claims pursuant to Staff Accounting Bulletin No. 92. For the year ended December 31, 1994, net income includes an extraordinary loss of $0.22 per share, as calculated for primary earnings per share, and $0.18 per share, as calculated for fully diluted earnings per share, relating to the charge off of unamortized deferred financing costs associated with the Company's prepayment of its senior term loan and working capital facility during the second quarter of 1994. For the year ended December 31, 1995, net loss includes a $0.01 per share extraordinary gain relating to the repurchase of $25.0 million of senior indebtedness net of the charge off of unamortized deferred financing costs. (g) Flagstar's bank credit agreement prohibits, and its public debt indentures significantly limit, distribution to FCI of funds that might otherwise be used by it to pay Common Stock dividends. See Note 4 to the accompanying Consolidated Financial Statements appearing elsewhere herein. (h) The ratio of earnings to fixed charges has been calculated by dividing pre-tax earnings by fixed charges. Earnings, as used to compute the ratio, equal the sum of income from continuing operations before income taxes and fixed charges excluding capitalized interest. Fixed charges are the total interest expense including capitalized interest, amortization of debt expenses and a rental factor that is representative of an interest factor (estimated to be one third) on operating leases. (i) The current assets and working capital deficiency amounts presented exclude assets held for sale of $480.8 million, $103.2 million, and $77.3 million as of December 31, 1992 through 1994, respectively and $5.1 million as of December 31, 1996. Such assets held for sale relate primarily to the Company's food and vending and concessions and recreation services subsidiaries. (j) A negative working capital position is not unusual for a restaurant operating company. The increase in the working capital deficiency from December 31, 1992 to December 31, 1993 is attributable primarily to an increase in restructuring and other liabilities. The decrease in the working capital deficiency from December 31, 1993 to December 31, 1994 is due primarily to an increase in cash following the sale of the Company's food and vending subsidiary during 1994. The decrease in the working capital deficiency from December 31, 1994 to December 31, 1995 is due primarily to an increase in cash following the 1995 sales of the Company's (i) distribution subsidiary, PFC, net of current assets and liabilities of such subsidiary, and (ii) the concession and recreation services subsidiaries. The increase in the working capital deficiency from December 31, 1995 to December 31, 1996 reflects the use of the proceeds from the 1995 sales noted above and the proceeds of the sale of both Portion-Trol Foods, Inc. and Mother Butler Pies for operating needs and for the acquisition of Coco's and Carrows. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." (k) Reflects the acquisition in May 1996 of Coco's and Carrows. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION The Company's Management's Discussion and Analysis is divided into two sections. The first section analyzes the results of operations; first on a consolidated basis, then for each of Flagstar's six restaurant concepts. The second section addresses the Company's liquidity and capital resources. This discussion should be read in conjunction with "Selected Financial Data" and the Consolidated Financial Statements and other more detailed financial information appearing elsewhere herein. 14 RESULTS OF OPERATIONS COMPANY CONSOLIDATED
($ IN MILLIONS) 1994 1995 1996 Net Company Sales........................................................ $2,620 $2,512 $2,471 Franchise Revenue........................................................ 46 59 71 Total Revenue............................................................ 2,666 2,571 2,542 Operating Expenses....................................................... 2,455 2,473 2,386 Operating Income......................................................... 211 98 156 Depreciation/Amortization................................................ 130 133 130 Net Interest Expense From Continuing Operations.......................... 227 229 255 Income Tax (Benefit)..................................................... (2) 0 (16) Net Income (Loss)........................................................ $ 364 $ (55) $ (85)
15 1996 RESTAURANT UNIT ACTIVITY
UNITS CONVERTED FROM COMPANY ENDING TO ENDING UNITS UNITS UNITS FRANCHISE UNITS 12/31/95 OPENED CLOSED (TURNKEY) 12/31/96 Denny's Company Owned 933 -- (20) (19) 894 Franchised Units 596 72 (10) 19 677 Int'l Licensees 24 1 -- -- 25 1,553 73 (30) -- 1,596 Hardee's 593 1 (b) (14) -- 580(c) Quincy's 203 -- (4) -- 199 El Pollo Loco Company Owned 103 1 -- (8) 96 Franchised Units 112 15 -- 8 135(c) Int'l Licensees 2 8 -- -- 10 217 24 -- -- 241 Subtotal 2,566 98 (48) -- 2,616 Coco's (a) Company Owned 188 -- (5) -- 183 Franchised Units 6 -- (1) -- 5 Int'l Licensees 252 26 -- -- 278 446 26 (6) -- 466 Carrows (a) 161 2 (3) -- 160 Subtotal 607 28 (9) -- 626 3,173 126 (57) -- 3,242
(a) Coco's and Carrows were acquired by Flagstar in May of 1996. Year-to-date data is provided for comparison purposes only. Coco's and Carrows restaurant unit activity since acquisition date is as follows:
UNITS CONVERTED FROM UNITS COMPANY AT TO ENDING ACQUISITION UNITS UNITS FRANCHISE UNITS DATE OPENED CLOSED (TURNKEY) 12/31/96 Coco's Company Owned 184 -- (1) -- 183 Franchised Units 6 -- (1) -- 5 Int'l Licensees 257 21 -- -- 278 Carrows 163 -- (3) -- 160 610 21 (5) -- 626
(b) Represents the re-opening of a unit that was temporarily closed at December 31, 1995. (c) Unit count includes one Hardee's and El Pollo Loco dual brand unit. 16 COMPANY CONSOLIDATED 1996 VS. 1995 OPERATING TRENDS: During 1996, the Company experienced comparable store sales increases at Denny's and El Pollo Loco, due to the continued success of Denny's value menu strategy, El Pollo Loco's successful menu positioning and new product introduction efforts, dual branding at El Pollo Loco with Foster's Freeze, and favorable results from remodeled restaurants. However, the Company continued to experience significant declines in comparable store sales at Hardee's due to continued competitive promotions by quick-service competitors. Quincy's also showed comparable store sales declines reflecting the general trend in the mid-scale family-steak category as well as operational issues relative to training, food quality, service and facilities. During the third quarter management began to address these operational issues. New products were developed and tested, training was implemented at all levels, facilities were improved and management made plans to relaunch the Quincy's brand. This program is still in its early stages and it will take time to measure its full impact on results. Primarily as a result of the lower revenues at Quincy's, the Company experienced a reduction in operating income of $7.3 million (after removing the impact on 1995 results of the restructuring and impairment charges taken in 1995 and removing the impact on 1996 results of the operating income decrease in 1996 resulting from the dispositions of PFC and PTF and the increases in operating income in 1996 attributable to the acquisition of Coco's and Carrows). Overall, the trends experienced by the Company since the 1989 leveraged buyout generally have continued through 1996; operating income has been insufficient to cover the interest and debt expense resulting in continued losses from continuing operations. The external factors that have contributed to these trends, including increased competition and intensive pressure on pricing due to discounting, are expected to continue. In recognition of these matters, in addition to addressing the negative trends at Hardee's and Quincy's, management has taken steps to address the Company's debt burden and its impact on operations. For further information, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources." The Company's CONSOLIDATED REVENUE for 1996 was $2,542.3 million, a decrease of $29.2 million, or 1.1%, compared to 1995. The impact on revenues of the Coco's and Carrows acquisition ($163.7 million and $131.4 million, respectively in revenue was contributed by Coco's and Carrows in 1996), was somewhat offset by the loss of revenue attributable to the dispositions of the Company's food distribution and processing operations, PFC and PTF, in September 1995 and 1996, respectively (the decrease in revenue in 1996 as compared to 1995 as a result of these dispositions totaled $218.2 million). Excluding the effects of such acquisition and dispositions, revenue, on a comparable basis, was $2,245.9 million in 1996, a decrease of $106.0 million (4.5%) compared to 1995. The revenue decrease primarily reflects the impact of lower comparable store sales at Hardee's and Quincy's and 63 fewer Company-operated restaurants as compared with the prior year (excluding the impact of the Coco's and Carrows acquisition), somewhat offset by an increase in franchise revenue of $11.7 million, reflecting 133 additional franchised units in 1996. At Hardee's and Quincy's, comparable store sales decreased 7.2% and 10.8%, respectively. Comparable store sales at Denny's and El Pollo Loco increased 1.7% and 7.2%, respectively; however due to decreases in the number of Company-operated restaurants in comparison to 1995, neither concept reported increases in revenue from Company-operated units. OPERATING EXPENSES decreased by $87.3 million (3.5%) in 1996 to $2,385.9 million as compared to 1995. This decrease reflects the impact of several significant events which affect the comparability of 1996 and 1995 results, including: a restructuring charge and charge for impaired assets totaling $67.2 million in 1995; a decrease in depreciation expense in 1996 of $5.4 million due to the impairment write-down in 1995; and a decrease in expenses in 1996 of $201.6 million due to the sales of PTF and PFC. These items are offset, in part, by the impact of the operating expenses of Coco's and Carrows which were acquired in 1996 and total $280.2 million. Excluding the effect of the items noted above, operating expenses decreased $93.3 million in 1996 in comparison to 1995. This decrease is primarily attributable to a decline in costs associated with the decline in operating revenue, the positive impact of cost cutting measures (reflected in improved margins at Denny's, Hardee's and El Pollo Loco), and the increase of $8.2 million of the current year amortization of the deferred gains attributable to the sales of PFC and PTF over the prior year amount. This amortization is recorded as a reduction of product costs. These decreases in operating expense are somewhat offset by a decrease in gains from the sales of restaurants to franchisees reflected in operating expenses from $24.5 million in 1995 to $8.4 million in 1996 and an increase in the cost to administer the consent decree entered into in 1993 of $5.9 million over the prior year to $11.3 million. OPERATING INCOME for 1996 increased by $58.2 million to $156.4 million in comparison to 1995 as a result of the factors noted in the preceding paragraphs. 17 INTEREST AND DEBT EXPENSE, NET, from continuing operations and discontinued operations totaled $254.7 million for the year ended December 31, 1996 as compared to $248.0 million for the prior year. The net increase is due principally to the addition of $17.6 million in interest and debt expense associated with the Coco's and Carrows acquisition. This increase is partially offset by the following: a decrease in interest expense of approximately $5.3 million due to a lower level of principal outstanding during the 1996 period (excluding the impact of the Coco's and Carrows acquisition) resulting primarily from the repurchase of approximately $25.0 million of senior indebtedness on September 30, 1995 and the scheduled repayments of long-term debt during 1996; an increase in interest income of $3.2 million during 1996 due to increased cash and cash equivalents prior to the acquisition of Coco's and Carrows; a decline of $1.6 million in interest expense during the 1996 period associated with lower interest rates related to interest rate exchange agreements; and the elimination of $0.8 million in interest expense associated with various operations that were sold in 1995. THE BENEFIT FROM INCOME TAXES from continuing operations for the year ended December 31, 1996 reflects an effective income tax rate of 16% compared with 0% for 1995. The change from the prior year can be attributed to the recognition of refunds in the current period due to the carryback of current year tax losses and the reversal of certain reserves established in prior years in connection with proposed deficiencies from the Internal Revenue Service (See Note 6 to the accompanying Consolidated Financial Statements for additional information). THE LOSS FROM CONTINUING OPERATIONS was $85.5 million for the year ended December 31, 1996 as compared with $132.9 million for the prior year. The net loss for the 1996 year end was $85.5 million compared to a net loss for the prior year of $55.2 million. The prior year included $77.2 million of income from discontinued operations reflecting gains of $77.9 million on the related sales of the discontinued operations in the fourth quarter of 1995. ACCOUNTING CHANGE In 1996, the Company adopted the disclosure-only provisions of Financial Accounting Standards Board Statement 123, "Accounting for Stock Based Compensation" (SFAS 123) while continuing to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its stock-based compensation plans. Under APB 25, because the exercise price of the Company's employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized. The adoption of SFAS 123 did not impact the Statements of Consolidated Operations or the Consolidated Balance Sheets included herein. 1995 VS. 1994 The Company's CONSOLIDATED REVENUE for 1995 decreased by approximately $94.5 million (3.5%) as compared with 1994 primarily reflecting the sale of PFC in September 1995 coupled with the continued weakness of the Company's Hardee's operations. The Company's OPERATING EXPENSES, before considering the effects of the provision for (recovery of) restructuring charges and charge for impaired assets, decreased by $55.7 million (2.3%) in 1995 as compared with 1994. Such decrease is principally due to a decrease of approximately $43.6 million attributable to the sale of Denny's distribution subsidiary, PFC, which was sold in September 1995 and an increase in gains on sales of restaurants from $8.8 million in 1994 to $24.5 million in 1995. TOTAL INTEREST AND DEBT EXPENSE from continuing and discontinued operations decreased by $18.1 million in 1995 as compared to 1994 (an $18.5 million decrease attributable to discontinued operations offset by a $0.4 million increase in continuing operations) principally as a result of a reduction in interest expense of $7.0 million following the payment during June 1994 of the principal amount ($170.2 million) outstanding under the term facility of the Company's credit agreement then outstanding and certain other indebtedness upon the sale of the Company's food and vending subsidiary, a reduction in interest expense of $4.0 million during 1995 for other indebtedness related to other subsidiaries which have been sold, and a decrease in interest expense of $6.1 million during 1995 related to interest rate exchange agreements. DISCONTINUED OPERATIONS The Company's concession and recreation services businesses were sold during 1995 resulting in a net gain of $77.9 million. These businesses have been accounted for as discontinued operations and recorded operating revenues of $322.3 million during 1995, a decrease of $3.1 million (0.9%) from 1994. Revenues related to the stadium concession subsidiary increased $9.2 million during 1995 to $190.8 million from $181.6 million in 1994. Operating income and depreciation and amortization expense of the concession subsidiary were $2.4 million and $10.9 million, respectively, during 18 1995 as compared with $6.5 million and $9.8 million, respectively, in 1994. Such decrease in operating income during 1995 is due principally to a decrease in average attendance at major league baseball games during the 1995 season. Revenues related to the recreation services subsidiary decreased by $12.3 million during 1995 to $131.5 million from $143.8 million during 1994. Operating income and depreciation and amortization expense of the recreation services subsidiary for 1995 were $14.7 million and $3.8 million, respectively, as compared with $16.3 million and $4.7 million, respectively, during 1994. Such decrease in revenues and operating income of the recreation services subsidiary is due principally to the loss of the service contract at the Kennedy Space Center during 1995. RESTRUCTURING Effective in the fourth quarter of 1995, as a result of a comprehensive financial and operational review, the Company approved a restructuring plan. The plan generally involved a reduction in personnel and a decision to outsource the Company's information systems function. Operating expenses for 1995 reflect a provision for restructuring of $15.9 million including charges for severance of $5.4 million, $7.6 million for the write-down of computer hardware and other assets, and $2.9 million for various other charges. ACCOUNTING CHANGE During 1995 the Company adopted Statement of Financial Accounting Standards No. 121 which resulted in a charge to operating expenses of $51.4 million for the write-down of Denny's, Hardee's and Quincy's restaurant properties. This charge reflected the write-down of 99 units which the Company planned to continue to operate and an additional 36 units which were to be closed or sold in 1996. Of the 36 units, the Company had closed 29 units through 1996. It intends to dispose of two of the remaining units in 1997 and continue to operate the other five. EXTRAORDINARY ITEMS The Company recognized an extraordinary gain totaling $0.5 million, net of income taxes, during 1995 which represents a gain on the repurchase of $25.0 million principal amount of certain indebtedness, net of the charge-off of the related unamortized deferred financing costs. During 1994, the Company also recognized an extraordinary loss totalling $11.7 million, net of income tax benefits of $0.2 million representing the charge-off of unamortized deferred financing costs associated with the prepayment in June 1994 of senior bank debt. RESTAURANT OPERATIONS DENNY'S
1994 1995 1996 ($ IN MILLIONS, EXCEPT AVG. UNIT DATA) Net Company Sales (a).................................................... $1,508 $1,442 $1,202 Franchise Revenue........................................................ 40 49 55 Total Revenue (a)........................................................ 1,548 1,491 1,257 Operating Expenses (a)................................................... 1,425 1,394 1,135 Operating Income (a)(b).................................................. 123 97 122 Depreciation/Amortization (a)............................................ $ 68 $ 70 $ 53 Comparable Store Sales Increase.......................................... 0.3% 2.4% 1.7% AVERAGE UNIT DATA: Average Annual Unit Sales ($ in thousands): Company Operated....................................................... $1,248 $1,283 $1,313 Franchised............................................................. 1,060 1,086 1,090 Average Guest Check...................................................... $ 4.75 $ 4.86 $ 5.03 Average Weekly Traffic Count............................................. 5,047 5,071 5,025 Operated Units Company Operated....................................................... 978 933 894 Franchise.............................................................. 512 596 677 International.......................................................... 58 24 25 Total............................................................. 1,548 1,553 1,596
19 (a) Includes the operating results of the Company's food processing (PTF) and distribution (PFC) operations. (b) Operating income reflects a provision for restructuring of $5 million and a charge for impaired assets of $24 million for the year ended December 31, 1995. For a discussion of the provision for restructuring and charge for impaired assets see Notes 1 and 3 to the Consolidated Financial Statements. 1996 VS. 1995 REVENUE from Company-owned units for 1996 decreased by $240.1 million (16.7%) from 1995 to $1,201.6 million. $218.2 million of this decrease can be attributed to the dispositions of PFC and PTF in 1995 and 1996, respectively. The remaining decrease of $52.2 million primarily results from operating 39 fewer Company-owned restaurants, partially offset by gains in comparable store sales of $30.3 million. Average unit sales in 1996 increased by 2.4% versus 1995. This increase is comprised of a 0.7% gain resulting from the impact of closed restaurants and those sold to franchisees, and a 1.7% gain in comparable store sales. The gains in comparable store sales were driven by an increase in average guest check, which was somewhat offset by a decrease in customer traffic. The full year gains in average check were aided by a September price increase that eliminated the $1.99 tier from the value menu. This price increase was triggered by commodity cost increases, minimum wage legislation and labor rate pressures. While the price increase had a positive impact on guest check averages, this increase was somewhat offset by a decline in customer counts. FRANCHISE REVENUE in 1996 increased by $6.2 million (12.7%) over 1995, to $55.1 million. The increase in franchise revenue is primarily attributable to 82 additional franchised units in 1996. $2.2 million of the increase was generated from initial fees from new franchise openings while the balance reflects an increase in royalties from units added in 1995 and 1996. Nineteen Company-owned units were sold to franchisees during 1996, generating $7.7 million in gains which are reflected as a reduction in operating expense. OPERATING EXPENSES for 1996 compared to 1995 decreased by $258.9 million (18.6%) to $1,134.9 million. This decrease is partially due to the restructuring charge and charge for impaired assets included in the 1995 results ($5.4 million and $23.9 million, respectively), a $2.8 million decrease in 1996 depreciation expense related to the 1995 impairment write-down, a $4.7 million increase in the current year amortization of the deferred gain attributable to the sales of PFC and PTF over the prior year amounts and a decrease of $201.6 million due to the dispositions of PFC and PTF. The effect of these items is somewhat offset by a decrease in the gains from restaurants sold to franchisees ($20.7 million in 1995 versus $7.7 million in 1996). Excluding these items, operating expenses decreased $33.5 million from the prior year. This decrease reflects several factors. Food costs and restaurant labor were favorable in comparison to 1995 by $14.0 million and $8.8 million, respectively, reflecting the decline in the number of Company-owned restaurants as well as the positive impact of cost control measures in the restaurants. These decreases were offset, in part, by higher commodity prices (particularly for pork, dairy, eggs and bread) over the prior year and increases in the Federal and state minimum wages. OPERATING INCOME for 1996 improved by $25.1 million (25.8%), as compared to 1995, to $121.9 million as a result of the factors noted above. 1995 VS. 1994 Denny's REVENUES decreased by $57.3 million (3.7%), of which $53.0 million was attributable to a decrease in outside revenues at the Company's food processing and distribution subsidiaries. Such revenue decrease reflects the sale of the Company's distribution subsidiary during the third quarter of 1995. The remaining decrease of $4.3 million is primarily due to a 45-unit net decrease in the number of Company-owned restaurants at December 31, 1995 as compared to December 31, 1994, which was partially offset by an 84-unit increase in the number of franchised restaurants. Comparable store sales at Denny's increased 2.4% during 1995 as compared with 1994, reflecting increases in average check of 2.3% and 0.2% in traffic. During 1995, Denny's completed remodels on 182 Company-owned restaurants. OPERATING EXPENSES before the provision for restructuring charges and charge for impaired assets at Denny's decreased $59.9 million principally due to decreases in product costs including $43.6 million attributable to Denny's distribution subsidiary which was sold in September 1995. Operating expenses for 1994 include twelve months of charges for the food distribution subsidiary; whereas, 1995 includes approximately nine months of such charges. Denny's operating expenses before the provision for restructuring charges and charge for impaired assets were also reduced during 1995 20 by gains on the sale of restaurants to franchisees of $20.7 million. This compares to gains in 1994 of $8.8 million. Such decreases in operating expenses were offset, in part, by an increase in advertising expense of $6.0 million. HARDEE'S
1994 1995 1996 ($ IN MILLIONS, EXCEPT AVG. UNIT DATA) Revenue.................................................................. $ 701 $ 660 $ 603 Operating Expenses....................................................... 625 656 562 Operating Income (a)..................................................... 76 4 41 Depreciation/Amortization................................................ $ 41 $ 42 $ 37 Comparable Store Sales (Decrease)........................................ (3.6%) (8.6%) (7.2%) AVERAGE UNIT DATA: Average Annual Unit Sales ($ in thousands)............................... $1,206 $1,104 $1,041 Average Guest Check...................................................... $ 3.11 $ 3.16 $ 3.17 Average Weekly Traffic Count............................................. 7,459 6,713 6,320 Operated Units........................................................... 595 593 580
(a) Operating income reflects a provision for restructuring of $8 million and a charge for impaired assets of $24 million for the year ended December 31, 1995. For a discussion of the provision for restructuring and charge for impaired assets, see Notes 1 and 3 to the Consolidated Financial Statements. 1996 VS. 1995 REVENUE for Hardee's for 1996 decreased by $56.9 million (8.6%) from 1995, to $602.9 million. The revenue decrease was primarily driven by 13 fewer restaurants in the Company's chain and a decrease in average unit sales in comparison to 1995. Comparable store sales decreased by 7.2% primarily due to decreased customer traffic in the face of continued aggressive "value/discounting" promotions by competitors within the quick-service segment and inclement weather during the first quarter. In the second half of the year, Flagstar's Hardee's began focusing less on discounting and more on overall value, introducing items which are somewhat higher priced but which management believes still offer good value for the money. The latest such promotion introduces the "Monster" line of items, featuring a large burger and a large omelet biscuit. This strategy has helped drive guest check averages; however, the increased average guest check has only marginally offset the decrease in traffic. OPERATING EXPENSES in 1996 decreased $93.4 million (14.2%), to $562.2 million, as compared to 1995. This decrease is partially driven by the restructuring charge and charge for impaired assets included in the 1995 results ($7.8 million and $23.7 million, respectively), a $2.3 million decrease in 1996 depreciation and amortization expense resulting from the impairment write-down in 1995 and a $1.9 million increase in the current year amortization of the deferred gain attributable to the sales of PFC and PTF over the prior year amount. This decrease also reflects the impact of lower comparable store sales, a decrease in the number of restaurants and management's increased focus on achieving improvement in operating efficiencies. The success of such cost control efforts is reflected by the fact that even after removing the impact on 1995 of the restructuring and impairment charges and the related reduction in depreciation in 1996, operating income would have increased $2.7 million over 1995, despite a decrease in revenue of $56.9 million. Labor savings had the most significant impact in reducing operating expenses. Labor as a percent of sales was 1% lower than in 1995. This was accomplished primarily by reducing in-store labor to become more competitive and more in line with quick-service industry standards, allowing management to reduce costs despite the impact of an increased Federal minimum wage. OPERATING INCOME for 1996 improved by $36.5 million, to $40.7 million, in comparison to 1995 as a result of the factors described above. 1995 VS. 1994 Hardee's REVENUE decreased during 1995 by $40.6 million, to $659.9 million, from $700.5 million during 1994, principally due to a decline of 8.6% in comparable store sales. The decrease in comparable store sales resulted from a 10.0% decline in traffic which was mitigated by a 1.6% increase in average check. The decline in traffic was impacted by continued aggressive promotions and discounting by quick-service competitors. During 1995, the Company remodeled 59 Hardee's restaurants. 21 At Hardee's, OPERATING EXPENSES before considering the effects of the provision for restructuring charges and charge for impaired assets decreased by $0.8 million. This reflects increased expenses during 1995 of $12.8 million for general and administrative, payroll and benefits, restructuring of field management, workers' compensation charges, and expenses related to promotional programs. Such increases were more than offset by a $13.6 million decrease in product costs directly associated with decreased revenues in 1995. QUINCY'S
1994 1995 1996 ($ IN MILLIONS, EXCEPT AVG. UNIT DATA) Revenue.................................................................. $ 284 $ 294 $ 259 Operating Expenses....................................................... 261 272 252 Operating Income (a)..................................................... 23 22 7 Depreciation/Amortization................................................ $ 11 $ 12 $ 11 Comparable Store Sales Increase (Decrease)............................... 2.9% 4.8% (10.8%) AVERAGE UNIT DATA: Average Annual Unit Sales ($ in thousands)............................... $1,350 $1,438 $1,301 Average Guest Check...................................................... $ 5.79 $ 5.88 $ 6.06 Average Weekly Traffic Count............................................. 4,486 4,703 4,132 Operated Units........................................................... 207 203 199
(a) Operating income reflects a restructuring charge and charge for impaired assets of $0.6 million for the year ended December 31, 1995. For a discussion of the provision for restructuring and charge for impaired assets see Notes 1 and 3 to the Consolidated Financial Statements. 1996 VS. 1995 REVENUE for Quincy's in 1996 decreased by $35.1 million (11.9%) from 1995, to $259.2 million. The revenue decrease was primarily driven by a decrease in customer traffic, as well as four fewer restaurants, offset somewhat by an increase in the average guest check. Customer traffic, which decreased by 12% versus 1995, was primarily responsible for the 10.8% decrease in comparable store sales. The significant decline in customer traffic reflects, among other things, continued traffic declines in the family-steak category, in general, as well as a difficult comparison to the prior year (which benefited from several newly remodeled units), in addition to the unsuccessful introduction of a new steak product earlier in the year. Also, over the last two years management has experimented with various formats at Quincy's, which has led to some customer confusion and a lack of focus for the concept. To address this issue, in October, management initiated a "Relaunch" program to re-establish the brand and give customers a consistent experience. In this regard, during the third quarter of 1996, new products were developed and tested, training was implemented at all levels, facilities were improved, and management rolled out a new value steak promotion, the "No Mistake Steak", which also introduced a number of new products accompanied by increased media advertising. Although the "Relaunch" results to date have been positive, management notes that the program is still in its early stages and that it will take time to measure its full impact on results. OPERATING EXPENSES in 1996 as compared to 1995 decreased by $19.4 million (7.1%), to $252.5 million. This decrease was driven by the decline in sales and a $1.2 million increase in the current year amortization of the deferred gain attributable to the sales of PFC and PTF over the prior year amount. These decreases were partially offset by the additional costs in product, labor and advertising to institute the "Relaunch" program. Primarily due to the training efforts related to re-launching the brand, labor costs increased $3.0 million (1.2%) over 1995. Also, after a period of no advertising for Quincy's in August and September as the Relaunch plan was formulated, advertising was increased significantly in the fourth quarter to support the reintroduction of the brand, resulting in an overall increase in advertising expense of approximately $3.0 million in 1996 over the prior year. OPERATING INCOME in 1996 as compared to 1995 declined by $15.7 million, to $6.6 million, as a result of the factors described above. 1995 VS. 1994 Quincy's REVENUES increased by $9.9 million (3.5%) during 1995 as compared to 1994 despite a four-unit decrease in the number of restaurants operated at December 31, 1995 as compared to December 31, 1994. Such increase in revenues 22 is primarily due to a 4.8% increase in comparable store sales as a result of increases of 3.3% in traffic and 1.5% in average check. During 1995, the increased traffic is partially attributable to the remodeling of 35 of its restaurants. An increase in OPERATING EXPENSES is principally attributable to increases in payroll and benefits expense of $4.4 million, product costs of $3.3 million associated primarily with the increase in revenues during 1995, and advertising expense of $2.7 million. EL POLLO LOCO
1994 1995 1996 ($ IN MILLIONS, EXCEPT AVG. UNIT DATA) Net Company Sales........................................................ $ 127 $ 117 $ 114 Franchise Revenue........................................................ 6 10 14 Total Revenue............................................................ 133 127 128 Operating Expenses....................................................... 124 114 114 Operating Income......................................................... 9 13 14 Depreciation/Amortization................................................ $ 6 $ 5 $ 6 Comparable Store Sales Increase.......................................... 6.5% 2.0% 7.2% AVERAGE UNIT DATA: Average Annual Unit Sales ($ in thousands): Company Operated....................................................... $ 932 $1,019 $1,155 Franchised............................................................. 893 858 852 Average Guest Check...................................................... $ 6.59 $ 6.76 $ 6.63 Average Weekly Traffic Count............................................. 2,720 2,894 3,350 Operated Units: Company Operated....................................................... 127 103 96 Franchise.............................................................. 78 112 135 International.......................................................... 4 2 10 Total............................................................. 209 217 241
1996 VS. 1995 REVENUE from Company-owned El Pollo Loco units for 1996 decreased by $1.6 million (1.4%) from 1995 to $114.7 million. The revenue decrease was primarily driven by a net decrease of seven restaurants (eight units sold to franchisees, one Company-owned unit opened), partially offset by gains in comparable store sales. Comparable store sales increased 7.2%, driven by increased guest traffic, which on a comparable store basis, increased 9.9%. The increased traffic was principally attributable to the highly successful "Pollo Bowl," rolled out in late 1995, which currently accounts for 11% of the menu mix, as well as other key promotions. Comparable store sales also benefited from the Foster's Freeze rollout. The decrease in average guest check was driven by a change in value focus in 1996. During 1995, most of the value offerings featured very large amounts of food (such as the $14.99 Holiday Feast), whereas in 1996, value was approached on a quantity and price basis (such as the Pollo Bowl and $9.99 for 12 pieces of chicken). FRANCHISE REVENUE in 1996 increased $3.3 million (31.7%) over 1995 to $13.7 million. The increase in revenue is primarily due to 31 additional franchise units in 1996. Of the increase in revenue, $0.8 million was generated from initial fees collected as new franchised units were opened, with the remainder coming from the ongoing royalty stream of the additional units. Eight units were sold to franchisees during 1996, generating $0.7 million in gains which are reflected as a reduction of operating expenses. OPERATING EXPENSES increased $0.5 million in 1996 over the prior year, to $114.6 million, due to a decrease in gains recognized on the sale of restaurants to franchisees, from $3.8 million in 1995 to $0.7 million in 1996. Removing the impact of the decrease in restaurant sales to franchisees, El Pollo Loco experienced a net decrease in operating expenses of $2.6 million reflecting, among other things, lower product costs associated with the Pollo Bowl and other new products, a decrease in direct labor costs due to improved labor scheduling and staffing initiatives, food cost control measures and a $0.4 million increase in the current year amortization of the deferred gain attributable to the sales of PFC and PTF over 23 the prior year amount. These improvements were attained despite an increase in chicken prices versus 1995, and the increased Federal and state minimum wages. OPERATING INCOME for 1996 in comparison to 1995, improved by $1.2 million (9.5%) to $13.8 million as a result of the factors discussed above. 1995 VS. 1994 REVENUES at El Pollo Loco decreased $6.4 million (4.8%) to $126.7 million during 1995, from $133.1 million during 1994, primarily due to a 24-unit net decrease in the number of Company-owned restaurants following the sale of units to franchisees. Comparable store sales at Company-owned El Pollo Loco units increased by 2.0% reflecting an increase in average check of 2.4% which was partially offset by a 0.4% decrease in traffic. During 1995, El Pollo Loco completed remodels on 57 of its Company-owned restaurants. OPERATING EXPENSES at El Pollo Loco decreased by $9.6 million during 1995 due primarily to a 24-unit net decrease at December 31, 1995 as compared with December 31, 1994 in the number of Company-operated restaurants following the sale of restaurants to franchisees. El Pollo Loco's operating expenses during 1995 included gains on the sale of restaurants of $3.8 million as compared with $1.2 million during 1994. COCO'S AND CARROWS The Company's operating results for the year ended December 31, 1996 include 31 weeks of Coco's and Carrows operations subsequent to their acquisition in May. Coco's and Carrows revenues for the period were $163.7 million and $131.4 million, respectively. Operating expenses for Coco's and Carrows were $155.5 million and $124.7 million, respectively. The following information is provided for analysis purposes only as it includes information for periods prior to the acquisition of Coco's and Carrows by the Company on May 23, 1996: COCO'S AND CARROWS
1995 1996 ($ IN MILLIONS, EXCEPT AVG. UNIT DATA) Net Company Sales....................................................................................... $ 502 $ 487 Franchise Revenue....................................................................................... 4 4 Total Revenue........................................................................................... 506 491 Operating Expenses...................................................................................... 474 477 Operating Income........................................................................................ 32 14 Depreciation/Amortization............................................................................... $ 28 $ 31 COCO'S Comparable Store Sales (Decrease)....................................................................... (5.0%) (1.6%) AVERAGE UNIT DATA: Average Annual Unit Sales ($ in thousands).............................................................. $1,506 $1,462 Average Guest Check..................................................................................... $ 6.72 $ 6.79 Average Weekly Traffic Count............................................................................ 4,271 4,159 Operated Units: Company Operated...................................................................................... 188 183 Franchise............................................................................................. 6 5 International......................................................................................... 252 278 Total............................................................................................ 446 466 CARROWS Comparable Store Sales (Decrease) Increase.............................................................. (0.2%) 0.1% AVERAGE UNIT DATA: Average Annual Unit Sales ($ in thousands).............................................................. $1,372 $1,343 Average Guest Check..................................................................................... $ 6.09 $ 6.26 Average Weekly Traffic Count............................................................................ 4,363 4,252 Operated Units.......................................................................................... 161 160
24 LIQUIDITY AND CAPITAL RESOURCES Historically, the Company has met its liquidity requirements with internally generated funds, external borrowings, and in recent years, proceeds from asset sales. The Company expects to continue to rely on internally generated funds, supplemented by available working capital advances under its Second Amended and Restated Credit Agreement, dated as of April 10, 1996, among TWS Funding, Inc., as borrower, Flagstar, certain lenders and co-administrative agents named therein, and Citibank, N.A., as funding agent (as amended, from time to time, the "Credit Agreement"), and other external borrowings, as its primary sources of liquidity. The following table sets forth, for each of the years indicated, a calculation of the Company's cash from operations available for debt repayment, dividends on the Preferred Stock (as defined below), and capital expenditures:
YEAR YEAR ENDED ENDED DECEMBER DECEMBER 31, 31, ($ IN MILLIONS) 1995 1996 Net loss.............................................................. $(55.2) $(85.5) Charge for impaired assets............................................ 51.4 -- Provision for restructuring charges................................... 15.9 -- Non-cash charges (credits)............................................ 120.3 119.9 Deferred income tax benefit........................................... (3.5) (9.0) Discontinued operations............................................... (77.2) -- Extraordinary items, net.............................................. (0.5) -- Change in certain working capital items............................... (6.1) 7.4 Change in other assets and other liabilities, net..................... (31.0) (16.1) Cash from operations available for debt repayment, dividends on Preferred Stock, and capital expenditures........................... $14.1 $16.7
The cash flows generated by Coco's and Carrows, which was acquired in May 1996, are required by the instruments governing the indebtedness incurred to finance such acquisition, to service the debt issued by FRD, Flagstar's acquisition subsidiary and, therefore, other than for the payment of certain management fees and tax reimbursements payable to Flagstar under certain conditions, are currently unavailable to be used to service the debt of Flagstar and its other subsidiaries. Coco's and Carrows' cash flows from operations included in the Company's total cash flow from operations, was $21.2 million in 1996. The Credit Agreement, which expires on April 10, 1999, provides Flagstar with a $150 million revolving credit facility. It is available for working capital advances and letters of credit, with a working capital advance sublimit of $75 million. As of December 31, 1996, there were no working capital advances outstanding under this credit facility, although approximately $79.7 million letters of credit were outstanding; accordingly, $70.3 million was available for additional letters of credit or working capital borrowings. The Credit Agreement and the indentures governing the Company's outstanding public debt contain negative covenants that restrict, among other things, the Company's ability to pay dividends, incur additional indebtedness, further encumber its assets and purchase or sell assets. In addition, the Credit Agreement includes provisions for the maintenance of a minimum level of interest coverage, limitations on ratios of indebtedness to earnings before interest, taxes, depreciation and amortization (EBITDA) and limitations on annual capital expenditures. In connection with the acquisition of Coco's and Carrows, FRI-M, which became thereby a wholly-owned subsidiary of the Company, obtained a new credit facility consisting of a $56 million term loan, which matures on August 31, 1999, and a $35 million revolving credit facility, which is available until August 31, 1999 for Coco's and Carrows general working capital advances and letters of credit. Such facility is unavailable to Flagstar and its other subsidiaries. 25 As of December 31, 1996, scheduled debt maturities of long-term debt relative to Flagstar and its subsidiaries for the years 1997 and thereafter are as follows:
FLAGSTAR EXCLUDING ($ IN MILLIONS) FRD FRD 1997............................................................ 43$.3 $ 19.6 1998............................................................ 34.2 23.6 1999............................................................ 27.5 23.7 2000............................................................ 323.3 3.4 2001............................................................ 277.9 3.1 Thereafter...................................................... 1,298.0 164.7
In addition to scheduled maturities of principal, on a consolidated basis, approximately $255 million of cash will be required in 1997 to meet interest payments on long-term debt and $14 million will be required for dividends on FCI's $2.25 Series A Cumulative Convertible Exchangeable Preferred Stock, par value $0.10 per share (the "Preferred Stock") should FCI's Board of Directors declare such dividends. Since the leveraged buyout of Flagstar in 1989, the Company has not achieved the revenue and earnings projections prepared at the time of the transaction, due in large part to increased competition, intensive pressure on pricing due to discounting, adverse economic conditions and relatively limited capital resources to respond to these changes. Such trends have generally continued through 1996. The Company's cash flows have been sufficient to fund its operations and make interest payments when due. However, the Company's core businesses have not experienced cash flow growth sufficient to provide adequate funds to invest for future growth. These conditions present both short-term and long-term financial challenges to the Company. To address these matters, management is developing plans to maintain its liquidity and improve its capital structure. Specifically, the Board of Directors elected not to declare the January 15, 1997 quarterly dividend on the Preferred Stock. In addition, the new management team that has been put in place during the last 18 months is identifying cost reduction and revenue enhancement strategies intended to improve operations. While these actions may enhance the short-term financial position of the Company, over the long-term management has concluded that a substantial restructuring or refinancing of the Company's debt, which may include a negotiated restructuring or other exchange transaction, will be required to allow the Company to meet its long-term debt obligations and will be a prerequisite to future growth through additional investment in its restaurants. Accordingly, on January 21, 1997, the Company hired Donaldson, Lufkin & Jenrette Securities Corporation as a financial advisor to assist in exploring alternatives to improve the Company's capital structure. Management intends to explore all alternatives to reduce the Company's debt service requirements and allow the Company to reinvest in its core businesses and grow the restaurant concepts over the long-term. There can be no assurance, however, that management will be successful in this regard. With respect to short-term liquidity, management believes that through a combination of cash generated from operations, funds available through the bank credit facility, various cash management measures and other sources, adequate liquidity exists to meet the Company's working capital, debt service and capital expenditure requirements for at least the next twelve months. Although no assurances can be given in this regard, management believes, based on the Company's historical relationship with its banks, that it will be able, as necessary, to maintain access to funds available under the Credit Agreement. The Company's principal capital requirements are those associated with opening new restaurants and remodeling and maintaining its existing restaurants and facilities. During 1996, total capital expenditures were approximately $67.3 million, of which approximately $1.3 million was used to remodel existing restaurants, $21.8 million was used to refurbish existing restaurants, $7.5 million was used for POS systems and other information technology assets, $0.8 million was used to open new restaurants, and $35.9 million was used to maintain existing facilities and equipment. Of the total capital expenditures, approximately $12.3 million were financed through capital leases. Capital expenditures during 1997 are expected to total approximately $90 million; however, the Company is not committed to spending this amount and could spend less if circumstances warrant. The Company is able to operate with a substantial working capital deficiency because (i) restaurant operations and most food service operations are conducted primarily on a cash (and cash equivalent) basis with a low level of accounts receivable, (ii) rapid turnover allows a limited investment in inventories, and (iii) accounts payable for food, beverages and supplies usually become due after the receipt of cash from the related sales. At December 31, 1996, the Company's 26 working capital deficiency, exclusive of net assets held for sale, was $297.7 million as compared with $122.2 million at the end of 1995. Such increase reflects the use of the Company's excess cash at December 31, 1995, which resulted from the sales of the Company's non-restaurant business in 1995, to acquire the Coco's and Carrows restaurant chains and to fund the Company's 1996 operations. On February 22, 1996, the Company entered into an agreement with Integrated Systems Solutions Corporation (ISSC). The ten year agreement for $340.6 million (including $17.6 million for FRD), which requires annual payments by the Company ranging from $24.0 million to $47.5 million, provides for ISSC to manage and operate the Company's information systems, as well as develop and implement new systems and applications to enhance information technology for the Company's corporate headquarters, restaurants, and field management. ISSC will oversee data center operations, applications development and maintenance, voice and data networking, help desk operations, and POS technology. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Index to Financial Statements which appears on page F-1 herein. FORM 11-K INFORMATION FCI, pursuant to Rule 15d-21 promulgated under the Securities Exchange Act of 1934, as applicable, will file as an amendment to this Annual Report of Form 10-K the information, financial statements and exhibits required by Form 11-K with respect to the Flagstar 401(k) Plan and the Denny's 401(k) Plan. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information required by this item with respect to the Company's directors and compliance by the Company's directors, executive officers and certain beneficial owners of the Company's Common Stock with Section 16(a) of the Securities Exchange Act of 1934 shall be furnished by incorporation by reference of all information under the captions entitled "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement for its 1997 Annual Meeting of the Stockholders (the "Proxy Statement") or included as an amendment to this Form 10-K to be filed no later than April 30, 1997. The information required by this item with respect to the Company's executive officers appears in Item I of Part I of this Annual Report on Form 10-K under the caption "Executive Officers of the Registrant." ITEM 11. EXECUTIVE COMPENSATION The information required by this item shall be furnished by incorporation by reference of all information under the caption entitled "Executive Compensation" in the Company's Proxy Statement or included as an amendment to this Form 10-K to be filed no later than April 30, 1997. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item shall be furnished by incorporation by reference of all information under the caption "General -- Ownership of Capital Securities" in the Company's Proxy Statement or included as an amendment to this Form 10-K to be filed no later than April 30, 1997. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS CERTAIN TRANSACTIONS The information required by this item shall be furnished by incorporation by reference of all information under the caption "Certain Transactions" in the Company's Proxy Statement or included as an amendment to this Form 10-K to be filed no later than April 30, 1997. 27 DESCRIPTION OF INDEBTEDNESS The following summary of the principal terms of the current indebtedness of the Company does not purport to be complete and is qualified in its entirety by reference to the documents governing such indebtedness, including the definitions of certain terms therein, copies of which have been filed as exhibits to this Annual Report on Form 10-K. Whenever particular provisions of such documents are referred to herein, such provisions are incorporated herein by reference, and the statements are qualified in their entirety by such reference. THE FLAGSTAR CREDIT AGREEMENT On April 10, 1996 Flagstar entered into the Credit Agreement which established a $150 million senior secured working capital and letter of credit facility, with a $75 million sublimit for working capital advances. Under the Credit Agreement, Flagstar is required to permanently reduce the facility by the aggregate amount of Net Cash Proceeds (as defined therein) received from (i) the sale, lease, transfer or other disposition of certain assets of Flagstar or any of its Restricted Subsidiaries (as defined therein) and (ii) the sale or issuance by FCI or any of its Restricted Subsidiaries of any Debt (as defined therein) (other than Debt permitted by the terms of the Credit Agreement and to the extent the Net Cash Proceeds are applied to refinance certain existing Subordinated Debt (as defined therein)). The Credit Agreement contains covenants customarily found in credit agreements for leveraged financings that restrict, among other things, the ability of Flagstar and its Restricted Subsidiaries to make, engage in or incur (i) liens and security interests other than liens securing the obligations under the Credit Agreement, certain liens existing as of the date of effectiveness of the Credit Agreement, certain liens in connection with the financing of capital expenditures, certain liens arising in the ordinary course of business, including certain liens in connection with intercompany transactions and certain other exceptions; (ii) Debt, other than Debt under the Loan Documents (as defined therein), certain capital lease obligations, certain Debt in existence on the date of the Credit Agreement, certain Debt in connection with the financing of capital expenditures, certain Debt in connection with Investments (as defined therein) in new operations, properties and franchises, certain trade letters of credit, certain unsecured borrowings in the ordinary course of business, certain intercompany indebtedness and certain other exceptions; (iii) lease obligations, other than obligations in existence as of the effectiveness of the Credit Agreement, certain leases entered into in the ordinary course of business, certain capital leases, certain intercompany leases and certain other exceptions; (iv) mergers or consolidations, except for certain intercompany mergers or consolidations and certain mergers to effect certain transactions otherwise permitted under the Credit Agreement; (v) sales of assets, other than certain dispositions of inventory and obsolete or surplus equipment in the ordinary course of business, certain dispositions in the ordinary course of business of properties no longer used or useful to the business of the Company, certain intercompany transactions, certain dispositions in connection with sale and leaseback transactions, certain exchanges of real property, fixtures and improvements for other real property, fixtures and improvements, certain dispositions of a portion of certain restaurant assets of Denny's Holdings, Inc., certain dispositions in connection with the sale of PTF and its subsidiaries, and dispositions of certain underperforming restaurants; (vi) Investments, other than certain intercompany indebtedness, certain investments made in connection with joint venture or franchise arrangements, certain loans to employees, investments in new operations, properties or franchises subject to certain limitations and certain other exceptions; (vii) payments of dividends or other distributions with respect to capital stock of Flagstar, other than dividends from Flagstar to FCI to enable FCI to repurchase Common Stock and FCI stock options from employees in certain circumstances, payments to FCI with respect to fees and expenses incurred in the ordinary course of business by FCI in its capacity as a holding company for Flagstar, payments enabling Flagstar and its Restricted Subsidiaries to pay their tax liabilities and certain other exceptions; (viii) sales or dispositions of the capital stock of subsidiaries other than sales by Restricted Subsidiaries of Flagstar to Flagstar or certain other subsidiaries and certain other exceptions; (ix) conduct by Flagstar or certain of its subsidiaries of business inconsistent with its status as a holding company or single purpose subsidiary, as the case may be, or entering into transactions inconsistent with such status; and (x) prepayments of Debt, other than certain payments of Debt in existence on the date of the Credit Agreement, certain payments to retire Debt in connection with permitted dispositions of assets, certain prepayments of advances under the Credit Agreement and certain other exceptions. The Credit Agreement also contains covenants that require Flagstar to meet certain financial ratios and tests described below: TOTAL DEBT TO EBITDA RATIO. Flagstar is required not to permit the ratio of (a) Total Debt (as defined below) outstanding on the last day of any fiscal quarter less surplus cash to (b) EBITDA (as defined below) of Flagstar and its 28 Restricted Subsidiaries on a consolidated basis for the Rolling Period (as defined below) then ended to be more than a specified ratio, ranging from a ratio of 8.40:1.00 applicable on December 31, 1996, to a ratio of 8.70:1.00 applicable on March 31, 1997, to a ratio of 6.00:1.00 applicable on or after December 31, 1998. SENIOR DEBT TO EBITDA RATIO. Flagstar is required not to permit the ratio of (a) Senior Debt (as defined therein) outstanding on the last day of any fiscal quarter less surplus cash to (b) EBITDA of Flagstar and its Restricted Subsidiaries on a consolidated basis for the Rolling Period then ended to be more than a specified ratio, ranging from a ratio of 4.05:1.00 applicable on December 31, 1996, to a ratio of 4.25:1.00 on March 31, 1997, to a ratio of 2.90:1.00 on or after December 31, 1998. INTEREST COVERAGE RATIO. Flagstar is required not to permit the ratio, determined on the last day of each fiscal quarter for the Rolling Period then ended, of (a) EBITDA of Flagstar and its Restricted Subsidiaries on a consolidated basis to (b) Cash Interest Expense (as defined below) of Flagstar and its Restricted Subsidiaries on a consolidated basis to be less than a specified ratio, ranging from a ratio of 1.05:1.00 applicable on December 31, 1996, to a ratio of 1.00:1:00 on March 31, 1997, to a ratio of 1.50:1.00 on or after December 31, 1998. CAPITAL EXPENDITURES TEST. Flagstar and its Restricted Subsidiaries on a consolidated basis are prohibited from making capital expenditures in excess of $80.0 million, $115.0 million and $115.0 million in the aggregate for the fiscal years ending December 31, 1996 through 1998, respectively. For the fiscal quarter ending March 31, 1999 Flagstar and its Restricted Subsidiaries are prohibited from making capital expenditures in excess of the sum of $30.0 million. CERTAIN DEFINED TERMS. As used in the Credit Agreement, the following terms shall have the following meanings. "Advance" means a working capital advance or a swing line advance or a letter of credit advance. "Cash Interest Expense" means, for any Rolling Period, without duplication, interest expense net of interest income, whether paid or accrued during such Rolling Period (including the interest component of capitalized lease obligations) on all Debt, INCLUDING, without limitation, (a) interest expense in respect of Advances (as defined above), the Senior Notes (as defined therein) and the Subordinated Debt (as defined therein), (b) commissions and other fees and charges payable in connection with letters of credit, (c) the net payment, if any, payable in connection with all interest rate protection contracts and (d) interest capitalized during construction, but EXCLUDING, in each case, interest not paid in cash (including amortization of discount and deferred debt expenses), all as determined in accordance with generally accepted accounting principles. "EBITDA" of any person means, for any period, on a consolidated basis, net income (or net loss) PLUS the sum of (a) interest expense net of interest income, (b) income tax expense, (c) depreciation expense, (d) amortization expense and (e) extraordinary or unusual losses included in net income (net of taxes to the extent not already deducted in determining such losses) LESS extraordinary or unusual gains included in net income (net of taxes to the extent not already deducted in determining such gains), in each case determined in accordance with generally accepted accounting principles. "Funded Debt" means the principal amount of Debt in respect of Advances (as defined above) and the principal amount of all Debt that should, in accordance with generally accepted accounting principles, be recorded as a liability on a balance sheet and matures more than one year from the date of creation or matures within one year from such date but is renewable or extendible, at the option of the debtor, to a date more than one year from such date or arises under a revolving credit or similar agreement that obligates the lender or lenders to extend credit during a period of more than one year from such date, including, without limitation, all amounts of Funded Debt required to be paid or prepaid within one year from the date of determination. "Restricted Subsidiaries" means all subsidiaries of Flagstar other than the Unrestricted Subsidiaries (as defined below). "Rolling Period" means, for any fiscal quarter, such quarter and the three preceding fiscal quarters. "Surplus Cash" means, as of any date, the lesser of (a) cash reflected on consolidated balance sheet of Flagstar and its Restricted Subsidiaries in excess of $13.0 million and (b) the aggregate of amounts on deposit in the Borrower Cash Collateral Account (as defined therein) and in Collateral Investment Accounts (as defined therein). "Total Debt" outstanding on any date means the sum, without duplication, of (a) the aggregate principal amount of all Debt of Flagstar and its Restricted Subsidiaries, on a consolidated basis, outstanding on such date to the extent such Debt constitutes indebtedness for borrowed money, obligations evidenced by notes, bonds, debentures or other similar instruments, obligations created or arising under any conditional sale or other title retention agreement with respect to property 29 acquired or obligations as lessee under leases that have been or should be, in accordance with generally accepted accounting principles, recorded as capital leases, (b) the aggregate principal amount of all Debt of Flagstar and its Restricted Subsidiaries, on a consolidated basis, outstanding on such date constituting direct or indirect guarantees of certain Debt of others and (c) the aggregate principal amount of all Funded Debt (as defined above) of Flagstar and its Restricted Subsidiaries on a consolidated basis consisting of obligations, contingent or otherwise, under acceptance, letter of credit or similar facilities. "Unrestricted Subsidiary" means FRD Acquisition Co., a wholly-owned subsidiary of Flagstar, formed as a vehicle for the acquisition of the Family Restaurant Division of Family Restaurants, Inc. (Coco's and Carrows) and such other subsidiaries of Flagstar as Flagstar shall designate as an Unrestricted Subsidiary in writing to the agents and the lenders under the Credit Agreement in accordance with the terms of the Credit Agreement, and any subsidiaries thereof. Under the Credit Agreement, an event of default will occur if, among other things, (i) any person or group of two or more persons acting in concert (other than KKR, Gollust Tierney & Oliver and their respective affiliates) acquires, directly or indirectly, beneficial ownership of securities of FCI representing, in the aggregate, more of the votes entitled to be cast by all voting stock of FCI than the votes entitled to be cast by all voting stock of FCI beneficially owned, directly or indirectly, by KKR and its affiliates, (ii) any person or group of two or more persons acting in concert (other than KKR and its affiliates) acquires by contract or otherwise, or enters into a contract or arrangement that results in its or their acquisition of the power to exercise, directly or indirectly, a controlling influence over the management or policies of Flagstar or FCI or (iii) Flagstar shall cease at any time to be a wholly-owned subsidiary of FCI. If such an event of default were to occur, the lenders under the Credit Agreement would be entitled to exercise a number of remedies, including acceleration of all amounts owed under the Credit Agreement. FLAGSTAR PUBLIC DEBT As part of the Recapitalization, Flagstar consummated on November 16, 1992 the sale of $300 million aggregate principal amount of 10 7/8% Senior Notes Due 2002 (of which $280 million remains outstanding) (the "10 7/8% Notes") and issued pursuant to an exchange offer for previously outstanding debt issues $722.4 million principal amount of 11.25% Senior Subordinated Debentures Due 2004 (the "11.25% Debentures"). On September 23, 1993, Flagstar consummated the sale of $275 million aggregate principal amount of 10 3/4% Senior Notes Due 2001 (of which $270 million remains outstanding) (the "10 3/4% Notes") and $125 million aggregate principal amount of 11 3/8% Senior Subordinated Debentures Due 2003 (the "11 3/8% Debentures"). The 10 7/8% Notes and the 10 3/4% Notes are general unsecured obligations of Flagstar and rank PARI PASSU in right of payment with Flagstar's obligations under the Credit Agreement. The 11.25% Debentures are general unsecured obligations of Flagstar and are subordinate in right of payment to the obligations of Flagstar under the Restated Credit Agreement, the 10 7/8% Notes and the 10 3/4% Notes. The 11.25% Debentures rank PARI PASSU in right of payment with the 11 3/8% Debentures. All such debt is senior in right of payment to the 10% Debentures. THE SENIOR NOTES. Interest on the 10 7/8% Notes is payable semi-annually in arrears on each June 1 and December 1. They will mature on December 1, 2002. The 10 7/8% Notes will be redeemable, in whole or in part, at the option of Flagstar, at any time on or after December 1, 1997, initially at a redemption price equal to 105.4375% of the principal amount thereof to and including November 30, 1998, at a decreased price thereafter to and including November 30, 1999 and thereafter at 100% of the principal amount thereof, together in each case with accrued interest. Interest on the 10 3/4% Notes is payable semi-annually in arrears on each March 15 and September 15. They will mature on September 15, 2001. The 10 3/4% Notes may not be redeemed prior to maturity. THE SENIOR SUBORDINATED DEBENTURES. Interest on the 11.25% Debentures is payable semi-annually in arrears on each May 1 and November 1. They will mature on November 1, 2004. The 11.25% Debentures will be redeemable, in whole or in part, at the option of Flagstar, at any time on or after November 1, 1997, initially at a redemption price equal to 105.625% of the principal amount thereof to and including October 31, 1998, at decreasing prices thereafter to and including October 31, 2002 and thereafter at 100% of the principal amount thereof, together in each case with accrued interest. Interest on the 11 3/8% Debentures is payable semi-annually in arrears on each March 15 and September 15. They will mature on September 15, 2003. The 11 3/8% Debentures will be redeemable, in whole or in part, at the option of Flagstar, at any time on or after September 15, 1998, initially at a redemption price equal to 105.688% of the principal amount thereof to and including September 14, 1999, at 102.844% of the principal amount thereof to and including September 14, 2000 and thereafter at 100% of the principal amount thereof, together in each case with accrued interest. 30 THE 10% DEBENTURES. Interest on the 10% Debentures is payable semi-annually in arrears on each May 1 and November 1. The 10% Debentures mature on November 1, 2014. Unless previously redeemed, the 10% Debentures are convertible at any time at the option of the holders thereof by exchange into shares of Common Stock at a conversion price of $24.00 per share, subject to adjustment. The 10% Debentures are redeemable, in whole or in part, at the option of the Company upon payment of a premium. The Company is required to call for redemption on November 1, 2002 and on November 1 of each year thereafter, through and including November 1, 2013, $7,000,000 principal amount of the 10% Debentures. A "Change of Control" having occurred on November 16, 1992, holders of the 10% Debentures had the right, under the indenture relating thereto, to require the Company, subject to certain conditions, to repurchase such securities at 101% of their principal amount together with interest accrued to the date of purchase. On February 19, 1993, the Company made such an offer to repurchase the $100 million of 10% Debentures then outstanding. On March 24, 1993 the Company repurchased $741,000 principal amount of the 10% Debentures validly tendered and accepted pursuant to such offer. MORTGAGE FINANCINGS A subsidiary of Flagstar had issued and outstanding, at December 31, 1996, $190.2 million in aggregate principal amount of 10 1/4% Guaranteed Secured Bonds due 2000. Interest is payable semi-annually in arrears on each November 15 and May 15. As a result of the downgrade of Flagstar's outstanding debt securities during 1994, certain payments by the Company which fund such interest payments are due and payable on a monthly basis. Principal payments total $12.5 million annually for the years 1997 through 1999; and $152.7 million in 2000. The bonds are secured by a financial guaranty insurance policy issued by Financial Security Assurance, Inc. and by collateral assignment of mortgage loans on 238 Hardee's and 148 Quincy's restaurants. Another subsidiary of Flagstar has outstanding $160 million aggregate principal amount of 11.03% Notes due 2000. Interest is payable quarterly in arrears, with the principal maturing in a single installment payable in July 2000. These notes are redeemable, in whole, at the subsidiary's option, upon payment of a premium. They are secured by a pool of cross-collateralized mortgages on approximately 240 Denny's restaurant properties. THE FRI-M CREDIT FACILITY In connection with the acquisition by FRD of Coco's and Carrows on May 23, 1996, FRI-M (the "Borrower"), a wholly-owned subsidiary of FRD, obtained a new credit facility (the "FRI-M Credit Facility") consisting of a $56 million term loan (the "FRI-M Term Loan") and a $35 million working capital facility (the "FRI-M Revolver"). Proceeds from the FRI-M Term Loan were used to fund the Coco's and Carrows acquisition and to pay the transactions costs associated therewith. Proceeds from the FRI-M Revolver are to be used for working capital requirements and other general corporate purposes, which may include the making of intercompany loans to any of the Borrower's wholly-owned subsidiaries for their own working capital and other general corporate purposes. Letters of credit may be issued under the FRI-M Revolver for the purpose of supporting (i) workers' compensation liabilities of the Borrower or any of its subsidiaries; (ii) the obligations of third party insurers of the Borrower or any of its subsidiaries; and (iii) certain other obligations of the Borrower and its subsidiaries. The FRI-M Term Loan matures on August 31, 1999. Principal installments of the FRI-M Term Loan are payable quarterly as follows: $4 million per quarter for four consecutive quarters beginning February 28, 1997; $5 million for four consecutive quarters beginning February 28, 1998; $6 million on February 28, 1999; and $7 million for two consecutive quarters beginning May 31, 1999. All amounts owing under the FRI-M Term Loan are required to be repaid on August 31, 1999. The commitment to make loans or issue letters of credit pursuant to the FRI-M Revolver expires, and all amounts outstanding under the FRI-M Revolver must be repaid, on August 31, 1999. All borrowings under the FRI-M Credit Facility accrue interest at a variable rate based on a base rate (as defined therein) or an adjusted Eurodollar rate. The rate at year end 1996 was 8.125%. The FRI-M Credit Facility requires the Borrower to make mandatory prepayments in certain circumstances out of its Consolidated Excess Cash Flow (as defined therein), out of cash proceeds of certain asset sales, out of assets distributed to FRD, the Borrower or any of Borrower's direct or indirect subsidiaries (each, a "Loan Party") in connection with an employee benefit plan termination and out of net cash proceeds received by a Loan Party from certain other sources. Any mandatory partial prepayment of the FRI-M Term Loan shall be applied to installments scheduled to be paid during the twelve months immediately following the date of such prepayment, with any excess being applied ratably to the scheduled installments of the FRI-M Term Loan. 31 The FRI-M Credit Facility contains certain restrictive covenants which, among other things, limit (subject to certain exceptions) the Borrower and its subsidiaries with respect to (a) incurrence of debt; (b) the existence of liens; (c) investments and joint ventures; (d) the declaration or payment of dividends; (e) the making of guarantees and other contingent obligations; (f) the amendment or waiver of certain related agreements; (g) mergers, consolidations, liquidations and sales of assets (including sale and leaseback transactions); (h) payment obligations under leases; (i) transactions with shareholders and affiliates; (j) the sale, assignment, pledge or other disposition of shares of Borrower or its subsidiaries by Borrower or its subsidiaries; (k) capital expenditures; and (l) material changes in their business. The FRI-M Credit Facility also imposes on FRD, the Borrower and its subsidiaries certain financial tests and minimum ratios which, among other things, require that Borrower (a) shall not permit the ratio determined on the last day of each fiscal quarter for such quarter and the three preceding quarters ("Rolling Period") then ended of Consolidated Adjusted EBITDA (as defined therein) to Consolidated Interest Expense (as defined therein) to be less than levels increasing from 1.50:1.00 on September 26, 1996 to 2.10:1.00 on September 23, 1999 and each fiscal quarter end thereafter; (b) permit the ratio determined on the last day of each fiscal quarter for the Rolling Period then ended of Consolidated Total Debt (as defined therein) to Consolidated Adjusted EBITDA (as defined) to exceed a level varying from 5.65:1.00 on September 26, 1996 to 3.65:1.00 on September 23, 1999 and each fiscal quarter end thereafter; and (c) shall not permit Consolidated Adjusted EBITDA determined on the last day of each fiscal quarter for the Rolling Period then ended to be less than an amount increasing from $11.2 million for the Rolling Period ending September 26, 1996 to $49.5 million for the Rolling Period ending June 25, 1998 and each Rolling Period thereafter. FRD and all of the Borrower's subsidiaries have guaranteed the obligations of the Borrower under the FRI-M Credit Facility and the other Loan Documents (as defined therein). All of the issued and outstanding common stock of the Borrower and its subsidiaries has been pledged as security for the obligations of FRD under the FRI-M Credit Facility and the other Loan Documents. The obligations of the Borrower under the FRI-M Credit Facility and the other Loan Documents are secured by substantially all assets of the Borrower and its subsidiaries. THE FRD SENIOR NOTES In connection with the May 23, 1996 acquisition of FRI-M, FRD issued $156.9 million principal amount of 12 1/2% FRD Senior Notes due 2004 (the "FRD Notes"). Interest on the FRD Notes accrues at the rate of 12 1/2% per annum and is payable semi-annually in arrears on January 15 and July 15, commencing on July 15, 1996. They will mature on July 15, 2004. The FRD Notes are senior unsecured, general obligations of FRD and rank senior in right of payment to all existing and future subordinated indebtedness of FRD and rank PARI PASSU in right of payment with all existing and future unsubordinated indebtedness of FRD. The FRD Notes are effectively subordinated to secured indebtedness of FRD, including borrowings under the FRI-M Credit Facility to the extent of the value of FRD's assets securing such indebtedness. Borrowings under the FRI-M Credit Facility are secured by substantially all of FRD's assets (The FRD Notes are structurally subordinated to all indebtedness of the Borrower (as defined above), including its indebtedness under the FRI-M Credit Facility). 32 PART IV ITEM 14. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a)(1) -- Financial Statements: See the Index to Financial Statements which appears on page F-1 hereof. (2) -- Financial Statement Schedules: No schedules are filed herewith because of the absence of conditions under which they are required or because the information called for is in the Consolidated Financial Statements or Notes thereto. (3) -- Exhibits: Certain of the exhibits to this Report, indicated by an asterisk, are hereby incorporated by reference to other documents on file with the Commission with which they are physically filed, to be a part hereof as of their respective dates.
EXHIBIT NO. DESCRIPTION * 3.1 Restated Certificate of Incorporation of FCI and amendment thereto dated November 16, 1992 (incorporated by reference to Exhibit 3.1 to FCI's 1992 Form 10-K, File No. 0-18051 (the "1992 Form 10-K")). * 3.2 Certificate of Designations for the $2.25 Series A Cumulative Convertible Exchangeable Preferred Stock of FCI (incorporated by reference to Exhibit 3.2 to the 1992 Form 10-K). * 3.3 Certificate of Ownership and Merger of FCI dated June 16, 1993 (incorporated by reference to Exhibit 3.3 to FCI's 1993 Form 10-K, File No. 0-18051 (the "1993 Form 10-K")). * 3.4 Certificate of Amendment to the Restated Certificate of Incorporation of FCI dated June 16, 1993 (incorporated by reference to Exhibit 3.4 to the 1993 Form 10-K). 3.5 By-Laws of FCI as amended through July 24, 1996. * 4.1 Specimen certificate of Common Stock of FCI (incorporated by reference to Exhibit 4.5 to the Registration Statement on Form S-1 (No. 33-29769) of FCI (the "Form S-1")). * 4.2 Specimen certificate of $2.25 Series A Cumulative Convertible Exchangeable Preferred Stock of FCI (incorporated by reference to Exhibit 4.25 to the Registration Statement on Form S-1 (No. 33-47339) of FCI (the "Preferred Stock S-1")). * 4.3 Indenture between Flagstar and United States Trust Company of New York, as Trustee, relating to the 10% Debentures (including the form of security) (incorporated by reference to Exhibit 4.9 to the Registration Statement on Form S-4 (No. 33-48923) of Flagstar (the "11.25% Debentures S-4")). * 4.4 Supplemental Indenture, dated as of August 7, 1992, between Flagstar and United States Trust Company of New York, as Trustee, relating to the 10% Debentures (incorporated by reference to Exhibit 4.9A to the 11.25% Debentures S-4). * 4.5 Indenture of Mortgage, Deed of Trust, Security Agreement, Financing Statement, Fixture Filing, and Assignment of Leases and Rents, from Denny's Realty, Inc. to State Street Bank and Trust Company, dated July 12, 1990 (incorporated by reference to Exhibit 4.9 to Post-effective Amendment No. 1 to the Registration Statement on Form S-1 (No. 33-29769) of FCI (the "Form S-1 Amendment")). * 4.6 Lease between Denny's Realty, Inc. and Denny's, Inc., dated as of December 29, 1989, as amended and restated as of July 12, 1990 (incorporated by reference to Exhibit 4.10 to the Form S-1 Amendment). * 4.7 Indenture dated as of July 12, 1990 between Denny's Realty, Inc. and State Street Bank and Trust Company relating to certain mortgage notes (incorporated by reference to Exhibit 4.11 to the Form S-1 Amendment). * 4.8 Mortgage Note in the amount of $10,000,000 of Denny's Realty, Inc., dated as of July 12, 1990 (incorporated by reference to Exhibit 4.15 to the 11.25% Debentures S-4). * 4.9 Mortgage Note in the amount of $52,000,000 of Denny's Realty, Inc., dated as of July 12, 1990 (incorporated by reference to Exhibit 4.16 to the 11.25% Debentures S-4). * 4.10 Mortgage Note in the amount of $98,000,000 of Denny's Realty, Inc., dated as of July 12, 1990 (incorporated by reference to Exhibit 4.17 to the 11.25% Debentures S-4). * 4.11 Indenture between Secured Restaurants Trust and The Citizens and Southern National Bank of South Carolina, dated as of November 1, 1990, relating to certain Secured Bonds (incorporated by reference to Exhibit 4.18 to the 11.25% Debentures S-4). * 4.12 Amended and Restated Trust Agreement between Spartan Holdings, Inc., as Depositor for Secured Restaurants Trust, and Wilmington Trust Company, dated as of October 15, 1990 (incorporated by reference to Exhibit 3.3 to the Registration Statement on Form S-11 (No. 33-36345) of Secured Restaurants Trust (the "Form S-11")).
33
EXHIBIT NO. DESCRIPTION * 4.13 Indenture between Flagstar and First Trust National Association, as Trustee, relating to the 10 7/8% Notes (incorporated by reference to Exhibit 4.13 to the 1992 Form 10-K). * 4.14 Supplemental Indenture between Flagstar and First Trust National Association, as Trustee, relating to the 10 7/8% Notes (incorporated by reference to Exhibit 4.14 to the 1992 Form 10-K). * 4.15 Form of 10 7/8% Note (incorporated by reference to Exhibit 4.15 to the 1992 Form 10-K). * 4.16 Indenture between Flagstar and NationsBank of Georgia, National Association, as Trustee, relating to the 11.25% Debentures (incorporated by reference to Exhibit 4.16 to the 1992 Form 10-K). * 4.17 Form of 11.25% Debenture (incorporated by reference to Exhibit 4.17 to the 1992 Form 10-K). * 4.18 Second Amended and Restated Credit Agreement, dated as of April 10, 1996 among TWS Funding, Inc., as borrower, Flagstar Corporation, certain lenders and co-agents named therein, and Citibanks, N.A., as funding agent (incorporated by reference to Exhibit 10.2 to FCI's Quarterly Report on Form 10-Q for the quarter ended June 30, 1996 (the "1996 Second Quarter 10-Q"). * 4.19 Amendment and Consent to the Second Amended and Restated Credit Agreement dated as of July 18, 1996 among TWS Funding, Inc., as borrower, Flagstar Corporation, certain lenders and co-agents named therein, and Citibank, N.A., as funding agents. (incorporated by reference to Exhibit 10.2.1 to FCI's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 (the "1996 Third Quarter 10-Q"). * 4.20 Second Amendment to the Second Amended and Restated Credit Agreement, dated as of August 6, 1996 (incorporated by reference to Exhibit 10.2.2 to the 1996 Third Quarter 10-Q). * 4.21 Third Amendment and Consent to the Second Amended and Restated Credit Agreement, dated as of September 30, 1996 (incorporated by reference to Exhibit 10.2.3 to the 1996 Third Quarter 10-Q). * 4.22 Credit Agreement, dated as of May 23, 1996, among FRD, FRI-M, certain lenders and co-agents named therein, and Credit Lyonnais New York Branch as administrative agent (the "FRI-M Credit Agreement") (incorporated by reference to Exhibit 10.1 of the Registration Statement on Forms S-1 and S-4 (333-07601) of FRD (the "FRD Form S-1/S-4"). * 4.23 First Amendment to the FRI-M Credit Agreement, dated July 1, 1996 (incorporated by reference to Exhibit 10.3.1 to the 1996 Third Quarter 10-Q). 4.24 Second Amendment to the FRI-M Credit Agreement, dated November 19, 1996. * 4.25 Indenture dated as of May 23, 1996 between FRD and the Bank of New York, as Trustee (the "FRD Indenture") (incorporated by reference to Exhibit 4.1 to the FRD Form S-1/S-4). * 4.26 Form of First Supplemental Indenture to the FRD Indenture dated as of August 23, 1996 (incorporated by reference to Exhibit 4.1.1 to the FRD Form S-1/S-4). * 4.27 Stock Purchase Agreement dated as of March 1, 1996 by and among Flagstar, Flagstar Companies, Inc., the Company, and Family Restaurants, Inc. (incorporated by reference to Exhibit 4.2 to the FRD Form S-1/S-4). * 4.28 Indenture between Flagstar and First Trust National Association, as Trustee, relating to the 10 3/4% Notes (incorporated by reference to Exhibit 4.23 to the 1993 Form 10-K). * 4.29 Form of 10 3/4% Note (incorporated by reference to Exhibit 4.24 to the 1993 Form 10-K). * 4.30 Indenture between Flagstar and NationsBank of Georgia, National Association, as Trustee, relating to the 11 3/8% Debentures (incorporated by reference to Exhibit 4.25 to the 1993 Form 10-K). * 4.31 Form of 11 3/8% Debenture (incorporated by reference to Exhibit 4.26 to the 1993 Form 10-K). *10.1 Warrant Agreement, dated November 16, 1992, among FCI, TW Associates and KKR Partners II (incorporated by reference to Exhibit 10.41 to the 1992 Form 10-K). *10.2 Consent Order dated March 26, 1993 between the U.S. Department of Justice, Flagstar and Denny's, Inc. (incorporated by reference to Exhibit 10.42 to the Registration Statement on Form S-2 (No. 33-49843) of Flagstar (the "Form S-2")). *10.3 Fair Share Agreement dated July 1, 1993 between FCI and the NAACP (incorporated by reference to Exhibit 10.43 to the Form S-2). *10.4 Amendment No. 2 to Stockholders' Agreement, dated as of April 6, 1993, among FCI, Gollust Tierney & Oliver ("GTO") and certain affiliated partnerships, DLJ Capital, Jerome J. Richardson and Associates (incorporated by reference to Exhibit 10 to Flagstar's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993, File No. 1-9364). *10.5 Amendment (No. 3) to Stockholders' Agreement, dated as of January 1, 1995, among FCI, GTO and certain affiliated partnerships, DLJ Capital, Jerome J. Richardson and Associates (incorporated by reference to Exhibit 10.6 to the 1994 Form 10-K). *10.6 Form of Agreement providing certain supplemental retirement benefits (incorporated by reference to Exhibit 10.7 to the 1992 Form 10-K).
34
EXHIBIT NO. DESCRIPTION *10.7 Form of Supplemental Executive Retirement Plan Trust of Flagstar (incorporated by reference to Exhibit 10.8 to the 1992 Form 10-K). 10.8 FCI 1989 Non-Qualified Stock Option Plan, as adopted December 1, 1989 and amended through December 13, 1996. *10.9 FCI 1990 Non-Qualified Stock Option Plan, as adopted July 31, 1990 and amended through April 28, 1992 (incorporated by reference to Exhibit 10.10 to the 1994 Form 10-K). *10.10 Form of Non-Qualified Stock Option Award Agreement pursuant to FCI 1990 Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10.10 to the Form S-1 Amendment). *10.11 Form of Mortgage related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.1 to the Form S-11). *10.12 Mortgage Note in the amount of $521,993,982, made by Flagstar Enterprises, Inc. in favor of Spartan Holdings, Inc., dated as of February 1, 1990, as amended and restated November 15, 1990 (incorporated by reference to Exhibit 10.12 to the 11.25% Debentures S-4). *10.13 Mortgage Note in the amount of $210,077,402, made by Quincy's Restaurants, Inc. in favor of Spartan Holdings, Inc., dated as of February 1, 1990, as amended and restated November 15, 1990 (incorporated by reference to Exhibit 10.13 to the 11.25% Debentures S-4). *10.14 Loan Agreement between Secured Restaurants Trust and Spardee's Realty, Inc., dated as of November 1, 1990 (incorporated by reference to Exhibit 10.14 to the 11.25% Debentures S-4). *10.15 Loan Agreement between Secured Restaurants Trust and Quincy's Realty, Inc., dated as of November 1, 1990 (incorporated by reference to Exhibit 10.15 to the 11.25% Debentures S-4). *10.16 Insurance and Indemnity Agreement, dated as of November 1, 1990, related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.16 to the 11.25% Debentures S-4). *10.17 Intercreditor Agreement, dated as of November 1, 1990, related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.17 to the 11.25% Debentures S-4). *10.18 Bank Intercreditor Agreement, dated as of November 1, 1990, related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.18 to the 11.25% Debentures S-4). *10.19 Indemnification Agreement, dated as of November 1, 1990, related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.19 to the 11.25% Debentures S-4). *10.20 Liquidity Agreement, dated as of November 1, 1990, related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.20 to the 11.25% Debentures S-4). *10.21 Financial Guaranty Insurance Policy, issued November 15, 1990, related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.21 to the 11.25% Debentures S-4). *10.22 Amended and Restated Lease between Quincy's Realty, Inc. and Quincy's Restaurants, Inc., dated as of November 1, 1990 (incorporated by reference to Exhibit 10.22 to the 11.25% Debentures S-4). *10.23 Amended and Restated Lease between Spardee's Realty, Inc. and Spardee's Restaurants, Inc., dated as of November 1, 1990 (incorporated by reference to Exhibit 10.23 to the 11.25% Debentures S-4). *10.24 Collateral Assignment Agreement, dated as of November 1, 1990, related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.24 to the 11.25% Debentures S-4). *10.25 Form of Assignment of Leases and Rents related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.12 to the Form S-11). *10.26 Spartan Guaranty, dated as of November 1, 1990, related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.26 to the 11.25% Debentures S-4). *10.27 Form of Hardee's License Agreement related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.14 to the Form S-11). *10.28 Stock Pledge Agreement among Flagstar Enterprises, Inc. and Secured Restaurants Trust, dated as of November 1, 1990 (incorporated by reference to Exhibit 10.28 to the 11.25% Debentures S-4). *10.29 Stock Pledge Agreement among Quincy's Restaurants, Inc. and Secured Restaurants Trust, dated as of November 1, 1990 (incorporated by reference to Exhibit 10.29 to the 11.25% Debentures S-4). *10.30 Management Agreement, dated as of November 1, 1990, related to the Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.30 to the 11.25% Debentures S-4). *10.31 Form of Collateral Assignment of Security Documents related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.17 to the Form S-11). *10.32 Flagstar Indemnity Agreement, dated as of November 1, 1990, related to Secured Restaurants Trust transaction (incorporated by reference to Exhibit 10.32 to the 11.25% Debentures S-4). *10.33 Subordinated Promissory Note, dated July 28, 1992, from Flagstar to FCI (incorporated by reference to Exhibit 10.33 to the 11.25% Debentures S-4). *10.34 Development Agreement between the Company and Hardee's Food Systems, Inc., dated January 1992 (incorporated by reference to Exhibit 10.33 to the Preferred Stock S-1).
35
EXHIBIT NO. DESCRIPTION *10.35 Stock and Warrant Purchase Agreement, dated as of August 11, 1992, between FCI and TW Associates (incorporated by reference to Exhibit 10.38 to the 11.25% Debentures S-4). *10.36 Stockholders' Agreement, dated as of August 11, 1992, among FCI, GTO (on behalf of itself and certain affiliated partnerships), DLJ Capital, Jerome J. Richardson and TW Associates (incorporated by reference to Exhibit 10.39 to the 11.25% Debentures S-4). *10.37 Technical Amendment to the Stockholders' Agreement dated as of September 30, 1992, among FCI, GTO and certain affiliated partnerships, DLJ Capital, Jerome J. Richardson and TW Associates (incorporated by reference to Exhibit 10.39A to the 11.25% Debentures S-4). *10.38 Richardson Shareholder Agreement, dated as of August 11, 1992, between FCI and Jerome J. Richardson (incorporated by reference to Exhibit 10.40 to the 11.25% Debentures S-4). *10.39 Employment Agreement, dated as of August 11, 1992, between Flagstar and Jerome J. Richardson (incorporated by reference to Exhibit 10.41 to the 11.25% Debentures S-4). *10.40 Amended and Restated Employment Agreement, dated as of January 1, 1996, between Flagstar and Jerome J. Richardson (incorporated by reference to Exhibit 10.41 to FCI's 1995 Form 10-K, File No. 0-18051). *10.41 Employment Agreement, dated as of January 10, 1995, between FCI and James B. Adamson (incorporated by reference to Exhibit 10.42 to the 1994 Form 10-K). *10.42 Adamson Shareholder Agreement, dated as of January 10, 1995, between Associates and James B. Adamson (incorporated by reference to Exhibit 10.43 to the 1994 Form 10-K.) *10.43 Amendment to Employment Agreement, dated as of February 27, 1995, between FCI and James B. Adamson (incorporated by reference to Exhibit 10.44 to the 1994 Form 10-K). *10.44 Form of Agreement providing certain severance benefits (incorporated by reference to Exhibit 10.48 to the 1994 Form 10-K) *10.45 Amended Consent Decree dated May 24, 1994 (incorporated by reference to Exhibit 10.50 to the 1994 Form 10-K). *10.46 Consent Decree dated May 24, 1994 among certain named claimants, individually and on behalf of all others similarly situated, Flagstar and Denny's, Inc. (incorporated by reference to Exhbit 10.51 to the 1994 Form 10-K). 10.47 Second Amendment to Employment Agreement, dated December 31, 1996, between FCI and James B. Adamson. 10.48 Form of Agreement providing certain retention incentives, severance and change of control benefits for Company management. 10.49 Information Systems Management Agreement, dated February 22, 1996 between Flagstar and Integrated Systems Solutions Corporation. 10.50 Employment Agreement, dated as of April 24, 1995, between Flagstar and C. Robert Campbell. 10.51 Employment Agreement, dated as of April 22, 1996, between Flagstar and Craig S. Bushey. 10.52 Employment Agreement, dated as of November 21, 1995, between Flagstar and John A. Romandetti. 10.53 Employment Agreement, dated as of May 24, 1996, between Flagstar and Mark L. Shipman. 11 Computation of Earnings (Loss) Per Share. 12 Computation of Ratio of Earnings to Fixed Charges. 21 Subsidiaries of Flagstar. 23 Consent of Deloitte & Touche LLP. 27 Financial Data Schedule. 99 Safe Harbor Under the Private Securities Litigation Reform Act of 1995.
* Certain of the exhibits to this Annual Report on Form 10-K, indicated by an asterisk, are hereby incorporated by reference to other documents on file with the Commission with which they are physically filed, to be part hereof as of their respective dates. (b) The Company filed a report on Form 8-K on December 23, 1996 providing certain information in Item 8. Change in Fiscal Year of such report. That filing reported a resolution adopted by the Company's Board of Directors to change its fiscal year. Beginning in 1997, the Registrant will move to a 4-4-5 week closing calendar pursuant to which each fiscal year shall end on the last Wednesday of the calendar year. No financial statements were included in the filing. 36 FLAGSTAR COMPANIES, INC. INDEX TO FINANCIAL STATEMENTS
PAGE Independent Auditors' Report........................................................................................... F-2 Statements of Consolidated Operations for the Three Years Ended December 31, 1994, 1995 and 1996....................... F-3 Consolidated Balance Sheets as of December 31, 1995 and 1996........................................................... F-4 Statements of Consolidated Cash Flows for the Three Years Ended December 31, 1994, 1995 and 1996....................... F-5 Notes to Consolidated Financial Statements............................................................................. F-7
F-1 INDEPENDENT AUDITORS' REPORT FLAGSTAR COMPANIES, INC. We have audited the accompanying consolidated balance sheets of Flagstar Companies, Inc. and subsidiaries (the Company) as of December 31, 1995 and 1996, and the related statements of consolidated operations and consolidated cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 1995 and 1996 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, in 1995 the Company changed its method of accounting for the impairment of long-lived assets. DELOITTE & TOUCHE LLP Greenville, South Carolina February 13, 1997 F-2 FLAGSTAR COMPANIES, INC. STATEMENTS OF CONSOLIDATED OPERATIONS
YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 1994 1995 1996 ($ IN THOUSANDS EXCEPT PER SHARE AMOUNTS) Operating revenue.............................................................. $2,665,966 $2,571,487 $2,542,302 Operating expenses: Product cost................................................................. 919,087 864,505 744,072 Payroll & benefits........................................................... 919,928 916,951 945,772 Depreciation & amortization expense.......................................... 129,633 132,872 129,948 Utilities expenses........................................................... 99,021 98,212 104,477 Other........................................................................ 394,012 393,482 461,641 Provision for (recovery of) restructuring charges (Note 3)................... (7,207) 15,873 -- Charge for impaired assets (Note 3).......................................... -- 51,358 -- 2,454,474 2,473,253 2,385,910 Operating income............................................................... 211,492 98,234 156,392 Other charges (credits): Interest and debt expense (Note 4)........................................... 232,515 232,874 261,633 Interest income (Note 12).................................................... (5,077) (3,725) (6,926) Other -- net (Note 12)....................................................... 3,087 2,005 3,537 230,525 231,154 258,244 Loss before income taxes....................................................... (19,033) (132,920) (101,852) Benefit from income taxes (Note 6)............................................. (2,213) (14) (16,392) Loss from continuing operations................................................ (16,820) (132,906) (85,460) Gain on sale of discontinued operation, net of income tax provision of: 1994 -- $9,999; 1995 -- $10,092 (Note 13)............................................ 399,188 77,877 -- Loss from discontinued operations, net of income tax provision (benefit) of: 1994 -- $471; 1995 -- $(1,361) (Note 13)..................................... (6,518) (636) -- Income (loss) before extraordinary items....................................... 375,850 (55,665) (85,460) Extraordinary items, net of income tax provision (benefit) of: 1994 -- $(174); 1995 -- $25 (Note 11)........................................................ (11,757) 466 -- Net income (loss).............................................................. 364,093 (55,199) (85,460) Dividends on preferred stock................................................... (14,175) (14,175) (14,175) Net income (loss) applicable to common shareholders............................ $ 349,918 $ (69,374) $ (99,635) Per share amounts applicable to common shareholders (Note 10): Primary Loss from continuing operations.............................................. $ (0.14) $ (3.47) $ (2.35) Income from discontinued operations, net..................................... 7.52 1.82 -- Income (loss) before extraordinary items..................................... 7.38 (1.65) (2.35) Extraordinary items, net..................................................... (0.22) 0.01 -- Net income (loss)............................................................ $ 7.16 $ (1.64) $ (2.35) Average outstanding and equivalent common shares............................. 52,223 42,431 42,434 Fully diluted Income (loss) from continuing operations..................................... $ 0.26 $ (3.47) $ (2.35) Income from discontinued operations, net..................................... 6.05 1.82 -- Income (loss) before extraordinary items..................................... 6.31 (1.65) (2.35) Extraordinary items, net..................................................... (0.18) 0.01 -- Net income (loss)............................................................ $ 6.13 $ (1.64) $ (2.35) Average outstanding and equivalent shares.................................... 64,921 42,431 42,434
See notes to consolidated financial statements. F-3 FLAGSTAR COMPANIES, INC. CONSOLIDATED BALANCE SHEETS
DECEMBER 31, DECEMBER 31, 1995 1996 ($ IN THOUSANDS) ASSETS Current Assets: Cash and cash equivalents...................................................................... $ 196,966 $ 92,369 Receivables, less allowance for doubtful accounts of: 1995 -- $2,506; 1996 -- $2,405............................................................................... 29,844 17,812 Loan receivable from former officer (Note 12).................................................. -- 13,922 Merchandise and supply inventories............................................................. 32,445 31,543 Net assets held for sale....................................................................... -- 5,114 Other.......................................................................................... 26,087 29,895 285,342 190,655 Property: Property owned (at cost) (Notes 2, 3 and 4): Land......................................................................................... 255,719 253,067 Buildings and improvements................................................................... 838,956 891,512 Other property and equipment................................................................. 484,684 536,886 Total property owned............................................................................. 1,579,359 1,681,465 Less accumulated depreciation.................................................................... 569,079 629,676 Property owned -- net............................................................................ 1,010,280 1,051,789 Buildings and improvements, vehicles, and other equipment held under capital leases (Note 5)..... 170,859 210,533 Less accumulated amortization.................................................................... 76,778 93,740 Property held under capital leases -- net........................................................ 94,081 116,793 1,104,361 1,168,582 Other Assets: Goodwill net of accumulated amortization of: 1996 -- $3,077 (Note 2)........................... -- 205,389 Other intangible assets, net of accumulated amortization: 1995 -- $17,051; 1996 -- $20,611..................................................................... 22,380 27,595 Deferred financing costs -- net (Note 11)...................................................... 63,482 64,153 Other (including loan receivable from former officer of: 1995 -- $16,454) (Note 12)............ 32,186 30,996 118,048 328,133 $ 1,507,751 $ 1,687,370 LIABILITIES Current Liabilities: Current maturities of long-term debt (Note 4).................................................. $ 38,835 $ 62,890 Accounts payable............................................................................... 125,467 160,444 Accrued salaries and vacations................................................................. 41,102 58,838 Accrued insurance.............................................................................. 48,060 52,244 Accrued taxes.................................................................................. 30,705 25,060 Accrued interest and dividends................................................................. 42,916 47,676 Other.......................................................................................... 80,445 76,123 407,530 483,275 Long-Term Liabilities: Debt, less current maturities (Note 4)......................................................... 1,996,111 2,179,393 Deferred income taxes (Note 6)................................................................. 18,175 16,361 Liability for self-insured claims.............................................................. 53,709 57,665 Other non-current liabilities and deferred credits............................................. 163,203 178,203 2,231,198 2,431,622 Commitments and Contingencies (Notes 4, 5 and 8) Shareholders' Equity (Deficit) (Notes 7 and 9): $2.25 Series A Cumulative Convertible Exchangeable Preferred Stock: $0.10 par value; 1995 and 1996, 25,000 shares authorized; 6,300 shares issued and outstanding; liquidation preference $157,500, excluding dividends in arrears................ 630 630 Common stock: $0.50 par value; shares authorized -- 200,000; issued and outstanding 1995 -- 42,434 1996 -- 42,434............................................................................. 21,218 21,218 Paid-in capital................................................................................ 724,912 724,912 Deficit........................................................................................ (1,877,274 ) (1,973,365 ) Minimum pension liability adjustment........................................................... (463 ) (922 ) (1,130,977 ) (1,227,527 ) $ 1,507,751 $ 1,687,370
See notes to consolidated financial statements. F-4 FLAGSTAR COMPANIES, INC. STATEMENTS OF CONSOLIDATED CASH FLOWS
YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 1994 1995 1996 ($ IN THOUSANDS) Cash Flows from Operating Activities: Net income (loss)........................................................... $ 364,093 $ (55,199 ) $ (85,460) Adjustments to Reconcile Net Income (Loss) to Cash Flows from Operating Activities: Provision for (recovery of) restructuring charges........................ (7,207 ) 15,873 -- Charge for impaired assets............................................... -- 51,358 -- Depreciation and amortization of property................................ 122,870 126,488 120,059 Amortization of goodwill................................................. -- -- 3,077 Amortization of other intangible assets.................................. 6,763 6,384 6,812 Amortization of deferred financing costs................................. 6,453 7,504 8,920 Deferred income tax benefit.............................................. (2,793 ) (3,451 ) (9,031) Other.................................................................... (7,363 ) (20,028 ) (19,004) Loss from discontinued operations, net................................... 6,518 636 -- Gain on sale of discontinued operation, net.............................. (399,188 ) (77,877 ) -- Extraordinary items, net................................................. 11,757 (466 ) -- Changes in Assets and Liabilities Net of Effects of Acquisition, Dispositions and Restructurings: Decrease (increase) in assets: Receivables.............................................................. (4,452 ) (4,713 ) 327 Inventories.............................................................. 340 (848 ) (833) Other current assets..................................................... (11,849 ) (7,086 ) (3,964) Other assets............................................................. 2,241 (2,622 ) (5,456) Increase (decrease) in liabilities: Accounts payable......................................................... 9,029 16,496 19,132 Accrued salaries and vacations........................................... 8,821 (5,551 ) 4,560 Accrued taxes............................................................ (9,582 ) (429 ) (5,502) Other accrued liabilities................................................ (16,696 ) (4,014 ) (6,283) Other noncurrent liabilities and deferred credits........................ (25,198 ) (28,364 ) (10,628) Net cash flows from operating activities...................................... 54,557 14,091 16,726 Cash Flows from Investing Activities: Purchase of property........................................................ (154,480 ) (123,739 ) (55,026) Proceeds from dispositions of property...................................... 20,135 25,693 14,323 Advances to discontinued operations, net.................................... (9,670 ) (6,952 ) -- Proceeds from sale of discontinued operations............................... 447,073 172,080 -- Proceeds from sales of subsidiaries......................................... -- 122,500 62,992 Acquisition of business, net of cash acquired............................... -- -- (127,068) Other long-term assets, net................................................. (6,205 ) (3,217 ) (4,670) Net cash flows provided by (used in) investing activities..................... 296,853 186,365 (109,449)
See notes to consolidated financial statements. F-5 FLAGSTAR COMPANIES, INC. STATEMENTS OF CONSOLIDATED CASH FLOWS (CONTINUED)
YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 1994 1995 1996 ($ IN THOUSANDS) Cash Flows from Financing Activities: Net borrowings (repayments) under credit agreements......................... $ (93,000 ) $ -- $ 56,000 Deferred financing costs.................................................... (25 ) -- (9,591) Long-term debt payments..................................................... (201,664 ) (56,035) (44,108) Cash dividends on preferred stock........................................... (14,175 ) (14,175) (14,175) Net cash flows used in financing activities................................. (308,864 ) (70,210) (11,874) Increase (decrease) in cash and cash equivalents............................ 42,546 130,246 (104,597) Cash and Cash Equivalents at: Beginning of period......................................................... 24,174 66,720 196,966 End of period............................................................... $ 66,720 $196,966 $ 92,369 Supplemental Cash Flow Information: Income taxes paid........................................................... $ 8,035 $ 3,591 $ 2,196 Interest paid............................................................... $ 244,478 $238,832 $239,284 Non-cash financing activities: Capital lease obligations................................................ $ 18,800 $ 5,505 $ 12,310 Dividends declared but not paid.......................................... $ 3,544 $ 3,544 $ -- Non Cash investing activities: Other investing.......................................................... $ -- $ 8,185 $ --
See notes to consolidated financial statements. F-6 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS INTRODUCTION Flagstar Companies, Inc. (Company) was incorporated under the laws of the State of Delaware on September 24, 1988 to effect the acquisition of Flagstar Corporation (Flagstar). Prior to June 16, 1993 the Company and Flagstar had been known, respectively, as TW Holdings, Inc. and TW Services, Inc. Flagstar, through its wholly-owned subsidiaries, Denny's Holdings, Inc., Spartan Holdings, Inc. and FRD Acquisition Co. (and their respective subsidiaries), owns and operates the Denny's, El Pollo Loco, Quincy's Family Steakhouse, Coco's and Carrows restaurant brands and is the largest franchisee of Hardee's. Denny's, a family-style restaurant chain, operates in forty-nine states, two U.S. territories, and six foreign countries, with principal concentrations in California, Florida, Texas, Washington, Arizona, Pennsylvania, Illinois, and Ohio. Hardee's competes in the quick-service hamburger category and Quincy's operates in the family-steak restaurant category. The Company's Hardee's and Quincy's restaurant chains are located primarily in the southeastern United States; El Pollo Loco is a quick-service flame-broiled chicken concept which operates primarily in southern California. Coco's and Carrows restaurant chains, acquired by Flagstar in May 1996, compete in the family-style category and are located primarily in the western United States. NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Accounting policies and methods of their application that significantly affect the determination of financial position, cash flows and results of operations are as follows: (a) CONSOLIDATED FINANCIAL STATEMENTS. The Consolidated Financial Statements include the accounts of the Company, and its subsidiaries. Certain prior year amounts have been reclassified to conform to the 1996 presentation. (b) FINANCIAL STATEMENT ESTIMATES. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the period reported. Actual results could differ from those estimates. (c) CASH AND CASH EQUIVALENTS. The Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents. (d) INVENTORIES. Merchandise and supply inventories are valued primarily at the lower of average cost or market. (e) PROPERTY AND DEPRECIATION. Owned property is stated at cost and is depreciated on the straight-line method over its estimated useful life. Property held under capital leases (at capitalized value) is amortized over its estimated useful life, limited generally by the lease period. The following estimated useful service lives were in effect during all periods presented in the financial statements: Merchandising equipment -- Principally five to ten years Buildings -- Fifteen to forty years Other equipment -- Two to ten years Leasehold improvements -- Estimated useful life limited by the lease period. (f) GOODWILL AND OTHER INTANGIBLE ASSETS. The excess of cost over the fair value of the net assets acquired of FRI-M Corporation (see Note 2 for further details) is being amortized over a 40-year period on the straight-line method. Other intangible assets consist primarily of costs allocated to tradenames, franchise and other operating agreements. Such assets are being amortized on the straight-line basis over the useful lives of the franchise or the contract period of the operating agreements. The Company assesses the recoverability of goodwill and other intangible assets by projecting future net income related to the acquired business, before the effect of amortization of intangible assets, over the remaining amortization period of such assets. (g) IMPAIRMENT OF LONG-LIVED ASSETS. During 1995, the Company adopted the provisions of Statement of Financial Accounting Standards No. 121 (SFAS No. 121) "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of ". Pursuant to this statement, the Company reviews long-lived assets and F-7 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued certain identifiable intangibles to be held and used for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. In addition, long-lived assets and certain identifiable intangibles to be disposed of are reported at the lower of carrying amount or estimated fair value less costs to sell. See Note 3 for further discussion of the impairment of long-lived assets. (h) DEFERRED FINANCING COSTS. Costs related to the issuance of debt are deferred and amortized as a component of interest and debt expense over the terms of the respective debt issues using the interest method. (i) PREOPENING COSTS. The Company capitalizes certain direct incremental costs incurred in conjunction with the opening of restaurants and amortizes such costs over a twelve month period from the date of opening. (j) INCOME TAXES. Income taxes are accounted for under the provisions of Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes." (k) INSURANCE. The Company is primarily self insured for workers compensation, general liability, and automobile risks which are supplemented by stop loss type insurance policies. The liabilities for estimated incurred losses are discounted to their present value based on expected loss payment patterns determined by independent actuaries or experience. The total discounted self-insurance liabilities recorded at December 31, 1995 and 1996 were $91.0 million and $100.1 million respectively, reflecting a 4% discount rate. The related undiscounted amounts at such dates were $98.0 million and $111.1 million, respectively. (l) INTEREST RATE EXCHANGE AGREEMENTS. As a hedge against fluctuations in interest rates, the Company has entered into interest rate exchange agreements to swap a portion of its fixed rate interest payment obligations for floating rates without the exchange of the underlying principal amounts. The Company does not speculate on the future direction of interest rates nor does the Company use these derivative financial instruments for trading purposes. Since such agreements are not entered into on a speculative basis, the Company uses the settlement basis of accounting. See Note 4 for further discussion of the interest rate exchange agreements. (m) ADVERTISING COSTS. Production costs for radio and television advertising are expensed as of the date the commercials are initially aired. Advertising expense for the years ended December 31, 1994, 1995 and 1996 was $85.8 million, $93.0 million, and $114.3 million, respectively. (n) DISCONTINUED OPERATIONS. The Company has allocated to discontinued operations a pro-rata portion of interest and debt expense related to its acquisition debt based on a ratio of the net assets of its discontinued operations to its total consolidated net assets as of the 1989 acquisition date. Interest included in discontinued operations for the years ended December 31, 1994 and 1995 was $37.4 million and $18.9 million, respectively. (o) DEFERRED GAINS. In September 1995, the Company sold its distribution subsidiary, Proficient Food Company (PFC), for approximately $122.5 million. In conjunction with the sale, the Company entered into an eight year distribution contract with the acquirer of PFC. This transaction resulted in a deferred gain of approximately $72.0 million that is being amortized over the life of the distribution contract as a reduction of product cost. During the third quarter of 1996, the Company sold Portion-Trol Foods, Inc. and the Mother Butler Pies division of Denny's, its two food processing operations. The sales were finalized in the fourth quarter of 1996 pursuant to the purchase price adjustment provisions of the related agreements. Consideration from the sales totaled approximately $72.1 million, including the receipt of approximately $60.6 million in cash. In conjunction with each of the sales, the Company entered into five year purchasing agreements with the acquirers. These transactions resulted in deferred gains totaling approximately $41.5 million that are being amortized over the lives of the respective purchasing agreements as a reduction of product cost. The portion of the deferred gains recognized as a reduction in product costs in 1995 and 1996 was approximately $2.8 million and $11.1 million, respectively. (p) CASH OVERDRAFTS. The Company has included in accounts payable on the accompanying consolidated balance sheets cash overdrafts totalling $54.4 million and $51.6 million at December 31, 1995 and 1996, respectively. F-8 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- Continued (q) FRANCHISE AND LICENSE FEES. Initial franchise and license fees are recognized when all material services have been performed and conditions have been satisfied. Initial fees for all periods presented are insignificant. Monthly fees are accrued as earned based on the respective monthly sales. Such fees totaled $46.4 million, $59.3 million, and $71.1 million for the years ended December 31, 1994, 1995 and 1996, respectively. NOTE 2 ACQUISITION On May 23, 1996, the Company, through FRD Acquisition Co. ("FRD"), a newly formed subsidiary, consummated the acquisition of the Coco's and Carrows restaurant chains consisting of 347 company-owned units within the family-style category. The acquisition price of $313.4 million plus acquisition costs (which was paid in exchange for all of the outstanding stock of FRI-M Corporation ("FRI-M"), the subsidiary of Family Restaurants Inc. ("FRI") which owns the Coco's and Carrows chains) was financed with $125.0 million in cash ($75.0 million of which was provided from the Company's cash balances and the remaining $50.0 million pursuant to bank term loans which totaled $56.0 million with the remaining $6.0 million being used to pay transaction fees), the issuance of $156.9 million in senior notes of FRD to the seller, including an additional $6.9 million principal amount of notes issued by FRD to FRI pursuant to the purchase price adjustment provisions of the Stock Purchase Agreement on September 4, 1996 and the assumption of certain capital lease obligations of approximately $31.5 million. The acquisition was accounted for using the purchase method of accounting. Accordingly, the assets and liabilities and results of operations of Coco's and Carrows are included in the Company's consolidated financial statements for the period subsequent to the acquisition. In accordance with the purchase method of accounting, the purchase price has been allocated to the underlying assets and liabilities of FRI-M based on their estimated respective fair values at the date of acquisition. The purchase price exceeded the fair value of the net assets acquired by approximately $209 million. The resulting goodwill is being amortized on a straight line basis over 40 years. This amount reflects a decrease from the original estimate of approximately $12 million. The revision, which was recorded during the fourth quarter of 1996, is primarily due to the completion of certain valuations and other studies which were prepared in order to estimate the fair value of the net assets acquired. No further revisions to the purchase price allocation are expected except for the potential impact of adjustments related to deferred income taxes, which are expected to be resolved in early 1997. The following unaudited pro forma financial information shows the results of operations of the Company as though the acquisition occurred as of January 1, 1995. These results include the straight-line amortization of the excess of purchase price over the net assets acquired over a 40-year period, a reduction of overhead expenses due to anticipated cost savings and efficiencies from combining the operations of the Company and FRI-M, an increase in interest expense as a result of the debt issued to finance the acquisition, and a reduction in FRI-M's income tax expense to reflect the fact that the Company's net operating losses will offset FRI-M's separate income tax provision (except for current foreign and state income taxes) when calculated on a consolidated basis.
YEARS ENDED DECEMBER 31, 1995 1996 ($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Revenue............................................................ $3,077.1 $2,738.2 Loss from continuing operations.................................... (126.6) (83.4) Net Loss........................................................... (48.9) (83.4) Loss per common share: Loss from continuing operations.................................. (3.32) (2.30) Net loss......................................................... (1.49) (2.30)
The pro forma financial information presented above does not purport to be indicative of either (i) the results of operations had the acquisition taken place on January 1, 1995 or (ii) future results of operations of the combined businesses. F-9 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 3 RESTRUCTURING AND IMPAIRMENT OF LONG-LIVED ASSETS Effective in the fourth quarter of 1995, as a result of a comprehensive financial and operational review, the Company approved a restructuring plan. The plan generally involved the reduction in personnel and a decision to outsource the Company's information systems function. In addition, the Company adopted SFAS No. 121 during 1995 (see Note 1(g)). In connection with such adoption, 99 restaurant units, which the Company intended to continue to operate were identified as impaired as the future undiscounted cash flows of each of these units was estimated to be insufficient to recover the related carrying value. As such, the carrying values of these units were written down to the Company's estimate of fair value based on sales of similar units or other estimates of selling price. During 1995, the Company also identified 36 underperforming units for sale or closure generally during 1996. The carrying value of these units was written down to estimated fair value, based on sales of similar units or other estimates of selling price, less costs to sell. The 36 units identified in 1995 for disposal had aggregate operating revenues of approximately $26.1 million, an operating loss of approximately $2.9 million during 1995, and an aggregate carrying value of approximately $5.8 million as of December 31, 1995. As of December 31, 1996, 29 units have been closed or sold. Management intends to dispose of two of the remaining units in 1997 and continue to operate the other five. The two units to be disposed of in 1997 had aggregate operating revenues of approximately $1.6 million and operating income of $0.04 million during 1996 and an aggregate carrying amount of $0.3 million at December 31, 1996. Charges attributable to the restructuring plan and the adoption of SFAS No. 121 during the year ended December 31, 1995 are comprised of the following: ($ in thousands) Restructuring: Severance................................................................................ $ 5,376 Write-down of computer hardware and software and other assets............................ 7,617 Other.................................................................................... 2,880 $15,873 Impairment of Long-lived Assets: Write-down attributable to the restaurant units the Company will continue to operate.............................................................. $41,670 Write-down attributable to the restaurant units to be disposed........................... 9,688 $51,358
The 1995 restructuring plan was substantially completed in 1996 except for certain asset replacement projects (where the assets to be replaced were written down as part of the restructuring) which were postponed in 1996 due to the Company's capital constraints. Such projects are expected to be completed in 1997. Pursuant to the restructuring plan, approximately 74 employees, primarily corporate and field management, have been terminated as of December 31, 1996, resulting in payments of approximately $4.5 million as of that date. Effective in the fourth quarter of 1993, the Company approved a restructuring plan, which, among other things, resulted in the identification for sale, conversion to another concept or closure of 240 restaurants. As of December 31, 1996, four units remain relative to the 1993 restructuring plan, of which two are scheduled for disposal in 1997. Management has decided to continue to operate the remaining two units. The two units to be disposed of in 1997 had operating revenues of approximately $1.3 million and operating income of $0.03 million during 1996 and an aggregate carrying amount that was immaterial at December 31, 1996. F-10 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 DEBT At December 31, 1996, the Flagstar Second Amended and Restated Credit Agreement (the "Credit Agreement") includes a working capital and letter of credit facility of up to a total of $150.0 million which includes a working capital advance sublimit of $75.0 million. At such date, the Company had no working capital advances outstanding; however, letters of credit outstanding were $79.7 million. The Credit Agreement terminates on April 10, 1999 and is subject to mandatory prepayments and commitment reductions under certain circumstances upon the Company's sale of assets or incurrence of additional debt. See also the discussion below. Long-term debt consists of the following:
DECEMBER 31, 1995 1996 ($ IN THOUSANDS) Notes and Debentures: 10.75% Senior Notes due September 15, 2001, interest payable semi-annually...................... $ 270,000 $ 270,000 10.875% Senior Notes due December 1, 2002, interest payable semi-annually....................... 280,025 280,025 11.25% Senior Subordinated Debentures due November 1, 2004, interest payable semi-annually................................................................................ 722,411 722,411 11.375% Senior Subordinated Debentures due September 15, 2003, interest payable semi-annually... 125,000 125,000 10% Convertible Junior Subordinated Debentures due 2014 (10% Convertible Debentures), interest payable semi-annually; convertible into Company common stock any time prior to maturity at $24.00 per share............................................................................. 99,259 99,259 12.5% Senior Notes of FRD due July 15, 2004, interest payable semi-annually..................... -- 156,897 Mortgage Notes Payable: 10.25% Guaranteed Secured Bonds due 2000........................................................ 202,715 190,164 11.03% Notes due 2000........................................................................... 160,000 160,000 Term loan of FRI-M, principal payable in quarterly installments................................. -- 56,000 Other notes payable, mature over various terms to 20 years, payable in monthly or quarterly installments with interest rates ranging from 7.5% to 13.25% (a)............................. 17,415 13,561 Capital lease obligations (see Note 5)............................................................ 144,573 160,226 Notes payable secured by equipment, mature over various terms up to 7 years, payable in monthly installments with interest rates ranging from 8.5% to 9.64%(b).................................. 13,548 8,740 Total............................................................................................. 2,034,946 2,242,283 Less current maturities (c)....................................................................... 38,835 62,890 $1,996,111 $2,179,393
(a) Collateralized by restaurant and other properties with a net book value of $20.9 million at December 31, 1996. (b) Collateralized by equipment with a net book value of $13.2 million at December 31, 1996. (c) Aggregate annual maturities during the next five years of long-term debt are as follows ($ in thousands): 1997 -- $62,890; 1998 -- $57,830; 1999 -- $51,169; 2000 -- $326,666; and 2001 -- $280,999. The borrowings under the Credit Agreement are secured by the stock of certain operating subsidiaries and certain of the Company's trade and service marks and are guaranteed by certain operating subsidiaries. Such guarantees are further secured by certain operating subsidiary assets. The Credit Agreement and indentures under which the debt securities have been issued contain a number of restrictive covenants. Such covenants restrict, among other things, the ability of Flagstar and its restricted subsidiaries to incur indebtedness, create liens, engage in business activities which are not in the same field as that in which the Company currently operates, mergers and acquisitions, sales of assets, transactions with affiliates and the payment of dividends. In addition, the Credit Agreement contains financial covenants including provisions for the maintenance of a minimum level of interest coverage (as defined), limitations on ratios of indebtedness (as defined) to earnings before interest, taxes, depreciation and amortization (EBITDA), and limitations on annual capital expenditures. F-11 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 DEBT -- Continued The Company was in compliance with the terms of the Credit Agreement at December 31, 1996. Under the most restrictive provision of the Credit Agreement (ratio of senior debt to EBITDA, as defined), at December 31, 1996, the Company could incur approximately $28.4 million of additional indebtedness. With respect to short-term liquidity, management believes that through a combination of cash generated from operations, funds available through the bank credit facility, various cash management measures and other sources, adequate liquidity exists to meet the Company's working capital, debt service and capital expenditure requirements for at least the next twelve months. Although no assurances can be given in this regard, management believes, based on the Company's historical relationship with its banks, that it will be able, as necessary, to maintain access to funds available under the credit agreement. At December 31, 1996, the 10.25% guaranteed bonds were secured by, among other things, mortgage loans on 386 restaurants, a lien on the related restaurant equipment, assignment of intercompany lease agreements, and the stock of the issuing subsidiaries. At December 31, 1996, the restaurant properties and equipment had a net book value of $317.6 million. In addition, the bonds are insured with a financial guaranty insurance policy written by a company that engages exclusively in such coverage. Principal and interest on the bonds are payable semiannually; certain payments are made by the Company on a monthly basis. Principal payments total $12.5 million annually through 1999 and $152.7 million in 2000. The Company through its operating subsidiaries covenants that it will maintain the properties in good repair and expend annually (or on a five year average basis) to maintain the properties at least $19.3 million in 1997 and increasing each year to $23.7 million in 2000. The 11.03% mortgage notes are secured by a pool of cross collateralized mortgages on 240 restaurants with a net book value at December 31, 1996 of $220.9 million. In addition, the notes are collateralized by, among other things, a security interest in the restaurant equipment, the assignment of intercompany lease agreements and the stock of the issuing subsidiary. Interest on the notes is payable quarterly with the entire principal due at maturity in 2000. The notes are redeemable, in whole, at the issuer's option, upon payment of a premium. The Company through its operating subsidiary covenants that it will use each property as a food service facility, maintain the properties in good repair and expend at least $5.3 million per annum and not less than $33 million, in the aggregate, in any five year period to maintain the properties. In connection with the acquisition by FRD of Coco's and Carrows on May 23, 1996, FRI-M (the "Borrower"), a wholly-owned subsidiary of FRD, obtained a new credit facility (the "FRI-M Credit Facility") consisting of a $56 million, 39-month term loan (the "FRI-M Term Loan") and a $35 million working capital facility (the "FRI-M Revolver"). Proceeds from the FRI-M Term Loan were used to fund the Coco's and Carrows acquisition, and to pay the transactions costs associated therewith. Proceeds from the FRI-M Revolver are to be used for working capital requirements and other general corporate purposes, which may include the making of intercompany loans to any of the Borrower's wholly owned subsidiaries for their own working capital and other general corporate purposes. Letters of credit may be issued under the FRI-M Revolver for the purpose of supporting (i) workers' compensation liabilities of the Borrower or any of its subsidiaries; (ii) the obligations of third party insurers of the Borrower or any of its subsidiaries; and (iii) certain other obligations of the Borrower and its subsidiaries. At December 31, 1996, there were no working capital borrowings outstanding; however, letters of credit outstanding were $20.8 million. Principal installments of the FRI-M Term Loan are payable quarterly as follows: $4.0 million per quarter for four consecutive quarters beginning February 28, 1997; $5.0 million for four consecutive quarters beginning February 28, 1998; $6 million on February 28, 1998; and $7 million for two consecutive quarters beginning May 31, 1999. The FRI-M Credit Facility expires, and all amounts under the Facility must be repaid, on August 31, 1999. All borrowings under the FRI-M Credit Facility accrue interest at a variable rate based on a base rate or an adjusted Eurodollar rate (8.125% at year end 1996) and are secured by the issued and outstanding stock, as well as substantially all the assets, of FRD and its subsidiaries. The FRI-M Credit Facility and the indenture under which the 12.5% senior notes have been issued contain a number of restrictive covenants which, among other things, limit (subject to certain exceptions) FRD and its subsidiaries with respect to the incurrence of debt, existence of liens, investments and joint ventures, the declaration or payment of dividends, the making of guarantees and other contingent obligations, mergers, the sale of assets, capital expenditures and F-12 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 DEBT -- Continued material change in their business. In addition, the FRI-M Credit Facility contains certain financial covenants including provisions for the maintenance of a minimum level of interest coverage (as defined), limitations on ratios of indebtedness (as defined) to earnings before interest, taxes, depreciation and amortization (EBITDA), maintenance of a minimum level of EBITDA, and limitations on annual capital expenditures. The cash flows from FRD are required to be used to service the debt issued in the Coco's and Carrows acquisition (the FRI-M Credit Facility and the 12.5% Senior Notes), and, therefore, other than for the payment of certain management fees and tax reimbursements payable to Flagstar under certain conditions, are currently unavailable to service the debt of Flagstar and its other subsidiaries. FRD's cash flows from operating activities, included in the Company's total cash flow from operating activities, were $21.2 million in 1996. FRD and its subsidiaries were in compliance with the terms of the FRI-M Credit Facility at December 31, 1996. Under the most restrictive provision of the FRI-M Credit Facility (ratio of Consolidated Adjusted EBITDA to interest expense), at December 31, 1996, FRD's consolidated EBITDA for the six months ended December 31, 1996 could be $5.6 million less and the Company would still be in compliance. At December 31, 1996, the Company has $575 million aggregate notional amount in effect of reverse interest rate exchange agreements with maturities ranging from one to thirty-six months. These notional amounts reflect only the extent of the Company's involvement in these financial instruments and do not represent the Company's exposure to market risk. The Company receives interest at fixed rates calculated on such notional amounts and pays interest at floating rates based on six months LIBOR in arrears calculated on like notional amounts. The net expense from such agreements is reflected in interest and debt expense and totalled $9.2 million, $3.1 million, and $1.4 million for the years ended December 31, 1994, 1995, and 1996, respectively. Management intends to maintain its exchange agreements until maturity, unless there is a material change in the underlying hedged instruments of the Company. The counterparties to the Company's interest rate exchange agreements are major financial institutions who participate in the Company's senior bank credit facility. Such financial institutions are leading market-makers in the financial derivatives markets, are well capitalized, and are expected to fully perform under the terms of such exchange agreements, thereby mitigating the credit risk to the Company. The Company is exposed to market risk for such exchange agreements due to the interest rate differentials described above. The Company monitors its market risk by periodically preparing sensitivity analyses of various interest rate fluctuation scenarios and the results of such scenarios on the Company's cash flows on a nominal and discounted basis. In addition, the Company obtains portfolio mark-to-market valuations from market-makers of financial derivatives products. Information regarding the Company's reverse interest rate exchange agreements at December 31, 1996 is as follows ($ in millions):
AMOUNT OF WEIGHTED AVERAGE YEAR OF NOTIONAL INTEREST RATE MATURITY PAYMENT RECEIVED PAID 1997 $ 275 5.22% 5.74% 1998 200 5.58% 5.72% 1999 100 5.82% 5.72% $ 575 5.45% 5.73%
The estimated fair value of the Company's long-term debt (excluding capital lease obligations) is approximately $1.7 billion at December 31, 1996. Such computations are based on market quotations for the same or similar debt issues or the estimated borrowing rates available to the Company. At December 31, 1996, the estimated fair value of the $575 million notional amount of reverse interest rate swaps was a net payable of approximately $3.7 million and represents the estimated amount that the Company would be required to pay to terminate the swap agreements at December 31, 1996. This estimate is based upon a mark-to-market valuation of the Company's swap portfolio obtained from a major financial institution which is one of the counterparties to the exchange agreements. F-13 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 4 DEBT -- Continued On January 21, 1997, the Company hired Donaldson, Lufkin & Jenrette Securities Corporation as a financial advisor to assist in exploring alternatives to improve the Company's capital structure. Management intends to explore all alternatives to reduce the Company's debt service requirements, which may include a negotiated restructuring or other exchange transaction. NOTE 5 LEASES AND RELATED GUARANTEES The Company's operations utilize property, facilities, equipment and vehicles leased from others. In addition, certain owned and leased property, facilities and equipment are leased to others. Buildings and facilities leased from others primarily are for restaurants and support facilities. At December 31, 1996, restaurants were operated under lease arrangements which generally provide for a fixed basic rent, and, in some instances, contingent rental based on a percentage of gross operating profit or gross revenues. Initial terms of land and restaurant building leases generally are not less than twenty years exclusive of options to renew. Leases of other equipment primarily consist of merchandising equipment, computer systems and vehicles, etc. Information regarding the Company's leasing activities at December 31, 1996 is as follows:
CAPITAL LEASES OPERATING LEASES MINIMUM MINIMUM MINIMUM MINIMUM LEASE SUBLEASE LEASE SUBLEASE PAYMENTS RECEIPTS PAYMENTS RECEIPTS ($ IN THOUSANDS) Year: 1997....................................................................... $ 41,517 $ 6,865 $ 61,395 $7,589 1998....................................................................... 35,321 6,363 58,514 7,422 1999....................................................................... 29,221 5,753 54,997 7,067 2000....................................................................... 23,380 4,938 51,173 6,749 2001....................................................................... 20,257 4,285 44,655 6,402 Subsequent years........................................................... 124,917 21,353 238,326 45,957 Total................................................................... 274,613 $49,557 $509,060 $81,186 Less imputed interest........................................................ 114,387 Present value of capital lease obligations................................... $160,226
Payments for certain FRD operating leases are being made by FRI in accordance with the provisions of the Stock Purchase Agreement. As such, these payments have been excluded from the amount of minimum lease payments and minimum sublease receipts reported above. The total rental expense included in the determination of operating income for the years ended December 31, 1994, 1995 and 1996 is as follows:
YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 1994 1995 1996 ($ IN THOUSANDS) Base rents.................................................................... $ 49,234 $ 48,269 $ 59,322 Contingent rents.............................................................. 12,178 11,274 10,929 Total......................................................................... $ 61,412 $ 59,543 $ 70,251
Total rental expense does not reflect sublease rental income of $9,975,000, $14,426,000, and $16,282,000 for the years ended December 31, 1994, 1995, and 1996, respectively. F-14 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 6 INCOME TAXES A summary of the provision for (benefit from) income taxes attributable to the loss before discontinued operations and extraordinary items is as follows:
YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 1994 1995 1996 ($ IN THOUSANDS) Current: Federal..................................................................... $ 365 $ 1,940 $ (6,074) State, Foreign and Other.................................................... 215 1,497 (1,287) 580 3,437 (7,361) Deferred: Federal..................................................................... -- -- (6,797) State, Foreign and Other.................................................... (2,793) (3,451) (2,234) (2,793) (3,451) (9,031) Benefit from income taxes..................................................... $ (2,213) $ (14) $(16,392) The total provision for (benefit from) income taxes related to: Loss before discontinued operations and extraordinary items................. $ (2,213) $ (14) $(16,392) Discontinued operations..................................................... 10,470 8,731 -- Extraordinary items......................................................... (174) 25 -- Total provision for (benefit from) income taxes............................... $ 8,083 $ 8,742 $(16,392)
For the years ended December 31, 1994 and 1995, the provision for income taxes relating to discontinued operations was reduced due to the utilization of regular tax net operating loss carryforwards of approximately $89 million in 1994 and $75 million in 1995. In addition, for the year ended December 31, 1996, the Company recorded a $7.3 million deferred Federal tax benefit related to the reversal of certain reserves established in connection with the proposed deficiencies from the Internal Revenue Service. F-15 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 6 INCOME TAXES -- Continued The following represents the approximate tax effect of each significant type of temporary difference and carryforward giving rise to deferred income tax liabilities or assets:
DECEMBER 31, 1995 1996 ($ IN THOUSANDS) Deferred tax assets: Deferred income......................................................................................... $24,326 $39,953 Self-insurance reserves................................................................................. 33,522 43,006 Capitalized leases...................................................................................... 15,823 19,869 Amortization of intangible assets....................................................................... -- 2,949 Other accruals and reserves............................................................................. 6,924 18,054 Alternative minimum tax credit carryforwards............................................................ 18,444 10,459 General business credit carryforwards................................................................... 21,623 19,232 Net operating loss carryforwards........................................................................ 9,764 32,135 Less: valuation allowance............................................................................... (54,452) (83,828) Total deferred tax assets............................................................................... 75,974 101,829 Deferred tax liabilities: Depreciation of fixed assets............................................................................ 89,787 118,190 Amortization of intangible assets....................................................................... 4,362 -- Total deferred tax liabilities.......................................................................... 94,149 118,190 Total deferred income tax liability..................................................................... $18,175 $16,361
The Company has provided a valuation allowance for the portion of the deferred tax asset for which it is more likely than not that a tax benefit will not be realized. The difference between the statutory federal income tax rate and the effective tax rate on loss from continuing operations before discontinued operations and extraordinary items is as follows:
YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 1994 1995 1996 Statutory rate................................................................ 35% 35% 35% Differences: State, foreign, and other taxes, net of federal income tax benefit.......... 12 -- 2 Amortization of goodwill.................................................... -- -- 1 Reversal of certain reserves established in connection with proposed Internal Revenue Service deficiencies.................................... -- -- 7 Portion of losses not benefited as a result of the establishment of valuation allowance...................................................... (35) (35) (29) Effective tax rate............................................................ 12% --% 16%
At December 31, 1996, the Company has available, to reduce income taxes that become payable in the future, general business credit carryforwards of approximately $19 million, most of which expire in 2002 through 2007; and alternative minimum tax (AMT) credits of approximately $10 million. The AMT credits may be carried forward indefinitely. In addition, the Company has available regular income tax net operating loss carryforwards of approximately $92 million which expire in 2007 through 2011. Due to the recapitalization of the Company which occurred during 1992, the Company's ability to utilize general business credits and AMT credits which arose prior to the recapitalization will be limited to a specified annual amount. The annual limitation for the utilization of the tax credit carryforwards is approximately $8 million. The net operating loss carryforward arose subsequent to the recapitalization and is presently not subject to any annual limitation. F-16 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 7 EMPLOYEE BENEFIT PLANS The Company maintains several defined benefit plans which cover a substantial number of employees. Benefits are based upon each employee's years of service and average salary. The Company's funding policy is based on the minimum amount required under the Employee Retirement Income Security Act of 1974. The Company also maintains defined contribution plans. Total net pension cost of defined benefit plans for the years ended December 31, 1994, 1995, and 1996 amounted to $4.0 million, $5.6 million and $3.5 million, respectively, of which $3.3 million related to funded defined benefit plans for all three years and $0.7 million, $2.3 million and $0.2 million related to nonqualified unfunded supplemental defined benefit plans for executives. The components of net pension cost of the funded and unfunded defined benefit plans for the years ended December 31, 1994, 1995, and 1996 determined under SFAS No. 87 follow:
YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, DECEMBER 31, 1994 1995 1996 ($ IN THOUSANDS) Service cost.................................................................. $ 3,076 $ 2,829 $ 3,151 Interest cost on projected benefit obligations................................ 2,427 2,651 2,895 Actual return on plan assets.................................................. 761 (3,722) (2,277) Net amortization and deferral................................................. (2,269) 2,074 (242) Curtailment/settlement losses (due to early retirements of certain participants)............................................................... -- 1,762 -- Net pension cost.............................................................. $ 3,995 $ 5,594 $ 3,527
The following table sets forth the funded status and amounts recognized in the Company's balance sheet for its funded defined benefit plans:
DECEMBER 31, 1995 1996 ($ IN THOUSANDS) Actuarial present value of accumulated benefit obligations: Vested benefits....................................................................................... $23,993 $27,661 Non-vested benefits................................................................................... 1,466 1,488 Accumulated benefit obligations......................................................................... $25,459 $29,149 Plan assets at fair value............................................................................... $26,513 $31,109 Projected benefit obligation............................................................................ (32,059) (36,416) Funded status........................................................................................... (5,546) (5,307) Unrecognized net loss from past experience different from that assumed.................................. 6,301 6,890 Unrecognized prior service cost......................................................................... 69 -- Prepaid pension costs................................................................................... $ 824 $ 1,583
Assets held by the Company's plans are invested in money market and other fixed income funds as well as equity funds. F-17 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 7 EMPLOYEE BENEFIT PLANS -- Continued The following sets forth the funded status and amounts recognized in the Company's balance sheet for its unfunded defined benefit plans:
DECEMBER 31, 1995 1996 ($ IN THOUSANDS) Actuarial present value of accumulated benefit obligations: Vested benefits........................................................................................ $ 4,080 $ 4,924 Non-vested benefits.................................................................................... 12 33 Accumulated benefit obligations.......................................................................... $ 4,092 $ 4,957 Plan assets at fair value................................................................................ $ -- $ -- Projected benefit obligation............................................................................. (4,188) (5,051) Funded status............................................................................................ (4,188) (5,051) Unrecognized net (gain) loss from past experience different from that assumed............................ (112) 616 Unrecognized prior service cost.......................................................................... 109 68 Unrecognized net asset at January 1, 1987 being amortized over 15 years.................................. (49) (9) Additional liability..................................................................................... (543) (974) Other 24 -- Accrued pension costs.................................................................................... $(4,759) $(5,350)
Significant assumptions used in determining net pension cost and funded status information for all the periods shown above are as follows:
1994 1995 1996 Discount rate......................................................... 8.3 % 8.0 % 8.0 % Rates of salary progression........................................... 4.0 % 4.0 % 4.0 % Long-term rates of return on assets................................... 10.0 % 10.0 % 10.0 %
In addition, the Company has defined contribution plans whereby eligible employees can elect to contribute from 1%-15% of their compensation to the plans. These plans include profit sharing and savings plans under which the Company makes matching contributions, with certain limitations. Amounts charged to income under these plans were $3.9 million for the years ended December 31, 1994 and 1995 respectively. The Company made no matching contributions for the year ended December 31, 1996. Incentive compensation plans provide for awards to management employees based on meeting or exceeding certain levels of income as defined by such plans The amounts charged to income under the plans for the years ended December 31, 1994, 1995, and 1996 were as follows: $4.2 million, $0.6 million, and $1.9 million. In addition to these incentive compensation plans, certain operations have incentive plans in place under which regional, divisional and local management participate. At December 31, 1996, the Company has two stock-based compensation plans, which are described below. The company has adopted the disclosure-only provisions of Financial Accounting Standards Board Statement 123, "Accounting for Stock Based Compensation" (SFAS 123) while continuing to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its stock-based compensation plans. Under APB 25, because the exercise price of the Company's employee stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized. The 1989 Stock Option Plan (the 1989 Plan) permits a Committee of the Board of Directors to grant options to key employees of the Company and its subsidiaries to purchase shares of common stock of the Company at a stated price established by the Committee. Such options are exercisable at such time or times either in whole or part, as determined by the Committee. The 1989 Plan authorizes grants of up to 6.5 million common shares. The exercise price of each option equals or exceeds the market price of the Company's stock on the date of grant. Options granted to officer level employees vest at a rate of 20% per annum beginning on the first anniversary date of the grant. Options granted to non-officer F-18 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 7 EMPLOYEE BENEFIT PLANS -- Continued level employees prior to August 13, 1996 vest at a rate of 25% per annum. Those granted on August 13, 1996 or subsequent thereto, vest at a rate of 20% per annum If not exercised, all options expire ten years from the date of grant. During January 1995, the Company issued 65,306 shares of common stock (Note 9) and granted an option under the 1989 Stock Option Plan to purchase 800,000 shares of the Company's common stock to an executive officer, at market value at date of grant, for a ten year period. Such grant becomes exercisable at a rate of 20% per year beginning on January 9, 1996 and each anniversary thereafter. On June 21, 1995, generally all of the outstanding options held by the then current employees of the Company under the 1989 Plan were repriced to $6.00 per share, the market value of the common stock on that date. All officer level employees were given the choice of either retaining their current options at their existing exercise prices and vesting schedule or surrendering their existing options in exchange for an option to purchase the same number of shares exercisable at a rate of 20% per annum beginning on the first anniversary date of the new grant. All non-officer employees received the new exercise price of $6.00 per share and retained their original vesting schedules for all of their outstanding options previously granted. Options of 4.3 million were outstanding at December 31, 1995, of which 728,221 were exercisable. Such options had exercise prices of between $5.13 and $17.50 per share. During 1995 no options were exercised. On December 13, 1996, the outstanding options of certain officers and senior staff, representing approximately 2.2 million outstanding options, were repriced to $1.25 per share, the closing price of the common stock on December 12, 1996. The repricing did not impact the option vesting schedules. In 1990, the Board of directors adopted a 1990 Non-qualified Stock Option Plan (the 1990 Plan) for its directors who do not participate in management and are not affiliated with GTO (See Note 12). Such plan authorizes the issuance of up to 110,000 shares of common stock. The plan is substantially similar in all respects to the 1989 Plan described above. At both December 31, 1995 and 1996, options outstanding under the 1990 Option Plan totaled 10,000 shares. Pro forma information regarding net income and earnings per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options granted or repriced during 1995 and 1996 under the fair value method of that statement. The fair value of these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions used for grants in 1995 and 1996, respectively: dividend yield of 0.0% for both years; expected volatility of 0.438 for both years; risk-free interest rates of 5.6% and 5.7%; and a weighted average expected life of the options of 8.3 years and 8.9 years. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
YEAR ENDED DECEMBER 31, ($ IN THOUSANDS, EXCEPT FOR EARNINGS PER SHARE) 1995 1996 Pro forma net loss............................................................. $(57,719) $(87,124) Pro forma loss per share: Primary...................................................................... (1.68) (2.39) Fully diluted................................................................ (1.68) (2.39)
Due to the fact that the pro forma amounts above include only the impact of the application of fair value accounting to options issued in 1995 and 1996 as prescribed by Statement 123, they are not, and will not be, indicative of future pro forma amounts until fair value accounting is applied to all outstanding nonvested awards. F-19 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 7 EMPLOYEE BENEFIT PLANS -- Continued A summary of the Company's stock option plans as of December 31, 1996 and changes during the year ended December 31, 1996 is presented below:
OPTIONS WEIGHTED-AVERAGE (000) EXERCISE PRICE Outstanding at beginning of year........................................ 4,338 $ 8.02 Granted Exercise price equals fair value at grant date........................ 687 2.75 Exercise price exceeds fair value at grant date....................... 3,167 2.68 Exercised............................................................... Forfeited/Expired....................................................... (3,873 ) 6.05 Outstanding at end of year.............................................. 4,319 $ 5.04 Exercisable at year-end................................................. 1,154 $ 9.84
The following table summarizes information about stock options outstanding at December 31, 1996:
NUMBER WEIGHTED-AVERAGE NUMBER OUTSTANDING AT REMAINING WEIGHTED-AVERAGE EXERCISABLE AT WEIGHTED-AVERAGE RANGE OF EXERCISE PRICES 12/31/96 CONTRACTUAL LIFE EXERCISE PRICE 12/31/96 EXERCISE PRICE $ 1.25-$1.25 2,210,895 9.06 $ 1.25 191,358 $ 1.25 $ 2.75-$2.75 126,700 9.62 2.75 -- -- $ 6.00-$6.13 1,381,280 7.71 6.07 482,475 6.04 $15.00-$17.50 600,000 1.88 17.08 480,000 17.08 4,318,875 7.64 $ 5.04 1,153,833 $ 9.84
The weighted average fair value per option of options granted during the years ended December 31, 1995 and 1996 are as follows:
1995 1996 Exercise price equals fair value at grant date....................................... $3.06 $1.65 Exercise price exceeds fair value at grant date...................................... 2.97 .78
NOTE 8 COMMITMENTS AND CONTINGENCIES There are various claims and pending legal actions against or indirectly involving the Company, including actions concerned with civil rights of employees and customers, other employment related matters, taxes, sales of franchise rights and businesses, and other matters. Certain of these are seeking damages in substantial amounts. The amounts of liability, if any, on these direct or indirect claims and actions at December 31, 1996, over and above any insurance coverage in respect to certain of them, are not specifically determinable at this time. In 1994, Flagstar was advised of proposed deficiencies from the Internal Revenue Service for federal income taxes totaling approximately $12.7 million. The proposed deficiencies relate to examinations of certain income tax returns filed by the Company and Flagstar for the seven taxable periods ended December 31, 1992. In the third quarter of 1996, this proposed deficiency was reduced by approximately $7.0 million as a direct result of the passage of the Small Business Jobs Protection Act ("the Act") in August 1996. The Act included a provision that clarified Internal Revenue Code Section 162(k) to allow for the amortization of borrowing costs incurred by a corporation in connection with a redemption of its stock. As the Company believes the remaining proposed deficiencies are substantially incorrect, it intends to continue to contest such proposed deficiencies. It is the opinion of Management (including General Counsel), after considering a number of factors, including but not limited to the current status of the litigation (including any settlement discussions), the views of retained counsel, the nature of the litigation or proposed tax deficiencies, the prior experience of the consolidated companies, and the amounts F-20 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 8 COMMITMENTS AND CONTINGENCIES -- Continued which the Company has accrued for known contingencies that the ultimate disposition of these matters will not materially affect the consolidated financial position or results of operations of the Company. The Company is guarantor on capital lease obligations of approximately $4.5 million at December 31, 1996 from the sale of PFC. See Note 1(o). On February 22, 1996, the Company entered into an agreement with Integrated Systems Solutions Corporation (ISSC). The ten year agreement for $340.6 million (including an additional $17.6 million for FRD), which requires annual payments ranging from $24.0 million to $47.5 million, provides for ISSC to manage and operate the Company's information systems, as well as develop and implement new systems and applications to enhance information technology for the Company's corporate headquarters, restaurants and field management. Under the agreement, ISSC has full oversight responsibilities for the data center operations, applications development and maintenance, voice and data networking, help desk operations, and point-of-sale technology. In conjunction with the sales of Portion-Trol Foods, Inc. and the Mother Butler Pies division of Denny's, the Company entered into five year purchasing agreements with the acquirers under which the Company is required to make minimum annual purchases over the contract terms. The aggregate estimated commitments remaining at December 31, 1996 relative to Portion-Trol Foods, Inc. and Mother Butler Pies, respectively, are approximately $450 million and $54 million. NOTE 9 SHAREHOLDERS' EQUITY (DEFICIT)
TOTAL TOTAL SHAREHOLDERS' OTHER EQUITY DEFICIT EQUITY (DEFICIT) ($ IN THOUSANDS) Balance December 31, 1993...................................................... $735,269 $(2,157,818) $ (1,422,549) Activity: Net Income................................................................ -- 364,093 364,093 Dividends declared on Preferred Stock..................................... -- (14,175) (14,175) Minimum pension liability adjustment...................................... 10,131 -- 10,131 Balance December 31, 1994...................................................... 745,400 (1,807,900) (1,062,500) Activity: Net Loss.................................................................. -- (55,199) (55,199) Dividends declared on Preferred Stock..................................... -- (14,175) (14,175) Issuance of Common Stock (Note 7)......................................... 400 -- 400 Minimum pension liability adjustment...................................... 497 -- 497 Balance December 31, 1995...................................................... 746,297 (1,877,274) (1,130,977) Activity: Net Loss.................................................................. -- (85,460) (85,460) Dividends declared on Preferred Stock..................................... -- (10,631) (10,631) Minimum pension liability adjustment...................................... (459) (459) Balance December 31, 1996...................................................... $745,838 $(1,973,365) $ (1,227,527)
Each share of the $2.25 Series A Cumulative Convertible Exchangeable Preferred Stock ($2.25 Preferred Stock) is convertible at the option of the holder, unless previously redeemed, into 1.359 shares of common stock. The Preferred Stock may be exchanged at the option of the Company, in up to two parts, at any dividend payment date for the Company's 9% Convertible Subordinated Debentures (Exchange Debentures) due July 15, 2017 in a principal amount equal to $25.00 per share of $2.25 Preferred Stock. Each $25.00 principal amount of Exchange Debenture, if issued, would be convertible at the option of the holder into 1.359 shares of common stock of the Company. The $2.25 Preferred Stock may be redeemed at the option of the Company, in whole or in part, on or after July 15, 1994 at $26.80 per share if F-21 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 9 SHAREHOLDERS' EQUITY (DEFICIT) -- Continued redeemed during the twelve month-period beginning July 15, 1994, and thereafter at prices declining annually to $25.00 per share on or after July 15, 2002. The Company did not make the fourth quarter 1996 dividend payment on its Preferred stock. Such cumulative dividends that have not been declared or paid total $3.5 million, or $.08 per share, at December 31, 1996. At December 31, 1996, there are warrants outstanding which entitle the holder, an affiliate of Kohlberg, Kravis, Roberts & Co. (KKR), a shareholder of the Company, to purchase 15 million shares of Company common stock at $17.50 per share, subject to adjustment for certain events. Such warrants may be exercised through November 16, 2000. NOTE 10 EARNINGS (LOSS) PER SHARE APPLICABLE TO COMMON SHAREHOLDERS The outstanding warrants as well as the stock options issued to management and directors are common stock equivalents. The $2.25 Preferred Stock and 10% Convertible Debentures, which are convertible into the common stock of the Company (see Note 4), are not common stock equivalents; however, such securities are considered "other potentially dilutive securities" which may become dilutive in the calculation of fully diluted per share amounts. The calculations of primary and fully diluted loss per share amounts for the years ended December 31, 1995 and 1996 have been based on the weighted average number of Company shares outstanding. The warrants, options, $2.25 Preferred Stock, and 10% Convertible Debentures have been omitted from the calculations for 1995 and 1996 because they have an antidilutive effect on loss per share. For the year ended December 31, 1994, the calculation of primary earnings per share has been based on the weighted average number of outstanding shares as adjusted by the assumed dilutive effect that would occur if the outstanding warrants and stock options were exercised, using the modified treasury stock method. The calculation of fully diluted earnings per share has been based on additional adjustments to the primary earnings per share amount for the dilutive effect of the assumed conversion of the $2.25 Preferred Stock and 10% Convertible Debentures. NOTE 11 EXTRAORDINARY ITEMS The Company recorded losses from extraordinary items as follows:
YEAR ENDED DECEMBER 31, 1994 INCOME LOSSES, TAX NET OF LOSSES BENEFITS TAXES ($ IN THOUSANDS) Prepayment of Term Loan: Write-off of unamortized deferred financing costs on indebtedness retired............. $11,931 $ (174) $11,757
YEAR ENDED DECEMBER 31, 1995 INCOME GAIN TAX (LOSS), GAIN PROVISION NET OF (LOSS) (BENEFITS) TAXES ($ IN THOUSANDS) Repurchase of Senior Indebtness: Gain on repurchase of senior indebtedness................................................ $ 1,461 $ 74 $ 1,387 Write-off of deferred financing costs on repurchase of senior indebtedness............... (970) (49) (921) Total...................................................................................... $ 491 $ 25 $ 466
During the second quarter of 1994, the Company sold Canteen Corporation, a wholly-owned subsidiary. A portion of the proceeds from the sale was used to prepay $170.2 million of term loans and $126.1 million of working capital advances F-22 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 11 EXTRAORDINARY ITEMS -- Continued which were outstanding under the Company's Restated Credit Agreement resulting in a charge-off of $11.9 million of unamortized deferred financing costs. During the third quarter of 1995, the Company recognized an extraordinary gain totaling $0.5 million, net of income taxes, which represents the repurchase of $25.0 million principal amount of certain senior indebtedness, net of the charge-off of the related unamortized deferred financing costs of $0.9 million. NOTE 12 RELATED PARTY TRANSACTIONS The Company expensed annual advisory fees of $250,000 for the year ended December 31, 1994 for Gollust Tierney & Oliver, Incorporated (GTO), a stockholder of the Company. KKR received annual financial advisory fees of approximately $1.3 million for the years ended December 31, 1994, 1995, and 1996. During January 1997, the Company settled its employment and benefits arrangments with, and loan receivable from, a former officer previously scheduled to mature in November 1997. The Company received net proceeds of $8.2 million and recorded a net charge of approximately $3.5 million which has been included in other non-operating expenses in the accompanying 1996 Statement of Consolidated Operations. Interest income for the loan receivable from the former officer for the years ended December 31, 1994, 1995 and 1996 totaled $842,000, $886,000 and $935,000, respectively. NOTE 13 DISCONTINUED OPERATIONS During April 1994, the Company announced the signing of a definitive agreement to sell the food and vending business and its intent to dispose of the remaining concession and recreation services businesses of its subsidiary, Canteen Holdings, Inc. The Company sold Canteen Corporation, a food and vending subsidiary, for $447.1 million during June 1994, and recognized a net gain of approximately $399.2 million, net of income taxes, during the year ended December 31, 1994. During December 1995, the Company sold TW Recreational Services, Inc., a concession and recreation services subsidiary, for $98.7 million and Volume Services, Inc., a stadium concession services subsidiary for $75.8 million, and recognized gains totaling $77.9 million, net of income taxes. The financial statements and related notes presented herein classify Canteen Holdings, Inc. and its subsidiaries as discontinued operations in accordance with Accounting Principles Board Opinion No. 30. Revenues and operating income (loss) of the discontinued operations for the years ended December 31, 1994, and 1995 were $859.7 million, and $322.3 million and $32.6 million, and $17.1 million, respectively. F-23 FLAGSTAR COMPANIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) NOTE 14 QUARTERLY DATA (UNAUDITED) The results for each quarter include all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for interim periods. The consolidated financial results on an interim basis are not necessarily indicative of future financial results on either an interim or an annual basis. Selected consolidated financial data for each quarter within 1995 and 1996 are as follows:
FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ($ IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Year Ended December 31, 1995: Operating Revenue............................................................ $636,464 $681,464 $676,899 $576,660 Operating expenses: Product costs.............................................................. 218,246 238,514 229,446 178,299 Payroll & benefits......................................................... 228,809 238,889 229,368 219,885 Depreciation & amortization expense........................................ 33,249 33,748 32,802 33,073 Utilities expense.......................................................... 23,261 23,708 27,361 23,882 Other...................................................................... 95,561 96,471 101,634 99,816 Provision for restructuring charges........................................ -- -- -- 15,873 Charge for impaired assets................................................. -- -- -- 51,358 Operating income (loss)...................................................... $ 37,338 $ 50,134 $ 56,288 $(45,526) Income (loss) before extraordinary item...................................... $(31,060) $(13,554) $ 13,765 $(24,816) Net income (loss) applicable to common shareholders.......................... $(34,604) $(17,098) $ 10,688 $(28,360) Primary and fully diluted per share amounts applicable to common shareholders: Income (loss) before extraordinary item.................................... $ (0.82) $ (0.40) $ 0.24 $ (0.67) Net income (loss).......................................................... $ (0.82) $ (0.40) $ 0.25 $ (0.67) Year Ended December 31, 1996: Operating Revenue............................................................ $550,425 $626,570 $703,838 $661,469 Operating expenses: Product costs.............................................................. 160,028 184,842 206,777 192,425 Payroll & benefits......................................................... 214,531 235,605 258,613 237,023 Depreciation & amortization expense........................................ 29,047 30,006 33,555 37,340 Utilities expense.......................................................... 22,754 24,329 30,698 26,696 Other...................................................................... 96,579 108,428 125,868 130,766 Operating income............................................................. $ 27,486 $ 43,360 $ 48,327 $ 37,219 Loss before extraordinary item............................................... $(27,310) $(17,435) $(12,519) $(28,196) Net loss applicable to common shareholders................................... $(30,854) $(20,979) $(16,062) $(31,740) Primary and fully diluted per share amounts applicable to common shareholders: Loss before extraordinary items............................................ $ (0.73) $ (0.49) $ (0.38) $ (0.75) Net loss................................................................... $ (0.73) $ (0.49) $ (0.38) $ (0.75)
During the fourth quarter of 1995, the Company sold its concession and recreation services subsidiaries and recorded a $77.9 million net gain on the sales of such discontinued operations. The effect of the Company's other potentially dilutive securities (see Note 10) on the computations of fully diluted loss per share amounts for all of the 1995 and 1996 quarters were anti-dilutive. Accordingly, the primary and fully diluted loss per share amounts for such quarters are equivalent. F-24 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FLAGSTAR COMPANIES, INC. By: /s/ RHONDA J. PARISH Rhonda J. Parish (Vice President, General Counsel and Secretary) Date: February 25, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE /s/ JAMES B. ADAMSON Director, Chairman, President and Chief February 25, 1997 Executive Officer (Principal Executive (James B. Adamson) Officer) /s/ C. ROBERT CAMPBELL Vice President and Chief Financial Officer February 25, 1997 (Principal Financial and Accounting Officer) (C. Robert Campbell) /s/ MICHAEL CHU Director February 25, 1997 (Michael Chu) /s/ VERA KING FARRIS Director February 25, 1997 (Vera King Farris) /s/ NICHOLAS deB. KATZENBACH Director February 25, 1997 (Nicholas deB. Katzenbach) /s/ HENRY R. KRAVIS Director February 25, 1997 (Henry R. Kravis) /s/ PAUL E. RAETHER Director February 25, 1997 (Paul E. Raether) (Clifton S. Robbins) Director (George R. Roberts) Director (Elizabeth A. Sanders) Director /s/ MICHAEL T. TOKARZ Director February 25, 1997 (Michael T. Tokarz)
EX-3 2 EXHIBIT 3.5 EXHIBIT 3.5 BY-LAWS (1) OF FLAGSTAR COMPANIES, INC. A Delaware Corporation ARTICLE I OFFICES SECTION 1. REGISTERED OFFICE. The registered office of the Corporation in the State of Delaware shall be in the City of Wilmington. SECTION 2. OTHER OFFICES. The Corporation may have other offices, either within or without the state of Delaware, at such place or places as the Board of Directors may from time to time determine or the business of the Corporation may require. ARTICLE II MEETING OF STOCKHOLDERS SECTION 1. ANNUAL MEETINGS. Annual meetings of stockholders for the election of directors and for such other business as may be stated in the notice of the meeting shall be held at such place, either within or without the state of Delaware, and at such time and date, commencing in the year 1989, as the Board of Directors, by resolution, shall determine and as set forth in the notice of the meeting. If the date of the annual meeting shall fall upon a legal holiday, the meeting shall be held on the next business day. At each annual meeting, the stockholders entitled to vote shall elect a Board of Directors and they may transact such other corporate business as shall be stated in the notice of the meeting. At an annual meeting of the stockholders, only such business shall be conducted as shall have been properly brought before the meeting. To be properly brought before an annual meeting, business must be (a) specified in the notice of meeting (or any supplement thereto) given by or at the direction of the Board of Directors, (b) otherwise properly brought before the meeting by or at the direction of the Board of Directors, or (c) otherwise properly brought before the meeting by a stockholder. For business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the Secretary of the Corporation. To be timely, a stockholder's notice must be delivered to or mailed and received at the principal executive offices of the (1) As amended through December 13, 1996 Corporation, not less than 60 days nor more than 90 days prior to the meeting; provided, however, that in the event that less than 70 days' notice or prior public disclosure of the date of the meeting is given or made to stockholders, notice by the stockholder to be timely must be so received not later than the close of business on the 10th day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure was made. A stockholder's notice to the Secretary shall set forth as to each matter the stockholder proposes to bring before the annual meeting (a) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (b) the name and address, as they appear on the Corporation's books, of the stockholder proposing such business, (c) the class and number of shares of the Corporation which are beneficially owned by the stockholder, and (d) any material interest of the stockholder in such business. Notwithstanding anything in the Bylaws to the contrary, no business shall be conducted at any annual meeting except in accordance with the procedures set forth in this Section. The Chairman of the annual meeting shall, if the facts warrant, determine and declare to the meeting that business was not properly brought before the meeting in accordance with the provisions of this Section, and if he should so determine, he shall so declare to the meeting, and any such business not properly brought before the meeting shall not be transacted. SECTION 2. OTHER MEETINGS. Special meetings of stockholders for any purpose may be held at such time and place, within or without the state of Delaware, as may be fixed by the Board of Directors and shall be stated in the notice of meeting. SECTION 3. INSPECTOR OF ELECTION. At each meeting of stockholders at which an election of directors is to be held, the chairman of the meeting may, but shall not be required to, appoint one person, who need not be a stockholder, to act as inspector of election at such meeting. The inspector so appointed, before entering on the discharge of his duties, shall take and subscribe to an oath or affirmation to faithfully execute the duties of inspector at such meeting with strict impartiality and according to the best of his ability, and thereupon the inspector shall take charge of the polls and after the balloting shall canvas the votes and make a certificate of the results of the vote taken. No director or candidate for the office of director shall be appointed inspector. SECTION 4. VOTING. At each meeting of the stockholders, each stockholder entitled to vote at such meeting in accordance with the terms of the Certificate of Incorporation and in accordance with the provisions of these By-laws shall be entitled to one vote, in person or by proxy, for each share of stock entitled to vote held by such stockholder, but no proxy shall be voted after three years from its date unless such proxy provides for a longer period. Every proxy must be executed in writing by the stockholder or by the stockholder's duly authorized attorney. Upon the demand of any stockholder, the vote for directors and the vote upon any question before the meeting, shall be by ballot. All elections for directors and all other questions shall be decided by majority vote except as otherwise provided by the Certificate of Incorporation or the laws of the state of Delaware. A complete list of the stockholders entitled to vote at the ensuing election, arranged in alphabetical order, with the address of each, and the number of shares held by each, shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the meeting during the whole time thereof, and may be inspected by any stockholder who is present. SECTION 5. QUORUM. At all meetings of the stockholders, except as otherwise required by law, by the Certificate of Incorporation or by these By-laws, the presence, in person or by proxy, of stockholders of record holding a majority of the shares of stock of the Corporation issued, outstanding and entitled to vote thereat shall constitute a quorum for the transaction of business. In case a quorum shall not be present at any meeting, the holders of record of a majority of the shares of stock entitled to vote thereat, present in person or by proxy, shall have the power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until the requisite amount of stock entitled to vote shall be present. At any such adjourned meeting at which the requisite amount of stock entitled to vote shall be represented, any business may be transacted which might have been transacted at the meeting as originally called; but only those stockholders entitled to vote at the meeting as originally called shall be entitled to vote at any adjournment or adjournments thereof. SECTION 6. SPECIAL MEETINGS. Special meetings of the stockholders for any purpose or purposes may be called by the Chairman of the Board of Directors, the President or the Secretary, or by resolution of the Board of Directors. SECTION 7. NOTICE OF MEETINGS. Written notice, stating the place, date and time of the meeting, and the general nature of the business to be considered, shall be given to each stockholder entitled to vote thereat at his address as it appears on the records of the Corporation, not less than ten nor more than sixty days before the date of the meeting. No business other than that stated in the notice shall be transacted at any meeting without the unanimous consent of all the stockholders entitled to vote thereat. SECTION 8. ACTION WITHOUT MEETING. Unless otherwise provided by the Certificate of Incorporation, any action required to be taken at any annual or special meeting of stockholders, or any action which may be taken at any annual or special meeting, may be taken without a meeting, without prior notice and without a vote, if a consent in writing, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted. Prompt notice of the taking of the corporate action without a meeting by less than unanimous written consent shall be given to those stockholders who have not consented in writing. Such written consent shall be filed in the minute book of the Corporation. ARTICLE III DIRECTORS SECTION 1. NUMBER AND TERM. The number of directors of the Corporation shall be not less than one nor more than fifteen. Within the limits above specified, the number of directors shall be determined from time to time by the stockholders or by the Board of Directors at any meeting thereof. The directors shall be elected at the annual meeting of the stockholders. Each director shall be elected to serve until his successor shall be elected and shall qualify or until his earlier death, resignation or removal as provided in these By-laws. Directors need not be stockholders. No person who has attained the age of 70 shall be eligible to stand for election or re-election by the stockholders or otherwise to be appointed to serve as a director of the Corporation unless pursuant to a special finding of the Board of Directors of the necessity for such an individual to serve as a director. SECTION 2. RESIGNATION. Any director, member of a committee or other officer may resign at any time. Such resignation shall be made in writing to the Board of Directors, the Chairman of the Board of Directors, the President or the Secretary. Unless otherwise specified therein, such resignation shall take effect on receipt thereof. The acceptance of a resignation shall not be necessary to make it effective. SECTION 3. VACANCIES. If the office of any director, member of a committee or other officer becomes vacant, the remaining directors in office, though less than a quorum, by a majority vote, may appoint any qualified person to fill such vacancy, who shall hold office for the unexpired term and until his successor shall be duly chosen or until his earlier death, resignation or removal. In the event that the resignation of any director shall specify that it shall take effect at a future date, the vacancy resulting from such resignation may be filled prospectively in the same manner as provided in this paragraph. SECTION 4. REMOVAL. Except as hereinafter provided, any director or directors may be removed either for or without cause at any time by the affirmative vote of the holders of a majority of all the shares of stock outstanding and entitled to vote, at a special meeting of the stockholders called for the purpose, and the vacancies thus created may be filled, at the meeting held for the purpose of removal, by the affirmative vote of a majority in interest of the stockholders entitled to vote. Any director may be removed at any time for cause by the action of the directors, at a special meeting called for that purpose, by the vote in favor of removal of a majority of the total number of directors. SECTION 5. INCREASE OF NUMBER. The maximum number of directors may be increased by amendment of these By-laws by the affirmative vote of a majority of the directors, though less than a quorum, or, by the affirmative vote of a majority interest of the stockholders, at the annual meeting or at a special meeting called for that purpose, and by like vote the additional directors may be chosen at such meeting to hold office until the next annual election and until their successors are elected and qualify or until their earlier death, resignation or removal. SECTION 6. POWERS. The Board of Directors shall exercise all of the powers of the Corporation except such as are by law, by the Certificate of Incorporation of the Corporation or by these By-laws conferred upon or reserved to the stockholders. SECTION 7. COMMITTEES. The Board of Directors may, by resolution or resolutions passed by a majority of the whole board, designate one or more committees, each committee to consist of two or more directors of the Corporation. The board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. In the absence or disqualification of any member of such committee or committees, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. Any such committee, to the extent provided in the resolution of the Board of Directors, or in these By-laws, shall have and may exercise all the powers and authority of the Board of Directors in the management of the business and affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it; but no such committee shall have the power or authority in reference to amending the Certificate of Incorporation, adopting an agreement of merger or consolidation, recommending to the stockholders the sale, lease or exchange of all or substantially all of the Corporation's property and assets, recommending to the stockholders a dissolution of the Corporation or a revocation of a dissolution, or amending the By-laws of the Corporation; and, unless the resolution, these By-laws, or the Certificate of Incorporation expressly so provide, no such committee shall have the power or authority to declare a dividend or to authorize the issuance of stock. SECTION 8. MEETINGS. The newly elected directors may hold their first meeting for the purpose of organization and the transaction of business, if a quorum be present, immediately after the annual meeting of the stockholders; or the time and place of such meeting may be fixed by consent in writing of all the directors. Regular meetings of the directors may be held without notice at such places and times as shall be determined from time to time by resolution of the directors. Special meetings of the Board of Directors may be called by the Chairman of the Board of Directors, the President or the Secretary on the written request of any two directors on at least two days' notice to each director and shall be held at such place or places as may be determined by the directors, or shall be stated in the call of the meeting. Unless otherwise restricted by the Certificate of Incorporation or by these By-laws, members of the Board of Directors, or any committee designated by the Board of Directors, may participate in a meeting of the Board of Directors, or any committee, by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and such participation in a meeting shall constitute presence in person at the meeting. SECTION 9. QUORUM. A majority of the total number of directors shall constitute a quorum for the transaction of business. If a quorum shall be present, the act of a majority of the directors present shall be the act of the Board of Directors, except as otherwise provided by law, by the Certificate of Incorporation or by these By-laws. If at any meeting of the Board of Directors there shall be less than a quorum present, a majority of those present may adjourn the meeting from time to time until a quorum is obtained, and no further notice thereof need be given other than by announcement at the meeting which shall be so adjourned. SECTION 10. COMPENSATION. Directors shall not receive any stated salary for their services as directors or as members of committees, but by resolution of the Board of Directors a fixed fee and expenses of attendance may be allowed for attendance at each meeting. Nothing herein contained shall be construed to preclude any director from serving the Corporation in any other capacity as an officer, agent or otherwise, and receiving compensation therefor. SECTION 11. ACTION WITHOUT MEETING. Any action required or permitted to be taken at any meeting of the Board of Directors, or of any committee thereof, may be taken without a meeting, if prior to such action a written consent thereto is signed by all members of the Board of Directors, or of such committee as the case may be, and such written consent is filed with the minutes of proceedings of the Board of Directors or committee. SECTION 12. RULES AND REGULATIONS. The Board of Directors may adopt such rules and regulations for the conduct of its meetings and for the management of the property, affairs and business of the Corporation as it may deem proper, except as otherwise provided by law, by the Certificate of Incorporation or by these By-laws. ARTICLE IV OFFICERS SECTION 1. OFFICERS. The officers of the Corporation shall be a Chairman of the Board of Directors, if any shall have been elected, a President, a Treasurer, and a Secretary, all of whom shall be elected by the Board of Directors and who shall hold office until their successors are elected and qualified or until their earlier death, resignation or removal. In addition, the Board of Directors may elect one or more Vice Presidents and such Assistant Secretaries and Assistant Treasurers as they may deem proper. None of the officers of the Corporation need be directors (except for the Chairman of the Board of Directors, if any) or stockholders. The officers shall be elected at the first meeting of the Board of Directors after each annual meeting. Any person may hold one or more offices. The compensation of all officers of the Corporation shall be fixed by the Board of Directors. SECTION 2. OTHER OFFICERS AND AGENTS. The Board of Directors may appoint such other officers and agents as it may deem advisable, who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board of Directors. The Board of Directors may delegate to any officer or officers the power to appoint any such officer, to fix their respective terms of office, to prescribe their respective powers and duties, to remove them and to fill vacancies in any such offices. SECTION 3. CHAIRMAN. The Chairman of the Board of Directors, if one be elected, shall preside at all meetings of the Board of Directors and of the stockholders, and absent instructions to the contrary by the Board of Directors, shall exercise general supervision over the property, affairs and business of the Corporation, shall authorize the other officers of the Corporation to exercise such powers as he may deem to be in the best interests of the Corporation and shall have and perform such other duties as from time to time may be assigned to him by the Board of Directors. SECTION 4. PRESIDENT. The President shall have such duties as may from time to time be delegated to him by the Board of Directors. In the event there shall be no Chairman, the President shall exercise all powers conferred on the Chairman by Section 3 of this Article. In the event a Chairman is elected, the President shall be the Chief Executive Officer of the Corporation and, in the absence or disability of the Chairman, shall have the powers of the Chairman. SECTION 5. VICE PRESIDENTS. Each Vice President shall have such powers and shall perform such duties as shall be assigned to him by the directors. The Board of Directors may further designate the area or areas of responsibility assigned to a Vice President by appropriate words, such as Senior Vice President or Group Vice President added to the title of the office or offices held by such Vice President. SECTION 6. TREASURER. The Treasurer shall have the custody of the corporate funds and securities and shall keep full and accurate account of receipts and disbursements in books belonging to the Corporation. He shall deposit all moneys and other valuables in the name and to the credit of the Corporation in such depositaries as may be designated by the Board of Directors. The Treasurer shall disburse the funds of the Corporation in such manner as may be ordered by the Board of Directors, the Chairman or the President, taking proper vouchers for such disbursements. He shall render to the Chairman, the President and the Board of Directors at the regular meetings of the Board of Directors, or whenever they may request it, an account of all his transactions as Treasurer and of the financial condition of the Corporation. SECTION 7. SECRETARY. The Secretary shall give, or cause to be given, notice of all meetings of stockholders and directors, and all other notices required by law or by these By-laws, and in case of his absence or refusal or neglect so to do, any such notice may be given by any person thereunto directed by the Chairman, the President, or the directors, or stockholders, upon whose requisition the meeting is called as provided in these By-laws. He shall record all the proceedings of the meetings of the Corporation and of the directors, in a book to be kept for that purpose, and shall perform such other duties as may be assigned to him by the directors, the Chairman or the President. He shall have the custody of the seal of the Corporation and shall affix the same to all instruments requiring it, when authorized by the directors or the President, and attest the same. SECTION 8. ASSISTANT TREASURERS AND ASSISTANT SECRETARIES. Assistant Treasurers and Assistant Secretaries, if any, shall be elected and shall have such powers and shall perform such duties as shall be assigned to them, respectively, by the directors. SECTION 9. RESIGNATION. Any officer may resign at any time, unless otherwise provided in any contract with the Corporation, by giving written notice to the Chairman, if any, or the President or the Secretary. Unless otherwise specified therein, such resignation shall take effect upon receipt thereof. SECTION 10. REMOVAL. Any officer may be removed at any time by an affirmative vote of a majority of the Board of Directors, with or without cause. Any officer not elected by the Board of Directors may be removed in such manner as may be determined by, or pursuant to delegation from the Board of Directors. SECTION 11. VACANCIES. If a vacancy shall occur in any office, such vacancy may be filled for the unexpired portion of the term by the Board of Directors. SECTION 12. SURETY BONDS. In the event the Board of Directors shall so require, any officer or agent of the Corporation shall execute to the Corporation a bond in such sum and with such surety or sureties as the Board of Directors may direct, conditioned on the faithful performance of the officer's duties to the Corporation. ARTICLE V MISCELLANEOUS SECTION 1. CERTIFICATES OF STOCK. A certificate or certificates of stock, signed by the Chairman of the Board of Directors, if one be elected, the President or a Vice President, and the Treasurer or an Assistant Treasurer, or Secretary or an Assistant Secretary, and sealed with the seal of the Corporation, shall be issued to each stockholder certifying the number of shares owned by him in the Corporation. Any of or all of the signatures may be facsimiles. The certificate or certificates of stock shall be in such form as the Board of Directors may from time to time adopt and shall be countersigned and registered in such manner, if any, as the Board of Directors may prescribe. In case any officer who shall have signed, or whose facsimile signature shall have been used on any such certificate, shall cease to be such officer of the Corporation before such certificate shall have been issued by the Corporation, such certificate may nevertheless be adopted by the Corporation and be issued and delivered as though the person who signed such certificate, or whose facsimile signature shall have been used thereon, had not ceased to be such officer; and such issuance and delivery shall constitute adoption of such certificate by the Corporation. There shall be entered on the books of the Corporation the number of each certificate issued, the number (and class or series, if any) of shares represented thereby, the name and address of the person to whom such certificate was issued and the date of issuance thereof. SECTION 2. LOST, STOLEN OR DESTROYED CERTIFICATES. A new certificate of stock may be issued in the place of any certificate theretofore issued by the Corporation, alleged to have been lost, stolen or destroyed, and the directors may, in their discretion, require the owner of the lost, stolen or destroyed certificate, or his legal representatives, to give the Corporation a bond, in such sum as they may direct, not exceeding double the value of the stock, to indemnify the Corporation against any claim that may be made against it on account of the alleged loss of any such certificate, or the issuance of any such new certificate and to provide such evidence of loss, theft or destruction as the Board of Directors may require. SECTION 3. TRANSFER OF SHARES. The shares of stock of the Corporation shall be transferable only upon its books by the holders of record thereof in person or by their duly authorized attorneys or legal representatives, and upon such transfer the old certificates shall be surrendered, along with such evidence of the authenticity of such transfer, authorization and other matters as the Corporation or its agents may reasonably require, to the Corporation by the delivery thereof to the person in charge of the stock and transfer books, or to such other person as the directors may designate, by whom they shall be cancelled, and new certificates shall thereupon be issued. A record shall be made of each transfer and whenever a transfer shall be made for collateral security, and not absolutely, it shall be so expressed in the entry of the transfer. SECTION 4. REGULATIONS, TRANSFER AGENTS AND REGISTRARS. The Board of Directors may make such rules and regulations as it may deem expedient concerning the issuance and transfer of certificates for shares of the stock of the Corporation, may appoint transfer agents or registrars, or both, and may require all certificates of stock to bear the signature of either or both. Nothing herein shall be construed to prohibit the Corporation from acting as its own transfer agent at any of its offices. SECTION 5. STOCKHOLDERS RECORD DATE. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which shall not be more than sixty nor less than ten days before the date of such meeting, nor more than sixty days prior to any other action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. SECTION 6. SHAREHOLDERS RECORD OWNERSHIP. The Corporation shall be entitled to recognize the exclusive right of a person registered as such on the books of the Corporation as the owner of shares of the Corporation's stock to receive dividends and to vote as such owner. The Corporation shall not be bound to recognize any equitable or other claim to or interest in such shares on the part of any other person, regardless of whether the Corporation shall have express or other notice thereof, except as otherwise provided by law. SECTION 7. DIVIDENDS AND RESERVES. Subject to the applicable provisions of law or of the Certificate of Incorporation, the Board of Directors may, out of funds legally available therefor, at any regular or special meeting, declare dividends upon the capital stock of the Corporation as and when they deem expedient. Before declaring any dividend there may be set apart out of any funds of the Corporation available for dividends, such sum or sums as the directors from time to time in their discretion deem proper for working capital, or as a reserve fund to meet contingencies, or for equalizing dividends, or for the purpose of repairing, maintaining or increasing the property or business of the Corporation or for such other purposes as the directors shall deem conducive to the interests of the Corporation. The Board of Directors may, in its discretion, modify or abolish any such reserve at any time. SECTION 8. SEAL. The corporate seal shall be circular in form and shall contain the name of the Corporation, the year of its creation and the words "CORPORATE SEAL, DELAWARE." Said seal may be used by causing it or a facsimile thereof to be impressed, affixed, reproduced, engraved, printed or otherwise represented. SECTION 9. FISCAL YEAR. The fiscal year of the Corporation shall be determined by resolution of the Board of Directors. SECTION 10. EXECUTION OF INSTRUMENTS. All agreements, deeds, contracts, proxies, covenants, bonds, checks, drafts or other orders for the payment of money, bills of exchange, notes, acceptances and endorsements, and all evidences of indebtedness and other documents, instruments or writings of any nature whatsoever, issued in the name of the Corporation, shall be signed by such officers, agents or employees of the Corporation, or by any one of them, and in such manner, as from time to time may be determined, either generally or in specific instances, by the Board of Directors or by such officer or officers to whom the Board of Directors may delegate the power to so determine. SECTION 11. STOCK OF OTHER CORPORATIONS. Subject to such limitations as the Board of Directors may from time to time prescribe, any officer of the Corporation shall have full power and authority on behalf of the Corporation to attend, to act and vote at, and to waive notice of, any meeting of stockholders of any corporations, shares of stock of which are owned by or stand in the name of the Corporation, and to execute and deliver proxies and actions in writing for the voting of any such shares, and at any such meeting or by action in writing may exercise on behalf of the Corporation any and all rights and powers incident to the ownership of such shares. SECTION 12. NOTICE AND WAIVER OF NOTICE. Whenever any notice is required by these By-laws to be given, personal notice is not meant unless expressly so stated, and any notice so required shall be deemed to be sufficient if given by depositing the same in the United States mail, postage prepaid, addressed to the person entitled thereto at his address as it appears on the records of the Corporation, and such notice shall be deemed to have been given on the day of such mailing. Stockholders not entitled to vote shall not be entitled to receive notice of any meetings except as otherwise provided by statute. Whenever any notice whatever is required to be given under the provisions of any law, or under the provisions of the Certificate of Incorporation of the Corporation or these By-laws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto. Attendance of a person at a meeting, whether of stockholders (in person or by proxy) or of directors or of any committee of the Board of Directors, shall constitute a waiver of notice of such meeting, except when such person attends such meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business on the ground that the meeting is not legally called or convened. SECTION 13. BOOKS, ACCOUNTS AND OTHER RECORDS. Except as otherwise provided by law, the books, accounts and other records of the Corporation shall be kept at such place or places (within or without the state of Delaware) as the Board of Directors, the Chairman or the President may from time to time designate. SECTION 14. INDEMNIFICATION. The Corporation shall, to the fullest extent permitted by Section 145 of the Delaware General Corporation Law, as the same exists or may hereafter be amended, indemnify all persons whom it may indemnify pursuant thereto. ARTICLE VI AMENDMENTS These By-laws may be altered, amended or repealed and By-laws may be made at any annual meeting of the stockholders or at any special meeting thereof if notice of the proposed alteration or repeal or By-law or By-laws to be made be contained in the notice of such special meeting, by the affirmative vote of a majority of the stock issued and outstanding and entitled to vote thereat, or by the affirmative vote of a majority of the Board of Directors, at any regular meeting of the Board of Directors, or at any special meeting of the Board of Directors, if notice of the proposed alteration or repeal, or By-law or By-laws to be made, be contained in the notice of such special meeting. EX-10 3 EXHIBIT 10.8 EXHIBIT 10.8 FLAGSTAR COMPANIES, INC. 1989 NON-QUALIFIED STOCK OPTION PLAN* 1. PURPOSE OF THE PLAN This Flagstar Companies, Inc. (formerly, TW Holdings, Inc.) ("FCI") 1989 Non-Qualified Stock Plan (the "Plan") is intended to promote the interests of FCI by providing the employees of and certain consultants to Flagstar Corporation, a wholly-owned subsidiary of the Company, (referred to herein collectively with FCI as the "Company"), who are largely responsible for the management, growth and protection of the business of the Company, with incentives and rewards to encourage them to continue in their employment or consulting relationship with the Company. 2. DEFINITIONS As used in the Plan, the following definitions apply to the terms indicated below: (a) "Board of Directors" shall mean the Board of Directors of FCI. (b) "Cause," when used in connection with the termination of a Participant's employment or consulting relationship with the Company, shall mean the termination of the Participant's employment by or consulting relationship with the Company because of (A) an act or acts by him, or any omission by him, constituting a felony, if the Participant has entered a guilty plea or confession to, or has been convicted of, such felony, (B) any act of fraud or dishonesty by the Participant which results in or is intended to result in any material financial or economic harm to the Company as determined by the Committee in its sole discretion or (C) a breach of a material provision of any employment or consulting agreement between the Participant and the Company. (c) "Code" shall mean the Internal Revenue Code of 1986, as amended from time to time. (d) "Committee" shall mean the Committee designated by the Board of Directors pursuant to Section 4 hereof from time to time. (e) "Common Stock" shall mean FCI's common stock, $0.50 par value per share. (f) "Company" shall mean FCI, a Delaware corporation, and each of its Subsidiaries. (g) "Disability" shall mean any physical or mental condition which would qualify a Participant for a disability benefit under the long-term disability plan maintained by the Company and applicable to that particular Participant. *As Adopted on 12/1/89, and amended on 11/16/92, 6/7/94, 5/2/95, 10/5/95, 8/12/96, and 12/13/96. (h) "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. (i) "Fair Market Value" of a share of Common stock on any day shall be (a) the closing sales price on the immediately preceding day of a share of Common Stock as reported on the principal securities exchange on which shares of Common Stock are then listed or admitted to trading or (B) if not so reported, the average of the closing bid and ask prices on the immediately preceding business day as reported on the National Association of Securities Dealers Automated Quotation System or (C) if not so reported, as furnished by any member of the National Association of Securities Dealers, Inc. selected by the Committee. In the event that the price of a share of Common Stock shall not be so reported, the Fair Market Value of a share of Common Stock shall be determined by the Committee in its absolute discretion. (j) "Option" shall mean an option to purchase shares of Common Stock granted pursuant to Section 6 hereof. Each Option shall be identified as a non-qualified stock option in the agreement by which it is evidenced. (k) "Participant" shall mean an individual who is eligible to participate in the Plan pursuant to Section 5 hereof and to whom an Option is granted pursuant to the Plan, and, upon his death, his successors, heirs, executors, and administrators, as the case may be. (l) "Plan" shall mean this Flagstar Companies, Inc. 1989 Non-Qualified Stock Option Plan, as it may be amended from time to time. (m) "Securities Act" shall mean the Securities Act of 1933, as amended. (n) "Subsidiary" shall mean any corporation in which, at the time of reference, FCI owns, directly or indirectly, stock comprising more than fifty percent of the total combined voting power of all classes of stock of such corporation. (o) "Voluntary Termination" shall mean any voluntary termination by the Participant of his employment or consulting relationship with the Company. 3. STOCK SUBJECT TO THE PLAN Subject to adjustment as provided in Section 7 hereof, the Committee may grant Options under the Plan with respect to a number of shares of Common Stock that, in the aggregate, does not exceed 6,500,000 shares and, with respect to any individual participant, does not exceed 5,000,000 shares during any calendar year. In the event that any outstanding Option expires, terminates or is cancelled for any reason, the shares of Common Stock subject to the unexercised portion of such Option shall again be available for grants under the Plan for purposes of the 6,500,000 share limit stated above. Shares of Common Stock issued under the Plan may be either newly issued shares or treasury shares, at the discretion of the Committee. 4. ADMINISTRATION OF THE PLAN The plan shall be administered by a Committee of the Board of Directors consisting of three or more persons as designated by the Board of Directors. The Committee shall, from time to time, designate those individuals who shall be granted Options and the number of shares of Common Stock covered by such Options. The Committee shall have full authority to administer the Plan, including authority to interpret and construe any provision of the Plan and the terms of any Option issued under it and to adopt such rules and regulations for administering the Plan as it may deem necessary. Decisions of the Committee shall be final and binding on all parties. The Committee may, in its absolute discretion, accelerate the date on which any Option becomes exercisable or upon termination of employment, permit the term of a terminated employee's options to continue for the remainder of the term of such options or any portion thereof. In addition, the Committee may, in its absolute discretion, grant Options to Participants on the condition that such Participants surrender to the Committee for cancellation such other Options (including, without limitation, options with higher exercise prices) as the Committee specifies. Notwithstanding Section 3 herein, prior to the surrender of such other Options, Options granted pursuant to the preceding sentence of this Section 4 shall not count against the limits set forth in such Section 3. The Committee shall determine whether an authorized leave of absence or absence in military or government service shall constitute termination of employment. The Committee shall have full authority to delegate to a subcommittee of directors (the "Subcommittee") any and all authority granted to the Committee with respect to the Plan, such subcommittee to be constituted and to have such authority as may be necessary to satisfy any and all requirements of Rule 16b-3 promulgated under Section 16 of the Exchange Act and/or Section 162(m) of the Code and the regulations thereunder with respect to any Option granted or exercised pursuant to the terms of the Plan. No member of the Committee or Subcommittee shall be liable for any action, omission, or determination relating to the Plan, and FCI shall indemnify and hold harmless each member of the Committee or Subcommittee and each other director or employee of the Company to whom any duty or power relating to the administration or interpretation of the Plan has been delegated against any cost or expense (including counsel fees) or liability (including any sum paid in settlement of a claim with the approval of FCI) arising out of any action, omission or determination relating to the Plan, unless, in either case, such action, omission or determination was taken or made by such member, director or employee in bad faith and without reasonable belief that it was in the best interests of the Company. 5. ELIGIBILITY The persons who shall be eligible to receive Options pursuant to the Plan shall be (1) such employees of the Company who are responsible for the Management, growth and protection of the business of the Company (including officers of FCI, whether or not they are directors of FCI) as the Committee in its sole discretion shall select from time to time, and (2) those persons who provide consulting services to the Company as the Committee in its sole discretion shall select from time to time. 6. OPTIONS Options granted pursuant to the Plan shall be evidenced by agreements in such form as the Committee shall from time to time approve. Options shall comply with and be subject to the following terms and conditions: (a) Identification of Options All Options granted under the Plan shall be identified in the agreement evidencing such Options as non-qualified stock options that are not intended to be incentive stock options within the meaning of Section 422 of the Code. (b) Exercise Price The exercise price in respect of each share of Common Stock covered by any Option granted under the Plan shall be such price as the Committee shall determine on the date on which such Option is granted; provided, that in the case of any Option granted prior to December 31, 1989 such exercise price shall be Four Dollars ($4.00) per share of Common Stock covered by such Option; and provided, further, that such exercise price may not be less than the minimum price required by law. (c) Term and Exercise of Options (1) Each Option shall be exercisable on such date or dates, during such period and for such number of shares of Common Stock as shall be determined by the Committee on the day on which such Option is granted and set forth in the Option agreement with respect to such Option; provided, however, that each Option shall be subject to earlier termination, expiration or cancellation as provided in this Plan. (2) Each Option shall be exercisable in whole or in part; provided that no partial exercise of an Option shall be (a) for an aggregate price of less than $1,000 or (b) in respect of less than 100 shares of Common Stock. The partial exercise of an Option shall not cause the expiration, termination or cancellation of the remaining portion thereof. Upon the partial exercise of an Option, the agreement evidencing such Option shall be returned to the Participant exercising such Option together with the delivery of the certificates described in Section 6(c)(5) hereof. (3) Subject to the provisions of Section 11 hereof, an Option shall be exercised by delivering notice to FCI's principal office, to the attention of its Secretary, no less than three business days in advance of the effective date of the proposed exercise. Such notice shall be accompanied by the agreement evidencing the Option, shall specify the number of shares of Common Stock with respect to which the Option is being exercised and the effective date of the proposed exercise, and shall be signed by the Participant. The Participant may withdraw such notice at any time prior to the close of business on the business day immediately preceding the effective date of the proposed exercise, in which case such agreement shall be returned to him. Payment for shares of Common Stock purchased upon the exercise of an option shall be made on the effective date of such exercise either (i) in cash, by certified check, bank cashier's check or wire transfer; (ii) subject to the prior written approval of the Committee, in shares of Common Stock owned by the Participant and valued at their Fair Market Value on the effective date of such exercise, or partly in shares of Common Stock with the balance in cash, by certified check, bank cashier's check or wire transfer, or (iii) subject to the approval of the Committee (which approval may be withheld for any reason whatsoever or for no reason) and at the election of the Participant, the Company shall withhold a number of such shares determined by such Participant, the Fair Market Value of which at the exercise date the Committee determines to be sufficient to pay the exercise price. Any payment in shares of Common Stock shall be effected by the delivery of such shares to the Secretary of FCI, duly endorsed in blank or accompanied by stock powers duly endorsed in blank, together with any other documents and evidences as the Secretary of FCI shall require from time to time. (4) Any Option granted under the Plan may be exercised by a broker-dealer acting on behalf of a Participant if (i) the broker-dealer has received from the Participant or the Company a fully- and duly-endorsed agreement evidencing such Option and instructions signed by the Participant requesting FCI to deliver the shares of Common Stock subject to such Option to the broker-dealer on behalf of the Participant and specifying the account into which such shares should be deposited, (ii) adequate provision has been made with respect to the payment of any withholding taxes due upon such exercise and (iii) the broker-dealer and the Participant have otherwise complied with Section 220.3(e)(4) of Regulation T, 12 CFR Part 220. (5) Certificates for shares of Common Stock purchased upon the exercise of an Option shall be issued in the name of the Participant and delivered to the Participant as soon as practicable following the effective date on which the Option is exercised. (6) During the lifetime of a Participant, each Option granted to him shall be exercisable only by him. No option shall be assignable or transferable otherwise than by will or by the laws of descent and distribution. (d) Effect of Termination of Employment Except as otherwise provided in the agreement evidencing the grant of an Option and subject to the provisions of Section 4 hereof: (1) In the event that the employment or consulting relationship of a Participant with the Company shall terminate for any reason other than for Cause or by reason of Voluntary Termination (i) Options granted to such Participant, to the extent that they were exercisable at the time of such termination of the employment or consulting relationship, shall remain exercisable until the expiration of one year after such termination, on which date they shall expire and terminate and (ii) Options granted to such Participant, to the extent that they were not exercisable at the time of such termination, shall expire and terminate at the close of business on the date of such termination; provided, however, that no Option shall be exercisable after the expiration of its term. (2) In the event of the Voluntary Termination of a Participant's employment or consulting relationship, all outstanding Options, to the extent that they were exercisable on the date of termination, shall continue to be exercisable for a period of 60 days from the date of termination. After the lapse of such 60 days, all Options, exercisable or not exercisable on the date of termination, shall expire and be terminated; provided, however, that no Option shall be exercisable after the expiration of its term. (3) In the event of the termination of a Participant's employment or consulting relationship for Cause, all outstanding Options granted to such Participant, exercisable or not exercisable, shall expire and terminate at the commencement of business on the date of such termination. (e) Certain Restrictions (1) Without limiting the provisions of Section 10 hereof, unless otherwise specified in the agreement pursuant to which an Option is granted, in the event a Participant's employment by the Company is terminated for Cause prior to July 5, 1994, such Participant shall be required to offer to sell to FCI or its designee all shares of Common Stock acquired by him pursuant to the exercise of such Option and at the time of such termination of employment owned by him, and FCI shall have the right to require such Participant to sell such shares to it or its designee, at a price per share equal to the exercise price with respect to each such share under such Option. Such offer and right shall be on the basis that the purchase and sale shall occur on a business day selected by FCI by written notice to the Participant, which business day shall be at least five calendar days after FCI gives the Participant written notice of its intent to purchase such shares and which business day shall be not more than ninety (90) days following such termination of employment. At the time of such purchase and sale, the Participant shall deliver to FCI the certificates representing the shares of Common Stock to be so purchased against payment of the purchase price therefor in cash or by certified check, wire transfer or bank cashier's check, as selected by FCI or its designee. (2) Without limiting the provisions of Section 10 hereof, certificates representing shares of Common Stock issued pursuant to this Plan shall bear such legends as the Committee, in its sole discretion, deems necessary or desirable to reflect the restrictions described in this Section 6(e) 7. ADJUSTMENT UPON CHANGES IN COMMON STOCK (a) Shares Available for Grants In the event of any change in the number of shares of Common Stock outstanding by reason of any stock dividend or split, recapitalization, merger, consolidation, combination or exchange of shares or similar corporate change, the maximum aggregate number of shares of Common Stock with respect to which the Committee may grant Options shall be appropriately adjusted by the Committee. In the event of any change in the number of shares of Common Stock outstanding by reason of any other event or transaction, the Committee may, but need not, make such adjustments in the number and class of shares of Common Stock with respect to which Options may be granted as the Committee may deem appropriate. (b) Outstanding Options - Increase or Decrease in Issued Shares Without Consideration Subject to any required action by the shareholders of FCI, in the event of any increase or decrease in the number of issued shares of Common Stock resulting from a subdivision or consolidation of shares of Common Stock or the payment of a stock dividend (but only on the shares of Common Stock), or any other increase or decrease in the number of such shares effected without receipt of consideration by FCI, the Committee shall proportionally adjust the number of shares of Common Stock subject to each outstanding Option and the exercise price per share of Common Stock in respect of each such Option. (c) Outstanding Options - Certain Mergers Subject to any required action by the shareholders of FCI, in the event that FCI shall be the surviving corporation in any merger or consolidation (except a merger or consolidation as a result of which the holders of shares of Common Stock receive securities of another corporation), each Option outstanding on the date of such merger or consolidation shall pertain to and apply to the securities which a holder of the number of shares of Common Stock subject to such Option would have received in such merger or consolidation. (d) Outstanding Options - Certain Other Transactions In the event of (i) a dissolution or liquidation of FCI, (ii) a sale of all or substantially all of FCI's assets, (iii) a merger or consolidation involving FCI in which FCI is not the surviving corporation or (iv) a merger or consolidation involving FCI in which FCI is the surviving corporation but the holders of shares of Common Stock receive securities of another corporation and/or other property, including cash, the Committee shall, in its absolute discretion, have the power to: (i) cancel, effective immediately prior to the occurrence of such event, each Option outstanding immediately prior to such event (whether or not then exercisable), and, in full consideration of such cancellation, pay to the Participant to whom such Option was granted an amount in cash, for each share of Common Stock subject to such Option, equal to the excess of (a) the value, as determined by the Committee in its absolute discretion, of the property (including cash) received or to be received by the holder of a share of Common Stock as a result of such event over (b) the exercise price in respect of each share of Common Stock covered by such Option; or (ii) provide for the exchange of each Option outstanding immediately prior to such event (whether or not then exercisable) for an option on some or all of the property for which each share of Common Stock subject to such Option is exchanged and, incident thereto, make an equitable adjustment as determined by the Committee in its absolute discretion in the exercise price of the option, or the number of shares or amount of property subject to the option or, if appropriate, provide for a cash payment to the Participant to whom such Option was granted in partial consideration for the exchange of the Option. (e) Outstanding Options - Other Changes In the event of any change in the capitalization of FCI or corporate change other than those specifically referred to in Section 7(a), (b), (c), or (d) hereof, the Committee may, in its absolute discretion, make such adjustments in the number and class of shares subject to Options outstanding on the date on which such change occurs and in the per share exercise price of each such Option as the Committee may consider appropriate to prevent dilution or enlargement of rights. (f) No Other Rights Except as expressly provided in the Plan, no Participant shall have any rights by reason of any subdivision or consolidation of shares of stock of any class, the payment of any dividend, any increase or decrease in the number of shares of stock of any class or any dissolution, liquidation, merger or consolidation of FCI or any other corporation. Except as expressly provided in the Plan, no issuance by FCI of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number of shares of Common Stock subject to an Option or the exercise price of any Option. 8. RIGHTS AS A STOCKHOLDER No person shall have any rights as a stockholder with respect to any shares of Common Stock covered by or relating to any Option granted pursuant to this Plan until the date of the issuance of a stock certificate with respect to such shares. Except as otherwise expressly provided in Section 7 hereof, no adjustment to any Option shall be made for dividends or other rights for which the record date occurs prior to the date on which such stock certificate is issued. 9. NO SPECIAL EMPLOYMENT RIGHTS; NO RIGHT TO OPTION Nothing contained in the Plan or any Option shall confer upon any Participant any right with respect to the continuation of his employment or consulting relationship with the Company or interfere in any way with the right of the Company, subject to the terms of any separate employment agreement to the contrary, at any time to terminate such relationship or to increase or decrease the compensation of the Participant from the rate in existence at the time of the grant of an Option. No person shall have any claim or right to receive an Option hereunder. The Committee's granting of an Option to a Participant at any time shall neither require the Committee to grant an Option to such Participant or any other Participant or other person at any time nor preclude the Committee from making subsequent grants to such Participant or any other Participant or other person. 10. SECURITIES MATTERS (a) FCI shall be under no obligation to effect the registration pursuant to the Securities Act of any shares of Common Stock to be issued hereunder or to effect similar compliance under any state laws. Notwithstanding anything herein to the contrary, FCI shall not be obligated to cause to be issued or delivered any certificates evidencing shares of Common Stock pursuant to the Plan unless and until FCI is advised by its counsel that the issuance and delivery of such certificates is in compliance with all applicable laws, regulations of governmental authority and the requirements of any securities exchange on which shares of Common Stock are traded. The Committee may require, as a condition of the issuance and delivery of certificates evidencing shares of Common Stock pursuant to the terms hereof, that the recipient of such shares make such covenants, agreements and representations, and that such certificates bear such legends, as the Committee, in its sole discretion, deems necessary or desirable. (b) The exercise of any Option granted hereunder shall only be effective at such time as counsel to FCI shall have determined that the issuance and delivery of shares of Common Stock pursuant to such exercise is in compliance with all applicable laws, regulations of governmental authority and the requirements of any securities exchange on which shares of Common Stock are traded. FCI may, in its sole discretion, defer the effectiveness of any exercise of an Option granted hereunder in order to allow the issuance of shares of Common Stock pursuant thereto to be made pursuant to an effective registration statement or an exemption from such registration or other methods for compliance available under federal or state securities laws. FCI shall inform the Participant in writing of its decision to defer the effectiveness of the exercise of an Option granted hereunder. During the period that the effectiveness of the exercise of an Option has been deferred, the Participant may, by written notice, withdraw such exercise and obtain the refund of any amount paid or delivered with respect thereto. 11. WITHHOLDING TAXES (a) Cash Remittance Whenever shares of Common Stock are to be issued upon the exercise of an Option, the Participant shall be required, as a condition to the exercise of the related Option, to remit to the Company in cash an amount sufficient to satisfy federal, state and local withholding tax requirements, if any, attributable to such exercise prior to the delivery of any certificate or certificates for such shares. (b) Stock Remittance At the election of the Participant, subject to the approval of the Committee (which approval may be withheld for any reason whatsoever or for no reason), when shares of Common Stock are to be issued upon the exercise of any Option, in lieu of the cash remittance required by Section 11(a) hereof, the Participant may tender to the Company a number of shares of Common Stock determined by such Participant, the Fair Market Value of which at the tender date the Committee determines, in its sole discretion, to be sufficient to satisfy the federal, state and local withholding tax requirements, if any, attributable to such exercise and not greater than the Participant's estimated total federal, state and local tax obligations associated with such exercise. (c) Stock Withholding At the election of the Participant, subject to the approval of the Committee (which approval may be withheld for any reason whatsoever or for no reason), when shares of Common Stock are to be issued upon the exercise of an Option, in lieu of the cash remittance required by Section 11(a) hereof, the Company shall withhold a number of such shares determined by such Participant, the Fair Market Value of which at the exercise date the Committee determines (in its sole discretion) to be sufficient to satisfy the federal, state and local withholding tax requirements, if any, attributable to such exercise and not greater than the Participant's estimated total federal, state and local tax obligations associated with such exercise. 12. AMENDMENT OF THE PLAN The Board of Directors or the Committee may at any time suspend or discontinue the Plan. Additionally, the Board of Directors or the Committee may revise or amend the Plan in any respect whatsoever 13. NO OBLIGATION TO EXERCISE The grant to a Participant of an Option shall impose no obligation upon such Participant to exercise such Option. 14. TRANSFERS UPON DEATH Upon the death of a Participant, outstanding Options granted to such Participant may be exercised only by the executors or administrators of the Participant's estate or by any person or persons who shall have acquired such right to exercise by will or by the laws of descent and distribution. No transfer by will or the laws of descent and distribution of any Option, or the right to exercise any Option, shall be effective to bind the Company unless the Committee shall have been furnished with (a) written notice thereof and with a copy of the will and/or such evidence as the Committee may deem necessary to establish the validity of the transfer and (b) an agreement by the transferee to comply with all the terms and conditions of the Option that are or would have been applicable to the Participant and to be bound by the acknowledgements made by the Participant in connection with the grant of the Option. 15. EXPENSES The expenses of the Plan shall be paid by the Company. 16. FAILURE TO COMPLY In addition to the remedies of the Company elsewhere provided for herein, if a Participant shall fail to comply with any of the terms or conditions of the Plan or the agreement executed by such Participant evidencing an option, the Committee may cancel such Option and cause such Option to be forfeited, in whole or in part, as the Committee, in its absolute discretion, may determine, unless such failure is remedied by such Participant within ten days after such Participant's receipt of written notice of such failure from the Committee or the Company. 17. EFFECTIVE DATE AND TERM OF THE PLAN The Plan was adopted by the Board of Directors on December 1, 1989, subject to approval by the shareholders of FCI in accordance with applicable laws and the requirements of Rule 16b-3 promulgated under Section 16(b) of the Exchange Act. Options may be granted under the Plan at any time prior to the receipt of such shareholder approval; provided, however, that each such grant shall be subject to such approval. Without limitation on the foregoing, no Option may be exercised prior to the receipt of such approval. If the Plan is not so approved prior to November 30, 1990, then the Plan and all Options then outstanding hereunder shall forthwith automatically terminate and be of no force and effect. EX-10 4 EXHIBIT 10.47 EXHIBIT 10.47 SECOND AMENDMENT TO EMPLOYMENT AGREEMENT BETWEEN FLAGSTAR COMPANIES, INC. AND JAMES B. ADAMSON This Second Amendment to Employment Agreement ("Amendment") is made and entered into as of December 31, 1996 between Flagstar Companies, Inc., a Delaware corporation (the "Company"), and James B. Adamson (the "Executive"). WITNESSETH: WHEREAS, the Company and the Executive entered into an Employment Agreement dated as January 10, 1995 (the "Agreement"); WHEREAS, the Company and the Executive desire to extend the term of the Executive's employment under the Agreement and the Company desires to provide the Executive with additional incentives to continue in the employ of the Company; NOW, THEREFORE, in consideration of the premises and the mutual covenants and obligations hereinafter set forth, the parties agree as follows: 1. The first two sentences of section 1 of the Agreement are amended and restated in their entirety to provide as follows: "The Company agrees to employ the Executive from the first day following the Executive's termination of his employment with his prior employer (the "Commencement Date") until the close of business on January 31, 1999, unless his employment is earlier terminated pursuant to section 5. (The Executive's period of employment under this Agreement, whether ending on January 31, 1999 or earlier pursuant to section 5 is hereinafter referred to as the "Employment Term," and each twelve consecutive month period or portion thereof beginning on the Commencement Date and each anniversary thereof during the Employment Term is hereinafter referred to as a "Contract Year.")" 2. Subsection (a) of section 3 of the Agreement is amended and restated in its entirety to provide as follows: "Base Compensation. During the Employment Term the Company shall pay the Executive an annual base salary (the "Base Salary") as compensation for his employment, in equal installments and at least twice in each calendar month. The Base Salary shall be at the annual rate of $950,000 for the first Contract Year; $1,000,000 for the second Contract Year; $1,050,000 for the third Contract Year; and $1,100,000 for the fourth Contract Year." 3. New subsections (i), (j) and (k) are added to section 3 of the Agreement after subsection (h) thereof, which new subsections shall provide as follows: "(i) 1996 Bonus. On January 7, 1997, the Company shall pay the Executive an Annual Bonus for calendar year 1996 in the amount of $100,000. (j) Extension Bonus. Upon execution of this Amendment, as a bonus for agreeing to extend the Employment Term, the Company shall forgive in full its advance of $325,000 of the Executive's 1996 Base Salary made on March 26, 1996. (k) Retention Bonuses. On January 7, 1997, as a retention bonus relating to services to be performed during the year ending on December 31, 1997, the Company shall pay the Executive $1,550,000. If the Executive is employed by the Company on January 1, 1998 or if prior to January 1, 1998 (i) the Executive's employment with the Company is terminated by the Company without Cause or (ii) the Executive terminates his employment with the Company under the circumstances described in clause (A) of subsection (c)(iv) of section 5, on January 2, 1998 the Company shall pay the Executive a retention bonus, relating to services to be 2 performed during the year ending on December 31, 1998, in the amount of $2,000,000; if the Executive's employment is terminated during said period by reason of the Executive's death or Permanent Disability, the amount of such retention bonus shall be $1,000,000, which shall be paid on January 2, 1998. If the Executive is employed by the Company on January 1, 1999 or if after January 1, 1998 and prior to January 1, 1999 (i) the Executive's employment with the Company is terminated by the Company without Cause or (ii) the Executive terminates his employment with the Company under the circumstances described in clause (A) of subsection (c)(iv) of section 5, on January 2, 1999 the Company shall pay the Executive a retention bonus, relating to services to be performed during the year ending on December 31, 1999, in the amount of $3,000,000; if the Executive's employment is terminated during said period by reason of the Executive's death or Permanent Disability, the amount of such retention bonus shall be $1,500,000, which shall be paid on January 2, 1999. The Company's obligation to pay the Executive the retention bonuses specified in this subsection (k) shall be guaranteed by Denny's Restaurants, Inc. ("Denny's") pursuant to the form of Guaranty and Security Agreement (the "Security Agreement") attached hereto as Appendix "A". The Company shall cause Denny's to execute and deliver the Security Agreement and to establish and fund the Security Account referred to in the Security Agreement with a bank reasonably acceptable to the Executive by no later than January 20, 1997. On or before January 20, 1997, Latham & Watkins shall deliver its opinion, in a form which is reasonably satisfactory to the Executive, with respect to the validity and perfection of the security interest contemplated by the Security Agreement. None of the retention bonuses provided for in this subsection (k) shall be subject to forfeiture by the Executive for any reason after the date the 3 Executive has become entitled to receive each such bonus pursuant to the provisions of this subsection (k)." 4. A new subsection (b)(v) is added to section 5 of the Agreement after subsection (b)(iv) thereof, which new subsection shall provide as follows: "(v) Notwithstanding subsection (b)(iv), in the event of a Change in Control of the Company during the Employment Term, during the period commencing on the effective date of the Change in Control and ending six months thereafter, the Executive may elect to tender his resignation to the Company and upon the effective date of such termination of employment the Company shall pay the Executive a lump sum payment equal to 299% of the sum of (x) the Executive's Base Salary for the twelve month period immediately preceding the date of termination and (y) a targeted bonus amount equal to 75% of such Base Salary. In addition, (A) the Executive and/or his Family shall be entitled until the earlier of (x) the second anniversary of the date of such termination of employment or (y) the commencement of coverage of the Executive and/or his Family by another group medical benefits plan providing substantially comparable benefits to the Welfare Benefits and which does not contain any pre-existing condition exclusions or limitations, to receive and participate in the Welfare Benefits in addition to any continuation coverage which the Executive and/or his Family is entitled to elect under Section 4980B of the Code, (B) the Option shall be vested and exercisable as of the effective date of such termination and (C) the Restricted Stock shall be 100% vested on the effective date of such termination. The foregoing payments and benefits shall also be provided to the Executive if the Executive's employment with the Company is terminated by the Company without Cause or the Executive terminates his employment with the Company under the circumstances described in clause (A) of subsection (c)(iv) of section 5 during the 4 period commencing on the effective date of such Change in Control and ending six months thereafter." 5. Subsection (a)(iii) of section 5 is amended and restated in its entirety to provide as follows: "(iii) the close of business on the date on which the Company gives the Executive written notice of the Company's termination of his employment as a "Termination without Cause" (as defined in subsection (c)) or the close of business on the effective date of a termination of the Executive's employment with the Company pursuant to clauses (A) through (D) of subsection (c)(iv) of section 5;" 6. Clause (B) of subsection (b)(iii) of section 5 is amended by inserting the following words at the beginning of such clause: "not later than 90 days after such termination,". 7. Subsection (c)(ii) of section 5 is amended and restated in its entirety to provide as follows: "(ii) A "Change in Control of the Company" shall occur on the date on which designees of TW Associates, L.P. and KKR Partners II, L.P. (collectively, "KKR") no longer constitute a majority of the Board." 8. Clause (A) of subsection (c)(iv) of section 5 is amended and restated in its entirety to provide as follows: "(A) upon (i) the failure of Denny's to execute and deliver the Security Agreement and to establish and fund the Security Account referred to in the Security Agreement with a bank reasonably acceptable to the Executive by no later than January 20, 1997, (ii) the occurrence of an Event of Default under the Security Agreement or (iii) 10 days' prior written notice from the Executive of his voluntary termination of his employment with the Company following a breach by the Company of a material provision of this Agreement or of the Security Agreement or a change by the 5 Company of the Executive's title or duties as Chairman of the Board and Chief Executive Officer of the Company without the Executive's consent, which breach or change the Company does not correct within 30 days or such longer reasonable amount of time required to correct such breach or change, not to exceed 90 days, after the Executive notifies the Board in writing of the action or omission which the Executive believes constitutes such a breach or change;" 9. Subsection (e) of section 5 is amended and restated in its entirety to provide as follows: "(e) In the event of any termination of the Executive's employment by the Company or by the Executive under the circumstances described in clauses (A) through (D) of subsection (c)(iv), the Executive shall not be required to seek other employment to mitigate damages, and any income earned by the Executive from other employment or self-employment shall not be offset against any obligations of the Company to the Executive under this Agreement." 10. The Executive and the Company each represent and warrant to the other that he or it has the authorization, power and right to deliver, execute, and fully perform his or its obligations under this Agreement in accordance with its terms. IN WITNESS WHEREOF, the parties have duly executed and delivered this Agreement as of the date first written above. Flagstar Companies, Inc. By /s/ Rhonda J. Parish ________________________ Title: /s/ James B. Adamson ------------------------- James B. Adamson 6 EX-10 5 EXHIBIT 10.48 EXHIBIT 10.48 January 15, 1997 PERSONAL AND CONFIDENTIAL - ------------- - ------------- - ------------- - ------------- Dear _________: This letter agreement supplements the existing employment agreement dated as of between (the "Executive") and Flagstar Corporation (the "Company"), as subsequently amended by letter agreement dated as of (collectively, the "Employment Agreement"), and is entered into as an inducement to the Executive to continue in the employ of the Company. 1. RETENTION BONUS. Notwithstanding any provision to the contrary set forth in the Employment Agreement and in addition to the payments and benefits therein provided, the Executive shall be entitled to receive the following payments (the "Retention Bonus") provided the Executive continues to be employed by the Company (or a subsidiary thereof) as of the accrual date indicated: Accrual Date Payment Amount ------------ -------------- June 30, 1997 $ 50,000 December 31, 1997 $100,000 June 30, 1998 $ 50,000 December 31, 1998 $125,000 June 30, 1999 $ 50,000 December 31, 1999 $175,000 Each such payment shall be due and payable to the Executive on or before fifteen (15) days following the corresponding accrual date. Any unaccrued portion of such Retention Bonus shall be forfeited upon termination of the Executive's employment for any reason. 2. REPRICING OF STOCK OPTIONS. The Board has also "repriced" all of your outstanding stock options to the price of $1.25. This means that any options you now hold at either $6.00 or $2.75 may (when vested) be exercised at the price of $1.25. Also, your vesting will remain unchanged, meaning you will not have to start your vesting schedule over again. 3. CHANGE OF CONTROL BENEFIT. Notwithstanding any provision to the contrary set forth in the Employment Agreement, in the event of a Change of Control (as defined below) of the Company, the Executive shall be entitled, during the Election Period (as defined below), to tender his/her resignation to the Company, in which case the Executive shall receive the sum of (i) 200% of the Executive's base salary as in effect on the date of such resignation, plus (ii) 200% of the Executive's target performance bonus for the year in which such resignation occurs (provided that the amount of such target performance bonus shall not be less than 65% of the Executive's then current base salary), plus (iii) an amount equal to 167% of the Company's actual subsidy (as in effect at the time of such resignation) for the Executive's (and his/her family members') medical coverage for an 18 month period following the date of such resignation (collectively, the "Change of Control Benefit"). The Executive shall also be entitled to receive the Change of Control Benefit in the event of his/her termination by the Company following a Change of Control, unless such termination is because of death or permanent disability of Executive (in accordance with Company policy) or for Cause as defined below, if such termination occurs prior to the end of the Election Period. For purposes of this agreement: (i) a Change of Control shall occur on the date on which designees of TW Associates, L.P. and KKR Partners II, L.P. (collectively, "KKR") no longer constitute a majority of the Board of Directors of Flagstar Companies, Inc.; and (ii) "Election Period" shall mean the period commencing upon the effective date of the Change of Control and ending six months thereafter. (iii) "Cause" shall mean (A) the Executive's habitual neglect of his material duties, (B) an act or acts by the Executive, or any omission by him, constituting a felony, and the Executive has entered a guilty plea or confession to, or has been convicted of, such felony, (C) the Executive's failure to follow any lawful directive of the Board or Chief Executive Officer ("CEO") consistent with the Executive's position and duties, (D) an act or acts of fraud or dishonesty by the Executive which results or is intended to result in financial or economic harm to the Company, or (E) breach of a material provision of this Agreement by the Executive; provided that the Company shall provide the Executive (x) written notice specifying the nature of the alleged Cause, and, with respect to Clauses (A), (C) and (E), (y) a reasonable opportunity to appear before the Board or CEO to discuss the matter, and (z) a reasonable opportunity to cure any such alleged Cause. The foregoing Change of Control Benefit shall be payable to the Executive in a lump sum within five (5) business days following any such triggering resignation or termination. In the event the Executive receives payment of the Change of Control Benefit hereunder, the Executive shall not be required to seek other employment to mitigate damages, and any income earned by the Executive from other employment or self-employment shall not be offset against any obligations of the Company to the Executive under this Agreement; provided, however, such payment shall be in lieu of any severance benefits otherwise payable to the Executive under the Employment Agreement of under any severance plan or policy of the Company. If the Executive remains with the Company after the expiration of the Election Period, the Executive's right to receive the Change of Control Benefit shall terminate and his/her severance benefits shall, subject to Sections 4 and 5 below, be governed exclusively by the Employment Agreement. Notwithstanding the foregoing, if the independent accountants acting as auditors for the Company on the date of a Change of Control determine that the Change of Control Benefit payments as provided above would constitute "excess parachute payments" pursuant to Section 280G of the Internal Revenue Code of 1986, as amended, and regulations thereunder, when added to any other parachute payments made by the Company or any affiliate thereof, then the Executive shall receive the greater of (i) the maximum amount which may be paid without the payments being "excess parachute payments," and (ii) the full amount of such Change of Control Benefit without reduction pursuant to (i) above, net of all excise taxes levied on the Executive as a result of such "excess parachute payments," in each case as determined by such auditors. In the event that (ii) above results in the greater benefit to the Executive, the Company shall pay to the Executive the full amount of the Change of Control Benefit as provided herein, and the Executive shall be fully responsible (subject to applicable withholding requirements) for the payment of all excise taxes levied on the Executive as a result of such "excess parachute payments." Any Change of Control Benefit payment made pursuant to this letter agreement shall not be considered compensation for the purpose of any plan or policy of the Company unless such plan or policy expressly so provides. 4. SEVERANCE PAYMENT. Notwithstanding any provision to the contrary set forth in the Employment Agreement, upon the occurrence of an event resulting in the termination of the Executive under circumstances that would entitle the Executive to severance benefits under the Employment Agreement (but not when the Change of Control Benefit is payable), such severance benefits shall be payable to the Executive in a single lump sum payment (the "Severance Payment") within five (5) business days following any such termination. Further, should such an event of termination of the Executive's employment occur, the Executive shall not be required to seek other employment to mitigate damages, and any income earned by the Executive from other employment or self-employment shall not be offset against any obligations of the Company to the Executive under this Agreement. 5. SUBSIDIARY GUARANTIES. The Company's payment obligations herein in respect of the Retention Bonus, the Change of Control Benefit, and the Severance Payment shall be unconditionally guaranteed by the Company's subsidiaries, Denny's, Inc., DFO, Inc., El Pollo Loco, Inc., Quincy's Restaurants, Inc., and Flagstar Enterprises, Inc., such subsidiaries being among the principal operating subsidiaries receiving the benefits of the Executive's continuing employment with the Company. Such subsidiary guaranties shall be "guaranties of payment" and not "guaranties of collection." Except as supplemented and modified hereby, the Employment Agreement and the severance benefits therein contained shall remain in effect and binding on the Executive and the Company. Nothing herein shall be deemed to modify in any respect the right of the Company to terminate the services of the Executive in accordance with the terms of the Employment Agreement and Company policies now or hereafter in effect. If you are in agreement with these terms, please sign one copy of this letter and return it to Stephen Wood. Sincerely, James B. Adamson Chairman, Chief Executive Officer and President cc: Rhonda J. Parish Stephen W. Wood Agreed and accepted: ________________________________ _________________ ___, 199__ By authority duly obtained as of the date first above written, the undersigned, Denny's, Inc., DFO, Inc., El Pollo Loco, Inc., Quincy's Restaurants, Inc., and Flagstar Enterprises, Inc., indirect subsidiaries of the Company, hereby jointly and severally guarantee the payment by the Company to the Executive of the Retention Bonus, the Change of Control Benefit, and the Severance Payment as provided above. In providing such guaranty, each such guarantor acknowledges that it is receiving and will receive substantial and meaningful benefits and services from the Executive's continued employment with the Company. Each such guaranty shall be a guaranty of payment and not of collection. Denny's, Inc. Quincy's Restaurants, Inc. By: By: -------------------------------- ------------------------------- DFO, Inc. Flagstar Enterprises, Inc. By: By: -------------------------------- ------------------------------- El Pollo Loco, Inc. By: -------------------------------- EX-10 6 EXHIBIT 10.49 EXHIBIT 10.49 INFORMATION SYSTEMS MANAGEMENT AGREEMENT This Agreement is entered into as of February 22, 1996 (the "Effective Date"), between 1. Integrated Systems Solutions Corporation, a Delaware corporation and a wholly owned subsidiary of International Business Machines Corporation ("ISSC") AND 2. Flagstar Corporation, a Delaware corporation whose registered office is at 203 E. Main Street, Spartanburg, South Carolina ("Flagstar"). The Parties agree to the terms and conditions set forth in this Agreement including the Supplement and Schedules A through T referenced in this Agreement. Signed for and on behalf of INTEGRATED SYSTEMS SOLUTIONS CORPORATION: By: /s/ George B. Richardson ---------------------------------------------- George B. Richardson, Director of Retail By: /s/ Linda K. Topper ---------------------------------------------- Linda K. Topper, Project Executive Signed for and on behalf of FLAGSTAR CORPORATION: By: /s/ James B. Adamson ---------------------------------------------- James Adamson, Chairman, President and CEO By: /s/ Rhonda J. Parish ---------------------------------------------- Rhonda J. Parish, Senior Vice President, General Counsel & Secretary By: /s/ Honorio J. Padron ---------------------------------------------- Honorio J. Padron, CIO and Vice President TABLE OF CONTENTS PAGE 1. PURPOSE OF AGREEMENT...................................... 1 2. DEFINITIONS AND AGREEMENT AND RELATIONSHIP PROTOCOLS...... 2 2.1 General Definitions.............................. 2 2.2 Evolving Nature of Relationship.................. 10 2.3 Required Consents................................ 11 2.4 Agency........................................... 12 2.5 Conflicts of Interests........................... 13 2.6 Alternate Providers.............................. 13 2.7 Use of Subcontractors............................ 14 3. THE SERVICES.............................................. 15 3.1 Obligation to Provide Services................... 15 3.2 Performance...................................... 15 3.3 Business and Information Systems Plan............ 16 3.4 Disaster Recovery Services....................... 16 3.5 Audits........................................... 16 3.6 Data Center...................................... 17 3.7 Security......................................... 17 3.8 Technology Refresh............................... 18 3.9 Software Licenses................................ 18 3.10 Software Currency................................ 19 3.11 Viruses.......................................... 19 3.12 Applications Software - Substitutions and Additions........................................ 20 4. TRANSITION................................................ 20 4.1 Transition Plan.................................. 20 4.2 Affected Employees............................... 21 4.3 Resources and Facilities......................... 21 5. SERVICES STAFFING AND MANAGEMENT AND ADMINISTRATION....... 22 5.1 Project Executives............................... 22 5.2 Replacement of Personnel......................... 22 5.3 Retention of Experienced Personnel............... 23 5.4 Efficient Use of Resources....................... 23 5.5 Flagstar Approvals and Notification.............. 23 6. CHARGES AND PAYMENTS...................................... 23 6.1 Disbursements.................................... 23 6.2 Annual Service Charge............................ 24 6.3 Additional Charges............................... 24 6.4 Cost of Living Adjustment........................ 24 6.5 Taxes............................................ 24 6.6 New Services..................................... 24 6.7 [Reserved]....................................... 25 6.8 Affiliates....................................... 25 6.9 Reduction of Flagstar Requirements............... 26 6.10 [Reserved]....................................... 26 6.11 Service Credits.................................. 26 6.12 ISSC Standard Retail Services.................... 27 6.13 Most Favored Customer............................ 27 7. INVOICING AND PAYMENT..................................... 27 7.1 Annual Service Charge Invoices................... 27 7.2 Cost of Living Adjustment........................ 27 7.3 Other Charges.................................... 27 7.4 Invoice Payment.................................. 28 7.5 Proration........................................ 28 7.6 Disputed Charges/Credits......................... 28 7.7 Other Credits.................................... 28 8. INTELLECTUAL PROPERTY RIGHTS.............................. 29 8.1 Ownership of Materials........................... 29 8.2 Obligations Regarding Materials.................. 30 9. CONFIDENTIALITY/DATA SECURITY............................. 30 9.1 Confidential Information......................... 30 9.2 Obligations...................................... 30 9.3 Exclusions....................................... 31 9.4 Loss of Company Information...................... 31 9.5 Limitation....................................... 31 9.6 Data............................................. 32 10. TERM AND TERMINATION...................................... 32 10.1 Term............................................. 32 10.2 Renewal and Expiration........................... 32 10.3 Termination By Flagstar.......................... 32 10.4 Termination by ISSC.............................. 33 10.5 Termination Charges.............................. 33 10.6 Termination Proration............................ 34 10.7 Extension of Services............................ 34 10.8 Services Transfer Assistance..................... 34 10.9 Other Rights Upon Termination.................... 35 10.10 Effect of Termination............................ 37 11. LIABILITY................................................. 37 11.1 Liability Caps................................... 37 11.2 Exclusions....................................... 37 11.3 Direct Damages................................... 37 11.4 Dependencies..................................... 38 11.5 Remedies......................................... 38 12. WARRANTIES/REPRESENTATIONS/COVENANTS...................... 38 12.1 Work Standards................................... 38 12.2 Noninfringement.................................. 38 12.3 Disabling Code................................... 39 12.4 Authorization and Enforceability................. 39 12.5 Disclaimer....................................... 39 12.6 Regulatory Proceedings........................... 39 13. INDEMNITIES............................................... 39 13.1 Indemnity by ISSC................................ 39 13.2 Indemnity by Flagstar............................ 41 13.3 Employment Actions............................... 42 13.4 Exclusive Remedy................................. 42 13.5 Indemnification Procedures....................... 42 14. INSURANCE AND RISK OF LOSS................................ 43 14.1 ISSC Insurance................................... 43 14.2 Flagstar Insurance............................... 44 14.3 Risk of Property Loss............................ 45 14.4 Mutual Waiver of Subrogation..................... 45 15. MANAGEMENT COMMITTEE/DISPUTE RESOLUTION/CHANGE CONTROL PROCESS.............................................. 45 15.1 Flagstar/ISSC Management Committee............... 45 15.2 Dispute Resolution............................... 46 15.3 Continued Performance............................ 47 15.4 Change Control Process........................... 47 16. GENERAL................................................... 48 16.1 Control of Services.............................. 48 16.2 Entire Agreement, Updates, Amendments and Modifications................................. 49 16.3 Force Majeure.................................... 49 16.4 Nonperformance................................... 50 16.5 Waiver........................................... 50 16.6 Severability..................................... 50 16.7 Limitations Period upon Termination.............. 50 16.8 Counterparts..................................... 50 16.9 Governing Law.................................... 50 16.10 Binding Nature and Assignment.................... 50 16.11 Notices.......................................... 51 16.12 No Third Party Beneficiaries..................... 51 16.13 Other Documents.................................. 51 16.14 Consents and Approvals........................... 52 16.15 Headings......................................... 52 16.16 Remarketing...................................... 52 TABLE OF SCHEDULES SCHEDULE TITLE A Applications Software - Applications Software - ISSC - Applications Software - Flagstar B Systems Software - ISSC Systems Software - IBM - Systems Software - OEM - Flagstar Systems Software C Flagstar Provided Hardware - Data Center - End User Machines - Existing POS Systems - Affected Employee Machines - Flagstar Server Configurations listed in Schedule I D ISSC Machines E Support Services, Performance Standards and Operational Responsibilities F Third Party Agreements G Disaster Recovery Services H Transition Plan I Network Locations - Flagstar LAN Software - ISSC LAN Software - Flagstar Server Configurations J ISSC Charges, Measures of Utilization and Financial Responsibilities K Operating Environment L Security Procedures M Help Desk Services N Projects O Affected Employees P Maintenance of End User and Existing POS Systems Listed in Schedule C Q Outstanding Employee Claims R [Reserved] S Services Transfer Assistance T Flagstar Corporate Facilities 1. PURPOSE OF AGREEMENT a) ISSC is provider of a broad range of information technology, information management, communications and related services and desires to provide to Flagstar certain information technology and perform for Flagstar certain of the information management and communications functions, responsibilities and tasks that are currently performed by the Flagstar Group for the Flagstar Business and Flagstar Group. Flagstar desires that the Flagstar information technology and information management and communications services functions, responsibilities and tasks be migrated from the Flagstar Group to ISSC, and that such technology and services be provided to the Flagstar Group by ISSC which is experienced and skilled in the administration, management, provision and performance of such functions, responsibilities and tasks. After consulting with experts in the information technology field and evaluating other alternative providers, Flagstar has determined that ISSC's service offerings can meet Flagstar's business requirements and purposes, and has, therefore, chosen ISSC as its information technology services provider. This Agreement documents the terms and conditions under which the Flagstar Group will obtain such migration, technology and information management and communications services from ISSC, and ISSC will administer, manage, provide and perform such functions, responsibilities and tasks for the Flagstar Group. b) In entering into this Agreement, the Parties have each identified objectives and goals that each intends that ISSC's performance pursuant to this Agreement will assist the Parties to achieve. Flagstar's objectives and goals include the following: (1) engaging ISSC to efficiently and timely operate and transition the existing Flagstar Group information management and communications technologies and systems to different information management and communications technologies and systems provided and operated by ISSC, which are intended to fulfill the support requirements for the Flagstar Group's administrative, management, planning, financial reporting and operating activities, (2) reducing the on-going monthly operating costs of the Flagstar Group; (3) securing favorable rates for additional resource consumption; (4) taking advantage of new technologies to improve performance and the cost to performance ratios experienced by the Flagstar Group; (5) enhancing the current functionality of the Flagstar Group's systems and levels of service; (6) minimizing any potential operating and financial risks to the Flagstar Group and (7) permitting ISSC to hire and provide career opportunities for certain employees of Flagstar whose positions within Flagstar will be eliminated. The parties intend to work cooperatively together to (1) ensure the integrity and security of existing and future hardware and software systems; (2) increase flexibility regarding resource commitments and availability and evolve technologies to meet the dynamic requirements of the Flagstar Group and Flagstar Business; (3) provide an opportunity for Flagstar to migrate to the "ISSC Standard Retail Services" proposal when and as developed by ISSC; (4) provide an opportunity to transition the Services back to the Flagstar Group or to another service provider from ISSC with minimal disruption; and (5) attempt to ensure that ISSC receives a fair return on its investment in providing the Services to the Flagstar Group. c) ISSC recognizes that the Flagstar Group expects to be treated as a valued customer and agrees that the definition of customer satisfaction goes beyond ISSC's performance against established Performance Standards and Minimum Service Levels and requires that ISSC exhibit customer service attitude focused on assisting Flagstar where possible in reducing its information technology operating costs and improving service to the Flagstar Group and the Flagstar Group customers. d) The provisions of this Section 1 are intended to be statement of the purpose of this Agreement and are not intended to alter the plain meaning of the terms and conditions of this Agreement or to require either Party to undertake performance obligations not required by this Agreement. To the extent that the terms and conditions of this Agreement are unclear or ambiguous, such terms and conditions are to be interpreted and construed consistent with the purposes set forth in this Section 1. Page 1 of 52 2. DEFINITIONS AND AGREEMENT AND RELATIONSHIP PROTOCOLS 2.1 GENERAL DEFINITIONS In this Agreement including the Supplement and Schedules A through T, the following terms will have the following meanings: Additional Resource Charge has the meaning given in Schedule J. or ARC AD/M means both Applications Development and Software Maintenance. AD/M Projects means the Applications Development and Software Maintenance performed in connection with the As Is Systems and To Be Systems after the production cutover date for the corresponding Schedule N Project and/or each New Service added during the Term requiring the performance of Applications Development and Software Maintenance by ISSC. Affiliates means, with respect to Party, any entity at any time Controlling, Controlled by or under common Control with such Party, excluding franchisees of the Flagstar Group in which the Flagstar Group does not own a greater than fifty percent (50%) interest. Affected Employees has the meaning set forth in Section 4.2. Agreement means this Information Systems Management Agreement, the Supplement, and Schedules A through T referenced herein. Annual Service Charge has the meaning given in Schedule J. Applications Development means the programming of any new applications software, and changes or enhancements to existing Applications Software requiring an FTE of 30 days or greater, and/or review/approval by the Change Control Process. Programming effort shall include the pre and post development analysis, planning, design, coding, testing, installation, provision of a single set of program and training documentation per Applications Software program and training necessary to complete the task. Applications Development means the pre and post development analysis, Methodology planning, design, coding, testing, installation, provision of a single set of program and training documentation per Application Software program and training necessary to complete the task. Applications Software means those programs and programming, including all supporting documentation and media, that perform specific user related data processing, data management and telecommunications tasks, including updates, enhancements, modifications, releases and Derivative Works thereof. Applications Software as of the Effective Date is listed in Schedule A, which Schedule shall be updated pursuant to Section 2.2 to reflect the then-current Applications Software. Applications Software - means the Applications Software listed on Flagstar Schedule A under such heading provided or to be provided by Flagstar. Applications Software - means the Applications Software listed on ISSC Schedule A under such heading provided or to be provided by ISSC. Page 2 of 52 As Is Systems means the information processing services that Flagstar provided to itself and the Flagstar Restaurants immediately prior to the Commencement Date. Baseline has the meaning given in Schedule J. Business and Information has the meaning given in Section 3.3. Systems Plan Cable or Cabling means the wires or cables that interconnect Machines and/or connect a Machine to a facility connection point. Change Control Process has the meaning given in Section 15.4 of this Schedule E. Change of Control means the transfer of the Control of a Party from the persons or persons who hold such control on the Effective Date to another person or persons, but shall not include a transfer of the Control of a Party to an Affiliate of such Party. Change Request has the meaning given in Section 15.4. Claim has the meaning given in Section 13.5(a). Code has the meaning given in Section 8. Commencement Date means March 1, 1996. Confidential Information has the meaning given in Section 9.1. Contract Year means each twelve (12) calendar month period beginning January 1 of each calendar year during the term. Control, Controlling, or means possessing, directly or indirectly, the Controlled power to direct or cause the direction of the management and policies of an entity, whether through ownership of voting securities, by contract or otherwise. Cost of Living has the meaning given in Schedule J. Adjustment ("COLA") CRF has the meaning given in Section 15.4. Data Center means the data center owned and operated by Flagstar located in the secured computer operations area of Level B2 of the Flagstar Plaza Building in Spartanburg, South Carolina, as of the Commencement Date. Data Network means all communication facilities and components that are used to transmit voice, image and data signals and which initially consist of the communications facilities and components used by Flagstar immediately prior to the Commencement Date to provide information communication services to the Flagstar Group, including without limitation, all Machines, Software, communications lines, Cabling and Wiring used to connect and transmit information among the Flagstar Corporate Facilities and the Network Locations, but does not include End User Machines or POS Machines. DBMS has the meaning given in paragraph III.F of Section E-1 of Schedule E. Deliverables has the meaning given in paragraph X.D of Section E-1 of Schedule E. Page 3 of 52 Derivative Work means a work based on one or more pre-existing works, including without limitation, a condensation, transformation, expansion or adaptation, which would constitute a copyright infringement if prepared without authorization of the owner of the copyright of such pre-existing work. Develop has the meaning given in Section 8. Direct Damages has the meaning given in Section 11.3. Direct Damages Cap has the meaning given in Section 11.2(a). Disaster Recovery means the location designated by such name or Center its equivalent in the Disaster Recovery plan. Disaster Recovery means the Disaster Recovery services described Services in Schedule G. Effective Date means the date set forth on the initial page of this Agreement. End User Machines means all workstations, terminals, printers, fax machines, and associated peripheral equipment used by end users and described in Schedule C, whether stationary or mobile equipment used by end users, but does not include POS Machines, equipment located within a Flagstar Restaurant, or the workstations being used by ISSC personnel in connection with the Schedule N Projects or the Flagstar Provided Hardware located in the Data Center. Existing Network has the meaning given in Schedule I. Existing POS System means the existing POS Machines as of the Commencement Date, and the Software, Cabling, Wiring and operations procedures manuals used in the Flagstar Restaurants. Flagstar Business means the business engaged in by the Flagstar Group and its franchisees. Flagstar Code means Code Developed by ISSC and/or its subcontractors independently or jointly with the Flagstar Group as part of the Services Flagstar Corporate has the meaning given in Schedule T. Facilities Flagstar Derivative means Developed Code which constitutes Code Derivative Work of software for which the copyright is owned by the Flagstar Group and/or their subcontractors. Flagstar Executive has the meaning given in Section 2.5(b). Technology Committee Flagstar Group means individually and collectively Flagstar and its existing and future Affiliates. Flagstar LAN Software has the meaning given in Schedule I. Flagstar/ISSC has the meaning given in Section 15.1. Management Committee Page 4 of 52 Flagstar Provided means the computer equipment peripheral Hardware devices, storage media, Cabling, connectors and other equipment (however described) provided from time to time by the Flagstar Group for use by ISSC to perform and deliver the Services and fulfill its obligations under this Agreement. The Flagstar Provided Hardware as of the Effective Date is listed on and/or referred to in Schedule C (including the Flagstar Server Configurations listed in Schedule I), which schedule shall be updated pursuant to Section 2.2 during the Term to reflect the then-current Flagstar Provided Hardware. Flagstar Restaurants means the restaurants owned and/or operated by Flagstar. Flagstar Server shall have the meaning given in Schedule I. Configurations Flagstar Software means Applications Software-Flagstar, Flagstar Systems Software and Flagstar LAN Software. Flagstar Systems Software means the systems software and general purpose software such as the database creation and management software, utility software and applications development tools software listed in Schedule B under such heading provided or to be provided by Flagstar. Flagstar Works means literary works of authorship (other than Code) Developed by ISSC and/or its subcontractors independently or jointly with the Flagstar Group, at Flagstar's expense, as part of the Services that is specifically related to the Flagstar Group or the Flagstar Business, including without limitation user manuals, charts, graphs and other written documentation, and machine-readable text and files. Force Majeure Event has the meaning given in Section 16.3. Help Desk means the ISSC help desk which is staffed by ISSC to provide support to Flagstar as described in Schedules E and M. Indemnified Party has the meaning given in Section 13.5(a). Indemnifying Party has the meaning given in Section 13.5(a). Indemnities has the meaning given in Section 13.1. ISSC Code means Code Developed by ISSC personnel at ISSC's expense, and used to provide the Services, which does not constitute a Derivative Work of any software owned by the Flagstar Group, ISSC, IBM or their respective Affiliates or subcontractors. ISSC Derivative Code means Code Developed under this Agreement, which constitutes Derivative Works of software for which the copyright is owned by ISSC, IBM, their respective Affiliates or their subcontractors. ISSC LAN Software has the meaning given in Schedule I. ISSC Indemnitees has the meaning given in Section 13.2. Page 5 of 52 ISSC Interfaces means Code and/or literary works of authorship created at ISSC's expense and used to interface or describe and instruct regarding the interface, between and among Applications Software and the Systems Software which does not constitute a Derivative Work of any software or literary works of authorship owned by Flagstar, ISSC, IBM or their respective Affiliates or subcontractors, including without limitation, user manuals, charts, graphs and other written documentation, and machine-readable text and files. ISSC Machines means the computer equipment, peripheral devices, storage media, cabling, connectors, extenders and other equipment (however described) including without limitation, the New POS Machines, modems, routers and termination boxes for the Network located in the Data Center and at the Network Locations (including the Flagstar headquarters and offices) used from time to time by ISSC to perform and deliver the Services and fulfill its obligations under this Agreement. The ISSC Machines as of the Effective Date are listed on Schedule D, which schedule shall be updated pursuant to Section 2.2 during the Term to reflect the then-current ISSC Machines. ISSC Software means the Applications Software-ISSC, ISSC Systems Software-IBM, Systems Software-OEM and ISSC LAN Software. ISSC Systems Software- means Systems Software listed on Schedule B IBM under the heading "ISSC Systems Software-IBM", provided or to be provided by ISSC. ISSC Works means literary works of authorship (other than Code) Developed at ISSC's expense, by ISSC personnel and/or its contractors and used to provide the Services, including without limitation user manuals, charts, graphs and other written documentation and machine-readable text and files. Level One Support has the meaning given in Schedule M. Level Two Support has the meaning given in Schedule M. Level Three Support has the meaning given in Schedule M. Listed Subcontractors has the meaning given in Section 2.7(a). Local Area Network (LAN) means all communications facilities and components that are used to transmit data signals within a local area network and which initially consist of the communications facilities and components in use by Flagstar immediately prior to the Commencement Date to provide local area network communications facilities to the Flagstar Group as described in Section of Schedule I, including without limitation the associated attachments, peripherals, features, software and accessories, communications lines and Cabling, including the wiring systems, at the locations specified in Sections 1 through 5 of Schedule I. Losses means all losses, liabilities, damages, penalties and claims (including taxes), and all related costs, expenses and other charges (including any and all reasonable attorneys' fees and reasonable costs of investigation, litigation, settlement, judgment, interest and penalties). Machines means the ISSC Machines and Flagstar Provided Hardware. Maintenance Release means those Software fixes and updates provided by the Software vendor as part of normal maintenance service for the Software. Page 6 of 52 Materials means the Flagstar Code, the Flagstar Derivative Code, the Flagstar Works, the ISSC Code, the ISSC Derivative Code, the ISSC Works and the ISSC Interfaces. Minimum Service Levels has the meaning given in Schedule E. Moves, Adds and Changes means the Cabling, relocation, replacement, (MACs) addition or removal of features, model changes and upgrades to End User Machines and telephone equipment and the replacement, addition or removal of Software on the LAN servers and End User Machines located at the Flagstar Corporate Facilities. MAC refers only to such services and does not include the provision of End User Machines, telephone equipment, software or other devices or functions necessary to effectuate a MAC. MAC does not include "construction", "fit up" or wiring activity for existing or new Flagstar locations. Network means the Data Network, Local Area Network and Voice Services. Network Locations has the meaning given in Sections 1 through 5 of Schedule I. Network Vendors means any third parties providing information communication services to Flagstar which are accessed or will be accessed through the Network. New POS Machines means the POS Machines to be utilized in connection with the Schedule N Project for point-of-sale services and managers integrated office systems, as described more specifically in Schedule N. New POS Systems means the point-of-sale and managers integrated office systems, Software and Machines as described in Schedule N. New Services has the meaning given in Section 6.6. Parties means ISSC and Flagstar as detailed on the initial page of this Agreement. Party means ISSC or Flagstar as detailed on the initial page of this Agreement. Performance Standards means the service levels and performance responsibilities under which the Services will be provided. The Performance Standards are described in Schedule E. Poll means to connect the Flagstar Corporate Facilities to the Flagstar Restaurants to retrieve restaurant data, perform menu downloads/updates and/or execute remote diagnostics. POS Machines means all point-of-sale workstations, terminals printers and associated peripheral equipment. Page 7 of 52 Required Consents means any consents or approvals required to be obtained (a) to allow ISSC to assume financial and/or support, operational, management and administrative responsibility for the Flagstar Software and Flagstar Provided Hardware in connection with the Services; (b) for the licensing, transfer and/or grant of the right to Flagstar to use the ISSC Software and ISSC Machines as contemplated by this Agreement; and (c) for Flagstar and ISSC to have access to and use of the space, equipment, software and/or third party services provided under the Third Party Agreements in connection with the Services as contemplated by this Agreement. Resource Unit ("RU") has the meaning given in Schedule J. Schedule N Project means the Applications Development and Software Maintenance projects set forth in Schedule N. Service Credits has the meaning set forth in Section 6.11. Service Employees has the meaning given in Section 10.9(g). Services means the administration, management, operation, provision and performance of the information technology services and systems and information management and communications services functions, responsibilities and tasks required to support the administrative, management, planning, financial reporting and operating activities of the Flagstar Group, and the migration and transition of (1) such systems and services from the Flagstar Group to ISSC, and (2) from the existing technology and systems used to perform such services to different technology and systems, all of the preceding as described and defined in, and required by, this Agreement. Services Transfer has the meaning given in Section 10.8. Assistance Similarly Situated means ISSC customers with substantially the Customers same mix and type of processing applications and systems resources utilization at similar or lesser volumes. Software means ISSC Software and Flagstar Software. Software Maintenance means defect identification and fixes; and installation of those fixes and updates provided by the software vendor as part of normal maintenance service for which there is no additional cost to ISSC for the Software: 1. regulatory/statutory changes; 2. version upgrades to Applications Software; and 3. changes or enhancements to existing Applications Software requiring an FTE of not to exceed thirty (30) days and/or review/approval by the Change Control Process. Special Funds has the meaning set forth in Schedule J. Supplement means the Supplement to this Agreement containing the charges and certain other necessary information. Page 8 of 52 System means the Machines, Software and Network provided under this Agreement and the operating environment therefore. Systems Software means those programs and programming (including all supporting documentation and media) that perform tasks related to the functioning of the data processing, and telecommunication equipment which is used to operate the Applications Software or otherwise to support the provision of the Services by ISSC under this Agreement, whether or not licensed to ISSC. Systems Software includes, but is not limited to, operating systems, software utilities, data security software, data network software, communications monitors and data base managers. Systems Software as of the Effective Date is listed in Schedule B, which schedule shall be updated pursuant to Section 2.2 to reflect the then current Systems Software. Systems Software-OEM means Systems Software listed in Schedule B under the heading "Systems Software-OEM", provided or to be provided by ISSC. Term has the meaning given in Section 10.1 and any extension and renewal term described in this Agreement. Termination Charge means the amount that will reimburse ISSC for the expenses incurred and investments made by ISSC to provide the ISSC Machines and ISSC Software and perform the functions, responsibilities and tasks that collectively comprise the Services, together with an ISSC profit based on such expenses and investments, that ISSC has not recovered as of a termination date occurring prior to the expiration of the Term, but such charge does not include any element of profit allocable to periods after the termination date or any charge for lost opportunity or expectancy, however described or denominated, before or after such date. Third Party Agreements means those contractual, leasing and licensing arrangements for which ISSC has undertaken financial, management and/or administrative responsibility and Flagstar receives third party products, software and/or services in connection with the provision of the Services. Third Party Agreements to which Flagstar is a party are listed on Schedule F, which schedule shall be updated pursuant to Section 2.2 to reflect the then-current Third Party Agreements. Third Party Provider means a business or entity other than Flagstar or ISSC that performs tasks by providing products, software and/or service under a Third Party Agreement, in support of the provision of the Services by ISSC. To Be Systems means, with respect to the Schedule N Projects, the information processing services to be provided to Flagstar by ISSC from the date of production cutover of the first Schedule N Project through the date of production cutover of the last Schedule N Project and with respect to information processing services implemented as a result of the Schedule N Projects, the information processing services related thereto through the expiration or earlier termination of the Agreement. Transition Plan has the meaning given in Section 4.1(a). Transition Period has the meaning given in Section 4.1(a). Transition Personnel has the meaning given in Section 4.1(b). Page 9 of 52 Version means those Software updates that generally add function to the existing Software and may be provided by the Software vendor at a fee over and above the standard software maintenance costs. Virus or Viruses has the meaning given in Section 3.11. Voice Services has the meaning given in Schedule E. Wind-Down Expenses means the amount that will reimburse ISSC for the actual costs that ISSC incurs in the disposition and/or reallocation of ISSC Machines, ISSC Software and the portion of the Data Center dedicated to the performance of the Services, the placement of ISSC personnel allocated to the delivery of the Services, and the termination, if appropriate, of the Third Party Agreements, in the event of a termination occurring prior to the expiration of the Term; provided, however, Flagstar shall have the right to mitigate such costs by purchase of, or assumption of the leases for, the ISSC Machines, assumption of the licenses and maintenance agreements for the ISSC Software, hiring the ISSC personnel delivering the Services, assuming Third Party Agreements and taking similar actions. 2.2 EVOLVING NATURE OF RELATIONSHIP a) The Supplement and Schedules A through T to this Agreement will be updated by the Parties as set forth in this Agreement as necessary or appropriate during the Term to accurately reflect the evolution of the Services and components and elements of the Services as described therein. b) For the one hundred-eighty (180) days following the Commencement Date, ISSC and Flagstar reserve the right to inventory, validate and update any information that is reflected in or omitted from the Agreement and attached Supplement and/or Schedules. If discrepancies are detected, the Agreement, Supplement and/or Schedules shall be promptly changed, modified, updated and adjusted to correct such discrepancies upon mutual agreement, so that the Agreement, Supplement and/or Schedules will be correct and accurately reflect the Services and charges provided by ISSC to Flagstar. If either Party disputes the existence of a discrepancy identified by the other Party, the Parties will submit the matter to the Flagstar/ISSC Management Committee for dispute resolution as specified in Section 15. c) Both Flagstar and ISSC agree that the Services provided may require adjustments to reflect the evolving business and operations of the Flagstar Group and ISSC, that the relationship memorialized by this Agreement is dynamic in nature and will evolve as the operating and business environment of the Flagstar Group changes and evolves, and that the scope of the Services that will be provided by ISSC during the Term may be changed and modified with the written agreement of the Parties pursuant to the Change Control Process. Therefore, the Flagstar/ISSC Management Committee will periodically evaluate the business and operating strategies of each Party and recommend modifications to, and evolution of, the Services (including the Performance Standards and Minimum Service Levels) to optimize such strategies. d) While the Parties will endeavor to update, modify and amend this Agreement, the Supplement and the Schedules as necessary or appropriate from time to time to reflect the parameters and changing nature of the Services and the requirements of the Flagstar Group and Flagstar Business, the Parties acknowledge that such activities may not always be documented with specificity. Therefore, the Parties agree to deal with each other in good faith to resolve all issues presented and any disputes that may arise. Page 10 of 52 2.3 REQUIRED CONSENTS a) The Flagstar Group shall remain the contracting party of record for the Third Party Agreements to which the Flagstar Group is a party on the Commencement Date. ISSC will provide Flagstar with advice and counsel regarding ISSC's experience and agreements with the vendors under the Third Party Agreements to which the Flagstar Group is a party on the Commencement Date with regard to obtaining any Required Consents, and the benefit of any relationship of ISSC with each such vendor to the extent permitted under the ISSC-vendor arrangement to obtain any Required Consent. ISSC and Flagstar will share management and administrative responsibilities for obtaining all Required Consents under the Third Party Agreements existing on the Commencement Date. Flagstar shall have the responsibility for timely obtaining all Required Consents under the Third Party Agreements entered into after the Commencement Date and for which Flagstar bears financial responsibility and pays the vendors directly thereunder, except Third Party Agreements to which any Affiliate of ISSC is a party. ISSC shall have the responsibility for timely obtaining all Required Consents under Third Party Agreements entered into after the Commencement Date (i) with affiliates of ISSC, and (ii) for which ISSC bears financial responsibility and pays the vendors directly or indirectly through a third party, thereunder. The provisions of this Section shall not be applicable to New Services unless provided by the Parties in the documentation governing New Services. b) Flagstar shall bear the costs, if any, of obtaining all Required Consents, including without limitation, all charges and fees related to obtaining the Required Consents (i) for the Third Party Agreements existing as of the Commencement Date, except Third Party Agreements to which any Affiliate of ISSC is a party or to which the vendor will charge for or not grant a Required Consent because ISSC is the outsourcing services provider to Flagstar but such vendor does not invoke such charge or refuse to grant a Required Consent as a standard policy with other outsourcing services providers generally, and (ii) for the Third Party Agreements entered into after the Commencement Date for which Flagstar bears financial responsibility and pays the vendor directly thereunder, except Third Party Agreements to which any Affiliate of ISSC is a party. ISSC shall bear such costs of obtaining all Required Consents (A) for the Third Party Agreements to which an ISSC Affiliate is a party as of the Commencement Date or during the Term, (B) for the Third Party Agreements to which the vendor will charge for or not grant a Required Consent because ISSC is the outsourcing services provider to Flagstar but such vendor does not invoke such charge or refuse to grant a Required Consent as a standard policy with other outsourcing services providers generally, and (C) for all Third Party Agreements entered into after the Commencement Date for which ISSC bears financial responsibility and pays the vendor directly or indirectly through a third party, thereunder. All Required Consents with regard to Third Party Agreements existing on the Commencement Date shall be obtained within ninety (90) days after the Effective Date unless otherwise agreed by the Parties in writing. In addition, Flagstar shall bear the costs, if any, associated with the cancellation and re-licensing of any Software licensed by Flagstar prior to the Commencement Date if required for ISSC to provide the Services after the Commencement Date, except Software licensed from ISSC or any Affiliate of ISSC and/or licensed from a vendor that requires such cancellation and re-licensing because ISSC is the outsourcing services provider but does not require such actions as a standard policy with other outsourcing services providers generally. ISSC shall bear the cost, if any, associated with the cancellation and re-licensing of any Software licensed by Flagstar prior to the Commencement Date licensed from ISSC or any Affiliate of ISSC and/or licensed from a vendor that requires such cancellation and re-licensing because ISSC is the outsourcing services provider but does not require such actions as a standard policy with other outsourcing services providers generally, if required for ISSC to provide the Services after the Commencement Date. The provisions of this Section shall not be applicable to New Services unless provided by the Parties in the documentation governing New Services. c) Flagstar will publish a list each month setting forth the status of each Required Consent until all Required Consents are obtained. ISSC shall timely cooperate with Flagstar in order to facilitate the proper and timely publication of such monthly Required Consents list. If any Required Consent is not obtained with respect Page 11 of 52 to any of the Third Party Agreements existing as of the Commencement Date, the Parties shall cooperate with each other in achieving a reasonable alternative arrangement for Flagstar to continue to process its work with minimum interference to its business operations unless and until such Required Consents are obtained. The cost of achieving such reasonable alternative arrangement shall be borne by ISSC if caused by Required Consents needed from (i) ISSC or Affiliates of ISSC, (ii) from the licensors of the ISSC Software, and/or (iii) from vendors under any Third Party Agreements treating outsourcing arrangements involving ISSC as the services provider differently than their standard policies afforded to other outsourcing services providers generally as described in Section 2.3(b), and in all other instances such cost shall be borne by Flagstar. 2.4 AGENCY a) Flagstar appoints ISSC as its agent for the limited purposes of administering, managing, operating under and paying under the Third Party Agreements to which Flagstar is a party in connection with the Services as contemplated by this Agreement. Under this Agreement Flagstar does not appoint ISSC as its agent for the purposes of entering into oral or written agreements with any individual or business entity for or in the name of Flagstar or its Affiliates, without the prior express written approval of Flagstar. Flagstar agrees to promptly notify all Third Party Providers under the Third Party Agreements to which Flagstar is a party of such appointment. Subject to its obligation to pay applicable penalties, damages, termination or other charges under Section 13.1, ISSC may cancel, substitute, terminate, change or add to the Third Party ------------ Providers under the Third Party Agreements as it chooses so long as ISSC continues to perform the Services in the manner required by this Agreement; provided however, ISSC must submit written notification to Flagstar and obtain Flagstar' written agreement prior to the termination, modification or addition of any Third Party Agreement to which Flagstar is a party. If Flagstar does not respond to such notice from ISSC within five (5) business days of Flagstar's receipt of such notice, Flagstar shall be deemed to have agreed to the termination, modification or addition described in the ISSC notice. If such termination will have an impact on the operations of users that are outside the scope of the Services, ISSC will provide or cause to be provided the services that are the subject of such Third Party Agreements to the users on terms no less favorable than the terms of the applicable Third Party Agreement. b) ISSC will perform its obligations and responsibilities as an agent pursuant to Section 2.4(a) under all Third Party Agreements to which the Flagstar Group is a party, subject to the provisions of Section 2.3, this Section 2.4, Section 6.1 and Section 9. Upon Flagstar's request, ISSC will provide to Flagstar all information and documentation related to its activities as the Flagstar Group's agent with regard to such Third Party Agreements. Flagstar may terminate or provide additional restrictions on ISSC's agency appointment with respect to any Third Party Agreement to which the Flagstar Group is a party if ISSC (i) fails to pay any amount due in a timely manner; (ii) permits an actual default to occur; or (iii) ISSC does not diligently pursue the service and financial benefits available to the Flagstar Group under such Third Party Agreement. If Flagstar terminates or provides additional restrictions on ISSC's agency appointment with respect to any Third Party Agreement to which the Flagstar Group is a party solely for the reason set forth in Section 2.4(b)(iii), then Flagstar shall relieve ISSC of the service level impact and/or reimburse ISSC for the additional costs directly attributable to such termination or additional restrictions to the extent Flagstar's action affects ISSC's ability to provide the Services and/or increases ISSC's costs of providing the Services. c) Beginning on the earlier of the Commencement Date or the Effective Date and for the Term, the Flagstar Group will not enter into any new, terminate or amend any existing Third Party Agreement to which the Flagstar Group is a party that adversely impacts ISSC's ability to provide the Services or increases ISSC's cost of providing such Service without the prior written consent of ISSC. Page 12 of 52 2.5 CONFLICTS OF INTERESTS a) Each Party recognizes that ISSC personnel providing Services to Flagstar under this Agreement may perform similar services for others and this Agreement shall not prevent ISSC from performing similar services for others subject to the restrictions set forth in Section 9; provided, however, ISSC shall not use any of the Machines or Software as licensed to perform such similar services for others, without the prior written consent of Flagstar. b) Neither Party shall knowingly solicit any employee of the other Party during the Term of the Agreement unless otherwise agreed in writing by the Parties and except as provided in Section 10.9(g). Flagstar or ISSC employee's responses to or employment resulting from general solicitations will be exempted from this provision. Notwithstanding the foregoing, ISSC will not hire, employ or engage as a consultant or in any other position, however described, any person who is a member of the "Flagstar Executive Technology Committee" during the Term while such person is engaged in any such capacity by any member of the Flagstar Group and for a period of one (1) year thereafter, without the prior written consent of Flagstar. Flagstar shall give ISSC written notice of the members of the Flagstar Executive Technology Committee on the Effective Date and from time to time during the Term as the membership changes. The Flagstar Executive Technology Committee shall not exceed twelve (12) members at any time. 2.6 ALTERNATE PROVIDERS a) During the Term, Flagstar shall have the right to retain third party suppliers to perform any service, function, responsibility or task that is within the scope of the Services or would constitute a New Service pursuant to Section 6.6, or to perform any such services, functions, responsibilities or tasks (whether all or ----------- a part of the Services or the New Services) internally. ISSC shall cooperate with any such third party supplier and Flagstar. Such cooperation shall include, without limitation, (1) providing reasonable physical and electronic access to the Data Center; (2) use of any Machines used by ISSC to perform services provided that such use of any Machines shall be for the purpose of providing services to the Flagstar Group for the Flagstar Business but may not be used by such third party supplier for the purpose of providing data processing services directly to customers and potential customers of the Flagstar Group; (3) use of any of the Software (other than any Software where the underlying license agreement does not authorize such access and consent permitting such access and use has not been obtained); (4) providing such information regarding the operating environment, System constraints, and other operating parameters as is reasonably necessary for the work product of the third party supplier or the Flagstar Group to be compatible with the Services or New Services; and (5) such other reasonable cooperation as mutually agreed by the Parties. b) ISSC's obligations hereunder shall be subject to the third party suppliers' compliance with reasonable Data Center data and physical security and other applicable standards and procedures, execution of appropriate confidentiality agreements, and reasonable scheduling of computer time and access to other resources to be furnished by ISSC pursuant to this Agreement. c) If ISSC's cooperation with Flagstar or any third party supplier performing work as described in Section 2.6(a), causes ISSC to expend additional resources that ISSC would not otherwise have expended but which fall within the scope of activities comprising the Services, such additional resources will be charged to Flagstar under the established charging mechanism and/or Resource Baseline therefor. The Parties further agree that if in ISSC's reasonable, good faith determination, a third party supplier's activities affect ISSC's ability to meet the Performance Standards or otherwise provide the Services in accordance with this Agreement, ISSC will provide written notice to Flagstar of such determination. The Parties will cooperate to determine and verify whether such effect is caused by a third party supplier, the extent of such affect, and how to ameliorate any such effect. ISSC shall be excused for any inability to meet the Performance Standards, Minimum Service Levels or otherwise provide any of the Services to the extent, and Page 13 of 52 only for the period, any such third party supplier's activities directly affect and impact ISSC's ability to meet any Performance Standard or Minimum Service Level or otherwise provide any of the Services in accordance with this Agreement. d) Flagstar's retention of third party suppliers pursuant to this Section 2.6 to perform services, functions, tasks or responsibilities within the scope of the services shall not relieve Flagstar of its obligations set forth in this Agreement to pay the ISSC applicable charges for such services, functions, tasks or responsibilities unless Flagstar is relieved from such charge pursuant to a provision of this Agreement or by the agreement of ISSC. 2.7 USE OF SUBCONTRACTORS a) Within thirty (30) days after the Effective Date, the Parties will develop and prepare a list of approved subcontractors that the Parties agree may be engaged by ISSC to perform and deliver the part or portion of the Services indicated on such list as a subcontractor to ISSC (the "Listed Subcontractors"). With respect to subcontractors which are not Listed Subcontractors, ISSC shall notify Flagstar at least five (5) business days prior to the proposed date of commencement by ISSC of any subcontractor's activity with respect to Flagstar or the Services, in writing of a decision to delegate or subcontract a function, responsibility or task to a subcontractor, or to change subcontractors for any function, responsibility or task, (i) that could have a material affect on the quality, timing, cost, consistency or performance of the Services or on the operations of the Flagstar Group or on the security of the Flagstar Group user data, or on the Flagstar Business or (ii) where the subcontractor will interface directly with the Flagstar Group. Upon Flagstar's request, ISSC shall promptly provide to Flagstar information regarding the proposed new or replacement subcontractors, the scope of the Services to be delegated thereto, experience and financial position of the proposed subcontractor, and ISSC's selection criteria therefor and conclusions regarding its selection in order to permit Flagstar to determine whether to grant its consent to such delegation or subcontract. Subject to ISSC's timely provision of the foregoing information to Flagstar, Flagstar shall be deemed to have accepted such delegation or subcontract or change that is the subject of the notification by ISSC to Flagstar, if Flagstar has not notified ISSC in writing of its good faith objections to such delegation or subcontract on or before the fifth (5th) day after receipt of such notice from ISSC. ISSC shall not delegate or subcontract or change subcontractors unless and until ISSC and Flagstar shall have resolved any objection timely made by Flagstar to such proposed action by ISSC. If Flagstar shall reject any subcontractor proposed by ISSC and no other qualified subcontractor is available with similar skills and capabilities, ISSC shall be relieved of the performance obligations directly affected by the rejection of such subcontractors by Flagstar to the extent ISSC cannot perform such obligations in the normal course of its operations with its own resources. In addition, ISSC shall not disclose any Confidential Information of the Flagstar Group to any subcontractor unless and until such subcontractor has agreed in writing to protect the confidentiality of such Confidential Information in a manner equivalent to that required of ISSC by Section 9. b) ISSC shall remain primarily liable and obligated to Flagstar for the timely and proper performance of all of its obligations hereunder even if such obligations are delegated to third party subcontractors, and the proper and timely performance and actions of any person or entity to which it delegates or subcontracts any such obligation. Page 14 of 52 3. THE SERVICES 3.1 OBLIGATION TO PROVIDE SERVICES Starting on the Commencement Date and continuing during the Term, ISSC shall provide and perform the Services to and for the Flagstar Group, as the Services may evolve and be supplemented and enhanced during the Term as provided in this Agreement, including the following: a) The Services as described and defined in this Agreement (including the Supplement and Schedules referenced in this Agreement); and b) There may be services, functions, responsibilities or tasks not specifically described in this Agreement which are required for the proper performance and provision of the Services and are an inherent part of, or a necessary sub-part included within, the Services described above in this Section 3. If such services, functions, responsibilities and tasks are determined to be required for the proper performance and provisions of the services or are an inherent part, or a necessary sub-part included within, the services, such functions, responsibilities and tasks shall be deemed to be implied by and included within the scope of the Services to the same extent and in the same manner as if specifically described in this Agreement. Each such determination shall be made by agreement of the parties or resolved pursuant to the dispute resolution provisions of Section 15. 3.2 PERFORMANCE a) ISSC agrees that its performance of the Services will meet or exceed each of the applicable Performance Standards and Minimum Service Levels set forth in Schedule E, subject to the limitations and in accordance with the provisions set forth in this Agreement. b) Concurrent with the annual Business and Information Systems Plan review process described in Section 3.3 and more often if requested by Flagstar, Flagstar and ISSC will review and agree to commercially reasonable changes of, modifications of, additions to, deletions of and replacements of the Performance Standards, the Minimum Service Levels and the Service Credits for the purposes of better and more timely reflecting, facilitating and supporting the continuing development of, and evolving priorities of, the Flagstar Group and the Flagstar Business. Any such changes will be implemented through the Change Control Process. The Performance Standards and the Minimum Service Levels shall not be changed, modified or adjusted downward or upward without the prior written agreement of the Parties. The Parties intend that the Performance Standards and the Minimum Service Levels will be improved over time. The Parties agree to cooperate and deal with each other in good faith to promptly resolve on a reasonable basis in consonance with the purposes of the review process, any differences between the Parties regarding appropriate changes to, modifications of, additions to, deletions of and replacements of the Performance Standards, the Minimum Service Levels and the Service Credits. c) ISSC will continue to use only the existing measurement and monitoring tools and procedures as required to set baseline measurements and to measure and report ISSC's performance of the Services against the Performance Standards and Minimum Service Levels in the As Is Systems environment. Subject to Flagstar's prior approval (which approval shall not be unreasonably withheld), ISSC shall implement the necessary measurement and monitoring tools and procedures required to set baseline measurements and to measure and report ISSC's performance of the Services against the Performance Standards and Minimum Service Levels in the To Be Systems environment. Such measurement and monitoring shall permit reporting at a reasonable level of detail sufficient to verify compliance with the Performance Standards and Minimum Service Levels and application of any attendant Service Credits and shall be subject to reasonable audit by Page 15 of 52 Flagstar. Upon request, ISSC shall provide Flagstar with information and reasonable access to such tools and procedures for purposes of verification of the reported performance levels. 3.3 BUSINESS AND INFORMATION SYSTEMS PLAN The Business and Information Systems Plan will be composed of a short-term, tactical plan and a long-range, strategic plan, both of which will be driven by the Flagstar Group's business goals and objectives. The short-term plan will include an identification of proposed operating software and hardware, enhancements and changes, as appropriate, and a projected time schedule for developing and implementing the proposed enhancements and changes. The long-range plan will treat the strategic aspects of the support of the business goals and objectives of the Flagstar Group, including, without limitation, flexible use of the Data Center and other information management resources in support of the Flagstar Group's business priorities and strategies. Flagstar will draft the Business and Information Systems Plan with ISSC's active participation, cooperation, and advice. The initial tactical plan will address the status of the As Is Systems and the Schedule N Projects. ISSC will also provide information regarding industry trends as input to the strategic plans. The final Business and Information Systems Plan will be provided by Flagstar and based on the mutual agreement of the Parties, with any disputed matters being submitted to the dispute resolution process set forth in Section 15. The first Business and Information Systems Plan under this Agreement will be completed on or before September 30, 1996. The Business and Information Systems Plan will be reviewed and updated at least annually thereafter. Any changes to the Agreement or the Services required by the Business and Information Systems Plan will be defined, approved and implemented in accordance with the Change Control Process set forth in Section 15.4. 3.4 DISASTER RECOVERY SERVICES ISSC will provide Disaster Recovery Services in accordance with Schedule G. If ISSC fails to provide Disaster Recovery Services to the extent and in accordance with the time table set forth in Schedule G for a period of seven (7) days, Flagstar will be entitled, at its election to terminate this Agreement pursuant to Section 10.3(a) (without giving the notices and observing the cure periods set forth in Section 10.3(a)) upon written notice to ISSC. If Flagstar elects to terminate this Agreement as described in this Section 3.4, Flagstar shall give notice to ISSC of such election within thirty (30) days after the occurrence of the event on which such termination is based. In the event of a termination authorized under this Section 3.4, Flagstar shall not be required to pay any Termination Charges or Wind-Down Expenses to ISSC; Flagstar shall receive the rights that are provided for it under Section 10.9(a) in the event of a termination of this Agreement pursuant to Section 10.3(a) Cause to receive title to the servers and associated peripheral equipment which are a part of the ISSC Machines; and such termination and rights pursuant to Section 10.3(a) shall constitute the sole and exclusive remedy of Flagstar for such failure of performance by ISSC. 3.5 AUDITS a) ISSC will assist the Flagstar Group in meeting their respective audit and regulatory requirements, including providing access to the Data Center to enable the Flagstar Group and its auditors and examiners to conduct appropriate audits and examinations of the Flagstar Group's operations, and ISSC's operations relating to the performance of the Services to verify the accuracy of ISSC's charges to Flagstar and that the Services are being provided in accordance with this Agreement and the Performance Standards and Minimum Service Levels. Such access will require forty-eight (48) hour notice to ISSC and will be provided at reasonable hours; provided, however, if any such audit activities interfere with ISSC's ability to perform the Services in accordance with the Performance Standards and Minimum Service Levels, ISSC shall be relieved of such performance obligations to the extent caused by such audit activity. If the assistance required of ISSC shall cause ISSC to expend substantial resources and incur substantial additional costs to provide such assistance, Page 16 of 52 Flagstar shall reimburse ISSC for such costs. ISSC will provide access only to information reasonably necessary to perform the audit as required by law, and by the standard financial reporting and planning practices of Flagstar. ISSC shall only permit the auditors of Flagstar and not Flagstar access to ISSC's proprietary data or other ISSC customer's data to the extent reasonably necessary to perform the audits described in this Section 3.5. b) Subject to Section 12.6, ISSC agrees to make any changes and take other actions which are necessary in order to maintain compliance with applicable laws or regulations applicable to its performance and provision of the Services. Flagstar may submit additional findings or recommendations regarding compliance with applicable laws and regulations to ISSC which ISSC will analyze and consider in good faith. ISSC shall promptly respond to Flagstar regarding ISSC's evaluation and activity plan for such findings and recommendations. If any audit or examination reveals that ISSC's invoices for the audited period are not correct other than amounts in dispute pursuant to Section 7.6, ISSC shall promptly reimburse Flagstar for the amount of any overcharges, or Flagstar shall promptly pay ISSC for the amount of any undercharges. 3.6 DATA CENTER a) ISSC will not relocate the portion of the Services provided from the Data Center without the prior written consent of Flagstar, which consent will not be unreasonably withheld. b) During the Term, ISSC will provide the Flagstar Group with reasonable access upon reasonable prior notice to the Data Center in order for Flagstar to provide tours of the Data Center in support of the Flagstar Group and the Flagstar Business. c) ISSC will provide reasonable access to the Data Center and attendant Machines and Software (i) to the Flagstar Group's authorized employees, agents and representatives as necessary or appropriate for the performance, delivery and use of the Services by the Flagstar Group and for the operation, maintenance, upgrade, support and use of any other Flagstar hardware, software and other resources located in the Data Center, and (ii) to Third Party Providers and third party vendors and suppliers of installation, maintenance, support and upgrade services, technology and hardware for the System and any other Flagstar hardware and/or software located in the Data Center serviced thereby. To the extent practical in light of such installation, maintenance, support and upgrade requirements, Flagstar will provide twenty-four (24) hours notice to ISSC prior to any visits by such Third Party Providers and third party vendors and suppliers. d) All access to the Data Center shall be subject to reasonable Data Center data and physical security measures (including Flagstar physical security requirements) and such Flagstar Group employees, agents and representatives and Third Party Providers' and third party vendors' suppliers' undertaking reasonable confidentiality requirements relating to such visits. 3.7 SECURITY Flagstar shall authorize all access to all Software operated by ISSC in support of the Services through the data security procedures as described in Schedule L. ISSC shall notify Flagstar of what entities and personnel are to be authorized access to the Systems Software utilized in support of the Services and the level of security access required by each. The Parties shall cooperate in administering security procedures regarding such access, in accordance with Schedule L. ISSC shall enable such access by persons as designated by Flagstar and deny such access to all other persons, in accordance with Schedule L. Page 17 of 52 3.8 TECHNOLOGY REFRESH As described in this Agreement, ISSC will refresh the information technologies employed in providing the Services. 3.9 SOFTWARE LICENSES a) Except as specifically relieved of such obligations in this Agreement, ISSC will comply with all license obligations under all licenses for the Software, including without limitation, the obligations of nondisclosure and scope of use; provided, however, ISSC will only be obligated under this Section 3.9(a) with regard to the licenses for Flagstar Software to the extent the license obligations thereunder are disclosed to and accepted by ISSC. ISSC shall be deemed to have reviewed and accepted the obligations under the licenses for the Flagstar Software listed on Schedule F on the Commencement Date, except as noted on Schedule F to the contrary. b) All Applications Software-ISSC and Systems Software-OEM provided by ISSC in connection with the Services and any Flagstar Software licensed under a Third Party Agreement shall be licensed (and the attendant maintenance arrangements contracted) in Flagstar's name and as licensee with ISSC having the right to access and use such Software in performing the Services, unless ISSC can procure such Software (and/or attendant maintenance arrangement) on a more cost effective basis in its own name. ISSC shall negotiate with the applicable Software vendors to provide for a right to assign or transfer any licenses (and attendant maintenance arrangements) for the Software licensed and contracted in ISSC's name to Flagstar upon termination or expiration of this Agreement, and ISSC shall promptly provide written documentation to Flagstar describing in detail, and attesting to the grant, of such rights by the vendors upon request by Flagstar from time to time, for copies of such documentation. c) Prior to (1) the addition to the ISSC Software of any software which is not listed in Schedules A or B or (2) any upgrade, enhancement or modification of any ISSC Software listed in Schedules A or B, ISSC shall (i) obtain Flagstar's prior written consent for any such actions, (ii) provide Flagstar with information regarding the amount of any fees and other reasonable requirements Flagstar would be required to undertake in order to obtain a license to and maintenance for such ISSC Software upon the expiration or termination of this Agreement, and (iii) use commercially reasonable efforts to obtain a firm commitment from the providers of such ISSC Software to license and provide maintenance for the ISSC Software to Flagstar upon the expiration or termination of this Agreement upon the payment of such fees and satisfaction by Flagstar of such requirements. If Flagstar does not respond to a request for consent from ISSC within fourteen (14) business days of receipt of such request together with the information and confirmation of the actions required of ISSC in this Section 3.9(c), Flagstar shall be deemed to have granted its consent to the actions for which ISSC requested consent. ISSC shall consider and take into account in the negotiation of its licensing arrangements with providers of the ISSC Software, Flagstar's reasonable concerns regarding the terms and conditions of such ISSC Software licenses and make such licenses and related documentation, excluding pricing information, available to Flagstar upon request. d) ISSC shall not terminate, extend, replace, amend or add licenses for the Software and/or the maintenance arrangements attendant therewith, in Flagstar's name without Flagstar's prior written agreement, provided, however, if Flagstar does not respond to such request for Flagstar's agreement within fourteen (14) business days of its receipt of such request from ISSC, Flagstar shall be deemed to have granted the agreement requested. ISSC may terminate, replace, amend or add licensees for the ISSC Software as it chooses so long as ISSC continues to perform the Services in the manner required by this Agreement; provided, however, ISSC agrees to provide fourteen (14) days written notification to Flagstar prior to each such termination, replacement, amendment or addition and concurrently with such notification, deliver to Flagstar a written report of the impact and ramifications on the Services of ISSC's proposed action. In addition, if such action Page 18 of 52 by ISSC with respect to a license and/or maintenance arrangement for the ISSC Software will have an impact on the Services or the monitoring and/or evaluation of the Services in a manner that in turn will have an impact on the operations or costs of the Flagstar Group or the ability of ISSC or Flagstar to monitor and/or evaluate the performance and delivery of the Services, ISSC will provide or cause to be provided the programs, services, rights and other benefits and resources that are the subject of such licenses to the Flagstar Group on terms no less favorable than the terms of such license and ensure that there shall be no negative impact on the ability of ISSC or Flagstar to monitor and/or evaluate the performance and delivery of the Services. If Flagstar in connection with or resulting from ISSC's termination, replacement, amendment or addition of any license for ISSC Software and/or maintenance arrangement incurs additional expenses or other costs, including but not limited to personnel costs, ISSC shall promptly reimburse Flagstar for such costs. 3.10 SOFTWARE CURRENCY The Parties agree to maintain reasonable currency for Maintenance Releases and Versions of Software in the "To Be Systems" environment (and the modules thereof as implemented pursuant to Schedule N), unless Flagstar requests otherwise. For purposes of this Section, "reasonable currency" shall mean that the next Maintenance Release or Version is installed not later than the longer of (a) twelve (12) months after the date the licensor makes such Maintenance Release or Version commercially available, or (b) within one (1) month after the date the licensor makes a subsequent Maintenance Release or Version commercially available which causes Flagstar to be more than one Maintenance Release or Version behind. In the event Flagstar requests ISSC to expedite installation of a Maintenance Release or Version or to delay upgrading of specific Software beyond such period or requires operation and maintenance of multiple versions of Software, ISSC shall do so, provided, that if ISSC reasonably determines that it will incur any costs as a result of such requests (e.g., Software support costs due to withdrawal of maintenance by the licensor, multiple version charges, etc.) outside of the scope of the Services, then ISSC will notify Flagstar of the amount of such costs in writing and Flagstar, at its option, will either delay installation of such Maintenance Release or Version or update the Software to the current level (as applicable) or reimburse ISSC for any demonstrable costs. The installation and promotion into production of each Maintenance Release and Version shall be performed in accordance with the Change Management Procedures. In addition, Flagstar shall relieve ISSC from any failure to meet a Performance Standard or Minimum Service Level to the extent directly impacted by the delay or acceleration of the next Maintenance Release or Version until such time as the affected Software is brought to "reasonable currency" as defined in this Section 3.10. 3.11 VIRUSES Each Party agrees to use diligent efforts to ensure that no viruses or similar items ("Viruses") are coded or introduced into the System and the operating environments used to provide the Services. ISSC will continue to perform the Virus protection procedures in place at Flagstar prior to the Commencement Date with the Affected Employees and As Is Systems resources, and make a good faith effort to review, analyze and implement, if feasible, ISSC's established virus prevention programs and processes. Such effort will be limited to the As Is Systems located in the Data Center. Once the migration from the As Is Systems located in the Data Center to the To Be Systems located in the Data Center is complete, ISSC will engage in and comply with ISSC's then current established virus prevention programs and processes for the To Be Systems located in the Data Center. If a Virus is found to have been introduced into the System and the operating environments used to provide the Services, ISSC shall use commercially reasonable efforts and diligently work to eliminate the effects of the Virus; provided, however, ISSC shall take immediate action if required due to the nature or severity of the Virus' proliferation. The Party that introduced or permitted a Virus shall Page 19 of 52 bear the costs associated with such efforts and the losses caused by such a Virus. If Flagstar introduces or permits the introduction of a Virus, ISSC shall be relieved of the Performance Standards to the extent such Virus impacts ISSC's ability to satisfy such Performance Standards. 3.12 APPLICATIONS SOFTWARE - SUBSTITUTIONS AND ADDITIONS a) If Flagstar requests a substitution of any Applications Software, Flagstar shall pay the amount by which the periodic license or maintenance fees attributable to the substituted Applications Software exceeds the then-current license or maintenance fees being paid by ISSC attributable to the Applications Software being replaced. If Flagstar deletes any Applications Software from Schedules A or N and does not immediately substitute any other new Applications Software therefor, Flagstar may utilize an amount equal to the then- current applicable license and/or maintenance fees attributable to such deleted Applications Software to offset the fees attributable to any new Applications Software. ISSC will provide Flagstar with the requisite license and/or maintenance fees support documentation to assist Flagstar in evaluating the decision to replace such Applications Software. b) Flagstar may add Applications Software to, or delete Applications Software from, Schedules A or N. ISSC agrees to promote into or remove from production, use and operate any Applications Software from a Third Party Provider selected by Flagstar, including without limitation, non-IBM brand software selected by Flagstar; provided, however, that any resources (software, hardware, personnel, etc.) required to install, delete and/or operate such added Applications Software that are not otherwise required to provide the Services hereunder, or covered under a current Resource Baseline will be provided as New Services pursuant to Sections 6.6. Flagstar shall be permitted by ISSC to audit, control and approve all new Applications Software prior to its promotion into production, and ISSC shall provide the cooperation, information and access necessary or appropriate to permit Flagstar to perform such functions. 4. TRANSITION 4.1 TRANSITION PLAN a) Within thirty (30) days after the Effective Date, ISSC and Flagstar will complete the development and preparation of, and will reach agreement on, the remaining details of the "Transition Plan" set forth in Schedule H, describing (i) the transition from Flagstar to ISSC of the Affected Employees; (ii) the transition of the administration, management, operation under and financial responsibility for the Third Party Agreements from Flagstar to ISSC; and (iii) the transition of the performance of the other functions, responsibilities and tasks currently performed by Flagstar to ISSC which constitute a part of the Services. The Transition Plan shall be implemented and completed over a mutually agreed period as set forth in the Transition Plan starting on the Commencement Date, which period shall in no event extend beyond September 1, 1996, without the prior written agreement of the Parties (the "Transition Period"). Notwithstanding the foregoing in this Section 4.1(a), ISSC's and Flagstar's responsibilities and obligations with respect to the Affected Employees, the Third Party Agreements and the other elements of the Services as set forth in this Agreement shall commence on the dates set forth in this Agreement but in no event later than the Commencement Date. b) During the Transition Period, Flagstar will cooperate with ISSC in implementing the Transition Plan by providing the personnel (or portions of the time of the personnel) set forth in the Transition Plan ("Transition Personnel") and performing the tasks described for Flagstar in the Transition Plan. During the Transition Period, ISSC will be responsible for the provision of the Services (including within the Services the implementation of the Transition Plan). Page 20 of 52 4.2 AFFECTED EMPLOYEES Flagstar will be eliminating certain of the positions within Flagstar associated with its information management and communications services functions commencing on the Commencement Date and through the end of the Transition Period. ISSC has, with Flagstar's consent, offered employment to each of the individuals listed on Schedule O, in accordance with the employment guidelines set forth on Schedule O (the "Affected Employees"). All costs and expenses incurred by ISSC in connection with the offer to employ and the employment of the Affected Employees shall be the responsibility of ISSC. ISSC will promptly reimburse Flagstar for the amount of salary and benefit costs incurred by Flagstar, if any, with respect to each Affected Employee after the Commencement Date for the period until they receive offers and reject such offers or become ISSC employees. 4.3 RESOURCES AND FACILITIES a) To enable ISSC to provide the Services, Flagstar agrees: (i) To provide, at no charge to ISSC, the use of the Flagstar Provided Hardware, the Data Center and such additional space as may be reasonably necessary for the performance of that portion of the Services performed with the Flagstar Provided Hardware and the Flagstar Software. This obligation includes the provision of reasonable office space, storage space, analog telephone capability (but excluding long-distance telephone charges, for which Flagstar will be reimbursed by ISSC), office support services (e.g., janitorial and security) office supplies and office furniture as agreed by the Parties. Flagstar shall be responsible for ensuring such Flagstar facilities provide for a safe working environment, including compliance with applicable laws and regulations. ISSC shall fully cooperate with Flagstar to ensure a safe working environment is maintained and shall take no action that will compromise such safety of such working environment or violate such laws and regulations. (ii) To provide at the Data Center and related Flagstar facilities provided to ISSC as set forth in Section 4.3(a), all heat, light, power, air conditioning, UPS and such other similar utilities as may reasonably be necessary for ISSC to perform the Services. (iii) To provide access to Flagstar parking (if any) facilities for ISSC employees. The use by ISSC of the Flagstar Data Center and other Flagstar facilities and resources described in this Section 4.3 does not constitute or create a leasehold interest. When the Flagstar Provided Hardware, the Data Center and other facilities and resources provided by Flagstar to ISSC to provide and deliver the Services are no longer deemed necessary to perform the Services, Flagstar's obligations set forth in this Section with respect to each such item of resources shall terminate. b) Except as provided in Section 4.3(a), ISSC will have the responsibility and obligation to provide all resources (including, without limitation, personnel, hardware, software, facilities, services and other items, however described) necessary or appropriate for ISSC to provide, perform and deliver the Services as described in this Agreement. c) In addition to the Affected Employees, ISSC will provide and have on site its Project Executive prior to the Commencement Date and for the duration of the Term, and will timely provide additional trained and qualified personnel as necessary or appropriate to facilitate and ensure the timely and proper definition, provision, performance and delivery of the Services in accordance with this Agreement. d) Upon twelve (12) months prior written notice to ISSC, Flagstar may move ISSC from the Data Center to an alternate Flagstar facility or terminate the use by ISSC of Flagstar facilities for the location and operation Page 21 of 52 of the Data Center. In either of these events, ISSC and Flagstar shall cooperate in good faith to adjust the fees paid by Flagstar for the Services in a fair and equitable manner in order to reflect any increased costs to ISSC, including, without limitation, costs of relocation, new space fit-up and other increases in costs experienced by ISSC as a result of the relocation, all based on relocation space of a kind and quality comparable to the Data Center. If such change of locations shall interfere with ISSC's ability to perform the Services in accordance with the Performance Standards and Minimum Service Levels, ISSC shall provide to Flagstar a report regarding the impact of such change of location to Flagstar within three (3) months after receipt of such notice from Flagstar. If such change of location shall interfere with ISSC's ability to perform the Services in accordance with the Performance Standards and Minimum Service Levels, ISSC shall be relieved of such performance obligations to the extent caused by such change in location. e) ISSC will have the right to change the location of the ISSC activities associated with the Services with the prior written consent of Flagstar, which consent shall not be unreasonably withheld. Among the factors Flagstar may consider in determining whether to grant any such consent, Flagstar may consider whether any and all changes in the location of such ISSC activities may result (i) in a reduction of ISSC's ability to perform the Services and the Business and Information Systems Plan; (ii) in any reduced accessibility to ISSC and/or the Services by the Flagstar Group; (iii) in any deterioration of the Services; and (iv) in any additional cost to Flagstar. 5. SERVICES STAFFING AND MANAGEMENT AND ADMINISTRATION 5.1 PROJECT EXECUTIVES a) Prior to the Commencement Date, ISSC and Flagstar will each designate a Project Executive to whom all the appointing Party's communications may be addressed and who has the authority to act for the appointing Party and its subcontractors in connection with all aspects of this Agreement. b) ISSC shall cause the person assigned as the ISSC Project Executive to devote his or her working time and effort in the employ of ISSC primarily to his or her responsibilities for the provision of the Services under this Agreement, subject to ISSC's reasonable holiday, vacation and medical leave policies and subject to occasional, short-term, non-recurring work on other assignments by ISSC related to the Project Executive's areas of expertise. Before the initial or subsequent assignment of an individual to such position, ISSC shall notify Flagstar of the proposed assignment, introduce the individual to appropriate Flagstar representatives, and consistent with ISSC's personnel practices, provide Flagstar with a resume and any other information about the individual reasonably requested by Flagstar. ISSC agrees to discuss with Flagstar any objections Flagstar may have to such assignment and the Parties will resolve such concerns on a mutually agreed basis. c) ISSC will give Flagstar at least ninety (90) days advance notice of a change of the person appointed as the ISSC Project Executive, will discuss with Flagstar any objections Flagstar may have to such change and the Parties will resolve such concerns on a mutually agreed basis. ISSC shall not reassign or replace any person assigned as the ISSC Project Executive during the first year of his or her assignment to the Flagstar service team, nor shall ISSC assign more than four (4) different individuals to such position during the Term, unless Flagstar consents to such reassignment or replacement, or the ISSC employee voluntarily resigns from ISSC, is terminated by ISSC or is unable to work due to his or her death or disability. 5.2 REPLACEMENT OF PERSONNEL If Flagstar reasonably and in good faith determines that it is not in Flagstar's best interests for any ISSC or subcontractor employee to be appointed to perform or to continue performing any of the Services, Flagstar shall give ISSC written notice specifying the reasons for its position and requesting that such employee not be appointed Page 22 of 52 or be removed from the ISSC employee group servicing Flagstar and be replaced with another ISSC employee or subcontractor. Promptly after its receipt of such a notice, ISSC shall investigate the matters set forth in the notice, discuss with Flagstar the results of the investigation, and resolve the matter on a mutually agreed basis with Flagstar. 5.3 RETENTION OF EXPERIENCED PERSONNEL If ISSC fails to meet the Performance Standards or Minimum Service Levels persistently or continuously and if Flagstar reasonably believes such failure is attributable in whole or in part to ISSC's reassignment, movement, or other changes in the human resources allocated by ISSC to the performance and delivery of the Services and/or to the ISSC subcontractors assigned to the Flagstar service team, Flagstar will notify ISSC of such belief. Upon receipt of such notice from Flagstar, ISSC (i) will promptly provide to Flagstar a report setting forth ISSC's position regarding the matters raised by Flagstar in its notice; (ii) will meet with Flagstar to discuss the matters raised by Flagstar in its notice and ISSC's positions with regard to such matters; and (iii) will diligently work to eliminate with respect to the Services any such ISSC human resource practices and/or processes identified and agreed to by the Parties as adversely impacting the performance and delivery of the Services by ISSC. 5.4 EFFICIENT USE OF RESOURCES ISSC shall take commercially reasonable actions (i) to efficiently administer, manage, operate and use the resources employed by ISSC to provide and perform the Services that are chargeable to Flagstar under this Agreement, and (ii) to diligently and continuously improve the performance and delivery of the Services by ISSC and the elements of the System that are used by ISSC to perform and deliver the Services, including, without limitation, tuning or optimizing the systems used to perform the Services. 5.5 FLAGSTAR APPROVALS AND NOTIFICATION For those areas of the Services where Flagstar (a) has reserved right-of-approval, consent or agreement, (b) is required to provide notification, and/or (c) is to perform a responsibility set forth in this Agreement, and such approval, consent, notification or performance is delayed or withheld beyond the period provided in this Agreement, Supplement or the Schedules without authorization or right and, such delay or withholding is not caused by ISSC and affects ISSC's ability to provide the Services under this Agreement, Flagstar will relieve ISSC of the responsibility for meeting the Minimum Service Levels for that portion of the Services to the extent, but only to the extent, directly affected by such delay or withholding and only during the period such approval, consent, notification or performance is delayed or withheld beyond the period provided in this Agreement, Supplement or the Schedules. Flagstar will reimburse ISSC in accordance with this Agreement for additional resources, if any, incurred during such period as a direct result thereof. If not specified otherwise in this Agreement, the period for such approval or notification shall be ten (10) business days unless another time period is otherwise agreed by the Parties. 6. CHARGES AND PAYMENTS 6.1 DISBURSEMENTS Beginning on the Commencement Date, ISSC will pay the Third Party Providers under the Third Party Agreements for the provision of the software, products and services under such Third Party Agreements, including without limitation, the Third Party Providers of Machines and Software, except as specifically set forth in Schedule F as the responsibility of Flagstar. In addition, ISSC will reimburse Flagstar in a timely manner for Flagstar's payments to such Third Party Providers under the Third Party Agreements for which ISSC has financial responsibility for amounts allocable to periods on and after the Commencement Date or the date specified in Schedule F, as Page 23 of 52 applicable. Flagstar will promptly reimburse ISSC for all payments to Third Party Providers made by ISSC for which Flagstar has financial responsibility if such payments are allocable to the periods prior to the Commencement Date or the date specified in Schedule F, as applicable, and are not otherwise the responsibility of ISSC under this Agreement. 6.2 ANNUAL SERVICE CHARGE For each Contract Year during the Term, Flagstar agrees to pay the Annual Service Charge as specified in the Supplement and Schedule J, together with the other amounts as described in this Section 6 and Schedule J. 6.3 ADDITIONAL CHARGES Beginning at the end of the initial month following the Transition Period and at the end of each month thereafter, Flagstar and ISSC will review the quantity of Resource Units utilized by Flagstar during the preceding month and calculate applicable net Additional Resource Charges (ARCs) for such month in accordance with Schedule J. Flagstar will pay the amount of the result of such calculation and netting in accordance with Section 7.4. 6.4 COST OF LIVING ADJUSTMENT Beginning in the first January after the Commencement Date, Flagstar will pay ISSC a Cost of Living Adjustment ("COLA"), in accordance with Section 7.2 and Schedule J. 6.5 TAXES a) The Annual Service Charges paid by Flagstar are inclusive of applicable sales, use, excise, personal property or other similar taxes attributable to the period on or after the Commencement Date based upon or measured by (i) ISSC's cost in acquiring or providing equipment, materials, supplies or third party services furnished to or used by ISSC in performing the Services, (ii) the value or cost of the ISSC Machines and ISSC Software; and (iii) all taxes payable by ISSC with respect to its revenues, income and profit; provided, however, Flagstar will be responsible for paying all personal property or use taxes due on or with respect to Flagstar-Provided Hardware and Flagstar Software. Each Party shall bear sole responsibility for all taxes, assessments and other real property-related levies on its owned or leased real property. b) The Parties agree to reasonably cooperate with each other in good faith to more accurately determine each Party's tax liability and to minimize such liability to the extent legally permissible. Each Party shall provide and make available to the other any resale certificates, and other exemption certificates or information reasonably requested by either Party. The Parties will also work together to segregate the Annual Service Charges and other charges, reimbursements and amounts payable hereunder, into separate payment streams for Services and components of the Services that are taxable, nontaxable, for which a sales, use or similar tax has already been paid by ISSC, and for which ISSC functions merely as a paying agent for Flagstar in receiving goods, supplies or services (including licensing arrangements) that otherwise are nontaxable or have previously been subjected to tax. c) Notwithstanding any other provision of this Agreement, if a services tax is assessed on ISSC's provision of the Services (or any New Services) to Flagstar or on ISSC's charges to Flagstar under this Agreement, Flagstar will be responsible for and pay the amount of any such tax. 6.6 NEW SERVICES a) If Flagstar requests ISSC to perform an additional function, responsibility or task that requires resources for which there is no current Resource Baseline or charging methodology (i.e. such function, responsibility or Page 24 of 52 task is not included in the Annual Service Charge or is not charged separately under another methodology other than this New Services provision), such additional function, responsibility or task will be considered a "New Service." b) If Flagstar's request for a New Service includes a request for ISSC to correspondingly reduce or eliminate one or more existing elements of the Services then being provided hereunder, ISSC shall determine the resources and expenses related to the element or elements of the Services being reduced or eliminated and to the services being added. Prior to performing such New Services, ISSC will provide a written quote to Flagstar setting forth the net increase or decrease in the Annual Service Charge and/or other charging methodologies, and if applicable, increases and decreases in resource baselines and additional resource baselines, if any, that will be attributable to such New Services, and concurrently deliver to Flagstar as a part of such quote a detailed description of and proposal for the New Services together with a report regarding the ramifications and impacts of such New Services on the Services. All changes in the Annual Service Charge and other charging methodologies will be based upon the required proportional increase in System and other resources applicable to the New Services relative to the Annual Service Charge and existing other charging methodologies. Upon receipt of such quote and other documentation, Flagstar may then elect to have ISSC perform the New Services, and the Annual Service Charge and, if applicable, other charging methodologies and Resource Baselines will be established and/or adjusted to reflect such New Services. Notwithstanding the foregoing, nothing herein shall be interpreted as obligating Flagstar to obtain New Services from ISSC. c) The Parties acknowledge that changes during the Term in functions, responsibilities and tasks that are within the scope of the Services will not be deemed to be New Services, if such functions, responsibilities and tasks evolved or were supplemented and enhanced during the Term by ISSC in its sole discretion or pursuant to the provisions of this Agreement. d) If the Parties cannot agree either that a function, responsibility or task falls within the definition of a New Service, ISSC shall nevertheless perform the disputed function, responsibility or task if requested by Flagstar. The determination of whether any function, responsibility or task is a New Service to be paid by Flagstar will be determined pursuant to the dispute resolution provisions in Section 15. Flagstar shall pay fifty percent (50%) of any charges for the disputed function, responsibility or task under this Section 6.6 to ISSC and fifty percent (50%) of any charges for the disputed function, responsibility or task under this Section 6.6 in accordance with Section 7.6, pending a resolution of the dispute in accordance with Section 15. Any payment to Flagstar of any such disputed charge paid by Flagstar to ISSC and into escrow pursuant to this Section 6.6(d) after resolution of the applicable dispute, shall be paid first from the amount in escrow with respect to such dispute and then by ISSC. All amounts paid by ISSC to Flagstar shall be paid promptly upon resolution of the disputed charge together with interest at the rate of two percent (2%) per month from the date of payment by Flagstar to ISSC through the date of payment by ISSC to Flagstar. 6.7 [RESERVED] 6.8 AFFILIATES If Flagstar acquires any additional Affiliates or other operations or assets during the Term and desires that ISSC provide the Services for such Affiliates or other operations or assets, ISSC will provide such Affiliates or other operations or assets with Services in accordance with this Agreement, subject to additional charges if acceptance of such responsibilities would require New Services as described in Section 6.6. Page 25 of 52 6.9 REDUCTION OF FLAGSTAR REQUIREMENTS a) During the Term, if Flagstar experiences significant changes in the scope or nature of the Flagstar Business, which have or are reasonably expected to have the effect of causing sustained decreases in the amount of any ISSC resources used in providing the Services (including, without limitation, sustained decreases in the amount of ISSC resources used in providing the Services due to and during the Services Transfer Assistance period described in Section 10.8), such changes shall be governed by this Section 6.9; provided, however, decreases in resources required in the following circumstances shall not qualify under this Section 6.9: (i) decreases in resources required due to Flagstar performing such Services (excluding a change in the technology platform used by Flagstar to perform such Services and decreases during the Services Transfer Assistance Period); and (ii) decreases in resources required due to Flagstar transferring the provision of such Services to another vendor (excluding a change in the technology platform used by Flagstar to perform such Services unless ISSC offers such technology platforms and decreases during the Services Transfer Assistance Period). b) Flagstar will notify ISSC of any event or discrete set of events which Flagstar concludes qualifies under this Section 6.9. ISSC will promptly identify the changes and the ISSC resource disposition and asset reallocation schedule that will need to be implemented in order to accommodate the decrease of resource requirements for the significant change in a cost-effective manner without disruption to Flagstar's ongoing operations. The disposition schedule and cost savings that will result therefrom will be promptly submitted to Flagstar for review and acceptance. Upon acceptance by Flagstar, ISSC will make the applicable adjustments to the Annual Service Charge and the Resource Baselines in accordance with such disposition schedule to reflect the foregoing in accordance with Section 16.2 and distribute an amended Supplement and Schedule J to Flagstar for acceptance. c) In order to comply with its audit, reporting and planning requirements and all laws and regulations applicable to the Flagstar Group, Flagstar may, at its option and expense, employ an accredited and mutually agreed upon independent auditor to verify that ISSC's methodology and cost and expense elements for calculating the savings referenced in this Section 6.9 is accurate and conforms to generally accepted accounting principles. ISSC will cooperate with such auditor and make such information and records available to the auditor as the auditor may request in order to effect the purpose of this Section 6.9(c); provided, however, the independent auditor shall not disclose any of ISSC's proprietary cost information elements to Flagstar. 6.10 [RESERVED] 6.11 SERVICE CREDITS If ISSC fails to provide the Services in accordance with the Minimum Service Levels, ISSC shall incur the charges set forth in Schedule E (each, a "Service Credit"; collectively, the "Service Credits") against the amounts owed to ISSC for the second month following the month in which the Service Credits were incurred. Service Credits are deemed by the Parties to be a fair estimate of the damages that the Flagstar Group will incur for each event for which a Service Credit is granted in this Agreement, that the actual damages incurred by the Flagstar Group in each such event would be difficult and costly to determine, and that the Service Credits are liquidated damages awarded in lieu of actual damages incurred by the Flagstar Group. The Parties agree that the Service Credits are not penalties and are the sole and exclusive remedy of Flagstar with respect to the incident or event with respect to which such Service Credits are paid or credited by ISSC to Flagstar subject to and as limited by the provisions of Sections 10 and 11. Page 26 of 52 6.12 ISSC STANDARD RETAIL SERVICES If during the Term, ISSC shall offer an "ISSC Standard Retail Services" that would satisfy a portion or all of the information management and communications systems requirements of the Flagstar Group, ISSC will extend to Flagstar a proposal to migrate and convert to such service upon the standard terms and conditions and for the standard pricing that will be offered by ISSC to other existing and potential ISSC customers and Flagstar may, at its election, accept or reject such opportunity. Notwithstanding the foregoing, if Flagstar accepts such offer and migrates to the ISSC Standard Retail Services, ISSC shall adjust the Annual Services Charge and applicable Baseline resources to reflect the charges for the ISSC Standard Retail Services. ISSC will migrate and convert Flagstar to the ISSC Standard Retail Services at a charge that will be the actual, direct, verified cost of ISSC to transition and convert Flagstar to the ISSC Standard Retail Services. 6.13 MOST FAVORED CUSTOMER In the event that ISSC offers revenue based discounts, or discounts based on an aggregation of products and services, or offers better pricing on an aggregation or any single product or service, to any ISSC customer that is purchasing a similar mix of services as that purchased by Flagstar hereunder as or as part of the Services or as a New Service, and such ISSC customer is purchasing similar or lesser volumes of services than Flagstar and using similar systems as provided by ISSC to Flagstar, ISSC will promptly notify Flagstar of such facts and offer such discounts and pricing to Flagstar for the products and services Flagstar acquired or proposes to acquire from ISSC, on substantially similar terms and conditions extended to such ISSC customer, effective as of the date such discounts and pricing were extended to such ISSC customer. 7. INVOICING AND PAYMENT 7.1 ANNUAL SERVICE CHARGE INVOICES On a monthly basis ISSC will invoice Flagstar the proportional amount of the Annual Service Charge for that month in advance, as specified in Schedule J. The invoice will separately state applicable taxes owed by Flagstar by tax jurisdiction. 7.2 COST OF LIVING ADJUSTMENT ISSC will charge Flagstar a COLA adjustment in accordance with the procedures set forth in Schedule J beginning in the first January after the Commencement Date if actual cumulative inflation exceeds the Protection Index. 7.3 OTHER CHARGES Any amount due under this Agreement including amounts described in Sections 7.1 and 7.2 shall be payable as described in Section 7.4. No invoice for any such amount shall be delivered to Flagstar until after the Services which are the subject of such invoice, have been provided to Flagstar; provided, however, any Services that are expressly stated as prepaid or paid in advance in this Agreement, shall be excluded from the limitation of this sentence to the extent, but only to the extent, expressly set forth in this Agreement. Page 27 of 52 7.4 INVOICE PAYMENT a) At its election, Flagstar will pay each invoice either by wire funds transfer or other electronic means acceptable to ISSC to an account specified by ISSC or by bank check within the calendar month in which such invoice is received by Flagstar, provided Flagstar receives the invoice on or before the tenth (10th) day of the month; otherwise such payment shall be made within thirty (30) days after the date of Flagstar's receipt of the invoice. In the event that any invoice payment is not received by ISSC within ten (10) business days following the date specified for such payment herein, a late payment fee of two percent (2%) per month, or the maximum amount permissible by law, whichever is less, of the unpaid, late invoice payment will be due and payable by Flagstar to ISSC from the date such payment became overdue through the date of payment to ISSC. b) In the event that on two (2) occasions in any twelve (12) calendar months of the first five (5) years of the Term, Flagstar fails to timely pay any invoice issued by ISSC to Flagstar within ten (10) business days of the payment date for such invoices as specified in Sections 7.1 and 7.2 hereof, Flagstar shall following the second such occurrence pay to ISSC an amount equal to the Annual Service Charge for the one (1) month immediately following such second occurrence as an advance payment of the Annual Service Charge. ISSC shall hold such amount in escrow. If Flagstar shall timely pay to ISSC all invoices issued to Flagstar pursuant to Sections 7.1 and 7.2 for a period of six (6) consecutive months thereafter, ISSC shall pay to Flagstar the amount of such escrow. This Section 7.4(b) shall not be applicable to nonpayment or late payment of disputed charges and credits described in Section 7.6. 7.5 PRORATION All periodic charges under this Agreement are to be computed on a calendar month basis, and will be prorated for any partial month, unless specifically stated otherwise in this Agreement. 7.6 DISPUTED CHARGES/CREDITS In the event Flagstar disputes the accuracy or applicability of a charge or credit (i.e., Annual Service Charge, ARC, COLA, Service Credits, pass-through billings, etc.), Flagstar shall notify ISSC of such dispute as soon as practicable after the discrepancy has been discovered. The Parties will investigate and resolve the dispute using the dispute resolution processes provided under Section 15 of this Agreement. Any undisputed amounts contained in an invoice containing a disputed charge, will be paid by Flagstar and any undisputed credit amounts will be promptly credited by ISSC. Flagstar, in the case of a disputed charge, or ISSC, in the case of a disputed credit, shall place the disputed amount in an escrow account until such dispute is resolved. Upon resolution of the dispute, the Parties shall be paid any interest having accrued on the disputed amounts held in escrow in connection with such dispute in proportion to the amount received by each Party with respect to such dispute, and the Parties shall each pay a portion of the escrow fees attributable to the disputed amount in an inverse proportion to the percentage of the disputed amount paid to each Party. Unpaid monies that are in dispute and placed in escrow will not be considered a basis for monetary default under this Agreement. 7.7 OTHER CREDITS Except as otherwise set forth in this Agreement, with respect to any amount to be paid or reimbursed to Flagstar by ISSC at the time any such amount is due and payable to Flagstar, ISSC may pay that amount to Flagstar by applying a credit for the month such amount is due and payable against the charges otherwise payable to ISSC hereunder, at ISSC's option. Notwithstanding the foregoing, if the amount to be so paid or reimbursed by ISSC in any specific month, exceeds the charges to Flagstar for such month, ISSC shall promptly pay any difference to Flagstar by check or wire transfer during such month. If ISSC fails to pay any amount due and payable to Flagstar or fails to apply a credit during the month such amount is due and payable, ISSC shall pay or credit such amount Page 28 of 52 together with interest thereon payable at a rate of two percent (2%) per month, or the maximum amount permissible by law, whichever is less, of the unpaid, late monies will be due and payable by ISSC to Flagstar from the date such monies became due to Flagstar through the date of payment or credit to Flagstar. 8. INTELLECTUAL PROPERTY RIGHTS ISSC, Flagstar and their subcontractors may develop, create, modify or personalize (collectively, "Develop") certain computer programming code, including source and object code ("Code") and documentation in order to perform the Services. 8.1 OWNERSHIP OF MATERIALS With respect to any Materials whether Developed solely by ISSC or its subcontractors, or jointly by the Flagstar Group personnel and ISSC or its subcontractors, ownership will be as follows: a) Flagstar Derivative Code and Flagstar Works shall be owned by Flagstar or another member of the Flagstar Group, as applicable. During the Term, ISSC shall have an irrevocable, nonexclusive, worldwide, paid-up license to use, execute, reproduce, display, perform, operate, distribute, modify, develop, personalize and create Derivative Works from such Materials internally, and the right to sublicense third parties to do any of the foregoing, for the sole purpose of performing the Services. b) ISSC Derivative Code, ISSC Code, ISSC Works, and Flagstar Code and ISSC Interfaces, shall be owned by ISSC. During the Term, the Flagstar Group shall have an irrevocable, nonexclusive, worldwide, paid-up license to use in the Flagstar Business, execute, operate, reproduce, display, perform, distribute, modify, Develop, personalize and create Derivative Works from, such Materials internally, and the right to sublicense third parties to do any of the foregoing for the Flagstar Group. c) With respect to any Materials whether or not Developed under this Agreement, which are or have been Developed solely by the Flagstar Group personnel, such Materials shall be owned by Flagstar. At Flagstar's sole option ISSC shall have an irrevocable, nonexclusive, worldwide, paid-up license to use, execute, operate, reproduce, display, perform, distribute, modify, Develop, personalize and create Derivative Works from such Materials internally and the right to sublicense third parties to do any of the foregoing, for the sole purpose of performing the Services during the Term. d) Any ownership or license rights herein granted to either Party or another member of the Flagstar Group or any other Authorized Users are limited by and subject to any patents and copyrights held by, and terms and conditions of any license agreements with, applicable Third Party Providers. e) To the extent that by operation of law, any of the Materials may not be owned by ISSC or the Flagstar Group to which ownership has been allocated under this Section 8, each Party agrees to promptly assign, or cause to be assigned, and take such actions and execute and deliver such documents as shall be necessary or appropriate to effect such assignment without further consideration. Each Party hereby assigns, without further consideration, the ownership of all right, title and interest in all U.S. and foreign copyrights, mask work rights (if any) and patents in the Materials to the other Party as set forth in this Section 8. Such assignee shall have the right to obtain and hold in its own name or transfer patents and copyrights, applications, registrations, renewals and all other rights relating or pertinent thereto. Page 29 of 52 8.2 OBLIGATIONS REGARDING MATERIALS a) The Parties agree to reproduce copyright legends which appear on any portion of the Materials which may be owned by the Parties and any and all third parties. b) Except as set forth in Section 9, this Agreement shall not preclude either Party from Developing materials or providing services which are competitive to the Materials or Services which might be delivered pursuant to this Agreement, except to the extent any of same may infringe any of the other Party's patent rights, copyrights or mask work rights. c) Neither this Agreement nor any disclosure made hereunder grants any license to either Party under any patents or copyrights, mask work rights of the other Party, except for the licenses expressly granted under this Section 8. 9. CONFIDENTIALITY/DATA SECURITY 9.1 CONFIDENTIAL INFORMATION ISSC and Flagstar each acknowledge that the other Party possesses and will continue to possess information, which has commercial value in its business and is not in the public domain, that has been created, discovered, developed by it or provided to it by a third party, and in which property rights have been assigned or otherwise conveyed to it. "Confidential Information" means any and all proprietary business information of the disclosing Party treated as secret by the disclosing party (that is, it is the subject of efforts by the disclosing Party or its Affiliates that are reasonable under the circumstances to maintain its secrecy) that does not constitute a Trade Secret (defined below), including, without limitation, any and all proprietary information of such Party of which the receiving Party becomes aware as a result of its access to and presence at the other Party's facilities. "Trade Secrets" mean information related to the services or business of the disclosing Party or its Affiliates which (a) derives economic value, actual or potential, from not being generally known to or readily ascertainable by other persons who can obtain economic value from its disclosure or use; and (b) is the subject of efforts by the disclosing Party or its Affiliates that are reasonable under the circumstances to maintain its secrecy, including without limitation (1) marking any information reduced to tangible form clearly and conspicuously with a legend identifying its confidential or proprietary nature; (2) identifying any oral presentation or communication as confidential immediately before, during or after such oral presentation or communication; or (3) otherwise, treating such information as confidential or secret. Assuming the criteria in sections (a) and (b) above are met, Trade Secrets include, but are not limited to, technical and nontechnical data, formulas, patterns, compilations, computer programs and software, devices, drawings, processes, methods, techniques, designs, programs, financial plans, product plans, and lists of actual or potential customers and suppliers. "Company Information" means collectively the Confidential Information and Trade Secrets. Company Information also includes information which has been disclosed to either Party by a third party which such Party is obligated to treat as confidential or secret. 9.2 OBLIGATIONS a) Flagstar and ISSC will each refrain from disclosing, will hold as confidential and will use the same level of care to prevent disclosing to third parties, the Company Information of the other Party as it employs to avoid disclosure, publication or dissemination of its own information of a similar nature but in no event less than a reasonable standard of care. Notwithstanding the foregoing, the Parties may disclose Company Information to authorized subcontractors involved in providing and using the Services under this Agreement where: (i) such disclosure is necessary to permit the subcontractor to perform its duties hereunder or use the Services; (ii) the subcontractor agrees in writing to observe the confidentiality and restricted use and disclosure covenants and standards of care set forth in this Section 9 and under which the disclosing Party Page 30 of 52 is a third party beneficiary for all purposes; and (iii) the receiving Party assumes full responsibility for the acts or omissions of its subcontractor, no less than if the acts or omissions were those of the receiving Party. b) Neither Flagstar nor ISSC shall use the Company Information of the other Party except in the case of ISSC and its subcontractors, in connection with the performance of the Services, and as otherwise specifically permitted in this Agreement, and in the case of Flagstar as specifically permitted in this Agreement and in connection with the use of the Services. ISSC shall be responsible to ensure that its subcontractors comply with this Section 9.2(b) and Flagstar shall be responsible to ensure that its subcontractors and contractors comply with this Section 9.2(b). c) Without limiting the generality of the foregoing, neither Party will publicly disclose the terms of this Agreement, except to the extent permitted by Sections 9.3 and 14.1 without the prior written consent of the other. Furthermore, neither ISSC nor Flagstar will make any use of the Company Information of the other Party except as contemplated by this Agreement; acquire any right in or assert any lien against the other Party's Company Information except as contemplated by this Agreement; or refuse to promptly return, provide a copy of or destroy such Company Information upon the request of the disclosing Party. d) Notwithstanding any other provision of the Agreement, neither Party will be restricted in using, in the development, manufacturing and marketing of its products and services and in its operations, any data processing, system operations, applications development or network management ideas, concepts, know-how and techniques which are retained in the minds of employees who have had access to the other Party's Company Information (without reference to any physical or electronic embodiment of such information), unless such use shall infringe any of such Party's patent rights, copyrights or mask works rights. 9.3 EXCLUSIONS Notwithstanding the foregoing, this Section 9 will not apply to any information which ISSC or Flagstar can demonstrate was: (a) at the time of disclosure to it, in the public domain; (b) after disclosure to it, published or otherwise becomes part of the public domain through no fault of the receiving Party; (c) without a breach of duty owed to the disclosing Party, is in the possession of the receiving Party at the time of disclosure to it; (d) received after disclosure to it from a third party who had a lawful right to and, without a breach of duty owed to the disclosing Party, did disclose such information to it; or (e) independently developed by the receiving Party without reference to Company Information of the disclosing Party. Further, either Party may disclose the other Party's Company Information to the extent required by law or order of a court or governmental agency. However, the recipient of such Company Information must give the other Party prompt notice and make a reasonable effort to obtain a protective order or otherwise protect the confidentiality of such information, all at the discloser's cost and expense. It is understood that the receipt of Company Information under this Agreement will not limit or restrict assignment or reassignment of employees of ISSC and Flagstar within or between the respective Parties and their Affiliates. 9.4 LOSS OF COMPANY INFORMATION The receiving Party will immediately notify the disclosing Party, orally or in writing in the event of any disclosure, loss, or use in violation of this Agreement of a disclosing Party's Company Information known to the receiving Party. 9.5 LIMITATION The covenants of confidentiality set forth herein (a) will apply after the Effective Date to any Company Information disclosed to the receiving Party before and after the Effective Date and (b) will continue and must be maintained from the Effective Date through the termination of the relationship between the Parties and (i) with respect to Trade Page 31 of 52 Secrets, for a period of five (5) years after termination of the Parties' relationship under this Agreement; and (ii) with respect to Confidential Information for a period equal to the shorter of two (2) years after termination of the Parties' relationship under this Agreement, or until such Confidential Information no longer qualifies as confidential under applicable law. ISSC will not be responsible for the security of data during transmission via public communications facilities, except to the extent that such breach of security is caused by the failure of ISSC to perform its obligations under this Agreement, or the negligent acts or omissions of ISSC, its subcontractors or Affiliates. 9.6 DATA All of Flagstar's Company Information (including, without limitation, Flagstar Group data and related reports regarding the Flagstar Group, the Flagstar Business and the Services) are the exclusive property of Flagstar and the furnishing of such information, data and reports to, or access to such items by, ISSC will not grant any express or implied license to ISSC relating to such information, data and reports except as required to perform the Services pursuant to this Agreement. Upon request by Flagstar at any time and without regard to the default status of the Parties under this Agreement, ISSC shall promptly deliver to Flagstar Flagstar's Company Information (including without limitation Authorized User Data and related reports regarding the Flagstar Group, the Flagstar Business and the Services) in electronic (tape) format and in such hard copy as existing on the date of the request by Flagstar. 10. TERM AND TERMINATION 10.1 TERM The term of this Agreement will begin as of 12:01 a.m. on the Effective Date and will end as of 12:00 midnight on February 21, 2006, (the "Term"), unless earlier terminated or extended in accordance with this Agreement. 10.2 RENEWAL AND EXPIRATION ISSC shall notify Flagstar in writing, whether it desires to renew this Agreement and of the proposed prices and terms to govern such renewal not less than twenty-four (24) calendar months prior to the expiration of the Term. If ISSC notifies Flagstar that it desires to renew this Agreement, Flagstar agrees to inform ISSC in writing whether it desires to renew not less than fourteen (14) calendar months prior to the expiration of the Term. If Flagstar notifies ISSC that it desires to renew the Agreement, but the Parties are unable to agree upon renewal prices, terms and conditions as of six (6) months prior to the expiration of the Term, this Agreement will be extended for one (1) year at the then-current prices, terms and conditions. If the Parties are unable to reach agreement on renewal during such extension period, this Agreement will expire at the end of such extension period. 10.3 TERMINATION BY FLAGSTAR Flagstar may terminate this Agreement for the following reasons: a) A material breach of this Agreement by ISSC that remains uncured for ten (10) days after receipt of written notice thereof; provided, however, if a material breach of this Agreement by ISSC occurs that cannot be cured by ISSC in such ten (10) day period but ISSC submits a written plan to Flagstar within such period to cure such breach after the ten (10) day period (but in no event more than thirty (30) days after such notice of breach) and the plan (including the timing of the cure set forth in the plan) is accepted by Flagstar in writing, the cure period for such breach shall be extended to the date set forth in the plan; or b) As determined by Flagstar, there exists a series of non-material or persistent breaches by ISSC that in the aggregate have a significant adverse impact on the Services support of the administrative, management, Page 32 of 52 planning, financial reporting or operations functions of the Flagstar Group or on the management of the Services; or c) After December 31, 1998, for convenience upon one hundred eighty (180) days prior notice by Flagstar to ISSC; or d) After December 31, 1996, upon a Change of Control of ISSC or Flagstar with one hundred eighty (180) days notice given within ninety (90) days after the later to occur of (i) the effective date of the Change of Control, or (ii) the date on which the affected Party gives the other Party written notice of the effective date of the Change of Control; or e) ISSC becomes insolvent or is unable to pay its debts or enters into or files (or has filed or commenced against it) a petition, arrangement, application, action or other proceeding seeking relief or protection under the bankruptcy laws of the United States or any similar laws of the United States or any state of the United States or any other country or transfers all or substantially all of its assets to another person or entity other than an Affiliate of International Business Machines Corporation; or f) ISSC incurs Direct Damages to Flagstar in excess of the ISSC Direct Damages Cap set forth in Section 11.1 (a) Per Event ISSC Direct Damages Cap, under the circumstances and resulting from the events described in Section 11.1(a) Per Event ISSC Direct Damages Cap. 10.4 TERMINATION BY ISSC ISSC may terminate this Agreement for a material default by Flagstar that remains uncured for a period of thirty (30) days after written notice thereof to Flagstar from ISSC. 10.5 TERMINATION CHARGES a) In the event of a termination by Flagstar pursuant to Sections 10.3(c) Convenience or (d) Change of Control and notwithstanding any other provision of this Agreement except Section 10.5(c), Flagstar shall only be responsible for the following payment obligations (i) all fees due and payable through the termination date, (ii) the Termination Charge, and (iii) the Wind-Down Expenses. However, in the event of a termination by Flagstar pursuant to Sections 10.3(a) Cause or (b) Persistent Failure or (e) Bankruptcy or (f) Per Event ISSC Direct Damages Cap and notwithstanding any other provision of this Agreement except Section 10.5(c), Flagstar shall only be responsible for the payment obligations described in Section 10.5(a)(i) above, but not for the amounts set forth in Sections 10.5(a)(ii) and (iii) above. Moreover, in the instances of a termination by Flagstar pursuant to Sections 10.3(a) Cause or (e) Bankruptcy, Flagstar may recover damages from ISSC for the defaults and breaches by ISSC giving rise to the termination, except as set forth in Section 10.5(c). In the instance of a termination by Flagstar pursuant to Section 10.3(f) Per Event ISSC Direct Damages Cap, Flagstar may only recover the damages from ISSC for the defaults and breaches by ISSC giving rise to the termination up to the full amount of the twenty-four (24) months of charges to Flagstar by ISSC for the Services as described and listed in Section 11.1(a), except as set forth in Section 10.5(c). Finally, in the instance of a termination by Flagstar pursuant to Section 10.3(b) Persistent Failure, Flagstar may not recover any damages from ISSC for the defaults and breaches by ISSC giving rise to the termination, except as set forth in Section 10.5(c). b) In the event of a termination by ISSC under Section 10.4 Cause and notwithstanding any other provision of this Agreement except Section 10.5(c), (i) if such termination is effective at any time while Flagstar is not permitted to terminate for Convenience under Section 10.3(c) or Change of Control under Section 10.3(d), ISSC may recover only the amount of its projected profits for the period between the effective date of such termination and the first date on which a termination for Convenience or Change of Control, as applicable, Page 33 of 52 by Flagstar could be effective under Sections 10.3(c) or (d), as applicable, plus the amounts payable by Flagstar to ISSC in Section 10.5 for a termination by Flagstar pursuant to Section 10.3(c) Convenience or Section 10.3(d) Change of Control, as applicable, on such date, and (ii) if such termination is effective at any time during the Term other than as described in item (i) above, ISSC may recover only the amounts payable by Flagstar to ISSC in Section 10.5 for a termination by Flagstar pursuant to Section 10.3(c) Convenience. c) The limitations on damages and recoveries set forth in Sections 10.3 and 10.4 shall be effective in all instances except such limitations shall not apply to the following: (i) monetary damages and recoveries covered under the Parties' respective indemnification obligations pursuant to Section 11; and monetary damages and recoveries arising out of or resulting from breaches of the confidentiality provisions of Section 9. 10.6 TERMINATION PRORATION Any Termination Charge will be prorated according to the following formula: [((A-B) / 12 months) x C] + B = Prorated Termination charge. where: A = the Termination Charge specified in the Supplement for the year in which termination is effective; B = the Termination Charge specified in the Supplement for the year after the year in which termination is effective; and C = the number of months remaining during the year in which termination is effective. 10.7 EXTENSION OF SERVICES Flagstar may request and ISSC will once extend the expiration or earlier termination date of the provision of Services and the Term for up to one (1) year ("Extension Period") upon not less than sixty (60) days prior written notice before the scheduled termination or expiration of this Agreement. However, in the event of a material breach by Flagstar either prior to or after the start of the Extension Period, ISSC will extend the provision of Services as described in this Section 10.7, only if Flagstar prepays the Annual Service Charges and a reasonable projection of other charges due under this Agreement for the entire period Flagstar requests such extension. 10.8 SERVICES TRANSFER ASSISTANCE a) It is the intent of the Parties that ISSC will cooperate with the Flagstar Group to assist in the orderly transfer of the services, functions, responsibilities, tasks and operations provided by ISSC hereunder to Flagstar itself or another services provider in connection with the expiration or earlier termination of this Agreement. Upon Flagstar's request ISSC shall provide transfer assistance in connection with migrating the work of the Flagstar Group to Flagstar itself or another services provider ("Services Transfer Assistance") commencing up to one (1) year prior to expiration or upon any notice of termination, or of non-renewal of this Agreement. In the event Flagstar shall fail to pay any amounts when due and payable under this Agreement with or without an attendant termination for cause by ISSC, ISSC shall not be required to provide Services Transfer Assistance unless Flagstar prepays the Annual Service Charge, if any, and a reasonable projection of other charges due under this Agreement for the entire period Flagstar requests Services Transfer Assistance. In no event will Flagstar's escrow of monies pursuant to Section 7.6 be considered a failure by Flagstar to pay amounts due and payable hereunder. Further, ISSC shall provide the Services Transfer Page 34 of 52 Assistance in accordance with this Section 10.8 even in the event of Flagstar's material breach (other than a payment default) with or without an attendant termination for cause by ISSC, if Flagstar prepays a reasonable projection of the other charges due under this Agreement (other than the Annual Services Charge which shall be paid monthly as provided in the Supplement) for the Services Transfer Assistance for the entire period Flagstar desires ISSC to provide such services to the Flagstar Group or its designees. Services Transfer Assistance shall be provided through the effective date of the expiration or termination of the Services, and upon request by Flagstar, the effective date of such expiration or termination shall be extended for up to one (1) year thereafter pursuant to the terms and conditions of this Agreement and such period shall be considered an extension of the Term. Services Transfer Assistance shall include, but not be limited to, providing the Flagstar Group and their respective agents, contractors and consultants, as necessary, with services described in Schedule S. b) If any Services Transfer Assistance provided by ISSC requires the utilization of additional resources that ISSC would not otherwise use in the performance of this Agreement but for which there is a current Resource Baseline, Flagstar will pay ISSC for such usage at the then-current Agreement charges and in the manner set forth in this Agreement. If the Services Transfer Assistance requires ISSC to incur costs that ISSC would not otherwise incur in the performance of the Services under this Agreement, then ISSC shall notify Flagstar of the identity and scope of the activities requiring that ISSC incur such costs and the projected amount of the costs that will be passed through to Flagstar for the performance of such assistance. Upon Flagstar's authorization, ISSC shall perform the assistance and invoice Flagstar for such costs. Within thirty (30) business days after the date of the invoice, Flagstar shall pay ISSC for authorized, additional costs incurred to provide such assistance to Flagstar. c) If Flagstar exercises its option to prepay the Annual Service Charges and other costs reasonably projected by ISSC for Services Transfer Assistance and it is determined that such prepayment is in excess of the actual costs associated with the Services Transfer Assistance, then ISSC shall apply such overpayment to monies otherwise due ISSC or, if no monies are due ISSC, promptly refund such overpayment to Flagstar at the end of such Services Transfer Assistance. Conversely, if the amount prepaid by Flagstar to ISSC for Services Transfer Assistance does not fully reimburse ISSC for the actual Annual Service Charges due and costs incurred by ISSC and chargeable to Flagstar hereunder for the provision of Services Transfer Assistance to Flagstar, then ISSC shall invoice Flagstar and Flagstar shall promptly pay ISSC for such additional amounts as incurred and invoiced to Flagstar. 10.9 OTHER RIGHTS UPON TERMINATION At the expiration or earlier termination of this Agreement for any reason, however described, ISSC agrees: a) Upon Flagstar's request, ISSC agrees to sell to Flagstar or its designee for the depreciated value thereof as carried on the books of ISSC, the ISSC Machines owned by ISSC then currently being used by ISSC on a dedicated basis to perform the Services. The ISSC machines will be expensed or fully depreciated by ISSC in accordance with either its standard financial reporting practices or its standard tax accounting practices for such assets, whichever is shorter, but in no event shall such period exceed five (5) years. In the case of dedicated ISSC Machines that ISSC is leasing, ISSC agrees to permit Flagstar or its designee to either buy-out the lease on the ISSC Machines and purchase the ISSC Machines from the lessor or assume the lease(s) and secure the release of ISSC thereon. Flagstar shall be responsible for any sales, use or similar taxes associated with such purchase of such ISSC Machines or the assumption of such leases. Notwithstanding the foregoing or any other provision of this Agreement (including without limitation Sections 10 and 11), if Flagstar terminates this Agreement pursuant to Sections 10.3(a) Cause or 10.3(f) Per Event ISSC Direct Damages Cap, ISSC will promptly transfer good and marketable title to all of the ISSC Machines to Flagstar free and clear of all liens and security interests, however described, for and in consideration of the payment by Flagstar to ISSC of one dollar ($1.00). Page 35 of 52 b) ISSC will grant to Flagstar and its Affiliates an irrevocable, nonexclusive, worldwide, perpetual, paid-up source and object code license to use, execute, operate, reproduce, display, perform, distribute, modify, Develop and personalize, and create Derivative Works from, the ISSC Derivative Code, ISSC Code, ISSC Works, Flagstar Code and ISSC Interfaces as a part of and in connection with the Flagstar Business, and the right to sublicense third parties to do any of the foregoing for the Flagstar Group; provided, however, ISSC shall not be required to grant to Flagstar a source code license for commercially available software programs owned and marketed generally by IBM or its affiliates. c) ISSC will provide to the Flagstar Group a source code and object code license for ISSC Software proprietary to ISSC and not otherwise owned by or licensed to Flagstar in accordance with Section 10.9(b) and not generally commercially available, with rights that are the same as those granted to Flagstar and its Affiliates in Section 10.9(b) for use by the Flagstar Group as a part of and in connection with the Flagstar Business, upon terms and prices to be mutually agreed upon by the Parties (which prices shall not be greater than those offered to other Similarly Situated Customers or, in the case where no Similarly Situated Customers exist, other third parties). At Flagstar's option, ISSC will recommend a mutually agreeable commercially available substitute, if available, to perform the same function. d) If ISSC has licensed or purchased and is using any generally commercially available ISSC Software to provide the Services to Flagstar at the date of expiration or termination, Flagstar may elect to take a transfer or an assignment of the license for such software (and any attendant maintenance agreement) and reimburse ISSC for the initial license or purchase charges for such ISSC Software in an amount equal to the remaining unamortized cost of such ISSC Software, if any, depreciated over a five (5) year life. Flagstar shall also pay any transfer fee or charge imposed by the applicable vendor and subject to Flagstar's acceptance of any applicable vendor terms and conditions, such licensed Software shall be transferred or assigned to Flagstar. e) If ISSC has licensed or purchased and is using any generally commercially available ISSC Software to provide the Services to the Flagstar Group and other ISSC customers in a shared environment at the date of expiration or termination, ISSC, upon request by Flagstar, will assist Flagstar in obtaining licenses for such software subject to Flagstar's payment of any license fee or charge imposed by the applicable vendor. f) ISSC will use commercially reasonable efforts to negotiate license arrangements with third parties that will minimize the amount of license transfer and assignment fees to be paid by Flagstar. Flagstar may participate in the negotiation of such license arrangements. ISSC shall provide reasonable advance written notice to Flagstar of such anticipated negotiations. g) Upon the date of expiration or termination of this Agreement, the Flagstar Group shall have the right to make offers of employment to any or all ISSC employees performing Services for the Flagstar Group hereunder ("Service Employees"). Promptly after either Party sends the other Party written notice of termination or expiration with the prior consent of each Services Employee (each of whom ISSC will notify of Flagstar's interest), ISSC agrees to supply Flagstar with the names and resumes requested by Flagstar for the purpose of exercising its rights under this Section 10.9, at no charge. Flagstar's rights under this Section 10.9 will take precedence over any ISSC/employee employment contract or covenant that may otherwise limit an employee's right to accept employment with the Flagstar Group. h) Upon Flagstar's request, ISSC will transfer or assign to Flagstar or its designee, on mutually acceptable terms and conditions, any Third Party Agreements not otherwise treated in this Section 10.9, applicable solely to services being provided to Flagstar, including, without limitation, Third Party Agreements for maintenance, Disaster Recovery Services and other necessary third party services then being used by ISSC to perform the Services subject to the payment by Flagstar of any transfer fee or charge imposed by the applicable vendors. Page 36 of 52 10.10 EFFECT OF TERMINATION/SURVIVAL OF SELECTED PROVISIONS Notwithstanding the expiration or earlier termination of the Services or this Agreement for any reason however described, the following Sections of this Agreement shall survive any such expiration or termination: Section 8, Section 9, Section 10.8, Section 10.9, Section 10.10, Section 11, Section 13, Section 14 and Section 16. 11. LIABILITY 11.1 LIABILITY CAPS The liability of ISSC to Flagstar arising out of or resulting from the performance or non-performance of ISSC and its subcontractors of the Services and its obligations under this Agreement shall be limited (a) to "Direct Damages" incurred by Flagstar for each event which is the subject matter of a claim or cause of action with a liability cap for each such event which is not declared by Flagstar as the basis for its termination of this Agreement pursuant to Section 10.3(a) Cause or (e) Bankruptcy, equal to the actual charges to Flagstar for the Services during the three (3) calendar months immediately following each such event, which damages in the aggregate shall not exceed the charges to Flagstar for the Services set forth in the Supplement during the twenty-four (24) months immediately following the first such event or if there are not twenty-four (24) months left in the Term after the first such event, the charges to Flagstar for the Services set forth in the Supplement during the last twenty-four (24) months of the Term; and (b) to the "Direct Damages" incurred by Flagstar for the event(s) which are the subject matter of claim(s) or cause(s) of action which are declared by Flagstar as the basis for its termination of this Agreement pursuant to Section 10.3(a) Cause or (e) Bankruptcy, with a liability cap for such event(s) and termination equal to the actual charges to Flagstar for the Services during the twelve (12) month period immediately preceding such event(s) or if twelve (12) months of the Term have not elapsed, the charges to Flagstar for the Services set forth in the Supplement for the first twelve (12) months of the Term (the "ISSC Direct Damages Cap"). The liability of Flagstar to ISSC arising out of or resulting from the performance and non-performance of its obligations under this Agreement shall be limited in all cases to Direct Damages which in the aggregate shall not exceed the amounts payable by Flagstar upon a termination for Convenience under Section 10.5(b) (the "Flagstar Direct Damages Cap"). The ISSC Direct Damages Cap and the Flagstar Direct Damages Cap are herein collectively called the "Direct Damages Caps". 11.2 EXCLUSIONS The Direct Damages Caps will not apply to (a) failure to pay charges for the Services that are due and payable hereunder up to the effective date of the early termination of this Agreement (excluding from this exception any payments due and payable by Flagstar upon a termination by Flagstar for Convenience or upon a Change of Control pursuant to Section 10.3(c) and (d) or upon a termination by ISSC pursuant to Section 10.4); (b) Losses covered under the Party's indemnification obligations to others pursuant to Section 13; (c) Losses arising from a violation of the confidentiality provisions of Section 9; (d) amounts to be paid or credited to Flagstar as Service Credits; (e) Losses incurred by either Party caused by or arising out of the inaccuracy or untruthfulness of the representations and warranties of the other Party contained in this Agreement; (f) amounts payable by ISSC under the force majeure provision of Section 16.3 of this Agreement; (g) amounts payable to Flagstar under Section 7.7 (Other Credits); and (h) ISSC's obligations to transfer title to the ISSC Machines to Flagstar pursuant to Section 10.9(a). 11.3 DIRECT DAMAGES Unless specifically provided to the contrary in this Agreement, neither party shall have any liability whether based on contract, tort (including without limitation, negligence), warranty, guarantee or any other legal or equitable grounds to the other party for any damages other than Direct Damages. "Direct Damages" mean actual, direct damages incurred by the claiming Party which include, by way of example but without limitation, (i) the costs of Page 37 of 52 cover incurred by the Flagstar Group to obtain services which are the same as or substantially similar to the Services, (ii) the costs to correct any deficiencies in the Services rendered by ISSC, (iii) the costs incurred by the Flagstar Group to transition to another provider of information management and communication services and/or to take some or all of such functions and responsibilities in-house, (iv) the difference in the amounts to be paid to ISSC hereunder and the charges to be paid to such other provider and/or the costs of providing such functions, responsibilities and tasks in-house, (v) the Service Credits, and (vi) similar damages, but "Direct Damages" shall not include (A) loss of interest, profit or revenue of the claiming Party or (B) incidental, consequential, special or indirect damages suffered by the Claiming Party (except as the damages described in (A) and (B) are included as a part of the Termination Charge and the Service Credits or as otherwise provided for in this Agreement) and shall not include punitive or exemplary damages suffered by the claiming Party arising from or related to this Agreement, even if such Party has been advised of the possibility of such losses or damages. 11.4 DEPENDENCIES In no event will ISSC or its subcontractors be liable for any damages if and to the extent caused by Flagstar's or its subcontractors' failure to perform its responsibilities hereunder; provided, however, for the purposes of this Section 11.4, neither ISSC nor its affiliates nor the Third Party Providers shall be considered a subcontractor of Flagstar. Neither Flagstar nor its subcontractors shall be liable for any damages if and to the extent caused by any failure to perform by ISSC or its subcontractors. 11.5 REMEDIES At its option, Flagstar may seek all remedies available to it under law and in equity or recover as liquidated damages the Service Credits, subject to the limitations and provisions specified in this Section 11. If ISSC's provision of the Services is such that ISSC would otherwise owe Flagstar a Service Credit and Flagstar elects to recover Service Credits, Flagstar's recovery of Service Credits shall constitute acknowledgement by Flagstar of full satisfaction and release of any claim by Flagstar that ISSC has breached its obligations under this Agreement with respect to any such event(s) giving rise to the Service Credits. However, within nine (9) calendar months of the receipt of any Service Credits Flagstar received with respect to any action or inaction by ISSC upon which Flagstar is basing termination for cause under Section 10.3(a) or termination for persistent breaches under Section 10.3(b), Flagstar may return, such Service Credits and pursue a damage claim against ISSC, if any such claim exists. 12. WARRANTIES/REPRESENTATIONS/COVENANTS 12.1 WORK STANDARDS ISSC covenants that (a) it has, and each of the ISSC employees and subcontractors that it will use to provide and perform the Services has, the necessary knowledge, skills, experience, qualifications, rights and resources to provide and perform the Services in accordance with the Agreement; (b) it has successfully provided and performed the Services or services that are substantially equivalent to the Services for other customers of ISSC; and (c) the Services will be performed for Flagstar in a diligent, workmanlike manner in accordance with industry standards applicable to the performance of such services. 12.2 NONINFRINGEMENT The Parties represent and warrant that they will perform their responsibilities under this Agreement in a manner that does not infringe, or constitute an infringement or misappropriation of, any patent, Trade Secret, copyright or other proprietary right of any third party. Notwithstanding this provision or any other provision in this Agreement, Flagstar makes no warranty or representation with respect to any claims for such infringement or misappropriation Page 38 of 52 by virtue of its compliance with obligations herein to provide ISSC access to, use of or benefits of any Third Party Agreements prior to receiving the necessary Required Consents. 12.3 DISABLING CODE ISSC covenants that ISSC will take commercially reasonable steps to ensure that no code in the Software which could have the effect of disabling or otherwise shutting down all or any portion of the Services, will be permitted to be invoked without the prior written consent of Flagstar. ISSC further represents and warrants that with respect to any disabling code that may be part of the Software, ISSC will not invoke disabling code at any time, including upon expiration or termination of this Agreement for any reason, without Flagstar's prior written consent. 12.4 AUTHORIZATION AND ENFORCEABILITY Each Party hereby represents and warrants that: a) it has all requisite corporate power and authority to enter, and fully perform pursuant to, into this Agreement; b) the execution, delivery and performance of this Agreement and the consummation of the transactions contemplated hereby have been duly and properly authorized by all requisite corporate action on the part of each Party; and c) this Agreement has been duly executed and delivered by such Party. 12.5 DISCLAIMER a) ISSC does not warrant the accuracy of any advice, report, data or other product delivered to Flagstar to the extent any inaccuracies are caused by data and/or software provided by Flagstar. Such products are delivered AS IS, and ISSC shall not be liable for any inaccuracy thereof. ISSC will promptly notify Flagstar of any such inaccuracies of which ISSC becomes aware and the cause therefore if known by ISSC. ISSC will provide reasonable assistance to Flagstar to remedy any problems. 12.6 REGULATORY PROCEEDINGS Each Party agrees at its cost and expense to obtain all necessary regulatory approvals applicable to its business, obtain any necessary permits, and to comply with all regulatory requirement applicable to the performance of its services to its customers. 13. INDEMNITIES 13.1 INDEMNITY BY ISSC ISSC will indemnify and hold the Flagstar Group and their respective officers, directors, employees, agents, successors and assigns (each an "Indemnitee") harmless from and against any and all Losses incurred by any of them arising from or in connection with: a) any Claims of infringement of any United States letters patent, or any copyright, trademark, service mark, trade name, trade secret, or similar property right conferred by contract or by common law or by any law of the United States or any state alleged to have been incurred because of any information technology and information management and communications services, equipment, software or other resources provided by Page 39 of 52 ISSC or its subcontractors in its performance of the Services; provided, however, ISSC will have no obligation with respect to any Losses to the extent arising from or in connection with Claims for copyright infringement and/or breach of software licenses related to the Services committed by an Indemnitee or any employee of an Indemnitee that is not the result of ISSC failing to perform its obligations under this Agreement including, without limitation, obtaining any Required Consent for which it has responsibility; provided, further, that ISSC will have no obligation with respect to any Losses to the extent arising out of or in connection with an Indemnitee's modification of a program or a machine provided by ISSC or its subcontractors or an Indemnitee's combination, operation or use of the services, equipment, software or other resources provided by ISSC or its subcontractors with devices, data or programs not furnished by ISSC or its subcontractors; b) any Claims accruing on or after the Effective Date (i.e., not arising or resulting from a breach by Flagstar before the Effective Date) regarding any Third Party Agreements, however described (including without limitation, failure to obtain Required Consents or arising from ISSC exercise of its rights to terminate, modify or change the Third Party Agreements pursuant to Section 2.4(a)); provided, however, ISSC will have no obligation with respect to any Losses to the extent arising out of or in connection with Claims for copyright infringement and/or breach of software licenses related to the Services committed by any Indemnitee or any employee of an Indemnitee that is not the result of ISSC failing to perform its obligations under this Agreement including, without limitation, obtaining any Required Consent for which it has responsibility; c) the untruthfulness or inaccuracy of any representation or warranty made by ISSC in this Agreement; d) any amounts, including without limitation, taxes, interest and penalties assessed against Flagstar which are obligations of ISSC under this Agreement; e) personal injuries, death or damage to tangible personal or real property of third parties including employees of ISSC, its contractors and subcontractors caused by the negligence or wilful misconduct of ISSC; provided that ISSC will have no obligation under this part, to the extent the same arise out of or in connection with the negligence or willful misconduct of the Flagstar Group; f) any Claims for amounts, including but not limited to taxes, interest and penalties, assessed against the Flagstar Group which are obligations of ISSC pursuant to Section 6.5; g) any Claims for a breach of software licenses related to the Services, committed by ISSC or any of its subcontractors or any employee of ISSC and its subcontractors that is not the result of Flagstar failing to perform its obligations under this Agreement including obtaining any Required Consent for which it has responsibility; h) any environmental Claim arising out of this Agreement or as a result of the Services performed at the Data Center or the other Flagstar Corporate Facilities or Flagstar Restaurant locations to the extent ISSC or its subcontractors has caused the environmental damage or violation of the environmental laws or regulations from which the Claim arises; i) any Claims directly attributable to ISSC's decision to request that Flagstar cancel, substitute, terminate, change, add or breach any Third Party Agreement and Flagstar' assent to and compliance with such decision and any Losses incurred by Flagstar associated with such decision by ISSC and compliance by Flagstar; j) any Claims for penalties, interest and other charges imposed by a taxing authority (except the actual taxes payable to Flagstar under the terms of this Agreement) arising out of or resulting from ISSC issuing an Page 40 of 52 incorrect invoice or other information provided to Flagstar in writing regarding its charges to Flagstar for the Services to Flagstar; and k) any Claims by any Affected Employees arising out of or resulting from their treatment by ISSC as employees of ISSC. In the event and to the extent that a Claim is made against an Indemnitee by an employee of ISSC, its contractors or subcontractors providing services, products and/or software hereunder, the Parties agree that ISSC shall indemnify and hold harmless the Indemnitee to the same extent as if the Claim was made by a non-employee of ISSC, its contractors or subcontractors. ISSC's indemnification hereunder shall be primary and immediate. Accordingly, in addition to other provisions herein, and in order to render the Parties' intent and this indemnification agreement fully enforceable, ISSC, in an indemnification claim hereunder, expressly and without reservation waives any defense or immunity it may have under any applicable workers' compensation law(s) or any other statute or judicial decision disallowing or limiting such indemnification and consents to a cause of action for indemnity. This waiver and consent to indemnification is made irrespective of and specifically waiving any defense or immunity under any statute or judicial decision. 13.2 INDEMNITY BY FLAGSTAR Flagstar will indemnify and hold harmless ISSC and its officers, directors, employees, agents, successors and assigns (each an "ISSC Indemnitee") harmless from and against any and all Losses incurred by ISSC arising from or in connection with a) any Claims of infringement of any United States letters patent, or any copyright, trademark, service mark, trade name, trade secret, or similar property right conferred by contract or by common law or by any law of the United States or any state alleged to have been incurred because of any information technology and information management and communications services equipment, software or other resources provided to ISSC by Flagstar in connection with the performance of the Services; provided, however, Flagstar will have no obligation with respect to any Losses to the extent arising out of or in connection with Claims for copyright infringement and/or breach of software licenses related to the Services, committed by an ISSC Indemnitee or any employee of an ISSC Indemnitee that is not the result of Flagstar failing to perform its obligations under this Agreement including, without limitation, obtaining any Required Consent for which it has responsibility; and provided, further, that Flagstar will have no obligation with respect to any Losses to the extent arising out of or in connection with an ISSC Indemnitee's modification of a program or a machine or an ISSC Indemnitee's combination, operation or use of the equipment, software or other resources provided by Flagstar; b) any Claims accruing before the Effective Date regarding any Third Party Agreements between Flagstar and a third party, including without limitation, failure to obtain Required Consents; c) the untruthfulness or inaccuracy of any representation or warranty made by Flagstar under this Agreement; d) any amounts, including without limitation, taxes, interest and penalties assessed against ISSC which are obligations of Flagstar under this Agreement; e) personal injuries, death or damage to tangible personal or real property of third parties including employees of Flagstar, its contractors and subcontractors caused by the negligence or wilful misconduct of Flagstar; provided that Flagstar will have no obligation, under this part, to the extent the same arise out of or in connection with the negligence of ISSC, its Affiliates and subcontractors; Page 41 of 52 f) any Claims arising out of or resulting from the operations of the Flagstar Group, including the remarketing of the Services by Flagstar, if such Claims do not arise out of a breach of this Agreement by ISSC and are not the subject of a specific indemnity provided to Flagstar by ISSC in Section 13.1; provided, however, that Flagstar will have no obligation under this item, to the extent the Claims arise out of or result from the negligence or wilful misconduct of ISSC, its Affiliates and subcontractors; g) any Claims for a breach of software licenses related to the Services, committed by the Flagstar Group or any employee of the Flagstar Group that is not the result of ISSC failing to perform its obligations under this Agreement including, without limitation, obtaining any Required Consent for which it has responsibility; h) any environmental Claim arising out of the Services performed at the Data Center or the other Flagstar Corporate Facilities or Flagstar Restaurant locations except to the extent that ISSC or its subcontractors has caused the environmental damage or violation of the environmental laws or regulations from which the Claim arises; and i) any claims by any Affected Employees arising out of or resulting from their employment with Flagstar. In the event and to the extent that a Claim is made by an employee of Flagstar against an ISSC Indemnitee, the Parties agree that Flagstar shall indemnify and hold harmless the ISSC Indemnitee to the same extent as if the Claim was made by a non-employee of Flagstar. Flagstar's indemnification hereunder shall be primary and immediate. Accordingly, in addition to other provisions herein, and in order to render' the Parties' intent and this indemnification agreement fully enforceable, Flagstar, in an indemnification Claim hereunder, expressly and without reservation waives any defense or immunity it may have under any applicable workers' compensation law(s) or any other statute or judicial decision disallowing or limiting such indemnification and consents to a cause of action for indemnity. This waiver and consent to indemnification is made irrespective of and specifically waiving any defense or immunity under any statute or judicial decision. 13.3 EMPLOYMENT ACTIONS It is understood and agreed that ISSC shall be solely and exclusively responsible for personnel decisions affecting ISSC's employees, contractors and agents (including without limitation, hiring, promotions, training, compensation, evaluation, discipline, and discharge). Flagstar shall be solely and exclusively responsible for personnel decisions affecting Flagstar's employees, contractors, and agents (including without limitation, hiring, promotion, training, compensation, evaluation, discipline and discharge). 13.4 EXCLUSIVE REMEDY The indemnification rights of each Indemnitee and ISSC Indemnitee (individually an "Indemnified Party") for third party Claims pursuant to Sections 13.1 and 13.2, shall be the sole and exclusive remedy of such Indemnified Party with respect to each such third party Claim to which such indemnification relates. 13.5 INDEMNIFICATION PROCEDURES a) Written notice shall be given to the Party that is obligated to provide indemnification under Sections 13.1 and 13.2 (the "Indemnifying Party"), if any civil, criminal, administrative or investigative action or proceeding is commenced or threatened (any of the above being a "Claim") against any Indemnified Party. Such notice shall be given as promptly as practicable but in all events, within a period that will not prejudice the rights of the Indemnified Party under this Agreement or to defend the Claim. After such notice, if the Indemnifying Party acknowledges in writing to the Indemnified Party that this Agreement applies with respect to such Claim, then the Indemnifying Party shall be entitled to take control of the defense and investigation of such Claim and to employ and engage attorneys of its sole choice to handle and defend the Page 42 of 52 same, at the Indemnifying Party's sole cost and expense. The Indemnifying Party must deliver written notice of its election of taking such control of the claim to the Indemnified Party not fewer than ten (10) days prior to the date on which a response to such Claim is due or such lesser period as is reasonable given the nature of the Claim and the notice and response time permitted by law or the facts and circumstances. The Indemnified Party shall cooperate in all reasonable respects with the Indemnifying Party and its attorneys in the investigation, trial, defense and settlement of such Claim and any appeal arising therefrom. The Indemnified Party may participate in such investigation, trial, defense and settlement of such Claim and any appeal arising therefrom, through its attorneys or otherwise, at its own cost and expense. No settlement of a Claim that involves a remedy other than the payment of money by the Indemnifying Party shall be entered into without the consent of the Indemnified Party, which consent will not be unreasonably withheld. b) After notice to the Indemnified Party of the Indemnifying Party's election to assume full control of the defense of any such Claim, the Indemnifying Party shall not be liable for any legal expenses incurred thereafter in connection with the defense of that Claim by the Indemnified Party. If the Indemnifying Party does not promptly assume full control over and diligently pursue the defense of a Claim as provided in this Section 13.5, the Indemnified Party shall have the right to defend, settle or otherwise resolve the Claim in ------------ such manner as it may deem appropriate, at the cost and expense of the Indemnifying Party, and the Indemnifying Party may participate in such defense, at its sole cost and expense. In no event shall any settlement of the Claim require the consent of the Indemnifying Party which consent shall not be unreasonably withheld. 14. INSURANCE AND RISK OF LOSS 14.1 ISSC INSURANCE During the Term of this Agreement, ISSC and each ISSC contractor and subcontractor shall maintain and keep in force, at its own expense, the following minimum insurance coverages and minimum limits: a) workers' compensation insurance, with statutory limits as required by the various laws and regulations applicable to the employees of ISSC or any ISSC contractor or subcontractor; b) employer's liability insurance, for employee bodily injuries and deaths, with a limit of $500,000 each accident; c) comprehensive or commercial general liability insurance, covering claims for bodily injury, death and property damage, including premises and operations, independent contractors, products and completed operations, personal injury, contractual, and broad-form property damage liability coverages, with limits as follows: (1) occurrence/aggregate limit of $1,000,000 for bodily injury, death and property damage each occurrence of $2,000,000 general aggregate; or (2) split liability limits of (i) $1,000,000 for bodily injury per person; (ii) $1,000,000 for bodily injury per occurrence; and (iii) $500,000 for property damage; d) comprehensive automobile liability insurance, covering owned, non-owned and hired vehicles, with limits as follows (1) combined single limit of $500,000 for bodily injury, death and property damage per occurrence; or (2) split liability limits of (i) $500,000 for bodily injury per person; (ii) $500,000 for bodily injury per occurrence; and (iii) $250,000 for property damage; and e) all-risk property insurance, on a replacement cost basis, covering the real property of ISSC which ISSC is obligated to insure by this Agreement. Such real property may include buildings, equipment, furniture, fixtures and supply inventory. Page 43 of 52 All such policies of insurance of ISSC and its contractors and subcontractors shall provide that the same shall not be canceled nor the coverage modified nor the limits changed without first giving thirty (30) days prior written notice thereof to Flagstar. No such cancellation, modification or change shall affect ISSC's obligation to maintain the insurance coverages required by this Agreement. Except for workers' compensation insurance, Flagstar shall be named as an additional insured on all such required policies. All liability insurance policies shall be written on an "occurrence" policy form. Flagstar shall be named as loss payee as its interest may appear on the property insurance policies of ISSC. ISSC shall be responsible for payment of any and all deductibles from insured claims under its policies of insurance. The coverage afforded under any insurance policy obtained by ISSC pursuant to this Agreement shall be primary coverage regardless of whether or not Flagstar has similar coverage. ISSC or its contractors and subcontractors shall not perform under this Agreement without the prerequisite insurance and/or self-insurance in effect. Upon Flagstar's request, ISSC shall provide Flagstar with certificates of such insurance including renewals thereof. ISSC shall have the right to self-insure any of the insurance coverages required by this Agreement upon prior written notification to Flagstar. Unless previously agreed to in writing by Flagstar, ISSC's contractors and subcontractors shall comply with the insurance requirements herein. The minimum limits of coverage required by this Agreement may be satisfied by a combination of primary and excess or umbrella insurance policies. If ISSC or its contractors or subcontractors shall fail to comply with any of the insurance requirements herein, upon written notice to ISSC by Flagstar and a thirty (30) day cure period, Flagstar may, without any obligation to do so, procure such insurance and ISSC shall pay Flagstar the cost thereof plus a reasonable administrative fee as designated by Flagstar. The maintenance of the insurance coverages required under this Agreement shall in no way operate to limit the liability of ISSC to Flagstar under the provisions of this Agreement. 14.2 FLAGSTAR INSURANCE During the Term of this Agreement, Flagstar and each Flagstar contractor and subcontractor shall maintain and keep in force, at its own expense, the following minimum insurance coverages and minimum limits: a) worker's compensation insurance, with statutory limits as required by the various laws and regulations applicable to the employees of Flagstar or any Flagstar contractor or subcontractor; b) employer's liability insurance, for employee bodily injuries and deaths, with a limit of $500,000 each accident; c) comprehensive or commercial general liability insurance, covering claims for bodily injury, death and property damage, including premises and operations, independent contractors, products and completed operations, personal injury, contractual, and broad-form property damage liability coverages, with limits as follows: (1) occurrence/aggregate limit of $1,000,000 for bodily injury, death and property damage each occurrence of $2,000,000 general aggregate; or (2) split liability limits of (i) $1,000,000 for bodily injury per person; (ii) $1,000,000 for bodily injury per occurrence; and (iii) $500,000 for property damage; d) comprehensive automobile liability insurance, covering owned, non-owned and hired vehicles, with limits as follows (1) combined single limit of $500,000 for bodily injury, death and property damage per occurrence; or (2) split liability limits of (i) $500,000 for bodily injury per person; (ii) $500,000 for bodily injury per occurrence; and (iii) $250,000 for property damage; and e) all-risk property insurance, on a replacement cost basis, covering the real property of Flagstar which Flagstar is obligated to insure by this Agreement. Such real property may include buildings, equipment, furniture, fixtures and supply inventory. All such policies of insurance of Flagstar and its contractors and subcontractors shall provide that the same shall not be canceled nor the coverage modified nor the limits changed without first giving thirty (30) days prior written notice thereof to ISSC. No such cancellation, modification or change shall affect Flagstar's obligation to maintain Page 44 of 52 the insurance coverages required by this Agreement. Except for workers' compensation insurance, ISSC shall be named as an additional insured on all such required policies. All liability insurance policies shall be written on an "occurrence" policy form. Flagstar shall be named as loss payee as its interest may appear on the property insurance policies of Flagstar. Flagstar shall be responsible for payment of any and all deductible's from insured claims under its policies of insurance. The coverage afforded under any insurance policy obtained by Flagstar pursuant to this Agreement shall be primary coverage regardless of whether or not ISSC has similar coverage. Flagstar or its contractors and subcontractors shall not perform under this Agreement without the prerequisite insurance or self insurance in effect. Flagstar shall have the right to self-insure any of the insurance coverages required by this Agreement upon prior written notification to ISSC. Unless previously agreed to in writing by ISSC, Flagstar's contractors and subcontractors shall comply with the insurance requirements herein. The minimum limits of coverage required by this Agreement may be satisfied by a combination of primary and excess or umbrella insurance policies. If Flagstar or its contractors or subcontractors shall fail to comply with any of the insurance requirements herein, upon written notice to Flagstar by ISSC and a thirty (30) day cure period, ISSC may, without any obligation to do so, procure such insurance and Flagstar shall pay ISSC the cost thereof plus a reasonable administrative fee as designated by ISSC. The maintenance of the insurance coverages required under this Agreement shall in no way operate to limit the liability of Flagstar to ISSC under the provisions of this Agreement. 14.3 RISK OF PROPERTY LOSS ISSC is responsible for risk of loss of, or damage to, the Software, Machines and Flagstar Group data in its possession, and Flagstar is responsible for risk of loss of, or damage to, the Software, Machines and Flagstar Group data in its possession. 14.4 MUTUAL WAIVER OF SUBROGATION a) To the extent permitted by law, ISSC, its contractors and subcontractors hereby waive their rights of subrogation against the Flagstar Group and their respective directors, officers, employees and agents for any loss or damage to the ISSC Machines, ISSC Software, and other tangible and intangible, real and personal property of ISSC, its contractors and subcontractors resulting from operations in connection with this Agreement. Each property insurance policy of ISSC, its contractors and subcontractors shall be endorsed to provide a waiver of any and all rights of subrogation against the Flagstar Group and their respective directors, officers, employees and agents for loss resulting from operations in connection with this Agreement. b) To the extent permitted by law, Flagstar, its directors, officers, employees and agents hereby waive their rights of subrogation against ISSC, its contractors and subcontractors for any loss or damage to the Flagstar- Provided Hardware, Flagstar Software and other tangible and intangible, real and personal property of Flagstar, its directors, officers, employees and agents resulting from operations in connection with this Agreement. Each property insurance policy of Flagstar shall be endorsed to provide a waiver of any and all rights of subrogation against ISSC, its contractors and subcontractors for loss resulting from operations in connection with this Agreement. 15. MANAGEMENT COMMITTEE/DISPUTE RESOLUTION/CHANGE CONTROL PROCESS 15.1 FLAGSTAR/ISSC MANAGEMENT COMMITTEE a) The Flagstar and ISSC Project Executives will meet as often as necessary, but at least monthly, to review the current status of the Services provided under this Agreement. The topics to be addressed include, but are not limited to: Page 45 of 52 - status of the AD/M Projects - status of the Schedule N Projects - review of Schedule J. Baseline utilization and projection of potential Baseline overruns - review of Performance Measurements - identification and prioritization of new projects - update on process improvements and operational efficiencies - other issues, concerns and topics proposed by each Project Executive b) A Flagstar/ISSC Management Committee will be established consisting of two (2) or more representatives from each organization. Management Committee meetings will be held at least quarterly to address the specific topics raised by the requirements of the Parties, to include, but not limited to: - quarterly reviews of the progress of Schedule N Projects/Milestones - quarterly review of performance objectives and measurements - quarterly review of Business and Information Systems Plan against the Services - advice and direction on technology changes - resolution of disputes between the Parties 15.2 DISPUTE RESOLUTION PROCEDURES a) Any dispute between the Parties either with respect to the interpretation of any provision of this Agreement or with respect to the performance by ISSC or by Flagstar hereunder shall be resolved as specified in this Section 15.2. 1) Upon the written request of either Party, each of the Parties will appoint a designated representative who does not devote substantially all of his or her time to performance under this Agreement, whose task it will be to meet for the purpose of endeavoring to resolve such dispute. 2) The designated representatives shall meet as often as necessary to gather and furnish to the other Party all information with respect to the matter in issue which is appropriate and germane in connection with its resolution. 3) Such representatives shall discuss the problem and negotiate in good faith in an effort to resolve the dispute without the necessity of any formal proceeding relating thereto. 4) During the course of such negotiation, all reasonable requests made by one Party to the other for nonprivileged information reasonably related to this Agreement, will be honored in order that each Party may be fully advised of the other Party's position. 5) The specific format for such discussions will be left to the discretion of the designated representatives, but may include the preparation of agreed upon statements of fact or written statements of position furnished to the other Party. b) If the designated representatives do not resolve the dispute within thirty (30) days after the date of receipt by the other Party of a request to appoint a designated representative as described in Section 15.2(a)(1) (the "Notice"), then the dispute shall be escalated to the Vice President of Technology of Flagstar and the ISSC Vice President of Distribution Industry Services, for their review and resolution within forty-five (45) days after receipt of the dispute for resolution. Page 46 of 52 c) If the vice presidents referred to in Section 15.2(b) do not resolve the dispute within forty-five (45) days after the Notice, then the dispute shall be escalated to the President of Flagstar and the President of ISSC, for their review and resolution within sixty (60) days after the Notice. d) If the dispute is not resolved by the Parties' Presidents within ninety (90) days after the Notice, the Parties agree to try in good faith to resolve the dispute by mediation under the Commercial Mediation Rules of the American Arbitration Association, before resorting to litigation or some other dispute resolution procedure. e) If the dispute is not resolved by mediation within one hundred twenty (120) days after the Notice, then the Parties may initiate formal proceedings; however, formal proceedings for the judicial resolution of any such dispute may not be commenced until the earlier of: 1) the designated representatives concluding in good faith that amicable resolution through continued negotiation of the matter in issue does not appear likely; or 2) one hundred twenty (120) days after the Notice; or 3) thirty (30) days before the statute of limitations governing any cause of action relating to such dispute would expire. Notwithstanding anything to the contrary in this Section 15.2(e), the Flagstar/ISSC Management Committee shall have the authority to stay the time periods set forth in this Section 15.2 upon unanimous vote of its members to take such action. f) Notwithstanding any other provision of this Section 15.2, either Party may resort to court action for injunctive relief at any time if the dispute resolution processes set forth in this Section would permit or cause irreparable injury due to delay to such Party or any third party claiming against such Party. 15.3 CONTINUED PERFORMANCE The Parties agree to continue performing their respective obligations under this Agreement while the dispute is being resolved unless and until such obligations are terminated or expire in accordance with the provisions of this Agreement. 15.4 CHANGE CONTROL PROCESS This process encompasses the efforts required to establish and maintain a change control process for activities, processes, provisions and operations under the Agreement (the "Change Control Process"). The objectives of the Change Control Process are (i) to review each request for a change to the Agreement to determine whether such change is appropriate (a "Change Request"), (ii) to determine whether such change constitutes in-scope Services or New Services, (iii) to prioritize all Change Requests and (iv) to minimize the risk of exceeding both time and cost estimates associated with the requested changes by identifying, documenting, quantifying, controlling, managing and communicating requested changes and their disposition. The Change Control Process shall identify the different roles, responsibilities and actions that shall be followed to implement the changes and the services to the Agreement. The Change Control Review Team, chaired by the Flagstar and ISSC Project Executives or their respective designess, shall be the focal point for all Change Requests, shall make the initial determination as to whether each Change Request is "in-scope" or a New Service, shall be responsible for the assessment of the impact of each Change Request, and shall be the source of direction for the implementation of each Change Request. Page 47 of 52 The Change Control Process shall include, at a minimum: a. Changes to the Agreement and Services may be requested by either Party. Since a change may affect the price, schedule or other terms, both the Flagstar and ISSC Project Executives must review and approve, in writing, each Change Request before any Change Request is implemented. b. The Party proposing a Change Request will write a Change Request Form ("CRF"), describing the change, the rationale for the change and the effect that change will have, if completed, or the impact it will have, if rejected, on the Agreement and/or the Services. c. Flagstar's or ISSC's representative, as appropriate, will review the proposed Change Request. If accepted, the CRF will be submitted to the other Party for review. If rejected, the CRF will be returned to the originator along with the reason for rejection. d. Flagstar's and ISSC's representatives will weigh the merits of the proposed Change Request and will decide whether further study of the Change Request is in order. Approval of a CRF proposed by Flagstar for further study constitutes authorization by Flagstar for ISSC to proceed to investigate the CRF and invoice Flagstar for such costs incurred by ISSC for resources outside of the Annual Service Charge or beyond an established Baseline. Approval of a CRF proposed by ISSC for further study constitutes authorization by the Parties to further investigate and study the Change Request without charge to Flagstar. e. ISSC will present the results of the study to the Flagstar Project Executive detailing the technical merits, effects on price, schedule, and impact on other terms, conditions and modifications that will result from implementation of the proposed Change Request. The Flagstar Project Executive shall then either approve or reject the Change Request. f. Each approved Change Request will be implemented through a written change authorization and the Agreement, Supplement and Schedules will be updated to reflect the changes in scope, price or terms and conditions, as appropriate. 16. GENERAL 16.1 CONTROL OF SERVICES This Agreement shall not be construed as constituting either Party as partner of the other or to create any other form of legal association that would impose liability upon one Party for the act or failure to act of the other or as providing either Party with the right, power or authority (express or implied) to create any duty or obligation of the other Party. Each Party shall be responsible for the management, direction and control of its employees and such employees shall not be employees of the other Party. Each Party will submit to the other Party all advertising, written sales promotion, press releases and other publicity matters relating to this Agreement in which the other Party's name or mark is mentioned or language from which the connection of said name or mark may be inferred or implied, and will not publish or use such advertising, sales promotion, press releases, or publicity matters without prior written approval of the other Party. However, either Party may include the other Party's name and a factual description of the work performed under this Agreement on employee bulletin boards, in its list of references and in the experience section of proposals to third parties, in internal business planning documents and in its annual report to stockholders, and whenever required by reason of legal, accounting or regulatory requirements. Page 48 of 52 16.2 ENTIRE AGREEMENT, UPDATES, AMENDMENTS AND MODIFICATIONS This Agreement including the Supplement and Schedules A through T, constitute the entire agreement of the Parties with regard to the Services and matters addressed therein, and all prior agreements, letters, proposals, discussions and other documents regarding the Services and the matters addressed in this Agreement (including the Supplement and Schedules) and are superseded and merged into this Agreement (including the Supplement and Schedules). Updates, amendments and modifications to this Agreement may not be made orally, but shall only be made by a written document signed by both Parties. Any terms and conditions varying from this Agreement (including the Supplement and Schedules) on any order or written notification from either Party shall not be effective or binding on the other Party. 16.3 FORCE MAJEURE a) Neither Party shall be liable for any default or delay in the performance of its obligations hereunder if and to the extent and while such default or delay is caused, directly or indirectly, by fire, flood, earthquake, elements of nature or acts of God, acts of war, terrorism, riots, civil disorders, rebellions or revolutions in the United States, strikes, lockouts, or labor difficulties or any other similar cause beyond the reasonable control of such Party other than strikes, lockouts, or labor difficulties initiated by such Party's or its subcontractor's employees; and provided such default or delay could not have been prevented by reasonable precautions and cannot reasonably be circumvented by the nonperforming Party through the use of alternate sources, work-around plans or other means, (individually, each being a "Force Majeure Event"). b) If a Force Majeure Event occurs, the nonperforming Party will be excused from any further performance or observance of the obligation(s) so affected for as long as such circumstances prevail and such Party continues to use commercially reasonable efforts to recommence performance or observance whenever and to whatever extent possible without delay. Any Party so delayed in its performance will immediately notify the other by telephone and describe at a reasonable level of detail the circumstances causing such delay (to be confirmed in writing within twenty-four (24) hours after the inception of such delay). c) If any Force Majeure Event substantially prevents, hinders, or delays performance of the Services necessary for the performance of Flagstar's critical functions for more than fifteen (15) consecutive days, then at Flagstar's option: 1) Flagstar may procure such Services from an alternate source. ISSC will directly and timely pay the alternate source the full amount charged by such alternate source for the provision of such Services to Flagstar until such time as ISSC is able to restore the Services and meet the Performance Standards but in no event for more than one hundred eighty (180) days; or 2) Flagstar may terminate this Agreement as of a date specified by Flagstar in a written notice of termination to ISSC, and Flagstar will pay all fees due and payable through the termination date. If Flagstar elects such termination, Flagstar shall not be obligated to pay any other termination or other fees, however described, to ISSC, except fees for Services Transfer Assistance through the expiration of any extension period beyond the termination date. d) This Section 16.3 does not limit or otherwise affect ISSC's obligation to provide Disaster Recovery Services in accordance with Schedule G. In the event of a Force Majeure Event affecting Flagstar this Section 16.3 will not limit or otherwise relieve Flagstar's obligation to pay any monies due ISSC under the terms of this Agreement, except as provided in Section 16.3(c)(2). Page 49 of 52 16.4 NONPERFORMANCE Except as otherwise provided in this Agreement, to the extent any nonperformance by either Party of its nonmonetary obligations under this Agreement results from or is caused by the other Party's failure to perform its obligations under this Agreement, such nonperformance shall be excused. 16.5 WAIVER No waiver of any breach of any provision of this Agreement shall constitute a waiver of any prior, concurrent or subsequent breach of the same or any other provisions hereof. 16.6 SEVERABILITY If any provision of this Agreement shall be held to be invalid, illegal or unenforceable, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby, and such provision shall be deemed to be restated to reflect the Parties' original intentions as nearly as possible in accordance with applicable law(s). 16.7 LIMITATIONS PERIOD UPON TERMINATION Neither Party may bring an action, regardless of form, arising out of this Agreement more than three (3) years after the cause of action has arisen or the date such cause of action was or should have been discovered. 16.8 COUNTERPARTS This Agreement shall be executed in counterparts. Each such counterpart shall be an original and together shall constitute but one and the same document. 16.9 GOVERNING LAW This Agreement shall be governed by the laws of the State of South Carolina as such laws are applied to contracts which are entered into and performed entirely within the State of South Carolina. The Parties agree that any lawsuit commenced by either Party shall be commenced in the appropriate court for Spartanburg County, South Carolina or the U.S. District Court for the District of South Carolina, Greenville division. Each of the Parties hereby consents to the jurisdiction of and service of process from the appropriate court for Spartanburg County, South Carolina and the U.S. District Court for the District of South Carolina, Greenville division. Nothing in this Section 16.9 shall be deemed to further restrict the Parties' procedural or substantive rights, including but not limited to, the right to seek removal of any action from state to Federal Court. 16.10 BINDING NATURE AND ASSIGNMENT This Agreement will be binding on the Parties and their respective successors and permitted assigns. Except as provided in this Section 16.10, neither Party may, or will have the power to, assign this Agreement without the prior written consent of the other, which consent shall not be unreasonably withheld, except that either Party may assign its rights and obligations under this Agreement to an Affiliate which expressly assumes such Party's obligations and responsibilities hereunder, without the approval of the other Party. The assigning Party shall remain fully liable for and shall not be relieved from the full performance of all obligations under this Agreement. Any attempted assignment that does not comply with the terms of this Section 16.10 shall be null and void. Any Party assigning its rights or obligations to an Affiliate in accordance with this Agreement shall provide written notice thereof to the other Party together with a copy of the assignment document, within three (3) business days of such assignment. Page 50 of 52 16.11 NOTICES a) Under this Agreement whenever one Party is required or permitted to give notice to the other Party, such notice will be in writing unless otherwise specifically provided herein and will be deemed given when delivered in hand, one (1) day after being given to an express courier with a reliable system for tracking delivery, or five (5) days after the day of mailing, when mailed by United States mail, registered or certified mail, return receipt requested, postage prepaid, or when sent by facsimile and thereafter delivered by one of the foregoing methods of delivery. b) Notifications will be addressed as follows: 1) For termination, breach or default, notify: In the case of ISSC: with a courtesy, but not legally required, copy to: ISSC Project Executive ISSC General Counsel 203 E. Main Street Route 1, Box 100 Spartanburg, SC 29319 Somers, New York 10589 Facsimile: _____________ Facsimile: 914-766-8444 In the case of Flagstar: with a courtesy, but not legally required, copy to: Flagstar Corporation Flagstar General Counsel 203 E. Main Street Rhonda J. Parish Spartanburg, SC 29319 203 E. Main Street Facsimile:_______________ Facsimile: 864-597-8327 2) For all other notices: In the case of ISSC: In the case of Flagstar: ISSC Project Executive Honorio Padron 203 E. Main Street CIO, VP Business Facsimile:_______________ Engineering & Technology Facsimile: 864-597-8327 Either Party hereto may from time to time change its address for notification purposes by giving the other prior written notice of the new address and the date upon which it will become effective. 16.12 NO THIRD PARTY BENEFICIARIES The Parties do not intend, nor will any Section hereof be interpreted, to create for any third party beneficiary rights with respect to either of the Parties, except as specifically provided in Section 13. 16.13 OTHER DOCUMENTS Upon request of the other Party, on or after the Effective Date and the date(s) of any amendments or revisions hereto each Party shall furnish to the other such certificate of its Secretary, certified copy of resolutions of its Board Page 51 of 52 of Directors, or opinion of its counsel as shall evidence that this Agreement or any amendment or revision hereto has been duly executed and delivered on behalf of such Party. 16.14 CONSENTS AND APPROVALS The Parties agree that in any instance where consent, approval or agreement is required of a Party in order for the other Party to perform under or comply with the terms and conditions of this Agreement, then such Party will not unreasonably withhold or delay such consent, approval or agreement and where consent, approval or agreement cannot be provided, the Party shall notify the other Party in a timely manner. 16.15 HEADINGS All headings herein and the table of contents are not to be considered in the construction or interpretation of any provision of this Agreement. This Agreement was drafted with the joint participation of both Parties and shall be construed neither against nor in favor of either, but rather in accordance with the fair meaning thereof. In the event of any apparent conflicts or inconsistencies between the Agreements, the Schedules or other attachments to this Agreement, to the extent possible such provisions shall be interpreted so as to make them consistent, and if such is not possible, the provisions of this Agreement shall prevail. 16.16 REMARKETING Flagstar may not remarket all or any portion of the Services provided under this Agreement, or make all or any portion of the Services available to any party, without the prior written consent of ISSC; provided, however, Flagstar may sell or make available to the other entities in the Flagstar Group, the Services under this Agreement. Flagstar shall independently set its own pricing and policies in connection with any such disposition of the Services. Nothing herein may be construed to limit or hinder Flagstar from (i) marketing, selling or performing its services to and for any other entity in the Flagstar Group and/or (ii) from providing any portion of the Services to any other entity in the Flagstar Group. Page 52 of 52 ____________ ___, 1997 Integrated Systems Solutions Corporation Route 1, Box 100 Somers, New York 10589 Gentlemen: In consideration of, but subsequent to, the execution and delivery by ISSC and Flagstar of that certain Information Systems Management Agreement, dated February 22, 1996 (the "Agreement"), ISSC and Flagstar agree that Schedule E, Section E-2, attached hereto as Exhibit A is hereby incorporated into the Agreement by this reference and made a part thereof. In the event of a conflict between the terms of this letter and the Agreement, this letter shall be controlling. Please indicate your acceptance of this letter agreement by signing in the space indicated below. FLAGSTAR CORPORATION By: --------------------------- Title: ----------------------- Accepted and agreed to ________ ___, 1997. INTEGRATED SYSTEM SOLUTIONS CORPORATION By: ---------------------- Title: ------------------- TABLE OF CONTENTS Page(s) Section E-1................................................................. 1 I. INTRODUCTION................................................ 1 II. SYSTEMS MANAGEMENT CONTROLS................................. 2 A. As Is Systems...................................... 2 B. To Be Systems...................................... 2 III. DATA CENTER OPERATIONS...................................... 4 A. Operation of Data Center........................... 4 B. Processing Operations.............................. 5 C. Production Control................................. 6 E. Tape Management.................................... 8 F. Data Base Administration........................... 9 G. Output............................................. 10 H. Quality Assurance.................................. 10 I. Emergency Restoration of Services.................. 11 J. Information Security............................... 11 IV. AS IS SYSTEMS............................................... 11 A. General............................................ 11 B. Existing POS Systems............................... 11 V. TO BE SYSTEMS............................................... 12 A. Implementation of Schedule N Projects.............. 13 B. New POS Systems Implementation..................... 13 VI. DATA NETWORK AND VOICE SERVICES............................. 14 A. Network Services................................... 14 B. Network Connectivity and Operations................ 14 C. Network Engineering................................ 16 D. Network Optimization............................... 17 E. Network Management................................. 18 VII. LOCAL AREA NETWORK.......................................... 19 A. LAN Support Services (General)..................... 19 B. LAN Support Services (Specific).................... 20 C. LAN MAC............................................ 21 VIII. HELP DESK................................................... 21 IX. CLIENT TECHNICAL SERVICES................................... 22 A. Client Technical Services.......................... 22 B. Client Technical Services MAC Support ............. 23 X. APPLICATIONS DEVELOPMENT.................................... 24 A. General Deliverables............................... 24 Page i of ii Page(s) B. AD/M Projects...................................... 24 C. Software Maintenance............................... 25 D. Schedule N Projects................................ 26 E. ISSC Responsibilities.............................. 26 F. Flagstar Responsibilities.......................... 29 G. Project Changes.................................... 30 H. Implementation..................................... 30 I. Customization and Enhancements..................... 31 J. Interfaces, Bridges and Data Conversion............ 31 XI. QUALITY ASSURANCE........................................... 31 Page ii of ii ISSC / FLAGSTAR CORPORATION AGREEMENT FOR INFORMATION TECHNOLOGY SERVICES SCHEDULE E SUPPORT SERVICES, PERFORMANCE STANDARDS AND OPERATIONAL RESPONSIBILITIES SECTION E-1 SUPPORT SERVICES I. INTRODUCTION This Section E-1 describes certain duties, obligations and responsibilities of ISSC, including, but not limited to: A. Data Center operations and management; B. Data Network operations and management; C. Voice Services operations and management; D. LAN operations and management; E. Help Desk operations and management; F. Client Technical Services operations and management; G. Applications Development; H. Software Maintenance; I. Production and quality assurance services; During the Term, ISSC will continue to provide information processing services to Flagstar using the Machines, Software, Network and related Flagstar Corporate Facilities provided by Flagstar and utilized by Flagstar prior to the Commencement Date to provide services to itself. The Parties contemplate that ISSC will operate the As Is Systems in the Flagstar Corporate Facilities "as is," unless otherwise required to complete the AD/M Projects or the Schedule N Projects or requested by Flagstar as New Services in accordance with Sections 6.6 and 6.7 of the Agreement. Therefore, the Page 1 of 32 descriptions contained in this Schedule E of specific types of As Is Systems, and methods and procedures used to perform the Services with respect thereto, set forth how ISSC will deliver the services Flagstar performed for itself prior to the Commencement Date. In addition, ISSC will provide the Schedule N Projects, will operate the To Be Systems and will provide such other services as requested and approved by Flagstar during the Term as New Services in accordance with Sections 6.6 and 6.7 of the Agreement. The Parties agree that the provision of Services should improve over the Term based on: 1. the migration from the As Is Systems to the To Be Systems; 2. ISSC's knowledge of, and access to, resources and technology; and 3. ISSC's implementation of improved methods and procedures for providing Services, and efficiencies arising from the use of ISSC as a service provider. The Parties agree that appropriate implementation details and procedures for the Services shall be incorporated into the Procedures Manual. During the Term, the Parties may, in addition to the Schedule N Projects delivered in accordance with Schedule N, agree on different or additional Services, Performance Standards and Minimum Service Levels, and will amend this Schedule E or the Procedures Manual in writing accordingly. All capitalized terms not defined in this Section E shall have the meanings given them in the Agreement, Supplement and other Schedules. II. SYSTEMS MANAGEMENT CONTROLS A. AS IS SYSTEMS - With respect to the As Is Systems, ISSC will utilize existing Flagstar procedures as in use by Flagstar on the Commencement Date. ISSC will review such existing Flagstar procedures and may recommend changes in accordance with the Change Control Process. B. TO BE SYSTEMS - With respect to the To Be Systems, ISSC will provide to Flagstar, and Flagstar and ISSC shall mutually agree on and use the following processes/procedures as the standard set of disciplines for managing information systems, the Systems Management Control ("SMC"), for use by ISSC and Flagstar. The SMC procedures shall be included in the Procedures Manual. In general, ISSC's SMC responsibilities shall include the following processes in the Flagstar Corporate Facilities: Page 2 of 32 1. BATCH MANAGEMENT - for controlling production batch work including the scheduling of resources, the processing of data and transactions and the distribution of data/information between Flagstar Group users and Flagstar Corporate Facilities. Flagstar's instructions on what, when and how to schedule and recover shall be provided to ISSC and included in the Procedures Manual. Setup and scheduling shall be performed and controlled by ISSC in accordance with the Procedures Manual and in accordance with Flagstar's business requirements. 2. CAPACITY MANAGEMENT - for the development and maintenance of tactical and strategic plans to ensure that the Flagstar Corporate Facilities and Network environments accommodate Flagstar's growing or changing business requirements. The capacity management procedures will, among other issues, provide for Flagstar's input and review of capacity management. 3. CHANGE MANAGEMENT - to assess the impact of the change, including without limitation, analysis of the effects of the proposed changes and the implementation, quality assurance and testing of the change, to validate the adequacy of the acceptance test, schedule the promotion from the test environment, notify the appropriate functions and verify successful implementation. 4. CONFIGURATION MANAGEMENT - for processing Machines and Software configuration changes and maintaining lists and diagrams of System configurations in the Procedures Manual. ISSC will provide revised configurations to Flagstar upon Flagstar's reasonable request. 5. INVENTORY MANAGEMENT - of the Machines (including incoming and outgoing) in the Flagstar Corporate Facilities and Network. This activity is to include, but not be limited to, vendor coordination and maintenance. 6. ON-LINE MANAGEMENT - for coordinating the appropriate skills, information, tools and procedures required to manage on-line connectivity to the Network and their supporting Machines and Software systems. This includes the staffing of a Help Desk facility for support of Flagstar's personnel. 7. PERFORMANCE MANAGEMENT - to monitor, measure, analyze and report System and Services performance as it compares to the Performance Standards. Where warranted, ISSC may request Flagstar to approve changes to the Applications Software to enable System performance Page 3 of 32 improvement. The performance management procedures will, among other issues, provide for Flagstar's input and review of performance management. 8. PROBLEM MANAGEMENT - to identify, record, track, and correct issues impacting Services delivery, recognize recurring problems, address procedural issues and contain or reduce the impact of problems that occur. 9. RECOVERY MANAGEMENT - for planning, establishing and testing the recovery procedures required to provide the Services in the event of a failure and reintegrate Services facilities once the primary Services location is available again, including without limitation, a failure giving rise to invoking the Disaster Recovery services described in Schedule G. The intent of this process is to anticipate and minimize the impact of System resource failure through the development of predefined, documented procedures and Software/Machine recovery capabilities. Flagstar's instructions on what and how to recover shall be provided to ISSC and included in the Procedures Manual. III. DATA CENTER OPERATIONS A. OPERATION OF DATA CENTER ISSC shall be responsible for the operation and management of the Data Center throughout the Term, which responsibility shall include establishing and maintaining a properly trained and adequately staffed Data Center population, including necessary management and support staff. The hours of operation of the Data Center shall be 24 hours per day, 7 days per week, exclusive of the regularly scheduled twelve (12) hour period from 11 a.m. through 11 p.m. on Sundays or unless otherwise agreed by the Parties. ISSC shall perform the Services in accordance with the Performance Standards and Minimum Service Levels. However, the Parties agree that the regularly scheduled weekly maintenance period will not impact ISSC's performance of the Services in accordance with the Performance Standards. In addition, ISSC will manage and optimize the existing Flagstar contract with Software Maintenance Specialists ("SMS") in La Mirada, California through successful completion of the migration to the To Be Systems environment. Page 4 of 32 B. PROCESSING OPERATIONS ISSC shall make available, monitor and process on-line and batch applications, including scheduled, unscheduled and on-request Services as well as Flagstar Group user initiated processing. Included in such responsibilitIes, ISSC shall: 1. support the test and production environments; 2. provide computer room operations support and perform console monitoring activities; 3. provide report generation; 4. install and maintain networking Machines, Software and LAN interfaces; 5. operate and provide application availability to present and future Applications Software to support the operating schedules of Flagstar with applicable System availability, 24 hours per day, 7 days per week (subject to Scheduled Downtime); 6. perform all technical System support operations, including file storage management, system programming, capacity planning, problem analysis, job abend/restart processing and performance tuning, including providing support for the Machines and Systems Software for the Machines; 7. with the approval of the Flagstar representative designated by the Flagstar Project Executive, schedule System maintenance with minimum interference with the business needs of Flagstar; 8. complete all processing schedules on time and in the sequence set forth in the Procedures Manual; 9. to the extent reasonably possible, process special request activities within the requested time frames and in the sequence defined by Flagstar; 10. monitor job submissions and ensure that these jobs are successfully completed as time permits in view of competing production resources; 11. provide reports and/or review meetings regarding the utilization of the Concept IS, Client Technical Services, Help Desk and AD/M Baselines as scheduled or requested by Flagstar; Page 5 of 32 12. continuously endeavor to enhance processing capabilities and efficiencies for the Machines in the Flagstar Corporate Facilities through System tuning, regular monitoring of utilization needs and efficiencies and other run-time improvements and report on tuning initiatives for the Machines; 13. consistent with the Agreement, operate, support and maintain third-party services and projects and products listed in Schedules A, B, C and D; and 14. refresh the Machines in accordance with the time schedule set forth in Schedule N. C. PRODUCTION CONTROL ISSC shall maintain production schedules and cooperate with Flagstar in responding to special processing requests and new processing requirements. Included in such responsibilities, ISSC shall: 1. prioritize and schedule batch jobs and report distribution systems in accordance with Flagstar's schedule parameters, including but not limited to, automated scheduling features in the operating and Applications Software and Flagstar's specific directions so on-line Applications dependent on batch processing and batch process outputs shall be available as scheduled; 2. distribute and obtain Flagstar's approval for production control schedules prior to implementation, as described in the Change Control Process; 3. update the scheduler data base, as required, to reflect changes to the production environment; 4. monitor scheduler related incidents, and develop and recommend refinements and revisions to the scheduler data base; 5. coordinate and modify schedules for special requests, subject to applicable Performance Standards attainment relief, and follow Flagstar's priorities and promptly notify Flagstar if special requirements shall affect the timely completion of other tasks, so that Flagstar can adjust the priorities if Flagstar so desires; and 6. respond expeditiously to requests from Flagstar for priority job execution. Page 6 of 32 D. FILE SERVICES ISSC shall manage files on the Machines in a manner which shall ensure the availability and integrity of all Flagstar data. Included in such responsibilities, ISSC shall: 1. ensure that all files under ISSC's control are current and available during requested access times; 2. initiate and complete required activities to ensure the data is processed according to the specifications set forth in the Procedures Manual and with data integrity in all processed files; 3. verify the successful receipt of all incoming files and the successful transmission of all outgoing files, using the tools existing as of the Commencement Date, those that are added in the To Be and/or such other ISSC-provided tools as ISSC deems necessary, and the procedures set forth in the Procedures Manual; 4. document, maintain and, as appropriate, update, and execute mutually approved file back-up and recovery procedures; 5. provide recovery procedures for restoring the data image to a previous level within a mutually agreed amount of time; 6. conduct routine back-up and recovery procedures as set forth in the Procedures Manual and as prioritized by Flagstar (e.g., data set restore) so as not to impact scheduled operations and provide recommendations to Flagstar regarding back-up and recovery considerations, such as improved levels of protections, efficiencies and cost reductions; 7. conduct routine monitoring and corrective action according to procedures prepared by ISSC and approved by Flagstar for intermediate files used for on-line and batch processing; 8. maintain current documentation of all files; 9. ensure that adequate file space is available for processing; 10. report Flagstar disk space utilization and requirements for capacity planning purposes and Flagstar equipment requirements support; Page 7 of 32 11. assist and advise Flagstar in utilizing disk storage resources in an efficient and cost effective manner; and 12. refresh the disk storage in accordance with the Schedule N. E. TAPE MANAGEMENT ISSC shall provide tape management services. Included in such responsibilities, ISSC shall: 1. update Flagstar's procedures governing time periods for retention of tapes, including reasonable periods for retention of tapes for auditing purposes, as appropriate and with Flagstar's consent, and include such procedures in the Procedures Manual; 2. provide logging and tracking of physical tapes in and out of the Flagstar Corporate Facilities, and provide required rotation of tapes for off-site vault storage; 3. establish procedures to log and track physical tapes that are checked in and checked out to Third Party Providers (e.g., tapes for Flagstar's vendors) and Flagstar Group users; 4. store tapes and paper documentation, as appropriate, at secure off-site vault storage and mark the retention time on each tape to be stored at secure off-site vault storage; 5. complete tape mounts in sufficient time to meet production processing requirements and complete tape mounts for nonproduction processing; 6. provide tape specifications to ensure tape media is reliable and read/write errors are kept to a minimum; 7. ensure equipment is properly cleaned and maintained at the required intervals in accordance with manufacturers' specifications to minimize problems and outages; 8. ensure adequate supplies for the tape environment are maintained and that the scratch tape pool is sufficient to service all required processing needs; 9. store tapes in the Flagstar Corporate Facilities storage area; Page 8 of 32 10. retrieve archived tapes and restore required files and data sets within mutually agreed time frames; 11. upon Flagstar's reasonable request, provide Flagstar with the right to, and access to, monitor tape management operations, mailing and receipt control; 12. report tape utilization; and 13. refresh the tape storage devices in accordance with Schedule N. F. DATA BASE ADMINISTRATION ISSC shall be responsible for managing the Flagstar and Flagstar Group user data and the data base environment. Included in such responsibilities, ISSC shall: 1. with respect to As Is Systems and To Be Systems, perform all logical and physical data base management system ("DBMS") data base control functions including, but not limited to: a. allocating physical DBMS data base files; b. performing all logical and physical DBMS data base functions to support the current As Is Systems and the planned To Be Systems, if any; and c. performing data base tuning and reorganization as reasonably required to maintain System performance requirements; d. performing logical data base design for Schedule N and AD/M Projects and reviewing designs with Flagstar on a regular basis for Flagstar's comment and approval; 2. plan for changes in the size of data bases due to business growth, Schedule N Projects and other AD/M Projects, and review plans with Flagstar on a regular basis for Flagstar's comment and approval; 3. provide test data base environments for Schedule N Projects and AD/M Projects that are separate from the production data base environment; 4. provide data base support for current data base environments and those established by ISSC; Page 9 of 32 5. maintain the physical data base design, create indices and make recommendations on practical methods to optimize Applications performance; 6. monitor data base performance and data base space utilization; 7. maintain or implement data base archive processes and procedures to meet Flagstar's business requirements and recover from a data base outage or corrupted data base within mutually agreed time frames as set forth in the Procedures Manual; 8. maintain data base definitions and make data base definitions for Schedule N Projects, AD/M Projects and other definition, as needed, and make such definitions available to Flagstar upon request; and 9. test and implement data base environment changes. G. OUTPUT ISSC shall provide output device processing and operational support necessary to accomplish such processing including production and delivery of fiche, optical print, files and tape. ISSC shall: 1. produce output on time and within established Performance Standards; 2. track, manage, communicate and resolve all problems related to output Services; 3. separate and package all output and ensure that it is properly distributed to the mutually agreed to distribution drop point in the Flagstar Corporate Facilities within the required time frames; 4. work with Flagstar personnel to find, trace or replace lost or missing items using ISSC monitoring tools and take appropriate action in accordance with the Procedures Manual; and 5. execute reruns of output requested by Flagstar and notify Flagstar if rerunning any output shall impact scheduled on-line or batch production processing. H. QUALITY ASSURANCE Page 10 of 32 ISSC shall be responsible for providing and implementing quality assurance processes and procedures that are reasonably necessary to ensure ISSC's responsibilities are executed accurately, efficiently and in a timely manner. Subject to the foregoing, the parties shall mutually agree upon terms and conditions for conducting checkpoint reviews. These procedures shall be included in the Procedures Manual. I. EMERGENCY RESTORATION OF SERVICES ISSC shall invoke the Disaster Recovery Plan, and provide Disaster Recovery planning in accordance with Schedule G. J. INFORMATION SECURITY ISSC shall use existing security access control tools for data, data bases and other information repositories and for Applications, operating systems and libraries as described in Schedule L. IV. AS IS SYSTEMS A. GENERAL From the Commencement Date through the date of completion of the cutover to production of each Schedule N Project, ISSC shall operate the As IS Systems to be replaced by such Schedule N Project and perform the support and management functions related thereto and currently performed by Flagstar. As more specifically described in this Section E-1 and Section E-3 of this Schedule E, ISSC's responsibilities shall include without limitation, the provision of the services, functions and responsibilities performed by the Affected Employees and the Third Party Providers performing services under Third Party Agreements prior to the Commencement Date that are related to the delivery of the As Is Systems until the production cutover date of the applicable replacement Schedule N Project, and writing and implementing Software code to interface the As Is Systems to the Schedule N Projects. B. EXISTING POS SYSTEMS ISSC shall act as Flagstar's agent to provide support and maintenance Services for the Flagstar Restaurants. Included in such responsibilities, ISSC shall provide support services for the Existing POS Systems through the ISSC Help Desk and shall provide Polling in accordance with the Procedures Manual through the cutover date for the Schedule N Project for point-of-sale Services. Page 11 of 32 Included in such responsibilities ISSC shall provide support, maintenance and Polling services for the Flagstar Restaurants listed in Schedule I, and described in Schedules M, N and P and Procedures Manual. Included in such responsibilities, ISSC shall: 1. provide Polling in accordance with the Procedures Manual, as follows: a. invoking and monitoring daily Polling to the Flagstar Restaurants, b. performing menu down-loads and other file transfers of information for the Flagstar Restaurants consistent with current Flagstar procedures on a mutually agreed schedule, c. performing remote diagnostic support of Flagstar Restaurants, and d. performing manual intervention for restaurants not successfully Polled per the processes described in the Procedures Manual; 2. provide single-point-of-contact via the ISSC Help Desk for problem reporting and resolution (7 days per week, 24 hours per day); 3. provide the maintenance for the Existing POS System, exclusive of the Wiring installed at the Flagstar Restaurants, consistent with the maintenance strategy used by Flagstar prior to the Commencement Date to include, but not be limited to, the following; a. providing Level One, Two and Three Support for problem isolation and resolution for POS Machines, exclusive of wiring b. provide Level One, Two and Three Support for problem isolation and resolution for POS Software and connections, and c. providing on-site maintenance in accordance with Schedule P and the third party vendor POS Machines maintenance contracts listed in Section F-3 of Schedule F; and 4. handle maintenance requests in accordance with Flagstar's prioritization procedures. V. TO BE SYSTEMS Page 12 of 32 A. IMPLEMENTATION OF SCHEDULE N PROJECTS ISSC shall implement each Schedule N Project in accordance with Schedule N. ISSC shall assume responsibility for the management and operation of the integration of each Schedule N Project into ISSC's on-going operational Services responsibilities for the To Be Systems as described in Schedules E and N. ISSC will implement the Schedule N Projects and use, operate, manage and support the Schedule N Projects and all related functions described in the Agreement, including without limitation the operational, network, tape/optical, technical support services, production services, data base services and Software services. ISSC will provide management and support for the Software including without limitation performing all services, functions, and responsibilities regarding the necessary maintenance and enhancements required to perform the Services. During the Term, ISSC will perform its responsibilities with respect to the transition of the As Is Systems, AD/M Projects and Schedule N Projects to the To Be Systems to ensure the interoperability of all Machines and Software. B. NEW POS SYSTEMS IMPLEMENTATION Flagstar shall operate the New POS Systems in the Flagstar Restaurants. ISSC shall assume responsibility for the management and operation of the integration of the New POS Systems with the other Services operations in the Flagstar Restaurants and Flagstar Corporate Facilities as described in Schedules E and N and for the replacement of all Existing POS Systems and the upgrade, replacement and addition of Applications and System Software for the New POS System in accordance with Schedule N, including without limitation: 1. disconnecting installed POS Machines for the Existing POS System and preparing same for shipment at Flagstar's request; 2. providing single-point-of-contact via the ISSC Help Desk for problem reporting and host System status; 3. providing maintenance for the New POS Machines, Software, Cabling and connections to the Flagstar Corporate Facilities' wiring installed at the Flagstar Restaurants to include, but not be limited to, the following; a. providing Level One, Two and Three Support for problem isolation and resolution for POS Machines, Page 13 of 32 b. providing Level One, Level Two and Level Three Support for problem isolation and resolution for POS Software and connections, and c. handling maintenance requests in accordance with Flagstar's prioritization procedures. VI. DATA NETWORK AND VOICE SERVICES A. NETWORK SERVICES ISSC's responsibilities shall include administering, at Flagstar's request, the procurement of, and directing the engineering, installation, operation, maintenance, and management of the Data Network and Voice Services as needed to support Network operational requirements, subject to the provisions of the Agreement. Using information provided by ISSC, Flagstar is responsible for negotiating the terms and conditions of the KKR Agreement and the CIO Agreement. In addition, using the tools available to Flagstar prior to the Commencement Date (or similar tools and techniques), ISSC shall monitor, to the extent capable of being monitored, the Flagstar End User Machines, if necessary to determine whether Network problems are caused by such devices, in which case ISSC shall initiate the appropriate support process(es). Network Services are defined as all the dial and leased line services provided as of the Commencement Date including, without limitation, those provided at Flagstar Corporate Facilities, dial telephone services at Flagstar Restaurants and Flagstar remote office sites necessary for telephone communications, and POS data polling to and from Flagstar Restaurants. Network Services include without limitation administering, MACs for telephone hardware and circuits required for capacity at Flagstar Corporate Facilities and Flagstar Restaurants, new Flagstar Restaurants and Flagstar remote office locations, or reconfigure existing telephone systems at concept sites. B. NETWORK CONNECTIVITY AND OPERATIONS ISSC shall manage and maintain the dial and leased circuit bandwidth as of the Commencement Date, necessary to deliver the Services and to meet the Performance Standards, and shall assume responsibility for the operation of the Network, including Network management and monitoring as currently performed by Flagstar, including without limitation, common carrier access management, equipment design, circuit ordering, maintenance, and problem prevention, Page 14 of 32 identification and resolution. Included in such responsibilities, ISSC shall perform the following functions related to Network connectivity and operations for the Data Network and Voice Services locations listed in Schedule I and as described in the Topology and Connectivity diagrams in Exhibits I-1 and I-2 and as updated during the verification and validation period described in Section 2.3 of the Agreement. 1. provide, manage, monitor and maintain connectivity between the Data Center and the Data Network and Voice Services locations necessary for the performance of the Services and to meet the Performance Standards; 2. maintain the Network bandwidth, Network Availability and Network response times, necessary to deliver the Services and to meet the Performance Standards; 3. upon Flagstar's request, reallocate the dial and leased circuit bandwidth provided that if such reallocation impacts ISSC's ability to provide the Services, ISSC shall notify Flagstar of the impact and, if Flagstar decides to proceed, then ISSC shall be relieved of the affected Performance Standards; 4. maintain Network availability in accordance with the Performance Standards set forth in this Schedule E; 5. oversee installation and maintenance of Network circuits and equipment to meet the Performance Standards; 6. provide cost estimates as required by the Change Control Process for all costs separately chargeable to Flagstar; 7. where possible, perform changes to the Network, in accordance with the Change Control Process, on an expedited basis at Flagstar's request; 8. schedule Network outages related to installation and maintenance during off-peak hours, as approved in advance by Flagstar, and/or as described in the Procedures Manual; 9. request management functions and equipment order pre-approval not less than two (2) business days prior to time required to ensure no delay to Flagstar operations; 10. serve as a single-point-of-contact for all Network needs; Page 15 of 32 11. coordinate with inter-exchange carriers to provide connectivity and maintain the Performance Standards and interface with third party services providers; 12. identify and resolve problems on the Network through the use of problem management and escalation procedures set forth in the Procedures Manual; 13. provide MAC for the telephone equipment at Flagstar Corporate Facilities, using the resources set forth under the Client Technical Services Baseline specified in the Supplement and described in Schedule J or, through Third Party Agreements in effect as of the Commencement Date, as follows; a. handle MAC requests on a first-in-first-out basis unless otherwise prioritized by Flagstar; b. provide on-site MAC during normal business hours, Monday through Friday at Flagstar Corporate Facilities, unless otherwise agreed by the Parties pursuant to the Change Control Process; 14. provide MAC for the PBX at Flagstar Corporate Facilities, using the resources set forth under the Client Technical Services Baseline specified in the Supplement and described in Schedule J or, through Third Party Agreements in effect as of the Commencement Date, as follows; a. handle MAC requests on a first-in-first-out basis unless otherwise prioritized by Flagstar; b. provide on-site MAC during normal business hours, Monday through Friday at Flagstar Corporate Facilities, unless otherwise agreed by the Parties pursuant to the Change Control Process; 15. manage Third Party Agreement provided software upgrades, replacements or new software on the PBXs at Flagstar Corporate Facilities through Third Party Agreements in effect as of the Commencement Date; and 16. As Is Systems and To Be Systems will be supported by ISSC with the Client Technical Services Baseline and in the same manner as is currently done, or as required for the AD/M Projects and Schedule N Projects. C. NETWORK ENGINEERING Page 16 of 32 ISSC shall perform support Services as currently performed by Flagstar as of the Commencement Date related to Network engineering for the Data Network and Voice Services locations. Included in such responsibilities, ISSC shall: 1. perform Network design activities, including recommending Flagstar Network design criteria and standards; 2. manage the capacity and configuration of the Network and maintain and deliver to Flagstar lists of any additions to the Machine inventories and changes to circuit diagrams, lists, and other Network documentation and information through the Change Control Process, but not less than once per quarter or otherwise as reasonably requested by Flagstar, and provide revised/updated lists and documentation to Flagstar at least twice a year; 3. perform engineering functions related to Network optimization; 4. perform engineering functions related to ordering, upgrading, and installing Network circuits, systems and equipment; 5. evaluate and verify that Network, terminal, and interface equipment is suitable for its intended use; 6. conduct site surveys, as appropriate, and as currently performed by Flagstar as of the Commencement Date; and 7. develop acceptance procedures for installation and changes to the Network and for verifying restoration of services following problems with Network circuits or equipment and include such procedures in the Procedures Manual according to the following: a. the acceptance procedures shall use objective and demonstrable criteria for verifying compliance with performance specifications and applicable criteria; and b. as specified in the Procedures Manual, Data Network and Voice Services, including but not limited to circuits or Machines shall not be deemed to be accepted until after ISSC has notified Flagstar that the installation change, or restoration has successfully passed ISSC's testing that has been mutually agreed to by both Parties. D. NETWORK OPTIMIZATION Page 17 of 32 ISSC shall research and evaluate on an on-going basis during the Term, means for optimizing the cost effectiveness and the performance efficiency and effectiveness of the Network as it relates to data line charges and other costs chargeable to Flagstar including analyzing rates and packages offered by communications common carriers. ISSC shall promptly in accordance with the Change Control Process advise Flagstar of any cost savings to Flagstar that can be realized by making changes to the Network that do not involve New Services or Replacement Services and ISSC shall implement such changes as requested by Flagstar. ISSC shall identify possible product and enhancement opportunities for improved performance, and notify Flagstar of these opportunities in accordance with the Change Control Process, as appropriate. ISSC shall make recommendations to Flagstar as to applications or other methods to optimize the efficiency and effectiveness of Flagstar's Network. E. NETWORK MANAGEMENT ISSC's Network Management operations Level 1 will: 1. monitor and control systems to ensure resources are allocated in the standard configurations and take appropriate actions in a timely and accurate manner; 2. determine system configurations and operating instructions and monitor Network operations and report any failures; 3. monitor and control the Network on-line services in accordance with the availability schedule; 4. answer and respond to telephone inquiries and requests and immediately refer complex issues or problems to the appropriate Level Two support organization; 5. assist Level Two Support personnel, as requested, with problem determination and resolution and escalate in accordance with procedures as specified in the Procedures Manual; and 6. log and record all Network Software, equipment and operations failures. Page 18 of 32 VII. LOCAL AREA NETWORK ISSC shall perform LAN support at Flagstar Corporate Facilities using the resources set forth under the Client Technical Services Baseline specified in the Supplement and described in Schedule J. A. LAN SUPPORT SERVICES (GENERAL) ISSC shall: 1. manage the LAN and LAN functions; 2. operate the LAN servers and monitors at Flagstar Corporate Facilities; 3. evaluate new and emerging LAN technologies and provide support to Flagstar technology planning activities; 4. perform LAN design and tactical planning; 5. set-up hardware/software for the LAN to include hubs, bridges, routers and servers; 6. provide Levels One, Two and Three Support for hardware and software problem isolation and resolution in the LAN; 7. provide single-point-of-contact via the help desk for problem reporting and MAC requests; 8. perform MACs for the LAN; 9. perform capacity and utilization planning and monitoring, security, back- up, recovery and notification to authorized Flagstar users regarding changes to the LAN environment and access procedures; 10. set-up hardware and software for the LAN resource management, monitoring and control platform; and 11. monitor LANs for availability and utilization. Page 19 of 32 B. LAN SUPPORT SERVICES (SPECIFIC) Examples of specific current Flagstar LAN responsibilities which will be taken over by ISSC include: 1. maintain backups of user and system data of critical file servers; 2. maintain mail gateways; 3. maintain dial up gateways (including but not limited to cc:Mail, Notes, Mainframe, Netware Connect); 4. installation, setup and maintain all Network related equipment, including without limitation, all file servers, Network routers that comprise the Flagstar Network; 5. topology (cabling) of LANs; 6. install, setup and maintain Network peripherals (including but not limited to CD ROMs, printers, distributed sniffers); 7. diagnostic troubleshooting and analysis of network (sniffers); 8. setup and configuration of Flagstar Group user, and vendor software; 9. reporting of hardware and software existence and use on LAN; 10. research and testing of new technologies relevant to network (including but not limited to, Web Server, Novell 4.x, Notes, Ether switches); 11. handle problem logs from help desk and user requests; 12. maintain UNIX HP servers; 13. implement security on all levels of Flagstar network; 14. configure Flagstar managements laptops; 15. support PC to mainframe (XCOM) file transfers. Page 20 of 32 C. LAN MAC ISSC shall perform MACs and maintenance for the LAN hardware, software and connections using the resources set forth under the Client Technical Services Baseline specified in the Supplement and described in Schedule J. These resources shall: 1. perform Levels One, Two and Three Support maintenance for the LAN hardware, Software, Cabling and connections to the Flagstar Network using the maintenance components or replacement Software provided by Flagstar; 2. provide Software Maintenance for the Network Software; 3. contact and coordinate problem resolution with the Level Two and Three Third Party Agreement vendors for hardware and software; 4. perform MACs for the LAN hardware, software, Cabling and connections to the Flagstar Network using the upgrades to, replacements for or new equipment, Cables and software provided as stated in the Agreement; 5. handle MAC and maintenance requests on a first-in-first-out basis unless otherwise prioritized by Flagstar; 6. provide on-site MAC and maintenance during normal business hours, Monday through Friday at the Flagstar Corporate Facilities unless otherwise agreed to by the Parties ; 7. manage the mutually agreed to Flagstar consigned inventory of maintenance components and replacement LAN equipment and LAN software in a Flagstar supplied secure area and notify Flagstar on a periodic, or as needed, basis of inventory status and requirements; and 8. advise Flagstar of discontinued LAN equipment and LAN software packages that ISSC will require for maintenance inventory prior to Flagstar disposition of same. VIII. HELP DESK ISSC will provide Help Desk to Flagstar Group users of the Services in accordance with Schedule M. Page 21 of 32 IX. CLIENT TECHNICAL SERVICES A. CLIENT TECHNICAL SERVICES As of the Commencement Date, ISSC shall provide support to Flagstar Group users, and perform the support and management functions related thereto currently performed by Flagstar (the "CLIENT TECHNICAL SERVICES"). ISSC's responsibilities include, without limitation, the provision of the Client Technical Services, functions and responsibilities performed by the Affected Employees and Third Party Providers prior to the Commencement Date. ISSC shall perform Client Technical Services support services for Flagstar Group users located at Flagstar locations using the resources set forth under the Client Technical Services Baseline specified in the Supplement and described in Schedule J. Included in such responsibilities, ISSC shall: 1. research configuration, determine need, procure, set-up, manage and maintain End User Machines and Software to include; a. assembly of End User Machine components, including Cabling and connection to the Flagstar Corporate Facilities' wiring, b. installation and configuration of End User Machine operating Systems Software, c. installation and configuration of communications and emulation Software, and d. installation and configuration of mutually agreed business and productivity Software, e. develop procedures/checklist for installing hardware and software to insure accuracy and client satisfaction; f. develop new product implementation plans; g. repair data used on End User Machines; 2. update LAN client Software resident on End User Machines connected to the LAN; Page 22 of 32 3. provide single-point-of-contact via the Help Desk for Client Technical Services problem reporting, MAC requests and host System status; AND 4. provide Level One and Level Two Support and contact and coordinate problem resolution with the Level Three Third Party Agreement vendor for End User Machines and Software, Cabling and connections to the Flagstar Corporate Facilities wiring, problem isolation and resolution for End User Machines. 5. assist with 3B2-400 and Ascend (backup dial connection for SMS) testing; 6. inventory and support of gateways and controllers; and 7. research current trends in technology. B. CLIENT TECHNICAL SERVICES MAC SUPPORT ISSC shall perform Client Technical Services MACs and maintenance for the End User Machines, Software and connections using the resources set forth under the Client Technical Services Baseline specified in the Supplement and described in Schedule J. These resources shall: 1. handle Client Technical Services MAC requests in accordance with Flagstar's prioritization procedures; 2. perform Client Technical Services MACs for the End User Machines, Software, Cabling and connections to the Flagstar Corporate Facilities Wiring; 3. provide on-site Client Technical Services MAC during normal business hours, Monday through Friday, at the Flagstar Corporate Facilities pursuant to Schedule J, unless otherwise agreed by the Parties according to the Change Control Process in accordance with the Performance Standards and Minimum Service Levels; Page 23 of 32 X. APPLICATIONS DEVELOPMENT A. GENERAL DELIVERABLES For each AD/M Project, ISSC will develop and provide to Flagstar for its review and approval the following Deliverables: 1. Business Impact and Work Plan - ISSC will deliver work plans for each of the AD/M Projects, including physical and logical data base design, programming design, and delivery schedules. 2. Test Plan - ISSC will deliver a test plan for each AD/M Project that will describe the test(s) (if appropriate) and will include acceptance criteria as provided by Flagstar adequate to demonstrate that the Deliverables under each AD/M Project perform in accordance with the agreed to specifications and provide the required functions specified for the Deliverables for such AD/M Project. 3. Delivered Software - ISSC will prepare a list of the Software to be developed in connection with each AD/M Project. 4. Delivered Machine and Network Configuration - ISSC will deliver a diagram of the Machines and Network configuration applicable to each AD/M Project. 5. Documented Processes - As part of the AD/M Projects performed by ISSC under this Agreement, ISSC will develop mutually agreed to management, operations, maintenance and support processes for the day-to-day production operating environments for such projects prior to promoting such projects to production. B. AD/M PROJECTS For each AD/M Project ISSC shall perform Applications Development and Software Maintenance on the Software specified on Schedules A and B as required to provide the Services and meet the Performance Standards, in accordance with this Agreement and as described below using the AD/M Baseline resources specified in the Supplement and Schedule J. 1. APPLICATIONS DEVELOPMENT Page 24 of 32 ISSC shall perform AD/M Projects for Flagstar at Flagstar's request, in accordance with the Applications Development Methodology defined as the application software development life cycle described in the Procedures Manual. For each AD/M Project, both Parties shall designate a single-point-of-contact with decision-making authority to whom Flagstar may communicate Flagstar's requirements and give its approvals and from whom ISSC and Flagstar may obtain information, as applicable. ISSC shall utilize the Change Control Process to the extent appropriate based on the scope of work and the complexity of the Deliverables to be provided under such AD/M Project to ensure that the AD/M Projects are using resources efficiently and that Deliverables are generated in a timely manner. ISSC shall update Flagstar on the status of each AD/M Project according to a time schedule mutually agreed to by the Parties, depending on the criticality of the particular AD/M Project, and shall provide Flagstar with such additional information at a level of detail to be mutually agreed upon, as Flagstar may reasonably request. ISSC shall immediately notify Flagstar of AD/M Project delays which could impact any established time frames. ISSC will meet or exceed the Application Development and Software Maintenance project Performance Standards mutually agreed by the parties from time to time. C. SOFTWARE MAINTENANCE 1. Scope of Software Maintenance Coverage a. ISSC will provide Software Maintenance for Software: 1) listed in Schedules A and B; 2) added under Schedule N Projects; and 3) added under New Services. b. ISSC will employ a Software Maintenance methodology described in the Procedures Manual, including standards for work plans, design and programming, as set forth in the Procedures Manual. 2. Off-hours Support Page 25 of 32 ISSC will provide on-call technical support and after-hours coverage for each Software product that executes or is used by Flagstar during after-hours times. The ISSC Help Desk will maintain phone lists and escalation procedures for ISSC's on-call support. 3. Other ISSC will provide Software support and maintenance, in addition to that specified above, as described in the Agreement and other Sections of this Schedule E. D. SCHEDULE N PROJECTS ISSC shall deliver the Schedule N Projects in accordance with Schedule N. ISSC shall provide the Applications Development and Software Maintenance resources required to complete ISSC's responsibilities as set forth in Schedule N. ISSC's performance of the Schedule N Projects shall be performed in accordance with the time schedule set forth in Schedule N. ISSC will procure and deliver to Flagstar the hardware, software, documentation, and services specified as "DELIVERABLES" for each of the Schedule N Projects. ISSC will provide the installation and implementation services described therein to complete each of the Schedule N Projects. Any future Application Development and Maintenance Projects for which ISSC will be responsible for project management, design, testing, documentation, implementation, training, etc., will be described in Schedule N from time to time. ISSC's delivery of the Schedule N Projects will include the deliverables described in Section X.A covering the scope of work including without limitation a description of the applicable required functions as determined by Flagstar, the Parties' respective responsibilities, the Deliverables to be provided and the acceptance criteria as provided by Flagstar for each and other term and conditions or requirements specific to the delivery to Flagstar of the required functions and the successful completion of each Schedule N Project. E. ISSC RESPONSIBILITIES ISSC will perform the following as part of the Services under the Agreement: Page 26 of 32 a. BACKLOG MANAGEMENT - collecting, tracking, reporting, and aging work requests, and responding to priorities for those requests as established by Flagstar. b. WORK MANAGEMENT - organizing, planning, tracking and reporting tasks associated with AD/M Projects. c. PROJECT MANAGEMENT - selecting and implementing a mutually agreed to standard Applications Development Methodology which will facilitate the planning, tracking, and reporting of activities required for the successful completion of AD/M Projects tasks. d. RELEASE MANAGEMENT - selecting and organizing work requests in logical units and the planning, tracking, and reporting of the work. e. ESTIMATING/PLANNING/SCHEDULING - establishing procedures and supporting tools which will aid members of AD/M Projects teams and owners, users, and members of support staffs to improve the accuracy and consistency of their estimates, plans, and schedules and to compare them with actual results so that the procedures can be refined over time. f. RISK MANAGEMENT - identifying the risks associated with AD/M Projects and developing detailed plans to manage and contain those risks. g. DEPENDENCY MANAGEMENT - identifying other AD/M Projects which may have impacts on the current AD/M Projects and developing detailed plans to manage those dependencies. h. SKILLS PLANNING/SKILLS BALANCING - planning for education and training of ISSC personnel for current and anticipated AD/M Projects and balancing those skills across AD/M Projects and efficiently and effectively. i. TECHNICAL VITALITY - making appropriate, prudent investments in training, education, and job experiences for ISSC employees to allow them to stay current with advances in their professions and to take creative, innovative approaches to their work. Page 27 of 32 j. TOOLS/TECHNIQUES/METHODS - evaluating, selecting, and acquiring tools, techniques, and methods for the staff and maintaining an inventory of them for use by all ISSC staff members. k. ASSURANCE - establishing and maintaining procedures and standards for AD/M Project Deliverables. Assurance activities include the following: 1) Technical reviews that may be formal or informal and are carried out by members of the AD/M Project or release team with the assistance of experts, when appropriate. 2) Project reviews that are carried out on a schedule which is appropriate for the AD/M Projects' scope, complexity, cost, or risk. 3) Inspections/walk-throughs that are carried out for AD/M Projects Deliverables such as requirements and design documents, code, test plans, and test results as well as AD/M Projects plans. 4) Joint application requirements and joint application design sessions ("JARS" and "JADS") that are carried out by members of the AD/M Project team and Flagstar Group user representatives selected by Flagstar to ensure the completeness, accuracy, and appropriateness of Application requirements and design early in the AD/M Project cycle. 5) Usability assessments that are carried out for new Applications and for major enhancements to existing Applications to establish usability objectives for the Applications in areas such as ease of learning and ease of use and to measure the results. 6) Process assurance that includes periodic assessments of standards and Applications Development Methodologies in terms of their currency and appropriateness in the light of what was learned from completed AD/M Project. 7) ISSC personnel will create the test cases and conduct user acceptance tests with criteria provided by Flagstar for all Application changes. Page 28 of 32 l. STATUS/TRENDS - ISSC and Flagstar will work together in the first 60 days to establish agreed upon measures to manage AD/M Baseline personnel, quality, results and budget management. F. FLAGSTAR RESPONSIBILITIES Flagstar will be responsible for the activities described in this clause and will maintain appropriate levels of skilled personnel to perform these activities throughout the term of the Agreement. a. Identifying opportunities for improvement within the current and Schedule N Application set including documenting and prioritizing activities. b. Prioritizing work requests, managing the work groups and subcommittees of Flagstar Group users, aligning the work requests with the tactical and strategic goals of Flagstar and its commitments to its customers as well as resource and budget constraints and ensuring that Flagstar's information systems investments are appropriate. c. Providing timely notification of all governmental and regulatory changes to ISSC in the form of work requests and including ISSC in planning activities for corporate-sponsored work requests which may be undertaken in support of Flagstar or its customers in other plans. d. Participating in working sessions with ISSC to establish task plans for work items which will be carried out by Flagstar personnel, including those tasks in a master plan for the AD/M Project or release, and reporting progress against the plan in a timely and accurate manner. e. Participating in the development of detailed requirements and design for applications during JARs and JADs for all AD/M Projects. f. ISSC and Flagstar will create functional test criteria will be developed for all AD/M Projects and changes that will be described in business terms so that user acceptance tests can be conducted. Page 29 of 32 g. Before the change is introduced into the production environment, Flagstar will certify that the business function delivered will meet the requirements established in the work request. h. Flagstar personnel will participate in reviews of completed AD/M Projects and releases and in periodic reviews of installed Applications and assess the completeness and accuracy of the business function provided, the adherence to established business controls, and the audibility of the Applications. G. PROJECT CHANGES Flagstar may request that ISSC delay, suspend or cancel the implementation of one or more of the AD/M Projects in accordance with the Change Control Process. H. IMPLEMENTATION 1. Architectural Validation During the thirty (30) day period prior to commencement of an AD/M Project or Schedule N Project, other than those listed in Schedule N as of the Commencement Date, the Parties shall perform an analysis comparing the functionality required to support Flagstar's required functions, with the functionality of the proposed solution. The Parties shall analyze the proposed software and hardware in light of the Flagstar required functions to ensure that the deliverables for such solution will provide Flagstar with the desired functionality relating to the To Be Systems and interfaces. In determining whether to overcome any gaps between As Is System and To Be System functionality by changing the proposed solution or changing Flagstar's then-current procedures, the Parties will consider and attempt to minimize the impact on Flagstar of the proposed solution to the To Be Systems implementation. 2. DEVELOPMENT PERSONNEL ISSC will be responsible for ensuring maximum productivity of the personnel assigned to AD/M Projects efforts, other than the Schedule N Projects set forth in Schedule N as of the Commencement Date, as described in the resource Baselines in the Supplement and Schedule J (the "Baseline Personnel"). Flagstar shall have the right to monitor the status Page 30 of 32 of the AD/M Projects. ISSC shall provide Flagstar with monthly reports in appropriate detail as reasonably requested by Flagstar, specifying how ISSC used the Baseline Personnel during the relevant period, ISSC's plan for using such Baseline Personnel in the next period and the status of each approved AD/M Project service request (either pending or in progress), as well as the status of on-going AD/M Projects assigned thereto. The report shall also specify the extent to which the Baseline Personnel are available to perform any new work. ISSC shall provide further status information upon Flagstar's reasonable request. In addition, ISSC shall make appropriate Personnel available to meet with Flagstar on at least a monthly basis to review the status of existing AD/M Projects, to discuss new AD/M Projects, and to review the utilization of the Baseline Personnel. If AD/M Projects are behind schedule the Parties may agreed to a greater frequency of review. I. CUSTOMIZATION AND ENHANCEMENTS In accordance with Schedules E, J and N, ISSC will provide customization and enhancement to the Applications Software as requested by Flagstar. Such requests shall be consistent with the Parties' mutual intent to keep such enhancements to a minimum to preserve the benefits of the manageability, reliability and cost savings of the Applications Software environment; provided, however, that such customization and enhancement will at a minimum provide for the deliverables set forth for each AD/M Project or the required functions for new AD/M Projects. J. INTERFACES, BRIDGES AND DATA CONVERSION ISSC will provide all necessary interfaces within and among the Software and to the Flagstar Corporate Facilities, Network, Machines and POS Machines as described in Schedule N. XI. QUALITY ASSURANCE ISSC shall be responsible for providing and implementing quality assurance processes and procedures that are reasonably necessary to ensure that ISSC's AD/M responsibilities are executed accurately, efficiently and in a timely manner. Subject to the foregoing, the Parties shall mutually agree upon terms and conditions for conducting checkpoint reviews, Software testing and acceptance and other quality assurance procedures. These procedures shall be included in the Procedures Manual. ISSC shall: Page 31 of 32 A. review problem reports and recommend/implement appropriate fixes with Flagstar's approval; B. in conjunction with Flagstar, review new Flagstar production jobs and job control languages for correctness and conformance to mutually agreed to standards for efficient resource utilization; C. organize and chair change control meetings with Flagstar designees in accordance with the Change Control Process, on a weekly basis or on such other frequency agreed to by the Parties; and D. prepare and distribute problem and change management reports. Page 32 of 32 EXHIBIT A SCHEDULE E SUPPORT SERVICES, PERFORMANCE STANDARDS AND OPERATIONAL RESPONSIBILITIES SECTION E-2 PERFORMANCE STANDARDS I. DEFINITIONS For purposes of this Schedule E, the following terms shall have the following meanings: A. "ACTUAL UPTIME" means of the Scheduled Hours, the aggregate number of hours in any month during which the Network and/or each defined critical Application is actually available for use by End Users. B. "APPLICATION SUBSYSTEM" means individual subsystems or environments comprising the Applications Software. C. "AVAILABILITY" means Actual Uptime plus Excusable Downtime divided by Scheduled Uptime. For purposes of determining whether ISSC's performance meets any availability Performance Standard, ISSC's availability performance will be measured based on a monthly average of daily measurements during each month of the Term, to be calculated once monthly within 15 business days following the end of each calendar month. D. "CATEGORY" means mutually agreed to Service for which a Performance Standard will apply. E. "EXCUSABLE DOWNTIME" means of the Scheduled Uptime, the aggregate number of hours in any month during which the Network and/or each defined Application is down due to: 1. action or inaction by Flagstar (i.e., failing to provide power for the Machines at the Data Center and power outages or systems outages attributable to Application defects and Applications incompatibility with the Systems Software, existing as of the Commencement Date, etc.); Page 1 of 13 2. a Force Majeure Event (as defined in Section 16.3 of the Agreement); 3. mutually agreed upon time for such things as preventive maintenance, system upgrades, etc.; or 4. a failure that has occurred despite ISSC'S provision of proper preventive or remedial maintenance. F. "FINAL OBSERVATION PERIOD" means the 90-day measurement period (1) which begins, with respect to the Categories to be measured in the As Is Systems environment, after the end of the seven-day period following completion of the Initial Observation Period, or (2) which begins, with respect to the Categories to be measured in the To Be Systems environment, after the completion of the cutover to production of each Application Subsystem in the To Be Systems for which Performance Standards will be established. G. "HOST SYSTEM" means the Data Center Machines and related System Software. H. "INITIAL OBSERVATION PERIOD" means the 90-day measurement period (1) which begins, with respect to the Categories to be measured in the As Is Systems environment on April 1st, or (2) which begins, with respect to the Categories to be measured in the To Be Systems environment, after completion of the cutover to production of each Application Subsystem in the To Be Systems for which Performance Standards will be established. I. "MINIMUM SERVICE LEVELS" means the level of service which, if not met, will entitle Flagstar to Service Credits. J. "ON-TIME DELIVERY" means that schedule if completed within five days of the scheduled completion date will be deemed to be on schedule. K. "SCHEDULED DOWNTIME" means of the Scheduled Hours, the aggregate number of hours in any month during which the Network and/or defined Application is scheduled to be unavailable for use by End Users due to such things as preventive maintenance, system upgrades, etc. Scheduled Downtime must be mutually agreed to by the Parties. L. "SCHEDULED HOURS" means the day of the week and hours per day that the Network and/or each defined Application is scheduled to be available for use by End Users, subject to adjustment for mutually agreed upon Scheduled Downtime. Page 2 of 13 M. "SCHEDULED UPTIME" means of the Scheduled Hours, the aggregate number of hours in any month during which the Network and/or each defined critical Application is scheduled to be available for use by End Users. II. PERFORMANCE STANDARDS - AS IS SYSTEMS A. By April 1st, 1996, the Parties will determine which Categories will be measured and the methodology to be utilized including tools and units of measure. If Flagstar is currently measuring particular Categories and has documented historical measurement levels, ISSC will review such information and the Parties will agree on mutually acceptable target performance levels for such Categories. B. During the Initial Observation Period, Flagstar will determine weighting factors for each Category, and, ISSC will track actual performance levels of each Category identified in Section II.A above and report the results of such performance measurements to Flagstar as set forth in Section V below. The Parties will review the performance measurement results reported during the Initial Observation Period and mutually agree to interim Performance Standards and Minimum Service Levels upon which ISSC's performance of the Services Categories will be measured. The Performance Standards and Minimum Service Levels for each Category will be documented in writing, mutually agreed upon and attached to this Schedule E, Section E-2 in accordance with Section 16.2 of the Agreement. ISSC will not accrue Service Credits for failure to meet the Minimum Service Levels for As Is System Categories measured during the Initial Observation Period for each such Category. C. During the seven-day period following the Initial Observation Period based on the performance measurements obtained during the Initial Observation Period, the Parties will mutually agree on the interim Performance Standards and Minimum Service Levels for each Category for which ISSC will be measured for the As Is Systems environment. D. During the Final Observation Period, ISSC will continue measuring its performance of the Services Categories for the As Is Systems environment and will provide Flagstar with monthly measurement reports in accordance with Section IV below. E. Upon completion of the Final Observation Period, the Parties will review the performance levels achieved for the As Is Systems Categories during the Final Observation Period which will be compared to the interim Performance Standards and Minimum Service Levels established during the seven-day Page 3 of 13 period immediately preceding the Final Observation Period. Upon completion of the Final Observation Period, a second 7-day review will take place during which the Parties will agree upon final Categories, Performance Standards, and weighting factors. F. Effective as of the first day of the Final Observation Period, Service Credits will be applied for failures to meet the Minimum Service Levels in accordance with Section VI below and Performance Incentive Credits will be applied for performance of Services eligible for Performance Incentive Credits that exceeds the Minimum Service Levels in accordance with Section VII below. G. After completion of the Final Observation Period, ISSC's performance of the As Is Systems Categories shall be measured and compared to the final Performance Standards and Minimum Service Levels on a monthly basis until completion of the Schedule N Projects applicable to the To Be Systems environment and the cutover to production of the final Schedule N Project for such To Be Systems. III. PERFORMANCE STANDARDS - TO BE SYSTEMS A. Prior to cutover to production of the first Application Subsystem of the first Schedule N Project, To Be Systems Categories for measurement of ISSC's performance of the To Be Systems will be established by mutual agreement of the parties based on the following methodology: 1. determine what new Performance Standards and Minimum Service Levels are required; 2. decide what Performance Standards and Minimum Service Levels from the As Is Systems Categories should be continued; and 3. decide weighting and weighting factors of each Minimum Service Level. The Parties agree that if the achievement of a particular Performance Standard and/or Minimum Service Level can be impacted by or is dependent upon the addition of an Application Subsystem or are system workload sensitive, such Performance Standards will not result in Service Credits until the entire Schedule N Project of which such Application Subsystem is a part is cutover to production. ISSC will, however, measure performance against such Performance Standards and/or Minimum Service Levels and provide the measurement results to Flagstar. Page 4 of 13 B. During the Initial Observation Period for each Application Subsystem, ISSC will track performance levels of each Category identified in Section III.A, and report the measurement results to Flagstar as set forth in Section V below. The Parties will review the measurement results and mutually agree to Performance Standards and Minimum Service Levels upon which ISSC will be measured subject to the qualifications listed in Section III.A. The Performance Standards and Minimum Service Levels for each Category will be documented in writing, mutually agreed upon and attached to this Schedule E, Section E-2 in accordance with Section 16.2 of the Agreement. C. During the seven-day period following the Initial Observation Period for each Application Subsystem in the To Be Systems environment based on the performance measurements obtained during the Initial Observation Period, the Parties will mutually agree on the interim Performance Standards and Minimum Service Levels for each Category for which ISSC will be measured for the To Be Systems environment. D. Upon completion of the Final Observation Period, the Parties will review the performance levels achieved for the To Be Systems Categories during the Final Observation Period which will be compared to the interim Performance Standards and Minimum Service Levels established during the seven-day period immediately preceding the Final Observation Period. Upon completion of the Final Observation Period, a second 7-day review will take place during which the Parties will agree upon final Categories, performance standards, and weighting factors. E. Effective as of the first day of the Final Observation Period, Service Credits will be applied for failures to meet the Minimum Service Levels for the To Be Systems Categories in accordance with Section VI below and Performance Incentive Credits will be applied for performance of To Be Systems Categories eligible for Performance Incentive Credits that exceeds the Minimum Service Levels in accordance with Section VII below. F. After completion of the Final Observation Period for each To Be System Category, ISSC's performance of such To Be Systems Category shall be measured and compared to the final Performance Standards and Minimum Service Levels therefor on a monthly basis during the Term. G. For each Schedule N Project, after all Applications Subsystems applicable to such Schedule N Project are installed and the entire Schedule N Project is cutover to production, there will be a Final Observation Period for such Schedule N Project during which all existing Performance Standards and Minimum Service Levels will be reviewed applicable thereto and may be Page 5 of 13 adjusted by the Parties and additional Performance Standards and Minimum Service Levels added as set forth in Section III below. Once the final Performance Standards are agreed to by the Parties, this Schedule E, Section E-2 will be updated and distributed to the Parties. IV. NEW OR ADDITIONAL CATEGORIES A. If new or additional Categories are selected by the Parties for the measurement of ISSC's performance of the Services in the As Is Systems or To Be Systems environment for which performance data was not collected during the Initial Observation Period or Final Observation Period for such As Is Systems or To Be Systems, the Parties will determine which Categories will be measured, the methodology to be utilized including tools and units of measure and the period of time during which measurements will be collected (the "Measurement Period") for each such new or additional Category. If Flagstar is currently measuring particular Categories and has documented historical measurement levels, ISSC will review such information and the Parties will agree on mutually acceptable target performance levels for such Categories. B. During the initial Measurement Period for each new or additional Category, Flagstar will determine weighting factors for each Category, and, ISSC will track actual performance levels of each Category identified in Section IV.A above and report the results of such performance measurements to Flagstar as set forth in Section V below. The Parties will review the performance measurement results reported during the initial Measurement Period and mutually agree to interim Performance Standards and Minimum Service Levels upon which ISSC's performance of the Services Categories will be measured. The Performance Standards and Minimum Service Levels for each new or additional Category will be documented in writing, mutually agreed upon and attached to this Schedule E, Section E-2 in accordance with Section 16.2 of the Agreement. ISSC will not accrue Service Credits for failure to meet the Minimum Service Levels for each new or additional Category measured during the initial Measurement Period for each such Category. C. During the seven-day period following the initial Measurement Period applicable to each new or additional Category based on the performance measurements obtained during the initial Measurement Period, the Parties will mutually agree on the interim Performance Standards and Minimum Service Levels for each Category. D. During the final Measurement Period, ISSC will continue measuring its performance of each new or additional Category and will provide Flagstar with monthly measurement reports in accordance with Section V below. Page 6 of 13 E. Upon completion of the final Measurement Period, the Parties will review the performance levels achieved for each new or additional Category during the final Measurement Period which will be compared to the interim Performance Standards and Minimum Service Levels established during the seven-day period immediately preceding the final Measurement Period. Upon completion of the final Measurement Period, a second 7-day review will take place during which the Parties will agree upon final Performance Standards, and weighting factors for each new or additional Category. F. Effective as of the first day of the applicable final Measurement Period, Service Credits will be applied for failures to meet the Minimum Service Levels in accordance with Section VII below and Performance Incentive Credits will be applied for performance of Services eligible for Performance Incentive Credits that exceeds the Minimum Service Levels in accordance with Section VII below. V. REPORTS; ERROR CORRECTION A. On a monthly basis, ISSC will submit to Flagstar a report or set of reports assessing ISSC's performance of the As Is Systems environment Categories during the previous calendar month against the Performance Standards and Minimum Service Levels for each such Category. B. Commencing on the first day of the Final Observation Period for each To Be Systems Category, ISSC will submit to Flagstar a report or set of reports assessing ISSC's performance of the To Be Systems environment Categories during the previous calendar month against the Performance Standards and Minimum Service Levels for each such Category. C. Commencing on the completion of the initial Measurement Period for each new or additional Category as described in Section IV above, ISSC will submit to Flagstar a report or set of reports assessing ISSC's performance of the new or additional Categories during the previous calendar month against the Performance Standards and Minimum Service Levels for each such Category. D. Each such report shall be provided to Flagstar by the fifth (5th) business day of each month for the Services provided and the Categories measured in the preceding month. E. ISSC will also be responsible for promptly investigating and correcting failures to meet Performance Standards and Minimum Service Levels by: 1. initiating problem investigations to identify root causes of failures; Page 7 of 13 2. promptly reporting problems to Flagstar that reasonably could be expected to have a material adverse effect on Flagstar's operations; 3. correcting the problem; and 4. making written recommendations to Flagstar including both ISSC actions and Flagstar actions to improve performance of the Services. F. ISSC shall identify root causes, correct problems and minimize recurrences of problems for which ISSC is responsible. Flagstar will correct and minimize the recurrence of problems for which Flagstar is responsible and which prevent ISSC from meeting the Performance Standards. G. ISSC shall be relieved of only those Performance Standard(s) and/or Minimum Service Levels where ISSC's failure to meet the Performance Standard(s) and/or Minimum Service Levels is due to one of the following occurrences and only to the extent such Performance Standard(s) and/or Minimum Service Levels is affected by such occurrence: 1. Flagstar's failure to perform its obligations under this Agreement to the extent such failure directly affects ISSC's ability to meet the Performance Standards and/or Minimum Service Levels; 2. Flagstar's prioritization of ISSC's people, equipment, applications and services to the extent such prioritization affects ISSC's ability to meet the Performance Standards and/or Minimum Service Levels; 3. circumstances that constitute a Force Majeure Event pursuant to Section 16.3 of the Agreement; 4. constraints imposed by systems capacity levels below the existing As Is Systems environment that directly affect ISSC's ability to provide the Services in a manner that meets the Performance Standards; and 5. constraints imposed by systems capacity levels below the To Be Systems environment described in Schedule N that directly affect ISSC's ability to provide the Services in a manner that meets the Performance Standards. [NOTE: ALTERNATIVELY, NEW DEFINED TERMS "AS IS BASELINE" AND "TO BE BASELINES" COULD BE USED IN ITEMS 4 AND 5 ABOVE, IF FLAGSTAR DEEMS IT ADVANTAGEOUS TO MUTUALLY AGREE WITH ISSC ON THE Page 8 of 13 SYSTEM BASELINES APPLICABLE TO THE ESTABLISHED MINIMUM SERVICE LEVELS AND PERFORMANCE STANDARDS. THE BASELINES LIKELY WOULD BE COMPRISED OF SPECIFIED NUMBERS FOR FTE'S, DASD, MB'S ETC. SUCH A FORMULA MAY HOWEVER REQUIRE A GREAT DEAL OF ADMINISTRATIVE TIME TO DEVELOP AND MAINTAIN OVER TIME.] VI. SERVICE CREDITS A. Through the As Is Initial Observation Period, no Service Credits will be issued with respect to the As Is Systems Categories. B. Flagstar shall provide ISSC with the weighting factors to be assigned to each As Is System Category during the Initial Observation Period for the As Is Systems. C. Each of the Categories will be assigned a weighting factor and the total of the weighting factors shall not exceed 1.0. D. The weighting factors for the As Is Systems environment, described in Section II and VI.B above, will be modified each time an Application Subsystem for a Schedule N Project is cut over to production to the To Be Systems environment; E. Failure to meet the Minimum Service Levels in a specific Category for a month will result in the calculation of a Service Credit amount for such month. The Service Credit amount for each Category will be determined by multiplying the Category weighting factor by ISSC's maximum liability for the applicable month. F. ISSC's maximum liability for Service Credits for As Is Systems Categories each month is 2% of the Annual Service Charges for that month. G. For the To Be Systems Categories, the Parties shall mutually establish Performance Standards and Minimum Service Levels in accordance with this Schedule E, Section E-2. The maximum liability for Service Credits for each To Be System Category that will be applied when the ISIP Project and POS/MIO Project are fully placed into production is an aggregate liability of 10% of the monthly Annual Service Charge for that month. H. Notwithstanding anything to the contrary contained herein, ISSC's aggregate monthly liability for Service Credits applicable to the POS/MIO Project rollout Page 9 of 13 will not exceed three (3) percent (as a portion of the 10%) of the Annual Service Charges for each month in which the rollout is scheduled to occur. On-Time Delivery of New POS Systems will be deemed to be on schedule if completed within two weeks of the scheduled completion date. Beginning in the first month of rollout for the POS Project, Service Credits that may be due to Flagstar for New POS Systems installed more than two weeks after the scheduled date of installation will be calculated as follows. The number of New POS Systems which are installed more than two weeks later than the scheduled date of installation will be divided by the total number of New POS Systems scheduled during that month. The resulting fraction will be multiplied by three percent (3%) to establish the percentage by which the monthly annual service charge will be multiplied to determine the Service Credits due for the POS Category for that month. New POS Systems for which a Service Credit has been paid by ISSC shall be rescheduled by mutual agreement of the parties. In addition, if ISSC fails to install New POS Systems in accordance with the rollout schedule, the Monthly Service Charges shall be adjusted on a pro rata basis as follows. The number of New POS Systems installed during the applicable period will be divided by the number of New POS Systems that were scheduled for installation during such period and the resulting percentage will be multiplied by the Monthly Service Charge for such period. Flagstar shall pay the amount derived from the foregoing calculation in lieu of the Monthly Service Charge. During any month in which ISSC installs more New POS Systems that originally scheduled in order to fulfill its obligations with respect to backlogged installations, Flagstar shall pay in lieu of the Monthly Service Charge for such month an amount equal to the number of such New POS Systems installed during such period divided by the number of New POS Systems scheduled to be installed during such period multiplied by the Monthly Service Charge for such period. I. As Application Subsystems for the Schedule N Projects are cut over to production in the To Be System environment a corresponding downward adjustment will be made to the 2% maximum liability for the As Is Systems Categories. Except as set forth in Section VI.J or otherwise agreed by the Parties with respect to specific projects and/or new Services, in no event will ISSC be liable to Flagstar for an amount that exceeds an overall maximum aggregate liability of 10% of the Annual Service Charges for each month taking into account the Service Credits for both the As Is Service Categories and the To Be System Categories taken together. Page 10 of 13 J. For the Integrated Systems Implementation Project (ISIP) in Schedule N, Section-N-2, upon completion of the Architecture Validation phase, ISSC and Flagstar will mutually agree on a set of Application Subsystem cut over milestones and weighting factor for each milestone for which Minimum Service Levels will apply. ISSC's maximum liability for Service Credits for all milestones in ISIP, will not exceed 10% of the adjusted price of ISIP following Architecture Validation. Failure to meet the Minimum Service Levels for each milestone will result in a Service Credit amount which will be determined by multiplying the corresponding weighting factor by ISSC's maximum liability for the adjusted price of ISIP following Architecture Validation. K. In no event will Performance Standards and Minimum Service Levels be decreased unless such reduction is necessitated by capacity or resource constraints of the existing systems and Flagstar elects not to increase such capacity. VII. PERFORMANCE INCENTIVE CREDITS A. ISSC and Flagstar agree that it is ISSC's responsibility under this Agreement to perform the Services in a manner that, at a minimum, meets the Performance Standards. The Parties further agree that it is advantageous to Flagstar if ISSC performs its responsibilities in a manner that exceeds the Performance Standards. In order to incent ISSC to continuously improve performance of the Services, ISSC will be eligible for a performance incentive based upon its performance above the Performance Standards of certain aspects of the Services that Flagstar determines have additional "value add" to Flagstar beyond performance as required by the Agreement in the normal course of its operations ("Performance Incentive Credits"). B. Flagstar will mutually determine with ISSC which Categories (if any) will permit ISSC to earn Performance Incentive Credits ("PICs"). The Parties acknowledge and agree that Categories for which PIC's may apply will be those Categories in which ISSC's performance above established Performance Standards produces an economic or other benefit to Flagstar's business that Flagstar determines as an appropriate Category for the application of a PIC. The value and weighting of the PIC established for any Category will be determined without regard to the value and weighting of the Service Credit that may apply to such Category. In the event ISSC exceeds the Performance Standards for such a Category then ISSC shall be entitled to receive a PIC as specified below. Page 11 of 13 C. The performance reports provided to Flagstar by ISSC pursuant to Section E-2, Section V will be used to determine whether ISSC has exceeded the Performance Standard in each Category. D. ISSC will be eligible for the accrual of PICs on a monthly basis for the same month for which Service Credits are initially calculated. E. Beginning on the fifteenth day of the month following the completion of the Final Observation Period for the As Is Systems Categories to which Performance Incentive Credits apply, if any, and on the fifteenth day of each subsequent month during the Term, ISSC will calculate whether the Services exceeded the Performance Standards for each As Is System Category for which it is eligible to receive a PIC during the preceding calendar month. F. Beginning on the fifteenth day of the month following the completion of the Final Observation Period for each To Be System Category or new or additional Category to which Performance Incentive Credits apply, if any, and on the fifteenth day of each subsequent month during the Term, ISSC will calculate whether the Services exceeded the Performance Standards for each such Category for which it is eligible to receive a PIC during the preceding calendar month. G. For purposes of determining whether a PIC will accrue to ISSC the actual performance attainment for each of the Categories will be considered independently of the other categories. H. The amount of PICs accruing to ISSC for any month during the Term must be used to offset Service Credits accruing for the same period. PICs accruing in a month may not be carried forward to any subsequent month. VIII. NETTING OF SERVICE CREDITS AND PERFORMANCE INCENTIVE CREDITS A. The amount of the PICs for which ISSC is eligible during a month, if any, will be netted against the Service Credits to which Flagstar will be entitled for such month. In no event shall ISSC be entitled to a PIC which is higher than the Service Credits which Flagstar accrues for the corresponding period. B. Flagstar shall be entitled to carryforward all Service Credits not used in the month in which such Service Credits accrue. C. If the calculation of the net amount of (1) all PICs and Service Credits accruing for a month and (2) all carryforward Service Credits to which Page 12 of 13 Flagstar is entitled for such month results in a net Service Credit, then ISSC will credit Flagstar against the Annual Service Charge for such month for the amount of the Service Credits less the PIC amounts for such month. D. If the calculation of the net sum of (1) all PICs and Service Credits accruing for a month and (2) all carryforward Service Credits to which Flagstar is entitled for such month results in a net PIC, then no amount will be credited to ISSC for such PIC against the Annual Service Charges for such month. Page 13 of 13 EX-10 7 EXHIBIT 10.50 EXHIBIT 10.50 April 24, 1995 Mr. C. Robert Campbell 4225 Santa Maria Street Coral Gables, FL 33146 Dear Bob: We are delighted that you have accepted our offer to join Flagstar as its Executive Vice President and Chief Financial Officer. This letter outlines the terms of our offer. BASE SALARY Your annual base salary will be $325,000.00, to be paid monthly (on the 18th of each month, or the nearest Thursday preceding the 18th, via direct deposit). START DATE You will report to work on May 1, 1995. SIGN-ON BONUS To assist you with your transition to Flagstar, and in recognition of certain rights and benefits you may be forfeiting by accepting our offer of employment, you will receive a signing bonus of $100,000.00. One-half of this amount ($50,000.00) will be paid to you as soon as practicable after you join us. The remainder will be paid to you in January, 1996. Applicable income and FICA taxes will be withheld from both payments. Should you leave the Company voluntarily within 12 months following your starting date, you agree to reimburse the Company the full $100,000.00 amount. ANNUAL INCENTIVE You will participate in our annual Senior Management Incentive Plan. For 1995, your target incentive will be 75% of your base salary. Payouts are dependent upon the achievement of predetermined goals, which are established annually. For 1995, we will guarantee payment of at least 50% of your target bonus ($121,875.00). This will be paid to you, less withholding for applicable income and FICA taxes, no later than February 28, 1996. Mr. C. Robert Campbell April 24, 1995 Page 2 STOCK OPTIONS We will recommend to the Compensation and Benefits Committee of the Board of Directors that you be granted the option to purchase 100,000 shares of Flagstar common stock at the stock's closing price on your starting date. These options will have a 10-year term and will vest as follows: 50% after 2 years; 75% after 3 years; and 100% after 4 years. These non-qualified options will be subject to other terms and conditions of the Company's Stock Option Plan, a copy of which is enclosed. BENEFITS You will be eligible to enroll in our group benefits program (medical, dental, vision, group term life, LTD, etc.) with coverage effective June 1, 1995. Enclosed is more information about the options available under the program. In addition, effective on the next entry date (January 1, 1996) you will be eligible to participate in Flagstar's Deferred Compensation Plan, a non-qualified, matched pre-tax deferral plan. Information about that program is also enclosed. Finally, you will be eligible to participate in the Flagstar Pension Plan. RELOCATION We offer a comprehensive relocation program per the materials that you have received (Plan 1). The program includes a buy-out option at the average of two independent appraisals. (You may select from a list of approved appraisers.) In addition to this relocation program, you will receive a relocation supplement of $100,000.00 (grossed-up for federal and state income taxes). This will be paid to you as soon as practical after you join us. If you voluntarily leave the Company before May 1, 1996 you agree to repay to the Company in full all relocation costs and expenses. Mr. C. Robert Campbell April 24, 1995 Page 3 SEVERANCE AGREEMENT You will be entitled to a lump sum payment equal to 200% of your then existing annual base salary, plus 75% of your existing base salary or target bonus, whichever is greater (less required withholding for income and FICA taxes) in the event you are involuntarily terminated for any reason other than fraud or illegal acts, or in the event that as a result of any actions taken by the Company, you no longer have the title or responsibility of CFO of Flagstar, or in the event your base salary is reduced. The payment of any severance benefit to you under this letter agreement is conditioned upon your signing a release of claims against Flagstar and its affiliates in a form satisfactory to Flagstar, and any such payment under this agreement will be in lieu of any other severance plan or practice of the Company. Bob, we are very pleased to offer you this position and are delighted you have decided to become part of our team. If you are in agreement with these terms, please sign one copy of this letter and return it to me. Very truly yours, /s/ Edna K. Morris Edna K. Morris Executive Vice President Human Resources and Corporate Affairs Enclosures cc: Stephen Wood Rhonda Parish AGREED AND ACCEPTED: /s/ C. Robert Campbell - ----------------------------- --------------------- C. Robert Campbell Date EX-10 8 EXHIBIT 10.51 EXHIBIT 10.51 April 22, 1996 Mr. Craig S. Bushey 15A Collingham Gardens SW5 London, ENGLAND SW50HS Dear Craig: We are delighted that you have accepted our offer to join Flagstar as its Senior Vice President and President of its Hardee's division. This letter outlines and confirms the terms of our offer. BASE SALARY Your annual base salary will be $300,000.00, to be paid monthly (on the 18th of each month, or the nearest Thursday preceding the 18th, via direct deposit). START DATE You will report to work on or before May 15, 1996. SIGN-ON BONUS To assist you with your transition to Flagstar, and in recognition of certain rights and benefits you may be forfeiting by accepting our offer of employment, you will receive a signing bonus of $150,000.00. One-half of this amount ($75,000.00) will be paid to you as soon as practicable after you join us. The remainder will be paid to you in May, 1997. Applicable income and FICA taxes will be withheld from both payments. Should you leave the Company voluntarily within 12 months following your starting date, you agree to reimburse the Company the full amount. ANNUAL INCENTIVE You will participate in our annual Incentive Plan. For 1996, your target incentive will be 65% of your base salary, prorated based on your starting date. In addition, your 1996 bonus payout will be no less than $75,000.00. Applicable income and FICA taxes will be withheld. Payouts under this annual plan are dependent upon the achievement of predetermined goals, which are established annually. Mr. Craig S. Bushey April 22, 1996 Page 2 STOCK OPTIONS We will recommend to the Compensation and Benefits Committee of the Board of Directors that you be granted the option to purchase 75,000 shares of Flagstar common stock at the greater of the stock's closing price on your starting date or $6.00 per share. These options will have a 10-year term and will vest 20% per year. These non-qualified options will be subject to other terms and conditions of the Company's Stock Option Plan. BENEFITS You will be eligible to enroll in our group benefits program (medical, dental, vision, group term life, LTD, etc.) with coverage effective on the first day of the month following 30 days of employment. Enclosed is more information about the options available under the program. In addition, effective on the next entry date (January 1, 1997) you will be eligible to participate in Flagstar's Deferred Compensation Plan, a non-qualified, pre-tax deferral plan. Information about that program is also enclosed. Finally, you will be eligible to participate in the Flagstar Pension Plan. RELOCATION We offer a comprehensive relocation program. I have enclosed a copy for your review. Due to the complexities of your return to the United States, we also have agreed to (a) provide you (at our expense) with interim housing in Greenville/Spartanburg for 60 days; (b) provide storage of household goods for up to 1 year; (c) reimburse you for income tax and/or tax equalization liabilities you may incur, up to $25,000.00, unless a review of your tax situation by qualified tax experts indicates that a larger reimbursement amount is necessary to make you financially whole; (d) reimburse you, up to $50,000.00, for any penalties you may be legally found to owe Burger King as a result of your early exit from your current assignment; and (e) provide you with up to $5,000 of tax preparation assistance in 1996 and 1997. Any amounts payable under these relocation related provisions will be treated as compensation and taxes withheld. Mr. Craig S. Bushey April 22, 1996 Page 3 SEVERANCE AGREEMENT In the event you are involuntarily terminated for a reason other than fraud, misconduct or illegal acts, you will receive a severance benefit equal to 24 months of your then-existing base pay. The payment of any severance benefit to you under this letter agreement is conditioned upon your signing a release of claims against Flagstar and its affiliates in a form satisfactory to Flagstar, and any such payment under this agreement will be in lieu of any other severance plan or practice of the Company. Craig, we are very pleased to offer you this position and are delighted you have decided to become part of our team. If you are in agreement with these terms, please sign one copy of this letter and return it to me. Very truly yours, /s/ Stephen W. Wood Stephen W. Wood Senior Vice President Human Resources Enclosures (to follow in overnight mail) cc: Jim Adamson Rhonda Parish AGREED AND ACCEPTED: /s/ Craig S. Bushey - ----------------------------- --------------------- Craig S. Bushey Date EX-10 9 EXHIBIT 10.52 EXHIBIT 10.52 TERMS & CONDITIONS OF EMPLOYMENT FOR JOHN ROMANDETTI POSITION: President, Denny's, Inc. and Senior Vice President, Flagstar Corporation BASE PAY: $325,000: Increase to $375,000 effective July 1997. ANNUAL BONUS: 1997 Target: 65% of base salary. For 1997, 50% tied to Denny's EBITDA performance against plan; 25% tied to Flagstar EBITDA performance against plan; and 25% discretionary. RETENTION BONUS: $100,000 if actively employed by Company on December 31, 1997; $100,000 if actively employed by Company on December 31, 1998; and $150,000 if actively employed by Company on December 31, 1999. SEVERANCE PROVISIONS: Same Change of Control Agreement as other members of Management Committee. Absent Change of Control, current employment agreement terms apply (2x base pay, and medical subsidy if terminated for a reason other than an illegal act or gross misconduct). If terminated not for cause, Company will provide relocation to anywhere in the continental United States. If still leasing apartment in Spartanburg, any lease liabilities will be covered. COMMUTING ALLOWANCE: For 1997: $36,000; For 1998: $18,000 (grossed up for taxes) Allowance is to cover cost of commuting home to Phoenix and to rent furnished apartment. DISABILITY PROTECTION: Should Romandetti become totally and permanently disabled while employed by the Company and before age 65 (totally and permanently disabled status as determined by the Company's LTD carrier), Romandetti to receive 12 months base pay continuation in addition to regular LTD benefits. RELOCATION: Entitled to Company's regular executive-level relocation benefits through December 31, 1998. Company will pay for spouse 's travel to Denny's headquarters city for homefinding trip. BUSINESS TRAVEL: First class air travel permitted. However, Romandetti will make reasonable attempts to use upgrade coupons, etc. when possible/feasible. AGREED: /s/ Stephen W. Wood __________________________________ _________________ Stephen W. Wood (for Flagstar) Date /s/ John R. Romandetti ---------------------------------- ----------------- John R. Romandetti Date EX-10 10 EXHIBIT 10.53 EXHIBIT 10.53 MEMORANDUM TO : MARK SHIPMAN FROM : STEPHEN WOOD RE : CONFIRMING YOUR NEW POSITION DATE : MAY 24, 1996 This is to confirm certain matters relative to your appointment as President of our Coco's/Carrows division. 1. You will be a Senior Vice President of Flagstar Corporation. 2. Your base salary will be $250,000, effective May 23, 1996. Flagstar has paid you in full through May. You will start on the Coco's/Carrows payroll on June 1, and will receive a retroactive payment for the difference in your new and old salaries for the May 23-31, period. 3. Your 1996 target bonus will remain at 65%. 4. You will be awarded the option to purchase an additional 50,000 shares of Flagstar common stock at the greater of the stock's closing price on the FRI transaction closing date, or $6.00. These additional options will have a 10 year term and vest 20% per year over 5 years. This will bring your total number of options to 75,000. 5. You will receive a $50,000 lump-sum relocation assistance bonus. It will be grossed up at 36% for federal taxes, and an additional amount for California state income and Medicare taxes. This will be paid to you by Coco's/Carrows. 6. You will receive our regular Plan 1 (the top plan) relocation benefits, including the cost-of-living adjustment allowances. If the homefinding/temporary living allowance (which is grossed-up) proves insufficient to meet your reasonable needs, you may request an additional allowance. 7. Should Flagstar terminate your employment for a reason other than fraud, dishonesty or other illegal acts, you will receive twenty-four (24) months of severance benefits at your then existing base pay upon the signing of a mutually acceptable release of claims. This protection will have no end date and will replace your current "CORE" agreement. 8. You will become covered under the Coco's/Carrows benefits programs effective June 1, 1996. Judy Painter will work with you to ensure there are no lapses of coverage, and to get you enrolled in coverages that best approximate your current coverage. A copy of this memo will be placed in your Human Resources file. EX-11 11 EXHIBIT 11 EXHIBIT 11 FLAGSTAR COMPANIES, INC. COMPUTATION OF EARNINGS (LOSS) PER SHARE
YEAR ENDED DECEMBER 31, ($ IN THOUSANDS EXCEPT PER SHARE AMOUNTS) 1992 (A) 1993 (A) 1994 1995 (A) 1996 (A) PRIMARY EARNINGS (LOSS) PER SHARE Adjustment of common and equivalent shares: Average number of common shares outstanding before adjustments................................. 24,883 42,370 42,369 42,431 42,434 Assumed exercise of stock warrants and options........ -- -- 9,854 -- -- Total average outstanding and equivalent common shares........................................... 24,883 42,370 52,223 42,431 42,434 Adjustment of net income (loss) applicable to common shareholders: Loss from continuing operations....................... $ (39,225) $(1,238,564) $ (16,820) $ (132,906) $ (85,460) Interest on senior debt, net.......................... -- -- 23,939 -- -- Dividends on preferred stock.......................... (6,064) (14,175) (14,175) (14,175) (14,175) Adjusted loss from continuing operations.............. (45,289) (1,252,739) (7,056) (147,081) (99,635) Income (loss) from discontinued operations............ (12,550) (409,671) 392,670 77,241 -- Adjusted income (loss) before extraordinary item and cumulative effect of change in accounting principle.......................................... (57,839) (1,662,410) 385,614 (69,840) (99,635) Extraordinary items, net.............................. (155,401) (26,405) (11,757) 466 -- Cumulative effect of change in accounting principle, net................................................ (17,834) (12,010) -- -- -- Adjusted net income (loss) applicable to common shareholders....................................... $(231,074) $(1,700,825) $ 373,857 $ (69,374) $ (99,635) Primary earnings (loss) per share applicable to common shareholders: On continuing operations.............................. $ (1.82) $ (29.56) $ (0.14) $ (3.47) $ (2.35) On discontinued operations, net....................... (0.50) (9.67) 7.52 1.82 -- On income (loss) before extraordinary items and cumulative effect of change in accounting principle.......................................... (2.32) (39.23) 7.38 (1.65) (2.35) On extraordinary items, net........................... (6.25) (0.62) (0.22) 0.01 -- On cumulative effect of change in accounting principle, net..................................... (0.72) (0.29) -- -- -- On net income (loss).................................. $ (9.29) $ (40.14) $ 7.16 $ (1.64) $ (2.35)
(A) The assumed exercise of the Company's warrants and options is not presented because such exercise would produce an anti-dilutive result. EXHIBIT 11 FLAGSTAR COMPANIES, INC. COMPUTATION OF EARNINGS (LOSS) PER SHARE
YEAR ENDED DECEMBER 31, ($ IN THOUSANDS EXCEPT PER SHARE AMOUNTS) 1992 (A) 1993 (A) 1994 1995 (A) 1996 (A) FULLY DILUTED EARNINGS (LOSS) PER SHARE Adjustment of common and equivalent shares: Average number of common shares outstanding before adjustments...................................... 24,883 42,370 42,369 42,431 42,434 Assumed exercise of stock warrants and options............. -- -- 9,854 -- -- Assumed conversion of convertible debentures............... -- -- 4,136 -- -- Assumed conversion of preferred stock...................... -- -- 8,562 -- -- Total average outstanding and equivalent common shares................................................ 24,883 42,370 64,921 42,431 42,434 Adjustment of net income (loss) applicable to common shareholders: Loss from continuing operations............................ $ (39,225) $(1,238,564) $(16,820) $(132,906) $(85,460) Interest on senior debt, net............................... -- -- 23,939 -- -- Interest on convertible debentures, net.................... -- -- 9,628 -- -- Dividends on preferred stock............................... (6,064) (14,175) -- (14,175) (14,175) Adjusted loss from continuing operations................... (45,289) (1,252,739) 16,747 (147,081) 99,635 Income (loss) from discontinued operations................. (12,550) (409,671) 392,670 77,241 -- Adjusted income (loss) before extraordinary item and cumulative effect of change in accounting principle............................................... (57,839) (1,662,410) 409,417 (69,840) (99,635) Extraordinary items, net................................... (155,401) (26,405) (11,757) 466 -- Cumulative effect of change in accounting principle, net... (17,834) (12,010) -- -- -- Adjusted net income (loss) applicable to common shareholders............................................ $(231,074) $(1,700,825) $397,660 $ (69,374) $(99,635) Fully diluted earnings (loss) per share applicable to common shareholders: On continuing operations................................... $ (1.82) $ (29.56) $ 0.26 $ (3.47) $ (2.35) On discontinued operations, net............................ (0.50) (9.67) 6.05 1.82 -- On income (loss) before extraordinary items and cumulative effect of change in accounting principle............................................... (2.32) (39.23) 6.31 (1.65) (2.35) On extraordinary items, net................................ (6.25) (0.62) (0.18) 0.01 -- On cumulative effect of change in accounting principle, net..................................................... (0.72) (0.29) -- -- -- On net income (loss)....................................... $ (9.29) $ (40.14) $ 6.13 $ (1.64) $ (2.35)
(A) The assumed exercise of the Company's warrants, options, 10% Convertible Debentures, and $2.25 Preferred Stock is not presented because such exercise and conversion would produce and anti-dilutive result. EX-12 12 EXHIBIT 12 EXHIBIT 12 FLAGSTAR COMPANIES, INC. COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
YEAR ENDED DECEMBER 31, ($ IN THOUSANDS) 1992 1993 1994 1995 1996 Loss from continuing operations before income taxes................................................... $(45,469) $(1,317,892) $ (19,033) $ (132,920) $(101,852) Add: Net interest expense excluding capitalized interest..... 232,058 203,709 220,985 221,645 245,787 Amortization of debt expense............................ 9,362 9,416 6,453 7,504 8,921 Interest factor in rents................................ 14,814 16,290 16,411 16,090 19,774 Total earnings (losses)............................ $210,765 $(1,088,477) $ 224,816 $ 112,319 $ 172,630 Fixed charges: Net interest expense including capitalized interest............................................. $232,348 $ 203,987 $ 221,245 $ 221,726 $ 245,787 Amortization of debt expense............................ 9,362 9,416 6,453 7,504 8,921 Interest factor in rents................................ 14,814 16,290 16,411 16,090 19,774 Total fixed charges................................ $256,524 $ 229,693 $ 244,109 $ 245,320 $ 274,482 Ratio of earnings (losses) to fixed charges............... -- -- -- -- -- Deficiency in the coverage of fixed charges by earnings (losses) before fixed charges........................... $ 45,759 $ 1,318,170 $ 19,293 $ 133,001 $ 101,852
For purposes of these computations, the ratio of earnings to fixed charges has been calculated by dividing pretax earnings by fixed charges. Earnings, as used to compute the ratio, equals the sum of income before income taxes and fixed charges excluding capitalized interest. Fixed charges are the total interest expenses including capitalized interest, amortization of debt expenses and a rental factor that is representative of an interest factor (estimated to be one third) on operating leases. EX-21 13 EXHIBIT 21 EXHIBIT 21 SUBSIDIARIES OF FLAGSTAR COMPANIES, INC.
NAME STATE OF INCORPORATION Flagstar Corporation Delaware TWS Funding, Inc. Delaware Denny's Holdings, Inc. New York FRD Acquisition Co. Delaware FRI-J Corporation Delaware Far West Concepts Delaware FRI-M Corporation Delaware FRI-NA Corporation Delaware FRI-C Corporation Delaware Spartan Holdings, Inc. New York Canteen Holdings, Inc. New York TWS 800 Corp. Delaware TWS 500 Corp. Delaware TWS 600 Corp. Delaware TWS 700 Corp. Delaware El Pollo Loco, Inc. Delaware Denny's, Inc. California DFO, Inc. Delaware Denny's Realty, Inc. Delaware Quincy's Restaurant, Inc. Alabama Flagstar Enterprises, Inc.* Alabama Spartan Realty, Inc. Delaware Flagstar Systems, Inc. Delaware Quincy's Realty, Inc. Alabama Spardee's Realty, Inc. Alabama
* Flagstar Enterprises, Inc. of Delaware is an assumed name for use only in Ohio. EX-23 14 EXHIBIT 23 EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 33-35098 and 33-35099 of Flagstar Companies, Inc. on Form S-8 of our report dated February 13, 1997 appearing in this Annual Report on Form 10-K of Flagstar Companies, Inc. for the year ended December 31, 1996. DELOITTE & TOUCHE LLP Greenville, South Carolina February 26, 1997 EX-27 15 EXHIBIT 27
5 YEAR YEAR DEC-31-1995 DEC-31-1996 DEC-31-1995 DEC-31-1996 196,966 92,369 0 0 32,350 20,217 2,506 2,405 32,445 31,543 285,342 190,655 1,750,218 1,891,998 645,857 723,416 1,507,751 1,687,370 407,530 483,275 1,996,111 2,179,393 0 0 630 630 21,218 21,218 (1,152,825) (1,249,375) 1,507,751 1,687,370 2,571,487 2,542,302 2,571,487 2,542,302 0 0 2,473,253 2,385,910 2,005 3,537 0 0 229,149 254,707 (132,920) (101,852) (14) (16,392) (132,906) (85,460) 77,241 0 466 0 0 0 (55,199) (85,460) (1.64) (2.35) (1.64) (2.35)
EX-99 16 EXHIBIT 99 EXHIBIT 99 SAFE HARBOR UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 The Private Securities Litigation Reform Act of 1995 (the "Act") provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about their companies, so long as those statements are identified as forward-looking and are accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those discussed in the statement. The Company desires to take advantage of the "safe harbor" provisions of the Act. Certain information, particularly information regarding future economic performance, finances and management's plans and objectives, including the development of plans to maintain the Company's liquidity and improve its capital structure over the short and long-terms, contained or incorporated by reference in the Company's 1996 Annual Report on Form 10-K is forward-looking. In some cases information regarding certain important factors that could cause actual results to differ materially from any such forward-looking statement appear together with such statement. Also, the following factors, in addition to other possible factors not listed, could affect the Company's actual results and cause such results to differ materially from those expressed in forward-looking statements: LIQUIDITY AND CAPITAL RESOURCES. Management has indicated in the Company's 1996 Annual Report on Form 10-K its intent to develop plans to maintain the Company's liquidity and improve its capital structure over the short and long terms. There can be no assurance, however, that management will be successful in this regard. Such success will be dependent upon numerous factors including, but not limited to, the ability of the Company to: (1) reverse negative operating trends experienced by the Company in recent years due to increased competition, intensive pressure on price due to discounting, declining customer traffic, and adverse economic conditions, (2) maintain access to funds available through the Company's bank credit facility, and (3) reduce its debt service requirements. COMPETITION. The Company's future performance will be subject to a number of factors that affect the restaurant industry generally, including competition. The restaurant business is highly competitive and the competition can be expected to increase. Price, restaurant location, food quality, quality and speed of service and attractiveness of facilities are important aspects of competition as are the effectiveness of marketing and advertising programs. The competitive environment is also often affected by factors beyond the Company's or a particular restaurant's control. The Company's restaurants compete with a wide variety of restaurants ranging from national and regional restaurant chains (some of which have substantially greater financial resources than the Company) to locally-owned restaurants. There is also active competition for advantageous commercial real estate sites suitable for restaurants. ECONOMIC, MARKET AND OTHER CONDITIONS. Food service businesses are often affected by changes in consumer tastes, national, regional and local economic conditions and demographic trends. The performance of individual restaurants may be adversely affected by factors such as traffic patterns, demographic considerations and the type, number and location of competing restaurants. Multi-unit food service chains such as the Company's can also be materially and adversely affected by publicity resulting from food quality, illness, injury or other health concerns or operating issues stemming from one restaurant or a limited number of restaurants. Dependence on frequent deliveries of fresh produce and groceries subjects food service businesses to the risk that shortages or interruptions in supply, caused by adverse weather or other conditions could adversely affect the availability, quality and cost of ingredients. In addition, unfavorable trends or developments concerning factors such as inflation, increased food, labor and employee benefit costs (including increases in hourly wage and minimum unemployment tax rates), regional weather conditions and the availability of experienced management and hourly employees may also adversely affect the food service industry in general and the Company's results of operations and financial condition in particular. IMPORTANCE OF LOCATIONS. The success of Company and franchised restaurants is significantly influenced by location. There can be no assurance that current locations will continue to be attractive, as demographic patterns change. It is possible the neighborhood or economic conditions where restaurants are located could decline in the future, resulting in potentially reduced sales in those locations. GOVERNMENT REGULATIONS. The Company and its franchisees are subject to Federal, state and local laws and regulations governing health, sanitation, environmental matters, safety, the sale of alcoholic beverages and hiring and employment practices. Restaurant operations are also subject to Federal and state laws that prohibit discrimination and laws regulating the design and operation of facilities, such as the Americans With Disabilities Act of 1990. The operation of the Company's franchisee system is also subject to regulations enacted by a number of states and rules promulgated by the Federal Trade Commission. The Company cannot predict the effect on its operations, particularly on its relationship with franchisees, caused by the future enactment of additional legislation regulating the franchise relationship. -----END PRIVACY-ENHANCED MESSAGE-----