-----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, QDJiWuA1J3gQXpyEMoYI5R7qWkaoZ/XC3mCX5h7kJ/Kq/9q/axw3hFGDkePqwodd pvO9DpY+NXXUCL5r4c4HxA== 0000950144-98-003885.txt : 19980401 0000950144-98-003885.hdr.sgml : 19980401 ACCESSION NUMBER: 0000950144-98-003885 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: AMEX FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERLOTT TECHNOLOGIES INC CENTRAL INDEX KEY: 0000873998 STANDARD INDUSTRIAL CLASSIFICATION: REFRIGERATION & SERVICE INDUSTRY MACHINERY [3580] IRS NUMBER: 311297916 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-12986 FILM NUMBER: 98582291 BUSINESS ADDRESS: STREET 1: 10830 MILLINGTON CT CITY: CINCINNATI STATE: OH ZIP: 45242 BUSINESS PHONE: (513)792-7000 MAIL ADDRESS: STREET 1: 6655 CREEK ROAD CITY: CINCINNATI STATE: OH ZIP: 45242 FORMER COMPANY: FORMER CONFORMED NAME: INTERNATIONAL LOTTERY INC DATE OF NAME CHANGE: 19940203 10-K405 1 INTERLOTT TECHNOLOGIES, INC. 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 [ ] 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 1-12986 INTERLOTT TECHNOLOGIES, INC. (Exact name of Registrant as specified in its charter) DELAWARE 31-1297916 (State of incorporation) (I.R.S. Employer Identification Number) 10830 Millington Court, Cincinnati, Ohio 45242 (Address of principal executive offices, including zip code) (513) 792-7000 (Registrant's telephone number, including area code) ------------ Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered - --------------------------------- ----------------------------------------- Common Stock, $.01 Par value American Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None ------------ Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of 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. X ----- The aggregate market value of the Registrant's outstanding Common Stock held by non-affiliates of the Registrant on March 25, 1998 was $10,312,500. There were 3,210,000 shares of Common Stock outstanding as of March 25, 1998. 2 DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's 1997 Annual Report are incorporated by reference in Part II hereof. Portions of the Registrant's Proxy Statement for the 1998 Annual Meeting of Stockholders to be held on May 7, 1998 are incorporated by reference in Part III hereof. -2- 3 INTERLOTT TECHNOLOGIES, INC. Annual Report On Form 10-K For the Fiscal Year Ended December 31, 1997 Table of Contents
Item Page Number Number - ------ ------ PART I 1. Business......................................................................................... 3 2. Properties....................................................................................... 23 3. Legal Proceedings................................................................................ 23 4. Submission of Matters to a Vote of Security Holders.............................................. 24 4(A). Executive Officers of the Registrant............................................................. 24 PART II 5. Market for Registrant's Common Equity and Related Stockholder Matters............................ 25 6. Selected Financial Data.......................................................................... 25 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............ 26 7(A). Quantitative and Qualitative Disclosure About Market Risk ....................................... 26 8. Financial Statements and Supplementary Data...................................................... 26 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............. 26 PART III 10. Directors and Executive Officers of the Registrant............................................... 26 11. Executive Compensation........................................................................... 27 12. Security Ownership of Certain Beneficial Owners and Management................................... 27 13. Certain Relationships and Related Transactions................................................... 27 PART IV 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................. 27 SIGNATURES......................................................... 30 INDEX OF FINANCIAL STATEMENT SCHEDULES............................. S-1 INDEX OF EXHIBITS.................................................. E-1
-2- 4 PART I ITEM 1. BUSINESS General In addition to historical information, this report and the Company's 1997 Annual Report include forward looking statements and information based on management's beliefs, plans, expectations and assumptions and on currently available information. The words "expect," "anticipate," "intend," "plan," "believe," "seek," "estimate" and similar expressions used in this report and the 1997 Annual Report are intended to identify forward looking statements, although this report and the 1997 Annual Report also contains other forward looking statements. The forward looking statements in this report are not guarantees of future performance and involve certain risks, uncertainties and assumptions, many of which are beyond the Company's control. Such factors include particularly, but are not limited to, the level of market acceptance of ITVMs and PCDMs generally as well as the demand for the Company's ITVMs and PCDMs. As a result of the various risks, uncertainties and assumptions underlying the forward looking statements in this report and the 1997 Annual Report, the Company's future actions, financial condition, results of operations and stockholder values could differ materially from any forward looking statement made by the Company. All written or oral forward looking statements attributable to the Company are expressly qualified in their entirety by the cautionary statements that explain or qualify the foward looking statements. Interlott Technologies, Inc. (the "Company") is engaged primarily in the design, manufacture, sale, lease and service of instant winner lottery ticket vending machines ("ITVMs"). ITVMs are used by public lotteries operated by states and foreign public entities to dispense instant winner lottery tickets primarily in retail locations such as supermarkets and convenience stores. An instant lottery commonly is played by players scratching off a latex coating from a pre-printed ticket or tearing pull-tabs from a pre-printed ticket to determine the outcome of the game. The Company's ITVMs dispense instant lottery tickets without the assistance of an employee of the lottery instant ticket retailer or agent, thereby permitting the retailer or agent to sell tickets without disrupting the normal duties of its employees. The Company's ITVMs dispense scratch-off instant lottery tickets using a dispensing process that incorporates the Company's patented "burster technology." The Company believes that this burster technology is superior to any other ITVM scratch-off dispensing technology on the market and considers it to be a key to its marketing efforts and the ITVM procurement decisions of the various lotteries. The Company is unaware of any competitor that incorporates a substantially equivalent or superior scratch-off dispensing mechanism in its ITVMs. To dispense pull-tab instant lottery tickets, the Company has developed an ITVM that incorporates a patented dispensing technology which is different than the burster technology but that is also believed by the Company to be superior to any other currently available pull-tab dispensing technology. ITVMs that dispense pull-tab tickets are sometimes referred to herein as "pull tab vending machines" or "PTVMs." The term "ITVM" includes both scratch-off vending machines and PTVMs unless the context indicates otherwise. As of December 31, 1997, the Company had sold or leased 12,414 ITVMs under agreements with 22 different state lotteries and six foreign jurisdictions, or their licensees or contractors. The Company was awarded four of the five domestic ITVM contracts that were awarded in 1996 and five of the six contracts that were awarded in 1997. Additionally, lotteries in eight states and eight foreign jurisdictions currently are testing the Company's ITVMs or have requested the Company to provide ITVMs for testing. The Company continually seeks to enhance its existing product lines and develop new products. The Company has developed a prepaid phone card dispensing machine ("PCDM") that enables providers of long distance telephone service to dispense prepaid telephone calling cards in retail locations without the assistance of an employee of the retailer. The dispensing process used in the Company's PCDM incorporates the same patented technology used in the Company's PTVM, and the Company believes that this dispensing technology is superior to any other PCDM dispensing technology on the market. Sales of the Company's PCDMs began in the latter part of 1995, and as of December 31, 1997, the Company had sold or leased a total of 695 PCDMs. PCDM revenues in 1996 and 1997 represented 2% and 2.5% of total revenues, respectively. The Company was incorporated on February 20, 1990 under the laws of Ohio and was reincorporated under the laws of Delaware on March 18, 1994. In April 1994, the Company completed an initial public offering of Common Stock, and the Company's Common Stock now trades on the American Stock Exchange under the symbol "ILI." -3- 5 Industry Overview ITVMS The popularity and success of lotteries has increased worldwide in recent years, and the popularity of instant lotteries has increased at a rate that is greater than that of lotteries generally. Currently 37 states and the District of Columbia operate lotteries as compared to 29 states as of June 30, 1989, and 37 states and the District of Columbia currently operate instant lotteries as compared to 28 states as of June 30, 1989. The Company believes that factors contributing to the rapid growth in the popularity and success of instant ticket games, which now comprise 45% of total lottery sales in the United States as compared to 24% in 1989, include more sophisticated marketing techniques, the introduction of new state instant ticket lotteries, a broader appeal among lottery consumers and increased technological advances in the distribution of instant tickets. ITVMs were first deployed to serve the instant lottery market in 1991, and the market for ITVMs has grown rapidly in subsequent years. The number of installed ITVMs has increased from approximately 900 in 2 states in 1991 to approximately 24,100 in 31 states, the District of Columbia and eight foreign jurisdictions as of December 31, 1997. Three states and four foreign jurisdictions currently are testing or preparing to test ITVMs in the field, and the Company believes that several other states and foreign jurisdictions are considering the use of ITVMs. Additionally, because states that utilize ITVMs typically introduce the ITVMs into the instant ticket distribution system in stages (preferring to test retail reception to a limited initial deployment of ITVMs before fully committing funds to the deployment of a significantly larger number of ITVMs), the Company believes that states currently utilizing ITVMs represent a growing market for the Company's ITVMs. Although the Company believes that sales of instant lottery tickets and the use of ITVMs will continue to increase, any decline in the popularity of instant lottery games or in the market acceptance of ITVMs, as well as any other event that results in a decrease in leasing or purchasing ITVMs by lotteries, would have a material adverse effect on the Company. The Company's ability to generate additional revenues and earnings will depend upon the continuation of existing leases of ITVMs, orders for additional ITVMs by the lotteries that currently utilize ITVMs, the implementation of programs that use ITVMs to distribute tickets in the six additional states as well as foreign jurisdictions that have instant ticket lotteries, and the approval of lotteries by the remaining states and foreign jurisdictions. Future orders of ITVMs by lotteries will depend in large part on continued market acceptance of ITVMs, of which there can be no assurance. Accordingly, there can be no assurance that any significant number of jurisdictions will implement or expand lottery programs that utilize ITVMs. -4- 6 PCDMS Like instant lottery tickets, the use of prepaid telephone calling cards also has grown significantly in the past few years. Prepaid telephone calling cards enable callers to make long distance calls at rates that typically are lower than the rates ordinarily charged for credit card or collect long distance telephone calls. This factor, together with the usage control that results from the pre-established value of the card, is perceived as a distinct value of the card and is believed to be responsible for the popularity of prepaid telephone calling cards. The use of PCDMs as a method of distribution of prepaid telephone calling cards has paralleled the market acceptance of the card. PCDMs are now being used successfully to sell prepaid telephone calling cards in truck stops, military bases, convenience stores, airports, and numerous other types of retail locations. The Company believes that the sale of prepaid long distance calling cards and the use of PCDMs are in the very early stages of market development in the United States and anticipates the continued development of the market. However, any decline in the popularity of prepaid telephone calling cards or in the market acceptance of PCDMs would limit the Company's ability to generate revenues and earnings from its PCDMs. There can be no assurance that the Company will be able to develop successfully the market for its PCDMs. Business Strategy The Company's business strategy involves the following elements: - Expansion of the Company's ITVM into new domestic and international markets. Lotteries are becoming increasingly aware of the success of ITVMs in increasing instant ticket revenues, and many domestic and international jurisdictions are currently testing and evaluating ITVMs. In the United States, the Company currently is testing or preparing for testing of ITVMs for lotteries in Idaho, Indiana and West Virginia. Internationally, the Company currently is testing or preparing for testing of ITVMs for lotteries in Costa Rica, France, Quebec and Switzerland. The Company plans to expand further into new and existing lottery jurisdictions by expanding its marketing efforts and lowering the cost associated with the procurement of its ITVMs. The Company also intends to continue to aggressively market its ITVM products and services to its existing customers to encourage expanded use of ITVMs in existing distribution systems. - PCDM market penetration. The Company has made only an initial and limited penetration of the PCDM market to date, but the Company is actively seeking to become a significant presence in the PCDM market in the United States. The Company believes that its ITVM has a reputation for quality, performance and reliability, and the Company intends to capitalize on this reputation in marketing its PCDM to providers of long distance telephone services. The Company also intends to demonstrate to such providers the advantages which its PCDM affords to the retailers that sell prepaid telephone calling cards, which in turn should lead to increased sales of prepaid calling cards by such providers. To this end, the Company is working closely with several providers of long distance telephone service to expand the use of PCDMs in the distribution of prepaid telephone calling cards. Four such providers are currently testing or preparing to test the Company's PCDM. The Company also intends to aggressively market its PCDM products to its existing customers and to expand its marketing efforts to both the providers and resellers of long distance services, as well as to market its PDCMs to retailers of prepaid telephone cards. -5- 7 - Continued product innovation and technological advances. Management believes that the Company's products are more technologically advanced than the products of its competitors and that the technological superiority of the Company's ITVM is a principal reason for its success to date. To further expand the Company's market opportunities, the Company continually seeks to enhance its existing products and develop complementary products that offer the superior operating performance of its ITVMs and PCDMs. For example, the Company has developed a compact, no-frills PCDM to address the needs of those customers who do not desire a full-service machine. The Company also has enhanced its software to interact with currency acceptors of foreign currency and display messages in foreign languages. Finally, the Company has improved its on-line communications system. - Manufacturing efficiencies. The Company continually seeks to enhance its manufacturing operations to improve its gross margins and overall profitability. The Company believes that through design refinements and continued higher production volumes, it will continue to achieve lower manufacturing costs by receiving more favorable terms from vendors. - Develop dispensing devices for other markets. The Company intends to expand its existing product lines by developing new dispensing devices for markets other than lotteries. For example, the Company is developing and testing a device which dispenses stored value "smart" cards for possible use by the financial services industry to the extent that consumer use of smart cards develops in the future. Products The ITVM In 1987, the Company's former President and current Vice Chairman, Edmund F. Turek, developed the technology for what the Company believes to be the first automated ITVM. This burster dispensing technology is a key component of the Company's ITVM for scratch-off instant lottery tickets and is protected by a patent that the Company acquired from Mr. Turek's family-owned corporation. See "Patents, Trademarks, and Copyrights" below. The Company's ITVMs automatically dispense instant lottery tickets upon payment from the user. Unlike the products of some of the Company's competitors, the burster technology in the Company's ITVMs automatically separates one scratch-off instant ticket from another along the perforations between tickets to help prevent tearing of the tickets or scarring of the latex on the tickets. The Company's burster technology, which the Company believes to be the most technologically advanced scratch-off dispensing system in the ITVM industry, also enables the Company's ITVM to dispense and account for virtually any known type of scratch-off instant lottery ticket, allowing the use of a wide range of sizes, shapes, paper stocks or perforations, without the intervention of a lottery retailer or agent. This feature allows lotteries to purchase virtually any known type of scratch-off instant ticket from their instant ticket manufacturer without having to request from the manufacturer major alterations in the ticket perforations. For example, the Company's ITVM, unlike the products of the Company's competitors, can dispense recyclable scratch-off tickets without tearing or scarring the tickets. The Company believes that lotteries will increasingly require the use of recyclable tickets in their ITVMs. This feature also is particularly beneficial to foreign lottery jurisdictions that may use non-standard sizes, shapes and paper stocks. In addition, the ITVM for scratch-off tickets is faster than manual sales of scratch-off tickets as the ITVM's entire dispensing process is completed in less than 1.5 seconds once the ticket selector button has been pushed. -6- 8 The Company's ITVMs for scratch-off tickets have a proven record of reliability. Based on an analysis of actual field service data regarding the dispensing of approximately 55 million scratch-off instant tickets by the Company's ITVMs during a 48 week period, the Company determined that the Mean Time Between Failure of these ITVMs is approximately 3.78 years and that the Mean Time to Repair is approximately 15 minutes. The data indicated that these ITVMs dispense an average of 392,800 scratch-off instant tickets between failures. The Company believes that it has developed an ITVM that has proven to be reliable and that requires less maintenance than the products of its competitors. The Company believes that the reliability of its ITVM and the lower maintenance requirements distinguish the Company's ITVM for scratch-off tickets from those of its competitors. See "Competition" below. The Company's ITVMs for scratch-off tickets have the capacity to dispense tickets from one to twelve different bins. Because each bin can dispense tickets of different sizes, paper stocks and price levels, lotteries can sell scratch-off tickets for up to twelve different instant winner games with a single ITVM. The ITVM can accommodate up to 12,000 tickets in the twelve-game unit and can dispense all tickets in the bin without manual intervention. When all of the tickets in a bin have been dispensed, tickets can be easily reloaded by an employee of the retailer or agent. This is in contrast to the products of the Company's competitors, which the Company believes require the retailer or other agent to tape the last few tickets in each bin to the next pack of tickets provided by the retailer or other agent. The ability of the Company's ITVM to dispense every ticket in each bin not only facilitates the ticket reloading process but also enhances the accuracy of the inventory and accounting functions. All of the Company's ITVMs accept bills in $1, $2, $5, $10 and $20 denominations and, in some applications, accept foreign currency. The size of the Company's ITVMs for scratch-off tickets varies from 69 inches tall, 28 inches wide and 24 inches deep for a twelve-game unit to 19.75 inches tall, 15.5 inches wide and 20.5 inches deep for a countertop unit. All models are anchored to the floor or counter. The ITVMs typically are custom designed to meet any color and other appearance specifications that a lottery may desire. All models are Underwriters Laboratory ("UL(R)") listed and Federal Communications Commission ("FCC") approved, which ensures that the ITVM has passed nationally recognized safety standards and stringent requirements designed to preclude machine damage and personal injury due to non-approved components, devices, installation or application. The Company was the first manufacturer of ITVMs to obtain UL(R) listing and FCC approval for its ITVMs. Each ITVM is standardized with an information display that provides the player with easy-to-read instructions on how to use the machine and gives the lottery retailer or agent the ability to read sales reports without printing the report. The ITVM can be ordered with a "BETA BRITE(R)" multi-color LED sign mounted on the top of the ITVM which is intended to increase attention to the machine and thereby increase ticket sales. The BETA BRITE(R) sign is programmed at the Company's manufacturing facility and can display any message the lottery may desire. The BETA BRITE(R) also may be programmed by the retailer or agent or can be programmed from the lottery headquarters by utilizing the Company's optional modem communications system. The Company currently is utilizing the BETA BRITE(R) on ITVMs installed throughout Arizona, Colorado, Florida, Georgia, Idaho, Indiana, New Hampshire, New Mexico and Rhode Island. For security and durability purposes, each of the Company's ITVM cabinets is manufactured with 16 gauge and 11 gauge steel. The surface of the ITVM is coated with durable and fade resistant paints. The display windows are fabricated from a flame resistant, high impact polycarbonate sheet material. This material is shatter resistant, and to date to the knowledge of the Company, none of the Company's installed ITVMs has had a polycarbonate window broken or shattered. Additionally, to the knowledge of the Company, the cabinets have not had any fading, marring, scratching, chipping or rusting. All of the -7- 9 Company's ITVMs are manufactured with high security locks which are coded to prevent unauthorized duplication, and each ITVM is keyed separately, except for ITVMs deployed in Maryland where the Lottery desired a master key system. For further security, each of the Company's bill acceptor units must be accessed with a key unique to the particular acceptor unit. All of the Company's ITVMs for scratch-off tickets utilize copyrighted software that can supply up to eleven different reports for accounting and inventory purposes. These reports can provide to the lottery and its retailers or agents a complete summary of daily sales, weekly sales, total sales, sales by game, current status of the machine, inventory of the product currently in the ITVM, the last three transactions of the ITVM and other types of information. The software system allows for a simple diagnostic test to identify any malfunction of the ITVM. The diagnostic mode communicates various information such as ticket size setting, status of electronics, status of each game and other information concerning the system software. The Company's ITVM software system may be programmed to the detail specifications of the specific lottery. In 1995, the Company completed the development of a common electronic system to be incorporated in all of the Company's equipment, providing efficiency in development of common software as well as cost efficiencies in acquiring electronic components. To dispense pull-tab instant lottery tickets, the Company's PTVM uses the same technology, design and specifications as are incorporated in the Company's PCDM. The Company's PCDM is described in detail below. THE PCDM Like the Company's ITVM for scratch-off tickets, the key component of the Company's PCDM is the dispensing technology. The Company has the exclusive right to the use of this patented dispensing technology, which it acquired from a company owned by Kazmier J. Kasper, a director of the Company. See "Item 13. Certain Relationships and Related Transactions." Similar to the Company's ITVM for scratch-off tickets, the Company's PCDM automatically dispenses prepaid telephone calling cards upon payment from the user. Unlike the products of some of the Company's competitors, the dispenser technology in the Company's PCDMs automatically pulls one prepaid telephone calling card from the bottom of the stack of cards without the jamming that is associated with other dispensing processes. The Company's dispensing technology, which the Company believes to be the most technologically advanced dispensing system in the PCDM industry, also enables the Company's PCDM to dispense and account for virtually any known thickness of calling card without the intervention of the retailer. In addition, the PCDM is faster than manual sales of prepaid telephone calling cards as the PCDM's entire dispensing process is completed in less than 3 seconds once the selector button has been pushed. The Company's PCDMs have the capacity to dispense cards from two to six different bins. The PCDM can accommodate up to 2,400 cards in the six bin unit and can dispense all prepaid telephone calling cards in the bin without manual intervention. When all of the cards in a bin have been dispensed, cards easily can be reloaded by an employee of the retailer. The ability of the Company's PCDM to dispense every card in each bin not only facilitates the card reloading process but also enhances the accuracy of the inventory and accounting functions. All of the Company's PCDMs accept bills in $1, $2, $5, $10 and $20 denominations and, in some applications, accept foreign currency. The size of the Company's PCDMs varies from 66 inches tall, 26 inches wide and 19 inches deep for a 6-bin dispenser unit to 22 inches tall, 14 inches wide and 10 inches -8- 10 deep for a countertop unit. All models are anchored to the floor or counter, except that the two bin model may be mounted on an optional pedestal. All models are UL(R) listed and FCC approved. Each PCDM is standardized with an information display that provides the user with easy-to-read instructions on how to use the machine and gives the retailer the ability to read sales reports without printing the report. For security and durability purposes, each of the Company's PCDM cabinets is manufactured with 16 gauge and 11 gauge steel. The surface of the PCDM is coated with durable and fade resistant paints. The display windows are fabricated from a flame resistant, high impact polycarbonate sheet material. To the knowledge of the Company, the cabinets have not had any fading, marring, scratching, chipping or rusting. All of the Company's PCDMs are manufactured with high security locks that are coded to prevent unauthorized duplication, and each PCDM is keyed separately. For further security, each of the Company's bill acceptor units must be accessed with a key unique to the particular acceptor unit. All of the Company's PCDMs utilize copyrighted software that can supply up to nine different reports for accounting and inventory purposes. These reports can provide retailers a complete summary of daily sales, weekly sales, total sales, sales by bin, current status of the machine, inventory of the product currently in the PCDM, the last three transactions of the PCDM and other types of information. The software system allows for a simple diagnostic test to identify any malfunction of the PCDM. Marketing and Sales ITVMS The Company markets its ITVMs to both domestic and international lotteries and their licensees or prime contractors. The Company attends lottery and gaming trade shows, maintains personal contact with lottery officials through its sales force of five employees and advertises in trade publications to increase its presence in the lottery industry. The focus of the Company's marketing strategy is on the superior performance and reliability of its ITVMs, as well as continued competitive pricing. Information developed through actual field use and product field tests demonstrates that a significant factor in increasing instant ticket sales is the reliability of the ITVM. Increased maintenance visits impair the ITVM "uptime," which in turn reduce ticket sales. The Company believes that its ITVMs, based on actual field performance and product testing, are the most reliable and technologically superior in the industry. Management believes that actual field demonstrations comparing the Company's ITVM with those of its competitors is the Company's best method of marketing. The Company has been awarded contracts to provide ITVMs for nine of the last 11 state lotteries that have requested bid proposals and five of the six domestic ITVM contracts that were awarded in 1997. The Company's ITVMs require preventive maintenance only twice a year. The ITVM "downtime" resulting from this semi-annual preventive maintenance averages approximately 20 minutes. On the other hand, the Company's principal competitor, On-Point Technology Systems, Inc. ("On-Point"), for example, recommends that preventive maintenance be performed on its ITVMs once a month. All of the Company's existing contracts which require the Company to provide preventive maintenance on its ITVMs provide for semi-annual preventive maintenance. To further increase the likelihood of receiving ITVM orders from lotteries, the Company intends to offer additional and more flexible financing alternatives to the lotteries. The Company believes that many state lotteries, due to budget considerations, cannot afford the high capital costs required to purchase ITVMs. However, if the Company can provide attractive variations of its standard and percentage lease financing options for the lotteries, the lotteries can more affordably deploy ITVMs. The Company believes that these types of financing alternatives will prove to be increasingly popular. -9- 11 The Company's ability to generate additional revenues and earnings from deployments of its ITVMs will depend upon continued market acceptance of ITVMs. The Company intends to expand its marketing presence with the retail grocers associations, convenience store operators associations, retail stores at both the corporate and store levels, and other types of corporate or association member entities to familiarize these groups with the Company's ITVM. These retailers are the lotteries' distribution system for all scratch-off and pull-tab lottery tickets, and management believes that increased exposure to lottery retailers will be a significant factor in the Company's ability to expand the market for its lottery products. As the distribution system for all lottery products, lottery retailers may advise the lotteries with regard to such matters as new lottery products, improved marketing strategy and improved product distribution. In many lottery jurisdictions, retailer advisory boards provide input to the lotteries on various issues affecting the lottery. While the lotteries must abide by the established procurement laws of their respective jurisdictions in selecting an ITVM manufacturer, the lotteries may solicit the opinions of the lottery retailers concerning the ITVMs under consideration by the lottery because the retailers are directly affected by the selection decision. The Company believes that retailers' opinions may be a significant factor in a customer's decision regarding which manufacturer's ITVM to deploy in its instant ticket distribution system. The Company will continue to participate in cooperative service arrangements with other lottery suppliers as the lotteries increasingly rely on these types of arrangements. These arrangements allow lotteries to reduce their operating costs while increasing lottery revenues. Additionally, these arrangements allow for a more efficient means for contracting products and services. The Company's ITVMs are deployed in Georgia and West Virginia pursuant to cooperative service arrangements between the Company and Scientific Games, Inc., which is a primary contractor for the Georgia and West Virginia Lotteries, and were deployed in New Jersey pursuant to a purchase agreement between the Company and GTECH Corporation, which is the on-line supplier to the New Jersey Lottery. Under these arrangements, the Company supplies ITVMs to Scientific Games, Inc. for use in Georgia and West Virginia and supply ITVMs to GTECH Corporation for use in New Jersey. The Company is responsible for installing, servicing and maintaining the ITVMs in Georgia but is not required to provide preventive maintenance or servicing for the ITVMs supplied for use in West Virginia and New Jersey. Management believes that the deployment of the Company's ITVMs in Georgia, West Virginia and New Jersey resulted in part from the Company's cooperative service arrangements with Scientific Games, Inc. and GTECH Corporation and that such cooperative service arrangements will prove to be increasingly attractive to both domestic and international lotteries in the future. PCDMS The Company has been marketing its PCDMs since late 1995 and to date has employed a marketing strategy that is similar to the strategy that it has used successfully to market its ITVMs. The focus of the Company's marketing strategy is on the superior performance and reliability of its PCDMs as well as on competitive pricing. The Company markets its PCDMs to both domestic and international providers of long distance telephone service. The Company attends telecommunications trade shows, maintains personal contact with telecommunications companies through its sales force of two employees and advertises in trade publications to increase its presence in the telecommunications industry. The Company's ability to generate additional revenues and earnings from the deployment of its PCDMs will depend upon continued market acceptance of PCDMs. The Company intends to expand its marketing presence with the retail grocers associations, convenience store operators associations, retail stores at both the corporate and store levels, and other types of corporate or association member entities to familiarize these groups with the Company's PCDM. These retailers are the distribution system for prepaid telephone calling cards, and management believes that increased exposure to PCDM retailers will be a -10- 12 significant factor in the Company's ability to expand the market for its PCDM products. To further increase the likelihood of receiving PCDM orders from sellers of prepaid telephone calling cards, the Company intends to offer additional and more flexible financing alternatives. Contracts ITVMS General. The Company's lottery contracts typically are entered into following a competitive bidding process. Once a lottery has determined to utilize ITVMs in its distribution network, the lottery usually will request proposals from ITVM providers. Lotteries within the United States typically follow a procedure whereby the lottery issues a Request for Proposal ("RFP") to determine the contract award for installation of ITVMs. The RFP generally seeks information concerning each company's products, cost of the products or services to be provided, quality of management, experience in the industry and other factors that the lottery may deem material to a contract award. The RFP also may specify product criteria and other qualifications or conditions that must be satisfied, such as UL(R) listing and FCC approval of the ITVM and in-state or minority supplier requirements. Generally, an evaluation committee comprised of key lottery staff members appraise the proposals based on an established point system, and the contract is awarded to the company with the most points. The nature of the RFP process varies from jurisdiction to jurisdiction. The length of time that a lottery might take to award a contract can be difficult to predict, and delays in the contract award process are frequent and unpredictable. Additionally, the point system or the weighing of the various points varies from jurisdiction to jurisdiction, which often makes it difficult for the bidding companies to determine the relative importance of the various factors to be considered by the evaluation committee. In certain cases the contract award is challenged by the losing bidder, which can result in protracted legal proceedings for all parties. The Company offers lotteries a choice of three types of contracts: (i) Standard Lease Agreements; (ii) Sales Agreements; and (iii) Percentage Lease Agreements. ITVM lease revenues as a percentage of the Company's total revenues were 47.3%, 63.3% and 67.3% in 1995, 1996 and 1997, respectively. The Standard Lease Agreements provide that the lottery will pay a fixed monthly price per machine for a specific period of time. These agreements typically specify a number of years for the initial contract term with additional option periods at the election of the lottery. The lottery may award a separate service contract for the maintenance of the machines, incorporate the cost of service into the established monthly lease price or perform machine service themselves. The lotteries also may select a similar type of arrangement as described above to procure the necessary supply of replacement parts for the ITVMs. As noted above, the lease payments provided for in the typical Standard Lease Agreement are fixed in most cases during the term of the agreement, and these agreements typically permit the lottery to order additional ITVMs at any time during the lease term. If the lottery orders a significant number of ITVMs near the end of the lease term, the Company would have to incur significant manufacturing costs but may receive lease payments for only a relatively short period of time through the remainder of the lease term. However, the Company believes that it is more likely that the lottery would elect to extend the lease term rather than return the ITVMs after only a short period of use. Additionally, the Company is unable to pass along to the lottery any increase in its manufacturing and service costs during the term of the typical Standard Lease Agreement. In the case of a Standard Lease Agreement which provides for a short initial term (such as one year) with an option for the lottery to extend the lease term for additional one-year periods, if the lottery does not extend the initial lease term, the Company might incur a loss on the manufacture of the ITVMs leased to the lottery under the initial lease agreement. -11- 13 Sales Agreements typically provide that the lottery will buy a certain number of ITVMs over a specific period of time. Under the Sales Agreement, the lottery generally pays for the ITVMs when delivered and has complete ownership of the ITVMs. The lottery usually will contract with a vendor to maintain and service the ITVMs, although some lotteries provide the maintenance and service with their own service staffs. The lottery generally will enter into a parts replacement contract with the vendor for replacement parts. All types of the ITVM contracts typically contain stringent installation, performance and maintenance requirements. Failure to perform the contract requirements may result in significant liquidated damages or contract termination. The Company has various contract performance standards to which it must adhere. To date, the Company has satisfied all of its contractual installation, performance and maintenance requirements and therefore has not had any contracts terminated by any lotteries. The Company's lottery contracts also typically require the Company to indemnify the lottery, its officers and retailers for any liabilities arising from the operation of the ITVMs or any services provided by the Company. The Company typically is required to obtain liability insurance, fidelity insurance and performance and litigation bonds to protect itself and the lottery from potential liability. No such indemnification or insurance claims have ever been asserted against the Company. The Company's contracts generally have an initial term of one to five years with options to extend the duration of the contracts for periods of between one and five years. The option extensions generally are at the lottery's discretion and are exercised under the same terms and conditions as the original contract. As of December 31, 1997, the initial term of nine of the Company's contracts had expired, and in each case, the lottery exercised its option to extend the term. The Company's contracts with lotteries, like most other types of state contracts, typically permit a lottery to terminate the contract upon 30 days written notice for any reason. Upon termination of a lease contract, the lottery would return the leased equipment to the Company. It is uncertain, however, whether the Company would be able to re-lease or sell any ITVMs that may be returned to the Company following the expiration or cancellation of a lease. To date, no lottery has terminated its contract with the Company. Upon termination of a contract, the lottery may award new contracts through a competitive bid process. As noted above, the Company believes that 31 states and the District of Columbia utilize ITVMs in some manner as part of their instant ticket distribution system. The Company's ITVMs have been deployed in 22 of those states as well as five foreign jurisdictions, and three additional states and four foreign jurisdictions currently are testing the Company's ITVMs or have requested that the Company provide ITVMs for testing. Set forth below is certain information regarding the Company's contract status and the number of Company ITVMs sold or leased in each of these jurisdictions as of December 31, 1997. All of the Company's existing contracts, except for the contract with the Maryland Lottery, have provisions that allow the lotteries to order additional ITVMs in the future.
Type of No. of ITVMS State Status of Contract Award Contract Sold or Leased - ----- ------------------------ -------- -------------- Arizona Awarded in October 1993; Standard Lease/ 222 renewed through June 1998, Maintenance with a six month renewal at the option of the lottery Colorado Awarded in June 1996; renewed Standard Lease/ 487
-12- 14 through June 2000 Maintenance District of Columbia Awarded December 1997; Standard Lease 10 expires December 1998 Florida Awarded September 1996 Standard Lease 500 expires June 1998 with two one-year renewals at the option of the lottery Georgia (1) Awarded in May 1993; Standard Lease/ 502 renewed through May 2003 Maintenance Idaho Purchases made by purchase Sales 185 orders in May and August 1995, August 1996 and August 1997 Indiana Awarded in July 1995; Standard Lease 690 expires in October 1997, with two one-year renewal at the option of the lottery; first renewal option has been exercised Iowa Awarded in August 1994; Standard Lease/ 531 expires in December 1998, Maintenance with two one-year renewals at the option of the lottery Kansas Awarded May 1997; expires Standard Lease 50 May 2000 with five one-year renewals at the option of the lottery Kentucky Awarded in June 1991; Sales 912 renewed through February 1998, with two subsequent one-year extensions at the option of the lottery Maine Awarded in July 1995; expires Standard Lease/ 200 in July 1998, with two one-year Maintenance extensions at the lottery's option Maryland Awarded in September 1993; Sales/Maintenance 301 expires in September 1998; additional contract awarded that expires June 2003 Minnesota Awarded in December 1996; Standard Lease/ 10 expires three years from Maintenance
-13- 15 acceptance of each ITVM, with two one-year renewals at the option of the lottery New Hampshire Awarded in August 1994; Standard Lease 250 renewed through June 2000 New Jersey (2) Purchase order received in Sales 200 December 1996 New Mexico Awarded May 1997; expires Standard Lease 200 May 2002, with five one-year renewals at the option of the lottery New York (3) Awards of purchase contracts Sales/ 2,554 made in May 1992 and January Maintenance/ January 1993; deployment Standard Lease completed in June 1992 and February 1993, respectively; initial one-year purchase and three-year maintenance contract entered into in March 1995, with a one-year renewal option by the lottery; initial five-year lease contract awarded in January 1997 for up to 1,000 units, with a one-year renewal option as mutually agreed Ohio Awarded in January Standard Lease/ 1,726 1992; extended in June 1993 and Maintenance June 1995; expired in June 1997; new contract awarded April 1997; extended through June 1999, with two two-year extensions at the option of the lottery Oregon Purchase orders issued in May Sales 520 1995 and January 1997 Rhode Island (4) Awarded in June 1994; Standard Lease/ 170 renewed through June 1998, Maintenance with one one-year renewal at the option of the lottery Texas Awarded in January 1995; Standard Lease/ 1,424 renewed through February Maintenance 1999, with a one-year renewal at the option of the lottery
-14- 16 West Virginia (3) Awarded in May 1992; Sales 55 initial deployment completed in June 1992; additional units deployed in April 1994 Barcelona, Spain (5) Awarded in February 1994; Standard Lease 11 additional units deployed in October 1995 Brazil Purchase order received in Sales 4 October 1996 Iceland Purchase orders issued in Sales 31 January and October 1997 Israel Purchase order issued in Sales 40 July 1997 Western Australia Purchase order received in Sales 8 May 1995 ------ Total Sold or Leased 11,793
- -------------------- (1) The Company's contract is for the lease of ITVMs to Scientific Games, Inc., the primary contractor for the Georgia Lottery. In September 1994, the Company and Scientific Games, Inc. agreed to convert the contract from a Percentage Lease Agreement to a Standard Lease Agreement. (2) The Company's contract is for the sale of 200 ITVMs to GTECH Corporation for use by the New Jersey Lottery, which were delivered in 1997. (3) The Company's contract was for the sale of ITVMs to Scientific Games, Inc. for use by the New York and West Virginia Lotteries. The Company is not the sole manufacturer of ITVMs for the New York Lottery. The Company entered into a sales/maintenance contract in March 1995 directly with the New York Lottery, including maintenance of ITVMs previously provided. The West Virginia Lottery also currently is conducting field tests on the Company's PTVM. (4) Effective October 1, 1995, the Company and the Rhode Island Lottery agreed to convert the contract from a Percentage Lease Agreement to a Standard Lease Agreement. (5) The Company's contract is with Entitat Autonomas, which provides lottery services to various Spanish lotteries. -------------- Substantially all of the Company's revenues are derived from its contracts with a limited number of state lottery authorities or their representatives for the lease, sale or service of ITVMs. During 1994 and 1995, contracts with the Ohio Lottery, the New York Lottery and Scientific Games, Inc. (the primary contractor for the Georgia Lottery) accounted for 83.3% and 72.9%, respectively, of the Company's revenues, and during 1996, contracts with the New York Lottery, the Ohio Lottery and the Texas Lottery -15- 17 accounted for 67.6% of the Company's revenues. During 1997, no single contract accounted for more than 20% of the Company's revenues. PCDMS Unlike the competitive bidding process applicable to the lotteries' awards of ITVM contracts, purchasers of PCDMs typically do not issue RFPs or otherwise mandate a competitive bidding process. Information regarding the Company and its PCDM, and information regarding a telephone company's product needs and criteria and other qualifications or conditions that must be satisfied, typically is exchanged on a less formal basis in sales presentations and subsequent meetings between representatives of the Company and representatives of the telephone company. Due to the often complex and highly structured organization of some telephone companies, the length of time that a company might take to decide whether to select the Company's PCDM can be difficult to predict and, similar to the lotteries' contract award process, delays in PCDM selection decisions can be frequent and unpredictable. Unlike the Company's experience in the ITVM industry in which a lottery typically enters into a lease or sales contract with the successful bidder, most purchasers of the Company's PCDMs to date have ordered PCDMs solely through purchase orders rather than contracts, although several customers entered into a lease agreement for PCDMs. Like contracts with the lotteries, however, these purchase orders may contain stringent installation, performance and service requirements. As of December 31, 1997, the Company had sold 658 PCDMs and had 37 PCDMs under lease. Manufacturing Process The manufacturing process consists of purchasing component parts, assembling the ITVMs and PCDMs and then testing the final products. Generally, the Company's machines use components which are built to Company specifications and are available from multiple sources. The Company has a strict policy of product procurement that emphasizes quality, satisfactory inventory of raw materials, and cost. The Company has a primary vendor and secondary suppliers for most of its components, and the Company typically has been able to obtain adequate supplies of required components on a timely basis from its suppliers or, when necessary, from alternative sources of supply. However, certain important components, such as components of the Company's ITVM burster and PCDM dispensing mechanisms and its bill acceptor mechanism, currently are purchased from a single source. The purchase of components from single-source suppliers subjects the Company to certain risks, including the continued availability of suppliers, price increases, potential quality assurance problems and lead time considerations. Because other suppliers exist that can duplicate these components should the Company elect or be forced to use a different supplier, the Company does not believe that any such change in suppliers would result in the termination of a production contract. However, the Company could experience a delay of 30 to 60 days in the production of machines should it elect or be forced to use other suppliers for these components. Such a delay adversely could affect the Company's ability to make timely deliveries of machines and to obtain new contracts. The single-source supplier of certain components of the Company's burster mechanism, PTVM dispensing mechanism and PCDM dispensing mechanism is Algonquin Industries, Inc. Kazmier J. Kasper, a director of the Company, is the President and owner of Algonquin Industries. See "Item 13. Certain Relationships and Related Transactions." The Company assembles the components utilizing a core group of manufacturing employees and, on an as needed basis, contracting with employment agencies for appropriately trained manufacturing labor. The use of temporary, contract manufacturing labor gives the Company the flexibility to meet the production schedules required by large orders. -16- 18 The Company's Quality Control Department has responsibility for measuring quality levels and overseeing appropriate corrective action in all areas of the business. This includes supplier performance, in-house manufacturing and field performance. The Quality Control Department is responsible for measuring part, operator and assembly quality performance at all stages of the production process, stopping the assembly line or stopping shipments if necessary to assure that quality standards are met. The Quality Control Department also is responsible for measuring vendor product quality and taking appropriate actions, including rejection and disposition of substandard material. The Quality Control Department also is responsible for vendor quality system evaluation and vendor disqualification if necessary to ensure superior product quality. The Company's manufacturing facility is located in Cincinnati, Ohio and has the capacity to produce and provide inventory for approximately 250 machines per week. The Company believes that this facility is suitable and adequate for its current and anticipated manufacturing needs at the present time. Research And New Product Development Since its inception, the Company has developed many of the technological advancements used in the ITVM industry. The Company believes that its ITVM was the first to obtain UL(R) listing and FCC approval. The Company also believes that it was the first to (i) manufacture and deliver ITVMs under a lease contract agreement, (ii) offer a "random play" push button selector option through which the ITVM rather than the player randomly selects the game to be played and (iii) receive patent protection for the technology used in its ITVM burster dispensing mechanism. The Company currently employs three engineers and two technicians for research and development but currently subcontracts the majority of its research and development projects to independent contractors to reduce costs. The Company's copyrighted software is upgraded continually to meet the different demands of the various lotteries. In many instances, after an ITVM feature has been developed for a specific lottery, it is incorporated into the product line as a standard feature of the machine. The Company retains proprietary rights in all such developments. The Company's ITVM may be purchased with an optional modem communication system which allows lotteries to gather sales data from each ITVM on an hourly, daily, weekly or monthly basis, depending on the needs of the customer. This data includes the daily or weekly sales totals and breakdown of these totals by game, including the total tickets sold. The Company has developed software to enable each ITVM equipped with the system to communicate to the host system automatically if there is a malfunction with the ITVM, thus greatly enhancing the Company's ability to provide prompt service for the ITVM. The Company has developed software to enable an ITVM equipped with the system to communicate with the host computer if a ticket bin is empty, which allows the lottery to call the retailer or agent and inform them of the situation. Additionally, by utilizing this system with the optional BETA BRITE(R) message display, the lottery can change the message display on any or all of its ITVMs. The Company has incorporated its patented pull-tab lottery ticket dispensing mechanism into a combination ITVM which also contains the Company's patented burster mechanism. The Company currently has six combination ITVMs under lease to the Iowa Lottery. The pull-tab dispensing mechanism also has been incorporated into the Company's PCDMs, and the Company believes that the ability of the mechanism to dispense a variety of thicknesses of prepaid telephone calling cards significantly differentiates the Company's PCDMs from those of its competitors. In an effort to expand its product lines into new markets, the Company is developing and testing a device which dispenses stored value "smart cards." This product may be marketed in the future to the financial services industry to the extent that consumer use of smart cards develops in the future. -17- 19 Research and development expenditures were $145,310, $665,449 and $545,039 for 1995, 1996, and 1997, respectively. The Company expects that its research and development efforts for the foreseeable future will be conducted by both Company employees and independent contractors. Customer Service and Product Repair Typically, the Company or its subcontractors install and service the machines purchased or leased by the Company's customers. The Company also provides maintenance of the ITVMs leased or sold to certain lotteries. Additionally, the Company provides part replacement, repair and technical services for various customers that have leased or purchased the Company's ITVMs and PCDMs. Service is provided to the retailers by the Company's staff of trained service technicians and dispatchers after a customer's representative informs the Company of the problem via the Company's toll-free telephone service line. The service dispatcher either resolves the matter over the telephone or immediately dispatches one of the Company's service technicians to the machine's location. The modular design and manufacturing standards of the Company's machines enable the Company to conduct any necessary repairs and maintenance quickly and efficiently. The Company estimates that meantime for all repairs is less than 15 minutes after the Company's service technician arrives at the machine's location. The Company believes, based on actual data collected from various customers that have installed the Company's ITVMs and PCDMs, that the Company's machines have experienced substantially fewer mechanical problems and machine failures than machines currently sold by other industry participants. The Company also believes that the superior performance of its ITVMs and PCDMs will assist in the increased acceptance of these products among lotteries and providers of long distance telephone service. The Company generally grants a 360-day repair or replacement warranty covering all parts and components of its machines. However, the warranty period may vary depending on the bid specifications. In certain circumstances the Company may warrant the product for the complete life of the contract. In these instances the contract generally will be a lease with the Company retaining ownership of the machine. Provisions for estimated warranty costs are recorded at the time of sale and are periodically adjusted to reflect actual experience. See Note 1 of Notes to Financial Statements contained in the Company's 1997 Annual Report, which is filed as Exhibit 13 to this report. Patents, Trademarks and Copyrights The Company currently has four U.S. patents and five pending patent application relating to its ITVMs and has filed disclosure documents with the United States Patent and Trademark Office ("PTO"), all as described below. The Company owns by assignment U.S. Patent No. 4,982,337 entitled "System for Distributing Lottery Tickets." The assignment is recorded at the PTO. This patent is for the Company's burster technology, which is the key component of the Company's ITVM. The patent expires no later than December 31, 2007. The Company believes this patent is essential to the Company's business. Additionally, the Company has developed an improvement to the burster technology disclosed in this patent and has U.S. and international patent applications pending on these improvements. The Company has developed a new system designed specifically for retail sale of lottery tickets and other items at the retail point of sale. The system utilizes the Company's burster technology and includes other modular and distributed components that can be adapted for use at the point of sale. The Company has a pending patent application at the PTO on this technology. -18- 20 The Company was issued U.S. Patent No. 5,330,185 on July 19, 1994 for the "Method and Apparatus for Random Play of Lottery Games." This patent expires no later than March 30, 2013 and has been assigned to the Company, and the assignment is recorded at the PTO. The technology disclosed in this patent allows a lottery game user to select a random play button as opposed to selecting a specific game of a multiple game ITVM. Once the random play button is pressed, the ITVM selects the game to be played based upon a random number generation algorithm, thereby adding another element of chance to the lottery ticket purchase. The Company believes that this patent gives the Company a competitive advantage over other manufacturers that do not have ITVMs with similar capabilities. The patent for the random play feature is considered important but not essential to the Company's business. The Company was issued U.S. Patent No. 5,472,247 on December 5, 1995, for a "Multi-Point High Security Locking Mechanism for Lottery Machines." This patent expires no later than July 18, 2014 and has been assigned to the Company, and the assignment is recorded at the PTO. Because of the threat of break-in and theft of cash and lottery tickets contained within the ITVMs, the machines must be secured against unauthorized break-in or theft. The technology disclosed in this patent is a locking mechanism which provides a number of resistance points, all of which function to impede the unauthorized opening of a door located on the chassis of the Company's ITVM. The patent for the multi-point, high security locking mechanism is considered important but not essential to the Company's business. The Company was issued U.S. Design Patent No. 376,621 on December 17, 1996 for the Company's double-game countertop ITVM. This patent expires no later than December 17, 2010 and has been assigned to the Company, and the assignment is recorded at the PTO. The Company believes that this patent is important but not essential to the Company's business. The Company has submitted an Information Disclosure Document to the PTO for the purpose of identifying technology relating to its "Software Release Control and Data Security for ITVMs." The technology allows secure remote transmissions of software updates and operations data between the ITVM and the Company or the respective lottery. The invention also includes a key management system to control the keys used to encrypt data sent to and decrypt the data received at the ITVM. The Disclosure Document was filed on April 28, 1993. The dispensing technology used in the Company's PTVM and PCDM was developed by Algonquin Industries, Inc. and is licensed to the Company pursuant to an exclusive license agreement with Algonquin Industries. Algonquin Industries has been granted U.S. Patent No. 5,335,822 for this mechanism. Under the terms of the license agreement, the Company is the sole entity entitled to use this technology on its ITVMs. See "Item 13. Certain Relationships and Related Transactions." The Company currently uses operating software to perform all functions required to dispense and account for instant lottery tickets and prepaid telephone calling cards. This software is a stand-alone program which does not require any other software to operate. The software is designed to allow updates to be made quickly and inexpensively. The software was designed by Future Designs, a subcontractor to the Company, and employees of the Company. Future Designs has assigned all of its right, title and interest in and to the software to the Company. The Company intends to continue to develop software using both employees and subcontractors who agree to assign the copyright to developed software to the Company. The Company has obtained federal registration in the United States of the following trademarks: INTERLOTT, INTERLOTT and design, and INSTANT SUCCESS. The Company also has obtained registration of the trademark INTERLOTT in Benelux, Hungary, Mexico and Spain. The Company does not deem the trademarks to be critical to the future of its business. -19- 21 The Company enforces a policy requiring all of its employees and subcontractors to execute confidentiality and proprietary rights agreements at the commencement of their employment or contract for service with the Company. The agreements generally provide that all inventions or discoveries and all confidential information developed or made known to the employees or subcontractors during the term of their employment or contract for service will be assigned to the Company and will be kept confidential and not disclosed to third parties. There can be no assurance that current or future patents and other intellectual property rights of the Company will afford meaningful protection of the Company's competitive position. Furthermore, the Company's competitors may have filed patent applications for, or have been issued patents relating to, products or technologies competitive with or superior to those of the Company. The scope and validity of others' patents, the extent to which the Company or its suppliers may be required to obtain licenses thereunder, and the availability and cost of any such licenses are unknown, and there is no assurance that the necessary licenses could be obtained on terms or conditions which would not have a material adverse effect upon the Company. If the Company's intellectual property rights are violated, the costs of litigation could be significant and could divert funds that otherwise would have been available for other purposes. Moreover, litigation concerning the alleged violation of intellectual property rights is inherently uncertain, and the claims and counterclaims that might be asserted against the Company, if successful, could have a material adverse effect upon the Company's financial condition and business operations. Competition Competition in the markets for the Company's ITVM and PCDM is based on a number of factors, including technological features, product quality and reliability, price, compatibility, ease of installation and use, marketing and distribution capabilities, product delivery time, and service and support. The Company is aware of four manufacturers of ITVMs and approximately forty manufacturers of PCDMs in the United States, and competition among these manufacturers is intense. Of the four ITVM competitors, the Company has the largest share of the ITVM market in the United States, followed by On-Point and two smaller manufacturers. The Company is not aware of any published data regarding market shares in the PCDM industry. The Company believes that of the forty PCDM competitors, Opal Manufacturing Co. has the largest PCDM market share in the United States, but there is no clear indication of the market shares of the remaining companies. In addition, the ITVM and PCDM markets are relatively new markets that have grown rapidly, and additional domestic and foreign manufacturers, some of which have substantially greater resources and experience than the Company, may elect to enter these markets. The instant ticket market also may face competition from other types of lottery and gaming products, including particularly on-line lottery products. The long distance telephone market similarly may face competition from other types of communications products, including facsimile, e-mail and other on-line products. The Company believes that its patented dispensing technologies make its ITVM and PCDM dispensing mechanisms technologically superior to the dispensing mechanisms of its competitors and that this is a significant competitive advantage for the Company. The Company also believes that its products have earned a strong reputation for their performance, reliability and cost effectiveness. To remain competitive, the Company believes that it will need to continue to incorporate new technological developments into its existing products and to develop new products, as well as to maintain a competitive price for its products. These efforts, together with the Company's continuing sales and marketing efforts, will be critical to the Company's future success. Although the Company believes that its current successes, coupled with its history of continued product enhancement and cost reduction, will enable it to compete favorably with its competitors, there can be no assurance that the Company will be able to maintain or improve its competitive position in the ITVM and PCDM markets. -20- 22 Government Regulation ITVMS Lotteries are not permitted in the various states and jurisdictions of the United States unless expressly authorized by legislation in the subject jurisdiction. Similarly, the commencement of ITVM sales and leasing in new jurisdictions requires authorizing legislation and implementing regulations at the state level. The Company cannot predict the nature of the regulatory process in any jurisdiction that may authorize the purchase and lease of ITVMs in the future. Any such regulatory process may be burdensome to the Company or its key personnel and stockholders and could include requirements that the Company would be unable to satisfy. Currently, 37 states and the District of Columbia have enacted legislation to allow for the operation of a lottery, and 32 of these jurisdictions utilize ITVMs in some manner as part of their instant ticket distribution process. The operation of the lotteries in each of these jurisdictions is strictly regulated. The formal rules and regulations governing lotteries vary from jurisdiction to jurisdiction but typically authorize the lottery, create the governing authority, dictate the prize structure, establish allocation of revenues, determine the type of games permitted, detail appropriate marketing structures, specify procedures for selecting vendors and define the qualifications of lottery personnel. No assurance can be given that there will not be an adverse change in the lottery laws of any jurisdiction in which the Company does business. Although the Company believes that it is unlikely that states which have enacted legislation that expressly authorize the use of ITVMs will adopt legislation in the foreseeable future that prohibits the use of ITVMs, there can be no assurance that such legislation will not be adopted in one or more jurisdictions in the foreseeable future. To ensure the integrity of the lottery, state laws provide for extensive background investigations of each of the lottery's vendors and their affiliates, subcontractors, officers, directors, employees and principal stockholders. These investigations generally require detailed disclosure on a continuous basis with respect to the vendors, affiliates, subcontractors, officers, directors, employees and principal shareholders and, in the event the lottery deems any of such persons to be unsuitable, the lottery may require the termination of such persons. The failure of any such persons associated with the Company to obtain or retain approval in any jurisdiction could have a material adverse effect on the Company. Generally, regulatory authorities have broad discretion when granting such approvals. Although the Company has never been disqualified from a lottery contract as a result of a failure to obtain any such approvals, no assurance can be given that such approvals will be obtained or retained in the future. The Federal Gambling Devices Act of 1962 (the "Act") makes it unlawful, with certain exceptions, for a person or entity to transport any gambling devices across interstate lines unless that person or entity has first registered with the United States Department of Justice. Although the Company believes that it is not required to register under such Act, the Company has voluntarily registered under the Act and intends to renew its registration annually. The Act also imposes various record keeping and equipment identification requirements. Violation of the Act may result in seizure or forfeiture of equipment, as well as other penalties. The Company may retain governmental affairs representatives in various jurisdictions of the United States to monitor legislation, advise the Company on contract proposals, and assist with other issues that may affect the Company. The Company believes it has complied with all applicable state regulatory provisions relative to disclosure concerning the activities of itself and its advisors. The Company is not dependent on any such representative for any material contract. -21- 23 International jurisdictions that operate lotteries also impose strict regulations. International regulations may vary from those in the United States. Additionally, international regulations frequently impose restrictions on foreign corporations doing business within the specific jurisdiction. As a result, the Company may contract with local representation or align itself with a local partner when pursuing international contracts. Laws and regulations of individual states and countries are subject to change. The failure to comply with such laws and regulations could have an adverse impact on the operations of the Company. PCDMs The Company is not aware of any federal, state or local regulations that apply to the manufacture, lease or sale of PCDMs. Backlog The Company's backlog of ITVMs committed for production as of December 31, 1997 was approximately $4,250,000, which was equal to the total base lease payments or sales value for the 847 ITVMs that were committed for production but had not been shipped to the Maryland and Ohio Lotteries as of December 31, 1997. See "Lottery Contracts." At December 31, 1996, the backlog of ITVMs committed for production was approximately $1,097,400, which was equal to the total base lease payments or sales value for the 460 ITVMs that were committed for production but had not been shipped to the Colorado, Indiana, New York and Texas Lotteries as of December 31, 1996. It is anticipated that substantially all of the Company's backlog at December 31, 1997 will be shipped on or before June 30, 1998. The Company had no backlog of PCDMs committed for production at December 31, 1997. The Company has entered into various lease or sales agreements that permit the lotteries, at their sole option, to lease or purchase up to a total of 1,100 additional ITVMs as of December 31, 1997. However, the Company does not include in backlog ITVMs that may be sold or leased under existing contracts unless the Company has received a firm order for the ITVMs. Due to the relatively large size of individual orders, the small number of customers and the long sales cycle of the lottery industry, management considers backlog to be an indicator of current activity and not necessarily predictive of future orders. Employees The Company utilizes a work force of full-time employees supported from time to time by temporary or contract manufacturing and engineering personnel. As of December 31, 1997, the Company had 128 full-time employees, of which 50 were manufacturing employees, 7 were engineering employees, 55 were service employees and 16 were executives or senior managers. Nine of the executives and senior managers were devoted to sales and seven were devoted to management and administration. The Company intends to increase sales and marketing personnel during 1998 through the addition of two employees, to increase engineering personnel through the addition of one employee and to increase management and administrative personnel through the addition of three employees. The Company's business requires that it continue to attract and retain additional personnel with a variety of skills, especially with engineering and marketing expertise. Significant competition exists for such personnel, and there can be no assurance that the Company will be able to attract and retain personnel with the skills and experience needed to achieve and manage growth. -22- 24 No Company employees are represented by any union, and the Company believes that its relations with its employees are good. ITEM 2. PROPERTIES The Company's manufacturing and distribution facilities currently are located in a facility containing approximately 35,000 square feet of leased space in Cincinnati, Ohio. The facility is comprised of approximately 5,000 square feet of office space and approximately 30,000 square feet of manufacturing space with the capacity to produce and provide inventory for approximately 250 machines per week. The lease is for a fixed term through December 31, 1999. Effective January 1, 1997, the Company entered into a lease for a second facility containing approximately 11,750 square feet of space located a very short distance from the current facility in Cincinnati. The second facility serves as the executive office of the Company housing the executive, administrative, sales, engineering and service personnel. The lease for the second facility also expires on December 31, 1999. The Company believes that these two facilities are suitable for and adequate to support its operations for the foreseeable future. The Company also leases approximately 1,000 square feet of warehouse and office space in Alpharetta, Georgia for the purpose of storing and repairing ITVMs used in connection with the Georgia Lottery. Scientific Games, Inc. provides this space to the Company at no cost under the terms of the Company's contract with Scientific Games. The lease is effective for the entire term of the contract, which has an initial term that expires in May 1998. See "Item 1. Business -- Contracts -- ITVMs." The Company believes that this facility is suitable for and adequate to support its operations for the Georgia Lottery. ITEM 3. LEGAL PROCEEDINGS In January 1996, the Company filed a lawsuit now pending in the United States District Court for the Southern District of Ohio against Lottery Enterprises, Inc. ("LEI," which subsequently changed its name to On-Point Technology Systems, Inc.) to collect sums that the Company alleges are owed to it under an Agreement in Principle dated March 23, 1995, relating to the Company's potential acquisition of LEI by merger (the "Transaction"). The parties did not consummate the Transaction. The Agreement in Principle required LEI to reimburse the Company's reasonable out-of-pocket expenses incurred in connection with the Transaction in the event the parties failed to execute a definitive merger agreement within 120 days of March 23, 1995, and the primary reason that the parties did not execute a definitive merger agreement was other than a breach of the Agreement in Principle by the Company. The Agreement in Principle also required LEI to pay the Company a "breakup fee" in the event that, within one year after the termination or abandonment of the Transaction by LEI, LEI entered into a binding commitment to engage in a recapitalization, debt issuance or working capital financing other than in the ordinary course of business, and the primary reason for the termination or abandonment of the Transaction was other than termination or breach of the Agreement in Principle by the Company. The Company seeks the reimbursement of approximately $241,000 in out-of-pocket expenses and a breakup fee of approximately $988,000. LEI denied any liability to the Company and also asserted counterclaims against the Company seeking unspecified money damages exceeding $500,000. LEI claimed that the Company competed unfairly with LEI and wrongfully interfered with LEI's business by misrepresenting LEI's financial condition to the Pennsylvania state lottery agency and by utilizing information about LEI received during the due diligence conducted in connection with the Transaction. LEI also claimed that it is entitled to -23- 25 recover from the Company unspecified costs and expenses that it incurred in connection with the Transaction and sought a declaration from the Court that it is not obligated to pay the Company a breakup fee under the Agreement in Principle. The Court granted partial summary judgment in the Company's favor on the Complaint, ruling that within one year after the Transaction was abandoned or terminated, LEI did enter into a recapitalization, debt issuance or working capital financing other than in the ordinary course of business. The Court left open the question whether LEI abandoned or terminated the Transaction (as opposed to the Company), which will be determined at trial. The Court also left open the question of whether LEI is obligated to reimburse the out-of-pocket expenses incurred by the Company in connection with the Transaction. The Court also has granted summary judgment in the Company's favor on LEI's counterclaims for unfair competition and tortious interference. The Company is unable to predict the likelihood of success on its remaining claims or on LEI's counterclaim. The Company is seeking approximately $240,000 in out-of-pocket expenses and $988,000 on its claim for the breakup fee, but is unable to predict how much, if any, of any judgment would be collectible. The Company also is unable to predict whether LEI will prevail on its counterclaims and, if so, the amount of damages that LEI might recover against the Company. The Company also is unable to predict the amount of any settlement that might be agreed upon by the parties in the future or the timing of any such events. However, the Company believes that LEI's remaining counterclaims are without merit and that any amount of any damages that ultimately may be awarded to LEI would not have a material adverse effect on the business, operations or financial condition of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted by the Company to a vote of its stockholders during the fourth quarter ended December 31, 1997. ITEM 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT Set forth below, in accordance with General Instruction G(3) to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K, is certain information regarding the executive officers of the Company. L. Rogers Wells, Jr., age 60, is Chairman of the Board and Chief Executive Officer of the Company and has been the principal stockholder of the Company since purchasing 80% of the Common Stock of the Company in September 1992. Mr. Wells served as a director of the Company from September 1992, and as Chairman of the Board and Chief Executive Officer of the Company from October 1993, until his resignation from these positions in October 1994. He was re-elected to these positions in February 1995. Additionally, Mr. Wells owns American Materials, Incorporated, which assembles and distributes automobile and truck components and serves as a regional warehousing and distribution center for various businesses. Mr. Wells also owns International Investments, Inc. ("III"), which invests in and provides financing to various businesses, including the Company. See "Item 13. Certain Relationships and Related Transactions." Mr. Wells has been active in various other industries, including manufacturing, mining, explosives and banking. From 1987 through 1991, Mr. Wells served as Secretary of Finance and Administration for the Commonwealth of Kentucky, and from 1989 through 1991 served as Secretary to the Governor's Executive Cabinet. During his tenure as Secretary of Finance and Administration, Mr. Wells served as Chairman of various finance and development authorities, including the Kentucky Rural Economic Development Authority, the Kentucky Infrastructure Authority and the Kentucky Housing Corporation. -24- 26 Edmund F. Turek, age 71, served as President and a director of the Company from February 1990 until May 1997 and served as Chairman of the Board and Chief Executive Officer of the Company from February 1990 to September 1992. In May 1997, Mr. Turek became Vice Chairman of the Company and continued to serve as a director. Mr. Turek began to develop the Company's ITVM in 1987 and has guided the product through six generations to the current model. Mr. Turek was Vice President of Peripheral Products in the computer division of SCI Systems, Inc. from 1984 to 1989 where he developed business opportunities in the commercial market for the design and manufacture of computer products. From 1953 to 1984, Mr. Turek held management, product development and operations positions with various companies in the computer and aerospace industries. David F. Nichols, age 36, has been President of the Company since May 1997 and was named a director in December 1997. Mr. Nichols served as Senior Vice President of Sales and Marketing of the Company from August 1994 to May 1997 and as Vice President-Operations of the Company from March 1993 until August 1994. From December 1991 to December 1992, he was Executive Director of the Board of Tax Appeals of the Commonwealth of Kentucky. From March 1990 to December 1991, he was Principal Assistant to the Secretary of Finance and Administration for the Commonwealth of Kentucky, and from March 1989 to March 1990, he was Principal Assistant to the Kentucky Office for Social Security. In these two capacities, he advised senior agency officials on policies, programs and operations of the agency and served as a liaison with the state legislature and other elected officials. From June 1988 to December 1988, he was Deputy Director of the Kentucky Democratic Party. Jerome J. Cain, age 53, has been Chief Financial Officer of the Company since 1992. From 1979 until 1991, he was Vice President-Finance and Administration of American Sign and Marketing Services, Inc., a sign manufacturing company. From 1972 to 1979, he was Controller of Lockwood Manufacturing Company, a sheet metal fabricating company. Mr. Cain also served as an auditor and management consultant with Coopers & Lybrand, certified public accountants. Mr. Cain is a certified public accountant. Thomas W. Stokes, age 34, has been Vice President of the Company since May 1997. Mr. Stokes served as Director of Operations from January 1996 to May 1997 and as Purchasing Manager from March 1993 to December 1995. From 1988 to 1992, he served as unit controller for a food management company. The executive officers of the Company are appointed by and serve at the discretion of the Board of Directors. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Information relating to the market for holders of and dividends paid on the Company's Common Stock is set forth under the caption "Corporate Data and Shareholder Information" on the inside back cover page of the Company's 1997 Annual Report. Such information is incorporated herein by reference. The 1997 Annual Report is filed as Exhibit 13 to this report. ITEM 6. SELECTED FINANCIAL DATA Selected financial data for the Company for each year of the five-year period ended December 31, 1997 are set forth under the caption "Selected Financial Data" on page 7 of the 1997 Annual Report. Such financial data are incorporated herein by reference. -25- 27 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS A discussion of the financial condition and results of operations of the Company at and for the dates and periods covered by the financial statements set forth in the 1997 Annual Report is set forth under the caption "Management's Discussion and Analysis" on pages 7 through 9 of the 1997 Annual Report. Such discussion is incorporated herein by reference. ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The following financial statements of the Company and the independent auditors' report thereon, which are set forth on pages 9 through 16 of the 1997 Annual Report, are incorporated herein by reference: Balance Sheets at December 31, 1996 and 1997 Statements of Operations for each of the years in the three-year period ended December 31, 1997 Statements of Stockholders' Equity (Deficit) for each of the years in the three-year period ended December 31, 1997 Statements of Cash Flows for each of the years in the three-year period ended December 31, 1997 Notes to Financial Statements The supplementary financial information required to be provided by Item 302 of Regulation S-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Within the two-year period ended December 31, 1997 and subsequently, the Company had no change in independent accountants or disagreements with independent accountants on accounting and financial disclosure. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information relating to the directors of the Company is set forth under the captions "Proposal 1 -- Election of Directors -- Nominees" and "Proposal 1 - -- Election of Directors -- Information Regarding Nominees and Continuing Directors" in the Company's Proxy Statement for its 1998 Annual Meeting of Stockholders to be held on May 7, 1998. Such information is incorporated herein by reference. Pursuant to Instruction 3 to Item 401(b) of Regulation S-K and General Instruction G(3) to Form 10-K, information relating to the executive officers of the Company is set forth in Part I, Item 4(A) of this report under the caption "Executive Officers of the Registrant." Information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, by directors and executive officers of the Company and beneficial owners of more than 10% of the Company's Common Stock is set forth under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement referred to in this Item 10 above. Such information is incorporated herein by reference. -26- 28 ITEM 11. EXECUTIVE COMPENSATION Information relating to executive compensation is set forth under the captions "Proposal 1 -- Election of Directors -- Director Compensation" and "Executive Compensation" in the Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information regarding ownership of the Company's Common Stock as of December 31, 1997 by certain persons is set forth under the captions "Voting -- Principal Stockholders" and "Proposal 1 -- Election of Directors -- Information Regarding Nominees and Continuing Directors" in the Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information regarding certain relationships and transactions between the Company and certain of its affiliates is set forth under the caption "Certain Transactions" in the Proxy Statement referred to in Item 10 above. Such information is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Documents Filed as Part of This Report. 1. Financial Statements The following financial statements of the Company and the independent auditors' report thereon are included in the Company's 1997 Annual Report and are incorporated by reference in Item 8 hereof: Balance Sheets at December 31, 1996 and 1997 Statements of Income for each of the years in the three-year period ended December 31, 1997 Statements of Stockholders' Equity for each of the years in the three-year period ended December 31, 1997 Statements of Cash Flows for each of the years in the three-year period ended December 31, 1997 Notes to Financial Statements 2. Financial Statement Schedules -27- 29 The following financial statement schedule and the independent auditors' report thereon are set forth beginning on page S-1 of this report: Schedule II - Valuation and Qualifying Accounts All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted because such schedules are not required under the related instructions or are inapplicable or because the information required is included in the financial statements or notes thereto. 3. Exhibits The following exhibits are filed with or incorporated by reference in this report. Where such filing is made by incorporation by reference to a previously filed registration statement or report, such registration statement or report is identified in parentheses. The Company will furnish any exhibit upon request to Jerome J. Cain, Chief Financial Officer of the Company, 10830 Millington Court, Cincinnati, Ohio 45242. There is a charge of $.50 per page to cover expenses of copying and mailing. 3.1 Certificate of Incorporation of the Company, as amended, including Certificate of Designation of Series A Preferred Stock (Exhibit 3.1 to the Company's Registration Statement on Form S-1, No. 33-75142). 3.2 Bylaws of the Company (Exhibit 3.2 to the Company's Registration Statement on Form S-1, No. 33-75142). 4.1 Promissory Note of the Company dated September 22, 1992 to Baumgartner & Brucher Radiology Associates, Inc. Profit Sharing Plan for the benefit of Thomas E. Turek, M.D. (Exhibit 4.2 to the Company's Registration Statement on Form S-1, No. 33-75142). 4.2 Promissory Note of the Company dated September 22, 1990 to Mr. Thomas Goila (Exhibit 4.3 to the Company's Registration Statement on Form S-1, No. 33-75142). 4.3 Loan Agreement dated October 29, 1997 between the Company and Mercantile Business Credit Inc. - filed herewith. 4.3(a) Revolving Credit Note dated October 29, 1997 between the Company and Mercantile Business Credit Inc. - filed herewith. 4.3(b) Security Agreement dated October 29, 1997 between the Company and Mercantile Business Credit Inc. - filed herewith. 4.3(c) Patent, Trademark and License Security Agreement dated October 29, 1997 between the Company and Mercantile Business Credit Inc. - filed herewith. 10.1 Assignment of United States Letters Patent from BLM Resources, Inc. to the Company with respect to United States Patent No. 4,982,337, "System for Distributing Lottery Tickets" (Exhibit 10.5 to the Company's Registration Statement on Form S-1, No. 33-75142). -28- 30 10.2 Pull-Tab Manufacturing and License Agreement between Algonquin Industries, Inc., Kazmier Kasper and the Company dated as of January 13, 1994 (Exhibit 10.6 to the Company's Registration Statement on Form S-1, No. 33-75142). 10.3 Lease Agreement dated January 14, 1991 by and between Gallenstein & Gallenstein and the Company related to the Company's premises located at 6665 Creek Road, Cincinnati, Ohio 45242 (Exhibit 10.7 to the Company's Registration Statement on Form S-1, No. 33-75142). 10.3(a) Addendum dated May 2, 1994 to Lease Agreement dated January 14, 1991 (Exhibit 10.7) by and between Gallenstein & Gallenstein and the Company related to the Company's premises located at 6665 Creek Road, Cincinnati, Ohio 45242 (Exhibit 10.7(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.4 Management Contracts and Compensatory Plans (a) 1994 Stock Incentive Plan (Exhibit 10.24 to the Company's Registration Statement on Form S-1, No. 33-75142). (b) 1994 Directors Stock Incentive Plan (Exhibit 10.25 to the Company's Registration Statement on Form S-1, No. 33-75142). (c) Employment Agreement effective February 1, 1995 between L. Rogers Wells, Jr. and the Company - filed herewith. 11 Statement Regarding Computation of Per Share Earnings - filed herewith. 13 1997 Annual Report - filed herewith. (1) 23 Consent of KPMG Peat Marwick LLP - filed herewith. 24 Powers of Attorney - filed herewith. 27 Financial Data Schedule (for SEC use only). (b) Reports on Form 8-K. No Current Reports on Form 8-K were filed by the Company during the quarter ended December 31, 1997. (c) See Item 14(a)(3) above. (d) See Item 14(a)(2) above. (1) Except for portions of the 1997 Annual Report that are expressly incorporated by reference into this Annual Report on Form 10-K, the 1997 Annual Report is furnished to the Commission solely for the information of the Commission and not deemed to be "filed" with the Commission for purposes of the Securities Exchange Act of 1934, as amended. -29- 31 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, on March 27, 1998. INTERLOTT TECHNOLOGIES, INC. (Registrant) By: /s/ L. Rogers Wells, Jr. ------------------------------------------------- L. Rogers Wells, Jr. Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 27, 1998.
Signature Title --------- ------ /s/ L. Rogers Wells, Jr. Chairman of the Board and Chief Executive Officer - --------------------------------------- L. Rogers Wells, Jr. /s/ Edmund F. Turek Vice Chairman and Director - --------------------------------------- Edmund F. Turek /s/ David F. Nichols President and Director - --------------------------------------- David F. Nichols John J. Wingfield* Director - --------------------------------------- John J. Wingfield /s/ H. Jean Marshall Director - --------------------------------------- H. Jean Marshall Gary S. Bell* Secretary, Treasurer and Director - --------------------------------------- Gary S. Bell Kazmier J. Kasper* Director - --------------------------------------- Kazmier J. Kasper /s/ Jerome J. Cain Chief Financial and Accounting Officer - --------------------------------------- Jerome J. Cain *By: /s/ L. Rogers Wells, Jr. ----------------------------------- L. Rogers Wells, Jr. as attorney-in-fact
-30- 32 INDEX OF FINANCIAL STATEMENT SCHEDULES
PAGE ---- Report of Independent Auditors.......................................... S-2 Schedule II - Valuation and Qualifying Accounts......................... S-3
S-1 33 [KPMG LETTERHEAD] Independent Auditor's Report The Board of Directors Interlott Technologies, Inc.: Under date of February 28, 1998, we reported on the balance sheets of Interlott Technologies, Inc. as of December 31, 1996 and 1997, and the related statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997, as contained in the 1997 annual report to stockholders. These financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1997. In connection with our audits of the aforementioned financial statements, we also audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits. In our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG PEAT MARWICK LLP Louisville, Kentucky February 28, 1998 S-2 34 INTERLOTT TECHNOLOGIES, INC. Schedule II - Valuation and Qualifying Accounts
- ------------------------------------------------------------------------------------------------------------------- COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E - ------------------------------------------------------------------------------------------------------------------- ADDITIONS - ------------------------------------------------------------------------------------------------------------------- BALANCE AT CHARGED TO CHARGED TO BALANCE AT BEGINNING COSTS AND OTHER END DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD - ------------------------------------------------------------------------------------------------------------------- Allowance for doubtful accounts - ------------------------------------------------------------------------------------------------------------------- 1995 55,150 145,000 0 98,537 101,613 - ------------------------------------------------------------------------------------------------------------------- 1996 101,613 57,500 0 43,688 115,425 - ------------------------------------------------------------------------------------------------------------------- 1997 115,425 52,500 0 74,425 93,500 - -------------------------------------------------------------------------------------------------------------------
S-3 35 INTERLOTT TECHNOLOGIES, INC. INDEX OF EXHIBITS The following exhibits are filed with or incorporated by reference in this report. Where such filing is made by incorporation by reference to a previously filed registration statement or report, such registration statement or report is identified in parenthesis.
EXHIBIT NO. DESCRIPTION PAGE - ----------- ----------- ---- 3.1 Certificate of Incorporation of the Company, as amended, including Certificate of Designation of Series A Preferred Stock (Exhibit 3.1 to the Company's Registration Statement on Form S-1, No. 33-75142). 3.2 Bylaws of the Company (Exhibit 3.2 to the Company's Registration Statement on Form S-1, No. 33-75142). 4.1 Promissory Note of the Company dated September 22, 1992 to Baumgartner & Brucher Radiology Associates, Inc. Profit Sharing Plan for the benefit of Thomas E. Turek, M.D. (Exhibit 4.2 to the Company's Registration Statement on Form S-1, No. 33-75142). 4.2 Promissory Note of the Company dated September 22, 1990 to Mr. Thomas Goila (Exhibit 4.3 to the Company's Registration Statement on Form S-1, No. 33-75142). 4.3 Loan Agreement dated October 29, 1997 between the Company and Mercantile Business Credit - filed herewith. 4.3(a) Revolving Credit Note dated October 29, 1997 between the Company and Mercantile Business Credit - filed herewith. 4.3(b) Security Agreement dated October 29, 1997 between the Company and Mercantile Business Credit - filed herewith. 4.3(c) Patent, Trademark and License Security Agreement dated October 29, 1997 between the Company and Mercantile Business Credit - filed herewith. 10.1 Assignment of United States Letters Patent from BLM Resources, Inc. to the Company with respect to United States Patent No. 4,982,337, "System for Distributing Lottery Tickets" (Exhibit 10.5 to the Company's Registration Statement on Form S-1, No. 33-75142).
E-1 36 10.2 Pull-Tab Manufacturing and License Agreement between Algonquin Industries, Inc., Kazmier Kasper and the Company dated as of January 13, 1994 (Exhibit 10.6 to the Company's Registration Statement on Form S-1, No. 33-75142). 10.3 Lease Agreement dated January 14, 1991 by and between Gallenstein & Gallenstein and the Company related to the Company's premises located at 6665 Creek Road, Cincinnati, Ohio 45242 (Exhibit 10.7 to the Company's Registration Statement on Form S-1, No. 33-75142). 10.3(a) Addendum dated May 2, 1994 to Lease Agreement dated January 14, 1991 (Exhibit 10.7) by and between Gallenstein & Gallenstein and the Company related to the Company's premises located at 6665 Creek Road, Cincinnati, Ohio 45242 (Exhibit 10.7(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1994). 10.4 Management Contracts and Compensatory Plans (a) 1994 Stock Incentive Plan (Exhibit 10.24 to the Company's Registration Statement on Form S-1, No. 33-75142). (b) 1994 Directors Stock Incentive Plan (Exhibit 10.25 to the Company's Registration Statement on Form S-1, No. 33-75142). (c) Employment Agreement effective February 1, 1995 between L. Rogers Wells and the Company - filed herewith. 11 Statement Regarding Computation of Per Share Earnings - filed herewith. 13 1997 Annual Report - filed herewith. (1) 23 Consent of KPMG Peat Marwick LLP - filed herewith. 24 Powers of Attorney - filed herewith. 27 Financial Data Schedule - (for SEC use only).
(1) Except for portions of the 1997 Annual Report that are expressly incorporated by reference into this Annual Report on Form 10-K, the 1997 Annual Report is furnished to the Commission soley for the information of the Commission and not deemed to be "filed" with the Commission for purposes of the Securities Exchange Act of 1934, as amended. E-2 EX-4.3 2 LOAN AGREEMENT BETWEEN COMPANY & MERCANTILE 1 EXHIBIT 4.3 LOAN AGREEMENT THIS LOAN AGREEMENT (this "Agreement") is made and entered into this 29th day of October, 1997, by and between INTERLOTT TECHNOLOGIES, INC., a Delaware corporation ("Borrower"), and MERCANTILE BUSINESS CREDIT INC., a Missouri corporation ("Lender"). WITNESSETH: WHEREAS, Borrower has applied for a revolving credit loan from Lender in an aggregate principal amount of up to $15,000,000.00; and WHEREAS, Lender is willing to make said revolving credit loan to Borrower upon, and subject to, the terms, provisions and conditions hereinafter set forth; NOW, THEREFORE, in consideration of the premises and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Borrower and Lender hereby mutually covenant and agree as follows: SECTION 1. DEFINITIONS. 1.01 Definitions. In addition to the terms defined elsewhere in this Agreement or in any Exhibit or Schedule hereto, when used in this Agreement, the following terms shall have the following meanings (such meanings shall be equally applicable to the singular and plural forms of the terms used, as the context requires): Account Debtor shall mean any Person who is and/or may become obligated to Borrower under or on account of any of the Accounts. Accounts shall mean all trade accounts receivable of Borrower for goods sold or services rendered by Borrower which have been invoiced by Borrower. Accounts shall not include any amounts due Borrower under or in respect of any Leases. Affiliate shall mean any Person (a) which directly or indirectly through one or more intermediaries controls, is controlled by or is under common control with Borrower or any Subsidiary, (b) which directly or indirectly through one or more intermediaries beneficially owns or holds or has the power to direct the voting power of Five Percent (5%) or more of any class of capital stock of Borrower or any Subsidiary, (c) which has Five Percent (5%) or more of any class of its capital stock (or, in the case of a Person which is not a corporation, Five Percent (5%) or more of its equity interest) beneficially owned or held, directly or indirectly, by Borrower or any Subsidiary or (d) who is a director, officer or employee of Borrower or any Subsidiary. For purposes of this definition, "control" shall mean the power to direct the management and policies of a Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise. Attorneys' Fees shall mean the reasonable value of the services (and costs, charges and expenses related thereto) of the attorneys (and all paralegals, accountants and other staff employed by such attorneys) employed by Lender from time to time (a) in connection with the negotiation, preparation, execution, delivery, amendment, modification, extension, renewal, administration and/or enforcement of this Agreement and/or any of the other Transaction Documents, (b) in connection with the preparation, negotiation or execution of any waiver or consent with respect to this Agreement or any of the other Transaction Documents, (c) in connection with any Default or Event of Default under this Agreement, (d) to represent Lender in any litigation, contest, dispute, suit or proceeding, or to commence, defend or intervene in any litigation, contest, dispute, suit or proceeding, or to file any petition, complaint, answer, motion or other pleading or to take any other action in or with respect to any litigation, contest, dispute, suit or proceeding (whether instituted by Lender, Borrower or any other Person and whether in bankruptcy or otherwise) in any way or respect relating to this Agreement or any of the other Transaction Documents, Borrower, any other Obligor, any Subsidiary, any Collateral or any Third Party Collateral, (e) to protect, collect, lease, sell, take possession of or liquidate any Collateral or any Third Party Collateral, (f) to attempt to enforce any security interest in or other Lien upon any 2 Collateral or any Third Party Collateral or to give any advice with respect to such enforcement and/or (g) to enforce any of the rights or remedies of Lender to collect any of the Borrower's Obligations. Borrower's Obligations shall mean any and all indebtedness (principal, interest, fees, collection costs and expenses, and other amounts), liabilities and obligations of Borrower to Lender evidenced by or arising under this Agreement, the Revolving Credit Note, any of the other Transaction Documents and/or any other agreement, document or instrument heretofore, now or hereafter executed and delivered by Borrower to Lender, in each case whether now existing or hereafter arising, absolute or contingent, joint and/or several, secured or unsecured, direct or indirect, expressed or implied in law, contractual or tortious, liquidated or unliquidated, at law or in equity, or otherwise, and whether created directly or acquired by Lender by assignment or otherwise, and any and all costs of collection and/or Attorneys' Fees incurred or to be incurred in connection therewith. Borrowing Base shall have the meaning ascribed thereto in Section 2.01 (b). Borrowing Base Certificate shall have the meaning ascribed thereto in Section 2.01 (c). Borrowing Notice shall have the meaning ascribed thereto in Section 2.02(a). Capital Expenditure shall mean any expenditure which, in accordance with GAAP, is required to be capitalized on the balance sheet of the Person making the same. For purposes of this Agreement, Capital Expenditures shall not include expenditures for items held for sale or lease by Borrower. Capitalized Lease shall mean any lease of Property, whether real and/or personal, by a Person as lessee which in accordance with GAAP is required to be capitalized on the balance sheet of such Person. Capitalized Lease Obligations of any Person shall mean, as of the date of any determination thereof, the amount at which the aggregate rental obligations due and to become due under all Capitalized Leases under which such Person is a lessee would be reflected as a liability on a balance sheet of such Person in accordance with GAAP. CERCLA shall mean the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act of 1986, 42 U.S.C. ss.ss. 9601 et seq., and as the same may from time to time be further amended. Change of Control Event shall mean each and every issue, sale, transfer or other disposition, directly or indirectly, of shares of capital stock of Borrower which, after giving effect thereto, results in (a) the Principal Shareholders legally or beneficially owning or controlling in the aggregate less than Thirty Percent (30%) (by number of votes) of the Voting Stock of Borrower and (b) any Person or group of Persons acting in concert (other than the Principal Shareholders) legally or beneficially owning or controlling in the aggregate more than Twenty Percent (20%) (by number of votes) of the Voting Stock of Borrower. Code shall mean the Internal Revenue Code of 1986, as amended, and any successor statute of similar import, together with the regulations thereunder, in each case as in effect from time to time. References to sections of the Code shall be construed to also refer to any successor sections. Collateral shall mean any Property or assets of Borrower which now or at any time hereafter secure the payment or performance of any of the Borrower's Obligations. Collateral Report shall have the meaning ascribed thereto in Section 3(a) of the Security Agreement. Consolidated Debt shall mean, as of the date of any determination thereof, all Debt of Borrower and its Subsidiaries as of such date (excluding any Subordinated Debt), determined on a consolidated basis and in accordance with GAAP. -2- 3 Consolidated Debt to Consolidated EBITDA Ratio shall mean, as of the last day of any fiscal quarter of Borrower, the ratio of (A) Consolidated Debt as of such day to (B) Consolidated EBITDA for the four (4) consecutive fiscal quarter period of Borrower ending on such day. Consolidated EBITDA shall mean, for the period in question, the sum of (a) Consolidated Net Income during such period plus (b) to the extent deducted in determining Consolidated Net Income, the sum of (i) Consolidated Interest Expense during such period, plus (ii) all provisions for any Federal, state, local and/or foreign income taxes made by Borrower and its Subsidiaries during such period (whether paid or deferred) plus (iii) all depreciation and amortization expenses of Borrower and its Subsidiaries during such period, all determined on a consolidated basis and in accordance with GAAP. Consolidated Interest Coverage Ratio shall mean, for the period in question, the ratio of (a) Consolidated EBITDA during such period to (b) Consolidated Interest Expense during such period, all determined on a consolidated basis and in accordance with GAAP. Consolidated Interest Expense shall mean, for the period in question, without duplication, all gross interest expense of Borrower and its Subsidiaries (including, without limitation, all commissions, discounts and/or related amortization and other fees and charges owed by Borrower and its Subsidiaries with respect to letters of credit, the net costs associated with interest swap obligations of Borrower and its Subsidiaries, capitalized interest expense, the interest portion of Capitalized Lease Obligations and the interest portion of any deferred payment obligation) during such period, all determined on a consolidated basis and in accordance with GAAP. Consolidated Net Income shall mean the after-tax net income (or loss) of Borrower and its Subsidiaries for the period in question, determined on a consolidated basis and in accordance with GAAP, but excluding from the definition of Consolidated Net Income any extraordinary gains and/or losses and any gains and/or losses from the sale or other disposition of assets other than in the ordinary course of business, all determined in accordance with GAAP. Consolidated Net Worth shall mean, as of the date of any determination thereof, the amount of the capital stock accounts (net of treasury stock, at cost and excluding the aggregate par value of all issued and outstanding shares of Series A Preferred Stock of Borrower) of Borrower and its Subsidiaries as of such date plus (or minus in the case of a deficit) the surplus and retained earnings of Borrower and its Subsidiaries as of such date, all determined on a consolidated basis and in accordance with GAAP. Consolidated Tangible Net Worth shall mean, as of the date of any determination thereof, the sum of (a) Consolidated Net Worth as of such date minus (b) the book value of all Intangible Assets of Borrower and its Subsidiaries as of such date, all determined on a consolidated basis and in accordance with GAAP. Default shall mean any event or condition the occurrence of which would, with the lapse of time or the giving of notice or both, become an Event of Default as defined in Section 6 hereof. Debt of any Person shall mean, as of the date of determination thereof, the sum of, without duplication, (a) all Indebtedness of such Person for borrowed money, plus) (b) all Indebtedness of such Person which has been incurred in connection with the purchase or other acquisition of Property or assets (other than unsecured trade accounts payable incurred in the ordinary course of business), plus (c) all Capitalized Lease Obligations of such Person plus (d) all Guarantees by such Person of Debt of others plus (e) in the case of Borrower, the aggregate par value of all issued and outstanding shares of Series A Preferred Stock of Borrower. Distribution in respect of any corporation shall mean: (a) dividends or other distributions (other than stock dividends and stock splits) on or in respect of any of the capital stock of such corporation; and (b) the redemption, repurchase or other acquisition of any capital stock of such corporation or of any warrants, rights or other options to purchase any such capital stock (except when solely in exchange for such stock). Domestic Business Day shall mean any day except a Saturday, Sunday or legal holiday observed by Lender or by commercial banks in St. Louis, Missouri. - 3 - 4 Eligible Accounts shall mean all Accounts other than: (a) Accounts which remain unpaid for more than ninety (90) days after their invoice dates and Accounts which are not due and payable within ninety (90) days after their invoice dates; (b) Accounts owing by a single Account Debtor, including a currently scheduled Account, if Twenty-Five Percent (25%) or more of the balance owing by said Account Debtor upon said Accounts is ineligible pursuant to clause (a) above; (c) Accounts with respect to which the Account Debtor is a shareholder or partner of Borrower or an Affiliate of Borrower; (d) Accounts with respect to which payment by the Account Debtor is or may be conditional and Accounts commonly known as bill and hold Accounts or Accounts of a similar or like arrangement; (e) Accounts with respect to which the Account Debtor is not a resident or citizen of or otherwise located in the United States of America, unless such Accounts are backed in full by an irrevocable letter of credit in form and substance satisfactory to Lender issued by a domestic commercial bank acceptable to Lender; (f) Accounts with respect to which the Account Debtor is the United States of America or any department, agency or instrumentality of the United States of America, unless such Accounts are duly assigned to Lender in accordance with all applicable governmental and regulatory rules and regulations (including, without limitation, the Federal Assignment of Claims Act of 1940, as amended, if applicable) so that Lender is recognized by the Account Debtor to have all of the rights of an assignee of such Accounts; (g) Accounts with respect to which the Account Debtor is any state of the United States or any department, agency or instrumentality of any state of the United States if such state or such department, agency or instrumentality is subject to or entitled to the benefits of any law, rule, regulation or ordinance which prohibits, restricts, impose conditions upon or requires notice to or consent of such state or such department, agency or instrumentality for or with respect to the assignment of, or the grant of a security interest in or lien on, any Accounts owed by such state or such department, agency or instrumentality, unless such Accounts are duly assigned to Lender in accordance with all such applicable laws, rules, regulations and ordinances so that Lender is recognized by the Account Debtor to have all of the rights of an assignee of such Accounts; (h) Accounts with respect to which Borrower is or may become liable to the Account Debtor for goods sold or services rendered by such Account Debtor to Borrower, but only to the extent of such Borrower's then aggregate liability to such Account Debtor (i.e. the excess of the aggregate face amount of Accounts of such Account Debtor over the aggregate liability of Borrower to such Account Debtor shall constitute an Eligible Account unless otherwise excepted under this definition of Eligible Accounts); (i) Accounts with respect to which the goods giving rise thereto have not been shipped and delivered to and accepted as satisfactory by the Account Debtor thereof or with respect to which the services performed giving rise thereto have not been completed and accepted as satisfactory by the Account Debtor thereof; (j) Accounts with respect to which possession and/or control of the goods sold giving rise thereto is held, maintained or retained by Borrower (or by any agent or custodian of Borrower) for the account of or subject to further and/or future direction from the Account Debtor thereof; (k) Accounts arising from a consignment sale, a "sale on approval" or a "sale or return"; (l) Accounts as to which Lender, at any time or times hereafter, determines in good faith, in -accordance with Lender's customary business practices exercised in a commercially reasonable manner, that the prospects of payment or performance by the Account Debtor is or will be impaired in any material respect; (m) Accounts of an Account Debtor to the extent, but only to the extent, that the same exceed a credit limit determined at any time or times hereafter by Lender in good faith in accordance with Lender's customary business practices exercised in a commercially reasonable manner; (n) Accounts with respect to which the Account Debtor is located in the State of New Jersey, the State of Minnesota or the State of West Virginia; provided, however, that such restriction shall not apply if Borrower (i) has filed and has effective (A) in respect of Account Debtors located in the State of New Jersey, a Notice of Business Activities Report with the State of New Jersey Division of Taxation for the then current year, (B) in respect of Account Debtors located in the State of Minnesota, a Minnesota Business Activity Report with the Minnesota Department of Revenue for the then current year or (C) in respect of Account Debtors located in the State of West Virginia, a West Virginia Business Activity Report with the West Virginia Department of Tax and Revenue for the then current year, as applicable, or (ii) is otherwise exempt from such reporting requirements under the laws of such State(s); and (o) Accounts which are not subject to a first priority perfected security interest in favor of Lender. Eligible Inventorv shall mean all Inventory of Borrower which consists of raw materials or finished goods (specifically excluding any Inventory of Borrower which consists of work-in-process) other than: (a) any Inventory which is Subject to Lease or has ever been Subject to Lease (this clause (a) shall not exclude Inventory which was but is not currently Subject to Lease and which has been reconditioned and put into Borrower's parts Inventory); (b) any Inventory which is obsolete; (c) any Inventory which Lender has in good faith determined, in accordance with Lender's customary business practices exercised in a commercially - 4 - 5 reasonable manner, is unacceptable due to age, type, category, quality and/or quantity; (d) any inventory which is not located in the continental United States of America; (e) any Inventory which is not located at the chief executive office of Borrower, one of the locations listed on Exhibit A to the Security Agreement or another location with respect to which Borrower has complied with all of the requirements of Section 2(h) of the Security Agreement; and (f) any Inventory which is not subject to a first priority perfected security interest in favor of Lender. Eligible Lease shall mean a Lease which (a) is a lease of one or more instant lottery vending machines, prepaid phone card dispensing machines and/or smart card dispensing machines (and not a maintenance-only contract) which are located in the United States of America and (b) as of the applicable date of determination, meets all of the following requirements: (i) the lessee under such Lease is (A) the United States of America or any state of the United States or any department, agency or instrumentality of any of the foregoing or (B) a Person who is a resident or citizen of or otherwise located in the United States of America and whose creditworthiness is reasonably acceptable to Lender (as determined from time to time by Lender); (ii) no payment due Borrower under such Lease (other than disputed payments aggregating less than $50,000.00) is more than (A) one hundred twenty (120) days past due if the lessee under such Lease is the United States of America or any state of the United States or any department, agency or instrumentality of any of the foregoing or (B) ninety (90) days past due if the lessee under such Lease is not the United States of America or a state of the United States or a department, agency or instrumentality of any of the foregoing; (iii) no other default or event of default under such Lease has been declared by Borrower or the applicable lessee(s); (iv) the lessee(s) under such Lease have not asserted any defenses, claims, counterclaims or set-offs against Borrower under or in respect of such Lease which, individually or in the aggregate, involve an amount in excess of $50,000.00; (v) it arises from a bona fide lease of the instant lottery vending machines, prepaid phone card dispensing machines and/or smart card dispensing machines covered thereby, is the legal, valid, binding and enforceable obligation of the lessee(s) thereunder and is in full force and effect and has not been terminated; (vi) such Lease complies with all applicable Federal, state and local laws, rules and regulations; (vii) such Lease is not subject to any defenses, claims, counterclaims or set-offs against Lender, including, without limitation, those resulting from acts or omissions of Borrower or its agents, which, individually or in the aggregate, involve an amount in excess of $50,000.00; (viii) such Lease (or an independent instrument executed by the applicable lessees)) expressly provides that all amounts (whether for rent or otherwise) from time to time payable to Borrower under such Lease are assignable by Borrower to Lender consistent with the terms of the Security Agreement (provided, however, that in order to permit Borrower time to obtain such consents, this clause (viii) shall not apply during the period commencing on the date of this Agreement and ending January 28, 1998); (ix) the Lease, the payments thereunder and the related Inventory are not subject to any security interest or other Lien except in favor of Lender under the Security Agreement; and (x) Borrower holds good title to the Lease and the payments due thereunder, Lender has a perfected security interest in such Lease and all payments due thereunder and the perfected security interest of Lender in such Lease and the payments due thereunder is a first priority security interest. Eligible Lease Payments shall mean, with respect to each Eligible Lease, as of any date, the aggregate minimum base rental payments (excluding any percentage rental payments) due or to become due under such Eligible Lease for instant lottery vending machines, prepaid phone card dispensing machines and/or smart card dispensing machines delivered to and accepted by the lessee(s) under such Eligible Lease on or prior to such date during the shorter of (a) the period commencing on such date and ending eighteen (18) months thereafter and (b) the remaining term of such Lease (determined without giving effect to any renewal or extension terms exercisable at the option of the lessee(s) which have not been exercised by such lessee(s)). Environmental Claim shall mean any administrative, regulatory or judicial action, judgment, order, consent decree, suit, demand, demand letter, claim, Lien, notice of noncompliance or violation, investigation or other proceeding arising (a) pursuant to any Environmental Law or governmental or regulatory approval issued under any such Environmental Law, (b) from the presence, use, generation, storage, treatment, Release, threatened Release, disposal, remediation or other existence of any Hazardous Substance, (c) from any removal, remedial, corrective or other response action pursuant to an Environmental Law or the order of any governmental or regulatory authority or agency, (d) from any third party seeking damages, contribution, indemnification, cost recovery, compensation, injunctive or other relief in connection with a Hazardous Substance or arising from alleged injury or threat of injury to health, safety, natural resources or the - 5 - 6 environment or (e) from any Lien against any Property owned, leased or operated by Borrower or any Subsidiary in favor of any governmental or regulatory authority or agency in connection with a Release, threatened Release or disposal of a Hazardous Substance. Environmental Law shall mean any international, Federal, state or local statute, law, rule, regulation, order, consent decree, judgment, permit, license, code, covenant, deed restriction, common law, treaty, convention, ordinance or other requirement relating to public health, safety or the environment, including, without limitation, those relating to Releases, discharges or emissions to air, water, land or groundwater, to the withdrawal or use of groundwater, to the use and handling of polychlorinated biphenyls or asbestos, to the disposal, treatment, storage or management of hazardous or solid waste, Hazardous Substances or crude oil, or any fraction thereof, to exposure to toxic or hazardous materials, to the handling, transportation, discharge or release of gaseous or liquid Hazardous Substances and any rule, regulation, order, notice or demand issued pursuant to such law, statute or ordinance, in each case applicable to any of the Property owned, leased or operated by Borrower or any Subsidiary or the operation, construction or modification of any such Property, including, without limitation, the following: CERCLA, the Solid Waste Disposal Act, as amended by the Resource Conservation and Recovery Act of 1976 and the Hazardous and Solid Waste Amendments of 1984, the Hazardous Materials Transportation Act, as amended, the Federal Water Pollution Control Act, as amended by the Clean Water Act of 1976, the Safe Drinking Water Control Act, the Clean Air Act of 1966, as amended, the Toxic Substances Control Act of 1976, the Occupational Safety and Health Act of 1970, as amended, the Emergency Planning and Community Right-to-Know Act of 1986, the National Environmental Policy Act of 1975, the Oil Pollution Act of 1990 and any similar or implementing state or local law, and any state or local statute and any further amendments to these laws providing for financial responsibility for cleanup or other actions with respect to the Release or threatened Release of Hazardous Substances or crude oil, or any fraction thereof and all rules, regulations, guidance documents and publication promulgated thereunder. ERISA shall mean the Employee Retirement Income Security Act of 1974, as amended, and any successor statute of similar import, together with the regulations thereunder, in each case as in effect from time to time. References to sections of ERISA shall be construed to also refer to any successor sections; ERISA Affiliate shall mean any corporation, trade or business that is, along with Borrower or any Subsidiary, a member of a controlled group of corporations or a controlled group of trades or businesses, as described in Sections 414(b) and 414(c), respectively, of the Code or Section 4001 of ERISA. Eurodollar Business Day shall mean any Domestic Business Day on which commercial banks are open for international business (including dealings in dollar deposits) in London. Event of Default shall have the meaning ascribed thereto in Section 6. Exchange Act shall mean the Securities Exchange Act of 1934, as amended. GAAP shall mean generally accepted accounting principles at the time in the United States. Guarantee by any Person shall mean any obligation (other than endorsements of negotiable instruments for deposit or collection in the ordinary course of business), contingent or otherwise, of such Person guaranteeing, or in effect guaranteeing, any Indebtedness, liability, dividend or other obligation of any other Person (the "primary obliger") in any manner, whether directly or indirectly, including, without limitation, all obligations incurred through an agreement, contingent or otherwise, by such Person: (a) to purchase such Indebtedness or obligation or any Property or assets constituting security therefor, (b) to advance or supply funds (i) for the purchase or payment of such Indebtedness or obligation, (ii) to maintain working capital or other balance sheet condition or otherwise to advance or make available funds for the purchase or payment of such Indebtedness or obligation, (iii) to lease property or to purchase securities or other property or services primarily for the purpose of assuring the owner of such Indebtedness or obligation of the ability of the primary obliger to make payment of the Indebtedness or obligation or (iv) otherwise to assure the owner of the Indebtedness or obligation of the primary obliger against loss in respect thereof. For the purposes of all computations made under this Agreement, a Guarantee in respect of any Indebtedness for borrowed money - 6 - 7 shall be deemed to be Indebtedness equal to the then outstanding principal amount of such Indebtedness for borrowed money which has been guaranteed or such lesser amount to which the maximum exposure of the guarantor shall have been specifically limited, and a Guarantee in respect of any other obligation or liability or any dividend shall be deemed to be Indebtedness equal to the maximum aggregate amount of such obligation, liability or dividend or such lesser amount to which the maximum exposure of the guarantor shall have been specifically limited. Guarantee when used as a verb shall have a correlative meaning. Hazardous Substance shall mean any hazardous or toxic material, substance or waste, pollutant or contaminant which is regulated under any Environmental Law or any other statute, law, ordinance, rule or regulation of any local, state, regional, Federal or international authority having jurisdiction over any of the Property owned, leased or operated by Borrower or any Subsidiary or its use, including, without limitation, any material, substance or waste which is: (a) defined as a hazardous substance under Section 311 of the Federal Water Pollution Control Act (33 U.S.C. ss.ss.1317), as amended; (b) regulated as a hazardous waste under Section 1004 or Section 3001 of the Federal Solid Waste Disposal Act, as amended by the Resource Conservation and Recovery Act (42 U.S.C. ss. ss.6901 et seq.), as amended; (c) defined as a hazardous substance under Section 101 of the Comprehensive Environmental Response, Compensation and Liability Act (42 U.S.C. ss. ss.9601 et seq.), as amended; or (d) defined or regulated as a hazardous substance or hazardous waste under any rules or regulations promulgated under any of the foregoing statutes. Indebtedness shall mean, with respect to any Person, without duplication, all indebtedness, liabilities and obligations of such Person which in accordance with GAAP are required to be classified upon a balance sheet of such Person as liabilities of such Person, and in any event shall include all (a) obligations of such Person for borrowed money or which have been incurred in connection with the purchase or other acquisition of Property or assets, (b) obligations secured by any Lien on, or payable out of the proceeds of or production from, any Property or assets owned by such Person, whether or not such Person has assumed or become liable for the payment of such obligations, (c) indebtedness, liabilities and obligations of third parties, including joint ventures and partnerships of which such Person is a venturer or general partner, recourse to which may be had against such Person, (d) obligations created or arising under any conditional sale or other title retention agreement with respect to Property acquired by such Person, notwithstanding the fact that the rights and remedies of the seller, lender or lessor under such agreement in the event of default are limited to repossession or sale of such Property, (e) Capitalized Lease Obligations of such Person, (f) indebtedness, liabilities and obligations of such Person under Guarantees and (f) unpaid reimbursement obligations of such Person with respect to letters of credit issued for the account of such Person. Intangible Assets shall mean all patents, trademarks, service marks, copyrights, trade names, goodwill (including any amounts, however designated, representing the cost of acquisition of business and investments in excess of the book value thereof), prepaid expenses, deferred tax assets (net of any deferred tax liabilities), unamortized debt discount and expense, unamortized deferred charges, deferred research and development costs, any write-up of asset value after the date of this Agreement, non-competition covenants, signing bonuses and any other assets treated as intangible assets under GAAP. Interest Period shall mean with respect to each LIBOR Loan: (a) initially, the period commencing on the date of such Revolving Credit Loan and ending one (1), two (2) or three (3) months thereafter (or such other period agreed upon in writing by Borrower and Lender), as Borrower may elect in the applicable Borrowing Notice; and (b) thereafter, each period commencing on the last day of the immediately preceding Interest Period applicable to such Revolving Credit Loan and ending one (1), two (2) or three (3) months thereafter (or such other period agreed upon in writing by Borrower and Lender), as Borrower may elect pursuant to Section 2.04; provided that: (c) subject to clauses (d) and (e) below, any Interest Period which would otherwise end on a day which is not a Eurodollar Business Day shall be extended to the next succeeding Eurodollar - 7 - 8 Business Day unless such Eurodollar Business Day falls in another calendar month, in which case such Interest Period shall end on the immediately preceding Eurodollar Business Day; (d) subject to clause (e) below, any Interest Period which begins on the last Eurodollar Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such Interest Period) shall end on the last Eurodollar Business Day of a calendar month; and (e) no Interest Period shall extend beyond the last day of the Revolving Credit Period. Inventory shall mean all personal property owned by Borrower and held for sale or lease, valued at the lower of cost or market in accordance with GAAP. Investment shall mean any investment by Borrower or any Subsidiary in any Person, whether payment therefor is made in cash or capital stock of Borrower or any Subsidiary, and whether such investment is by acquisition of stock or Indebtedness, or by loan, advance, transfer of property out of the ordinary course of business, capital contribution, equity or profit sharing interest, extension of credit on terms other than those normal in the ordinary course of business or otherwise. Lease shall mean a lease agreement entered into by Borrower, as lessor, in the ordinary course of business with a Person who is not an Affiliate of Borrower or any Subsidiary. Lease Payments shall mean all rents and other sums payable to or receivable by Borrower from the lessee(s) under or pursuant to the provisions of the Leases, whether as rent, late fees, interest, casualty payments, indemnity payments, liquidated or unliquidated damages or otherwise. Lender's Revolving Credit Commitment shall mean the sum of $15,000,000.00. Letter of Credit shall mean each commercial and/or standby letter of credit issued for the account of Borrower with respect to which Lender has agreed to indemnify the issuer of such letter of credit in accordance with Section 2.06 of this Agreement; and Letters of Credit shall mean all of the foregoing. LIBOR Base Rate shall mean, with respect to the applicable Interest Period, (a) the LIBOR Index Rate for such Interest Period, if such rate is available or (b) if the LIBOR Index Rate cannot be determined, the average (rounded upward, if necessary, to the next higher 1/100 of 1%) of the respective rates per annum of interest at which deposits in dollars are offered to Mercantile Bank National Association (or its successor) in the London interbank market by two (2) Eurodollar dealers of recognized standing, selected by Mercantile Bank National Association (or its successor) in its sole discretion, at such time on the date two (2) Eurodollar Business Days before the first day of such Interest Period as Mercantile Bank National Association (or its successor) in its sole discretion elects, for delivery on the first day of the applicable Interest Period for a number of days comparable to the number of days in such Interest Period and in an amount approximately equal to the principal amount of the LIBOR Loan to which such Interest Period is to apply. LIBOR Index Rate shall mean, with respect to the applicable Interest Period, the rate per annum (rounded upwards, if necessary, to the next higher 1/100 of 1%) for deposits in U.S. Dollars for a period equal to such Interest Period, which appears on the Telerate Page 3750 as of 9:00 a.m. (St. Louis time) on the day two (2) Eurodollar Business Days before the commencement of such Interest Period. LIBOR Loan shall mean any Revolving Credit Loan bearing interest at the LIBOR Rate. LIBOR Margin shall mean Two Percent (2%) per annum. LIBOR Rate shall mean (a) the quotient of the (i) LIBOR Base Rate divided by (ii) one minus the applicable LIBOR Reserve Percentage plus (b) the LIBOR Margin. The LIBOR Rate shall be adjusted automatically on and as of the effective date of any change in the LIBOR Reserve Percentage. - 8 - 9 LIBOR Reserve Percentage shall mean for any day that percentage (expressed as a decimal) which is in effect on such day, as prescribed by the Board of Governors of the Federal Reserve System (or any successor), for determining the maximum reserve requirement for a member bank of the Federal Reserve System in St. Louis, Missouri with respect to "Eurocurrency liabilities" (or in respect of any other category of liabilities which includes deposits by reference to which the interest rate on LIBOR Loans is determined or any category of extensions of credit or other assets which include loans by a non-United States office of Mercantile Bank National Association (or its successor) to United States residents). Lien shall mean any interest in Property securing an obligation owed to, or a claim by, a Person other than the owner of the Property, whether such interest is based on common law, statute or contract, including, without limitation, any security interest, mortgage, deed of trust, pledge, hypothecation, judgment lien or other lien or encumbrance of any kind or nature whatsoever, any conditional sale or trust receipt, any lease, consignment or bailment for security purposes and any Capitalized Lease. The term "Lien" shall include reservations, exceptions, encroachments, easements, rights-of-way, covenants, conditions, restrictions, leases and other title exceptions and encumbrances affecting Property. Material Adverse Effect shall mean (a) a material adverse effect on the Properties, assets, liabilities, business, operations, prospects, income or condition (financial or otherwise) of Borrower and its Subsidiaries taken as a whole, (b) material impairment of Borrower's ability to perform any of its obligations under this Agreement, the Revolving Credit Note or any of the other Transaction Documents or (c) material impairment of the enforceability of the rights of, or benefits available to, Lender under this Agreement, the Revolving Credit Note or any of the other Transaction Documents. Moody's shall mean Moody's Investors Service, Inc. Multi-Employer Plan shall mean a "multi-employer plan" as defined in Section 4001(a)(3) of ERISA which is maintained for employees of Borrower, any Subsidiary or any ERISA Affiliate or to which Borrower, any Subsidiary or any ERISA Affiliate has contributed in the past or currently contributes. Obligor shall mean Borrower and each other Person who is or shall at any time hereafter become primarily or secondarily liable on any of the Borrower's Obligations or who grants Lender a Lien upon any of the Property or assets of such Person as security for any of the Borrower's Obligations; provided, however, that neither an Account Debtor on an Account nor a lessee under a Lease shall be deemed to be an Obligor solely because such Person is such an Account Debtor or lessee. Occupational Safety and Health Laws shall mean the Occupational Safety and Health Act of 1970, as amended, and any other Federal, state or local statute, law, ordinance, code, rule, regulation, order or decree regulating, relating to or imposing liability or standards of conduct concerning employee health and/or safety, as now or at any time hereafter in effect. Patent, Trademark and License Security Agreement shall mean that certain Patent, Trademark and License Security Agreement dated the date hereof and executed by Borrower in favor of Lender, as the same may from time to time be amended, modified, extended or renewed. PBGC shall mean the Pension Benefit Guaranty Corporation and any entity succeeding to any or all of its functions under ERISA. Pension Plan shall mean a "pension plan," as such term is defined in Section 3(2) of ERISA, which is established or maintained by Borrower, any Subsidiary or any ERISA Affiliate, other than a Multi-Employer Plan. Permitted Liens shall mean any of the following: (a) Liens on Property or assets of a Subsidiary to secure obligations of such Subsidiary to Borrower; - 9 - 10 (b) Liens for property taxes and assessments or governmental charges or levies and Liens securing claims or demands of mechanics and materialmen, provided payment thereof is not at the time required by Section 5.01(d) and/or 5.01(e); (c) Liens (other than any Liens imposed by ERISA) incidental to the conduct of business or the ownership of Properties and assets (including Liens in connection with worker's compensation, unemployment insurance and other like laws, warehousemen's and attorneys' liens and statutory landlords' liens) and Liens to secure the performance of bids, tenders or trade contracts, or to secure statutory obligations, surety or appeal bonds or other Liens of like general nature incurred in the ordinary course of business and not in connection with the borrowing of money or the purchase or other acquisition of Property; provided in each case the obligation secured is not overdue or, if overdue, is being contested in good faith by appropriate actions or proceedings being diligently conducted and for which adequate reserves in accordance with GAAP have been set aside; (d) minor survey exceptions or minor encumbrances, easements or reservations, or rights of others for rights-of-way, utilities and other similar purposes, or zoning or other restrictions as to the use of real properties, which are necessary or desirable for the conduct of the activities of Borrower and its Subsidiaries or which customarily exist on properties of corporations engaged in similar activities and similarly situated and which do not in any event materially impair the use of such real properties in the operation of the business of the Borrower and its Subsidiaries; (e) Liens existing as of the date of this Agreement and listed on Schedule 4.12 attached hereto; (f) purchase money Liens granted to a Person financing a Capital Expenditure permitted by Section 5.02(m) of this Agreement so long as (i) the Lien granted is limited to the specific fixed assets acquired and the proceeds thereof, (ii) the aggregate principal amount of Debt secured by the Lien is not more than the acquisition cost of the specific fixed assets on which the Lien is granted and (iii) the transaction does not violate any other provision of this Agreement; (g) Capitalized Leases permitted by Section 5.02(m) of this Agreement; and (h) the rights of a lessee under a Lease to the Inventory subject to such Lease. Person shall mean any individual, sole proprietorship, partnership, joint venture, limited liability company, trust, unincorporated organization, association, corporation, institution, entity or government (whether national, Federal, state, county, city, municipal or otherwise, including, without limitation, any instrumentality, division, agency, body or department thereof). Prime Loan shall mean any Revolving Credit Loan bearing interest at the Prime Rate. Prime Rate shall mean the interest rate announced from time to time by Mercantile Bank National Association (or its successor) as its "prime rate" (which rate shall fluctuate as and when said prime rate shall change). Borrower acknowledges that such "prime rate" is a reference rate and does not necessarily represent the lowest or best rate offered by Lender or Mercantile Bank National Association to its customers. Principal Shareholders shall mean and include (a) L. Rogers Wells, (b) the spouses, lineal descendants and spouses of the lineal descendants of one or more of the individuals listed in clause (a) above, (c) the estates of one or more of the individuals listed in clauses (a) or (b) above and (d) trusts established solely for the benefit of one or more of the individuals listed in clauses (a) or (b) above. Property shall mean any interest in any kind of property or asset, whether real, personal or mixed, or tangible or intangible. Properties shall mean the plural of Property. For purposes of this Agreement, Borrower and each Subsidiary shall be deemed to be the owner of any Property which it has acquired or holds subject to a conditional sale agreement, financing lease or other arrangement pursuant to which title to the Property has been retained by or vested in some other Person for security purposes. - 10 - 11 Rate of Dilution of Borrower's Accounts shall mean the value of all non-cash credits to Borrower's Accounts (including, without limitation, bad debt expense) during the twelve (12) month period immediately preceding the date of calculation divided by Borrower's sales during said period. The Rate of Dilution shall be calculated by Lender in connection with each of its collateral examinations of the Borrower's Accounts (which calculation shall be conclusive in the absence of manifest error), and the Rate of Dilution as so calculated by Lender shall be and remain the applicable Rate of Dilution until the next collateral examination is performed by Lender. If the Rate of Dilution at the time of any calculation thereof has increased or decreased from the prior calculation thereof, then Lender shall adjust the advance rate for Accounts used in the Borrowing Base accordingly. RCRA shall mean the Solid Waste Disposal Act, as amended by the Resource Conservation and Recovery Act of 1976 and Hazardous and Solid Waste Amendments of 1984, 42 U.S.C. SS.SS. 6901 et seq., and any future amendments. Regulation D shall mean Regulation D of the Board of Governors of the Federal Reserve System, as amended. Regulatory Change shall mean if (a) Regulation D or (b) after the date hereof, the adoption of any applicable law, rule or regulation, or any change therein, or any change in the interpretation or administration thereof by any governmental or regulatory authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by Lender with any request or directive (whether or not having the force of law) of any such governmental or regulatory authority, central bank or comparable agency shall (i) subject Lender to any tax, duty or other charge with respect to any of the LIBOR Loans, the Revolving Credit Note or Lender's obligation to make, maintain or fund any of the LIBOR Loans, or shall change the basis of taxation of payments to Lender of the principal of or interest on any of the LIBOR Loans or any other amounts due under this Agreement in respect of any of the LIBOR Loans or its obligation to make, maintain or fund any of the LIBOR Loans (except for taxes on or changes in the rate of tax on the overall net income of Lender) or (ii) impose, modify or deem applicable any reserve (including, without limitation, any reserve imposed by the Board of Governors of the Federal Reserve System), special deposit, capital or similar requirement against assets of, deposits with or for the account of, or credit extended or committed to be extended by, Lender or shall, with respect to Lender or the London interbank market, impose, modify or deem applicable any other condition affecting any of the LIBOR Loans, the Revolving Credit Note or Lender's obligation to make, maintain or fund any of the LIBOR Loans. Release shall mean any spilling, leaking, pumping, pouring, emitting, emptying, discharging, injecting, escaping, leaching, dumping or disposing into the environment, including, without limitation, the abandonment or discarding of barrels, drums, containers, tanks and/or other receptacles containing (or containing traces of) any Hazardous Substance. Reportable Event shall have the meaning given to such term in ERISA. Restricted Investment shall mean any Investment, or any expenditure or any incurrence of any liability to make any expenditure for an Investment, other than: (a) loans and/or advances by any Subsidiary to Borrower which are subordinated in writing to the payment of the Borrower's Obligations in form and substance satisfactory to Lender; (b) direct obligations of the United States of America or any instrumentality or agency thereof, the payment of which is unconditionally guaranteed by the United States of America or any instrumentality or agency thereof (all of which Investments must mature within twelve (12) months from the time of acquisition thereof); (c) Investments in readily marketable commercial paper which, at the time of acquisition thereof by Borrower or any Subsidiary, is rated A-1 or better by S&P and P-1 or better by Moody's and which matures within 270 days from the date of acquisition thereof, provided that the issuer of such - 11 - 12 commercial paper shall, at the time of acquisition of such commercial paper, have a senior long-term debt rating of at least A by S&P and Moody's; (d) negotiable certificates of deposit or negotiable bankers acceptances issued by Mercantile Bank National Association or any other bank or trust company organized under the laws of the United States of America or any state thereof, which bank or trust company (other than Mercantile Bank National Association to which such restrictions shall not apply) is a member of both the Federal Deposit Insurance Corporation and the Federal Reserve System and is rated B or better by Thompsons Bank Watch Service (all of which Investments must mature within twelve (12) months from the time of acquisition thereof); (e) repurchase agreements, which shall be collateralized for at least 102% of face value, issued by Mercantile Bank National Association or any other bank or trust company organized under the laws of the United States or any state thereof, which bank or trust company (other than Mercantile Bank National Association to which such restrictions shall not apply) is a member of both the Federal Deposit Insurance Corporation and the Federal Reserve System and is rated B or better by Thompsons Bank Watch Service (all of which Investments must mature within twelve (12) months from the time of acquisition thereof); (f) Investments existing as of the date hereof as described in Schedule 4.18 attached hereto, and any future retained earnings in respect thereof; and (g) loans or advances in the usual and ordinary course of business to officers and/or employees of Borrower or a Subsidiary for business expenses in the aggregate principal amount of up to $25,000.00 at any one time outstanding. Revolving Credit Loan and Revolving Credit Loans shall have the meanings ascribed thereto in Section 2.01 (a). Revolving Credit Note shall have the meaning ascribed thereto in Section 2.03. Revolving Credit Period shall mean the period commencing on the date of this Agreement and ending October 29, 2000; provided, however, that notwithstanding the foregoing, (a) so long as no Default or Event of Default under this Agreement has occurred and is then continuing, the Revolving Credit Period shall be automatically extended for subsequent successive one (1) year periods unless Borrower or Lender provides written notice to the other at least sixty (60) days prior to the expiration of the then current period that it does not wish to extend the Revolving Credit Period (in which event the Revolving Credit Period shall expire at the end of the then current period) and (b) the Revolving Credit Period shall end on the date of the termination of this Agreement by Borrower or Lender (Lender may terminate this Agreement prior to the end of the Revolving Credit Agreement only if an Event of Default under this Agreement has occurred and is continuing). S&P shall mean Standard and Poor's Ratings Group. Security Agreement shall mean that certain Security Agreement dated the date hereof and executed by Borrower in favor of Lender, as the same may from time to time be amended, modified, extended or renewed. Subject To Lease shall mean, with respect to any Inventory, that such Inventory has been delivered to a lessee by Borrower, and accepted by such lessee, under the terms of a Lease. Subordinated Debt shall mean, as of the date of any determination thereof, the aggregate principal amount of all Debt of Borrower outstanding as of such date which is subordinated in writing (either by its terms or pursuant to a subordination agreement) to the payment and priority of all of the Borrower's Obligations in form and substance satisfactory to Lender. - 12 - 13 Subsidiary shall mean any corporation of which more than Fifty Percent (50%) of the issued and outstanding capital stock entitled to vote for the election of directors (other than by reason of default in the payment of dividends) is at the time owned directly or indirectly by Borrower or any Subsidiary. Telerate Page 3750 shall mean the display designated as "Page 3750" on the Telerate Service (or such other page as may replace Page 3750 on that service or such other service as may be nominated by the British Bankers' Association as the information vendor for the purpose of displaying British Bankers' Association Interest Settlement Rates for U.S. Dollar Deposits). Third Party Collateral shall mean any Property or assets of any Obligor other than Borrower which now or at any time hereafter secure the payment or performance of any of the Borrower's Obligations. Total Revolving Credit Outstandings shall mean, as of any date, the sum of (a) the aggregate principal amount of all Revolving Credit Loans outstanding as of such date, plus (b) the aggregate undrawn face amount of all Letters of Credit outstanding as of such date. Transaction Documents shall mean this Agreement, the Revolving Credit Note, the Security Agreement, the Patent, Trademark and License Security Agreement and all other agreements, documents and instruments heretofore, now or hereafter delivered to Lender with respect to or in connection with or pursuant to this Agreement, any Revolving Credit Loans made hereunder or any of the other Borrower's Obligations, and executed by or on behalf of Borrower, all as the same may from time to time be amended, modified, extended or renewed. Unused Availability shall mean, as of any date, the sum of (a) the lesser of (i) the Lender's Revolving Credit Commitment as of such date or (ii) the Borrowing Base as of such date minus (b) the Total Revolving Credit Outstandings as of such date. Voting Stock shall mean, with respect to any corporation, any shares of stock of such corporation whose holders are entitled under ordinary circumstances to vote for the election of directors of such corporation (irrespective of whether at the time stock of any other class or classes shall have or might have voting power by reason of the happening of any contingency). Welfare Plan shall mean a "welfare plan" as such term is defined in Section 3(1) of ERISA, which is established or maintained by Borrower, any Subsidiary or any ERISA Affiliate, other than a Multi-Employer Plan. 1.02 Accounting Terms and Determinations. Except as otherwise specified in this Agreement, all accounting terms used in this Agreement shall be interpreted, all accounting determinations under this Agreement shall be made and all financial statements required to be delivered under this Agreement shall be prepared in accordance with GAAP as in effect from time to time, applied on a basis consistent (except for changes approved by Lender and by Borrower's independent certified public accountants) with the most recent audited financial statements of Borrower delivered to Lender. SECTION 2. THE REVOLVING CREDIT LOANS. 2.01 Revolving Credit Loans. (a) Subject to the terms and conditions of this Agreement, during the Revolving Credit Period of this Agreement, and so long as no Default or Event of Default under this Agreement has occurred and is continuing, Lender hereby agrees to make such loans (individually, a "Revolving Credit Loan" and collectively, the "Revolving Credit Loans") to Borrower as Borrower may from time to time request pursuant to Section 2.02(a) or 2.02(b). Each Revolving Credit Loan under this Section 2.01 (a) which is a LIBOR Loan shall be for an aggregate principal amount of at least $1,000,000.00 or any larger multiple of $1,000,000.00. The aggregate principal amount of Revolving Credit Loans which Lender shall be required to have outstanding under this Agreement at any one time shall not exceed the sum of (i) the lesser of (A) the Lender's Revolving Credit Commitment or (B) the Borrowing Base minus (ii) the aggregate undrawn face amount of all outstanding Letters of Credit. Subject to the terms and conditions of this Agreement, Borrower may borrow, repay and reborrow - 13 - 14 such sums from Lender, provided, however, that in no event may the Total Revolving Credit Outstandings on any given day exceed the lesser of (a) the Lender's Revolving Credit Commitment as of such day or (b) the Borrowing Base as of such day. All Revolving Credit Loans not paid prior to the last day of the Revolving Credit Period, together with all accrued and unpaid interest thereon, shall be due and payable on the last day of the Revolving Credit Period. (b) For purposes of this Agreement, the "Borrowing Base" shall mean the sum of: (i) (A) Eighty-Five Percent (85%) if the Rate of Dilution of Borrower's Accounts is less than or equal to Five Percent (5%), (B) Eighty Percent (80%) if the Rate of Dilution of Borrower's Accounts is greater than Five Percent (5%) but less than or equal to Eight Percent (8%), (C) Seventy-Five Percent (75%) if the Rate of Dilution of Borrower's Accounts is greater than Eight Percent (8%) but less than or equal to Ten Percent (10%) or (D) such percentage as Lender may determine in its sole and absolute discretion if the Rate of Dilution of Borrower's Accounts is greater than Ten Percent (10%), of the face amount of all then existing Eligible Accounts (less maximum discounts, credits and allowances which may be taken by or granted to Account Debtors in connection therewith and/or adjustments for reserves and allowances deemed appropriate by Lender in its good faith discretion exercised in accordance with its customary business practices and in a commercially reasonable manner to protect Lender with respect to the repayment of the Borrower's Obligations); plus (ii) the lesser of (A) Fifty Percent (50%) of the Eligible Inventory of Borrower, valued at the lower of cost or market in accordance with GAAP or (B) $2,500,000.00; plus (iii) Sixty-Five Percent (65%) of the aggregate amount of all Eligible Lease Payments of Borrower; provided, however, that in no event may the aggregate amount of all Eligible Lease Payments of Borrower which are due from lessees who are not the United States of America or a state of the United States or a department, agency or instrumentality of any of the foregoing exceed the sum of $500,000.00. Notwithstanding any provision contained in this Section 2.01 (b) to the contrary, Lender may at any time and from time to time, in its sole and absolute discretion, loan to Borrower more than the above stated percentage of Eligible Accounts, more than the above stated percentage of the value of Eligible Inventory and/or more than the above stated percentage of Eligible Lease Payments, without notice to Borrower; provided, however, that no such over-advance shall establish a custom or course of dealing or entitle Borrower to any subsequent over-advance under the same or different circumstances. Lender reserves the right at any time and from time to time in its good faith discretion, exercised in a commercially reasonable manner to protect Lender with respect to the repayment of the Borrower's Obligations, to increase or decrease the percentage advance rates on Eligible Accounts, Eligible Inventory and/or Eligible Lease Payments specified in this Section 2.01(b) upon seven (7) days' prior written notice to Borrower. (c) Borrower shall deliver to Lender on the date of execution of this Agreement (calculated as of August 31, 1997) and on the first (1st) day of each month thereafter during the Revolving Credit Period (provided, however, that if any Default or Event of Default under this Agreement occurs or if the Unused Availability of Borrower is ever less than $ 1,500,000.00, Borrower shall deliver such Borrowing Base Certificates to Lender on at least one (1) Domestic Business Day during each week (or at such other intervals as Lender shall require from time to time)), a borrowing base certificate in the form of Exhibit A attached hereto and incorporated herein by reference (or in such other form as Lender shall require from time to time) (each, a "Borrowing Base Certificate") setting forth: (i) the Borrowing Base and its components as of the end of the immediately preceding Domestic Business Day; (ii) the aggregate principal amount of all Revolving Credit Loans outstanding as of the end of the immediately preceding Domestic Business Day; - 14 - 15 (iii) the aggregate undrawn face amount of all Letters of Credit outstanding as of the end of the immediately preceding Domestic Business Day; and (iv) the difference, if any, between the Borrowing Base and the sum of the Total Revolving Credit Outstandings as of the end of the immediately preceding Domestic Business Day. The Borrowing Base shown in such Borrowing Base Certificate (subject to adjustment for collections of Accounts received by Lender since the date of such Borrowing Base Certificate) shall be and remain the Borrowing Base hereunder until the next Borrowing Base Certificate is delivered to Lender, at which time the Borrowing Base shall be the amount shown in such subsequent Borrowing Base Certificate. Each Borrowing Base Certificate shall be certified as to truth and accuracy by the chairman, chief executive officer, president, chief financial officer or chief accounting officer of Borrower. Borrower shall have the right to submit Borrowing Base Certificates to Lender more frequently than from time to time required by Lender. (d) If at any time the Total Revolving Credit Outstandings are greater than the Borrowing Base as shown on the most recent Borrowing Base Certificate, Borrower shall be required to, upon oral or written demand by Lender, immediately repay the Revolving Credit Loans and/or surrender for cancellation the outstanding Letters of Credit, in either case in an amount sufficient to reduce the amount of the Total Revolving Credit Outstandings to the amount of the Borrowing Base. (e) Borrower may not have outstanding and Lender shall not be obligated to make more than ten (10) LIBOR Loans at any one time. 2.02 Procedure for Borrowing. (a) Borrower shall give oral or written notice (a "Borrowing Notice") to Lender by 10:00 a.m. (St. Louis time) on the Domestic Business Day of each Prime Loan, and by 10:00 a.m. (St. Louis Time) at least three (3) Eurodollar Business Days before each LIBOR Loan, specifying: (i) the date of such Revolving Credit Loan, which shall be a Domestic Business Day in the case of a Prime Loan and a Eurodollar Business Day in the case of a LIBOR Loan, (ii) the aggregate principal amount of such Revolving Credit Loan, (iii) whether such Revolving Credit Loan is to be a Prime Loan or a LIBOR Loan, and (iv) in the case of a LIBOR Loan, the duration of the initial Interest Period applicable thereto, subject to the provisions of the definition of Interest Period. (b) In addition to Revolving Credit Loans requested by Borrower pursuant to Section 2.02(a) above, Borrower hereby irrevocably requests and authorizes Lender, without any other request or authorization from Borrower and without any notice to Borrower, to automatically make a Prime Loan to Borrower at the end of each Domestic Business Day on which any checks are presented for payment on Borrower's controlled disbursement account (Account No. 1005008600) at Mercantile Bank National Association (the "Controlled Disbursement Accounts), by crediting the amount of such Prime Loan, which shall be in an amount equal to the aggregate amount of all checks presented for payment on the Controlled Disbursement Account on such Domestic Business Day, to the Controlled Disbursement Account. Notwithstanding the foregoing, Borrower acknowledges and agrees that Lender has no obligation to make any Revolving Credit Loan requested under this Section 2.02(b) if (i) after giving effect to such Revolving Credit Loan the Total Revolving Credit Outstandings would be greater than the lesser of (A) the Lender's Revolving Credit Commitment or (B) the Borrowing Base or (ii) any applicable condition set forth in Section 3 has not been satisfied. (c) A Borrowing Notice for a LIBOR Loan shall not be revocable by Borrower. (d) Subject to the terms and conditions of this Agreement, provided that Lender has received the Borrowing Notice, Lender shall (unless any applicable condition specified in Section 3 has not been satisfied) make any Revolving Credit Loan requested by Borrower pursuant to Section 2.02(a) above to Borrower by crediting the amount of such Revolving Credit Loan to an account of Borrower at Mercantile Bank National - 15 - 16 Association or such other bank as may from time to time be acceptable to Lender, not later than 2:30 p.m. (St. Louis time) on the Domestic Business Day or Eurodollar Business Day, as the case may be, specified in said Borrowing Notice. (e) If Lender makes a new Revolving Credit Loan hereunder on a day on which Borrower is required to or has elected to repay all or any part of an outstanding Revolving Credit Loan, Lender shall apply the proceeds of the new Revolving Credit Loan to make such repayment and only an amount equal to the difference (if any) between the amount being borrowed and the amount being repaid shall be made available by Lender to Borrower as provided in subsection Id) of this Section, or remitted by Borrower to Lender as provided in Section 2.11, as the case may be. (f) Borrower hereby irrevocably authorizes Lender to rely on telephonic, telegraphic, telecopy, telex or written instructions of any individual identifying himself or herself as one of the individuals listed on Schedule 2.02(f) attached hereto (or any other individual from time to time authorized to act on behalf of Borrower pursuant to a resolution adopted by the Board of Directors of Borrower and certified by the Secretary of Borrower and delivered to Lender) with respect to any request to make a Revolving Credit Loan or a repayment hereunder, and on any signature which Lender believes to be genuine, and Borrower shall be bound thereby in the same manner as if such person were actually authorized or such signature were genuine. Borrower also hereby agrees to indemnify Lender and hold Lender harmless from and against any and all claims, demands, damages, liabilities, losses, costs and expenses (including, without limitation, reasonable attorneys' fees and expenses) relating to or arising out of or in connection with the acceptance of instructions for making Revolving Credit Loans or repayments hereunder. 2.03 Revolving Credit Note. (a) The Revolving Credit Loans of Lender to Borrower shall be evidenced by a Revolving Credit Note of Borrower dated the date hereof and payable to the order of Lender in the principal amount of $15,000,000.00, which Revolving Credit Note shall be in substantially the form of Exhibit B attached hereto and incorporated herein by reference (as the same may from time to time be amended, modified extended or renewed, the "Revolving Credit Note"). (b) Lender shall record in its books and records the date, amount, type and maturity of each Revolving Credit Loan made by it and the date and amount of each payment of principal and/or interest made by Borrower with respect thereto. The books and records of Lender showing the account between Lender and Borrower shall be admissible in evidence in any action or proceeding and shall, absent manifest error, constitute prima facie proof of the items therein set forth. 2.04 Duration of Interest Periods and Selection of Interest Rates. (a) The duration of the initial Interest Period for each LIBOR Loan shall be as specified in the applicable Borrowing Notice. Borrower shall elect the duration of each subsequent Interest Period applicable to such LIBOR Loan and the interest rate to be applicable during such subsequent Interest Period (and Borrower shall have the option (i) in the case of any Prime Loan, to elect that such Revolving Credit Loan become a LIBOR Loan and the Interest Period to be applicable thereto, and (ii) in the case of any LIBOR Loan, to elect that such Revolving Credit Loan become a Prime Loan), by giving notice of such election to Lender by 10:00 a.m. (St. Louis time) on the Domestic Business Day of, in the case of the election of the Prime Rate, and by 10:00 a.m. (St. Louis time) at least three (3) Eurodollar Business Days before, in the case of the election of the LIBOR Rate, the end of the immediately preceding Interest Period applicable thereto, if any; provided, however, that notwithstanding the foregoing, in addition to and without limiting the rights and remedies of Lender under Section 6 hereof, so long as any Default or Event of Default under this Agreement has occurred and is continuing, Borrower shall not be permitted to renew any LIBOR Loan as a LIBOR Loan or to convert any Prime Loan into a LIBOR Loan. (b) If Lender does not receive a notice of election for a Revolving Credit Loan pursuant to Section 2.04(a) above within the applicable time limits specified therein, Borrower shall be deemed to have elected to pay such Revolving Credit Loan in whole pursuant to Section 2.10 on the last day of the current Interest Period with respect thereto and to reborrow the principal amount of such Revolving Credit Loan on such date as a Prime Loan. - 16 - 17 2.05 Interest Rates. (a) So long as no Event of Default under this Agreement has been declared by Lender and is continuing, each Prime Loan shall bear interest prior to maturity at a rate per annum equal to the Prime Rate (fluctuating as and when the Prime Rate shall change). So long as any Event of Default under this Agreement has been declared by Lender and is continuing, each Prime Loan shall bear interest prior to maturity at a rate per annum equal to Four Percent (4%) over and above the Prime Rate (fluctuating as and when the Prime Rate shall change). Interest on Prime Loans shall be payable monthly in arrears on the first (1st) day of each month, commencing on the first such date after such Prime Loan is made, and at the maturity of the Revolving Credit Note, whether by reason of acceleration or otherwise. From and after the maturity of the Revolving Credit Note, whether by reason of acceleration or otherwise, each Prime Loan shall bear interest payable on demand until paid at a rate per annum equal to Four Percent (4%) over and above the Prime Rate (fluctuating as and when the Prime Rate shall change). (b) So long as no Event of Default under this Agreement has been declared by Lender and is continuing, each LIBOR Loan shall bear interest on the outstanding principal amount thereof for each Interest Period applicable thereto at a rate per annum equal to the applicable LIBOR Rate. So long as any Event of Default under this Agreement has been declared by Lender and is continuing, each LIBOR Loan shall bear interest on the outstanding principal amount thereof for each Interest Period applicable thereto at a rate per annum equal to Four Percent (4%) over and above the applicable LIBOR Rate. Interest on the LIBOR Loans shall be payable for each Interest Period on the last day thereof and at the maturity of the Revolving Credit Note, whether by reason of acceleration or otherwise. From and after the maturity of the Revolving Credit Note, whether by reason of acceleration or otherwise, each LIBOR Loan shall bear interest payable on demand until paid at a rate per annum equal to Four Percent (4%) over and above the Prime Rate (fluctuating as and when the Prime Rate shall change). (c) Subject to and in accordance with the provisions of this Agreement, Lender shall determine the interest rate applicable to each Revolving Credit Loan hereunder and its determination thereof shall be conclusive in the absence of manifest error. 2.06 Letters of Credit. Lender may, in its sole and absolute discretion, provide indemnification for the payment of letters of credit issued at the request and for the account of the Borrower by financial institutions acceptable to Lender. No Letter of Credit shall have a term extending beyond the last day of the Revolving Credit Period. In no event may (a) the aggregate undrawn face amount of all outstanding Letters of Credit exceed the sum of $500,000.00 or (b) the Total Revolving Credit Outstandings exceed the lesser of (i) the Lender's Revolving Credit Commitment or (ii) the Borrowing Base. In consideration of Lender's indemnification with respect to such Letter(s) of Credit, Borrower hereby agrees to pay Lender a nonrefundable indemnity fee at the rate of Two and One-Half Percent (2-1/2%) per annum on the aggregate undrawn face amount of all Letters of Credit which are outstanding for the account of Borrower, which indemnity fee shall be (i) computed on a daily basis, (ii) payable monthly in arrears on the first (1st) day of each month and (iii) calculated on an actual day, 360-day year basis. Said indemnity fee shall be in addition to any fees charged by the issuers of such Letters of Credit. In the event of any payment by Lender on or in respect of its indemnity obligations with respect to a Letter of Credit, Borrower agrees to pay Lender in immediately available funds at the time of such payment an amount equal to the amount of such payment. In the event any payment is made by Lender on or in respect of its indemnity obligations with respect to a Letter of Credit prior to Lender's receipt of payment from Borrower, such payment by Lender shall constitute a request by Borrower for a Revolving Credit Loan under Section 2.01 (a) above (and Lender may make such Revolving Credit Loan to Borrower regardless of whether such Revolving Credit Loan would otherwise be permitted under the requirements of Sections 2.01 of this Agreement) and the proceeds of such Revolving Credit Loan shall be retained by Lender and applied by Lender to the payment of any amounts owed by Borrower to Lender under this Section 2.06. Notwithstanding any provision contained in this Agreement to the contrary: (a) if any Letters of Credit remain outstanding on the last day of the Revolving Credit Period or, if earlier, the date of the termination of this Agreement, Borrower shall, on or before 12:00 noon (St. Louis time) on the last day of the Revolving Credit Period or, if earlier, the date of the termination of this Agreement, (i) surrender the originals of the applicable Letter(s) of Credit to Lender for cancellation or (ii) provide Lender with cash collateral (or other collateral acceptable to Lender in its sole and absolute discretion) in an amount at least equal to the aggregate - 17 - 18 undrawn face amount of all Letter(s) of Credit which remain outstanding at such time and execute and deliver to Lender such agreements as Lender may require to grant Lender a first priority perfected security interest in such cash or other collateral; and (b) upon the occurrence of any Event of Default under this Agreement (including, without limitation, Borrower's failure to comply with the requirements of clause (a) above), at Lender's option and without demand or further notice to Borrower, an amount equal to the aggregate undrawn face amount of all Letter(s) of Credit then outstanding shall be deemed (as between Lender and Borrower) to have been paid or disbursed by Lender under its indemnity obligations to the issuing bank(s) (notwithstanding that such amounts may not in fact have been so paid or disbursed by Lender), and a Revolving Credit Loan to Borrower in such amount to have been made and accepted by Borrower, which Revolving Credit Loan shall be immediately due and payable. In lieu of the foregoing, at the election of Lender, Borrower shall, upon Lender's demand, (i) deliver to Lender cash, or other collateral acceptable to Lender in its sole and absolute discretion, having a value, as determined by Lender, at least equal to aggregate undrawn face amount of all outstanding Letters of Credit and (ii) execute and deliver to Lender such agreements as Lender may require to grant Lender a first priority perfected security interest in such cash or other collateral. Any such collateral and/or any amounts received by Lender in payment of the Revolving Credit Loan made pursuant to this Section 2.06 shall be held by Lender in a separate account at Mercantile Bank National Association (or its successor) appropriately designated as a cash collateral account in relation to this Agreement and the Letters of Credit and retained by Lender as collateral security for the payment of the Borrower's Obligations. Cash amounts delivered to Lender pursuant to the foregoing requirements of this Section 2.06 shall be invested, at the request and for the account of Borrower, in investments of a type and nature and with a term acceptable to Lender. Such amounts, including in the case of cash amounts invested in the manner set forth above, any investment realized thereon, may, at Lender's option, be applied by Lender to reimburse Lender for any amounts paid by Lender in respect of its indemnity obligations with respect to the Letters of Credit, or if no such indemnity payments are required to the payment of such other of the Borrower's Obligations as Lender shall determine. Any amounts remaining in any cash collateral account established pursuant to this Section 2.06 after the payment in full of all of the Borrower's Obligations and the expiration or cancellation of all of the Letters of Credit shall be returned to Borrower (after deduction of Lender's reasonable expenses, if any). 2.07 Method of Making Interest and Other Payments; Application of Payments. Lender may, at its option, deem interest and other amounts payable under this Agreement (other than the principal balance of the Revolving Credit Loans) to be paid by causing a Revolving Credit Loan to be made to Borrower in such amount(s). Solely for the purpose of calculating interest earned by Lender, payment by or for the account of Borrower shall be applied by the Lender on account of the Borrower's Obligations on the first (1st) Domestic Business Day after a deposit of funds is made in the amount of that payment in Lender's operating account at Mercantile Bank National Association or to such other operating account at such other financial institution as Lender shall designate. Deposits received after 3:00 p.m. (St. Louis time) shall be deemed to have been received or deposited on the following Domestic Business Day. 2.08 Fees. (a) Borrower hereby agrees to pay Lender a nonrefundable commitment fee in the amount of $25,000.00 prior to or contemporaneously with the execution of this Agreement, receipt of which fee is hereby acknowledged by Bank. (b) Borrower hereby agrees to pay Lender a nonrefundable origination fee in the amount of $75,000.00 contemporaneously with the execution of this Agreement. (c) Borrower hereby agrees to pay Lender a nonrefundable anniversary fee in the amount of $15,000.00 on each October 29 during the Revolving Credit Period commencing October 29, 1998. (d) During the Revolving Credit Period, Borrower hereby agrees to pay Lender a minimum monthly fee of $30,000.00 (the "Minimum Monthly Fee"), which Minimum Monthly Fee shall be reduced by the aggregate amount of accrued interest actually paid by Borrower with respect to the Revolving Credit Loans during such month and which Minimum Monthly Fee shall be payable monthly in arrears on the first (1st) day of each month commencing December 1, 1997, and on the last day of the Revolving Credit Period. - 18 - 19 (e) Borrower hereby agrees to pay Lender a quarterly collateral examination fee in the amount of $2,500.00 payable on the date hereof and every three (3) months thereafter during the Revolving Credit Period. In addition to said quarterly collateral examination fee, Borrower hereby agrees to reimburse Lender upon demand for any reasonable out-of-pocket costs and expenses incurred by Lender in connection with any collateral examination conducted by Lender (Lender agrees that the maximum amount of such out-of-pocket costs and expenses for which it will seek reimbursement from Borrower will not exceed the sum of $1,000.00 per collateral examination or $4,000.00 per calendar year so long as no Default or Event of Default under this Agreement has occurred and is continuing). (f) If Borrower fails to make any payment of any principal of or interest on any Revolving Credit Loan within ten (10) days after the date the same shall become due and payable, whether by reason of maturity, acceleration or otherwise, in addition to all of the other rights and remedies of Lender under this Agreement and at law or in equity, Borrower shall pay Lender on demand with respect to each such late payment a late fee in an amount equal to the greater of $100.00 or Five Percent (5%) of the amount of each such late payment. 2.09 Early Termination and Early Termination Fee. Borrower may elect to terminate this Agreement at any time. Borrower hereby agrees that in the event that Lender or Borrower elects to terminate this Agreement (including, without limitation, any termination by Lender as a result of the occurrence of an Event of Default under this Agreement), Borrower will pay to Lender the total of the following: (a) any amount of interest accrued through the date of termination with respect to the outstanding Borrower's Obligations; and (b) the outstanding Borrower's Obligations. 2.10 Early Payments. (a) Borrower may, upon notice to Lender specifying that it is paying the Prime Loans, prepay without penalty or premium the Prime Loans in whole or in part at any time or from time to time by paying the principal amount to be paid. (b) Borrower may, upon at least one (1) Eurodollar Business Day's prior notice to Lender specifying that it is paying the LIBOR Loans, prepay any or all of its LIBOR Loans in whole, or in part in amounts aggregating $1,000,000.00 or any larger multiple of $1,000,000.00, by paying the principal amount to be paid together with all accrued and unpaid interest thereon to and including the date of payment and any funding losses and other amounts payable under Section 2.12; provided, however, that in no event may Borrower make a partial payment of LIBOR Loans which results in the total outstanding LIBOR Loans with respect to which a given Interest Period applies being greater than $0.00 but less than $1,000,000.00. (c) A notice of payment pursuant to this Section shall not be revocable by Borrower. 2.11 General Provisions as to Payments. Borrower shall make each payment of principal of, and interest on, the Revolving Credit Loans and of fees and all other amounts payable by Borrower under this Section 2, not later than 3:00 p.m. (St. Louis time) on the date when due to Lender at its address referred to in Section 7.07. Any such payment received by Lender after 3:00 p.m. (St. Louis time) shall be deemed to have been paid on the next succeeding Domestic Business Day. Whenever any payment of principal of, or interest on, the Revolving Credit Loans or of fees shall be due on a day which is not a Domestic Business Day, the date for payment thereof shall be extended to the next succeeding Domestic Business Day. If the date for any payment of principal is extended by operation of law or otherwise, interest thereon, at the then applicable rate, shall be payable for such extended time. 2.12 Funding Losses. Notwithstanding any provision contained in this Agreement to the contrary, if Borrower makes any payment of principal with respect to any LIBOR Loan Pursuant to Sections 2 or 6 or otherwise) on any day other than the last day of an Interest Period applicable thereto, or if Borrower fails to borrow or pay any LIBOR Loan after notice has been given to Lender in accordance with Sections 2.02, 2.04 or 2.10(b) by Borrower, Borrower shall reimburse Lender on demand for any resulting losses and expenses incurred by it, including, without limitation, any losses incurred in obtaining, liquidating or employing deposits from third parties and any loss of margin for the period after any such payment, provided that Lender shall - 19 - 20 have delivered to Borrower a certificate as to the amount of such losses and expenses, which certificate shall be conclusive in the absence of manifest error. 2.13 Basis for Determining Interest Rate Inadequate or Unfair. If with respect to any Interest Period: (i) deposits in dollars (in the applicable amounts) are not being offered to Lender in the relevant market for such Interest Period, or (ii) the LIBOR Rate as determined by Lender in good faith will not adequately and fairly reflect the cost to Lender of maintaining or funding the LIBOR Loans for such Interest Period, Lender shall forthwith give notice thereof to Borrower, whereupon until the circumstances giving rise to such suspension no longer exist, (a) the obligations of Lender to make LIBOR Loans shall be suspended and (b) Borrower shall repay in full the then outstanding principal amount of each of the LIBOR Loans together with all accrued and unpaid interest thereon, on the last day of the then current Interest Period applicable to such Revolving Credit Loan. Concurrently with repaying each such LIBOR Loan pursuant to this Section, Borrower may borrow a Prime Loan in an equal principal amount from Lender, and, if Borrower so elects, Lender shall make such a Prime Loan to Borrower. 2.14 Illegality. If, after the date of this Agreement, the adoption of any applicable law, rule or regulation, or any change therein, or any change in the interpretation or administration thereof by any governmental or regulatory authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by Lender with any request or directive (whether or not having the force of law) of any such governmental or regulatory authority, central bank or comparable agency shall make it unlawful or impossible for Lender to make, maintain or fund its LIBOR Loans to Borrower, Lender shall so notify Borrower. Upon receipt of such notice, Borrower shall repay in full the then outstanding principal amount of each of the LIBOR Loans, together with all accrued and unpaid interest thereon to the date of prepayment and any funding losses and other amounts due under Section 2.12, on either (a) the last day of the then current Interest Period applicable to such LIBOR Loan if Lender may lawfully continue to maintain and fund the LIBOR Loans to such day or (b) immediately if Lender may not lawfully continue to fund and maintain the LIBOR Loans to such day. Concurrently with repaying each LIBOR Loan, Borrower may borrow a Prime Loan in an equal principal amount from Lender, and, if Borrower so elects, Lender shall make such a Prime Loan to Borrower. 2.15 Increased Cost. (a) If any Regulatory Change occurs and the result of any such Regulatory Change is to increase the cost to (or in the case of Regulation D, to impose a cost on or increase the cost to) Lender of making, maintaining or funding any LIBOR Loan, or to reduce the amount of any sum received or receivable by Lender under this Agreement or under the Revolving Credit Note with respect thereto, by an amount deemed by Lender, in its good faith judgment, to be material, and if Lender is not otherwise fully compensated for such increase in cost or reduction in amount received or receivable by virtue of the inclusion of the reference to "LIBOR Reserve Percentage" in the calculation of the interest rate applicable to LIBOR Loans, then, within fifteen (15) days after notice by Lender to Borrower together with a copy of the official notice of the applicable change in law (if applicable) and a work sheet showing how the increase in cost or reduction in amount received or receivable was calculated, Borrower shall pay Lender, as additional interest, such additional amount or amounts as will compensate Lender for such increased cost or reduction. Lender will promptly notify Borrower of any event of which it has knowledge, occurring after the date hereof, which will entitle Lender to compensation pursuant to this Section. The determination by Lender under this Section of the additional amount or amounts to be paid to it hereunder shall be conclusive in the absence of manifest error. In determining such amount or amounts, Lender may use any reasonable averaging and attribution methods. (b) If Lender demands compensation under this Section, Borrower may at any time, upon at least two (2) Domestic Business Days' prior notice to Lender, repay in full its then outstanding LIBOR Loans from Lender, together with all accrued and unpaid interest thereon to the date of prepayment and any funding losses and other amounts due under Section 2.12. Concurrently with repaying such LIBOR Loans, Borrower may borrow from Lender a Prime Loan in an amount equal to the aggregate principal amount of such LIBOR Loans, and, if Borrower so elects, Lender shall make such a Prime Loan to Borrower. - 20 - 21 2.16 Prime Loans Substituted for Affected LIBOR Loans. If notice has been given by Lender pursuant to Sections 2.13 or 2.14 or by Borrower pursuant to Section 2.15 requiring the LIBOR Loans to be repaid, then, unless and until the circumstances giving rise to such repayment no longer apply, all Revolving Credit Loans which would otherwise be made by Lender to Borrower as LIBOR Loans shall be made instead as Prime Loans. Lender shall promptly notify Borrower if and when the circumstances giving rise to such repayment no longer apply. 2.17 Capital Adequacy. If Lender shall have determined in good faith that the adoption after the date of this Agreement of any applicable law, rule, regulation or guideline regarding capital adequacy, or any change therein, or any change after the date of this Agreement in the interpretation or administration thereof by any governmental or regulatory authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by Lender with any request or directive regarding capital adequacy (whether or not having the force of law) of any such authority, central bank or comparable agency, has or will have the effect of reducing the rate of return on Lender's capital in respect of its obligations under this Agreement with respect to the Revolving Credit Loans to a level below that which Lender could have achieved but for such adoption, change or compliance (taking into consideration Lender's policies with respect to capital adequacy), then from time to time Borrower shall pay to Lender upon demand such additional amount or amounts as will compensate Lender for such reduction. All determinations made in good faith by Lender of the additional amount or amounts required to compensate Lender in respect of the foregoing shall be conclusive in the absence of manifest error. In determining such amount or amounts, Lender may use any reasonable averaging and attribution methods. 2.18 Survival of Indemnities. All indemnities and all provisions relating to reimbursement to Lender of amounts sufficient to protect the yield to Lender with respect to the Revolving Credit Loans, including, without limitation, Sections 2.12, 2.13, 2.14, 2.15 and 2.17 hereof, shall survive the payment of the Revolving Credit Loans and the other Borrower's Obligations and the termination of this Agreement. 2.19 Discretion of Lender as to Manner of Funding. Notwithstanding any provision contained in this Agreement to the contrary, Lender shall be entitled to fund and maintain its funding of all or any part of the LIBOR Loans in any manner it elects, it being understood, however, that for purposes of this Agreement all determinations hereunder (including, without limitation, the determination of Lender's funding losses and expenses under Section 2.12) shall be made as if Lender had actually funded and maintained each LIBOR Loan through the purchase of deposits having a maturity corresponding to the maturity of the applicable Interest Period relating to the applicable LIBOR Loan and bearing an interest rate equal to the applicable LIBOR Rate. 2.20 Computation of Interest. Interest on Prime Loans hereunder shall be computed on the basis of a year of 360 days and paid for the actual number of days elapsed (including the first day but excluding the last day). Interest on LIBOR Loans shall be computed on the basis of a year of 360 days and paid for the actual number of days elapsed, calculated as to each Interest Period from and including the first day thereof to but excluding the last day thereof. SECTION 3. PRECONDITIONS TO REVOLVING CREDIT LOANS. 3.01 Initial Revolving Credit Loan. Notwithstanding any provision contained in this Agreement to the contrary, Lender shall have no obligation to make the initial Revolving Credit Loan under this Agreement unless Lender shall have first received: (a) this Agreement and the Revolving Credit Note, each executed by a duly authorized officer of Borrower; (b) the Security Agreement (which must be in form and substance satisfactory to Lender) and such Uniform Commercial Code financing statements and other documents as Lender may require in connection therewith, each executed by a duly authorized officer of Borrower; - 21 - 22 (c) the Patent, Trademark and License Security Agreement (which must be in form and substance satisfactory to Lender) and such Uniform Commercial Code financing statements and other documents as Lender may require in connection therewith, each executed by a duly authorized officer of Borrower; (d) a copy of resolutions of the Board of Directors of Borrower, duly adopted, which authorize the execution, delivery and performance of this Agreement, the Revolving Credit Note and the other Transaction Documents, certified by the Secretary of Borrower; (e) a copy of the Certificate of Incorporation of Borrower, including any amendments thereto, certified by the Secretary of State of the State of Delaware; (f) a copy of the By-Laws of Borrower, including any amendments thereto, certified by the Secretary of Borrower; (g) an incumbency certificate, executed by the Secretary of Borrower, which shall identify by name and title and bear the signatures of all of the officers of Borrower executing any of the Transaction Documents; (h) certificates of corporate good standing of Borrower issued by the Secretaries of State of the States of Delaware and Ohio; (i) an opinion of counsel of Taft, Stettinius & Hollister, outside counsel to Borrower, in form and substance satisfactory to Lender and Lender's counsel; (j) the initial Borrowing Base Certificate required by Section 2.01(c) and the initial Collateral Report required by Section 3(a) of the Security Agreement; (k) the Borrowing Notice required by Section 2.02(a), if applicable; and (l) evidence of the proper filing of UCC-1 Financing Statements perfecting first priority security interests in favor of Lender in all of the Collateral; (m) UCC-3 Termination Statements for all UCC-1 Financing Statements filed of record against Borrower other than UCC-1 Financing Statements relating to Permitted Liens; (n) evidence satisfactory to Lender of the insurance required by this Agreement and the other Transaction Documents together with loss payable endorsements in form and substance satisfactory to Lender, duly executed by the insurance company; (o) copies of all financial statements and other Exhibits and Schedules required by this Agreement and the other Transaction Documents; and (p) a letter of direction from Borrower with respect to the disbursement of the proceeds of the initial Revolving Credit Loans under this Agreement; (q) such mortgagee, bailee, landlord or warehousemen's waivers as Lender may deem necessary regarding locations at which Collateral is or will be stored or otherwise located; (r) a pay-off letter from Princeton Capital Finance Corporation in form and substance satisfactory to Lender; (s) evidence satisfactory to Lender that, after the pay-off of Princeton Capital Finance Corporation, Borrower has Unused Availability of at least $500,000.00; (t) the results of reference, record, background and credit checks (including Equifax Reports) on the senior management of Borrower, which results must be satisfactory to Lender; - 22 - 23 (u) a consent in form and substance satisfactory to Lender, duly executed by Algonquin Industries, Inc. and Kazmier Kasper with respect to Borrower's granting Lender a security interest in the pull-tab manufacturing and license agreement dated January 13, 1994, by and among Algonquin Industries, Inc. and Kazmier Kasper, as licensors, and Borrower, as licensee, regarding a pull-tab ticket mechanism; (v) letter agreements in form and substance satisfactory to Lender, duly executed by each bonding company which has issued a bond for the account of Borrower in favor a lessee under a Lease; and (w) such other agreements, documents, instruments and certificates as Lender may reasonably request. 3.02 All Revolving Credit Loans. Notwithstanding any provision contained in this Agreement to the contrary, Lender shall have no obligation to make any Revolving Credit Loan under this Agreement unless: (a) Lender shall have received a current Borrowing Base Certificate as required by Section 2.01(c) and a current Collateral Report as required by Section 3(a) of the Security Agreement; (b) if such Revolving Credit Loan is requested by Borrower pursuant to Section 2.02(a), Lender shall have received a Borrowing Notice for such Revolving Credit Loan; (c) on the date of and immediately after such Revolving Credit Loan, no Default or Event of Default under this Agreement shall have occurred and be continuing; (d) no material adverse change in the Properties, assets, liabilities, business, operations, prospects, income or condition (financial or otherwise) of Borrower and its Subsidiaries taken as a whole shall have occurred since the date of this Agreement and be continuing; and (e) all of the representations and warranties of Borrower contained in this Agreement and in the other Transaction Documents shall be true and correct in all material respects on and as of the date of such Revolving Credit Loan as if made on and as of the date of such Revolving Credit Loan. Each request for a Revolving Credit Loan by Borrower under this Agreement (whether pursuant to Section 2.02(a) or 2.02(b) or otherwise) shall be deemed to be a representation and warranty by Borrower on the date of such Revolving Credit Loan as to the facts specified in clauses (c), (d) and (e) of this Section 3.02. SECTION 4. REPRESENTATIONS AND WARRANTIES. Borrower hereby represents and warrants to Lender that: 4.01 Corporate Existence and Power. Borrower and each Subsidiary: (a) is duly incorporated, validly existing and in good standing under the laws of the jurisdiction of its incorporation; (b) has all requisite corporate powers required to carry on its business as now conducted; (c) has all requisite governmental and regulatory licenses, authorizations, consents and approvals required to carry on its business as now conducted, except such licenses, authorizations, consents and approvals the failure to have could not reasonably be expected to have a Material Adverse Effect; and (d) is qualified to transact business as a foreign corporation in, and is in good standing under the laws of, all states in which it is required by applicable law to maintain such qualification and good standing except for those states in which the failure to qualify or maintain good standing could not reasonably be expected to have a Material Adverse Effect. 4.02 Corporate Authorization. The execution, delivery and performance by Borrower of this Agreement, the Revolving Credit Note and the other Transaction Documents are within the corporate powers of Borrower and have been duly authorized by all necessary corporate action. 4.03 Binding Effect. This Agreement, the Revolving Credit Note and the other Transaction Documents have been duly executed and delivered by Borrower and constitute the legal, valid and binding obligations of Borrower enforceable in accordance with their respective terms, except as such enforceability - 23 - 24 may be limited by bankruptcy, insolvency or other similar laws affecting creditors' rights generally and by general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). 4.04 Financial Statements. Borrower has furnished Lender with the following financial statements, identified by the chief financial officer of Borrower: (a) a balance sheet and the statements of income, retained earnings and cash flows of Borrower as of and for the fiscal year ended December 31, 1996, all audited by Borrower's independent certified public accountants, which financial statements have been prepared in accordance with GAAP consistently applied; and (b) an unaudited balance sheet and statements of income, retained earnings and cash flows of Borrower as of and for the fiscal quarter ended June 30, 1997, certified by the chief financial officer of Borrower as being true and correct to the best of his or her knowledge and as being prepared in accordance with GAAP consistently applied (subject to normal year-end adjustments and the absence of footnotes). Borrower further represents and warrants to Lender that (a) said balance sheets and their accompanying notes fairly present the condition of Borrower as of the dates thereof, (b) there has been no material adverse change in the condition or operation, financial or otherwise, of Borrower since June 30, 1997, and (c) Borrower did not have any direct or contingent liabilities which were not disclosed on said financial statements or the notes thereto (to the extent such disclosure is required by GAAP). 4.05 Litigation. Except as disclosed on Schedule 4.05 attached hereto, there is no action or proceeding pending or, to the knowledge of Borrower, threatened against or affecting Borrower or any Subsidiary before any court, arbitrator or any governmental, regulatory or administrative body, agency or official which, if adversely determined against Borrower or any Subsidiary, could reasonably be expected to have a Material Adverse Effect. Neither Borrower nor any Subsidiary is in default with respect to any order, writ, injunction, decision or decree of any court, arbitrator or any governmental, regulatory or administrative body, agency or official, a default under which could reasonably be expected to have a Material Adverse Effect. There are no outstanding judgments against Borrower or any Subsidiary. 4.06 Pension and Welfare Plans. Each Pension Plan and Welfare Plan complies in all material respects with ERISA and all other applicable statutes and governmental and regulatory rules and regulations; no Reportable Event has occurred and is continuing with respect to any Pension Plan; neither Borrower nor any Subsidiary nor any ERISA Affiliate has withdrawn from any Multi-Employer Plan in a "complete withdrawal" or a "partial withdrawal" as defined in Sections 4203 or 4205 of ERISA, respectively; neither Borrower nor any Subsidiary nor any ERISA Affiliate has entered into an agreement pursuant to Section 4204 of ERISA; neither Borrower nor any Subsidiary nor any ERISA Affiliate has in the past contributed to or currently contributes to a Multi-Employer Plan; neither Borrower nor any Subsidiary nor any ERISA Affiliate has any withdrawal liability with respect to a Multi-Employer Plan; no steps have been instituted by Borrower or any Subsidiary or any ERISA Affiliate to terminate any Pension Plan; no condition exists or event or transaction has occurred in connection with any Pension Plan, Multi-Employer Plan or Welfare Plan which could result in the incurrence by Borrower or any Subsidiary or any ERISA Affiliate of any material liability, fine or penalty; and neither Borrower nor any Subsidiary nor any ERISA Affiliate is a "contributing sponsor" as defined in Section 4001 (a)(13) of ERISA of a "single-employer plan" as defined in Section 4001 (a)(15) of ERISA which has two or more contributing sponsors at least two of whom are not under common control. Except as disclosed on the consolidated financial statements of Borrower and its Subsidiaries delivered by Borrower to Lender, neither Borrower nor any Subsidiary nor any ERISA Affiliate has any liability with respect to any Welfare Plan. 4.07 Tax Returns and Payment. Borrower and its Subsidiaries have filed all Federal, state, local and other income and other tax returns which are required to be filed and have paid all taxes which have become due pursuant to such returns and all other taxes, assessments, fees and other governmental charges upon Borrower and its Subsidiaries and upon their respective Properties, assets, income and franchises which have become due and payable by Borrower or any of its Subsidiaries, except those wherein the amount, applicability or validity are being contested by Borrower or any such Subsidiary by appropriate proceedings being diligently conducted in good faith and in respect of which adequate reserves in accordance with GAAP have been established. There is no proposed, asserted or assessed tax deficiency against Borrower or any of its Subsidiaries which, if adversely determined, could reasonably be expected to have a Material Adverse Effect. - 24 - 25 4.08 Subsidiaries. Borrower has no Subsidiaries other than as identified on Schedule 4.08 attached hereto, as the same may from time to time be amended, modified or supplemented as provided herein. Schedule 4.08 attached hereto correctly sets forth, for each Subsidiary, the number of shares of each class of common and preferred stock authorized for such Subsidiary, the number of outstanding and the percentage of the outstanding shares of each such class owned, directly or indirectly, by Borrower or one or more of its Subsidiaries. All of the issued and outstanding capital stock of each Subsidiary is duly authorized, validly issued and fully paid and nonassessable. Except as disclosed on Schedule 4.08 attached hereto, neither Borrower nor any of its Subsidiaries, individually or collectively, owns or holds, directly or indirectly, any capital stock or equity security of, or any equity interest in, any corporation or business other than Borrower's Subsidiaries. Borrower may at any time amend, modify or supplement Schedule 4.08 by notifying Lender in writing of any changes thereto, including any formation, acquisition, merger or liquidation of Subsidiaries or any change in the capitalization of any Subsidiary, in each case, in accordance with the terms of this Agreement, and thereby the representations and warranties contained in this Section 4.08 shall be amended accordingly so long as such amendment, modification or supplement is made within thirty (30) days after the occurrence of any such changes in the facts stated therein and that such changes reflect transactions that are permitted under this Agreement. 4.09 Compliance With Other Instruments; None Burdensome. Neither Borrower nor any Subsidiary is a party to any contract or agreement or subject to any charter or other corporate restriction which could reasonably be expected to have a Material Adverse Effect and which is not disclosed on Borrower's financial statements heretofore submitted to Lender; none of the execution and delivery by Borrower of the Transaction Documents, the consummation of the transactions therein contemplated or the compliance with the provisions thereof will violate any law, rule, regulation, order, writ, judgment, injunction, decree or award binding on Borrower, or any of the provisions of the Certificate or Articles of Incorporation or By-Laws of Borrower or any of the provisions of any indenture, agreement, document, instrument or undertaking to which Borrower is a party or subject, or by which Borrower or any Property or assets of Borrower is bound, or conflict with or constitute a default thereunder or result in the creation or imposition of any Lien pursuant to the terms of any such indenture, agreement, document, instrument or undertaking (other than in favor of Lender pursuant to the Transaction Documents). No order, consent, approval, license, authorization or validation of, or filing, recording or registration with, or exemption by, any governmental, regulatory, administrative or public body or authority, or any subdivision thereof, or any other Person is required to authorize, or is required in connection with, the execution, delivery or performance of, or the legality, validity, binding effect or enforceability of, any of the Transaction Documents, except for any consents required under the Leases to permit the grant of a security interest in Borrower's rights thereunder to Lender and the assignment of the Lease Payments due thereunder to Lender. 4.10 Other Debt. Guarantees and Capitalized Leases. Except as disclosed on Schedule 4.10 attached hereto, neither Borrower nor any Subsidiary is a borrower, guarantor or obligor with respect to, or a lessee under, any Debt, Guarantees or Capitalized Leases. Borrower may at any time amend, modify or supplement Schedule 4.10 by notifying Lender in writing of any changes thereto, and thereby the representations and warranties contained in this Section 4.10 shall be amended accordingly so long as such amendment, modification or supplement is made within thirty (30) days after the occurrence of any such changes in the facts stated therein and that such changes reflect transactions that are permitted under this Agreement. 4.11 Labor Matters. Neither Borrower nor any Subsidiary is a party to any labor dispute which could reasonably be expected to have a Material Adverse Effect. There are no strikes or walkouts relating to any labor contract to which Borrower or any Subsidiary is subject. Hours worked and payments made to the employees of Borrower and its Subsidiaries have not been in violation of (a) the Fair Labor Standards Act or (b) any other applicable law dealing with such matters, the violation of which could reasonably be expected to have a Material Adverse Effect. All payments due from Borrower or any Subsidiary, or for which any claim may be made against any of them, in respect of wages, employee health and welfare insurance and/or other benefits have been paid or accrued as a liability on their respective books. 4.12 Title to Property. Borrower and each Subsidiary is the sole and absolute owner of, or has the legal right to use and occupy, all Property it claims to own or which is necessary for Borrower or such - 25 - 26 Subsidiary to conduct its business, and all of such Property is free and clear of all Liens other than Permitted Liens. Borrower and its Subsidiaries enjoy peaceful and undisturbed possession in all material respects under all leases under which they are operating as lessees. 4.13 Regulation U. Borrower is not engaged principally, or as one of its important activities, in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulation U of The Board of Governors of the Federal Reserve System, as amended) and no part of the proceeds of any Revolving Credit Loan will be used, whether directly or indirectly, and whether immediately, incidentally or ultimately (i) to purchase or carry margin stock or to extend credit to others for the purpose of purchasing or carrying margin stock, or to refund or repay indebtedness originally incurred for such purpose or (ii) for any purpose which entails a violation of, or which is inconsistent with, the provisions of any of the Regulations of The Board of Governors of the Federal Reserve System, including, without limitation, Regulations G, U, T or X thereof, as amended. If requested by Lender, Borrower shall furnish to Lender a statement in conformity with the requirements of Federal Reserve Form U-1 referred to in Regulation U. 4.14 Multi-Employment Pension Plan Amendments Act of 1980. Borrower and each Subsidiary is in compliance with the Multi-Employer Pension Plan Amendments Act of 1980, as amended ("MEPPAA"), and has no liability for pension contributions pursuant to MEPPAA. 4.15 Investment Company Act of 1940; Public Utility Holding Company Act of 1935. Borrower is not an "investment company" as that term is defined in, and is not otherwise subject to regulation under, the Investment Company Act of 1940, as amended. Borrower is not a "holding company" as that term is defined in, and is not otherwise subject to regulation under, the Public Utility Holding Company Act of 1935, as amended. 4.16 Patents, Trademarks, Copyrights. Licenses, Etc. Except as disclosed on Schedule 4.16 attached hereto, neither Borrower nor any Subsidiary has any patents, patent applications, patent rights, trademarks, trademark applications, trademark rights, copyrights or licenses which are material to the business of Borrower or any Subsidiary. Borrower may at any time amend, modify or supplement Schedule 4.16 by notifying Lender in writing of any changes thereto, and thereby the representations and warranties contained in the first sentence of this Section 4.16 shall be amended accordingly so long as such amendment, modification or supplement is made within thirty (30) days after the occurrence of any such changes in the facts stated therein and that such changes reflect transactions that are permitted under this Agreement. Borrower and each Subsidiary possesses all necessary patents, patent rights, trademarks, trademark rights, trade names, trade name rights, copyrights and licenses to conduct its business without conflict with any patent, patent right, trademark, trademark right, trade name, copyright or license of any other Person. 4.17 Environmental and Safety and Health Matters. Except as disclosed on Schedule 4.17 attached hereto: (i) the operations of Borrower and each Subsidiary comply with all applicable Environmental Laws and all applicable Occupational Safety and Health Laws, the violation or noncompliance with which could reasonably be expected to have a Material Adverse Effect; (ii) none of the operations of Borrower or any Subsidiary are subject to any Environmental Claim or any judicial, governmental, regulatory or administrative proceeding alleging the violation of any Occupational Safety and Health Law, which, if adversely determined, could reasonably be expected to have a Material Adverse Effect; (iii) none of the operations of Borrower or any Subsidiary is the subject of any Federal or state investigation evaluating whether any remedial action is needed to respond to any Release of Hazardous Substances or any unsafe or unhealthful condition at any premises owned, leased or operated by Borrower or such Subsidiary; (iv) neither Borrower nor any Subsidiary has filed any notice under any Environmental Law or Occupational Safety and Health Law indicating or reporting (A) any past or present spillage, leakage or Release into the environment of, or treatment, storage or disposal of, any Hazardous Substance or (B) any unsafe or unhealthful condition at any premises owned, leased or operated by Borrower or such Subsidiary; and (v) neither Borrower nor any Subsidiary has any material contingent liability in connection with (A) any spillage, disposal or Release into the environment of, or otherwise with respect to, any Hazardous Substances or (B) any unsafe or unhealthful condition at any premises owned, leased or operated by Borrower or such Subsidiary. - 26 - 27 4.18 Investments. Neither Borrower nor any Subsidiary has any Restricted Investments. 4.19 No Default. No Default or Event of Default under this Agreement has occurred and is continuing. There is no existing default or event of default under or with respect to any indenture, contract, agreement, lease or other instrument to which Borrower or any Subsidiary is a party or by which any Property of Borrower or any Subsidiary is bound or affected, a default under which could reasonably be expected to have a Material Adverse Effect. Borrower and each Subsidiary of Borrower has and is in full compliance with and in good standing with respect to all governmental permits, licenses, certificates, consents and franchises necessary to continue to conduct its business as previously conducted by it and to own or lease and operate its Properties as now owned or leased by it, the failure to have or noncompliance with which could reasonably be expected to have a Material Adverse Effect, and, to the best of Borrower's knowledge, none of said permits, certificates, consents or franchises contain any term, provision, condition or limitation more burdensome than such as are generally applicable to Persons engaged in the same or similar business as Borrower or such Subsidiary, as the case may be. Neither Borrower nor any Subsidiary of Borrower is in violation of any applicable statute, law, rule, regulation or ordinance of the United States of America, of any state, city, town, municipality, county or of any other jurisdiction, or of any agency thereof, a violation of which could reasonably be expected to have a Material Adverse Effect. 4.20 Disclosure. Neither this Agreement nor any of the Exhibits or Schedules hereto nor any certificate or other data furnished to Lender in writing by or on behalf of Borrower or any Subsidiary in connection with the transactions contemplated by this Agreement contains any untrue or incorrect statement of a material fact. To the best knowledge of Borrower, there is no fact peculiar to Borrower or any of its Subsidiaries which presently has a Material Adverse Effect or in the future (so far as Borrower can now foresee) could reasonably be expected to have a Material Adverse Effect, which has not heretofore been disclosed in writing by Borrower to Lender. SECTION 5. COVENANTS. 5.01 Affirmative Covenants of Borrower. Borrower covenants and agrees that, so long as Lender has any obligation to make any Revolving Credit Loan under this Agreement, any Letter of Credit remains outstanding or any of the Borrower's Obligations remain unpaid, unless the prior written consent of Lender is obtained: (a) Information. Borrower will deliver to Lender: (i) as soon as available and in any event within one hundred twenty (120) days after the end of each fiscal year of Borrower, consolidated and consolidating balance sheets of Borrower and its Subsidiaries as of the end of such fiscal year and the related consolidated and consolidating statements of income, retained earnings and cash flows for such fiscal year, setting forth in each case, in comparative form, the figures for the previous fiscal year, all such financial statements to be prepared in accordance with GAAP consistently applied and reported on by and accompanied by the unqualified opinion of KPMG Peat Marwick LLP or other independent certified public accountants selected by Borrower and reasonably acceptable to Lender; provided, however, that delivery within the time period specified above of copies of the Annual Report on Form 10-K of Borrower for such fiscal year as filed with the Securities and Exchange Commission (together with Borrower's annual report to shareholders, if any, prepared pursuant to Rule 14a-3 under the Exchange Act) together with the accountant's certificate described above shall be deemed to satisfy the requirements of this Section 5.01 (a)(i) with respect to delivery of the audited consolidated financial statements referred to above; (ii) as soon as available and in any event within forty-five (45) days after the end of the first three (3) fiscal quarters of each fiscal year of Borrower, consolidated and consolidating balance sheets of Borrower and its Subsidiaries as of the end of such fiscal quarter and the related consolidated and consolidating statements of income, retained earnings and cash flows for such fiscal quarter and for the portion of Borrower's fiscal year ended at the end of such fiscal quarter, setting forth in each case in comparative form, the figures for the corresponding fiscal quarter and the corresponding portion of Borrower's previous fiscal year, all in reasonable detail and satisfactory in form to Lender and certified - 27 - 28 (subject to normal year-end adjustments and footnote disclosures) as to fairness of presentation, GAAP and consistency by the chief financial officer of Borrower; provided, however, that delivery within the time period specified above of copies of the Quarterly Report on Form 10-Q of Borrower for such fiscal quarter as filed with the Securities and Exchange Commission shall be deemed to satisfy the requirements of this Section 5.01 (a)(ii) with respect to consolidated financial statements; (iii) as soon as available and in any event within forty-five (45) days after the end of each fiscal month of Borrower which is not the end of a fiscal quarter or fiscal year of Borrower, consolidated and consolidating balance sheets of Borrower and its Subsidiaries as of the end of such fiscal month and the related consolidated and consolidating statements of income, retained earnings and cash flows for such fiscal month and for the portion of Borrower's fiscal year ended at the end of such fiscal month, setting forth in each case in comparative form, the figures for the corresponding fiscal month and the corresponding portion of Borrower's previous fiscal year, all in reasonable detail and satisfactory in form to Lender; (iv) simultaneously with the delivery of each set of financial statements referred to in Sections 5.01 (a)(i) and (ii) above, a certificate of the chief financial officer of Borrower (or such other officer of Borrower as shall be reasonably acceptable to Lender) in the form attached hereto as Exhibit C and incorporated herein by reference, accompanied by supporting financial work sheets where appropriate, (A) evidencing Borrower's compliance with the financial covenants contained in Sections 5.01 (o) and 5.02(m) of this Agreement, (B) stating whether there exists on the date of such certificate any Default or Event of Default and, if any Default or Event of Default then exists, setting forth the details thereof and the action which Borrower is taking or proposes to take with respect thereto and (C) certifying that all of the representations and warranties of Borrower contained in this Agreement and in the other Transaction Documents are true and correct in all material respects on and as of the date of such certificate as if made on and as of the date of such certificate; (v) promptly upon transmission thereof, one copy of (A) each financial statement, report, notice or proxy statement sent by Borrower or any Subsidiary generally to its stockholders or to its creditors (other than Borrower or another Subsidiary) and (B) each regular or periodic report, each registration statement (without exhibits except as expressly requested by Lender), and each prospectus and all amendments thereto filed by Borrower or any Subsidiary with the Securities and Exchange Commission (or any governmental body or agency succeeding to the functions of the Securities and Exchange Commission) and of each press release and other statement made available generally by Borrower or any Subsidiary to the public concerning developments that are material; (vi) promptly upon receipt thereof, any reports (including, without limitation, any management reports) submitted to Borrower or any Subsidiary (other than reports previously delivered pursuant to Sections 5.01(a)(i) above) by independent accountants in connection with any annual, interim or special audit made by them of the books of Borrower or any Subsidiary; (vii) within fifteen (15) days after the end of each fiscal month of Borrower, (i) an accounts receivable aging of Borrower indicating which Accounts are less than 30, 30 to 60, 60 to 90 and 90 days or more past the invoice date and including, if requested by Lender, a listing of the names and addresses of all applicable Account Debtors and (B) a summary of accounts payable of Borrower showing which accounts payable are current, up to 30, 30 to 60, 60 to 90 and 90 days or more past due and including, if requested by Lender, a listing of the names and addresses of applicable creditors, all in form and detail reasonably satisfactory to Lender and certified as being true, correct and complete by the chief financial officer of Borrower; (viii) at such intervals as Lender may request (but not more often than monthly so long as no Default or Event of Default under this Agreement has occurred and is continuing and Borrower has Unused Availability of at least $1,500,000.00), such information and reports regarding Borrower's Inventory as Lender may from time to time request, all in form and detail reasonably satisfactory to Lender and certified as being true, correct and complete by the chief financial officer of Borrower; - 28 - 29 (ix) at such intervals as Lender may request (but not more often than monthly so long as no Default or Event of Default under this Agreement has occurred and is continuing and Borrower has Unused Availability of at least $1,500,000.00), such information and reports regarding the Leases, the Eligible Leases, the Lease Payments and the Eligible Lease Payments as Lender may from time to time request, all in form and detail reasonably satisfactory to Lender and certified as being true, correct and complete by the chief financial officer of Borrower; (x) within ten (10) days after the execution thereof, a copy of each Lease and of each amendment, modification, extension, renewal, termination or cancellation of any Lease; (xi) as soon as available and in any event within thirty (30) days before the beginning of each fiscal year of Borrower, consolidated and consolidating balance sheet, income statement and cash flow projections for Borrower and its Subsidiaries for such fiscal year on a month-by-month basis, all in form and detail reasonably acceptable to Lender; and (xii) with reasonable promptness, such further information regarding the business, affairs and financial condition of Borrower or any Subsidiary as Lender may from time to time reasonably request. Lender is hereby authorized to deliver a copy of any financial statement or other information made available by Borrower or any Subsidiary to any regulatory authority having jurisdiction over Lender, pursuant to any request therefor. (b) Payment of Debt; Performance of Lease Obligations. Borrower will, and it will cause each of its Subsidiaries to, (i) pay and discharge any and all Debt payable or Guaranteed by Borrower or such Subsidiary, as the case may be, and any interest or premium thereon, when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) in accordance with the agreement, document or instrument relating to such Debt or Guarantee and (ii) faithfully perform, observe and discharge all covenants, conditions and obligations which are imposed upon Borrower or such Subsidiary, as the case may be, by any and all agreements, documents, instruments and indentures evidencing, securing or otherwise relating to such Debt or Guarantee. Borrower will faithfully perform, observe and discharge all covenants, conditions, obligations and duties which are imposed upon Borrower under or in connection with the Leases. (c) Maintenance of Books and Records; Consultations and Inspections. Borrower will, and it will cause each of its Subsidiaries to, maintain books and records in accordance with GAAP and in which full, true and correct entries shall be made of all dealings and transactions in relation to its business and activities. Borrower will, and it will cause each of its Subsidiaries to, permit Lender (and any Person appointed by Lender to whom Borrower does not reasonably object) to discuss the affairs, finances and accounts of Borrower and each Subsidiary with the officers of Borrower and each Subsidiary, all at such reasonable times and as often as Lender may from time to time reasonably request. Borrower will also permit, and will cause each of its Subsidiaries to permit, inspection of its Properties, books and records by the Lender during normal business hours and at other reasonable times upon at least one (1) Domestic Business Day's prior oral or written notice from Lender to Borrower (provided, however, that no such notice need be given by Lender if any Default or Event of Default under this Agreement has occurred and is continuing). Borrower will reimburse Lender upon demand for ail reasonable costs and expenses incurred by Lender in connection with any such inspection conducted by Lender while any Default or Event of Default under this Agreement has occurred and is continuing. Borrower irrevocably authorizes Lender to, if any Default or Event of Default under this Agreement has occurred and is continuing, communicate directly with its independent public accountants and irrevocably authorizes and directs such accountants to disclose to Lender any and all information with respect to the business and financial condition of Borrower and its Subsidiaries as Lender may from time to time reasonably request in writing (with a copy of such request to be sent to Borrower). (d) Payment of Taxes. Borrower will, and it will cause each of its Subsidiaries to, duly file all Federal, state and local income tax returns and all other tax returns and reports of Borrower or such Subsidiary, as the case may be, which are required to be filed and duly pay and discharge promptly all taxes, assessments and other governmental charges imposed upon it or any of its Property; provided, however, that neither Borrower nor any Subsidiary shall be required to pay any such tax, assessment or other governmental charge - 29 - 30 the payment of which is being contested in good faith and by appropriate proceedings being diligently conducted and for which adequate reserves in accordance with GAAP have been provided, except that Borrower or such Subsidiary, as the case may be, shall pay or cause to be paid all such taxes, assessments and governmental charges forthwith upon the commencement of proceedings to foreclose any Lien which is attached as security therefor, unless such foreclosure is stayed by the filing of an appropriate bond in a manner reasonably satisfactory to Lender. (e) Payment of Claims. Borrower will, and it will cause each of its Subsidiaries to, promptly pay and discharge (i) all trade accounts payable in accordance with usual and customary business practices (but in no event later than thirty (30) days after the due date thereof) and (ii) all claims for work, labor or materials which if unpaid might become a Lien upon any of its Property or assets; provided, however, that neither Borrower nor any Subsidiary shall be required to pay any such account payable or claim the payment of which is being contested in good faith and by appropriate proceedings being diligently conducted and for which adequate reserves in accordance with GAAP have been provided, except that Borrower or such Subsidiary, as the case may be, shall pay or cause to be paid all such accounts payable and claims forthwith upon the commencement of proceedings to foreclose any Lien which is attached as security therefor, unless such foreclosure is stayed by the filing of an appropriate bond in a manner reasonably satisfactory to Lender. (f) Corporate Existence. Borrower will, and it will cause each of its Subsidiaries to, do all things necessary to (i) preserve and keep in full force and effect at all times its corporate existence and all permits, licenses, franchises and other rights material to its business and (ii) be duly qualified to do business and be in good standing in all jurisdictions where the nature of its business or its ownership of Property requires such qualification except for those jurisdictions in which the failure to qualify or be in good standing could not reasonably be expected to have a Material Adverse Effect. (g) Maintenance of Property. Borrower will, and it will cause each of its Subsidiaries to, at all times, preserve and maintain all of the Property used or useful in the conduct of its business in good condition, working order and repair, ordinary wear and tear excepted. (h) Compliance with Laws, Regulations, Etc. Borrower will, and it will cause each of its Subsidiaries to, comply with any and all laws, ordinances and governmental and regulatory rules and regulations to which Borrower or such Subsidiary, as the case may be, is subject (including, without limitation, all Occupational Safety and Health Laws and all Environmental Laws) and obtain any and all licenses, permits, franchises and other governmental and regulatory authorizations necessary to the ownership of its Properties or to the conduct of its business, which violation or failure to obtain could reasonably be expected to have a Material Adverse Effect. (i) Environmental Matters. Borrower shall give Lender prompt written notice of (i) any Environmental Claim or any other action or investigation with respect to the existence or potential existence of any Hazardous Substances instituted or threatened with respect to Borrower or any Subsidiary or any of the Properties or facilities owned, leased or operated by Borrower or any Subsidiary which, if determined adversely to Borrower or any Subsidiary, could reasonably be expected to have a Material Adverse Effect and (ii) any condition or occurrence on any of the Properties or facilities owned, leased or operated by Borrower or any Subsidiary which constitutes a violation of any Environmental Laws, the violation of which could reasonably be expected to have a Material Adverse Effect or which gives rise to a reporting obligation or requires removal or remediation under any Environmental Laws. Within thirty (30) days after the giving of any such notice, Borrower shall deliver to Lender Borrower's plan with respect to removal or remediation and Borrower agrees to take all action which is reasonably necessary in connection with such action, investigation, condition or occurrence in accordance with such plan with due diligence and to complete such removal or remediation as promptly as possible and in all events within the time required by any Environmental Laws or any other applicable law, rule or regulation. Borrower shall promptly provide Lender with copies of all documentation relating thereto, and such other information with respect to environmental matters as Lender may request from time to time. (j) ERISA Compliance. If Borrower, any Subsidiary or any ERISA Affiliate shall have any Pension Plan, Borrower, such Subsidiary or such ERISA Affiliate, as the case may be, shall comply with all requirements - 30 - 31 of ERISA relating to such Pension Plan, the violation of or noncompliance with which could reasonably be expected to have a Material Adverse Effect. Without limiting the generality of the foregoing, Borrower will not, and it will not cause or permit any Subsidiary or any ERISA Affiliate to: (i) permit any Pension Plan maintained by Borrower, any Subsidiary or any ERISA Affiliate to engage in any nonexempt "prohibited transaction," as such term is defined in Section 4975 of the Code; (ii) permit any Pension Plan maintained by Borrower, any Subsidiary or any ERISA Affiliate to incur any "accumulated funding deficiency", as such term is defined in Section 302 of ERISA, 29 U.S.C. ss. 1082, whether or not waived; (iii) terminate any Pension Plan in a manner which could result in the imposition of a Lien on any Property of Borrower, any Subsidiary or any ERISA Affiliate pursuant to Section 4068 of ERISA, 29 U.S.C. ss. 1368; or (iv) take any action which would constitute a complete or partial withdrawal from a Multi-Employer Plan within the meaning of Sections 4203 or 4205 of Title IV of ERISA. Notwithstanding any provision contained in this Section 5.01(j) to the contrary, an act by Borrower or any Subsidiary shall not be deemed to constitute a violation of this Section 5.01(j) unless the Lender determines in good faith that said action, individually or cumulatively with other acts of Borrower and its Subsidiaries, has or could reasonably be expected to have a Material Adverse Effect. (k) Notices. Borrower will notify Lender in writing of any of the following within three (3) Domestic Business Days after learning of the occurrence thereof, describing the same and, if applicable, the steps being taken by the Person(s) affected with respect thereto: (i) the occurrence of any Default or Event of Default under this Agreement; (ii) the occurrence of any default or event of default by Borrower, any other Obligor or any Subsidiary under any note, indenture, loan agreement, mortgage, deed of trust, security agreement, lease or other similar agreement, document or instrument to which Borrower, any other Obligor or any Subsidiary, as the case may be, is a party or by which it is bound or to which it is subject; (iii) the institution of any litigation, arbitration proceeding or governmental or regulatory proceeding affecting Borrower, any other Obligor or any Subsidiary, whether or not considered to be covered by insurance, in which the prayer or claim for relief seeks recovery of an amount in excess of $100,000.00 (or, if no dollar amount is specified in the prayer or claim for relief, in which there is a reasonable likelihood of recovery of an amount in excess of $100,000.00) or any form of equitable relief; (iv) the entry of any judgment or decree against Borrower, any other Obligor or any Subsidiary; (v) the occurrence of a Reportable Event with respect to any Pension Plan; the filing of a notice of intent to terminate a Pension Plan by Borrower, any ERISA Affiliate or any Subsidiary; the institution of proceedings to terminate a Pension Plan by the PBGC or any other Person; the withdrawal in a "complete withdrawal" or a "partial withdrawal" as defined in Sections 4203 and 4205, respectively, of ERISA by Borrower, any ERISA Affiliate or any Subsidiary from any Multi-Employer Plan; or the incurrence of any material increase in the contingent liability of Borrower or any Subsidiary with respect to any "employee welfare benefit plan" as defined in Section 3(1) of ERISA which covers retired employees and their beneficiaries; (vi) the occurrence of any material adverse change in the Properties, assets, liabilities, business, operations, prospects, income or condition (financial or otherwise) of Borrower, any other Obligor or any Subsidiary; - 31 - 32 (vii) any change in the name of Borrower, any other Obligor or any Subsidiary; (viii) any proposed opening, closing or other change of any place of business of borrower, any other obligor or any Subsidiary; (ix) any material change in Borrower's or any Subsidiary's line(s) of business; (x) the occurrence of any Change of Control Event; and (xi) any notices required to be provided pursuant to other provisions of this Agreement and notice of the occurrence of such other events as Lender may from time to time reasonably specify. (l) Insurance. Borrower will, and it will cause each of its Subsidiaries to, insure all of its Property of the character usually insured by corporations engaged in the same or similar businesses similarly situated, against loss or damage of the kind customarily insured against by such corporations, unless higher limits or coverage are reasonably required in writing by Lender, and carry adequate liability insurance and other insurance of a kind and in an amount generally carried by corporations engaged in the same or similar businesses similarly situated, unless higher limits or coverage are reasonably required in writing by Lender; provided, however, that Borrower shall not be required to maintain casualty insurance on Inventory which is in the possession of a lessee under a Lease. All insurance required by this Section 5.01(1) shall be with insurers rated A-XI or better by A.M Best Company (or accorded a similar rating by another nationally or internationally recognized insurance rating agency of similar standing if A.M. Best Company is not then in the business of rating insurers or rating foreign insurers) or such other insurers as may from time to time be reasonably acceptable to Lender. All such insurance may be subject to reasonable deductible amounts. Simultaneously with each delivery of financial statements under Section 5.01 (a)(i), Borrower shall deliver to Lender a certificate of an officer of Borrower specifying the details of all insurance then in effect and evidence of the payment of all premiums therefor. UNLESS BORROWER PROVIDES EVIDENCE OF THE INSURANCE COVERAGE REQUIRED UNDER THIS AGREEMENT AND THE OTHER TRANSACTION DOCUMENTS, LENDER MAY PURCHASE INSURANCE AT BORROWER'S EXPENSE TO PROTECT LENDERS INTEREST IN THE COLLATERAL. THIS INSURANCE MAY, BUT NEED NOT, PROTECT BORROWER'S INTERESTS. THE COVERAGE THAT LENDER PURCHASES MAY NOT PAY ANY CLAIM THAT BORROWER MAY MAKE OR ANY CLAIM THAT IS MADE AGAINST BORROWER IN CONNECTION WITH THE COLLATERAL. BORROWER MAY LATER CANCEL ANY INSURANCE PURCHASED BY LENDER, BUT ONLY AFTER PROVIDING EVIDENCE THAT BORROWER HAS OBTAINED INSURANCE AS REQUIRED BY THIS AGREEMENT AND THE OTHER TRANSACTION DOCUMENTS. IF LENDER PURCHASES INSURANCE FOR THE COLLATERAL, BORROWER WILL BE RESPONSIBLE FOR THE COSTS OF THAT INSURANCE, INCLUDING THE INSURANCE PREMIUM, INTEREST AND ANY OTHER CHARGES LENDER MAY IMPOSE IN CONNECTION WITH THE PLACEMENT OF INSURANCE, UNTIL THE EFFECTIVE DATE OF THE CANCELLATION OR EXPIRATION OF THE INSURANCE. THE COSTS OF THE INSURANCE MAY BE ADDED TO THE BORROWER'S OBLIGATIONS. THE COSTS OF THE INSURANCE MAY BE MORE THAN THE COST OF INSURANCE BORROWER MAY BE ABLE TO OBTAIN ON ITS OWN. (m) Further Assurances. Borrower will execute and deliver to Lender, at any time and from time to time, any and all further agreements, documents and instruments, and take any and all further actions which may be required under applicable law, or which Lender may from time to time reasonably request, in order to effectuate the transactions contemplated by this Agreement and the other Transaction Documents. (n) Accountant. Borrower will give Lender prompt notice of any change of Borrower's independent certified public accountants and a statement of the reasons for such change. Borrower shall at all times utilize independent certified public accountants reasonably acceptable to Lender. (o) Financial Covenants. (i) Maximum Consolidated Debt to Consolidated EBITDA Ratio. Borrower will have and maintain a Consolidated Debt to Consolidated EBITDA Ratio of not more than 2.0 to 1.0 as of the last day of each fiscal quarter of Borrower commencing with the fiscal quarter of Borrower ended September 30, 1997. - 32 - 33 (ii) Minimum Consolidated Tangible Net Worth. Borrower will keep and maintain a Consolidated Tangible Net Worth plus Subordinated Debt in an amount not less than (i) $9,200,000.00 as of the last day of each fiscal quarter of Borrower ending during the period commencing September 30, 1997, and ending December 30, 1997, (ii) $9,450,000.00 as of the last day of each fiscal quarter of Borrower ending during the period commencing December 31, 1997, and ending December 30, 1998, (iii) $9,950,000.00 as of the last day of each fiscal quarter of Borrower ending during the period commencing December 31,1998, and ending December 30, 1999, and (iv) $10,450,000.00 as of the last day of each fiscal quarter of Borrower ending on or after December 31, 1999. (iii) Minimum Consolidated Interest Coverage Ratio. Borrower will have and maintain a Consolidated Interest Coverage Ratio of at least 5.0 to 1.0 for each period of four (4) consecutive fiscal quarters of Borrower commencing with the four (4) consecutive fiscal quarter period ended September 30, 1997. (p) Lease Consents. Borrower will use its best efforts to obtain from each lessee under a Lease which is in existence on the date of this Agreement a written consent expressly providing that all amounts (whether for rent or otherwise) from time to time payable to Borrower under such Lease are assignable by Borrower to Lender consistent with the terms of the Security Agreement. Borrower will use its best efforts to cause each Lease executed after the date of this Agreement (or an independent instrument executed by the applicable lessee(s)) to contain a provision expressly providing that all amounts (whether for rent or otherwise) from time to time payable to Borrower under such Lease are assignable by Borrower to Lender consistent with the terms of the Security Agreement. 5.02 Negative Covenants of Borrower. Borrower covenants and agrees that, so long as Lender has any obligation to make any Revolving Credit Loan under this Agreement, any Letter of Credit remains outstanding or any of the Borrower's Obligations remain unpaid, unless the prior written consent of Lender is obtained: (a) Limitation on Indebtedness. Borrower will not, and it will not cause or permit any of its Subsidiaries to, incur or be obligated on any Indebtedness, either directly or indirectly, by way of Guarantee, suretyship or otherwise, other than: (i) the Borrower's Obligations; (ii) unsecured trade accounts payable and other normal accruals incurred in the ordinary course of business which are not more than thirty (30) days past due (provided, however, that neither Borrower nor any Subsidiary shall be required to pay any such account payable or other accrual the payment of which is being contested in good faith and by appropriate proceedings being diligently conducted and for which adequate reserves in accordance with GAAP have been provided, except that Borrower or such Subsidiary, as the case may be, shall pay or cause to be paid all such accounts payable and accruals forthwith upon the commencement of proceedings to foreclose any Lien which is attached as security therefor, unless such foreclosure is stayed by the filing of an appropriate bond in a manner reasonably satisfactory to Lender); (iii) Indebtedness under performance bonds issued for the account of Borrower and for the benefit of lessees under Leases so long as no amount owed by Borrower under or in respect of any such performance bond is past due; (iv) Indebtedness existing as of the date of this Agreement and listed on Schedule 5.10 attached hereto (nothing contained in this Agreement is intended to prohibit Borrower from making payments required to be made to the holders of the promissory note of Borrower dated September 22, 1992, and payable to the order of Thomas Turek, M.D. in the original principal amount of $400,000.00 and/or the promissory note of Borrower dated September 25, 1992, and payable to the order of Thomas L. Goila in the original principal amount of $79,000.00 in accordance with the terms of such promissory notes so long as such payments do not violate or result in the violation of any of the financial covenants contained in Section 5.01(o) of this Agreement); - 33 - 34 (v) Subordinated Debt; (vi) purchase money Indebtedness incurred solely to finance Capital Expenditures permitted by, and Capitalized Lease Obligations permitted by, Section 5.02(m) of this Agreement; and (vii) other Indebtedness not otherwise permitted by this Section 5.02(a) in an amount not to exceed $100,000.00 in the aggregate at any one time outstanding for Borrower and all of its Subsidiaries. (b) Limitation on Liens. Borrower will not, and will not cause or permit any of its Subsidiaries to, create, incur or assume, or suffer to be incurred or to exist, any Lien on any of its or their Property or assets, whether now owned or hereafter acquired, or upon any income or profits therefrom, except for Permitted Liens. (c) Consolidation, Merger, Sale of Assets, Etc. (i) Borrower will not, and it will not cause or permit any Subsidiary to, directly or indirectly merge or consolidate with or into any other Person or permit any other Person to merge into or with or consolidate with it. (ii) Borrower will not, and will not cause or permit any of its Subsidiaries to, (A) sell, assign, lease, transfer, abandon or otherwise dispose of any of its Property or assets (including, without limitation, any shares of capital stock of a Subsidiary owned by Borrower or another Subsidiary) or (B) issue, sell or otherwise dispose of any shares of capital stock of any Subsidiary, except for (1) sales or leases of Inventory in the ordinary course of business (which does not include a sale, transfer or lease of Inventory in partial or total satisfaction of any Indebtedness), (2) sales of fixed assets which are obsolete, worn-out or otherwise not used or useable in the ordinary course of its business, so long as the net proceeds thereof are used solely to purchase replacement fixed assets or assets of comparable quality or to pay or prepay Debt of Borrower or such Subsidiary, as the case may be, and (3) other sales of fixed assets which are not used or useable in the ordinary course of its business, so long as the gross sale proceeds from all such asset sales by Borrower and its Subsidiaries does not exceed $25,000.00 in the aggregate in any fiscal year. (d) Sale and Leaseback Transactions. Borrower will not, and it will not cause or permit any of its Subsidiaries to, enter into any arrangement, directly or indirectly, whereby Borrower or such Subsidiary shall in one or more related transactions sell, transfer or otherwise dispose of any Property owned by Borrower or such Subsidiary to any Person and then rent or lease, as lessee, such Property or any part thereof for a period or periods which in the aggregate would exceed twelve (12) months from the date of commencement of the lease term. (e) Sale or Discount of Accounts or Chattel Paper. Borrower will not, and it will not cause or permit any of its Subsidiaries to, sell or discount any of its notes or accounts receivable, any of its chattel paper or any of its Leases, other than discounts of Eligible Accounts permitted by Section 3(f) of the Security Agreement and other than ordinary course settlements of Accounts which are not Eligible Accounts in an amount not to exceed $10,000.00 in any one instance. (f) Transactions with Affiliates. Borrower will not, and it will not cause or permit any of its Subsidiaries to, enter into or be a party to any transaction or arrangement with any Affiliate (including, without limitation, the purchase from, sale to or exchange of Property with, or the rendering of any service by or for, any Affiliate), except in the ordinary course of business and pursuant to the reasonable requirements of Borrower's or such Subsidiary's business and upon fair and reasonable terms no less favorable to Borrower or such Subsidiary than would be obtained in a comparable arm's-length transaction with a Person not an Affiliate. (g) Changes in Nature of Business. Borrower will not, and it will not cause or permit any of its Subsidiaries to, engage in any business if, as a result, the general nature of the business which would then - 34 - 35 be engaged in by Borrower and its Subsidiaries, considered as a whole, would be substantially changed from the general nature of the business engaged in by Borrower and its Subsidiaries as of the date of this Agreement, which is the business of the manufacture and distribution of instant lottery vending machines, prepaid phone card dispensing machines and stored value card dispensing machines. (h) Fiscal Year. Borrower will not, and it will not cause or permit any of its Subsidiaries to, change its fiscal year. (i) Stock Redemptions and Distributions. Borrower will not, and it will not cause or permit any of its Subsidiaries to, declare or incur any liability to make any Distribution in respect of the capital stock of Borrower or the capital stock of such Subsidiary, as the case may be, except that so long as no Default or Event of Default under this Agreement has occurred and is continuing or is created thereby or would result therefrom, (i) Borrower shall be permitted to redeem shares of its Series A Preferred Stock as and when required by the provisions thereof as in effect on the date of this Agreement and (ii) if no shares of Series A Preferred Stock of Borrower are issued and outstanding, during each fiscal year of Borrower, Borrower shall be permitted to declare and pay cash dividends on its capital stock and/or redeem shares of its capital stock for cash so long as the aggregate amount paid or committed to be paid by Borrower in connection with such dividends and/or redemptions does not exceed an amount equal to Twenty-Five Percent (25%) of the Consolidated Net Income of Borrower during the immediately preceding fiscal year of Borrower. (j) Pension Plans. Borrower will not, and it will not cause or permit any of its Subsidiaries to, (a) permit any condition to exist in connection with any Pension Plan which might constitute grounds for the PBGC to institute proceedings to have such Pension Plan terminated or a trustee appointed to administer such Pension Plan or (b) engage in, or permit to exist or occur, any other condition, event or transaction with respect to any Pension Plan which could result in the incurrence by Borrower, any Subsidiary or any ERISA Affiliate of any material liability, fine or penalty. (k) Subordinated Debt. Borrower will not make any payments of principal, interest or other amounts on or with respect to any of its Subordinated Debt to the extent prohibited by the subordination provisions governing the same. (l) Restricted Investments. Borrower will not, and it will not cause or permit any of its Subsidiaries to, directly or indirectly, make any Restricted Investments. (m) Capital Expenditures and Capitalized Leases. Borrower will not, and it will not cause or permit any of its Subsidiaries to, make any Capital Expenditure or enter into any Capitalized Lease if the sum of (i) the aggregate amount of all Capital Expenditures (including the Capital Expenditure in question) made by Borrower and its Subsidiaries during any fiscal year of Borrower plus (ii) the aggregate amount of all rental and other payments in respect of Capitalized Leases (including the Capitalized Lease in question) made or required to be made by Borrower and its Subsidiaries during such fiscal year of Borrower would exceed $200,000.00. (n) Maximum Officer Compensation. Borrower will not cause or permit the aggregate amount of salaries, consulting fees, bonuses and/or other compensation (other than dividends and amounts paid in redemption of capital stock to the extent, if any, permitted by Section 5.02(i) of this Agreement) paid or committed to be paid by Borrower to all of the shareholders, directors and/or officers of Borrower (taken as a group) during any fiscal year of Borrower to exceed One Hundred Twenty-Five Percent (125%) of the aggregate amount of salaries, consulting fees, bonuses and/or other compensation (other than dividends and amounts paid in redemption of capital stock to the extent, if any, permitted by Section 5.02(i) of this Agreement) paid by Borrower to all of the shareholders, directors and/or officers of Borrower (taken as a group) during the immediately preceding fiscal year of Borrower. (o) Subsidiaries. Borrower will not, and it will not cause or permit any of its Subsidiaries to, create, form or acquire any Subsidiaries. 5.03 Use of Proceeds. Borrower covenants and agrees that (i) the proceeds of the Revolving Credit Loans will be used solely for the working capital and general corporate purposes of Borrower, (ii) no part of - 35 - 36 the proceeds of any Revolving Credit Loan will be used in violation of any applicable law, rule or regulation and (iii) no part of the proceeds of any Revolving Credit Loan will be used, whether directly or indirectly, and whether immediately, incidentally or ultimately (A) to purchase or carry margin stock or to extend credit to others for the purpose of purchasing or carrying margin stock, or to refund or repay indebtedness originally incurred for such purpose or (B) for any purpose which entails a violation of, or which is inconsistent with, the provisions of any of the Regulations of The Board of Governors of the Federal Reserve System, including, without limitation, Regulations G, U, T or X thereof, as amended. SECTION 6. EVENTS OF DEFAULT. If any of the following (each of the following herein sometimes called an "Event of Default") shall occur and be continuing: 6.01 Borrower shall fail to pay any of the Borrower's Obligations as and when the same shall become due and payable, whether by reason of demand, maturity, acceleration or otherwise, and any such failure shall remain unremedied for five (5) days; 6.02 Any representation or warranty of Borrower made in this Agreement, in any other Transaction Document to which Borrower is a party or in any certificate, agreement, instrument or statement furnished or made or delivered pursuant hereto or thereto or in connection herewith or therewith, shall prove to have been untrue or incorrect in any material respect when made or effected; 6.03 Borrower shall fail to perform or observe any term, covenant or provision contained in Section 5.01 (c), Section 5.01 (k), Section 5.01 (1), Section 5.01 (m), Section 5.01 (o)(iii), Section 5.02 or Section 5.03; 6.04 Borrower shall fail to perform or observe any term, covenant or provision contained in Sections 2.01 (d) or 5.01 (f) and any such failure shall remain unremedied for five (5) days after the earlier of (i) written notice of default is given to Borrower by Lender or (ii) any officer of Borrower obtaining knowledge of such default; 6.05 Borrower shall fail to perform or observe any term, covenant or provision contained in Sections 5.01(o)(i) or 5.01 (o)(ii) and any such failure shall remain unremedied for five (5) days after the earliest of (i) written notice of default is given to Borrower by Lender, (ii) any officer of Borrower obtaining knowledge of such default or (iii) completion of Borrower's financial statements for the applicable period; 6.06 Borrower shall fail to perform or observe any other term, covenant or provision contained in this Agreement (other than those specified in Sections 6.01, 6.02, 6.03, 6.04 or 6.05 above) and any such failure shall remain unremedied for fifteen (15) days after the earlier of (i) written notice of default is given to Borrower by Lender or (ii) any officer of Borrower obtaining knowledge of such default; 6.07 This Agreement or any of the other Transaction Documents shall at any time for any reason cease to be in full force and effect or shall be declared to be null and void by a court of competent jurisdiction, or if the validity or enforceability thereof shall be contested or denied by Borrower, or if the transactions completed hereunder or thereunder shall be contested by Borrower or if Borrower shall deny that it has any further liability or obligation hereunder or thereunder; 6.08 Borrower, any other Obligor or any Subsidiary shall (i) voluntarily commence any proceeding or file any petition seeking relief under Title 11 of the United States Code or any other Federal, state or foreign bankruptcy, insolvency, receivership, liquidation or similar law, (ii) consent to the institution of, or fail to contravene in a timely and appropriate manner, any such proceeding or the filing of any such petition, (iii) apply for or consent to the appointment of a receiver, trustee, custodian, sequestrator or similar official of itself or of a substantial part of its Property or assets, (iv) file an answer admitting the material allegations of a petition filed against itself in any such proceeding, (v) make a general assignment for the benefit of creditors, (vi) become unable, admit in writing its inability or fail generally to pay its debts as they become due or (vii) take any corporate or other action for the purpose of effecting any of the foregoing; - 36 - 37 6.09 (i) An involuntary proceeding shall be commenced or an involuntary petition shall be filed in a court of competent jurisdiction seeking relief in respect of Borrower, any other Obligor or any Subsidiary, or of a substantial part of the Property or assets of Borrower, any other Obligor or any Subsidiary, under Title 11 of the United States Code or any other Federal, state or foreign bankruptcy, insolvency, liquidation or similar law and such proceeding or petition shall continue undismissed for thirty (30) consecutive days or an order or decree approving or ordering any proceeding or petition shall continue unstayed and in effect for thirty (30) consecutive days; (ii) the appointment of a receiver, trustee, custodian, sequestrator or similar official of Borrower, any other Obligor or any Subsidiary or of a substantial part of the Property or assets of Borrower, any other Obligor or any Subsidiary, and such appointment shall continue in effect for thirty (30) consecutive days or an order or decree approving or ordering any such appointment shall continue unstayed and in effect for thirty (30) consecutive days; or (iii) the entry of any order or decree approving or ordering any winding-up or liquidation of Borrower, any other Obligor or any Subsidiary, and any such order or decree shall continue unstayed and in effect for thirty (30) consecutive days; 6.10 Any "Event of Default" (as defined therein) shall occur under or within the meaning of the Security Agreement; 6.11 The Patent, Trademark and License Security Agreement shall at any time for any reason cease to be in full force and effect or shall be declared to be null and void by a court of competent jurisdiction, or if the validity or enforceability thereof shall be contested or denied by Borrower, or if Borrower shall deny that it has any further liability or obligation thereunder or if Borrower shall fail to comply with or observe any of the terms, provisions or conditions contained in the Patent, Trademark and License Security Agreement and any such failure shall remain unremedied for fifteen (15) days after the earlier of (i) written notice of default is given to Borrower by Lender or (ii) any officer of Borrower obtaining knowledge of such default; 6.12 Borrower, any other Obligor or any Subsidiary shall be declared by Lender to be in default on, or pursuant to the terms of, (i) any other present or future obligation to Lender, including, without limitation, any other loan, line of credit, revolving credit, guaranty or letter of credit reimbursement obligation, or (ii) any other present or future agreement purporting to convey to Lender a Lien upon any Property or assets of Borrower, such other Obligor or such Subsidiary, as the case may be; 6.13 The occurrence of any default or event of default under or within the meaning of any agreement, document or instrument evidencing, securing, guaranteeing the payment of or otherwise relating to any Debt of Borrower, any other Obligor or any Subsidiary (other than the Borrower's Obligations) having an aggregate outstanding principal balance in excess of $100,000.00 which is not cured within any applicable cure or grace period (if any); 6.14 Borrower, any other Obligor or any Subsidiary shall have a judgment entered against it by a court having jurisdiction in the premises and such judgment shall not be appealed in good faith or satisfied by Borrower, such other Obligor or such Subsidiary, as the case may be, within thirty (30) days after the entry of such judgment; 6.15 The occurrence of a Reportable Event with respect to any Pension Plan; the filing of a notice of intent to terminate a Pension Plan by Borrower, any ERISA Affiliate or any Subsidiary; the institution of proceedings to terminate a Pension Plan by the PBGC or any other Person; the withdrawal in a "complete withdrawal" or a "partial withdrawal" as defined in Sections 4203 and 4205, respectively, of ERISA by Borrower, any ERISA Affiliate or any Subsidiary from any Multi-Employer Plan; or the incurrence of any material increase in the contingent liability of Borrower or any Subsidiary with respect to any "employee welfare benefit plan" as defined in Section 3(1) of ERISA which covers retired employees and their beneficiaries; 6.16 The institution by Borrower, any ERISA Affiliate or any Subsidiary of steps to terminate any Pension Plan if, in order to effectuate such termination, Borrower, such ERISA Affiliate or such Subsidiary, as the case may be, would be required to make a contribution to such Pension Plan, or would incur a liability or obligation to such Pension Plan, in excess of $100,000.00; or the institution by the PBGC of steps to terminate any Pension Plan; - 37 - 38 6.17 The occurrence of any Change of Control Event; or 6.18 The occurrence of any default or event of default on the part of Borrower under or within the meaning of any of the Leases which is declared by the lessee(s) under such Lease and is not cured by Borrower or waived by such lessee(s) within thirty (30) days after the declaration of such default and which could reasonably be expected to have a Material Adverse Effect; THEN, and in each such event (other than an event described in Sections 6.08 or 6.09), Lender may declare that its obligation to make Revolving Credit Loans under this Agreement has terminated, whereupon such obligation of Lender shall be immediately and forthwith terminated, and Lender may further declare the entire outstanding principal balance of and all accrued and unpaid interest on the Revolving Credit Note and all of the other Borrower's Obligations to be forthwith due and payable, whereupon all of the unpaid principal balance of and all accrued and unpaid interest on the Revolving Credit Note and all of such other Borrower's Obligations shall become and be immediately due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by Borrower, and Lender may exercise any and all other rights and remedies which it may have under any of the other Transaction Documents or under applicable law; provided, however, that upon the occurrence of any event described in Sections 6.08 or 6.09, Lender's obligation to make Revolving Credit Loans under this Agreement shall automatically terminate and the entire outstanding principal balance of and all accrued and unpaid interest on the Revolving Credit Note and all of the other Borrower's Obligations shall automatically become immediately due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by Borrower, and Lender may exercise any and all other rights and remedies which it may have under any of the other Transaction Documents or under applicable law. If any Default or Event of Default under this Agreement has occurred and is continuing, in addition to all of Lender's other rights and remedies under this Agreement and the other Transaction Documents and at law or in equity, Lender shall have the right, in its sole and absolute discretion, to (a) reduce the amount of the Lender's Revolving Credit Commitment, (b) create reserves and/or allowances against Unused Availability, Eligible Accounts, Eligible Inventory and/or Eligible Lease Payments and/or (c) reduce the advance rates against Eligible Accounts, Eligible Inventory and/or Eligible Lease payments set forth in the definition of the Borrowing Base. SECTION 7. GENERAL. 7.01 No Waiver. No failure or delay by Lender in exercising any right, remedy, power or privilege hereunder or under any other Transaction Document shall operate as a waiver thereof; nor shall any single or partial exercise thereof preclude any other or further exercise thereof or the exercise of any other right, remedy, power or privilege. The remedies provided herein and in the other Transaction Documents are cumulative and not exclusive of any remedies provided by law. Nothing herein contained shall in any way affect the right of Lender to exercise any statutory or common law right of banker's lien or set-off. 7.02 Right of Set-Off. Upon the occurrence and during the continuance of any Event of Default, Lender is hereby authorized at any time and from time to time, without notice to Borrower (any such notice being expressly waived by Borrower) and to the fullest extent permitted by law, to set-off and apply any and all deposits (general or special, time or demand, provisional or final) at any time held by Lender and any and all other indebtedness at any time owing by Lender to or for the credit or account of Borrower against any and all of the Borrower's Obligations irrespective of whether or not Lender shall have made any demand hereunder or under any of the other Transaction Documents and although such obligations may be contingent or unmatured. Lender agrees to promptly notify Borrower after any such set-off and application made by Lender, provided, however, that the failure to give such notice shall not affect the validity of such set-off and application. The rights of Lender under this Section 7.02 are in addition to any other rights and remedies (including, without limitation, other rights of set-off) which Lender may have. Nothing contained in this Agreement or any other Transaction Document shall impair the right of Lender to exercise any right of set-off or counterclaim it may have against Borrower and to apply the amount subject to such exercise to the payment of indebtedness of Borrower unrelated to this Agreement or the other Transaction Documents. 7.03 Cost and Expenses. Borrower agrees, whether or not any Revolving Credit Loan is made hereunder, to pay Lender upon demand for (i) all out-of-pocket costs and expenses and all Attorneys' Fees - 38 - 39 incurred by Lender in connection with the preparation, documentation, negotiation, execution and/or administration of this Agreement, the Revolving Credit Note and/or any of the other Transaction Documents, (ii) all recording, filing and search fees and expenses incurred by Lender in connection with this Agreement and the other Transaction Documents, (iii) all out-of-pocket costs and expenses and all Attorneys' Fees incurred by Lender in connection with the (A) the preparation, documentation, negotiation and execution of any amendment, modification, extension or renewal of this Agreement, the Revolving Credit Note and/or any of the other Transaction Documents, (B) the preparation of any waiver or consent hereunder or under any of the other Transaction Documents or (C) any Default or Event of Default or alleged Default or Event of Default hereunder, (iv) if an Event of Default occurs, all out-of-pocket costs and expenses and all Attorneys' Fees incurred by Lender in connection with such Event of Default and collection and other enforcement proceedings resulting therefrom and (v) all other Attorneys' Fees incurred by Lender relating to or arising out of or in connection with this Agreement or any of the other Transaction Documents. Borrower further agrees to pay or reimburse Lender for any stamp or other taxes which may be payable with respect to the execution, delivery, recording and/or filing of this Agreement, the Revolving Credit Note or any of the other Transaction Documents. All of the obligations of Borrower under this Section 7.03 shall survive the satisfaction and payment of the Borrower's Obligations and the termination of this Agreement. 7.04 Environmental Indemnity. Borrower hereby agrees to indemnify Lender and hold Lender harmless from and against any and all losses, liabilities, damages, injuries, costs, expenses and claims of any and every kind whatsoever (including, without limitation, court costs and attorneys' fees and expenses) which at any time or from time to time may be paid, incurred or suffered by, or asserted against, Lender for, with respect to or as a direct or indirect result of the violation by Borrower or any Subsidiary of any Environmental Laws; or with respect to, or as a direct or indirect result of the presence on or under, or the Release from, properties owned, leased or operated by Borrower and/or any Subsidiary in the conduct of their respective businesses into or upon any land, the atmosphere or any watercourse, body of water or wetland, of any Hazardous Substances or any other hazardous or toxic waste, substance or constituent or other substance (including, without limitation, any losses, liabilities, damages, injuries, costs, expenses or claims asserted or arising under the Environmental Laws); and the provisions of and undertakings and indemnification set out in this Section 7.04 shall survive the satisfaction and payment of the Borrower's Obligations and the termination of this Agreement. 7.05 General Indemnity. In addition to the payment of expenses pursuant to Section 7.03, whether or not the transactions contemplated hereby shall be consummated, Borrower hereby agrees to indemnify, pay and hold Lender and any holder(s) of the Revolving Credit Note, and the officers, directors, employees, agents and affiliates of Lender and such holder(s) (collectively, the "Indemnities") harmless from and against any and all other liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, expenses and disbursements of any kind or nature whatsoever (including, without limitation, the reasonable fees and disbursements of counsel for such Indemnities in connection with any investigative, administrative or judicial proceeding commenced or threatened, whether or not such Indemnitees shall be designated a party thereto), that may be imposed on, incurred by or asserted against the Indemnitees, in any manner relating to or arising out of this Agreement, any of the other Transaction Documents or any other agreement, document or instrument executed and delivered by Borrower or any other Obligor in connection herewith or therewith, the statements contained in any commitment letters delivered by Lender, Lender's agreement to make the Revolving Credit Loans hereunder or the use or intended use of the proceeds of any Revolving Credit Loan hereunder (collectively, the "indemnified liabilities"); provided that Borrower shall have no obligation to an Indemnitee hereunder with respect to indemnified liabilities arising from the gross negligence or willful misconduct of that Indemnitee as determined by a court of competent jurisdiction in a final nonappealable order. To the extent that the undertaking to indemnify, pay and hold harmless set forth in the preceding sentence may be unenforceable because it is violative of any law or public policy, Borrower shall contribute the maximum portion that it is permitted to pay and satisfy under applicable law to the payment and satisfaction of all indemnified liabilities incurred by the Indemnitees or any of them. The provisions of the undertakings and indemnification set out in this Section 7.05 shall survive satisfaction and payment of the Borrower's Obligations and the termination of this Agreement. 7.06 Authority to Act. Lender shall be entitled to act on any notices and instructions (telephonic or written) believed by Lender in good faith to have been sent or delivered by any person authorized to act on - 39 - 40 behalf of Borrower pursuant hereto, regardless of whether such notice or instruction was in fact delivered by a person authorized to act on behalf of Borrower, and Borrower hereby agrees to indemnify Lender and hold Lender harmless from and against any and all losses and expenses, if any, ensuing from any such action. 7.07 Notices. Any notice, request, demand, consent, confirmation or other communication hereunder shall be in writing and delivered in person or sent by telecopy or registered or certified mail, return receipt requested and postage prepaid, to the applicable party at its address or telecopy number set forth on the signature pages hereof (with a copy, in the case of notices sent to Borrower, to be sent to John McCoy, Esq., Taft, Stettinius & Hollister, 1800 Star Bank Center, 425 Walnut Street, Cincinnati, Ohio 45202), or at such other address or telecopy number as any party hereto may designate as its address for communications hereunder by notice so given. Such notices shall be deemed effective on the day on which delivered or sent if delivered in person or sent by telecopy, or on the third (3rd) Domestic Business Day after the day on which mailed, if sent by registered or certified mail. 7.08 Consent to Jurisdiction: Waiver of Jury Trial. BORROWER IRREVOCABLY SUBMITS TO THE NON-EXCLUSIVE JURISDICTION OF ANY MISSOURI STATE COURT OR ANY UNITED STATES OF AMERICA COURT SITTING IN THE EASTERN DISTRICT OF MISSOURI, AS LENDER MAY ELECT, IN ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY OTHER TRANSACTION DOCUMENT. BORROWER HEREBY IRREVOCABLY AGREES THAT ALL CLAIMS IN RESPECT TO SUCH SUIT, ACTION OR PROCEEDING MAY BE HELD AND DETERMINED IN ANY OF SUCH COURTS. BORROWER IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, ANY OBJECTION WHICH BORROWER MAY NOW OR HEREAFTER HAVE TO THE LAYING OF VENUE OF ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT, AND BORROWER FURTHER IRREVOCABLY WAIVES ANY CLAIM THAT SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM. BORROWER HEREBY EXPRESSLY WAIVES ALL RIGHTS OF ANY OTHER JURISDICTION WHICH BORROWER MAY NOW OR HEREAFTER HAVE BY REASON OF ITS PRESENT OR SUBSEQUENT DOMICILES. BORROWER AUTHORIZES THE SERVICE OF PROCESS UPON BORROWER BY REGISTERED MAIL SENT TO BORROWER AT ITS ADDRESS SET FORTH IN SECTION 7.07. BORROWER AND LENDER HEREBY IRREVOCABLY WAIVE THE RIGHT TO TRIAL BY JURY WITH RESPECT TO ANY ACTION IN WHICH BORROWER AND LENDER ARE PARTIES RELATING TO OR ARISING OUT OF OR IN CONNECTION WITH THIS AGREEMENT OR ANY OF THE OTHER TRANSACTION DOCUMENTS. 7.09 Governing Law. This Agreement, the Revolving Credit Note and all of the other Transaction Documents shall be governed by and construed in accordance with the substantive laws of the State of Missouri (without reference to conflict of law principles). 7.10 Amendments and Waivers. Any provision of this Agreement, the Revolving Credit Note or any of the other Transaction Documents may be amended or waived if, but only if, such amendment or waiver is in writing and is signed by Borrower and Lender. 7.11 References; Headings for Convenience. Unless otherwise specified herein, all references herein to Section numbers refer to Section numbers of this Agreement, all references herein to Exhibits "A", "B" and "C" refer to annexed Exhibits "A", "B" and "C" which are hereby incorporated herein by reference and all references herein to Schedules 2.02(f), 4.05, 4.08, 4. 10, 4. 12, 4. 16, 4.1 7 and 4.18 refer to annexed Schedules 2.02(f), 4.05, 4.08, 4.10, 4.12, 4.16, 4.17 and 4.18 which are hereby incorporated herein by reference. The Section headings are furnished for the convenience of the parties and are not to be considered in the construction or interpretation of this Agreement. 7.12 Successors and Assigns. The provisions of this Agreement shall be binding upon and inure to the benefit of Borrower and Lender and their respective successors and assigns, except that Borrower may not assign or otherwise transfer any of its rights or delegate any of its obligations under this Agreement. 7.13 NO ORAL AGREEMENTS; ENTIRE AGREEMENT. ORAL AGREEMENTS OR COMMITMENTS TO LOAN MONEY, EXTEND CREDIT OR TO FORBEAR FROM ENFORCING REPAYMENT OF A DEBT, INCLUDING PROMISES TO EXTEND OR RENEW SUCH DEBT, ARE NOT ENFORCEABLE. TO PROTECT BORROWER AND LENDER FROM MISUNDERSTANDING OR DISAPPOINTMENT, ANY AGREEMENTS REACHED BY BORROWER - 40 - 41 AND LENDER COVERING SUCH MATTERS ARE CONTAINED IN THIS AGREEMENT AND THE OTHER TRANSACTION DOCUMENTS, WHICH AGREEMENT AND OTHER TRANSACTION DOCUMENTS ARE A COMPLETE AND EXCLUSIVE STATEMENT OF THE AGREEMENTS BETWEEN BORROWER AND LENDER, EXCEPT AS BORROWER AND LENDER MAY LATER AGREE IN WRITING TO MODIFY THEM. This Agreement: embodies the entire agreement and understanding between the parties hereto and supersedes all prior agreements and understandings (oral or written) relating to the subject matter hereof. 7.14 Severability. In the event any one or more of the provisions contained in this Agreement should be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein shall not in any way be affected or impaired thereby. 7.15 Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. 7.16 Resurrection of the Borrower's Obligations. To the extent that Lender receives any payment on account of any of the Borrower's Obligations, and any such payment(s) or any part thereof are subsequently invalidated, declared to be fraudulent or preferential, set aside, subordinated and/or required to be repaid to a trustee, receiver or any other Person under any bankruptcy act, state or Federal law, common law or equitable cause, then, to the extent of such payment(s) received, the Borrower's Obligations or part thereof intended to be satisfied and any and all Liens upon or pertaining to any Property or assets of Borrower and theretofore created and/or existing in favor of Lender as security for the payment of such Borrower's Obligations shall be revived and continue in full force and effect, as if such payment(s) had not been received by Lender and applied on account of the Borrower's Obligations. 7.17 Independence of Covenants. All of the covenants contained in this Agreement and the other Transaction Documents shall be given independent effect so that if a particular action, event or condition is prohibited by any one of such covenants, the fact that it would be permitted by an exception to, or otherwise be in compliance within the provisions of, another covenant shall not avoid the occurrence of a Default or Event of Default if such action is taken, such event occurs or such condition exists. 7.18 Subsidiary Reference. Any reference in this Agreement to a Subsidiary of Borrower, and any financial definition, ratio, restriction or other provision of this Agreement which is stated to be applicable to Borrower and its Subsidiaries or which is to be determined on a "consolidated" or "consolidating" basis, shall apply only to the extent Borrower has any Subsidiaries and, where applicable, to the extent any such Subsidiaries are consolidated with Borrower for financial reporting purposes in accordance with GAAP. 7.19 Compliance with Usury Laws. It is the intent of Borrower and Lender in the execution and performance of this Agreement, the Revolving Credit Note and the other Transaction Documents to contract in strict compliance with any and all applicable usury laws, including conflicts of law concepts, governing the Revolving Credit Loans. In furtherance thereof, Lender and Borrower stipulate and agree that none of the terms and provisions contained in this Agreement, the Revolving Credit Note or any of the other Transaction Documents shall ever be construed to create a contract to pay, as consideration for the use, forbearance or detention of money, interest at a rate in excess of the highest rate permitted by applicable law (the "Highest Lawful Rate") and that for purposes hereof "interest" shall include the aggregate of all charges which constitute interest under such laws that are contracted for, charged or received under this Agreement, the Revolving Credit Note or any of the other Transaction Documents; and in the event that, notwithstanding the foregoing, under any circumstances the aggregate amounts taken, reserved, charged, received or paid on the Revolving Credit Loans include amounts which by applicable law are deemed interest which would exceed the Highest Lawful Rate, then such excess shall be deemed to be a mistake and Lender shall credit the same on the principal balance of the Revolving Credit Loans hereunder (or if all of the Borrower's Obligations shall have been paid in full, refund said excess to Borrower). In the event of demand for payment of the Revolving Credit Note and/or any of the other Borrower's Obligations by Lender, or in the event of any required or permitted prepayment, then such consideration that constitutes interest may never include more than the Highest Lawful Rate and any excess interest, if any, provided for in this Agreement, the Revolving Credit Note or otherwise shall be canceled automatically as of the date of such acceleration or prepayment and, if theretofore paid, shall be credited against the principal balance of the Revolving Credit Loans hereunder (or, if all of the Borrower's - 41 - 42 Obligations shall have been repaid in full, refunded to Borrower). The provisions of the section shall control over all other provisions of this Agreement, the Revolving Credit Note and/or the other Transaction Documents which may be in apparent conflict herewith. IN WITNESS WHEREOF, Borrower and Lender have executed this Loan Agreement this 29th day of October, 1997. INTERLOTT TECHNOLOGIES, INC. By /s/ Jerome J. Cain ---------------------------- Title: Chief Executive Officer ------------------------ By /s/ L. Rogers Wells ---------------------------- Title: Chief Executive Officer ------------------------ 10830 Millington Court Cincinnati, Ohio 45242 Attention: Chief Executive Officer and Chief Financial Officer Telecopy number:(513) 792-7001 -------------- MERCANTILE BUSINESS CREDIT INC. By /s/ Marian H. Kammerer ---------------------------- Title: Vice President ------------------------ 100 South Brentwood Boulevard Suite 500 St. Louis, Missouri 63105 Attention: Senior Credit Officer Telecopy number: (314) 579-8480 -42- 43 SCHEDULE 2.02(f) Authorized Individuals L. Rogers Wells David F. Nichols Jerome J. Cain -43- 44 SCHEDULE 4.05 - LITIGATION In January 1996, Borrower filed a civil action in the Court of Common Pleas for Hamilton County, Ohio against Lottery Enterprises, Inc. ("LEI") to collect sums allegedly owed to it under an agreement in principle with LEI. That action has been removed to Federal Court, and is styled International Lottery, Inc. v. Lottery Enterprises, Inc. Case No. C-1-96-205, United States District Court, Southern District of Ohio, Western Division. Borrower's claims under the agreement in principle arose in connection with a potential merger transaction between Borrower and LEI in 1995 that was not consummated. The agreement in principle provided for the reimbursement of Borrower's expenses by LEI, and the payment by LEI of a break-up fee to Borrower, under certain circumstances. LEI has denied Borrower's allegations, and has asserted counterclaims against Borrower for breach or contract, unfair competition, and tortious interference with its business, seeking damages in excess of $500,000. Westwood Fabrication & Sheetmetal, Inc. filed suit against Borrower in the Montgomery County, Ohio Court of Common Pleas on May 6, 1997. Westwood alleges that Borrower has failed to pay for merchandise (ITVM dispensing machine cabinets) valued at $36,910. Borrower admits that it ordered the cabinets. However, Borrower denies that it is obliged to pay for the cabinets, which were defective. Borrower has made a counterclaim for $40,454, which represents the costs incurred by Borrower as a result of Westwood's delivery of defective cabinets. Discovery in the case has not been completed. The case is set for trial on February 3,1998. [Please note that Borrower is listing the Westwood litigation in the interest of full disclosure and that Borrower does not consider the amount in controversy in this matter to be material.] Default judgment against Borrower in Forms Plus Inc. v. Interlott, Inc. in the amount of $779.63 Default judgment against Borrower in Blue Chip Fasteners v. Interlott, Inc. in the amount of $1,091.39 45 SCHEDULE 4.08 Subsidiaries NONE -45- 46 SCHEDULE 4.10 - OTHER DEBT, GUARANTIES AND CAPITAL LEASES Promissory Note of Borrower payable to the order of Thomas E. Turek, M.D. in the principal sum of $400,000.00 dated September 22, 1992. Amended and Restated Promissory Note of Borrower payable to the order of Thomas L. Goila in the principal sum of $79,000.00 dated September 25, 1992. 1,335,000 issued and outstanding shares of the Borrower's Series A Preferred Stock. The Borrower's preferred stock is nonparticipating and has no rights to dividends. The holders of the preferred stock are entitled to sell to the Borrower all of their shares of preferred stock at a price of $1.00 per share upon (i) the payment of all debts of the Borrower outstanding as of September 25, 1992, (ii) the reporting by the Borrower of retained earnings of at least $1,000,000 determined in accordance with generally accepted accounting principles, and (iii) the payment in full by the Borrower of a promissory note in the original amount of $400,000 to Thomas E. Turek. The Borrower may, at its discretion, redeem all or part of the outstanding preferred stock at any time. The redemption price for the preferred stock is $1.00 per share and may be payable in the form of a promissory note. 47 SCHEDULE 4.12 - EXISTING LIENS Lien by the Ohio Bureau of Employment Services dated April 3, 1992 filed with the Hamilton County Recorder's Office for unpaid unemployment compensation in the amount of $273.00. Personal Property Tax Lien dated December 15, 1992 filed with the Hamilton County Recorder's Office in the amount of $315.83. 48 SCHEDULE 4.16 - PATENTS. TRADEMARKS. COPYRIGHTS AND LICENSES Patents 5,472,247 Multipoint high security locking mechanism for lottery machines 5,330,185 Method and apparatus for random play of lottery games D376,621 Double game ticket vending machine 4,982,337 System for distributing lottery tickets
Trademarks Reg. No. 1,949,978 - Instant Success Reg. No. 1,822,517 - Interlott (word only) Reg. No. R1840378 - Interlott (word and design) Copyrights None Licenses Pull-tab manufacturing and license agreement among Algonquin Industries, Inc., Kazmier Kasper and Borrower dated January 13, 1994 regarding a pull-tab ticket mechanism. 49 SCHEDULE 4.17 Environmental and Health and Safetv Matters NONE -49- 50 SCHEDULE 4.18 Existing Investments NONE -50- 51 EXHIBIT A BORROWING BASE CERTIFICATE This Borrowing Base Certificate is delivered pursuant to Section 2.01 (c) of that certain Loan Agreement dated October 29, 1997, by and among Interlott Technologies, Inc. ("Borrower") and Mercantile Business Credit Inc. ("Lender"), as the same may from time to time be amended, modified, extended or renewed (the "Loan Agreement"). All capitalized terms used and not otherwise defined herein shall have the respective meanings ascribed to them in the Loan Agreement. Borrower hereby represents and warrants to Lender that the following information is true and correct as of ___________, 19___: 1. 85% of face amount of Eligible Accounts of Borrower $ ------------- 2. 50% of Eligible Inventory of Borrower, valued in accordance with GAAP $ ------------- 3. Inventory Sublimit $ 2,500,000.00 4. Inventory Availability (Lesser of Item 2 or Item 3) -------------- 5. 65% of Eligible Lease Payments $ -------------- 6. Borrowing Base (Sum of Item 1 plus Item 4 plus Item 5) $ ---- ---- -------------- 7. Lender's Revolving Credit Commitment $15,000,000.00 8. Borrower's Maximum Availability (Lesser of Item 6 or Item 7) $ -------------- 9. Aggregate principal amount of outstanding Revolving Credit Loans $ -------------- 10. Aggregate undrawn face amount of outstanding Letters of Credit $ -------------- 11. Total Outstandings [Sum of Item 9 plus Item 10] $ ---- -------------- 12. Borrowing Availability Excess (Deficit) [Item 8 minus Item 11] $ ----- (Negative amount represents mandatory repayment) --------------
If Item 12 above is negative, this Certificate is accompanied by the mandatory repayment required by Section 2.01(d) of the Loan Agreement. This Borrowing Base Certificate is dated the_______ day of________, 19___. INTERLOTT TECHNOLOGIES, INC. By: ------------------------------------------------ Title: --------------------------------------------- -51- 52 EXHIBIT B REVOLVING CREDIT NOTE $15,000,000.00 St. Louis, Missouri October 29, 1997 FOR VALUE RECEIVED, on the last day of the Revolving Credit Period, the undersigned, INTERLOTT TECHNOLOGIES, INC., a Delaware corporation ("Borrower"), hereby promises to pay to the order of MERCANTILE BUSINESS CREDIT INC., a Missouri corporation ("Lender"), the principal sum of Fifteen Million Dollars ($15,000,000.00), or such lesser sum as may then constitute the aggregate unpaid principal amount of all Revolving Credit Loans made by Lender to Borrower pursuant to the Loan Agreement referred to below. The aggregate principal amount of Revolving Credit Loans which Lender shall be committed to have outstanding under this Note at any one time shall not exceed Fifteen Million Dollars ($15,000,000.00), which amount may be borrowed, paid, reborrowed and repaid, in whole or in part, subject to the terms and conditions of this Note and of the Loan Agreement referred to below. Borrower further promises to pay to the order of Lender interest on the unpaid principal balance from time to time outstanding under this Note on the dates and at the rates set forth in the Loan Agreement referred to below. All payments received by Lender under this Note shall be allocated among the principal, interest, collection costs and expenses and other amounts due under this Note as follows: (a) so long as no Event of Default under the Loan Agreement has occurred and is continuing, as directed by Borrower; and (b) so long as any Event of Default under the Loan Agreement has occurred and is continuing, in such order and manner as Lender shall elect. The amount of interest accruing under this Note shall be computed on an actual day, 360-day year basis. All payments of principal and interest under this Note shall be made in lawful currency of the United States at the office of Lender situated at 100 South Brentwood Boulevard, Suite 500, St. Louis, Missouri 63105, or at such other place as the holder of this Note may from time to time designate in writing. Lender shall record in its books and records the date and amount of each Revolving Credit Loan made by it to Borrower and the date and amount of each payment of principal and/or interest made by Borrower with respect thereto; provided, however, that the obligation of Borrower to repay each Revolving Credit Loan made to Borrower under this Note shall be absolute and unconditional, notwithstanding any failure of Lender to make any such recordation or any mistake by Lender in connection with any such recordation. The books and records of Lender showing the account between Lender and Borrower shall be admissible in evidence in any action or proceeding and shall constitute prima facie proof of the items therein set forth in the absence of manifest error. Subject to the terms of the Loan Agreement referred to below, Borrower shall have the right to prepay all at any time or any portion from time to time of the unpaid principal of this Note prior to maturity, without penalty or premium. This Note is the Revolving Credit Note referred to in that certain Loan Agreement dated the date hereof by and between Borrower and Lender (as the same may from time to time be amended, modified, extended or renewed, the "Loan Agreement"). The Loan Agreement, among other things, contains provisions for acceleration of the maturity of this Note upon the occurrence of certain stated events and also for prepayments on account of the principal of this Note and interest on this Note prior to the maturity of this Note upon the terms and conditions specified therein. All capitalized terms used and not otherwise defined in this Note shall have the respective meanings ascribed to them in the Loan Agreement. This Note is secured by, among other things, that certain Security Agreement dated the date hereof and executed by Borrower in favor of Lender (as the same may from time to time be amended, modified, extended or renewed, the "Security Agreement") and that certain Patent, Trademark and License Security Agreement dated the date hereof and executed by Borrower in favor of Lender (as the same may from time to time be amended, modified, extended or renewed, the "Patent, Trademark and License Security 53 Agreement"), to which Security Agreement and Patent, Trademark and License Security Agreement reference is hereby made for a description of the security and a statement of the terms and conditions upon which this Note is secured. If any Event of Default under the Loan Agreement shall occur and be continuing, then Lender's obligation to make additional Revolving Credit Loans under this Note may be terminated in the manner and with the effect as provided in the Loan Agreement and the entire outstanding principal balance of this Note and all accrued and unpaid interest thereon may be declared to be immediately due and payable in the manner and with the effect as provided in the Loan Agreement. In the event that any payment of any principal of or interest on this Note is not paid when due, whether by reason of maturity, acceleration or otherwise, and this Note is placed in the hands of an attorney or attorneys for collection or for foreclosure of the Security Agreement or the Patent, Trademark and License Security Agreement, or if this Note is placed in the hands of an attorney or attorneys for representation of Lender in connection with bankruptcy or insolvency proceedings relating hereto, Borrower promises to pay to the order of Lender, in addition to all other amounts otherwise due hereon, the costs and expenses of such collection, foreclosure and representation, including, without limitation, reasonable attorneys' fees and expenses (whether or not litigation shall be commenced in aid thereof). All parties hereto severally waive presentment for payment, demand for payment, protest, notice of protest and notice of dishonor. This Note shall be governed by and construed in accordance with the substantive laws of the State of Missouri (without reference to conflict of law principles). INTERLOTT TECHNOLOGIES, INC. By: ----------------------------------------- Title: -------------------------------------- By: ----------------------------------------- Title: -------------------------------------- -2- 54 EXHIBIT C __________, 19____ Mercantile Business Credit Inc. 100 South Brentwood Boulevard Suite 500 St. Louis, Missouri 63105 Attention: Senior Credit Officer Ladies and Gentlemen: Reference is hereby made to that certain Loan Agreement dated October 29, 1997, by and between you and the undersigned, as the same may from time to time amended, modified, extended or renewed (the "Loan Agreement"). All capitalized terms used and not otherwise defined herein shall have the respective meanings ascribed to them in the Loan Agreement. Borrower hereby certifies to Lender that as of the date hereof: (a) all of the representations and warranties of Borrower contained in the Loan Agreement and in the other Transaction Documents are true and correct in all material respects on and as of the date hereof as if made on and as of the date hereof; (b) no violation or breach of any of the affirmative covenants of Borrower contained in the Loan Agreement has occurred and is continuing; (c) no violation or breach of any of the negative covenants of Borrower contained in the Loan Agreement has occurred and is continuing; (d) no Default or Event of Default under or within the meaning of the Loan Agreement has occurred and is continuing; (e) the financial statements of Borrower [and its subsidiaries] delivered to you with this letter are true, correct and complete and have been prepared in accordance with GAAP consistently applied [(subject to normal year-end adjustments and absence of footnotes)]; and (f) the financial covenant information set forth in Schedule 1 to this letter is true and correct. Very truly yours, INTERLOTT TECHNOLOGIES, INC. By: ------------------------------------ Title: --------------------------------- -53- 55 SCHEDULE 1 Financial Covenant Information as as of , 19 ----------------- Financial Covenant Actual Required - ------------------ ------ --------
-54- EX-4.3.(A) 3 REVOLVING CREDIT NOTE 1 EXHIBIT 4.3(a) REVOLVING CREDIT NOTE $15,000,000.00 St. Louis, Missouri October 29, 1997 FOR VALUE RECEIVED, on the last day of the Revolving Credit Period, the undersigned, INTERLOTT TECHNOLOGIES, INC., a Delaware corporation ("Borrower"), hereby promises to pay to the order of MERCANTILE BUSINESS CREDIT INC., a Missouri corporation ("Lender"), the principal sum of Fifteen Million Dollars ($15,000,000.00), or such lesser sum as may then constitute the aggregate unpaid principal amount of all Revolving Credit Loans made by Lender to Borrower pursuant to the Loan Agreement referred to below. The aggregate principal amount of Revolving Credit Loans which Lender shall be committed to have outstanding under this Note at any one time shall not exceed Fifteen Million Dollars ($15,000,000.00), which amount may be borrowed, paid, reborrowed and repaid, in whole or in part, subject to the terms and conditions of this Note and of the Loan Agreement referred to below. Borrower further promises to pay to the order of Lender interest on the unpaid principal balance from time to time outstanding under this Note on the dates and at the rates set forth in the Loan Agreement referred to below. All payments received by Lender under this Note shall be allocated among the principal, interest, collection costs and expenses and other amounts due under this Note as follows: (a) so long as no Event of Default under the Loan Agreement has occurred and is continuing, as directed by Borrower; and (b) so long as any Event of Default under the Loan Agreement has occurred and is continuing, in such order and manner as Lender shall elect. The amount of interest accruing under this Note shall be computed on an actual day, 360-day year basis. All payments of principal and interest under this Note shall be made in lawful currency of the United States at the office of Lender situated at 100 South Brentwood Boulevard, Suite 500, St. Louis, Missouri 63105, or at such other place as the holder of this Note may from time to time designate in writing. Lender shall record in its books and records the date and amount of each Revolving Credit Loan made by it to Borrower and the date and amount of each payment of principal and/or interest made by Borrower with respect thereto; provided, however, that the obligation of Borrower to repay each Revolving Credit Loan made to Borrower under this Note shall be absolute and unconditional, notwithstanding any failure of Lender to make any such recordation or any mistake by Lender in connection with any such recordation. The books and records of Lender showing the account between Lender and Borrower shall be admissible in evidence in any action or proceeding and shall constitute prima facie proof of the items therein set forth in the absence of manifest error. Subject to the terms of the Loan Agreement referred to below, Borrower shall have the right to prepay all at any time or any portion form time to time of the unpaid principal of this Note prior to maturity, without penalty or premium. This Note is the Revolving Credit Note referred to in that certain Loan Agreement dated the date hereof by and between Borrower and Lender (as the same may from time to time be amended, modified, extended or renewed, the "Loan Agreement"). The Loan Agreement, among other things, contains provisions for acceleration of the maturity of this Note upon the occurrence of certain stated events and also for prepayments on account of the principal of this Note and interest on this Note prior to the maturity of this Note upon the terms and conditions specified therein. All capitalized terms used and not otherwise defined in this Note shall have the respective meanings ascribed to them in the Loan Agreement. This Note is secured by, among other things, that certain Security Agreement dated the date hereof and executed by Borrower in favor of Lender (as the same may from time to time be amended, modified, extended or renewed, the "Security Agreement") and that certain Patent, Trademark and License Security Agreement dated the date hereof and executed by Borrower in favor of Lender (as the same may from time to time be amended, modified, extended or renewed, the "Patent, Trademark and License Security Agreement"), to which Seucrity Agreement and Patent, Trademark and License Security Agreement reference 2 is hereby made for a description of the security and a statement of the terms and conditions upon which this Note is secured. If any Event of Default under the Loan Agreement shall occur and be continuing, then Lender's obligation to make additional Revolving Credit Loans under this Note may be terminated in the manner and with the effect as provided in the Loan Agreement and the entire outstanding principal balance of this Note and all accrued and unpaid interest thereon may be declared to be immediately due and payable in the manner and with the effect as provided in the Loan Agreement. In the event that any payment of any principal of or interest on this Note is not paid when due, whether by reason of maturity, acceleration or otherwise, and this Note is placed in the hands of an attorney or attorneys for collection or for foreclosure of the Security Agreement of the Patent, Trademark and License Security Agreement, or if this Note is placed in the hands of an attorney or attorneys for representation of Lender in connection with bankruptcy or insolvency proceedings relating hereto, Borrower promises to pay to the order of Lender, in addition to all other amounts otherwise due hereon, the costs and expenses of such collection, foreclosure and representation, including, without limitation, reasonable attorneys' fees and expenses (whether or not litigation shall be commenced in aid thereof). All parties hereto severally waive presentment for payment, demand for payment, protest, notice of protest and notice of dishonor. This Note shall be governed by and construed in accordance with the substantive laws of the State of Missouri (without reference to conflict of law principles). INTERLOTT TECHNOLOGIES, INC. By /s/ Jerome J. Cain ---------------------------- Title: Chief Executive Officer ------------------------ By /s/ L. Rogers Wells ---------------------------- Title: Chief Executive Officer ------------------------ -2- EX-4.3.(B) 4 SECURITY AGREEMENT 1 Exhibit 4.3(b) SECURITY AGREEMENT THIS SECURITY AGREEMENT (this "Agreement") is made this 29th day of October, 1997, by INTERLOTT TECHNOLOGIES, INC., a Delaware corporation ("Borrower"), in favor of MERCANTILE BUSINESS CREDIT INC., a Missouri corporation ("Lender"). WITNESSETH: WHEREAS, Borrower and Lender are herewith entering into that certain Loan Agreement dated the date hereof (as the same may from time to time be amended, modified, extended or renewed, the "Loan Agreement"; all capitalized terms used and not otherwise defined in this Agreement shall have the respective meanings ascribed to them in the Loan Agreement); and WHEREAS, as a condition precedent to Lender entering into the Loan Agreement, Lender has required that Borrower execute and deliver this Agreement to Lender; and WHEREAS, in order to induce Lender to enter into the Loan Agreement, Borrower has agreed to execute and deliver this Agreement to Lender; NOW, THEREFORE, in consideration of the premises and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Borrower hereby covenants and agrees with Lender as follows: 1. Grant of Security Interest. For value received, Borrower hereby grants Lender a security interest in and lien on all of Borrower's now owned and existing and hereafter created, acquired or arising right, title and interest in, to and under the following described property, wherever located (collectively, the "Collateral"): (a) all accounts, accounts receivable, lease payments, rental payments, lease rights, contract rights, documents, instruments and other forms of obligation and other rights to the payment of money, and all goods whose sale, lease, rental or other disposition by Borrower have given rise to accounts and have been returned to or repossessed or stopped in transit by Borrower; (b) all inventory of Borrower, wherever located, whether under lease, in transit, held by others for Borrower's account, covered by warehouse receipts, purchase orders and/or contracts, or in the possession of any lessees, renters, carriers, forwarding agents, truckers, warehousemen, vendors or other Persons, including, without limitation, all raw materials, work in process, finished goods, supplies, goods, incidentals, office supplies and packaging and shipping materials; (c) all chattel paper of any kind or nature whatsoever, including, without limitation, all leases, rental agreements, installment sale agreements, conditional sale agreements and other chattel paper relating to or arising out of the sale, rental, lease or other disposition of any of the Collateral; (d) all general intangibles of any kind or nature whatsoever, including, without limitation, all patents, trademarks, copyrights and other intellectual property, and all applications for, registrations of and licenses of the foregoing, and all computer software, product specifications, trade secrets, licenses, trade names, service marks, goodwill, tax refunds and rights to tax refunds; (e) all goods, machinery, equipment, motor vehicles, trucks, tractors, trailers, appliances, furniture, furnishings, tools, dies, jigs and other tangible personal property and all accessories and parts relating thereto; 2 (f) all monies, reserves, deposits, certificates of deposit and deposit accounts and interest or dividends thereon, securities, cash, cash equivalents and other property now or at any time or times hereafter in the possession or under the control of Lender or any bailee of Lender; (g) all books, records, computer records, computer disks, ledger cards, programs and other computer materials, customer and supplier lists, invoices, orders and other property and general intangibles at any time evidencing or relating to any of the Collateral; (h) all accessions to any of the property described above and all substitutions, renewals, improvements and replacements of and additions thereto; and (i) all proceeds, including, without limitation, proceeds which constitute property of the types described in (a), (b), (c), (d), (e), (f), (g) and/or (h) above and any rents and profits of any of the foregoing items, whether cash or noncash, immediate or remote, including, without limitation, all income, accounts, contract rights, general intangibles, chattel paper, notes, drafts, acceptances, instruments and other rights to the payment of money arising out of the sale, rental, lease, exchange or other disposition of any of the foregoing items (provided, however, that nothing contained herein or in any financing statement shall be deemed to permit or assent to any such disposition other than (i) the sale or lease of inventory in the ordinary course of business (which does not include any sale or other transfer or lease of inventory in partial or total satisfaction of any Indebtedness) and (ii) other sales and dispositions permitted by the Loan Agreement), and insurance proceeds, and all products, of (a), (b), (c), (d), (e), {f), (g) and/or (h) above, and any indemnities, warranties and guaranties payable by reason of loss or damage to or otherwise with respect to any of the foregoing items; to secure the payment of (i) any and all of the present and future Borrower's Obligations, (ii) any and all present and future indebtedness, liabilities and obligations of Borrower under this Agreement, (iii) any and all other indebtedness, liabilities and obligations of Borrower to Lender of every kind and character, now existing or hereafter arising, absolute or contingent, joint or several or joint and several, otherwise secured or unsecured, due or not due, direct or indirect, expressed or implied in law, contractual or tortious, liquidated or unliquidated, at law or in equity, or otherwise, and whether heretofore or hereafter incurred or given by Borrower as principal, surety, endorser, guarantor or otherwise, and whether created directly or acquired by Lender by assignment or otherwise and (iv) any and all costs of collection and reasonable attorneys' fees and expenses incurred by Lender upon the occurrence of an Event of Default under this Agreement, in collecting or enforcing payment of any such indebtedness, liabilities or obligations or in preserving, protecting or realizing on the Collateral hereunder or in representing Lender in connection with bankruptcy or insolvency proceedings (hereinafter collectively referred to as the "Secured Obligations"). 2. Representations and Covenants of Borrower. Borrower hereby represents and warrants to Lender, and covenants and agrees with Lender, that: (a) Borrower is and will remain a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware; (b) Borrower has full corporate power and authority to borrow money and obtain other extensions of credit from Lender and to grant to Lender the security interest in the Collateral hereby stated to be granted; (c) the officer(s) of Borrower executing this Agreement have been duly elected and qualified and have been duly authorized and empowered to execute, deliver and perform the terms of this Agreement on behalf of Borrower; - 2 - 3 (d) the execution, delivery and performance of this Agreement by Borrower do not and will not violate any of the terms or provisions of the Certificate of Incorporation or By-Laws of Borrower; (e) the execution, delivery and performance of this Agreement by Borrower do not and will not violate any law, rule, regulation, order, writ, judgment, injunction, decree, determination or award presently in effect having applicability to Borrower or the terms of any of the Leases or any other indenture, agreement, document, instrument or undertaking to which Borrower is a party or by which it or any of its Properties is bound; (f) Borrower's chief executive office and the location of the only office where it keeps its books and records respecting the Collateral is that given at the end of this Agreement and all other places of business of Borrower are listed on Exhibit A attached hereto and incorporated herein by reference; (g) unless otherwise consented to in writing by Lender: (i) all of the Collateral (other than any Collateral consisting of Inventory which is in the possession of a lessee under a Lease, is in transit to a lessee under a Lease or is stored for a period of thirty (30) days or less at a warehouse located in one of the jurisdictions listed on Exhibit B attached hereto and incorporated herein by reference while in the process of being delivered to a lessee under a Lease) (A) is and will be kept solely at Borrower's chief executive office or at one of the other locations of Borrower listed on Exhibit A attached hereto and incorporated herein by reference (if mobile equipment or equipment of a type normally used in more than one location, remaining there when not in use), (B) is not of a type normally used in more than one state and will not be so used, (C) will not be attached or affixed in any manner to or become a part of any real estate or other personal property apart from other items of the Collateral and (D) is in the exclusive possession and control of Borrower; and (ii) all of the Collateral consisting of Inventory which is in the possession of a lessee under a Lease (A) is and will be kept solely within one of the jurisdictions listed on Exhibit B attached hereto and incorporated herein by reference and (B) will not be attached or affixed in any manner to or become a part of any real estate or other personal property apart from other items of the Collateral; (h) Borrower will not (i) change the location of its chief executive office, (ii) change the location of any of its other places of business, (iii) change the location of any of the Collateral (other than any Collateral which is in the possession of a lessee under a Lease) or permit the location of any of the Collateral (other than any Collateral which is in the possession of a lessee under a Lease) to be changed from Borrower's chief executive office or one of the other locations listed on Exhibit A attached hereto and incorporated herein by reference or (iv) establish any additional places of business or additional locations at which any of the Collateral (other than any Collateral which is in the possession of a lessee under a Lease) is stored, kept or processed, unless (A) Borrower gives Lender thirty (30) days prior written notice of the same and (B) prior to making any such change or establishing any such new location, Borrower executes and/or obtains and delivers to Lender any and all additional financing statements and/or amendments thereto, mortgagee waivers, bailee waivers, landlord waivers, warehousemen waivers and other agreements, documents or notices as may be reasonably required by Lender (provided, however, so long as no Event of Default and no event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing, Lender agrees that it will not require warehouseman waivers from warehouses which store Inventory which is in the process of being delivered to lessees under Leases for periods of thirty (30) days or less); and Borrower will not cause or permit any of the Collateral which is in the possession of a lessee under a Lease to be located at a location which is not within one of the jurisdictions listed on Exhibit B attached hereto and incorporated herein by reference unless (A) Borrower gives Lender thirty (30) days prior written notice of the same and (B) prior to causing or permitting any such change or any such new location, if such collateral location is in the United States of America, Borrower executes and delivers to Lender any and all additional financing statements and/or - 3 - 4 amendments thereto as may be necessary or as Lender may reasonably request to perfect Lender's security interest in such Collateral. In addition, Borrower covenants and agrees that if any Event of Default or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing or if the aggregate book value of all Inventory and other Collateral located outside of the United States of America exceeds the sum of $500,000.00, if requested by Lender, Borrower will promptly execute and/or obtain and deliver to Lender any and all agreements, documents and/or instruments as may be necessary or as Lender may reasonably request to perfect or protect Lender's security interest in and lien on any Inventory or other Collateral which is located outside of the United States of America; (i) Borrower is, or, as to Collateral acquired after the date hereof, will be, the sole and absolute owner of all of the Collateral, free and clear of any and all Liens and claims of any kind or nature whatsoever other than the security interest granted hereby and other Permitted Liens, and Borrower will defend the Collateral against all claims and demands of all persons at any time claiming the same or any interest therein; (j) no financing statement (other than any filed on behalf of Lender and any filed with respect to Permitted Liens) covering any of the Collateral is or will be on file in any public office at any time during the term of this Agreement; (k) Borrower will not, without the prior written consent of Lender, sell, transfer, lease or otherwise dispose of or offer to dispose of any of the Collateral or any interest therein other than (i) sales and leases of inventory by Borrower in the ordinary course of its business (which does not include any sale or other transfer or lease of inventory in partial or total satisfaction of any Indebtedness) and (ii) other sales, transfers, leases and dispositions permitted by the Loan Agreement; (l) Borrower will at all times keep (or cause the lessee(s) under the applicable Lease to keep) all of the Collateral consisting of inventory, goods, machinery, equipment and/or other tangible personal property in good order and repair (ordinary wear and tear excepted), excepting any loss, damage or destruction which is fully covered by proceeds of insurance, and will not use any of the Collateral or permit any of the Collateral to be used in violation of any law, rule, regulation, ordinance or insurance policy; (m) Borrower will pay when due (or cause the lessee(s) under the applicable Lease to pay when due) all taxes and assessments on the Collateral or for its use or operation or upon this Agreement or any of the Secured Obligations or with respect to the perfection of any security interest hereunder; (n) Borrower will at all times keep all of the Collateral of an insurable nature insured against loss, damage, theft and other risks, in such amounts and companies and under policies in such form, all as shall be required under Section 5.01(l) of the Loan Agreement; provided, however, that the foregoing shall not require Borrower to maintain such insurance on any Collateral which is in the possession of a lessee under a Lease. All insurance required by this Section 2(n) shall be with insurers rated A-XI or better by A.M. Best Company (or accorded a similar rating by another nationally or internationally recognized insurance rating agency of similar standing if A.M. Best Company is not then in the business of rating insurers or rating foreign insurers) or such other insurers as may from time to time be reasonably acceptable to Lender. Such policies of insurance shall contain an endorsement acceptable to Lender naming Lender as loss payee as its interests may appear. Such endorsement, or an independent instrument furnished to Lender, shall provide that the insurance companies will give Lender at least thirty (30) days written notice before any such policy or policies of insurance shall be amended or cancelled and that no act or default of Borrower, any lessee(s) under any Lease or any other Person shall affect the right of Lender to recover under such policy or policies of insurance in the event of any loss of or damage to any of the Collateral. Borrower hereby - 4 - 5 directs all insurers under such policies of insurance to pay all proceeds payable thereunder directly to Lender as its interest may appear. So long as no Event of Default under this Agreement and no event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing, all insurance proceeds received by Lender on account of any loss of or damage to any of the Collateral consisting of machinery, equipment, motor vehicles and/or other tangible personal property (other than Inventory), after deducting therefrom the reasonable charges and expenses paid or incurred in connection with the collection and disbursement of said proceeds, may, at the option of Borrower, either be used and applied for the sole purpose of paying the cost of repair, restoration or replacement of the Collateral damaged or destroyed, or be applied to the payment of the Secured Obligations in such order as directed by Borrower. All insurance proceeds received by Lender on account of any loss of or damage to any of the other Collateral (including, without limitation, any of the Collateral consisting of Inventory), after deducting therefrom the reasonable charges and expenses paid or incurred in connection with the collection and disbursement of said proceeds, shall be applied to the payment of the Secured Obligations in such order and manner as Lender may elect unless otherwise consented to in writing by Lender. If any Event of Default under this Agreement or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing, all insurance proceeds received or held by Lender on account of any loss of or damage to any of the Collateral, after deducting therefrom the reasonable charges and expenses paid or incurred in connection with the collection and disbursement of said proceeds, shall be applied to the payment of the Secured Obligations in such order and manner as Lender may elect unless otherwise consented to in writing by Lender. Borrower irrevocably makes, constitutes and appoints Lender (and all officers, employees or agents designated by Lender) as Borrower's true and lawful attorney (and agent-in-fact) to, if any Event of Default under this Agreement or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing or if Borrower fails to do upon the demand of Lender, (i) make, settle and adjust claims under such policies of insurance, (ii) endorse the name of Borrower on any check, draft, instrument or other item of payment of the proceeds of such policies of insurance and (iii) make all determinations and decisions with respect to such policies of insurance. In the event Borrower at any time or times hereafter shall fail to obtain or maintain any of the policies of insurance required above or to pay any premium in whole or in part relating thereto, then Lender, without waiving or releasing any obligation or default by Borrower hereunder, may at any time or times thereafter (but shall be under no obligation to do so) obtain and maintain such policies of insurance and pay such premium and take any other action with respect thereto which Lender deems advisable (and if Lender takes any of the foregoing actions it will give Borrower oral or written notice thereof within five (5) Domestic Business Days after the taking of such action). All sums so disbursed by Lender, including, without limitation, reasonable attorneys' fees, court costs, expenses and other charges relating thereto, shall be part of the Secured Obligations, payable by Borrower to Lender on demand; (o) Borrower will permit (and it will use its best efforts to cause the lessees under the Leases to permit) Lender to examine and inspect the Collateral or any part thereof, wherever located, at any reasonable time or times upon at least one (1) Domestic Business Day's prior oral or written notice from Lender to Borrower (provided, however, that no such notice need be given by Lender if any Event of Default or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing); (p) Borrower has not during the past five (5) years conducted business under any names other than "International Lottery, Inc.", "Interlott Technologies, Inc." and "Interlott". Borrower does not now and will not at any time during the term of this Agreement conduct business under any name other than the name "Interlott Technologies, Inc." and Borrower will not change its name or adopt or use any fictitious business name or trade name (other than - 5 - 6 the trade name "Interlott") without giving thirty (30) days prior written notice of the same to Lender; (q) if any of the Accounts is evidenced by a promissory note or other "instrument" (as defined in the Uniform Commercial Code or other applicable law), Borrower will, unless Lender otherwise agrees in writing, endorse such promissory note or other instrument "Pay to the order of Mercantile Business Credit Inc." and deliver the original(s) of such promissory note or other instrument to Lender; (r) if any Event of Default under this Agreement or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing, if requested by Lender, Borrower will immediately (i)) conspicuously mark each original of each Lease with the following legend "THIS LEASE HAS BEEN ASSIGNED BY INTERLOTT TECHNOLOGIES, INC. TO MERCANTILE BUSINESS CREDIT INC. PURSUANT TO A SECURITY AGREEMENT DATED OCTOBER 29, 1997, AS AMENDED" and deliver a copy of each Lease (as so marked) to Lender and/or (ii) deliver possession of all originals of each of the Leases to Lender, as requested by Lender; (s) if any Event of Default under this Agreement or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing, if requested by Lender, Borrower will immediately assign to Lender (pursuant to Uniform Commercial Code assignments in recordable form) all Uniform Commercial Code financing statements relating to Inventory which is then Subject to a Lease and which have been signed by the lessee(s), as debtor(s), in favor of Borrower, as secured party; (t) Borrower will from time to time, at its own expense, execute, deliver and file such financing and continuation statements and such amendments thereto under the Uniform Commercial Code or other applicable law in each jurisdiction where Borrower or any of the Collateral may be located and such other agreements, documents and instruments and do such other acts and things as may be necessary or as Lender may from time to time reasonably request, to establish and maintain a valid and perfected first priority security interest in the Collateral in favor of Lender to secure the payment of the Secured Obligations, including, without limitation, the execution and filing of applications for certificates of title naming Lender as first lienholder and the delivery of the originals of such certificates of title to Lender. Borrower hereby authorizes Lender to file one or more financing or continuation statements or amendments thereto relating to all or any part of the Collateral without the signature of Borrower where permitted by law; provided, however, that nothing in this Agreement shall relieve Borrower of its obligation to file all necessary financing and continuation statements and amendments thereto under the Uniform Commercial Code or other applicable law in each jurisdiction where Borrower or any of the Collateral may be located in order to perfect and protect the security interest granted to Lender under this Agreement. In addition, Borrower covenants and agrees that with respect to Accounts with respect to which the Account Debtor is the United States of America, any state of the United States or any other governmental body or any department, agency or instrumentality of any of the foregoing, if requested by Lender, Borrower will take such action and execute, deliver and file such agreements, documents and instruments as may be necessary or as Lender may reasonably request to insure that such Accounts are duly assigned to Lender in compliance with all applicable governmental requirements (including, without limitation, the Federal Assignment of Claims Act of 1940, as amended, if applicable) so that Lender is recognized by the Account Debtor to have all of the rights of an assignee of such Accounts; (u) Borrower will reimburse Lender upon demand for (i) all costs and expenses incident to perfecting, maintaining or terminating the security interest granted hereby, including filing and recording fees, fees for obtaining and transferring certificates of title, all taxes and all other out-of-pocket fees and expenses (including, without limitation, all reasonable - 6 - 7 attorneys' fees and expenses) paid or incurred by Lender in connection with any of the foregoing and (ii) all costs and expenses, including, without limitation, reasonable attorneys' fees and expenses, incurred by Lender in seeking to collect or enforce any rights under this Agreement or incurred by Lender in seeking to collect or enforce any of the Secured Obligations, all of which costs and expenses shall constitute a part of the Secured Obligations and be payable by Borrower to Lender on demand; (v) based on the locations of Borrower's offices and places of business and the location of the Collateral (including, without limitation, any Collateral which is in the possession of a lessee under a Lease), Exhibit C attached hereto and incorporated herein by reference sets forth a complete list of all of the filing offices where financing statements must be filed in order to perfect Lender's security interest in the Collateral (other than any Collateral consisting of Inventory which is located outside of the United States of America) to the extent such security interest can be perfected by the filing of financing statements under the Uniform Commercial Codes of the applicable state(s); and (w) this Agreement shall not transfer to or impose upon Lender or subject Lender to any of the obligations, duties, warranties, covenants, undertakings or liabilities of Borrower to any Person under the terms of any of the Leases, and this Agreement shall not affect, modify, relieve or release Borrower from any of its obligations, duties, warranties, covenants, undertakings and/or liabilities under the terms of any of the Leases, it being understood that, notwithstanding this Agreement, all of such obligations, duties, warranties, covenants, undertakings and liabilities of Borrower under or with respect to the Leases shall be and remain enforceable by the parties thereto against, and only against, Borrower and not against Lender, it being further understood that this Agreement is executed as security for the Secured Obligations, and that Lender has not assumed and shall not be deemed to have assumed any of the Leases or any obligation, duty or liability of Borrower thereunder. 3. Representations and Covenants of Borrower re: Accounts, Inventory and Other Collateral. Borrower hereby represents and warrants to Lender, and covenants and agrees with Lender, that: (a) Borrower will provide Lender with a written report on the first (1st) day of each month (provided, however, that if any Event of Default or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement occurs or if the Unused Availability of Borrower is ever less than $1,500,000.00, Borrower shall deliver such Collateral Reports to Lender on at least one (1) Domestic Business Day during each week (or at such other intervals as Lender shall require from time to time)), in the form of Exhibit D attached hereto and incorporated herein by reference reflecting activity of Borrower up to and including the preceding Domestic Business Day (each, a "Collateral Report") describing, in the form required by the Collateral Report the information required to be delivered pursuant to the Collateral Report. In addition, if any Event of Default or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement occurs or if the Unused Availability of Borrower is ever less than $1,500,000.00, if requested by Lender, Borrower shall execute and deliver to Lender, at such intervals as requested by Lender, (i) schedules identifying all Accounts and all Lease Payments created or acquired by Borrower subsequent to the immediately preceding Collateral Report and all amounts collected by Borrower on Accounts and Lease Payments subsequent to the immediately preceding Collateral Report, (ii) schedules of Inventory specifying Borrower's cost of Inventory and of Eligible Inventory and such other matters and information relating to Inventory and Eligible Inventory as Lender may from time to time request and (iii) copies of any other reports or information, in a form and with such specificity as is reasonably satisfactory to Lender, concerning Accounts, Inventory, Eligible Leases, Lease Payments and any other Collateral requested by the Lender, including, without limitation, but only if specifically requested by Lender, copies of all invoices prepared in connection with any Accounts; - 7 - 8 (b) With respect to Accounts scheduled, listed or referred to on the initial Collateral Report or on any subsequent Collateral Report, Borrower represents and warrants to Lender that, except as otherwise disclosed on the applicable Collateral Report: (i) they are genuine, in all respects what they purport to be and are not evidenced by a judgment; (ii) they represent undisputed, bona fide transactions completed in accordance with the terms and provisions contained in the invoices and other documents related thereto; (iii) the amounts thereof shown on the applicable Collateral Report are actually and absolutely owing to Borrower and are not contingent for any reason; (iv) no payments have been or shall be made thereon except payments immediately delivered to Lender pursuant to Section 4 of this Agreement; (v) there are no setoffs, counterclaims or disputes existing or asserted with respect thereto and Borrower has not made any agreement with any Account Debtor thereof for any deduction therefrom except a discount or allowance allowed by Borrower in the ordinary course of its business for prompt payment; (vi) to the best of Borrower's knowledge, there are no facts, events or occurrences which in any way impair the validity or enforcement thereof or tend to reduce the amount payable thereunder from the amount thereof as shown on the applicable Collateral Report; (vii) to the best of Borrower's knowledge, all Account Debtors thereof have the capacity to contract and are solvent; (viii) the goods sold and/or services furnished giving rise thereto are not subject to any Lien or claim except that of Lender; (ix) Borrower has no knowledge of any fact or circumstance which would impair the validity or collectibility thereof; (x) to the best of Borrower's knowledge, there are no proceedings or actions which are threatened or pending against any Account Debtor thereof which might result in any material adverse change in its financial condition; and (xi) all of such Accounts are subject to a first priority perfected security interest in favor of Lender; (c) With respect to Lease Payments scheduled, listed or referred to on the initial Collateral Report or on any subsequent Collateral Report, Borrower represents and warrants to Lender that, except as otherwise disclosed on the applicable Collateral Report: (i) they are genuine, in all respects what they purport to be and are not evidenced by a judgment; (ii) they arise out of an Eligible Lease; (iii) the amounts thereof shown on the applicable Collateral Report are actually and absolutely owing to Borrower and are not contingent for any reason; (iv) no payments have been or shall be made thereon except payments immediately delivered to Lender pursuant to Section 4 of this Agreement; (v) there are no setoffs, counterclaims or disputes existing or asserted with respect thereto and Borrower has not made any agreement with any lessee for any deduction therefrom; (vi) to the best of Borrower's knowledge, there are no facts, events or occurrences which in any way impair the validity or enforcement thereof or tend to reduce the amount payable thereunder from the amount thereof as shown on the applicable Collateral Report; (vii) to the best of Borrower's knowledge, the applicable lessee(s) have the capacity to contract and are solvent; (viii) the Inventory leased under the applicable Eligible Lease is not subject to any Lien or claim except that of Lender; (ix) Borrower has no knowledge of any fact or circumstance which would impair the validity or collectibility thereof; (x) to the best of Borrower's knowledge, there are no proceedings or actions which are threatened or pending against the applicable lessee(s) which might result in any material adverse change in its financial condition; and (xi) all of such Lease Payments are subject to a first priority perfected security interest in favor of Lender; (d) Any officers, employees or agents of Lender shall have the right, at any time or times hereafter, in the name of Lender or Borrower or in the name of a nominee of Lender, to verify the validity, amount or any other matter relating to any Accounts or any Lease Payments by mail, telephone, telegraph or otherwise. All reasonable costs, fees and expenses relating thereto incurred by Lender (or for which Lender becomes obligated) during the continuation of any Event of Default or any event which with the passage of time or the giving of notice or both would become an Event of Default under this Agreement shall become part of the Secured Obligations and be payable by Borrower to Lender on demand; (e) Borrower will at all times maintain a record of Accounts and Lease Payments at its chief executive office, keeping correct and accurate records itemizing and describing the - 8 - 9 names and addresses of Account Debtors and lessees, relevant invoice numbers, shipping dates and due dates, collection histories and Account and Lease Payment agings, all of which records shall be available during such Borrower's usual business hours at the request of any of Lender's officers, employees or agents upon at least one (1) Domestic Business Day's prior oral or written notice from Lender to Borrower (provided, however, that no such notice need be given by Lender if any Event of Default or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing). Borrower will cooperate fully with Lender and its officers, employees and agents who shall have the right at any time or times during Borrower's normal business hours to inspect the Accounts, the Lease Payments and the records with respect thereto upon at least one (1) Domestic Business Day's prior oral or written notice from Lender to Borrower (provided, however, that no such notice need be given by Lender if any Event of Default or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing). Borrower will conduct a review (or cause its independent certified public accountants to conduct a review) of its bad debt reserves and collection histories at least once each year and promptly following such review shall supply Lender with a report in a form and with such specificity as may be reasonably satisfactory to Lender concerning such review of the Accounts and the Lease Payments (which report may consist of a management letter from Borrower's independent certified public accountants if such accountants conducted such bad debt reserve review); (f) Unless Lender notifies Borrower in writing that Lender suspends any one or more of the following requirements, Borrower will: (i) within three (3) Domestic Business Days after Borrower's learning thereof, inform Lender, in writing, of any material delay in Borrower's performance of any of its obligations to any Account Debtor with respect to any Eligible Account in an amount in excess of $10,000.00 and of any assertion of any claims, offsets or counterclaims in an amount in excess of $10,000.00 by any Account Debtor with respect to any Eligible Account and of any allowances, credits and/or other monies in an amount in excess of $10,000.00 granted by Borrower to any Account Debtor with respect to any Eligible Account; (ii) within three (3) Domestic Business Days after Borrower's learning thereof, inform Lender, in writing, of any material delay in Borrower's performance of any of its obligations to any lessee with respect to any Eligible Lease and of any assertion of any claims, offsets or counterclaims in excess of $10,000.00 by any lessee with respect to any Eligible Lease Payment(s) and of any allowances, credits and/or other monies in an amount in excess of $10,000.00 granted by Borrower to any lessee with respect to any Eligible Lease Payment; (iii) not, without the prior written consent of Lender, permit or agree to any extension, compromise or settlement or make any change or modification of any kind or nature with respect to any Eligible Account or any Eligible Lease Payment, including any of the terms relating thereto, if (A) such extension, compromise, settlement, change or modification involves an amount in excess of $10,000.00 or (B) after giving effect to such extension, compromise, settlement, change or modification (and the effect of the same on the current Borrowing Base), Borrower has Unused Availability of less than $1.00; (iv) within three (3) Domestic Business Days after Borrower's receipt or learning thereof, furnish to and inform Lender of all material adverse information relating to the financial condition of any Account Debtor who in the aggregate owes Borrower more than $10,000.00 or any lessee under an Eligible Lease who in the aggregate owes Borrower more than $10,000.00; and (v) within three (3) Domestic Business Days after Borrower's learning thereof, notify Lender in writing which of its then existing Accounts involving an amount in excess of $10,000.00 are no longer Eligible Accounts and which of its then existing Lease Payments involving an amount in excess of $10,000.00 are no longer Eligible Lease Payments; (g) From and after the occurrence of any Event of Default under this Agreement and so long as such Event of Default is continuing, Lender shall have the right, in its sole and absolute discretion, without notice thereof to Borrower: (i) to notify any or all Account Debtors that the Accounts have been assigned to Lender and that Lender has a security interest - 9 - 10 therein; (ii) to notify any or all lessees that the Leases and the Lease Payments have been assigned to Lender and that Lender has a security interest therein; (iii) to direct any or all Account Debtors to make all payments due from them to Borrower upon the Accounts directly to Lender; (iv) to direct any or all lessees to make all Lease Payments due from them to Borrower directly to Lender; and (v) to enforce payment of and collect, by legal proceedings or otherwise, the Accounts and the Lease Payments in the name of Lender and/or Borrower; (h) Borrower will, at its own expense, use commercially reasonable efforts to collect, as and when due, all amounts due with respect to the Accounts and the Lease Payments; (i) Promptly upon Borrower's receipt thereof, Borrower will deliver or cause to be delivered to Lender, with appropriate endorsement and assignment to vest title, with full recourse to Borrower, and possession in Lender, all instruments and chattel paper which Borrower now owns or may at any time or times hereafter acquire; (j) With respect to Inventory scheduled, listed or referred to in any report to Lender, Borrower represents and warrants to Lender that, except as otherwise disclosed in such reports: (i) such Inventory is located at Borrower's chief executive office, one of the other locations of Borrower listed on Exhibit A attached hereto and incorporated herein by reference, one of the jurisdictions listed on Exhibit B attached hereto and incorporated herein by reference or another location with respect to which Borrower has complied with all of the requirements of Section 2(h) of this Agreement; (ii) Borrower has good, indefeasible and merchantable title to such Inventory and such Inventory is not subject to any Lien or claim whatsoever except for the security interest granted to Lender under this Agreement and except for Permitted Liens; (iii) such Inventory is of good and merchantable quality, free from any defects (except for Inventory Subject to Lease which is subject to normal wear and tear); (iv) such Inventory is not subject to any licensing, patent, royalty, trademark, trade name or copyright agreements with any third parties; (v) subject to any rights of lessees in any Inventory Subject to Lease, the completion of manufacture and sale or other disposition of such Inventory by Lender following an Event of Default will not require the consent of any Person and will not constitute a breach or default under any contract or agreement to which Borrower is a party or to which any of the Inventory is subject; (vi) such Inventory has not been produced in violation of the Fair Labor Standards Act and is not subject to the so-called "hot goods" provision contained in Title 29 U.S.C. ss.215(a)(1); and (vii) such Inventory is not on consignment with Borrower; (k) Borrower will at all times maintain an inventory system keeping correct and accurate records itemizing and describing the kind, type, quality and quantity of Inventory and of Eligible Inventory, Borrower's cost therefor and daily withdrawals therefrom and additions thereto, all of which records shall be available during Borrower's usual business hours at the request of any of Lender's officers, employees or agents upon one (1) Domestic Business Day's prior oral or written notice from Lender to Borrower (provided, however, that no such notice need be given by Lender if any Event of Default or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing). Borrower will cooperate fully with Lender and its officers, employees and agents who shall have the right at any time or times to inspect the Inventory and the records with respect thereto during Borrower's usual business hours and at other reasonable times and upon one (1) Domestic Business Day's prior oral or written notice from Lender to Borrower (provided, however, that no such notice need be given by Lender if any Event of Default or any event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing). Borrower will conduct such physical counts of all or any portion of its Inventory as Lender may from time to time reasonably request (but Lender will not request more than one physical count per calendar year so long as no Event of Default and no event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing) and will supply Lender with a report in a form and with such - 10 - 11 specificity as may be satisfactory to the Lender concerning any physical count of any or all of the Inventory of Borrower (whether such count was requested by Lender or not); and (l) Lender shall not be responsible for (unless Lender takes possession of the Inventory after the occurrence of an Event of Default under this Agreement, and then only to the extent directly caused by Lender's gross negligence or wilful misconduct as determined by a court of competent jurisdiction in a final, nonappealable order): (i) the safekeeping of any of the Inventory; (ii) any loss or damage to any of the Inventory; (iii) any diminution in the value of any of the Inventory; or (iv) any act or default of any carrier, warehouseman, bailee, forwarding agency or any other Person. As between Borrower and Lender, all risk of loss, damage, destruction or diminution in value of the Inventory shall be borne by Borrower. Borrower will not sell any Inventory to any customer on approval or on any other basis which entitles the customer to return, or which may obligate Borrower to repurchase, such Inventory. From and after the occurrence of any Event of Default under this Agreement and so long as any such Event of Default is continuing, Lender, in its sole and absolute discretion, may require that Inventory be stored with a bailee, warehouseman or similar party and warehouse receipts therefor be issued in Lender's name and be delivered to Lender. Borrower agrees to do whatever acts are required to effectuate the foregoing. 4. Lockbox and Blocked Account. Borrower hereby agrees to establish and maintain throughout the term of this Agreement a lock box (a "Lock Box") in Borrower's name with Mercantile Bank National Association or another bank (a "Collecting Bank") which is acceptable to Lender (subject to irrevocable instructions acceptable to Lender as hereinafter set forth) to which Borrower shall direct all Account Debtors to directly remit all payments on Accounts and all lessees to directly remit all Lease Payments and in which Borrower shall on each Domestic Business Day deposit all cash payments made for Inventory and other cash payments constituting proceeds of Collateral in the identical form in which such payment was made, whether by cash, check or otherwise. Lender understands that there will be a transition period between the time Borrower notifies its Account Debtors and lessees to make payments directly to the Lock Box (which notification Borrower agrees to make within three (3) Domestic Business Days after the date of this Agreement) and the time such Account Debtors and lessees will make payments directly to the Lock Box and Lender acknowledges and agrees that Princeton Capital Finance Company's agreement to promptly remit to Lender all payments made by such Account Debtors and lessees to the lock box maintained by Borrower with Core States Bank will satisfy the requirements of the immediately preceding sentence during such transition period. In addition, Borrower hereby agrees to establish and maintain throughout the term of this Agreement a depository account at its Collecting Bank (a "Blocked Account"). The Collecting Bank shall acknowledge and agree, in a manner satisfactory to Lender, that all payments made to the Lock Box and the Blocked Account are the sole and exclusive property of Lender and that the Collecting Bank has no right of setoff against the Lock Box or the Blocked Account and that all such payments, whether by cash, check, wire transfer or any other instrument, made to such Lock Box or Blocked Account or otherwise received by Borrower and whether on the Accounts or the Lease Payments or as proceeds of any other Collateral or otherwise are and will be the sole and exclusive property of Lender. Borrower shall irrevocably instruct the Collecting Bank to on a daily basis on each Domestic Business Day (i) transfer all payments or deposits to Borrower's Lock Box into Borrower's Blocked Account and (ii) all funds in the Blocked Account of Borrower shall be transferred (by way of debit, ACH debit, wire transfer or other means, as directed by Lender) on a daily basis on each Domestic Business Day to an account of Lender at Mercantile Bank National Association or such other bank as Lender may from time to time specify in writing to be applied by Lender to the payment of the Secured Obligations as follows: (a) so long as no Event of Default under this Agreement has occurred and is continuing, as directed by Borrower and (b) so long as any Event of Default under this Agreement has occurred and is continuing, in such order and manner as Lender may elect. Lender agrees that, so long as no Event of Default and no event which with the passage of time or the giving of notice or both would constitute an Event of Default under this Agreement has occurred and is continuing, if the application of funds received by Lender from the Blocked Account would result in the prepayment of a LIBOR Loan, Borrower may, at its option, invest such funds in a cash collateral account at Mercantile Bank National Association (pursuant to documentation acceptable to Lender granting Lender a first - 11 - 12 priority perfected security interest in such account and the proceeds thereof) until the expiration of the Interest Period for such LIBOR Loan. Borrower shall have no right to withdraw any funds out of the Lock Box and/or the Blocked Account. Borrower, and each of its Affiliates, employees, agents and/or other Persons acting for or in concert with Borrower, shall, acting as trustee for Lender, receive, as the sole and exclusive property of Lender, any monies, checks, notes, drafts and any other payments relating to and/or proceeds of Accounts, Lease Payments and/or other Collateral which come into the possession or under the control of Borrower or any Affiliates, employees, agents or other Persons acting for or in concert with Borrower, and immediately upon receipt thereof, Borrower or such Persons shall cause the same to be deposited into Borrower's Lock Box on each Domestic Business Day. 5. Additional Actions by Lender. Lender, at its option, may from time to time perform any agreement of Borrower hereunder which Borrower shall fail to perform and take any other action which Lender in good faith deems necessary for the maintenance or preservation of any of the Collateral or its interest therein (including, without limitation, the discharge of taxes or liens of any kind against the Collateral or the procurement of insurance or the payment of warehousing charges, landlord's bills or other charges or the performance of any of Borrower's obligations under the Leases), and Borrower agrees to forthwith reimburse Lender for all reasonable costs and expenses incurred by Lender in connection with the foregoing, together with interest thereon at a rate per annum equal to the lesser of (i) Four Percent (4%) over and above the Prime Rate (fluctuating as and when the Prime Rate changes) and (ii) the highest rate of interest allowed by applicable law, from the date incurred until reimbursed by Borrower. Lender may for the foregoing purposes act in its own name or that of Borrower and may also so act for the purposes of adjusting, settling or cancelling any policy of insurance on the Collateral or endorsing any draft received in connection therewith, in payment of a loss or otherwise, for all of which purposes Borrower hereby grants to Lender its power of attorney, irrevocable during the term of this Agreement. 6. Defaults. The occurrence of any of the following events or conditions shall constitute an "Event of Default" under this Agreement: (a) non-payment of any principal of, interest on or other amount with respect to any of the Secured Obligations within five (5) days after the same shall first become due and payable, whether by reason of demand, maturity, acceleration or otherwise; (b) default by Borrower in the due performance or observance of any of the terms, provisions, covenants or agreements contained in Sections 2(h), 2(i), 2(j), 2(k), 2(n), 2(o), 2(p), 2(r), 2(s), 3(e), 3(f), 3(l) or 4 of this Agreement; (c) default by Borrower in the due performance or observance of any of the terms, provisions, covenants or agreements contained in Sections 2(g), 2(q), 3(a) or 3(i) of this Agreement and any such default shall remain unremedied for five (5) days after the earlier of (i) written notice of default is given to Borrower by Lender or (ii) any officer of Borrower obtains knowledge of such default; (d) default by Borrower in the due performance or observance of any of the other terms, provisions, covenants or agreements contained in this Agreement and any such default shall remain unremedied for fifteen (15) days after the earlier of (i) written notice of default is given to Borrower by Lender or (ii) any officer of Borrower obtains knowledge of such default; (e) any representation or warranty made by Borrower in this Agreement shall prove to be untrue or incorrect in any material respect when made or deemed made; or (f) any "Event of Default" (as defined therein) shall occur under or within the meaning of the Loan Agreement. 7. Remedies. Upon the occurrence and during the continuation of any Event of Default under this Agreement: (a) notwithstanding any provision contained in the Loan Agreement or any of the other Transaction Documents to the contrary, Lender may, at its option, declare that the obligation of Lender to make Revolving Credit Loans under the Loan Agreement has terminated, whereupon such obligation of Lender shall be immediately and forthwith terminated, and Lender may, at its option, declare the entire outstanding principal balance of and all accrued and unpaid interest on the Revolving Credit Note and all of the other Secured Obligations to be forthwith due and payable, whereupon all of the unpaid principal balance of and all accrued and unpaid interest on the Revolving Credit Note and all of the other Secured Obligations shall become and be immediately due and payable, without presentment, demand, protest or further notice of any kind, all of which are hereby expressly waived by Borrower; (b) whether or not any or all of the Secured Obligations are declared to be forthwith due and payable, Lender shall have the right to take immediate possession of the Collateral covered hereby, - 12 - 13 and, for that purpose may pursue the same wherever said Collateral may be found, and may enter upon any of the premises of Borrower with or without force or process of law, wherever said Collateral may be or may be supposed to be, and search for the same, and, if found, take possession of and remove and sell and dispose of said Collateral, or any part thereof; (c) Lender may, at its option, notify any Account Debtor with respect to any Account to make all payments under the Accounts directly to Lender and demand, collect, receipt for, settle, compromise, adjust, sue for, foreclose and realize on the Accounts and all amounts due under the Accounts as Lender may determine; (d) Lender may, at its option, notify any lessee under a Lease to make all Lease Payments under such Lease directly to Lender and demand, collect, receipt for, settle, compromise, adjust, sue for, foreclose and realize on the Lease Payments and all other amounts due under the Leases as Lender may determine; (e) Lender may, at its option, exercise such of the other rights and remedies accruing to a secured party under the Uniform Commercial Code of the relevant state or states and any other applicable law upon default by a debtor as Lender may elect; and (f) Lender may, at its option, enter, with or without process of law and without breach of the peace, any premises where the books and records of Borrower pertaining to the Accounts, the Lease Payments or any of the other Collateral are or may be located, and without charge or liability on the part of Lender therefor seize and remove said books and records from said premises or remain upon said premises and use the same for the purpose of collecting, preparing and disposing of the Collateral and/or for the purpose of identifying and locating any of the Collateral. Borrower shall, upon Lender's request, assemble the Collateral and make the Collateral available to Lender at any place designated by Lender which is reasonably convenient to Borrower. 8. Foreclosure. Foreclosure on the Collateral covered hereby may be had at public or private sale or sales, disposing of such portion or portions of the Collateral at each such sale, for cash or on credit, on such terms, at such place or places, and with or without the Collateral being present at such sale, all as Lender in its sole and absolute discretion shall determine from time to time. In the case of public sale, notice thereof shall be deemed and held to be adequate and reasonable if such notice shall appear three (3) times in a newspaper published in the City or County wherein the sale is to be held, the first such publication being at least ten (10) days before such sale and the last such publication being not more than three (3) days before such sale. In the case of a private sale, notice thereof shall be deemed and held to be adequate and reasonable if such notice shall be mailed to Borrower at its last known address at least ten (10) days before such sale. The enumeration of these methods of notice shall not be deemed or construed to render unreasonable any other method of notice which would otherwise be reasonable under the circumstances. 9. Application of Proceeds and Deficiency. Lender may apply the net proceeds of any sale, lease or other disposition of any of the Collateral or of any other collection of the proceeds of any of the Collateral, after deducting all costs and expenses of every kind incurred therein or incidental to the retaking, holding, preparing for sale, selling, leasing or the like of the Collateral on Borrower's premises, or elsewhere, or in any way related to Lender's rights hereunder including, without limitation, reasonable attorneys' fees and expenses, court costs, bonds and other legal expenses, insurance, security guard and alarm expenses incurred in connection with the holding of the Collateral, advertisements of sale of the Collateral, and rental and utilities expense on the premises or elsewhere in connection with storage and sale of the Collateral) to the payment, in whole or in part, of the Secured Obligations, whether due or not due, absolute or contingent, and only after payment by Lender of any other amounts required by any existing or future provision of law (including Section 9-504(1)(c) of the Uniform Commercial Code or any comparable statutory provision of any jurisdiction in which any of the Collateral may at the time be located) need Lender account to Borrower for the surplus, if any. The proceeds of any sale(s), lease(s) or other disposition(s) of any of the Collateral and/or of any collection(s) of any of the Collateral shall be applied by Lender in the following order: (1) first, to the payment of all costs, expenses, liabilities and advances made or incurred by Lender in connection with the collection and enforcement of the Secured Obligations and the sale or other realization upon the Collateral; provided, however, that nothing herein is intended to relieve Borrower of its obligation to pay such costs, expenses, liabilities and advances; (2) second, to the payment of the Secured Obligations in such order and manner as Lender, in its discretion, may elect; and (3) third, to the payment of any surplus remaining after the payment of the amounts mentioned, to Borrower or to. - 13- 14 whomsoever may be lawfully entitled thereto. Borrower shall remain liable to Lender for the payment of any deficiency, with interest. 10. Lender's Care of Collateral. Lender shall be deemed to have exercised reasonable care in the custody and preservation of the Collateral in its possession if it takes such action for that purpose as Borrower requests in writing, but failure of Lender to comply with any such request shall not of itself be deemed a failure to exercise reasonable care, and no failure of Lender to preserve or protect any rights with respect to such Collateral against prior parties shall be deemed a failure to exercise reasonable care in the custody or preservation of such Collateral. 11. Amendments; Waivers; Remedies Cumulative. No delay on the part of Lender in the exercise of any right hereunder shall operate as a waiver thereof and no single or partial exercise by Lender of any right shall preclude other or further exercise thereof or the exercise of any other right. Each and every right granted to Lender hereunder, under the Loan Agreement and under the other Transaction Documents, or at law or in equity, shall be deemed cumulative and may be exercised from time to time. Lender shall not by any act, delay, omission or otherwise be deemed to have waived any of its rights or remedies hereunder and no waiver whatsoever shall be valid unless in writing and signed by Lender and then only to the extent therein set forth. A waiver by Lender of any right or remedy hereunder on any one occasion shall not be construed as a bar to any right or remedy which Lender would otherwise have on any future occasion. This Agreement may not be amended except by a writing duly signed by Borrower and Lender. The headings of the paragraphs hereof shall not be considered in the construction or interpretation of this Agreement. 12. Irrevocable Power of Attorney. Borrower hereby irrevocably makes, constitutes and appoints Lender (and all Persons designated by Lender) as the true and lawful agent and attorney-in fact of Borrower with full power of substitution to: (a) if any Event of Default under this Agreement has occurred and is continuing, (i) demand payment of the Accounts and the Lease Payments, (ii) enforce payment of the Accounts and the Lease Payments by legal proceedings or otherwise, (iii) exercise all of Borrower's rights and remedies with respect to proceedings brought to collect any Account or Lease Payment, (iv) sell or assign any Account or Lease Payment upon such terms, for such amount and at such time or times as Lender deems advisable, (v) settle, adjust, compromise, extend or renew any Account or Lease Payment, (vi) discharge and release any Account or Lease Payment, (vii) prepare, file and sign Borrower's name on any proof of claim in bankruptcy or other similar document against an Account Debtor or a lessee under a Lease, (viii) have access to any lockbox or postal box into which Borrower's mail is deposited, (ix) notify the postal authorities of any change of the address for delivery of Borrower's mail to an address designated by Lender, and open all mail addressed to Borrower for the purpose of collecting Accounts and Lease Payments and the proceeds of any other Collateral (with all other mail to be promptly returned to Borrower) and (x) do all acts and things which are necessary, in Lender's sole discretion, to fulfill the Borrower's obligations under this Agreement; and (b) at any time, (i) take control in any manner of any item of payment or proceeds of any Account or Lease Payment or any other Collateral, (ii) have access to the Lockbox, (iii) endorse Borrower's name upon any items of payment or proceeds thereof and deposit the same in the Lender's account on account of the Secured Obligations, (iv) endorse Borrower's name upon any chattel paper, document, instrument, invoice or similar document or agreement relating to any Account or Lease Payment or any goods pertaining thereto, (v) execute in Borrower's name and on Borrower's behalf any financing statements and/or continuations thereof and/or amendments thereto under the Uniform Commercial Code or other applicable law in any jurisdiction where Borrower or any of the Collateral may be located, (vi) endorse Borrower's name on any verification of Accounts or Lease Payments and notices thereof to Account Debtors and lessees and (vii) do any and all things necessary and take such actions in the name and on behalf of Borrower to carry out the intent of this Agreement, including, without limitation, the grant of the security interest granted under this Agreement and to perfect and protect the security interest granted to Lender in respect to the Collateral and Lender's rights created under this Agreement. Borrower agrees that neither Lender nor any of its agents, designees or attorneys-in-fact will be liable for any acts of commission or omission (other than for acts of commission or omission which constitute gross negligence or willful misconduct as determined by a court of competent jurisdiction in a final, nonappealable order), or for any error of judgment or - 14 - 15 mistake of fact or law in respect to the exercise of the power of attorney granted under this Section. The power of attorney granted under this Section shall be irrevocable during the term of this Agreement. 13. Notices. All notices provided for in this Agreement shall be in writing and shall be deemed to have been given when delivered personally or when deposited in the United States mail, registered or certified mail, return receipt requested and postage prepaid, addressed as follows, or to such other address as may hereafter be designated in writing by the respective parties hereto: if to Lender to 100 South Brentwood Boulevard, Suite 500, St. Louis, Missouri 63105, Attention: Senior Credit Officer, and if to Borrower, to the address of the chief executive office of Borrower listed at the end of this Agreement and to the attention of Borrower's Chief Executive Officer and Chief Financial Officer, and with a copy to John J. McCoy, Esq., Taft, Stettinius & Hollister, 1800 Star Bank Center, 425 Walnut Street, Cincinnati, Ohio 45202. 14. Applicable Law and Severability. It is the intention of the parties hereto that this Agreement is entered into pursuant to the provisions of the Uniform Commercial Code as it is in force in the State of Missouri (the "UCC"). Any applicable provisions of the UCC, not specifically included herein, shall be deemed a part of this Agreement in the same manner as if set forth herein at length; and any provisions of this Agreement that might in any manner be in conflict with any provision of the UCC shall be deemed to be modified so as not to be inconsistent with the UCC. In all respects this Agreement and all transactions, assignments and transfers hereunder, and all the rights of the parties, shall be governed as to validity, construction, enforcement and in all other respects by the substantive laws of the State of Missouri (without reference to conflict of law principles); provided, however, that the perfection, priority and enforcement of the security interest created by this Agreement on any Property located in any jurisdiction other than the State of Missouri shall in all respects be governed, construed, applied and enforced in accordance with the substantive laws of the applicable jurisdiction. To the extent any provision of this Agreement is not enforceable under applicable law, such provision shall be deemed null and void and shall have no effect on the remaining portions of this Agreement. 15. Successors and Assigns: Other Secured Obligations; Duration of Security Interest. This Agreement shall be binding upon Borrower and shall inure to the benefit of Lender and its successors and assigns. Borrower may not assign any of its rights or delegate any of its obligations under this Agreement. This Agreement shall continue in full force and effect and the security interest granted hereby and all of the representations, warranties, covenants and agreements of Borrower hereunder and all of the terms, conditions and provisions hereof relating thereto shall continue to be fully operative until such time as (a) Borrower shall have paid or caused to be paid, or otherwise discharged, all of the Secured Obligations and (b) there shall be no remaining commitment or obligation of Lender to advance funds, make loans or extend credit to Borrower under the Loan Agreement, any of the other Transaction Documents or otherwise. Borrower expressly agrees that to the extent a payment or payments to Lender, or any part thereof, are subsequently invalidated, declared to be void or voidable or set aside and are required to be repaid to a trustee, custodian, receiver or any other party under any bankruptcy act, state or federal law, common law or equitable cause, then to the extent of such payment or repayment, the obligation or part thereof intended to be satisfied shall be revived and continued in full force and effect as if said payment had not been made. 16. Consent to Jurisdiction; Waiver of Jury Trial. BORROWER IRREVOCABLY SUBMITS TO THE NON-EXCLUSIVE JURISDICTION OF ANY MISSOURI STATE COURT OR ANY UNITED STATES OF AMERICA COURT SITTING IN THE EASTERN DISTRICT OF MISSOURI, EASTERN DIVISION, AS LENDER MAY ELECT, IN ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT. BORROWER HEREBY IRREVOCABLY AGREES THAT ALL CLAIMS IN RESPECT TO SUCH SUIT, ACTION OR PROCEEDING MAY BE HELD AND DETERMINED IN ANY OF SUCH COURTS. BORROWER IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY LAW, ANY OBJECTION WHICH BORROWER MAY NOW OR HEREAFTER HAVE TO THE LAYING OF VENUE OF ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT, AND BORROWER FURTHER IRREVOCABLY WAIVES ANY CLAIM THAT SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM. BORROWER - 15 - 16 NOW OR HEREAFTER HAVE BY REASON OF ITS PRESENT OR SUBSEQUENT DOMICILES. BORROWER AUTHORIZES THE SERVICE OF PROCESS UPON BORROWER BY REGISTERED MAIL SENT TO BORROWER AT ITS ADDRESS SET FORTH IN SECTION 13. BORROWER AND LENDER IRREVOCABLY WAIVE THE RIGHT TO TRIAL BY JURY WITH RESPECT TO ANY ACTION IN WHICH BORROWER AND LENDER ARE PARTIES RELATING TO OR ARISING OUT OF OR IN CONNECTION WITH THIS AGREEMENT. IN WITNESS WHEREOF, Borrower has executed this Security Agreement this 29th day of October, 1997. IN THE EVENT ANY OF THE SECURED OBLIGATIONS ARE PAYABLE ON DEMAND, NEITHER THIS AGREEMENT NOR ANYTHING CONTAINED HEREIN SHALL BE DEEMED TO ALTER OR IMPINGE UPON THE DEMAND CHARACTER OF SUCH OBLIGATION. INTERLOTT TECHNOLOGIES, INC. ("Borrower") By /s/ Jerome J. Cain ---------------------------- Title: Chief Executive Officer ------------------------ By /s/ L. Rogers Wells ---------------------------- Title: Chief Executive Officer ------------------------ Address of Chief Executive Office of Borrower and Location of Books and Records of Borrower: 10830 Millington Court Cincinnati, Ohio 45242 Accepted this 29th day of October, 1997. MERCANTILE BUSINESS CREDIT INC. By /s/ Marian H. Kammerer ---------------------------- Title: Vice President ------------------------ -16- 17 EXHIBIT A Additional Locations of Places of Business of Borrower 6665 Creek Road Cincinnati, Ohio 45242 - 17 - 18 EXHIBIT B Permissible Collateral Locations State of Ohio State of Arizona State of Colorado State of Florida State of Georgia State of Indiana State of Iowa State of Kansas State of Maine State of Maryland State of Minnesota State of New Hampshire State of New Mexico State of New York State of Rhode Island State of Texas Argentina Brazil Buenos Aries Chile Costa Rica Mexico Israel Ireland Iceland Denmark Norway Spain Western Australia Quebec, Canada Switzerland - 18 - 19 EXHIBIT C UCC Filing Offices Ohio Secretary of State Hamilton County, Ohio Arizona Secretary of State Colorado Secretary of State Florida Secretary of State Georgia Secretary of State Indiana Secretary of State Iowa Secretary of State Kansas Secretary of State Maine Secretary of State Maryland Secretary of State Minnesota Secretary of State New Hampshire Secretary of State New Mexico Secretary of State New York Secretary of State Rhode Island Secretary of State Texas Secretary of State - 19 - 20 EXHIBIT D [Form of Collateral Report] - 20 - 21 EXHIBIT 10.10 EXHIBIT D
Mercantile Business Credit, Inc. COLLATERAL REPORT Report No. Date(Mo., DAY & YEAR) ----------------------------------------------- - ------------------------------------------------------------------------------------------------------------------------- COMBINED ACCOUNTS RECEIVABLE/INVENTORY ACTIVITY - ------------------------------------------------------------------------------------------------------------------------- 1. Accounts Receivable Balance (From line 8 of Previous Report) $ - ------------------------------------------------------------------------------------------------------------------------- 2. Add: Sales Assignments FROM (MO., DAY, YEAR) TO (MO., DAY, YEAR) / / / / - -------------------------------------------------------------------------------------------------- 3. Other Adjustments - ------------------------------------------------------------------------------------------------------------------------- 4. Total Additions (Line 2 + Line 3) $ - ------------------------------------------------------------------------------------------------------------------------- 5. Less: Collection Reports No(s). GROSS ($ ) Net Cash --------------- Deductions Over payments - -------------------------------------------------------------------------------------------------- 6. Less: Other Credits ($ ) - ------------------------------------------------------------------------------------------------------------------------- 7. Total Deductions (Line 5 + Line 6) ($ ) - ------------------------------------------------------------------------------------------------------------------------- 8. Total Accounts Receivable $ (Line 1 + Line 4 - Line 7) - ------------------------------------------------------------------------------------------------------------------------- 9. Less: Ineligible Accounts ($ ) - ------------------------------------------------------------------------------------------------------------------------- 10. Total Eligible Accounts Receivable $ - ------------------------------------------------------------------------------------------------------------------------- 11. Beginning Inventory Value $ (from Line 15 Previous Report) - ------------------------------------------------------------------------------------------------------------------------- 12. Add: Purchases for Period FROM (MO., DAY, YEAR) TO (MO., DAY, YEAR) / / / / - -------------------------------------------------------------------------------------------------- 13. Other Adjustments - -------------------------------------------------------------------------------------------------- 14. Less: Cost of Goods Sold % X Line 2 (above) - ------------------------------------------------------------------------------------------------------------------------- 15. Ending Inventory Value $ (Line 11 + 12)-(Line 13 + 14) - ------------------------------------------------------------------------------------------------------------------------- 16. Less: Ineligible Inventory ($ ) - ------------------------------------------------------------------------------------------------------------------------- 17. Total Eligible Inventory $ - ------------------------------------------------------------------------------------------------------------------------- 18. Accounts Receivable % of Line 10(above) $ Availability - -------------------------------------------------------------------------------------------------- 19. Inventory Availability: % of Line 17(above) $ - -------------------------------------------------------------------------------------------------- 20. Eligible Lease Payments at 65% $ - ------------------------------------------------------------------------------------------------------------------------- NOT TO EXCEED 21. Total Availability (Line 18 + Line 19 + 20) $ $ - ------------------------------------------------------------------------------------------------------------------------- 22. Beginning Loan Balance $ (Line 26 Previous Report) - -------------------------------------------------------------------------------------------------- NET 23. Less: Remittances (Deposits) See Line 5, Net Cash ($ ) - -------------------------------------------------------------------------------------------------- 24. Advance Requested Since Last Report $ - -------------------------------------------------------------------------------------------------- 25. Other Adjustments (ie. Interest, Return Items, Misc. Charges) $ - ------------------------------------------------------------------------------------------------------------------------- 26. New Loan Balance (Line 22 - Line 23 + Line 24 and Line 25) $ - ------------------------------------------------------------------------------------------------------------------------- 27. Remaining Availability (line 21 - Line 26) $ - ------------------------------------------------------------------------------------------------------------------------- The undersigned represents and warrants that the foregoing information is true, complete and correct, and the receivables and inventory reflected herein complies with the representations and warranties set forth in the security agreement and supplements or amendments, if any, thereto between the undersigned and Mercantile Business Credit, Inc. - ------------------------------------------------------------------------------------------------------------------------- COMPANY BY DATE - ------------------------------------------------------------------------------------------------------------------------- LOCATION TITLE - ------------------------------------------------------------------------------------------------------------------------- CUSTOMER RETURN (White, Yellow, Pink Copies) TO MBCI, KEEP GOLDENROD (PT 4) FOR YOUR RECORDS
EX-4.3.(C) 5 PATENT, TRADEMARK AND LICENSE SECURITY AGREEMENT 1 EXHIBIT 4.3(c) PATENT, TRADEMARK AND LICENSE SECURITY AGREEMENT THIS PATENT, TRADEMARK AND LICENSE SECURITY AGREEMENT (this "Agreement") is made and entered into as of the 29th day of October, 1997, by INTERLOTT TECHNOLOGIES, INC., a Delaware corporation ("Borrower"), in favor of MERCANTILE BUSINESS CREDIT INC., a Missouri corporation ("Lender"). WITNESSETH: WHEREAS, Borrower and Lender are herewith entering into that certain Loan Agreement dated the date hereof (as the same may from time to time be amended, modified, extended or renewed, the "Loan Agreement"; all capitalized terms used and not otherwise defined in this Agreement shall have the respective meanings ascribed to them in the Loan Agreement); and WHEREAS, as a condition precedent to Lender entering into the Loan Agreement, Lender has required that Borrower execute and deliver this Agreement to Lender; and WHEREAS, in order to induce Lender to enter into the Loan Agreement, Borrower has agreed to execute and deliver this Agreement to Lender; and WHEREAS, this Agreement is being executed in connection with and in addition to that certain Security Agreement dated the date hereof and executed by Borrower in favor of Lender, as the same may from time to time be amended, modified, extended or renewed, pursuant to which Borrower has granted Lender a security interest in, among other things, all accounts, inventory, general intangibles, machinery, equipment, books, records, goodwill, patents, trademarks and licenses now owned or hereafter acquired by Borrower and all proceeds thereof; NOW, THEREFORE, in consideration of the premises and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Borrower hereby covenants and agrees with Lender as follows: 1. Grant of Security Interest. For value received, Borrower hereby grants Lender a security interest in all of Borrower's right, title and interest in, to and under the following described property, whether now owned and existing or hereafter created, acquired or arising: (a) all patents and patent applications, and the inventions and improvements described and claimed therein, including, without limitation, each patent and patent application listed on Schedules A and B, respectively, attached hereto and incorporated herein by reference (as the same may be amended pursuant hereto from time to time) and (i) the reissues, divisions, continuations, renewals, extensions and continuations-in-part thereof, (ii) all income, damages and payments now and hereafter due or payable under or with respect thereto, including, without limitation, damages and payments for past or future infringements thereof, (iii) the right to sue for past, present and future infringements thereof and (iv) all rights corresponding thereto throughout the world (all of the foregoing patents and patent applications together with the items described in clauses (i) through (iv) of this subsection (a) are hereinafter collectively referred to herein as the "Patents"); (b) all trademarks, service marks, trademark or service mark registrations, trade names, trade styles, trademark or service mark applications and brand names, including, without limitation, common law rights and each trademark and trademark application listed on Schedules C and D, respectively, attached hereto and incorporated herein by reference (as the same may be amended pursuant hereto from time to time); and (i) renewals or extensions thereof, (ii) all income, damages and payments now and hereafter due or payable with respect thereto, including, without limitation, damages and payments for past or future infringements thereof, (iii) the right to sue for past, present and future infringements thereof and (iv) all rights corresponding thereto throughout the world (all of the foregoing trademarks, trade names, service marks and applications and registrations thereof together with the items described in clauses (i) through (iv) of this subsection (b) are hereinafter collectively referred to herein as the "Trademarks"); 2 (c) the license(s) listed on Schedule E attached hereto and incorporated herein by reference and all other license agreements (to the extent such license agreements may be assigned without violating the terms of any such license agreement) with respect to any of the Patents or any of the Trademarks or any other patent, trademark, service mark or any application or registration thereof or any other trade name or trade style between Borrower and any other party, whether Borrower is licensor or licensee (all of the forgoing license agreements and Borrower's rights thereunder are hereinafter collectively referred to as the "Licenses"); (d) the goodwill of Borrower's business connected with and symbolized by the Trademarks; and (e) all proceeds, including, without limitation, proceeds which constitute property of the types described in (a), (b), (c) and (d) above and any rents and profits of any of the foregoing items, whether cash or noncash, immediate or remote, and insurance proceeds, and all products of (a), (b), (c) and (d) above, and any indemnities, warranties and guaranties payable by reason of loss or damage to or otherwise with respect to any of the foregoing items; to secure the payment of any and all of the present and future Borrower's Obligations (hereinafter collectively referred to "Secured Obligations"). 2. Representations, Warranties and Covenants of Borrower. Borrower hereby represents and warrants to Lender, and covenants and agrees with Lender, that: (a) all United States patents owned by Borrower as of the date of this Agreement are listed on Schedule A attached hereto; (b) all United States patent applications of Borrower as of the date of this Agreement are listed on Schedule B attached hereto; (c) all United States trademarks owned by Borrower as of the date of this Agreement are listed on Schedule C attached hereto; (d) all United States trademark applications of Borrower as of the date of this Agreement are listed on Schedule D attached hereto; (e) all Licenses to which Borrower is a party as of the date of this Agreement are listed on Schedule E attached hereto; (f) to the best of Borrower's knowledge, all of the Patents, Trademarks and Licenses are subsisting and have not been adjudged invalid or unenforceable, in whole or in part, and are not at this time the subject of any challenge to their validity or enforceability; (g) to the best of Borrower's knowledge, each of the Patents, Trademarks and Licenses is valid and enforceable; (h) to the best of Borrower's knowledge, no claim has been made that the use of any of the Patents, Trademarks or Licenses does or may violate the rights of any third person; (i) to the best of Borrower's knowledge, no claims for patent infringement have been commenced in connection with any of the Patents; (j) to the best of Borrower's knowledge, no claims for trademark infringement have been commenced in connection with any of the Trademarks; (k) Borrower is the sole and exclusive owner of the entire and unencumbered right, title and interest in and to each of the Patents, Trademarks and Licenses, free and clear of any and all liens, charges and encumbrances, including, without limitation, any and all pledges, assignments, licenses, registered user - 2 - 3 agreements, shop rights and covenants by Borrower not to sue third persons, excluding only security interests granted to Lender; (l) Borrower has the unqualified right to enter into this Agreement and perform its terms; (m) Borrower has used, and will continue to use for the duration of this Agreement, proper statutory notice in connection with its use of the Patents, Trademarks and Licenses; (n) Borrower has the exclusive, royalty-free right and license to use the Patents and Trademarks and agrees not to transfer any rights or interest in any of the Patents, Trademarks or Licenses during the term of this Agreement; (o) Borrower will not amend, modify or terminate (or consent or agree to any amendment, modification or termination of) any of the Licenses without the prior written consent of Lender, which consent shall not be unreasonably withheld; and (p) Borrower has no notice of any suits or actions commenced or threatened with reference to any of the Patents, Trademarks or Licenses. 3. Inspection Rights; Product Quality. Borrower will permit inspection of its facilities which manufacture, inspect or store products sold under any of the Patents, Trademarks and/or Licenses and inspection of the products and records relating thereto by Lender during normal business hours and at other reasonable times upon at least one (1) Domestic Business Day's prior oral or written notice from Lender to Borrower (provided, however, that no such notice need be given by Lender if any Event of Default under the Loan Agreement has occurred and is continuing). Borrower will reimburse Lender upon demand for all reasonable costs and expenses incurred by Lender in connection with any such inspection conducted by Lender while any Default or Event of Default under the Loan Agreement has occurred and is continuing. Borrower agrees (i) to maintain the quality of any and all products in connection with which the Trademarks are used, consistent with commercially reasonable practices and (ii) to provide Lender, upon Lender's reasonable request from time to time, with a certificate of any officer of Borrower certifying Borrower's compliance with the foregoing. 4. Further Assurances. Borrower covenants and agrees that, until (i) all of the Secured Obligations have been paid in full, (ii) Lender has no further commitment or obligation to make any additional loans or advances or other extensions of credit to Borrower under the Loan Agreement or otherwise and (iii) the Loan Agreement has been terminated, it will not enter into any agreement (for example, a license or sublicense agreement) which is inconsistent with Borrower's obligations under this Agreement or the Loan Agreement, without the prior written consent of Lender and Borrower covenants and agrees that it will not take any action or permit any action to be taken by others subject to its control, including licensees to the extent subject to Borrower's control, or fail to take any action, which could affect the validity or enforcement of the rights transferred to Lender under this Agreement. Borrower further covenants and agrees that at any time and from time to time, at the expense of Borrower, Borrower will promptly execute and deliver to Lender any and all further instruments and documents and take any and all further action that may be necessary, or that Lender may reasonably request, in order to perfect and protect the security interest granted hereby with respect to the Patents, Trademarks and Licenses or to enable Lender to exercise its rights and remedies hereunder with respect to the same. 5. Additional Patents, Trademarks and Licenses. If Borrower shall (i) become aware of any existing Patents, Trademarks or Licenses of which Borrower has not previously informed Lender, (ii) obtain rights to any new patentable inventions, Patents, Trademarks or Licenses or (iii) become entitled to the benefit of any Patents, Trademarks or Licenses which benefit is not in existence on the date hereof, the provisions of this Agreement shall automatically apply thereto and Borrower shall give Lender prompt written notice thereof. 6. Modification by Lender. Borrower authorizes Lender to modify this Agreement by amending Schedules A, B, C, D and E to include any future patents and patent applications, any future trademarks, service marks, trademark or service mark registrations, trade names, and trademark or service applications, and - 3 - 4 any future licenses, covered by Paragraphs 1 and 5 hereof, without the signature of Borrower if permitted by applicable law. 7. Use of Patents, Trademarks and Licenses. So long as no Event of Default under the Loan Agreement has occurred and is continuing, Borrower may use the Patents and Trademarks and exercise its rights under the Licenses in any lawful manner not inconsistent with this Agreement on and in connection with products sold or leased by Borrower, for Borrower's own benefit and account and for none other. 8. Default. If any Event of Default under the Loan Agreement shall have occurred and be continuing, Lender shall have, in addition to all other rights and remedies given it by this Agreement, those allowed by law and the rights and remedies of a secured party under the Uniform Commercial Code as enacted in any jurisdiction in which the Patents, Trademarks and Licenses may be located and, without limiting the generality of the foregoing, Lender may immediately, without demand of performance and without other notice (except as set forth next below) or demand whatsoever to Borrower, all of which are hereby expressly waived, and without advertisement, sell at public or private sale or otherwise realize upon, all or from time to time any of the Patents, Trademarks (together with the goodwill of Borrower associated therewith) or Licenses, or any interest which Borrower may have therein, and after deducting from the proceeds of sale or other disposition of the Patents, Trademarks or Licenses all costs and expenses (including, without limitation, all expenses for brokers' fees and all reasonable attorneys' fees and expenses), shall apply the residue of such proceeds toward the payment of the Secured Obligations in such order and manner as Lender may in its discretion elect. Notice of any sale or other disposition of any of the Patents, Trademarks or Licenses shall be given to Borrower at least five (5) business days before the time of any intended public or private sale or other disposition of such Patents, Trademarks and/or Licenses is to be made, which Borrower hereby agrees shall be reasonable notice of such sale or other disposition. At any such sale or other disposition, Lender or any holder of any of the Secured Obligations may, to the extent permissible under applicable law, purchase the whole or any part of the Patents, Trademarks or Licenses sold, free from any right of redemption on the part of Borrower, which right is hereby waived and released. Borrower agrees that upon the occurrence and continuance of any Event of Default under the Loan Agreement, the use by Lender of the Patents, Trademarks and Licenses shall be worldwide, and without any liability for royalties or other related charges from Lender to Borrower. If an Event of Default under the Loan Agreement shall occur and be continuing, Lender shall have the right, but shall in no way be obligated, to bring suit in its own name to enforce any and all of the Patents, Trademarks and Licenses, and, if Lender shall commence any such suit, Borrower shall, at the request of Lender, do any and all lawful acts and execute any and all proper documents required by Lender in aid of such enforcement and the Borrower shall promptly, upon demand, reimburse and indemnify Lender for all costs and expenses (including, without limitation, reasonable attorneys' fees and expenses) incurred by Lender in the exercise of its rights under this Agreement. 9. Termination of Agreement. At such time as (i) Borrower shall pay all of the Secured Obligations in full, (ii) Lender shall have no further commitment or obligation to make any additional loans or advances or other extensions of credit to Borrower under the Loan Agreement or otherwise and (iii) the Loan Agreement shall be terminated, this Agreement shall terminate and Lender shall, at Borrower's expense, execute and deliver to Borrower all instruments as may be necessary or proper to extinguish Lender's mortgage on and security interest in, and to reassign, retransfer and reconvey to Borrower, the Patents, Trademarks and Licenses, subject to any disposition thereof which may have been made by Lender pursuant hereto. 10. Expenses. Any and all fees, costs and expenses of whatever kind or nature, including, without limitation, the reasonable attorneys' fees and expenses incurred by Lender in connection with the preparation of this Agreement and all other documents relating hereto and the consummation of this transaction, the filing or recording of any documents (including all taxes in connection therewith) in public offices, the payment or discharge of any taxes, counsel fees, maintenance fees, encumbrances or other amounts in connection with protecting, maintaining or preserving the Patents, Trademarks and/or Licenses, or in defending or prosecuting any actions or proceedings arising out of or related to the Patents, Trademarks and/or Licenses, shall be borne and paid by Borrower on demand by Lender and until so paid shall be added to the principal amount of the Secured Obligations and shall bear interest at a rate per annum equal to the lesser of Four Percent (4%) over and above the Prime Rate (which interest rate shall fluctuate as and when the Prime Rate shall change) or the highest rate of interest allowed by law from the date incurred until reimbursed by Borrower. - 4 - 5 11. Preservation of Patents, Trademarks and Licenses. Borrower shall, consistent with Borrower's reasonable determination of how most effectively to protect and conduct its business in a commercially reasonable manner, (i) file and prosecute diligently any patent, trademark or service mark applications pending as of the date hereof or hereafter, {ii) make application on unpatented but patentable inventions and on trademarks and service marks and (iii) preserve and maintain all rights in the Patents, Trademarks and Licenses. Any expenses incurred in connection with Borrower's obligations under this Section 11 shall be borne by Borrower. 12. Lender Appointed Attorney-ln-Fact. If any Event of Default under the Loan Agreement shall have occurred and be continuing, Borrower hereby authorizes and empowers Lender to make, constitute and appoint any officer or agent of Lender as Lender may select, in its sole discretion, as Borrower's true and lawful attorney-in-fact, with the power to endorse Borrower's name on all applications, documents, papers and instruments necessary for Lender to use the Patents, Trademarks and Licenses, or to grant or issue any exclusive or non-exclusive license under the Patents, Trademarks and Licenses to anyone else, or necessary for Lender to assign, pledge, convey or otherwise transfer title to or dispose of the Patents, Trademarks and Licenses to anyone else. Borrower hereby ratifies all that such attorney shall lawfully do or cause to be done by virtue hereof. This power of attorney is coupled with an interest and shall be irrevocable for the duration of this Agreement. 13. No Waiver. No course of dealing between Borrower and Lender, nor any failure to exercise, nor any delay in exercising, on the part of Lender, any right, power or privilege hereunder shall operate as a waiver thereof; nor shall any single or partial exercise of any right, power or privilege hereunder preclude any other or further exercise thereof or the exercise of any other right, power or privilege. 14. Severabilitv. The provisions of this Agreement are severable, and if any clause or provision shall be held invalid and unenforceable in whole or in part in any jurisdiction, then such invalidity or unenforceability shall affect only such clause or provision, or part thereof, in such jurisdiction, and shall not in any manner affect such clause or provision in any other jurisdiction, or any other clause or provision of this Agreement in any jurisdiction. 15. Amendments. This Agreement is subject to amendment or modification only by a writing signed by Borrower and Lender, except as provided in Paragraph 6 above. 16. Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of Borrower and Lender and their respective successors and assigns, except that Borrower may not assign or delegate any of its rights of obligations under this Agreement. 17. Governing Law. The validity and interpretation of this Agreement and the rights and obligations of the parties hereto shall be governed by and construed in accordance with the Federal laws of the United States of America and the substantive laws of the State of Missouri (without reference to conflict of law principles). - 5 - 6 IN WITNESS WHEREOF, Borrower and Lender have executed this Patent, Trademark and License Security Agreement as of the 29th day of October, 1997. INTERLOTT TECHNOLOGIES, INC. ("Borrower") By /s/ Jerome J. Cain ---------------------------- Title: Chief Executive Officer ------------------------ By /s/ L. Rogers Wells ---------------------------- Title: Chief Executive Officer ------------------------ MERCANTILE BUSINESS CREDIT INC. ("LENDER") By /s/ Marian H. Kammerer ---------------------------- Title: Vice President ------------------------ -6- 7 CERTIFICATE OF ACKNOWLEDGEMENT STATE OF OHIO ) ) COUNTY OF HAMILTON ) On this 28th day of October, 1997, before me personally appeared L. Rogers Wells, to me personally known, who, being by me duly sworn, did say that he is the CEO of INTERLOTT TECHNOLOGIES, INC., a Delaware corporation, and that said instrument was signed on behalf of said corporation by authority of its Board of Directors; and said L. Rogers Wells acknowledged said instrument to be the free act and deed of said corporation. IN TESTIMONY WHEREOF, I have hereunto set my hand and affixed my official seal in the County and State aforesaid, the day and year first above written. /s/ Frederick H. Rikes (Seal) ----------------------- Notary Public Frederick H. Rikes My Commission Expires: 12/7/97. Notary Public, State of Ohio My Commission Expires Dec. 7, 1997 STATE OF MISSOURI ) ) CITY OF ST. LOUIS ) On this 29th day of October, 1997, before me personally appeared Jerome J. Cain, to me personally known, who, being by me duly sworn, did say that he is the CFO of INTERLOTT TECHNOLOGIES, INC., a Delaware corporation, and that said instrument was signed on behalf of said corporation by authority of its Board of Directors; and said Jerome J. Cain acknowledged said instrument to be the free act and deed of said corporation. IN TESTIMONY WHEREOF, I have hereunto set my hand and affixed my official seal in the City and State aforesaid, the day and year first above written. CHRISTINE BLISSENBACH Notary Public - Notary Seal (Seal) STATE OF MISSOURI City of St. Louis /s/ Christine Blissenbach My Commission Expires: November 11, 2000 ------------------------- Notary Public My Commission Expires:________. -7- 8 STATE OF MISSOURI ) ) CITY OF ST. LOUIS ) On this 29th day of October, 1997, before me appeared Marian Kammerer, to me personally known, who, being by me duly sworn, did say that he is a Vice President of MERCANTILE BUSINESS CREDIT INC., a Missouri corporation, and that said instrument was signed on behalf of said corporation, by authority of its Board of Directors; and said Marian Kammerer acknowledged said instrument to be the free act and deed of said corporation. IN TESTIMONY WHEREOF, I have hereunto set my hand, and affixed my official seal in the City and State aforesaid, the day and year first above written. CHRISTINE BLISSENBACH Notary Public - Notary Seal (Seal) STATE OF MISSOURI City of St. Louis /s/ Christine Blissenbach My Commission Expires: November 11, 2000 ------------------------- Notary Public My Commission Expires:________. -8- 9 SCHEDULE A United States Patents
Patent No. Date Issued Inventor Description - ---------- ----------- -------- ----------- 5,472,247 12/5/95 Gavin M. Monson Multi-point high security locking mechanism for lottery machines 5,330,185 7/19/94 L. Rogers Wells Method and apparatus for random play of lottery games D376,621 12/17/96 L. Rogers Wells Double game ticket vending machine 4,982,337 1/1/91 Robert L. Burr System for distributing lottery tickets
-9- 10 SCHEDULE B United States Patent Applications
Patent Application No. Date Filed Description - ---------------------- ---------- ----------- *PCT/US97/05761 4/7/91 Improved Lottery Ticket Dispenser *International patent application designating the United States.
-10- 11 SCHEDULE C United States Trademarks
Registration No. Registration Date Mark Registered - ---------------- ----------------- --------------- 1,949,978 1/23/96 Instant Success 1,822,517 2/22/94 Interlott (word and design) R1840378 6/21/94 Interlott (word)
-11- 12 SCHEDULE D United States Trademark Applications Registration No. Registration Date Mark Registered - ---------------- ----------------- --------------- None -12- 13 SCHEDULE E Licenses Pull-tab manufacturing and license agreement among Algonquin Industries, Inc., Kazmier Kasper and Borrower dated January 13, 1994 regarding a pull-tab ticket mechanism. -13- EX-10.4.(C) 6 EMPLOYMENT AGREEMENT 1 EXHIBIT 10.4 (c) EMPLOYMENT AGREEMENT BETWEEN L. ROGERS WELLS, JR. AND INTERNATIONAL LOTTERY, INC. 2 EMPLOYMENT AGREEMENT THIS AGREEMENT is made and entered into as of the 1st day of February, 1995, by and between INTERNATIONAL LOTTERY, INC., WELLS, JR., a resident of the Commonwealth of Kentucky (hereinafter referred to as the "Employee"). WITNESSETH: WHEREAS, the Employer desires to employ the Employee in an executive management capacity upon the terms and conditions hereinafter set forth, and the Employee is willing to enter into this Employment Agreement (the "Agreement") with respect to his employment upon the terms and conditions hereinafter set forth; NOW, THEREFORE, in consideration of the mutual covenants and obligations contained herein, the Employer hereby employs the Employee and the Employee hereby accepts employment upon the terms and conditions hereinafter set forth: 1. TERM OF AGREEMENT. The term of this Agreement shall be for a period of three (3) years from the date of this Agreement, unless this Agreement is terminated prior to the expiration of said period as hereinafter provided. The term of employment may be extended by mutual written agreement of the Employer and the Employee. 2. DUTIES OF EMPLOYEE. It is anticipated that the Employee shall be employed in the capacity of Chairman of the Board of Directors and Chief Executive Officer, reporting directly to the Board of Directors of the Employer, in the execution of his duties and that the duties will include authority for management, financial, personnel, and project decisions to the extent granted by the Board of Directors. The Employee shall not, during his employment by the Employer, unless otherwise agreed to in advance in writing by the Employer, seek or accept any other activities which are detrimental to the business of the Employer. 3. CASH COMPENSATION. For the services rendered by the Employee under this Agreement, the Employer shall pay the Employee annual gross salary in the amount of One Hundred fifty thousand Dollars ($150,000.00), payable at least monthly, during the term Agreement according to the policies of the Employer than in effect. 4. BENEFITS (a) EXPENSE REIMBURSEMENT. The Employee shall be reimbursed for travel and other expenses incurred for benefit of the Employer and in accord with the current Employer expense reimbursement policy. (b) GROUP INSURANCE. The Employee shall be entitled to the standard group health and life insurance package provided to employees by the Employer under the policies, terms and conditions in effect at the time. 3 (c) Other Employee Benefits. The Employee shall participate in such other employee benefit plans as may be authorized and adopted from time to time by the Employer, including personal leave, holidays, professional insurance, if any, and all other fringe benefits, provided however, that the Employee must meet any and all eligibility provisions required under such other employee benefit plans. 5. Termination of Agreement. The Agreement shall terminate upon the occurrence of one of the following events: (a) Termination for Cause. The Employer may terminate the Agreement and the employment relationship for "cause," by serving fifteen (15) days prior written notice to the Employee. For purposes hereof, "cause" for termination shall be deemed to include determination by the Board of Directors of the Employer that Employee has; (i) refused or materially failed to perform his duties hereunder; (ii) breached any provision of this Agreement; (iii) has committed any act of fraud, misappropriation or embezzlement against the Employer; (iv) engaged in conduct or activities materially damaging to the business of the Employer (with the understanding that neither conduct nor activities pursuant to the Employee's exercise of his good faith business judgement nor unintentional physical damage to any property of the Employer by the Employee shall be grounds for such a determination by the Board) and that such conduct continues for a period of fifteen (15) days after written notice by the Employer to the Employee; and (v) been convicted of any felony or any act or offense involving moral turpitude federal, state, or local law. (b) Voluntary Termination by Employee. The Employee shall have the right to terminate the Agreement and his employment relationship, and resign his positions with the Employer, upon thirty (30) days' prior written notice. (c) Disability or Death of Employee. In the event of total and permanent disability or the death of Employee, the Agreement shall terminate as of the date of such death or disability. For this purpose, "total and permanent disability" shall mean a determination of the inability of Employee, due to mental and/or physical conditions, to perform the majority of his duties of his position with the Employer, for a continuous period of sixty (60) days. (d) Expiration. The Agreement shall terminate at the end of the term specified in Section 1, if it has not earlier terminate due to the reason described in subsection (a) through (c) above. 6. Rights Upon Termination. Upon termination of this Agreement, Employer shall pay all compensation to Employee pursuant to Section 3 hereof that is due and payable prior to and including the effective date of such termination. Upon termination of employment hereunder, the Employee shall be entitled to those employee benefits normally provided to employees of the Employer upon their termination of employee benefits normally provided to employees of the Employer upon their termination of employment, as may be applicable from time to time, and no further compensation shall be paid pursuant to this Agreement. -2- 4 7. Attorneys' Fees. If any action at law or in equity is necessary to enforce or interpret the terms of this Agreement, the prevailing party shall be entitled to reasonable attorney's fees, costs and necessary disbursements in addition to any other relief to which he or it may be entitled. 8. Products, Notes and Records. All memoranda, notes, records, and other documents, made or complied by Employee or made available to him during the term of this Agreement concerning the business of Employer, including, without limitation, all technical data, billing information, bidding data and other technical material of Employer, shall be Employer's property and shall be delivered to Employer within ten (10) days after termination of this Agreement. 9. Covenant Not to Compete. (a) General Covenant Not to Compete. In consideration of the Employer's employment of the Employee, Employee hereby covenants and agrees that, during the period of his employment with the Employer and for a period of one (1) year after termination of employment (whether for cause or by voluntary termination), he will not, without the Employer's consent, directly or indirectly, compete with the Employer by: (i) performing the duties of an officer, manager, owner, director, consultant, partner, salesman or stockholder (except as a stockholder less than 5% interest in a corporation which is traded on a national exchange or over-the-counter), in or for any business entity engaged in direct competition with the Employer, or (ii) perform activities or duties substantially similar or related to the functions, activities or duties performed by Employee for the Employer from time to time for any business entity engaged in direct competition with the Employer. A business entity shall be considered to be "in direct competition" with the Employer if it is engaged in the design, sale, manufacture, distribution, servicing or repairing of machinery or equipment used for or in connection with the distribution of lottery tickets or any other business that Employer engages in as of the date the Employee terminates employment with the Employer. The restrictions in this Section will apply to all functions, activities and duties performed in a Restricted Territory, or performed for or on behalf of any business which is located in or does business in a Restricted Territory, regardless of where Employee actually performs such functions, activities or duties. "Restricted Territory" means: (a) Any state within the United States, or any other country or political or geographic subdivision thereof, in which Employer has submitted a bid to function as a contractor or subcontractor furnishing or maintaining lottery ticket machines within the twelve months immediately proceeding Employee's termination of employment. -3- 5 The parties expressly agree and acknowledge that the nature of Employer's business is unique, in that Employer's services are furnished on a state-wide, or region-wide, or in some instances country-wide basis, and that therefore the restrictions herein are reasonable and necessary of for the protection of Employer's legitimate business interests. (b) Covenant Related to Customers. Employee will not in any way, directly or indirectly, except as an employee of the Employer, solicit, divert or take away, or attempt to solicit, divert to take away, the business of any of the customers of the Employer which were served or solicited by Employee for the Employer during the term of his/her employment, or any of the prospective customers of the Employer that Employee served or solicited for the Employer within one (1) year prior to the termination of his/her employment, for the purpose of selling to any such customer or prospective customer any product or service substantially similar to any product or service that was offered by the Employer during his employment. Employee will not directly or indirectly attempt or seek to cause any of the foregoing customers or prospective customers of the Employer to refrain from maintaining or acquiring from or through the Employer any product or service that was offered by the Employer during his employment and will not assist any other person to do so. (c) Covenant Related to Other Employee. Employee will not solicit for employment, directly or through or on behalf of any other party, any persons who are then employees of the Employer, or induce or attempt to induce the termination of any such person's employment with the Employer. 10. Confidentiality and Nondisclosure. Employee acknowledges and agrees that, during the term of this Agreement, he will have access to trade secrets and other confidential information unique to Employer's business and that the disclosure or unauthorized use of such trade secrets or confidential information by Employee will injure Employer's business. Therefore, Employee agrees that he will not, at any time during or after the term of this Agreement, use, reveal or divulge any trade secrets or any other confidential information which while not trade secrets or information unique to Employer's business, is highly confidential and constitutes a valuable asset of Employer by reason of the material investment of Employer's time and money in the production of such information. Employee agrees that during the term of this Agreement and for a period of three (3) years therefore, he will not use, reveal or divulge any general confidential and customer information. 11. Miscellaneous. (a) The Agreement may not be modified except by an agreement in writing executed by the parties. (b) The Agreement contains the entire understanding of the parties relating to the subject matter contained herein. -4- 6 (c) All notices required to be given under the Agreement shall be given in writing by personal delivery or by first class mail. (d) The invalidity or unenforceability of any provision hereof shall not affect the validity or enforceability of any other provision. (e) Upon termination of the Agreement, the Agreement and its terms and conditions shall be deemed terminated for all purposes, except of the surviving covenants and provisions set forth herein. Upon termination of this Agreement, if Employee continues in employment with the Employer, Employee shall be deemed a common law employee subject to all policies and procedures of the Employer, applicable to Employee as one of its personnel, as adopted from time to time. 12. Property of Employer. The Employee acknowledges that from time to time in the course of providing services pursuant to this Agreement he shall have the opportunity to inspect and use certain property, both tangible and intangible, of the Employer and the Employee hereby agrees that said property shall remain the exclusive property of the Employer and the Employee shall have no right or proprietary interest in such property, whether tangible or intangible, including, without limitation, the employer's customer and supplier lists, contract forms, books of account, computer programs and similar property. 13. Notice, Monetary Damages and Equitable Relief. (a) The Employee acknowledges that the services to be rendered by him are of special, unique, unusual, extraordinary and intellectual character, which gives them a peculiar value and the loss of which cannot reasonably or adequately be compensated in damages in an action at law; and that a breach by him of any of the provisions contained in this Agreement will cause the Employer irreparable injury and damage. The Employee further acknowledges that he possesses unique skills, knowledge and ability and that any material breach of the provisions of this Agreement would be extremely detrimental to the Employer. By reason thereof, the Employee agrees that the Employer shall be entitled, in addition to any other remedies it may have under this Agreement or otherwise, to injunctive and other equitable relief to prevent or curtail any breach of this Agreement by him. (b) The Employer and the Employee agree that in the event of a breach of the provisions of this Agreement by the Employee, that Employer shall give the Employee written notice of such breach and may terminate the Agreement pursuant to Section 5 hereof. In the event of a breach by affiliates shall be entitled to recover full monetary damages for such breach and shall have a right of set off against any sums or property owing to Employee, under this or any other agreement. 14. Successors Bound: Assignability. The Agreement shall be binding upon the Employer and the Employee, their respective heirs, executors, administrators or successors in interest, including without limitation, -5- 7 any corporation into which the Employer may be merged or by which it may be acquired. The Agreement is nonassignable except that the Employer's rights, duties and obligations under this Agreement may be assigned to its acquiror in the event the Employer is merged, acquired or sells substantially all of its assets. 15. Severability. In the event that any one or more of the provisions of this Agreement or any word, phrase, clause, sentence or other portion thereof shall be deemed to be illegal or unenforceable for any reason, such provision or portion thereof shall be modified or deleted in such a manner so as to make this Agreement as modified legal and enforceable to the fullest extent permitted under applicable law. 16. Entire Agreement. This Agreement constitutes the entire Agreement between the parties hereto with regard to the subject matter hereof, and there are not agreements, understandings, specific restrictions, warranties or representations relating to said subject matter between the parties other than those set forth herein or herein provided for. Neither this Agreement nor any provision hereof may be changed, waived, discharged or terminated orally, but only by an agreement in waiver, discharge or termination is sought. 17. Prior Agreements. This Agreement supersedes and replaces in its entirety any and all other employment or compensation agreements entered into between the Employer and the Employee prior to the date of this Agreement, including (but not limited to) that certain Employment Agreement dated April 27, 1979, and that certain Employment Agreement dated May 1, 1982, and that certain Compensation and Benefits Agreement between the Employer and the Employee dated June 5, 1990 and that certain Employment Agreement dated April 21, 1994. 18. Governing Law. The terms of this Agreement shall be governed by and construed in accordance with the laws of the State of Ohio. -6- 8 IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. "EMPLOYER" INTERNATIONAL LOTTERY, INC. By: /s/ Gary S. Bell ------------------------------------ Chairman, Compensation Committee By: /s/ Gary S. Bell - /s/ ------------------------------------ Secretary Counsel "EMPLOYEE" /s/ L. Rogers Wells, Jr. ---------------------------------------- L. Rogers Wells, Jr. -7- EX-11 7 STATEMENT RE: COMPUTATION EPS 1 EXHIBIT 11 INTERLOTT TECHNOLOGIES, INC. COMPUTATION OF EARNING PER SHARE
THREE MONTHS ENDED YEAR ENDED DECEMBER 31, DECEMBER 31, 1997 1996 1997 1996 ---- ---- ---- ---- Weighted average common shares outstanding during the period 3,210,000 3,210,000 3,210,000 3,210,000 Net income 436,709 $ 726,384 $1,451,654 $1,320,597 Net income per share $ 0.14 $ 0.13 $ 0.45 $ 0.41 Assuming full dilution: Weighted average common shares outstanding during the period 3,210,000 3,210,000 3,210,000 3,210,000 Assuming exercise of options 4,870 2,000 2,661 2,000 Weighted average common shares outstanding as adjusted 3,214,870 3,212,000 3,212,661 3,212,000 Net income $ 436,709 $ 726,384 $1,451,654 $1,320,597 Earning per common share assuming full dilution $ 0.14 $ 0.13 $ 0.45 $ 0.41
EX-13 8 ANNUAL REPORT TO SHAREHOLDERS 1 ANNUAL REPORT PHOTO: Woman on phone holding phone card PHOTO: Woman holding VISA(R) cash card PHOTO: Man holding lottery tickets VISIT OUR WEBSITE... WWW.INTERLOTT.COM PHOTO: Hand removing phone card from PCDM PHOTO: Hand removing smart card from SCDM PHOTO: Hand removing Instant Ticket from ITVM TO DISTRIBUTE DISPENSING TECHNOLOGIES THE SCIENCE OF TECHNICAL PROCESSES
Table of Contents - ----------------------------------------------------------- To Our Stockholders 1 - ----------------------------------------------------------- Lottery 3 - ----------------------------------------------------------- Phone Card and Other Card Markets 4 - ----------------------------------------------------------- International Markets 6 - ----------------------------------------------------------- Selected Financial Data 7 - ----------------------------------------------------------- Management's Discussion & Analysis 7 - ----------------------------------------------------------- Financial Statements 10 - ----------------------------------------------------------- Corporate Data & Stockholder Information 17 - -----------------------------------------------------------
[INTERLOTT TECHNOLOGIES, INC. LOGO] 2 inside front cover/1 3/26/98 4:09 PM Page 1 During the first quarter of 1997, the Board of Directors of International Lottery, Inc. voted to change the name of the Company to Interlott Technologies, Inc. to better reflect and communicate our expertise with high technology dispensing devices for an unlimited variety of applications. Current trends in product line interest indicate imminent shifts from the present income revenue breakdown of [ ] 87% Lottery, [ ]3% Phone Card, [ ]9% Service Contracts, and [ ] less than 1% other interests, to a more balanced distribution of revenue sources. Interlott Technologies, Inc. (dba Interlott) designs, manufactures, sells, leases and services dispensing machines for the lottery, telecommunications and financial services industries. Interlott is the leading provider of Instant Ticket Vending Machines (ITVMs) and Pull Tab Vending Machines (PTVMs) for U.S. and international lotteries. Interlott continues to offer a full line of Phone Card Dispensing Machines (PCDMs) and Smart Card Vending Machines (SCDMs), as well. PHOTO: Thomas W. Stokes Jerome J. Cain, and David F. Nichols To our Stockholders: PHOTO: Portrait of L. Rogers Wells, Jr. Dear Fellow Stockholders: I am pleased to report that 1997 was a continuation of our growth as a premier provider of dispensing technologies. We continue to broaden our leading position in the lottery industry, while expanding our presence in the high potential telephone market and experiencing substantial growth in interest and activity in the international marketplace. All of these activities have combined to provide strong financial results. Pre-tax income more than doubled on a 3% revenue increase illustrating the value of our emphasis on leasing rather than selling our dispensing equipment. Cash flow from operations (net income plus depreciation and amortization) increased to a new high of $5,595,062 or $1.74 per share. The 10% increase in net income is significant when the tax rate of 40% for 1997 is compared to the tax benefit rate of 17% in 1996. During 1997, we deployed machines, under leases to Florida, Kansas, and New Mexico, in addition to deploying machines under a new lease contract to Ohio. Also, during 1997 we were chosen to provide machines to the District of Columbia Lottery and were awarded the new contract for additional machines to be provided to the Maryland Lottery. In total, we are now the vendor of choice in 22 of 32 U.S. lotteries employing vending technology for their instant/scratch-off ticket program. The majority of machines deployed in 1997 were our twelve bin instant ticket vending machines, which provide the retailer with a greater variety of tickets being sold through our vending technology while using less floor space than our previous eight game models. We also provided to the Kansas Lottery our new pull tab/break open ticket dispensing equipment, and early results indicate that this machine continues the success in increasing sales that our other models have provided to the lotteries. International interest in our vending technology increased during 1997, with machines being shipped to Denmark, Iceland, Ireland, and Israel. We fully anticipate continued growth in the international marketplace during 1998 and beyond. During 1997 the popularity of prepaid telephone cards expanded significantly with sales of the cards in the U.S. reaching $1 billion and industry expectations of a market in the U.S. for the cards exceeding $2.5 billion by the year 2000. We believe that this industry expansion will drive the demand for dispensing technology similar to the growth in the lottery industry. In 1997 the Company changed its name to Interlott Technologies, Inc. to reflect the Company's growing diversity as a provider of leading-edge dispensing technologies for a variety of industries worldwide. In 1998 our goal will be to accelerate the growth of our new markets, while further developing our core lottery business, leveraging Interlott's position as a premier provider of dispensing technology and products. We will continue to place an emphasis on leasing rather than selling equipment to build on our annuity of future revenues which should enhance profitability and stockholder value. In May, I was proud to announce that our Board of Directors appointed David F. Nichols president of the Company. He replaced Edmund F. Turek, our founder and a great contributor to the development of Interlott, who now serves as vice chairman. I can think of no one more qualified than David to run our day-to-day operations. He spearheaded our entry into many of our new markets and was a leader in cultivating our lottery business. On behalf of management and our Board of Directors, I would like to express our appreciation for the continued support of Interlott's employees, customers, vendors, and stockholders. I look forward to reporting upon further progress in 1998. /s/ L. Rogers Wells, Jr. Sincerely, L. Rogers Wells, Jr. Chairman of the Board and Chief Executive Officer 1 [PAGE] 2 *PHOTO: OH 12 game ITVM WI 8 game ITVM and KS 8 game PTVM 3 LOTTERY Sales of instant scratch-off tickets constitute nearly 50% of the revenue earned by U.S. lotteries annually. But with over-the-counter sales, the popularity and profitability of instants has been overshadowed by the time consuming transactions, lack of security, and labor-intensive accounting incurred by retailers. Interlott's ITVM revolutionized instant ticket sales when introduced in 1990, and our complete product line continues to multiply sales nearly a decade later. Interlott ITVMs showcase up to twelve instant games while providing complete security and detailed sales reports to lottery retailers. Our patented bursting mechanism, which cleanly separates each ticket from the fanfolded ticket pack without cutting or tearing, is the key feature that sets Interlott's ITVMs apart from the competition. Twenty-two of the 32 states that utilize ITVMs designate Interlott as their vendor of choice. PHOTO: Interlott's patented burster Successful ticket sales, ITVM reliability, and efficient maintenance resulted in several new contract awards, contract renewals, and additional ITVM orders during 1997. Interlott sold or leased ITVMs to four new states while receiving substantial orders for additional equipment from eight existing customers. The Ohio Lottery has leased Interlott ITVMs since early in 1992. During this time, more than 300 million tickets have been dispensed through our ITVMs, returning over $85 million to the state after payouts and administrative costs. The Florida Lottery kicked off 1997 with the installation of 500 twelve game ITVMs statewide. Players enjoyed the new convenience so much that instant sales shot up 22% over 1996 figures. Success stories like these have prompted lotteries such as Kansas, Iowa and Indiana to look to ITVMs to promote slower moving, lower margin lottery products such as pull tabs or break open tickets. Interlott offers the most compact and efficient PTVMs available to date. In the first weeks after installation of just 50 PTVMs, Kansas' pull tab sales were boosted by over $100,000, an increase of over 50%. All indications are that other states will follow suit in 1998. Through technological innovation, we continue to focus on expansion of equipment features, reduction of floor space required, and attraction of the greatest number of players. The Ohio Lottery has been the first in the nation to take advantage of the dial-up modem capabilities of our ITVMs. Each newly installed ITVM is capable of calling up the central host system to transmit detailed daily and lifetime sales data. The lottery is able to analyze this valuable information on an ongoing basis to determine not only what types of locations are best for instant sales, but specifically which games are the most popular. PHOTO: Interlott 12 game ITVM Installing the first 500 new Interlott 12 game ITVMs in Florida during the first quarter of 1997 sent positive shock waves from retailer locations straight to the lottery's profit column. PHOTO: Interlott PTVM advertisement State lotteries are amazed to find that boosting pull tab sales is as easy as installing an Interlott PTVM along side of an Interlott ITVM. Our advertisement supports this growing trend. GRAPH: Percentage of lotteries that utilize ITVMs 69% of the U.S. lotteries that utilize ITVMs designate Interlott as their vendor of choice. PHOTO: Service representative pushing keypad The majority of our lottery customers also have service contracts with us to provide preventative maintenance and on-site repair. These contracts accounted for 9% of overall revenue in 1997. PHOTO: Man and woman viewing chart on computer screen The dial-up modem capability of our ITVMs provides invaluable up-to-the-minute sales data to lotteries for detailed marketing analysis. 4 PHONECARD AND OTHER CARD MARKETS If 1997's rising interest in PCDMs is any indication of future market potential, then Interlott's patience is in line for a payoff. More frequent inquiries and test machine orders are leading to a steady increase in purchased or leased PCDMs, more notably by the top four telecommunications companies but also by many start-up phone card companies which have built revenue and reputation from over-the-counter sales. Sales to these younger companies represent more than half of Interlott's PCDM sales in 1997. It is becoming almost imperative for long distance carriers to offer PCDMs to their vendors as viable solutions to security and administrative concerns connected with handling this higher priced, profitable product. Since their introduction to the U.S. in the early 1990's, prepaid phone cards have received measurable success with annual growth rates of more than 33%. Industry estimates for 1998 revenues are ranging from $750 million to $1.3 billion, with sales predicted to reach $2.5 billion by the year 2000. With the increased installation of PCDMs, the effect on overall sales figures is becoming more apparent, as shown in the charts below. Paralleling our position as of 1992 with the growth level of ITVMs in the lottery industry, we anticipate significant growth in PCDM sales. We did it before and we believe we can do it again. PHOTO: Montage of plastic cards OTHER CARD MARKETS Our unique, patented ShurShuttle(R) dispensing mechanism dispenses individual paper or plastic cards of any thickness without jamming. The beauty of this mechanism is that it can be "housed" in any secure cabinet for installation in virtually any environment where the need for card vending becomes apparent: public transit and parking cards, theme park debit cards, and smart cards for closed systems such as military bases and college campuses. In such locations where smart cards can be used for nearly all purchases and transactions, the initial investment in vending and validation equipment is necessary and immediately appreciated. Familiarity with such systems in these environments is paving the way for comfortable acceptance of the smart card, as we steadily move toward a society less dependent on cash. In contrast, an antiquated phone system in Europe coupled with the high cost of processing credit card transactions, has forced Europeans to accept and use smart cards as cash on a daily basis, while Americans have been slower to embrace the idea. Several ongoing tests are being conducted across the country. Interlott remains the only VISA(R) certified provider of smart card dispensing machines. With U.S. sales of smart cards expected to approach $600 million by the year 2000, up from merely $15 million in 1996, we wait patiently for the market to catch up with our advanced technology. PHOTO: Speedway DC4 PCDM PCDM sales to start-up phone card companies, which are finding it necessary to provide secure, dependable dispensing solutions for their vendors, increased dramatically in 1997. PHOTO: King's Island DC2 PCDM Several card vending test studies are being conducted in controlled, closed environments. Results will be evaluated closely by all those involved. PHOTO: Close-up of ShurShuttle(R) mechanism Any paper or plastic card can be efficiently dispensed by means of our patented ShurShuttle(R) dispensing technology for a limitless variety of end users. PHOTO: CPC2 PCDM The Interlott CPC2 was engineered and designed for use at retail checkouts where counter space is at a premium. PHOTO: Woman removing card from SCDM Interlott is the only VISA(R) certified provider of smart card dispensing machines. 5 PHOTO: Woman holding phone card talking on phone in front of both a DC4 and DC2 PCDM INTERNATIONAL MARKETS The year 1997 was one of realization for foreign markets, both in the lottery and the telecommunications industries. ITVMs were proven to be very successful tools in selling instant lottery tickets in the U.S. This success was recognized by the 50 or more international lotteries that also market instant tickets. Simply stated, in the early years, the Interlott sales team had to knock on their doors to present the benefits and features of our ITVM and PCDM lines. In contrast, the end of 1997 found lotteries from all corners of the world knocking on our door with inquiries about every aspect of our product lines and performance results. Iceland, Ireland, Norway, and Spain have purchased equipment and are witnessing very positive sales results. Post-test contracts are currently being negotiated with several other countries. Quebec in early 1998 became the first of our Canadian neighbors to award Interlott a contract for the purchase of ITVMs. The economic status of the progressive Western European lotteries is nearly a mirror image of those in the U.S. Interest by Western European lotteries in ITVMs, therefore, is extremely keen. The stabilizing of economies in South American countries has been very positive for Interlott. In late 1996, Interlott entered into an agreement with Garza Argentina to manufacture PCDMs for distribution throughout South America. This agreement to participate with a leading fabrication firm in South America allows Interlott to distribute our product throughout the region at a more favorable cost to Interlott. Desire for Interlott's proprietary dispensing technology is expanding worldwide, particularly in the telecommunications and financial services industries. This interest, combined with the growing popularity of public lotteries in many foreign countries, should enhance the international market opportunities available to Interlott in the future. PHOTO: Iceland 6 game ITVM Six game ITVMs are working to increase instant ticket sales in Iceland. PHOTO: Telerj 2 bin PCDM PCDMs have been distributed throughout South America. PHOTO: 8 game ITVM for Israel The National Lottery of Israel has received an initial order of ITVMs. 6 SELECTED FINANCIAL DATA
- ---------------------------------------------------------------------------------------------------------- Year Ended - ---------------------------------------------------------------------------------------------------------- Dec.31 Dec. 31 Dec. 31 Dec. 31 Dec. 31 1993 1994 1995 1996 1997 - ---------------------------------------------------------------------------------------------------------- Revenues - ---------------------------------------------------------------------------------------------------------- Machine sales $ 3,688,528 40,650 9,746,339 5,596,698 4,567,441 - ---------------------------------------------------------------------------------------------------------- Machine leases 3,335,420 6,093,528 9,132,132 11,766,623 12,828,823 - ---------------------------------------------------------------------------------------------------------- Other 199,785 250,442 435,137 1,235,368 1,669,160 - ---------------------------------------------------------------------------------------------------------- Net revenues 7,223,733 6,384,620 19,313,608 18,598,689 19,065,424 - ---------------------------------------------------------------------------------------------------------- Net income (loss) 276,907 (932,100) 1,987,219 1,320,597 1,451,654 - ---------------------------------------------------------------------------------------------------------- Net income (loss) per share(1) 0.13 (0.32) 0.62 0.41 0.45 - ---------------------------------------------------------------------------------------------------------- Depreciation and amortization 1,028,844 1,884,855 2,982,547 3,902,387 4,143,408 - ---------------------------------------------------------------------------------------------------------- Leased ITVMs, less accumulated depreciation 4,556,743 8,392,946 10,779,929 10,940,398 14,740,642 - ---------------------------------------------------------------------------------------------------------- Total assets 10,236,989 15,020,321 20,483,686 20,992,733 24,874,884 - ---------------------------------------------------------------------------------------------------------- Total debt 10,750,614 5,398,103 9,040,784 7,715,140 12,545,661 - ---------------------------------------------------------------------------------------------------------- Redeemable preferred stock 1,335,000 1,335,000 1,335,000 1,335,000 1,335,000 - ----------------------------------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION & ANALYSIS The words "expect", "anticipate", "intend", "plan", "believe", "seek", "estimate" and similar expressions used in this report are intended to identify forward-looking statements, although this report also contains other forward-looking statements. Any forward-looking statements in this report are made pursuant to the "safe harbor" provisions of the Private Securities Litigation Act of 1995. Investors are cautioned that actual results may differ substantially from such forward-looking statements. Forward-looking statements involve risks and uncertainties including, but not limited to, continued acceptance of the Company's products and services in the marketplace, competitive factors, new products and technological changes, dependence upon third party vendors, a limited number of customers, political and other uncertainties related to customer purchases, and other risks detailed in the Company's periodic filings with the Securities and Exchange Commission. OVERVIEW The Company's revenue base consists of (i) payments from ITVM and PCDM leases, (ii) sales of ITVMs and PCDMs, (iii) and to a lesser extent, sales of parts for ITVMs and PCDMs and service agreements. The Company emphasizes leasing rather than selling ITVMs to lotteries when possible. Leases provide the Company with a consistent revenue stream, opportunities to generate income on financing, and the potential to deploy a greater number of ITVMs within a lottery's budget due to the lower initial cash outlay required by the lottery. Leasing ITVMs also gives the lotteries the flexibility to enhance their ITVMs in the future with new technology from the Company. On the other hand, leasing ITVMs requires the Company to invest capital or otherwise finance the manufacture of ITVMs, unlike sales of ITVMs which result in the receipt of payment in full upon delivery of the ITVMs. When the Company sells ITVMs, the Company generally is able to manufacture and deliver the ITVMs and receive full payment for them before it must pay for the materials used to manufacture the ITVMs. Nevertheless, the Company believes that the advantages of leasing ITVMs as described above, justify the initial capital investment or financing costs required to manufacture ITVMs for lease. For similar reasons, the Company emphasizes leasing rather than selling PCDMs to providers of prepaid telephone cards. As with ITVMs, the Company believes that the benefits to the Company of leasing PCDMs warrant the initial capital investment required to manufacture PCDMs. However, the great majority of the PCDMs deployed to date, have been sold rather than leased. The Company historically has experienced fluctuations in its financial results due to its dependence upon a relatively small number of customers, and the unpredictable nature, timing and results of the lotteries' contract bid and award process. The Company's revenues and capital expenditures can vary significantly from period to period because the Company's sales cycle may be relatively long and because the amount and timing of revenues and capital expenditures depend on factors such as the amount and timing of awarded contracts, changes in customer budgets and demands, and general economic conditions. Operating results may be affected by the lead time sometimes required for business opportunities to result in signed lease or sales agreements, working capital requirements associated with manufacturing ITVMs pursuant to new orders, increased competition and the extended time that may elapse between the award of a contract and the receipt of revenues from the sale or lease of ITVMs. RESULTS OF OPERATIONS The table at right presents selected financial information derived from the Company's statements of income expressed as a percentage of revenues for the years indicated.
Year Ended ---------------------------- Dec. 31 Dec. 31 DEC. 31 1995 1996 1997 Revenues - -------------------------------------------------------------------------------- Machine sales 50.5% 30.1% 24.0% - -------------------------------------------------------------------------------- Machine leases 47.3 63.3 67.3 - -------------------------------------------------------------------------------- Other 2.2 6.6 8.7 - -------------------------------------------------------------------------------- Total revenues 100.0 100.0 100.0 - -------------------------------------------------------------------------------- Cost of revenues, excluding depreciation 52.3 47.6 41.5 - -------------------------------------------------------------------------------- Depreciation 14.7 20.3 20.8 - -------------------------------------------------------------------------------- Gross margin 33.0 32.1 37.7 - -------------------------------------------------------------------------------- Selling, general and administrative expenses 18.3 18.6 18.3 - -------------------------------------------------------------------------------- Research and development costs .8 3.6 2.9 - -------------------------------------------------------------------------------- Operating income 13.9 9.9 16.5 - -------------------------------------------------------------------------------- Interest expense, net 3.6 3.8 3.7 - -------------------------------------------------------------------------------- Income before income taxes 10.3 6.1 12.8 - -------------------------------------------------------------------------------- Income taxes -- (1.0) 5.2 - -------------------------------------------------------------------------------- Net income 10.3% 7.1% 7.6% - --------------------------------------------------------------------------------
SUMMARY QUARTERLY FINANCIAL DATA Quarterly financial data for the years ended December 31, 1997 and 1996 shown here (in thousands, except for per share data).
1996 FIRST SECOND THIRD FOURTH - -------------------------------------------------------------------------------- Net sales $4,544 5,324 4,089 4,642 - -------------------------------------------------------------------------------- Gross profit 1,521 1,601 1,392 1,449 - -------------------------------------------------------------------------------- Net earnings 166 435 288 432 - -------------------------------------------------------------------------------- Basic earnings per share 0.05 0.14 0.09 0.13 - -------------------------------------------------------------------------------- Diluted earnings per share 0.05 0.13 0.09 0.13 - -------------------------------------------------------------------------------- 1997 FIRST SECOND THIRD FOURTH - -------------------------------------------------------------------------------- Net sales $4,164 6,931 3,841 4,129 - -------------------------------------------------------------------------------- Gross profit 1,232 2,478 1,527 1,941 - -------------------------------------------------------------------------------- Net earnings 30 777 208 437 - -------------------------------------------------------------------------------- Basic earnings per share 0.01 0.24 0.06 0.14 - -------------------------------------------------------------------------------- Diluted earnings per share 0.01 0.24 0.06 0.13 - --------------------------------------------------------------------------------
The Company recognized revenues from foreign sources of $44,332, $60,961 and $431,714 for the years ended December 31, 1995, 1996, and 1997, respectively. 7 7 1996 COMPARED TO 1997 Total revenues increased by $466,735 or 3% from $18,598,689 in 1996 to $19,065,424 in 1997, due primarily to a $1,062,200 increase in lease revenues accompanied by a $433,792 increase in other revenues offset by a $1,029,257 decrease in sales of ITVMs and PCDMs. Revenues from leases increased by 9% from $11,766,623 in 1996 to $12,828,823 in 1997, resulting from the continuation of leases in nine states with the addition of leases in three states, and the renewal of a lease in another state which had reached the conclusion of the original term. Revenues from sales decreased by 18% from $5,596,698 in 1996 to $4,567,441 in 1997, as a result of a decrease from 1,254 ITVMs and PCDMs sold in 1996 to 821 ITVMs and PCDMs sold in 1997. The decrease of units sold was partially offset by a greater number of higher priced units sold in 1997 as compared to those sold in 1996. The total number of ITVMs and PCDMs under lease increased to 6,834 in 1997 as a result of deployment of 1,547 units, offset by the retirement of 833 units. Lease revenues were 63% and 67% of total revenues for 1996 and 1997, respectively. Revenues from sales of ITVMs and PCDMs were 30% and 24% of total revenues in 1997 and 1996, respectively. Other revenues increased by 35% from $1,235,368 in 1996 to $1,669,160 in 1997 as ITVMs were deployed in one additional state and machines deployed prior to 1997, generated revenue for the entire year. Cost of revenues for machine sales and other decreased 28% from $6,052,763 in 1996 to $4,378,669 in 1997. This decrease reflects the 35% decrease in number of machines sold in 1997, offset by the higher cost of the higher priced units sold in 1997. Cost of revenues for leased ITVMs and PCDMs, excluding depreciation, increased 26% from $2,839,162 in 1996 to $3,584,017 in 1997. The increase in cost of leased revenues was the result of higher warranty parts costs and higher personnel and subcontractor costs related to the larger number of machines deployed during 1997. Cost of lease revenues, excluding depreciation, includes all costs of preventative maintenance and warranties under various service agreements for all ITVMs leased by the Company. Depreciation of ITVMs and PCDMs increased by 4% from $3,744,065 in 1996 to $3,924,244 in 1997. The increase was lower than the related increase in number of ITVMs and PCDMs, as certain units had been fully depreciated by the end of 1996. Selling, general and administrative expenses increased 1% from $3,461,364 in 1996 to $3,492,020 in 1997. Selling, general and administrative expenses as a percentage of revenues, decreased slightly from 19% in 1996 to 18% in 1997. Research and development costs decreased by 18% from $665,449 in 1996 to $545,039 in 1997. This decrease resulted from the wind-down of major projects such as the SCDM. The Company maintains its philosophy of using contractors as the primary source of research and development efforts, allowing the Company to focus its expenditures on the technical expertise necessary to accomplish the specific project. Operating income increased by 71% from $1,835,886 in 1996 to $3,141,435 in 1997. This increase resulted from the continuing benefit of revenues derived from machines deployed in prior periods, including machines which had been fully depreciated, combined with the control of operating expenses. Net interest expense decreased by 1% from $708,289 in 1996 to $701,381 in 1997. The decrease reflects the increased interest income associated with the first lease which has been recognized as a sales type lease rather than an operating lease. To a lesser extent, interest expense was affected by the reduced interest rate of the new credit facility entered into in October 1997. The significant change in income taxes resulted from the Company having used available loss carryovers in 1996 and as a result, incurring taxes at an effective tax rate of 40% in 1997. As a result of the above factors, the Company's net income increased by 10% from $1,320,597 in 1996 to $1,451,654 in 1997. 1995 COMPARED TO 1996 Total revenues decreased by $714,919 or 4% from $19,313,608 in 1995 to $18,598,689 in 1996, due primarily to a $4,149,641 decrease in sales of ITVMs and PCDMs, offset by a $2,634,491 increase in lease revenues and a $800,231 increase in other revenues. Revenues from sales of ITVMs and PCDMs decreased by 43% from $9,746,339 in 1995 to $5,596,698 in 1996 corresponding to a decrease of 910 units from 2,164 ITVMs sold in 1995 to 1,103 ITVMs and 151 PCDMs sold in 1996. Lease revenues increased by 29% from $9,132,132 in 1995 to $11,766,623 in 1996, due to leases of ITVMs to the Arizona, Colorado, Georgia, Indiana, Iowa, Maine, New Hampshire, Ohio, Rhode Island, and Texas lotteries. The total number of ITVMs under lease increased by 1,043, or 21%, from 5,072 at December 31, 1995 to 6,115 at December 31, 1996. As a percent of total revenues, lease revenues were 47% and 63%, while sales revenues were 50% and 30%, in 1995 and 1996, respectively. The increase in lease revenues and decrease in sales revenues from 1995 to 1996 is due primarily to the cumulative effect of the incremental revenue from machines deployed under leases in 1996 added to continuing revenues from machines deployed under leases in 1995 and prior, combined with the decrease in the number of units sold in 1996, as compared to the number of units sold in 1995. This trend reflects the Company's emphasis on leasing of equipment. Other revenues increased by $800,231 from $435,137 in 1995 to $1,235,368 in 1996, a 184% increase. This increase is the result of the continued maintenance revenues from ITVMs deployed under the Maryland and New York contracts and sales of replacement parts to the Kentucky, Oregon, and West Virginia lotteries. Cost of revenues for machine sales and other decreased by $2,055,814, or 25%, from $8,108,577 in 1995 to $6,052,763 in 1996. This decrease reflects a 42% decrease in units from 1995 to 1996, partially offset by an increase in the number of higher priced units sold during 1996. Cost of revenues for leased ITVMs, excluding depreciation, increased by $846,909 from $1,992,253 in 1995 to $2,839,162 in 1996, a 43% increase. As a percentage of lease revenues, cost of revenues for leased ITVMs, excluding depreciation, increased from 22% in 1995 to 24% in 1996. The 27% increase in cost of revenues of leased equipment from 1995 to 1996 was primarily due to an increase in warranty parts cost and service subcontract costs resulting from the greater number of machines deployed. Cost of lease revenues, excluding depreciation, includes all costs of preventive maintenance and warranties under various service agreements for all ITVMs leased by the Company. Depreciation of ITVMs and PCDMs increased by $902,786 from $2,841,279 in 1995 to $3,744,065 in 1996, an increase of 32%. This increase resulted from the additional leased ITVMs and PCDMs deployed in 1996, as well as the full year of depreciation on ITVMs and PCDMs deployed in 1995 and prior years. Selling, general and administrative expenses decreased slightly from $3,541,302 in 1995 to $3,461,364 in 1996, a decrease of $79,938 or 2%. Selling, general and administrative expenses, as a percentage of revenues, increased slightly from 18% in 1995 to 19% in 1996. Research and development costs increased by $520,139, or 358%, from $145,310 in 1995 to $665,449 in 1996. This increase reflected the continuing development of the Company's SCDM and the initial development of two variations of the Company's ITVM dispensing technology to meet the perceived needs of the lottery industry. The increased expenditures were primarily amounts paid to contractors, in line with the Company philosophy that the use of contractors does not commit the Company to continuing expenses at the completion of the project. Operating income decreased by $849,000 or 32%, from $2,684,887 in 1995 to $1,835,886 in 1996. When revenue is recognized as a sale, the entire gross margin is recognized in the period of shipment, whereas the recognition of revenue as a lease spreads the recognition of the gross margin over the life of the lease. The decrease in operating income from 1995 to 1996 reflects the decrease in gross margin resulting from an increase in the revenues reported as leases from 47% of revenues in 1995 to 63% of revenues in 1996 and the decrease of revenues reported as sales from 50% of revenues in 1995 to 30% of revenues in 1996. The increase reflects slightly higher average borrowings in 1996 as compared to 1995, offset by slightly lower interest rates. 8 8 The Company reported an income tax benefit for 1996 as compared to no tax provision in 1995. This benefit results from the recognition of the value of future net operating loss carryovers, offset by the current provision for taxes on corporate income. As a result of the above factors, the Company's net income decreased by $666,622 or 34%, from $1,987,219 in 1995 to $1,320,597 in 1996. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities increased 34% from $5,446,262 in 1996 to $7,281,457 in 1997. Net cash used in investing activities increased 129% from $3,952,392 in 1996 to $9,069,836 in 1997. Net cash provided by financing activities increased by 232% from net cash used by financing activities of $1,352,644 in 1996 to net cash provided by financing activities of $1,742,864 in 1997. The Company's liquidity and capital resources are directly impacted by its decision to use leasing as a means to market its ITVMs and PCDMs. Leasing generally offers the Company better gross margins than direct sales agreements. However, leasing inherently requires more capital and a longer term payout than sales. As of December 31, 1997, the Company had a total of 7,034 ITVMs and PCDMs under operating and sales type leases. At December 31, 1996 and 1997, the Company had working capital deficits of $989,430 and $4,328,068, respectively. These deficits reflect the classification of the Company's revolving credit facility as a current debt due to the revolver clause of the facility. At December 31, 1997, the Company was indebted to Mercantile Business Credit, Inc. (MBC) in the aggregate principal amount of $8,978,036 pursuant to a revolving credit agreement entered into as of October 29, 1997. The facility permits the Company to borrow through October, 2000 with two one year extensions to October 2002, up to $15,000,000 at the prime interest rate. Borrowings under this facility are collateralized by all of the assets of the Company and assignment of proceeds from lease agreements. No cash dividends may be declared or paid until the Company has retired debt owed to two stockholders and the preferred stock of the Company. At December 31, 1997, the Company had $6,021,964 available under this agreement. At December 31, 1997, the Company also was indebted to stockholders in the aggregate principal amount of $479,000 incurred to finance the manufacture of ITVMs. See Note 7 of Notes to Financial Statements. The Company's capital expenditures totaled $3,952,392 and $9,069,836 for 1996 and 1997, respectively. These amounts include $3,904,534 and $8,710,315 for the manufacture of machines leased during the respective periods. Other expenditures represent machinery and equipment costs for expanded office capacity. The Company had no material commitments for additional capital expenditures as of December 31, 1997 other than for the manufacture of ITVMs and PCDMs for future lease. At December 31, 1997, the Company had estimated tax net operating loss carryforwards of approximately $1,200,000, which are available to offset future federal taxable income, if any, through 2009. The use of these carryforwards is subject to certain annual limitations due to ownership changes in 1992. EFFECT OF RECENTLY ISSUED ACCOUNTING STANDARDS In June, 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information." SFAS No. 130 defines comprehensive income as the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. The Statement requires comprehensive income to be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement is effective for fiscal years beginning after December 15, 1997. The Company does not expect the implementation of the Statement to have a material effect on the financial statements. SFAS No. 131 changes the way public companies report information about segments of their business in their annual financial statements and requires them to report selected segment information in their quarterly report to shareholders. The Statement requires that companies disclose segment data based on how management makes decisions about allocating resources to segments and measuring their performance. The Statement is effective for fiscal years beginning after December 15, 1997. The Company does not expect the implementation of this Statement to have a material effect on the financial statements. IMPACT OF THE YEAR 2000 Like any other company, advances and changes in available technology can significantly impact the business and operations of the Company. For example, a challenging problem exists as many computer systems worldwide do not have the capability of recognizing the year 2000 or the years thereafter. No easy technological "quick fix" has yet been developed for this problem. The Company presently believes that by converting to new software, which is scheduled for completion in 1998, the Year 2000 problem will not pose significant operational problems for the Company's computer systems. There can be no assurance, however, that the systems of other companies on which the Company's systems rely also will be timely converted or that any such failure to convert by another company would not have an adverse effect on the Company's systems. INDEPENDENT AUDITORS' REPORT The Board of Directors We have audited the accompanying balance sheets of Interlott Technologies, Inc. as of December 31, 1996 and 1997, and the related statements of income, stockholders' equity and cash flows for each of the years in the three year period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Interlott Technologies, Inc., as of December 31, 1996 and 1997, and the results of its operations and its cash flows for each of the years in the three year period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ KPMG Peat Marwick LLP Louisville, Kentucky February 26, 1998 9 9 BALANCE SHEETS
December 31, ----------------------------- 1996 1997 - ------------------------------------------------------------------------------------------------ ASSETS - ------------------------------------------------------------------------------------------------ Current assets: - ------------------------------------------------------------------------------------------------ Cash $ 188,586 143,071 - ------------------------------------------------------------------------------------------------ Accounts receivable, less allowance for doubtful accounts of $115,425 in 1996 and $93,501 in 1997 3,217,019 2,918,092 - ------------------------------------------------------------------------------------------------ Investment in sales type lease, current portion -- 216,485 - ------------------------------------------------------------------------------------------------ Inventories 5,086,547 4,051,495 - ------------------------------------------------------------------------------------------------ Prepaid expenses 154,254 147,450 ================================================================================================ Total current assets 8,646,406 7,476,593 ================================================================================================ Property and equipment: - ------------------------------------------------------------------------------------------------ Leased machines 20,872,885 25,718,832 - ------------------------------------------------------------------------------------------------ Machinery and equipment 318,360 519,388 - ------------------------------------------------------------------------------------------------ Building and leasehold improvements 195,225 265,854 - ------------------------------------------------------------------------------------------------ Furniture and fixtures 36,495 124,359 ================================================================================================ 21,422,965 26,628,433 - ------------------------------------------------------------------------------------------------ Less accumulated depreciation and amortization (10,192,638) (11,382,120) ================================================================================================ 11,230,327 15,246,313 ================================================================================================ Investment in sales type lease, less current portion -- 1,051,011 - ------------------------------------------------------------------------------------------------ Product development rights, net of accumulated amortization of $440,000 in 1996 and $513,333 in 1997 660,000 586,667 - ------------------------------------------------------------------------------------------------ Deferred tax asset 456,000 252,300 ================================================================================================ $ 20,992,733 $ 24,612,884 ================================================================================================ LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------------------------------------------------------------------ Current liabilities: - ------------------------------------------------------------------------------------------------ Notes payable to financial institutions $ 7,230,171 8,978,036 - ------------------------------------------------------------------------------------------------ Current installments of long-term debt 5,641 968 - ------------------------------------------------------------------------------------------------ Accounts payable 924,213 1,142,065 - ------------------------------------------------------------------------------------------------ Accounts payable - related parties 306,529 328,960 - ------------------------------------------------------------------------------------------------ Accrued expenses 1,067,532 1,254,182 - ------------------------------------------------------------------------------------------------ Income taxes payable 101,750 100,450 ================================================================================================ Total current liabilities 9,635,836 11,804,661 ================================================================================================ Long-term debt, excluding current installments 328 -- - ------------------------------------------------------------------------------------------------ Notes payable - related parties 479,000 479,000 ================================================================================================ Total liabilities 10,115,164 12,283,661 ================================================================================================ Series A, preferred stock, $.01 par value, $1.00 stated value, 20,000,000 shares authorized; 1,335,000 shares issued and outstanding in 1996 and 1997 1,335,000 1,335,000 ================================================================================================ Stockholders' equity: - ------------------------------------------------------------------------------------------------ Common stock, $.01 par value, 20,000,000 shares authorized; 3,210,000 shares issued and outstanding in 1996 and 1997 32,100 32,100 - ------------------------------------------------------------------------------------------------ Additional paid-in capital 10,376,017 10,376,017 - ------------------------------------------------------------------------------------------------ Accumulated (deficit) earnings (865,548) 586,106 ================================================================================================ Total stockholders' equity 9,542,569 10,994,223 - ------------------------------------------------------------------------------------------------ Commitments and contingent liabilities $ 20,992,733 24,612,884 ================================================================================================
See accompanying notes to financial statements. 10 10 STATEMENTS OF INCOME
Years Ended December 31, ---------------------------------------------- 1995 1996 1997 - ------------------------------------------------------------------------------------------------- Revenues: - ------------------------------------------------------------------------------------------------- Machine sales $ 9,746,339 5,596,698 4,567,441 - ------------------------------------------------------------------------------------------------- Machine leases 9,132,132 11,766,623 12,828,823 - ------------------------------------------------------------------------------------------------- Other 435,137 1,235,368 1,669,160 ================================================================================================= 19,313,608 18,598,689 19,065,424 ================================================================================================= Cost of revenues: - ------------------------------------------------------------------------------------------------- Machines sales and other 8,108,577 6,052,763 4,378,669 - ------------------------------------------------------------------------------------------------- Machine leases 4,833,532 6,583,227 7,508,261 ================================================================================================= 12,942,109 12,635,990 11,886,930 ================================================================================================= Gross margin 6,371,499 5,962,699 7,178,494 ================================================================================================= Operating expenses: - ------------------------------------------------------------------------------------------------- Selling, general and administrative expenses 3,541,302 3,461,364 3,492,020 - ------------------------------------------------------------------------------------------------- Research and development costs 145,310 665,449 545,039 ================================================================================================= Total operating expenses 3,686,612 4,126,813 4,037,059 ================================================================================================= Operating income 2,684,887 1,835,886 3,141,435 ================================================================================================= Other income (expense): - ------------------------------------------------------------------------------------------------- Interest expense (714,765) (718,642) (747,008) - ------------------------------------------------------------------------------------------------- Interest income 17,097 10,353 45,627 ================================================================================================= (697,668) (708,289) (701,381) ================================================================================================= Income before income taxes 1,987,219 1,127,597 2,440,054 - ------------------------------------------------------------------------------------------------- Income taxes -- (193,000) 988,400 ================================================================================================= Net income $ 1,987,219 1,320,597 1,451,654 ================================================================================================= Basic and diluted net income per share $ .62 .41 .45 =================================================================================================
See accompanying notes to financial statements. STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Years ended December 31, 1995, 1996 and 1997 - ------------------------------------------------------------------------------------------------------ Common Stock Additional (Accumulated ----------------------- Paid-in Deficit) Shares Amount Capital Retained Earnings Total - ------------------------------------------------------------------------------------------------------ Balances at December 31, 1994 3,202,598 $ 32,026 10,307,961 (4,173,364) 6,166,623 - ------------------------------------------------------------------------------------------------------ Issuance of common stock 7,402 74 68,056 -- 68,130 - ------------------------------------------------------------------------------------------------------ Net income -- -- -- 1,987,219 1,987,219 ====================================================================================================== Balances at December 31, 1995 3,210,000 32,100 10,376,017 (2,186,145) 8,221,972 - ------------------------------------------------------------------------------------------------------ Net income -- -- -- 1,320,597 1,320,597 ====================================================================================================== Balances at December 31, 1996 3,210,000 32,100 10,376,017 (865,548) 9,542,569 - ------------------------------------------------------------------------------------------------------ Net income -- -- -- 1,451,654 1,451,654 ====================================================================================================== Balances at December 31, 1997 3,210,000 $ 32,100 10,376,017 586,106 10,994,223 ======================================================================================================
See accompanying notes to financial statements. 11 11 STATEMENTS OF CASH FLOWS
Years Ended December 31, ------------------------------------------- 1995 1996 1997 - -------------------------------------------------------------------------------------------------------------- Cash flows from operating activities: - -------------------------------------------------------------------------------------------------------------- Net income $ 1,987,219 1,320,597 1,451,654 - -------------------------------------------------------------------------------------------------------------- Adjustments to reconcile net income to net cash provided by operating activities: - -------------------------------------------------------------------------------------------------------------- Depreciation and amortization 2,982,547 3,902,387 4,143,408 - -------------------------------------------------------------------------------------------------------------- Principal portion of sales type lease received -- -- 164,194 - -------------------------------------------------------------------------------------------------------------- (Increase) decrease in deferred income taxes -- (456,000) 203,700 - -------------------------------------------------------------------------------------------------------------- Gain on sale of equipment under sales type lease -- -- (447,915) - -------------------------------------------------------------------------------------------------------------- (Increase) decrease in accounts receivable (2,078,058) 607,423 298,927 - -------------------------------------------------------------------------------------------------------------- (Increase) decrease in inventories (1,409,852) (605,391) 1,035,052 - -------------------------------------------------------------------------------------------------------------- (Increase) decrease in prepaid expenses (189,157) 183,152 6,804 - -------------------------------------------------------------------------------------------------------------- Decrease in other assets 214,242 -- -- - -------------------------------------------------------------------------------------------------------------- (Decrease) increase in accounts payable (49,079) (100,288) 217,852 - -------------------------------------------------------------------------------------------------------------- (Decrease) increase in accounts payable - related parties (204,161) 306,416 22,431 - -------------------------------------------------------------------------------------------------------------- Increase in accrued expenses 86,705 206,216 186,650 - -------------------------------------------------------------------------------------------------------------- (Decrease) increase in income taxes payable -- 101,750 (1,300) ============================================================================================================== Net cash provided by operating activities 1,340,406 5,466,262 7,281,457 ============================================================================================================== - -------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: - -------------------------------------------------------------------------------------------------------------- Cost of leased machines (5,228,262) (3,904,534) (8,710,315) - -------------------------------------------------------------------------------------------------------------- Purchases of property and equipment (100,781) (47,858) (359,521) - -------------------------------------------------------------------------------------------------------------- Receipts from collateral bonds 250,000 -- -- ============================================================================================================== Net cash used in investing activities (5,079,043) (3,952,392) (9,069,836) ============================================================================================================== - -------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: - -------------------------------------------------------------------------------------------------------------- Change in notes payable to financial institutions 7,051,156 (1,320,985) 1,747,865 - -------------------------------------------------------------------------------------------------------------- Repayments of long-term debt (3,296,975) (4,659) (5,001) - -------------------------------------------------------------------------------------------------------------- Repayment of notes payable to related parties, net (111,500) -- -- ============================================================================================================== Net cash provided by (used in) financing activities 3,642,681 (1,325,644) 1,742,864 ============================================================================================================== - -------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash (95,956) 188,226 (45,515) - -------------------------------------------------------------------------------------------------------------- Cash at beginning of year 96,316 360 188,586 - -------------------------------------------------------------------------------------------------------------- Cash at end of year $ 360 188,586 143,071 ============================================================================================================== - -------------------------------------------------------------------------------------------------------------- Supplemental disclosures of cash flow information: - -------------------------------------------------------------------------------------------------------------- Interest paid $ 696,718 643,822 671,515 - -------------------------------------------------------------------------------------------------------------- Income taxes paid $ -- -- 631,610 ==============================================================================================================
See accompanying notes to financial statements. 12 12 NOTES TO FINANCIAL STATEMENTS Years ended December 31, 1995, 1996, and 1997 1. Summary of Significant Accounting Policies a. Business Description Interlott Technologies, Inc. (the Company), as renamed in June 1997, formerly International Lottery, Inc., was incorporated in February 1990 under the laws of Ohio and was reincorporated under the laws of Delaware on March 18, 1994 and does business under the name Interlott. The Company designs, manufactures, leases, sells and services vending machines for use in connection with public lotteries operated by states and foreign public entities, as well as for use by providers of prepaid telephone cards. b. Operating and Sales Type Leases Depending on the specific terms contained in the lease agreement, the lease is either classified as an operating lease or capitalized as a sales type lease, in accordance with Statement of Financial Accounting Standards (SFAS)No. 13, Accounting for Leases, as amended. The net investment in operating leases consists of leased machines, which is carried at cost, less the amount depreciated to date. Operating lease revenue consists of the contractual lease payments and is recognized ratably over the lease term. Expenses are principally depreciation of the leased machines (see note 1d). The net investment in sales types lease consists of the present value of the future minimum lease payments. Sales type lease revenue consists of the profit earned on the sale of the leased machines and interest earned on the present value of the lease payments. Interest revenue is recognized as a constant percentage return on the net investment. Any future losses related to lease cancellations would be recorded in the period such losses become known and estimable. c. Inventories Inventories consist of parts and supplies, and vending machines assembled or in the process of assembly. Inventories are stated at the lower of cost or market, with cost determined using standard costing which approximates the first-in, first-out method. d. Property and Equipment Property and equipment are stated at cost. Depreciation of property and equipment is calculated on the straight-line method over the estimated useful lives of the assets to the Company's estimate of the assets, residual values as follows: ---------------------------------------------------------------------- Leased machines 5 years Machinery and equipment 10 years Furniture and fixtures 5 years ----------------------------------------------------------------------
Leasehold improvements are amortized on the straight-line method over the lease term. Amortization of assets held under leasehold improvements is included with depreciation expense. e. Product Development Rights Product development rights represent the exclusive rights to certain patents and other related manufacturing technologies to manufacture and assemble the instant ticket vending machines. The asset is amortized on the straight-line method over fifteen years, which represents the lower of the remaining life of the patents or the estimated remaining life of the technology currently in use. The Company assesses the recoverability of this intangible asset by determining whether the amortization of the asset balance over its remaining life can be recovered through undiscounted future cash flows of the Company. The amount of the asset impairment, if any, is measured based on projected discounted operating cash flows using a discount rate reflecting the Company's average cost of funds. The assessment of the recoverability of the asset will be impacted if estimated future operating cash flows are not achieved. f. Income Taxes The Company accounts for income taxes using the asset and liability method. Pursuant to this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under this method, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the rate change enactment date. g. Disclosure About Fair Value of Financial Instruments SFAS No. 107, Disclosure About Fair Value of Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The carrying amounts as of December 31, 1997 of cash, accounts receivable, accounts payable, accounts payable - related parties, accrued expenses and income taxes payable approximate fair value due to the short maturity of these investments. The carrying amount of notes payable and notes payable-related parties approximate fair value, as such borrowings bear interest at the Company's current rates for such type of instruments. h. Stock Incentive Plans Prior to January 1, 1996, the Company accounted for its stock incentive plans in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On January 1, 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. i. Warranty Costs Provision for estimated warranty costs on machines sold is recorded at the time of sale and periodically adjusted to reflect actual experience. j. Research and Development Costs Research and development costs are charged to expense in the year incurred. k. Earnings Per Share Effective December 31, 1997, the Company adopted SFAS No. 128 Earnings Per Share, which simplifies the standards for computing earnings per share. There was no material impact on the Company's previously reported annual or interim period earnings per share, as a result of the adoption. Basic earnings per share is based upon the weighted average number of common shares outstanding. Diluted earnings per share is based upon the weighted average number of common shares outstanding, including the effects of all dilutive potential common shares outstanding. l. Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. 13 13 NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. Investment in Sales Type Lease The Company leases 200 instant ticket vending machines (ITVMs) to one state lottery under a sales type lease that commenced in May, 1997. The components of the net investment in sales type lease as of December 31, 1997 are as follows:
1997 ----------------------------------------------------------------------- Minimum lease payments receivable $1,851,200 Less unearned revenue on lease payments receivable 583,704 ----------------------------------------------------------------------- 1,267,496 Less current portion 216,485 ----------------------------------------------------------------------- Investment in sales type lease, less correct portion $1,051,011 -----------------------------------------------------------------------
Future minimum lease payments to be received by the Company under this sales type lease are as follows:
Years ending December 31, -------------------------------------------------------------------------- 1998 $ 427,200 1999 427,200 2000 427,200 2001 427,200 2002 142,400 -------------------------------------------------------------------------- $1,851,200 --------------------------------------------------------------------------
3. Inventories Inventories at December 31, 1996 and 1997 consist of the following:
1996 1997 ----------------------------------------------------------------------- Finished goods $1,634,657 1,155,808 Work in process 322,515 82,162 Raw materials and supplies 3,129,375 2,813,525 ----------------------------------------------------------------------- Total inventories $5,086,547 4,051,495 -----------------------------------------------------------------------
4. Leased Machines At December 31, 1996 and 1997, the Company leased 6,071 and 6,834 ITVMs to 10 and 14 state lotteries respectively, under operating leases. The leases generally provide for the lotteries to make monthly or quarterly payments for rentals of the ITVMs over various lease terms. The components of the net investment in operating leases, which includes estimated residual values, as of December 31, 1996 and 1997 are as follows: 1996 1997 ----------------------------------------------------------------------- Leased machines $20,872,885 25,718,832 Less accumulated depreciation 9,932,487 10,978,370 ----------------------------------------------------------------------- $10,940,398 14,740,462 -----------------------------------------------------------------------
Future minimum lease payments to be received by the Company under operating leases are as follows:
Years ending December 31, ----------------------------------------------------------------------- 1998 $12,234,467 1999 4,242,160 2000 1,039,380 ----------------------------------------------------------------------- $17,516,007 -----------------------------------------------------------------------
5. Notes Payable In September 1995, the Company entered into a revolving credit facility with a financial institution that permitted the Company to borrow through September 1998 up to $12,500,000 at the prime interest rate plus 1.0% (9.25% at December 31, 1996). Draws against this facility were made in the form of demand notes. The Company paid an annual commitment fee of .25% on the unused portion of the commitment and a monthly usage fee equal to .25% of the highest outstanding balance during each month. Borrowings under this agreement were collateralized by all assets of the Company and assignment of proceeds from lease agreements. At December 31, 1996, the Company had borrowings of $7,230,171 outstanding under this credit facility. This borrowing was retired with proceeds from the new borrowing entered into in October, 1997. In October, 1997, the Company entered into a revolving credit facility with a financial institution that permits the Company to borrow through October, 2000 up to $15,000,000 at the prime interest rate (8.50% at December 31, 1997). Initial proceeds from the note were used to retire the prior revolving credit facility. In conjunction with the establishment of the facility the Company opened a lockbox and controlled disbursement account with the bank parent of the financial institution. All lockbox receipts are recorded as payments against the facility and presented checks are recorded as draws on the facility. Borrowings under this credit facility are collateralized by all of the assets of the Company and assignment of proceeds from lease agreements. At December 31, 1997, the Company had borrowings of $8,978,036 outstanding with additional borrowings of $6,021,964 available under the facility. 6. Long-Term Debt Term note payable to a bank with final payment due February 20, 1998, payable in monthly installments of $448, including interest at a rate of 7.99% per annum. The note is collateralized by automotive equipment.
1996 1997 $5,969 968 Less current installments 5,641 968 Long term debt, excluding current installments $ 328 --
7. Notes Payable - Related Parties The Company has the following notes payable to related parties at December 31, 1996 and 1997:
1996 1997 ----------------------------------------------------------------------- Note payable to a stockholder due in annual installments equal to twenty-five percent (25%) of the net profits, if any, of the Company from its business operations as reported in the Company's annual financial statements prepared in accordance with generally accepted accounting principles. The payments shall begin on the first business day of the fourth month of the Company's fiscal year, for income tax purposes, immediately following (1) the payment of all debts of the Company outstanding as of September 25, 1992 and (2) the posting by the Company of retained earnings of at least $1,000,000 determined in accordance with generally accepted accounting principles, and continue on the same day each year until the principal and unpaid interest is paid in full. The note bears interest at the prime rate of Chase Manhattan Bank of New York (8.50% at December 31, 1997). The note is unsecured. $400,000 400,000 Note payable to a stockholder due and limited to twenty-five percent (25%) of the net profits of the Company, if any, from its business operations as reported in the Company's annual financial statements prepared in accordance with generally accepted accounting principles. The payments shall begin on the first business day of the fourth month of the Company's first year, for income tax purposes, immediately following (1) the payments of all debts of the Company outstanding as of September 25, 1992; (2) the posting by the Company of retained earnings of at least $1,000,000 determined in accordance with generally accepted accounting principles; and (3) payment in full of principal and interest due by the Company to a stockholder in the amount of $400,000. The note does not provide for any interest and is unsecured. 79,000 79,000 ----------------------------------------------------------------------- 479,000 479,000 Less current portion -- -- ----------------------------------------------------------------------- $479,000 479,000 -----------------------------------------------------------------------
14 14 NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. Income Taxes Income tax expense (benefit) is summarized as follows:
Year ended December 31 ------------------------------------------------------------------------ 1995 1996 1997 ------------------------------------------------------------------------ Current Federal $ -- 200,000 557,400 State and local -- 63,000 156,000 Deferred Federal -- (456,000) 275,000 State and local -- -- -- ------------------------------------------------------------------------ Total $ -- (193,000) 988,400 ------------------------------------------------------------------------
A reconciliation of income tax expense (benefit) in relation to the amounts computed by application of the U.S. federal income tax rate of 34% to pretax income follows:
December 31 ---------------------------------------------------------------------------------------- 1995 1996 1997 ---------------------------------------------------------------------------------------- Federal income tax expense at the statutory rate $ 676,000 383,000 830,000 Increase (reduction) in income taxes resulting from: Change in the beginning-of-the-year balance of the valuation allowance for the deferred tax assets allocated to income tax expense. (713,000) (672,000) -- Amortization of product development rights 25,000 25,000 -- State and local taxes, net of federal benefit -- 63,000 103,000 Other 12,000 8,000 55,400 ---------------------------------------------------------------------------------------- Total $ -- (193,000) 988,400 ----------------------------------------------------------------------------------------
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1996 and 1997 are presented below:
1996 1997 --------------------------------------------------------------------- Deferred tax assets: Bad debt allowance $ 39,000 32,000 Warranty costs 12,000 9,000 Net operating loss carryforwards 510,000 400,000 Other, net (105,000) 73,300 --------------------------------------------------------------------- Total gross deferred tax assets 456,000 514,300 --------------------------------------------------------------------- Deferred tax liabilities: Property and equipment, principally due to differences in depreciation $ -- 127,000 Investment in sales type lease -- 135,000 --------------------------------------------------------------------- Total gross deferred tax liabilities -- 262,000 --------------------------------------------------------------------- Net deferred tax asset $456,000 252,300 ---------------------------------------------------------------------
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future income and tax planning strategies in making this assessment. At December 31, 1997, the Company has net operating loss carryforwards for Federal income tax purposes of approximately $1,200,000 which are available to offset future Federal taxable income, if any, through 2009. However, due to an ownership change on September 25, 1992, utilization of these carryforwards is subject to certain annual limitations. 9. Redeemable Preferred Stock The Company's preferred stock is nonparticipating and has no rights to dividends. The holders of the preferred stock are entitled to sell to the Company all of their shares of preferred stock at a price of $1.00 per share upon (i) the payment of all debts of the Company outstanding as of September 25, 1992, (ii) the reporting by the Company of retained earnings of at least $1,000,000 determined in accordance with generally accepted accounting principles, and (iii) the payment in full by the Company of a promissory note in the original amount of $400,000 to a related party. Due to the redemption feature of the preferred stock, it has been classified separately from stockholders' equity in the Company's balance sheet. The Company may, at its discretion, redeem all or part of the outstanding preferred stock at any time. The redemption price for the preferred stock is $1.00 per share and may be payable in the form of a promissory note. 10. Stock Incentive Plans In March 1994, the Company and its Board of Directors approved and adopted the Company's 1994 Stock Incentive Plan and the Company's 1994 Directors' Stock Incentive Plan (collectively, the Plans), which became effective at the date of the initial public offering. The Plans provide for the issuance of up to 260,000 shares of common stock to officers, employees, consultants and other supporters of the Company and up to 60,000 shares of common stock to nonemployee directors of the Company. Stock options are granted with an exercise price equal to the stock's fair market value at the date of grant. Options may be exercised subject to a vesting schedule which provides for the vesting each year for a period of four years subject to the recipient's continued employment or service to the Company, and must be exercised within 10 years after that date. As permitted by SFAS No. 123, the Company applies the intrinsic value method prescribed by APB Opinion No. 25 and related interpretations in accounting for its stock option plans. Accordingly, no compensation cost has been recognized in the accompanying statements of income. A summary of the status of the Company's stock option plans as of December 31, 1995, 1996, and 1997 and the changes therein for the years then ended is presented below:
1995 1996 1997 ---------------------------------------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ---------------------------------------------------------------------------------------------------- Outstanding at beginning of year 49,975 $ 11.50 131,725 $ 9.66 147,225 $ 9.38 Granted 81,750 8.54 15,500 7.00 27,000 8.00 Exercised -- -- -- -- -- -- Forfeited -- -- -- -- 3,350 11.50 ---------------------------------------------------------------------------------------------------- Outstanding at end of year 131,725 9.66 147,225 9.38 170,875 9.12 ---------------------------------------------------------------------------------------------------- Options exercisable at year-end 14,494 10.79 46,926 10.05 79,660 .77 ---------------------------------------------------------------------------------------------------- Weighted-average fair value of options granted during the year $ 6.22 5.11 5.82 ----------------------------------------------------------------------------------------------------
Had compensation cost for options granted during 1995, 1996 and 1997 been determined consistent with the fair value methodology of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts presented below:
1995 1996 1997 --------------------------------------------------------------------------- Net income As reported $1,987,219 1,320,597 1,451,654 Pro forma 1,898,908 1,307,807 1,324,003 Earnings per share As reported .62 .41 .45 Pro forma .59 .41 .41 ---------------------------------------------------------------------------
15 15 NOTES TO FINANCIAL STATEMENTS (CONTINUED) The full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income amounts presented above because compensation cost is recognized over the options' vesting period of four years and compensation cost for options granted prior to January 1, 1995 is not considered. The fair value of options granted during 1995, 1996 and 1997 for purposes of the accompanying pro forma disclosures is estimated on the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions: no dividends paid, as it has been the Company's policy not to declare or pay dividends since its initial public offering in 1994 and the Company does not anticipate paying dividends in the foreseeable future; expected volatility of 52%, 52% and 56%, respectively based on the calculated volatility of the Company's stock since its initial public offering; risk-free rates of return of 7.46%, 6.66% and 5.86%, respectively; and expected lives of 10 years. Information about stock options outstanding at December 31, 1997 is as follows:
Options Outstanding Options Exercisable ------------------------------------------------------------------------------------- Range Weighted-Avg. of Remaining Weighted-Avg. Weighted-Avg. Exercise Number Contractual Exercise Number Exercisable Prices Outstanding Life Price Exercisable Price ------------------------------------------------------------------------------------- $6.50 - 8.63 124,250 8.0 yrs $ 8.23 44,691 $ 8.41 11.50 46,625 6.3 yrs 11.50 34,969 11.50 ------------------------------------------------------------------------------------- 170,875 7.5 yrs $ 9.12 79,660 $ 9.77 -------------------------------------------------------------------------------------
11. Earnings Per Share
----------------------------------------------------------------------------------------------- Net Per Income Shares Share 1995 (Numerator) (Denominator) Amount ----------------------------------------------------------------------------------------------- Basic earnings per share: Net earnings available to common stock $1,987,219 3,210,000 .62 ----------------------------------------------------------------------------------------------- Diluted earnings per share: Effect on dilutive securities stock options -- (2,413) Earnings available to common stock-holders and assumed conversions $1,987,219 3,207,587 .62 ----------------------------------------------------------------------------------------------- 1996 ----------------------------------------------------------------------------------------------- Basic earnings per share: Net earnings available to common stock $1,320,597 3,210,000 .41 ----------------------------------------------------------------------------------------------- Diluted earnings per share: Effect on dilutive securities stock options -- 2,000 Earnings available to common stock-holders and assumed conversions $1,320,597 3,212,000 .41 ----------------------------------------------------------------------------------------------- 1997 ----------------------------------------------------------------------------------------------- Basic earnings per share: Net earnings available to common stock $1,451,654 3,210,000 .45 ----------------------------------------------------------------------------------------------- Diluted earnings per share: Effect on dilutive securities stock options -- 2,661 Earnings available to common stock-holders and assumed conversions $1,451,654 3,212,661 .45 -----------------------------------------------------------------------------------------------
Options to purchase 131,725, 49,925, and 129,725 shares of common stock were outstanding in 1995, 1996 and 1997, respectively, but were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of common shares. 12. Noncash Investing Activities The Company wrote-off approximately $2,900,000 in fully depreciated leased machines in 1997. Such machines were returned to the Company upon lease expiration. The Company intends to use parts from these machines in the manufacturing of future machines. 13. Related Party Transactions Accounts payable - related parties are $306,529 and $328,960 at December 31, 1996 and 1997, respectively, and represent management fees and expenses payable to a company owned 100% by the majority stockholder and parts expenses payable to an entity which is owned by a director. Amounts expensed related to the company owned by the majority stockholder were $135,566, $73,321 and $36,000 for the years ended December 31, 1995, 1996 and 1997, respectively. The entity owned by a director supplies the Company with certain parts for its dispensing mechanisms. In addition, on January 13, 1994, the Company entered into a manufacturing and license agreement with this entity pursuant to which the Company purchased an exclusive license to make, use and sell pull-tab lottery ticket dispensing mechanisms produced by this entity. The Company had purchases from this entity which were charged to cost of revenues of approximately $1,848,000, $1,986,000 and $2,996,000 for the years ended December 31, 1995, 1996 and 1997, respectively. Interest expense arising from notes payable-related parties amounted to $97,018, $33,085 and $33,714 for the years ended December 31, 1995, 1996 and 1997, respectively. 14. Customer and Supplier Concentrations A significant portion of the Company's revenues are derived from a limited number of state lottery authorities or their representatives for the lease, sale or service of instant ticket vending machines. For the years ended December 31, 1995, 1996 and 1997, one customer generated 55%, 45% and 29%, respectively, of the machine lease revenues. In addition, single state contracts generated 67%, 69% and 32% of the machine sales revenues for the years ended December 31, 1995, 1996 and 1997, respectively. Future revenue from machine sales is dependent upon winning awards in a competitive bidding process. The Company currently purchases certain components used in its vending machines, including components used in its burster mechanism and its bill acceptor mechanism, from single suppliers. The purchase of components from outside suppliers on a sole source basis subjects the Company to certain risks, including the continued availability of suppliers, price increases and potential quality assurance problems. Because other suppliers exist that can duplicate these components should the Company elect or be forced to use a different supplier, the Company does not believe that any such change in suppliers would result in the termination of a production contract. However, the Company could experience a delay of 30 to 60 days in the production of vending machines should it elect or be forced to use other suppliers for these components. Any delay of more than 30 to 60 days could adversely affect the Company's ability to make timely deliveries of vending machines and to obtain new contracts. 15. Lease Commitments The Company leases its office and manufacturing facilities under noncancelable operating leases. The leases expire on December 31, 1999, and require lease payments of $50,000 and $91,000 a year, respectively through expiration. Total rent expense under these leases approximated $91,000, $91,000 and $141,000 for the years ended December 31, 1995, 1996 and 1997 respectively. *Total future minimum lease payment requirements under this lease are as follows:
Year ending December 31, ----------------------------------------------------------------------- 1998 $141,000 1999 141,000 ----------------------------------------------------------------------- $282,000 -----------------------------------------------------------------------
16. Commitments and Contingent Liabilities As of December 31, 1997, the Company had outstanding purchase commitments for raw materials of approximately $5,853,000, of which $5,320,000 and $505,000 are used in the manufacturing of instant ticket and prepaid telephone card vending machines, respectively. Management intends to utilize these commitments as machines are produced. While the market for instant ticket vending machines has been proven, the prepaid telephone card market is new and difficult to predict. If the prepaid telephone card market does not prove successful for the Company, management is of the opinion that this will not have a material adverse effect on the Company's financial position or results of operations. 16 16 Inside back cover 3/26/98 4:43 PM Page 1 CORPORATE DATA & STOCKHOLDER INFORMATION HEADQUARTERS - --------------------------------- Interlott Technologies, Inc. 10830 Millington Court Cincinnati, OH 45242 (513) 792-7000 INVESTOR INQUIRIES - --------------------------------- Chief Financial Officer 10830 Millington Court Cincinnati, OH 45242 (513) 792-7000 REGISTRAR AND TRANSFER AGENT - --------------------------------- First Union National Bank 230 South Tryon Street Charlotte, NC 28288-1154 CORPORATE COUNSEL - --------------------------------- Alston & Bird LLP Atlanta, Georgia Taft, Stettinius & Hollister LLP Cincinnati, Ohio INDEPENDENT AUDITORS - --------------------------------- KPMG Peat Marwick LLP Louisville, Kentucky The Company's Common Stock has been traded to the American Stock Exchange under the symbol "ILI" since the Company's initial public offering of Common Stock in April 1994. Prior to the initial public offering, there was no established trading market for the Company's Common Stock. The following tables show the high and low closing sale prices per share for the Common Stock as reported by the American Stock Exchange for the periods indicated:
1996 HIGH LOW - -------------------------------------------------- First Quarter $ 11 8 - -------------------------------------------------- Second Quarter 12 3/4 10 1/2 - -------------------------------------------------- Third Quarter 11 6 1/2 - -------------------------------------------------- Fourth Quarter 8 5/8 6 13/16 - -------------------------------------------------- 1997 HIGH LOW - -------------------------------------------------- First Quarter $ 8 1/8 6 5/8 - -------------------------------------------------- Second Quarter 8 1/4 6 1/2 - -------------------------------------------------- Third Quarter 10 11/16 6 7/8 - -------------------------------------------------- Fourth Quarter 10 5/8 7 5/8 - --------------------------------------------------
At March 24, 1998, there were approximately 71 stockholders of record and an unknown number of beneficial owners holding stock in nominee or "street" name. The Company has paid no cash dividends on its Common Stock and currently intends to retain all future earnings for use in the development of its business. DIRECTORS - -------------------------------- L. Rogers Wells, Jr. Chairman of the Board and Chief Executive Officer Edmund F. Turek Vice Chairman Gary S. Bell Secretary and Treasurer Kazmier J. Kasper President, Algonquin Industries, Inc. a manufacturer of metal and machined parts H. Jean Marshall Project Director for the City of Cincinnati David F. Nichols President John J. Wingfield Manager, A.G. Edwards & Sons, Inc., Louisville an investment banking company OFFICERS - -------------------------------- L. Rogers Wells, Jr. Chairman of the Board and Chief Executive Officer David F. Nichols President Edmund F. Turek Vice Chairman Gary S. Bell Secretary and Treasurer Thomas W. Stokes Vice President of Operations Jerome J. Cain Chief Financial Officer FORM 10-K: A copy of the Company's 1997 Annual Report on Form 10-K, as filed with the Securities and Exchange Commission, is available, without exhibits, free of charge to stockholders. Requests should be addressed to: Stockholder Relations Interlott Technologies, Inc. 10830 Millington Court Cincinnati, OH 45242 The 1998 Annual Meeting will be held at The Holiday Inn Cincinnati North located at I-275 and Route 42, on May 7, 1998 at 10:00 am, local time. EX-23 9 CONSENT OF KPMG PEAT MARWICK LLP 1 [KPMG PEAT MARWICK LLP LETTERHEAD] Consent of Independent Auditors The Board of Directors Interlott Technologies, Inc.: We consent to incorporation by reference in the Registration Statement No. 333-08999 on Form S-3 of Interlott Technologies, of our report dated February 28, 1998, relating to the balance sheets of Interlott Technologies Inc. as of December 31, 1996 and 1997, and the related statements of income, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997, and the related schedule, which report appears in the 1997 annual report to stockholders, which is incorporated by reference in December 31, 1997 Form 10-K of Interlott Technologies, Inc. KPMG PEAT MARWICK LLP Louisville, Kentucky March 27, 1998 EX-24 10 POWERS OF ATTORNEY 1 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENT, that the undersigned constitutes and appoints L. Rogers Wells, Jr. and Jerome J. Cain and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Interlott Technologies, Inc. for the fiscal year ended December 31, 1997, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the American Stock Exchange, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. This 30th day of March, 1998. /s/ John J. Wingfield --------------------- John J. Wingfield 2 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENT, that the undersigned constitutes and appoints L. Rogers Wells, Jr. and Jerome J. Cain and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Interlott Technologies, Inc. for the fiscal year ended December 31, 1997, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the American Stock Exchange, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitutes, may lawfully do or cause to be done by virtue hereof. This 30th day of March, 1998 /s/ Gary S. Bell ------------------------------ Gary S. Bell 3 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENT, that the undersigned constitutes and appoints L. Rogers Wells, Jr. and Jerome J. Cain and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Interlott Technologies, Inc. for the fiscal year ended December 31, 1997, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the American Stock Exchange, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitutes, may lawfully do or cause to be done by virtue hereof. This 30th day of March, 1998 /s/ Kazmier J. Kasper ------------------------------ Kazmier J. Kasper EX-27 11 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM INTERLOTT TECHNOLOGIES, INC.'S FINANCIAL STATEMENTS FOR THE PERIOD ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1997 DEC-31-1997 143 0 2,918 0 4,051 7,477 26,628 11,382 24,875 11,805 479 1,335 0 32 10,994 24,875 4,567 19,065 0 15,924 0 0 701 2,440 988 1,452 0 0 0 1,452 0.45 0.45 AMOUNTS INAPPLICABLE OR NOT DISCLOSED AS A SEPARATE LINE ON THE CONDENSED BALANCE SHEETS AND STATEMENT OF OPERATIONS ARE REPORTED AS 0 HEREIN. NOTES AND ACCOUNTS RECEIVABLE - TRADE ARE REPORTED NET OF ALLOWANCES FOR DOUBTFUL ACCOUNTS IN THE CONDENSED BALANCE SHEETS.
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